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

Form 10Q
Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

x   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2003

 

¨   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

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)

 

600 Century Plaza Drive, Suite 140, Houston, Texas

(Address of Principal Executive Offices)

 

77073-6033

(Zip Code)

 

(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 May 5, 2003.

 

$0.001 Par Value Common Stock

  

22,861,199 shares

 



Table of Contents

QUARTERLY REPORT ON FORM 10-Q

FOR THE PERIOD ENDED MARCH 31, 2003

 

TABLE OF CONTENTS

 

         

Page Number


Part I.

  

Financial Information

    

        Item 1.

  

Financial Statements

    
    

Condensed Consolidated Statements of Income for the Three Months ended March 31, 2003 and
March 31, 2002

  

1

    

Condensed Consolidated Balance Sheets at March 31, 2003 and December 31, 2002

  

2

    

Condensed Consolidated Statements of Cash Flows for the Three Months ended March 31, 2003 and March 31, 2002

  

3

    

Notes to Condensed Consolidated Financial Statements

  

4

        Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

  

8

        Item 3.

  

Quantitative and Qualitative Disclosures about Market Risk

  

11

        Item 4.

  

Controls and Procedures

  

11

Part II.

  

Other Information

    

        Item 1.

  

Legal Proceedings

  

11

        Item 2.

  

Changes in Securities and Use of Proceeds

  

12

        Item 3.

  

Defaults Upon Senior Securities

  

12

        Item 4.

  

Submission of Matters to a Vote of Security Holders

  

12

        Item 5.

  

Other Information

  

12

        Item 6.

  

Exhibits and Reports on Form 8-K

  

12

    

Signature

  

13

 

 

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Table of Contents

 

Part I.    Financial Information

Item 1.    Financial Statements

 

ENGlobal Corporation

Condensed Consolidated Statements Of Income

(Unaudited)

 

    

For The Three Months Ended March 31,

 
    

2003


    

2002


 

OPERATING REVENUES

  

$

23,603,480

 

  

$

20,702,727

 

OPERATING EXPENSES:

                 

Direct costs

  

 

19,484,451

 

  

 

17,478,606

 

Selling, general and administrative

  

 

2,842,414

 

  

 

2,444,228

 

Depreciation and amortization

  

 

246,130

 

  

 

220,390

 

    


  


    

 

22,572,995

 

  

 

20,143,224

 

    


  


Operating income

  

 

1,030,485

 

  

 

559,503

 

OTHER INCOME (EXPENSE):

                 

Other income (expense)

  

 

(29,681

)

  

 

117,073

 

Interest income (expense)

  

 

(201,658

)

  

 

(233,340

)

    


  


Total other income (expense)

  

 

(231,339

)

  

 

(116,267

)

    


  


INCOME BEFORE PROVISION FOR INCOME TAXES

  

 

799,146

 

  

 

443,236

 

PROVISION FOR INCOME TAXES

  

 

291,492

 

  

 

177,294

 

    


  


NET INCOME

  

 

507,654

 

  

 

265,942

 

PREFERRED DIVIDENDS

  

 

51,759

 

  

 

50,000

 

    


  


EARNINGS AVAILABLE TO COMMON SHAREHOLDERS

  

$

455,895

 

  

$

215,942

 

    


  


EARNINGS PER COMMON SHARE (BASIC)

  

$

0.02

 

  

$

0.01

 

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING (BASIC)

  

 

22,861,199

 

  

 

22,861,199

 

EARNINGS PER COMMON SHARE (DILUTED)

  

$

0.02

 

  

$

0.01

 

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING (DILUTED)

  

 

23,289,661

 

  

 

22,861,199

 

 

See accompanying notes to interim condensed consolidated financial statements.

 

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Table of Contents

 

ENGlobal Corporation

Condensed Consolidated Balance Sheets

 

ASSETS

  

March 31,

2003


  

December 31, 2002


    

(unaudited)

    

CURRENT ASSETS:

             

Cash

  

$

35,193

  

$

75,095

Accounts receivable—trade, less allowance for doubtful accounts of approximately $207,000 for 2003 and $209,000 for 2002

  

 

15,321,357

  

 

16,491,847

Inventory

  

 

495,652

  

 

531,575

Cost and estimated earnings in excess of billings on uncompleted contracts

  

 

2,168,619

  

 

2,043,603

Prepaid and other

  

 

672,881

  

 

759,330

Deferred tax asset

  

 

461,000

  

 

461,000

    

  

Total current assets

  

 

19,154,702

  

 

20,362,450

GOODWILL

  

 

13,211,628

  

 

13,211,628

PROPERTY AND EQUIPMENT, net

  

 

5,726,378

  

 

5,758,386

DEFERRED TAX ASSET

  

 

152,000

  

 

402,000

OTHER ASSETS

  

 

292,250

  

 

333,552

    

  

Total assets

  

$

38,536,958

  

$

40,068,016

    

  

LIABILITIES AND STOCKHOLDERS’ EQUITY

CURRENT LIABILITIES:

             

Accounts payable

  

$

3,576,667

  

$

4,039,818

Accrued compensation and benefits

  

 

4,840,131

  

 

3,900,499

Billings and estimated earnings in excess of cost on uncompleted contracts

  

 

980,705

  

 

811,845

Other liabilities

  

 

892,383

  

 

932,934

Current portion—long term debt

  

 

728,680

  

 

743,039

Notes payable

  

 

278,566

  

 

485,850

Dividends payable

  

 

172,533

  

 

120,773

Current portion—capital lease payable

  

 

54,700

  

 

53,392

Income taxes payable

  

 

348,929

  

 

319,228

    

  

Total current liabilities

  

 

11,873,294

  

 

11,407,378

Long term debt, net of current portion

  

 

10,140,114

  

 

12,579,702

Capital lease payable, net of current portion

  

 

90,874

  

 

104,155

    

  

Total liabilities

  

 

22,104,282

  

 

24,091,235

PREFERRED STOCK:

             

Series A Redeemable convertible preferred stock; 5,000,000 shares authorized, 2,588,000 shares issued and outstanding at March 31, 2003 and December 31, 2002, respectively

  

 

2,588,000

  

 

2,588,000

STOCKHOLDERS’ EQUITY:

             

Common stock, $.001 par value; 75,000,000 shares authorized; 22,861,199 issued and outstanding at March 31, 2003 and December 31, 2002, respectively

  

 

22,862

  

 

22,862

Additional paid-in capital

  

 

9,335,471

  

 

9,335,471

Retained earnings

  

 

4,486,343

  

 

4,030,448

    

  

Total stockholders’ equity

  

 

13,844,676

  

 

13,388,781

    

  

Total liabilities and stockholders’ equity

  

$

38,536,958

  

$

40,068,016

    

  

 

See accompanying notes to interim condensed consolidated financial statements.

 

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Table of Contents

 

ENGlobal Corporation

Condensed Consolidated Statements Of Cash Flows

(Unaudited)

 

    

For the Three Months Ended

March 31,

 
    

2003


    

2002


 

CASH FLOWS FROM OPERATING ACTIVITIES:

                 

Net income

  

$

507,654

 

  

$

265,942

 

Adjustment for non-cash items

  

 

246,130

 

  

 

220,390

 

Changes in working capital, net

  

 

2,057,270

 

  

 

2,238,502

 

    


  


Net cash provided by operating activities

  

 

2,811,054

 

  

 

2,724,834

 

CASH FLOWS FROM INVESTING ACTIVITIES:

                 

Property and equipment acquired

  

 

(170,601

)

  

 

(112,883

)

Proceeds from sale of property

  

 

—  

 

  

 

42,523

 

    


  


Net cash used by investing activities

  

 

(170,601

)

  

 

(70,360

)

    


  


CASH FLOW FROM FINANCING ACTIVITIES:

                 

Proceeds from borrowings under line of credit

  

 

23,537,173

 

  

 

24,179,355

 

Payments on line of credit

  

 

(25,814,281

)

  

 

(26,955,906

)

Short-term note repayments

  

 

(207,285

)

  

 

—  

 

Lease repayments

  

 

(11,972

)

  

 

(15,065

)

Long-term debt repayments

  

 

(183,990

)

  

 

(736,881

)

    


  


Net cash used by financing activities

  

 

(2,680,355

)

  

 

(3,528,497

)

    


  


NET CHANGE IN CASH

  

 

(39,902

)

  

 

(874,023

)

CASH, at beginning of period

  

 

75,095

 

  

 

1,244,907

 

    


  


CASH, at end of period

  

$

35,193

 

  

$

370,884

 

    


  


SUPPLEMENTAL DISCLOSURES:

                 

Interest paid

  

$

191,540

 

  

$

153,044

 

NON-CASH:

                 

Accrual of preferred dividends

  

 

51,759

 

  

 

—  

 

 

See accompanying notes to interim condensed consolidated financial statements.

 

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Table of Contents

ENGlobal Corporation

Notes To Condensed Consolidated Financial Statements

 

 

1.    BASIS OF PRESENTATION

 

The condensed consolidated financial statements of ENGlobal Corporation, formerly known as Industrial Data Systems Corporation (“ENGlobal” or the “Company”), included herein, are unaudited for the three-month period ended March 31, 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.

 

2.    NAME CHANGE

 

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.

 

3.    LINE OF CREDIT AND DEBT

 

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. At March 31, 2003, $7,807,000 was outstanding on the line of credit. The line of credit matures on June 30, 2005. The interest rate on the line of credit is one-quarter of one percent plus prime (4.50 percent at March 31, 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 March 31, 2003, were $3,694,000 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.

 

4


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ENGlobal Corporation

Notes To Condensed Consolidated Financial Statements

 

 

        
    

March 31, 2003


    

December 31, 2002


 
    

(in thousands)

 

Fleet Credit Facility—

                 

Line of credit, prime plus 0.25% (4.50% at March 31, 2003), maturing in 2005

  

$

7,807

 

  

$

10,084

 

Equus note payable, interest at 9.5%, principal payments in installments of $110,000 plus interest due quarterly maturing through 2005

  

 

2,670

 

  

 

2,780

 

Petrocon Arabia Limited uncollateralized note payable, interest at 8%, principal and interest due monthly in decreasing amounts starting at $25,000, maturing in August 2004

  

 

384

 

  

 

451

 

Miscellaneous

  

 

8

 

  

 

8

 

    


  


    

 

10,869

 

  

 

13,323

 

Less—current maturities

  

 

(729

)

  

 

(743

)

    


  


Long-term debt, net of current portion

  

$

10,140

 

  

$

12,580

 

    


  


 

Current notes payable include a note which finances commercial insurance on a short-term basis, with a balance of $279,000 and $485,000 as of March 31, 2003 and December 31, 2002, respectively.

 

4.    PREFERRED STOCK DIVIDENDS

 

One stockholder, Equus II Incorporated, holds the Company’s Series A Preferred Stock, $0.001 par value per share. Dividends on outstanding shares of Series A Preferred Stock are payable annually on the last day of May beginning in 2002 at a rate of 8% of the liquidation amount which 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 Preferred Stock. On May 31, 2002, the Company issued 88,000 shares of Series A Preferred Stock as a stock dividend and paid $219 for fractional shares.

 

5.    ALLOCATION OF GOODWILL

 

The Company’s plan to pursue potential acquisitions of complementary businesses was realized on December 21, 2001 through its Merger with Petrocon. 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 an intangible, 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.

 

5


Table of Contents

ENGlobal Corporation

Notes To Condensed Consolidated Financial Statements

 

 

6.    FIXED FEE CONTRACTS

 

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

 

    

March 31,

2003


    

December 31,

2002


 

Costs incurred on uncompleted contracts

  

$

15,186

 

  

$

18,629

 

Estimated earnings on uncompleted contracts

  

 

3,025

 

  

 

3,096

 

    


  


Earned revenues

  

 

18,211

 

  

 

21,725

 

Less billings to date

  

 

17,023

 

  

 

20,493

 

    


  


Net cost and estimated earnings in excess of billings on uncompleted contracts

  

$

1,188

 

  

$

1,232

 

    


  


Costs and estimated earnings in excess of billings on uncompleted contracts

  

$

2,169

 

  

$

2,044

 

Billings and estimated earnings in excess of costs on uncompleted contracts

  

 

(981

)

  

 

(812

)

    


  


Net cost and estimated earnings in excess (under) billings on uncompleted contracts

  

$

1,188

 

  

$

1,232

 

    


  


 

7.    TAXES

 

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 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 $613,000 and $863,000 as of March 31, 2003 and December 31, 2002, respectively. The reduction in deferred tax assets during the first quarter of 2003 reflects the expected usage of net operating loss carryforwards in 2003 to offset taxable income.

 

8.    STOCK OPTION PLANS

 

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 three months ended March 31, 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 FAS 148, Accounting for Stock-Based Compensation Transition and Disclosure, issued in December 2002.

 

    

Three Months Ended

March 31,


 
    

2003


    

2002


 
    

(in thousands)

 

Pro forma impact of fair value method (FAS 148):

                 

Net income attributable to common stockholders, as reported

  

$

456

 

  

$

216

 

Less compensation expense determined under fair value method

  

 

(1

)

  

 

(37

)

    


  


Pro forma net income attributable to common stockholders

  

$

455

 

  

$

179

 

    


  


 

6


Table of Contents

ENGlobal Corporation

Notes To Condensed Consolidated Financial Statements

 

Earnings per share (basic and diluted):

                 

As reported

  

$

0.02

 

  

$

0.01

 

Pro forma

  

$

0.02

 

  

$

0.01

 

Weighted average Black-Scholes fair value assumptions:

                 

Risk free interest rate

  

 

5.0

%

  

 

5-5.75

%

Expected life

  

 

7–10 years

 

  

 

2-10 years

 

Expected volatility

  

 

93

%

  

 

93

%

Expected dividend yield

  

 

0.0

%

  

 

0.0

%

 

  9.    SEGMENT INFORMATION

 

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 for the three months ended March 31, 2003 and 2002, respectively, was as follows (in thousands):

 

2003


  

Engineering Services


  

Engineered Systems


    

Manufacturing


    

Corporate


    

Total


Net sales from external customers

  

$

18,316

  

$

4,690

    

$

597

 

  

$

—  

 

  

$

23,603

Operating profit (loss)

  

 

2,236

  

 

295

    

 

(15

)

  

 

(1,486

)

  

 

1,030

2002


  

Engineering Services


  

Engineered Systems


    

Manufacturing


    

Corporate


    

Total


Net sales from external customers

  

$

17,875

  

$

2,287

    

$

541

 

  

$

—  

 

  

$

20,703

Operating profit (loss)

  

 

1,461

  

 

174

    

 

(53

)

  

 

(1,023

)

  

 

559

 

 

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Item 2.    Management’s Discussion And Analysis And Results Of Operations

 

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 closing of the transaction for the sale of Thermal has been impeded due to the inability of the buyer to secure adequate financing. The Company has been considering various alternatives as well as restructuring the terms of the agreement to include owner financing. 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 Company operates in three segments, the engineering services segment, the engineered systems segment, and the manufacturing segment. The following table sets forth, for the periods indicated, the percentage of sales generated by each of the operating segments.

 

    

Percentage of Revenue


 
    

For the three months ended March 31,

 

Operating Segment


  

2003


    

2002


 

    Engineering services

  

77.6

%

  

86.3

%

Engineered systems

  

19.9

%

  

11.1

%

Manufacturing

  

2.5

%

  

2.6

%

    

  

Total revenue

  

100.0

%

  

100.0

%

 

Three Months Ended March 31, 2003 Compared to Three Months Ended March 31, 2002

 

Total Revenue. Total revenue increased by $2,900,000 or 14% for the three months ended March 31, 2003 compared to the three months ended March 31, 2002. All segments reported an increase in sales

 

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during the period. Engineering services segment increased from $17,875,000 in 2002 to $18,316,000 in 2003 or $441,000, a 2% increase. The revenue increase in engineering services resulted primarily from the continuation of a large EPC project (engineering, procurement, and construction) in the Beaumont office. The engineered systems segment, which represents 20% of total revenues increased by $2,403,000 or 105% from $2,287,000 for the three months, ended March 31, 2002 to $4,690,000 for the same period in 2003. This increase occurred at ENGlobal Systems resulting from large fixed price sales of process systems to two clients. The manufacturing segment increased sales for the three months ended March 31, 2003 by $56,000 or 10% from $541,000 for the three months ended March 31, 2002 to $597,000 for the same period in 2003. The revenues in 2002 were lower than normal due to the lingering effects of the September 11, 2001 terrorist attack that significantly impacted the market in which Thermal operates.

 

Gross Profit. The gross profit increased $895,000 or 28% for the three months ended March 31, 2003 as compared to the three months ended March 31, 2002. Engineering services gross profit as a percentage of revenue, improved from 15% to 17%. This resulted in a $527,000 increase over 2002 due primarily to better utilization of manpower.

 

The engineered systems segment gross profit increased $311,000 or 63% from $492,000 to $803,000 for the three months ended March 31, 2002 and 2003, respectively. However, gross profit as a percent of revenue declined from 22% in 2002 to 17% for the same period in 2003. This decline in gross profit as a percent of revenue from 2002 to 2003 was primarily due to competitive market pressures on contract pricing and budget over-runs on three fixed price projects.

 

The manufacturing segment increased gross profit by $56,000 or 41% for the three months ended March 31, 2003 compared to the same period for 2002. This increase was due to Thermal reducing expenses by eliminating contract labor and decreasing accrued expenses.

 

Selling, General, and Administrative. Expenses related to selling, general and administrative, including depreciation and amortization increased $424,000 or 16% for the three months ended March 31, 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, including the salaries and expenses of several marketing representatives. These salaries and expenses contributed approximately $300,000 to the first three months of 2003. In addition, the accounting system was upgraded and the cost of the consultants in 2003 added $90,000 and depreciation related to the software increased by $25,000.

 

Operating Income. Operating income increased by $471,000 to $1,030,000 for the three months ended March 31, 2003, compared to $560,000 for the same period in 2002. As a percentage of revenues, operating income increased from 3% to 4%. The increase is attributable primarily to the EPC work in the engineering services segment, which contributed $2,235,000 to operating income before deducting corporate selling, general, and administrative expenses.

 

Net income. Net income after taxes increased by $242,000 or 91% from $266,000 to $508,000 for the three months ended March 31, 2002 and 2003, respectively. As a percentage of total revenue, the net income percentage increased from 1% to 2%.

 

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 March 31, 2003, $7,807,000 was outstanding on the line of credit. The Credit Facility matures on June 30, 2005. The interest rate on the line of credit 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 March 31, 2003 were $3,694,000 after consideration of the borrowing base

 

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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.

 

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 March 31, 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 three months ended March 31, 2003 was $1,277,000. Any future decrease in demand for the Company’s services or products would reduce the availability of funds through operations.

 

The Company benefited from Peterson’s net operating loss carryforwards at the time of the merger. Based on the completion of research and advice of tax counsel, the realization of an additional loss carryforward asset is available to the Company. The Company has net operating loss carryforwards of $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 $613,000 and $863,000 as of March 31, 2003 and December 31, 2002, respectively. The reduction in deferred tax assets during the first quarter of 2003 reflects the expected usage of net operating loss carryforwards in 2003 to offset taxable income.

 

The Company’s working capital was $7,281,000 and $8,955,000 at March 31, 2003 and December 31, 2002, respectively. The decrease in working capital resulted primarily from a decrease in trade receivables, attributable to the active collection process, and an increase in first quarter accrued payroll taxes to be paid in April.

 

The Company had long-term debt outstanding of $10,869,000 and $13,323,000 as of March 31, 2003 and December 31, 2002, respectively. This long-term debt includes the Credit Facility of $7,807,000 on the line of credit as of March 31, 2003 that matures on June 30, 2005.

 

Cash Flow

 

Operating activities provided net cash totaling $2,811,000 and $2,725,000 for the three months ended March 31, 2003 and 2002, respectively. The increase in cash provided by operating activities primarily reflects the increase in net income for the three months ended March 31, 2003 as compared to the same period in 2002.

 

Investing activities used cash totaling $171,000 for the three months ended March 31, 2003 and $70,000 for the same period in 2002. The Company’s investing activities that used cash during the period ended March 31, 2003 was for the purchase of property and equipment.

 

Financing activities used cash totaling $2,680,000 for the three months ended March 31, 2003, as compared to $3,528,000 for the same period in 2002. The decrease in cash used for financing activities reflects lower payments on debt in 2003 as compared to 2002.

 

The Company believes that it has available necessary cash 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 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.

 

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 $15,321,000 and $16,492,000

 

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at March 31, 2003 and December 31, 2002, respectively. The number of days’ sales outstanding in trade accounts receivable was 61 days and 60 days, respectively.

 

Item   3. Quantitative and Qualitative Disclosures About Market Risk

 

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

 

We do not utilize financial instruments for trading purposes and we do not hold any derivative financial instruments that could expose us to significant market risk. Our exposure to market risk for changes in interest rates relates primarily to our obligations under the Fleet Credit Facility. As of March 31, 2003, $7,807,000 had been borrowed under the line of credit, accruing interest at 4.5% 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 March 31, 2003 would be 45 basis points. Such an increase in interest rates would increase our annual interest expense by approximately $35,000 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.

 

Item 4. Controls and Procedures

 

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 March 31, 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.

 

PART II. Other Information

 

Item 1. Legal Proceedings

 

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.

 

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Engineered Carbons, Inc. filed a claim in 2000 against the Company in the 60th 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 14th 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. The jury verdict is subject to appeal by both the Company and Arch.

 

Item 2. Changes in Securities

 

None.

 

Item 3. Defaults Upon Senior Securities

 

None.

 

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

 

None.

 

Item 5. Other Information

 

None.

 

Item 6. Exhibits and Reports on Form 8-K

 

a. Exhibits

 

10.70

  

Lease Agreement between PEI Investments and Petrocon Engineering, dated July 1, 2002.

10.71

  

Copyright registration for PETRODOCS software.

99.9

  

Certification Pursuant to Section 906 of the Sarbanes-Oxley Act for 2002 for the First Quarter 2003.

99.10

  

Certification Pursuant to Section 302 of the Sarbanes-Oxley Act for 2002 for the First Quarter 2003.

 

b. Form 8-K

 

None.

 

 

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SIGNATURE

 

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

 

    

ENGlobal Corporation

Dated: May 13, 2003

  

By:

 

/s/ Robert W. Raiford


Robert W. Raiford, Chief Financial Officer and Treasurer

 

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