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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, 2004
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)
600 Century Plaza Drive, Suite 140, Houston, Texas 77073-6033
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(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (281) 821-7100
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 American Stock Exchange
Securities registered pursuant to Section 12(g) of the Exchange Act:
None
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shortened period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
Yes No X
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes No X
--- ---
The aggregate market value of the registrant's common stock held by
non-affiliates of the registrant on June 30, 2004 was $20,777,935 (based upon
the closing price for shares of common stock as reported by the American Stock
Exchange on that date).
The number of shares outstanding of the registrant's common stock on
March 16, 2005 is as follows:
$0.001 Par Value Common Stock 23,474,839 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 2005 Annual Meeting of Stockholders
to be filed with the Securities and Exchange Commission on or before April 30,
2005.
Transitional Small Business Disclosure Format: Yes No X
--- ---
ENGlobal Corporation
2004 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 4
ITEM 2. PROPERTIES 19
ITEM 3. LEGAL PROCEEDINGS 20
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 20
PART II
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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS 21
ITEM 6. SELECTED FINANCIAL DATA 23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION 25
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 35
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 35
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE 64
ITEM 9A. CONTROLS AND PROCEDURES 64
PART III
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ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 65
ITEM 11. EXECUTIVE COMPENSATION 65
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT 65
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 65
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES 65
PART IV
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ITEM 15. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON
FORM 8-K 66
SIGNATURES
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SIGNATURES 72
2
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, among others,
could cause the Company's actual results to differ materially from the
forward-looking statements contained in this Report: (i) the effect of changes
in laws and regulations with which the Company must comply, and the associated
costs of compliance with such laws and regulations, either currently or in the
future, as applicable; (ii) the effect of changes in accounting policies and
practices as may be adopted by regulatory agencies, as well as by the Financial
Accounting Standards Board; (iii) the effect of changes in the Company's
organization, compensation and benefit plans; (iv) the effect on the Company's
competitive position within its market area of the increasing consolidation
within its services industries, including the increased competition from larger
regional and out-of-state engineering services organizations; (v) the effect of
increases and decreases in oil prices; (vi) the availability of parts from
vendors; (vii) our ability to increase or renew our line of credit; (viii) our
ability to identify attractive acquisition candidates, consummate acquisitions
on terms that are favorable to the Company and integrate the acquired businesses
into the Company's operations; (ix) the ability to hire and retain qualified
personnel; (x) the ability to retain existing customers and get new customers
and (xi) the effect of changes in the business cycle and downturns in local,
regional and national economies. The Company cautions that the foregoing list of
important factors is not exclusive. We are under no duty and have no plans to
update any of the forward-looking statements after the date of this Report to
conform such statements to actual results.
The following summary is qualified in its entirety by, and should be read in
connection with the more detailed information contained herein and in the
Company's Consolidated Financial Statements, and the Notes thereto, included
elsewhere in this Report.
3
ITEM 1. BUSINESS
General
ENGlobal Corporation (which may be referred to as "ENGlobal," the "Company,"
"we," "us" or "our") is a leading provider of engineering services and systems
principally to the petroleum refining, petrochemical, pipeline, production and
process industries throughout the United States and internationally. The
services provided by our multi-disciplined staff span the lifecycle of a project
and include feasibility studies, design, procurement and construction
management. We also supply automation, control and uninterruptible electrical
power systems to our clients worldwide.
The Company was incorporated as Industrial Data Systems Corporation in the State
of Nevada in June 1994. In December 2001, we merged with Petrocon Engineering,
Inc. ("Petrocon") and in June 2002, we changed the name of the Company from
Industrial Data Systems Corporation to ENGlobal Corporation. Effective June 16,
2002, the Company's trading symbol for its common stock, traded on the American
Stock Exchange, changed from IDS to ENG.
In the last five years, the Company's net revenue from continuing operations has
grown from $13.6 million in 2000 to $148.9 million in 2004, a compounded annual
growth rate of approximately 82%. Since the merger with Petrocon, the Company's
net revenue from continuous operations has grown from $89.1 million in 2002, a
compounded annual growth rate of approximately 29%. We have accomplished this
growth by expanding our engineering and systems services and geographic presence
through a series of strategic acquisitions and through internal growth
initiatives. We now have more than 1,400 full-time equivalent employees in
offices strategically located in Houston, Beaumont, Freeport, Midland and
Dallas, Texas; Baton Rouge and Lake Charles, Louisiana; and Tulsa and Cleveland,
Oklahoma.
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 450
Fifth Street, N.W., 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 that contains information we
file electronically with the SEC, that can be accessed over the Internet at
www.sec.gov. Our common stock is listed on the American Stock Exchange (AMEX:
ENG), and you can obtain information about ENGlobal at the offices of the
American Stock Exchange, 86 Trinity Place, New York, New York 10006-1872 or at
their website www.amex.com.
ENGlobal Website
You can find financial and other information about ENGlobal at the Company's
website at the URL address www.englobal.com. Copies of our annual reports on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and
amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of the Securities Exchange Act of 1934 are provided free of charge through
the Company's website and are available as soon as reasonably practicable after
filing such material electronically or otherwise furnishing it 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 at www.englobal.com under
the Investor Relations link. We will provide any of the foregoing information
without charge upon written request to Investor Relations Officer, ENGlobal
Corporation, 600 Century Plaza Drive, Building 140, Houston, Texas 77073-6033.
As of June 1, 2005, the Company will relocate its corporate headquarters to 654
North Sam Houston Parkway E, Suite 400, Houston, Texas 77060-5914.
4
ITEM 1. BUSINESS (Continued)
Business Segments
During 2004, we operated two business segments: engineering and systems. The
respective contributions to our total sales in 2004, 2003 and 2002 for the
engineering and the systems segments are summarized below.
Percentage of Revenues
-----------------------------------
Segment: (1) 2004 2003 2002
-------- -------- --------
Engineering 89.8% 87.6% 84.1%
Systems 10.2% 12.4% 15.9%
------- ------- -------
100.0% 100.0% 100.0%
======= ======= =======
(1) Does not include manufacturing segment, which was sold in December
2003.
The shift in the percentage of revenue figures between the engineering and
systems business segments highlights the growth the engineering segment has
experienced over the last three years. Revenues from the systems segment have
remained constant over the three-year period, while engineering revenues
increased 45% and 23%, respectively, during the periods 2002 to 2003 and 2003 to
2004.
Engineering Segment
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2004 2003 2002
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(Amounts in thousands)
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Revenues from external customers $133,630 $108,380 $ 74,971
Operating profit $ 10,512 $ 10,716 $ 7,148
Total assets $ 46,122 $ 35,531 $ 30,615
General
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Our engineering segment offers engineering consulting services to clients in the
petroleum refining, petrochemical, pipeline, production and process industries
for the development, management and turnkey execution of engineering projects
and provides inspection services throughout the United States. The engineering
segment is currently comprised of the following wholly-owned subsidiaries of
ENGlobal Corporation: ENGlobal Engineering, Inc. ("EEI"), RPM Engineering, Inc.
d/b/a ENGlobal Engineering, Inc. ("RPM"), ENGlobal Construction Resources, Inc.
("ECR") and ENGlobal Design Group, Inc. ("EDG"). EEI and RPM focus primarily on
providing services to the downstream petroleum refining and petrochemical
industry, including refineries and processing plants, upstream and midstream
pipeline companies and gas plants. ECR primarily provides inspection services to
industrial plants throughout the United States. EDG primarily provides Automated
Fuel Handling Systems and services to branches of the U.S. military. The
engineering segment derives revenues primarily from fees charged for
professional and technical services. As a service company, we are more labor
than capital intensive and our income results from our ability to generate
revenues and collect cash under contracts for our employees' time in excess of
any subcontract, pass-thru materials and equipment and non-labor costs and our
selling, general and administrative (SG&A) expenses.
The engineering segment has approximately 73 existing blanket service contracts
pursuant to which it provides clients either with services on a time and
materials basis or with services on a fixed fee, turnkey basis. Our engineering
segment operates out of offices in Baton Rouge and Lake Charles, Louisiana;
Beaumont, Dallas, Houston, Midland and Freeport, Texas; and Cleveland and Tulsa,
Oklahoma. Our engineering segment also makes unique, custom-made process related
fabricated systems, designed to customer specifications.
5
ITEM 1. BUSINESS (Continued)
Business Segments (Continued)
During 2003, as part of our plan to extend our geographical range and to serve
the downstream petrochemical industries, such as the petroleum refining,
petrochemical and process industries in the Freeport, Texas area, ENGlobal
acquired selected assets of Petro-Chem Engineering, Inc. ("Petro-Chem").
Petro-Chem had a staff of 55 engineers, designers, inspectors and support
personnel engaged on contract projects with several Freeport area clients. This
acquisition allowed us to expand into the Freeport area with experienced staff
that has an established reputation. The Freeport office currently provides
on-site engineering, design and support personnel to a leading chemical client
that has facilities in Freeport and Port Arthur, Texas and in Geismar,
Louisiana.
During 2004, the engineering segment continued its geographical expansion with
new offices in Dallas and Midland, Texas and Cleveland, Oklahoma, plus an
additional office in Tulsa, Oklahoma. In January, through EDG, we acquired
certain assets of Engineering Design Group, Inc. ("EDGI") located in Tulsa,
Oklahoma. EDG provides design, installation and maintenance of various
government and public sector facilities, the most active sector being Automated
Fuel Handling Systems serving the U.S. military. In August, we announced the
expansion of its operation in the sulfur reduction business to be operated from
Dallas, Texas. In September, through ECR, we acquired certain assets of AmTech
Inspection located in Midland, Texas. The new division's revenues are derived
primarily from providing inspectors for regional refining and pipeline
operations. In October, again through ECR, ENGlobal acquired certain assets of
Cleveland Inspection Services, Inc. ("CIS") located in Cleveland, Oklahoma. CIS
provides inspection and construction management services in support of the oil
and gas, utility and pipeline industries.
In March 2005, ENGlobal Engineering formed ENGlobal Automation Group ("EAG") to
provide services relating to the implementation of process control, advance
automation and information technology projects providing our clients with a full
range of services, including but not limited to, front-end engineering
feasibility studies and the execution of turnkey engineering, procurement, and
construction projects. By focusing on large-scope projects, EAG intends to
pursue distributed control systems ("DCS") conversion and new installation
projects by utilizing its own resources as well as resources from both ENGlobal
Engineering and ENGlobal Systems. EAG will promote our proven capabilities for
plant automation services and products to respond to an industry progression
toward replacing obsolete technology with new open system architecture
distributed control systems.
Our engineering segment offers its expertise to a broad range of industrial
clients. We participate in projects involving both the modification of existing
facilities and construction of new facilities. Our predominant type of contract
is a blanket services contract that typically provides our clients with
engineering, procurement and project management services on a time and materials
basis. We also enter into contracts to complete capital projects on a full
service, turnkey basis. The engineering staff has the capability of developing a
project from the initial planning stages through detailed design and
construction management. Services that we provide include:
o conceptual studies;
o project definition;
o cost estimating;
o engineering design;
o inspection;
o material procurement; and
o project and construction management.
We provide services for major energy-related firms at facilities such as
chemical plants, crude oil refineries, electric power generation facilities,
cross-country pipelines, pipeline facilities and production processing
facilities.
6
ITEM 1. BUSINESS (Continued)
Business Segments (Continued)
The engineering segment seeks to offer its clients a wide range of services from
a single source provider. In addition, the segment uses an internal virtual
private network so that the employees in one location can work on projects
housed in other offices. This "work sharing" capability allows us to provide a
greater depth and breadth of expertise to our clients and helps stabilize the
workload in our various offices.
Competition
- -----------
Our engineering segment competes with a large number of firms of various sizes,
ranging from the industry's largest firms, which operate on a worldwide basis,
to much smaller regional and local firms. Typical engineering segment
competitors include (in alphabetical order): CDI Engineering Group; Jacobs
Engineering Group; Matrix Engineering; Mustang Engineering; S&B Engineering; SNC
Lavilan GDS, Inc; and TAG. Many of our competitors are larger than we are and
have significantly greater financial and other resources available to them than
we do.
Competition is primarily centered on performance and the ability to provide the
engineering, planning and project execution skills required to complete projects
in a timely and cost efficient manner. The technical expertise of our management
team and technical personnel and the timeliness and quality of our support
services, are key competitive factors. Larger projects, especially international
work, typically include pricing alternatives designed to shift risk to the
service provider, or at least to cause the service provider to share a portion
of the risks associated with cost overruns in service delivery. These
alternatives include fixed-price, guaranteed maximum price, incentive fee,
competitive bidding and other "value based" pricing arrangements.
Systems Segment
- ---------------
-------------------------------
2004 2003 2002
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(Amounts in thousands)
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Revenues to external customers $ 15,258 $ 15,339 $ 14,151
Operating profit (loss) $ 585 $ (38) $ 851
Total assets $ 7,806 $ 3,913 $ 6,186
General
Our systems segment designs, assembles, programs, installs, integrates and
services control and instrumentation systems for specific applications in the
energy and processing related industries. The systems segment currently consists
of the following four wholly-owned subsidiaries: ENGlobal Systems, Inc. ("ESI"),
ENGlobal Constant Power, Inc. ("ECP"), ENGlobal Technologies, Inc. ("ETI") and
Senftleber & Associates L.P. ("Senftleber"). Beginning in 2005, the operations
of ECP, ETI and Senftleber were merged into ESI and Senftleber was dissolved
effective December 31, 2004. The Company now intends to dissolve ECP and ETI.
The systems segment derives revenues primarily from fees on contracts for the
design and assembly of control and instrumentation systems. Income from the
systems segment is derived from our ability to generate revenues and collect
cash on fixed price contracts in excess of our costs for labor, materials and
equipment and transportation costs, plus our SG&A expenses.
ESI's control and instrumentation systems are custom designed and include both
conventional pneumatic and hydraulic control systems, as well as electronic,
microprocessor-based controls employing programmable logic. Typical applications
for control and instrumentation systems include oil and gas production safety
systems; refinery, petrochemical and chemical plant controls; analyzer
packaging; fire and gas detection systems; pipeline facility controls; data
acquisition systems; and control systems for various processing equipment. We
perform all facets of control and instrumentation system design, engineering,
assembly and testing in-house. Field installation and technical staff perform
start-up and commissioning services, modification to existing systems, on-site
training and routine maintenance procedures for client operating personnel.
7
ITEM 1. BUSINESS (Continued)
Business Segments (Continued)
ESI also operates (previously through ECP) in the industrial electrical power
backup and conditioned power systems marketplace and fabricates industrial grade
uninterruptible electrical power systems and battery chargers. Both standard and
custom-designed products and systems are fabricated and sold in a wide array of
power ranges. These products include:
o battery chargers;
o battery monitoring systems;
o DC power supplies;
o DC/AC inverters;
o uninterruptible power systems ("UPS"); and
o power distribution systems and solar photo-voltaic systems.
In addition, ESI provides field service support for installation and maintenance
of the foregoing products. Most of the products are made pursuant to
specifications required for a particular order. Refineries, petrochemical
plants, pipeline facilities, utilities, offshore platforms and other commercial,
industrial and governmental facilities across the United States utilize these
products. ESI's USGS Intellicharger(TM) product line of microprocessor
controlled battery chargers has been used as an integral component in major
power systems and is now included in a majority of system units that contain
battery chargers.
Additionally, ESI provides products and services supporting the advanced
automation and environmental technology fields. Advanced automation services
provided by ESI include automation technology audits, consulting, advanced
process controls and process computer services, multivariable control,
optimization (on-line and off-line), neural net applications, operator training
simulators, expert systems and on-site support. ESI supports the environmental
technology field by providing predictive emissions monitoring ("PEMS"),
continuous emissions monitoring system ("CEMS"), Flare-MonTM (flare monitoring
system) and air emissions consulting.
In October 2003, through ETI, the Company acquired a small software services
company, Senftleber & Associates, LP, of Houston, Texas, which provides support
services for the pipeline industry, primarily through provision of technical
personnel with expertise in Supervisory Control and Data Acquisition (SCADA)
systems. In December 2004, ESI purchased contract rights and other assets of
InfoTech Engineering Company ("InfoTech"), headquartered in Baton Rouge,
Louisiana. The InfoTech acquisition expands ESI's capability in controls system
integration in both the automation and process control services. Info Tech's
primary experience is in the onshore and offshore oil and gas and petrochemical
industries.
In February of 2005, ESI, along with EPIC Technical Services, Inc., a subsidiary
of EPIC Group, Inc., formed a new company, EPIC ENGlobal, LLC ("EPIC ENGlobal"),
in order to offer turnkey integrated engineering, automation and construction
services. The new company plans to become a single source provider of
construction and engineering services in both domestic and international markets
providing services to include preliminary detailed engineering, process control,
power systems, instrumentation, system integration, control panel and component
fabrication, construction and maintenance. EPIC ENGlobal expects to focus on
both upstream and downstream energy sectors, as well as chemical, petrochemical,
food and beverage, power, and pharmaceutical industries. EPIC ENGlobal intends
to provide ESI with an immediate presence in the upstream engineering,
construction and fabrication marketplace. Equally, EPIC Technical Services
anticipates that it will be able to use ESI's engineering, analytical,
distributive control, and systems integration and packaging capabilities. Each
company brings complementary expertise with the ultimate goal of attaining a
broader reach across the target markets.
8
ITEM 1. BUSINESS (Continued)
Business Segments (Continued)
Competition
The systems segment has been impacted by price variations attributable to
cyclical conditions in the oil and gas, petroleum and processing industries. In
addition, during 2004, a large percentage of ESI revenues were derived from
fabrication which has a lower profit margin than other activities. ESI's control
systems and modular facilities compete with similar systems built by other
companies, most of which compete primarily on the basis of pricing. Typical
systems competitors include (in alphabetical order): Aspen Technologies;
Honeywell; ICS/Triplex; PasTech; Puffer Sweiven; Scallon Controls; and Siemens.
Competition in ESI's market for power systems and battery backup products is
characterized by a small number of larger companies that dominate the market and
a large number of similarly sized companies that compete for a limited share of
the market. Companies that compete in the power systems arena are (in
alphabetical order): Custom Power; Gutor; LaMarche Mfg.; Powerware; SCI; and
Toshiba.
For advanced control consulting, ESI competes directly with large companies such
as Honeywell Hyspec. Smaller independent contractors provide low prices but
generally do not provide long-term support and backup. Aspen Technologies and
James/Magnum Associates are also competitors in this area of business. We
believe that pricing, technical competence and ability to provide superior
service are the primary bases of competition.
Acquisitions and Sales
We have grown our business over the past several years through both internal
initiatives and 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
to further complement our existing business base; however, we are also focusing
on opportunities for internal growth. 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.
One of the Company's subsidiaries, ENGlobal Design Group, Inc. ("EDG"),
purchased certain assets of Tulsa-based Engineering Design Group, Inc. ("EDGI")
effective January 23, 2004. We expect that the acquisition of these assets will
enhance its capabilities to obtain contracts relating to government and public
sector facilities. EDG's most active sector involves Automated Fuel Handling
Systems for the U.S. Military. In connection with the purchase, EDG issued two
$150,000 notes bearing interest at 5% maturing in December 2008 and a $2.5
million five-year contingent promissory note, with payments due annually, as
part of an earn-out structure based on revenues of the EDG operations over the
next five years. EDG did not pay any cash or issue any stock in the transaction.
The original consideration given for the purchase of certain EDGI assets
approximated the fair value; therefore the transaction did not result in any
goodwill. Principal and interest on the $2.5 million five-year contingent
promissory note will be charged to goodwill. As of December 31, 2004, $139,000
in principal and interest on the contingent promissory note was charged to
goodwill.
In October 2004, one of the Company's subsidiaries, ENGlobal Construction
Resources, Inc., purchased the name and certain assets of Cleveland Inspection
Services, Inc. ("CIS"). CIS provides inspection and construction management
services in support of the oil and gas, utility, and pipeline industries. In
exchange for the assets acquired, the Company paid $2.0 million consisting of
cash, a promissory note and assumption of certain designated contract
obligations and entered into non-compete agreements with CIS and its principals.
In connection with the acquisition, we hired approximately 180 former CIS
employees. CIS is operated as a division of ENGlobal Construction Resources,
Inc., marketing its services using the Cleveland Inspection Services name.
9
ITEM 1. BUSINESS (Continued)
Acquisitions and Sales (Continued)
In December 2004, ESI purchased contract rights and other assets of InfoTech
Engineering Company, LLC, a limited liability company ("InfoTech"),
headquartered in Baton Rouge, Louisiana. In exchange for the contract rights and
other certain assets, the Company paid $325,000 consisting of cash, a promissory
note and entered into a non-compete agreement with the former owner. The
InfoTech acquisition expands ESI's capability in controls system integration in
both the automation and process control services. Info Tech's primary experience
is in the onshore and offshore oil and gas and petrochemical industries.
During fiscal 2003, the Company completed two acquisitions of operating
companies. Petro-Chem Engineering, Inc. ("Petro-Chem"), acquired by EEI, and
Senftleber & Associates, L.P. ("Senftleber"), acquired by ETI, were acquired
during the third and fourth quarters, respectively. Petro-Chem operates
primarily in Freeport, Texas. Petro-Chem primarily provides on-site engineering,
design and support personnel to a client that has facilities in Freeport and
Port Arthur, Texas and Geismar, Louisiana. Senftleber is a Houston-based
provider of technical personnel with expertise in software systems such as SCADA
systems.
In December 2003, we completed the sale of certain assets of our subsidiary,
Thermaire, Inc., d/b/a Thermal Corporation, which comprised our manufacturing
segment, to Nailor Industries of Texas, Inc., a medium sized HVAC equipment
manufacturer. The disposition had been actively pursued since November 2001 in
order to permit us to strategically focus on our core operations. The sale
resulted in a $26,000 gain, net of tax. The 37,000 square foot office and
manufacturing facility owned by Thermaire was not included in the transaction.
The Company sold the real property previously used by Thermaire in March 2005
(see Item 2. - Properties). Information relating to all prior periods throughout
this Report treats the manufacturing segment as discontinued and excludes it
from continuing operations.
Business Strategy
Our objective is to strengthen the Company's position as a leading engineering
and consulting services provider while enhancing the services we offer and
expanding our geographic presence. To achieve this objective, we have developed
a strategy comprised of the following key elements:
o Enhance and Strengthen Our Ability to Perform Engineering, Procurement
and Construction Projects. We rely heavily on repeat business and
referrals from existing customers, industry members and manufacturing
representatives. The engineering segment's strategy is to increase
revenues by developing and marketing its ability to perform full
service turnkey projects, also called EPC (Engineering, Procurement
and Construction) projects. The engineering segment has traditionally
been responsible only for the engineering portion of its projects,
which usually represents between five to fifteen percent of a
project's total installed cost.
o Continue to Recruit and Retain Qualified Personnel. We believe
recruiting and retaining qualified, skilled professionals is crucial
to our success and growth. As a result, we have dedicated staff
focused on recruiting personnel with experience in the petrochemical
industry. We have used inter-company recruiting to retain key
personnel.
o Maintain High Quality Service. To maintain high quality service, we
focus on being responsive to our customers, working diligently and
responsibly and maintaining schedules and budgets. The Company has a
quality control and assurance program to maintain standards and
procedures for performance and documentation and to audit and monitor
compliance with procedures and quality standards.
10
ITEM 1. BUSINESS (Continued)
Business Strategy (Continued)
o Expand and Enhance Technical Capabilities. We believe that it is
important to develop our capabilities in three-dimensional
computer-aided design and drafting ("3D CADD"). To achieve this
objective, we purchased computer hardware and software during 2003 to
implement Intergraph's SmartPlant 3D software, which is the next
generation platform for the design of plant systems. This initiative
should enhance our marketing position strategically with many
customers along the Texas Gulf Coast. We are also developing our own
3D CADD software tools and acquiring 3D CADD software tools from other
suppliers. In 2003, we created a Polymers Division. In 2004, the
Company acquired certain assets of Engineering Design Group, Inc. to
provide a platform for performing governmental and military projects.
The Company also expanded its operations in the sulfur reduction
business.
o Improve Utilization of Resources. We have developed a work-sharing
program through the use of an internal virtual private network that
gives our clients access to technical resources located in any of our
offices and allows for higher utilization of our resources. The
work-sharing program has reduced employee turnover and provide for a
more stable work environment. We are also moving toward
standardization of engineering processes and procedures among our
offices, which we believe will enhance our work-sharing ability and
provide our clients with more consistent and higher quality services.
o Pursue Foreign Technical Resources. Our engineering operations
continue to test the use of offshore technical resources to establish
longer-term access to professional engineering and design work in
lower cost countries such as Mexico, India and the Far East. If these
tests are ultimately successful, it will allow us to lower our
contract bid prices and enhance our competitive position.
o Acquire Complementary Businesses. If appropriate opportunities arise,
we intend to grow in market segments where we currently have a strong
competitive position by acquiring complementary businesses that will
permit us to expand or enhance our existing services. However, due to
opportunities for internal growth, we anticipate fewer acquisitions in
the immediate future.
o Continue to Increase Name Recognition. We intend to continue to
present a more cohesive image and continue to increase name
recognition whereas all of ENGlobal's operating subsidiaries will
adopt "ENGlobal" as part of their name.
Sales and Marketing
Our various subsidiaries derive revenues primarily from two sources: (1)
in-house direct sales and (2) referrals from existing customers, industry
members and manufacturing representatives. Our in-house sales managers are
assigned to industry segments and territories within the United States.
Management believes that this method of selling should result in increased
account penetration and enhanced customer service, which should, in turn, create
and maintain the foundation for long-term customer relationships. Our growth
depends in large measure on our ability to attract and retain qualified sales
representatives and sales management personnel. Management believes that
in-house marketing and sales of our products allows for more accountability and
control, thus increasing profitability.
Products and services are also promoted through general and trade advertising,
participation in trade shows and through on-line Internet communication via our
corporate home page at www.englobal.com. The ENGlobal site provides information
about both of our operating segments. We utilize in-house resources to maintain
and update our website and those of our subsidiaries on an ongoing basis.
Through the ENGlobal website, we seek to provide visitors with a single point of
contact for obtaining information on the services and products offered by the
ENGlobal family of companies.
Our business development department focuses on building long-term relationships
with customers and providing customers with product application, engineering and
after-the-sale services. Additionally, we seek to capitalize on cross-selling
opportunities existing between our various subsidiaries. Sales leads are often
jointly developed and pursued by the sales personnel from a number of these
subsidiaries.
11
ITEM 1. BUSINESS (Continued)
Sales and Marketing (Continued)
Much of our business is repeat business and we are introduced to new customers
in most cases by referrals from existing customers and industry members, such as
manufacturers' representatives. If the Company continues its acquisition
program, we would anticipate that our existing customer base and the potential
for business development activities would be expanded with each new acquisition.
We currently employ 14 full-time professional in-house marketers in our business
development department who concentrate on the engineering services segment, and
three full-time professional in-house marketers in our systems segment. We have
retained business development agents in the Middle East and the United Kingdom.
We have also formed alliances with other engineering and construction firms in
Mexico City and South America.
Customers
Our customer base consists primarily of Fortune 500 companies representing
numerous industries primarily within the United States. While we do not have
continuing dependence on any single client or a limited group of clients, one or
a few clients may contribute a substantial portion of our revenues in any given
year or over a period of several consecutive years due to major engineering
projects. For example, during 2004, 59% of our total revenues were attributable
to work done by our engineering segment and our systems segment for one major
refining and petrochemical client, ExxonMobil, through multiple client
subsidiaries and plant locations. The majority of this work was performed
through the Beaumont location of our engineering segment on a large EPC project.
We have had success undertaking new projects for prior clients and providing
ongoing services to clients following the completion of the projects.
Nevertheless, in order to generate revenues in future years, we must continue
efforts to obtain new engineering projects. Historically, we have not generated
significant revenues from government clients. We hope to increase revenues from
the government market beyond the $3.3 million in revenue generated from the EDG
acquisition.
In recent years, the continuing trend among engineering clients and their
industry counterparts has been toward outsourcing and sole sourcing. This trend
has fostered the development of ongoing, longer-term arrangements with clients,
rather than one-time limited engagements. These arrangements often referred to
as partnering relationships, alliances or sole source contracts, vary in scope,
duration and degree of commitment. For example, engagements may provide for:
o a minimum number of work man-hours over a specified period;
o the provision of at least a designated percentage of the client's
requirements;
o the designation of the Company as the client's sole source of
engineering at a specific location or locations; or
o a non-binding preference or intent, or a general contractual framework
for what the parties expect will be an ongoing relationship.
Despite their variety, the Company believes that these partnering relationships
have a stabilizing influence on our service revenues. At present, we maintain
some form of partnering or alliance arrangement with approximately 16 major oil
and chemical companies. Most of our projects are specific in nature and we
generally have multiple projects with the same clients. If we were to lose one
or more of our significant clients and are unable to replace them with other
customers or other projects, our business would be materially adversely
affected.
In the systems segment, our clients include end-users and operators of
facilities relating to oil and gas products, pipelines, refineries, chemical
companies and processing plants. Other clients include equipment manufacturers,
construction contractors and other engineering firms that incorporate our
control systems into facilities and products they design, construct and
manufacture. As in the engineering segment, in any given year, a small number of
clients may account for a large percentage of the systems segment's revenues for
that year, depending on the number of major projects undertaken. Though the
systems segment frequently receives work from repeat clients, its client list
may vary significantly from year to year.
12
ITEM 1. BUSINESS (Continued)
Customers (Continued)
Our ten largest customers, who vary from one period to the next, accounted for
78% and 69% of our total revenue in 2004 and 2003, respectively. For 2004, our
largest clients, in alphabetical order include:
o Engineering: Basell; BASF; Chevron Phillips; Coffeyville; ExxonMobil;
Frontier; Huntsman Corporation; Motiva Enterprises; Premcor; Sasol
North America; and Valero Energy
o Systems: Conoco Phillips; ExxonMobil; Honeywell, Inc.; Jacobs
Engineering; and Yokogawa Corp of America
We do not have any long-term commitments from these clients and sales of
products from the systems segment are typically made according to the client's
specifications on a purchase order basis. Our potential revenues are, therefore,
dependent on continuing relationships with these customers.
Contracts
We generally enter into two principal types of contracts with our clients: time
and materials contracts and fixed-price contracts. In fiscal 2004, 91% and 9% of
our net revenue was derived from time and materials and fixed-price contracts,
respectively. Our various clients determine which type of contract we will enter
into for a particular engagement.
o Time and Materials. Under our time and materials contracts, we are
paid for labor at either negotiated hourly billing rates or reimbursed
for allowable hourly rates and for other expenses. Profitability on
these contracts is driven by billable headcount and cost control. Some
of these contracts may have upper limits, referred to as "not to
exceed." If our costs generate billings that exceed the contract
ceiling or are not allowable, we will not be able to obtain full
reimbursement. Further, the continuation of each contract partially
depends upon the customer's discretionary periodic assessment of our
performance on that contract.
o Fixed-Price. Under a fixed-price contract, we provide the customer a
total project for an agreed-upon price, subject to project
circumstances and changes in scope. Fixed-price contracts carry
certain inherent risks, including risks of losses from underestimating
costs, delays in project completion, problems with new technologies
and economic and other changes that may occur over the contract
period. Another risk includes our ability to secure written change
orders prior to commencing work on such orders, which may prevent our
getting paid for work performed. Consequently, the profitability of
fixed-price contracts may vary substantially.
Backlog
Backlog represents the total value of all awarded contracts that have not been
completed and will be recognized as revenues over the life of the project. At
February 28, 2005, our gross revenue backlog was approximately $143 million,
compared to $67.5 million at February 29, 2004. We estimate that our backlog at
December 31, 2004 was approximately $135 million. We estimate that approximately
75% of the gross revenue backlog at December 31, 2004 will be recognized during
fiscal 2005.
Gross revenue includes backlog under two types of contracts: (1) contracts for
which work authorizations have been received on a fixed-price basis and
not-to-exceed projects that are well defined and (2) time and material evergreen
contracts at an assumed 12 month run-rate, where we place employees at our
clients' site to perform day-to-day project efforts.
Although backlog reflects business that we consider to be firm, cancellations or
scope adjustments may occur. Further, most contracts with clients may be
terminated at will, in which case the client would only be obligated to us for
services provided through the termination date. We have adjusted backlog to
reflect project cancellations, deferrals and revisions in scope and cost (both
upward and downward) known at the reporting date; however, future contract
modifications or cancellations may increase or reduce backlog and future
revenues. As a result, no assurances can be given that the amounts included in
backlog will ultimately be realized.
13
ITEM 1. BUSINESS (Continued)
Customer Service and Support
We provide service and technical support to our customers in varying degrees
depending upon the business line and on customer contractual arrangements. The
Company's technical support staff provides initial telephone support services
for end-user customers and distributors. These services include isolating and
verifying reported product failures and authorizing repair services in support
of customer requirements. We also provide on-site engineering support if a
technical issue cannot be resolved over the telephone. On projects for which we
have provided engineering systems, we provide worldwide start-up and
commissioning services. We also provide the manufacturers' limited warranty
coverage for products we sell.
Dependence Upon Suppliers
Our ability to provide clients with services and products 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 product availability
and maintain quality control, we generally procure components from multiple
distributors.
For example, all of the product components used by our systems segment are
fabricated using components and materials that are available from numerous
domestic suppliers. There are approximately 36 principal suppliers of these
components, each of whom can be replaced by an equally viable competitor. No one
manufacturer or vendor provides products that account for 10% or more of our
revenues. Thus, we anticipate little or no difficulty in obtaining components in
sufficient quantities and in a timely manner to support our manufacturing and
assembly operations. Units produced through the systems segment are normally not
produced for inventory and component parts are typically purchased on an
as-needed basis.
Despite the foregoing, some of our subsidiaries rely on certain suppliers for
necessary components and there can be no assurance that these components will
continue to be available on acceptable terms. If a subsidiary terminates a
long-standing supply relationship, it may be difficult to obtain alternative
sources of supply without a material disruption in our ability to provide
products and services to our customers. While we do not believe that such a
disruption is likely, if it did occur, it could have a material adverse effect
on our financial condition and results of operations.
Patents, Trademarks, Licenses
Our success depends in part upon our ability to protect our proprietary
technology, which we do primarily through protection of our trade secrets and
confidentiality agreements. The U.S. Patent and Trademark Office approved our
application for the uses of "ENGlobal" and "Integrated Rack" in September 2004
and March 2005, respectively. In addition, we have pending trademark
applications on file with the U.S. Patent and Trademark Office for the names
"Flare-Mon" and "Purchased Data." There can be no assurance that the protective
measures we currently employ will be adequate to prevent the unauthorized use or
disclosure of our technology, or the independent third party development of the
same or similar technology. Although our competitive position to some extent
depends on our ability to protect our proprietary and trade secret information,
we believe that other factors, such as the technical expertise and knowledge
base of our management and technical personnel, as well as the timeliness and
quality of the support services we provide, will also help us to maintain our
competitive position.
Government Regulations
The Company and certain of our subsidiaries are subject to various foreign,
federal, state, and local laws and regulations relating to our business and
operations, and various health and safety regulations as established by the
Occupational Safety and Health Administration. The Company and members of its
professional staff are subject to a variety of state, local and foreign
licensing, registration and other regulatory requirements governing the practice
of engineering. Currently, we are not aware of any situation or condition
relating to the regulation of the Company, its subsidiaries, or personnel that
we believe is likely to have a material adverse effect on our results of
operations or financial condition.
14
ITEM 1. BUSINESS (Continued)
Employees
As of December 31, 2004, the Company and its subsidiaries employed 1,329
individuals. Of these employees, 17 were employed in sales and marketing; 703
were employed in engineering and related positions; 153 were employed in
technical production positions; 171 were employed as inspectors; 219 were
employed as project support staff; and 66 were employed in administration,
finance and management information systems. We believe that our ability to
recruit and retain highly skilled and experienced technical, sales and
management personnel has been and will continue to be, critical to our ability
to execute our business plan. None of our employees is represented by a labor
union or is subject to a collective bargaining agreement. We believe that
relations with our employees are good.
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.
1. 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, could give them a competitive advantage over us.
2. The failure to attract and retain key professional personnel could
adversely affect the Company.
Our success depends on attracting and retaining qualified personnel in a
competitive environment. We are dependent upon our ability to attract and
retain highly qualified managerial, technical and business development
personnel. Competition for key personnel is intense. We cannot be certain
that we will retain our key managerial, technical and business development
personnel or that we will attract or assimilate key personnel in the
future. Failure to retain or attract such personnel could 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.
3. Our business and operating results could be adversely affected by our
inability to accurately estimate the overall risks, revenue or costs on a
contract.
We generally enter into two principal types of contracts with our clients:
time and materials contracts and fixed-price contracts. Under our
fixed-price contracts, we receive a fixed-price irrespective of the actual
costs we incur and, consequently, we are exposed to a number of risks.
These risks include underestimation of costs, problems with new
technologies, unforeseen expenditures or difficulties, delays beyond our
control and economic and other changes that may occur during the contract
period. Our ability to secure change orders on scope changes and our
ability to invoice for such changes poses an additional risk. In fiscal
2004, approximately 9% of our net revenue was derived from fixed-price
contracts.
Under our time and materials contracts, we are paid for labor at negotiated
hourly billing rates or reimbursement at specified mark-up hourly rates and
negotiated rates for other expenses. Profitability on these contracts is
driven by billable headcount and cost control. Some time and materials
contracts are subject to contract ceiling amounts, which may be fixed or
performance-based. If our costs generate 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.
15
ITEM 1. BUSINESS (Continued)
Risk Factors (Continued)
Revenue recognition for a contract requires judgment relative to assessing
the contract's estimated risks, revenue and costs and on making judgments
on other 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.
4. 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 economic conditions. During economic
downturns, the ability of both private and governmental entities to make
expenditures 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.
5. Our dependence on one or a few customers could adversely affect us.
One or a few clients have in the past and may in the future contribute a
significant portion of our consolidated revenues in any one year or over a
period of several consecutive years. In 2004, approximately 59% of our
revenues were from six subsidiaries of ExxonMobil and approximately 6% of
our revenues were from Chevron Phillips. As our backlog frequently reflects
multiple projects for individual clients, one major customer may comprise a
significant percentage of our backlog at any point in time. Because these
significant customers generally contract with us for specific projects, we
may lose these customers from year to year as their projects with us are
completed. If we do not replace them with other customers or other
projects, our business could be materially adversely affected.
Additionally, we have long-standing relationships with many of our
significant customers. Our contracts with these customers, however, are on
a project-by-project basis and the customers may unilaterally reduce or
discontinue their purchases at any time. The loss of business from any one
of such customers could have a material adverse effect on our business or
results of operations.
6. Additional acquisitions may adversely affect our ability to manage our
business.
Our growth has been, in large part, the result of acquisitions of
companies. We plan to continue making acquisitions in the future on terms
management considers favorable to us. The successful acquisition of other
companies involves an assessment of future revenue opportunities, operating
costs, economies and earnings after the acquisition is complete, potential
industry and business risks and liabilities beyond our control. This
assessment is necessarily inexact and its accuracy is inherently uncertain.
In connection with our assessments, we perform reviews of the subject
acquisitions we believe to be generally consistent with industry practices.
These reviews, however, may not reveal all existing or potential problems,
nor will they permit a buyer to become sufficiently familiar with the
target companies to assess fully their deficiencies and capabilities. We
cannot assure you that we will identify, finance and complete additional
suitable acquisitions on acceptable terms. We may not successfully
integrate future acquisitions. Any acquisitions 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.
7. Seasonality of our industry may cause our revenues to fluctuate.
Holidays and employee vacations during our fourth quarter exert downward
pressure on revenues for that quarter, which is only partially offset by
the year-end efforts on the part of many clients to spend any remaining
funds budgeted for engineering services or capital expenditures during the
year. The annual budgeting and approval process under which these clients
operate is normally not completed until after the beginning of each new
year, which can depress results for the first quarter. Principally due to
these factors, our revenues during the first and fourth quarters generally
tend to be lower than in the second and third quarters.
16
ITEM 1. BUSINESS (Continued)
Risk Factors (Continued)
8. 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 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.
9. If the operating result of either segment is adversely affected, an
impairment of goodwill could result in a write down.
Based on factors and circumstances impacting ENGlobal and the business
climate in which it operates, the Company may determine that it is
necessary to re-evaluate the carrying value of its goodwill by conducting
an impairment test in accordance with SFAS No. 142. The Company has
assigned goodwill to the two segments based on estimates of the relative
fair value of each segment. If changes in the industry, market conditions,
or government regulation negatively impact either of the Company's segments
resulting in lower operating income, if assets are harmed, if anticipated
synergies or cost savings are not realized with newly acquired entities, or
if any circumstance occurs which result in the fair value of either segment
reducing below its carrying value, an impairment to goodwill could be
created. In accordance with SFAS No. 142, the Company would be required to
write down the carrying value of goodwill.
10. 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 50,880,784 shares of common stock and an additional
2,265,167 shares of preferred stock. These shares may be issued without
stockholder approval unless the issuance is 20% or more of our outstanding
common stock, in which case the American Stock Exchange requires
stockholder approval. We may issue shares of stock in the future in
connection with acquisitions or financings. In addition, we may issue
shares in connection with our Employee Stock Purchase Plan and we may issue
options as incentives under our 1988 Incentive Option Plan. Future
issuances of substantial amounts of common stock, or the perception that
these sales could occur, may affect the market price of our common stock.
In addition, the ability of the board of directors to issue additional
stock may discourage transactions involving actual or potential changes of
control of the Company, including transactions that otherwise could involve
payment of a premium over prevailing market prices to holders of our common
stock.
11. Our backlog is subject to unexpected adjustments and cancellations and is,
therefore, an uncertain indicator of our future revenues or earnings.
As of December 31, 2004, our backlog was approximately $135 million. We
cannot assure investors that the revenues projected in our backlog will be
realized or, if realized, will result in profits. Projects may remain in
our backlog for an extended period of time prior to project execution and,
once project execution begins, it may occur unevenly over the current and
multiple future periods. In addition, project terminations, suspensions or
reductions in scope may occur from time to time with respect to contracts
reflected in our backlog. Such backlog reductions would reduce the revenue
and profit we actually receive from contracts reflected in our backlog.
Future project cancellations and scope adjustments could further reduce the
dollar amount of our backlog and the revenues and profits that we actually
earn.
17
ITEM 1. BUSINESS (Continued)
Risk Factors (Continued)
12. 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.
13. Our quarterly operating results may fluctuate significantly, which could
have a negative effect on the price of our common stock.
Our quarterly revenues, expenses and operating results may fluctuate
significantly because of a number of factors, including:
o Unanticipated changes in contract performance that may affect
profitability, particularly with contracts that have funding
limits;
o The seasonality of the spending cycle of our clients;
o Acquisitions or the integration of acquired companies;
o Employee hiring and utilization rates;
o The number and significance of client engagements commenced and
completed during a quarter;
o Credit worthiness and solvency of clients;
o The ability of our clients to terminate engagements without
penalties;
o Delays incurred in connection with an engagement;
o The size and scope of engagements;
o The timing of expenses incurred for corporate initiatives;
o Reductions in the prices of services offered by our competitors;
o Changes in accounting rules; and
o General economic or political conditions.
Variations in any of these factors could cause significant fluctuations in
our operating results from quarter to quarter and could result in net
losses. These fluctuations could result in downward pressure on the market
price of our common stock.
14. 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. 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.
15. If we are not able to successfully manage internal growth initiatives, our
business and results of operations may be adversely affected.
The Company's growth strategy seeks to utilize its technical expertise in
conjunction with industry trends. To support this strategy, the Company may
elect to fund internal growth initiatives targeted at markets that the
Company believes may have significant potential needs for the Company's
services. The downside risks are that such initiatives could have a
negative effect on current earnings until such initiatives reach critical
mass or that industry trends have been misread or delayed and continued
funding could have a negative impact on long term earnings.
18
ITEM 1. BUSINESS (Continued)
Risk Factors (Continued)
16. The price of our common stock may be volatile.
Our common stock may be subject to substantial price volatility. The stock
market has experienced extreme price and volume fluctuations that have
affected the market price of many companies and that have often been
unrelated to the operating performance of these companies. The overall
market for and the price of our common stock may continue to fluctuate
greatly. The trading price of our common stock may be significantly
affected by various factors, including:
o Quarter to quarter variations in our financial results, including
revenues, profits and other measures of financial performance or
financial condition;
o Announcements by us or our competitors of significant
acquisitions;
o Threatened or pending litigation;
o Changes in investors' and analysts' perceptions of our business,
our competitors' businesses, or the businesses we serve;
o Investors' and analysts' assessments of reports prepared or
conclusions reached by third parties;
o Broader market fluctuations; and
o General economic or political conditions.
Additionally, volatility or a lack of positive performance in our stock
price may adversely affect our ability to retain key employees, many of
whom are granted stock options, the value of which are dependent on the
performance of our stock price.
17. A small number of stockholders own a significant portion of our outstanding
common stock, thus limiting the extent to which other stockholders can
effect decisions subject to stockholder vote.
Directors, executive officers and principal stockholders of ENGlobal and
their affiliates, beneficially own approximately 50% of our outstanding
common stock on a fully diluted basis. Accordingly, these stockholders, as
a group, are able to control the outcome of stockholder votes, including
votes concerning the adoption or amendment of provisions in our Articles of
Incorporation or bylaws and the approval of mergers and other significant
corporate transactions. The existence of these levels of ownership
concentrated in a few persons makes it unlikely that any other holder of
common stock will be able to affect the management or direction of the
Company. These factors may also have the effect of delaying or preventing a
change in management or voting control of the Company.
ITEM 2. PROPERTIES
Facilities
We lease 12 buildings in the U.S. totaling approximately 306,000 square feet,
and we own an office building in Baton Rouge, Louisiana with 27,500 square feet.
The leases have remaining terms ranging from monthly to 6 years and are at what
we consider to be commercially reasonable rental rates. Our principal office
locations are in Houston and Beaumont, Texas, and Tulsa, Oklahoma. We have other
offices in Freeport and Midland, Texas, Baton Rouge and Lake Charles, Louisiana,
and Cleveland, Oklahoma. Approximately 214,000 square feet of our total office
space is designated for our professional, technical and administrative
personnel. We believe that our office and other facilities are well maintained
and adequate for existing and planned operations at each operating location.
Our systems segment performs fabrication assembly in two shop facilities. One
facility is in Houston, Texas with approximately 62,600 square feet of space and
a second facility is in Beaumont, Texas with approximately 23,600 square feet of
space.
We lease approximately 14,000 square feet of office space in Beaumont, Texas
with an expiration date of June, 2005 from a joint venture owned one-third by
each of: ENGlobal Engineering, Inc., Michael L. Burrow (the Company's CEO), and
a stockholder of the Company who owns less than 1% of the Company's stock. We
believe that this lease is at a commercially reasonable rental rate.
19
ITEM 2. PROPERTIES
Facilities (Continued)
On March 4, 2005, the Company completed the sale of the 37,000 square foot
office and manufacturing facility formerly occupied by Thermaire for $885,000.
This space has not been included in the office or warehouse statistics. The net
proceeds from the sale were used to reduce the Company's long-term debt.
Below is a complete listing of the space leased and owned with the expiration
dates of the leases.
Location Square Feet Lease Expiration Date
--------------- ------------------- ---------------------
Beaumont: 42,880 2011
37,798 2005
13,590 Month to Month
Houston: 51,816 2005
62,641 2008
33,759 2011
Lake Charles 8,178 2006
Tulsa 32,555 2005
Freeport 23,000 2007
Baton Rouge 27,500 Owned
-------------------
333,717
===================
In March 2005, we entered into a lease agreement for the relocation of our
corporate headquarters and Houston engineering office to a 33,759 square foot
facility in North Houston. Effective June 1, 2005, approximately 60 employees
will move to our new location at 654 North Sam Houston Parkway E, Suite 400,
Houston, Texas 77060-5914, which can accommodate up to 150 employees with
appropriate space planning. We have executed a six-year lease valued in excess
of $2.3 million, with an option to lease additional space.
ITEM 3. LEGAL PROCEEDINGS
During 2005, the Company and its subsidiaries were successful in obtaining the
dismissal of all but one of the remaining petitions filed against the Company
and its subsidiaries in 2003, on behalf of former employees of Barnard and Burk,
Inc. The Company believes that the remaining petition is without merit and
immaterial to the Company's business and financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
20
PART II
-------
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
Market Information and Holders
The Company's common stock has been quoted on the American Stock Exchange
("AMEX") since June 16, 1998, and is currently traded under the symbol "ENG."
From its initial listing on AMEX on June 16, 1998 to June 15, 2002, the
Company's stock was traded under the symbol "IDS." Newspaper stock listings
identify us as "ENGlobal."
The following table sets forth the high and low sales prices of our common stock
for the periods indicated.
Fiscal Year Ended December 31
----------------------------------
2004 2003
----------------------------------
High Low High Low
----------------------------------
First Quarter 2.32 1.96 1.98 1.00
Second Quarter 2.43 1.44 2.97 1.70
Third Quarter 1.75 1.20 3.80 2.24
Fourth Quarter 3.19 1.21 2.89 1.87
The foregoing figures, based on information published by AMEX, do not reflect
retail mark-ups or markdowns and may not represent actual trades.
In connection with our December 2001 merger with Petrocon, we issued 2,500,000
shares of Series A Preferred Stock, $0.001 par value per share, to Equus II
Incorporated. In 2002 and 2003, we issued dividends to Equus in the form of
234,833 shares of Series A Preferred Stock. Effective August 2003, the Company
exercised its right to convert all outstanding Series A Preferred Stock to
1,149,089 shares of common stock.
As of February 28, 2005, approximately 234 stockholders of record held the
Company's common stock. This does not include individual participants in
security position listings.
21
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES (Continued)
Equity Compensation Plan Information
The following table sets forth certain information concerning the Company's
equity compensation plans as of December 31, 2004.
Number of Securities
Remaining Available for
Number of Securities to Weighted-Average Future Issuance Under
be Issued Upon Exercise Exercise Price of Equity Compensation Plans
of Outstanding Options, Outstanding Options, [Excluding Securities in
Warrants and Rights (a) Warrants and Rights (b) Column (a)] (c)
----------------------- ----------------------- -------------------------
Equity compensation plans
approved by security
holders 1,527,150 (1) 2.15 463,999
Equity compensation plans
not approved by security
holders 234,774 (2) 4.26 -
----------------------- --------------------------
Total 1,761,924 463,999
======================= ==========================
Dividend Policy
The Company has never declared or paid a cash dividend on its common stock. The
Company intends to retain any future earnings for reinvestment in its business
and does not intend to pay cash dividends in the foreseeable future. In
addition, restrictions contained in our loan agreements governing our credit
facility with Comerica Bank preclude us from paying any dividends on our common
stock while any debt under those agreements is outstanding. The payment of
dividends in the future will depend on numerous factors, including the Company's
earnings, capital requirements, operating and financial position and general
business conditions.
Dividends on outstanding shares of Series A Preferred Stock were paid on the
last day of May in 2002 and 2003 in shares of stock of Series A Preferred Stock
at a rate of 0.08 shares for each outstanding share of Series A Preferred Stock.
The Company elected to convert all shares of preferred stock to 1,149,089 shares
of common stock in August 2003.
- -----------------------
(1) Includes options issued through our 1998 Incentive Plan. For a brief
description of the material features of the Plan, see Note 10 of the Notes to
the Consolidated Financial Statements. Also includes incentive options granted
as replacement options for outstanding Petrocon incentive options pursuant to
the terms of the December 2001 Merger Agreement with Petrocon. Effective with
the Petrocon merger, 1,737,473 shares were placed in escrow by a group of
significant Petrocon stockholders under the terms of an Option Escrow Agreement.
Under this agreement, shares from the Option Escrow were used to replace shares
issued by ENGlobal due to the exercise of converted Petrocon options and
warrants, preventing future dilution to ENGlobal stockholders from the exercise
of converted Petrocon options and warrants. This agreement was terminated in
September 2004. During 2004, options to acquire 38,242 shares of common stock
were exercised through the Option Escrow Agreement.
(2) Includes non-qualified options granted as replacement options for
outstanding Petrocon options pursuant to the terms of the Merger Agreement (see
Note 10 to the Consolidated Financial Statements).
22
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, 2004, 2003, and 2002 have been derived from the audited
financial statements appearing elsewhere in this document. The data as of
December 31, 2002, 2001 and 2000 and for the years ended December 31, 2001 and
2000 have been derived from audited financial statements not appearing in this
document. You should read the selected financial data set forth below in
conjunction with our financial statements and the notes thereto included in Part
II, Item 8, Part II, Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations," and other financial information appearing
elsewhere in this document. In addition, the merger with Petrocon in December
2001 should be considered in connection with your review of this information.
Note: Due to the sale of Thermaire, all items related to the previously reported
manufacturing segment have been reclassified to discontinued operations in order
to provide comparative results. Previously reported amounts will not agree to
the amounts presented below except net income.
Years Ended December 31,
------------------------------------------------------------
2004 2003 2002 2001 2000
------------------------------------------------------------
(in thousands, except per share amounts)
------------------------------------------------------------
Statement of Operations:
Revenues -
Engineering $ 133,630 $ 108,380 $ 74,971 $ 14,235 $ 10,740
Systems 15,258 15,339 14,151 3,575 2,815
--------- --------- --------- --------- ---------
Total revenues 148,888 123,719 89,122 17,810 13,555
--------- --------- --------- --------- ---------
Costs and expenses -
Engineering 117,205 93,579 62,877 10,433 8,175
Systems 13,090 13,167 11,840 3,107 2,156
Selling, general and administrative 14,101 12,439 10,632 2,836 2,679
--------- --------- --------- --------- ---------
Total costs and expenses 144,396 119,185 85,349 16,376 13,010
--------- --------- --------- --------- ---------
Operating income 4,492 4,534 3,773 1,434 545
Interest income (expense), net (590) (784) (821) 14 49
Other income (expense), net 118 (355) 143 14 23
--------- --------- --------- --------- ---------
Income from continuing operations before provision 4,020 3,395 3,095 1,462 617
for income taxes
Provision for income taxes 1,656 1,110 1,197 595 151
--------- --------- --------- --------- ---------
Income from operations 2,364 2,285 1,898 867 466
Income (loss) from discontinued operations, net of
taxes -- (154) (146) 115 (85)
Income from disposal of discontinued operations -- 26 -- -- --
--------- --------- --------- --------- ---------
Net income $ 2,364 $ 2,157 $ 1,752 $ 982 $ 381
========= ========= ========= ========= =========
23
ITEM 6. SELECTED FINANCIAL DATA (Continued)
Summary Selected Historical Consolidated Financial Data (Continued)
Years Ended December 31,
-------------------------------------------------------
2004 2003 2002 2001 2000
-------------------------------------------------------
(in thousands, except per share amounts)
-------------------------------------------------------
Per Share Data:
Basic earnings (loss) per share -
Continuing operations $ 0.10 $ 0.09 $ 0.07 $ 0.07 $ 0.04
Discontinued operations -- -- -- -- (0.01
-------- -------- -------- -------- --------
Net income per share $ 0.10 $ 0.09 $ 0.07 $ 0.07 $ 0.03
======== ======== ======== ======== ========
Weighted average common
shares outstanding - basic 23,455 23,301 22,861 13,236 12,965
Diluted earnings (loss) per share -
Continuing operations $ 0.10 $ 0.09 $ 0.07 $ 0.07 $ 0.04
Discontinued operations -- -- -- -- (0.01)
-------- -------- -------- -------- --------
Net income per share $ 0.10 $ 0.09 $ 0.07 $ 0.07 $ 0.03
======== ======== ======== ======== ========
Weighted average common
shares outstanding - diluted 23,786 23,734 23,013 13,236 12,965
Cash Flow Data:
Operating activities, net $ (2,391) $ 6,557 $ 1,302 $ 744 $ 27
Investing activities, net (1,811) (471) (1,290) 5 (468)
Financing activities, net 4,170 (6,122) (1,182) 253 19
-------- -------- -------- -------- --------
Net change in cash and cash equivalents $ (32) $ (36) $ (1,170) $ 1,002 $ (422)
======== ======== ======== ======== ========
Balance Sheet Data:
Working capital $ 14,503 $ 6,505 $ 8,416 $ 5,703 $ 3,217
Property and equipment, net $ 5,262 $ 4,302 $ 4,779 $ 4,095 $ 460
Total assets $ 57,261 $ 42,530 $ 40,068 $ 38,286 $ 7,052
Long-term debt, net of current portion $ 15,585 $ 7,506 $ 12,580 $ 1,357 $ 21
Long-term capital leases, net of current portion $ -- $ 12 $ 17 $ 48 $ 24
Stockholders' equity $ 20,051 $ 18,175 $ 13,389 $ 11,846 $ 4,159
24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
The following discussion is qualified in its entirety by, and should be read in
conjunction with, our Consolidated Financial Statements including the Notes
thereto, included elsewhere in this Annual Report on Form 10-K. Note 17 to the
Financial Statements contains segment information.
Forward-Looking Statements
Certain information contained in this Form 10-K Annual Report, the Company's
Annual Report to Stockholders, as well as other written and oral statements made
or incorporated by reference from time to time by the Company and its
representatives in other reports, filings with the SEC, press releases,
conferences, or otherwise, may be deemed to be forward-looking statements within
the meaning of Section 21E of the Securities Exchange Act of 1934. This
information includes, with limitation, statements concerning the Company's
future financial position and results of operations; planned capital
expenditures; business strategy and other plans for future operations; the
future mix of revenues and business; commitments and contingent liabilities; and
future demand and industry conditions. Although the Company believes that the
expectations reflected in such forward-looking statements are reasonable, it can
give no assurance that such expectations will prove to have been correct. When
used in this report, the words "anticipate," "believe," "estimate," "expect,"
"may," and similar expressions, as they relate to the Company and its
management, identify forward-looking statements that could differ materially
from the results described in the forward-looking statements due to the risks
and uncertainties set forth in this Annual Report on Form 10-K.
Overview
We furnish engineering consulting and control system services to the petroleum
refining, petrochemical, pipeline, production and processing industries. Our
business consists of two segments: engineering and systems. Our engineering
segment offers engineering consulting services to clients for the development,
management and turnkey execution of engineering projects, construction
management, and inspection services. Our systems segment designs, assembles,
programs, installs, integrates and services control and instrumentation systems
for specific applications in the energy and processing related industries.
Contract revenue and contract costs are recorded primarily using the
percentage-of-completion (cost-to-cost) method. Under this method, revenue on
long-term contracts is recognized in the ratio that contract costs actually
incurred bears to total estimated costs. Revenue and profit on long-term
contracts are subject to revision throughout the lives of the contracts and any
required adjustments are made in the period in which the revisions become known.
Losses on contracts are recorded in full as they are identified.
In the course of providing our services, we routinely provide major engineering,
materials, equipment and subcontractor services. Generally, these materials,
equipment and subcontractor costs are passed through to our clients and, in
accordance with industry practice and generally accepted accounting principles,
are included in revenue. Because the use of subcontractor services can change
significantly from project to project, changes in revenue may not be indicative
of business trends.
For analytical purposes only, we segregate from our total revenue the revenues
recorded from non-labor material, equipment and subcontractor costs, and the
revenue derived from material assets or companies acquired during the current
year, as well as the revenue recognized from material assets or companies
acquired during the first 12 months following their respective dates of
acquisition. Revenue recognized from acquired assets or companies during such
first 12 months is referred to as "Acquisition" revenue. We also segregate gross
profits and SG&A expenses derived from material assets or company acquisitions
on the same basis as we segregate revenues.
Our other contract costs include professional compensation and related benefits,
together with certain direct and indirect variable overhead costs. Professional
compensation and related benefits represent the majority of these costs.
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.
25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION (Continued)
Overview (Continued)
Corporate SG&A expense is comprised primarily of marketing and proposal costs,
as well as costs related to the executive, finance, accounting, safety, human
resources and information technology departments and other costs generally
unrelated to specific client projects, but which can vary as costs are incurred
to support corporate activities and initiatives.
Results of Operations
The following table sets forth, for the periods indicated, certain financial
data derived from our consolidated statements of operations and indicates
percentage of total revenue for each item. The manufacturing segment is reported
in "Income/(Loss) from Discontinued Operations."
Years Ended December 31,
------------------------------------------------------------------------
2004 2003 2002
--------------------- --------------------- ---------------------
Amount % Amount % Amount %
------------------------------------------------------------------------
(in thousands)
------------------------------------------------------------------------
Revenue
Engineering - labor $ 85,929 57.7 $ 77,507 62.6 $ 69,239 77.7
Engineering - non-labor 38,578 25.9 29,388 23.8 5,732 6.4
Systems 13,965 9.4 14,892 12.0 14,151 15.9
Acquisition 10,416 7.0 1,932 1.6 - -
------------- ------------ -------------
Total revenue $ 148,888 100.0 $ 123,719 100.0 $ 89,122 100.0
============= ============ =============
Gross profit
Engineering - labor $ 14,824 17.3 $ 13,714 17.7 $ 12,095 17.5
Engineering - non-labor 159 0.4 938 3.2 - -
Systems 1,937 13.9 2,109 14.2 2,311 16.3
Acquisition 1,673 16.1 212 11.0 - -
------------- ------------ -------------
Total gross profit $ 18,593 12.5 $ 16,973 13.7 $ 14,406 16.2
============= ============ =============
Selling, general and administrative
Non-acquisition $ 12,267 8.2 $ 12,274 9.9 $ 10,632 11.9
Acquisition 1,834 1.2 165 0.1 - -
------------- ------------ -------------
Total $ 14,101 9.5 $ 12,439 10.1 $ 10,632 11.9
============= ============ =============
Income from continuing operations $ 2,364 1.6 $ 2,285 1.8 $ 1,898 2.1
Income (loss) on discontinued operations - - (128) (0.1) (146) (0.1)
------------- ------------ -------------
Net income $ 2,364 1.6 $ 2,157 1.7 $ 1,752 2.0
============= ============ =============
Total revenue increased $25.2 million or 20.3% from $123.7 million in revenue in
2003 to $148.9 million in revenue in 2004. Overall gross profit increased $1.6
million or 9.5% from $17.0 million in 2003 to $18.6 million in 2004 even though
as a percentage of revenue, gross profit decreased from 13.7% in 2003 to 12.5%
in 2004. Total SG&A expense increased $1.7 million or 13.4% from $12.4 million
in 2003 to $14.1 million in 2004. Income from continuing operations improved by
almost $100,000 from $2.3 million in 2003 to $2.4 million in 2004.
26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION (Continued)
Year Ended December 31, 2004 Compared to Year Ended December 31, 2003
Total Revenue
-------------
Total engineering revenue, both labor and non-labor, accounted for 83.6% of
our total revenue for the year, increasing $17.6 million from $106.9
million in revenue in 2003 to $124.5 million in revenue in 2004. The
increase in total engineering revenue is attributable to $9.2 million in
additional non-labor revenue and $8.4 million in labor revenue.
The increase in non-labor revenue during 2004 represented 52.2% of the
increase in total engineering revenue for the year. The $9.2 million
additional non-labor revenue resulted from an increase in non-labor revenue
of $25.5 million on a co-generation project that began in 2003, offset by
$16.3 in lower non-labor revenue from a cyclohexane project that began in
2002. Both the co-generation and cyclohexane projects are being executed
out of our Beaumont office and both are expected to be complete in 2005.
During any reporting period non-labor revenue could have a significant
impact on total revenue, but normally such non-labor revenue would
represent lower margin activity on EPC type projects. The non-labor based
revenue for engineering was $38.6 million, $29.4 million and $5.7 million
in 2004, 2003 and 2002, respectively. By comparison, labor-based revenue,
without the addition of labor-based revenue from acquisitions, totaled
$85.9 million, $77.5 million and $69.2 million in 2004, 2003 and 2002,
respectively. Non-labor revenue includes certain material, equipment and
subcontractor cost passed through to clients with no mark-up or at a
mark-up well below that normally achieved on labor revenue. In accordance
with generally accepted accounting principles, non-labor revenue is
included in total revenue. Non-labor revenue is expected to increase in
2005 due to activity on both the Coffeyville and Frontier projects.
The increase of $8.4 million in engineering labor revenue during 2004 came
primarily from additional labor revenue of $4.9 million through the Tulsa
office, $2.4 million through the Beaumont office and $1.1 million from all
other office locations. Our engineering segment has been successful in
obtaining major projects in the petroleum refining industry in the
mid-continent area for the Tulsa office, but we do not currently have a
large project that would replace the co-generation project when it is
completed by our Beaumont office.
In 2005, the Company was awarded two significant projects to be completed
primarily out of our Tulsa office. Coffeyville Resources Refining &
Marketing, LLC ("CRRM") has entered into an agreement with ENGlobal for
detailed engineering and procurement services for CRRM's ultra low sulfur
diesel fuel facilities at its Coffeyville, Kansas refinery on a cost
reimbursable basis. We estimate that the agreement will result in
approximately 150,000 man-hours in engineering and related activities in
addition to a significant amount of revenue attributable to the procurement
of materials and equipment. The project began in January 2005 and is
scheduled to conclude in the third quarter of 2006. Frontier Refining, Inc.
has awarded ENGlobal a contract to provide lump sum turnkey services for
engineering, procurement and construction for modifications to produce
ultra low sulfur diesel at Frontier's Cheyenne, Wyoming refinery. The
Company estimates revenue from the Frontier contract to be approximately $7
million. The project began in February 2005 and is scheduled to complete in
the spring of 2006.
The systems segment contributed 9.4% of our total revenue for the year, as
its revenue declined $900,000 from $14.9 million in 2003 to $14.0 million
in revenue in 2004. Our systems segment began 2005 with a project backlog
of $7.6 million, representing the largest booking of new work in the
segment's history.
During the fourth quarter of 2004, the systems segment was awarded projects
totaling $2.8 million from Honeywell to build eight turnkey remote
instrument enclosures ("RIEs") of which six units are scheduled for
completion during the second quarter and additional units following in the
third and fourth quarters of 2005. In the first quarter of 2005, Honeywell
awarded the Company three additional turnkey RIEs totaling $1.6 million
with one unit scheduled for delivery in the second quarter and two units
scheduled for delivery in the fourth quarter of 2005.
27
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION (Continued)
Year Ended December 31, 2004 Compared to Year Ended December 31, 2003
(Continued)
Revenue from acquired companies accounted for 7.0% of our total revenue
during 2004, increasing by $8.5 million or 447% from $1.9 million in
revenue in 2003 to $10.4 million in revenue in 2004. Revenue recognized
from acquired assets or companies during the first 12 months of their
operation within ENGlobal is referred to as "Acquisition" revenue.
Acquisition revenue in 2004 includes revenue of $3.6 million, $3.3 million,
$1.7 million, $1.3 million and $500,000 from EDG, CIS, Petro-Chem,
Senftleber and AmTech, respectively.
We formerly operated a third segment, the manufacturing segment. Certain
assets of this segment were sold in December 2003 and March 2005 and its
financial results during 2003 and 2004 are reported in "Income/(Loss) from
Discontinued Operations."
Gross Profit
------------
Gross profit from engineering labor increased $1.1 million or 8.1% from
$13.7 million in 2003 to $14.8 million in 2004. Gross profit from our Tulsa
location improved $1.7 million or 286.1% from $600,000 in 2003 to $2.3
million in 2004. Gross profits based on engineering labor revenue from all
other engineering operations decreased $600,000 or 4.7%. Gross profit from
labor declined as a percentage of labor revenue from 17.7% in 2003 to 17.3%
in 2004. Gross margin from in-office projects increased from 22.8% in 2003
to 23.3% in 2004 only to be offset by higher non-project labor cost
invested in estimating larger EPC projects and in internal growth
initiatives such as low sulfur diesel. Margins from our field service
operation were lower by .3% primarily due to the impact of integration
costs and recognition of lower profits on $3.3 million in revenue generated
by the acquisition of CIS during the last quarter of 2004.
Gross profit from engineering non-labor revenue declined $779,000 or 83%
from $938,000 in 2003 to $159,000 in 2004 as a direct result of the
decrease of $16.3 million in non-labor revenue on the cyclohexane project.
The Coffeyville project began in January 2005 and includes cost
reimbursable procurement services including a fee on approximately $24
million in materials and equipment.
Gross profit for our systems segment declined $200,000 or 8.2% from $2.1
million in 2003 to $1.9 million in 2004. Competitive market pressures on
pricing, project management, cost containment against project budgets, and
stronger support service controls continue to provide challenges for
management in response to growth initiatives and record backlog levels. The
acquisition of contract rights and other assets from InfoTech during the
fourth quarter of 2004 could have a short-term negative impact on the
systems segment's gross profit until new employees and new projects are
fully integrated into the Company's operations.
Gross profits from acquisitions increased $1.5 million or 689.2% from
$200,000 in 2003 to $1.7 million in 2004. Gross profit from acquired assets
or companies during their first 12 months of operations within the Company
is recorded and referred to as "Acquisition" gross profit. Acquisition
gross profit in 2004 includes gross profit of $800,000, $400,000, $200,000,
$200,000, and $100,000 from EDG, CIS, Petro-Chem, Senftleber and AmTech,
respectively.
28
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION (Continued)
Year Ended December 31, 2004 Compared to Year Ended December 31, 2003
(Continued)
Selling, General and Administrative ("SG&A") Expenses
-----------------------------------------------------
Selling, general and administrative expenses not directly related to
acquisitions remained level at $12.3 million for both 2003 and 2004 and as
a percentage of total revenue decreased from 10% in 2003 to 8.9% in 2004.
In March 2004, the Company announced organizational changes intended to
reduce overhead and enhance profitability. The Company eliminated four
operational facilities and consolidated offices to improve efficiency. For
example, effective January 2004, within the systems segment, ECP relocated
offices and shop facilities into the same facility as ESI resulting in
improved shop personnel utilization, reduction of duplicative overhead
functions and reduction of facility expenses. As a result, during 2004, the
systems segment SG&A expenses decreased $500,000 or 28.6% from $2.0 million
in 2003 to $1.5 million in 2004. Corporate SG&A charges increased $198,000
due to additional software enhancements to our billings system to meet
client format demands, plus $222,000 related to proposal and internal
growth initiatives. Engineering SG&A expenses increased $80,000 due to
numerous miscellaneous items.
SG&A expenses from acquisitions increased $1.7 million from $100,000 in
2003 to $1.8 million in 2004. SG&A expenses from acquired assets or
companies during their first 12 months of operations within the Company
have been recorded and are referred to as "Acquisition" under SG&A
expenses. Acquisition SG&A in 2004 includes $1.3 million, $250,000, and
$150,000 from EDG, CIS, Petro-Chem respectively, plus $100,000 for all
other acquisition activity.
Operating Profit
----------------
Operating profit remained constant at $4.5 million in 2003 and 2004,
decreasing as a percentage of total revenue from 3.7% in 2003 to 3.0% in
2004. If total revenue and total operating profit are both adjusted whereby
the impact of non-labor material, equipment and subcontractor cost are
eliminated from both total revenue and total operating profit, our adjusted
operating profit as a percentage of adjusted revenue would have increased
from 3.8% to 3.9%.
Other Income (Expense)
----------------------
Other income (expense) changed from $355,000 expense in 2003 to $118,000
income in 2004. The expense in 2003 was the result of a book basis loss on
the sale of the vacant office building in Baton Rouge, as compared to the
income in 2004, which resulted from a legal settlement.
Provision for Income Taxes
--------------------------
Additional tax expense during the year increased the 2004 effective tax
rate to 42% from 33% in 2003. The effective tax now and in the future will
be approximately 38%.
29
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION (Continued)
Year Ended December 31, 2003 Compared to Year Ended December 31, 2002
Total Revenue
-------------
Total revenue increased by $34.6 million or 38.8% from revenues of $89.1
million in 2002 to $123.7 million in 2003. The revenue growth for 2003
compared to 2002 is primarily attributable to the engineering segment,
which was awarded engineering, procurement and construction ("EPC") phases
of major projects. The engineering segment realized an increase in its
engineering revenues of $33.4 million primarily due to the co-generation
and cyclohexane projects. These projects contributed revenues of more than
$42.4 million during 2003, including non-labor revenue from materials,
equipment and subcontractors' charges of $29.4 million. Usually the
engineering segment's revenues are derived from direct labor. Procurement
activities contributed to a significant increase in revenues but at a lower
mark-up on these EPC projects. The labor-based revenue for engineering were
$77.5 million and $69.2 million in 2003 and 2002, respectively. By
comparison, the procurement-based revenues were $34.5 million and $5.2
million in 2003 and 2002, respectively.
Performance in the other areas of the engineering segment was mixed.
Significant growth occurred in the Tulsa area during 2003 with an increase
in revenues of 84%, from $2.5 million in 2002 to $4.6 million in 2003. This
growth was due to a concerted marketing effort to bring work to this
location. The Houston area, which has traditionally serviced the pipeline
industry, had lower than expected sales. The pipeline industry continues to
be over leveraged, and many capital expansions have been on hold for over
two years while the industry focused on debt reduction. The economy in the
Baton Rouge area continued to be flat during the early part of 2003, but
improved in the fourth quarter. However, competition in this area resulted
in lower margins. Revenues for 2003 decreased from 2002 by $5.1 million in
the Baton Rouge area. The fourth quarter showed signs of improvement as
Baton Rouge revenues improved 24% during the last quarter in 2003 as
compared to the same quarter in 2002.
The systems segment's revenues improved $700,000 from $14.2 million in 2002
to $14.9 million in 2003. ESI's revenues improved $2.1 million from $11.0
million in 2002 to $12.8 million in 2003. This growth was attributable to
large fixed-price sales of remote instrument enclosures to two clients.
Offsetting this increase was a decrease in revenues at ECP of $1.5 million.
As of January 2004, ECP has physically moved into the Houston ESI location
to help reduce its overhead expenses by sharing employees and reducing rent
and utility costs. ETI, a previously dormant entity, which was reactivated
in 2003, and Senftleber, a November 2003 acquisition, generated combined
revenues of $0.6 million in 2003.
The manufacturing segment was discontinued when certain assets of Thermaire
were sold in December 2003. Operational results of this segment are
reflected in the caption "Income (Loss) from Discontinued Operations."
Gross Profit
------------
Gross profit for the Company increased by $2.6 million or 17.8% from $14.4
million in 2002 to $17.0 million in 2003. The margin as a percentage of
revenue, however, decreased from 16.2% in 2002 to 13.7% in 2003. This
decrease is primarily due to the increase in EPC types of projects worked
in the engineering segment.
The gross profit for the engineering segment increased by $2.7 million or
22.4% from 2002 to 2003. The engineering segment's 2003 gross profit as a
percentage of revenue decreased from 16.1% in 2002 to 13.7% in 2003. EEI
has many contracts pursuant to which ENGlobal employees are assigned to
work at client facilities. These contracts are generally low-risk, with
virtually no overhead, and therefore, low margin. Also, the engineering
service segment, which normally functions as a source of professional
labor, was awarded EPC jobs in 2003 and 2002 with large quantities of
material and subcontract work. These jobs have traditionally had low
mark-ups on the materials and subcontractors' work, which decreases the
Company's margins. Engineering contributed 87.2% of the total gross profits
in 2003.
The systems segment gross margin as a percentage of sales decreased from
16.3% in 2002 to 14.2% in 2003. The decline in gross profits was primarily
due to cost overruns on fixed-price projects and competitive market
pressures on contract pricing. The cost overruns occurred due to rapid
growth in ESI's revenues. Management initiated stronger administrative and
support services controls in response to the cost overruns.
30
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION (Continued)
Year Ended December 31, 2003 Compared to Year Ended December 31, 2002
(Continued)
The Company combined three employee medical insurance plans into one
self-insured health plan at the beginning of 2003. Claim trends throughout
the year were lower than expected levels based on past years' experiences.
Adjustments to lower the insurance reserve were made in the third and
fourth quarters totaling $1.6 million, which resulted in improved gross
profits in both the engineering and systems segments. The engineering
segment received approximately 90% of the benefit, and the systems segment
received approximately 10% of the benefit.
Selling, General and Administrative Expenses
--------------------------------------------
Selling, general and administrative expenses increased by $1.8 million, or
17.0%, from $10.6 million in 2002 to $12.4 million in 2003 primarily due to
the creation of a business development department, which substantially
combined all the marketing activities of the engineering segment into one
centralized group and added several new marketing representatives.
Operating Profit
----------------
Operating profit increased by $0.8 million or 20.1% from $3.8 million in
2002 to $4.5 million in 2003. However, operating profits decreased as a
percentage of total revenue from 4.2% in 2002 to 3.7% in 2003. This
decrease was the result of the overall higher revenues and lower profit
margins.
Other Income (Expense)
----------------------
Other income decreased from $143,000 to expense of $355,000 from 2002 to
2003, respectively. The expense in 2003 is the loss on the sale of the
vacant building in Baton Rouge, as compared to the income in 2002, which
resulted from a legal settlement.
Provision for Income Taxes
--------------------------
The Company received a one-time tax benefit of approximately $138,000 in
2003 from the recapture of depreciation on segregated expenditures in
Company owned buildings in Baton Rouge. The one-time tax benefit decreased
the 2003 effective tax rate for income taxes from 39% in 2002 to 33%. The
Company does not expect the benefit to recur in future tax periods.
Liquidity and Capital Resources
Historically, we have satisfied our cash requirements through operations and
borrowings under a revolving credit facility. The Company's current credit
facility is with Comerica Bank ("Comerica") and consists of a line of credit
maturing July 27, 2007. The loan agreement positions Comerica as senior to all
other debt. The line of credit is limited to $22.0 million subject to loan
covenant restrictions. The Comerica Credit Facility is collateralized by
substantially all the assets of the Company. As of December 31, 2004, the
outstanding balance on the line of credit was $13.5 million and we had working
capital of $14.5 million. Our total long-term debt outstanding on December 31,
2004 was $16.2 million (see Note 7), an increase from $8.1 million as of
December 31, 2003. Our long-term debt includes $13.5 million outstanding under
our revolving credit facility with Comerica, and other long-term debt of $2.7
million. Under the terms and conditions of our revolving credit facility, as of
December 31, 2004, we have additional borrowing capacity of approximately $4
million after consideration of borrowing base limitations. We are not currently
subject to any other standby letters of credit, guarantees, repurchase
obligations, or other commitments. We have no off-balance sheet arrangements.
The Company has been awarded a significant project with Coffeyville Resources
Refining & Marketing, LLC ("CRRM") and entered into an Agreement for Engineering
and Procurement Services to provide detailed engineering and procurement
services for CRRM's ultra low sulphur diesel fuel facilities at its Coffeyville,
Kansas refinery on a cost reimbursable basis. We estimate that the agreement
will result in approximately 150,000 man-hours in engineering and related
activities in addition to a significant amount of revenue attributable to the
procurement of materials and equipment. The terms of the agreement require that
any progress payments made by CRRM for project items must be secured by one or
more irrevocable stand-by letters of credit issued on the account of ENGlobal.
The project began in January 2005 and is scheduled to complete in the third
quarter of 2006.
31
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION (Continued)
Liquidity and Capital Resources (Continued)
The following table summarizes our contractual obligations as of December 31,
2004:
Payments Due by Period
---------------------------------------------------------
2005 2006 2007 2008 2009 and Total
thereafter
------- ------- ------- ------- ------- -------
(in thousands)
---------------------------------------------------------
Long-term debt $ 622 $ 748 $14,065 $ 535 $ 237 $16,207
Capital leases 4 -- -- -- -- 4
Operating leases 1,551 1,221 1,333 968 2,556 7,629
------- ------- ------- ------- ------- -------
Total contractual cash obligations $ 2,177 $ 1,969 $15,398 $ 1,503 $ 2,793 $23,840
======= ======= ======= ======= ======= =======
We have several long-term notes that are subordinate to the Comerica debt.
o $255,000 in two notes of $127,500 each to Sterling Planet and EDGI,
each bearing interest at 5% and maturing in 2008. Principal amounts of
$15,000 are paid quarterly with accrued interest. The Sterling Planet
and EDGI notes were issued as part of the purchase of certain assets
of EDGI.
o $385,000 payable to Significant PEI shareholders resulting from
termination of the 2001 agreements (see Note 18 in consolidated
financial statements); payable in two remaining equal installments
before December 31, 2005 and 2006.
o $1,762,000 in four notes to Cleveland Inspection Services, Inc., CIS
Technical, Inc., and F. D. Curtis, each discounted using 5% interest
rate maturing in 2009. Principal amounts of $100,000 are paid
quarterly. The notes were issued as part of the purchase of certain
assets of Cleveland Inspection Services, Inc.
o $195,000 in a note to InfoTech Engineering, Inc., bearing interest at
5% and maturing in 2007. Principal amounts of $65,000 are paid
annually with accrued interest. The note was issued as a part of the
acquisition of certain assets of InfoTech Engineering, Inc.
Cash Flow
Operating activities required the use of $2.4 million in cash for the fiscal
year ended December 31, 2004. During the fiscal years ended December 31, 2003
and 2002, operating activities provided net cash totaling $6.6 million and $1.3
million, respectively. Much of the decrease in our cash flow from operating
activities occurred early in the fourth quarter of 2004 due to the acquisition
of CIS which was completed in October 2004. Subsequently, cash flow returned to
a positive position in January 2005 as the integration of the CIS acquisition
was substantially completed.
Investing activities used cash totaling $1.8 million in 2004, compared to
$471,000 in 2003 and $1.3 million in 2002. In 2004, our investing activities
consisted of capital additions of $1.2 million primarily for computers and
leasehold improvements to our Beaumont office. We used $625,000 in the fourth
quarter of 2004 to close the acquisitions of EDGI, AmTech, Cleveland Inspection
Services, Inc., and InfoTech.
Financing activities provided cash totaling $4.2 million in 2004 and used cash
totaling $6.1 million and $1.2 million during 2003 and 2002, respectively. Our
primary financing mechanism is our revolving line of credit. The line of credit
has been used principally to finance accounts receivable. During 2004, our
borrowings, net of payments, on the line of credit were $8.0 million, and we
repaid an aggregate of $3.8 million on our short-term and long-term debt.
Non-cash transactions include $2.6 million notes payable issued related to
acquisitions and $592,000 note payable issued for treasury stock. Non-cash
transactions include the issuance of stock dividends of $147,000 and $88,000
during 2003 and 2002, respectively. During 2003, our preferred stock was
converted to common stock valued at $2,735,000. We also acquired insurance with
notes payable of $1,092,000, $1,085,000, and $772,000 in 2004, 2003, and 2002,
respectively.
32
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION (Continued)
Cash Flow (Continued)
The Company believes that it has available necessary cash for operations for the
next 12 months. Cash and the availability of cash could be materially restricted
if circumstances prevent the timely internal processing of invoices into
accounts receivable, if such accounts are not collected timely, or if our
project mix shifts from cost reimbursable to fixed cost contracts during
significant periods of growth.
If losses occur, we may not be able to meet our monthly fixed charge ratio
covenant under our credit facility with Comerica. In that event, if we are
unable to obtain a waiver or amendment of the covenant, we may be unable to make
further borrowings and may be required to repay all loans then outstanding under
the credit facility.
We do not hold any derivative financial instruments for trading purposes or
otherwise. Furthermore, we have not engaged in energy or commodity trading
activities and do not anticipate doing so in the future, nor do we have any
transactions involving unconsolidated entities or special purpose entities.
Asset Management
We typically sell our products and services on short-term credit and seek to
minimize our credit risk by performing credit checks and conducting our own
collection efforts. Our trade accounts receivable increased to $30.8 million
from $20.2 million as of December 31, 2004 and 2003, respectively, primarily due
to increased revenue growth and timing issues related to delays in client
payments to both EEI and ESI totaling $3.0 million each. Trade receivables
increased $1.6 million and $1.4 million respectively for CIS and EDG, primarily
due to a delay in integration of CIS billings immediately following the
acquisition and a large foreign receivable from a client of EDG. Delays in
client payments beyond contract terms specifying a shortened five-day payment
cycle and our extending 60-day payment terms to a major client have contributed
to the increase in the number of days outstanding for trade accounts receivable
from 54 days at December 31, 2003 to 62 days at December 31, 2004. Our actual
bad debt expense has been approximately 0.2% of revenues for the periods ending
December 31, 2004 and 2003. We increased our allowance for doubtful accounts
from $376,000 to $476,000 or 1.8% and 1.5% of the trade accounts receivable
balance for 2003 and 2004, respectively.
Related Party Transactions
ENGlobal Engineering, Inc. leases office space from PEI Investments, a joint
venture in which ENGlobal Engineering, Inc. has a one-third interest, Michael L.
Burrow (the Company's CEO) has a one-third interest, and a stockholder who owns
less than 1% of the Company's common stock has a one-third interest. Rentals
paid under the lease were $135,000, $135,000 and $124,000 for 2004, 2003 and
2002, respectively. The lease expires in 2005. We believe that this lease is at
a commercially reasonable rental rate.
Risk Management
In performing services for our clients, we could potentially be liable for
breach of contract, personal injury, property damage or negligence, including
professional errors and omissions. We often agree to indemnify our clients for
losses and expenses incurred as a result of our negligence and, in certain
cases, the concurrent negligence of our clients. Our quality control and
assurance program includes a control function to establish standards and
procedures for performance and for documentation of project tasks, and an
assurance function to audit and to monitor compliance with procedures and
quality standards. We maintain liability insurance for bodily injury and
third-party property damage, professional errors and omissions, and workers
compensation coverage, which we consider sufficient to insure against these
risks, subject to self-insured amounts.
Seasonality
Holidays and employee vacations during our fourth quarter exert downward
pressure on revenues for that quarter, which is only partially offset by the
year-end efforts on the part of many clients to spend any remaining funds
budgeted for engineering services or capital expenditures during the year. The
annual budgeting and approval process under which these clients operate is
normally not completed until after the beginning of each new-year, which can
depress results for the first quarter. Principally due to these factors, our
revenues during the first and fourth quarters generally tend to be lower than in
the second and third quarters.
33
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION (Continued)
Critical Accounting Policies
Revenue Recognition
-------------------
Our revenues are largely composed of engineering service revenue and
product sales. The majority of our services are provided through
time-and-material contracts (also referred to as cost-plus contracts), many
of which have not-to-exceed provisions that place a cap on the revenue that
we may receive under a particular contract. These time and material
billings are produced every two weeks.
On occasion, we serve as purchasing agent by procuring subcontractors,
material and equipment on behalf of a client and passing the cost on to the
client with no mark-up or profit. In accordance with Statement of Position
("SOP") 81-1, revenues and costs for these type purchases are not included
in total revenues and costs. For financial reporting this "pass-through"
type of transaction is reported net.
Profits and losses on fixed-fee contracts are recorded on the
percentage-of-completion method of accounting, measured by the
percentage-of-contract costs incurred to date to estimated total contract
costs for each contract. Contract costs include amounts paid to
subcontractors. Anticipated losses on uncompleted construction contracts
are charged to operations as soon as such losses can be estimated. Changes
in job performance, job conditions, estimated profitability and final
contract settlements may result in revisions to costs and income and are
recognized in the period in which the revisions are determined.
The asset, "costs and estimated earnings in excess of billings on
uncompleted contracts," represents revenues recognized in excess of amounts
billed on fixed-fee contracts. The liability "billings in excess of costs
and estimated profits on uncompleted contracts" represents amounts billed
in excess of revenues recognized on fixed-fee contracts.
Goodwill
--------
In conjunction with each acquisition, we must allocate the cost of the
acquired entity to the assets and liabilities assumed based on their
estimated fair values at the date of acquisition. As additional information
becomes available, adjustments may be made to the original estimates within
a short time subsequent to the acquisition. Goodwill is not amortized but
instead is periodically assessed for impairment. The impairment testing
entails estimating current market value of the segments, based on
management's estimate of market conditions including pricing, demand,
competition, operating costs and other factors. Determining the fair value
of assets and liabilities acquired involves professional judgment and is
ultimately based on management's assessment of the value of the assets
acquired. We believe our estimates for these items are reasonable, but
there is no assurance that actual amounts will not vary significantly from
estimated amounts. Consistent with SFAS 142, we have not amortized goodwill
related to the merger with Petrocon, but instead tested the balance for
impairment.
Recent Accounting Pronouncements
In December 2004, the FASB issued Statement of Financial Accounting Standards
No. 123, (revised 2004) `Share-Based Payment" ("SFAS 123(R)"). This statement is
a revision of Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" as amended ("SFAS123"), and requires entities to
measure the cost of employee services received in exchange for an award of
equity instruments based on the grant-date fair value of the award. The cost
will be recognized over the period during which an employee is required to
provide services in exchange for the award (usually the vesting period). SFAS
123(R) covers various share-based compensation arrangement rights and employee
share purchase plans. SFAS 123(R) eliminates the ability to use the intrinsic
value methods of accounting for share options, as provided in Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB 25"). SFAS 123(R) is effective as of the beginning of the first interim
period that begins after June 15, 2005, with early adoption encouraged. The
Company is currently evaluating the statement's transition methods and does not
expect this statement to have an effect materially different than that of the
pro forma SFAS 123 disclosures provided in Note 10 to the Company's Consolidated
Financial Statements.
34
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION (Continued)
Recent Accounting Pronouncements (Continued)
In December 2004, the FASB issued Statement of Financial Accounting Standards
No. 153, "Exchanges of Non-monetary Assets, an amendment of APB Opinion No. 29"
("SFAS 153"). This Statement amends APB Opinion No. 29 to permit the exchange of
non-monetary assets to be recorded on a carry over basis when the non-monetary
assets do not have commercial substance. This is an exception to the basic
measurement principal of measuring a non-monetary asset exchange at fair value.
A non-monetary asset exchange has commercial substance if the future cash flows
of the entity are expected to change significantly as a result of the exchange.
SFAS 153 is effective for non-monetary asset exchanges occurring in fiscal
periods beginning after June 15, 2005. The adoption of this standard is not
expected to impact the Company's Consolidated Financial Statements.
In January 2003, the Financial Accounting Standard Board ("FASB") issued
Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities"
FIN 46 clarifies the application of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements," and addresses consolidation by business
enterprises of variable interest entities (more commonly known as "Special
Purpose Entities" or "SPE's"). In December 2003, FASB issued FIN No. 46R which
replaced FIN 46 and clarified ARB 51. This interpretation provides guidance on
how to identify a variable interest entity and determine when the assets,
liabilities, non-controlling interests and results of operations of a variable
interest entity should be consolidated by the primary beneficiary. The primary
beneficiary is the enterprise that will absorb a majority of the variable
interest entity's expected losses or receive a majority of the expected residual
returns as a result of holding variable interests. This FIN requires the
consolidation of results of variable interest entities in which the Company is
the primary beneficiary of the variable interest entity. As of December 31,
2004, the Company did not own an interest in a variable interest entity that met
the consolidation requirements and as such the adoption of FIN No. 46R did not
have any effect on the financial condition, results of operations, or liquidity
of the Company. Interests in entities acquired or created after December 31,
2003 will be evaluated based on FIN No. 46R criteria and consolidated, if
required.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of December 31, 2004 and 2003, the Company did not participate in any
derivative financial instruments or other financial and commodity instruments
for which fair value disclosure would be required under SFAS No 107. There are
no investments at December 31, 2004. Accordingly, the Company has no
quantitative information concerning the market risk of participating in such
investments.
As of December 31, 2004 and 2003, the Company did not participate in any
derivative financial instruments or other financial and commodity instruments
for which fair value disclosure would be required under SFAS No. 133.
The Company's primary interest rate risk relates to its variable-rate line of
credit debt obligation, which totaled $13.5 million and $5.6 million as of
December 31, 2004 and 2003, 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 4.38% as of December 31, 2004, to an average
interest rate of 4.82%), annual interest expense would have been approximately
$42,000 higher in 2004 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, 2004. Currently, the Company does not engage in foreign currency
hedging activities nor is the Company exposed to currency exchange rate
fluctuation.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMTARY DATA
The audited consolidated balance sheets for ENGlobal Corporation, as of December
31, 2004 and 2003 and statements of income, cash flows and stockholders' equity
for the three-year period ended December 31, 2004, are attached hereto and made
part hereof.
35
INDEX
Page
-------------
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 37
CONSOLIDATED BALANCE SHEETS
December 31, 2004 and 2003 38
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2004, 2003 and 2002 39
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 2004, 2003 and 2002 40
CONSOLIDATED STATEMENTS OF CASH FLOW
Years Ended December 31, 2004, 2003 and 2002 41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 42
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON FINANCIAL STATEMENT SCHEDULE 62
SCHEDULE II
Valuation and Qualifying Accounts 63
36
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
ENGlobal Corporation
We have audited the accompanying consolidated balance sheets of ENGlobal
Corporation as of December 31, 2004 and 2003, and the related consolidated
statements of income, stockholders' equity and cash flows for each of the years
in the three-year period ended December 31, 2004. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. The Company
has determined that it is not required to have, nor were we engaged to perform,
an audit of its internal controls over financial reporting. Our audit included
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the Company's
internal control over financial reporting. Accordingly, we express no such
opinion. An audit also includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
ENGlobal Corporation and Subsidiaries as of December 31, 2004 and 2003, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2004, in conformity with U.S. generally
accepted accounting principles.
/s/ Hein & Associates LLP
- -------------------------
Hein & Associates LLP
Houston, Texas
March 10, 2005
37
ENGLOBAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2004 AND 2003
ASSETS
------
2004 2003
Current Assets ------------ ------------
Cash $ 8,006 $ 39,439
Trade receivables, net 30,839,597 20,244,172
Prepaid expenses and other current assets 1,984,274 1,260,296
Costs and estimated earnings in excess of billings on uncompleted contracts 1,113,330 1,022,726
Deferred tax asset 640,380 477,000
Inventories 172,715 118,340
Assets held for sale 678,106 --
Federal income taxes receivable 118,000 --
------------ ------------
Total Current Assets 35,554,408 23,161,973
Property and Equipment, net 5,262,370 4,302,430
Net Assets of Discontinued Operations -- 860,728
Goodwill 15,284,220 13,752,564
Other Assets 1,159,750 452,695
------------ ------------
Total Assets $ 57,260,748 $ 42,530,390
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current Liabilities
Accounts payable $ 10,512,123 $ 9,821,030
Accrued compensation and benefits 6,059,221 4,302,136
Notes payable 839,606 771,225
Current portion of long-term debt 622,410 623,230
Current portion of capital lease 4,371 7,818
Billings and estimated earnings in excess of costs on uncompleted contracts 2,313,954 374,339
Federal income taxes payable -- 103,609
Other liabilities 699,601 653,881
------------ ------------
Total Current Liabilities 21,051,286 16,657,268
Net Liabilities of Discontinued Operation -- 24,164
Long-Term Debt, net of current portion 15,585,152 7,506,062
Long-Term Leases, net of current portion -- 12,042
Deferred Tax Liability 573,380 156,000
------------ ------------
Total Liabilities 37,209,818 24,355,536
------------ ------------
Commitments and Contingencies (Notes 8, 9, 11, 15, 18 and 19)
Stockholders' Equity
Series A redeemable convertible preferred stock - $0.001 par value, with fair
value of $1.00 per share; 2,265,167 shares authorized 2004 and 2003,
respectively; 0 shares issued and outstanding 2004 and 2003, respectively -- --
Common stock - $0.001 par value; 75,000,000 shares authorized; 23,466,839
and 24,034,288 shares outstanding and 24,119,216 and 24,034,288 issued at
December 31, 2004 and 2003, respectively 24,119 24,034
Additional paid-in capital 12,198,215 12,094,382
Retained earnings 8,420,827 6,056,438
Treasury stock - 652,377 shares at cost (592,231) --
------------ ------------
Total Stockholders' Equity 20,050,930 18,174,854
------------ ------------
Total Liabilities and Stockholders' Equity $ 57,260,748 $ 42,530,390
============ ============
See accompanying notes to these consolidated financial statements.
38
ENGLOBAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31,
-----------------------------------------------
2004 2003 2002
------------- ------------- -------------
Operating Revenues
Engineering $ 133,630,281 $ 108,380,100 $ 74,971,506
Systems 15,257,960 15,339,002 14,151,089
------------- ------------- -------------
Total Revenue 148,888,241 123,719,102 89,122,595
------------- ------------- -------------
Direct Costs
Engineering 117,204,900 93,578,716 62,876,626
Systems 13,089,874 13,166,811 11,839,820
------------- ------------- -------------
Total Direct Costs 130,294,774 106,745,527 74,716,446
------------- ------------- -------------
Gross Profit 18,593,467 16,973,575 14,406,149
Selling, General, and Administrative Expenses 14,101,497 12,439,408 10,632,357
------------- ------------- -------------
Operating Income 4,491,970 4,534,167 3,773,792
Interest Expense (590,227) (784,227) (820,976
Other income (expense) 118,409 (355,175) 142,559
------------- ------------- -------------
Income from Continuing Operations
before Provisions for Income Taxes 4,020,152 3,394,765 3,095,375
Provision for Income Taxes 1,655,763 1,109,496 1,197,067
------------- ------------- -------------
Income from Continuing Operations 2,364,389 2,285,269 1,898,308
Income/(Loss) from Discontinued Operations
Loss from operations of discontinued segment,
net of tax ($75,066, $92,373 benefit, respectively) -- (154,615 (146,485
Gain from sale of discontinued segment,
net of tax ($12,834) -- 26,434 --
------------- ------------- -------------
Net Income 2,364,389 2,157,088 1,751,823
Preferred Dividends -- 131,100 208,992
------------- ------------- -------------
Net Income Available for Common Stock $ 2,364,389 $ 2,025,988 $ 1,542,831
============= ============= =============
Basic Earnings per Share from Continuing Operations $ 0.10 $ 0.09 $ 0.07
Basic Earnings per Share from Discontinued Operations -- -- --
------------- ------------- -------------
Basic Earnings per Share from Net Income
Available for Common Stock $ 0.10 $ 0.09 $ 0.07
============= ============= =============
Weighted Average Common Shares Outstanding for Basic 23,454,545 23,300,600 22,861,199
============= ============= =============
Diluted Earnings per Share from Continuing Operations $ 0.10 $ 0.09 $ 0.07
Diluted Earnings per Share from Discontinued Operations -- -- --
------------- ------------- -------------
Diluted Earnings per Share from Income
Available for Common Stock $ 0.10 $ 0.09 $ 0.07
============= ============= =============
Weighted Average Common Shares Outstanding for Diluted 23,785,939 23,733,807 23,013,016
============= ============= =============
See accompanying notes to these consolidated financial statements.
39
ENGLOBAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
Common Stock Additional Total
---------------------------- Paid-In Retained Treasury Stockholders'
Shares Stock Capital Earnings Stock Equity
------------ ------------ ------------ ------------ ------------ ------------
BALANCES-JANUARY 1, 2002 22,861,199 $ 22,862 $ 9,335,471 $ 2,487,617 $ -- $ 11,845,950
Preferred stock dividend -- -- -- (208,992) -- (208,992)
Net income -- -- -- 1,751,823 -- 1,751,823
------------ ------------ ------------ ------------ ------------ ------------
BALANCES-DECEMBER 31, 2002 22,861,199 22,862 9,335,471 4,030,448 -- 13,388,781
Preferred stock dividend -- -- -- (131,098) -- (131,098)
Conversion of preferred stock
2.38 preferred shares to
each common share 1,149,089 1,148 2,733,685 -- -- 2,734,833
Exercise of stock options 24,000 24 25,226 -- -- 25,250
Net income -- -- -- 2,157,088 -- 2,157,088
------------ ------------ ------------ ------------ ------------ ------------
BALANCES-DECEMBER 31, 2003 24,034,288 24,034 12,094,382 6,056,438 -- 18,174,854
Exercise of options 38,242 38 42,474 -- -- 42,512
Common stock purchased for
treasury (652,377) -- -- -- (592,231) (592,231)
Common stock issued through
employee stock purchase plan 46,686 47 61,359 -- -- 61,406
Net income -- -- -- 2,364,389 -- 2,364,389
------------ ------------ ------------ ------------ ------------ ------------
BALANCES-DECEMBER 31, 2004 23,466,839 $ 24,119 $ 12,198,215 $ 8,420,827 $ (592,231) $ 20,050,930
============ ============ ============ ============ ============ ============
See accompanying notes to these consolidated financial statements.
40
ENGLOBAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
-----------------------------------------------
2004 2003 2002
------------- ------------- -------------
Cash Flows from Operating Activities
Net income $ 2,364,389 $ 2,157,088 $ 1,751,823
Adjustments to reconcile net income to net cash
provided by (used in) operating activities -
Depreciation and amortization 1,246,532 824,476 712,991
Deferred income tax expense 254,000 542,000 437,000
Loss on disposal of property, plant and equipment 2,564 312,307 --
Changes in current assets and liabilities, net of acquisitions -
Trade receivables (10,595,425) (3,947,817) (1,117,211)
Inventories (54,375) 110,056 462,652
Costs and estimated earnings in excess of billings (90,604) 1,020,877 (1,313,096)
Prepaid expenses and other assets 231,401 372,419 251,530
Accounts payable 691,093 5,695,662 (1,265,601)
Accrued compensation and benefits 1,713,253 403,724 1,198,724
Billings in excess of costs and estimated earnings 1,939,616 (437,506) 34,133
Other liabilities 128,114 (280,166) (169,822)
Income taxes receivable (payable) (221,610) (215,619) 319,228
------------- ------------- -------------
Net cash provided by (used in) operating activities (2,391,052) 6,557,501 1,302,351
------------- ------------- -------------
Cash Flows from Investing Activities
Purchase of property and equipment (1,195,588) (1,146,351) (423,344)
Software upgrade -- -- (909,627)
Proceeds from sale of Baton Rouge building -- 554,866 42,523
Additional consideration for acquisitions (625,000) (424,900) --
Proceeds from sale of equipment 9,897 -- --
Proceeds from sale of Thermaire -- 545,198 --
------------- ------------- -------------
Net cash used in investing activities (1,810,691) (471,187) (1,290,448)
------------- ------------- -------------
Cash Flows from Financing Activities
Borrowings on line of credit 134,571,349 127,650,133 111,764,457
Payments on line of credit (126,597,915) (132,178,422) (110,574,665)
Proceeds from issuance of common stock 103,918 25,250 --
Short-term borrowings (repayments) (1,071,885) (484,023) (684,626)
Preferred dividends accrual -- -- (120,773)
Capital lease repayments (12,478) (4,364) (50,661)
Long-term debt repayments (2,822,679) (1,130,544) (1,515,447)
------------- ------------- -------------
Net cash provided by (used in) financing activities 4,170,310 (6,121,970) (1,181,715)
------------- ------------- -------------
Net Change in Cash and Cash Equivalents (31,433) (35,656) (1,169,812)
Cash and Cash Equivalents - beginning of year 39,439 75,095 1,244,907
------------- ------------- -------------
Cash and Cash Equivalents - end of year $ 8,006 $ 39,439 $ 75,095
============= ============= =============
Non-Cash Transactions
Stock issued for preferred dividend $ -- $ 146,833 $ 88,000
Insurance acquired with notes payable 1,092,096 1,085,363 771,502
Conversion of preferred stock to common stock -- 2,734,834 --
Acquisition of assets of EDG, AmTech, CIS and InfoTech with
issuance of notes payable 2,575,000 -- --
Acquisition of treasury stock with note payable 592,231 -- --
Supplemental Cash Flow Information
Cash paid during the year for -
Interest $ 420,627 $ 771,793 $ 744,103
State and federal income taxes 1,196,761 734,615 486,697
Dividend payment -- 105,040 --
Refund from state franchise taxes -- -- 389,714
See accompanying notes to these consolidated financial statements.
41
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BACKGROUND AND BASIS OF PRESENTATION
Basis of Presentation
- ---------------------
Our consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America. Our Company
consolidates all of its wholly-owned subsidiaries and all significant
inter-company accounts and transactions have been eliminated in the
consolidation.
Organization
- ------------
Brief descriptions of the active companies included in the consolidated group
follow:
ENGlobal Corporation ("ENGlobal") - our public holding company.
ENGlobal Corporate Services, Inc. ("ECS") - provides the corporate
oversight function.
ENGlobal Engineering, Inc. ("EEI") - provides general engineering for
industrial customers primarily in the United States with specialties in the
areas of distributive control systems, power distribution, process design
and process safety management.
ENGlobal Construction Resources, Inc. ("ECR") - provides technical and
inspection personnel within client facilities for the petroleum industry.
RPM Engineering, Inc. d/b/a ENGlobal Engineering, Inc. ("RPM") - provides
engineering services primarily in southeast Louisiana.
ENGlobal Systems, Inc. ("ESI") - provides design, fabrication,
installation, start-up, checkout and maintenance of specialized systems
such as programmable logic controller (PLC) systems integration,
supervisory controls and data acquisition (SCADA) and triple modular
redundancy (TMR) systems, distribution control system (DCS), and analyzer
systems.
ENGlobal Constant Power, Inc. ("ECP") - fabricates industrial grade
uninterruptible electrical power systems, battery chargers and
microprocessor systems for service in the high-end industrial market.
ENGlobal Technologies, Inc. ("ETI") - reactivated in January 2003; provides
advanced automation controls such as software analyzers and intelligent
optimization software for the power and processing industries.
Senftleber & Associates, L.P. ("Senftleber") - provides pipeline support
and consulting along the Gulf Coast.
ENGlobal Design Group, Inc. ("EDG") - provides design, installation and
maintenance of various government and public sector facilities, the most
active sector being Automated Fuel Handling Systems serving the U.S.
Military.
42
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, 2004. The Company's banking system
provides for daily replenishment of major bank accounts for check-clearing
requirements. Accordingly, there were negative book balances of $3.3 million on
December 31, 2004 and $0.9 million on December 31, 2003. Such balances result
from outstanding checks that have not yet been paid by the bank and are
reclassified to accounts payable in the accompanying consolidated balance
sheets.
Inventories
- -----------
Inventories carried by our ECP subsidiary are composed primarily of raw
materials and component parts (enclosures, electronics, PC boards and wire) and
are carried at the lower of cost or market value, with cost determined on the
first-in, first-out ("FIFO") method of accounting.
Revenue Recognition
- -------------------
The Company's revenues are composed of engineering service revenue and product
sales. The Company recognizes service revenue as soon as such services are
performed. The majority of the Company's services are provided through cost-plus
contracts.
On occasion, the Company, serving as an agent for the client, procures material
and equipment on behalf of the client whereby the cost of such material and
equipment is reimbursed with no mark-up or profit. In accordance with Statement
of Position (SOP) 81-1, revenues and costs for these type purchases are not
included in total revenues and costs. For financial reporting this
"pass-through" type of transaction is reported net. During 2004 and 2003,
pass-through transactions totaled $15.9 million and $5.6 million, respectively.
Profits and losses on fixed-fee contracts are recorded on the
percentage-of-completion method of accounting, measured by the
percentage-of-contract costs incurred to date relative to estimated total
contract costs. Contract costs include total labor, material, subcontractors and
supplies. 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.
The asset, "costs and estimated earnings in excess of billings on uncompleted
contracts," represents revenues recognized in excess of amounts billed on
fixed-fee contracts. The liability "billings in excess of costs and estimated
profits on uncompleted contracts" represents amounts billed in excess of
revenues recognized on fixed-fee contracts.
Property and Equipment
- ----------------------
All property and equipment is stated at cost, adjusted for accumulated
depreciation. Depreciation is calculated using a straight-line method over the
estimated useful lives of the related assets. The useful life is estimated to be
3 years for computers and autos, 5 years for software, furniture and fixtures,
10 years for machinery and equipment, and 39 years for buildings. Leasehold
improvements are amortized over the term of the related lease.
Goodwill
- --------
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS 142 requires that goodwill and intangible assets with indefinite
useful lives no longer be amortized, but instead tested for impairment at least
annually. SFAS 142 also requires that intangible assets with estimable useful
lives be amortized over their respective estimated useful lives to their
estimated residual values and reviewed for impairment in accordance with SFAS
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets."
43
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
The Company adopted SFAS 142 effective January 1, 2002. Upon adoption, the
Company tested goodwill for impairment at January 1, 2002 according to the
provisions of SFAS 142, which resulted in no impairment required as a cumulative
effect of accounting change. The Company tested goodwill for impairment at
December 31, 2003 and 2004 resulting in no impairment of goodwill.
In 2004, acquisitions of assets of several companies resulted in an increase of
$1,725,00 to goodwill. Acquisitions of the assets of Engineering Design Group,
Inc. ("EDGI"), InfoTech, and Cleveland Inspection Services, Inc. ("CIS")
resulted in increases to goodwill of $139,000, $270,000 and $1,316,000,
respectively.
In 2003, the Petro-Chem and Senftleber acquisitions resulted in increases in
goodwill of $115,000 and $428,000, respectively and an adjustment to lower
goodwill by $2,000 was made as a result of the sale of Thermaire.
Long-lived Assets
- -----------------
The Company reviews long-lived assets and certain identifiable intangible assets
for impairment annually or whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. An impairment loss
would be recognized when estimated future cash flows expected to result from the
use of the asset and its eventual disposition is less than its carrying amount.
The Company has not identified any such impairment losses.
Software Development Costs
- --------------------------
Under the provisions of SOP-98-1 ENGlobal capitalizes costs associated with
software developed or obtained for internal use when both the preliminary
project stage is completed and when management authorizes funding for the
project which is deemed probable of completion. Costs include 1) external direct
costs of materials and services incurred in obtaining and developing the
software, and 2) payroll and payroll related costs for employees who are
directly associated with and devote time to the project. Capitalization of these
costs ceases no later than the point at which the project is substantially
complete and ready for its intended use. At that time, the costs are
reclassified to fixed assets. The accounting system upgrade was completed at the
end of 2002 and depreciation began in January 2003.
The project controls system upgrade was completed at the end of 2004 and
depreciation on costs of $350,000 will begin in January 2005.
Dispositions - Assets Held for Sale and Discontinued Operations
- ---------------------------------------------------------------
In management's ongoing strategic efforts to increase the Company's focus on
core engineering consulting services, the Company sold its Thermaire
manufacturing operations. During 2001, ENGlobal decided to seek a buyer for
Thermaire, its only company in the manufacturing segment. Thermaire manufactured
air-handling equipment for commercial heating, ventilation and cooling systems.
The sale benefited the Company by improving its strategic focus on engineering
services and systems.
Effective November 2001, the Board of Directors authorized the sale of
Thermaire. A significant portion of Thermaire's assets was sold to Nailor
Industries on December 15, 2003. This business has been included in
"Income/(Loss) from Discontinued Operations" and the assets and liabilities have
been separately identified on the Balance Sheet for all periods presented. The
revenues from discontinued operations for the years ended December 31, 2003,
2002 were $2.0 million and $2.4 million, respectively. These revenues were
excluded from revenues from continuing operations reported on the income
statement. Thermaire experienced pre-tax losses during 2003 and 2002 of $230,000
and $239,000, respectively. The loss from discontinued operations does not
include any charges to reduce the book value of the business held for sale to
its fair market value less cost to sell, since the fair value of the business
exceeded book value.
44
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Dispositions - Assets Held for Sale and Discontinued Operations (Continued) The
major classes of assets and liabilities "held for sale" included in the
Consolidated Balance Sheets as of December 31 are as follows:
2004 2003
----------------------
(in thousands)
----------------------
Assets
Accounts receivable, net $ -- $ 183
Property, plant and equipment, net,
held for sale 678 678
-------- --------
Total assets "held for sale" $ 678 $ 861
======== ========
Liabilities
Accounts payable $ -- $ 2
Other current liabilities -- 22
-------- --------
Total liabilities associated with
assets "held for sale" $ -- $ 24
======== ========
Income Taxes
- ------------
The Company accounts for deferred income taxes in accordance with the asset and
liability method, whereby deferred income taxes are recognized for the tax
consequences of temporary differences by applying enacted statutory tax rates
applicable to future years to differences between the financial statement and
tax bases of its existing assets and liabilities. The provision for income taxes
represents the current tax payable or refundable for the period plus or minus
the tax effect of the net change in the deferred tax assets and liabilities
during the period.
Stock Based Compensation
- ------------------------
The Company applies SFAS No. 123, Accounting for Stock-Based Compensation, which
encourages, but does not require, companies to recognize compensation expense
for grants of stock, stock options, and other equity instruments to employees
based on fair value. The Company has elected to record compensation expense in
accordance with Accounting Principles Board (APB) Opinion No. 25, which
calculates compensation as the difference between an option's exercise price and
the current price of the underlying stock. (For equity instruments issued to
employees, see Note 10 that contains required pro forma disclosure of the impact
of adopting SFAS No. 123)
45
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Earnings Per Share
- ------------------
Basic earnings per share was computed as follows:
Reconciliation of Earnings per Share Calculation
------------------------------------------------------------------------------------------
2004 2003 2002
--------------------------- ---------------------------- ----------------------------
Basic Diluted Basic Diluted Basic Diluted
------------ ------------ ------------ ------------ ------------ ------------
Income from continuing operations $ 2,364,389 $ 2,364,389 $ 2,285,269 $ 2,285,269 $ 1,898,308 $ 1,898,308
Preferred dividends -- -- 131,100 131,100 208,992 208,992
------------ ------------ ------------ ------------ ------------ ------------
Income available for common stock from
continuing operations 2,364,389 2,364,389 2,154,169 2,154,169 1,689,316 1,689,316
Loss from discontinued operations -- -- (128,181) (128,181) (146,485) (146,485)
------------ ------------ ------------ ------------ ------------ ------------
Net income available for common stock $ 2,364,389 $ 2,364,389 $ 2,025,988 $ 2,025,988 $ 1,542,831 $ 1,542,831
============ ============ ============ ============ ============ ============
Weighted average number of shares
outstanding for basic 23,454,545 23,300,600 22,861,199
Weighted average number of shares
outstanding for diluted 23,785,939 23,733,807 23,013,016
Net income (loss) per share available
for common stock
Income from continuing operations $ 0.10 $ 0.10 $ 0.09 $ 0.09 $ 0.07 $ 0.07
Loss from discontinued operations -- -- -- -- -- --
Net income available for common
stock 0.10 0.10 0.09 0.09 0.07 0.07
Diluted earnings per share are computed including the impact of all potentially
dilutive securities. Potentially dilutive securities that have not been included
in the computation of earnings per share include 497,171 options exercisable
from $4.26 to $6.24, issued from 1995 through 2003. These options were not
included because the exercise prices were greater than the market price of the
common stock and, therefore, the effect would be anti-dilutive.
The following table sets forth the shares outstanding for the earnings per share
calculations for the years ended December 31, 2004, 2003 and 2002.
2004 2003 2002
----------- ----------- -----------
Common stock issued - beginning of year 24,034,288 22,861,199 22,861,199
Weighted average common stock issued (repurchased) (579,743) 439,401 --
----------- ----------- -----------
Shares used in computing basic earnings per share 23,454,545 23,300,600 22,861,199
Assumed conversion of dilutive stock options 331,394 433,207 151,817
----------- ----------- -----------
Shares used in computing diluted earnings per share 23,785,939 23,733,807 23,013,016
=========== =========== ===========
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, accounts payable and notes payable, closely approximate the carrying
values of the instruments due to the short-term maturities of such instruments.
46
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Comprehensive Income
- --------------------
Comprehensive income is defined as all changes in stockholders' equity,
exclusive of transactions with owners, such as capital investments.
Comprehensive income includes net income or loss, changes in certain assets and
liabilities that are reported directly in equity, such as translation
adjustments on investments in foreign subsidiaries and certain changes in
minimum pension liabilities. The Company's comprehensive income is equal to its
net income for all periods presented in these financial statements.
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 December 2004, the FASB issued Statement of Financial Accounting Standards
No. 123, (revised 2004) "Share-Based Payment" ("SFAS 123(R)"). This statement is
a revision of Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" as amended ("SFAS123"), and requires entities to
measure the cost of employee services received in exchange for an award of
equity instruments based on the grant-date fair value of the award. The cost
will be recognized over the period during which an employee is required to
provide services in exchange for the award (usually the vesting period). SFAS
123(R) covers various share-based compensation arrangement rights and employee
share purchase plans. SFAS 123(R) eliminates the ability to use the intrinsic
value methods of accounting for share options, as provided in Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB 25"). SFAS 123(R) is effective as of the beginning of the first interim
period that begins after June 15, 2005, with early adoption encouraged. The
Company is currently evaluating the statement's transition methods and does not
expect this statement to have an effect materially different than that of the
pro forma SFAS 123 disclosures provided in Note 10 to the Company's Consolidated
Financial Statements.
In December 2004, the FASB issued Statement of Financial Accounting Standards
No. 153, "Exchanges of Non-monetary Assets, an amendment of APB Opinion NO. 29"
("SFAS 153"). This Statement amends APB Opinion No 29 to permit the exchange of
non-monetary assets to be recorded on a carry over basis when the non-monetary
assets do not have commercial substance. This is an exception to the basic
measurement principal of measuring a non-monetary asset exchange at fair value.
A non-monetary asset exchange has commercial substance if the future cash flows
of the entity are expected to change significantly as a result of the exchange.
SFAS 153 is effective for non-monetary asset exchanges occurring in fiscal
periods beginning after June 15, 2005. The adoption of this standard is not
expected to impact the Company's Consolidated Financial Statements.
In January 2003, the Financial Accounting Standard Board ("FASB") issued
Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities."
FIN 46 clarifies the application of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements," and addresses consolidation by business
enterprises of variable interest entities (more commonly known as Special
Purpose Entities or SPE's). In December 2003, FASB issued FIN No. 46R which
replaced FIN 46 and clarified ARB 51. This interpretation provides guidance on
how to identify a variable interest entity and determine when the assets,
liabilities, non-controlling interests and results of operations of a variable
interest entity should be consolidated by the primary beneficiary. The primary
beneficiary is the enterprise that will absorb a majority of the variable
interest entity's expected losses or receive a majority of the expected residual
returns as a result of holding variable interests. This FIN requires the
consolidation of results of variable interest entities in which the Company is
the primary beneficiary of the variable interest entity. As of December 31, 2003
and 2004, the Company did not own an interest in a variable interest entity that
met the consolidation requirements and as such the adoption of FIN No. 46R did
not have any effect on the financial condition, results of operations, or
liquidity of the Company. Interests in entities acquired or created after
December 31, 2004 will be evaluated based on FIN No. 46R criteria and
consolidated, if required.
47
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at December 31, 2004 and 2003:
2004 2003
------- -------
(in thousands)
------------------
Land $ 202 $ 202
Building 1,359 1,357
Computer equipment and software 4,038 2,855
Shop equipment 783 362
Furniture and fixtures 303 121
Building and leasehold improvement 692 671
Autos and trucks 169 79
------- -------
7,546 5,647
Accumulated depreciation and amortization (2,645) (1,642)
------- -------
4,901 4,005
Software upgrade in process 361 297
------- -------
Property and equipment, net $ 5,262 $ 4,302
======= =======
Depreciation expense was $1,002,000, $781,000, and $601,000 in 2004, 2003 and
2002, respectively.
The Company owned an office building in Baton Rouge, which had been vacated due
to the consolidation of the Baton Rouge operations into one facility. The
Company sold the building in September 2003 resulting in cash proceeds of
$555,000 and a book loss of $312,000. The Company used the cash proceeds from
the sale of the building to reduce long-term debt.
The office and manufacturing facility owned by Thermaire has been reclassified
to Assets held for sale for 2004 from Assets of Discontinued Operations for 2003
and 2002. (See Note 16)
NOTE 5 - DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS
The components of trade receivables as of December 31, 2004 and 2003 are as
follows:
2004 2003
-------- --------
(in thousands)
--------------------
Amounts billed at December 31 $ 21,204 $ 14,133
Amounts billable at December 31,
billed January of the following year 9,177 6,093
Retainage 935 394
Less: Allowance for un-collectible accounts (476) (376)
-------- --------
Trade receivables, net $ 30,840 $ 20,244
======== ========
The components of other liabilities as of December 31, 2004 and 2003 are as
follows:
2004 2003
---- ----
(in thousands)
-----------
Reserve for known contingencies (Note 18) $ 51 $478
Accrued interest 161 48
State taxes 198 39
Other 290 97
---- ----
Other liabilities $700 $662
==== ====
48
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 - FIXED-FEE CONTRACTS
Costs, estimated earnings and billings on uncompleted contracts consisted of the
following at December 31, 2004 and 2003:
2004 2003
-------- --------
(in thousands)
--------------------
Costs incurred on uncompleted contracts $ 8,292 $ 14,333
Estimated earnings on uncompleted contracts 1,584 1,862
-------- --------
Earned revenues 9,876 16,195
Less: Billings to date (11,077) (15,546)
-------- --------
Net costs and estimated earnings in excess of
billings on uncompleted contracts $ (1,201) $ 649
======== ========
Costs and estimated earnings in excess of
billings on uncompleted contracts $ 1,113 $ 1,023
Billings in excess of costs and estimated
earnings on uncompleted contracts (2,314) (374)
-------- --------
Net costs and estimated earnings in excess of
billings on uncompleted contracts $ (1,201) $ 649
======== ========
NOTE 7 - LINE OF CREDIT AND DEBT
At the end of the year, the Company had a Credit Facility with Comerica Bank
("Comerica") that consisted of a line of credit maturing on July 27, 2007 (the
"Comerica Credit Facility"). The loan agreement positioned Comerica as senior to
all other debt. The line of credit is limited to $22.0 million, subject to loan
covenant restrictions. The Comerica Credit Facility is collateralized by
substantially all the assets of the Company. The outstanding balance on the line
of credit as of December 31, 2004 was $13.5 million. At the election of the
Company, the interest rate will be the lesser of prime or a three tiered
Eurodollar rate, plus 150, 175, or 200 basis points, respectively, based on the
ratio of total funded debt to EBITDA for the trailing 12 months of less than
2.00, between 2.00 and 2.50, and greater than 2.50, respectively. The commitment
fee of the unused line of credit is 0.250%. The remaining borrowings available
under the line of credit as of December 31, 2004 were $4.0 million after
consideration of loan covenant restrictions.
The Comerica Credit Facility contains covenants requiring the Company, as of the
end of each calendar month, to maintain certain ratios, including total average
funded debt to EBITDA; total average funded debt to total liabilities, plus net
worth; and total funded debt to accounts/unbilled receivables. The Company is
also required, as of the end of each quarter, to maintain minimum levels of net
worth, plus the Company must comply with an annual limitation on capital
expenditures. The Company was in compliance with all covenants under the
Comerica Credit Facility as of December 31, 2004.
49
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 - LINE OF CREDIT AND DEBT (Continued)
Long-term debt consisted of the following at December 31, 2004 and 2003:
2004 2003
-------- --------
(in thousands)
--------------------
Comerica Credit Facility - Line of credit, prime (5.25% at December 31,
2004), maturing in July 2007 $ 13,530 --
Fleet Credit Facility - retired in July 2004 -- 5,556
The following notes are subordinate to the credit facility
and are unsecured:
Equus II - Note payable, interest at 9.5%, principal and interest
due quarterly in installments of $110,000, scheduled to mature
in December 2005, retired July 2004 -- 2,340
Petrocon Arabia Limited - Note payable, interest at 8%, principal
due in monthly payments of $25,000 and interest due annually,
retired in June 2004 -- 151
Petro-Chem - Note payable, principal due in annual installments of
$25,000, scheduled to mature in January 2006, retired in April 2004 -- 75
Sterling Planet and EDGI - Notes payable, interest at 5%, principal
payments installments of $15,000 and interest due quarterly,
maturing in December 2008 255 --
Significant PEI Shareholders (See Note 18) 385 --
Cleveland Inspection Services, Inc., CIS Technical Services and
F.D. Curtis - Notes payable, discounted at 5% interest, principal in
installments of $100,000 due quarterly scheduled to mature October 2009 1,762 --
Info Tech Engineering, Inc. - Note payable, interest at 5%, principal
payments in installments of $65,000 plus interest due annually,
maturing in December 2007 195 --
Miscellaneous 80 7
-------- --------
Total long-term debt 16,207 8,129
Less: Current maturities (622) (623)
-------- --------
Long-term debt, net of current portion $ 15,585 $ 7,506
======== ========
Maturities of long-term debt as of December 31, 2004, are as follows:
Maturities
-----------
(in thousands)
-----------
Years Ending December 31,
2005 $ 622
2006 748
2007 14,065
2008 535
2009 and after 237
-----------
Total long-term debt $ 16,207
===========
Current notes payable include a note at both December 31, 2004 and 2003, to
finance commercial insurance on a short-term basis, with a balance of $840,000
and $771,000 as of December 31, 2004 and 2003, respectively. The current note
payable for 2004 bears interest at 4.87% and is payable in monthly installments
of principal and interest totaling $122,000 through July 2005.
50
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8 - 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, 2004
are as follows:
Operating
------------
(in thousands)
------------
Years Ending December 31,
2005 $ 1,551
2006 1,221
2007 1,333
2008 968
2009 and after 2,556
-----------
Total minimum lease payments $ 7,629
===========
NOTE 9 - PROFIT SHARING PLAN
The Company terminated one of its two 401(k) profit sharing plans at the end of
2003 and employee participants are now covered under the remaining 401(k) Plan.
For eligible employees, the Company makes mandatory matching contributions equal
to 50% of employee contributions up to 4% of employee compensation, as defined.
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 $221,000, $144,000
and $172,000, respectively, for the years ended December 31, 2004, 2003, and
2002.
NOTE 10 - STOCK OPTION PLAN
The Company has an incentive plan that provides for the issuance of options to
acquire up to 2,200,000 shares of common stock. The incentive plan ("Option
Plan") provides for grants of non-statutory options, incentive stock options,
restricted stock awards and stock appreciation rights. No compensation cost has
been recognized for grants under the Option Plan because the exercise price of
the options granted to employees equaled or exceeded the market price of the
stock on the date of the grant. Had the method prescribed by SFAS No. 123 been
applied, the Company's net income available to common stockholders for the years
ended December 31, 2004, 2003 and 2002 would have been changed to the pro forma
amount indicated below:
2004 2003 2002
----------- ----------- -----------
Net income available for common stock-as reported $ 2,364,389 $ 2,025,988 $ 1,542,831
Compensation expenses if the fair value method had been
applied to the grants (112,830) (64,492) (233,361)
----------- ----------- -----------
Net income available for common stock-pro forma $ 2,251,559 $ 1,961,496 $ 1,309,470
=========== =========== ===========
Net income per share-as reported
Basic 0.10 0.09 0.07
Diluted 0.10 0.09 0.07
Net income available per share-pro forma
Basic 0.10 0.08 0.06
Diluted 0.10 0.08 0.06
51
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 - STOCK OPTION PLAN (Continued)
The Company applies the intrinsic value method of accounting prescribed by APB
Opinion No. 25 and related interpretations in accounting for stock-based
compensation plans. Accordingly, compensation cost for stock options is measured
as the excess, if any, of the quoted market price of the Company's stock at the
date of grant over the amount an employee must pay to acquire the stock. 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 2004, 2003, and 2002: dividend yield of 0%,
expected volatility of 56%, 73%, and 93%, risk-free interest rates of 5% for
each year presented, and expected lives of two years.
Each option granted in 2004 has an exercise price of $1.81 to $2.05 per share,
and vests over 12 months. The Petrocon converted options granted in 2001
effective with the Merger have exercise prices ranging from $0.96 to $6.24.
Other options have exercise prices of $1.00 and $1.25 per share. The maximum
term of the options is ten years. Substantially all of the options were granted
at the market price of the stock on the date of the grant.
The following table summarizes stock option activity for the periods indicated:
Options at Exercise Prices
-----------------------------------------------------
$0.96-$2.39 $4.26 $6.24 Total
---------- ---------- ---------- ----------
Outstanding - January 1, 2002 941,530 129,082 202,131 1,272,743
Granted 20,000 -- -- 20,000
Canceled or expired (35,000) (2,085) (729) (37,814)
Exercised -- -- -- --
---------- ---------- ---------- ----------
Outstanding - December 31, 2002 926,530 126,997 201,402 1,254,929
Granted 120,000 -- -- 120,000
Canceled or expired (2,909) (63,142) -- (66,051)
Exercised (51,710) -- -- (51,710)
---------- ---------- ---------- ----------
Outstanding - December 31, 2003 991,911 63,855 201,402 1,257,168
Granted 386,000 -- -- 386,000
Cancelled or expired (25,826) (1,401) (1,459) (28,686)
Exercised (87,332) -- -- (87,332)
---------- ---------- ---------- ----------
Outstanding - December 31, 2004 1,264,753 62,454 199,943 1,527,150
========== ========== ========== ==========
Exercisable at December 31, 2004 1,112,686 62,454 167,869 1,343,009
========== ========== ========== ==========
Available for grant at December 31, 2004 463,999
Weighted-average fair value of options at grant date, granted in 2004 $ 2.15
Weighted-average fair value of options, granted in 2003 $ 2.01
Weighted-average exercise price all outstanding options at
December 31, 2004 $ 2.10
Weighted-average remaining vesting life of all options outstanding
at December 31, 2004 2.5 years
The summary above does not include 234,774 non-qualified options issued at the
time of the Merger to replace existing options issued by Petrocon in
consideration for services. Such options have an exercise price of $4.26 per
share and expire in September 2006.
Replacement warrants of 305,102 (not included in the table above) with an
exercise price of $6.24 expired in October 2003.
52
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 - RELATED-PARTY TRANSACTIONS
ENGlobal Engineering leases office space from PEI Investments, a joint venture
in which ENGlobal Engineering, Inc. has a one-third interest, Michael L. Burrow
(the Company's CEO) has a one-third interest, and a stockholder who owns less
than 1% of the Company's common stock has a one-third interest. Rentals paid
under these leases were $135,000, $135,000 and $124,000 for 2004, 2003 and 2002,
respectively. The lease expires in 2005.
NOTE 12 - CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMERS
The Company provides engineering and fabricated systems and services primarily
to major integrated oil and gas companies throughout the world. It also
fabricates power systems and battery chargers. The Company performs ongoing
credit evaluations of its customers and generally does not require collateral.
Management reviews all trade receivable balances that exceed 30 days past due
and based on its assessment of current credit worthiness, estimate what portion,
if any seems doubtful for collection. A valuation allowance that reflects
management's best estimate of the amounts that will not be collected is
established.
For the years ended December 31, 2004, 2003, and 2002, the Company had sales in
the engineering segment totaling approximately $87.9 million, $45.2 million and
$30.6 million attributable to a single customer. During 2004, sales to one major
customer represented over 59% of total sales. During 2003 and 2002, a single
customer represented approximately 36% and 30% of total sales, respectively. At
December 31, 2004, the Company had amounts due from one customer totaling $7.0
million; no other customer exceeded 10% of trade receivables at that date. At
December 31, 2003, one customer had amounts in excess of 10% of trade
receivables, totaling $5.1 million.
NOTE 13 - REDEEMABLE PREFERRED STOCK
ENGlobal has a class of preferred stock with 5,000,000 shares originally
authorized for issuance. The Company issued to Equus II Incorporated 2,500,000
shares of preferred stock in 2001 and stock dividends totaling 88,000 shares in
2002 and 146,833 shares in 2003. Par value for the preferred stock was $0.001
with a fair value of $1.00 per share at the time of issuance. The preferred
shares outstanding were converted into 1,149,089 shares of common stock in
August 2003. Following the conversion, the Company reduced the authorized shares
of preferred stock to 2,265,167.
NOTE 14 - FEDERAL INCOME TAXES
The components of income tax expense (benefit) from continuing operations for
the years ended December 31, 2004, 2003 and 2002 were as follows:
2004 2003 2002
------- ------- -------
(in thousands)
---------------------------
Current
Federal $ 975 $ 536 $ 800
State 427 30 (40)
------- ------- -------
1,402 566 760
Deferred 254 543 437
------- ------- -------
Total tax provision $ 1,656 $ 1,109 $ 1,197
======= ======= =======
53
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 14 - FEDERAL INCOME TAXES (Continued)
The components of the deferred tax asset (liability) consisted of the following
at December 31, 2004 and 2003:
2004 2003
----- -----
(in thousands)
----------------
Deferred tax asset
Allowance for doubtful accounts $ 162 $ 128
Net operating loss from prior ownership change -- 135
Accruals not yet deductible for tax purposes 478 349
----- -----
Deferred tax assets 640 612
----- -----
Deferred tax liabilities
Depreciation (558) (291)
Goodwill (15) --
----- -----
Deferred tax liability (573) (291)
----- -----
Deferred tax asset, net $ 67 $ 321
===== =====
During the year ended December 31, 2002, the Company resolved certain issues
related to a net operating loss carry forward ("NOL"). Upon such resolution, the
Company recorded a purchase price adjustment from goodwill to a deferred tax
asset totaling approximately $1.3 million and decreased the valuation allowance
accordingly.
The following is a reconciliation of expected to actual income tax expense from
continuing operations:
2004 2003 2002
------- ------- -------
(in thousands)
----------------------------
Federal income tax expense at 34% $ 1,147 $ 1,154 $ 1,052
State and foreign taxes, net of tax effect 212 2 (26)
Nondeductible expenses 53 31 15
Prior year tax under-accrual 190 -- --
Other 54 (78) 156
------- ------- -------
$ 1,656 $ 1,109 $ 1,197
======= ======= =======
The Company's net operating loss carry forward at December 31, 2001 of
approximately $1,416,000 has been fully utilized in the 2004 tax year.
NOTE 15 - ACQUISITIONS
The Company's acquisition strategy is focused on developing breadth and depth of
expertise within the organization by continuing to search for candidates that
fit into one of two profiles. First, the Company considers acquisition
candidates with revenues in the $10 million range that would provide new service
capabilities for its clients. Second, the Company considers acquisition
candidates of various sized operations that have capabilities in a given market
segment or geographic location.
Assets acquired and liabilities assumed by the Company have been recorded on the
Company's Consolidated Balance Sheets as of the respective acquisition dates
based upon their estimated fair values at such dates. The results of operations
of our acquisitions have been included in the Company's Consolidated Statement
of Income since their respective dates of acquisition. The excess of the
purchase price over the estimated fair values of the underlying assets acquired
and liabilities assumed has been allocated to goodwill.
54
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 15 - ACQUISITIONS (Continued)
In September 2004, the Company retained Sanders Morris Harris ("SMH") as the
exclusive advisor to the Company to identify strategic transactions. Sanders
Morris Harris is a full service investment bank focused on providing corporate
finance and merger and acquisition services to private and public middle-market
companies. In connection with its engagement, Sanders Morris Harris will assist
the Company in formulating, evaluating and implementing possible alternatives
for enhancing shareholder value. The Company emphasized that there is no
assurance the strategic review will lead to any transaction and that it is
committed to its continuing operations while strategic opportunities are
identified and reviewed. The engagement of SMH was suspended in February 2005
(see Note 19).
One of the Company's subsidiaries, ENGlobal Design Group, ("EDG"), purchased
certain assets of Tulsa-based Engineering Design Group, Inc. ("EDGI") effective
February 1, 2004. The Company expects that the acquisition of these assets will
enhance its capabilities related to various government and public sector
facilities. EDG's most active sector is the Automated Fuel Handling Systems that
serve the U.S. Military. In connection with the purchase, the Company acquired
$344,000 in tangible assets including furniture and fixtures, computer equipment
and software being amortized over an average of 4.6 years. EDG also assumed
liability for $44,000 in accrued compensated absences for former EDGI employees
hired at the time of the purchase, issued two $150,000 notes bearing interest at
5% maturing in December 2008 and a $2.5 million five-year contingent promissory
note, with payments due annually, as part of an earn-out structure based on
revenues of the EDG operations over the next five years. EDG did not pay any
cash or issue any stock in the transaction. The original consideration given for
the purchase of certain EDGI assets approximated the fair value of the net
assets acquired; therefore no goodwill arose from the transaction. Principal and
interest on the $2.5 million five-year contingent promissory note will be
charged to goodwill. As of December 31, 2004, $139,000 in principal and interest
on the contingent promissory note has been charged to goodwill and is being
amortized over 15 years for tax purposes.
In October 2004, one of the Company's subsidiaries, ENGlobal Construction
Resources, Inc., purchased the name and certain assets of Cleveland Inspection
Services, Inc. ("CIS"). CIS provides inspection and construction management
services in support of the oil and gas, utility, and pipeline industries. The
Company paid $2.5 million consisting of cash, discounted promissory notes and
assumption of certain designated contract obligations and entered into
non-compete agreements with CIS and its principals in exchange for approximately
$1.0 million in machinery and equipment, furniture and fixtures, computer
equipment, software and other intangible assets with all intangible assets are
being amortized over 5 years. The acquisition also resulted in approximately
$1.3 million in goodwill being recorded and amortized over 15 years for tax
purposes. In addition, the Company hired approximately 180 former CIS employees
and operates its newly purchased assets as a division of ENGlobal Construction
Resources, Inc., marketing its services using the Cleveland Inspection Services
name.
In December 2004, ESI purchased contract rights and other assets of InfoTech
Engineering Company, LLC, a limited liability company ("InfoTech"),
headquartered in Baton Rouge, Louisiana. The Company paid $325,000 in cash, a
promissory note and entered into a non-compete agreement with the former owner
in exchange for approximately $55,000 in computer equipment with all intangible
assets being amortized over 3 years. The acquisition resulted in approximately
$270,000 in goodwill being recorded and amortized over 15 years for tax
purposes. The InfoTech acquisition expands ESI's capability in controls system
integration in both the automation and process control services. Info Tech's
primary experience is in the onshore and offshore oil and gas and petrochemical
industries.
55
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 15 - ACQUISITIONS (Continued)
Two acquisitions were completed in 2003, Senftleber & Associates, L.P. and
Petro-Chem Engineering, Inc. Through the Petro-Chem transaction, selected assets
were acquired expanding the Company's presence in Freeport, Texas and
surrounding area. The new Freeport operations began in June as a division of
EEI. Senftleber, a limited partnership, provides support in the pipeline
industry in Houston. The Senftleber acquisition occurred in November as a
subsidiary of ETI. The acquisitions had an aggregate cost of $425,000. There is
no earn-out provision in either transaction. Goodwill was created with both
transactions: $115,000 for Petro-Chem and $428,000 for Senftleber. Since these
acquisitions are accounted for as a purchase transaction, the accounting is
prospective and the operations are combined as of the date of the purchase.
The unaudited pro forma combined historical results, as if the significant
acquisitions had taken place at the beginning of the fiscal 2004, 2003 and 2002,
respectively are estimated to be:
2004 2003 2002
--------- --------- ---------
(in thousands)
-----------------------------------
Net sales as reported $ 148,888 $ 123,719 $ 89,123
Pro forma sales of acquired companies 486 13,434 6,092
--------- --------- ---------
Pro forma net sales 149,374 137,153 95,215
========= ========= =========
Net income as reported 2,364 2,157 1,751
Pro forma income (loss) of acquired companies (128) (1,824) 493
--------- --------- ---------
$ 2,236 $ 333 $ 2,244
========= ========= =========
Basic per share data as reported 0.10 0.09 0.07
Pro forma per share data of acquired companies (0.01) (0.01) 0.02
Pro forma basic per share data 0.10 0.01 0.01
Diluted per share data as reported 0.10 0.09 0.07
Pro forma per share data of acquired companies -- (0.01) 0.02
Pro forma diluted per share data 0.10 0.01 0.01
NOTE 16 - SALE OF THERMAIRE
The Company completed its sale of assets of its subsidiary, Thermaire, Inc.,
d/b/a Thermal Corporation, the only company in the manufacturing segment, to a
medium-sized HVAC equipment manufacturer in December 2003. The disposition had
been actively pursued since November 2001 in order to permit the Company to
strategically focus on its core operations. This discontinued segment had
reported losses from operations of $154,000 and $146,000 in 2003 and 2002,
respectively, and income of $115,000 in 2001. The sale resulted in the receipt
of $545,000 in cash and a $26,000 gain, net of tax. The proceeds were used to
reduce long-term debt. The 37,000 square foot office and manufacturing facility
owned by Thermaire was not included in the transaction and has been separately
listed for sale. The office and manufacturing facility was sold in March 2005
(see Note 19).
56
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 - SEGMENT INFORMATION
With the sale of the manufacturing segment, the Company now operates in two
business segments: engineering and systems. The engineering segment provides
services primarily to major integrated oil and gas companies. The systems
segment operates primarily full-service systems/controls engineering and
integration with some uninterruptible power systems and battery chargers. 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.
Segment information for 2004, 2003 and 2002 was as follows (in thousands):
Engineering Systems Corporate Total
---------------------------------------------
(in thousands)
---------------------------------------------
2004
- --------------------------------------------------------------------------------
Net sales from external customers $133,630 $ 15,258 $ -- $148,888
Operating profit (loss) 10,512 585 (6,605) 4,492
Depreciation and amortization 706 108 432 1,246
Tangible assets 31,971 6,673 3,332 41,976
Goodwill 14,151 1,133 -- 15,284
Capital expenditures 1,378 20 67 1,465
2003
- --------------------------------------------------------------------------------
Net sales from external customers $108,380 $ 15,339 $ -- $123,719
Operating profit (loss) 10,716 (38) (6,144) 4,534
Depreciation and amortization 375 89 360 824
Tangible assets 22,642 3,049 3,048 28,762
Goodwill 12,889 864 -- 13,753
Capital expenditures 902 105 139 1,146
2002
- --------------------------------------------------------------------------------
Net sales from external customers $ 74,971 $ 14,151 -- $ 89,122
Operating profit (loss) 7,148 851 (4,225) 3,774
Depreciation and amortization 376 49 288 713
Tangible assets 17,841 5,751 3,267 26,859
Goodwill 12,774 435 -- 13,209
Capital expenditures 156 56 1,121 1,333
57
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 18 - COMMITMENTS AND CONTINGENCIES
In connection with the 2001 merger of Petrocon Engineering, Inc. ("Petrocon")
and a wholly-owned subsidiary of ENGlobal Corporation, certain former Petrocon
shareholders (the "Significant PEI Shareholders") entered into an
Indemnification Escrow Agreement, an Option Escrow Agreement, a Voting Agreement
and a Significant PEI Shareholder Voting Agreement (collectively, the "2001
Agreements"). In August 2004, the Company and the requisite percentage of
Significant PEI Shareholders entered into a Termination Agreement (the
"Termination Agreement") terminating the 2001 Agreements. The 2001 Agreements
included the following:
Indemnification Escrow.
Pursuant to the Indemnification Escrow Agreement, 1,000,000 shares of
ENGlobal common stock owned by the Significant PEI Shareholders were
deposited into an escrow to serve as a fund against which the Company could
make claims for indemnity pursuant to the Merger Agreement with Petrocon.
Pursuant to the terms of the Termination Agreement, the remaining shares in
the Indemnification Escrow agreement will be released pro rata to the
Significant PEI Shareholders.
Voting Agreement.
ENGlobal, the Significant PEI Shareholders, and certain other parties
entered into a Voting Agreement which obligated the parties thereto to vote
for certain persons to serve on the Board of Directors of ENGlobal.
Pursuant to the terms of the Termination Agreement, the Voting Agreement
has been terminated.
Significant PEI Shareholder Voting Agreement.
The Significant PEI Shareholders entered into a Significant PEI
Shareholders Voting Agreement governing the manner in which they would
designate three ENGlobal director nominees under the Voting Agreement and
vote shares held in escrow. Pursuant to the terms of the Termination
Agreement, the Significant PEI Shareholders Voting Agreement has been
terminated.
Option Escrow.
Pursuant to the Option Escrow Agreement, the Significant PEI Shareholders
deposited 1,737,473 shares of ENGlobal common stock into an escrow account.
The Option Escrow Agreement required that if ENGlobal issued shares of its
common stock on the exercise of incentive options granted as replacement
options for outstanding Petrocon incentive options ("Replacement Options"),
a like number of shares of ENGlobal common stock would be surrendered from
the escrow account to ENGlobal. As a result, no dilution to ENGlobal
stockholders would occur upon the exercise of Replacement Options.
The Company's management has since determined that, due to the cost and
complexity associated with administering the 2001 Agreements, it would be in the
best interest of the Company and its stockholders to terminate the same.
Pursuant to the terms of the Termination Agreement, ENGlobal purchased the
652,377 shares being held in escrow underlying the Replacement Options with an
exercise price of $0.96 per share for a discounted payment of $592,231, payable
over three years to the Significant PEI Shareholders. ENGlobal also terminated
its rights to any of the remaining shares held in escrow and those shares were
distributed to the Significant PEI Shareholders. The transaction resulted in
652,377 shares of Treasury Stock and a decrease in Shareholders' Equity of
$592,231 until such time as the replacement options are exercised and the
exercise price is remitted to the Company.
58
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 18 - COMMITMENTS AND CONTINGENCIES (Continued)
Employment Agreements
- ---------------------
The Company has employment agreements with its executive officers and certain
other officers, the terms of which expire through June 2007. Such agreements
provide for minimum salary levels. The aggregate commitment for future salaries
at December 31, 2004, excluding bonuses, was approximately $3.0 million. If the
Company terminates the employment of the employee for any reason other than 1)
termination for cause, 2) voluntary resignation, or 3) employee's death, the
Company is obligated to provide a severance benefit equal to two or six months
of the employee's salary, and, at its option, an additional four months at 50%
of the employee's salary. These agreements are renewable for one year at the
Company's option. On October 20, 2004, the Company exercised its right to extend
the term of the agreements for one additional one-year period beginning on
December 21, 2004.
Litigation
- ----------
From time to time, the Company and its subsidiaries become parties to various
legal proceedings arising in the ordinary course of normal business activities.
While we cannot predict the outcome of these proceedings, in our opinion and
based on reports of counsel any liability arising from such matters,
individually or in the aggregate, are not expected to have a material affect
upon the consolidated financial position or operations of the Company, after
giving effect of recorded reserves.
Insurance
- ---------
The Company carries a broad range of insurance coverage, including general and
business automobile liability, commercial property, professional errors and
omissions, workers' compensation insurance and a general umbrella policy. The
Company has not incurred significant claims in excess of insurance recoveries.
ENGlobal is partially self-funded for health insurance claims. Provisions for
expected future payments are accrued based on the Company's experience. Specific
stop loss levels provide protection for the Company with $125,000 per occurrence
and approximately $4.2 million in aggregate in each policy year being covered by
a separate insurance policy.
NOTE 19 - SUBSEQUENT EVENTS
On February 11, 2005, the Company's errors and omissions insurance carrier
settled the claim filed by Engineered Carbons, Inc. against the Company in the
60th District Court at Jefferson County, Texas (see Note 18) within the
Company's errors and omissions policy limits. As a result of the settlement and
after all material expenses were accounted for, the Company was able to reduce
the combined level of its reserves and recorded a $98,000 benefit against
operating results for 2004.
On March 4, 2005, the Company completed the sale of the 37,000 square feet
office and manufacturing facility owned by Thermaire for $885,000 (see Note 16).
The proceeds were used to reduce long-term debt.
During February and March of 2005, the Company and its subsidiaries were
successful in getting dismissal of all but one of the petitions for damages
filed in various district courts in Louisiana on behalf of former employees of
Barnard and Burk, Inc. alleging exposure to asbestos during the course of their
employment (see Note 18). The Company believes that the remaining petition is
without merit and immaterial to the Company's business and financial condition.
On February 28, 2005, the Company suspended the engagement of Sanders Morris
Harris as the exclusive advisor to the Company to identify strategic acquisition
opportunities and assist the Company in evaluating and negotiating the terms of
potential strategic transactions. The Company will engage SMH in the future on
an as needed basis to assist in the evaluation and possible negotiation of terms
for any specific strategic transaction.
59
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20 - QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
All quarterly periods and the annual data have been restated to reflect the
discontinued operations separate from continuing operations. The quarterly data
for 2003 will not agree to previously issued quarterly statements as a result of
this restatement.
For the Quarters Ended - 2004
March June September December
------- ------- --------- --------
(in thousands, except per share amounts)
-------------------------------------------
Revenues per segment
Engineering $28,463 $31,470 $32,796 $40,901
Systems 2,529 2,813 4,476 5,440
------- ------- ------- -------
Total $30,992 $34,283 $37,272 $46,341
======= ======= ======= =======
Gross profit per segment
Engineering $ 3,876 $ 4,020 $ 4,010 $ 4,519
Systems 324 216 810 819
------- ------- ------- -------
Total $ 4,200 $ 4,236 $ 4,820 $ 5,338
======= ======= ======= =======
Gross profit percentage
Engineering 13.6% 12.8% 12.2% 11.0%
Systems 12.8% 7.7% 18.1% 15.1%
Total 13.6% 12.4% 12.9% 11.5%
Net income $ 471 $ 421 $ 755 $ 717
Earnings per share - basic 0.02 0.02 0.03 0.03
Earnings per share - diluted 0.02 0.02 0.03 0.03
60
ENGLOBAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20 - QUARTERLY FINANCIAL INFORMATION (UNAUDITED) (Continued)
For the Quarters Ended - 2003
March June September December
------- ------- --------- --------
(in thousands, except per share amounts)
-------------------------------------------
Revenues per segment
Engineering $18,315 $25,257 $32,376 $32,432
Systems 4,691 4,015 3,059 3,574
------- ------- ------- -------
Total $23,006 $29,272 $35,435 $36,006
======= ======= ======= =======
Gross profit per segment
Engineering $ 3,123 $ 3,782 $ 3,941 $ 3,955
Systems 804 441 400 527
------- ------- ------- -------
Total $ 3,927 $ 4,223 $ 4,341 $ 4,482
======= ======= ======= =======
Gross profit percentage
Engineering 17.1% 15.0% 12.2% 12.2%
Systems 17.1% 11.0% 13.1% 14.7%
Total 17.1% 14.4% 12.3% 12.4%
Income from continuing operations $ 514 $ 563 $ 393 $ 815
Loss on discontinued segment (6) (29) (11) (108)
Gain on disposal of discontinued
segment - - - 26
------- ------- ------- -------
Net income $ 508 $ 534 $ 382 $ 733
======= ======= ======= =======
Earnings per share - basic
Income from continuing
operations $ 0.02 $ 0.02 $ 0.02 $ 0.03
Loss on discontinued operations - - - -
------- ------- ------- -------
Net income $ 0.02 $ 0.02 $ 0.02 $ 0.03
======= ======= ======= =======
Earnings per share - diluted
Income from continuing
operations $ 0.02 $ 0.02 $ 0.02 $ 0.03
Loss on discontinued operations - - - -
------- ------- ------- -------
Net income $ 0.02 $ 0.02 $ 0.02 $ 0.03
======= ======= ======= =======
61
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON FINANCIAL STATEMENT SCHEDULE
To the Board of Directors and Stockholders
ENGlobal Corporation
We have audited, in accordance with auditing the standards of the Public Company
Accounting Oversight Board (United States), the consolidated financial
statements of ENGlobal Corporation and Subsidiaries included in this Form 10-K
and have issued our report thereon dated March 10, 2005. Our audits were made
for the purpose of forming an opinion on the basic financial statements taken as
a whole. The financial statement schedule listed in Schedule II - Valuation and
Qualifying Accounts is the responsibility of the Company's management and is
presented for the purpose of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. The
financial statement schedule has been subjected to the auditing procedures
applied to the audits of the basic financial statements and in our opinion, is
fairly stated in all material respects with the financial data required to be
set forth therein in relation to the basic financial statements taken as a
whole.
/s/ Hein & Associates LLP
- -------------------------
Hein & Associates LLP
Houston, Texas
March 10, 2005
62
Schedule II
-----------
ENGlobal Corporation
VALUATION AND QUALIFYING ACCOUNTS
Description Balance - Balance-
Beginning Deductions- End of
of Period Additions Write offs Period
- --------------------------------------------------------------------------------
(in thousands)
--------------------------------------------
Allowance for doubtful accounts
For year ended December 31, 2004 $ 376 $ 134 $ (34) $ 476
For year ended December 31, 2003 $ 282 $ 282 $(188) $ 376
For year ended December 31, 2002 $ 271 $ 215 $(204) $ 282
63
ITEM 9. CHANAGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There are no changes in or disagreements with the Company's accountants on
accounting and financial disclosure.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. We maintain disclosure
controls and procedures designed to provide reasonable assurance that
information required to be disclosed in the periodic reports we file with
the SEC is recorded, processed, summarized and reported within the time
periods specified in the rules and forms of the SEC. We carried out an
evaluation as of December 31, 2004, under the supervision and the
participation of our management, including our chief executive officer and
chief financial officer, of the design and operation of the disclosure
controls and procedures pursuant to Rules 13a-14 and 15d-14 under the
Securities Exchange Act of 1934. Based upon that evaluation, our chief
executive officer and chief financial officer concluded that our disclosure
controls and procedures are effective in timely alerting them to material
information relating to the Company that is required to be included in our
periodic SEC filings.
(b) Changes in Internal Controls over Financial Reporting. There have been no
changes in internal control over financial reporting during the fiscal
quarter ended December 31, 2004 that has materially affected, or is
reasonably likely to affect, the registrant's internal control over
financial reporting.
64
PART III
--------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information under the captions Election of Directors, Section 16(a)
Beneficial Ownership Reporting Compliance and Corporate Code of Conduct, in our
definitive proxy statement for our 2005 annual meeting of stockholders to be
filed with the SEC pursuant to Regulation 14A under the Securities and Exchange
Act of 1034, as amended, is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information under the caption Executive Compensation contained in our
definitive proxy statement for our 2005 annual meeting of stockholders to be
filed with the SEC pursuant to Regulation 14A under the Securities and Exchange
Act of 1034, as amended, is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information under the caption Security Ownership of Certain Beneficial
Owners and Management contained in our definitive proxy statement for our 2005
annual meeting of stockholders to be filed with the SEC pursuant to Regulation
14A under the Securities and Exchange Act of 1034, as amended, is incorporated
herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information under the caption Certain Relationships and Related Transactions
contained our definitive proxy statement for our 2005 annual meeting of
stockholders to be filed with the SEC pursuant to Regulation 14A under the
Securities and Exchange Act of 1034, as amended, is incorporated herein by
reference.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information under the caption Principal Accounting Fees and Services in our
definitive proxy statement for our 2005 annual meeting of stockholders to be
filed with the SEC pursuant to Regulation 14A under the Securities and Exchange
Act of 1034, as amended, is incorporated herein by reference.
65
PART IV
-------
ITEM 15. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES
Financial Statements
Reference is made to the consolidated financial statements, the reports
herein, the notes herein and supplemental data in PART II, Item 8 on page
35 of this Form 10-K.
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 Financial Statements and notes thereto.
66
INDEX OF EXHIBITS
Number Description
- ------ -----------
2.1 Agreement and Plan of Merger by and between Industrial Data Systems
Corporation, IDS Engineering Management, LC, PEI Acquisition, Inc. and
Petrocon Engineering, Inc., incorporated by reference to the Company's
Quarterly Report on Form 10-QSB for the quarter ended June 30, 2001
filed with the Securities and Exchange Commission on August 14, 2001.
2.2 First Amendment of the Agreement and Plan of Merger, incorporated by
reference to Amendment One of the Company's Form S-4 filed with the
Securities and Exchange Commission on October 19, 2001.
2.3 Letter Agreement of the Agreement and Plan of Merger, incorporated by
reference to Amendment One of the Company's Form S-4 filed with the
Securities and Exchange Commission on October 19, 2001.
3.1 Restated Articles of Incorporation of ENGlobal Corporation dated
August 8, 2002, incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarter ended September 30, 2002 filed
with the Securities and Exchange Commission on November 14, 2002.
4.1 Form of Common Stock Certificate of Industrial Data Systems
Corporation, incorporated by reference to Amendment One of the
Company's Form S-4 filed with the Securities and Exchange Commission
on October 19, 2001.
10.1 Blanket Service Contract - Exxon Pipeline Company, incorporated by
reference as Exhibit 10.6 to the Company's Annual Report on Form
10-KSB/A for the year ended December 31, 1996 filed with the
Securities and Exchange Commission on May 14, 1997.
10.2 Blanket Service Contract - Marathon Oil Company, incorporated by
reference as Exhibit 10.7 to the Company's Annual Report on Form
10-KSB/A for the year ended December 31, 1996 filed with the
Securities and Exchange Commission on May 14, 1997.
10.3 Blanket Service Contract with Caspian Consortium-R, incorporated by
reference as Exhibit 10.32 to the Company's Annual Report on Form
10-KSB for the year ended December 31, 1999.
10.4 Blanket Service Contract with Caspian Consortium-K, incorporated by
reference Exhibit 10.33 to the Company's Annual Report on Form 10-KSB
for the year ended December 31, 1999.
10.5 Standard Industrial Lease Agreement between Houston Industrial Assets,
L.P. and Constant Power Manufacturing, Inc. dated May 30, 2001,
incorporated by reference to the Company's Quarterly Report on Form
10-QSB for the quarter ended June 30, 2001 filed with the Securities
and Exchange Commission on August 14, 2001.
10.6 Settlement Agreement and Plan of Reorganization dated July 31, 2001
among Petrocon Engineering, Inc., Industrial Data Systems Corporation,
PEI Acquisition, Inc., and Equus II Incorporated, incorporated by
reference to the Company's Annual Report on Form 10-KSB for the year
ended December 31, 2001.
10.7 Promissory Note between Petrocon Engineering, Inc. and Equus II
Incorporated dated December 21, 2001, incorporated by reference to the
Company's Annual Report on Form 10-KSB for the year ended December 31,
2001.
10.8 Form of Guaranty by and among Fleet Capital Corporation, Petrocon
Engineering, Inc., PEI Acquisition, Inc., and Equus II Incorporated
dated December 21, 2001, incorporated by reference to the Company's
Annual Report on Form 10-KSB for the year ended December 31, 2001.
10.9 Security Agreement among Fleet Capital Corporation, Petrocon
Engineering, Inc., and Equus II Incorporated dated December 21,2001,
incorporated by reference to the Company's Annual Report on Form
10-KSB for the year ended December 31, 2001.
10.10 Mortgage and Security Agreement among Fleet Capital Corporation, Equus
II Incorporated, and Petrocon Engineering, Inc. dated December 21,
2001, incorporated by reference to the Company's Annual Report on Form
10-KSB for the year ended December 31, 2001.
10.11 Option Pool Agreement between Industrial Data Systems Corporation and
Alliance 2000, Ltd. Dated December 21, 2001, incorporated by reference
to the Company's Annual Report on Form 10-KSB for the year ended
December 31, 2001.
10.12 Indemnification Escrow Agreement among Industrial Data Systems
Corporation, PEI Acquisitions, the individuals listed as "Significant
PEI Shareholders", and Johnny Williams, Escrow Agent dated December
21, 2001, incorporated by reference to the Company's Annual Report on
Form 10-KSB for the year ended December 31, 2001.
67
INDEX OF EXHIBITS
Number Description
- ------ -----------
10.13 Option Escrow Agreement among Industrial Data Systems Corporation, PEI
Acquisitions, the individuals listed as "Significant PEI
Shareholders", and Johnny Williams, Escrow Agent dated December 21,
2001, incorporated by reference to the Company's Annual Report on Form
10-KSB for the year ended December 31, 2001.
10.14 Voting Agreement among Industrial Data Systems Corporation, Equus II
Corporation, Alliance 2000, Ltd. and individuals listed as
"Significant PEI Shareholders" dated December 21, 2001, incorporated
by reference to the Company's Annual Report on Form 10-KSB for the
year ended December 31, 2001.
10.15 Second Amended and Restated Loan and Security Agreement by and among
IDS Engineering, Inc., Thermaire, Inc., Constant Power Manufacturing,
Inc., Industrial Data Systems, Inc., IDS Engineering Management, LC,
Petrocon Engineering, Inc., Triangle Engineers and Constructors, Inc.,
Petrocon Systems, Inc., Petrocon Engineering of Louisiana, Inc.,
R.P.M. Engineering, Inc., Petrocon Construction Resources, Inc.,
Alliance Engineering Associates, Inc., and Fleet Capital Corporation
dated December 21, 2001, incorporated by reference to the Company's
Annual Report on Form 10-KSB for the year ended December 31, 2001.
10.16 Amended and Restated Revolving Note between Fleet Capital Corporation
and IDS Engineering, Inc., Thermaire, Inc., Constant Power
Manufacturing, Inc., Industrial Data Systems, Inc., IDS Engineering
Management, LC, Petrocon Engineering, Inc., Triangle Engineers and
Constructors, Inc., Petrocon Systems, Inc., Petrocon Engineering of
Louisiana, Inc., R.P.M. Engineering, Inc., Petrocon Construction
Resources, Inc., Alliance Engineering Associates, Inc. dated December
21, 2001, incorporated by reference to the Company's Annual Report on
Form 10-KSB for the year ended December 31, 2001.
10.17 Stock Pledge Agreement between Industrial Data Systems, Inc. and Fleet
Capital Corporation dated December 21, 2001, incorporated by reference
to the Company's Annual Report on Form 10-KSB for the year ended
December 31, 2001.
10.18 Amended and Restated Stock Pledge Agreement between Petrocon
Engineering, Inc. and Fleet Capital Corporation dated December 21,
2001, incorporated by reference to the Company's Annual Report on Form
10-KSB for the year ended December 31, 2001.
10.19 Continuing Guaranty Agreement between Fleet Capital Corporation and
"Borrowers" known as IDS Engineering, Inc., Thermaire, Inc., Constant
Power Manufacturing, Inc., Industrial Data Systems, Inc., IDS
Engineering Management, LC, Petrocon Engineering, Inc., Triangle
Engineers and Constructors, Inc., Petrocon Systems, Inc., Petrocon
Engineering of Louisiana, Inc., R.P.M. Engineering, Inc., Petrocon
Construction Resources, Inc., Alliance Engineering Associates, Inc.
dated December 21, 2001, incorporated by reference to the Company's
Annual Report on Form 10-KSB for the year ended December 31, 2001.
10.20 Amended and Restated Patent Security Agreement between Petrocon
Engineering, Inc. and Fleet Capital Corporation dated December 21,
2001, incorporated by reference to the Company's Annual Report on Form
10-KSB for the year ended December 31, 2001.
10.21 Amended and Restated Patent Security Agreement between Petrocon
Technologies, Inc. and Fleet Capital Corporation dated December 21,
2001, incorporated by reference to the Company's Annual Report on Form
10-KSB for the year ended December 31, 2001.
10.22 Amended and Restated Trademark Security Agreement between R.P.M.
Engineering, Inc. and Fleet Capital Corporation dated December 21,
2001, incorporated by reference to the Company's Annual Report on Form
10-KSB for the year ended December 31, 2001.
10.23 Intercreditor Agreement by and among Fleet Capital Corporation, Equus
II Incorporated, Petrocon Engineering, Inc. (Borrower) together with
the Loan Party (Industrial Data Systems Corporation, IDS Engineering,
Inc., Thermaire, Inc., Constant Power Manufacturing, Inc., Industrial
Data Systems, Inc., IDS Engineering Management, LC, Triangle Engineers
and Constructors, Inc., Petrocon Systems, Inc., Petrocon Engineering
of Louisiana, Inc., R.P.M. Engineering, Inc., Petrocon Construction
Resources, Inc., Petrocon Technologies, Inc., and Alliance Engineering
Associates, Inc. dated December 21, 2001, incorporated by reference to
the Company's Annual Report on Form 10-KSB for the year ended December
31, 2001.
10.24 Second Amended and Restated Lease Agreement between Corporate Property
Associates 4 and Petrocon Engineering, Inc. for Beaumont office space
dated February 28, 2002, incorporated by reference to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2002
filed with the Securities and Exchange Commission on August 12, 2002.
68
INDEX OF EXHIBITS
Number Description
- ------ -----------
10.25 Guaranty and Suretyship Agreement between Industrial Data Systems
Corporation and Corporate Property Associates 4 dated April 26, 2002,
incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 2002 filed with the Securities and
Exchange Commission on August 12, 2002.
10.26 ENGlobal Corporation Incentive Bonus Plan dated June 12, 2002,
incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 2002 filed with the Securities and
Exchange Commission on August 12, 2002.
10.27 Amendment of the 1998 Incentive Plan, incorporated by reference to the
Company's Form S-8 Registration Statement filed with the Securities
and Exchange Commission on June 9, 2003.
10.28 Amendment No. 2 of the 1998 Incentive Plan, incorporated by reference
to the Company's Form S-8 Registration Statement filed with the
Securities and Exchange Commission on June 9, 2003.
10.29 Lease Agreement between Petrocon Engineering, Inc. and Phelan
Investments on July 25, 2002, incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2002 filed with the Securities and Exchange Commission
on November 14, 2002.
10.30 Second Amendment of the Second Amended and Restated Loan and Security
Agreement as of July 31, 2002 between IDS Engineering and Subsidiaries
and Fleet Capital Corporation, incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2002 filed with the Securities and Exchange Commission
on November 14, 2002.
10.31 Amendment of the Intercreditor Agreement between Fleet Capital
Corporation, Equus II Incorporated and ENGlobal Corporation dated July
31, 2002, incorporated by reference to the Company's Quarterly Report
on Form 10-Q for the quarter ended September 30, 2002 filed with the
Securities and Exchange Commission on November 14, 2002.
10.32 Fifth Amendment of Lease Agreement between IDS and 600 C.C. Business
Park Ltd., incorporated by reference to the Company's Quarterly Report
on Form 10-Q for the quarter ended September 30, 2002 filed with the
Securities and Exchange Commission on November 14, 2002.
10.33 Lease Agreement between PEI Investments and Petrocon Engineering, Inc.
dated July 1, 2002, incorporated by reference to the Company's
Quarterly Report on Form 10-Q for the quarter ended March 31, 2003
filed with the Securities and Exchange Commission on May 13, 2003.
10.34 Lease Agreement between Petro-Chem Engineering and ENGlobal
Engineering, Inc. dated June 4, 2003, incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarter ended June 30,
2003 filed with the Securities and Exchange Commission on August 14,
2003.
10.35 Contract between BASF and ENGlobal Engineering, Inc. dated June 9,
2003, incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 2003 filed with the
Securities and Exchange Commission on August 14, 2003.
10.36 Sublease Agreements between Family Connect, Inc., a tenant of CitiPlex
Towers Building and IDS Engineering dated February 2, 2003,
incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 2003 filed with the
Securities and Exchange Commission on November 14, 2003.
10.37 Lease Agreement between Oral Roberts University and IDS Engineering,
dba ENGlobal Engineering, Inc. dated October 20, 2003, incorporated by
reference to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2003 filed with the Securities and
Exchange Commission on November 14, 2003.
10.38 Sixth Amendment of the Second Amended and Restated Loan and Security
Agreement as of June 30, 2003 between ENGlobal Corporation and
Subsidiaries and Fleet Capital Corporation, incorporated by reference
to the Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2003 filed with the Securities and Exchange Commission
on November 14, 2003.
10.39 Second Amendment of the ENGlobal Engineering, Inc. 401(k) Plan dated
January 1, 2004 (formerly called the "Petrocon Engineering, Inc.
401(k) Plan"), incorporated by reference as Exhibit 10.77 to the
Company's Annual Report on Form 10-K for the year ended December 31,
2003 filed with the Securities and Exchange Commission on March 30,
2004.
69
INDEX OF EXHIBITS
Number Description
- ------ -----------
10.40 ENGlobal Corporation Employee Stock Purchase Plan dated March 2, 2004,
incorporated by reference as Exhibit 10.1 to the Company's Form S-8
registration statement filed with the Securities and Exchange
Commission on March 12, 2004, incorporated by reference as Exhibit
10.78 to the Company's Annual Report on Form 10-K for the year ended
December 31, 2003 filed with the Securities and Exchange Commission on
March 30, 2004.
10.41 Lease Agreement between between ENGlobal Design Group, Inc. and TC
Meridian Tower LP dated January 24, 2004, incorporated by reference as
Exhibit 10.79 to the Company's Annual Report on Form 10-K for the year
ended December 31, 2003 filed with the Securities and Exchange
Commission on March 30, 2004.
10.42 Credit Agreement by and between Comerica Bank and ENGlobal Corporation
and its subsidiaries dated July 27, 2004, incorporated by reference as
Exhibit 10.1 to the Company's Form 8-K filed with the Securities and
Exchange Commission on August 9, 2004.
10.43 Security Agreement by and between Comerica Bank and ENGlobal
Corporation and its subsidiaries dated July 27, 2004, incorporated by
reference as Exhibit 10.2 to the Company's Form 8-K filed with the
Securities and Exchange Commission on August 9, 2004.
10.44 Master Revolving Note by and between Comerica Bank and ENGlobal
Corporation and its subsidiaries dated July 27, 2004, incorporated by
reference as Exhibit 10.3 to the Company's Form 8-K filed with the
Securities and Exchange Commission on August 9, 2004.
10.45 Termination Agreement by and among ENGlobal Corporation, Equus II
Incorporated, Alliance 2000, Ltd., Significant PEI Shareholders,
Michael L. Burrow, as shareholder representative for the Significant
PEI Shareholders, and Johnny J. Williams, Esq., as Escrow Agent, dated
September 28, 2004, incorporated by reference as Exhibit 99.1 to the
Company's Form 8-K filed with the Securities and Exchange Commission
on October 1, 2004.
10.46 ENGlobal Corporation Key Manager Incentive Plan dated December 16,
2004, incorporated by reference as Exhibit 10.1 to the Company's Form
8-K filed with the Securities and Exchange Commission on December 21,
2004.
10.47 ENGlobal Corporation Executive Level Incentive Plan dated December 16,
2004, incorporated by reference as Exhibit 10.1 to the Company's Form
8-K filed with the Securities and Exchange Commission on December 21,
2004.
10.48* Third Amendment of the ENGlobal Engineering, Inc. 401(k) Plan
(formerly called the "Petrocon Engineering, Inc. 401(k) Plan"). dated
March 9, 2005 and effective January 1, 2005.
11.1 Statement Regarding Computation of Per Share Earnings is included as
Note 2 to the Notes to Consolidated Financial Statements.
14.1 ENGlobal Corporation Code of Ethics for Chief Executive Officer and
Senior Financial Officers dated March 25, 2004, incorporated by
reference as Exhibit 99.5 to the Company's Annual Report on Form 10-K
for the year ended December 31, 2003 filed with the Securities and
Exchange Commission on March 30, 2004.
14.2 ENGlobal Corporation Code of Business Conduct and Ethics dated March
25, 2004, incorporated by reference as Exhibit 99.6 to the Company's
Annual Report on Form 10-K for the year ended December 31, 2003 filed
with the Securities and Exchange Commission on March 30, 2004.
21.1 Subsidiaries of the Registrant, incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended December 31,
2002 filed with the Securities and Exchange Commission on March 27,
2003, incorporated by reference as Exhibit 21.1 to the Company's
Annual Report on Form 10-K for the year ended December 31, 2003 filed
with the Securities and Exchange Commission on March 30, 2004.
23.1* Consent of Hein & Associates LLP
31.1* Certification pursuant to Section 302 of the Sarbanes-Oxley Act for
2002 for the Year Ended December 31, 2004 for the Chief Executive
Officer
31.2* Certification pursuant to Section 302 of the Sarbanes-Oxley Act for
2002 for the Year Ended December 31, 2004 for the Chief Financial
Officer
70
INDEX OF EXHIBITS
Number Description
- ------ -----------
32.1* Certification pursuant to Section 906 of the Sarbanes-Oxley Act for
2002 for the Year Ended December 31, 2004 for the Chief Executive
Officer
32.2* Certification pursuant to Section 906 of the Sarbanes-Oxley Act for
2002 for the Year Ended December 31, 2004 for the Chief Financial
Officer
- -------------
* Filed herewith.
71
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 24, 2005
By: //s// Michael L. Burrow
Michael L. Burrow, P.E.,
Chairman of the Board,
Chief Executive Officer, Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated:
By: //s// Michael L. Burrow
Michael L. Burrow, P.E.
Chairman of the Board,
Chief Executive Officer, Director
By: //s// William A. Coskey
William A. Coskey, P.E.
President, 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
72