SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
|X| ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934.
For the fiscal year ended January 31, 2005
OR
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934.
For the transition period from _____________ to _____________
Commission file number 001-31756
ARGAN, INC.
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(Name of Small Business Issuer in Its Charter)
Delaware 13-1947195
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(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
One Church Street, Suite 302, Rockville, Maryland 20850
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(Address of Principal Executive Offices) (Zip Code)
301-315-0027
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(Issuer's Telephone Number)
Securities registered under Section 12(b) of the Exchange Act:
Common Stock, $0.15 par value
-----------------------------
(Title of Class)
Securities registered under Section 12(g) of the Exchange Act: None
Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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 |_|
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendments to this Form 10-KSB. |_|
State issuer's revenues for its most recent fiscal year: $14,518,000
The aggregate market value of the Common Stock held by non-affiliates of the
Registrant was approximately $ 3,011,000 as of April 15, 2005, based upon the
closing price on the NASDAQ Electronic Bulletin Board System reported for such
date. Shares of Common Stock held by each Officer and Director and by each
person who owns 5% or more of the outstanding Common Shares have been excluded
because such persons may be deemed to be affiliates. The determination of
affiliate status is not necessarily a conclusive determination for other
purposes.
Number of shares of Common Stock outstanding as of April 15, 2005: 2,758,845
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Items 9, 10, 11, 12 and 14 of Part III is
incorporated by reference to the Registrant's definitive proxy statement to be
filed within 120 days after the end of the fiscal year covered by this form
pursuant to Regulation 14A in connection with its 2005 Annual Meeting of
Stockholders.
Transitional Small Business Disclosure Format (check one): Yes |_| No |X|
ARGAN, INC.
2005 FORM 10-KSB ANNUAL REPORT
TABLE OF CONTENTS
Page
PART I
ITEM 1. Description of Business....................................... 4
ITEM 2. Description of Property........................................ 17
ITEM 3. Legal Proceedings.............................................. 17
ITEM 4. Submission of Matters to a Vote of Security Holders............ 18
PART II
ITEM 5. Market for Common Equity and Related Stockholder Matters ..... 18
ITEM 6. Management's Discussion and Analysis or Plan of Operation...... 20
ITEM 7. Financial Statements........................................... 32
ITEM 8. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure....................................... 55
ITEM 8A. Controls and Procedures........................................ 55
ITEM 8B. Other Information.............................................. 55
PART III
ITEM 9. Directors, Executive Officers, Promoters and Control
Persons; Compliance with Section 16(a) of The Exchange Act..... 55
ITEM 10. Executive Compensation......................................... 56
ITEM 11. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters..................... 56
ITEM 12. Certain Relationships and Related Transactions................. 56
ITEM 13. Exhibits....................................................... 56
ITEM 14. Principal Accountant Fees and Services......................... 58
PART I
ITEM 1. DESCRIPTION OF BUSINESS.
We conduct our operations through our wholly owned subsidiaries Vitarich
Laboratories, Inc. (VLI) and Southern Maryland Cable, Inc. (SMC) that we
acquired in August 2004 and July 2003, respectively. Through VLI, we develop,
manufacture and distribute premium nutritional supplements, whole-food dietary
supplements and personal care 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. The Company is
actively pursuing acquisitions in the nutraceutical and other industries. Our
strategy is to become a geographically and customer diversified nutraceutical
manufacturer and distribution company.
Through VLI, we are dedicated to the research, development, manufacture and
distribution of premium nutritional supplements, whole-food dietary supplements
and personal care products. Several have garnered honors including the National
Nutritional Foods Association's prestigious People's Choice Awards for best
products of the year in their respective category.
We provide nutrient-dense, super-food concentrates, vitamins and supplements.
Our target customers include health food store chains, mass merchandisers,
network marketing companies, pharmacies and major retailers.
We intend to enhance our position in the fast growing global nutrition industry
through our innovative product development and research. We believe that we will
be able to expand our distribution channels by providing continuous quality
assurance and by focusing on timely delivery of superior nutraceutical products.
We intend to seek acquisitions in the nutrition industry to evolve into a
customer and product diverse nutraceutical products company with a reputation
for high quality and on-time delivery of products.
Through SMC, we currently provide inside plant, premise wiring services to the
Federal Government and have plans to expand that work to commercial customers
who regularly need upgrades in their premise wiring systems to accommodate
improvements in security, telecommunications and network capabilities.
We continue to participate in the expansion of the telecommunications industry
by working with various telecommunications providers. We provide maintenance and
upgrade services for their outside plant systems that increase the capacity of
existing infrastructure. We also provide outside plant services to the power
industry by providing maintenance and upgrade services to utilities.
We intend to emphasize our high quality reputation, customer base and highly
motivated work force in competing for larger and more diverse contracts. We
believe that our high quality and well maintained fleet of vehicles and
construction machinery and equipment is essential to meet customers' needs for
high quality and on-time service. We are committed to our repair and maintenance
capabilities to maintain the quality and life of our equipment. Additionally, we
invest annually in new vehicles and equipment.
We were organized as a Delaware corporation in May 1961. On October 23, 2003,
our shareholders approved a plan providing for the internal restructuring of the
Company whereby we became a holding company, and our operating assets and
liabilities relating to our Puroflow Incorporated ("Puroflow") business were
transferred to a newly-formed, wholly owned subsidiary. The subsidiary then
changed its name to "Puroflow Incorporated" and we changed our name from
Puroflow Incorporated to "Argan, Inc."
On October 31, 2003, pursuant to a certain Stock Purchase Agreement ("Stock
Purchase Agreement"), we completed the sale of Puroflow to Western Filter
Corporation (WFC) for approximately $3.5 million in cash, of which $300,000 is
being held in escrow to indemnify WFC from losses resulting from any damages
from the breach of the representations and warranties made by us pursuant to
that sale. During the twelve months ended January 31, 2005, WFC asserted that
the Company breached certain representations and warranties under the Stock
Purchase Agreement. (See Note 12 to consolidated financial statements.)
4
HOLDING COMPANY STRUCTURE
We intend to make additional acquisitions and/or investments. We intend to have
more than one industrial focus and to identify those companies that are in
industries with significant potential to grow profitably both internally and
through acquisitions. We expect that companies acquired in each of these
industrial groups will be held in separate subsidiaries that will be operated in
a manner that best provides cashflow and value for the Company.
We are a holding company with no operations other than our investments in VLI
and SMC. At January 31, 2005, there were no restrictions with respect to
dividends or other payments from VLI and SMC to Argan.
Our principal executive offices are located at One Church Street, Suite 302,
Rockville, Maryland 20850. Our phone number at that address is (301) 315-0027.
We maintain a website on the Internet at www.arganinc.com. Information on our
website is not incorporated by reference into this report.
Unless the context otherwise requires, references in this Form 10-KSB to
"Argan," the "Company," "we," "us" or "our" refer to Argan, Inc., a Delaware
corporation, and its subsidiaries. Our fiscal year for financial reporting ends
on January 31.
Recent Events
Private Sale of Stock
On January 28, 2005, the Company sold and issued to MSR I SBIC, L.P., a Delaware
limited partnership ("Investor"), 129,032 shares (the "Shares") of our common
stock, pursuant to a Subscription Agreement dated as of January 28, 2005 between
the Company and Investor (the "Subscription Agreement"). The Shares were issued
at a purchase price of $7.75 per share ("Share Price"), yielding aggregate
proceeds of $999,998. The Investor is an entity controlled by Daniel Levinson, a
director of the Company. Pursuant to the Subscription Agreement, the Company has
agreed to issue additional shares of our common stock to Investor in accordance
with the Subscription Agreement under certain conditions upon the earlier of (i)
the Company's issuance of additional shares of common stock generating aggregate
proceeds of at least $2,500,000 for a consideration per share less than the
Share Price, subject to certain exclusions; and (ii) July 31, 2005. Shares would
be issued in amounts determined by reference to the Company's prevailing
thirty-day average stock price. The number of additional shares to be issued
would effectively reduce the Investor's purchase price per share of common stock
as set forth in the Subscription Agreement.
Merger of Vitarich
On August 31, 2004, pursuant to an Agreement and Plan of Merger ("Merger
Agreement"), the Company acquired all of the common stock of Vitarich
Laboratories, Inc. ("Vitarich") by way of a merger of Vitarich with and into a
wholly-owned subsidiary of the Company ("VLI"), with VLI as the surviving
company of the Merger. Vitarich (now VLI) is a developer, manufacturer and
distributor of premium nutritional supplements, whole food dietary supplements
and personal care products.
In connection with the Merger Agreement, the Company paid Kevin J. Thomas
("Thomas"), the former shareholder of Vitarich, initial consideration consisting
of (i) $6.1 million in cash; and (ii) 825,000 shares of the Company's common
stock which was valued at $5,132,000 or $6.22 per share utilizing the quoted
market price two days before and after the acquisition date. These 825,000
shares were registered on Form S-3 under the Securities Act of 1933, as amended,
on February 25, 2005.
Pursuant to the Merger Agreement, in addition to the initial consideration paid
at closing, the Company shall pay Thomas additional consideration equal to (a)
5.5 times the Adjusted EBITDA of Vitarich (as defined in the Merger Agreement)
for the 12 months ended February 28, 2005 (b) less the initial consideration
paid at closing (provided however, that in no event shall the additional
consideration be less than zero or require repayment by Thomas of any portion of
the initial consideration paid at closing) ("Additional Cash Consideration").
Such Additional Cash Consideration shall be paid 50% in cash and 50% through
issuance of additional common stock of the Company.
The Merger Agreement also provides that, if between the closing date and the
payment date of the Additional Cash Consideration, the Company raises additional
capital by issuance of stock pursuant to a public or private offering for a
price less than $7.75 per share (the "Additional Capital Subscription Price"),
then the number of shares of the Company's common stock issued to Thomas as
initial consideration in the merger shall be adjusted to the number of shares of
the Company's common stock that would have been issued at the closing of the
merger had the value of each share of the Company's common stock been the
Additional Capital Subscription Price.
5
In connection with the Merger Agreement, the Company assumed approximately $1.6
million of Vitarich indebtedness (including approximately $1.1 million of
equipment leases and working capital credit lines and approximately $507,000
that was due to Thomas by Vitarich at the time of the merger) as well as
Vitarich accounts payable and accrued liabilities. The Company also assumed
certain real property leases and other obligations of Vitarich in connection
with the merger. The Company paid the $507,000 that was due to Thomas at the
closing of the merger and paid approximately $714,000 of the assumed equipment
leases and working capital credit lines following the closing of the merger.
In connection with the Merger Agreement, VLI and Thomas entered into an
employment agreement, pursuant to which VLI agreed to employ Thomas as its
Senior Operating Executive for an initial term of 3 years, subject to successive
automatic one-year renewal terms after the initial term unless either party
provides notice of its election not to renew; and the Company entered into a
supply agreement with a supply company owned by Thomas, pursuant to which the
supply company committed to sell to the Company, and the Company committed
purchase on an as-needed basis, certain organic agriculture products produced by
the supply company.
Also in connection with the Merger Agreement, Argan effected certain changes to
its existing credit facility with Bank of America, N.A. ("BOA"), pursuant to a
certain Third Amendment to Financing and Security Agreement (the "Third
Amendment"), dated as of August 31, 2004, by and among Argan, SMC and VLI, as
borrowers, and BOA, as lender; a certain Amended and Restated Revolving Credit
Note (the "Amended Revolving Note"), dated August 31, 2004, in the amount of
$3,500,000, by and among Argan, SMC and VLI, as borrowers, in favor of BOA, as
lender; a certain First Amendment to Term Note (the "First Amendment to Term
Note"), dated as of June 29, 2004, by and among Argan and SMC, as borrowers, and
BOA, as lender; and an Additional Borrowers Joinder Supplement (the "Supplement"
and together with the Third Amendment, the Amended Revolving Note and the First
Amendment to Term Note, the "Financing Document Amendments"), dated as of August
31, 2004, by and among Argan, the other Existing Borrowers (as such term is
defined in the Supplement) and VLI, as borrowers, and BOA, as lender. Pursuant
to the Financing Document Amendments, Argan's existing credit facility with BOA
was principally amended to (i) increase the amount available for borrowing under
the revolving credit facility from $1,750,000 to $3,500,000, (ii) extend the
maturity date of the revolving credit facility to May 31, 2005, (iii) increase
the interest rate on the revolving credit facility to LIBOR plus 3.25% for the
remaining term of the facility, (iv) increase the interest rate on the term loan
facility to LIBOR plus 3.45% from July 1, 2004 to the maturity date (July 31,
2006), and (v) subject borrowings under the revolving credit facility to a
borrowing base calculation based upon eligible accounts receivable and eligible
inventory. The Financing Document Amendments also amended certain covenants to
require the ratio of funded debt to earnings before interest, taxes,
depreciation and amortization ("EBITDA") to not exceed 2.5 to 1 (the first test
date being January 31, 2005) and to require a fixed charge coverage ratio of not
less than 1.25 to 1 (the first test date being January 31, 2005.) The Financing
Document Amendments also deleted covenants which had required Argan to maintain
certain minimum levels of liquidity and positive net income during the Company's
fiscal quarters ended July 31, 2004 and October 31, 2004. Argan drew
approximately $2.1 million under the BOA revolving credit facility in connection
with the Merger and for working capital for the newly acquired business.
Subordination of Certain Debt
On January 31, 2005, the Company entered into a Debt Subordination Agreement
("Subordination Agreement") with Thomas, SMC (SMC and the Company together are
referred to herein as, the "Debtor") and Bank of America, N.A. ("Lender") to
reconstitute as subordinated debt the Additional Cash Consideration that Debtor
will owe to Thomas in connection with the Merger Agreement. Pursuant to the
Subordination Agreement, Debtor and Thomas have agreed to reconstitute the
Additional Cash Consideration as subordinated debt and in furtherance thereof,
the Company has agreed to execute and deliver to Thomas a Subordinated
Promissory Note in an amount equal to the amount that would otherwise be due
Thomas as Additional Cash Consideration under the Merger Agreement. Accordingly,
under the Subordination Agreement, Debtor subordinated all of the Junior Debt
(as such term is defined in the Subordination Agreement) to the full and final
payment of all the Superior Debt (as such term is defined in the Subordination
Agreement) to the extent provided in the Subordination Agreement, and Thomas
transferred and assigned to Lender all of his rights, title and interest in the
Junior Debt and appointed Lender as his attorney-in-fact for the purchases
provided in the Subordination Agreement for as long as any of the Superior Debt
remains outstanding. Except as otherwise provided in the Subordination Agreement
and until such time that the Superior Debt is satisfied in full, Debtor shall
not, among other things, directly or indirectly, in any way, satisfy any part of
the Junior Debt, nor shall Creditor, among other things, enforce any part of the
Junior Debt or accept payment from Debtor or any other person for the Junior
Debt or give any subordination in respect of the Junior Debt.
6
Amendment of Financing Arrangements
On April 8, 2005, the Company agreed to amend the existing financing
arrangements with the BOA whereby the revolving line of credit was increased to
$4.25 million in maximum availability, expiring May 31, 2006. The amended
financing arrangement waives the January 31, 2005 and April 30, 2005 measurement
of certain financial covenants including requiring the ratio of debt to pro
forma earnings before interest, taxes, depreciation and amortization (EBITDA)
not to exceed 2.5 to 1 (with the next test date being July 31, 2005) requiring
pro forma fixed charge coverage ratio not less than 1.25 to 1 (with the next
test date being July 31, 2005). BOA 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. BOA has released to
the Company $300,000 which it was holding in escrow as collateral.
VRP Letter of Intent
On October 28, 2004, the Company entered into a letter of intent with Vitamin
Research Products, Inc. ("VRP") to acquire all of the common stock of VRP. The
consummation of the transaction is contingent upon the completion of the
Company's due diligence, the signing of definitive purchase and sale agreement,
approval of both companies' board of directors and other conditions.
Competition
The market for nutritional products is highly competitive. Our direct
competition consists primarily of publicly and privately owned companies which
tend to be highly fragmented in terms of both geographical market coverage and
product categories. These companies compete with us on different levels in the
development, manufacture and marketing of nutritional supplements. Many of these
companies have broader product lines and larger sales volume, are significantly
larger than us, have greater name recognition, financial, personnel,
distribution and other resources than we do and may be better able to withstand
volatile market conditions. There can be no assurance that our customers and
potential customers will regard our products as sufficiently distinguishable
from competitive products. Our inability to compete successfully would have a
material adverse effect on our business.
We operate in the fragmented and competitive telecom and infrastructure services
industry. We compete with service providers ranging from small regional
companies, which service a single market, to larger firms servicing multiple
regions, as well as large national and multi-national contractors. We believe
that we compete favorably with the other companies in the telecom and utility
infrastructure services industry.
Materials
Raw materials used in VLI's products consist of nutrient powders, excipients,
adaptogens, empty capsules and necessary components for packaging and
distribution of finished nutritional and whole-food dietary supplements and
personal care products.
We purchase the raw materials and empty capsules from manufacturers in the
United States and foreign countries. Although we purchase raw materials from
reputable suppliers, we continuously evaluate samples, certificates of analysis,
material safety data sheets and the support research and documentation of both
active and inactive ingredients. We have not experienced difficulty in obtaining
adequate sources of supply, and generally a number of suppliers are available
for most raw materials. Although we cannot assure that adequate sources will
continue to be available, we believe we should be able to secure sufficient raw
materials in the future.
Generally, our telecom infrastructure services customers supply most or all of
the materials required for a particular contract and we provide the personnel,
tools and equipment to perform the installation services. However, with respect
to a portion of our contracts, we may supply part or all of the materials
required. In these instances, we are not dependent upon any one source for the
materials that we customarily utilize to complete the job. We are not presently
experiencing, nor do we anticipate experiencing, any difficulties in procuring
an adequate supply of materials.
7
Customers
During the twelve months ended January 31, 2005, we provided nutritional and
whole-food supplements as well as personal care products to customers in the
global nutrition industry and also services to telecommunications and utilities
customers as well as to the Federal Government, through a contract with General
Dynamics Corp. (GD). Certain of our more significant customer relationships are
with Southern Maryland Electrical Cooperative (SMECO), GD, TriVita Corporation
(TVC), and CyberWize.com, Inc. (C). SMECO accounted for approximately 23% of
consolidated net sales during the twelve months ended January 31, 2005. GD
accounted for approximately 14% of consolidated net sales during the twelve
months ended January 31, 2005. During fiscal year 2005, GD has substantially
reduced its level of activity on certain contracts under which it used SMC as a
subcontractor. During fiscal year 2006, we expect that GD will substantially
increase its level of activity on certain contracts under which it uses SMC as a
subcontractor. The Federal Government, through our contract with GD, has been a
major customer for three years. TVC and C have been customers of VLI for five
and two years, respectively, and accounted for 17% and 8% of consolidated net
sales for the twelve months ended January 31, 2005.
Backlog
At January 31, 2005, we had a backlog of $2.2 million for manufacturing
nutraceutical products and $7.5 million to perform telecom infrastructure
services in the next year. At January 31, 2004, we had a backlog of $5 million
to perform telecom infrastructure services during fiscal year 2005.
Regulation
The formulation, manufacturing, packaging, labeling, advertising, distribution
and sale of our products are subject to regulation by one or more federal
agencies, including the Food and Drug Administration (FDA), the Federal Trade
Commission (FTC), the Consumer Product Safety Commission, the U.S. Department of
Agriculture, the Environmental Protection Agency, and also by various agencies
of the states, localities and foreign countries in which our products are sold.
In particular, the FDA, pursuant to the Federal Food, Drug and Cosmetic Act
(FDCA), regulates the formulation, manufacturing, packaging, labeling,
distribution and sale of dietary supplements, including vitamins, minerals and
herbs, and of over-the-counter (OTC) drugs, while the FTC has jurisdiction to
regulate advertising of these products, and the Postal Service regulates
advertising claims with respect to such products sold by mail order. The FDCA
has been amended several times with respect to dietary supplements, most
recently by the Nutrition Labeling and Education Act of 1990 and the Dietary
Supplement Health and Education Act of 1994. Our inability to comply with these
federal regulations may result in, among other things, injunctions, product
withdrawals, recalls, product seizures, fines and criminal prosecutions.
In addition, our products are also subject to regulations under various state
and local laws that include provisions governing, among other things, the
formulation, manufacturing, packaging, labeling, advertising and distribution of
dietary supplements and OTC drugs.
Our telecom infrastructure services operations are subject to various federal,
state and local laws and regulations including: licensing for contractors;
building codes; permitting and inspection requirements applicable to
construction projects; regulations relating to worker safety and environmental
protection; and special bidding, procurement and security clearance requirements
on government projects. Many state and local regulations governing construction
require permits and licenses to be held by individuals who have passed an
examination or met other requirements. We believe that we have all the licenses
required to conduct our operations and that we are in substantial compliance
with applicable regulatory requirements. Our failure to comply with applicable
regulations could result in substantial fines or revocation of our operating
licenses
Safety and Risk Management
We are committed to ensuring that our nutraceutical products and telecom
infrastructure services employees perform their work in a safe environment. We
regularly communicate with our employees to promote safety and to instill safe
work habits. Our telecom infrastructure services safety director, an SMC
employee, reviews accidents and claims, examines trends and implements changes
in procedures or communications to address any safety issues.
8
Risk Management, Insurance and Performance Bonds
Contracts in the telecom infrastructure services industry which we serve may
require performance bonds or other means of financial assurance to secure
contractual performance. If we are unable to obtain surety bonds or letters of
credit in sufficient amounts or at acceptable rates, we might be precluded from
entering into additional contracts with certain of our customers. At this time,
we do not have significant surety bonds or letters of credit outstanding.
Employees
At January 31, 2005, we had approximately 164 employees, all of whom were
full-time. None of these employees is represented by a labor organization. We
are not aware of any employees seeking organization. We believe that our
employee relations are good.
Risk Factors
You should carefully consider the following risk factors before making an
investment decision. If any of the following risks actually occur, our business,
financial condition, or results of operations could be materially and adversely
affected. In such case, the trading price of our common stock could decline, and
you may lose all or part of your investment.
General Risks Relating to our Company
Our officers and directors have limited experience in managing our business and,
as a result, may be unsuccessful in doing so.
In April 2003, Rainer H. Bosselmann became Chairman and Chief Executive Officer,
H. Haywood Miller III became Executive Vice President and Arthur F. Trudel
became Senior Vice President and Chief Financial Officer of the Company. Upon
consummation of the private placement, four of our existing directors (Warren
Lichtenstein, Glen Kassan, Joshua Schechter and Robert Smith) resigned and were
replaced by Mr. Bosselmann and three new directors designated by Mr. Bosselmann
(DeSoto S. Jordan, James W. Quinn and Daniel A. Levinson). In addition, in June
2003, Peter L. Winslow was elected by the Board of Directors to fill a vacancy
caused by the resignation of Travis Bradford, and in October, 2003, W.G.
Champion Mitchell was elected to our Board of Directors at our 2003 Annual
Meeting replacing Michael H. Figoff who did not stand for re-election. Although
Messrs. Bosselmann, Miller, Trudel, Jordan, Quinn, Levinson, Winslow and
Mitchell have experience as executive officers and directors of other public
companies, they have limited experience in managing our business and, as a
result, may be unsuccessful in doing so.
Purchasers of our common stock will be unable to evaluate future acquisitions
and/or investments.
We recently completed our acquisition of Vitarich in August 2004. Prior to our
acquisition of Vitarich, we acquired SMC in July 2003. Accordingly, purchasers
of our common stock may be unable to evaluate the business, prospects, operating
results, management or other material factors relating to future acquisitions
and/or investments that we make. In addition, there can be no assurance that
future acquisitions will occur, or if they occur, will be beneficial to us and
our stockholders.
We may be unsuccessful at integrating companies that we acquire.
We may not be able to successfully integrate companies that we acquire with our
other operations without substantial costs, delays or other operational or
financial problems. Integrating acquired companies involves a number of special
risks which could materially and adversely affect our business, financial
condition and results of operations, including:
o failure of acquired companies to achieve the results we expect;
o diversion of management's attention from operational matters;
o difficulties integrating the operations and personnel of acquired
companies;
o inability to retain key personnel of acquired companies;
o risks associated with unanticipated events or liabilities;
9
o the potential disruption of our business; and
o the difficulty of maintaining uniform standards, controls,
procedures and policies.
If one of our acquired companies suffers customer dissatisfaction or performance
problems, the reputation of our entire company could be materially and adversely
affected. In addition, future acquisitions could result in issuances of equity
securities that would reduce our stockholders' ownership interest, the
incurrence of debt, contingent liabilities, deferred stock based compensation or
expenses related to the valuation of goodwill or other intangible assets and the
incurrence of large, immediate write-offs.
We may not be able to raise additional capital and, as a result, may not be able
to successfully execute our business plan.
We will need to raise additional capital to finance future business acquisitions
and/or investments. Additional financing may not be available on terms that are
acceptable to us or at all. If we raise additional funds through the issuance of
equity or convertible debt securities, the percentage ownership of our
stockholders would be reduced. Additionally, these securities might have rights,
preferences and privileges senior to those of our current stockholders. If
adequate funds are not available on terms acceptable to us, our ability to
finance future business acquisitions and/or investments and to otherwise pursue
our business plan would be significantly limited.
We cannot readily predict the timing, size and success of our acquisition
efforts and therefore the capital we will need for these efforts. Using cash for
acquisitions limits our financial flexibility and makes us more likely to seek
additional capital through future debt or equity financings. When we seek
additional debt or equity financings, we cannot be certain that additional debt
or equity will be available to us at all or on terms acceptable to us.
We may be unsuccessful at generating internal growth.
Our ability to generate internal growth will be affected by, among other
factors, our success in:
o expanding the range of services and products we offer to customers
to address their evolving needs;
o attracting new customers;
o hiring and retaining employees; and
o reducing operating and overhead expenses.
Many of the factors affecting our ability to generate internal growth may be
beyond our control. Our strategies may not be successful and we may not be able
to generate cash flow sufficient to fund our operations and to support internal
growth. Our inability to achieve internal growth could materially and adversely
affect our business, financial condition and results of operations.
Our business growth could outpace the capability of our corporate management
infrastructure. Our operations and ability to execute our business plan could be
adversely effected as a result.
We cannot be certain that our infrastructure will be adequate to support our
operations as they expand. Future growth also could impose significant
additional responsibilities on members of our senior management, including the
need to recruit and integrate new senior level managers and executives. We
cannot be certain that we can recruit and retain such additional managers and
executives. To the extent that we are unable to manage our growth effectively,
or are unable to attract and retain additional qualified management, we may not
be able to expand our operations or execute our business plan. Our financial
condition and results of operations could be materially and adversely affected
as a result.
Loss of key personnel could prevent us from successfully executing our business
plan and otherwise adversely affect our business.
Our ability to maintain productivity and profitability will be limited by our
ability to employ, train and retain skilled personnel necessary to meet our
requirements. We cannot be certain that we will be able to maintain an adequate
skilled labor force necessary to operate efficiently and to support our growth
strategy or that our labor expenses will not increase as a result of a shortage
in the supply of these skilled personnel. Labor shortages or increased labor
costs could impair our ability or maintain our business or grow our revenues.
10
We depend on the continued efforts of our executive officers and on senior
management of the businesses we acquire. We cannot be certain that any
individual will continue in such capacity for any particular period of time. The
loss of key personnel, or the inability to hire and retain qualified employees,
could negatively impact our ability to manage our business.
We have experienced losses in the past and may experience additional losses in
the future.
As of January 31, 2005, we had an accumulated deficit of approximately $4.9
million resulting primarily from past losses. We may experience additional
losses in the future.
Any general increase in interest rate levels will increase our cost of doing
business. Our results of operations, cash flow and financial condition may
suffer as a result.
As of January 31, 2005, we have approximately $2.3 million of unhedged variable
rate debt. Any general increase in interest rate levels will increase our cost
of doing business.
Specific Risks Relating To Our Nutritional Supplement Business
If our business or our products are the subject of adverse publicity, our
business could suffer.
Our business depends, in part, upon the public's perception of our integrity and
the safety and quality of our products. Any adverse publicity, whether or not
accurate, could negatively affect the public's perception of us and could result
in a significant decline in our operations. Our business and products could be
subject to adverse publicity regarding, among other things:
o the nutritional supplements industry;
o competitors;
o the safety and quality of our products and ingredients; and
o regulatory investigations of our products or competitors' products.
Our inability to respond to changing consumers' demands and preferences could
adversely affect our business.
The nutritional industry is subject to rapidly changing consumer demands and
preferences. There can be no assurance that customers will continue to favor the
products provided and manufactured by us. In addition, products that gain wide
acceptance with consumers may result in a greater number of competitors entering
the market which could result in downward price pressure which could adversely
impact our financial condition. We believe that our growth will be materially
dependent upon our ability to develop new techniques and processes necessary to
meet the needs of our customers and potential customers. Our inability to
anticipate and respond to these rapidly changing demands could have an adverse
effect on our business operations.
There can be no assurance we will be able to obtain our necessary raw materials
in a timely manner.
Although we believe that there are adequate sources of supply for all of our
principal raw materials we require, there can be no assurance that our sources
of supply for our principal raw materials will be adequate in all circumstances.
In the event that such sources are not adequate, we will have to find alternate
sources. As a result we may experience delays in locating and establishing
relationships with alternate sources which could result in product shortages and
backorders for our products, with a resulting loss of revenue to us.
There are limited conclusive clinical studies available on human consumption of
our products.
Although many of the ingredients in our products are vitamins, minerals, herbs
and other substances for which there is a long history of human consumption,
some of our products contain innovative ingredients or combinations of
ingredients. Although we believe all of our products to be safe when used as
directed, there may be little long-term experience with human consumption of
certain of these product ingredients or combinations thereof. Therefore, no
assurance can be given that our products, even when used as directed, will have
the effects intended. Although we test the formulation and production of our
products, we have not sponsored or conducted clinical studies on the effects of
human consumption.
11
In the event we are exposed to product liability claims, we may be liable for
damages and expenses, which could adversely affect our financial condition.
We could face financial liability due to product liability claims if the use of
our products results in significant loss or injury. To date, we have not been
the subject of any product liability claims. However, we can make no assurances
that we will not be exposed to future product liability claims. Such claims may
include that our products contain contaminants, that we provide consumers with
inadequate instructions regarding product use, or that we provide inadequate
warnings concerning side effects or interactions of our products with other
substances. We believe that we maintain adequate product liability insurance
coverage. However, a product liability claim could exceed the amount of our
insurance coverage or a product claim could be excluded under the terms of our
existing insurance policy, which could adversely affect our financial condition.
The nutritional industry is intensely competitive and the strengthening of any
of our competitors could harm our business.
The market for nutritional products is highly competitive. Our direct
competition consists primarily of publicly and privately owned companies, which
tend to be highly fragmented in terms of both geographical market coverage and
product categories. These companies compete with us on different levels in the
development, manufacture and marketing of nutritional supplements. Many of these
companies have broader product lines and larger sales volume, are significantly
larger than us, have greater name recognition, financial personnel, distribution
and other resources than we do and may be better able to withstand volatile
market conditions. There can be no assurance that our customers and potential
customers will regard our products as sufficiently distinguishable from
competitive products. Our inability to compete successfully would have a
material adverse effect on our business.
Our violation of government regulations, or our inability to obtain necessary
government approvals for our products could harm our business.
The formulation, manufacturing, packaging, labeling, advertising, distribution
and sale of our products are subject to regulation by one or more federal
agencies, including the Food and Drug Administration (FDA), the Federal Trade
Commission (FTC), the Consumer Product Safety Commission, the U.S. Department of
Agriculture, the Environmental Protection Agency, and also by various agencies
of the states, localities and foreign countries in which our products are sold.
In particular, the FDA, pursuant to the Federal Food, Drug, and Cosmetic Act
(FDCA), regulates the formulation, manufacturing, packaging, labeling,
distribution and sale of dietary supplements, including vitamins, minerals and
herbs, and of over-the-counter (OTC) drugs, while the FTC has jurisdiction to
regulate advertising of these products, and the Postal Service regulates
advertising claims with respect to such products sold by mail order. The FDCA
has been amended several times with respect to dietary supplements, most
recently by the Nutrition Labeling and Education Act of 1990 and the Dietary
Supplement Health and Education Act of 1994. Our inability to comply with these
federal regulations may result in, among other things, injunctions, product
withdrawals, recalls, product seizures, fines and criminal prosecutions.
In addition, our products are also subject to regulations under various state
and local laws that include provisions governing, among other things, the
formulation, manufacturing, packaging, labeling, advertising and distribution of
dietary supplements and OTC drugs.
In the future, we may become subject to additional laws or regulations
administered by the FDA or by other federal, state, local or foreign regulatory
authorities, to the repeal of laws or regulations that we consider favorable, or
to more stringent interpretations of current laws or regulations. We can neither
predict the nature of such future laws, regulations, repeals or interpretations,
nor can we predict what effect additional governmental regulation, when and if
it occurs, would have on our business. These regulations could, however, require
reformation of certain products to meet new standards, recalls or discontinuance
of certain products not able to be reformulated, additional record-keeping
requirements, increased documentation of the properties of certain products,
additional or different labeling, additional scientific substantiation or other
new requirements. Any of these developments could have a material adverse effect
on our business.
12
Our inability to adequately protect our products from replication by competitors
could have a material adverse effect on our business.
We own proprietary formulas for certain of our nutritional products. We regard
our proprietary formulas as valuable assets and believe they have significant
value in the marketing of our products. Because we do not have patents or
trademarks on our products, there can be no assurance that another company will
not replicate one or more of our products.
Specific Risks Relating to Our Telecommunications Infrastructure Business
We are substantially dependent on economic conditions in the telecommunications
infrastructure industry. Adverse economic conditions in the industry could have
a material adverse effect on our future operating results.
We are involved in the telecom and utility infrastructure services industries,
which can be negatively affected by rises in interest rates, downsizings in the
economy and general economic conditions. In addition, our activities may be
hampered by weather conditions and an inability to plan and forecast activity
levels. Adverse economic conditions in the telecommunications infrastructure and
construction industries may have a material adverse effect on our future
operating results.
The industry served by our business is subject to rapid technological and
structural changes that could reduce the demand for the services we provide.
The utility, telecommunications and computer networking industries are
undergoing rapid change as a result of technological advances that could in
certain cases reduce the demand for our services or otherwise negatively impact
our business. New or developing technologies could displace the wireline systems
used for voice, video and data transmissions, and improvements in existing
technology may allow telecommunications companies to significantly improve their
networks without physically upgrading them. In addition, consolidation,
competition or capital constraints in the utility, telecommunications or
computer networking industries may result in reduced spending or the loss of one
or more of our customers. Additionally, our work in the telecommunications
infrastructure services industry could be negatively affected by rises in
interest rates, downsizings in the economy and general economic conditions.
Our telecommunications infrastructure services business is seasonal and our
operating results may vary significantly from quarter to quarter.
Our quarterly results are affected by seasonal fluctuations in our business. Our
quarterly results may also be materially affected by:
o variations in the margins or products performed during any
particular quarter;
o regional or general economic conditions;
o the budgetary spending patterns of customers, including government
agencies;
o the timing and volume of work under new agreements;
o the timing of our significant promotional activities;
o costs that we incur to support growth internally or through
acquisitions or otherwise;
o losses experienced in our operations not otherwise covered by
insurance;
o the change in mix of our customers, contracts and business;
o the timing of acquisitions;
o the timing and magnitude of acquisition assimilation costs; and
o increases in construction and design costs.
13
Accordingly, our operating results in any particular quarter may not be
indicative of the results that you can expect for any other quarter or for the
entire year.
Our operations with regard to our telecommunications business are expected to
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
is primarily due to the effect of winter weather on 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.
We intend to actively pursue larger infrastructure projects with our customers.
The positive impact of major contracts requires that we undertake extensive up
front preparations with respect to staffing, training and relocation of
equipment. Consequently, we may incur significant period costs in one fiscal
period and realize the benefit of contractual revenues in subsequent periods.
Our financial results are dependent on government programs and spending, the
termination of which would have a material adverse effect on our business.
A significant portion of our business relates to structured cabling work for
military and other government agencies. As such, our business is reliant upon
military and other government programs. Reliance on government programs has
certain inherent risks. Among others, contracts, direct or indirect, with United
States government agencies are subject to unilateral termination at the
convenience of the government, subject only to the reimbursement of certain
costs plus a termination fee.
We are substantially dependent upon fixed price contracts and are exposed to
losses that may occur on such contracts in the event that we fail to accurately
estimate, when bidding on a contract, the costs that we will be required to
incur to complete the project.
We currently generate, and expect to continue to generate, a significant portion
of our revenues under fixed price contracts. We must estimate the costs of
completing a particular project to bid for these fixed price contracts. Although
historically we have been able to estimate costs, the cost of labor and
materials may, from time to time, vary from costs originally estimated. These
variations, along with other risks inherent in performing fixed price contracts,
may cause actual revenue and gross profits for a project to differ from those we
originally estimated and could result in reduced profitability or losses on
projects. Depending upon the size of a particular project, variations from the
estimated contract costs can have a significant impact on our operating results
for any fiscal quarter or year.
Many of our customer contracts may be canceled on short notice and we may be
unsuccessful in replacing contracts as they are completed or expire. As a
result, our business, financial condition and results of operations may be
adversely affected.
Any of the following contingencies may have a material adverse effect on our
business:
o our customers cancel a significant number of contracts;
o we fail to win a significant number of our existing contracts upon
re-bid; or
o we complete the required work under a significant number of
non-recurring projects and cannot replace them with similar
projects.
Many of our customers may cancel their contracts on short notice, typically 30
to 90 days, even if we are not in default under the contract. Certain of our
customers assign work to us on a project-by-project basis under master service
agreements. Under these agreements, the customers often have no obligation to
assign work to us. Our operations could be materially and adversely affected if
the volume of work we anticipate receiving from these customers is not assigned
to us. Many of our contracts, including our master service agreements, are
opened to public bid at the expiration of their terms. We may not be the
successful bidder on existing contracts that come up for bid.
14
Loss of significant customers could adversely affect our business.
Sales to our two largest telecom infrastructure services customers, General
Dynamics and Southern Maryland Electric Cooperative (SMECO) currently account
for most of our telecommunications business. General Dynamics accounted for
approximately 14% of consolidated net sales during the year ended January 31,
2005. SMECO accounted for approximately 23% of consolidated net sales during the
year ended January 31, 2005. The loss of any of these customers could have a
material adverse effect on our business, unless the loss is offset by increases
in sales to other customers.
We operate in highly competitive markets. If we fail to compete successfully
against current or future competitors, our business, financial condition and
results of operations will be materially and adversely affected.
We operate in highly competitive markets. We compete with service providers
ranging from small regional companies which service a single market, to larger
firms servicing multiple regions, as well as large national and multi-national
entities. In addition, there are few barriers to entry in the telecommunications
infrastructure industry. As a result, any organization that has adequate
financial resources and access to technical expertise may become one of our
competitors.
Competition in the telecommunications infrastructure industry depends on a
number of factors, including price. Certain of our competitors may have lower
overhead cost structures than we do and may, therefore, be able to provide their
services at lower rates than we can provide the same services. In addition, some
of our competitors are larger and have significantly greater financial resources
than we do. Our competitors may develop the expertise, experience and resources
to provide services that are superior in both price and quality to our services.
Similarly, we may not be able to maintain or enhance our competitive position
within our industry. We may also face competition from the in-house service
organizations of our existing or prospective customers.
A significant portion of our business involves providing services, directly or
indirectly as a subcontractor, to the United States government under government
contracts. The United States government may limit the competitive bidding on any
contract under a small business or minority set-aside, in which bidding in
limited to companies meeting the criteria for a small business or minority
business, respectively. We are currently qualified as a small business concern,
but not a minority business.
We may not be able to compete successfully against our competitors in the
future. If we fail to compete successfully against our current or future
competitors, our business, financial condition, and results of operations would
be materially and adversely affected.
We are subject to significant government regulation. This may increase the costs
of our operations and expose us to substantial civil and criminal penalties in
the event that we violate applicable law.
We provide, either directly as a contractor or indirectly as a sub-contractor,
products and services to the United States government under government
contracts. United States government contracts and related customer orders
subject us to various laws and regulations governing United States government
contractors and subcontractors, generally which are more restrictive than for
non-government contractors. These include subjecting us to examinations by
government auditors and investigators, from time to time, to ensure compliance
and to review costs. Violations may result in costs disallowed, and substantial
civil or criminal liabilities (including, in severe cases, denial of future
contracts).
If we are unable to obtain surety bonds or letters of credit in sufficient
amounts or at acceptable rates, we might be precluded from entering into
additional contracts with certain of our customers. This may adversely affect
our business.
Contracts in the industries we serve may require performance bonds or other
means of financial assurance to secure contractual performance. The market for
performance bonds has tightened significantly. If we are unable to obtain surety
bonds or letters of credit in sufficient amounts or at acceptable rates, we
might be precluded from entering into additional contracts with certain of our
customers.
15
Risks Relating to our Securities
Our Board of Directors may issue preferred stock with rights that are superior
to our common stock.
Our Certificate of Incorporation, as amended, permits our Board of Directors to
issue shares of preferred stock and to designate the terms of the preferred
stock. The issuance of shares of preferred stock by the Board of Directors could
adversely affect the rights of holders of common stock by, among other matters,
establishing dividend rights, liquidation rights and voting rights that are
superior to the rights of the holders of the common stock.
Our common stock is thinly traded. As a result, our stock price may be volatile
and you may have difficulty disposing of your investment at prevailing market
prices.
Since August 4, 2003, our common stock has been listed on the Boston Stock
Exchange under the symbol "AGX" and is traded on the Bulletin Board System and
reported by the National Quotation Service under the symbol "AGAX.OB." Prior to
our listing on the Boston Stock Exchange, our common stock was traded on the
Bulletin Board System and reported by the National Quotation Service under the
symbol "PFLW.OB." Our common stock is thinly and sporadically traded and no
assurances can be given that a larger market will ever develop, or if developed,
that it will be maintained.
Our acquisition strategy may result in dilution to our stockholders.
Our business strategy calls for strategic acquisition of other businesses. In
connection with our acquisition of VLI, among other consideration, we issued
825,000 shares of our common stock as initial consideration and we agreed to
issue additional shares of our common stock if certain pro forma EBITDA
thresholds for the twelve months ending February 28, 2005 are met. We anticipate
that future acquisitions will require cash and issuances of our capital stock,
including our common stock. To the extent we are required to pay cash for any
acquisition, we anticipate that we would be required to obtain additional equity
and/or debt financing. Equity financing would result in dilution for our then
current stockholders. Stock issuances and financing, if obtained, may not be on
terms favorable to us and could result in substantial dilution to our
stockholders at the time(s) of these stock issuances and financings.
Availability of significant amounts of our common stock for sale could adversely
affect its market price.
As of January 31, 2005, there were approximately 2,759,000 shares of our common
stock outstanding. In March 2004, we registered with the Securities and Exchange
Commission on Form S-3, for resale, from time to time, by the investors in the
April 2003 private placement of 1,533,974 shares of our common stock (including
230,000 shares of our common stock that are issuable upon exercise of warrants
that were issued in connection with the private placement). In March, 2005, we
registered 954,032 shares of our common stock on Form S-3 for resale, by the
selling stockholders named therein consisting of shares issued in connection
with (i) the private sale of our common stock and (ii) our acquisition of VLI.
In addition, we agreed, in connection with our acquisition of VLI, to issue
additional shares of our common stock if certain pro forma EBITDA thresholds for
the twelve months ending February 28, 2005 are met, as well as register for
resale such additional shares of our common stock. If our stockholders sell
substantial amounts of our common stock in the public market, including shares
registered under any registration statement on Form S-3, the market price of our
common stock could fall.
We do not expect to pay dividends for the foreseeable future.
We have not paid cash dividends on our common stock since our inception and
intend to retain earnings, if any, to finance the development and expansion of
our business. As a result, we do not anticipate paying dividends on our common
stock in the foreseeable future. Payment of dividends, if any, will depend on
our future earnings, capital requirements and financial position, plans for
expansion, general economic conditions and other pertinent factors.
Our officers, directors and a certain key employee have substantial control over
the Company.
As of January 31, 2005, our executive officers and directors as a group own
approximately 38% of our voting shares (giving effect to an aggregate of 230,000
shares of common stock that may be purchased upon exercise of warrants held by
our executive officers and directors and 451,616 shares beneficially held in the
name of MSR Advisors and affiliates for which one of our directors is President)
and therefore, may have the power to influence corporate actions such as an
amendment to our certificate of incorporation, the consummation of any merger,
or the sale of all or substantially all of our assets, and may influence the
election of directors and other actions requiring stockholder approval.
16
In addition, Kevin J. Thomas, our Senior Operating Executive, owns approximately
28% of our outstanding voting shares. In addition, we will issue to Mr. Thomas
shares of our common stock as additional consideration in connection with our
acquisition of VLI if certain pro forma earnings before interest, taxes,
depreciation and amortization (EBITDA) thresholds for the twelve months ending
February 28, 2005 are met. Therefore, Mr. Thomas, individually, may have the
power to influence corporate actions.
Our executive officers and directors, together with Kevin J. Thomas, currently
own approximately 57% of our outstanding voting shares which will allow our
executive officers and directors, together with Kevin J. Thomas, to approve
almost any corporate action requiring a minimum majority vote without a meeting
or prior notice to our other stockholders.
Provisions of our certificate of incorporation and Delaware law could deter
takeover attempts.
Provisions of our certificate of incorporation and Delaware law could delay,
prevent, or make more difficult a merger, tender offer or proxy contest
involving us. Among other things, under our certificate of incorporation, our
board of directors may issue up to 500,000 shares of our preferred stock and may
determine the price, rights, preferences, privileges and restrictions, including
voting and conversion rights, of these shares of preferred stock. In addition,
Delaware law limits transactions between us and persons that acquire significant
amounts of our stock without approval of our board of directors.
Materials Filed with the Securities and Exchange Commission
The public may read any materials that we file with the Securities and Exchange
Commission (SEC) at the SEC's public reference room at 450 Fifth Street, N.W.,
Washington, D.C. 20549. The public may obtain information on the operation of
the public reference room by calling the SEC at 1-800-SEC-0330. The SEC
maintains an Internet site that contains reports, proxy and information
statements and other information regarding issuers that file electronically with
the SEC at http://www.sec.gov.
Copies of the Annual Report on Form 10-KSB as filed with the Securities and
Exchange Commission are available without charge upon written request to:
Corporate Secretary
Argan, Inc.
Suite 302
One Church Street
Rockville, Maryland 20850
ITEM 2. DESCRIPTION OF PROPERTY
Our corporate headquarters which is under a lease expiring June 30, 2006, is
located in Rockville, Maryland. VLI's headquarters are located in Naples,
Florida in four facilities with one under monthly lease and three under leases
with expiration dates ranging from December 31, 2006 through August 7, 2009. Two
of the facilities are leased from the former owner of VLI. VLI's plant includes
four buildings which contain warehouse facilities with an aggregate of 26,000
square feet, office space with 8,000 square feet, as well as manufacturing
facilities with 10,000 square feet and laboratory facilities with 1,000 square
feet. SMC's headquarters are located in Tracy's Landing, Maryland in a facility
leased from a former owner of SMC with an initial lease term expiring December
31, 2006 and extensions available through December 31, 2020. The facility
includes approximately four acres of land, a 2,400 square foot maintenance
facility and 3,900 square feet of office space.
SMC's principal operations are conducted at local construction offices,
equipment yards. These facilities are temporary in nature with most of SMC's
services performed on customer premises or job sites. Because equally suitable
temporary facilities are available in all areas where SMC does business, these
facilities are not material to SMC's operations.
ITEM 3. LEGAL PROCEEDINGS
During the twelve months ended January 31, 2005, Western Filter Corporation
(WFC) notified the Company in writing that the Company breached certain
representations and warranties under the Stock Purchase Agreement in connection
with the sale of Puroflow Incorporated to WFC. WFC asserts damages in excess of
the $300,000 escrow which is being held by a third party in connection with the
Stock Purchase Agreement.
17
The Company has reviewed WFC's claim and believes that substantially all of the
claims are without merit. The Company will vigorously contest WFC's claim.
On March 22, 2005, WFC filed a complaint in Los Angeles Superior Court alleging
the Company and its executive officers, individually, committed breach of
contract, intentional misrepresentation, concealment and non-disclosure,
negligent misrepresentation and false promise. WFC seeks declaratory relief and
compensatory and punitive damages in an amount to be proven at trial as well as
the recovery of attorneys' fees.
During the twelve months ended January 31, 2005, the Company recorded an accrual
for a loss related to this matter of $260,000 for losses and legal expenses
related to WFC's claim that it considers to be probable and that can be
reasonably estimated. Although the ultimate amount of liability at January 31,
2005 that may result from this matter for which the Company has recorded an
accrual is not ascertainable, the Company believes that any amounts exceeding
the aforementioned accrual should not materially affect the Company's financial
condition. It is possible, however, that the ultimate resolution of WFC's claim
could result in a material adverse effect on the Company's results of operations
for a particular reporting period.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company did not submit any matters to a vote of security holders during the
fourth quarter of the fiscal year covered by this report.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is listed on the Boston Stock Exchange under the symbol AGX and
traded on the National Association of Securities Dealers, Inc., Electronic
Bulletin Board System ("EBBS") under the symbol AGAX.
The following table sets forth the high and low bid quotations for our common
stock for the periods indicated as reported by EBBS. These quotations represent
inter-dealer prices and do not include retail markups, markdowns or commissions
and may not necessarily represent actual transactions. Although we have been
listed and registered on the Boston Stock Exchange since August 4, 2003, there
have been no sales of the Company's securities on the Boston Stock Exchange
during the below periods.
High Bid Low Bid
======== =======
Fiscal year Ended January 31, 2004
1st Quarter.................................... $ 8.00 $ 6.10
2nd Quarter ................................... 8.50 7.75
3rd Quarter.................................... 8.55 6.60
4th Quarter.................................... 7.75 6.80
Fiscal year Ended January 31, 2005
1st Quarter.................................... 7.75 6.91
2nd Quarter ................................... 7.01 5.75
3rd Quarter.................................... 6.60 5.62
4th Quarter.................................... 6.50 5.63
As of April 15, 2005, the Company had approximately 462 stockholders of record.
To date, Argan has not declared or paid cash dividends to its stockholders.
Argan has no plans to declare and pay cash dividends in the near future.
18
Equity Compensation Plan Information
The Company has authorized the following equity securities for issuance under
equity compensation plans at January 31, 2005:
Number of securities
remaining available for
Number of securities to Weighted average future issuance under
be issued upon exercise exercise price of equity compensation plans
of outstanding options, outstanding options, (excluding securities
warrants and rights warrants and rights reflected in column [a])
[a] [b] [c]
Equity compensation plans
approved by security holders 312,000(1) $ 7.77 162,000(2)
Equity compensation plans not
approved by security holders -- -- --
----------- ----------- -----------
Total 312,000 $ 7.77 162,000
=========== =========== ===========
(1) Represents 82,000 shares issuable upon exercise of options granted under
the 2001 Stock Option Plan as of January 31, 2005 and 230,000 shares
issuable upon exercise of warrants as described below.
(2) Represents 162,000 shares remaining available for grant under the 2001
Stock Option Plan as of January 31, 2005.
On April 29, 2003, Argan completed a private placement of its common stock, in
which we sold 1,303,974 shares of our common stock to a group of accredited
investors at a price of $7.75 per share. In connection with the private
placement, Rainer Bosselmann, H. Haywood Miller III, Arthur F. Trudel and MSR
Advisors, Inc., received warrants to purchase an aggregate of 230,000 shares of
our common stock at a purchase price of $7.75 per share. The Company raised a
total of $10,107,000 (before giving effect to offering expenses of approximately
$472,000 and 230,000 warrants issued in connection with the private placement).
The private offering was approved by shareholders' vote on April 15, 2003. The
shares in the private placement were issued pursuant to an exemption provided by
Section 4(2) of the Securities Act of 1933, as amended ("the Securities Act")
resale of the shares of common stock and the shares of common stock underlying
the warrants issued in the private placement were registered under the
Securities Act on Form S-3 filed with the Securities and Exchange Commission
(SEC) on March 15, 2004.
On August 31, 2004, Argan acquired VLI by way of a merger of Vitarich with and
into our wholly-owned subsidiary. In connection with the merger, Argan issued
825,000 shares of common stock to Mr. Kevin Thomas, the former sole stockholder
of Vitarich. The shares were issued pursuant to an exemption provided by Section
4(2) of the Securities Act. The resale of these shares were registered under the
Securities Act on Form S-3 filed with the SEC on February 25, 2005.
On January 28, 2005, the Company sold and issued to MSR I SBIC, L.P., a Delaware
limited partnership ("Investor"), 129,032 shares (the "Shares") of common stock
of the Company pursuant to a Subscription Agreement between the Company and
Investor (the "Agreement"). The Shares were issued at a purchase price of $7.75
per share, yielding aggregate proceeds of $999,998. The Investor is an entity
controlled by Daniel Levinson, a director of the Company. Pursuant to the
Agreement, we have agreed to issue additional shares of our common stock to
Investor in accordance with the Agreement under certain conditions upon the
earlier of (i) our issuance of additional shares of common stock having an
aggregate purchase price of at least $2,500,000 for a consideration per share
less than $7.75 per share, subject to certain exclusions; and (ii) July 31,
2005. Shares would be issued in amounts determined by reference to our
prevailing thirty-day average stock price. The number of additional shares to be
issued would effectively reduce the Investor's purchase price per common share
as set forth in the Agreement. The shares were issued pursuant to an exemption
provided by Section 4(2) of the Securities Act. The resale of the shares were
registered under the Securities Act on Form S-3 filed with the SEC on February
25, 2005.
19
On October 28, 2004, the Company entered into a letter of intent with Vitamin
Research Products, Inc. ("VRP") to acquire all of the common stock of VRP. The
consummation of the transaction is contingent upon the completion of the
Company's due diligence, the signing of definitive purchase and sale agreement,
approval of both companies' board of directors and other conditions.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
This Form 10-KSB contains certain forward-looking statements within the meaning
of Section 21E of the Securities Exchange Act of 1934, as amended, which are
intended to be covered by the safe harbor created thereby. These statements
relate to future events or our future financial performance, including
statements relating to our products, customers, suppliers, business prospects,
financings, investments and effects of acquisitions. In some cases, forward
looking statements can be identified by terminology such as "may," "will,"
"should," "expect," "anticipate," "intend," "plan," "believe," "estimate,"
"potential," or "continue," the negative of these terms or other comparable
terminology. These statements involve a number of risks and uncertainties,
including preliminary information; the effects of future acquisitions and/or
investments; competitive factors; business and economic conditions generally;
changes in government regulations and policies; our dependence upon third-party
suppliers; continued acceptance of our products in the marketplace;
technological changes; and other risks and uncertainties that could cause actual
events or results to differ materially from any forward-looking statement.
GENERAL
We conduct our operations through our wholly owned subsidiaries, Vitarich
Laboratories, Inc. (VLI) that we acquired in August, 2004 and Southern Maryland
Cable, Inc. (SMC) that we acquired in July 2003. 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.
We were organized as a Delaware corporation in May 1961. On October 23, 2003,
our shareholders approved a plan providing for the internal restructuring of the
Company whereby we became a holding company, and our operating assets and
liabilities relating to our Puroflow business were transferred to a
newly-formed, wholly owned subsidiary. The subsidiary then changed its name to
"Puroflow Incorporated" and we changed our name from Puroflow Incorporated to
"Argan, Inc."
RECENT EVENTS
On January 28, 2005, the Company sold and issued to MSR I SBIC, L.P., a Delaware
limited partnership ("Investor"), 129,032 shares (the "Shares") of our common
stock, pursuant to a Subscription Agreement dated as of January 28, 2005 between
the Company and Investor (the "Subscription Agreement"). The Shares were issued
at a purchase price of $7.75 per share ("Share Price"), yielding aggregate
proceeds of $999,998. The Shares were issued pursuant to the exemption provided
by Section 4(2) of the Securities Act of 1933, as amended. The Investor is an
entity controlled by Daniel Levinson, a director of the Company.
Pursuant to the Subscription Agreement, the Company has agreed to issue
additional shares of our common stock to Investor in accordance with the
Subscription Agreement under certain conditions upon the earlier of (i) the
Company's issuance of additional shares of our common stock generating aggregate
proceeds of at least $2,500,000 for a consideration per share less than the
Share Price, subject to certain exclusions; and (ii) July 31, 2005. Shares would
be issued in amounts determined by reference to the Company's prevailing
thirty-day average stock price. The number of additional shares to be issued
would effectively reduce the Investor's purchase price per share of our common
stock as set forth in the Subscription Agreement.
On January 31, 2005, the Company entered into a Debt Subordination Agreement
("Subordination Agreement") with Kevin J. Thomas ("Thomas"), Southern Maryland
Cable, Inc., a wholly owned subsidiary of the Company ("SMC," and together with
the Company, the "Debtor") and Bank of America, N.A. ("Lender") to reconstitute
as subordinated debt certain additional cash consideration ("Additional Cash
Consideration") that Debtor will owe to Thomas in connection with the Merger
Agreement.
Debtor entered into a certain Financing and Security Agreement dated as of
August 19, 2003, as amended, with Lender whereby Lender extended to Debtor
certain loans. On August 31, 2004, with the consent of Lender, the Debtor
entered into an Agreement and Plan of Merger (the "Merger Agreement"), whereby
the Company acquired all of the common stock of Vitarich Laboratories, Inc.
("Vitarich") by way of merger of Vitarich with and into a wholly-owned
subsidiary of the Company, with Vitarich (now VLI) as the surviving company.
Pursuant to the Merger Agreement, Thomas (who was a shareholder of Vitarich) is
entitled to receive from Debtor, subject to certain conditions, Additional Cash
Consideration as provided in the Merger Agreement. See "Acquisition of Vitarich
Laboratories, Inc." under this Item 6 for additional information relating to the
Merger Agreement.
20
Pursuant to the Subordination Agreement, Debtor and Thomas have agreed to
reconstitute the Additional Cash Consideration as subordinated debt and in
furtherance thereof, the Company has agreed to execute and deliver to Thomas a
Subordinated Promissory Note in an amount equal to the amount that would
otherwise be due Thomas as Additional Cash Consideration under the Merger
Agreement. Accordingly, under the Subordination Agreement, Debtor subordinated
all of the Junior Debt (as such term is defined in the Subordination Agreement)
to the full and final payment of all the Superior Debt (as such term is defined
in the Subordination Agreement) to the extent provided in the Subordination
Agreement, and Thomas transferred and assigned to Lender all of his rights,
title and interest in the Junior Debt and appointed Lender as his
attorney-in-fact for the purchases provided in the Subordination Agreement for
as long as any of the Superior Debt remains outstanding. Except as otherwise
provided in the Subordination Agreement and until such time that the Superior
Debt is satisfied in full, Debtor shall not, among other things, directly or
indirectly, in any way, satisfy any part of the Junior Debt, nor shall Creditor,
among other things, enforce any part of the Junior Debt or accept payment from
Debtor or any other person for the Junior Debt or give any subordination in
respect of the Junior Debt.
On April 8, 2005, the Company agreed to amend the existing financing
arrangements with the Bank of America, N.A. ("the Bank") whereby the revolving
line of credit was increased to $4.25 million in maximum availability, expiring
May 31, 2006. The amended financing arrangements waives the January 31, 2005 and
April 30, 2005 measurement of certain financial covenants including requiring
the ratio of debt to pro forma earnings before interest, taxes, depreciation and
amortization (EBITDA) not to exceed 2.5 to 1 (with the next test date being July
31, 2005) requiring pro forma fixed charge coverage ratio not less than 1.25 to
1 (with the next test date being July 31, 2005). Bank 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 Bank
has released to the Company $300,000 which it was holding in escrow as
collateral.
On October 31, 2003, we completed the sale of Puroflow Incorporated (a
wholly-owned subsidiary) to Western Filter Corporation (WFC) for approximately
$3.5 million in cash, of which $300,000 is held in escrow to indemnify WFC from
losses resulting from a breach of the representations and warranties made by us
in connection with that sale. During the twelve months ended January 31, 2005,
WFC notified the Company asserting that the Company breached certain
representations and warranties under the Stock Purchase Agreement. WFC asserts
damages in excess of the $300,000 escrow which is being held by a third party.
On March 22, 2005, WFC filed a complaint in Los Angeles Superior Court alleging
the Company and its executive officers, individually, committed breach of
contract, intentional misrepresentation, concealment and non-disclosure,
negligent misrepresentation and false promise. WFC seeks declaratory relief and
compensatory and punitive damages in an amount to be proven at trial as well as
the recovery of attorneys' fees. The Company has reviewed WFC's claim and
believes that the claims are substantially without merit. The Company will
vigorously contest WFC's claims.
During the twelve months ended January 31, 2005, the Company recorded an accrual
for loss and legal expenses related to this matter of $260,000 with respect to
this claim. (See Note 12 to the Company's consolidated financial and legal
expenses statements for further information.)
HOLDING COMPANY STRUCTURE
We intend to make additional acquisitions and/or investments. We intend to have
more than one industrial focus and to identify those companies that are in
industries with significant potential to grow profitably both internally and
through acquisitions. We expect that companies acquired in each of these
industrial groups will be held in separate subsidiaries that will be operated in
a manner that best provides cashflow and value for the Company.
We are a holding company with no operations other than our investments in VLI
and SMC. At January 31, 2005, there were no restrictions with respect to
dividends or other payments from VLI and SMC to Argan.
21
NUTRITIONAL PRODUCTS
We are dedicated to the research, development, manufacture and distribution of
premium nutritional supplements, whole-food dietary supplements and personal
care products. Several have garnered honors including the National Nutritional
Foods Association's prestigious Peoples Choice Awards for best products of the
year in its respective category.
We provide nutrient-dense, super-food concentrates, vitamins and supplements.
Our customers include health food store chains, mass merchandisers, network
marketing companies, pharmacies and major retailers.
We intend to enhance our position in the fast growing global nutrition industry
through our innovative product development and research. We believe that we will
be able to expand our distribution channels by providing continuous quality
assurance and by focusing on timely delivery of superior nutraceutical products.
We are focused on efficiently utilizing the strong cash flow potential from
manufacturing nutritional products. To ensure that working capital is
effectively allocated, we closely monitor our inventory turns as well as the
number of days sales that we have in our accounts receivable.
TELECOM INFRASTRUCTURE SERVICES
We currently provide inside plant, premise wiring services to the Federal
Government and have plans to expand that work to commercial customers who
regularly need upgrades in their premise wiring systems to accommodate
improvements in security, telecommunications and network capabilities.
Despite the slowdown during the twelve months ended January 31, 2005 by our
primary fixed price contract customer, we continue to participate in the
expansion of the telecommunications industry by working with various
telecommunications providers. We are actively pursuing contracts with a wide
variety of telecommunications providers. We provide maintenance and upgrade
services for their outside plant systems that increase the capacity of existing
infrastructure. We also provide outside plant services to the power industry by
providing maintenance and upgrade services to utilities.
We intend to emphasize our high quality reputation, outstanding customer base
and highly motivated work force in competing for larger and more diverse
contracts. We believe that our high quality and well maintained fleet of
vehicles and construction machinery and equipment is essential to meet
customers' needs for high quality and on-time service. We are committed to
invest in our repair and maintenance capabilities to maintain the quality and
life of our equipment. Additionally, we invest annually in new vehicles and
equipment.
Critical Accounting Policies
Management is required to make judgments, assumptions and estimates that affect
the amounts reported when we prepare financial statements and related
disclosures in conformity with generally accepted accounting principles. Note 1
to the consolidated financial statements describes the significant accounting
policies and methods used in the preparation of our consolidated financial
statements. Estimates are used for, but not limited to our accounting for
revenue recognition, allowance for doubtful accounts, inventory valuation,
long-lived assets and deferred income taxes. Actual results could differ from
these estimates. The following critical accounting policies are impacted
significantly by judgments, assumptions and estimates used in the preparation of
our consolidated financial statements.
Revenue Recognition
Vitarich Laboratories, Inc.
We manufacture products for our customers based on their orders. We typically
ship the orders immediately after production, keeping relatively little on-hand
as finished goods inventory. We recognize customer sales at the time title and
the risks and rewards of ownership passes to our customer. Cost of goods and
finished goods inventory sold include materials and direct labor as well as
other direct costs combined with allocations of indirect operational costs.
22
Southern Maryland Cable, Inc.
We generate revenue under various arrangements, including contracts under which
revenue is determined on a fixed price basis and on a time and materials basis.
Revenues from time and materials contracts are recognized when the related
service is provided to the customer. Revenues from fixed price contracts,
including a portion of estimated profit, are recognized as services are
provided, based on costs incurred and estimated total contract costs using the
percentage of completion method.
The timing of billing to customers varies based on individual contracts and
often differs from the period of revenue recognition. Estimated earnings in
excess of billings totaled $323,000 at January 31, 2005.
Contract costs are recorded when incurred and include direct labor and other
direct costs combined with allocations of operational indirect costs. Management
periodically reviews the costs incurred and revenue recognized from contracts
and adjusts recognized revenue to reflect current expectations. Provisions for
estimated losses on incomplete contracts are provided in full in the period in
which such losses become known.
Inventories
Inventories are stated at the lower of cost or market (net realizable value).
Cost is determined on the weighted average first-in first-out (FIFO) method.
Appropriate consideration is given to obsolescence, excessive inventory levels,
product deterioration and other factors in evaluating net realizable value.
Impairment of Long-Lived Assets
Long-lived assets, consisting primarily of property and equipment are reviewed
for impairment whenever events or changes in circumstances indicate that the
carrying amount should be assessed pursuant to SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." We determine impairment by
comparing the carrying value of these long-lived assets to the undiscounted
future cash flows expected to result from the use of these assets. In the event
we determine that an impairment exists, a loss would be recognized based on the
amount by which the carrying value exceeds the fair value of the assets, which
is generally determined by using quoted market prices or valuation techniques
such as the discounted present value of expected future cash flows, appraisals,
or other pricing models as appropriate.
Impairment of Goodwill
In accordance with SFAS No. 142, we will conduct annually on November 1, a
review of our goodwill and intangible assets with an indefinite useful life to
determine whether their carrying value exceeds their fair market value. Should
this be the case, a detailed analysis will be performed to determine if the
goodwill and other intangible assets are impaired. We will also review the
finite intangible assets when events or changes in circumstances indicate that
the carrying amount may not be recovered.
We will test for impairment of Goodwill and indefinite lived intangible assets
more frequently if events or changes in circumstances indicate that the asset
might be impaired.
During the twelve months ended January 31, 2005, we recognized that an
impairment existed on an interim basis with respect to SMC's goodwill,
contractual customer relationships and trade name. (See further discussion of
our results of operations for the twelve months ended January 31, 2005.)
Contractual Customer Relationships ("CCR's")
The fair value of the Contractual Customer Relationships (CCR's) was determined
at the time of the acquisition of SMC by discounting the cash flows expected
from SMC's continued relationships with three customers - General Dynamics
Corp., Verizon Communications and Southern Maryland Electric Cooperative.
Expected cash flows were based on historical levels, current and anticipated
projects and general economic conditions. In some cases, the estimates of future
cash flows reflect periods beyond those of the current contracts in place. The
expected cash flows were discounted based on a rate that reflects the perceived
risk of the CCR's, the estimated weighted average cost of capital and SMC's
asset mix. We are amortizing the CCR's over a seven year weighted average life
given the long standing relationships SMC has with Verizon and SMECO.
During the twelve months ended January 31, 2005, we recognized that an
impairment existed on an interim basis with respect to SMC's goodwill,
contractual customer relationships and trade name. (See further discussion of
our results of operations on the twelve months ended January 31, 2005.)
23
Trade Name
The fair value of the SMC Trade Name was estimated using a relief-from-royalty
methodology. We determined that the useful life of the Trade Name was indefinite
since it is expected to contribute directly to future cash flows in perpetuity.
The Company has also considered the effects of demand and competition including
its customer base. While SMC is not a nationally recognized Trade Name, it is a
regionally recognized name in Maryland and the Mid-Atlantic region, SMC's
primary region of operations.
We are using the relief-from-royalty method described above to test the Trade
Name for impairment annually on November 1 and on an interim basis if events or
changes in circumstances between annual tests indicate the Trade Name might be
impaired. Based on the annual impairment test, no impairment was recorded.
During the twelve months ended January 31, 2005, we recognized that an
impairment existed on an interim basis with respect to SMC's goodwill,
contractual customer relationships and trade name. (See further discussion of
our results of operations on the twelve months ended January 31, 2005.)
Proprietary Formulas
The Fair Value of the Proprietary Formulas (PF's) was determined at the time of
the acquisition of VLI by discounting the cash flows expected from developed
formulations based on relative technology contribution and estimates regarding
product lifecycle and development costs and time. The expected cash flows were
discounted based on a rate that reflects the perceived risk of the PF's, the
estimated weighted average cost of capital and VLI's asset mix. We are
amortizing the PF's over a three year life based on the estimated contributory
life of the proprietary formulations utilizing estimated historical product
lifecycles and changes in technology.
Non-Contractual Customer Relationships
The fair value of the Non-Contractual Customer Relationships (NCR's) was
determined at the time of acquisition of VLI by discounting the net cash flows
expected from existing customer revenues. Although VLI does not operate using
long-term contracts, historical experience indicates that customer repeat orders
due to the costs associated with changing suppliers. VLI has had a relationship
of five years or more with most of its currently significant customers. The
expected cash flows were discounted based on a rate that reflects the perceived
risk of the NCR's, the estimated weighted average cost of capital and VLI's
asset mix. We are amortizing the NCR's over a five year life based on the length
of VLI's significant customer relationships.
Non-Compete Agreement
The fair value of the Non-Compete Agreement (NCA) was determined at the time of
acquisition of VLI by discounting the estimated reduction in the cash flows
expected if one key employee, the former sole shareholder of VLI, were to leave.
The key employee signed a non-compete clause prohibiting the employee from
competing directly or indirectly for five years. The estimated reduced cash
flows were discounted based on a rate that reflects the perceived risk of the
NCA, the estimated weighted average cost of capital and VLI's asset mix. We are
amortizing the NCA over five years, the length of the non-compete agreement.
Deferred Tax Assets and Liabilities
We account for income taxes under the asset and liability method. The approach
requires the recognition of deferred tax assets and liabilities for the expected
future tax consequences of temporary differences between the carrying amounts
and the tax basis of assets and liabilities. Developing our provision for income
taxes requires significant judgment and expertise in Federal and state income
tax laws, regulations and strategies, including the determination of deferred
tax assets and liabilities and, if necessary, any valuation allowances that may
be required for deferred tax assets.
At January 31, 2005, we have net operating loss carry forward aggregating
$858,000 which expires in 2024 and 2025.
Stock Based Compensation
We continue to apply APB Opinion No. 25 and related interpretations to its stock
based compensation awards. The fair value of the options granted in fiscal 2005
and 2004 have been estimated at the date of grant using the Black-Scholes
option-pricing model. Because option valuation models require the use of
subjective assumptions, any changes in these assumptions can materially impact
the fair value.
24
Pro Forma Disclosures
Years Ended January 31, 2005 and 2004
2005 2004
----------- -----------
Net loss, as reported $(2,579,000) $ (597,000)
Add: Stock based compensation recorded in
the financial statements -- 5,000
Deduct: Total stock-based employees compensation
expense determined under fair value based
methods for all awards, net of amounts
already recorded (59,000) (145,000)
----------- -----------
Pro forma net loss $(2,638,000) $ (737,000)
=========== ===========
Basic and diluted loss per share:
Basic and diluted - as reported $ (1.20) $ (0.41)
Based and diluted - pro forma $ (1.23) $ (0.50)
Weighted average fair value of options granted $ 2.23 $ 3.58
Risk-free interest rate 3.49% 3.28%
Expected volatility 57% 60%
Expected life 5 years 10 years
Dividend yield 0% 0%
ACQUISITION OF VITARICH LABORATORIES, INC.
On August 31, 2004, pursuant to an Agreement and Plan of Merger ("Merger
Agreement"), the Company acquired all of the common stock of Vitarich
Laboratories, Inc. (Vitarich) by way of a merger of Vitarich with and into a
wholly-owned subsidiary of the Company (VLI), with VLI as the surviving company
of the Merger. Vitarich (now VLI) is a developer, manufacturer and distributor
of premium nutritional supplements, whole-food dietary supplements and personal
care products.
In connection with the Merger Agreement, the Company paid Kevin J. Thomas
(Thomas), the former shareholder of Vitarich, initial consideration consisting
of (i) $6.1 million in cash; and (ii) 825,000 shares of the Company's common
stock which was valued at $5,132,000 or $6.22 per share utilizing the quoted
market price two days before and after the acquisition date. These 825,000
shares were registered on Form S-3 under the Securities Act of 1933, as amended,
on February 25, 2005.
Pursuant to the Merger Agreement, in addition to the initial consideration paid
at closing, the Company shall pay Thomas additional consideration equal to (a)
5.5 times the Adjusted EBITDA of Vitarich (as defined in the Merger Agreement)
for the 12 months ended February 28, 2005 (b) less the initial consideration
paid at closing (provided, however, that in no event shall the additional
consideration be less than zero or require repayment by Thomas of any portion of
the initial consideration paid at closing) ("Additional Cash Consideration").
Such Additional Cash Consideration shall be paid 50% in the form of a
subordinated note and 50% through issuance of additional common stock of the
Company.
The Merger Agreement also provides that, if between the closing date and the
payment date of the Additional Cash Consideration, the Company raises additional
capital by issuance of stock pursuant to a public or private offering for a
price less than $7.75 per share (the Additional Capital Subscription Price),
then the number of shares of the Company's common stock issued to Thomas as
initial consideration in the merger shall be adjusted to the number of shares of
the Company's common stock that would have been issued at the closing of the
merger had the value of each share of the Company's common stock been the
Additional Capital Subscription Price.
25
In connection with the Merger Agreement, the Company assumed approximately $1.6
million of Vitarich indebtedness (including approximately $1.1 million of
equipment leases and working capital credit lines and approximately $507,000
that was due to Thomas by Vitarich at the time of the merger) as well as
Vitarich accounts payable and accrued liabilities. The Company also assumed
certain real property leases and other obligations of Vitarich in connection
with the merger. The Company paid the $507,000 that was due to Thomas at the
closing of the merger and paid approximately $714,000 of the assumed equipment
leases and working capital credit lines following the closing of the merger.
In connection with the Merger Agreement, VLI and Thomas entered into an
employment agreement, pursuant to which VLI agreed to employ Thomas as its
Senior Operating Executive for an initial term of 3 years, subject to successive
automatic one-year renewal terms after the initial term unless either party
provides notice of its election not to renew; and the Company entered into a
supply agreement with a supply company majority owned by Thomas, pursuant to
which the supply company committed to sell to the Company, and the Company
committed to purchase on an as-needed basis, certain organic agriculture
products produced by the supply company.
Also in connection with the Merger Agreement, Argan effected certain changes to
its existing credit facility with Bank of America, N.A. ("BOA"), pursuant to a
certain Third Amendment to Financing and Security Agreement (the "Third
Amendment"), dated as of August 31, 2004, by and among Argan, SMC and VLI, as
borrowers, and BOA, as lender; a certain Amended and Restated Revolving Credit
Note (The "Amended Revolving Note"), dated August 31, 2004, in the amount of
$3,500,000, by and among Argan, SMC and VLI, as borrowers, in favor of BOA, as
lender; a certain First Amendment to Term Note (the "First Amendment to Term
Note"), dated as of June 29, 2004, by and among Argan and SMC, as borrowers, and
BOA, as lender; and an Additional Borrowers Joinder Supplement (the "Supplement"
and together with the Third Amendment, the Amended Revolving Note and the First
Amendment to Term Note, the "Financing Document Amendments"), dated as of August
31, 2004, by and among Argan, the other Existing Borrowers (as such term is
defined in the Supplement) and VLI, as borrowers, and BOA, as lender. Pursuant
to the Financing Document Amendments, Argan's existing credit facility with BOA
was principally amended to (i) increase the amount available for borrowing under
the revolving credit facility from $1,750,000 to $3,500,000, (ii) extend the
maturity date of the revolving credit facility to May 31, 2005, (iii) increase
the interest rate on the revolving credit facility to LIBOR plus 3.25% for the
remaining term of the facility, (iv) increase the interest rate on the term loan
facility to LIBOR plus 3.45% from July 1, 2004 to the maturity date (July 31,
2006), and (v) subject borrowings under the revolving credit facility to a
borrowing base calculation based upon eligible accounts receivable and eligible
inventory. The Financing Document Amendments also amended certain covenants to
require the ratio of funded debt to earnings before interest, taxes,
depreciation and amortization ("EBITDA") to not exceed 2.5 to 1 (the first test
date being January 31, 2005) and to require a fixed charge coverage ratio of not
less than 1.25 to 1 (the first test date being January 31, 2005.) The Financing
Document Amendments also deleted covenants which had required Argan to maintain
certain minimum levels of liquidity and positive net income during the Company's
fiscal quarters ended July 31, 2004 and October 31, 2004.
On January 31, 2005, the Company entered into a Debt Subordination Agreement
("Subordination Agreement") with Thomas, SMC, and the Company referred herein as
the "Debtor" and Bank of America, N.A. ("Lender") to reconstitute as
subordinated debt Additional Cash Consideration that Debtor will owe to Thomas
in connection with the Merger Agreement.
Pursuant to the Subordination Agreement, Debtor and Thomas have agreed to
reconstitute the Additional Cash Consideration as subordinated debt and in
furtherance thereof, the Company has agreed to execute and deliver to Thomas a
Subordinated Promissory Note in an amount equal to the amount that would
otherwise be due Thomas as Additional Cash Consideration under the Merger
Agreement. Accordingly, under the Subordination Agreement, Debtor subordinated
all of the Junior Debt (as such term is defined in the Subordination Agreement)
to the full and final payment of all the Superior Debt (as such term is defined
in the Subordination Agreement) to the extent provided in the Subordination
Agreement, and Thomas transferred and assigned to Lender all of his rights,
title and interest in the Junior Debt and appointed Lender as his
attorney-in-fact for the purposes provided in the Subordination Agreement for as
long as any of the Superior Debt remains outstanding. Except as otherwise
provided in the Subordination Agreement and until such time that the Superior
Debt is satisfied in full, Debtor shall not, among other things, directly or
indirectly, in any way, satisfy any part of the Junior Debt, nor shall Creditor,
among other things, enforce any part of the Junior Debt or accept payment from
Debtor or any other person for the Junior Debt or give any subordination in
respect of the Junior Debt.
26
ACQUISITION OF SOUTHERN MARYLAND CABLE, INC.
On July 17, 2003, we acquired all of the common stock of SMC, a provider of
telecommunications and other infrastructure services including project
management, construction and maintenance to the Federal Government,
telecommunications and broadband service providers, as well as electric
utilities.
The results of operations of SMC are included in the consolidated results of the
Company from July 17, 2003, the date of the acquisition. The estimated purchase
price was approximately $4 million in cash, plus the assumption of approximately
$971,000 in debt.
We accounted for the acquisition of SMC using the purchase method of accounting
whereby the excess of cost over the net amounts assigned to assets acquired and
liabilities assumed is allocated to goodwill and intangible assets based on
their estimated fair values. Such intangible assets include $1,600,000 and
$680,000 allocated to Contractual Customer Relationships ("CCR") and Trade Name,
respectively, and $1,680,000 to Goodwill. We are amortizing the CCR's over a
weighted average life of seven years. The Trade Name was determined to have an
indefinite useful life and is not being amortized.
During the twelve months ended January 31, 2005, we recorded impairment losses
for goodwill and intangible assets which were acquired in the acquisition. (See
further discussion of our resulting operations for the twelve months ended
January 31, 2005.)
SALE OF MANUFACTURING OPERATIONS
On October 31, 2003, we, as part of our plan to reallocate our capital to our
acquisition program, sold PI to WFC. The sales price of approximately $3,500,000
was satisfied in cash of which $300,000 is being held in escrow to indemnify WFC
from any damages resulting from a breach of representations and warranties under
the Stock Purchase Agreement. We recognized a gain on sale of approximately
$167,000, net of income taxes of $506,000. We utilized net operating losses to
offset the gain on sale and thus, have no current tax liability in connection
with the sale. The $506,000 is the amount of the Puroflow deferred tax assets at
the date of sale related to Puroflow which has been sold. In accordance with
SFAS No. 144 "Accounting for the impairment or Disposal of Long-Lived Assets,"
we classified the operating results of PI as discontinued operations in the
accompanying statements of operations.
During the twelve months ended January 31, 2005, WFC asserted that the Company
breached certain representations and warranties under the Stock Purchase
Agreement. (See Note 12 to the Consolidated Financial Statements.)
The results of the discontinued operations which are included in the
consolidated statements of operations for the year ended January 31, 2004 are as
follows:
Year Ended
January 31, 2004
----------------
Net sales $ 5,050,000
Cost of goods sold 3,834,000
----------------
Gross profit 1,216,000
Selling, general and administrative 1,701,000
----------------
Loss from discontinued operations (485,000)
Other expense (11,000)
----------------
Loss from discontinued operations before
income tax provision (496,000)
Income tax provision 245,000
Gain from discontinued operations, net of
income tax provision of $506,000 167,000
----------------
Net loss from discontinued operations $ (574,000)
================
RESULTS OF OPERATIONS
COMPARISON OF THE FISCAL YEARS ENDED JANUARY 31, 2005 AND 2004
The following unaudited pro forma statements of operations summarize the results
of our operations for the years ended January 31, 2005 and 2004, as if the
acquisitions of VLI and SMC were completed on February 1, 2003. The unaudited
pro forma statements of operations do not include the operating results of
Puroflow, which have been reclassified as discontinued operations.
27
The unaudited pro forma statements of operations does not purport to be
indicative of the results that would have actually been obtained if the
aforementioned acquisitions and disposition had occurred on February 1, 2003, or
that may be obtained in the future. VLI and SMC previously reported their
results of operations using a calendar year-end. No material events occurred
subsequent to these reporting periods that would require adjustment to our
unaudited pro forma statements of operations.
Year Ended
January 31
2005 2004
------------ ------------
Net sales $ 24,131,000 $ 25,124,000
Cost of good sold 18,313,000 18,736,000
------------ ------------
Gross profit 5,818,000 6,388,000
Selling and general and administrative expenses 6,757,000 6,216,000
Impairment loss 1,942,000 --
------------ ------------
(Loss) income from operations (2,881,000) 172,000
Other expense, net (106,000) (15,000)
------------ ------------
(Loss) income from continuing operations before income taxes (2,987,000) 157,000
Income tax (benefit) provision (866,000) 55,000
------------ ------------
Net (loss) income from continuing operations ($ 2,121,000) $ 102,000
============ ============
Pro Forma Net Sales
Pro forma net sales were $24,131,000 for the year ended January 31, 2005,
compared to pro forma net sales of $25,124,000 for the year ended January 31,
2004. The decrease in pro forma net sales of $993,000 or 4% is due primarily to
a decrease of $3.6 million in net sales at SMC attributed primarily to its
largest fixed price contract customer which reduced the level of activity on the
Company's largest fixed price contract. VLI experienced approximately $2.7
million in increased combined revenues from a new customer and from its two
largest customers, TriVita Corporation and Cyberwize.com, Inc., which offset, in
part, the revenue decline at SMC.
Pro Forma Cost of Goods Sold
For the year ended January 31, 2005, pro forma cost of goods sold was
$18,313,000 or 76% of pro forma net sales compared to $18,736,000 or 75% of pro
forma net sales for the year ended January 31, 2004. SMC experienced lower
margins due to inefficiencies in downsizing its skilled workforce as the revenue
from its largest fixed price contract customer declined. Because initially SMC
expected the customer to resume normal levels of activity for awarded and
in-process projects and because rehiring of skilled technicians is problematic,
SMC did not immediately move to reduce its skilled workforce. VLI experienced a
decrease of cost of goods sold as a percentage of pro forma net sales of 1% due
to increased pricing which it passed onto its customer base.
Pro Forma Selling, General and Administrative Expenses
For the year ended January 31, 2005, pro forma selling general and
administrative expenses were $6,757,000 or 28% of pro forma net sales compared
to $6,216,000 or 25% of net sales for the year January 31, 2004. Pro forma
selling, general and administrative expenses increased in connection with the
WFC claim ($260,000) and for the corporate management team whose efforts focused
on expansion into the nutraceuticals business and other industries aggregated
$1,330,000 for the year ended January 31, 2005 compared to $978,000 for the year
ended January 31, 2004. The corporate team was in place for nine months during
the prior fiscal year compared to twelve months for the year ended January 31,
2005.
Impairment of Goodwill and Intangibles
During the three months ended July 31, 2004, the Company determined that both
events and changes in circumstances with respect to its business climate would
have a significant effect on its future estimated cash flows. During the three
months ended July 31, 2004, SMC had a customer contract terminated which had
historically provided positive margins and cash flows. In addition, SMC
experienced revenue levels well below expectations for its largest fixed price
contract customer. As a consequence, SMC has reduced its future expectations of
cash flows and the Company concluded that there was an indication that its
intangible assets not subject to amortization might be impaired. The Company
determined the fair value of SMC's Goodwill and Trade Name and compared it to
its respective carrying amounts. The carrying amounts exceeded SMC's Goodwill
and Trade Name's respective fair values by $740,000 and $456,000, respectively,
which the Company recorded as an impairment loss for the three months ended July
31, 2004.
28
During the three months ended July 31, 2004, the Company terminated a customer
contract. The impact of the termination indicated that its Contractual Customer
Relationships (CCR) carrying amount was not fully recoverable. Accordingly, the
Company determined the fair value of the CCR's and compared it to its carrying
amount. The Company recorded an impairment loss of $746,000 as this is the
amount by which the CCR's carrying amount exceeded its fair value.
Pro Forma Other Expense, Net
We had pro forma other expense, net of $106,000 for the year ended January 31,
2005 compared to pro forma other expense, net of $15,000 for the year ended
January 31, 2004. Other pro forma expense, net increased primarily due to
interest expense for borrowings related to greater levels of inventory on-hand
at VLI.
Pro Forma Income Tax (Benefit) Provision
AI's effective pro forma income tax benefit rate was 28% for the twelve months
ended January 31, 2005 compared to a 35% pro forma income tax rate for the
twelve months ended January 31, 2004. We recorded a $740,000 impairment charge
related to goodwill for the twelve months ended January 31, 2005 which is
treated as a permanent difference for income tax reporting purposes. We
considered the aforementioned permanent difference in AI's pro forma effective
tax rate.
LIQUIDITY AND CAPITAL RESOURCES
Cash Position and Indebtedness
We had $2.7 million in working capital at January 31, 2005, including $167,000
of cash and cash equivalents. In addition we had $1.7 million available under
credit facilities.
Working capital decreased by $5.6 million to $2.7 million at January 31, 2005
from $8.3 million at January 31, 2004. This decrease was primarily due to a
decrease in cash and cash equivalents resulting from the acquisition of VLI in
August 2004. The cash portion of the purchase cost was approximately $6.6
million inclusive of all costs associated with the acquisition.
On January 28, 2005, we sold and issued to MSR I SBIC L.P. (MSR) 129,032 shares
of common stock under a Subscription Agreement at a purchase price of $7.75 per
share or approximately $1,000,000. Such proceeds were used by the Company to pay
down certain of its existing obligations. We have agreed to issue additional
shares upon the earlier of (i) the Company's issuance of additional shares of
common stock having an aggregate purchase price of at least $2.5 million at a
price per share less than that paid by MSR subject to certain exclusions; or
(ii) July 31, 2005. Shares would be issued in amounts determined by reference to
our prevailing thirty-day average stock price. The number of additional shares
to be issued would effectively reduce MSR's purchase price per common share as
set forth in the Agreement. MSR is an entity controlled by Daniel Levinson, one
of our directors.
As previously mentioned on January 31, 2005, we entered into a debt
subordination agreement with Kevin Thomas to delay the timing of the payment of
Additional Cash Consideration to the earlier August 1, 2006 or in the event that
the Company raises more than $1 million in equity, Thomas would be paid the
excess over the amount provided that such payment would not cause Argan to be in
default of its financing arrangements.
Cash Flows
Net cash used in operations for the year ended January 31, 2005 was $2,213,000
compared with $278,000 of cash used in operations for the year ended January 31,
2004. The increase in cash used in operations is primarily due to our net loss
and decreases in accounts payable as we paid vendors for inventory shipped to
VLI to support sales growth and the new adaptogen products, much of which was
acquired prior to VLI's acquisition date.
Net cash used for investing activities was $3,892,000 and $4,063,000 for the
twelve months ended January 31, 2005 and 2004, respectively. During the twelve
months ended January 31, 2005, we had cash of $6,650,000 used in the purchase of
VLI and cash provided by the net redemption of $3,000,000 in investments. During
the twelve months ended January 31, 2004, we had cash of $3,751,000 used in the
purchase of SMC, cash used in the net purchase of investments of $3,000,000 and
cash of $3,200,000 provided by the sale of PI.
Net cash provided by financing activities was $1,060,000 and $9,553,000 for the
twelve months ended January 31, 2005 and 2004, respectively. During the twelve
months ended January 31, 2005, we had $1 million in cash provided by the sale of
common stock to MSR, cash of $3,109,000 provided by the amended financing
arrangements with Bank of America, N.A. ("the Bank"), cash of $1,450,000 used in
payments on the amended financing arrangement, cash of $1,104,000 used in
payments on term debt under credit lines and cash of $507,000 used in the
acquisition of VLI to pay a loan to former owner of VLI. During the twelve
months ended January 31, 2004, we had cash of $9,635,000 provided from financing
activities from the private placement of 1.3 million shares of our common stock,
cash of $1,200,000 provided by the financing arrangement with Bank of America,
cash of $1,091,000 used in payment of term debt on credit lines and cash of
$215,000 used in payment of PI's credit facilities.
29
In August 2003, we entered into a financing arrangement with the Bank
aggregating $2,950,000 in available financing in two facilities - a revolving
line of credit with $1,750,000 in availability, expiring July 31, 2004 and
bearing interest at LIBOR plus 2.75%, and a three year term note with an
original outstanding balance of $1,200,000, expiring July 31, 2006 and bearing
interest at LIBOR plus 2.95%. The proceeds from the term note were used to pay
off the SMC lines of credit and for working capital. As of January 31, 2005, we
had $600,000 outstanding under the term note.
In August 2004, the Company agreed to amend the existing financing arrangements
with the Bank whereby the revolving line of credit was increased to $3.5 million
in maximum availability, expiring May 31, 2005. Availability on a monthly basis
under the revolving line is determined by reference to accounts receivable and
inventory on hand which meet certain Bank criteria. The aforementioned three
year note remains in effect.
The amended financing arrangement contains financial as well as nonfinancial
covenants including requiring the ratio of debt to pro forma earnings before
interest, taxes, depreciation and amortization of 2.5 to 1(with the first test
date being January 31, 2005) requiring a pro forma fixed charge coverage ratio
of 1.25 to 1(with the first test date being January 31, 2005), as well as
requirements for bank consent for acquisitions and divestitures. At January 31,
2005, the Company was not in compliance with the ratio of debt to EBITDA and
received a waiver from the Bank with respect to the breach of the covenant. The
Bank has waived covenant compliance for January 31, 2005 and April 30, 2005.
Under the amended financing arrangement, the three-year note bears interest at
LIBOR plus 3.45% and the revolving line of credit bears interest at LIBOR plus
3.25%
The amended financing arrangement eliminates certain previously existing
covenants which had required the Company to maintain certain minimum levels of
liquidity and had required the Company to maintain positive net income during
the Company's fiscal quarters ended July 31, 2004 and October 31, 2004.
As of January 31, 2005 the Company has $1,659,000 outstanding under the
revolving line of credit. Because of the disposition of PI, we deposited
$300,000 as additional collateral in a restricted cash account with the bank.
The Company continues to pledge the majority of the Company's assets to secure
the financing arrangements.
Subsequent to January 31, 2005, the Company agreed to amend the existing
financing arrangements whereby the revolving line of credit was increased to
$4.25 million in maximum availability, expiring May 31, 2006. Under the amended
financing arrangements, amounts outstanding under the revolving line of credit
and the three-year note bear interest at LIBOR plus 3.25% and 3.45%,
respectively. Availability on a monthly basis under the revolving line is
determined by reference to accounts receivable and inventory on hand which meet
certain Bank criteria. The aforementioned three-year note remains in effect and
the final monthly scheduled payment of $33,000 is due on July 31, 2006.
The amended financing arrangements waives the January 31, 2005 and April 30,
2005 measurement of certain financial covenants including requiring the ratio of
debt to pro forma earnings before interest, taxes, depreciation and amortization
(EBITDA) not to exceed 2.5 to 1 (with the next test date being July 31, 2005)
requiring pro forma fixed charge coverage ratio not less than 1.25 to 1 (with
the next test date being July 31, 2005). Bank 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 Bank has
released $300,000 to the Company which it was holding in escrow as collateral.
Management believes that cash generated from the Company's operations combined
with capital resources available under its renewed line of credit is adequate to
meet the Company's future operating cash needs. Any future acquisitions, other
significant unplanned costs or cash requirements may require the Company to
raise additional funds through the issuance of debt and equity securities. There
can be no assurance that such financing will be available on terms acceptable to
the Company, or at all. If additional funds are raised by issuing equity
securities, significant dilution to the existing stockholders may result.
Contractual Obligations
Our current contractual obligations include long-term debt and operating leases
for our office, warehouse and manufacturing facilities. See Note 6 and Note 11
of our consolidated financial statements for a discussion of our contractual
obligations.
30
Principal maturities of long-term debt and future minimum lease payments at
January 31, 2005 are as follows:
Payment Due by Period
-------------------------------------------------- More than
Contractual Obligations Total One Year 1-3 Years 4-5 Years 5 Years
----------------------- ---------- ---------- ---------- ---------- ----------
Long-term debt $1,143,000 $ 662,000 $ 391,000 $ 90,000 --
Operating Leases 2,456,000 478,000 814,000 450,000 $ 714,000
---------- ---------- ---------- ---------- ----------
Total $3,599,000 $1,140,000 $1,205,000 $ 540,000 $ 714,000
========== ========== ========== ========== ==========
Customers
During the twelve months ended January 31, 2005, we provided nutritional and
whole-food supplements as well as personal care products to customers in the
global nutrition industry and services to telecommunications and utilities
customers as well as to the Federal Government, through a contract with General
Dynamics Corp. ("GD"). Certain of our more significant customer relationships
are with Southern Maryland Electrical Cooperative (SMECO), GD, TriVita
Corporation (TVC), and CyberWize.com, Inc. (C). SMECO accounted for
approximately 23% of consolidated net sales during the twelve months ended
January 31, 2005. GD accounted for approximately 14% of consolidated net sales
during the twelve months ended January 31, 2005. In fiscal year 2005, GD
substantially reduced its level on certain contracts under which it used SMC as
a subcontractor. During fiscal 2006 we expect an increase in levels on these
certain contracts under GD. The Federal Government, through our contract with
GD, has been a major customer for three years. TVC and C have been customers of
VLI for five and two years, respectively, and accounted for 17% and 8% of
consolidated net sales for the twelve months ended January 31, 2005. Combined
SMECO, GD, TVC and C accounted for approximately 62% of consolidated net sales
during the twelve months ended January 31, 2005.
SEASONALITY
The Company's telecom infrastructure services operations are expected to have
seasonally weaker results in the first and fourth quarters of the fiscal year,
and may produce stronger results in the second and third quarters. This
seasonality is primarily due to the effect of winter weather on 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.
IMPACT OF CHANGES IN ACCOUNTING STANDARDS
In December 2004, the Financial Accounting Standards Board issued FASB Statement
No. 123 (revised 2004), Share-Based Payment ("SFAS 123(R)"). SFAS 123(R)
supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees and amends FASB Statement No. 95, Statement of Cash Flows.
SFAS 123(R) requires all share-based payments to employees, including grants of
employee stock options, to be recognized in the income statement based on their
fair values. Pro forma disclosure is no longer an alternative. We will adopt
SFAS 123(R) on February 1, 2006. We have not determined the impact of adopting
the new standard and are still evaluating the impact.
EFFECTS OF INFLATION ON BUSINESS
Management believes that inflation has not had a material effect on the
Company's operations.
31
ITEM 7. FINANCIAL STATEMENTS
The following financial statements (including the notes thereto and the Report
of the Independent Registered Public Account Firm with respect thereto), are
filed as part of this Annual Report on Form 10-KSB.
Report of Ernst & Young LLP, Independent Registered Public Accounting Firm
Consolidated Balance Sheets at January 31, 2005 and 2004.
Consolidated Statements of Operations for each of the two years in the
period ended January 31, 2005.
Consolidated Statements of Stockholders' Equity for each of the two years
in the period ended January 31, 2005.
Consolidated Statements of Cash Flows for each of the two years in the
period ended January 31, 2005.
Notes to Consolidated Financial Statements.
32
REPORT OF ERNST & YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders of Argan, Inc.
We have audited the accompanying consolidated balance sheets of Argan, Inc. (the
Company) as of January 31, 2005 and 2004, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
two years in the period ended January 31, 2005. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. We were not engaged to perform an
audit of the Company's internal control over financial reporting. Our audits
included consideration of internal control over financial reporting as a basis
for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the
Company's internal control over financial reporting. Accordingly, we express no
such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Argan,
Inc. at January 31, 2005 and 2004, and the consolidated results of its
operations and its cash flows for each of the two years in the period ended
January 31, 2005, in conformity with U.S. generally accepted accounting
principles.
/s/ ERNST & YOUNG LLP
McLean, Virginia
April 8, 2005
33
ARGAN, INC.
Consolidated Balance Sheets
January 31, January 31,
2005 2004
============ ============
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 167,000 $ 5,212,000
Investments -- 3,000,000
Accounts receivable, net 2,951,000 1,523,000
Receivable from affiliated entity, net 112,000 --
Escrowed cash 604,000 601,000
Estimated earnings in excess of billings 323,000 514,000
Inventories, net 3,465,000 --
Prepaid expenses and other current assets 622,000 150,000
------------ ------------
TOTAL CURRENT ASSETS 8,244,000 11,000,000
------------ ------------
Property and equipment, net 2,703,000 1,913,000
Other assets 35,000 --
Contractual customer relationships, net 564,000 1,476,000
Trade name 224,000 680,000
Proprietary formulas, net 2,153,000 --
Non-contractual customer relationships, net 1,833,000 --
Non-compete agreement, net 1,650,000 --
Goodwill 7,532,000 1,680,000
------------ ------------
TOTAL ASSETS $ 24,938,000 $ 16,749,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,803,000 $ 918,000
Billings in excess of estimated earnings -- 20,000
Due to affiliates 47,000 --
Accrued expenses 1,187,000 488,000
Deferred income tax liability 144,000 188,000
Line of credit 1,659,000 --
Current portion of long-term debt 662,000 1,092,000
------------ ------------
TOTAL CURRENT LIABILITIES 5,502,000 2,706,000
------------ ------------
Deferred income tax liability 2,520,000 1,064,000
Long-term debt 481,000 109,000
STOCKHOLDERS' EQUITY
Preferred stock, par value $.10 per share -
authorized 500,000 shares - issued - none -- --
Common stock, par value $.15 per share - 12,000,000
shares authorized - 2,762,078 shares issued at
January 31, 2005 and 1,806,046 shares issued at
January 31, 2004 and 2,758,845 shares outstanding
at January 31, 2005 and 1,802,813 shares outstanding
at January 31, 2004 414,000 270,000
Warrants outstanding 849,000 849,000
Additional paid-in capital 20,121,000 14,121,000
Accumulated deficit (4,916,000) (2,337,000)
Treasury stock at cost:
3,233 shares at January 31, 2005 and 2004 (33,000) (33,000)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 16,435,000 12,870,000
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 24,938,000 $ 16,749,000
============ ============
See Accompanying Notes
34
ARGAN, INC.
Consolidated Statements of Operations
Years Ended January 31
2005 2004
============ ============
Net sales $ 14,518,000 $ 6,780,000
Cost of goods sold 11,333,000 5,184,000
------------ ------------
Gross profit 3,185,000 1,596,000
Selling, general and administrative expenses 4,810,000 1,912,000
Impairment loss 1,942,000 --
------------ ------------
Loss from operations (3,567,000) (316,000)
------------ ------------
Interest expense 124,000 47,000
Other income, net (67,000) (51,000)
------------ ------------
Loss from continuing operations before income taxes (3,624,000) (312,000)
Income tax benefit 1,045,000 289,000
------------ ------------
Loss from continuing operations (2,579,000) (23,000)
------------ ------------
Loss from discontinued operations, net of income tax
provision of $751,000 -- 574,000
------------ ------------
Net loss $ (2,579,000) $ (597,000)
============ ============
Basic and diluted loss per share:
Continuing operations $ (1.20) $ (0.02)
============ ============
Discontinued operations -- $ (0.39)
============ ============
Net loss $ (1.20) $ (0.41)
============ ============
Weighted average number of shares outstanding: 2,149,000 1,480,000
============ ============
See Accompanying Notes
35
ARGAN, INC.
Consolidated Statements of Stockholders' Equity
For the Years Ended January 31, 2005 and 2004
NOTES
RECEIVABLE
COMMON FROM
STOCK ADDITIONAL ACCUMULATED STOCKHOLDERS
PAR WARRANTS PAID-IN DEFICIT AND TREASURY
SHARES VALUE OUTSTANDING CAPITAL TOTAL STOCK TOTAL
------------ ------------ ------------ ------------ ------------ ------------ ------------
Balance at
January 31, 2003 494,306 $ 74,000 $ -- $ 5,502,000 $ (1,740,000) $ (39,000) $ 3,797,000
Private placement,
net of offering
cost of $472,000 1,303,974 196,000 849,000 8,590,000 -- -- 9,635,000
Exercise of stock
options 4,533 -- -- 29,000 -- -- 29,000
Other -- -- -- -- -- 6,000 6,000
Net loss -- -- -- -- (597,000) -- (597,000)
------------ ------------ ------------ ------------ ------------ ------------ ------------
Balance at
January 31, 2004 1,802,813 270,000 849,000 14,121,000 (2,337,000) (33,000) 12,870,000
Acquisition of Vitarich
Laboratories, Inc. 825,000 124,000 -- 5,008,000 -- -- 5,132,000
Exercise of Stock
Options 2,000 1,000 -- 11,000 -- -- 12,000
Issuance of Common
Stock 129,032 19,000 -- 981,000 -- -- 1,000,000
Net loss -- -- -- -- (2,579,000) -- (2,579,000)
------------ ------------ ------------ ------------ ------------ ------------ ------------
Balance at
January 31, 2005 2,758,845 $ 414,000 $ 849,000 $ 20,121,000 $ (4,916,000) $ (33,000) $ 16,435,000
============ ============ ============ ============ ============ ============ ============
See Accompanying Notes
36
ARGAN, INC.
Consolidated Statements of Cash Flows
Years Ended January 31
2005 2004
============ ============
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (2,579,000) $ (597,000)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation and amortization 1,377,000 309,000
Impairment loss on goodwill and intangibles 1,942,000 --
Non-cash stock option compensation expense -- 5,000
Deferred income taxes (1,108,000) (320,000)
Changes in operating assets and liabilities:
Accounts receivable, net (57,000) (109,000)
Receivable from affiliated entity, net (13,000) --
Estimated earnings in excess of billings 191,000 (337,000)
Due to Affiliate 47,000 --
Inventories, net (218,000) --
Prepaid expenses and other current assets (99,000) (345,000)
Accounts payable and accrued expenses (1,640,000) 473,000
Billings in excess of estimated earnings (20,000) (50,000)
Other (36,000) --
Non-cash charges and working capital
changes of discontinued operations -- 693,000
------------ ------------
Net cash used in operating activities (2,213,000) (278,000)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of Southern Maryland Cable, Inc., net -- (3,751,000)
Proceeds from sale of subsidiary, net of escrow funds held -- 3,200,000
Purchase of Vitarich Laboratories, Inc., net (6,650,000) --
Purchase of investments (9,000,000) (30,000,000)
Redemptions of investments 12,000,000 27,000,000
Purchases of property and equipment (242,000) (424,000)
Investing activities of discontinued operations -- (88,000)
------------ ------------
Net cash used in investing activities (3,892,000) (4,063,000)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from private placement of common stock,
net of offering costs -- 9,635,000
Proceeds from sale of common stock 1,000,000 --
Proceeds from exercise of stock options 12,000 24,000
Proceeds from long-term debt facility -- 1,200,000
Proceeds from short-term debt 3,109,000 --
Payments on short-term debt (1,450,000) --
Principal payments on credit lines (1,104,000) (1,091,000)
Payment of former owner's loan to Vitarich Laboratories, Inc. (507,000) --
Financing activities of discontinued operations -- (215,000)
------------ ------------
Net cash provided by financing activities 1,060,000 9,553,000
------------ ------------
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 5,212,000 --
------------ ------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (5,045,000) 5,212,000
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 167,000 $ 5,212,000
============ ============
See Accompanying Notes
37
ARGAN, INC.
Consolidated Statements of Cash Flows (Continued)
Years Ended January 31
2005 2004
============ ============
Supplemental disclosure of non-cash investing and
Financing activities:
Cash paid during the period for:
Interest $ 124,000 $ 36,000
============ ============
Income taxes $ 373,000 $ 101,000
============ ============
Issuance of warrants -- $ 849,000
============ ============
Acquisitions of VLI and SMC:
Fair value of net assets acquired
Accounts receivable $ 1,470,000 $ 1,590,000
Inventories 3,247,000 --
Other current assets 372,000 101,000
Property and equipment 1,064,000 1,653,000
Other non-current assets 42,000 6,000
------------ ------------
Total non-cash assets 6,195,000 3,350,000
Accounts payable and accrued expenses 3,209,000 775,000
Short-term borrowings and current maturities of debt 1,191,000 427,000
Other current liabilities -- 555,000
Other non-current liabilities 2,564,000 1,546,000
Long-term debt 371,000 544,000
------------ ------------
7,335,000 3,847,000
Net non-cash assets acquired (1,140,000) (497,000)
Cash and cash equivalents -- 288,000
------------ ------------
Fair value of net assets acquired (1,140,000) (209,000)
------------ ------------
Excess of costs over fair value of net assets acquired 12,922,000 3,960,000
------------ ------------
Purchase price $ 11,782,000 $ 3,751,000
============ ============
Cash paid, net $ 6,650,000 $ 3,751,000
Stock issued 5,132,000 --
------------ ------------
Purchase Price $ 11,782,000 $ 3,751,000
============ ============
See Accompanying Notes
38
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
Argan, Inc. (AI or the Company) conducts its operations through its wholly owned
subsidiaries, Vitarich Laboratories, Inc. (VLI) which it acquired in August
2004, and Southern Maryland Cable, Inc. (SMC) which it acquired in July 2003.
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 and maintenance to the
Federal Government, telecommunications and broadband service providers, as well
as electric utilities primarily in the Mid-Atlantic region.
AI was organized as a Delaware corporation in May 1961. On October 23, 2003, our
shareholders approved a plan providing for the internal restructuring of the
Company whereby AI became a holding company and its operating assets and
liabilities relating to its Puroflow business were transferred to a
newly-formed, wholly owned subsidiary. The subsidiary then changed its name to
"Puroflow Incorporated" (PI) and AI changed its name from Puroflow Incorporated
to "Argan, Inc." At the time of the transfer, SMC was the other wholly owned
operating subsidiary of AI.
On October 31, 2003, the Company completed the sale of PI to Western Filter
Corporation (WFC) for approximately $3.5 million in cash of which $300,000 is
being held in escrow to indemnify WFC from any damages resulting from the breach
of representations and warranties under the Stock Purchase Agreement. (See Note
12)
Management's Plans, Liquidity and Business Risks
As of January 31, 2005, the Company had an accumulated deficit of $4.9 million.
Further, as a result of recurring losses, the Company has experienced negative
cash flows from operations. At January 31, 2005, the Company had $1.7 million
available under its revolving line of credit with the Bank. The Company operates
in two unique and distinct markets. The market for nutritional products is
highly competitive and the telecom and infrastructure services industry is
fragmented and also very competitive. The successful execution of the Company's
business plan is dependent upon the Company's ability to integrate acquired
businesses and acquired assets into its operations, its ability to increase and
retain its customers, the ability to maintain compliance with significant
government regulation, the ability to attract and retain key employees and the
Company's ability to manage its growth and expansion, among other factors.
On January 28, 2005, the Company raised approximately $1 million through the
issuance of 129,032 shares of common stock to an Investor. Such proceeds were
used by the Company to pay down certain of its existing obligations. Pursuant to
the Agreement, the Company has agreed to issue additional shares of common stock
to the Investor upon the earlier of (i) the Company's issuance of additional
shares of common stock having an aggregate purchase price of at least $2.5
million at a price per share less than that paid by the Investor, subject to
certain exclusions; or (ii) July 31, 2005. (See Note 7)
The Company also entered into an agreement with the former owner of VLI, Kevin
J. Thomas (Thomas) to delay the timing of the payment of contingent cash
consideration to the earlier of August 1, 2006 or the Company's issuance of
additional equity having an aggregate purchase price of more than $1 million,
Thomas would be paid the remaining contingent consideration up to the excess
over that amount provided that such payment would not put Argan in default of
its current financing arrangement with the Bank. (See Notes 2 and 6)
The Company's line of credit was due to expire on May 31, 2005. On April 8,
2005, the Company renewed its line of credit with the Bank, extending the
maturity date to May 31, 2006. The availability under the line of credit was
increased to $4.25 million and the Bank released $300,000 in cash to the Company
which it was holding in escrow as collateral. (See Note 6)
Management believes that capital resources available under its renewed line of
credit combined with cash generated from the Company's operations is adequate to
meet the Company's future operating cash needs. Accordingly, the carrying value
of the assets and liabilities in the accompanying balance sheet do not reflect
any adjustments should the Company be unable to meet its future operating cash
needs in the ordinary course of business. The Company continues to take various
actions to align its cost structure to appropriately match its expected
revenues, including limiting its operating expenditures and controlling its
capital expenditures. Any future acquisitions, other significant unplanned costs
or cash requirements may require the Company to raise additional funds through
the issuance of debt and equity securities. There can be no assurance that such
financing will be available on terms acceptable to the Company, or at all. If
additional funds are raised by issuing equity securities, significant dilution
to the existing stockholders may result.
39
BASIS OF PRESENTATION
The consolidated financial statements include AI and its wholly owned
subsidiaries. The preparation of consolidated financial statements in conformity
with GAAP requires management to make use of estimates and assumptions that
affect the reported amount of assets and liabilities, revenues and expenses and
certain financial statement disclosures. Estimates are used for but not limited
to our accounting for revenue recognition, allowance for doubtful accounts,
inventory valuation, long lived assets and deferred taxes. Actual results could
differ from these estimates.
The Company's fiscal year ends on January 31. The results of companies acquired
or disposed of during the year are included in the consolidated financial
statements from the effective date of the acquisition or up to the date of
disposal. All significant intercompany balances and transactions have been
eliminated in consolidation. The Company reflects, as discontinued operations,
the disposition of its wholly owned subsidiary, PI, in 2003 according to
Statement of Financial Accounting Standards No. 144 "Accounting for Impairment
or Disposal of Long-Lived Assets." (See Note 14)
Cash and Equivalents - Cash and equivalents include cash balances on deposit in
banks, overnight investments in mutual funds, and other financial instruments
having an original maturity of three months or less. For purposes of the
consolidated statements of cash flow, the Company considers these amounts to be
cash equivalents.
Investments - The Company acquires various financial instruments with original
maturities greater than three months. The Company considers these financial
instruments to be short-term investments.
Revenue Recognition - Vitarich Laboratories, Inc. - Customer sales are
recognized at the time title and the risks and rewards of ownership passes. This
typically is when products are shipped per customer's instructions.
VLI provides for an allowance for doubtful accounts based on historical
experience and a review of its accounts receivable, net and receivable from
affiliated entity, net. Accounts receivable, net and receivable from affiliated
entity, net are presented net of an allowance for doubtful accounts of $72,000
and $84,000, respectively, at January 31, 2005.
Revenue Recognition - Southern Maryland Cable, Inc. - The Company generates
revenue under various arrangements, including contracts under which revenue is
based on a fixed price basis and on a time and materials basis. Revenues from
time and materials contracts are recognized when the related service is provided
to the customer. Revenue from fixed price contracts, including a portion of
estimated profit, is recognized as services are provided, based on costs
incurred and estimated total contract costs using the percentage of completion
method.
The timing of billing to customers varies based on individual contracts and
often differs from the period of revenue recognition. These differences are
included in estimated earnings.
The retainage included in accounts receivable, net in the accompanying balance
sheets represents amounts withheld by contract with respect to SMC accounts
receivable was $53,000 at January 31, 2005 and none at January 31, 2004. The
Company expects to collect substantially all the retainage within one year.
SMC provides for an allowance for doubtful accounts based on historical
experience and a review of its receivables. SMC's receivables are presented net
of an allowance for doubtful accounts of $13,000 at January 31, 2005 and none at
January 31, 2004.
Cost Recognition - Southern Maryland Cable, Inc. - Direct contract costs
includes all direct material, labor, subcontractor costs and those indirect
costs related to contract performance, such as equipment, supplies and tools
where a reasonable allocation of such costs to contracts can be made. Selling,
general and administrative costs are charged to expense when incurred. At
January 31, 2005, the Company did not have any uncompleted contracts for which
it anticipated a significant loss.
40
Inventories -
Inventories are stated at the lower of cost or market (net realizable value).
Cost is determined on the weighted average first-in, first-out (FIFO) method.
Appropriate consideration is given to obsolescence, excessive inventory levels,
product deterioration, and other factors in evaluating net realizable value.
Inventories at January 31, 2005 consist of the following:
Raw materials $ 3,206,000
Work-in-process 61,000
Finished goods 198,000
-----------
$ 3,465,000
===========
Property and Equipment - Property and equipment are stated at historical cost.
Depreciation is provided principally using the straight-line method over the
estimated useful lives of the assets, which are generally from five to twenty
years. Maintenance and repairs (totaling $99,000 and $19,000 for the years ended
January 31, 2005 and 2004, respectively,) are expensed as incurred and 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.
Impairment of Long-Lived Assets - Long-lived assets, consisting primarily of
property and equipment are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount should be assessed pursuant to
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets."
The Company determines whether any impairment exists by comparing the carrying
value of these long-lived assets to the undiscounted future cash flows expected
to result from the use of these assets. In the event the Company determines that
an impairment exists, a loss would be recognized based on the amount by which
the carrying value exceeds the fair value of the assets, which is generally
determined by using quoted market prices or valuation techniques such as the
discounted present value of expected future cash flows, appraisals, or other
pricing models as appropriate.
Goodwill and Other Intangible Assets - In June 2001, Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 142 "Goodwill and Other Intangible Assets." SFAS No. 142
establishes standards for goodwill and other intangible assets acquired in a
business combination, eliminates amortization of goodwill, and sets forth
methods to periodically evaluate goodwill and other intangible assets for
impairment. In accordance with SFAS No. 142, the Company annually conducts on
November 1, a review of its Goodwill and other intangible assets to determine
whether their carrying value exceeds their fair market value.
The Company uses an estimate of future cash flows which are discounted based at
a rate that reflects perceived risk of the Company and the estimated weighted
average cost of capital. The Company will test for impairment of Goodwill and
other intangible assets more frequently if events or changes in circumstances
indicate that the asset might be impaired. The Company recorded an impairment
loss with respect to goodwill and intangible assets for the twelve months ended
January 31, 2005. (See Note 3)
Contractual Customer Relationships - The fair value of the Contractual Customer
Relations (CCR's) was determined at the time of the acquisition of SMC by
discounting the cash flows expected from the Company's continued relationships
with their most significant customers. Expected cash flows were based on
historical levels, current and anticipated projects and general economic
conditions. In some cases, the estimates of future cash flows reflected periods
beyond those of the current contracts in place. The expected cash flows were
discounted based on a rate that reflects the perceived risk of the CCR's, the
estimated weighted average cost of capital and SMC's asset mix. The Company is
amortizing the CCR's over a seven year weighted average life given the long
standing relationships SMC had with Verizon and SMECO. The Company recorded an
impairment loss with respect to CCR's for the twelve months ended January 31,
2005. (See Note 3)
Trade Name - The fair value of the SMC Trade Name was estimated using a
relief-from-royalty methodology. The Company has determined that the useful life
of the Trade Name is indefinite since it is expected to contribute directly to
future cash flows in perpetuity. The Company has also considered the effects of
demand and competition including its customer base. While SMC is not a
nationally recognized Trade Name, it is a regionally recognized name in Maryland
and the Mid-Atlantic region, SMC's primary region of operations.
The Company, using the relief-from-royalty method described above, tests the
Trade Name for impairment annually on November 1 and on an interim basis if
events or changes in circumstances between annual tests indicate the Trade Name
might be impaired. The Company recorded an impairment loss with respect to Trade
Name for the twelve months ended January 31, 2005. (See Note 3)
41
Proprietary Formulas - The Fair Value of the Proprietary Formulas (PF's) was
determined at the time of the acquisition of VLI by discounting the cash flows
expected from developed formulations based on relative technology contribution
and estimates regarding product lifecycle and development costs and time. The
expected cash flows were discounted based on the estimated contributory life of
the proprietary formulations utilizing estimated historical product lifecycles
and changes in technology. The Company is amortizing the PF's over a three-year
life based on the estimated contributory life of the proprietary formulations
utilizing estimated historical product lifecycles and changes in technology.
Non-Contractual Customer Relationships - The fair value of the Non-Contractual
Customer Relationships (NCR's) was determined at the time of acquisition of VLI
by discounting the net cash flows expected from existing customer revenues.
Although VLI does not operate using long-term contracts, historical experience
indicates that customers repeat orders due to the costs associated with changing
suppliers. VLI has had a relationship of five years or more with most of its
currently significant customers. The expected cash flows were discounted based
on a rate that reflects the perceived risk of the NCR's, the estimated weighted
average cost of capital and VLI's asset mix. The Company is amortizing the NCR's
over a five-year life based on the length of VLI's significant customer
relationships.
Non-Compete Agreement - The fair value of the Non-Compete Agreement (NCA) was
determined at the time of acquisition of VLI by discounting the estimated
reduction in the cash flows expected if one key employee, the former sole
shareholder of VLI, were to leave. The key employee signed a non-compete clause
prohibiting the employee from competing directly or indirectly for five years.
The estimated reduced cash flows were discounted based on a rate that reflects
the perceived risk of the NCA, the estimated weighted average cost of capital
and VLI's asset mix. The Company is amortizing the NCA over five years, the
length of the non-compete agreement.
Research and Development Expenditures - Vitarich Laboratories, Inc. - Research
and Development is a key component of VLI's business development efforts. VLI
develops product formulations for its customers. VLI focuses its research and
development capabilities particularly on new and emerging raw materials and
products. Research and development expenses relate primarily to VLI's
proprietary formulations and are expensed as incurred. The Company recorded
$12,000 of research and development expenses during the twelve months ended
January 31, 2005.
Income Taxes - The Company files a consolidated federal income tax return.
Deferred income taxes are provided for the temporary differences between the
financial reporting basis and the tax basis of its assets and liabilities.
Seasonality - The Company's telecom infrastructure services operations are
expected to 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 is primarily due to the effect of winter weather on 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.
Fair Value of Financial Instruments - The carrying amount of certain of the
Company's financial instruments, including investments, accounts receivable and
accounts payable, approximates fair value due to the relatively short maturity
of such instruments. The Company's variable rate short-term line of credit and
variable rate long-term debt approximate fair value.
Credit Risk - Financial instruments, which potentially subject the Company to
concentration of credit risk, consist principally of trade accounts receivable,
cash and investments.
AI's four largest customers, Southern Maryland Electric Cooperative (SMECO),
TriVita Corporation (TVC), General Dynamics Corp. (GD) and CyberWize.com, Inc.
(C) accounted for 23%, 17%, 14%, and 8%, respectively of consolidated net sales
for the year ended January 31, 2005. AI's three largest customers, Verizon
Communications, SMECO and GD account for 19%, 26% and 51%, respectively, of
consolidated net sales at January 31, 2004. The Company generally does not
require collateral and does not believe that it is exposed to significant credit
risk due to the credit worthiness of its customers.
The Company typically has had cash or short-term financial instruments on
deposit in a bank in excess of federally insured limits.
42
Income Per Share - (Loss) income per share is computed by dividing loss from
continuing operations, income (loss) from discontinued operations and net income
(loss) by the weighted average number of common shares outstanding for the
period. Outstanding stock options and warrants were anti-dilutive during the
years ended January 31, 2005 and 2004 due to the Company's loss from continuing
operations.
Stock Option Plans - For the year ended January 31, 2004, $5,000 in stock-based
compensation cost is reflected in net loss for stock options whose vesting date
was accelerated and which were exercised. All remaining option grants had an
exercise price equal to or greater than the market value of the underlying
common stock on the date of grant; consequently no cost was reflected in net
loss for the year ended January 31, 2005.
The Company continues to apply APB Opinion No. 25 and related interpretations to
its stock-based compensation awards. The fair value of the options granted in
fiscal 2005 and 2004 have been estimated at the date of grant using the
Black-Scholes option-pricing model. Option valuation models require the use of
subjective assumptions and changes in these assumptions can materially impact
the fair value of the options.
The Pro Forma disclosures required by SFAS No. 148 are reflected below:
Pro Forma Disclosures
For the years Ended January 31
2005 2004
=========== ===========
Net loss, as reported ($2,579,000) $ (597,000)
Add: Stock-based compensation recorded
in the financial statements -- 5,000
Deduct: Total stock-based employee compensation
expense determined under fair value
based methods (59,000) (145,000)
----------- -----------
Pro forma net loss $(2,638,000) $ (737,000)
=========== ===========
Basic and diluted loss per share:
Basic and diluted - as reported $ (1.20) $ (0.41)
=========== ===========
Basic and diluted - pro forma $ (1.23) $ (0.50)
=========== ===========
Weighted average fair value of options
granted $ 2.23 $ 3.58
Risk-free interest rate 3.49% 3.28%
Expected volatility 57% 60%
Expected life 5 years 10 years
Dividend yield 0% 0%
43
IMPACT OF CHANGES IN ACCOUNTING STANDARDS
In December 2004, the Financial Accounting Standards Board issued FASB Statement
No. 123 (revised 2004). Share-Based Payment ("SFAS 123(R) supersedes Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees and
amends FASB Statement No. 95, Statement of Cash Flows. SFAS 123(R) requires all
share-based payments to employees, including grants of employee stock options,
to be recognized in the income statement based on their fair values. Pro forma
disclosure is no longer an alternative. AI will adopt SFAS 123(R) on February 1,
2006. The Company has not determined the impact of adopting the new standard and
is continuing its analysis of the impact.
NOTE 2 - ACQUISITIONS
Vitarich Laboratories, Inc.
On August 31, 2004, the Company acquired, by merger, all of the common stock of
VLI, a developer, manufacturer and distributor of premium nutritional
supplements, whole-food dietary supplements and personal care products. The
Company's purchase of VLI is focused on acquiring VLI's long-standing customer
and exclusive vendor relationships and its well established position in the fast
growing global nutrition industry which supports the premium paid over the fair
value of the tangible assets acquired.
The results of operations of the acquired company are included in the
consolidated results of the Company from August 31, 2004, the date of
acquisition.
The estimated purchase price was approximately $6.7 million in cash, including
expenses, and 825,000 shares of the Company's common stock with fair value of
$5,132,000 or $6.22 per share utilizing the quoted market price two days before
and after the acquisition date. The Company also assumed approximately $1.6
million in debt. The merger agreement contains provisions for payment of
additional consideration ("Additional Consideration") by the Company to the
former VLI shareholder to be satisfied in the Company's common stock and cash if
certain Earnings Before Interest Taxes Depreciation and Amortization (EBITDA)
thresholds for the twelve months ended February 28, 2005 are met. To meet the
EBITDA thresholds, VLI must have adjusted EBITDA in excess of $2.3 million.
Results in excess of the adjusted EBITDA threshold serve as the basis to
determine the amount of additional payment. (See Note 15)
The merger agreement also provides that, if between the closing date and the
additional consideration payment date, the Company raises additional capital by
issuance of stock pursuant to a public or private offering for a price less than
$7.75 per share (the Additional Capital Subscription Price), then the number of
shares of the Company's common stock issued to Thomas as initial consideration
will be adjusted to the number of common shares that would have been issued at
the closing of the merger had the value of each share of the Company's common
stock been the Additional Capital Subscription Price. Any additional payments
earned under the terms of the purchase agreement will be recorded as an increase
in goodwill.
The Company's preliminary accounting for the acquisition of VLI uses the
purchase method of accounting whereby the excess of cost over the net amounts
assigned to assets acquired and liabilities assumed is allocated to goodwill and
intangible assets based on their estimated fair values. Such intangible assets
identified by the Company include $6,592,000, $2,500,000, $2,000,000 and
$1,800,000, respectfully, allocated to goodwill, Proprietary Formulas (PF),
Non-Contractual Customer Relationships (NCR) and a Non-Compete Agreement (NCA).
The Company is amortizing PF over three years and NCR and NCA over five years.
Accumulated amortization is $347,000, $167,000 and $150,000 at January 31, 2005,
respectively for PF, NCR and NCA. The aggregate amortization for each of the
five succeeding years is:
2006 $ 1,593,000
2007 1,593,000
2008 1,246,000
2009 760,000
2010 444,000
-----------
$ 5,636,000
===========
44
On January 31, 2005, the Company entered into a Debt Subordination Agreement
("Subordination Agreement") with Thomas, SMC (and together with the Company, the
"Debtor") and Bank of America, N.A. ("Lender") to reconstitute certain
Additional Consideration that Debtor will owe to Thomas as subordinated debt.
Except as otherwise provided in the Subordination Agreement and until such time
that the Superior Debt (as such term is defined in the Subordination Agreement)
is satisfied in full, Debtor shall not, among other things, directly or
indirectly, in any way, satisfy any part of the Junior Debt (as such term is
defined in the Subordination Agreement), nor shall Thomas, among other things,
enforce any part of the Junior Debt or accept payment from Debtor or any other
person for the Junior Debt or give any subordination in respect of the Junior
Debt.
Southern Maryland Cable, Inc.
On July 17, 2003, the Company acquired all of the common stock of SMC, a
provider of telecommunications and other infrastructure services including
project management, construction and maintenance to the Federal Government,
telecommunications and broadband service providers, as well as electric
utilities.
The results of operations of the acquired company are included in the
consolidated results of the Company from July 17, 2003, the date of the
acquisition. The purchase price was approximately $3.8 million in cash, plus the
assumption of approximately $971,000 in debt.
The Company accounted for the acquisition of SMC using the purchase method of
accounting whereby the excess of cost over the net amounts assigned to
identifiable assets acquired and liabilities assumed is allocated to goodwill
and intangible assets based on their estimated fair values. Such intangible
assets include $1,600,000 and $680,000 allocated to Contractual Customer
Relationships ("CCR") and Trade Name, respectively, and $1,680,000 to Goodwill.
The Company is amortizing the CCR over a weighted average life of seven years.
As of January 31, 2005, accumulated amortization was $290,000, excluding the
impairment loss. The Trade Name was determined to have an indefinite useful life
and is not being amortized. SMC's amortization of CCR for each of the next four
years ended January 31, 2006, 2007, 2008 and 2009 is $103,000 and for the year
ended January 31, 2010 is $69,000.
The following unaudited pro forma statements of operations for the twelve months
ended January 31, 2005 and 2004 does not purport to be indicative of the results
that would have actually been obtained if the aforementioned acquisitions had
occurred on February 1, 2003, or that may be obtained in the future. The pro
forma presentation also excludes the discontinued operations of PI. VLI and SMC
previously reported their results of operations using a calendar year end. No
material events occurred subsequent to this reporting period that would require
adjustment to our unaudited pro forma statements of operations. The number of
shares outstanding used in calculating pro forma earnings per share assume that
the shares issued in connection with the private offering in April 2003,
discussed in Note 7, and the 825,000 shares issued in connection with the
acquisition of VLI were outstanding since February 1, 2003.
Years Ended January 31
Pro Forma Statement Operations 2005 2004
============ ============
Net Sales $ 24,131,000 $ 25,124,000
Cost of goods sold 18,313,000 18,736,000
------------ ------------
Gross profit 5,818,000 6,388,000
Selling, general and administrative expenses 6,757,000 6,216,000
Impairment loss 1,942,000 --
------------ ------------
(Loss) income from operations (2,881,000) 172,000
Other expense, net (106,000) (15,000)
------------ ------------
(Loss) income from continuing operations before income taxes (2,987,000) 157,000
Income tax (benefit) provision (866,000) 55,000
------------ ------------
Net (loss) income from continuing operations $ (2,121,000) $ 102,000
============ ============
(Loss) Income per share:
- basic $ (0.81) $ 0.04
------------ ------------
- diluted $ (0.81) $ 0.04
------------ ------------
Weighted average shares outstanding:
- basic 2,631,000 2,624,000
------------ ------------
- diluted 2,631,000 2,624,000
------------ ------------
45
NOTE 3 - IMPAIRMENT OF GOODWILL AND OTHER INTANGIBLE ASSETS
During the three months ended July 31, 2004, the Company determined that both
events and changes in circumstances with respect to SMC's business climate would
have a significant effect on its future estimated cash flows. During the three
months ended July 31, 2004, SMC terminated a customer contract which had
historically provided positive margins and cash flows. In addition, SMC
experienced revenue levels well below expectations for its largest fixed-priced
contract customer. As a consequence, SMC has reduced its future forecasts and
expectations of cash flows. As a result of these events, the Company believed
that there was an indication that its intangible assets not subject to
amortization might be impaired. The Company determined the fair value of its
Goodwill and Trade Name and compared it to the respective carrying amounts. The
carrying amounts exceeded the Goodwill and Trade Name's respective fair values
by $740,000 and $456,000, respectively, which the Company recorded as an
impairment loss for the three months ended July 31, 2004.
During the three months ended July 31, 2004, the Company terminated the above
mentioned customer contract. The impact of the termination indicated that the
Company's CCR carrying amount was not fully recoverable. Accordingly, the
Company determined the fair value of the CCR's and compared it to its carrying
amount. The Company recorded an impairment loss of $746,000, as this was the
amount by which the CCR carrying amount exceeded its fair value.
NOTE 4 - RELATED PARTY TRANSACTIONS
On January 28, 2005, the Company sold and issued to MSR I SBIC, L.P., a Delaware
limited partnership ("Investor"), 129,032 shares (the "Shares") of common stock
of the Company pursuant to a Subscription Agreement dated as of January 28, 2005
between the Company and Investor (the "Subscription Agreement"). The Shares were
issued at a purchase price of $7.75 per share ("Share Price"), yielding
aggregate proceeds of $999,998. The Shares were issued pursuant to the exemption
provided by Section 4(2) of the Securities Act of 1933, as amended. The Investor
is an entity controlled by Daniel Levinson, a director of the Company.
Pursuant to the Subscription Agreement, the Company has agreed to issue
additional shares of Common Stock to Investor in accordance with the
Subscription Agreement under certain conditions upon the earlier of (i) the
Company's issuance of additional shares of Common Stock having an aggregate
purchase price of at least $2,500,000 for a consideration per share less than
the Share Price, subject to certain exclusions; and (ii) July 31, 2005. Shares
would be issued in amounts determined by reference to the prevailing thirty-day
average stock price. The number of additional shares to be issued would
effectively reduce the Investor's purchase price per common share as set forth
in the Subscription Agreement.
In addition, the Company has agreed, pursuant to a Registration Rights Agreement
dated as of January 28, 2005 between the Company and Investor, to file a
registration statement relating to the resale of the Shares by Investor, or any
of Investor's successors or permitted assigns, not later than 180 days following
January 28, 2005, subject to certain conditions. The resale of the shares were
registered under the Securities Act of 1933 on Form S-3, filed with the
Securities and Exchange Commission on February 25, 2005.
The Company leases administrative, manufacturing and warehouse facilities from
individuals who are officers of SMC and VLI. The total expense under these
arrangements were $134,000 and $72,000 for the years ended January 31, 2005 and
2004, respectively. The future minimum lease commitments under these
arrangements during each fiscal year ended January 31 through fiscal year ended
January 31, 2010 is:
2006 $ 290,000
2007 292,000
2008 231,000
2009 231,000
2010 152,000
Thereafter 714,000
----------
$1,910,000
==========
46
AI also entered into a supply agreement with an entity owned by the former
shareholder of VLI whereby the supplier committed to sell to AI and AI committed
to purchase on an as-needed basis, certain organic products. VLI made $47,000 in
purchases under the supply agreement for the period from acquisition (August 31,
2004) through January 31, 2005. At January 31, 2005, AI had an $8,000 note with
the aforementioned seller-owned entity.
The Company also sells its products in the normal course of business to an
entity in which the former owner of VLI has an ownership interest. The pricing
on such transactions is consistent with VLI's general customer pricing for
nonaffiliated entities. VLI had approximately $242,000 in sales with this entity
for the period from acquisition (August 31, 2004) to January 31, 2005. At
January 31, 2005, the affiliated entity owed $112,000 to VLI net of an allowance
for doubtful accounts of $84,000.
NOTE 5 - PROPERTY AND EQUIPMENT
Property and equipment consists of the following at January 31, 2005:
Estimated
2005 2004 Useful Lives
------------ ------------
Leasehold improvements $ 400,000 $ 184,000 5 to 20 years
Machinery and equipment 2,093,000 1,079,000 5 to 7 years
Trucks 889,000 823,000 5 to 7 years
------------ ------------
3,382,000 2,086,000
Less accumulated depreciation (679,000) (173,000)
------------ ------------
Property and equipment, net $ 2,703,000 $ 1,913,000
============ ============
Depreciation expense for the fiscal years ended January 31, 2005 and 2004 was
$508,000, and $173,000, respectively.
NOTE 6 - DEBT
In August, 2003, the Company entered into a financing arrangement with Bank of
America, N.A. ("Bank") aggregating $2,950,000 in available financing in two
facilities - a revolving line of credit with $1,750,000 in availability, having
an initial expiration of July 31, 2004 and bearing interest at LIBOR plus 2.75%,
and a three year term note with an original outstanding balance of $1,200,000,
expiring July 31, 2006 and bearing interest at LIBOR plus 2.95%. The proceeds
from the term note were used to pay off the SMC lines of credit and for working
capital.
In August 2004, the Company agreed to amend the existing financing arrangements
with the Bank whereby the revolving line of credit was increased to $3.5 million
in maximum availability, expiring May 31, 2005. Availability on a monthly basis
under the revolving line is determined by reference to accounts receivable and
inventory on hand which meet certain Bank criteria. On April 8, 2005, the
Company agreed to amend the existing financing arrangements with the Bank
whereby the revolving line of credit was increased to $4.25 million in maximum
availability, expiring May 31, 2006. Under the amended financing arrangements,
amounts outstanding under the revolving line of credit and the three year note
bear interest at LIBOR plus 3.25% and 3.45%, respectively. Availability on a
monthly basis under the revolving line is determined by reference to accounts
receivable and inventory on hand which meet certain Bank criteria. The
aforementioned three year note remains in effect and the final monthly scheduled
payment of $33,000 is due on July 31, 2006. As of January 31, 2005, the Company
had $600,000 outstanding under the term note and $1,659,000 outstanding under
the revolving line of credit.
The amended financing arrangement of August 2004 contains financial and
nonfinancial covenants including requiring that the ratio of debt to pro forma
earnings before interest, taxes, depreciation and amortization (EBITDA) not
exceed 2.5 to 1 (with the first test date being January 31, 2005); requiring a
pro forma fixed charge coverage ratio of not less than 1.25 to 1 (with the first
test date being January 31, 2005); and bank consent for acquisitions and
divestitures. The Company continues to pledge the majority of the Company's
assets to secure the financing arrangements. At January 31, 2005, the Company
was not in compliance with the ratio of debt to EBITDA. The financing
arrangements amended on April 8, 2005 waives the January 31, 2005 and April 30,
2005 measurement of certain financial covenants including requiring that the
ratio of debt to pro forma earnings before interest, taxes, depreciation and
amortization (EBITDA) not exceed 2.5 to 1 (with the next test date being July
31, 2005); requiring pro forma fixed charge coverage ratio not less than 1.25 to
1 (with the next test date being July 31, 2005). Bank 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. In
conjunction with the amendment, the Bank also released to the Company $300,000,
which it was holding in escrow as collateral in connection with the sale of PI.
47
Information regarding the three year term note as of January 31, 2005 is
included in the table below:
2005 2004
---------- ----------
Long term debt: current $ 400,000 $1,000,000
Weighted average interest rate at January 31 5.6% 4.35%
Weighted average borrowing outstanding throughout the fiscal year 800,000 $1,100,000
Weighted average interest rate during the fiscal year 4.9% 4.30%
Maximum outstanding during the year $1,000,000 $1,200,000
Principal paid during the fiscal year $ 400,000 $ 200,000
Minimum repayments of principal on the term notes are as follows for the fiscal
year ending January 31:
2006 $ 400,000
2007 200,000
------------
TOTAL $ 600,000
============
The Company has also separately financed vehicles and machinery which will be
substantially repaid over the next 53 months with a weighted average interest
rate of 5.28% and 6.67% at January 31, 2005 and 2004. Information regarding
these loans is included in the table below:
2005 2004
-------- --------
Long-term debt $543,000 $201,000
Less: Current portion 262,000 92,000
-------- --------
Long-term debt excluding
current portion $281,000 $109,000
======== ========
NOTE 7 - PRIVATE OFFERINGS OF COMMON STOCK
On January 28, 2005, the Company sold and issued to MSR I SBIC, L.P., a Delaware
limited partnership ("Investor"), 129,032 shares (the "Shares") of the Company's
common stock, pursuant to a Subscription Agreement dated as of January 28, 2005
between the Company and Investor. The Shares were issued at a purchase price of
$7.75 per share ("Share Price"), yielding aggregate proceeds of $999,998. The
Shares were issued pursuant to the exemption provided by Section 4(2) of the
Securities Act of 1933, as amended. The Investor is an entity controlled by
Daniel Levinson, a director of the Company. (See Note 4)
48
On April 29, 2003, the Company completed a private offering of approximately
1,304,000 shares of common stock at a price of $7.75 per share. The proceeds of
the private offering were approximately $10,107,000 prior to giving effect to
offering costs of $472,000, with additional future proceeds that may be derived
from the future exercise of 230,000 warrants issued in connection with the
private placement. The warrants were issued at an exercise price of $7.75 per
share and have a ten year term. A portion of the net proceeds of the private
placement was used in the acquisitions of VLI and SMC and in final payment of
the Company's credit facility with U.S. Bancorp. The remaining net proceeds were
used for working capital. The private offering was approved by shareholder vote
on April 15, 2003.
NOTE 8 - STOCK BASED COMPENSATION
The Company established a stock option plan (the "Plan") in August 2001,
pursuant to which the Company's Board of Directors (the "Board") may grant stock
options to officers, directors and key employees. The Plan, was amended in April
2003 to authorize the grant of options for up to 250,000 shares of common stock.
Under a previous plan, the Company had issued stock options to certain officers,
directors and key employees to purchase shares of its Common Stock within
prescribed periods at prices that varied between $3.75 to $12.15 per share. This
plan was terminated upon the consummation of the August 2001 Incentive Stock
Option Plan.
Stock options granted may be "Incentive Stock Options" ("ISOs") or "Nonqualified
Stock Options" ("NSOs"). ISOs have an exercise price at least equal to the
stock's fair market value at the date of grant, a ten-year term and vest and
become fully exercisable one year from the date of grant. NSOs may be granted at
an exercise price other than the stock's fair market value at the date of grant
and have up to a ten-year term, and vest and become fully exercisable as
determined by the Board.
During fiscal 2005, the Board granted 3,000 ISO's and 35,000 NSO's to employees.
The ISO's and NSO's were granted at $7.75 per share and generally vest over one
year with a maximum life of five years.
During fiscal 2004, the Board granted 20,000 ISOs and 30,000 NSOs to employees
and Directors. The ISOs and NSOs were granted at $7.90 per share.
Stock option activity is as follows:
No. of Average
Options Exercise Price
--------- --------------
Balance at January 31, 2003 18,000 $ 7.77
Granted 50,000 $ 7.90
Exercised (5,000) $ 5.47
Forfeited (9,000) $ 7.98
--------- --------------
Balance at January 31, 2004 54,000 $ 8.04
Granted 38,000 $ 7.75
Exercised (2,000) $ 5.70
Forfeited (8,000) $ 8.53
--------- --------------
Balance at January 31, 2005 82,000 $ 7.83
========= ==============
At January 31, 2005, the range of exercise prices, the number of options
outstanding and the weighted average remaining contractual life of these options
are as follows:
Exercise No. of Weighted Average
Price Options Remaining Life
----- ------- --------------
$ 7.75 37,000 5.1
$ 7.90 45,000 3.5
------- --------------
82,000 4.2
======= ==============
49
At January 31, 2005 and 2004, 45,000 and 6,000 options, respectively, were
exercisable at a weighted average exercise price of $7.90 and $5.70,
respectively.
In connection with the Company's private placement in April 2003, the Company
issued warrants to purchase 230,000 shares of the Company's common stock at a
price of $7.75 per share with a ten year term. 180,000 of the warrants were
granted to three individuals who became the executive officers of the Company
upon completion of the offering. In addition, MSR Advisors, Inc. ("MSR")
received warrants to purchase 50,000 shares of the Company's common stock. A
director of the Company is the Chief Executive Officer of MSR. The fair value of
the warrants of $849,000 was recognized as offering costs. All warrants are
exercisable.
At January 31, 2005, there were 474,000 shares of the Company's common stock
reserved for issuance upon exercise of stock options and warrants.
NOTE 9 - INCOME TAXES
Income tax (benefit) expense related to continuing operations for the years
ended January 31, 2005 and 2004 is as follows:
2005 2004
=========== ===========
Current:
Federal $ -- $ --
State 63,000 31,000
----------- -----------
63,000 31,000
=========== ===========
Deferred:
Federal (934,000) (268,000)
State (174,000) (52,000)
----------- -----------
(1,108,000) (320,000)
----------- -----------
Total tax benefit ($1,045,000) ($ 289,000)
=========== ===========
The actual income tax benefit for the years ended January 31, 2005 and 2004
differs from the "expected" tax computed by applying the U.S. Federal corporate
income tax rate of 34% to income from continuing operations before income tax as
follows:
2005 2004
=========== ===========
Computed "expected" tax benefit $(1,232,000) $ (106,000)
Increase (decrease) resulting from:
State income taxes, net (100,000) 17,000
Permanent differences 287,000 4,000
Net operating loss of discontinued operations(a) -- (187,000)
Other -- (17,000)
----------- -----------
$(1,045,000) $ (289,000)
=========== ===========
(a) The fiscal 2004 loss from operations generated by Puroflow prior to its
disposition is included in (loss) income from discontinued operations for
financial reporting purposes; however, such loss is included in Argan's
consolidated taxable income (loss) for income tax reporting purposes.
50
The tax effects of temporary differences for continuing operations that give
rise to deferred tax assets and liabilities at January 31, 2005 and 2004 are as
follows:
2005 2004
========== ==========
Assets:
Accrued bonus $ -- $ 58,000
Inventory and receivable reserves 56,000 --
Accrued vacation 41,000 --
Accrued WFC claim 98,000 --
Net operating loss 324,000 187,000
---------- ----------
519,000 245,000
---------- ----------
Liabilities:
SMC cash to accrual adjustment 172,000 246,000
Property and equipment 578,000 412,000
Purchased intangibles 2,429,000 832,000
Other 4,000 7,000
---------- ----------
3,183,000 1,497,000
---------- ----------
Net deferred tax liabilities $2,664,000 $1,252,000
========== ==========
At January 31, 2005, AI has a net operating loss carryforward aggregating
$858,000 which expires in 2024 and 2025.
NOTE 10 - SEGMENT REPORTING
Effective with the acquisition of VLI, the Company has two operating segments.
Operating segments are defined as components of an enterprise about which
separate financial information is available that is evaluated regularly by the
chief operating decision maker, or decision making group, in deciding how to
allocate resources and assessing performance.
The Company's two reportable segments are telecom infrastructure services and
nutraceutical products. The Company conducts its operations through its wholly
owned subsidiaries - VLI and SMC. The "Other" column includes the Company's
corporate and unallocated expenses.
The Company's reportable segments are organized in separate business units with
different management, customers, technology and services. The respective
segments account for the respective businesses using the accounting policies in
Note 1. Summarized financial information concerning the Company's reportable
segments is shown in the following tables:
For the Twelve Months
Ended January 31, 2005
Telecom
Nutraceutical Infrastructure
Products(1) Services Other Consolidated
------------ ------------ ------------ ------------
Net sales $ 6,805,000 $ 7,713,000 $ -- $ 14,518,000
Cost of goods sold 4,774,000 6,559,000 -- 11,333,000
------------ ------------ ------------ ------------
Gross profit 2,031,000 1,154,000 -- 3,185,000
Selling, general and
administrative expenses 1,630,000 1,590,000 1,590,000 4,810,000
Impairment loss -- 1,942,000 -- 1,942,000
------------ ------------ ------------ ------------
Income (Loss) from operations 401,000 (2,378,000) (1,590,000) (3,567,000)
Interest expense 73,000 48,000 3,000 124,000
Other income, net -- (6,000) (61,000) (67,000)
------------ ------------ ------------ ------------
Income (loss) from continuing
operations before income taxes $ 328,000 $ (2,420,000) $ (1,532,000) (3,624,000)
============ ============ ============ ------------
Income tax benefit 1,045,000
------------
Net loss $ (2,579,000)
============
Depreciation $ 122,000 $ 384,000 $ 2,000 $ 508,000
============ ============ ============ ============
Amortization of intangibles $ 664,000 $ 166,000 $ 39,000 $ 869,000
============ ============ ============ ============
Goodwill $ 6,592,000 $ 940,000 -- $ 7,532,000
============ ============ ============ ============
Total Assets $ 19,310,000 $ 5,007,000 $ 621,000 $ 24,938,000
============ ============ ============ ============
(1) Operating results of VLI are included since date of acquisition,
August 31, 2004.
51
The Company has customers whose sales represent a significant portion of
enterprise and segment net sales. Nutraceutical sales to two customers, TriVita
Corporation and Cyberwize.com, Inc., accounted for 17% and 8% of consolidated
net sales, respectively, while telecom infrastructure services to two customers,
Southern Maryland Electric Cooperative and General Dynamics Corp. aggregated 23%
and 14% respectively, of consolidated net sales.
NOTE 11 - COMMITMENTS AND CONTINGENCIES
The Company and its subsidiaries have entered into various non-cancelable
operating leases for facilities, machinery, equipment and trucks. Total rent
expense for all operating leases including related parties was approximately
$268,000 and $75,000 for the years ended January 31, 2005 and 2004,
respectively. The following is a schedule of future minimum lease payments for
operating leases that had initial or remaining non-cancelable lease terms in
excess of one year as of January 31, 2005:
2006 $ 478,000
2007 449,000
2008 365,000
2009 298,000
2010 152,000
Thereafter 714,000
------------
$ 2,456,000
============
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 the current claims and proceedings will
have a material effect on the Company's consolidated financial statements.
NOTE 12 - WESTERN FILTER CORPORATION LITIGATION
During the twelve months ended January 31, 2005, WFC notified the Company
asserting that the Company breached certain representations and warranties under
the Stock Purchase Agreement. WFC asserts damages in excess of the $300,000
escrow which is being held by a third party in connection with the Stock
Purchase Agreement.
The Company has reviewed WFC's claim and believes that substantially all of the
claims are without merit. The Company will vigorously contest WFC's claim.
On March 22, 2005, WFC filed a complaint in Los Angeles Superior Court alleging
the Company and its executive officers, individually, committed breach of
contract, intentional misrepresentation, concealment and non-disclosure,
negligent misrepresentation and false promise. WFC seeks declaratory relief and
compensatory and punitive damages in an amount to be proven at trial as well as
the recovery of attorneys' fees.
During the twelve months ended January 31, 2005, the Company recorded an accrual
related to this matter of $260,000 for losses and legal fees related to WFC's
claim that it considers to be probable and that can be reasonably estimated.
Although the ultimate amount of liability at January 31, 2005, that may result
from this matter for which the Company has recorded an accrual is not
ascertainable, the Company believes that any amounts exceeding the
aforementioned accrual should not materially affect the Company's financial
condition. It is possible, however, that the ultimate resolution of WFC's claim
could result in a material adverse effect on the Company's results of operations
for a particular reporting period.
52
NOTE 13 - DEFINED CONTRIBUTION PLAN
The Company has a 401-(K) Savings Plan covering all of its employees, whereby
the Company makes discretionary contributions for its eligible employees. The
Company's expense for these defined contribution plans totaled $17,000 and
$15,000 for the years ended January 31, 2005 and 2004, respectively.
NOTE 14 - DISCONTINUED OPERATIONS
Part A - Sale of PI and Restatement of Financial Statements
On October 31, 2003, AI, as part of its plan to reallocate its capital to its
acquisition program, sold PI to WFC. The sales price of approximately $3,500,000
was satisfied in cash of which $300,000 is being held in escrow to indemnify WFC
from any damages resulting from a breach of representation and warranties under
the Stock Purchase Agreement. (See Note 12) AI recognized a gain on sale of
approximately $167,000, net of income taxes of $506,000. The Company utilized
net operating losses to offset the gain on sale and thus, has no current tax
liability. The $506,000 is the amount of the deferred tax assets related to PI
which has been sold. In accordance with SFAS No. 144 "Accounting for the
impairment or disposal of Long-Lived Assets," the Company classified the
operating results of PI as discontinued operations in the accompanying
statements of operations.
The results of the discontinued operations which are included in the
Consolidated statement of operations for the year ended January 31, 2004 is as
follows:
Year Ended
January 31, 2004
---------------
Net sales $ 5,050,000
Cost of goods sold 3,834,000
---------------
Gross profit 1,216,000
Selling, general and administrative expenses 1,701,000
---------------
Operating (loss) income from discontinued operations (485,000)
Other (expense) income (11,000)
---------------
(Loss) income from discontinued operations
before income taxes (496,000)
Income tax expense 245,000
Gain from discontinued operations, net of
income tax expense of $506,000 167,000
---------------
(Loss) income from discontinued operations $ (574,000)
===============
RESEARCH AND DEVELOPMENT EXPENSES OF DISCONTINUED OPERATIONS
Research and development expenditures are expensed as incurred and are
approximately $78,000 for the year ended January 31, 2004.
SEGMENT REPORTING OF DISCONTINUED OPERATIONS
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information" establishes standards for reporting information about operating
segments in interim financial reports issued to stockholders. It also
establishes standards for related disclosures about products and services and
geographic areas. Operating segments are defined as components of an enterprise
about which separate financial information is available that is evaluated
regularly by the chief operating decision maker, or decision making group, in
deciding how to allocate resources and assessing performance.
53
PI's two reportable segments were aerospace filter manufacturing and air bag
filter manufacturing. PI manufactured both lines of filters at a single
manufacturing facility utilizing in common PI's employees, physical plant and
sales force. Puroflow manufactured and sold a broad range of filtration products
for original equipment manufacturers, military users, government direct,
automotive and aviation aftermarket users, as well as a number of commercial and
industrial applications.
PI's reportable segments were primarily two categories of products sold to
different customers. The respective segments had common use of PI's
manufacturing employees and facilities, as well as selling and administrative
employees. The segments accounted for the respective businesses using the same
accounting policies used in the consolidated financial statements. Financial
information concerning PI's reportable segments is shown in the following
tables.
54
YEAR ENDED
January 31, 2004
Aerospace Air Bag
Manufacturing Manufacturing Total
----------- ----------- -----------
External sales $ 4,053,000 $ 997,000 $ 5,050,000
Cost of goods sold 3,082,000 752,000 3,834,000
----------- ----------- -----------
Gross profit $ 971,000 $ 245,000 $ 1,216,000
=========== =========== ===========
PI operated out of one manufacturing facility and did not identify commonly used
assets and related costs for an individual segment. In addition, selling,
general and administrative costs were not separately captured for each segment.
NOTE 15 - SUBSEQUENT EVENTS
On August 31, 2004, AI acquired VLI under a merger agreement, which provides,
that in addition to the initial consideration of $6,050,000 and 825,000 shares
of AI common stock, Thomas, the former owner, shall have the right to receive
additional consideration equal to (1) 5.5 times the adjusted EBITDA of VLI for
the twelve months ended February 28, 2005, (b) less the initial consideration.
The merger agreement provided that the additional consideration would be paid
one-half in cash and one-half in AI common stock. AI's preliminary estimate of
the additional consideration is approximately $2.7 million in cash and
approximately 350,000 shares of AI common stock. The cash portion of the
additional consideration will be paid on August 1, 2006 subject to a
subordination agreement entered into between AI and Kevin Thomas. (See Note 2)
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 8A. CONTROLS AND PROCEDURES.
The Company, under the supervision and with the participation of our Chief
Executive Officer and Chief Financial Officer, carried out an evaluation of the
effectiveness of the Company's disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e), as of the end of the period covered
by this Annual Report on Form 10-KSB. Based on that evaluation, the Chief
Executive Officer and the Chief Financial Officer each concluded that the
Company's disclosure controls and procedures are effective in providing
reasonable assurance that information required to be disclosed by the Company in
reports that it files under the Securities Exchange Act of 1934, as amended, is
recorded, processed, summarized and reported within the time periods specified
by the rules and forms of the Securities and Exchange Commission.
There were no changes in the Company's internal control over financial reporting
that occurred during the Company's most recent fiscal quarter that have
materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting. The Chief Executive Officer
and Chief Financial Officer of the Company have provided the Certifications
required by Sections 302 and 906 of the Sarbanes-Oxley Act of 2002 as Exhibits
31.1, 31.2, 32.1 and 32.2.
ITEM 8B. OTHER INFORMATION
None.
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(a) OF THE EXCHANGE ACT
We have adopted a Code of Ethics applicable to our principal executive officer
and our principal financial and accounting officer and executive vice president,
a copy of which is filed as an exhibit to our annual report on Form 10-KSB filed
with the SEC on April 27, 2004 and which is posted on our website at
www.arganinc.com. A copy of the Code of Ethics may also be obtained without
charge by writing to Mr. Haywood Miller, Executive Vice President and Secretary,
Argan, Inc., One Church Street, Suite 302, Rockville, Maryland 20850.
The remaining information required under this item is incorporated by reference
to the Company's Proxy Statement for the 2005 Annual Meeting of Stockholders to
be filed within 120 days of the end of the fiscal year covered by this report.
55
ITEM 10. EXECUTIVE COMPENSATION
The information required under this item is incorporated by reference to the
Company's Proxy Statement for the 2005 Annual Meeting of Stockholders to be
filed within 120 days of the end of the fiscal year covered by this report.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information required under this item is incorporated by reference to the
Company's Proxy Statement for the 2005 Annual Meeting of Stockholders to be
filed within 120 days of the end of the fiscal year covered by this report.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required under this item is incorporated by reference to the
Company's Proxy Statement for the 2005 Annual Meeting of Stockholders to be
filed within 120 days of the end of the fiscal year covered by this report.
ITEM 13. EXHIBITS
Exhibit No. Description
================================================================================
3.1 Certificate of Incorporation, as amended.(5)
3.2 Bylaws.(1)
10.6 2001 Incentive Stock Option Plan.(2)
10.7 Financing and Security Agreement dated as of August 19, 2003
among Puroflow Incorporated, Southern Maryland Cable, Inc. and
Bank of America, N.A. (3)
10.8 First Amendment to Financing and Security Agreement dated as
of February 27, 2004.(5)
10.9 Form of Subscription Agreement, dated as of April 29, 2003, by
and among the Company and Investors in the April 29, 2003
private placement.(4)
10.10 Registration Rights Agreement, dated as of April 29, 2003, by
and among the Company and the Investors in the April 29, 2003
private placement.(4)
10.11 Form of Common Stock Purchase Warrant dated April 29, 2003.(5)
10.12 Agreement and Plan of Merger dated July 17, 2003 by and
between Southern Maryland Cable, Inc., Puroflow Incorporated,
and PFLW/SMC Acquisition Corporation.(9)
10.13 Agreement and Plan of Merger dated as of August 31, 2004 by
and between Kevin J. Thomas, Vitarich Laboratories, Inc.,
Argan, Inc., and AGAX/VLI Acquisition Corporation.(7)
10.14 Registration Right Agreement dated as of August 31, 2004 by
and between Argan, Inc. and Kevin J. Thomas .(6)
10.15 Employment Agreement dated as of August 31, 2004 by and
between AGAX/VLI Acquisition Corporation and Kevin J.
Thomas.(6)
10.16 Third Amendment to Financing and Security Agreement as of
August 19, 2003 dated as of August 31, 2004 by and among
Argan, Inc., Southern Maryland Cable, Inc., and AGAX/VLI
Acquisition Corporation, as borrowers, in favor of Bank of
America, N.A., as lender.(6)
10.17 Amended and Restated Revolving Credit Note dated as of August
31, 2004 by and among Argan, Inc., Southern Maryland Cable,
Inc., and AGAX/VLI Acquisition Corporation, as Borrowers, in
favor of Bank of America, N.A., as lender. (6)
56
10.18 First Amendment to Term Note dated as of June 29, 2004 by and
among Argan, Inc., Southern Maryland Cable, Inc., as
borrowers, and Bank of America, N.A., as lender. (6)
10.19 Additional Borrowers Joinder Supplement dated as of August 31,
2004, by and among Argan, Inc., the other Existing Borrowers
(as such term is defined in the agreement) and AGAX/VLI
Acquisition Corporation, as borrowers, and Bank of America,
N.A., as lender. (6)
10.20 Employment Agreement dated as of January 3, 2005 by and
between Argan, Inc. and Rainer H. Bosselmann.(8)
10.21 Employment Agreement dated as of January 3, 2005 by and
between Argan, Inc. and H. Haywood Miller, III.(8)
10.22 Employment Agreement dated as of January 3, 2005 by and
between Argan, Inc. and Arthur F. Trudel, Jr.(8)
10.23 Debt Subordination Agreement dated as of January 31, 2005 by
and among Argan, Inc., Kevin J. Thomas, Southern Maryland
Cable, Inc., and Bank of America, N.A. (includes as Exhibit A,
a Form of Subordinated Term Note). (10)
10.24 Financing and Security Agreement dated as of August 19, 2003
among Puroflow Incorporated, Southern Maryland Cable, Inc.,
and Bank of America, N.A. (11)
14.1 Code of Ethics.(5)
----------------
(1) Incorporated by reference to the Company's Registration
Statement on Form S-1, filed with the Securities and Exchange
Commission on October 15, 1991, (Registration No. 33-43228).
(2) Incorporated by reference to the Company's Proxy Statement
filed on Schedule 14A with the Securities and Exchange
Commission on August 6, 2001.
(3) Incorporated by reference to the Company's Form 10-QSB filed
with the Securities and Exchange Commission on December 12,
2003.
(4) Incorporated by reference to the Company's Form S-3/A filed
with the Securities and Exchange Commission on January 29,
2004.
(5) Incorporated by reference to Company's Form 10-KSB filed with
the Securities and Exchange Commission on April 27, 2004.
(6) Incorporated by reference to the Company's Form 8-K filed with
the Securities and Exchange Commission on September 7, 2004.
(7) Incorporated by reference to the Company's Form 8-K/A filed
with the Securities and Exchange Commission on September 17,
2004.
(8) Incorporated by reference to the Company's Form 8-K dated
January 3, 2005, filed with the Securities and Exchange
Commission on January 5, 2005.
(9) Incorporated by reference to the Company's Form 8-K dated July
17, 2003, filed with the Securities and Exchange Commission on
July 29, 2003.
(10) Incorporated by reference to the Company's Form 8-K dated
January 31, 2005, filed with the Securities and Exchange
Commission on February 4, 2005.
(11) Incorporated by reference to the Company's Form 10-QSB, filed
with the Securities and Exchange Commission on December 15,
2003.
57
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The Information required under this item is incorporated by reference to the
Company's Proxy Statement for the 2005 Annual Meeting of Stockholders to be
filed within 120 days of the end of the fiscal year covered by this report.
58
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
ARGAN, INC.
By: /s/ Rainer H. Bosselmann
-------------------------------------------------
Rainer H. Bosselmann
Chairman of the Board and Chief Executive Officer
Dated: April 26, 2005
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
Name Title Date
/s/ Rainer H. Bosselmann Chairman of the Board April 26, 2005
------------------------------ and Chief Executive Officer
Rainer H. Bosselmann (Principal Executive Officer)
/s/ Arthur F. Trudel Senior Vice President April 26, 2005
------------------------------ and Chief Financial Officer
Arthur F. Trudel (Principal Accounting and Financial Officer)
/s/ DeSoto S. Jordan Director April 26, 2005
------------------------------
DeSoto S. Jordan
/s/ Daniel A. Levinson Director April 26, 2005
------------------------------
Daniel A. Levinson
/s/ T. Kent Pugmire Director April 26, 2005
------------------------------
T. Kent Pugmire
/s/ James W. Quinn Director April 26, 2005
------------------------------
James W. Quinn
/s/ Peter L. Winslow Director April 26, 2005
------------------------------
Peter L. Winslow
/s/ W. G. Champion Mitchell Director April 26, 2005
------------------------------
W. G. Champion Mitchell
59
EXHIBIT INDEX
Exhibit No. Description
--------------------------------------------------------------------------------
21 Subsidiaries of the Company.
23 Consent of Ernst & Young LLP, Independent Registered Public
Accounting Firm.
31.1 Certification of CEO required by Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of CFO required by Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of CEO required by Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of CFO required by Section 906 of the
Sarbanes-Oxley Act of 2002.
60