ENGLOBAL CORP - Annual Report: 2003 (Form 10-K)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

(Mark One)

For the fiscal year ended December 31, 2003

For the transition period from              to             

Commission File No. 001-14217

ENGlobal Corporation

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (281) 821-7100

Securities registered pursuant to Section 12(b) of the Exchange Act:

Securities registered pursuant to Section 12(g) of the Exchange Act:

None

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shortened period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x    No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes ¨    No x

The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant on June 30, 2003 was $18,461,710 (based upon the closing price for shares of common stock as reported by the American Stock Exchange on that date).

The number of shares outstanding of the registrant’s common stock on March 16, 2004 is as follows:

DOCUMENTS INCORPORATED BY REFERENCE

Responses to Items 10, 11, 12, and 13 of Part III of this report are incorporated herein by reference to certain information contained in the Company’s definitive proxy statement for its 2004 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission on or before April 30, 2004.

Transitional Small Business Disclosure Format: Yes ¨    No x

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ENGlobal Corporation

2003 ANNUAL REPORT ON FORM 10-K

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PART I

CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K (“Report”), including “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” as well as oral statements made by the Company and its officers, directors or employees, contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Such forward-looking statements are based on Management’s beliefs, current expectations, estimates and projections about the industries that the Company and its subsidiaries serve, the economy and the Company in general. The words “expect,” “anticipate,” “intend,” “plan,” “believe,” “seek,” “estimate” and similar expressions are intended to identify such forward-looking statements; however, this Report also contains other forward-looking statements in addition to historical information. Although we believe that the expectations reflected in the forward-looking statements are reasonable, such forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to differ materially from historical results or from any results expressed or implied by such forward-looking statements. The Company cautions readers that the following important factors, among others, could cause the Company’s actual results to differ materially from the forward-looking statements contained in this Report: (i) the effect of changes in laws and regulations with which the Company must comply, and the associated costs of compliance with such laws and regulations, either currently or in the future, as applicable; (ii) the effect of changes in accounting policies and practices as may be adopted by regulatory agencies, as well as by the Financial Accounting Standards Board; (iii) the effect of changes in the Company’s organization, compensation and benefit plans; (iv) the effect on the Company’s competitive position within its market area of the increasing consolidation within its services industries, including the increased competition from larger regional and out-of-state engineering services organizations; (v) the effect of increases and decreases in oil prices; (vi) the inability to get parts from vendors; (vii) our inability to renew our line of credit; (viii) our ability to identify attractive acquisition candidates, consummate acquisitions on terms that are favorable to the Company and integrate the acquired businesses into the Company’s operations; and (ix) the effect of changes in the business cycle and downturns in local, regional and national economies. The Company cautions that the foregoing list of important factors is not exclusive. We are under no duty and have no plans to update any of the forward-looking statements after the date of this Report to conform such statements to actual results.

The following summary is qualified in its entirety by, and should be read in connection with the more detailed information contained herein and in the Company’s Consolidated Financial Statements, and the Notes thereto, included elsewhere in this Report.

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Item 1.    Business

General

ENGlobal Corporation (which may be referred to as “ENGlobal,” the “Company,” “we,” “us” or “our”) is a leading provider of engineering services and systems principally to the petroleum refining, petrochemical, pipeline, production and process industries throughout the United States and internationally. The services provided by our multi-disciplined staff span the lifecycle of a project and include feasibility studies, design, procurement and construction management. We also supply automation, control, and uninterruptible electrical power systems to our clients worldwide.

The Company was incorporated as Industrial Data Systems Corporation in the State of Nevada in June 1994. In December 2001, we merged with Petrocon Engineering, Inc. and in June 2002, we changed the name of the Company from Industrial Data Systems Corporation to ENGlobal Corporation. Effective June 16, 2002, the Company’s trading symbol for its common stock, traded on the American Stock Exchange, changed from IDS to ENG.

Since 1999, our net revenue has grown by a compound annual growth rate of 192% and our net income has grown at a compound annual growth rate of 161%. We have accomplished this growth by expanding our service offerings and geographic presence through a series of strategic acquisitions and through internal growth. We now have offices strategically located in Houston, Beaumont and Freeport, Texas, Baton Rouge and Lake Charles, Louisiana and Tulsa, Oklahoma.

The Company streamlined its organizational structure and increased name recognition in 2003. As part of the restructuring, the Company sold selected assets of its manufacturing segment and reorganized the subsidiaries in its two remaining segments: the engineering segment and the systems segment. In addition, substantially all of the Company’s wholly-owned subsidiaries adopted the ENGlobal name.

Available Information

We file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (“SEC”). You can read and copy any materials filed with the SEC at its Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. You can obtain information about the operations of the SEC Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website that contains information we file electronically with the SEC, that can be accessed over the Internet at www.sec.gov. Our common stock is listed on the American Stock Exchange (AMEX: ENG), and you can obtain information about ENGlobal at the offices of the American Stock Exchange, 86 Trinity Place, New York, New York 10006-1872 or at their website www.amex.com.

ENGlobal Website

You can find financial and other information about ENGlobal at the Company’s website at the URL address www.englobal.com. Copies of our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are provided free of charge through the Company’s website and are available as soon as reasonably practicable after filing such material electronically or otherwise furnishing it to the SEC.

Information relating to corporate governance at ENGlobal, including our Code of Business Conduct and Ethics for all of our Directors and employees, including our Chief Executive Officer and Chief Financial Officer; and information concerning our Directors, and our Board Committees, including Committee charters, and transactions in ENGlobal securities by Directors and officers, is available on our website at www.englobal.com under the Investor Relations caption. We will provide any of the foregoing information without charge upon written request to Investor Relations Officer, ENGlobal Corporation, 600 Century Plaza Drive, Building 140, Houston, Texas 77073-6033.

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Business Segments

During 2003, we operated three business segments: engineering (previously referred to as engineering services), systems (previously referred to as engineered systems) and manufacturing. The manufacturing segment was reclassified as a discontinued operation due to the December 2003 sale of certain assets of the Company’s wholly-owned subsidiary, Thermaire, Inc. d/b/a Thermal Corporation. The respective contributions to our total sales in 2003, 2002 and 2001 for the engineering segment and the systems segment are summarized below.

Engineering

General

Our engineering segment offers engineering consulting services to clients in the petroleum refining, petrochemical, pipeline, production and process industries for the development, management and turnkey execution of engineering projects and provides inspection services throughout the United States. The engineering segment is currently comprised of the following wholly-owned subsidiaries of ENGlobal Corporation: ENGlobal Engineering, Inc. (“EEI”), RPM Engineering, Inc. d/b/a ENGlobal Engineering, Inc. (“RPM”) and ENGlobal Construction Resources, Inc. (“ECR”). EEI and RPM focus primarily on providing services to the downstream petroleum refining and petrochemical industry, including refineries and processing plants, upstream and midstream pipeline companies and gas plants. ECR primarily provides inspection services to industrial plants throughout the United States.

The engineering segment has approximately 70 existing blanket service contracts pursuant to which it provides clients either with services on a time and materials basis or with services on a fixed fee, turnkey basis. Our engineering segment operates out of offices in Baton Rouge and Lake Charles, Louisiana; Beaumont, Houston and Freeport, Texas; and Tulsa, Oklahoma. Our engineering segment also makes unique, custom-made metering skids and other process related fabricated systems, designed to customer specifications.

During 2002 and 2003, the engineering segment continued to grow geographically throughout the United States and into international markets and increased the range of services it provides. As part of our plan to extend our geographical range to serve the downstream industries, such as the petroleum refining, petrochemical and process industries in the Freeport Texas area, ENGlobal acquired selected assets of Petro-Chem Engineering, Inc. (“Petro-Chem”). Petro-Chem has a staff of 55 engineers, designers, inspectors and support personnel who are engaged on contract projects with several Freeport area clients. This acquisition allowed us to expand into the Freeport area with experienced staff who have an established reputation for expertise. The Freeport office currently provides on-site engineering, design and support personnel to a leading chemical client that has facilities in Freeport and Port Arthur, Texas and Geismar, Louisiana.

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Our engineering segment offers its expertise to a broad range of industrial clients. We participate in projects involving both the modification of existing facilities and construction of new facilities. Our predominant type of contract is a blanket services contract that typically provides our clients with engineering, procurement and project management services on a time and materials basis. We also enter into contracts to complete capital projects on a full service, turnkey basis. The engineering staff has the capability of developing a project from the initial planning stages through the detailed design and construction management. Services that we provide include:

We provide services for major energy-related firms at facilities such as chemical plants, crude oil refineries, electric power generation facilities, cross-country pipelines, pipeline facilities and production processing facilities.

The engineering segment seeks to offer its clients a wide range of services from a single source provider. In addition, the segment uses an internal virtual private network so that the employees in one location can work on projects housed in other offices. This capability allows us to provide a greater depth and breadth of expertise to our clients and helps stabilize the workload in our various offices.

Competition

Our engineering segment competes with a large number of firms of various sizes, ranging from the industry’s largest firms, which operate on a worldwide basis, to much smaller regional and local firms. Typical engineering segment competitors include (in alphabetical order): CDI Engineering Group, Jacobs Engineering Group, Matrix Engineering, Mustang Engineering, S&B Engineering, SNC Lavilan GDS, Inc. and TAG. Many of our competitors are larger than we are and have significantly greater financial and other resources available to them than we do.

Competition is primarily centered on performance and the ability to provide the engineering, planning and project execution skills required to complete projects in a timely and cost efficient manner. The technical expertise of our management team and technical personnel and the timeliness and quality of our support services, are key competitive factors. Larger projects, especially international work, typically include pricing alternatives designed to shift risk to the service provider, or at least to cause the service provider to share a portion of the risks associated with cost overruns in service delivery. These alternatives include fixed-price, guaranteed maximum price, incentive fee, competitive bidding and other “value based” pricing arrangements.

Systems

General

Our systems segment designs, assembles, programs, installs, integrates and services control and instrumentation systems for specific applications in the energy and processing related industries. The systems

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segment currently consists of the following five wholly-owned subsidiaries of ENGlobal Corporation: ENGlobal Systems, Inc. (“ESI”), ENGlobal Constant Power, Inc. (“ECP”), ENGlobal Technologies, Inc. (“ETI”), Senftleber & Associates L.P. (“Senftleber”) and ENGlobal Design Group (“EDG”).

ESI’s control and instrumentation systems are custom designed and include both conventional pneumatic and hydraulic control systems, as well as electronic, microprocessor-based controls employing programmable logic. Typical applications for control and instrumentation systems include oil and gas production safety systems; refinery, petrochemical and chemical plant controls; analyzer packaging; fire and gas detection systems; pipeline facility controls; data acquisition systems; and control systems for various processing equipment. We perform all facets of control and instrumentation system design, engineering, assembly and testing in-house. Field installation and technical staff perform start-up and commissioning services, modifications to existing systems, on-site training and routine maintenance procedures for client operating personnel.

ECP operates in the industrial electrical power backup and conditioned power systems marketplace and fabricates industrial grade uninterruptible electrical power systems and battery chargers. Both standard and custom-designed products and systems are fabricated and sold in a wide array of power ranges. These products include:

In addition, ECP provides field service support for installation and maintenance of the foregoing products. Most of the products are made pursuant to specifications required for a particular order. Refineries, petrochemical plants, pipeline facilities, utilities, offshore platforms and other commercial, industrial and governmental facilities across the United States utilize the products sold by ECP. ECP’s USGS Intellicharger^™ product line of microprocessor controlled battery chargers has been used as an integral component in major power systems and is now included in a majority of ECP system units that contain battery chargers.

ETI, a wholly-owned subsidiary that was not operational prior to 2003, provides products and services supporting the advanced automation and environmental technology fields. Advanced automation services provided by ETI include automation technology audits, consulting, advanced process controls and process computer services, multivariable control, optimization (on-line and off-line), neural net applications, operator training simulators, expert systems and on-site support. ETI supports the environmental technology field by providing predictive emissions monitoring (“PEMS”), continuous emissions monitoring system (“CEMS”), Flare-Mon^® (flare monitoring system) and air emissions consulting. In October 2003, ETI acquired a small software services company, Senftleber & Associates, LP, of Houston, Texas, which provides support services for the pipeline industry, primarily through provision of technical personnel with expertise in SCADA (Supervisory Control and Data Acquisition) systems.

In January 2004, ENGlobal Design Group, Inc. acquired certain assets of Engineering Design Group, Inc. (“EDG”) in Tulsa, Oklahoma. EDG provides design, installation and maintenance of various government and public sector facilities, the most active sector being Automated Fuel Handling Systems serving the U.S. military.

Competition

The systems segment has been impacted by an increased emphasis on pricing by our clients and competitors and the fact that prices are subject to variations attributable to cyclical conditions in the oil and gas, petroleum and processing industries. ESI’s control systems and modular facilities compete with similar systems built by

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other companies, most of which compete primarily on the basis of pricing. Typical systems competitors include (in alphabetical order): Aspen Technologies, ICS/Triplex, Puffer Sweiven, PasTech, Scallon Controls, Honeywell and Siemens.

ECP’s market is characterized by a small number of larger companies that dominate the market and a large number of similarly sized companies that compete for a limited share of the market. Companies that compete in the power systems arena are Custom Power, Gutor, LaMarche Mfg., Powerware, SCI and Toshiba.

ETI competes directly with large companies such as Honeywell Hyspec for advanced control consulting. Smaller independent contractors provide low prices but generally do not provide long-term support and backup. Aspen Technologies and James/Magnum Associates are also competitors of ETI. We believe that pricing, technical competence and ability to provide superior service are the primary bases of competition.

Manufacturing

In December 2003, we sold selected assets of our only manufacturing operation, Thermaire, Inc., which was engaged in designing, manufacturing and selling air handling equipment under the Thermal brand name. The 38,000 square foot office and manufacturing facility owned by Thermaire was not included in the sale. The operations formerly conducted by this subsidiary are reflected in this Report as discontinued operations.

Acquisitions and Sales

We have grown our business over the past several years through both internal initiatives and strategic mergers and acquisitions. These mergers and acquisitions have allowed us to (i) expand our client base and the range of services that we provide to our clients; and (ii) gain access to new geographic areas. We expect to continue evaluating and assessing acquisition opportunities to further complement our existing business base. We believe that strategic acquisitions will enable us to more efficiently serve the technical needs of national and international clients and strengthen our financial performance. We will also continue to evaluate and assess current operations and from time to time, sell assets when strategic conditions warrant.

Two acquisitions of operating companies were completed during fiscal 2003. Petro-Chem Engineering, Inc. (“Petro-Chem”), acquired by EEI and Senftleber & Associates, L.P. (“Senftleber”), acquired by ETI, were acquired during the third and fourth quarters, respectively. Petro-Chem operates primarily in the Freeport, Texas and surrounding area. This acquisition primarily provides on-site engineering, design and support personnel to an existing client that has facilities in Freeport and Port Arthur, Texas and Geismar, Louisiana. Senftleber is a Houston-based provider of technical personnel with expertise in software systems such as the SCADA system, a service we believe a number of our clients will be interested in. In January 2004, ENGlobal Design Group, Inc. acquired certain assets of Engineering Design Group, Inc. (“EDG”) in Tulsa, Oklahoma. EDG provides design, installation and maintenance of various government and public sector facilities, the most active sector being Automated Fuel Handling Systems serving the U.S. military. EDG produced revenues of $14.4 million (unaudited) in 2003. The acquisition of these assets expands our capabilities into government-related engineering and significantly increases our operations in the Tulsa market.

In December 2003, we completed the sale of certain assets of our subsidiary, Thermaire, Inc., d/b/a Thermal Corporation, which comprised our manufacturing segment, to Nailor Industries of Texas, Inc., a medium sized HVAC equipment manufacturer. The disposition had been actively pursued since November 2001 in order to permit us to strategically focus on our core operations. The sale resulted in a $26,000 gain, net of tax. The 38,000 square foot office and manufacturing facility owned by Thermaire was not included in the transaction. The Company plans to sell this facility. Information relating to all prior periods throughout this Report treats the manufacturing segment as discontinued and excludes it from continuing operations.

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Business Strategy

Our objective is to strengthen the Company’s position as a leading engineering and consulting services provider while enhancing the services we offer and expanding our geographic presence. To achieve this objective, we have developed a strategy comprised of the following key elements:

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Sales and Marketing

Our various subsidiaries derive revenues primarily from three sources: (1) in-house direct sales; (2) sales generated by our network of sales representatives; and (3) referrals from existing customers, industry members and manufacturing representatives. Our sales representatives are teamed with in-house sales managers and are assigned to industry segments in the United States. Management believes that this method of selling should result in increased account penetration and enhanced customer service, which should, in turn, create and maintain the foundation for long-term customer relationships. Our growth depends in large measure on our ability to attract and retain qualified sales representatives and sales management personnel. Management believes that in-house marketing and sales of our products allows for more accountability and control, thus increasing profitability.

Products and services are also promoted through general and trade advertising, participation in trade shows and through on-line Internet communication via our corporate home page at www.englobal.com. The ENGlobal site provides information about both of our operating segments. We currently use a third-party service provider to maintain and update our website and those of our subsidiaries on an ongoing basis. Through the ENGlobal website, we seek to provide visitors with a single point of contact for obtaining information on the services and products offered by the ENGlobal family of companies.

Our business development department focuses on building long-term relationships with customers and providing customers with product application, engineering and after-the-sale services. Additionally, we seek to capitalize on cross-selling opportunities existing between our various subsidiaries. Sales leads are often jointly developed and pursued by the sales personnel from a number of these subsidiaries.

Much of our business is repeat business and we are introduced to new customers in most cases by referrals from existing customers and industry members, such as manufacturers’ representatives. Further, we anticipate that our existing customer base and the potential for business development activities will be expanded with each new acquisition.

We currently employ 13 full-time professional in-house marketers in our business development department who concentrate on the engineering services segment, and three full-time professional in-house marketers in our systems segment. We have retained business development agents in the Middle East and the United Kingdom. We have also formed alliances with other engineering and construction firms in Mexico City and South America.

Customers

Our customer base consists primarily of Fortune 500 companies representing numerous industries within the United States. While we do not have continuing dependence on any single client or a limited group of clients, one or a few clients may contribute a substantial portion of our revenues in any given year or over a period of several consecutive years due to major engineering projects. For example, during 2003, 36% of our total revenues were attributable to work done by our engineering segment and our systems segment for one major refining and petrochemical client, ExxonMobil, through multiple client subsidiaries and plant locations. The majority of this work was performed through the Beaumont location of our engineering segment on a large EPC project.

We have had success undertaking new projects for prior clients and providing ongoing services to clients following the completion of the projects. Nevertheless, in order to generate revenues in future years, we must continue efforts to obtain new engineering projects. Historically, we have not generated significant revenues from government clients, but we hope to further penetrate the government market as a result of the EDG acquisition.

In recent years, the continuing trend among engineering clients and their industry counterparts has been toward outsourcing and sole sourcing. This trend has fostered the development of ongoing, longer-term

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arrangements with clients, rather than one-time limited engagements. These arrangements, often referred to as partnering relationships, alliances, or sole source contracts, vary in scope, duration and degree of commitment. For example, engagements may provide for:

Despite their variety, the Company believes that these partnering relationships have a stabilizing influence on our service revenues. At present, we maintain some form of partnering or alliance arrangement with approximately 50 major oil and chemical companies. Most of our projects are specific in nature and we generally have multiple projects with the same clients. If we were to lose one or more of our significant clients and are unable to replace them with other customers or other projects, our business would be materially adversely affected.

In the systems segment, our clients include end-users and operators of facilities relating to oil and gas products, pipelines, refineries, chemical companies and processing plants. Other clients include equipment manufacturers, construction contractors and other engineering firms that incorporate our control systems into facilities and products they design, construct and manufacture. As in the engineering segment, in any given year, a small number of clients may account for a large percentage of the systems segment’s revenues for that year, depending on the number of major projects undertaken. Though the systems segment frequently receives work from repeat clients, its client list may vary significantly from year to year.

Our ten largest customers, which vary from one period to the next, accounted for 69% and 60% of our total revenue in 2003 and 2002, respectively. For 2003, our largest clients, in alphabetical order include:

We do not have any long-term commitments from these clients and sales of products from the systems segment are typically made according to the client’s specifications on a purchase order basis. Our potential revenues are, therefore, dependent on continuing relationships with these customers.

Contracts

We generally enter into two principal types of contracts with our clients: time and materials contracts and fixed-price contracts. In fiscal 2003, 85% and 15% of our net revenue was derived from time and materials and fixed-price contracts, respectively. Our various clients determine which type of contract we will enter into for a particular engagement.

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Backlog

Backlog represents the total value of all awarded contracts that have not been completed and will be recognized as revenues over the life of the project. At February 29, 2004, our gross revenue backlog was approximately $67.5 million, compared to $54.4 million at December 31, 2002. We estimate that approximately 75% of the gross revenue backlog at February 29, 2004 will be recognized during fiscal 2004.

Gross revenue includes backlog under two types of contracts: (1) contracts for which work authorizations have been received on a fixed-price basis and not-to-exceed projects that are well defined and (2) time and material evergreen contracts at an assumed 12 month run-rate, where we place employees at our clients’ site to perform day-to-day project efforts.

Although backlog reflects business that we consider to be firm, cancellations or scope adjustments may occur. Further, most contracts with clients may be terminated at will, in which case the client would only be obligated to us for services provided through the termination date. We have adjusted backlog to reflect project cancellations, deferrals and revisions in scope and cost (both upward and downward) known at the reporting date; however, future contract modifications or cancellations may increase or reduce backlog and future revenues. As a result, no assurances can be given that the amounts included in backlog will ultimately be realized.

Customer Service and Support

We provide service and technical support to our customers in varying degrees depending upon the business line and on customer contractual arrangements. The Company’s technical support staff provides initial telephone support services for end-user customers and distributors. These services include isolating and verifying reported product failures and authorizing repair services in support of customer requirements. We also provide on-site engineering support if a technical issue cannot be resolved over the telephone. On projects for which we have provided engineering systems, we provide worldwide start-up and commissioning services. We also provide the manufacturers’ limited warranty coverage for products we sell.

Dependence Upon Suppliers

Our ability to provide clients with services and products in a timely and competitive manner depends on the availability of products and parts from our suppliers at competitive prices and on reasonable terms. Our suppliers are not obligated to have products on hand for timely delivery nor can they guarantee product availability in sufficient quantities to meet our demands. There can be no assurance that we will be able to obtain necessary supplies at prices or on terms we find acceptable. However, in an effort to maximize product availability and maintain quality control, we generally procure components from multiple distributors.

For example, all of the product components used by our systems segment are fabricated using components and materials that are available from numerous domestic suppliers. There are approximately 36 principal suppliers of these components, each of whom can be replaced by an equally viable competitor. No one manufacturer or vendor provides products that account for 10% or more of our revenues. Thus, we anticipate little or no difficulty in obtaining components in sufficient quantities and in a timely manner to support our manufacturing and assembly operations. Units produced through the systems segment are normally not produced for inventory and component parts are typically purchased on an as-needed basis.

Despite the foregoing, some of our subsidiaries rely on certain suppliers for necessary components and there can be no assurance that these components will continue to be available on acceptable terms. If a subsidiary terminates a long-standing supply relationship, it may be difficult to obtain alternative sources of supply without

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a material disruption in our ability to provide products and services to our customers. While we do not believe that such a disruption is likely, if it did occur, it could have a material adverse effect on our financial condition and results of operations.

Patents, Trademarks, Licenses

Our success depends in part upon our ability to protect our proprietary technology, which we do primarily through protection of our trade secrets and confidentiality agreements. We have pending trademark applications on file with the U.S. Patent and Trademark Office for the names “ENGlobal,” “Flare-Mon” and “Purchased Data.” There can be no assurance that the protective measures we currently employ will be adequate to prevent the unauthorized use or disclosure of our technology, or the independent third party development of the same or similar technology. Although our competitive position to some extent depends on our ability to protect our proprietary and trade secret information, we believe that other factors, such as the technical expertise and knowledge-base of our management and technical personnel and the timeliness and quality of the support services we provide, will also help us to maintain our competitive position.

Government Regulations

The Company and certain of our subsidiaries are subject to various foreign, federal, state, and local laws and regulations relating to our business and operations, and various health and safety regulations as established by the Occupational Safety and Health Administration. The Company and members of its professional staff are subject to a variety of state, local, and foreign licensing, registration and other regulatory requirements governing the practice of engineering. Many of our engineering professionals are licensed or registered in several states and foreign jurisdictions. Currently, we are not aware of any situation or condition relating to the regulation of the Company, its subsidiaries, or personnel that we believe is likely to have a material adverse effect on our results of operations or financial condition.

Employees

As of December 31, 2003, the Company and its subsidiaries employed 1,023 individuals. Of these employees, 16 were employed in sales and marketing; 606 were employed in engineering and related positions; 116 were employed in technical production positions; 30 were employed as inspectors; 220 were employed as project support staff; and 35 were employed in administration, finance and management information systems. We believe that our ability to recruit and retain highly skilled and experienced technical, sales and management personnel has been and will continue to be, critical to our ability to execute our business plan. None of our employees are represented by a labor union or are subject to a collective bargaining agreement. We believe that relations with our employees are good.

2003 Restructure

To streamline our operations, in December 2003, we dissolved a number of inactive subsidiaries, merged certain subsidiaries out of existence and transferred ownership of other subsidiaries in order to more clearly delineate, in terms of corporate structure, between our engineering segment and our systems segment. Also in December 2003, we sold assets of our manufacturing segment, which had been owned by Thermaire, Inc. d/b/a Thermal Corporation. We no longer operate a manufacturing segment. In addition, to increase our name recognition, all of our active subsidiaries, except for Senftleber & Associates, L.P., adopted “ENGlobal” as part of their names. Currently, the subsidiaries in our segments are:

Engineering segment: ENGlobal Engineering, Inc., RPM Engineering, Inc. d/b/a ENGlobal Engineering, Inc. and ENGlobal Construction Resources, Inc.

Systems segment: ENGlobal Systems, Inc., ENGlobal Constant Power, Inc., ENGlobal Technologies, Inc., Senftleber & Associates, L.P. and ENGlobal Design Group, Inc.

ENGlobal is also the parent of ENGlobal Corporate Services, Inc., which serves as an administrative and financing subsidiary.

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Risk Factors

Set forth below and elsewhere in this Report and in other documents we file with the SEC are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this Report. You should be aware that the occurrence of any of the events described in these risk factors and elsewhere in this Report could have a material adverse effect on our business, financial condition and results of operations and that upon the occurrence of any of these events, the trading price of our common stock could decline.

We are engaged in highly competitive businesses and must typically bid against competitors to obtain engineering and service contracts.

We are engaged in highly competitive businesses in which customer contracts are typically awarded through competitive bidding processes. We compete with other general and specialty contractors, both foreign and domestic, including large international contractors and small local contractors. Some competitors have greater financial and other resources than we do, which, in some instances, could give them a competitive advantage over us.

Our business and operating results could be adversely affected by our inability to accurately estimate the overall risks, revenue or costs on a contract.

We generally enter into two principal types of contracts with our clients: time and materials contracts and fixed-price contracts. Under our fixed-price contracts, we receive a fixed-price irrespective of the actual costs we incur and, consequently, we are exposed to a number of risks. These risks include underestimation of costs, problems with new technologies, unforeseen expenditures or difficulties, delays beyond our control and economic and other changes that may occur during the contract period. Our ability to secure change orders on scope changes and our ability to invoice for such changes poses an additional risk. In fiscal 2003, approximately 15% of our net revenue was derived from fixed-price contracts.

Under our time and materials contracts, we are paid for labor at negotiated hourly billing rates or reimbursement at specified mark-up hourly rates and negotiated rates for other expenses. Profitability on these contracts is driven by billable headcount and cost control. Some time and materials contracts are subject to contract ceiling amounts, which may be fixed or performance-based. If our costs generate billings that exceed the contract ceiling or are not allowable under the provisions of the contract or any applicable regulations, we may not be able to obtain reimbursement for all of our costs.

Revenue recognition for a contract requires judgment relative to assessing the contract’s estimated risks, revenue and costs and on making judgments on other technical issues. Due to the size and nature of many of our contracts, the estimation of overall risk, revenue and cost at completion is complicated and subject to many variables. Changes in underlying assumptions, circumstances or estimates may also adversely affect future period financial performance.

Economic downturns could have a negative impact on our businesses.

Demand for the services offered by us has been and is expected to continue to be, subject to significant fluctuations due to a variety of factors beyond our control, including economic conditions. During economic downturns, the ability of both private and governmental entities to make expenditures may decline significantly. We cannot be certain that economic or political conditions will be generally favorable or that there will not be significant fluctuations adversely affecting our industry as a whole or key markets targeted by us.

Our dependence on one or a few customers could adversely affect us.

One or a few clients have in the past and may in the future contribute a significant portion of our consolidated revenues in any one year or over a period of several consecutive years. In 2003, approximately 36%

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of our revenues were from ten subsidiaries of ExxonMobil and approximately 20% of our revenues were from Chevron Phillips. As our backlog frequently reflects multiple projects for individual clients, one major customer may comprise a significant percentage of our backlog at any point in time. Because these significant customers generally contract with us for specific projects, we may lose these customers from year to year as their projects with us are completed. If we do not replace them with other customers or other projects, our business could be materially adversely affected. Additionally, we have long-standing relationships with many of our significant customers. Our contracts with these customers, however, are on a project-by-project basis and the customers may unilaterally reduce or discontinue their purchases at any time. The loss of business from any one of such customers could have a material adverse effect on our business or results of operations.

Our loan agreement also specifies limits in concentration of receivables to any one client (other than ExxonMobil) to 20% of all trade account balances, thereby reducing our ability to borrow. The limit on the ExxonMobil balance is set at 30% of all trade receivables.

Additional acquisitions may adversely affect our ability to manage our business.

Our growth has been, in large part, the result of acquisitions of companies. We plan to continue making acquisitions in the future on terms management considers favorable to us. The successful acquisition of other companies involves an assessment of future revenue opportunities, operating costs, economies and earnings after the acquisition is complete, potential industry and business risks and liabilities beyond our control. This assessment is necessarily inexact and its accuracy is inherently uncertain. In connection with our assessments, we perform reviews of the subject acquisitions we believe to be generally consistent with industry practices. These reviews, however, may not reveal all existing or potential problems, nor will they permit a buyer to become sufficiently familiar with the target companies to assess fully their deficiencies and capabilities. We cannot assure you that we will identify, finance and complete additional suitable acquisitions on acceptable terms. We may not successfully integrate future acquisitions. Any acquisitions may require substantial attention from our management, which may limit the amount of time that management can devote to day-to-day operations. Our inability to find additional attractive acquisition candidates or to effectively manage the integration of any businesses acquired in the future could adversely affect our ability to grow profitably or at all.

Seasonality of our industry may cause our revenues to fluctuate.

Holidays and employee vacations during our fourth quarter exert downward pressure on revenues for that quarter, which is only partially offset by the year-end efforts on the part of many clients to spend any remaining funds budgeted for engineering services or capital expenditures during the year. The annual budgeting and approval process under which these clients operate is normally not completed until after the beginning of each new year, which can depress results for the first quarter. Principally due to these factors, our revenues during the first and fourth quarters generally tend to be lower than in the second and third quarters.

The failure to attract and retain key professional personnel could adversely affect the Company.

Our success depends on attracting and retaining qualified personnel in a competitive environment. We are dependent upon our ability to attract and retain highly qualified managerial, technical and business development personnel. Competition for key personnel is intense. We cannot be certain that we will retain our key managerial, technical and business development personnel or that we will attract or assimilate key personnel in the future. Failure to retain or attract such personnel could materially adversely affect our businesses, financial position, results of operations and cash flows.

Liability claims could result in losses.

Providing engineering and design services involves the risk of contract, professional errors and omissions and other liability claims, as well as adverse publicity. Further, many of our contracts will require us to indemnify our

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clients not only for our negligence, if any, but also for the concurrent negligence of our clients. We currently maintain liability insurance coverage, including coverage for professional errors and omissions. However, claims outside of or exceeding our insurance coverage may be made. A significant claim could result in unexpected liabilities, take management time away from operations and have a material adverse impact on our cash flow.

If the operating result of either segment is adversely affected, an impairment of goodwill could result in a write down.

Based on factors and circumstances impacting ENGlobal and the business climate in which it operates, the Company may determine that it is necessary to re-evaluate the carrying value of its goodwill by conducting an impairment test in accordance with SFAS No. 142. The Company has assigned goodwill to the two segments based on estimates of the relative fair value of each segment. If changes in the industry, market conditions, or government regulation negatively impact either of the Company’s segments resulting in lower operating income, if assets are harmed, if anticipated synergies or cost savings are not realized with newly acquired entities, or if any circumstance occurs which result in the fair value of either segment reducing below its carrying value, an impairment to goodwill could be created. In accordance with SFAS No. 142, the Company would be required to write down the carrying value of goodwill.

Our Board of Directors may authorize future sales of ENGlobal common stock, which could result in a decrease in value to existing stockholders of the shares they hold.

Our Articles of Incorporation authorize our board of directors to issue up to an additional 49,912,621 shares of common stock and an additional 2,265,167 shares of preferred stock. These shares may be issued without stockholder approval unless the issuance is 20% or more of our outstanding common stock, in which case the American Stock Exchange requires stockholder approval. We may issue shares of stock in the future in connection with acquisitions or financings. In addition, we may issue shares in connection with our Employee Stock Purchase Plan and we may issue options as incentives under our Option Plan. Future issuances of substantial amounts of common stock, or the perception that these sales could occur, may affect the market price of our common stock. In addition, the ability of the board of directors to issue additional stock may discourage transactions involving actual or potential changes of control of the Company, including transactions that otherwise could involve payment of a premium over prevailing market prices to holders of our common stock.

Our backlog is subject to unexpected adjustments and cancellations and is, therefore, an uncertain indicator of our future earnings.

As of February 29, 2004, our backlog was approximately $67.5 million. We cannot assure investors that the revenues projected in our backlog will be realized or, if realized, will result in profits. Projects may remain in our backlog for an extended period of time prior to project execution and, once project execution begins, it may occur unevenly over the current and multiple future periods. In addition, project termination, suspensions or reductions in scope may occur from time to time with respect to contracts reflected in our backlog. Such backlog reductions would reduce the revenue and profit we actually receive from contracts reflected in our backlog. Future project cancellations and scope adjustments could further reduce the dollar amount of our backlog and the revenues and profits that we actually earn.

Our dependence on subcontractors and equipment manufacturers could adversely affect us.

We rely on third-party subcontractors as well as third-party suppliers and manufacturers to complete our projects. To the extent that we cannot engage subcontractors or acquire supplies or materials, our ability to complete a project in a timely fashion or at a profit may be impaired. If the amount we are required to pay for these goods and services exceeds the amount we have estimated in bidding for fixed-price or cost-plus contracts, we could experience losses in the performance of these contracts. In addition, if a subcontractor or supplier is unable to deliver its services or materials according to the negotiated terms for any reason, including the

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deterioration of its financial condition, we may be required to purchase the services or materials from another source at a higher price. This may reduce the profit to be realized or result in a loss on a project for which the services or materials were needed.

Our quarterly operating results may fluctuate significantly, which could have a negative effect on the price of our common stock.

Our quarterly revenue, expenses and operating results may fluctuate significantly because of a number of factors, including:

Variations in any of these factors could cause significant fluctuations in our operating results from quarter to quarter and could result in net losses. These fluctuations could result in downward pressure on the market price of our common stock.

If we are not able to successfully manage our growth strategy, our business and results of operations may be adversely affected.

We have grown rapidly over the last several years. Our growth presents numerous managerial, administrative, operational and other challenges. Our ability to manage the growth of our operations will require us to continue to improve our management information systems and maintain discipline in our internal systems and controls. In addition, our growth will increase our need to attract, develop, motivate and retain both our management and professional employees. The inability of our management to effectively manage our growth or the inability of our employees to achieve anticipated performance could have a material adverse effect on our business.

The price of our common stock may be volatile.

Our common stock may be subject to substantial price volatility. The stock market has experienced extreme price and volume fluctuations that have affected the market price of many companies and that have often been unrelated to the operating performance of these companies. The overall market and the price of our common stock may continue to fluctuate greatly. The trading price of our common stock may be significantly affected by various factors, including:

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Additionally, volatility or a lack of positive performance in our stock price may adversely affect our ability to retain key employees, many of whom are granted stock options, the value of which are dependent on the performance of our stock price.

A small number of stockholders own a significant portion of our outstanding common stock, thus limiting the extent to which other stockholders can effect decisions subject to stockholder vote.

Directors, executive officers and principal stockholders of ENGlobal and their affiliates, beneficially own approximately 62% of our outstanding common stock on a fully diluted basis. Accordingly, these stockholders, as a group, are able to control the outcome of stockholder votes, including votes concerning the adoption or amendment of provisions in our Articles of Incorporation or bylaws and the approval of mergers and other significant corporate transactions. The existence of these levels of ownership concentrated in a few persons makes it unlikely that any other holder of common stock will be able to affect the management or direction of the Company. These factors may also have the effect of delaying or preventing a change in management or voting control of the Company.

Nominees for the board of directors are designated by a voting agreement so stockholders who are not parties to the voting agreement may not have a meaningful vote in the election of directors.

In connection with our merger with Petrocon Engineering, Inc, holders of approximately 56% of the outstanding shares of the Company entered into a voting agreement agreeing to vote their shares in the election of directors in favor of three nominees of Alliance 2000, Ltd. (“Alliance”), two nominees of certain former shareholders of Petrocon, one nominee of Equus II Incorporated (“Equus”) (the Equus nominee becoming a nominee of certain former shareholders of Petrocon once the Equus debt is paid) and one nominee selected by the mutual agreement of Alliance and certain former shareholders of Petrocon. In 2003, Equus forfeited its right to have a nominee on the board of directors. As a result, under the terms of the voting agreement, certain former shareholders of Petrocon are entitled to the additional nominee made available through the Equus forfeiture.

Item 2.    Properties

Facilities

We lease eleven buildings in the U.S. totaling approximately 250,000 square feet and we own an office building in Baton Rouge, Louisiana with 27,500 square feet. The leases have remaining terms ranging from monthly to seven years and are at what we consider to be commercially reasonable rental rates. Our principal office locations are in Houston and Beaumont, Texas, with other offices in Freeport, Texas, Baton Rouge and Lake Charles, Louisiana, and Tulsa, Oklahoma. Approximately 199,000 square feet of our total office space is designated for use by our professional, technical and administrative personnel. We believe that our office and other facilities are well maintained and adequate for existing and planned operations at each operating location. Our systems segment performs fabrication assembly at two shop facilities in Houston, Texas with approximately 46,800 square feet of warehouse space.

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We lease approximately 14,000 square feet of office space in Beaumont, Texas with an expiration date of June, 2005 from a joint venture owned one-third by each of: ENGlobal Engineering, Inc., Michael L. Burrow (the Company’s CEO), and a stockholder of the Company who owns less than 1% of the Company’s stock. We believe that this lease is at a commercially reasonable rental rate.

The building formerly occupied by Thermaire, totaling approximately 38,000 square feet, is vacant and on the market for sale. This space has not been included in the office or warehouse statistics.

One leased facility, formerly occupied by ECP, has been vacated and an early termination notice has been sent to the landlord. ECP relocated effective January 1, 2004 to a site that ESI occupies to reduce overhead expenses. The lease on the vacant space will terminate in June 2004 unless a subleasee can be found.

In Tulsa, we are utilizing approximately 60% of our available space. In Houston, we have approximately a 90% utilization of available office space. In Beaumont, we are utilizing 100% of the available space. The Lake Charles office is approximately 50% occupied and the Baton Rouge and Freeport facilities are approximately 70% utilized. The Houston warehouse facilities are approximately 70% utilized.

Below is a complete listing of the space leased and owned with the expiration dates of the leases.

Item 3.    Legal Proceedings

From time to time, we are involved in various legal proceedings arising in the ordinary course of business that are incidental to our business. As of the date of this filing, we are party to several legal proceedings that have been reserved for or are covered by insurance, or that, if determined adversely to us individually or in the aggregate, would not have a material adverse effect on our results of operations or financial position.

During 2003, the Company and its subsidiaries, and more than 40 other parties were named defendants in several petitions for damages filed in various district courts in Louisiana (East Baton Rouge, Calcasieu, Iberville, Ascension, and Orleans Parishes) on behalf of former employees of Barnard and Burk, Inc. The plaintiffs, who allege exposure to asbestos during the course of their employment, were employees of Barnard and Burk, Inc. during a period covering the late 1950’s through the early 1980’s at facilities in Louisiana. In 1994, AMEC Engineering, Inc. assigned the trade name “Barnard and Burk” to RPM Engineering, Inc. along with selected assets. No liabilities were assumed by RPM. The Company’s wholly-owned subsidiary, ENGlobal Engineering, Inc., formerly known as Petrocon Engineering, Inc., acquired RPM (along with the “Barnard and Burk” trade name) in 1996 pursuant to a stock purchase agreement. Because Petrocon acquired only the “Barnard and Burk” trade name, and none of its liabilities, the Company is seeking to be extricated from the suits via summary judgment. The Company believes the lawsuits are without merit and intends to defend them vigorously.

Item 4.    Submission of Matters to a Vote of Security Holders

Not applicable.

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PART II

Item 5.    Market for Registrant’s Common Equity and Related Stockholder Matters

Market Information and Holders

The Company’s common stock has been quoted on the American Stock Exchange (“AMEX”) since June 16, 2002, under the symbol “ENG.” From its initial listing on AMEX on June 16, 1998 to June 15, 2002, the Company’s stock was traded under the symbol “IDS.” Newspaper stock listings identify us as “ENGlobal.”

The following table sets forth the high and low sales prices of our common stock for the periods indicated.

The foregoing figures, based on information published by AMEX, do not reflect retail mark-ups or markdowns and may not represent actual trades.

In connection with our December 2001 merger with Petrocon, we issued 2,500,000 shares of Series A Preferred Stock, $0.001 par value per share, to Equus II Incorporated. In 2002 and 2003, we issued dividends to Equus in the form of 88,000 shares and 146,833 shares of Series A Preferred Stock. Effective August 2003, the Company exercised its right to convert all outstanding Series A Preferred Stock to 1,149,089 shares of common stock.

As of February 28, 2004, approximately 233 stockholders of record held the Company’s common stock. This does not include individual participants in security position listings.

Equity Compensation Plan Information

The following table sets forth certain information concerning the Company’s equity compensation plans as of December 31, 2003.

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Dividend Policy

The Company has never declared or paid a cash dividend on its common stock. The Company intends to retain any future earnings for reinvestment in its business and does not intend to pay cash dividends in the foreseeable future. In addition, restrictions contained in our loan agreements governing our credit facility with Fleet Capital Corporation preclude us from paying any dividends on our common stock while any debt under those agreements is outstanding. The payment of dividends in the future will depend on numerous factors, including the Company’s earnings, capital requirements, operating and financial position and general business conditions.

Dividends on outstanding shares of Series A Preferred Stock were paid on the last day of May in 2002 and 2003 in shares of stock of Series A Preferred Stock at a rate of 0.08 shares for each outstanding share of Series A Preferred Stock. The Company elected to convert all shares of preferred stock to 1,149,089 shares of common stock in August 2003.

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Item 6.    Selected Financial Data

Summary Selected Historical Consolidated Financial Data

The following tables set forth our selected financial data. The data for the years ended December 31, 2003, 2002, and 2001 have been derived from the audited financial statements appearing elsewhere in this document. The data as of December 31, 2001 and for the years ended December 31, 2000 and 1999 have been derived from audited financial statements not appearing in this document. You should read the selected financial data set forth below in conjunction with our financial statements and the notes thereto included in Part IV, Item 15, and Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and other financial information appearing elsewhere in this document. In addition, the merger with Petrocon in December 2001 should be considered in connection with your review of this information.

Note: Due to the sale of Thermaire, all items related to the previously reported manufacturing segment have been reclassified to discontinued operations in order to provide comparative results. Previously reported amounts will not agree to the amounts presented below except net income.

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Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operation

The following discussion is qualified in its entirety by, and should be read in conjunction with, our Consolidated Financial Statements including the Notes thereto, included elsewhere in this Annual Report on Form 10-K. Footnote 17 to the Financial Statements contains segment information.

Forward-Looking Statements

Certain information contained in this Form 10-K Annual Report, the Company’s Annual Report to Stockholders, as well as other written and oral statements made or incorporated by reference from time to time by the Company and its representatives in other reports, filings with the SEC, press releases, conferences, or otherwise, may be deemed to be forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. This information includes, with limitation, statements concerning the Company’s future financial position and results of operations; planned capital expenditures; business strategy and other plans for future operations; the future mix of revenues and business; commitments and contingent liabilities; and future demand and industry conditions. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. When used in this report, the words “anticipate,” “believe,” “estimate,” “expect,” “may,” and similar expressions, as they relate to the Company and its management, identify forward-looking statements that could differ materially from the results described in the forward-looking statements due to the risks and uncertainties set forth in this Annual Report on Form 10-K.

Overview

We furnish engineering consulting and control system services to the petroleum refining, petrochemical, pipeline, production and processing industries. Our business consists of two segments: engineering and systems. Our engineering segment offers engineering consulting services to clients for the development, management and turnkey execution of engineering projects and inspection services. Our systems segment designs, assembles, programs, installs, integrates and services control and instrumentation systems for specific applications in the energy and processing related industries.

In 2003, the engineering segment accounted for 87.6% of our total revenues for the year, and realized a $33.4 million increase in its revenues over fiscal year 2002. This increase in revenues is primarily attributable to a large co-generation project and a large cyclohexane project, both of which originated out of our Beaumont office. We expect to complete the cyclohexane project in the first quarter of 2004 and to continue working on the cogeneration project until 2005. Our engineering segment has been successful in obtaining major projects in the petroleum refining industry along the Texas Gulf Coast, and mid-continent area. However, we do not currently have any projects that would replace the cogeneration project when it is completed.

The systems segment contributed 12.4% of our total revenues for fiscal 2003, as its revenues improved $1.2 million from $14.2 million in 2002 to $15.3 million in 2003. This growth is attributable to large fixed-price sales of remote instrument enclosures to two clients. Although the revenues for this segment improved over 2002, the gross profit declined due to cost overruns on fixed-price projects and competitive market pressures on pricing.

We formerly operated a third segment, the manufacturing segment. Certain assets of this segment were sold in December 2003 and its financial results are reported in Discontinued Operations.

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Results of Operations

The following table sets forth, for the periods indicated, certain financial data derived from our consolidated statements of operations and indicates percentage of total revenue for each item (in thousands). The manufacturing segment is in Discontinued Operations.

Year Ended December 31, 2003 Compared to Year Ended December 31, 2002

Total Revenue.    Total revenue increased by $34.6 million or 38.8% from revenues of $89.1 million in 2002 to $123.7 million in 2003. The revenue growth for 2003 compared to 2002 is primarily attributable to the engineering segment, which was awarded engineering, procurement, and construction (“EPC”) phases of major projects. The engineering segment realized an increase in its engineering revenues of $33.4 million primarily due to two large projects at the Beaumont location, a co-generation project and a cyclohexane project. These projects contributed revenues of more than $42.4 million during 2003, including materials and subcontractors’ revenues of $29.8 million. Usually the engineering segment’s revenues are derived from direct labor. Procurement activities contributed to a significant increase in revenues but at a lower mark-up on these EPC projects. The labor-based revenues for engineering were $73.9 million, $69.8 million, and $13.6 million in 2003, 2002, and 2001, respectively. By comparison, the procurement-based revenues were $34.5 million, $5.2 million, and $0.6 million in 2003, 2002, and 2001, respectively. Revenues generated from procurement activities are anticipated to be lower in 2004 than 2003 since the cyclohexane project is concluding in the first quarter of 2004. Gross profit margins are expected to increase as a percentage of revenues in 2004 because the profits on procurement activities are lower than profits on direct labor.

Performance in the other areas of the engineering segment was mixed. Significant growth occurred in the Tulsa area during 2003 with an increase in revenues of 84%, from $2.5 million in 2002 to $4.6 million in 2003. This growth was due to a concerted marketing effort to bring work to this location. The Houston area, which has traditionally serviced the pipeline industry, has had disappointing sales. The pipeline industry continues to be over leveraged, and capital expansions have been on hold for over two years while the industry focuses on debt reduction. The economy in the Baton Rouge area continued to be very disappointing during the early part of 2003, but improved in the fourth quarter. However, competition in this area resulted in lower margins. Revenues for 2003 decreased from 2002 by $5.1 million in the Baton Rouge area. Fortunately, the fourth quarter showed signs of improvement; Baton Rouge revenues improved 24% during the last quarter in 2003 as compared to the same quarter in 2002.

The systems segment’s revenues improved $1.1 million from $14.2 million in 2002 to $15.3 million in 2003. ESI’s revenues improved $2.1 million from $11.0 million in 2002 to $13.2 million in 2003. This growth was attributable to large fixed-price sales of remote instrument enclosures to two clients. Offsetting this increase

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was a decrease in revenues at ECP of $1.5 million. As of January 2004, ECP has physically moved into the Houston ESI location to help reduce its overhead expenses by sharing employees and reducing rent and utility costs. ETI, a previously dormant entity, which was reactivated in 2003, and Senftleber, a November 2003 acquisition, generated combined revenues of $0.6 million in 2003.

The manufacturing segment was discontinued when certain assets of Thermaire were sold in December 2003. Operational results of this segment are reflected in the caption “Income (loss) from discontinued operations.”

Gross Profit.    Gross profit for the Company increased by $2.6 million or 17.8% from $14.4 million in 2002 to $17.0 million in 2003. The margin as a percentage of revenue, however, decreased from 16.2% in 2002 to 13.7% in 2003. This decrease is primarily due to the increase in EPC types of projects worked in the engineering segment.

The gross profit for the engineering segment increased by $2.7 million or 22.4% from 2002 to 2003. The engineering segment’s 2003 gross profit as a percentage of revenue decreased from 16.1% in 2002 to 13.7% in 2003. EEI has many contracts pursuant to which ENGlobal employees are assigned to work at client facilities. These contracts are generally low-risk, with virtually no overhead, and therefore, low margin. Also, the engineering service segment, which normally functions as a source of professional labor, was awarded EPC jobs in 2003 and 2002 with large quantities of material and subcontract work. These jobs have traditionally had low mark-ups on the materials and subcontractors’ work, which deflates the Company’s margins. Engineering contributed 87.2% of the total gross profits in 2003. Despite its lower margins, the Company would like to obtain additional EPC contracts in 2004, but currently, no such projects are in the Company’s backlog.

The systems segment gross margin as a percentage of sales decreased from 16.3% in 2002 to 14.2% in 2003. The decline in gross profits was primarily due to cost overruns on fixed-price projects and competitive market pressures on contract pricing. The cost overruns occurred due to rapid growth in ESI’s revenues. Management has initiated stronger administrative and support services controls in response to the cost overruns.

The Company combined three employee medical insurance plans into one self-insured health plan at the beginning of 2003. Claim trends throughout the year were lower than expected levels based on past years’ experience. Adjustments to lower the insurance reserve were made in the third and fourth quarters totaling $1.6 million, which resulted in improved gross profits in both engineering and systems segment. The engineering segment received approximately 90% of the benefit, and the systems segment received approximately 10% of the benefit.

Selling, General and Administrative Expenses.    Selling, general and administrative expenses increased by $1.8 million, or 17.0%, from $10.6 million in 2002 to $12.4 million in 2003 primarily due to the creation of a business development department, which substantially combined all the marketing activities of the engineering segment into one centralized group and added several new marketing representatives. We believe this centralized effort will result in better coordination of the Company’s marketing efforts.

Operating Profit.    Operating profit increased by $0.8 million or 20.1% from $3.8 million in 2002 to $4.5 million in 2003. However, operating profits decreased as a percentage of total revenue from 4.2% in 2002 to 3.7% in 2003. This decrease was the result of the overall higher revenues and lower profit margins.

In March 2004, the Company announced organizational changes intended to reduce overhead and enhance profitability. The Company eliminated four operational facilities and consolidated offices to improve efficiency. For example, ECP was moved into the same facility as ESI, effective January 2004, resulting in improved shop personnel utilization, reduction of duplicative overhead functions, and reduction of facility expenses. Additionally, senior management has been realigned to improve operational efficiencies and to better integrate the Company’s acquisitions into its operations.

Other Income (Expense).    Other income decreased from $143,000 to expense of $355,000 from 2002 to 2003, respectively. The expense in 2003 is the loss on the sale of the vacant building in Baton Rouge, as compared to the income in 2002, which resulted from a legal settlement.

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Provision for Income Taxes.    The Company received a one-time tax benefit of approximately $138,000 in 2003 from the recapture of depreciation on segregated expenditures in Company owned buildings in Baton Rouge. The one-time tax benefit decreased the 2003 effective tax rate for income taxes from 39% in 2002 to 33%. The Company does not expect the benefit to recur in future tax periods.

Year Ended December 31, 2002 Compared to Year Ended December 31, 2001

Total Revenue.    Total revenue increased by $71.3 million or 400% from $17.8 million in 2001 to $89.1 million in 2002. Revenue from the engineering segment, which comprised 84.1% and 79.9% of total revenue in 2002 and 2001, respectively, increased by $60.7 million or 427%. This increase was due to the Company’s merger with Petrocon (the engineering segment of which is referred to as “EEI”). Excluding the revenue from the merged company, the change in revenues was a decrease from $17.8 million in 2001 to $15.3 million in 2002. We believe that this decrease was primarily due to the depressed economics of our clients’ industries, which resulted in restraints on capital expenditures.

In 2002, the Beaumont office of EEI was awarded a large EPC contract with a significant client that generated over $5 million in revenue, net of $9 million in materials purchased as agent. Due to the depressed economy in other areas of the country, revenues in the Baton Rouge and Tulsa offices decreased from $5.8 million in 2001 to $0.8 million in 2002. Houston’s revenues also decreased from 2001 by $1.3 million as a result of poor economic conditions.

The systems segment contributed 15.9% of total revenues in 2002. Revenues increased from $3.6 million to $14.2 million in 2001 and 2002, respectively. The increase in sales was due to the acquisition of Petrocon Systems, Inc. (the systems segment of which is referred to as “ESI”). ESI contributed revenues of $11.2 million to total 2002 revenues. Without the merger, revenues would have decreased from $3.5 million to $3.0 million in 2001 and 2002, respectively. The decrease was due to the depressed market conditions in chargers and battery backup systems.

Gross Profit.    Gross profit increased by $10.1 million or 237% from $4.3 million in 2001 to $14.4 million in 2002. Gross profit from the pre-merger operations decreased in 2002 from 2001 due to the depressed markets as indicated by lower revenues. The Company decided to maintain key personnel rather than downsize at the risk of losing short-term profits. The merged operations contributed $12.4 million in gross profits. The overall margin as a percentage of revenue, however, decreased from 24.0% to 16.2% in 2001 and 2002. This decrease is primarily due to the shift in types of projects worked in the engineering services segment.

The gross profit for the engineering segment increased by $8.3 million or 218% from 2001 to 2002. The engineering’s 2002 gross profit as a percentage of revenue decreased from 26.7% to 16.1%. Many of the projects acquired in connection with the merger were client directed, whereby the employee works at the client site, under the supervision of the client. These jobs are generally low-risk, have virtually no overhead, and intense competition results in low margins. Engineering services contributed 84.0% of the total gross profits in 2002.

The systems segment gross margin as a percentage of sales increased from 13.1% in 2001 to 16.3% in 2002. This increase was attributable to the merger with Petrocon. ESI has higher profit, higher risk, fixed fee projects. ECP also experienced a write-off of inventory in 2001 that was not repeated in 2002, thereby increasing 2002 margins.

Selling, General and Administrative Expenses.    Selling, general and administrative expenses increased by $7.8 million or 275% from $2.8 million in 2001 to $10.6 million in 2002. With the larger entity, expenses increased for several overhead departments, including executive, accounting, human resources, safety, information technology, and business development. Due to the increase in revenues, as a percentage of revenues, these expenses decreased by 4% from 15.9% to 11.9% in 2001 and 2002, respectively.

Interest Income (Expense).    The 2001 interest income of $14,000 resulted from interest on a receivable. In 2002, the interest expense resulted from an increase in the line of credit increase caused by the Petrocon merger.

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Liquidity and Capital Resources

Historically, we have satisfied our cash requirements through operations and borrowings under a revolving credit facility with Fleet Capital Corporation (“Fleet”). As of December 31, 2003, we had working capital of $6.5 million. Long-term debt outstanding on this same date was $8.1 million, reduced from $13.3 million as of December 31, 2002. Our long-term debt includes $5.6 million outstanding under our revolving credit facility with Fleet, and other long-term debt of $2.5 million. Under the terms and conditions of our revolving credit facility, as of December 31, 2003, we have additional borrowing capacity of approximately $4.7 million after consideration of borrowing base limitations. We are not subject to any other standby letters of credit, guarantees, repurchase obligations, or other commitments. We have no off-balance sheet arrangements.

The following table summarizes our contractual obligations as of December 31, 2003:

Our revolving credit facility with Fleet is senior to all other debt and includes a line of credit that is limited to $15 million, subject to borrowing base restrictions. The line of credit is collateralized by eligible trade accounts receivable and substantially all of the other assets of the Company and its subsidiaries. Eligible trade accounts include any account arising in the ordinary course of ENGlobal’s or any of its subsidiaries’ business, which are due and unpaid no more than 90 days after the original invoice date. Our financial covenants under the senior credit facility are based on monthly senior debt to EBITDA, cumulative fixed charge ratio, and cost in excess of billings maximum amount. Negative covenants in the agreement require us to obtain Fleet’s written consent before making capital expenditures which in the aggregate exceed the 2003 limit of $1.2 million. The loan agreement also limits collateral eligibility on accounts arising out of fixed cost contracts to a total unpaid amount to $3.0 million and on performance accounts with respect to accrued time on cost reimbursable contracts to $5.0 million. The loan agreement places limits on concentration of accounts receivable balances of any one client. Our ability to borrow is effected if any client (except ExxonMobil) has 20% of the net amount of all eligible accounts. ExxonMobil’s concentration balance is limited to 30% of the net amount of all eligible accounts. The line of credit matures on June 14, 2005 at which time we intend to refinance with Fleet or another bank. The interest rate on the line of credit is one-quarter of one percent plus prime (4.25% at December 31, 2003), and the commitment fee on the unused line of credit is 0.375%.

Our credit facility with Fleet Capital Corporation requires that we report monthly to Fleet on the status of our compliance with our covenants. The breach of specific covenants, as well as other events, constitute an “Event of Default” under the terms of the agreement. Upon the occurrence and during the continuance of an Event of Default, all or any portion of the obligations under the agreement shall, at the option of Fleet, become due and payable. Also, while an Event of Default exists, the principal amount of all loans bears interest at a rate per annum equal to two percent above the current rate. The Company must meet all covenants through the maturity date of the credit facility. We believe that the Company will remain in compliance with all the loan covenants although no assurances can be given that we will be able to do so. The credit facility between Fleet and the Company was modified to increase the limit on 2003 capital expenditures to $1.2 million.

We also have three long-term notes, subordinate to the Fleet debt:

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In connection with our merger with Petrocon, we issued 2,500,000 shares of our Series A convertible preferred stock to Equus II Incorporated, entitling Equus to receive cumulative dividends at an annual rate of 8.0% payable in cash or in kind. Stock dividends of 88,000 shares of preferred stock were issued in 2002, and 146,833 shares were issued in 2003. In August 2003, the Company elected to convert all outstanding preferred stock held by Equus to 1,149,089 shares of common stock.

Cash Flow

Operating activities provided net cash totaling $6.6 million, $1.3 million, and $744,000 during fiscal years 2003, 2002, and 2001, respectively. Much of the increase in our cash flow from operating activities is attributable to the growth in our engineering segment.

Investing activities used cash totaling $471,000 in 2003, compared to $1.3 million in 2002; they provided $5,000 in 2001. In 2003, our investing activities consisted of capital additions of $1.1 million primarily for computers and leasehold improvements to our Beaumont office. We used $425,000 for the acquisitions of Senftleber and Petro-Chem. Partially offsetting these expenditures were cash proceeds from the sale of our building in Baton Rouge and from the sale of Thermaire.

Financing activities used cash totaling $6.1 million and $1.2 million, and provided cash of $253,000 during 2003, 2002, and 2001, respectively. Our primary financing mechanism is our revolving line of credit with Fleet. The line of credit has been used principally to finance accounts receivable. During 2003, our payments, net of borrowings, on the line of credit were $4.5 million, and we repaid an aggregate of $1.1 million on our long-term debt to Equus and PAL.

The merger with Petrocon in December 2001 was a $23.8 million non-cash purchase transaction made through the issuance of common and preferred stock and assumption of debt. Non-cash transactions include the issuance of stock dividends of $102,000 and $88,000 during 2003 and 2002, respectively. During 2003, our preferred stock was converted to common stock valued at $2,735,000. We also acquired insurance with notes payable of $1,085,000, $772,000, and $228,000 in 2003, 2002, and 2001, respectively.

We received tax refunds of $390,000 in 2002 from state authorities for franchise taxes related to prior years for the Petrocon companies. No such refunds were received in 2003.

The Company believes that it has available necessary cash for operations for the next 12 months. Cash and the availability of cash could be materially restricted if circumstances prevent the timely internal processing of invoices into accounts receivable, if such accounts are not collected within 90 days of the original invoice date, or if our project mix shifts from cost reimbursable to fixed cost contracts during significant periods of growth.

Our loan agreement places limits on our ability to borrow based on the concentration of sales to individual clients. The accounts receivable balance of any one customer (except ExxonMobil) may not exceed 20% of all net eligible accounts. ExxonMobil’s concentration balance is limited to 30% of all net eligible accounts. As of December 31, 2003, our additional borrowing capacity was reduced by $865,000 due to the concentration limit.

If losses occur, we may not be able to meet our monthly fixed charge ratio covenant under our credit facility with Fleet. In that event, if we are unable to obtain a waiver or amendment of the covenant, we may be unable to make further borrowings and may be required to repay all loans then outstanding under the credit facility.

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We do not hold any derivative financial instruments for trading purposes or otherwise. Furthermore, we have not engaged in energy or commodity trading activities and do not anticipate doing so in the future, nor do we have any transactions involving unconsolidated entities or special purpose entities.

Asset Management

We typically sell our products and services on short-term credit terms and seek to minimize our credit risk by performing credit checks and conducting our own collection efforts. Our trade accounts receivable increased to $20.2 million from $16.0 million as of December 31, 2003 and 2002, respectively, primarily due to increased sales in the Beaumont area. Some of our contract terms specify a shortened five-day payment cycle. This has reduced the number of days outstanding for trade accounts receivable from 65 days at December 31, 2002 to 54 days at December 31, 2002. Bad debt expenses have been insignificant (approximately 0.2% of revenues and 0.2% of revenues in 2003 and 2002, respectively). We have increased our allowance for doubtful accounts from $282,000 to $376,000, or 1.7% and 1.8% of the trade accounts receivable balance for 2002 and 2003, respectively.

Related Party Transactions

ENGlobal Engineering leases office space from PEI Investments, a joint venture in which ENGlobal Engineering has a one-third interest, Michael L. Burrow (the Company’s CEO) has a one-third interest, and a stockholder who owns less than 1% of the Company’s common stock has a one-third interest. Rentals paid under the lease were $100,000 for each of 2003, 2002 and 2001. The lease expires in 2005. We believe that this lease is at a commercially reasonable rental rate.

Risk Management

In performing services for our clients, we could potentially be liable for breach of contract, personal injury, property damage, or negligence, including professional errors and omissions. We often agree to indemnify our clients for losses and expenses incurred as a result of our negligence and, in certain cases, the concurrent negligence of the clients. Our quality control and assurance program includes a control function to establish standards and procedures for performance and for documentation of project tasks, and an assurance function to audit and to monitor compliance with procedures and quality standards. We maintain liability insurance for bodily injury and third-party property damage, professional errors and omissions, and workers compensation coverage, which we consider sufficient to insure against these risks, subject to self-insured amounts.

Holidays and employee vacations during our fourth quarter exert downward pressure on revenues for that quarter, which is only partially offset by the year-end efforts on the part of many clients to spend any remaining funds budgeted for engineering services or capital expenditures during the year. The annual budgeting and approval process under which these clients operate is normally not completed until after the beginning of each new year, which can depress results for the first quarter. Principally due to these factors, our revenues during the first and fourth quarters generally tend to be lower than in the second and third quarters.

Critical Accounting Policies

Revenue Recognition—Our revenues are largely composed of engineering service revenue and product sales. We recognize service revenue as soon as such services are performed and we recognize revenue from the sales of products upon shipment to the customer. The majority of our services are provided through time-and-material contracts (also referred to as cost-plus contracts), many of which have not-to-exceed provisions that place a cap on the revenue that we may receive under a particular contract. These time and material billings are produced every two weeks.

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On occasion, we serve as purchasing agent, procuring subcontractors, material, and equipment on behalf of a client and passing the cost on to the client with no mark-up or profit. In accordance with Statement of Position (“SOP”) 81-1, revenues and costs for these type purchases are not included in total revenues and costs. For financial reporting this “pass-through” type of transaction is reported net.

Profits and losses on fixed-fee contracts are recorded on the percentage-of-completion method of accounting, measured by the percentage-of-contract costs incurred to date to estimated total contract costs for each contract. Contract costs include amounts paid to subcontractors. Anticipated losses on uncompleted construction contracts are charged to operations as soon as such losses can be estimated. Changes in job performance, job conditions, estimated profitability and final contract settlements may result in revisions to costs and income and are recognized in the period in which the revisions are determined.

The asset, “costs and estimated earnings in excess of billings on uncompleted contracts,” represents revenues recognized in excess of amounts billed on fixed-fee contracts. The liability “billings in excess of costs and estimated profits on uncompleted contracts” represents amounts billed in excess of revenues recognized on fixed-fee contracts.

Use of Estimates—The preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in these financial statements and accompanying results. Actual results could differ from these estimates. One example includes the estimates of uncollectability of our accounts receivable. Management specifically analyzes the accounts receivable balances, historical bad debts, customer credit-worthiness, and changes in our customers’ payment trends when evaluating the provisions for bad debts.

Goodwill—In conjunction with each acquisition, we must allocate the cost of the acquired entity to the assets and liabilities assumed based on their estimated fair values at the date of acquisition. As additional information becomes available, adjustments may be made to the original estimates within a short time subsequent to the acquisition. Goodwill is not amortized but instead is periodically assessed for impairment. The impairment testing entails estimating current market value of the segments, based on management’s estimate of market conditions including pricing, demand, competition, operating costs and other factors. Determining the fair value of assets and liabilities acquired involves professional judgment and is ultimately based on management’s assessment of the value of the assets acquired. We believe our estimates for these items are reasonable, but there is no assurance that actual amounts will not vary significantly from estimated amounts. Consistent with SFAS 142, we have not amortized goodwill related to the merger with Petrocon, but instead tested the balance for impairment.

Litigation—We are subject to legal proceedings and claims that have arisen in the ordinary course of its business. Based on legal analysis and advice from our attorneys, allowances have been made for any litigation that management believes could have a material adverse effect on our financial condition or results of operations.

Principles of Consolidation—The consolidated financial statements include the accounts of ENGlobal and all wholly owned subsidiaries. ENGlobal owns 100% of all of its affiliates. All intercompany transactions and accounts are eliminated in the consolidation.

Recent Accounting Pronouncements

SFAS No. 150, issued in May 2003, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, establishes standards for the measurement and classification of such financial instruments. If the instrument has characteristics of liability, it is to be classified as a debt instrument. The effective date of the statement is June 15, 2003. We have adopted the statement; however, management does not believe the effect of adopting this statement will have a material impact on our financial position, results of operations, or cash flows.

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In January 2003, the Financial Accounting Standard Board (“FASB”) issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities,” FIN 46 clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” and addresses consolidation by business enterprises of variable interest entities (more commonly known as “Special Purpose Entities” or “SPE’s”). In December 2003, FASB issued FIN No. 46R which replaced FIN 46 and clarified ARB 51. This interpretation provides guidance on how to identify a variable interest entity and determine when the assets, liabilities, non-controlling interests and results of operations of a variable interest entity should be consolidated by the primary beneficiary. The primary beneficiary is the enterprise that will absorb a majority of the variable interest entity’s expected losses or receive a majority of the expected residual returns as a result of holding variable interests. This FIN requires the consolidation of results of variable interest entities in which the Company is the primary beneficiary of the variable interest entity. As of December 31, 2003, the Company did not own an interest in a variable interest entity that met the consolidation requirements and as such the adoption of FIN No. 46R did not have any effect on the financial condition, results of operations, or liquidity of the Company. Interests in entities acquired or created after December 31, 2003 will be evaluated based on FIN No. 46R criteria and consolidated, if required.

Item 7A.    Quantitative and Qualitative Disclosures About Market Risk

As of December 31, 2003 and 2002, the Company did not participate in any derivative financial instruments or other financial and commodity instruments for which fair value disclosure would be required under SFAS No 107. There are no investments at December 31, 2003. Accordingly, the Company has no quantitative information concerning the market risk of participating in such investments.

As of December 31, 2003 and 2002, the Company did not participate in any derivative financial instruments or other financial and commodity instruments for which fair value disclosure would be required under SFAS No. 133.

The Company has no market risk exposure in the areas of interest rate risk because there is no investment portfolio as of December 31, 2003. Currently, the Company does not engage in foreign currency hedging activities nor is the Company exposed to currency exchange rate fluctuation.

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Item 8.    Financial Statements and Supplementary Data

The audited consolidated balance sheets for ENGlobal Corporation, as of December 31, 2003 and 2002 and statements of income, cash flows, and stockholders’ equity for the three-year period ended December 31, 2003, are attached hereto and made part hereof.

INDEX

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INDEPENDENT AUDITOR’S REPORT

To the Board of Directors and Stockholders

ENGlobal Corporation

We have audited the accompanying consolidated balance sheets of ENGlobal Corporation as of December 31, 2003 and 2002, and the related consolidated statements of income, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2003. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of ENGlobal Corporation and Subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.

/s/ Hein & Associates LLP

Hein & Associates LLP

Houston, Texas

March 12, 2004

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ENGLOBAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

December 31, 2003 and 2002

See accompanying notes to these consolidated financial statements.

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ENGLOBAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME