NOTES
TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE
1 – BASIS OF PRESENTATION
The
accompanying unaudited condensed consolidated financial statements of ENGlobal Corporation (which may be referred to as “ENGlobal,”
the “Company,” “we,” “us,” or “our”) were prepared in accordance with accounting
principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and
the rules and regulations of the Securities and Exchange Commission. Accordingly, these condensed financial statements do not
include all of the information or note disclosures normally included in annual financial statements prepared in accordance with
U.S. GAAP. These condensed financial statements should be read in conjunction with the audited financial statements for the year
ended December 30, 2017, included in the Company’s 2017 Annual Report on Form 10-K filed with the Securities and Exchange
Commission.
The
condensed financial statements included herein are unaudited for the three and nine month periods ended September 29, 2018 and
September 30, 2017, and in the case of the condensed balance sheet as of December 30, 2017 have been derived from the audited
financial statements of the Company. These financial statements reflect all adjustments (consisting of normal recurring adjustments),
which are, in the opinion of management, necessary to fairly present the results for the periods presented.
The
Company has assessed subsequent events through the date of filing of these condensed financial statements with the Securities
and Exchange Commission and believes that the disclosures made herein are adequate to make the information presented herein not
misleading.
We
had no items of other comprehensive income in any period presented; therefore, no other components of comprehensive income are
presented.
Each
of our quarters is comprised of 13 weeks.
NOTE
2 – ACCOUNTING STANDARDS
In
May 2014, the Financial Statements Accounting Board (“FASB”) issued ASU No. 2014-09
, Revenue From Contracts with
Customers (Topic 606),
a comprehensive new revenue recognition standard that supersedes most of the existing revenue recognition
guidance under U.S. GAAP. The core principle of the new guidance is that a company should recognize revenue to depict the transfer
of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled
in exchange for those goods or services. The standard creates a five step model that requires companies to exercise judgment when
considering the terms of a contract and all relevant facts and circumstances. The standard also requires expanded disclosures
regarding the qualitative and quantitative information of an entity’s nature, amount, timing and uncertainty of revenue
and cash flows arising from contracts with customers. This new revenue recognition standard became effective for annual reporting
periods beginning after December 15, 2017, including interim periods within that reporting period. The standard allows for several
transition methods. We adopted the new standard effective December 31, 2017 utilizing the modified retrospective method. There
was no cumulative-effect adjustment to retained earnings upon adoption of this standard. See “Note 3 Critical Accounting
Policies Update” within these consolidated financial statements for additional information.
In
August 2016, the FASB issued ASU No. 2016-15,
Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts
and Cash Payments.
This amendment addresses how certain specified cash receipts and cash payments are presented in the statement
of cash flows. This guidance became effective for interim and annual reporting periods beginning after December 15, 2017. The
adoption of this standard had an immaterial impact to our consolidated statements of cash flows and related disclosures.
New
Accounting Pronouncements Not Yet Adopted
In
February 2016, the FASB issued ASU No. 2016-02,
Leases (Topic 842)
, that will amend the accounting standards for leases.
This new standard retains a distinction between finance leases and operating leases but the primary change is the recognition
of lease assets and lease liabilities by lessees for those leases classified as operating leases on the lessee’s balance
sheet and certain aspects of lease accounting have been simplified. This new standard requires additional qualitative and quantitative
disclosures along with specific quantitative disclosures required by lessees and lessors to meet the objective of enabling users
of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. This pronouncement is
effective for interim and annual reporting periods beginning after December 15, 2018, with early application permitted. In July
2018, the FASB issued ASU 2018-11,
Leases (Topic 842): Targeted Improvements
, which allows for an additional transition
method under the modified retrospective approach for the adoption of Topic 842. The two permitted transition methods are now:
(1) to apply the new lease requirements at the beginning of the earliest period presented, and (2) to apply the new lease requirements
at the effective date. Under both transition methods there is a cumulative effect adjustment. We intend to adopt the standard
on the effective date of December 30, 2018. We are currently evaluating our population of leased assets in order to assess the
impact of the ASU on our lease portfolio and designing and implementing new processes and controls. Until this effort is completed,
we cannot determine the effect of the ASU on our results of operations, financial condition or cash flows.
In
January 2017, the FASB issued ASU No. 2017-04,
Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill
Impairment
. This amendment removes the second step of the two-step goodwill impairment test. When adopted, an entity will
apply a one-step quantitative test and record the amount of goodwill impairment as the excess of a reporting unit’s carrying
amount over its fair value, not to exceed the total amount of goodwill allocated to the reporting unit. This pronouncement is
effective for the Company’s annual or any interim goodwill impairment tests in fiscal years beginning after December 15,
2019, with early adoption permitted. We are currently evaluating the provisions of this pronouncement and are assessing its potential
impact on our financial position, results of operations, cash flows and related disclosures.
NOTE
3 – CRITICAL ACCOUNTING POLICIES UPDATE
Our
critical accounting policies are detailed in “Note 2 – Accounting Policies and New Accounting Pronouncements”
within Item 8 of our Annual Report on Form 10-K for the year ended December 30, 2017. Significant changes to our accounting policies
as a result of adopting Topic 606 are discussed below:
Revenue
Recognition
– Our revenue is comprised of engineering, procurement and construction management services and sales of
fabricated systems and integrated control systems that we design and assemble. The majority of our services are provided under
time-and-material contracts. Some time-and-material contracts may have limits. Revenue is not recognized over these limits until
authorization by the client has been received.
A
majority of sales of fabrication and assembled systems are under fixed-price contracts. We account for a contract when it has
approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract
has commercial substance and collectability of consideration is probable.
We
generally recognize revenue over time as we perform because of continuous transfer of control to the customer. Our customer typically
controls the work in process as evidenced either by contractual termination clauses or by our rights to payment for work performed
to date plus a reasonable profit to deliver products or services that do not have an alternative use to the Company. The selection
of the method to measure progress towards completion requires judgment and is based on the nature of the products or service to
be provided, which measures the ratio of costs incurred to date to the total estimated costs at completion of the performance
obligation. We generally use the cost-to-cost method of revenue recognition to measure progress for our contracts because it best
depicts the transfer of control to the customer which occurs as we consume the costs on the contracts. Therefore, revenues and
estimated profits are recorded proportionally as costs are incurred.
Under
the typical payment terms of our fixed-price contracts, the customer pays us progress payments. These progress payments are based
on quantifiable measures of performance or on the achievement of specified events or milestones. The customer may retain a small
portion of the contract price until completion of the contract. Revenue recognized in excess of billings is recorded as a contract
asset on the balance sheet. Amounts billed and due from our customers are classified as receivables on the balance sheet. The
portion of the payments retained by the customer until final contract settlement is not considered a significant financing component
because the intent is to protect the customer should we fail to adequately complete some or all of our obligations under the contract.
For some contracts we may receive advance payments from the customer. We record a liability for these advance payments in contract
liabilities on the balance sheet. The advance payment typically is not considered a significant financing component because it
is used to meet working capital demand that can be higher in the early stages of a contract and to protect us from the other party
failing to adequately complete some or all of its obligations under the contract.
To
determine proper revenue recognition for contracts, we evaluate whether two or more contracts should be combined and accounted
for as one single performance obligation or whether a single contract should be accounted for as more than one performance obligation.
This evaluation requires significant judgment and the decision to combine a group of contracts or separate a single contract into
multiple performance obligations could change the amount of revenue and profit recorded in a given period. For most of our contracts,
we provide a significant service of integrating a complex set of tasks and components into a single project. Hence, the entire
contract is accounted for as one performance obligation. Less commonly, we may provide distinct goods or services within a contract
in which case we separate the contract into more than one performance obligation. If a contract is separated into more than one
performance obligation, we allocate the total transaction price to each performance obligation in an amount based on the estimated
relative standalone selling price of the promised goods or services underlying each performance obligation and use the expected
cost plus margin approach to estimate the standalone selling price of each performance obligation. Due to the nature of the work
require to be performed on many of our performance obligations, the estimation of total revenue and cost at completion is complex,
subject to variables and requires significant judgment. We estimate variable consideration at the most likely amount to which
we expect to be entitled. We include estimated amounts in the transaction price to the extent it is probable that a significant
reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved.
Our estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are
based largely on an assessment of our anticipated performance and all information (historical, current and forecasted) that is
reasonably available to us.
Contracts
are often modified to account for changes in contract specifications and requirements. We consider contract modifications to exist
when the modification either creates new or changes the existing enforceable rights and obligations. Most of our contract modifications
are for goods or services that are not distinct from the existing contract due to the significant integration service provided
in the context of the contract and are accounted for as if they were part of that existing contract. The effect of a contract
modification on the transaction price and our measure of progress for the performance obligation to which it relates, is recognized
as an adjustment to revenue (either as an increase or a reduction of revenue) on a cumulative catch-up basis.
We
have a standard, monthly process in which management reviews the progress and execution of our performance obligations. As part
of this process, management reviews information including, but not limited to, any outstanding key contract matters, progress
towards completion and the related program schedule, identified risks and opportunities and the related changes in estimates of
revenues and costs. The risks and opportunities include management’s judgment about the ability and cost to achieve the
schedule, technical requirements, and other contractual requirements. Management must make assumptions and estimates regarding
labor productivity and availability, the complexity of the work to be performed, the availability of materials, the length of
time to complete the performance obligation, execution by our subcontractors, the availability and timing of funding from our
customer and overhead cost rates, among other variables.
Based
on this analysis, any adjustments to revenue, operating costs and the related impact to operating income are recognized as necessary
in the period they become known. These adjustments may result from positive performance and may result in an increase in operating
income during the performance of individual performance obligations if we determine we will be successful in mitigating risks
surrounding the technical, schedule and cost aspects of those performance obligations or realizing related opportunities. When
estimates of total costs to be incurred exceed total estimates to be earned, a provision for the entire loss on the performance
obligation is recognized in the period the loss is recorded. Likewise, these adjustments may result in a decrease in operating
income if we determine we will not be successful in mitigating these risks or realizing related opportunities. Changes in estimates
of net revenue, operating costs and the related impact to operating income are recognized monthly on a cumulative catch-up basis,
which recognizes in the current period the cumulative effect of the changes on current and prior periods based on a performance
obligation’s percentage of completion. A significant change in one or more of these estimates could affect the profitability
of one or more of our performance obligations. See “Note 6 – Segment Information” for disaggregated revenue
information.
Incremental
Costs
– Our incremental costs of obtaining a contract, which consists of sales commission and proposal costs, are reviewed
and those costs that are immaterial to the financial statements are expensed as they occur. Those costs that are deemed to be
material to the contract are deferred and amortized over the period of contract performance. We classify incremental costs as
current or noncurrent based on the timing of when we expect to recognize the expense. The current and noncurrent portions of incremental
costs are included in prepaid expenses and other current assets and other assets, net, respectively in our consolidated balance
sheet. We had no amortization expense related to incremental costs in the third quarter of 2018 or 2017.
NOTE
4 – CASH, CASH EQUIVALENTS AND RESTRICTED CASH
The
following table provides a reconciliation of cash, cash equivalents and restricted cash reported within the consolidated financial
statements:
|
|
September 29, 2018
|
|
|
December 30, 2017
|
|
|
|
(dollars in thousands)
|
|
Cash and cash equivalents
|
|
$
|
5,252
|
|
|
$
|
8,988
|
|
Restricted cash
|
|
|
—
|
|
|
|
660
|
|
Total cash, cash equivalents and restricted cash
|
|
$
|
5,252
|
|
|
$
|
9,648
|
|
Amounts
included in restricted cash represent those required to be set aside to collateralize a letter of credit required by a customer.
This letter of credit expired on December 31, 2017.
NOTE
5 – CONTRACT ASSETS AND CONTRACT LIABILITIES
Our
contract assets consist of unbilled amounts typically resulting from sales under long-term contracts when the cost-to-cost method
of revenue recognition is utilized and revenue recognized exceeds the amount billed to the customer. Our contract liabilities
consist of advance payments and billings in excess of costs incurred and deferred revenue. The noncurrent portion of deferred
revenue is included in other long-term liabilities in our consolidated balance sheets.
Costs,
estimated earnings and billings on uncompleted contracts consisted of the following at September 29, 2018 and December 30, 2017:
|
|
September 29, 2018
|
|
|
December 30, 2017
|
|
|
|
(dollars in thousands)
|
|
Costs incurred on uncompleted contracts
|
|
$
|
35,213
|
|
|
$
|
57,916
|
|
Estimated earnings on uncompleted contracts
|
|
|
7,068
|
|
|
|
15,423
|
|
Earned revenues
|
|
|
42,281
|
|
|
|
73,339
|
|
Less: billings to date
|
|
|
38,277
|
|
|
|
69,400
|
|
Net costs and estimated earnings in excess of billings on uncompleted contracts
|
|
$
|
4,004
|
|
|
$
|
3,939
|
|
|
|
|
|
|
|
|
|
|
Contract assets
|
|
$
|
4,291
|
|
|
$
|
5,273
|
|
Contract liabilities
|
|
|
(287
|
)
|
|
|
(1,334
|
)
|
Net contract assets
|
|
$
|
4,004
|
|
|
$
|
3,939
|
|
NOTE
6 – SEGMENT INFORMATION
Our
segments are strategic business units that offer different services and products and therefore require different marketing and
management strategies. During 2017, ENGlobal changed the reporting structure within the Company by placing an operational leader
in charge of its engineering offices and a separate operational leader in charge of its automation offices, including the office
that contracts with government agencies. The operating performance is regularly reviewed with these two operational leaders, the
chief executive officer (“CEO”), the chief financial officer (“CFO”) and others. This group represents
the chief operating decision maker (“CODM”) for ENGlobal.
The
Engineering, Procurement and Construction Management (“EPCM”) segment provides services relating to the development,
management and execution of projects requiring professional engineering and related project services primarily to the energy industry
throughout the United States. The Automation segment provides services related to the design, integration and implementation of
advanced automation, information technology, process distributed control systems, analyzer systems, and electrical projects primarily
to the upstream and downstream sectors throughout the United States. The Automation segment includes the government services group,
which provides engineering, design, installation and operation and maintenance of various government, public sector and international
facilities and the fabrication operation.
We
have revised our segment reporting to reflect our current management approach and recast prior periods to conform to the current
segment presentation.
Effective
December 31, 2017, we adopted the requirements of Topic 606 using the modified retrospective method as discussed in “Note
2 – Accounting Standards.” The presentation of our business segments, including corporate, set forth in these consolidated
financial statements reflect these changes.
Revenues,
operating income, and identifiable assets for each segment are set forth in the following table. The amount identified as Corporate
includes those activities that are not allocated to the operating segments and includes costs related to business development,
executive functions, finance, accounting, safety, human resources and information technology that are not specifically identifiable
with the segments.
Segment
information for the three months ended September 29, 2018 and September 30, 2017 is as follows (dollars in thousands):
For the three months ended September 29, 2018:
|
|
EPCM
|
|
|
Automation
|
|
|
Corporate
|
|
|
Consolidated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
6,821
|
|
|
$
|
7,434
|
|
|
$
|
—
|
|
|
$
|
14,255
|
|
Gross profit
|
|
|
1,133
|
|
|
|
1,160
|
|
|
|
—
|
|
|
|
2,293
|
|
Gross Profit Margin
|
|
|
16.6
|
%
|
|
|
15.6
|
%
|
|
|
|
|
|
|
16.1
|
%
|
SG&A
|
|
|
469
|
|
|
|
633
|
|
|
|
1,381
|
|
|
|
2,483
|
|
Operating income (loss)
|
|
|
664
|
|
|
|
527
|
|
|
|
(1,381
|
)
|
|
|
(190
|
)
|
Other income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11
|
|
Interest expense, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1
|
)
|
Tax expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(17
|
)
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(197
|
)
|
For the three months ended September 30, 2017:
|
|
EPCM
|
|
|
Automation
|
|
|
Corporate
|
|
|
Consolidated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
5,399
|
|
|
$
|
7,497
|
|
|
$
|
—
|
|
|
$
|
12,896
|
|
Gross profit
|
|
|
411
|
|
|
|
1,210
|
|
|
|
—
|
|
|
|
1,621
|
|
Gross Profit Margin
|
|
|
7.6
|
%
|
|
|
16.1
|
%
|
|
|
|
|
|
|
12.6
|
%
|
SG&A
|
|
|
516
|
|
|
|
699
|
|
|
|
1,826
|
|
|
|
3,041
|
|
Operating income (loss)
|
|
|
(105
|
)
|
|
|
511
|
|
|
|
(1,826
|
)
|
|
|
(1,420
|
)
|
Other income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2
|
|
Interest expense, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(19
|
)
|
Tax expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(10,717
|
)
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(12,154
|
)
|
Segment
information for the nine months ended September 29, 2018 and September 30, 2017 is as follows (dollars in thousands):
For the nine months ended September 29, 2018:
|
|
EPCM
|
|
|
Automation
|
|
|
Corporate
|
|
|
Consolidated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
18,568
|
|
|
$
|
22,746
|
|
|
$
|
—
|
|
|
$
|
41,314
|
|
Gross profit
|
|
|
2,879
|
|
|
|
3,080
|
|
|
|
—
|
|
|
|
5,959
|
|
Gross Profit Margin
|
|
|
15.5
|
%
|
|
|
13.5
|
%
|
|
|
|
|
|
|
14.4
|
%
|
SG&A
|
|
|
1,426
|
|
|
|
2,001
|
|
|
|
4,508
|
|
|
|
7,935
|
|
Operating income (loss)
|
|
|
1,453
|
|
|
|
1,079
|
|
|
|
(4,508
|
)
|
|
|
(1,976
|
)
|
Other expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(367
|
)
|
Interest expense, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(14
|
)
|
Tax expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(31
|
)
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(2,388
|
)
|
For the nine months ended September 30, 2017:
|
|
EPCM
|
|
|
Automation
|
|
|
Corporate
|
|
|
Consolidated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
16,976
|
|
|
$
|
24,360
|
|
|
$
|
—
|
|
|
$
|
41,336
|
|
Gross profit
|
|
|
1,742
|
|
|
|
4,123
|
|
|
|
—
|
|
|
|
5,865
|
|
Gross Profit Margin
|
|
|
10.3
|
%
|
|
|
16.9
|
%
|
|
|
|
|
|
|
14.2
|
%
|
SG&A
|
|
|
1,614
|
|
|
|
2,106
|
|
|
|
5,783
|
|
|
|
9,503
|
|
Operating income (loss)
|
|
|
128
|
|
|
|
2,017
|
|
|
|
(5,783
|
)
|
|
|
(3,638
|
)
|
Other income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
57
|
|
Interest expense, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(95
|
)
|
Tax expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(10,250
|
)
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(13,926
|
)
|
Total Assets by Segment
|
|
As of
September 29, 2018
|
|
|
As of
December 30, 2017
|
|
|
|
(dollars in thousands)
|
|
EPCM
|
|
$
|
6,457
|
|
|
$
|
5,976
|
|
Automation
|
|
|
12,388
|
|
|
|
12,485
|
|
Corporate
|
|
|
5,415
|
|
|
|
10,791
|
|
Consolidated
|
|
$
|
24,260
|
|
|
$
|
29,252
|
|
NOTE
7 – FEDERAL AND STATE INCOME TAXES
The
Company accounts for income taxes in accordance with FASB Accounting Standards Codification 740, “Income Taxes” (“ASC
740”). Under ASC 740-270 we estimate an annual effective tax rate based on year-to-date operating results and our projection
of operating results for the remainder of the year. We apply this annual effective tax rate to the year-to-date operating results.
If our actual results differ from the estimated annual projection, our estimated annual effective tax rate can change affecting
the tax expense for successive interim results as well as the estimated annual tax expense results. Certain states are not included
in the calculation of the estimated annual effective tax rate because the underlying basis for the tax is related to revenues
and not taxable income. Amounts for Texas margin taxes are reported as income tax expense.
The
Company applies a more likely than not recognition threshold for all tax uncertainties. The FASB guidance for uncertain tax positions
only allows the recognition of those tax benefits, based on their technical merits that are greater than 50 percent likelihood
of being sustained upon examination by the taxing authorities. Management has reviewed the Company’s tax positions and determined
there are no uncertain tax positions requiring recognition in the financial statements. U.S. federal tax returns prior to 2014
and Texas margins tax returns prior to 2014 are closed. Generally, the applicable statues of limitations are three to four years
from their filings.
The
Company recorded income tax expense of $17 thousand for the three months ended September 29, 2018 as compared to income tax expense
of $10.7 million for the three months ended September 30, 2017. The Company recorded income tax expense of $31 thousand for the
nine months ended September 29, 2018 as compared to income tax expense of $10.3 million for the nine months ended September 30,
2017. No tax benefit is provided on the book loss for the nine months ended September 29, 2018 because of the full valuation allowance
on any unrecognized benefit.
The
effective income tax rate for the three months ended September 29, 2018 was (9.3)% as compared to (745.50)% for the three months
ended September 30, 2017. The effective tax rate differed from the federal statutory rate of 21% primarily due to the effect of
the valuation allowances related to the expected unrealized deferred tax asset generated by the current year benefit.
NOTE
8 – COMMITMENTS AND CONTINGENCIES
From
time to time, ENGlobal or one or more of its subsidiaries is involved in various legal proceedings or is subject to claims that
arise in the ordinary course of business alleging, among other things, claims of breach of contract or negligence in connection
with the performance or delivery of goods and/or services. The outcome of any such claims or proceedings cannot be predicted with
certainty. Management is not aware of any pending or threatened lawsuits or proceedings that are expected to have a material effect
on our financial position, results of operations or liquidity.
We
carry a broad range of insurance coverage, including general and business automobile liability, commercial property, professional
errors and omissions, workers’ compensation insurance, directors’ and officers’ liability insurance and a general
umbrella policy, all with standard self-insured retentions/deductibles. We also provide health insurance to our employees (including
vision and dental), and are partially self-funded for these claims. Provisions for expected future payments are accrued based
on our experience, and specific stop loss levels provide protection for the Company. We believe we have adequate reserves for
the self-funded portion of our insurance policies. We are not aware of any material litigation or claims that are not covered
by these policies or which are likely to materially exceed the Company’s insurance limits.
ENGLOBAL
CORPORATION AND SUBSIDIARIES