MANAGEMENT’S DISCUSSION AND ANALYSIS
ITEM
2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Forward-Looking Statements
Certain information contained in this Quarterly Report on Form 10-Q, as well as other written and oral statements made or incorporated by reference from time to time by the Company and its representatives in other reports, filings with the Securities and Exchange Commission, press releases, conferences or otherwise, may be deemed to be forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. This information includes, without limitation, statements concerning the Company's future financial position and results of operations, planned capital expenditures, business strategy and other plans for future operations, the future mix of revenues and business, customer retention, project reversals, commitments and contingent liabilities, future demand and industry conditions. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Generally, the words “anticipate,” “believe,” “estimate,” “expect,” “may” and similar expressions, identify forward-looking statements, which generally are not historical in nature. Actual results could differ materially from the results described in the forward-looking statements due to the risks and uncertainties set forth in this Quarterly Report on Form 10-Q, the specific risk factors identified in the Company's Annual Report on Form 10-K for the year ended December 26, 2015, and those described from time to time in our future reports filed with the Securities and Exchange Commission.
The following discussion is qualified in its entirety by, and should be read in conjunction with, the Company's condensed consolidated financial statements, including the notes thereto, included in this Quarterly Report on Form 10-Q and the Company's Annual Report on Form 10-K for the year ended December 26, 2015.
Overview
ENGlobal Corporation (which may be referred to as “ENGlobal,” the “Company,” “we,” “us” or “our”), incorporated in the State of Nevada in June 1994, is a leading provider of engineering and professional services principally to the energy industry through two segments: Engineering, Procurement and Construction Management (“EPCM”) and Automation engineering and integrated products (“Automation”).
Results of Operations
The Company recognizes service revenue when the services are performed. The majority of the Company's engineering services have historically been provided through time-and-material contracts and a majority of the Company's engineered automation system revenues 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 general 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 percentage of revenue may not be indicative of the Company's core business trends. Segment 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. Corporate SG&A expenses include finance, accounting, human resources, legal and information technology which are unrelated to specific projects but which are incurred to support corporate activities.
ENGLOBAL CORPORATION AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS
Comparison of the three months ended March 26, 2016 versus the three months ended March 28, 2015
The following table, for the three months ended March 26, 2016 versus the three months ended March 28, 2015, provides relevant financial data that is derived from our consolidated statements of operations (amounts in thousands except per share data).
Operations Data
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|
EPCM
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|
|
Automation
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|
|
Corporate
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|
|
Consolidated
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|
|
|
Three months ended
March 26, 2016:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
8,527
|
|
|
$
|
6,285
|
|
|
$
|
—
|
|
|
$
|
14,812
|
|
|
|
100.0
|
%
|
Gross profit
|
|
|
634
|
|
|
|
1,039
|
|
|
|
—
|
|
|
|
1,673
|
|
|
|
11.3
|
%
|
SG&A
|
|
|
769
|
|
|
|
743
|
|
|
|
1,878
|
|
|
|
3,390
|
|
|
|
22.9
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%
|
Operating income (loss)
|
|
|
(135
|
)
|
|
|
296
|
|
|
|
(1,878
|
)
|
|
|
(1,717
|
)
|
|
|
(11.6
|
)%
|
Other income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6
|
|
|
|
|
|
Interest expense, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(36
|
)
|
|
|
|
|
Tax benefit
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
998
|
|
|
|
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(749
|
)
|
|
|
(5.1
|
)%
|
Diluted income (loss) per share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(0.03
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended
March 28, 2015:
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
13,298
|
|
|
$
|
9,804
|
|
|
$
|
—
|
|
|
$
|
23,102
|
|
|
|
100.0
|
%
|
Gross profit
|
|
|
2,058
|
|
|
|
2,064
|
|
|
|
—
|
|
|
|
4,122
|
|
|
|
17.8
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%
|
SG&A
|
|
|
724
|
|
|
|
706
|
|
|
|
2,574
|
|
|
|
4,004
|
|
|
|
17.3
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%
|
Operating income (loss)
|
|
|
1,334
|
|
|
|
1,358
|
|
|
|
(2,574
|
)
|
|
|
118
|
|
|
|
0.5
|
%
|
Other income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
619
|
|
|
|
|
|
Interest expense, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(22
|
)
|
|
|
|
|
Tax expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(92
|
)
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
623
|
|
|
|
2.7
|
%
|
Diluted income (loss) per share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
0.02
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase (Decrease) in
Operating Results:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
(4,771
|
)
|
|
$
|
(3,519
|
)
|
|
$
|
—
|
|
|
$
|
(8,290
|
)
|
|
|
(35.9
|
)%
|
Gross profit (loss)
|
|
|
(1,424
|
)
|
|
|
(1,025
|
)
|
|
|
—
|
|
|
|
(2,449
|
)
|
|
|
(59.4
|
)%
|
SG&A
|
|
|
45
|
|
|
|
37
|
|
|
|
(696
|
)
|
|
|
(614
|
)
|
|
|
(15.4
|
)%
|
Operating income (loss)
|
|
|
(1,469
|
)
|
|
|
(1,062
|
)
|
|
|
696
|
|
|
|
(1,835
|
)
|
|
|
(1555.1
|
)%
|
Other income (expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(613
|
)
|
|
|
|
|
Interest expense, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(14
|
)
|
|
|
|
|
Tax expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,090
|
|
|
|
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(1,372
|
)
|
|
|
(120.2
|
)%
|
Diluted income (loss) per share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(0.08
|
)
|
|
|
|
ENGLOBAL CORPORATION AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS
Revenue –
Revenue decreased $8.3 million to $14.8 million from $23.1 million, or a decline of 35.9%, for the three months ended March 26, 2016, as compared to the three months ended March 28, 2015. Revenue from the EPCM segment decreased $4.8 million to $8.5 million from $13.3 million, or a decline of 36.1%, for the three months ended March 26, 2016, as compared to the three months ended March 28, 2015. Revenue from the Automation segment decreased $3.5 million to $6.3 million from $9.8 million, or a decline of 36.1%, for the three months ended March 26, 2016, as compared to the three months ended March 28, 2015. Revenue for both the EPCM and Automation segments were negatively impacted by the significant decline in oil and gas prices and the subsequent drop in our clients’ activities in the upstream, midstream and downstream sectors of the energy industry. Recognizing the implications of declining oil prices in 2015, we have taken steps to mitigate and reverse the declining revenue trends. In the latter half of 2015, we hired three seasoned business development professionals and another in the first quarter of 2016. While it will require time for these efforts to generate revenue, our proposal activity has increased and our backlog has improved. We expect to see the continued benefits of these efforts in the second half of 2016 subject to the overall level of spending in the energy sectors that we concentrate in.
Gross Profit –
Gross profit decreased $2.4 million to $1.7 million from $4.1 million, or a decline of 59.4%, and the gross profit margin declined to 11.3% from 17.8% for the three months ended March 26, 2016, as compared to the three months ended March 28, 2015. The gross profit for the EPCM segment decreased $1.4 million to $0.6 million from $2.0 million and the gross profit margin decreased to 7.4% from 15.5% for the three months ended March 26, 2016, as compared to the three months ended March 28, 2015. The gross profit for the Automation segment decreased $1.1 million to $1.0 million from $2.1 million and the gross profit margin decreased to 16.5% from 21.1% for the three months ended March 26, 2016, as compared to the three months ended March 28, 2015. The gross profit margin for both the EPCM segment and the Automation segment were negatively impacted by higher variable labor costs as a result of lower manpower utilization which increased to 10.4% of revenue from a more typical 5.3% of revenue on a consolidated basis for the three months ended March 26, 2016 compared to the three months ended March 28, 2015. We have initiated cost savings measures in the second quarter by introducing a furlough program and reducing our payroll burden which should positively impact our gross profit margins for future periods. We intend to monitor labor utilization for both the EPCM and the Automation segments with the goal of improving gross profit margins while remaining positioned for a potential rebound and growth in future periods.
Selling, General and Administrative –
Overall our SG&A expenses decreased by $0.6 million to $3.4 million from $4.0 million for the three months ended March 26, 2016, as compared to the three months ended March 28, 2015. This decrease was due to a $0.3 million bonus the Company paid in the first quarter of 2015 to cover payroll taxes for employees who received restricted stock pursuant to the Company’s equity incentive plan which was not repeated in the first quarter of 2016, a $0.1 million decrease in office expenses, a decrease of $0.1 million in contract services and a $0.1 million decrease in depreciation and amortization. We have initiated cost savings measures in the second quarter to reduce corporate operating expenses and payroll burden costs in line with market conditions while remaining positioned for a potential rebound and growth in future periods.
Other Income (Expense)
– Other income was $0.0 million versus $0.6 million for the three months ended March 26, 2016, as compared to the three months ended March 28, 2015. The quarter last year benefitted from $0.6 million in the collection and recognition of a gain on a notes receivable that had been fully reserved for.
Interest Expense, net -
Interest expense was essentially flat and was less than $0.1 million for both the three months ended March 26, 2016 and the three months ended March 28, 2015. Our interest expense consists primarily of interest on our capital leases, amortization of the cost of entering into the Loan Agreement with Regions Bank, Loan Agreement commitment fees and other fees associated with the Loan Agreement. We currently have no amounts outstanding under the Loan Agreement
.
Tax Expense –
The Company recorded a $1.0 million income tax benefit versus a $0.1 income tax expense for the three months ended March 26, 2016, as compared to the three months ended March 28, 2015. The tax benefit was principally due to a pre-tax loss for the three months ended March 26, 2016, as compared to pretax income for the three months ended March 28, 2015. The effective income tax rate for the three months ended March 26, 2016 was 56% as compared to 13% for the three months ended March 28, 2015. The effective tax rate for the three months ended March 26, 2016 differed from the federal statutory rate of 35% primarily due to state income taxes and a partial valuation allowance on foreign tax credits. The effective tax rate in the three months ended March 28, 2015 differed from the federal statutory rate of 35% primarily due to the valuation allowance placed against deferred tax assets. In the fourth quarter of fiscal 2015, we released the majority of our valuation allowances.
Net Income –
Net loss for the three months was $0.7 million or a $1.3 million decrease from the $0.6 million in earnings for the three months ended March 26, 2016, as compared to the three months ended March 28, 2015 as a result of lower revenues and gross profit, partially offset by lower selling and administrative expenses and an income tax benefit.
ENGLOBAL CORPORATION AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS
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. Our primary sources of liquidity are internally generated funds and up to $10 million of availability under the Loan Agreement with Regions Bank discussed under “Line of Credit Facility” below. There were no borrowings outstanding under the facility as of March 26, 2016, or as of December 26, 2015. We had cash of approximately $11.8 million at March 26, 2016, and $7.8 million as of December 26, 2015. Our working capital as of March 26, 2016 was $23.9 million versus $25.6 million as of December 26, 2015. We believe our current cash on hand, availability under the Loan Agreement and our other working capital are sufficient to fund our ongoing operations.
Cash and the availability of cash could be materially restricted if (1) outstanding invoices billed are not collected or are not collected in a timely manner, (2) circumstances prevent the timely internal processing of invoices, (3) we lose one or more of our major customers, or (4) we are unable to win new projects that we can perform on a profitable basis. Actions outside of our control may hinder or preclude the collection of these receivables.
Cash Flows from Operating Activities
Operating activities generated $4.4 million in cash versus a use of $0.7 million for the three months ended March 26, 2016, as compared to the three months ended March 28, 2015. The primary drivers of our increase in cash provided by operations for the three months ended March 26, 2016 were an increase in collections of trade receivables, reductions to cost in excess of billings and prepaid expenses offset by a net loss of $1.8 million
Cash Flows from Investing Activities
Investing activities used cash of $0.1 million versus generating $0.7 million for the three months ended March 26, 2016, as compared to the three months ended March 28, 2015. Expenditures for property and equipment were $0.1 million versus $0.3 million for the three months ended March 26, 2016, as compared to the three months ended March 28, 2015. The period ended March 28, 2015 included a $1.0 payment for notes receivable that had been reserved for in prior periods. Expenditures for property and equipment for full year 2016 are budgeted to be approximately $0.5 million. The Loan Agreement with Regions Bank limits our annual capital expenditures to $3.5 million.
Cash Flows from Financing Activities
Financing activities used cash totaling approximately $0.3 million versus $0.2 million for the three months ended March 26, 2016, as compared to the three months ended March 28, 2015. The primary use of cash in this quarter was from the repurchase of common stock and to a lesser extent payment of obligations under capital leases.
Line of Credit Facility
On September 16, 2014, the Company entered into a three year Loan and Security Agreement (“Loan Agreement”) with Regions Bank (“Lender”) pursuant to which the Lender agreed to extend credit to the Company in the form of revolving loans of up to the lesser of $10.0 million (the "Commitment") or the Borrowing Base. The Loan Agreement includes a sub-facility for standby and / or trade letters of credit up to an amount not to exceed $2.5 million. There were no loans outstanding under this Loan Agreement as of March 26, 2016 or December 26, 2015.
Borrowing Base:
The Borrowing Base is an amount equal to the sum of (a) 85% of the total amount of Eligible Approved Cost Plus Contract Amounts, plus (b) the lesser of (i) 85% of the total amount of Eligible Approved Fixed Price Contract Accounts or (ii) $2,500,000, plus (c) the lesser of (i) 85% of the total amount of Eligible Approved Government Contract Accounts or (ii) $1,000,000, plus (d) the lesser of (i) 75% of the total amount of Eligible Unbilled Accounts or (ii) total revenues from all Accounts over the preceding 30-day period, provided that to the extent that any Eligible Unbilled Accounts consist of Accounts that would be Eligible Approved Government Contracts and be included in provision (c) above if billed there shall be a limitation in eligibility thereof under this provision (d) of $800,000, plus (e) 75% of the total amount of Eligible Costs in Excess of Billings, and minus (f) such amounts as may be required by Lender to be reserved at any time and from time to time.
ENGLOBAL CORPORATION AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS
Interest:
Any loans will bear interest at a rate per annum equal to the LIBOR Index Rate plus 2.25%. If the loan is converted to a Base Rate Loan, then such loan will bear interest at a rate per annum equal to the Base Rate (defined as a rate per annum equal to the greatest of (a) the Federal Funds Rate in effect on such day plus 0.50%, (b) the Prime Rate in effect on such day, or (c) a per annum rate equal to LIBOR determined with respect to an interest period of one month plus 1.00%) plus 1.25%.
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).
Term
: All loans and all other obligations outstanding under the Loan Agreement shall be payable in full on September 14, 2017, unless otherwise terminated pursuant to the terms of the Loan Agreement.
Material Covenants:
The Loan Agreement requires the Company to comply with various financial, affirmative and negative covenants affecting its businesses and operations, including:
·
The Company will not be a party to mergers, acquisitions, consolidations, reorganizations or similar transactions.
|
·
The Company will not sell, lease, transfer or otherwise dispose of any of its properties or assets (subject to certain exceptions set forth in the Loan Agreement).
|
·
The Company will not declare, pay or make any dividend or distribution on any shares of common or preferred stock or make any cash payment to repurchase or otherwise retire any common or preferred stock, provided that the Company may repurchase up to $2 million of its common stock pursuant to its announced stock repurchase plan, subject to certain conditions.
|
·
The fixed charge coverage ratio must not be less than 1.10 to 1.00.
|
·
The Company will not permit capital expenditures during any fiscal year to exceed $3.5 million.
|
The Company is in compliance with all of the material covenants of the Loan Agreement as of March 26, 2016.
Stock Repurchase Program:
On April 21, 2015, the Company announced that its Board of Directors had authorized the repurchase of up to $2.0 million of the Company’s common stock from time to time through open market or privately negotiated transactions, based on prevailing market conditions. The Company is not obligated to repurchase any dollar amount or specific number of shares of common stock under the repurchase program, which may be suspended or discontinued at any time. As of March 26, 2016, the Company had purchased 318,355 shares for an aggregate amount of $305 thousand under the repurchase program.