UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2007
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No. 001-14217
ENGlobal Corporation
--------------------
(Exact name of registrant as specified in its charter)
Nevada
------
(State or other jurisdiction of
incorporation or organization)
88-0322261
----------
(I.R.S Employer Identification No.)
654 N. Sam Houston Parkway E., Suite 400, Houston, TX 77060-5914
----------------------------------------------------- ----------
(Address of principal executive offices) (Zip code)
(281) 878-1000
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shortened period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (check
one):
Large Accelerated Filer [ ] Accelerated Filer [X] Non-Accelerated Filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the close of business of August 1, 2007.
$0.001 Par Value Common Stock 26,921,225 shares
QUARTERLY REPORT ON FORM 10-Q
FOR THE PERIOD ENDED JUNE 30, 2007
TABLE OF CONTENTS
Page
Number
------
Part I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Statements of Income for the Three Months Ended
And Six Months Ended June 30, 2007 and June 30, 2006 3
Consolidated Statements of Comprehensive Income for the Three Months Ended
And Six Months Ended June 30, 2007 and June 30, 2006 4
Condensed Consolidated Balance Sheets at June 30, 2007 and December 31, 2006 5
Condensed Consolidated Statements of Cash Flows for the Six Months 6
Ended June 30, 2007 and June 30, 2006
Notes to Condensed Consolidated Financial Statements 8-15
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 16-28
Item 3. Quantitative and Qualitative Disclosures About Market Risk 29
Item 4. Controls and Procedures 29-31
Part II. Other Information
Item 1. Legal Proceedings 32
Item 1A. Risk Factors 32
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 32
Item 3. Defaults Upon Senior Securities 32
Item 4. Submission of Matters to a Vote of Security Holders 32
Item 5. Other Information 32
Item 6. Exhibits 32
Signature 33
2
PART I. - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ENGlobal Corporation
Condensed Consolidated Statements Of Income
(Unaudited)
For the Three Months For the Six Months
Ended June 30, Ended June 30,
------------------------------ ------------------------------
2007 2006 2007 2006
------------- ------------- ------------- -------------
Operating Revenue $ 89,576,296 $ 75,065,714 $ 171,234,929 $ 141,692,550
------------- ------------- ------------- -------------
Operating Expenses:
Direct cost 75,357,142 64,337,124 143,738,050 122,742,331
Selling, general and administrative 6,570,025 6,812,569 13,615,778 12,510,241
Depreciation and amortization 719,917 353,720 1,417,852 756,400
------------- ------------- ------------- -------------
Total operating expenses 82,647,084 71,503,413 158,771,679 136,008,972
------------- ------------- ------------- -------------
Operating income 6,929,212 3,562,301 12,463,249 5,683,578
Other Income (Expense):
Other income 515,247 387,355 515,117 409,107
Interest income (expense), net (700,088) (252,996) (1,259,931) (415,142)
------------- ------------- ------------- -------------
Total other income (expense) (184,841) 134,359 (744,814) (6,035)
------------- ------------- ------------- -------------
Income before Provision for Income Taxes 6,744,371 3,696,660 11,718,435 5,677,543
Provision for Income Taxes 2,831,074 1,365,225 4,650,795 2,111,965
------------- ------------- ------------- -------------
Net Income $ 3,913,297 $ 2,331,435 $ 7,067,640 $ 3,565,578
============= ============= ============= =============
Net Income Per Common Share:
Basic $ 0.15 $ 0.09 $ 0.26 $ 0.14
Diluted $ 0.14 $ 0.09 $ 0.26 $ 0.13
Weighted Average Shares Used in Computing Net
Income Per Share:
Basic 26,864,358 26,444,185 26,839,184 26,388,702
Fully Diluted 27,290,047 27,191,617 27,208,578 27,218,982
See accompanying notes to interim condensed consolidated financial statements.
3
ENGlobal Corporation
Consolidated Statements of Comprehensive Income
(Unaudited)
For the Three Months For the Six Months
Ended June 30, Ended June 30,
-------------------------- --------------------------
2007 2006 2007 2006
----------- ----------- ----------- -----------
Net Income $ 3,913,297 $ 2,331,435 $ 7,067,640 $ 3,565,578
----------- ----------- ----------- -----------
Other Comprehensive Income (Loss):
Foreign currency translation adjustment (25,629) 10,238 (26,739) 9,535
Income tax effect 9,995 (3,942) 10,428 (3,671)
----------- ----------- ----------- -----------
Net other comprehensive income (15,634) 6,296 (16,311) 5,864
----------- ----------- ----------- -----------
Net Comprehensive Income $ 3,897,663 $ 2,337,731 $ 7,051,329 $ 3,571,442
=========== =========== =========== ===========
See accompanying notes to interim condensed consolidated financial statements.
4
ENGlobal Corporation
Condensed Consolidated Balance Sheets
(Unaudited)
ASSETS
------
June 30, December 31,
2007 2006
------------- -------------
Current Assets:
Cash $ 2,325,145 $ 1,402,880
Trade receivables, net 69,649,366 60,247,612
Prepaid expenses and other current assets 1,456,088 1,723,907
Current portion of notes receivable 53,611 52,031
Costs and estimated earnings in excess of billings on uncompleted contracts 10,188,515 5,390,111
Deferred tax asset 2,310,106 2,310,106
Federal and state income taxes receivable -- 638,266
------------- -------------
Total Current Assets 85,982,831 71,764,913
Property and Equipment, net 6,929,346 8,724,902
Goodwill 19,941,170 19,202,197
Other Intangible Assets, net 4,845,904 5,426,824
Long term notes receivable, net of current portion 1,587,022 129,105
Other Assets 927,080 468,864
------------- -------------
Total Assets $ 120,213,353 $ 105,716,805
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current Liabilities:
Accounts payable $ 10,285,684 $ 14,672,165
Federal and state income taxes 1,370,780 --
Accrued compensation and benefits 16,588,289 12,806,919
Notes payable 252,563 1,109,772
Current portion of long-term debt 1,554,556 1,418,029
Deferred rent 618,073 678,583
Billings in excess of costs and estimated earnings on uncompleted contracts 3,399,936 539,910
Other liabilities 3,205,651 5,352,886
------------- -------------
Total Current Liabilities 37,275,532 36,578,264
Long-Term Debt, net of current portion 33,317,984 27,162,263
Deferred Tax Liability 1,037,208 1,114,224
------------- -------------
Total Liabilities 71,630,724 64,854,751
------------- -------------
Commitments and Contingencies (Note 11)
Stockholders' Equity:
Common stock - $0.001 par value; 75,000,000 shares authorized; 26,907,335
and 26,807,460 shares issued and outstanding at June 30, 2007 and
December 31, 2006, respectively 27,559 27,459
Additional paid-in capital 31,796,816 31,147,343
Retained earnings 16,784,993 9,717,354
Accumulated other comprehensive loss (26,739) (30,102)
------------- -------------
Total Stockholders' Equity 48,582,629 40,862,054
------------- -------------
Total Liabilities and Stockholders' Equity $ 120,213,353 $ 105,716,805
============= =============
See accompanying notes to interim condensed consolidated financial statements.
5
ENGlobal Corporation
Condensed Consolidated Statements Of Cash Flows
(Unaudited)
For the Six Months Ended
June 30,
--------------------------
2007 2006
----------- -----------
Cash Flows from Operating Activities:
Net income $ 7,067,640 $ 3,565,578
Adjustments to reconcile net income to net cash used in
operating activities -
Depreciation and amortization 1,942,564 1,253,070
Share based compensation expense 455,108 491,199
Loss on disposal of property, plant and equipment (552,562) 36,030
Deferred income tax benefit (77,016) (73,889)
Changes in current assets and liabilities, net of acquisitions -
Trade receivables (9,401,755) (2,869,847)
Costs and estimated earnings in excess of billings (4,798,403) (1,467,014)
Prepaid expenses and other assets (784,928) (77,889)
Accounts payable (4,386,481) (7,055,855)
Accrued compensation and benefits 3,781,371 1,367,860
Billings in excess of costs and estimated earnings 2,860,026 1,741,821
Other liabilities (4,364,188) 306,288
Income taxes receivable (payable) 3,849,950 802,170
----------- -----------
Net cash used in operating activities (4,408,674) (1,980,478)
----------- -----------
Cash Flows from Investing Activities:
Property and equipment acquired and construction in progress (1,051,344) (1,624,592)
Proceeds from sale of equipment -- 12,200
Proceeds from sale of other assets 710,790 50,000
Proceeds from note receivable 20,502 8,126
Business acquired in purchase transaction, net of cash acquired 18,125 (5,935,162)
Partnership distribution -- 350,000
Insurance proceeds -- 68,317
----------- -----------
Net cash used in investing activities (301,927) (7,071,111)
----------- -----------
Cash Flows from Financing Activities:
Net borrowings (payments) on line of credit 6,959,125 9,703,310
Proceeds from issuance of common stock 194,465 442,857
Long-term debt repayments (1,524,086) (383,387)
----------- -----------
Net cash provided by financing activities 5,629,504 9,762,780
----------- -----------
----------- -----------
Effect of Exchange Rate Changes on Cash 3,362 13,556
----------- -----------
Net change in cash 922,265 724,747
Cash, at beginning of period 1,402,880 159,414
----------- -----------
Cash, at end of period $ 2,325,145 $ 884,161
=========== ===========
Supplemental Disclosures:
Interest paid $ 827,201 $ 212,237
=========== ===========
Income taxes paid $ 3,442,783 $ 1,306,947
=========== ===========
See accompanying notes to interim condensed consolidated financial statements.
6
ENGlobal Corporation
Condensed Consolidated Statements Of Cash Flows
(Unaudited)
(Continued)
For the Six Months Ended
June 30,
--------------------------
2007 2006
----------- -----------
Non-Cash:
Issuance of note for purchase of WRC Corporation $ $ 2,400,000
=========== ===========
Issuance of common stock for purchase of WRC Corporation $ $ 1,400,000
=========== ===========
Issuance of note for ATI assets $ $ 1,000,000
=========== ===========
Acceptance of note for Constant Power assets $ $ (216,000)
=========== ===========
Acceptance of note from Oak Tree $(1,480,000) $ --
=========== ===========
See accompanying notes to interim condensed consolidated financial statements.
7
Notes to Condensed Consolidated Financial Statements
----------------------------------------------------
NOTE 1 - BASIS OF PRESENTATION
The condensed consolidated financial statements of ENGlobal Corporation
(which may be referred to as "ENGlobal", the "Company", "we", "us", or
"our") included herein are unaudited for the three month and six month
periods ended June 30, 2007 and 2006. These financial statements reflect
all adjustments (consisting of normal recurring adjustments), which are, in
the opinion of management, necessary to fairly present the results for the
periods presented. Certain information and note disclosures, normally
included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America, have been
condensed or omitted pursuant to rules and regulations of the Securities
and Exchange Commission. It is suggested that these condensed financial
statements be read in conjunction with the Company's audited financial
statements for the year ended December 31, 2006, included in the Company's
Annual Report on Form 10-K filed with the Securities and Exchange
Commission on March 16, 2007 and as amended on Form 10K/A filed with the
Securities and Exchange Commission on March 29, 2007 (collectively referred
to as "2006 Annual Report on Form 10-K"). The Company believes that the
disclosures made herein are adequate to make the information presented not
misleading.
NOTE 2 - CRITICAL ACCOUNTING POLICIES
A summary of critical accounting policies is disclosed in Note 2 to the
Consolidated Financial Statements included in our 2006 Annual Report on
Form 10-K. Our critical accounting policies are further described under the
caption "Critical Accounting Policies" in Management's Discussion and
Analysis of Financial Condition and Results of Operation in our 2006 Annual
Report on Form 10-K.
The Company's adoption of SFAS No. 123(R), "Share-Based Payment," became
effective January 1, 2006 and is further described in Note 3, below.
On July 13, 2006, the FASB issued FIN 48, "Accounting for Uncertainty in
Income Taxes, and Related Implementation Issues," which provides guidance
on the financial statement recognition, measurement, presentation and
disclosure of uncertain tax positions that a company has taken or expects
to take on a tax return. Under FIN 48, financial statements should reflect
expected future tax consequences of such positions presuming the taxing
authorities have full knowledge of the position and all relevant facts.
This interpretation also revises the disclosure requirements and was
adopted by the Company effective as of January 1, 2007. There are currently
no material tax positions identified as uncertain for the Company or its
subsidiaries. As of June 30, 2007, we have not recognized interest or
penalties relating to any uncertain tax positions.
The Company is subject to Federal and state income tax audits from time to
time that could result in proposed assessments. The Company cannot predict
with certainty the timing of such audits, how these audits would be
resolved and whether the Company would be required to make additional tax
payments, which may or may not include penalties and interest. The Company
was subject to a Federal tax audit for the years 2002 and 2003. That
examination has been closed.
WRC Corporation, which was acquired by the Company on May 26, 2006,
recently underwent a Federal tax audit for the pre-acquisition fiscal year
ended September 30, 2005. This audit was closed on July 12, 2007, with no
significant tax impact on the Company. The Company does not have any other
on-going Internal Revenue Service examinations, and the open years
currently subject to audit are tax years 2004-2006. For most states where
the Company conducts business, the Company is subject to examination for
the preceding three to six years.
NOTE 3 - SHARE BASED COMPENSATION
The Company currently sponsors a stock-based compensation plan as described
below. Effective January 1, 2006, the Company adopted the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 123 (Revised),
"Share-Based Payment" ("SFAS No. 123(R)"). Under the fair value recognition
provisions of SFAS No. 123(R), stock-based compensation is measured at the
grant date based on the value of the awards and is recognized as an expense
over the requisite service period (usually a vesting period). The Company
8
Notes to Condensed Consolidated Financial Statements
----------------------------------------------------
selected the modified prospective method of adoption described in SFAS No.
123(R). The fair values of the stock awards recognized under SFAS No.
123(R) are determined based on the vested portion of the awards; however,
the total compensation expense is recognized on a straight-line basis over
the vesting period.
In accordance with the provisions of SFAS No. 123(R), total stock-based
compensation expense in the amount of $222,143 and $405,894 was recorded
for the three months ended June 30, 2007 and June 30, 2006, respectively,
and $455,107 and $491,198 was recorded the six months ended June 30, 2007
and June 30, 2006, respectively. The total stock-based compensation expense
was recorded in selling, general and administrative expense. The total
income tax benefit recognized in the condensed consolidated statements of
income for the share-based arrangements for the three months ended June 30,
2007 was $38,509 and for the six months ended June 30, 2007 was $77,018.
Prior to January 1, 2006, the Company accounted for stock-based
compensation using the intrinsic value method prescribed in Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. Under APB Opinion No. 25, no
compensation expense was recognized for stock options issued to employees
because the grant price equaled or was above the market price on the date
of grant for options issued by the Company.
The average price per share for the three months ended June 30, 2007 and
2006 was $8.83 per share and $9.53 per share, respectively, and for the six
months ended June 30, 2007 and 2006 was $7.44 per share and $10.33 per
share, respectively.
Stock Option and Incentive Plans
The Company maintains a stock option plan (the "Option Plan") under which
the Company may issue stock options to employees and non-employee
directors. On March 30, 2007, the Board of Directors approved (subject to
stockholder approval which occurred on June 14, 2007) an amendment to the
Option Plan to increase the number of shares available for issuance under
the Plan from 2,650,000 to 3,250,000. The Company intends to issue
stock-based awards under the option plan in order to enhance its ability to
attract, retain and compensate employees and non-employee directors of
outstanding ability. As of June 30, 2007, 600,806 shares remain available
for grant under the Option Plan.
The Company's policy regarding share issuance upon option exercise takes
into consideration the optionee's eligibility and vesting status. Upon
receipt of an optionee's exercise notice and payment, and the Company's
subsequent determination of eligibility, the Company's Chief Governance
Officer or the Chairman of the Compensation Committee instructs our
transfer agent to issue shares of our Common Stock to the optionee.
Stock options have been granted with exercise prices at or above the market
price on the date of grant. The granted options have vested generally over
one year for non-employee directors and ratably over four years for
officers and employees. The options generally have a ten-year term.
Compensation expense of $1.4 million related to previously granted stock
option awards which are not vested had not yet been recognized at June 30,
2007. This compensation expense is expected to be recognized over a
weighted-average period of approximately 12 months.
9
Notes to Condensed Consolidated Financial Statements
----------------------------------------------------
The following summarizes stock option activity for the second quarter of
2007:
Weighted
Weighted Average
Average Remaining Aggregate
Number of Exercise Contractual Intrinsic *
Options Price Term (Years) Value (000's)
--------- --------- ------------ -------------
Balance at December 31, 2006 1,422,494 $ 5.16 7.9 years $ 2,871
Granted 150,000 10.93 10.0 years -
Exercised 99,875 1.66 - 587
Canceled or expired 20,000 2.05 - -
--------- --------- ------------ -----------
Balance at June 30, 2007 1,452,619 $ 6.04 7.8 $ 3,458
========= ========= ============ ===========
Exercisable at June 30, 2007 1,047,419 $ 5.08 7.8 $ 4,974
========= ========= ============ ===========
*Based on average stock price for the second quarter 2007 of $8.83 per
share. The average stock price for the same period in 2006 was $9.53 per
share.
The total intrinsic value of options exercised was $405,000 and $608,000
for the three months ended June 30, 2007 and 2006, respectively, and
$587,000 and $930,000 for the six months ended June 30, 2007 and 2006,
respectively.
NOTE 4 - FIXED FEE CONTRACTS
Costs, estimated earnings and billings on uncompleted contracts consisted
of the following at June 30, 2007 and December 31, 2006:
June 30, December 31,
2007 2006
--------------------
(in thousands)
--------------------
Costs incurred on uncompleted contracts $ 84,214 $ 75,317
Estimated earnings (losses) on uncompleted contracts (7,417) (7,390)
-------- --------
Earned revenues 76,797 67,927
Less: Billings to date 70,008 63,077
-------- --------
Net costs and estimated earnings in excess of billings
on uncompleted contracts $ 6,789 $ 4,850
======== ========
Costs and estimated earnings in excess of billings on uncompleted contracts $ 10,189 $ 5,390
Billings and estimated earnings in excess of cost on uncompleted contracts (3,400) (540)
-------- --------
Net costs and estimated earnings in excess of billings
on uncompleted contracts $ 6,789 $ 4,850
======== ========
NOTE 5 - COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) represents net earnings and any revenue,
expenses, gains and losses that, under accounting principles generally
accepted in the United States of America, are excluded from net earnings
and recognized directly as a component of stockholders' equity. At June 30,
2007, comprehensive income included losses of ($16,659) and ($17,380) for
the quarter and year to date, respectively, from foreign currency
translation adjustments.
NOTE 6 - GOODWILL
In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets,"
goodwill is no longer amortized over its estimated useful life, but rather
is subject to at least an annual assessment for impairment. SFAS 142 also
requires that intangible assets with estimable useful lives be amortized
over their respective estimated useful lives to their estimated residual
10
Notes to Condensed Consolidated Financial Statements
----------------------------------------------------
values and reviewed for impairment in accordance with SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets." Goodwill
has been allocated to the Company's two reportable segments. The test for
impairment is made on each of these reporting segments. No impairment of
goodwill has been incurred to date.
Reference is made to NOTE 16 - ACQUISITIONS, in the Company's 2006 Annual
Report on Form 10K for the period ended December 31, 2006. A third party
valuation of intangible assets was received relating to the Company's
acquisition of WRC Corporation. A portion of the goodwill was allocated to
intangible assets based on the value and nature of the agreements and is
being amortized accordingly over the term of the agreements. During the
three months ended March 31, 2007, the Company consulted with the third
party valuation provider and revised the allocation to intangible assets
resulting in approximately $669,000 being re-allocated back to goodwill. As
a result, in 2006, we amortized $70,000 more of intangibles than we would
have amortized based on the second valuation. The Company's amortization of
the affected intangible assets will be adjusted over the remaining five
year term of those assets and will not have a material effect on the
current or future period financial results.
NOTE 7 - LINE OF CREDIT AND DEBT
At the end of the reporting period, the Company had a Credit Facility (the
"Comerica Credit Facility") with Comerica Bank ("Comerica") that consisted
of a line of credit maturing on July 26, 2009. The Comerica Credit Facility
positions the Comerica debt as senior to all other debt. The line of credit
is limited to $35 million, subject to loan covenant restrictions and is
collateralized by substantially all the assets of the Company. The
outstanding balance on the line of credit as of June 30, 2007 was $30.9
million. The remaining borrowings available under the line of credit as of
June 30, 2007 were $4.1 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
the total funded debt to EBITDA; total funded debt to total liabilities
plus net worth; and total funded debt to accounts/unbilled receivables. The
Company is also required, as of the end of each quarter, to maintain
minimum levels of net worth, and 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 June 30, 2007.
11
Notes to Condensed Consolidated Financial Statements
----------------------------------------------------
June 30, December 31,
2007 2006
--------------------
(in thousands)
--------------------
Schedule of Long-Term Debt:
Comerica Credit Facility - Line of credit, prime (8.25% at June 30, 2007),
maturing in July 2009 $ 30,922 $ 23,963
Sterling Planet and EDGI - Notes payable, interest at 5%, principal payments in
installments of $15,000 plus interest due quarterly, maturing in December 2008 90 120
Cleveland Inspection Services, Inc., CIS Technical Services and F.D. Curtis
- Notes payable, discounted at 5% interest, principal in installments of
$100,000 due quarterly, maturing in October 2009 936 1,109
InfoTech Engineering, Inc. - Note payable, interest at 5%, principal payments in
installments of $65,000 plus interest due annually, maturing in December 2007 75 75
A.T.I. Inc. - Note payable, interest at 6%, principal payments in installments of
$30,422 including interest due monthly, maturing in January 2009 550 713
Michael Lee - Note payable, interest at 5%, principal payments in installments of
$150,000 plus interest due quarterly, maturing in July 2010 1,800 2,100
Watco Management, Inc. - Note payable, interest at 4%, principal payments in
installments of $137,745 including interest annually, maturing in October 2010 500 500
Miscellaneous -- --
-------- --------
Total long-term debt 34,873 28,580
Less: Current maturities (1,555) (1,418)
-------- --------
Long-term debt, net of current portion $ 33,318 $ 27,162
======== ========
NOTE 8 - SEGMENT INFORMATION
The Company operates in two business segments: (1) engineering, providing
services primarily to major companies involved in the hydrocarbon and
chemical processing industries, pipelines, oil and gas development, and
cogeneration units that, for the most part, are located in the United
States; and (2) systems, providing design and implementation of control
systems for specific applications primarily in the energy and process
industries, and uninterruptible power systems and battery chargers to
customers that, for the most part, are located in the United States.
Revenue and operating income for each segment are set forth in the
following table. The amount under Corporate includes those activities that
are not allocated to the operating segments and include costs related to
business development, executive function, finance, accounting, investor
relations/governance, project controls, information technology, legal,
safety and human resources that are not specifically identifiable with the
two segments. Inter-company elimination includes the amount of
administrative costs allocated to the segments. Corporate functions support
both business segments and therefore cannot be specifically assigned to
either. Significant portions of Corporate cost are allocated to each
segment based on each segment's revenues and eliminated in consolidation.
12
Notes to Condensed Consolidated Financial Statements
----------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
2007 2006 2007 2006
--------- --------- --------- ---------
(in thousands)
------------------------------------------------
Revenue:
Engineering $ 84,263 $ 69,869 $ 160,706 $ 132,499
Systems 5,767 5,576 11,277 9,888
Less intercompany revenue (454) (379) (748) (694)
--------- --------- --------- ---------
Total revenue $ 89,576 $ 75,066 $ 171,235 $ 141,693
========= ========= ========= =========
Operating income (loss):
Engineering $ 10,495 $ 6,596 $ 19,996 $ 11,486
Systems (60) 55 (240) (127)
Corporate (3,506) (3,089) (7,293) (5,676)
--------- --------- --------- ---------
Total operating income $ 6,929 $ 3,562 $ 12,463 $ 5,683
========= ========= ========= =========
Financial information about geographic areas
--------------------------------------------
Revenue from the Company's non-U.S. operations is currently not material.
Long-lived assets (principally leasehold improvements and computer
equipment) outside the United States were $98,539 as of June 30, 2007, net
of accumulated depreciation.
NOTE 9 - FEDERAL INCOME TAXES
The components of income tax expense (benefit) for the three and six months
ended June 30, 2007 and 2006 were as follows:
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ------------------
2007 2006 2007 2006
------- ------- ------- -------
(in thousands)
----------------------------------------
Current $ 2,869 $ 1,423 $ 4,728 $ 2,186
Deferred (38) (58) (77) (74)
------- ------- ------- -------
Total tax provision $ 2,831 $ 1,365 $ 4,652 $ 2,112
======= ======= ======= =======
13
Notes to Condensed Consolidated Financial Statements
----------------------------------------------------
NOTE 10 - EARNINGS PER SHARE
The following table reconciles the denominator used to compute basic
earnings per share to the denominator used to compute diluted earnings per
share ("EPS").
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- -----------------------
2007 2006 2007 2006
---------- ---------- ---------- ----------
(in thousands)
-------------------------------------------------
Weighted average shares outstanding
(denominator used to compute basic EPS) 26,864,358 26,444,185 26,839,184 26,388,702
Effect of employee and outside director stock options 425,689 747,432 369,394 830,280
---------- ---------- ---------- ----------
Denominator used to compute diluted EPS 27,290,047 27,191,617 27,208,578 27,218,982
========== ========== ========== ==========
NOTE 11 - CONTINGENCIES
Employment Agreements
The Company has employment agreements with certain of its executive
officers, the latest of which expires in February 2009. The agreements
provide for minimum salary levels. If the Company terminates the employment
of the employee for any reason other than 1) termination for cause, 2)
voluntary resignation, or 3) employee's death, the Company is obligated to
provide a severance benefit equal to six months of the employee's salary,
and, at its option, an additional six months at 50% to 100% of the
employee's salary in exchange for an extension of a non- competition
provision. These agreements are renewable for one year at the Company's
option. The Company has employment agreements with certain other officers
which contain the elements of those agreements with its executive officers
but are in effect from three to five years.
Litigation
From time to time, the Company is involved in various legal proceedings
arising in the ordinary course of business alleging, among other things,
breach of contract or tort in connection with the performance of
professional services, the outcome of which cannot be predicted with
certainty. As of the date of this filing, we are party to several legal
proceedings for which we have reserves, which are covered by insurance, or
that, if determined adversely to us individually or in the aggregate, would
not have a material adverse effect on our results of operations or
financial position.
Insurance
The Company carries a broad range of insurance coverage, including general
and business automobile liability, commercial property, professional errors
and omissions, workers' compensation insurance and a general umbrella
policy. The Company is not aware of any claims in excess of insurance
recoveries. ENGlobal is partially self-funded for health insurance claims.
Provisions for expected future payments are accrued based on the Company's
experience. Specific stop loss levels provide protection for the Company
with $175,000 per occurrence and approximately $12.1 million in aggregate
in each policy year being covered by a separate insurance policy.
Unapproved Change Orders and Claims
At June 30, 2007, the Company had outstanding unapproved change
orders/claims of approximately $18.6 million. The Company recorded $1.2
million in revenue during the year ended December 31, 2006 related to these
claims. No additional amounts have been recognized during 2007 related to
these claims. Generally, collection of amounts related to unapproved change
orders and claims is expected within twelve months. However, clients
generally will not pay these amounts until final resolution of related
claims, thus accordingly, collection of these amounts may extend beyond one
year. In the future, if the Company determines collection of any unapproved
change order/claim is not probable, it will post a charge to earnings in
the period such determination is made.
14
Notes to Condensed Consolidated Financial Statements
----------------------------------------------------
NOTE 12 - SUBSEQUENT EVENT
On August 6, 2007, the Company entered into a Credit Agreement (the "Credit
Agreement"), provides a three-year, $50 million senior secured revolving
credit facility (the "New Credit Facility"). Becoming effective August 8,
2007, the New Credit Facility is guaranteed by substantially all of
Company's subsidiaries and is secured by a lien on substantially all of the
Company's assets. The New Credit Facility replaced a $35 million senior
revolving credit facility that would have expired in July 2009.
The New Credit Facility may be used for working capital, issuances of
letters of credit or other lawful corporate purposes. The Credit Agreement
contains customary affirmative and negative covenants that place certain
limitations and restrictions on the Company. These covenants place certain
limitations on the Company including limits on new debt, mergers, asset
sales, investments, and fixed price contracts along with restrictions on
certain distributions. The Company must also maintain certain financial
covenants as of the end of each calendar month, including the following:
o Leverage Ratio not to exceed 3.00 to 1.00;
o Asset Coverage Ratio to be less than 1.00 to 1.00; and
o Net Worth must be greater than the sum of $40.1 million plus 75%
of positive Net Income earned in each fiscal quarter after
January 1, 2007 plus 100% of the net proceeds of any offering,
sale or other transfer of any capital stock or any equity
securities.
At the Company's option, amounts borrowed under the New Credit Facility
will bear interest at LIBOR or an Alternate Base Rate, plus in each case,
an additional margin based on the Leverage Ratio. The Alternate Base Rate
is the greater of the Prime Rate or the Fed Funds Effective Rate, plus
1.0%. The additional margin ranges from 0% on the Alternate Base Rate loans
and 1.50% to 2.0% on the LIBOR-based loans.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Forward-Looking Statements
--------------------------
Certain information contained in this Quarterly Report on Form 10-Q, the
Company's 2006 Annual Report on Form 10-K, as well as other written and
oral statements made or incorporated by reference from time to time by the
Company and its representatives in other reports, filings with the
Securities and Exchange Commission, press releases, conferences, or
otherwise, may be deemed to be forward-looking statements with the meaning
of Section 21E of the Securities Exchange Act of 1934. This information
includes, without limitation, statements concerning the Company's future
financial position and results of operations; planned capital expenditures;
business strategy and other plans for future operations; the future mix of
revenues and business; customer retention; project reversals; commitments
and contingent liabilities; and future demand and industry conditions.
Although the Company believes that the expectations reflected in such
forward-looking statements are reasonable, it can give no assurance that
such expectations will prove to have been correct. We undertake no
obligation to publicly update or revise any forward-looking statements,
whether as a result of new information, future events or otherwise.
Generally, the words "anticipate," "believe," "estimate," "expect," "may,"
and similar expressions, identify forward-looking statements, which
generally are not historical in nature. Actual results could differ
materially from the results described in the forward-looking statements due
to the risks and uncertainties set forth in this Quarterly Report on Form
10-Q, the specific risk factors identified in the Company's 2006 Annual
Report on Form 10-K and those described from time to time in our future
reports filed with the Securities and Exchange Commission.
The following discussion is qualified in its entirety by, and should be
read in conjunction with, the Company's Consolidated Financial Statements,
including the notes thereto, included in this Quarterly Report on Form 10-Q
and the Company's 2006 Annual Report on Form 10-K.
MD&A Overview
-------------
The following list sets forth a general overview of the more significant
changes in the Company's financial condition and results of operations for
the three and six months ended June 30, 2007, compared to the corresponding
period in 2006.
During the three months During the six months
ended June 30, 2007 ended June 30, 2007
($ in millions) % ($ in millions) %
--------------- ------ --------------- ------
Revenue $ 14.5 19.3% $ 29.5 20.8%
Gross profit 3.5 32.7% 8.5 44.7%
Operating income 3.3 91.7% 6.8 119.3%
SG&A expense 0.1 1.4% 1.7 12.8%
Net income 1.6 70.0% 3.5 97.2%
Long-term debt, net of current portion, increased 22.4%, or $6.1million,
from $27.2 million at December 31, 2006 to $33.3 million at June 30, 2007,
and as a percentage of stockholders' equity, long-term debt increased to
68.6% from 66.5% at these same dates. The primary reason for the increase
in long-term debt is the timing difference related to meeting short-term
bi-weekly payroll obligations from our growth and longer collection periods
on receipts from our clients. On average, our accounts receivable days
outstanding is 70 days for the three months ended June 30, 2007, compared
to 64 days for the three months ended June 30, 2006. The Company continues
to work toward improving billing and collection processes.
Total stockholders' equity increased 18.8%, or $7.7 million, from $40.9
million as of December 31, 2006 to $48.6 million as of June 30, 2007.
16
MD&A/Results of Operations (continued)
--------------------------------------
Consolidated Results of Operations for the Three and Six Months
Ended June 30, 2007 and 2006
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------------------- -----------------------------------------
2007 2006 2007 2006
------------------- ------------------- ------------------- -------------------
(dollars in thousands)
------------------------------------------------------------------------------------
Revenue:
Engineering $ 83,938 93.7 % $ 69,752 92.9 % $ 160,087 93.5 % $ 132,339 93.4 %
Systems 5,638 6.3 % 5,314 7.1 % 11,148 6.5 % 9,354 6.6 %
---------- ------ ---------- ------ ---------- ------ ---------- ------
Total revenue $ 89,576 100.0 % $ 75,066 100.0 % $ 171,235 100.0 % $ 141,693 100.0 %
========== ========== ========== ==========
Gross profit:
Engineering $ 13,967 15.6 % $ 10,189 13.6 % $ 26,996 15.7 % $ 17,986 12.7 %
Systems 252 0.3 % 539 0.7 % 501 0.3 % 964 0.7 %
---------- ------ ---------- ------ ---------- ------ ---------- ------
Total gross profit 14,219 15.9 % 10,728 14.3 % 27,497 16.0 % 18,950 13.4 %
---------- ---------- ---------- ----------
SG&A expense:
Engineering 3,472 3.9 % 3,593 4.8 % 7,000 4.1 % 6,500 4.6 %
Systems 312 0.3 % 484 0.6 % 741 0.4 % 1,091 0.8 %
Corporate 3,506 4.0 % 3,089 4.1 % 7,293 4.3 % 5,676 4.0 %
---------- ------ ---------- ------ ---------- ------ ---------- ------
Total SG&A expense 7,290 8.2 % 7,166 9.5 % 15,034 8.8 % 13,267 9.4 %
---------- ---------- ---------- ----------
Operating income:
Engineering 10,495 11.7 % 6,596 8.8 % 19,996 11.7 % 11,486 8.1 %
Systems (60) - % 55 - % (240) (0.2)% (127) (0.1)%
Corporate (3,506) (4.0)% (3,089) (4.0)% (7,293) (4.3)% (5,676) (4.0)%
---------- ------ ---------- ------ ---------- ------ ---------- ------
Total operating income 6,929 7.7 % 3,562 4.8 % 12,463 7.2 % 5,683 4.0 %
---------- ---------- ---------- ----------
Other income (expense), net (185) (0.2)% 134 0.1)% (745) (0.4)% (6) - %
Tax provision (2,831) (3.1)% (1,365) (1.8)% (4,650) (2.7)% (2,112) (1.5)%
---------- ------ ---------- ------ ---------- ------ ---------- ------
Net income $ 3,913 4.4 % $ 2,331 3.1 % $ 7,067 4.1 % $ 3,565 2.5 %
========== ========== ========== ==========
All percentages are based on total revenue.
Other financial comparisons:
----------------------------
As of June 30,
-------------------
2007 2006
-------- --------
(in thousands)
-------------------
Working capital $ 48,707 $ 31,051
Total assets $120,213 $ 93,053
Long-term debt, net of current portion $ 33,318 $ 16,943
Stockholders' equity $ 48,583 $ 45,777
17
MD&A/Results of Operations (continued)
--------------------------------------
We recorded net income of $3.9 million, or $0.15 per diluted share for the
three months ended June 30, 2007, compared to net income of $2.3 million,
or $0.09 per diluted share for the corresponding period last year.
We recorded net income of $7.1 million, or $0.26 per diluted share for the
six months ended June 30, 2007, compared to net income of $3.6 million, or
$0.13 per diluted share for the corresponding period last year.
The following table presents, for the periods indicated, the approximate
percentage of total revenues and operating income or loss attributable to
our reportable segments:
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ------------------
2007 2006 2007 2006
------ ------ ------ ------
Revenue:
Engineering 93.7 % 92.9 % 93.5 % 93.4 %
Systems 6.3 % 7.1 % 6.5 % 6.6 %
Operating income (loss):
As a % of Total Revenues
Engineering 11.7 % 8.8 % 11.7 % 8.1 %
Systems - % - % (0.2)% (0.1)%
The Company's revenue is composed of engineering, construction and
procurement service revenue, systems, land/management and related product
sales. The Company recognizes service revenue as soon as the services are
performed. The majority of the Company's engineering services have
historically been provided through cost-plus contracts whereas a majority
of the Company's product sales are earned on fixed-price contracts.
However, our engineering segment recognized approximately $8.0 million in
fixed-price revenue in the six months ended June 30, 2007, compared to
$14.8 million of similar revenue in the same period in 2006.
Revenue is recorded primarily using the percentage-of-completion
(cost-to-cost) method. Under this method, revenue on long-term contracts is
recognized in the ratio that contract costs incurred bear to total
estimated contract costs. Revenue and gross margin on contracts are subject
to revision throughout the lives of the contracts and any required
adjustments are made in the period in which the revisions become known.
Losses on contracts are recorded in full as they are identified.
In the course of providing our services, we routinely provide engineering,
materials, and equipment and may provide construction services on either a
subcontracted or direct hire basis. Generally, these materials, equipment
and subcontractor costs are passed through to our clients and reimbursed,
along with fees, which in the aggregate, are at margins lower than those of
our core business. In accordance with industry practice and generally
accepted accounting principles, all costs and fees are included in revenue.
The use of subcontractor services can change significantly from project to
project; therefore, changes in revenue may not be indicative of business
trends.
For analytical purposes only, we segregate from our total revenue the
revenues derived from material assets or companies acquired during the
first 12 months following their respective dates of acquisition and refer
to such revenue as "Acquisition" revenue. We also segregate gross profits
and SG&A expenses derived from material assets or company acquisitions on
the same basis as we segregate revenues.
Operating SG&A expense includes management and staff compensation, office
costs such as rents and utilities, depreciation, amortization, travel and
other expenses generally unrelated to specific client contracts, but
directly related to the support of a segment's operation.
18
MD&A/Results of Operations (continued)
--------------------------------------
Corporate SG&A expense is comprised primarily of marketing costs, as well
as costs related to the executive, investor relations/governance, finance,
accounting, safety, human resources, project controls, legal and
information technology departments and other costs generally unrelated to
specific client projects, but which are incurred to support corporate
activities and initiatives.
Industry Overview:
Many ENGlobal offices have benefited from the strong refinery market. We
expect significant capital projects to be generated by refinery operations
over the next several years given increasing demand for refined products,
improved margins, and an aging refining infrastructure in the U.S. Overall,
projects that relate to expanding capacity at existing refineries or those
projects that relate to processing lower cost grades of crude have trended
upward. Given that global demand for energy has tightened the supply of
both crude oil as well as refined products, we believe each ENGlobal
business segment is well positioned within the industry, and to perform
services primarily in the North American market.
The petrochemical industry has historically been a good source of projects
for ENGlobal. We have seen a small increase in both maintenance and capital
spending on domestic facilities after several years of relative inactivity.
In the Company's view, large capital projects in the petrochemical industry
are currently being undertaken outside the U.S., in areas of the world with
increasing product demand or lower cost feedstock.
The Company is currently seeing a significant increase in North American
pipeline project activity. It is projected that this activity in terms of
pipeline miles built will increase approximately 70% in 2007, when compared
to 2006. Moving products through cross country pipelines requires other
installations on which the Company performs services, such as pump
stations, gas compression facilities, tank farms, metering and surveillance
installations. As a general statement, pipeline projects tend to require
less engineering man hours as the scope of engineering work is somewhat
smaller than for similar sized downstream projects.
ENGlobal is seeing significant increased activity on projects related to
alternative and renewable energy. In many cases, our clients for these
projects are new project developers, as opposed to our historical client
base that are much larger in size and with long operating histories. In
this area, the Company primarily focuses its marketing efforts on
facilities that will utilize biomass technologies, including those related
to ethanol, biodiesel, coal to liquids and utilization of refinery
petroleum coke as an energy source.
Revenue:
Revenue increased $29.5 million, or 20.8%, to $171.2 million for the six
months ended June 30, 2007 from $141.7 million for the comparable prior
year period with approximately $27.8 million of the increase coming from
our engineering segment and $1.7 attributable to our systems segment. This
is discussed further in our segment information.
Revenue increased $14.5 million, or 19.3%, to $89.6 million for the three
months ended June 30, 2007 from $75.1 million for the comparable prior year
period with approximately $14.1 million of the increase coming from our
engineering segment and $0.3 million attributable to our systems segment.
This is discussed further in our segment information.
Gross Profit:
Gross profit increased $8.5 million, or 44.7%, to $27.5 million for the six
months ended June 30, 2007 from $19.0 million for the comparable prior year
period. As a percentage of revenue, gross profit increased 2.6% from 13.4%
for the six months ended June 30, 2006 to 16.0% for the quarter ended June
30, 2007. Of the overall $8.5 million increase in gross profit,
approximately $3.9 million was primarily due to the $29.5 million increase
in revenue and approximately $4.6 million was due to equivalent lower
costs.
Gross profit increased $3.5 million, or 32.7%, to $14.2 million for the
three months ended June 30, 2007 from $10.7 million for the comparable
prior year period. As a percentage of revenue, gross profit increased 1.6%
from 14.3% for the three months ended June 30, 2006 to 15.9% for the
quarter ended June 30, 2007. Of the overall $3.5 million increase in gross
profit, approximately $2.1 million was primarily due to the $14.5 million
increase in revenue and approximately $1.4 million was due to equivalent
lower costs.
19
MD&A/Results of Operations (continued)
--------------------------------------
Selling, General, and Administrative:
As a percentage of revenue, SG&A expense decreased 0.6% to 8.8% for the six
months ended June 30, 2007 from 9.4% for the comparable prior year period.
Total expense for SG&A increased $1.7 million, or 12.8%, to $15.0 million
for the six months ended June 30, 2007 from $13.3 million for the
comparable prior year period.
As a percentage of revenue, SG&A expense decreased 1.3% to 8.2% for the
three months ended June 30, 2007 from 9.5% for the comparable prior year
period. Total expense for SG&A increased $0.1 million, or 1.4%, to $7.3
million for the three months ended June 30, 2007 from $7.2 million for the
comparable prior year period.
As a percentage of revenue, Corporate SG&A expense increased 0.3% to 4.3%
for the six months ended June 30, 2007 from 4.0% for the comparable prior
year period. Corporate SG&A expense increased approximately $1.6 million,
or 28.1%, to $7.3 million for the six months ended June 30, 2007 from $5.7
million for the comparable prior year period.
Corporate SG&A grew as personnel increased to 92 employees for the six
months ended June 30, 2007 compared to 75 employees for the six months
ended June 30, 2006. The Company increased the Business Development, Human
Resources, Accounting and IT departments to support the overall growth of
the Company. Facilities expenses of approximately $100,000 were added over
this timeframe to add additional office space in Houston and Denver and to
add to our office network.
As a percentage of revenue, Corporate SG&A expense decreased 0.1% to 4.0%
for the three months ended June 30, 2007 from 4.1% for the comparable prior
year period. Corporate SG&A expense increased approximately $0.4 million,
or 12.9%, to $3.5 million for the three months ended June 30, 2007 from
$3.1 million for the comparable prior year period.
Operating Income:
Operating income increased approximately $6.8 million, or 119.3%, to $12.5
million for the six months ended June 30, 2007 from $5.7 million compared
to the same period in 2006. As a percentage of revenue, operating income
increased 3.2% to 7.2% for the six months ended June 30, 2007 from 4.0% for
the comparable prior year period.
Operating income increased approximately $3.3 million, or 91.7%, to $6.9
million for the three months ended June 30, 2007 from $3.6 million compared
to the same period in 2006. As a percentage of revenue, operating income
increased 2.9% to 7.7% for the three months ended June 30, 2007 from 4.8%
for the comparable prior year period.
Other Expense, net:
Other expense increased $739,000 for the six months ended June 30, 2007
from the comparable prior year period. Interest expense increased $845,000
due to an increased outstanding balance on our line of credit. Other income
increased $106,000 due to a gain of $483,000 recorded for the sale of our
office building located in Baton Rouge, Louisiana. Other income for the six
months ended June 30, 2006 was mainly from insurance proceeds related to
Hurricane Rita damage.
Other expense increased $319,000 for the three months ended June 30, 2007
from the comparable prior year period. Interest expense increased $447,000
due to an increased outstanding balance on our line of credit. Other income
increased $128,000 due to the gain on the sale of the building.
Tax Provision:
Income tax expense increased $2.6 million, or 123.8%, to $4.7 million for
the six months ended June 30, 2007 from $2.1 million for the comparable
prior year period. The estimated effective tax rate was 39.7% for the six
months ended June 30, 2007 compared to 37.2% for the comparable prior year
period. The change in the effective tax rate is the result of increasing
state income taxes.
20
MD&A/Results of Operations (continued)
--------------------------------------
Income tax expense increased $1.4 million, or 100.0%, to $2.8 million for
the three months ended June 30, 2007 from $1.4 million for the comparable
prior year period. The estimated effective tax rate was 42.0% for the three
months ended June 30, 2007 compared to 36.9% for the comparable prior year
period. The change in the effective tax rate is the result of increasing
state income taxes.
As we experienced greater earnings in a broader range of jurisdictions
compared to 2006, we realized the need to recognize greater tax obligations
to those jurisdictions. The effective rate of 42.0% for the three months
ended June 30, 2007 compared to the 39.7% effective rate for the six months
ended June 30, 2007, indicates that the increased estimates were booked in
the second quarter. Our expected effective rate for 2007, annualizing the
impact of Federal and state taxes, should average approximately 41%.
The estimated effective tax rates are based on estimates using historical
rates adjusted by recurring and non-recurring book to tax differences.
Estimates at June 30, 2006 included the effect of non-recurring differences
in tax estimates from the 2005 year end. Estimates at June 30, 2007 are
based on results of the 2006 year end and adjusted for estimates of
non-recurring differences from the prior year, as well as anticipated book
to tax differences for 2007.
Net Income:
Net income for the six months ended June 30, 2007 increased $3.5 million,
or 97.2%, to $7.1 million from $3.6 for the comparable prior year period.
As a percentage of revenue, net income increased 1.6% to 4.1% for the six
months ended June 30, 2007 from 2.5% for the period ended June 30, 2006.
Net income for the three months ended June 30, 2007 increased $1.6 million,
or 69.6%, to $3.9 million from $2.3 for the comparable prior year period.
As a percentage of revenue, net income increased 1.3% to 4.4% for the three
months ended June 30, 2007 from 3.1% for the period ended June 30, 2006.
Liquidity and Capital Resources
-------------------------------
Historically, cash requirements have been satisfied through operations and
borrowings under a revolving line of credit, which is currently in effect
with Comerica Bank (the "Comerica Credit Facility"). As of June 30, 2007,
we had working capital of $49.1 million. Long-term debt, net of current
portion, was $33.3 million as of June 30, 2007, including $30.9 million
outstanding under the Comerica Credit Facility.
The Comerica Credit Facility positions the Comerica debt as senior to all
other debt. The line of credit is limited to $35 million, subject to loan
covenant restrictions and is collateralized by substantially all the assets
of the Company. The outstanding balance on the line of credit as of June
30, 2007 was $30.9 million. The remaining borrowings available under the
line of credit as of June 30, 2007 were $4.1 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
the total funded debt to EBITDA; total funded debt to total liabilities
plus net worth; and total funded debt to accounts/unbilled receivables. The
Company is also required, as of the end of each quarter, to maintain
minimum levels of net worth, and 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 June 30, 2007.
We are not currently subject to any obligations under standby letters of
credit, guarantees, repurchase obligations or other commitments. We have no
off-balance sheet arrangements.
As of June 30, 2007, management believes the Company's cash position is
sufficient to meet its working capital requirements for at least the next
twelve months. Any future decrease in demand for the Company's services or
products would reduce the availability of funds through operations.
On August 6, 2007, the Company entered into a Credit Agreement (the "Credit
Agreement"), provides a three-year, $50 million senior secured revolving
credit facility (the "New Credit Facility"). Becoming effective August 8,
2007, the New Credit Facility is guaranteed by substantially all of
Company's subsidiaries and is secured by a lien on substantially all of the
Company's assets. The New Credit Facility replaced a $35 million senior
revolving credit facility that would have expired in July 2009.
21
MD&A/Results of Operations (continued)
--------------------------------------
The New Credit Facility may be used for working capital, issuances of
letters of credit or other lawful corporate purposes. The Credit Agreement
contains customary affirmative and negative covenants that place certain
limitations and restrictions on the Company. These covenants place certain
limitations on the Company including limits on new debt, mergers, asset
sales, investments, and fixed price contracts along with restrictions on
certain distributions. The Company must also maintain certain financial
covenants as of the end of each calendar month, including the following:
o Leverage Ratio not to exceed 3.00 to 1.00;
o Asset Coverage Ratio to be less than 1.00 to 1.00; and
o Net Worth must be greater than the sum of $40.1 million plus 75%
of positive Net Income earned in each fiscal quarter after
January 1, 2007 plus 100% of the net proceeds of any offering,
sale or other transfer of any capital stock or any equity
securities.
At the Company's option, amounts borrowed under the New Credit Facility
will bear interest at LIBOR or an Alternate Base Rate, plus in each case,
an additional margin based on the Leverage Ratio. The Alternate Base Rate
is the greater of the Prime Rate or the Fed Funds Effective Rate, plus
1.0%. The additional margin ranges from 0% on the Alternate Base Rate loans
and 1.50% to 2.0% on the LIBOR-based loans.
Cash Flow
---------
The Company believes that it has available the necessary cash required for
operations for the next 12 months. Cash and the availability of cash could
be materially restricted if circumstances prevent the timely internal
processing of invoices, if amounts billed are not collected, if project mix
shifts from cost reimbursable to fixed cost contracts during significant
periods of growth, if the Company was to lose one or more of its major
customers, if demand for the Company's services decreases, or if the
Company is not able to meet the covenants of the Comerica Credit Facility.
If any such event occurs, the Company would be forced to consider
alternative financing options.
Operating activities:
Net cash used in operating activities was $4.4 million for the six months
ended June 30, 2007, compared with net cash used of $2.0 million in the
same period in 2006. For the three months ended June 30, 2007, the
Company's operating activities provided approximately $500,000 of cash
compared with approximately $1.2 million of cash provided during the same
period in 2006. The credit facility increased from $29.6 million as of
March 31, 2007 and from $13.5 million as of June 30, 2006 to $30.9 million
as of June 30, 2007.
Our average days of sales outstanding ("DSO") was 70 days for the three
months ended June 30, 2007 compared to 64 days for the comparable three
month period in 2006 and 69 days for the period ended December 31, 2006.
The Company revised the method used for calculating DSO changing from
annualized average revenue and accounts receivable totals to average
quarterly revenue and accounts receivable totals. The average DSO for all
periods referenced herein and for all future periods have been and will be
calculated under the new method.
The decrease in our cash needs for the three months ended June 30, 2007 was
primarily due to:
1) an increase in net income;
2) an increase in accrued compensation and benefits due to timing of
the quarter's last bi-weekly payroll;
3) an increase in billings in excess of costs on fixed price
engineering projects; offset by:
a) an increase in trade receivables due to increased revenue
and past due accounts;
b) an increase in costs in excess of billings in our systems
manufacturing segment; and
c) a decrease in accrued liabilities due to subcontractor
payments made against reserves related to the fixed price
contract losses in 2006.
22
MD&A/Results of Operations (continued)
--------------------------------------
Accounts payable are not expected to materially impact cash during the
third quarter as the two fixed price EPC projects are scheduled to be
completed during that period with final billings and retention collections
expected to have a positive cash impact. A continued increase in costs and
estimated earnings in excess of billings is not expected during the third
quarter even though improvements can only be made with more favorable
contractual terms.
Investing activities:
Net cash used in investing activities was $302,000 for the six months ended
June 30, 2007, compared with net cash used of $7,071,000 in the same period
in 2006. In the first six months of 2006, the Company acquired the assets
of ATI, Inc. for $750,000 cash and a note payable and the Company acquired
the assets of WRC for $10.1 million. That transaction included $4.3 million
assumption of debt, $2 million in cash, notes payable of
$2.4 million and ENGlobal shares of common stock valued at $1.4 million.
The Company also used cash for capital expenditures in the six months ended
June 30, 2007 of $1.1 million and $1.6 million in the comparable prior year
period.
Financing activities:
Net cash provided by financing activities was $5.6 million for the six
months ended June 30, 2007, compared with net cash provided of $9.8 million
in the same period in 2006. In the first six months of 2007, the Company
increased its outstanding credit facility by $7.0 million for working
capital needs compared to an increase in the credit facility of $9.7
million in the same period in 2006.
Asset Management
----------------
The Company's cash flow from operations has been affected primarily by the
timing of its collection of trade accounts receivable. The Company
typically sells its products and services on short-term credit terms and
seeks to minimize its credit risk by performing credit checks and
conducting its own collection efforts. The Company had net trade accounts
receivable of $69.6 million and $60.2 million at June 30, 2007 and December
31, 2006, respectively. The DSO in trade accounts receivables was 70 days
at June 30, 2007 and at December 31, 2006.
23
Engineering Segment Results (continued)
---------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------------- -------------------------------------
2007 2006 2007 2006
----------------- ----------------- ----------------- -----------------
(dollars in thousands)
-----------------------------------------------------------------------------
Gross revenue $ 84,263 $ 69,869 $ 160,706 $ 132,499
Less intercompany revenue (325 (117) (619) (160)
--------- --------- --------- ---------
Total Revenue: $ 83,938 100% $ 69,752 100% $ 160,087 100% $ 132,339 100%
Gross profit: $ 13,967 16.6% $ 10,189 14.6% $ 26,996 16.8% $ 17,986 13.6%
Operating SG&A expense: $ 3,472 4.1% $ 3,593 5.2% $ 7,000 4.4% $ 6,500 4.9%
Operating income: $ 10,495 12.5% $ 6,596 9.5% $ 19,996 12.5% $ 11,486 8.7%
Overview of Engineering Segment:
Our engineering segment continues to benefit from a large project load
generated primarily by its downstream clients and to a lesser extent by its
midstream clients. The industry's refining segment continues to be very
active, supplying a large percentage of the Company's backlog. ENGlobal is
benefiting from the renewed interest of its chemical/petrochemical clients
in maintenance and retrofit projects as product margins in this marketplace
improve.
Even though some of our subsidiary entities may focus more on one
discipline than another, each of the entities provides services to our
clients in the petrochemical and energy industries. As our clients have
downsized and began limiting the number of vendors and subcontractors, we
have attempted to become a "one-stop shop" solution for an entire project
or large portion of that project with more than one entity providing a
portion of the work, while other times only one entity may provide one or
more portions of the entire project. For example, we may have a project in
which WRC provides right of way services, EEI provides engineering and
design services, and ECR provides construction management and inspection
services. The client would view the work as one project under one contract.
We provide these services based on the client requirements.
We provide services to a wide range of industrial sectors including:
petroleum refining, gas processing, pipeline and product movement,
petrochemical, production, sulfur processing, manufacturing, chemical
exploration, and co-generation. Each of our subsidiaries can service
customers in these industries. The various entities also share similar
processes for delivery of services.
All of our entities are greatly impacted by the general availability of
qualified engineers and other technical professional staff and employees
are often shared among entities as needed.
Revenue
Year over year revenue increased $27.8 million, or 21.0%, to $160.1 million
for the six months ended June 30, 2007 from $132.3 million for the
comparable prior year period. The increase in engineering revenue resulted
primarily from increased activity in the engineering and construction
markets. Refining related activity has been particularly strong, including
projects to satisfy environmental mandates, expand existing facilities and
utilize heavier sour crude. Capital spending in the pipeline area is also
trending higher, with numerous projects in North America currently underway
to deliver crude oil, natural gas, petrochemicals and refined products.
Renewable energy appears to be an emerging area of activity and potential
growth, with the Company currently performing a variety of services for
ethanol, biodiesel, coal to liquids, petroleum coke to ammonia, and other
biomass processes. The acquisition of WRC in May 2006, together with our
clients' increased demand for in-plant and inspection resources, stimulated
growth in our staffing services division.
24
Engineering Segment Results (continued)
---------------------------------------
The following table illustrates the composition of the Company's revenue
mix quarter over quarter for the six months ended June 30, 2007 and 2006,
and provides a comparison of the changes in revenue and revenue trends
period over period.
Six Months Ended June 30,
--------------------------------------------------------------
2007 % rev 2006 % rev $ change % change
-------- ----- -------- ----- -------- --------
(dollars in millions)
Detail-design $ 72.0 45% $ 56.0 43% $ 16.0 29 %
Field services & inspection 73.3 46% 44.6 34% 28.7 64 %
Procurement & construction 6.8 4% 16.9 13% (10.1) (60)%
Design-build fixed price 8.0 5% 14.8 10% (6.8) (46)%
-------- -------- --------
$ 160.1 100% $ 132.3 100% $ 27.8 21 %
======== ======== ========
o The largest increase in revenue came from field services and
inspection activity which increased $28.7 million, or
approximately 64%, to $73.3 million for the six months ended June
30, 2007 from $44.6 million for the comparable prior year period.
o Detail-design services increased $16.0 million, or approximately
29% for the six months ended June 30, 2007. Our core engineering
segment's activities accounted for approximately 91% of
engineering's total revenue mix during the six months ended June
30, 2007 compared to approximately 77% for the comparable prior
year period.
o Revenue from non-labor procurement and construction activity
decreased $10.1 million from $16.9 million during the six months
ended June 30, 2006 to $6.8 million during the six months ended
June 30, 2007.
o The design-build fixed price revenue decreased $6.8 million, or
(46)%, from $14.8 million for the six months ended June 30, 2006
to $8.0 million for the same period in 2007 and accounted for
approximately 5% of engineering's total revenue.
Quarter over quarter revenue increased $14.1 million, or 20.2%, to $83.9
million for the three months ended June 30, 2007 from $69.8 million for the
comparable prior year period. The following table illustrates the
composition of the Company's revenue mix quarter over quarter for the three
months ended June 30, 2007 and 2006, and provides a comparison of the
changes in revenue and revenue trends period over period:
Three Months Ended June 30,
---------------------------------------------------------
2007 % rev 2006 % rev $ change % change
-------- ----- -------- ----- -------- --------
(dollars in millions)
Detail-design $ 36.1 43% $ 28.4 41% $ 7.7 27 %
Field services & inspection 38.2 45% 25.0 36% 13.2 53 %
Procurement & construction 5.5 7% 6.3 9% (0.8) (13)%
Design-build fixed price 4.2 5% 10.1 14% (5.9) (58)%
-------- -------- --------
$ 84.0 100% $ 69.8 100% $ 14.2 20 %
======== ======== ========
Gross Profit:
Gross profit increased $9.0 million, or 50.0%, to $27.0 million for the six
months ended June 30, 2007 from $18.0 million for the comparable prior year
period. As a percentage of revenue, gross profit increased by 3.2% to 16.8%
from 13.6% for the six months ended June 30, 2007 and 2006, respectively.
Of the overall $9.0 million increase in gross profit, approximately $3.8
million was attributable to the $27.8million increase in total revenue, and
approximately $5.2 million was attributable to improved margins. The
increase in margins can be attributed to the reduced activity in low
margin/high dollar procurement projects being replaced with higher margin
core revenue derived from labor activity. Included in gross profit for the
six months ended June 30, 2007, were $456,000 of additional losses related
to the completion of the two fixed price contracts.
25
Engineering Segment Results (continued)
---------------------------------------
Gross profit increased $3.8 million, or 37.3%, to $14.0 million for the
three months ended June 30, 2007 from $10.2 million for the comparable
prior year period. As a percentage of revenue, gross profit increased by
2.0% to 16.6% from 14.6% for the three months ended June 30, 2007 and 2006,
respectively. Of the overall $3.8 million increase in gross profit,
approximately $2.1 million was attributable to the $14.1million increase in
total revenue, and approximately $1.7 million was attributable to improved
margins. The increase in margins can be attributed to the reduced activity
in low margin/high dollar procurement projects being replaced with higher
margin core revenue derived from labor activity. Included in gross profit
for the three months ended June 30, 2007, were $456,000 of additional
losses related to the completion of the two fixed price contracts.
At June 30, 2007, the Company had outstanding unapproved change
orders/claims of approximately $18.6 million. The Company recorded $1.2
million in revenue during the year ended December 31, 2006 related to these
claims. No additional amounts have been recognized during 2007 related to
these claims. Generally, collection of amounts related to unapproved change
orders and claims is expected within twelve months. However, clients
generally will not pay these amounts until final resolution of related
claims, thus accordingly, collection of these amounts may extend beyond one
year. In the future, if the Company determines collection of any unapproved
change order/claim is not probable, it will post a charge to earnings in
the period such determination is made.
Selling, General, and Administrative:
As a percentage of revenue, SG&A expense decreased 0.5% to 4.4% for the six
months ended June 30, 2007 from the comparable prior year period. SG&A
expense increased $0.5 million, or 7.7%, to $7.0 million for the six months
ended June 30, 2007 from $6.5 million for the comparable prior year period.
As a percentage of revenue, SG&A expense decreased 1.1% to 4.1% for the
three months ended June 30, 2007 from 5.2% for the comparable prior year
period. SG&A expense decreased $0.1 million, or (2.8)%, to $3.5 million for
the three months ended June 30, 2007 from $3.6 million for the comparable
prior year period.
Operating Income:
Operating income increased $8.5 million, or 73.9%, to $20.0 million for the
six months ended June 30, 2007 from $11.5 million for the comparable prior
year period. As a percentage of revenue, operating income increased to
12.5% for the six months ended June 30, 2007 from 8.7% for the comparable
prior year period.
Operating income increased $3.9 million, or 59.1%, to $10.5 million for the
three months ended June 30, 2007 from $6.6 million for the comparable prior
year period. As a percentage of revenue, operating income increased to
12.5% for the three months ended June 30, 2007 from 9.5% for the comparable
prior year period.
26
Systems Segment Results
-----------------------
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------------- --------------------------------------
2007 2006 2007 2006
------------------ --------------- ---------------- ------------------
(dollars in thousands)
-------------------------------------------------------------------------------
$ 5,767 $ 5,576 $11,277 $ 9,888
Gross revenue
Less intercompany revenue 129 262 129 534
------- ------- ------- -------
Total revenue: $ 5,638 100.0 % 5,314 100.0% $11,148 100.0 % $ 9,354 100.0 %
Gross profit: $ 252 4.5 % $ 539 10.1% $ 501 4.5 % $ 964 10.3 %
------- ------- ------- -------
Operating SG&A expense: 312 5.5 % 484 9.1% 741 6.7 % 1,091 11.7 %
------- ------- ------- -------
Operating income: (60) (1.1)% 55 1.0% (240) (2.2)% (127) (1.4)%
======= ======= ======= =======
Overview of Systems Segment:
The systems segment began a detailed review process in the fourth quarter
of 2006. As a continuation of this initiative in the first six months of
2007, the Company initiated more detailed project cost control/forecasting
was initiated on all active lump sum projects in order to identify
potential areas of remediation and improve financial results.
Revenue:
Revenue increased approximately $1.7 million, or 18.1%, to $11.1 million
for the six months ended June 30, 2007 from $9.4 million for the comparable
prior year period.
Revenue increased approximately $0.3 million, or 5.7%, to $5.6 million for
the three months ended June 30, 2007 from $5.3 million for the comparable
prior year period.
A general turnaround in the oil and gas industry, together with the
acquisition of Analyzer Technology International, Inc. ("ATI") in January
2006 has increased the demand for systems services. Another factor
positively affecting systems business is that the computer-based
distributed control systems equipment used for facility plant automation
becomes technologically obsolete over time, requiring ongoing replacement
of these systems.
Gross profit:
Gross profit decreased approximately $463,000, or 48.0%, to $501,000 for
the six months ended June 30, 2007 from $964,000 for the comparable prior
year period. As a percentage of revenue, gross profit decreased to 4.5%
from 10.3% for the respective periods. Lower margins on fixed price work
accounted for 3% of the decrease. The remainder was caused by increased
project management costs and increased variable costs associated with labor
to perform proposals.
Gross profit decreased approximately $287,000, or 53.2%, to $252,000 for
the three months ended June 30, 2007 from $539,000 for the comparable prior
year period and, as a percentage of revenue, gross profit decreased to 4.5%
from 10.1% for the respective periods.
Selling, General, and Administrative:
SG&A expense decreased approximately $350,000, or 32.1%, to $741,000 for
the six months ended June 30, 2007 from $1,091,000 for the same period in
2006 and, as a percentage of revenue, SG&A expense decreased to 6.7% from
11.7% for the respective periods. Salaries and related expenses decreased
by $535,000 for a variety of reasons. The expenses of four sales persons
were moved to Corporate SG&A from Operations; some salaries were moved to
direct costs variable; and the Company's Systems segment personnel
decreased. Amortization expense increased by $290,000 as a result of the
non-compete intangible related to the ATI acquisition. Facilities and
related expenses decreased by $27,000 as a result of consolidating the
offices of ATI and Systems.
27
Systems Segment Results
-----------------------
SG&A expense decreased approximately $172,000, or 35.5%, to $312,000 for
the three months ended June 30, 2007 from $484,000 for the same period in
2006 and, as a percentage of revenue, SG&A expense decreased to 5.5% from
9.1% for the respective periods as a result of the measures described for
the six months ended above.
Operating Income:
The systems segment recorded an operating loss of $240,000 for the six
months ended June 30, 2007 compared to an operating loss of $127,000 for
the six months ended June 30, 2006.
The systems segment recorded an operating loss of $60,000 for the three
months ended June 30, 2007 compared to operating income of $55,000 for the
three months ended June 30, 2006.
28
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our financial instruments include cash and cash equivalents, accounts
receivable, accounts payable, notes and capital leases payable, and debt
obligations. The book value of cash and cash equivalents, accounts
receivable, accounts payable and short-term notes payable are considered to
be representative of fair value because of the short maturity of these
instruments.
We do not utilize financial instruments for trading purposes and we do not
hold any derivative financial instruments that could expose us to
significant market risk. In the normal course of business, our results of
operations are exposed to risks associated with fluctuations in interest
rates and currency exchange rates.
Our exposure to market risk for changes in interest rates relates primarily
to our obligations under the Comerica Facility. As of June 30, 2007, $30.9
million had been borrowed under the Comerica Credit Facility, accruing
interest at 8.25% per year, excluding amortization of prepaid financing
costs. A 10% increase in the short-term borrowing rates on the Comerica
Credit Facility outstanding as of June 30, 2007 would be 83 basis points.
Such an increase in interest rates would increase our annual interest
expense by approximately $256,000, assuming the amount of debt outstanding
remains constant.
In general, our exposure to fluctuating exchange rates relates to the
effects of translating the financial statements of our Canadian subsidiary
from the Canadian dollar to the U.S. dollar. We follow the provisions of
SFAS No. 52 - "Foreign Currency Translation" in preparing our consolidated
financial statements. Currently, we do not engage in foreign currency
hedging activities.
ITEM 4. CONTROLS AND PROCEDURES
a. Evaluation of Disclosure Controls and Procedures
Our management is responsible for establishing and maintaining our
disclosure controls and procedures. As of June 30, 2007, we carried out an
evaluation, under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of our disclosure
controls and procedures or "disclosure controls." Disclosure controls are
controls and procedures designed to ensure that information required to be
disclosed in our reports filed under the Securities Exchange Act of 1934 is
properly recorded, processed, summarized, and reported within the time
periods specified in the U.S. Securities and Exchange Commission's rules
and forms. Disclosure controls include processes to accumulate and evaluate
relevant information and communicate such information to management,
including the CEO and CFO, as appropriate to allow timely decisions
regarding required disclosure. In designing and evaluating the disclosure
controls and procedures, management recognizes that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and
management is required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures.
Based on the controls evaluation, our CEO and CFO have concluded that, as a
result of the matters discussed below with respect to our internal control
over financial reporting, our disclosure controls as of June 30, 2007, were
not effective.
A material weakness in internal control over financial reporting is a
significant deficiency, or combination of significant deficiencies, that
results in more than a remote likelihood that a material misstatement of
the annual or interim financial statements will not be prevented or
detected. Management's assessment identified the following material
weaknesses in our internal control over financial reporting as of December
31, 2006, which remained outstanding as of June 30, 2007:
o Deficiencies in the Company's Control Environment. Our control
environment did not sufficiently promote effective internal control
over financial reporting throughout the organization. Specifically, we
had a shortage of support and resources in our accounting department,
which resulted in insufficient: (i) documentation and communication of
our accounting policies and procedures; and (ii) internal audit
processes of our accounting policies and procedures.
29
o Deficiencies in the Company's Information Technology Access Controls.
We did not maintain effective controls over preventing access by
unauthorized personnel to end-user spreadsheets and other information
technology programs and systems.
o Deficiencies in the Company's Accounting System Controls. We did not
effectively and accurately close the general ledger in a timely manner
and we did not provide complete and accurate disclosure in our notes
to financial statements, as required by generally accepted accounting
principles.
o Deficiencies in the Company's Controls Regarding Purchases and
Expenditures. We did not maintain effective controls over the tracking
of our commitments and actual expenditures with third-party
subsidiaries on a timely basis.
o Deficiencies in the Company's Controls Regarding Fixed-Price Contract
Information. We did not maintain effective controls over the complete,
accurate, and timely processing of information relating to the
estimated cost of fixed-price contracts.
o Deficiencies in the Company's Revenue Recognition Controls. We did not
maintain effective policies and procedures relating to revenue
recognition of fixed price contracts, which accounted for
approximately 11% of the Company's revenues in 2006.
o Deficiencies in the Company's Controls over Income Taxes. We did not
maintain sufficient internal controls to ensure that amounts provided
for in our financial statements for income taxes accurately reflected
our income tax position as of December 31, 2006.
o Management assessed the effectiveness of our internal control over
financial reporting as of December 31, 2006, but management did not
complete its assessment until March 2, 2007. Due to the lack of
adequate time to permit Hein to audit management's assessment, Hein
was unable to render an opinion on our assessment of the effectiveness
of our internal control over financial reporting as of December 31,
2006. Accordingly, management identified this as a material weakness.
Management's assessment process did not conclude in adequate time to
permit Hein to audit management's assessment due to a number of
factors, including: (i) our failure to prepare and plan for a timely
completion of management's assessment, including adding the resources
necessary to do so; and (ii) our failure to ensure that our accounting
department was adequately staffed and sufficiently trained to meet
deadlines.
Except as noted below under the heading "Remediation Initiatives," no
change in our internal control over financial reporting (as defined in Rule
13a-15(f) under the Securities Exchange Act of 1934) occurred during the
quarter ended June 30, 2007, that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
b. Remediation Initiatives
Management, with oversight from the Audit Committee of the Board of
Directors, has been addressing the material weaknesses disclosed in its
2006 Annual Report on Form 10-K/A and is committed to effectively
remediating known weaknesses as expeditiously as possible. These remedial
steps have not been completed; however, the Company has performed
additional analysis and procedures in order to ensure that the consolidated
financial statements contained in this Quarterly Report on Form 10-Q were
prepared in accordance with generally accepted accounting principles in the
United States of America. Although the Company's remediation efforts are
underway, control weaknesses will not be considered remediated until new
internal controls over financial reporting are implemented and operational
for a sufficient period of time to allow for effective testing and are
tested, and management and its independent registered certified public
accounting firm conclude that these controls are operating effectively.
Management, its outside consultants, and the Audit Committee of the
Company's Board of Directors have begun working with the Company's auditors
to determine the most effective way to implement the remedial measures
listed below, and, if necessary, to develop additional remedial measures to
address the internal control deficiencies identified above. The Company
will monitor the effectiveness of planned actions and will make any other
changes and take such other actions as management or the Audit Committee
determines to be appropriate. The Company's remediation plans include:
30
o We plan to hire additional personnel to assist us with documenting and
communicating our accounting policies and procedures to ensure the
proper and consistent application of those policies and procedures
throughout the Company. Recruitment for these positions has begun and
the selection process is ongoing.
o We plan to implement formal processes requiring periodic
self-assessments, independent tests, and reporting of our personnel's
adherence to our accounting policies and procedures.
o We plan to design effective policies and procedures to control
security of and access to spreadsheet information. If necessary, we
will also consider implementing a software solution with automatic
control checkpoints for day-to-day business processes.
o We plan to (i) require additional training for our current accounting
personnel; (ii) to hire additional accounting personnel to enable the
allocation of job functions among a larger group of accounting staff;
(iii) to engage outside consultants with technical accounting
expertise, as needed; and (iv) to consider restructuring our
accounting department, each to increase the likelihood that our
accounting personnel will have the resources, experience, skills, and
knowledge necessary to effectively perform the accounting system
functions assigned to them. During the second quarter, the Company
conducted training for the accounting staff, with an emphasis to
improve various accounting functions going forward.
o We plan to improve procurement and operational efficiencies by
implementing a software system and a matrix organization to more
completely, accurately, and timely track commitments on Company-wide
purchase and expenditure transactions.
o We plan to improve revenue recognition policies and procedures
relating to fixed-price contracts by evaluating the level of economic
success achieved by past fixed-price contracts and by stressing
throughout the Company the importance of (i) accurately estimating
costs, (ii) timely updating cost estimates to reflect the accuracy of
the cost savings, (iii) accurately estimating expected profit, (iv)
timely identifying when a project's scope changes, (v) promptly
reporting man hours and costs in excess of those originally estimated;
and (vi) closely scrutinizing the bid process.
o In the first six months of 2007, we have begun to train personnel to
effectively implement and evaluate the overall design of the Company's
fixed-price project control processes. Specifically, we plan to
enhance and tighten controls as they relate to the initial bid process
and the attendant recognition and management of risk by only bidding
on large procurement and construction activities on a cost plus basis.
Management recognizes that many of these enhancements require continual
monitoring and evaluation for effectiveness. The development of these
actions is an iterative process and will evolve as the Company continues to
evaluate and improve our internal controls over financial reporting. In
conjunction with the Company's SOX Section 404 Steering Committee,
management will review progress on these activities on a consistent and
ongoing basis at the Chief Executive Officer and senior management level in
conjunction with our Audit Committee. We have also begun to take additional
steps to elevate Company awareness about and communication of these
important issues through formal channels such as Company meetings,
departmental meetings, and training.
During the second quarter, the Company's external auditors began its review
of the 2007 internal controls audit. In July 2007, the Company hired a
third-party consultant to oversee the testing of its internal financial and
information technology controls. A quarterly review by consultants will
assist the Company with its remediation plan will assist its independent
auditors in their preparation for the final assessment in the third and
fourth quarters, allowing for any remediation before December 31, 2007.
31
PART II. - OTHER INFORMATION
----------------------------
ITEM 1. LEGAL PROCEEDINGS
From time to time, the Company and its subsidiaries become parties to
various legal proceedings arising in the ordinary course of normal business
activities. While we cannot predict the outcome of these proceedings, in
our opinion and based on reports of counsel, any liability arising from
such matters, individually or in the aggregate, is not expected to have a
material effect upon the consolidated financial position or operations of
the Company.
ITEM 1A. RISK FACTORS
In addition to the other information set forth in this report, you should
carefully consider the factors discussed in Part I, "Item 1A. Risk Factors"
in our 2006 Annual Report on Form 10-K. which could materially affect our
business, financial condition or future results. The risks described in our
Annual Report on Form 10-K are not the only risks facing our Company.
Additional risks and uncertainties not currently known to us or that we
currently deem to be immaterial also may materially adversely affect our
business, financial conditions or operating results.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
31.1 Certifications Pursuant to Rule 13a - 14(a) of the Exchange Act
of 2002 for the Second Quarter 2007
31.2 Certifications Pursuant to Rule 13a - 14(a) of the Exchange Act
of 2002 for the Second Quarter 2007
32 Certification Pursuant to Rule 13a - 14(b) of the Exchange Act
and 18U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 for the Second Quarter 2007
32
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
ENGlobal Corporation
Dated: August 7, 2007
By: /s/ Robert W. Raiford
-------------------------
Robert W. Raiford
Chief Financial Officer and Treasurer
33