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.