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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC  20549

 

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended July 31, 2008

 

Commission File No. 000-1409171

 

TITAN MACHINERY INC.

(Exact name of registrant as specified in its charter)

 

 

4876 Rocking Horse Circle
Fargo, ND 58104-6049

(Address of Principal Executive Offices)

 

Registrant’s telephone number (701) 356-0130

 

 

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  x    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.

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES  o    NO  x

 

The number of shares outstanding of the registrant’s common stock as of September 1, 2008 was: Common Stock, $0.00001 par value, 17,639,722 shares.

 

 

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TITAN MACHINERY INC.

QUARTERLY REPORT ON FORM 10-Q

 

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PART I.		FINANCIAL INFORMATION
ITEM 1.			FINANCIAL STATEMENTS
						Consolidated Balance Sheets as of July 31, 2008 and January 31, 2008
						Consolidated Statements of Operations for the three and six months ended July 31, 2008 and 2007
						Consolidated Statements of Stockholders’ Equity for the fiscal year ended January 31, 2008 and six months ended July 31, 2008
						Consolidated Statements of Cash Flows for the six months ended July 31, 2008 and 2007
						Notes to Consolidated Financial Statements
ITEM 2.				MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 3.				QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 4.				CONTROLS AND PROCEDURES
PART II.	OTHER INFORMATION
ITEM 1.				LEGAL PROCEEDINGS
ITEM 1A.				RISK FACTORS
ITEM 2.				UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
ITEM 3.				DEFAULTS UPON SENIOR SECURITIES
ITEM 4.				SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
ITEM 5.				OTHER INFORMATION
ITEM 6.				EXHIBITS
Signatures
Exhibit Index

 

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PART I. – FINANCIAL INFORMATION

 

ITEM 1.                  FINANCIAL STATEMENTS

 

TITAN MACHINERY INC.

CONSOLIDATED BALANCE SHEETS

 

		July 31,			January 31,
		2008			2008
		(Unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents		$	86,986,230		$	42,802,505
Receivables, net		30,990,211			22,061,275
Inventories		183,170,750			145,766,866
Prepaid expenses		377,570			215,312
Income taxes receivable		649,822			1,074,216
Deferred income taxes		1,174,000			1,027,000
Total current assets		303,348,583			212,947,174
INTANGIBLES AND OTHER ASSETS
Parts inventory in excess of amounts expected to be sold currently		1,899,000			1,480,000
Goodwill		8,998,264			8,271,133
Intangible assets, net of accumulated amortization		226,051			337,242
Other		377,321			311,581
		11,500,636			10,399,956
PROPERTY AND EQUIPMENT, net of accumulated depreciation		23,161,056			16,022,336
		$	338,010,275		$	239,369,466
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES
Accounts payable		$	13,118,133		$	9,244,064
Floorplan notes payable		118,148,218			105,847,648
Current maturities of long-term debt		1,556,920			5,653,840
Customer deposits		29,347,882			19,309,533
Accrued expenses		6,376,984			6,137,842
Total current liabilities		168,548,137			146,192,927
LONG-TERM LIABILITIES
Long-term debt, less current maturities		2,712,474			13,082,795
Deferred income taxes		2,662,000			1,865,000
Other long term liabilities		2,045,209			811,689
		7,419,683			15,759,484
SUBORDINATED DEBENTURES		—			1,300,000
STOCKHOLDERS’ EQUITY
Common stock, par value $.00001 per share, authorized - 25,000,000 shares; issued and outstanding - 17,636,367 at July 31, 2008 and 13,440,654, at January 31, 2008		176			134
Additional paid-in-capital		137,385,435			58,179,695
Retained earnings		24,656,844			17,937,226
		162,042,455			76,117,055
		$	338,010,275		$	239,369,466

 

See Notes to Consolidated Financial Statements

 

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TITAN MACHINERY INC.

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

 

		Three Months Ended						Six Months Ended
		July 31,						July 31,
		2008			2007			2008			2007
REVENUE
Equipment		$	97,840,658		$	61,379,738		$	218,754,141		$	122,482,367
Parts		23,612,450			14,851,106			45,116,466			27,176,063
Service		10,787,741			7,647,462			19,731,969			13,040,797
Other, including trucking and rental		2,664,647			1,933,562			3,884,832			2,939,351
TOTAL REVENUE		134,905,496			85,811,868			287,487,408			165,638,578
COST OF REVENUE
Equipment		86,986,321			55,643,074			194,904,237			110,532,663
Parts		16,689,276			10,866,465			32,482,985			20,016,144
Service		3,907,049			2,669,663			7,324,779			4,887,586
Other, including trucking and rental		1,894,049			1,290,608			2,747,256			2,041,358
TOTAL COST OF REVENUE		109,476,695			70,469,810			237,459,257			137,477,751
GROSS PROFIT		25,428,801			15,342,058			50,028,151			28,160,827
OPERATING EXPENSES		19,470,026			11,405,643			37,651,968			21,452,384
INCOME FROM OPERATIONS		5,958,775			3,936,415			12,376,183			6,708,443
OTHER INCOME (EXPENSE)
Interest and other income		450,404			70,976			760,778			84,634
Floorplan interest expense		(577,877		)	(952,023		)	(1,299,466		)	(1,831,354		)
Subordinated debt interest expense		—			(469,874		)	(20,917		)	(878,992		)
Interest expense other		(229,811		)	(139,992		)	(521,960		)	(386,272		)
INCOME BEFORE INCOME TAXES		5,601,491			2,445,502			11,294,618			3,696,459
PROVISION FOR INCOME TAXES		(2,269,000		)	(989,000		)	(4,575,000		)	(1,467,663		)
NET INCOME		$	3,332,491		$	1,456,502		$	6,719,618		$	2,228,796
ADJUSTMENTS TO INCOME:
Amortization of syndication fees		—			(5,296		)	—			(10,592		)
Unpaid accumulated preferred dividends		—			(25,594		)	—			(51,188		)
INCOME AVAILABLE TO COMMON STOCKHOLDERS		$	3,332,491		$	1,425,612		$	6,719,618		$	2,167,016
EARNINGS PER SHARE - BASIC		$	0.20		$	0.33		$	0.45		$	0.50
EARNINGS PER SHARE - DILUTED		$	0.19		$	0.22		$	0.43		$	0.34
WEIGHTED AVERAGE SHARES - BASIC		16,629,671			4,344,753			15,005,930			4,344,753
WEIGHTED AVERAGE SHARES - DILUTED		17,169,719			7,049,941			15,511,739			7,022,385

 

See Notes to Consolidated Financial Statements

 

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TITAN MACHINERY INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (UNAUDITED)

 

							Additional
		Common Stock					Paid-In			Retained
		Shares		Amount			Capital			Earnings			Total
BALANCE, JANUARY 31, 2007		4,344,753		$	43		$	514,864		$	12,863,630		$	13,378,537
Common stock issued in initial public offering		5,442,395		55			41,793,588			—			41,793,643
Issuance of shares for stock acquisition		235,294		2			1,999,997			—			1,999,999
Issuance of shares for conversion of debt/conversion of redeemable securities/exercise of warrants		3,339,792		33			13,729,791			—			13,729,824
Stock based compensation expense		78,420		1			141,455			—			141,456
Unpaid accumulated dividends		—		—			—			(87,791		)	(87,791		)
Amortization of syndication fees		—		—			—			(51,311		)	(51,311		)
Net income		—		—			—			5,212,698			5,212,698
BALANCE, JANUARY 31, 2008		13,440,654		134			58,179,695			17,937,226			76,117,055
Common stock issued in follow-on offering		4,180,000		42			78,856,657			—			78,856,699
Common stock issued on exercise of stock options		15,713		—			40,004			—			40,004
Stock based compensation expense		—		—			309,079			—			309,079
Net income		—		—			—			6,719,618			6,719,618
BALANCE, JULY 31, 2008		17,636,367		$	176		$	137,385,435		$	24,656,844		$	162,042,455

 

See Notes to Consolidated Financial Statements

 

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TITAN MACHINERY INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 

		Six Months Ended July 31,
		2008			2007
OPERATING ACTIVITIES
Net income		$	6,719,618		$	2,228,796
Adjustments to reconcile net income to net cash from operations
Depreciation		1,762,282			1,042,241
Amortization		111,191			52,149
Gain on sale of equipment		(14,450		)	(21,668		)
Deferred income taxes		80,355			—
Net change in other assets		(65,740		)	4,779
Stock based compensation expense		309,079			108,000
Changes in assets and liabilities, net of purchase of equipment dealerships assets and assumption of liabilities
Receivables		(7,674,260		)	(402,438		)
Inventories		(6,953,477		)	(47,151		)
Prepaid expenses		(162,258		)	(58,276		)
Floorplan notes payable		(1,744,716		)	(673,097		)
Accounts payable		3,528,481			1,016,070
Other long-term liabilities		1,233,520			—
Customer deposits		9,646,917			1,721,548
Accrued expenses		196,004			98,535
Income taxes		424,394			8,400
NET CASH PROVIDED BY OPERATING ACTIVITIES		7,396,940			5,077,888
INVESTING ACTIVITIES
Property and equipment purchases		(3,689,567		)	(4,087,337		)
Net proceeds from sale of equipment		146,631			103,174
Purchase of equipment dealerships, net of cash purchased		(20,329,409		)	(5,126,577		)
NET CASH USED FOR INVESTING ACTIVITIES		(23,872,345		)	(9,110,740		)
FINANCING ACTIVITIES
Proceeds from follow-on offering of common stock net of underwriting discount of $4,389,000 and other direct costs of $354,301		78,856,699			—
Net change in non-manufacturer floor plan payable		(1,985,140		)	(4,606,468		)
Proceeds from long-term debt borrowings and subordinated debentures		564,567			4,062,755
Principal payments on long-term debt and subordinated debentures		(16,817,000		)	(1,728,045		)
Other		40,004			(45,268		)
NET CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES		60,659,130			(2,317,026		)
NET CHANGE IN CASH AND CASH EQUIVALENTS		44,183,725			(6,349,878		)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		42,802,505			7,572,000
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	86,986,230		$	1,222,122

 

See Notes to Consolidated Financial Statements

 

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		Six Months Ended July 31,
		2008			2007
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period
Income taxes, net of refunds		$	4,070,000		$	1,476,063
Interest		1,927,245			3,101,046
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES
Dividends on preferred redeemable stock charged to retained earnings		$	—		$	51,188
Acquisition of equipment dealership assets in exchange for cash and assumption of liabilities including purchase accounting adjustments on prior acquisitions
Accounts receivable		$	(1,254,676	)	$	(112,788	)
Inventories		(18,199,975		)	(8,107,415		)
Property and equipment		(5,343,616		)	(772,685		)
Goodwill		(727,131		)	(2,500,000		)
Accounts payable		345,588			1,385,932
Floorplan notes payable		3,360,994			3,148,704
Customer deposits		391,432			—
Accrued expenses		43,138			831,675
Income taxes payable		241,915			—
Long term debt		485,192			1,000,000
Deferred income taxes, net		327,730			—
Cash paid for dealerships		$	(20,329,409	)	$	(5,126,577	)

 

See Notes to Consolidated Financial Statements

 

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TITAN MACHINERY INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

NOTE 1 -  BUSINESS ACTIVITY AND SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

The unaudited financial statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission for interim reporting.  Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the six month period ended July 31, 2008 are not necessarily indicative of the results that may be expected for the year ended January 31, 2009.  The information contained in the balance sheet as of January 31, 2008 was derived from the Company’s audited financial statements for the year then ended.

 

Nature of Business

 

Titan Machinery Inc. (the “Company”) is engaged in the retail sale, service and rental of agricultural and industrial machinery through stores in North Dakota, South Dakota, Minnesota, Nebraska and Iowa.

 

Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Transportation Solutions, LLC. All significant accounts, transactions and profits between the consolidated companies have been eliminated in consolidation.

 

Recently Issued Accounting Pronouncements

 

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Accounting Standards (“SFAS”) No. 157, Fair Value Measurements (“SFAS 157”).  This standard defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements.  This standard applies under other accounting pronouncements that require or permit fair value measurements, but does not require any new fair value measurements.  SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, which is the year beginning February 1, 2008 for the Company.  The Company adopted SFAS 157 effective February 1, 2008. The adoption of SFAS 157 for financial assets and liabilities held by the Company did not have a material effect on the Company’s financial statements or notes thereto.

 

In February 2008, the FASB issued FSP FAS 157-2, Effective Date of FASB Statement No. 157 (“FSP FAS 157-2”), which permits a one year deferral of the application of SFAS 157 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The Company will adopt SFAS 157 for non-financial assets and non-financial liabilities on February 1, 2009 and does not expect the provisions to have a material effect on its results of operations, financial position or cash flows.

 

In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”).  SFAS 159 provides companies with an option to report selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose

 

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different measurement attributes for similar types of assets and liabilities.  SFAS 159 is effective for fiscal years beginning after November 15, 2007.  The Company has elected not to apply the fair value option to the specified financial assets and liabilities, and accordingly, the adoption of SFAS No. 159 had no financial statement impact.

 

In December 2007, the FASB issued SFAS No. 141 (Revised 2007), Business Combinations (“SFAS 141R”).  SFAS 141R provides additional guidance on improving the relevance, representational faithfulness, and comparability of the financial information that a reporting entity provides in its financial reports about a business combination and its effects.  SFAS 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.  The Company is in the process of evaluating the effect that the adoption of this standard will have on the Company’s financial statements.

 

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements (“SFAS 160”).  SFAS 160 applies to all entities that prepare consolidated financial statements and have an outstanding noncontrolling interest in one or more subsidiaries.  SFAS 160 amends Accounting Research Bulletin No. 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary.  SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008.   The Company is in the process of evaluating the effect that the adoption of this standard will have on the Company’s financial statements.

 

On December 21, 2007 the SEC staff issued Staff Accounting Bulletin No. 110 (“SAB 110”), which, effective January 1, 2008, amends and replaces SAB 107, Share-Based Payment. SAB 110 expresses the views of the SEC staff regarding the use of a “simplified” method in developing the expected life assumption in accordance with FASB Statement No. 123(R), Share-Based Payment. The use of the “simplified” method, was scheduled to expire on December 31, 2007. SAB 110 extends the use of the “simplified” method in certain situations. The SEC staff does not expect the “simplified” method to be used when sufficient information regarding exercise behavior, such as historical exercise data or exercise information from external sources, becomes available.  The Company plans to track and capture employee exercise behavior in the future as a basis for our valuation assumptions.  The Company currently uses simplified estimates due to the limited number of options exercised.

 

Earnings Per Share

 

Basic earnings per share were computed by dividing income available to common stockholders by the weighted average number of shares of common stock outstanding during the respective periods.  Accumulated preferred dividends and amortization of syndication fees were subtracted from net income to arrive at income available to common stockholders.  Nonvested restricted stock is excluded from the calculation of basic weighted-average shares outstanding.

 

Diluted earnings per share were computed by dividing income available to common stockholders plus assumed conversions by the weighted-average common shares outstanding after adjusting for potential dilution related to the conversion of all dilutive securities into common stock.  All potentially dilutive securities were included in the computation of diluted earnings per share.

 

The components of basic earnings per share are as follows:

 

		Three Months Ended July 31,						Six Months Ended July 31,
Basic - Earnings Per Share		2008			2007			2008			2007
Net Income		$	3,332,491		$	1,456,502		$	6,719,618		$	2,228,796
Less: Amortization of syndication fees		—			(5,296		)	—			(10,592		)
Less: Preferred stock dividends - unpaid		—			(25,594		)	—			(51,188		)
Income available to common stockholders		$	3,332,491		$	1,425,612		$	6,719,618		$	2,167,016
Basic weighted-average shares outstanding		16,629,671			4,344,753			15,005,930			4,344,753
Basic – Earnings Per Share		$	0.20		$	0.33		$	0.45		$	0.50

 

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The components of diluted earnings per share are as follows:

 

		Three Months Ended July 31,						Six Months Ended July 31,
Diluted - Earnings Per Share		2008			2007			2008			2007
Income available to common stockholders		$	3,332,491		$	1,425,612		$	6,719,618		$	2,167,016
Plus: Income impact of assumed conversions
Amortization of syndication fees		—			5,296			—			10,592
Preferred stock dividends - unpaid		—			25,594			—			51,188
Interest on convertible debentures, net of tax effect		—			80,581			—			161,162
Income available to common stockholders plus assumed conversions		$	3,332,491		$	1,537,083		$	6,719,618		$	2,389,958
Diluted weighted-average shares outstanding:
Basic weighted-average shares outstanding		16,629,671			4,344,753			15,005,930			4,344,753
Plus: Incremental shares from assumed conversions
Convertible debentures		—			2,006,667			—			2,006,667
Convertible preferred shares		—			466,673			—			466,673
Restricted Stock		85,452			11,487			85,128			11,487
Warrants		115,699			168,443			113,018			145,540
Options		338,897			51,918			307,663			47,265
Diluted weighted-average shares outstanding		17,169,719			7,049,941			15,511,739			7,022,385
Diluted - EPS		$	0.19		$	0.22		$	0.43		$	0.34

 

NOTE 2 -   INVENTORIES

 

		July 31,			January 31,
		2008			2008
New equipment		$	109,940,953		$	78,409,999
Used equipment		42,641,642			44,478,010
Parts, tires and attachments		27,515,918			20,462,680
Work in process		3,072,237			2,416,177
		$	183,170,750		$	145,766,866

 

In addition to the above amounts, the Company has estimated that a portion of its parts inventory will not be sold in the next operating cycle. Accordingly, these balances have been classified as noncurrent assets.

 

NOTE 3 -   LINE OF CREDIT

 

The Company entered into a new line of credit agreement with Bremer Bank National Association (“Bremer”) on August 28, 2008.  The agreement provides for available borrowings of $25,000,000 and carries a variable interest rate of prime minus .25%, and has a maturity date of August 1, 2009.  This agreement replaces the previous line of $12,000,000 which existed on July 31, 2008.  Similar to the previous line of credit, the new agreement contains certain financial covenants which impose minimum levels of current ratio, debt service coverage, and inventory turnover ratio and a maximum level of debt to tangible net worth ratio.  The line is secured by substantially all assets of the Company.  The personal guarantee by our Chief

 

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Executive Officer is no longer required under the new agreement.  The Company had no amount outstanding on the Bremer line of credit at July 31, 2008 and January 31, 2008.

 

NOTE 4 -   LONG TERM DEBT

 

		July 31,			January 31,
		2008			2008
Variable rate notes payable to CNH Capital America LLC (CNH), variable rates at prime plus 0.3% - 1.6%, varying monthly installment payments maturing August 2012, secured by rental fleet equipment.		$	1,520,079		$	1,952,440
Non-interest bearing notes to CNH, in varying monthly installments, various maturity dates through February 2010, secured by parts		649,173			1,162,146
Non-interest bearing note to CNH, monthly payments of $27,147 maturing October 2009, secured by parts, variable interest rate at prime plus 1.6% rate beginning November 2008		407,200			570,080
Fixed rate notes payable to Ford Motor Credit and GMAC, (5.99% to 9.85%), due in monthly installments including interest and various maturity dates through December 2012, secured by vehicles		472,027			291,428
Fixed rate note to Avoca Implement and Greenfield Implement 10.0%, monthly payments of $18,920, matures January 2011, secured by equipment		681,869			759,080
Fixed rate note to Textron Financial, 7.09%, monthly payments of $4,969, matures January 2018, secured by a company asset		539,046			549,583
Notes paid in full during six month period ended July 31, 2008		—			13,451,878
		4,269,394			18,736,635
Less current maturities		(1,556,920		)	(5,653,840		)
		$	2,712,474		$	13,082,795

 

Additionally, under covenants of the above notes payable with CNH Capital America LLC and a CNH Capital America LLC floorplan agreement, the Company has agreed, among other things, to maintain various financial ratio levels and to submit certain financial information.

 

As of July 31, 2008, the Company was in compliance with all of the above covenants.

 

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Long-term debt maturities are as follows:

 

12 Months Ending July 31,		Amount
2009		$	1,556,920
2010		864,085
2011		737,115
2012		348,773
2013		351,318
Thereafter		411,183
		$	4,269,394

 

NOTE 5 -   FLOORPLAN NOTES PAYABLE

 

Floorplan notes payable with a bank and manufacturers carry various interest rates ranging from 1.35 to 10.35% and are secured by substantially all assets of the Company.  Repayment terms vary by individual notes, but generally payments are made from sales proceeds or rental revenue from the related inventories.  The Bremer floorplan note payable, with a balance of $138,849 at July 31, 2008, was secured by the personal guarantee of the Company’s Chief Executive Officer. The balance of the Bremer floorplan note payable was paid off in August 2008, and the floorplan component of the loan facility with Bremer Bank, including the personal guarantee, has been terminated.

 

NOTE 6 -   SUBORDINATED DEBENTURES

 

During the first quarter of the current fiscal year the Company repaid all $1,300,000 subordinated debentures that were outstanding as of January 31, 2008.

 

NOTE 7 -   STOCK WARRANTS, STOCK OPTIONS AND RESTRICTED STOCK

 

Common Stock Warrants

 

In April 2003, the Company issued stock warrants to Cherry Tree Securities, LLC, whose chairman is a director of the Company, for 11,917 shares of common stock at an exercise price of $3.00 per share. The warrants terminate on April 7, 2013.  In August 2004, the Company issued an additional 6,071 stock warrants to Cherry Tree Securities at an exercise price of $3.50 per share.  These warrants terminate on July 1, 2014.

 

In addition, the Company issued stock warrants in April 2005 to an outside party for 115,650 shares of common stock at an exercise price of $3.50 per share. These warrants expire on April 7, 2013.

 

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The following is a summary of outstanding stock purchase warrants as of July 31, 2008:

 

				Exercise			Fair Value
Issue Date		Number		Price			Assigned			Purpose of Issuance
April 2003		11,917		$	3.00		$	11,200		Facilitate preferred stock issuance
August 2004		6,071		$	3.50		$	6,600		Facilitate preferred stock issuance
April 2005		115,650		$	3.50		$	126,000		Subordinated debt financing transaction
		133,638

 

Outstanding stock warrants are valued using the Black-Scholes option pricing model. Assumptions used to value the warrants are similar to those used in valuing the stock options as described below. Warrants issued in conjunction with a debt offering are valued and classified as Additional Paid-In Capital per Accounting Principles Board No. 14 Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants.

 

Stock Award Plans

 

The Company implemented the 2005 Equity Incentive Plan, a stock-based compensation plan (the “Plan”), during the year ended January 31, 2006.   In August 2007, the Plan was amended to increase the number of shares available under the Plan from 500,000 to 1,000,000 shares.  The purpose of the Plan is to provide incentive compensation to participants for services that have been or will be performed for continuing as employees or members of the Board of Directors of the Company. Under the Plan, the Company may grant incentive stock options, non-qualified stock options and restricted stock for up to 1,000,000 shares of common stock under all forms of awards. The Company accounts for stock options and restricted stock using the fair value method under SFAS 123(R).  Shares issued for stock-based awards may be either authorized but unissued shares, or shares of treasury stock acquired in the open market.

 

Compensation cost charged to operations under the equity incentive plan was $309,079 for the six months ended July 31, 2008 and $108,000 for the six months ended July 31, 2007.  The income tax benefit recognized from all stock based compensation arrangements was $123,600 for the six months ended July 31, 2008 and $42,100 for the six months ended July 31, 2007.

 

Stock Options

 

The Company grants stock options as part of its long-term incentive compensation to employees and members of the Board of Directors of the Company.  Stock options vest over a period of four to six years for employees and immediately for members of the Board of Directors and have contractual terms of five to ten years.

 

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The following table summarizes stock option activity for the six months ended July 31, 2008:

 

				Weighted
				Average			Aggregate
		Number of		Exercise			Intrinsic
		Options		Price			Value
Outstanding at January 31, 2008		483,252		$	7.43
Granted		85,000		21.58
Exercised		(6,667	)	6.00
Forfeited		(16,665	)	7.50
Outstanding at July 31, 2008		544,920		$	9.65		$	9,682,641
Options exercisable at July 31, 2008		65,753		$	4.89		$	1,481,681

 

The aggregate intrinsic value of stock options exercised was $151,669 for the six months ended July 31, 2008.  There were no options exercised for the six months ended July 31, 2007.

 

The fair value of each stock option granted is estimated using the Black-Scholes pricing model.  The following assumptions were made in estimating fair value:

 

		For the Six Months Ended July 31,
Assumption		2008		2007
Dividend Yield		0	%	0	%
Risk-free interest rate		3.2 - 3.6	%	4.9	%
Expected life of options		6.75 - 8 years		10 years
Expected volatility		34 - 37	%	22	%

 

Prior to the Company’s initial public offering the expected volatility was based upon management’s best estimate of the value of the shares based upon the Company’s internal market.  Due to the limited historical stock price data available since our initial public offering, the Company currently estimates its volatility using a blended rate based on quoted market prices of our stock and other similar companies determined by Company management.  The expected life of options is estimated consistent with the “simplified” method identified in SAB 107, the use of which was extended by SAB 110.  The simplified method calculates the expected term as the average of the vesting and contractual terms of the award.  The risk-free interest rate assumption is based on observed interest rates appropriate for the term of the options.  The Company uses historical data to estimate pre-vesting option forfeitures and records share-based compensation expense only for those awards that are expected to vest.  The Company recognizes the fair value of stock options as compensation expense ratably over the vesting period of the award.

 

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