UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K/A
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
--- EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2006
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 repo
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):
Non-accelerated
Large accelerated filer Accelerated filer X filer
--- --- ---
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, 2006 was $126,159,307 (based upon
the closing price for shares of common stock as reported by the American Stock
Exchange on that date).
The number of shares outstanding of the registrant's common stock on March 15,
2007 is as follows:
$0.001 Par Value Common Stock 26,829,090 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 2007 Annual Meeting of Stockholders
to be filed with the Securities and Exchange Commission on or before April 30,
2007.
2
EXPLANATORY NOTE
This Amendment No. 1 (this "Form 10-K/A") to our Annual Report on Form 10-K for
the year ended December 31, 2006 that was originally filed on March 16, 2007
(the "Original Filing"), is being filed to correct certain references and
clerical errors.
For the convenience of the reader, this Form 10-K/A sets out the Original Filing
in its entirety. However, this Form 10-K/A only amends and restates the
following Items of the Original Filing:
Cover Page - A clerical error on the cover page has been corrected; the Original
Filing should have indicated that disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K will be contained in the definitive proxy statement.
Page 42 - Report of Independent Registered Public Accounting Firm on Internal
Control Over Financial Reporting, the last sentence should read: "Our report
thereon dated March 15, 2007 expressed an unqualified opinion."
Page 44 - Report of Independent Registered Public Accounting Firm on
Consolidated Financial Statements, the last sentence was omitted and should
read: "As discussed in Note 11 to the consolidated financial statements, the
Company adopted Statement of Accounting Standards No. 123 (revised 2004),
"Share-Based Payment", during the year ended December 31, 2006.
Page 81 - Part III, Items 10, 12, 13 and 14 should refer to the 2007 annual
meeting of stockholders.
Finally, in order to provide for completeness in our annual report filing,
certain exhibits that were not available in a form acceptable for filing with
the SEC, have been added. The Exhibit listing is provided in its entirety on
pages 82 through 86.
No attempt has been made in this Form 10-K/A to modify or update other
disclosures presented in the Original Filing, other than to correct
typographical and other immaterial errors. This Form 10-K/A does not reflect
events occurring after the filing of the Original Filing or modify or update
disclosures affected by subsequent events. None of the additional exhibits filed
herewith update or are affected by subsequent events. Accordingly, this Form
10-K/A should be read in conjunction with our filings made with the Securities
and Exchange Commission subsequent to the filing of the Original Filing,
including our current reports on Form 8-K filed on March 16, 2007.
i
ENGlobal Corporation
--------------------
2006 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 20
ITEM 2. PROPERTIES 20
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 22
SECURITIES
ITEM 6. SELECTED FINANCIAL DATA 25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATION 27
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK 40
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 40
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE 77
ITEM 9A. CONTROLS AND PROCEDURES 77
PART III
--------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 81
ITEM 11. EXECUTIVE COMPENSATION 81
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS 81
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 81
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES 81
PART IV
-------
ITEM 15. EXHIBITS, FINANCIAL STATEMENTS AND SCHEDULES 82
SIGNATURES
----------
SIGNATURES 87
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) our ability to collect
accounts receivable in a timely manner; (ii) our ability to accurately estimate
costs and fees on fixed-price contracts; (iii) 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; (iv) 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; (v) the effect of changes in the Company's organization,
compensation and benefit plans; (vi) 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; (vii) the effect of
increases and decreases in oil prices; (viii) the availability of parts from
vendors; (ix) our ability to increase or renew our line of credit; (x) 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; (xi) our ability to hire and retain qualified
personnel; (xii) our ability to retain existing customers and get new customers
and (xiii) 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,
and procurement and construction management. We also supply automation,
control and instrumentation systems to our clients worldwide. On May 25,
2006, the Company purchased Denver-based WRC Corporation, expanding our
engineering services, by providing integrated land management, engineering,
and related services.
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".
Since the Company's merger with Petrocon, the net revenue from continuous
operations has grown from $89.1 million in 2002 to $303.1 million in 2006,
a compounded annual growth rate of approximately 35.8%. 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 2,100 full-time equivalent employees in offices
strategically located in Houston, Beaumont, Clear Lake, Freeport, and
Midland, Texas; Baton Rouge and Lake Charles, Louisiana; Tulsa, Cleveland
and Blackwell, Oklahoma; Denver, Colorado; and Calgary, Alberta, Canada.
In December 2006, ENGlobal Engineering, Inc. began its plan to cease
operations in Dallas, Texas. Some project activities previously performed
in the Dallas office have been transferred to other ENGlobal offices. On
February 19, 2007, the Company entered into agreements with another firm
providing for the sale of the majority of Dallas assets and for the partial
sublease of Dallas office space. These actions were the result of a
decision to consolidate the Company's Texas-based operations while
streamlining or reducing overhead costs. A small number of the Company's
former Dallas personnel transferred to other ENGlobal offices and others
were asked to remain with the Company through May 31, 2007, to allow for an
orderly transfer of on-going projects. However, the majority of the
previous Dallas employees are now employed by the firm which purchased
certain of the Dallas assets, and the Company expects to utilize some on a
subcontract basis for a short period of time and on a discretionary basis
to complete projects. Currently the Company has no plans to sell the assets
of consolidate any of its other office locations.
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.
5
ITEM 1. BUSINESS (Continued)
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.
Business Segments
-----------------
During 2006, we operated two business segments: engineering and systems.
The respective contributions to our total sales in 2006, 2005 and 2004 for
the engineering and the systems segments are summarized below.
Note: Previously, within the Systems Segment, ESI provided products and
services supporting the advanced automation and integrated controls fields.
In January 2006, EAG assumed responsibility for these services, which
resulted in a move of this division of ESI to the Engineering Segment.
Revenues and expenses have been reclassified between the segments to
provide comparative results. Amounts will tie in total to prior reporting,
however, individual segments will vary from prior reports.
Percentage of Revenues
--------------------------------------
Segment 2006 2005 2004
------- ------- --------
Engineering 91.8% 93.9% 90.5%
Systems 8.2% 6.1% 9.5%
------- -------- --------
100.0% 100.0% 100.0%
======= ======== ========
Revenues from the systems segment remained constant from 2004 to 2005, but
increased 75.4% from 2005 to 2006 primarily as a result of the acquisition
of certain assets of Analyzer Technology International, Inc. ("ATI") in
January 2006. Engineering revenues increased 62.8% and 26.8%, respectively,
from 2004 to 2005 and from 2005 to 2006.
Engineering Segment
---------------------------------------------------------------------------
2006 2005 2004
-----------------------------------
(Amounts in thousands)
-----------------------------------
Revenues $278,157 $219,426 $134,778
Operating profit $ 9,084 $ 18,911 $ 10,437
Total assets $ 70,549 $ 54,342 $ 46,122
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"), ENGlobal Construction
Resources, Inc. ("ECR"), ENGlobal Technical Services, Inc. ("ETS"),
ENGlobal Automation Group, Inc. ("EAG"), ENGlobal Canada ULC ("ENGlobal
Canada"), WRC Corporation ("WRC") and WRC Canada. EEI focuses 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 pipeline inspection services to the oil and gas,
utility and pipeline industries and turnaround, asset management, and
start-up services for the petrochemical industry. ETS primarily
provides Automated Fuel Handling Systems and services to branches of
the U.S. military and public sector companies. EAG and
6
ITEM 1. BUSINESS (Continued)
ENGlobal Canada provide engineering services relating to the
implementation of process controls, instrumentation, advanced
automation and information technology projects. Further expanding our
services within the pipeline industry, WRC and WRC Canada primarily
provide land management, right-of-way services, environmental
compliance, and governmental regulatory services to pipeline, utility
and telecom companies and other owner/operators of "infrastructure"
facilities. The engineering segment derives revenues primarily from
cost-plus fees charged for professional and technical services. We also
enter into contracts providing for the execution of projects on a
fixed-price basis, whereby some or all of the project activities
related to engineering, material procurement and construction are
performed for a lump sum amount. As a service company, we are more
labor than capital intensive. Our income primarily results from our
ability to generate revenues and collect cash under both cost-plus and
fixed-price contracts that is in excess of any cost for employees,
material, equipment and subcontracts and selling, general and
administrative (SG&A) expenses.
As of December 31, 2006, the engineering segment had more than one
hundred 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, Clear Lake, Houston, Midland and Freeport, Texas; Tulsa,
Cleveland and Blackwell, Oklahoma; Denver, Colorado; and Calgary,
Alberta.
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 2005, 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.
During 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.
In May 2006, ENGlobal Corporation purchased Denver-based WRC
Corporation ("WRC") and its subsidiary WRC Canada further expanding our
services within the pipeline industry. WRC provides land management,
environmental compliance, and governmental regulatory services to the
pipeline, utility and telecom companies and other owner/operators of
"infrastructure facilities."
In October 2006, ENGlobal Construction Resources acquired selected
assets of Watco Management, Inc. located in Clear Lake, Texas. As a
result, we now provide turnaround, asset management, and start-up
services for the refining and petrochemical industry. The addition of
WATCO will provide ECR with opportunities to expand its current
7
ITEM 1. BUSINESS (Continued)
services to existing WATCO clients to a complementary business,
allowing expansion of current services to both existing and future
clients.
In the first quarter of 2007, the Dallas office was closed with the
majority of assets being sold, a major portion of the office lease
obligations being assumed by others and remaining operations being
transferred to other offices.
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 fixed-price,
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 include:
o conceptual studies;
o project definition;
o cost estimating;
o engineering design;
o inspection;
o land management;
o environmental compliance;
o material procurement; and
o project and construction management.
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
-----------------------------------------------------------------------
Note: Previously, within the Systems Segment, ESI provided products and
services supporting the advanced automation and integrated controls
fields. In January 2006, EAG assumed responsibility for these services,
which resulted in a move of this division of ESI to the Engineering
Segment. Revenues and expenses have been reclassified between the
segments to provide comparative results. Amounts will tie in total to
prior reporting, however, individual segments will vary from prior
reports.
2006 2005 2004
---------------------------------
(Amounts in thousands)
---------------------------------
Revenues $24,933 $ 14,159 $14,110
Operating profit (loss) $ (14) $ (852) $ 660
Total assets $16,099 $ 6,159 $ 7,806
General
-------
Our systems segment designs, assembles, 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 from fees on contracts for the design, assembly and servicing
of control and instrumentation systems. Income from the systems segment
is primarily 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 are
typically based on electronic, programmable controls, however ESI's
work also includes conventional pneumatic and hydraulic systems.
Typical applications for ESI's systems include refinery, petrochemical
and pipeline facility controls; analyzer packaging; fire and gas
detection systems; data acquisition systems; oil and gas production
safety 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 relocated 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 2006, 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 comprise
the basis of competition for ESI's marketplace.
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, 2006.
Name/Location/Business Unit Date Acquired Primary Services
--------------------------- ------------- ----------------
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
Analyzer Technology International, Inc. January 2006 Process Analyzer Systems
Houston, TX
Operates as s Division of ESI
WRC Corporation and May 2006 Integrated Land Management
WRC Canada
Denver, CO
PEI Investments May 2006 Real Estate
Beaumont, TX
WATCO Management, Inc. October 2006 Turnaround
Clearlake, TX Asset Management
Operates as a Division of ECR Project Commissioning
Construction Management
10
ITEM 1. BUSINESS (Continued)
Business Strategy
-----------------
In the past year, the Company has focused considerable attention on
streamlining its organizational structure and strengthening its leadership
team. It anticipates that these efforts will be ongoing in 2007. In
addition, 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.
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
has partnered with several offshore technical resources to
establish longer-term access to professional engineering and
design work in lower cost countries such as Mexico, Venezuela,
Costa Rica and the Far East. The Company has entered into an
agreement with a Malaysian firm that provides for "low cost, high
value" engineering and drafting services. We believe these
partnerships, both formal and informal, 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. One of the engineering
segment's goals is to increase revenues by developing and
marketing its ability to perform full service turnkey projects,
also called EPC (Engineering, Procurement and Construction)
projects, that is expected to emphasize a cost plus contracting
strategy. 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. The
Company intends to audit and monitor compliance with these
procedures and quality standards.
o Expand and Enhance Technical Capabilities. We believe that it is
important to develop and enhance our overall technical
capabilities in the markets we serve. To achieve this objective
in the area of advanced computer-aided process simulation, design
and drafting, 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 include an active business development program, together
with selected initiatives to start new business operations. We
also pursue acquisitions that will allow us to offer expanded
engineering and control system services
11
ITEM 1. BUSINESS (Continued)
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 we anticipate that
newly acquired entities will adopt ENGlobal as a part of their
name within 12 to 18 months of their acquisition.
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. 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 also believes that our acquisition program, although
small, has provided the benefit of expanding our existing customer base.
We currently employ 25 full-time professional in-house marketers in our
business development department who concentrate on both the engineering and
systems segments. We have formed alliances, which include marketing
activities, with other engineering and construction firms in Mexico City,
Central and South America and Malaysia.
Customers
---------
In 2007, the Company will focus substantial attention on improving customer
services in certain of its offices in order to enhance satisfaction and
increase customer retention. 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. We have had
success undertaking new projects for prior clients and providing ongoing
services to clients following the completion of the projects.
The Company believes that about two-thirds of our revenue is generated
through sources such as in-plant staffing and alliance relationships that
we consider longer-term in nature and that are not typically limited to one
project. As an example, our In Plant Staffing division of EEI provides
outsourced technical and other personnel that are assigned to work at
client locations. The Company's past experience with this activity is that
the term of these assignments on average spans multiple projects and
multiple years.
12
ITEM 1. BUSINESS (Continued)
A major long-term trend among our clients and their industry counterparts
has been toward outsourcing of engineering services, and more recently,
sole-sourcing. This trend has fostered the development of ongoing,
longer-term alliance arrangements with clients, rather than one-time
limited engagements. These arrangements vary in scope, duration and degree
of commitment. While there is typically no guarantee of work that will
result from these alliance agreements, often they form the basis for a
longer-term relationship with our clients. Despite their variety, we
believe that these partnering relationships have a stabilizing influence on
our service revenues. At December 31, 2006, we maintained some form of
partnering or alliance arrangement with 16 major oil and chemical
companies. For example, alliance 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.
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. Also during 2006 we generated
$26 million in revenues away from the historical large "owner/operator"
type Fortune 500 companies to smaller developer type entities such as
smaller refiners and developers of renewable energy.
In the engineering segment, our ten largest customers, who vary from one
period to the next, accounted for 71% of our total revenue for 2006, 77% of
total revenue for 2005, and 80% of total revenue for 2004. 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. Our top
three clients in 2006 were ConocoPhillips, ExxonMobil and Motiva.
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.
In the systems segment, our ten largest customers, who vary from one period
to the next, accounted for 64% of our total revenue for 2006, 70% of total
revenue for 2005, and 77% of total revenue for 2004. During 2006, foreign
customers accounted for 31% of our systems segment revenue compared to less
than 1% during both 2005 and 2004. The increase in revenue from foreign
customers is based on the expansion of the analytical division that
provides online process analyzer systems, through the acquisition of ATI.
Our ability to provide analyzer systems is dependent on fundamental
contracts with customers doing business in oil producing regions. The loss
of business from anyone of such customers could have a material adverse
effect on our systems business or results of operations, but not the
company as a whole. Other factors affecting our analyzer systems business
that are beyond our control include: political instability or armed
conflict, the level of customer demand, the willingness of clients to make
payments, and to make those payments timely.
We do not have any long-term commitments from systems segment 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 our engineering
segment, in fiscal 2006, 89% and 11% of our net revenue was derived from
time and materials and fixed-price contracts, respectively, compared to 95%
and 5% of net revenue from time and materials and fixed-price contract
respectively in 2005. In our systems segment, in fiscal 2006, 7% and 93% of
our net revenue was derived from time and materials and fixed-price
contracts, respectively, compared to 3% and 97% of net revenues from time
and materials and fixed-price contracts, respectively in 2005. Our clients
typically determine the type of contract to be utilized for a particular
engagement, with the specific terms and conditions of a contract resulting
from a negotiation process between the Company and our client.
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. We
are paid for material and contracted services at an agreed upon
multiplier of our cost, and at times pass these non-labor
services through with no profit. Profitability on these contracts
is driven by billable headcount, the amount of non-labor related
services, 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 projects
vary in scope, including some engineering activities and related
services, and procurement of material and construction
responsibility. 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,
and we plan to limit the size and scope of fixed-price contracts
that we enter into in the future due to significant losses on two
fixed-price contracts.
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, 2006, our backlog was $192.0 million compared to an
estimated $170.0 million at December 31, 2005. We expect that a majority of
the $192.0 million in backlog to be completed during 2007.
The backlog at December 31, 2006 consists of $187.0 million with commercial
customers and $5.0 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.
There is no assurance as to what percentage of backlog will be recognized.
14
ITEM 1. BUSINESS (Continued)
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 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.
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 5 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 7% 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;
rather, they 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 or one of its suppliers 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 "Engineered for Growth" and "ENGlobal CARES -
Communicating Appropriate Responses in Emergency Situations", "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
15
ITEM 1. BUSINESS (Continued)
Company, its subsidiaries, or personnel that we believe is likely to have a
material adverse effect on our results of operations or financial
condition.
Employees
---------
As of December 31, 2006, the Company and its subsidiaries employed 2,100
individuals. Of these employees, 1,127 were employed in engineering and
related positions; 332 were employed as inspectors; 310 were employed as
project support staff; 211 were employed in technical production positions;
95 were employed in administration, finance and management information
systems and 25 were employed in sales and marketing. 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.
16
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.
Our indebtedness could limit our ability to finance future operations
or engage in other business activities. As of December 31, 2006, we had
$24 million of total outstanding indebtedness against our revolving
line of credit currently limited to $30 million. Significant factors
that could increase our indebtedness and/or limit our ability to
finance future operations include:
o our inability to collect accounts receivable within contractual
terms;
o client demands for extending contractual payment terms;
o material losses and/or negative cash flows on significant
projects;
o client's ability to pay our invoices due to economic conditions;
and
o our ability to meet current credit facility financial ratios and
covenants.
Although we are in compliance with all current credit facility
covenants, our indebtedness could limit our ability to finance future
operations or engage in other business activities.
Force majeure events such as natural disasters have negatively impacted
and could further negatively impact the economy and the industries we
service, which may affect our financial condition, results of
operations and cash flows.
Force majeure events such as Hurricanes Katrina and Rita that affected
the Gulf Coast in August and September of 2005 could negatively impact
the economies in which we operate. For example, these two hurricanes
caused considerable damage along the Gulf Coast not only to the
refining and petrochemical industry but also the commercial segment
which competes for labor, materials and equipment resources needed
throughout the entire United States. We typically remain obligated to
perform our services after such a natural disaster and even though our
contract may contain force majeure clause. If we are not able to react
quickly and/or negotiate contractual relief under a force majeure
event, our operations may be affected significantly, which would have
a negative impact on our financial condition, results of operation and
cash flows.
16
ITEM 1A. RISK FACTORS (Continued)
Our future revenues depend on our ability to consistently bid and win
new contracts and to maintain and renew existing contracts and,
therefore, our failure to effectively obtain future contracts could
adversely affect our profitability.
Our future revenues and overall results of operations require us to
successfully bid on new contracts and renew existing contracts.
Contract proposals and negotiations are complex and frequently involve
a lengthy bidding and selection process, which is affected by a number
of factors, such as market conditions, financing arrangements and
required governmental approvals. For example, a client may require us
to provide a bond or letter of credit to protect the client should we
fail to perform under the terms of the contract. If negative market
conditions arise, or if we fail to secure adequate financial
arrangements or the required governmental approval, we may not be able
to pursue particular projects, which could adversely affect our
profitability.
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 attract and retain
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.
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 they reach critical
mass, that industry trends have been misread or delayed or that they
Company is unable to successfully execute on these initiatives. In
these cases, continued funding could have a negative impact on long
term earnings.
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 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.
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.
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
18
ITEM 1A. RISK FACTORS (Continued)
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 2006, approximately 17.9%
of our net revenue was derived from fixed-price contracts, and we
recorded losses of $13 million on two significant fixed-price EPC
projects.
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
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 need 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 2006, approximately 15%
of our revenues were from ConocoPhillips, approximately 14% of our
revenues were from ExxonMobil and another 10% were from Motiva. 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. Also, the majority of
our contracts can be terminated at will. 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.
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.
18
ITEM 1A. RISK FACTORS (Continued)
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, 2006, our backlog was approximately $192 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, reducing
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.
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.
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.
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
factors, our first an fourth quarters may be less robust than our
second and third quarters.
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.
19
ITEM 1A. RISK FACTORS (Continued)
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.
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. As of
December 31, 2006, directors, executive officers and principal
stockholders of ENGlobal and their affiliates, beneficially owned
approximately 41% 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.
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 47,518,533 shares of common stock and an
additional 2,000,000 shares of blank check preferred stock as of the
date of filing. 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 or under a new equity
incentive 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.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2. PROPERTIES
Facilities
We lease space in 23 buildings in the U.S. and Canada totaling
approximately 458,600 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
commercially reasonable rental rates. On May 26, 2006, the Company entered
into an exclusive agreement with a third-party, national real estate firm
for tenant representation services that covers most of our facilities.
Our principal office locations are in Houston and Beaumont, Texas, and
Tulsa, Oklahoma. We have other offices in Clear Lake, Freeport, and
Midland, Texas; Baton Rouge and Lake Charles, Louisiana; Cleveland and
Blackwell, Oklahoma; Denver, Colorado; and Calgary, Alberta Canada.
Approximately 357,000 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.
On May 25, 2006, the Company, through its wholly-owned subsidiary ENGlobal
Corporate Services, Inc., purchased a one-third partnership interest in PEI
Investments, A Texas Joint Venture ("PEI"), from Michael L. Burrow, the
Company's President and CEO, and another one-third interest from a
stockholder who owns less than 1% of the Company's common stock. The
partnership interests were purchased for a total of $69,000. The
20
ITEM 2. PROPERTIES (Continued)
remaining one-third interest was already held by the Company through its
wholly-owned subsidiary EEI. PEI owns the land on which our Beaumont, Texas
office building, destroyed by Hurricane Rita in September 2005, was
located. The remains of the building were razed in July 2006. In September
2006, the Company acquired approximately 1.2 acres immediately adjacent to
the former facility and is developing plans to construct a new facility
utilizing both parcels of land.
On February 16, 2007, the Company, through its wholly-owned subsidiary, RPM
Engineering, Inc. ("RPM"), entered into an agreement (the "Agreement") to
sell the Company's property located in Baton Rouge, Louisiana. The purchase
price is approximately $1.9 million with 20% of the purchase price being
paid at closing and the balance self-financed for a period no longer than
60 months, amortized over 180 months, payable in equal monthly installments
and one irregular installment consisting of the interest and principal due
at the end of the 60 months. The initial interest rate is 8.5% based on an
agreed rate of NY prime plus .25%. Under certain conditions, prior to
closing and up to 60 days from the last signing of the Agreement, the
Purchaser is entitled to terminate the agreement and demand the return in
full of any deposit held by RPM. The financed portion of the purchase price
is secured by a first mortgage on the property. The Company's basis in the
property, together with the building and all improvements, is approximately
$1.4 million. The Company expects to close this transaction May 31, 2007.
The Company has leased approximately 31,000 square feet of space in two
separate facilities to house its EEI and EAG operations in Baton Rouge.
On March 2, 2007, the Company, through its wholly-owned subsidiary,
ENGlobal Automation Group, Inc. ("EAG"), entered into a 39 month lease
agreement for approximately 4,489 square feet of office space in
Alpharetta, Georgia (a suburb of Atlanta).
ITEM 3. LEGAL PROCEEDINGS
From time to time, we are involved in various legal proceedings arising in
the ordinary course of business alleging, among other things, breach of
contract or tort in connection with the performance of professional
services, the outcome of which cannot be predicted with certainty. As of
the date of this filing, we are party to several legal proceedings that
have been reserved for or are covered by insurance, or that, if determined
adversely to us individually or in the aggregate, would not have a material
adverse effect on our results of operations or financial position.
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
-------------------------------------------
2006 2005
-------------------------------------------
High Low High Low
-------------------------------------------
First Quarter 14.61 9.14 2.87 2.04
Second Quarter 14.70 6.91 4.03 2.01
Third Quarter 8.88 5.71 9.10 3.69
Fourth Quarter 8.15 5.92 8.75 5.87
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.
The Company's stockholders at its June, 2006 meeting approved the
elimination of the 2,265,167 shares of available and unissued Series A
Preferred Stock from its capital structure, and approved the authorization
of a like number of "blank check" preferred stock.
The Company's stockholders, at the Company's June, 2006 meeting, approved a
new class of capital stock of the Company consisting of 2,000,000 shares of
Preferred Stock, par value $0.001 per share (the "Preferred Stock"). The
Preferred Stock is referred to as a "blank check" because the Board of
Directors, in their discretion, will be authorized to provide for the
issuance of all or any shares of the stock in one or more classes or
series, specifying the terms of the shares, subject to the limitations of
Nevada law. The Board of Directors would make a determination as to whether
to approve the terms and issuance of any shares of Preferred Stock based on
its judgment as to the best interests of the Company and its stockholders.
As of December 31, 2006, approximately 314 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)
The following line graph compares the total returns (assuming reinvestment
of dividends) to our Common Stock, the AMEX US Index and the S&P 600
SmallCap Index for the five-year period ended December 31, 2006. This
comparison assumes the investment of $100 on December 31, 2000 and the
reinvestment of all dividends.
2001 2002 2003 2004 2005 2006
---- ---- ---- ---- ---- ----
ENGlobal (ENG) 100.00 57.14 82.29 136.00 225.14 354.29
S&P 600 SmallCap Index 100.00 84.68 116.47 141.61 151.03 172.29
Amex US Index 100.00 81.74 110.63 127.83 138.33 160.48
23
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, 2006. 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 1,422,494 (1) $5.16 150,806
approved by security
holders
------------------------- -----------------------------
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, and
operating and financial position and on 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. The
Company's stockholders eliminated this series of preferred stock at its
June, 2006 stockholders meeting.
-----------------------------
(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.
24
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, 2006, 2005, and 2004 have been derived from
the audited financial statements appearing elsewhere in this document. The
data as of December 31, 2003 and 2002 and for the years ended December 31,
2003 and 2002 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.
Note: Previously, within the Systems Segment, ESI provided products and
services supporting the advanced automation and integrated controls fields.
In January 2006, EAG assumed responsibility for these services, which
resulted in a move of this division of ESI to the Engineering Segment.
This, along with the sale of Thermaire in 2003, has caused reclassification
to provide comparative results. Revenues and expenses have been
reclassified between the segments to provide comparative results. Amounts
will tie in total to prior reporting, however, individual segments will
vary from prior reports.
Years Ended December 31,
--------------------------------------------------------------------
2006 2005 2004 2003 2002
--------------------------------------------------------------------
(in thousands, except per share amounts)
--------------------------------------------------------------------
Statement of Operations
Revenues
Engineering $ 278,157 $ 219,426 $ 134,778 $ 110,535 $ 75,817
Systems 24,933 14,159 14,110 13,184 13,305
------------ ------------ ------------ ------------ ------------
Total revenues 303,090 233,585 148,888 123,719 89,122
------------ ------------ ------------ ------------ ------------
Costs and expenses
Engineering 254,031 192,264 118,805 95,021 63,322
Systems 22,795 13,048 11,891 11,725 11,395
Selling, general and administrative 29,885 19,689 13,700 12,439 10,632
------------ ------------ ------------ ------------ ------------
Total costs and expenses 306,711 225,001 144,396 119,185 85,349
------------ ------------ ------------ ------------ ------------
Operating income (loss) (3,621 ) 8,584 4,492 4,534 3,773
Interest income (expense), net (1,312 ) (800 ) (590 ) (784 ) (821 )
Other income (expense), net 652 116 118 (355 ) 143
Foreign currency gain (loss) (19 ) (2 ) - - -
------------ ------------ ------------ ------------ ------------
Income (loss) from continuing operations before
provision for income taxes (4,300 ) 7,898 4,020 3,395 3,095
Provision for income taxes (814 ) 3,116 1,656 1,110 1,197
------------ ------------ ------------ ------------ ------------
Income (loss) from operations (3,486 ) 4,782 2,364 2,285 1,898
Income (loss) from discontinued operations, net of
taxes - - - (154 ) (146 )
Income (loss) from disposal of discontinued
operations - - - 26 -
------------ ------------ ------------ ------------ ------------
Net income (loss) $ (3,486 ) $ 4,782 $ 2,364 $ 2,157 $ 1,752
============ ============ ============ ============ ============
25
ITEM 6. SELECTED FINANCIAL DATA (Continued)
Years Ended December 31,
--------------------------------------------------------------------
2006 2005 2004 2003 2002
--------------------------------------------------------------------
(in thousands, except per share amounts)
--------------------------------------------------------------------
Per Share Data
Basic earnings (loss) per share
Continuing operations $ (0.13 ) $ 0.20 $ 0.10 $ 0.09 $ 0.07
Discontinued operations - - - - -
------------ ------------ ------------ ------------ ------------
Net income per share $ (0.13 ) $ 0.20 $ 0.10 $ 0.09 $ 0.07
============ ============ ============ ============ ============
Weighted average common
shares outstanding - basic 26,538 24,300 23,455 23,301 22,861
Diluted earnings (loss) per share
Continuing operations $ (0.13 ) $ 0.19 $ 0.10 $ 0.09 $ 0.07
Discontinued operations - - - - -
------------ ------------ ------------ ------------ ------------
Net income per share $ (0.13 ) $ 0.19 $ 0.10 $ 0.09 $ 0.07
============ ============ ============ ============ ============
Weighted average common
shares outstanding - diluted 26,538 25,250 23,786 23,734 23,013
Cash Flow Data
Operating activities, net $ (8,953 ) $ (920 ) $ (2,391 ) $ 6,557 $ 1,302
Investing activities, net (9,330 ) (2,417 ) (1,811 ) (471 ) (1,290 )
Financing activities, net 19,553 3,492 4,170 (6,122 ) (1,182 )
Exchange rate changes (26 ) (4 ) - - -
------------ ------------ ------------ ------------ ------------
Net change in cash and cash equivalents $ 1,244 $ 151 $ (32 ) $ (36 ) $ (1,170 )
============ ============ ============ ============ ============
Balance Sheet Data
Working capital $ 35,187 $ 21,825 $ 14,503 $ 6,505 $ 8,416
Property and equipment, net $ 8,725 $ 6,861 $ 5,262 $ 4,302 $ 4,779
Total assets $ 106,227 $ 75,936 $ 57,261 $ 42,530 $ 40,068
Long-term debt, net of current portion $ 27,162 $ 5,228 $ 15,585 $ 7,506 $ 12,580
Long-term capital leases, net of current portion $ - $ - $ - $ 12 $ 17
Stockholders' equity $ 40,862 $ 39,865 $ 20,051 $ 18,175 $ 13,389
26
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 contain 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, inspection services, land management and
environmental compliance services. Our systems segment designs, assembles,
integrates and services control and instrumentation systems for specific
applications in the energy and process 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, and equipment and may provide construction services on a
subcontractor basis. Generally, these materials, equipment and
subcontractor costs are passed through to our clients and reimbursed, along
with fees, which in total are at margins 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.
27
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.
Note: Previously, within the Systems Segment, ESI provided products and
services supporting the advanced automation and integrated controls fields.
In January 2006, EAG assumed responsibility for these services, which
resulted in a move of this division of ESI to the Engineering Segment.
Revenues and expenses have been reclassified between the segments to
provide comparative results. Amounts will tie in total to prior reporting,
however, individual segments will vary from prior reports.
Years Ended December 31,
------------------------------------------------------------------------
2006 2005 2004
--------------------- --------------------- ---------------------
Amount % Amount % Amount %
------------------------------------------------------------------------
(in thousands)
------------------------------------------------------------------------
Revenue
Engineering $ 261,389 86.3 $ 207,368 88.8 $ 124,362 83.5
Systems 24,933 8.2 14,159 6.0 14,110 9.5
Acquisition 16,768 5.5 12,058 5.2 10,416 7.0
------------- ------- ------------ ------- ------------- -------
Total revenue $ 303,090 100.0 $ 233,585 100.0 $ 148,888 100.0
============ =========== ============
Gross profit
Engineering $ 21,737 8.3 $ 25,940 12.5 $ 14,300 11.5
Systems 2,138 8.6 1,111 7.8 2,219 15.7
Acquisition 2,389 14.2 1,222 10.1 1,673 16.1
------------ ----------- ------------
Total gross profit $ 26,264 8.7 $ 28,273 12.1 $ 18,192 12.2
============ =========== ============
Selling, general and administrative
Non-acquisition $ 28,211 9.9 $ 18,863 8.5 $ 11,866 8.6
Acquisition 1,674 10.0 826 6.9 1,834 17.6
------------ ----------- ------------
Total $ 29,885 9.9 $ 19,689 8.4 $ 13,700 9.2
============ =========== ============
Net income (loss) $ (3,486) (1.2) $ 4,782 2.1 $ 2,364 1.6
============ ======= =========== ======= ============= =======
Total revenue increased 29.8% or $69.5 million from 2005 to 2006.
Overall gross profit decreased 7.1%, or $2.0 million from 2005 to 2006.
Total SG&A expense increased 51.8%, or $10.2 million from 2005 to 2006.
Income from continuing operations decreased 172.9%, or $8.3 million from
2005 to 2006.
28
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION (Continued)
Year Ended December 31, 2006 Compared to Year Ended December 31, 2005
Note: Previously, within the Systems Segment, ESI provided products and
services supporting the advanced automation and integrated controls fields.
In January 2006, EAG assumed responsibility for these services, which
resulted in a move of this division of ESI to the Engineering Segment.
Revenues and expenses have been reclassified between the segments to
provide comparative results. Amounts will tie in total prior to reporting,
however, individual segments will vary from prior reports.
Total Revenue
-------------
Engineering revenue accounted for 91.8% of our total revenue for the
year, increasing $58.8 million from $219.4 million in 2005 to $278.2
million in 2006.
The increase in engineering revenue was primarily brought about by
increased activity in the engineering and construction markets.
Refining related activity has been particularly strong, including
projects to satisfy environmental mandates, expand existing facilities
and utilize heavier sour crude. Capital spending in the pipeline area
is also trending higher, with numerous projects in North America
currently underway to deliver crude oil, natural gas, petrochemicals
and refined products. Renewable energy appears to be an emerging area
of activity and potential growth, with the Company currently performing
a variety of services for ethanol, biodiesel, coal to liquids,
petroleum coke to ammonia, and other biomass processes. The
acquisitions of WRC in the second quarter of 2006, together with our
clients' increased demand for in-plant and inspection resources,
stimulated growth in our staffing services division where revenues
increased 90.6%, or $50.9 million, from $56.2 million in 2005 to $107.1
million in 2006.
Revenue from procurement services decreased 67.6%, or $40.2 million,
from $59.5 million in 2005 to $19.3 million in 2006. This significant
decrease is primarily related to three projects, two of which began in
2003 and one of which began in 2005 and were materially completed in
2006. The level of procurement services is expected to vary over time
depending on the volume of procurement activity our customers choose to
do themselves as opposed to using our services on larger EPC contracts.
In 2005, the Company was awarded two significant fixed-price
engineering, procurement and construction ("EPC") projects in the
refining industry that included procurement and subcontractor
activities within our scope of work. This accounts for the higher level
in that year. Together these two fixed-price EPC projects accounted for
approximately $20.2 million of the engineering segment revenues during
2006 compared to approximately $1.8 million during 2005. The current
combined contract value of these two projects is approximately $24.6
million and both are currently scheduled for completion by the end of
the second quarter of 2007. As a result of revised estimates of the
percentage of completion of these projects, the Company suffered a
reversal of $6.6 million in the third quarter of 2006 and $7.1 million
in the fourth quarter of 2006. Due to losses incurred in the execution
of these contracts, we anticipate that we will enter into this type of
contract only on a very limited basis, if at all.
The systems segment contributed 8.2% of our total revenue for the year,
as its revenue increased $10.7 million, or 75.4%, from $14.2 million in
2005 to $24.9 million in revenue in 2006. A general turnaround in the
oil and gas industry, together with the acquisition of ATI in January
2006 has increased the demand for ESI's services. Another factor
positively affecting ESI's business is that the computer-based
distributed control systems equipment used for facility plant
automation becomes technologically obsolete over time, which supports
ongoing replacement of these systems. Backlog for ESI at December 31,
2006 reached $10.0 million, compared to $9.1 million at December 31,
2005.
Gross Profit
------------
Primarily due to losses on two EPC fixed-price contracts in our
engineering segment, as discussed above, total gross profit decreased
$2.0 million, or 7.1%, from $28.3 million in 2005 to $26.3 million in
2006 and, as a percentage of total revenue, decreased from 12.1% to
8.7% during the same period.
29
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION (Continued)
Due to the material financial impact of the losses on two significant
fixed-price EPC projects* during 2006, the following "non-GAAP"
proforma financial is being presented to demonstrate the performance of
the historical core business within the Engineering segment.
Non-GAAP Proforma Years Ended December 31,
------------------------------------------------------------------------
Financial Information 2006 2005 2004
--------------------- --------------------- ---------------------
Amount % Amount % Amount %
------------------------------------------------------------------------
(in thousands)
------------------------------------------------------------------------
Revenue
Engineering - Actual $ 261,389 $ 207,368 $ 124,362
Less fixed-price projects* 20,155 - -
----------- ------------ ------------
Engineering - Revised $ 241,234 85.3 $ 207,368 88.8 $ 124,362 83.5
Systems 24,933 8.8 14,159 6.0 14,110 9.5
Acquisition 16,768 5.9 12,058 5.2 10,416 7.0
----------- ------- ------------ ------- ------------ -------
Total revenue $ 282,935 100.0 $ 233,585 100.0 $ 148,888 100.0
=========== ============ ============
Gross profit
Engineering - Actual $ 21,737 $ 25,940 $ 14,300
Less fixed-price projects* (13,740 ) - -
Engineering - Revised $ 35,477 14.7 $ 25,940 12.5 $ 14,300 11.5
Systems 2,138 8.6 1,111 7.8 2,219 15.7
Acquisition 2,389 14.2 1,222 10.1 1,673 16.1
----------- ------------ ------------
Total gross profit $ 40,004 14.1 $ 28,273 12.1 $ 18,192 12.2
=========== ============ ============
* Excluding revenues on two significant fixed-price EPC projects, our
Engineering segment, exclusive of acquisition revenue, would have
accounted for 85.3% of our total revenue for the year, increasing $33.8
million from $207.4 million in 2005 to $241.2 million in 2006, or an
increase of 16.3%.
* Again, excluding the recorded losses on two significant fixed-price
EPC projects, our Engineering segment, net of acquisition gross profit,
would have reported a gross profit of $35.5 million, an increase of
$9.6 million from $25.9 million in 2005, or an increase year-over-year
of 37.1%. As a percentage of revenue, the proforma gross profit for our
Engineering segment, exclusive of gross profit from acquisitions, would
have increased by 17.6%, increasing from 12.5% in 2005 to 14.7% in
2006.
* Also, excluding the recorded losses on the two significant
fixed-price EPC projects, our total gross profit would have increased
$11.7 million from $28.3 million in 2005 to $40.0 million in 2006, or
an increase year-over-year of 41.3%. As a percentage of revenue, total
gross profit, again, excluding the recorded losses on two significant
fixed-price EPC projects, would have increased 16.5%, increasing from
12.1% in 2005 to 14.1% in 2006.
Due to the significant losses on these two projects the Company plans
to limit the size and scope of fixed-price EPC contracts in the future.
Both of the significant fixed-price EPC projects are scheduled for
completion by the end of the second quarter of 2007.
Also during the past year, the Company has shifted a portion of its
services to developer type work for customers that are typically
smaller than its historical customer base. The viability of these
projects and the creditworthiness of these types of customers must be
carefully analyzed to assure profitable results. In the future, the
Company intends to analyze these projects much more carefully before
accepting them.
The Company has also engaged in a number of entrepreneurial ventures
over the past several years, not all of which have been profitable. In
the future, the Company intends to scrutinize these projects much more
carefully before engaging in them and exit them more quickly if they
are not successful.
30
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION (Continued)
Gross profit from engineering, including the breakout of acquisitions,
decreased $3.1 million, or 11.4%, from $27.2 million in 2005 to $24.1
million in 2006 and, as a percentage of revenue, decreased from 12.4%
in 2005 to 8.7% in 2006 primarily due to estimated losses of
approximately $13.7 million on two EPC fixed-price contracts. Both
projects are currently scheduled for completion by the end of the
second quarter of 2007.
The staffing services division , consisting of our in-plant staffing,
land management and inspection operations, increased gross profit $7.4
million, or 113.8%, from $6.5 million in 2005 to $13.9 million in 2006.
We earn a lower margin on procurement services as compared to the
margin we earn on our core engineering services. As an example,
procurement services for 2005 produced a 1.7% gross profit margin.
Comparably, in 2006 gross profit margin on core engineering services
was 8.3%. Our level of procurement revenue has recently trended down,
from $59.5 million or 25.5% of total revenue for 2005 to $19.3 million
or 6.4% of total revenue for 2006.
Any shift from engineering only to EPC projects that include material
procurement and construction responsibility will negatively impact
engineering gross profit as a percentage of revenue. In this case,
lower gross profit will occur 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.
At December 31, 2006, we had outstanding unapproved change
orders/claims of approximately $17.4 million, net of reserves of $1.2
million associated with ongoing fixed-price EPC projects. If in the
future we determine collection of the unapproved change orders/claims
is not probable, it will result in a charge to earnings in the period
such determination is made.
Gross profit for our systems segment increased $1.0 million, or 90.9%,
from $1.1 million in 2005 to $2.1 million in 2006. However, as a
percent of revenue, gross profit increased by 0.8% from 7.8% in 2005 to
8.6% in 2006.
Selling, General and Administrative ("SG&A") Expenses
Selling, general and administrative expenses increased $10.2 million,
or 51.8%, from $19.7 million in 2005 to $29.9 million in 2006,
primarily due to increases in salaries and burdens, facilities and
office expenses, amortization expense and travel. As a percent of
revenue, SG&A increased 1.5% from 8.4% in 2005 to 9.9% in 2006.
Salaries and burden expenses increased $5.0 million in 2006 over 2005
of which $2.2 million of this increase was related to stock
compensation expense recorded during the year. The Company did not
record stock compensation expense during 2005, as the Company adopted
SFAS No. 123R on January 1, 2006 (see Note 11). An additional $0.6
million of the increase was due to increases in corporate salaries, as
employees were added, primarily in Business Development, Accounting and
IT, 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 and EAG's continued growth
during the year.
Facilities and office expenses increased $2.4 million in 2006 over 2005
due to the expansion of EEI's offices in Tulsa, Houston, and Beaumont
to meet both current and projected growth requirements, plus the
additional cost of facilities utilized by acquisitions made throughout
the year.
Amortization expense increased approximately $700,000 primarily as a
result of our completing the valuation of intangible assets acquired in
acquisitions completed during 2006 (see Note 16).
31
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION (Continued)
Increased business development activity pushed marketing and travel
expenses up by over $600,000 in 2006 over similar expenses in 2005.
Operating Profit
----------------
Operating profit decreased $12.2 million to $(3.6) million in 2006 as
compared to $8.6 million in 2005, decreasing, as a percentage of total
revenue, from 3.7% in 2005 to (1.2)% in 2006. This decrease was
primarily the result of the Company's performance on two fixed-price
contracts.
Other Income (Expense)
----------------------
Other income increased from $116,000 in 2005 to $651,500 in 2006. The
income in 2005 resulted from a legal settlement. The income in 2006 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.
32
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
Note: Previously, within the Systems Segment, ESI provided products and
services supporting the advanced automation and integrated controls fields.
In January 2006, EAG assumed responsibility for these services, which
resulted in a move of this division of ESI to the Engineering Segment.
Revenues and expenses have been reclassified between the segments to
provide comparative results. Amounts will tie in total to prior reporting,
however, individual segments will vary from prior reports.
Total Revenue
-------------
Engineering revenue accounted for 94.0% of our total revenue for 2005,
an increase of $84.6 million from $134.8 million in 2004 to $219.4
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 54.4%, or $19.8 million,
from $36.4 million in 2004 to $56.2 million in 2005.
Revenue from procurement services increased 55.8%, or $21.3 million,
from 2004 to 2005 and contributed 25.7%, or $21.3 million, of the
increase in total engineering revenue during the same period. The level
of procurement services varies 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 systems segment contributed 6.0% of our total revenue for the year,
as its revenue increased $0.1 million, or 0.7%, from $14.1 million in
2004 to $14.2 million in revenue in 2005. 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.
Acquisition revenue, represented only 5.2% of total revenue for 2005,
increased 16.3%, or $1.7 million, during the comparable periods,
primarily from nine months of revenue generated in 2005 through
acquisitions completed in the 4th quarter of 2004.
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 $11.2 million, or 70.0%, from
$16.0 million in 2004 to $27.2 million in 2005 and, as a percentage of
revenue, increased from 11.5% in 2004 to 12.5% 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 $2.2 million, or 51.2%, from $4.3 million in
2004 to $6.5 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.
33
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 decreased $1.1 million, or 50.0%,
from $2.2 million in 2004 to $1.1 million in 2005. Also, as a percent
of revenue, gross profit decreased by 7.9% from 15.7% in 2004 to 7.8%
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 drove down margins on projects overall. Corrective measures
were taken during the first quarter of 2006 to replace all contract
labor with more stable, direct-hire employees and additional staffing
and systems within the estimating and proposal group should improve
proposal pricing.
During the fourth quarter of 2005, 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 was completed in 2006, resulting in a corresponding
delay in our recognition of revenues and profits.
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
0.8% 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.
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.
34
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION (Continued)
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.
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 26, 2009. The loan
agreement positions Comerica as senior to all other debt. The line of
credit is limited to $30.0 million subject to loan covenant
restrictions. The Comerica Credit Facility is collateralized by
substantially all the assets of the Company. As of December 31, 2006,
the outstanding balance on the line of credit was $24.0 million and we
had working capital of $35.2 million. Our total long-term debt
outstanding on December 31, 2006 was $27.2 million (see Note 8), an
increase from $5.2 million as of December 31, 2005. Under the terms and
conditions of our revolving credit facility, as of December 31, 2006,
we have additional borrowing capacity of approximately $6.0 million
after consideration of borrowing base limitations with no letters of
credit outstanding at December 31, 2006.
The following table summarizes our contractual obligations as of
December 31, 2006:
Payments Due by Period
---------------------------------------------------------------------------------
2007 2008 2009 2010 2011 and Total
thereafter
------------ ------------ ------------ ------------ ------------- ------------
(in thousands)
---------------------------------------------------------------------------------
Long-term debt(1) $ 4,747 $ 3,683 $ 27,140 $ 441 $ - $ 36,011
Operating leases 4,366 2,754 2,165 1,938 1,423 12,646
----------- ----------- ------------ ------------ --------- ----------
Total contractual cash obligations $ 9,113 $ 6,437 $ 29,305 $ 2,379 $ 1,423 $ 48,657
=========== =========== ============ ============ ========= ==========
(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, 2006. The
Company's interest rate on its revolving credit facility fluctuates
with the prime rate.
Cash Flow
We believe that we have sufficient available cash required for
operations for the next 12 months. However, cash and the availability
of cash could be materially restricted if circumstances prevent the
timely internal processing of invoices, if amounts billed are not
collected or are not collected in a timely manner, if project mix
shifts from cost reimbursable to fixed costs contracts during
significant periods of growth, if the Company was to lose one or more
of its major customers, if the Company experiences further costs
overruns on fixed- price contract, or if we not able to meet the
covenants of the Comerica Credit Facility. If any such event occurs, we
would be forced to consider alternative financing options.
35
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION (Continued)
Operating Activities:
Operating activities required the use of $9.0 million, $0.9 million, and
$2.4 million in net cash in 2006, 2005 and 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.
The primary factors impacting the increase in our need for cash and the
year-over-year increase in average accounts receivable days outstanding
were:
1) a past due accounts receivable balance of approximately $3.7
million as of December 31, 2006 related to delays in receipts
for services on the start-up of a major alliance agreement that
began during the second quarter of this year;
2) a decrease in billings in excess of costs from approximately
$3.8 million to $540,000 as of December 31, 2005 and 2006
respectively; and
3) an increase in costs and estimated earnings-in-excess of
billings from approximately $4.1 million to $5.4 million as of
December 31, 2005 and 2006, respectively.
Although the above factors are all within rights and restrictions of
contractual terms and conditions within client contracts, we are taking
measures to remediate each of these factors and at this time do not expect
their impact to continue beyond the first quarter of 2007.
Investing Activities:
Investing activities used cash totaling $9.3 million in 2006, compared to
$2.4 million in 2005 and $1.8 million in 2004. In 2006, our investing
activities consisted of capital additions of $3.4 million primarily for
computers and leasehold improvements to our offices and software
implementations. In the fourth quarter, $500,000 was used to complete the
acquisition of Watco Management, Inc. 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, 2006, we amended
our line of credit to permit an increase in annual capital expenditure
limits from $3.25 million to $3.5 million.
Financing Activities:
Financing activities provided cash totaling $19.6 million, $3.5 million,
and $4.2 million in 2006, 2005, and 2004, respectively. Our primary
financing mechanism is our revolving line of credit. The line of credit has
been used principally to finance acquisitions and accounts receivable.
During 2006, our borrowings, on the line of credit were $143.8 million, and
we repaid an aggregate of $123.6 million on our short-term and long-term
bank and other debt.
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 $4.7 million.
In 2006, non-cash transactions included $216,000 notes receivable issued
for sale of assets and $3.9 million notes payable issued for acquisitions.
Also in 2006, $1.4 million of stock was issued associated with the
acquisition of WRC. 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. We also acquired insurance with notes payable of $1.3
million, $198,000, and $1.1 million in 2006, 2005, and 2004, respectively.
36
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION (Continued)
Due to significant losses incurred on two fixed-price projects during the
third and fourth quarter, the Company requested and was successful in
obtaining a waiver and subsequent amendment to its credit agreement with
Comerica Bank in order to meet the monthly fixed charge ratio. If we had
not been able to obtain a waiver or amendment of the covenant, we may have
been unable to make further borrowings and may have been 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 $60.2
million from $46.2 million as of December 31, 2006 and 2005, respectively.
The number of days outstanding for trade accounts receivable increased from
59 days at December 31, 2005, to 62 days at December 31, 2006. Our actual
bad debt expense has been approximately .03% and .01% of revenues for the
years ending December 31, 2006 and 2005. We increased our allowance for
doubtful accounts from $503,000 to $670,000 or 1.1% of trade accounts
receivable balance for each of the years 2005 and 2006, respectively.
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 sole or 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. However, in 2006, the Company
suffered reversals due to its failure to accurately estimate revenue
recognition on our two significant fixed-price EPC contracts.
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. However, timing of accounts receivable collections has
resulted in a serious impact in the Company's liquidity. Also, the
Company is engaging in more development contracts with smaller
companies. We anticipate that collection risk will be a larger risk on
these projects.
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),
of which have not-to-exceed provisions that place a cap on the revenue
that we may receive under a particular contract.
37
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION (Continued)
These time and material billings are produced every two weeks. Most of
the contracts with not-to-exceed provisions are minor in nature.
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
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.
Change Orders
-------------
Change orders are modifications of an original contract that
effectively change deliverables under a 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. In those
cases, we are taking a risk that the customer will not sign a change
order or at a later time the customer will seek to negotiate the
pricing of the additional work. 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.
38
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION (Continued)
Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements."
This statement establishes a framework for measuring fair value in
generally accepted accounting principles and expands disclosures about fair
value measurements. SFAS No. 157 is effective for financial statements
issued for fiscal years beginning after November 15, 2007, and interim
periods within those fiscal years. The provisions of SFAS No. 157 should be
applied prospectively as of the beginning of the fiscal year in which SFAS
No. 157 is initially applied, except in limited circumstances. The Company
expects to adopt SFAS No. 157 beginning January 1, 2008. The Company is
currently evaluating the impact that this interpretation may have on its
consolidated financial statements.
In September 2006, the SEC released Staff Accounting Bulletin No. 108,
"Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements" (SAB No. 108), which
provides interpretive guidance on how the effects of the carryover or
reversal of prior year misstatements should be considered in quantifying a
current year misstatement. The SEC staff believes that registrants should
quantify errors using both a balance sheet and an income statement approach
and evaluate whether either approach results in quantifying a misstatement
that, when all relevant quantitative and qualitative factors are
considered, is material. The provisions of SAB No. 108 are effective for
the Company beginning in the first quarter of 2007. The Company does not
expect any impact to its consolidated financial statements upon adoption of
SAB No. 108.
In June 2006, FASB Interpretation (FIN) No. 48, "Accounting for Uncertainty
in Income Taxes", an interpretation of FASB Statement 109 Accounting for
Income Taxes, was issued. FIN No. 48 describes accounting for uncertainty
in income taxes, and includes a recognition threshold and measurement
attribute for recognizing the effect of a tax position taken or expected to
be taken in a tax return. FIN No. 48 is effective for fiscal years
beginning after December 15, 2006. The Company adopted FIN No. 48 on
January 1, 2007, and the Company expects that it will not have a material
effect on the its' financial condition, results of operations, or cash
flows.
In December 2004, SFAS No. 123 "Accounting for Stock-Based Compensation"
was revised ("SFAS No. 123R"). SFAS No. 123R focuses primarily on
accounting for transactions in which an entity obtains employee services in
share-based payment transactions and requires that companies record
compensation expense for employee stock option awards. SFAS No. 123R is
effective for annual periods beginning after June 15, 2005. The Company
adopted SFAS No, 123R on January 1, 2006 using the modified prospective
method. See Note 11.
In March 2005, FASB Interpretation No. 47, "Accounting for Conditional
Asset Retirement Obligations - An interpretation of FASB Statement No.
143", was issued. FIN No. 47 clarifies the term conditional asset
retirement obligation as used in SFAS No. 143, "Accounting for Asset
Retirement Obligations", and clarifies when an entity would have sufficient
information to reasonably estimate the fair value of an asset retirement
obligation. FIN No. 47 was effective for the year ended December 31, 2005,
but did not have a material effect on the Company's financial condition,
results of operations or cash flows.
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain
Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and
140". SFAS No. 155 amends SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", and SFAS No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities". This Statement also resolves issues addressed in Statement
No. 133 Implementation Issue No. D1, "Application of Statement 133 to
Beneficial Interests in Securitized Financial Assets." SFAS No. 155 permits
fair value re-measurement for any hybrid financial instrument that contains
an embedded derivative that otherwise would require bifurcation and
clarifies which interest-only strips and principal-only strips are not
subject to the requirements of SFAS No. 133. SFAS No. 140 is amended to
eliminate the prohibition on a qualifying special-purpose entity from
holding a derivative financial instrument that pertains to a beneficial
interest other than another derivative financial instrument. SFAS No. 155
is effective for all financial instruments acquired or issued during fiscal
years beginning after September 15, 2006. The Company does not expect this
statement to have a material impact on its consolidated financial
statements.
39
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, 2006 and 2005, 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 $24.0 million and $3.8 million as
of December 31, 2006 and 2005, 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 8.25% as of December 31, 2006, to an
average interest rate of 9.08%, annual interest expense would have been
approximately $115,000 higher in 2006 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, 2006.
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 SUPPLEMENTARY DATA
The audited consolidated balance sheets for ENGlobal Corporation, as of
December 31, 2006 and 2005 and statements of income, cash flows and
stockholders' equity for the three-year period ended December 31, 2006, are
attached hereto and made part hereof.
40
INDEX
Page
------------
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON INTERNAL CONTROL OVER FINANCIAL REPORTING 42
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON CONSOLIDATED FINANCIAL STATEMENTS 44
CONSOLIDATED BALANCE SHEETS
December 31, 2006 and 2005 45
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2006, 2005 and 2004 46
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 2006, 2005 and 2004 47
CONSOLIDATED STATEMENTS OF CASH FLOW
Years Ended December 31, 2006, 2005 and 2004 48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 50
SCHEDULE II
Valuation and Qualifying Accounts 76
41
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL CONTROL
OVER FINANCIAL REPORTING
Board of Directors
Englobal Corporation
Houston, Texas
We were engaged to audit management's assessment included in the accompanying
Management's Report on Internal Control over Financial Reporting that ENGlobal
Corporation and Subsidiaries (the "Company") did not maintain effective internal
control over financial reporting as of December 31, 2006, because of the effect
of material weaknesses described therein, based on criteria established in
Internal Control -- Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission ("COSO"). The Company's management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting.
The scope of our audit of management's assessment and the effectiveness of
internal control over financial reporting was limited as a result of
management's substantial delay in the performance of and delivery to us of its
completed assessment. Specifically, we were provided substantially all of the
documentation related to management's assessment subsequent to December 31, 2006
and, as a result, we were unable to obtain sufficient evidence that the controls
were designed and operating effectively at December 31, 2006.
A material weakness is a significant deficiency, or combination of significant
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim consolidated financial statements will not
be prevented or detected. The following material weaknesses have been identified
and included in management's assessment as of December 31, 2006:
1. Deficiencies in the Company's Control Environment. Our control
environment did not sufficiently promote effective internal
control over financial reporting throughout the organization.
Specifically, the Company had a shortage of support and resources
in our accounting department, which resulted in insufficient: (i)
documentation and communication of our accounting policies and
procedures; and (ii) internal audit processes of our accounting
policies and procedures.
2. Deficiencies in the Company's Information Technology Access
Controls. The Company did not maintain effective controls over
preventing access by unauthorized personnel to end-user
spreadsheets and other information technology programs and
systems.
3. Deficiencies in the Company's Accounting System Controls. The
Company did not effectively and accurately close the general
ledger in a timely manner and we did not provide complete and
accurate disclosure in our notes to financial statements, as
required by generally accepted accounting principles.
4. Deficiencies in the Company's Controls Regarding Purchases and
Expenditures. The Company did not maintain effective controls
over the tracking of our commitments and actual expenditures with
third-party subsidiaries on a timely basis.
5. Deficiencies in the Company's Controls Regarding Fixed-Price
Contract Information. The Company did not maintain effective
controls over the complete, accurate, and timely processing of
information relating to the estimated cost of fixed-price
contracts.
6. Deficiencies in the Company's Revenue Recognition Controls. The
Company did not maintain effective policies and procedures
relating to revenue recognition of fixed price contracts.
42
7. Deficiencies in the Company's Controls over Income Taxes. The
Company did not maintain sufficient internal controls to ensure
that amounts provided for in the financial statements for income
taxes accurately reflected the Company's income tax position as
of December 31, 2006.
8. Deficiency in Completing Management's Assessment of Internal
Control over Financial Reporting in a Timely Manner. The Company
did not meet the documentation and testing requirements under
section 404 of the Sarbanes-Oxley Act of 2002 as of December 31,
2006. As a result, management was unable to assess the
effectiveness of the Company's internal control over financial
reporting as of December 31, 2006 as required by the
Sarbanes-Oxley Act of 2002 in sufficient time for an audit of
management's assessment to be completed as of December 31, 2006.
These material weaknesses were considered in determining the nature, timing, and
extent of the audit tests applied in our audit of the 2006 consolidated
financial statements, and this report does not affect our report dated March 15,
2007 on those consolidated financial statements.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of consolidated financial statements for external purposes
in accordance with accounting principles generally accepted in the United States
of America. A company's internal control over financial reporting includes those
policies and procedures that (i) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the transactions and
dispositions of the assets of the company; (ii) provide reasonable assurance
that transactions are recorded as necessary to permit preparation of financial
statements in accordance with accounting principles generally accepted in the
United States of America, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
Since management failed to provide us with timely documentation of the Company's
internal control over financial reporting and we were unable to apply other
procedures to satisfy ourselves as to the effectiveness of the Company's
internal control over financial reporting, the scope of our work was not
sufficient to enable us to express, and we do not express, an opinion on either
management's assessment or on the effectiveness of the Company's internal
control over financial reporting as of December 31, 2006.
We do not express an opinion or any other form of assurance on management's
statements referring to any and all remediation steps taken.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of
ENGlobal Corporation and subsidiaries as of December 31, 2006 and 2005, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the years in the three year period ended December 31, 2006.
Our report thereon dated March 15, 2007 expressed an unqualified opinion.
Hein & Associates LLP
Houston, Texas
March 15, 2007
43
ENGLOBAL CORPORATION AND SUBSIDIARIES
Report of Independent Registered Public Accounting Firm on
Consolidated Financial Statements
Board of Directors
ENGlobal Corporation
Houston, Texas
We have audited the accompanying consolidated balance sheets of ENGlobal
Corporation and subsidiaries (the"Company") as of December 31, 2006 and 2005,
and the related consolidated statements of operations, stockholders' equity, and
cash flows for each of the years in the three year period ended December 31,
2006. We have also audited the schedule listed in the accompanying Item 16.
These consolidated financial statements and schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and schedule 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 audit to obtain reasonable assurance about whether the
consolidated financial statements and schedule are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the consolidated financial statements and
schedule, assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall presentation of the
consolidated financial statements and schedule. 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 financial position of ENGlobal Corporation
and subsidiaries at December 31, 2006 and 2005, and the results of their
operations and their cash flows for each of the years in the three year period
ended December 31, 2006 in conformity with accounting principles generally
accepted in the United States of America.
Also, in our opinion, the schedule presents fairly, in all material respects,
the information set forth, therein in relation to the financial statements taken
as a whole.
We were also engaged to audit, in accordance with the standards of Public
Company Accounting Oversight Board (United States), management's assessment and
the effectiveness of ENGlobal Corporation and subsidiaries internal control over
financial reporting as of December 31, 2006, based on criteria established in
Internal Control Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Our report dated March 15, 2007, did
not express an opinion on management's assessment and the effectiveness of
internal control over financial reporting.
As discussed in Note 11 to the consolidated financial statements, the Company
adopted Statement of Accounting Standards No. 123 (revised 2004), "Share-Based
Payment", during the year ended December 31, 2006.
Hein & Associates LLP
Houston, Texas
March 15, 2007
See accompanying notes to these consolidated financial statements.
44
ENGLOBAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2006 AND 2005
ASSETS
------
Current Assets 2006 2005
--------------- ---------------
Cash $ 1,402,880 $ 159,414
Trade receivables, net 60,247,612 46,248,458
Prepaid expenses and other current assets 1,723,907 1,600,369
Current portion of notes receivable 52,031 -
Costs and estimated earnings in excess of billings on uncompleted contracts 5,390,111 4,148,275
Deferred tax asset 2,310,106 305,258
Inventories - 153,968
Federal income taxes receivable 1,148,014 52,818
-------------- --------------
Total Current Assets 72,274,661 52,668,560
Property and Equipment, net 8,724,902 6,861,361
Goodwill and Other Intangibles 19,202,197 15,454,583
Other Intangible Assets, net 5,426,824 413,596
Long term notes receivable, net of current portion 129,105 -
Non-current Deferred Tax Asset - 74,892
Other Assets 468,864 462,938
-------------- --------------
Total Assets $ 106,226,553 $ 75,935,930
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current Liabilities
Accounts payable $ 14,672,165 15,211,331
Accrued compensation and benefits 12,806,919 9,799,074
Notes payable 1,109,772 -
Current portion of long-term debt 1,418,029 547,934
Deferred rent 678,583 361,292
Billings in excess of costs and estimated earnings on uncompleted contracts 539,910 3,775,625
Other liabilities 5,862,634 1,148,079
-------------- --------------
Total Current Liabilities 37,088,012 30,843,335
Long-Term Debt, net of current portion 27,162,263 5,227,976
Deferred Tax Liability 1,114,224 -
-------------- --------------
Total Liabilities 65,364,499 36,071,311
-------------- --------------
Commitments and Contingencies (Notes 9, 10, 12, 16, 19 and 20)
Stockholders' Equity
Common stock - $0.001 par value; 75,000,000 shares authorized; 26,807,460
and 26,289,567 shares outstanding and 26,807,460 and 26,941,944 issued
at December
31, 2006 and 2005, respectively 27,459 26,941
Additional paid-in capital 31,147,343 27,230,332
Retained earnings 9,717,354 13,203,208
Treasury stock - 0 and 652,377 shares at cost, at December 31, 2006 and 2005,
respectively - (592,231)
Accumulated other comprehensive income (loss) (30,102) (3,631)
-------------- --------------
Total Stockholders' Equity 40,862,054 39,864,619
-------------- --------------
Total Liabilities and Stockholders' Equity $ 106,226,553 $ 75,935,930
============== ==============
See accompanying notes to these consolidated financial statements.
45
ENGLOBAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31,
-------------------------------------------------------
2006 2005 2004
------------- ------------- -------------
Operating Revenues
Engineering $ 278,157,053 $ 219,425,730 $ 134,778,281
Systems 24,933,308 14,159,103 14,109,960
------------- ------------- -------------
Total Revenue 303,090,361 233,584,833 148,888,241
------------- ------------- -------------
Direct Costs
Engineering 254,031,157 192,263,673 118,804,896
Systems 22,794,971 13,048,500 11,891,287
------------- ------------- -------------
Total Direct Costs 276,826,128 205,312,173 130,696,183
------------- ------------- -------------
Gross Profit 26,264,233 28,272,660 18,192,058
Selling, General, and Administrative Expenses 29,884,682 19,688,765 13,700,088
------------- ------------- -------------
Operating Income (Loss) (3,620,449) 8,583,895 4,491,970
Interest Expense (1,311,794) (800,072) (590,227)
Other income 632,880 114,538 118,409
------------- ------------- -------------
Income (Loss) before Provision for Income Taxes (4,299,363) 7,898,361 4,020,152
Provision for Income Taxes (813,510) 3,115,980 1,655,763
------------- ------------- -------------
Net Income (Loss) $ (3,485,853) $ 4,782,381 $ 2,364,389
============= ============= =============
Basic Earnings per Share $ (0.13) $ 0.20 $ 0.10
Weighted Average Common Shares Outstanding for Basic 26,538,290 24,300,114 23,454,545
============= ============= =============
Diluted Earnings per Share $ (0.13) $ 0.19 $ 0.10
Weighted Average Common Shares Outstanding for Diluted 26,538,290 25,250,487 23,785,939
============= ============= =============
See accompanying notes to these consolidated financial statements.
46
ENGLOBAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
Accumulated
Common Stock Additional Comprehensive Total
---------------------- Paid-In Translation Retained Treasury Stockholders'
Shares Stock Capital Gain/(Loss) Earnings Stock Equity
---------- --------- ---------- ----------- ----------- --------- ----------
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
Exercise of options 329,273 329 729,580 - - - 729,909
Shares issued at acquisition
for WRC 175,000 175 1,399,825 - - - 1,400,000
Common stock issued through
employee stock purchase
plan 13,620 14 102,954 - - - 102,968
Common stock issued through
private placement - - (40,000) - - (40,000)
Stock based compensation - - 2,176,162 - - 2,176,162
Treasury shares retirement (592,231) - 592,231 -
Tax benefit of non-qualified
options exercised - - 140,721 - - - 140,721
Net income - - - - (3,485,853) - (3,485,853)
Rounding
difference - - - - (1) - (1)
Comprehensive income:
Foreign currency
translation adjustment - - - (26,471) - - (26,471)
---------- -------- ---------- ----------- ------------ ---------- -----------
BALANCES-DECEMBER 31, 2006 26,807,460 $ 27,459 $31,147,343 $ (30,102) $ 9,717,354 - $ 40,862,054
========== ======== =========== =========== ============ ========== ===========
See accompanying notes to these consolidated financial statements.
47
ENGLOBAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
---------------------------------------------------
2006 2005 2004
------------- ------------- -------------
Cash Flows from Operating Activities
Net income (loss) $ (3,485,853) $ 4,782,381 $ 2,364,389
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities -
Depreciation and amortization 3,369,244 1,836,376 1,246,532
Stock based compensation 2,176,162 -- --
Deferred income tax expense (2,317,275) (313,150) 254,000
(Gain) Loss on disposal of property, plant and equipment 42,315 (131,732) 2,564
Changes in current assets and liabilities, net of acquisitions -
Trade receivables (9,825,423) (15,462,947) (10,595,425)
Inventories 153,968 18,747 (54,375)
Costs and estimated earnings in excess of billings (1,244,902) (2,980,859) (90,604)
Prepaid expenses and other assets 509,362 630,559 231,401
Accounts payable (1,235,758) 4,699,207 691,093
Accrued compensation and benefits 2,261,018 3,739,853 1,713,253
Billings in excess of costs and estimated earnings (3,235,715) 1,461,670 1,939,616
Other liabilities 5,078,829 326,655 128,114
Income taxes receivable (payable) (1,198,936) 473,523 (221,610)
------------- ------------- -------------
Net cash provided by (used in) operating activities (8,952,964) (919,717) (2,391,052)
------------- ------------- -------------
Cash Flows from Investing Activities
Purchase of property and equipment (3,405,141) (3,229,925) (1,195,588)
Additional consideration for acquisitions -- (26,368) (625,000)
Proceeds from insurance 68,317 -- --
Partnership distributions 350,000 -- --
Acquisitions of businesses, net of cash acquired (6,528,583) -- --
Proceeds from sale of assets 185,106 15,400 9,897
Proceeds from sale of Thermaire -- 823,350 --
------------- ------------- -------------
Net cash used in investing activities (9,330,301) (2,417,543) (1,810,691)
------------- ------------- -------------
Cash Flows from Financing Activities
Borrowings on line of credit 143,820,724 92,151,545 134,571,349
Payments on line of credit (123,631,669) (101,907,187) (126,597,915)
Proceeds from issuance of common stock 933,598 15,034,940 103,918
Proceeds from notes receivable 38,119 -- --
Short-term borrowings (repayments) -- (1,037,399) (1,071,885)
Capital lease repayments -- (4,371) (12,478)
Long-term debt repayments (1,607,959) (745,229) (2,822,679)
------------- ------------- -------------
Net cash provided by (used in) financing activities 19,552,813 3,492,299 4,170,310
Effect of Exchange Rate Changes on Cash (26,082) (3,631) --
------------- ------------- -------------
Net Change in Cash and Cash Equivalents 1,243,466 151,408 (31,433)
Cash and Cash Equivalents - beginning of year 159,414 8,006 39,439
------------- ------------- -------------
Cash and Cash Equivalents - end of year $ 1,402,880 $ 159,414 $ 8,006
============= ============= =============
See accompanying notes to these consolidated financial statements.
48
ENGLOBAL CORPORATION AND SUBSIDIARIES
Supplemental Cash Flow Information Years Ended December 31,
------------------------------------------------
2006 2005 2004
------------ ----------- -----------
Non-Cash Transactions
Issuance of note for insurance 1,347,232 197,794 1,092,096
Retirement of treasury stock 592,231 -- --
Acceptance of note for Constant Power assets (216,000) -- --
Issuance of common stock for purchase of WRC Corporation 1,400,000 -- --
Acquisition of treasury stock with note payable -- -- 592,231
Issuance of note for ATI assets 1,000,000 -- --
Issuance of note for purchase of WRC Corporation 2,400,000 -- --
Issuance of note for Watco assets 500,000 -- --
Issuance of notes payable for assets of EDG, AmTech, CIS
and Infotech -- -- 2,575,000
Supplemental Cash Flow Information
Cash paid during the year for -
Interest $ 976,841 $ 890,266 $ 420,627
State and federal income taxes 2,464,848 2,959,133 1,196,761
Refund from state franchise taxes -- 48,531 --
See accompanying notes to these consolidated financial statements.
49
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 pipeline
inspection services to the oil and gas, utility and pipeline
industries and turnaround, asset management, and start-up services for
the petrochemical 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.
WRC Corporation ("WRC") - primarily provides land management,
right-of-way services, environmental compliance, and governmental
regulatory services to pipeline, utility and telecom companies and
other owner/operators of "infrastructure" facilities.
WRC Canada - provides land management and inspection services.
50
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, 2006. The Company's banking
system provides for daily replenishment of major bank accounts for
check-clearing requirements. Accordingly, there were negative book balances
of $2.7 million on December 31, 2006 and $2.0 million on December 31, 2005.
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.
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 2006 and 2005, pass-through transactions totaled $8.9 million
and $20.6 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 in
contract costs 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.
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
51
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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 five 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").
Cost-Plus, Not-To-Exceed
------------------------
Under cost-plus, not-to-exceed contracts, clients are charged on the same
basis as either cost-plus, labor plus fixed mark-up, or cost-plus fixed
labor rate contracts. The contract is awarded with a set maximum aggregate
revenue, referred to as the not-to-exceed amount. The Company does not earn
revenue over the not-to-exceed amount unless we obtain a change order. The
Company is not obligated to complete the contract once the not-to-exceed
amount has been reached.
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").
Guaranteed Max
--------------
Under a guaranteed max contract, clients are charged on the same basis as
either cost-plus, labor plus fixed markup or cost-plus fixed labor rate.
The contract is awarded with a set maximum aggregate revenue amount
referred to as the guaranteed max amount. The Company is required to
complete the scope of contract even if they have reached the guaranteed max
amount. Therefore, the Company recognizes revenue on guaranteed max
contracts using the percentage of completion method described above and
commonly treats them the same as fixed-price contracts. In order to
52
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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 deliverables under 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 required or requested 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.
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.
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.
53
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Intangible Assets and Goodwill
------------------------------
Intangible assets is comprised of non-compete covenants and customer
relationships acquired through acquisitions. As of December 31, 2006 and
December 31, 2005, the cost and accumulated amortization of our intangible
assets were as follows:
Non-Compete Customer
Covenants Use of Name Relationships Total
------------- ------------- ------------ -----------
As of December 31, 2006
Intangible assets $ 3,846 $ 10 $ 2,547 $ 6,403
Less: accumulated amortization 704 6 266 976
------------- ----------- ------------ -----------
Intangible assets, net $ 3,142 $ 4 $ 2,281 $ 5,427
============= =========== ============ ===========
As of December 31, 2005
Intangible assets $ 550 $ 10 $ - $ 560
Less: accumulated amortization 142 4 - 146
------------- ----------- ------------ -----------
Intangible assets, net $ 408 $ 6 $ - $ 414
============= =========== ============ ===========
Intangible assets are amortized using the straight-line method based on the
estimated useful life of the intangible assets. Expected amortization
expense of our amortizable intangible assets is as follows:
Non-Compete Customer
Years Ending, December 31 Covenants Use of Name Relationships Total
--------------------------------------------- -------------- ------------- ----------- ----------
2007 $ 683 $ 2 $ 457 $ 1,142
2008 671 2 456 1,129
2009 650 - 456 1,106
2010 570 - 456 1,026
2011 568 - 456 1,024
-------------- ---------- ----------- ----------
$ 3,142 $ 4 $ 2,281 $ 5,427
============== ========== =========== ==========
Weighted Average Amortization
Period Remaining at December 31, 2006 (years) 4.8 2.0 5.0
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."
54
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, 2005 and 2006
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
primarily from earn-outs related to acquisitions. In 2006, goodwill
increased $3.0 million primarily from the deferred tax benefit realized on
acquisitions of WRC plus additional earn-outs related to acquisitions.
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.
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.
In June 2006, FASB Interpretation (FIN) No. 48, "Accounting for Uncertainty
in Income Taxes", an interpretation of FASB Statement 109 Accounting for
Income Taxes, was issued. FIN No. 48 describes accounting for uncertainty
in income taxes, and includes a recognition threshold and measurement
attribute for recognizing the effect of a tax position taken or expected to
be taken in a tax return. FIN No. 48 is effective for fiscal years
beginning after December 15, 2006. The Company adopted FIN No. 48 on
January 1, 2007, and will not have a material effect on the Company's
financial condition, results of operations, or cash flows.
Stock Based Compensation
------------------------
The Company currently sponsors a stock-based compensation plan as described
below. Effective January 1, 2006, the Company adopted the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 123 (Revised),
"Share-Based Payment" ("SFAS No. 123(R)"). Under the fair value recognition
provisions of SFAS No. 123 (R), stock-based compensation is measured at the
grant date based on the value of the awards and is recognized as expense
over the requisite service period (usually a vesting period). The Company
selected the modified prospective method of adoption described in SFAS No.
123(R). The fair values of the stock awards recognized under SFAS No.
123(R) are determined based on the vested portion of the awards; however,
the total compensation expense is recognized on a straight-line basis over
the vesting period.
55
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Prior to January 1, 2006, the Company accounted for stock-based
compensation using the intrinsic value method prescribed in Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. Under APB Opinion No. 25, no
compensation expense was recognized for stock options issued to employees
because the grant price equaled, or was above, the market price on the date
of grant for options issued by the Company.
Earnings Per Share
Earnings per share was computed as follows:
Reconciliation of Earnings per Share Calculation
---------------------------------------------------------------------------------
2006 2005 2004
-------------------------- -------------------------- --------------------------
Basic Diluted Basic Diluted Basic Diluted
------------ ------------ ------------- ------------ ------------ ------------
Net Income (Loss) $ (3,485,853) $(3,485,853) $ 4,782,381 $ 4,782,381 $ 2,364,389 $ 2,364,389
============ =========== ============ =========== =========== ===========
Weighted average number of shares
outstanding for basic 26,538,290 24,300,114 23,454,545
Weighted average number of shares
outstanding for diluted 26,538,290 25,250,487 23,785,939
Net income (loss) per share available
for common stock
Net Income (Loss) $ (0.13) (0.13) $ 0.20 $ 0.19 $ 0.10 $ 0.10
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, 2006, 2005 and 2004.
2006 2005 2004
----------------- ----------------- ----------------
Common stock issued - beginning of year 26,289,567 23,466,839 24,034,288
Weighted average common stock issued (repurchased) 248,723 833,275 (579,743)
---------------- ---------------- ---------------
Shares used in computing basic earnings per share 26,538,290 24,300,114 23,454,545
Assumed conversion of dilutive stock options - 950,373 331,394
---------------- ---------------- ---------------
Shares used in computing diluted earnings per share 26,538,290 25,250,487 23,785,939
================ ================ ===============
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.
56
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.
NOTE 3 - RECENT ACCOUNTING PRONOUNCEMENTS
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements."
This statement establishes a framework for measuring fair value in
generally accepted accounting principles and expands disclosures about fair
value measurements. SFAS No. 157 is effective for financial statements
issued for fiscal years beginning after November 15, 2007, and interim
periods within those fiscal years. The provisions of SFAS No. 157 should be
applied prospectively as of the beginning of the fiscal year in which SFAS
No. 157 is initially applied, except in limited circumstances. The Company
expects to adopt SFAS No. 157 beginning January 1, 2008. The Company is
currently evaluating the impact that this interpretation may have on its
consolidated financial statements.
In September 2006, the SEC released Staff Accounting Bulletin No. 108,
"Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements" (SAB No. 108), which
provides interpretive guidance on how the effects of the carryover or
reversal of prior year misstatements should be considered in quantifying a
current year misstatement. The SEC staff believes that registrants should
quantify errors using both a balance sheet and an income statement approach
and evaluate whether either approach results in quantifying a misstatement
that, when all relevant quantitative and qualitative factors are
considered, is material. The provisions of SAB No. 108 are effective for
the Company beginning in the first quarter of 2007. The Company does not
expect any impact to its consolidated financial statements upon adoption of
SAB No. 108.
In June 2006, FASB Interpretation (FIN) No. 48, "Accounting for Uncertainty
in Income Taxes", an interpretation of FASB Statement 109 Accounting for
Income Taxes, was issued. FIN No. 48 describes accounting for uncertainty
in income taxes, and includes a recognition threshold and measurement
attribute for recognizing the effect of a tax position taken or expected to
be taken in a tax return. FIN No. 48 is effective for fiscal years
beginning after December 15, 2006. The Company is in the process of
assessing the impact on its financial statements, but does not expect any
material impact on the Company's financial condition, results of
operations, or cash flows.
In December 2004, SFAS No. 123 "Accounting for Stock-Based Compensation"
was revised ("SFAS No. 123R"). SFAS No. 123R focuses primarily on
accounting for transactions in which an entity obtains employee services in
share-based payment transactions and requires that companies record
compensation expense for employee stock option awards. SFAS No. 123R is
effective for annual periods beginning after June 15, 2005. The Company
adopted SFAS No, 123R on January 1, 2006 using the modified prospective
method. See Note 11.
In March 2005, FASB Interpretation No. 47, "Accounting for Conditional
Asset Retirement Obligations - An interpretation of FASB Statement No.
143", was issued. FIN No. 47 clarifies the term conditional asset
retirement obligation as used in SFAS No. 143, "Accounting for Asset
Retirement Obligations", and clarifies when an entity would have sufficient
information to reasonably estimate the fair value of an asset retirement
obligation. FIN No. 47 was effective for the year ended December 31, 2005,
but did not have a material effect on the Company's financial condition,
results of operations or cash flows.
57
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - RECENT ACCOUNTING PRONOUNCEMENTS (Continued)
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain
Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and
140". SFAS No. 155 amends SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", and SFAS No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities". This Statement also resolves issues addressed in Statement
No. 133 Implementation Issue No. D1, "Application of Statement 133 to
Beneficial Interests in Securitized Financial Assets." SFAS No. 155 permits
fair value remeasurement for any hybrid financial instrument that contains
an embedded derivative that otherwise would require bifurcation and
clarifies which interest-only strips and principal-only strips are not
subject to the requirements of SFAS No. 133. SFAS No. 140 is amended to
eliminate the prohibition on a qualifying special-purpose entity from
holding a derivative financial instrument that pertains to a beneficial
interest other than another derivative financial instrument. SFAS No. 155
is effective for all financial instruments acquired or issued during fiscal
years beginning after September 15, 2006. The Company does not expect this
statement to have a material impact on its consolidated financial
statements.
NOTE 4 - COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) represents net earnings (loss) and any
revenue, expenses, gains and losses that, under accounting principles
generally accepted in the United States of America, are excluded from net
earnings (loss) and recognized directly as a component of stockholders'
equity.
Accumulated other comprehensive income is as follows:
2006 2005 2004
---------- ---------- ---------
(in thousands)
-------------------------------------
Net income (loss) Before Foreign Currency Translation (3,486) $ 4,782 $ 2,364
Other comprehensive income: - - -
Foreign Currency Translation Adjustment (26) (4) -
--------- --------- ----------
Comprehensive Income (Loss) (3,512) $ 4,778 $ 2,364
========= ========= ==========
NOTE 5 - PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at December 31, 2006 and 2005:
2006 2005
--------- ---------
(in thousands)
-------------------------
Land $ 418 $ 202
Building 1,331 1,359
Computer equipment and software 9,048 6,374
Shop equipment 1,093 904
Furniture and fixtures 628 477
Building and leasehold improvement 2,018 1,561
Autos and trucks 260 191
---------- ----------
14,796 11,068
Accumulated depreciation and amortization (6,536) (4,254)
---------- ----------
8,260 6,814
Project controls and software upgrade in process 465 47
---------- ----------
Property and equipment, net $ 8,725 $ 6,861
========== ==========
58
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, 2006 and 2005 are as follows:
2006 2005
-------- --------
(in thousands)
-------------------------------
Amounts billed $ 43,655 $ 28,964
Amounts billable
billed January of the following year 15,689 16,523
Retainage 1,573 1,265
Less: Allowance for uncollectible accounts (670) (503)
-------- --------
Trade receivables, net $ 60,247 $ 46,249
======== ========
The components of other liabilities as of December 31, 2006 and 2005 are as follows:
2006 2005
------------ ------------
(in thousands)
-----------------------------
Reserve for known contingencies $ 4,724 $ --
Accrued interest 297 144
Federal and State Taxes Payable 510 408
Other 332 596
------ ------
Other liabilities $5,863 $1,148
====== ======
NOTE 7 - FIXED-PRICE CONTRACTS
Costs, estimated earnings and billings on uncompleted contracts consisted of the following at December 31, 2006 and 2005:
2006 2005
-------- --------
(in thousands)
-----------------------------
Costs incurred on uncompleted contracts $ 75,317 $ 23,426
Estimated earnings (losses) on uncompleted contracts (7,390) 4,437
-------- --------
Earned revenues 67,927 27,863
Less: Billings to date 63,077 27,490
-------- --------
Net costs and estimated earnings in excess of
billings on uncompleted contracts $ 4,850 $ 373
======== ========
Costs and estimated earnings in excess of
billings on uncompleted contracts $ 5,390 $ 4,148
Billings in excess of costs and estimated
earnings on uncompleted contracts (540) (3,775
-------- --------
Net costs and estimated earnings in excess of
billings on uncompleted contracts $ 4,850 $ 373
======== ========
59
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8 - LINE OF CREDIT AND DEBT
The Company has a Credit Facility with Comerica Bank ("Comerica").
Effective July 27, 2006, the Company and Comerica entered into an amendment
to the Company's existing Credit Facility (the "Comerica Credit Facility").
The maturity date of the Comerica Credit Facility was extended to July 26,
2009 and the limit on the revolving note was increased from $22 million to
$30 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, 2006 and
2005 was $24.0 million and $3.8 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, 2006 and 2005, respectively, were $6.0 and $12.0 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, and the Company must comply with
an annual limitation on capital expenditures. Due to additional losses
incurred on two fixed-price projects during the fourth quarter, the Company
requested and was successful in obtaining a waiver and subsequent amendment
to its credit agreement with Comerica Bank in order to meet the monthly
fixed charge ratio. The Company was in compliance with all covenants under
the Comerica Credit Facility as of December 31, 2006.
Letters of credit
-----------------
As of December 31, 2006, the Company had no standby letters of credit
outstanding. Standby letters of credit had previously been issued to a
refining client to cover contractual obligations funded by the client for
progress payments made to equipment manufacturers for major project items.
That contractual obligation expired in August 2006.
60
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8 - LINE OF CREDIT AND DEBT (Continued)
Long-term debt consisted of the following at December 31, 2006 and 2005:
2006 2005
---------- ----------
(in thousands)
--------------------------
Comerica Credit Facility - Line of credit, prime (8.25% at December 31, $ 23,963 $ 3,774
2006), maturing in July 2009
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 120 195
Significant PEI Shareholders (See Note 19) - 188
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 1,109 1,444
InfoTech Engineering, Inc. - Note payable, interest at 5%, principal
payments in installments of $65,000 plus interest due annually,
maturing in December 2007 75 130
ATI Technologies - Note payable, interest at 6%, principal payments in
installments of $30,422 including interest due monthly, maturing in
January 2009 713 -
Michael Lee - Note payable, interest at 5%, principal payments in
installments of $150,000 plus interest due quarterly, maturing in July
2010 2,100 -
Watco Management, Inc. - Note payable, interest at 4%, principal
payments in installments of $137,745 including interest annually,
maturing in October 2010 500 -
Miscellaneous - 45
---------- ----------
Total long-term debt 28,580 5,776
Less: Current maturities (1,418) (548)
---------- ----------
Long-term debt, net of current portion $ 27,162 $ 5,228
========== ==========
Maturities of long-term debt as of December 31, 2006, are as follows:
Maturities
------------
(in
thousands)
------------
Years Ending December 31,
2007 $ 1,418
2008 1,535
2009 25,109
2010 432
----------
Total long-term debt $ 28,580
==========
61
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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,
2006 are as follows:
Operating
------------
(in
thousands)
------------
Years Ending December 31,
2007 $ 4,366
2008 2,754
2009 2,165
2010 1,938
2011 and after 1,423
----------
Total minimum lease payments $ 12,646
==========
Rent expense for the years ended December 31, 2006, 2005 and 2004 was
$5,502,000, $2,167,000 and $1,754,000, 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 $1,310,000,
$401,000, and $221,000, respectively, for the years ended December 31,
2006, 2005, and 2004. Effective April 1, 2006, the Company increased 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
exert maximum efforts for the success of the Company. ENGlobal intended
that options to purchase stock granted under the Plan would qualify as
options granted under an "employee stock purchase plan" as defined in
Section 423(b) of the Code. The Plan was 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, although not significant, was used to meet the Company's cash
requirements or was 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 result, the Company elected to terminate the Plan
effective December 31, 2005.
62
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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. All stock option grants
are for a ten-year term. Stock options issued to executives and management
generally vest over a four-year period; one-fifth at grant date and one-fifth at
December 31 of each year until they are fully vested. Stock options issued to
directors vest one-half on grant date and the remaining half upon the first
anniversary of grant date. In 2006 one grant was issued fully vested following
termination of a series under which the employee held a similar amount of
shares. All stock options grants are issued at the market value of the Company's
stock on the date of the grant.
Effective January 1, 2006, the Company adopted SFAS No. 123(R). This statement
requires compensation expense relating to share-based payments to be recognized
in net income using a fair-value measurement method. Under the fair value
method, the estimated fair value of awards is charged over the requisite service
period, which is generally the vesting period. The Company elected the modified
prospective method as prescribed in SFAS No. 123(R) and therefore, prior periods
were not restated. Under the modified prospective method, this statement was
applied to new awards granted after the time of adoption.
Options Granted in 2006 Fair Values, Assumptions, and Impact on Net Income
--------------------------------------- --------------------- --------------------- ---------------------- -----------------------
Weighted
Average
Series $ 11.97 $ 9.15 $ 6.83 Fair Value
--------------------- ------------------ --------------- ----------------
Grant Date 4/17/2006 6/1/2006 12/4/2006
Number of Options Granted(1) 205,000 150,000 175,000 530,000
Strike Price $ 11.97 $ 9.15 $ 6.83
Market Price - Date of Grant $ 11.97 $ 9.15 $ 6.83
Total Compensation at Grant Date 1,622,494 906,090 754,606 3,283,189
Compensation Recognized
Vesting In 2006 630,079 453,045 754,606 1,837,729
Amount Remaining to Be
Recognized in Compensation 992,415 453,045 - 1,445,460
Weighted Average Fair Value
At Grant Date $ 7.91 $ 6.04 $ 4.31 $ 6.19
Assumptions
Expected Life (months) 70.42 63.75 60.00
Risk-Free Rate of Return 4.93% 5.05% 5.20%
Expected Volatility 73.75% 74.45% 75.06%
Expected Dividend Yield 0.00% 0.00% 0.00%
Expected Forfeiture Rate 2.80% 0.00% 2.80%
(1) The 11.97 Series had 193,000 options remaining at year end due to
employee termination and forfeiture. Compensation recognized for 2006
was adjusted to reflect the forfeitures.
Stock compensation expenses will be recognized over a weighted average remaining
life of 2.41 years.
63
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 - STOCK OPTION PLAN (Continued)
Amount of Compensation Expense 2006 Grants Pre-2006 Grants Total Compensation
--------------------------------------------------- -------------------- --------------------- -----------------------
2006 $ 1,837,729 $ 338,433 $ 2,176,162
2007 758,625 293,095 1,051,719
2008 305,580 119,862 425,441
2009 305,580 - 305,580
$ 3,207,514 $ 751,389 $ 3,958,903
No compensation cost has been recognized for grants under the Option Plan prior
to 2006 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 and 2004
would have been changed to the pro forma amount indicated below:
2005 2004
--------------- --------------
Net income available for common stock-as reported $ 4,782,381 $ 2,364,389
Compensation expenses if the fair value method had been applied to the
grants, net of taxes (538,273) (112,830)
-------------- --------------
Net income available for common stock-pro forma $ 4,244,108 $ 2,251,559
============== ==============
Net income per share-as reported
Basic $ 0.20 $ 0.10
Diluted $ 0.19 $ 0.10
Net income available per share-pro forma
Basic $ 0.17 $ 0.10
Diluted $ 0.17 $ 0.10
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 the pro-forma years 2005 and 2004,
dividend yield of 0%, expected volatility of 73.8% to 75.1%, and risk-free
interest rates of 4.93% to 5.20%, 5% and 5% for each year presented, and
expected lives of two to six years based on the simplified-method
calculation. The maximum term of each option is ten years.
The Company's policy for exercising options begins with the option holder
submitting an "Exercise Notice" to the Investor Relations Officer ("IRO").
The IRO determines the option holder's eligibility and current employment
status. The IRO then prepares the "Option Exercise Notification Form".
Options holders at the "Named Executive" level must be approved to exercise
their options by the Compensation Committee. Any required notice is then
filed with the SEC. The options holder may then purchase shares at the
exercise price.
64
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, 2003 through December 31, 2006:
Weighted
Number of Shares Average
Outstanding Exercise Price
------------------
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 3.91
Exercised (493,019) .98
Canceled or expired (21,164) 1.43
-----------------
Balance at December 31, 2005 1,437,967 3.07
Granted 530,000 9.47
Exercised (329,273) 2.22
Canceled or expired (216,200) 6.33
-----------------
Balance at December 31, 2006 1,422,494 5.16
=================
The following table summarizes information concerning outstanding and
exercisable Company common stock options at December 31, 2006.
Average Options Un-Vested Options
Options Average Remaining Fully-Vested Market Value
Exercise Outstanding at Exercise Contractual And Exercisable at At Balance at
Prices December 31,2006 Price Life Dece,ber 31, 2006 Grant Date December 31, 2006
----------- ----------------- ---------- ----------- ------------------ ------------- -----------------
$ 0.96 104,656 $ 0.96 3.8 104,656 $ 0.96 -
$ 1.00 20,000 $ 1.00 4.2 20,000 $ 1.00 -
$ 1.25 60,000 $ 1.25 3.0 60,000 $ 1.25 -
$ 1.81 40,000 $ 1.81 7.5 40,000 $ 1.81 -
$ 1.87 34,000 $ 1.87 6.3 34,000 $ 1.87 -
$ 1.97 25,000 $ 1.97 7.2 25,000 $ 1.97 -
$ 2.05 171,650 $ 2.05 7.2 122,250 $ 2.05 49,400
$ 2.32 40,000 $ 2.32 6.4 40,000 $ 2.32 -
$ 2.39 80,000 $ 2.39 8.1 40,000 $ 2.39 40,000
$ 2.50 75,000 $ 2.50 8.2 45,000 $ 2.50 30,000
$ 3.75 150,000 $ 3.75 8.5 150,000 $ 3.75 -
$ 6.24 4,188 $ 6.24 1.0 4,188 $ 6.24 -
$ 6.71 100,000 $ 6.71 8.9 60,000 $ 6.71 40,000
$ 6.83 175,000 $ 6.83 9.9 175,000 $ 6.83 -
$ 9.15 150,000 $ 9.15 9.4 75,000 $ 9.15 75,000
$ 11.97 193,000 $ 11.97 9.3 77,200 $ 11.97 115,800
-------------- -------------- ---------------
1,422,494 1,072,294 350,200
============== ============== ===============
65
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 - STOCK OPTION PLAN (Continued)
Total intrinsic value of options outstanding at December 31, 2006 (000's) $ 4,738
Total intrinsic value of options exercisable at December 31, 2006 (000's) $ 4,031
Total intrinsic value of options exercised during 2006 (000's) $ 2,466
Available for grant at December 31, 2006 150,806
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 remaining life of all options outstanding at December 31, 2006 7.9 years
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
On May 25, 2006, the Company, through its wholly-owned subsidiary ENGlobal
Corporate Services, Inc., purchased a one-third partnership interest in PEI
Investments, A Texas Joint Venture ("PEI"), from Michael L. Burrow, the
Company's President and CEO, and another one-third interest from a
stockholder who owns less than 1% of the Company's common stock. The
partnership interests were purchased for a total of $69,000. The remaining
one-third interest was already held by the Company through its wholly-owned
subsidiary EEI. PEI owns the land on which our Beaumont, Texas office
building, destroyed by Hurricane Rita in September 2005, was located. The
remains of the building were razed in July 2006. In September 2006, the
Company acquired approximately 1.2 acres immediately adjacent to the former
facility and is developing plans to construct a new facility utilizing both
parcels of land.
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, 2006, 2005, and 2004, the Company had
sales in the engineering segment totaling approximately $42.5 million,
$84.8 million and $87.9 million attributable to a single customer. In 2006,
approximately 16% of our revenues were from one client, approximately 15%
of our revenues were from another client and another 10% were from a third
client. During 2005 and 2004, a single customer represented approximately
44% and 59% of total sales, respectively. As of December 31, 2006 the
Company had amounts due from 2 customers totaling $11.7 million with 1
customer exceeding 10% of trade receivables. At December 31, 2005, the
Company had amounts due from two customer 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.
66
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 14 - RETIREMENT OF TREASURY SHARES AND REDEEMABLE PREFERRED STOCK
Treasury stock was recorded on our books at $592,231. Upon
retirement/cancellation of the shares in 2006 our Paid in Capital account
was reduced by $592,231 and the treasury stock account was credited to
reduce it to zero.
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. This
class of preferred stock was eliminated by a vote of the Company's
stockholders in June, 2006.
A new class of capital stock of the Company, consisting of 2,000,000 shares
of Preferred Stock, par value $0.001 per share (the "Preferred Stock") was
approved by the Company's stockholders at its June 2006 meeting. The Board
of Directors have the authority to approve the issuance of all or any
shares of these shares of Preferred Stock in one or more series, to
determine the number of shares constituting any series and to determine any
voting powers, conversion rights, dividend rights, and other designations,
preferences, limitations, restrictions and rights relating to such shares
without any further action by the stockholders. The designations,
preferences, limitations, restrictions and rights of any series of
Preferred Stock designated by the Board of Directors will be set forth in
an amendment to the Amended and Restated Articles of Incorporation
("Amended Articles") filed in accordance with Nevada law.
Blank Check Authority
---------------------
The Preferred Stock is referred to as a "blank check" because the Board of
Directors, in their discretion, will be authorized to provide for the
issuance of all or any shares of the stock in one or more classes or
series, specifying the terms of the shares, subject to the limitations of
Nevada law. The Board of Directors would make a determination as to whether
to approve the terms and issuance of any shares of Preferred Stock based on
its judgment as to the best interests of the Company and its stockholders.
Reason for the Authorization of "Blank Check" Preferred Stock. The reason
for authorizing blank check Preferred Stock is to provide the Company with
the flexibility in connection with its future growth. Although the Company
presently has no intentions of issuing shares of Preferred Stock,
opportunities may arise that require the Board to act quickly, such as
businesses becoming available for acquisition or favorable market
conditions for the sale of a particular type of Preferred Stock. The Board
believes that the authorization to issue Preferred Stock is advisable in
order to enhance the Company's ability to respond to these and similar
opportunities.
67
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, 2006, 2005 and 2004 were as follows:
2006 2005 2004
----------------- ----------------- ---------------
(in thousands)
---------------------------------------------------------
Current
Federal $ 1,047 $ 3,016 $ 975
Foreign 53 - -
State 403 413 427
----------------- ---------------- ---------------
1,503 3,429 1,402
----------------- ---------------- ---------------
Deferred
Federal (1,917) (313) 254
Foreign (38) - -
State (362) - -
----------------- -------------- --------------
(2,317) (313) 254
----------------- -------------- --------------
Total tax provision $ (814) $ 3,116 $ 1,656
================= ================ ===============
The components of the deferred tax asset (liability) consisted of the
following at December 31, 2006 and 2005:
2006 2005
----------------- -----------------
(in thousands)
-------------------------------------
Deferred tax asset
Allowance for doubtful accounts $ 255 $ 171
Net operating loss carry-forward 665 474
Accruals not yet deductible for tax purposes 2,636 310
Stock Options 235
Alternative minimum tax credit carry-forward - 194
---------------- ----------------
Deferred tax assets 3,791 1,149
---------------- ----------------
Less: Valuation Allowance 308 -
Deferred tax assets 3,483 -
---------------- ----------------
Deferred tax liabilities
Depreciation (403) (436)
Prepaid expenses (477) (293)
Goodwill (1,407) (40)
---------------- ----------------
Deferred tax liability (2,287) (769)
---------------- ----------------
Deferred tax asset, net $ 1,196 $ 380
================ ================
68
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 15 - FEDERAL INCOME TAXES (Continued)
The following is a reconciliation of expected to actual income tax expense
from continuing operations:
2006 2005 2004
----------------- ----------------- ---------------
(in thousands)
---------------------------------------------------------
Federal income tax expense at 34% $ (1,462) $ 2,685 $ 1,147
State and foreign taxes, net of tax effect (16) 273 212
Nondeductible expenses 102 9 53
Stock compensation expense 530 - -
Valuation allowance 308 - -
Prior year correction (169) - -
Other (107) 149 244
---------------- ---------------- ---------------
$ (814) $ 3,116 $ 1,656
================ ================ ===============
The Company has a federal net operating loss carryforward at December 31,
2006 of approximately $1,049,000. 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 carry-forward that will be
available for utilization in 2007 through 2010.
The Company also has a foreign net operating loss carryforward at December
31, 2006 of approximately $770,000. This loss is available for utilization
in 2007 through 2016.
The Company is unsure of its ability to fully utilize the foreign net
operating loss. Therefore, the Company has set up a valuation allowance of
$308,000 against the entire net operating loss.
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 Operations since the 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.
During 2006, the Company acquired Denver-based WRC Corporation ("WRC") and
certain assets of Analyzer Technology International, Inc. ("ATI"), and
accounted for the acquisitions using the purchase method of accounting for
business combinations. In both cases, the purchase price and costs
associated with the acquisitions exceeded the preliminary estimated fair
value of net assets acquired by approximately $5.6 million and $1.8 million
respectively, which was preliminarily assigned to goodwill. During early
2007, the Company completed the valuation of the intangible assets acquired
in both the WRC and the ATI transactions and pursuant to those valuations
has re-assigned approximately $4.0 million and $1.8 million respectively
from goodwill to non-compete agreements and customer relationships with
such assets being amortized over 5-6 years.
On October 6, 2006, the Company, through its wholly-owned subsidiary,
ENGlobal Construction Resources, Inc. ("ECR"), acquired certain assets of
WATCO Management, Inc. ("WATCO"), a Houston-based business providing
construction management, turnaround management, asset management, and
project commissioning and start-up services, and related services for
projects and facilities located in process plants. The addition of WATCO
will provide ECR with opportunities to expand its current services to
existing WATCO clients in addition to a complementary business allowing
expansion of current services to both existing and future clients. The
aggregate purchase price was $1.0 million, including $500,000 in cash and
an unsecured promissory note in the principal amount of $500,000 payable in
four equal annual installments, bearing interest at the rate of 4% per
annum. The estimated fair values of the acquired assets include
approximately $800,000 in intellectual property, $52,000 in fixed assets
69
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16 - ACQUISITIONS (Continued)
and $148,000 in goodwill. The Company is in the process of obtaining
third-party valuations of the intangible assets; thus the allocation of the
purchase price is subject to adjustment.
The Company purchased Denver-based WRC Corporation ("WRC") on May 25, 2006.
WRC provides integrated land management, engineering, and related services
to the pipeline, power, and transportation industries, among others. WRC
has become a wholly-owned subsidiary of ENGlobal and will now serve as the
Company's provider of land management, environmental compliance and
governmental regulatory services. WRC currently has approximately 200
employees, with revenues in the 12 months prior to the acquisition
exceeding $20 million. The Company expects to utilize WRC's Denver facility
as a beachhead for expansion of its services into the Rocky Mountain and
Western U.S. regions. ENGlobal purchased all of the outstanding capital
stock of WRC in exchange for consideration of cash, a promissory note of
$2.4 million to be paid over four years, 175,000 shares of ENGlobal common
stock and the repayment of certain obligations of WRC as part of the
transaction. At June 30, 2006, goodwill from this transaction was estimated
to be $1.5 million.
In January 2006, one of the Company's subsidiaries, ENGlobal Systems, Inc.
("ESI") acquired certain assets of Analyzer Technology International, Inc.
("ATI"), a Houston-based analyzer systems provider of online process
analyzer systems. ATI relocated 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 anlayzer sector, especially for
larger downstream opportunities of foreigh grassroots projects.
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.
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
constructionmanagement 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.
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 believes that the acquisition of
these assets enhance its capabilities related to various government and
public sector facilities. ETS's most active sector is the Automated Fuel
Handling Systems which serves 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% per annum 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
five years following the acquisition. 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
70
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16 - ACQUISITIONS (Continued)
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.
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.
71
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 18 - SEGMENT INFORMATION (Continued)
Segment information for 2006, 2005 and 2004 was as follows:
Note: Previously, within the Systems Segment, ESI provided products and
services supporting the advanced automation and integrated controls fields.
In January 2006, EAG assumed responsibility for these services, which
resulted in a move of this division of ESI to the Engineering Segment.
Revenues and expenses have been reclassified between the segments to
provide comparative results. Amounts will tie in total to prior reporting,
however, individual segments will vary from prior reports.
Intercompany
Engineering Systems Corporate Eliminations Total
(in thousands)
-------------------------------------------------------------------------------
2006
----
Net sales from external
customers $ 278,157 $ 24,933 $ - $ - $ 303,090
Operating profit (loss) 9,084 (14) (12,690) 1 (3,620)
Depreciation and
amortization 1,419 344 512 - 2,275
Tangible assets 65,339 15,122 6,563 - 87,024
Goodwill 18,224 978 - - 19,202
Capital expenditures 3,286 185 674 - 4,145
2005
----
Net sales from external
customers $ 219,426 $ 14,159 $ - $ - $ 233,585
Operating profit (loss) 18,911 (851) 733 (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 $ 134,778 $ 14,110 $ - $ - $ 148,888
Operating profit (loss) 10,461 636 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
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.
72
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 have been
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 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, 2006, all payments due to Significant PEI Shareholders had
been made.
Employment Agreements
---------------------
The Company has employment agreements with certain of its executive
officers and certain other officers, the terms of which expire in January
2009. Such agreements provide for minimum salary levels. If the Company
terminates the employment of the employee for any reason other than 1)
termination for cause, 2) voluntary resignation, or 3) employee's death,
the Company is obligated to provide a severance benefit equal to six months
of the employee's salary, and, at its option, an additional six months at
50% to 100% of the employee's salary in exchange for an extension of the
non-compete. These agreements are renewable for one year at the Company's
option.
73
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 19 - COMMITMENTS AND CONTINGENCIES (Continued)
Litigation
----------
From time to time, we are involved in various legal proceedings arising in
the ordinary course of business alleging, among other things, breach of
contract or tort in connection with the performance of professional
services, the outcome of which cannot be predicted with certainty. As of
the date of this filing, we are party to several legal proceedings that
have been reserved for or are covered by insurance, or that, if determined
adversely to us individually or in the aggregate, would not have a material
adverse effect on our results of operations or financial position.
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 $175,000 per occurrence and approximately $12.1million in aggregate in
each policy year being covered by a separate insurance policy.
NOTE 20 - SUBSEQUENT EVENTS
In December 2006, ENGlobal Engineering, Inc. began its plan to merge its
Dallas, Texas operations with operations being performed at the Tulsa,
Oklahoma and Houston, Texas offices. The transfer of activities at the
Dallas office was the result of a decision to consolidate the Company's
Texas-based operations while streamlining or reducing overhead costs. A
large number of the 25 Dallas employees were offered transfers to
ENGlobal's Tulsa, Oklahoma or Houston, Texas offices. Certain employees
were asked to remain with the Company in Dallas through March 31, 2007 to
allow for an orderly transfer of on-going projects.
On February 14, 2007, the Company ceased operations through its Dallas
office and transferred all remaining operational support to its Tulsa
office. At the same time, the Company entered into a sublease commencing on
March 1, 2007, for approximately 75% of the continuing lease obligations
and sold a majority of the assets which were valued at approximately
$90,000. The Company will calculate the remaining obligations related to
the move from the Dallas area and record a charge during the first quarter
of 2007. The Company estimates the charge will range from $100,000 to
$125,000.
On February 16, 2007, the Company, through its wholly-owned subsidiary, RPM
Engineering, Inc. ("RPM"), entered into an Agreement to Purchase and Sell
the property (the "Agreement"), together with the building and all
improvements thereon located in Baton Rouge, Louisiana for approximately
$1.9 million with 20% of purchase price being paid at closing and the
balance self-financed for a period no longer than 60 months, amortized over
180 months, payable in equal monthly installments and one irregular
installment consisting of the interest and principle due at the end of the
60 months. The interest rate is based on NY prime plus .25%, initially to
be 8.5%. Under certain conditions prior to closing and up to sixty days for
the last signing of the Agreement, the purchaser may be entitled to the
return in full of any deposit held by RPM. The financed portion of the
purchase price is secured by a first mortgage on the property. The
Company's basis in the property, together with the building and all
improvements is approximately $1.4 million at December 31, 2006. It is
intended that the closing shall take place on or about April 30, 2007.
74
NOTE 21 - QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
For the Quarters Ended - 2006
March June September December
------------- ------------ -------------- ------------
(in thousands, except per share amounts)
Revenues per segment
Engineering $ 62,587 93.9% $ 69,752 92.9% $ 76,617 92.9% $ 69,201 87.7%
Systems 4,040 6.1% 5,314 7.1% 5,887 7.1% 9,692 12.3%
------------- ----------- ------------ -----------
Total $ 66,627 100.0% $ 75,066 100.0% $ 82,504 100.0% $ 78,893 100.0%
============= =========== ============ ===========
Gross profit per segment
Engineering $ 7,796 12.5% $ 10,189 14.6% $ 4,426 5.8% $ 1,715 2.5%
Systems 426 10.5% $ 539 10.1% 123 2.1% 1,050 10.8%
------------- ----------- ------------ -----------
Total $ 8,222 12.3% $ 10,728 14.3% $ 4,549 5.5% $ 2,765 3.5%
============= =========== ============ ===========
Net income (loss) $ 1,234 $ 2,331 $ (1,570) $ (5,481)
============= =========== ============ ===========
Earnings per share - basic $ 0.05 $ 0.09 $ (0.06) $ (0.21)
Earnings per share - diluted $ 0.05 $ 0.09 $ (0.06) $ (0.21)
For the Quarters Ended - 2005
March June September December
------------- ------------ -------------- ------------
(in thousands, except per share amounts)
Revenues per segment
Engineering $ 41,226 92.4% $ 54,962 92.5% $ 55,923 94.4% $ 67,315 95.8%
Systems 3,403 7.6% 4,457 7.5% 3,343 5.6% 2,956 4.2%
------------ ------------ ------------ -----------
Total $ 44,629 100.0% $ 59,419 100.0% $ 59,266 100.0% $ 70,271 100.0%
============ ============ ============ ===========
Gross profit per segment
Engineering $ 5,405 13.1% $ 6,925 12.6% $ 7,635 13.7% $ 7,197 10.7%
Systems 294 8.6% 354 7.9% 203 6.1% 260 8.8%
------------ ------------ ------------ -----------
Total $ 5,699 12.8% $ 7,279 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
Note: Previously, within the Systems Segment, ESI provided products and
services supporting the advanced automation and integrated controls fields.
In January 2006, EAG assumed responsibility for these services, which
resulted in a move of this division of ESI to the Engineering Segment.
Revenues and expenses have been reclassified between the segments to
provide comparative results. Amounts will tie in total to prior reporting,
however, individual segments will vary from prior reports.
75
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, 2006 $ 503 $ 251 $ (84) $ 670
For year ended December 31, 2005 $ 476 $ 53 $ (26) $ 503
For year ended December 31, 2004 $ 376 $ 134 $ (34) $ 476
76
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
Disclosure controls and procedures are controls and other procedures of a
registrant designed to ensure that information required to be disclosed by the
registrant in the reports that it files or submits under the Exchange Act is
properly recorded, processed, summarized, and reported, within the time periods
specified in the Securities and Exchange Commission's ("SEC") rules and forms.
Disclosure controls and procedures include processes to accumulate and evaluate
relevant information and communicate such information to a registrant's
management, including its Chief Executive Officer and Chief Financial Officer,
as appropriate, to allow for timely decisions regarding required disclosures.
We evaluated the effectiveness of the design and operation of our disclosure
controls and procedures as of December 31, 2006, as required by Rule 13a-15 of
the Exchange Act. As described below, under "Management's Report on Internal
Control Over Financial Reporting," material weaknesses were identified in our
internal control over financial reporting as of December 31, 2006, relating to
our control environment, information technology access, accounting system,
purchases and expenditures, fixed-price contract information, and revenue
recognition. Based on the evaluation described above, our Chief Executive
Officer and Chief Financial Officer have concluded that, as of December 31,
2006, our disclosure controls and procedures were not effective to ensure (1)
that information required to be disclosed by us in the reports we file or submit
under the Exchange Act is recorded, processed, summarized, and reported, within
the time periods specified in the SEC's rules and forms, and (2) information
required to be disclosed by us in our reports that we file or submit under the
Exchange Act is accumulated and communicated to our management, including our
Chief Executive Officer and Chief Financial Officer, as appropriate, to allow
timely decisions regarding required disclosure.
(b) Management's Report on Internal Control over Financial Reporting
Effective June 30, 2006, ENGlobal Corporation met the definition of "accelerated
filer," as described by Rule 12b-2 of the Exchange Act. As an accelerated filer,
we are required by the Sarbanes-Oxley Act of 2002 to include an assessment of
our internal control over financial reporting for the year ended December 31,
2006. Our management is responsible for establishing and maintaining adequate
internal control over financial reporting. Our internal control over financial
reporting is a process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of our financial
statements for external reporting purposes in accordance with generally accepted
accounting principles.
Internal control over financial reporting cannot provide absolute assurance of
achieving financial reporting objectives because of its inherent limitations.
Internal control over financial reporting is a process that involves human
diligence and compliance and is subject to lapses in judgment and breakdowns
resulting from human failures. Internal control over financial reporting also
can be circumvented by collusion or improper management override. Because of
such limitations, there is a risk that material misstatements may not be
prevented or detected on a timely basis by internal control over financial
reporting. However, these inherent limitations are known features of the
financial reporting process. Therefore, it is possible to design into the
process safeguards to reduce, though not eliminate, this risk.
A material weakness in internal control over financial reporting (as defined in
Auditing Standard No. 2 of the Public Company Accounting Oversight Board) is a
significant deficiency, or combination of significant deficiencies, that results
in more than a remote likelihood that a material misstatement of the annual or
interim financial statements will not be prevented or detected. A significant
deficiency is a control deficiency, or combination of control deficiencies,
77
ITEM 9A. CONTROLS AND PROCEDURES (continued)
that adversely affects a company's ability to initiate, authorize, record,
process, or report external financial data reliably in accordance with generally
accepted accounting principles, such that there is more than a remote likelihood
that a misstatement of the company's annual or interim financial statements that
is more than inconsequential will not be prevented or detected.
Management assessed the effectiveness of the Company's internal control over
financial reporting as of December 31, 2006, the end of the fiscal period
covered by this report, but management did not complete its assessment until
March 2, 2007. Due to the lack of adequate time to permit Hein to audit
management's assessment, Hein is unable to render an opinion on our assessment
of the effectiveness of our internal control over financial reporting as of
December 31, 2006. Accordingly, management has identified this as a material
weakness. Management's assessment process did not conclude in adequate time to
permit Hein to audit management's assessment due to a number of factors,
including: (i) our failure to prepare and plan for a timely completion of
management's assessment, including adding the resources necessary to do so; and
(ii) our failure to ensure that our accounting department was adequately staffed
and sufficiently trained to meet deadlines.
Management assessed the effectiveness of our internal control over financial
reporting as of December 31, 2006, using the criteria set forth by the Committee
of Sponsoring Organizations of the Treadway Commission ("COSO") in Internal
Control--Integrated Framework. In assessing the effectiveness of our internal
control over financial reporting, management identified the following additional
material weaknesses in internal control over financial reporting as of December
31, 2006:
1. Deficiencies in the Company's Control Environment. Our control
environment did not sufficiently promote effective internal
control over financial reporting throughout the organization.
Specifically, we had a shortage of support and resources in our
accounting department, which resulted in insufficient: (i)
documentation and communication of our accounting policies and
procedures; and (ii) internal audit processes of our accounting
policies and procedures.
2. Deficiencies in the Company's Information Technology Access
Controls. We did not maintain effective controls over preventing
access by unauthorized personnel to end-user spreadsheets and
other information technology programs and systems.
3. Deficiencies in the Company's Accounting System Controls. We did
not effectively and accurately close the general ledger in a
timely manner and we did not provide complete and accurate
disclosure in our notes to financial statements, as required by
generally accepted accounting principles.
4. Deficiencies in the Company's Controls Regarding Purchases and
Expenditures. We did not maintain effective controls over the
tracking of our commitments and actual expenditures with
third-party subsidiaries on a timely basis.
5. Deficiencies in the Company's Controls Regarding Fixed-Price
Contract Information. We did not maintain effective controls over
the complete, accurate, and timely processing of information
relating to the estimated cost of fixed-price contracts.
6. Deficiencies in the Company's Revenue Recognition Controls. We
did not maintain effective policies and procedures relating to
revenue recognition of fixed price contracts, which accounted for
approximately 11% of the Company's revenues in 2006.
7. Deficiencies in the Company's Controls over Income Taxes. We did
not maintain sufficient internal controls to ensure that amounts
provided for in our financial statements for income taxes
accurately reflected our income tax position as of December 31,
2006.
78
ITEM 9A. CONTROLS AND PROCEDURES (continued)
As a result of the material weaknesses described above, our management concluded
that we did not maintain effective internal control over financial reporting as
of December 31, 2006, based on the criteria established by COSO.
(c) Changes in Internal Controls Over Financial Reporting
No change in our internal control over financial reporting (as defined in Rule
13a-15(f) under the Securities Exchange Act of 1934) occurred during the fourth
quarter of fiscal 2006 that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting. Management and
the Audit Committee of the Company's Board of Directors have begun to develop
remedial measures to address the internal control deficiencies identified above.
The Company will monitor the effectiveness of planned actions and will make any
other changes and take such other actions as management or the Audit Committee
determines to be appropriate.
(d) Remediation Initiatives
During 2007, we plan to implement a number of remediation measures to address
the material weaknesses described above. The Company's remediation plans
include:
1. We plan to hire additional personnel to assist us with
documenting and communicating our accounting policies and
procedures to ensure the proper and consistent application of
those policies and procedures throughout the Company. Recruitment
for this position(s) has begun and the selection process is
expected to be completed during the second quarter of 2007.
2. We plan to implement formal processes requiring periodic
self-assessments, independent tests, and reporting of our
personnel's adherence to our accounting policies and procedures.
3. We plan to design effective policies and procedures to control
security of and access to spreadsheet information. If necessary,
we will also consider implementing a software solution with
automatic control checkpoints for day-to-day business processes.
4. We plan to (i) require additional training for our current
accounting personnel; (ii) to hire additional accounting
personnel to enable the allocation of job functions among a
larger group of accounting staff; (iii) to engage outside
consultants with technical accounting expertise, as needed; and
(iv) to consider restructuring our accounting department, each to
increase the likelihood that our accounting personnel will have
the resources, experience, skills, and knowledge necessary to
effectively perform the accounting system functions assigned to
them.
5. We plan to improve procurement and operational efficiencies by
implementing a software system and a matrix organization to more
completely, accurately, and timely track commitments on
Company-wide purchase and expenditure transactions.
6. We plan to improve revenue recognition policies and procedures
relating to fixed-price contracts by evaluating the level of
economic success achieved by past fixed-price contracts and by
stressing throughout the Company the importance of (i) accurately
estimating costs, (ii) timely updating cost estimates to reflect
the accuracy of the cost savings, (iii) accurately estimating
expected profit, (iv) timely identifying when a project's scope
changes, (v) promptly reporting man hours and costs in excess of
those originally estimated; and (vi) closely scrutinizing the bid
process.
79
ITEM 9A. CONTROLS AND PROCEDURES (continued)
7. We plan to train personnel to effectively implement and evaluate
the overall design of the Company's fixed-price project control
processes. Specifically, we plan to enhance and tighten controls
as they relate to the initial bid process and the attendant
recognition and management of risk by only bidding on large
procurement and construction activities on a cost plus basis.
Management recognizes that many of these enhancements require continual
monitoring and evaluation for effectiveness. The development of these actions is
an iterative process and will evolve as the Company continues to evaluate and
improve our internal controls over financial reporting.
Management will review progress on these activities on a consistent and ongoing
basis at the Chief Executive Officer and senior management level in conjunction
with our Audit Committee. We also plan to take additional steps to elevate
Company awareness about and communication of these important issues through
formal channels such as Company meetings, departmental meetings, and training.
80
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 2007 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, and Report of the
Compensation Committee on Executive Compensation and Comparative
Stock Performance Graph contained in our definitive proxy
statement for our 2007 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 2007 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 2007 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 2007 annual
meeting of stockholders to be filed with the SEC pursuant to
Regulation 14A under the Exchange Act is incorporated herein by
reference.
81
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.
(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
82
EXHIBIT INDEX
Incorporated by Reference to:
------------ ---------------------------------------------------- ------------ ----------------------------------------
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
Exhibit No. Description Form or Exhibit No. Filing Date SEC File
Schedule 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 Merger S-4/A 2.24 11/6/01 333-68288
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
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 29, S-3 4.5 10/31/05 333-129336
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 1998 Incentive Plan S-8 10.49 8/24/05 333-127803
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
10.4 Amendment No. 1 to 1998 Incentive Plan S-8 10.65A 6/9/03 333 - 105966
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
10.5 Amendment No. 2 to the 1998 Incentive Plan S-8 10.65A 6/9/03 333 - 105966
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
10.6 Amendment No. 3 to the 1998 Incentive Plan S-8 10.52 8/24/05 333-127803
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
10.7 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
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
10.8 Lease Agreement between Petrocon Engineering, Inc. 10-Q 10.66 11/14/02 001-14217
and Phelan Investments on July 25, 2002
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
83
Incorporated by Reference to:
------------ ---------------------------------------------------- ------------ ----------------------------------------
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
Exhibit No. Description Form or Exhibit No. Filing Date SEC File
Schedule with SEC Number
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
10.9 Lease Agreement between Petro-Chem Engineering and 10-Q 10.72 8/14/03 001-14217
ENGlobal Engineering, Inc. dated June 4, 2003
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
10.10 Contract between BASF and ENGlobal Engineering, 10-Q 10.73 8/14/03 001-14217
Inc. dated June 9, 2003
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
10.11 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
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
10.12 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
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
10.13 Second Amendment of the ENGlobal Engineering, Inc. 10-K 10.77 3/30/04 001-14217
401(k) Plan dated January 1, 2004 (formerly called
the "Petrocon Engineering, Inc. 401(k) Plan")
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
10.14 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
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
10.15 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
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
10.16 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
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
10.17 Master Revolving Note by and between Comerica Bank 8-K 10.3 8/9/04 001-14217
and ENGlobal Corporation and its subsidiaries
dated July 27, 2004
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
10.18 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
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
*10.19 Option to Purchase Share Agreement between Yong
Choy Lin @ Yong Chai Lin and ENGlobal Engineering,
Inc. effective September 8, 2006
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
*10.20 Management Agreement between ENGlobal Engineering,
Inc. and SchmArt Technologies Sdn. Bhd effective
September 8, 2006
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
*10.21 First Amendment of the ENGlobal 401(k) Plan
effective December 21, 2001
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
*10.22 Amended and Restated ENGlobal 401(k) Plan
effective October 1, 2005
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
*10.23 Second Amendment to the ENGlobal 401(k) Plan
effective April 1, 2006
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
*10.24 Third Amendment to the ENGlobal 401(k) Plan
effective July 1, 2006
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
84
Incorporated by Reference to:
------------ ---------------------------------------------------- ------------ ----------------------------------------
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
Exhibit No. Description Form or Exhibit No. Filing Date SEC File
Schedule with SEC Number
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
*10.25 Regulations Amendment to the ENGlobal 401(k) Plan
effective January 1, 2006
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
*10.26 First Amendment to the Lease Agreement between
Oral Roberts University and ENGlobal Engineering,
Inc. dated April 5, 2005
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
*10.27 Second Amendment to the Lease Agreement between
Oral Roberts University and ENGlobal Engineering,
Inc. dated June 15, 2005
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
*10.28 Third Amendment to the Lease Agreement between
Oral Roberts University and ENGlobal Engineering,
Inc. dated December 28, 2005
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
*10.29 Fourth Amendment to the Lease Agreement between
Oral Roberts University and ENGlobal Engineering,
Inc. dated February 27, 2006
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
*10.30 Fifth Amendment to the Lease Agreement between
Oral Roberts University and ENGlobal Engineering,
Inc. dated July 28, 2006
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
*10.31 First Amendment to Credit Agreement by and among Comerica Bank and
ENGlobal Corporation and its subsidiaries dated September 30, 2004
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
*10.32 Second Amendment to Credit Agreement by and among Comerica Bank and
ENGlobal Corporation and its subsidiaries dated April 1, 2005
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
*10.33 Third Amendment to Credit Agreement by and among Comerica Bank and
ENGlobal Corporation and its subsidiaries dated July 31, 2005
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
*10.34 Fourth Amendment to Credit Agreement by and among Comerica Bank and
ENGlobal Corporation and its subsidiaries dated December 31, 2005
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
*10.35 Fifth Amendment to Credit Agreement by and among Comerica Bank and
ENGlobal Corporation and its subsidiaries dated July 26, 2006
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
*10.36 Sixth Amendment to Credit Agreement by and among Comerica Bank and
ENGlobal Corporation and its subsidiaries effective December 31,
2006
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
*10.37 ENGlobal Corporation Key Manager Incentive Plan
effective January 1, 2006
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
*10.38 ENGlobal Corporation Executive Level Incentive
Plan effective January 1, 2006
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
85
Incorporated by Reference to:
------------ ---------------------------------------------------- ------------ ----------------------------------------
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
Exhibit No. Description Form or Exhibit No. Filing Date SEC File
Schedule with SEC Number
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
*10.39 ENGlobal Corporation Key Executive Employment
Agreement - William A. Coskey effective January 1,
2006
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
*10.40 ENGlobal Corporation Key Executive Employment
Agreement - Michael L. Burrow effective January
1, 2006
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
*10.41 ENGlobal Corporation Key Executive Employment
Agreement - Robert W. Raiford effective January 1,
2006
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
*10.42 ENGlobal Corporation Key Executive Employment
Agreement - Michael M. Patton effective January 1,
2006
------------ ---------------------------------------------------- ------------ ------------ ------------- -------------
*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
86
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 15, 2007
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
87