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.
   

Richard Industrial Group - A Company On The Move ☆

by Denny Robertson, P.E.

Richard Industrial Group (RIG) is a private corporation comprised of a number of entities, which include the engineering division, Richard Design Services, Inc. (RDS), Richard Construction Inc. (RCI) and Richard Automation and Electrical (RAE).  Let’s take a look at their primary group, the engineering division, RDS.  It is one of less than a handful of sizable engineering firms currently headquartered in the southeast Texas region.  Compared to their rivals, RDS is thriving and growing at an incredible pace.  The engineering division is comprised of about 500 engineers and designers.  Headcount of the entire organization, RIG, is currently at about 2,000 personnel.

Founders

RIG heritage started with Arthur R. Richard, probably the most respected pioneer-consulting engineer in southeast Texas.  He started Matrix Engineering with partners in the early 1970s.  Following in their father’s successful footsteps, Arthur’s sons, Brent and Art Richard, formed their own highly successful engineering company seven years ago - RDS.

Current Projects (partial)

RDS and RCI both have significant projects ongoing with Valero, Total, Motiva and others.  RDS performed the OSBL and Sour Water Stripper engineering and RCI is constructing the new Hydrocracker complex at Valero in St. Charles Parish, Louisiana.  RDS and RCI recently completed Flare Gas Recovery Units for Valero in Ardmore, OK and St. Charles, LA.  RDS performed the process design and construction on both of those projects.  Included was an alky flare gas scrubber for St. Charles.  RDS also performed the OSBL engineering for the Valero, Port Arthur, TX Hydrocracker project.  With successful completion of the design phase the project is currently under construction.  Additionally, RDS recently performed Phase III and IV engineering for the revamp of a crude unit and tank farm blending to handle Canadian Crude for Valero in Port Arthur.

Engineering for the Future

With a vision for the future RDS has also moved into renewable fuels.  They performed the Phase II, III and IV engineering for a 10,000 BPD Green DieselTM Unit located in St. Charles, LA for Diamond Green Diesel, LLC.  RDS has also partnered with Turner Construction in building the unit, which is scheduled to start production by the end of 2012.  Diamond Green Diesel, LLC is a partnership between Valero Energy Corporation and Darling International, Inc. (DAR) of Arlington, TX.  They are the largest processor of animal byproduct, waste vegetable oils and greases in the United States.  This plant will take in 10,000 BPD of beef tallow or vegetable oils by rail car or truck and convert it almost entirely to premium diesel fuel with a small amount of propane and light naphtha as byproducts.

RDS possesses an unusual blend of chemical plant and refinery process engineering expertise that make it the ideal supplier of various renewable energy ventures.  Of all the renewable energy ventures that have been conceived of in recent years, diesel production from animal and vegetable oils has the most potential for long-term viability.  The Diamond Green Diesel project is the largest animal/vegetable oil to diesel plant ever conceived and the worlds largest ever built.  It is truly state-of-the-art.  The heart of the unit is licensed technology from Honeywell UOP (Des Plaines, IL) called EcofiningTM.  In fact, the product name, Green DieselTM is a trademarked UOP name.  RDS was instrumental in marrying the pretreatment unit designed by Desmet Ballestra (Marietta, GA) with the EcofiningTM unit and integrating the entire complex OSBL facilities, control room, engineering offices, admin offices, MCCs, warehouse, tank farm, wastewater treating, cooling tower, steam system, oil rail unloading, powder rail and truck unloading, diesel storage, barge and ship loading, pipeline blending, etc.  RIG is a talented multidiscipline engineering, procurement and construction corporation.

Conclusion

After 35 years in this business and 21 of them in contract engineering, I look at RDS viability and ask myself how does this happen?  I see three solid elements:

1.            Excellence comes from the top down and the bottom up.  The management of RDS strives to be the best and they create an atmosphere that everyone enthusiastically participates in a spirit of excellence.

2.         The product quality of the Piping Department whether in design, engineering or construction, is again, the best.  I am continually impressed with how quickly and accurately the pipers design a large unit using 3D CAD.  Civil/structural, instrument/electrical and the process and mechanical engineers, are also excellent…but more about that in a future posting.

3.            Organic growth.  This team of managers, engineers and designers has progressed over the years by ensuring quality performance, being on schedule and not losing money.

RIG has grown by excelling at each job they are awarded and by performing the next job even better than the last.  They are loyal to their customers but, more importantly for RDS, their customers return that loyalty.

Comments are welcome. 

Editor's note: Denny Robertson started his career at Dow Chemical in Freeport, TX and then made Halar® plastic for three years working for Ausimont (now Solvay) in Orange, Texas.  After 12 years of working on the manufacturing side of the business, Denny began his contract engineering career working for Petrocon in Beaumont, which evolved into ENGlobal Corporation. Over a span of 18 years, he formed the first Process Engineering department there and by the time he left ENGlobal he had developed a vibrant group of over twenty process engineers.  He has been at RDS now for three years and is currently serving as Process Engineering Manager.