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25 May 2012

Richard Industrial Group - A Company On The Move ☆


by Denny Robertson, P.E.

Richard Industrial Group (RIG) is a private corporation comprised of a number of entities, which include the engineering division, Richard Design Services, Inc. (RDS), Richard Construction Inc. (RCI) and Richard Automation and Electrical (RAE).  Let’s take a look at their primary group, the engineering division, RDS.  It is one of less than a handful of sizable engineering firms currently headquartered in the southeast Texas region.  Compared to their rivals, RDS is thriving and growing at an incredible pace.  The engineering division is comprised of about 500 engineers and designers.  Headcount of the entire organization, RIG, is currently at about 2,000 personnel.

Founders

RIG heritage started with Arthur R. Richard, probably the most respected pioneer-consulting engineer in southeast Texas.  He started Matrix Engineering with partners in the early 1970s.  Following in their father’s successful footsteps, Arthur’s sons, Brent and Art Richard, formed their own highly successful engineering company seven years ago - RDS.

Current Projects (partial)

RDS and RCI both have significant projects ongoing with Valero, Total, Motiva and others.  RDS performed the OSBL and Sour Water Stripper engineering and RCI is constructing the new Hydrocracker complex at Valero in St. Charles Parish, Louisiana.  RDS and RCI recently completed Flare Gas Recovery Units for Valero in Ardmore, OK and St. Charles, LA.  RDS performed the process design and construction on both of those projects.  Included was an alky flare gas scrubber for St. Charles.  RDS also performed the OSBL engineering for the Valero, Port Arthur, TX Hydrocracker project.  With successful completion of the design phase the project is currently under construction.  Additionally, RDS recently performed Phase III and IV engineering for the revamp of a crude unit and tank farm blending to handle Canadian Crude for Valero in Port Arthur.

Engineering for the Future

With a vision for the future RDS has also moved into renewable fuels.  They performed the Phase II, III and IV engineering for a 10,000 BPD Green DieselTM Unit located in St. Charles, LA for Diamond Green Diesel, LLC.  RDS has also partnered with Turner Construction in building the unit, which is scheduled to start production by the end of 2012.  Diamond Green Diesel, LLC is a partnership between Valero Energy Corporation and Darling International, Inc. (DAR) of Arlington, TX.  They are the largest processor of animal byproduct, waste vegetable oils and greases in the United States.  This plant will take in 10,000 BPD of beef tallow or vegetable oils by rail car or truck and convert it almost entirely to premium diesel fuel with a small amount of propane and light naphtha as byproducts.

RDS possesses an unusual blend of chemical plant and refinery process engineering expertise that make it the ideal supplier of various renewable energy ventures.  Of all the renewable energy ventures that have been conceived of in recent years, diesel production from animal and vegetable oils has the most potential for long-term viability.  The Diamond Green Diesel project is the largest animal/vegetable oil to diesel plant ever conceived and the worlds largest ever built.  It is truly state-of-the-art.  The heart of the unit is licensed technology from Honeywell UOP (Des Plaines, IL) called EcofiningTM.  In fact, the product name, Green DieselTM is a trademarked UOP name.  RDS was instrumental in marrying the pretreatment unit designed by Desmet Ballestra (Marietta, GA) with the EcofiningTM unit and integrating the entire complex OSBL facilities, control room, engineering offices, admin offices, MCCs, warehouse, tank farm, wastewater treating, cooling tower, steam system, oil rail unloading, powder rail and truck unloading, diesel storage, barge and ship loading, pipeline blending, etc.  RIG is a talented multidiscipline engineering, procurement and construction corporation.

Conclusion

After 35 years in this business and 21 of them in contract engineering, I look at RDS viability and ask myself how does this happen?  I see three solid elements:

1.            Excellence comes from the top down and the bottom up.  The management of RDS strives to be the best and they create an atmosphere that everyone enthusiastically participates in a spirit of excellence.

2.         The product quality of the Piping Department whether in design, engineering or construction, is again, the best.  I am continually impressed with how quickly and accurately the pipers design a large unit using 3D CAD.  Civil/structural, instrument/electrical and the process and mechanical engineers, are also excellent…but more about that in a future posting.

3.            Organic growth.  This team of managers, engineers and designers has progressed over the years by ensuring quality performance, being on schedule and not losing money.

RIG has grown by excelling at each job they are awarded and by performing the next job even better than the last.  They are loyal to their customers but, more importantly for RDS, their customers return that loyalty.

Comments are welcome. 


Editor's note: Denny Robertson started his career at Dow Chemical in Freeport, TX and then made Halar® plastic for three years working for Ausimont (now Solvay) in Orange, Texas.  After 12 years of working on the manufacturing side of the business, Denny began his contract engineering career working for Petrocon in Beaumont, which evolved into ENGlobal Corporation. Over a span of 18 years, he formed the first Process Engineering department there and by the time he left ENGlobal he had developed a vibrant group of over twenty process engineers.  He has been at RDS now for three years and is currently serving as Process Engineering Manager.

21 May 2012

Spring 2012 Updates

Rev 5.5

We have begun introducing more Engineering companies. RIG was the first feature. I am not familiar with some companies as many of you may be. If you would like to see a company featured and would like to make an overview submission of that company and services please make a suggestion and start writing.

In the eleventh hour a credit facility deal was announced on 31 May. The CF bank is PNC, which was an earlier predicted guess in the 8 May posting. The maximum amount is $35 million with a variable formula for borrowing capability. From the news release, “The PNC facility allows the Company to borrow up to $35 million pursuant to a borrowing base formula based primarily on the Company's eligible accounts receivable.” Obviously the CF comes with limitations. I do not believe any similar formula was in place on any previous CF. Is this the improved flexibility Mr. Pagano spoke of? Will those limitations help present management guide ENGlobal into a unknown future that recent past history is our only basis for prediction?

This entire result to acquire a new CF is quite an accomplishment and I find this impressive even with the formula limitations. I would like to know given the numbers and accounting methods (explored in previous analysis) is how they did it? More later. [That "more later" is now published as the DSO Discrepancy.]

With the immediate threat of bankruptcy removed I would expect some improvement in the stock for a period of time - that has not happened so far. However, just as a rising tide lifts all boats, the converse is true. The general economic outlook is poor and stocks are trending down on European worries and job reports. You can expect that investment risk in ENGlobal (just as any company) will be view accordingly with the environment. Investors will trend toward safe harbors. There is a new post out covering the CF and 8K with an overview analysis. It was quite a challenge to read at over 100 pages longer, including the preambles, than the 2009 CF. All the information was subject to verification, editing and expert analysis to get it correct for you. After you read it you see the announced preliminary information about the CF was spinning faster than pizza dough. 

Newly Extended Life - In the 16 May posting I direct you to a key paragraph: "The real questions you have to ask yourself are:  If you get a new CF, what is next? What has really changed or will change in the management practices that got us to this point in the last two years?"

Amendment To Previous Posting

I am changing an opinion made in the 1 April posting. Under the section headed “The South Louisiana Ethanol Project” I made the following statement as the second opinion finding: “…apparently from the way the document was worded ENG’s lawyers angered the court with their proceedings. ENG management should have supervised their lawyers.” Upon reflection and experience I wish to amend and elaborate. There are times when lawyers fail to do their jobs and there are more times when lawyers do their jobs well and the case fails anyway. There are many factors that can contribute to this later case. Such as, when the client got into a doomed project unprepared, performed weakly or was plain wrong, etc. This case started with a bad condition that ENGlobal was not licensed in the state they performed the work in! The PWA liens made by ENG in Louisiana were declared invalid.

It seems easy that most non-lawyer people quickly jump on the almost fun bandwagon to denigrate lawyers and their profession. In reality, most people know a lawyer that is a friend or family and they are, of course, an exception. Lawyers provide a necessary service to society.

Where as I believe that management should supervise legal council, that management should not circumvent a case or interfere with the strategy, especially when it is in motion. The real possibility overlooked is that cases and lawyers may experience interference. I observed this firsthand when I was ‘the client’ as COO of a conglomerate. My CEO made the case a real challenge for our lawyers and affected the case direction. I had to intervene to eventually win that case. Therefore, I changed the wording in the 1 April original section to reflect this possibility and to acknowledge the myriad of conditions good lawyers deal with.

I will strive to bring you truthful information, analysis and opinion based on facts and logic. When I discover that something needs to change or be revisited with expanded explanation I will do so. Thank you.

More news: If you try to access this blog from most of ENGlobal's system you will probably see it is blocked.

Now the ENGlobal day job monitoring will come from upper management and the IT guys. No wonder the hits started to spike from iPhone, Android and other smart phones. Engineering people are smart - they find a way. In my experience these situations usually backfire. You may draw your own conclusions. Good luck to everyone.

Comments are welcome.

18 May 2012

ENGlobal Corporation: Q1 2012 10Q Analysis


The 10Q was filed on the 16th, and not later on the 15th as advertised. Normally these quarterly filings can be tedious and a challenge to search through but there are some important details that indicate a deteriorating situation at ENGlobal. Some of those details further support the previous idea that the numbers were embellished. I understand that other issues are occurring on a daily basis so I will try to cover the important ‘indicator’ items and illuminate those that are critical.

Before I dive into the 10Q I wanted to ask those of you that are investors to look at the ballot which is asking you for another half million shares with more undoubtedly ending up with your BOD. If you doubt this assumption do a little research over the last 10 years and see where the majority of ENG options and restricted stock have gone. I won’t opine on this but simply ask you if they deserve stock payment?

Now let’s get into the latest 10Q and look at statements and numbers. When you look at the Consolidated Balance Sheets (Unaudited) on page 4 of the 10Q notice these line items (the figures shown are in thousands): 

Item 1)
Costs and estimated earnings in excess of billings (CIEB) on uncompleted contracts:

3/31/2012            12/31/2011
$12,573                 $6,790

An increase of $5.783 million since 12/31/2011…

This line indicates the Company has incurred approximately $5.8 million in additional project costs on fixed price contracts for which it has not billed to their client. So why does this matter? An increase in CIEB has a negative impact on CASH and could impact the Company’s ability to make payroll, pay vendors and suppliers and meet statutory obligations. Why does this happen?  Options as to what is causing this increase include delays in getting client billings out the door due to inefficient processes and/or administrative approvals, bad contractual terms on billing milestones or project failures to meet milestone deliverables. All of options are the results of decisions made by or controlled by ENG management. Regardless of the reason, the current trend is going in the wrong direction.  CIEB as of December 31, 2010 was only $3.146 million. Do you like this fast-paced trend?

Item 2)
Notes Payable

3/31/2012            12/31/2011
$336                       $0
           
An increase of $336k since 12/31/2011…
ENGlobal must have to sign notes with vendors and materials suppliers to get equipment and materials for client projects.

Item 3)
Billings in excess of costs and estimated earnings (BIEC) on uncompleted contracts:      

3/31/2012            12/31/2011
$2,236                   $4,421

This line indicates the Company has lost approximately $2.2 million in pre-billings for project costs on fixed price contracts billed to their client. So why does this matter? A decrease in BIEC also has a negative impact on CASH and again could impact the Company’s ability to make payroll, pay vendors and suppliers and meet statutory obligations. Why does this happen?  Options as to what is causing this increase include delays in getting client billings out the door due to inefficient processes and/or administrative approvals, bad contractual terms on billing milestones or project failures to meet milestone deliverables. All of these options are the results of decisions made by or controlled by ENG management. Regardless of the reason, the current trend is going in the wrong direction.  BIEC as of December 31, 2010 was $0.947 million.

Item 4)
Other Current Liabilities (totals)  

3/31/2012            12/31/2011
$2,331                    $3,072

Remember this section covering Reserve from previous 10K comments?  This was the table that included the $2.1 million of “known”, but not detailed, liabilities.  It appears they paid the accrued interest of $86k and cleared the $655k in customer prepayments for a net change of $741k.  Just an FYI, customer prepayments are where clients are billed and then prepay for services yet performed at the end of one reporting period and then services are performed and earned in a later reporting period.  Hopefully the reduction of the $655k in these liabilities was taken against the later produced AR billings for those delayed services and not as a credit against the costs on those projects. Could that be the reason for the GP improvement in FS?  Time will tell if this is the case because when the later AR billings do not get cleared by the client (because he has already paid in a prior period) they will have to be written off or charged back to the projects and result in much lower GP in the current reporting period.

As you remember in the last two posts I alerted readers to how operating contingencies and reserve can be used to embellish earnings. Since the practice is not regulated you will see no required disclosure statements. However, it does show up as a sudden and abnormal increase in GP and margins. That did seem to happen and let's dive into this from where we left off in the last post. I would recommend new readers to review the last two postings to prepare for this new information.

Page 20: “Our gross profit and gross profit margin increased primarily due to reduced variable costs and improved efficiencies in our Automation Segment, resulting in higher profit margins.” [On the CC the CEO stated this was the problem segment!]  “However, we are still affected by intense competition and pricing pressures. In addition, our E&C and Field Solutions segments experienced increases in gross profit and gross profit margins due to higher revenues and increased efficiencies.”

I think the problem is variable conclusions and variable accounting as you may conclude as you read on. Let us look at one of those mentioned divisions that experienced increases and compare it to the previous year – Field Solutions (FS).




Q1 2011Q2 2011
  Rev21,692
 18,020
  GP1,659 7.6% 1,208 6.7%
  SG&A2,081 9.6% 964 5.3%
  Oper Inc(422)-1.9% 244 1.4%






Q3 2011Q4 2011
  Rev19,306
16,126
  GP1,685 8.7%1,289 8.0%
  SG&A1,567 8.1%1,069 6.6%
  Oper Inc118 0.6%220 1.4%






 YTD 2011  Q1 2012
  Rev 75,144
 16,268
  GP 5,841 7.8% 1,762 10.8%
  SG&A 5,681 7.6% 1,030 6.3%
  Oper Inc 160 0.2% 732 4.5%


The four quarters and YTD of 2011 are represented along with 1Q 2012 for comparison. The percentages given are percent of revenue for the applicable time period. Notice most prominently is that FS made more profit, $732,000, in Q1 2012 than in all of 2011, which came in at only $160,000! At 2011 GP percentages they should have made ~ $500,000 less. Look at the GP and Operating income for all four quarters of 2011, then the YTD and compare to Q1 2012. Why the sudden and extraordinary jump in profit and margins to 4.5%?  The Q1 2012 Field Solutions GP margins of 10.8 % even beat Engineering & Construction same period margins of 9.6%! My guess is that FS had more operating contingency money available than E&C. Does this meet your smell test?

Moreover, if you don’t know, the FS division is a cost-plus, low-margin segment. Let’s put all this into another perspective and look at the statement on pages 17 & 18 of the 10Q: “During the recent period of industry-wide decline in demand for the types of services ENGlobal provides, we reduced our rates significantly, as was required to obtain and retain business. Although the level of demand has increased (although FS revenues were down from Q1 2011), pricing in certain geographical markets is still extremely competitive and we have not yet been able to increase our margins to prior levels.”

By now you are feeling the contradictions. How can you make a statement like that and show massive increases in GP and Margins? This comment further supports the question of how the GP increased in the Field Services segment. There may be a valid reason but without more meaningful disclosure we are left to speculate.

Now let's deal with the Why? The CEO sees his survival as paramount even to the company’s survival. I would like to note that even Bill Coskey had the presence of mind to step back when the company trend wasn’t good. Unfortunately, it eroded further since then. But the company does have to survive for the CEO's job to continue. For that to happen, the company needs a Credit Facility to operate.

On page 11 of the 10K you see this clue: “Due to the net loss for the first quarter ended March 31, 2012, the Company failed to comply with the positive net income covenant added in the Amendment Extension and Wells Fargo has agreed not to exercise its rights with respect to this failure to comply until after May 31, 2012.”

First, we see that ENGlobal broke another covenant. They were required to make a profit in Q1. There is one motive for trying to embellish earnings by using operational contingency money buried within the segments and/or reserve money – to prevent Wells Fargo from exercising its rights (which they have agreed to delay until after 31 May). The other and primary motive is so the CEO can save his job. I say that logically because all these company conditions are known to the CEO and compare that to Bill Coskey choosing to step aside.

Second, why would the CEO agree to a covenant of positive net income approx 6 weeks ago when they should have known at the time they were not going to make a profit? If they thought then they were going to make a profit what changed in those 6 weeks? One thought is that it may be related to the increase in DEFERRED REVENUE (see the last paragraph in Note 10 – Contracts). It was stated… “The Company recognizes service revenue as soon as the services are performed. For clients that we consider higher risk, due to past payment history or history of not providing written work authorizations, we defer revenue recognition until we receive either a written authorization or a payment. The current amount of revenue deferred for these reasons is approximately $1.7 million as of March 31, 2012, compared to $0.3 million as of December 31, 2011. We expect a majority of the deferred revenue amount to be realized by year end 2012”. In Q1 deferred revenue increased $1.4 million!  Could that be a Change Order yet to be approved which was not accounted for until the end of the quarter?  Must not have been because on the CC the CEO, when asked if there were any material losses or problem projects during the period, he could not recall.  I would think he would recall a $1.4 million revenue reversal!  Maybe it's related to one of the fixed price projects announced last September, which were scheduled to be completed in Q2 of 2012.

We now should move on to stark matters.

Credit Facility

This subject is paramount for ENGlobal’s survival. In a moment you will read a statement that will resound deeply with you if you have not seen it already.

Page 22:

“Due to the net loss for the first quarter ended March 31, 2012, the Company failed to comply with the positive net income covenant in the Amendment Extension and Wells Fargo has agreed not to exercise its rights with respect to this failure to comply until after May 31, 2012.”

Item 1A under Risk Factors, p. 24:

“…If we are unable to enter into the proposed credit facility, we will not have sufficient capital to repay the Wells Fargo Credit Facility at May 31, 2012 and as a result, we would be unable to fund our working capital needs and would need to secure additional capital or financing to fund our working capital requirements and to repay the outstanding debt under the Wells Fargo Credit Facility. We cannot assure you that we will be successful in entering into a new credit facility (including the proposed credit facility), obtaining a further extension from Well Fargo beyond the current maturity date of May 31, 2012 or in connection with raising additional capital, that any amount, if raised, will be sufficient to meet our cash requirements. If the Wells Fargo Credit Facility is not repaid in full by May 31, 2012 or if the current maturity date is not otherwise extended, Wells Fargo may exercise its rights and remedies under the credit facility, including initiating foreclosure or insolvency proceedings; in such event our business will be materially and adversely affected, and we may be forced to sharply curtail or cease operations.”

How about that for a statement? I am sure independent legal council recommended it.

But there is more to this. Please put this in context with what management said only a few weeks ago in the 10K on page 42 in the Overview section under Liquidity and Capital Resources: “We believe that we have sufficient available cash required for operations for the next 12 months”

Conclusion

Management should be changed ASAP. I hear of more personnel leaving ENGlobal daily and this further erodes capacity and capability. Bills are not being paid on time (Notes Payable) and this hurts a hard earned reputation. Will ENGlobal get more ‘Feature Projects’ like the Caspian Sea Project or Government Group’s (EAS) $200 million SPAWAR contract?  I doubt it if this trend and direction continues. You have a voice, both individual and collective as investors and employees. I posted many times that in the past Senior Management and BOD was available to listen. I even remember mention of an employee hotline and investors have their avenues through Investor Relations. It is your company too. Good luck to everyone.

16 May 2012

ENGlobal Corporation: 1Q 2012 and Conference Call Analysis

Rev. 2.1
Earnings were late on release time, coming out at 0950. Trading appeared to be halted on ENG stock and opened a few minutes after the news release was posted. Since I know Ms. Hairston is professional about the job she performs so very well my senses are that lately she is dealing with confusion, delays and inaccurate information within the chain sequence she depends on to get the news out on time. Since these issues did not occur in the past and people usually get better at their jobs with time the logical reason is usually a changing environment around them and bosses. Therefore, since Ms. Hairston is the best at what she does I am positive these difficulties are further indicative of the comparatively chaotic environment presently at ENGlobal.

Earnings or rather “non-earnings” came in at -0.01 cent loss rounded from a fraction. This was a delta of 2 cents lower than analyst’s expectations and even on the lower end of what I predicted. Revenue came in below expectations also at $75.4 million. I suspect revenues were materially impacted by the fact the company could not pay vendors to ship materials and equipment to project and manufacturing sites.  This probably impacted Automation’s manufacturing division the most.  The “problem” with Automation may in fact have been created by the CEO/CFO failure to secure an extension on the WF credit facility.

Remember what I alerted readers to in the last post concerning a surprise and significant jump in profit margins? I was preparing readers to be aware of the bottom line being boosted by using operating contingency money and/or leftover reserve money (from last year) to embellish it. That appears to have happened with a jump in Gross Profit from operations of $7.5 million, an increase of 41.7%. Moreover, Consolidated Gross Profit as a percentage of revenue was 9.9%, an increase from 7.7%. For example: Did you notice Field Solutions Gross Profit for Q1 was 10.8%!  That’s more than the core business E&C produced in Q1 at 9.6% AND it represents an increase of 3% over the year-to-date performance of 7.8% for Field Solution during all of 2011. Do you believe these increases are normal?

I also mentioned previously that explanations of these monies are not regulated or required and in the CC we heard nothing mentioned. In fact, despite gross profit and margins being listed as bullet points on the news release no revealing discussion ensued? A guess is that discussion would lead to questions. My personal opinion is that you did not get a margin jump from 7.7% to 9.9% suddenly from good management practices because you traditionally see continual and incremental changes over time. You will have to ask yourself if this issue meets the smell test?

What happens if you use operating contingencies to boost the bottom line and margins? You get a short-term gain – at the cost of not being able to handle long-term problems in your projects. If you have problems in the future then you are SOL. What happens if you use cash reserve to the same end? You simply lose the reserve and are unable use it when and where you need it in the future. This money is profit withheld from the bottom line from earlier periods and is true profit earned. Potentially it can embellish the results of a different quarter and is not reflective of true operations in that later quarter used. If they did use cash reserve and/or operating contingencies to embellish the bottom line; what would have been the loss if it were not brought up to –0.01 cent? I will leave these thoughts with you.

Credit Facility

Remember folks; the CF is not a done deal. Look very closely at the wording on the previous news release – “ENGlobal Announces Update on Financing Initiative” – “Update” & “Initiative” are far from a done deal. This is why Mr. Pagano states in the news release, “We are presently focused on completing a solid, new banking relationship as one of the final steps of our process to reposition ENGlobal." I added the underlining. Notice also the top three listed issues in the recent Safe Harbor Statement:

“(1) Our ability to comply with the terms of our existing Wells Fargo credit facility; (2) our ability to enter into our proposed $35 million senior secured credit facility by May 31, 2012; (3) if we are unable to enter into our proposed $35 million senior secured credit facility by May 31, 2012, our ability to extend the maturity date of our existing Wells Fargo credit facility and, depending on the status of the proposed credit facility, to secure additional capital or financing to fund our working capital requirements and to repay outstanding debt;…”

The Wells Fargo credit facility increased from $16.4 million at 12/31/2011 to $17.5 million at 3/31/2012 to $20.5 million as of 5/11/2012.  Do you see the trend? Do you think a new facility will change that trend? Even with an improved DSO their cash position seems to continue to deteriorate.

The real questions you have to ask yourself are:  If you get a new CF, what is next? What has really changed or will change in the management practices that got us to this point in the last two years? This is really classic BOD evaluation material (in two degrees).

Conference Call

I listened to the conference call and heard a few interesting points made. I think Mr. Pagano did generally well on the call considering the company’s position, especially in a market I acknowledge is not good but not insurmountable either. To the later point, Burrows Global, LLC is a great example of what the potential is on the success side in the same marketplace. Mr. Pagano’s outlook on the business future was mediocre at best – sadly, I think he was very realistic. He did list a lot of “hopefuls” and of course with more beautiful language.

From the CC we heard that ENGlobal employee count increased from 1,900 to 2,000 quarter over quarter? Somehow I doubt this with all the more people I hear leaving. Discussion about backlog was nebulous. There was no mention of Automation losing the big ConocoPhillips job but Mr. Pagano did say Automation segment needed more backlog.

He also said the Caspian Sea Project profits would be delayed to future quarters (nothing specific); and that the negative cash flow from that project was soon to be cut in half… cut in half from what figure or to what new figure?

The CFO reported that the DSO Q over Q reduced from 63 days to 61 days. He also stated that they [accounting] plan to get DSO down to the mid 50s by middle summer. Hey, that would be back down to where Mr. Raiford and Ms. Barnes had it before! Great, it’s been a year but they are finally getting it. Stay tuned.

Extra Cheese

Saving the best for last Mr. Pagano states in the news release:

"While the first quarter of 2012 improved on 2011, we remain committed to returning to profitability in the coming quarters," Well hasn’t this statement been recycled a few times – I have lost count.

And this, "Our first quarter results were in line with our 2012 budget, however, the months of March and April were impacted by our internal focus on credit issues, creating a challenging operating environment." Therein lies the problem – “Our first quarter results were in line with our 2012 budget…” They budgeted for a loss!

In my final quote Mr. Pagano says, “I am personally committed to returning ENGlobal to a position of leadership among small, well-respected engineering firms with a focus on innovation, superior client services and profitable growth." I have never heard anyone refer to ENG desiring to be a SMALL company. What happened to the billion-dollar revenue target?

If he is trying to return ENGlobal to a 'well-respected position among small firms' where does this place ENGlobal now? This is indicative of a CEO that has lost direction.

Milestones and Conclusions

These are my impressions of the 1Q 2012 report and CC. I may revise or add details to this report as I come across new or illuminated information. Thanks to those offering comments and asking questions that help form these reports. I wish to also to note that this website went over 35,900 hits recently (there is a counter at the page bottom) and I appreciate all the readers whether you agree or not. Readership comes from the following countries: United States, Canada, Australia, New Zealand, Russia, Saudi Arabia, United Arab Emirates, Oman, Iraq, Pakistan, Sweden, Finland, Latvia, Poland, Germany, Argentina, Uruguay, Brazil, Colombia, Ecuador, Chile, Panama, Costa Rica,Trinidad and Tobago, Dominican Republic, Japan, South Korea, Netherlands, Hong Kong, Singapore, Thailand, Vietnam, Indonesia. China, England, Ireland, Spain, France, Belgium, Italy, Switzerland, Ukraine, Romania, Bulgaria, Hungary, Slovenia, Serbia, Georgia, Moldova, Malaysia, Philippines, Israel, Tanzania, India, Sri Lanka, Algeria, Gabon and South Africa. Thank you.

I posed some real and serious questions within and in earlier reports. You will have to make your own minds up as to what is happening and what needs to be changed. You will have to judge whether you accept the numbers - GAAP, Non-GAAP or potentially boosted. You will need to do this while balancing risk and profit as an investor and/or evaluating your future as employees. Let your management and BOD hear from you just like the employees in Beaumont did at Mr. Pagano’s “town hall” meeting last week. Yes, ladies and gentlemen, I heard about that – big thumbs up!

Good luck to everyone.

Comments are welcomed.

08 May 2012

ENGlobal Corporation: More 10K Analysis and 1Q Preview


ENG’s 1Q report date has been set for 15 May with a conference call afterward. In the meantime we are all wondering about a replacement credit facility (CF). According to the SEC filing DEF 14A a short resume’ indicates the current CFO, John Beall, has held several positions in the bank and finance sector. He should be able to secure a CF from one of his old companies such as PNC. A new CF will have to be larger than the previous one to pay off the debt and allow ammunition for continuing operations. It would have to be at least one pay cycle larger that the original one, therefore, it should be in the neighborhood of $33-35 million. I would expect this to be addressed soon because as pointed out in the 17 April post ENG is cutting it close on cash. I have heard plenty of comments and seen written issues of non-payment or delayed payments, etc. However, instead of dealing with those I chose to rely on that previous calculation that ENG was cutting it close and low on cash.

From the 10 K: “In particular, we are focused on international expansion as we believe that the many significant projects will be located outside of the United States”. ENGlobal has placed emphasis on international projects. Will the new CF cover international projects (with the given money exchange issues); or, cover lump-sum projects for that matter? [As a post script a news release was issued the day after this posting that ENG secured a credit facility for $35 million. No other details, including those that would answer the questions above, about the agreement were given.]

The backlog may have decreased lately. I have heard from two different companies that former ENG employees are applying for work after being laid off of a big DCS (Automation) job at midstream in the project. This project is being performed in a series of contracts. This work was in California for ConocoPhillips and I think valued originally at ~$120 Million. I believe they were halfway through the total project. In the 17 April post the organic (Domestic US) backlog was calculated to be only $221 million. Now it looks like backlog could be reduced to ~$161 million ($221 million - $60 million). Since ENG only reports backlog annually at year-end you will not see an updated backlog reported 1Q.

Additional staffing losses include senior managers in Denver, Houston (both in Engineering) and Manufacturing of the Automation Group. I can remember when ENGlobal was proud of their “Hiring from the Top Down” technique by hiring senior managers that bring their staff with them. Unfortunately it works in reverse just as well. Moreover, you lose business because the client relationships follow the people who created them.

More 10K Analysis

I had difficulty-understanding sections of this year’s 10K. Earlier ones seemed easier to understand when the former CFO was responsible for the numbers product output. It looks to me like unbillable corporate (“other”) support overhead has been pushed out to operations and impacting the three segments. It appears SG&A went down from 2010 to 2011 by showing a decrease of $8.712 million. This initially looks good but there is something that is hiding the real number. Let’s compare continuing operations and take out a legacy issue that the CEO had no control over. The South Louisiana Ethanol (SLE) project failure added ~$10 million overhead via a bad debt reserve to SG&A in 2010. Remove this charge and 2010 SG&A drops to $29.9 million and compare that to $31.2 million SG&A in 2011. Well folk’s, looks like SG&A actually INCREASED $1.3 million in additional overhead for 2011 and the comparable net loss from continuing operations doubled from $2.2 million in 2010 to $4.2 million in 2011. That is a bad trend for continuing operations. Decentralizing support staff adding additional staff (and costs…) for human resources, safety, and accounting; pushing SG&A out to operations; increasing SG&A; increasing DSO (17 April post) are all at the heart of why profit is not made from present revenues.

From the 10K: “The decrease in all other SG&A expense for the twelve months ended December 31, 2011 as compared to the comparable 2010 period, was primarily the result of decreases of $1.1 million in salaries and employee related expenses, offset by an increase of $0.1 million in professional services expenses.”  The net of these two variances indicate an overall decrease of $1.0 million while the consolidated details for 2011 vs. 2010 indicate an overall decrease of $78k!  What happened to the other $922k?

Cash flow notables include a tax refund of $6.7 million in October 2011. Just think what the credit facility debt would be if they had not received this refund – ENG would have totaled ~$23.6 million in debt!

From the 10K: “In 2011, investing activities were primarily used for capital additions.” Only $664k was detailed to Property and Equipment Acquired, while $2.275 million is shown as restricted cash. What constitutes restricted cash? No explanation is found for over $2.2 million. Could it be collateral required for the letter of credit on the international project? Restricted cash hit the Balance Sheet in 3Q and the Statement of Cash Flows in 4Q?

Note 8 in the 10K details certain balance sheet accounts. I find this interesting especially since their auditors make specific statements in their opinion letter that…“We have also audited the schedule listed in the accompanying Item 8” and “Also, in our opinion, the schedule presents fairly, in all material respects, the information set forth, therein in relation to the financial statements taken as a whole.”

The components of Other Current Liabilities as of December 31, 2011 and 2010 are as follows:












2011
    
2010


(in thousands)

Accrual for known contingencies
$
2,061

    
$
831


Customer prepayments
655

   
309


Accrued interest
86

   
73


Other
270

   
81


Other current liabilities
$
3,072


$
1,294



















The accrual for known contingencies seems rather high since it was taken primarily for litigation and legal expenses for two lawsuits discussed earlier in the section. Relating to the Phillips case and they state…“the claim is still pending but it is not expected to have a material adverse effect on our results of operations or financial position” so could we reasonably expect little or no reserve related to this case?  As for the SLE lawsuit, they still show $0.9 million ($845,500) in a long-term notes receivable so they may have reserved that amount within the $2.061 million. The final judgment was issued 15 February 2011 and in the court settlement ENG got only $242 thousand (and this was known as of writing and prior to the release of the 10K). The $845K looks lost – so where is the balance of over $1.2 million going to land? They breakout customer prepayments of $655k and accrued interest of $86k and yet $2.331 million is just lumped together as either “known” or “other”.  If these liabilities are “known” why not share the details?   

Earnings

1Q earnings could be a real wildcard for 2012. One could reasonably expect that the delay in final reporting of 2011 financial results gave ample time for all legacy issues to be vetted and properly accounted for as 2012 January and February monthly financial results should have already been completed by April 12th.  Year-end accruals, work-in-process estimates, the allowance for bad debt, and material liability accounts covered by burden rates should have easily been reconciled, tested, and reviewed. 

If 1Q is a loss, that could reflect the continuing downward operational trend and the actual increase in SG&A revealed earlier in this posting.

If 1Q is a surprise positive, be wary of how that gain got to the bottom line. Before you are thrilled by a gain understand if a profit was truly made. Dissection will be necessary and keep in mind the past use of Non-GAAP methods. Be aware that reserves left from last year can be placed on the bottom line this year with no explanation required or necessary. Additionally, contingencies from fixed-sum projects may also be called in from operations and used to embellish the bottom line with no explanations or accounting. Watch the margins, if there is a sudden increase you can bet there was contingency or reserve pumping to increase the bottom line. I would love to see analysts' questions address these topics.

I think a reasonable estimate for 1Q will be $80-$82 million in revenues with EPS between ($0.01) to $(0.03).  

If the 10K were easier to read and understand as it was in past years and better disclosures were being utilized I would be less cautious about 1Q forward. But for now we have a company on the edge. Recovery would be fantastic – but what put ENGlobal in risk of viability deserves serious review.
 
Good luck to everyone.

 

Comments are welcomed.