UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended April 30, 2005 Commission File Number 001-31756
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Argan, Inc.
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(Exact name of small business issuer as specified in its charter)
DELAWARE 13-1947195
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(State or other jurisdiction of incorporation (IRS Employer identification No.)
or organization)
One Church Street, Suite 302, Rockville MD 20850
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(Address of principal executive offices) (ZIP Code)
Issuer's telephone number, including area code: (301) 315-0027
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 twelve 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 |_|
Securities registered pursuant to Section 12(b) of the Act:
Common Stock Shares outstanding
Common Stock, $.15 Par Value 2,758,845 as of June __, 2005
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Transitional Small Business Disclosure Format (Check One): Yes |_| No |X|
ARGAN, INC.
INDEX
Page No.
PART I. FINANCIAL INFORMATION..................................................3
Item 1. Financial Statements...................................................3
Condensed Consolidated Balance Sheets - April 30, 2005 and January 31, 2005....3
Condensed Consolidated Statements of Operations for the Three Months
Ended April 30, 2005 and 2004.....................................4
Condensed Consolidated Statements of Cash Flows for the Three Months
Ended April 30, 2005 and 2004......................................5
Notes to Condensed Consolidated Financial Statements...........................6
Item 2. Management's Discussion and Analysis or Plan of Operation.............13
Item 3. Controls and Procedures...............................................23
PART II. OTHER INFORMATION...................................................23
Item 1. Legal Proceedings....................................................23
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds..........23
Item 3. Defaults Upon Senior Securities......................................23
Item 4. Submission of Matters to a Vote of Security Holders..................24
Item 5. Other Information....................................................24
Item 6. Exhibits.............................................................24
SIGNATURES....................................................................25
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2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ARGAN, INC.
Condensed Consolidated Balance Sheets
(Unaudited)
April 30, January 31,
2005 2005
============ ============
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 107,000 $ 167,000
Accounts receivable, net 3,751,000 2,951,000
Receivable from affiliated entity, net 134,000 112,000
Escrowed cash 300,000 604,000
Estimated earnings in excess of billings 365,000 323,000
Inventories, net 3,259,000 3,465,000
Prepaid expenses and other current assets 680,000 622,000
------------ ------------
TOTAL CURRENT ASSETS 8,596,000 8,244,000
------------ ------------
Property and equipment, net 2,644,000 2,703,000
Other assets 35,000 35,000
Contractual customer relationships, net 539,000 564,000
Trade name 224,000 224,000
Proprietary formulas, net 1,944,000 2,153,000
Non-contractual customer relationships, net 1,733,000 1,833,000
Non-compete agreement, net 1,560,000 1,650,000
Goodwill 12,461,000 7,532,000
------------ ------------
TOTAL ASSETS $ 29,736,000 $ 24,938,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,990,000 $ 1,803,000
Billings in excess of cost and earnings 6,000 --
Due to affiliates -- 47,000
Accrued expenses 1,230,000 1,187,000
Deferred income tax liability 119,000 144,000
Line of credit 1,661,000 1,659,000
Current portion of long-term debt 557,000 662,000
------------ ------------
TOTAL CURRENT LIABILITIES 5,563,000 5,502,000
------------ ------------
Deferred income tax liability 2,556,000 2,520,000
Deferred rent 12,000 --
Long-term debt 362,000 481,000
Long-term subordinated debt due to former owner of Vitarich
Laboratories, Inc. 4,788,000 --
STOCKHOLDERS' EQUITY
Preferred stock, par value $.10 per share -
500,000 shares authorized- issued - none
Common stock, par value $.15 per share -
12,000,000 shares authorized -2,762,078 shares
issued at April 30, 2005 and January 31, 2005 and
2,758,845 shares outstanding at April 30, 2005 and
January 31, 2005 414,000 414,000
Warrants outstanding 849,000 849,000
Additional paid-in capital 20,121,000 20,121,000
Accumulated deficit (4,896,000) (4,916,000)
Treasury stock at cost:
3,233 shares at April 30, 2005 and January 31, 2005 (33,000) (33,000)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 16,455,000 16,435,000
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 29,736,000 $ 24,938,000
============ ============
See Accompanying Notes.
3
ARGAN, INC.
Condensed Consolidated Statements of Operations
(Unaudited)
Three months ended April 30,
2005 2004
============ ============
Net sales $ 7,156,000 $ 1,807,000
Cost of goods sold 5,181,000 1,608,000
------------ ------------
Gross profit 1,975,000 199,000
Selling, general and administrative expenses 1,891,000 791,000
------------ ------------
Income (loss) from operations 84,000 (592,000)
Interest expense 56,000 7,000
Other income, net (4,000) (29,000)
------------ ------------
Income (loss) from operations before income taxes 32,000 (570,000)
Income tax provision (benefit) 12,000 (218,000)
------------ ------------
Net income (loss) $ 20,000 ($ 352,000)
============ ============
Income (loss) per share:
- Basic $ 0.01 $ (0.20)
============ ============
- Diluted $ 0.01 $ (0.20)
============ ============
Weighted average number of shares outstanding:
- Basic 2,992,000 1,803,000
============ ============
- Diluted 3,460,000 1,803,000
============ ============
See Accompanying Notes.
4
ARGAN, INC.
Consolidated Statements of Cash Flows
(unaudited)
Three Months Ended
April 30,
2005 2004
============ ============
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 20,000 $ (352,000)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation and amortization 195,000 95,000
Amortization of purchase intangibles 424,000 61,000
Deferred income taxes 11,000 (222,000)
Changes in operating assets and liabilities:
Accounts receivable, net (800,000) 640,000
Receivable from affiliated entity, net (22,000) --
Escrowed cash 304,000 --
Estimated earnings in excess of billings (42,000) 10,000
Inventories, net 206,000 --
Prepaid expenses and other current assets (58,000) (117,000)
Accounts payable and accrued expenses 60,000 (522,000)
Billings in excess of estimated earnings 6,000 8,000
Due to affiliates (47,000) --
Other 23,000 5,000
------------ ------------
Net cash provided by (used in) operating activities 280,000 (394,000)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of investments -- (19,500,000)
Redemptions of investments -- 17,000,000
Purchases of property and equipment (118,000) (22,000)
------------ ------------
Net cash used in investing activities (118,000) (2,522,000)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from short-term debt 600,000 --
Proceeds from long-term debt 8,000 --
Payments on line of credit (598,000) --
Principal payments on term debt (232,000) (123,000)
------------ ------------
Net cash used in financing activities (222,000) (123,000)
------------ ------------
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 167,000 5,212,000
NET DECREASE IN CASH AND CASH EQUIVALENTS (60,000) (3,039,000)
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 107,000 $ 2,173,000
============ ============
See Accompanying Notes.
5
ARGAN, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1- ORGANIZATION AND BASIS OF PRESENTATION
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.
The Company operates in two reportable segments. (See Note 7)
MANAGEMENT'S PLANS, LIQUIDITY AND BUSINESS RISKS
As of April 30, 2005, the Company had an accumulated deficit of $4.9 million.
Further, as a result of recurring losses, the Company has historically
experienced negative cash flows from operations. At April 30, 2005, the Company
had $2.5 million available under its revolving line of credit with the Bank of
America, N.A. (the Bank). The Company operates in two 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 Notes 4 and 6)
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 the Company in default
of its current financing arrangement with the Bank. (See Notes 3 and 9)
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 $304,000 in cash to
the Company which it was holding in escrow as collateral. (See Note 5)
6
During the three months ended April 30, 2005, the Company had positive cash
flows from operations of $280,000.
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.
BASIS OF PRESENTATION
The condensed consolidated balance sheet as of April 30, 2005 and the condensed
consolidated statements of operations and cash flows for the three months ended
April 30, 2005 and 2004, respectively, are unaudited. In the opinion of
management, the accompanying financial statements contain all adjustments, which
are of a normal and recurring nature, considered necessary to present fairly the
financial position of the Company as of April 30, 2005 and the results of its
operations and its cash flows for the periods presented. The Company prepares
its interim financial information using the same accounting principles as it
does for its annual financial statements.
These financial statements do not include all disclosures associated with annual
financial statements and, accordingly, should be read in conjunction with the
footnotes contained in the Company's consolidated financial statements for the
year ended January 31, 2005, together with the independent registered public
accounting firm's report, included in the Company's Annual Report on Form
10-KSB, as filed with the Securities and Exchange Commission. The results of
operations for any interim period are not necessarily indicative of the results
of operations for any other interim period or for a full fiscal year.
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES
Inventories - Inventories are stated at the lower of cost or market (net
realizable value). Cost is determined on the 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 April 30, 2005 consist of the following:
Raw materials $ 2,735,000
Work-in process 154,000
Finished goods 370,000
-------------
$ 3,259,000
=============
Income Per Share - Income (loss) per share is computed by dividing net income
(loss) by the weighted average number of common shares outstanding for the
period. Diluted income per share reflects the maximum dilution that would have
resulted from contingently issuable shares. Diluted income per share is computed
by dividing net income by the weighted average number of common shares and all
dilutive securities.
7
Outstanding stock options and warrants were antidilutive during the three months
ended April 30, 2005 and 2004. The option and warrant exercise prices exceeded
the average market price per share for the three months ended April 30, 2005 and
2004.
For the Three Months
Ended April 30, 2005
Earnings Net
Per Share Shares Income
-------------- -------------- --------------
Basic $ 0.01 2,992,000 $ 20,000
Effect of estimated contingently issuable shares -- 468,000 --
-------------- -------------- --------------
Diluted $ 0.01 3,460,000 $ 20,000
============== ============== ==============
The contingently issuable shares represent additional shares the Company
estimates it will issue in connection with the acquisition of VLI and the sale
and issuance of common stock to MSRI SBIC, L.P.
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.
Stock Issued to Employees -The Company follows Accounting Principles Board
Opinion 25, Accounting for Stock Issued to Employees, to account for stock
option plans, which generally does not require income statement recognition of
options granted at the market price on the date of issuance.
The Pro Forma disclosures required by Statement of Financial Accounting
Standards No. 148 "Accounting for Stock Based Compensation" are reflected below:
Pro Forma Disclosures
For the three months ended April 30,
2005 2004
============ ============
Net income (loss), as reported $ 20,000 $ (352,000)
Add: Stock based compensation recorded
in the financial statements -- --
Deduct: Total stock-based employee compensation
expense determined under fair value based methods 20,000 18,000
------------ ------------
Pro forma net loss -- $ (370,000)
============ ============
Basic and diluted per share:
Basic and diluted - as reported -- $ (0.20)
============ ============
Basic and diluted - pro forma -- $ (0.21)
============ ============
IMPACT OF CHANGES IN ACCOUNTING STANDARDS
In December 2004, the Financing 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 of Cash Flows. SFAS 123(R) requires all share-based
8
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. The Company will adopt SFAS 123(R) on
February 1, 2006. The Company has not determined the impact of adopting the new
standards and is continuing its analysis of the impact.
NOTE 3- ACQUISITION OF 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 was focused on acquiring VLI's long-standing customer
and exclusive vendor relationships and its well established position in the fast
growing global nutrition industry, each of 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.
The Company's preliminary estimate of the Additional Consideration is
approximately $2.7 million in cash and approximately 350,000 shares of AI common
stock with an estimated value of $2.1 million. The Company is in the process of
reviewing and finalizing the calculation of the amount of Additional
Consideration.
On January 31, the Company entered into a debt subordination agreement with
Thomas, the former owner of VLI, SMC and the Bank, to reconstitute the cash
portion of the Additional Consideration as subordinated debt payable on August
1, 2006 unless such payment would put the Company in default of its financing
arrangements with the Bank.
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 and the
preliminary estimate of the Additional Consideration 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
9
based on their estimated fair values. Such intangible assets identified by the
Company include $11,521,000, $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 $556,000, $267,000 and $240,000 at April 30, 2005 for PF, NCR
and NC, respectively.
The following unaudited pro forma statement of operations of the Company for the
three months ended April 30, 2004 does not purport to be indicative of the
results that would have actually been obtained if the aforementioned acquisition
had occurred on February 1, 2004, or that may be obtained in the future. VLI
previously reported its 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 statement of operations. The number of
shares outstanding used in calculating pro forma earnings per share assume that
the shares issued in connection with the acquisition of VLI were outstanding
since February 1, 2004.
Three Months Ended
April 30, 2004
Pro Forma Statement of Operations
Net sales $ 5,386,000
Cost of goods sold 4,264,000
------------
Gross profit 1,122,000
Selling, general and
administrative expenses 1,689,000
------------
Loss from operations (567,000)
Other income, net 10,000
------------
Loss before income tax benefit (557,000)
Income tax benefit 213,000
------------
Net loss ($ 344,000)
============
Loss per share ($ 0.13)
============
Weighted average shares outstanding 2,628,000
============
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.
The Company leases administrative, manufacturing and warehouse facilities from
individuals who are officers of SMC and VLI. The total expense under these
arrangements were $69,000 and $18,000 for the three months ended April 30, 2005
and 2004, respectively.
The Company also entered into a supply agreement with an entity owned by the
former shareholder of VLI whereby the supplier committed to sell to the Company
and the Company committed to purchase on an as-needed basis, certain organic
products. VLI made $24,000 in purchases under the supply agreement during the
10
three months ended April 30, 2005. 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
$149,000 in sales with this entity for three months ended April 30, 2005. At
April 30, 2005, the affiliated entity owed $134,000 to VLI, net of an allowance
for doubtful accounts of $75,000.
NOTE 5 - DEBT
In August 2003, the Company 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, 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%.
In August 2004 and April 2005, the Company agreed to amend the existing
financing arrangements with the Bank whereby the revolving line of credit was
initially increased to $3.5 million and ultimately to $4.3 million in maximum
availability. The latest amendment extended the expiration of the revolving line
of credit to May 31, 2006. Under the amended financing arrangements, amounts
outstanding under the revolving line of credit and the three year term 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 term note remains in effect and the final monthly scheduled payment of
$33,000 is due on July 31, 2006. As of April 30, 2005, the Company had $500,000
outstanding under the term note and $1,661,000 outstanding under the revolving
line of credit.
The financing arrangements amended on April 8, 2005, waives the 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) and
requiring pro forma fixed charge coverage ratio not less than 1.25 to 1 (with
the next test date being July 31, 2005). However, at April 30, 2005, the Company
was in compliance with the financial and non financial covenants of the
financing arrangement that would have been in place at that date. 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 $304,000, which it was holding in escrow as collateral.
NOTE 6 - PRIVATE OFFERING 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)
11
NOTE 7 - SEGMENT REPORTING
Effective with the acquisition of VLI on August 31, 2004, the Company has two
reportable 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 operating segments are nutraceutical products and telecom
infrastructure services. 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 operating 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 to the Company's Form 10-KSB and Note 2 in this filing. Summarized
financial information concerning the Company's operating segments is shown in
the following tables:
For the Three Months
Ended April 30, 2005
Telecom
Nutraceutical Infrastructure
Products Services Other Consolidated
-------------- -------------- -------------- --------------
Net sales $ 4,728,000 $ 2,428,000 $ -- $ 7,156,000
Cost of goods sold 3,274,000 1,907,000 -- 5,181,000
-------------- -------------- -------------- --------------
Gross profit 1,454,000 521,000 -- 1,975,000
Selling, general and administrative
expenses 1,137,000 354,000 400,000 1,891,000
-------------- -------------- -------------- --------------
Income (Loss) from operations 317,000 167,000 (400,000) 84,000
Interest expense (income) 58,000 11,000 (13,000) 56,000
Other income, net -- 2,000 2,000 4,000
-------------- -------------- -------------- --------------
Income (loss) before income taxes $ 259,000 $ 158,000 $ (385,000) 32,000
============== ============== ============== --------------
Income tax provision 12,000
--------------
Net income $ 20,000
==============
Depreciation and amortization $ 77,000 $ 98,000 $ 20,000 $ 195,000
============== ============== ============== ==============
Amortization of intangibles $ 399,000 $ 25,000 -- $ 424,000
============== ============== ============== ==============
Goodwill $ 11,521,000 $ 940,000 -- $ 12,461,000
============== ============== ============== ==============
Total Assets $ 24,105,000 $ 5,204,000 $ 427,000 $ 29,736,000
============== ============== ============== ==============
NOTE 8 - WESTERN FILTER CORPORATION LITIGATION
During the twelve months ended January 31, 2005, WFC asserted in writing 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.
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
12
compensatory and punitive damages in an amount to be proven at trial as well as
the recovery of attorney's fees. 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.
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 April 30, 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 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
This Form 10-QSB 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.
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 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
13
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.
Subordination of Certain Debt
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.
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 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 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.
Amendment of Financing Arrangements
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 $304,000 which it was holding in escrow as
collateral.
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Western Filter Corporation Litigation
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 in writing, 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 attorney's 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.
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 April 30, 2005, there were no restrictions with respect to dividends
or other payments from VLI and SMC to the Company.
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
15
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, 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
contained in the Company's consolidated financial statements for the year ended
January 31, 2005 included in the Company's Annual Report contained in Form
10-KSB, as filed with the Securities and Exchange Commission 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 pass to our customer. Cost of goods and
finished goods inventory sold include materials and direct labor as well as
other direct costs combine with allocations of indirect operational costs.
Southern Maryland Cable, Inc.
We generate 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. 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 and billings in excess of estimated earnings totaled $365,000
and $6,000, respectively, at April 30, 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.
16
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.
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.
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.
17
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 April 30, 2005, we have cumulatively recorded a net operating loss carry
forward aggregating $161,000 which expires in 2024 and 2025.
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
18
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.
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.
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
19
Debtor or any other person for the Junior Debt or give any subordination in
respect of the Junior Debt.
Results of Operations for the Three Months Ended April 30, 2005 Compared to the
Pro Forma Results of Operations for the Three Months ended April 30, 2004
The following summarizes the results of our operations for the three months
ended April 30, 2005 compared to the pro forma results for the three months
ended April 30, 2004, as if the acquisition of VLI was completed on February 1,
2004. The unaudited statements of operations do not purport to be indicative of
the results that would have actually been obtained if the aforementioned
acquisition had occurred on February 1, 2004, or that may be obtained in the
future. VLI previously reported its results of operations using a calendar
year-end. No material events occurred subsequent to the reporting period that
would require adjustment to our unaudited pro forma results in the statements of
operations.
Three Months Ended
April 30,
Statements of Operations 2005 2004
------------ ------------
(Pro forma)
Net sales $ 7,156,000 $ 5,386,000
Cost of goods sold 5,181,000 4,264,000
------------ ------------
Gross profit 1,975,000 1,122,000
Selling general and
administrative expenses 1,891,000 1,689,000
------------ ------------
Income (loss) from operations 84,000 (567,000)
Other (expense) income (52,000) 10,000
------------ ------------
Income (loss) from operations
before income taxes 32,000 (557,000)
Income tax provision (benefit) 12,000 (213,000)
------------ ------------
Net income (loss) $ 20,000 ($ 344,000)
============ ============
Net sales
Net sales were $7,156,000 for the three months ended April 30, 2005 compared to
pro forma net sales of $5,386,000 for the three months ended April 30, 2004. The
increase of $1,770,000 or 33% is due primarily to an increase of $1,149,000 in
sales volume at VLI. Sales increased to VLI's largest customer as well as
substantial sales to a new customer provided most of the sales increase. In
addition, SMC experienced an increase of $504,000 in sales volume from
infrastructure services provided to SMC's customers under fixed-priced
contracts.
Cost of goods sold
For the three months ended April 30, 2005, cost of goods sold was $5,181,000 or
72% of net sales compared to $4,264,000 or 79% of pro forma net sales for the
three months ended April 30, 2004. Decreased costs as a percent of net sales is
due to efficiencies experienced as SMC's volume and number of fixed-priced
contracts increased during the three months ended April 30, 2005. In addition,
VLI had a decreased cost of goods sold as a percentage of net sales due to
increased pricing which it passed onto its customer base.
20
Selling general and administrative expenses
Selling, general and administrative expenses were $1,891,000 or 26% of net sales
for the three months ended April 30, 2005 compared to $1,689,000 or 31% of pro
forma net sales for the three months ended April 30, 2004, an increase of
$202,000. SMC reduced its selling, general and administrative expenses by
$76,000 due to the streamlining its support staff. In addition, corporate
expenses as a percentage of net sales decreased from 20% to 6% due to corporate
costs increasing at a slower rate than the overall growth of net sales.
Other expense, net
We had other expense, net of $52,000 for the three months ended April 30, 2005
compared to pro forma other income, net of $10,000 for the three months ended
April 30, 2004. The Company's interest expense is due to the funding of VLI's
increased inventory to support increased net sales.
Income tax (benefit) provision
The Company's effective income tax rate was 38% for the three months ended April
30, 2005 compared to a 38% pro forma income tax rate for the three months ended
April 30, 2004.
LIQUIDITY AND CAPITAL RESOURCES
Cash Position and Indebtedness
We had $3 million in working capital at April 30, 2005, including $107,000 of
cash and cash equivalents. In addition we had $2 million available under credit
facilities.
Working capital increased by $300,000 to $3 million at April 30, 2005 from $2.7
million at January 31, 2005. This increase was primarily due to the strong
operating performances of VLI and SMC. The Company had income before taxes of
$32,000. The Company's non-cash expenses included in the determination of income
before income taxes included $424,000 for amortization of purchase intangibles
and $195,000 for depreciation and other amortization.
Cash Flows
Net cash provided by operations for the three months ended April 30, 2005 was
$280,000 compared with $394,000 of cash used in operations for the three months
ended April 30, 2004.
During the three months ended April 30, 2005, the Bank released $304,000 in
escrows to us (see discussion below). Net cash used for investing activities was
$118,000 and $2,522,000 for the three months ended April 30, 2005 and 2004,
respectively. During the three months ended April 30, 2005, we had cash of
$118,000 used in the purchase of property and equipment. During the three months
ended April 30, 2004, we had cash of $2,500,000 used in the net purchase of
investments and cash used in purchase of property and equipment of $22,000.
Net cash used by financing activities was $222,000 and $123,000 for the three
months ended April 30, 2005 and 2004, respectively. During the three months
ended April 30, 2005, we used cash of $232,000 to pay down term-debt.
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%.
In August 2004 and April 2005, we agreed to amend the existing financing
arrangements with the Bank whereby the revolving line of credit was initially
increased to $3.5 million and ultimately to $4.3 million in maximum
availability. Under the latest amendment the line of credit is extended to May
31, 2006. 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 term note remains in effect with
its last monthly payment of $33,000 due July 31, 2006. As of April 30, 2005, the
21
Company had $1,661,000 outstanding under the revolving line of credit. Under the
amended financing arrangements, amounts outstanding under the revolving line of
credit and the three-year term note bear interest at LIBOR plus 3.25% and 3.45%,
respectively.
The amended financing arrangements waives the 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. At April 30, 2005, the Company was in compliance
with the covenants under the amended financing arrangements. The Company
continues to pledge the majority of the Company's assets to secure the financing
arrangements. The Bank has released $304,000 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.
Customers
During the three months ended April 30, 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 TriVita Corporation (TVC), Rob Reiss Companies (RRC), Southern Maryland
Electrical Cooperative (SMECO), GD, and CyberWize.com, Inc. (C). TVC, RRC and C
are VLI customers. SMC's significant customers are SMECO and GD. TVC, RRC and C
accounted for approximately 23%, 14% and 6% of consolidated net sales during the
three months ended April 30, 2005. SMECO and GD accounted for approximately 12%
and 9% of consolidated net sales during the three months ended April 30, 2005.
Combined TVC, RRC, SMECO, GD, and C accounted for approximately 64% of
consolidated net sales during the three months ended April 30, 2005.
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.
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.
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ITEM 3. CONTROLS AND PROCEDURES
The Company carried out an evaluation, under the supervision and with the
participation of the Company's Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of the Company's
disclosure controls and procedures, as of the end of the period covered by this
report. Based upon this evaluation, the Company's Chief Executive Officer and
Chief Financial Officer concluded that the Company's disclosure controls and
procedures were effective in timely alerting them to material information
required to be included in the Company's periodic SEC reports. There have been
no changes in the Company's internal control over financial reporting that
occurred during the Company's most recent fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
PART ll
OTHER INFORMATION
ITEM 1. 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.
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 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
a) Exhibits:
Exhibit No. Title
----------- -----
Exhibit: 31.1 Certification of Chief Executive Officer,
pursuant to Rule 13a-14(c) under the Securities
Exchange Act of 1934
Exhibit: 31.2 Certification of Chief Financial Officer,
pursuant to Rule 13a-14(c) under the Securities
Exchange Act of 1934
Exhibit: 32.1 Certification of Chief Executive Officer,
pursuant to 18 U.S.C. Section 1350
Exhibit: 32.2 Certification of Chief Financial Officer,
pursuant to 18 U.S.C. Section 1350
24
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto, duly
authorized.
ARGAN, INC.
June 10, 2005 By: /s/ Rainer Bosselmann
-------------------------------------------------
Rainer Bosselmann
Chairman of the Board and Chief Executive Officer
June 10, 2005 By: /s/ Arthur F. Trudel
-------------------------------------------------
Arthur F. Trudel
Chief Financial Officer
25