ENGlobal Corp (ENG) 2007 Q2 法說會逐字稿

Greetings and welcome to the ENGlobal Corporation second-quarter 2007 earnings conference call. At this time all participants are in a listen-only mode. A brief question-and-answer will follow the formal presentation. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Natalie Hairston, Investor Relations officer and Chief Governance Officer. Thank you, Ms. Hairston, you may begin.

Thank you, operator. Good morning, everyone, and thank you for joining us today. With me on the call are Bill Coskey, Chairman and CEO of ENGlobal Corporation, and Bob Raiford, CFO and Treasurer. In a moment I will turn the call over to Bill Coskey who will highlight managements' perspective on our financial results for the quarter ended June 30, 2007. 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 began I would like to remind everyone that some of the information discussed on this call will contain forward-looking statements that involve risks and uncertainty. 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 -- are contained in the risk factor section of previously filed forms 10-K and 10-Q. All of those filings are available on the Investor Relations page of ENGlobal's website at ENGlobal.com. Our filings with the SEC are also available on the SEC's website at SEC.gov.

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. And now I would like to introduce our Chairman and CEO, Mr. Coskey. Go ahead, Bill.

Thank you, Natalie. Good morning. I believe ENGlobal's entire management team can take pride in our second-quarter results that were announced this morning as by almost any measure comparisons with our historical financials are very good. Our earnings per share in a basic calculation came in at a quarterly record of $0.15 for the three months just ended which compares to $0.12 for the first quarter of this year and $0.09 for the second quarter last year.

What I would like to do this morning is to go through some parts of our financials and hopefully provide a little more explanation and perspective on our results. In very general terms ENGlobal is continuing to benefit from an upward trend in cost-plus global work in our engineering segment which is being seen by most of our operations. In particular I would point to our field services and inspection operations, several of our engineering offices and our automation group is providing much of this upward trend in billable hours.

In addition, we have been able to realize further progress on our goal of increasing operating margins and much of our success with operating margins this quarter came from our ability to leverage overhead expenses. For comparison purposes, ENGlobal's operating profit margins have trended from 4.8% in the second quarter of last year to 6.8% in the first quarter of this year to 7.7% in the latest quarter.

To review, if I had to give a quick summary of what drove our record earnings that were just reported it would consist of those two main factors -- number one, an increased level of business consisting mainly of cost-plus billable work; and number two, the success we have experienced with some of our measures to improve operating profitability.

In terms of revenue, ENGlobal continues to be a growing company, as our top line grew 19% from the same quarter of last year and it's also important to note that roughly one-half of our quarter-over-quarter revenue increase was attributable to organic or non acquisition growth. Sequentially our revenue grew an impressive 10% going from the first to the second quarter of this year.

Probably the most important thing to notice on the subject of revenue is how our mix of business has changed over time, with this change being mostly intentional on our part. Using the breakdown of revenue shown in our press release as a guide, the Company has successfully reduced the level of its fixed-price EPC work and replaced it with much more predictable cost-plus billable work that is being performed both at our offices and infield locations.

This same chart shows our fastest growth occurring in the area of field services and inspection which has seen success in growing activities like pipeline inspection and construction management. We have also seen good growth at several of our engineering offices and in plant staffing operations as indicated in the detailed line item of that chart.

A good indication of increasing activity in our business is our biweekly billable hours which averaged 189,000 hours, up 39% from the second quarter of last year. In fact, we reached a record 201,000 billable hours in a two-week period late in the second quarter of 2007, an 11% increase over the comparable period.

The Company's overall utilization percentage inclusive of overhead personnel is approximately 91% for the second-quarter of 2007 compared to 88% for the comparable period of 2006 and up 1 percentage point from 90% during the first quarter of 2007. We are also proud to announce that ENGlobal successfully added 190 employees to our staff in the second quarter alone. And as of June 30th of this year we had 2477 employees on the ENGlobal team which is up 29% from one year ago.

Our gross profit for the second quarter increased $3.5 million to $14.2 million or up 33% when compared to the second quarter last year. Looking at our gross profit margin percentage, it showed an increase of 1.6 percentage points when doing the same year-over-year comparison from 14.3% to 15.9%. However, our gross profit margin showed a fractional decrease on a sequential comparison from the first quarter this year, decreasing from 16.3% or 4/10 of a percentage point to 15.9%.

There are two factors I would point to here with one being a larger amount of our revenue mix currently coming from field inspection activities which is great work and it's showing lots of growth, but at a lower margin than our consolidated average. The second factor is that we recorded a relatively small amount of budgetary reversals during the second quarter for the two lump sum projects which had previously been the subject of discussion. These totaled $457,000 and we had no such corresponding charges in the first quarter.

As a brief update, both of the projects reached mechanical completion during the second quarter and each are expected to reach startup during the third quarter of this year. We've been in the process of completing a number of (inaudible) items and expect total turnover to the client very soon. We do not expect any further charges or cash impact from either of these projects in the future. In addition, we continue to process and negotiate claims previously submitted to our clients.

Another item that we would consider to be nonrecurring on our financials this quarter is a $483,000 gain on the sale of our building in Baton Rouge with this gain being recorded in other income. This happens to be the last building owned by ENGlobal; we now lease all of our office and fabrication space and I was proud to attend the ribbon-cutting ceremony for our new Baton Rouge office space last Thursday.

SG&A expenses decreased to 8.2% of revenue during our most recent quarter which was down a significant 1.3 percentage points from the 9.5% level of overhead seen in both the second quarter of 2006 and also in the first quarter of 2007. In fact, overhead expenses on an absolute basis dropped $450,000 from the first to the second quarter of this year. This fact combined with our revenue growth resulted in good leverage of our overhead expenses with the savings coming from reduced levels of stock expenses and lower overhead personnel costs.

ENGlobal's philosophy is to manage our ongoing overhead expense exclusive of any acquisitions in absolute dollar terms as opposed to managing overhead as a percentage of revenue. We would like to manage these expenses for this year not to exceed the total amount of overhead that was recorded in 2006 which was approximately $30 million last year. And that number equates to $7.5 million per quarter or $2.5 million per month on average.

In the first quarter of this year we recorded SG&A expense of $7.7 million, slightly over our baseline level of $7.5 million per quarter. We just reported overhead expenses of $7.3 million, slightly under this baseline target. We do expect to see an upcoming increase in S-Ox related expense, so it would not surprise me to see our overhead expense increase somewhat for the remainder of this year with it still hopefully being around our target for the full year.

Interest expense totaled $700,000 for the second quarter, a significantly higher level than the $253,000 interest expense from the same quarter last year. This is simply due to our higher level of borrowings under our line of credit.

One positive note is that after two consecutive positive earnings quarters, our first and second quarter of this year, our bank covenants will allow the Company to borrow under a LIBOR based interest calculation as opposed to a prime rate. This should result in a reduced effective interest rate of 1.4% on the amount the Company chooses to put on the LIBOR rate which is expected to be a majority of the outstanding balance under our line of credit.

On another positive note that Bob will discuss further was a new credit facility that was announced this morning that we just set up yesterday with our lead bank, Comerica. Our total line of credit, subject to certain covenants and borrowing based calculations, has been increased from $35 million to $50 million. We believe this increase in our borrowing capacity affirms our fundamental strength while providing us with the flexibility to pursue additional growth.

Much of our current business activity continues to come from our capabilities in four general areas and we have been talking about these same areas for at least a year. Number one of these areas is refining with current projects mainly focused on increasing capacity at existing domestic refineries and also modifications to run lower-cost grades of crude.

The number two active area is pipelines with one study from industrial info projecting 70% growth in the amount of pipeline miles constructed in North America over the next year. This creates a need for additional facilities to support these new miles of pipelines such as pumping stations, gas compression facilities, tank farms, metering and surveillance installations. We perform a wide variety of services for the pipeline industry from beginning to end including right-of-way acquisition, engineering design, construction management and inspection.

The number three active area is alternative energy. Our company is currently working on biomass related projects such as ethanol, biofuels, [coke] and liquids and the use of refinery [tech] coke. The same study I referred to above actually projects more capital spending on alternative energy projects over the next year in North America than refining and pipeline projects combined.

And the last active area I would point to is automation and control systems. Our company has a long history in designing, programming, fabricating and commissioning computer-based distributed control systems. These automation systems are widely used in our industry and being computer-based we see a lot of recurring business due to technological obsolescence. This fact results in projects for us to replace outdated systems with newer technology.

In the closing we should think back to our first-quarter conference call in May of this year when I commented to the effect that the $0.12 per share earnings for the first quarter was hopefully a baseline amount for the entire year. I also remember making the comment that there was a possibility for upside during the remainder of 2007 if we could continue to grow our business and be successful at various measures aimed at improving our profitability.

The financial results we just announced this morning demonstrate our ability to deliver on both of these goals that were previously stated, growth and profitability. We are currently seeing a continuation of good trends in our business and therefore we remain optimistic about our prospects for the balance of 2007 and beyond. Thank you for your time this morning. I will now turn the call over to Bob Raiford, our CFO. Bob?

Thanks, Bill. Good morning, everyone. Our tax provision increased $2.6 million to $4.7 million for the six-month period ended June 30, 2007 from $2.1 million from the comparable prior year period. For the three-month period ended June 30, 2007 our tax provision increased $1.4 million to $2.8 million compared to $1.4 million for the comparable prior year period.

The Company's effective tax rate of 42% for the second quarter was higher than in recent past, 36.9% for the comparable prior year period. This is primarily due to an unexpectedly high level of income taxes from many of the jurisdictions we operate in and changes to the rates in some of the states such as Texas. Our expected effective rate for 2007 annualizing the impact of federal and state taxes should average approximately 41%.

We recorded a onetime gain of approximately $483,000 on the sale of our previously owned facility in Baton Rouge. As stated previously, ENGlobal prefers to lease instead of own real estate, thus allowing capital and credit facilities to be dedicated for the use of both internal and external growth. Thus our business facilities are now structured under leasing arrangements.

I'm glad to report that operating activities were slightly cash-flow positive during the second quarter if only by approximately $500,000. We still see room for improvement; this is the first time operating activities have produced positive cash since the same three-month period in 2006. For the six months operating activities have used approximately $4.4 million.

We continue to focus on processes to lower our average days of sales outstanding or our DSO. Earlier this year we reached an all-time high of 71 days. For the latest period we reduced our DSO to 70. Again we are not where we expect or need to be but it is a trend in the right direction. One of the primary reasons for the increase in days outstanding has been finalizing the conversion of WRC Corporation to the Company's billing system. Excluding both the revenue and the accounts receivable balances attributed to this acquisition our average days outstanding would have been reduced to 67 days during the second quarter.

We spent approximately $524,000 on CapEx during the quarter which is in line with the first quarter and the lowest level of expenditures since the second quarter of 2005. In total we spent approximately $1.1 million during the first six-month period of 2007 compared to $1.6 million during the same six-month period last year. The Company does not expect a material change in the level of capital investments during the remainder of the year.

The outstanding balance on our line of credit as of June 30, 2007 was $30.9 million with the remaining borrowings available to $4.1 million as loan covenant restrictions do not limit the available borrowings. Yesterday on August 6, 2007 the Company entered into a credit agreement that provides a three-year $50 million senior secured revolving credit facility. Becoming effective August 8th, the new credit facility is guaranteed by all of the Company's subsidiaries and is secured by a lien on substantially all of the Company's assets.

The new credit facility replaced the previous $35 million senior revolving credit facility that would have expired in July of 2009. We expect the increase in availability provided by the new credit facility will be utilized [but buy us] working capital for further internal growth and/or will be used for cash consideration for small and midsize acquisition opportunities. Thank you for your time this morning. I will now turn the call back over to the moderator.

(OPERATOR INSTRUCTIONS). Rich Wesolowski, Sidoti & Co.

Bill, you reported about $10 million in revenue from the two categories design build fixed-price and procurement construction. How much of that $10 million was for the troubled projects that are being worked off in the September quarter?

Relatively little, Rich.

Very little?

Right.

So that revenue is for ongoing work and it is not expected to really fall off?

That's correct.

Can you just even maybe qualitatively give me an idea of how much of the change in headcount in the quarter was for billable personnel?

Almost all. I'd have to say the vast majority. There might have been a few overhead position that we added, but I would say at least 90% if not more would have been billable staff.

Can you talk about the level of turnover you're seeing in the field, whether it has changed much during the past three months?

It really hasn't changed too much, Rich. I think we've been saying for a while that we're seeing about 10% turnover in our office on an annual basis. Our turnover is higher at our field locations which is about 30%, and so on average we're seeing about 20% annual turnover of our entire employee base, higher in the field and lower in the office.

Okay. With the backlog of projects you see the quoting activity, the ongoing Evergreen contracts you have -- for how long can you definitively say you'll be able to maintain the utilization rate of 90% or greater?

Our company has successfully maintained a very good utilization rate, it's almost been a flat line over many years which has kind of gone from 89 to 91%, in that range if you look back many, many years. So we've done that in good times and bad times because that's what we have to do in our business.

So there's really not too much chance of that changing much over the next say six quarters of the foreseeable future?

I would not see the utilization rate getting outside the range of the 89 to 91% range that we've historically been in for many years.

Okay, I know you guys get different labor multipliers depending on what area of the country you're working on. Do you see a possibility within the next year or two, even looking out to '09, if the business stays at the pace it is now that the industry wide labor multipliers rise above the range that it's held over the past couple of years?

Depending upon how long you think the cycle is going to last, we feel like there's an opportunity for maybe a second round of price increases. We feel like we've been through many of our contracts and gotten the first round and if we go on for another couple years, three years there's probably another round coming where we can get additional price concessions from our clients. And it's something we will do.

On a lot of our business where we've billed on fixed professional billing rates we actually go to our clients each year and ask for smaller increases. On the part of our business that is more multiplier based we're billing on a multiple of a direct pay rate. Those multipliers are negotiated typically when contracts expire every two or three years. But depending upon how we're doing, how the contract is structured, that's when we go negotiate with our clients.

Okay.

For the biggest part we have an opportunity once every two or three years to negotiate multipliers.

And finally, Bill, you mentioned in your prepared comments a couple of times I think several engineering divisions are growing and doing very well. Last call you had cited 14 different profit centers in the engineering group. How many fell short of your expectations, how many were unprofitable? Are those in the office or in the plant? Maybe a little detail on those.

We have one group up in Tulsa, ENGlobal Technology -- excuse me, Global Technical Service which supports various government contracts. And they actually landed a very nice piece of business. They had been losing a small amount of money since the 1st of the year but they landed some work during the quarter and we expect for them to turn profitable during the third quarter. They work on fuel handling facilities for the Navy and the Air Force. And so that's a bright spot. We think we can turn around another one of our operations.

Systems was roughly a breakeven business. For the second quarter -- that's been a subject of discussion for quite a while. What Systems is, it's a real marketing tool or what I call the smart part of the automation business, where we do the design and programming which is high margin work. It's nice to be able to go to our clients and say we can design and we can program and we can also fabricate this equipment in our own facility and do a checkout in our facility and I really think that gets us a lot of work.

And so, yes, we're trying to improve ENGlobal Systems, especially from a material cost standpoint and a labor cost standpoint and from a productivity standpoint. We feel like we can get it slightly profitable but the real benefit of ENGlobal Systems is just what it does for the other part of our global automation business. And those are really the only two areas I would point to that we still need to focus on.

Okay, so you take those out or say they turn breakeven or maybe generate a little bit of profit in the second half of the year, and you also account for the 450,000 pre tax that you did in the troubled projects, say those are off the books in the September quarter, you'll be running at between 16 and 17% gross margin, is that fair to say?

Rich, I think it's going to depend on where our current market mix is going to be. If our field services area continues to grow the margin percentage is certainly not going to reach those levels. If we continue to grow in our design and build area with the higher margins that will go up.

Okay, great. Thanks a lot.

Maybe given the same mix of business -- given the same mix of business we saw in the second quarter what you say is true, the real variables are lower margin revenue which is pass-through revenue in the field services revenue. Those are the two variables that could lower our margins.

Okay. Thanks again.

Debra Fiakas, Crystal Equity Research.

I wondered if we could turn to the business pipeline which, especially for the second quarter, appears to be fairly robust. And I know you mentioned in your opening comments that your business is largely coming from four areas. I wondered if you could maybe characterize the business pipeline a little bit more by telling us perhaps which areas may be most dominant and also give us an idea of what the differences might be in margins among those four areas.

Well, as you know, Debra, we don't publish backlog on a quarterly basis, we only do that once a year. I would just say that the four areas I mentioned are equally strong I think. And I would think they all produce above-average margins for us. But if you look at most of those, they all involve engineering and design work, professional services which is our highest margin category.

So if you look at refining that's the case, if you look at alternate energy that turns out to be some of our highest margin work because typically we're dealing with smaller customers, new developer type customers and sometimes we can get better rates from those customers than we can with large integrated oil companies. Pipeline and midstream rates are usually good, just on par with the others and their automations get -- from a margin standpoint, I'm sorry to be flying around here, but I think they're all about equal from an engineering standpoint.

I think, Bill, if any of the refining (inaudible) because it includes the field services we'd probably have a lower margin than the other three.

But when we're working in the field and doing inspection in the field that's -- field services in general, that's a lower margin category for us which is typically in the low teens I would say in terms of gross profit margin. The work we do in our office and the more professional service should be 20% gross profit margin and higher and can get much higher depending upon the contract we're working under.

Okay, good. And just looking again into your business pipeline or those projects apparently which are perhaps nearing final decisions and so forth, or those that you have just won recently, are any of them -- particularly I think maybe in the alternative energy -- are any of them dependent on financings that are not yet in place or do you feel that any of them could be in jeopardy given turmoil in the credit markets?

I'm not aware of any projects that would be in jeopardy at this point and I'm really not privy to their financing situations. All I know is we're continuing to work on them today and we have been for quite a few months. I think our clients are committed to completing these projects which is all I can say.

Okay. And then if I could just go back and follow-up on the questions that were being asked earlier about the various profit centers, you mentioned the ENGlobal Technical Services I think it's called and your systems were not performing as well as you might like. Is it a matter of volume that would lead to greater profitability in those two segments or do you need to make some sort of operational adjustment there the way you go about (multiple speakers)?

That's purely within -- ENGlobal Technical Services is purely a matter of volume because the way the government contracts work your overhead is covered and billable to the government and you normally receive a fixed profit percentage of 7% or thereabouts. And so it's just strictly getting critical mass and getting revenue through there and that's what these projects will allow us to do. It's more maintenance -- maintenance of fuel handling systems at government installations and so certain we can kind of go into the year knowing that certain base of business. I don't see any operational changes that need to be made in that business. The operational changes in systems, which I mentioned ENGlobal Systems, I think are in progress and have already been made and continue to be made. That's an ongoing process.

Okay, very good. Thank you.

Craig Bell, SMH Capital.

Good morning. I was interested in your SG&A, sort of where you got your cost reductions in there because that's very impressive. And then just wondering if you think that there's a significant amount more that you could get there or you had said sort of $7.5 million is your run rate there. I mean do you foresee any other opportunities to gain there?

I don't see many opportunities to reduce the absolute amount of our quarterly or monthly SG&A. I see the opportunity to further leverage our overhead expenses. I believe we can grow to a higher level -- somewhat of a higher level and maintain that same level, that would be my hope. But in our business you walk a fine line between having too much overhead and not enough. It requires a certain amount to do business development, maintain an IT infrastructure and all these different overhead functions and so you really don't want to have too little or you quit growing and you don't want to have too much either, so --.

Okay. And then last quarter WRC appeared to be extremely profitable for you just on the breakout. Are your running at similar profit levels there do you think?

I'll let Bob speak to that.

Yes, Craig, I think we continue to expect WRC -- they're kind of a field services outsourcing -- that's a lower margin business, but it's pretty static. It's a cost reimbursable operation, so we don't expect the margins to materially change quarter-over-quarter with them.

Okay. And then sort of related to that, are you continuing to see more business in your Denver beachhead there? I know you got the new contract that you announced recently there, but just in addition to that, are you continuing to see some gains from putting engineers up there?

They've been slightly increasing and the office had been showing a positive contribution to our bottom line. And I wouldn't characterize it as going gangbusters, but I think they're making progress up in Denver.

Okay. And then just real quickly, with the new credit facility being in place, that means you have approximately $21 million available, would that be about right?

That's right.

Great. Thanks a lot.

(OPERATOR INSTRUCTIONS). Rich Wesolowski.

Bob Raiford, could you explain again just quickly why the tax rate was higher and is expected to be higher?

Primarily had to do with our tax provision on the states that we operate in, Rich. Particularly in the state of Texas I guess with the franchise tax change in the state of Texas, so we're seeing a significant increase in that. We're going to try to meet and see what we can do to manage that a little bit better. But overall as we do business in outlying states, not only in the WRC operation but also in the Cleveland inspection operation, we're just doing more work in states that have changed or increased their tax rates. But principally it's effective tax rates we're seeing in the state of Texas on materials and equipment that we're buying that we can't deduct for state tax purposes.

So we should model like 41 to 42% out through '08?

Well, I think we're talking about 41% as an effective tax rate for 2007. We're going to go through and look at that to see what we can do to manage those costs. At this point it would probably be a little bit too early to tell whether we're going to go to 42% or get any higher than that.

Okay. Should we interpret the higher debt capacity as a signal that you're going to be back looking aggressively for acquisitions over the next few quarters?

I think so, yes. I think we've been through the first half of this year and taken some measures and it's given us some better financial results and I think it's time for us again to look at some external growth and we have a number of opportunities we're looking at. And so this facility gives us room to maybe do a small or midsize deal, it would not allow us to do a game change and cut back with a merger, but it's (inaudible) allow us to do smaller ones.

Does that also maybe reflect a greater confidence -- you're going to be generating cash if you're willing to use up the higher bit of spare capacity you have for an acquisition, maybe that would suggest your receivables turnover is going to continue going down and you're going to be generating cash throughout the balance of '07 into '08, is that the expectation?

It all depends on how fast we grow. Of course if I had my choice I'd rather grow internally than externally because it's a lot less dilutive to our stockholders, it's a lot less expensive to accomplish. And so if we're able to land some really nice projects in here it could be we reach our growth objectives through internal means and we don't have to go through acquisitions, that's one thing. But, yes, if we see things leveling off here, that would -- we wouldn't use our line if we didn't think we were going to at least be cash flow neutral or cash flow positive. We wouldn't put ourselves into a stressful situation.

Okay, thank you.

There are no further questions in the queue at this time. Do you have any closing comments?

Yes, thank you, operator. As always, I'll be available to answer any follow-up questions this afternoon or you can always e-mail me directly at IRatENGlobal.com. Thank you for being on the call today and thank you, as always, for your continued support of ENGlobal Corporation. Goodbye.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time.