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 31, 2016, included in the Company’s 2016 Annual Report on Form 10-K filed with the Securities and Exchange
Commission.
The
condensed financial statements included herein are unaudited for the three month periods ended April 1, 2017 and March 26, 2016,
and in the case of the condensed balance sheet as of December 31, 2016, 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 or
comprehensive income are presented.
Each
of our quarters is comprised of 13 weeks.
Changes
in Accounting
In
March 2016, the Financial Statements Accounting Board (“FASB”) issued Accounting Standards Update (“ASU”)
No. 2016-09,
Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting
,
to change several aspects of accounting for share-based payment transactions, including a requirement to recognize all excess
tax benefits and tax deficiencies as income tax expense or benefit in the income statement, classification of awards as either
equity or liabilities, and classification on the statement of cash flows. This pronouncement is effective for interim and annual
reporting periods beginning after December 31, 2016, with early adoption permitted. Varying transition methods (modified retrospective,
retrospective or prospective) are applied to different provisions of the standard. We have adopted this pronouncement in the first
quarter of 2017 by electing to account for forfeitures in compensation costs as they occur and reflecting this change in accounting
policy on a modified retrospective basis through a non-material, cumulative-effect adjustment reducing accumulated earnings as
of the beginning of 2017. We recognized a benefit in stock compensation related to forfeitures of $.01 million in the three months
ended April 1, 2017.
In
November 2016, the FASB Issued Update 2016-18,
Statement of Cash flows (Topic 230): Restricted Cash (a consensus of the FASB
Emerging Issues Task Force)
. This update addresses the presentation of restricted cash or restricted cash equivalents in the
statement of cash flows. This pronouncement is effective for interim and annual reporting periods beginning after December 15,
2017, with early application permitted. We have adopted this pronouncement in the first quarter of 2017 and have reported restricted
cash as a component of ending cash, cash equivalents and restricted cash on the Statements of Cash Flows.
New
Accounting Pronouncements Not Yet Adopted
In
May 2014, the FASB issued ASU No. 2014-09
, Revenue From Contracts with Customers (Topic 606)
, that will supersede most
of the existing revenue recognition requirements in U.S. GAAP and will require entities to recognize revenue at an amount that
reflects the consideration to which we expect to be entitled in exchange for transferring goods or services to a customer. This
new standard also requires significantly 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. In May 2016, the FASB
issued ASU No. 2016-12 to clarify certain narrow aspects of Topic 606 such as assessing the collectability criterion, presentation
of sales taxes and other similar taxes collected from customers, non-cash consideration, contract modifications at transition,
completed contracts at transition, and other technical corrections. This new accounting standard, as updated, is effective for
interim and annual reporting periods beginning after December 15, 2017. We have begun the process of evaluating the principles
in the new standard following the five step approach and we are assessing its potential impact on our financial position, results
of operations, cash flows and related disclosures. Through our initial evaluation, we believe the impact to our financial statements
will be immaterial and we do not believe the implementation will have a material impact on our business practices.
ENGLOBAL CORPORATION
AND SUBSIDIARIES
NOTES
TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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. 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. However we are currently unable to reasonably estimate the impact this pronouncement
will have on our financial statements and related disclosures.
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 becomes effective for interim and annual reporting periods beginning after December 15, 2017. 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.
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
2 – 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:
|
|
April
1, 2017
|
|
|
December
31, 2016
|
|
|
|
(dollars
in thousands)
|
|
Cash and cash equivalents
|
|
$
|
13,713
|
|
|
$
|
15,687
|
|
Restricted cash
|
|
|
660
|
|
|
|
—
|
|
Total cash, cash
equivalents and restricted cash
|
|
$
|
14,373
|
|
|
$
|
15,687
|
|
Amounts
included in restricted cash represent those required to be set aside to collateralize a letter of credit required by a customer.
NOTE
3 - CONTRACTS
Costs,
estimated earnings and billings on uncompleted contracts consisted of the following at April 1, 2017 and December 31, 2016:
|
|
April
1, 2017
|
|
|
December
31, 2016
|
|
|
|
(dollars
in thousands)
|
|
Costs incurred on uncompleted
contracts
|
|
$
|
59,101
|
|
|
$
|
58,933
|
|
Estimated earnings
on uncompleted contracts
|
|
|
24,534
|
|
|
|
24,694
|
|
Earned revenues
|
|
|
83,635
|
|
|
|
83,627
|
|
Less: billings
to date
|
|
|
81,679
|
|
|
|
82,564
|
|
Net costs and
estimated earnings in excess of billings on uncompleted contracts
|
|
$
|
1,956
|
|
|
$
|
1,063
|
|
|
|
|
|
|
|
|
|
|
Costs and estimated earnings in excess
of billings on uncompleted contracts
|
|
$
|
3,429
|
|
|
$
|
2,434
|
|
Billings in excess
of costs and estimated earnings on uncompleted contracts
|
|
|
(1,473
|
)
|
|
|
(1,371
|
)
|
Net costs and
estimated earnings in excess of billings on uncompleted contracts
|
|
$
|
1,956
|
|
|
$
|
1,063
|
|
ENGLOBAL CORPORATION
AND SUBSIDIARIES
NOTES
TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Revenue
on fixed-price contracts is recorded primarily using the percentage-of-completion (cost-to-cost) method. Revenue and gross margin
on fixed-price contracts are subject to revision throughout the lives of the contracts and any required adjustments are made in
the period in which the revisions become known. To manage unknown risks, management may use contingency amounts to increase the
estimated costs, therefore, lowering the earned revenues until the risks are better identified and quantified or have been mitigated.
We currently have $0.5 million in contingency amounts as of April 1, 2017 compared to $0.9 million as of December 31, 2016. Losses
on contracts are recorded in full as they are identified. Fixed price contracts generally include retainage provisions under which
a percentage of the contract price is withheld until the project is complete and has been accepted by our customer. We currently
have $1.0 million in retainage as of April 1, 2017 compared to $1.4 million as of December 31, 2016.
We
recognize service revenue as soon as the services are performed. For clients that we consider higher risk, due to past payment
history or history of not providing written work authorizations, we have deferred revenue recognition until we receive either
a written authorization or a payment. We currently have $0.4 million in deferred revenue recognition as of April 1, 2017 compared
to $0.1 million as of December 31, 2016. This deferred revenue represents work on not–to-exceed contracts that has been
performed but has not been billed or booked as revenue due to our revenue recognition policies as the work was performed outside
the contracted amount without obtaining proper work order changes. It is uncertain as to whether these revenues will eventually
be recognized by us or the proceeds collected. The costs associated with these billings have been expensed as incurred.
NOTE
4 – LINE OF CREDIT AND LETTER OF CREDIT FACILITIES
Line
of Credit Facility
On
March 31, 2017, the Company terminated its credit facility with Regions Bank. There were no loans outstanding under that facility
on that date. See “Note 6 - Credit Facilities” to our financial statements included in our 2016 Annual Report on Form
10-K for a description of the material terms of the Regions Bank credit facility. The facility was terminated because the Company
believes that its cash on hand, internally generated funds and other working capital are sufficient to fund its current operations
and near term growth. In addition, the elimination of the facility, which was scheduled to expire in September 2017, will significantly
reduce costs to the Company.
NOTE
5 – SEGMENT INFORMATION
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 EPCM segment includes the government services group, which provides engineering, design, installation
and operation and maintenance of various government, public sector and international facilities. The Automation segment provides
services related to the design, fabrication and implementation of process distributed control and analyzer systems, advanced automation,
information technology and electrical projects primarily to the upstream and downstream sectors throughout the United States as
well as a specific project in Central Asia.
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 April 1, 2017 and March 26, 2016 is as follows (dollars in thousands):
For
the three months ended April 1, 2017:
|
|
EPCM
|
|
|
Automation
|
|
|
Corporate
|
|
|
Consolidated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
8,165
|
|
|
$
|
4,308
|
|
|
$
|
-
|
|
|
$
|
12,473
|
|
Gross profit
|
|
|
942
|
|
|
|
789
|
|
|
|
-
|
|
|
|
1,731
|
|
SG&A
|
|
|
917
|
|
|
|
607
|
|
|
|
1,882
|
|
|
|
3,406
|
|
Operating income
(loss)
|
|
|
25
|
|
|
|
182
|
|
|
|
(1,882
|
)
|
|
|
(1,675
|
)
|
Other income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3
|
|
Interest expense,
net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(65
|
)
|
Tax
benefit
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
859
|
|
Net
loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(878
|
)
|
For
the three months ended March 26, 2016:
|
|
EPCM
|
|
|
Automation
|
|
|
Corporate
|
|
|
Consolidated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
8,527
|
|
|
$
|
6,285
|
|
|
$
|
-
|
|
|
$
|
14,812
|
|
Gross profit
|
|
|
634
|
|
|
|
1,039
|
|
|
|
-
|
|
|
|
1,673
|
|
SG&A
|
|
|
769
|
|
|
|
743
|
|
|
|
1,878
|
|
|
|
3,390
|
|
Operating income (loss)
|
|
|
(135
|
)
|
|
|
296
|
|
|
|
(1,878
|
)
|
|
|
(1,717
|
)
|
Other income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6
|
|
Interest expense,
net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(36
|
)
|
Tax
benefit
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
998
|
|
Net
loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(749
|
)
|
Total
Assets by Segment
|
|
As
of
April
1, 2017
|
|
|
As
of
December
31, 2016
|
|
|
|
(dollars
in thousands)
|
|
EPCM
|
|
$
|
7,084
|
|
|
$
|
6,530
|
|
Automation
|
|
|
8,578
|
|
|
|
10,296
|
|
Corporate
|
|
|
26,680
|
|
|
|
27,610
|
|
Consolidated
|
|
$
|
42,342
|
|
|
$
|
44,436
|
|
ENGLOBAL
CORPORATION AND SUBSIDIARIES
NOTES
TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE
6 – 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, 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 have a 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 2013 and Texas margins tax
returns prior to 2013 are closed. Generally, the applicable statues of limitations are three to four years from their filings.
During the three months ended April 1, 2017, the Company recognized an income tax benefit of $0.9 million. The Company’s
effective tax rate was 49.6% for the three months ended April 1, 2017 as compared with 55.7% for the three months ended March
26, 2016. The effective tax rate for the three months ended April 1, 2017 differed from the federal statutory rate of 35% primarily
due to state income taxes, adjustments of federal tax credits, adjustments of state tax NOLs, federal tax credits expected for
the current year, permanently non-deductible items, the impact of foreign income taxes and the effect of applying the estimated
effective tax rate for the year to the current quarter ended April 1, 2017. The effective tax rate for the three months ended
March 26, 2016 differed from the federal statutory rate of 35% primarily due state income taxes and a partial valuation allowance
on foreign tax credits.
NOTE
7 – STOCK REPURCHASE PROGRAM
On
April 21, 2015, the Company announced that its Board of Directors authorized the repurchase of up to $2 million of the Company’s
common stock from time to time through open market or privately negotiated transactions, based on prevailing market conditions.
The Company is not obligated to repurchase any dollar amount or specific number of shares of common stock under the repurchase
program, which may be suspended or discontinued at any time. As of April 1, 2017, the Company had purchased and retired 1,127,894
shares for $1.4 million under this program. No shares were purchased in the three months ended April 1, 2017.
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