SEC Company Response from ENGLOBAL CORP (ENG) (CIK 0000933738) — Aug 19, 2005
ENGLOBAL CORP (ENG) (CIK 0000933738)
Date: Aug. 19, 2005 · CIK: 0000933738 · Accession: 0001050502-05-000424
AI Filing Summary & Sentiment
Letter
Re: ENGlobal Corporation - Form 10-K for the Fiscal Year ended December 31, 2004 and Form 10-Q for the Quarter ended March 31, 2005 SEC File No. 1-14217
VIA EDGAR - CORRESPONDENCE FILING Securities and Exchange Commission 450 Fifth Street, N.W. Washington, D.C. 20549-0510
Ladies and Gentlemen:
On August 12, 2005, ENGlobal Corporation (the "Company") received your letter from Rufus Decker dated August 10, 2005 requesting that we provide the Securities and Exchange Commission (the "Commission") with additional responses to certain items included in our correspondence dated July 14, 2005 for the year ended December 31, 2004. This letter sets forth the information requested in that letter. For your convenience, the paragraphs included in this letter are numbered to correspond to the comments in your letter.
General -------
1. Where a comment below requests additional disclosures or other revisions, please show us in your supplemental response what the revisions will look like. These revisions should be included in your future filings, including interim filings where applicable.
Our responses herein indicate, where applicable, the revisions to be included in future filings, which revisions are, in each case, subject to such changes as are dictated by future changes in the Company's business.
2. We have reviewed your response to comment 7. Please clarify whether all depreciation and amortization expense is included in the selling, general and administrative costs line item. If so, please tell us how you determined this treatment is appropriate given the guidance of paragraph 72 of SOP 81-1. If amounts are allocated to direct costs, please disclose your method for allocating these amounts.
Depreciation and amortization expense is included solely in selling, general and administrative costs. In our judgment, depreciation of fixed assets that would potentially contribute to direct costs have been immaterial to gross profit margin and, as a result, we have not specifically segregated them from selling, general and administrative costs.
Certain depreciable fixed assets, specifically a building, furniture and fixtures, leasehold improvements, and software are non-allocable to contract costs based on the requirements of paragraph 72 of SOP 81-1. These assets are strictly operations related and do not contribute to revenue production.
Other fixed assets that are potentially includable in direct costs are machinery and equipment, autos and trucks, and computer hardware. We have determined that these assets are used for the production of revenues. Depreciation expense for 2004 was $1,128,000 in total. Of this expense, approximately $565,000 was related to machinery and equipment, autos and trucks, and computer hardware. The approximate effect of classifying these depreciation expenses as direct costs rather than selling, general and administrative would have caused a .38% reduction in gross profit percentage from 12.34% to 11.96%. We believe that this is immaterial to the financial statements as presented for 2004.
Page 1 of 7
<PAGE>
Due to continued growth of the Company, and projected future capital expenditure increases due to engineering technological needs, management has determined that a segregation of depreciation expense to direct costs is warranted. In future filings, we will identify and segregate depreciable assets so that they will be included in gross profit for both the current and comparable periods presented.
Amortization expense is the result of systematic write off of non-competition and trademark license and acquisition agreements. We believe that these costs also are not allocable to contract costs. Total amortization of non-competition and trademark license and acquisition agreements in the year ended December 31, 2004 totaled $118,000.
3. We have reviewed your response to comment 11. Please tell us more about your lease containing step rent provisions and capital improvement funding. Specifically address the following:
o Tell us when the lease was initiated and when the rent concessions were provided;
The original lease, which had no step rent provisions or capital improvement funding, was effective June 1, 1990. The amended lease, which contained both step rent provisions and capital improvement funding, was effective January 1, 2002.
o Provide us with a summary of the lease terms including when the lease terminates; and
The amended lease covers approximately 34,300 square feet of office space for the period January 1, 2002 through December 31, 2011 and includes increasing annual lease amounts beginning each January 1st for years 2004, 2006, 2008, and 2010. The lease terminates on December 31, 2011. The lease included up to $315,000 in a "Tenant Allowance" for improvements. If the costs of improvements had exceeded the allowance, the Company would have been responsible for any excess costs; but if actual costs had been less than the allowance, the Company would not have been entitled to the difference between the actual costs and the allowance. The lease also included an escalation clause to cover increases in operating expenses for costs exceeding similar costs over the 2000 base year. A July 29, 2003 amendment to the lease added 8,580 square feet in additional office space and included an additional "Tenant Allowance" of $100,000 towards the costs of construction of tenant improvements once we had contributed $120,000 toward such improvements.
o Tell us how you accounted for the rent concessions in the period they were provided.
The rent concessions were not taken into account in computing the minimum lease payments and rent expense has not been recognized on a straight-line basis over the lease term.
Page 2 of 7 <PAGE> <TABLE> <CAPTION>
Impact on filings: As In Accordance Recorded with GAAP Under/(Over) Statement Per Year --------------------------------------------------------------------------- Balance Sheet 2002 2003 2004 ----------- ----------- ----------- Leasehold improvements, net <S> <C> <C> <C> <C> <C> 2002 $ 0 $ 283,500 $ 283,500 2003 $ 0 $ 343,432 $ 343,432 2004 $ 0 $ 300,503 $ 300,503
As a percentage of total assets 0.71% 0.00% 0.00% Total assets for the periods ending $40,068,016 $42,530,390 $57,260,748
As In Accordance Recorded with GAAP Under/(Over) Statement Per Year --------------------------------------------------------------------------- Statement of Income 2002 2003 2004 ----------- ----------- -----------
Rent expense 2002 $279,888 $ 265,675 $ 14,213 2003 $349,901 $ 314,860 $ 35,041 2004 $360,192 $ 331,255 $ 28,937
Amortization expense 2002 $ 0 $ 31,500 $ (31,500) 2003 $ 0 $ 40,068 $ (40,068) 2004 $ 0 $ 42,929 $ (42,929) ----------- ----------- ----------- Total $989,981 $1,026,287 $ (17,287) $ (5,027) $ (13,992) =========== =========== ===========
As a percentage of pre-tax income 0.00% 0.00% -1.07% Total pre-tax income for the periods ending $ 3,095,375 $ 3,394,765 $ 4,020,152
</TABLE>
4. We have reviewed your response to comment 12. Please address the following related to your investment in PEI:
o Tell us the amount each partner initially invested in PEI as well as when PEI was created;
PEI was created on March 1, 1990 with each partner making an initial investment of $21,000.00
o Tell us the amount that was paid by PEI for the purchase of the building;
The building was purchased March 20, 1990 for $650,000.00.
o Tell us the amount of equity income (loss) you recorded for each of the three years ended December 31, 2004 related to this investment.
2002 $ 0.00 2003 $25,965.00 2004 $36,000.00
Page 3 of 7 <PAGE>
o Tell us why your one-third investment in PEI was valued at zero at December 31, 2004;
We have accounted for our investment in PEI on the cash basis from 1999 through 2004. During 2003, cumulative cash distributions received from PEI investments exceeded our investment balance and we then recognized income for distributions received subsequently. Had we accounted for this investment on an accrual basis, our investment at December 31, 2004 would have been $164,000 and income from PEI would have been as follows for the years indicated.
2002 $ 34,925 2003 $ 39,646 2004 $ 32,951
o Tell us if you intend to renew the lease for office space with PEI that expires in 2005 and the terms of the new lease, if applicable; and
Effective August 1, 2005, we renewed the lease with PEI for five (5) years ending July 31, 2010. The triple-net lease, which has no step rent provisions, covers 12,474 square feet of office space at an annual cost of $146,694.20 and includes an escalation clause for increases in taxes, insurance and utilities costs based on like expenses for the calendar year 2004.
o Provide us with a comprehensive explanation of how you determined that the conditions provided in paragraph 5 of FIN 46(R) do not exist. Your explanation should address each condition and the specific facts and circumstances that led you to believe the condition did not exist.
We have addressed each condition in paragraph 5 of FIN 46(R) below with the text from FIN 46(R) and our explanation following:
An entity shall be subject to consolidation according to the provisions of this Interpretation if, by design, the conditions in a, b or c exists:
a. The total equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support provided by any parties, including equity holders. For this purpose, the total equity investment at risk: (1) Includes only equity investments in the entity that participate significantly in profits and losses even if those investments do not carry voting rights (2) Does not include equity interests that the entity issued in exchange for subordinated interests in other variable interest entities (3) Does not include amounts provided to the equity investor directly or indirectly by the entity or by other parties involved with the entity (for example, by fees, charitable contributions, or other payments), unless the provider is a parent, subsidiary, or affiliate of the investor that is required to be included in the same set of consolidated financial statements as the investor
Page 4 of 7 <PAGE>
(4) Does not include amounts financed for the equity investor (for example, by loans or guarantees of loans) directly by the entity or by other parties involved with the entity, unless that party is a parent, subsidiary, or affiliate of the investor that is required to be included in the same set of consolidated financial statements as the investor.
Paragraphs 9 and 10 discuss the amount of the total equity investment at risk that is necessary to permit an entity to finance its activities without additional subordinated financial support.
PEI is debt free and has equity, on a cash basis, equal to 100% of its total assets at December 31, 2004 and throughout 2005. In addition, ENGlobal only leases 50.6% of the available space for lease in the building. For the year ended December 31, 2004, PEI had total revenues, on a cash basis, of $259,748, of which $124,792 was supplied by tenants other than ENGlobal. PEI's net income for the year ended December 31, 2004, on a cash basis, amounted to $98,851. Paragraph 9 of FIN 46(R) states the equity investment at risk necessary to permit an entity to finance its own activities without additional subordinated financial support is 10%. It is our view that PEI has sufficient equity and cash flows, independent of lease payments from ENGlobal, to finance its operations without additional subordinated support from the Company or the other PEI investors. Therefore, we do not believe paragraph 5a (noted above) is applicable to the Company's investment in PEI.
b. As a group, the holders of the equity investment at risk lack any one of the following three characteristics of a controlling financial interest:
(1) The direct or indirect ability through voting rights or similar rights to make decisions about an entity's activities that have a significant effect on the success of the entity. The investors do not have that ability through voting rights or similar rights if no owners hold voting rights or similar rights (such as those of a common shareholder in a corporation or a general partner in a partnership).
PEI is owned equally by the Company, the Company's CEO (a less than 10% owner of the Company's common stock), and a third individual who owns less than 5% of the Company's common stock. Each owner of PEI has unfettered voting rights. No agreement is in place that would cause any two or more of PEI's owners to vote in tandem on any matter relating to PEI. As a result, neither the Company not its CEO controls the outcome of any PEI vote. In addition, the CEO has a much greater ownership interest in PEI (33.3%) than he has in the Company (less than 10%.
From the Company's perspective, any related party transaction, including those related to PEI, require action by the Company's Audit Committee as provided by the Committee's Charter. This Charter was initially adopted on December 18, 2003. The Company's Audit
Show Raw Text
<DOCUMENT>
<TYPE>CORRESP
<SEQUENCE>1
<FILENAME>filename1.txt
<TEXT>
VIA EDGAR - CORRESPONDENCE FILING
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0510
Re: ENGlobal Corporation - Form 10-K for the Fiscal Year ended December
31, 2004 and Form 10-Q for the Quarter ended March 31, 2005
SEC File No. 1-14217
Ladies and Gentlemen:
On August 12, 2005, ENGlobal Corporation (the "Company") received your letter
from Rufus Decker dated August 10, 2005 requesting that we provide the
Securities and Exchange Commission (the "Commission") with additional responses
to certain items included in our correspondence dated July 14, 2005 for the year
ended December 31, 2004. This letter sets forth the information requested in
that letter. For your convenience, the paragraphs included in this letter are
numbered to correspond to the comments in your letter.
General
-------
1. Where a comment below requests additional disclosures or other revisions,
please show us in your supplemental response what the revisions will look like.
These revisions should be included in your future filings, including interim
filings where applicable.
Our responses herein indicate, where applicable, the revisions to be included in
future filings, which revisions are, in each case, subject to such changes as
are dictated by future changes in the Company's business.
2. We have reviewed your response to comment 7. Please clarify whether all
depreciation and amortization expense is included in the selling, general and
administrative costs line item. If so, please tell us how you determined this
treatment is appropriate given the guidance of paragraph 72 of SOP 81-1. If
amounts are allocated to direct costs, please disclose your method for
allocating these amounts.
Depreciation and amortization expense is included solely in selling, general and
administrative costs. In our judgment, depreciation of fixed assets that would
potentially contribute to direct costs have been immaterial to gross profit
margin and, as a result, we have not specifically segregated them from selling,
general and administrative costs.
Certain depreciable fixed assets, specifically a building, furniture and
fixtures, leasehold improvements, and software are non-allocable to contract
costs based on the requirements of paragraph 72 of SOP 81-1. These assets are
strictly operations related and do not contribute to revenue production.
Other fixed assets that are potentially includable in direct costs are machinery
and equipment, autos and trucks, and computer hardware. We have determined that
these assets are used for the production of revenues. Depreciation expense for
2004 was $1,128,000 in total. Of this expense, approximately $565,000 was
related to machinery and equipment, autos and trucks, and computer hardware. The
approximate effect of classifying these depreciation expenses as direct costs
rather than selling, general and administrative would have caused a .38%
reduction in gross profit percentage from 12.34% to 11.96%. We believe that this
is immaterial to the financial statements as presented for 2004.
Page 1 of 7
<PAGE>
Due to continued growth of the Company, and projected future capital expenditure
increases due to engineering technological needs, management has determined that
a segregation of depreciation expense to direct costs is warranted. In future
filings, we will identify and segregate depreciable assets so that they will be
included in gross profit for both the current and comparable periods presented.
Amortization expense is the result of systematic write off of non-competition
and trademark license and acquisition agreements. We believe that these costs
also are not allocable to contract costs. Total amortization of non-competition
and trademark license and acquisition agreements in the year ended December 31,
2004 totaled $118,000.
3. We have reviewed your response to comment 11. Please tell us more about your
lease containing step rent provisions and capital improvement funding.
Specifically address the following:
o Tell us when the lease was initiated and when the rent concessions
were provided;
The original lease, which had no step rent provisions or capital improvement
funding, was effective June 1, 1990. The amended lease, which contained both
step rent provisions and capital improvement funding, was effective January 1,
2002.
o Provide us with a summary of the lease terms including when the lease
terminates; and
The amended lease covers approximately 34,300 square feet of office space for
the period January 1, 2002 through December 31, 2011 and includes increasing
annual lease amounts beginning each January 1st for years 2004, 2006, 2008, and
2010. The lease terminates on December 31, 2011. The lease included up to
$315,000 in a "Tenant Allowance" for improvements. If the costs of improvements
had exceeded the allowance, the Company would have been responsible for any
excess costs; but if actual costs had been less than the allowance, the Company
would not have been entitled to the difference between the actual costs and the
allowance. The lease also included an escalation clause to cover increases in
operating expenses for costs exceeding similar costs over the 2000 base year. A
July 29, 2003 amendment to the lease added 8,580 square feet in additional
office space and included an additional "Tenant Allowance" of $100,000 towards
the costs of construction of tenant improvements once we had contributed
$120,000 toward such improvements.
o Tell us how you accounted for the rent concessions in the period they
were provided.
The rent concessions were not taken into account in computing the minimum lease
payments and rent expense has not been recognized on a straight-line basis over
the lease term.
Page 2 of 7
<PAGE>
<TABLE>
<CAPTION>
Impact on filings:
As In Accordance
Recorded with GAAP Under/(Over) Statement Per Year
---------------------------------------------------------------------------
Balance Sheet 2002 2003 2004
----------- ----------- -----------
Leasehold improvements, net
<S> <C> <C> <C> <C> <C>
2002 $ 0 $ 283,500 $ 283,500
2003 $ 0 $ 343,432 $ 343,432
2004 $ 0 $ 300,503 $ 300,503
As a percentage of total assets 0.71% 0.00% 0.00%
Total assets for the periods ending $40,068,016 $42,530,390 $57,260,748
As In Accordance
Recorded with GAAP Under/(Over) Statement Per Year
---------------------------------------------------------------------------
Statement of Income 2002 2003 2004
----------- ----------- -----------
Rent expense
2002 $279,888 $ 265,675 $ 14,213
2003 $349,901 $ 314,860 $ 35,041
2004 $360,192 $ 331,255 $ 28,937
Amortization expense
2002 $ 0 $ 31,500 $ (31,500)
2003 $ 0 $ 40,068 $ (40,068)
2004 $ 0 $ 42,929 $ (42,929)
----------- ----------- -----------
Total $989,981 $1,026,287 $ (17,287) $ (5,027) $ (13,992)
=========== =========== ===========
As a percentage of pre-tax income 0.00% 0.00% -1.07%
Total pre-tax income for the periods ending $ 3,095,375 $ 3,394,765 $ 4,020,152
</TABLE>
4. We have reviewed your response to comment 12. Please address the following
related to your investment in PEI:
o Tell us the amount each partner initially invested in PEI as well as
when PEI was created;
PEI was created on March 1, 1990 with each partner making an initial investment
of $21,000.00
o Tell us the amount that was paid by PEI for the purchase of the
building;
The building was purchased March 20, 1990 for $650,000.00.
o Tell us the amount of equity income (loss) you recorded for each of
the three years ended December 31, 2004 related to this investment.
2002 $ 0.00
2003 $25,965.00
2004 $36,000.00
Page 3 of 7
<PAGE>
o Tell us why your one-third investment in PEI was valued at zero at
December 31, 2004;
We have accounted for our investment in PEI on the cash basis from 1999 through
2004. During 2003, cumulative cash distributions received from PEI investments
exceeded our investment balance and we then recognized income for distributions
received subsequently. Had we accounted for this investment on an accrual basis,
our investment at December 31, 2004 would have been $164,000 and income from PEI
would have been as follows for the years indicated.
2002 $ 34,925
2003 $ 39,646
2004 $ 32,951
o Tell us if you intend to renew the lease for office space with PEI
that expires in 2005 and the terms of the new lease, if applicable;
and
Effective August 1, 2005, we renewed the lease with PEI for five (5) years
ending July 31, 2010. The triple-net lease, which has no step rent provisions,
covers 12,474 square feet of office space at an annual cost of $146,694.20 and
includes an escalation clause for increases in taxes, insurance and utilities
costs based on like expenses for the calendar year 2004.
o Provide us with a comprehensive explanation of how you determined that
the conditions provided in paragraph 5 of FIN 46(R) do not exist. Your
explanation should address each condition and the specific facts and
circumstances that led you to believe the condition did not exist.
We have addressed each condition in paragraph 5 of FIN 46(R) below
with the text from FIN 46(R) and our explanation following:
An entity shall be subject to consolidation according to the
provisions of this Interpretation if, by design, the conditions in a,
b or c exists:
a. The total equity investment at risk is not sufficient to
permit the entity to finance its activities without
additional subordinated financial support provided by any
parties, including equity holders. For this purpose, the
total equity investment at risk:
(1) Includes only equity investments in the entity that
participate significantly in profits and losses even if
those investments do not carry voting rights
(2) Does not include equity interests that the entity
issued in exchange for subordinated interests in other
variable interest entities
(3) Does not include amounts provided to the equity
investor directly or indirectly by the entity or by
other parties involved with the entity (for example, by
fees, charitable contributions, or other payments),
unless the provider is a parent, subsidiary, or
affiliate of the investor that is required to be
included in the same set of consolidated financial
statements as the investor
Page 4 of 7
<PAGE>
(4) Does not include amounts financed for the equity
investor (for example, by loans or guarantees of loans)
directly by the entity or by other parties involved
with the entity, unless that party is a parent,
subsidiary, or affiliate of the investor that is
required to be included in the same set of consolidated
financial statements as the investor.
Paragraphs 9 and 10 discuss the amount of the total equity
investment at risk that is necessary to permit an entity to
finance its activities without additional subordinated
financial support.
PEI is debt free and has equity, on a cash basis, equal to 100% of its total
assets at December 31, 2004 and throughout 2005. In addition, ENGlobal only
leases 50.6% of the available space for lease in the building. For the year
ended December 31, 2004, PEI had total revenues, on a cash basis, of $259,748,
of which $124,792 was supplied by tenants other than ENGlobal. PEI's net income
for the year ended December 31, 2004, on a cash basis, amounted to $98,851.
Paragraph 9 of FIN 46(R) states the equity investment at risk necessary to
permit an entity to finance its own activities without additional subordinated
financial support is 10%. It is our view that PEI has sufficient equity and cash
flows, independent of lease payments from ENGlobal, to finance its operations
without additional subordinated support from the Company or the other PEI
investors. Therefore, we do not believe paragraph 5a (noted above) is applicable
to the Company's investment in PEI.
b. As a group, the holders of the equity investment at risk
lack any one of the following three characteristics of a
controlling financial interest:
(1) The direct or indirect ability through voting rights or
similar rights to make decisions about an entity's
activities that have a significant effect on the
success of the entity. The investors do not have that
ability through voting rights or similar rights if no
owners hold voting rights or similar rights (such as
those of a common shareholder in a corporation or a
general partner in a partnership).
PEI is owned equally by the Company, the Company's CEO (a less than 10% owner of
the Company's common stock), and a third individual who owns less than 5% of the
Company's common stock. Each owner of PEI has unfettered voting rights. No
agreement is in place that would cause any two or more of PEI's owners to vote
in tandem on any matter relating to PEI. As a result, neither the Company not
its CEO controls the outcome of any PEI vote. In addition, the CEO has a much
greater ownership interest in PEI (33.3%) than he has in the Company (less than
10%.
From the Company's perspective, any related party transaction, including those
related to PEI, require action by the Company's Audit Committee as provided by
the Committee's Charter. This Charter was initially adopted on December 18,
2003. The Company's Audit