ARGAN INC - Quarter Report: 2008 July (Form 10-Q)
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
(Mark
One)
| x |
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF
1934
|
For
the Quarterly Period Ended July
31, 2008
or
| o |
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT
|
For the
Transition Period from
to
Commission
File Number 001-31756
Argan,
Inc.
(Exact
Name of Registrant as Specified in Its Charter)
|
Delaware
|
13-1947195
|
|
|
(State
or Other Jurisdiction of Incorporation
or
Organization)
|
(I.R.S.
Employer Identification No.)
|
One
Church Street, Suite 401, Rockville Maryland 20850
(Address
of Principal Executive Offices) (Zip Code)
(301)
315-0027
(Registrant’s
Telephone Number, Including Area Code)
(Former
Name, Former Address and Former Fiscal Year,
if
Changed since Last Report)
Indicate
by check mark whether the Registrant (1) has filed all reports required to
be
filed by Section 13 or 15 (d) of the Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the Registrant was required to file
such reports), and (2) has been subject to such filing requirements for the
past
90 days. Yes þ
No
o
Indicate
by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company.
See
the definitions of “large accelerated filer,” “accelerated filer,” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act (check one):
Large
accelerated filer o
Accelerated
filer o
Non-accelerated
filer o
Smaller
reporting company þ
Indicate
by check mark whether the Registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes o
No
þ
Indicate
the number of shares outstanding of each of the Registrant’s classes of common
stock, as of the latest practicable date: Common Stock, $0.15 par value,
13,415,451 shares at September 2, 2008.
ARGAN,
INC. AND SUBSIDIARIES
INDEX
|
|
|
Page
No.
|
|
|
|
|
|
PART
I.
|
FINANCIAL
INFORMATION
|
3
|
|
|
|
|
|
Item
1.
|
Financial
Statements (unaudited)
|
3
|
|
|
|
|
|
|
Condensed
Consolidated Balance Sheets – July 31, 2008 and January 31,
2008
|
3
|
|
|
|
|
|
|
Condensed
Consolidated Statements of Operations for the Three and Six Months
Ended
July 31, 2008 and 2007
|
4
|
|
|
|
|
|
|
Condensed
Consolidated Statements of Cash Flows for the Six Months Ended July
31,
2008 and 2007
|
5
|
|
|
|
|
|
|
Notes
to Condensed Consolidated Financial Statements
|
6
|
|
|
|
|
|
Item
2.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operation
|
18
|
|
|
|
|
|
Item
3.
|
Quantitative
and Qualitative Disclosures about Market Risk
|
27
|
|
|
|
|
|
Item
4.
|
Controls
and Procedures
|
27
|
|
|
|
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|
PART
II.
|
OTHER
INFORMATION
|
28
|
|
|
|
|
|
Item
1.
|
Legal
Proceedings
|
28
|
|
|
|
|
|
Item
1A.
|
Risk
Factors
|
29
|
|
|
|
|
|
Item
2.
|
Unregistered
Sales of Equity Securities and Use of Proceeds
|
30
|
|
|
|
|
|
Item
3.
|
Defaults
upon Senior Securities
|
30
|
|
|
|
|
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Item
4.
|
Submission
of Matters to a Vote of Security Holders
|
30
|
|
|
|
|
|
Item
5.
|
Other
Information
|
30
|
|
|
|
|
|
Item
6.
|
Exhibits
|
30
|
|
|
|
|
|
SIGNATURES
|
|
31
|
-
2 -
Condensed
Consolidated Balance Sheets
(unaudited)
|
|
July
31,
|
January
31,
|
|||||
|
|
2008
|
2008
|
|||||
|
ASSETS
|
|||||||
|
CURRENT
ASSETS
|
|
|
|||||
|
Cash
and cash equivalents
|
$
|
104,001,000
|
$
|
66,827,000
|
|||
|
Escrowed
cash
|
10,312,000
|
14,398,000
|
|||||
|
Accounts
receivable, net of allowance for doubtful accounts
|
22,806,000
|
30,481,000
|
|||||
|
Inventories,
net of reserve for obsolescence
|
2,662,000
|
2,808,000
|
|||||
|
Current
deferred tax assets
|
1,120,000
|
406,000
|
|||||
|
Prepaid
expenses and other current assets
|
2,045,000
|
1,330,000
|
|||||
|
TOTAL
CURRENT ASSETS
|
142,946,000
|
116,250,000
|
|||||
|
Property
and equipment, net of accumulated depreciation
|
1,492,000
|
2,892,000
|
|||||
|
Goodwill
|
19,416,000
|
20,337,000
|
|||||
|
Other
intangible assets, net of accumulated amortization
|
4,036,000
|
5,296,000
|
|||||
|
Investment
in unconsolidated subsidiary
|
435,000
|
—
|
|||||
|
Deferred
tax assets
|
1,478,000
|
828,000
|
|||||
|
Other
assets
|
192,000
|
260,000
|
|||||
|
TOTAL
ASSETS
|
$
|
169,995,000
|
$
|
145,863,000
|
|||
|
|
|||||||
|
CURRENT
LIABILITIES
|
|||||||
|
Accounts
payable
|
$
|
44,356,000
|
$
|
35,483,000
|
|||
|
Accrued
expenses
|
7,330,000
|
9,370,000
|
|||||
|
Billings
in excess of cost and earnings
|
41,988,000
|
52,313,000
|
|||||
|
Current
portion of long-term debt
|
2,548,000
|
2,581,000
|
|||||
|
TOTAL
CURRENT LIABILITIES
|
96,222,000
|
99,747,000
|
|||||
|
Long-term
debt
|
2,875,000
|
4,134,000
|
|||||
|
Other
liabilities
|
75,000
|
116,000
|
|||||
|
TOTAL
LIABILITIES
|
99,172,000
|
103,997,000
|
|||||
|
COMMITMENTS
AND CONTINGENCIES (Note
14)
|
|||||||
|
STOCKHOLDERS'
EQUITY
|
|||||||
|
Preferred
stock, par value $0.10 per share; 500,000 shares authorized; no
shares issued and outstanding
|
—
|
—
|
|||||
|
Common
stock, par value $0.15 per share; 30,000,000
shares authorized; 13,413,684 and 11,113,534 shares issued and
13,410,451
and 11,110,301 shares outstanding at 7/31/08 and 1/31/08,
respectively
|
2,011,000
|
1,667,000
|
|||||
|
Warrants
outstanding
|
790,000
|
834,000
|
|||||
|
Additional
paid-in capital
|
84,113,000
|
57,861,000
|
|||||
|
Accumulated
other comprehensive loss
|
(63,000
|
)
|
(107,000
|
)
|
|||
|
Accumulated
deficit
|
(15,995,000
|
)
|
(18,356,000
|
)
|
|||
|
Treasury
stock, at cost; 3,233 shares at 7/31/08 and 1/31/08
|
(33,000
|
)
|
(33,000
|
)
|
|||
|
TOTAL
STOCKHOLDERS' EQUITY
|
70,823,000
|
41,866,000
|
|||||
|
TOTAL
LIABILITIES AND STOCKHOLDERS' EQUITY
|
$
|
169,995,000
|
$
|
145,863,000
|
|||
The
accompanying notes are an integral part of the condensed consolidated financial
statements.
-
3 -
ARGAN,
INC. AND SUBSIDIARIES
Condensed
Consolidated Statements of Operations
(unaudited)
|
|
Three
Months Ended July 31,
|
Six
Months Ended July 31,
|
|||||||||||
|
|
2008
|
2007
|
2008
|
2007
|
|||||||||
|
Net
revenues
|
|
|
|
|
|||||||||
|
Power
industry services
|
$
|
70,639,000
|
$
|
45,599,000
|
$
|
114,647,000
|
$
|
88,953,000
|
|||||
|
Nutritional
products
|
2,226,000
|
5,036,000
|
4,625,000
|
9,985,000
|
|||||||||
|
Telecommunications
infrastructure services
|
2,233,000
|
2,502,000
|
4,232,000
|
4,631,000
|
|||||||||
|
Net
revenues
|
75,098,000
|
53,137,000
|
123,504,000
|
103,569,000
|
|||||||||
|
Cost
of revenues
|
|||||||||||||
|
Power
industry services
|
63,108,000
|
40,590,000
|
101,684,000
|
83,835,000
|
|||||||||
|
Nutritional
products
|
2,395,000
|
4,122,000
|
4,718,000
|
8,288,000
|
|||||||||
|
Telecommunications
infrastructure services
|
1,875,000
|
1,858,000
|
3,649,000
|
3,701,000
|
|||||||||
|
Cost
of revenues
|
67,378,000
|
46,570,000
|
110,051,000
|
95,824,000
|
|||||||||
|
Gross
profit
|
7,720,000
|
6,567,000
|
13,453,000
|
7,745,000
|
|||||||||
|
|
|||||||||||||
|
Selling,
general and administrative expenses
|
4,016,000
|
4,773,000
|
8,027,000
|
9,334,000
|
|||||||||
|
Impairment
losses of Vitarich Laboratories, Inc.
|
1,946,000
|
—
|
1,946,000
|
—
|
|||||||||
|
Income
(loss) from operations
|
1,758,000
|
1,794,000
|
3,480,000
|
(1,589,000
|
)
|
||||||||
|
|
|||||||||||||
|
Interest
expense
|
(108,000
|
)
|
(185,000
|
)
|
(228,000
|
)
|
(378,000
|
)
|
|||||
|
Interest
income
|
432,000
|
657,000
|
936,000
|
1,279,000
|
|||||||||
|
Equity
in the net loss of unconsolidated subsidiary
|
(165,000
|
)
|
—
|
(165,000
|
)
|
—
|
|||||||
|
Income
(loss) from operations before
|
|||||||||||||
|
income
taxes
|
1,917,000
|
2,266,000
|
4,023,000
|
(688,000
|
)
|
||||||||
|
Income
tax (expense) benefit
|
(1,111,000
|
)
|
(932,000
|
)
|
(1,662,000
|
)
|
7,000
|
||||||
|
Net
income (loss)
|
$
|
806,000
|
$
|
1,334,000
|
$
|
2,361,000
|
$
|
(681,000
|
)
|
||||
|
|
|||||||||||||
|
Earnings
per share:
|
|||||||||||||
|
Basic
|
$
|
0.07
|
$
|
0.12
|
$
|
0.21
|
$
|
(0.06
|
)
|
||||
|
Diluted
|
$
|
0.07
|
$
|
0.12
|
$
|
0.20
|
$
|
(0.06
|
)
|
||||
|
Weighted
average number of shares outstanding:
|
|||||||||||||
|
Basic
|
11,860,000
|
11,094,000
|
11,493,000
|
11,094,000
|
|||||||||
|
Diluted
|
12,226,000
|
11,196,000
|
11,854,000
|
11,094,000
|
|||||||||
The
accompanying notes are an integral part of the condensed consolidated financial
statements.
-
4 -
Condensed
Consolidated Statements of Cash Flows
(unaudited)
|
Six
Months Ended July 31,
|
|||||||
|
|
2008
|
2007
|
|||||
|
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
|||||||
|
Net
income (loss)
|
$
|
2,361,000
|
$
|
(681,000
|
)
|
||
|
Adjustments
to reconcile net income (loss) to net cash provided by operating
activities:
|
|||||||
|
Impairment
losses
|
1,946,000
|
—
|
|||||
|
Amortization
of purchased intangibles
|
1,174,000
|
4,089,000
|
|||||
|
Depreciation
and other amortization
|
683,000
|
644,000
|
|||||
|
Deferred
income taxes
|
(1,501,000
|
)
|
(1,411,000
|
)
|
|||
|
Non-cash
stock option compensation expense
|
788,000
|
100,000
|
|||||
|
Equity
in net loss of unconsolidated subsidiary
|
165,000
|
—
|
|||||
|
Other
|
274,000
|
150,000
|
|||||
|
Changes
in operating assets and liabilities:
|
|||||||
|
Escrowed
cash
|
4,086,000
|
(3,000
|
)
|
||||
|
Accounts
receivable, net
|
7,737,000
|
(7,270,000
|
)
|
||||
|
Estimated
earnings in excess of billings
|
(56,000
|
)
|
8,084,000
|
||||
|
Inventories,
net
|
(25,000
|
)
|
(147,000
|
)
|
|||
|
Prepaid
expenses and other assets
|
(715,000
|
)
|
(869,000
|
)
|
|||
|
Accounts
payable and accrued expenses
|
9,115,000
|
(10,233,000
|
)
|
||||
|
Billings
in excess of cost and earnings
|
(10,325,000
|
)
|
30,518,000
|
||||
|
Other
|
(1,000
|
)
|
4,000
|
||||
|
Net
cash provided by operating activities
|
15,706,000
|
22,975,000
|
|||||
|
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
|||||||
|
Payment
of contingent acquisition price
|
(2,000,000
|
)
|
—
|
||||
|
Investment
in unconsolidated subsidiary
|
(600,000
|
)
|
—
|
||||
|
Purchases
of property and equipment, net
|
(259,000
|
)
|
(206,000
|
)
|
|||
|
Proceeds
from sale of investments
|
—
|
2,272,000
|
|||||
|
Net
cash (used in) provided by investing activities
|
(2,859,000
|
)
|
2,066,000
|
||||
|
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
|||||||
|
Net
proceeds from the private placement sale of common stock
|
24,982,000
|
—
|
|||||
|
Proceeds
from the exercise of stock options and warrants
|
637,000
|
—
|
|||||
|
Principal
payments on long-term debt
|
(1,292,000
|
)
|
(1,294,000
|
)
|
|||
|
Net
cash provided by (used in) financing activities
|
24,327,000
|
(1,294,000
|
)
|
||||
|
NET
INCREASE IN CASH AND CASH EQUIVALENTS
|
37,174,000
|
23,747,000
|
|||||
|
CASH
AND CASH EQUIVALENTS, BEGINNING OF PERIOD
|
66,827,000
|
25,393,000
|
|||||
|
CASH
AND CASH EQUIVALENTS, END OF PERIOD
|
$
|
104,001,000
|
$
|
49,140,000
|
|||
|
SUPPLEMENTAL
CASH FLOW INFORMATION:
|
|||||||
|
Cash
paid for interest and income taxes as follows:
|
|||||||
|
Interest
|
$
|
228,000
|
$
|
729,000
|
|||
|
Income
taxes
|
$
|
3,390,000
|
$
|
2,700,000
|
|||
|
Non-cash
investing and financing activities are as follows:
|
|||||||
|
Net
(increase) decrease in the fair value of interest rate
swaps
|
$
|
(44
,000
|
)
|
$
|
9,000
|
||
The
accompanying notes are an integral part of the condensed consolidated financial
statements.
-
5 -
ARGAN,
INC.
AND SUBSIDIARIES
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JULY
31, 2008
(unaudited)
NOTE
1 – DESCRIPTION OF THE BUSINESS AND BASIS OF
PRESENTATION
Organization
Argan,
Inc. (“Argan”) conducts its operations through its wholly-owned subsidiaries,
Gemma Power Systems, LLC and affiliates (“GPS”) which were acquired in December
2006, Vitarich Laboratories, Inc. (“VLI”) which was acquired in August 2004, and
Southern Maryland Cable, Inc. (“SMC”) which was acquired in July 2003. Argan and
its consolidated wholly-owned subsidiaries are hereinafter referred to as the
“Company.” Through GPS, the Company provides a full range of development,
consulting, engineering, procurement, construction, commissioning, operating
and
maintenance services to the power generation market for a wide range of
customers including public utilities, independent power project owners,
municipalities, public institutions and private industry. Through VLI, the
Company develops, manufactures and distributes premium nutritional supplements,
whole-food dietary supplements and personal care products. Through SMC, the
Company provides telecommunications infrastructure services including project
management, construction, installation and maintenance primarily to the federal
government, telecommunications and broadband service providers, and electric
utilities in the Mid-Atlantic region. Each of the wholly-owned subsidiaries
represents a separate reportable segment.
In
June
2008, the Company announced that GPS entered into a business partnership with
Invenergy Wind Management LLC, for the design and construction of wind farms
located in the United States and Canada. The partners each own 50% of a new
company, Gemma Renewable Power, LLC (“GRP”). The Company expects that GRP will
provide engineering, procurement and construction services for new wind farms
generating electrical power including the design and construction of roads,
foundations, and electrical collection systems, as well as the erection of
towers, turbines and blades. The new venture also plans to offer ongoing
maintenance services to the wind farms.
Basis
of Presentation
The
condensed consolidated financial statements include the accounts of Argan and
its wholly-owned subsidiaries. The Company’s fiscal year ends on January 31. The
results of companies acquired during a reporting period are included in the
consolidated financial statements from the effective date of the acquisition.
All significant inter-company balances and transactions have been eliminated
in
consolidation. As discussed in Note 7, the Company accounts for its investment
in GRP using the equity method.
The
condensed consolidated balance sheet as of July 31, 2008, the condensed
consolidated statements of operations for the three and six months ended July
31, 2008 and 2007, and the condensed consolidated statements of cash flows
for
the six months ended July 31, 2008 and 2007 are unaudited. The condensed
consolidated balance sheet as of January 31, 2008 has been derived from audited
financial statements. Certain comparative amounts have been reclassified to
conform with the presentation in the condensed consolidated financial statements
for the current periods. In the opinion of management, the accompanying
condensed consolidated financial statements contain all adjustments, which
are
of a normal and recurring nature, considered necessary to present fairly the
financial position of the Company as of July 31, 2008 and the results of its
operations and its cash flows for the interim periods presented. The
results of operations for any interim period are not necessarily indicative
of
the results of operations for any other interim period or for a full fiscal
year.
These
condensed consolidated financial statements have been prepared pursuant to
the
rules and regulations of the Securities and Exchange Commission (the “SEC”).
Certain information and note disclosures normally included in annual financial
statements prepared in accordance with U.S. GAAP have been condensed or omitted
pursuant to those rules and regulations, although the Company believes that
the
disclosures made are adequate to make the information not misleading. The
accompanying condensed consolidated financial statements and notes should be
read in conjunction with the consolidated financial statements, the notes
thereto, and the independent registered public accounting firm’s report thereon
that are included in the Company’s Annual Report on Form 10-K filed with the SEC
for the fiscal year ended January 31, 2008.
-
6 -
Recently
Issued Accounting Pronouncements
In
May
2008, the Financial Accounting Standards Board (the “FASB”) issued Statement of
Financial Accounting Standards No. 162, “The Hierarchy of Generally Accepted
Accounting Principles”. This statement identifies the sources of accounting
principles and the framework for selecting the principles used in the
preparation of financial statements of nongovernmental entities that are
presented in conformity with U.S. GAAP (the “GAAP Hierarchy”) and mandates that
the GAAP Hierarchy reside in the accounting literature as opposed to the audit
literature. This pronouncement will become effective 60 days following approval
by the SEC. The Company does not believe this pronouncement will impact its
consolidated financial statements.
In
April
2008, the FASB issued FASB Staff Position (“FSP”) FAS 142-3, “Determination of
the Useful Life of Intangible Assets.” This FSP amends the factors that should
be considered in developing renewal or extension assumptions used to determine
the useful life of a recognized intangible asset under Statement of Financial
Accounting Standards No. 142, “Goodwill and Other Intangible Assets.”
(“SFAS No. 142”) and intends to improve the consistency between the useful life
of a recognized intangible asset under SFAS No. 142 and the period of expected
cash flows used to measure the fair value of the asset under FASB Statement
of
Financial Accounting Standards No. 141R (see description below) and other
U.S. generally accepted accounting principles. This FSP is effective for the
Company’s interim and annual financial statements beginning in the fiscal year
ending January 31, 2010. The Company does not expect the adoption of this FSP
to
have a material impact on its consolidated financial statements.
In
March
2008, the FASB issued Statement of Financial Accounting Standards No. 161,
“Disclosures about Derivative Instruments and Hedging Activities – An Amendment
of FASB Statement No. 133.” This new standard requires enhanced disclosures
about an entity’s derivative and hedging activities with the intent of improving
the transparency of financing reporting as the use and complexity of derivative
instruments and hedging activities have increased significantly over the past
several years. Currently, the Company uses interest rate swap agreements to
hedge the risks related to the variable interest paid on its term loans. The
current effects of the Company’s hedging activities are not significant to its
consolidated financial statements. However, the new standard will require the
Company to provide an enhanced understanding of 1) how and why it uses
derivative instruments, 2) how it accounts for derivative instruments and the
related hedged items, and 3) how derivatives and related hedged items affect
its
financial position, financial performance and cash flows. Adoption of this
new
accounting standard will first be required for the Company’s consolidated
financial statements covering the quarter ending April 30, 2009.
In
December 2007, the FASB issued Statement of Financial Accounting Standards
No. 141R, “Business Combinations” (“SFAS No. 141R”). SFAS No. 141R
replaces SFAS No. 141 and provides greater consistency in the accounting and
financial reporting of business combinations. SFAS No. 141R requires the
acquiring entity in a business combination to recognize all assets acquired
and
liabilities assumed in the transaction, establishes the acquisition-date fair
value as the measurement objective for all assets acquired and liabilities
assumed, establishes principles and requirements for how an acquirer recognizes
and measures any non-controlling interest in the acquiree and the goodwill
acquired, and requires the acquirer to disclose the nature and financial effect
of the business combination. Among other changes, this statement also requires
that “negative goodwill” be recognized in earnings as a gain attributable to the
acquisition, that acquisition-related costs are to be recognized separately
from
the acquisition and expensed as incurred and that any deferred tax benefits
resulted in a business combination are recognized in income from continuing
operations in the period of the combination. SFAS No. 141(R) will be
effective for the Company for business combinations occurring subsequent to
January 31, 2009. The accounting for future acquisitions, if any, may be
affected by certain new requirements of this pronouncement that will be
evaluated by the Company at that time.
In
December 2007, the FASB also issued Statement of Financial Accounting Standards
No. 160, “Noncontrolling Interests in Consolidated Financial Statements,” that
establishes accounting and reporting standards for minority interests in
consolidated subsidiaries. This standard will be effective for the Company
on
February 1, 2009, and its adoption would not affect the Company’s current
consolidated financial statements.
In
February 2007, the FASB issued Statement of Financial Accounting Standards
No.
159, “The Fair Value Option for Financial Assets and Financial Liabilities.”
This standard permits companies to measure many financial instruments and
certain other items at fair value at specified election dates. The provisions
of
this new standard were effective for the Company beginning February 1, 2008
and
did not have a significant impact on the consolidated financial
statements.
In
September 2006, the FASB issued Statement of Financial Accounting Standards
No.
157, “Fair Value Measurements.” This standard defines fair value, establishes a
framework for measuring fair value in generally accepted accounting principles
and expands disclosures about fair value measurements. Certain provisions of
this standard relating to financial assets and financial liabilities were also
effective for the Company beginning February 1, 2008; they did not have a
significant impact on the consolidated financial statements. Adoption of the
other provisions of this new standard relating primarily to nonfinancial assets
and nonfinancial liabilities will first be required for the Company’s
consolidated financial statements covering the quarter ending April 30, 2009.
The significant nonfinancial items included in the Company’s consolidated
balance sheet include property and equipment, goodwill and other purchased
intangible assets. Adoption of the new provisions is not expected to have a
significant impact on the Company’s consolidated financial
statements.
-
7 -
NOTE
2 - CASH, CASH EQUIVALENTS AND ESCROWED CASH
The
Company considers all liquid investments with original maturities of three
months or less at the time of purchase to be cash equivalents. The Company
holds
cash on deposit at banks in excess of federally insured limits. However, due
to
a belief in the financial strength of the financial institutions, primarily
Bank
of America (the “Bank”), management does not believe that the risk associated
with keeping deposits in excess of federal deposit limits represents a material
risk currently.
Pursuant
to the GPS acquisition agreement, the Company deposited $12.0 million into
an
escrow account with the Bank. Of this amount, $10.0 million secures a letter
of
credit that was issued in support of a bonding commitment. The remaining amount
of $2.0 million was set aside for the payment of up to $2.0 million of
additional purchase price in the event that GPS would meet certain financial
objectives in 2007. As the earnings before interest, taxes, depreciation and
amortization (“EBITDA”) of GPS for the twelve months ended December 31, 2007, as
defined in the acquisition agreement, exceeded the required amount of $12.0
million, the $2.0 million in additional purchase price was paid to the former
owners of GPS in March 2008. The obligation to pay the former owners was
included in accrued liabilities in the accompanying condensed consolidated
balance sheet at January 31, 2008.
In
2003,
Argan completed the sale of Puroflow Incorporated, a wholly-owned subsidiary,
to
Western Filter Corporation (“WFC”). Proceeds in the amount of $300,000 are
currently being held in escrow, and were included in the condensed consolidated
balance sheets at July 31, 2008 and January 31, 2008, to indemnify WFC from
any
damages resulting from any breach of representations and warranties under the
stock purchase agreement (see Note 14).
For
certain construction projects, cash may be held in escrow as a substitute for
retainage. Cash held in escrow for retainage at January 31, 2008 in the amount
of approximately $2.1 million related to a completed project was released and
paid to the Company in the first quarter of the current fiscal year.
NOTE
3 - ACCOUNTS RECEIVABLE AND ESTIMATED EARNINGS IN EXCESS OF
BILLINGS
Accounts
receivable and estimated earnings in excess of billings represent amounts due
from customers for services rendered or products delivered. The timing of
billing to customers under construction-type contracts varies based on
individual contracts and often differs from the period in which revenue is
recognized. The amounts of estimated earnings in excess of billings included
in
the condensed consolidated balance sheets at July 31, 2008 and January 31,
2008
were $298,000 and $242,000, respectively, and were expected to be billed and
collected in the normal course of business. Retainages included in accounts
receivable represent amounts withheld by construction customers until a defined
phase of a contract or project has been completed and accepted by the customer.
Retainage amounts included in accounts receivable were approximately $3.0
million and $5.6 million at July 31, 2008 and January 31, 2008, respectively.
The length of retainage periods may vary, but they are typically between six
months and two years.
The
Company conducts business and may extend credit to customers based on an
evaluation of the customers’ financial condition, generally without requiring
collateral. Exposure to losses on accounts receivable is expected to vary by
customer due to the different financial condition of each customer. The Company
monitors its exposure to credit losses and maintains allowances for anticipated
losses considered necessary under the circumstances based on historical
experience with uncollected accounts and a review of its current accounts
receivable. The Company’s allowance for doubtful accounts amounts at July 31,
2008 and January 31, 2008 were $36,000 and $70,000, respectively. The Company
incurred bad debt expense of $58,000 for the six months ended July 31, 2007,
and
had bad debt recoveries of $91,000, $17,000 and $6,000 for the three months
ended July 31, 2008 and 2007, and the six months ended July 31, 2008,
respectively. These amounts were reflected in selling, general and
administrative expenses in the accompanying condensed consolidated statements
of
operations.
NOTE
4 - INVENTORIES
Inventories
are stated at the lower of cost or market (i.e., net realizable value). Cost
is
determined on the first-in first-out (FIFO) method and includes material, labor
and overhead costs. Fixed overhead is allocated to inventory based on the normal
capacity of the Company’s production facilities. Any costs related to idle
facilities, excess spoilage, excess freight or re-handling are expensed
currently as period costs. Appropriate consideration is given to obsolescence,
excessive inventory levels, product deterioration and other factors (i.e. -
lot
expiration dates, the ability to recertify or test for extended expiration
dates, the number of products that can be produced using the available raw
materials and the market acceptance or regulatory issues surrounding certain
materials) in evaluating net realizable value. The Company’s provision amounts
expensed for inventory obsolescence were approximately $103,000 and $56,000,
respectively, during the three months ended July 31, 2008 and 2007, and were
approximately $171,000 and $92,000, respectively, during the six months ended
July 31, 2008 and 2007.
-
8 -
Inventories
consisted of the following amounts at July 31, 2008 and January 31,
2008:
|
|
July
31,
2008
|
January
31,
2008
|
|||||
|
Raw
materials
|
$
|
2,755,000
|
$
|
2,846,000
|
|||
|
Work-in
process
|
37,000
|
43,000
|
|||||
|
Finished
goods
|
150,000
|
144,000
|
|||||
|
Less:
reserves
|
(280,000
|
)
|
(225,000
|
)
|
|||
|
Inventories,
net
|
$
|
2,662,000
|
$
|
2,808,000
|
|||
NOTE
5 - PROPERTY AND EQUIPMENT
Property
and equipment are stated at cost. Depreciation is determined using the
straight-line method over the estimated useful lives of the assets, which are
generally from five to twenty years. Leasehold improvements are amortized on
a
straight-line basis over the estimated useful life of the related asset or
the
lease term, whichever is shorter. Depreciation expense amounts for property
and
equipment, including assets under capital leases, were approximately $308,000
and $280,000, respectively, for the three months ended July 31, 2008 and 2007,
and were approximately $611,000 and $560,000, respectively, for the six months
ended July 31, 2008 and 2007. The costs of maintenance and repairs (totaling
approximately $138,000 and $247,000 for the three and six months ended July
31,
2008) are expensed as incurred. Such costs were approximately $138,000 and
$258,000, respectively, for the three and six months ended July 31, 2007. Major
improvements are capitalized. When assets are sold or retired, the cost and
related accumulated depreciation are removed from the accounts and the resulting
gain or loss is included in income. During the three months ended July 31,
2008,
the Company recorded an impairment loss in the amount of $939,000 related to
the
fixed assets of VLI as described in Note 6.
Property
and equipment at July 31, 2008 and January 31, 2008 consisted of the
following:
|
|
July
31,
2008
|
January
31,
2008
|
|||||
|
Leasehold
improvements
|
$
|
829,000
|
$
|
1,051,000
|
|||
|
Machinery
and equipment
|
2,869,000
|
3,778,000
|
|||||
|
Trucks
and other vehicles
|
1,293,000
|
1,263,000
|
|||||
|
4,991,000
|
6,092,000
|
||||||
|
Less
– accumulated depreciation
|
(3,499,000
|
)
|
(3,200,000
|
)
|
|||
|
Property
and equipment, net
|
$
|
1,492,000
|
$
|
2,892,000
|
|||
NOTE
6 - INTANGIBLE ASSETS
In
connection with the acquisitions of GPS, VLI and SMC, the Company recorded
goodwill and other purchased intangible assets including contractual and other
customer relationships, proprietary formulas, non-compete agreements and trade
names. In accordance with FASB Statement of Financial Accounting Standards
No.
142 “Goodwill and Other Intangible Assets,” the Company reviews for impairment,
at least annually, the carrying values of goodwill and other purchased
intangible assets deemed to have an indefinite life. The Company tests for
impairment of goodwill and these other intangible assets more frequently if
events or changes in circumstances indicate that the asset value might be
impaired. Long-lived assets, including purchased intangible assets deemed to
have finite lives, are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount should be assessed pursuant
to
FASB Statement of Financial Accounting Standards No. 144, “Accounting for the
Impairment or Disposal of Long-Lived Assets.”
During
the three months ended July 31, 2008, VLI continued to report operating results
that were below expected results. The loss of major customers and the reduction
in the amounts of orders received from currently major customers have caused
net
revenues to continue to decline and this business to operate at a loss.
Accordingly, during the current quarter, we conducted analyses in order to
determine whether additional impairment losses have occurred related to the
goodwill and the long-lived assets of VLI. The assessment analyses indicated
that the carrying value of the business exceeded its fair value, that the
carrying values of VLI’s long-lived assets were not recoverable and that the
carrying values of the long-lived assets exceeded their corresponding fair
values. As a result, VLI recorded impairment losses related to goodwill, other
purchased intangible assets, and fixed assets in the amounts of $921,000,
$86,000 and $939,000, respectively, that were included in the condensed
consolidated statements of operations for the three and six months ended July
31, 2008.
-
9 -
The
Company’s intangible assets consisted of the following at July 31, 2008 and
January 31, 2008:
|
July
31, 2008
|
||||||||||||||||
|
Estimated
Useful
Life
|
Gross
Carrying
Amount
|
Accumulated
Amortization
|
Net
Amount
|
January 31,
2008
Net Amount
|
||||||||||||
|
Intangible
assets being amortized:
|
||||||||||||||||
|
Contractual
customer relationships
- VLI and SMC
|
5-7
years
|
$
|
2,190,000
|
$
|
1,988
,000
|
$
|
202,000
|
$
|
379,000
|
|||||||
|
Customer
relationships - GPS
|
1-2
years
|
6,678,000
|
6,678,000
|
—
|
904,000
|
|||||||||||
|
Proprietary
formulas - VLI
|
3
years
|
|
1,813,000
|
1,813,000
|
—
|
—
|
||||||||||
|
Non-compete
agreements - GPS and VLI
|
5
years
|
1,731,000
|
1,365,000
|
366,000
|
424,000
|
|||||||||||
|
Trade
name - GPS
|
15
years
|
3,643,000
|
399,000
|
3,244,000
|
3,365,000
|
|||||||||||
|
Intangible
assets not being amortized:
|
||||||||||||||||
|
Trade
name - SMC
|
Indefinite
|
224,000
|
—
|
224,000
|
224,000
|
|||||||||||
|
Total
other intangible assets
|
$
|
16,279,000
|
$
|
12,243,000
|
$
|
4,036,000
|
$
|
5,296,000
|
||||||||
|
Goodwill
|
Indefinite
|
$
|
19,416,000
|
$
|
—
|
$
|
19,416,000
|
$
|
20,337,000
|
|||||||
Amortization
expense totaling $402,000 for the three months ended July 31, 2008, consisted
of
$313,000, $61,000 and $28,000 for contractual customer relationships, the trade
name and non-compete agreements, respectively. Amortization expense totaling
$2,025,000 for the three months ended July 31, 2007, consisted of $1,733,000,
$116,000, $115,000 and $61,000 for contractual customer relationships,
non-compete agreements, proprietary formulas and the trade name,
respectively.
Amortization
expense totaling $1,174,000 for the six months ended July 31, 2008, consisted
of
$995,000, $122,000 and $57,000 for contractual customer relationships, the
trade
name and non-compete agreements, respectively. Amortization expense totaling
$4,089,000 for the six months ended July 31, 2007, consisted of $3,505,000,
$232,000, $230,000 and $122,000 for contractual customer relationships,
non-compete agreements, proprietary formulas, and the trade name,
respectively.
NOTE
7 – INVESTMENT IN UNCONSOLIDATED SUBSIDIARY
In
June
2008, the Company announced that GPS had entered into a business partnership
with Invenergy Wind Management LLC for the design and construction of
wind-energy farms located in the United States and Canada. The business partners
each own 50% of a new company, Gemma Renewable Power, LLC (“GRP”). The Company
expects that GRP will provide engineering, procurement and construction services
for new wind farms generating electrical power including the design and
construction of roads, foundations, and electrical collection systems, as well
as the erection of towers, turbines and blades. It is anticipated that the
new
venture shall also assist with some of the ongoing maintenance of the wind
farms. In connection with the formation of GRP, each partner made cash
investments totaling $600,000 during the current quarter. Pursuant to the
formation agreement, each partner is obligated to make additional cash
contributions of $2.4 million by September 15, 2008.
The
Company accounts for its investment in GRP using the equity method. Under this
method, the Company records its proportionate share of GRP’s net income or loss
based on the most recent available quarterly financial statements. As GRP
follows a calendar year basis of financial reporting, the Company’s results of
operations for the three and six months ended July 31, 2008 included the
Company’s share of GRP's net loss from the date of formation (May 27, 2008)
through June 30, 2008; the Company’s share of the net loss for this period was
approximately $165,000. The net investment in GRP was included in the Company’s
condensed consolidated balance sheet at July 31, 2008 in the amount of
$435,000.
During
the start-up period of this business and under an agreement with GRP, GPS is
incurring certain reimbursable costs on behalf of GRP. In addition, GPS provides
certain administrative and accounting services for GRP. The amount of such
reimbursable costs in the three months ended July 31, 2008 was approximately
$539,000. At July 31, 2008, the unpaid portion of this amount, approximately
$141,000, was included in prepaid expenses and other current assets in the
condensed consolidated balance sheet.
-
10 -
NOTE
8 - DEBT
The
Company has financing arrangements with the Bank including an amended 3-year
term loan for VLI in the amount of $1.4 million which bears interest at LIBOR
(2.46% at July 31, 2008) plus 3.25%; a 4-year term loan in the amount of $8.0
million which bears interest at LIBOR plus 3.25%, the proceeds from which were
used to acquire GPS; and a revolving loan with a maximum borrowing amount of
$4.25 million available until May 31, 2010, with interest at LIBOR plus 3.25%.
The outstanding principal amounts of the VLI and GPS loans were $542,000 and
$4,833,000, respectively, as of July 31, 2008; no borrowed amounts were
outstanding under the revolving loan as of July 31, 2008.
The
financing arrangements with the Bank require compliance with certain financial
covenants at the Company’s fiscal year end and at each of the Company’s fiscal
quarter ends (using a rolling 12-month period), including requirements that
the
ratio of total funded debt to EBITDA not exceed 2 to 1, that the fixed charge
coverage ratio be not less than 1.25 to 1, and that the ratio of senior funded
debt to EBITDA not exceed 1.50 to 1. The Bank’s consent continues to be required
for acquisitions and divestitures. The Company continues to pledge the majority
of the Company’s assets to secure the financing arrangements. The amended
financing arrangements contain an acceleration clause which allows the Bank
to
declare amounts outstanding under the financing arrangements due and payable
if
it determines in good faith that a material adverse change has occurred in
the
financial condition of the Company or any of its subsidiaries. The Company
believes that it will continue to comply with its financial covenants under
the
financing arrangements. If the Company’s performance does not result in
compliance with any of its financial covenants, or if the Bank seeks to exercise
its rights under the acceleration clause referred to above, the Company would
seek to modify its financing arrangements, but there can be no assurance that
the Bank would not exercise its rights and remedies under the financing
arrangements including accelerating payments of all outstanding senior debt
due
and payable. At July 31, 2008 and January 31, 2008, the Company was in
compliance with the covenants of its amended financing
arrangements.
During
the year ended January 31, 2007, the Company entered into interest rate swap
agreements as cash flow hedges related to the VLI and GPS loans with a total
initial notional amount of $5,125,000 and terms of three years. Under the swap
agreements, the Company receives a floating rate based on the LIBOR interest
rate and pays fixed rates; the Company’s weighted-average fixed rate related to
its interest rate swap agreements is 5.22%. At July 31, 2008 and January 31,
2008, the Company’s consolidated balance sheets included liabilities in the
amounts of $63,000 and $107,000, respectively, in order to recognize the fair
value of the interest rate swaps; these amounts were included in other long-term
liabilities in the accompanying condensed consolidated balance sheets.
Total
interest expense amounts related to the VLI and GPS loans were $106,000 and
$180,000 for the three months ended July 31, 2008 and 2007, respectively, and
were $225,000 and $368,000 for the six months ended July 31, 2008 and 2007,
respectively.
The
Company may obtain standby letters of credit from the Bank in the ordinary
course of business in amounts not to exceed $10.0 million in the aggregate.
On
December 11, 2006, the Company pledged $10.0 million in cash to the Bank in
order to secure a standby letter of credit that was issued by the Bank for
the
benefit of Travelers Casualty and Surety Company of America in connection with
the bonding facility provided to GPS.
NOTE
9 – PRIVATE PLACEMENT OF COMMON STOCK
In
July
2008, the Company completed a private placement sale of 2.2 million shares
of
common stock to investors at a price of $12.00 per share that provided net
proceeds of approximately $25 million. It is expected that the proceeds will
provide resources to support GPS’s cash requirements relating to the new
wind-power energy subsidiary described in Note 7 and will make available
additional collateral to support the bonding requirements associated with future
energy plant construction projects.
Allen
& Company LLC (“Allen”) served as placement agent for the stock offering and
was paid a fee of approximately $1.3 million for their services by the Company.
One of the members of our Board of Directors is a managing director of Allen.
NOTE
10 - STOCK-BASED COMPENSATION
The
Company has a stock option plan which was established in August 2001 (the
“Option Plan”). Under the Option Plan, the Company’s Board of Directors may
grant stock options to officers, directors and key employees. Stock options
granted may be incentive stock options or nonqualified stock options. Currently,
the Company is authorized to grant options for up to 1,150,000 shares of the
Company’s common stock, including 500,000 shares that were authorized for award
at the Company’s Annual Meeting for Stockholders held in June
2008.
-
11 -
A
summary
of stock option activity under the Option Plan during the six months ended
July
31, 2008 is presented below:
|
Options
|
Shares
|
Weighted-
Average
Exercise
Price
|
Weighted-
Average
Remaining
Contract
Term
(Years)
|
Weighted-
Average
Fair
Value
|
|||||||||
|
Outstanding,
January 31, 2008
|
426,000
|
$
|
6.07
|
||||||||||
|
Granted
|
120,000
|
$
|
12.05
|
||||||||||
|
Exercised
|
(88,000
|
)
|
$
|
6.14
|
|||||||||
|
Forfeited
or expired
|
(1,000
|
)
|
$
|
7.87
|
|||||||||
|
Outstanding,
July 31, 2008
|
457,000
|
$
|
7.62
|
7.6
|
$
|
4.35
|
|||||||
|
Exercisable,
July 31, 2008
|
232,000
|
$
|
4.19
|
6.2
|
$
|
2.40
|
|||||||
|
Exercisable,
January 31, 2008
|
235,000
|
$
|
4.16
|
6.9
|
$
|
2.19
|
|||||||
The
weighted-average grant date fair value amount per share for stock options
awarded during the six months ended July 31, 2008 was $6.68.
Compensation
expense amounts relating to vesting stock options were $391,000 and $86,000,
respectively, in the three months ended July 31, 2008 and 2007 and were $788,000
and $100,000, respectively, in the six months ended July 31, 2008 and 2007.
At
July 31, 2008, there was $625,000 unrecognized compensation cost related to
stock options granted under the Option Plan. The end of the period over which
the compensation expense for these awards is expected to be recognized is June
2009. The total intrinsic value of the stock options exercised during the six
months ended July 31, 2008 was approximately $798,000. The aggregate intrinsic
value amount for exercisable stock options at July 31, 2008 was approximately
$2,851,000.
The
fair
value of each stock option granted in the six months ended July 31, 2008 was
estimated on the date of award using the Black-Scholes option-pricing model
based on the following weighted average assumptions.
|
|
Six Months
Ended July 31,
2008
|
|||
|
Dividend yield
|
—
|
|||
|
Expected
volatility
|
61
|
%
|
||
|
Risk-free
interest rate
|
4.00
|
%
|
||
|
Expected
life in years
|
5
|
|||
The
Company also has outstanding warrants to purchase 214,000 shares of the
Company’s common stock as of July 31, 2008, exercisable at a per share price of
$7.75, that were issued in connection with the Company’s private placement in
April 2003 to three individuals who became the executive officers of the Company
upon completion of the offering and also to an investment advisory firm. A
director of the Company is the chief executive officer of the investment
advisory firm. The fair value of the issued warrants of $849,000 was recognized
as offering costs. All warrants are exercisable and expire in April
2013.
At
July
31, 2008, there were 1,257,000 shares of the Company’s common stock available
for issuance upon the exercise of stock options and warrants, including 587,000
shares of the Company’s common stock available for award under the Option
Plan.
NOTE
11 - NET INCOME (LOSS) PER SHARE
Basic
income per share amounts for the three and six months ended July 31, 2008,
and
the three months ended July 31, 2007, were computed by dividing net income
by
the weighted average number of common shares outstanding for the respective
period. Diluted income per share was computed by dividing net income by the
weighted average number of common shares outstanding during the period plus
366,000, 361,000 and 102,000 shares representing the total dilutive effects
of
outstanding stock options and warrants for the three and six months ended July
31, 2008, and the three months ended July 31, 2007, respectively.
-
12 -
Basic
loss per share for the six months ended July 31, 2007 was calculated by dividing
the net loss for the period by the weighted average number of common shares
outstanding for the applicable period. Common stock equivalents, including
stock
options and warrants, were not considered because the effect of their inclusion
would be anti-dilutive.
NOTE
12 - INCOME TAXES
The
Company’s income tax (expense) benefit for the six months ended July 31, 2008
and 2007 differs from the expected income tax (expense) benefit computed by
applying the U.S. Federal corporate income tax rate of 34% to the income (loss)
from operations before income taxes as shown in the table below. For the six
months ended July 31, 2008, the unfavorable tax effect of permanent items
relates primarily to the impairment loss recorded in the current year related
to
the goodwill of VLI. This impairment loss is not deductible for income tax
reporting purposes.
|
|
2008
|
2007
|
|||||
|
Computed
expected income tax (expense) benefit
|
$
|
(1,368,000
|
)
|
$
|
234,000
|
||
|
State
income taxes, net
|
(150,000
|
)
|
(203,000
|
)
|
|||
|
Permanent
differences
|
(144,000
|
)
|
(24,000
|
)
|
|||
|
|
$
|
(1,662,000
|
)
|
$
|
7,000
|
||
As
of
July 31, 2008 and January 31, 2008, accrued expenses included income tax amounts
currently payable of approximately $498,000 and $1,003,000, respectively.
The
Company adopted the provisions of FASB Interpretation No. 48, “Accounting for
Uncertainty in Income Taxes - an interpretation of SFAS No. 109” (“FIN 48”), on
February 1, 2007. FIN 48 clarifies the accounting for uncertainty in income
taxes recognized in an enterprise’s financial statements in accordance with SFAS
No. 109, “Accounting for Income Taxes,” and prescribes a recognition threshold
and measurement process for financial statement recognition and measurement
of
tax positions taken or expected to be taken in a tax return. FIN 48 also
provides guidance on de-recognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition. There was no material
effect on the Company’s consolidated financial statements as a result of
adopting this standard.
NOTE
13 - TERMINATED CONSTRUCTION CONTRACT
Under
the
terms of an amended agreement with a customer covering the engineering,
procurement and construction of an ethanol production facility (the “EPC
Agreement”), March 19, 2008 was the deadline for the customer to obtain
financing for the completion of the project. Financing was not obtained and
the
EPC Agreement was terminated. GPS continues to cooperate with the customer
in
its efforts to obtain financing. GPS is uncertain as to the ultimate resolution
of this matter. As of July 31, 2008 and January 31, 2008, the Company’s
consolidated balance sheets included assets and liabilities related to the
terminated construction contract. The Company has classified these assets and
liabilities as current assets and current liabilities in the accompanying
condensed consolidated balance sheets due to the expectation that the assets
will be realized and the liabilities will be extinguished. Although cash may
be
required to make payment on accounts payable to project subcontractors that
are
included in the condensed consolidated balance sheet at July 31, 2008, GPS
does
not anticipate any losses to arise from the resolution of this EPC Agreement.
No
net revenues were recorded in the six months ended July 31, 2008 related to
this
project.
NOTE
14 - LEGAL CONTINGENCIES
In
the
normal course of business, the Company has pending claims and legal proceedings.
It is the opinion of the Company’s management, based on information available at
this time, that none of current claims and proceedings will have a material
effect on the Company’s consolidated financial statements other than the matters
discussed below.
Western
Filter Corporation Litigation
On
March
22, 2005, WFC filed a civil action against the Company, and its executive
officers. The suit was filed in the Superior Court of the State of California
for the County of Los Angeles. WFC purchased the capital stock of the Company's
wholly owned subsidiary, Puroflow Incorporated, pursuant to the terms of the
Stock Purchase Agreement dated October 31, 2003. WFC alleged that the Company
and its executive officers breached the Stock Purchase Agreement between WFC
and
the Company and engaged in misrepresentations and negligent conduct with respect
to the Stock Purchase Agreement. WFC sought declaratory relief, compensatory
and
punitive damages in an amount to be proven at trial as well as the recovery
of
attorney's fees. This action was removed to the United States District Court
for
the Central District of California. The Company and its officers deny that
any
breach of contract or that any misrepresentations or negligence occurred on
their part.
-
13
-
This
case
was scheduled for trial on April 10, 2007. On March 15, 2007, the District
Court
granted the Company and its executive officers' motion for summary judgment,
thereby dismissing WFC's lawsuit against the Company and its executive officers
in its entirety. WFC appealed the District Court’s decision. The parties filed
their appellate briefs and oral arguments occurred on June 3, 2008. On
August
25, 2008, the Ninth Circuit Court of Appeals reversed the summary judgment
decision and remanded the case back to the District Court.
The
Company has reviewed WFC’s claims and continues to believe that they are without
merit. The Company intends to continue vigorously defending this litigation.
It
is
possible, however, that the ultimate resolution of the WFC litigation could
result in a material adverse effect on the results of operations of the Company
for a particular future reporting period. The Company’s condensed consolidated
balance sheet at July 31, 2008 included an amount in accrued expenses reflecting
the Company’s estimate of the amount of future legal fees that it expects to be
billed in connection with the completion of this litigation.
Kevin
Thomas Litigation
On
August
27, 2007, Kevin Thomas, the former owner of VLI, filed a lawsuit against the
Company, VLI and the Company’s Chief Executive Officer (the “CEO”) in the
Circuit Court of Florida for Collier County. The Company acquired VLI by way
of
merger on August 31, 2004. Mr. Thomas alleges that the Company, VLI and the
CEO
breached various agreements regarding his compensation and employment package
that arose from the acquisition of VLI. Mr. Thomas has alleged contractual
and
tort-based claims arising from his compensation and employment agreements and
seeks rescission of his covenant not to compete against VLI. The Company, VLI
and the CEO deny that any breach of contract or tortious conduct occurred on
their part. The Company and VLI have also asserted four counterclaims against
Mr. Thomas for breach of the merger agreement, breach of his employment
agreement, breach of fiduciary duty and tortious interference with contractual
relations because Mr. Thomas violated his non-solicitation, confidentiality
and
non-compete obligations after he left VLI. The Company intends to vigorously
defend this lawsuit and prosecute its counterclaims.
Although
the Company has reviewed the claims of Mr. Thomas and believes that they are
without merit, the Company’s condensed consolidated balance sheet at July 31,
2008 included an amount in accrued expenses reflecting the Company’s estimate of
the amount of future legal fees that it expects to be billed in connection
with
this matter. It is possible however, that the ultimate resolution of the
litigation with Mr. Thomas could result in a material adverse effect on the
results of operations of the Company for a particular future reporting
period.
On
March
4, 2008, Vitarich Farms, Inc. (“VFI”) filed a lawsuit against VLI and its
current president in the Circuit Court of Florida for Collier County. VFI,
which
is owned by Kevin Thomas, supplied VLI with certain organic raw materials used
in the manufacture of VLI products. VFI has asserted a breach of contract claim
against VLI and alleges that VLI breached a supply agreement with VFI by
acquiring the organic products from a different supplier. VFI also asserted
a
claim for defamation against VLI’s president alleging that he made false
statements regarding VFI’s organic certification to one of VLI's customers. VLI
and its president filed their Answer and Affirmative Defenses on May 8, 2008.
VLI and its president deny that VLI breached any contract or that its president
defamed VFI. The defendants intend to continue to vigorously defend this
lawsuit. The Company’s condensed consolidated balance sheet at July 31, 2008
included an amount in accrued expenses reflecting the Company’s estimate of the
amount of future legal fees that it expects to be billed in connection with
this
matter.
On
March
4, 2008, Mr. Thomas filed a lawsuit against VLI's president in the Circuit
Court
of Florida for Collier County. Mr. Thomas has filed this new lawsuit against
VLI’s president for defamation. Mr. Thomas alleges that VLI’s president made
false statements to third-parties regarding Mr. Thomas' conduct that is the
subject of counterclaims by the Company and VLI in the litigation matter
discussed above and that these statements have caused him damage to his business
reputation. VLI’s president filed his answer with the court on May 8, 2008.
VLI’s president denies that he defamed Mr. Thomas and intends to continue to
vigorously defend this lawsuit.
NOTE
15 - RELATED PARTY TRANSACTIONS
The
Company leased administrative, manufacturing and warehouse facilities for VLI
from an individual who was the former officer and shareholder of VLI. The lease
costs through March 2007, the date of his employment termination, were
considered related party expenses. The total prior year expense amount under
this arrangement of $45,000 was recorded in the quarter ended April 30,
2007.
-
14
-
The
Company entered into a supply agreement with an entity owned by the former
shareholder of VLI whereby the supplier committed to sell to the Company and
the
Company committed to purchase on an as-needed basis, certain organic products.
Last year, VLI made $47,000 in purchases under the supply agreement through
March 2007, the date on which the former officer and shareholder of VLI was
terminated.
The
Company also sold its products in the normal course of business to an entity
in
which the former shareholder of VLI had an ownership interest. VLI had
approximately $117,000 in prior year net revenues related to this entity through
the aforementioned termination in March 2007 which were recorded in the quarter
ended April 30, 2007; this amount was collected.
NOTE
16 - SEGMENT REPORTING AND MAJOR CUSTOMERS
The
Company’s three reportable segments are power industry services, nutritional
products and telecommunications infrastructure services. The Company conducts
these operations through its wholly owned subsidiaries - GPS, VLI and SMC,
respectively. The “Other” column includes the Company’s corporate and
unallocated expenses. The
Company’s operating segments are organized in separate business units with
different management, customers, technologies and services.
The
following business segment information is presented for the three and six months
ended July 31, 2008 and 2007, except for total assets and goodwill which amounts
are presented as of those dates:
|
Three
Months Ended July 31, 2008
|
Power Industry
Services
|
Nutritional
Products
|
Telecom
Infrastructure
Services
|
Other
|
Consolidated
|
|||||||||||
|
Net revenues
|
$
|
70,639,000
|
$
|
2,226,000
|
$
|
2,233,000
|
—
|
$
|
75,098,000
|
|||||||
|
Cost
of revenues
|
63,108,000
|
2,395,000
|
1,875,000
|
—
|
67,378,000
|
|||||||||||
|
Gross
profit
|
7,531,000
|
(169,000
|
)
|
358,000
|
—
|
7,720,000
|
||||||||||
|
Selling,
general and administrative expenses
|
1,579,000
|
799,000
|
408,000
|
1,230,000
|
4,016,000
|
|||||||||||
|
Impairment
losses of VLI
|
—
|
1,946,000
|
—
|
—
|
1,946,000
|
|||||||||||
|
Income
(loss) from operations
|
5,952,000
|
(2,914,000
|
)
|
(50,000
|
)
|
(1,230,000
|
)
|
1,758,000
|
||||||||
|
Interest
expense
|
(92,000
|
)
|
(16,000
|
)
|
—
|
—
|
(108,000
|
)
|
||||||||
|
Interest
income
|
390,000
|
—
|
—
|
42,000
|
432,000
|
|||||||||||
|
Equity
in the net loss of unconsolidated subsidiary
|
(165,000
|
)
|
—
|
—
|
—
|
(165,000
|
)
|
|||||||||
|
Income
(loss) before income taxes
|
$
|
6,085,000
|
$
|
(2,930,000
|
)
|
$
|
(50,000
|
)
|
$
|
(1,188,000
|
)
|
1,917,000
|
||||
|
Income
tax expense
|
(1,111,000
|
)
|
||||||||||||||
|
Net
income
|
$
|
806,000
|
||||||||||||||
|
Amortization
of purchased intangibles
|
$
|
355,000
|
$
|
21,000
|
$
|
26,000
|
$
|
—
|
$
|
402,000
|
||||||
|
Depreciation
and other amortization
|
$
|
51,000
|
$
|
149,000
|
$
|
141,000
|
$
|
3,000
|
$
|
344,000
|
||||||
|
Goodwill
|
$
|
18,476,000
|
$
|
—
|
$
|
940,000
|
$
|
—
|
$
|
19,416,000
|
||||||
|
Total
assets
|
$
|
130,399,000
|
$
|
4,980,000
|
$
|
4,243,000
|
$
|
30,373,000
|
$
|
169,995,000
|
||||||
|
Fixed
asset additions
|
$
|
40,000
|
$
|
75,000
|
$
|
31,000
|
$
|
—
|
$
|
146,000
|
||||||
-
15
-
|
Three
Months Ended July 31, 2007
|
Power Industry
Services
|
Nutritional
Products
|
Telecom
Infrastructure
Services
|
Other
|
Consolidated
|
|||||||||||
|
Net revenues
|
$
|
45,599,000
|
$
|
5,036,000
|
$
|
2,502,000
|
$
|
—
|
$
|
53,137,000
|
||||||
|
Cost
of revenues
|
40,590,000
|
4,122,000
|
1,858,000
|
—
|
46,570,000
|
|||||||||||
|
Gross
profit
|
5,009,000
|
914,000
|
644,000
|
—
|
6,567,000
|
|||||||||||
|
Selling,
general and administrative expenses
|
2,553,000
|
1,015,000
|
340,000
|
865,000
|
4,773,000
|
|||||||||||
|
Income
(loss) from operations
|
2,456,000
|
(101,000
|
)
|
304,000
|
(865,000
|
)
|
1,794,000
|
|||||||||
|
Interest
expense
|
(155,000
|
)
|
(30,000
|
)
|
—
|
—
|
(185,000
|
)
|
||||||||
|
Interest
income
|
657,000
|
—
|
—
|
—
|
657,000
|
|||||||||||
|
Income
(loss) before income taxes
|
$
|
2,958,000
|
$
|
(131,000
|
)
|
$
|
304,000
|
$
|
(865,000
|
)
|
2,266,000
|
|||||
|
Income
tax expense
|
(932,000
|
)
|
||||||||||||||
|
Net
income
|
$
|
1,334,000
|
||||||||||||||
|
Amortization
of purchased intangibles
|
$
|
1,695,000
|
$
|
304,000
|
$
|
26,000
|
$
|
—
|
$
|
2,025,000
|
||||||
|
Depreciation
and other amortization
|
$
|
41,000
|
$
|
149,000
|
$
|
126,000
|
$
|
4,000
|
$
|
320,000
|
||||||
|
Goodwill
|
$
|
16,476,000
|
$
|
6,565,000
|
$
|
940,000
|
$
|
—
|
$
|
23,981,000
|
||||||
|
Total
assets
|
$
|
116,531,000
|
$
|
14,850,000
|
$
|
4,484,000
|
$
|
2,689,000
|
$
|
138,554,000
|
||||||
|
Fixed
asset additions
|
$
|
—
|
$
|
39,000
|
$
|
85,000
|
$
|
—
|
$
|
124,000
|
||||||
|
Six
Months Ended July 31, 2008
|
Power Industry
Services
|
Nutritional
Products
|
Telecom
Infrastructure
Services
|
Other
|
Consolidated
|
|||||||||||
|
Net revenues
|
$
|
114,647,000
|
$
|
4,625,000
|
$
|
4,232,000
|
—
|
$
|
123,504,000
|
|||||||
|
Cost
of revenues
|
101,684,000
|
4,718,000
|
3,649,000
|
—
|
110,051,000
|
|||||||||||
|
Gross
profit
|
12,963,000
|
(93,000
|
)
|
583,000
|
—
|
13,453,000
|
||||||||||
|
Selling,
general and administrative expenses
|
3,420,000
|
1,515,000
|
751,000
|
2,341,000
|
8,027,000
|
|||||||||||
|
Impairment
losses of VLI
|
—
|
1,946,000
|
—
|
—
|
1,946,000
|
|||||||||||
|
Income
(loss) from operations
|
9,543,000
|
(3,554,000
|
)
|
(168,000
|
)
|
(2,341,000
|
)
|
3,480,000
|
||||||||
|
Interest
expense
|
(195,000
|
)
|
(33,000
|
)
|
—
|
—
|
(228,000
|
)
|
||||||||
|
Interest
income
|
894,000
|
—
|
—
|
42,000
|
936,000
|
|||||||||||
|
Equity
in the net loss of unconsolidated subsidiary
|
(165,000
|
)
|
—
|
—
|
—
|
(165,000
|
)
|
|||||||||
|
Income
(loss) before income taxes
|
$
|
10,077,000
|
$
|
(3,587,000
|
)
|
$
|
(168,000
|
)
|
$
|
(2,299,000
|
)
|
4,023,000
|
||||
|
Income
tax expense
|
(1,662,000
|
)
|
||||||||||||||
|
Net
income
|
$
|
2,361,000
|
||||||||||||||
|
Amortization
of purchased intangibles
|
$
|
1,079,000
|
$
|
43,000
|
$
|
52,000
|
$
|
—
|
$
|
1,174,000
|
||||||
|
Depreciation
and other amortization
|
$
|
99,000
|
$
|
297,000
|
$
|
283,000
|
$
|
4,000
|
$
|
683,000
|
||||||
|
Fixed
asset additions
|
$
|
89,000
|
$
|
131,000
|
$
|
44,000
|
$
|
—
|
$
|
264,000
|
||||||
-
16
-
|
Six
Months Ended July 31, 2007
|
Power Industry
Services
|
Nutritional
Products
|
Telecom
Infrastructure
Services
|
Other
|
Consolidated
|
|||||||||||
|
Net revenues
|
$
|
88,953,000
|
$
|
9,985,000
|
$
|
4,631,000
|
—
|
$
|
103,569,000
|
|||||||
|
Cost
of revenues
|
83,835,000
|
8,288,000
|
3,701,000
|
—
|
95,824,000
|
|||||||||||
|
Gross
profit
|
5,118,000
|
1,697,000
|
930,000
|
—
|
7,745,000
|
|||||||||||
|
Selling,
general and administrative expenses
|
5,105,000
|
2,185,000
|
698,000
|
1,346,000
|
9,334,000
|
|||||||||||
|
Income
(loss) from operations
|
13,000
|
(488,000
|
)
|
232,000
|
(1,346,000
|
)
|
(1,589,000
|
)
|
||||||||
|
Interest
expense
|
(316,000
|
)
|
(61,000
|
)
|
—
|
(1,000
|
)
|
(378,000
|
)
|
|||||||
|
Interest
income
|
1,266,000
|
—
|
10,000
|
3,000
|
1,279,000
|
|||||||||||
|
Income
(loss) before income taxes
|
$
|
963,000
|
$
|
(549,000
|
)
|
$
|
242,000
|
$
|
(1,344,000
|
)
|
(688,000
|
)
|
||||
|
Income
tax benefit
|
7,000
|
|||||||||||||||
|
Net
loss
|
$
|
(681,000
|
)
|
|||||||||||||
|
Amortization
of purchased intangibles
|
$
|
3,428,000
|
$
|
609,000
|
$
|
52,000
|
$
|
—
|
$
|
4,089,000
|
||||||
|
Depreciation
and other amortization
|
$
|
94,000
|
$
|
293,000
|
$
|
249,000
|
$
|
8,000
|
$
|
644,000
|
||||||
|
Fixed
asset additions
|
$
|
4,000
|
$
|
124,000
|
$
|
96,000
|
$
|
—
|
$
|
224,000
|
||||||
During
the three and six months ended July 31, 2008, the majority of the Company’s net
revenues related to engineering, procurement and construction services provided
by GPS to the power industry. Total net revenues from power industry services
accounted for approximately 94% and 93% of consolidated net revenues for the
periods, respectively. The Company’s most significant current year customer
relationships included two power industry service customers which accounted
for
approximately 52% and 42%, respectively, of consolidated net revenues for the
current quarter, and approximately 43% and 49%, respectively, of consolidated
net revenues year to date. VLI, which provides nutritional and whole-food
supplements as well as personal care products to customers in the global
nutrition industry, accounted for approximately 3% and 4% of consolidated net
revenues for the three and six months ended July 31, 2008. SMC, which provides
infrastructure services to telecommunications and utility customers as well
as
to the federal government, accounted for approximately 3% of consolidated net
revenues for both the three and six month periods ended July 31,
2008.
For
both
the three and six months ended July 31, 2007, net revenues from power industry
services accounted for approximately 86% of consolidated net revenues. The
Company’s most significant customer relationships during this period included
four power industry service customers, which accounted for approximately 27%,
22%, 22% and 8%, respectively, of consolidated net revenues for the three months
ended July 31, 2007, and approximately 27%, 19%, 19% and 13%, respectively,
of
consolidated net revenues for the six months ended July 31, 2007. VLI and SMC
accounted for approximately 10% and 5%, respectively, of consolidated net
revenues for the three months ended July 31, 2007, and approximately 10% and
5%,
respectively, of consolidated net revenues for the six months ended July 31,
2007.
NOTE
17 - SUBSEQUENT EVENT
On
September 4, 2008, one of the major subcontractors on the terminated
construction contract discussed in Note 13 filed a third-party complaint
against
GPS in the United States District Court for the Eastern District of Virginia
seeking payment of certain amounts for equipment plus interest. GPS believes
that the condensed consolidated balance sheet at July 31, 2008 includes all
amounts owed under the subcontractor agreement and intends to vigorously
defend
this lawsuit.
-
17
-
ITEM
2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The
following discussion summarizes the financial position of Argan, Inc. and its
subsidiaries as of July 31, 2008, and the results of operations for the three
and six months ended July 31, 2008 and 2007, and should be read in conjunction
with (i) the unaudited condensed consolidated financial statements and
notes thereto included elsewhere in this Quarterly Report on Form 10-Q and
(ii) the consolidated financial statements and accompanying notes included
in our Annual Report on Form 10-K for the fiscal year ended January 31, 2008
that was filed with the Securities and Exchange Commission on April 24, 2008
(the “2008 Annual Report”).
Cautionary
Statement Regarding Forward Looking Statements
The
Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for
certain forward-looking statements. We have made statements in this Item 2
and
elsewhere in this Quarterly Report on Form 10-Q that may constitute
“forward-looking statements”. The words “believe,” “expect,” “anticipate,”
“plan,” “intend,” “foresee,” “should,” “would,” “could,” or other similar
expressions are intended to identify forward-looking statements. These
forward-looking statements are based on our current expectations and beliefs
concerning future developments and their potential effects on us. There can
be
no assurance that future developments affecting us will be those that we
anticipate. All comments concerning our expectations for future revenues and
operating results are based on our forecasts for our existing operations and
do
not include the potential impact of any future acquisitions. These
forward-looking statements involve significant risks and uncertainties (some
of
which are beyond our control) and assumptions. They are subject to change based
upon various factors including, but not limited to, the risks and uncertainties
described in Item 1A of our 2008 Annual Report and Item 1A in Part II of this
Quarterly Report on Form 10-Q. Should one or more of these risks or
uncertainties materialize, or should any of our assumptions prove incorrect,
actual results may vary in material respects from those projected in the
forward-looking statements. We undertake no obligation to publicly update or
revise any forward-looking statements, whether as a result of new information,
future events or otherwise.
Introduction
Argan,
Inc. (the “Company,” “we,” “us,” or “our”) conducts operations through our
wholly-owned subsidiaries, Gemma Power Systems, LLC and affiliates (“GPS”) that
we acquired in December 2006, Vitarich Laboratories, Inc. (“VLI”) that we
acquired in August 2004, and Southern Maryland Cable, Inc. (“SMC”) that we
acquired in July 2003. Through GPS, we provide a full range of development,
consulting, engineering, procurement, construction, commissioning, operations
and maintenance services to the power generation market for a wide range of
customers including public utilities, independent power project owners,
municipalities, public institutions and private industry. Through VLI, we
develop, manufacture and distribute premium nutritional products. Through SMC,
we provide telecommunications infrastructure services including project
management, construction and maintenance to the Federal Government,
telecommunications and broadband service providers as well as electric
utilities. Each of the wholly-owned subsidiaries represents a separate
reportable segment - power industry services, nutritional products and
telecommunications infrastructure services, respectively.
The
preparation of consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America requires us to
make use of estimates and assumptions that affect the reported amount of assets
and liabilities, net revenues, expenses, and certain financial statement
disclosures. We believe that the estimates, judgments and assumptions upon
which
we rely are reasonable based upon information available to us at the time that
these estimates, judgments and assumptions are made. Estimates are used for,
but
not limited to, the Company’s accounting for revenue recognition, allowance for
doubtful accounts, inventory obsolescence, goodwill and other intangible assets
with indefinite lives, long lived assets, contingent obligations, and deferred
taxes. Actual results could differ from these estimates.
New
Accounting Pronouncements
In
May
2008, the Financial Accounting Standards Board (the “FASB”) issued Statement of
Financial Accounting Standards No. 162, “The Hierarchy of Generally Accepted
Accounting Principles.” This statement identifies the sources of accounting
principles and the framework for selecting the principles used in the
preparation of financial statements of nongovernmental entities that are
presented in conformity with U.S. GAAP (the “GAAP Hierarchy”) and mandates that
the GAAP Hierarchy reside in the accounting literature as opposed to the audit
literature. This pronouncement will become effective 60 days following approval
by the SEC. We do not believe this pronouncement will impact our consolidated
financial statements.
-
18
-
In
April
2008, the FASB issued FASB Staff Position (“FSP”) FAS 142-3, “Determination of
the Useful Life of Intangible Assets.” This FSP amends the factors that should
be considered in developing renewal or extension assumptions used to determine
the useful life of a recognized intangible asset under FASB Statement of
Financial Accounting Standards No. 142, “Goodwill and Other Intangible
Assets.” (“SFAS No. 142”) and intends to improve the consistency between the
useful life of a recognized intangible asset under SFAS No. 142 and the period
of expected cash flows used to measure the fair value of the asset under FASB
Statement of Financial Accounting Standards No. 141R (see description
below) and other U.S. generally accepted accounting principles. This FSP is
effective for our interim and annual financial statements beginning in the
fiscal year commencing February 1, 2009. We do not expect the adoption of this
FSP to have a material impact on our consolidated financial
statements.
In
March
2008, the FASB issued Statement of Financial Accounting Standards No. 161,
“Disclosures about Derivative Instruments and Hedging Activities - An Amendment
of FASB Statement No. 133.” This new standard requires enhanced disclosures
about an entity’s derivative and hedging activities with the intent of improving
the transparency of financing reporting as the use and complexity of derivative
instruments and hedging activities have increased significantly over the past
several years. Currently, we use interest rate swap agreements to hedge the
risks related to the variable interest paid on our term loans. The current
effects of our hedging activities are not significant to our consolidated
financial statements. However, the new standard will require us to provide
an
enhanced understanding of 1) how and why we use derivative instruments, 2)
how
we account for derivative instruments and the related hedged items, and 3)
how
derivatives and related hedged items affect our financial position, financial
performance and cash flows. Adoption of this new accounting standard will first
be required for our consolidated financial statements covering the quarter
ending April 30, 2009.
In
December 2007, the FASB issued Statement of Financial Accounting Standards
No. 141R, “Business Combinations” (“SFAS No. 141R”) which replaces SFAS No.
141 and provides greater consistency in the accounting and financial reporting
of business combinations. SFAS No. 141R requires the acquiring entity in a
business combination to recognize all assets acquired and liabilities assumed
in
the transaction, establishes the acquisition-date fair value as the measurement
objective for all assets acquired and liabilities assumed, establishes
principles and requirements for how an acquirer recognizes and measures any
non-controlling interest in the acquiree and the goodwill acquired, and requires
the acquirer to disclose the nature and financial effect of the business
combination. Among other changes, this statement also requires that “negative
goodwill” be recognized in earnings as a gain attributable to the acquisition,
that acquisition-related costs are to be recognized separately from the
acquisition and expensed as incurred and that any deferred tax benefits resulted
in a business combination are recognized in income from continuing operations
in
the period of the combination. For us, SFAS No. 141R will be effective for
business combinations occurring subsequent to January 31, 2009. The accounting
for future acquisitions, if any, may be affected by certain new requirements
of
this pronouncement that will be evaluated at that time.
In
December 2007, the FASB also issued Statement of Financial Accounting Standards
No. 160, “Noncontrolling Interests in Consolidated Financial Statements,” that
establishes accounting and reporting standards for minority interests in
consolidated subsidiaries. This standard will be effective for us on February
1,
2009, and its adoption would not affect our current consolidated financial
statements.
In
February 2007, the FASB issued Statement of Financial Accounting Standards
No.
159, “The Fair Value Option for Financial Assets and Financial Liabilities.”
This standard permits companies to measure many financial instruments and
certain other items at fair value at specified election dates. The provisions
of
this new standard were effective for us beginning February 1, 2008 and did
not
have a significant impact on the consolidated financial statements.
In
September 2006, the FASB issued Statement of Financial Accounting Standard
No.
157, “Fair Value Measurements.” This standard defines fair value, establishes a
framework for measuring fair value in generally accepted accounting principles
and expands disclosures about fair value measurements. Certain provisions of
this standard relating to financial assets and financial liabilities were also
effective for us beginning February 1, 2008; they did not have a significant
impact on the consolidated financial statements. Adoption of the other
provisions of this new standard relating primarily to nonfinancial assets and
nonfinancial liabilities will first be required for our consolidated financial
statements covering the quarter ending April 30, 2009. The significant
nonfinancial items included in our consolidated balance sheet include property
and equipment, goodwill and other purchased intangible assets. Adoption of
the
new provisions is not expected to have a significant impact on our consolidated
financial statements.
Recent
Events
Construction
Projects and Backlog. In
May
2008, the Company announced that GPS signed an engineering, procurement and
construction agreement with Pacific Gas & Electric Company (“PG&E”) in
the amount of $336 million for the design and construction of a natural
gas-fired power plant in Colusa, California. This energy plant will be a 640
megawatt combined cycle facility and construction is expected to be completed
in
the summer of 2010. GPS commenced activity on this project in the fourth quarter
ended January 31, 2008 under an interim notice to proceed that it received
from
PG&E in December 2007.
-
19
-
In
July
2008, the Company announced that GPS signed an engineering, procurement and
construction agreement and received a limited notice to proceed from Competitive
Power Ventures Inc. (“CPV”) to design and build the Sentinel Power Project. This
project, valued at $211 million, consists of eight simple cycle gas-fired
peaking plants with a total power rating of 800 megawatts to be located in
southern California. The first phase of the project, including the construction
of five units, is expected to be completed in the summer of 2010. The second
phase includes the construction of the remaining three units and is expected
to
be completed in the spring of 2011. CPV has a power supply agreement with
Southern California Edison covering five of the units.
The
addition of these contracts increased our energy-plant construction contract
backlog to approximately $530 million at July 31, 2008. The construction
contract backlog of GPS was $122 million at January 31, 2008.
Under
the
terms of an amended agreement with a customer covering the engineering,
procurement and construction of an ethanol production facility (the “EPC
Agreement”), March 19, 2008 was the deadline for the customer to obtain
financing for the completion of the project. Financing was not obtained and
the
EPC Agreement was terminated. GPS continues to cooperate with the customer
in
its efforts to obtain financing. GPS is uncertain as to the ultimate resolution
of this matter. As of July 31, 2008 and January 31, 2008, our condensed
consolidated balance sheets included assets and liabilities related to the
terminated construction contract. We have classified these assets and
liabilities as current assets and current liabilities in the accompanying
condensed consolidated balance sheets due to the expectation that the assets
will be realized and the liabilities will be extinguished. Although cash may
be
required to make payment on accounts payable to project subcontractors that
are
included in the condensed consolidated balance sheet at July 31, 2008, GPS
does
not anticipate any losses to arise from the resolution of this EPC Agreement.
No
net revenues were recorded in the six months ended July 31, 2008 related to
this
project.
Investment
in Unconsolidated Subsidiary. In
June
2008, the Company announced that GPS had entered into a business partnership
with Invenergy Wind Management LLC, for the design and construction of wind
farms located in the United States and Canada. The business partners each own
50% of a new company, Gemma Renewable Power, LLC (“GRP”). The Company expects
that GRP will provide engineering, procurement and construction services for
new
wind farms generating electrical power including the design and construction
of
roads, foundations, and electrical collection systems, as well as the erection
of towers, turbines and blades. It is expected that GRP will also assist with
some of the ongoing servicing of the wind farms. During the start-up phase
of
this new business and pursuant to the formation document, GPS has contributed
$600,000 cash to GRP. In accordance with the equity method of accounting for
unconsolidated subsidiaries, the condensed consolidated statements of operations
for the three and six months ended July 31, 2008 include our share of the net
loss incurred to date by GRP in the amount of approximately $165,000.
Performance
of VLI.
VLI
continued to report operating results that were below expected results. The
loss
of major customers and the reduction in the amounts of orders received from
currently major customers have caused net revenues to continue to decline and
this business to operate at a loss. VLI is actively pursuing opportunities
to
expand the volume of business related to current customers and secure business
from new customers. However, there is no assurance that business will improve.
Accordingly, during the current quarter, we conducted analyses in order to
determine whether additional impairment losses have occurred related to the
goodwill and the long-lived assets of VLI. The assessment analyses indicated
that the carrying value of the business exceeded its fair value, that the
carrying values of VLI’s long-lived assets were not recoverable and that the
carrying values of the long-lived assets exceeded their corresponding fair
values. As a result, VLI recorded impairment losses related to goodwill, other
purchased intangible assets, and fixed assets in the amounts of $921,000,
$86,000 and $939,000, respectively, that were included in the condensed
consolidated statements of operations for the three and six months ended July
31, 2008. These adjustments eliminated the remaining carrying value of VLI’s
goodwill and reduced the carrying values of VLI’s other purchased intangible
assets and fixed assets to approximately $8,000 and $135,000, respectively.
Legal
Matters.
As
described in Item 1 of Part II of this Form 10-Q and in Note 14 to the condensed
consolidated financial statements, Vitarich Farms, Inc. (“VFI”) filed a lawsuit
against VLI and its current president in March 2008. VFI, which is owned by
Kevin Thomas, the former owner of VLI, supplied VLI with certain organic raw
materials used in the manufacture of VLI's products. VFI has asserted a breach
of contract claim against VLI and alleges that VLI breached a supply agreement
with VFI by acquiring the organic products from a different supplier. VFI also
asserted a claim for defamation against VLI’s president alleging that he made
false statements regarding VFI’s organic certification to one of VLI's
customers. In March 2008, Mr. Thomas filed a lawsuit against VLI's president
for
defamation. The Company, VLI and VLI’s president deny all of the new allegations
and intend to vigorously defend these lawsuits.
-
20
-
As
described in Item 1 of Part II of this Form 10-Q and in Note 14 to the condensed
consolidated financial statements, in March 2007, the United States District
Court for the Central District of California granted our motion for summary
judgment, thereby dismissing the civil action brought by Western Filter
Corporation (“WFC”) relating to WFC’s purchase of the capital stock of Puroflow
Incorporated (“Puroflow”), formerly our wholly-owned subsidiary. WFC appealed
the District Court’s decision. On August 25, 2008, the Ninth Circuit Court of
Appeals reversed the summary judgment decision and remanded the case back to
the
District Court. We continue to believe that WFC’s claims are without merit and
intend to continue to defend this litigation vigously. It is possible, however,
that the ultimate resolution of the WFC litigation could result in a material
adverse effect on the results of operations of the Company for a particular
future reporting period. The Company’s condensed consolidated balance sheet at
July 31, 2008 included an amount in accrued expenses reflecting the Company’s
estimate of the amount of future legal fees that it expects to be billed in
connection with the completion of this litigation.
Comparison
of the Results of Operations for the Three Months Ended July 31, 2008 and
2007
The
following schedule compares the results of our operations for the three months
ended July 31, 2008 and 2007. Except where noted, the percentage amounts
represent the percentage of net revenues for the corresponding
period.
|
Three Months Ended July 31,
|
|||||||||||||
|
2008
|
2007
|
||||||||||||
|
Net
revenues
|
|||||||||||||
|
Power
industry services
|
$
|
70,639,000
|
94.1
|
%
|
$
|
45,599,000
|
85.8
|
%
|
|||||
|
Nutritional
products
|
2,226,000
|
2.9
|
%
|
5,036,000
|
9.5
|
%
|
|||||||
|
Telecommunications
infrastructure services
|
2,233,000
|
3.0
|
%
|
2,502,000
|
4.7
|
%
|
|||||||
|
Net
revenues
|
75,098,000
|
100.0
|
%
|
53,137,000
|
100.0
|
%
|
|||||||
|
Cost
of revenues **
|
|||||||||||||
|
Power
industry services
|
63,108,000
|
89.3
|
%
|
40,590,000
|
89.0
|
%
|
|||||||
|
Nutritional
products
|
2,395,000
|
107.6
|
%
|
4,122,000
|
81.9
|
%
|
|||||||
|
Telecommunications
infrastructure services
|
1,875,000
|
84.0
|
%
|
1,858,000
|
74.3
|
%
|
|||||||
|
Cost
of revenues
|
67,378,000
|
89.7
|
%
|
46,570,000
|
87.6
|
%
|
|||||||
|
Gross
profit
|
7,720,000
|
10.3
|
%
|
6,567,000
|
12.4
|
%
|
|||||||
|
Selling,
general and administrative expenses
|
4,016,000
|
5.4
|
%
|
4,773,000
|
9.0
|
%
|
|||||||
|
Impairment
losses of VLI
|
1,946,000
|
2.6
|
%
|
—
|
—
|
%
|
|||||||
|
Income
from operations
|
1,758,000
|
2.3
|
%
|
1,794,000
|
3.4
|
%
|
|||||||
|
Interest
expense
|
(108,000
|
)
|
*
|
(185,000
|
)
|
*
|
|||||||
|
Interest
income
|
432,000
|
*
|
657,000
|
1.2
|
%
|
||||||||
|
Equity
in the net loss of unconsolidated subsidiary
|
(165,000
|
)
|
*
|
—
|
—
|
%
|
|||||||
|
Income
from operations before income taxes
|
1,917,000
|
2.6
|
%
|
2,266,000
|
4.3
|
%
|
|||||||
|
Income
tax expense
|
(1,111,000
|
)
|
(1.5
|
)%
|
(932,000
|
)
|
(1.8
|
)%
|
|||||
|
Net
income
|
$
|
806,000
|
1.1
|
%
|
$
|
1,334,000
|
2.5
|
%
|
|||||
*
Less
than 1%.
**
The
percentage amounts for cost of revenues represent the percentage of net revenues
of the applicable segment.
The
following analysis provides information as to the results of our operations
for
the three month periods ended July 31, 2008 and 2007. As analyzed below, we
reported net income of $806,000 for the three months ended July 31, 2008, or
$0.07 per diluted share. For the three months ended July 31, 2007, we reported
net income of $1.3 million, or $0.12 per diluted share.
Net
Revenues. Net
revenues increased by approximately 41.3% in the three months ended July 31,
2008 compared with the three months ended July 31, 2007 due to an increase
in
the net revenues of GPS, partially offset by a 55.8% reduction in the net
revenues of VLI and 10.8% reduction in the net revenues of SMC.
The
business of GPS represented 94.1% of consolidated net revenues for the quarter
ended July 31, 2008. This business represented 85.8% of consolidated net
revenues for the quarter ended July 31, 2007. The two significant customers
of
the power industry services business for the current quarter represented
approximately 55.1% and 44.6% of the net revenues of this business segment
for
the current quarter, respectively, and represented approximately 51.8% and
42.1%
of our consolidated net revenues for the current quarter, respectively. The
net
revenues were boosted in the current quarter by the effect of equipment
purchases occurring during the early portion of the power plant project.
-
21
-
The
four
significant customers of the power industry services business for the quarter
ended July 31, 2007 represented approximately 91.7% of its net revenues for
the
quarter ended July 31, 2007. The net revenues for these four customers
represented approximately 26.7%, 22.3%, 21.5% and 8.2% of the Company’s
consolidated net revenues for the three months ended July 31, 2007,
respectively.
The
net
revenues from the sale of nutritional products by VLI were $2.2 million for
the
three months ended July 31, 2008, and represented 2.9% of consolidated net
revenues. The net revenues from the sale of nutritional products were $5.0
million for the three months ended July 31, 2007. This amount represented 9.5%
of consolidated net revenues for the prior-year period. The decrease in the
net
revenues of nutritional products of $2.8 million, or 55.8%, primarily was due
to
the loss of several customers and declines in the sales of products to most
of
VLI’s largest current customers.
Cost
of Revenues.
The cost
of revenues for the power industry services business of GPS increased in the
three months ended July 31, 2008 to $63.1 million from $40.6 million in the
three months ended July 31, 2007. The cost of revenues as a percentage of
corresponding net revenues remained constant between years; the percentage
was
89.3% in the current quarter compared with 89.0% in the second quarter of last
year. The portion of the loss on one significant project that was recorded
in
last year’s second quarter was offset by the favorable profit performance of
other large projects during the period.
Although
the cost of revenues for the nutritional products business of VLI decreased
in
the three-month period ended July 31, 2008 to $2.4 million from $4.1 million
in
the three months ended July 31, 2007, the cost of revenues percentage increased
to 107.6% of net revenues in the current quarter from a percentage of 81.9%
in
the corresponding quarter of the prior year. On an overall basis, raw material
costs as a percentage of net revenues increased between quarters due primarily
to product pricing pressure from customers and a $103,000 charge for inventory
obsolescence recorded in the current quarter. Direct labor and related
manufacturing overhead costs have been reduced between quarters. However, the
reductions have not occurred in proportion to the reduction in net
revenues.
Cost
of
revenues for the telecommunication infrastructure services business of SMC
increased by $17,000, or approximately 1.0%, in the current quarter compared
with the same quarter a year ago, but increased as a percentage of corresponding
net revenues to 84.0% in the current quarter from 74.3% in the first quarter
last year.
Primarily
as a result of the improvement in the performance of GPS, our overall gross
profit increased to $7.7 million for the three months ended July 31, 2008 from
$6.6 million for the three months ended July 31, 2007. However, our gross profit
percentage declined to 10.3% for the current quarter from a percentage of 12.4%
in the corresponding period of the prior year due to the profitability declines
experienced by VLI and SMC during the current quarter.
Selling,
General and Administrative Expenses.
These
costs decreased to $4.0 million for the three months ended July 31, 2008 from
$4.8 million for the three months ended July 31, 2007, a reduction of
approximately $757,000, or 15.9%.
Amortization
expense related to purchased intangible assets decreased by approximately $1.6
million in the current quarter compared with the second quarter of last year
as
the amortization expense related to contractual and other customer relationships
decreased between quarters by approximately $1.4 million. Most of this decrease
was scheduled and attributable to backlog for construction contracts completed
by GPS last year. In addition, the impairment losses recorded by VLI last year
served to reduce its amortization expense related to customer relationships
and
the noncompete agreement prospectively, and the amortization of propriety
formulas was completed last year. Partially offsetting the favorable effects
of
the amortization expense reductions were increases in other selling, general
and
administrative expenses at each company, most significantly salary expense
at
GPS and corporate legal expenses.
-
22
-
Impairment
Losses.
During
the current quarter and as described above, VLI recorded impairment losses
related to goodwill, other purchased intangible assets, and fixed assets in
the
amounts of $921,000, $86,000 and $939,000, respectively.
Interest
Income and Expense.
We
reported interest income of $432,000 for the three months ended July 31, 2008
compared to interest income of $657,000 for the three months ended July 31,
2007. During the current year, our cash balances have been invested in liquid
money-market type collective funds. Although favorable cash flow from operations
during the past fifteen months and the proceeds of the private placement sale
of
our common stock in the current quarter have increased the balance of our cash
and cash equivalents, investment returns have declined as short-term interest
rates have dropped substantially over the last year. Interest expense declined
to $108,000 in the current quarter from $185,000 in the comparable quarter
of
the prior year due to the overall reduction in the level of debt between
quarters. Debt payments have reduced the total balance of debt (including
current and noncurrent portions) to approximately $5.4 million at July 31,
2008
from approximately $8.0 million at July 31, 2007.
Income
Tax Expense and Benefit.
For the
three months ended July 31, 2008, we incurred income tax expense of $1.1 million
reflecting an effective income tax rate of 58.0%. The effective tax rate for
the
current quarter differs from the expected federal income tax rate of 34% due
primarily to the effect of the impairment loss recorded in the current quarter
related to the goodwill of VLI. This loss is not deductible for income tax
reporting purposes. It was treated as a discreet item in the determination
of
the current year effective income tax rate. In addition, we established a
valuation allowance during the current quarter related to the deferred state
taxes of VLI in the amount of $57,000.
The
following schedule compares the results of our operations for the six months
ended July 31, 2008 and 2007. Except where noted, the percentage amounts
represent the percentage of net revenues for the corresponding
period.
|
Six Months Ended July 31,
|
|||||||||||||
|
2008
|
2007
|
||||||||||||
|
Net
revenues
|
|||||||||||||
|
Power
industry services
|
$
|
114,647,000
|
92.8
|
%
|
$
|
88,953,000
|
85.9
|
%
|
|||||
|
Nutritional
products
|
4,625,000
|
3.8
|
%
|
9,985,000
|
9.6
|
%
|
|||||||
|
Telecommunications
infrastructure services
|
4,232,000
|
3.4
|
%
|
4,631,000
|
4.5
|
%
|
|||||||
|
Net
revenues
|
123,504,000
|
100.0
|
%
|
103,569,000
|
100.0
|
%
|
|||||||
|
Cost
of revenues **
|
|||||||||||||
|
Power
industry services
|
101,684,000
|
88.7
|
%
|
83,835,000
|
94.2
|
%
|
|||||||
|
Nutritional
products
|
4,718,000
|
102.0
|
%
|
8,288,000
|
83.0
|
%
|
|||||||
|
Telecommunications
infrastructure services
|
3,649,000
|
86.2
|
%
|
3,701,000
|
79.9
|
%
|
|||||||
|
Cost
of revenues
|
110,051,000
|
89.1
|
%
|
95,824,000
|
92.5
|
%
|
|||||||
|
Gross
profit
|
13,453,000
|
10.9
|
%
|
7,745,000
|
7.5
|
%
|
|||||||
|
Selling,
general and administrative expenses
|
8,027,000
|
6.5
|
%
|
9,334,000
|
9.0
|
%
|
|||||||
|
Impairment
losses of VLI
|
1,946,000
|
1.6
|
%
|
—
|
—
|
%
|
|||||||
|
Income
(loss) from operations
|
3,480,000
|
2.8
|
%
|
(1,589,000
|
)
|
(1.5
|
)%
|
||||||
|
Interest
expense
|
(228,000
|
)
|
*
|
(378,000
|
)
|
*
|
|||||||
|
Interest
income
|
936,000
|
*
|
1,279,000
|
1.2
|
%
|
||||||||
|
Equity
in the net loss of unconsolidated subsidiary
|
(165,000
|
)
|
*
|
—
|
—
|
%
|
|||||||
|
Income
(loss) from operations before income taxes
|
4,023,000
|
3.2
|
%
|
(688,000
|
)
|
*
|
|||||||
|
Income
tax (expense) benefit
|
(1,662,000
|
)
|
(1.3
|
)%
|
7,000
|
*
|
|||||||
|
Net
income (loss)
|
$
|
2,361,000
|
1.9
|
%
|
$
|
(681,000
|
)
|
*
|
|||||
*
Less
than 1%.
**
The
percentage amounts for cost of revenues represent the percentage of net revenues
of the applicable segment.
The
following analysis provides information as to the results of our operations
for
the six month periods ended July 31, 2008 and 2007. As analyzed below, we
reported net income of $2.4 million for the six months ended July 31, 2008,
or
$0.20 per diluted share. For the six months ended July 31, 2007, we reported
a
net loss of $681,000, or $(0.06) per share.
-
23
-
Net
Revenues. Our
consolidated net revenues increased by approximately 19.2% in the six months
ended July 31, 2008 compared with the six months ended July 31, 2007 due to
a
28.9% increase in the net revenues of GPS, partially offset by a 53.7% reduction
in the net revenues of VLI and 8.6% reduction in the net revenues of
SMC.
The
business of GPS represented 92.8% of consolidated net revenues for the six
months ended July 31, 2008. This business represented 85.9% of consolidated
net
revenues for the quarter ended July 31, 2007. The net revenues related to two
customers represented approximately 52.8% and 46.8% of the net revenues of
this
business segment for the current year period, respectively, and represented
approximately 49.0% and 43.4% of our consolidated net revenues for the current
year period, respectively.
The
power
industry services business had four significant customers in the six-month
period ended July 31, 2007. In total, GPS recognized approximately 89.7% of
its
net revenues for the prior year period under contracts with these customers.
The
net revenues for these four customers represented approximately 26.6%, 19.1%,
18.2% and 12.6% of the Company’s consolidated net revenues for the six months
ended July 31, 2007, respectively.
Net
revenues from the sale of nutritional products by VLI were $4.6 million for
the
six months ended July 31, 2008, and represented 3.8% of consolidated net
revenues. Net revenues from the sale of nutritional products were $10.0 million
for the six months ended July 31, 2007. This amount represented 9.6% of
consolidated net revenues for the prior year period. The decrease in the net
revenues of nutritional products between years was approximately $5.4 million,
or 53.7%.
Net
revenues of the telecommunications infrastructure services of SMC were $4.2
million for the six months ended July 31, 2008 compared to $4.6 million for
the
six months ended July 31, 2007, representing a decrease in the net revenues
of
SMC of approximately 8.6%. The net revenues of this business segment for the
six
months ended July 31, 2008 and 2007 were 3.4% and 4.5% of consolidated net
revenues for the corresponding periods, respectively. Net revenues related
to
inside premises customers increased by approximately 51.5% for the six months
ended July 31, 2008 compared with the corresponding six months of the prior
year. However, like for the current quarter, this strong performance was more
than offset by a reduction in the net revenues related to outside plant jobs.
The net revenues of the largest customers of this business have declined between
years.
Cost
of Revenues.
The cost
of revenues for the power industry services business of GPS increased in the
six
months ended July 31, 2008 to $101.7 million from $83.8 million in the six
months ended July 31, 2007. The cost of revenues as a percentage of
corresponding net revenues declined between the periods. The percentage was
88.7% in the current year period compared with 94.2% in the prior year period
which reflected a substantial loss on one significant project that was recorded
last year.
Although
the cost of revenues for the nutritional products business of VLI decreased
in
the six-month period ended July 31, 2008 to $4.7 million from $8.3 million
in
the six months ended July 31, 2007, the cost of revenues percentage increased
to
102.0% of net revenues in the current quarter from a percentage of 83.0% in
the
corresponding period of the prior year as declining sales and competitive
product pricing pressures continued to squeeze gross margins and increased
the
recurring cost of excess production capacity.
The
cost
of revenues for the telecommunication infrastructure services business of SMC
declined by $52,000, or approximately 1.4%, in the current year period compared
with the corresponding period a year ago, but increased as a percentage of
corresponding net revenues to 86.2% in the current period from 79.9% in the
comparable period last year. On an overall basis, direct labor and related
costs
have been reduced between the periods. Despite the increased inside plant work
requiring an increase in the use of subcontractors and an increase in job
material and supply costs, the profitability of the inside plant work has
improved between the periods. On the other hand, the effect of reduced net
revenue and competitive pricing pressures have decreased the profitability
of
the outside plant work between the periods.
Primarily
as a result of the improvement in the performance of GPS, our overall gross
profit increased to $13.5 million for the six months ended July 31, 2008 from
$7.7 million for the six months ended July 31, 2007, and our gross profit
percentage increased to 10.9% for the current year period from a percentage
of
7.5% in the corresponding period of the prior year.
Selling,
General and Administrative Expenses.
These
costs decreased to $8.0 million for the six months ended July 31, 2008 from
$9.3
million for the six months ended July 31, 2007, a reduction of $1.3 million,
or
14.0%.
Amortization
expense related to purchased intangible assets decreased by approximately $2.9
million in the current year period compared with the corresponding period of
last year as the amortization expense related to contractual and other customer
relationships decreased between quarters by approximately $2.5 million. As
also
reflected in the current quarter operating results, most of this decrease was
scheduled and attributable to backlog for construction contracts completed
by
GPS last year, the impairment losses recorded by VLI last year served to reduce
its amortization expense related to customer relationships and the noncompete
agreement prospectively, and the amortization of propriety formulas was
completed last year. Partially offsetting the favorable effects of the
amortization expense reductions in the current period were an increase in stock
compensation expense of $688,000 and an increase in salary expense at GPS of
$272,000.
-
24
-
Impairment
Losses.
The
statement of operations for the six months ended July 31, 2008 included the
VLI
impairment losses related to goodwill, other purchased intangible assets,
and
fixed assets in the total amount of approximately $1,946,000. No impairment
losses were recorded in the comparable prior year period.
Interest
Income and Expense.
We
reported interest income of $936,000 for the six months ended July 31, 2008
compared to interest income of $1,279,000 for the six months ended July 31,
2007, reflecting the decline in short-term investment returns over the last
year. Interest expense declined to $228,000 in the current year period from
$378,000 in the comparable period of the prior year due to the overall reduction
in the level of debt between periods.
Income
Tax Expense and Benefit.
For the
six months ended July 31, 2008, we incurred income tax expense of $1.7 million
reflecting an effective income tax rate of 41.3%. The effective tax rate
for the
current quarter differs from the expected federal income tax rate of 34%
due
primarily to the effect of the impairment loss recorded in the current year
related to the goodwill of VLI. This loss is not deductible for income tax
reporting purposes. It was treated as a discreet item in the determination
of
the current year effective income tax rate. In addition, we established a
valuation allowance during the current quarter related to the deferred state
taxes of VLI in the amount of $57,000. These unfavorable effects of these
factors were offset partially in the current period by the favorable effect
of
the domestic manufacturing deduction, which is treated as a permanent difference
for income tax accounting purposes, and a credit to the deferred tax provision
in the approximate amount of $116,000 reflecting the effect of the current
year
change in state income tax rates applied to our deferred tax items.
Liquidity
and Capital Resources as of July 31, 2008
Cash
and
cash equivalents have increased during the current year by approximately
$37.2
million to approximately $104.0 million as of July 31, 2008 compared to $66.8
million as of January 31, 2008. We also have an available balance of $4.3
million under our revolving line of credit financing arrangement with our
bank.
The Company’s consolidated working capital increased during the current year
from approximately $16.5 million as of January 31, 2008 to approximately
$46.7
million as of July 31, 2008. During the current year, we also reached agreement
with the bank extending the availability of the revolving line of credit
to May
2010.
Net
cash
provided by operations for the six months ended July 31, 2008 was approximately
$15.7 million. We
reported net income of approximately $2.4 million and our net non-cash expenses
were approximately $3.5 million including impairment losses and the amortization
of purchased intangible assets. Cash was also provided by a decrease in accounts
receivable of $7.7 million and an increase in accounts payable and accrued
expenses of $9.1 million. In addition, cash in the amount of $4.1 million
was
released from escrow accounts as described in Note 2 to the condensed
consolidated financial statements. Cash was used during the current year
in
connection with the increase in billings in excess of contract revenues in
the
amount of $10.3 million.
For
the
six months ended July 31, 2007, despite a net loss of $681,000, net cash
provided by operations was $23.0 million. In the prior year, a reduction
in
unbilled contract receivables and an increase in billings in excess of contract
revenues combined to provide approximately $38.6 million in cash in the six
months ended July 31, 2007. On the other hand, cash was used to reduce accounts
payable and accrued expenses by $10.2 million and in connection with the
increase in billed accounts receivable of $7.3 million. The net amount of
non-cash expenses in the prior year period, including the amortization of
purchased intangible assets, was approximately $3.6 million.
During
the six months ended July 31, 2008, investing activities consisted of the
payment of $2,000,000 in contingent acquisition price to the former owners
of
GPS (see Note 2 to the condensed consolidated financial statements) and the
capital contribution of $600,000 to GRP made in connection with the formation
and start-up of this unconsolidated subsidiary. We have also purchased equipment
for a net cost of $259,000 during the current year. Last year, net cash of
approximately $2.1 million was provided by investing activities as the sale
of
investments and equipment provided cash proceeds of $2.3 million but we used
$206,000, net, in the purchase of new equipment.
Net
cash
of approximately $24.3 million was provided by financing activities during
the
six months ended July 31, 2008. We completed the private placement sale of
2.2
million shares of our common stock in July 2008, providing net cash proceeds
of
$25.0 million, and issued approximately 100,000 shares of our common stock
in
connection with the exercise of stock options and warrants, providing net
cash
proceeds of approximately $637,000. We used cash to make debt principal payments
of $1.3 million.
-
25
-
The
financing arrangements with our bank provide for the measurement at our fiscal
year-end and at each of our fiscal quarter-ends (using a rolling 12-month
period) of certain financial covenants, determined on a consolidated basis,
including requirements that the ratio of total funded debt to EBITDA not
exceed
2 to 1, that the ratio of senior funded debt to EBITDA not exceed 1.50 to
1, and
that the fixed charge coverage ratio not be less than 1.25 to 1. At
the end of the fiscal year and at the end of the most recent fiscal
quarter, the Company was in compliance with each of these financial
covenants. The
Bank’s consent is required for acquisitions and divestitures. The Company
continues to pledge the majority of the Company’s assets to secure the financing
arrangements.
The
amended financing arrangement contains an acceleration clause which allows
the
bank to declare amounts outstanding under the financing arrangements due
and
payable if it determines in good faith that a material adverse change has
occurred in the financial condition of any of our companies. We believe that
the
Company will continue to comply with its financial covenants under the financing
arrangement. If the Company’s performance does not result in compliance with any
of its financial covenants, or if the bank seeks to exercise its rights under
the acceleration clause referred to above, we would seek to modify the financing
arrangement, but there can be no assurance that the bank would not exercise
its
rights and remedies under the financing arrangement including accelerating
payment of all outstanding senior debt due and payable.
We
believe that cash on hand, cash generated from the Company’s future operations
and funds available under the Company’s line of credit will be adequate to meet
our future operating cash needs. Any future acquisition, or other significant
unplanned cost or cash requirement may require us to raise additional funds
through the issuance of debt and/or equity securities. Despite our success
in
completing the private placement transaction in July 2008, there can be no
assurance that such future financing will be available on terms acceptable
to
us, or at all. If additional funds are raised by issuing equity securities,
significant dilution to the existing stockholders may result.
Earnings
before Interest, Taxes, Depreciation and Amortization (Non-GAAP
Measurement)
We
present Earnings before Interest, Taxes, Depreciation and Amortization
(“EBITDA”) to provide investors with a supplemental measure of our operating
performance. The following table shows our calculations of EBITDA for the
six
months ended July 31, 2008 and 2007:
|
|
Six
Months Ended July 31,
|
||||||
|
|
2008
|
2007
|
|||||
|
Net
income (loss), as reported
|
$
|
2,361,000
|
$
|
(681,000
|
)
|
||
|
Impairment
losses of VLI
|
1,946,000
|
—
|
|||||
|
Amortization
of purchased intangible assets
|
1,174,000
|
4,089,000
|
|||||
|
Stock
option compensation expense
|
788,000
|
100,000
|
|||||
|
Depreciation
and other amortization
|
683,000
|
644,000
|
|||||
|
Interest
expense
|
228,000
|
378,000
|
|||||
|
Income
tax expense (benefit)
|
1,662,000
|
(7,000
|
)
|
||||
|
EBITDA
|
$
|
8,842,000
|
$
|
4,523,000
|
|||
Management
uses EBITDA, a non-GAAP financial measure, for planning purposes, including
the
preparation of operating budgets and to determine appropriate levels of
operating and capital investments. Management believes that EBITDA provides
additional insight for analysts and investors in evaluating the Company's
financial and operational performance and in assisting investors in comparing
the Company's financial performance to those of other companies in the Company's
industry. However, EBITDA is not intended to be an alternative to financial
measures prepared in accordance with GAAP and should not be considered in
isolation from our GAAP results of operations. Pursuant to the requirements
of
SEC Regulation G, reconciliations between the Company's GAAP and non-GAAP
financial results for the six months ended July 31, 2008 and 2007 are provided
above and investors are advised to carefully review and consider this
information as well as the GAAP financial results that are disclosed in our
SEC
filings.
-
26
-
Seasonality
The
Company's telecommunications infrastructure service operations may have
seasonally weaker results in the first and fourth quarters of the year, and
may
produce stronger results in the second and third quarters. This seasonality
may
be due to the effect of winter weather on construction and outside plant
activities as well as reduced daylight hours and customer budgetary constraints.
Certain customers tend to complete budgeted capital expenditures before the
end
of the year, and postpone additional expenditures until the subsequent fiscal
period.
ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
Not
required for a smaller reporting company.
ITEM
4. CONTROLS AND PROCEDURES
Evaluation
of disclosure controls and procedures.
Our
management, with the participation of our chief executive officer and chief
financial officer, evaluated the effectiveness of our disclosure controls
and
procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Exchange
Act)
as of July 31, 2008. Management recognizes that any controls and procedures,
no
matter how well designed and operated, can provide only reasonable assurance
of
achieving their objectives, and management necessarily applies its judgment
in
evaluating the cost-benefit relationship of possible controls and procedures.
Based on the evaluation of our disclosure controls and procedures as of July
31,
2008, our chief executive officer and chief financial officer concluded that,
as
of such date, our disclosure controls and procedures were effective at the
reasonable assurance level.
Changes
in internal controls over financial reporting.
No
change in our internal control over financial reporting (as defined in Rules
13a-15 or 15d-15 under the Exchange Act) occurred during the fiscal quarter
ended July 31, 2008 that has materially affected, or is reasonably likely
to
materially affect, our internal control over financial
reporting.
-
27
-
PART
II
OTHER
INFORMATION
|
1)
|
On
March 22, 2005, WFC filed a civil action against the Company and
its
executive officers. The suit was filed in the Superior Court of
the State
of California for the County of Los Angeles. WFC purchased the
capital
stock of the Company's wholly-owned subsidiary, Puroflow Incorporated,
pursuant to the terms of the Stock Purchase Agreement dated October
31,
2003. WFC alleged that the Company and its executive officers breached
the
Stock Purchase Agreement between WFC and the Company and engaged
in
misrepresentations and negligent conduct with respect to the Stock
Purchase Agreement. WFC sought declaratory relief, compensatory
and
punitive damages in an amount to be proven at trial as well as
the
recovery of attorney's fees. This action was removed to the United
States
District Court for the Central District of California. The Company
and its
officers deny that any breach of contract or that any misrepresentations
or negligence occurred on their
part.
|
This
case
was scheduled for trial on April 10, 2007. On March 15, 2007, the District
Court
granted the Company and its executive officers' motion for summary judgment,
thereby dismissing WFC's lawsuit against the Company and its executive officers
in its entirety. WFC appealed the District Court’s decision. The parties filed
their appellate briefs and oral arguments occurred on June 3, 2008. On August
25, 2008, the Ninth Circuit Court of Appeals reversed the summary judgment
decision and remanded the case back to the District Court. The Company has
reviewed WFC’s claims and continues to believe that they are without merit. The
Company intends to continue vigorously defending this litigation.
|
2)
|
On
August 27, 2007, Kevin Thomas, the former owner of VLI, filed a
lawsuit
against the Company, VLI and the Company’s Chief Executive Officer (the
“CEO”) in the Circuit Court of Florida for Collier County. The Company
acquired VLI by way of merger on August 31, 2004. Mr. Thomas alleges
that
the Company, VLI and the CEO breached various agreements regarding
his
compensation and employment package that arose from the acquisition
of
VLI. Mr. Thomas has alleged contractual and tort-based claims arising
from
his compensation and employment agreements and seeks rescission
of his
covenant not to compete against VLI. The Company, VLI and the CEO
deny
that any breach of contract or tortious conduct occurred on their
part.
The Company and VLI have also asserted four counterclaims against
Mr.
Thomas for breach of the merger agreement, breach of his employment
contract, breach of fiduciary duty and tortious interference with
contractual relations for the violation of his non-solicitation,
confidentiality and non-compete obligations after he left VLI (the
“VLI
Merger Litigation”). The Company intends to vigorously defend this lawsuit
and prosecute its counterclaims.
|
|
3)
|
On
March 4, 2008, Vitarich Farms, Inc. (“VFI”) filed a lawsuit against VLI
and its current president in the Circuit Court of Florida for Collier
County. VFI, which is owned by Kevin Thomas, supplied VLI with
certain
organic raw materials used in the manufacture of VLI products.
VFI has
asserted a breach of contract claim against VLI and alleges that
VLI
breached a supply agreement with VFI by acquiring the organic products
from a different supplier. VFI also asserted a claim for defamation
against VLI’s president alleging that he made false statements regarding
VFI’s organic certification to one of VLI's customers. VLI and its
president filed their Answer and Affirmative Defenses on May 8,
2008. VLI
and its president deny that VLI breached any contract or that its
president defamed VFI. The defendants intend to continue to vigorously
defend this lawsuit.
|
|
4)
|
On
March 4, 2008, Mr. Thomas filed a lawsuit against VLI's president
in the
Circuit Court of Florida for Collier County. Mr. Thomas has filed
this new
lawsuit against VLI’s president for defamation. Mr. Thomas alleges that
VLI’s president made false statements to third-parties regarding Mr.
Thomas' conduct that is the subject of counterclaims by the Company
and
VLI in the VLI Merger Litigation discussed above, and that these
statements have caused damage to his business reputation. VLI’s president
filed his answer with the court on May 8, 2008 denying that he
defamed Mr.
Thomas. He intends to continue to vigorously defend this
lawsuit.
|
In
the
normal course of business, the Company has pending claims and legal proceedings.
It is our opinion, based on information available at this time, that none
of the
other current claims and proceedings will have a material effect on our
condensed consolidated financial statements.
-
28
-
ITEM
1A.
RISK
FACTORS
Investing
in our securities involves a high degree of risk. Our business, financial
position and future results of operations may be impacted in a materially
adverse manner by risks associated with the execution of our strategic plan
and
the creation of a profitable and cash-flow positive business, our ability
to
obtain capital or to obtain capital on terms acceptable to us, the successful
integration of acquired companies into our consolidated operations, our ability
to successfully manage diverse operations that are remotely located, our
ability
to successfully compete in highly competitive industries, the successful
resolution of ongoing litigation, our dependence upon key managers and employees
and our ability to retain them, and potential fluctuations in quarterly
operating results, among other risks.
In
addition, we note the following risks related to our power industry services
business that provided approximately 93% of consolidated net revenues for
the
six months ended July 31, 2008.
Interruption
of power plant construction projects could adversely affect future results
of
operations.
At
any
time, GPS has a limited number of construction contracts. Should any unexpected
suspension, termination or delay of the work under such contracts occur,
our
results of operations may be materially and adversely affected.
Investment
in the wind energy farm business partnership may occur without expected
returns.
In
June
2008, we announced that GPS had formed a 50%-owned unconsolidated subsidiary
company with lnvenergy Wind Management LLC for the design and construction
of
wind energy farms. We expect that the new company, Gemma Renewable Power,
LLC
(“GRP”) will annually provide engineering, procurement and construction services
for new wind energy farms generating more than an estimated 300 megawatts
of
electrical power. Should the future construction and other related services
of
GRP be at lower revenue levels than expected, or should GRP fail to profitably
execute the projects that it may obtain, GPS may fail to receive returns
from
GRP as anticipated which may adversely affect our future results of our
operations.
Resolution
of the terminated construction contract may require cash payments by
us.
Under
the
terms of an amended agreement with a customer covering the engineering,
procurement and construction of an ethanol production facility (the “EPC
Agreement”), March 19, 2008 was the deadline for the customer to obtain
financing for the completion of the project. Financing was not obtained and
the
EPC Agreement was terminated. GPS continues to cooperate with the customer
in
its efforts to obtain financing. GPS is uncertain as to the ultimate resolution
of this matter. As of July 31, 2008 and January 31, 2008, our condensed
consolidated balance sheets included assets and liabilities related to the
terminated construction contract. We expect that these assets will be realized
and the liabilities extinguished. Although GPS does not anticipate any losses
to
arise from the resolution of this EPC Agreement, cash may be required to
make
payment on accounts payable to project subcontractors that are included in
the
condensed consolidated balance sheet at July 31, 2008 in advance of our receipt
of any additional cash payments on outstanding accounts receivable from the
customer.
Our
dependence on large construction contracts may result in uneven quarterly
financial results.
Our
power
industry service activities in any one fiscal quarter are typically concentrated
on a few large construction projects for which we use the
percentage-of-completion method to determine contract revenues. To a substantial
extent, construction contract revenues are recognized as services are provided
based on the amount of costs incurred. As the timing of equipment purchases,
subcontractor services and other contract events may not be evenly distributed
over the lives of our contracts, the amount of total contract costs may vary
from quarter to quarter, creating uneven amounts of quarterly contract revenues.
In addition, the timing of contract commencements and completions may exacerbate
the uneven pattern.
As
a
result of the foregoing, future amounts of consolidated net revenues, cash
flow
from operations, net income and earnings per share reported on a quarterly
basis
may vary in an uneven pattern and may not be indicative of the operating
results
expected for any other quarter or for an entire fiscal year, thus rendering
consecutive quarter comparisons of our consolidated operating results a less
meaningful way to assess the growth of our business.
Before
investing in our securities, please consider the risks summarized in this
Item
1A and those risks described in our Annual Report on Form 10-K for the year
ended January 31, 2008 (our “2008 Annual Report”). Should one or more of these
risks or uncertainties materialize, or should any of our assumptions prove
incorrect, actual results may vary in material respects from those projected
in
any forward-looking statements. We undertake no obligation to publicly update
or
revise any forward-looking statements, whether as a result of new information,
future events or otherwise.
Our
future results may also be impacted by other risk factors listed from time
to
time in our future filings with the SEC, including, but not limited to, our
Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and Annual Reports
on Form 10-K. These documents are available free of charge from the SEC or
from
our corporate headquarters. Access to these documents is also available on
our
website. For more information about us and the announcements we make from
time
to time, you may visit our website at www.arganinc.com
.
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29
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Our
2008
Annual Report, under Item 1A entitled “Risk Factors,” included an expanded
discussion of our risk factors. There have been no material revisions to
the
risk factors that were described therein other than those described above.
ITEM
2.
UNREGISTERED
SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On
Form
8-K filed with the Securities and Exchange Commission (the “SEC”) on July 7,
2008, the Company described the completion of a private placement sale of
2.2
million shares of its common stock. The Company’s registration statement on Form
S-3 covering the resale of these shares by the selling stockholders identified
therein, filed with the SEC on July 16, 2008, was declared effective on July
24,
2008.
ITEM
3.
DEFAULTS
UPON SENIOR SECURITIES
None.
ITEM
4.
SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS
The
Company held its 2008 Annual Meeting of Stockholders in New York City on
June
18, 2008 (the “Annual Meeting”). The following sets forth the matters submitted
to a vote of the Company’s stockholders at the Annual Meeting.
|
1.
|
Seven
members were elected to the Board of Directors, each to serve until
the
next annual meeting of the Company and until their respective successors
have been elected to the Board of Directors and qualified. The
following
seven individuals were elected to the Board of Directors by the
stockholders of the Company:
|
Rainer
H.
Bosselmann, DeSoto S. Jordan, William F. Leimkuhler, Daniel A. Levinson,
W. G.
Champion Mitchell, James W. Quinn and Henry A. Crumpton.
Messrs.
Bosselmann, Levinson and Crumpton were elected with the affirmative vote
of
7,328,437 shares of common stock, with 19,162 shares of common stock withheld;
Mr. Mitchell was elected with an affirmative vote of 7,328,337 shares of
common
stock, with 19,262 shares of common stock withheld; and Messrs. Jordan,
Leimhuhler and Quinn were elected with the affirmative vote of 7,327,951
shares
of common stock, with 19,648 shares of common stock withheld
|
2.
|
The
stockholders of the Company approved the amendment to the 2001
Stock
Option Plan to increase the number of shares of common stock reserved
for
issuance from 650,000 shares to 1,150,000 shares with an affirmative
vote
of 5,028,595 shares of common stock. Votes representing 88,147
shares of
common stock were cast against the proposal and there were 631
abstaining
votes.
|
|
3.
|
The
stockholders of the Company ratified the appointment of Grant Thornton
LLP
as our independent registered public accounting firm for the fiscal
year
ending January 31, 2009 with an affirmative vote of 7,347,166 shares
of
common stock. Votes representing 122 shares of common stock were
cast
against the proposal and there were 311 abstaining
votes
|
ITEM
5.
OTHER
INFORMATION
ITEM
6. EXHIBITS
|
Exhibit
No.
|
|
Title
|
|
Exhibit:
31.1
|
|
Certification
of Chief Executive Officer, pursuant to Rule 13a-14(c) under the
Securities Exchange Act of 1934
|
|
Exhibit:
31.2
|
|
Certification
of Chief Financial Officer, pursuant to Rule 13a-14(c) under the
Securities Exchange Act of 1934
|
|
Exhibit:
32.1
|
|
Certification
of Chief Executive Officer, pursuant to 18 U.S.C. Section
1350
|
|
Exhibit:
32.2
|
|
Certification
of Chief Financial Officer, pursuant to 18 U.S.C. Section
1350
|
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30
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SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant
has
duly caused this report to be signed on its behalf by the undersigned,
thereunto, duly authorized.
|
|
ARGAN,
INC.
|
|
|
September
11, 2008
|
By:
|
/s/ Rainer
H. Bosselmann
|
|
Rainer
H. Bosselmann
Chairman
of the Board and Chief Executive
Officer
|
||
|
September
11, 2008
|
By:
|
/s/ Arthur
F. Trudel
|
|
Arthur
F. Trudel
Senior
Vice President, Chief Financial Officer
and Secretary |
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