UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2007
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No. 001-14217
ENGlobal Corporation
--------------------
(Exact name of registrant as specified in its charter)
Nevada
------
(State or other jurisdiction of
incorporation or organization)
88-0322261
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(I.R.S Employer Identification No.)
654 N. Sam Houston Parkway E., Suite 400, Houston, TX 77073-6033
----------------------------------------------------- ----------
(Address of principal executive offices) (Zip code)
(281) 878-1000
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shortened period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (check
one):
Large Accelerated Filer [ ] Accelerated Filer [X] Non-Accelerated Filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the close of business of May 1, 2007.
$0.001 Par Value Common Stock 26,853,090 shares
QUARTERLY REPORT ON FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2007
TABLE OF CONTENTS
Page
Number
------
Part I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Statements of Operations for the Three Months Ended
March 31, 2007 and March 31, 2006 3
Consolidated Statements of Comprehensive Income for the Three Months Ended
March 31, 2007 and March 31, 2006 4
Condensed Consolidated Balance Sheets at March 31, 2007 and December 31, 2006 5
Condensed Consolidated Statements of Cash Flows for the Three Months
Ended March 31, 2007 and March 31, 2006 6
Notes to Condensed Consolidated Financial Statements 7-13
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 14-23
Item 3. Quantitative and Qualitative Disclosures About Market Risk 24
Item 4. Controls and Procedures 24
Part II. Other Information
Item 1. Legal Proceedings 27
Item 1A. Risk Factors 27
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 27
Item 3. Defaults Upon Senior Securities 27
Item 4. Submission of Matters to a Vote of Security Holders 27
Item 5. Other Information 27
Item 6. Exhibits 27
Signatures 28
2
PART I. - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ENGlobal Corporation
Condensed Consolidated Statements Of Operations
(Unaudited)
For the Three Months
Ended March 31,
----------------------------
2007 2006
------------ ------------
Operating Revenue $ 81,658,632 $ 66,626,836
------------ ------------
Operating Expenses:
Direct cost 68,380,907 58,405,208
Selling, general and administrative 7,743,688 6,100,351
------------ ------------
Total operating expense 76,124,595 64,505,559
------------ ------------
Operating income 5,534,037 2,121,277
Other Income (Expense):
Other income (expense) (131) 21,752
Interest income (expense), net (559,843) (162,146)
------------ ------------
Total other income (expense) (559,974) (140,394)
------------ ------------
Income before Provision for Income Taxes 4,974,063 1,980,883
Provision for Income Taxes 1,819,720 746,740
------------ ------------
Net Income $ 3,154,343 $ 1,234,143
============ ============
Net Income Per Common Share:
Basic $ 0.12 $ 0.05
Diluted $ 0.12 $ 0.05
Weighted Average Shares Used in Computing Net Income Per Share:
Basic 26,809,006 26,332,602
Diluted 27,259,948 27,246,347
See accompanying notes to interim condensed consolidated financial statements.
3
ENGlobal Corporation
Consolidated Statements of Comprehensive Income
(Unaudited)
For the Three Months
Ended March 31,
--------------------------
2007 2006
----------- -----------
Net Income $ 3,154,343 $ 1,234,143
Foreign currency translation adjustment, net (683) (433)
----------- -----------
Net Comprehensive Income $ 3,153,660 $ 1,233,710
=========== ===========
See accompanying notes to interim condensed consolidated financial statements.
4
ENGlobal Corporation
Condensed Consolidated Balance Sheets
(Unaudited)
ASSETS
------
March 31, December 31,
2007 2006
------------- -------------
Current Assets:
Cash $ 949,652 $ 1,402,880
Trade receivables, net 64,113,264 60,247,612
Prepaid expenses and other current assets 1,950,000 1,723,907
Current portion of notes receivable 52,815 52,031
Costs and estimated earnings in excess of billings on uncompleted contracts 8,068,993 5,390,111
Deferred tax asset 2,310,106 2,310,106
Federal income taxes receivable 101,135 1,148,014
------------- -------------
Total Current Assets 77,545,965 72,274,661
Property and Equipment, net 8,474,181 8,724,902
Goodwill 19,688,030 19,202,197
Other Intangible Assets, net 4,747,347 5,426,824
Long term notes receivable, net of current portion 120,727 129,105
Other Assets 624,867 468,864
------------- -------------
Total Assets $ 111,201,117 $ 106,226,553
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current Liabilities:
Accounts payable $ 10,636,078 $ 14,672,165
Federal and State Income Taxes 1,159,796 509,748
Accrued compensation and benefits 13,399,534 12,806,919
Notes payable 624,978 1,109,772
Current portion of long-term debt 1,427,352 1,418,029
Deferred rent 648,328 678,583
Billings in excess of costs and estimated earnings on uncompleted contracts 1,697,445 539,910
Other liabilities 3,737,345 5,352,886
------------- -------------
Total Current Liabilities 33,330,856 37,088,012
Long-Term Debt, net of current portion 32,473,627 27,162,263
Deferred Tax Liability 1,075,716 1,114,224
------------- -------------
Total Liabilities 66,880,199 65,364,499
------------- -------------
Commitments and Contingencies (Note 11)
Stockholders' Equity:
Common stock - $0.001 par value; 75,000,000 shares authorized; 26,829,090
and 26,807,460 shares issued and outstanding at March 31, 2007 and
December 31, 2006, respectively 27,481 27,459
Additional paid-in capital 31,422,851 31,147,343
Retained earnings 12,871,696 9,717,354
Accumulated other comprehensive income (loss) (1,110) (30,102)
------------- -------------
Total Stockholders' Equity 44,320,918 40,862,054
------------- -------------
Total Liabilities and Stockholders' Equity $ 111,201,117 $ 106,226,553
============= =============
See accompanying notes to interim condensed consolidated financial statements.
5
ENGlobal Corporation
Condensed Consolidated Statements Of Cash Flows
(Unaudited)
For the Three Months Ended
March 31,
----------------------------
2007 2006
------------ ------------
Cash Flows from Operating Activities:
Net income $ 3,154,343 $ 1,234,143
Adjustments to reconcile net income to net cash used in operating activities -
Depreciation and amortization 1,068,649 648,703
Share based compensation expense 232,964 85,305
Gain on disposal of property, plant and equipment (13,561) (10,000)
Deferred income tax expense (38,508) (15,900)
Changes in current assets and liabilities, net of acquisitions -
Trade receivables (3,865,652) (2,870,680)
Inventories -- 153,968
Costs and estimated earnings in excess of billings (2,678,882) (381,574)
Prepaid expenses and other assets (462,064) 54,136
Accounts payable (4,036,087) (3,409,896)
Accrued compensation and benefits 592,615 (1,083,098)
Billings in excess of costs and estimated earnings 1,157,535 1,956,996
Other liabilities (1,775,443) (143,704)
Income taxes receivable (payable) 1,731,914 592,639
------------ ------------
Net cash used in operating activities (4,932,177) (3,188,962)
Cash Flows from Investing Activities:
Property and equipment acquired (574,759) (696,456)
Proceeds from sale of equipment 48,460 10,000
Proceeds from note receivable 7,594 --
Proceeds from sale of other assets 90,204 50,000
Net cash paid for acquisitions -- (649,251)
------------ ------------
Net cash used in investing activities (428,501) (1,285,707)
------------ ------------
Cash Flows from Financing Activities:
Borrowings on line of credit 39,411,802 32,604,288
Payments on line of credit (33,758,819) (28,278,338)
Proceeds from issuance of common stock 42,565 212,361
Long-term debt repayments (817,090) (205,971)
------------ ------------
Net cash provided by financing activities 4,878,458 4,332,340
------------ ------------
Effect of Exchange Rate Changes on Cash 28,992 2,928
------------ ------------
Net change in cash (453,228) (139,401)
Cash, at beginning of period 1,402,880 159,414
------------ ------------
Cash, at end of period $ 949,652 $ 20,013
============ ============
Supplemental Disclosures:
Interest paid $ 353,549 $ 90,254
------------ ------------
Income taxes paid $ (134,912) $ 248,867
------------ ------------
Non-Cash:
Issuance of note for ATI assets $ -- $ 1,000,000
------------ ------------
Acceptance of note for Constant Power assets $ -- $ 216,000
============ ============
See accompanying notes to interim condensed consolidated financial statements.
6
Notes to Condensed Consolidated Financial Statements
----------------------------------------------------
NOTE 1 - BASIS OF PRESENTATION
The condensed consolidated financial statements of ENGlobal Corporation
(which may be referred to as "ENGlobal", the "Company", "we", "us", or
"our") included herein, are un-audited for the three-month periods ended
March 31, 2007 and 2006. These financial statements reflect all adjustments
(consisting of normal recurring adjustments), which are, in the opinion of
management, necessary to fairly present the results for the periods
presented. Certain information and note disclosures, normally included in
financial statements prepared in accordance with accounting principles
generally accepted in the United States of America, have been condensed or
omitted pursuant to rules and regulations of the Securities and Exchange
Commission. It is suggested that these condensed financial statements be
read in conjunction with the Company's audited financial statements for the
year ended December 31, 2006, included in the Company's Annual Report on
Form 10-K filed with the Securities and Exchange Commission on March 16,
2007 and Form 10K/A filed on March 29, 2007. The Company believes that the
disclosures made herein are adequate to make the information presented not
misleading.
NOTE 2 - CRITICAL ACCOUNTING POLICIES
A summary of critical accounting policies is disclosed in Note 2 to the
Consolidated Financial Statements included in our 2006 Annual Report on
Form 10-K. Our critical accounting policies are further described under the
caption "Critical Accounting Policies" in Management's Discussion and
Analysis of Financial Condition and Results of Operation in our 2006 Annual
Report on Form 10-K.
The Company's adoption of SFAS No. 123(R), "Share-Based Payment," became
effective January 1, 2006 and is further described in Note 3, below.
On July 13, 2006, the FASB issued FIN 48, "Accounting for Uncertainty in
Income Taxes, and Related Implementation Issues," which provides guidance
on the financial statement recognition, measurement, presentation and
disclosure of uncertain tax positions that a company has taken or expects
to take on a tax return. Under FIN 48, financial statements should reflect
expected future tax consequences of such positions presuming the taxing
authorities have full knowledge of the position and all relevant facts.
This interpretation also revises the disclosure requirements and was
adopted by the Company effective as of January 1, 2007. There are currently
no material tax positions identified as uncertain for the Company or its'
subsidiaries.
We recognize interest related to uncertain tax positions in interest
expense and penalties related to uncertain tax positions in governmental
penalties. As of March 31, 2007, we have not recognized interest or
penalties relating to any uncertain tax positions.
The Company is subject to federal and state income tax audits from time to
time that could result in proposed assessments. The Company cannot predict
with certainty the timing of such audits, how these audits would be
resolved and whether the Company would be required to make additional tax
payments, which may or may not include penalties and interest. The Company
was subject to a Federal tax audit for the years 2002 and 2003. That
examination has been closed.
As of March 31, 2007, the Company has been notified that its' recently
acquired subsidiary, WRC Corporation is subject to an audit for the
pre-acquisition fiscal year ending September 30, 2005. The Company does not
have any other examination on-going by the Internal Revenue Service, and
the open years subject to audit are currently tax years 2004-2006. For most
states where the Company conducts business, the Company is subject to
examination for the preceding three to six years.
NOTE 3 - SHARE BASED COMPENSATION
The Company currently sponsors a stock-based compensation plan as described
below. Effective January 1, 2006, the Company adopted the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 123 (Revised),
"Share-Based Payment" ("SFAS No. 123(R)"). Under the fair value recognition
provisions of SFAS No. 123(R), stock-based compensation is measured at the
grant date based on the value of the awards and is recognized as expense
7
Notes to Condensed Consolidated Financial Statements
----------------------------------------------------
over the requisite service period (usually a vesting period). The Company
selected the modified prospective method of adoption described in SFAS No.
123(R). The fair values of the stock awards recognized under SFAS No.
123(R) are determined based on the vested portion of the awards; however,
the total compensation expense is recognized on a straight-line basis over
the vesting period.
In accordance with the provisions of SFAS No. 123(R), total stock-based
compensation expense in the amount of $232,964 and $85,366 was recorded in
the three months ended March 31, 2007, and March 31, 2006, respectively.
The total stock-based compensation expense was recorded in selling, general
and administrative expense. The total income tax benefit recognized in the
condensed consolidated statements of income for the share-based
arrangements for the three months ended March 31, 2007 was $38,509.
Prior to January 1, 2006, the Company accounted for stock-based
compensation using the intrinsic value method prescribed in Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. Under APB Opinion No. 25, no
compensation expense was recognized for stock options issued to employees
because the grant price equaled or was above the market price on the date
of grant for options issued by the Company.
The total fair value of vested options during the three months ended March
31, 2007 and 2006 was $6.5 million and $10.7 million, respectively. The
average price per share for the three months ended March 31, 2007 and 2006
was $6.00 per share and $11.14 per share, respectively.
Stock Option and Incentive Plans
The Company maintains a stock option plan (the "Option Plan") under which
the Company may issue incentive stock options to employees and non-employee
directors. Under the Option Plan, a maximum of 2,650,000 shares of our
common stock was approved to be issued or transferred to certain
non-employee directors, officers and employees pursuant to stock based
awards granted. As of March 31, 2007, 150,806 shares remain available for
grant under the Option Plan.
On March 30, 2007, the Board of Directors approved, subject to stockholder
approval on June 14, 2007, an amendment to the Option Plan. The proposed
amendment would increase the number of shares available for issuance under
the Plan from 2,650,000 to 3,250,000 in order to enhance the ability of
ENGlobal to compensate its non-employee directors and to attract employees
of outstanding ability.
The Company's policy regarding share issuance upon option exercise takes
into consideration the optionee's eligibility and vesting status. Upon
receipt of an optionee's exercise notice and payment, and the Company's
subsequent determination of eligibility, the Company's Chief Governance
Officer or the Chairman of the Compensation Committee instructs our
transfer agent to issue shares of our Common Stock to the optionee.
Stock options have been granted with exercise prices at or above the market
price on the date of grant. The granted options have vested generally over
one year for non-employee directors and ratably over four years for
officers and employees. The granted options generally have ten year
contractual terms.
Compensation expense of $1,480,583 related to previously granted stock
option awards which are non-vested had not yet been recognized at March 31,
2007. This compensation expense is expected to be recognized over a
weighted-average period of approximately 20 months.
8
Notes to Condensed Consolidated Financial Statements
----------------------------------------------------
The following summarizes stock option activity for the first quarter of 2007.
Weighted
Weighted Average
Average Remaining Aggregate
Number of Exercise Contractual Intrinsic *
Options Price Term (Years) Value (000's)
----------- --------- ------------- -------------
Balance at December 31, 2006 1,422,494 $ 5.16 7.9 years $ 2,871
Granted - - - -
Exercised 21,630 1.97 - 77
Canceled or expired - - - -
----------- --------- ------------- ----------
Balance at March 31, 2007 1,400,864 $ 5.21 7.7 $ 2,948
=========== ========= ============= ==========
Exercisable at March 31, 2007 1,088,164 $ 4.66 7.7 $ 2,504
=========== ========= ============= ==========
*Based on average stock price for the first quarter 2007 of $6.00 per
share. The average stock price for the same period in 2006 was $11.14 per
share.
The total intrinsic value of options exercised was $77,000 and $488,000 for
the three months ended March 31, 2007 and 2006, respectively.
NOTE 4 - FIXED FEE CONTRACTS
Costs, estimated earnings and billings on uncompleted contracts consisted
of the following at March 31, 2007 and December 31, 2006:
March 31, December 31,
2007 2006
--------------------
(in thousands)
--------------------
Costs incurred on uncompleted contracts $ 72,600 $ 75,317
Estimated earnings (losses) on uncompleted contracts (7,792) (7,390)
-------- --------
Earned revenues 64,808 67,927
Less: Billings to date 58,438 63,077
-------- --------
Net costs and estimated earnings in excess of billings $ 6,370 $ 4,850
on uncompleted contracts
======== ========
Costs and estimated earnings in excess of billings on uncompleted contracts $ 8,068 $ 5,390
Billings and estimated earnings in excess of cost on uncompleted contracts (1,698) (540)
-------- --------
Net costs and estimated earnings in excess of billings
on uncompleted contracts $ 6,370 $ 4,850
======== ========
NOTE 5 - COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) represents net earnings and any revenue,
expenses, gains and losses that, under accounting principles generally
accepted in the United States of America, are excluded from net earnings
and recognized directly as a component of stockholders' equity. At March
31, 2007, comprehensive income included a loss of $683 from foreign
currency translation adjustments.
NOTE 6 - GOODWILL
In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets,"
goodwill is no longer amortized over its estimated useful life, but rather
is subject to at least an annual assessment for impairment. SFAS 142 also
requires that intangible assets with estimable useful lives be amortized
over their respective estimated useful lives to their estimated residual
values and reviewed for impairment in accordance with SFAS No. 144,
9
Notes to Condensed Consolidated Financial Statements
----------------------------------------------------
"Accounting for the Impairment or Disposal of Long-Lived Assets." Goodwill
has been allocated to the Company's two reportable segments. The test for
impairment is made on each of these reporting segments. No impairment of
goodwill has been incurred to date.
Reference is made to NOTE 16 - ACQUISITIONS, in the Company's Report to
Shareholders on Form 10K for the period ending December 31, 2006. A
third-party valuation of intangible assets was received relating to the
Company's acquisition of WRC Corporation. A portion of the goodwill was
allocated to intangible assets based on the value and nature of the
agreements and is being amortized accordingly over the term of the
agreements. During the three month period ending March 31, 2007, the
Company consulted with the third-party valuation provider and revised the
allocation to intangible assets resulting in approximately $669,000 being
re-allocated back to goodwill. This caused an additional $70,000 of
amortization of intangibles during 2006 than would have been recognized
given the final analysis of the WRC acquisition. The Company's amortization
of the affected intangible assets will be adjusted over the remaining five
year term of those assets and will not have a material effect on the
current or future period financial results.
NOTE 7 - LINE OF CREDIT AND DEBT
Effective March 30, 2007, the Company and Comerica Bank ("Comerica")
entered into an amendment to the Company's existing Credit Facility (the
"Comerica Credit Facility") whereby the limit on the revolving credit note
was increased from $30 million to $35 million, subject to loan covenant
restrictions. The maturity date of the Comerica Credit Facility will remain
at July 26, 2009. The loan agreement positions Comerica as senior to all
other debt and the Comerica Credit Facility is collateralized by
substantially all the assets of the Company. The outstanding balance on the
line of credit as of March 31, 2007 was $29.6 million. The remaining
borrowings available under the line of credit as of March 31, 2007 were
$5.4 million as loan covenant restrictions did not limit the available
borrowings.
The Comerica Credit Facility contains covenants requiring the Company, as
of the end of each calendar month, to maintain certain ratios, including
total funded debt to EBITDA; total funded debt to total liabilities, plus
net worth; and total funded debt to accounts/unbilled receivables. The
Company is also required, as of the end of each quarter, to maintain
minimum levels of net worth, plus the Company must comply with an annual
limitation on capital expenditures. The Company was in compliance with all
covenants under the Comerica Credit Facility as of March 31, 2007 and had
no standby letters of credit outstanding. Standby letters of credit
previously issued to a refining client expired in August 2006.
10
Notes to Condensed Consolidated Financial Statements
----------------------------------------------------
March 31, December 31,
2007 2006
--------------------
(in thousands)
--------------------
Schedule of Long-Term Debt:
Comerica Credit Facility - Line of credit, prime (8.25% at March 31, 2007),
maturing in July 2009 $ 29,616 $ 23,963
Sterling Planet and EDGI - Notes payable, interest at 5%, principal payments in
installments of $15,000 plus interest due quarterly, maturing in December 2008 105 120
Cleveland Inspection Services, Inc., CIS Technical Services and F.D. Curtis - Notes
payable, discounted at 5% interest, principal in installments of $100,000 due
quarterly, maturing in October 2009 1,023 1,109
InfoTech Engineering, Inc. - Note payable, interest at 5%, principal payments in
installments of $65,000 plus interest due annually, maturing in December 2007 75 75
A.T.I. Inc. - Note payable, interest at 6%, principal payments in installments of
$30,422 including interest due monthly, maturing in January 2009 632 713
Michael Lee - Note payable, interest at 5%, principal payments in installments of
$150,000 plus interest due quarterly, maturing in July 2010 1,950 2,100
Watco Management, Inc. - Note payable, interest at 4%, principal payments in
installments of $137,745 including interest annually, maturing in October 2010 500 500
Miscellaneous -- --
-------- --------
Total long-term debt 33,901 28,580
Less: Current maturities (1,427) (1,418)
-------- --------
Long-term debt, net of current portion $ 32,474 $ 27,162
======== ========
NOTE 8 - SEGMENT INFORMATION
The Company operates in two business segments: (1) engineering, providing
services primarily to major companies involved in the hydrocarbon and
chemical processing industries, pipelines, oil and gas development, and
cogeneration units that, for the most part, are located in the United
States; and (2) systems, providing design and implementation of control
systems for specific applications primarily in the energy and process
industries, and uninterruptible power systems and battery chargers to
customers that, for the most part, are located in the United States.
Revenue and operating income for each segment are set forth in the
following table. The amount under Corporate includes those activities that
are not allocated to the operating segments and include costs related to
business development, executive function, finance, accounting, investor
relations/governance, project controls, information technology, legal,
safety and human resources that are not specifically identifiable with the
two segments. Inter-company elimination includes the amount of
administrative costs allocated to the segments. Corporate functions support
both business segments and therefore cannot be specifically assigned to
either. Significant portions of Corporate cost are allocated to each
segment based on each segment's revenues and eliminated in consolidation.
11
Notes to Condensed Consolidated Financial Statements
----------------------------------------------------
Three Months Ended
March 31,
----------------------
2007 2006
-------- --------
(in thousands)
Revenue:
Engineering $ 76,149 $ 62,587
Systems 5,510 4,040
-------- --------
Total revenue $ 81,659 $ 66,627
======== ========
Operating income (loss):
Engineering $ 9,501 $ 4,890
Systems (180) (182)
Corporate 683 129
Inter-company eliminations (4,470) (2,716)
-------- --------
Total operating income $ 5,534 $ 2,121
======== ========
Financial information about geographic areas
--------------------------------------------
Revenue from the Company's non-U.S. operations is currently not material.
Long-lived assets (principally leasehold improvements and computer
equipment) outside the United States were $76,741 as of March 31, 2007, net
of accumulated depreciation.
NOTE 9 - FEDERAL INCOME TAXES
The components of income tax expense (benefit) for the periods ended March
31, 2007 and 2006 were as follows:
Three Months Ended
March 31,
----------------------
2007 2006
------- -------
(in thousands)
Current $ 1,820 $ 763
Deferred (39) (16)
------- -------
Total tax provision $ 1,781 $ 747
======= =======
12
Notes to Condensed Consolidated Financial Statements
----------------------------------------------------
NOTE 10 - EARNINGS PER SHARE
The following table reconciles the denominator used to compute basic
earnings per share to the denominator used to compute diluted earnings per
share ("EPS").
Three Months Ended
March 31,
---------------
2007 2006
------ ------
(in thousands)
Weighted average shares outstanding
(denominator used to compute basic EPS) 26,809 26,333
Effect of employee and outside director stock options 451 913
------ ------
Denominator used to compute diluted EPS 27,260 27,246
====== ======
NOTE 11 - CONTINGENCIES
Employment Agreements
The Company has employment agreements with certain of its executive
officers and certain other officers, the terms of which expire in January
2009. Such agreements provide for minimum salary levels. If the Company
terminates the employment of the employee for any reason other than 1)
termination for cause, 2) voluntary resignation, or 3) employee's death,
the Company is obligated to provide a severance benefit equal to six months
of the employee's salary, and, at its option, an additional six months at
50% to 100% of the employee's salary in exchange for an extension of the
non-compete. These agreements are renewable for one year at the Company's
option.
Litigation
From time to time, the Company is 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 $12.1 million in aggregate
in each policy year being covered by a separate insurance policy.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Forward-Looking Statements
--------------------------
Certain information contained in this Form 10-Q, the Company's Annual
Report on Form 10-K, as well as other written and oral statements made or
incorporated by reference from time to time by the Company and its
representatives in other reports, filings with the Securities and Exchange
Commission, press releases, conferences, or otherwise, may be deemed to be
forward-looking statements with the meaning of Section 21E of the
Securities Exchange Act of 1934. This information includes, without
limitation, statements concerning the Company's future financial position
and results of operations; planned capital expenditures; business strategy
and other plans for future operations; the future mix of revenues and
business; customer retention; project reversals; commitments and contingent
liabilities; and future demand and industry conditions. Although the
Company believes that the expectations reflected in such forward-looking
statements are reasonable, it can give no assurance that such expectations
will prove to have been correct. We undertake no obligation to publicly
update or revise any forward-looking statements, whether as a result of new
information, future events or otherwise. Generally, the words "anticipate,"
"believe," "estimate," "expect," "may," and similar expressions, identify
forward-looking statements, which generally are not historical in nature.
Actual results could differ materially from the results described in the
forward-looking statements due to the risks and uncertainties set forth in
this Form 10-Q, the specific risk factors identified in the Company's
Annual Report on Form 10-K for the year ended December 31, 2006 and those
described from time to time in our future reports filed with the Securities
and Exchange Commission.
The following discussion is qualified in its entirety by, and should be
read in conjunction with, the Company's Consolidated Financial Statements,
including the notes thereto, included in this Form 10-Q and the Company's
Annual Report on Form 10-K for the year ended December 31, 2006.
MD&A Overview
-------------
The following list sets forth a general overview of the more significant
changes in the Company's financial condition and results of operations for
the three month period ended March 31, 2007, compared to the corresponding
period in 2006.
During the three month period
ended March 31, 2007
-----------------------------
Revenue Increased 23%
Gross profit Increased 62%
Operating income Increased 161%
SG&A expense Increased 27%
Net income Increased 156%
Long-term debt, net of current portion, increased 19.6%, or $5.3 million,
from $27.2 million at December 31, 2006 to $32.5 million at March 31, 2007,
and as a percentage of stockholders' equity, long-term debt increased to
73.3% from 66.5% at these same dates. The primary reason for the increase
in long-term debt is the timing difference related to meeting short-term
bi-weekly payroll obligations from our growth and longer collection periods
on receipts from our clients. On average, our accounts receivable days
outstanding has increased to 71 days for the three month period ended March
31, 2007, from 66 days for the comparable period in 2006. The Company
continues to work toward improving billing and collection processes.
Total stockholders' equity increased 8.5%, or $3.4 million, from $40.9
million as of December 31, 2006 to $44.3 million as of March 31, 2007.
14
MD&A/Results of Operations (continued)
--------------------------------------
Consolidated Results of Operations for the Three Months
Ended March 31, 2007 and 2006
(Unaudited)
Three Months Ended
March 31,
---------------------------------------------
2007 2006
---------------------------------------------
(In thousands)
---------------------------------------------
Revenue:
Engineering $ 69,262 84.8 % $ 62,587 93.9 %
Systems 5,510 6.8 % 4,040 6.1 %
Acquisition 6,887 8.4 % - - %
------------ ------------
Total revenue $ 81,659 100.0 % $ 66,627 100.0 %
============ ============
Gross profit:
Engineering $ 11,779 17.0 % $ 7,796 12.5 %
Systems 249 4.5 % 426 10.6 %
Acquisition 1,250 18.2 % - - %
------------ ------------
Total gross profit 13,278 16.3 % 8,222 12.3 %
------------ ------------
SG&A expense:
Engineering 2,946 4.3 % 2,906 4.6 %
Systems 429 7.8 % 608 15.1 %
Corporate 3,787 4.6 % 2,587 3.9 %
Acquisition 582 8.5 % - - %
------------ ------------
Total SG&A expense 7,744 9.5 % 6,101 9.2 %
------------ ------------
Operating income:
Engineering 8,832 12.8 % 4,890 7.8 %
Systems (180) (3.3)% (182) (4.5)%
Corporate (3,787) (4.6)% (2,587) (3.9)%
Acquisition 669 9.7 % - - %
------------ ------------
Total operating income 5,534 6.8 % 2,121 3.2 %
------------ ------------
Other income (expense), net (560) (0.7)% (140) (0.2)%
Tax provision (1,820) (2.2)% (747) (1.1)%
------------ ------------
Net income $ 3,154 3.9 % $ 1,234 1.9 %
============ ============
Other financial comparisons:
----------------------------
March 31, March 31,
2007 2006
-------------------
(In thousands)
-------------------
Working capital $ 44,215 $ 26,062
Total assets $111,201 $ 80,474
Long-term debt, net of current portion $ 32,474 $ 9,910
Stockholders' equity $ 44,321 $ 41,314
15
MD&A/Results of Operations (continued)
--------------------------------------
We recorded net income of $3.2 million, or $0.12 per diluted share for the
three months ended March 31, 2007, compared to net income of $1.2 million,
or $0.05 per diluted share for the corresponding period last year.
The following table presents, for the periods indicated, the approximate
percentage of total revenues and operating income or loss attributable to
our reportable segments:
Three Months Ended
March 31,
2007 2006
------ ------
Revenue:
Engineering 93.2 % 93.9 %
Systems 6.8 % 6.1 %
Operating income (loss):
Engineering 12.5 % 7.8 %
Systems (3.3)% (4.5)%
The Company's revenue is composed of engineering, construction and
procurement service revenue, systems, land/management and related 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.
However, our engineering segment recognized approximately $3.8 million in
fixed-price revenue in the three month period ended March 31, 2007,
compared to less than $4.7 million of similar revenue in the same period in
2006. Of the fixed price revenue, $1.8 million and $2.7 million for the
three month period ending March 31, 2007 and March 31, 2006, respectively,
were related to the two projects with recorded losses during 2006.
Revenue is recorded primarily using the percentage-of-completion
(cost-to-cost) method. Under this method, revenue on long-term contracts is
recognized in the ratio that contract costs incurred bear to total
estimated contract costs. Revenue and gross margin on contracts are subject
to revision throughout the lives of the contracts and any required
adjustments are made in the period in which the revisions become known.
Losses on contracts are recorded in full as they are identified.
In the course of providing our 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 segregate from our total revenue the
revenues derived from material assets or companies acquired during the
first 12 months following their respective dates of acquisition and refer
to such revenue as "Acquisition" revenue. We also segregate gross profits
and SG&A expenses derived from material assets or company acquisitions on
the same basis as we segregate revenues.
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, investor relations/governance, finance,
accounting, safety, human resources, project controls, legal and
information technology departments and other costs generally unrelated to
specific client projects, but which are incurred to support corporate
activities and initiatives.
16
MD&A/Results of Operations (continued)
--------------------------------------
Industry Overview:
Many ENGlobal offices have benefited from the strong refinery market. We
expect significant capital projects to be generated by refinery operations
over the next several years and we will continue to research other markets
that value our services. Overall, projects related to refining capacity and
environmental mandates have trended upward. Given that global demand for
oil products has tightened the supply of both crude oil as well as refinery
products, we believe each of ENGlobal's business segments is well
positioned within the industry should refinery capacity be added in the
United States of America and the overseas markets continue to rise.
The petrochemical industry has recently been a good source of projects for
ENGlobal. We have seen an increase in both maintenance and capital spending
after several years of relative inactivity. The petrochemical industry
along the Gulf Coast continues to struggle with the aftermath of Hurricane
Katrina and Hurricane Rita. Although it will take several years to rebuild,
we expect that we will assist our clients with repairs to regional
petrochemical facilities in order to resolve current supply limitations.
Despite past downturns in the industry, pipeline projects have remained
constant for the most part, and we have recently seen an increase in
project activity. Pipeline projects tend to require less engineering man
hours as the scope of engineering work is typically smaller than for
similar sized downstream projects. In addition, the project awards in the
pipeline segment are smaller in nature than those in other industries.
Revenue:
Revenue increased $15.0 million, or 22.5%, to $81.7 million for the three
months ended March 31, 2007 from $66.7 million for the comparable prior
year period with approximately $6.6 million of the increase coming from our
engineering segment, $6.9 million attributable to the acquisition of WRC,
and $1.5 attributable to our systems segment. This is discussed further in
our segment information.
Gross Profit:
Gross profit increased $5.1 million, or 62.0%, to $13.3 million for the
three months ended March 31, 2007 from $8.2 million for the comparable
prior year period. As a percentage of revenue, gross profit increased 4.0%
from 12.3% for the three months ended March 31, 2006 to 16.3% for the
quarter ended March 31, 2007. Of the overall $5.1 million increase in gross
profit, approximately $1.9 million was primarily due to the $15.0 million
increase in revenue plus approximately $3.2 million in equivalent lower
costs.
Selling, General, and Administrative:
As a percentage of revenue, SG&A expense remained relatively level
increasing 0.3% to 9.5% for the three months ended March 31, 2007 from 9.2%
for the comparable period in 2006. Total expense for SG&A increased $1.6
million, or 26.2%, to $7.7 million for the three months ended March 31,
2007 from $6.1 million for the comparable prior year period.
As a percentage of revenue, Corporate SG&A expense increased 0.7% to 4.6%
for the three months ended March 31, 2007 from 3.9% for the comparable
prior year period. Corporate SG&A expense increased approximately $1.2
million, or 46.4%, to $3.8 million for the three months ended March 31,
2007 from $2.6 million for the comparable prior year period. The increase
over prior year in Corporate SG&A was related to $243,000 in costs incurred
on the continuing preparation and review related to SOX compliance;
$264,000 in accrued management incentives; $148,000 related to increased
stock compensation expense; $244,000 related to additional salaries and
related expenses for business development; $200,000 related to the new
Corporate Services and Legal departments and $149,000 for increases in cost
for other support services. The increase in business development costs was
due to a change in reporting of our systems' sales personnel from
operations to corporate, and the addition of personnel to support our
growth, including the WRC acquisition.
Operating Income:
Operating income increased approximately $3.4 million, or 160.3%, to $5.5
million for the three months ended March 31, 2007 from $2.1 million
compared to the same period in 2006. As a percentage of revenue, operating
income increased 3.6% to 6.8% for the three months ended March 31, 2007
from 3.2% for the comparable prior year period.
17
MD&A/Results of Operations (continued)
--------------------------------------
Other Expense, net:
Other expense increased $ 420,000, to $560,000 for the three month period
ended March 31, 2007 from $140,000 for the comparable prior year period,
primarily due to higher net interest expense related to an increased
outstanding balance on our line of credit.
Tax Provision:
Income tax expense increased $1.1 million, or 143.6%, to $1.8 million for
the three months ended March 31, 2007 from $0.7 million for the comparable
prior year period. The estimated effective tax rate was 36.6% for the
three-month period ended March 31, 2007 compared to 37.7% for the
comparable prior year period. The change in the effective tax rate is the
result of utilization of net operating loss for the 2006 year.
The estimated effective tax rates are based on estimates using historical
rates adjusted by recurring and non-recurring book to tax differences.
Estimates at March 31, 2006 included the effect of non-recurring
differences in tax estimates from the 2005 year-end. Estimates at March 31,
2007 are based on results of the 2006 year-end and adjusted for estimates
of non-recurring differences from the prior year, as well as anticipated
book to tax differences for 2007.
Net Income:
Net income for the three months ended March 31, 2007 increased $2.0
million, or 166.7%, to $3.2 million from $1.2 for the comparable prior year
period. As a percentage of revenue, net income increased 2.0% to 3.9% for
the three month period ended March 31, 2007 from 1.9% for the period ended
March 31, 2006.
Liquidity and Capital Resources
-------------------------------
Historically, cash requirements have been satisfied through operations and
borrowings under a revolving line of credit, which is currently in effect
with Comerica Bank (the "Comerica Credit Facility"). As of March 31, 2007,
we had working capital of $44.2 million. Long-term debt, net of current
portion, was $32.5 million as of March 31, 2007, including $29.6 million
outstanding under the Comerica Credit Facility.
The Comerica Credit Facility is senior to all other debt, and the line of
credit is limited to $35.0 million, after consideration of loan covenant
restrictions.. The Comerica Credit Facility is collateralized by
substantially all of the assets of the Company. The Comerica Credit
Facility contains covenants requiring the Company, as of the end of each
calendar month, to maintain certain ratios, including total funded debt to
EBITDA; total funded debt to total liabilities, plus net worth; and total
funded debt to accounts/unbilled receivables. The Company is also required,
as of the end of the most recent quarter then ended, to maintain minimum
levels of net worth, and must comply with an annual limitation on capital
expenditures. The Company is currently in compliance with all loan
covenants, although no assurances can be given regarding such compliance in
the future. We are not currently subject to any obligations under standby
letters of credit, guarantees, repurchase obligations or other commitments.
We have no off-balance sheet arrangements.
As of March 31, 2007, management believes the Company's cash position is
sufficient to meet its working capital requirements. Any future decrease in
demand for the Company's services or products would reduce the availability
of funds through operations.
Cash Flow
---------
The Company believes that it has available the necessary cash required for
operations for the next 12 months. Cash and the availability of cash could
be materially restricted if circumstances prevent the timely internal
processing of invoices, if amounts billed are not collected, if project mix
shifts from cost reimbursable to fixed cost contracts during significant
periods of growth, if the Company was to lose one or more of its major
customers, or if the Company is not able to meet the covenants of the
Comerica Credit Facility. If any such event occurs, the Company would be
forced to consider alternative financing options.
Operating activities:
Net cash used in operating activities was $4.9 million for the three-month
period ended March 31, 2007, compared with net cash used of $3.2 million in
the same period in 2006. Changes in working capital due to the timing of
18
MD&A/Results of Operations (continued)
--------------------------------------
collections of trade receivables and payments for trade payables and
accruals, contributed to the negative cash flows from operations in the
first quarter of 2007. During the quarter, the line of credit increased
from $24.0 million as of December 31, 2006 to $29.6 million as of March 31,
2007.
Our average days sales outstanding ("DSO") was 71 days for the three month
period ended March 31, 2007 compared to 66 days for the comparable period
in 2006 and 69 days for the period ended December 31, 2006. We have revised
the method used for calculating DOS changing from annualized average
revenue and accounts receivable totals to quarterly revenue and accounts
receivable balances. The average DSO for all periods referenced herein and
for all future periods have been and will be calculated under the new
method.
The primary factors impacting the increase in our need for cash and the
increases in average DSO during the three month period ending March 31,
2007 were:
1) a decrease in accounts payable of approximately $4 million
primarily related to contractor payments on the two fixed-price
EPC projects;
2) an increase in accounts receivable of approximately $4 million
primarily due to delays in processing billings within the
Engineering segment, particularly in getting the WRC acquisition
billings current following its conversion to the ENGlobal
financial accounting system on December 31, 2006; and
3) an increase in costs and estimated earnings-in-excess of billings
from approximately $5.4 million as of December 31, 2006 to $8.1
million for the three month period ended March 30, 2007 primarily
related to extended payment terms and milestones on fixed price
contracts within our Systems segment.
Accounts payable are not expected to materially impact cash during the
second quarter as the two fixed-price EPC projects are scheduled to be
completed during that period with final billings and retention collections
expected to have a positive cash impact. Also, the Company expects to have
Engineering segment billings current before the end of the three month
period ending June 30, 2007.
A continued increase in costs and estimated earnings-in-excess of billings
is not expected during the second quarter even though improvements can only
be made with more favorable contractual terms.
Investing activities:
Net cash used in investing activities was $429,000 for the three-month
period ended March 31, 2007, compared with net cash provided of $1.3
million in the same period in 2006. In the first quarter of 2006, the
Company acquired the assets of ATI, Inc. for $750,000 cash and a note
payable. The Company also used cash for capital expenditures in the first
three months of 2007 and 2006.
Financing activities:
Net cash provided by financing activities was $4.9 million for the
three-month period ended March 31, 2007, compared with net cash provided of
$4.3 million in the same period in 2006. In the first quarter of 2007, the
Company increased its outstanding line of credit by $5.7 million for
working capital needs compared to an increase in the outstanding line of
credit of $4.3 million in the same period in 2006.
Asset Management
----------------
The Company's cash flow from operations has been affected primarily by the
timing of its collection of trade accounts receivable. The Company
typically sells its products and services on short-term credit terms and
seeks to minimize its credit risk by performing credit checks and
conducting its own collection efforts. The Company had net trade accounts
receivable of $64.1 million and $60.2 million at March 31, 2007 and
December 31, 2006, respectively. The number of days sales outstanding in
trade accounts receivables was 71 days and 69 days at March 31, 2007 and
December 31, 2006, respectively.
19
Engineering Segment Results
---------------------------
Three Months Ended
March 31,
-------------------------------------------------
2007 2006
-------------------------------------------------
(In thousands)
-------------------------------------------------
Revenue:
Engineering $ 69,262 91.0 % $ 62,587 100.0 %
Acquisition 6,887 9.0 % - - %
------------- ------------
Total revenue $ 76,149 100.0 % $ 62,587 100.0 %
============= ============
Gross profit:
Engineering $ 11,779 17.0 % $ 7,796 12.5 %
Acquisition 1,250 18.2 % - - %
------------- ------------
Total gross profit 13,029 17.1 % 7,796 12.5 %
------------- ------------
Operating SG&A expense:
Engineering 2,946 4.3 % 2,906 4.6 %
Acquisition 582 8.5 % - - %
------------- ------------
Total SG&A expense 3,528 4.6 % 2,906 4.6 %
------------- ------------
Operating income:
Engineering 8,832 12.8 % 4,890 7.8 %
Acquisition 669 9.7 % - - %
------------- ------------
Total operating income $ 9,501 12.5 % $ 4,890 7.8 %
------------- ------------
Overview of Engineering Segment:
Our engineering segment continues to benefit from a large project load
generated primarily by its downstream clients and to a lesser extent by its
midstream clients. The industry's refining segment continues to be very
active, supplying a large percentage of the Company's backlog. ENGlobal is
benefiting from the renewed interest of its chemical/petrochemical clients
in maintenance and retrofit projects as product margins in this marketplace
improve.
Acquisition totals for the three months ended March 31, 2007 are from the
results of operations related to the acquisition of WRC Corporation. There
were no acquisition totals for the engineering segment for the three months
ended March 31, 2006, as all previous acquisitions had been fully
integrated.
20
Engineering Segment Results (continued)
---------------------------------------
Revenue:
Revenue increased $13.5 million, or 21.6%, to $76.1 million for the three
months ended March 31, 2007 from $62.6 million for the comparable prior
year period. The following table illustrates the composition of the
Company's revenue mix quarter over quarter for the three month periods
ended March 31, 2007 and 2006, and provides a comparison of the changes in
revenue (in thousands) and revenue trends period over period:
2007 % rev 2006 % rev $ change % change
------ ------ ------ ------ -------- --------
Detail-design 35.8 47% 27.6 44% 8.2 30%
Field services & inspection 35.2 46% 19.6 31% 15.6 80%
Procurement & construction 1.3 2% 10.6 17% (9.3) (88)%
Design-build fixed price 3.8 5% 4.7 8% (.9) (19)%
------ ------ ------ ------ ------- -------
76.1 100% 62.5 100% 13.6 22%
The increase in engineering revenue was primarily brought about by
increased activity in the engineering and construction markets. Refining
related activity has been particularly strong, including projects to
satisfy environmental mandates, expand existing facilities and utilize
heavier sour crude. Capital spending in the pipeline area is also trending
higher, with numerous projects in North America currently underway to
deliver crude oil, natural gas, petrochemicals and refined products.
Renewable energy appears to be an emerging area of activity and potential
growth, with the Company currently performing a variety of services for
ethanol, biodiesel, coal to liquids, petroleum coke to ammonia, and other
biomass processes. The acquisition of WRC in May 2006, together with our
clients' increased demand for in-plant and inspection resources, stimulated
growth in our staffing services division.
The largest increase in revenue came from field services and inspection
activity that increased $15.6 million, or approximately 80%, to $35.2
million for the first quarter of 2007 from $19.6 million for the comparable
period in 2006. Approximately $6.9 million of the increase in field
services revenue is directly related to the acquisition of WRC in May of
2006 which provides integrated land management, engineering, and related
services (Reference is made to NOTE 16 - ACQUISITIONS, in the Company's
Report to Shareholders on Form 10K for the period ending December 31,
2006).
On a combined basis, with the increase in detail-design services of $8.2
million, or approximately 30%, our core engineering segment's activities
accounted for approximately 93% of engineering's total revenue mix during
the three month period ended March 31, 2007 compared to approximately 75%
for the comparable period of 2006.
Revenue from non-labor procurement and construction activity decreased $9.3
million from $10.6 million during the three months ended March 31, 2006 to
$1.3 million for the first quarter of 2007.
The design-build fixed price revenue decreased approximately $900,000, or
(19)%, from $4.7 million for the three month period ended March 31, 2006 to
$3.8 million for the same period in 2007 and accounted for approximately 5%
of engineering's total revenue. If the revenue from the two fixed-price EPC
projects that recorded losses in 2006, which totaled $1.8 and $2.7 million
during the three month periods ending March 31, 2007 and March 31, 2006,
respectively, were eliminated for comparison purposes, fixed price revenue
would have remained the same at $2.0 million for the comparable periods,
but would have decreased as a percentage of revenue by 0.5% from 3.2% in
2006 to 2.7% in 2007. Approximately $900,000 of the total fixed-price
revenue during the three month period ending March 31, 2007 came from one
fixed-price, engineering-only project with a contract value of
approximately $6.9 million, but also includes reimbursable material and
construction costs estimated to be approximately $34 million. The project
is scheduled to be completed during the first quarter of 2008.
Gross Profit:
Gross profit increased $5.2 million, or 66.7%, to $13.0 million for the
three months ended March 31, 2007 from $7.8 million for the comparable
period in 2006. As a percentage of revenue, gross profit increased by 4.6%
to 17.1% from 12.5% for the three-month periods ended March 31, 2007 and
2006, respectively. Of the overall $5.2 million increase in gross profit,
approximately $1.7 million was attributable to the $13.5 million increase
in total revenue, plus approximately $3.5 million in improved margins. The
increase in margins can be attributed to the reduced activity in low
margin/high dollar procurement projects being replaced with higher margin
core revenue derived from labor activity.
21
Engineering Segment Results (continued)
---------------------------------------
At March 31, 2007, we had outstanding unapproved change orders/claims of
approximately $17.4 million, net of reserves of $1.2 million associated
with ongoing fixed-price EPC projects. If in the future we determine
collection of the unapproved change orders/claims is not probable, it will
result in a charge to earnings in the period such determination is made for
the reserves of $1.2 million.
Selling, General, and Administrative:
As a percentage of revenue, SG&A expense was 4.6% for both the three-month
periods ended March 31, 2007 and March 31, 2006. SG&A expense increased
$0.6 million, or 20.6%, to $3.5 million for the three months ended March
31, 2007 from $2.9 million for the comparable prior year period. The
increase in SG&A expense included $68,000 attributable to the support of
expanded facilities and supplies as offices in Tulsa, Houston, and Beaumont
were expanded to meet both current and projected growth requirements.
Additional increases came from salaries, burdens and benefits of $194,000,
amortization and depreciation expense of $169,000 primarily related to
amortization of intangible assets from the acquisition of WRC (reference is
made to NOTE 5 - GOODWILL, page 9), and $69,000 in other charges. An
additional bad debt expense of $135,000 was also recorded during the period
to increase the allowance for doubtful accounts primarily related to
changes in client mix.
Operating Income:
Operating income increased $4.6 million, or 94.1%, to $9.5 million for the
three months ended March 31, 2007 from $4.9 million for the comparable
prior year period. As a percentage of revenue, operating income increased
to 12.5% for the three months ended March 31, 2007 from 7.8% for the
comparable prior year period.
22
Systems Segment Results
-----------------------
Three Months Ended
March 31,
-------------------------------------------
2007 2006
--------------------- --------------------
(In thousands)
-------------------------------------------
$ 5,510 100.0 % $ 4,040 100.0 %
Revenue:
=========== ===========
Gross profit: $ 249 4.5 % $ 426 10.6 %
----------- -----------
Operating SG&A expense: 429 7.8 % 608 15.1 %
----------- -----------
Operating income: (180) (3.3)% (182) (4.5)%
=========== ===========
Overview of Systems Segment:
The systems segment began a detailed review process in the fourth quarter
of 2006. Continuing on this trend of self-improvement in the first quarter
of 2007, project cost control/forecasting was initiated on all active lump
sum projects in order to identify potential areas of remediation and
improve financial results. Going into 2007, the systems segment had record
backlog of $17.7 million with several large projects being booked in April.
In addition, the systems segment is planning to reduce overhead costs to
drive efficiency and profitability upwards.
Revenue:
Revenue increased approximately $1.5 million, or 37.1%, to $5.5 million for
the three month period ended March 31, 2007 from $4.0 million for the
comparable prior year period.
A general turnaround in the oil and gas industry, together with the
acquisition of Analyzer Technology International, Inc. ("ATI") in January
2006 has increased the demand for systems services. Another factor
positively affecting systems business is that the computer-based
distributed control systems equipment used for facility plant automation
becomes technologically obsolete over time, which supports ongoing
replacement of these systems.
Gross profit:
Gross profit decreased approximately $177,000, or 41.5%, to $249,000 for
the three months ended March 31, 2007 from $426,000 for the comparable
prior year period and, as a percentage of revenue, gross profit decreased
to 4.5% from 10.6% for the respective periods. The decrease in gross profit
was attributable to lower margins of fixed price work accounting for 3% of
the margin changes. The remainder was increased variable costs associated
with labor to perform proposals and increased project management.
Selling, General, and Administrative:
SG&A expense decreased approximately $179,000, or 29.4%, to $429,000 for
the three months ended March 31, 2007 from $608,000 for the same period in
2006 and, as a percentage of revenue, SG&A expense decreased to 7.8% from
15.0% for the respective periods. Salaries and related expenses decreased
by $288,000 due to the fact the expenses of four sales persons were moved
to Corporate SG&A from Operations; some salaries were moved to direct costs
variable; and the Company's personnel decreased. Amortization expense
increased by $138,000 in relation to the non-compete intangible that was
created with the purchase price analysis related to the ATI acquisition.
Facilities and related expenses decreased by $27,000 as a result of moving
the office for the ATI acquisition into the existing Systems office.
Operating Income:
The systems segment recorded an operating loss of $180,000 for the three
months ended March 31, 2007 compared to an operating loss of $182,000 for
the three month period ended March 31, 2006.
23
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our financial instruments include cash and cash equivalents, accounts
receivable, accounts payable, notes and capital leases payable, and debt
obligations. The book value of cash and cash equivalents, accounts
receivable, accounts payable and short-term notes payable are considered to
be representative of fair value because of the short maturity of these
instruments.
We do not utilize financial instruments for trading purposes and we do not
hold any derivative financial instruments that could expose us to
significant market risk. In the normal course of business, our results of
operations are exposed to risks associated with fluctuations in interest
rates and currency exchange rates.
Our exposure to market risk for changes in interest rates relates primarily
to our obligations under the Comerica Credit Facility. As of March 31,
2007, $29.6 million had been borrowed under the Credit Facility, accruing
interest at 8.25% per year, excluding amortization of prepaid financing
costs. A 10% increase in the short-term borrowing rates on the Credit
Facility outstanding as of March 31, 2007 would be 83 basis points. Such an
increase in interest rates would increase our annual interest expense by
approximately $244,000, assuming the amount of debt outstanding remains
constant.
In general, our exposure to fluctuating exchange rates relates to the
effects of translating the financial statements of our Canadian subsidiary
from the Canadian dollar to the U.S. dollar. We follow the provisions of
SFAS No. 52 - "Foreign Currency Translation" in preparing our consolidated
financial statements. Currently, we do not engage in foreign currency
hedging activities.
ITEM 4. CONTROLS AND PROCEDURES
a. Evaluation of Disclosure Controls and Procedures
Our management is responsible for establishing and maintaining our
disclosure controls and procedures. As of March 31, 2007, we carried out an
evaluation, under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of our disclosure
controls and procedures or "disclosure controls." Disclosure controls are
controls and procedures designed to ensure that information required to be
disclosed in our reports filed under the Securities Exchange Act of 1934 is
properly recorded, processed, summarized, and reported within the time
periods specified in the U.S. Securities and Exchange Commission's rules
and forms. Disclosure controls include processes to accumulate and evaluate
relevant information and communicate such information to management,
including the CEO and CFO, as appropriate to allow timely decisions
regarding required disclosure. In designing and evaluating the disclosure
controls and procedures, management recognizes that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and
management is required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures.
Based on the controls evaluation, our CEO and CFO have concluded that, as a
result of the matters discussed below with respect to our internal control
over financial reporting, our disclosure controls as of March 31, 2007,
were not effective.
A material weakness in internal control over financial reporting is a
significant deficiency, or combination of significant deficiencies, that
results in more than a remote likelihood that a material misstatement of
the annual or interim financial statements will not be prevented or
detected. Management's assessment identified the following material
weaknesses in our internal control over financial reporting as of December
31, 2006, which remained outstanding as of March 31, 2007:
o 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.
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o Deficiencies in the Company's Information Technology Access Controls.
We did not maintain effective controls over preventing access by
unauthorized personnel to end-user spreadsheets and other information
technology programs and systems.
o Deficiencies in the Company's Accounting System Controls. We did not
effectively and accurately close the general ledger in a timely manner
and we did not provide complete and accurate disclosure in our notes
to financial statements, as required by generally accepted accounting
principles.
o Deficiencies in the Company's Controls Regarding Purchases and
Expenditures. We did not maintain effective controls over the tracking
of our commitments and actual expenditures with third-party
subsidiaries on a timely basis.
o Deficiencies in the Company's Controls Regarding Fixed-Price Contract
Information. We did not maintain effective controls over the complete,
accurate, and timely processing of information relating to the
estimated cost of fixed-price contracts.
o Deficiencies in the Company's Revenue Recognition Controls. We did not
maintain effective policies and procedures relating to revenue
recognition of fixed price contracts, which accounted for
approximately 11% of the Company's revenues in 2006.
o Deficiencies in the Company's Controls over Income Taxes. We did not
maintain sufficient internal controls to ensure that amounts provided
for in our financial statements for income taxes accurately reflected
our income tax position as of December 31, 2006.
o Management assessed the effectiveness of our internal control over
financial reporting as of December 31, 2006, 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
was 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 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.
Except as noted below under the heading "Remediation Initiatives," 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
quarter ended March 31, 2007, that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
b. Remediation Initiatives
Management, with oversight from the Audit Committee of the Board of
Directors, has been addressing the material weakness disclosed in its 2006
Annual Report on Form 10-K and is committed to effectively remediating
known weaknesses as expeditiously as possible. Due to the fact that these
remedial steps have not been completed, the Company performed additional
analysis and procedures in order to ensure that the consolidated financial
statements contained in this Form 10-Q were prepared in accordance with
generally accepted accounting principles in the United States of America.
Although the Company's remediation efforts are well underway, control
weaknesses will not be considered remediated until new internal controls
over financial reporting are implemented and operational for a sufficient
period of time to allow for effective testing and are tested, and
management and its independent registered certified public accounting firm
conclude that these controls are operating effectively. Management and the
Audit Committee of the Company's Board of Directors have begun working with
the Company's auditors to determine the most effective way to implement the
remedial measures listed below, and, if necessary, to develop additional
remedial measures to address the internal control deficiencies identified
25
above. The Company will monitor the effectiveness of planned actions and
will make any other changes and take such other actions as management or
the Audit Committee determines to be appropriate. The Company's remediation
plans include:
o We plan to hire additional personnel to assist us with documenting and
communicating our accounting policies and procedures to ensure the
proper and consistent application of those policies and procedures
throughout the Company. Recruitment for this position(s) has begun and
the selection process is expected to be completed during the second
quarter of 2007.
o We plan to implement formal processes requiring periodic
self-assessments, independent tests, and reporting of our personnel's
adherence to our accounting policies and procedures.
o We plan to design effective policies and procedures to control
security of and access to spreadsheet information. If necessary, we
will also consider implementing a software solution with automatic
control checkpoints for day-to-day business processes.
o We plan to (i) require additional training for our current accounting
personnel; (ii) to hire additional accounting personnel to enable the
allocation of job functions among a larger group of accounting staff;
(iii) to engage outside consultants with technical accounting
expertise, as needed; and (iv) to consider restructuring our
accounting department, each to increase the likelihood that our
accounting personnel will have the resources, experience, skills, and
knowledge necessary to effectively perform the accounting system
functions assigned to them. The Company currently has three days of
in-house training scheduled for the accounting staff at the end of May
2007, to improve our accounting functions as we prepare to report the
second quarter, as well as to improve the remainder of the year.
o We plan to improve procurement and operational efficiencies by
implementing a software system and a matrix organization to more
completely, accurately, and timely track commitments on Company-wide
purchase and expenditure transactions.
o We plan to improve revenue recognition policies and procedures
relating to fixed-price contracts by evaluating the level of economic
success achieved by past fixed-price contracts and by stressing
throughout the Company the importance of (i) accurately estimating
costs, (ii) timely updating cost estimates to reflect the accuracy of
the cost savings, (iii) accurately estimating expected profit, (iv)
timely identifying when a project's scope changes, (v) promptly
reporting man hours and costs in excess of those originally estimated;
and (vi) closely scrutinizing the bid process.
o We plan to train personnel to effectively implement and evaluate the
overall design of the Company's fixed-price project control processes.
Specifically, we plan to enhance and tighten controls as they relate
to the initial bid process and the attendant recognition and
management of risk by only bidding on large procurement and
construction activities on a cost plus basis.
Management recognizes that many of these enhancements require continual
monitoring and evaluation for effectiveness. The development of these
actions is an iterative process and will evolve as the Company continues to
evaluate and improve our internal controls over financial reporting.
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.
During the second quarter, the Company will begin its 2007 internal
controls audit and the Investor Relations/Governance department expects to
hire a third-party consultant to oversee the testing of its internal
financial and information technology controls. A quarterly review by
consultants will assist the Company and its independent auditors in
preparing for the final assessment in September 2007, allowing for any
remediation by December 31, 2007.
26
PART II. - OTHER INFORMATION
----------------------------
ITEM 1. LEGAL PROCEEDINGS
From time to time, the Company and its subsidiaries become parties to
various legal proceedings arising in the ordinary course of normal business
activities. While we cannot predict the outcome of these proceedings, in
our opinion and based on reports of counsel, any liability arising from
such matters, individually or in the aggregate, is not expected to have a
material effect upon the consolidated financial position or operations of
the Company.
ITEM 1A. RISK FACTORS
In addition to the other information set forth in this report, you should
carefully consider the factors discussed in Part I, "Item 1A. Risk Factors"
in our Annual Report on Form 10-K for the year ended December 31, 2006,
which could materially affect our business, financial condition or future
results. The risks described in our Annual Report on Form 10-K are not the
only risks facing our Company. Additional risks and uncertainties not
currently known to us or that we currently deem to be immaterial also may
materially adversely affect our business, financial conditions or operating
results.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
10.1 Seventh Amendment to Credit Agreement by and among Comerica Bank
and ENGlobal Corporation and its subsidiaries dated April 18,
2007, effective retroactive to March 30, 2007.
31.1 Certifications Pursuant to Rule 13a - 14(a) of the Exchange Act
of 2002 for the First Quarter 2007
31.2 Certifications Pursuant to Rule 13a - 14(a) of the Exchange Act
of 2002 for the First Quarter 2007
32 Certification Pursuant to Rule 13a - 14(b) of the Exchange Act
and 18U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 for the First Quarter 2007
27
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
ENGlobal Corporation
Dated: May 9, 2007
By: /s/ Robert W. Raiford
-------------------------
Robert W. Raiford
Chief Financial Officer and Treasurer
28