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ENGlobal Corporation (NASDAQ:ENG)

Q3 2009 Earnings Call

November 09, 2009; 11:00 am ET

Executives

Bill Coskey - Chairman & Chief Executive Officer

Bob Raiford - Chief Financial Officer

Natalie Hairston - Vice President of Investor Relations & Chief Governance Officer

Analysts

Graham Madison - Lazard Capital Market

Tahira Afzal - KeyBanc Capital Markets Incorporated

[Jon Brods - Kansas City Capital]

Craig Bell - SMG Capital

Operator

Greetings ladies and gentlemen and welcome ENGlobal Corporation third quarter 2009 Earnings Call. (Operator Instructions).

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

Natalie Hairston

Thank you Joe. Good morning everyone and thank you for joining us today. With me on the call are Bill Coskey, Chairman and Chief Executive Officer of ENGlobal Corporation; and Bob Raiford, Chief Financial Officer and Treasurer. In a moment, I will turn the call over to Bill Coskey, who will highlight management’s perspective on our financial results for the quarter ended September 30, 2009. 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 I 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 and 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 factor 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.

As usual, during the Q&A please limit yourself to one question and then one follow-up if necessary. And now, I would like to introduce our Chairman and Chief Executive Officer, Mr. Coskey. Go ahead, Bill.

Bill Coskey

Thank you Natalie, and good morning everyone. Our break-even financial results in each of the last two reporting quarters demonstrate the reality of the current market for ENGlobal services in the mid stream and down stream domestic energy sectors.

I emphasized the word domestic because international project activity especially for the downstream sectors, is currently much stronger than in the US. As a recap of ENGlobal’s performance for the last year, our business trends, such as billable man hours were ramping downward during both the fourth quarter of 2008 and the first quarter of 2009. However, ENGlobal’s business has somewhat stabilized during the second and third quarters of this year.

Unfortunately, over this time period, we’ve seen about one-third lower levels of billable man hours than we enjoyed at the same time last year. For a number of years, we’ve hoped that ENGlobal business having around two-thirds of its revenue coming from sources that are sustainable and recurring. In fact, we can now feel fortunate to have these sources of sustainable revenue because that is primarily what we’ve been operating all this year. These are activities like number one, in-plant personnel staffing, which has proven to be very stable during the downturn.

Number two, is from smaller projects we call run and maintain, most of which were maintenance related. While clients have cut their maintenance budgets, these projects never go completely away.

Number three, a work that is provided as a result of our long-term client relationship, these used to be called alliance relationships, however, now most of our clients prefer to use the term preferred provider.

Number four, is projects created by technological [Inaudible] of automated control equipment, such as retrofitting, old distributed control systems and analyze our equipments and process plants with fewer technology.

Finally, another big category of sustainable and recurring revenue of work that has a regulatory driver and which has been mandated by various agencies with the federal government, from those like reducing plant emissions, process, safety improvements and pipeline integrity. So, while again we can feel fortunate, the type of work that has been sustaining us tends to produce more of a profit margin. In addition, during the lean time, it becomes less more difficult to maintain utilization of our resources at historical levels.

So to recap, our last two quarters, our various sustainable portions of revenue have produced sufficient profit margins to approximately offset our fixed overhead expenses.

Operating in this manner has allowed ENGlobal to keep its core business structure impact thus preserving our ability to respond quickly to our customer’s needs from capital spending in our markets rebound.

ENGlobal’s management believes that our stockholders were better served in the long run by managing our business in this way during a downturn as opposed to decimating our business structure just to report a small profit. Basically, we’ve made a strategic decision to only clean the tree so far.

As most of you know, historically ENGlobal’s engineering segment and specifically the services we perform in our offices have contributed a majority of the profits for our company over many years. Over the course of this year, in-office engineering has been impacted to the greatest extent, mainly due to a reduced number of capital projects being undertaken by our clients.

Recently, we have been encouraged by improving size within the industry such as, increased proposal activity and client spending plans. We’ve also seen improving clients within our company, such as, upward trends in our bi-weekly billable hours and utilization of resources. In addition, our employee talent has grown from 2200 on June 30th to 2300 at September the 30th.

Towards the end of the third quarter, billable hours and utilization rates have continued to trend slowly upwards. As you might guess, ENGlobal’s business development strategy has changed this year, primarily due to the ongoing recession. Our basic mission is to replace higher margin revenue we have lost from our heritage markets. There really isn’t anything positive about an economic recession, but there is one thing it would be that it forces the businesses to look farther and wider to work.

For example, in our weekly senior management conference call last Friday, our team was encouraged by what we perceive to be increasing project rewards and opportunities from our heritage clients, which are mainly refiners, chemical and petrochemical plants and pipeline operators, but in addition, we spent about the same amount of time discussing recent awards and initiatives in areas that are new to ENGlobal.

And there are three general categories we talked about. Number one is infrastructure projects for state and local governments. Number two, is international mid-stream and downstream opportunities, and number three is renewable energy where a proposal activity has increased, given improved availability of project financing and a similar stimulus package that provides 30% government grants to qualify ENGlobal’s projects.

We also have an active acquisition program in place, and are currently evaluating a number of opportunities and are optimistic that we can close the number of these opportunities over the next 12 months.

In summary, well the current business environments remains uncertain and sluggish, the prospects for our business seem to be slowly improving, but these internal and external trends that I discussed getting traction, we could see a much improved business picture beginning some time next year. The potential for ENGlobal’s return to profitability will involve three things. First, increased capital spending by our clients in our heritage domestic areas of operations and again, this already seems to be getting underway.

Second is success with our internal initiatives in pursuing new lines of business. Some of these opportunities have awarded could be significant for ENGlobal, this emerging area for us will involve infrastructure projects for governmental entities, international energy projects and renewable energy.

Finally, the potential for growth from strategic acquisitions, as we are going to target 10% to 15% annual top line growth are external means by the end of 2010. In the meantime, and in closing, I would like to thank our stockholders for their patience and support during the challenges times your company has faced the past year.

I will now turn the call over to Bob.

Bob Raiford

Thanks Bill. Good morning everyone. A lot of these specific details of our third quarter results were disclosed in our press release this morning, but I would like to highlight other selected items.

Unless otherwise stated the financial comparisons I will make compared to third quarter 2009 results to those of third quarter of 2008. Liquidity remained strong; operations produced approximately $4.5 million in net cash during the third quarter, compared to approximately $3.5 million in cash requirements during the comparable period in 2008.

For the current year, operations has produced approximately $18.5 million in net cash during the nine months ended September 30, 2009. Non-cash items in both third quarters of 2009 and 2008 totaled approximately $1.1 million with amortization of intangibles totaling approximately $445,000 and $225,000 respectively for comparable periods during 2009 and 2008.

Third quarter working capital was positively impacted by a net decrease of approximately $4.5 million in credit receivables the re-class accounts converted to note receivable and cost in excess of billings plus an increase of approximately $2.7 million in accounts payable and accrued compensation and benefits.

Capital expenditures during the third quarter totaled $300,000, compared to expenditures of $233,000 during the third quarter of 2008. We perceived minimum capital expenditures in the fourth quarter and we do not expect to exceed our credit facilities annual limit of $3.25 million for CapEx commitments during 2009.

Our long term commitments, net of current portions decreased approximately $22.7 million from $23.6 million at the end of December 2008 to $900,000 as of September 30 2009. Decrease in our net cash long term debt during the third quarter was almost entirely due to the re-class of our existing credit facility to a current liability. As a percentage of stockholder’s equity our total debt at the end of the third quarter decreased to 14.8% compared to 33.5% at the end of 2008.

Total liquidity, which includes cash plus availability under our credit facility was $39.8 million at the end of the third quarter, compared to $21 million for the same period in 2008. The outstanding balance in our line of credit at the end of the third quarter were $10 million with remaining available borrowings of $39.4 million.

Our outstanding letters of credit were approximately $600,000 primarily to cover project retentions and deductibles under insurance policies. Our credit agreement with Comerica Bank provided 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 subsidiaries, is secured by substantially all of the Company’s assets and positions Comerica as senior to all other debt.

At the company’s options amounts borrowed under the credit facility for an interest at prime or a euro, dollar based rate plus additional margin ranging from 125 to 175 basis points. This additional margin is based on our most recent leverage ratio. Currently, we have $10 million of our outstanding credit facility on a 30-day Euro based rate internal. As of August 10, 2009, our credit agreement did by its terms become due in less than a year. As such the total outstanding balance under that agreement with reclassified to our current liability.

We are reviewing our options for replacing this credit facility primarily due to certain covenant limitations. We are in compliance with all our covenants and continue to weigh our options giving the current banking environment. Our average days outstanding was 65-days for the quarter just ended compared to 61-days at the end of the third quarter in 2008. Our DSO was 64-days at the end of 2008, and 72-days and 69-days for the respective first and second quarter results during the current year.

We do not expect our average days outstanding to materially change in the fourth quarter although, we do expect the see improving trend for the year continue if revenue stabilize and aged accounts are collected. Our effective tax rate for the nine months ended 2009 was 44.1%, compared to a rate of 40.3% for the first nine months period in 2008 and a rate of 39.9% for the year ended December 31, 2008.

We computed effective tax rate for the three months period ended September 30, 2009 is higher because we raised out estimates for fiscal year, effective tax rate to reflect proportionate changes and components of pre-tax income for the year. We do not expect our tax rate for 2009 to materially change for the balance of the year unless we see material changes in earnings during that period.

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 Graham Madison - Lazard Capital Market.

Graham Madison - Lazard Capital Market

I wondered if you could just sort of comment, you talked about activity levels and bid activity improvement, could you compare this to sort of the level that you saw the company last year at this time or even two years ago at this time?

Bill Coskey

Well, the best way we can look at that really is through billable man hours and I would say in the second and third quarters of the last year our billable man hours were running $230,000 and $240,000 for biweekly periods. And probably our most latest number is around a $180,000. So by that measure we are still roughly down about 25% from our best levels of last year.

Graham Madison - Lazard Capital Market

So then looking back sort of two years ago or the early part of the cycle, how could we compare that?

Bill Coskey

Well, we are pretty much a growing company up through about the third quarter of last year, 2008. And so, I haven’t looked up far back, but I would say the levels we have now are comparable to ones we were showing maybe in 2007 or something like that.

Graham Madison - Lazard Capital Market

Then in terms of, looking at your land group, could you just give a little bit more color in terms of what you are seeing there? I mean, obviously the pipeline market seems to be picking up, are you still adding people in that division and is there room for a potential market expansion?

Bill Coskey

Yes Graham, in the last month we have added about 17 people for our land group. Primarily we are going to be doing some land acquisition work on a pipeline project that runs out of the Haynesville to that ridge, a fairly large diameter line, and we are doing a portion of that line. I think 30% or 40% of the link to that line will be acquiring right away, and so pipeline activities mainly being driven by the shale employees, Haynesville Marcellus, the Balkan, Rocky Mountains.

We are starting to see a bigger piece of our land business involved in electric transmission lines and I believe has grown to maybe even be about a third of that business right now being involved in electric power transmission about two third’s pipeline.

Graham Madison - Lazard Capital Market

Then just one last question if I could, I mean overall if you look out to next year and you started to, we have definitely stabilized and are beginning to pick backup. The recovery, do you see it more weighted towards the second half of the year or do you think the recovery could be more towards the first half of the year and then continue to grow throughout?

Bill Coskey

That’s difficult to say. Obviously I believe as certain things happen especially with our newer areas of focus, it could be in the first half of the year. But the stronger area right now is really the pipeline area for us, that’s where we are seeing continued large capital spending.

The downstream areas continuing to produce a good number of run and maintain projects, but what we are lacking is the large capital work in domestic downstream, and that’s why we are looking into new areas to replace this lost revenue.

Operator

Your next question comes from Tahira Afzal - KeyBanc Capital Markets Inc.

Tahira Afzal - KeyBanc Capital Markets Inc

My first question has to do with your engineering segment. As you look at your performance in the third quarter and you look at the pipeline of projects, if you look at that $32 million, could you give some color on how much of that is sort of maintenance procuring business versus maybe some project legacy, projects that are still running through your backlog and hence through your numbers?

Bill Coskey

I would say in the third quarter we had very little legacy work, I would say we had very little large capital work, what we saw running through in the third quarter was maintenance related activity, small maintenance work. In general run and maintain.

Tahira Afzal - KeyBanc Capital Markets Inc

So, I mean, as you look at the second and third quarter and we see sort of the engineering lines stabilizing at let’s say, $32, $33 million, would you say that decent steady run rate as you make, there is no material change on the project side?

Bill Coskey

I think given the nature of our business that’s probably a stabilized run rate, we have to consider a little bit of seasonality in the fourth quarter, maybe not that much this year. But, again, our billable hours are up when compared to levels we saw in both the second and third quarter and we hope we are starting to see the beginning of slow upturn of our metrics.

Tahira Afzal - KeyBanc Capital Markets Inc

As soon as you look at your pipeline of projects would you say that’s similar as well as essentially baseline maintenance regarding projects on the engineering side now?

Bill Coskey

Yes. With the exception of few specific opportunities and especially ones in these three new areas I have pointed out, most of the domestic engineering opportunities that run and maintain smaller variety and that’s out feeds our machine on a daily basis.

Tahira Afzal - KeyBanc Capital Markets Inc

I have one more question and then I will jump back in the queue Bill and queue up for some more. If you look at the documents that you have seen in your margins, it’s clearly the engineering segment and the utilization and pricing has been the impact, if you look year on year, is it possible to give an idea of how much of the operating margin fall off is due to utilization versus pricing?

Bill Coskey

I’ll let Bob answer that. Do you have a data point on that.

Bob Raiford

Yes. I think we looked at it will be detailed on our Q. I think for the third quarter probably about two 2.4% of our margin we could attribute to I guess the lower utilization rates on a year-to-date basis probably about 2.7%. So we have seen some improvement in the third quarter, probably in the utilization and improving that result.

Operator

Your next question comes from [Jon Brods - Kansas City Capital].

Jon Brods - Kansas City Capital

Bill you touched on three areas of new business focus, the infrastructure international and renewable, when you look at your billable hours, how much of your billable hours are now in those areas? How small percent is that? And can you give us a sense as to what may be an objective or a goal or a target whatever you want to call in terms of percentage billable hours?

Bill Coskey

That’s an excellent question. I would say right now my fancy number would be about 5% of our current man hours. From work on foreign projects work on infrastructure project and renewable energy.

I think the thing we are excited about is really the magnitude of some of these opportunities in renewable energy and in infrastructure and in foreign it really could provide some of that big man hour, large man hour work that we are lacking here in the US right now.

I don’t really have a target in mind to what it become; it can be 20%, 30%, 35%. But in each one of these areas we have undertaken the number of initiative. In some cases we hired individuals on our staff to develop business. In some cases we’ve retained commission agents, in particular in the case of infrastructure that’s the case that have contacts in the governmental markets.

In renewables, a lot of times it’s the partnering with technology companies and bringing technology to developers is what helps us out. It’s a working in process is what I would say. Given the size, I mean some goals could be performing $50 million or $60 million projects for various renewable projects, or performing $30 million, or $40 million or $50 million projects overseas. So, compared to where we are today that could be similar.

Jon Brods - Kansas City Capital

Yes, okay, the other thing as you mentioned, that you are doing a little bit more work in the land area regarding the transmission, and I had just read a couple of reports that some of the utility companies seem to be scaling back their capital spending plans maybe even beyond sort of the G&D area, and more and into the transmission area. Have you seen any weakness in that regard? You said, you are going to do more, but have you seen any projects canceled or delayed postponed?

Bill Coskey

Well, I think we are already doing more, I think we’ve seen some deferrals, plan stretch out, I don’t think we’ve seen any cancellation. Most of our work in the transmission area is in the west.

Involving western wind power, solar power, bringing that to market and most of our work would be smaller, we might be doing, 100 mile, 150 mile power lines in much bigger projects, and so, we haven’t seen any curtailment work, we still have good opportunities out there for us.

Operator

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

Craig Bell - SMG Capital

You had talked about your credit facility moving to current. When do you hope to have that wrapped up in terms of a re-negotiator or a new one in place?

Bob Raiford

We’ve started, I guess, to look at some opportunities out there, and just may have one by the end of; I guess the fourth quarter may be the first quarter of 2010. I see a lot there Greg. To do that Greg, I guess because we have such a good interest rates.

Craig Bell - SMG Capital

Yes, and then you are contemplating something about similar size?

Bob Raiford

No, I would suspect we will cut that down; we don’t need that unless we see a return immediately of our markets, we quite listen to them, maybe like a 50% of our current credit.

Craig Bell - SMG Capital

Okay, and then looking at your engineering segment, and Bill, you talked a little bit about it, but I mean are you getting increased confidence, that we are going to see that bottom out in terms of the revenue declines?

Bill Coskey

From the numbers I’m saying we have been through a bottoming process, really all through the second and third quarter, if you would just look at man hours in that segment, it’s been a longer bottom and starting to see the first inclines that are turning up.

Operator

Your next question comes from Tahira Afzal - KeyBanc Capital Markets Inc.

Tahira Afzal - KeyBanc Capital Markets Inc

Bill, just to follow up. You reached this point where hopefully the engineering segment is reaching a steady state perhaps rising while we are stabilizing, as you look over the near term versus the long term which I assume a lot of these opportunities will take hold, what would you say would be key drivers to you moving beyond sort of breakeven point, is it more cost cut, cost trimming, or would you say it’s utilization on specific businesses?

Bill Coskey

I think we can make some slight improvements to our current utilization, we are running in the high 80s right now, historically we’ve run around 90%, the latest number I got was right at 89.8% for utilization. So, 90% and plus amount of a couple of percentage points is the band we would like to run in.

I don’t think cost cutting is where that, I think it’s just increased work, it’s just bringing in increased level of revenue particularly over our fixed overhead base of operations is what it’s going to be, and I really don’t see any continued pressure on margins or billing structures. I think that’s pretty much in this.

I think it’s going to be a little bit our domestic clients spending more money on capital work, and I think there is going to be some success in these three year period that we mentioned, it’s what’s going to bring our engineering company back.

Tahira Afzal - KeyBanc Capital Markets Inc

And you mentioned earlier on Bill that you are seeing some of your clients sort of showing a creative amount of commitment to growing ahead with their plans, are they on the refinery and on the downstream side, are these guides do then really firming up the CapEx budget for 2010 or is it just a general macro improvement and that’s really making them spend, get a little more comfortable with spending on some of the deferred projects etcetera that they had.

Bill Coskey

I think what we are seeing right now from the domestic downstream area is deferred maintenance work. I don’t think we have seen any significant large capital work to speak of.

We are expecting an extended, I mean I am expecting an extended period of time of low capital spending in the domestic downstream inventory, a lot of that’s driven by and certainly created around Cap and trade, and if you have an old plan and you are refining, why would you want to go make a big investment in it, if you have that sort of hanging over your head. And a lot of it relates to utilization of these facilities and margins and spreads.

So, there is not many positives out there right now for the processing business of large capital work, and that’s really what stimulates us to look at these other areas. And it will eventually come back as it always does, but I think it’s going to be an extended period of time before it does.

Tahira Afzal - KeyBanc Capital Markets Inc

And Bill, if you look at a year back you had the $60 million sort of run rate on the engineering side and now you are down to the 30s, how much of that do you think is related to deferred maintenance versus capital projects going away?

Bill Coskey

I don’t have a number on top of my head, but I would say a lot, if not most of it, will have to be a reduction in capital work. And I believe what we are seeing is a base load of maintenance work in our engineering segment right now.

Operator

There are no further questions at this time. I would like to turn the floor back over to management for any additional or closing comments.

Natalie Hairston

Thank you Joe. Hello again everyone. I will be able to answer any follow-up questions this afternoon 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.

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Source: ENGlobal Corporation Q3 2009 Earnings Call Transcript.
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