UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
- ----- ACT OF 1934
For the fiscal year ended December 31, 2005
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- ----- EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File No. 001-14217
ENGlobal Corporation
--------------------
(Exact name of registrant as specified in its charter)
Nevada 88-0322261
------ ----------
(State or other jurisdiction of (I.R.S Employer Identification No.)
incorporation or organization)
654 North Sam Houston Parkway East, Suite 400 77060-5914
- --------------------------------------------- ----------
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (281) 878-1000
Securities registered pursuant to Section 12(b) of the Exchange Act:
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
Common Stock, $0.001 par value American Stock Exchange
Securities registered pursuant to Section 12(g) of the Exchange Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act
Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15 (d) of the Act
Yes [ ] No [X]
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
Yes [ ] No [X]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act)
Yes [ ] No [X]
The aggregate market value of the registrant's common stock held by
non-affiliates of the registrant on June 30, 2005 was $42,561,564 (based upon
the closing price for shares of common stock as reported by the American Stock
Exchange on that date).
1
The number of shares outstanding of the registrant's common stock on March 23,
2006 is as follows:
$0.001 Par Value Common Stock 26,352,781 shares
DOCUMENTS INCORPORATED BY REFERENCE
Responses to Items 10, 11, 12, 13 and 14 of Part III of this report are
incorporated herein by reference to certain information contained in the
Company's definitive proxy statement for its 2006 Annual Meeting of Stockholders
to be filed with the Securities and Exchange Commission on or before April 30,
2006.
2
ENGlobal Corporation
2005 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
-----------------
PART I
------
PAGE
----
ITEM 1. BUSINESS 5
ITEM 1A. RISK FACTORS 16
ITEM 1B. UNRESOLVED STAFF COMMENTS 19
ITEM 2. PROPERTIES 19
ITEM 3. LEGAL PROCEEDINGS 21
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 21
PART II
-------
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES 22
ITEM 6. SELECTED FINANCIAL DATA 24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION 26
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 38
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 38
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE 69
ITEM 9A. CONTROLS AND PROCEDURES 69
PART III
--------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 70
ITEM 11. EXECUTIVE COMPENSATION 70
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS 70
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 70
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES 70
PART IV
-------
ITEM 15. EXHIBITS, FINANCIAL STATEMENTS AND SCHEDULES 71
SIGNATURES
----------
SIGNATURES 78
3
PART I
------
CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K ("Report"), including "Management's Discussion
and Analysis of Financial Condition and Results of Operations," as well as oral
statements made by the Company and its officers, directors or employees,
contains forward-looking statements within the meaning of Section 21E of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). Such
forward-looking statements are based on Management's beliefs, current
expectations, estimates and projections about the industries that the Company
and its subsidiaries serve, the economy and the Company in general. The words
"expect," "anticipate," "intend," "plan," "believe," "seek," "estimate" and
similar expressions are intended to identify such forward-looking statements;
however, this Report also contains other forward-looking statements in addition
to historical information. Although we believe that the expectations reflected
in the forward-looking statements are reasonable, such forward-looking
statements are not guarantees of future performance and are subject to risks,
uncertainties and other factors that may cause the actual results, performance
or achievements of the Company to differ materially from historical results or
from any results expressed or implied by such forward-looking statements. The
Company cautions readers that the following important factors and the risks
described in the section of this report entitled "Risk Factors", among others,
could cause the Company's actual results to differ materially from the
forward-looking statements contained in this Report: (i) the effect of changes
in laws and regulations with which the Company must comply, and the associated
costs of compliance with such laws and regulations, either currently or in the
future, as applicable; (ii) the effect of changes in accounting policies and
practices as may be adopted by regulatory agencies, as well as by the Financial
Accounting Standards Board; (iii) the effect of changes in the Company's
organization, compensation and benefit plans; (iv) the effect on the Company's
competitive position within its market area of the increasing consolidation
within its services industries, including the increased competition from larger
regional and out-of-state engineering services organizations; (v) the effect of
increases and decreases in oil prices; (vi) the availability of parts from
vendors; (vii) our ability to increase or renew our line of credit; (viii) our
ability to identify attractive acquisition candidates, consummate acquisitions
on terms that are favorable to the Company and integrate the acquired businesses
into the Company's operations; (ix) the ability to hire and retain qualified
personnel; (x) the ability to retain existing customers and get new customers
and (xi) the effect of changes in the business cycle and downturns in local,
regional and national economies. The Company cautions that the foregoing list of
important factors is not exclusive. We are under no duty and have no plans to
update any of the forward-looking statements after the date of this Report to
conform such statements to actual results.
4
ITEM 1. BUSINESS
General
-------
ENGlobal Corporation (which may be referred to as "ENGlobal," the
"Company," "we," "us" or "our") is a leading provider of engineering
services and systems principally to the petroleum refining, petrochemical,
pipeline, production and process industries throughout the United States
and internationally. The services provided by our multi-disciplined staff
span the lifecycle of a project and include feasibility studies, design,
procurement and construction management. We also supply automation, control
and instrumentation 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, we merged with Petrocon
Engineering, Inc. ("Petrocon") and in June 2002, we changed the name of the
Company 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".
In the last five years, the Company's net revenue from continuing
operations has grown from $17.8 million in 2001 to $233.6 million in 2005,
a compounded annual growth rate of approximately 90.3%. Since the merger
with Petrocon, the Company's net revenue from continuous operations has
grown from $89.1 million in 2002, a compounded annual growth rate of
approximately 37.9%. We have accomplished this growth by expanding our
engineering and systems services and geographic presence through internal
growth, including new initiatives and to a lesser extent, through a series
of strategic acquisitions. We now have more than 1,700 full-time equivalent
employees in offices strategically located in Houston, Beaumont, Freeport,
Midland and Dallas, Texas; Baton Rouge and Lake Charles, Louisiana; and
Tulsa, Cleveland and Blackwell, Oklahoma and Calgary, Alberta, Canada.
Available Information
---------------------
We file annual, quarterly and current reports, proxy statements and other
information with the Securities and Exchange Commission ("SEC"). You can
read and copy any materials filed with the SEC at its Public Reference Room
at 100 F. Street, N.E., Washington, D.C. 20549. You can obtain information
about the operations from the SEC Public Reference Room by calling the SEC
at 1-800-SEC-0330. The SEC also maintains a website, which contains
information we file electronically with the SEC, which can be accessed over
the Internet at www.sec.gov. Our common stock is listed on the American
Stock Exchange (AMEX: ENG), and you can obtain information about ENGlobal
at the offices of the American Stock Exchange, 86 Trinity Place, New York,
New York 10006-1872 or at their website www.amex.com.
ENGlobal Website
----------------
You can find financial and other information about ENGlobal at the
Company's website at the URL address www.englobal.com. Copies of our annual
reports on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K, and amendments to those reports filed or furnished pursuant to
Section 13(a) or 15(d) of the Exchange Act are provided free of charge
through the Company's website and are available as soon as reasonably
practicable after filing electronically or otherwise furnishing reports to
the SEC.
Information relating to corporate governance at ENGlobal, including: (i)
our Code of Business Conduct and Ethics for all of our employees, including
our Chief Executive Officer and Chief Financial Officer; (ii) our Code of
Ethics for our Chief Executive Officer and Senior Financial Officers; (iii)
information concerning our Directors, and our Board Committees, including
Committee charters, and (iv) information concerning transactions in
ENGlobal securities by Directors and officers, is available on our website
under the Investor Relations link. Our website and the information
contained therein or connected thereto are not intended to be incorporated
into this Annual Report on Form 10-K. We will provide any of the foregoing
information without charge upon written request to Investor Relations
Officer, ENGlobal Corporation, 654 North Sam Houston Parkway East, Suite
400, Houston, Texas 77060-5914.
5
ITEM 1. BUSINESS (Continued)
Business Segments
-----------------
During 2005, we operated two business segments: engineering and systems.
The respective contributions to our total sales in 2005, 2004 and 2003 for
the engineering and the systems segments are summarized below.
Percentage of Revenues
----------------------------------------
Segment (1) 2005 2004 2003
--------- --------- ---------
Engineering 92.3% 89.8% 87.6%
Systems 7.7% 10.2% 12.4%
--------- --------- ---------
100.0% 100.0% 100.0%
========= ========= =========
(1) Does not include manufacturing segment, which was sold in December
2003.
The shift in the percentage of revenue between the engineering and systems
business segments highlights the growth of the engineering segment over the
last three years. Revenues from the systems segment remained constant from
2003 to 2004, and increased 17.2% from 2004 to 2005. Engineering revenues
increased 23.3% and 61.4%, respectively, from 2003 to 2004 and 2004 to
2005.
Engineering Segment
-------------------
------------------------------
2005 2004 2003
------------------------------
(Amounts in thousands)
------------------------------
Revenues from external customers $215,698 $133,630 $108,380
Operating profit $ 17,752 $ 10,512 $ 10,716
Total assets $ 54,342 $ 46,122 $ 35,531
General
-------
Our engineering segment offers engineering consulting services to clients
in the petroleum refining, petrochemical, pipeline, production and process
industries for the development, management and turnkey execution of
engineering projects and provides inspection services throughout the United
States. The engineering segment is currently comprised of the following
wholly-owned subsidiaries of ENGlobal Corporation: ENGlobal Engineering,
Inc. ("EEI"), RPM Engineering, Inc. d/b/a ENGlobal Engineering, Inc.
("RPM"), ENGlobal Construction Resources, Inc. ("ECR"), ENGlobal Technical
Services, Inc. ("ETS"), ENGlobal Automation Group, Inc. ("EAG") and
ENGlobal Canada ULC ("ENGlobal Canada"). EEI and RPM focus primarily on
providing services to the downstream petroleum refining and petrochemical
industry, including refineries and processing plants, upstream and
midstream pipeline companies and gas processing plants. ECR primarily
provides inspection services to industrial plants throughout the United
States. ETS primarily provides Automated Fuel Handling Systems and services
to branches of the U.S. military and public sector companies. EAG and
ENGlobal Canada provide engineering services relating to the implementation
of process controls, instrumentation, advanced automation and information
technology projects. The engineering segment derives revenues primarily
from fees charged for professional and technical services. As a service
company, we are more labor than capital intensive. Our income results from
our ability to generate revenues and collect cash under contracts for our
employees' time in excess of any subcontract, pass-thru materials and
equipment, non-labor costs and our selling, general and administrative
(SG&A) expenses.
The engineering segment has approximately 104 existing blanket service
contracts pursuant to which it provides clients either with services on a
time and materials basis or with services on a fixed fee, turnkey basis.
Our engineering segment operates out of offices in Baton Rouge and Lake
Charles, Louisiana; Beaumont, Dallas, Houston, Midland and Freeport, Texas;
Tulsa, Cleveland and Blackwell, Oklahoma; and Calgary, Alberta. Our
engineering segment also provides unique, custom-designed process related
fabricated systems, designed to customer specifications.
6
ITEM 1. BUSINESS (Continued)
During 2003, as part of our plan to extend our geographical range and to
serve the downstream petrochemical industries, such as the petroleum
refining, petrochemical and process industries in the Freeport, Texas area,
we acquired selected assets of Petro-Chem Engineering, Inc. ("Petro-Chem").
Petro-Chem had a staff of 55 engineers, designers, inspectors and support
personnel engaged on contract projects with several Freeport area clients.
This acquisition allowed us to expand into the Freeport area with
experienced staff that has an established reputation. The Freeport office
currently provides on-site engineering, design and support personnel to a
leading chemical client that has facilities in Freeport and Port Arthur,
Texas and in Geismar, Louisiana.
During 2004, the engineering segment continued its geographical expansion
with new offices in Dallas and Midland, Texas and Cleveland, Oklahoma, plus
an additional office in Tulsa, Oklahoma. In January, through ETS, we
acquired certain assets of Engineering Design Group, Inc. ("EDGI") located
in Tulsa, Oklahoma. As a result of this acquisition, ETS now provides
design, installation and maintenance services for various government and
public sector facilities, the most active sector being Automated Fuel
Handling Systems serving the U.S. military. In August 2005, we announced
the expansion of EEI's operation in the sulfur recovery business in Dallas,
Texas. In September, through ECR, we acquired certain assets of AmTech
Inspection located in Midland, Texas. The new division's revenues are
derived primarily from providing inspectors for regional refining and
pipeline operations. In October, again through ECR, we acquired certain
assets of Cleveland Inspection Services, Inc. ("CIS") located in Cleveland,
Oklahoma. As a result of this acquisition, we now provide inspection and
construction management services in support of the oil and gas, utility and
pipeline industries.
In March 2005, ENGlobal Engineering formed ENGlobal Automation Group, Inc.
("EAG") to provide services relating to the implementation of process
control, advance automation and information technology projects providing
our clients with a full range of services, including but not limited to,
front-end engineering feasibility studies and the execution of turnkey
engineering, procurement, and construction projects. By focusing on
large-scope projects, EAG intends to pursue distributed control systems
(DCS) conversion and new installation projects by utilizing its own
resources as well as resources from both ENGlobal Engineering and ENGlobal
Systems. EAG will promote our proven capabilities for plant automation
services and products to respond to an industry progression toward
replacing obsolete technology with newer DCS.
In June 2005, we formed ENGlobal Canada, based in Calgary, Alberta, Canada.
ENGlobal Canada is a wholly-owned subsidiary of EAG.
Our engineering segment offers its expertise to a broad range of industrial
clients. We participate in projects involving both the modification of
existing facilities and construction of new facilities. Our predominant
type of contract is a blanket services contract that typically provides our
clients with engineering, procurement and project management services on a
time and materials basis. We also enter into contracts to complete capital
projects on a full service, turnkey basis. The engineering staff has the
capability of developing a project from the initial planning stages through
detailed design and construction management. The engineering services that
we provide include:
o conceptual studies;
o project definition;
o cost estimating;
o engineering design;
o inspection;
o material procurement; and
o project and construction management.
7
ITEM 1. BUSINESS (Continued)
We provide services for major energy-related firms at facilities such as
chemical plants, crude oil refineries, electric power generation
facilities, cross-country pipelines, pipeline facilities and production
processing facilities.
The engineering segment offers a wide range of services from a single
source provider. The segment uses an internal virtual private network so
that employees in one location can work on projects based in other offices.
This "work sharing" capability allows us to provide a greater depth and
breadth of expertise to our clients and helps stabilize the workload in our
various offices.
Competition
-----------
Our engineering segment competes with a large number of firms of various
sizes, ranging from the industry's largest firms, which operate on a
worldwide basis, to much smaller regional and local firms. Many of our
competitors are larger than we are and have significantly greater financial
and other resources available to them than we do.
Competition is primarily centered on performance and the ability to provide
the engineering, planning and project execution skills required to complete
projects in a timely and cost efficient manner. The technical expertise of
our management team and technical personnel and the timeliness and quality
of our support services, are key competitive factors. Larger projects,
especially international work, typically include pricing alternatives
designed to shift risk to the service provider, or at least to cause the
service provider to share a portion of the risks associated with cost
overruns in service delivery. These alternatives include fixed-price,
guaranteed maximum price, incentive fee, competitive bidding and other
"value based" pricing arrangements.
8
ITEM 1. BUSINESS (Continued)
Systems Segment
---------------
------------------------------
2005 2004 2003
------------------------------
(Amounts in thousands)
------------------------------
Revenues to external customers $ 17,887 $ 15,258 $ 15,339
Operating profit (loss) $ 309 $ 585 $ (38)
Total assets $ 6,159 $ 7,806 $ 3,913
General
-------
Our systems segment designs, assembles, programs, installs, integrates and
services control and instrumentation systems for specific applications in
the energy and processing related industries. The systems segment currently
consists of ENGlobal Systems, Inc. ("ESI"). Beginning in 2005, the
operations of ENGlobal Constant Power, ENGlobal Technologies, Inc. and
Senftleber & Associates, LP were merged into ESI. The systems segment
derives revenues primarily from fees on contracts for the design and
assembly of control and instrumentation systems. Income from the systems
segment is derived from our ability to generate revenues and collect cash
on fixed price contracts in excess of our costs for labor, materials and
equipment and transportation costs, plus our SG&A expenses.
ESI's control and instrumentation systems are custom designed and include
both conventional pneumatic and hydraulic control systems, as well as
electronic, microprocessor-based controls employing programmable logic.
Typical applications for control and instrumentation systems include oil
and gas production safety systems; refinery, petrochemical and chemical
plant controls; online process; analyzer packaging; fire and gas detection
systems; pipeline facility controls; data acquisition systems; and control
systems for various processing equipment. We perform all facets of control
and instrumentation system design, engineering, assembly and testing
in-house. Field installation and technical staff perform start-up and
commissioning services, modification to existing systems, on-site training
and routine maintenance procedures for client operating personnel.
ESI previously provided products and services supporting the advanced
automation and environmental technology fields. Advanced automation
services provided by ESI included automation technology audits, consulting,
advanced process controls and process computer services, multivariable
control, optimization (on-line and off-line), neural net applications,
operator training simulators, expert systems and on-site support. In
January 2006, EAG assumed responsibility for the provision of these
services.
In January 2006 ESI acquired certain assets of Analyzer Technology
International, Inc. ("ATI"), a Houston-based analyzer systems provider of
online process analyzer systems. ATI will relocate its operation to ESI's
Houston facility, which the Company expects will enable ESI's clients to
perform a more efficient factory adaptable test by temporarily connecting
both control and analyzer systems onsite prior to delivery. The addition of
ATI will provide ESI with a greater presence in the process analyzer
sector, especially for larger downstream opportunities of foreign
grassroots projects.
Competition
-----------
The systems segment has been impacted by price variations attributable to
cyclical conditions in the oil and gas, petroleum and processing
industries. In addition, during 2005, a large percentage of ESI's revenues
were derived from fabrication, which has a lower profit margin than other
services. ESI's control systems and modular facilities compete with similar
systems built by other companies, most of which compete primarily on the
basis of pricing.
We believe that pricing, technical competence and ability to provide
superior service are the primary bases of competition.
9
ITEM 1. BUSINESS (Continued)
Acquisitions and Sales
----------------------
We have grown our business over the past several years through both
internal initiatives and through strategic mergers and acquisitions. These
mergers and acquisitions have allowed us to (i) expand our client base and
the range of services that we provide to our clients; and (ii) gain access
to new geographic areas. We expect to continue evaluating and assessing
acquisition opportunities that will either complement our existing business
base or that will provide the Company with additional capabilities or
geographical coverage. We believe that strategic acquisitions will enable
us to more efficiently serve the technical needs of national and
international clients and strengthen our financial performance. The
following table lists the businesses we have acquired during the three-year
period ended December 31, 2005.
Name/Location/Business Unit Date Acquired Primary Services
--------------------------- ------------- ----------------
Petro-Chem Engineering July 2003 Onsite Design and Engineering
Freeport, TX
Operates as a Division of ECR
Senftleber & Associates, L.P. October 2003 Onsite Programmers
Washington, TX
Operates as a Division of EAG
Engineering Design Group, Inc. January 2004 Automated Fuel Handling & Tank
Tulsa, OK Gauging Systems
Operates as ETS, formerly EDG
AmTech Inspection, LLC September 2004 Onsite Inspection and Plant
Midland, TX Process Safety Mgt
Operates as a Division of ECR
Cleveland Inspection Services, Inc. October 2004 Onsite Pipeline Inspection
Cleveland, OK
Operates as a Division of ECR
Instrument Services Company, LLC November 2004 Onsite Instrument and
Tulsa, OK Electrical Technicians
Operates as a Division of ETS
InfoTech Engineering, LLC December 2004 Advanced Automation System
Baton Rouge, LA Design
Operates as a Division of EAG
Business Strategy
-----------------
Our objective is to strengthen the Company's position as a leading
engineering and consulting services provider while enhancing the services
we offer and expanding our geographic presence. To achieve this objective,
we have developed a strategy comprised of the following key elements:
o Continue to Recruit and Retain Qualified Personnel. We believe
recruiting and retaining qualified, skilled professionals is
crucial to our success and growth. As a result, we have dedicated
staff focused on recruiting personnel with experience in the
energy industry. We have also used inter-company recruiting to
retain key personnel.
10
ITEM 1. BUSINESS (Continued)
o Improve Utilization of Resources. We have developed a
work-sharing program through the use of an internal virtual
private network that gives our clients access to technical
resources located in any of our offices and allows for higher
utilization of our resources. We believe the work-sharing program
has reduced employee turnover and provides for a more stable work
environment. We are also moving toward standardization of
engineering processes and procedures among our offices, which we
believe will enhance our work-sharing ability and provide our
clients with more consistent and higher quality services.
o Pursue Foreign Technical Resources. Our engineering operations
continue to test the use of offshore technical resources to
establish longer-term access to professional engineering and
design work in lower cost countries such as Mexico, India and the
Far East. If these tests are ultimately successful, it will allow
us to lower our contract bid prices and enhance our competitive
position.
o Enhance and Strengthen Our Ability to Perform Engineering,
Procurement and Construction Projects. We rely heavily on repeat
business and referrals from existing customers, industry members
and manufacturing representatives. The engineering segment's
strategy is to increase revenues by developing and marketing its
ability to perform full service turnkey projects, also called EPC
(Engineering, Procurement and Construction) projects. The
engineering segment has traditionally been responsible only for
the engineering portion of its projects, which usually represents
between five to fifteen percent of a project's total installed
cost.
o Maintain High Quality Service. To maintain high quality service,
we focus on being responsive to our customers, working diligently
and responsibly, and maintaining schedules and budgets. The
Company has a quality control and assurance program to maintain
standards and procedures for performance and documentation and to
audit and monitor compliance with procedures and quality
standards.
o Expand and Enhance Technical Capabilities. We believe that it is
important to develop our capabilities in advanced computer-aided
process simulation, design and drafting. To achieve this
objective, we have purchased computer hardware and software from
several suppliers in order to have the latest platforms for the
design of plant systems. This initiative should enhance our
marketing position with many of our customers who are currently
utilizing these design platforms.
o Pursue Balanced Growth. We continue to pursue balanced growth for
our business, utilizing both external acquisitions as well as
internal measures as a means of future growth. The internal
measures will include an active business development program,
together with initiatives to start new business operations. We
also pursue acquisitions that will allow us to offer expanded
engineering and control system services to a broad energy
complex, increase our technical capabilities, grow our business
geographically and improve our market share.
o Continue to Increase Name Recognition. We intend to continue to
present a more cohesive image and continue to increase name
recognition. All of ENGlobal's operating subsidiaries have
adopted "ENGlobal" as part of their name, and newly acquired
entities will adopt ENGlobal as a part of their name within 12 to
18 months of their acquisition.
11
ITEM 1. BUSINESS (Continued)
Sales and Marketing
-------------------
Our various subsidiaries derive revenues primarily from two sources: (1)
in-house direct sales and (2) referrals from existing customers and
industry members and manufacturing representatives. Our in-house sales
managers are assigned to industry segments and territories within the
United States. Management believes that this method of selling should
result in increased account penetration and enhanced customer service,
which should, in turn, create and maintain the foundation for long-term
customer relationships. Our growth depends in large measure on our ability
to attract and retain qualified sales representatives and sales management
personnel. Management believes that in-house marketing allows for more
accountability and control, thus increasing profitability.
Products and services are also promoted through general and trade
advertising, participation in trade shows and through on-line Internet
communication via our corporate home page at www.englobal.com. The ENGlobal
site provides information about both of our operating segments. We use
in-house resources to maintain and update our website and our subsidiaries'
web sites on an ongoing basis. Through the ENGlobal website, we seek to
provide visitors with a single point of contact for obtaining information
on the services and products offered by the ENGlobal family of companies.
Our business development department focuses on building long-term
relationships with customers and providing customers with product
application, engineering and after-the-sale services. Additionally, we seek
to capitalize on cross-selling opportunities between our various
subsidiaries. Sales leads are often jointly developed and pursued by the
sales personnel from a number of these subsidiaries.
Much of our business is repeat business and we are introduced to new
customers in most cases by referrals from existing customers and industry
members. The Company believes that our acquisition program, although small,
has the benefit of expanding our existing customer base.
We currently employ 17 full-time professional in-house marketers in our
business development department who concentrate on the engineering services
segment, and 6 full-time professional in-house marketers in our systems
segment. We have retained business development agents in the Middle East
and the United Kingdom. We have also formed alliances, which include
marketing activities, with other engineering and construction firms in
Mexico City and South America.
Customers
---------
Our customer base consists primarily of Fortune 500 companies representing
a variety of industries in the United States. While we do not have
continuing dependence on any single client or a limited group of clients,
one or a few clients may contribute a substantial portion of our revenues
in any given year or over a period of several consecutive years due to
major engineering projects. For example, during 2005, 37% of our total
revenues were attributable to a large EPC project completed by our
engineering segment and our systems segment for one major refining and
petrochemical client and its subsidiaries.
We have had success undertaking new projects for prior clients and
providing ongoing services to clients following the completion of the
projects.
Nevertheless, in order to generate revenues in future years, we must
continue efforts to obtain new engineering projects. Historically, we have
not generated significant revenues from government clients. We hope that
our 2004 acquisition of Engineering Design Group, Inc. will allow us to
increase revenues from the government market beyond the $2.0 million in
revenue that we generated in 2005.
12
ITEM 1. BUSINESS (Continued)
In recent years, the continuing trend among engineering clients and their
industry counterparts has been toward outsourcing and sole sourcing. This
trend has fostered the development of ongoing, longer-term arrangements
with clients, rather than one-time limited engagements. These arrangements
are often referred to as partnering relationships, alliances or sole source
contracts, and vary in scope, duration and degree of commitment. For
example, engagements may provide for:
o a minimum number of work man-hours over a specified period;
o the provision of at least a designated percentage of the client's
requirements;
o the designation of the Company as the client's sole source of
engineering at specific locations; or
o a non-binding preference or intent, or a general contractual
framework, for what the parties expect will be an ongoing
relationship.
Despite their variety, we believe that these partnering relationships have
a stabilizing influence on our service revenues. At present, we maintain
some form of partnering or alliance arrangement with 16 major oil and
chemical companies. Most of our projects are specific in nature and we
generally have multiple projects with the same clients. If we were to lose
one or more of our significant clients and were unable to replace them with
other customers or other projects, our business would be materially
adversely affected.
In the systems segment, our clients include end-users and operators of
facilities relating to oil and gas products, pipelines, refineries,
chemical companies and processing plants. Other clients include equipment
manufacturers, construction contractors and other engineering firms that
incorporate our control systems into facilities and products that they
design, construct and manufacture. As in the engineering segment, in any
given year, a small number of clients may account for a large percentage of
the systems segment's revenues for that year, depending on the number of
major projects undertaken. Though the systems segment frequently receives
work from repeat clients, its client list may vary significantly from year
to year.
Our ten largest customers, who vary from one period to the next, accounted
for 78% of our total revenue in both 2005 and 2004.
We do not have any long-term commitments from these clients and sales of
products from the systems segment are typically made according to the
client's specifications on a purchase order basis. Our potential revenues
are, therefore, dependent on continuing relationships with these customers.
13
ITEM 1. BUSINESS (Continued)
Contracts
---------
We generally enter into two principal types of contracts with our clients:
time and materials contracts and fixed-price contracts. In fiscal 2005, 88%
and 12% of our net revenue was derived from time and materials and
fixed-price contracts, respectively. Our various clients determine which
type of contract we will enter into for a particular engagement.
o Time and Materials. Under our time and materials contracts, we
are paid for labor at either negotiated hourly billing rates or
reimbursed for allowable hourly rates and for other expenses.
Profitability on these contracts is driven by billable headcount
and cost control. Some of these contracts may have upper limits,
referred to as "not to exceed." If our costs generate billings
that exceed the contract ceiling or are not allowable, we will
not be able to obtain reimbursement for any excess cost. Further,
the continuation of each contract partially depends upon the
customer's discretionary periodic assessment of our performance
on that contract.
o Fixed-Price. Under a fixed-price contract, we provide the
customer a total project for an agreed-upon price, subject to
project circumstances and changes in scope. Fixed-price contracts
carry certain inherent risks, including risks of losses from
underestimating costs, delays in project completion, problems
with new technologies and economic and other changes that may
occur over the contract period. Another risk includes our ability
to secure written change orders prior to commencing work on such
orders, which may prevent our getting paid for work performed.
Consequently, the profitability of fixed-price contracts may vary
substantially.
Backlog
-------
Backlog represents gross revenue of all awarded contracts that have not
been completed and will be recognized as revenues over the life of the
project. Although backlog reflects business that we consider to be firm,
cancellations or scope adjustments may occur. Further, most contracts with
clients may be terminated at will, in which case the client would only be
obligated to us for services provided through the termination date. We have
adjusted backlog to reflect project cancellations, deferrals and revisions
in scope and cost (both upward and downward) known at the reporting date;
however, future contract modifications or cancellations may increase or
reduce backlog and future revenues. As a result, no assurances can be given
that the amounts included in backlog will ultimately be realized.
At December 31, 2005, our backlog was $170 million compared to an estimated
$135 million at December 31, 2004. We estimate that approximately 75% of
the backlog at December 31, 2005 will be recognized during fiscal 2006.
The backlog at December 31, 2005 consists of $165 million with commercial
customers and $5 million with the United States Federal Government. Backlog
on the federal programs includes only the portion of the contract award
that has been funded by the U.S. Government.
Backlog includes gross revenue under two types of contracts: (1) contracts
for which work authorizations have been received on a fixed-price basis and
not-to-exceed projects that are well defined, and (2) time and material
evergreen contracts at an assumed 12 month run-rate, where we place
employees at our clients' site to perform day-to-day project efforts.
Customer Service and Support
----------------------------
We provide service and technical support to our customers in varying
degrees depending upon the business line and on customer contractual
arrangements. The Company's technical staff provides initial telephone
support services for its customers. These services include isolating and
verifying reported product failures and authorizing repair services in
support of customer requirements. We also provide on-site engineering
support if a technical issue cannot be resolved over the telephone. On
projects for which we have provided engineering systems, we provide
worldwide start-up and commissioning services. We also provide the
manufacturers' limited warranty coverage for products we re-sell.
14
ITEM 1. BUSINESS (Continued)
Dependence Upon Suppliers
-------------------------
Our ability to provide clients with services and systems in a timely and
competitive manner depends on the availability of products and parts from
our suppliers at competitive prices and on reasonable terms. Our suppliers
are not obligated to have products on hand for timely delivery nor can they
guarantee product availability in sufficient quantities to meet our
demands. There can be no assurance that we will be able to obtain necessary
supplies at prices or on terms we find acceptable. However, in an effort to
maximize availability and maintain quality control, we generally procure
components from multiple distributors.
For example, all of the product components used by our systems segment are
fabricated using components and materials that are available from numerous
domestic suppliers. There are approximately 36 principal suppliers of these
components, each of whom can be replaced by an equally viable competitor.
No one manufacturer or vendor provides products that account for 10% or
more of our revenues. Thus, we anticipate little or no difficulty in
obtaining components in sufficient quantities and in a timely manner to
support our manufacturing and assembly operations. Units produced through
the systems segment are normally not produced for inventory and component
parts are typically purchased on an as-needed basis.
Despite the foregoing, some of our subsidiaries rely on certain suppliers
for necessary components and there can be no assurance that these
components will continue to be available on acceptable terms. If a
subsidiary terminates a long-standing supply relationship, it may be
difficult to obtain alternative sources of supply without a material
disruption in our ability to provide products and services to our
customers. While we do not believe that such a disruption is likely, if it
did occur, it could have a material adverse effect on our financial
condition and results of operations.
Patents, Trademarks, Licenses
-----------------------------
Our success depends in part upon our ability to protect our proprietary
technology, which we do primarily through protection of our trade secrets
and confidentiality agreements. The U.S. Patent and Trademark Office
approved our application for the uses of "ENGlobal" and "Integrated Rack"
in September 2004 and March 2005, respectively. In addition, we have
pending trademark applications on file with the U.S. Patent and Trademark
Office for the names "Flare-Mon" and "Purchased Data." There can be no
assurance that the protective measures we currently employ will be adequate
to prevent the unauthorized use or disclosure of our technology, or the
independent third party development of the same or similar technology.
Although our competitive position to some extent depends on our ability to
protect our proprietary and trade secret information, we believe that other
factors, such as the technical expertise and knowledge base of our
management and technical personnel, as well as the timeliness and quality
of the support services we provide, will also help us to maintain our
competitive position.
Government Regulations
----------------------
The Company and certain of our subsidiaries are subject to various foreign,
federal, state, and local laws and regulations relating to our business and
operations, and various health and safety regulations as established by the
Occupational Safety and Health Administration. The Company and members of
its professional staff are subject to a variety of state, local and foreign
licensing, registration and other regulatory requirements governing the
practice of engineering. Currently, we are not aware of any situation or
condition relating to the regulation of the Company, its subsidiaries, or
personnel that we believe is likely to have a material adverse effect on
our results of operations or financial condition.
15
ITEM 1. BUSINESS (Continued)
Employees
---------
As of December 31, 2005, the Company and its subsidiaries employed 1,724
individuals. Of these employees, 23 were employed in sales and marketing;
918 were employed in engineering and related positions; 174 were employed
in technical production positions; 273 were employed as inspectors; 256
were employed as project support staff; and 80 were employed in
administration, finance and management information systems. We believe that
our ability to recruit and retain highly skilled and experienced technical,
sales and management personnel has been and will continue to be, critical
to our ability to execute our business plan. None of our employees is
represented by a labor union or is subject to a collective bargaining
agreement. We believe that relations with our employees are good.
ITEM 1A. RISK FACTORS
Set forth below and elsewhere in this Report and in other documents we file
with the SEC are risks and uncertainties that could cause actual results to
differ materially from the results contemplated by the forward-looking
statements contained in this Report. You should be aware that the
occurrence of any of the events described in these risk factors and
elsewhere in this Report could have a material adverse effect on our
business, financial condition and results of operations and that upon the
occurrence of any of these events, the trading price of our common stock
could decline.
We are engaged in highly competitive businesses and must typically bid
against competitors to obtain engineering and service contracts.
We are engaged in highly competitive businesses in which customer
contracts are typically awarded through competitive bidding processes.
We compete with other general and specialty contractors, both foreign
and domestic, including large international contractors and small
local contractors. Some competitors have greater financial and other
resources than we do, which, in some instances, gives them a
competitive advantage over us.
The failure to attract and retain key professional personnel could
adversely affect the Company.
Our success depends on attracting and retaining qualified personnel in
a competitive environment. We are dependent upon our ability to
attract and retain highly qualified managerial, technical and business
development personnel. Competition for key personnel is intense. We
cannot be certain that we will retain our key managerial, technical
and business development personnel or that we will attract or
assimilate key personnel in the future. Failure to retain or attract
such personnel would materially adversely affect our businesses,
financial position, results of operations and cash flows. This is a
major risk factor that could materially impact our operating results.
Our business and operating results could be adversely affected by our
inability to accurately estimate the overall risks, revenue or costs
on a contract.
We generally enter into two principal types of contracts with our
clients: time and materials contracts and fixed-price contracts. Under
our fixed-price contracts, we receive a fixed-price irrespective of
the actual costs we incur and, consequently, we are exposed to a
number of risks. These risks include underestimation of costs,
problems with new technologies, unforeseen expenditures or
difficulties, delays beyond our control and economic and other changes
that may occur during the contract period. Our ability to secure
change orders on scope changes and our ability to invoice for such
changes poses an additional risk. In fiscal 2005, approximately 12% of
our net revenue was derived from fixed-price contracts.
Under our time and materials contracts, we are paid for labor at
negotiated hourly billing rates or reimbursement at specified mark-up
hourly rates and negotiated rates for other expenses. Profitability on
these contracts is driven by billable headcount and cost control. Some
time and materials contracts are subject to contract ceiling amounts,
which may be fixed or performance-based. If our costs generate
16
ITEM 1A. RISK FACTORS (Continued)
billings that exceed the contract ceiling or are not allowable under
the provisions of the contract or any applicable regulations, we may
not be able to obtain reimbursement for all of our costs.
Revenue recognition for a contract requires judgment relative to
assessing the contract's estimated risks, revenue and costs, and
technical issues. Due to the size and nature of many of our contracts,
the estimation of overall risk, revenue and cost at completion is
complicated and subject to many variables. Changes in underlying
assumptions, circumstances or estimates may also adversely affect
future period financial performance. This is a major risk factor that
could materially impact our operating results.
Economic downturns could have a negative impact on our businesses.
Demand for the services offered by us has been and is expected to
continue to be, subject to significant fluctuations due to a variety
of factors beyond our control, including demand for engineering
services in the petroleum refining, petroleum chemical and pipeline
industries and in other industries that we provide services to. During
economic downturns in these industries, our customer's ability to
engage us may decline significantly. We cannot be certain that
economic or political conditions will be generally favorable or that
there will not be significant fluctuations adversely affecting our
industry as a whole or key markets targeted by us.
Our dependence on one or a few customers could adversely affect us.
One or a few clients have in the past and may in the future contribute
a significant portion of our consolidated revenues in any one year or
over a period of several consecutive years. In 2005, approximately 44%
of our revenues were from one client, approximately 12% of our
revenues were from another client and another 12% were from a third
client. As our backlog frequently reflects multiple projects for
individual clients, one major customer may comprise a significant
percentage of our backlog at any point in time. Because these
significant customers generally contract with us for specific
projects, we may lose these customers from year to year as their
projects with us are completed. If we do not replace them with other
customers or other projects, our business could be materially
adversely affected. Additionally, we have long-standing relationships
with many of our significant customers. Our contracts with these
customers, however, are on a project-by-project basis and the
customers may unilaterally reduce or discontinue their purchases at
any time. The loss of business from any one of such customers could
have a material adverse effect on our business or results of
operations.
Additional acquisitions may adversely affect our ability to manage our
business.
Acquisitions have contributed to our growth over the past three years
and we plan to continue making acquisitions in the future on terms
management considers favorable to us. The successful acquisition of
other companies involves an assessment of future revenue
opportunities, operating costs, economies and earnings after the
acquisition is complete, potential industry and business risks and
liabilities beyond our control. This assessment is necessarily inexact
and its accuracy is inherently uncertain. In connection with our
assessments, we perform reviews of the subject acquisitions we believe
to be generally consistent with industry practices. These reviews,
however, may not reveal all existing or potential problems, nor will
they permit a buyer to become sufficiently familiar with the target
companies to assess fully their deficiencies and capabilities. We
cannot assure you that we will identify, finance and complete
additional suitable acquisitions on acceptable terms. We may not
successfully integrate future acquisitions. Any acquisition may
require substantial attention from our management, which may limit the
amount of time that management can devote to day-to-day operations.
Our inability to find additional attractive acquisition candidates or
to effectively manage the integration of any businesses acquired in
the future could adversely affect our ability to grow profitably or at
all.
Seasonality of our industry may cause our revenues to fluctuate.
Holidays and employee vacations during our fourth quarter exert
downward pressure on revenues for that quarter, which is only
partially offset by the year-end efforts on the part of many clients
to spend any remaining funds budgeted for engineering services or
capital expenditures during the year. The annual budgeting and
approval process under which these clients operate is normally not
completed until after the beginning of each new year, which can
depress results for the first quarter. Principally due to these
17
ITEM 1A. RISK FACTORS (Continued)
factors, our revenues during the first and fourth quarters generally
tend to be lower than in the second and third quarters.
Liability claims could result in losses.
Providing engineering and design services involves the risk of
contract, professional errors and omissions and other liability
claims, as well as adverse publicity. Further, many of our contracts
will require us to indemnify our clients not only for our negligence,
if any, but also for the concurrent negligence and in some cases, sole
negligence of our clients. We currently maintain liability insurance
coverage, including coverage for professional errors and omissions.
However, claims outside of or exceeding our insurance coverage may be
made. A significant claim could result in unexpected liabilities, take
management time away from operations, and have a material adverse
impact on our cash flow.
If the operating result of either segment is adversely affected, an
impairment of goodwill could result in a write down.
Based on factors and circumstances impacting ENGlobal and the business
climate in which it operates, the Company may determine that it is
necessary to re-evaluate the carrying value of its goodwill by
conducting an impairment test in accordance with SFAS No. 142. The
Company has assigned goodwill to its two segments based on estimates
of the relative fair value of each segment. If changes in the
industry, market conditions, or government regulation negatively
impact either of the Company's segments resulting in lower operating
income, if assets are harmed, if anticipated synergies or cost savings
are not realized with newly acquired entities, or if any circumstance
occurs which results in the fair value of either segment declining
below its carrying value, an impairment to goodwill would be created.
In accordance with SFAS No. 142, the Company would be required to
write down the carrying value of goodwill.
Our Board of Directors may authorize future sales of ENGlobal common
stock, which could result in a decrease in value to existing
stockholders of the shares they hold.
Our Articles of Incorporation authorize our board of directors to
issue up to an additional 48,058,056 shares of common stock and an
additional 2,265,167 shares of preferred stock. These shares may be
issued without stockholder approval unless the issuance is 20% or more
of our outstanding common stock, in which case the American Stock
Exchange requires stockholder approval. We may issue shares of stock
in the future in connection with acquisitions or financings. In
addition, we may issue options as incentives under our 1998 Incentive
Option Plan. Future issuances of substantial amounts of common stock,
or the perception that these sales could occur, may affect the market
price of our common stock. In addition, the ability of the board of
directors to issue additional stock may discourage transactions
involving actual or potential changes of control of the Company,
including transactions that otherwise could involve payment of a
premium over prevailing market prices to holders of our common stock.
Our backlog is subject to unexpected adjustments and cancellations and
is, therefore, an uncertain indicator of our future revenues or
earnings.
As of December 31, 2005, our backlog was approximately $170 million.
We cannot assure investors that the revenues projected in our backlog
will be realized or, if realized, will result in profits. Projects may
remain in our backlog for an extended period of time prior to project
execution and, once project execution begins, it may occur unevenly
over the current and multiple future periods. In addition, project
terminations, suspensions or reductions in scope may occur from time
to time with respect to contracts reflected in our backlog. Such
backlog reductions would reduce the revenue and profit we actually
receive from contracts reflected in our backlog. Future project
cancellations and scope adjustments could further reduce the dollar
amount of our backlog and the revenues and profits that we actually
earn.
18
ITEM 1A. RISK FACTORS (Continued)
Our dependence on subcontractors and equipment manufacturers could
adversely affect us.
We rely on third-party subcontractors as well as third-party suppliers
and manufacturers to complete our projects. To the extent that we
cannot engage subcontractors or acquire supplies or materials, our
ability to complete a project in a timely fashion or at a profit may
be impaired. If the amount we are required to pay for these goods and
services exceeds the amount we have estimated in bidding for
fixed-price or cost-plus contracts, we could experience losses in the
performance of these contracts. In addition, if a subcontractor or
supplier is unable to deliver its services or materials according to
the negotiated terms for any reason, including the deterioration of
its financial condition or over-commitment of its resources, we may be
required to purchase the services or materials from another source at
a higher price. This may reduce the profit to be realized or result in
a loss on a project for which the services or materials were needed.
If we are not able to successfully manage our growth strategy, our
business and results of operations may be adversely affected.
We have grown rapidly over the last several years. Our growth presents
numerous managerial, administrative, operational and other challenges.
Our ability to manage the growth of our operations will require us to
continue to improve our management information systems and maintain
discipline in our internal systems and controls. Industry trends and
our strategy to pursue larger fixed-price EPC projects, our ability to
manage and measure project performance will require us to strengthen
our internal project and cost control systems within operations that
have traditionally operated in a cost plus environment. In addition,
our growth will increase our need to attract, develop, motivate and
retain both our management and professional employees. The inability
of our management to effectively manage our growth or the inability of
our employees to achieve anticipated performance could have a material
adverse effect on our business.
If we are not able to successfully manage internal growth initiatives,
our business and results of operations may be adversely affected.
Our growth strategy is to use our technical expertise in conjunction
with industry trends. To support this strategy, the Company may elect
to fund internal growth initiatives targeted at markets that the
Company believes may have significant potential needs for the
Company's services. The downside risks are that such initiatives could
have a negative effect on current earnings until such initiatives
reach critical mass or that industry trends have been misread or
delayed and continued funding could have a negative impact on long
term earnings.
A small number of stockholders own a significant portion of our
outstanding common stock, thus limiting the extent to which other
stockholders can effect decisions subject to stockholder vote.
Directors, executive officers and principal stockholders of ENGlobal
and their affiliates, beneficially own approximately 40% of our
outstanding common stock on a fully diluted basis. Accordingly, these
stockholders, as a group, are able to affect the outcome of
stockholder votes, including votes concerning the adoption or
amendment of provisions in our Articles of Incorporation or bylaws and
the approval of mergers and other significant corporate transactions.
The existence of these levels of ownership concentrated in a few
persons makes it unlikely that any other holder of common stock will
be able to affect the management or direction of the Company. These
factors may also have the effect of delaying or preventing a change in
management or voting control of the Company.
ITEM 1B. UNRESSOLVED STAFF COMMENTS
Not applicable.
ITEM 2. PROPERTIES
Facilities
----------
We lease space in 15 buildings in the U.S. and Canada totaling
approximately 365,000 square feet, and we own an office building in Baton
Rouge, Louisiana with 27,500 square feet. The leases have remaining terms
ranging from monthly to six years and are at what we consider to be
19
ITEM 2. PROPERTIES (Continued)
commercially reasonable rental rates. Our principal office locations are in
Houston and Beaumont, Texas, and Tulsa, Oklahoma. We have other offices in
Freeport, Midland and Dallas, Texas, Baton Rouge and Lake Charles,
Louisiana, Cleveland and Blackwell, Oklahoma and Calgary, Alberta Canada.
Approximately 214,000 square feet of our total office space is designated
for our professional, technical and administrative personnel. We believe
that our office and other facilities are well maintained and adequate for
existing and planned operations at each operating location.
Our systems segment performs fabrication assembly in two shop facilities.
One facility is in Houston, Texas with approximately 62,600 square feet of
space and a second facility is in Beaumont, Texas with approximately 30,000
square feet of space.
During 2005, we leased approximately 14,000 square feet of office space in
Beaumont, Texas from a joint venture owned one-third by each of: ENGlobal
Engineering, Inc., Michael L. Burrow (the Company's CEO), and a stockholder
of the Company who owns less than 1% of the Company's stock. We believe
that this lease was at a commercially reasonable rental rate. The lease was
renewed in August 2005. In September 2005, the building was damaged by
Hurricane Rita and all tenants have relocated to other locations. No
further lease payments have been made by the Company since September 2005
and the insurance claim filed by PEI Investments remains unsettled.
Below is a complete listing of the space leased and owned with the
expiration dates of the leases.
Location Square Feet Lease Expiration Date
---------------- ----------------- -----------------------
Beaumont 42,880 2011
30,250 2008
23,616 2010
13,590 Month to Month
** 2,300 2006
Houston 62,641 2008
48,979 2011
Midland 4,400 2008
Richardson 14,323 2008
Lake Charles 12,183 2006
1,140 2007
Tulsa 68,882 2008
678 2007
Cleveland 8,600 2006
Blackwell 1,800 Month to Month
Freeport 23,000 2007
Baton Rouge 27,500 Owned
Calgary, Alberta 5,157 2010
-----------------
391,919
=================
** Began January 10, 2006
In March 2005, we entered into a lease agreement for the relocation of our
corporate headquarters and Houston engineering office to a 33,759 square
foot facility in North Houston. Effective June 1, 2005, approximately 60
employees moved to our new location at 654 North Sam Houston Parkway E,
Suite 400, Houston, Texas 77060-5914, which can accommodate up to 150
employees with appropriate space planning. We executed a six-year lease
requiring aggregate lease payments in excess of $2.3 million, with a right
of refusal covering all remaining space in the building. In the second
quarter of 2006, we expect to lease additional space in the same building
for planned growth.
20
ITEM 3. LEGAL PROCEEDINGS
During 2005, the Company and its subsidiaries were successful in obtaining
the dismissal of all but one of the remaining petitions filed against the
Company and its subsidiaries in 2003, on behalf of former employees of
Barnard and Burk, Inc. The Company believes that the remaining petition is
without merit and immaterial to the Company's business and financial
condition and plans to vigorously defend itself in this lawsuit.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
21
PART II
-------
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information and Holders
------------------------------
The Company's common stock has been quoted on the American Stock Exchange
("AMEX") since June 16, 1998, and is currently traded under the symbol
"ENG." From its initial listing on AMEX on June 16, 1998 to June 15, 2002,
the Company's stock was traded under the symbol "IDS." Newspaper stock
listings identify us as "ENGlobal."
The following table sets forth the high and low sales prices of our common
stock for the periods indicated.
Fiscal Year Ended December 31
--------------------------------------------------
2005 2004
-------------------------- -----------------------
High Low High Low
------------ ------------- ---------- ------------
First Quarter 2.87 2.04 2.32 1.96
Second Quarter 4.03 2.01 2.43 1.44
Third Quarter 9.10 3.69 1.75 1.20
Fourth Quarter 8.75 5.87 3.19 1.21
The foregoing figures, based on information published by AMEX, do not
reflect retail mark-ups or markdowns and may not represent actual trades.
In connection with our December 2001 merger with Petrocon, we issued
2,500,000 shares of Series A Preferred Stock, $0.001 par value per share,
to Equus II Incorporated. In 2002 and 2003, we issued dividends to Equus in
the form of 234,833 shares of Series A Preferred Stock. Effective August
2003, the Company exercised its right to convert all outstanding Series A
Preferred Stock to 1,149,089 shares of common stock. The Series A Preferred
Stock had fixed terms that were specific to the 2001 merger with Petrocon.
Therefore, the Company intends to seek stockholder approval to eliminate
the 2,265,167 shares of available and unissued Series A Preferred Stock
from its capital structure.
As of March 24, 2006, approximately 200 stockholders of record held the
Company's common stock. We do not have current information regarding the
number of holders of beneficial interest holding our common stock.
22
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES (Continued)
Equity Compensation Plan Information
------------------------------------
The following table sets forth certain information concerning the Company's
equity compensation plans as of December 31, 2005. See Note 11 in the
attached financial statements.
Number of Securities
Remaining Available for
Number of Securities to Weighted-Average Future Issuance Under
be Issued Upon Exercise Exercise Price of Equity Compensation Plans
of Outstanding Options, Outstanding Options, [Excluding Securities in
Warrants and Rights (a) Warrants and Rights (b) Column (a)] (c)
----------------------- ----------------------- --------------------------
Equity compensation plans
approved by security
holders 1,438,234 (1) 3.07 509,260
----------------------- --------------------------
Dividend Policy
---------------
The Company has never declared or paid a cash dividend on its common stock.
The Company intends to retain any future earnings for reinvestment in its
business and does not intend to pay cash dividends in the foreseeable
future. In addition, restrictions contained in our loan agreements
governing our credit facility with Comerica Bank preclude us from paying
any dividends on our common stock while any debt under those agreements is
outstanding. The payment of dividends in the future will depend on numerous
factors, including the Company's earnings, capital requirements, operating
and financial position and general business conditions.
Dividends on outstanding shares of Series A Preferred Stock were paid on
the last day of May in 2002 and 2003 in shares of stock of Series A
Preferred Stock at a rate of 0.08 shares for each outstanding share of
Series A Preferred Stock. The Company elected to convert all shares of
preferred stock to 1,149,089 shares of common stock in August 2003.
- --------------------
(1) Includes options issued through our 1998 Incentive Plan. For a brief
description of the material features of the Plan, see Note 11 of the Notes to
the Consolidated Financial Statements. Some of these options, also granted
through the 1998 Incentive Plan were options granted as replacement options for
outstanding Petrocon incentive options pursuant to the terms of the December
2001 Merger Agreement with Petrocon.
23
ITEM 6. SELECTED FINANCIAL DATA
Summary Selected Historical Consolidated Financial Data
-------------------------------------------------------
The following tables set forth our selected financial data. The data for
the years ended December 31, 2005, 2004, and 2003 have been derived from
the audited financial statements appearing elsewhere in this document. The
data as of December 31, 2003, 2002 and 2001 and for the years ended
December 31, 2002 and 2001 have been derived from audited financial
statements not appearing in this document. You should read the selected
financial data set forth below in conjunction with our financial statements
and the notes thereto included in Part II, Item 8, Part II, Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," and other financial information appearing elsewhere in this
document. In addition, the merger with Petrocon in December 2001 should be
considered in connection with your review of this information.
Note: Due to the sale of Thermaire, all items related to the previously
reported manufacturing segment have been reclassified to discontinued
operations in order to provide comparative results. Previously reported
amounts will not agree to the amounts presented below except net income.
Years Ended December 31,
-------------------------------------------------------------
2005 2004 2003 2002 2001
-------------------------------------------------------------
(in thousands, except per share amounts)
-------------------------------------------------------------
Statement of Operations
Revenues
Engineering $ 215,698 $ 133,630 $ 108,380 $ 74,971 $ 14,235
Systems 17,887 15,258 15,339 14,151 3,575
--------- --------- --------- --------- ---------
Total revenues 233,585 148,888 123,719 89,122 17,810
--------- --------- --------- --------- ---------
Costs and expenses
Engineering 189,696 117,606 93,579 62,877 10,433
Systems 15,616 13,090 13,167 11,840 3,107
Selling, general and administrative 19,689 13,700 12,439 10,632 2,836
--------- --------- --------- --------- ---------
Total costs and expenses 225,001 144,396 119,185 85,349 16,376
--------- --------- --------- --------- ---------
Operating income 8,584 4,492 4,534 3,773 1,434
Interest income (expense), net (800) (590) (784) (821) 14
Other income (expense), net 116 118 (355) 143 14
Foreign currency gain (loss) (2) -- -- -- --
--------- --------- --------- --------- ---------
Income from continuing operations before provision
for income taxes 7,898 4,020 3,395 3,095 1,462
Provision for income taxes 3,116 1,656 1,110 1,197 595
--------- --------- --------- --------- ---------
Income from operations 4,782 2,364 2,285 1,898 867
Income (loss) from discontinued operations, net of
taxes -- -- (154) (146) 115
Income from disposal of discontinued operations -- -- 26 -- --
--------- --------- --------- --------- ---------
Net income $ 4,782 $ 2,364 $ 2,157 $ 1,752 $ 982
========= ========= ========= ========= =========
24
ITEM 6. SELECTED FINANCIAL DATA (Continued)
Years Ended December 31,
--------------------------------------------------------
2005 2004 2003 2002 2001
--------------------------------------------------------
(in thousands, except per share amounts)
--------------------------------------------------------
Per Share Data
Basic earnings (loss) per share
Continuing operations $ 0.20 $ 0.10 $ 0.09 $ 0.07 $ 0.07
Discontinued operations -- -- -- -- --
-------- -------- -------- -------- --------
Net income per share $ 0.20 $ 0.10 $ 0.09 $ 0.07 $ 0.07
======== ======== ======== ======== ========
Weighted average common
shares outstanding - basic 24,300 23,455 23,301 22,861 13,236
Diluted earnings (loss) per share
Continuing operations $ 0.19 $ 0.10 $ 0.09 $ 0.07 $ 0.07
Discontinued operations -- -- -- -- --
-------- -------- -------- -------- --------
Net income per share $ 0.19 $ 0.10 $ 0.09 $ 0.07 $ 0.07
======== ======== ======== ======== ========
Weighted average common
shares outstanding - diluted 25,250 23,786 23,734 23,013 13,236
Cash Flow Data
Operating activities, net $ (920) $ (2,391) $ 6,557 $ 1,302 $ 744
Investing activities, net (2,417) (1,811) (471) (1,290) 5
Financing activities, net 3,492 4,170 (6,122) (1,182) 253
Exchange rate changes (4) -- -- -- --
-------- -------- -------- -------- --------
Net change in cash and cash equivalents $ 151 $ (32) $ (36) $ (1,170) $ 1,002
======== ======== ======== ======== ========
Balance Sheet Data
Working capital $ 21,825 $ 14,503 $ 6,505 $ 8,416 $ 5,703
Property and equipment, net $ 6,861 $ 5,262 $ 4,302 $ 4,779 $ 4,095
Total assets $ 75,936 $ 57,261 $ 42,530 $ 40,068 $ 38,286
Long-term debt, net of current portion $ 5,228 $ 15,585 $ 7,506 $ 12,580 $ 1,357
Long-term capital leases, net of current portion $ -- $ -- $ 12 $ 17 $ 48
Stockholders' equity $ 39,865 $ 20,051 $ 18,175 $ 13,389 $ 11,846
25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
The following discussion is qualified in its entirety by, and should be
read in conjunction with, our Consolidated Financial Statements including
the Notes thereto, included elsewhere in this Annual Report on Form 10-K.
Note 18 to the Financial Statements contains segment information.
Overview
--------
We furnish engineering consulting and control system services to the
petroleum refining, petrochemical, pipeline, production and processing
industries. Our business consists of two segments: engineering and systems.
Our engineering segment offers engineering consulting services to clients
for the development, management and turnkey execution of engineering
projects, construction management, and inspection services. Our systems
segment designs, assembles, programs, installs, integrates and services
control and instrumentation systems for specific applications in the energy
and processing related industries.
The Company's revenue is composed of engineering, construction and
procurement 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-price contracts.
In the course of providing our services, we routinely provide engineering,
materials, equipment and may provide construction services on a
subcontractor basis. Generally, these materials, equipment and
subcontractor costs are passed through to our clients and reimbursed, along
with fees, which in total are at margins lower than those of our normal
core business. In accordance with industry practice and generally accepted
accounting principles, all costs and fees are included in revenue. The use
of subcontractor services can change significantly from project to project;
therefore, changes in revenue may not be indicative of business trends.
For analytical purposes only, we have historically segregated from our
total revenue the revenues derived from material assets or companies
acquired during the first 12 months following their respective dates of
acquisition and referred to such revenue as "Acquisition" revenue. We also
segregate gross profits and SG&A expenses derived from material assets or
company acquisitions on the same basis as we segregate revenues. We
analyze, for internal purposes only, the percentage of our revenue that
comes from staffing services versus the percentage that comes from
engineering services, as engineering services have a higher margin than
staffing services.
Operating SG&A expense includes management and staff compensation, office
costs such as rents and utilities, depreciation, amortization, travel and
other expenses generally unrelated to specific client contracts, but
directly related to the support of a segment's operation.
Corporate SG&A expense is comprised primarily of marketing costs, as well
as costs related to the executive, governance/investor relations, finance,
accounting, safety, human resources, project controls and information
technology departments and other costs generally unrelated to specific
client projects, but which can vary as costs are incurred to support
corporate activities and initiatives.
26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION (Continued)
Results of Operations
---------------------
The following table sets forth, for the periods indicated, certain
financial data derived from our consolidated statements of operations and
indicates the percentage of total revenue for each item. The manufacturing
segment is reported in "Income/(Loss) from Discontinued Operations."
Years Ended December 31,
------------------------------------------------------------------------
2005 2004 2003
--------------------- --------------------- ---------------------
Amount % Amount % Amount %
------------------------------------------------------------------------
(in thousands)
------------------------------------------------------------------------
Revenue
Engineering $ 203,640 87.2 $ 124,507 83.6 $ 106,895 86.4
Systems 17,887 7.7 13,965 9.4 14,892 12.0
Acquisition 12,058 5.2 10,416 7.0 1,932 1.6
------------- ------------ ------- ------------- -------
Total revenue $ 233,585 100.0 $ 148,888 100.0 $ 123,719 100.0
============= ============ =============
Gross profit
Engineering $ 24,780 12.2 $ 14,351 11.5 $ 14,652 13.7
Systems 2,271 12.7 2,168 15.5 2,109 14.2
Acquisition 1,222 10.1 1,673 16.1 212 11.0
------------- ------------ -------------
Total gross profit $ 28,273 12.1 $ 18,192 12.2 $ 16,973 13.7
============= ============ =============
Selling, general and administrative
Non-acquisition $ 18,863 8.5 $ 11,866 8.0 $ 12,274 9.9
Acquisition 826 6.9 1,834 1.2 165 0.1
------------- ------------ -------------
Total $ 19,689 8.4 $ 13,700 9.2 $ 12,439 10.1
============= ============ =============
Income from continuing operations $ 4,782 2.1 $ 2,364 1.6 $ 2,285 1.8
Income (loss) on discontinued operations - - - - (128) (0.1)
------------- ------------ -------------
Net income $ 4,782 2.1 $ 2,364 1.6 $ 2,157 1.7
============= ============ =============
Total revenue increased 56.9% or $84.7 million from 2004 to 2005.
Overall gross profit increased 55.5%, or $10.1 million, from 2004 to 2005.
Total SG&A expense increased 43.8%, or $6.0 million, in 2005. Income from
continuing operations increased 102.3%, or $2.4 million.
27
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION (Continued)
Year Ended December 31, 2005 Compared to Year Ended December 31, 2004
---------------------------------------------------------------------
Total Revenue
-------------
Engineering revenue accounted for 87.2% of our total revenue for the
year, increasing $79.1 million from $124.5 million in 2004 to $203.6
million in 2005.
The increase in engineering revenue was primarily brought about by
increased activity in the engineering and construction markets.
Refining related activity has been particularly strong, including
projects to satisfy environmental mandates, expand existing facilities
and utilize heavier sour crude. Acquisitions in the fourth quarter of
2004, together with our client's increased demand for in-house
technical and inspection resources, stimulated growth in our staffing
services division where revenues increased 58.8%, or $21.4 million,
from $36.4 million in 2004 to $57.8 million in 2005.
Revenue from procurement services increased 55.5%, or $21.3 million,
from 2004 to 2005 and contributed 25.1%, or $21.3 million, of the
increase in total engineering revenue during the same period. The level
of procurement services will vary depending on the volume of
procurement activity our customers choose to do themselves as opposed
to using our services on the larger EPC contracts.
In 2005, the Company was awarded two significant fixed-price
engineering, procurement and construction ("EPC") projects in the
refining industry that includes procurement and subcontractor
activities within our scope of work. The shift to more fixed-price, EPC
type projects is expected to continue into 2006 and beyond as clients
look to sole source responsibility on the larger projects.
The systems segment contributed 7.7% of our total revenue for the year,
as its revenue increased $3.9 million, or 27.9%, from $14.0 million in
2004 to $17.9 million in revenue in 2005. A general turnaround in the
oil and gas industry has helped to increase the demand for ESI's
services. Projects from one major supplier of distributed control
systems ("DCS") equipment, together with projects from a large
engineering and construction firm, contributed most of the increase in
revenue in 2005. The completion of turnkey remote instrument enclosures
("RIE's") from projects awarded in the fourth quarter of 2004
contributed $4.7 million to ESI's revenue in 2005. Backlog for ESI at
December 31, 2005 reached $9.1 million.
Acquisition revenue, representing only 5.2% of total revenue for 2005,
increased 15.8%, or $1.6 million, during the comparable periods,
primarily from nine months of revenue generated in 2005 through
acquisitions completed in the 4th quarter of 2004.
We formerly operated a third segment, the manufacturing segment.
Certain assets of this segment were sold in December 2003 and its
financial results during 2003 are reported in "Income/(Loss) from
Discontinued Operations."
Gross Profit
------------
Total gross profit increased $10.1 million, or 55.5%, from $18.2
million in 2004 to $28.3 million in 2005 although, as a percentage of
total revenue, decreased slightly from 12.2% to 12.1% during the same
period.
Gross profit from engineering increased $10.4 million, or 72.2%, from
$14.4 million in 2004 to $24.8 million in 2005 and, as a percentage of
revenue, increased from 11.5% in 2004 to 12.2% in 2005. Gross profit
was negatively impacted by approximately $249,000 during 2005 due to
start-up expenses and non-reimbursable proposal activity conducted by
two of the Company's internal start-up initiatives, ENGlobal Sulfur
Group and ENGlobal Automation Group. The staffing services division
increased gross profit $2.4 million, or 55.8%, from $4.3 million in
2004 to $6.7 million in 2005 on margins remaining relatively stable
over the comparable periods, although such margins are approximately 1%
lower than average margins on all other engineering revenues.
28
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION (Continued)
We earn a lower margin on procurement services as compared to the
margin we earn on our core engineering services. In 2005, $21.5
million, or 25.1% of the increase in our total revenue was from
procurement services, providing a 1.7% gross profit margin. Comparably,
gross profit margin on core engineering services was 12.1%. In 2004,
procurement services produced a .4% gross profit margin. Due to the
increase in procurement services in 2005 over 2004, our overall gross
profit, as a percentage of total revenue, was negatively impacted by
4.0% and 3.6%, respectively.
Again, the shift to more fixed-price EPC type projects will negatively
impact engineering gross profit as a percentage of revenue because
higher historical cost plus margins on engineering labor recognized
during the period in which it was earned will now be combined with the
lower margins on procurement services and construction subcontractor
charges and recorded throughout the overall duration and completion of
the projects.
Gross profit for our systems segment increased $103,000, or 4.5%, from
$2.2 million in 2004 to $2.3 million in 2005. However, as a percent of
revenue, gross profit decreased by 2.8% from 15.5% in 2004 to 12.7% in
2005. The lower margin in 2005 is a result of several factors. The
increase in the workload created a shortage in shop labor which was
filled by hiring contract labor leading to inefficiencies and rework.
This led to overruns in shop labor on projects, thus dropping margins
below already tight budgeted margins. Secondly, with the increase in
proposal work, estimates of material and labor cost were
underestimated, thus causing lower profit margins. Lastly, market
pressures have driven down margins on projects overall. Corrective
measures have been taken during the first quarter of 2006 to replace
all contract labor with more stable, direct-hire employees. Additional
staffing and systems within the estimating and proposal group should
improve proposal pricing.
During the fourth quarter, ESI experienced delays in receiving major
components for a project that were being supplied by a third party
vendor. As a result, the work ESI expected to perform on such project
during 2005 will be completed in 2006, resulting in a corresponding
delay in our recognition of revenues and profits.
One current project representing 25% of the systems segment's backlog
at December 31, 2005 has a 13.6% budgeted margin.
Selling, General and Administrative ("SG&A") Expenses
-----------------------------------------------------
Selling, general and administrative expenses increased $6.0 million, or
43.8%, from $13.7 million in 2004 to $19.7 million in 2005, primarily
due to increases in salaries and burdens, facilities and office
expenses, and travel. However, as a percent of revenue, SG&A decreased
.8% from 9.2% in 2004 to 8.4% in 2005.
Salaries and burden expenses increased $3.6 million in 2005 over 2004.
$1.0 million of this increase was related to additional incentives paid
under the 2005 incentive plans. An additional $1.0 million of the
increase was due to increases in corporate salaries, primarily in
Business Development, Accounting and Project Controls, to support
Company growth. The remainder of the increase came from increases in
operation salaries and burdens primarily due to increases in
administrative staffing from acquisitions, EAG's start-up during the
year, ESI's expansion into the Beaumont area, and increases in their
administrative support staffing in the Houston facility; plus
additional overhead due to the growth of EEI's offices in Beaumont and
Tulsa.
29
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION (Continued)
Facilities and office expenses increased $1.4 million in 2005 over 2004
due to the expansion of EEI's offices in Tulsa, Houston, Dallas, and
Beaumont to meet both current and projected growth requirements, plus
the additional cost of facilities utilized by acquisitions made in the
fourth quarter of 2004.
Increased business development activity pushed marketing and travel
expenses up by almost $500,000 in 2005 over similar expenses in 2004.
Operating Profit
----------------
Operating profit increased $4.1 million to $8.6 million in 2005 as
compared to $4.5 million in 2004, increasing, as a percentage of total
revenue, from 3.0% in 2004 to 3.7% in 2005. Although operating profit
for 2005 exceeded operating profit for 2004, our net operating profit
for the fourth quarter of 2005 was down approximately $1.2 million, or
39%, over third quarter operating results, primarily due to losses of
approximately $659,000 in start-up expenses and non-reimbursable
proposal activity conducted by two of the Company's internal start-up
initiatives, ENGlobal Sulfur Group and EAG. For 2005, the combined
operating loss for both groups was approximately $817,000.
Other Income (Expense)
----------------------
Other income decreased from $118,000 in 2004 to $116,000 in 2005. The
income in 2004 resulted from a legal settlement. The income in 2005 was
derived from distributions from PEI Investments, insurance proceeds
from Hurricane Rita losses, and income from the sale of assets,
partially offset by a reclassification of financing costs.
30
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION (Continued)
Year Ended December 31, 2004 Compared to Year Ended December 31, 2003
---------------------------------------------------------------------
Total Revenue
-------------
Total engineering revenue accounted for 83.6% of our total revenue for
the year, increasing $17.6 million from $106.9 million in revenue in
2003 to $124.5 million in revenue in 2004.
Revenue from procurement services increased $9.2 million in 2004, or
52% of the total increase in engineering revenue. This was the result
of additional revenue of $25.5 million on a co-generation project that
began in 2003, offset by $16.3 million in lower revenue from a
cyclohexane project that began in 2002. The remaining increase of $8.4
million in revenue came from an additional $4.9 million through the
Tulsa office, $2.4 million through the Beaumont office and $1.1 million
from all other office locations. Our engineering segment has been
successful in obtaining major projects in the petroleum refining
industry in the mid-continent area for the Tulsa office, but we do not
currently have a project that would replace the co-generation project
when it is completed in the Beaumont office.
In 2005, the Company was awarded two significant projects to be
completed primarily out of our Tulsa office. Coffeyville Resources
Refining & Marketing, LLC ("CRRM") has entered into an agreement with
ENGlobal for detailed engineering and procurement services for CRRM's
ultra low sulfur diesel fuel facilities at its Coffeyville, Kansas
refinery on a cost reimbursable basis. We estimate that the agreement
will result in approximately 150,000 man-hours in engineering and
related activities in addition to a significant amount of revenue
attributable to the procurement of materials and equipment. The project
began in January 2005 and is scheduled to conclude in the third quarter
of 2006. Frontier Refining, Inc. has awarded ENGlobal a contract to
provide lump sum turnkey services for engineering, procurement and
construction for modifications to produce ultra low sulfur diesel at
Frontier's Cheyenne, Wyoming refinery. The Company estimates revenue
from the Frontier contract to be approximately $7 million. The project
began in February 2005 and is scheduled to complete in the spring of
2006.
The systems segment contributed 9.4% of our total revenue for the year,
as its revenue declined $900,000 from $14.9 million in 2003 to $14.0
million in revenue in 2004. Our systems segment began 2005 with a
project backlog of $7.6 million, representing the largest booking of
new work in the segment's history.
During the fourth quarter of 2004, the systems segment was awarded
projects totaling $2.8 million from Honeywell to build eight turnkey
remote instrument enclosures ("RIEs") of which six units are scheduled
for completion during the second quarter and additional units following
in the third and fourth quarters of 2005. In the first quarter of 2005,
Honeywell awarded the Company three additional turnkey RIEs totaling
$1.6 million with one unit scheduled for delivery in the second quarter
and two units scheduled for delivery in the fourth quarter of 2005.
31
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION (Continued)
Revenue from acquired companies accounted for 7.0% of our total revenue
during 2004, increasing by $8.5 million or 447% from $1.9 million in
revenue in 2003 to $10.4 million in revenue in 2004. Revenue recognized
from acquired assets or companies during the first 12 months of their
operation within ENGlobal is referred to as "Acquisition" revenue.
Acquisition revenue in 2004 includes revenue of $3.6 million, $3.3
million, $1.7 million, $1.3 million and $500,000 from EDG, CIS,
Petro-Chem, Senftleber and AmTech, respectively.
We formerly operated a third segment, the manufacturing segment.
Certain assets of this segment were sold in December 2003 and March
2005 and its financial results during 2003 and 2004 are reported in
"Income/(Loss) from Discontinued Operations."
Gross Profit
------------
Gross profit from our engineering segment decreased $301,000 from $14.7
million in 2003 to $14.4 million in 2004. Gross profit declined as a
percent of revenue from 13.7% in 2003 to 11.5% in 2004. This decrease
was the result of higher non-project labor cost invested in estimating
larger EPC projects and in internal growth initiatives such as low
sulfur diesel. Margins from our field service operations were lower by
.3% primarily due to the impact of integration costs and recognition of
lower profits on $3.3 million in revenue generated by the acquisition
of CIS during the last quarter of 2004.
Gross profit for our systems segment increased $100,000 or 4.8% from
$2.1 million in 2003 to $2.2 million in 2004. Competitive market
pressures on pricing, project management, cost containment against
project budgets, and stronger support service controls continue to
provide challenges for management in response to growth initiatives and
record backlog levels. The acquisition of contract rights and other
assets from InfoTech during the fourth quarter of 2004 could have a
short-term negative impact on the systems segment's gross profit until
new employees and new projects are fully integrated into the Company's
operations.
Gross profits from acquisitions increased $1.5 million or 689.2% from
$200,000 in 2003 to $1.7 million in 2004. Gross profit from acquired
assets or companies during their first 12 months of operations within
the Company is recorded and referred to as "Acquisition" gross profit.
Acquisition gross profit in 2004 includes gross profit of $800,000,
$400,000, $200,000, $200,000, and $100,000 from EDG, CIS, Petro-Chem,
Senftleber and AmTech, respectively.
32
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION (Continued)
Selling, General and Administrative ("SG&A") Expenses
-----------------------------------------------------
Selling, general and administrative expenses not related to
acquisitions decreased $300,000 from $16.8 million in 2003 to $16.5
million in 2004. Depreciation expenses of $401,400 were reclassed from
SG&A expenses to direct costs for presentation in the consolidated
statements of income included herein in 2004. As depreciation expense
in 2003 related to direct costs was immaterial, no reclassification was
made for that year.
In March 2004, the Company announced organizational changes intended to
reduce overhead and enhance profitability. The Company eliminated four
operational facilities and consolidated offices to improve efficiency.
For example, effective January 2004, within the systems segment, ECP
relocated offices and shop facilities into the same facility as ESI
resulting in improved shop personnel utilization, reduction of
duplicative overhead functions and reduction of facility expenses. As a
result, during 2004, the systems segment SG&A expenses decreased
$500,000 or 28.6% from $2.0 million in 2003 to $1.5 million in 2004.
Corporate SG&A charges increased $198,000 due to additional software
enhancements to our billings system to meet client format demands, plus
$222,000 related to proposal and internal growth initiatives.
Engineering SG&A expenses increased $80,000 due to numerous
miscellaneous items.
SG&A expenses from acquisitions increased $1.7 million from $165,000 in
2003 to $1.8 million in 2004. SG&A expenses from acquired assets or
companies during their first 12 months of operations within the Company
have been recorded and are referred to as "Acquisition" under SG&A
expenses. Acquisition SG&A in 2004 includes $1.3 million, $250,000, and
$150,000 from EDG, CIS, Petro-Chem respectively, plus $100,000 for all
other acquisition activity.
Operating Profit
----------------
Operating profit remained constant at $4.5 million in 2003 and 2004,
decreasing as a percentage of total revenue from 3.7% in 2003 to 3.0%
in 2004.
Other Income (Expense)
----------------------
Other income (expense) changed from $355,000 expense in 2003 to
$118,000 income in 2004. The expense in 2003 was the result of a book
basis loss on the sale of the vacant office building in Baton Rouge, as
compared to the income in 2004, which resulted from a legal settlement.
Liquidity and Capital Resources
-------------------------------
Historically, we have satisfied our cash requirements through operations
and borrowings under a revolving credit facility. The Company's current
credit facility is with Comerica Bank ("Comerica") and consists of a line
of credit maturing July 27, 2007. The loan agreement positions Comerica as
senior to all other debt. The line of credit is limited to $22.0 million
subject to loan covenant restrictions. The Comerica Credit Facility is
collateralized by substantially all the assets of the Company. As of
December 31, 2005, the outstanding balance on the line of credit was $3.8
million and we had working capital of $22.0 million. Our total long-term
debt outstanding on December 31, 2005 was $5.2 million (see Note 8), a
decrease from $15.6 million as of December 31, 2004. Under the terms and
conditions of our revolving credit facility, as of December 31, 2005, we
have additional borrowing capacity of approximately $12.0 million after
consideration of borrowing base limitations and outstanding letters of
credit of $6.2 million at December 31, 2005.
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 down our existing line-of-credit debt.
33
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION (Continued)
The Company has been awarded a significant project with a central states
refinery and entered into an Agreement for Engineering and Procurement
Services to provide detailed engineering and procurement services for ultra
low sulphur diesel fuel facilities on a cost reimbursable basis. The terms
of the agreement require that any progress payments made by our client for
engineered and manufactured 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 complete in the third
quarter of 2006.
The following table summarizes our contractual obligations as of December
31, 2005:
Payments Due by Period
---------------------------------------------------------
2006 2007 2008 2009 2010 and Total
thereafter
------- ------- ------- ------- --------- -------
(in thousands)
---------------------------------------------------------
Long-term debt(1) $ 910 $ 4,724 $ 486 $ 403 $ -- $ 6,523
Operating leases 2,227 2,482 1,520 1,507 1,772 9,508
------- ------- ------- ------- ------- -------
Total contractual cash obligations $ 3,137 $ 7,206 $ 2,006 $ 1,910 $ 1,772 $16,031
======= ======= ======= ======= ======= =======
(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 December 31, 2005. The Company's interest rate
on its revolving credit facility fluctuates with the prime rate.
Cash Flow
---------
Operating activities required the use of $920,000 and $2.4 million in net
cash for the fiscal years ended December 31, 2005 and December 31, 2004,
respectively. 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 2006 and beyond. Future uses of cash in operations will continue to be
primarily for labor and material costs required in connection with contract
performance.
Our cash flow has been negatively impacted beginning in the fourth quarter
of 2005 by a slow-down in our ability to invoice certain clients primarily
due to the temporary relocation of the accounting department to Houston in
early October followed by its relocation to Beaumont in mid-November. In
addition, we have experienced slower collections of our accounts receivable
from our Beaumont and Lake Charles customers as a result of Hurricanes Rita
and Katrina. The accounting and invoice functions are fully restored and we
believe the collection situation is temporary pending recovery from the
hurricanes.
Investing activities used cash totaling $2.4 million in 2005, compared to
$1.8 in 2004 and $500,000 in 2003. In 2005, our investing activities
consisted of capital additions of $3.2 million primarily for computers and
leasehold improvements to our offices. In the first quarter of 2005, we
completed the sale of the Thermaire building, receiving $823,000 in cash
from the sale. We used $625,000 in the fourth quarter of 2004 to complete
the acquisitions of EDGI, AmTech, Cleveland Inspection Services, Inc., and
InfoTech. 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. On December 31, 2005, we amended our line of credit to permit an
increase in annual capital expenditure limits from $2.5 million to $3.25
million.
Financing activities provided cash totaling $3.5 million and $4.2 million
in 2005 and 2004, respectively. Financing activities used $6.1 million
during 2003. Our primary financing mechanism is our revolving line of
credit. The line of credit has been used principally to finance accounts
receivable. During 2005, our borrowings, on the line of credit were $92.2
million, and we repaid an aggregate of $101.9 million on our short-term and
long-term bank and other debt. On September 30, 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.
34
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION (Continued)
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, including interest for the coming year, are
estimated to be $910,000.
In addition, our cash flow was impacted during the fourth quarter of 2005
by our decision to pay $1.0 million in insurance renewals rather than
financing that payment, by investing $1.0 million in capital expenditures
and by funding our
growth. We also extended hardship allowances in an aggregate amount of
$192,000 to a number of our employees to assist them with hurricane
recovery. Most of this amount has been repaid.
The Company's requirement on its letters of credit for a major project has
declined from $6.9 million in January 2006 to $3.1 million in February
2006. We believe that all letter of credit obligations on this project will
be fulfilled by May 2006.
There were no significant non-cash transactions in 2005. In 2004, non-cash
transactions include $2.6 million notes payable issued related to
acquisitions and $592,000 note payable issued for treasury stock. During
2003, our preferred stock was converted to common stock valued at $27
million. We also acquired insurance with notes payable of $198,000, $1.1
million, and $1.1 million in 2005, 2004, and 2003, respectively.
The Company believes that it has available necessary cash 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 into accounts receivable, if such accounts are not
collected timely, or if our project mix shifts from cost reimbursable to
fixed cost contracts during significant periods of growth.
If losses occur, we may not be able to meet our monthly fixed charge ratio
covenant under our credit facility with Comerica. In that event, if we are
unable to obtain a waiver or amendment of the covenant, we may be unable to
make further borrowings and may be required to repay all loans then
outstanding under the credit facility.
We do not hold any derivative financial instruments for trading purposes or
otherwise. Furthermore, we have not engaged in energy or commodity trading
activities and do not anticipate doing so in the future, nor do we have any
transactions involving unconsolidated entities or special purpose entities.
Asset Management
----------------
We typically sell our products and services on short-term credit and seek
to minimize our credit risk by performing credit checks and conducting our
own collection efforts. Our trade accounts receivable increased to $46.2
million from $30.8 million as of December 31, 2005 and 2004, respectively,
primarily due to increased revenue growth. The number of days outstanding
for trade accounts receivable decreased from 62 days at December 31, 2004
to 59 days at December 31, 2005. Our actual bad debt expense has been
approximately 0.05% and 0.02% of revenues for the periods ending December
31, 2005 and 2004. We increased our allowance for doubtful accounts from
$476,000 to $503,000 or 1.5% and 1.1% of the trade accounts receivable
balance for 2004 and 2005, respectively.
Related Party Transactions
--------------------------
ENGlobal Engineering, Inc. leases office space from PEI Investments, a
joint venture in which ENGlobal Engineering, Inc. has a one-third interest,
Michael L. Burrow (the Company's CEO) has a one-third interest, and a
stockholder who owns less than 1% of the Company's common stock has a
one-third interest. Rentals paid under the lease were $105,000, $135,000
and $135,000 for 2005, 2004 and 2003, respectively. The lease was renewed
in August 2005. In September 2005, the building was damaged by Hurricane
Rita and all tenants have relocated to other locations. No further lease
payments have been made by the Company since September 2005 and the
insurance claim filed by PEI Investments remains unsettled.
35
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION (Continued)
Risk Management
---------------
In performing services for our clients, we could potentially be liable for
breach of contract, personal injury, property damage or negligence,
including professional errors and omissions. We often agree to indemnify
our clients for losses and expenses incurred as a result of our negligence
and, in certain cases, the concurrent negligence of our clients. Our
quality control and assurance program includes a control function to
establish standards and procedures for performance and for documentation of
project tasks, and an assurance function to audit and to monitor compliance
with procedures and quality standards. We maintain liability insurance for
bodily injury and third-party property damage, professional errors and
omissions, and workers compensation coverage, which we consider sufficient
to insure against these risks, subject to self-insured amounts.
Seasonality
-----------
Holidays and employee vacations during our fourth quarter exert downward
pressure on revenues for that quarter, which is only partially offset by
the year-end efforts on the part of many clients to spend any remaining
funds budgeted for engineering services or capital expenditures during the
year. The annual budgeting and approval process under which these clients
operate is normally not completed until after the beginning of each
new-year, which can depress results for the first quarter. Principally due
to these factors, our revenues during the first and fourth quarters
generally tend to be lower than in the second and third quarters.
Critical Accounting Policies
----------------------------
Revenue Recognition
-------------------
Because the majority of the Company's revenues are 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.
Our revenues are largely composed of engineering service revenue and
product sales. The majority of our services are provided through
time-and-material contracts (also referred to as cost-plus contracts),
many of which have not-to-exceed provisions that place a cap on the
revenue that we may receive under a particular contract. These time and
material billings are produced every two weeks.
On occasion, we serve as purchasing agent by procuring subcontractors,
material and equipment on behalf of a client and passing the cost on to
the client with no mark-up or profit. In accordance with Statement of
Position ("SOP") 81-1, revenues and costs for these type purchases are
not included in total revenues and costs. For financial reporting this
"pass-through" type of transaction is reported net.
Profits and losses on fixed-fee contracts are recorded on the
percentage-of-completion method of accounting, measured by the
percentage-of-contract costs incurred to date to estimated total
contract costs for each contract. Contract costs include amounts paid
to subcontractors. Anticipated losses on uncompleted construction
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.
The asset, "costs and estimated earnings in excess of billings on
uncompleted contracts," represents revenues recognized in excess of
amounts billed on fixed-fee contracts. The liability "billings in
excess of costs and estimated profits on uncompleted contracts"
represents amounts billed in excess of revenues recognized on fixed-fee
contracts.
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.
In conjunction with each acquisition, we must allocate the cost of the
acquired entity to the assets and liabilities assumed based on their
estimated fair values at the date of acquisition. As additional
36
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION (Continued)
information becomes available, adjustments may be made to the original
estimates within a short time subsequent to the acquisition. Goodwill
is not amortized but instead is periodically assessed for impairment.
The impairment testing entails estimating current market value of the
segments, based on management's estimate of market conditions including
pricing, demand, competition, operating costs and other factors.
Determining the fair value of assets and liabilities acquired involves
professional judgment and is ultimately based on management's
assessment of the value of the assets acquired. We believe our
estimates for these items are reasonable, but there is no assurance
that actual amounts will not vary significantly from estimated amounts.
Consistent with SFAS 142, we have not amortized goodwill related to the
merger with Petrocon, but instead tested the balance for impairment.
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 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. 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.
Recent Accounting Pronouncements
--------------------------------
In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 123, (revised 2004) "Share-Based Payment" ("SFAS 123(R)").
This statement is a revision of Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation" as amended ("SFAS123"),
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 123(R) covers various share-based
compensation arrangement rights and employee share purchase plans. SFAS
123(R) 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
123(R) is effective as of the beginning of the first interim period that
begins after June 15, 2005, with early adoption encouraged. The Company is
currently evaluating the statement's transition methods and does not expect
this statement to have an effect materially different than that of the pro
forma SFAS 123 disclosures provided in Note 11 to the Company's
Consolidated Financial Statements.
In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 153, "Exchanges of Non-monetary Assets, an amendment of APB
Opinion No. 29" ("SFAS 153"). This Statement amends APB Opinion No. 29 to
permit the exchange of non-monetary assets to be recorded on a carry over
basis when the non-monetary assets do not have commercial substance. This
is an exception to the basic measurement principal of measuring a
non-monetary asset exchange at fair value. A non-monetary asset exchange
has commercial substance if the future cash flows of the entity are
expected to change significantly as a result of the exchange. SFAS 153 is
effective for non-monetary asset exchanges occurring in fiscal periods
beginning after June 15, 2005. The adoption of this standard is not
expected to impact the Company's Consolidated Financial Statements.
37
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION (Continued)
In January 2003, the Financial Accounting Standard Board ("FASB") issued
Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest
Entities." FIN 46 clarifies the application of Accounting Research Bulletin
No. 51, "Consolidated Financial Statements," and addresses consolidation by
business enterprises of variable interest entities (more commonly known as
"Special Purpose Entities" or "SPE's"). In December 2003, FASB issued FIN
No. 46R which replaced FIN 46 and clarified ARB 51. This interpretation
provides guidance on how to identify a variable interest entity and
determine when the assets, liabilities, non-controlling interests and
results of operations of a variable interest entity should be consolidated
by the primary beneficiary. The primary beneficiary is the enterprise that
will absorb a majority of the variable interest entity's expected losses or
receive a majority of the expected residual returns as a result of holding
variable interests. This FIN requires the consolidation of results of
variable interest entities in which the Company is the primary beneficiary
of the variable interest entity. As of December 31, 2005, the Company did
not own an interest in a variable interest entity that met the
consolidation requirements and as such the adoption of FIN No. 46R did not
have any effect on the financial condition, results of operations, or
liquidity of the Company. Interests in entities acquired or created after
December 31, 2003 will be evaluated based on FIN No. 46R criteria and
consolidated, if required.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of December 31, 2005 and 2004, the Company did not participate in any
derivative financial instruments or other financial and commodity
instruments for which fair value disclosure would be required under SFAS No
107. There are no investments at December 31, 2005. Accordingly, the
Company has no quantitative information concerning the market risk of
participating in such investments.
As of December 31, 2005 and 2004, the Company did not participate in any
derivative financial instruments or other financial and commodity
instruments for which fair value disclosure would be required under SFAS
No. 133.
The Company's primary interest rate risk relates to its variable-rate line
of credit debt obligation, which totaled $3.8 million and $13.5 million as
of December 31, 2005 and 2004, respectively. Assuming a 10% increase in the
interest rate on this variable-rate debt obligation (i.e., an increase from
the actual average interest rate of 6.19% as of December 31, 2005, to an
average interest rate of 6.81%), annual interest expense would have been
approximately $47,000 higher in 2005 based on the annual average balance.
The Company does not have any interest rate swap or exchange agreements.
The Company has no market risk exposure in the areas of interest rate risk
from investments because the Company did not have an investment portfolio
as of December 31, 2005.
Currently, the Company does not engage in foreign currency hedging
activities. Transactions in Canadian dollars in our Canadian subsidiary
have been translated into U.S. dollars using the current rate method, such
that assets and liabilities are translated at the rates of exchange in
effect at the balance sheet date and revenue and expenses are translated at
the average rates of exchange during the appropriate fiscal period. As a
result, the carrying value of the Company's investments in Canada is
subject to the risk of foreign currency fluctuations. Additionally, any
revenues received from the Company's international operations in other than
U.S. dollars will be subject to foreign exchange risk.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMTARY DATA
The audited consolidated balance sheets for ENGlobal Corporation, as of
December 31, 2005 and 2004 and statements of income, cash flows and
stockholders' equity for the three-year period ended December 31, 2005, are
attached hereto and made part hereof.
38
INDEX
Page
-------------
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 40
CONSOLIDATED BALANCE SHEETS
December 31, 2005 and 2004 41
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2005, 2004 and 2003 42
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 2005, 2004 and 2003 43
CONSOLIDATED STATEMENTS OF CASH FLOW
Years Ended December 31, 2005, 2004 and 2003 44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 45
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON FINANCIAL STATEMENT SCHEDULE 67
SCHEDULE II
Valuation and Qualifying Accounts 68
39
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
ENGlobal Corporation
We have audited the accompanying consolidated balance sheets of ENGlobal
Corporation as of December 31, 2005 and 2004, and the related consolidated
statements of income, stockholders' equity and cash flows for each of the years
in the three-year period ended December 31, 2005. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. The Company
has determined that it is not required to have, nor were we engaged to perform,
an audit of its internal controls over financial reporting. Our audit included
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the Company's
internal control over financial reporting. Accordingly, we express no such
opinion. An audit also includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
ENGlobal Corporation and Subsidiaries as of December 31, 2005 and 2004, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2005, in conformity with U.S. generally
accepted accounting principles.
/s/ Hein & Associates LLP
- -------------------------
Hein & Associates LLP
Houston, Texas
March 17, 2006
40
ENGLOBAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2005 AND 2004
ASSETS
------
2005 2004
Current Assets ------------ ------------
Cash $ 159,414 $ 8,006
Trade receivables, net 46,248,458 30,839,597
Prepaid expenses and other current assets 1,600,369 1,984,274
Costs and estimated earnings in excess of billings on uncompleted contracts 4,148,275 1,113,330
Deferred tax asset 305,258 640,380
Inventories 153,968 172,715
Assets held for sale -- 678,106
Federal income taxes receivable 52,818 118,000
------------ ------------
Total Current Assets 52,668,560 35,554,408
Property and Equipment, net 6,861,361 5,262,370
Goodwill 15,454,583 15,284,220
Non-current Deferred Tax Asset 74,892 --
Other Assets 876,534 1,159,750
------------ ------------
Total Assets $ 75,935,930 $ 57,260,748
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current Liabilities
Accounts payable $ 15,211,331 $ 10,512,123
Accrued compensation and benefits 9,799,074 6,059,221
Notes payable -- 839,606
Deferred rent 361,292 --
Current portion of long-term debt 547,934 622,410
Current portion of capital lease -- 4,371
Billings and estimated earnings in excess of costs on uncompleted contracts 3,775,625 2,313,954
Other liabilities 1,148,079 699,601
------------ ------------
Total Current Liabilities 30,843,335 21,051,286
Long-Term Debt, net of current portion 5,227,976 15,585,152
Deferred Tax Liability -- 573,380
------------ ------------
Total Liabilities 36,071,311 37,209,818
------------ ------------
Commitments and Contingencies (Notes 9, 10, 12, 16, 19 and 20)
Stockholders' Equity
Series A redeemable convertible preferred stock - $0.001 par value, with
fair value of $1.00 per share; 2,265,167 shares authorized 2005 and
2004, respectively; 0 shares issued and outstanding 2005 and 2004,
respectively -- --
Common stock - $0.001 par value; 75,000,000 shares authorized; 26,289,567
and 23,466,839 shares outstanding and 26,941,944 and 24,119,216 issued
at December 31, 2005 and 2004, respectively 26,941 24,119
Additional paid-in capital 27,230,332 12,198,215
Retained earnings 13,203,208 8,420,827
Treasury stock - 652,377 shares at cost (592,231) (592,231)
Accumulated other comprehensive income (loss) (3,631) --
------------ ------------
Total Stockholders' Equity 39,864,619 20,050,930
------------ ------------
Total Liabilities and Stockholders' Equity $ 75,935,930 $ 57,260,748
============ ============
See accompanying notes to these consolidated financial statements.
41
ENGLOBAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31,
-----------------------------------------------
2005 2004 2003
------------- ------------- -------------
Operating Revenues
Engineering $ 215,698,073 $ 133,630,281 $ 108,380,100
Systems 17,886,760 15,257,960 15,339,002
------------- ------------- -------------
Total Revenue 233,584,833 148,888,241 123,719,102
------------- ------------- -------------
Direct Costs
Engineering 189,696,352 117,606,309 93,578,716
Systems 15,615,821 13,089,874 13,166,811
------------- ------------- -------------
Total Direct Costs 205,312,173 130,696,183 106,745,527
------------- ------------- -------------
Gross Profit 28,272,660 18,192,058 16,973,575
Selling, General, and Administrative Expenses 19,688,765 13,700,088 12,439,408
------------- ------------- -------------
Operating Income 8,583,895 4,491,970 4,534,167
Interest Expense (800,072) (590,227) (784,227)
Other income (expense) 114,538 118,409 (355,175)
------------- ------------- -------------
Income from Continuing Operations
before Provisions for Income Taxes 7,898,361 4,020,152 3,394,765
Provision for Income Taxes 3,115,980 1,655,763 1,109,496
------------- ------------- -------------
Income from Continuing Operations 4,782,381 2,364,389 2,285,269
Income/(Loss) from Discontinued Operations
Loss from operations of discontinued segment,
net of tax of $75,066 -- -- (154,615)
Gain from sale of discontinued segment,
net of tax of $12,834 -- -- 26,434
------------- ------------- -------------
Net Income 4,782,381 2,364,389 2,157,088
Preferred Dividends -- -- 131,100
------------- ------------- -------------
Net Income Available for Common Stock $ 4,782,381 $ 2,364,389 $ 2,025,988
============= ============= =============
Basic Earnings per Share from Continuing Operations $ 0.20 $ 0.10 $ 0.09
Basic Earnings per Share from Discontinued Operations -- -- --
------------- ------------- -------------
Basic Earnings per Share from Net Income $ 0.20 $ 0.10 $ 0.09
Available for Common Stock
============= ============= =============
Weighted Average Common Shares Outstanding for Basic 24,300,114 23,454,545 23,300,600
============= ============= =============
Diluted Earnings per Share from Continuing Operations $ 0.19 $ 0.10 $ 0.09
Diluted Earnings per Share from Discontinued Operations -- -- --
------------- ------------- -------------
Diluted Earnings per Share from Income $ 0.19 $ 0.10 $ 0.09
Available for Common Stock
============= ============= =============
Weighted Average Common Shares Outstanding for Diluted 25,250,487 23,785,939 23,733,807
============= ============= =============
See accompanying notes to these consolidated financial statements.
42
ENGLOBAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
Accumulated
Common Stock Additional Comprehensive Total
--------------------------- Paid-In Income Retained Treasury Stockholders'
Shares Stock Capital (Loss) Earnings Stock Equity
------------ ------------ ------------ ------------ ------------ ------------ ------------
BALANCES-JANUARY 1, 2003 22,861,199 $ 22,862 $ 9,335,471 $ -- $ 4,030,448 $ -- $ 13,388,781
Preferred stock dividend -- -- -- -- (131,098) -- (131,098)
Conversion of preferred stock
2.38 preferred shares to
each common share 1,149,089 1,148 2,733,685 -- -- -- 2,734,833
Exercise of stock options 24,000 24 25,226 -- -- -- 25,250
Net income -- -- -- -- 2,157,088 -- 2,157,088
------------ ------------ ------------ ------------ ------------ ------------ ------------
BALANCES-DECEMBER 31, 2003 24,034,288 24,034 12,094,382 -- 6,056,438 -- 18,174,854
Exercise of options 38,242 38 42,474 -- -- -- 42,512
Common stock purchased for
treasury (652,377) -- -- -- -- (592,231) (592,231)
Common stock issued through
employee stock purchase
plan 46,686 47 61,359 -- -- -- 61,406
Net income -- -- -- -- 2,364,389 -- 2,364,389
------------ ------------ ------------ ------------ ------------ ------------ ------------
BALANCES-DECEMBER 31, 2004 23,466,839 24,119 12,198,215 -- 8,420,827 (592,231) 20,050,930
Exercise of options 727,793 728 1,484,981 -- -- -- 1,485,709
Common stock issued through
employee stock purchase
plan 94,935 94 231,044 -- -- -- 231,138
Common stock issued through
private placement 2,000,000 2,000 13,071,092 -- -- -- 13,073,092
Tax benefit of non-qualified
options exercised -- -- 245,000 -- -- -- 245,000
Net income -- -- -- -- 4,782,381 -- 4,782,381
Comprehensive income:
Foreign currency
translation adjustment -- -- -- (3,631) -- -- (3,631)
------------ ------------ ------------ ------------ ------------ ------------ ------------
BALANCES-DECEMBER 31, 2005 26,289,567 $ 26,941 $ 27,230,332 $ (3,631) $ 13,203,208 $ (592,231) $ 39,864,619
============ ============ ============ ============ ============ ============ ============
See accompanying notes to these consolidated financial statements.
43
ENGLOBAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
---------------------------------------------
2005 2004 2003
------------- ------------- -------------
Cash Flows from Operating Activities
Net income $ 4,782,381 $ 2,364,389 $ 2,157,088
Adjustments to reconcile net income to net cash
provided by (used in) operating activities -
Depreciation and amortization 1,836,376 1,246,532 824,476
Deferred income tax expense (313,150) 254,000 542,000
(Gain) Loss on disposal of property, plant and equipment (131,732) 2,564 312,307
Changes in current assets and liabilities, net of acquisitions -
Trade receivables (15,462,947) (10,595,425) (3,947,817)
Inventories 18,747 (54,375) 110,056
Costs and estimated earnings in excess of billings (2,980,859) (90,604) 1,020,877
Prepaid expenses and other assets 630,559 231,401 372,419
Accounts payable 4,699,207 691,093 5,695,662
Accrued compensation and benefits 3,739,853 1,713,253 403,724
Billings in excess of costs and estimated earnings 1,461,670 1,939,616 (437,506)
Other liabilities 326,655 128,114 (280,166)
Income taxes receivable (payable) 473,523 (221,610) (215,619)
------------- ------------- -------------
Net cash provided by (used in) operating activities (919,717) (2,391,052) 6,557,501
------------- ------------- -------------
Cash Flows from Investing Activities
Purchase of property and equipment (3,229,925) (1,195,588) (1,146,351)
Proceeds from sale of property -- -- 554,866
Additional consideration for acquisitions (26,368) (625,000) (424,900)
Proceeds from sale of equipment 15,400 9,897 --
Proceeds from sale of Thermaire 823,350 -- 545,198
------------- ------------- -------------
Net cash used in investing activities (2,417,543) (1,810,691) (471,187)
------------- ------------- -------------
Cash Flows from Financing Activities
Borrowings on line of credit 92,151,545 134,571,349 127,650,133
Payments on line of credit (101,907,187) (126,597,915) (132,178,422)
Proceeds from issuance of common stock 15,034,940 103,918 25,250
Short-term borrowings (repayments) (1,037,399) (1,071,885) (484,023)
Capital lease repayments (4,371) (12,478) (4,364)
Long-term debt repayments (745,229) (2,822,679) (1,130,544)
------------- ------------- -------------
Net cash provided by (used in) financing activities 3,492,299 4,170,310 (6,121,970)
Effect of Exchange Rate Changes on Cash (3,631) -- --
------------- ------------- -------------
Net Change in Cash and Cash Equivalents 151,408 (31,433) (35,656)
Cash and Cash Equivalents - beginning of year 8,006 39,439 75,095
------------- ------------- -------------
Cash and Cash Equivalents - end of year $ 159,414 $ 8,006 $ 39,439
============= ============= =============
Non-Cash Transactions
Stock issued for preferred dividend $ -- $ -- $ 146,833
Insurance acquired with notes payable 197,794 1,092,096 1,085,363
Conversion of preferred stock to common stock -- -- 2,734,834
Acquisition of assets of EDG, AmTech, CIS and InfoTech with
issuance of notes payable -- 2,575,000 --
Acquisition of treasury stock with note payable -- 592,231 --
Supplemental Cash Flow Information
Cash paid during the year for -
Interest $ 890,266 $ 420,627 $ 771,793
State and federal income taxes 2,959,133 1,196,761 734,615
Dividend payment -- -- 105,040
Refund from state franchise taxes 48,531 -- --
See accompanying notes to these consolidated financial statements.
44
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BACKGROUND AND BASIS OF PRESENTATION
Basis of Presentation
---------------------
Our consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America.
Our Company consolidates all of its wholly-owned subsidiaries and all
significant inter-company accounts and transactions have been eliminated in
the consolidation.
Organization
------------
Brief descriptions of the active companies included in the consolidated
group follow:
ENGlobal Corporation ("ENGlobal") - our public holding company.
ENGlobal Corporate Services, Inc. ("ECS") - provides the corporate
oversight function.
ENGlobal Engineering, Inc. ("EEI") - provides general engineering,
construction and procurement services for industrial customers
primarily in the United States with specialties in the areas of
distributive control systems, power distribution, process design and
process safety management.
ENGlobal Construction Resources, Inc. ("ECR") - provides technical and
inspection personnel within client facilities for the petroleum
industry.
RPM Engineering, Inc. d/b/a ENGlobal Engineering, Inc. ("RPM") -
provides engineering services primarily in southeast Louisiana.
ENGlobal Systems, Inc. ("ESI") - provides design, fabrication,
installation, start-up, checkout and maintenance of specialized
systems such as programmable logic controller (PLC) systems
integration, supervisory controls and data acquisition (SCADA) and
triple modular redundancy (TMR) systems, distribution control system
(DCS), and analyzer systems.
ENGlobal Automation Group, Inc. ("EAG") - formerly ENGlobal
Technologies, Inc. ("ETI") - provides service relating to the
implementation of process controls, advanced automation, and
information technology projects.
ENGlobal Technical Services, Inc. ("ETS") - formerly ENGlobal Design
Group, Inc. ("EDG") - provides design, installation and maintenance of
various government and public sector facilities, the most active
sector being Automated Fuel Handling Systems serving the U.S.
Military.
ENGlobal Canada, ULC - provides engineering services relating to the
implementation of process controls, instrumentation, advanced
automation and information technology projects.
45
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash
----
Cash includes cash in bank at December 31, 2005. The Company's banking
system provides for daily replenishment of major bank accounts for
check-clearing requirements. Accordingly, there were negative book balances
of $2.0 million on December 31, 2005 and $3.3 million on December 31, 2004.
Such balances result from outstanding checks that have not yet been paid by
the bank and are reclassified to accounts payable in the accompanying
consolidated balance sheets.
Inventories
-----------
Inventories carried by our ESI subsidiary are composed primarily of raw
materials and component parts (enclosures, electronics, PC boards and wire)
and are carried at the lower of cost or market value, with cost determined
on the first-in, first-out ("FIFO") method of accounting. Inventory is
classified as assets held for sale on December 31, 2005 pending a sale of
the ENGlobal Constant Power division of ESI which occurred in January,
2006.
Revenue Recognition
-------------------
The Company's revenue is composed of engineering, construction and
procurement 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. During 2005 and 2004, pass-through transactions totaled $20.6 million
and $15.9 million, respectively.
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. Any freight charges and inspection costs are
directly charged to the project to which the charges relate. 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 plan 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.
Variable costs such as travel, repairs and maintenance, supplies and
depreciation directly related to producing revenues are included to arrive
at gross profit.
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.
46
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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
may be segmented if the customer had the right to accept separate elements
of a contract and the total economic returns and risks of the separate
contract elements are similar to the economic returns and risks of the
overall contract. For segmented contracts, we recognize revenue 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, clients are charged
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, clients are charged 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, clients are charged an agreed amount
negotiated in advance of a specific scope of work, be it related to
engineering, construction and procurement 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.
47
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Change orders occur when changes are experienced after work on a contract
has begun. Change orders are documented and the terms of change orders are
agreed with the client before the work is performed. Circumstances, at
times, 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.
Inspection and Acceptance (Cost-plus Contracts)
-----------------------------------------------
Generally, other than on fixed price contracts, 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.
Property and Equipment
----------------------
All property and equipment is stated at cost, adjusted for accumulated
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. Leasehold improvements are amortized over the term of the
related lease.
Goodwill
--------
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS 142 requires that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead tested for
impairment at least annually. SFAS 142 also requires that intangible assets
with estimable useful lives be amortized over their respective estimated
useful lives to their estimated residual values and reviewed for impairment
in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal
of Long-Lived Assets."
48
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
The Company adopted SFAS 142 effective January 1, 2002. Upon adoption, the
Company tested goodwill for impairment at January 1, 2002 according to the
provisions of SFAS 142, which resulted in no impairment identified. The
Company tested goodwill for impairment at December 31, 2004 and 2005
resulting in no impairment of goodwill.
In 2004, acquisitions of assets of several companies resulted in an
increase of $1,725,000 to goodwill. Acquisitions of the assets of
Engineering Design Group, Inc. ("EDGI"), InfoTech, and Cleveland Inspection
Services, Inc. ("CIS") resulted in increases to goodwill of $139,000,
$270,000 and $1,316,000, respectively. In 2005, goodwill increased
$170,000.
Long-lived Assets
-----------------
The Company reviews long-lived assets and certain identifiable intangible
assets for impairment annually or whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. An impairment loss would be recognized when estimated future
cash flows expected to result from the use of the asset and its eventual
disposition is less than its carrying amount. The Company has not
identified any such impairment losses.
Software Development Costs
--------------------------
Under the provisions of SOP-98-1 ENGlobal capitalizes costs associated with
software developed or obtained for internal use when both the preliminary
project stage is completed and when management authorizes funding for the
project which is deemed probable of completion. Costs include 1) external
direct costs of materials and services incurred in obtaining and developing
the software, and 2) payroll and payroll related costs for employees who
are directly associated with and devote time to the project. Capitalization
of these costs ceases no later than the point at which the project is
substantially complete and ready for its intended use. At that time, the
costs are reclassified to fixed assets. Amortization of such costs is
provided on the straight-line basis over 5 years.
The project controls system upgrade was completed at the end of 2004 and
amortization began in January 2005.
Dispositions - Assets Held for Sale
-----------------------------------
During 2005, the building previously occupied by Thermaire was sold. The
sale resulted in proceeds of $823,350 and a gain of $119,000 which amount
is included in other income. As of December 31, 2004, the building was the
sole asset recorded as "assets held for sale" in the amount of $678,106.
49
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Income Taxes
------------
The Company accounts for deferred income taxes in accordance with the asset
and liability method, whereby deferred income taxes are recognized for the
tax consequences of temporary differences by applying enacted statutory tax
rates applicable to future years to differences between the financial
statement and tax bases of its existing assets and liabilities. The
provision for income taxes represents the current tax payable or refundable
for the period plus or minus the tax effect of the net change in the
deferred tax assets and liabilities during the period.
Stock Based Compensation
------------------------
The Company applies SFAS No. 123, Accounting for Stock-Based Compensation,
as amended by SFAS 148, which encourages, but does not require, companies
to recognize compensation expense for grants of stock, stock options, and
other equity instruments to employees based on fair value. The Company has
elected to record compensation expense in accordance with Accounting
Principles Board (APB) Opinion No. 25, which calculates compensation as the
difference between an option's exercise price and the current price of the
underlying stock. (For equity instruments issued to employees, see Note 10
that contains required pro forma disclosure of the impact of adopting SFAS
No. 123)
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 APB No. 25. SFAS 123R is
effective as of the beginning of the first annual reporting period that
begins after June 15, 2005.
The Company will adopt SFAS 123(R) in its first quarter of 2006 utilizing
the modified prospective method. The modified prospective method requires
that compensation expense be recorded for all unvested stock options and
restricted stock awards as of December 31, 2005 over the requisite service
period (generally the vesting schedule). At December 31, 2005, the Company
had approximately 423,400 unvested stock options and awards that vest
through 2008. The Company is currently in the process of evaluating the
impact of the adoption of SFAS 123(R). For equity instruments issued to
employees, see Note 11 that contains required pro forma disclosure of the
impact of adopting SFAS No. 123.
50
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Earnings Per Share
------------------
Earnings per share was computed as follows:
Reconciliation of Earnings per Share Calculation
----------------------------------------------------------------------------------
2005 2004 2003
------------------------- ------------------------- --------------------------
Basic Diluted Basic Diluted Basic Diluted
----------- ----------- ----------- ----------- ----------- -----------
Income from continuing operations $ 4,782,381 $ 4,782,381 $ 2,364,389 $ 2,364,389 $ 2,285,269 $ 2,285,269
Preferred dividends -- -- -- -- 131,100 131,100
----------- ----------- ----------- ----------- ----------- -----------
Income available for common stock from 4,782,381 $ 4,782,381 2,364,389 2,364,389 2,154,169 2,154,169
continuing operations
Loss from discontinued operations -- -- -- -- (128,181) (128,181)
----------- ----------- ----------- ----------- ----------- -----------
Net income available for common stock $ 4,782,381 $ 4,782,381 $ 2,364,389 $ 2,364,389 $ 2,025,988 $ 2,025,988
=========== =========== =========== =========== =========== ===========
Weighted average number of shares
outstanding for basic 24,300,114 23,454,545 23,300,600
Weighted average number of shares
outstanding for diluted 25,250,487 23,785,939 23,733,807
Net income (loss) per share available
for common stock
Income from continuing operations $ 0.20 $ 0.19 $ 0.10 $ 0.10 $ 0.09 $ 0.09
Gain (loss) from discontinued
operations -- -- -- -- -- --
Net income available for common stock $ 0.20 $ 0.19 $ 0.10 $ 0.10 $ 0.09 $ 0.09
Diluted earnings per share are computed including the impact of all
potentially dilutive securities. The following table sets forth the shares
outstanding for the earnings per share calculations for the years ended
December 31, 2005, 2004 and 2003.
2005 2004 2003
----------- ----------- -----------
Common stock issued - beginning of year 23,466,839 24,034,288 22,861,199
Weighted average common stock issued (repurchased) 833,275 (579,743) 439,401
----------- ----------- -----------
Shares used in computing basic earnings per share 24,300,114 23,454,545 23,300,600
Assumed conversion of dilutive stock options 950,373 331,394 433,207
----------- ----------- -----------
Shares used in computing diluted earnings per share 25,250,487 23,785,939 23,733,807
=========== =========== ===========
Use of Estimates
----------------
The preparation of the Company's consolidated financial statements in
conformity with accounting principles generally accepted in the United
States of America requires the Company's management to make estimates and
assumptions that affect the amounts reported in these financial statements
and accompanying results. Actual results could differ from these estimates.
Fair Value of Financial Instruments
-----------------------------------
The fair value of financial instruments, primarily accounts receivable,
notes receivable and accounts payable, closely approximate the carrying
values of the instruments due to the short-term maturities of such
instruments. Based on the borrowing rate currently available to the Company
for loans with similar terms, we believe the fair value of the long-term
obligations approximate their carrying value.
51
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Comprehensive Income
--------------------
Comprehensive income is defined as all changes in stockholders' equity,
exclusive of transactions with owners, such as capital investments.
Comprehensive income includes net income or loss, changes in certain assets
and liabilities that are reported directly in equity, such as translation
adjustments on investments in foreign subsidiaries and certain changes in
minimum pension liabilities. The cumulative translation adjustment is
included in accumulated other comprehensive income. (See Note 4)
Reclassifications
-----------------
Amounts in prior years' financial statements are reclassified as necessary
to conform to the current year's presentation. Such reclassifications had
no effect on net income. Certain categories of depreciation expense were
reclassified in 2004 to direct costs. As depreciation expense in 2003
related to direct costs was immaterial, no reclassification was made for
that year.
NOTE 3 - RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 123, (revised 2004) "Share-Based Payment" ("SFAS 123(R)").
This statement is a revision of Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation" as amended ("SFAS123"),
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 123(R) covers various share-based
compensation arrangement rights and employee share purchase plans. SFAS
123(R) 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
123(R) is effective as of the beginning of the first interim period of the
first annual period that begins after June 15, 2005, with early adoption
encouraged. The Company is currently evaluating the statement's transition
methods and does not expect this statement to have an effect materially
different than that of the pro forma SFAS 123 disclosures provided in Note
10 to the Company's Consolidated Financial Statements.
In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 153, "Exchanges of Non-monetary Assets, an amendment of APB
Opinion NO. 29" ("SFAS 153"). This Statement amends APB Opinion No 29 to
permit the exchange of non-monetary assets to be recorded on a carry over
basis when the non-monetary assets do not have commercial substance. This
is an exception to the basic measurement principal of measuring a
non-monetary asset exchange at fair value. A non-monetary asset exchange
has commercial substance if the future cash flows of the entity are
expected to change significantly as a result of the exchange. SFAS 153 is
effective for non-monetary asset exchanges occurring in fiscal periods
beginning after June 15, 2005. The adoption of this standard is not
expected to impact the Company's Consolidated Financial Statements.
In January 2003, the Financial Accounting Standard Board ("FASB") issued
Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest
Entities." FIN 46 clarifies the application of Accounting Research Bulletin
No. 51, "Consolidated Financial Statements," and addresses consolidation by
business enterprises of variable interest entities (more commonly known as
Special Purpose Entities or SPE's). In December 2003, FASB issued
52
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - RECENT ACCOUNTING PRONOUNCEMENTS (Continued)
FIN No. 46R which replaced FIN 46 and clarified ARB 51. This interpretation
provides guidance on how to identify a variable interest entity and
determine when the assets, liabilities, non-controlling interests and
results of operations of a variable interest entity should be consolidated
by the primary beneficiary. The primary beneficiary is the enterprise that
will absorb a majority of the variable interest entity's expected losses or
receive a majority of the expected residual returns as a result of holding
variable interests. This FIN requires the consolidation of results of
variable interest entities in which the Company is the primary beneficiary
of the variable interest entity. As of December 31, 2004 and 2005, the
Company did not own an interest in a variable interest entity that met the
consolidation requirements and as such the adoption of FIN No. 46R did not
have any effect on the financial condition, results of operations, or
liquidity of the Company. Interests in entities acquired or created after
December 31, 2005 will be evaluated based on FIN No. 46R criteria and
consolidated, if required.
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.
Accumulated other comprehensive income is as follows:
2005 2004 2003
------- ------- -------
(in thousands)
----------------------------
Net income $ 4,782 $ 2,364 $ 2,157
Other comprehensive income:
Foreign currency translation adjustment (4) -- --
------- ------- -------
Comprehensive income $ 4,778 $ 2,364 $ 2,157
======= ======= =======
NOTE 5 - PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at December 31, 2005 and
2004:
2005 2004
-------- --------
(in thousands)
--------------------
Land $ 202 $ 202
Building 1,359 1,359
Computer equipment and software 6,374 4,038
Shop equipment 904 783
Furniture and fixtures 477 303
Building and leasehold improvement 1,561 692
Autos and trucks 191 169
-------- --------
11,068 7,546
Accumulated depreciation and amortization (4,254) (2,645)
-------- --------
6,814 4,901
Project controls and software upgrade in process 47 361
-------- --------
Property and equipment, net $ 6,861 $ 5,262
======== ========
Depreciation and amortization expense were $1,836,000, $1,246,000, and
$824,000 in 2005, 2004 and 2003, respectively.
53
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 - DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS
The components of trade receivables as of December 31, 2005 and 2004 are as
follows:
2005 2004
-------- --------
(in thousands)
--------------------
Amounts billed at December 31 $ 28,964 $ 21,204
Amounts billable at December 31,
billed January of the following year 16,523 9,177
Retainage 1,265 935
Less: Allowance for uncollectible accounts (503) (476)
-------- --------
Trade receivables, net $ 46,249 $ 30,840
======== ========
The components of other liabilities as of December 31, 2005 and 2004 are as
follows:
2005 2004
------ ------
(in thousands)
------------------
Reserve for known contingencies $ -- $ 51
Accrued interest 144 161
Sales taxes 322 6
State taxes 408 198
Other 274 284
------ ------
Other liabilities $1,148 $ 700
====== ======
NOTE 7 - FIXED-PRICE CONTRACTS
Costs, estimated earnings and billings on uncompleted contracts consisted
of the following at December 31, 2005 and 2004:
2005 2004
-------- --------
(in thousands)
--------------------
Costs incurred on uncompleted contracts $ 23,426 $ 8,292
Estimated earnings on uncompleted contracts 4,437 1,584
-------- --------
Earned revenues 27,863 9,876
Less: Billings to date 27,490 (11,077)
-------- --------
Net costs and estimated earnings in excess of
billings on uncompleted contracts $ 373 $ (1,201)
======== ========
Costs and estimated earnings in excess of
billings on uncompleted contracts $ 4,148 $ 1,113
Billings in excess of costs and estimated
earnings on uncompleted contracts (3,775) (2,314)
-------- --------
Net costs and estimated earnings in excess of
billings on uncompleted contracts $ 373 $ (1,201)
======== ========
54
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8 - LINE OF CREDIT AND DEBT
The Company had a Credit Facility with Comerica Bank ("Comerica") that
consisted of a line of credit maturing on July 27, 2007 (the "Comerica
Credit Facility"). The loan agreement positioned Comerica as senior to all
other debt. The line of credit is limited to $22.0 million, subject to loan
covenant restrictions. The Comerica Credit Facility is collateralized by
substantially all the assets of the Company. The outstanding balance on the
line of credit as of December 31, 2005 and 2004 was $3.8 million and $13.5
million, respectively. At the election of the Company, the interest rate
will be the lesser of prime or a three tiered Eurodollar rate, plus 150,
175, or 200 basis points, respectively, based on the ratio of total funded
debt to EBITDA for the trailing 12 months of less than 2.00, between 2.00
and 2.50, and greater than 2.50, respectively. The commitment fee on the
unused line of credit is 0.250%. The remaining borrowings available under
the line of credit as of December 31, 2005 and 2004, respectively, were
$12.0 and $4.0 million after consideration of loan covenant restrictions.
The Comerica Credit Facility contains covenants requiring the Company, as
of the end of each calendar month, to maintain certain ratios, including
total average funded debt to EBITDA; total average funded debt to total
liabilities, plus net worth; and total funded debt to accounts/unbilled
receivables. The Company is also required, as of the end of each quarter,
to maintain minimum levels of net worth, plus the Company must comply with
an annual limitation on capital expenditures. The Company was in compliance
with all covenants under the Comerica Credit Facility as of December 31,
2005.
Letters of credit
-----------------
As of December 31, 2005, the Company had $6.2 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 decrease each month until the obligations are fully
released in May 2006. As of February 23, 2006, the Company had $3.1 million
outstanding in standby letters of credit.
Long-term debt consisted of the following at December 31, 2005 and 2004:
2005 2004
-------- --------
(in thousands)
--------------------
Comerica Credit Facility - Line of credit, prime (7.25% at
December 31, 2005), maturing in July 2007 $ 3,774 $ 13,530
The following notes are subordinate to the credit facility
and are unsecured:
Sterling Planet and EDGI - Notes payable, interest at 5%,
principal payment installments of $15,000 plus interest
due quarterly, maturing in December 2008 195 255
Significant PEI Shareholders (See Note 19) 188 385
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 1,444 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 130 195
Miscellaneous 45 80
-------- --------
Total long-term debt 5,776 16,207
Less: Current maturities (548) (622)
-------- --------
Long-term debt, net of current portion $ 5,228 $ 15,585
======== ========
55
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8 - LINE OF CREDIT AND DEBT (Continued)
Maturities of long-term debt as of December 31, 2005, are as follows:
Maturities
----------
(in thousands)
----------
Years Ending December 31,
2006 $ 548
2007 4,396
2008 444
2009 388
---------
Total long-term debt $ 5,776
=========
NOTE 9 - OPERATING LEASES
The Company leases equipment and office space under long-term operating
lease agreements.
The future minimum rental payments on operating leases (with initial or
remaining non-cancelable terms in excess of one year) as of December 31,
2005 are as follows:
Operating
------------
(in thousands)
------------
Years Ending December 31,
2006 $ 2,227
2007 2,482
2008 1,520
2009 1,507
2010 and after 1,772
-----------
Total minimum lease payments $ 9,508
===========
Rent expense for the years ended December 31, 2005, 2004 and 2003 was
$2,167,000, $1,754,000 and $1,268,000, respectively.
NOTE 10 - EMPLOYEE BENEFIT PLANS
The Company sponsors a 401(k) profit sharing plan for its employees.
Effective October 1, 2005, the Company amended the Plan to implement a
mandatory matching contribution equal to 25% of employee contributions up
to 4% of employee compensation for non-regular employees. For regular
employees, the Company makes mandatory matching contributions equal to 50%
of employee contributions up to 4% of employee compensation. The Company,
as determined by the Board of Directors, may make other discretionary
contributions. The employees may elect to make contributions pursuant to a
salary reduction agreement upon meeting age and length-of-service
requirements. The Company made contributions of approximately $401,000,
$221,000, and $144,000, respectively, for the years ended December 31,
2005, 2004, and 2003. Effective April 1, 2006, the Company will increase
its matching contributions to the ENGlobal Corporation 401(k) Plan equal to
50% of regular employee contributions up to 6% of employee compensation,
and all other employees will be matched at 33.33% of employee contribution
up to 6% of compensation, as defined.
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
56
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 - EMPLOYEE BENEFIT PLANS (Continued)
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 is 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. Because of requirements of SFAS 123(R), and
probable reduction of benefits that would be required, the Company elected
to terminate the Plan effective December 31, 2005.
NOTE 11 - STOCK OPTION PLAN
The Company has an incentive plan that provides for the issuance of options
to acquire up to 2,650,000 shares of common stock. The incentive plan
("Option Plan") provides for grants of non-statutory options, incentive
stock options, restricted stock awards and stock appreciation rights. No
compensation cost has been recognized for grants under the Option Plan
because the exercise price of the options granted to employees equaled or
exceeded the market price of the stock on the date of the grant. Had the
method prescribed by SFAS No. 123 been applied, the Company's net income
available to common stockholders for the years ended December 31, 2005,
2004 and 2003 would have been changed to the pro forma amount indicated
below:
2005 2004 2003
----------- ----------- -----------
Net income available for common stock-as reported $ 4,782,381 $ 2,364,389 $ 2,025,988
Compensation expenses if the fair value method had been
applied to the grants (538,273) (112,830) (64,492)
----------- ----------- -----------
Net income available for common stock-pro forma $ 4,244,108 $ 2,251,559 $ 1,961,496
=========== =========== ===========
Net income per share-as reported
Basic $ 0.20 $ 0.10 $ 0.09
Diluted $ 0.19 $ 0.10 $ 0.09
Net income available per share-pro forma
Basic $ 0.17 $ 0.10 $ 0.08
Diluted $ 0.17 $ 0.10 $ 0.08
The fair value of each option granted is estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted
average assumptions used for grants in 2005, 2004, and 2003: dividend yield
of 0%, expected volatility of 74.5% to 79.1%, 56% and 73%, and risk-free
interest rates of 3.42% to 4.50%, 5% and 5% for each year presented, and
expected lives of two to four years. The maximum term of each option is ten
years.
57
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 - STOCK OPTION PLAN (Continued)
The following table summarizes total aggregate stock option activity for
the period December 31, 2002 through December 31, 2005.
Weighted
Number of Shares Average
Outstanding Exercise Price
-------------- --------------
Balance at December 31, 2002 1,254,929 1.79
Granted 120,000 2.09
Exercised (51,710) 1.02
Canceled or expired (66,051) 1.00
--------------
Balance at December 31, 2003 1,257,168 2.11
Granted 386,000 2.01
Exercised (87,332) 1.03
Canceled or expired (28,686) 1.19
--------------
Balance at December 31, 2004 1,527,150 2.10
Granted 425,000 3.79
Exercised (492,019) .99
Canceled or expired (21,897) 1.88
--------------
Balance at December 31, 2005 1,438,234 3.07
==============
The following table summarizes information concerning outstanding and
exercisable Company common stock options at December 31, 2005.
Average
Weighted Remaining Weighted
Exercise Options Average Contractual Options Average
Prices Outstanding Exercise Price Life Exercisable Exercise Price
------ ----------- -------------- ---- ----------- --------------
$ 0.96 179,884 $ 0.96 4.8 179,884 $ 0.96
$ 1.00 20,000 $ 1.00 5.2 20,000 $ 1.00
$ 1.25 80,000 $ 1.25 3.95 80,000 $ 1.25
$ 1.81 60,000 $ 1.81 8.5 60,000 $ 1.81
$ 1.87 60,000 $ 1.87 7.3 60,000 $ 1.87
$ 1.97 25,000 $ 1.97 8.2 25,000 $ 1.97
$ 2.05 266,850 $ 2.05 8.2 158,450 $ 2.05
$ 2.32 60,000 $ 2.32 7.4 60,000 $ 2.32
$ 2.39 100,000 $ 2.39 9.1 40,000 $ 2.39
$ 2.50 75,000 $ 2.50 9.2 30,000 $ 2.50
$ 3.75 150,000 $ 3.75 9.5 - $ -
$ 4.26 61,766 $ 4.26 .7 61,766 $ 4.26
$ 6.24 199,734 $ 6.24 1.8 199,734 $ 6.24
$ 6.71 100,000 $ 6.71 9.9 40,000 $ 6.71
--------- ----------
1,438,234 1,014,834
========= ==========
Available for grant at December 31, 2005 509,260
Weighted-average fair value of options at grant date, granted in 2005 $ 3.52
Weighted-average fair value of options at grant date, granted in 2004 $ 2.15
Weighted-average fair value of options at grant date, granted in 2003 $ 2.01
Weighted-average remaining vesting life of all options outstanding at December 31, 2005 1.5 years
58
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 - STOCK OPTION PLAN (Continued)
For 2002 through 2004, the summary above does not include 234,774
non-qualified options issued at the time of the Merger to replace existing
options issued by Petrocon in consideration for services. Such options had
an exercise price of $4.26 per share. In September 2005, these options were
exercised.
Replacement warrants of 305,102 (not included in the table above) with an
exercise price of $6.24 expired in October 2003.
NOTE 12 - RELATED-PARTY TRANSACTIONS
The Company leases office space from PEI Investments, a joint venture in
which ENGlobal Engineering, Inc. has a one-third interest, Michael L.
Burrow (the Company's CEO) has a one-third interest, and a stockholder who
owns less than 1% of the Company's common stock has a one-third interest.
Rentals paid under these leases were $105,000, $135,000, and $135,000 for
2005, 2004 and 2003, respectively. The lease was renewed in August, 2005.
In September 2005, the building was damaged by Hurricane Rita and all
tenants have relocated to other locations. No further lease payments have
been made by the Company since September 2005 and the insurance claim filed
by PEI Investments remains unsettled.
NOTE 13 - CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMERS
The Company provides engineering and fabricated systems and services
primarily to major integrated oil and gas companies throughout the world.
It also fabricates power systems and battery chargers. The Company performs
ongoing credit evaluations of its customers and generally does not require
collateral. Management reviews all trade receivable balances that exceed 30
days past due and based on its assessment of current credit worthiness,
estimate what portion, if any seems doubtful for collection. A valuation
allowance that reflects management's best estimate of the amounts that will
not be collected is established.
For the years ended December 31, 2005, 2004, and 2003, the Company had
sales in the engineering segment totaling approximately $84.8 million,
$87.9 million and $45.2 million attributable to a single customer. . In
2005, approximately 44% of our revenues were from one client, approximately
12% of our revenues were from another client and another 12% were from a
third client. During 2004 and 2003, a single customer represented
approximately 59% and 36% of total sales, respectively. At December 31,
2005 the Company had amounts due from two customers totaling $8.3 million
with neither customer exceeding 10% of trade receivables. At December 31,
2004, the Company had amounts due from one customer totaling $7.0 million;
no other customer exceeded 10% of trade receivables at that date. At
December 31, 2003, one customer had amounts in excess of 10% of trade
receivables, totaling $5.1 million.
NOTE 14 - REDEEMABLE PREFERRED STOCK
ENGlobal has a class of preferred stock with 5,000,000 shares originally
authorized for issuance. The Company issued to Equus II Incorporated
2,500,000 shares of preferred stock in 2001 and stock dividends totaling
88,000 shares in 2002 and 146,833 shares in 2003. Par value for the
preferred stock was $0.001 with a fair value of $1.00 per share at the time
of issuance. The preferred shares outstanding were converted into 1,149,089
shares of common stock in August 2003. Following the conversion, the
Company reduced the authorized shares of preferred stock to 2,265,167.
59
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 15 - FEDERAL INCOME TAXES
The components of income tax expense (benefit) from continuing operations
for the years ended December 31, 2005, 2004 and 2003 were as follows:
2005 2004 2003
------- ------- -------
(in thousands)
----------------------------
Current
Federal $ 3,016 $ 975 $ 536
State 413 427 30
------- ------- -------
3,429 1,402 566
Deferred
Federal (313) 254 543
------- ------- -------
Total tax provision $ 3,116 $ 1,656 $ 1,109
======= ======= =======
The components of the deferred tax asset (liability) consisted of the
following at December 31, 2005 and 2004:
2005 2004
------- -------
(in thousands)
------------------
Deferred tax asset
Allowance for doubtful accounts $ 171 $ 162
Net operating loss carryforward 474 --
Accruals not yet deductible for tax purposes 310 478
Alternative minimum tax credit carryforward 194 --
------- -------
Deferred tax assets 1,149 640
------- -------
Deferred tax liabilities
Depreciation (436) (558)
Prepaid expenses (293) --
Goodwill (40) (15)
------- -------
Deferred tax liability (769) (573)
------- -------
Deferred tax asset, net $ 380 $ 67
======= =======
The following is a reconciliation of expected to actual income tax expense
from continuing operations:
2005 2004 2003
------- ------- -------
(in thousands)
---------------------------
Federal income tax expense at 34% $ 2,685 $ 1,147 $ 1,154
State and foreign taxes, net of tax effect 273 212 2
Nondeductible expenses 9 53 31
Other 149 244 (78)
------- ------- -------
$ 3,116 $ 1,656 $ 1,109
======= ======= =======
The Company has a net operating loss carryforward at December 31, 2005 of
approximately $1,393,000. Earlier utilization of the net operating loss on
the Company's 2002 and 2003 consolidated tax returns was disallowed by the
IRS which resulted in a reinstated carryforward that will be available for
utilization in 2006 through 2010. The Company believes, based on favorable
market conditions in the foreseeable future, that the net operating loss
will be fully utilized.
60
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16 - ACQUISITIONS
Assets acquired and liabilities assumed by the Company in acquisitions have
been recorded on the Company's Consolidated Balance Sheets as of the
respective acquisition dates based upon their estimated fair values at such
dates. The results of operations of our acquisitions have been included in
the Company's Consolidated Statement of Income since their respective dates
of acquisition. The excess of the purchase price over the estimated fair
values of the underlying assets acquired and liabilities assumed has been
allocated to goodwill.
One of the Company's subsidiaries, ENGlobal Technical Services, Inc.
("ETS") (formerly known as ENGlobal Design Group, Inc. ("EDG")), purchased
certain assets of Tulsa-based Engineering Design Group, Inc. ("EDGI")
effective February 1, 2004. The Company expects that the acquisition of
these assets will enhance its capabilities related to various government
and public sector facilities. ETS's most active sector is the Automated
Fuel Handling Systems that serve the U.S. Military. In connection with the
purchase, the Company acquired $344,000 in tangible assets including
furniture and fixtures, computer equipment and software. The Company also
assumed a liability for $44,000 in accrued compensated absences for former
EDGI employees hired at the time of the purchase, issued two $150,000 notes
bearing interest at 5% maturing in December 2008 and a $2.5 million
five-year contingent promissory note, with payments due annually, as part
of an earn-out based on revenues of the ETS operations over the next five
years. ETS did not pay any cash or issue any stock in the transaction. The
original consideration given for the purchase of certain EDGI assets
approximated the fair value of the net assets acquired; therefore no
goodwill arose from the transaction. Principal and interest on the $2.5
million five-year contingent promissory note is being charged to goodwill.
As of December 31, 2005, $218,000 in principal and interest payments on the
contingent promissory note has been charged to goodwill and is being
amortized over 15 years for tax purposes.
In October 2004, one of the Company's subsidiaries, ENGlobal Construction
Resources, Inc., purchased the name and certain assets of Cleveland
Inspection Services, Inc. ("CIS"). CIS provides inspection and construction
management services in support of the oil and gas, utility, and pipeline
industries. The Company paid $2.5 million consisting of cash, discounted
promissory notes and the assumption of certain designated contract
obligations and entered into non-compete agreements with CIS and its
principals in exchange for approximately $1.0 million in machinery and
equipment, furniture and fixtures, computer equipment, software and other
intangible assets. The acquisition resulted in approximately $1.3 million
in goodwill which is being recorded and amortized over 15 years for tax
purposes.
In December 2004, ESI purchased contract rights and other assets of
InfoTech Engineering Company, LLC, a limited liability company
("InfoTech"), headquartered in Baton Rouge, Louisiana. The Company paid
$325,000 in cash, a promissory note in the amount of $225,000 and entered
into a non-compete agreement with the former owner in exchange for
approximately $55,000 in computer equipment and certain intangible assets.
The acquisition resulted in approximately $270,000 in goodwill which is
being recorded and amortized over 15 years for tax purposes. The InfoTech
acquisition expands ESI's capability in controls system integration in both
the automation and process control services. InfoTech's primary experience
is in the onshore and offshore oil and gas and petrochemical industries.
Two acquisitions were completed in 2003, Senftleber & Associates, L.P. and
Petro-Chem Engineering, Inc. Through the Petro-Chem transaction, selected
assets were acquired expanding the Company's presence in Freeport, Texas
and surrounding area. The new Freeport operations began in June as a
division of EEI. Senftleber, a limited partnership, provides support in the
pipeline industry in Houston. The Senftleber acquisition occurred in
November as a subsidiary of ETI. The acquisitions had an aggregate cost of
$425,000. Goodwill was created with both transactions: $115,000 for
Petro-Chem and $428,000 for Senftleber.
61
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 - SALE OF THERMAIRE
The Company completed its sale of assets of its subsidiary, Thermaire,
Inc., d/b/a Thermal Corporation, the only company in the manufacturing
segment, to a medium-sized HVAC equipment manufacturer in December 2003.
The disposition had been actively pursued since November 2001 in order to
permit the Company to strategically focus on its core operations. This
discontinued segment had reported losses from operations of $154,000 in
2003. The sale resulted in the receipt of $545,000 in cash and a $26,000
gain, net of tax. The 37,000 square foot office and manufacturing facility
owned by Thermaire was not included in the transaction and has been
separately listed for sale.
In March 2005, the Company completed the sale of the building formerly
occupied by Thermaire, Inc. The Company received proceeds of $823,350. The
Company realized a gain on the sale of the building of $119,000.
NOTE 18 - SEGMENT INFORMATION
With the sale of the manufacturing segment, the Company operates in two
business segments: engineering and systems. The engineering segment
provides services primarily to major integrated oil and gas companies that
for the most part are located in the United States. The systems segment
operates primarily full-service systems/controls engineering and
integration with some uninterruptible power systems and battery chargers
that for the most part are located in the United States. Sales, operating
income, identifiable assets, capital expenditures and depreciation for each
segment are set forth in the following table. The amount in the corporate
segment includes those activities that are not allocated to the operating
segments and include costs related to business development, executive
functions, finance, accounting, safety, human resources and information
technology that are not specifically identifiable with the two segments.
The inter-company elimination column includes the amount of administrative
costs allocated to the segments. The Corporate function supports both
business segments and therefore cannot be specifically assigned to either.
A significant portion of Corporate costs are allocated to each segment
based on each segment's revenues and subsequently eliminated in
consolidation.
Financial information about geographic areas
--------------------------------------------
Revenues from the Company's non-U.S. operations are currently not material.
Long-lived assets located in Canada are currently not material.
62
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 18 - SEGMENT INFORMATION (Continued)
Segment information for 2005, 2004 and 2003 was as follows:
Intercompany
Engineering Systems Corporate Eliminations Total
(in thousands)
2005
----
Net sales from external
customers $ 215,699 $ 17,886 $ - $ - $ 233,585
Operating profit (loss) 17,752 309 732 (10,209) 8,584
Depreciation and
amortization 1,256 101 479 - 1,836
Tangible assets 52,602 5,460 2,419 - 60,481
Goodwill 14,756 699 - - 15,455
Capital expenditures 2,569 172 489 - 3,230
2004
----
Net sales from external
customers $ 133,630 $ 15,258 $ - $ - $ 148,888
Operating profit (loss) 10,512 585 2,267 (8,872) 4,492
Depreciation and
amortization 706 108 432 - 1,246
Tangible assets 31,971 6,673 3,332 - 41,976
Goodwill 14,585 699 - - 15,284
Capital expenditures 1,378 20 67 - 1,465
2003
----
Net sales from external
customers $ 108,380 $ 15,339 $ - $ - $ 123,719
Operating profit (loss) 10,716 (38) 762 (6,906) 4,534
Depreciation and
amortization 375 89 360 - 824
Tangible assets 22,642 3,049 3,048 - 28,762
Goodwill 12,889 864 - - 13,753
Capital expenditures 902 105 139 - 1,146
Tangible assets include cash, accounts receivable, costs in excess of
billings, prepaid expenses, income tax receivables, deferred tax assets,
property and equipment and deferred financing. Goodwill, investments in
subsidiaries, and inter-company accounts receivables and payables are
excluded.
63
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 19 - COMMITMENTS AND CONTINGENCIES
In connection with the 2001 merger of Petrocon Engineering, Inc.
("Petrocon") and a wholly-owned subsidiary of ENGlobal Corporation, certain
former Petrocon shareholders (the "Significant PEI Shareholders") entered
into an Indemnification Escrow Agreement, an Option Escrow Agreement, a
Voting Agreement and a Significant PEI Shareholder Voting Agreement
(collectively, the "2001 Agreements"). In August 2004, the Company and the
requisite percentage of Significant PEI Shareholders entered into a
Termination Agreement (the "Termination Agreement") terminating the 2001
Agreements. The 2001 Agreements included the following:
Indemnification Escrow.
-----------------------
Pursuant to the Indemnification Escrow Agreement, 1,000,000 shares of
ENGlobal common stock owned by the Significant PEI Shareholders were
deposited into an escrow to serve as a fund against which the Company
could make claims for indemnity pursuant to the Merger Agreement with
Petrocon. Pursuant to the terms of the Termination Agreement, the
remaining shares in the Indemnification Escrow agreement will be
released pro rata to the Significant PEI Shareholders.
Voting Agreement.
-----------------
ENGlobal, the Significant PEI Shareholders, and certain other parties
entered into a Voting Agreement which obligated the parties thereto to
vote for certain persons to serve on the Board of Directors of
ENGlobal. Pursuant to the terms of the Termination Agreement, the
Voting Agreement has been terminated.
Significant PEI Shareholder Voting Agreement.
---------------------------------------------
The Significant PEI Shareholders entered into a Significant PEI
Shareholders Voting Agreement governing the manner in which they would
designate three ENGlobal director nominees under the Voting Agreement
and vote shares held in escrow. Pursuant to the terms of the
Termination Agreement, the Significant PEI Shareholders Voting
Agreement has been terminated.
Option Escrow.
--------------
Pursuant to the Option Escrow Agreement, the Significant PEI
Shareholders deposited 1,737,473 shares of ENGlobal common stock into
an escrow account. The Option Escrow Agreement required that if
ENGlobal issued shares of its common stock on the exercise of
incentive options granted as replacement options for outstanding
Petrocon incentive options ("Replacement Options"), a like number of
shares of ENGlobal common stock would be surrendered from the escrow
account to ENGlobal. As a result, no dilution to ENGlobal stockholders
would occur upon the exercise of Replacement Options.
The Company's management has since determined that, due to the cost and
complexity associated with administering the 2001 Agreements, it would be
in the best interest of the Company and its stockholders to terminate the
same. Pursuant to the terms of the Termination Agreement, ENGlobal
purchased the 652,377 shares being held in escrow underlying the
Replacement Options with an exercise price of $0.96 per share for a
discounted payment of $592,231, payable over three years to the Significant
PEI Shareholders. ENGlobal also terminated its rights to any of the
remaining shares held in escrow and those shares were distributed to the
Significant PEI Shareholders. The transaction resulted in 652,377 shares of
Treasury Stock and a decrease in Shareholders' Equity of $592,231 until
such time as the replacement options are exercised and the exercise price
is remitted to the Company. As of December 31, 2005, remaining payments due
to Significant PEI Shareholders are $188,000.
64
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 19 - COMMITMENTS AND CONTINGENCIES (Continued)
Employment Agreements
---------------------
The Company has employment agreements with certain of its executive
officers and certain other officers, the terms of which expire through
January 2009. Such agreements provide for minimum salary levels. During the
last twelve months the Company executed new employment agreements with
certain other officers. If the Company terminates the employment of the
employee for any reason other than 1) termination for cause, 2) voluntary
resignation, or 3) employee's death, the Company is obligated to provide a
severance benefit equal to six months of the employee's salary, and, at its
option, an additional six months at 50% to 100% of the employee's salary.
These agreements are renewable for one year at the Company's option.
The Company has not renewed employment agreements with the Chairman, Chief
Executive Officer and President and Chief Financial Officer which expired
on December 21, 2005.
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 affect upon the consolidated financial position or operations of
the Company, after giving effect of recorded reserves.
Insurance
---------
The Company carries a broad range of insurance coverage, including general
and business automobile liability, commercial property, professional errors
and omissions, workers' compensation insurance and a general umbrella
policy. The Company is not aware of any claims in excess of insurance
recoveries. ENGlobal is partially self-funded for health insurance claims.
Provisions for expected future payments are accrued based on the Company's
experience. Specific stop loss levels provide protection for the Company
with $125,000 per occurrence and approximately $8.6 million in aggregate in
each policy year being covered by a separate insurance policy.
NOTE 20 - SUBSEQUENT EVENTS
On January 9, 2006 the Company through its wholly-owned subsidiary,
ENGlobal Systems, Inc. ("ESI") acquired certain assets of Analyzer
Technology International, Inc. ("ATI"), a Houston-based analyzer systems
provider. ATI, which specializes in the design and fabrication of online
process analyzer systems, will relocate its operation to ESI's Houston
facility. Co-locating enables ESI's clients to perform a more efficient
factory acceptable test by temporarily connecting both control and analyzer
systems onsite prior to delivery. The addition of ATI will provide ESI with
a greater presence in the process analyzer sector, especially in Middle
Eastern petrochemical facilities.
65
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 21 - QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
All quarterly periods and the annual data have been restated to reflect the
discontinued operations separate from continuing operations and
reclassification of depreciation expense to direct costs.
For the Quarters Ended - 2005
March June September December
------------- ------------ -------------- ------------
(in thousands, except per share amounts)
Revenues per segment
Engineering $ 40,299 90.3% $ 54,028 90.9% $ 55,143 93.0% $ 66,229 94.2%
Systems 4,330 9.7% 5,391 9.1% 4,123 7.0% 4,042 5.8%
------------- ------------ ------------- ------------
Total $ 44,629 100.0% $ 59,419 100.0% $ 59,266 100.0% $ 70,271 100.0%
============= ============ ============= ============
Gross profit per segment
Engineering $ 5,131 12.7% $ 6,594 12.2% $ 7,328 13.3% $ 6,920 10.4%
Systems 567 13.1% 686 12.7% 510 12.4% 537 13.3%
------------- ------------ ------------- ------------
Total $ 5,698 12.8% $ 7,280 12.3% $ 7,838 13.2% $ 7,457 10.6%
============= ============ ============= ============
Net income $ 921 $ 1,520 $ 1,620 $ 721
============= ============ ============= ============
Earnings per share - basic $ 0.04 $ 0.06 $ 0.07 $ 0.03
Earnings per share - diluted $ 0.04 $ 0.06 $ 0.07 $ 0.03
For the Quarters Ended - 2004
March June September December
------------- ------------ -------------- -------------
(in thousands, except per share amounts)
Revenues per segment
Engineering $ 28,463 91.8% $ 31,470 91.8% $ 32,796 88.0% $ 40,901 88.3%
Systems 2,529 8.2% 2,813 8.2% 4,476 12.0% 5,440 11.7%
------------- ------------ ------------- -------------
Total $ 30,992 100.0% $ 34,283 100.0% $ 37,272 100.0% $ 46,341 100.0%
============= ============ ============= =============
Gross profit per segment
Engineering $ 3,805 13.4% $ 3,925 12.5% $ 3,899 11.9% $ 4,394 10.7%
Systems 324 12.8% 216 7.7% 810 18.1% 819 15.1%
------------- ------------ ------------- -------------
Total $ 4,129 13.3% $ 4,141 12.1% $ 4,709 12.6% $ 5,213 11.2%
============= ============ ============= =============
Net income $ 471 $ 421 $ 755 $ 717
============= ============ ============= =============
Earnings per share - basic $ 0.02 $ 0.02 $ 0.03 $ 0.03
Earnings per share - diluted $ 0.02 $ 0.02 $ 0.03 $ 0.03
66
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON FINANCIAL STATEMENT SCHEDULE
To the Board of Directors and Stockholders
ENGlobal Corporation
We have audited, in accordance with auditing the standards of the Public Company
Accounting Oversight Board (United States), the consolidated financial
statements of ENGlobal Corporation and Subsidiaries included in this Form 10-K
and have issued our report thereon dated March 17, 2006. Our audits were made
for the purpose of forming an opinion on the basic financial statements taken as
a whole. The financial statement schedule listed in Schedule II - Valuation and
Qualifying Accounts is the responsibility of the Company's management and is
presented for the purpose of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. The
financial statement schedule has been subjected to the auditing procedures
applied to the audits of the basic financial statements and in our opinion, is
fairly stated in all material respects with the financial data required to be
set forth therein in relation to the basic financial statements taken as a
whole.
/s/ Hein & Associates LLP
Hein & Associates LLP
Houston, Texas
March 17, 2006
67
Schedule II
-----------
ENGlobal Corporation
VALUATION AND QUALIFYING ACCOUNTS
Balance - Balance -
Beginning Deductions- End of
Description of Period Additions Write offs Period
- -------------------------------------------------------------------------------------------------
(in thousands)
--------------------------------------------------
Allowance for doubtful accounts
For year ended December 31, 2005 $ 476 $ 53 $ (26) $ 503
For year ended December 31, 2004 $ 376 $ 134 $ (34) $ 476
For year ended December 31, 2003 $ 282 $ 282 $ (188) $ 376
68
ITEM 9. CHANAGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. We maintain
disclosure controls and procedures designed to provide reasonable
assurance that information required to be disclosed in the periodic
reports we file with the SEC is recorded, processed, summarized and
reported within the time periods specified in the rules and forms of
the SEC. We carried out an evaluation as of December 31, 2005, under
the supervision and the participation of our management, including our
chief executive officer and chief financial officer, of the design and
operation of the disclosure controls and procedures pursuant to Rules
13a-14 and 15d-14 under the Securities Exchange Act of 1934. Based
upon that evaluation, our chief executive officer and chief financial
officer concluded that our disclosure controls and procedures are
effective in timely alerting them to material information relating to
the Company that is required to be included in our periodic SEC
filings.
(b) Changes in Internal Controls over Financial Reporting. There have been
no changes in internal control over financial reporting during the
fiscal quarter ended December 31, 2005 that has materially affected,
or is reasonably likely to affect, the registrant's internal control
over financial reporting.
69
PART III
--------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information under the captions Election of Directors and Executive
Officers Section 16(a) Beneficial Ownership Reporting Compliance and
Corporate Code of Conduct, in our definitive proxy statement for our 2006
annual meeting of stockholders to be filed with the SEC pursuant to
Regulation 14A under the Exchange Act is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information under the captions Executive Compensation, Director
Compensation, Compensation Committee, Report of the Compensation Committee
on Executive Compensation and Comparative Stock Performance Graph contained
in our definitive proxy statement for our 2006 annual meeting of
stockholders to be filed with the SEC pursuant to Regulation 14A under the
Exchange Act is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information under the caption Security Ownership of Certain Beneficial
Owners and Management contained in our definitive proxy statement for our
2006 annual meeting of stockholders to be filed with the SEC pursuant to
Regulation 14A under the Exchange Act is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information under the caption Certain Relationships and Related
Transactions contained our definitive proxy statement for our 2006 annual
meeting of stockholders to be filed with the SEC pursuant to Regulation 14A
under the Exchange Act is incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information under the caption Principal Accounting Fees and Services in
our definitive proxy statement for our 2006 annual meeting of stockholders
to be filed with the SEC pursuant to Regulation 14A under the Exchange Act
is incorporated herein by reference.
70
PART IV
-------
ITEM 15. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES
(a)(1) Financial Statements
The consolidated financial statements filed as part of this Form
10-K are listed and indexed in Part II, Item 8, on page 38.
(a)(2) Schedules
All schedules have been omitted since the information required by
the schedule is not applicable, or is not present in amounts
sufficient to require submission of the schedule, or because the
information required is included in the consolidated financial
statements and notes thereto.
(a)(3) Exhibits
71
EXHIBIT INDEX
Incorporated by Reference to:
-----------------------------------
Form or Filing Date SEC File
Exhibit No. Description Schedule Exhibit No. with SEC Number
- ----------- ----------- -------- ----------- -------- ------
2.1 Agreement and Plan of Merger by and between 10-QSB 2.23 8/14/01 001-14217
Industrial Data Systems Corporation, IDS
Engineering Management, LC, PEI Acquisition, Inc.
and Petrocon Engineering, Inc.
2.2 First Amendment of the Agreement and Plan of S-4/A 2.24 11/6/01 333-68288
Merger
2.3 Letter Agreement of the Agreement and Plan of S-4/A 2.25 11/6/01 333-68288
Merger
3.1 Restated Articles of Incorporation of ENGlobal 10-Q 3.1 11/14/02 001-14217
Corporation
3.2 Amended and Restated Bylaws of Registrant S-3 4.4 10/31/05 333-129336
4.1 Specimen common stock certificate S-3 4.1 10/31/05 333-129336
4.2 Registration Rights Agreement, dated as of S-3 4.2 10/31/05 333-129336
September 29, 2005, by and among ENGlobal
Corporation and Certain Investors named therein
4.3 Securities Purchase Agreement, dated September S-3 4.5 10/31/05 333-129336
29, 2005, by and between Tontine Capital
Partners, L.P. and Registrant
4.4 Form of Subscription Agreement by and among S-3 4.6 10/31/05 333-129336
Registrant, Michael L. Burrow, Alliance 2000,
Ltd. and certain subscribers
10.1 Option Pool Agreement between Industrial Data 10-KSB 10.48 4/1/2002 001-14217
Systems Corporation and Alliance 2000, Ltd. Dated
December 21, 2001
10.2 Guaranty and Suretyship Agreement between 10-Q 10.64 8/12/02 001-14217
Industrial Data Systems Corporation and Corporate
Property Associates 4 dated April 26, 2002
10.3 ENGlobal Corporation Incentive Bonus Plan dated 10-Q 10.65 8/12/02 001-14217
June 12, 2002
10.4 1998 Incentive Plan S-8 10.49 8/24/05 333-127803
10.5 Amendment No. 1 to 1998 Incentive Plan S-8 10.65A 6/9/03 333 - 105966
10.6 Amendment No. 2 to the 1998 Incentive Plan S-8 10.65A 6/9/03 333 - 105966
10.7 Amendment No. 3 to the 1998 Incentive Plan S-8 10.52 8/24/05 333-127803
10.8 Form of ENGlobal Corporation (f/k/a Industrial S-8 10.80 8/24/05 333-127803
Data Systems Corporation) Non-qualified Stock
Option Agreement Granted Outside of 1998
Incentive Plan
10.9 Lease Agreement between Petrocon Engineering, 10-Q 10.66 11/14/02 001-14217
Inc. and Phelan Investments on July 25, 2002
72
Incorporated by Reference to:
-----------------------------------
Form or Filing Date SEC File
Exhibit No. Description Schedule Exhibit No. with SEC Number
- ----------- ----------- -------- ----------- -------- ------
10.10 Second Amendment of the Second Amended and 10-Q 10.67 11/14/02 001-14217
Restated Loan and Security Agreement as of July
31, 2002 between IDS Engineering and Subsidiaries
and Fleet Capital Corporation
10.11 Amendment of the Intercreditor Agreement between 10-Q 10.68 11/14/02 001-14217
Fleet Capital Corporation, Equus II Incorporated
and ENGlobal Corporation dated July 31, 2002
10.12 Fifth Amendment of Lease Agreement between IDS 10-Q 10.69 11/14/02 001-14217
and 600 C.C. Business Park Ltd.
10.13 Lease Agreement between PEI Investments and 10-Q 10.70 5/13/03 001-14217
Petrocon Engineering, Inc. dated July 1, 2002
10.14 Lease Agreement between Petro-Chem Engineering 10-Q 10.72 8/14/03 001-14217
and ENGlobal Engineering, Inc. dated June 4, 2003
10.15 Contract between BASF and ENGlobal Engineering, 10-Q 10.73 8/14/03 001-14217
Inc. dated June 9, 2003
10.16 Sublease Agreements between Family Connect, Inc., 10-Q 10.74 11/14/03 001-14217
a tenant of CitiPlex Towers Building and IDS
Engineering dated February 2, 2003
10.17 Lease Agreement between Oral Roberts University 10-Q 10.75 11/14/03 001-14217
and IDS Engineering, dba ENGlobal Engineering,
Inc. dated October 20, 2003
10.18 Sixth Amendment of the Second Amended and 10-Q 10.76 11/14/03 001-14217
Restated Loan and Security Agreement as of June
30, 2003 between ENGlobal Corporation and
Subsidiaries and Fleet Capital Corporation
10.19 Second Amendment of the ENGlobal Engineering, 10-K 10.77 3/30/04 001-14217
Inc. 401(k) Plan dated January 1, 2004 (formerly
called the "Petrocon Engineering, Inc. 401(k)
Plan")
10.20 ENGlobal Corporation Employee Stock Purchase Plan S-8 10.1 3/12/04 333-113554
dated March 2, 2004
10.21 Lease Agreement between ENGlobal Design Group, 10-K 10.79 3/30/04 001-14217
Inc. and TC Meridian Tower LP dated January 24,
2004
10.22 Credit Agreement by and between Comerica Bank and 8-K 10.1 8/9/04 001-14217
ENGlobal Corporation and its subsidiaries dated
July 27, 2004
10.23 Security Agreement by and between Comerica Bank 8-K 10.2 8/9/04 001-14217
and ENGlobal Corporation and its subsidiaries
dated July 27, 2004
10.24 Master Revolving Note by and between Comerica 8-K 10.3 8/9/04 001-14217
Bank and ENGlobal Corporation and its
subsidiaries dated July 27, 2004
10.25 Termination Agreement by and among ENGlobal 8-K 99.1 10/1/04 001-14217
Corporation, Equus II Incorporated, Alliance
2000, Ltd., Significant PEI Shareholders, Michael
L. Burrow, as shareholder representative for the
Significant PEI Shareholders, and Johnny J.
Williams, Esq., as Escrow Agent, dated September
28, 2004
73
Incorporated by Reference to:
-----------------------------------
Form or Filing Date SEC File
Exhibit No. Description Schedule Exhibit No. with SEC Number
- ----------- ----------- -------- ----------- -------- ------
10.26 ENGlobal Corporation Key Manager Incentive Plan 8-K 10.1 12/21/04 001-14217
dated December 16, 2004
10.27 ENGlobal Corporation Executive Level Incentive 8-K 10.1 12/21/04 001-14217
Plan dated December 16, 2004
10.28 Third Amendment of the ENGlobal Engineering, Inc. 10-K 10.48 3/30/05 001-14217
401(k) Plan (formerly called the "Petrocon
Engineering, Inc. 401(k) Plan") dated March 9,
2005 and effective January 1, 2005.
*11.1 Statement Regarding Computation of Per Share
Earnings is included as Note 2 to the Notes to
Consolidated Financial Statements.
14.1 ENGlobal Corporation Code of Ethics for Chief 10-K 99.5 3/30/04 001-14217
Executive Officer and Senior Financial Officers
dated March 25, 2004
14.2 ENGlobal Corporation Code of Business Conduct and 10-K 99.6 3/30/04 001-14217
Ethics dated March 25, 2004
*21.1 Subsidiaries of the Registrant
*23.1 Consent of Hein & Associates LLP
*31.1 Certification of Chief Executive Officer pursuant
to Exchange Act Rules 13a-14 or 15d-14
*31.2 Certification of Chief Financial Officer pursuant
to Exchange Act Rules 13a-14 or 15d-14
*32.1 Certification of Chief Executive Officer pursuant
to Exchange Act Rules 13a-14(b) or 15d-14(b) and
18 U.S.C. Section 1350
*32.2 Certification of Chief Financial Officer pursuant
to Exchange Act Rules 13a-14(b) or 15d-14(b) and
U.S.C. Section 1350
* Filed herewith
74
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934,
the Registrant has caused this Annual Report on Form 10-K to be signed on its
behalf by the undersigned, thereunto duly authorized.
ENGlobal CORPORATION
Dated: March 30, 2006
By: //s// Michael L. Burrow
Michael L. Burrow, P.E.,
Chief Executive Officer, Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated:
By: //s// Michael L. Burrow
Michael L. Burrow, P.E.
Chief Executive Officer, Director
By: //s// William A. Coskey
William A. Coskey, P.E.
Chairman of the Board, Director
By: //s// Robert W. Raiford
Robert W. Raiford
Chief Financial Officer, Treasurer
By: //s// David W. Gent
David W. Gent, P.E., Director
By: //s// Randall B. Hale
Randall B. Hale, Director
By: //s// David C. Roussel
David C. Roussel, Director
75