Quarterly Report



Table of Contents



 
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 December 31, 2016

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

For the transition period from              to             

Commission File No. 1-15461
__________________________________________
MATRIX SERVICE COMPANY
(Exact name of registrant as specified in its charter)
__________________________________________
DELAWARE
 
73-1352174
(State of incorporation)
 
(I.R.S. Employer Identification No.)
5100 East Skelly Drive, Suite 500, Tulsa, Oklahoma 74135
(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   ý     No   ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Inter Active Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   ý     No   ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer”, “large accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
¨
Accelerated filer
 
ý
 
 
 
 
Non-accelerated filer
 
o
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨     No   ý
As of February 7, 2017 there were 27,888,217 shares of the Company’s common stock, $0.01 par value per share, issued and 26,593,791 shares outstanding.
 



Table of Contents



TABLE OF CONTENTS
 
 
PAGE
FINANCIAL INFORMATION
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
OTHER INFORMATION
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
 




Table of Contents



PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Matrix Service Company
Condensed Consolidated Statements of Income
(In thousands, except per share data)
(unaudited)
 
Three Months Ended
 
Six Months Ended
 
December 31,
2016
 
December 31,
2015
 
December 31,
2016
 
December 31,
2015
Revenues
$
312,655

 
$
323,529

 
$
654,436

 
$
642,860

Cost of revenues
284,443

 
293,524

 
593,946

 
578,271

Gross profit
28,212

 
30,005

 
60,490

 
64,589

Selling, general and administrative expenses
19,975

 
25,070

 
37,952

 
44,553

Operating income
8,237

 
4,935

 
22,538

 
20,036

Other income (expense):
 
 
 
 
 
 
 
Interest expense
(497
)
 
(252
)
 
(740
)
 
(515
)
Interest income
26

 
60

 
38

 
91

Other
47

 
(148
)
 
54

 
(202
)
Income before income tax expense
7,813

 
4,595

 
21,890

 
19,410

Provision for federal, state and foreign income taxes
2,563

 
1,477

 
7,298

 
6,553

Net income
5,250

 
3,118

 
14,592

 
12,857

Less: Net loss attributable to noncontrolling interest

 
(2,313
)
 

 
(2,515
)
Net income attributable to Matrix Service Company
$
5,250

 
$
5,431

 
$
14,592

 
$
15,372

 
 
 
 
 
 
 
 
Basic earnings per common share
$
0.20

 
$
0.20

 
$
0.55

 
$
0.58

Diluted earnings per common share
$
0.20

 
$
0.20

 
$
0.54

 
$
0.56

Weighted average common shares outstanding:
 
 
 
 
 
 
 
Basic
26,553

 
26,721

 
26,470

 
26,598

Diluted
26,832

 
27,248

 
26,842

 
27,229

See accompanying notes.

- 1 -





Matrix Service Company
Condensed Consolidated Statements of Comprehensive Income
(In thousands)
(unaudited)
 
 
Three Months Ended
 
Six Months Ended
 
December 31,
2016
 
December 31,
2015
 
December 31,
2016
 
December 31,
2015
Net income
$
5,250

 
$
3,118

 
$
14,592

 
$
12,857

Other comprehensive loss, net of tax:
 
 
 
 
 
 
 
Foreign currency translation loss (net of tax of $69 and $106 for the three and six months ended December 31, 2016, respectively, and $204 and $384 for the three and six months ended December 31, 2015, respectively)
(1,718
)
 
(1,366
)
 
(1,997
)
 
(3,815
)
Comprehensive income
3,532

 
1,752

 
12,595

 
9,042

Less: Comprehensive loss attributable to noncontrolling interest

 
(2,313
)
 

 
(2,515
)
Comprehensive income attributable to Matrix Service Company
$
3,532

 
$
4,065

 
$
12,595

 
$
11,557

See accompanying notes.

- 2 -





Matrix Service Company
Condensed Consolidated Balance Sheets
(In thousands)
(unaudited)


December 31,
2016

June 30,
2016
Assets



Current assets:
 

 
Cash and cash equivalents
$
66,230


$
71,656

Accounts receivable, less allowances (December 31, 2016— $8,313 and June 30, 2016—$8,403)
248,712


190,434

Costs and estimated earnings in excess of billings on uncompleted contracts
80,296


104,001

Inventories
4,194


3,935

Income taxes receivable
486

 
9

Other current assets
8,318


5,411

Total current assets
408,236


375,446

Property, plant and equipment at cost:
 

 
Land and buildings
39,348


39,224

Construction equipment
91,587


90,386

Transportation equipment
48,254


49,046

Office equipment and software
34,946


29,577

Construction in progress
4,563


7,475

Total property, plant and equipment - at cost
218,698


215,708

Accumulated depreciation
(137,414
)

(130,977
)
Property, plant and equipment - net
81,284


84,731

Goodwill
113,019


78,293

Other intangible assets
29,351


20,999

Deferred income taxes
2,512

 
3,719

Other assets
1,388


1,779

Total assets
$
635,790


$
564,967

See accompanying notes.











- 3 -





Matrix Service Company
Condensed Consolidated Balance Sheets
(In thousands, except share data)
(unaudited)

December 31,
2016
 
June 30,
2016
Liabilities and stockholders’ equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
108,260

 
$
141,445

Billings on uncompleted contracts in excess of costs and estimated earnings
74,858

 
58,327

Accrued wages and benefits
21,162

 
27,716

Accrued insurance
9,171

 
9,246

Income taxes payable
1,293

 
2,675

Other accrued expenses
15,539

 
6,621

Total current liabilities
230,283

 
246,030

Deferred income taxes
2,855

 
3,198

Borrowings under senior revolving credit facility
72,412

 

Other liabilities
411

 
173

Total liabilities
305,961

 
249,401

Commitments and contingencies


 


Stockholders’ equity:
 
 
 
Matrix Service Company stockholders' equity:
 
 
 
Common stock—$.01 par value; 60,000,000 shares authorized; 27,888,217 shares issued as of December 31, 2016, and June 30, 2016; 26,588,643 and 26,297,145 shares outstanding as of December 31, 2016 and June 30, 2016
279

 
279

Additional paid-in capital
124,659

 
127,058

Retained earnings
237,749

 
223,157

Accumulated other comprehensive loss
(8,842
)
 
(6,845
)
 
353,845

 
343,649

Less: Treasury stock, at cost — 1,299,574 shares as of December 31, 2016, and 1,591,072 shares as of June 30, 2016
(22,840
)
 
(26,907
)
Total Matrix Service Company stockholders’ equity
331,005

 
316,742

Noncontrolling interest
(1,176
)
 
(1,176
)
Total stockholders' equity
329,829

 
315,566

Total liabilities and stockholders’ equity
$
635,790

 
$
564,967

See accompanying notes.


- 4 -





Matrix Service Company
Condensed Consolidated Statements of Cash Flows
(In thousands)
(unaudited)
 
Six Months Ended
 
December 31,
2016

December 31,
2015
Operating activities:
 
 
 
Net income
$
14,592

 
$
12,857

Adjustments to reconcile net income to net cash used by operating activities, net of effects from acquisitions:
 
 
 
Depreciation and amortization
9,988

 
10,720

Deferred income tax
970

 
1,390

Gain on sale of property, plant and equipment
(131
)
 
(37
)
Provision for uncollectible accounts
(34
)
 
5,544

Stock-based compensation expense
3,547

 
3,509

Other
133

 
119

Changes in operating assets and liabilities increasing (decreasing) cash, net of effects from acquisitions:
 
 
 
Accounts receivable
(48,972
)
 
(13,820
)
Costs and estimated earnings in excess of billings on uncompleted contracts
24,451

 
4,328

Inventories
(259
)
 
85

Other assets and liabilities
(3,974
)
 
(8,861
)
Accounts payable
(34,276
)
 
(16,743
)
Billings on uncompleted contracts in excess of costs and estimated earnings
4,883

 
17,436

Accrued expenses
(1,826
)
 
(6,840
)
Net cash provided (used) by operating activities
(30,908
)
 
9,687

Investing activities:
 
 
 
Acquisitions (Note 2)
(39,798
)
 

Acquisition of property, plant and equipment
(4,208
)
 
(7,516
)
Proceeds from asset sales
196

 
145

Net cash used by investing activities
$
(43,810
)
 
$
(7,371
)

  See accompanying notes.



















- 5 -








Matrix Service Company
Condensed Consolidated Statements of Cash Flows
(In thousands)
(unaudited)
 
Six Months Ended
 
December 31,
2016
 
December 31,
2015
Financing activities:
 
 
 
Advances under senior revolving credit facility
$
102,084

 
$
2,753

Repayments of advances under senior revolving credit facility
(29,672
)
 
(4,331
)
Payment of debt amendment fees
(168
)
 

Issuances of common stock
222

 
457

Proceeds from issuance of common stock under employee stock purchase plan
169

 
166

Repurchase of common stock for payment of statutory taxes due on equity-based compensation
(2,270
)
 
(4,488
)
Capital contributions from noncontrolling interest

 
8,433

Net cash provided by financing activities
70,365

 
2,990

Effect of exchange rate changes on cash and cash equivalents
(1,073
)
 
(2,114
)
Increase (decrease) in cash and cash equivalents
(5,426
)
 
3,192

Cash and cash equivalents, beginning of period
71,656

 
79,239

Cash and cash equivalents, end of period
$
66,230

 
$
82,431

Supplemental disclosure of cash flow information:
 
 
 
Cash paid during the period for:
 
 
 
Income taxes
$
8,361

 
$
9,112

Interest
$
399

 
$
521

Non-cash investing and financing activities:
 
 
 
Purchases of property, plant and equipment on account
$
421

 
$
726


  See accompanying notes.


- 6 -






Matrix Service Company
Condensed Consolidated Statements of Changes in Stockholders’ Equity
(In thousands, except share data)
(unaudited)
 
 
Common
Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Treasury
Stock
 
Accumulated
Other
Comprehensive
Income(Loss)
 
Non-Controlling Interest
 
Total
Balances, July 1, 2016
$
279

 
$
126,958

 
$
223,257

 
$
(26,907
)
 
$
(6,845
)
 
$
(1,176
)
 
$
315,566

Retrospective adjustment upon adoption of ASU 2016-09 (see Note 1)

 
100

 
(100
)
 

 

 

 

Balances, July 1, 2016, as adjusted
279

 
127,058

 
223,157

 
(26,907
)
 
(6,845
)
 
(1,176
)
 
315,566

Net income

 

 
14,592

 

 

 

 
14,592

Other comprehensive loss

 

 

 

 
(1,997
)
 

 
(1,997
)
Treasury shares sold to Employee Stock Purchase Plan (9,577 shares)

 
12

 

 
157

 

 

 
169

Exercise of stock options (21,713 shares)

 
(273
)
 

 
495

 

 

 
222

Issuance of deferred shares (393,530 shares)

 
(5,685
)
 

 
5,685

 

 

 

Treasury shares purchased to satisfy tax withholding obligations (133,322 shares)

 

 

 
(2,270
)
 

 

 
(2,270
)
Stock-based compensation expense

 
3,547

 

 

 

 

 
3,547

Balances, December 31, 2016
$
279

 
$
124,659

 
$
237,749

 
$
(22,840
)
 
$
(8,842
)
 
$
(1,176
)
 
$
329,829

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balances, July 1, 2015
$
279

 
$
123,038

 
$
194,394

 
$
(18,489
)
 
$
(5,926
)
 
$
(8,742
)
 
$
284,554

Capital contributions from noncontrolling interest

 

 

 

 

 
8,433

 
8,433

Net income (loss)

 

 
15,372

 

 

 
(2,515
)
 
12,857

Other comprehensive loss

 

 

 

 
(3,815
)
 

 
(3,815
)
Treasury shares sold to Employee Stock Purchase Plan (8,382 shares)

 
89

 

 
77

 

 

 
166

Exercise of stock options (50,337 shares)

 
(7
)
 

 
464

 

 

 
457

Issuance of deferred shares (615,395 shares)

 
(5,706
)
 

 
5,706

 

 

 

Treasury shares purchased to satisfy tax withholding obligations (200,019 shares)

 

 

 
(4,488
)
 

 

 
(4,488
)
Tax effect of exercised stock options and vesting of deferred shares

 
3,245

 

 

 

 

 
3,245

Stock-based compensation expense

 
3,509

 

 

 

 

 
3,509

Balances, December 31, 2015
$
279

 
$
124,168

 
$
209,766

 
$
(16,730
)
 
$
(9,741
)
 
$
(2,824
)
 
$
304,918

See accompanying notes.


- 7 -





Matrix Service Company
Notes to Condensed Consolidated Financial Statements
(unaudited)
Note 1 – Basis of Presentation and Accounting Policies
The condensed consolidated financial statements include the accounts of Matrix Service Company (“Matrix”, “we”, “our”, “us”, “its” or the “Company”) and its subsidiaries, unless otherwise indicated. Intercompany balances and transactions have been eliminated in consolidation.
The accompanying unaudited condensed 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. The information furnished reflects all adjustments, consisting of normal recurring adjustments, that are, in the opinion of management, necessary for a fair statement of the results of operations, cash flows and financial position for the interim periods presented. The accompanying condensed financial statements should be read in conjunction with the audited financial statements for the year ended June 30, 2016 , included in the Company’s Annual Report on Form 10-K for the year then ended. The results of operations for the six month period ended December 31, 2016 may not necessarily be indicative of the results of operations for the full year ending June 30, 2017 .
Recently Issued Accounting Standards
Accounting Standards Update 2014-09, Revenue from Contracts with Customers (Topic 606)
On May 28, 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09. The standard outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that “an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” The ASU also requires entities to disclose both quantitative and qualitative information that enables users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The ASU's disclosure requirements are significantly more comprehensive than those in existing revenue standards. The ASU applies to all contracts with customers except those that are within the scope of other topics in the FASB Accounting Standards Codification ("ASC").
The ASU is effective for annual reporting periods beginning after December 15, 2017, with early adoption permitted on a limited basis. Upon adoption, the Company may elect one of two application methods, a full retrospective application or a modified retrospective application. We expect to adopt this standard on July 1, 2018 and are currently evaluating its expected impact on our financial statements.
Accounting Standards Update 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern
On August 27, 2014, the FASB issued ASU 2014-15, which provides guidance on determining when and how reporting entities must disclose going-concern uncertainties in their financial statements. The new standard requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date of issuance of the entity’s financial statements. Further, an entity must provide certain disclosures if there is “substantial doubt about the entity’s ability to continue as a going concern.” The FASB believes that requiring management to perform the assessment will enhance the timeliness, clarity, and consistency of related disclosures and improve convergence with international financial reporting standards ("IFRSs") (which emphasize management’s responsibility for performing the going-concern assessment). However, the time horizon for the assessment (look-forward period) and the disclosure thresholds under U.S. GAAP and IFRSs will continue to differ. The ASU is effective for annual periods ending after December 15, 2016, and interim periods thereafter; early adoption is permitted.
The ASU was adopted during the Company's first fiscal quarter ending September 30, 2016. In connection with the adoption of the ASU, the Company now performs an assessment of its ability to continue as a going concern on a quarterly basis. Disclosure regarding the status of the Company's ability to continue as a going concern is required when there are conditions or events that raise substantial doubt about its ability to continue as a going concern within one year after the date that the financial statements are issued.

- 8 -


Matrix Service Company
Notes to Condensed Consolidated Financial Statements
(unaudited)


Accounting Standards Update 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments
On September 25, 2015, the FASB issued ASU 2015-16 to simplify the accounting for measurement-period adjustments. The ASU was issued in response to stakeholder feedback that restatements of prior periods to reflect adjustments made to provisional amounts recognized in a business combination increase the cost and complexity of financial reporting but do not significantly improve the usefulness of the information. Under the ASU, an acquirer must recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The ASU also requires acquirers to present separately on the face of the income statement, or disclose in the notes, the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. For public business entities, the ASU is effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. We adopted this standard on July 1, 2016 with no material impact to the Company's financial statements.
Accounting Standards Update 2016-02, Leases (Topic 842)
On February 25, 2016, the FASB issued ASU 2016-02. The amendments in this update require, among other things, that lessees recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Lessees and lessors must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. For public business entities, the ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. We are currently evaluating the ASU's expected impact on our financial statements.
Accounting Standards Update 2016-09, Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting
On March 30, 2016, the FASB issued ASU 2016-09, which simplified several aspects of accounting for stock-based compensation transactions, including the accounting for income taxes and forfeitures and statutory tax withholding requirements. The ASU is effective for the Company on July 1, 2017 and early adoption is permitted. The Company adopted the ASU during its first fiscal quarter ending September 30, 2016. The following is a description of the key provisions of the ASU and their impacts to the Company's financial statements:
Accounting for Income Taxes : The amendments require the Company to recognize excess tax benefits or tax deficiencies in its provision for income taxes in its consolidated statements of income during the period of vesting or exercise of its nonvested deferred share awards and stock options, respectively, for which it expects to receive an income tax deduction. Previously, the Company recognized any excess tax benefits in additional paid-in capital ("APIC") in the balance sheet and any tax deficiencies were recognized as a reduction of APIC to the extent the Company has accumulated excess tax benefits. Any tax deficiencies in excess of accumulated excess tax benefits in APIC were recognized in the provision for income taxes. The amendments also require the Company to only present excess tax benefits and tax deficiencies in the operating section of its statements of cash flows as a component of deferred tax activity. Previously, the Company was required to present such items in both the financing section and operating section of its statements of cash flows. Amendments related to the recognition of excess tax benefits and tax deficiencies in income are required to be applied prospectively, and amendments related to the cash flow statement presentation of excess tax benefits and tax deficiencies may be applied either retrospectively or prospectively.
The Company applied the amendments requiring the recognition of excess tax benefits and tax deficiencies in income prospectively. As a result, the Company recognized $0.1 million and $0.5 million of excess tax benefits in its provision for income taxes during the three and six months ended December 31, 2016, respectively, which increased basic and diluted earnings per share by $0.01 and $0.02 , respectively. Under the prior accounting standard, the Company would have recognized the excess tax benefits in equity as additional paid-in capital. The amendments relating to the presentation of excess tax benefits and tax deficiencies in the statement of cash flows were applied retrospectively. The effect of the retrospective adjustment was to eliminate the presentation of an operating cash outflow and a financing cash inflow for excess tax benefits on exercised stock options and vesting of deferred shares. These eliminations increased net cash provided by operating activities by $3.2 million and decreased net cash provided by financing activities by $3.2 million for the six months ended December 31, 2015. Net cash flows did not change as a result of the retrospective adjustment.

- 9 -


Matrix Service Company
Notes to Condensed Consolidated Financial Statements
(unaudited)


Accounting for Forfeitures : The amendments in this ASU allow the Company to elect, as a company-wide accounting policy, either to continue to estimate the amount of forfeitures to exclude from compensation expense or to exclude forfeitures from compensation expense as they occur. Upon the adoption of the ASU during the first quarter of fiscal 2017, the Company elected to account for forfeitures as they occur. The Company is required to apply these amendments on a modified retrospective basis with a cumulative adjustment to retained earnings as of the beginning of the fiscal year. The Company recorded a modified retrospective adjustment to reduce the June 30, 2016 retained earnings balance and increase the additional paid-in capital balance by $0.1 million each.
Statutory Tax Withholding Requirements : Under the prior accounting standard, an entire award must be classified as a liability if the fair value of the shares withheld exceeds the Company's minimum statutory withholding obligation. Under the ASU, the Company is allowed to withhold shares with a fair value up to the amount of tax owed using the maximum statutory tax rate in the employee's applicable jurisdictions. The Company is allowed to determine one maximum rate for all employees in each jurisdiction, rather than a rate for each employee in the jurisdiction. Also, the ASU requires that cash outflows to reacquire shares withheld for taxes to be classified in the financing section of the statement of cash flows.
The Company adopted the ASU during the first quarter of fiscal 2017. Since the Company did not have any awards classified as liabilities due to statutory tax withholding requirements as of December 31, 2016, and since the Company already presented its cash outflows for reacquiring shares withheld for taxes as a financing activity in its statements of cash flows, these amendments did not have any impact on its financial statements upon adoption. The Company does not expect changes to employee withholdings for stock compensation to have a material impact to the financial statements.
Accounting Standards Update 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments
On June 16, 2016, the FASB issued ASU 2016-13, which will change how the Company accounts for its allowance for uncollectible accounts. The amendments in this update require a financial asset (or a group of financial assets) to be presented at the net amount expected to be collected. The income statement will reflect any increases or decreases of expected credit losses that have taken place during the period. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectibility of the reported amount.
Current GAAP delays the recognition of the full amount of credit losses until the loss is probable of occurring. The amendments in this update eliminate the probable initial recognition threshold and, instead, reflect the Company's current estimate of all expected credit losses. In addition, current guidance limits the information the Company may consider in measuring a credit loss to its past events and current conditions. The amendments in this update broaden the information the Company may consider in developing its expected credit loss estimate to include forecasted information.
The amendments in this update are effective for the Company on July 1, 2020 and the Company may early adopt on July 1, 2019. The Company must apply the amendments in this update through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. At this time, the Company does not expect this update to have a material impact to its estimate of the allowance for uncollectible accounts.



- 10 -


Note 2 – Acquisitions
Purchase of Houston Interests, LLC
On December 12, 2016 , the Company completed the acquisition of Houston Interests, LLC ("Houston Interests"), a premier global solutions company that provides consulting, engineering, design, construction services and systems integration. Houston Interests brings expertise to the Company in natural gas processing; sulfur recovery, processing and handling; liquid terminals, silos and other bulk storage; process plant design; power generation environmental controls and material handling; industrial power distribution; electrical, instrumentation and controls; marine structures; material handling systems and terminals for cement, sulfur, fertilizer, coal and grain; and process heaters. The business has been included in our Matrix PDM Engineering, Inc. subsidiary, and its operating results have been allocated between the Oil Gas & Chemical and Industrial segments.
The Company purchased all of the equity interests of Houston Interests for $39.8 million in cash, net of working capital adjustments and cash acquired. The consideration paid is as follows (in thousands):
Cash paid for equity interest
$
46,000

Cash paid for working capital
4,129

Less: cash acquired
(10,331
)
Net purchase price
$
39,798

The Company funded the equity interest portion of the consideration paid from borrowings under the Company's senior secured revolving credit facility (See Note 5). The remaining consideration was paid with cash on hand.
The net purchase price was allocated to the major categories of assets and liabilities based on their estimated fair value at the acquisition date.
The following table summarizes the preliminary net purchase price allocation (in thousands):
Current assets
$
20,803

Property, plant and equipment
942

Goodwill
35,028

Other intangible assets
10,220

Total assets acquired
66,993

Current liabilities
16,674

Other liabilities
190

Net assets acquired
50,129

Cash
10,331

Net purchase price
$
39,798

The goodwill recognized from the acquisition is primarily attributable to the technical expertise of the acquired workforce and the complementary nature of Houston Interests' operations, which the Company believes will enable the combined entity to expand its service offerings and enter new markets. All of the goodwill recognized is deductible for income tax purposes. The fair value of the net assets acquired is preliminary pending the final valuation of those assets. As a result, goodwill is also preliminary since it has been recorded as the excess of the purchase price over the estimated fair value of the net assets acquired.
The Company has agreed to pay the previous owners up to $2.6 million for any unused portion of acquired warranty obligations outstanding as of June 30, 2017. In addition, the sellers have agreed to reimburse the Company for any warranty costs incurred in connection with the acquired warranties in excess of $2.6 million. All acquired warranties will expire by June 30, 2017. Any amounts paid to or received from the seller will be accounted for as a working capital adjustment, which will be reflected as a change to the net purchase price. None of the acquired warranties have expired as of December 31, 2016.
The Company incurred $0.4 million of expenses related to closing the acquisition during the three and six months ended December 31, 2016, which were included within selling, general and administrative expenses in the consolidated statements of income. The acquired business contributed revenues of $2.3 million and an operating loss of $0.2 million during the three and six months ended December 31, 2016.

- 11 -


The unaudited financial information in the table below summarizes the combined results of operations of Matrix Service Company and Houston Interests for the three and six months ended December 31, 2016 and 2015, on a pro forma basis, as though the companies had been combined as of July 1, 2015. The pro forma financial information presented in the table below is for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place at July 1, 2015 nor should it be taken as indicative of future consolidated results of operations.
 
Three Months Ended
Six Months Ended

December 31, 2016
December 31, 2015
December 31, 2016
December 31, 2015

(In thousands, except per share data)
Revenues
$
329,523

$
357,975

$
690,485

$
712,158

Net income attributable to Matrix Service Company
$
7,884

$
9,445

$
18,763

$
17,928

Basic earnings per common share
$
0.30

$
0.35

$
0.71

$
0.68

Diluted earnings per common share
$
0.29

$
0.35

$
0.70

$
0.67

The pro forma financial information presented in the table above includes the following adjustments to the combined entities' historical financial statements:
The combined entities recorded approximately $3.0 million of acquisition and integration expenses during the three and six months ended December 31, 2016, which were transferred in the pro forma earnings to the six months ended December 31, 2015 in order to report them as if they were incurred on July 1, 2015. Pro forma earnings were adjusted to include integration expenses that would have been recognized had the acquisition occurred on July 1, 2015 of $0.4 million and $0.8 million during the three and six months ended December 31, 2016, respectively, and $0.3 million and $0.5 million during the three and six months ended December 31, 2015, respectively.
Interest expense for the combined entities was increased by $0.3 million and $0.7 million during each of the three and six months ended December 31, 2016 and 2015, respectively. The increase was attributable to the assumption that the Company's borrowings of $46.0 million used to fund a portion of the net purchase price had been outstanding as of July 1, 2015. This increase was partially offset by the assumption that Houston Interests' former debt was extinguished as of July 1, 2015.
Depreciation and intangible asset amortization expense for the combined entities was reduced by $0.2 million and $0.3 million during the three and six months ended December 31, 2016, respectively, and was increased by $0.5 million and $0.9 million during the three and six months ended December 31, 2015, respectively. These adjustments are primarily due to the recognition of amortizable intangible assets as part of the acquisition and the effect of fair value adjustments to acquired property, plant and equipment.
Pro forma earnings were adjusted to include additional income tax expense of $1.9 million and $3.3 million during the three and six months ended December 31, 2016, respectively, and $2.5 million and $2.1 million during the three and six months ended December 31, 2015, respectively. Houston Interests was previously an exempt entity and income taxes were not assessed in its historical financial information.
Purchase of Baillie Tank Equipment, Ltd.
On February 1, 2016 , the Company completed the acquisition of all outstanding stock of Baillie Tank Equipment, Ltd. (“BTE”) , an internationally-based company with nearly 20 years of experience in the design and manufacture of products for use on aboveground storage tanks. Founded in 1998, BTE is a provider of tank products including geodesic domes, aluminum internal floating roofs, floating suction and skimmer systems, roof drain systems, and seals. BTE is headquartered in Sydney, Australia with a manufacturing facility in Seoul, South Korea. The Company acquired BTE to expand its service offerings of certain technical solutions for aboveground storage tanks. The business is now known as Matrix Applied Technologies, and its operating results are included in the Storage Solutions segment.
The Company purchased BTE with cash on-hand for a net purchase price of $13.0 million . The Company paid $15.4 million when including the subsequent repayment of long-term debt acquired and the settlement of certain other liabilities acquired, and excluding the cash acquired and certain amounts owed to the former owners for working capital adjustments. The net purchase price was allocated to the major categories of assets and liabilities based on their estimated fair value at the acquisition date.

- 12 -


The following table summarizes the final purchase price allocation (in thousands):
Current assets
$
5,574

Property, plant and equipment
4,347

Goodwill
7,030

Other intangible assets
720

Other assets
233

Total assets acquired
17,904

Current liabilities
1,669

Deferred income taxes
329

Long-term debt
1,858

Other liabilities
407

Net assets acquired
13,641

Cash acquired
592

Net purchase price
$
13,049

The goodwill recognized from the acquisition is attributable to the synergies of combining our operations and the technical expertise of the acquired workforce. None of the goodwill recognized is deductible for income tax purposes.
The Company incurred $0.8 million of expenses related to the acquisition during fiscal 2016, which were included within selling, general and administrative expenses in the consolidated statements of income. The acquired business contributed revenues of $1.8 million and $2.8 million during the three and six months ended December 31, 2016, respectively, and contributed operating income of $0.7 million and $0.3 million during the three and six months ended December 31, 2016.
Note 3 – Uncompleted Contracts
Contract terms of the Company’s construction contracts generally provide for progress billings based on project milestones. The excess of costs incurred and estimated earnings over amounts billed on uncompleted contracts is reported as a current asset. The excess of amounts billed over costs incurred and estimated earnings recognized on uncompleted contracts is reported as a current liability. Gross and net amounts on uncompleted contracts are as follows:  
 
December 31,
2016
 
June 30,
2016
 
(in thousands)
Costs incurred and estimated earnings recognized on uncompleted contracts
$
1,983,345

 
$
1,875,014

Billings on uncompleted contracts
1,977,907

 
1,829,340

 
$
5,438

 
$
45,674

Shown in balance sheet as:
 
 
 
Costs and estimated earnings in excess of billings on uncompleted contracts
$
80,296

 
$
104,001

Billings on uncompleted contracts in excess of costs and estimated earnings
74,858

 
58,327

 
$
5,438

 
$
45,674

Progress billings in accounts receivable at December 31, 2016 and June 30, 2016 included retentions to be collected within one year of $51.4 million and $29.7 million , respectively. Contract retentions collectible beyond one year are included in other assets in the condensed consolidated balance sheet and totaled $0.3 million as of June 30, 2016 . There were no retentions collectible beyond one year as of December 31, 2016 .

- 13 -


Matrix Service Company
Notes to Condensed Consolidated Financial Statements
(unaudited)


Other
Under percentage of completion accounting for fixed-priced contracts, contract revenues and earnings are recognized ratably over the contract term based on the proportion of actual costs incurred to total estimated costs. As of December 31, 2016, the Company is performing work on two previously announced significant multi-year projects that are contracted on a fixed price basis. The first project is expected to complete in fiscal 2017 and revenue will continue to decline as this project nears completion. The second project is expected to be completed in fiscal 2018.
On the project that is expected to be completed in fiscal 2018, the Company executed a change order in the second quarter that settled the claims outstanding on the effective date of the change order, updated the project schedule, and increased the contract value to allow for the recovery of increased costs. The settlement resulted in a second quarter reduction in earnings related to adjusting the gross profit margin and the percent complete on the project due to the increased project size. In addition, the change order contained provisions that require the achievement of defined schedule milestones to earn a portion of the additional contract value. At December 31, 2016, the Company’s schedule assessment indicates that it is probable that these schedule milestones will be achieved. Although this change order reduced the financial risk inherent in this project, it is possible that future changes in contract estimates, including those related to project costs, project timeline, and future change orders or claims, could occur and have a material positive or negative impact to our results of operations and financial position in subsequent accounting periods.
Note 4 – Intangible Assets Including Goodwill
Goodwill
The changes in the carrying value of goodwill by segment are as follows:
 
Electrical
Infrastructure
 
Oil Gas &
Chemical
 
Storage
Solutions
 
Industrial
 
Total
 
(In thousands)
Net balance at June 30, 2016
$
42,170

 
$
14,008

 
$
16,681

 
$
5,434

 
$
78,293

Purchase of Houston Interests (Note 2)

 
28,723

 

 
6,305

 
35,028

Purchase price adjustment for BTE (Note 2)

 

 
88

 

 
88

Translation adjustment (1)
(227
)
 

 
(121
)
 
(42
)
 
(390
)
Net balance at December 31, 2016
$
41,943

 
$
42,731

 
$
16,648

 
$
11,697

 
$
113,019

(1)
The translation adjustments relate to the periodic translation of Canadian Dollar and South Korean Won denominated goodwill recorded as a part of prior acquisitions in Canada and South Korea, in which the local currency was determined to be the functional currency.
The Company performed its annual goodwill impairment test as of May 31, 2016, which did not indicate the existence of any impairment at that time. While the operating results for the Oil Gas & Chemical and Industrial segments indicated a loss for the three and six months ended December 31, 2016, the Company does not consider these results to be a triggering event requiring the performance of an interim goodwill impairment test since the fundamentals of the industries driving these segments has not significantly deteriorated since the annual test was performed. The Company continues to consider these segments as core to its business and believes current operating results are not indicative of future performance. The Company will continue to monitor its operating results for indicators of impairment and perform additional tests as necessary.

- 14 -


Matrix Service Company
Notes to Condensed Consolidated Financial Statements
(unaudited)


Other Intangible Assets
Information on the carrying value of other intangible assets is as follows:
 
 
 
At December 31, 2016
   
Useful Life
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Net Carrying
Amount
 
(Years)
 
(In thousands)
Intellectual property
9 to 15
 
$
2,579

 
$
(1,336
)
 
$
1,243

Customer-based
1 to 15
 
38,057

 
(10,914
)
 
27,143

Non-compete agreements
4 to 5
 
1,453

 
(1,192
)
 
261

Trade names
1 to 5
 
1,795

 
(1,091
)
 
704

Total amortizing intangible assets
 
 
$
43,884

 
$
(14,533
)
 
$
29,351

 
 
 
 
At June 30, 2016
 
Useful Life
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Net Carrying
Amount
 
(Years)
 
(In thousands)
Intellectual property
9 to 15
 
$
2,579

 
$
(1,246
)
 
$
1,333

Customer-based
1.5 to 15
 
28,179

 
(9,655
)
 
18,524

Non-compete agreements
4 to 5
 
1,453

 
(1,102
)
 
351

Trade names
3 to 5
 
1,615

 
(824
)
 
791

Total amortizing intangible assets
 
 
$
33,826

 
$
(12,827
)
 
$
20,999

The increase in the gross carrying amount of other intangible assets at December 31, 2016 compared to June 30, 2016 is primarily due to the December 12, 2016 acquisition of Houston Interests (See Note 2). The specifically identifiable intangible assets recognized in the Houston Interests acquisition consist of:
customer-based intangibles with a fair value of $10.0 million and useful life of between 1 and 9 years; and
trade name with a fair value of $0.2 million and useful life of 1 year.

Amortization expense totaled $1.0 million and $1.8 million during the three and six months ended December 31, 2016 , respectively, and $0.8 million and $1.6 million during the three and six months ended December 31, 2015, respectively. The Company recognized $0.1 million of amortization expense during the three and six months ended December 31, 2016 for intangible assets recorded as part of the Houston Interests acquisition.

We estimate that the remaining amortization expense at December 31, 2016 will be as follows (in thousands):
Period ending:
 
Remainder of Fiscal 2017
$
3,100

Fiscal 2018
4,757

Fiscal 2019
3,482

Fiscal 2020
3,472

Fiscal 2021
3,454

Fiscal 2022
2,615

Thereafter
8,471

Total estimated remaining amortization expense at December 31, 2016
$
29,351


- 15 -


Matrix Service Company
Notes to Condensed Consolidated Financial Statements
(unaudited)


Note 5 – Debt
On December 12, 2016, the Company amended its credit agreement, under which it has a senior secured revolving credit facility (the "Credit Agreement"). The amendments are as follows:
The aggregate revolving loan capacity increased from $200.0 million to $250.0 million .
The maximum aggregate amount, or sublimit, for Canadian Dollar loans was increased from U.S. $40.0 million to U.S. $50.0 million .
During any "Acquisition Adjustment Period", as defined in the amended credit agreement, the Company's Senior Leverage Ratio, as defined in the amended credit agreement, may not exceed 3.00 to 1.00 . At all other times, the Senior Leverage Ratio may not exceed 2.50 to 1.00 .
The Credit Agreement includes a Senior Leverage Ratio covenant - which provides that Consolidated Funded Indebtedness, as of the end of any fiscal quarter, may not exceed 3.0 times Consolidated EBITDA, as defined in the Credit Agreement, during any Acquisition Adjustment Period and may not exceed 2.5 times Consolidated EBITDA at all other times, over the previous four quarters. For the four quarters ended December 31, 2016 , Consolidated EBITDA was $84.0 million . Consolidated Funded Indebtedness at December 31, 2016 was $80.0 million .
Availability under the senior revolving credit facility at December 31, 2016 was as follows:  
 
December 31,
2016
 
June 30,
2016
 
(In thousands)
Senior revolving credit facility
$
250,000

 
$
200,000

Capacity constraint due to the Senior Leverage Ratio

 
20,138

Capacity under the credit facility
250,000

 
179,862

Borrowings outstanding
72,412

 

Letters of credit
15,378

 
20,755

Availability under the senior revolving credit facility
$
162,210

 
$
159,107

Outstanding borrowings at December 31, 2016 under our Credit Agreement were primarily used to fund the acquisition of Houston Interests (See Note 2) and working capital needs in our Canadian business due to the timing of collections and disbursements on the previously announced power generating project.
At December 31, 2016, the Company was in compliance with all affirmative, negative, and financial covenants under the Credit Agreement.
Subsequent Event
On February 8, 2017, the Company entered into the Fourth Amended and Restated Credit Agreement (the "New Credit Agreement"), by and among the Company and certain foreign subsidiaries, as Borrowers, various subsidiaries of the Company, as Guarantors, JPMorgan Chase Bank, N.A., as Administrative Agent, Sole Lead Arranger and Sole Bookrunner, and the other Lenders party thereto, which replaced the Third Amended and Restated Credit Agreement dated as of November 7, 2011, as previously amended (the "Prior Credit Agreement").
The New Credit Agreement provides for a five-year senior secured revolving credit facility of $300.0 million that expires February 8, 2022, which replaces the $250.0 million senior secured revolving credit facility under the Prior Credit Agreement. The new credit facility may be used for working capital, acquisitions, capital expenditures, issuances of letters of credit and other lawful purposes.

- 16 -


Matrix Service Company
Notes to Condensed Consolidated Financial Statements
(unaudited)


The New Credit Agreement includes the following covenants and borrowing limitations:
Our Leverage Ratio, determined as of the end of each fiscal quarter, may not exceed 3.00 to 1.00.
As with the Prior Credit Agreement, we are required to maintain a Fixed Charge Coverage Ratio, determined as of the end of each fiscal quarter, greater than or equal to 1.25 to 1.00.
Asset dispositions (other than dispositions in which 100% of the net cash proceeds therefrom are reinvested into the Company and dispositions of inventory and obsolete or unneeded equipment in the ordinary course of business) are limited to $20.0 million per 12-month period.
The new credit facility will include a sub-facility for revolving loans denominated in Australian Dollars, Canadian Dollars, Euros and Pounds Sterling in an aggregate amount not to exceed the U.S. Dollar equivalent of $75.0 million and a $200.0 million sublimit for letters of credit. Each revolving borrowing under the New Credit Agreement will bear interest at a rate per annum equal to:
The ABR or the Adjusted LIBO Rate, in the case of revolving loans denominated in U.S. Dollars;
The Canadian Prime Rate or the CDOR rate, in the case of revolving loans denominated in Canadian Dollars;
The Adjusted LIBO Rate, in the case of revolving loans denominated in Pounds Sterling or Australian Dollars;
The EURIBO Rate, in the case of revolving loans denominated in Euros,

in each case, plus the Applicable Margin, which is based on the Company's Leverage Ratio. The Applicable Margin on ABR loans ranges between 0.625% and 1.625%. The Applicable Margin for Adjusted LIBO, EURIBO and CDOR loans ranges between 1.625% and 2.625% and the Applicable Margin for Canadian Prime Rate loans ranges between 2.125% and 3.125%.
The unused credit facility fee is between 0.20% and 0.45% based on the Leverage Ratio.
Note 6 – Income Taxes
We use the asset and liability approach for financial accounting and reporting for income taxes. Deferred income tax assets and liabilities are computed annually for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances based on our judgments and estimates are established when necessary to reduce deferred tax assets to the amount expected to be realized in future operating results. Company management believes that realization of deferred tax assets in excess of the valuation allowance is more likely than not. Our estimates are based on facts and circumstances in existence as well as interpretations of existing tax regulations and laws applied to the facts and circumstances.
The Company provides for income taxes regardless of whether it has received a tax assessment. Taxes are provided when it is considered probable that additional taxes will be due in excess of amounts included in the tax return. The Company regularly reviews exposure to additional income taxes due, and as further information is known or events occur, adjustments may be recorded.
Our effective tax rate for the three and six months ended December 31, 2016 was 32.8% and 33.3% , respectively, compared to 32.1% and 33.8% in the same periods a year earlier. The Company recorded discrete benefits of $0.3 million and $0.5 million during the three and six months ended December 31, 2016 , respectively, and recorded $0.9 million and $1.4 million of discrete benefits during the three and six months ended December 31, 2015 , respectively. The fiscal 2017 discrete benefits primarily relate to the application of ASU 2016-09 (See Note 1) and the fiscal 2016 tax rate was positively impacted by a discrete item related to the retroactive application of the R&D tax credit and a foreign currency item related to our Canadian operations.
Note 7 – Commitments and Contingencies
Insurance Reserves
The Company maintains insurance coverage for various aspects of its operations. However, exposure to potential losses is retained through the use of deductibles, self-insured retentions and coverage limits.

- 17 -


Matrix Service Company
Notes to Condensed Consolidated Financial Statements
(unaudited)


Typically our contracts require us to indemnify our customers for injury, damage or loss arising from the performance of our services and provide warranties for materials and workmanship. The Company may also be required to name the customer as an additional insured up to the limits of insurance available, or we may be required to purchase special insurance policies or surety bonds for specific customers or provide letters of credit in lieu of bonds to satisfy performance and financial guarantees on some projects. Matrix maintains a performance and payment bonding line sufficient to support the business. The Company generally requires its subcontractors to indemnify the Company and the Company’s customer and name the Company as an additional insured for activities arising out of the subcontractors’ work. We also require certain subcontractors to provide additional insurance policies, including surety bonds in favor of the Company, to secure the subcontractors’ work or as required by the subcontract.
There can be no assurance that our insurance and the additional insurance coverage provided by our subcontractors will fully protect us against a valid claim or loss under the contracts with our customers.
Unapproved Change Orders and Claims
Costs and estimated earnings in excess of billings on uncompleted contracts included revenues for unapproved change orders and claims of $14.4 million at December 31, 2016 and $10.3 million at June 30, 2016 . Generally, collection of amounts related to unapproved change orders and claims is expected within twelve months. However, since customers may not pay these amounts until final resolution of related claims, collection of these amounts may extend beyond one year.
Other
The Company and its subsidiaries are participants in various legal actions. It is the opinion of management that none of the known legal actions will have a material impact on the Company’s financial position, results of operations or liquidity.
Note 8 – Earnings per Common Share
Basic earnings per share (“Basic EPS”) is calculated based on the weighted average shares outstanding during the period. Diluted earnings per share (“Diluted EPS”) includes the dilutive effect of stock options and nonvested deferred shares.
The computation of basic and diluted earnings per share is as follows:
 
Three Months Ended
 
Six Months Ended
 
December 31,
2016
 
December 31,
2015
 
December 31,
2016
 
December 31,
2015
 
(In thousands, except per share data)
Basic EPS:
 
 
 
 
 
 
 
Net income attributable to Matrix Service Company
$
5,250

 
$
5,431

 
$
14,592

 
$
15,372

Weighted average shares outstanding
26,553

 
26,721

 
26,470

 
26,598

Basic earnings per share
$
0.20

 
$
0.20

 
$
0.55

 
$
0.58

Diluted EPS:

 

 

 

Weighted average shares outstanding – basic
26,553

 
26,721

 
26,470

 
26,598

Dilutive stock options
55

 
76

 
53

 
81

Dilutive nonvested deferred shares
224

 
451

 
319

 
550

Diluted weighted average shares
26,832

 
27,248

 
26,842

 
27,229

Diluted earnings per share
$
0.20

 
$
0.20

 
$
0.54

 
$
0.56

 
The following securities are considered antidilutive and have been excluded from the calculation of Diluted EPS:
 
Three Months Ended
 
Six Months Ended
 
December 31,
2016
 
December 31,
2015
 
December 31,
2016
 
December 31,
2015
 
(In thousands)
Nonvested deferred shares
64

 
86

 
137

 
105


- 18 -


Matrix Service Company
Notes to Condensed Consolidated Financial Statements
(unaudited)


Note 9 – Segment Information
We operate our business through four reportable segments: Electrical Infrastructure, Oil Gas & Chemical, Storage Solutions, and Industrial.
The Electrical Infrastructure segment primarily encompasses construction and maintenance services to a variety of power generation facilities, such as combined cycle plants, natural gas fired power stations, and renewable energy installations. We also provide high voltage services to investor owned utilities, including construction of new substations, upgrades of existing substations, short-run transmission line installations, distribution upgrades and maintenance, and storm restoration services.
The Oil Gas & Chemical segment includes turnaround activities, plant maintenance, engineering and construction in the downstream and midstream petroleum industries. Our customers in these industries are engaged in refining crude oil and processing, fractionating, and marketing of natural gas and natural gas liquids. Another key offering is industrial cleaning services, which include hydroblasting, hydroexcavating, chemical cleaning and vacuum services. We also perform work in the petrochemical and upstream petroleum markets.
The Storage Solutions segment includes new construction of crude and refined products aboveground storage tanks (“ASTs”), as well as planned and emergency maintenance services. The Storage Solutions segment also includes balance of plant work in storage terminals and tank farms. Also included in the Storage Solutions segment is work related to specialty storage tanks, including liquefied natural gas (“LNG”), liquid nitrogen/liquid oxygen (“LIN/LOX”), liquid petroleum (“LPG”) tanks and other specialty vessels, including spheres. Finally, we offer AST products, including geodesic domes, aluminum internal floating roofs, floating suction and skimmer systems, roof drain systems and floating roof seals.
The Industrial segment primarily includes construction and maintenance work in the iron and steel, mining and minerals, and agricultural industries. Our work in the mining and minerals industry is primarily for customers engaged in the extraction of copper. Our work in the agricultural industry includes the engineering and design of grain silos, docks and handling systems; the design of control system automation and materials handling for the food industry; and engineering, construction, process design and balance of plant work for fertilizer production facilities. We also perform work in bulk material handling, thermal vacuum chambers, and other industrial markets.
The Company evaluates performance and allocates resources based on operating income. The accounting policies of the reportable segments are the same as those described in the Summary of Significant Accounting Policies footnote included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2016 . Intersegment sales and transfers are recorded at cost; therefore, no intersegment profit or loss is recognized.
Segment assets consist primarily of cash and cash equivalents, accounts receivable, costs and estimated earnings in excess of billings on uncompleted contracts, property, plant and equipment, goodwill and other intangible assets.


- 19 -


Matrix Service Company
Notes to Condensed Consolidated Financial Statements
(unaudited)


Results of Operations
(In thousands)
 
Three Months Ended

Six Months Ended
 
December 31,
2016

December 31,
2015

December 31,
2016

December 31,
2015
Gross revenues







Electrical Infrastructure
$
103,158


$
91,398


$
191,183


$
157,023

Oil Gas & Chemical
56,913


63,472


94,741


132,431

Storage Solutions
128,927


122,647


328,577


267,217

Industrial
25,026


48,390


47,753


89,725

Total gross revenues
$
314,024


$
325,907


$
662,254


$
646,396

Less: Inter-segment revenues







Oil Gas & Chemical
1,199

 
1,932

 
$
6,485

 
$
2,580

Storage Solutions
170

 
478

 
298

 
812

Industrial

 
(32
)
 
1,035

 
144

Total inter-segment revenues
$
1,369


$
2,378


$
7,818


$
3,536

Consolidated revenues







Electrical Infrastructure
$
103,158


$
91,398


$
191,183


$
157,023

Oil Gas & Chemical
55,714


61,540


88,256


129,851

Storage Solutions
128,757


122,169


328,279


266,405

Industrial
25,026


48,422


46,718


89,581

Total consolidated revenues
$
312,655


$
323,529


$
654,436


$
642,860

Gross profit







Electrical Infrastructure
$
7,225


$
4,021


$
12,475


$
8,729

Oil Gas & Chemical
2,431


5,971


2,432


11,654

Storage Solutions
17,071


14,426


43,524


34,658

Industrial
1,485


5,587


2,059


9,548

Total gross profit
$
28,212


$
30,005


$
60,490


$
64,589

Operating income (loss)







Electrical Infrastructure
$
2,164

 
$
(723
)
 
$
3,221

 
$
477

Oil Gas & Chemical
(1,950
)
 
(3,029
)
 
(4,855
)
 
(1,613
)
Storage Solutions
8,242

 
6,374

 
25,015

 
17,923

Industrial
(219
)
 
2,313

 
(843
)
 
3,249

Total operating income
$
8,237


$
4,935


$
22,538


$
20,036

Total assets by segment were as follows:

 
December 31,
2016

June 30,
2016
Electrical Infrastructure
 
$
159,388

 
$
135,298

Oil Gas & Chemical
 
148,095

 
91,350

Storage Solutions
 
194,397

 
201,875

Industrial
 
78,348

 
67,569

Unallocated assets
 
55,562

 
68,875

Total segment assets
 
$
635,790


$
564,967


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

CRITICAL ACCOUNTING ESTIMATES
There have been no material changes in our critical accounting policies from those reported in our fiscal 2016 Annual Report on Form 10-K filed with the SEC. For more information on our critical accounting policies, see Part II, Item 7 of our fiscal 2016 Annual Report on Form 10-K. The following section provides certain information with respect to our critical accounting estimates as of the close of our most recent quarterly period.
Revenue Recognition
Under percentage of completion accounting for fixed-priced contracts, contract revenues and earnings are recognized ratably over the contract term based on the proportion of actual costs incurred to total estimated costs. As of December 31, 2016, the Company is performing work on two previously announced significant multi-year projects that are contracted on a fixed price basis. The first project is expected to complete in fiscal 2017 and revenue will continue to decline as this project nears completion. The second project is expected to be completed in fiscal 2018.
On the project that is expected to be completed in fiscal 2018, the Company executed a change order in the second quarter that settled the claims outstanding on the effective date of the change order, updated the project schedule, and increased the contract value to allow for the recovery of increased costs. The settlement resulted in a second quarter reduction in earnings related to adjusting the gross profit margin and the percent complete on the project due to the increased project size. In addition, the change order contained provisions that require the achievement of defined schedule milestones to earn a portion of the additional contract value. At December 31, 2016, the Company’s schedule assessment indicates that it is probable that these schedule milestones will be achieved. Although this change order reduced the financial risk inherent in this project, it is possible that future changes in contract estimates, including those related to project costs, project timeline, and future change orders or claims, could occur and have a material positive or negative impact to our results of operations and financial position in subsequent accounting periods.
Goodwill
We performed our annual impairment test in the fourth quarter of fiscal 2016 to determine whether an impairment existed and to determine the amount of headroom. We define "headroom" as the percentage difference between the fair value of a reporting unit and its carrying value. The amount of headroom varies by reporting unit. Approximately 54% of our goodwill balance at May 31, 2016 was attributable to one reporting unit. This unit had headroom of 158%. The remaining goodwill was attributable to six reporting units, with headroom of between 17% and 488%. Our significant assumptions, including revenue growth rates, gross margins, discount rate, interest expense and other factors may change in light of changes in the economic and competitive environment in which we operate.
While the operating results for the Oil Gas & Chemical and Industrial segments indicated a small operating loss for the three and six months ended December 31, 2016, the Company does not consider these results to be a triggering event requiring the performance of an interim goodwill impairment test since the fundamentals of the industries driving these segments has not significantly deteriorated since the annual test was performed. The Company continues to consider these segments as core to its business and believes that current operating results are not indicative of future performance. The Company will continue to monitor its operating results for indicators of impairment and perform additional tests as necessary.
Other Intangible Assets
Intangible assets that have finite useful lives are amortized by the straight-line method over their useful lives ranging from 1 to 15 years. The Company evaluates intangible assets with finite lives for impairment whenever events or circumstances indicate that the carrying value may not be recoverable. The Company did not observe any events or circumstances during the three months ended December 31, 2016 that would indicate that the carrying value of its intangible assets may not be recoverable. The Company's evaluation included values assigned to customer relationships in the iron and steel industry which is currently experiencing short to medium term weakness. If the Company's view of this market adversely changes or if other factors develop which change our view of the value of these relationships, the Company will reevaluate this conclusion.

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Unapproved Change Orders and Claims
Costs and estimated earnings in excess of billings on uncompleted contracts included revenues for unapproved change orders and claims of $14.4 million at December 31, 2016 and $10.3 million at June 30, 2016 . The amounts ultimately realized may be significantly different than the recorded amounts resulting in a material adjustment to future earnings.
Insurance Reserves
We maintain insurance coverage for various aspects of our operations. However, we retain exposure to potential losses through the use of deductibles, self-insured retentions and coverage limits. We establish reserves for claims using a combination of actuarially determined estimates and management judgment on a case-by-case basis and update our evaluations as further information becomes known. Judgments and assumptions, including the assumed losses for claims incurred but not reported, are inherent in our reserve accruals; as a result, changes in assumptions or claims experience could result in changes to these estimates in the future. If actual results of claim settlements are different than the amounts estimated, we may be exposed to gains and losses that could be significant.
Recently Issued Accounting Standards
Accounting Standards Update 2014-09, Revenue from Contracts with Customers (Topic 606)
On May 28, 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09. The standard outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that “an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” The ASU also requires entities to disclose both quantitative and qualitative information that enables users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The ASU's disclosure requirements are significantly more comprehensive than those in existing revenue standards. The ASU applies to all contracts with customers except those that are within the scope of other topics in the FASB Accounting Standards Codification ("ASC").
The ASU is effective for annual reporting periods beginning after December 15, 2017, with early adoption permitted on a limited basis. Upon adoption, the Company may elect one of two application methods, a full retrospective application or a modified retrospective application. We expect to adopt this standard on July 1, 2018 and are currently evaluating its expected impact on our financial statements.
Accounting Standards Update 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern
On August 27, 2014, the FASB issued ASU 2014-15, which provides guidance on determining when and how reporting entities must disclose going-concern uncertainties in their financial statements. The new standard requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date of issuance of the entity’s financial statements. Further, an entity must provide certain disclosures if there is “substantial doubt about the entity’s ability to continue as a going concern.” The FASB believes that requiring management to perform the assessment will enhance the timeliness, clarity, and consistency of related disclosures and improve convergence with international financial reporting standards ("IFRSs") (which emphasize management’s responsibility for performing the going-concern assessment). However, the time horizon for the assessment (look-forward period) and the disclosure thresholds under U.S. GAAP and IFRSs will continue to differ. The ASU is effective for annual periods ending after December 15, 2016, and interim periods thereafter; early adoption is permitted.
The ASU was adopted during the Company's first fiscal quarter ending September 30, 2016. In connection with the adoption of the ASU, the Company now performs an assessment of its ability to continue as a going concern on a quarterly basis. Disclosure regarding the status of the Company's ability to continue as a going concern is required when there are conditions or events that raise substantial doubt about its ability to continue as a going concern within one year after the date that the financial statements are issued.

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Accounting Standards Update 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments
On September 25, 2015, the FASB issued ASU 2015-16 to simplify the accounting for measurement-period adjustments. The ASU was issued in response to stakeholder feedback that restatements of prior periods to reflect adjustments made to provisional amounts recognized in a business combination increase the cost and complexity of financial reporting but do not significantly improve the usefulness of the information. Under the ASU, an acquirer must recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The ASU also requires acquirers to present separately on the face of the income statement, or disclose in the notes, the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. For public business entities, the ASU is effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. We adopted this standard on July 1, 2016 with no material impact to the Company's financial statements.
Accounting Standards Update 2016-02, Leases (Topic 842)
On February 25, 2016, the FASB issued ASU 2016-02. The amendments in this update require, among other things, that lessees recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Lessees and lessors must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. For public business entities, the ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. We are currently evaluating the ASU's expected impact on our financial statements.
Accounting Standards Update 2016-09, Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting
On March 30, 2016, the FASB issued ASU 2016-09, which simplified several aspects of accounting for stock-based compensation transactions, including the accounting for income taxes and forfeitures and statutory tax withholding requirements. The ASU is effective for the Company on July 1, 2017 and early adoption is permitted. The Company adopted the ASU during its first fiscal quarter ending September 30, 2016. The following is a description of the key provisions of the ASU and their impacts to the Company's financial statements:
Accounting for Income Taxes : The amendments require the Company to recognize excess tax benefits or tax deficiencies in its provision for income taxes in its consolidated statements of income during the period of vesting or exercise of its nonvested deferred share awards and stock options, respectively, for which it expects to receive an income tax deduction. Previously, the Company recognized any excess tax benefits in additional paid-in capital ("APIC") in the balance sheet and any tax deficiencies were recognized as a reduction of APIC to the extent the Company has accumulated excess tax benefits. Any tax deficiencies in excess of accumulated excess tax benefits in APIC were recognized in the provision for income taxes. The amendments also require the Company to only present excess tax benefits and tax deficiencies in the operating section of its statements of cash flows as a component of deferred tax activity. Previously, the Company was required to present such items in both the financing section and operating section of its statements of cash flows. Amendments related to the recognition of excess tax benefits and tax deficiencies in income are required to be applied prospectively, and amendments related to the cash flow statement presentation of excess tax benefits and tax deficiencies may be applied either retrospectively or prospectively.
The Company applied the amendments requiring the recognition of excess tax benefits and tax deficiencies in income prospectively. As a result, the Company recognized $0.1 million and $0.5 million of excess tax benefits in its provision for income taxes during the three and six months ended December 31, 2016, respectively, which increased basic and diluted earnings per share by $0.01 and $0.02, respectively. Under the prior accounting standard, the Company would have recognized the excess tax benefits in equity as additional paid-in capital. The amendments relating to the presentation of excess tax benefits and tax deficiencies in the statement of cash flows were applied retrospectively. The effect of the retrospective adjustment was to eliminate the presentation of an operating cash outflow and a financing cash inflow for excess tax benefits on exercised stock options and vesting of deferred shares. These eliminations increased net cash provided by operating activities by $3.2 million and decreased net cash provided by financing activities by $3.2 million for the six months ended December 31, 2015. Net cash flows did not change as a result of the retrospective adjustment.
 

- 23 -





Accounting for Forfeitures : The amendments in this ASU allow the Company to elect, as a company-wide accounting policy, either to continue to estimate the amount of forfeitures to exclude from compensation expense or to exclude forfeitures from compensation expense as they occur. Upon the adoption of the ASU during the first quarter of fiscal 2017, the Company elected to account for forfeitures as they occur. The Company is required to apply these amendments on a modified retrospective basis with a cumulative adjustment to retained earnings as of the beginning of the fiscal year. The Company recorded a modified retrospective adjustment to reduce the June 30, 2016 retained earnings balance and increase the additional paid-in capital balance by $0.1 million each.
Statutory Tax Withholding Requirements : Under the prior accounting standard, an entire award must be classified as a liability if the fair value of the shares withheld exceeds the Company's minimum statutory withholding obligation. Under the ASU, the Company is allowed to withhold shares with a fair value up to the amount of tax owed using the maximum statutory tax rate in the employee's applicable jurisdictions. The Company is allowed to determine one maximum rate for all employees in each jurisdiction, rather than a rate for each employee in the jurisdiction. Also, the ASU requires that cash outflows to reacquire shares withheld for taxes to be classified in the financing section of the statement of cash flows.
The Company adopted the ASU during the first quarter of fiscal 2017. Since the Company did not have any awards classified as liabilities due to statutory tax withholding requirements as of December 31, 2016, and since the Company already presented its cash outflows for reacquiring shares withheld for taxes as a financing activity in its statements of cash flows, these amendments did not have any impact on its financial statements upon adoption. The Company does not expect changes to employee withholdings for stock compensation to have a material impact to the financial statements.
Accounting Standards Update 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments
On June 16, 2016, the FASB issued ASU 2016-13, which will change how the Company accounts for its allowance for uncollectible accounts. The amendments in this update require a financial asset (or a group of financial assets) to be presented at the net amount expected to be collected. The income statement will reflect any increases or decreases of expected credit losses that have taken place during the period. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectibility of the reported amount.
Current GAAP delays the recognition of the full amount of credit losses until the loss is probable of occurring. The amendments in this update eliminate the probable initial recognition threshold and, instead, reflect the Company's current estimate of all expected credit losses. In addition, current guidance limits the information the Company may consider in measuring a credit loss to its past events and current conditions. The amendments in this update broaden the information the Company may consider in developing its expected credit loss estimate to include forecasted information.
The amendments in this update are effective for the Company on July 1, 2020 and the Company may early adopt on July 1, 2019. The Company must apply the amendments in this update through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. At this time, the Company does not expect this update to have a material impact to its estimate of the allowance for uncollectible accounts.


- 24 -





RESULTS OF OPERATIONS
Overview
We operate our business through four reportable segments: Electrical Infrastructure, Oil Gas & Chemical, Storage Solutions, and Industrial.
The Electrical Infrastructure segment primarily encompasses construction and maintenance services to a variety of power generation facilities, such as combined cycle plants, natural gas fired power stations, and renewable energy installations. We also provide high voltage services to investor owned utilities, including construction of new substations, upgrades of existing substations, short-run transmission line installations, distribution upgrades and maintenance, and storm restoration services.
The Oil Gas & Chemical segment includes turnaround activities, plant maintenance, engineering and construction in the downstream and midstream petroleum industries. Our customers in these industries are engaged in refining crude oil and processing, fractionating, and marketing of natural gas and natural gas liquids. Another key offering is industrial cleaning services, which include hydroblasting, hydroexcavating, chemical cleaning and vacuum services. We also perform work in the petrochemical and upstream petroleum markets.
The Storage Solutions segment includes new construction of crude and refined products aboveground storage tanks (“ASTs”), as well as planned and emergency maintenance services. The Storage Solutions segment also includes balance of plant work in storage terminals and tank farms. Also included in the Storage Solutions segment is work related to specialty storage tanks, including liquefied natural gas (“LNG”), liquid nitrogen/liquid oxygen (“LIN/LOX”), liquid petroleum (“LPG”) tanks and other specialty vessels, including spheres. Finally, we offer AST products, including geodesic domes, aluminum internal floating roofs, floating suction and skimmer systems, roof drain systems and floating roof seals.
The Industrial segment primarily includes construction and maintenance work in the iron and steel, mining and minerals, and agricultural industries. Our work in the mining and minerals industry is primarily for customers engaged in the extraction of copper. Our work in the agricultural industry includes the engineering and design of grain silos, docks and handling systems; the design of control system automation and materials handling for the food industry; and engineering, construction, process design and balance of plant work for fertilizer production facilities. We also perform work in bulk material handling, thermal vacuum chambers, and other industrial markets.
Three Months Ended December 31, 2016 Compared to the Three Months Ended December 31, 2015
Consolidated
Consolidated revenue was $312.7 million for the three months ended December 31, 2016 , compared to $323.5 million in the same period in the prior fiscal year. On a segment basis, consolidated revenue decreased in the Industrial and Oil Gas & Chemical segments by $23.4 million and $5.8 million, respectively. These decreases were partially offset by increases in the Electrical Infrastructure and Storage Solutions segments of $11.8 million and $6.6 million, respectively.
Consolidated gross profit decreased from $ 30.0 million in the three months ended December 31, 2015 to $28.2 million in the three months ended December 31, 2016 . Gross margin decreased to 9.0% in the three months ended December 31, 2016 compared to 9.3% in the same period in the prior fiscal year. The reduction in gross margin in fiscal 2017 is primarily attributable to lower direct margins and increased under recovery of construction overhead costs in the Oil Gas & Chemical and Industrial segments, which were partially offset by higher direct margins in the Storage Solutions and Electrical Infrastructure segments.
Consolidated SG&A expenses were $20.0 million in the three months ended December 31, 2016 compared to $25.1 million in the same period a year earlier. The decrease in SG&A expense in fiscal 2017 was primarily attributable to a non-routine bad debt charge of $5.2 million from a client bankruptcy in fiscal 2016. Fiscal 2017 SG&A expense included $0.7 million of acquisition and integration costs from the Houston Interests, LLC ("Houston Interests") acquisition (See Item 1. Financial Statements, Note 2 - Acquisitions).
Net interest expense was $0.5 million and $0.2 million in the three months ended December 31, 2016 and 2015, respectively. The higher interest expense in fiscal 2017 is primarily attributable to the higher average debt balance in the current year, which is largely attributable to the borrowings used to fund the Houston Interests acquisition.
Our effective tax rate for the three months ended December 31, 2016 was 32.8% and 32.1% in the same period a year earlier. The fiscal 2017 tax rate was positively impacted by a discrete item related to the excess tax benefit realized upon the vesting of deferred shares which is more fully described in Item 1. Financial Statements, Note 1 - Basis of Presentation and Accounting Policies. The fiscal 2016 tax rate was positively impacted by a $0.9 million discrete item primarily related to the retroactive application of the R&D tax credit and a foreign currency item related to our Canadian operations.

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For the three months ended December 31, 2016 , net income attributable to Matrix Service Company and the related fully diluted earnings per share were $5.3 million and $0.20 compared to $5.4 million and $0.20 in the same period a year earlier.
Electrical Infrastructure
Revenue for the Electrical Infrastructure segment increased $11.8 million to $103.2 million in the three months ended December 31, 2016 compared to $91.4 million in the same period a year earlier primarily as a result from continued work on a power generating facility being constructed in Canada. The gross margin of 7.0% in fiscal 2017 was impacted by a settlement adjustment on the project, which is more fully described in Note 3 - Uncompleted Contracts. The fiscal 2016 gross margin of 4.4% was negatively impacted by $5.4 million of charges on an acquired EPC joint venture project.
Oil Gas & Chemical
Revenue for the Oil Gas & Chemical segment was $55.7 million in the three months ended December 31, 2016 compared to $61.5 million in the same period a year earlier. The decrease of $5.8 million is related to lower volume across the business as refiners continue to limit spending as the result of continued volatility in commodity prices and market uncertainty. The gross margin was 4.4% for the three months ended December 31, 2016 compared to 9.7% in the same period last year. The gross margin for fiscal 2017 was affected by project execution and lower volume which led to the under recovery of overhead costs.
Storage Solutions
Revenue for the Storage Solutions segment was $128.8 million in the three months ended December 31, 2016 compared to $122.2 million in the same period a year earlier, an increase of $6.6 million. The increase is primarily attributable to increased activity on the previously announced project for the construction of crude gathering terminals that support the Dakota Access Pipeline and higher Canadian volumes. These increases were partially offset by lower volumes in our remaining domestic storage business. The gross margin was 13.3% in the three months ended December 31, 2016 and 11.8% in the three months ended December 31, 2015 as a result of effective project execution in both periods. Work on the terminals that support the Dakota Access Pipeline is expected to complete in fiscal 2017 and revenue will continue to decline as this project nears completion.
Industrial
Revenue for the Industrial segment decreased $23.4 million to $25.0 million in the three months ended December 31, 2016 compared to $48.4 million in the same period a year earlier. The decline in revenue is primarily attributable to lower business volumes in the iron and steel and mining markets, and lower revenue recognized on a large fertilizer project. The gross margin was 5.9% in the three months ended December 31, 2016 compared to 11.5% in the same period a year earlier. The fiscal 2017 gross margin was negatively impacted by the under recovery of construction overhead costs due to reduced volume and a higher percentage of lower margin iron and steel work. The fiscal 2016 gross margin was positively impacted by the mix of work and strong project execution.
Six Months Ended December 31, 2016 Compared to the Six Months Ended December 31, 2015
Consolidated
Consolidated revenue was $654.4 million for the six months ended December 31, 2016 , compared to $642.9 million in the same period in the prior fiscal year. On a segment basis, consolidated revenue increased in the Storage Solutions and Electrical Infrastructure segments by $61.9 million and $34.2 million, respectively. These increases were partially offset by decreases in revenue in the Industrial and Oil Gas & Chemical segments of $42.9 million and $41.6 million, respectively.
Consolidated gross profit decreased from $64.6 million in the six months ended December 31, 2015 to $60.5 million in the six months ended December 31, 2016 . Gross margin decreased to 9.2% in the six months ended December 31, 2016 compared to 10.0% in the same period in the prior fiscal year. The reduction in gross margin in fiscal 2017 is primarily attributable to lower direct margins and increased under recovery of construction overhead costs in the Oil Gas & Chemical and Industrial segments, which were partially offset by higher direct margins in the Storage Solutions segment.
Consolidated SG&A expenses were $38.0 million in the six months ended December 31, 2016 compared to $44.6 million in the same period a year earlier. The decrease in SG&A expense in fiscal 2017 was primarily attributable to a non-routine bad debt charge of $5.2 million from a client bankruptcy in fiscal 2016. Fiscal 2017 SG&A expense included $0.7 million of acquisition and integration costs from the Houston Interests acquisition.

- 26 -





Net interest expense was $0.7 million and $0.4 million in the six months ended December 31, 2016 and 2015, respectively.
Our effective tax rate for the six months ended December 31, 2016 was 33.3% and 33.8% in the same period a year earlier. The fiscal 2017 tax rate was positively impacted by a discrete item related to the excess tax benefit realized upon the vesting of deferred shares which is more fully described in Note 1 - Basis of Presentation and Accounting Policies. The fiscal 2016 tax rate was positively impacted by a discrete item related to our Canadian operations.
For the six months ended December 31, 2016 , net income attributable to Matrix Service Company and the related fully diluted earnings per share were $14.6 million and $0.54 compared to $15.4 million and $0.56 in the same period a year earlier.
Electrical Infrastructure
Revenue for the Electrical Infrastructure segment increased $34.2 million to $191.2 million in the six months ended December 31, 2016 compared to $157.0 million in the same period a year earlier primarily as a result of continued work on a power generating facility being constructed in Canada. The fiscal 2017 gross margin was 6.5% compared to 5.6% in the same period last year. The gross margin in fiscal 2017 was negatively affected by the settlement charge on the project, which is more fully described in Note 3 - Uncompleted Contracts, and the gross margin in fiscal 2016 was impacted by $5.5 million of charges on an acquired EPC joint venture project.
Oil Gas & Chemical
Revenue for the Oil Gas & Chemical segment was $88.3 million in the six months ended December 31, 2016 compared to $129.9 million in the same period a year earlier. The decrease of $41.6 million is related to lower volume across the business as refiners continue to limit spending as the result of continued volatility in commodity prices and market uncertainty. The gross margin was 2.8% for the six months ended December 31, 2016 compared to 9.0% in the same period last year. The gross margin for fiscal 2017 was affected by lower volume which led to the under recovery of overhead costs and project execution.
Storage Solutions
Revenue for the Storage Solutions segment was $328.3 million in the six months ended December 31, 2016 compared to $266.4 million in the same period a year earlier, an increase of $61.9 million. The increase is primarily attributable to increased activity on a previously announced project for the construction of crude gathering terminals that support the Dakota Access Pipeline and higher Canadian volumes. These increases were partially offset by lower volumes in our remaining domestic storage business. The gross margin was 13.3% in the six months ended December 31, 2016 and 13.0% in the six months ended December 31, 2015 as a result of effective project execution in both periods. Work on the terminals that support the Dakota Access Pipeline is expected to complete in fiscal 2017 and revenue will continue to decline as this project nears completion.
Industrial
Revenue for the Industrial segment decreased $42.9 million to $46.7 million million in the six months ended December 31, 2016 compared to $89.6 million in the same period a year earlier. The decline in revenue is primarily attributable to lower business volumes in the iron and steel and mining markets, and lower revenue recognized on a large fertilizer project. The gross margin was 4.4% in the six months ended December 31, 2016 compared to 10.7% in the same period a year earlier. The fiscal 2017 gross margin was negatively impacted by the under recovery of construction overhead costs due to reduced volume and a higher percentage of lower margin iron and steel work. The fiscal 2016 gross margin was positively impacted by the mix of work and strong project execution.
Backlog
We define backlog as the total dollar amount of revenue that we expect to recognize as a result of performing work that has been awarded to us through a signed contract, notice to proceed or other type of assurance that we consider firm. The following arrangements are considered firm:

fixed-price awards;

minimum customer commitments on cost plus arrangements; and

certain time and material arrangements in which the estimated value is firm or can be estimated with a reasonable amount of certainty in both timing and amounts.

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For long-term maintenance contracts and other established customer arrangements, we include only the amounts that we expect to recognize into revenue over the next 12 months. For all other arrangements, we calculate backlog as the estimated contract amount less revenue recognized as of the reporting date.
The following table provides a summary of changes in our backlog for the three months ended December 31, 2016 :  
 
Electrical
Infrastructure
 
Oil Gas &
Chemical
 
Storage
Solutions
 
Industrial
 
Total
 
(In thousands)
Backlog as of September 30, 2016
$
354,286

 
$
179,274

 
$
198,141

 
$
54,911

 
$
786,612

Project awards
87,285

 
59,443

 
116,107

 
47,501

 
310,336

Acquired backlog from Houston Interests

 
26,502

 

 
3,195

 
29,697

Revenue recognized
(103,158
)
 
(55,714
)
 
(128,757
)
 
(25,026
)
 
(312,655
)
Backlog as of December 31, 2016
$
338,413

 
$
209,505

 
$
185,491

 
$
80,581

 
$
813,990

The following table provides a summary of changes in our backlog for the six months ended December 31, 2016 :  
 
Electrical
Infrastructure
 
Oil Gas &
Chemical
 
Storage
Solutions
 
Industrial
 
Total
 
(In thousands)
Backlog as of June 30, 2016
$
369,791

 
$
91,478

 
$
359,013

 
$
48,390

 
$
868,672

Project awards
159,805

 
179,781

 
154,757

 
75,714

 
570,057

Acquired backlog from Houston Interests

 
26,502

 

 
3,195

 
29,697

Revenue recognized
(191,183
)
 
(88,256
)
 
(328,279
)
 
(46,718
)
 
(654,436
)
Backlog as of December 31, 2016
$
338,413

 
$
209,505

 
$
185,491

 
$
80,581

 
$
813,990

Project awards in all segments are cyclical and are typically the result of a sales process that can take several months to complete. Backlog in the Storage Solutions and Electrical Infrastructure segments generally have the greatest volatility because individual project awards can be less frequent and more significant.
The change in backlog in the Electrical Infrastructure segment during the six months ended December 31, 2016 is mainly attributable to the work related to the previously announced Napanee Power Generating Station project largely offset by power delivery awards which continue to meet the Company's expectations.
The increase in backlog in the Oil, Gas & Chemical segment during the six months ended December 31, 2016 is mainly attributable to backlog acquired from Houston Interests and increased project awards such as the previously announced Ultra-Low Gasoline Project awarded by KBR, Inc.
The decline in backlog in the Storage Solutions segment during the six months ended December 31, 2016 is attributable to the work related to the previously announced project for the construction of terminals supporting the Dakota Access Pipeline. In addition, a more cautious approach to decision-making on the part of clients, more stringent financial and regulatory requirements, and prolonged market uncertainty is delaying the timing of awards.
The increase in backlog in the Industrial segment during the six months ended December 31, 2016 is primarily attributable to increased project awards, including an award for a thermal vacuum chamber project during the second quarter.
Seasonality and Other Factors
Our operating results can exhibit seasonal fluctuations, especially in our Oil Gas & Chemical segment, for a variety of reasons. Turnarounds and planned outages at customer facilities are typically scheduled in the spring and the fall when the demand for energy is lower. Within the Electrical Infrastructure segment, transmission and distribution work is generally scheduled by the public utilities when the demand for electricity is at its lowest. Therefore, revenue volume in the summer months is typically lower than in other periods throughout the year. Also, we typically see a lower level of operating activity relating to construction projects during the winter months and early in the calendar year because many of our customers’ capital budgets have not been finalized. Our business can also be affected, both positively and negatively, by seasonal factors such as energy demand or weather conditions including hurricanes, snowstorms, and abnormally low or high temperatures. Some of these seasonal factors may cause some of our offices and projects to close or reduce activities temporarily. In addition to the above noted factors, the general timing of project starts and completions could exhibit significant fluctuations. Accordingly, results for any interim period may not necessarily be indicative of operating results for the full year.

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Other factors impacting operating results in all segments come from work site permitting delays or customers accelerating or postponing work. The differing types, sizes, and durations of our contracts, combined with their geographic diversity and stages of completion, often results in fluctuations in the Company's operating results.
Impact of Commodity Price Volatility and Market Uncertainty
The prolonged decline in crude prices continues to impact our income from operations and project awards, particularly in the Oil Gas & Chemical and Storage Solutions segments. The Industrial segment continues to be negatively impacted by the low prices of other commodities, principally steel and copper. The decline in commodity prices has not had, and we do not expect a significant impact on the Electrical Infrastructure segment.
Our Oil Gas & Chemical segment continues to see lower volumes of routine maintenance and turnaround work as well as award delays caused by slower than expected improvements in commodity pricing and regulatory uncertainties. If commodity prices remain at current levels or the current uncertainty continues, spending levels may continue to be reduced.
In our Storage Solutions segment, our customers continue to take a long-term view of the market, but continue to be cautious short-term. Based on current market conditions, we are seeing a continued reduction in customer spending and project award delays. Although we are seeing signs of market improvement, we cannot predict the direction of commodity prices or our customers’ ultimate reaction to the market and therefore cannot predict the magnitude of the impact to our future earnings.
In the Industrial segment, our iron and steel customers are facing challenges related to the import of cheaper foreign steel, global steel production over-capacity and the strong United States Dollar, which continues to be a headwind for steel exports. These conditions have reduced steel mill utilization in the U.S., which has reduced the capital, expansion and elective maintenance spending of our customers. Although we are seeing some encouraging political developments with respect to U.S. trade, we do not expect higher levels of spending until the factors that led to lower steel mill utilization are relieved. In the mining and minerals markets, we continue to see lower spending due to the softness of other commodity prices. However, copper prices, to which our clients are particularly exposed, have increased in recent months.
Non-GAAP Financial Measure
EBITDA is a supplemental, non-GAAP financial measure. EBITDA is defined as earnings before interest expense, income taxes, depreciation and amortization. We have presented EBITDA because it is used by the financial community as a method of measuring our performance and of evaluating the market value of companies considered to be in similar businesses. We believe that the line item on our Consolidated Statements of Income entitled “Net Income” is the most directly comparable GAAP measure to EBITDA. Since EBITDA is not a measure of performance calculated in accordance with GAAP, it should not be considered in isolation of, or as a substitute for, net earnings as an indicator of operating performance. EBITDA, as we calculate it, may not be comparable to similarly titled measures employed by other companies. In addition, this measure is not a measure of our ability to fund our cash needs. As EBITDA excludes certain financial information compared with net income, the most directly comparable GAAP financial measure, users of this financial information should consider the type of events and transactions that are excluded. Our non-GAAP performance measure, EBITDA, has certain material limitations as follows:

It does not include interest expense. Because we have borrowed money to finance our operations, pay commitment fees to maintain our credit facility, and incur fees to issue letters of credit under the credit facility, interest expense is a necessary and ongoing part of our costs and has assisted us in generating revenue. Therefore, any measure that excludes interest expense has material limitations.

It does not include income taxes. Because the payment of income taxes is a necessary and ongoing part of our operations, any measure that excludes income taxes has material limitations.

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

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A reconciliation of EBITDA to net income follows:
 
 
Three Months Ended
 
Six Months Ended
 
December 31,
2016
 
December 31,
2015
 
December 31,
2016
 
December 31,
2015
 
(In thousands)
Net income attributable to Matrix Service Company
$
5,250

 
$
5,431

 
$
14,592

 
$
15,372

Interest expense
497

 
252

 
740

 
515

Provision for income taxes
2,563

 
1,477

 
7,298

 
6,553

Depreciation and amortization
5,084

 
5,291

 
9,988

 
10,720

EBITDA
$
13,394

 
$
12,451

 
$
32,618

 
$
33,160



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FINANCIAL CONDITION AND LIQUIDITY
Overview
We define liquidity as the ongoing ability to pay our liabilities as they become due, fund business operations and meet all monetary contractual obligations. Our primary sources of liquidity for the six months ended December 31, 2016 were cash on hand, capacity under our senior revolving credit facility and cash generated from operations before consideration of changes in working capital. Cash on hand at December 31, 2016 totaled $66.2 million and availability under the senior revolving credit facility totaled $162.2 million resulting in available liquidity of $ 228.4 million .
Factors that routinely impact our short-term liquidity and may impact our long-term liquidity include, but are not limited to:
Changes in costs and estimated earnings in excess of billings on uncompleted contracts and billings on uncompleted contracts in excess of costs due to contract terms that determine the timing of billings to customers and the collection of those billings

Some cost plus and fixed price customer contracts are billed based on milestones which may require us to incur significant expenditures prior to collections from our customers.

Time and material contracts are normally billed in arrears. Therefore, we are routinely required to carry these costs until they can be billed and collected.

Some of our large construction projects may require significant retentions or security in the form of letters of credit.

Other changes in working capital

Capital expenditures
Other factors that may impact both short and long-term liquidity include:

Acquisitions of new businesses

Strategic investments in new operations

Purchases of shares under our stock buyback program

Contract disputes which can be significant

Collection issues, including those caused by weak commodity prices or other factors which can lead to credit deterioration of our customers

Capacity constraints under our credit facility and remaining in compliance with all covenants contained in the credit agreement

A default by one of the major financial institutions for which our deposits exceed insured deposit limits

Cash on hand outside of the United States that cannot be repatriated without incremental taxation.

As discussed under the caption "Senior Revolving Credit Facility" included in this Financial Condition and Liquidity section of the Form 10-Q, our Credit Agreement includes a Senior Leverage Ratio covenant, which provides that Consolidated Funded Indebtedness, as of the end of any fiscal quarter, may not exceed 3.0 times Consolidated EBITDA, as defined in the Credit Agreement, during any Acquisition Adjustment Period and 2.5 times Consolidated EBITDA at all other times, over the previous four quarters.

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Cash Flow for the Six Months Ended December 31, 2016
Cash Flows Used by Operating Activities
Cash used by operating activities for the six months ended December 31, 2016 totaled $30.9 million . The various components are as follows:

Net Cash Used by Operating Activities
(In thousands)
 
Net income
$
14,592

Non-cash expenses
13,370

Deferred income tax
970

Cash effect of changes in working capital
(59,973
)
Other
133

Net cash used by operating activities
$
(30,908
)
Working capital changes, net of effects from acquisitions, at December 31, 2016 in comparison to June 30, 2016 include the following:

Accounts receivable, net of bad debt expense recognized during the period, increased by $49.0 million during the six months ended December 31, 2016 . The variance is primarily attributable to the timing of billing and collections on our previously announced projects for the construction of terminals supporting the Dakota Access Pipeline and the Napanee Power Generating Station.

Accounts payable decreased by $34.3 million during the six months ended December 31, 2016 . The variance is primarily attributable to the timing of vendor payments. Costs and estimated earnings in excess of billings on uncompleted contracts ("CIE") decreased $24.4 million while billings on uncompleted contracts in excess of costs and estimated earnings ("BIE") increased $4.9 million. The net change in CIE and BIE increased cash $29.3 million for the six months ended December 31, 2016. CIE and BIE balances can experience significant fluctuations based on the timing of when job costs are incurred, the invoicing of those job costs to the customer, and other working capital management factors.

Cash Flows Used for Investing Activities
Investing activities used $43.8 million of cash in the six months ended December 31, 2016 primarily due to the Houston Interests acquisition, which used $39.8 million, and $4.2 million of capital expenditures. Capital expenditures consisted of purchases of: $2.0 million for office equipment, $1.1 million for construction equipment, $0.7 million for transportation and fabrication equipment, and $0.4 million for land and buildings. Proceeds from asset sales provided $0.2 million of cash.
Cash Flows Provided by Financing Activities
Financing activities provided $70.4 million of cash in the six months ended December 31, 2016 primarily due to net borrowings of $72.4 million under our credit facility that were partially offset by the repurchase of $2.3 million of Company stock for payment of withholding taxes due on equity-based compensation. The net borrowings under our credit facility were primarily used to fund $46.0 million of cash purchase price for the Houston Interests acquisition and working capital needs of our Canadian business.

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Senior Revolving Credit Facility
As noted previously in Note 5 of the Notes to Condensed Consolidated Financial Statements included in Part 1, Item 1 of this Quarterly Report on Form 10-Q, the Company amended its senior secured revolving credit facility on December 12, 2016 (the "Credit Agreement"). The amendments are as follows:
The aggregate revolving loan capacity increased from $200.0 million to $250.0 million.
The maximum aggregate amount, or sublimit, for Canadian Dollar loans was increased from U.S. $40.0 million to U.S. $50.0 million.
During any Acquisition Adjustment Period, as defined in the amended credit agreement, the Company's Senior Leverage Ratio, as defined in the amended credit agreement, may not exceed 3.00 to 1.00. At all other times, the Senior Leverage Ratio may not exceed 2.50 to 1.00.
The Credit Agreement includes a Senior Leverage Ratio covenant - which provides that Consolidated Funded Indebtedness, as of the end of any fiscal quarter, may not exceed 3.0 times Consolidated EBITDA during any Acquisition Adjustment Period and may not exceed 2.5 times Consolidated EBITDA at all other times, over the previous four quarters. For the four quarters ended December 31, 2016 , Consolidated EBITDA, as defined in the Credit Agreement, was $84.0 million . Consolidated Funded Indebtedness at December 31, 2016 was $80.0 million .
Availability under the senior credit facility at December 31, 2016 was as follows:  
 
December 31,
2016
 
June 30,
2016
 
(In thousands)
Senior revolving credit facility
$
250,000

 
$
200,000

Capacity constraint due to the Senior Leverage Ratio

 
20,138

Capacity under the credit facility
250,000

 
179,862

Borrowings outstanding
72,412

 

Letters of credit
15,378

 
20,755

Availability under the senior revolving credit facility
$
162,210

 
$
159,107

Outstanding borrowings at December 31, 2016 under our Credit Agreement were primarily used to fund the acquisition of Houston Interests (See Part 1, Item 1, Note 2 - Acquisitions) and working capital needs in our Canadian business due to the timing of collections and disbursements on the previously announced power generating project.
At December 31, 2016, the Company was in compliance with all affirmative, negative, and financial covenants under the Credit Agreement.
New Credit Agreement
On February 8, 2017, the Company entered into the Fourth Amended and Restated Credit Agreement (the "New Credit Agreement"), by and among the Company and certain foreign subsidiaries, as Borrowers, various subsidiaries of the Company, as Guarantors, JPMorgan Chase Bank, N.A., as Administrative Agent, Sole Lead Arranger and Sole Bookrunner, and the other Lenders party thereto, which replaced the Third Amended and Restated Credit Agreement dated as of November 7, 2011, as previously amended (the "Prior Credit Agreement").
The New Credit Agreement provides for a five-year senior secured revolving credit facility of $300.0 million that expires February 8, 2022, which replaces the $250.0 million senior secured revolving credit facility under the Prior Credit Agreement. The new credit facility may be used for working capital, acquisitions, capital expenditures, issuances of letters of credit and other lawful purposes.

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The New Credit Agreement includes the following covenants and borrowing limitations:
Our Leverage Ratio, determined as of the end of each fiscal quarter, may not exceed 3.00 to 1.00.
As with the Prior Credit Agreement, we are required to maintain a Fixed Charge Coverage Ratio, determined as of the end of each fiscal quarter, greater than or equal to 1.25 to 1.00.
Asset dispositions (other than dispositions in which 100% of the net cash proceeds therefrom are reinvested into the Company and dispositions of inventory and obsolete or unneeded equipment in the ordinary course of business) are limited to $20.0 million per 12-month period.
The new credit facility will include a sub-facility for revolving loans denominated in Australian Dollars, Canadian Dollars, Euros and Pounds Sterling in an aggregate amount not to exceed the U.S. Dollar equivalent of $75.0 million and a $200.0 million sublimit for letters of credit. Each revolving borrowing under the New Credit Agreement will bear interest at a rate per annum equal to:
The ABR or the Adjusted LIBO Rate, in the case of revolving loans denominated in U.S. Dollars;
The Canadian Prime Rate or the CDOR rate, in the case of revolving loans denominated in Canadian Dollars;
The Adjusted LIBO Rate, in the case of revolving loans denominated in Pounds Sterling or Australian Dollars;
The EURIBO Rate, in the case of revolving loans denominated in Euros,

in each case, plus the Applicable Margin, which is based on the Company's Leverage Ratio. The Applicable Margin on ABR loans ranges between 0.625% and 1.625%. The Applicable Margin for Adjusted LIBO, EURIBO and CDOR loans ranges between 1.625% and 2.625% and the Applicable Margin for Canadian Prime Rate loans ranges between 2.125% and 3.125%.
The unused credit facility fee is between 0.20% and 0.45% based on the Leverage Ratio.
Dividend Policy
We have never paid cash dividends on our common stock, and the terms of our New Credit Agreement limit the amount of cash dividends we can pay. Under our New Credit Agreement, we may declare and pay dividends on our capital stock during any fiscal year up to an amount which, when added to all other dividends paid during such fiscal year, does not exceed 50% of our cumulative net income for such fiscal year to such date. While we currently do not intend to pay cash dividends, any future dividend payments will depend on our financial condition, capital requirements and earnings as well as other relevant factors.
Stock Repurchase Program and Treasury Shares
Treasury Shares
On December 12, 2016, the Board of Directors approved a new stock buyback program (the "December 2016 Program"). Under the December 2016 Program, the Company may repurchase common stock of the Company in any calendar year commencing with calendar year 2016 and continuing through calendar year 2018, up to a maximum of $25.0 million per calendar year. The Company may repurchase its stock from time to time in the open market at prevailing market prices or in privately negotiated transactions. The December 2016 Program will continue through December 31, 2018 unless and until revoked by the Board of Directors. No shares have been repurchased under the December 2016 Program as of December 31, 2016.
In addition to the stock buyback program, the Company may withhold shares of common stock to satisfy the tax withholding obligations upon vesting of an employee’s deferred shares. Matrix withheld 133,322 shares in the first six months of fiscal 2017 to satisfy these obligations. These shares were returned to the Company’s pool of treasury shares.
The Company has 1,299,574 treasury shares as of December 31, 2016 and intends to utilize these treasury shares solely in connection with equity awards under the Company’s stock incentive plans.

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FORWARD-LOOKING STATEMENTS
This Form 10-Q includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements, other than statements of historical facts, included in this Form 10-Q which address activities, events or developments which we expect, believe or anticipate will or may occur in the future are forward-looking statements. The words “believes,” “intends,” “expects,” “anticipates,” “projects,” “estimates,” “predicts” and similar expressions are also intended to identify forward-looking statements.
These forward-looking statements include, among others, such things as:
the impact to our business of crude oil, natural gas and other commodity prices;