ENGlobal Corporation: 4Q/Year-End 2011 & Conference Call Analysis

Let’s get a few things out of the way first. With the earnings release and CC we learned ENG lost its credit facility and has to negotiate to get a new one by May 31st. If they don’t get a new credit facility in place by then the company is done or they may be forced to take on an equity partner, who would certainly bring about higher costs, possibly a Board seat and for sure a management change. Even if they do get a credit facility it will be a tight squeeze anyway (more later…). What I do not understand is that losing the credit facility was an extremely important, seemingly material event and required or at least deserved an 8K news release. It was a material change in their credit agreement and could directly impact the company’s future liquidity and viability. I think the NT 10K discussing the general topic but with no detail was supposed to suffice and soften the issue rather than an 8K. A more detailed description ended up in the 10K later.

As a post script an 8K was finally filed on 17 April 2012 describing the credit facility problem. Here is what I find interesting - that 8K says the information was released earlier in a news release on 5 April. The only problem is there was no news release on 5 April! So why is that in an SEC filing? This problem can be solved two ways, either get the facts right the first time or get a time machine.

The earnings release further went on to say two major financial institutions are in due diligence to determine if they will provide ENGlobal with a replacement credit facility. Mr. Pagano states, “…We believe the new facility will provide additional flexibility for our senior credit needs and, once completed, will better position the Company for future growth." Never mind the ‘cart before the horse’ attitude, lets be realistic, this statement is poor form to treat Well Fargo this way while trying to make this situation look positive. The truth is that ENG had violated the covenants of the credit facility multiple times and I believe Wells Fargo has lost faith in the CEO and CFO’s performance. By the way, if you haven’t noticed, Wells Fargo has been improving their balance sheet, results and company strength by shaping up their risks (Back at you).

Currently a new credit facility has to be secured with the previous borrowed amount, $16.4 million, as debt and approximately $8.9 million in letters of credit guarantees must be satisfied. I get the feeling we are in a trial period here - to see if we get a new credit facility, a new CEO and a new CFO, or all of the above.

Analysis

I did listen to the conference call and overall I thought the tone was good and positive for such a bad report. I did think some metrics (covered below) were left out on purpose to change the impact on the listeners. One analyst asked for one of those metrics – DSO, Days Sales Outstanding. This is how you keep your cash flow, by getting your invoices out on time and then handling collections to be paid in a timely manner, AND a key point here folks – not using the credit facility and its associated costs. The 4Q DSO was 70 days, 25% decrease (YoY), which is pretty bad. A DSO of 70 days puts approximately $12.03 million in additional investment cash on the Balance Sheet in the form of uncollected AR, and unbilled cost-plus and fixed price CIEB invoices, plus, they had $8.9 million in accounts receivable exclusions under the credit facility.

To give you an example how the DSO should be, look at when Mr. Raiford and Ms. Barnes were the CFO and Controller. The DSO’s ran in the mid 50 days and they worked constantly to keep the number low and cash up. I think their method was a tight centralized accounting system. It makes one wonder what type of accounting system is in place, especially in view of my previous report’s comments.

The basic numbers for 4Q: A reported (.15) loss on $76.1 million in revenue and 26% decrease in billable hours YoY and an 18% decrease from 3Q. The utilization rate is nearly unchanged at 90% so that indicates something is wrong even on lower revenue. The delta from the analysts' expectations was .18 cents less. More dialogs on the analysts later. A major component loss in 4Q was the predicted loss (my last report) that turned out to be $4.3 million from the Electrical Division within the Automation Division.

FY 2011 showed a (.27) loss on $312 million in revenue. There were some positive comparisons over last year but a loss is a loss, and even worse without a credit facility. I want to introduce some common sense thinking here that I learned from using Total Cost Analysis during lawsuits. I call it Total Operational Analysis and you don’t have to be a genius to understand it. What you do need is a good memory. Look back at the reports from ENGlobal’s early profitable periods. Remember when ENGlobal had much less than $312 million in revenue or near that and still made good profit? You got to ask yourself – Why no profit now? I think SG&A is one prime suspect. You can see it is too high but my guess is much of it is unnoticed and is being pushed out to operations by new accounting methods, that we are not seeing the whole truth. What I did see in recent past was the CFO, Controller and five other accountants leave ENGlobal with some subsequent Non-GAAP reporting and numbers that don’t make sense to me. What it all does come down to is the way the company is being managed. Perhaps Wells Fargo ending a relationship with current management is an indicator. Moreover, when I see Mr. Pagano stating, "During this year of transition, ENGlobal positioned itself to capture future business opportunities by improving the intellectual capital of the organization as well as creating a more efficient Company…”. I have a difficult time seeing any of these words impacting on the bottom line.

Next up: Backlog. Hey it looks good, at first, up 24% YoY to $302 million. Now let’s take out the Caspian Sea Project. It is 6 months behind schedule (via CC) and foreign projects are volatile. Total Backlog from the three segments is $302M minus the Caspian Sea project impact on those same segments ~ $80.3M* indicates an organic backlog of only $221M. So in reality, it looks as though domestic Backlog actually is less than the $244.2M reported in 2010 and $227M in 2009.

*Calculation - The Caspian Project award was for approx. $85 million over a 4-year period and on the call Mr. Pagano indicated that the project was approx. 6 months behind. Automation's non-fabrication revenue increased just $1.5 million year over year and Caspian could not have had much impact in the early stages. On a straight-line basis ($85 mil/48 months) and being 6 months behind would allow for approximately two to three months of Caspian revenue in 2011 and that would equal $3.5 to $5.3 million. Let’s use $4.7 million for our impact above ($85.0 M, less $4.7 M = $80.3 M).

Backlog was a listed Risk Factor in the 2010 10K (#14) and in the 2011 10K (#5). Why the major move up in risk factor order? Since risk factors are based on management opinions it does not look like too much confidence is placed in the backlog from their point of view! To support thinking on this topic look at Risk Factor #4 “dependence on one or few contracts” – removing the Caspian Sea Project gives one food for thought and the inherent vulnerabilities ENGlobal is dealing with. If the Caspian Sea Project falters – they will have big trouble. Since we are on the topic of Risk Factors, look at #1 – Indebtedness!

Some Balance Sheet Sales details that are of interest are ‘Amounts Unbilled’ up 3% indicating delay in cost-plus billing and ‘Cost in Excess’ up 5.5% indicating they are not getting fixed price work billed out timely or not meeting contract milestones. Again, what is going on in accounting?

Conclusions

So how close is ENGlobal cutting it on their credit facility problem? The total facility is $35M less $16.4M (loan balance) and $8.9M (Caspian Sea Letter of Credit) = $9.7M left. If you have 2000 employees @ $50/hr and 80 hours/biweekly period = $8M; now add $1.6M burden @ 20% = $9.6M payroll per bi-weekly period. ENGlobal only has $9.7M left – therefore, that is what I meant earlier by cutting it close. Oh and yes, the margin is a little improved because they are reporting 1900 employees now. Does that make you feel better?

Back to my Total Operational Analysis: I think you can agree the trend is still downward, the credit facility unsecured and performance numbers don’t even equal profitable periods in the past with same or lower revenues. It is all management folks. It needs to be changed. They need to be held responsible like Sarbanes-Oxley Act mandates truthful reporting. This is where companies have to make a statement of certification as to the truthfulness of their accounting practices. ENGlobal just filed their 10K with such a statement. Take a look at it quickly – look at Exhibit 31.2 where the CFO certifies the numbers. Notice the name that appears as ENGlobal’s CFO - Robert W. Raiford, with a signature at the bottom. This indicates a major problem that those of you formally in the military would recognize the term as a SNAFU. Here is the problem – The CFO is not Mr. Raiford. He resigned last July, some 9 months ago. And ENGlobal is certifying to the SEC that the numbers are true and correct with the wrong CFO. The irony is simply outstanding. Consider all the people in management that should review this document, including the CEO and they list their CFO wrong? Stand by for a 10K amended filing. As a post script 10 K/A with the correct CFO name was posted on 19 April.

http://sec.gov/Archives/edgar/data/933738/000144530512001012/eng-123111exh312.htm

I think Mr. Coskey should take this company back over, at least temporarily, and get it back under control. I think he will need to have accounting remodeled back to where it can control the company and there is no better person to do that than Mr. Raiford. I also think someone else should be involved that most have forgotten that had a past high level of success – Hulda Coskey. I am dead serious and if you research past IDS and early ENGlobal growth and performance I think her involvement and the company’s performance speak for themselves. She has strong accounting and operations knowledge, is very smart, and I think could help at least temporarily. Additionally, I think the Coskey’s performed better as a team with balancing strengths. I don’t want to hear anything about nepotism either, she helped build this company – I saw it, she did an excellent job and would make a fantastic CEO herself. ENGlobal needs to look for these qualities – people who do their job and don’t need to embellish nonperformance. ENG has a Machiavellian type environment that has replaced the family atmosphere that was prevalent before – it is time to get back to that and basic sense.

The stock didn’t take much of a hit, so far. Why has it held up to price levels much higher than when ENG used to make small profits? First, see my blog report dated 04 November 2009 (second half). I believe the stock is being held up by institutions that have a lot to lose if it dips sustained under $1/share and becomes delisted by NASDAQ. As for analysts, how can you even believe them with predicted numbers for so long missing every single time? They seem to be just tracking and guessing while producing nothing useful.

So what business is best served by the current CEO? I was in South Daytona a few weeks ago and had lunch somewhere that caused me to think about this. I found the whole experience enlightening...

Good luck to everyone.

Comments are welcomed.

ENGlobal Corporation - Last Two Years, 4Q and Year-End 2011

Rev 1.3 (see Spring 2012 Updates)

It has been a while since my last posting. You may notice I have changed the name of this blog to basic Engineering, that I may comment toward other engineering companies.

I have been watching ENGlobal to see what was going to develop with the new CEO, Edd Pagano. It has been about two years now and I am sad to say Mr. Pagano has been a disappointment by most any measure. First, lets cover some old business. ENGlobal made a big mistake when they pushed out Mike Burrow years ago. Yes, the announcement said he would retire, but did he? No. He waited a year or so, presumably to clear a non compete agreement and started Burrow Global LLC. My point is made that he obviously didn’t retire. Not only did he start an engineering firm in the recession but grew it to over 730 personnel and made money during a period in which ENGlobal produced continued losses. ENGlobal cut a person who could best guide ENG during this protracted recession, they put him in a position to be a primary competitor and the potential for ENG to lose contracts. The proof is in the results for both companies.

What has Mr. Pagano done? I watched and read all the announcements. I think I lost count of the upper management shuffle, especially the Business Development position. For a while the CEO was shuffling the same deck of cards moving management, adding no new people, and came up with no real results. Then he added more management, again with no results other than increasing overhead. In his two years he managed to black ink one quarter with a fraction of a penny that was lucky enough to round up to a 1-cent profit. All the rest of the quarters were like the previous quarters prior to his hiring – losses. Most of these quarterly losses were exaggerated by adding additional losses to the unimproved continued operations due to “Special or One-Time Charges”. This begs the investor with a memory to ask. “How many Special Charges can you have before they are NOT Special anymore?”

The Exodus

I have watched so many quality people leave ENGlobal that I have doubts of its viability in a recession. I am not talking tens; I am talking many dozens of primary experienced middle and upper management people that have left. They generally seem to be going to four competing companies that I am told have plenty of other resumes in their inboxes.

ENGlobal lost the head of Engineering. I’m not even going to address the earlier hire and resend fiasco that made the CEO look plain stupid. They lost the head of the Construction Division (and restructured so it wasn’t noticeable). They lost head of Field Solutions (Land) Division. Watch for a drop in this segment. And, they lost the head of the Automation Division – more on that later.

They also lost their excellent CFO, Bob Raiford. He did not retire - he flat resigned. Subsequent to his departure ENGlobal started Non-GAAP reporting of financial results. I also learned ENGlobal’s competent long-time Controller, Meredith Barnes, quit and took six of the top accountants with her to a new company. A total of eight top people left accounting, Non-GAAP reporting started and there was a sudden decrease in SG&A (?). Management has stated this method of reporting better reflects their financial position. I’m not buying any of it. When accountants roll it is a bad sign. When numbers start to change with no positive results I don’t believe that either.

The South Louisiana Ethanol Project

This failed project manifested in 2006. Mike Burrow was the CEO but the project was let out under a cost center that was not under Mr. Burrow’s control or supervision. The Chairman and the CEO had divided the company into cost centers under separate supervisions. Mr. Burrow took the blame anyway but still lead the company profitably under his “Back To Basics Plan”. This plan worked brilliantly, even after Mr. Burrow’s departure. But any plan has limitations especially without the designer present to steer and tweak it. And so as third quarter 2008 neared and while the markets were crashing ENGlobal announced a surprise miss in a special release. The stock tanked. I say surprise because the second quarter 2008 was ENG’s top record of 24 cents profit. Then CEO Mr. Coskey stated in the conference call that the third quarter would meet or exceed the second quarter. I have this recording. You can hear for yourself in archived recordings and in transcripts. That statement, folks, was guidance no matter what the company says that they do not give guidance. It may have been that once, but they gave guidance and got caught not minding the ship.

The Ethanol Project went through the courts. ENGlobal stated they may receive millions in the end - I remember a figure of 9 million. This was not so. The final outcome was released not long ago and I will provide a link at the end of this section. The final document was fairly complex and convoluted. I was requested to write an abstract interpretation of the final document for another company. This is what I found and represents my opinion: One, ENG started the work in Louisiana without being licensed there – this caused major problems. Two, apparently from the way the document was worded ENG’s case angered the court as proceeded. ENG management should have been supervising their lawyers. That management action should never potentially compromise any case. Three, the final recovery was only $242,746.44. This may not even cover the "in-house" multi-year attorney's costs. Since the judge left it open for other claimants to proceed against ENG on this recovery, they may get nothing or even lose money. Watch the year-end report. ENGlobal lost over 6 million on this project.

http://www.leagle.com/xmlResult.aspx?xmldoc=In%20BCO%2020120215611.xml&docbase=CSLWAR3-2007-CURR

Automation Division

Olan Weeks, originally ran this division and it was day-to-day managed by James Dorsey. Both of these talented managers have left ENGlobal. As I reflect on the past glory of this division I can see both these men have the key characteristics of being visionaries and ritual daily diligence. Automation was not only profitable but had the potential to make huge money when run properly. Conversely, it could be a huge loss if run poorly and not managed consistently. Later Shelly Leedy came from Honeywell to run this division and did so very well under Mike Burrow’s supervision. After that and under two other CEO’s she was moved around and given other duties while expected to still run the division from afar. We just saw the immediate resignation of Shelly Leedy. Someone on the ENGlobal message Board posted a letter from Edd Pagano announcing her immediate resignation. I assume this was an intra-company letter that filtered out via email from an employee that does not care of its release or posting. Ms. Leedy's "resignation" coincides as the fourth quarter and year-end results were being tabulated with, by my guess, more Non-GAAP and GAAP methods. I can tell you from experience her immediate departure was probably due to a surprise loss from a contract or discovered loss from discontinued operations in the division revealed by the 4Q/Year-End calculations. As I mentioned before, this division has the potential for huge losses as well as gains. Watch for a loss, probably a big one, from this division. As a post script, the conference called revealed a 4.3 million dollar loss from the Electrical Division.

4Q/Year-End and the Board of Directors

For the third time this earnings date has been moved or postponed. Considering what I have noted earlier and ENGlobal's earnings history, this is not good news. Moreover, considering ENG's statement citing their credit facility I think the news is worse. The credit facility is a big indicator of ENGlobal's future and the bank's confidence in management. For some time I have been mystified why the Board Of Directors have let Edd Pagano fly this company into the ground. Clearly he has used this opportunity as OJT (On the Job Training). It has been painful to watch this decline of ENGlobal and erosion of experience personnel. I believe the Board Of Directors have abandoned their fiduciary responsibility to shareholders by continuing with this CEO.

The only explanation I can think of why this condition would be allowed to continue would be due to a plan, unbeknownst to shareholders, to sell the company. There have been rumors and discussions for years about this but it is the only situation to me that makes feasible sense given the obvious deterioration. Otherwise, we have a very slow Board Of Directors and I would expect soon to see the departure of Mr. Pagano. That would have a positive effect on the company and the stock. It is time for someone else that is pragmatic and sensible to run this company. For sure there are negotiations with the bank or new banks concerning the credit facility as they stated in the postponement announcement. They may be looking for an equity partner as well, pure speculation. As for earnings I unfortunately expect ENGlobal to announce one of it’s biggest yearly losses ever. The debilitation is a shame and I have long admired this company from the first day I invested in IDS. However, I have always told you the truth about what I saw potentially. It just isn’t very good now. Can it be saved? This is debatable for sure, I have a vision how to do it but if the Board Of Directors continues to operate this way the future looks dim or bankrupt. Good luck to everyone.

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