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, 2005
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- ----- EXCHANGE ACT OF 1934
Commission File No. 001-14217
ENGlobal Corporation
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(Exact name of registrant as specified in its charter)
Nevada
------------------------------
(State or other jurisdiction of
incorporation or organization)
88-0322261
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(I.R.S. Employer Identification No.)
654 North Sam Houston Parkway East,
Suite 400, Houston, TX 77060-5914
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(Address of principal executive offices) (Zip code)
(281) 878-1000
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(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 shortened 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 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 October 26, 2005.
$0.001 Par Value Common Stock 26,267,406 shares
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005
TABLE OF CONTENTS
Page
Number
------
Part I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Statements of Income
for the Three Months Ended and Nine
Months Ended September 30, 2005 and
September 30, 2004 3
Condensed Consolidated Balance Sheets at
September 30, 2005 and December 31, 2004 4
Condensed Consolidated Statements of Cash Flows
for the Nine Months Ended September 30,
2005 and September 30, 2004 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 14
Item 3. Quantitative and Qualitative Disclosures
about Market Risk 28
Item 4. Controls and Procedures 28
Part II. Other Information
Item 1. Legal Proceedings 29
Item 2. Unregistered Sales of Equity Securities
and Use of Proceeds 29
Item 3. Defaults Upon Senior Securities 29
Item 4. Submission of Matters to a Vote of Security Holders 29
Item 5. Other Information 29
Item 6. Exhibits 30
Signature 31
2
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
September 30, Ended September 30,
-------------------------------- --------------------------------
2005 2004 2005 2004
------------- ------------- ------------- -------------
Operating Revenue $ 59,265,617 $ 37,272,033 $ 163,314,149 $ 102,547,298
------------- ------------- ------------- -------------
Operating Expenses:
Direct cost 51,427,251 32,562,744 142,498,567 89,567,709
Selling, general and administrative 4,815,324 3,256,566 12,991,480 9,535,940
Depreciation and amortization 257,786 210,377 814,178 581,552
------------- ------------- ------------- -------------
Total operating expenses 56,500,361 36,029,687 156,304,225 99,685,201
------------- ------------- ------------- -------------
Operating income 2,765,256 1,242,346 7,009,924 2,862,097
Other Income (Expense):
Other income 5,809 23,996 79,054 52,064
Interest income (expense), net (199,096) (122,211) (642,647) (418,167)
------------- ------------- ------------- -------------
Total other income (expense) (193,287) (98,215) (563,593) (366,103)
------------- ------------- ------------- -------------
Income before Provision for Income Taxes 2,571,969 1,144,131 6,446,331 2,495,994
Provision for Income Taxes 951,629 389,005 2,385,143 848,638
------------- ------------- ------------- -------------
Net Income $ 1,620,340 $ 755,126 $ 4,061,188 $ 1,647,356
============= ============= ============= =============
Net Income Per Common Share:
Basic $ 0.07 $ 0.03 $ 0.17 $ 0.07
Diluted $ 0.07 $ 0.03 $ 0.17 $ 0.07
Weighted Average Shares Used in Computing Net
Income Per Share:
Basic 23,890,842 24,060,689 23,637,345 24,043,734
Diluted 24,898,045 24,216,826 24,460,313 24,199,871
See accompanying notes to interim condensed consolidated financial statements.
3
ENGlobal Corporation
Condensed Consolidated Balance Sheets
September 30, December 31,
2005 2004
------------ ------------
(unaudited)
ASSETS
------
Current Assets:
Cash $ 2,959,313 $ 8,006
Accounts receivable - trade, less allowance for
doubtful accounts of approximately
$507,000 and $472,000, respectively 31,200,064 30,839,597
Costs and estimated earnings in excess of
billings on uncompleted contracts 4,628,852 1,113,330
Prepaid and other 953,537 1,984,274
Inventories 172,332 172,715
Assets held for sale -- 678,106
Deferred tax asset 757,247 640,380
Income taxes receivable -- 118,000
------------ ------------
Total Current Assets 40,671,345 35,554,408
Property and Equipment, net 6,257,078 5,262,370
Goodwill 15,424,112 15,284,220
Other Assets 933,523 1,159,750
------------ ------------
Total Assets $ 63,286,058 $ 57,260,748
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current Liabilities:
Accounts payable - trade $ 10,461,711 $ 10,512,123
Accrued salaries and benefits 7,169,844 6,059,221
Note payable -- 839,606
Current portion - long-term debt 553,249 622,410
Capital lease payable -- 4,371
Billings and estimated earnings in excess of
costs on uncompleted contracts 1,726,454 2,313,954
Income taxes payable 615,268 --
Other liabilities 1,810,926 699,601
------------ ------------
Total Current Liabilities 22,337,452 21,051,286
Long-Term Debt, net of current portion 1,825,926 15,585,152
Deferred Tax Liability 99,810 573,380
------------ ------------
Total Liabilities 24,263,188 37,209,818
Contingencies (Note 11)
Stockholders' Equity:
Series A redeemable convertible preferred stock,
$0.001 par value; 2,265,167 shares
authorized; 0 shares issued and outstanding -- --
Common stock, $0.001 par value; 75,000,000 shares
authorized; 26,201,057 and 23,466,839 outstanding
and 26,853,434 and 24,119,216 issued at
September 30, 2005 and December 31, 2004, respectively 26,853 24,119
Additional paid-in capital 27,104,257 12,198,215
Accumulated other comprehensive income 1,976 --
Retained earnings 12,482,015 8,420,827
Treasury stock, 652,377 shares at cost (592,231) (592,231)
------------ ------------
Total Stockholders' Equity 39,022,870 20,050,930
------------ ------------
Total Liabilities and Stockholders' Equity $ 63,286,058 $ 57,260,748
============ ============
See accompanying notes to interim condensed consolidated financial statements.
4
ENGlobal Corporation
Condensed Consolidated Statements of Cash Flows
(Unaudited)
For the Nine Months
Ended September 30,
--------------------------------------
2005 2004
------------ ------------
Cash Flows from Operating Activities:
Net income $ 4,061,188 $ 1,647,356
Adjustments for non-cash items 619,240 860,882
Changes in working capital (229,816) (165,651)
------------ ------------
Net cash provided by operating activities 4,450,612 2,342,587
------------ ------------
Cash Flows from Investing Activities:
Property and equipment acquired (2,184,929) (858,929)
Proceeds from sale of equipment 15,400 3,260
Proceeds from sale of assets held for sale 823,350 --
Additional consideration for acquisitions (77,297) --
------------ ------------
Net cash used in investing activities (1,423,476) (855,669)
------------ ------------
Cash Flows from Financing Activities:
Net borrowings (payments) on line of credit (13,529,496) 1,764,448
Proceeds from issuance of common stock 14,663,776 58,429
Short-term note repayments (837,714) (719,395)
Capital lease repayments (4,371) (6,186)
Long-term debt repayments (370,000) (2,608,163)
------------ ------------
Net cash used in financing activities (77,805) (1,510,867)
Effect of Exchange Rate Changes on Cash 1,976 --
------------ ------------
Net change in cash 2,951,307 (23,949)
Cash, at beginning of period 8,006 39,439
------------ ------------
Cash, at end of period $ 2,959,313 $ 15,490
============ ============
Supplemental Disclosures:
Interest paid $ 605,170 $ 328,386
Income taxes paid $ 2,193,351 $ 701,982
Non-Cash:
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.
5
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 unaudited for the three-month and nine-month
periods ended September 30, 2005 and 2004. 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. Certain reclassifications have been
made to prior period balances to conform to the current presentation. These
reclassifications did not affect net income. 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, 2004, which
are included in the Company's annual report on Form 10-K for the year ended
December 31, 2004. The Company believes that the disclosures made herein
are adequate to make the information presented not misleading.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
-------------------
The Company's revenue is composed of engineering service revenue and
product sales. The Company recognizes service revenue as soon as the
services are performed. The majority of the Company's engineering services
have historically been provided through cost-plus contracts whereas a
majority of the Company's product sales are earned on fixed-fee contracts.
On occasion, the Company, serving as an agent for the client, procures
materials and equipment on behalf of the client and the cost of such
materials and equipment is reimbursed with no mark-up or profit. In
accordance with Statement of Position (SOP) 81-1, revenue and cost for
these types of purchases are not included in total revenue and cost. For
financial reporting, this "pass-through" type of transaction is reported
net. Pass-through transactions totaled $6.1 million and $16.9 million,
respectively, for the three months and nine months ending September 30,
2005.
Profits and losses on fixed-fee contracts are recorded on the
percentage-of-completion method of accounting, measured by the
percentage-of-contract cost incurred to date relative to estimated total
direct contract cost. Direct contract cost includes professional
compensation and related benefits, materials, subcontractor services and
other direct cost of projects. Direct contract cost also includes variable
costs such as travel, repairs and maintenance, supplies and depreciation
directly related to producing revenues. The cost recognized for labor
includes all actual employee compensation plus a burden factor to cover
estimated variable labor expenses for the year. These variable labor
expenses consist of payroll taxes, self-insured medical expenses, workers
compensation insurance, general liability insurance, and employee benefits
for paid time off. The actual periodic cost for these expenses is adjusted
at the end of each quarter to provide consistent cost recognition
throughout the year. On a project that requires the purchase of a large
amount of permanent materials, including the cost of these materials in
calculating the percentage-of-completion may overstate the actual progress
on the project. For these types of projects, the cost-to-cost method does
not appropriately reflect the progress of the projects; accordingly, we use
alternative methods such as actual labor hours for measuring progress on
the project and we recognize revenue accordingly.
Under the percentage-of-completion method, revenue recognition is dependent
upon the accuracy of a variety of estimates, including the progress of
engineering and design efforts, material installation, labor productivity,
cost estimates and others. These estimates are based on various
professional judgments made with respect to the factors noted and are
difficult to accurately determine until projects are significantly
underway. Due to uncertainties inherent to the estimation process, it is
possible that actual completion costs may vary materially from estimates.
Anticipated losses on uncompleted contracts are charged to operations as
soon as such losses can be estimated. Changes in job performance, job
conditions, estimated profitability and final contract settlements may
result in revisions to costs and income and are recognized in the period in
which the revisions are determined.
Selling, general and administrative cost includes management and staff
compensation, office cost such as rents and utilities, depreciation,
amortization, travel and other expenses that are unrelated to specific
client contracts, but directly relate to the support of each segment's
operations.
6
Occasionally, it is appropriate under SOP 81-1 to combine or segment
contracts. Contracts are combined in those limited circumstances when they
are negotiated as a package in the same economic environment with an
overall profit margin objective and constitute, in essence, an agreement to
do a single project. In such cases, we recognize revenue and cost over the
performance period of the combined contracts as if they were one. Contracts
are segmented in limited circumstances if the customer had the right to
accept separate elements of a contract and the total economic returns of
the separate contract elements are similar to the economic returns of the
overall contract. For segmented contracts, we recognize revenue and cost as
if they were separate contracts over the performance periods of the
individual elements or phases.
We have three major types of contracts:
Cost-Plus, Labor Plus Fixed Mark-up
-----------------------------------
Under cost-plus, labor plus fixed mark-up contracts, we charge clients
based on actual labor rates plus a fixed mark-up that includes estimated
recoverable direct and indirect cost and a profit component, which is
applied as a percentage of the recoverable labor, to arrive at a total
dollar estimate in negotiating a cost-plus, labor plus fixed mark-up
contract. We recognize revenue based on a multiple of the actual total
number of labor hours completed on a project multiplied by the actual labor
rates and multiplied by the negotiated fixed mark-up percentage, plus other
non-labor costs at cost plus a fixed mark-up that we negotiate at the time
of contract award. Aggregate revenue from cost-plus, labor plus fixed
mark-up contracts may vary in scope and we generally must obtain a change
order in order to receive additional revenue relating to any additional
costs that exceed the original contract estimate (see "Change Orders").
Cost-Plus, Fixed Labor Rate
---------------------------
Under cost-plus, fixed labor rate contracts, we charge clients based on
fixed labor rates by work classification (Project Manager, Sr. Engineer,
Designer, CADD Operator, etc.) whereby the fixed labor rate includes
estimated recoverable direct and indirect cost plus a profit component. In
negotiating cost-plus, fixed labor rate contracts the total dollar estimate
is a multiple of the fixed labor rates times the recoverable work class
labor man-hours estimated to complete the project. We recognize revenues
based on a multiple of the fixed labor rates times the actual total number
of labor hours completed on a project, plus other non-labor costs at cost
plus a fixed rate negotiated at the time of contract award. Aggregate
revenues from cost-plus, fixed labor rate contracts may vary in scope and
we generally must obtain a change order in order to receive additional
revenues relating to any additional cost that exceed the original contract
estimate (see "Change Orders").
Fixed Price
-----------
Under fixed price contracts, the Company only charges its clients an agreed
amount negotiated in advance of a specific scope of work, be it related to
engineering service revenue or product sales. We recognize revenue on
fixed-price contracts using the percentage-of-completion method described
above. Prior to completion, gross profit recognition on any fixed-price
contract is dependent upon the accuracy of our estimates and will increase
to the extent that current estimates of aggregate actual cost are below the
amounts previously estimated. Conversely, if the Company's current
estimated cost exceeds prior estimates, gross profit will decrease and we
may realize a loss on a project. In order to increase aggregate revenue on
a contract, we generally must obtain a change order to receive payment for
additional cost (see "Change Orders").
Change Orders
-------------
Change orders are modifications of an original contract that effectively
change the provisions of the contract without adding new provisions. Either
we or our clients may initiate change orders. Change orders may include
changes in specifications or design, manner of performance, equipment,
materials, scope of work and/or the period of completion of the project.
Change orders occur when changes are experienced after work on a contract
has begun. Change orders are sometimes documented and the terms of change
orders are agreed with the client before the work is performed. Other
times, circumstances may require that work progress without the client's
written agreement before the work is performed. Cost related to change
orders is recognized when they are incurred. Change orders are included in
the total estimated contract revenue when it is probable that the change
orders will result in a bona fide addition to value that can be reliably
estimated.
7
Inspection and Acceptance (Cost-plus Contracts)
-----------------------------------------------
Generally, clients inspect and accept work as executed based on designated
milestones or billing cycles, although such acceptance does not waive the
client's right to a claim under a warranty provision for work deficiencies
that fail to meet industry standards. If we are required to remedy
defective work, the client normally reimburses all cost except for the
labor cost necessary to correct such defects.
Inspection and Acceptance (Fixed Price Contracts)
-------------------------------------------------
Generally, clients inspect and accept work based on designated milestones,
although such acceptance does not waive the client's right to a claim under
a warranty provision for work deficiencies. If we are required to remedy
defective work, the client normally reimburses all costs except for the
labor cost necessary to correct such defects.
Contract Termination Provisions
-------------------------------
Generally, our clients may terminate at any time and for any reason any
part of the Company's project work by giving proper notice, specifying the
part of the work to be terminated and the effective date of the
termination. If any part of the work on a project is terminated, the
client, with respect to such work, is required to reimburse the Company for
all cost incurred prior to the effective date of termination and for all
additional amounts that are directly related to the work performed. The
client is required to issue a change order with respect to any termination.
NOTE 3 - DEBT AND LINE OF CREDIT
Line of credit:
At the end of the reporting period, the Company had a Credit Facility (the
"Comerica Credit Facility") with Comerica Bank ("Comerica") that consisted
of a line of credit maturing on July 27, 2007. The loan agreement positions
Comerica as senior to all other debt. The line of credit is limited to $22
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, 2005 was
zero. The remaining borrowings available under the line of credit as of
September 30, 2005 were $18.7 million after consideration of loan covenant
restrictions and outstanding standby letters of credit aggregating to $3.3
million.
The Comerica Credit Facility contains covenants requiring the Company, as
of the end of each calendar month, to maintain certain ratios, including
the average total outstanding principal balance of the line of credit to
EBITDA; the average total outstanding principal balance of the line of
credit to total liabilities plus net worth; and the average total
outstanding principal balance of the line of credit to accounts/unbilled
receivables. The Company is also required, as of the end of each quarter,
to maintain minimum levels of net worth, and 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,
2005.
Letters of credit:
As of September 30, 2005, the Company had $3.3 million outstanding in
standby letters of credit issued to a refining client to cover contractual
obligations funded by the client for progress payments made to equipment
manufacturers for major project items. We expect obligations under standby
letters of credit to increase to approximately $6.7 million during December
2005 and decrease each month following until obligations are released in
May 2006.
8
September 30, December 31,
2005 2004
------------------------------
(in thousands)
------------------------------
Schedule of Long-Term Debt:
Comerica Credit Facility - Line of credit, prime
(6.75% at September 30, 2005),
maturing in July 2007 $ -- $ 13,530
Sterling Planet and EDGI - Notes payable, interest
at 5%, principal payments in installments of
$15,000 plus interest due quarterly, maturing in December 2008 210 255
Significant PEI Shareholders - Note payable, discounted at
4.5% interest, principal payments in installments of
$208,761 due annually, maturing in December 2006 394 385
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 1,525 1,762
InfoTech Engineering, Inc. - Note payable, interest at
5%, principal payments in installments of $65,000 plus
interest due annually, maturing in December 2007 195 195
Miscellaneous 55 80
-------- --------
Total long-term debt 2,379 16,207
Less: Current maturities (553) (622)
-------- --------
Long-term debt, net of current portion $ 1,826 $ 15,585
======== ========
NOTE 4 - 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.
The ending accumulated other comprehensive income is as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- -------------------------
2005 2004 2005 2004
------ ------- ------ -----------
(in thousands) (in thousands)
Net income $1,620 $ 755 $4,061 $ 1647
Other comprehensive income:
Foreign currency translation adjustment 2 -- 2 --
------ ------ ------ ------------
Comprehensive income $1,622 $ 755 $4,063 $ 1,647
====== ====== ====== ============
NOTE 5 - RECENT ACCOUNTING PRONOUNCEMENTS
In May 2005 the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 154, "Accounting Changes and Error Corrections, a replacement
of APB Opinion No. 20 and FASB Statement No. 3." SFAS 154 requires
retrospective application to prior periods' financial statements for
changes in accounting principles, unless it is impracticable to determine
either the period-specific effects or the cumulative effect of the change.
SFAS 154 also requires that retrospective application of a change in
accounting principle be limited to the direct effects of the change.
Indirect effects of a change in accounting principle, such as a change in
non-discretionary profit-sharing payments resulting from an accounting
change, should be recognized in the period of the accounting change. SFAS
154 also requires that a change in depreciation, amortization, or
9
depletion method for long-lived, non-financial assets be accounted for as
a change in accounting estimate affected by a change in accounting
principle. SFAS 154 is effective for accounting changes and corrections of
errors made in fiscal years beginning after December 15, 2005. Early
adoption is permitted for accounting changes and corrections of errors
made in fiscal years beginning after the date SFAS 154 was issued. The
Company is required to adopt the provisions of SFAS 154, as applicable,
for the year beginning January 1, 2006.
In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 123, (revised 2004) "Share-Based Payment" ("SFAS 123R").
This statement is a revision of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" as amended
("SFAS 123"), and requires entities to measure the cost of employee
services received in exchange for an award of equity instruments based on
the grant-date fair value of the award. The cost will be recognized over
the period during which an employee is required to provide services in
exchange for the award (usually the vesting period). SFAS 123R covers
various share-based compensation arrangement rights and employee share
purchase plans. SFAS 123R eliminates the ability to use the intrinsic
value methods of accounting for share options, as provided in Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB 25"). SFAS 123R was scheduled to be effective as of the
beginning of the first interim period that begins after June 15, 2005,
with early adoption encouraged.
On April 14, 2005, the Securities and Exchange Commission issued a release
announcing the adoption of a new rule delaying the required implementation
of SFAS No. 123R. Under this rule, SFAS No. 123R is effective as of the
beginning of the first annual reporting period that begins after June 15,
2005. We are currently evaluating the provisions of SFAS No. 123R and will
adopt the provision beginning in the first quarter of 2006, as required.
NOTE 6 - 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. A change in assumptions in the estimation of the fair market value of
the segments would unlikely give rise to an impairment of goodwill without
deteriorating operating results in the segments.
NOTE 7 - FIXED FEE CONTRACTS
Costs, estimated earnings and billings on uncompleted contracts consisted
of the following at September 30, 2005 and December 31, 2004:
September 30, December 31,
2005 2004
------------------------
(in thousands)
-------------------------
Costs incurred on uncompleted contracts $ 17,827 $ 8,292
Estimated earnings on uncompleted contracts 4,125 1,584
-------- --------
Earned revenues 21,952 9,876
Less billings to date (19,050) (11,077
-------- --------
Net costs and estimated earnings in excess of billings
on uncompleted contracts $ 2,902 $ (1,201
======== ========
Costs and estimated earnings in excess of billings on uncompleted contracts $ 4,629 $ 1,113
Less billings and estimated earnings in excess of cost on uncompleted contracts (1,727) (2,314)
-------- --------
Net costs and estimated earnings in excess of billings
on uncompleted contracts $ 2,902 $ (1,201)
======== ========
10
NOTE 8 - STOCK OPTION PLAN
The Company accounts for its 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 had exercise
prices 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 and nine months ended September 30, 2005 and
2004, respectively, as if the Company had applied the fair value
recognition provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation."
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- -------------------------
2005 2004 2005 2004
----------- ------------ ---------- -----------
(in thousands) (in thousands)
Pro forma impact of fair value method (SFAS 148):
Net income attributable to common stockholders, as reported $ 1,620 $ 755 $ 4,061 $ 1,647
Less compensation expense determined under fair value
method, net of tax (54) (4) (162) (132)
---------- ----------- ---------- ----------
Pro forma net income attributable to common stockholders $ 1,566 $ 751 $ 3,899 $ 1,515
========== =========== ========== ==========
Earnings per share (basic):
As reported $ 0.07 $ 0.03 $ 0.17 $ 0.07
Pro forma $ 0.07 $ 0.03 $ 0.16 $ 0.07
Earnings per share (diluted):
As reported $ 0.07 $ 0.03 $ 0.16 $ 0.07
Pro forma $ 0.06 $ 0.03 $ 0.16 $ 0.06
Weighted average Black-Scholes fair value assumptions:
Risk free interest rate 5.5% 5% 5% 5%
Expected life 3-10 years 3-10 years 3-10 years 3-10 years
Expected volatility 50% 61% 50% 61%
Expected dividend yield 0.0% 0.0% 0.0% 0.0%
NOTE 9 - 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 deferred by participants into the plan has been used to
meet the Company's cash requirements or has been applied to the reduction
of the Company's long-term debt.
NOTE 10 - EARNINGS PER SHARE
For the three months and nine months ended September 30, 2005, the number
of shares used in determining weighted average shares used for computing
basic and diluted net income per share was reduced by the repurchase by the
Company of 652,377 shares of stock in November 2004.
11
NOTE 11 - 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.
In June 2005, we created a new, indirect subsidiary named ENGlobal Canada
ULC ("ENGlobal Canada"), which is operating out of Calgary, Canada.
ENGlobal Canada is a wholly-owned subsidiary of ENGlobal Automation Group,
Inc. ("EAG"), formerly known as ENGlobal Technologies, Inc., a wholly-owned
subsidiary of ENGlobal Engineering, Inc. ("EEI"). ENGlobal Canada is in the
early marketing stages and, to date, has not generated revenue. Results
will be reported in the engineering segment.
Revenue and operating income for each segment are set forth in the
following table. The amount under Corporate includes those activities that
are not allocated to the operating segments and include costs related to
business development, executive function, finance, accounting, safety,
investor relations/governance, human resources, project controls and
information technology that are not specifically identifiable with the two
segments. Inter-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 cost are allocated to each segment based
on each segment's revenues and eliminated in consolidation.
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
2005 2004 2005 2004
--------- --------- --------- ---------
(in thousands) (in thousands)
Revenue:
Engineering $ 55,132 $ 32,796 $ 149,459 $ 92,730
Systems 4,134 4,476 13,855 9,817
--------- --------- --------- ---------
Total revenue $ 59,266 $ 37,272 $ 163,314 $ 102,547
========= ========= ========= =========
Operating income (loss):
Engineering $ 5,236 $ 2,589 $ 13,453 $ 7,672
Systems 19 439 281 134
Corporate 1,018 439 2,940 1,156
Intercompany eliminations (3,508) (2,225) (9,664) (6,100)
--------- --------- --------- ---------
Total operating income $ 2,765 $ 1,242 $ 7,010 $ 2,862
========= ========= ========= =========
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 $77,000 as of September 30, 2005.
NOTE 12 -CONTINGENCIES
Litigation
----------
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 effect upon the consolidated financial position or operations of
the Company.
In January 2004, ENGlobal Design Group, Inc. ("EDG") purchased selected
assets of Engineering Design Group Inc. ("EDGI"), including certain of
EDGI's contract rights with the Department of the Navy. In July 2005, EDG
received notification from the Department of the Navy that unresolved
12
liabilities under predecessor contracts with EDGI were interfering with the
ability of the Dallas office of the Defense Contract Management Agency
("DCMA") to process novation agreements required by FAR 42.12 and that in
order to protect the DCMA's contractual interests, EDG would not be
solicited for any future proposals for work under the predecessor contracts
until the novation agreements were executed. EDG revenue under these
contracts totaled $3.3 million and $1.7 million respectively for the year
ended December 31, 2004 and the nine-month period ended September 30, 2005
and represented approximately 92% and 45% respectively of EDG's total
revenue during such periods. EDG's current backlog under these contracts is
$5.5 million. We do not expect the DCMA's action to have a material effect
on the consolidated financial position or operation of ENGlobal and are
seeking resolution of this matter.
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 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; 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. 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 in this 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, 2004.
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, 2004.
MD&A Overview
-------------
The following list sets forth a general overview of the more
significant changes in the Company's financial condition and results of
operations for the three and nine month periods ending September 30,
2005, compared to the corresponding periods in 2004.
During the three month period During the nine month period
--------------------------------------------------------------
Revenue Increased 59% Increased 59%
Operating income Increased 133% Increased 141%
As a percentage of revenue Increased 42% Increased 54%
Net income Increased 100% Increased 156%
As a percentage of revenue Increased 40% Increased 56%
Long-term debt, net of current portion, decreased 89%, or $13.8
million, from $15.6 million as of December 31, 2004 to $1.8 million at
September 30, 2005, and as a percentage of stockholders' equity,
long-term debt decreased from 78% to 5% during the same periods.
Total stockholders' equity increased 94%, or $18.9 million, from $20.1
million as of December 31, 2004 to $39.0 million as of September 30,
2005.
In general, the increase in revenue during the three months and nine
months ended September 30, 2005 relates to the growth in activity at
both our Tulsa, Oklahoma and Dallas, Texas offices from clients in the
refining industry relating to expansion and low-sulfur diesel projects,
combined with the added effect of the growth in inspection services as
a result of our acquisitions of AmTech in September 2004 and Cleveland
Inspection in October 2004.
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
14
span the lifecycle of a project and include feasibility studies,
design, procurement services and construction management. We also
supply automation, control process analyzer 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, it 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 and
operating divisions 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 six
subsidiary companies, including ENGlobal Engineering, Inc., RPM
Engineering, Inc. d/b/a ENGlobal Engineering, Inc., ENGlobal
Construction Resources, Inc., ENGlobal Automation Group, Inc., ENGlobal
Canada ULC, 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 based on
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 process-related industries. The systems
segment currently consists of one company, ENGlobal Systems, Inc.
("ESI"). 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 revenue and collect cash on fixed price contracts in excess of
our costs for labor, materials and equipment and transportation costs,
plus our SG&A expenses.
Hurricane Rita
--------------
Mandatory evacuation orders related to the anticipated landfall of
Hurricane Rita and the resulting damages from the storm caused the
facilities in Beaumont, Texas and Lake Charles, Louisiana to close from
September 22, 2005 to October 6, 2005 and October 10, 2005,
respectively. The primary loss to the Company is revenue and gross
profits lost due to our inability to work on projects at the effected
locations. Our administrative operations have been temporarily
relocated to our Houston corporate offices as a result of the extensive
damage to our administrative offices in Beaumont, Texas. Our human
resources and safety departments have already returned to Beaumont
along with a portion of our accounting department staff. The balance of
our accounting staff is scheduled to return to the Beaumont area by
mid-November.
We estimate that Hurricane Rita negatively impacted our third quarter
income by approximately $217,000 on an after-tax basis. The loss was
related to a decrease in billable man-hours and subsequent earnings in
the Beaumont, Texas and Lake Charles, Louisiana. We expect the loss
attributable to Hurricane Rita in the fourth quarter 2005 to be less
than that estimated in the third quarter 2005.
15
Results of Operations
---------------------
The following table presents, for the periods indicated, the
approximate percentage of total revenue and operating income or loss
attributable to our reportable segments:
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ---------------------
2005 2004 2005 2004
------ ------ ------ ------
Revenue:
Engineering 93.0 % 88.0 % 91.5 % 90.4 %
Systems 7.0 % 12.0 % 8.5 % 9.6 %
Operating income (loss):
Engineering 99.6 % 85.5 % 98.0 % 98.3 %
Systems 0.4 % 14.5 % 2.0 % 1.7 %
Revenue 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 cost incurred bear
to total estimated contract cost. 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.
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 of 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.
Gross profit includes the gross margin on contracts, less indirect
variable labor and non-labor expenses not directly related to projects.
The primary indirect labor expenses include compensation and benefit
costs for indirect technical support staff, for employees on stand-by
time and for time required for technical staff to prepare cost
estimates and project schedules for proposals requested through
business development representatives.
Operating SG&A expense includes management and staff compensation,
office cost, 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 of cost related to business
development, executive function, finance, accounting, safety, investor
relations/governance, human resources, project controls, and
information technology functions, as well as depreciation and
amortization and other cost generally unrelated to specific client
projects.
Critical Accounting Policies:
A summary of significant accounting policies is disclosed in Note 2 to
the Consolidated Financial Statements included in our 2004 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 2004 Annual Report on Form 10-K. There have been no
changes in the nature of our critical accounting policies or the
application of those policies since December 31, 2004. Additional
disclosure regarding specific policies is as follows:
16
Revenue Recognition:
Because the majority of the Company's revenue is recognized under
cost-plus contracts, significant estimates are generally not involved
in determining revenue recognition. In addition, most of our contracts
are with Fortune 500 companies. As a result, collection risk is
generally not a relevant factor in the recognition of revenue.
Goodwill:
A change in assumptions in the estimation of the fair market value of
the segments would unlikely give rise to an impairment of goodwill
without deteriorating operating results in the segments.
Change Orders:
Change orders are modifications of an original contract that
effectively change the provisions of the contract without adding new
provisions. Either we or our clients may initiate change orders. Change
orders may include changes in specifications or design, manner of
performance, equipment, materials, scope of work, and/or the period of
completion of the project.
Change orders occur when changes are experienced once a contract is
begun. Change orders are sometimes documented and the terms of change
orders are agreed on with the client before the work is performed.
Other times, circumstances may require that work progress before the
client provides written consent. Costs related to change orders are
recognized when they are incurred. Change orders are included in the
total estimated contract revenue when it is probable that the change
orders will result in a bona fide addition to value that can be
reliably estimated.
We have a favorable history of negotiating and collecting for work
performed under change orders and our bi-weekly billing cycle has
proven to be timely enough to properly account for change orders.
Depreciation:
Depreciation is calculated using a straight-line method over the
estimated useful lives of the related assets. The useful life is
estimated to be 3 years for computers and autos, 5 years for software,
furniture and fixtures, 10 years for machinery and equipment and 39
years for buildings.
Depreciation expense related to those assets (specifically machinery
and equipment, autos, trucks and computer hardware) that are used in
the production of service revenue are charged to contract cost.
Operating SG&A expense includes depreciation expense for assets that
are generally related to administrative operations.
17
Consolidated Results of Operations
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------------------- --------------------------------------------
2005 2004 2005 2004
--------------------- --------------------- --------------------- ---------------------
(in thousands) (in thousands)
Revenue:
Engineering - labor $ 30,507 51.5% $ 20,429 54.8% $ 86,791 53.2% $ 57,507 56.1%
Engineering - non-labor 19,579 33.0% 10,790 28.9% 51,443 31.5% 30,349 29.5%
Systems 4,123 7.0% 4,060 10.9% 13,845 8.5% 8,468 8.3%
Acquisition 5,057 8.5% 1,993 5.4% 11,235 6.8% 6,223 6.1%
--------- ----- --------- ----- --------- ----- --------- -----
Total revenue $ 59,266 100.0% $ 37,272 100.0% $ 163,314 100.0% $ 102,547 100.0%
========= ========= ========= =========
Gross profit:
Engineering $ 6,850 13.7% $ 3,698 11.9% $ 18,023 13.0% $ 10,865 12.4%
Systems 510 12.4% 737 18.2% 1,734 12.5% 1,092 12.9%
Acquisition 478 9.5% 274 13.7% 1,059 9.4% 1,023 16.4%
--------- --------- --------- ---------
Total gross profit 7,838 13.2% 4,709 12.6% 20,816 12.7% 12,980 12.7%
--------- --------- --------- ---------
SG&A expense:
Engineering 1,937 3.9% 957 3.1% 4,859 3.5% 2,773 3.2%
Systems 495 12.0% 311 7.7% 1,458 10.5% 1,012 12.0%
Corporate 2,368 4.0% 1,786 4.8% 6,722 4.1% 4,944 4.8%
Acquisition 273 5.4% 413 20.7% 767 6.8% 1,389 22.3%
--------- --------- --------- ---------
Total SG&A expense 5,073 8.6% 3,467 9.3% 13,806 8.5% 10,118 9.9%
--------- --------- --------- ---------
Operating income:
Engineering 4,913 9.8% 2,741 8.8% 13,164 9.5% 8,092 9.2%
Systems 15 0.4% 426 10.5% 276 2.0% 80 0.9%
Corporate (2,368) (4.0)% (1,786) (4.8)% (6,722) (4.1)% (4,944) (4.8)%
Acquisition 205 4.1% (139) (7.0)% 292 2.6% (366) (5.9)%
--------- --------- --------- ---------
Total operating income 2,765 4.7% 1,242 3.3% 7,010 4.3% 2,862 2.8%
--------- --------- --------- ---------
Other income (expense), net (193) (0.3)% (98) (0.3)% (564) (0.3)% (366) (0.4)%
Tax provision (952) (1.6)% (389) (1.0)% (2,385) (1.5)% (849) (0.8)%
--------- --------- --------- ---------
Net income $ 1,620 2.8% $ 755 2.0% $ 4,061 2.5% $ 1,647 1.6%
========= ========= ========= =========
Other financial comparisons: September 30, December 31,
- ---------------------------- 2005 2004
------- -------
Working capital $18,334 $14,503
Total assets $63,286 $57,261
Long-term debt, net of current portion $ 1,826 $15,585
Stockholders' equity $39,023 $20,051
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"). In the
results for the three and nine months ended September 30, 2004, "Acquisition"
totals are the combined results of operations related to assets acquired from
Amtech, Petro-Chem, Senftleber, and EDG. For analytical purposes only, results
from acquired companies or acquired assets are shown separately for the first 12
months after closing.
18
Industry Overview:
Many ENGlobal offices have benefited from the strong 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 related to refining capacity and
environmental mandates have trended upward. Higher margins in the energy
industry were recently spurred by the associated impact of Hurricanes
Katrina and Rita. As stated in our 2003 annual letter to stockholders, the
global demands for oil products has tightened the supply of both crude oil
as well as refinery products. With this current demand, we believe each of
ENGlobal's business segments are well positioned within the industry should
refinery capacity be added in the United States of America and the overseas
markets continue to rise.
The petrochemical industry has recently been a good source of projects for
ENGlobal. We have seen an increase in both maintenance and capital spending
after several years of relative inactivity. The petrochemical industry
along the Gulf Coast continues to struggle with the aftermath of the
hurricanes. 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, and we have recently seen an increase in
project activity. Pipeline projects tend to require less engineering man
hours as the scope of engineering work is typically smaller than for
similar sized downstream projects. In addition, the project awards in the
pipeline segment are smaller in nature than those in other industries. In
addition to the refinery and petrochemical markets, we have offered
assistance to clients in the pipeline operations market along the Gulf
Coast that were affected by Hurricanes Katrina and Rita.
Revenue:
Revenue increased $22.0 million, or approximately 59%, to $59.3 million for
the three months ended September 30, 2005 from $37.3 million for the
comparable prior year period. Revenue increased $60.8 million, or
approximately 59%, to $163.3 million for the nine months ended September
30, 2005 from $102.5 million for the comparable prior year period.
Excluding non-labor engineering revenue, the Company's adjusted revenue for
the three months ended September 30, 2005 increased $13.2 million, or
approximately 50%, over comparable revenue for the three months ended
September 30, 2004 and the Company's adjusted revenue for the nine months
ended September 30, 2005 increased $39.7 million, or approximately 55%,
over comparable revenue for the nine months ended September 30, 2004.
Acquisition revenue contributed $3.1 million, or 23%, and $5.0 million, or
13% of the increase in adjusted revenue for the three and nine months ended
September 30, 2005, respectively, compared to the comparable periods in
2004.
The increases in engineering revenue reflect the economic impact of
increased oil and crude prices. The increased profits generated by the
increase in prices as well as regulatory compliance mandates have led many
clients to begin capital improvement projects. For example, we have
contracts with clients who are improving their clean fuel refining
capabilities. Two new contracts in 2005, providing services for ultra low
sulfur diesel fuel projects through our Tulsa office, have contributed
$21.8 million to our revenue for the current year. This has helped expand
our growth in revenue. Revenue from our materials procurement services were
$16.4 million and $39.1 million for the three months and nine months ended
September 30, 2005, respectively as compared to $9.9 million and $26.8
million for the comparable prior year periods. Procurement services provide
low or no margins and are provided in addition to engineering and
subcontractor services.
Revenue in the systems segment decreased slightly in the three months ended
September 30, 2005, compared to the three months ended September 30, 2004.
Continued spending by the segment's customers on capital projects to meet
environmental requirements and increasing capacities contributed to the
increase in revenue for the nine months ended September 30, 2005, compared
to the same period in the prior year.
Gross Profit:
Gross profit increased $3.1 million, or approximately 66%, to $7.8 million
for the three months ended September 30, 2005 from $4.7 million for the
comparable prior year period. Acquisition gross profit contributed $0.5
million, or approximately 6%, of the total gross profit for the three
19
months ended September 30, 2005. Gross profit increased $7.8 million, or
approximately 60%, to $20.8 million for the nine months ended September 30,
2005 from $13.0 million for the comparable prior year period. Acquisition
gross profit contributed $1.1 million, or approximately 5%, of the total
gross profit for the nine months ended September 30, 2005. As a percentage
of revenue, gross profit increased to 13.2% for the three months ended
September 30, 2005 from 12.6% for the quarter ended September 30, 2004 and
remained at 12.7% for the nine months ended September 30, 2005 and
September 30, 2004, respectively.
Gross profit percentages in the engineering segment continue to be affected
by low margins on the procurement services portion of EPC projects. Margins
on procurement services range from no markup to 6.5% markup.
Selling, General, and Administrative:
As a percentage of revenue, SG&A expense decreased to 8.6% for the three
months ended September 30, 2005 from 9.3% for the three months ended
September 30, 2004 and 8.5% for the nine months ended September 30, 2005
from 9.9% for the nine months ended September 30, 2004. SG&A expense
increased $1.6 million, or approximately 46%, to $5.1 million for the three
months ended September 30, 2005 from $3.5 million for the comparable prior
year period and increased $3.7 million, or approximately 37%, to $13.8
million for the nine months ended September 30, 2005 from $10.1 million for
the comparable prior year period. Each reporting area except acquisitions
incurred additional costs for the three and nine months ended September 30,
2005 (Engineering - $1 million and $2.1 million, respectively; Systems -
$0.2 million and $0.5 million, respectively; Corporate - $0.6 million and
$1.8 million, respectively, and Acquisition - $(0.1) million and $(0.6)
million, respectively).
Corporate SG&A expense increased $0.6 million, or approximately 33%, to
$2.4 million for the three months ended September 30, 2005 from $1.8
million for the comparable prior year period. This increase is primarily
due to an increase in accrued incentive plan compensation ($146,000 and
$294,000 for the three months ended September 30, 2004 and 2005,
respectively), and an increase in salaries and burden ($908,000 and $1.3
million, respectively for the nine months ended September 30, 2004 and
2005, respectively). As a percentage of total revenue, corporate SG&A
expense decreased to 4% for the three months ended September 30, 2005 from
4.8% for the comparable prior year period and decreased to 4.1% for the
nine months ended September 30, 2005 from 4.8% for the comparable prior
year period. Corporate SG&A expense increased $1.8 million, or
approximately 37%, to $6.7 million for the nine months ended September 30,
2005 from $4.9 million for the comparable prior year period.
Operating Income:
Operating income increased $1.6 million, or approximately 133%, to $2.8
million for the three months ended September 30, 2005 from $1.2 million in
the same period in 2004 and increased $4.1 million, or approximately 141%,
to $7.0 million for the nine months ended September 30, 2005 from $2.9
million in the same period in 2004. As a percentage of revenue, operating
income increased to 4.7% for the three months ended September 30, 2005 from
3.3% for the comparable prior year period and increased to 4.3% for the
nine months ended September 30, 2005 from 2.8% for the comparable prior
year period.
Other Income/Expense, net:
Other expense increased 97% and 54%, respectively, for the three and nine
month periods ended September 30, 2005 from the comparable prior year
periods. The increases are due to increased interest expense on our credit
facility as interest rates have increased from 4.75% at September 30, 2004
to 6.75% at September 30, 2005. As a result paying off the line of credit
at the end of the third quarter of 2005, the Company expects a significant
reduction of interest expense in the fourth quarter of 2005
Tax Provision:
Income tax expense increased $0.6 million, or approximately 150%, to $1.0
million for the three months ended September 30, 2005 from $0.4 million for
the comparable prior year period and increased $1.5 million, or
approximately 166%, to $2.4 million for the nine months ended September 30,
2005 from $0.9 million for the comparable prior year period. The estimated
effective tax rate was 37% for the three-month and nine-month periods ended
September 30, 2005 compared to 34% for the comparable prior year periods.
20
Net Income:
Net income for the three months ended September 30, 2005 increased $0.8
million, or approximately 100%, to $1.6 million from $0.8 million for the
comparable prior year period. For the nine months ended September 30, 2005,
net income increased $2.5 million, or approximately 156%, to $4.1 million
from $1.6 million for the comparable prior year period. As a percentage of
revenue, net income increased to 2.8% for the three-month period ended
September 30, 2005 from 2.0% for the three-month period ended September 30,
2004 and increased to 2.5% for the nine-month period ended September 30,
2005 from 1.6% for the period ended September 30, 2004.
Segment Results
---------------
Engineering
-----------
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------------------ ------------------------------------------
2005 2004 2005 2004
------------------- -------------------- ------------------- --------------------
(in thousands) (in thousands)
Revenue:
Engineering - labor $ 30,507 55.3% $ 20,429 62.3% $ 86,791 58.1% $ 57,507 62.0%
Engineering - non-labor 19,579 35.5% 10,790 32.9% 51,443 34.4% 30,349 32.7%
Acquisition 5,057 9.2% 1,577 4.8% 11,235 7.5% 4,874 5.3%
-------- ----- -------- ----- -------- ----- -------- -----
Total revenue $ 55,143 100.0% $ 32,796 100.0% $149,469 100.0% $ 92,730 100.0%
======== ======== ======== ========
Gross profit:
Engineering $ 6,850 13.7% $ 3,698 11.9% $ 18,023 13.0% $ 10,865 12.4%
Acquisition 478 9.5% 209 13.3% 1,059 9.4% 788 16.2%
-------- -------- -------- --------
Total gross profit 7,328 13.3% 3,907 11.9% 19,082 12.8% 11,653 12.6%
-------- -------- -------- --------
Operating SG&A expense:
Engineering 1,937 3.9% 957 3.1% 4,859 3.5% 2,773 3.2%
Acquisition 273 5.4% 361 22.9% 767 6.8% 1,208 24.8%
-------- -------- -------- --------
Total SG&A expense 2,210 4.0% 1,318 4.0% 5,626 3.8% 3,981 4.3%
-------- -------- -------- --------
Operating income:
Engineering 4,913 9.8% 2,741 8.8% 13,164 9.5% 8,092 9.2%
Acquisition 205 4.1% (152) (9.6)% 292 2.6% (420) (8.6)%
-------- -------- -------- --------
Total operating income $ 5,118 9.3% $ 2,589 7.9% $ 13,456 9.0% $ 7,672 8.3%
-------- -------- -------- --------
Overview:
The Beaumont, Texas, and Lake Charles and Baton Rouge, Louisiana
engineering offices have increased their proposal activity as the result of
Hurricanes Katrina and Rita. We expect to be more involved in our client's
assessment of the storm damage. At present, we are assisting several
clients with conceptual front-end loading studies for preliminary
engineering on new capital projects. Specifically, we have been asked to
scope a large central control room project for a refinery expansion project
in Port Arthur, Texas. Employees based in the Beaumont and Lake Charles
areas will contribute to this project through the first two quarters of
2006.
The engineering segment's profitability has shown a significant increase
for both the three months and nine months ended September 30, 2005. The
Company's Tulsa location experienced the largest increase with a $4.1
million growth, or 286% increase through September 30, 2005 as compared to
the same period in 2004. This increase is the result of the two projects
that were announced in the first quarter of 2005 and continue to provide a
significant revenue stream for the Company.
21
The Sulfur Group, based in Dallas, has seen significant growth during the
third quarter of 2005 and will provide preliminary engineering services for
the construction of a sulfur recovery facility for a large West Coast
refinery. As previously reported, we estimate the contract award to be
valued at approximately $19 million. The facility will be designed and
constructed as modularized units, with the project consisting of a sulfur
recovery unit, a tail gas treating unit and an incineration unit with waste
heat recovery. In addition to design engineering, we will provide material
procurement and construction services, with the entire project scheduled to
be completed in the third quarter of 2006.
The Houston office has sustained its profitability by concentrating on
pipeline engineering projects; however, the office has recently expanded
its business development efforts to help diversify its workload to other
energy industry segments..
ENGlobal's newest and first international subsidiary, ENGlobal Canada, was
opened in September 2005 as a part of our ongoing internal growth
initiative.. ENGlobal Canada, a division of ENGlobal Automation Group, Inc.
("EAG"), is based in Calgary and will spotlight a multitude of projects in
Northern Alberta, specifically in the oil sands area. Initial business
development efforts to date have led to several strong alliances with
vendors offering distributed control systems (DCS) services and specific
partnerships to facilitate the pursuit of projects. EAG has increased its
proposal activity over the third quarter of 2005. For the nine months ended
September 30, 2005, we have incurred approximately $142,000 in losses
through EAG and ENGlobal Canada. These losses have reduced gross margin and
increased SG&A expenses in the engineering segment in 2005.
The field services staffing operation, which includes ENGlobal Construction
Resources, Inc., increased its overall profit by 69% to $2.9 million for
the nine months ended September 30, 2005 compared to the same period in
2004. The increase resulted in part from the acquisitions of AmTech in
September 2004 and Cleveland in October 2004, which contributed an
aggregate $397,000, or 33% of the increase, to the overall field services
operations. The additional 66% of the increase in field services can be
attributed to the increased demand for outsourced technical personnel at
other field services locations.
Acquisition totals for the three and nine months ended September 30, 2005
relate to assets acquired from Cleveland Inspection. For the three and nine
month periods ended September 30, 2004, acquisition totals relate to assets
acquired from AmTech, Petro-Chem and EDG.
Revenue:
Revenue increased $22.3 million, or 68%, to $55.1 million for the three
months ended September 30, 2005 from $32.8 million for the comparable prior
year period. Revenue increased $56.8 million, or 61%, to $149.5 million for
the nine months ended September 30, 2005 from $92.7 million for the
comparable prior year period. Excluding non-labor revenue, revenue for the
three months ended September 30, 2005 increased $13.6 million, or 62%, over
comparable revenue for the three months ended September 30, 2004. Revenue
for the nine months ended September 30, 2005 increased $35.6 million, or
57%, over comparable revenue for the nine months ended September 30, 2004.
Of this increase, acquisition revenue accounted for $3.5 million and
revenue from internal growth accounted for $10.1 million for the
three-month period ended September 30, 2005, and acquisition revenue
accounted for $6.4 million and revenue from internal growth accounted for
$29.3 million for the nine-month period ended September 30, 2005. Revenue
from internal growth, not related to acquisitions or non-labor items, for
the three months ended September 30, 2005 represented a 50% increase over
such revenue for the comparable period in 2004. For the nine months ended
September 30, 2005, such revenue represented a 51% increase over that for
the comparable period in 2004.
Non-labor revenue represented 36% of the total engineering revenue for the
quarter ended September 30, 2005 and increased $8.8 million to $19.6
million from $10.8 million for the three months ended September 30, 2004.
This increase in non-labor revenue represented 39% of our total engineering
revenue increase in the third quarter of 2005 compared to the same period
in 2004. Non-labor revenue represented 34% of the total engineering revenue
for the nine months ended September 30, 2005 and increased $21.1 million to
$51.4 million from $30.3 million for the nine months ended September 30,
2004. This increase in non-labor revenue represented 37% of the total
engineering revenue increase in the nine months ended September 30, 2005
compared to the same period in 2004.
22
Field services staffing operations contributed $39 million in labor revenue
and $1.9 million in non-labor revenue for the first nine months of 2005
which represents 69% and 297% revenue increase, respectively, over the same
periods in 2004. The increase was largely due to the acquisitions of AmTech
in September 2004 and Cleveland Inspection in October 2004, which
contributed $10.6 million in labor revenue and $1.3 million in non-labor
revenue to the overall field services operation.
Gross Profit:
Gross profit increased $3.4 million, or 87%, to $7.3 million for the three
months ended September 30, 2005 from $3.9 million for the comparable period
in 2004. Gross profit increased $7.4 million, or 63%, to $19.1 million for
the nine months ended September 30, 2005 from $11.7 million for the same
period in 2004. The increase in gross profit is attributable to an increase
in work under both existing and new contracts during the 2005 periods. As a
percentage of revenue, excluding acquisitions, engineering gross profit
increased to 13.7% from 11.9% for the three-month period ended September
30, 2005 as compared to the prior year period, and increased to 13.0% from
12.4% for the nine-month period ended September 30, 2005 as compared to the
same period in 2004. Gross profit includes non-project variable labor
expenses for internal growth initiatives related to low sulfur diesel,
polymers, advanced automation and integrated controls, plus the additional
cost of technical staff to produce cost estimates and project schedules to
cover increased proposal activity. These costs increased to $0.9 million
for the three-month period ended September 30, 2005 from $0.5 million for
the comparable period ended September 30, 2004, and to $2.9 million for the
nine-month period ended September 30, 2005 from $1.6 million for the
comparable period in 2004.
Acquisition gross profit increased $269,000, or 129%, to $478,000 for the
three months ended September 30, 2005 from $209,000 for the three months
ended September 30, 2004. For the nine months ended September 30, 2005,
gross profit from acquisitions increased $271,000, or 34%, to $1,059,000
from $788,000 for the same period in 2004.
Selling, General, and Administrative:
As a percentage of revenue, excluding non-labor revenue, SG&A expense
increased to 6.2% for the quarter ended September 30, 2005 from 6.0% for
the comparable prior year period and decreased to 5.7% for the nine-month
period ended September 30, 2005 from 6.4% for the same period in 2004. SG&A
expense increased $0.9 million overall, or 69%, to $2.2 million for the
three months ended September 30, 2005 from $1.3 million for the comparable
prior year period. This increase was primarily related to expansion of our
office space (rents - $588,000) and administrative support staff (salaries
- $218,000), plus $94,000 in other support activities. As a percentage of
revenue, excluding non-labor revenue, SG&A expense increased 40% to $5.6
million for the nine months ended September 30, 2005 from $4.0 million for
the comparable prior year period primarily to expansion of our office space
(rents - $1.1 million) and administrative support staff (salaries -
$706,000).
Operating Income:
Operating income increased $2.5 million, or 96%, to $5.1 million for the
quarter ended September 30, 2005 compared to the third quarter of 2004 and
increased $5.8 million, or 75%, to $13.5 million for the nine months ended
September 30, 2005 compared to the same period in 2004. As a percentage of
revenue, operating income increased to 9.3% for the three months ended
September 30, 2005 from 7.9% for the comparable prior year period and
increased to 9.0% for the nine months ended September 30, 2005 from 8.3%
for the comparable prior year period.
23
Systems
-------
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------------- -----------------------------------------
2005 2004 2005 2004
------------------ ------------------ ------------------ --------------------
(in thousands) (in thousands)
Revenue:
Systems 4,123 100.0% $ 4,060 90.7% 13,845 100.0% $ 8,468 86.3%
Acquisition -- -- % 416 9.3% -- -- % 1,349 13.7%
------- ----- ------- ----- ------- ----- ------- -----
Total revenue $ 4,123 100.0% $ 4,476 100.0% $13,845 100.0% $ 9,817 100.0%
======= ======= ======= =======
Gross profit:
Systems 510 12.4% $ 737 18.2% 1,734 12.5% $ 1,092 12.9%
Acquisition -- -- % 65 15.6% -- -- % 235 17.4%
------- ------- ------- -------
Total gross profit 510 12.4% 802 17.9% 1,734 12.5% 1,327 13.5%
------- ------- ------- -------
Operating SG&A expense:
Systems 495 12.0% 311 7.7% 1,458 10.5% 1,012 12.0%
Acquisition -- -- % 52 12.5% -- -- % 181 13.4%
------- ------- ------- -------
Total SG&A expense 495 12.0% 363 8.1% 1,458 10.5% 1,193 12.2%
------- ------- ------- -------
Operating income:
Systems 15 0.4% 426 10.5% 276 1.9% 80 0.9%
Acquisition -- -- % 13 3.1% -- -- % 54 4.0%
------- ------- ------- -------
Total operating income $ 15 0.4% $ 439 9.8% $ 276 1.9% $ 134 1.4%
------- ------- ------- -------
Overview:
For the nine months ended September 30, 2005, new sales awards increased by
8% compared to the nine months ended September 30, 2004. For the three
months ended September 30, 2005, new sales awarded were down 52% compared
to the first quarter of 2005 and down 39% compared to the second quarter of
2005. Revenue and direct cost continue to increase; however, gross profit
has decreased over the past three years. Material, engineering and
fabrication labor overruns have contributed to the decreased margins. These
overruns negatively impacted the operating income for the period and for
the nine months ended September 30, 2005. For the first six months of 2005,
the large influx of new work plus lower operating costs as a result of
reorganization of the segment offset the reduction in operating income for
the nine months ended September 30, 2005.
Acquisition totals for the three and nine months ended September 30, 2004
relate to the purchase of Senftleber. There was no Acquisition activity for
the three and nine months ended September 30, 2005.
Revenue:
Revenue decreased $400,000, or 9%, to $4.1 million for the three months
ended September 30, 2005 compared to the prior year period and increased
$4.0 million, or 41%, to $13.8 million for the nine months ended September
30, 2005 from $9.8 million for the comparable prior year period.
Gross Profit:
Gross profit decreased $292,000, or 36%, to $510,000 for the three months
ended September 30, 2005 from $802,000 for the comparable prior year period
and increased $0.4 million, or 31%, to $1.7 million for the nine months
ended September 30, 2005 compared to $1.3 million for the prior year
period. As a percentage of revenue, gross profit decreased to 12.4% for the
three months ended September 30, 2005 from 17.9% for the comparable prior
year period and decreased to 12.5% for the nine months ended September 30,
2005 from 13.5% for the comparable prior year period.
24
Selling, General, and Administrative:
SG&A expense increased $132,000, or 36%, to $495,000 for the three months
ended September 30, 2005 from $363,000 for the comparable prior year period
and increased $300,000, or 25%, to $1.5 million for the nine months ended
September 30, 2005 from $1.2 million for the same period in 2004. As a
percentage of revenue, SG&A expense increased to 12.0% for the three months
ended September 30, 2005 from 8.1% for the comparable prior year period and
decreased to 10.5% for the nine months ended September 30, 2005 from 12.2%
for the same period in 2004.
Operating Income:
Operating income decreased $424,000, or 97%, to $15,000 for the three
months ended September 30, 2005 from $439,000 for the comparable prior year
period and increased $142,000, or 106%, to $276,000 for the nine months
ended September 30, 2005 from $134,000 for the same period in 2004.
Liquidity and Capital Resources
- -------------------------------
Historically, cash requirements have been satisfied through operation
contribution and borrowings under a revolving line of credit, currently in
place with Comerica Bank (the "Comerica Credit Facility" or the "Credit
Facility"). As of September 30, 2005, we had working capital of $18.1
million. Long-term debt on September 30, 2005 was $2.4 million, with no
amounts outstanding under the Comerica Credit Facility.
On September 29, 2005, we entered into and closed on a definitive agreement
to issue and sell 2,000,000 shares of our $.001 par value per share Common
Stock in a private placement to Tontine Capital Partners, L.P., a Delaware
limited partnership. The purchase agreement provided $14,000,000 in gross
proceeds which were used to pay all of our existing line-of-credit debt.
The Comerica Credit Facility is senior to all other debt, and the line of
credit 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. The Comerica Credit Facility contains covenants
requiring the Company, as of the end of each calendar month, to maintain
certain ratios, including the average total outstanding principal balance
of the line of credit to EBITDA; the average total outstanding principal
balance of the line of credit to total liabilities, plus net worth; and the
average total outstanding principal balance of the line of credit to
accounts/unbilled receivables. The Company is also required, as of the end
of each quarter, to maintain minimum levels of net worth, and must comply
with an annual limitation on capital expenditures. We are currently in
compliance with all loan covenants, although no assurances can be given
regarding such compliance in the future. The Company is not currently
subject to any guarantees, repurchase obligations or other commitments. We
have no off-balance sheet arrangements, other than standby letters of
credit.
As of September 30, 2005, the Company had $3.3 million outstanding in
standby letters of credit issued to a refining client to cover contractual
obligations funded by the client for progress payments made to equipment
manufacturers for major project items. We expect obligations under standby
letters of credit to increase to approximately $6.7 million during December
2005 and decrease each month following until obligations are released in
May 2006.
The Company has been awarded a significant project with a central states
refining company and entered into an Agreement for Engineering and
Procurement Services to provide detailed engineering and procurement
services on a cost reimbursable basis. We estimate that the agreement will
result in a significant amount of revenue attributable to the procurement
of materials and equipment. Per the terms of the agreement, any progress
payments made by the client for project items must be secured by one or
more irrevocable stand-by letters of credit issued on the account of
ENGlobal. The project began in January 2005 and is scheduled to be
completed in the third quarter of 2006. As of September 30, 2005, letters
of credit totaling $3.3 million were outstanding on this project. The
requirement of letters of credit will negatively impact the Company's
liquidity.
As of September 30, 2005, management believes the Company's cash position
is sufficient to meet its working capital requirements. However, the
Company is exploring options to increase its available cash for
acquisitions, internal expansion and working capital in case a future
decrease in demand for the Company's services or products was to reduce the
availability of funds through operations.
25
The following table summarizes our contractual obligations as of September
30, 2005:
Payments Due by Period
---------------------------------------------------------
2009 and
2005 2006 2007 2008 thereafter Total
------- ------- ------- ------- ------- -------
(in thousands)
---------------------------------------------------------
Long-term debt(1) $ 408 $ 745 $ 542 $ 542 $ 479 $ 2,716
Operating leases(2) 539 2,218 2,208 1,431 1,195 7,591
------- ------- ------- ------- ------- -------
Total contractual cash obligations $ 947 $ 2,963 $ 2,750 $ 1,973 $ 1,674 $10,307
======= ======= ======= ======= ======= =======
(1) Long-term debt includes future interest payments assuming the existing
long-term debt and revolving credit facility remain outstanding with the
interest rate in effect at September 30, 2005. The Company's interest rate
on its revolving credit facility fluctuates with the prime rate. At
September 30, 2005, the balance of the revolving credit facility was zero.
(2) These operating leases are predominantly real estate leases.
Cash Flow
- ---------
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 the project
mix shifts from cost reimbursable to fixed costs contracts during
significant periods of growth, if the Company was to lose one or more of
its major customers, 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. Due to the impact of
Hurricane Rita in late September, the Company has experienced delays in
processing client billings. Management expects client billings to be
materially current by mid-November and is working to collect from clients
whose facilities may have been closed following the Hurricane.
On September 29, 2005, we entered into and closed on a definitive agreement
to issue and sell 2,000,000 shares of our $.001 par value per share Common
Stock in a private placement to Tontine Capital Partners, L.P., a Delaware
limited partnership. The purchase agreement provided $14,000,000 in gross
proceeds which were used to pay all of our existing line-of-credit debt.
Operating activities:
Net cash provided by operating activities was $4.4 million for the
nine-month period ended September 30, 2005, compared to $2.3 in the same
period in 2004. Changes in working capital, due to the timing of
collections of trade receivables, payments for trade payables, and
accruals, contributed to the strong cash flows from operations in the first
nine months of 2005. During the period, the line of credit decreased from
$13.5 million as of December 31, 2004, to zero as of September 30, 2005.
Net income was the primary driver of the Company's positive cash flows from
operations in the first nine months of 2005. Though a decline in revenues
would be likely to adversely impact our cash flow from operations, we
believe that future cash flows, our ability to manage the timing of
acquisitions, and our borrowing capacity under our line of credit will
allow us to meet cash requirements in 2005 and beyond. Future uses of cash
in operations will continue to be primarily for labor and material costs
required in connection with contract performance.
Investing activities:
Net cash used in investing activities was $1.4 million for the nine-month
period ended September 30, 2005, compared with net cash used of $856,000 in
the same period in 2004. In the first nine months of 2005, the Company
completed the sale of the Thermaire building, receiving $823,000 in cash
from the sale. The Company also used cash for capital expenditures in the
first nine months of 2005 and 2004 primarily for computers and software.
The large increase in property and equipment purchases is a result of
26
growth in our Tulsa, Dallas and Houston offices and an increase in the
number of employees. Future investing activities are anticipated to remain
consistent with prior years and include capital additions for leasehold
improvements, technical applications software, and equipment, such as
upgrades to computers. Annual capital expenditures are limited to $2.5
million under the line of credit agreement.
Financing activities:
Net cash used by financing activities was $78,000 for the nine-month period
ended September 30, 2005, compared with $1.5 million used in the same
period in 2004. In the first nine months of 2005, we reduced our
outstanding line of credit by $13.5 million using cash generated from
working capital and the sale of 2,000,000 shares of our Common Stock in a
private placement as compared to a net $1.8 million increase in the
outstanding line of credit in the same period in 2004. Future cash flows
from financing activities are anticipated to be borrowings, payments on the
line of credit and payments on long-term debt instruments. Line of credit
fluctuations are a function of timing related to operations obligations and
payments received on accounts receivable. Payments on long-term debt for
the coming year are estimated to be $553,000.
Asset Management
- ----------------
Our cash flow from operations has been affected primarily by the timing of
our collection of trade accounts receivable. We typically sell our products
and services on short-term credit terms and seek to minimize our credit
risk by performing credit checks and conducting our own collection efforts.
We had net trade accounts receivable of $31.2 million and $30.8 million at
September 30, 2005 and December 31, 2004, respectively. The number of days
sales outstanding in trade accounts receivables was 51 days and 62 days at
September 30, 2005 and December 31, 2004, respectively.
Income Taxes Payable
- --------------------
Due to the results of a recent audit by the Internal Revenue Service of the
Company's Form 1120 filing for the tax-year ended December 31, 2003, we
recorded an additional income tax payable (for tax-years 2002, 2003 and
2004) and a deferred tax asset equaling $590,000. The re-classification of
the tax liability and deferred tax asset were the result of a
re-calculation on the limitation of the net operating loss ("NOL")
carry-forwards occurring prior to the merger in 2001. The additional
deferred tax asset will be available to offset income in tax-years 2005
through 2009. Interest was assessed in the amount of $56,200, although no
penalties were assessed as a result of the audit. During August 2005, we
paid the United States Treasury Department approximately $622,000 for the
additional tax liability and interest charges.
In the third quarter, we recorded a tax benefit of $245,000 with a
corresponding addition to paid-in capital as the result of the exercise of
non-qualified stock options by a former employee.
27
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. As of September 30, 2005, nothing was outstanding under
the Credit Facility, which accrues interest at 6.75% per year, excluding
amortization of prepaid financing costs. A 10% increase in the short-term
borrowing rates on the Credit Facility outstanding as of September 30, 2005
would be 67.5 basis points. Such an increase in interest rates would not
increase our annual interest expense, assuming the amount of debt
outstanding remains at zero.
The Company has no market risk exposure in the areas of interest rate risk
from investments because we did not have an investment portfolio as of
September 30, 2005. Currently, the Company does not engage in foreign
currency hedging activities. With the opening of ENGlobal Canada, we are
exposed to foreign currency risks that arise from normal business
operations. These risks include the translation of local currency balances
of the Canadian operation and transactions with customers, suppliers and
employees that are denominated in Canadian dollars. Our objective is to
minimize our exposure to these risks through our normal operating
activities.
Foreign currency transactions gains and losses are recognized in the
results of operations based on the difference between the foreign exchange
rate on the transaction date and on the settlement date. There were no
foreign currency exchange gains or losses recorded as of September 30,
2005.
ITEM 4. CONTROLS AND PROCEDURES
As of September 30, 2005, 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, 2005, such disclosure controls
and procedures were effective to ensure that information required to be
disclosed by us in the reports we file or submit under the Exchange Act is
recorded, processed, summarized and reported within the time periods
specified in the rules and forms of the Securities and Exchange Commission,
and accumulated and communicated to our management, including our Chief
Executive Officer and Chief Financial Officer, as appropriate to allow
timely decisions regarding required disclosure.
In designing and evaluating the disclosure controls and procedures, our
management recognized that any controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of achieving
the desired control objectives and, in reaching a reasonable level of
assurance, our management necessarily was required to apply its judgment in
evaluating the cost-benefit relationship of possible controls and
procedures.
There were no changes in our internal controls over financial reporting
during the quarter ended September 30, 2005 that materially affected, or
are reasonably likely to materially affect, our internal controls over
financial reporting.
28
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 effect upon the consolidated financial position or operations of
the Company.
In January 2004, ENGlobal Design Group, Inc. ("EDG") purchased selected
assets of Engineering Design Group Inc. ("EDGI"), including certain of
EDGI's contract rights with the Department of the Navy. In July 2005, EDG
received notification from the Department of the Navy that unresolved
liabilities under predecessor contracts with EDGI were interfering with the
ability of the Dallas office of the Defense Contract Management Agency
("DCMA") to process novation agreements required by FAR 42.12 and that in
order to protect the DCMA's contractual interests, EDG would not be
solicited for any future proposals for work under the predecessor contracts
until the novation agreements were executed. EDG revenue under these
contracts totaled $3.3 million and $1.7 million respectively for the year
ended December 31, 2004 and the nine-month period ended September 30, 2005
and represented approximately 92% and 45% respectively of EDG's total
revenue during such periods. EDG's current backlog under these contracts is
$5.5 million. We do not expect the DCMA's action to have a material effect
on the consolidated financial position or operation of ENGlobal and are
seeking resolution of this matter.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On September 29, 2005, we entered into and closed on a definitive agreement
to sell 2,000,000 shares of our $.001 par value per share Common Stock in a
private placement to Tontine Capital Partners, L.P., a Delaware limited
partnership. Additional information regarding this transaction has been
included in a Current Report on Form 8-K filed by the Company with the
Securities and Exchange Commission on October 5, 2005.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
29
ITEM 6. EXHIBITS
31.1 Certifications Pursuant to Rule 13a - 14(a) of the Exchange Act
for 2002 for the Third Quarter 2005
31.2 Certifications Pursuant to Rule 13a - 14(a) of the Exchange Act
for 2002 for the Third Quarter 2005
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 2005
30
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 10, 2005
By: /s/ Robert W. Raiford
-------------------------
Robert W. Raiford
Chief Financial Officer and Treasurer
31