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 29, 2018, included in the Company’s 2018 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 six month periods ended June 29, 2019 and June
30, 2018, and in the case of the condensed balance sheet as of December 29, 2018 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
February 2016, the Financial Statements Accounting Board (“FASB”) issued ASU No. 2016-02,
Leases (Topic 842)
,
that amends 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 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 adopted the standard effective December 30, 2018 using the modified retrospective transition approach and elected not to adjust
prior comparative periods. The Company elected the practical expedient to not reassess prior conclusions related to contracts
containing leases, lease classification, lease term and initial direct costs. Upon adoption, the Company recognized right-of-use
assets and lease liabilities of $1.3 million at December 30, 2018.
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 29, 2018 . 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 5 – Segment Information for disaggregated revenue information.
Adoption of ASC Topic
606 did not have a material impact on our revenue or associated costs.
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 second quarter of 2019 or 2018.
NOTE
4 – 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 June 29, 2019 and December 29, 2018:
|
|
June 29, 2019
|
|
|
December 29, 2018
|
|
|
|
(dollars in thousands)
|
|
Costs incurred on uncompleted contracts
|
|
$
|
18,912
|
|
|
$
|
34,800
|
|
Estimated earnings on uncompleted contracts
|
|
|
4,544
|
|
|
|
6,921
|
|
Earned revenues
|
|
|
23,456
|
|
|
|
41,721
|
|
Less: billings to date
|
|
|
23,916
|
|
|
|
39,150
|
|
Net costs and estimated earnings in excess of billings (billings in excess of costs) on uncompleted contracts
|
|
$
|
(460
|
)
|
|
$
|
2,571
|
|
|
|
|
|
|
|
|
|
|
Contract assets
|
|
$
|
2,190
|
|
|
$
|
3,175
|
|
Contract liabilities
|
|
|
(2,650
|
)
|
|
|
(604
|
)
|
Net contract assets (liabilities)
|
|
$
|
(460
|
)
|
|
$
|
2,571
|
|
NOTE
5– SEGMENT INFORMATION
Our
segments are strategic business units that offer different services and products and therefore require different marketing and
management strategies. The operating performance is regularly reviewed with these two operational leaders in charge of its engineering
offices and its automation offices, 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.
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 June 29, 2019 and June 30, 2018 is as follows (dollars in thousands):
For the three months ended June 29, 2019:
|
|
EPCM
|
|
|
Automation
|
|
|
Corporate
|
|
|
Consolidated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
5,659
|
|
|
$
|
7,962
|
|
|
$
|
—
|
|
|
$
|
13,621
|
|
Gross profit
|
|
|
828
|
|
|
|
1,114
|
|
|
|
—
|
|
|
|
1,942
|
|
Gross Profit Margin
|
|
|
14.6
|
%
|
|
|
14.0
|
%
|
|
|
|
|
|
|
14.3
|
%
|
SG&A
|
|
|
589
|
|
|
|
390
|
|
|
|
1,471
|
|
|
|
2,450
|
|
Operating income (loss)
|
|
|
239
|
|
|
|
724
|
|
|
|
(1,471
|
)
|
|
|
(508
|
)
|
Other income, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
26
|
|
Interest expense, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(4
|
)
|
Tax expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(31
|
)
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(517
|
)
|
For
the three months ended June 30, 2018:
|
|
EPCM
|
|
|
Automation
|
|
|
Corporate
|
|
|
Consolidated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
6,652
|
|
|
$
|
7,220
|
|
|
$
|
—
|
|
|
$
|
13,872
|
|
Gross profit
|
|
|
1,330
|
|
|
|
923
|
|
|
|
—
|
|
|
|
2,253
|
|
Gross Profit Margin
|
|
|
20.0
|
%
|
|
|
12.8
|
%
|
|
|
|
|
|
|
16.2
|
%
|
SG&A
|
|
|
531
|
|
|
|
663
|
|
|
|
1,675
|
|
|
|
2,869
|
|
Operating income (loss)
|
|
|
799
|
|
|
|
260
|
|
|
|
(1,675
|
)
|
|
|
(616
|
)
|
Other expense, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(373
|
)
|
Interest expense, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(5
|
)
|
Tax benefit
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2
|
|
Net
loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(992
|
)
|
Segment
information for the six months ended June 29, 2019 and June 30, 2018 is as follows (dollars in thousands):
For
the six months ended June 29, 2019:
|
|
EPCM
|
|
|
Automation
|
|
|
Corporate
|
|
|
Consolidated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
11,292
|
|
|
$
|
14,492
|
|
|
$
|
—
|
|
|
$
|
25,784
|
|
Gross profit
|
|
|
1,499
|
|
|
|
1,781
|
|
|
|
—
|
|
|
|
3,280
|
|
Gross Profit Margin
|
|
|
13.3
|
%
|
|
|
12.3
|
%
|
|
|
|
|
|
|
12.7
|
%
|
SG&A
|
|
|
1,176
|
|
|
|
819
|
|
|
|
2,760
|
|
|
|
4,755
|
|
Operating income (loss)
|
|
|
323
|
|
|
|
962
|
|
|
|
(2,760
|
)
|
|
|
(1,475
|
)
|
Other expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
41
|
|
Interest expense, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(6
|
)
|
Tax expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(51
|
)
|
Net
loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(1,491
|
)
|
For
the six months ended June 30, 2018:
|
|
EPCM
|
|
|
Automation
|
|
|
Corporate
|
|
|
Consolidated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
11,747
|
|
|
$
|
15,312
|
|
|
$
|
—
|
|
|
$
|
27,059
|
|
Gross profit
|
|
|
1,746
|
|
|
|
1,919
|
|
|
|
—
|
|
|
|
3,665
|
|
Gross Profit Margin
|
|
|
14.9
|
%
|
|
|
12.5
|
%
|
|
|
|
|
|
|
13.5
|
%
|
SG&A
|
|
|
957
|
|
|
|
1,367
|
|
|
|
3,127
|
|
|
|
5,451
|
|
Operating income (loss)
|
|
|
789
|
|
|
|
552
|
|
|
|
(3,127
|
)
|
|
|
(1,786
|
)
|
Other expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(378
|
)
|
Interest expense, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(14
|
)
|
Tax expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(14
|
)
|
Net
loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(2,192
|
)
|
Total Assets by Segment
|
|
As of
June 29, 2019
|
|
|
As of
December 29, 2018
|
|
|
|
(dollars in thousands)
|
|
EPCM
|
|
$
|
6,597
|
|
|
$
|
4,792
|
|
Automation
|
|
|
8,673
|
|
|
|
10,550
|
|
Corporate
|
|
|
9,914
|
|
|
|
6,964
|
|
Consolidated
|
|
$
|
25,184
|
|
|
$
|
22,306
|
|
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 740-270 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 $31 thousand and $51 thousand for the three and six months ended June 29, 2019, respectively,
as compared to income tax benefit of $2 thousand and income tax expense of $14 thousand for the three and six months ended June
30, 2018, respectively.
The
effective income tax rate for the three and six months ended June 29, 2019 was (2.06)% and (0.20)%, respectively, as compared
to 0.0% and (0.05)% for the three and six months ended June 30, 2018. The effective tax rate differed from the federal statutory
rate of 21% primarily due to the effect of the valuation allowances related to the unrealized deferred tax asset generated by
the current year benefit.
NOTE
7 – 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.
NOTE
8 – LEASES
The
Company leases land, office space and equipment. Arrangements are assessed at inception to determine if a lease exists and, with
the adoption of ASC 842, “Leases,” right-of-use (“ROU”) assets and lease liabilities are recognized based
on the present value of lease payments over the lease term. Because the Company’s leases do not provide an implicit rate
of return, the Company uses its incremental borrowing rate at the inception of a lease to calculate the present value of lease
payments. The Company has elected to apply the short-term lease exception for all asset classes, excluding lease liabilities from
the balance sheet and recognizing the lease payments in the period they are incurred.
The
Company’s finance leases are immaterial to its consolidated financial statements.
The
components of lease expense were as follows:
|
|
Six
months ended
June
29, 2019
|
|
Operating leases:
|
|
|
|
|
Operating
costs
|
|
$
|
418
|
|
Selling,
general and administrative expenses
|
|
|
922
|
|
|
|
|
1,340
|
|
Short-term leases:
|
|
|
|
|
Operating costs
|
|
|
—
|
|
Selling,
general and administrative expenses
|
|
|
255
|
|
|
|
|
255
|
|
Total
lease expense
|
|
$
|
1,595
|
|
Supplemental
balance sheet information related to leases was as follows:
|
|
Financial
Statement Classification
|
|
June
29, 2019
|
|
Operating
ROU assets
|
|
Right
of Use asset
|
|
$
|
2,619
|
|
|
|
|
|
|
|
|
Operating lease liabilities:
|
|
|
|
|
|
|
Current operating
lease liabilities
|
|
Other current liabilities
|
|
$
|
933
|
|
Noncurrent
operating lease liabilities
|
|
Long
Term Leases
|
|
|
1,718
|
|
Total
operating lease liabilities
|
|
|
|
$
|
2,651
|
|
The
weighted average remaining lease term and weighted average discount rate were as follows:
|
|
At
June 29, 2019
|
|
Weighted average remaining lease term of operating
leases
|
|
|
2.7 years
|
|
Weighted average discount
rate of operating leases
|
|
|
4.0
|
%
|
Maturities
of operating lease liabilities as of June 29, 2019 are as follows:
Year
ending:
|
|
Amount
|
|
2019 (remaining months)
|
|
$
|
504
|
|
2020
|
|
|
1,012
|
|
2021
|
|
|
958
|
|
2022
|
|
|
288
|
|
Total lease payments
|
|
$
|
2,762
|
|
Less: imputed
interest
|
|
|
(111
|
)
|
Total lease liabilities
|
|
$
|
2,651
|
|
The
aggregate amount of future minimum annual rental payments applicable to non-cancelable leases as of December 29, 2018 were as
follows:
Year
ending:
|
|
Minimal
Rental Payments
|
|
2019
|
|
$
|
445
|
|
2020
|
|
|
445
|
|
2021
|
|
|
387
|
|
2022
|
|
|
64
|
|
Total
|
|
$
|
1,341
|
|
ENGLOBAL
CORPORATION AND SUBSIDIARIES