ENGlobal Corporation 2Q 2012 Results and 10Q Analysis

It is hard to not become overwhelmed by the staggering $0.37/share loss ENGlobal has reported for 2Q 2012. I am sure many of you are wondering as I do; will there be a 3Q 2012? Let’s start with answering some of questions posed in the earlier post covering 2Q possibilities and then move through the 10Q information:


"What If" results:

Yes, DSO increased! Depending on how you calculate it was 78 to 82 days. At 65 days they could have pulled $11.1 to $14.5 million in cash off the Balance Sheet.

Yes, vendors and subcontractors continue to not get paid as accounts payable increased $2.6 million over 1Q.

Yes, billable hours decreased 4% from 1Q and 14% from the same period in 2011. It seems illogical that staffing levels hold and hours decline.

No, manpower utilization did not increase. We did not get a figure for 1Q of 2012 so we cannot compare Q over Q but compared to 2Q 2011 the current quarter’s utilization decreased 3%

Q over Q for 2012

E&C revenue was down from $45.6 mil to $44.8 mil and gross profit down from 9.6% to 6.4%. Issues seem to be in both growth and performance. Quality issues maybe under this iceberg!
Automation revenue was up from $13.6 mil to $14.3 mil and gross profit even at 10.2%. This seems to be the stable segment anchored by the Caspian project.
Field Services revenue was up from $16.3 mil to $17.8 mil and gross profit down from 10.8% to 7.3%. I think we questioned the margins from FS last quarter and thought they were higher than normal.
Overall revenue was up from $75.4 mil to $76.9 mil but gross profit down from 9.9% to 7.3%

What’s wrong with this “Outlook”?

“Although we are in active discussions with PNC Bank and Wells Fargo, we cannot assure you that we will be successful in obtaining the cure or waiver of the defaults under their respective facilities. If we fail to obtain the cure or waiver of the defaults under the facilities with PNC Bank and Wells Fargo, PNC Bank and Wells Fargo may exercise any and all rights and remedies available to them under their respective agreements, including demanding immediate repayment of all amounts then outstanding or initiating foreclosure or insolvency proceedings. In such event and if we are unable to obtain alternative financing, our business will be materially and adversely affected, and we may be forced to sharply curtail or cease operations.”

In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2011 , which outlines factors that could materially affect our business, financial condition or future results, and the additional risk factors below. The risks described, in our Annual Report on Form 10-K and below, are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial conditions or operating results.

If we are unable to obtain the cure or waiver of defaults under the PNC Credit Facility and Ex-Im Bank Facility, our business may be materially and adversely affected and we may be forced to sharply curtail or cease operations.

Historically, we have relied upon a revolving credit facility to provide us with adequate working capital to operate our business. On May 29, 2012, we replaced our Wells Fargo Credit Facility with a new $35 million revolving credit facility provided by PNC Bank, National Association (the “PNC Credit Facility”). The PNC Credit Facility has a maturity date of May 29, 2015. In July 2011, with the support of Wells Fargo's Global Banking Group, ENGlobal and the Export-Import Bank of the United States (“Ex-Im Bank”) entered into a separate $9.5 million letter of credit facility (the “Ex-Im Bank Facility”) to support the Company's Caspian Pipeline Consortium (CPC) project. Under the terms of this agreement, the Company may issue letters of credit to CPC for its performance under the CPC project. The PNC Facility and the Ex-Im Bank Facility require us to maintain compliance with specified financial ratios and satisfy certain financial condition tests. As of June 30, 2012, we were in default with respect to certain of these ratios and financial condition tests and other covenants. As of the date of this filing, we were in active discussions with PNC Bank and Wells Fargo regarding the cure or waiver of the defaults under the PNC Credit Facility and the Ex-Im Bank Facility.

Failure to obtain the cure or waiver of the defaults under the PNC Credit Facility and the Ex-Im Bank Facility could result in all indebtedness outstanding under the PNC Facility and the Ex-Im Bank Facility becoming immediately due and payable. If that should occur, we may not be able to pay all such amounts or borrow sufficient funds to refinance them. Even if new financing were then available, it may not be on terms that are acceptable to us. If we were unable to repay those amounts, the lenders could accelerate the maturity of the debt or proceed against any collateral granted to them to secure such defaulted debt. In such an event, our business will be materially and adversely affected and we may be forced to sharply curtail or cease operations.

As a result of the defaults under the PNC Credit Facility and the Ex-Im Bank Facility described below, additional borrowings under these facilities may be limited or restricted. As of August 15, 2012, unrestricted cash on hand totaled approximately $0.7 million and availability under the PNC Credit Facility totaled approximately $1.3 million, subject to certain restrictions on revolving advances and the requirement to maintain Average Excess Availability of not less than $3.5 million measured monthly. As of August 15, 2012, one $9.1 million letter of credit was outstanding under the Ex-Im Bank Facility and collateralized by $2.3 million in cash. As a result, the Company's ability to pay liabilities as they become due, fund business operations and meet monetary contractual obligations, currently depends primarily on cash flow from operations and the timely collection of outstanding invoices.

Cash and the availability of cash could be materially restricted if:

• Outstanding invoices billed are not collected or are not collected in a timely manner,

• Circumstances prevent the timely internal processing of invoices,

• We lose one or more of our major customers,

• We are unable to win new projects that we can perform on a profitable basis, or

• We are unable to obtain the cure or waiver of existing defaults under the PNC Credit Facility or the Ex-Im Bank Facility.

Tax Expense:

ASC Topic 825, “Income Taxes” requires all available evidence, both positive and negative, be considered to determine whether, based on the weight of that evidence, a valuation allowance is needed. During the current quarter, based upon the Company's recent performance, management determined the realization of deferred tax assets is uncertain as the Company is unable to consider tax planning strategies or projections of future taxable income in its evaluation of the realizability of its deferred tax assets as of June 30, 2012. Under these circumstances, deferred tax assets may only be realized through future reversals of taxable temporary differences and carryback of net operating losses to available carryback periods. We have performed such an analysis and a valuation allowance of approximately $6.2 million has been provided against deferred tax assets as of June 30, 2012.

This basically means they do not think ENG will make enough money to take advantage of the tax benefits from past losses for the periods such credits remain. It seems the losses have exceeded ENG’s future profit expectations.

I think it will be difficult to keep PNC out of their office until resolutions to address defaults are achieved. Will this be the next in a long list of distractions for ENG management?

Goodwill

With the Company’s somewhat bleak outlook and going concern issues did they not consider this as a triggering event for impairment testing?

Conclusion

A two-year slide has seemingly hit the bottom of the hill. It appears the Titanic has hit the iceberg, backed up and hit it again while management was concerned over what to select for dessert. Where has the Chairman and the Board been as we sat in the stands and watched ENG go sailing by?

Maybe the analysts that follow ENG will ask some questions to get full disclosure and transparency for the shareholders. ENG lists the following analysts providing coverage:

Enerecap Partners – Craig Bell

Keybanc – Matt Tucker & Ahird Afzal

Lazard Capital – Will Gabrielski

8/21 0753 EDT KeyBanc Downgrades ENGlobal Corporation (ENG) to Hold; Q2 Miss, Visibility Weak (see Blog Update)

Listen in to the Conference Call tomorrow. Good luck to everyone.