ENGlobal Corporation - 3Q Press Release and 10Q Analyses

Rev. 1.1

It was a record breaking quarterly report so let’s take a look.

Press Release

“ENGlobal reported a net loss of $22.3 million, or $0.83 per diluted share, for the quarter ended September 29, 2012…” Well folks, one thing we have learned about ENGlobal, they always seem to deliver more than you expect.

I am astounded. Are you guys kidding me? When you go cleaning up the books and get a number that bad it is sure sign the BOD, CEO and many others were not doing their jobs.

The next paragraph was a standard we have heard for x number of quarters (I have lost count for 3+ years). “Commenting on the results, William A. Coskey, P.E., ENGlobal's Founder, Chairman and Chief Executive Officer, said, "To a large extent, the third quarter is comprised of heritage financial items that have impacted our Company and mask some recent improving financial trends in our business.  For example, we continue to see gradual improvements across several of our working capital-related metrics. I am very pleased with current business activity in our operations, and also the progress we have made on several fronts since August 1st of this year."

Well you didn’t see gradual improvements in DOS as it appeared to increase to around 85 days for 3Q.  Wonder why ENG stopped reporting that metric?

Some facts here:

• Mr. Pagano resigned at the beginning of August. 
• He was CEO for one month of the third quarter. 

Examine "Heritage financial items". Is Mr. Coskey throwing Mr. Pagano under the bus or patting himself on the back, or maybe both? For once, I would like to see a CEO or Chairman of the Board take responsibility for results and not try to 'Pass the Buck'. Regardless, who was the Chairman of the Board during the creation of these “heritage financial items”? I am surprised it wasn't Bush's fault.

Too bad the miniscule positives don’t outweigh continuing operations' negatives, much less the every quarter “non-recurring special event”. These improvements are really just polishing the silverware on the Titanic. To explain it another way. Lets say you have stalled your aircraft and are in an unrecoverable spin with a downward velocity of 10,000 ft per minute. You eject and your upward velocity for a short period is 2,000 ft per minute. Guess what? You are still losing altitude and if you don't have enough altitude above ground level you are going to impact. 

Results were so bad ENGlobal is not even going to hold a conference call. If ever they needed a conference call it is now!  If Mr. Coskey truly believes this rhetoric he should get on the line and tell the world about all their accomplishments and provide some supportive details for the, I quote, “progress on our strategic priorities, including collaborating with our management consultant to improve financial performance, reorganizing our management team, pursuing opportunities to improve margins and reduce expenses, and completing the divestiture of our Land and Right-of-Way division of the Field Solutions segment”.  Details would be a nice change from the ongoing ‘trust us’ situation because we have seen what that got us for those x number of quarters.


10Q Analysis

From the Condensed Consolidated Balance Sheets (Unaudited):

Goodwill - $2,805,000

How does this remain?  Any Goodwill has been lost to the clients, employees, and shareholders.  They did say it was an interim assessment so there is more to come!

Long-term trade and notes receivable, net of current portion and allowances - $899,000

This looks like another SLE write-down if not collected in the forth quarter.

Current portion of debt - $29,406,000 

Almost doubled since the end of the year. The right-away sale should help reduce this amount by approx. $4.5 mil as retained AR is collected because there was no immediate cash in the deal!

Total Stockholders' Equity - $26,352,000

Lost $32.1 mil in equity in 9 months.  Book value @ approx. $0.98 per share; Tangible Net Worth (book value less Goodwill and Other Intangibles) @ $0.80 per share)


From Condensed Consolidated Statements of Cash Flows (Unaudited):

Net cash provided by (used in) operating activities for the first nine months - ($8,278,000)

Still negative cash flow for the year but positive for the 3rd quarter by $910k… a good sign!


Note 2 - Liquidity

"Although we have sold assets and reduced personnel in an attempt to improve our liquidity position, we cannot assure you that we will be successful in obtaining the cure or waiver of the defaults under the respective credit facilities. If we fail to obtain the cure or waiver of the defaults under the facilities after any forbearance period, the lenders 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 our operations. In addition, based on current conditions, it is probable that our independent registered public accounting firm will include an explanatory paragraph with respect to our ability to continue as a going concern in its report on our financial statements for the year ending December 31, 2012."


Notes to Unaudited Interim Condensed Consolidated Financial Statements:

"The Company has been unable to sell the Electrical Services group as planned and has decided to dispose of substantially all of the group’s remaining assets. During the third quarter of 2012, the Company completed the disposal of the group’s remaining assets concurrent with the completion of the last remaining lump sum project. During the third quarter, the Company incurred approximately $0.5 million of costs to complete the remaining lump sum project. Going forward, the Company will have no continuing involvement with these operations after the completion of the remaining lump sum project."

I wonder when this discontinued project will be completed? This was going to be taken care of several quarters ago.

"On September 10, 2012, the Company entered into a definitive agreement to sell its Field Solutions segment...The transaction was valued at approximately $7.5 million, consisting of approximately $4.5 million in working capital at closing to the Company [NO CASH!] and a $3 million promissory note payable to the Company over four years."

"The results of the discontinued operations are shown on the Condensed Consolidated Statements of Operations as "Loss from discontinued operations, net of taxes". During the third quarter, the Company incurred or accrued approximately $3.6 million [shows $3.717 mil in the actual table] of additional costs (which includes a loss on the sale of the Land and Right-of-Way division of approximately $1.1 million) related to the sale of these divisions."

Sounds like the Electrical Group took another $2.5 mil hit on the project.


Note 7 - Line of Credit and Debt

"Pursuant to generally accepted accounting principles, the combination of both a subjective acceleration clause and a lock-box arrangement required by the lender results in borrowings outstanding under the PNC Credit Facility being classified as short-term obligations despite the three-year term of the agreement."

Nothing like long-term being classified as short-term. Unfortunately by the same token ENGlobal finally now has long-term losses.


Notes to Unaudited Interim Condensed Consolidated Financial Statements:

"On October 30, 2012, the Forbearance Period was extended to November 15, 2012.  On November 14, 2012, the Forbearance Period was extended to November 30, 2012 (or earlier should any forbearance default occur)."

Looks like PNC is only giving ENG relief in 2-week increments. Wonder if ENG has received another 2-week extension last Friday?

"As of the result of covenant violations, including those described above, the Company is currently in default under the terms of the PNC Credit Facility. As of the date of this filing, the Agent has not taken any action with respect to the Company's defaults and the Company was actively discussing with the Agent the terms under which such defaults may be cured or waived. Although the Company is in active discussions with the Agent, if the Company is not successful in obtaining the cure or waiver of such defaults, at the end of the Forbearance Period, the Agent may exercise any and all rights and remedies available to it, 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 our operations."

Now we get the same for the Ex-Im Bank Facility.

"As of the result of covenant violations, including those described above, the Company is currently in default under the terms of the Ex-Im Bank Facility.  As of the date of this filing, Wells Fargo had not taken any action with respect to the Company's defaults and the Company was actively discussing with Wells Fargo the terms under which such defaults may be cured or waived.  Although the Company is in active discussions with Wells Fargo, if the Company is not successful in obtaining the cure or waiver of such defaults, Wells Fargo may exercise any and all rights and remedies available to it, up to and including terminating the Ex-Im Bank Facility. In such event and if we are unable to obtain an alternative facility, our business will be materially and adversely affected, and we may be forced to sharply curtail or cease our operations."


Notes to Unaudited Interim Condensed Consolidated Financial Statements, Total Assets by Segment, As of September 29, 2012:

If you subtract the discontinued operations (see the asterisk note) in the table from the Total Assets ($86,493,000) it looks like continuing operations has only $72,680,00 in assets!

Now stroll down to Net Loss ($22,330,000):

If you add back Goodwill at $14.6 mil and Discontinued Ops at $3.7 mil continuing Ops still lost $4.0 million! Consider E&C making 6.5% and Automation making 16.4% in margin with overall rate at 5.7%.  With a $6.0 million overhead they need to double revenue to just break even OR they need to double margins.


Note 12 – Subsequent Events

Notice of Delisting:

"The Company intends to consider available options to resolve the noncompliance with the minimum bid price requirement. No determination regarding the Company’s response has been made at this time. There can be no assurance that the Company will be able to regain compliance with the minimum bid price requirement or will otherwise be in compliance with other NASDAQ listing criteria."

Closing of Sale of the Land and Right of Way Division of the Field Solutions Segment:

"Pursuant to the final agreement, the Company will retain approximately $4.5 million of this division's working capital at the time of closing [again, that means no cash received], in addition to receiving a $3.0 million promissory note payable over four years."

"As previously reported, the original agreement provided for the sale of substantially all of the assets of both divisions of its Field Solutions segment, the Land and Right-of-Way, and Inspection. However, the Inspection division was not sold as part of the final transaction, and ENGlobal will retain the Tulsa-based business for the foreseeable future, while actively pursuing its sale and reporting its financial position and results of operations as discontinued operations. The Company expects no changes to the personnel of its Inspection operation as a result of this transaction."

Maybe another mandate from division management and employees to ‘sell or we leave’ will prompt accelerate selling activity.


Financial Overview of Continuing Operations:

"Improving our margins on our existing work is an important area of focus.  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. We have recently engaged a management consultant to assist us in improving our profit margins."

Does that mean the remaining management cannot come up with ideas to improve margins?  Are they "energized" but just do not know what to do?


Results of Continuing Operations– Three Months ended September 29, 2012 versus September 30, 2011:

Overall comments - As noted in the summary Revenue down 5% and Gross Profit down 52%.  Concerned should be that the core business is no longer able to make margins to cover SG&A.  The drop in revenue probably comes out of in-office projects, which is making margins (as a percent of revenue) decline, as in-plant revenue becomes a bigger piece of the pie. Bad market mix for E&C. Risk of losing Caspian due to ENG’s cash issues and paying subs. A loss or delay of the next phase of the work could materially impact revenue and margins coming out of Automation. SG&A is saddled with office rents that are not easily re-negotiated and will make it difficult to downsize quickly.

Gross Profit (Loss):

"Gross profit for the three months ended September 29, 2012, as compared to the comparable 2011 period, decreased by approximately $3.5 million, or 5.8%.  As a percentage of revenue, gross profit decreased from 11.2% to 5.7% [massive] for the three months ended September 29, 2012, as compared to the same period in 2011"

"Our gross profit and gross profit margin decreased primarily due to increased direct and variable costs [wonder what their utilization rate is running, or how billable man-hours are trending?] in our E&C Segment, resulting in lower profit margins.  We continue to be affected by intense competition and pricing pressures."

This seems to be a rather lame excuse when you look at apparent growth of competition in similar markets.


Liquidity and Capital Resources

Overview:

"ENGlobal does not intend to provide updates or make any further comment regarding its exploration and evaluation of strategic alternatives unless and until the Board of Directors has approved a definitive course of action."

Based on the Board’s reactions to what appear to be critical items this could take a while for them to approve anything. This does not really surprise you, does it?

Cash Flows from Operating Activities:

"The primary changes in working capital during the nine months ended September 29, 2012 included increased Costs in Excess of Billings [not getting billings out on time] and Decreased Billings in Excess of Costs [not getting favorable contract terms to allow for positive cash flows on lump sum projects] on uncompleted contracts of $1.3 million on fixed price projects where billing milestones have not been met, partially offset by an increase in accounts receivable of $2.8 million."

Again, bad terms, or poor order-to-cash processes.


PNC Credit Facility:

"Forbearance Period was subsequently extended to November 15, 2012 and again to November 30, 2012 (or earlier should any forbearance default occur) at a cost of $17,500 for each extension."

That could get expensive at $35k per month.


Conclusions and Opinion

Glancing at the latest financials posted (November 24th) and the revenue trends certainly are an eye opener!  Revenue trends over the last 4 quarters go from approx. $150mm as December 2011, $75mm in Q1, $77mm in Q2, and then $23mm in Q3 although I suspect the December 2011 numbers may not be correct*.  The Q3 results give ENG a current continuing revenue run-rate of less than $95mm which is about where it started in 2001.  Would be interesting to look back at what level of SG&A ENG had at that time.

*(According to SEC filings ENG 2011 annual revenue was approx $313mm and the 2011 3Q revenue was approx $222mm, or a net revenue for the 4th quarter of approx $91mm.)

Back to the press release and 10Q - OK folks, it is a disaster. No profit is going to be made. So what is going to happen?

Let's look at the recent history. ENG's losses were increasing. It is obvious PNC didn't trust management anymore. A consultant was forced upon ENG through the Credit Facility by PNC to manage ENGlobal.

Then, parts of the company are/were being sold and this continues. It is a liquidation process in my honest opinion.

Now another firm comes in (Simmons) assigned to help determine the future of ENG, however, ENG is not indicating any particular avenue. Cutting through the BS, I believe they are trying to sell the company. Moreover, we are getting close to that time. Why? One, for tax reasons - before the end of the year. Two, it sure looks like they threw in everything that would be a loss into this quarter to take all problems off the balance sheet. This would clean up those books for a potential sale. Three, PNC would never extend more time to ENGlobal with their risks increasing from further company losses unless a deal is imminent.

If you own stock I think you will get something for it, either in stock trade or cash. This is better than nothing. If you have a job there you may continue to have one, adjustments will be made. Who will buy ENG? First, let me say the deeper the buyer’s pockets are the better off you will be. In addressing who would be a buyer - who wants to create or increase their presence in the Golden Triangle, someone like CDI, Jacobs or CDI.

Good luck to everyone.

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.