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ENGlobal Inc. (NASDAQ:ENG)

Q3 2008 Earnings Call

November 6, 2008; 11:00 am ET

Executives

William Coskey - Chairman and Chief Executive Officer

Robert Raiford - Chief Financial Officer and Treasurer

Natalie Hairston - Investor Relations Officer and Chief Governance Officer

Analysts

Craig Bell - SMH Capital

Graham Mattison - Lazard Capital Markets

Rich Wesolowski - Sidoti & Company

Matt Tucker - KeyBanc Capital Markets

J.D. Padgett - Boston Company

Operator

Greetings and welcome to the ENGlobal third quarter 2008 earnings results conference call. At this time all participants are on a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions)

It is now my pleasure to introduce your host Natalie Hairston, Vice President of Investor Relations and Chief Governance Office of ENGlobal. Thank you. Ms. Hairston, you may now begin.

Natalie Hairston

Thank you operator. Good morning, everyone and thank you for joining for us today. With me on the call are Bill Coskey, Chairman and CEO of ENGlobal and Bob Raiford, CFO and Treasurer.

In a moment, I will turn this call over to Bill Coskey who will highlight management’s perspective on our financial results for the quarter ended September 30, 2008. Bob Raiford will then review other financial points of interest for the quarter and in particular those topics that relate to our balance sheet and cash flow.

Before we begin, I would like to remind everyone that some of the information discussed on this call will contain forward-looking statements that involve risks and uncertainties. These statements are based on current expectations.

Actual results may differ materially from those set forth in such statements. Additional information concerning factors that may cause actual results to differ is contained in the Risk Factors section of our previously filed Form 10-K and 10-Q. All of those filings are available on the Investor Relations page of ENGlobal’s website at www.englobal.com. Our filings with the SEC are also available on the SEC’s website at www.sec.gov.

In addition, non-GAAP measures maybe referenced during the conference call. Proforma data is provided for informational purposes only and is not a measure of financial performance under GAAP. This data does not represent and should not be considered as an alternative to net income, operating income, net cash provided by operating activities or any other measure for determining operating performance, or liquidity calculated in accordance with GAAP.

After our opening remarks, we will have a question-and-answer session. In order to give as many callers as possible the chance to ask a question, please limit yourself to one question and then one follow-up if necessary.

Now I’d like to introduce our Chairman and Chief Executive Officer, Mr. Coskey. Go ahead Bill.

William Coskey

Thank you, Natalie, and good morning. I would like to start by mentioning my recent open letter to ENGlobal stockholders, employees, clients and vendors which was filed as a Form 8-K on October 29, 2008.

I’m sure many of you on this call have already seen and read the letter and therefore I don’t plan to spend time reviewing the same information in any detail this morning, but I point this out mainly for those of you who are new to ENGlobal and this should be a good starting point to help understand our business.

Especially important for investors to understand is the list of 10 different factors in the letter that we expect will continue to support ENGlobal’s business going forward. We’ve been talking about these same points for several years and continue to believe our company is well positioned in our industry, especially given the current economic environment.

Today, ENGlobal reported earnings of $0.13 per diluted share for the third quarter of 2008, which is a $0.01 per share decrease from the $0.14 reported in the prior year period. It’s also down from the $0.24 per share we reported for the second quarter.

For the nine months of this year, our company has produced earnings of $0.51 per diluted share, up about 27% from our $0.40 in the prior year period. We continue to grow as our revenues for the nine months year-to-date increased to $357 million, a 33% increase over the same period last year with all of this growth coming from internal measures.

Our business and many of our people unfortunately had to suffer through the effects of two hurricanes during the third quarter. The company’s operations in Baton Rouge were impacted by the landfall of hurricane Gustav on September 1 and Hurricane Ike’s landfall on September 13, impacted approximately one-third of the company’s operations.

Ike was particularly devastating to our Houston and Beaumont, Texas operations; the power outages lasting up to 10 days and affecting nine of our offices. It’s difficult to calculate the full cost of these hurricanes from lost billable hours, from inefficiencies while restoring our operations and from delayed shipments of equipment needed to complete work, but our business is all about our people and I want to publicly thank our employees who showed so much resilience during this time by returning to work when possible and also by assisting our clients with restoration of their facilities.

I want to spend some time this morning discussing backlog, given the current focus on our industry and the general outlook for future work. First of all, the history of our business has centered on the performance of many hundreds of small to mid sized projects each year.

Many of the projects we perform are called run and maintain. Basically, maintenance related work at existing facilities and a good number of these are awarded and completed within the course of the year. Therefore, I feel the backlog is not always a reliable metric for us as much as it might be for larger ENC firms that have a totally different project profile.

With that being said, a snapshot of ENGlobal’s backlog on September 30, 2008 shows that it has increased roughly 15% since the beginning of this year. I would attribute our backlog to the same 10 factors discussed in the open letter that have driven our business for years, with a few good examples being (1) projects received from long term alliance relationships and (2) requirements for outsourcing our staff to offsite locations.

One trend we are seeing is that current growth in our backlog is coming from lower margin activities such as inspection work in our construction group and implant staffing at our engineering group. To execute on this backlog, our staffing level remains relatively steady at around 2900 employees over the course of the third quarter.

Operating margins in the third quarter fell by 5%, down from 8% in the prior year period and also down from 8.5% in the second quarter. It’s also certainly much less than our annual 2008 goal of 8%; so what happened?

We have identified four general topics that we believe caused our margins to drop and cost the company approximately $0.10 to $0.12 in reduced earnings per share during the third quarter.

The first factor is the hurricanes previously discussed, the resulting loss of billable hours as well as other impacts that are difficult to quantify.

The second point is higher labor burdens which we experienced during the third quarter due to increasing employee benefits and a higher level of health claims and this adjustment to our burden rate was made late in the quarter. However, we have taken action that should result in lowering our labor burden expense starting January 1 of next year.

The third factor is our Automation segment, which had a disappointing third quarter losing almost $600,000 after recording about the same level of profit contribution in the second quarter.

We have lower revenue in the Automation group mainly due to lower first half 2008 bookings and receipt of equipment was delayed due to the hurricane. In addition, reversals were taken during the third quarter on two projects totaling around $500K.

Some positive news from Automation is that they have been very busy responding to proposal requests and has successfully booked $40 million in new business since July 1 of this year. So three things; performance on this new work, plus a higher level of current activity assisting our clients with hurricane recovery, and the recent acquisition of advance controlled engineering in late September; these three things are all expected to contribute to better performance starting in the four quarter for the automation group.

The fourth factor is our construction group and the results here are largely driven at anytime by the mix of business either higher margin construction management work or lower margin inspection work. As previously reported, we are taking action to raise inspection margins, but not much of this is expected to take effect until January 1, because a lot of it is benefit driven.

We also encountered a gap in construction management work starting in September as a large project was demobilized. The personnel that came off this work have now been reassigned during the course of October.

Construction overhead has also increased as there is a significant business development focus to ramp up the higher margin construction management part of our business. We’re starting to see early results from this investment in business development in our construction group and I believe this will be a good investment for our stockholders.

As for our other two groups, Engineering’s profit was down being the most affected by the hurricanes and increased labor burdens. Our land group, mainly acquired in light of projects away from the gulf coast was least impacted by the hurricanes and continue to perform well, ahead of the budget for the year.

I’m proud to report that ENGlobal’s selling, general, and administrative expense for the third quarter 2008 with $7.4 million, a little less than our $7.5 million quarterly target for these expenses. We continue to benefit from good leverage on our SG&A expense as we grow and this expense fell to 6% of revenue in the latest report, which is a new quarterly low from our recent fiscal.

As an update on our South Louisiana Ethanol project and as previously reported, about a year ago, ENGlobal terminated its work on this project due to the failure of our client to obtain permanent financing.

We are continuing with our legal action in the Louisiana Federal Court foreclosing on our mortgage and lien rights and seeking damages of $15.8 million. We have now joined SLE’s bank to this suit and given the fairly straightforward facts in this case that relate to lien priority, we expect to prevail in enforcing our priority position and recovering the amount owed.

As for the fourth quarter, we will be facing some cross currents. Certainly, we don’t expect to see more hurricanes, but our business has always faced some headwind in the fourth quarter. Historically, our billable hours in the fourth quarter are about 15% lower due to seasonal factors when compared to the rest of the year, but in summary, we have taken action and we’ll continue to take action to improve our financial performance in the areas of our business that need to improve.

Just as important for the future, our sense of the market is that the general level of activity for our type of work remains unchanged and that our people continue to have the same optimism and the same excitement about the future that we have had in the recent past. So for these reasons I continue to be encouraged about our prospects for continued growth with improve profitability into the future.

I will now turn the call over to Bob.

Robert Raiford

Thanks, Bill. Good morning, everyone. A lot of the specific details of our third quarter results were disclosed in our press release early this morning, but I would like to highlight other selected items. Unless otherwise stated, the financial comparisons I will make will be to compare the third quarter 2008 results to those of third quarter 2007.

Operations used approximately $3.5 million in net case during the third quarter, compared to approximately $5 million used during the same period in 2007. For the nine months ended, our most recent quarter operations had provided approximately $1 million.

The results of our financial performance and non-cash items were offset by an unfavorable change in working capital during the period. Although the third quarter working capital was positively impacted by decreasing accounts receivable, we experienced unfavorable impacts during the quarter as a result of: A decrease in accounts payable primarily related to significant past through procurement and subcontractor services recorded in the second quarter; a decrease in our accrued compensation and benefits primarily related to the timing of our biweekly payrolls; and a payment of our third quarter federal tax estimate.

We have projected approximately $1.2 million in payments related to the ethanol project to be made during the third quarter, but due to delays in execution of final release agreements with various vendors and subcontractors, we still have approximately $860,000 remaining to fully satisfy our cash commitments to that project. We expect that majority of those payments will be made during the fourth quarter for the current year.

We had invested approximately $233,000 in capital assets during the third quarter compared to a prior year quarterly investment of approximately $791,000. We had expected an additional $500,000 capital investment in the third quarter to complete an IT infrastructure upgrade to meet our internal growth but that investment has been delayed and is expected to be finalized in the fourth quarter. We do not expect a material change in the level of capital investment for the balance of the year.

Additional investing activity included the receipt of $1.4 million from the sale of the office building previously owned in Baton Rouge, Louisiana and $2.8 million in cash requirements for acquisitions.

Overall our long-term commitments, net of current portion increased approximately 21% or approximately $5.6 million from $26.5 million at the end of the second quarter to $32.1 million as of the end of the third quarter. The increase in our overall long-term commitments was primary related to the increase in our credit facility.

For the nine-month period just ended, our overall long-term commitments, net of current portion has increased approximately 10% or approximately $2.8 million from $29.3 million as of December 31, 2007.

As a percentage of stockholders’ equity, our overall long-term debt at the end of the third quarter decreased to 47.4% from 52.5% as of December 31, 2007. Total liquidity, which includes cash plus availability under our credit facility, was $21 million and $15.4 million for the third quarters of 2008 and 2007 respectively.

The outstanding balance on our line of credit at the end of the third quarter was $30.1 million with remaining borrowings available of $19.6 million. We have one outstanding letter of credit issued in November of last year for $247,000 to cover deductibles on our insurance policy period expiring September 30, 2008.

Our credit facility is with Comerica Bank. It provides with a $50 million senior secured revolving credit facility that matures in August of 2010. The agreement is guaranteed by substantially all of the company’s assets and positions Comerica as a senior to all other debt.

Our average day sales outstanding were 61 days for the third quarter compared to 66 days for the comparable three-month period of 2007 and 61 days for the 12-month period ended December 31, 2007. Although our current DSO remains in the mid 50s, we believe more aggressive contract payment terms, improvements in our internal billing process and a more aggressive collection process will be necessary if we are to achieve that goal.

Our effective tax rate for the third quarter was 40.5% compared to 42% during the third quarter of last year at a rate of 39.7% for the year ended December 31, 2007. Our tax provision decreased approximately $88,000 during the third quarter of 2008 compared to a similar provision at last year’s second quarter tax rate.

Our effective tax rate for the nine-month period of 2008 was 40.3% compared to a rate of 41.2% for the comparable prior year period. Our tax provision decreased approximately $63,000 for the nine-month period of 2008, compared to a similar provision of last year’s year-to-date tax rate. We do not expect our tax rate for 2008 to materially change from the effective tax rate for the nine-month period of the current year.

I’d like to thank and give recognition to our accounting staff, our auditors, our consultants, our IT staff and particularly to Terry Allen for their efforts in getting our third quarter filing completed.

As you are aware due to Hurricane Ike, the administrative office in the Beaumont area was damaged. The staff was required to work from home, in crowded conference rooms and other ENGlobal facilities until trailers could be brought in. We are looking forward to moving in to the new facility in latter to mid December.

Thank you for your time this morning. I will now turn the call back to the operator.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Craig Bell - SMH Capital.

Craig Bell - SMH Capital

Bill, you’ve talked a little bit in the letter you had sent out and a little bit in your prepared remarks about the good things you see going on in the business and I guess given the way that your company is set up, you have a lot of sort of the recurring revenue with your in-plant staffing, so you get some insulation from turbulent economy.

Do you see any problem issues with, say maybe call it the alternative projects, like any of the ethanol plants or coal liquids out there, do you see any of those running into further financing problems and I’m not necessarily asking about current projects that you’re working on, but maybe potential ones that might limit the amount of business you can get in the coming months?

William Coskey

I think that type of client is the one most likely to have their project, the ones that are not self-financed, but are not the ExxonMobils and the Chevrons, but the smaller developers. I’ve been surprised that these alternative energy projects are going on and continuing to get financed and I talked to a group out of California yesterday and they have financing coming out of Europe to finance some biofuel projects.

So, what I’ve been told is there is a lot of money waiting on the sidelines and funds ready to be invested and investors feel like alternative energy is a good place to put the money. I believe there is some political wins in the sales now for this effort and will be for the coming years. I think it’s going to be a great area and really to specifically answer your question, I haven’t seen financing to be a limiting factor yet on alternative energy.

Craig Bell – SMH Capital

And then just quickly on the automation business. In the past you had some underperformance there, you’ve made some changes over time. The first couple of quarters of this year, it looked like that was getting back on track. We can see the margins improving and then you have this issue here in the third quarter. I mean what’s it going to take to get this business up to sort of acceptable levels and I mean when do you think you can get it there?

William Coskey

To start with that, I think we’re going to have a very good fourth quarter, our automation factors are mentioned and they’ve landed a lot of work, we’re doing a lot of performance on hurricane recovery. Those things are looking good right now.

The problem I see with automation has been very unpredictable and I think you get some positive surprises, you get a lot of negative surprises just all over the map, and that’s what it is tough to deal with. I think we need to do better forecasting in that group. I think no one like these surprises and I think just better forecasting, probably higher management of our business will be important.

That might be one of the kind of the soft consequences of the hurricane, because that business maybe you can’t account for it on a spreadsheet or financial statement, but maybe that was some of the impact to our business in the third quarter from the hurricane. It was just the fact that certain key people weren’t available to run the business for a pretty good period of time.

Craig Bell – SMH Capital

Okay and then just one quite housekeeping. Bob, did you give what the actual receivables number was or an approximation of it?

Robert Raiford

I’m not sure, what’s your question on the receivables.

Craig Bell – SMH Capital

Just what was the amount of accounts receivables at the end of the quarter?

Robert Raiford

It was $85 million.

Operator

Your next question comes from Graham Mattison - Lazard Capital Markets.

Graham Mattison – Lazard Capital Markets

I just want to follow-up on the automation group. Now in the quarter, the reversal on the two projects, was that related to the hurricane? I thought that was just project specific things and I was wondering if you could just give a little more color on that.

William Coskey

You’re correct. The reversals were on two different projects, one was the [Inaudible] project where we over run the “do not exceed limit” on our release order and another was a fixed price job in the fabrication environment where we put more money to complete the work that we had previously budgeted.

On neither of those projects did we lose money, we just took reversals because we made less profit than previously expected to and we do expect to recover some portion of that amount through change orders which are not yet approved. We’re seeking to recover that amount through change orders, but we can’t count that until our client approves it.

Graham Mattison – Lazard Capital Markets

And then looking at the $40 million in new bookings that have come in, I think you mentioned in the beginning of July, what’s different in the way that you’re signing up that project and what could we look for as the level of comfort in terms of why these same problems wouldn’t pop up on some of these $40 million?

William Coskey

Let’s say it’s a closer level of budgeting, project reviews during the course of the projects are very important. I believe we just have much more project control and attention paid on that group than we used to have.

Graham Mattison – Lazard Capital Markets

So again, is that a more basic blocking tackling as you use to refer to it?

William Coskey

It’s basic blocking and tackling, yes and again forecasting results at the beginning of the quarter instead of finding out at the end.

Graham Mattison – Lazard Capital Markets

And then just in terms of the basic blocking and tackling as a whole, do you think these issues will be taken care of in the fourth quarter or is this really something we’re not going to see the benefits of until the beginning of next year?

William Coskey

Well, if you look at the four issues, the hurricane issue takes care of itself; the labor burden mostly will get taken care of in the first quarter of next year. I believe we will see improvements in automation in the fourth quarter given the reason that I’ve already listed and construction we should see some possible improvement in the fourth quarter.

There were two other issues we didn’t pay a lot of attention to. We had less procurement pass through revenue in the third quarter. That cost us about $0.01 per share from the low margin procurement pass through, but that was approximately offset by lower corporate expenses. They were each about $0.01 per share and they just offset each other, so we didn’t pay a lot of attention with those.

Operator

Your next question comes from Rich Wesolowski - Sidoti & Company.

Rich Wesolowski - Sidoti & Company

Bill, how much procurement pass through revenue was there in the September quarter?

William Coskey

It’s about $7.6 million.

Rich Wesolowski – Sidoti & Company

$7.6 and you had $17 in the June quarter. What would you expect that to be for 4Q?

William Coskey

Well, I mean from this hurricane recovery work, we understand it should go up. I think it’ll be higher than it was in the third quarter from some specific projects for hurricane recovery. I don’t have a number in mind.

Rich Wesolowski – Sidoti & Company

So that will be a positive effect sequentially and then on the other hand, you get a seasonal 15% decline in hours typically.

William Coskey

Right, from the holidays.

Rich Wesolowski – Sidoti & Company

Okay, on the labor benefits, I’m a little confused; you mentioned in the release that the improved employee benefits are one of the reasons why you didn’t perform to your expectations in September, although you stated in the remarks that you’re reducing the benefits. You’re going to get some proven as of January 1; can you flush that out?

William Coskey

Yes, over the course of a year, a year and a half, to retain employees, recruit employees with very hot job market, you give employees better benefits. I mean you share more of the profit basically and I believe we had to bring some of that back in. I think we’ve got a little bit excessive and I think we saw the full forces that in the third quarter, some of the steps we had taken and so we’ve not drastically cut our employee benefit program, we’ve made some kind of selective changes that we feel like will reduce our labor burden.

Rich Wesolowski – Sidoti & Company

Do you think any of these changes would impede what has been a pretty good pattern of headcount growth?

William Coskey

I don’t. We’ve already had several employees on our meetings and have had no negative responses thus far.

Rich Wesolowski – Sidoti & Company

Do you expect to be hiring into 2009?

William Coskey

Yes, we’ll be hiring. Sure, we expect to hire in to 2009.

Rich Wesolowski – Sidoti & Company

Okay. The land group you said was performing well and I understand that it’s uneven quarter-to-quarter, but the gross margin was just 1% versus the high teens rate that you marked in the first half; is there anything to be aware of there?

William Coskey

Land group? I might have to look at that one. I thought they performed roughly equally with the second quarter.

Rich Wesolowski – Sidoti & Company

Unless my math was wrong, you have over $2 million in gross profit in the June quarter and just a couple of 100K in September.

Robert Raiford

No. You’ll have to help me with the numbers on that one.

Rich Wesolowski – Sidoti & Company

Okay, but there was nothing out of the ordinary that impeded the land group?

Robert Raiford

No, they were almost consistent with the results of the second quarter.

Rich Wesolowski – Sidoti & Company

Okay, then my math was off, I apologize. You mentioned that a large portion of the backlog was in the lower margin services, the in-plant; can you discuss what a reasonable margin expectation would be for the four divisions over the next year; gross margin?

William Coskey

I don’t really have an exact number I can give you. Bob can you help me with that?

Robert Raiford

We haven’t completed our budget process for 2009, Rich. We’ll have a better view over that probably in the latter part of November once we finish that process.

Rich Wesolowski – Sidoti & Company

Well, is it reasonable to expect ENGlobal to get back to a 15% plus gross margin that you recorded in 2007?

William Coskey

Well a lot of it depends on our mix of work and it depends on how much faster revenue we have, but I think I’m not backing off our target of 9% operating margins next year. I believe that’s very doable for us still.

Rich Wesolowski – Sidoti & Company

And then finally what was cash from operations if you didn’t say it, Bob; I didn’t catch it.

Robert Raiford

For the quarter we were down $3.5 million.

Rich Wesolowski – Sidoti & Company

Would you expect to generate cash from ops in the fourth quarter?

Robert Raiford

Yes, we would with the receipts from the payments that were made and that we talked about in the third quarter. So we are currently year-to-date cash positive. We would expect that for the balance of the year.

Operator

(Operator Instructions) Your next question comes from [Matt Tucker] - KeyBanc Capital Markets.

Matt Tucker – KeyBanc Capital Markets

My first question is with respect to your cross selling efforts, how much that you see in the quarter and if you could touch on some of the momentum or direction of where that’s headed.

William Coskey

I think it’s very good. More and more of projects involve more and more from our groups and typically what we see is one group. I’ll give as one example, a hurricane recovery job we just landed over in Beaumont and one group pretty much led the effort and brought a couple of other groups along with them and now we’re getting revenue and profit for three of our groups and I’m seeing that more and more.

It’s just a more common occurrence in our company. So I think it’s one of the benefits of the new way we are selling as ENGlobal and branding ourselves as only one company instead of four different companies. It takes a while to get there.

Matt Tucker – KeyBanc Capital Markets

My next question is if you could touch on the pipeline business a little bit, what you kind of activity you’re seeing there currently and maybe kind of near term outlook?

William Coskey

My best gauge, I have two things on that. I used to look at this oil and gas journal study about their expected models of pipeline, expected for next year and I believe that’s going to be slightly less. If my memory serves me correct, there is about 20,000 miles of pipeline expected to be built in 2008 and that was going to be slightly off in 2009.

Really, the best gauge I have is the number of inspectors we have out in pipeline jobs which currently stands at around 800 and that’s continued to stay at a high level. We’ll drop off a little bit during the holidays due to seasonal reasons, but at this point in time, our pipeline activity within our business is still very hot.

We’ve not seen any drop off, and we’ve landed a nice project up in the Balkan, built a crude oil pipeline in that part of the country and that’s an example of where we’ll do some engineering and we’ll do inspection and construction management and several different parts of our company will get to participate.

Matt Tucker – KeyBanc Capital Markets

My final question is, we heard Valero say recently that the queues for engineering work were diminishing. I was wondering if that’s consistent with what you’ve seen and if you think that maybe smaller players are more affected in that sense?

William Coskey

I really think smaller players like us are less affected. I think our company is not usually dependent on multi billion dollar projects and the refiners I’ve talked to still have a long list of maintenance related projects to perform, so a lot of them are compliance driven. I think you will see less huge capital projects. Those types of projects really don’t benefit our company as much as the day-to-day maintenance work.

Matt Tucker – KeyBanc Capital Markets

Actually, just one more question. I know you spoke quite a bit about the automation group, but unless I missed it, if you could touch a little bit about the outlook there?

William Coskey

The outlook as I said for the fourth quarter is very good. We’ve landed a lot of work in the last four or five months. We’re working on one specific project to help a client recover from the hurricane in Beaumont and that’s got a lot of people in that group busy and so we expect to have a good fourth quarter in our automation. The problem again being is there’s no predictability and we just need to try to level out and find some way to get some steady performance out of that group.

Operator

Your next question comes from J.D. Padgett - Boston Company.

J.D. Padgett – Boston Company

A couple of questions; one, I think some of the segment margins in the press release are wrong. I think that was what Rich was looking at when he was computing the gross profits for the segments.

Robert Raiford

We talking about that this morning and I guess they’re really not wrong. The presentation is a little bit different than what we’ve had in the past JD. We’re going to re-issue that release and really the segment profit margins as a percent of total revenue, not of the segment revenue. That’s what kind of distorts it. If you try to calculate that out, it doesn’t quite fit. So we’ll reprint that.

J.D. Padgett – Boston Company

So those are as a percentage of total revenue?

Robert Raiford

Yes. That’s segments a gross profit as a percentage of total revenue not as a percentage of the segment revenue.

J.D. Padgett – Boston Company

The other question was just reflecting back to the last quarter. I thought you guys talked about the procurement or construction of the past two revenues as being something you could sustain in the third quarter? I think most of that was well with the Alon project?

Robert Raiford

Right and they curtailed that project. We expected that project to run through mid fourth quarter. So they kind of curtailed the project for us and it wasn’t anything we could control.

William Coskey

My understanding is the work has been deferred into next year and that was some of the impact in our construction group.

Robert Raiford

They kind of cut it short and unprepared, they just kind of cut it off and we just had to regroup and had some people on the bench so to speak while we’re regrouping in that respect and that’s kind of happens too.

I think it’s the previous caller who asked about our size and our perception is our size gives us a lot of flexibility and the ability to respond to clients not unlike the Alon fire situation or in fact the hurricane damage. We can respond into this client’s seat of responsiveness and to meet their needs. They used us to procure things equivalent to even office furniture or big-engineered type of equipment to get back on track as soon as possible. So I think our size is a positive for us in today’s market in meeting the client needs.

J.D. Padgett – Boston Company

What is your ability to respond to some of those short term needs, you mentioned the hurricane rebuild. Do you need to staff up to do that or do you have the capacity to do that?

Robert Raiford

I think we have capacity and we have employees. We’re working in some cases seven days a week, 12 hours a day to meet the client needs and we’re getting a lot of positive response. That’s kind of what we did on the Alon project and of course timing wise, coming off the Alon project, and coming into the damage from the hurricane, we were well positioned to have staff readily available almost on a day’s notice to put them on site.

J.D. Padgett – Boston Company

Another question I have too is, you mentioned the reason for the short fall in the third quarter was because of employee benefits and so forth. I kind of at that point took that to mean you had to step some things up to make sure that you’re able to retain people and now you’re talking about looking to I guess control that more tightly going forward. It just seems kind of odd, the timing in that; one month you’re needing to boost that to retain people and now you’re think you can drop it back down. I wasn’t really understanding the rationale there.

William Coskey

Well, I guess possibly we overshot somewhat during a very hot job market and without getting into a whole lot of specifics, I think we still had a very competitive benefit plan. We just reigned it back in a little bit.

J.D. Padgett – Boston Company

That just suddenly became apparent in Q3 that maybe you were kind of on the generous side of things?

William Coskey

Yes.

J.D. Padgett – Boston Company

And then you had to take some accruals or something to bring that in line?

Robert Raiford

We did and I think Bill mentioned burden rates and it’s not just employee benefits. Everything that we drive in burden rates is our general liability calls or worker’s comp, our E&O policy coverage, those type of things and not only our medical plan, our 41K plan. We have a partially self-funded medical plan and it adjusted from time to time and we normally reconcile it on a quarterly basis so that’s when we see it.

So, when we put some reserves in, we’re trying to do some things in our benefit, in our risk plan for our business insurance to increase our deductibles, so we’ve taken some additional reserves to give us some room to increase our deductibles and certainly lower our costs going forward.

J.D. Padgett – Boston Company

Okay. Another question is just on the construction business. I know you have some big jobs that are winding down there and you talked about that being disruptive, re-deploying those people, but if you look at the construction revenue it was actually up pretty nicely, September over June. From that, could you infer that those people quickly found a home or how otherwise could have that revenue had been so strong compared to the second quarter.

William Coskey

Well, I guess the inspection-side of our construction business has continued to grow. That’s where the increase in revenue came, more on the inspection field services side of that business as opposed to the construction management side. The asset management, the turnaround management, and this great construction type work. The growth was in our inspection group as opposed to the construction side.

J.D. Padgett – Boston Company

So, the construction management was actually down but then the pipeline inspection was so strong that it offset that and the segment overall grew?

William Coskey

Yes.

J.D. Padgett – Boston Company

Okay. I guess just a final question from me. What’s the methodology that you guys use right now during the course of the quarter; you, as an executive team, to kind of monitor progress of each of the segments and any change you foresee in that given some of the missteps this last quarter?

Robert Raiford

What we do, we produce our monthly statements, and of course we monitor our projects on daily and weekly and biweekly basis in our internal reporting. Everything is subjected to estimates that employees make on percent completion and where they are and we are going to change a few things and tweak some things probably from a benefits or burden standpoint. Try to look at that more on a monthly basis as opposed to a quarterly basis.

There’s a lot of this impacted by our labor numbers. It’s kind of like a fixed charge that you amortize over a labor base and if that labor base goes up or down, it will impact the burden impact for the quarter. So we’re going to start doing that on a monthly basis, so we can keep Bill more apprised of where things are.

J.D. Padgett – Boston Company

Will that type of review process also catch things like the big construction project has wound down and these people seem to be finding homes a little bit more slower than we thought and that would be something that could be communicated more real time versus kind of coming up at the end of quarter when you’re rolling everything up?

Robert Raiford

I think the systems in place are making our management aware of it. I think we’re human beings and policies are realistic into thinking we can place the people and want to hold onto them, because we made an investment in our construction segment and I think when we go forward, we got some core staff we want to retain. So when we do get work available, we can respond to those clients quickly.

J.D. Padgett – Boston Company

Yes, it really wasn’t so much that, it was more question around can you get more real time controls around things when they’re not playing out like you’d like so you can make some adjustments mid stream versus rolling it all up at the end of the quarter and saying, “Dang, we had a couple of short falls here that weren’t apparent to us until just now and by now it’s too late to course correct.”

William Coskey

One thing I’d say, J.D., is that we have a good record for keeping our utilization high over 90% over a long period of time. We did have a process that’s in place like biweekly reports, utilization reports we sent out each manager. That’s an important metric. That’s one of the most important metric we have in our company, is tracking utilization of our available resources and that’s how we’ve been able to keep our utilizations up high over many years, so I don’t really see that to be an issue, but some of your other comments I can agree with, about doing a better job of forecasting results throughout the quarter.

J.D. Padgett – Boston Company

And just staying on top of those forecasts, like we have some short falls in automation, before we make that up as opposed to the end of quarter saying “Darn, we are blindsided by this stuff and here it is.”

William Coskey

Yes, this is the quarter where we had some adjustments, maybe late into the quarter. That’s just like a burden adjustment that we didn’t really know about but I agree we should do a better job of backing out on a monthly basis.

Operator

Your next question comes from Graham Mattison - Lazard Capital Markets.

Graham Mattison – Lazard Capital Markets

Just a follow-up on the gross margins; would it be possible to get those on a like-like basis?

Robert Raiford

On what type of basis?

Graham Mattison – Lazard Capital Markets

You said that they were presented in a different manner than they were in prior quarters, following-up on the question on gross margins.

William Coskey

We’ve got to reissue the press release. [Inaudible] You’re talking about the table in the press release?

Graham Mattison – Lazard Capital Markets

Yes.

William Coskey

We will correct that and reissue that.

Graham Mattison – Lazard Capital Markets

Thank you. Just looking at sort of overall pricing dynamics out there in terms of the market, how do you guys see expanding margins going forward in the current levels? Is it going to be through negotiating better contracts or what’s going to get you up into that 9% operating margin number that you talked about?

William Coskey

Well I’ll say that we have a lot of long term alliances, long term clients and a base load of business and the history has been as we don’t negotiate with others very much, what we have though is when we get a new pieces of business we sign those up at higher rates and so that’s how we’re going to raise our margins. It’s basically through change in the mix of our business towards higher margin work, our billing structures. Keeping the best of the old and bringing in some of the new.

Graham Mattison – Lazard Capital Markets

And given the environment, where the labor markets not as tight as it was, do you see it when you’re negotiating contracts now; are the multipliers sort of leveling off or coming down or are clients a little bit more reluctant to pay the higher rates?

Robert Raiford

I think our rates are typically below market anyway compared to some of our larger people in our sector and so some of the clients are pleased when they get our rates, because they’re used to paying a lot more from some larger firms. I think we still have very competitive billing rights and we do have some room to move them up.

Graham Mattison – Lazard Capital Markets

But generally, the recent changes in the marketplace haven’t impacted those?

Robert Raiford

No. That’s correct.

Graham Mattison – Lazard Capital Markets

Okay and then also do you still have your staff of recruiters? I believe that’s something you’d talked about before that you had to build that group out. Is that still an important part of growth going forward?

Robert Raiford

Yes, it is. We still have the same staff recruits, probably nine or 10 people in that department. They still work every day and locate people and bring them to our company.

Graham Mattison – Lazard Capital Markets

But just overall, do you not happen to give out as robust of benefit packages as you were three, four or five months ago?

Robert Raiford

Let’s not overstate this benefits package thing. The changes we’ve made were fairly minor I believe, so we didn’t make wholesale slashes to our benefit package. We just did a few minor tweaks to it that we believe will lower our labor burden.

Operator

Your next question comes from Rich Wesolowski - Sidoti & Company.

Rich Wesolowski – Sidoti & Company

Just one last follow-up on the automation group; are there any benchmarks or yardsticks Bill, that you internally have to say that if the division doesn’t improve by X date or doesn’t generate sort of profits, then you will have some internal discussions about the going concern status of the division?

William Coskey

I think the fourth quarter will be very telling for that division and drive a lot of our decisions for the future.

Rich Wesolowski – Sidoti & Company

Has that every been discussed internally before?

William Coskey

Yes, it’s been discussed before at our board level.

Operator

Ms. Hairston, there are no further questions at this time. I would like to turn the floor over to you for closing comments.

Natalie Hairston

Thank you, operator, and hello again everyone. I’ll be available to answer any follow-up questions after the call or you can always e-mail me directly at ir@englobal.com. Thank you for being on the call today and thank you as always for your continued support of ENGlobal.

Operator

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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Source: ENGlobal Corporation Q3 2008 Earnings Call Transcript
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