ENGlobal Corporation - New Credit Facility 8K Analysis

After reading through the new Credit Facility (CF) twice I think you will agree when you read it that is both complicated and long. Actually, at over 106 pages long it is at least 600% longer with more onerous terms and conditions than seen in the past. The WF agreement from 12/29/2009 was only 15 pages long! Why so long? PNC is trying to protect them from getting stuck with a big problem. ENGlobal on the other hand, is under the gun, needs help quickly to survive and is willing to agree to such costs, reporting requirements and lender controls.

It is so complicated it is hard to find a place to start. Since documents like this are generally boring and full of tedious detail I will highlight some points and issues. I may amend this post over time as discoveries are made. For now, let's start with reporting requirements, see Exhibit 9.2:

Notice the required monthly reporting of AR, AP, unbilled, CIEB, backlog and Caspian cash flow. Additionally, notice that ENG is required to make weekly reporting providing copies of client invoices, delivery information and inventory reports. Is this mistrust or verification, take your pick? Everything seems delayed or “last moment” at ENG from Quarterly Reports, News Releases  & the CF. If they cannot make their financial reporting deadlines (decentralized accounting) on a monthly basis I would think they would find it difficult to gather information together on a weekly basis. It is a staffing and organization issue.

The agreement also gives the bank the right to verify all receivables. Imagine how ENG clients will react to calls from the bank to verify an account balance or check on payments. Clients rarely respond to year-end auditor confirmations how do you think they will view ENG’s financial health now, and in turn, wanting to do longer business with them?

Asset based credit facilities are always on a formula basis and you are limited by the amount of eligible receivables be it AR, unbilled, CEIB or government billings.  There are also disqualifiers for over 90-Day invoices, accounts with 25% over 90 days are eliminated in total, etc. Notice that PNC will only allow domestic and Canadian accounts, while international accounts require Letters Of Credit or guarantees from the clients.  Based on those conditions ENG would not have been able to take on the Caspian project as they did in the past. I wonder if the CEO figures this new requirement into his international strategy!

Since mentioning the Caspian project, there is a default condition if they lose or have a material change in that project AND that it must be cash positive and remain cash positive by the end of 2012 (see 10.20). I hope they asked the Project Manager about the possibility of that happening. If you missed the conference call, I mentioned in the 1Q 2012 Analysis the CEO made references to reducing the negative cash flow by one half this fall. He never gave any figures so “one half” is meaningless of an acknowledged bad condition. I expect this will be a problem soon because in that same CC the CEO pushed the profitable period into 2013. Isn’t it amazing how quickly information can change?

Now let's look at the pre-payment penalties.  ENG would have to pay 3% of the commitment if prepaid in the first year (that's $1,050,000), 2% in the second year ($750,000) and 1% in the third year ($350,000). They also paid $175k origination fee to PNC, plus all their legal fees!  Did you notice who signed the agreement?  It was not the CFO as was past practice.  Is the CFO going somewhere?

If ENG was struggling to meet their cash commitments with Wells Fargo I suspect they will experience similar pressures with PNC. I did not see where they get much relief (extra money) or at least enough to make a difference with this new CF. They must also maintain $3.5 mil in excess availability, which comes off their overall availability level, which again limits their borrowing.

With a new CF in place I think vendors are standing in line to be paid. ENGlobal will again have to comply with a bank "lockbox"! That change will have to be announced to all the clients, as they will have to change the "remit to" addresses in their AP systems.  That will be another red flag to ENG's financial issues.  Clients will perceive this to be similar to a factoring of ENG's invoices.

The fixed charge ratio of 1.10 to 1.00 is lower than the 1.75 to 1.00 within the former Wells Fargo facility but in 3Q 2011 ENG only produced a ratio of .90 to 1.00. This, by the way, was one of the repeated broken covenants that contributed to the end the old CF and Wells Fargo relationship. With the new CF and PNC as a lender making money is still a requirement!

Lets look at PNC’s role. Are they the sole lending bank now and the future? The agreement is constructed as though they were going to syndicate the loan, as PNC is referred to as an agent in a few places referencing percentage of commitments and repayments. While in one of the schedules it shows PNC as furnishing 100% of the funding. Opinion: It looks as though PNC has built in some options if the weekly required reported numbers start deteriorating. If this happens, have they got a sweet opportunity for you?

Conclusion

I anticipated the CF was going to be heavy and laden with numerous levels of protection for PNC. What would you expect for a company with 3+ years of losses. I think that since ENG declined into such a tenuous condition the CF was written in a way that PNC actually manages the company where management has been deficient. Think about this for a moment with all the controls and required reporting. Mergers, acquisitions and stock issuance all have to be approved by PNC. Although PNC is managing the company on such basis through these reports and controls to protect itself there may be some forced benefit upon ENGlobal’s management that helps investors. You see situations very similar to this in Chapter 13 companies.

I believe ENG will be forced to make internal changes and cut overhead. This new CF is far more structured and limiting, and quite the opposite than the greater flexibility advertised by the CEO. The decentralized accounting system does not work for reasons designed and has cost ENG time, control and money. Watch for changes. I hope they will happen soon and in time. Good luck to everyone.

Comments are welcome.