UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
----- EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2006
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 77073-6033
----------------------------------------------------------------
(Address of principal executive offices) (Zip code)
(281) 878-1000
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shortened period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (check
one):
Large Accelerated Filer Accelerated Filer Non-Accelerated Filer X
--- --- ---
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes No X
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the close of business of May 8, 2006.
$0.001 Par Value Common Stock 26,373,435 shares
1
QUARTERLY REPORT ON FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2006
TABLE OF CONTENTS
Page
Number
------
Part I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Statements of Income for the
Three Months Ended March 31, 2006 and March 31, 2005 3
Consolidated Statements of Comprehensive Income for the
Three Months Ended March 31, 2006 and March 31, 2005 4
Condensed Consolidated Balance Sheets at March 31, 2006
and December 31, 2005 5
Condensed Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 2006 and March 31, 2005 6
Notes to Condensed Consolidated Financial Statements 7-12
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13-22
Item 3. Quantitative and Qualitative Disclosures About Market
Risk 22
Item 4. Controls and Procedures 23
Part II. Other Information
Item 1. Legal Proceedings 24
Item 1A. Risk Factors 24
Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds 24
Item 3. Defaults Upon Senior Securities 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 5. Other Information 24
Item 6. Exhibits 24
Signature 25
2
PART I. - FINANCIAL INFORMATION
-------------------------------
ITEM 1. FINANCIAL STATEMENTS
ENGlobal Corporation
Condensed Consolidated Statements Of Income
(Unaudited)
For the Three Months
Ended March 31,
----------------------------
2006 2005
------------ ------------
Operating Revenue $ 66,626,836 $ 44,629,262
------------ ------------
Operating Expenses:
Direct cost 58,405,208 38,931,064
Selling, general and administrative 6,100,351 4,068,873
------------ ------------
Total operating expense 64,505,559 42,999,937
------------ ------------
Operating income 2,121,277 1,629,325
Other Income (Expense):
Other income 21,752 28,945
Interest income (expense), net (162,146) (196,824)
------------ ------------
Total other income (expense) (140,394) (167,879)
------------ ------------
Income before Provision for Income Taxes 1,980,883 1,461,446
Provision for Income Taxes 746,740 540,735
------------ ------------
Net Income $ 1,234,143 $ 920,711
============ ============
Net Income Per Common Share:
Basic $ 0.05 $ 0.04
Diluted $ 0.05 $ 0.04
Weighted Average Shares Used in Computing Net Income Per Share:
Basic 26,332,602 23,500,064
Diluted 27,246,347 24,012,375
See accompanying notes to interim condensed consolidated financial statements.
3
ENGlobal Corporation
Consolidated Statements of Comprehensive Income
For the Three Months
Ended March 31,
---------------------------
2006 2005
----------- -----------
Net Income $ 1,234,143 $ 920,711
----------- -----------
Other Comprehensive Income (Loss):
Foreign currency translation adjustment (703) --
Income tax benefit 270 --
----------- -----------
Net other comprehensive income (433) --
----------- -----------
Net Comprehensive Income $ 1,233,710 $ 920,711
=========== ===========
See accompanying notes to interim condensed consolidated financial statements.
4
ENGlobal Corporation
Condensed Consolidated Balance Sheets
March 31, December 31,
2006 2005
------------ ------------
(unaudited)
ASSETS
------
Current Assets:
Cash $ 20,013 $ 159,414
Trade receivables, less allowance for doubtful accounts of approximately
$496,000 and $503,000, respectively 49,119,138 46,248,458
Costs and estimated earnings in excess of billings on uncompleted contracts 4,529,849 4,148,275
Prepaid expenses and other current assets 1,287,668 1,600,369
Current portion of note receivable 49,747 --
Inventories -- 153,968
Deferred tax asset 305,258 305,258
Federal income taxes receivable -- 52,818
------------ ------------
Total Current Assets 55,311,673 52,668,560
Property and Equipment, net 6,963,772 6,861,361
Goodwill 17,126,822 15,454,583
Note receivable, net of current portion 136,500 --
Non-current Deferred Tax Asset 90,792 74,892
Other Assets 844,195 876,534
------------ ------------
Total Assets $ 80,473,754 $ 75,935,930
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current Liabilities:
Accounts payable $ 11,801,435 $ 15,211,331
Accrued compensation and benefits 8,801,280 9,799,074
Deferred rent 493,186 361,292
Current portion of long-term debt 1,008,961 547,934
Billings and estimated earnings in excess of costs on uncompleted contracts 5,732,621 3,775,625
Federal income taxes payable 539,823 --
Other liabilities 872,480 1,148,079
------------ ------------
Total Current Liabilities 29,249,786 30,843,335
Long-Term Debt, net of current portion 9,909,917 5,227,976
------------ ------------
Total Liabilities 39,159,703 36,071,311
Contingencies (Note 10)
Stockholders' Equity:
Series A redeemable convertible preferred stock - $0.001 par value;
2,265,167 shares authorized March 31, 2006 and December 31, 2005,
respectively; 0 shares issued and
outstanding March 31, 2006 and December 31, 2005, respectively -- --
Common stock, $0.001 par value; 75,000,000 shares authorized; 26,352,781 and 26,289,567
outstanding and 27,005,158 and 26,941,944 issued at March 31, 2006 and December 31,
2005, respectively 27,005 26,941
Additional paid-in capital 27,442,630 27,230,332
Retained earnings 14,437,350 13,203,208
Treasury stock - 652,377 shares at cost (592,231) (592,231)
Accumulated other comprehensive income (loss) (703) (3,631)
------------ ------------
Total Stockholders' Equity 41,314,051 39,864,619
------------ ------------
Total Liabilities and Stockholders' Equity $ 80,473,754 $ 75,935,930
============ ============
See accompanying notes to interim condensed consolidated financial statements.
5
ENGlobal Corporation
Condensed Consolidated Statements Of Cash Flows
(Unaudited)
For the Three Months Ended
March 31,
--------------------------
2006 2005
----------- -----------
Cash Flows from Operating Activities:
Net income $ 1,234,143 $ 920,711
Adjustments to reconcile net income to net cash provided by
(used in) operating activities -
Depreciation and amortization 648,703 428,871
Share based compensation expense 85,305 --
(Gain) Loss on disposal of property, plant and equipment (10,000) (333)
(Gain) Loss on assets held for sale -- (134,447)
Deferred income tax expense (15,900) --
Changes in current assets and liabilities, net of acquisitions -
Trade receivables (2,870,680) 1,881,491
Inventories 153,968 (4,895)
Costs and estimated earnings in excess of billings (381,574) (488,913)
Prepaid expenses and other assets 54,136 638,928
Accounts payable (3,409,896) (1,307,247)
Accrued compensation and benefits (1,083,098) 2,039,376
Billings in excess of costs and estimated earnings 1,956,996 (85,777)
Other liabilities (143,704) (86,973)
Income taxes receivable (payable) 592,639 738,164
----------- -----------
Net cash provided by (used in) operating activities (3,188,962) 4,538,956
Cash Flows from Investing Activities:
Property and equipment acquired (696,456) (682,651)
Proceeds from sale of equipment 10,000 15,000
Proceeds from sale of other assets 50,000 823,350
Net cash paid for acquisitions (649,251) (10,000)
----------- -----------
Net cash provided by (used in) investing activities (1,285,707) 145,699
----------- -----------
Cash Flows from Financing Activities:
Net borrowings (payments) on line of credit 4,325,950 (4,229,395)
Proceeds from issuance of common stock 212,361 41,899
Short-term note repayments -- (356,894)
Capital lease repayments -- (1,611)
Long-term debt repayments (205,971) (140,000)
----------- -----------
Net cash provided by (used in) financing activities 4,332,340 (4,686,001)
----------- -----------
Effect of Exchange Rate Changes on Cash 2,928 --
----------- -----------
Net change in cash (139,401) (1,346)
Cash, at beginning of period 159,414 8,006
----------- -----------
Cash, at end of period $ 20,013 $ 6,660
=========== ===========
Supplemental Disclosures:
Interest paid $ 90,254 $ 181,052
=========== ===========
Income taxes paid $ 248,867 $ 2,144
=========== ===========
Non-Cash:
Issuance of note for ATI assets $ 1,000,000 $ --
=========== ===========
Acceptance of note for Constant Power assets $ 216,000 $ --
=========== ===========
See accompanying notes to interim condensed consolidated financial statements.
6
NOTE 1 - BASIS OF PRESENTATION
The condensed consolidated financial statements of ENGlobal Corporation
(which may be referred to as "ENGlobal", the "Company", "we", "us", or
"our") included herein, are un-audited for the three-month periods ended
March 31, 2006 and 2005. 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, 2005, included in the Company's Annual Report on
Form 10-K filed with the Securities and Exchange Commission on March 31,
2006. The Company believes that the disclosures made herein are adequate to
make the information presented not misleading.
Certain amounts in the 2005 financial statements have been reclassified to
more closely conform to the 2006 presentation.
NOTE 2 - SHARE BASED COMPENSATION
The Company currently sponsors a stock-based compensation plan as described
below. Effective January 1, 2006, the Company adopted the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 123 (Revised),
"Share-Based Payment" ( "SFAS No. 123(R)"). Under the fair value
recognition provisions of SFAS No. 123(R), stock-based compensation is
measured at the grant date based on the value of the awards and is
recognized as expense over the requisite service period (usually a vesting
period). The Company selected the modified prospective method of adoption
described in SFAS No. 123(R). The fair values of the stock awards
recognized under SFAS No. 123(R) are determined based on the vested portion
of the awards; however, the total compensation expense is recognized on a
straight-line basis over the vesting period.
In accordance with the provisions of SFAS No. 123(R), total stock-based
compensation expense in the amount of $85,305 was recorded in the three
months ended March 31, 2006. The total stock-based compensation expense was
recorded in selling, general and administrative expense. The total income
tax benefit recognized in the condensed consolidated statements of income
for the share-based arrangements for the three months ended March 31, 2006
was $15,900.
Prior to January 1, 2006, the Company accounted for stock-based
compensation using the intrinsic value method prescribed in Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. Under APB Opinion No. 25, no
compensation expense was recognized for stock options issued to employees
because the grant price equaled or was above the market price on the date
of grant for options issued by the Company.
The total fair value of shares vested during the three months ended March
31, 2006 and 2005 was $10.7 million and $3.1 million, respectively.
Stock Option and Incentive Plans
The Company maintains a stock option plan (the "Option Plan") under which
the Company may issue incentive stock options to employees and non-employee
directors. Under the Option Plan, a maximum of 2,650,000 shares of our
common stock was approved to be issued or transferred to certain
non-employee directors, officers and employees pursuant to stock based
awards granted. As of March 31, 2006, 514,833 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.
7
Stock options have been granted with exercise prices at or above the market
price on the date of grant. The granted options have vested generally over
one year for non-employee directors and ratably over four years for
officers and employees. The granted options generally have ten year
contractual terms.
Compensation expense of $477,000 related to previously granted stock option
awards which are non-vested had not yet been recognized at March 31, 2006.
This compensation expense is expected to be recognized over a
weighted-average period of approximately 20 months.
The following summarizes stock option activity for the first quarter of
2006.
Weighted
Weighted Average
Average Remaining Aggregate
Number of Exercise Contractual Intrinsic
Options Price Term (Years) Value (000's)
---------- -------- ----------- -------------
Balance at December 31, 2005 1,438,234 3.07
Granted -- --
Exercised (49,594) 1.29
Canceled or expired (5,573) 3.04
----------
Balance at March 31, 2006 1,383,067 $ 3.14 6.4 $ 6,392
========== ======== ======= ==========
Exercisable at March 31, 2006 963,400 $ 3.28 5.6 $ 3,026
========== ======== ======= ==========
The total intrinsic value of options exercised was $488,000 and $8,600 for
the three months ended March 31, 2006 and 2005, respectively.
Pro Forma Effects
If compensation expense for the stock options that we granted had been
recognized based upon the estimated fair value on the grant date under the
fair value methodology prescribed by SFAS No. 123, as amended by SFAS No.
148 and SFAS No. 123(R), our net income and net income per share for the
quarter ended March 31, 2005 would have been as follows:
Three Months Ended
March 31,
2005
------------
(in thousands)
Net income available for common stock - as reported $ 921
Compensation expenses if the fair value method had been applied (17)
----------
Net income available for common stock - pro forma $ 904
==========
Net income per share - as reported
Basic $ 0.04
Diluted $ 0.04
Net income available per share - pro forma
Basic $ 0.04
Diluted $ 0.04
8
The fair value of each stock option granted under the Company's stock
option plans was estimated on the date of grant using the Black-Scholes
option-pricing model. The following key assumptions were used to value the
option grants issued at March 31, 2005.
Weighted Average Average Expected Expected
Risk Free Rate Expected Life Volatility Dividend Yield
---------------- ------------- -------------- --------------
2005 3.4 - 4.5% 4 Years 74.5 - 79.1% 0.00%
2006 No options were granted during the three month period ended
March 31, 2006.
The Company recognized the pro forma fair value compensation cost on a
straight-line basis over the requisite service period for each separately
vesting portion of the awards.
NOTE 3 - FIXED FEE CONTRACTS
Costs, estimated earnings and billings on uncompleted contracts consisted
of the following at March 31, 2006 and December 31, 2005:
March 31, December 31,
2006 2005
--------------------
(in thousands)
--------------------
Costs incurred on uncompleted contracts $ 26,281 $ 23,426
Estimated earnings on uncompleted contracts 4,150 4,437
-------- --------
Earned revenues 30,431 27,863
Less billings to date (31,634) (27,490)
-------- --------
Net costs and estimated earnings in excess of billings
on uncompleted contracts $ (1,203) $ 373
======== ========
Costs and estimated earnings in excess of billings on uncompleted contracts $ 4,530 $ 4,148
Less billings and estimated earnings in excess of cost on uncompleted contracts (5,733) (3,775)
-------- --------
Net costs and estimated earnings in excess of billings
on uncompleted contracts $ (1,203) $ 373
======== ========
NOTE 4 - COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) represents net earnings and any revenue,
expenses, gains and losses that, under accounting principles generally
accepted in the United States of America, are excluded from net earnings
and recognized directly as a component of stockholders' equity. At March
31, 2006, comprehensive income included a loss of $703 from foreign
currency translation adjustments.
NOTE 5 - 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. 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.
NOTE 6 - 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 27, 2007. The loan agreement positions
Comerica as senior to all other debt. The line of credit is limited to
$22.0 million, subject to loan covenant restrictions. The Comerica Credit
Facility is collateralized by substantially all the assets of the Company.
The outstanding balance on the line of credit as of March 31, 2006 was $8.1
million. The remaining borrowings available under the line of credit as of
March 31, 2006 were $10.8 million after consideration of loan covenant
restrictions.
9
The Comerica Credit Facility contains covenants requiring the Company, as
of the end of each calendar month, to maintain certain ratios, including
total funded debt to EBITDA; total funded debt to total liabilities, plus
net worth; and total funded debt to accounts/unbilled receivables. The
Company is also required, as of the end of each quarter, to maintain
minimum levels of net worth, plus the Company must comply with an annual
limitation on capital expenditures. The Company was in compliance with all
covenants under the Comerica Credit Facility as of March 31, 2006.
As of March 31, 2006, the Company had $3.1 million outstanding in standby
letters of credit issued to a refining client to cover contractual
obligations funded by the client for progress payments made to equipment
manufacturers for major project items. As of May 3, 2006, the balance of
our outstanding standby letters of credit had been reduced to $1.9 million.
We expect our current obligations under standby letters of credit to
decrease each month until obligations are fully released in June 2006.
March 31, December 31,
2006 2005
--------------------
(in thousands)
--------------------
Schedule of Long-Term Debt:
Comerica Credit Facility - Line of credit, prime (7.75% at March 31, 2006),
maturing in July 2007 $ 8,100 $ 3,774
Sterling Planet and EDGI - Notes payable, interest at 5%, principal payments in
installments of $15,000 plus interest due quarterly, maturing in December 2008 165 195
Significant PEI Shareholders - Note payable, discounted at 4.5% interest, principal
payments in installments of $208,761 due annually, maturing in December 2006 193 188
Cleveland Inspection Services, Inc., CIS Technical Services and F.D. Curtis - Notes
payable, discounted at 5% interest, principal in installments of $100,000 due
quarterly, maturing in October 2009 1,362 1,444
InfoTech Engineering, Inc. - Note payable, interest at 5%, principal payments in
installments of $65,000 plus interest due annually, maturing in December 2007 130 130
A.T.I. Inc. - Note payable, interest at 6%, principal payments in installments of
$30,422 including interest due monthly, maturing in January 2009 949
Miscellaneous 20 45
-------- --------
Total long-term debt 10,919 5,776
Less: Current maturities (1,009) (548)
-------- --------
Long-term debt, net of current portion $ 9,910 $ 5,228
======== ========
NOTE 7 - 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, safety,
investor relations/governance, human resources, project controls and
information technology that are not specifically identifiable with the two
10
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.
Three Months Ended
March 31,
--------------------
2006 2005
-------- --------
(in thousands)
Revenue:
Engineering $ 62,587 $ 41,510
Systems 4,040 3,119
-------- --------
Total revenue $ 66,627 $ 44,629
======== ========
Operating income (loss):
Engineering $ 4,890 $ 3,767
Systems (182) (188)
Corporate 129 670
Inter-company eliminations (2,716) (2,620)
-------- --------
Total operating income $ 2,121 $ 1,629
======== ========
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 $100,600 as of March 31, 2006.
NOTE 8 - FEDERAL INCOME TAXES
The components of income tax expense (benefit) for the periods ended March
31, 2006 and 2005 were as follows:
Three Months Ended
March 31,
------------------
2006 2005
----- -----
(in thousands)
Current $ 763 $ 921
Deferred (16) --
----- -----
Total tax provision $ 747 $ 921
===== =====
11
NOTE 9 - EARNINGS PER SHARE
The following table reconciles the denominator used to compute basic
earnings per share to the denominator used to compute diluted earnings per
share ("EPS").
Three Months Ended
March 31,
---------------
2006 2005
------ ------
(in thousands)
Weighted average shares outstanding
(denominator used to compute basic EPS) 26,333 23,500
Effect of employee and outside director stock options 913 512
------ ------
Denominator used to compute diluted EPS 27,246 24,012
====== ======
NOTE 10 - CONTINGENCIES
From time to time, the Company and its subsidiaries become parties to
various legal proceedings arising in the ordinary course of normal business
activities. While we cannot predict the outcome of these proceedings, in
our opinion, and based on reports of counsel, any liability arising from
such matters, individually or in the aggregate, are not expected to have a
material effect upon the consolidated financial position or operations of
the Company.
On April 21, 2006 the Company, through one of its subsidiaries, received
notification that ABB Lummus Global, Inc. ("ABB"), a customer of the
Company, filed a voluntary petition for relief under chapter 11 of title 11
of the United States Code with the Clerk of the United States Bankruptcy
Court for the District of Delaware. ABB is continuing to operate its
business and manage its affairs as a debtor and debtor in possession
pursuant to sections 1107(a) and 1108 of the Bankruptcy Code.
The Company began performing work on contracts for ABB in December 2005 and
to date has billed ABB approximately $4.6 million for labor, materials and
equipment through mid April 2006. As of April 28, 2006, the Company had
approximately $1.4 million in outstanding billings to or current
receivables from ABB. The Company continues to receive payments within
terms agreed upon. The Company will continue to monitor the bankruptcy case
to determine the status of past and future payments from ABB.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Forward-Looking Statements
--------------------------
Certain information contained in this Form 10-Q, the Company's Annual
Report on Form 10-K, as well as other written and oral statements made
or incorporated by reference from time to time by the Company and its
representatives in other reports, filings with the Securities and
Exchange Commission, press releases, conferences, or otherwise, may be
deemed to be forward-looking statements with the meaning of Section
21E of the Securities Exchange Act of 1934. This information includes,
without limitation, statements concerning the Company's future
financial position and results of operations; planned capital
expenditures; business strategy and other plans for future operations;
the future mix of revenues and business; customer retention; project
reversals; commitments and contingent liabilities; and future demand
and industry conditions. Although the Company believes that the
expectations reflected in such forward-looking statements are
reasonable, it can give no assurance that such expectations will prove
to have been correct. We undertake no obligation to publicly update or
revise any forward-looking statements, whether as a result of new
information, future events or otherwise. Generally, the words
"anticipate," "believe," "estimate," "expect," "may," and similar
expressions, identify forward-looking statements, which generally are
not historical in nature. Actual results could differ materially from
the results described in the forward-looking statements due to the
risks and uncertainties set forth in this Form 10-Q, the specific risk
factors identified in the Company's Annual Report on Form 10-K for the
year ended December 31, 2005 and those described from time to time in
our future reports filed with the Securities and Exchange Commission.
The following discussion is qualified in its entirety by, and should
be read in conjunction with, the Company's Consolidated Financial
Statements, including the notes thereto, included in this Form 10-Q
and the Company's Annual Report on Form 10-K for the year ended
December 31, 2005.
MD&A Overview
-------------
The following list sets forth a general overview of the more
significant changes in the Company's financial condition and results
of operations for the three month period ended March 31, 2006,
compared to the corresponding period in 2005.
During the three month period
ended March 31, 2006
-----------------------------
Revenue Increased 49%
Gross profit Increased 44%
Operating income Increased 30%
SG&A expense Increased 50%
Net income Increased 34%
Long-term debt, net of current portion, increased 90%, or $4.7
million, from $5.2 million at December 31, 2005 to $9.9 million at
March 31, 2006, and as a percentage of stockholders' equity, long-term
debt increased from 13.1% to 24.0% 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 client. On
average, our accounts receivable days outstanding has increased to 64
days for the three month period ended March 31, 2006, from 58 days for
the comparable period in 2005. The Company continues to work toward
improving billing and collection processes.
Total stockholders' equity increased 4%, or $1.4 million, from $39.9
million as of December 31, 2005 to $41.3 million as of March 31, 2006.
13
Critical Accounting Policies
----------------------------
A summary of critical accounting policies is disclosed in Note 2 to
the Consolidated Financial Statements included in our 2005 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 2005 Annual Report on Form 10-K. Other
than the adoption of SFAS No. 123(R), there have been no changes in
the nature of our critical accounting policies or the application of
those policies which is described in Note 2 to the Interim Condensed
Consolidated Financial Statements included in this Form 10-Q, since
December 31, 2005.
Results of Operations
---------------------
Consolidated Results of Operations for the Three Months
Ended March 31, 2006 and 2005
(unaudited)
Three Months Ended
March 31,
-----------------------------------------
2006 2005
-----------------------------------------
(In thousands)
-----------------------------------------
Revenue:
Engineering $ 62,587 93.9% $ 38,579 86.4%
Systems 4,040 6.1% 3,119 7.0%
Acquisition -- -- % 2,931 6.6%
----------- -----------
Total revenue $ 66,627 100.0% $ 44,629 100.0%
=========== ===========
Gross profit:
Engineering $ 7,796 12.5% $ 5,061 13.1%
Systems 426 10.6% 249 8.0%
Acquisition -- -- % 388 13.2%
----------- -----------
Total gross profit 8,222 12.3% 5,698 12.8%
----------- -----------
SG&A expense:
Engineering 2,906 4.6% 1,395 3.6%
Systems 608 15.1% 437 14.1%
Corporate 2,587 3.9% 1,948 4.4%
Acquisition -- -- % 288 9.8%
----------- -----------
Total SG&A expense 6,101 9.2% 4,068 9.1%
----------- -----------
Operating income:
Engineering 4,890 7.8% 3,667 9.5%
Systems (182) 4.5% (188) (6.1)%
Corporate (2,586) 3.9% (1,950) (4.4)%
Acquisition -- -- % 100 3.4%
----------- -----------
Total operating income 2,121 3.2% 1,629 3.7%
----------- -----------
Other income (expense), net (140) (0.2)% (167) (0.4)%
Tax provision (747) (1.1)% (541) (1.2)%
Net income $ 1,234 1.9% $ 921 2.1%
=========== ===========
14
Other financial comparisons:
----------------------------
March 31, March 31,
2006 2005
------------------
(In thousands)
------------------
Working capital $26,062 $10,915
Total assets $80,474 $54,697
Long-term debt, net of current portion $ 9,910 $11,241
Stockholders' equity $41,314 $21,014
Certain assets of Analyzer Technology International, Inc. ("ATI") were
acquired in our systems segment during the three months ended March
31, 2006 and integrated immediately into existing operations. As such,
the results of ATI will not be presented in "Acquisition" totals. All
previous acquisitions have been fully integrated and reported in
segment details. In the results presented for the first quarter of
2005, "Acquisition" totals include the combined results of operations
related to assets acquired from Cleveland Inspection Services, Inc.
("Cleveland") and AmTech Inspection, LLC ("AmTech"). For analytical
purposes only, results from acquired companies or acquired assets are
shown separately for the first 12 months after closing.
Results presented for the first quarter of 2005 have been reclassified
to more closely conform to the 2006 presentation.
We recorded net income of $1.2 million, or $0.05 per diluted share for
the three months ended March 31, 2006, compared to net income of
$921,000, or $0.04 per diluted share for the corresponding period last
year. We adopted SFAS 123(R) on January 1, 2006, and our results of
operations for the three months ended March 31, 2006 include $85,305
of expense related to stock options. These amounts have been included
in selling, general and administrative ("SG&A") expenses in the
accompanying Condensed Consolidated Statements of Income.
The following table compares the effects of SFAS 123(R) on net income
and earnings per share for the three months ended March 31, 2006.
Net income
As reported $1,234,143
Effect of SFAS 123(R) 85,305
----------
Net income before the effects of SFAS 123(R) $1,319,448
==========
Diluted earnings per share
As reported $ 0.05
Effect of SFAS 123(R) 0.00
----------
Net earnings per share before the effects of SFAS 123(R) $ 0.05
==========
The following table presents, for the periods indicated, the
approximate percentage of total revenues and operating income or loss
attributable to our reportable segments:
Three Months Ended
March 31,
2006 2005
------ ------
Revenue:
Engineering 93.9 % 93.0 %
Systems 6.1 % 7.0 %
Operating income (loss):
Engineering 7.8 % 9.1 %
Systems (4.5)% (6.0)%
15
The Company's revenue is composed of engineering, construction and
procurement service revenue and product sales. The Company recognizes
service revenue as soon as the services are performed. The majority of
the Company's engineering services have historically been provided
through cost-plus contracts whereas a majority of the Company's
product sales are earned on fixed-price contracts. However, our
engineering segment recognized approximately $5.2 million in
fixed-price EPC revenue in the three month period ended March 31,
2006, compared to less than $150,000 of similar revenue in the same
period in 2005.
Revenue is recorded primarily using the percentage-of-completion
(cost-to-cost) method. Under this method, revenue on long-term
contracts is recognized in the ratio that contract costs incurred bear
to total estimated contract costs. Revenue and gross margin on
contracts are subject to revision throughout the lives of the
contracts and any required adjustments are made in the period in which
the revisions become known. Losses on contracts are recorded in full
as they are identified.
In the course of providing our services, we routinely provide
engineering, materials, and equipment and may provide construction
services on a subcontractor basis. Generally, these materials,
equipment and subcontractor costs are passed through to our clients
and reimbursed, along with fees, which in total are at margins lower
than those of our normal core business. In accordance with industry
practice and generally accepted accounting principles, all costs and
fees are included in revenue. The use of subcontractor services can
change significantly from project to project; therefore, changes in
revenue may not be indicative of business trends.
For analytical purposes only, we segregate from our total revenue the
revenues derived from material assets or companies acquired during the
first 12 months following their respective dates of acquisition and
refer to such revenue as "Acquisition" revenue. We also segregate
gross profits and SG&A expenses derived from material assets or
company acquisitions on the same basis as we segregate revenues. We
analyze, for internal purposes only, the percentage of our revenue
that comes from staffing services versus the percentage that comes
from engineering services, as engineering services have a higher
margin than field or staffing services.
Operating SG&A expense includes management and staff compensation,
office costs such as rents and utilities, depreciation, amortization,
travel and other expenses generally unrelated to specific client
contracts, but directly related to the support of a segment's
operation.
Corporate SG&A expense is comprised primarily of marketing costs, as
well as costs related to the executive, governance/investor relations,
finance, accounting, safety, human resources, project controls and
information technology departments and other costs generally unrelated
to specific client projects, but which 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 and we will continue to
research other markets that value our services. Overall, projects
related to refining capacity and environmental mandates have trended
upward. As stated in our 2003 annual letter to stockholders, the
global demand for oil products has tightened the supply of both crude
oil as well as refinery products. With this current demand, we believe
each of ENGlobal's business segments are well positioned within the
industry should refinery capacity be added in the United States of
America and the overseas markets continue to rise.
The petrochemical industry has recently been a good source of projects
for ENGlobal. We have seen an increase in both maintenance and capital
spending after several years of relative inactivity. The petrochemical
industry along the Gulf Coast continues to struggle with the aftermath
of the hurricanes. Although it will take several years to rebuild, we
expect that we will assist our clients with repairs to regional
petrochemical facilities in order to resolve current supply
limitations.
Despite past downturns in the industry, pipeline projects have
remained constant for the most part, and we have recently seen an
increase in project activity. Pipeline projects tend to require less
engineering man hours as the scope of engineering work is typically
smaller than for similar sized downstream projects. In addition, the
project awards in the pipeline segment are smaller in nature than
those in other industries.
16
Revenue:
Revenue increased $22.0 million, or 49.3%, to $66.6 million for the
three months ended March 31, 2006 from $44.6 million for the
comparable prior year period with approximately $21.1 million of the
increase coming from our engineering segment and $900,000 attributable
to our systems segment.
Gross Profit:
Gross profit increased $2.5 million, or 43.9%, to $8.2 million for the
three months ended March 31, 2006 from $5.7 million for the comparable
prior year period. As a percentage of revenue, gross profit decreased
0.5% from 12.8% for the three months ended March 31, 2005 to 12.3% for
the quarter ended March 31, 2006. Of the overall $2.5 million increase
in gross profit, approximately $2.8 million was primarily due to the
$22.0 million increase in revenue offset by approximately $300,000 in
equivalent additional costs.
Selling, General, and Administrative:
As a percentage of revenue, SG&A expense increased only 0.1% to 9.2%
for the three months ended March 31, 2006 from 9.1% for the comparable
period in 2005 even though total expense for SG&A increased $2.0
million, or 48.8%, to $6.1 million for the three months ended March
31, 2006 from $4.1 million for the comparable prior year period.
As a percentage of revenue, Corporate SG&A expense decreased 0.5% to
3.9% for the three months ended March 31, 2006 from 4.4% for the
comparable prior year period. Corporate SG&A expense increased
approximately $700,000, or 36.8%, to $2.6 million for the three months
ended March 31, 2006 from $1.9 million for the comparable prior year
period primarily from business development ($300,000); support
services including accounting, investor relations, human resources,
information technology and safety ($300,000) and project controls
($100,000).
Operating Income:
Operating income increased approximately $500,000, or 31.3%, to $2.1
million for the three months ended March 31, 2006 from $1.6 million
compared to the same period in 2005. As a percentage of revenue,
operating income decreased 0.5% to 3.2% for the three months ended
March 31, 2006 from 3.7% for the comparable prior year period. Our
systems segment reported a loss of approximately $182,000 for the
three month period ended March 31, 2006 compared to a loss of
approximately $188,000 for the comparable period in 2005.
Other Expense, net:
Other expense decreased $27,000, to $140,000 for the three month
period ended March 31, 2006 from $167,000 for the comparable prior
year period, primarily due to lower net interest expense ($35,000).
Tax Provision:
Income tax expense increased $206,000, or 38.1%, to $747,000 for the
three months ended March 31, 2006 from $541,000 for the comparable
prior year period. The estimated effective tax rate was 38.5% for the
three-month period ended March 31, 2006 compared to 37.0% for the
comparable prior year period. The change in the effective tax rate is
the result of utilization of net operating loss for the 2005 year.
The estimated effective tax rates are based on estimates using
historical rates adjusted by recurring and non-recurring book to tax
differences. Estimates at March 31, 2005 included the effect of
non-recurring differences in tax estimates from the 2004 year-end.
Estimates at March 31, 2006 are based on results of the 2005 year-end
and adjusted for estimates of non-recurring differences from the prior
year, as well as, anticipated book to tax differences for 2006.
Net Income:
Net income for the three months ended March 31, 2006 increased
$300,000, or 33.3%, to $1.2 million from $900,000 for the comparable
prior year period. As a percentage of revenue, net income decreased to
1.9% for the three month period ended March 31, 2006 from 2.1% for the
period ended March 31, 2005.
17
Segment Results
---------------
Engineering
-----------
Three Months Ended
March 31,
--------------------------------------
2006 2005
--------------------------------------
(In thousands)
--------------------------------------
Revenue:
Engineering $ 62,587 100.0% $ 38,579 92.9%
Acquisition -- -- 2,931 7.1%
--------- --------
Total revenue $ 62,587 100.0% $ 41,510 100.0%
========= ========
Gross profit:
Engineering $ 7,796 12.5% $ 5,061 13.1%
Acquisition -- -- 388 13.2%
--------- --------
Total gross profit 7,796 12.5% 5,449 13.1%
--------- --------
Operating SG&A expense:
Engineering 2,906 4.6% 1,395 3.6%
Acquisition -- -- 288 9.8%
--------- --------
Total SG&A expense 2,906 4.6% 1,683 4.1%
--------- --------
Operating income:
Engineering 4,890 7.8% 3,667 9.5%
Acquisition -- -- 100 3.4%
--------- --------
Total operating income $ 4,890 7.8% $ 3,767 9.1%
--------- --------
Overview:
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.
Beginning January 1, 2006, the Company re-assigned all advanced
automation and integrated controls projects previously reported under
the systems segment to the newly created ENGlobal Automation Group
within the engineering segment. Results presented for the first
quarter of 2005 have been reclassified to reflect the re-assignment.
There were no acquisition totals for the engineering segment for the
three months ended March 31, 2006, as all previous acquisitions have
been fully integrated. Acquisition totals for the three months ended
March 31, 2005 are from results of operations related to assets
acquired from Cleveland and AmTech. In the results for the three-month
period ended March 31, 2004, acquisition totals are from results of
operations related to assets acquired from Petro-Chem.
18
Revenue:
Revenue increased $21.1 million, or 50.9%, to $62.6 million for the
three months ended March 31, 2006 from $41.5 million for the
comparable prior year period. The following table illustrates the
composition of the Company's revenue mix quarter over quarter for the
three month periods ended March 31, 2006 and 2005, and provides a
comparison of the changes in revenue (in thousands) and revenue trends
period over period:
2006 % rev 2005 % rev $ change % change
---- ----- ---- ----- -------- --------
Detail-design 34.3 55% 21.1 51% 13.2 63%
Field services & inspection 16.5 26% 12.5 30% 4.0 32%
Procurement & construction 6.6 11% 7.8 19% (1.2) -15%
Design-build fixed price 5.2 8% 0.1 0% 5.1 5100%
----- ----- -------
62.6 100% 41.5 100% 21.1
The largest increase in revenue came from our core detail-design and
field service activity that increased $17.2 million, or 51% to $50.8
million for the first quarter of 2006 from $33.6 million for the
comparable period in 2005 and on a combined basis accounted for
approximately 81% of engineering's total revenue mix in each of the
comparable three month periods. The design-build revenue increased
$5.1 million, or 5100%, from almost no activity for the three month
period ended March 31, 2005 to $5.2 million for the same period in
2006 and accounted for approximately 8% of engineering's total
revenue. Revenue from non-labor procurement and construction activity
decreased $1.2 million from $7.8 million during the three months ended
March 31, 2005 to $6.6 million for the first quarter of 2006.
Individually, detail-design revenue was the major contributor in our
overall $21.1 million revenue increase adding $13.2 million and
increasing its share of our overall revenue from 51% for the three
months ended March 31, 2005 to 55% for the first quarter of 2006. Our
field services revenue also increased by $4.0 million for the first
quarter of 2006 compared to the comparable prior year period, but as a
percentage of our overall revenue mix, decreased from 30% in 2005 to
26% in 2006. Although management anticipates positive trends for all
labor-based revenue, they expect the growth trend in both
detail-design and design-build projects to continue to bring
opportunities from both current and new clients.
Gross Profit:
Gross profit increased $2.3 million, or 42.6%, to $7.8 million for the
three months ended March 31, 2006 from $5.4 million for the comparable
period in 2005, and, as a percentage of revenue, decreased slightly by
.6% from 13.1% to 12.5% for the three-month periods ended March 31,
2005 and 2006, respectively. Of the overall $2.3 million increase in
gross profit, approximately $2.7 million was attributable to the $21.1
million increase in total revenue, offset by approximately $400,000 in
reduced margins. Reversals related to cost overruns and rework on four
fixed price detail-design and design-build projects reduced margins by
approximately $289,000 during the current period. Also, approximately
$9.1 million, or 43%, of the increase in our revenue came through
lower margin field service work and design-build, fixed price projects
with lower margin percentages. Fixed price design-build projects
negatively impact gross profit ratios as a percentage of revenue when
compared to prior reporting periods because higher cost-plus margins
on engineering labor that historically have been recognized
immediately are now being combined with lower, pass-thru margins on
procurement and construction, and subcontractor charges and are
recognized throughout the duration of the EPC project.
Selling, General, and Administrative:
As a percentage of revenue, SG&A expense increased to 4.6% for the
three-month period ended March 31, 2006 from 4.1% for the three-month
period ended March 31, 2005. SG&A expense increased $1.2 million, or
70.6%, to $2.9 million for the three months ended March 31, 2006 from
$1.7 million for the comparable prior year period. The increase in
SG&A expense included $536,000 attributable to the support of expanded
facilities and supplies. Offices in Tulsa, Houston, Dallas and
Beaumont were expanded to meet both current and projected growth
requirements. Additional increases came from salaries, burdens and
benefits of $525,000, travel expense of $64,000, and $75,000 in other
charges.
Operating Income:
Operating income increased $1.1 million, or 28.9%, to $4.9 million for
the three months ended March 31, 2006 from $3.8 million for the
comparable prior year period. As a percentage of revenue, operating
income deceased to 7.8% for the three months ended March 31, 2006 from
9.1% for the comparable prior year period.
19
Systems
-------
Three Months Ended
March 31,
-----------------------------------------
2006 2005
------------------- -------------------
(In thousands)
-----------------------------------------
Revenue: $ 4,040 100.0% $ 3,119 100.0%
=========== ===========
Gross profit: $ 426 10.6% $ 249 8.0%
----------- -----------
Operating SG&A expense: 608 15.1% 437 14.1%
----------- -----------
Operating income: (182) (4.5)% (188) (6.0)%
=========== ===========
Overview:
In the fourth quarter of 2005, the Company began an internal
initiative to provide heat tracing products and design and
construction management services to new and existing clients.
Beginning January 1, 2006, the Company re-assigned all advanced
automation and integrated controls projects previously reported in the
systems segment to the ENGlobal Automation Group within the
engineering segment. Results presented for the first quarter of 2005
have been reclassified to reflect the re-assignment.
Also in January, the Company sold certain assets related to the
operation of Constant Power Manufacturing Company ("CPM"), a division
that provided uninterruptible power supplies, metering services and
battery maintenance. The assets that were sold primarily included
inventory items, supplies and work-in-process. CPM was dissolved
during the fourth quarter of 2005.
During February, the Company acquired certain assets of ATI, a
Houston-based analyzer systems provider specializing in the design and
fabrication of online process analyzer systems. ATI expects to realize
efficiencies in its operation following its move to ESI's Houston
facility. Approximately $8.8 million in project awards, directly
related to the acquisition of ATI, have been received with $3.5
million and $5.3 million of this amount scheduled for completion
during the first and second quarters of 2007, respectively.
The systems segment recorded an operating loss during the three months
ended March 31, 2006. The operating loss was due primarily to the
following activities and results:
o $86,000 in expenses related to the ATI acquisition;
o $52,000 in additional costs related to the sale of the
Constant Power assets; and
o $65,000 in a net investment in the internal heat tracing
initiative.
Approximately $86,000 in expense directly related to the acquisition
of ATI was incurred during the three months ended March 31, 2006. The
expense included rents, utilities, legal, travel, labor and benefit
costs associated with the integration and consolidation of ATI into
our Houston facility. Approximately $66,000 of the expense recorded
during the period will not recur in the future.
Approximately $52,000 in additional cost was recorded during the
period related to the work-in-progress portion of the sale of those
certain assets of CPM. The Company does not expect to incur any future
charges related to this transaction.
Our investment in the internal heat tracing initiative resulted in a
loss of approximately $65,000 during the period, primarily for
administrative and sales expenses associated with marketing activity.
20
Revenue:
Revenue increased approximately $900,000, or 29.1%, to $4.0 million
for the three month period ended March 31, 2006 from $3.1 million for
the comparable prior year period. The general turnaround in the oil
and gas industry continues to increase the demand for remote
instrument enclosures and process analyzer systems. The Company
expects that the acquisition of ATI will generate additional revenue,
which expectation is supported by the $8.8 million in project awards
received since the acquisition was completed in February.
Gross profit:
Gross profit increased approximately $177,000, or 71.1%, to $426,000
for the three months ended March 31, 2006 from $249,000 for the
comparable prior year period and, as a percentage of revenue, gross
profit increased to 10.6% from 8.0% for the respective periods.
Corrective actions taken during the first quarter of the year to
replace all contract shop labor with more stable, direct-hire
employees and the additional staffing within estimating are helping to
improve margins and reduce the amount of overruns on projects.
Non-recurring costs related to the CPM work-in-progress negatively
impacted gross profit approximately $52,000 during the period.
Selling, General, and Administrative:
SG&A expense increased approximately $171,000, or 39.2%, to $608,000
for the three months ended March 31, 2006 from $437,000 for the same
period in 2005 and, as a percentage of revenue, SG&A expense increased
to 15.1% from 14.1% for the respective periods. SG&A expense for the
period included approximately $85,000 in expense directly related to
the ATI acquisition, of which approximately $65,000 is not expected to
recur in the future, and $73,000 of which were attributable to our
investment in heat tracing.
Operating Income:
The systems segment recorded an operating loss of $182,000 for the
three months ended March 31, 2006 compared to an operating loss of
$188,000 recorded for the three months period ended March 31, 2005.
Liquidity and Capital Resources
-------------------------------
Historically, cash requirements have been satisfied through operations
and borrowings under a revolving line of credit, which is currently in
effect with Comerica Bank (the "Comerica Credit Facility"). As of
March 31, 2006, we had working capital of $26.1 million. Long-term
debt, net of current portion, was $9.9 million as of March 31, 2006,
including $8.1 million outstanding under the Comerica Credit Facility.
The Comerica Credit Facility is senior to all other debt, and the line
of credit is limited to $22.0 million, subject to borrowing base
restrictions. The Comerica Credit Facility is collateralized by
substantially all of the assets of the Company. The Comerica Credit
Facility contains covenants requiring the Company, as of the end of
each calendar month, to maintain certain ratios, including total
funded debt to EBITDA; total funded debt to total liabilities, plus
net worth; and total funded debt to accounts/unbilled receivables. The
Company is also required, as of the end of the most recent quarter
then ended, to maintain minimum levels of net worth, and must comply
with an annual limitation on capital expenditures. The Company is
currently in compliance with all loan covenants, although no
assurances can be given regarding such compliance in the future.
Except for $3.1 million in standby letters of credit issued to a
refining client covering contractual obligations funded by the client
for progress payments made to equipment manufacturers for major
project items, we are not currently subject to any other guarantees,
repurchase obligations or other commitments. As of May 3, 2006, the
balance of our outstanding standby letters of credit had been reduced
to $1.9 million. We expect our current obligations under standby
letters of credit to be released during June 2006. We have no
off-balance sheet arrangements.
As of March 31, 2006, management believes the Company's cash position
is sufficient to meet its working capital requirements. Any future
decrease in demand for the Company's services or products would reduce
the availability of funds through operations.
Cash Flow
---------
The Company believes that it has available the necessary cash required
for operations for the next 12 months. Cash and the availability of
cash could be materially restricted if circumstances prevent the
timely internal processing of invoices, if amounts billed are not
collected, if project mix shifts from cost reimbursable to fixed costs
contracts during significant periods of growth, if the Company was to
lose one or more of its major customers, or if the Company is not able
to meet the covenants of the Comerica Credit Facility. If any such
event occurs, the Company would be forced to consider alternative
financing options.
21
Cash flow continues to be negatively impacted by timing differences
related to the growth in payroll and slower collections of our
accounts receivable from clients as evidenced by the fact that our
average accounts receivable days outstanding has increased to 64 days
for the three month period ended March 31, 2006 from 58 days for the
comparable period in 2005. Payments made during the quarter related to
incentive plans for 2005 and investments in both capital equipment and
asset acquisitions also contributed to the additional requirements for
cash.
Operating activities:
Net cash used in operating activities was $3.2 million for the
three-month period ended March 31, 2006, compared with net cash
provided of $4.5 million in the same period in 2005. Changes in
working capital due to the timing of collections of trade receivables
and payments for trade payables and accruals, contributed to the
negative cash flows from operations in the first quarter of 2006.
During the quarter, the line of credit increased from $3.8 million as
of December 31, 2005 to $8.1 million as of March 31, 2006.
Investing activities:
Net cash used in investing activities was $1.3 million for the
three-month period ended March 31, 2006, compared with net cash
provided of $146,000 in the same period in 2005. In the first quarter
of 2006, the Company acquired the assets of ATI, Inc. for $750,000
cash and a note payable. The Company also used cash for capital
expenditures in the first three months of 2006 and 2005.
Financing activities:
Net cash provided by financing activities was $4.3 million for the
three-month period ended March 31, 2006, compared with net cash used
of $4.7 million in the same period in 2005. In the first quarter of
2006, the Company increased the outstanding line of credit by $4.3
million for working capital needs, as well as financing the ATI
acquisition, compared to a decrease in the outstanding line of credit
of $4.2 million in the same period in 2005.
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 $49.1 million and $46.2 million at March 31,
2006 and December 31, 2005, respectively. The number of days sales
outstanding in trade accounts receivables was 64 days and 59 days at
March 31, 2006 and December 31, 2005, respectively.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our financial instruments include cash and cash equivalents, accounts
receivable, accounts payable, notes and capital leases payable, and debt
obligations. The book value of cash and cash equivalents, accounts
receivable, accounts payable and short-term notes payable are considered to
be representative of fair value because of the short maturity of these
instruments.
We do not utilize financial instruments for trading purposes and we do not
hold any derivative financial instruments that could expose us to
significant market risk. In the normal course of business, our results of
operations are exposed to risks associated with fluctuations in interest
rates and currency exchange rates.
Our exposure to market risk for changes in interest rates relates primarily
to our obligations under the Comerica Credit Facility. As of March 31,
2006, $8.1 million had been borrowed under the Credit Facility, accruing
interest at 7.75% per year, excluding amortization of prepaid financing
costs. A 10% increase in the short-term borrowing rates on the Credit
Facility outstanding as of March 31, 2006 would be 77.5 basis points. Such
an increase in interest rates would increase our annual interest expense by
approximately $63,000, assuming the amount of debt outstanding remains
constant.
22
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
As of March 31, 2006, 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," as such term is
defined under Exchange Act Rules 13a-15(e) and 15d-15(e).
Based on this evaluation, our Chief Executive Officer and Chief Financial
Officer concluded that, as of March 31, 2006, such disclosure controls and
procedures were effective to ensure that information required to be
disclosed by us in the reports we file or submit under the Exchange Act is
recorded, processed, summarized and reported within the time periods
specified in the rules and forms of the Securities and Exchange Commission,
and accumulated and communicated to our management, including our Chief
Executive Officer and Chief Financial Officer, as appropriate to allow
timely decisions regarding required disclosure.
There were no changes in our internal controls over financial reporting
during the quarter ended March 31, 2005 that materially affected, or are
reasonably likely to materially affect, our internal controls over
financial reporting.
23
PART II. - OTHER INFORMATION
----------------------------
ITEM 1. LEGAL PROCEEDINGS
From time to time, the Company and its subsidiaries become parties to
various legal proceedings arising in the ordinary course of normal business
activities. While we cannot predict the outcome of these proceedings, in
our opinion and based on reports of counsel any liability arising from such
matters, individually or in the aggregate, is not expected to have a
material effect upon the consolidated financial position or operations of
the Company.
ITEM 1A. RISK FACTORS
In addition to the other information set forth in this report, you should
carefully consider the factors discussed in Part I, "Item 1A. Risk Factors"
in our Annual Report on Form 10-K for the year ended December 31, 2005,
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 First Quarter 2006
31.2 Certifications Pursuant to Rule 13a - 14(a) of the Exchange Act
of 2002 for the First Quarter 2006
32 Certification Pursuant to Rule 13a - 14(b) of the Exchange Act
and 18U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 for the First Quarter 2006
24
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
ENGlobal CORPORATION
Dated: May 12, 2006
By: /s/ Robert W. Raiford
--------------------------
Robert W. Raiford
Chief Financial Officer and Treasurer
25