2Q 2012 10Q More Analysis

In looking at the 10Q closer there are more interesting notes and comments to make. Let’s look at it by section:

Note 3 - Discontinued Operations

"The Company has been unable to sell the Electrical Services group business as planned and has decided to sell substantially all of the assets of this business. The Company expects to complete the disposal of its discontinued operations concurrent with the completion of the last remaining lump sum project, which is expected to occur in the third quarter of 2012. During the second quarter, the Company accrued approximately $0.5 million of additional costs expected to be incurred to complete the remaining lump sum project. The Company will have no continuing involvement with these operations after the sale or disposal."

The trend in losses since the election of “discontinued operations”:
    06/30/2011 – loss of $0.430 mil
    09/30/2011 – loss of $1.036 mil
    12/31/2011 – loss of $0.933 mil
    03/31/2012 – loss of $0.113 mil;
That’s $2.512 mil in the prior 4 quarters and now another $2.073 mil in 2Q of 2012!  Sounds like it was not discontinued... Where was project controls and internal audit on assessment of ETC on this project?  Where is the credibility that such project will now be completed in 3Q?  What additional losses will we see?

Note 4 – Stock Compensation Plans

I find this section generally painful to read considering company results:

"In April 2012, the Compensation Committee of the Board of Directors approved an increase of 500,000 shares, which was subsequently approved by our shareholders. As of August 17, 2012, 470,773 shares of restricted stock have been granted under the Equity Plan, of which 133,115 remain subject to outstanding awards."

Where did the 470,773 shares go?  Who produced results to get such grants other than the board?  As you recall the CEO and the board received just over 151,000 shares for their efforts and direction.

Note 5 – Contracts

“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 June 30, 2012, compared to $0.3 million as of December 31, 2011.” - THEY ARE STILL DOING WORK WITHOUT CHANGE ORDERS!

“We expect a majority of the deferred revenue amount to be realized by year end 2012.” If they expect this revenue to be realized why are they deferring?

Credit Facility

You need to read the sections concerning the Credit Facility in the 10Q. The facility was covered previously within a dedicated post. I had several people read that lengthy and onerous money contract and contribute their thoughts to that post to get that monster right. It is tough and restrictive contract as noted then. The information within the current 10Q is a good, well-written abstract synopsis of that Credit Facility - too bad ENG fell into such financial condition that this was the result. The abstract is shorter than the approximately 114 pages of the actual CF, however it is still lengthy so I will provide you a link, see section labeled "PNC Credit Facility". As a side note see the section above it labeled "Current Classification of Borrowings under the PNC Credit Facility". I find it humorous that a three-year term agreement is classified as "Current".

http://sec.gov/Archives/edgar/data/933738/000093373812000012/eng-10qx063012q.htm

Note 8 – Federal and State Income Taxes

Remember the big percentage of this quarter’s loss?

"During the 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."

Translation: Basically we do not think we will make enough money to take advantage of the deferred tax asset… if that’s true why wouldn’t this be a triggering event for goodwill impairment?

MD&A Overview

“After a period of declining revenues due to poor domestic economic conditions, we were encouraged by our project proposal activity during the fourth quarter of 2011 and into the first quarter of 2012, which resulted in an increase in backlog and revenue." Where are the awards?  We have not seen any press releases sharing any recent successes.

"In the first quarter of 2012, we were notified by Wells Fargo Bank that they were no longer willing to support the Company with its credit facility. In response, we began looking for a replacement credit facility to meet our working capital needs, while curtailing unnecessary expenditures. The majority of our vendors and customers have been amenable to working with us through this transition."

Really, so vendors have agreed to work without pay and customers have agreed to pay early?  We can see where AP has increased since December 31, 2011 from $8.4 mil to $8.9 mil at the end of March 30, 2012 and $11.5 mil at the end of June 30, 2012 but what we cannot see customer help with early payments?

"As a result of the uncertainty created by the credit facility transition, we spent valuable time reassuring our stakeholders. Unfortunately, the internal focus - while necessary - was also counterproductive to our business development momentum. As a result, our sales throughout the second quarter have been weaker than expected." REALLY? Profits would be the most assuring thing for the stakeholders.  How about spending time making that happen?

Management's Discussion and Analysis

"During the recent period of industry-wide decline in demand for the types of services we provide, we reduced our rates significantly, as was required to obtain and retain business. Although the level of demand has increased, pricing in certain geographical markets is still extremely competitive and we have not yet been able to increase our margins to prior levels." - What?  Tell that to Richard Industrial Group and Burrow Global. Competitors are growing!

Revenue:
"The Field Solutions segment experienced decreased revenue in the Land division due to decreased project activity with major midstream energy companies while the Inspection Division experienced decreased revenue due to completion of the Ruby Pipeline Project." Where does the flight of senior management fit into the chicken and the egg theory within Field Solutions?

Selling, General, and Administrative:
“The $1.1 million increase in SG&A expense for the three months ended June 30, 2012 , as compared to the same period for 2011 , primarily resulted from increased salary and related expenses of approximately $0.8 million incurred primarily as a result of initiatives undertaken in anticipation of increased activity for the remainder of the year.” Who was reading these tealeaves?  Maybe it is just rose-colored glasses or the smoke from burning pizza!

"As a percentage of revenue, SG&A expense increased to 10.2% for the three months ended June 30, 2012, from 9.2% for the comparable prior year period. During June, we began reducing overhead and staff levels in response to reduced activity levels. These staff reductions resulted in severance costs of approximately $0.2 million during the quarter.”  Surely there will be other severance costs for the CEO, the VP of HSE, the SVP of Field Solutions and others both voluntary and due to staff reductions that will come in Q3.  Have those costs been taken or accrued? What about the bonuses being paid to keep staff in tact?

Liquidity and Capital Resources

This section speaks for itself:

"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.

If any such event occurs and continues without remedy, we would be required to consider alternative financing options." L

"The primary changes in working capital accounts during the six months ended June 30, 2012 were increased Costs in Excess of Billings and Decreased Billings in Excess of Costs on uncompleted contracts of $8.4 million on fixed price projects where billing milestones have not been met [Could this be due to performance issues related to the loss of staff?] and increased Accounts Receivable of $1.0 million."

Conclusion

There is not much cash left and once again ENGlobal is in a workout group, this time with PNC. This is virtually the same predicament as in May, same company - different lender. Can it be worked out? Sure, however, I think it will be with more restrictions. Additionally, cash will need to be raised. How? An equity partner and/or sale of assets as noted in previous commentary is most likely.

I get a lot of questions about liquidation and bankruptcy. I do not wish to amplify the subjects above their natural possibilities so please keep that in mind. In the case of bankruptcy the stock is always cancelled - zero value to shareholders.

In addressing liquidation start looking at Tangible Net Worth:
   
Current assets - $78 mil
Current liabilities - $60 mil
That is a net of $18 mil for shareholders
   
Why, we have $48.7 in stockholder equity?  The balance of approx. $30.8 million is made up of:

$3.3 mil in PP&E, which would not offer much cash
$25.0 mil in goodwill & other intangibles
$899K in a note held by the courts on a legal claim
$1.6 mil in “Other Assets” whatever that includes

$18 - $21mil for shareholders equates to $0.67 to $0.78 per share in liquidation scenario.

The best path is for ENGlobal to manage better, probably downsize to viable capability and rebuild as conditions and management capability permits. Good luck to everyone.

Comments are welcome.
   

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.

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.

Comments are invited via the link below. There is an email link for sharing this open distribution information or you may email the link with your own account or domain.