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ENG > SEC Filings for ENG > Form 10-K on 15-Apr-2013All Recent SEC Filings

Show all filings for ENGLOBAL CORP

Form 10-K for ENGLOBAL CORP


15-Apr-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion is qualified in its entirety by, and should be read in conjunction with, our Consolidated Financial Statements and Notes thereto, included elsewhere in this Annual Report on Form 10-K.

Overview

The substantial losses we incurred in 2012 and the resulting defaults under our credit facilities raise substantial doubt about our ability to continue as a going concern. See Note 3 to the Consolidated Financial Statements included in this Report. While ENGlobal experienced a difficult 2012 and continues to face a number of challenges, we are cautiously optimistic about the prospects for 2013. Because of the losses in 2011 and 2012, we have divested our least attractive businesses and are now focused on our core business segments, Engineering and Construction and Automation. In this regard, we have reduced our expenses by reducing employee headcount, closing offices and creating an enhanced operational focus on cost controls. In addition, we are seeing an increase in capital project spending in limited markets in 2013. Although we are in default under the PNC Credit Facility and the Ex-Im Bank Facility, we continue to discuss with our lenders the terms under which the defaults may be cured or waived..

Despite the relative increase in capital project spending in certain limited markets, we believe that overall, client spending continues to be limited, which we believe may be due to the uncertainty experienced by businesses regarding the political climate in Washington D.C. and the sluggish improvement in the economy overall. In addition, pricing continues to be very competitive. However, we have an ongoing, extremely focused marketing effort and we have seen an increase in proposal activity, as well as an increase in backlog. In particular, we are focused on both international expansion as well as significant projects located inside of the United States.

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 & Co. ("Simmons") 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.

Amounts reported as continuing operations in 2011 and 2012 are reported for the two segments that we continue to operate (Engineering and Construction and Automation). Results reported as discontinued operations (Electrical Services and Field Solutions) are the result of management's decision to divest from these operations.

Results of Continuing Operations

The Company's revenue from continuing operations is composed of engineering, procurement and construction management (EPCM) services revenue and the sale of fabricated engineered automation systems. The Company recognizes service revenue as soon as the services are performed. The majority of the Company's engineering services have historically been provided through time-and-material contracts whereas a majority of the Company's engineered automation system sales are earned on fixed-price contracts.

In the course of providing our services, we routinely provide materials and equipment and may provide construction or construction management services on a subcontractor basis. Generally, these materials, equipment and subcontractor costs are passed through to our clients and reimbursed, along with handling 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, SG&A expense and operating income as a percent of revenue may not be indicative of the Company's core business trends.


Table of Contents

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)

Operating SG&A expense includes management, business development and staff compensation, office costs such as rents and utilities, depreciation, amortization, travel, bad debt and other expenses generally unrelated to specific client contracts, but directly related to the support of a segment's operations. Other SG&A expenses includes investor relations/governance, finance, accounting, health/safety/environmental, human resources, legal and information technology which are unrelated to specific projects but which are incurred to support corporate activities.

Comparison of the year ended December 29, 2012 versus December 31, 2011

The following table set forth below, for the year ended December 29, 2012 versus December 31, 2011, provides relevant financial data that is derived from our consolidated statements of operations.

Year ended December 29,
          2012             Engineering and
 (dollars in thousands)      Construction        Automation       Corporate       Consolidated
Revenues                   $        168,930     $     58,986     $         -     $      227,916
Gross profit                         12,524            6,246             (50 )           18,720            8.2  %
SG&A                                  8,877            4,257          12,105             25,239           11.1  %
Goodwill impairment                  14,568                -               -             14,568            6.4  %
Operating income (loss)             (10,921 )          1,989         (12,155 )          (21,087 )         (9.3 )%
Other income (expense)                                                                     (100 )            -  %
Interest income
(expense)                                                                                (1,875 )         (0.8 )%
Tax provision                                                                            (7,001 )         (3.1 )%
Net loss from continuing
operations                                                                       $      (30,063 )        (13.2 )%
Loss per share from
continuing operations                                                            $        (1.12 )



Year ended December 31,
          2011             Engineering and
 (dollars in thousands)      Construction        Automation       Corporate       Consolidated
Revenues                   $        175,387     $     62,216     $         -     $      237,603
Gross profit                         15,354            6,084               -             21,438            9.0  %
SG&A                                  7,519            4,047          14,016             25,582           10.8  %
Goodwill impairment                       -                -               -                  -            0.0  %
Operating income (loss)               7,835            2,037         (14,016 )           (4,144 )         (1.8 )%
Other income (expense)                                                                      (61 )          0.0  %
Interest income
(expense)                                                                                (1,028 )         (0.4 )%
Tax provision                                                                               831            0.3 %
Net loss from continuing
operations                                                                       $       (4,402 )         (1.9 )%
Loss per share from
continuing operations                                                            $        (0.16 )


Table of Contents

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)

  Change in Operating
        Results            Engineering and
 (dollars in thousands)      Construction        Automation       Corporate      Consolidated
Revenues                   $         (6,457 )   $    (3,230 )   $         -     $       (9,687 )         (4.3 )%
Gross profit                         (2,830 )           162             (50 )           (2,718 )         (1.2 )%
SG&A                                  1,358             210          (1,911 )             (343 )         (0.2 )%
Goodwill impairment                  14,568               -               -             14,568            6.1  %
Operating income (loss)             (18,756 )           (48 )         1,861            (16,943 )         (7.1 )%
Other income (expense)                                                                     (39 )          0.0  %
Interest income
(expense)                                                                                 (847 )         (0.3 )%
Tax provision                                                                           (7,832 )         (3.4 )%
Net loss from continuing
operations                                                                      $      (25,661 )        (10.8 )%

Loss per share from continuing operations $ (0.96 )

Revenues

The $9.7 million overall decrease in revenues for the year ended December 29, 2012, as compared to the comparable 2011 period, resulted from a decrease of $3.0 million in our Automation segment and $6.7 million to our Engineering and Construction segment. Overall revenue decreased in 2012 as a result of less project work from new clients. In addition, 2012 revenues were impacted by existing projects that were either finished or experienced significantly diminished activity during the 12-month period. Our clients are continuing to perform smaller maintenance projects but not new capital expansions. Competition for the project work continues to be intense.

Gross Profit

The decrease in gross profit as a percentage of revenues in 2012 relative to 2011 was caused by several factors including reduced revenues, higher material costs as a function of current project requirements and higher variable labor costs due to an operational focus on utilization, resulting in higher margins.

Selling, General and Administrative ("SG&A") Expenses

The decrease in operating SG&A expenses for the year ended December 29, 2012, as compared to the comparable 2011 period, is primarily the result of decreases of $0.8 million in salaries and employee related expenses and decreases of $0.7 million in professional services, offset by an increase of $1.2 million due to software upgrades and maintenance expenses. As a percentage of revenues, SG&A expenses increased to 11.1% for the year ended December 29, 2012, from 10.8% for the comparable prior year period.

Goodwill Impairment

Because of deteriorating market conditions in 2012, our declining financial performance and the decision to sell several of our assets, we performed an interim assessment of the carrying value of our goodwill as of September 29, 2012. We reviewed a number of factors on a segment by segment basis, including market conditions, projected cash flows, cost of capital, growth rates and other factors that could significantly impact the reported value of our goodwill. As a result of this review, we recorded a goodwill impairment of approximately $16.9 million as of December 29, 2012. Of this amount, approximately $14.5 million related to continuing operations and approximately $2.4 million relating to discontinued operations.

Operating Income (Loss)

The increase in operating loss for the year ended December 31, 2012, as compared to the comparable 2011 period, was attributable to an impairment of goodwill in the engineering and construction segment of $14.5 million, lower revenue levels as well as increased costs for both travel expenses and variable labor. These increased costs also contributed to increased operating loss as a percentage of revenue.


Table of Contents

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)

Interest Income (Expense)

Interest expense increased between 2012 and 2011 due to the increase in borrowings under the PNC Credit Facility as well as increasing interest rates in 2012, as compared to 2011. In addition, as a result of defaults under the PNC Credit Facility, the interest rate applicable to the borrowings under the PNC Credit Facility increased from 4% to 7% in June 2012.

Net Income (Loss)

As a result of changes detailed above, our net loss increased $25.7 million to a loss of $30.1 million in 2012 from a loss of $4.4 million in 2011, increasing as a percentage of total revenue from (1.9)% in 2011 to (13.2)% in 2012 .

Discontinued Operations

During the third quarter of 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 due to its operational differences. As a result, effective July 1, 2011, the Company initiated a plan to sell the operations of its Electrical Services group. The Company was unable to sell the Electrical Services group as planned and 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. The Company has no continuing involvement with these operations.

On September 10, 2012, the Company entered into a definitive agreement to sell its Field Solutions segment. The Field Solutions segment includes the Land and Right-of-Way and Inspection divisions, primarily serving pipeline and electric power companies. 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. The transaction was valued at approximately $7.5 million, consisting of approximately $4.5 million in retained working capital and a $3.0 million promissory note payable to the Company over four years.

Effective January 3, 2013, the Company completed the divestiture of the Inspection division. The transaction was valued at approximately $7.9 million, consisting of $1.0 million cash at closing, $5.0 million in retained working capital and a $1.9 million promissory note payable to the Company over four years.

The operations of the Electrical Services group and the Field Solutions segment have been classified as discontinued operations and accordingly, are presented as discontinued operations in the Company's re-cast consolidated financial statements. The results of the discontinued operations are shown on the Consolidated Statements of Operations as "Loss from discontinued operations, net of taxes". Summarized financial information for the discontinued operations is shown below:

                                           December 29,       December 31,
          Statement of Operations Data:        2012               2011
                                               (dollars in thousands)
          Revenues                        $       60,822     $       92,551
          Operating costs                         62,076             96,708
          Goodwill impairment                     (2,397 )                -
             Operating loss                       (3,651 )           (4,157 )
          Other income (expense)                       -                  1
          Gain on sale                               113                  -
             Total loss before taxes              (3,538 )           (4,156 )
          Tax expense (benefit)                        -             (1,482 )
             Net loss                     $       (3,538 )   $       (2,674 )


Table of Contents

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)

Liquidity and Capital Resources

Overview

The Company defines liquidity as its ability to pay liabilities as they become due, fund business operations and meet monetary contractual obligations. Historically, our primary sources of liquidity have been cash flow from operations and availability under our credit facilities, including the PNC Credit Facility and the Ex-Im Bank Facility. As a result of the defaults under the PNC Credit Facility and the Ex-Im Bank Facility described below, additional borrowings under the PNC Credit Facility are at the sole discretion of PNC Bank. As of December 29, 2012, we had $18.5 million in working capital (defined as current assets minus current liabilities). As of March 15, 2013, unrestricted cash on hand totaled approximately $1.2 million. As of March 15, 2013, 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,
we are unable to obtain the cure or waiver of the defaults under the PNC Credit or Ex-Im Bank Facilities, or
the availability of borrowings under the PNC Credit Facility is further reduced.

If any such event occurs and continues without remedy, we would be required to consider alternative financing options. See "Senior Revolving Credit Facility - PNC Credit Facility," "Ex-IM Bank Facility" below and "Item 1A- Risk Factors" for additional information about existing defaults under the PNC Credit Facility and the Ex-Im Bank Facility.

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. 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.

Cash Flows from Operating Activities

Operating activities used $4.9 million in cash in 2012 and provided $5.6 million in cash in 2011. For the year ended December 31, 2012, the changes in working capital were primarily due to decreased trade receivables of $3.7 million, increased accounts payable of $2.3 million and decreased accrued compensation and benefits and other liabilities of $5.0 million. Our days sales outstanding has increased from 64 days for the 12-month period ended December 31, 2011 to 78 days for the 12-month period ended December 31, 2012. The Company manages its billing and client collection processes toward reducing days sales outstanding to the extent practicable. We believe that our allowance for bad debt is adequate to cover any potential non-payment by our customers.

Cash Flows from Investing Activities

Investing activities used cash totaling $3.9 million in 2012, compared to $2.9 million in 2011. In 2012 and 2011, investing activities were primarily attributable to restricted cash requirements related to the Caspian project and PNC Credit Facility, in addition to capital expenditures mainly in the form of leasehold improvements.


Table of Contents

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)

Future investing activities are anticipated to remain consistent with prior years and include capital additions for leasehold improvements, technical applications software and equipment, such as upgrades to computers, as well as acquisitions. The PNC Credit Facility discussed under "Senior Revolving Credit Facility - PNC Credit Facility" below limits annual capital expenditures to $3.5 million and acquisitions require prior approval by PNC Bank.

Cash Flows from Financing Activities

Financing activities provided cash totaling $9.5 million in 2012 and used cash totaling $2.7 million in 2011. During 2012 and 2011, our primary financing mechanism was our line of credit under the PNC Credit Facility and its predecessor the Wells Fargo Credit Facility. The line of credit was used principally to finance working capital requirements. During 2012, our borrowings under the line of credit were $205.3 million in the aggregate and we repaid an aggregate of $194.8 million. During 2011, our borrowings under the line of credit were $159.9 million in the aggregate and we repaid an aggregate of $162.2 million.

We anticipate that future cash flows from financing activities will be borrowings, payments on the line of credit and payments on long-term debt instruments. Line of credit fluctuations are a function of timing related to operations, obligations and payments received on accounts receivable.

Senior Revolving Credit Facility - PNC Credit Facility

On May 29, 2012, the Company entered into the PNC Credit Facility with PNC Bank, National Association, as administrative agent (the "Agent") for the lenders (the "Lenders") pursuant to which the Lenders agreed to extend credit to the Company in the form of loans (each a "Loan" and collectively, the "Loans") on a revolving basis of up to $35.0 million (the "Commitment"). Capitalized terms used but not otherwise defined herein shall have the meaning given to them in the loan agreement. Set forth below are certain of the material terms of the loan agreement:

Revolving Advances - Each Lender, severally and not jointly, will make revolving advances to the Company in aggregate amounts outstanding at any time equal to such Lender's Commitment Percentage of the lesser of (a) $35.0 million less the maximum undrawn amount on all outstanding letters of credit, or (b) an amount equal to the sum of: (i) up to 85% of Eligible Receivables, plus (ii) up to the lesser of (x) up to 85% of Eligible Extended Term Receivables or (y) $3.0 million, plus (iii) up to the lesser of (x) up to 85% of Eligible Government Receivables or (y) $800,000, plus (iv) up to the lesser of (x) 75% of Eligible Unbilled Receivables or (y) $8.5 million; provided, however, that no more than $800,000 of the amount resulting from the calculation of this part (iv) may be attributable to Eligible Unbilled Receivables owed by Government Customers, plus
(v) up to the lesser of (x) up to 50% of Eligible Costs in Excess of Billings or
(y) $4.0 million, minus (vi) the Maximum Undrawn Amount of all outstanding letters of credit, minus (vii) such reserves as Agent may deem proper and necessary in the exercise of its discretion. Certain of the percentages and dollar amounts discussed above may be increased or decreased by Agent at any time, so long as such increase or decrease is reasonable and done in good faith.

Interest - Any Loans will bear interest at (a) the sum of the Alternate Base Rate (defined as a fluctuating rate equal to the highest of (x) the commercial lending rate of Agent as publicly announced and in effect on such day, (y) the daily federal funds open rate as quoted by ICAP North America, Inc. in effect on such day plus 1/2 of 1%, and (z) the Daily Libor Rate plus 1% (with the Daily LIBOR Rate determined by taking the LIBOR rate published in the Wall Street Journal and dividing it by a number equal to 1 minus the reserve percentage on that day as determined by the Board of Governors of the Federal Reserve), plus the Applicable Margin (defined below) for Domestic Rate Loans or (b) the sum of the Eurodollar Rate (defined as a fluctuating rate determined by Agent by dividing the quoted LIBOR rate by a number equal to 1 minus the reserve percentage on that day as determined by the Board of Governors of the Federal Reserve), plus the Applicable Margin with respect to Eurodollar Rate Loans.


Table of Contents

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)

Collateral - All obligations of the Company under the loan agreement are secured by a first priority perfected lien against any and all personal property assets of the Company (other than certain excluded property, including certain accounts receivable related to the Caspian Pipeline Consortium pledged under the Ex-Im Transaction Specific Credit Agreement dated as of July 13, 2011 between ENGlobal US and Wells Fargo Bank).

Term - All Loans and all other obligations outstanding under the loan agreement shall be payable in full on May 29, 2015, unless otherwise terminated pursuant to the terms of the loan agreement.

Covenants - The loan agreement requires the Company to comply with various financial, affirmative and negative covenants affecting their businesses and operations, including:

Maintain as of the last day of each applicable period a Tangible Net Worth at least equal to the amount set forth for such period: (a) for each of the fiscal quarters ending June 30, 2012, September 29, 2012 and December 29, 2012, a minimum Tangible Net Worth of 90% of the Tangible Net Worth of the Company on a consolidated basis on the Closing Date, and (b) for the fiscal quarter ending March 31, 2013, and as of the last day of each fiscal quarter thereafter, a minimum Tangible Net Worth equal to that required on December 29 of the immediately preceding fiscal year plus (i) 75% of the Company's after tax net income for such year if such after tax net income is greater than $0, or (ii) $0, if the Company's after tax net income for such year is less than or equal to $0.

Maintain a Fixed Charge Coverage Ratio of not less than 1.10 to 1.00, measured as of (a) June 30, 2012, for the fiscal quarter then most recently ended, (b) September 29, 2012, for the two fiscal quarter period then most recently ended, (c) December 29, 2012, for the three fiscal quarter period then most recently ended, (d) March 31, 2013 and as of the last day of each fiscal . . .

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