UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2006March 31, 2007
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No. 001-14217
ENGlobal Corporation
--------------------
(Exact name of registrant as specified in its charter)
Nevada
------
(State or other jurisdiction of
incorporation or organization)
88-0322261
----------
(I.R.S Employer Identification No.)
654 NorthN. Sam Houston Parkway E., Suite 400, Houston, TX 77060-5914
--------------------------------------------------------77073-6033
----------------------------------------------------- ----------
(Address of principal executive offices) (Zip code)
(281) 878-1000
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shortershortened period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (check
one):
Large Accelerated Filer [ ] Accelerated Filer [ ][X] Non-Accelerated Filer [X][ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the close of business of November 9, 2006.May 1, 2007.
$0.001 Par Value Common Stock 26,706,92526,853,090 shares
QUARTERLY REPORT ON FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2006MARCH 31, 2007
TABLE OF CONTENTS
Page
Number
------
Part I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Statements of IncomeOperations for the Three Months Ended
March 31, 2007 and Nine
Months Ended September 30,March 31, 2006 and September 30, 2005 3
Consolidated Statements of Comprehensive Income for the Three Months Ended
September 30,March 31, 2007 and March 31, 2006 and September 30, 2005 4
Condensed Consolidated Balance Sheets at September 30, 2006March 31, 2007 and December 31, 20052006 5
Condensed Consolidated Statements of Cash Flows for the NineThree Months
6-7
Ended September 30,March 31, 2007 and March 31, 2006 and September 30, 20056
Notes to Condensed Consolidated Financial Statements 8-147-13
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 15-3114-23
Item 3. Quantitative and Qualitative Disclosures About Market Risk 3224
Item 4. Controls and Procedures 32-3324
Part II. Other Information
Item 1. Legal Proceedings 3427
Item 1A. Risk Factors 3427
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 3427
Item 3. Defaults Upon Senior Securities 3427
Item 4. Submission of Matters to a Vote of Security Holders 3427
Item 5. Other Information 3427
Item 6. Exhibits 34
Signature 3527
Signatures 28
2
PART I. - FINANCIAL INFORMATION
-------------------------------
ITEM 1. FINANCIAL STATEMENTS
ENGlobal Corporation
Condensed Consolidated Statements of IncomeOf Operations
(Unaudited)
For the Three Months
Ended For the Nine Months
September 30, Ended September 30,
------------------------------ ------------------------------March 31,
----------------------------
2007 2006
2005 2006 2005
------------- ------------- ------------- ------------------------- ------------
Operating Revenue $ 82,503,54881,658,632 $ 59,265,617 $ 224,196,098 $ 163,314,149
------------- ------------- ------------- -------------66,626,836
------------ ------------
Operating Expenses:
Direct cost 77,954,573 51,427,251 200,696,904 142,498,56768,380,907 58,405,208
Selling, general and administrative (Note 2) 6,411,171 4,815,324 18,921,412 12,991,480
Depreciation and amortization 393,253 257,786 1,149,654 814,178
------------- ------------- ------------- -------------7,743,688 6,100,351
------------ ------------
Total operating expenses 84,758,997 56,500,361 220,767,970 156,304,225
------------- ------------- ------------- -------------expense 76,124,595 64,505,559
------------ ------------
Operating income (loss) (2,255,449) 2,765,256 3,428,128 7,009,9245,534,037 2,121,277
Other Income (Expense):
Other income (expense) (19,912) 5,809 389,196 79,054(131) 21,752
Interest income (expense), net (371,141) (199,096) (786,283) (642,647)
------------- ------------- ------------- -------------(559,843) (162,146)
------------ ------------
Total other income (expense) (391,053) (193,287) (397,087) (563,593)
------------- ------------- ------------- -------------(559,974) (140,394)
------------ ------------
Income before Provision for Income Taxes (2,646,502) 2,571,969 3,031,041 6,446,3314,974,063 1,980,883
Provision for Income Taxes (1,076,116) 951,629 1,035,849 2,385,143
------------- ------------- ------------- -------------1,819,720 746,740
------------ ------------
Net Income (loss) $ (1,570,386)3,154,343 $ 1,620,340 $ 1,995,192 $ 4,061,188
============= ============= ============= =============1,234,143
============ ============
Net Income Per Common Share:
Basic $ (0.06) 0.070.12 $ 0.08 0.170.05
Diluted $ (0.06) 0.070.12 $ 0.07 0.170.05
Weighted Average Shares Used in Computing Net Income Per Share:
Basic 26,645,830 23,890,842 26,475,353 23,637,34526,809,006 26,332,602
Diluted 26,645,830 24,898,045 27,027,931 24,460,31327,259,948 27,246,347
See accompanying notes to interim condensed consolidated financial statementsstatements.
3
ENGlobal Corporation
Condensed
Consolidated Statements of Comprehensive Income
(Unaudited)
For the Three Months
For the Nine Months
Ended September 30, Ended September 30,March 31,
--------------------------
--------------------------2007 2006 2005 2006 2005
----------- -----------
----------- -----------
Net Income (loss) $(1,570,386) $ 1,620,3403,154,343 $ 1,995,192 $ 4,061,188
----------- ----------- ----------- -----------
Other Comprehensive Income (loss):1,234,143
Foreign currency translation adjustment, (9,733) -- 3,433 --
Income tax effect 3,747 -- (1,322) --
----------- ----------- ----------- -----------
Net other comprehensive income (5,986) -- 2,111 --
----------- -----------net (683) (433)
----------- -----------
Net Comprehensive Income (loss) $(1,576,372) $ 1,620,3403,153,660 $ 1,997,303 $ 4,061,188
=========== ===========1,233,710
=========== ===========
See accompanying notes to interim condensed consolidated financial statementsstatements.
4
ENGlobal Corporation
Condensed Consolidated Balance Sheets
September 30,(Unaudited)
ASSETS
------
March 31, December 31,
2007 2006
2005
------------ ------------
(unaudited)
ASSETS
------------------- -------------
Current Assets:
Cash $ 1,070,656949,652 $ 159,4141,402,880
Trade receivables, less allowance for doubtful accountsnet 64,113,264 60,247,612
Prepaid expenses and other current assets 1,950,000 1,723,907
Current portion of approximately $565,000 and
$507,000, respectively 54,998,258 46,248,458notes receivable 52,815 52,031
Costs and estimated earnings in excess of billings on uncompleted contracts 9,553,209 4,148,275
Prepaid expenses and other current assets 650,687 1,600,369
Current portion of note receivable 51,258 --
Inventories -- 153,9688,068,993 5,390,111
Deferred tax asset 305,258 305,2582,310,106 2,310,106
Federal income taxes receivable 544,139 52,818
------------ ------------101,135 1,148,014
------------- -------------
Total Current Assets 67,173,465 52,668,56077,545,965 72,274,661
Property and Equipment, net 7,959,774 6,861,3618,474,181 8,724,902
Goodwill 23,160,320 15,454,583
Note19,688,030 19,202,197
Other Intangible Assets, net 4,747,347 5,426,824
Long term notes receivable, net of current portion 120,760 --
Non-current Deferred Tax Asset 159,192 74,892120,727 129,105
Other Assets 810,389 876,534
------------ ------------624,867 468,864
------------- -------------
Total Assets $ 99,383,900111,201,117 $ 75,935,930
============ ============106,226,553
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current Liabilities:
Accounts payable $ 16,218,65310,636,078 $ 15,211,33114,672,165
Federal and State Income Taxes 1,159,796 509,748
Accrued compensation and benefits 11,347,907 9,799,074
Deferred rent 708,847 361,29213,399,534 12,806,919
Notes payable 624,978 1,109,772
Current portion of long-term debt 1,612,392 547,9341,427,352 1,418,029
Deferred rent 648,328 678,583
Billings and estimated earnings in excess of costs and estimated earnings on uncompleted contracts 1,054,551 3,775,6251,697,445 539,910
Other liabilities 728,183 1,148,079
------------ ------------3,737,345 5,352,886
------------- -------------
Total Current Liabilities 31,670,533 30,843,33533,330,856 37,088,012
Long-Term Debt, net of current portion 22,831,222 5,227,976
------------ ------------32,473,627 27,162,263
Deferred Tax Liability 1,075,716 1,114,224
------------- -------------
Total Liabilities 54,501,755 36,071,311
------------ ------------66,880,199 65,364,499
------------- -------------
Commitments and Contingencies (Note 10)11)
Stockholders' Equity:
PreferredCommon stock - $0.001 par value; 2,000,000 shares authorized; none outstanding -- --
Common stock, $0.001 par value; 75,000,000 shares authorized; 26,700,92526,829,090
and 26,289,56726,807,460 shares issued and outstanding and 27,353,302 and 26,941,944 issued at September 30, 2006March 31, 2007 and
December 31, 2005,2006, respectively 27,353 26,94127,481 27,459
Additional paid-in capital 29,656,591 27,230,33231,422,851 31,147,343
Retained earnings 15,198,399 13,203,208
Treasury stock - none and 652,377 shares at cost at September 30, 2006 and
December 31, 2005, respectively -- (592,231)12,871,696 9,717,354
Accumulated other comprehensive income (loss) (198) (3,631)
------------ ------------(1,110) (30,102)
------------- -------------
Total Stockholders' Equity 44,882,145 39,864,61944,320,918 40,862,054
------------- -------------
Total Liabilities and Stockholders' Equity $ 99,383,900111,201,117 $ 75,935,930
============ ============106,226,553
============= =============
See accompanying notes to interim condensed consolidated financial statementsstatements.
5
ENGlobal Corporation
Condensed Consolidated Statements ofOf Cash Flows
(Unaudited)
For the NineThree Months Ended
September 30,March 31,
----------------------------
2007 2006 2005
------------ ------------
Cash Flows from Operating Activities:
Net income $ 1,995,1923,154,343 $ 4,061,1881,234,143
Adjustments to reconcile net income to net cash provided by (used in)used in operating activities -
Depreciation and amortization 1,925,266 1,341,4091,068,649 648,703
Share based compensation expense 894,759 --
Loss232,964 85,305
Gain on disposal of property, plant and equipment 99,281 2,715
(Gain) on assets held for sale -- (134,447)(13,561) (10,000)
Deferred income tax benefit/expense (133,736) (590,437)(38,508) (15,900)
Changes in current assets and liabilities, net of acquisitions -
Trade receivables (4,576,070) (360,467)(3,865,652) (2,870,680)
Inventories -- 153,968 383
Costs and estimated earnings in excess of billings (5,404,934) (3,515,522)(2,678,882) (381,574)
Prepaid expenses and other assets 344,896 1,076,862(462,064) 54,136
Accounts payable 310,730 (50,412)(4,036,087) (3,409,896)
Accrued compensation and benefits 802,006 1,110,622592,615 (1,083,098)
Billings in excess of costs and estimated earnings (2,721,074) (587,501)1,157,535 1,956,996
Other liabilities 216,554 1,117,949(1,775,443) (143,704)
Income taxes receivable (payable) (666,832) 978,2701,731,914 592,639
------------ ------------
Net cash provided by (used in)used in operating activities (6,759,994) 4,450,612
------------ ------------(4,932,177) (3,188,962)
Cash Flows from Investing Activities:
Property and equipment acquired (2,496,064) (2,184,929)
Construction in progress (292,482) --(574,759) (696,456)
Proceeds from sale of equipment 12,836 15,40048,460 10,000
Proceeds from note receivable 7,594 --
Proceeds from sale of other assets 90,204 50,000
823,350
Proceeds from note receivable 15,343 --
Additional considerationNet cash paid for acquisitions 62,117 (77,297)
Business acquired in purchase transaction, net of cash acquired (6,028,585) -- Partnership distribution 350,000 --
Insurance proceeds 68,317 --(649,251)
------------ ------------
Net cash provided by (used in)used in investing activities (8,258,518) (1,423,476)(428,501) (1,285,707)
------------ ------------
Cash Flows from Financing Activities:
Net borrowings (payments)Borrowings on line of credit 15,928,759 (13,529,496)39,411,802 32,604,288
Payments on line of credit (33,758,819) (28,278,338)
Proceeds from issuance of common stock converted from options 724,142 663,776
Proceeds from issuance of common stock from private placement -- 14,000,000
Short-term note repayments -- (837,714)
Capital lease repayments -- (4,371)42,565 212,361
Long-term debt repayments (726,970) (370,000)(817,090) (205,971)
------------ ------------
Net cash provided by (used in) financing activities 15,925,931 (77,805)4,878,458 4,332,340
------------ ------------
Effect of Exchange Rate Changes on Cash 3,823 1,97628,992 2,928
------------ ------------
Net change in cash 911,242 2,951,307(453,228) (139,401)
Cash, at beginning of period 1,402,880 159,414 8,006
------------ ------------
Cash, at end of period $ 1,070,656949,652 $ 2,959,31320,013
============ ============
Supplemental Disclosures:
Interest paid $ 448,846353,549 $ 605,170
============ ============90,254
------------ ------------
Income taxes paid $ 1,759,202(134,912) $ 2,200,614
============ ============
Tax refunds received (314,221)248,867
------------ ------------
Non-Cash:
Issuance of note for ATI assets $ (7,263)-- $ 1,000,000
------------ ------------
Acceptance of note for Constant Power assets $ -- $ 216,000
============ ============
See accompanying notes to interim condensed consolidated financial statementsstatements.
6
ENGlobal Corporation
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(Continued)
Non-Cash:
Issuance of note for purchase of WRC Corporation $ 2,400,000 $ --
=========== ===========
Issuance of common stock for purchase of WRC Corporation $ 1,400,000 $ --
=========== ===========
Issuance of note for ATI assets $ 1,000,000 $ --
=========== ===========
Acceptance of note for Constant Power assets $ (216,000) $ --
=========== ===========
See accompanying notes to interim condensed financial statements
7
Notes to Condensed Consolidated Financial Statements
----------------------------------------------------
NOTE 1 - BASIS OF PRESENTATION
The condensed consolidated financial statements of ENGlobal Corporation
(which may be referred to as "ENGlobal", the "Company", "we", "us", or
"our") included herein, are unauditedun-audited for the three month and nine monththree-month periods ended
September 30, 2006March 31, 2007 and 2005.2006. These financial statements reflect all adjustments
(consisting of normal recurring adjustments), which are, in the opinion of
management, necessary to fairly present the results for the periods
presented. Certain information and note disclosures, normally included in
financial statements prepared in accordance with accounting principles
generally accepted in the United States of America, have been condensed or
omitted pursuant to rules and regulations of the Securities and Exchange
Commission. It is suggested that these condensed financial statements be
read in conjunction with the Company's audited financial statements for the
year ended December 31, 20052006, included in the Company's annual reportAnnual Report on
Form 10-K filed with the Securities and Exchange Commission on March 31, 2006.16,
2007 and Form 10K/A filed on March 29, 2007. The Company believes that the
disclosures made herein are adequate to make the information presented not
misleading.
Certain amountsNOTE 2 - CRITICAL ACCOUNTING POLICIES
A summary of critical accounting policies is disclosed in Note 2 to the
2005Consolidated Financial Statements included in our 2006 Annual Report on
Form 10-K. Our critical accounting policies are further described under the
caption "Critical Accounting Policies" in Management's Discussion and
Analysis of Financial Condition and Results of Operation in our 2006 Annual
Report on Form 10-K.
The Company's adoption of SFAS No. 123(R), "Share-Based Payment," became
effective January 1, 2006 and is further described in Note 3, below.
On July 13, 2006, the FASB issued FIN 48, "Accounting for Uncertainty in
Income Taxes, and Related Implementation Issues," which provides guidance
on the financial statement recognition, measurement, presentation and
disclosure of uncertain tax positions that a company has taken or expects
to take on a tax return. Under FIN 48, financial statements should reflect
expected future tax consequences of such positions presuming the taxing
authorities have full knowledge of the position and all relevant facts.
This interpretation also revises the disclosure requirements and was
adopted by the Company effective as of January 1, 2007. There are currently
no material tax positions identified as uncertain for the Company or its'
subsidiaries.
We recognize interest related to uncertain tax positions in interest
expense and penalties related to uncertain tax positions in governmental
penalties. As of March 31, 2007, we have not recognized interest or
penalties relating to any uncertain tax positions.
The Company is subject to federal and state income tax audits from time to
time that could result in proposed assessments. The Company cannot predict
with certainty the timing of such audits, how these audits would be
resolved and whether the Company would be required to make additional tax
payments, which may or may not include penalties and interest. The Company
was subject to a Federal tax audit for the years 2002 and 2003. That
examination has been reclassifiedclosed.
As of March 31, 2007, the Company has been notified that its' recently
acquired subsidiary, WRC Corporation is subject to more closely conforman audit for the
pre-acquisition fiscal year ending September 30, 2005. The Company does not
have any other examination on-going by the Internal Revenue Service, and
the open years subject to audit are currently tax years 2004-2006. For most
states where the 2006 presentation.Company conducts business, the Company is subject to
examination for the preceding three to six years.
NOTE 23 - SHARE BASED COMPENSATION
The Company currently sponsors a stock-based compensation plan as described
below. Effective January 1, 2006, the Company adopted the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 123 (Revised),
"Share-Based Payment" ("SFAS No. 123(R)"). Under the fair value recognition
provisions of SFAS No. 123(R), stock-based compensation is measured at the
grant date based on the value of the awards and is recognized as expense
7
Notes to Condensed Consolidated Financial Statements
----------------------------------------------------
over the requisite service period (usually a vesting period). The Company
selected the modified prospective method of adoption described in SFAS No.
123(R). The fair values of the stock awards recognized under SFAS No.
123(R) are determined based on the vested portion of the awards; however,
the total compensation expense is recognized on a straight-line basis over
the vesting period.
In accordance with the provisions of SFAS No. 123(R), total stock-based
compensation expense in the amount of $404,000$232,964 and $895,000, respectively,$85,366 was recorded in
the three and nine months ended September 30, 2006.March 31, 2007, and March 31, 2006, respectively.
The total stock-based compensation expense was recorded in selling, general
and administrative expense. The total income tax benefit recognized in the
condensed consolidated statements of income for the share-based
arrangements for the three and nine months ended September 30, 2006March 31, 2007 was $59,847 and $133,736, respectively.$38,509.
Prior to January 1, 2006, the Company accounted for stock-based
compensation using the intrinsic value method prescribed in Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. Under APB Opinion No. 25, no
compensation expense was recognized for stock options issued to employees
because the grant price equaled or was above the market price on the date
of grant for options issued by the Company.
The total fair value of shares that vested options during the ninethree months ended September 30,March
31, 2007 and 2006 and 2005 was $5.8$6.5 million and $7.8$10.7 million, respectively. The
average price per share for the three months ended March 31, 2007 and 2006
was $6.00 per share and $11.14 per share, respectively.
Stock Option and Incentive Plans
The Company maintains a stock option plan (the "Option Plan") under which
the Company may issue incentive stock options to employees and non-employee
directors. Under the Option Plan, a maximum of 2,650,000 shares of our
common stock has beenwas approved to be issued or transferred to certain
non-employee directors, and to officers and employees pursuant to stock based
awards granted. Shares with respect to awards under the Option Plan that expire,
are cancelled, or otherwise terminate are added back to the number of
shares issuable under the Option Plan. As of September 30, 2006, options
representing 1,449,620 shares are currently issued and outstanding under
the Option Plan, of which 858,383 shares are vested; 325,806March 31, 2007, 150,806 shares remain available for
grant under the Option Plan.
On March 30, 2007, the Board of Directors approved, subject to stockholder
approval on June 14, 2007, an amendment to the Option Plan. The proposed
amendment would increase the number of shares available for issuance under
the Plan from 2,650,000 to 3,250,000 in order to enhance the ability of
ENGlobal to compensate its non-employee directors and to attract employees
of outstanding ability.
The Company's policy regarding share issuance upon option exercise takes
into consideration the optionee's eligibility and vesting status. Upon
receipt of an optionee's exercise notice and payment, and the Company's
or
the Chairman of the Compensation Committee's subsequent determination of eligibility, the Company's Chief Governance
Officer or the Chairman of the Compensation Committee instructs our
transfer agent to issue shares of our Common Stock to the optionee.
8
Stock options have been granted with exercise prices at or above the market
price on the date of grant. In most cases, theThe granted options vesthave vested generally over
one year for non-employee directors and ratably over four years for
officers and employees. Beginning in 2006, options granted to
non-employee directors vest ratably and quarterly over one year from the
date of grant. The granted options generally have ten year
contractual terms.
Compensation expense of $1.9 million$1,480,583 related to previously granted stock
option awards which are non-vested had not yet been recognized at September 30, 2006 will be recognized
in future periods.March 31,
2007. This compensation expense is expected to be recognized over a
weighted-average period of approximately 1820 months.
The following summarizes stock option activity for the nine months ended
September 30, 2006.8
Notes to Condensed Consolidated Financial Statements
----------------------------------------------------
The following summarizes stock option activity for the first quarter of 2007.
Weighted
Weighted Average
WeightedAverage Remaining Aggregate
Number of AverageExercise Contractual Intrinsic *
Options Exercise Price Term (Years) Value (000's)
---------- -------------- ----------------------- --------- ------------- -------------
Balance at December 31, 2005 1,438,234 3.072006 1,422,494 $ 5.16 7.9 years $ 2,871
Granted 355,000 10.77- - - -
Exercised (222,738) 2.3621,630 1.97 - 77
Canceled or expired (171,546) 5.99- - - -
----------- --------- ------------- ----------
Balance at September 30, 2006 1,398,950March 31, 2007 1,400,864 $ 4.79 7.645.21 7.7 $ 3,124
==========2,948
=========== ========= ======================= ==========
Exercisable at September 30,March 31, 2007 1,088,164 $ 4.66 7.7 $ 2,504
=========== ========= ============= ==========
*Based on average stock price for the first quarter 2007 of $6.00 per
share. The average stock price for the same period in 2006 829,750 $ 3.04 6.71 $ 1,853
========== ========= ========== ==========was $11.14 per
share.
The total intrinsic value the difference between the exercise price and
market price on the date of exercise, of options exercised during the three
monthswas $77,000 and nine months ended September 30, 2006 was $219,000 and $1.0
million, respectively.
Pro Forma Effects
If compensation expense for the stock options that we granted had been
recognized based upon the estimated fair value on the grant date under the
fair value methodology prescribed by SFAS No. 123, as amended by SFAS No.
148 and SFAS No. 123(R), our net income and net income per share$488,000 for
the three months ended March 31, 2007 and nine months ended September 30, 2005 would have been as
follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2005 2005
--------- ---------
(in thousands)
-----------------------------
Net income available for common stock - as reported $ 1,620 $ 4,061
Less compensation expense determined under fair value
method, net of tax (54) (162)
--------- ---------
Net income available for common stock - pro forma $ 1,566 $ 3,899
========= =========
Net income per share - as reported
Basic $ 0.07 $ 0.17
Diluted $ 0.07 $ 0.17
Net income available per share - pro forma
Basic $ 0.07 $ 0.16
Diluted $ 0.06 $ 0.16
9
The fair value of each stock option granted under the Option Plan was
estimated on the date of grant using the Black-Scholes option-pricing
model. The following key assumptions were used to value the option grants
issued during the nine month periods ended September 30, 2005 and 2006.
Weighted Average Average Expected Expected
Risk Free Rate Expected Life Volatility Dividend Yield
-------------- ------------- ---------- --------------
2005 5.5% 3-10 Years 50% 0.00%
2006, 4.93 - 5.05%respectively.
NOTE 4 Years 73.8 - 79.1% 0.00%
The Company recognized the pro forma fair value compensation cost on a
straight-line basis over the requisite service period for each separately
vesting portion of each award.
NOTE 3 - FIXED FEE CONTRACTS
Costs, estimated earnings and billings on uncompleted contracts consisted
of the following at September 30, 2006March 31, 2007 and December 31, 2005:
September 30,2006:
March 31, December 31,
2007 2006
2005
-------- ----------------------------
(in thousands)
-------------------------------------------
Costs incurred on uncompleted contracts $ 58,15372,600 $ 23,42675,317
Estimated earnings (losses) on uncompleted contracts (968) 4,437(7,792) (7,390)
-------- --------
Earned revenues 57,185 27,863
Less billings64,808 67,927
Less: Billings to date (48,687) (27,490)58,438 63,077
-------- --------
Net costs and estimated earnings in excess of billings $ 6,370 $ 4,850
on uncompleted contracts
======== ========
Costs and estimated earnings in excess of billings on uncompleted contracts $ 8,068 $ 5,390
Billings and estimated earnings in excess of cost on uncompleted contracts (1,698) (540)
-------- --------
Net costs and estimated earnings in excess of billings
on uncompleted contracts $ 8,4986,370 $ 373
======== ========
Costs and estimated earnings in excess of billings on uncompleted contracts $ 9,553 $ 4,148
Less billings and estimated earnings in excess of cost on uncompleted contracts (1,055) (3,775)
-------- --------
Net costs and estimated earnings in excess of billings
on uncompleted contracts $ 8,498 $ 3734,850
======== ========
NOTE 45 - COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) represents net earnings and any revenue,
expenses, gains and losses that, under accounting principles generally
accepted in the United States of America, are excluded from net earnings
and recognized directly as a component of stockholders' equity. For the
nine month period ended September 30, 2006,At March
31, 2007, comprehensive income included a gainloss of $3,433$683 from foreign
currency translation adjustments.
NOTE 5 - ACQUISITIONS
The Company's acquisition strategy is focused on developing breadth and
depth of expertise within the organization by continuing to search for
candidates that fit into one of two profiles. First, the Company considers
acquisition candidates with revenues at or over the $10 million that would
provide new service capabilities for its clients. Second, the Company
considers acquisition candidates of various sized operations that have
capabilities similar to those it currently provides and will assist the
Company in gaining a larger position in a given market segment or
geographic location.
The Company purchased Denver-based WRC Corporation ("WRC") on May 25, 2006.
WRC provides integrated land management, engineering, and related services
to the pipeline, power, and transportation industries, among others. WRC
has become a wholly-owned subsidiary of ENGlobal and will now serve as the
Company's provider of land management, environmental compliance and
governmental regulatory services. WRC currently has approximately 200
employees, with revenues in the 12 months prior to the acquisition
exceeding $20 million. The Company expects to utilize WRC's Denver facility
as a beachhead for expansion of its services into the Rocky Mountain and
Western U.S. regions.
10
In exchange for all of the outstanding capital stock of WRC, the Company
paid cash, delivered a promissory note payable over four years, issued
175,000 shares of ENGlobal common stock, and agreed to pay certain
obligations of WRC. At June 30, 2006, goodwill (deductible for tax
purposes) from this transaction was estimated to be $5.9 million. The
acquisition has been accounted for as a purchase in accordance with
Statement of Financial Standards No. 141, "Business Combinations,"
("SFAS141"). The purchase price allocation has been prepared on a
preliminary basis and reasonable changes are expected as additional
information becomes available. Beginning June 2006, ENGlobal included the
WRC operating results in its financial statements.
The unaudited proforma combined historical results, as if the WRC
acquisition had taken place at the beginning of 2006 and 2005,
respectively, are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ---------------------
2006 2005 2006 2005
--------- --------- --------- ---------
(in thousands)
-----------------------------------------------
Revenue as reported $ 59,266 $ 224,196 $ 163,314
Proforma revenues of WRC 4,405 7,146 10,182
--------- --------- ---------
Proforma revenues $ 63,671 $ 231,342 $ 173,496
========= ========= =========
Net income as reported $ 1,620 $ 1,995 $ 4,061
Proforma income (loss) of WRC 12 (804) 130
--------- --------- ---------
Proforma net income $ 1,632 $ 1,191 $ 4,191
========= ========= =========
Basic per share data as reported $ 0.07 $ 0.08 $ 0.17
Proforma basic per share data $ 0.07 $ 0.06 $ 0.18
Diluted per share data as reported $ 0.07 $ 0.07 $ 0.17
Proforma diluted per share data $ 0.07 $ 0.06 $ 0.17
NOTE 6 - GOODWILL
In accordance with Statement of Financial Accounting StandardsSFAS No. 142, "Goodwill and Other Intangible Assets",Assets,"
goodwill is no longer amortized over its estimated useful life, but rather
will beis subject to at least an annual assessment for impairment. SFAS 142 also
requires that intangible assets with estimable useful lives be amortized
over their respective estimated useful lives to their estimated residual
values and reviewed for impairment in accordance with SFAS No. 144,
9
Notes to Condensed Consolidated Financial Statements
----------------------------------------------------
"Accounting for the Impairment or Disposal of Long-Lived Assets." Goodwill
has been allocated to the Company's two reportable segments. The test for
impairment is made on each of these reporting segments. No impairment of
goodwill has been incurred to date.
Reference is made to NOTE 16 - ACQUISITIONS, in the Company's Report to
Shareholders on Form 10K for the period ending December 31, 2006. A
third-party valuation of intangible assets was received relating to the
Company's acquisition of WRC Corporation. A portion of the goodwill was
allocated to intangible assets based on the value and nature of the
agreements and is being amortized accordingly over the term of the
agreements. During the three month period ending March 31, 2007, the
Company consulted with the third-party valuation provider and revised the
allocation to intangible assets resulting in approximately $669,000 being
re-allocated back to goodwill. This caused an additional $70,000 of
amortization of intangibles during 2006 than would have been recognized
given the final analysis of the WRC acquisition. The Company's amortization
of the affected intangible assets will be adjusted over the remaining five
year term of those assets and will not have a material effect on the
current or future period financial results.
NOTE 7 - LINE OF CREDIT AND DEBT
Effective July 27, 2006,March 30, 2007, the Company and Comerica Bank ("Comerica")
entered into an amendment to the Company's existing Credit Facility (the
"Comerica Credit Facility"). The maturity date of the Comerica Credit Facility was
extended to July 26, 2009 and whereby the limit on the revolving credit note
was increased from $22$30 million to $30$35 million, subject to loan covenant
restrictions. The maturity date of the Comerica Credit Facility will remain
at July 26, 2009. The loan agreement positions Comerica as senior to all
other debt. Thedebt and the Comerica Credit Facility is collateralized by
substantially all the assets of the Company. The outstanding balance on the
line of credit as of September 30, 2006March 31, 2007 was $19.7$29.6 million. The remaining
borrowings available under the line of credit as of September 30, 2006March 31, 2007 were
$10.3$5.4 million after
consideration ofas loan covenant restrictions.restrictions did not limit the available
borrowings.
The Comerica Credit Facility contains covenants requiring the Company, as
of the end of each calendar month, to maintain certain ratios, including
the total funded debt to EBITDA; total funded debt to total liabilities, plus
net worth; and
to total funded debt to accounts/unbilled receivables. The
Company is also required, as of the end of each quarter, to maintain
minimum levels of net 11
worth, andplus the Company must comply with an annual
limitation on capital expenditures. The Company was in compliance with all
covenants under the Comerica Credit Facility as of September 30, 2006.
AsMarch 31, 2007 and had
no standby letters of September 30, 2006, all standbycredit outstanding. Standby letters of credit
previously issued to a refining client expired in August 2006.
10
Notes to cover contractual obligations for progress payments
made to equipment manufacturers for major project items had expired.
September 30,Condensed Consolidated Financial Statements
----------------------------------------------------
March 31, December 31,
2007 2006
2005
--------- ----------------------------
(in thousands)
--------------------------------------------
Schedule of Long-Term Debt:
Comerica Credit Facility - Line of credit, $12,703,000prime (8.25% at prime and $7,000,000 at
30 day LIBOR plus 150 bps (8.25% and 6.83% respectively at September 30, 2006)March 31, 2007),
maturing in July 2009 $ 19,70329,616 $ 3,77423,963
Sterling Planet and EDGI - Notes payable, interest at 5%, principal payments in
installments of $15,000 plus interest due quarterly, maturing in December 2008 150 195
Significant PEI Shareholders - Note payable, discounted at 4.5% interest, principal
payments in installments of $208,761 due annually, maturing in December 2006 203 188105 120
Cleveland Inspection Services, Inc., CIS Technical Services and F.D. Curtis - Notes
payable, discounted at 5% interest, principal in installments of $100,000 due
quarterly, maturing in October 2009 1,194 1,4441,023 1,109
InfoTech Engineering, Inc. - Note payable, interest at 5%, principal payments in
installments of $65,000 plus interest due annually, maturing in December 2007 130 13075 75
A.T.I. Inc. - Note payable, interest at 6%, principal payments in installments of
$30,422 including interest due monthly, maturing in January 2009 793 --632 713
Michael H. Lee - Note payable, interest at 5%, principal payments in installments of
$150,000 plus interest due quarterly, maturing June 10,in July 2010 2,2501,950 2,100
Watco Management, Inc. - Note payable, interest at 4%, principal payments in
installments of $137,745 including interest annually, maturing in October 2010 500 500
Miscellaneous -- Miscellaneous 20 45--
-------- --------
Total long-term debt 24,443 5,77633,901 28,580
Less: Current maturities (1,612) (548)(1,427) (1,418)
-------- --------
Long-term debt, net of current portion $ 22,83132,474 $ 5,22827,162
======== ========
NOTE 8 - SEGMENT INFORMATION
The Company operates in two business segments: (1) engineering, providing
services primarily to major companies involved in the hydrocarbon and
chemical processing industries, pipelines, oil and gas development, and
cogeneration units that, for the most part, are located in the United
States; and (2) systems, providing design and implementation of control
systems for specific applications primarily in the energy and process
industries, and uninterruptible power systems and battery chargers to
customers that, for the most part, are located in the United States.
Beginning January 1, 2006, the Company re-assigned all advanced automation
and integrated controls projects previously reported under the systems
segment to the newly created ENGlobal Automation Group, Inc. ("EAG") within
the engineering segment. Results presented have been reclassified to
reflect the re-assignment.
Results attributable to the activity of the latest acquisition, WRC, are
included in the engineering segment.
Revenue and operating income for each segment are set forth in the
following table. The amount inunder Corporate includes those activities that
are not allocated to the operating segments and includesinclude costs related to
business development, executive function, finance, accounting, safety,
12
investor
relations/governance, human resources, project controls, and
information technology, legal,
safety and human resources that are not specifically identifiable with the
two segments. IntercompanyInter-company elimination includes the amount of
administrative costs allocated to the segments. Corporate functions support
both business segments and therefore cannot be specifically assigned to
either. Significant portions of Corporate costscost are allocated to each
segment based on each segment's labor revenues and eliminated in consolidation.
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2006 2005 2006 2005
--------- --------- --------- ---------
(in thousands)
------------------------------------------------
Revenue:
Engineering $ 76,617 $ 55,923 $ 208,955 $ 152,111
Systems 5,887 3,343 15,241 11,203
--------- --------- --------- ---------
Total revenue $ 82,504 $ 59,266 $ 224,196 $ 163,314
========= ========= ========= =========
Operating income (loss):
Engineering $ 705 $ 5,548 $ 12,192 $ 14,340
Systems (281) (293) (409) (608)
Corporate 348 1,017 749 2,942
Intercompany eliminations (3,027) (3,507) (9,104) (9,664)
--------- --------- --------- ---------
Total operating income $ (2,255) $ 2,765 $ 3,428 $ 7,010
========= ========= ========= =========
Financial information about geographic areas
--------------------------------------------
Revenues from the Company's non-U.S. operations for the three months and
nine months ended September 30, 2006 were $1.5 million and $2.5 million,
respectively. Long-lived assets (principally leasehold improvements and
computer equipment) outside the United States were $94,000 as of September
30, 2006.
NOTE 9 - EARNINGS PER SHARE
The following table reconciles the denominator used to compute basic
earnings per share to the denominator used to compute diluted earnings per
share ("EPS").
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
2006 2005 2006 2005
---------- ---------- ---------- ----------
(in thousands)
-------------------------------------------------
Weighted average shares outstanding
(denominator used to compute basic EPS) 26,645,830 23,890,842 26,475,353 23,637,345
Effect of employee and outside director stock options -- 1,007,203 552,578 822,968
---------- ---------- ---------- ----------
Denominator used to compute diluted EPS 26,645,830 24,898,045 27,027,931 24,460,313
========== ========== ========== ==========11
Notes to Condensed Consolidated Financial Statements
----------------------------------------------------
Three Months Ended
March 31,
----------------------
2007 2006
-------- --------
(in thousands)
Revenue:
Engineering $ 76,149 $ 62,587
Systems 5,510 4,040
-------- --------
Total revenue $ 81,659 $ 66,627
======== ========
Operating income (loss):
Engineering $ 9,501 $ 4,890
Systems (180) (182)
Corporate 683 129
Inter-company eliminations (4,470) (2,716)
-------- --------
Total operating income $ 5,534 $ 2,121
======== ========
Financial information about geographic areas
--------------------------------------------
Revenue from the Company's non-U.S. operations is currently not material.
Long-lived assets (principally leasehold improvements and computer
equipment) outside the United States were $76,741 as of March 31, 2007, net
of accumulated depreciation.
NOTE 9 - FEDERAL INCOME TAXES
The components of income tax expense (benefit) for the periods ended March
31, 2007 and 2006 were as follows:
Three Months Ended
March 31,
----------------------
2007 2006
------- -------
(in thousands)
Current $ 1,820 $ 763
Deferred (39) (16)
------- -------
Total tax provision $ 1,781 $ 747
======= =======
12
Notes to Condensed Consolidated Financial Statements
----------------------------------------------------
NOTE 10 - EARNINGS PER SHARE
The following table reconciles the denominator used to compute basic
earnings per share to the denominator used to compute diluted earnings per
share ("EPS").
Three Months Ended
March 31,
---------------
2007 2006
------ ------
(in thousands)
Weighted average shares outstanding
(denominator used to compute basic EPS) 26,809 26,333
Effect of employee and outside director stock options 451 913
------ ------
Denominator used to compute diluted EPS 27,260 27,246
====== ======
NOTE 11 - CONTINGENCIES
Employment Agreements
The Company has employment agreements with certain of its executive
officers and certain other officers, the terms of which expire in January
2009. Such agreements provide for minimum salary levels. If the Company
terminates the employment of the employee for any reason other than 1)
termination for cause, 2) voluntary resignation, or 3) employee's death,
the Company is obligated to provide a severance benefit equal to six months
of the employee's salary, and, at its option, an additional six months at
50% to 100% of the employee's salary in exchange for an extension of the
non-compete. These agreements are renewable for one year at the Company's
option.
Litigation
----------
From time to time, the Company and its subsidiaries become parties tois involved in various legal proceedings
arising in the ordinary course of normal business activities. While we cannot predictalleging, among other things,
breach of contract or tort in connection with the performance of
professional services, the outcome of thesewhich cannot be predicted with
certainty. As of the date of this filing, we are party to several legal
proceedings in
our opinion, and based on reports of counsel, any liability arising from
such matters,that have been reserved for or are covered by insurance, or
that, if determined adversely to us individually or in the aggregate, arewould
not expected to have a material adverse effect upon the consolidatedon our results of operations or
financial position or operationsposition.
Insurance
The Company carries a broad range of the Company.
13
NOTE 11 - SUBSEQUENT EVENTS
On October 6, 2006, the Company, through its wholly-owned subsidiary,
ENGlobal Construction Resources, Inc. ("ECR"), acquired certain assets of
WATCO Management, Inc. ("WATCO"),insurance coverage, including general
and business automobile liability, commercial property, professional errors
and omissions, workers' compensation insurance and a Houston-based business providing
construction management, turnaround management, asset management and
project commissioning and start-up services and related services for
projects and facilities located in process plants. The addition of WATCO
will provide ECR with opportunities to expand its current services to
existing WATCO clients in addition to a complementary business allowing
expansion of current services to both existing and future clients. The
aggregate purchase price was $1.0 million, including $500,000 in cash and
an unsecured promissory note in the principal amount of $500,000 payable in
four equal annual installments, bearing interest at the rate of 4% per
annum. The estimate, fair values of the acquired assets include
approximately $800,000 in intellectual property, $52,000 in fixed assets
and $148,000 in goodwill.general umbrella
policy. The Company is not aware of any claims in excess of insurance
recoveries. ENGlobal is partially self-funded for health insurance claims.
Provisions for expected future payments are accrued based on the process of obtaining
third-party valuations of the certain intangible assets; thus the
allocation of the purchase price is subject to adjustment.
In September 2006,Company's
experience. Specific stop loss levels provide protection for the Company
through its wholly-owned subsidiary,
ENGlobal Engineering, Inc., entered into two agreements with SchmArt
Engineering, Inc. based in Beaumont, Texas ("SchmArt"): (1) a one year,
non-exclusive License Agreement on SchmArt's Relief++Software,$175,000 per occurrence and (2) a
Hiring Agreement covering the Company's hiring of any SchmArt employee in
the future. In October 2006, the Company responded to two "Notice of Levy"
advisements from the Department of Treasury - Internal Revenue Service
related to taxes owed by SchmArt. The Company has responded to each notice
and fully expects to comply with all requirements of such notices.
Effective September 1, 2006, we entered into an Investment and Development
Agreement (the "Agreement") with US Syngas, LLC, a Delaware limited
liability company ("USS") relating to USS's development of Stage Three of a
coke-to-ammonia plant (the `Project"). The Agreement contemplates an
additional agreement between USS and one of its wholly owned subsidiaries
(the "Subsidiary") to sell the Project's production. Under the Agreement,
ENGlobal invested $100,000 cash, agreed to license sell certain software
valued at $243,750 one month after Project kick-off, and agreed to invest
an additional $156,250 in cash four months after Project kick-off. Two
other investors have invested an aggregate of $4approximately $12.1 million in the Project. In
order to meet the milestones required for construction financing, USS will
need to raise significant additional construction financing and the
Subsidiary will need to enter into agreements for an unspecified amount of
debt financing and equity financing (the "Equity Financing").
The Agreement contemplates the formation ofaggregate
in each policy year being covered by a limited liability company in
which USS will own all of the common Unites and ENGlobal and other
investors will own Preferred Units. ENGlobal will receive interest at the
rate of 7% per annum on the Preferred Units, or if ENGlobal fully funds its
required investment, the Preferred Units will be redeemed at 175% of
ENGlobal's investment. USS will have a right to convert ENGlobal's
investment into securities to be issued in the equity financing. In
addition, ENGlobal will have a right to invest in the Equity Financing.
On May 25, 2006, the Company, through its wholly-owned subsidiary ENGlobal
Corporate Services, Inc., purchased a one-third partnership interest in PEI
Investments, A Texas Joint Venture ("PEI"), from Michael L. Burrow, the
Company's President and CEO, and another one-third interest from a
stockholder who owns less than 1% of the Company's common stock. The
partnership interests were purchased for a total of $69,000. The remaining
one-third interest was already held by the Company through its wholly-owned
subsidiary EEI. PEI owns the land on which our Beaumont, Texas office
building, destroyed by Hurricane Rita in September 2005, was located. The
remains of the building were razed in July 2006. In September 2006, the
Company acquired approximately 1.2 acres immediately adjacent to the former
facility and is developing plans to construct a new facility utilizing both
parcels of land. On October 26, 2006, the Company received final proceeds
in the amount of $200,456 from anseparate insurance claim for the building.
14policy.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Forward-Looking Statements
--------------------------
Certain information contained in this Form 10-Q, the Company's Annual
Report on Form 10-K, 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 with 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; and 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 Form 10-Q, the specific risk factors identified in the Company's
Annual Report on Form 10-K for the year ended December 31, 20052006 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 Consolidated Financial Statements,
including the notes thereto, included in this Form 10-Q and the Company's
Annual Report on Form 10-K for the year ended December 31, 2005.2006.
MD&A Overview
-------------
The following list sets forth a general overview of the more significant
changes in ourthe Company's financial condition and results of operations for
the three and nine month periodsperiod ended September 30, 2006,March 31, 2007, compared to the corresponding
periodsperiod in 2005.
During the three month period During the nine month period
ended September 30, 2006 ended September 30, 2006
-------------------------------------------------------------
Revenue Increased 39.2% Increased 37.3%
Gross profit Decreased 42.0% Increased 12.9%
SG&A expense Increased 34.1% Increased 45.4%
Operating income Decreased 181.6% Decreased 51.1%
Net income Decreased 196.9% Decreased 50.9%
2006.
During the three month period
ended March 31, 2007
-----------------------------
Revenue Increased 23%
Gross profit Increased 62%
Operating income Increased 161%
SG&A expense Increased 27%
Net income Increased 156%
Long-term debt, net of current portion, increased 337%19.6%, or $17.6$5.3 million,
from $5.2$27.2 million at December 31, 20052006 to $22.8$32.5 million at September 30,
2006,March 31, 2007,
and as a percentage of stockholders' equity, long-term debt increased to
73.3% from 13.1% to 50.9%66.5% at these same dates. The primary reason for the increase
in long-term debt is primarily attributablethe timing difference related to approximately $10.4 million usedmeeting short-term
bi-weekly payroll obligations from our growth and longer collection periods
on receipts from our clients. On average, our accounts receivable days
outstanding has increased to acquire71 days for the assets of ATI and the stock of WRC, additional investments in capital
equipment totaling approximately $2.8 million, plus delays in collections
of fees, primarily on a new alliance contract, totaling approximately $5.6
million. The increase in the ratio of long-term debt as a percentage of
stockholders' equitythree month period ended March
31, 2007, from 66 days for the comparable periods is primarily the result of
the increaseperiod in total long-term debt along with the negative impact2006. The Company
continues to work toward improving billing and collection processes.
Total stockholders' equity increased 8.5%, or $3.4 million, from $40.9
million as a result of the Company's current reporting period
loss.
Primarily dueDecember 31, 2006 to losses incurred on two fixed-price contracts, we$44.3 million as of March 31, 2007.
14
MD&A/Results of Operations (continued)
- --------------------------------------
Consolidated Results of Operations for the Three Months
Ended March 31, 2007 and 2006
(Unaudited)
Three Months Ended
March 31,
---------------------------------------------
2007 2006
---------------------------------------------
(In thousands)
---------------------------------------------
Revenue:
Engineering $ 69,262 84.8 % $ 62,587 93.9 %
Systems 5,510 6.8 % 4,040 6.1 %
Acquisition 6,887 8.4 % - - %
------------ ------------
Total revenue $ 81,659 100.0 % $ 66,627 100.0 %
============ ============
Gross profit:
Engineering $ 11,779 17.0 % $ 7,796 12.5 %
Systems 249 4.5 % 426 10.6 %
Acquisition 1,250 18.2 % - - %
------------ ------------
Total gross profit 13,278 16.3 % 8,222 12.3 %
------------ ------------
SG&A expense:
Engineering 2,946 4.3 % 2,906 4.6 %
Systems 429 7.8 % 608 15.1 %
Corporate 3,787 4.6 % 2,587 3.9 %
Acquisition 582 8.5 % - - %
------------ ------------
Total SG&A expense 7,744 9.5 % 6,101 9.2 %
------------ ------------
Operating income:
Engineering 8,832 12.8 % 4,890 7.8 %
Systems (180) (3.3)% (182) (4.5)%
Corporate (3,787) (4.6)% (2,587) (3.9)%
Acquisition 669 9.7 % - - %
------------ ------------
Total operating income 5,534 6.8 % 2,121 3.2 %
------------ ------------
Other income (expense), net (560) (0.7)% (140) (0.2)%
Tax provision (1,820) (2.2)% (747) (1.1)%
------------ ------------
Net income $ 3,154 3.9 % $ 1,234 1.9 %
============ ============
Other financial comparisons:
- ----------------------------
March 31, March 31,
2007 2006
-------------------
(In thousands)
-------------------
Working capital $ 44,215 $ 26,062
Total assets $111,201 $ 80,474
Long-term debt, net of current portion $ 32,474 $ 9,910
Stockholders' equity $ 44,321 $ 41,314
15
MD&A/Results of Operations (continued)
- --------------------------------------
We recorded a net lossincome of $1.6$3.2 million, or $(0.06)$0.12 per diluted share for the
three months ended September 30, 2006,March 31, 2007, compared to net income of $1.6$1.2 million,
or $0.07$0.05 per diluted share for the corresponding period last year. We recorded
15
net income of $2.0 million, or $0.07 per diluted share for the nine months
ended September 30, 2006, compared to net income of $4.1 million, or $0.17
per diluted share for the corresponding period last year.
We adopted SFAS 123(R) on January 1, 2006, and our results of operations
for the three and nine months ended September 30, 2006, respectively,
include $404,000 and $895,000 of expense related to stock options. These
amounts have been included SG&A expense in the accompanying Condensed
Consolidated Statements of Income.
Stockholders' equity increased 12.5%, or $5.0 million, from $39.9 million
as of December 31, 2005 to $44.9 million as of September 30, 2006.
Critical Accounting Policies
----------------------------
A summary of critical accounting policies is disclosed in Note 2 to the
Consolidated Financial Statements included in our 2005 Annual Report on
Form 10-K. Our critical accounting policies are further described under the
caption "Critical Accounting Policies" in Management's Discussion and
Analysis of Financial Condition and Results of Operation in our 2005 Annual
Report on Form 10-K. Other than the adoption of SFAS No. 123(R), which is
described in Note 2 to the Interim Condensed Consolidated Financial
Statements included in this Form 10-Q, there have been no changes in the
nature of our critical accounting policies or the application of those
policies since December 31, 2005.
16
Results of Operations
---------------------
The following table illustrates the composition of the Company's revenue
and operating expense mix quarter over quarter for the three and nine-month
periods ended September 30, 2006 and 2005, and provides a comparison of the
changes in revenue and operating expense and trends period over period:
Consolidated Results of Operations for the Three and Nine Months
Ended September 30, 2006 and 2005
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------------- -----------------------------------------
2006 2005 2006 2005
----------------- ----------------- ------------------- ------------------
(dollars in thousands)
----------------------------------------------------------------------------------
Revenue:
Engineering $ 69,311 84.0 % $ 50,866 85.8 % $ 198,984 88.8 % $ 140,876 86.3 %
Systems 5,887 7.1 % 3,343 5.6 % 15,241 6.8 % 11,203 6.9 %
Acquisition 7,306 8.9 % 5,057 8.6 % 9,971 4.4 % 11,235 6.9 %
-------- -------- --------- ---------
Total revenue $ 82,504 100.0 % $ 59,266 100.0 % $ 224,196 100.0 % $ 163,314 100.0 %
======== ======== ========= =========
Gross profit:
Engineering $ 3,456 5.0 % $ 7,157 14.1 % $ 21,035 10.6 % $ 18,907 13.4 %
Systems 123 2.1 % 203 6.1 % 1,087 7.1 % 850 7.6 %
Acquisition 970 13.3 % 478 9.5 % 1,377 13.8 % 1,059 9.4 %
-------- -------- --------- ---------
Total gross profit 4,549 5.5 % 7,838 13.2 % 23,499 10.5 % 20,816 12.7 %
-------- -------- --------- ---------
SG&A expense:
Engineering 3,203 4.6 % 1,814 3.6 % 9,436 4.7 % 4,859 3.5 %
Systems 404 6.9 % 496 14.9 % 1,496 9.8 % 1,458 13.0 %
Corporate 2,679 3.2 % 2,490 4.2 % 8,355 3.7 % 6,722 4.1 %
Acquisition 518 7.1 % 273 5.4 % 784 7.9 % 767 6.8 %
-------- -------- --------- ---------
Total SG&A expense 6,804 8.2 % 5,073 8.6 % 20,071 8.9 % 13,806 8.5 %
-------- -------- --------- ---------
Operating income:
Engineering 253 0.4 % 5,343 10.5 % 11,599 5.8 % 14,048 10.0 %
Systems (281) (4.8)% (293) (8.8)% (409) (2.7)% (608) (5.4)%
Corporate (2,679) (3.2)% (2,490) (4.2)% (8,355) (3.7)% (6,722) (4.1)%
Acquisition 452 6.2 % 205 4.1 % 593 6.0 % 292 2.6 %
-------- -------- --------- ---------
Total operating income (2,255) (2.7)% 2,765 4.7 % 3,428 1.5 % 7,010 4.3 %
-------- -------- --------- ---------
Other income (expense), net (391) (0.5)% (193) (0.3)% (397) (0.2)% (564) (0.3)%
Tax provision 1,076 1.3 % (952) (1.6)% (1,036 (0.5)% (2,385) (15)%
-------- -------- --------- ---------
Net income $ (1,570) (1.9)% $ 1,620 2.7 % $ 1,995 0.9 % $ 4,061 2.5 %
======== ======== ========= =========
17
Other financial comparisons:
----------------------------
As of September 30,
-------------------
2006 2005
------- -------
(in thousands)
-----------------
Working capital $35,503 $18,334
Total assets $99,384 $63,286
Long-term debt, net of current portion $22,831 $ 1,826
Stockholders' equity $44,882 $39,023
In the results presented for the three and nine months ended September 30,
2006, "Acquisition" totals include the results of operations related to the
acquisition of WRC. All previous acquisitions have been fully integrated
and reported in segment details. In the results presented for the three and
nine months ended September 30, 2005, "Acquisition" totals include the
combined results of operations related to assets acquired from Cleveland
Inspection Services, Inc. ("Cleveland") and AmTech Inspection, LLC
("AmTech"). For analytical purposes only, results from acquired companies
or acquired assets are shown separately for the first 12 months after
closing.
Results presented for the three and nine months ended September 30, 2005
have been reclassified to more closely conform to the 2006 presentation.
Primarily due to losses incurred on two fixed-price contracts, we recorded
a net loss of $1.6 million, or $(0.06) per diluted share for the three
months ended September 30, 2006, compared to net income of $1.6 million, or
$0.07 per diluted share for the corresponding period last year. We recorded
net income of $2.0 million, or $0.07 per diluted share for the nine months
ended September 30, 2006, compared to net income of $4.1 million, or $0.17
per diluted share for the corresponding period last year. We adopted SFAS
123(R) on January 1, 2006, and our results of operations for the three and
nine months ended September 30, 2006, respectively, include $404,000 and
$895,000 of expense related to stock options. These amounts have been
included SG&A expense in the accompanying Condensed Consolidated Statements
of Income.
The following table compares the effects of SFAS 123(R) on net income
(loss) and earnings per share for the three and nine months ended September
30, 2006.
Three Months Nine Months
Ended Ended
---------- ---------
September 30, 2006
-----------------------
(in thousands)
-----------------------
Net income (loss)
As reported $ (1,570) $ 1,995
Effect of SFAS 123(R) (net of tax) 188 417
--------- ---------
Net income (loss) before the effects of SFAS 123(R) $ (1,382) $ 2,412
========= =========
Diluted earnings per share
As reported $ (0.06) $ 0.07
Effect of SFAS 123(R) 0.01 0.01
--------- ---------
Net earnings per share before the effects of SFAS 123(R) $ (0.05) $ 0.08
========= =========
18
The following table presents, for the periods indicated, the approximate
percentage of total revenues and operating income or loss attributable to
our reportingreportable segments:
Three Months Ended
Nine Months Ended
September 30, September 30,
-------------------- -----------------March 31,
2007 2006 2005 2006 2005
------ ------
------ ------
Revenue:
Engineering 92.9% 94.4% 93.2% 93.1%93.2 % 93.9 %
Systems 7.1% 5.6% 6.8% 6.9%6.8 % 6.1 %
Operating income (loss):
Engineering 166.3% 105.6% 103.5% 104.4%12.5 % 7.8 %
Systems (66.3)(3.3)% (5.6)% (3.5)% (4.4)(4.5)%
The Company's revenue is composed of engineering, construction and
procurement service revenue, systems, land/management and revenue from our manufactured systemsrelated product
sales. We recognizeThe Company recognizes service revenue as soon as the services are
performed. The majority of ourthe Company's engineering services have
historically been provided through cost-plus contracts whereas a majority
of the Company's systemsproduct sales are earned on fixed-price contracts.
However, our engineering segment recognized approximately $12.4 million and $27.2$3.8 million in
fixed-price revenue in the three and nine month periodsperiod ended September 30, 2006,March 31, 2007,
compared to approximately $3.3 million and $6.3less than $4.7 million of similar revenuesrevenue in each of the same periodsperiod in
2005.2006. Of the fixed price revenue, $1.8 million and $2.7 million for the
three month period ending March 31, 2007 and March 31, 2006, respectively,
were related to the two projects with recorded losses during 2006.
Revenue on fixed-price contracts is recorded primarily using the percentage-of-completion
(cost-to-cost) method. Under this method, revenue on long-term contracts is
recognized in the ratio that contract costs incurred bear to total
estimated contract costs. Revenue and gross margin on contracts are subject
to revision throughout the lives of the contracts and any required
adjustments are made in the period in which the revisions become known.
Losses on contracts are recorded in full as they are identified.
In the course of providing our complement of services, we routinely provide engineering,
materials, and equipment and may provide construction services on a
subcontractor basis. Generally, these materials, equipment and
subcontractor costs are passed through to our clients and reimbursed, along
with fees, which in total are at margins much 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 and purchase of materials can change significantly from project to project;
therefore, changes in revenue may not be indicative of business trends.
For analytical purposes only, we segregate from our total revenue the
revenues derived from material assets or companies acquired during the
first 12 months following their respective dates of acquisition and we
refer
to such revenue as "Acquisition" revenue. We also segregate gross profits
and SG&A expenses derived from material assets or company acquisitions on
the same basis as we segregate revenues. We elected not to
segregated the revenue, gross profit and SG&A expenses resulting from
acquired assets of ATI primarily because almost immediate following the
close of that transaction those assets and the ATI staff were fully
integrated into the ESI's facility and operation. We analyze, for internal
purposes only, the percentage of our revenue that comes from staffing
services versus the percentage that comes from engineering services, as
engineering services have a higher margin than field or staffing services.
Operating SG&A expense includes management and staff compensation, office
costs such as rents and utilities, depreciation, amortization, travel and
other expenses generally unrelated to specific client contracts, but
directly related to the support of a segment's operation.
Corporate SG&A expense is comprised primarily of marketing costs, as well
as costs related to the executive, governance/investor relations,relations/governance, finance,
accounting, safety, human resources, project controls, legal and
information technology departments and other costs generally unrelated to
specific client projects, but which are incurred to support corporate
activities and initiatives.
1916
The Company's acquisition strategy is focused on developing breadth and
depthMD&A/Results of expertise within the organization by continuing to search for
candidates that fit into one of two profiles. First, the Company considers
acquisition candidates with revenues at or over the $10 million that would
provide new service capabilities for its clients. Second, the Company
considers acquisition candidates of various sized operations that have
capabilities similar to those it currently provides in order to assist the
Company in gaining a larger position in a given market segment or
geographic location.Operations (continued)
- --------------------------------------
Industry Overview:
Downstream
Many ENGlobal offices have benefited from the strong market for refining
related projects.refinery market. We
expect significant capital projects to be generated by refinery operations
over the next several years and we will continue to research other markets
that value our services. Overall, projects in the
U.S. for expandingrelated to refining capacity and
for utilization of heavy sour
crude as feed-stocks are trending upward, while projects actively related
to environmental mandates have peaked and are trending downward. As stated
in our 2003 annual letter to stockholders, thetrended upward. Given that global demand for
oil products has tightened the supply of both crude oil as well as refinery
products. With this current demand,products, we believe each of ENGlobal's business segments areis well
positioned within the industry ifshould refinery capacity be added in the
U.S.United States of America and the overseas markets continuescontinue to rise.
The petrochemical industry has recently been a good source of projects for
ENGlobal. In the last two years, weWe have seen an increase in petrochemicalboth maintenance and capital spending
after an extended periodseveral years of relative inactivity. The petrochemical industry
along the Gulf Coast hascontinues to struggle with the aftermath of Hurricane
Katrina and Hurricane Rita. Although it will take several years to rebuild,
we expect that we will assist our clients with repairs to regional
petrochemical facilities in order to resolve current supply limitations.
Despite past downturns in the industry, pipeline projects have remained
constant for the most part, recovered from the aftermath of the hurricanes, with construction
contractors and material suppliers being the primary beneficiary of the
recovery effort. Our major workloadwe have recently seen an increase in
the petrochemical area continues to
be smaller capital and maintenance projects for U.S. plants.
Midstream
Capital spending for major pipeline projects is projected to be robust,
after several years of lower activity that resulted in part from pipeline
operators' diversion of their capital budgets to mandated integrity
projects. New pipeline projects are being planned to transport natural gas
from several new LNG plants; for new crude deliveries from Canada to
facilitate new refinery and petrochemical plants; and for fuel supplies to
new co-generation and power plants. In addition, large pipeline capital
projects are currently being planned to deliver natural gas away from the
Rocky Mountain region, and also to deliver refined products to various
locations, but primarily to the Midwest and Northeast U.S.project activity. Pipeline projects tend to require less engineering man
hours as the scope of engineering work is typically smaller than for
similarlysimilar sized downstream projects. ENGlobal is positioned to participate in pipeline related land
regulatory services through its 2006 acquisition of WRC, and in inspection
services through its 2004 acquisition of Cleveland Inspection
Upstream
We do not have a significant market presenceIn addition, the project awards in the
upstream sector.
Currently, our only revenuespipeline segment are smaller in the upstream markets come from projects for
remote instrument building and gas processing facilities. However, the
Company will consider acquisition targetsnature than those in this area to increase the
suite of capabilities already offered to our clients.
Alternative Fuels
High prices for energy related commodities, as well as governmental
initiatives and incentives, have created increasing demand for sources of
alternative energy. Alternative energy sources currently supply
approximately 6% of U.S. energy demand, with approximately 47% of the
alternative sources coming from biomass processes such as ethanol. It is
expected that the number and scope of ENGlobal's alternative energy related
projects will increase along with an expanding market, and that the
Company's participation will primarily be in biomass related processes.other industries.
Revenue:
Revenue increased $23.2$15.0 million, or 39.2%22.5%, to $82.5$81.7 million for the three
months ended September 30, 2006March 31, 2007 from $59.3$66.7 million for the comparable prior
year period with approximately $20.7$6.6 million of the increase coming from our
engineering segment, $6.9 million attributable to the acquisition of WRC,
and $2.5 million$1.5 attributable to our systems segment. 20
Revenue increased $60.9 million, or 37.3%, to $224.2 million for the nine
months ended September 30, 2006 from $163.3 million for the comparable
prior year period with approximately $56.9 million of the increase coming
fromThis is discussed further in
our engineering segment and $4.0 million attributable to our systems
segment.information.
Gross Profit:
Gross profit decreased $3.3increased $5.1 million, or 42.0%62.0%, to $4.5$13.3 million for the
three months ended September 30, 2006March 31, 2007 from $7.8$8.2 million for the comparable
prior year period. As a percentage of revenue, gross profit decreased 7.7%increased 4.0%
from 13.2%12.3% for the three months ended September 30, 2005March 31, 2006 to 5.5%16.3% for the
quarter ended March 31, 2007. Of the overall $5.1 million increase in gross
profit, approximately $1.9 million was primarily due to the $15.0 million
increase in revenue plus approximately $3.2 million in equivalent lower
costs.
Selling, General, and Administrative:
As a percentage of revenue, SG&A expense remained relatively level
increasing 0.3% to 9.5% for the three months ended September 30,March 31, 2007 from 9.2%
for the comparable period in 2006. Of the overall $3.3 million decrease
in gross profit, approximately $3.1 million was due to the increase in
revenue and approximately $6.4 million was due toTotal expense for SG&A increased costs. The
primary reason for increased costs and the decrease in gross profit during
the period relates to approximately $6.6 million from productivity delays
and cost overruns on two fixed price EPC projects in the Company's
engineering segment.
Gross profit increased $2.7$1.6
million, or 12.9%26.2%, to $23.5$7.7 million for the ninethree months ended September 30, 2006March 31,
2007 from $20.8$6.1 million for the comparable prior year period.
As a percentage of revenue, gross profit decreased 2.2%
from 12.7% for the nine months ended September 30, 2005 to 10.5% for the
quarter ended September 30, 2006. Of the overall $2.7 million increase in
gross profit, approximately $7.8 million was due to the increase in revenue
and approximately $5.1 million was due to increased costs. Again, the
primary reason for increased costs and the decrease in gross profit during
the period relates to approximately $6.6 million from productivity delays
and cost overruns on two fixed price EPC projects in the Company's
engineering segment.
At September 30, 2006, we had outstanding unapproved change orders/claims
of approximately $2.4 million, net of reserves of $1.2 million associated
with ongoing projects. If in the future we determine collection of these
unapproved change orders/claims is not probable, it would result in a
charge to earnings in the period such determination is made.
Selling, General, and Administrative:
As a percentage of revenue, totalCorporate SG&A expense decreased 0.4%increased 0.7% to 8.2%4.6%
for the three months ended September 30, 2006March 31, 2007 from 8.6% for the comparable
period in 2005. Total expense for SG&A increased $1.7 million, or 34.1%, to
$6.8 million for the three months ended September 30, 2006 from $5.1
million for the comparable prior year period.
As a percentage of revenue, Operating SG&A expense increased 0.6%, from
4.4% to 5.0% and 0.8% from 4.4% to 5.2% for the three and nine month
periods, respectively, ended September 30, 2006 and the comparable 2005
periods. Operating SG&A increased approximately $1.5 million, from $2.6
million to $4.1 million, and $4.6 million, from $7.1 million to $11.7
million for the three and nine month periods ended September 30, 2006
against results for the comparable prior year periods of 2005. The
variances in Operating SG&A expense are discussed in further detail under
segment results.
As a percentage of revenue, Corporate SG&A expense decreased 1.0% to 3.2%
for the three months ended September 30, 2006 from 4.2%3.9% for the comparable
prior year period. Corporate SG&A expense increased approximately $200,000,$1.2
million, or 8.0%46.4%, to $2.7$3.8 million for the three months ended September 30, 2006March 31,
2007 from $2.5$2.6 million for the comparable prior year period. The major areas
impacting the quarterincrease
over quarter increaseprior year in Corporate SG&A expense werewas related to $243,000 in costs incurred
on the general investmentcontinuing preparation and review related to SOX compliance;
$264,000 in accrued management incentives; $148,000 related to increased
stock compensation expense; $244,000 related to additional salaries and
related expenses for business development; $200,000 related to the new
Corporate Services and Legal departments and $149,000 for increases in cost
for other support services. The increase in business development costs was
due to a change in reporting of both our currentsystems' sales personnel from
operations to corporate, and long-term growth
plans, plus the addition of stock-based compensation expense offset by
lower executive and key manager incentive plan expense with each
contributing $724,000, $176,000 and ($700,000), respectively. Duringpersonnel to support our
growth, including the three months ended September 30, 2006, we invested approximately $245,000
towards business development related activities; $131,000 toward investor
relations; $107,000 to our continuing upgrade in the area of information
technology; $68,000 toward ongoing efforts to standardize and improve our
project controls systems and procedures plus approximately $173,000 divided
between the areas of accounting, executive, human resources and safety.
As a percentage of revenue, total SG&A expense increased 0.4% to 8.9% for
the nine months ended September 30, 2006 from 8.5% for the comparable
period in 2005. Total expense for SG&A increased $6.3 million, or 45.4%, to
$20.1 million for the nine months ended September 30, 2006 from $13.8
million for the comparable prior year period.
21
As a percentage of revenue, Corporate SG&A expense decreased 0.4% to 3.7%
for the nine months ended September 30, 2006 from 4.1% for the comparable
prior year period. Corporate SG&A expense increased approximately $1.7
million, or 25.4%, to $8.4 million for the nine months ended September 30,
2006 from $6.7 million for the comparable prior year period. The major
areas impacting the year over year increase in Corporate SG&A expense were
the general investment in support of both our current and long-term growth
plans, plus the addition of stock-based compensation expense offset by
lower executive and key manager incentive plan expense with each
contributing $2,307,000, $393,000 and ($1,000,000), respectively. During
the nine months ended September 30, 2006, we invested approximately
$1,044,000 towards business development related activities; $331,000 to our
continuing upgrade in the area of information technology; $219,000 toward
ongoing efforts to standardize and improve our project controls systems and
procedures; $170,000 toward investor relations and governance plus
approximately $543,000 in the areas of accounting, executive, human
resources and safety.
In the course of providing our services, we routinely provide engineering,
materials, and equipment and may provide construction services on a
subcontractor basis. Generally, these materials, equipment and
subcontractor costs are passed through to our clients and reimbursed, along
with fees, which, in total, are at margins much 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 and purchase of materials can
change significantly from project to project; therefore, changes in revenue
may not be indicative of business trends.
For analytical purposes, if we adjusted total revenue by excluding these
subcontractor services and all other non-labor revenue, Corporate SG&A as a
percentage of this adjusted revenue would have actually shown a decrease of
2.3% for the three months ended September 30, 2006 and a decrease of 1.2%
for the nine months ended September 30, 2006 when compared to similar
periods in 2005.WRC acquisition.
Operating Income:
Operating income decreasedincreased approximately $5.0$3.4 million, or 181.6%160.3%, to $(2.3)$5.5
million for the three months ended September 30, 2006March 31, 2007 from $2.8$2.1 million
compared to the same period in 2005.2006. As a percentage of revenue, operating
income decreased 7.4%increased 3.6% to (2.7%)6.8% for the three months ended September 30,
2006March 31, 2007
from 4.7%3.2% for the comparable prior year period.
Operating income decreased approximately $3.6 million, or 51.1%, to $3.4
million for the nine months ended September 30, 2006 from $7.0 million
compared to the same period in 2005. As a percentage17
MD&A/Results of revenue, operating
income decreased 2.8% to 1.5% for the nine months ended September 30, 2006
from 4.3% for the comparable prior year period.Operations (continued)
- --------------------------------------
Other Income (Expense):Expense, net:
Other expense increased $198,000,$ 420,000, to $391,000$560,000 for the three month period
ended September 30, 2006March 31, 2007 from $193,000$140,000 for the comparable prior year period,
primarily due to higher net interest expense related to an increase in interestincreased
outstanding balance on our debt facility. Other
expense decreased $167,000, to $397,000 for the nine month period ended
September 30, 2006 from $564,000 for the comparable prior year period,
primarily due to receiptline of a partnership distribution of $350,000 from
PEI, plus additional proceeds related to insurance claims for building
damages from Hurricane Rita in September 2005 as discussed above.credit.
Tax Provision:
Income tax expense decreased $2.1increased $1.1 million, or 213.0%143.6%, to ($1.1)$1.8 million for
the three months ended September 30, 2006March 31, 2007 from $1.0 million for the
comparable prior year period as a result of losses on two fixed-price
contracts.
Income tax expense decreased $1.4 million, or 56.6%, to $1.0 million for
the nine months ended September 30, 2006 from $2.4$0.7 million for the comparable
prior year period. The estimated effective tax rate was 40.7% and 34.2%36.6% for the
three and
nine-month periodsthree-month period ended September 30, 2006, respectively,March 31, 2007 compared to 37%37.7% for boththe
comparable prior year periods.period. The change in the effective tax rate is affected by the
deferred tax benefit arising from recognitionresult of stock-based compensation on non-qualified options vesting each quarter.
22
utilization of net operating loss for the 2006 year.
The estimated effective tax rates are based on estimates using historical
rates adjusted by recurring and non-recurring book to tax differences.
Estimates at September 30,March 31, 2006 includeincluded the effect of non-recurring
differences in tax estimates from the 2005 year-end andyear-end. Estimates at March 31,
2007 are based on results of the 2005 year end,2006 year-end and are adjusted for estimates
of non-recurring differences from the prior year.year, as well as anticipated
book to tax differences for 2007.
Net Income:
Net income for the three months ended September 30, 2006 decreasedMarch 31, 2007 increased $2.0
million, or 166.7%, to $3.2 million or 200.0%, to $(1.6) million from $1.6 million$1.2 for the comparable prior year
period. As a percentage of revenue, net income decreasedincreased 2.0% to (1.9)%3.9% for
the three month period ended September 30, 2006March 31, 2007 from 2.7%1.9% for the period ended
September 30, 2005.
Net income for the nine months ended September 30, 2006 decreased $2.1
million, or 51.2%, to $2.0 million from $4.1 million for the comparable
prior year period. As a percentage of revenue, net income decreased to 0.9%
for the nine month period ended September 30, 2006 from 2.5% for the period
ended September 30, 2005.
23
Segment Results
- ---------------
Engineering
The following table illustrates the composition of our engineering segment
revenue and operating expense mix quarter over quarter for the three and
nine-month periods ended September 30, 2006 and 2005, and provides a
comparison of the changes in revenue and operating expense and trends
period over period:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------------- -------------------------------------
2006 2005 2006 2005
----------------- ----------------- ----------------- -----------------
(dollars in thousands)
-----------------------------------------------------------------------------
Revenue:
Engineering $ 69,311 90.5% $ 50,866 91.0% $198,984 95.2% $140,876 92.6%
Acquisition 7,306 9.5% 5,057 9.0% 9,971 4.8% 11,235 7.4%
-------- -------- -------- --------
Total revenue $ 76,617 100.0% $ 55,923 100.0% $208,955 100.0% $152,111 100.0%
======== ======== ======== ========
Gross profit:
Engineering $ 3,456 5.0% $ 7,157 14.1% $ 21,035 10.6% $ 18,907 13.4%
Acquisition 970 13.3% 478 9.5% 1,377 13.8% 1,059 9.4%
-------- -------- -------- --------
Total gross profit 4,426 5.8% 7,635 13.7% 22,412 10.7% 19,966 13.1%
-------- -------- -------- --------
Operating SG&A expense:
Engineering 3,203 4.6% 1,814 3.6% 9,436 4.7% 4,859 3.4%
Acquisition 518 7.1% 273 5.4% 784 7.9% 767 6.8%
-------- -------- -------- --------
Total SG&A expense 3,721 4.9% 2,087 3.8% 10,220 4.9% 5,626 3.7%
-------- -------- -------- --------
Operating income:
Engineering 253 0.4% 5,343 10.5% 11,599 6.1% 14,048 10.0%
Acquisition 452 6.2% 205 4.1% 593 6.0% 292 2.6%
-------- -------- -------- --------
Total operating income $ 705 0.9% $ 5,548 10.0% $ 12,192 5.8% $ 14,340 9.4%
-------- -------- -------- --------
Overview:
Summary of financial results during the three and nine-month periods ended
September 30, 2006 compared to the three and nine month periods ended
September 30, 2005
Revenue up 36.7% quarter-over-quarter and 37.4% year-over-year
Gross profit down 42.0% quarter-over-quarter and up 12.3%
year-over-year
Operating SG&A as a percent of revenue up 1.5% quarter-over-quarter
and 1.4% year-over-year
Operating income down 87.3% for quarter-over-quarter and 15.0%
year-over-year
The primary reason for the decline in the overall financial results during
the most recent quarter can be attributed to approximately $6.6 million in
losses on two fixed price EPC projects as a result of material escalation
and productivity delays.
Our engineering segment continues to benefit from a large project load
generated primarily by its downstream clients and to a lesser extent by its
midstream clients. The industry's refining segment continues to be very
active supplying a large percentage of our backlog. ENGlobal is benefiting
from the renewed interest of its chemical/petrochemical clients in
maintenance and retrofit projects as product margins in this marketplace
improve. The Company is also benefiting from increased activity for
pipeline related and alternative energy projects.
24
Beginning January 1, 2006, we re-assigned all advanced automation and
integrated controls projects previously reported under the systems segment
to the newly created EAG within the engineering segment. Results presented
for the first quarter of 2005 have been reclassified to reflect this
re-assignment.
In the results presented for the three and nine months ended September 30,
2006, "Acquisition" totals include the results of operations of WRC.
Acquisition totals for the three and nine months ended September 30, 2005
include results of operations related to assets acquired from Cleveland and
Amtech.
Revenue:
Revenue in our engineering segment increased $20.6 million, or 36.7%, to
$76.6 million for the three months ended September 30, 2006 from $56.0
million for the comparable prior year period.
Revenue increased $56.9 million, or 37.4%, to $209.0 million for the nine
months ended September 30, 2006 from $152.1 million for the comparable
prior year period.
The following table illustrates the composition of our revenue mix quarter
over quarter for the three and nine-month periods ended September 30, 2006
and 2005, and provide a comparison of the changes in revenue and revenue
trends period over period:
Three Months Ended September 30,
----------------------------------------------------
2006 % rev 2005 % rev $ change % change
---- ----- ---- ----- -------- --------
(dollars in millions)
Detail-design $33.9 44% $21.6 39% $ 12.3 57 %
Field services 29.0 38% 14.3 26% 14.7 103 %
Procurement & construction 1.3 2% 16.7 30% (15.4) (92)%
Design-build fixed price 12.4 16% 3.3 5% 9.1 276 %
----- ----- ------
$76.6 100% $55.9 100% $ 20.7
===== ===== ======
Nine Months Ended September 30,
-------------------------------------------------------
2006 % rev 2005 % rev $ change % change
---- ----- ---- ----- -------- --------
(dollars in millions)
Detail-design $ 89.9 43% $ 67.3 44% $ 22.6 34 %
Field services 73.7 35% 39.8 26% 33.9 85 %
Procurement & construction 18.2 9% 38.7 26% (20.5) (53)%
Design-build fixed price 27.2 13% 6.3 4% 20.9 332 %
------ ------ -------
$209.0 100% $152.1 100% $ 56.9
====== ====== =======
The largest increase in revenue came from our core detail-design and field
services, which also includes inspection and land services, activity which
increased $27.0 million, or 75%, to $62.9 million for the third quarter of
2006 from $35.9 million for the comparable period in 2005 and on a combined
basis accounted for approximately 82% and 78% of engineering's total
revenue mix for the three and nine month periods ended September 30, 2006,
respectively. Design-build revenue increased $9.1 million, or 276%, from
$3.3 million for the three month period ended September 30, 2005 to $12.4
million for the same period in 2006 and accounted for approximately 16% of
engineering's total revenue during the three month period. Design-build
revenue increased $20.9 million, or 332%, from $6.3 million to $27.2
million for the nine month period ended September 30, 2006 compared to the
comparable prior year period and during the current nine month period
accounted for approximately 11% of engineering's total revenue. Revenue
from non-labor procurement and construction activity decreased $15.4
million from $16.7 million during the three months ended September 30, 2005
to $1.3 million for the third quarter of 2006 and was down $20.5 million
from $38.7 million during the nine months ended September 30, 2005 to $18.2
million for the comparable period inMarch 31, 2006. Due to projects requiring
procurement or construction support being completed, or nearing completion,
procurement and construction revenue has decreased as a percentage of total
engineering revenue from 30% to 2% and 26% to 9% for the comparable three
and nine month periods ended September 30, 2005 and September 30, 2006.
Individually, our field services revenue was the most significant
contributor to our overall $20.7 million revenue increase for the three
months ended September 30, 2006 adding $14.7 million and increasing its
25
share of our overall revenue from 26% for the three months ended September
30, 2005 to 38% for the third quarter of 2006. Field services revenue was
also a major growth area during the nine month period ended September 30,
2006 increasing $33.9 million to $73.7 million, or 85%, from $39.8 million
for the comparable period in 2005 and grew as a percentage of engineering's
total revenue from 26% during the nine month period ended September 30,
2005 to 35% for the same period during 2006. Field services revenue
includes $7.3 million and $10.0 million related to the acquisition of WRC
for the three and nine month periods ended September 30, 2006,
respectively. Although management anticipates positive trends for all
labor-based revenue, we expect the growth trend in both detail-design and
design-build projects to continue to bring opportunities from both current
and new clients.
Gross Profit:
Gross profit decreased $3.2 million, or 42.0%, to $4.4 million for the
three months ended September 30, 2006 from $7.9 million for the comparable
period in 2005, and, as a percentage of revenue, decreased by 7.4% from
13.7% to 5.8% for the three month periods ended September 30, 2005 and
2006, respectively. Of the overall $3.2 million decrease in gross profit,
approximately $2.8 million was attributable to the $20.7 million increase
in total revenue offset by approximately $6.0 million in higher costs. The
primary reason for increased costs and the decrease in gross profit during
the period relates to approximately $6.6 million from productivity delays
and cost overruns on two fixed price EPC projects. Excluding approximately
$6.6 million of charges related to the two fixed price EPC projects and on
a proforma basis, our engineering segment's gross profit for the three
months ended September 30, 2006 would have been approximately $11.0
million, or approximately 14.3% as a percentage of revenue. Overall, total
losses related to fixed price projects were approximately $6.7 million
during the quarter.
Gross profit increased $2.4 million, or 12.3%, to $22.4 million for the
nine months ended September 30, 2006 from $20.0 million for the comparable
period in 2005, and, as a percentage of revenue, decreased by 2.5% from
13.2% to 10.7% for the nine month periods ended September 30, 2005 and
2006, respectively. Of the overall $2.4 million increase in gross profit,
approximately $7.5 million was attributable to the $56.9 million increase
in total revenue offset by approximately $5.1 million in higher costs. The
primary reason for increased costs and the decrease in gross profit during
the period relates to approximately $6.6 million from productivity delays
and cost overruns on two fixed price EPC projects. Excluding approximately
$6.6 million of charges related to the two fixed price EPC projects and on
a proforma basis, our engineering segment's gross profit for the nine
months ended September 30, 2006 would have been approximately $29.0
million, or approximately 13.9% as a percentage of revenue. Overall, total
losses related to fixed price projects were approximately $7.1 million
during the nine months ended September 30, 2006.
At September 30, 2006 we had outstanding unapproved change orders/claims of
approximately $2.4 million, net of reserves of $1.2 million associated with
ongoing projects. If in the future, we determine collection of these
unapproved change orders/claims is not probable, it would result in a
charge of $1.2 million to earnings in the period such determination is
made.
Selling, General, and Administrative:
As a percentage of revenue, SG&A expense increased to 4.9% for the three
month period ended September 30, 2006 from 3.8% for the three month period
ended September 30, 2005. SG&A expense increased approximately $1.6
million, or 78.3%, to $3.7 million for the three months ended September 30,
2006 from $2.1 million for the comparable prior year period. The increase
in SG&A expense includes costs of $322,000 attributable to the support of
expanded facilities to meet both current and projected growth requirements;
$463,000 related to new costs related to the start-up of EAG; $518,000
related to new costs associated to the acquisition of WRC; $128,000 in
stock-compensation expense and $169,000 in other additional costs.
As a percentage of revenue, SG&A expense increased to 4.9% for the nine
month period ended September 30, 2006 from 3.7% for the nine month period
ended September 30, 2005. SG&A expense increased approximately $4.6
million, or 81.7%, to $10.2 million for the nine months ended September 30,
2006 from $5.6 million for the comparable prior year period. The increase
in SG&A expenses included $1,264,000 attributable to the support of
expanded facilities to meet both current and projected growth requirements;
$762,000 in salaries and benefits; $1,157,000 in new costs related to the
start-up of EAG; $784,000 in new costs related to the acquisition of WRC;
$270,000 in stock-compensation expense and $363,000 in additional costs.
26
Operating Income:
Operating income decreased $4.8 million, or 87.3%, to $0.7 million for the
three months ended September 30, 2006 from $5.5 million for the comparable
prior year period. As a percentage of revenue, operating income decreased
to 0.9% for the three months ended September 30, 2006 from 10.0% for the
comparable prior year period. Excluding approximately $6.6 million of
losses related to the two fixed price EPC projects and on a proforma basis,
our engineering segment's operating income for the three months ended
September 30, 2006 would have been approximately $7.3 million, or
approximately 9.5% as a percentage of revenue.
Operating income decreased $2.1 million, or 15.0%, to $12.2 million for the
nine months ended September 30, 2006 from $14.3 million for the comparable
prior year period. As a percentage of revenue, operating income decreased
to 5.8% for the nine months ended September 30, 2006 from 9.4% for the
comparable prior year period. Excluding approximately $6.6 million of
losses related to the two fixed price EPC projects and on a proforma basis,
our engineering segment's operating income for the nine months ended
September 30, 2006 would have been approximately $18.8 million, or
approximately 9.0% as a percentage of revenue.
27
Systems
The following table illustrates the composition of our systems revenue and
operating expense mix quarter over quarter for the three and nine-month
periods ended September 30, 2006 and 2005, and provides a comparison of the
changes in revenue and operating expense and trends period over period:
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------------- --------------------------------------
2006 2005 2006 2005
------------------ ---------------- ---------------- ------------------
(dollars in thousands)
--------------------------------------------------------------------------------
Revenue: $ 5,887 100 % $ 3,343 100 % $15,241 100 % $ 11,203 100 %
======= ======= ======= ========
Gross profit: $ 123 2.1 % $ 203 6.1 % $ 1,087 7.1 % $ 850 7.6 %
------- ------- ------- --------
Operating SG&A expense: 404 6.9 % 496 14.9 % 1,496 9.9 % 1,458 13.1 %
------- ------- ------- --------
Operating loss: (281) (4.8)% (293) (8.8)% (409) (2.7)% (608) (5.5)%
======= ======= ======= ========
Overview:
Summary of financial results during the three and nine month periods ended
September 30, 2006 compared to the three and nine month periods ended
September 30, 2005
Revenue up 76% quarter-over-quarter and up 36% year-over-year
Gross profit down 39% quarter-over-quarter but up 28% year-over-year
Operating SG&A as a percent of revenue down 8.0% quarter-over-quarter
and down 3.2% year-over-year
Operating loss down 4.1% quarter-over-quarter and down 32.8%
year-over-year
The primary reason for the operating loss in our systems segment's overall
financial results during the most recent quarter can be primarily
attributed to losses in our engineered systems division on projects related
to larger remote instrument enclosures.
Revenue:
Revenue increased approximately $2.5 million, or 78.8%, to $5.9 million for
the three month period ended September 30, 2006 from $3.3 million for the
comparable prior year period and increased approximately $4.0 million, or
35.8%, to $15.2 million for the nine month period ended September 30, 2006
from $11.2 million for the comparable prior year period.
The increases in revenue for both the three and nine month periods ended
September 30, 2006 were primarily the result of growth in our process
analyzer systems fabrication as a result of our acquisition of certain
assets of ATI during the first quarter of this year. The Analytical
Division's revenues total $4.4 million and $9.0 million, respectively, for
the three and nine month periods ended September 30, 2006. Approximately
$18.4 million in project awards directly related to the ATI acquisition has
been received during the current year, and is scheduled to be completed by
the first half of 2007. The majority of the analyzer awards are for
international projects.
Revenues from our Engineered Systems Division have decreased approximately
$2.3 million, or 65.8%, to $1.2 million for the three month period ended
September 30, 2006 from $3.5 million for the comparable prior year period
and decreased approximately $5.1 million, or 45.2%, to $6.2 million for the
nine month period ended September 30, 2006 from $11.3 million for the
comparable prior year period. The decline in Engineered Systems Division
revenues is a result of decreased demand and increased competition for
Remote Instrument Enclosures in the first nine months of 2006. While there
are a number of large projects in the market, which will require Engineered
Systems Division products, most of these projects are still in the early
development phases.
Gross profit:
Gross profit decreased approximately $80,000, or 39.4%, to $123,000 for the
three months ended September 30, 2006 from $203,000 for the comparable
prior year period and, as a percentage of revenue, gross profit decreased
to 2.1% from 6.1% for the respective periods. The primary reason for lower
profits recorded during the quarter related to losses of approximately
$266,000 on seven projects.
28
Three projects in the Engineered Systems Division accounted for losses of
approximately $95,000 primarily as the result of serve delivery extensions
on major construction components and services from third party suppliers.
Lower margins were also recorded in the Analytical Division due to an
incentive plan accrual of approximately $112,000 of which approximately
$87,000 applied to the most recent quarter. Additional accruals for the
incentive plan will continue in future quarters when plan benchmarks are
achieved. Three projects in the Analytical Division also experienced losses
of approximately $135,000. Errors in engineering design and procurement
were the primary reasons for the reversals. The ATI acquisition
significantly strengthened the engineering design capabilities of the
systems segment which we believe will eliminate similar errors in the
future.
One of the projects in the Heat Tracing Division experienced a profit loss
of approximately $36,000.
For the nine month period ended September 30, 2006, gross profit increased
approximately $250,000, or 29.5%, to $1.1 million for the nine months ended
September 30, 2006 from $850,000 for the comparable prior year period and,
as a percentage of revenue, gross profit decreased to 7.1% from 7.6% for
the respective periods. The increased gross profit for nine month period
ended September 30, 2006 was primarily the result of increasing profits in
the Analytical Division offsetting declining profits in the Engineered
Systems Division.
Selling, General, and Administrative:
SG&A expense decreased approximately $92,000, or 18.5%, to $404,000 for the
three months ended September 30, 2006 from $496,000 for the same period in
2005 and, as a percentage of revenue, SG&A expense decreased to 6.9% from
14.9% for the respective periods. The decrease in costs during the most
recent quarter is primarily attributable to a net reduction in compensation
costs and expenses associated with the July I, 2006 transfer of the
marketing department to our corporate business development group with
ENGlobal Corporate Services, offset by the increase in costs associated
with management and associated expenses from the ATI acquisition which was
completed in the first quarter of the year.
SG&A expense increased approximately $38,000, or 2.6%, to $1,496,000 for
the nine months ended September 30, 2006 from $1,458,000 for the same
period in 2005 but, as a percentage of revenue, SG&A expense decreased to
9.9% from 13.1% for the respective periods. The increase in costs during
the most recent nine month period is attributable to increases in
facilities expense of $102,000, which primarily occurred during the first
six months of the year, plus additional depreciation and amortization
expense of approximately $16,000 and other costs of approximately $12,000
offset by costs primarily attributable to a net reduction in compensation
costs and expenses associated with the transfer of the marketing department
to our corporate business development group and the increase in costs
associated with management and associated expenses from the ATI acquisition
completed in the first quarter of the year.
Operating Income:
The systems segment recorded an operating loss of $281,000 for the three
months ended September 30, 2006 compared to an operating loss of $293,000
for the three month period ended September 30, 2005. An operating loss of
$409,000 was recorded for the nine months ended September 30, 2006 compared
to an operating loss of $608,000 for the nine month period ended September
30, 2005.
Our investment in the internal heat tracing initiative resulted in an
operating loss of $25,000 for the three months ended September 30, 2006 and
has recorded operating losses of $140,000 for the nine month period ended
September 30, 2005. The heat tracing initiative was discontinued at the end
of the third quarter and should not have any material impact on operating
income in future periods.
29
Liquidity and Capital Resources
-
-------------------------------
Historically, cash requirements have been satisfied through operations and
borrowings under a revolving line of credit, which is currently in effect
with Comerica Bank (the "Comerica Credit Facility"). Terms of an amendment,
effective as of July 27, 2006, modified the Comerica Credit Facility to
extend the maturity date to July 26, 2009 and enlarged the revolving credit
note from $22 million to a limit of $30 million. As of September 30, 2006,March 31, 2007,
we had working capital of $35.8$44.2 million. Long-term debt, net of current
portion, was $22.8$32.5 million as of September 30, 2006,March 31, 2007, including $19.7$29.6 million
outstanding under the Comerica Credit Facility.
The Comerica Credit Facility is senior to all other debt, and the $30
million line of
credit continuesis limited to be subject to borrowing base
restrictions.$35.0 million, after consideration of loan covenant
restrictions.. The Comerica Credit Facility is collateralized by
substantially all of the assets of the Company. The Comerica Credit
Facility contains covenants requiring the Company, as of the end of each
calendar month, to maintain certain ratios, including total funded debt to
EBITDA; total funded debt to total liabilities, plus net worth; and total
line of creditfunded debt to accounts and accounts/unbilled receivables. The Company is also required,
as of the end of eachthe most recent quarter then ended, to maintain minimum
levels of net worth, and the Company must comply with an annual limitation on capital
expenditures. The Company is currently in compliance with all loan
covenants, although no assurances can be given regarding future compliance.
All standby letters of credit previously issued to a refining client
covering contractual obligations funded bysuch compliance in
the client for progress payments
made to equipment manufacturers for major project items matured on August
31, 2006.future. We are not currently subject to any otherobligations under standby
letters of credit, guarantees, repurchase obligations or commitments andother commitments.
We have no off-balance sheet arrangements.
As of September 30, 2006,March 31, 2007, management believes the Company's availability of
cash position is
sufficient to meet its working capital requirements for the next 12
months.requirements. Any future decrease in
demand for ourthe Company's services or products would reduce the availability
of funds through operations.
Cash Flow
- ---------
We believeThe Company believes that we have sufficientit has available the necessary cash required for
operations for the next 12 months. However, cashCash and the availability of cash could
be materially restricted if circumstances prevent the timely internal
processing of invoices, if amounts billed are not collected, or are not
collected in a timely manner, if project mix
shifts from cost reimbursable to fixed costscost contracts during significant
periods of growth, if the Company was to lose one or more of its major
customers, or if the Company experiences further costs overruns on fixed price contract, or if weis not able to meet the covenants of the
Comerica Credit Facility. If any such event occurs, wethe Company would be
forced to consider alternative financing options.
Operating activities:
DuringNet cash used in operating activities was $4.9 million for the first nine months of 2006, our operations used $6.8 million of
cash flowsthree-month
period ended March 31, 2007, compared with net cash providedused of $4.4$3.2 million in
the same period in 2005. The change was primarily a result2006. Changes in working capital due to the timing of
contract losses during
the three month period ending September 30, 2006, continued timing
differences between18
MD&A/Results of Operations (continued)
- --------------------------------------
collections of trade receivables and payments for labor services, billing our clients for
those servicestrade payables and
then collecting our accounts, andaccruals, contributed to the negative cash flows from operations in additionthe
first quarter of 2007. During the quarter, the line of credit increased
from $24.0 million as of December 31, 2006 to $134,000$29.6 million as of benefits of tax deductions in excess of recognized compensation
cost from an operating to a financing cash flow as required by SFAS No.
123(R). Although ourMarch 31,
2007.
Our average for accounts receivable days sales outstanding increased to 60("DSO") was 71 days for the nine month period ended September 30, 2006
from 51 days for the comparable period in 2005 the current year trend has
improved from 64 days at the end of the three month
period ended March 31, 2006 and from 63 days at the end of the six month period ended June 30,
2006. Our average for accounts receivable days outstanding was 592007 compared to 66 days for the yearcomparable period
in 2006 and 69 days for the period ended December 31, 2005.2006. We have revised
the method used for calculating DOS changing from annualized average
revenue and accounts receivable totals to quarterly revenue and accounts
receivable balances. The average DSO for all periods referenced herein and
for all future periods have been and will be calculated under the new
method.
The primary factors impacting the increase in our need for cash and the
year-over-year increaseincreases in average accounts receivable days outstandingDSO during the three month period ending March 31,
2007 were:
1) a past due account balancedecrease in accounts payable of approximately $3.7$4 million
as of
September 30, 2006primarily related to delays in receipts for servicescontractor payments on the start-up of a major alliance agreement that began during the second
quarter of this year;two fixed-price
EPC projects;
2) an increase in retention receivables fromaccounts receivable of approximately $1$4 million
primarily due to $2.1 million as of September 30, 2005 and 2006 respectively;delays in processing billings within the
Engineering segment, particularly in getting the WRC acquisition
billings current following its conversion to the ENGlobal
financial accounting system on December 31, 2006; and
3) an increase in costs and estimated earnings-in-excess of billings
from approximately $4.1 million to $9.6$5.4 million as of SeptemberDecember 31, 2006 to $8.1
million for the three month period ended March 30, 2005 and 2006, respectively.
30
Although the above factors are all within rights and restrictions of
contractual2007 primarily
related to extended payment terms and conditionsmilestones on fixed price
contracts within client contracts, weour Systems segment.
Accounts payable are taking
measuresnot expected to remediate each of these factorsmaterially impact cash during the
second quarter as the two fixed-price EPC projects are scheduled to be
completed during that period with final billings and at this time do not expect
their impactretention collections
expected to continue beyondhave a positive cash impact. Also, the fourth quarterCompany expects to have
Engineering segment billings current before the end of the year. We have
been able to lower our accounts receivable days outstanding primarily
through an expanded focus on collectionsthree month
period ending June 30, 2007.
A continued increase in costs and estimated earnings-in-excess of past due accounts.billings
is not expected during the second quarter even though improvements can only
be made with more favorable contractual terms.
Investing activities:
Net cash used in investing activities was $8.3 million$429,000 for the nine-monththree-month
period ended September 30, 2006,March 31, 2007, compared towith net cash usedprovided of $1.4$1.3
million in the same period in 2005. Approximately $6.0 million in net cash has been
used during2006. In the first nine monthsquarter of 2006, for acquisitions, and we incurred
approximately $2.8 million in capital and construction in progress
expenditures during that same period. During September, the
Company acquired approximately 1.2 acresthe assets of land with proceeds to be received from
the final payment on an insurance claimATI, Inc. for damages to our Beaumont
facility. We are developing plans to rebuild$750,000 cash and a new facility and parking
complex covering both the old and newly acquired property.
Annualnote
payable. The Company also used cash for capital expenditures are limited to $3.25 million underin the Comerica
Credit Facilityfirst
three months of 2007 and at this time, we do not see our capital needs
exceeding that limit. Cash provided by investing activities included
approximately $559,000, primarily from partnership distributions, insurance
proceeds and sales of assets.
We continue to evaluate and selectively seek opportunities to expand our
business through acquisitions of complementary businesses. Completing an
acquisition will involve the use of cash or may require debt or equity
financing.2006.
Financing activities:
Net cash flows provided fromby financing activities was $16.3$4.9 million for the
nine-monththree-month period ended September 30, 2006,March 31, 2007, compared with net cash usedprovided of
$78,000$4.3 million in the same period in 2005. Approximately $15.9 million in proceeds
came from net borrowings and repayments on our line-of-credit while $1.1
million resulted from2006. In the issuancefirst quarter of common stock, primarily from the
exercise of stock options and $700,000 was used for repayment of long-term
debt.
As of September 30, 2006,2007, the
Company had increased the amountits outstanding on the Comerica Credit Facilityline of credit by $15.9$5.7 million since the beginning of the
yearfor
working capital needs compared to a decrease of $13.5 millionan increase in the outstanding line of
credit forof $4.3 million in the same period in 2005. It should be noted that on September
29, 2005, the Company entered into and closed on a definitive agreement to
issue and sell 2,000,000 shares of Common Stock in a private placement with
the $14,000,000 in gross proceeds used to pay all of the Company's then
existing line-of-credit debt.2006.
Asset Management
- ----------------
OurThe Company's cash flow from operations has been affected primarily by the
timing of its collection of trade accounts receivable. WeThe Company
typically sell oursells its products and services on short-term credit terms and
seekseeks to minimize its credit risk by performing credit checks and
conducting ourits own collection efforts. As of
September 30, 2006 and December 31, 2005 weThe Company had net trade accounts
receivable of $55.0$64.1 million and $46.2$60.2 million at March 31, 2007 and
December 31, 2006, respectively. The number of days sales outstanding in
trade accounts receivables was 71 days and 69 days at March 31, 2007 and
December 31, 2006, respectively.
19
Engineering Segment Results
- ---------------------------
Three Months Ended
March 31,
-------------------------------------------------
2007 2006
-------------------------------------------------
(In thousands)
-------------------------------------------------
Revenue:
Engineering $ 69,262 91.0 % $ 62,587 100.0 %
Acquisition 6,887 9.0 % - - %
------------- ------------
Total revenue $ 76,149 100.0 % $ 62,587 100.0 %
============= ============
Gross profit:
Engineering $ 11,779 17.0 % $ 7,796 12.5 %
Acquisition 1,250 18.2 % - - %
------------- ------------
Total gross profit 13,029 17.1 % 7,796 12.5 %
------------- ------------
Operating SG&A expense:
Engineering 2,946 4.3 % 2,906 4.6 %
Acquisition 582 8.5 % - - %
------------- ------------
Total SG&A expense 3,528 4.6 % 2,906 4.6 %
------------- ------------
Operating income:
Engineering 8,832 12.8 % 4,890 7.8 %
Acquisition 669 9.7 % - - %
------------- ------------
Total operating income $ 9,501 12.5 % $ 4,890 7.8 %
------------- ------------
Overview of Engineering Segment:
Our engineering segment continues to benefit from a large project load
generated primarily by its downstream clients and to a lesser extent by its
midstream clients. The industry's refining segment continues to be very
active, supplying a large percentage of the Company's backlog. ENGlobal is
benefiting from the renewed interest of its chemical/petrochemical clients
in maintenance and retrofit projects as product margins in this marketplace
improve.
Acquisition totals for the three months ended March 31, 2007 are from the
results of operations related to the acquisition of WRC Corporation. There
were no acquisition totals for the engineering segment for the three months
ended March 31, 2006, as all previous acquisitions had been fully
integrated.
20
Engineering Segment Results (continued)
- ---------------------------------------
Revenue:
Revenue increased $13.5 million, or 21.6%, to $76.1 million for the three
months ended March 31, 2007 from $62.6 million for the comparable prior
year period. The following table illustrates the composition of the
Company's revenue mix quarter over quarter for the three month periods
ended March 31, 2007 and 2006, and provides a comparison of the changes in
revenue (in thousands) and revenue trends period over period:
2007 % rev 2006 % rev $ change % change
------ ------ ------ ------ -------- --------
Detail-design 35.8 47% 27.6 44% 8.2 30%
Field services & inspection 35.2 46% 19.6 31% 15.6 80%
Procurement & construction 1.3 2% 10.6 17% (9.3) (88)%
Design-build fixed price 3.8 5% 4.7 8% (.9) (19)%
------ ------ ------ ------ ------- -------
76.1 100% 62.5 100% 13.6 22%
The increase in engineering revenue was primarily brought about by
increased activity in the engineering and construction markets. Refining
related activity has been particularly strong, including projects to
satisfy environmental mandates, expand existing facilities and utilize
heavier sour crude. Capital spending in the pipeline area is also trending
higher, with numerous projects in North America currently underway to
deliver crude oil, natural gas, petrochemicals and refined products.
Renewable energy appears to be an emerging area of activity and potential
growth, with the Company currently performing a variety of services for
ethanol, biodiesel, coal to liquids, petroleum coke to ammonia, and other
biomass processes. The acquisition of WRC in May 2006, together with our
clients' increased demand for in-plant and inspection resources, stimulated
growth in our staffing services division.
The largest increase in revenue came from field services and inspection
activity that increased $15.6 million, or approximately 80%, to $35.2
million for the first quarter of 2007 from $19.6 million for the comparable
period in 2006. Approximately $6.9 million of the increase in field
services revenue is directly related to the acquisition of WRC in May of
2006 which provides integrated land management, engineering, and related
services (Reference is made to NOTE 16 - ACQUISITIONS, in the Company's
Report to Shareholders on Form 10K for the period ending December 31,
2006).
On a combined basis, with the increase in detail-design services of $8.2
million, or approximately 30%, our core engineering segment's activities
accounted for approximately 93% of engineering's total revenue mix during
the three month period ended March 31, 2007 compared to approximately 75%
for the comparable period of 2006.
Revenue from non-labor procurement and construction activity decreased $9.3
million from $10.6 million during the three months ended March 31, 2006 to
$1.3 million for the first quarter of 2007.
The design-build fixed price revenue decreased approximately $900,000, or
(19)%, from $4.7 million for the three month period ended March 31, 2006 to
$3.8 million for the same period in 2007 and accounted for approximately 5%
of engineering's total revenue. If the revenue from the two fixed-price EPC
projects that recorded losses in 2006, which totaled $1.8 and $2.7 million
during the three month periods ending March 31, 2007 and March 31, 2006,
respectively, were eliminated for comparison purposes, fixed price revenue
would have remained the same at $2.0 million for the comparable periods,
but would have decreased as a percentage of revenue by 0.5% from 3.2% in
2006 to 2.7% in 2007. Approximately $900,000 of the total fixed-price
revenue during the three month period ending March 31, 2007 came from one
fixed-price, engineering-only project with a contract value of
approximately $6.9 million, but also includes reimbursable material and
construction costs estimated to be approximately $34 million. The project
is scheduled to be completed during the first quarter of 2008.
Gross Profit:
Gross profit increased $5.2 million, or 66.7%, to $13.0 million for the
three months ended March 31, 2007 from $7.8 million for the comparable
period in 2006. As a percentage of revenue, gross profit increased by 4.6%
to 17.1% from 12.5% for the three-month periods ended March 31, 2007 and
2006, respectively. Of the overall $5.2 million increase in gross profit,
approximately $1.7 million was attributable to the $13.5 million increase
in total revenue, plus approximately $3.5 million in improved margins. The
increase in margins can be attributed to the reduced activity in low
margin/high dollar procurement projects being replaced with higher margin
core revenue derived from labor activity.
21
Engineering Segment Results (continued)
- ---------------------------------------
At March 31, 2007, we had outstanding unapproved change orders/claims of
approximately $17.4 million, net of reserves of $1.2 million associated
with ongoing fixed-price EPC projects. If in the future we determine
collection of the unapproved change orders/claims is not probable, it will
result in a charge to earnings in the period such determination is made for
the reserves of $1.2 million.
Selling, General, and Administrative:
As a percentage of revenue, SG&A expense was 4.6% for both the three-month
periods ended March 31, 2007 and March 31, 2006. SG&A expense increased
$0.6 million, or 20.6%, to $3.5 million for the three months ended March
31, 2007 from $2.9 million for the comparable prior year period. The
increase in SG&A expense included $68,000 attributable to the support of
expanded facilities and supplies as offices in Tulsa, Houston, and Beaumont
were expanded to meet both current and projected growth requirements.
Additional increases came from salaries, burdens and benefits of $194,000,
amortization and depreciation expense of $169,000 primarily related to
amortization of intangible assets from the acquisition of WRC (reference is
made to NOTE 5 - GOODWILL, page 9), and $69,000 in other charges. An
additional bad debt expense of $135,000 was also recorded during the period
to increase the allowance for doubtful accounts primarily related to
changes in client mix.
Operating Income:
Operating income increased $4.6 million, or 94.1%, to $9.5 million for the
three months ended March 31, 2007 from $4.9 million for the comparable
prior year period. As a percentage of revenue, operating income increased
to 12.5% for the three months ended March 31, 2007 from 7.8% for the
comparable prior year period.
22
Systems Segment Results
- -----------------------
Three Months Ended
March 31,
-------------------------------------------
2007 2006
--------------------- --------------------
(In thousands)
-------------------------------------------
$ 5,510 100.0 % $ 4,040 100.0 %
Revenue:
=========== ===========
Gross profit: $ 249 4.5 % $ 426 10.6 %
----------- -----------
Operating SG&A expense: 429 7.8 % 608 15.1 %
----------- -----------
Operating income: (180) (3.3)% (182) (4.5)%
=========== ===========
Overview of Systems Segment:
The systems segment began a detailed review process in the fourth quarter
of 2006. Continuing on this trend of self-improvement in the first quarter
of 2007, project cost control/forecasting was initiated on all active lump
sum projects in order to identify potential areas of remediation and
improve financial results. Going into 2007, the systems segment had record
backlog of $17.7 million with several large projects being booked in April.
In addition, the systems segment is planning to reduce overhead costs to
drive efficiency and profitability upwards.
Revenue:
Revenue increased approximately $1.5 million, or 37.1%, to $5.5 million for
the three month period ended March 31, 2007 from $4.0 million for the
comparable prior year period.
A general turnaround in the oil and gas industry, together with the
acquisition of Analyzer Technology International, Inc. ("ATI") in January
2006 has increased the demand for systems services. Another factor
positively affecting systems business is that the computer-based
distributed control systems equipment used for facility plant automation
becomes technologically obsolete over time, which supports ongoing
replacement of these systems.
Gross profit:
Gross profit decreased approximately $177,000, or 41.5%, to $249,000 for
the three months ended March 31, 2007 from $426,000 for the comparable
prior year period and, as a percentage of revenue, gross profit decreased
to 4.5% from 10.6% for the respective periods. The decrease in gross profit
was attributable to lower margins of fixed price work accounting for 3% of
the margin changes. The remainder was increased variable costs associated
with labor to perform proposals and increased project management.
Selling, General, and Administrative:
SG&A expense decreased approximately $179,000, or 29.4%, to $429,000 for
the three months ended March 31, 2007 from $608,000 for the same period in
2006 and, as a percentage of revenue, SG&A expense decreased to 7.8% from
15.0% for the respective periods. Salaries and related expenses decreased
by $288,000 due to the fact the expenses of four sales persons were moved
to Corporate SG&A from Operations; some salaries were moved to direct costs
variable; and the Company's personnel decreased. Amortization expense
increased by $138,000 in relation to the non-compete intangible that was
created with the purchase price analysis related to the ATI acquisition.
Facilities and related expenses decreased by $27,000 as a result of moving
the office for the ATI acquisition into the existing Systems office.
Operating Income:
The systems segment recorded an operating loss of $180,000 for the three
months ended March 31, 2007 compared to an operating loss of $182,000 for
the three month period ended March 31, 2006.
23
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our financial instruments include cash and cash equivalents, accounts
receivable, accounts payable, notes and capital leases payable, and debt
obligations. The book value of cash and cash equivalents, accounts
receivable, accounts payable and short-term notes payable are considered to
be representative of fair value because of the short maturity of these
instruments.
We do not utilize financial instruments for trading purposes and we do not
hold any derivative financial instruments that could expose us to
significant market risk. In the normal course of business, our results of
operations are exposed to risks associated with fluctuations in interest
rates and currency exchange rates.
Our exposure to market risk for changes in interest rates relates primarily
to our obligations under the Comerica Credit Facility. As of September 30,
2006, $19.7March 31,
2007, $29.6 million had been borrowed under the Credit Facility, $7.0
million and $12.7 million accruing
interest at 6.83% and 8.25% per year,
respectively, excluding amortization of prepaid financing
costs. A 10% increase in the short-term borrowing rates on the Credit
Facility outstanding as of September 30, 2006March 31, 2007 would be 82.583 basis points. Such an
increase in interest rates would increase our annual interest expense by
approximately $163,000,$244,000, assuming the amount of debt outstanding remains
constant.
In general, our exposure to fluctuating exchange rates relates to the
effects of translating the financial statements of our Canadian subsidiary
from the Canadian dollar to the U.S. dollar. We follow the provisions of
SFAS No. 52 - "Foreign Currency Translation" in preparing our consolidated
financial statements. Currently, we do not nor do we expect to engage in foreign currency
hedging activities.
ITEM 4. CONTROLS AND PROCEDURES
a. Evaluation of Disclosure Controls and Procedures
----------------------------------Our management is responsible for establishing and maintaining our
disclosure controls and procedures. As of September 30, 2006,March 31, 2007, we carried out an
evaluation, under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of our "disclosure controls and procedures," as
such term is defined under Exchange Act Rules 13a-15(e) and 15d-15(e).
Based on this evaluation, our Chief Executive Officer and Chief Financial
Officer concluded that, as of September 30, 2006, such disclosure
controls and procedures were effectiveor "disclosure controls." Disclosure controls are
controls and procedures designed to ensure that information required to be
disclosed by us in theour reports we file or submitfiled under the Securities Exchange Act of 1934 is
properly recorded, processed, summarized, and reported within the time
periods specified in the rules and forms of theU.S. Securities and Exchange Commission,Commission's rules
and accumulatedforms. Disclosure controls include processes to accumulate and communicatedevaluate
relevant information and communicate such information to our management,
including our Chief
Executive Officerthe CEO and Chief Financial Officer,CFO, as appropriate to allow timely decisions
regarding required disclosure. ChangesIn designing and evaluating the disclosure
controls and procedures, management recognizes that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and
management is required to apply its judgment in Internal Control over Financial Reporting
----------------------------------------------------
Item 308evaluating the cost-benefit
relationship of Regulation S-K promulgated under Section 404possible controls and procedures.
Based on the controls evaluation, our CEO and CFO have concluded that, as a
result of the Sarbanes-Oxley Act of 2002 requires that public companies annually evaluate
the effectiveness of theirmatters discussed below with respect to our internal control
over financial reporting, at the
endour disclosure controls as of each fiscal year, and include a management report assessing the
effectiveness of suchMarch 31, 2007,
were not effective.
A material weakness in internal control over financial reporting is a
significant deficiency, or combination of significant deficiencies, that
results in allmore than a remote likelihood that a material misstatement of
the annual reports. Item 308 of Regulation S-K also requires thator interim financial statements will not be prevented or
detected. Management's assessment identified the independent accountants of public companies attest to, and report on,
management's assessment of itsfollowing material
weaknesses in our internal control over financial reporting.
The initial compliance date with respect to these requirements depends on
whether a company is an "accelerated filer" as determined by Rule 12b-2 of
the Exchange Act.
As previously reported, ENGlobal became an "accelerated filer" effectivereporting as of December
31, 2006, because the aggregate market value of ENGlobal's
common stock held by non-affiliates of ENGlobalwhich remained outstanding as of June 30, 2006 was
greater than $75.0 million. ENGlobal is now required to comply withMarch 31, 2007:
o Deficiencies in the rules regarding management's report onCompany's Control Environment. Our control
environment did not sufficiently promote effective internal control
over financial reporting for fiscal 2006.
ENGlobal continues to make concerted efforts to prepare itself to be able
to comply with such requirements. Ifthroughout the organization. Specifically, we
fail to timely complete our
evaluationhad a shortage of support and testing in order to allow for the assessment by our
32
management, or if our independent registered public accounting firm cannot
timely attest to our management's assessment, we could be subject to
regulatory scrutiny and a loss of public confidenceresources in our accounting department,
which resulted in insufficient: (i) documentation and communication of
our accounting policies and procedures; and (ii) internal audit
processes of our accounting policies and procedures.
24
o Deficiencies in the Company's Information Technology Access Controls.
We did not maintain effective controls over preventing access by
unauthorized personnel to end-user spreadsheets and other information
technology programs and systems.
o Deficiencies in the Company's Accounting System Controls. We did not
effectively and accurately close the general ledger in a timely manner
and we did not provide complete and accurate disclosure in our notes
to financial statements, as required by generally accepted accounting
principles.
o Deficiencies in the Company's Controls Regarding Purchases and
Expenditures. We did not maintain effective controls over the tracking
of our commitments and actual expenditures with third-party
subsidiaries on a timely basis.
o Deficiencies in the Company's Controls Regarding Fixed-Price Contract
Information. We did not maintain effective controls over the complete,
accurate, and timely processing of information relating to the
estimated cost of fixed-price contracts.
o Deficiencies in the Company's Revenue Recognition Controls. We did not
maintain effective policies and procedures relating to revenue
recognition of fixed price contracts, which accounted for
approximately 11% of the Company's revenues in 2006.
o Deficiencies in the Company's Controls over Income Taxes. We did not
maintain sufficient internal controls which could harmto ensure that amounts provided
for in our business andfinancial statements for income taxes accurately reflected
our stock price. Further, if
our independent registered public accounting firm are not satisfied withincome tax position as of December 31, 2006.
o Management assessed the effectiveness of our internal controlscontrol over
financial reporting or withas of December 31, 2006, but management did not
complete its assessment until March 2, 2007. Due to the level at which
they are documented, designed, operated or reviewed, it may declinelack of
adequate time to attestpermit Hein to audit management's assessment, or may issue a qualified report
identifying a material weakness inHein
was unable to render an opinion on our internal controls. This could result
in significant additional expenditures responding to the Section 404
internal control audit, a diversion of management attention and a decline
in our stock price.
We are exposed to increased costs associated with complying with these
requirements, and will be spending management time and resources to
document and test our internal controls in anticipation of Section 404
reporting requirements. Furthermore, our independent registered public
accounting firm, Hein & Associates, will be required to attest to whether
its assessment of the effectiveness
of our internal control over financial reporting is fairly statedas of December 31,
2006. Accordingly, management identified this as a material weakness.
Management's assessment process did not conclude in all material respectsadequate time to
permit Hein to audit management's assessment due to a number of
factors, including: (i) our failure to prepare and separately report
on whether it believes we maintained,plan for a timely
completion of management's assessment, including adding the resources
necessary to do so; and (ii) our failure to ensure that our accounting
department was adequately staffed and sufficiently trained to meet
deadlines.
Except as noted below under the heading "Remediation Initiatives," no
change in all material respects, effectiveour internal control over financial reporting as of December 31, 2006.
In addition, ENGlobal acquired WRC on May 26, 2006. WRC utilizes separate
information and accounting systems and processes. The Company intends to
extend its Sarbanes-Oxley Section 404 compliance program to include WRC.
However, management anticipates excluding WRC from the 2006 Assessment(as defined in accordance with the guidance from the Division of Corporation Finance and
Office of the Chief Accountant ofRule
13a-15(f) under the Securities and Exchange Commission.
Management intends to complete its assessmentAct of the effectiveness of
internal control over financial reporting for the acquired WRC business
within 18 months of the date of the acquisition. In the meantime, WRC's
accounting and information systems are currently being converted to the
same platform as the rest of ENGlobal.
Other than the effects of our acquisition of WRC, there were no changes in
our internal controls over financial reporting1934) occurred during the
most recent
quarter ended March 31, 2007, that has materially affected, or areis
reasonably likely to materially affect, our internal control over financial
reporting.
b. Remediation Initiatives
Management, with oversight from the Audit Committee of the Board of
Directors, has been addressing the material weakness disclosed in its 2006
Annual Report on Form 10-K and is committed to effectively remediating
known weaknesses as expeditiously as possible. Due to the fact that these
remedial steps have not been completed, the Company performed additional
analysis and procedures in order to ensure that the consolidated financial
statements contained in this Form 10-Q were prepared in accordance with
generally accepted accounting principles in the United States of America.
Although the Company's remediation efforts are well underway, control
weaknesses will not be considered remediated until new internal controls
over financial reporting are implemented and operational for a sufficient
period of time to allow for effective testing and are tested, and
management and its independent registered certified public accounting firm
conclude that these controls are operating effectively. Management and the
Audit Committee of the Company's Board of Directors have begun working with
the Company's auditors to determine the most effective way to implement the
remedial measures listed below, and, if necessary, to develop additional
remedial measures to address the internal control deficiencies identified
25
above. The Company will monitor the effectiveness of planned actions and
will make any other changes and take such other actions as management or
the Audit Committee determines to be appropriate. The Company's remediation
plans include:
o We plan to hire additional personnel to assist us with documenting and
communicating our accounting policies and procedures to ensure the
proper and consistent application of those policies and procedures
throughout the Company. Recruitment for this position(s) has begun and
the selection process is expected to be completed during the second
quarter of 2007.
o We plan to implement formal processes requiring periodic
self-assessments, independent tests, and reporting of our personnel's
adherence to our accounting policies and procedures.
o We plan to design effective policies and procedures to control
security of and access to spreadsheet information. If necessary, we
will also consider implementing a software solution with automatic
control checkpoints for day-to-day business processes.
o We plan to (i) require additional training for our current accounting
personnel; (ii) to hire additional accounting personnel to enable the
allocation of job functions among a larger group of accounting staff;
(iii) to engage outside consultants with technical accounting
expertise, as needed; and (iv) to consider restructuring our
accounting department, each to increase the likelihood that our
accounting personnel will have the resources, experience, skills, and
knowledge necessary to effectively perform the accounting system
functions assigned to them. The Company currently has three days of
in-house training scheduled for the accounting staff at the end of May
2007, to improve our accounting functions as we prepare to report the
second quarter, as well as to improve the remainder of the year.
o We plan to improve procurement and operational efficiencies by
implementing a software system and a matrix organization to more
completely, accurately, and timely track commitments on Company-wide
purchase and expenditure transactions.
o We plan to improve revenue recognition policies and procedures
relating to fixed-price contracts by evaluating the level of economic
success achieved by past fixed-price contracts and by stressing
throughout the Company the importance of (i) accurately estimating
costs, (ii) timely updating cost estimates to reflect the accuracy of
the cost savings, (iii) accurately estimating expected profit, (iv)
timely identifying when a project's scope changes, (v) promptly
reporting man hours and costs in excess of those originally estimated;
and (vi) closely scrutinizing the bid process.
o We plan to train personnel to effectively implement and evaluate the
overall design of the Company's fixed-price project control processes.
Specifically, we plan to enhance and tighten controls as they relate
to the initial bid process and the attendant recognition and
management of risk by only bidding on large procurement and
construction activities on a cost plus basis.
Management recognizes that many of these enhancements require continual
monitoring and evaluation for effectiveness. The development of these
actions is an iterative process and will evolve as the Company continues to
evaluate and improve our internal controls over financial reporting.
33Management will review progress on these activities on a consistent and
ongoing basis at the Chief Executive Officer and senior management level in
conjunction with our Audit Committee. We also plan to take additional steps
to elevate Company awareness about and communication of these important
issues through formal channels such as Company meetings, departmental
meetings, and training.
During the second quarter, the Company will begin its 2007 internal
controls audit and the Investor Relations/Governance department expects to
hire a third-party consultant to oversee the testing of its internal
financial and information technology controls. A quarterly review by
consultants will assist the Company and its independent auditors in
preparing for the final assessment in September 2007, allowing for any
remediation by December 31, 2007.
26
PART II. - OTHER INFORMATION
----------------------------
ITEM 1. LEGAL PROCEEDINGS
From time to time, the Company and its subsidiaries become parties to
various legal proceedings arising in the ordinary course of normal business
activities. While we cannot predict the outcome of these proceedings, in
our opinion and based on reports of counsel, any liability arising from
such matters, individually or in the aggregate, areis not expected to have a
material effect upon the consolidated financial position or operations of
the Company.
ITEM 1A. RISK FACTORS
In addition to the other information set forth in this report, you should
carefully consider the factors discussed in Part I, "Item 1A. Risk Factors"
in our Annual Report on Form 10-K for the year ended December 31, 2005,2006,
which could materially affect our business, financial condition or future
results. The risks described in our Annual Report on Form 10-K are not the
only risks facing our Company. Additional risks and uncertainties not
currently known to us or that we currently deem to be immaterial also may
materially adversely affect our business, financial conditionconditions or operating
results.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
10.1 Seventh Amendment to Credit Agreement by and among Comerica Bank
and ENGlobal Corporation and its subsidiaries dated April 18,
2007, effective retroactive to March 30, 2007.
31.1 Certifications Pursuant to Rule 13a - 14(a) of the Exchange Act
forof 2002 for the ThirdFirst Quarter 20062007
31.2 Certifications Pursuant to Rule 13a - 14(a) of the Exchange Act
forof 2002 for the ThirdFirst Quarter 20062007
32 Certification Pursuant to Rule 13a - 14(b) of the Exchange Act
and 18U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 for the ThirdFirst Quarter 2006
342007
27
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
ENGlobal CORPORATIONCorporation
Dated: ________May 9, 2007
By: /s/ Robert W. Raiford
-------------------------
Robert W. Raiford
Chief Financial Officer and Treasurer
3528