UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 2007
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
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(Exact name of registrant as specified in its charter)
Nevada 88-0322261
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(State or other jurisdiction of (I.R.S Employer Identification No.)
incorporation or organization)
654 North Sam Houston Parkway East, Suite 400 77060-5914
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(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
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Common Stock, $0.001 par value NASDAQ
Securities registered pursuant to Section 12(g) of the Exchange Act:
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None
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act
Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15 (d) of the Act
Yes [ ] No [X]
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shortened period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
[X]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of "large accelerated filer," "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ] Accelerated filer [X]
Non-accelerated filer [ ] Smaller reporting company [ ]
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act)
Yes [ ] No [X]
1
The aggregate market value of the registrant's common stock held by
non-affiliates of the registrant on June 30, 2007 was $326,924,120 (based upon
the closing price for shares of common stock as reported by the NASDAQ on that
date).
The number of shares outstanding of the registrant's common stock on March 27,
2008 is as follows:
$0.001 Par Value Common Stock 27,063,541 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 2008 Annual Meeting of Stockholders
to be filed with the Securities and Exchange Commission on or before April 29,
2008.
2
ENGlobal Corporation
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2007 ANNUAL REPORT ON FORM 10-K
-------------------------------
TABLE OF CONTENTS
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PART I
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PAGE
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ITEM 1. BUSINESS 5
ITEM 1A. RISK FACTORS 21
ITEM 1B. UNRESOLVED STAFF COMMENTS 27
ITEM 2. PROPERTIES 27
ITEM 3. LEGAL PROCEEDINGS 28
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 28
PART II
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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES 29
ITEM 6. SELECTED FINANCIAL DATA 32
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 35
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 55
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 55
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE 96
ITEM 9A. CONTROLS AND PROCEDURES 96
PART III
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ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 102
ITEM 11. EXECUTIVE COMPENSATION 102
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS 102
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 102
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES 102
PART IV
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ITEM 15. EXHIBITS, FINANCIAL STATEMENTS AND SCHEDULES 103
SIGNATURES
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SIGNATURES 107
3
PART I
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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 and professional service 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 our operations; (xi) our ability to hire and retain
qualified personnel; (xii) our ability to retain existing customers and get new
customers; (xiii) the effect of changes in the business cycle and downturns in
local, regional and national economies; (xiv) our ability to mitigate losses;
(xv) our ability to achieve our business strategy while effectively managing
costs and expenses; (xvi) our ability to estimate exact project completion
dates; and (xvii) the continued strong performance of the energy sector. 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
Overview
--------
ENGlobal Corporation (which may be referred to as "ENGlobal," the "Company,"
"we," "us" or "our"), incorporated in the State of Nevada in June 1994, is a
leading provider of engineering and professional services principally to the
energy sector. ENGlobal's net revenue from continuous operations has grown from
$89.1 million in 2002 to $363.2 million in 2007, a compounded annual growth rate
of approximately 32.5%. We have accomplished this growth by expanding our
engineering and professional service capabilities and also our geographic
presence through internal growth, including new initiatives and to a lesser
extent, through a series of strategic acquisitions.
We now have more than 2,443 full-time equivalent employees in 24 offices and
491,800 square feet of office and manufacturing space strategically located in
the following cities: Houston, Beaumont, Clear Lake, Freeport, and Midland,
Texas; Baton Rouge and Lake Charles, Louisiana; Tulsa, Cleveland and Blackwell,
Oklahoma; Broomfield, Colorado; Atlanta, Georgia; and Calgary, Alberta, Canada
and San Jose, Costa Rica. ENGlobal closed its Dallas, Texas office in the first
quarter of 2007. There was no material reorganization expense associated with
that closure.
In September 2007, ENGlobal opened an office in San Jose, Costa Rica to perform
computer aided design (CAD) services. ENGlobal Ingenieria EGICR, S.A. was formed
through a 50%-50% limited partnership with a CAD firm based in Houston, Texas
that had operated an office in Costa Rica for several years.
During the first three quarters of 2007, the Company managed and reported
through two business segments: Engineering and Systems. In the fourth quarter of
2007, due to the past and anticipated growth in certain areas of our business
and change in leadership during 2007, we reevaluated our reportable segments
under Financial Accounting Standards Board Statement No. 131, "Disclosures about
Segments of an Enterprise and Related Information." As a result, we have elected
to realign both management and reporting into four business segments:
Engineering, Construction, Automation and Land.
The Engineering Segment
-----------------------
The Engineering segment provides consulting services relating to the
development, management and execution of projects requiring professional
engineering and related project services. Services provided by the Engineering
segment include feasibility studies, engineering, design, procurement and
construction management. The Engineering segment provides these services to the
upstream, midstream and downstream energy industries and branches of the U.S.
military, and in some instances, it delivers its services via in-plant personnel
assigned throughout the United States and internationally.
The Construction Segment
------------------------
The Construction segment provides construction management personnel and services
in the areas of inspection, mechanical integrity, vendor and turnaround
surveillance, field support, construction, quality assurance and plant asset
management. Its customers include pipeline, refining, utility, chemical,
petroleum, petrochemical, oil and gas, and power industries throughout the
United States. Construction segment personnel are typically assigned to client
facilities throughout the United States.
The Automation Segment
----------------------
The Automation segment provides services related to the design, fabrication, and
implementation of process distributed control and analyzer systems, advanced
automation, and information technology projects. The Automation segment's
customers include members of the domestic and foreign energy related industries.
Automation segment personnel assist in on-site commissioning, start-up and
training for the Company's specialized systems.
5
The Land Segment
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The Land segment provides land management, right-of-way, environmental
compliance, and governmental regulatory compliance services primarily to the
pipeline, utility and telecom companies and other owner/operators of
infrastructure facilities throughout the United States and Canada.
Available Information
---------------------
We file annual, quarterly and current reports, proxy statements and other
information with the Securities and Exchange Commission ("SEC"). You can read
and copy any materials filed with the SEC at its Public Reference Room at 100 F.
Street, N.E., Washington, D.C. 20549. You can obtain information about the
operations from the SEC Public Reference Room by calling the SEC at
1-800-SEC-0330. The SEC also maintains a website, which contains information we
file electronically with the SEC, which can be accessed over the Internet at
www.sec.gov.
ENGlobal Website
----------------
You can find financial and other information about ENGlobal at the Company's
website at the URL address www.englobal.com. Copies of our annual reports on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8- K, and
amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of the Exchange Act are provided free of charge through the Company's
website and are available as soon as reasonably practicable after filing
electronically or otherwise furnishing reports to the SEC. Information relating
to corporate governance at ENGlobal, including: (i) our Code of Business Conduct
and Ethics for all of our employees, including our Chief Executive Officer and
Chief Financial Officer; (ii) our Code of Ethics for our Chief Executive Officer
and Senior Financial Officers; (iii) information concerning our Directors, and
our Board Committees, including Committee charters, and (iv) information
concerning transactions in ENGlobal securities by Directors and officers, is
available on our website under the Investor Relations link. Our website and the
information contained therein or connected thereto are not intended to be
incorporated into this Annual Report on Form 10-K. We will provide any of the
foregoing information, for a reasonable fee, upon written request to Investor
Relations, ENGlobal Corporation, 654 North Sam Houston Parkway East, Suite 400,
Houston, Texas 77060-5914.
6
Business Segments
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During the first three quarters of 2007, the Company managed and reported
through two business segments: Engineering and Systems. In the fourth quarter of
2007, due to the past and anticipated growth in certain areas of our business
and change in leadership during 2007, we reevaluated our reportable segments
under Financial Accounting Standards Board Statement No. 131, "Disclosures about
Segments of an Enterprise and Related Information." As a result, we have elected
to realign both management and reporting into four business segments:
Engineering, Construction, Automation and Land.
The total amounts reported for prior periods will remain the same, but amounts
reported on a segment basis are reported in the four segments that the Company
now operates in, rather than the two segments the Company previously operated
and reported in.
Percentage of Revenue
----------------------------------------
Segments 2007 2006 2005
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Engineering 61.0% 71.1% 82.8%
Construction 20.2% 11.9% 9.4%
Automation 10.4% 11.5% 7.8%
Land 8.4% 5.5% --%
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100.0% 100.0% 100.0%
========= ========= =========
Engineering Segment
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Selected Financial Data
2007 2006 2005
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(Amounts in thousands)
-----------------------------------
Revenue $ 221,787 $ 215,306 $ 193,376
Operating profit $ 28,301 $ 6,195 $ 16,814
Total assets $ 63,265 $ 57,995 $ 60,047
General
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The Engineering segment provides consulting services relating to the
development, management and execution of projects requiring professional
engineering and related project services. Our Engineering segment offers
engineering consulting services primarily to clients in the petroleum refining,
petrochemical, pipeline, production and process industries for the development
and management of engineering projects throughout the United States. The
Engineering segment currently operates through ENGlobal's wholly-owned
subsidiary, ENGlobal Engineering, Inc. ("EEI"), and EEI's wholly-owned
subsidiary, ENGlobal Technical Services, Inc. ("ETS"). EEI focuses primarily on
providing services to downstream petroleum refining, petrochemical and other
processing plants, and also to upstream and midstream pipeline companies and gas
processing plants. ETS primarily provides Automated Fuel Handling Systems and
services to branches of the U.S. military and public sector companies. The
Engineering segment derives revenue 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
(EPC) are performed for a fixed-price amount. As a service-based business, the
Engineering segment is more labor than capital intensive. Our income primarily
results from our ability to generate revenue and collect cash under both
cost-plus and fixed-price contracts that is in excess of any cost for employees
and benefits, material, equipment and subcontracts, plus our selling, general
and administrative (SG&A) expenses.
Our domestic base of energy related clients has generally experienced an economy
healthier than the national average, with a high level of spending for both
capital and maintenance projects. The highest areas of project activity
currently are in the refining, pipeline, petrochemical and alternative energy
industries, with the unemployment rate in our market area generally being less
than the national average. In addition, our clients are either planning or have
begun several multi-billion dollar projects, which are expected to continue
through at least 2010. While ENGlobal Corporation is currently participating in
a number of these major projects, we perform services on a large number of
smaller maintenance and retrofit projects mainly in the United States.
7
As of December 31, 2007, 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-price
basis. The Company strives to establish longer term alliance relationships with
our clients that can be expected to provide a steadier stream of work. In
addition, the Company has found that the outsourcing of its personnel to client
facilities provides for a steadier stream of work. Our Engineering segment
operates out of offices in Baton Rouge and Lake Charles, Louisiana; Beaumont,
Houston, and Freeport, Texas; Tulsa, Oklahoma; and Broomfield, Colorado. In the
first quarter of 2007, the Dallas office was closed, the majority of its assets
were sold, a major portion of the office lease obligations were assumed by
others, and its operations were transferred to other Engineering 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 engineering design of new facilities. We most often use a blanket
services contract that typically provides our clients with EPC project
management services on a time-and-materials basis. We also enter into contracts
to complete capital projects on a fixed-price 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 environmental compliance;
o material procurement; and
o project management.
The Engineering segment offers a wide range of services from a single source
provider.
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. However, the largest firms in our industry are
sometimes our clients, as they perform as program managers for very large scale
projects and then subcontract a portion of their scope of work to the Company.
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
Construction Segment
--------------------
Selected Financial Data
2007 2006 2005
-----------------------------------
(Amounts in thousands)
-----------------------------------
Revenue $ 73,210 $ 36,128 $ 21,898
Operating profit $ 7,133 $ 1,579 $ 1,288
Total assets $ 17,226 $ 11,287 $ 6,536
General
-------
Our Construction segment focuses on energy infrastructure projects in the United
States by offering construction management personnel and services in the areas
of inspection, mechanical integrity, vendor and turnaround surveillance, field
support, construction, quality assurance and plant asset management to clients
in the pipeline, refining, utility, chemical, petroleum, petrochemical, oil and
gas, and power industries throughout the United States. The Construction segment
operates through our wholly-owned subsidiary ENGlobal Construction Resources,
Inc. ("ECR"). The Construction segment derives revenue from cost-plus fees
charged for professional and technical services. As a service company, we are
more labor than capital intensive. Our income primarily results from our ability
to generate revenue and collect cash under cost-plus contracts that is in excess
of any cost for employees and benefits, material, equipment and subcontracts,
plus our selling, general and administrative (SG&A) expenses.
Our Construction segment operates out of offices in Baton Rouge and Lake
Charles, Louisiana; Beaumont, Clear Lake, Midland and Freeport, Texas; and
Cleveland, Blackwell and Tulsa, Oklahoma.
Competition
-----------
Our Construction segment competes with a range of small and midsize inspection
and construction management service companies. The principal elements of
competition among these types of companies are rates, terms of service and
flexibility and reliability of services. The inspection and construction
management business is affected by industry pressure on costs, fueled by intense
competition for contracts.
Competition is primarily centered on performance and the ability to provide the
services in a timely and cost-efficient manner. The technical expertise of our
personnel is a key competitive factor. Our goal is to establish key long-term
customer relationships.
9
Automation Segment
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Selected Financial Data
2007 2006 2005
-----------------------------------
(Amounts in thousands)
-----------------------------------
Revenue $ 37,766 $ 34,888 $ 18,311
Operating profit $ (58) $ 579 $ (41)
Total assets $ 17,468 $ 18,841 $ 6,934
General
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The Automation segment provides services related to the design, fabrication, and
implementation of process distributed control and analyzer systems, advanced
automation, and information technology projects. The Automation segment also
designs, assembles, integrates and services control and instrumentation systems
for specific applications in the energy and processing related industries. These
services are offered to clients in the petroleum refining, petrochemical,
pipeline, production and process industries throughout the United States and
Canada as well as internationally. The Automation segment currently operates
through ENGlobal Systems, Inc. ("ESI") and ENGlobal Automation Group, Inc.
("EAG"), both wholly-owned subsidiaries of ENGlobal, and EAG's wholly owned
subsidiary, ENGlobal Canada ULC ("ECAN"). EAG and ECAN focus primarily on
providing design and engineering services, while ESI primarily provides
fabrication, testing and integration services. The Automation segment derives
revenue from both cost-plus fees charged for professional and technical services
on a fixed-price basis, whereby some or all of the project activities related to
engineering, material procurement and fabrication 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 revenue and collect cash
under both cost-plus and fixed-price contracts that is in excess of any cost for
employees and benefits, material, equipment and subcontracts, plus our selling,
general and administrative (SG&A) expenses.
Our Automation segment operates out of offices in Baton Rouge, Louisiana;
Beaumont and Houston, Texas; Atlanta, Georgia; and Calgary, Alberta.
In January 2006, ESI acquired certain assets of Analyzer Technology
International, Inc. ("ATI"), a Houston-based analyzer systems provider of online
process analyzer systems, and ATI has relocated its operation to ESI's Houston
facility. The addition of ATI has provided ESI with a greater presence in the
process analyzer sector, especially for larger downstream opportunities of
foreign grassroots projects.
Competition
-----------
Our Automation 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, assembly and integration 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.
10
Land Segment
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Selected Financial Data
2007 2006 2005
------------------------------------
(Amounts in thousands)
------------------------------------
Revenue $ 30,464 $ 16,768 $ -
Operating profit (loss) $ 2,105 716 $ -
Total assets $ 15,096 $ 11,540 $ -
General
-------
Our Land segment provides land management, right-of-way, environmental
compliance, and governmental regulatory compliance services primarily to the
pipeline, utility and telecom companies and other owner/operators of
infrastructure facilities throughout the United States and Canada. General
population growth and development result in high demand for rights-of-way
(pipelines, transmission lines and telecommunication cables). The Land segment
operates through the Company's wholly-owned subsidiary, ENGlobal Land,
Inc.("ELI"), formerly known as WRC Corporation, and its wholly-owned subsidiary
WRC Canada ("WRC Canada"). ELI provides land management, environmental
compliance, and governmental regulatory services to the pipeline, utility and
telecom companies and other owner/operators of infrastructure facilities. WRC
Canada provides land management and inspection services. The Land segment
derives revenue from cost-plus fees charged for professional and technical
services. As a service company, we are more labor than capital intensive. Our
income primarily results from our ability to generate revenue and collect cash
under cost-plus contracts that is in excess of any cost for employees and
benefits, material, equipment and subcontracts, plus our selling, general and
administrative (SG&A) expenses.
Our Land segment operates out of offices in Houston, Texas, Broomfield,
Colorado, and Calgary, Alberta, as well as other satellite offices across the
United States.
In January 2008, WRC Corporation changed its name to "ENGlobal Land, Inc." to
support and to better identify with the ENGlobal brand.
Competition
-----------
The Land segment competes with a range of small and midsize firms that provide
right-of-way mapping, title assistance, appraisals, landowner negotiations, and
eminent domain-condemnation.
Competition is primarily centered on retaining experienced landmen and other
qualified professionals. Land and right-of-way specialists must have a thorough
understanding of governmental and public regulatory factors. These professionals
must consider socioeconomic and environmental factors and coordinate planning
for the relocation of utilities, displaced persons and businesses. Also, they
must often assist in developing replacement housing units, which may involve
large sums, condemnation, damages, restriction of access, and similar
complicating factors. Retaining these qualified, skilled professionals is
crucial to the success and growth of our Land segment.
11
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 four-year period ended December 31, 2007.
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 part 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 part of ECR
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 a part of ESI
WRC Corporation and May 2006 Integrated Land Management
WRC Canada
Denver, CO
Operates as ELI, formerly WRC
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
12
ENGlobal Corporation transitions acquisitions under the ENGlobal brand name as
soon as feasible, given the size and scope of the acquisition, but typically
within two years. This strengthens ENGlobal's market position as a diversified
supplier of engineering and related services and focuses on the quality of the
ENGlobal name. Smaller acquisitions are almost immediately integrated as a
division of an existing organization.
Business Strategy
-----------------
In the past year, ENGlobal has focused considerable attention on realigning its
organizational structure and strengthening its leadership team. In the fourth
quarter of 2007, ENGlobal decided that it would operate in four, rather than
two, business segments. These four segments are: Engineering, Construction,
Automation and Land. The Company anticipates that these efforts, together with
expansion of our geographical presence, will continue in 2008.
In addition, our objective is to strengthen the Company's position as a leading
full-service engineering and professional service provider by enhancing our
overall range of capabilities through automation, construction and land
services. To achieve this objective, we have developed a strategy comprised of
the following key elements:
o 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 a dedicated recruitment staff focused
on recruiting qualified personnel with experience in the energy
industry. Improved employee benefits, such as increased 401(k)
matching and competitive healthcare offerings, together with various
incentive programs, have helped us to retain valued employees.
o Improve Utilization of Resources. We have developed a work-sharing
program through the use of an internal virtual private network that
gives our staff and our client's access to technical resources located
in any of our offices, which allows for higher utilization of human
and computer 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 all of our
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 operation has
entered into a 50-50 limited partnership with a Houston-based design
firm. The venture, ENGlobal Ingenieria EGICR, S.A., was established in
San Jose, Costa Rica to provide long-term access to professional
engineering and design resources. In order to control our work
processes and subsequent quality, we have staffed the Costa Rican
office with one of our U.S. managers with substantial foreign work
experience. We believe the venture offers our clients low cost, high
value engineering, design and drafting services and often allows 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 other
business representatives. One of the Engineering segment's goals is to
increase revenue by developing and marketing its ability to perform
full service turnkey projects, also called EPC (Engineering,
Procurement and Construction Management) projects, while pursuing 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. By performing the procurement and
construction management portions of the project on a cost-plus basis,
we are able to capture additional proceeds under the 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 safety standards, schedules and budgets.
ENGlobal has a quality control and assurance program to maintain
standards and procedures for performance and documentation. To enhance
these efforts, we have added an officer level position responsible for
project auditing and monitoring compliance with these internal project
procedures and quality standards.
13
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
utilize technical software from numerous suppliers. By being vendor
neutral, ENGlobal is able to provide high-quality technology and
platforms for the design of plant systems such as 3D modeling, process
simulation, and other technical applications. We find it beneficial to
match the design tools we use with those being utilized by our
clients, many of whom are currently utilizing these design platforms.
o Pursue Balanced Growth. We continue to follow a balanced growth
strategy for our business, utilizing both external acquisitions as
well as internal measures as a means of future growth. Our goal is to
achieve roughly 25% top line growth divided between internal and
external growth objectives. The internal measures include an active
business development program within all of our business segments. Our
external growth will likely come from acquisitions and mergers that
allow us to (i) offer expanded engineering and professional services
to a broad energy complex, (ii) add new technical capabilities that
can be marketed to our existing client base, (iii) grow our business
geographically, and (iv) capture more of a project's value.
o Increase Name Recognition. We intend to continue to present a more
unified position for the Company by building a cohesive image and
increasing ENGlobal's name recognition. We have redesigned our website
to highlight our four businesses: Engineering, Construction,
Automation and Land. Effective January 1, 2008, we will not brand our
various legal subsidiary names such as ENGlobal Engineering, Inc.,
ENGlobal Systems, Inc., but instead focus on one name: ENGlobal. Our
new image presents ENGlobal as one company, wherein our four business
segments can work together as a team to offer their many capabilities
seamlessly, with a continued focus on better serving our clients.
Sales and Marketing
-------------------
ENGlobal derives revenue primarily from three sources: (1) in-house direct
sales, (2) alliance agreements with strategic clients, and (3) referrals from
existing customers and industry members. We currently employ 28 full-time
professional in-house marketers in our business development department who
concentrate primarily on the Company's Engineering and Automation business
segments. Our Senior Vice President of Business Development supervises the
in-house sales managers who 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. In addition, relationships can be nurtured by our geographic
advantage of having office locations near our larger clients. By having clients
in close proximity, we are able to provide single, dedicated points of contact.
Our growth depends in large measure on our ability to attract and retain
qualified business development managers and business development personnel with
a respected reputation in the energy industry. Management believes that in-house
marketing allows for more accountability and control, thus increasing
profitability.
Products and services are also promoted through trade advertising, participation
in industry conferences and trade shows, and through on-line Internet
communication via our corporate home page at www.englobal.com. The ENGlobal site
provides information about our four operating segments and illustrates our
Company's full range of services and capabilities. We use internal and external
resources to maintain and update our website on an ongoing basis. Through the
ENGlobal website, we seek to provide visitors with a single point of contact for
obtaining information on ENGlobal's services.
Our business development department focuses on building long-term relationships
with customers and providing our customers and potential clients with
engineering solutions and after-the-sale services. Additionally, we seek to
capitalize on cross-selling opportunities among our various businesses -
Engineering, Construction, Automation, and Land. Sales leads are often jointly
developed and pursued by the sales personnel from these various businesses.
ENGlobal develops alliance agreements with clients in order to facilitate repeat
business. The Company currently has 19 alliances with 14 customers. These
alliance agreements, also known as master services agreements, or umbrella
agreements, are typically two to three years in length. Although the agreement
14
is not a guarantee for work under a certain project, ENGlobal generally offers a
slightly reduced billing structure to clients willing to commit to arrangements
that are expected to provide a steady stream of work. With the terms of the
contract settled, add-on projects with alliance customers are easier to
negotiate. Management believes that alliance agreements can serve to stabilize
project centered operations such as the engineering and construction industry.
Alliances tend to provide a steady and more predictable source of revenue each
year. In 2007, ENGlobal's alliance agreements accounted for 73% of the Company's
revenue.
Much of our business is repeat business and we are introduced to new customers
in many cases by referrals from existing customers and industry members.
Management believes referrals provide the opportunity for increased
profitability because referrals do not involve direct selling, but instead,
allows satisfied customers to sell our services and products on our behalf.
ENGlobal strives to develop our clients' trust, then benefits by word-of-mouth
referrals.
Our acquisition program has provided the benefit of expanding our existing
customer base. Management believes that cross-selling among our businesses is an
effective way to build client loyalty because cross-selling can clearly solidify
a client relationship thereby reducing attrition and increasing the lifetime
profitability of each client. The Company also believes that cross-selling can
help to ensure a greater predictability of revenue and can be a cost effective
way to grow.
Customers
---------
In 2008, the Company will focus substantial attention on improving customer
services 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 revenue 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.
Almost 75% 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. For example, EEI provides outsourced
technical and other personnel that are assigned to work at client locations. In
the past, these assignments often span multiple projects and multiple years.
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 revenue. At December 31, 2007, we
maintained some form of partnering or alliance arrangement with 14 major oil and
chemical companies. 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.
Overall, our ten largest customers, who vary from one period to the next,
accounted for 57% of our total revenue for 2007, 62% of total revenue for 2006,
and 77% of total revenue for 2005. 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 2007 were Motiva, ConocoPhillips and
ExxonMobil. Even though we frequently receive work from repeat clients, our
client list may vary significantly from year to year. Our potential revenue of
all segments are dependent on continuing relationships with our customers.
15
Engineering Segment:
In the Engineering segment, our ten largest customers vary from one period to
the next. These customers accounted for 74% of our total revenue for 2007, 83%
of total revenue for 2006, and 87% of total revenue for 2005. Our top three
clients in 2007 were Motiva, ConocoPhillips and ExxonMobil.
Though the Engineering segment frequently receives work from repeat clients, its
client list may vary significantly from year to year. In order to generate
revenue in future years, we must continue efforts to obtain new engineering
projects.
Construction Segment:
In the Construction segment, our ten largest customers vary from one period to
the next. Our ten largest customers accounted for 82% of our total revenue for
2007, 75% of total revenue for 2006, and 71% of total revenue for 2005. Our top
three clients in 2007 were Spectra Energy, Gulf South Pipeline and Southern
Natural Gas.
The revenue for the Construction segment 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.
Automation Segment:
In the Automation segment, our ten largest customers, who also vary from one
period to the next, accounted for 73% of our total revenue for 2007, 62% of
total revenue for 2006, and 74% of total revenue for 2005. Our top three clients
in 2007 were E.I. Dupont, Yanbu National Petrochemical and Yokogawa Corp of
America. Total foreign customers accounted for 22% of our Automation segment
revenue for both 2007 and 2006 and less than 1% in 2005. The increase in revenue
from foreign customers is the result of the acquisition of ATI in 2006, which
allowed for the expansion of the analytical division that provides online
process analyzer systems. During 2007, 3% of our revenue came from our Canadian
operations compared to 1% in 2006.
Though the Automation segment frequently receives work from repeat clients, its
client list may vary significantly from year to year. Factors affecting our
analytical systems business that are beyond our control include: political
instability or armed conflict, the level of customer demand, the willingness of
clients to allow for and make milestone progress payments, and the timeliness of
clients' payments within terms of contracts.
Land Segment:
In the Land segment, our ten largest customers vary from one period to the next.
These customers accounted for 70% of our total revenue for 2007 and 83% of total
revenue for 2006. Our top three clients in 2007 were Spectra Energy, Enterprise
Products and Ozark Gas Transmission.
16
Contracts
---------
We generally enter into two principal types of contracts with our clients:
time-and-materials contracts and fixed-price contracts. Our mix of net revenue
between time-and-materials and fixed-price is shown in the table below. 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.
Revenue in thousands
Time-and-material % Fixed-price %
Engineering $ 204,600 $ 17,187
Construction 73,210 -
Automation 15,421 22,345
Land 30,464 -
----------------------- ---------------------
Total company $ 323,695 89.1 $ 39,532 10.9
o Time-and-Materials. Under our time-and-materials contracts, we are
paid for labor at either negotiated hourly billing rates or we are
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 we pass non-labor costs for equipment,
materials and sub-contractor 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 scope is not defined under a "not-to-exceed" agreement we are not
under any obligation to provide services beyond the limits of the
contract, but if we generate costs and 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, sometimes referred to as
"guaranteed maximum", 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, the
economy, as it may relate to labor shortages and inflation of
equipment and material costs, natural disasters, 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 EPC
fixed-price contracts that we enter into in the future due to
significant losses on two fixed-price contracts during 2006.
Backlog
-------
Backlog represents gross revenue of all awarded contracts that have not been
completed and will be recognized as revenue 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
revenue. As a result, no assurances can be given that the amounts included in
backlog will ultimately be realized.
At December 31, 2007, our backlog was $289.2 million compared to an estimated
$192.0 million at December 31, 2006. We expect a majority of the $289.2 million
in backlog to be completed during 2008.
17
The backlog at December 31, 2007 consists of $273.1 million with commercial
customers and $16.1 million with the United States government. Backlog on the
federal programs includes only the portion of the contract award that has been
funded. The backlog for each of our segments at December 31, 2007 is as follows:
Engineering segment $ 150.8 million
Construction segment 88.2 million
Automation segment 19.6 million
Land segment 30.6 million
Backlog includes gross revenue under two types of contracts: (1) contracts for
which work authorizations have been received on a fixed-price basis and
time-and-material projects that are well defined, and (2) time-and-material
evergreen contracts at an assumed 12 month run-rate, under which we place
employees at our clients' site to perform day-to-day project efforts. There is
no assurance as to the percentage of backlog that will be recognized.
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 Automation segment are
fabricated using components and materials that are available from numerous
domestic suppliers. There are approximately five 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 more than 6% of our
revenue. 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 Automation 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 registered our
trademark application for the use of "ENGlobal"(R) with our products in
September 2004 and the Company claims common law trademark rights for
"ENGlobal"TM with our services. We have pending trademark applications for
"Integrated Rack"TM and "Engineered for Growth,"TM respectively. ENGlobal claims
common law trademark rights for "Global Thinking... Global Solutions,"TM "CARES
- Communicating Appropriate Responses in Emergency Situations,"TM "Flare-Mon"TM
and "Purchased Data."TM
18
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 and other professional disciplines. Currently, we are not aware
of any situation or condition relating to the regulation of the Company, its
subsidiaries, or personnel that we believe is likely to have a material adverse
effect on our results of operations or financial condition.
Employees
---------
As of December 31, 2007, the Company and its subsidiaries employed 2,443
individuals. Of these employees, 1,024 were employed in engineering and related
positions; 719 were employed as inspectors; 358 were employed as project support
staff; 237 were employed in technical production positions; 77 were employed in
administration, finance and management information systems and 28 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.
Benefit Plans
-------------
The Company sponsors a 401(k) profit sharing plan for its employees. The Company
makes mandatory matching contributions equal to 50% of employee contributions up
to 6% of employee compensation for regular employees. All other employees will
be matched at 33.33% of employee contribution up to 6% of compensation, as
defined by the plan. 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
$2,147,000, $1,310,000, and $401,000, respectively, for the years ended December
31, 2007, 2006, and 2005.
19
Stock Compensation
------------------
The Company has an incentive plan that provides for the issuance of options to
acquire up to 3,250,000 shares of common stock. The incentive plan ("Option
Plan") provides for grants of non-statutory options, incentive stock options,
restricted stock awards and stock appreciation rights. All stock option grants
are for a ten-year term. Stock options issued to executives and management
generally vest over a four-year period; one-fifth at grant date and one-fifth at
December 31 of each year until they are fully vested. Details of the Company's
stock compensation are included in Footnote 11 to the financial statements.
Pre-2006 Total
Amount of Compensation Expense 2007 Grants 2006 Grants Grants Compensation
------------------------------ ----------- ----------- ------ ------------
($ in thousands)
2006 $ -- $1,838 $ 338 $2,176
2007 529 758 152 1,439
2008 529 306 120 955
2009 -- 305 -- 305
------ ------ ------ ------
$1,058 $3,207 $ 610 $4,875
No compensation cost was 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.
Geographic Areas
----------------
In 2005, the Company formed ENGlobal Canada ULC, located in Calgary, Alberta to
expand our Automation segment into Canada. Then in 2006, the acquisition of WRC
Corporation brought along WRC Canada to expand our Land segment into Canada.
While this gives us opportunities for expansion, our foreign bases are small in
comparison to the Company as a whole.
2007 2006 2005
--------- --------- ---------
(dollars in thousands)
---------------------------------
US revenue $ 360,309 $ 299,333 $ 233,496
Canadian(1) revenue 2,918 3,757 89
--------- --------- ---------
Total revenue $ 363,227 $ 303,090 $ 233,585
1 Stated in U.S. Dollars for consolidation purposes
Long-lived assets consist of property, plant and equipment, net of depreciation
("PPE").
2007 2006 2005
------- ------- -------
(dollars in thousands)
---------------------------
US PPE $ 6,378 $ 8,642 $ 6,758
Canadian(1) PPE 94 83 103
------- ------- -------
Total PPE $ 6,472 $ 8,725 $ 6,861
1 Stated in U.S. Dollars for consolidation purposes
The Company does not own real property in Canada. There is a net loss
carry-forward related to ENGlobal Canada of approximately $1.3 million which the
Company may utilize through 2017.
20
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.
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.
Our future revenue depends on our ability to consistently bid and win new
contracts and to maintain and renew existing contracts. Our failure to
effectively obtain future contracts could adversely affect our profitability.
-----------------------------------------------------------------------------
Our future revenue 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.
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.
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 the Company is unable to successfully execute on these initiatives. In
these cases, continued funding could have a negative impact on long term
earnings.
Our business and operating results could be adversely affected by our inability
to accurately estimate the overall risks, revenue or costs on a contract.
-------------------------------------------------------------------------
We generally enter into two principal types of contracts with our clients:
time-and-materials contracts and fixed-price contracts. Under our fixed-price
contracts, we receive a fixed-price irrespective of the actual costs we incur
and, consequently, we are exposed to a number of risks. These risks include
underestimation of costs, problems with new technologies, unforeseen
expenditures or difficulties, delays beyond our control and economic and other
changes that may occur during the contract period. Our ability to secure change
orders on scope changes and our ability to invoice for such changes poses an
additional risk. In 2006, we suffered significant losses as a result of two
fixed-price contracts. In fiscal 2007, approximately 10.9% of our net revenue
was derived from fixed-price contracts.
21
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
customers' 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.
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.
Additional acquisitions may adversely affect our ability to manage our business.
--------------------------------------------------------------------------------
Acquisitions have contributed to our growth in the past 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, and 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 that 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.
Our indebtedness could limit our ability to finance future operations or engage
in other business activities.
-----------------------------
As of December 31, 2007, we had $27.8 million of total outstanding indebtedness
against our revolving line of credit currently limited to $50 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 clients' ability to pay our invoices due to economic conditions; and
o our ability to meet current credit facility financial ratios and
covenants.
22
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.
If we are unable to collect our receivables, our results of operations and cash
flows could be adversely affected.
----------------------------------
Our business depends on our ability to successfully obtain payment from our
clients of the amounts they owe us for work performed and materials supplied. We
bear the risk that our clients will pay us late or not at all. Though we
evaluate and attempt to monitor our clients' financial condition, there is no
guarantee that we will accurately assess their creditworthiness. Financial
difficulties or business failure experienced by one or more of our major
customers could have a material adverse affect on both our ability to collect
receivables and our results of operations.
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.
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 revenue in any one year or over a period
of several consecutive years. In 2007, approximately 11% of our revenue was from
Motiva, approximately 10% of our revenue was from ConocoPhillips and another 9%
were from ExxonMobil. 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 them in other years 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.
Our backlog is subject to unexpected adjustments and cancellations and is,
therefore, an uncertain indicator of our future revenue or earnings.
--------------------------------------------------------------------
As of December 31, 2007, our backlog was approximately $289.2 million. We cannot
assure investors that the revenue 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 revenue and profits that we actually
earn.
If the operating result of any 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 Statement on Financial Accounting Standards No. 142, Goodwill
and Other Intangible Assets, ("SFAS No. 142"). The Company has assigned goodwill
to its segments based on estimates of the relative fair value of each segment.
If changes in the industry, market conditions, or government regulation
negatively impact any 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 any 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. In 2007,
the Company determined that goodwill within the Automation segment was impaired
in the amount of $432,000.
A small number of stockholders own the majority of our outstanding common stock,
thus limiting the extent to which other stockholders can affect decisions
subject to stockholder vote.
----------------------------
A small number of stockholders own the majority of our outstanding common stock,
thus limiting the extent to which other stockholders can effect decisions
subject to stockholder vote. As of December 31, 2007, ENGlobal's directors and
23
executive officers beneficially owned approximately 33.8% of our outstanding
common stock and our principal stockholders beneficially owned approximately
22.9% of our outstanding common stock. Collectively these stockholders
beneficially own approximately 56.7% of our outstanding common stock and are
thus 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 stockholders
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.
Seasonality of our industry may cause our revenue to fluctuate.
---------------------------------------------------------------
Holidays and employee vacations during our fourth quarter exert downward
pressure on revenue 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 services and 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 and fourth
quarters may be less robust than our second and third quarters.
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 47,295,857 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 NASDAQ 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.
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. In some cases, we remain
obligated to perform our services after such a natural disaster even though our
contracts may contain force majeure clauses. 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 operations and cash flows.
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.
24
Unsatisfactory safety performance can affect customer relationships, result in
higher operating costs and result in high employee turnover.
------------------------------------------------------------
Our workers are subject to the normal hazards associated with providing services
on constructions sites and industrial facilities. Even with proper safety
precautions, these hazards can lead to personal injury, loss of life, damage to,
or destruction, of property, plant and equipment, and environmental damage. We
are intensely focused on maintaining a safe environment and reducing the risk of
accidents. However, poor safety performance may limit or eliminate potential
revenue streams from many of our largest customers and may materially increase
our future insurance and other operating costs.
Our growth strategy requires that we increase the size of our workforce. While
we normally target experienced personnel for employment, we also hire
inexperienced employees. Even with thorough safety training, inexperienced
employees have a higher likelihood of injury which could lead to higher
operating costs and insurance rates.
The terms of our contracts could expose us to unforeseen costs and costs not
within our control, which may not be recoverable and could adversely affect our
results of operations and financial condition.
----------------------------------------------
Under fixed-price contracts, we agree to perform the contract for a fixed price
and, as a result, can improve our expected profit by superior contract
performance, productivity, worker safety and other factors resulting in cost
savings. However, we could incur cost overruns above the approved contract
price, which may not be recoverable. Under certain incentive fixed-price
contracts, we may agree to share with a customer a portion of any savings we are
able to generate while the customer agrees to bear a portion of any increased
costs we may incur up to a negotiated ceiling. To the extent costs exceed the
negotiated ceiling price, we may be required to absorb some or all of the cost
overruns.
Fixed-price contract prices are established based largely upon estimates and
assumptions relating to project scope and specifications, personnel and material
needs. These estimates and assumptions may be inaccurate or conditions may
change due to factors out of our control, resulting in cost overruns, which we
may be required to absorb and that could have a material adverse effect on our
business, financial condition and results of our operations. In addition, our
profits from these contracts could decrease and we could experience losses if we
incur difficulties in performing the contracts or are unable to secure
fixed-pricing commitments from our manufacturers, suppliers and subcontractors
at the time we enter into fixed-price contracts with our customers. In 2006, we
suffered significant losses as a result of two fixed-price contracts.
Under cost-plus contracts, we perform our services in return for payment of our
agreed upon reimbursable costs plus a profit. The profit component is typically
expressed in the contract either as a percentage of the reimbursable costs we
actually incur or is factored into the rates we charge for labor or for the cost
of equipment and materials, if any, we are required to provide. Some cost-plus
contracts provide for the customer's review of the accounting and cost control
systems used by us to calculate these labor rates and to verify the accuracy of
the reimbursable costs invoiced. These reviews could result in reductions in
amounts previously billed to the customer and in an adjustment to amounts
previously reported by us as our profit on the contract.
Many of our fixed-price or cost-plus contracts require us to satisfy specified
progress milestones or performance standards in order to receive a payment.
Under these types of arrangements, we may incur significant costs for labor,
equipment and supplies prior to receipt of payment. If the customer fails or
refuses to pay us for any reason, there is no assurance we will be able to
collect amounts due to us for costs previously incurred. In some cases, we may
find it necessary to terminate. In certain cases, we may attempt to recoup some
or all of the cost overruns by entering into a claims recovery process. We may
even retain a third-party consultant to assist us with necessary due diligence.
However, there can be no assurance that we would be able to recover some or all
of the cost overruns through the claims recovery process or on terms favorable
to the Company.
We may incur significant costs in providing services in excess of original
project scope without having an approved change order.
------------------------------------------------------
After commencement of a contract, we may perform, without the benefit of an
approved change order from the customer, additional services requested by the
customer that were not contemplated in our contract price due to customer
changes or to incomplete or inaccurate engineering, project specifications and
other similar information provided to us by the customer. Our construction
contracts generally require the customer to compensate us for additional work or
expenses incurred under these circumstances.
25
A failure to obtain adequate compensation for these matters could require us to
record in the current period an adjustment to revenue and profit recognized in
prior periods under the percentage-of-completion accounting method. Any such
adjustments, if substantial, could have a material adverse effect on our results
of operations and financial condition, particularly for the period in which such
adjustments are made. We cannot assure you that we will be successful in
obtaining, through negotiation, arbitration, litigation or otherwise, approved
change orders in an amount adequate to compensate us for our additional work or
expenses.
Failure to maintain adequate internal controls could adversely affect us.
-------------------------------------------------------------------------
Failure to achieve and maintain effective internal controls in accordance with
Section 404 of the Sarbanes-Oxley Act could have a material adverse effect on
our business and stock price. Our internal controls over financial reporting may
not be adequate and our independent auditors may not be able to certify as to
their adequacy, which could have a significant and adverse effect on our
business and reputation. We may be exposed to potential risks resulting from new
requirements that we evaluate our internal control over financial reporting
under Section 404 of the Sarbanes-Oxley Act.
If we fail to maintain an effective system of internal controls, we may not be
able to accurately report our financial results or prevent fraud. If we identify
deficiencies in our internal control over financial reporting, our business and
our stock price could be adversely affected. We have identified material
weaknesses in our internal controls, which could affect our ability to ensure
timely and reliable financial reports and the ability of our auditors to attest
to the effectiveness of our internal controls.
26
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2. PROPERTIES
Facilities
----------
We lease space in 24 buildings in the U.S. and Canada totaling approximately
491,800 square feet. The leases have remaining terms ranging from monthly to
five years and are on terms that we consider commercially reasonable. ENGlobal
has no major encumbrances related to these properties. A discussion of the
locations of the various segments is included in Item 7. 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;
Broomfield, Colorado; Atlanta, Georgia; and Calgary, Alberta Canada.
Approximately 397,100 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 Automation 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 then 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 has recently signed an
agreement for a third party developer to construct a new 50,000 square foot
facility using both parcels of land, and lease this new facility to the Company.
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 4,500 square feet of office space in Alpharetta, Georgia, a suburb
of Atlanta.
On June 28, 2007, the Company, through its wholly-owned subsidiary, RPM
Engineering, Inc. ("RPM"), sold the Company's property located in Baton Rouge,
Louisiana. The purchase price was approximately $1.9 million with 20% of the
purchase price being paid at closing and the balance self-financed for a period
of 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%. 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, was approximately
$1.4 million. The Company has leased approximately 31,900 square feet of space
in two separate facilities to house its EEI and EAG operations in Baton Rouge.
27
ITEM 3. LEGAL PROCEEDINGS
From time to time, one or more of ENGlobal Corporation's individual subsidiary
business entities are involved in various legal proceedings or are subject to
claims that arise in the ordinary course of business alleging, among other
things, claims of breach of contract or negligence in connection with the
performance or delivery of goods and/or services, and the outcome of any such
claims or proceedings cannot be predicted with certainty. As of the date of this
filing, all such active proceedings and claims of substance that have been
raised against any subsidiary business entity have been adequately reserved for,
or are covered by insurance, such that, if determined adversely to those
entities, individually or in the aggregate, they 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
No matters were submitted to a vote of stockholders during the quarter ended
December 31, 2007. However, on June 14, 2007, the Company held its Annual
Meeting of Stockholders, the summary results of which are incorporated by
reference to the Company's Current Report on Form 8-K filed with the Securities
and Exchange Commission on June 18, 2007.
On June 14, 2007, the Company's stockholders elected the following four persons
as directors, each to serve until the next Annual Meeting of Stockholders or
until his successor is elected or appointed: William A. Coskey, P.E., David W.
Gent, P.E., Randall B. Hale, and David C. Roussel. The Company's stockholders
also voted to approve an amendment to the Company's 1998 Incentive Plan to
increase the number of shares reserved for issuance under the Plan from
2,650,000 to 3,250,000.
The number of shares voted, and withheld, with respect to each director was as
follows:
Election of Directors For Withheld
--------------------- --- --------
William A. Coskey, P.E. 23,714,112 561,405
David W. Gent, P.E. 23,642,251 633,266
Randall B. Hale 23,685,669 589,848
David C. Roussel 23,758,392 517,125
The number of shares voted with respect to the approval of an amendment to the
Company's 1998 Incentive Plan to increase the number of shares reserved for
issuance under the Plan from 2,650,000 to 3,250,000 was as follows:
For Against Abstain
--- ------- -------
12,175,988 5,638,871 36,923
28
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 NASDAQ Global Stock Market
(NASDAQ) since December 18, 2007, and is traded under the symbol "ENG". From
June 16, 1998 to December 18, 2007, the Company's stock was traded on the
American Stock Exchange. 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
------------------------------------------------------
2007 2006
---------------------------- -------------------------
High Low High Low
-------------- ------------- ------------ ------------
First quarter $ 7.18 $ 5.05 $ 14.61 $ 9.14
Second quarter 12.73 5.66 14.70 6.91
Third quarter 12.90 8.87 8.88 5.71
Fourth quarter 14.81 9.78 8.15 5.92
The foregoing figures, based on information published by AMEX or NASDAQ, do not
reflect retail mark-ups or markdowns and may not represent actual trades.
As of December 31, 2007, approximately 258 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.
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
has the authority to approve the issuance of all or any 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.
The Preferred Stock is referred to as a "blank check" because the Board of
Directors, in its 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.
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.
29
Performance Graph
The Company's common stock has been quoted on the NASDAQ Global Stock Market
(NASDAQ) since December 18, 2007. From June 16, 1998 to December 18, 2007, the
Company's stock was traded on the American Stock Exchange. Accordingly, the
performance graph for fiscal year 2007 includes data from both stock exchanges.
The following graph compares the percentage change in (i) the cumulative total
stockholder return on the Company's Common Stock for the five-year period ended
December 31, 2007 with (ii) the cumulative total return on (a) the S&P SmallCap
600 Index, (b) the NASDAQ Market Index (US), (c) self-constructed peer group,
consisting of the following companies: Fermanite Corporation (formerly Xanser
Corporation), Michael Baker Corporation, Matrix Service Company, Tetra Tech,
Inc., Willbros Group, and VSE Corporation, and (d) the American Stock Exchange
(U.S. Index).
The comparison assumes (i) an investment of $100 on December 31, 2002 in each of
the foregoing indices and (ii) reinvestment of dividends, if any. In December
2007, the Company listed its common stock on the NASDAQ Global Stock Market and
voluntarily delisted from the American Stock Exchange. Accordingly, the Company
has added the NASDAQ Global Stock Market (U.S. index) to its performance graph
in order to enable a comparison to equity securities trading on the same
exchange as the Company.
THE STOCK PRICE PERFORMANCE SHOWN ON THE GRAPH BELOW REPRESENTS HISTORICAL PRICE
PERFORMANCE AND IS NOT NECESSARILY INDICATIVE OF ANY FUTURE STOCK PRICE
PERFORMANCE.
COMPARISON OF 5-YEAR CUMULATIVE TOTAL
AMONG ENGLOBAL, S&P SMALLCAP 600 INDEX,
NASDAQ MARKET INDEX (U.S.) AND PEER GROUP INDEX
[GRAPHIC ON FILE]
ASSUMES $100 INVESTED ON DECEMBER 31, 2002
ASSUMES DIVIDEND REINVESTED
FISCAL YEAR ENDING DECEMBER 31, 2007
2002 2003 2004 2005 2006 2007
------ ------ ------ ------ ------ ------
ENGLOBAL CORP. 100.00 165.55 260.50 705.88 540.34 954.62
PEER GROUP INDEX 100.00 193.57 170.23 159.55 191.49 303.90
S&P SMALLCAP 600 100.00 138.79 170.22 183.30 211.01 210.38
AMEX MARKET INDEX 100.00 136.11 155.86 171.89 192.45 216.06
NASDAQ MARKET INDEX (U.S.) 100.00 152.01 165.75 171.72 192.65 211.26
Notwithstanding anything to the contrary set forth in any of the Company's
previous filings under the Securities Act of 1933, as amended, or the Exchange
Act, which might incorporate future filings made by the Company under those
statutes, the Company's Stock Performance Graph will not be incorporated by
reference into any of those prior filings, nor will such report or graph be
incorporated by reference into any future filings made by the Company under
those Acts.
30
Equity Compensation Plan Information
------------------------------------
The following table sets forth certain information concerning the Company's only
equity compensation plan as of December 31, 2007. 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 plan
approved by security
holders 1,306,500 (1) $6.26 622,494
----------------------- -------------------------
At the June 14, 2007, Annual Meeting of Stockholders, the Company's stockholders
voted to approve an amendment to the Company's 1998 Incentive Plan to increase
the number of shares reserved for issuance under the plan from 2,650,000 to
3,250,000.
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.
----------
(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.
31
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, 2007, 2006, and 2005 have been derived from the audited
financial statements appearing elsewhere in this document. The data as of
December 31, 2004 and 2003 and for the years ended December 31, 2004 and 2003
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.
Years Ended December 31,
-------------------------------------------------------------
2007 2006 2005 2004 2003
-------------------------------------------------------------
(in thousands, except per share amounts)
-------------------------------------------------------------
Statement of Operations
Revenue
Engineering $ 221,787 $ 215,306 $ 193,376 $ 127,299 $ 105,099
Construction 73,210 36,128 21,898 8,046 4,606
Automation 37,766 34,888 18,311 13,543 14,014
Land 30,464 16,768 -- -- --
--------- --------- --------- --------- ---------
Total revenue 363,227 303,090 233,585 148,888 123,719
--------- --------- --------- --------- ---------
Costs and expenses
Engineering 181,821 199,645 169,773 112,389 90,712
Construction 63,486 32,403 19,483 7,110 4,192
Automation 34,382 30,400 16,056 11,418 11,842
Land 25,921 14,378 -- -- --
Selling, general and administrative 34,774 29,884 19,689 13,479 12,439
--------- --------- --------- --------- ---------
Total costs and expenses 340,384 306,710 225,001 144,396 119,185
--------- --------- --------- --------- ---------
Operating income 22,843 (3,620) 8,584 4,492 4,534
Interest income (expense), net (2,514) (1,312) (800) (590) (784)
Other income (expense), net 345 652 116 118 (355)
Foreign currency gain (loss) (1) (19) (2) -- --
--------- --------- --------- --------- ---------
Income from continuing operations before provision
for income taxes 20,673 (4,299) 7,898 4,020 3,395
Provision for income taxes 8,209 (813) 3,116 1,656 1,110
--------- --------- --------- --------- ---------
Income from operations 12,464 (3,486) 4,782 2,364 2,285
Income (loss) from discontinued operations, net of
taxes -- -- -- -- (154)
Income (loss) from disposal of discontinued
operations -- -- -- -- 26
--------- --------- --------- --------- ---------
Net income $ 12,464 $ (3,486) $ 4,782 $ 2,364 $ 2,157
========= ========= ========= ========= =========
32
ITEM 6. SELECTED FINANCIAL DATA (Continued)
Years Ended December 31,
-------------------------------------------------------------
2007 2006 2005 2004 2003
-------------------------------------------------------------
(in thousands, except per share amounts)
-------------------------------------------------------------
Per Share Data
Basic earnings (loss) per share
Continuing operations $ 0.46 $ (0.13) $ 0.20 $ 0.10 $ 0.09
Discontinued operations -- -- -- -- --
--------- --------- --------- --------- ---------
Net income (loss) per share $ 0.46 $ (0.13) $ 0.20 $ 0.10 $ 0.09
========= ========= ========= ========= =========
Weighted average common
shares outstanding - basic (000's) 26,916 26,538 24,300 23,455 23,301
Diluted earnings (loss) per share
Continuing operations $ 0.45 $ (0.13) $ 0.19 $ 0.10 $ 0.09
Discontinued operations -- -- -- -- --
--------- --------- --------- --------- ---------
Net income (loss) per share $ 0.45 $ (0.13) $ 0.19 $ 0.10 $ 0.09
========= ========= ========= ========= =========
Weighted average common
shares outstanding - diluted (000's) 27,435 26,538 25,250 23,786 23,734
Cash Flow Data
Operating activities, net $ (1,980) $ (8,953) $ (920) $ (2,391) $ 6,557
Investing activities, net (1,707) (9,330) (2,418) (1,811) (471)
Financing activities, net 3,167 19,553 3,493 4,170 (6,122)
Exchange rate changes 25 (26) (4) -- --
--------- --------- --------- --------- ---------
Net change in cash and cash equivalents $ (495) $ 1,244 $ 151 $ (32) $ (36)
========= ========= ========= ========= =========
Balance Sheet Data
Working capital $ 42,915 $ 35,187 $ 21,825 $ 14,503 $ 6,505
Property and equipment, net $ 6,472 $ 8,725 $ 6,861 $ 5,262 $ 4,302
Total assets $ 119,590 $ 106,227 $ 75,936 $ 57,261 $ 42,530
Long-term debt, net of current portion $ 29,318 $ 27,162 $ 5,228 $ 15,585 $ 7,506
Long-term capital leases, net of current portion $ -- $ -- $ -- $ -- $ 12
Stockholders' equity $ 55,797 $ 40,862 $ 39,864 $ 20,051 $ 18,175
Material Events and Uncertainties
---------------------------------
The Company experienced events in 2007 and 2006 that had a material adverse
effect on net income from operations. In 2007, the Company was notified by its
client, South Louisiana Ethanol ("SLE"), to stop work on a large project due to
difficulties it was having in obtaining permanent financing. Also in 2007, price
and labor increases on materials contributed to the loss reported for the
Automation segment. In 2006, the Company incurred losses on two large EPC
contracts, which caused the overall loss reported for that year. Details of
these losses are more fully explained in Item 7 and throughout this Annual
Report on Form 10-K.
The Company's involvement with the 2007 SLE project resulted from the Company's
efforts to diversify its client base. Historically, the Company has performed
large projects with Fortune 500 Companies, which generally have good cash flow
and established credit. The SLE project involved a smaller developer that
planned to retrofit a 20-year old ethanol plant. Due to a number of factors,
including, among others, increased corn prices and declining ethanol prices, SLE
has not yet secured permanent financing for the project.
33
Current Remediation Issues
--------------------------
The Company has resolved claims related to the two fixed-price EPC projects that
caused losses in 2006. On March 5, 2008, ENGlobal announced that it had
successfully reached settlements with the two clients, totaling approximately
$2.0 million in excess of what had previously been reserved.
The Company is currently assessing its strategic alternatives with respect to
SLE.
Efforts to Mitigate Losses Currently
------------------------------------
The Company has stopped work on the SLE project, and is providing this client
with introductions to third parties that could potentially result in SLE
obtaining permanent financing for the project, securing equity partners for the
project, or selling the uncompleted facility.
Project controls is reviewing projects that may be experiencing degradations on
margins to determine methods for protecting current margins.
Prevention of Future Losses
---------------------------
The Company will examine not only the economics of development projects in the
future, but it will also examine the creditworthiness of the developer clients.
Due to the current tight credit market, even economically sound projects may
face difficulties in acquiring permanent financing. The Company has placed
controls on projects estimated at over $5 million and project managers are
required to provide updates at least quarterly. In addition, the Company's
project control team is implementing more oversight on large projects to
identify problems that may degrade the project margins earlier in the project's
life. Also, project managers are becoming more involved in collecting
receivables before they become collections issues.
The Company believes the management of enterprise risks is an integral part of
our strategy and our day-to-day operations. Our Enterprise Risk Management
Committee, led by the Vice President - Legal Affairs and Contracts, was
established to ensure that risks are timely identified, adequately understood,
properly assessed and effectively responded to by responsible employees at all
levels within the Company. This enables us to better achieve our short-term and
long-term goals and fulfill our obligations to our employees and clients.
The Company is in the process of changing the way it bids fixed-price contracts
to better protect against unforeseen increases in materials and labor. We are
taking a hard look at our business practices, not only to improve the quality of
our services for our clients, but also the quality of our earnings for our
stockholders.
The impact of these losses is shown in the following table:
--------------------------------
2007 2006 2005
---- ---- ----
(in thousands)
Revenue
Fixed-price EPC $ 2,000 $ 20,155 $ --
Gross profit
Fixed-price EPC 2,000 (13,740) --
SG&A
Goodwill impairment 432 -- --
Note collectability reserve - SLE 3,178 -- --
Operating income (1,610) (13,740) --
Other income
Settlement on hurricane loss -- 418 --
Gain on sale of office buildings 483 -- 119
34
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion is qualified in its entirety by, and should be read in
conjunction with, our Consolidated Financial Statements including the Notes
thereto, included elsewhere in this Annual Report on Form 10-K. Note 18 to the
Financial Statements contains segment information.
Overview
Results of Operations
---------------------
During the first three quarters of 2007, the Company managed and reported
through two business segments: Engineering and Systems. In the fourth quarter of
2007, due to the past and anticipated growth in certain areas of our business
and change in leadership during 2007, we reevaluated our reportable segments
under Financial Accounting Standards Board Statement No. 131, "Disclosures about
Segments of an Enterprise and Related Information." As a result, we have elected
to realign both management and reporting into four business segments:
Engineering, Construction, Automation and Land.
The Engineering segment provides consulting services relating to the
development, management and execution of projects requiring professional
engineering and related project services. Services provided by the Engineering
segment include feasibility studies, engineering, design, procurement, and
construction management. The Construction segment provides construction
management personnel and services in the areas of inspection, mechanical
integrity, vendor and turnaround surveillance, field support, construction,
quality assurance and plant asset management. The Automation segment provides
services related to the design, fabrication, and implementation of process
distributed control and analyzer systems, advanced automation, and information
technology projects. The Land segment provides land management, right-of-way,
and governmental regulatory compliance services primarily to the pipeline,
utility and telecom companies and other owner/operators of infrastructure
facilities throughout the United States and Canada.
The Company's revenue is composed of engineering, procurement and construction
service revenue and engineered systems 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 engineered system 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 direct hire
or 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.
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.
Corporate SG&A expense may vary as costs are incurred to support corporate
activities and initiatives.
35
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.
Years Ended December 31,
------------------------------------------------------------------------
2007 2006 2005
--------------------- --------------------- ---------------------
Amount % Amount % Amount %
------------------------------------------------------------------------
(in thousands)
------------------------------------------------------------------------
Revenue
Engineering $ 221,787 61.0 $ 215,306 71.1 $ 193,376 82.8
Construction 73,210 20.2 36,128 11.9 21,898 9.4
Automation 37,766 10.4 34,888 11.5 18,311 7.8
Land 30,464 8.4 16,768 5.5 - 0.0
------------- ------- ------------ ------- ------------- -------
Total revenue $ 363,227 100.0 $ 303,090 100.0 $ 233,585 100.0
============= ============ =============
Gross profit
Engineering $ 39,966 11.0 $ 15,661 5.2 $ 23,603 10.1
Construction 9,724 2.7 3,725 1.2 2,415 1.0
Automation 3,384 0.9 4,488 1.5 2,255 1.0
Land 4,543 1.3 2,390 0.8 - 0.0
------------- ------- ------------ ------- ------------- -------
Total gross profit $ 57,617 15.9 $ 26,264 8.7 $ 28,273 12.1
============= ============ =============
Selling, general and administrative
Engineering $ 11,665 3.2 $ 9,466 3.1 $ 6,789 2.9
Construction 2,591 0.7 2,146 0.7 1,127 0.5
Automation 3,442 1.0 3,909 1.3 2,296 1.0
Land 2,438 0.7 1,674 0.6 - -
Corporate 14,638 4.0 12,689 4.2 9,475 4.0
------------- ------- ------------ ------- ------------- -------
Total SG&A $ 34,774 9.6 $ 29,884 9.9 $ 19,687 8.4
============= ============ =============
Net income (loss) $ 12,464 3.4 $ (3,486) (1.2) $ 4,782 2.1
============= ======= ============ ======= ============= =======
OVERALL COMPARISONS
-------------------
Revenue
-------
Overall revenue increased 19.8%, or $60.1 million, from $303.1 million in 2006
to $363.2 million in 2007 and increased 29.8%, or $69.7 million, from $233.6
million in 2005. Approximately 36% of our revenue growth from 2006 to 2007 was
external growth as a result of the incremental revenue contribution from 2006
acquisitions. The balance of the revenue growth from 2006 to 2007 occurred as a
result of internal measures.
Gross Profit
------------
Gross profit increased $31.3 million, or 119.0%, from $26.3 million in 2006 to
$57.6 million in 2007 but decreased $2.0 million, or 7.1%, from $28.3 million in
2005. As a percentage of revenue, gross profit increased by 7.2% from 8.7% in
2006 to 15.9% in 2007 but decreased 3.4% in 2006 from 12.1% in 2005. The major
factors that contributed to improved gross profit margins in 2007 relative to
2006 were improved billing rate structures, a mix of work that had less
low-margin pass-through procurement and subcontracted construction revenue, and
losses on two fixed-price projects that negatively impacted 2006.
Selling, General and Administrative ("SG&A") Expenses
-----------------------------------------------------
Overall SG&A expenses increased $4.9 million, or 16.4%, from $29.9 million in
2006 to $34.8 million in 2007. In 2006, overall SG&A expense increased $10.2
million, or 51.8%, from $19.7 million in 2005. As a percentage of revenue, SG&A
decreased 0.3% from 9.9% in 2006 to 9.6% in 2007 and increased 1.5% from 8.4% in
2005. Details relating to the changes in each segment are discussed further in
Item 7.
36
Corporate SG&A expenses increased $1.9 million, or 15.0%, from $12.7 million in
2006 to $14.6 million in 2007. The increase relates primarily to salaries and
employee-related expenses, which increased $1.7 million. Of these expenses, $0.9
million relates to the management incentive plan. Since the Company experienced
losses in 2006, we incurred no management incentive plan expense during that
year. The remainder is attributable to a general increase in corporate overhead
positions to support company growth. There was also an increase in professional
services for items such as Sarbanes-Oxley ("SOX") compliance and audits totaling
$0.2 million and an increase of amortization and depreciation expense of $0.2
million. These increases were offset by a decrease in stock compensation expense
of $0.5 million. As a percent of revenue, corporate SG&A decreased 0.2% from
4.2% in 2006 to 4.0% in 2007.
Corporate selling, general and administrative expenses increased $3.2 million,
or 33.7%, from $9.5 million in 2005 to $12.7 million in 2006. Of the $3.2
million increase, $1.7 million is attributable to stock compensation expense and
$0.4 million is attributable to professional services. The Company did not
record stock compensation expense during 2005, as the Company adopted SFAS No.
123(r) on January 1, 2006 (see Note 11). Professional services included
increases for SOX compliance and audits. Also, salaries and employee-related
expenses increased $0.7 million as a result of the addition of corporate
overhead positions in the business development, accounting, and IT departments.
Facilities and office expenses increased $0.2 million. As a percent of revenue,
SG&A increased 0.2% from 4.0% in 2005 to 4.2% in 2006.
Operating Profit
----------------
Operating profit increased $26.4 million to $22.8 million in 2007 as compared to
$(3.6) million in 2006, increasing, as a percentage of total revenue, from
(1.2)% in 2006 to 6.3% in 2007. This increase was primarily the result of the
Company's performance in 2006 on two fixed-price contracts that did not recur in
2007. However, the operating profit of 2007 was reduced by a $4.0 million charge
taken in relation to the SLE project. 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.
Other Income (Expense)
----------------------
Other income decreased from $651,500 in 2006 to $379,600 in 2007. Other income
was $116,000 in 2005. Other income in 2007 was derived mainly from the sale of
the building in Baton Rouge offset by a loss on the sale of assets for the
closing of our Dallas office. Other income in 2006 was primarily derived from
insurance proceeds received by PEI Investments relating to our Hurricane Rita
losses. PEI's portion, prior to the May 25, 2006 purchase of two-thirds of the
partnership interest by ECS, was $400,000. From that time to December 31, 2006,
almost $314,000 more in insurance was received. This is offset by approximately
$30,000 in government penalties and the remainder in the write-off of software
licenses.
Net Income
----------
Net Income increased $16.0 million to $12.5 million in 2007 as compared to
$(3.5) million in 2006, increasing, as a percentage of total revenue, from
(1.2)% in 2006 to 3.4% in 2007. Net Income decreased $8.3 million to $(3.5)
million in 2006 as compared to $4.8 million in 2005, decreasing, as a percentage
of total revenue, from 2.1% in 2005 to (1.2)% in 2006.
37
2007 Compared to 2006 and 2006 Compared to 2005
Engineering Segment:
Twelve Months Ended
December 31,
----------------------------------------------------------
2007 2006 2005
----------------- ------------------ -----------------
(dollars in thousands)
----------------------------------------------------------
Gross revenue $ 221,802 $ 215,444 $ 193,376
Less intercompany revenue (15) (138) --
--------- --------- ---------
Total revenue:
Detail-design 132,210 59.6% 111,503 51.8% 89,904 46.4%
Field services 56,379 25.4% 53,921 25.0% 34,312 17.8%
Procurement services 16,011 7.2% 19,271 9.0% 59,527 30.8%
Fixed-price 17,187 7.8% 30,611 14.2% 9,633 5.0%
--------- --------- ---------
Total revenue: $ 221,787 100.0% $ 215,306 100.0% $ 193,376 100.0%
Gross profit: $ 39,966 18.0% $ 15,661 7.3% $ 23,603 12.2%
Operating SG&A expense: $ 11,665 5.3% $ 9,466 4.4% $ 6,789 3.5%
--------- --------- ---------
Operating income: $ 28,301 12.8% $ 6,195 2.9% $ 16,814 8.7%
Revenue
-------
Engineering revenue accounted for 61.0% of our total revenue for the year,
increasing $6.5 million from $215.3 million in 2006 to $221.8 million in 2007.
During 2006, revenue increased $21.9 million from $193.4 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. 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 Engineering segment's estimated
backlog at December 31, 2007 was $150.8 million.
Our detail design services proved strong with revenues increasing 18.6%, or
$20.7 million, from $111.5 million in 2006 to $132.2 million in 2007. In 2006,
these services increased 24.0%, or $21.6 million, from $89.9 million in 2005. As
a percent of total engineering revenue, detail design revenue increased 7.8% to
59.6% in 2007 from 51.8% in 2006 and increased 5.4% in 2006 from 46.4% in 2005.
Our field services revenues remained relatively stable with an increase of 4.6%,
or $2.5 million, from $53.9 million in 2006 to $56.4 million in 2007. In 2006,
field services revenue increased 57.2%, or $19.6 million, from $34.3 million in
2005. This was due to an increased demand from our existing customers for
in-plant resources. As a percent of total engineering revenue, field services
revenue increased 0.4% to 25.4% in 2007 from 25.0% in 2006 and increased 7.2% in
2006 from 17.8% in 2005.
Revenue from procurement services decreased 17.1%, or $3.3 million, from $19.3
million in 2006 to $16.0 million in 2007. In 2006, these services decreased
67.6%, or $40.2 million, from $59.5 million in 2005. This significant decrease
is primarily related to three projects, two of which began in 2003 and one of
which began in 2005 and all of which were materially completed in 2006. As a
percent of total engineering revenue, procurement services revenue decreased
1.8% to 7.2% in 2007 from 9.0% in 2006 and decreased a significant 21.8% from
30.8% in 2005. The level of procurement services varies over time depending on
the volume of procurement activity our customers choose to do themselves as
opposed to using our services.
38
Fixed-price revenues decreased 43.8%, or $13.4 million, from $30.6 million in
2006 to $17.2 million in 2007. There was an increase in 2006 of 215.5%, or $20.9
million, from $9.7 million in 2005. As a percent of total engineering revenue,
fixed-price revenue decreased 6.4% to 7.8% in 2007 from 14.2% in 2006, but in
2006 it increased 9.2% from 5.0% in 2005. 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 of
procurement revenue 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 have been completed. As a result of revised estimates of the percentage of
completion of these projects, the Company suffered reversals 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 connection with these contracts, we anticipate entering into
this type of contract in the future only on a very limited basis.
Gross Profit
------------
Our Engineering segment's total gross profit increased $24.3 million, or 155.2%,
from $15.7 million in 2006 to $40.0 million in 2007. As a percentage of total
gross profit, the Engineering segment's gross profit increased from 7.3% to
18.0% during the same period. Due to losses on two EPC fixed-price contracts in
our Engineering segment, as discussed above, total gross profit in 2006
decreased $7.9 million, or 33.5%, from $23.6 million in 2005. The increase in
2007 was primarily due to the lack of similar loss activities in 2007.
While the two EPC contracts did contribute approximately $20.2 million to
revenue, increasing revenues for 2006, the cost and loss recognition for the
same time period was $33.9 million. The net result was a negative impact of
approximately $13.7 million to gross profit. Both of the significant fixed-price
EPC projects were completed in 2007.
In 2006, the Company shifted a portion of its services to developer-type work
for customers that are typically smaller than its historical customer base,
including SLE. 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 on a more
comprehensive basis 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. During 2007, one
of those ventures was discontinued in March with the closing of our Dallas
office as the location did not provide the intended benefits.
We earn a lower margin on procurement services than we earn on our core
engineering services. For example, procurement services for 2007 produced a 2.8%
gross profit margin, whereas core engineering services produced a gross profit
margin of 19.3%. If the Company's business shifts away from predominantly
engineering projects to EPC projects which include material procurement and
construction responsibility, engineering gross profit as a percentage of revenue
will be negatively impacted. This shift would precipitate lower gross profit
because higher cost-plus margins on engineering labor, recognized during the
period in which it was earned, would now be combined with the lower margins on
procurement services and construction subcontractor charges and recorded
throughout the duration of the projects.
Operating Selling, General and Administrative ("SG&A") Expenses
---------------------------------------------------------------
Our Engineering segment's SG&A expenses increased $2.2 million, or 23.2%, from
$9.5 million in 2006 to $11.7 million in 2007. In 2006, the Engineering
segment's SG&A expenses increased $2.7 million, or 39.7%, from $6.8 million in
2005. As a percent of revenue, SG&A increased 0.9% from 4.4% in 2006 to 5.3% in
2007, and it increased 0.9% in 2006 from 3.5% in 2005.
The Engineering segment's SG&A expenses increased $4.7 million in 2007 over 2006
as a result of increases for bad debt expense. Of this increase, $4.0 was
related to creation of the reserve against the SLE notes receivable, while the
39
remainder comprised general increases to the allowance for doubtful accounts. To
offset these increases, facilities and office expenses decreased by $1.2 million
due to the closing of the Dallas office in March 2007. Also, salaries and
employee expenses decreased by $0.9 million as a result of the reclassification
of some employees from overhead to direct expense positions. Additional savings
were recognized in stock compensation expense and professional services.
The Engineering segment's SG&A expenses increased $2.7 million in 2006 over
2005, primarily as a result of increases of $1.5 million in facilities and
office expense. These increases resulted from expansions in the Tulsa, Houston
and Beaumont offices to meet both current and projected growth requirements.
Salaries and burden expenses increased $0.4 million and stock compensation
expense increased $0.3 million. The Company did not record stock compensation
expense during 2005, as the Company adopted SFAS No. 123(r) on January 1, 2006
(see Note 11).
Operating Profit
----------------
Operating profit increased $22.1 million to $28.3 million in 2007 as compared to
$6.2 million in 2006, which decreased $10.6 million from $16.8 million in 2005.
As a percentage of total revenue, operating profit increased to 12.8% in 2007
from 2.9% in 2006, but decreased from 8.7% in 2005. This increase was primarily
the result of the Company's performance in 2006 on two fixed-price contracts
that did not recur in 2007.
40
Construction Segment:
Twelve Months Ended
December 31,
------------------------------------------------------------
2007 2006 2005
----------------- ------------------ ------------------
(dollars in thousands)
------------------------------------------------------------
Gross revenue $ 86,811 $ 37,083 $ 22,696
Less intercompany revenue (13,601) (955) (798)
--------- --------- ---------
Total revenue:
Pipeline 60,430 82.5% 28,987 80.2% 16,639 76.0%
Non-pipeline 12,780 17.5% 7,141 19.8% 5,259 24.0%
--------- --------- ---------
Total revenue: $ 73,210 100.0% $ 36,128 100.0% $ 21,898 100.0%
Gross profit: $ 9,724 13.3% $ 3,725 10.3% $ 2,415 11.0%
Operating SG&A expense: $ 2,591 3.5% $ 2,146 5.9% $ 1,127 5.1%
Operating income: $ 7,133 9.7% $ 1,579 4.4% $ 1,288 5.9%
Revenue
-------
The Construction segment contributed 20.2% of our total revenue for 2007, as its
revenue increased $37.1 million, or 102.8%, from $36.1 million in 2006 to $73.2
million in 2007. The revenue in 2006 for this segment increased 64.8%, or $14.2
million, from $21.9 million in 2005. Additional growth is expected as the demand
for pipeline and OSHA plant inspection, as well as plant turnaround and
construction management support projects and high-tech maintenance services,
continues to be sourced. The Construction segment's estimated backlog at
December 31, 2007 was $88.2 million.
A general increase in the construction markets along with increased capital
spending in the pipeline area, particularly in inspection services, has
contributed to the increases in revenue in the Construction segment. Also
contributing to the increase in revenue was the acquisition of certain assets,
including ongoing projects, of Watco Management in the fourth quarter of 2006.
The revenue from this segment comes entirely from field services that are not
typically limited to one project. The Company's past experience with this
activity is that the term of these assignments on average spans multiple
projects and multiple years.
Gross Profit
------------
The Construction segment's gross profit increased $6.0 million, or 162.7%, from
$3.7 million in 2006 to $9.7 million in 2007. In 2006, this segment's gross
profit increased $1.3 million, or 54.2%, from $2.4 million in 2005. As a percent
of revenue gross profit increased by 3.0%, from 10.3% in 2006 to 13.3% in 2007,
but it decreased 0.7% in 2006 from 11.0% in 2005.
There has been a significant increase in activity for this segment resulting in
higher gross profits. Gross profit as a percent of revenue has also increased
due to higher margin services, such as turnaround support and high-tech
maintenance, provided as a result of the acquisition of certain assets of Watco
Management in the fourth quarter of 2006.
Operating Selling, General and Administrative ("SG&A") Expenses
---------------------------------------------------------------
The Construction segment's SG&A expenses increased $0.4 million, or 19.1%, from
$2.1 million in 2006 to $2.6 million in 2007. In 2006, SG&A expenses increased
$1.0 million, or 90.9%, from $1.1 million in 2005. As a percent of revenue, SG&A
decreased 2.4% from 5.9% in 2006 to 3.5% in 2007, but it increased 0.8% in 2006
from 5.1% in 2005.
41
The Construction segment's SG&A expenses increased $0.4 million in 2007 over
2006 mainly due to increases in salaries and related employee expenses of
$362,000. Overhead positions were added to accommodate the internal and
acquisition-related growth of this segment. Additionally, facilities expense
increased $75,000 as a result of additional office space leased to house
acquired operations.
The $1.0 million increase in our Construction segment's SG&A expenses in 2006
over 2005 was mainly attributable to salaries and related employee expenses of
$714,000. Facilities and office expenses increased $80,000 and stock
compensation expense increased $142,000. The Company did not record stock
compensation expense during 2005, as the Company adopted SFAS No. 123(r) on
January 1, 2006 (see Note 11).
Operating Profit
----------------
This segment's operating profit increased $5.5 million to $7.1 million in 2007
from $1.6 million in 2006, and it increased $300,000 in 2006 from $1.3 million
in 2005. As a percentage of total revenue, operating profit increased to 9.7% in
2007 from 4.4% in 2006, but it decreased in 2006 from 5.9% in 2005.
42
Automation Segment:
Twelve Months Ended
December 31,
-------------------------------------------------------
2007 2006 2005
---------------- ----------------- ----------------
(dollars in thousands)
-------------------------------------------------------
Gross revenue $ 39,115 $ 37,206 $ 19,889
Less intercompany revenue (1,349) (2,318) (1,578)
-------- -------- --------
Total revenue:
Fabrication 22,814 60.4% 26,032 74.6% 14,159 77.3%
Non-fabrication 14,952 39.6% 8,856 25.4% 4,152 22.7%
-------- -------- --------
Total revenue: $ 37,766 100.0% $ 34,888 100.0% $ 18,311 100.0%
Gross profit: $ 3,384 9.0% $ 4,488 12.9% $ 2,255 12.3%
Operating SG&A expense: $ 3,442 9.1% $ 3,909 11.2% $ 2,296 12.5%
Operating income: $ (58) (0.2%) $ 579 1.7% $ (41) (0.2%)
Revenue
-------
The Automation segment contributed 10.4% of our total revenue for the year, as
its revenue increased $2.9 million, or 8.3%, from $34.9 million in 2006 to $37.8
million in 2007. This segment's revenue also increased 90.7% in 2006, or $16.6
million, from $18.3 million in 2005.
The Company began to focus more on automation services beginning in 2005 and
began marketing them more aggressively at that time. Refining-related activity
has been particularly strong, including projects to satisfy environmental
mandates. This, together with the acquisition of Analyzer Technology
International, Inc. ("ATI") in January 2006, has increased the demand for
automation services. Another factor positively affecting the automation business
is that the computer-based distributed control systems equipment used for
facility plant automation becomes technologically obsolete over time, supporting
ongoing replacement. The Automation segment's estimated backlog at December 31,
2007 was $19.6 million.
Gross Profit
------------
The Automation segment's gross profit decreased $1.1 million, or 24.5%, from
$4.5 million in 2006 to $3.4 million in 2007. In 2006, it increased $2.2
million, or 95.7%, from $2.3 million in 2005. Also, as a percent of revenue,
gross profit decreased by 3.9% from 12.9% in 2006 to 9.0% in 2007, and it
increased 0.6% in 2006 from 12.3% in 2005.
During 2007, the Automation segment expanded into several new regions, resulting
in higher increased costs in relation to revenues. Also during 2007, an
unanticipated shortage of available experienced labor caused an increase in
labor hourly rates of approximately 25%. During that same period, most material
costs unexpectedly increased approximately 8% to 10%, and the price of copper
wire increased 300%. These increases in labor and material costs adversely
affected project margins on fixed-price projects.
Selling, General and Administrative ("SG&A") Expenses
-----------------------------------------------------
The Automation segment's SG&A expenses decreased $0.5 million, or 12.8%, from
$3.9 million in 2006 to $3.4 million in 2007. In 2006, SG&A expenses increased
$1.6 million, or 69.6%, from $2.3 million in 2005. As a percent of revenue, SG&A
decreased 2.1% from 11.2% in 2006 to 9.1% in 2007, and it decreased 1.3% in 2006
from 12.5% in 2005.
This segment's SG&A expenses decreased $467,000 in 2007 over 2006, mainly due to
decreases in salaries and related employee expenses of $896,000. Salaries and
expenses for business development personnel were moved to corporate overhead in
July 2006 to be consistent with the reporting of these costs throughout the
43
Company. The reduction of overhead personnel and the transfer of Automation
segment overhead personnel expense to direct expense also contributed to this
decrease. We also recognized professional services savings of $152,000 and
$85,000 less in bad debt expense. Offsetting these savings, amortization costs
increased by $674,000. Of these additional costs, $432,000 was goodwill
impairment.
The Automation segment's SG&A expenses increased $1.6 million in 2006 over 2005
as a result of increased salaries and related employee expenses of $649,000.
Facilities and office expenses increased $378,000 for expansion of office and
warehouse space. Amortization and depreciation increased $339,000 mainly due to
a non-compete agreement that was entered into with the acquisition of ATI in
January 2006. Professional services increased $134,000 and stock compensation
expense increased $37,000. The Company did not record stock compensation expense
during 2005, as the Company adopted SFAS No. 123(r) on January 1, 2006 (see Note
11).
Operating Profit
----------------
This segment's operating profit decreased $637,000 to a loss of ($58,000) in
2007 as compared to $579,000 in 2006. Operating profit in 2006 increased
$620,000 from a loss of ($41,000) in 2005. As a percentage of total revenue,
operating profit decreased to (0.2)% in 2007 from 1.7% in 2006, but it increased
in 2006 from (0.2)% in 2005.
44
Land Segment:
Twelve Months Ended
December 31,
-------------------------------------------------------
2007 2006 2005
---------------- ----------------- ----------------
(dollars in thousands)
-------------------------------------------------------
Gross revenue $ 30,464 $ 16,768 $ -
Less intercompany revenue - - -
-------- -------- --------
Total Revenue: $ 30,464 100.0% $ 16,768 100.0% $ - - %
Gross profit: $ 4,543 14.9% $ 2,390 14.2% $ - - %
Operating SG&A expense: $ 2,438 8.0% $ 1,674 10.0% $ - - %
Operating income: $ 2,105 6.9% $ 716 4.3% $ - - %
The Land segment was created through an acquisition of WRC Corporation in May
2006. Therefore, financial information for 2006 only includes seven months of
activity compared to a complete year in 2007 and there was no activity for 2005
for this segment.
Revenue
-------
The Land segment contributed 8.4% of our total revenues for 2007, as its revenue
increased $13.7 million, or 81.6%, from $16.8 million in 2006 to $30.5 million
in 2007. The WRC Corporation acquisition in May 2006 was the foundation for this
segment. Therefore, 2006 financial information only includes seven months of
activity. This acquisition has given ENGlobal additional cross-selling
capabilities and allows us to offer our clients a turkey solution for a pipeline
project - from right-of-way acquisition through the Land group to detail design
through the Engineering group.
A general increase in capital spending by our clients has contributed to this
increase in Land segment revenue. We have also been able to increase our client
base. The Land segment's estimated backlog at December 31, 2007 was $30.6
million.
Gross Profit
------------
Gross profit for our Land segment increased $2.2 million, or 91.7%, from $2.4
million in 2006 to $4.5 million in 2007. Also, as a percent of revenue, gross
profit increased by 0.7% from 14.2% in 2006 to 14.9% in 2007.
Selling, General and Administrative ("SG&A") Expenses
-----------------------------------------------------
The Land segment's SG&A expenses increased $0.7 million, or 41.2%, from $1.7
million in 2006 to $2.4 million in 2007. As a percent of revenue, SG&A decreased
2.0% from 10.0% in 2006 to 8.0% in 2007.
The increase is primarily due to the extended months reported for 2007. However,
in reviewing SG&A as a percentage of revenue, there were decreases in
facilities, marketing, and salaries and related employee expenses. In 2007, the
Houston operations of the former WRC Corporation moved into the existing
ENGlobal facilities and the Engineering segment took over some of the former WRC
Corporation's facilities in Denver.
Operating Profit
----------------
The Land segment's operating profit increased $1.4 million to $2.1 million in
2007 from $0.7 million in 2006, increasing, as a percentage of total revenue,
from 4.3% in 2006 to 6.9% in 2007.
45
Liquidity and Capital Resources
Overview
The Company defines liquidity as its ability to pay liabilities as they become
due, fund the business operations and meet monetary contractual obligations. Our
primary source of liquidity during the year ended December 31, 2007 was
borrowings under our senior revolving credit facility with Comerica Bank,
discussed under "Senior Revolving Credit Facility" below (the "Comerica Credit
Facility"). Cash on hand at December 31, 2007 totaled $0.9 million and
availability under the Comerica Credit Facility totaled $22.2 million resulting
in total liquidity of $23.1 million. 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:
(1) circumstances prevent the timely internal processing of invoices,
(2) amounts billed are not collected or are not collected in a timely
manner,
(3) project mix shifts from cost-reimbursable to fixed-price contracts
during significant periods of growth,
(4) the Company loses one or more of its major customers,
(5) the Company experiences further cost overruns on fixed-price
contracts,
(6) our client mix shifts from our historical owner-operator client base
to more developer based clients,
(7) acquisitions are not integrated timely, or
(8) 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.
Cash Flows from Operating Activities
Operating activities required the use of $2.0 million, $9.0 million, and $0.9
million in net cash in 2007, 2006 and 2005, respectively. For the year ended
December 31, 2007, cash generated from operations was offset by the increase in
working capital and the reclassification of accounts and unbilled receivables to
a long-term note receivable. The increase in working capital was primarily due
to increased trade receivables of $3.9 million, increased costs in excess of
billings of $1.6 million, and increased notes receivable of $9.2 million. The
increase in receivables was due to higher revenues and the increase in costs in
excess of billings was primarily related to contractual billing milestones on
fixed-price projects in our Automation segment. The decrease in accounts payable
primarily related to sub-contractor payments of approximately $8.7 million
related to the EPC projects. The note receivable re-classification on the SLE
project was related to the client's obligation in the principle amount of $12.3
million. Additional sub-contractor and vendor payments of $3.3 million related
to the suspended ethanol project are scheduled for payment through the second
quarter of 2008.
Cash flows from operating activities were significantly lower in 2006 than in
2005 and 2007 primarily due to the $13.7 million in operating losses recorded
during 2006 on two fixed price EPC contracts.
Cash Flows from Investing Activities
Investing activities used cash totaling $1.7 million in 2007, compared to $9.3
million in 2006 and $2.4 million in 2005. In 2007, our investing activities
consisted of capital additions of $2.2 million primarily for computers and
technical software applications. 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. Our new credit agreement with Comerica Bank (the "New Credit
Agreement"), discussed under "Senior Revolving Credit Facility" below, limits
annual capital expenditures to $3.25 million. The investing activity in 2006,
which was significantly higher than in 2005 and 2007, was primarily a result of
the investments made in acquiring WRC Corporation, and certain assets of both
ATI and Watco.
Cash Flows from Financing Activities
Financing activities provided cash totaling $3.2 million, $19.6 million, and
$3.5 million in 2007, 2006, and 2005, respectively. Our primary financing
mechanism is our revolving line of credit. The line of credit has been used
principally to finance accounts receivable. During 2007, our borrowings on the
line of credit were $175.7 million in the aggregate, and we repaid an aggregate
46
of $171.8 million on our short-term and long-term bank and other debt. Cash flow
from financing activity in 2006, which was significantly higher than in 2005 and
2007, was primarily a result of borrowings related to the acquisition activities
related to WRC Corporation, ATI, and Watco plus the losses related to the two
fixed-price contracts.
We anticipate that future cash flows from financing activities will 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. We
estimate that payments on long-term debt, including interest for the coming
year, will be $1.5 million.
Senior Revolving Credit Facility
Historically, we have satisfied our cash requirements through operations and
borrowings under a revolving credit facility. Effective August 8, 2007, the
Company entered into the New Credit Agreement with Comerica Bank, which provides
a three-year, $50 million senior secured revolving credit facility ("Revolver").
The New Credit Agreement is guaranteed by substantially all of Company's
subsidiaries, is secured by substantially all of the Company's assets, and
positions Comerica as senior to all other debt. It replaced a $35 million senior
revolving credit facility that would have expired in July 2009. The outstanding
balance on the New Credit Agreement as of December 31, 2007 was $27.8 million.
The remaining borrowings available under the New Credit Agreement as of December
31, 2007 were $22.0 million after consideration of loan covenant restrictions.
At the Company's option, amounts borrowed under the New Credit Agreement will
bear interest at LIBOR or an Alternate Base Rate, plus in each case, an
additional margin based on the Leverage Ratio. The Alternate Base Rate is the
greater of the Prime Rate or the Fed Funds Effective Rate, plus 1.0%. The
additional margin ranges from 0% on the Alternate Base Rate loans and 1.50% to
2.0% on the LIBOR-based loans.
Upon maturity, the LIBOR debt will automatically roll into the Revolver unless
the Company elects to renew, at which time a new maturity date and interest rate
will be set.
The New Credit Agreement requires the Company to maintain certain financial
covenants as of the end of each calendar month, including the following:
o Leverage Ratio not to exceed 3.00 to 1.00;
o Asset Coverage Ratio to be less than 1.00 to 1.00; and
o Net Worth must be greater than the sum of $40.1 million plus 75% of
positive Net Income earned in each fiscal quarter after January 1,
2007 plus 100% of the net proceeds of any offering, sale or other
transfer of any capital stock or any equity securities.
The New Credit Agreement also contains covenants that place certain limitations
on the Company including limits on new debt, mergers, asset sales, investments,
fixed-price contracts, and restrictions on certain distributions. The Company
was in compliance with all covenants under the New Credit Agreement as of
December 31, 2007.
Due to significant losses incurred on two fixed-price projects during the third
and fourth quarters of 2006, the Company requested and was successful in
obtaining a waiver and subsequent amendment to the New 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 Comerica Credit Facility.
Letters of Credit
-----------------
As of December 31, 2007, the Company had one letter of credit outstanding in the
amount of $247,000 to cover self-insured deductibles under both our general
liability and workers' compensation insurance policies. The letter of credit was
issued in November 2007 and covers the policy period from September 30, 2007
through September 30, 2008.
47
Long-term Debt
Our total long-term debt outstanding on December 31, 2007 was $30.8 million (see
Note 8), an increase from $27.1 million as of December 31, 2006. As of December
31, 2007, the Company had one letter of credit outstanding in the amount of
$247,000 to cover self-insured deductibles under both our general liability and
workers compensation insurance policies. The letter of credit was issued in
November 2007 and covers our policy period September 30, 2007 through September
30, 2008.
The following table summarizes our contractual obligations as of December 31,
2007:
Payments Due by Period
----------------------------------------------------------
2012 and
2008 2009 2010 2011 thereafter Total
------- ------- ------- ------- ---------- -------
(in thousands)
---------------------------------------------------------
Long-term debt $ 1,508 $ 1,050 $28,268 $ -- $ -- $30,826
Contractual interest
and discount on certain notes(1) 2,067 1,998 1,957 -- -- 6,022
------- ------- ------- ------- ------- -------
Subtotal long-term debt 3,575 3,048 30,225 -- -- 36,848
Insurance note payable 931 -- -- -- -- 931
Operating leases 4,341 3,527 3,272 2,649 1,418 15,207
------- ------- ------- ------- ------- -------
Total contractual cash obligations $ 8,847 $ 6,575 $33,497 $ 2,649 $ 1,418 $52,986
======= ======= ======= ======= ======= =======
(1)Future interest consists primarily of interest on the line of credit under
the New Credit Agreement. The rate applicable to debt outstanding at December
31, 2007, was 7.25% and fluctuates with the prime rate. Interest and discount
rates on the remainder of the Company's Notes Payable vary from 4% to 6%, with
the weighted average being 5.8% at December 31, 2007.
2007 Non-Cash Transactions
In 2007, non-cash transaction included $1,480,000 note receivable issued upon
the sale of a building the Company owned in Baton Rouge, Louisiana and a note
receivable in the principal amount of $12.3 million issued to South Louisiana
Ethanol ("SLE") and evidenced by a hand note filed as Exhibits 10.19, 10.20 and
10.21. 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
Corporation. There were no significant non-cash transactions in 2005. We also
acquired insurance with notes payable of $1.2 million, $1.3 million, and
$198,000 in 2007, 2006, and 2005, respectively.
Derivative Financial Instruments
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.
Long-term Note Receivable
In the first quarter of 2007, ENGlobal Engineering, Inc. ("EEI") and South
Louisiana Ethanol, LLC ("SLE") executed an agreement for EPC services relating
to the retro-fit of an ethanol plant in southern Louisiana. The history of the
SLE project (the "Project") is described in Note 12 to the Company's financial
statements included in its Quarterly Report on Form 10-Q for the quarter ended
September 30, 2007 (the "Third Quarter 10-Q").
After funding certain initial stages of the Project with cash, temporary
financing was obtained from SLE's bridge lending bank in the amount of $20
million until permanent financing for the Project could be obtained. The parties
anticipated that permanent financing would be obtained from other lenders no
later than August 31, 2007. SLE had engaged a major commercial bank to assist
with finding permanent financing. Further, SLE informed EEI that this commercial
48
bank had obtained permanent financing for numerous other ethanol facilities.
Based on this, as well as on conversations between the Company's Chief Executive
Officer and representatives of this commercial bank, EEI expected the financing
for the Project to be consummated on a timely basis. Given this expectation,
together with the favorable prices for corn and for ethanol, and the robust
credit markets, EEI believed that the Project would be successful and commenced
work in the fourth quarter of 2006.
In the late summer of 2007, although SLE was current in its payments, it had not
obtained permanent financing, corn prices began to increase and ethanol prices
began to decline. Accordingly the Company decided that it was advisable to
obtain security for the amount due. On August 31, 2007, SLE executed a
Collateral Mortgage, a Collateral Note, and a Promissory Note in the amount of
up to $15 million, securing payment of the amount due, and the Company
re-classed the amounts receivable from SLE to a Note Receivable. In connection
with this Promissory Note, and as provided for under Louisiana law, SLE executed
another promissory note (the "Hand Note") on or about October 22, 2007. The Hand
Note had a principle balance of approximately $12.3 million, constituting all
amounts then due.
SLE was current on all invoices through September 18, 2007. However, on
September 20, 2007, SLE requested that EEI immediately demobilize its activity
and instruct its subcontractors to do the same. EEI complied with this request.
Because collectability was not assured, the Company reserved the amounts which
were in excess of the Hand Note.
Although work has not recommenced on the Project and SLE has not obtained
permanent financing, the Company continues to believe that, due to the value of
the Collateral, the Note Receivable is fully collectible. Specifically, an
updated appraisal from the bridge lending bank's appraiser indicates a fair
market value of $35.8 million, an orderly liquidation value of $25.3 million,
and a forced liquidation value of $20.0 million. Moreover, SLE may seek equity
financing for the Project in lieu of or in addition to debt financing.
While the Company believes that in the event the Collateral is liquidated, SLE's
obligations to the Company would be paid in full pursuant to the Collateral
Mortgage in favor of the Company, collectability is not assured at this time. As
a result, in the fourth quarter the Company recorded a valuation reserve and
subsequent charge against Bad Debt expense in the amount of $3.2 million to
reduce the Note Receivable to the amount of the Hand Note. The Company will
continue to evaluate the SLE situation and, if required in the future, make
adjustments to the reserve as necessary to remain in compliance with generally
accepted accounting principles.
Contingent Liabilities and Commitments
--------------------------------------
To our knowledge, the Company is not involved in any environmental clean-up
issues.
The Company does not have any product liability issues. Lease commitments are
included in Footnote 2 of the financial statements. The Company leases all of
its office space.
There are no off-balance sheet financing arrangements.
Income Tax Provision
--------------------
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.
49
We recognize interest related to uncertain tax positions in interest expense and
penalties related to uncertain tax positions in governmental penalties. As of
December 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.
During 2007, the Company's subsidiary, WRC Corporation was subject to an audit
for the pre-acquisition fiscal year ending September 30, 2005. There was no
material adjustment as a result of this audit, and it has been closed. 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.
50
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION (Continued)
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 $64.1 million
from $60.2 million as of December 31, 2007 and 2006, respectively. The number of
days outstanding for trade accounts receivable decreased from 69 days at
December 31, 2006, to 61 days at December 31, 2007. Our actual bad debt expense
has been approximately .08% and .03% of revenue for the years ended December 31,
2007 and 2006. We increased our allowance for doubtful accounts from $670,000 to
$1.4 million or 3.0% of trade accounts receivable balance for each of the years
2006 and 2007, respectively.
Risk Management
In performing services for our clients, we could potentially face liability 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 services and 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 and fourth
quarters may be less robust than our second and third quarters.
Critical Accounting Policies
Revenue Recognition
-------------------
Because the majority of the Company's revenue is recognized under cost-plus
contracts, significant estimates are generally not involved in determining
revenue recognition. During the fourth quarter, the collectability of revenue
for the SLE project became questionable. Therefore, we did not recognize any
revenue on this projects during the fourth quarter of 2007.
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
greater on these projects. However, as a result of the SLE project collection
issues, we have instituted new policies relating to ascertaining the
creditworthiness of new customers.
Our revenue is 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). Some contracts (typically
smaller contracts) have not-to-exceed provisions that place a cap on the revenue
that we may receive under a particular contract. The contract is awarded with a
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. Billings on time-and-material contracts
are produced every two weeks.
51
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,
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 2007 and 2006, pass-through transactions totaled $0.5
million and $8.9 million, respectively
Profits and losses on fixed-price 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 revenue recognized in excess of amounts billed on
fixed-price contracts. The liability "billings in excess of costs and estimated
profits on uncompleted contracts" represents amounts billed in excess of revenue
recognized on fixed-price contracts.
Goodwill
--------
Goodwill and intangible assets with indefinite useful lives are not amortized
and are tested at least annually for impairment. We perform our annual analysis
as of the fourth quarter of each fiscal year and in any period in which
indicators of impairment warrant an additional analysis. Goodwill represents the
excess of the purchase price of acquisitions over the fair value of the net
assets acquired. Goodwill is evaluated for impairment by first comparing
management's estimate of the fair value of a reporting unit with its carrying
value, including goodwill. Reporting units for the purpose of goodwill
impairment calculations are components one level below our reportable operating
segments.
Management utilizes a discounted cash flow analysis to determine the estimated
fair value of our reporting units. Significant judgments and assumptions
including the discount rate, anticipated revenue growth and gross margins,
estimated operating and interest expense, capital expenditures are inherent in
these fair value estimates which are based on our internal operating budgets. As
a result, actual results may differ from the estimates utilized in our
discounted cash flow analysis. The use of alternate judgments and/or assumptions
could results in a fair value that differs from our estimate and could result in
the recognition of an impairment charge in the financial statements.
As a result of these uncertainties, we utilize multiple scenarios and assign
probabilities to each of the scenarios in the discounted cash flow analysis. The
results of the discounted cash flow analysis are then compared to the carrying
value of the reporting unit. If the carrying value of a reporting unit exceeds
its fair value, a computation of the implied fair value of goodwill is compared
with its carrying value. If the carrying value of the reporting unit goodwill
exceeds the implied value fair value of that goodwill, an impairment loss is
recognized in the amount of the excess. If an impairment charge is incurred, it
negatively impacts our results of operations and financial position.
The results of our annual goodwill impairment analysis for the year ended
December 31, 2007 indicated impairment to the recorded value of a goodwill asset
within our Automation segment, specifically of ENGlobal Systems, Inc (ESI). As a
result, the Company recorded an impairment charge of $432,000 in our Automation
segment in the quarter ended December 31, 2007. The impairment stemmed primarily
from a continuing decline in operating results and reduced cash flows from ESI.
The $432,000 charge was a full impairment of the goodwill asset previously
allocated and recorded to ESI as a result of the merger between Industrial Data
Systems Corporation and Petrocon Engineering, Inc. in December 2001.
The Company did not have any impairment under the provisions of SFAS No. 142 as
of December 31, 2006, or December 31, 2005.
52
Impairment and Restructuring
----------------------------
Except as described above, there was no additional impairment recognized as of
December 31, 2007. Recognition of goodwill impairment for the systems component
did not cause impairment of any other goodwill in the Automation segment. The
restructuring of the segments was not a result of goodwill impairment
recognition nor did the restructuring of the segments create the goodwill
impairment charge.
In addition, there were no restructuring charges incurred for the year ended
December 31, 2007. The closure of the Company's Dallas office in March 2007, as
disclosed in the 2006 10-K, did not result in any restructuring charges. There
were no restructuring charges incurred for the years ended December 31, 2006,
and December 31, 2005.
Deferred Tax
------------
The Company had net deferred tax assets of $3.2 million and 2.3 million on its
balance sheet for the years ended December 31, 2007 and December 31, 2006,
respectively. These net deferred tax assets are primarily related to timing
differences and are identified in Footnote 15 to the financial statements.
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
upon 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.
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board ("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
adopted SFAS No. 157 as of January 1, 2008. The Company is currently evaluating
the impact that this interpretation may have on its consolidated financial
statements.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in
Consolidated Financial Statements--an amendment of ARB No. 51." This statement
establishes accounting and reporting standards for the noncontrolling interest
in a subsidiary and for the deconsolidation of a subsidiary. This statement is
effective prospectively, except for certain retrospective disclosure
requirements, for fiscal years beginning after December 15, 2008. The Company
expects to adopt SFAS No. 160 beginning January 1, 2009. The Company is
currently evaluating the impact that this interpretation may have on its
consolidated financial statements.
53
In December 2007, the FASB issued SFAS No. 141(R), "Business Combinations--a
replacement of FASB Statement No. 141", which significantly changes the
principles and requirements for how the acquirer of a business recognizes and
measures in its financial statements, the identifiable assets acquired, the
liabilities assumed, and any noncontrolling interest in the acquiree. The
statement also provides guidance for recognizing and measuring the goodwill
acquired in the business combination and determines what information to disclose
to enable users of the financial statements to evaluate the nature and financial
effects of the business combination. This statement is effective prospectively,
except for certain retrospective adjustments to deferred tax balances, for
fiscal years beginning after December 15, 2008. The Company expects to adopt
SFAS No. 160 beginning January 1, 2009. The Company does not expect this
statement to have a material impact on its consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities--including an amendment to FASB
Statement No. 115," which permits entities to choose to measure many financial
instruments and certain other items at fair value that are not currently
required to be measured at fair value. The statement is effective for fiscal
years beginning after November 15, 2007. In all likelihood, the Company will
choose not to adopt the measurements in this provision.
Inflation and Changing Prices
-----------------------------
The Company is planning to implement certain provisions in its fixed-price
contracts, which would allow the Company to recover a portion of certain
unforeseen price changes in materials and labor that are not in the range of
normally expected inflation.
54
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of December 31, 2007 and 2006, 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 or SFAS No.
133. There are no investments at December 31, 2007. Accordingly, the Company has
no quantitative information concerning the market risk of participating in such
investments.
The Company's primary interest rate risk relates to its variable-rate line of
credit debt obligation, which totaled $27.8 million and $24.0 million as of
December 31, 2007 and 2006, respectively. Assuming a 10% increase in the
interest rate on this variable-rate debt obligation i.e., an increase from the
actual average interest rate of 6.74% as of December 31, 2007, to an average
interest rate of 7.42%, annual interest expense would have been approximately
$188,000 higher in 2007 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, 2007.
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 revenue received from the Company's
international operations in other than U.S. dollars will be subject to foreign
exchange risk. The percentage of revenue received from foreign customers is
identified in the discussion of segment revenue. Most revenue received from
foreign customers is paid to the Company in U. S. currency, except for those
revenue collected by our Canadian subsidiaries. The Canadian dollar is not
subject to volatile price fluctuations compared to the U.S. dollar.
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.
55
INDEX
Page
----
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL
CONTROL OVER FINANCIAL REPORTING 57
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON CONSOLIDATED FINANCIAL STATEMENTS 59
CONSOLIDATED BALANCE SHEETS
December 31, 2007 and 2006 60
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2007, 2006 and 2005 61
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 2007, 2006 and 2005 62
CONSOLIDATED STATEMENTS OF CASH FLOW
Years Ended December 31, 2007, 2006 and 2005 63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 65
SCHEDULE II
Valuation and Qualifying Accounts 95
56
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL
CONTROL OVER FINANCIAL REPORTING
To the Board of Directors and Stockholders
ENGlobal Corporation
We have audited ENGlobal Corporation's internal control over financial reporting
as of December 31, 2007, based on criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). ENGlobal Corporation'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 included in the accompanying Management's
Report on Internal Control over Financial Reporting. Our responsibility is to
express an opinion on the company's internal control over financial reporting
based on our audit.
We conducted our audit 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 effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, and
testing and evaluating the design and operating effectiveness of internal
control based on the assessed risk. Our audit also included performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
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 financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) 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.
57
A material weakness is a deficiency, or a combination of deficiencies, in
internal control over financial reporting, such that there is a reasonable
possibility that a material misstatement of the company's annual or interim
financial statements will not be prevented or detected on a timely basis. The
following material weakness has been identified and included in management's
assessment:
The company lacks sufficient knowledge and expertise in financial reporting
to adequately handle complex or non-routine accounting issues.
This material weakness was considered in determining the nature, timing, and
extent of audit tests applied in our audit of the 2007 financial statements, and
this report does not affect our report dated March 27, 2008 on those financial
statements.
In our opinion, because of the effect of the material weakness described above
on the achievement of the objectives of the control criteria, ENGlobal
Corporation has not maintained effective internal control over financial
reporting as of December 31, 2007, based on criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of
ENGlobal Corporation. as of December 31, 2007 and 2006, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 2007, of ENGlobal and
our report dated March 27, 2008 expressed an unqualified opinion thereon.
/s/ Hein & Associates LLP
-------------------------
Hein & Associates LLP
Houston, Texas
March 27, 2008
58
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, 2007 and 2006,
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,
2007. We have also audited the schedule listed in the accompanying Item 8. 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, 2007 and 2006, and the results of their
operations and their cash flows for each of the years in the three year period
ended December 31, 2007 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.
As discussed in Notes 1 and 11 to the consolidated financial statements, the
Company adopted Statement of Financial Accounting Standards No. 123(r),
"Share-Based Payment," effective January 1, 2006.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), ENGlobal Corporation's internal
control over financial reporting as of December 31, 2007, based on criteria
established in Internal Control--Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO). Our report dated
March 27, 2008 expressed an opinion that ENGlobal Corporation had not maintained
effective internal control over financial reporting as of December 31, 2007,
based on criteria established in Internal Control--Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
/s/ Hein & Associates LLP
-------------------------
Hein & Associates LLP
Houston, Texas
March 27, 2008
59
ENGLOBAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2007 AND 2006
(in thousands)
ASSETS
------
Current Assets 2007 2006
--------- ---------
Cash $ 908 $ 1,403
Trade receivables, net 64,141 60,248
Prepaid expenses and other current assets 2,125 1,724
Current portion of notes receivable 154 52
Costs and estimated earnings in excess of billings on uncompleted
contracts 6,981 5,390
Deferred tax asset 3,081 2,310
Federal income taxes receivable -- 1,148
--------- ---------
Total current assets 77,390 72,275
Property and equipment, net 6,472 8,725
Goodwill 19,926 19,202
Other intangible assets, net 4,112 5,427
Long-term notes receivable, net of current portion and allowance for
uncollectible debt 10,593 129
Deferred tax asset, non-current 77 --
Other assets 1,020 469
--------- ---------
Total assets $ 119,590 $ 106,227
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current Liabilities
Accounts payable $ 10,482 $ 14,672
Accrued compensation and benefits 16,182 12,807
Notes payable 931 1,110
Current portion of long-term debt 1,508 1,418
Deferred rent 558 679
Billings in excess of costs and estimated earnings on uncompleted
contracts 963 540
Other liabilities 3,851 5,862
--------- ---------
Total current liabilities 34,475 37,088
Long-Term Debt, net of current portion 29,318 27,163
Deferred Tax Liability -- 1,114
--------- ---------
Total liabilities 63,793 65,365
--------- ---------
Commitments and Contingencies (Notes 9, 10, 12, 16, 19 and 20)
Stockholders' Equity
Common stock - $0.001 par value; 75,000,000 shares authorized; 27,051,766
and 22,051,766 shares outstanding and 27,051,766 and 26,807,460 issued
at December 31, 2007 and 2006, respectively 28 28
Additional paid-in capital 33,593 31,147
Retained earnings 22,181 9,717
Accumulated other comprehensive income (loss) (5) (30)
--------- ---------
Total stockholders' equity 55,797 40,862
--------- ---------
Total liabilities and stockholders' equity $ 119,590 $ 106,227
========= =========
See accompanying notes to these consolidated financial statements.
60
ENGLOBAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31,
-----------------------------------
(in thousands)
-----------------------------------
2007 2006 2005
--------- --------- ---------
Operating Revenue
Engineering $ 221,787 $ 215,306 $ 193,376
Construction 73,210 36,128 21,898
Automation 37,766 34,888 18,311
Land 30,464 16,768 --
--------- --------- ---------
Total revenue 363,227 303,090 233,585
--------- --------- ---------
Direct Costs
Engineering 181,821 199,645 169,773
Construction 63,486 32,403 19,483
Automation 34,382 30,400 16,056
Land 25,921 14,378 --
--------- --------- ---------
Total direct costs 305,610 276,826 205,312
--------- --------- ---------
Gross Profit 57,617 26,264 28,273
Selling, General, and Administrative Expenses 34,774 29,884 19,689
--------- --------- ---------
Operating Income (Loss) 22,843 (3,620) 8,584
Interest expense (2,514) (1,312) (800)
Other 344 633 114
--------- --------- ---------
Income (loss) before provision for income taxes 20,673 (4,299) 7,898
Provision for Income Taxes 8,209 (813) 3,116
--------- --------- ---------
Net Income (Loss) $ 12,464 $ (3,486) $ 4,782
========= ========= =========
Basic earnings (loss) per share $ 0.46 $ (0.13) $ 0.20
Weighted average common shares outstanding for basic 26,916 26,538 24,300
========= ========= =========
Diluted earnings (loss) per share $ 0.45 $ (0.13) $ 0.19
Weighted average common shares outstanding for diluted 27,435 26,538 25,250
========= ========= =========
See accompanying notes to these consolidated financial statements.
61
ENGLOBAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005
(in thousands)
Accumulated
Additional Comprehensive Total
Common Stock Paid-In Translation Retained Treasury Stockholders'
Shares Stock Capital Gain/(Loss) Earnings Stock Equity
-------- -------- -------- ----------- -------- -------- --------
BALANCES-DECEMBER 31, 2004 23,467 $ 24 $ 12,198 $ -- $ 8,421 $ (592) $ 20,051
Exercise of options 728 1 1,485 -- -- -- 1,486
Common stock issued through
employee stock purchase
plan 95 -- 231 -- -- -- 231
Common stock issued through
private placement 2,000 2 13,071 -- -- -- 13,073
Tax benefit of non-qualified
options exercised -- -- 245 -- -- -- 245
Net income -- -- -- -- 4,782 -- 4,782
Comprehensive income:
Foreign currency
translation adjustment -- -- -- (4) -- -- (4)
-------- -------- -------- -------- -------- -------- --------
BALANCES-DECEMBER 31, 2005 26,290 $ 27 $ 27,230 $ (4) $ 13,203 $ (592) $ 39,864
======== ======== ======== ======== ======== ======== ========
Exercise of options 329 -- 730 -- -- -- 730
Shares issued at acquisition
for WRC 175 1 1,399 -- -- -- 1,400
Common stock issued through
employee stock purchase
plan 14 -- 103 -- -- -- 103
Common stock issued through
private placement -- -- (40) -- -- (40)
Stock based compensation -- -- 2,176 -- -- 2,176
Treasury shares retirement (592) -- 592 --
Tax benefit of non-qualified
options exercised -- -- 141 -- -- -- 141
Net loss -- -- -- -- (3,486) -- (3,486)
Comprehensive income:
Foreign currency
translation adjustment -- -- (26) -- -- (26)
-------- -------- -------- -------- -------- -------- --------
BALANCES-DECEMBER 31, 2006 26,808 $ 28 $ 31,147 $ (30) $ 9,717 $ -- $ 40,862
======== ======== ======== ======== ======== ======== ========
Exercise of options 243 -- 745 -- -- -- 745
Stock based compensation -- -- 1,439 -- -- 1,439
Tax benefit of non-qualified
options, net -- -- 262 -- -- -- 262
Net income -- -- -- -- 12,464 -- 12,464
Comprehensive income: -- 12,464
Foreign currency
translation adjustment -- -- -- 25 -- -- 25
-------- -------- -------- -------- -------- -------- --------
BALANCES-DECEMBER 31, 2007 27,051 $ 28 $ 33,593 $ (5) $ 22,181 $ -- $ 55,797
======== ======== ======== ======== ======== ======== ========
See accompanying notes to these consolidated financial statements.
62
ENGLOBAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
-----------------------------------
(in thousands)
-----------------------------------
2007 2006 2005
--------- --------- ---------
Cash Flows from Operating Activities
Net income (loss) $ 12,464 $ (3,486) $ 4,782
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities -
Depreciation and amortization 4,550 3,369 1,836
Goodwill impairment 432 -- --
Stock based compensation 1,439 2,176 --
Deferred income tax expense (1,962) (2,316) (313)
(Gain) Loss on disposal of property, plant and equipment (408) 42 (132)
Changes in current assets and liabilities, net of acquisitions -
Trade receivables (3,894) (9,825) (15,463)
Notes receivable (12,329) -- --
Reserve on notes receivable 3,150 -- --
Inventories -- 154 19
Costs and estimated earnings in excess of billings (1,591) (1,245) (2,981)
Prepaid expenses and other assets (1,652) 508 630
Accounts payable (4,190) (1,236) 4,699
Accrued compensation and benefits 3,375 2,261 3,740
Billings in excess of costs and estimated earnings 423 (3,235) 1,462
Other liabilities (3,416) 5,079 327
Income taxes receivable (payable) 1,629 (1,199) 474
--------- --------- ---------
Net cash used in operating activities (1,980) (8,953) (920)
--------- --------- ---------
Cash Flows from Investing Activities
Purchase of property and equipment (2,195) (3,405) (3,230)
Additional consideration for acquisitions 18 -- (26)
Proceeds from insurance -- 68 --
Partnership distributions -- 350 --
Acquisitions of businesses, net of cash acquired -- (6,528) --
Proceeds from sale of assets 470 185 15
Proceeds from sale of Thermaire -- -- 823
--------- --------- ---------
Net cash used in investing activities (1,707) (9,330) (2,418)
--------- --------- ---------
Cash Flows from Financing Activities
Borrowings on line of credit 175,674 143,821 92,152
Payments on line of credit (171,802) (123,632) (101,907)
Proceeds from issuance of common stock 1,007 934 15,035
Proceeds from notes receivable 93 38 --
Short-term borrowings (repayments) -- -- (1,038)
Capital lease repayments -- -- (4)
Long-term debt repayments (1,805) (1,608) (745)
--------- --------- ---------
Net cash provided by financing activities 3,167 19,553 3,493
Effect of Exchange Rate Changes on Cash 25 (26) (4)
--------- --------- ---------
Net change in cash and cash equivalents (495) 1,244 151
Cash and Cash Equivalents - beginning of year 1,403 159 8
--------- --------- ---------
Cash and Cash Equivalents - end of year $ 908 $ 1,403 $ 159
========= ========= =========
See accompanying notes to these consolidated financial statements.
63
ENGLOBAL CORPORATION AND SUBSIDIARIES
Supplemental Cash Flow Information Years Ended December 31,
-----------------------------
2007 2006 2005
------- ------- -------
Non-Cash Transactions
Acceptance of note for asset sale $ 1,480 $ -- $ --
Issuance of note for insurance 1,296 1,347 198
Retirement of treasury stock -- 592 --
Acceptance of note for Constant Power assets -- (216) --
Issuance of common stock for purchase of WRC Corporation -- 1,400 --
Issuance of note for ATI assets -- 1,000 --
Issuance of note for purchase of WRC Corporation -- 2,400 --
Issuance of note for Watco assets -- 500 --
Supplemental Cash Flow Information
Cash paid during the year for -
Interest $ 2,575 $ 977 $ 890
State and federal income taxes 9,025 2,465 2,959
Refund from state franchise taxes (56) -- 49
See accompanying notes to these consolidated financial statements.
64
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") - focuses primarily on providing
services to downstream petroleum refining, petrochemical and other
processing plants, and also to upstream and midstream pipeline companies
and gas processing plants.
ENGlobal Construction Resources, Inc. ("ECR") - focuses on energy
infrastructure projects in the United States by offering construction
management personnel and services.
RPM Engineering, Inc. d/b/a ENGlobal Engineering, Inc. ("RPM") - provides
engineering services primarily in southeast Louisiana.
ENGlobal Systems, Inc. ("ESI") - primarily provides fabrication, testing
and integration services.
ENGlobal Automation Group, Inc. ("EAG") - formerly ENGlobal Technologies,
Inc. ("ETI") - focuses primarily on providing design and engineering
services.
ENGlobal Technical Services, Inc. ("ETS") - formerly ENGlobal Design Group,
Inc. ("EDG") - primarily provides Automated Fuel Handling Systems and
services to branches of the U.S. military and public sector companies.
ENGlobal Canada, ULC - focuses primarily on providing design and
engineering services.
ENGlobal Land, Inc., f/k/a WRC Corporation ("ELI") - provides land
management, environmental compliance, and governmental regulatory services
to the pipeline, utility and telecom companies and other owner/operators of
infrastructure facilities.
WRC Canada - provides land management and inspection services.
65
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, 2007. The Company's banking system
provides for daily replenishment of major bank accounts for check-clearing
requirements. Accordingly, there were negative book balances of $2.9 million on
December 31, 2007 and $2.7 million on December 31, 2006. 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-price contracts.
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,
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 2007 and 2006, pass-through transactions totaled $0.5
million and $8.9 million, respectively.
Profits and losses on fixed-price 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 revenue 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
66
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
combined contracts as if they were one. Contracts may be segmented if the
customer had the right to accept separate elements of a contract and the total
economic returns and risks of the separate contract elements are similar to the
economic returns and risks of the overall contract. For segmented contracts, we
recognize revenue as if they were separate contracts over the performance
periods of the individual elements or phases.
We have two principal types of contracts, further defined as follows:
Time-and-Materials 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 revenue 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 revenue from cost-plus, fixed labor rate contracts may
vary in scope and we generally must obtain a change order in order to receive
additional revenue 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 Contracts
---------------------
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").
67
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Guaranteed Max
--------------
Under a guaranteed max contract, clients are charged on the same basis; either
as 1) cost-plus, labor plus fixed markup or 2) as 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 it has reached the guaranteed max amount. Therefore, the
Company recognizes revenue on guaranteed max contracts using the percentage of
completion method described above and treats them the same as fixed-price
contracts. 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").
Pre-Contract Costs
------------------
Pre-contract costs otherwise called Proposal costs are recorded in accordance
with SOP 81-1. Costs that are incurred for a specific anticipated contract and
that will result in no future benefits unless the contract is obtained should
not be included in contract costs or inventory before the receipt of the
contract. Costs related to anticipated contracts are charged to expenses as
incurred because their recovery is not considered probable and are not
reinstated by a credit to income on the subsequent receipt of the contract. The
Company expenses pre-contract costs as they are incurred.
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, resulting, in some cases, in a payment risk. 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.
68
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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. Leasehold improvements are amortized over
the term of the related lease.
Intangible Assets
-----------------
Intangible assets are comprised of non-compete covenants and customer
relationships acquired through acquisitions. As of December 31, 2007 and
December 31, 2006, 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, 2007
Intangible assets $ 3,729 $ 7 $ 2,767 $ 6,503
Less: accumulated amortization 1,619 6 766 2,391
------- ------ ------- -------
Intangible assets, net $ 2,110 $ 1 $ 2,001 $ 4,112
======= ====== ======= =======
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
======= ====== ======= =======
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
------------------------------------------- --------- ----------- ------------- -----
2008 $ 858 $ 1 $ 501 $ 1,360
2009 678 -- 500 1,178
2010 475 -- 500 975
2011 99 -- 500 599
------- ------ ------- -------
$ 2,110 $ 1 $ 2,001 $ 4,112
======= ====== ======= =======
Weighted average amortization
period remaining at December 31, 2007 (years) 3.1 1.0 4.0
Amortization expense has been $1,922,000, $1,087,000 and $125,000 for the three
years 2007, 2006 and 2005, respectively.
69
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Goodwill
--------
Goodwill is not amortized and is tested at least annually for impairment. We
perform our annual analysis as of the fourth quarter of each fiscal year and in
any period in which indicators of impairment warrant an additional analysis.
Goodwill represents the excess of the purchase price of acquisitions over the
fair value of the net assets acquired. Goodwill is evaluated for impairment by
first comparing management's estimate of the fair value of a reporting unit with
its carrying value, including goodwill. Reporting units for the purpose of
goodwill impairment calculations are components one level below our reportable
operating segments.
Management utilizes a discounted cash flow analysis to determine the estimated
fair value of our reporting units. Significant judgments and assumptions
including the discount rate, anticipated revenue growth and gross margins,
estimated operating and interest expense, capital expenditures are inherent in
these fair value estimates which are based on our internal operating budgets. As
a result, actual results may differ from the estimates utilized in our
discounted cash flow analysis. The use of alternate judgments and/or assumptions
could results in a fair value that differs from our estimate and could result in
the recognition of an impairment charge in the financial statements.
As a result of these uncertainties, we utilize multiple scenarios and assign
probabilities to each of the scenarios in the discounted cash flow analysis. The
results of the discounted cash flow analysis are then compared to the carrying
value of the reporting unit. If the carrying value of a reporting unit exceeds
its fair value, a computation of the implied fair value of goodwill is compared
with its carrying value. If the carrying value of the reporting unit goodwill
exceeds the implied value fair value of that goodwill, an impairment loss is
recognized in the amount of the excess. If an impairment charge is incurred, it
negatively impacts our results of operations and financial position.
The results of our annual goodwill impairment analysis for the year ended
December 31, 2007 indicated impairment to the recorded value of a goodwill asset
within our Automation segment, specifically of ENGlobal Systems, Inc (ESI). As a
result, the Company recorded an impairment charge of $432,000 in our Automation
segment in the quarter ended December 31, 2007. The impairment stemmed primarily
from a continuing decline in operating results and reduced cash flows from ESI.
The $432,000 charge was a full impairment of the goodwill asset previously
allocated and recorded to ESI as a result of the merger between Industrial Data
Systems Corporation and Petrocon Engineering, Inc. in December 2001.
70
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company did not have any impairment under the provisions of SFAS No. 142 as
of December 31, 2006, or December 31, 2005. Goodwill remaining on the books of
the Company is as follows:
Goodwill
--------------------------------------------------------------------------
Engineering Automation Construction Land Total
----------- ---------- ------------ ---- -----
($ in thousands)
Balance at December 31, 2005 $ 12,916 $ 1,131 $ 1,408 $ -- $ 15,455
-------- -------- -------- -------- --------
Additions due to earnouts 124 279 107 -- 510
Acquisition additions -- -- -- 3,237 3,237
-------- -------- -------- -------- --------
Balance at December 31, 2006 13,040 1,410 1,515 3,237 19,202
Additions due to earnouts 146 -- 602 -- 748
Reclassification to
intangibles -- (279) -- -- (279)
Reclassification from
intangibles -- -- -- 687 687
Recognition of impairment -- (432) -- -- (432)
-------- -------- -------- -------- --------
Balance at December 31, 2007 $ 13,186 $ 699 $ 2,117 $ 3,924 $ 19,926
-------- -------- -------- -------- --------
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 the preliminary project
stage is completed, when management authorizes funding for the project, and the
project 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
71
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
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 were computed as follows:
Reconciliation of Earnings per Share Calculation
---------------------------------------------------------------------------
2007 2006 2005
--------------------- ---------------------- ---------------------
Basic Diluted Basic Diluted Basic Diluted
---------------------------------------------------------------------------
($ in thousands)
Net Income (Loss) $ 12,464 $ 12,464 $ (3,486) $ (3,486) $ 4,782 $ 4,782
======== ======== ======== ======== ======== ========
Weighted average number of shares 26,916 -- 26,538 -- 24,300 --
outstanding for basic
Weighted average number of shares
outstanding for diluted -- 27,434 -- 26,538 -- 25,250
Net income (loss) per share available
for common stock $ 0.46 $ 0.45 $ (0.13) $ (0.13) $ 0.20 $ 0.19
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, 2007, 2006 and 2005.
2007 2006 2005
---------- ---------- ----------
Common stock issued - beginning of year 26,807,460 26,289,567 23,466,839
Weighted average common stock issued (repurchased) 108,749 248,723 833,275
---------- ---------- ----------
Shares used in computing basic earnings per share 26,916,209 26,538,290 24,300,114
Assumed conversion of dilutive stock options 518,324 -- 950,373
---------- ---------- ----------
Shares used in computing diluted earnings per share 27,434,533 26,538,290 25,250,487
========== ========== ==========
72
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
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 Financial Accounting Standards Board ("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
adopted SFAS No. 157 as of January 1, 2008. The Company is currently evaluating
the impact that this interpretation may have on its consolidated financial
statements.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in
Consolidated Financial Statements--an amendment of ARB No. 51." This statement
establishes accounting and reporting standards for the noncontrolling interest
in a subsidiary and for the deconsolidation of a subsidiary. This statement is
effective prospectively, except for certain retrospective disclosure
requirements, for fiscal years beginning after December 15, 2008. The Company
expects to adopt SFAS No. 160 beginning January 1, 2009. The Company is
currently evaluating the impact that this interpretation may have on its
consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141(R), "Business Combinations--a
replacement of FASB Statement No. 141", which significantly changes the
principles and requirements for how the acquirer of a business recognizes and
measures in its financial statements, the identifiable assets acquired, the
liabilities assumed, and any noncontrolling interest in the acquiree. The
statement also provides guidance for recognizing and measuring the goodwill
acquired in the business combination and determines what information to disclose
to enable users of the financial statements to evaluate the nature and financial
effects of the business combination. This statement is effective prospectively,
73
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
except for certain retrospective adjustments to deferred tax balances, for
fiscal years beginning after December 15, 2008. The Company expects to adopt
SFAS No. 160 beginning January 1, 2009. The Company does not expect this
statement to have a material impact on its consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities-including an amendment to FASB
Statement No. 115," which permits entities to choose to measure many financial
instruments and certain other items at fair value that are not currently
required to be measured at fair value. The statement is effective for fiscal
years beginning after November 15, 2007. In all likelihood, the Company will
choose not to adopt the measurements in this provision.
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:
2007 2006 2005
-------- -------- --------
(in thousands)
-----------------------------------------------
Net income (loss) before foreign currency translation $ 12,464 $ (3,486) $ 4,782
Other comprehensive income: -- -- --
Foreign currency translation adjustment (5) (26) (4)
-------- -------- --------
Comprehensive income (loss) $ 12,459 $ (3,512) $ 4,778
======== ======== ========
NOTE 5 - PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at December 31, 2007 and 2006:
2007 2006
-------- --------
(in thousands)
---------------------------------
Land $ 216 $ 418
Building -- 1,331
Computer equipment and software 10,770 9,048
Shop equipment 1,267 1,093
Furniture and fixtures 812 628
Building and leasehold improvement 2,128 2,018
Autos and trucks 273 260
-------- --------
15,466 14,796
Accumulated depreciation and amortization (9,165) (6,536)
-------- --------
6,301 8,260
Project controls and software upgrade in process 171 465
-------- --------
Property and equipment, net $ 6,472 $ 8,725
======== ========
Depreciation expense has been $2,898,000, $2,282,000 and $1,609,000 for the
three years 2007, 2006 and 2005, respectively.
74
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, 2007 and 2006 are as
follows:
2007 2006
-------- --------
(in thousands)
----------------------------------
Amounts billed $ 47,941 $ 43,655
Amounts unbilled 16,322 15,689
Retainage 1,283 1,574
Less: Allowance for uncollectible accounts (1,405) (670)
-------- --------
Trade receivables, net $ 64,141 $ 60,248
======== ========
The components of long-term notes receivable as of December 31, 2007 and 2006
are as follows:
2007 2006
-------- --------
(in thousands)
----------------------------------
Notes receivable - South Louisiana Ethanol $ 12,329 $ --
Less: Reserve on long-term notes receivable (3,150) --
Notes receivable - Oak Tree Holdings 1,439 --
Other notes receivable and current portion (25) 129
-------- --------
$ 10,593 $ 129
======== ========
On August 31, 2007, SLE executed a Collateral Mortgage, a Collateral Note, and a
Promissory Note in the amount of up to $15 million, securing payment of the
amounts due. In connection with this Promissory Note, and as provided for under
Louisiana law, SLE executed another promissory note (the "Hand Note") on or
about October 22, 2007. The Hand Note had a principle balance of approximately
$12.3 million, constituting all amounts then due.
The Company continues to believe that, due to the value of the Collateral, the
Note Receivable is fully collectible. Specifically, an updated appraisal from
the bridge lending bank's appraiser indicates a fair market value of $35.8
million, an orderly liquidation value of $25.3 million, and a forced liquidation
value of $20.0 million. Moreover, SLE may seek equity financing for the Project
in lieu of or in addition to debt financing. Thus, under any valuation, the
Company expects to receive payment on the Promissory Note.
While the Company believes that in the event the Collateral is liquidated, SLE's
obligations to the Company would be paid in full pursuant to the Collateral
Mortgage in favor of the Company, collectability is not assured at this time. As
a result, the Company has recorded valuation reserve and subsequent charge
against Bad Debt expense in the amount of $3.2 million to reduce the receivable
to the amount of the Hand Note. The Company will continue to evaluate the SLE
situation and, if required in the future, make adjustments to the reserve as
necessary to remain in compliance with sound accounting principles.
The principal amount of the note receivable to Oak Tree Holdings was $1,480,000.
The note was accepted, with cash, in payment of an office building located in
Baton Rouge, Louisiana, which the Company sold in June 2007. The building
remains collateral for the note. Payments are being made in monthly
installments, with the final payment due in June 2012. Oak Tree Holdings is
current on all payments as of December 31, 2007.
The components of other liabilities as of December 31, 2007 and 2006 are as
follows:
2007 2006
------ ------
(in thousands)
---------------------
Reserve for known contingencies $1,777 $4,724
Accrued interest 292 297
Federal and state taxes payable 963 510
Other 819 331
------ ------
Other liabilities $3,851 $5,862
====== ======
75
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 - FIXED-PRICE CONTRACTS
Costs, estimated earnings and billings on uncompleted contracts consisted of the
following at December 31, 2007 and 2006:
2007 2006
-------- --------
(in thousands)
--------------------
Costs incurred on uncompleted contracts $ 74,599 $ 75,317
Estimated earnings (losses) on uncompleted contracts (1,686) (7,390)
-------- --------
Earned revenue 72,913 67,927
Less: Billings to date 66,895 63,077
-------- --------
Net costs and estimated earnings in excess of
billings on uncompleted contracts $ 6,018 $ 4,850
======== ========
Costs and estimated earnings in excess of
billings on uncompleted contracts $ 6,981 $ 5,390
Billings in excess of costs and estimated
earnings on uncompleted contracts (963) (540)
-------- --------
Net costs and estimated earnings in excess of
billings on uncompleted contracts $ 6,018 $ 4,850
======== ========
NOTE 8 - LINE OF CREDIT AND DEBT
Historically, we have satisfied our cash requirements through operations and
borrowings under a revolving credit facility. Effective August 8, 2007, the
Company entered into a new credit agreement (the "New Credit Agreement") with
Comerica Bank, which provides a three-year, $50 million senior secured revolving
credit facility. The New Credit Agreement is guaranteed by substantially all of
Company's subsidiaries, is secured by substantially all of the Company's assets,
and positions Comerica as senior to all other debt. It replaced a $35 million
senior revolving credit facility that would have expired in July 2009. The
outstanding balance on the New Credit Agreement as of December 31, 2007 was
$27.8 million. The remaining borrowings available under the New Credit Agreement
as of December 31, 2007 were $22.0 million after consideration of loan covenant
restrictions.
At the Company's option, amounts borrowed under the New Credit Agreement will
bear interest at LIBOR or an Alternate Base Rate, plus in each case, an
additional margin based on the Leverage Ratio. The Alternate Base Rate is the
greater of the Prime Rate or the Fed Funds Effective Rate, plus 1.0%. The
additional margin ranges from 0% on the Alternate Base Rate loans and 1.50% to
2.0% on the LIBOR-based loans.
Upon maturity, the LIBOR debt will automatically roll into the Revolver unless
the Company elects to renew, at which time a new maturity date and interest rate
will be set.
The New Credit Agreement requires the Company to maintain certain financial
covenants as of the end of each calendar month, including the following:
o Leverage Ratio not to exceed 3.00 to 1.00;
o Asset Coverage Ratio to be less than 1.00 to 1.00; and
o Net Worth must be greater than the sum of $40.1 million plus 75% of
positive Net Income earned in each fiscal quarter after January 1,
2007 plus 100% of the net proceeds of any offering, sale or other
transfer of any capital stock or any equity securities.
76
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The New Credit Agreement also contains covenants that place certain limitations
on the Company including limits on new debt, mergers, asset sales, investments,
fixed-price contracts, and restrictions on certain distributions. The Company
was in compliance with all covenants under the New Credit Agreement as of
December 31, 2007.
Letters of Credit
-----------------
As of December 31, 2007, the Company had one letter of credit outstanding in the
amount of $247,000 to cover self-insured deductibles under both our general
liability and workers' compensation insurance policies. The letter of credit was
issued in November 2007 and covers the policy period from September 30, 2007
through September 30, 2008.
77
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Long-term debt consisted of the following at December 31, 2007 and 2006:
2007 2006
-------- --------
(in thousands)
------------------------
Comerica Credit Facility - Line of credit, prime (6.74% at December 31, $ 27,835 $ 23,963
2007), maturing in July 2010
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 60 120
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 667 1,110
InfoTech Engineering, Inc. - Note payable, interest at 5%, principal
payments in installments of $65,000 plus interest due annually,
maturing in December 2007 -- 75
ATI Technologies - Note payable, interest at 6%, principal payments in
installments of $30,422 including interest due monthly, maturing in
January 2009 382 713
Michael Lee - Note payable, interest at 5%, principal payments in
installments of $150,000 plus interest due quarterly, maturing in
July 2010 1,500 2,100
Watco Management, Inc. - Note payable, interest at 4%, principal
payments in installments of $137,745 including interest annually,
maturing in October 2010 382 500
-------- --------
Total long-term debt 30,826 28,580
Less: Current maturities (1,508) (1,418)
-------- --------
Long-term debt, net of current portion $ 29,318 $ 27,163
======== ========
Maturities of long-term debt as of December 31, 2007, are as follows:
Maturities
------------
(in thousands)
------------
Years Ending December 31,
2008 $ 1,508
2009 1,050
2010 28,268
--------
Total long-term debt $ 30,826
========
78
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, 2007
are as follows:
Operating
------------
(in thousands)
------------
Years Ending December 31,
2008 $ 4,341
2009 3,527
2010 3,272
2011 2,649
2012 and after 1,418
-------
Total minimum lease payments $15,207
=======
Rent expense for the years ended December 31, 2007, 2006 and 2005 was
$3,875,000, $5,502,000 and $2,167,000, 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
$2,147,000, $1,310,000, and $401,000, respectively, for the years ended December
31, 2007, 2006, and 2005. 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 stockholders 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.
NOTE 11 - STOCK OPTION PLAN
The Company has an incentive plan that provides for the issuance of options to
acquire up to 3,250,000 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
79
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
directors vest one-half on grant date and the remaining half upon the first
anniversary of grant date. In 2007 no incentive stock options were issued to
employees. At the 2007 Annual Meeting of Corporate Stockholders, grants were
approved for 50,000 shares to each external Board member. 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.
The fair value of the 2007 options granted to directors is estimated on the date
of grant using the Black-Scholes option-pricing model as follows:
Options Granted in 2007 Fair Values, Assumptions, and Impact on Net Income
--------------------------------------------------------------------------
Series $ 10.93
-----------------------
Grant date 6/14/2007
Number of options granted 150,000
Strike Price $ 10.93
Market price - date of grant $ 10.93
Total compensation at grant date 1,058,361
Compensation recognized
vesting in 2007 529,181
Amount remaining to be
recognized in compensation 529,181
Weighted average fair value
at grant date 7.06
Assumptions
Expected life (months) 75
Risk-free rate of return 4.93 %
Expected volatility 76.275%
Expected dividend yield 0.00 %
Expected forfeiture rate 9.10 %
80
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
Pre-2006 Total
Amount of Compensation Expense 2007 Grants 2006 Grants Grants Compensation
----------------------------------------- -------------- -------------- ------------- -----------------
($ in thousands)
2006 $ - $ 1,838 $ 338 $ 2,176
2007 529 758 152 1,439
2008 529 306 120 955
2009 305 - 305
----------- ------------ ----------- --------------
Total Stock Compensation Expense $ 1,058 $ 3,207 $ 610 $ 4,875
81
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
No compensation cost was 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(r) been applied, the Company's net income available
to common stockholders for the year ended December 31, 2005 would have been
changed to the pro forma amount indicated below:
$ in thousands
2005
---------------
Net income available for common stock-as reported $ 4,782
Compensation expenses if the fair value method had been
applied to the grants, net of taxes (538)
---------------
Net income available for common stock-pro forma $ 4,244
===============
Net income per share-as reported
Basic $ 0.20
Diluted $ 0.19
Net income available per share-pro forma
Basic $ 0.17
Diluted $ 0.17
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, dividend yield of 0%,
expected volatility of 73.8% to 75.1%, and risk-free interest rates of 4.93% to
5.20%, 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.
The following table summarizes total aggregate stock option activity for the
period December 31, 2004 through December 31, 2007:
Vested & Weighted
Exercisable Number of Shares Average
Balance Outstanding Exercise Price
----------------- ------------------ ------------------
Balance at December 31, 2004 1,527,150 $ 2.10
Granted 425,000 3.91
Exercised (493,019) 0.98
Canceled or expired (21,164) 1.43
------------------
Balance at December 31, 2005 1,103,542 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 1,072,294 1,422,494 5.16
Granted 150,000 10.93
Exercised (244,306) 3.05
Canceled or expired (21,688) 2.38
------------------
Balance at December 31, 2007 1,099,300 1,306,500 $ 6.26
==================
82
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes information concerning outstanding and
exercisable Company common stock options at December 31, 2007.
Options
Options Fully-Vested Un-Vested
Outstanding Average And Options
Exercise at Remaining Exercisable at Balance at
Prices(1) December 31, Contractual December 31, December 31,
(series) 2007 Life 2007 2007
------------- -------------- ------------- --------------- -----------------
$ 0.96 53,450 2.8 53,450 -
$ 1.00 20,000 3.2 20,000 -
$ 1.25 60,000 2.0 60,000 -
$ 1.81 40,000 6.5 40,000 -
$ 1.87 20,000 5.3 20,000 -
$ 1.97 15,000 6.2 15,000 -
$ 2.05 85,050 6.2 85,050 -
$ 2.32 40,000 5.4 40,000 -
$ 2.39 40,000 7.1 20,000 20,000
$ 2.50 75,000 7.2 60,000 15,000
$ 3.75 150,000 7.5 150,000 -
$ 6.71 40,000 7.9 20,000 20,000
$ 6.83 175,000 8.9 175,000 -
$ 9.15 150,000 8.4 150,000 -
$ 11.97 193,000 8.3 115,800 77,200
$ 10.93 150,000 9.5 75,000 75,000
------------- -------------- ----------------
1,306,500 1,099,300 207,200
============= ============== ================
1 The exercise price indicates the market value at grant date and is the
strike price at exercise. For each series, the exercise price is the
weighted average exercise price of the series.
Total intrinsic value of options outstanding at December 31, 2007 (000's) $ 6,775
Total intrinsic value of options exercisable at December 31, 2007 (000's) $ 6,463
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
Total intrinsic value of options outstanding at December 31, 2005 (000's) $ 7,147
Total intrinsic value of options exercisable at December 31, 2005 (000's) $ 5,485
Total intrinsic value of options exercised during 2005 (000's) $ 1,755
Total intrinsic value of options exercised during 2007 (000's) $ 1,605
Available for grant at December 31, 2007 622,494
Weighted-average fair value of options at grant date, granted in 2005 $ 3.52
Weighted-average remaining life of all options outstanding at December 31, 2007 7.4 years
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 former 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
83
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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. The Company has completed
development of plans for a new facility utilizing both parcels of land. The
Company plans to enter into an agreement whereby it will sell the property and
enter into a long-term lease with a third party who will construct the new
facility. Further discussion is included in Footnote 20.
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. 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, 2007, 2006 and 2005, the Company had sales
totaling approximately $33.0 million, $42.1 million and $84.8 million
attributable to a single customer. In 2007 approximately 11% of our revenue was
from one customer, approximately 12% was from another customer and another 11%
was from a third customer. During 2006 and 2005, a single customer represented
approximately 15% and 35% of total sales, respectively.
As of December 31, 2007, the Company had amounts due from 2 customers totaling
$7.5 million with 1 customer equaling 10% of trade receivables. 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.
NOTE 14 - RETIREMENT OF TREASURY SHARES AND REDEEMABLE PREFERRED STOCK
Treasury stock was recorded on our books at $592,231. Upon
retirement/cancellation of treasury 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 had a class of preferred stock with 5,000,000 shares originally
authorized for issuance. 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
has the authority to approve the issuance of all or any 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 its 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.
The reason for authorizing blank check Preferred Stock is to provide the Company
with 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.
84
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, 2007, 2006 and 2005 were as follows:
2007 2006 2005
----------------- ----------------- ---------------
(in thousands)
---------------------------------------------------------
Current
Federal $ 8,619 $ 1,047 $ 3,016
Foreign 42 53 -
State 1,510 403 413
---------------- ---------------- ---------------
10,172 1,503 3,429
---------------- ---------------- ---------------
Deferred
Federal (1,890) (1,917) (313)
Foreign 4 (38) -
State (76) (361) -
---------------- ---------------- ---------------
(1,962) (2,316) (313)
---------------- ---------------- ---------------
Total tax provision $ 8,209 $ (813) $ 3,116
================ ================ ===============
The components of the deferred tax asset (liability) consisted of the
following at December 31, 2007 and 2006:
2007 2006
----------------- -----------------
(in thousands)
--------------------------------------
Deferred tax asset
Allowance for doubtful accounts $ 1,721 $ 255
Net operating loss carry-forward 763 665
Accruals not yet deductible for tax purposes 2,082 2,636
Stock options 1,007 235
Alternative minimum tax credit carry-forward - -
---------------- ----------------
Deferred tax assets 5,573 3,791
---------------- ----------------
Less: Valuation allowance (516) 308
Deferred tax assets 5,057 3,483
---------------- ----------------
Deferred tax liabilities
Depreciation (398) (403)
Prepaid expenses (641) (477)
Goodwill (860) (1,407)
---------------- ----------------
Deferred tax liability (1,899) (2,287)
---------------- ----------------
Deferred tax asset, net $ 3,158 $ 1,196
================ ================
85
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:
2007 2006 2005
----------------- ----------------- ---------------
(in thousands)
---------------------------------------------------------
Federal income tax expense at 35% for 2007, 34% for 2006 and $ 7,235 $ (1,462) $ 2,685
2005, respectively
State and foreign taxes, net of tax effect 935 (16) 273
Nondeductible expenses 106 102 9
Stock compensation expense (268) 530 -
Valuation allowance 208 308 -
Prior year correction - (169) -
Other, net (7) (106) 149
---------------- ---------------- ---------------
Total tax provision $ 8,209 $ (813) $ 3,116
================ ================ ===============
The Company had a federal net operating loss carryforward at December 31, 2007
of approximately $705,000. 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
2008 through 2010.
The Company also has a foreign net operating loss carryforward at December 31,
2007 of approximately $1,290,000. This loss is available for utilization in 2008
through 2017, however, application of the net operating loss is restricted to
the income of ENGlobal Canada. 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 $516,000 against the entire net operating loss.
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
December 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.
During 2007, the Company's subsidiary, WRC Corporation was subject to an audit
for the pre-acquisition fiscal year ended September 30, 2005. There was no
material adjustment as a result of this audit, and it has been closed. 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.
86
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16 - ACQUISITIONS
There were no new acquisition transactions during the year ended December 31,
2007.
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.
The Company purchased WRC and its wholly-owned subsidiary, WRC Canada ("WRCC")
on May 25, 2006. The results of WRC's operations have been included in the
consolidated financial statements since that date. WRC, now known as ENGlobal
Land, Inc. ("ELI"), provides integrated land management, engineering, and
related services to the pipeline, power, and transportation industries, among
others. ELI is a wholly-owned subsidiary of ENGlobal and now serves as the
Company's provider of land management, environmental compliance and governmental
regulatory services. The Company expects to utilize the former WRC's Denver
facility as a beachhead for expansion of the Company's services into the Rocky
Mountain and Western U.S. regions, as well as into Western Canada.
In the twelve months prior to acquisition, WRC had revenue exceeding $20 million
and had approximately 200 employees. ENGlobal purchased all of the outstanding
capital stock of WRC in exchange for a consideration package of $10.1 million.
Components of the package were the payment of $4.3 million of debt on behalf of
WRC, which included $50,000 in long-term debt assumption, $2 million cash, a
promissory note of $2.4 million, payable over 4 years, bearing an interest rate
of 5%, and 175,000 shares of ENGlobal common stock, valued at $1.4 million. The
$8 market value of the 175,000 shares of ENGlobal common stock was determined
based on the average closing market price of ENGlobal's common shares over the
3-day period before and after the terms of the acquisition were agreed to and
announced.
87
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the fair values of the assets acquired and the
liabilities assumed at the date of acquisition.
WRC and WRCC
Acquisition Summary
At May 25, 2006 (Revised)
$ in thousands
--------------------------------------------------------------------------------
Current assets $ 4,292
Property, plant and equipment 208
Intangible assets
Customer relationships 2,767
Non-compete agreements 656
Goodwill 3,924
-------
Total assets acquired $11,847
-------
Tax liabilities $ 1,747
Current liabilities 4,250
Long-term debt 50
-------
Total liabilities assumed $ 6,047
-------
Net assets acquired $ 5,800
=======
The Company engaged Herrera Partners to perform a third-party valuation of the
WRC acqusition. A total of $7.3 million was determined attributable to acquired
intangible assets. Of this amount, $2.8 million was assigned to customer
relationships and $0.7 million was assigned to non-compete agreements. While
each category was examined independently in determining the appropriate
amortization period, it was determined that each category should be amortized
over 5.6 years, from closing date to December 31, 2011. This valuation has been
revised from the date of acquisition as additional liabilities became known.
Goodwill from this transaction was estimated to be $3.9 million and is assigned
to the WRC subsidiary.
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 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.
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 foreign grassroots projects. The aggregate purchase price was
$1.75 million, including $750,000 in cash and an unsecured promissory note in
the principal amount of $1,000,000 payable monthly over 36 months, bearing
interest at the rate of 6% per annum. In addition to the purchase price agreed
88
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
to at closing, there are also payments contingent on the performance of projects
that were a part of ATI's backlog at closing. The earnout amount calculated at
December 31, 2006 was $287,958. The estimated fair values of the acquired assets
include intellectual property and existing backlog and have been entirely
recognized in a non-compete agreement to be amortized. The non-compete
agreements are expected to be amortized based on the earnout amounts over a
period of six years.
NOTE 17 - SALE OF ASSET
On June 28, 2007, the Company completed the sale of a building in Baton Rouge,
Louisiana. The Company recognized a gain of $483,483 on the transaction. Total
sales price was $1.85 million. The Company received cash of $370,000 and
accepted a Note Receivable for the remaining $1.48 million. The note accrues
interest initially at 8.5% and is payable on or before June 29, 2012. The
interest changes annually to NY prime plus .25%.
NOTE 18 - SEGMENT INFORMATION
During the first three quarters of 2007, the Company managed and reported
through two business segments: Engineering and Systems. In the fourth quarter of
2007, due to the past and anticipated growth in certain areas of our business
and change in leadership during 2007, we reevaluated our reportable segments
under Financial Accounting Standards Board Statement No. 131, "Disclosures about
Segments of an Enterprise and Related Information." As a result, we have elected
to realign both management and reporting into four business segments:
Engineering, Construction, Automation and Land.
The Engineering segment provides consulting services relating to the
development, management and execution of projects requiring professional
engineering and related project services. Services provided by the Engineering
segment include feasibility studies, engineering, design, procurement and
construction management. The Construction segment provides construction
management personnel and services in the areas of inspection, mechanical
integrity, vendor and turnaround surveillance, field support, construction,
quality assurance and plant asset management. The Automation segment provides
services related to the design, fabrication, and implementation of process
distributed control and analyzer systems, advanced automation, and information
technology projects. The Land segment provides land management, right-of-way,
environmental compliance, and governmental regulatory compliance services
primarily to the pipeline, utility and telecom companies and other
owner/operators of infrastructure facilities throughout the United States and
Canada.
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 segments. The
inter-company elimination column includes the amount of administrative costs
allocated to the segments. The Corporate function supports all business segments
and therefore cannot be specifically assigned to any specific segment. A
significant portion of Corporate costs are allocated to each segment based on
each segment's revenue and subsequently eliminated in consolidation.
Financial information about geographic areas
--------------------------------------------
Revenue from the Company's non-U.S. operations is currently not material.
Long-lived assets located in Canada are currently not material.
89
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Segment information for 2007, 2006 and 2005 was as follows:
Due to the restructuring of two segments to four, amounts will tie in total to
prior reporting; however, individual segments will vary from prior reports.
Engineering Construction Automation Land Corporate Total
(in thousands)
--------------------------------------------------------------------------------------
2007
Net sales from
external customers $ 221,787 $ 73,210 $ 37,766 $ 30,464 $ - $ 363,227
Operating profit
(loss) 28,301 7,133 (58) 2,105 (14,638) 22,843
Depreciation and
amortization 1,910 436 1,186 640 801 4,973
Tangible assets 50,077 14,928 15,393 8,775 6,379 95,552
Goodwill 13,187 2,116 699 3,924 - 19,926
Other intangible
assets 1 182 1,376 2,397 - 3,956
Capital
expenditures 1,123 24 420 7 621 2,195
2006
Net sales from
external customers $ 215,306 $ 36,128 $ 34,888 $ 16,768 $ - $ 303,090
Operating profit
(loss) 6,195 1,579 579 716 (12,689) (3,620)
Depreciation and
amortization 1,684 257 483 457 512 3,393
Tangible assets 44,952 9,488 15,956 4,639 6,563 81,598
Goodwill 13,040 1,515 1,410 3,237 - 18,923
Other intangible
assets 3 284 1,475 3,664 - 5,705
Capital
expenditures 1,948 1,122 384 167 840 4,461
2005
Net sales from
external customers $ 193,376 $ 21,898 $ 18,311 $ - $ - $ 233,585
Operating profit
(loss)* 16,814 1,288 (41) - (9,477) 8,584
Depreciation and
amortization 1,055 197 106 - 479 1,837
Tangible assets 47,123 4,742 5,783 - 2,419 60,067
Goodwill 12,916 1,408 1,131 - - 15,455
Other intangible
assets 8 386 20 - - 414
Capital
expenditures 2,418 43 280 - 489 3,230
* The total operating profit includes (2) for the discontinued
manufacturing segment for 2005. This is the only activity for that
closed segment so it is not disclosed as a separate column in the
table above.
90
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Net Sales in our Engineering segment increased 3.0% to $221,787 in 2007 from
$215,306 in 2006. The increase for 2006 was 11.3% from $193,376 in 2005.
Dollars in Thousands 2007 2006 2005
------------ ------------ -----------
Total Engineering revenue:
Detail-design 132,210 59.6% 111,503 51.8% 89,904 46.4%
Field services 56,379 25.4% 53,921 25.0% 34,312 17.8%
Procurement services 16,011 7.2% 19,271 9.0% 59,527 30.8%
Fixed-price 17,187 7.8% 30,611 14.2% 9,633 5.0%
------------ ------------ -----------
Total Engineering revenue: $ 221,787 100.0% $ 215,306 100.0% $ 193,376 100.0%
============= ============ ===========
The Construction segment contributed 20.2% of our total revenue for 2007, as its
revenue increased $37.1 million, or 102.8%, from $36.1 million in 2006 to $73.2
million in 2007. The revenue in 2006 for this segment increased 64.8%, or $14.2
million, from $21.9 million in 2005.
Dollars in Thousands 2007 2006 2005
------------------ -------------------- --------------------
Total Construction revenue:
Pipeline 60,430 82.5% 28,987 80.2% 16,639 76.0%
Non-pipeline 12,780 17.5% 7,141 19.8% 5,259 24.0%
------------ ------------ ------------
Total Construction revenue: $ 73,210 100.0% $ 36,128 100.0% $ 21,898 100.0%
============ ============ ============
The Automation segment contributed 10.4% of our total revenue for the year, as
its revenue increased $2.9 million, or 8.3%, from $34.9 million in 2006 to $37.8
million in 2007. This segment's revenue also increased 90.7% in 2006, or $16.6
million, from $18.3 million in 2005.
Dollars in Thousands 2007 2006 2005
-------------------- -------------------- --------------------
Total Automation revenue:
Fabrication 22,814 60.4% 26,032 74.6% 14,159 77.3%
Non-fabrication 14,952 39.6% 8,856 25.4% 4,152 22.7%
----------- ------------ -----------
Total Automation revenue: $ 37,766 100.0% $ 34,888 100.0% $ 18,311 100.0%
=========== ============ ===========
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, other intangible assets, investments
in subsidiaries, and inter-company accounts receivables and payables are
excluded.
NOTE 19 - COMMITMENTS AND 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 employment is terminated 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.
91
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Litigation
----------
From time to time, one or more of ENGlobal Corporation's individual subsidiary
business entities are involved in various legal proceedings or are subject to
claims that arise in the ordinary course of business alleging, among other
things, claims of breach of contract or negligence in connection with the
performance or delivery of goods and/or services, and the outcome of any such
claims or proceedings cannot be predicted with certainty. As of the date of this
filing, all such active proceedings and claims of substance that have been
raised against any subsidiary business entity have been adequately reserved for,
or are covered by insurance, such that, if determined adversely to those
entities individually or in the aggregate, they 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 $13.9 million in aggregate in each policy year being covered by a
separate insurance policy.
92
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20 - SUBSEQUENT EVENTS
In June 2007, the Company received comments from the SEC staff related to our
Annual Report on Form 10-K/A and interim reports. On March 12, 2008, the Company
received notification from the SEC that all issues have been cleared.
On February 28, 2008, ENGlobal entered into a lease agreement with a third party
who will construct a new facility in Beaumont, Texas. This agreement has a
ten-year term, but the lease term will not commence until the sale of the
property to the developer/lessor has been completed. This property was the site
of a number of ENGlobal departments in 2005, when the building was destroyed by
Hurricane Rita. See also Note 12 - Related Party Transactions.
93
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 21 - QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
For the Quarters Ended - 2007
---------------------------------------------------------------------------------------
March June September December
--------- -------- --------- --------
(in thousands, except per share amounts)
Revenue per segment
Engineering $ 51,449 63.0% $ 56,966 63.6% $ 61,680 63.7% $ 51,692 54.3%
Construction 13,785 16.9% 15,988 17.6% 18,999 19.6% 24,438 25.7%
Automation 9,538 11.7% 9,518 10.6% 8,526 8.9% 10,184 10.7%
Land 6,887 8.4% 7,104 8.2% 7,620 7.8% 8,853 9.3%
--------- -------- --------- --------
Total $ 81,659 100.0% $ 89,576 100.0% $ 96,825 100.0% $ 95,167 100.0%
========= ======== ========= ========
Gross profit per segment
Engineering $ 9,164 17.8% $ 9,584 16.8% $ 10,801 17.6% $ 10,416 20.2%
Construction 2,082 15.1% 2,646 16.6% 3,678 19.4% 1,319 5.4%
Automation 781 8.2% 1,112 11.7% 774 9.1% 717 7.0%
Land 1,250 18.2% 877 12.4% 1,086 14.3% 1,330 15.0%
--------- -------- --------- --------
Total $ 13,277 16.3% $ 14,219 15.9% $ 16,339 16.9% $ 13,782 14.5%
========= ======== ========= ========
Net income $ 3,155 $ 3,913 $ 3,975 $ 1,421
========= ======== ========= ========
Earnings per share - basic $ 0.12 $ 0.15 $ 0.15 $ 0.05
Earnings per share - diluted $ 0.12 $ 0.14 $ 0.14 $ 0.05
For the Quarters Ended - 2006
-----------------------------------------------------------------------------------------
March June September December
--------- -------- --------- ---------
(in thousands, except per share amounts)
Revenue per segment
Engineering $ 54,358 81.6% $ 57,127 76.1% $ 57,434 69.7% $ 46,387 58.8 %
Construction 6,166 9.3% 7,326 9.8% 9,270 11.3% 13,366 17.0 %
Automation 6,103 9.1% 7,948 10.6% 8,494 10.3% 12,343 15.7 %
Land 0 0.0% 2,665 3.5% 7,306 8.7% 6,797 8.5 %
--------- -------- --------- ---------
Total $ 66,627 100.0% $ 75,066 100.0% $ 82,504 100.0% $ 78,893 100.0 %
========= ======== ========= =========
Gross profit per segment
Engineering $ 6,570 80.0% $ 8,535 15.0% $ 1,645 2.9% $ (1,089) (2.4)%
Construction 745 9.1% 704 9.6% 1,095 11.9% 1,181 8.9 %
Automation 907 10.9% 1,082 13.7% 839 9.9% 1,660 13.5 %
Land 0 0.0% 407 15.3% 970 13.3% 1,013 14.9 %
--------- -------- --------- ---------
Total $ 8,222 12.4% $ 10,728 14.3% $ 4,549 5.6% $ 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)
94
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, 2007 $ 670 $ 840 $ (105) $1,405
For year ended December 31, 2006 $ 503 $ 251 $ (84) $ 670
For year ended December 31, 2005 $ 476 $ 53 $ (26) $ 503
Reserve on current notes receivable for the year ended
December 31, 2007 $ - $ 120 $ - $ 120
Reserve on long-term notes receivable for the year
ended December 31, 2007 $ - $3,150 $ - $3,150
95
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
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, 2007, as required by Rule 13a-15 of
the Exchange Act. As described below, under "Management's Report on Internal
Control Over Financial Reporting," a material weakness was identified in our
internal control over financial reporting as of December 31, 2007. Based on the
evaluation described above, our Chief Executive Officer and Chief Financial
Officer have concluded that, as of December 31, 2007, our disclosure controls
and procedures were not effective to ensure that information required to be
disclosed by us in the reports we file or submit under the Exchange Act is
recorded, processed, summarized, and reported, within the time periods specified
in the SEC's rules and forms.
Changes in Internal Control Over Financial Reporting
In our Form 10-K for the year ended December 31, 2006, we disclosed certain
material weaknesses in internal control over financial reporting. Several of
those material weaknesses were remediated during the three months ended December
31, 2007. Below is a list of the remediation activities that were completed
during the quarter to remediate those material weaknesses:
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 as of December 31, 2006.
96
A. Actions Taken to Remediate the Weakness
o We hired additional staff in various accounting functions.
o We provided several supplementary training courses to our Accounting
Managers, Staff Accounts and clerical personnel on topics including:
the month-end financial close process, The Sarbanes-Oxley Act of 2002,
payroll, accounts payable, accounts receivable, and billings training
for our financial accounting system, and general accounting processes
and procedures.
o We retained a third-party tax consultant to frequently assess tax
requirements, prepare filings, and assist in the preparation of our
tax provision in accordance with SFAS 109.
o We restructured our back office departments by appointing senior level
personnel to provide additional oversight.
o We purchased various continuing education subscriptions for back
office departments.
o We engaged a third-party public accounting firm to perform independent
tests of controls and assist us in our evaluation of internal control
over financial reporting.
o We modified and strengthened our existing internal Management's
Discussion & Analysis (MD&A) process to include self-assessment
certifications regarding disclosure controls and procedures and
internal controls over financial reporting.
o We hired a Vice President, Project Controls to help align our project
reporting policies and procedures with our operational decisions and
our financial reporting.
o We hired a Vice President, Quality Assurance/Quality Control to help
align our project reporting policies and procedures with our
operational decisions and our financial reporting.
o We created a monthly status report procedure as a part of the
month-end financial close process.
B. Status of Material Weakness
Although significant progress has been made in remediating this material
weakness as described above, this weakness was not fully remediated as of
December 31, 2007, due to a lack of sufficient knowledge and expertise in
financial reporting to adequately handle complex or non-routine accounting
issues. This issue has been identified as a material weakness in our evaluation
of internal control over financial reporting as of December 31, 2007, as
described below in "Management's Report on Internal Control over Financial
Reporting."
2. Deficiencies in the Company's Information Technology Access Controls.
------------------------------------------------------------------------
We did not maintain effective controls sufficient to prevent access by
unauthorized personnel to end-user spreadsheets and other information technology
programs and systems as of December 31, 2006.
97
A. Actions Taken to Remediate the Weakness
We implemented the use of a password for access to any spreadsheets sent outside
of the Accounting Department and established additional password controls
specific to the Chief Financial Officer and Controller.
B. Status of Material Weakness
The above material weakness was remediated as of December 31, 2007.
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 of December 31, 2006, as required by generally accepted
accounting principles.
A. Actions Taken to Remediate the Weakness
In addition to the actions listed above under "Deficiencies in the Company's
Control Environment," we took the following actions:
o We engaged various third-party consultants to assist us with specific
technical accounting issues to help ensure that our disclosures are
complete and accurate in accordance with generally accepted accounting
principles.
o We implemented quarterly and annual disclosure checklists that are
completed prior to the completion of our quarterly financial
statements.
B. Status of Material Weakness
Although significant progress has been made in remediating this material
weakness as described above, this weakness was not fully remediated as of
December 31, 2007, due to a lack of sufficient knowledge and expertise in
financial reporting to adequately handle complex or non-routine accounting
issues. This issue has been identified as a material weakness in our evaluation
of internal control over financial reporting as of December 31, 2007, as
described below in "Management's Report on Internal Control over Financial
Reporting."
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 as of
December 31, 2006.
98
A. Actions Taken to Remediate the Weakness
o We implemented a commitments and contingencies questionnaire based on
the criteria described in SFAS 5, "Accounting for Contingencies," that
is completed as part of our quarterly internal MD&A process and that
is provided to the Chief Executive Officer and Chief Financial Officer
prior to completion of our periodic reports.
o We have reinforced the purchase order process when making expenditures
across the organization.
o We have updated and reinforced our expenditure approval authority
matrix.
o We have incorporated into our monthly project review process a review
of project purchase commitments.
B. Status of Material Weakness
The above material weakness was remediated as of December 31, 2007.
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 as of December 31, 2006.
A. Actions Taken to Remediate the Weakness
o We added Fixed-Price Status Reports that are provided monthly as a
part of our month-end financial close process.
o Our Automation segment added a monthly project review to discuss the
Fixed-Price Status Reports.
o We issued guidance and procedures that address the requirements,
standards and responsibilities for estimating and reporting project
cost and schedules, including trending and forecasting required costs.
o Our estimating department reinforced relationships with other
execution centers, which perform independent assessments of estimates
prior to formal issuance.
o We established new standard project cost status reports to identify
contract change order information and cost requirements and highlight
man hour and cost variances, cost savings and current profitability of
each project over $1 million in the Engineering segment (and soon to
be implemented throughout the organization).
o We incorporated a request for information on fixed-price projects over
$500,000 in project value from the heads of our segments and corporate
functions as part of our quarterly internal MD&A process, which is
provided to the Chief Executive Officer and Chief Financial Officer
prior to completion of our periodic reports.
99
B. Status of Material Weakness
The above material weakness was remediated as of December 31, 2007.
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 as of December 31, 2006, which accounted
for approximately 11% of the Company's revenues in 2006.
A. Actions Taken to Remediate the Weakness
See "Deficiencies in the Company's Controls Regarding Fixed-Price Contract
Information" listed above.
B. Status of Material Weakness
The above material weakness was remediated as of December 31, 2007.
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.
A. Actions Taken to Remediate the Weakness
See "Deficiencies in the Company's Control Environment" listed above.
B. Status of Material Weakness
The above material weakness was remediated as of December 31, 2007.
b) Management's Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal
control over financial reporting as that term is defined in Exchange Act Rule
13a-15(f). 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 ("GAAP"). Our
internal control over financial reporting includes those policies and procedures
that (i) pertain to the maintenance of records that, in reasonable detail,
100
accurately and fairly reflect our transactions and dispositions of our assets;
(ii) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of our financial statements in accordance with GAAP, and that
our receipts and expenditures are being made only in accordance with
authorizations of our management and directors; and (iii) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition,
use or disposition of our assets that could have a material effect on our
financial statements.
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 safeguards into
the process to reduce, although not eliminate, this risk. In addition,
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
because the degree of compliance with the policies or procedures may
deteriorate.
In order to evaluate the effectiveness of our internal control over financial
reporting as of December 31, 2007, as required by Section 404 of the
Sarbanes-Oxley Act of 2002, our management conducted an assessment, including
testing, based on the criteria set forth in Internal Control--Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (the "COSO Framework"). A material weakness is a control deficiency,
or a combination of control deficiencies, that results in more than a remote
likelihood that a material misstatement of our annual or interim financial
statements will not be prevented or detected. In assessing the effectiveness of
our internal control over financial reporting, management identified the
following material weakness in internal control over financial reporting as of
December 31, 2007:
o The Company lacks sufficient knowledge and expertise in financial
reporting to adequately handle complex or non-routine accounting
issues, resulting in the following:
- Failure in a timely manner to properly evaluate goodwill for
potential impairment in accordance with SFAS 142, "Goodwill and
Other Intangible Assets."
- Difficulty in obtaining timely resolution of SEC comments related
to the above item, causing a delay in the Company's period-end
closing process for its 2007 Form 10-K.
- Failure to effectively utilize third-party specialists in a
timely manner to assist with complex or non-routine accounting
issues.
Based on the material weaknesses described above and the criteria set forth by
the COSO Framework, we have concluded that our internal control over financial
reporting at December 31, 2007, was not effective.
The Company's independent registered public accounting firm, Hein & Associates,
has issued the following attestation report on the Company's internal control
over financial reporting.
101
PART III
--------
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by Items 401, 405, 406, and 407(c)(3), (d)(4), and
(d)(5) of Regulation S-K will appear under the captions "Election of Directors,"
"Section 16(a) Beneficial Ownership Reporting Compliance" and "Corporate
Governance" in our 2008 Proxy Statement. For the limited purpose of providing
the information necessary to comply with this Item 10, the 2008 Proxy Statement
is incorporated herein by this reference.
We have adopted a written code of conduct that applies to our directors,
officers, and employees. In addition, we have a code of ethics specific for our
chief executive officer, chief financial officer, and senior accounting officers
or persons performing similar functions. Both codes can be found on our web
site, which is located at www.englobal.com, and are also exhibits to this
report. We intend to make all required disclosures concerning any amendments to,
or waivers from, our code of ethics on our web site.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 402 and paragraphs (e)(4) and (e)(5) of Item
407 of Regulation S-K will appear under the captions "Director Compensation" and
"Executive Compensation Tables" including "Compensation Discussion and
Analysis," "Compensation Committee Interlocks and Insider Participation" and
"Compensation Committee Report" in our 2008 Proxy Statement. For the limited
purpose of providing the information necessary to comply with this Item 11, the
2008 Proxy Statement is incorporated herein by this reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Items 201(d) and 403 of Regulation S-K will appear
under the headings "Beneficial Ownership of Common Stock" and "Securities
Authorized for Issuance under Equity Compensation Plans" in our 2008 Proxy
Statement. For the limited purpose of providing the information necessary to
comply with this Item 12, the 2008 Proxy Statement is incorporated herein by
this reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Items 404 and 407(a) of Regulation S-K will appear
under the captions "Certain Relationships and Related Transactions" and
"Director Independence" in our 2008 Proxy Statement. For the limited purpose of
providing the information necessary to comply with this Item 13, the 2008 Proxy
Statement is incorporated herein by this reference.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
This information required by Item 9(e) of Schedule 14A will appear under the
caption "Principal Auditor Fees and Services" in our 2008 Proxy Statement. For
the limited purpose of providing the information necessary to comply with this
Item 14, the 2008 Proxy Statement is incorporated herein by this reference.
102
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
103
EXHIBIT INDEX
Incorporated by Reference to:
------------------------------------------------
Filing
Form or Date with SEC File
Schedule Exhibit No. SEC Number
-------- ----------- --------- --------
Exhibit No. Description
----------- -----------
3.1 Restated Articles of Incorporation of 10-Q 3.1 11/14/02 001-14217
ENGlobal Corporation
3.2 Amendment to the Restated Articles of 8-A12B 3.1 12/17/07 001-14217
Incorporation of the Registrant, filed with the
Nevada Secretary of State on June 2, 2006
*3.3 Amended and Restated Bylaws of Registrant dated
November 6, 2007
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 S-3 4.5 10/31/05 333-129336
September 29, 2005, by and between Tontine
Capital Partners, L.P. and Registrant
4.4 Form of Subscription Agreement by and among S-3 4.6 10/31/05 333-129336
Registrant, Michael L. Burrow, Alliance 2000,
Ltd. and certain subscribers
10.1 Option Pool Agreement between Industrial Data 10-KSB 10.48 4/1/02 001-14217
Systems Corporation and Alliance 2000, Ltd. dated
December 21, 2001
*10.2 Amended and Restated Alliance Stock Option Pool
Agreement effective December 20, 2006
10.3 Second Amended and Restated Alliance Stock Option 8-K 10.2 5/23/07 001-14217
Agreement dated effective December 20, 2006
10.4 Second Amended and Restated Lease Agreement 10-Q 10.63 8/12/02 001-14217
between Petrocon Engineering, Inc. and Corporate
Property Associates 4dated February 28, 2002
(Exec I)
10.5 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 (Exec
I)
*10.6 Amended and Restated 1998 Incentive Plan dated
June 8, 2006
*10.7 First Amendment to the Amended and Restated 1998
Incentive Plan dated June 14, 2007
*10.8 Form of ENGlobal Corporation Incentive Stock
Option Award Agreement of 1998 Incentive Plan
10.9 Form of ENGlobal Corporation Non-qualified Stock S-8 10.80 8/24/05 333-127803
Option Agreement Granted Outside of 1998
Incentive Plan
10.10 Lease Agreement between Petrocon Engineering, 10-Q 10.66 11/14/02 001-14217
Inc. and Phelan Investments on July 25, 2002
(Exec III)
104
Incorporated by Reference to:
------------------------------------------------
Filing
Form or Date with SEC File
Schedule Exhibit No. SEC Number
-------- ----------- --------- --------
Exhibit No. Description
----------- -----------
*10.11 Lease Agreement between Oral Roberts University
and ENGlobal Engineering, Inc. dated January 27,
2005
10.12 First Amendment to the Lease Agreement between 10-K/A 10.26 03/29/07 001-14217
Oral Roberts University and ENGlobal Engineering,
Inc. dated April 5, 2005
10.13 Second Amendment to the Lease Agreement between 10-K/A 10.27 03/29/07 001-14217
Oral Roberts University and ENGlobal Engineering,
Inc. dated June 15, 2005
10.14 Third Amendment to the Lease Agreement between 10-K/A 10.28 03/29/07 001-14217
Oral Roberts University and ENGlobal Engineering,
Inc. dated December 28, 2005
10.15 Fourth Amendment to the Lease Agreement between 10-K/A 10.29 03/29/07 001-14217
Oral Roberts University and ENGlobal Engineering,
Inc. dated February 27, 2006
10.16 Fifth Amendment to the Lease Agreement between 10-K/A 10.30 03/29/07 001-14217
Oral Roberts University and ENGlobal Engineering,
Inc. dated July 28, 2006
*10.17 Sixth Amendment to the Lease agreement between
Oral Roberts University and ENGlobal Engineering,
Inc. dated June 20, 2007
10.18 Credit Agreement by and between Comerica Bank and 10-Q 10.1 11/09/07 001-14217
ENGlobal Corporation and it subsidiaries dated
August 8, 2007
10.19 Hand Note between South Louisiana Ethanol LLC and 10-Q 10.2 11/09/07 001-14217
ENGlobal Engineering, Inc dated October 22, 2007
10.20 Collateral Mortgage between South Louisiana 10-Q 10.3 11/09/07 001-14217
Ethanol LLC, and ENGlobal Engineering, Inc. dated
August 26, 2007
10.21 Collateral Mortgage between South Louisiana 10-Q 10.4 6/14/07 001-14217
Ethanol LLC and ENGlobal Engineering, Inc. dated
August 31, 2007
10.22 Amended and Restated ENGlobal 401(k) Plan 10-K/A 10.22 03/29/07 001-14217
effective October 1, 2005
10.23 First Amendment of the ENGlobal 401(k) Plan 10-K/A 10.21 03/29/07 001-14217
effective December 21, 2001
10.24 Second Amendment to the ENGlobal 401(k) Plan 10-K/A 10.23 03/29/07 001-14217
effective April 1, 2006
10.25 Third Amendment to the ENGlobal 401(k) Plan 10-K/A 10.24 03/29/07 001-14217
effective July 1, 2006
10.26 Regulations Amendment to the ENGlobal 401(k) Plan 10-K 10.21 03/16/07 001-14217
effective January 1, 2006
105
Incorporated by Reference to:
------------------------------------------------
Filing
Form or Date with SEC File
Schedule Exhibit No. SEC Number
-------- ----------- --------- --------
Exhibit No. Description
----------- -----------
10.27 ENGlobal Corporation Key Manager Incentive Plan 8-K 10.43 04/10/07 001-14217
effective January 1, 2007
10.28 ENGlobal Corporation Key Executive Employment 10-K/A 10.39 03/29/07 001-14217
Agreement (W. Coskey) effective January 1, 2006
10.29 ENGlobal Corporation Key Executive Employment 10-K/A 10.42 03/29/07 001-14217
Agreement (Robert Raiford) effective
January 1, 2006
10.30 Separation Agreement and Release between ENGlobal 8-K 10.1 05/23/07 001-14217
Corporation and Michael L. Burrow dated April 2,
2007
*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 Business Conduct and
Ethics dated August 6, 2007
*14.2 ENGlobal Corporation Code of Ethics for Chief
Executive Officer and Senior Financial Officers
dated August 6, 2007
*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
106
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 27, 2008
By: //s// William A Coskey
William A. Coskey, 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// William A. Coskey
William A. Coskey, 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
107