ENGlobal Corp (ENG) 2008 Q2 法說會逐字稿

Greetings and welcome to the ENGlobal corporation second quarter 2008 earnings conference call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Natalie Hairston, Vice President of Investor Relations and chief governance officer for ENGlobal corporation. 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 Chief Executive Officer at ENGlobal; 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 June 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 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 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 ENGlobal.com. Our filings with the SEC are also available on the SEC's website at SEC.gov.

In addition Non-GAAP measures may be referenced during this conference call. Pro forma 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. And now I would like to introduce our Chairman and Chief Executive Officer, Mr. Coskey. Go ahead, Bill.

Thank you, Natalie and good morning, everyone. I would like to start by thanking and also congratulating ENGlobal's management team for their excellent performance. Underlying the many financial numbers we will discuss this morning you should be able to see some obvious signs of what our management team and employees have been able to accomplish. They definitely deserve the credit for their efforts.

Today we reported earnings of $0.24 per diluted share for the second quarter of 2008. Which represents a 72% increase from the prior year period. In terms of the big picture, our earnings expansion is mostly being driven by a combination of two factors. The first factor is that ENGlobal is benefiting from a healthy market for our services with our top line growing at an exceptional rate, 52% in the latest quarter. All of this growth was internally generated which makes it even better.

Second is something that the Company has talked about for several years, this being our efforts over time to improve our operating profitability. In the latest quarter we are proud to report that our operating margin increased to 8.5%, and increased from 7.7%.

Most of you already know that ENGlobal has stated a compound annual revenue growth target of 25%, together with an operating margin goal of 8.0% for the full year 2008. We are on track to either meet or exceed both of these targets this year.

In our press release this morning, we provided two tables which I believe provide a very good view of our Company's current business. The first table on page one is a detail of revenue and profitability by segment, then on page two of the press release we have provided a list of the four operations that provided us with substantially all of our $46 million of revenue increase for the second quarter. These operations are, first, our inspection operation where growth is directly related to the number of inspection personnel we now have working on pipeline construction spreads. It is a good indicator of the strong trends for domestic pipeline activity.

Number two is our detailed design category that includes personnel who work in-house at ENGlobal's offices and perform engineering, design and other support functions on both Midstream and downstream projects. The revenue increase in this area is not so much due to additional personnel as it is to increasing salaries that drive higher billing rates.

Third is our procurement subcontracting activity. Which showed a $12 million increase. This is a call plus activity at a low margin and sometimes referred to as procurement pass-through revenue. We expect this increased level of procurement pass-through activity to continue into the third quarter of 2008.

Finally, our land group has added staff that provides right-of-way acquisition support mainly on pipeline and electric power transmission projects. Overall, ENGlobal's headcount has exceeded our expectations, reaching approximately 2900 employs in the second quarter 2008. And we added 300 employees in the second quarter alone. Most of which were added to our pipeline inspection group. ENGlobal's consolidated gross profit margin decreased 1 percentage point to 14.9% in the latest quarter from 15.9%. This decrease is primarily a function of our revenue mix, and is especially influenced by quarterly changes in the lower margin procurement pass-through revenue I just mentioned.

On a pro forma basis, and eliminating the procurement pass-through revenue and margin, our consolidated gross profit margin on this basis would have increased from the 14.9% that we reported, to approximately 16.2%. However, the other side of the story is that our earnings per share would have been reduced by approximately $0.02 under this scenario.

ENGlobal's selling, general and administrative expense for the second quarter 2008 was $8.7 million, an increase of $1.4 million from the prior year quarter, and up roughly the same amount sequentially from the first quarter of this year. Our Company thinks about SG&A spend on an absolute basis with a target of $7.5 million per quarter exclusive of acquisitions. Charges related to bad debt and reserves for possible claims amounted to $1.3 million in the second quarter, therefore, on a continuing basis, and exclusive of these charges which we believe are one-time, we were about at our expected level for SG&A expense this quarter.

As previously reported during the third quarter 2007, ENGlobal terminated its work on a large project due to the failure of its client, South Louisiana Ethanol, to obtain permanent financing. As a result of their continued failure to obtain either financing or a project partner, on May 30, of 2008 we filed suit in Louisiana Federal Court basically foreclosing on our mortgage and lien rights, seeking damages of $15.8 million . We continue to be optimistic that given our legal rights, together with an independent appraisal of the forced liquidation value of the assets, that the Company will be able to recover all of the amounts owed.

One other expected item that we are monitoring closely is the recent chapter 11 bankruptcy announcement by one of our Tulsa client, Syncrude LT which occurred about two weeks ago. Syncrude is the general partner for the White Cliff pipeline project for which we are continuing to perform various services. However, the White Cliff's pipeline entity itself has not filed for reorganization. Last Friday, Syncrude paid ENGlobal approximately $940,000 to bring its account current to that date. Accounts receivable from Syncrude are in the $2 million range with substantially all of our receivables being current. Our expectation is that this pipeline project will be completed by either crude or their lender and that ENGlobal will be paid all amounts owed.

Regarding external growth, we continue to target acquisitions that equate to roughly 10% additional revenue over the next year. We choose to do these transactions for two reasons. First of all, we have had good success cross-selling newly acquired capabilities to our existing clients. Number two, we are seeking new locations to better serve our clients within North America. One particular transaction was mentioned in our first quarter call and this has progressed slower than anticipated. However, we believe this $10 million revenue automation related transaction will be closed by the end of this quarter.

Our preference continues to be for smaller businesses that do not carry the financial or integration risk of larger targets. We do not expect to have to dilute our stockholders in order to carry out our external growth plan.

I would like to close with a few comments about why I am still excited about ENGlobal's future. First of all, our Engineering segment. For our anchor business, I really like our consistent and predictable business model, as our Engineering work mainly consists of alliance performance on small to mid-sized cost plus projects. Many of our projects are driven by ongoing maintenance issues, retrofits of existing facilities or government compliance mandates.

Alternative energy is an exciting growth area because there is now more money being spent on alternative energy projects in North America than on refining or pipeline facilities. I believe our Engineering operation is well managed and supported by a top notch group of business development professionals and we also have several interesting internal growth initiatives currently under way.

Second is our Construction segment. We have recently changed management at our inspection group, which should serve to drive some needed margin improvement. As inspection has really grown and currently represents about 87% of our Construction segment. The higher margin piece of our Construction group, which specializes in managing EPC projects, plant turnarounds and commissioning new facilities, is a very aggressive group. Given their many current opportunities, my expectation is that our Construction group will continue to be a fast growing business with improving profitability over time, given a shift toward our higher margin capabilities.

In terms of Automation, during 2008 we have landed two significant multi-year projects to upgrade control analyzer systems at large refineries. New management at our control fabrication operation has done a great job, and what used to be a drain on our Company is now a profit contributor. Financial results from the professional services side of our Automation group need to improve which is that work is slowly getting started on the recent awards. Therefore, Automation's billable hours should increase and variable overhead should decrease over the balance of this year and next.

Also promising is that there are several more significant Automation proposals pending, similar to the ones we have been awarded. I like the fact that our Automation business is being driven by our client's need to replace obsolete electronic and pneumatic control systems as well as analyzer equipment and this provides a recurring stream of work.

Finally, our Land group. Pretty simply, I see continued strong pipeline activity both for gathering and main line projects that drives demand for new right-of-way. This together with the emerging projects to build electric power transmission lines should keep our land business busy for the foreseeable future.

I'll close my portion of the call by commenting on the increased amount of teamwork I have seen throughout our operation. As a Company grows, the importance of cooperation between business units cannot be overlooked. While definitely not a GAAP measurement, I'm proud that ENGlobal has not lost sight of this important metric for growing a great business. I will now turn the call over to Bob Raiford, our CFO.

Thanks, Bill. Good morning, everyone. A lot of the specific details of our second quarter results were disclosed in our press release this morning. But I would like to highlight some selected items. We recorded approximately $1.3 million in bad debt expense and claims reserve during the second quarter, compared to approximately $174,000 during the comparable quarter of 2007. Approximately $1 million of the second quarter charges were directly related to four claims on projects from the prior year. We expect these specific project reserves to be of a non-recurring nature and fully expect that the reserves taken during the period will meet all material coverage deductibles, legal expenses and settlement levels.

Our operations generated approximately $4.1 million in net cash during the second quarter, compared to $523,000 net cash generated during the same period in 2007 and approximately $400,000 generated during the first quarter of this year. At this time, we expect operations to remain in a positive cash flow position for the balance of the year. The result of our fine performance and non-cash items were offset by an unfavorable change in working capital during the period. The primary unfavorable impact on working capital during the second quarter was the increase in trade receivables and particular in the timing and processing of unbilled receivables as a result of our growth. We have projected approximately $2 million in payments related to the ethanol project to be made during the second quarter. Due to delays in execution of final release agreements and various -- with various vendors and subcontractors, we have approximately $1.2 million remaining to fully satisfy our current cash commitments to that project. We expect majority of those payments to be made during the third quarter.

The July 24th payoff of the $1.4 million note receivable for the sale of our office building, the Company previously owned in Baton Rouge, Louisiana, will positively impact cash requirements during the third quarter. Overall, our long-term commitments, net of current portion, decreased approximately 13% or approximately $4.1 million from $30 million, $30.9 million at the end of the first quarter to $26.8 million as of the end of the second quarter. For the six month period just ended, our overall long-term commitments, net of current portion, decreased approximately 9% or approximately $2.5 million from $29.3 million as of December 31, of 2007. As a percentage of stockholders' equity, our overall long-term commitments at the end of the second quarter have decreased to 39.2% from 52.5% as of December 31. Total liquidity which includes cash, plus availability under our $50 million credit facility, was $26.5 million from $6.4 million for the second quarters ended 2008 and 2007 respectively.

The outstanding balance of our line of credit at the end of the second quarter was $25.5 million, with remaining borrowings available of $24.2 million. We have one outstanding letter of credit for approximately $300,000 due to expire September 30, 2008. Our average days sales outstanding was 61 days for the second quarter, compared to 70 days for the comparable three month period in 2007, and 61 days for the 12 month period ended December 31, 2007. Although our targeted DSO remains in the mid-50s, we believe more aggressive contract payment terms, improvements in our internal billing process and a more aggressive collections process will be necessary if we are to achieve that goal.

We invested approximately $892,000 in capital assets during the second quarter compared to a prior year quarterly investment of approximately $524,000. Our second quarter investment was approximately double the amount invested during the first quarter of the year, primarily as a result of the capital lease commitment of $500,000 for an infrastructure upgrade needed to meet our growth. We expect a similar capital investment in the third quarter to complete the upgrade. We do not expect a material change in the level of capital investment for the balance of the year to exceed that of our investment during the first six month period.

Our effective tax rate for the second quarter was 40.4%, compared to a rate of 42% during the second quarter last year and a rate of 39.7% for the year ended December 31, 2007. Our tax provision decreased approximately $179,000 during the second quarter of 2008 compared to a similar provision at last year's second quarter tax rate. Our effective tax rate for the first six month period of 2008 was 40.2% compared to a rate of 39.7% for the comparable prior year period. Our tax provision decreased approximately $94,000 for the first six month period of 2008 compared to a similar provision at last year's six month tax rate. We do not expect our tax rate for 2008 to materially change from approximately 40% effective tax rate for the first six month period of the current year. Thank you for your time this morning. I will now turn the call back to the operator.

Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. (OPERATOR INSTRUCTIONS) Our first question is from Rich Wesolowski with Sidoti & Company. Please state your question.

Thanks a lot. Good morning.

Good morning, Rich.

Good morning, Rich.

Bill, in the first quarter we saw virtually all the growth coming from inspection whereas here in June it was a lot more broad-based. You mentioned also in the press release an increasingly varied client mix. Which of the end markets are the customer types that you're now getting business where there was little or none before?

I think what we're seeing is an expansion in the current markets we serve, Midstream and downstream. I think we are able to gain more pipeline clients and also more downstream clients and so it's not like a really new market, it's just more clients within the same markets is what I would say.

And the follow-up, your revenue per average employee has been a very steady number in the 150,000 range, even going back to '05. It's really never been above 160K. Now this quarter we get almost 200,000 per employee. Your utilization has always been around 90%. So why was there the big jump this quarter?

I could probably point to three reasons. One of them is the contribution from the pass-through procurement revenue which comes through our revenue line which I believe Bob was--?

$17.5 million.

$17.5 million this quarter. Another is the fact that we've been -- our people have been getting some pretty significant pay raises in this active environment in our business and so you multiply that times the billing factor and our billing rates go up to our clients. And then lastly, improvements in utilization, possibly working some more overtime on projects would contribute to revenues per employee increasing.

Just a quick follow-up to the follow-up. You mentioned the pay raises as second on that list. Have you had any increases in the multiples or has that all been the wage inflation passing through at the same multiple?

I think what we see is we have a -- probably a base load of long-term, maybe Alliance clients that stay at about the same multiplier level. I think what we have is a new generation of clients coming in that we would put under higher billing structures. Kind of like our incremental business that we sell would be done at higher billing structures. I think what we've seen over several years is a steadily increasing -- a steady increase to our effective multiplier. So like a needle going from low to high and I think the needle continues to move up slowly in terms of a building multiplier.

Excellent. Thank you.

Our next question is from Craig Bell with SMH Capital. Please go ahead with your question.

Good morning. It was a pretty impressive quarter. Just kind of following up on Rich's questions there, since you're saying that a significant amount of the increase is related to pay raises and billing rates, does that sort of imply that maybe this level of revenue is sustainable going forward, because in the past you had good, solid increases quarter-to-quarter but it's been pretty consistent and then in this quarter has had such a significant jump up. Do you think you can maintain sort of that level?

Yes, I don't see anything over the near term taking us off the track we're currently on and I wouldn't be surprised to see our third quarter meter exceed what we did in the second quarter.

Okay. And then on the last conference call you kind of talked about the mix of business and that had put some pressure on your gross margin. Obviously we see some improvement here this quarter. Do you see any changes in the second half of this year in terms of mix of business and how it's impacting on margin?

No, I really don't see that much change in mix. I guess if I were to analyze ENGlobal I would probably subtract out the impact of the pass-through procurement revenue and that gives you more of a steady state idea of how we're performing in terms of gross profit margin. It debalances I guess those results.

Craig, I would follow-up further with that, what Bill said. I guess the procurement revenue is $17.5 million. We incurred during the second quarter. If you look at the last year's second quarter, it was about $5 million. I think there was a $12 million increase in that and I think we look for that to continue in the third quarter, but beyond that we can't be assured that that's going to continue because basically that's on one project we're working on right now and that may tail off. So if you make an adjustment in our revenues for the procurement, probably give you a better steady state look.

Bob, what was the amount of receivables at the end of the quarter?

I think it was $92 million.

Okay.

Which includes our unbilled, includes everything.

Great. Thanks a lot.

Next question is from Graham Madison with Lazard Capital Markets. Please go ahead with your question.

Hi, good morning, guys, this is quite a quarter. Congratulations. Quickly, in the past you had mentioned that looking at the quarters over the year that 3Q tends to be better than 2Q. Is there any reason to think that that wouldn't be the case this year? I mean, was there any projects that moved to the second quarter which helped boost the revenue and the performance?

I've always equated our second and third quarter and equated our first and fourth quarter, I don't know that I've really ever ranked them to be one, two, three, four. Throughout the balance of the year, I would look for our third quarter to be similar to our second and our fourth to be similar to our first. Kind of the way our year goes.

Then just looking at some of the margin improvements in the other segments outside of engineering, what was driving that? Was that more would you say on a broader scope that's more of an impact of better contracting terms that you're signing up or is it more a result of the better management execution and operational execution that you talked about in prior quarters?

I think it's a little of both. I think we continually are working on better contracts, new business we bring in just provides better margins for our Company. I think we've just made some efforts to improve our efficiencies, improve utilization. Bob, would you have anything to add to that?

It's a lot of blocking and tackling. It's not any one magic bullet.

There's nothing to think that some of these margins wouldn't -- other than what you mentioned earlier, wouldn't be sustainable going forward?

No, I would see our margins to be sustainable going forward, especially after you back out the impact of the pass-through revenue.

All right. Great. I'll jump back in queue. Thank you very much.

Next question is from Richard Nelson with Jesup & Lamont. Please go ahead with your question.

Actually my questions have been answered. Very nice quarter. Congratulations.

Thank you.

(OPERATOR INSTRUCTIONS) The next question is a follow-up from Rich Wesolowski with Sidoti & Company. Please go ahead with your question.

Thanks, Bill, I just want to clarify a statement you made in the prepared remarks that the pass-through revenue, the inclusion depressed gross margin but increased earnings, I assume you're talking about the earnings contribution from the project which carries that pass-through and what earnings for the Company would have been without that contribution?

I was talking about earnings per share and as an example, if we had had, again, 16 million or $17 million of pass-through revenue and we marked that up maybe 6%, 5 or 6%,.

Oh, so it's not completely passed through, there is a bit of margin on there.

There is a little bit of margin. That incremental margin improved earnings per share but it depressed our gross profit margin as a percentage.

Your margins within each segment as you now define them have been all over the map as you go back to the data from '05 -- or, excuse me, I think '06. Could you give us maybe a gross margin for each segment that you would consider to be strong and realistic performance in today's environment?

I think what I would say for our engineering segment it's going to be right around that same area on an ongoing basis, possibly ticking up very incrementally. I would expect to see some pretty good improvement in our Automation and Construction group, just based on the project awards, just based -- especially in the Construction group where we had this huge mix of inspections, pipeline inspection revenue which by nature is low margin and as we tend to change that mix over to some of our higher value services like managing EPC project or managing turnaround projects. My belief is that over time, that mix will change from 87/13 to much more favorable on the high margin side. I believe our land group should be pretty steady going forward and kind of it is what it is today. We might see some incremental improvement. So engineering and land, probably about the same, slightly improving. We have the opportunity to make some pretty significant improvements in Automation and Construction.

Okay. That's very helpful. Thank you. Just a little bit of point of confusion. You mentioned that the 300 headcount that you added in the quarter, most of that was in pipeline inspection.

It was.

Can you reconcile that with the expectation that the other part of Construction is going to be going up as a percentage of that revenue?

Based on my knowledge and some opportunities they have and also based on my knowledge of efforts that are being made to raise margins within the inspection group itself after the change in management. I believe we're going to do two things. We're going to improve the inspection margins plus we're going to change the mix based on some opportunities we have there.

Thanks again.

Next question is from Graham Madison with Lazard Capital Markets. Please go ahead with your question.

Hey, guys, just a follow-up on the inspection and Construction margin. Now that you've made the personnel changes, did we see any of the margin improvement or the benefits in that personnel change in this quarter or will that be something we'll see in coming quarters more?

I think that's something you should look for in coming quarters. That's a fairly recent change. I don't believe any of that impacts at the second quarter.

Okay. Great. And then on the land group, I mean, would it be fair to say that we could see revenue growth sort of consistently drive up with the increase in pipeline work that's going on out there?

Their limiting factor is the ability to access right-of-way for their projects. I think they're limited by the ability to add staff than anything. I think there's more projects than staff. But yes, there's many, many opportunities especially with this emerging build-out of electric power transmission that we can participate in. That's another area.

That's great. All right. Great. Thank you very much.

There are no further questions in queue. I would like to turn the call back over to management for closing remarks.

Thank you, operator. Hello, again, everyone. I'll be available 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 as always for your continued support of ENGlobal.

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