UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB/A Amendment No. 1
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended April 30, 2005
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Commission File Number 001-31756
--------------------------------
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 (IRS Employer identification No.)
incorporation 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 10, 2005
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Transitional Small Business Disclosure Format (Check One): Yes | | No |X|
Amendment No. 1 Overview
We are filing Amendment No. 1 (Amendment) to the Argan, Inc. Quarterly Report on
Form 10-QSB for the quarter ended April 30, 2005.
On September 19, 2005, senior management and the Audit Committee of the Board of
Directors of the Company concluded that the Company's financial statements for
the fiscal year ended January 31, 2005 and for the quarter ended April 30, 2005
should be restated.
The restatements relate to the Company's amendment of its accounting for an
investment made by MSR I SBIC, L.P. ("MSR") on January 28, 2005 ("Investment"),
for the value of shares issued in the acquisition of Vitarich Laboratories, Inc.
(VLI), and for an agreement entered into with Kevin Thomas (Thomas) on January
28, 2005 with respect to a debt subordination and related concessions
("Concessions") given to Thomas in connection with consummating the agreement as
described below. The Company is also restating inventory and cost of goods sold
for the quarter ended April 30, 2005 related to an error in inventory valuation
accounting.
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 agreed to issue additional shares of our common stock to Investor
in accordance with the Agreement based upon the earlier of (i) our issuance of
additional shares of common stock having an aggregate purchase price of at least
$2,500,000 at a price per share less than $7.75, or (ii) July 31, 2005. The
additional shares of common stock to be issued would equal the price paid by
Investor divided by the lower of (i) the weighted average of all stock sold by
the Company prior to July 31, 2005, or (ii) ninety percent of the average bid
price of Argan's common stock for the thirty days ended July 31, 2005, if the
price was less than $7.75 per share, less the 129,032 shares previously issued.
Any additional shares 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 was registered under the Securities Act on Form S-3 filed
with the SEC on February 25, 2005.
The provision in the agreement which allows the investor to receive additional
shares under certain conditions represents a derivative under Statement of
Financial Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities." Accordingly, $139,000 of the proceeds received upon
issuance was accounted for as a liability for a derivative financial instrument.
This liability relates to the obligation to issue Investor additional shares
under certain conditions. The derivative financial instrument is subject to
adjustment for changes in fair value subsequent to issuance through July 31,
2005. The Company recorded a fair value adjustment for a $1,000 gain and a
$343,000 loss at April 30, 2005 and July 31, 2005, respectively, which is also
reflected as a change in liability for the derivative financial instruments. The
fair value adjustment was recorded as a change in the Company's other expenses
or income and net loss. The liability for the derivative financial instruments
related to the Investor was settled as a non-cash transaction by the issuance of
additional shares of the Company's common stock on August 13, 2005.
On August 31, 2004, Argan acquired VLI for approximately $6.7 million in cash
and 825,000 shares of the Company's common stock with fair value of $4,950,000
or $6.00 per share utilizing the quoted market price on the acquisition date.
The Company also assumed $1.6 million in debt. The value of the shares issued in
the acquisition of VLI has been revised to reflect the price per share of $6.00
of the Company's common stock at August 31, 2004 as opposed to $6.22, the quoted
market price of the stock two days before and after the acquisition date. The
impact of this change was to reduce the amount of goodwill and additional
paid-in capital by $182,000. The purchase agreement also provides for contingent
consideration based on EBITDA for the twelve months ended February 28, 2005. The
additional contingent consideration would be paid in both cash and stock. The
Company's Additional Consideration was approximately $275,000 in cash, $2.7
million in a subordinated note and approximately 348,000 shares of AI common
stock with a fair value of $2.1 million or $6.00 per share utilizing the quoted
market price on February 28, 2005.
2
On January 28, 2005 the Company entered into a Letter Agreement with Thomas in
consideration for his agreement to delay the timing of the payment of contingent
cash consideration and for entering into a Debt Subordination Agreement
(Subordination Agreement), reconstituting such additional cash consideration as
subordinated debt. The Letter Agreement includes certain concessions to Thomas
allowing him to receive additional consideration based on the market price of
the Company's common stock. The concessions provide that in addition to
providing Thomas additional shares if the Company issued additional shares at a
price less than $7.75, if the Company did not raise additional shares at a price
less than $7.75 per share then the Company would issue additional shares to
Thomas based on the average closing price of the Company's common stock for the
30 days ended July 31, 2005, if the price was below $7.75 per share. These
concessions allowing Thomas to receive additional shares under certain
conditions represent a freestanding financial instrument and should be accounted
for in accordance with EITF 00-19 "Accounting for Derivative Financial
Instruments Indexed to and Potentially Settled in a Company's Own Stock." The
Company has recorded the freestanding financial instrument as a liability for
the fair value of $1,115,000 ascribed to the obligations of the Company to issue
Thomas additional shares.
$501,000 of the charge related to the liability for derivative financial
instrument is recorded as deferred issuance cost for subordinated debt which
will be amortized over the life of the subordinated debt and $614,000 of the
charge is recorded as compensation expense due to Thomas. The amortization of
the deferred loan issuance cost will increase the Company's future interest
expense through August 1, 2006, the maturity date of the note, and reduce net
income. The charge for compensation to Thomas was classified as non-cash
compensation expense and increased the net loss by $614,000 for the year January
31, 2005. The derivative financial instrument will be subject to adjustment for
changes in fair value subsequent to issuance through July 31, 2005. The fair
value adjustment will be recorded as a change in the liability for the
derivative financial instrument and as a charge to the Company's other expenses
and net loss. The liability for the derivative financial instrument was settled
as a non-cash transaction by the issuance of additional shares of the Company's
common stock on September 1, 2005. (See Note 2 for the impact of the
restatement).
The Company is also restating its consolidated financial statements for the
quarter ended April 30, 2005 related to an error in inventory valuation
accounting. The error is the result of the Company incorrectly recording a write
down of inventory in purchase accounting to the incorrect inventory items. The
impact of correcting this error is to increase the cost of sales by $105,000,
and reduce inventory by $105,000 and net income by $60,000 for the quarter ended
April 30, 2005.
In August 2005, the Company re-evaluated the write down of the inventory in
purchase accounting. Based on the Company's updated analysis, management
believes it is appropriate to reverse the reduction for the contingent asset
impairment as it is within one year of the acquisition. The impact of reversing
the inventory write-down will be recorded in the quarter ended July 31, 2005 and
will result in an increase in inventory and a related reduction in goodwill of
$264,000.
The consolidated financial statements and accompanying notes for the quarter
ended April 30, 2005 have been restated to correct the aforementioned errors.
These restatements are described in Note 2 to the consolidated financial
statements. Details of the impact of the restatement on the accompanying balance
sheet and statements of operations for the quarter ended April 30, 2005 are also
described in Note 2 to the consolidated financial statements.
3
We have amended and restated in its entirety each item of the Original Form
10-QSB that has been affected by the restatement. This Amendment No. 1 to Form
10-QSB does not reflect events occurring after the filing of the Original Form
10-QSB or modify or update those disclosures (including disclosures relating to
risks, uncertainties and other factors that may affect our future performance)
in any way, except as to reflect the effects of the restatement.
4
ARGAN, INC.
INDEX
Page No.
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PART I. FINANCIAL INFORMATION ..............................................6
Item 1. Financial Statements ...............................................6
Condensed Consolidated Balance Sheets - April 30, 2005 and
January 31, 2005 ..................................................6
Condensed Consolidated Statements of Operations for the Three Months
Ended April 30, 2005 and 2004 .....................................7
Condensed Consolidated Statements of Cash Flows for the Three Months
Ended April 30, 2005 and 2004 .....................................8
Notes to Condensed Consolidated Financial Statements .......................9
Item 2. Management's Discussion and Analysis or Plan of Operation ..........20
Item 3. Controls and Procedures ............................................33
PART II. OTHER INFORMATION ................................................34
Item 1. Legal Proceedings .................................................34
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds .......34
Item 3. Defaults Upon Senior Securities ...................................34
Item 4. Submission of Matters to a Vote of Security Holders ...............34
Item 5. Other Information .................................................34
Item 6. Exhibits ..........................................................34
SIGNATURES .................................................................36
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5
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ARGAN, INC.
Condensed Consolidated Balance Sheets
(Unaudited)
April 30, 2005 January 31, 2005
-------------- ----------------
ASSETS Restated - Restated
See Note 2
CURRENT ASSETS:
Cash and cash equivalents $ 107,000 $ 167,000
Accounts receivable, net of allowance for doubtful accounts
of $68,000 at 4/30/2005 and $85,000 at 1/31/2005 3,751,000 2,951,000
Receivable from affiliated entity, net of allowance for doubtful
accounts of $75,000 at 4/30/2005 and $84,000 at 1/31/2005 134,000 112,000
Escrowed cash 300,000 604,000
Estimated earnings in excess of billings 365,000 323,000
Inventories, net 3,153,000 3,465,000
Prepaid expenses and other current assets 680,000 622,000
-------------- ----------------
TOTAL CURRENT ASSETS 8,490,000 8,244,000
-------------- ----------------
Property and equipment, net of accumulated depreciation
of $854,000 at 4/30/2005 and $679,000 at 1/31/2005 2,644,000 2,703,000
Issuance cost for subordinated debt 501,000 501,000
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 12,279,000 7,350,000
-------------- ----------------
TOTAL ASSETS $ 29,949,000 $ 25,257,000
============== ================
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
Liability for derivative financial instruments 1,231,000 1,254,000
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 6,794,000 6,756,000
-------------- ----------------
Deferred income tax liability 2,515,000 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 4/30/2005 and 1/31/2005 and 2,758,845 shares
outstanding at 4/30/2005 and 1/31/2005 414,000 414,000
Warrants outstanding 849,000 849,000
Additional paid-in capital 19,800,000 19,800,000
Accumulated deficit (5,552,000) (5,530,000)
Treasury stock at cost: - 3,233 shares at 4/30/2005
and 1/31/2005 (33,000) (33,000)
-------------- ----------------
TOTAL STOCKHOLDERS' EQUITY 15,478,000 15,500,000
-------------- ----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 29,949,000 $ 25,257,000
============== ================
See Accompanying Notes.
6
ARGAN, INC.
Condensed Consolidated Statements of Operations
(Unaudited)
Three months ended
April 30,
2005 2004
----------- -----------
Restated -
See Note 2
Net sales $ 7,156,000 $ 1,807,000
Cost of sales 5,286,000 1,608,000
----------- -----------
Gross profit 1,870,000 199,000
Selling, general and administrative expenses 1,891,000 791,000
----------- -----------
Loss from operations (21,000) (592,000)
Interest expense 56,000 7,000
Other income, net 27,000 29,000
----------- -----------
Loss from operations before income taxes (50,000) (570,000)
Income tax benefit 28,000 218,000
----------- -----------
Net loss ($ 22,000) ($ 352,000)
=========== ===========
Basic and diluted loss per share ($ 0.01) ($ 0.20)
=========== ===========
Weighted average number of shares outstanding
- basic and diluted 2,992,000 1,803,000
=========== ===========
See Accompanying Notes.
7
ARGAN, INC.
Condensed Consolidated Statements of Cash Flows
(unaudited)
Three Months Ended
April 30,
2005 2004
------------ ------------
Restated -
See Note 2
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ($ 22,000) ($ 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 (30,000) (222,000)
Unrealized gain on liability for derivative
financial instruments (23,000) --
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 312,000 --
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 line of credit 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.
8
ARGAN, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1- ORGANIZATION
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 8)
MANAGEMENT'S PLANS, LIQUIDITY AND BUSINESS RISKS
As of April 30, 2005, the Company had an accumulated deficit of $5.6 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 $2.0 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 $7.75, or (ii) July 31, 2005. The
additional shares of common stock to be issued would equal the price paid by
Investor divided by the lower of (i) the weighted average of all stock sold by
the Company prior to July 31, 2005, or (ii) ninety percent of the average bid
price of the Company's common stock for the thirty days ended July 31, 2005, if
the price was less than $7.75, less the 129,032 shares previously issued. (See
Notes 2, 5 and 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 $1 million provided that such payment would not put the Company in default
of its current financing arrangement with the Bank. (See Notes 2 and 4)
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 6)
At July 31, 2005, the Company failed to comply with certain financial covenants
under its borrowing arrangements with the Bank. The Bank waived the failure for
the measurement period ended July 31, 2005. (See Note 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.
NOTE 2 - RESTATEMENT
On September 19, 2005, senior management and the Audit Committee of the Board of
Directors of the Company concluded that the Company's financial statements for
the fiscal year ended January 31, 2005 and for the quarter ended April 30, 2005
should be restated.
The restatements relate to the Company's amendment of its accounting for an
investment made by MSR I SBIC, L.P. ("MSR") on January 28, 2005 ("Investment"),
for the value of shares issued in the acquisition of VLI, and for an agreement
entered into with Thomas on January 28, 2005 with respect to a debt
subordination and related concessions ("Concessions") given to Thomas in
connection with consummating the agreement as described below. The Company is
also restating inventory and cost of goods sold for the quarter ended April 30,
2005 related to an error in inventory valuation accounting.
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 agreed to issue additional shares of our common stock to Investor
in accordance with the Agreement based upon the earlier of (i) our issuance of
additional shares of common stock having an aggregate purchase price of at least
$2,500,000 at a price per share less than $7.75, or (ii) July 31, 2005. The
additional shares of common stock to be issued would equal the price paid by
Investor divided by the lower of (i) the weighted average of all stock sold by
the Company prior to July 31, 2005, or (ii) ninety percent of the average bid
price of Argan's common stock for the thirty days ended July 31, 2005, if the
price was less than $7.75 per share. Any additional shares 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 was registered
under the Securities Act on Form S-3 filed with the SEC on February 25, 2005.
10
The provision in the agreement which allows the investor to receive additional
shares under certain conditions represents a derivative under Statement of
Financial Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities." Accordingly, $139,000 of the proceeds received at
issuance was accounted for as a liability for a derivative financial instrument.
This liability relates to the obligation to issue Investor additional shares
under certain conditions. The derivative financial instrument is subject to
adjustment for changes in fair value subsequent to issuance. The Company
recorded a fair value adjustment for a $1,000 gain and a $343,000 loss at April
30, 2005 and July 31, 2005 respectively, which is also reflected as a change in
the liability for the derivative financial instruments. The fair value
adjustment was recorded as a change in the Company's other expense or income and
net loss. The liability for derivative financial instruments related to the
Investor was settled as a non-cash transaction by the issuance of additional
shares of the Company's common stock on August 13, 2005.
On August 31, 2004, Argan acquired VLI for approximately $6.7 million in cash
and 825,000 shares of the Company's common stock with fair value of $4,950,000
or $6.00 per share utilizing the quoted market price on the acquisition date.
The Company also assumed $1.6 million in debt. The value of the shares issued in
the acquisition of VLI has been revised to reflect the price per share of $6.00
of the Company's common stock at August 31, 2004 as opposed to $6.22, the quoted
market price of the stock two days before and after the acquisition date. The
impact of this change was to reduce the amount of goodwill and additional
paid-in capital by $182,000. The purchase agreement also provides for contingent
consideration based on EBITDA for the twelve months ended February 28, 2005. The
Company's Additional Consideration was approximately $275,000 in cash, $2.7
million in a subordinated note and approximately 348,000 shares of AI common
stock with a fair value of $2.1 million or $6.00 per share utilizing the quoted
market price on February 28, 2005. The additional contingent consideration would
be paid in both cash and stock. (See Note 4)
On January 28, 2005 the Company entered into a letter agreement ("Letter
Agreement") with Thomas in consideration for his agreement to delay the timing
of the payment of contingent cash consideration and for entering into a Debt
Subordination Agreement (Subordination Agreement), reconstituting such
additional cash consideration as subordinated debt. The Letter Agreement
includes certain concessions to Thomas allowing him to receive additional
consideration based on the market price of the Company's common stock. The
concessions provide that in addition to providing Thomas additional shares if
the Company issued additional shares at a price less than $7.75, if the Company
did not issue additional shares at a price less than $7.75 per share then the
Company would issue additional shares to Thomas based on the average closing
price of the Company's common stock for the 30 days ended July 31, 2005, if the
price were below $7.75 per share. These concessions allowing Thomas to receive
additional shares under certain conditions represent a freestanding financial
instrument and should be accounted for in accordance with EITF 00-19. The
Company has recorded the freestanding financial instrument as a liability for
the fair value of $1,115,000 ascribed to the obligations of the Company to issue
Thomas additional shares.
$501,000 of the charge related to the liability for derivative financial
instrument is recorded as deferred issuance cost for subordinated debt which
will be amortized over the life of the subordinated debt and $614,000 of the
charge was recorded as compensation expense due to Thomas. The amortization of
the deferred loan issuance cost will increase the Company's future interest
expense through August 1, 2006, the maturity date of the note, and reduce net
income. The charge for compensation to Kevin Thomas was classified as non-cash
compensation expense and increased the net loss by $614,000 for the year January
31, 2005. The derivative financial instrument will be subject to adjustment for
changes in fair value subsequent to issuance through July 31, 2005. The fair
value adjustment will be recorded as a change in liability for the derivative
financial instrument and as a charge to the Company's other expenses or income
and net loss. The liability for the derivative financial instrument was settled
as a non-cash transaction by the issuance of additional shares of the Company's
common stock on September 1, 2005.
11
The Company is also restating its consolidated financial statements for the
quarter ended April 30, 2005 related to an error in inventory valuation
accounting. The error is the result of the Company incorrectly recording a write
down of inventory in purchase accounting to the incorrect inventory items. The
impact of correcting this error is to increase the cost of sales by $105,000,
and reduce inventory by $105,000 and net income by $60,000 for the quarter ended
April 30, 2005.
In August 2005, the Company re-evaluated the write down of inventory in purchase
accounting. Based on the Company's updated analysis, management believes it is
appropriate to reverse the reduction for the contingent asset impairment as it
is within one year of the acquisition. The impact of reversing the inventory
write-down will be recorded in the quarter ended July 31, 2005 and will result
in an increase to inventory and a related reduction in goodwill of $264,000.
As a result of the revised accounting for Investment and Concessions and the
correction of the error in accounting for inventory, the Company restated its
financial statements which resulted in a change from net income of $20,000 to a
net loss of $22,000 and a change in earnings per share from $0.01 per share to a
loss per share of ($0.01) for the three months ended April 30, 2005.
The following tables set forth the effects of the restatement on certain line
items within the Company's consolidated balance sheet as of April 30, 2005 and
consolidated statement of operations for the three months ended April 30, 2005.
As Reported As Restated
Balance Sheet April 30, 2005 April 30, 2005
------------- -------------- --------------
Inventories, net $3,259,000 $3,153,000
Issuance cost for subordinated debt -- $501,000
Goodwill $12,461,000 $12,279,000
Total assets $29,736,000 $29,949,000
Liability for derivative financial instruments -- $1,231,000
Total current liabilities $ 5,563,000 $6,794,000
Deferred income tax liability $ 2,556,000 $2,515,000
Additional paid-in capital $20,121,000 $19,800,000
Accumulated deficit ($4,896,000) ($5,552,000)
Total stockholders' equity $16,455,000 $15,478,000
Total liabilities and stockholders' equity $29,736,000 $29,949,000
12
As Reported As Restated
Three Months Three Months
Ended Ended
Statement of Operations April 30, 2005 April 30, 2005
----------------------- -------------- ----------------
Cost of sales $5,181,000 $5,286,000
Gross profit $1,975,000 $1,870,000
Income (loss) from operations $84,000 ($21,000)
Other income, net $4,000 $27,000
Income (loss) from operations before income taxes $32,000 ($50,000)
Income tax provision (benefit) $12,000 ($28,000)
Net income (loss) $20,000 ($22,000)
Income (loss) per share:
- Basic $0.01 ($0.01)
- Diluted $0.01 antidilutive
As Reported As Restated
Three Months Three Months
Statement of Cash Flows April 30, 2005 April 30, 2005
----------------------- -------------- --------------
Net income (loss) $20,000 ($22,000)
Deferred income taxes $11,000 ($30,000)
Unrealized gain on liability for derivative
financial instruments -- ($23,000)
Inventories, net $206,000 $312,000
NOTE 3 - SIGNIFICANT ACCOUNTING POLICIES
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
2004 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.
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 (Restated - See Note 2) at April 30, 2005 consist of the following:
Raw materials $ 2,629,000
Work-in process 154,000
Finished goods 370,000
-----------
$ 3,153,000
===========
Income Per Share - (Loss) income per share is computed by dividing net (loss)
income by the weighted average number of common shares outstanding for the
period. Outstanding stock options, warrants and contingently issuable shares
were antidilutive during the three months ended April 30, 2005 and 2004.
13
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.
Derivative Financial Instruments - The Company accounts for derivative financial
instruments in accordance with Statement of Financial Accounting Standards No.
133 "Accounting for Derivative Instruments and Hedging Activities," and Emerging
Issues Task Force Issue No. 00-19 "Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in a Company's Own Stock." The
derivative financial instruments are carried at fair value with changes in fair
value recorded as other expense or income, net. The determination of fair value
for our derivative financial instruments is subject to the volatility of our
stock price as well as certain underlying assumptions which include the
probability of raising additional capital.
Shipping Fees and Costs - The Company accounts for shipping fees and costs in
accordance with Emerging Issues Task Force Issue No. 00-10 "Accounting for
Shipping and Handling Fees and Costs." Amounts billed to customers in sales
transactions related to shipping recorded in net sales were $30,000 for the
three months ended April 30, 2005. Costs associated with shipping goods to
customers which aggregate $51,000 are accounted for as part of selling expenses
for the three months ended April 30, 2005.
The Pro Forma disclosures required by Statement of Financial Accounting
Standards No. 148 "Accounting for Stock Based Compensation" are reflected below:
Pro Forma Disclosures
For the three months ended April 30,
2005 2004
-------------- --------------
Restated - See
Note 2
Net loss, as reported ($ 22,000) ($ 352,000)
Add: Stock based compensation recorded
in the financial statements -- --
Deduct: Total stock-based employee compensation
expense determined under fair value based 20,000 18,000
-------------- --------------
Pro forma net loss ($ 42,000) ($ 370,000)
============== ==============
Basic and diluted per share:
Basic and diluted - as reported ($ 0.01) ($ 0.20)
============== ==============
Basic and diluted - pro forma ($ 0.01) ($ 0.21)
============== ==============
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. 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.
14
In November 2005, the Financial Accounting Standards Board issued FASB Statement
No. 151 "Inventory Costs - an amendment of ARB No. 43, Chapter 4 (SFAS 151)."
This Statement amends the guidance in ARB No. 43, Chapter 4 "Inventory Pricing,"
to clarify the accounting for abnormal amounts of idle facility expense,
freight, handling costs, and wasted material (spoilage). Paragraph 5 of ARB 43,
Chapter 4, previously stated that "...under some circumstances, items such as
idle facility expense, excessive spoilage, double freight, and rehandling costs
may be so abnormal as to require treatment as current period charges... "This
Statement requires that those items be recognized as current-period charges
regardless of whether they meet the criterion of "so abnormal." In addition,
this Statement requires that allocation of fixed production overheads to the
costs of conversion be based on the normal capacity of the production
facilities.
The Company will SFAS No. 151 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 4- 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
$4,950,000 or $6.00 per share utilizing the quoted market price on 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, 2005, 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.
15
On January 28, 2005, the Company entered into a letter agreement ("Letter
Agreement") with Thomas in consideration for his agreement to delay the timing
of the payment of contingent cash consideration and for entering in a debt
subordination agreement, reconstituting such additional cash consideration as
subordinated debt. Pursuant to the Letter Agreement, the Company agreed to issue
additional shares of common stock to Thomas upon the earlier of (i) Company's
issuance of additional shares of our common stock at a price per share less than
$7.75, or (ii) July 31, 2005. The additional shares of common stock to be issued
would equal the price paid by Thomas divided by the lower of (i) the weighted
average of all stock sold by the Company prior to July 31, 2005, or (ii) if the
Company did not issue additional shares, the Company would issue additional
shares to Thomas at the average closing price of Argan's common stock for the
thirty days ended July 31, 2005 if the price was less than $7.75. The
Concessions given to Thomas pursuant to the Letter Agreement whereby the Company
agreed that should it not issue additional shares for consideration, it would
issue additional shares to Thomas at a price determined by reference to the
Company's prevailing thirty-day average stock price were accounted for as a
derivative financial instrument. The Company recorded a liability for derivative
financial instrument of $1,115,000, deferred loan issuance cost for subordinated
debt of $501,000, and compensation expense to Thomas of $614,000 at January 31,
2005. The liability for derivative financial instrument is subject to adjustment
for changes in fair value at April 30, 2005 for which the Company recorded a
$22,000 gain in other income.
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
based on their estimated fair values. Such intangible assets identified by the
Company include $11,339,000, $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 NCA, 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 sales 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
==============
16
NOTE 5 - 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 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 (See Note 2). 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 based 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, at a price per share less than $7.75, or (ii) July 31, 2005. The
additional shares of common stock to be issued would equal the price paid by
Investor divided by the lower of (i) the weighted average of all stock sold by
the Company prior to July 31, 2005 or (ii) ninety percent of the average bid
price of the Company's common stock for the thirty days ended July 31, 2005, if
the price was less than $7.75 per share, less the 129,032 shares previously
issued. Any additional shares issued would effectively reduce the Investor's
purchase price per common share as set forth in the Subscription Agreement.
The provision in the agreement which allows the investor to receive additional
shares under certain conditions represents a derivative under Statement of
Financial Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities." Accordingly, $139,000 of the proceeds received at
issuance was accounted for as a liability for a derivative financial instrument.
This liability relates to the obligation to issue Investor additional shares
under certain conditions. The derivative financial instrument is subject to
adjustment for changes in fair value subsequent to issuance. During the three
months ended April 30, 2005, the Company recorded a fair value adjustment of a
$1,000 gain which is recorded in other income, net.
The Company leases administrative, manufacturing and warehouse facilities from
individuals who are officers of SMC and VLI. The total expense under these
arrangements was $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
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 6 - 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%.
17
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 $4.25 million in maximum
availability. The April 2005 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). 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.
At July 31, 2005, the Company failed to comply with the aforementioned financial
covenants. The Bank waived the failure for the measurement period ended July 31,
2005. For future measurement periods, the Bank revised the definitions of
certain components of the financial covenants to specifically exclude the impact
of items associated with derivative financial instruments such as, valuation
gains and losses, compensation expense which are settled with the non-cash
issuance of the Company's common stock and non-cash issuance amortization .
NOTE 7 - 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 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 5) Pursuant to the Subscription Agreement,
the Company has agreed to issue additional shares of Common Stock to Investor in
accordance with the Subscription Agreement based 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 at a price per share less than $7.75, or
(ii) July 31, 2005. The additional shares of common stock to be issued would
equal the price paid by Investor divided by the lower of (i) the weighted
average of all stock sold by the Company prior to July 31, 2005 or; (ii) ninety
percent of the average bid price of Argan's common stock for the thirty days
ended July 31, 2005 if the price was less than $7.75, less the 129,032 shares
previously issued. Any additional shares issued would effectively reduce the
Investor's purchase price per common share as set forth in the Subscription
Agreement.
18
The provision in the agreement which allows the investor to receive additional
shares under certain conditions represents a derivative under Statement of
Financial Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities." Accordingly, at January 31, 2005, $139,000 of the
proceeds was accounted for as a liability for a derivative financial instrument.
This liability relates to the obligation to issue Investor additional shares
under certain conditions. The derivative financial instrument is subject to
adjustment for changes in fair value subsequent to issuance through July 31,
2005. During the three months ended April 30, 2005, the Company recorded a fair
value adjustment of a $1,000 gain which is recorded in other income, net.
NOTE 8 - 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 3 to the Company's Form 10-KSB and Note 3 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
------------- -------------- ----------- ------------
Restated Restated
Net sales $ 4,728,000 $ 2,428,000 $ -- $ 7,156,000
Cost of sales 3,379,000 1,907,000 -- 5,286,000
------------- -------------- ----------- ------------
Gross profit 1,349,000 521,000 -- 1,870,000
Selling, general and
administrative expenses 1,137,000 354,000 400,000 1,891,000
------------- -------------- ----------- ------------
Income (Loss) from operations 212,000 167,000 (400,000) (21,000)
Interest expense (income) 58,000 11,000 (13,000) 56,000
Other income, net -- 2,000 25,000 27,000
------------- -------------- ----------- ------------
Income (loss) before income taxes $ 154,000 $ 158,000 ($ 362,000) (50,000)
============= ============== =========== ------------
Income tax benefit 28,000
------------
Net loss ($ 22,000)
============
Depreciation and amortization $ 77,000 $ 98,000 $ 20,000 $ 195,000
============= ============== =========== ============
Amortization of intangibles $ 399,000 $ 25,000 -- $ 424,000
============= ============== =========== ============
Goodwill $ 11,339,000 $ 940,000 -- $ 12,279,000
============= ============== =========== ============
Total Assets $ 23,817,000 $ 5,204,000 $ 928,000 $ 29,949,000
============= ============== =========== ============
19
NOTE 9 - Contingencies
During the twelve months ended January 31, 2005, WFC asserted in writing that
WFC believes 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
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 estimated payments 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.
In addition to the aforementioned WFC claim, 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 other current claims and proceedings will have a material effect on the
Company's consolidated financial statements.
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.
RESTATEMENT
On September 19, 2005, senior management and the Audit Committee of the Board of
Directors of the Company concluded that the Company's financial statements for
the fiscal year ended January 31, 2005 and for the quarter ended April 30, 2005
should be restated.
The restatements relate to the Company's amendment of its accounting for an
investment made by MSR I SBIC, L.P. ("MSR") on January 28, 2005 ("Investment"),
for the value of the shares issued in the acquisition of VLI, and for an
agreement entered into with Kevin Thomas (Thomas) on January 28, 2005 with
respect to a debt subordination and related concessions ("Concessions") given to
Thomas in connection with consummating the agreement as described below. The
Company is also restating inventory and cost of goods sold for the quarter ended
April 30, 2005 related to an error in inventory valuation accounting.
20
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 agreed to issue additional shares of our common stock to Investor
in accordance with the Agreement based upon the earlier of (i) our issuance of
additional shares of common stock having an aggregate purchase price of at least
$2,500,000, at a price per share less than $7.75, or (ii) July 31, 2005. The
additional shares of common stock to be issued would equal the price paid by
Investor divided by the lower of (i) the weighted average of all stock sold by
the Company prior to July 31, 2005 or (ii) ninety percent of the average bid
price of Argan's common stock for the thirty days ended July 31, 2005, if the
price was less than $7.75, less the 129,032 shares previously issued. Any
additional shares 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 was registered under the Securities Act on Form S-3 filed with the
SEC on February 25, 2005.
The provision in the agreement which allows the investor to receive additional
shares under certain conditions represents a derivative under Statement of
Financial Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities." Accordingly, $139,000 of the proceeds received at
issuance was accounted for as a liability for a derivative financial instrument.
This liability relates to the obligation to issue Investor additional shares
under certain conditions. The derivative financial instrument is subject to
adjustment for changes in fair value subsequent to issuance through July 31,
2005. The Company recorded a fair value adjustment for a $1,000 gain and a
$343,000 loss at April 30, 2005 and July 31, 2005 respectively, which is also
reflected as a change in the liability for the derivative financial instruments.
The fair value adjustment was recorded as a change in the Company's other
expenses or income and net loss. The liability for derivative financial
instruments related to the Investor was settled as a non-cash transaction by the
issuance of additional shares of the Company's common stock on August 13, 2005.
On August 31, 2004, Argan acquired VLI for approximately $6.7 million in cash
and 825,000 shares of the Company's common stock or $4,950,000 in fair value.
The Company also assumed $1.6 million in debt. The value of the shares issued in
the acquisition of VLI has been revised to reflect the price per share of $6.00
of the Company's common stock at August 31, 2004 as opposed to $6.22, the quoted
market price of the stock two days before and after the acquisition date. The
impact of this change was to reduce the amount of goodwill and additional
paid-in capital by $182,000. The purchase agreement also provides for contingent
consideration based on EBITDA for the twelve months ended February 28, 2005. The
additional contingent consideration would be paid in both cash and stock. The
Company's Additional Consideration was approximately $275,000 in cash, $2.7
million in a subordinated note and approximately 348,000 shares of AI common
stock with a fair value of $2.1 million or $6.00 per share utilizing the quoted
market price on February 28, 2005.
On January 28, 2005 the Company entered into a Letter Agreement with Thomas in
consideration for his agreement to delay the timing of the payment of contingent
cash consideration and for entering into a Debt Subordination Agreement
(Subordination Agreement), reconstituting such additional cash consideration as
subordinated debt. The Letter Agreement includes certain concessions to Thomas
allowing him to receive additional consideration based on the market price of
the Company's common stock. The concessions provide that in addition to
providing Thomas additional shares if the Company raised additional shares at a
price less than $7.75, if the Company did not issue additional shares at a price
less than $7.75 per share then the Company would issue additional shares to
Thomas based on the average closing price of the Company's common stock for the
30 days ended July 31, 2005, if the price were below $7.75 per share. These
concessions allowing Thomas to receive additional shares under certain
conditions represent a freestanding financial instrument and should be accounted
for in accordance with EITF 00-19. The Company has recorded the freestanding
financial instrument as a liability for the fair value of $1,115,000 ascribed to
the obligations of the Company to issue Thomas additional shares.
21
$501,000 of the charge related to the liability for derivative financial
instrument is recorded as deferred issuance cost for subordinated debt which
will be amortized over the life of the subordinated debt and $614,000 of the
charge is recorded as compensation expense due to Thomas. The amortization of
the deferred loan issuance cost will increase the Company's future interest
expense through August 1, 2006, the maturity date of the note, and reduce net
income. The charge for compensation to Thomas was classified as non-cash
compensation expense and increased net loss by $614,000 for the year January 31,
2005. The derivative financial instrument is subject to adjustment for changes
in fair value subsequent to issuance through the July 31, 2005. The fair value
adjustment will be recorded as a change in liability for the derivative
financial instrument and as a charge to the Company's other expenses and net
income. The liability for the derivative financial instrument was settled as a
non-cash transaction by the issuance of additional shares of the Company's
common stock on September 1, 2005.
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 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 agreed to issue additional
shares of our common stock to Investor in accordance with the Subscription
Agreement based 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
at a price per share less than $7.75, or (ii) July 31, 2005. The additional
shares of common stock to be issued would equal the price paid by Investor
divided by the lower of (i) the weighted average of all stock sold by the
Company prior to July 31, 2005, or (ii) ninety percent of the average bid price
of the Company's common stock for the thirty days ended July 31, 2005, if the
price was less than $7.75 per share, less the 129,032 shares previously issued.
Any additional shares issued would effectively reduce the Investor's purchase
price per share of our common stock as set forth in the Subscription Agreement.
22
The provision in the agreement which allows the investor to receive additional
shares under certain conditions represents a derivative under Statement of
Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging
Activities." Accordingly, $139,000 of the proceeds received at issuance was
accounted for as a liability for a derivative financial instrument. This
liability relates to the obligation to issue Investor additional shares under
certain conditions. The derivative financial instrument is subject to adjustment
for changes in fair value subsequent to issuance through July 31, 2005. During
the three months ended April 30, 2005, the Company recorded a fair value
adjustment of a $1,000 gain as other income, net.
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.
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.
On January 28, 2005, the Company entered into a letter agreement ("Letter
Agreement") with Thomas in consideration for his agreement to delay the timing
of the payment of contingent cash consideration and for entering in a debt
subordination agreement, reconstituting such additional cash consideration as
subordinated debt. Pursuant to the Letter Agreement, the Company has agreed to
issue additional shares of our common stock to Thomas under certain conditions
upon the earlier of (i) the Company's issuance of additional shares of our
common stock at a price per share less than $7.75 or (ii) July 31, 2005. The
additional shares of common stock to be issued would equal the price paid by
Thomas divided by the lower of (i) the weighted average of all stock sold by the
Company prior to July 31, 2005, or (ii) if the Company did not issue additional
shares at a price less than $7.75 per share then the Company would issue
additional shares to Thomas based on the average closing price of the Company's
common stock for the thirty days ended July 31, 2005, if the price were below
$7.75 per share.
The Concessions given to Thomas pursuant to the Letter Agreement are being
accounted for as liability for derivative financial instrument under EITF 00-19.
The Company recorded a liability for derivative financial instrument of
$1,115,000, deferred loan issuance cost for subordinated debt of $501,000, and
compensation expense of $614,000 at January 31, 2005. The liability for
derivative financial instrument is subject to adjustment for changes in fair
value at April 30, 2005 for which the Company recorded a $22,000 gain in other
income and $1,609,000 in other expense at settlement on July 31, 2005.
23
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) and 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.
At July 31, 2005, the Company failed to comply with the aforementioned financial
covenants. The Bank waived the failure for the measurement period ended July 31,
2005. For future measurement periods, the Bank revised the definitions of
certain components of the financial covenants to specifically exclude the impact
of items associated with derivative financial instruments such as, valuation
gains and losses, compensation expense which are settled with the non-cash
issuance of the Company's common stock and non-cash issuance amortization.
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 WFC believes 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 estimated payments 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.
24
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
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 3
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/A, 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.
25
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.
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.
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.
26
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.
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.
27
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.
Derivative Financial Instruments
The Company accounts for derivative financial instruments in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 133 "Accounting for
Derivative Instruments and Hedging Activities" and Emerging Issues Task Force
Issue No. 00-19, "Accounting for Derivative Financial Instruments Indexed to,
and Potentially Settled in a Company's Own Stock." The derivative financial
instruments are carried at fair value with changes in fair value recorded as
other expense, net. The determination of fair value for our derivative financial
instruments is subject to the volatility of our stock price as well as certain
underlying assumptions which include the probability of raising additional
capital.
Shipping Fees and Costs
The Company accounts for shipping fees and costs in accordance with Emerging
Issues Task Force Issue No. 00-10 "Accounting for Shipping and Handling Fees and
Costs." Amounts billed to customers in sales transactions related to shipping
recorded in net sales were $30,000 for the three months ended April 30, 2005.
Costs associated with shipping goods to customers which aggregate $51,000 is
accounted for as part of selling expenses for the three months ended April 30,
2005.
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 $266,000 which expires in 2024 and 2025.
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.
28
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
$4,950,000 or $6.00 per share utilizing the quoted market price on 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.
On January 28, 2005, the Company entered into a letter agreement ("Letter
Agreement") with Thomas in consideration for his agreement to delay the timing
of the payment of contingent cash consideration and for entering in a debt
subordination agreement, reconstituting such additional cash consideration as
subordinated debt. Pursuant to the Letter Agreement dated January 28, 2005, the
Company has agreed to issue additional shares of our common stock to Thomas
based upon the earlier of (i) the Company's issuance of additional shares of our
common stock at a price per share less than $7.75 or (ii) July 31, 2005. The
additional shares of common stock to be issued would equal the price paid by
Thomas divided by the lower of (i) the weighted average of all stock sold by the
Company prior to July 31, 2005, or (ii) the average closing price of Argan's
common stock for the thirty days ended July 31, 2005 if the price was less than
$7.75. The Concessions given to Thomas pursuant to the Letter Agreement whereby
the Company agreed that should it not issue additional shares for consideration,
it would issue additional shares to Thomas at a price determined by reference to
the Company's prevailing thirty-day average stock price were accounted for as a
derivative financial instrument. The Company recorded liability for derivative
financial instrument of $1,115,000, deferred loan issuance cost for subordinated
debt of $501,000, and compensation expense to Kevin Thomas of $614,000. The
liability for derivative financial instrument is subject to adjustment for
changes in fair value at April 30, 2005 for which the Company recorded a $22,000
gain as other income, net.
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
based on their estimated fair values. Such intangible assets identified by the
Company include $11,339,000, $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 NCA, respectively.
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
29
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
Restated (Pro Forma)
Net sales $ 7,156,000 $ 5,386,000
Cost of sales 5,286,000 4,264,000
----------- -----------
Gross profit 1,870,000 1,122,000
Selling general and
administrative expenses 1,891,000 1,689,000
----------- -----------
Loss from operations (21,000) (567,000)
Other (expense) income, net (29,000) 10,000
----------- -----------
Loss from operations
before income taxes (50,000) (557,000)
Income tax benefit (28,000) (213,000)
----------- -----------
Net loss ($ 22,000) ($ 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 sales
For the three months ended April 30, 2005, cost of sales was $5,286,000 or 74%
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
decrease in cost of sales as a percentage of net sales due to increased pricing
which it passed onto its customer base.
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.
30
Other expense, net
We had other expense, net of $29,000 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 experienced interest expense due to the funding of
VLI's increased inventory to support increased net sales which was offset, in
part, by the fair value adjustment gain of $23,000 for the liability for
financial instruments.
Income tax (benefit) provision
The Company's effective income tax benefit rate was 56% for the three months
ended April 30, 2005 compared to a 38% pro forma income tax benefit rate for the
three months ended April 30, 2004.
The Company's effective income tax benefit rate was increased by the impact of
the fair value adjustment for liability for derivative financial instruments
which is a permanent difference for income tax reporting purposes.
LIQUIDITY AND CAPITAL RESOURCES
Cash Position and Indebtedness
We had $1.7 million in working capital at April 30, 2005, including $107,000 of
cash and cash equivalents. In addition we had $2.0 million available under
credit facilities.
Working capital increased by $200,000 to $1.7 million at April 30, 2005 from
$1.5 million at January 31, 2005. This increase was primarily due to the strong
operating performances of VLI and SMC. The Company had loss before taxes of
$50,000. 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 $4.25 million in maximum
availability. Under the April 2005 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 Company had $1,661,000 outstanding under the revolving line of credit
and additional availability of $2.0 million. 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.
31
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) and 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
$304,000 to the Company which it was holding in escrow as collateral.
At July 31, 2005, the Company failed to comply with the aforementioned financial
covenants. The Bank waived the failure for the measurement period ended July 31,
2005. For future measurement periods, the Bank revised the definitions of
certain components of the financial covenants to specifically exclude the impact
of items associated with derivative financial instruments such as, valuation
gains and losses, compensation expense which are settled with the non-cash
issuance of the Company's common stock and non-cash issuance amortization.
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.
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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.
In November 2005, the Financial Accounting Standards Board issued FASB Statement
No. 151 "Inventory Costs - an amendment of ARB No. 43, Chapter 4 (SFAS 151)."
This Statement amends the guidance in ARB No. 43, Chapter 4 "Inventory Pricing,"
to clarify the accounting for abnormal amounts of idle facility expense,
freight, handling costs, and wasted material (spoilage). Paragraph 5 of ARB 43,
Chapter 4, previously stated that "...under some circumstances, items such as
idle facility expense, excessive spoilage, double freight, and rehandling costs
may be so abnormal as to require treatment as current period charges... "This
Statement requires that those items be recognized as current-period charges
regardless of whether they meet the criterion of "so abnormal." In addition,
this Statement requires that allocation of fixed production overheads to the
costs of conversion be based on the normal capacity of the production
facilities.
The Company will SFAS No. 151 on February 1, 2006. The Company has not
determined the impact of adopting the new standards and is continuing its
analysis of the impact.
ITEM 3. CONTROLS AND PROCEDURES
In the Company's 2005 Form 10-KSB, management concluded that its internal
control over financial reporting was effective as of January 31, 2005. Recently,
management determined that a material agreement was not disclosed or accounted
for properly in the Company's consolidated financial statements for the year
ended January 31, 2005 and that an error occurred related to inventory valuation
accounting in the quarter ended April 30, 2005. As a result, Management
concluded that the Company's financial statements for the fiscal year ended
January 31, 2005 and for the first quarter ended April 30, 2005 were required to
be restated to account for the agreement and to adjust inventory and cost of
goods sold. Further, management concluded that both of these errors resulted
from material weaknesses in the Company's internal controls over financial
reporting. Specifically, management has identified deficiencies in the design of
the Company's process surrounding disclosure controls and in the operating
effectiveness of inventory accounting controls.
To address these material weaknesses and to mitigate these issues, management
has instituted more formalized processes for all members of senior management
and outside counsel to review all material agreements and filings with the SEC
prior to their release. Material agreements will be accumulated at their
corporate offices for review and evaluation. In addition, the Company will begin
to receive sub certifications from their division level executives. Management
has also enhanced the quality of their accounting expertise at the VLI
subsidiary and have begun to incorporate a more thorough and comprehensive
review and monitoring process of the Company's subsidiaries financial
information. As part of this comprehensive review, the Company has enhanced
their review of cost and gross margin to detect errors associated with inventory
valuation.
33
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 WFC believes 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 estimated payments 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 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. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
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
34
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.
December 2, 2005 By: /s/ Rainer Bosselmann
------------------------------------------
Rainer Bosselmann
Chairman of the Board and
Chief Executive Officer
December 2, 2005 By: /s/ Arthur F. Trudel
-----------------------------------------
Arthur F. Trudel
Chief Financial Officer
35