ENGLOBAL CORP - Quarter Report: 2003 June (Form 10-Q)

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

       For the quarterly period ended June 30, 2003

Commission File Number: 001-14217

ENGlobal Corporation

(Exact name of registrant as specified in its charter)

Nevada

(State or, other Jurisdiction of

corporation or organization)

88-0322261

(I.R.S. Employer Identification Number)

(281) 821-3200

(Registrant’s telephone number, including area code)

Indicate by check mark whether the issuer (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 shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x  No  ¨

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the close of business of July 25, 2003.

Table of Contents

QUARTERLY REPORT ON FORM 10-Q

FOR THE PERIOD ENDED JUNE 30, 2003

TABLE OF CONTENTS

i

Table of Contents

ENGlobal Corporation

Condensed Consolidated Statements Of Income

(Unaudited)

See accompanying notes to interim condensed consolidated financial statements.

1

Table of Contents

ENGlobal Corporation

Condensed Consolidated Balance Sheets

See accompanying notes to interim condensed consolidated financial statements.

2

Table of Contents

ENGlobal Corporation

Condensed Consolidated Statements Of Cash Flows

(Unaudited)

See accompanying notes to interim condensed consolidated financial statements.

3

Table of Contents

ENGlobal Corporation

Notes To Condensed Consolidated Financial Statements

The condensed consolidated financial statements of ENGlobal Corporation, (“ENGlobal” or the “Company”), included herein, are unaudited for the six-month period ended June 30, 2003 and 2002. These financial statements reflect all adjustments (consisting of normal recurring adjustments), which are, in the opinion of management, necessary to fairly depict the results for the periods presented. Certain information and note disclosures, normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America, have been condensed or omitted pursuant to rules and regulations of the Securities and Exchange Commission. It is suggested these condensed financial statements be read in conjunction with the Company’s audited financial statements for the years ended December 31, 2002 and 2001, which are included in the Company’s annual report on Form 10-K. The Company believes that the disclosures made herein are adequate to make the information presented not misleading.

On June 6, 2002, the stockholders voted on a proposal to amend the Articles of Incorporation to change the name of the Company from Industrial Data Systems Corporation to ENGlobal Corporation. The Company believes the new name reflects its broader capabilities and vision for future growth, providing a common identity, which will build name recognition and credibility among existing and potential customers.

The ENGlobal name change has been adopted by the Company’s operating subsidiaries effective January 25, 2003 (except Thermal Corporation).

The Company has a Credit Facility with Fleet Capital Corporation (“Fleet”) that consists of a line of credit. The loan agreement positions the Fleet debt as senior to all other debt. The line of credit is limited to $15,000,000, subject to borrowing base restrictions. The Credit Facility is collateralized by substantially all the assets of the Company. The outstanding balance on the line of credit as of June 30, 2003 was $10,321,000. The Credit Facility matures on June 30, 2005. The interest rate is one-quarter of one percent plus prime (4.25 percent at June 30, 2003), and the commitment fee on the unused line of credit is 0.375 percent. The remaining borrowings available under the line of credit as of June 30, 2003, were $3,035,000 after consideration of the borrowing base limitations. The Company’s Credit Facility contains covenants which require the maintenance of certain ratios, including cumulative fixed charge coverage and debt coverages and specified levels of certain other items.

An amendment to the Credit Facility was agreed upon between Fleet and the Company effective June 30, 2003 whereby the annual capital expenditures limit for 2003 increases from $600,000 to $1,200,000. The amendment also includes more favorable terms on eligible accounts, increasing the sub-limits on unbilled amounts.

4

Table of Contents

ENGlobal Corporation

Notes To Condensed Consolidated Financial Statements

Current notes payable include a note which finances commercial insurance on a short-term basis, with a balance of $68,000 and $485,000 as of June 30, 2003 and December 31, 2002, respectively.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, effective for quarters beginning after June 15, 2003. SFAS No. 150 establishes standards for classification and measurement of certain financial instruments with characteristics of both liabilities and equity. Effective July 1, 2003, ENGlobal will adopt SFAS No. 150 at which time $2,690,000 of mandatory redeemable preferred stock will be reclassified as a liability. The adoption of SFAS No. 150 and the resulting reclassification of mandatory redeemable preferred stock will not have a material impact on the Company’s consolidated financial statements.

One stockholder, Equus II Incorporated, holds the Company’s Series A Convertible Preferred Stock, $0.001 par value per share. Dividends on outstanding shares of Series A Convertible Preferred Stock are payable annually on the last day of May at a rate of 8% of the liquidation amount that is $1.00 per share plus accrued and unpaid dividends. Dividends may be paid in cash, or at the option of the Company, in shares of Series A Convertible Preferred Stock. On May 31, 2003, the Company issued 102,000 shares of Series A Convertible Preferred Stock as a stock dividend and paid $105,040 in cash.

5

Table of Contents

ENGlobal Corporation

Notes To Condensed Consolidated Financial Statements

The Company’s plan to pursue potential acquisitions of complementary businesses was realized on December 21, 2001 through its merger with Petrocon (the “Merger”). The Company entered into a letter of intent on April 3, 2001 to acquire, through merger with a wholly owned subsidiary, Petrocon Engineering, Inc., an engineering support services company, with offices along the Texas and Louisiana gulf coast, in exchange for 9,800,000 shares of the Company, valued at $0.71 per share. The purchase price totaled $23,806,000. The transaction was financed by issuance of common stock valued at $6,637,000, net of registration costs, issuance of preferred stock with a liquidation value of $2,500,000 and assumption of debt totaling $13,737,000. The purchase resulted in the recognition of goodwill of $13,211,000, and deferred tax assets.

In accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” goodwill is no longer amortized over its estimated useful life, but rather will be subject to at least an annual assessment for impairment. The initial test for impairment, as of January 1, 2002, was completed by the end of the second quarter of 2002 and no impairment occurred. The second annual test for impairment was completed effective January 1, 2003 and no impairment occurred.

Effective June 30, 2003, the Company acquired selected assets of Petro-Chem Engineering, Inc., an engineering services firm in Freeport, Texas. This asset acquisition was financed by issuing a $100,000 note payable for assets with a fair value of $25,000, resulting in $75,000 in goodwill. The June 30, 2003 balance in the goodwill account increased to $13,286,628 as a result of this acquisition.

Costs, estimated earnings and billings on uncompleted contracts consisted of the following at June 30, 2003 and December 31, 2002 (in thousands):

The Company benefited from Petrocon’s net operating loss carryforwards at the time of the Merger. Based on the completion of the research and advice of tax counsel, the realization of an additional net operating loss carryforward asset is available to the Company. The Company has net

6

Table of Contents

ENGlobal Corporation

Notes To Condensed Consolidated Financial Statements

operating loss carryforwards of approximately $1,592,000 as of December 31, 2002 with an annual limitation of $1,176,000. Current and non-current deferred tax assets representing the net operating loss carryforward and other timing differences total $464,000 and $863,000 as of June 30, 2003 and December 31, 2002, respectively. The reduction in deferred tax assets during the six months ended June 30, 2003 reflects the expected usage of net operating loss carryforwards in 2003 to offset taxable income.

The Company accounts for its nonqualified incentive stock option plan under the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees and related interpretations. Accordingly, no stock-based compensation cost is reflected in the net income, as all options granted under those plans were equal to the market value of the Company’s stock on the date of grant. The following table illustrates the effect on net income and earnings per share for the six months ended and three months ended June 30, 2003 and 2002, if the Company had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS 148, Accounting for Stock-Based Compensation Transition and Disclosure, issued in December 2002.

7

Table of Contents

ENGlobal Corporation

Notes To Condensed Consolidated Financial Statements

The Company operates in three business segments: (1) engineering services, primarily to major integrated oil and gas companies; (2) engineered systems, providing design and implementation of control systems for specific applications primarily in the energy and process industries, uninterruptible power systems and battery chargers; and (3) manufacturing of air handling equipment for commercial heating, ventilation and cooling systems. Sales and operating income set forth in the following table are the results of these segments.

Segment information was as follows (in thousands):

8

Table of Contents

Forward-Looking Statements

Certain information contained in this Form 10-Q Quarterly 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 Securities and Exchange Commission, press releases, conferences, or otherwise, may be deemed to be forward-looking statements with the meaning of Section 21E of the Securities Exchange Act of 1934. This information includes, 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. Actual results could differ materially from the results described in the forward-looking statements due to the risks and uncertainties set forth with this Quarterly Report on Form 10-Q.

The following discussion is qualified in its entirety by, and should be read in conjunction with, the Company’s Consolidated Financial Statements including the notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.

Update on the Sale of Thermal

The transaction for the sale of the Company’s wholly owned subsidiary, Thermaire, Inc. d/b/a Thermal Corporation (“Thermal”) has yet to close due to the inability of the potential buyer, Pivot Group LLC, to secure adequate financing. This transaction is unlikely to close prior to December 31, 2003, and the Company may have to seek other buyers. The Company has contracted with the Pivot Group LLC to provide dedicated management services to Thermal through the end of the current year.

Results of Operations

The following is a discussion of the results of operations for the second quarter and first six months of 2003 compared to the second quarter and first six months of 2002 with a discussion of the changes in financial condition during the first six months of 2003.

Three Months Ended June 30, 2003 Compared to Three Months Ended June 30, 2002

Total Revenue. Total revenue increased by $7,080,000 or 31.0% for the three months ended June 30, 2003 compared to the three months ended June 30, 2002. The engineering services and engineered systems segments reported an increase in sales during the period; manufacturing incurred a decline.

9

Table of Contents

Revenues in the engineering services segment increased $6,632,000 (35.6%) to $25,257,000 for the three-month period ended June 30, 2003. The revenue increase resulted primarily from several large projects including an EPC project (engineering, procurement, and construction) in the Beaumont office that began in early 2003, the engineering and construction management portion of that project being awarded in the fall of 2002 and the procurement portion being awarded in late December 2002. The procurement phase commenced during the three months ended June 30, 2003 and will be performed on a cost plus basis, providing an estimated $28 million in total revenues over the life of the project. Revenues recognized from procurement activities during the period totaled $4,800,000. The Beaumont office, our largest office, achieved a 129% increase in revenues or $6,963,000 over last year for the three months ended June 30. Excluding the revenues generated from the procurement activities, our core business in Beaumont, engineering services, increased $2,163,000 or 40%. Several other locations experienced improvements in revenues, including Tulsa and Lake Charles, where new clients contributed to the increases. Partially offsetting these increases, the Baton Rouge and Houston offices continued to see declines in revenues due to the market conditions in their respective areas.

The engineered systems segment, which represents 13.4% of total revenues increased by $575,000 or 16.7% from $3,440,000 for the three months ended June 30, 2002 to $4,015,000 for the same period in 2003. This increase occurred at ENGlobal Systems resulting from large fixed price sales of remote instrument enclosures to two clients. Partially offsetting this increase was the ENGlobal Constant Power (“ECP”) decrease in revenues of over $800,000. In our opinion, the market has not rebounded for battery chargers or UPS systems. The ECP sales department has been reorganized to enhance marketing activities.

The manufacturing segment decreased in revenues for the three months ended June 30, 2003 by $127,000 or 16.9% from $749,000 for the three months ended June 30, 2002 to $622,000 for the same period in 2003. We attribute the lower than normal revenues in 2002 to the lingering effects of the September 11, 2001 terrorist attack. Economic conditions during 2003 have continued to exert downward pressure on Thermal, which operates in a very competitive market.

10

Table of Contents

Gross Profit. The gross profit increased $408,000 or 10.3% for the three months ended June 30, 2003 as compared to the three months ended June 30, 2002. Gross profit and percentage of revenue follows:

Due to increased sales, gross profit for the engineering services segment increased by $692,000 during the three months ended June 30, 2003 as compared to the same period in 2002. The margin decreased from 16.6% to 15.0% due primarily to large material purchases on an EPC project, which have a lower markup and tend to deflate the overall gross profit percentage. The margin for our core business, engineering services, after excluding the procurement activities, increased to 17.3% in this segment.

The engineered systems segment gross profit decreased $211,000 or 32.3% from $653,000 to $442,000 for the three months ended June 30, 2002 and 2003, respectively. Gross profit as a percent of revenue declined from 19.0% in 2002 to 11.0% for the same period in 2003. This deterioration in gross profit from 2002 to 2003 was due primarily to budget over-runs on three fixed price projects coupled with competitive market pressures on contract pricing. Additionally, the loss of revenues at ECP resulted in a net loss in this area for the three months ended June 30, 2003. Due to the rapid growth in revenues at ESI, new initiatives have been put in place to strengthen administrative and support service controls.

The manufacturing segment also saw a decrease in gross profit by $73,000 or 34.8% for the three months ended June 30, 2003 compared to the same period for 2002. Competition on pricing forced Thermal to lower their margins in order to compete for projects.

Selling, General, and Administrative. Expenses related to selling, general and administrative, including depreciation and amortization increased $404,000 or 15.0% for the three months ended June 30, 2003 as compared to the same period in 2002. A majority of the increased costs resulted from the creation of a business development department in the corporate division, which combined all marketing activities for engineering services and added several new marketing representatives. These salaries and expenses added approximately $300,000 in expenses to the increase for the three months ended June 30, 2003.

Operating Income. Operating income increased by $4,000 to $1,064,000 for the three months ended June 30, 2003, compared to $1,060,000 for the same period in 2002. Operating income did not increase along with the 31.0% increase in revenues because the direct cost on engineering services projects contained large material purchases which have lower markups, tending to deflate the profits. Also contributing to the lower levels of operating income were cost overruns on systems projects, and higher marketing, general, and administrative expenses.

11

Table of Contents

Net Income. Net income after taxes increased by $35,000 or 7.0% from $499,000 to $534,000 for the three months ended June 30, 2002 and 2003, respectively. As a percentage of total revenue, the net income percentage decreased from 2.2% to 1.8%.

Six Months Ended June 30, 2003 Compared to Six Months Ended June 30, 2002

Total Revenue. Total revenue increased by $9,981,000 or 22.9% for the six months ended June 30, 2003 compared to the six months ended June 30, 2002. The engineering services segment and the engineered systems segment each reported increases in sales during the period.

The engineering services segment increased revenues by $7,073,000, or 19.4%, to $43,572,000 during the six months ended June 30, 2003. The revenue increase in engineering services resulted from several large projects including a large EPC project (engineering, procurement, and construction), in the Beaumont office which began in early 2003. The engineering and construction management portion of this project was awarded in the fall of 2002 and the procurement portion was awarded in late December 2002. The procurement phase commenced during the three months ended June 30, 2003 and will be performed on a cost plus basis, providing an estimated $28 million in total revenues over the life of the project. Revenues recognized from procurement activities during the period total $5,500,000. The Beaumont office, our largest office, experienced a 64% or $9,318,000 increase in revenues for the six months ended June 30, 2003 over the same period in 2002. Excluding the revenues generated from the procurement activities, our core business in Beaumont, engineering services, increased $3,818,000 or 36.9%. Lake Charles and Tulsa revenues improved during the six months ended June 30, 2003 versus the six months ended June 30, 2002 due to new clients. Baton Rouge revenues for the six months ended June 30, 2003 lagged behind the revenues for the same period in 2002 due to the completion of lump sum projects and the general economic malaise in Louisiana.

12

Table of Contents

Revenues in the engineered systems segment, which represents 16.3% of total revenues increased by 52.0% or $2,978,000 from $5,728,000 in revenues for the six months ended June 30, 2002 to $8,706,000 in revenues for the same period in 2003. Rapid growth occurred at ENGlobal Systems with increasing revenues of approximately $3,900,000. This growth is attributable to large fixed-price sales of remote instrument enclosures to two clients. Offsetting this increase was a decrease in revenues at ECP. We believe that the market has not rebounded for battery chargers or UPS systems. The ECP sales department has been reorganized to enhance marketing activities.

Revenues in the manufacturing segment decreased for the six months ended June 30, 2003 by $70,000 or 5.4% from $1,290,000 for the six months ended June 30, 2002 to $1,220,000 for the same period in 2003. Revenues in 2002 were lower than normal due to the lingering effects of the September 11, 2001 terrorist attack that significantly impacted the market. Economic conditions during 2003 have continued to put pressure on Thermal which operates in a very competitive market.

Gross Profit. The gross profit increased $1,303,000 or 18.2% for the six months ended June 30, 2003 as compared to the six months ended June 30, 2002. Gross profit and percentage of revenue follows:

The gross profit in the engineering services segment improved from 15.6% to 15.8%. The improved margins resulted in a $1,219,000 increase over 2002 due primarily to better utilization of manpower, partially offset by the reduced margins on large material procurement on the EPC project. The margin for our core business, engineering services, after excluding procurement activities, increased to 17.4% in this segment.

The engineered systems segment gross profit increased $100,000 or 8.8% from $1,145,000 to $1,245,000 for the six months ended June 30, 2002 and 2003, respectively. However, gross profit as a percent of revenue declined from 20.0% in 2002 to 14.3% for the same period in 2003. This decline in gross profit was due primarily to budget over-runs on three fixed-price projects and competitive market pressures on contract pricing. Due to the rapid growth in revenues at ESI, new initiatives have been put in place to strengthen the administrative and support service controls. Gross profit for ECP decreased due to the loss in revenues during the period.

Gross profit in the manufacturing segment decreased by $16,000 or 4.7% for the six months ended June 30, 2003 compared to the same period for 2002. This decrease was due to competition in pricing partially offset by a reduction in contract labor costs and decreased expenses during the first quarter of 2003.

Selling, General, and Administrative. Expenses related to selling, general and administrative, including depreciation and amortization increased $828,000 or 14.9% for the six months ended June 30, 2003 as compared to the same period in 2002. A majority of the increase resulted from the creation of a business development department in the corporate division, which combined all marketing activities for engineering services and added several new

13

Table of Contents

marketing representatives. These salaries and expenses contributed approximately $500,000 to the increase for the first six months of 2003 with an additional $40,000 in direct advertising. Other sources of increased expenses during 2003 related to increased consulting services for the accounting system of $115,000 and related depreciation for the accounting system, which increased by $60,000, and approximately $90,000 in additional corporate governance and investor relations expenses.

Operating Income. Operating income increased by $476,000 to $2,095,000 for the six months ended June 30, 2003, compared to $1,619,000 for the same period in 2002. As a percentage of revenues, operating income increased from 3.7% to 3.9%. The increase is attributable primarily to the increased sales in the engineering services segment, which contributed $1,772,000 more in 2003 than in 2002 to operating income before deducting corporate selling, general, and administrative expenses.

Net Income. Net income after taxes increased by $276,000 or 36.1% from $765,000 to $1,041,000 for the six months ended June 30, 2002 and 2003, respectively. As a percentage of total revenue, the net income percentage increased from 1.8% to 1.9%.

Liquidity and Capital Resources

The Company has a financing arrangement with Fleet Capital Corporation (“Fleet”) known as the Credit Facility, which is comprised of a line of credit. The loan agreement positions the Fleet debt as senior to all other debt with the line of credit limited to $15,000,000, subject to borrowing base restrictions. The Credit Facility is collateralized by substantially all the assets of the Company. At June 30, 2003, $10,321,000 was outstanding on the line of credit. The Credit Facility matures on June 30, 2005. The interest rate is one-quarter of one percent plus prime, and the commitment fee on the unused line of credit is 0.375 percent. The remaining borrowings available under the line of credit as of June 30, 2003 were $3,035,000 after consideration of the borrowing base limitations. The Company’s Credit Facility contains covenants, which require the maintenance of certain ratios, including cumulative fixed charge coverage and debt coverages and specified levels of certain other items.

An amendment to the Credit Facility was agreed upon between Fleet and the Company effective June 30, 2003 whereby the annual capital expenditures limit for 2003 increases from $600,000 to $1,200,000. The amendment also includes more favorable terms on eligible accounts, increasing the sub-limits on unbilled amounts.

The Company must meet all covenants through the maturity date of the Credit Facility. The Company is currently in compliance and Management believes it will remain in compliance with all loan covenants, although no assurances can be given regarding such compliance.

As of June 30, 2003, Management believes the Company’s cash position was sufficient to meet its working capital requirements. EBITDA (earnings before interest, taxes, depreciation and amortization) for the six months ended June 30, 2003 was $2,495,000. Any future decrease in demand for the Company’s services or products would reduce the availability of funds through operations.

The Company benefited from Petrocon’s net operating loss carryforwards at the time of the Merger. Based on the research and advice of tax counsel, the realization of an additional net operating loss carryforward asset is available to the Company. The Company has net operating loss carryforwards of approximately $1,592,000 as of December 31, 2002 with an annual limitation of $1,176,000. Current and non-current deferred tax assets representing the net operating loss carryforward and timing differences total $464,000 and $863,000 as of June 30, 2003 and December 31, 2002, respectively. The reduction in deferred tax assets during the six months ended June 30, 2003 reflects the expected usage of net operating loss carryforwards in 2003 to offset taxable income.

The Company’s working capital was $9,780,000 and $8,955,000 at June 30, 2003 and December 31, 2002, respectively. The increase in working capital resulted primarily from the growth of trade receivables, attributable to the increased sales.

14

Table of Contents

The Company had long-term debt outstanding of $13,281,000 and $13,323,000 as of June 30, 2003 and December 31, 2002, respectively. This long-term debt includes the Credit Facility of $10,321,000 on the line of credit as of June 30, 2003 that matures on June 30, 2005.

One component of our business strategy is to expand our presence in new or existing markets by acquiring additional businesses. We may acquire businesses using cash, equity and debt, with some acquisitions also involving assumed liabilities and contingent payments. Acquisitions involve a number of special risks, including:

We may not be able to identify, acquire or profitably manage additional businesses or integrate successfully any acquired businesses without substantial expense, delay or other operational or financial problems. Without additional acquisitions, we are unlikely to maintain historical growth rates.

Cash Flow

Operating activities provided net cash totaling $1,289,000 and $1,932,000 for the six months ended June 30, 2003 and 2002, respectively. The decrease in cash provided by operating activities primarily reflects the increase in trade receivables for the period ended June 30, 2003 as compared to the same period in 2002.

Investing activities used cash totaling $738,000 for the six months ended June 30, 2003 and $151,000 for the same period in 2002. The Company’s investing activities that used cash during the period ended June 30, 2003 consisted of leasehold improvements being made on our Beaumont offices, purchases of computer equipment and software, and web site development.

Financing activities used cash totaling $572,000 for the six months ended June 30, 2003, as compared to $2,957,000 for the same period in 2002. The decrease in cash used for financing activities reflects lower net payments on the line of credit in 2003 as compared to 2002.

The Company believes that it has adequate access to cash for the next 12 months through expected operating cash flow and availability under the line of credit. Cash and the availability of cash, could be materially restricted if circumstances prevent the timely internal processing of invoices into receivable accounts, if such accounts are not collected within 90 days of the original invoice date, if project mix shifts from cost reimbursable to fixed costs contracts during significant periods of growth, or if ENGlobal is not able to meet the monthly covenants of the Fleet Credit Facility. If any such events occur the Company would be forced to consider alternative financing options.

15

Table of Contents

Asset Management

The Company’s cash flow from operations has been affected primarily by the timing of its collection of trade accounts receivable. The Company typically sells its products and services on short-term credit terms and seeks to minimize its credit risk by performing credit checks and conducting its own collection efforts. The Company had net trade accounts receivable of $17,371,000 and $16,492,000 at June 30, 2003 and December 31, 2002, respectively. The number of days’ sales outstanding in trade accounts receivable was 57 days and 60 days, respectively.

Our financial instruments include cash and cash equivalents, accounts receivable, accounts payable, notes and capital leases payable, and debt obligations. The book value of cash and cash equivalents, accounts receivable, accounts payable and short-term notes payable are considered to be representative of fair value because of the short maturity of these instruments.

We do not utilize financial instruments for trading purposes and we do not hold any derivative financial instruments that could expose us to significant market risk. Our exposure to market risk for changes in interest rates relates primarily to our obligations under the Fleet Credit Facility. As of June 30, 2003, $10,321,000 had been borrowed under the line of credit, accruing interest at 4.25% per year, excluding amortization of prepaid financing costs. A ten percent increase in the short-term borrowing rates on the Credit Facility outstanding as of June 30, 2003 would be 43 basis points. Such an increase in interest rates would increase our annual interest expense by approximately $44,000 assuming the amount of debt outstanding remains constant.

The above sensitivity analysis for interest rate risk excludes accounts receivable, accounts payable and accrued liabilities because of the short-term maturity of such instruments. The analysis does not consider the effects this movement may have on other variables including changes in revenue volumes that could be indirectly attributed to changes in interest rates. The actions that Management would take in response to such a change are also not considered. If it were possible to quantify this impact, the results could well be different than the sensitivity effects shown above.

With the participation of Management, the Company’s chief executive officer and chief financial officer reviewed and evaluated the Company’s disclosure controls and procedures as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended as of a date within 90 days prior to the filing of this report. Based on this evaluation, the chief executive officer and chief financial officer concluded that the disclosure controls and procedures are effective in bringing to their attention on a timely basis information relating to the Company and its consolidated subsidiaries in connection with the Company’s filing of its quarterly report on Form 10-Q for the period ended June 30, 2003. There have been no significant changes in the Company’s internal controls for financial reporting or in other factors that could significantly affect these controls, including any significant deficiencies or material weaknesses of internal controls that would require corrective action. In connection with the new rules, the Company is currently in the process of further reviewing and documenting the disclosure controls and procedures, including its internal accounting controls, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that the Company’s systems evolve with its business.

16

Table of Contents

From time to time, the Company is involved in various legal proceedings arising in the ordinary course of business. The Company is currently party to legal proceedings that have been reserved for, are covered by insurance, or that, if determined adversely to us individually or in the aggregate, would not have a material affect on the Company’s results of operations.

Engineered Carbons, Inc. filed a claim in 2000 against the Company in the 60^th District Court of Jefferson County, Texas, alleging failure of contractual performance purportedly caused by faulty design. The claim is covered by the Company’s errors and omissions insurance. The Company has further reserved $100,000, the amount of its deductible under such insurance. This litigation remains pending and is in the discovery phase. Engineered Carbons has yet to specify the relief that it is seeking in the litigation.

The Company recently resolved a prior claim filed in 2000 by Arch Chemicals, Inc. in the 14^th District Court of the Parish of Calcasieu, Louisiana, alleging failure of contractual performance purportedly by faulty design. On April 26, 2003 a jury found that both Arch and the Company were concurrently negligent and required that the Company pay $17,740 to Arch, including interest, which is within the remaining balance of the reserve, after legal fees. Final settlement occurred during June 2003.

During the first six months of 2003, the Company (and/or its subsidiaries, in particular RPM Engineering, Inc.), and more than forty (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 located within the state of Louisiana. In 1994 AMEC Engineering, Inc. assigned the trade name “Barnard and Burk” to RPM Engineering, Inc. The Company’s indirect wholly owned subsidiary, ENGlobal Engineering, Inc., formerly known as Petrocon Engineering, Inc., acquired RPM (RPM along with the “Barnard and Burk” trade name) in 1996 pursuant to a stock purchase agreement with Willie E. Rigsby and Robert A. Marks (collectively, the “Sellers”). 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. In addition, AMEC has an obligation to indemnify RPM, and furthermore, the Company is seeking indemnification from the Sellers in connection with claims relating to products shipped or manufactured by, or any services provided by, RPM and any of its subsidiaries prior to Petrocon’s acquisition of RPM.

None.

None.

17

Table of Contents

The Annual Meeting of Stockholders of the Company was held on June 5, 2003 at 2:00 p.m. at the corporate offices of the Company in Houston, Texas. A total of 20,469,073 shares of common stock, which is 87.53% of the shares outstanding on April 8, 2003 were represented at the meeting, either in person or by proxy. The stockholders approved three proposals, solicited by proxy. The vote tabulations follow:

These were all the matters submitted to the Stockholders at the Annual Meeting.

None.

18

Table of Contents

May 14, 2003. Item 9. Regulation FD Disclosure. A press release regarding the first quarter results was issued on May 13, 2003 and a copy was filed with the SEC under Regulation FD on Form 8-K. (Headline: ENGlobal Reports Record First Quarter Results; EPS Doubles from Same Period 2002)

19

Table of Contents

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.