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ENG > SEC Filings for ENG > Form 10-Q on 19-Nov-2012All Recent SEC Filings

Show all filings for ENGLOBAL CORP

Form 10-Q for ENGLOBAL CORP


19-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

Certain information contained in this Quarterly Report on Form 10-Q, as well as other written and oral statements made or incorporated by reference from time to time by the Company and its representatives in other reports, filings with the Securities and Exchange Commission, press releases, conferences or otherwise, may be deemed to be forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. This information includes, without limitation, statements concerning the Company's future financial position and results of operations, planned capital expenditures, business strategy and other plans for future operations, the future mix of revenues and business, customer retention, project reversals, commitments and contingent liabilities, future demand and industry conditions. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Generally, the words "anticipate," "believe," "estimate," "expect," "may" and similar expressions, identify forward-looking statements, which generally are not historical in nature. Actual results could differ materially from the results described in the forward-looking statements due to the risks and uncertainties set forth in this Quarterly Report on Form 10-Q, the specific risk factors identified in the Company's Annual Report on Form 10-K for the year ended December 31, 2011, and those described from time to time in our future reports filed with the Securities and Exchange Commission. The following discussion is qualified in its entirety by, and should be read in conjunction with, the Company's condensed consolidated financial statements, including the notes thereto, included in this Quarterly Report on Form 10-Q and the Company's Annual Report on Form 10-K for the year ended December 31, 2011.

Business Overview

For the three and nine-month periods ended September 29, 2012, the Company reported net losses of approximately $22.3 million and $32.3 million, respectively. Included in the third quarter results were non-cash charges totaling approximately $17.5 million relating to an impairment of goodwill, a litigation accrual and a write-down of the assets of the Field Solutions segment currently classified as held-for-sale.

Accounting standards require companies to evaluate the carrying value of goodwill when there are events or changes in circumstance that indicate a possible impairment. As a result of the Company's continuing losses and its recent decision to sell its Field Solutions segment, the Company concluded that it was appropriate to evaluate the carrying value of its goodwill. As a result of this evaluation, the Company recognized a non-cash goodwill impairment charge of approximately $16.9 million. Of this amount, approximately $14.6 million related to the Engineering and Construction segment and is included in continuing operations and approximately $2.4 million (of which approximately $1.1 million represented the write-down of the assets of the Land and Right-of-Way division of the Field Solutions segment the sale of which closed on November 2, 2012) related to the Field Solutions segment and is included in discontinued operations.

In June 2012, a contractor filed an action against the Company. The contractor alleges that the Company, through the Inspection division of the Field Solutions segment, failed to properly inspect and verify welds on portions of a pipeline system were completed in accordance with state and federal regulations and contract specifications. We are still gathering facts on our exposure, discussing coverage with our carriers and have accrued a $0.6 million liability that is included in discontinued operations.

During the quarter, the Company finished a very difficult project in its Electrical division, which is included in Discontinued Operations. This is the last remaining project in this division and one where the Company underestimated the strict working environment of the project which significantly increased the labor required on the project, the quality of the available labor pool which also increased the labor required on the project and scope of the project. As a result, the Company recorded significant losses from this project. The Company recorded a reserve on this project of $0.5 million during this quarter.

During the quarter, the Company completed a large, fixed price project for one of its customers. During the project, the scope of the project changed significantly resulting in significant increases in the costs. These increases were not passed on to the customer in a timely manner resulting in disputed costs. While the Company is in continuing discussion with its customer and believes it has sufficient grounds to prevail, it has recorded a loss on this project during the quarter of approximately $0.6 million.


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The results for the nine-month period ended September 29, 2012 include the impact of the items discussed above and a non-cash charge of approximately $6.2 million relating to a valuation allowance established in connection with the Company's deferred tax assets during the second quarter of 2012.

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. As a result of the uncertainty created by the credit facility transition, we spent valuable time reassuring our customers, vendors and stakeholders. Unfortunately, the internal focus, while necessary, was also counterproductive to our business development. As a result, our sales throughout the second and third quarters have been weaker than expected.

In May 2012, we closed on a new three-year secured revolving credit facility with PNC Bank, N.A. The PNC Credit Facility allows the Company to borrow up to $35 million pursuant to a borrowing base formula based primarily on the Company's eligible accounts receivable. The PNC Credit Facility was used to repay the outstanding indebtedness under the former credit facility with Wells Fargo Bank and to provide ongoing working capital. ENGlobal's existing letter of credit facility with Export-Import Bank of the United States remains in place to support the Company's Caspian Pipeline Consortium (CPC) project. We have failed to comply with all of the covenants of these facilities and are presently in default with respect to both facilities.

On September 27, 2012, the Company entered into the First Amendment to Revolving Credit and Security Agreement and Forbearance Agreement, with the Lenders regarding the PNC Credit Facility. Under the terms of the Forbearance Agreement, the Lenders agreed to forbear, during the Forbearance Period (as defined below), from exercising their rights and remedies, under the PNC Credit Facility, with respect to events of default, including those discussed in Note 7. The Forbearance Period commenced on the Effective Date and ended on October 31, 2012. 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 forebearance default occur). After that date, PNC Bank 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.

On October 11, 2012, we announced that our Board of Directors had initiated a process to explore and consider possible strategic alternatives for enhancing shareholder value and supporting the Company's long-term financial strength. The Board of Directors retained Simmons & Company International as its financial advisor during this process. We continue to take actions to streamline our operations, including the divestiture of our Field Solutions segment, the implementation of expense reduction initiatives, and the retention of a management consultant to perform advisory services. We have not made any decision to engage in any specific strategic alternative at this time, and the exploration of strategic alternatives may not result in any specific action or transaction. 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.


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Financial Overview of Continuing Operations

The following financial information sets forth a general overview of our
financial condition and results of operations for the three and nine months
ended September 29, 2012, compared to the corresponding periods in 2011.

       Selected Results of        During the three months     During the nine months
            Operations            ended September 29, 2012   ended September 30, 2012
   Revenues                       Decreased            5.0 % Increased            7.9 %
   Gross profit                   Decreased           51.7 % Decreased           22.4 %
   Selling, general and
   administrative expense         Decreased            7.8 % Increased            3.1 %



                                     As of                  As of               As of
                                 September 29,           December 31,       September 30,
Selected Balance Sheet
Comparisons                           2012                   2011                2011
                                                   (amounts in thousands)
Working capital                $       16,428         $       32,053           $       35,175
Total assets*                  $       86,493         $      104,179           $      116,283
Accounts receivable (net)      $       46,949         $       44,159           $       46,231
Stockholders' equity           $       26,352         $       58,500           $       62,305

*Includes $13.8 million, $19.1 million, and $22.2 million of assets held for sale from discontinued operations at September 29, 2012, December 31, 2011, and September 30, 2011, respectively.

The Company recognizes service revenue as soon as the services are performed. For clients that we consider higher risk, such as developer clients, clients with a late payment history or history of not providing written work authorizations, we have deferred revenue recognition until we receive either a written authorization or payment. The current amount of revenue deferred for these reasons is approximately $0.1 million. We expect a majority of the deferred revenue amount to be realized by year end.

Revenue on fixed-price contracts is recorded primarily using the percentage-of-completion (cost-to-cost) method. Under this method, revenue is recognized in the ratio that contract costs incurred bear to total estimated contract costs. Revenue and gross margin on fixed-price contracts are subject to revision throughout the lives of the contracts and any required adjustments are made in the period in which the revisions become known. To manage unknown risks, management may use contingency amounts to increase the estimated costs, therefore lowering the earned revenues until the risks are better identified and quantified or have been mitigated. Losses on contracts are recorded in full as they are identified.

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.

Early on, the CPC project was hampered by administrative issues related to two major design revisions, which ultimately delayed our portion of the project by several months. In addition, the client's slow responsiveness on document approvals also contributed to the delay. Over the course of the year, we have worked diligently to understand the client's processes in order to reduce the lag time between the time documents are submitted for and ultimately receive approval. We have been focusing on improving our cash flow position on this project by expediting our client's approval of our work which is a precondition to invoicing for milestones. As a result of these efforts, the project was essentially cash flow neutral as of September 29, 2012. Despite these issues, we believe we have a solid working relationship with the client and we still anticipate completing the project and recognizing approximately $86 million in revenue over the life of the project. We continue to manage our overall billing and client collection processes toward reducing days of sales outstanding to the extent practicable.


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In the course of providing our services, we routinely provide engineering, materials and equipment and may provide construction services on a subcontractor basis. Generally, the materials, equipment and subcontractor costs are passed through to our clients and reimbursed, along with fees, which in total are at margins lower than those of our normal core business. In accordance with industry practice and generally accepted accounting principles, all such costs and fees are included in revenue. The use of subcontractor services can change significantly from project to project; therefore, changes in revenue and gross profit, selling, general and administrative expense and operating income as a percent of revenue may not be indicative of the Company's core business trends.

Selling, general and administrative expense in the segments includes management and staff compensation, office costs such as rents and utilities, depreciation, amortization, travel, bad debt and other expenses generally unrelated to specific contracts, but directly related to the support of a segment's operations. All other selling, general and administrative expense is comprised primarily of business development costs, as well as costs related to the executive, investor relations/governance, finance, corporate accounting, health, safety, and environmental, human resources, legal and information technology departments and other costs generally unrelated to specific projects but which are incurred to support corporate activities and initiatives. We have recently reviewed these expense items and have made some reductions in personnel and departmental expenses. We will continue to review these expenses and seek further reductions where appropriate.

Discontinued Operations

In 2011, as part of its strategic evaluation of operations, the Company determined that the expected future profitability of the Electrical Services group was not sufficient to support maintaining it as a viable business and that it did not fit within the future strategic plan. As a result, effective July 1, 2011, the Company initiated a plan to sell the operations of its Electrical Services group. In addition, on September 10, 2012, we announced an agreement to sell our Field Solutions segment (see Note 3 - "Discontinued Operations"). These assets, liabilities and their related operations have been classified as discontinued operations in the Company's consolidated financial statements.

On November 2, 2012, the Company completed the divestiture of its Land and Right-of-Way division of its Field Solutions segment effective October 26, 2012, and retained the Inspection division pursuant to the terms of the amended agreement. The transaction was valued at approximately $7.5 million, consisting of approximately $4.5 million in working capital at closing to the Company and a $3 million promissory note payable to the Company over four years.


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

Results of operations for the three months ended September 29, 2012 and September 30, 2011 are summarized below:

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