UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 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, 2004
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 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 Number)
600 Century Plaza Drive, Suite 140, Houston, Texas 77073-6033
-------------------------------------------------- ----------
(Address of Principal Executive Offices) (Zip Code)
(281) 821-3200
--------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the issuer (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 shorter 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 an accelerated filer (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 2, 2004.
$0.001 Par Value Common Stock................................23,448,597 shares
QUARTERLY REPORT ON FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004
TABLE OF CONTENTS
Page
Number
------
Part I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Statements of Income for the
Three Months Ended and the Nine Months Ended
September 30, 2004 and September 30, 2003........................1
Condensed Consolidated Balance Sheets at
September 30, 2004 and December 31, 2003.........................2
Condensed Consolidated Statements of Cash Flows
for the Nine Months Ended September 30, 2004 and
September 30, 2003...............................................3
Notes to Condensed Consolidated Financial Statements..........4-10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations..........................11-20
Item 3. Quantitative and Qualitative Disclosures about Market Risk......20
Item 4. Controls and Procedures.........................................20
Part II. Other Information
Item 1. Legal Proceedings...............................................21
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.....21
Item 3. Defaults Upon Senior Securities.................................21
Item 4. Submission of Matters to a Vote of Security Holders.............21
Item 5. Other Information...............................................21
Item 6. Exhibits........................................................21
Signature.......................................................22
i
Part I. Financial Information
Item 1. Financial Statements
ENGlobal Corporation
Condensed Consolidated Statements Of Income
(Unaudited)
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
------------------------------- -------------------------------
2004 2003 2004 2003
------------- ------------- ------------- -------------
OPERATING REVENUE $ 37,272,033 $ 35,435,192 $ 102,547,298 $ 87,713,230
OPERATING EXPENSE:
Direct cost 32,452,087 31,093,865 89,291,398 75,221,803
Selling, general and administrative 3,256,566 2,933,411 9,535,940 8,553,969
Depreciation and amortization 321,034 216,895 857,863 594,853
------------- ------------- ------------- -------------
Total operating expense 36,029,687 34,244,171 99,685,201 84,370,625
------------- ------------- ------------- -------------
Operating income 1,242,346 1,191,021 2,862,097 3,342,605
OTHER INCOME (EXPENSE):
Other income (expense) 23,996 (316,599) 52,064 (360,219)
Interest income (expense), net (122,211) (203,624) (418,167) (610,543)
------------- ------------- ------------- -------------
Total other income (expense) (98,215) (520,223) (366,103) (970,762)
------------- ------------- ------------- -------------
INCOME BEFORE PROVISION FOR INCOME TAX 1,144,131 670,798 2,495,994 2,371,843
PROVISION FOR INCOME TAX 389,005 277,276 848,638 900,813
------------- ------------- ------------- -------------
INCOME FROM CONTINUING OPERATIONS 755,126 393,522 1,647,356 1,471,030
LOSS FROM DISCONTINUED OPERATIONS, Net of tax benefit
($7,675 and $27,211 respectively) -- (11,512) -- (47,339)
------------- ------------- ------------- -------------
NET INCOME 755,126 382,010 1,647,356 1,423,691
PREFERRED STOCK DIVIDENDS -- 26,900 -- 131,100
------------- ------------- ------------- -------------
EARNINGS AVAILABLE TO COMMON STOCKHOLDERS $ 755,126 $ 355,110 $ 1,647,356 $ 1,292,591
============= ============= ============= =============
EARNINGS PER COMMON SHARE (BASIC)
From continuing operations $ .03 $ .02 $ .07 $ .06
From discontinued operations -- -- -- --
------------- ------------- ------------- -------------
From net income $ .03 $ .02 $ .07 $ .06
============= ============= ============= =============
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 24,060,689 23,447,429 24,043,734 23,056,609
(BASIC)
EARNINGS PER COMMON SHARE (DILUTED)
From continuing operations $ .03 $ .01 $ .07 $ .05
From discontinued operations -- -- -- --
------------- ------------- ------------- -------------
From net income $ .03 $ .01 $ .07 $ .05
============= ============= ============= =============
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 24,216,826 24,061,823 24,199,871 23,637,894
(DILUTED)
See accompanying notes to interim condensed consolidated financial statements.
1
ENGlobal Corporation
Condensed Consolidated Balance Sheets
September 30, December 31,
2004 2003
------------- ------------
(unaudited)
ASSETS
------
CURRENT ASSETS:
Cash $ 15,490 $ 39,439
Accounts receivable - trade, less allowance for doubtful accounts of
approximately $472,000 for 2004 and $376,000 for 2003 21,390,218 20,244,172
Cost and estimated earnings in excess of billings on uncompleted
contracts 1,022,893 1,022,726
Prepaid and other 808,851 1,260,296
Inventory 128,920 118,340
Assets held for sale 678,106 --
Deferred tax asset 477,000 477,000
------------ ------------
Total current assets 24,521,478 23,161,973
NET ASSETS FROM DISCONTINUED OPERATIONS -- 860,728
PROPERTY AND EQUIPMENT, net 4,755,084 4,302,430
GOODWILL 13,838,523 13,752,564
OTHER ASSETS 652,442 452,695
------------ ------------
Total assets $ 43,767,527 $ 42,530,390
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable - trade $ 7,182,936 $ 9,821,030
Accrued salaries and benefits 7,173,928 4,302,137
Notes payable 50,000 771,225
Current portion - long term debt 293,760 623,230
Current portion - capital lease 7,789 --
Billings in excess of costs 847,179 374,339
Income tax payable 271,293 103,609
Other liabilities 555,032 661,699
------------ ------------
Total current liabilities 16,381,917 16,657,269
16,381,917
Net liabilities from discontinued operations -- 24,164
Long term debt, net of current portion 7,938,981 7,506,062
Capital lease payable, net of current portion 2,222 12,042
Deferred tax liability 156,000 156,000
------------ ------------
Total liabilities 24,479,120 24,355,537
STOCKHOLDERS' EQUITY:
Common stock, $0.001 par value; 75,000,000 shares authorized; 23,423,618 and
24,034,288 outstanding and 24,075,995 and 24,034,288 issued at September
30, 2004 and December 31, 2003,
respectively 24,076 24,034
Treasury stock, at cost 652,377 shares and no shares at September 30,
2004 and December 31, 2003, respectively (592,231) --
Additional paid-in capital 12,152,769 12,094,382
Retained earnings 7,703,793 6,056,437
------------ ------------
Total stockholders' equity 19,288,407 18,174,853
------------ ------------
Total liabilities and stockholders' equity $ 43,767,527 $ 42,530,390
============ ============
See accompanying notes to interim condensed consolidated financial statements.
2
ENGlobal Corporation
Condensed Consolidated Statements Of Cash Flows
(Unaudited)
For the Nine Months Ended September 30,
---------------------------------------
2004 2003
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,647,356 $ 1,423,691
Adjustments for non-cash items 860,882 1,384,325
Changes in working capital (165,651) 1,047,667
----------- -----------
Net cash provided by operating activities 2,342,587 3,855,683
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property and equipment acquired (858,929) (1,049,280)
Proceeds from sale of equipment 3,260 554,865
----------- -----------
Net cash used by investing activities (855,669) (494,415)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (payments) on line of credit 1,764,448 (2,159,841)
Issuance of common stock upon exercise of options 58,429 21,250
Short-term note repayments (719,395) (484,021)
Capital lease repayments (6,186) (36,517)
Long-term debt repayments (2,608,163) (651,974)
----------- -----------
Net cash used by financing activities (1,510,867) (3,311,103)
----------- -----------
NET CHANGE IN CASH (23,949) 50,165
CASH, at beginning of period 39,439 75,095
----------- -----------
CASH, at end of period $ 15,490 $ 125,260
=========== ===========
SUPPLEMENTAL DISCLOSURES:
Interest paid $ 328,386 $ 574,240
Income taxes paid $ 701,982 $ 547,210
Dividend payments $ -- $ 105,040
NON-CASH:
Accrual of preferred dividends $ -- $ 131,100
Issuance of preferred stock dividends $ -- $ 146,833
Conversion of all preferred stock to common $ -- $ 2,734,834
Goodwill upon acquisition of Petro-Chem $ -- $ 75,000
Issuance of notes for EDGI assets $ 300,000 $ --
Issuance of note for AmTech assets $ 50,000 $ --
Record debt for acquisition of treasury stock $ 592,231 $ --
See accompanying notes to interim condensed consolidated financial statements.
3
ENGlobal Corporation
Notes to Condensed Consolidated Financial Statements
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 unaudited for the three and nine-month periods
ended September 30, 2004 and 2003. 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 these condensed financial
statements be read in conjunction with the Company's audited financial
statements for the years ended December 31, 2003 and 2002, which are
included in the Company's annual reports on Form 10-K. The Company believes
that the disclosures made herein are adequate to make the information
presented not misleading.
2. Line of Credit and Debt
-----------------------
At the end of the reporting period, the Company had a Credit Facility with
Comerica Bank ("Comerica") that consisted of a line of credit maturing on
July 27, 2007 (the "Comerica Credit Facility"). The loan agreement
positioned Comerica as senior to all other debt. The line of credit is
limited to $22.0 million, subject to loan covenant restrictions. 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, 2004 was $7.3 million. At the election of the Company, the
interest rate will be the lesser of prime or a three tiered Eurodollar
rate, plus 150, 175, or 200 basis points, respectively, based on the ratio
of total funded debt to EBITDA for the trailing 12 months of less than
2.00, between 2.00 and 2.50, and greater than 2.50, respectively. The
commitment fee on the unused line of credit is 0.250%. The remaining
borrowings available under the line of credit as of September 30, 2004 were
$14.5 million after consideration of borrowing base limitations and cash
timing differences.
The Comerica Credit Facility contains covenants requiring the Company, as
of the end of each calendar month then ended, to maintain certain ratios,
including total funded debt to EBITDA; total funded debt to total
liabilities, plus net worth; and 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 worth, plus 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 the last
reporting period on September 30, 2004.
4
ENGlobal Corporation
Notes to Condensed Consolidated Financial Statements
September 30, December 31,
2004 2003
---------------------------------
(in thousands)
Schedule of long-term debt:
Comerica Credit Facility - Line of credit, prime (4.5% at September
30, 2004), maturing in July 2007 $ 7,321 $ -
Fleet Credit Facility - Line of credit, retired in July 2004 - 5,556
Equus II - Note payable (unsecured), interest at 9.5%, principal
payments in installments of $110,000 plus interest due
quarterly scheduled to mature in December 2005, retired in July
2004 - 2,340
Petrocon Arabia Limited - Note payable (unsecured), interest at 8%,
principal due monthly in installments of $25,000, interest paid
annually, retired in June 2004 - 151
Petro-Chem - Note payable (unsecured), payments of $25,000 due
annually, scheduled to mature January 2006, retired in April
2004 - 75
Sterling Planet and EDGI - Notes payable (unsecured) interest at 5%,
principal payments in installments of $15,000 plus interest due
quarterly, maturing in December 2008 270 -
AmTech - Note payable (unsecured), non-interest bearing, principal
payments in installments of $25,000 due annually, scheduled
to mature January 2006 50 -
Significant PEI Shareholders (See Note 11) 592
Miscellaneous - 7
------------- -----------
Total long-term debt 8,233 8,129
Less--current maturities (294) (623)
------------- -----------
Long-term debt, net of current portion $ 7,939 $ 7,506
============= ===========
Current notes payable include notes to Mrs. Senftleber and the Senftleber
Family Trust for the acquisition of Senftleber & Associates, L.P. in
October 2003. The notes had balances of $50,000 at September 30, 2004 and
December 31, 2003 and mature in October 2004.
3. 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 in the $10 million range 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 that the Company currently provides in order
to assist the Company in gaining a larger position in a given market
segment or geographic location.
In September 2004, the Company retained Sanders Morris Harris as the
exclusive advisor to the Company to identify strategic acquisition
opportunities and assist the Company in evaluating and negotiating the
terms of potential strategic transactions. Sanders Morris Harris is a full
service investment bank focused on providing corporate finance and merger
and acquisition services to private and public middle-market companies. In
connection with its engagement, Sanders Morris Harris will assist the
Company in formulating, evaluating and implementing possible alternatives
for enhancing shareholder value. The Company emphasized that there is no
assurance the strategic review will lead to any transaction and that it is
committed to its continuing operations while strategic opportunities are
identified and reviewed.
5
ENGlobal Corporation
Notes to Condensed Consolidated Financial Statements
One of the Company's subsidiaries, ENGlobal Design Group ("EDG"), purchased
certain assets of Tulsa-based Engineering Design Group, Inc. ("EDGI")
effective February 1, 2004. The Company expects that the acquisition of
these assets will enhance its capabilities related to various government
and public sector facilities. EDG's most active sector is the Automated
Fuel Handling Systems that serve the U.S. military. In connection with the
purchase, EDG issued two $150,000 notes bearing interest at 5% maturing in
December 2008 and a $2.5 million five-year contingent promissory note, with
payments due annually, as part of an earn-out structure based on revenues
of the EDG operations over the next five years. EDG did not pay any cash or
issue any stock in the transaction. The original consideration given for
the purchase of certain EDGI assets approximated the fair value; therefore
no goodwill arose from the transaction. Principal payments on the $2.5
million five-year contingent promissory note will be charged to goodwill.
The unaudited proforma combined historical results, as if the EDGI asset
acquisition had taken place at the beginning of 2003 and 2004,
respectively, are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- -----------------------------
2004 2003 2004 2003
---------- ---------- --------- ---------
(in thousands) (in thousands)
Revenue as reported $ 37,272 $ 35,435 $ 102,547 $ 87,713
Proforma revenues of EDGI -- 2,401 486 11,033
---------- --------- --------- ---------
Proforma revenues $ 37,272 $ 37,836 $ 103,033 $ 98,746
========== ========= ========= =========
Net income as reported $ 755 $ 382 $ 1,647 $ 1,424
Proforma loss of EDGI -- (1,003) (128) (877)
---------- --------- --------- ---------
Proforma net income $ 755 $ (621) $ 1,519 $ 547
========== ========= ========= =========
Basic per share data as reported $ .03 $ (.03) $ .07 $ .06
Proforma basic per share data $ .03 $ (.03) $ .06 $ .02
Diluted per share data as reported $ .03 $ (.03) $ .07 $ .06
Proforma diluted per share data $ .03 $ (.03) $ .06 $ .02
4. Goodwill
--------
In accordance with Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets, goodwill is no longer amortized over
its estimated useful life, but rather will be subject to at least an annual
assessment for impairment. 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.
The Company cannot predict at this time the amount of any such impairment.
6
ENGlobal Corporation
Notes to Condensed Consolidated Financial Statements
5. Fixed Fee Contracts
-------------------
Costs, estimated earnings and billings on uncompleted contracts consisted
of the following at September 30, 2004 and December 31, 2003:
September 30, December 31,
2004 2003
------------- ------------
(in thousands)
Costs incurred on uncompleted contracts $ 6,955 $ 14,333
Estimated earnings on uncompleted contracts 1,234 1,862
-------- --------
Earned revenues 8,189 16,195
Less billings to date (8,013) (15,546)
-------- --------
Net cost and estimated earnings in excess of billings on
uncompleted contracts $ 176 $ 649
======== ========
Cost and estimated earnings in excess of billings on uncompleted
contracts $ 1,023 $ 1,023
Less billings and estimated earnings in excess of cost on uncompleted
contracts (847) (374)
-------- --------
Net cost and estimated earnings in excess of billings on
uncompleted contracts $ 176 $ 649
======== ========
6. Preferred Stock Dividends
-------------------------
ENGlobal has a class of preferred stock with 5,000,000 shares originally
authorized for issuance. The Company issued to Equus II Incorporated
("Equus II") 2,500,000 shares of preferred stock and stock dividends
totaling 234,833 shares. Par value for the preferred stock was $0.001 with
a liquidation preference value of $1.00 per share. All preferred shares
outstanding were converted into 1,149,089 shares of common stock in August
2003. Following the conversion, the Company reduced the authorized shares
of preferred stock to 2,265,167. There are currently no shares of preferred
stock issued and outstanding.
7. Discontinued Operations and Assets Held for Sale
------------------------------------------------
In our ongoing strategic efforts to increase the Company's focus on core
engineering consulting services, the Thermaire manufacturing operations and
a significant portion of its assets were sold on December 15, 2003.
Thermaire manufactured air-handling equipment for commercial heating,
ventilation and cooling systems. The operating results of the business are
included in "Discontinued operations" and the assets and liabilities are
separately identified on the Balance Sheet for 2003. As of 2004, all
liabilities relating to the Thermaire operations have been extinguished and
the remaining assets, the land and building, have been prepared for sale
and listed with an agent.
8. Employee Stock Purchase Plan
----------------------------
On June 17, 2004, ENGlobal shareholders ratified the Company's adoption of
the 2004 Employee Stock Purchase Plan ("Plan"). Beginning April 2004, the
Company provided eligible employees with the opportunity and a convenient
means to purchase shares of the Company's Common Stock as an incentive to
exert maximum efforts for the success of the Company. ENGlobal intends that
options to purchase stock granted under the Plan qualify as options granted
under an "employee stock purchase plan" as defined in Section 423(b) of the
Code. The Plan will be construed so as to be consistent with Section 423 of
the Code, including Section 423(b)(5) which requires that all participants
have the same rights and privileges with respect to options granted under
the Plan. The cash contributed by the participants has been used to meet
the Company's cash requirements or has been applied to the reduction of the
Company's long-term debt.
7
ENGlobal Corporation
Notes to Condensed Consolidated Financial Statements
9. Stock Option Plan
-----------------
The Company accounts for its nonqualified incentive stock option plan under
the recognition and measurement principles of Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees and related
interpretations. Accordingly, no stock-based compensation cost is reflected
in net income, as all options granted under the Company's plan were equal
to or greater than the market value of the Company's stock on the date of
grant.
The following table illustrates the effect on net income and earnings per
share for the three months ended and nine months ended September 30, 2004
and 2003, respectively, as if the Company had applied the fair value
recognition provisions of SFAS No. 123, Accounting for Stock-Based
Compensation, as amended by SFAS 148, Accounting for Stock-Based
Compensation Transition and Disclosure, issued in December 2002.
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- ---------------------
2004 2003 2004 2003
------- ------- ------- -------
(in thousands) (in thousands)
Pro forma impact of fair value method (SFAS 148):
Net income attributable to common stockholders, as reported $ $ 755 $ 355 $ 1,647 $ 1,293
Less compensation expense determined under fair value
method, net of tax (4) (14) (132) (56)
------- ------- ------- -------
Pro forma net income attributable to common stockholders $ 751 $ 341 $ 1,515 $ 1,237
======= ======= ======= =======
Earnings per share (basic):
As reported $ 0.03 $ 0.02 $ 0.07 $ 0.06
Pro forma $ 0.03 $ 0.01 $ 0.07 $ 0.05
Earnings per share (diluted):
As reported $ 0.03 $ 0.01 $ 0.07 $ 0.05
Pro forma $ 0.03 $ 0.01 $ 0.06 $ 0.05
Weighted average Black-Scholes fair value assumptions:
Risk free interest rate 5% 5% 5% 5%
Expected life 3-10 years 3-10 years 3-10 years 3-10 years
Expected volatility 61% 83% - 93% 61% 83% - 93%
Expected dividend yield 0.0% 0.0% 0.0% 0.0%
10. Segment Information
-------------------
With the sale of the manufacturing segment in December 2003, the Company
now operates in two business segments: (1) engineering, providing services
primarily to major integrated oil and gas companies; 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. Revenue and operating
income for each segment are set forth in the following table.
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
2004 2003 2004 2003
--------- --------- --------- ----------
(in thousands) (in thousands)
Revenue:
Engineering $ 32,796 $ 32,376 $ 92,730 $ 75,948
Systems 4,476 3,059 9,817 11,765
--------- --------- ---------
Total revenue $ 37,272 $ 35,435 $ 102,547 $ 87,713
========= ========= ========= =========
Operating income (loss):
Engineering $ 2,589 $ 2,887 $ 7,672 $ 7,891
Systems 439 (144) 134 57
Corporate (1,786) (1,552) (4,944) (4,605)
--------- --------- --------- ---------
Total operating income $ 1,242 $ 1,191 $ 2,862 $ 3,343
========= ========= ========= =========
8
ENGlobal Corporation
Notes to Condensed Consolidated Financial Statements
11. Commitments and Contingencies
-----------------------------
In connection with the 2001 merger of Petrocon Engineering, Inc.
("Petrocon") and a wholly owned subsidiary of ENGlobal Corporation, certain
former Petrocon shareholders (the "Significant PEI Shareholders") entered
into an Indemnification Escrow Agreement, an Option Escrow Agreement, a
Voting Agreement and a Significant PEI Shareholder Voting Agreement
(collectively, the "2001 Agreements"). In August 2004, the Company and the
requisite percentage of Significant PEI Shareholders entered into a
Termination Agreement (the "Termination Agreement") terminating the 2001
Agreements. The 2001 Agreements included the following:
Indemnification Escrow. Pursuant to the Indemnification Escrow
Agreement, 1,000,000 shares of ENGlobal common stock owned by the
Significant PEI Shareholders were deposited into an escrow to serve as
a fund against which the Company could make claims for indemnity
pursuant to the Merger Agreement with Petrocon. Pursuant to the terms
of the Termination Agreement, the remaining shares in the
Indemnification Escrow agreement will be released pro rata to the
Significant PEI Shareholders.
Voting Agreement. ENGlobal, the Significant PEI Shareholders, and
certain other parties entered into a Voting Agreement which obligated
the parties thereto to vote for certain persons to serve on the Board
of Directors of ENGlobal. Pursuant to the terms of the Termination
Agreement, the Voting Agreement has been terminated.
Significant PEI Shareholder Voting Agreement. The Significant PEI
Shareholders entered into a Significant PEI Shareholders Voting
Agreement governing the manner in which they would designate three
ENGlobal director nominees under the Voting Agreement and vote shares
held in escrow. Pursuant to the terms of the Termination Agreement,
the Significant PEI Shareholders Voting Agreement has been terminated.
Option Escrow. Pursuant to the Option Escrow Agreement, the
Significant PEI Shareholders deposited 1,737,473 shares of ENGlobal
common stock into an escrow account. The Option Escrow Agreement
required that if ENGlobal issued shares of its common stock on the
exercise of incentive options granted as replacement options for
outstanding Petrocon incentive options ("Replacement Options"), a like
number of shares of ENGlobal common stock would be surrendered from
the escrow account to ENGlobal. As a result, no dilution to ENGlobal
stockholders would occur upon the exercise of Replacement Options.
The Company's management has since determined that, due to the cost and
complexity associated with administering the 2001 Agreements, it would be
in the best interest of the Company and its stockholders to terminate the
same. Pursuant to the terms of the Termination Agreement, ENGlobal
purchased the 652,377 shares being held in escrow underlying the
Replacement Options with an exercise price of $0.96 per share for a
discounted payment of $592,231, payable over three years to the Significant
PEI Shareholders. ENGlobal also terminated its rights to any of the
remaining shares held in escrow and those shares were distributed to the
Significant PEI Shareholders. The transaction resulted in 652,377 shares of
Treasury Stock and a decrease in Shareholders' Equity of $592,231 until
such time as the replacement options are exercised and the exercise price
is remitted to the Company.
9
ENGlobal Corporation
Notes to Condensed Consolidated Financial Statements
12. Subsequent Events
-----------------
In October 2004, one of the Company's subsidiaries, ENGlobal Construction
Resources, Inc., purchased the name and certain assets of Cleveland
Inspection Services, Inc. ("CIS"). CIS provides inspection and construction
management services in support of the oil and gas, utility, and pipeline
industries. In exchange for the assets acquired, the Company paid $2.0
million consisting of cash, a promissory note and assumption of certain
designated contract obligations and entered into non-compete agreements
with CIS and its principals. In addition, the Company hired approximately
180 former CIS employees and operates its newly purchased assets as a
division of ENGlobal Construction Resources, Inc., marketing its services
using the Cleveland Inspection Services name.
12
Item 2. Management's Discussion And Analysis And Results Of Operations
Forward-Looking Statements
Certain information contained in this Quarterly Report on Form 10-Q, the
Company's Annual Report to Stockholders, 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, with 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; 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. When used in this report, the words "anticipate," "believe,"
"estimate," "expect," "may," and similar expressions, as they relate to the
Company, its subsidiaries, and management, identify forward-looking statements.
Actual results could differ materially from the results described in the
forward-looking statements due to the risks and uncertainties set forth with
this Quarterly Report on Form 10-Q and the specific risk factors identified in
the Company's Annual Report on Form 10-K for the year ended December 31, 2003.
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 the Company's Annual Report on Form 10-K for the year
ended December 31, 2003.
Overview
ENGlobal Corporation is a leading provider of engineering services and systems
principally to the petroleum refining, petrochemical, pipeline, production and
process industries throughout the United States and internationally. The
services provided by our multi-disciplined staff span the lifecycle of a project
and include feasibility studies, design, procurement and construction
management. We also supply automation, control and uninterruptible electrical
power systems to our clients worldwide.
The Company was incorporated as Industrial Data Systems Corporation in the State
of Nevada in June 1994. In December 2001, the Company merged with Petrocon
Engineering, Inc. and in June 2002, changed its name from Industrial Data
Systems Corporation to ENGlobal Corporation. Effective June 16, 2002, the
Company's trading symbol for its common stock, traded on the American Stock
Exchange, changed from IDS to ENG. The Company streamlined its organizational
structure and took steps to increase name recognition in 2003. As part of its
restructuring, the Company sold selected assets of its manufacturing segment and
reorganized its subsidiaries into two segments. In addition, substantially all
of the Company's wholly-owned subsidiaries adopted the ENGlobal name.
Our business is managed under two reportable segments; engineering and systems.
The engineering segment provides engineering consulting services primarily to
major oil and gas companies through four subsidiary companies including ENGlobal
Engineering, Inc., RPM Engineering, Inc. d/b/a ENGlobal Engineering, Inc.,
ENGlobal Construction Resources, Inc., and ENGlobal Design Group, Inc. The
engineering segment earns revenue primarily from fees for professional and
technical services. As a service company, we are labor rather than capital
intensive and our income is derived from our ability to generate revenues and
collect cash under cost reimbursable contracts for our employees' time in excess
of any subcontract expense, the cost of pass-through materials and equipment,
non-labor costs, and our selling, general and administrative (SG&A) expenses.
Our systems segment designs, assembles, programs, installs, integrates and
services control and instrumentation systems for specific applications in the
energy and processing-related industries. The systems segment currently consists
of three subsidiary companies including ENGlobal Systems, Inc. ("ESI"), ENGlobal
Constant Power, Inc.("ECP"), and ENGlobal Technologies, Inc. ("ETI"). The
systems segment earns revenue primarily from fees on contracts for the design
and assembly of control and instrumentation systems. Income from the systems
segment is derived from our ability to generate revenues and collect cash on
fixed price contracts in excess of our costs for labor, materials and equipment
and transportation costs, plus our selling, general and administrative (SG&A)
expenses.
11
The following table presents, for the periods indicated, the approximate
percentage of total revenues and operating income or loss attributable to our
reportable segments:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
Revenue:
Engineering 88.0% 91.4% 90.4% 86.6%
Systems 12.0 8.6 9.6 13.4
Operating income (loss):
Engineering 85.5% 105.2% 98.3% 99.3%
Systems 14.5 (5.2) 1.7 .7
Contract revenue and contract costs are 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 costs. Revenue and profit on long-term 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.
For internal analytical purposes only, we review total revenue less 1) revenue
received from non-labor material, equipment and subcontractor costs, and 2)
revenue received from material assets or companies acquired during the current
year, as well as revenue received from acquisitions of material assets or
companies during the first 12 months following their respective dates of
acquisition. In the course of providing our services, we routinely provide major
engineering materials, equipment and subcontract services. Generally, these
materials, equipment and subcontractor costs are passed through to our clients
and, in accordance with industry practice and generally accepted accounting
principles, are included in revenue. Because subcontractor services can change
significantly from project to project, changes in non-labor revenue may not be
indicative of our core business trends. Revenue recognized from acquired assets
or companies during the first 12 months after closing is referred to as
"Acquisition" revenue. We also review gross profit and SG&A expense from
material asset or company acquisitions on the same basis as we review total
revenue.
Our other contract costs include professional compensation and related benefits,
together with certain direct and indirect variable overhead costs. Professional
compensation and related benefits represent the majority of these costs.
Operating SG&A expense includes management and staff compensation, office costs
such as rents, 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, bid and proposal
costs, as well as costs related to the executive, finance, accounting, safety
and information technology departments, and other costs generally unrelated to
specific client projects, but which can vary as costs are incurred to support
corporate activities and initiatives.
12
Consolidated Results of Operations for the Three and Nine Months Ended September
30, 2004
The table that follows presents a summary of performance indicators for the
Company:
Three months ended Nine months ended
September 30, September 30,
---------------------------- ----------------------------
2004 2003 2004 2003
--------- --------- --------- ---------
(in thousands) (in thousands)
Revenue:
Engineering - labor $ 20,429 $ 19,107 $ 57,507 $ 54,278
Engineering - non-labor 10,790 13,269 30,349 21,670
Systems 4,060 3,059 8,468 11,765
Acquisition 1,993 -- 6,223 --
--------- --------- --------- ---------
Total revenue $ 37,272 $ 35,435 $ 102,547 $ 87,713
========= ========= ========= =========
Gross profit:
Engineering $ 3,792 $ 3,941 $ 11,096 $ 10,846
Systems 745 400 1,114 1,645
Acquisition 283 -- 1,046 --
--------- --------- --------- ---------
Total gross profit 4,820 4,341 13,256 12,491
--------- --------- --------- ---------
Operating SG&A expense:
Engineering 1,051 1,054 3,004 2,955
Systems 319 544 1,034 1,588
Corporate 1,786 1,552 4,944 4,605
Acquisition 422 -- 1,412 --
--------- --------- --------- ---------
Total SG&A expense 3,578 3,150 10,394 9,148
--------- --------- --------- ---------
Operating income:
Engineering 2,741 2,887 8,092 7,891
Systems 426 (144) 80 57
Corporate (1,786) (1,552) (4,944) (4,605)
Acquisition (139) -- (366) --
--------- --------- --------- ---------
Total operating income 1,242 1,191 2,862 3,343
Other income (expense), net (98) (520) (366) (971)
Tax provision (389) (277) (849) (901)
Loss from discontinued operations -- (12) -- (47)
Preferred stock dividends -- (27) -- (131)
--------- --------- --------- ---------
Net Income $ 755 $ 355 $ 1,647 $ 1,293
========= ========= ========= =========
Working capital $ 8,140 $ 8,490
Total assets $ 43,768 $ 41,288
Long-term debt, net of current portion $ 7,939 $ 10,020
Stockholders' equity $ 19,288 $ 17,437
13
Revenue. Revenue increased overall $1.8 million, or 5.2%, to $37.3 million for
the three months ended September 30, 2004 from $35.4 million for the comparable
prior year period. Excluding engineering - non-labor revenue, revenue for the
three months ended September 30, 2004 increased $4.3 million, or 19.5%, over
comparable revenue for the three months ended September 30, 2003, with
acquisition revenue contributing $2.0 million, or 46.2% of the increase. For the
nine month period ended September 30, 2004, revenue increased $14.8 million, or
16.9%, to $102.5 million from $87.7 million for the comparable prior year
period.
Excluding non-labor revenue from engineering, revenue for the nine months ended
September 30, 2004 increased $6.2 million, or 9.3%, over comparable revenue for
the nine month period ended September 30, 2003, with acquisition revenue
contributing more than 100% to our growth, as the increase in engineering
revenue was offset by the decrease in systems revenue.
Gross Profit. Gross profit increased overall $479,000, or 11.0%, to $4.8 million
for the three months ended September 30, 2004 from $4.3 million for the
comparable prior year period, with acquisition gross profit contributing
$283,000, or 59%, of the total increase. As a percentage of revenue, gross
profit increased to 12.9% for the three months ended September 30, 2004 from
12.3% for the quarter ended September 30, 2003.
Gross profit increased $765,000, or 6.1%, to $13.3 million for the nine months
ended September 30, 2004 from $12.5 million for the nine month period ended
September 30, 2003, with acquisition gross profit contributing $1.0 million, or
136.7% of the total increase. As a percentage of revenue, gross profit decreased
to 12.9% for the nine months ended September 30, 2004 from 14.2% for the nine
month period ended September 30, 2003.
Selling, General, and Administrative. Overall, SG&A expense increased $428,000,
or 13.6%, to $3.6 million for the three months ended September 30, 2004 from
$3.2 million for the comparable prior year period, with acquisition SG&A expense
contributing $422,000, or 98.6% to the overall increase in SG&A costs. As a
percentage of revenue, SG&A expense increased to 9.6% for the three months ended
September 30, 2004 from 8.9% for the three months ended September 30, 2003.
For the nine month period ended September 30, 2004, SG&A expense increased $1.2
million, or 13.6%, to $10.4 million from $9.1 million for the nine month period
ended September 30, 2003, with acquisition SG&A expense contributing $1.4
million to the overall increase in SG&A costs. SG&A expense from the operating
segments, not including SG&A costs associated with acquisitions (see details in
Segment Results), decreased $228,000 and $505,000, respectively, for the three
and nine month periods ended September 30, 2004 compared to prior year periods.
Corporate SG&A expense increased $234,000, or 15.1%, to $1.8 million for the
three months ended September 30, 2004 from $1.6 million for the comparable
period last year, due primarily to incentive plan compensation, our increased
marketing and proposal efforts in our Tulsa office and additional depreciation
and amortization costs. As a percentage of revenue, corporate SG&A expense
increased to 4.8% for the three months ended September 30, 2004 from 4.4% for
the comparable prior year period.
For the nine months ended September 30, 2004, corporate SG&A expense increased
$339,000, or 7.4%, to $4.9 million from $4.6 million for the comparable prior
year period, again due primarily to incentive plan compensation, our increased
marketing and proposal efforts in our Tulsa office and additional depreciation
and amortization costs. As a percentage of revenue, corporate SG&A expense
decreased to 4.8% for the nine months ended September 30, 2004 from 5.3% for the
comparable prior year period.
Operating Income. Operating income increased 4.3% for the three months ended
September 30, 2004 although remaining relatively unchanged at $1.2 million
compared to the same period in 2003. As a percentage of revenue, operating
income decreased to 3.3% for the three months ended September 30, 2004 from 3.4%
for the comparable prior year period.
For the nine month period ended September 30, 2004, operating income was down
approximately $500,000, or 14.4%, to $2.8 million from $3.3 million for the nine
month period ended September 30, 2003. As a percentage of revenue, operating
income decreased to 2.8% for the nine month period ended September 30, 2004 from
3.8% for the comparable prior year period.
14
Other Expense, net. Other expense decreased $422,000, to $98,000 for the three
month period ended September 30, 2004 from $520,000 for the comparable prior
year period, primarily due to a decrease of $80,000 in net interest expense and
a decrease of $342,000 in other expense. Net interest expense decreased 40.2% to
$122,000 for the three months ended September 30, 2004 from $204,000 for the
comparable prior year period. For the nine month period ended September 30,
2004, net interest expense decreased 31.6% to $418,000 from $610,000 for the
comparable prior year period. For both the three and nine month periods ended
September 30, 2004, the lower interest expense is primarily related to the
reduction of long-term senior debt and the payment of the Equus II note. The
Equus II note, carrying an interest rate of 9.5%, was retired in July 2004 with
the Company's refinancing of senior debt through Comerica Bank. The decrease in
other expense for both the three and nine month periods ended September 30, 2004
was due to the one-time, book basis loss recorded on the sale of the Baton Rouge
office building during the comparable periods in 2003.
Tax Provision. Income tax expense increased $112,000, or 40.4%, to $389,000 for
the three months ended September 30, 2004 from $277,000 for the comparable prior
year period. For the nine months ended September 30, 2004, net income tax
expense decreased $52,000, or 5.8%, to $849,000 from $901,000 for the comparable
prior year period. Our estimated effective tax rate was 34% for the three and
nine month periods ended September 30, 2004.
Net Income. Net income for the three months ended September 30, 2004 increased
$373,000, or 97.6%, to $755,000 from $355,000 for the comparable prior year
period. Net income for the nine months ended September 30, 2004 increased
$224,000, or 15.7%, to $1,647,000 for the comparable prior year period.
Segment Results
Engineering____________________________________________________________________
Three months ended Nine months ended
September 30, September 30,
---------------------------- ----------------------------
2004 2003 2004 2003
-------- -------- -------- --------
(in thousands) (in thousands)
Revenue:
Engineering - labor $ 20,429 $ 19,107 $ 57,507 $ 54,278
Engineering - non-labor 10,790 13,269 30,349 21,670
Acquisition 1,577 -- 4,874 --
-------- -------- -------- --------
Total revenue $ 32,796 $ 32,376 $ 92,730 $ 75,948
======== ======== ======== ========
Gross profit:
Engineering $ 3,792 $ 3,941 $ 11,096 $ 10,846
Acquisition 218 -- 811 --
-------- -------- -------- --------
Total gross profit 4,010 3,941 11,907 10,846
-------- -------- -------- --------
Operating SG&A expense:
Engineering 1,051 1,054 3,004 2,955
Acquisition 370 -- 1,231 --
-------- -------- -------- --------
Total SG&A expense 1,421 1,054 4,235 2,955
-------- -------- -------- --------
Operating income (loss):
Engineering 2,741 2,887 8,092 7,891
Acquisition (152) -- (420) --
-------- -------- -------- --------
Total operating income $ 2,589 $ 2,887 $ 7,672 $ 7,891
======== ======== ======== ========
Acquisition totals are the combined results of operations related to assets
acquired from AmTech in September 2004, Petro-Chem in June 2003 and from EDGI in
January 2004.
Overview. Our engineering segment continues to perform well and we anticipate
future growth in this segment. Billable manhours increased noticably in mid-July
with another increase in September 2004, to a new level of bi-weekly billable
hours which is over 15% above the late July levels, while utilization rates
remain high. Based on recent increases in our backlog and new contract awards,
we believe this internal growth is sustainable for the foreseeable future,
although it may be slowed to some degree in the fourth quarter due to holiday
and vacation time. Due to recent contract awards we have added over 40 people in
15
Tulsa and expect to add another eighty people by second quarter 2005. Tulsa
margins are higher than those generally experienced on the Gulf Coast, thus this
trend could have a positive impace on our future earnings.
Within the engineering segment, the Beaumont office remains our strongest profit
center followed by our in-plant services operation. The Tulsa office has become
our third largest profit center with both revenue and profit growth exceeding
our other segment operations.
Revenue. Revenue increased $420,000, or 1.3%, to $32.8 million for the three
months ended September 30, 2004 from $32.4 million for the comparable period in
2003. Excluding non-labor revenue, revenue for the three months ended September
30, 2004 increased $2.9 million, or 15.2%, over comparable revenue for the three
months ended September 30, 2003 with revenue from acquisitions accounting for
$1.6 million and revenue from internal growth accounting for $1.3 million.
Revenue from internal growth, not related to acquisitions, for the three months
ended September 30, 2004 represented a 6.9% increase over revenue for the
comparable period ended September 30, 2003.
Revenue increased $16.8 million, or 22.1%, to $92.7 million for the nine month
period ended September 30, 2004 from $75.9 million for the nine month period
ended September 30, 2003. Excluding non-labor revenue, revenue for the nine
month period ended September 30, 2004 increased $8.1 million, or 14.9% over
comparable revenue for the nine month period ended September 30, 2003 with
revenue from acquisitions accounting for $4.9 million and revenue from internal
growth accounting for $3.2 million. Revenue from internal growth, not related to
acquisitions, for the nine month period ended September 30, 2004 represented a
5.9% increase over revenue for the comparable period ended September 30, 2003.
Revenue attributed to both our acquisitions and our internal growth increased at
a faster rate during the three month period ended September 30, 2004 than
revenue increased for the nine month period ended September 30, 2004. Revenue
from acquisitions has been derived from in-plant operations while our internal
growth is attributable primarily to growth in our Tulsa office.
Revenue attributed to both our acquisitions and our internal growth increased at
a faster rate during the three month period ended September 30, 2004 than
revenue increased for the nine month period ended September 30, 2004. Revenue
from acquisitions has been derived from in-plant operations while our internal
growth is attributable primarily to growth in our Tulsa office.
Gross Profit. Gross profit increased $69,000, or 1.8%, to $4.0 million for the
three months ended September 30, 2004 from $3.9 million for the comparable
period in 2003. Excluding gross profit from procurement revenue, gross profit
increased $408,000, or 11.4%, for the three months ended September 30, 2004 when
compared to the three months ended September 30, 2003, with gross profit from
internal growth accounting for $190,000. Gross profit from internal growth for
the three months ended September 30, 2004 represented a 5.3% increase over gross
profit for the comparable period ended September 30, 2003. As a percentage of
revenue, gross profit remained unchanged at 12.2% for the comparable three month
periods ended September 30th for both years 2004 and 2003.
Gross profit increased $1.1 million, or 9,8%, to $11.9 million for the the nine
month period ended September 30, 2004 from $10.8 million for the nine month
period ended September 30, 2003. Excluding gross profit from procurement
revenue, gross profit increased $1.4 million, or 13.1%, for the nine month
period ended September 30, 2004 when compared to the nine month period ended
September 30, 2003, with gross profit from internal growth accounting for
$551,000. Gross profit from internal growth for the nine month period ended
September 30, 2004 represented a 5.3% increase over gross profit for the
comparable period ended September 30, 2003. As a percentage of revenue, gross
profit decreased to 12.8% for the nine month period ended September 30, 2004
from 14.3% for the comparable period in 2003.
Gross profit on procurement revenues decreased $339,000 for the three months
ended September 30, 2004 and decreased $301,000 for the nine month period ended
September 30, 2004 when compared to the same periods in 2003.
16
Operating Selling, General, and Administrative. SG&A expense increased $367,000
overall, or 34.8%, to $1.4 million for the three months ended September 30, 2004
from $1.1 million for the comparable period in 2003, primarily related to
$370,000 in acquisition SG&A expense.
During the nine month period ended September 30, 2004, SG&A expense increased
$1.3 million overall, or 43.3%, to $4.2 million for the nine month period ended
September 30, 2004 from $2.9 million for the nine month period ended September
30, 2003, primarily related to $1.2 million in acquisition SG&A expense.
Operating Income. Operating income decreased $298,000, or 10.3%, to $2.6 million
for the three months ended September 30, 2004 from $2.9 million for the
comparable prior year period. As a percentage of revenue, operating income
decreased to 7.9% for the three months ended September 30, 2004 from 8.9% for
the comparable prior year period.
Operating income decreased $219,000, or 2.8%, to $7.7 million for the nine month
period ended September 30, 2004 from $7.9 million for the nine month period
ended September 30, 2003. As a percentage of revenue, operating income decreased
to 8.3% for the nine month period ended September 30, 2004 from 10.4% for the
nine month period ended September 30, 2003.
Systems_________________________________________________________________________
Three months ended Nine months ended
September 30, September 30,
------------------------- -------------------------
2004 2003 2004 2003
------- ------- ------- -------
(in thousands) (in thousands)
Revenue:
Systems $ 4,060 $ 3,059 $ 8,468 $ 1,765
Acquisition 416 -- 1,349 --
------- ------- ------- -------
Total revenue $ 4,476 $ 3,059 $ 9,817 $ 1,765
======= ======= ======= =======
Gross profit:
Systems $ 745 $ 400 $ 1,114 $ 1,645
Acquisition 65 -- 235 --
------- ------- ------- -------
Total gross profit 810 400 1,349 1,645
------- ------- ------- -------
Operating SG&A expense:
Systems 319 544 1,034 1,588
Acquisition 52 -- 181 --
------- ------- ------- -------
Total SG&A expense 371 544 1,215 1,588
------- ------- ------- -------
Operating income:
Systems 426 (144) 80 57
Acquisition 13 -- 54 --
------- ------- ------- -------
Total operating income $ 439 $ 144) $ 134 $ 57
======= ======= ======= =======
Acquisition totals are from results of operations related to the purchase of
Senftleber & Associates, L.P. in October, 2003.
Overview. Our systems segment's financial results during the three months ended
September 30, 2004 more than offset the overall loss that had been incurred
during the first six months of the year. The primary reason for the turnaround
was directly related to the large influx of new work during the period,
accounting for 45.6% of the total revenue for the year. We have also lowered our
operating costs through a reduction of personnel and a reorganization of the
entire systems segment. As of July 1, 2004, ESI, ECP and ETI were consolidated
into one operation overseen by the former President of the ETI subsidiary. We
remain concerned about the relative underperformance of this segment, as
personnel changes and reorganization will likely result in some transitional
costs. We expect the systems segment to remain profitable for the next several
months, but recognize there are still problems to be corrected and those are
being addressed.
17
Revenue. Revenue increased $1.4 million, or 46.3%, to $4.5 million for the three
months ending September 30, 2004 from $3.1 million for the comparable prior year
period, with acquisition revenue contributing $416,000, or 29.4% of the overall
growth during the period. ESI and ECP each increased revenue $500,000 for the
three months ended September 30, 2004 compared to the same period in 2003 due
primarily to ECP completing one significant project during the period and a
general improvement in ESI's market.
Revenue decreased $1.9 million, or 16.6%, to $9.8 million for the nine month
period ended September 30, 2004 from $11.8 million for the nine month period
ended September 30, 2003. Acquisition revenue contributed $1.3 million and ECP
contributed an additional $500,000 in revenue for the nine month period ended
September 30, 2004 to offset a $3.7 million decline in revenue from ESI. One
significant project, completed by ECP during the three month period ended
September 30, 2004, was the major contributor to improved revenue for the nine
month period ended September 30, 2004. ECP's $500,000 increase in revenue for
the three month period ended September 30, 2004, when compared to the same
period in 2003, could not offset the decline in ESI's market and the impact of
completing significant projects just prior to the nine month period ending
September 30, 2003.
Gross Profit. Gross profit increased $410,000, or 102.5%, to $810,000 for the
three months ended September 30, 2004 from $400,000 for the comparable prior
year period. ECP contributed 55.1% of the overall gross profit increase as a
result of the completing one significant project during the period, our
acquisition contributed 15.9% to the overall increase in gross profit, and with
the balance of the increase coming as a result of increased revenue during the
period. As a percentage of revenue, gross profit increased to 18.1% for the
three months ended September 30, 2004 from 13.1% for the comparable prior year
period.
Gross profit decreased $296,000, or 18.0%, to $1.3 million for the nine month
period ended September 30, 2004 from $1.6 million for the nine month period
ended September 30, 2003. ECP gross profit increased $300,000 and our
acquisition contributed $235,000 gross profit for the nine month period ended
September 30, 2004 to offset a $831,000 decline in gross profit from ESI. The
ECP improvement was a result of the increased revenues and margins while the
decline at ESI was due mainly from $3.7 million in lower revenue during the
period. As a percentage of revenue, gross profit decreased to 13.7% for the nine
month period ended September 30, 2004 from 14.0% for the nine month period ended
September 30, 2004.
Operating Selling, General, and Administrative. SG&A expense decreased $173,000
overall, or 31.8%, to $371,000 for the three months ended September 30, 2004
from $544,000 for the comparable prior year period. A cost savings of $225,000
resulted from combining all systems operations into one office facility and
eliminating administrative expense related to rents, utilities, and support
staff, offset by $52,000 in acquisition SG&A expense. As a percentage of
revenue, SG&A expense decreased to 8.3% for the three months ended September 30,
2004 from 17.8% for the comparable prior year period.
For the nine month period ended September 30, 2004, SG&A expense decreased by
$373,000, or 23.5%, to $1.2 million from $1.6 million for the nine month period
ended September 30, 2003. A savings of $554,000 in reduced costs from combining
operations into one office facility and eliminating administrative expense
related to rents, utilities and support staff was offset by $181,000 in SG&A
expense related to acquisitions. The personnel changes and reorganization
initiated during the three months ended September 30, 2004 have also contributed
to the decrease in SG&A expense when comparing results for the nine month period
ending September 30, 2004 to the comparable prior year period.
Operating Income. Operating income increased $583,000, or 404.9%, to $439,000
for the three months ended September 30, 2004 from a loss of $144,000 for the
comparable prior year period. Operating income increased $77,000, or 135.1%, to
$134,000 for the nine month period ended September 30, 2004 from $57,000 for the
nine month period ended September 30, 2003 with $54,000 of the improvement
coming from acquisition income. As a percent of revenue, operating income
increased to 1.4% for the nine month period ended September 30, 2004 from .5%
for the nine month period ended September 30, 2003.
Liquidity and Capital Resources
Historically, cash requirements have been satisfied through operations and
borrowings under a revolving line of credit. As of September 30, 2004, we had
working capital of $8.1 million. Long-term debt, net of current portion, on
September 30, 2004 was $7.9 million, including $7.3 million outstanding under
the Comerica Credit Facility.
18
The Comerica debt is senior to all other debt with the Comerica Credit Facility,
and is limited to $22.0 million, subject to borrowing base restrictions. The
Comerica Credit Facility is collateralized by substantially all the assets of
the Company. At the election of the Company, the interest rate is the lesser of
prime or a three tiered Eurodollar rate, plus 150, 175, or 200 basis points,
respectively, based on the ratio of total funded debt to EBITDA (earnings before
interest, taxes, depreciation and amortization) for the trailing 12 months of
less than 2.00, between 2.00 and 2.50, and greater than 2.50. The commitment fee
on the unuseed line of credit is 0.250%. 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 funded debt to
accounts/unbilled receivables. The Company is also required, as of the end of
the most recent quarters then ended, to maintain minimum levels of net worth,
and must comply with an annual limitation on capital expenditures.
As of September 30, 2004, we had the following long-term debt:
o $270,000 in two notes of $135,000 each to Sterling Planet and EDGI,
each bearing interest at 5% per annum and maturing in 2008. Principal
amounts of $15,000 are payable quarterly with accrued interest. The
Sterling Planet and EDGI notes were issued as part of the purchase of
certain assets of EDGI.
o $50,000 in a note to AmTech, non-interest bearing, maturing in 2006.
Principal amounts of $25,000 are payable annually. The note was issued
as part of the purchase price of certain assets of AmTech.
o $592,231 payable to Significant PEI Shareholders resulting from
termination of the 2001 agreements; payable in three equal
installments before December 31 of 2004, 2005 and 2006 (See Note 11)
As of September 30, 2004, management believes the Company's cash position is
sufficient to meet its working capital requirements. EBITDA for the nine months
ended September 30, 2004 was $3,720,000. Any future decrease in demand for the
Company's services or products would reduce the availability of funds through
operations.
On July 28, 2004, the Company paid $2,156,000 in principal and interest to Equus
II for the balance of the $3 million term loan executed in December 2001. The
loan bore interest at 9.5%, with principal and interest payments due quarterly.
The loan was scheduled to mature in December 2005 and carried no prepayment
penalty. Funding for the retirement was made available through the refinancing
of the Company's credit facility through Comerica.
The Company believes that it has available the necessary cash required for
operations for the next 12 months. Cash and the availability of cash could be
materially restricted if circumstances prevent the timely internal processing of
invoices, if amounts billed are not collected, if project mix shifts from cost
reimbursable to fixed costs contracts during significant periods of growth, or
if the Company is not able to meet the covenants of the Comerica Credit
Facility. If any such events occur, the Company would be forced to consider
alternative financing options.
The Company's cash flow from operations has been affected primarily by the
timing of its collection of trade accounts receivable. The Company typically
operates on short-term credit terms and seeks to minimize its credit risk by
performing credit checks and conducting its own collection efforts. The Company
had net trade accounts receivable of $21.4 million and $20.2 million at
September 30, 2004 and December 31, 2003, respectively. The number of days'
sales outstanding in trade accounts receivable was 55 days and 54 days at
September 30, 2004 and December 31, 2003, respectively. Retention receivables
increased to $912,000 at September 30, 2004 from $394,000 at December 31, 2003.
The increase is primarily the result of two significant cost-reimbursible
projects on contracts requiring retainage to be held until certain project
milestones are completed and accepted by the owner.
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. Our exposure to market risk for changes in interest rates relates
primarily to our obligations under the Comerica Credit Facility.
19
As of September 30, 2004, $7.3 million was borrowed under the Comerica Credit
Facility. The credit facility currently accrues interest at the annual rate of
4.5%, excluding amortization of prepaid financing cost, a 10% increase in the
short-term borrowing rates on the Comerica Credit Facility outstanding as of
September 30, 2004 would be 45 basis points and would increase our annual
interest expense by approximately $33,000, assuming the amount of debt
outstanding remains constant.
This analysis does not consider the effects this movement may have on other
variables including changes in revenue volumes that could be indirectly
attributed to changes in interest rates. The actions that management would take
in response to such a change are also not considered. If it were possible to
quantify this impact, the results could well be different than the sensitivity
effects discussed above.
Item 4. Controls and Procedures
-----------------------
With the participation of management, the Company's chief executive officer and
chief financial officer reviewed and evaluated the Company's disclosure controls
and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, for the period ended September 30, 2004 and have concluded
that they are effective as of September 30, 2004, in providing reasonable
assurance that such information is identified and communicated on a timely
basis. During the quarter ended September 30, 2004, there have been no
significant changes in the Company's internal controls for financial reporting
or in other factors that could significantly affect these controls, including
discovery of any significant deficiencies or material weaknesses in the
Company's internal controls that would require corrective action. In connection
with new federal and American Stock Exchange rules, the Company is currently in
the process of further reviewing and documenting its disclosure controls and
procedures, including its internal accounting controls, and may from time to
time make changes aimed at enhancing their effectiveness and ensuring that the
Company's systems evolve with its business.
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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, are not expected to have a
material affect upon the consolidated financial position or operations of
the Company, after giving effect of recorded reserves. The Company is
currently a party to the following significant legal proceedings.
Engineered Carbons, Inc. filed a claim in 2000 against the Company in the
60th District Court of Jefferson County, Texas, alleging failure of
contractual performance purportedly caused by faulty design. This claim has
been accepted, without reservation by the Company's errors and omissions
insurance carrier. The Company has reserved the amount of its deductible
under such insurance. Engineered Carbons, Inc. has offered to settle the
case for an amount within the Company's errors and omissions policy limits.
While denying any liability whatsoever, the Company has made demand on the
carrier to settle the case within the policy limits. Until the case is
settled, the Company is cooperating with the carrier to contest the case
vigorously.
During 2003, the Company, its subsidiaries, and more than 40 other parties
were named defendants in several petitions for damages filed in various
district courts in Louisiana (East Baton Rouge, Calcasieu, Iberville,
Ascension, and Orleans Parishes) on behalf of former employees of Barnard
and Burk, Inc. The plaintiffs, who allege exposure to asbestos during the
course of their employment, were employees of Barnard and Burk, Inc. during
a period covering the late 1950's through the early 1980's at facilities
located within the State of Louisiana. In 1994, AMEC Engineering, Inc.
assigned the trade name "Barnard and Burk" to RPM Engineering, Inc. along
with selected assets. No liabilities were acquired by RPM. The Company's
wholly-owned subsidiary, ENGlobal Engineering, Inc., formerly known as
Petrocon Engineering, Inc., acquired RPM (along with the "Barnard and Burk"
trade name) in 1996 pursuant to a stock purchase agreement. Because
Petrocon acquired only the "Barnard and Burk" trade name, and none of its
liabilities, the Company is seeking to be extricated from the suits via
summary judgment. The Company believes the lawsuits are without merit and
intends to defend them vigorously.
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
31.1 Certifications Pursuant to Rule 13a - 14(a) of the Exchange Act for
2002 for the Third Quarter 2004
31.2 Certifications Pursuant to Rule 13a - 14(a) of the Exchange Act for
2002 for the Third Quarter 2004
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 Third quarter 2004
21
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 Corporation
Dated: November 11, 2004 By: /s/ Robert W. Raiford
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Robert W. Raiford, Chief Financial Officer and
Treasurer
22