UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 31, 2005 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 incorporation (IRS Employer identification No.)
or organization)
One Church Street, Suite 302, Rockville MD 20850
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(Address of principal executive offices) (ZIP Code)
Issuer's telephone number, including area code: (301) 315-0027
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15 (d) of the Exchange Act during the past twelve months (or for such
shorter period that the Registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes |X| No |_|
Securities registered pursuant to Section 12(b) of the Act:
Common Stock 3,814,008 Shares outstanding
Common Stock, $.15 Par Value as of December 12, 2005
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Transitional Small Business Disclosure Format (Check One): Yes |_| No |X|
ARGAN, INC.
INDEX
Page No.
PART I. FINANCIAL INFORMATION......................................................................................3
Item 1. Financial Statements.......................................................................................3
Condensed Consolidated Balance Sheets - October 31, 2005 and January 31, 2005......................................3
Condensed Consolidated Statements of Operations for the Three Months and Nine Months
Ended October 31, 2005 and 2004.......................................................................4
Condensed Consolidated Statements of Cash Flows for the Nine Months
Ended October 31, 2005 and 2004........................................................................5
Notes to Condensed Consolidated Financial Statements...............................................................6
Item 2. Management's Discussion and Analysis or Plan of Operation..................................................17
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.........................................................................................35
Item 6. Exhibits..................................................................................................35
SIGNATURES.........................................................................................................36
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2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ARGAN, INC.
Condensed Consolidated Balance Sheets
October 31, 2005 January 31, 2005
================ ================
ASSETS (Unaudited) Restated
CURRENT ASSETS:
Cash and cash equivalents $ 27,000 $ 167,000
Accounts receivable, net of allowance for doubtful accounts of
$88,000 at 10/31/2005 and $85,000 at 1/31/2005 3,529,000 2,951,000
Receivable from affiliated entity, net of allowance for doubtful
accounts of $0 at 10/31/2005 and $84,000 at 1/31/2005 175,000 112,000
Escrowed cash 300,000 604,000
Estimated earnings in excess of billings 348,000 323,000
Inventories, net of reserves of $84,000 at 10/31/2005 and
$62,000 at 1/31/2005 2,639,000 3,465,000
Prepaid expenses and other current assets 485,000 622,000
---------------- ----------------
TOTAL CURRENT ASSETS 7,503,000 8,244,000
---------------- ----------------
Property and equipment, net of accumulated depreciation of
$1,186,000 at 10/31/2005 and $679,000 at 1/31/2005 3,341,000 2,703,000
Issuance cost for subordinated debt 375,000 501,000
Other assets 36,000 35,000
Contractual customer relationships, net 487,000 564,000
Trade name 224,000 224,000
Proprietary formulas, net 1,528,000 2,153,000
Non-contractual customer relationships, net 1,533,000 1,833,000
Non-compete agreement, net 1,380,000 1,650,000
Goodwill 13,315,000 7,350,000
---------------- ----------------
TOTAL ASSETS $ 29,722,000 $ 25,257,000
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 2,446,000 $ 1,803,000
Due to affiliates 112,000 47,000
Accrued expenses 1,132,000 1,187,000
Liability for derivative financial instruments -- 1,254,000
Deferred income tax liability 74,000 144,000
Line of credit 1,378,000 1,659,000
Current portion of long-term debt 418,000 662,000
Subordinated debt due to former owner of
Vitarich Laboratories, Inc. 3,292,000 --
---------------- ----------------
TOTAL CURRENT LIABILITIES 8,852,000 6,756,000
---------------- ----------------
Deferred income tax liability 2,159,000 2,520,000
Deferred rent 10,000 --
Long-term debt 202,000 481,000
Long-term debt due to former owner of Vitarich Laboratories, Inc. 422,000
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 -3,740,596 and 2,762,078 shares
issued at 10/31/2005 and 1/31/2005 and 3,737,363 and
2,758,845 shares outstanding at 10/31/2005 and 1/31/2005 560,000 414,000
Warrants outstanding 849,000 849,000
Additional paid-in capital 24,926,000 19,800,000
Accumulated deficit (8,225,000) (5,530,000)
Treasury stock at cost: 3,233 shares at 10/31/2005 and 1/31/2005 (33,000) (33,000)
---------------- ----------------
TOTAL STOCKHOLDERS' EQUITY 18,077,000 15,500,000
---------------- ----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 29,722,000 $ 25,257,000
================ ================
See Accompanying Notes
3
ARGAN, INC.
Condensed Consolidated Statements of Operations
(Unaudited)
Three months ended October 31 Nine months ended October 31
2005 2004 2005 2004
============ ============ ============ ============
Net sales $ 7,133,000 $ 4,850,000 $ 21,141,000 $ 8,485,000
Cost of sales 5,431,000 3,483,000 16,211,000 6,698,000
------------ ------------ ------------ ------------
Gross profit 1,702,000 1,367,000 4,930,000 1,787,000
Selling, general and administrative expenses
1,847,000 1,513,000 5,721,000 2,991,000
Impairment loss -- -- -- 1,942,000
------------ ------------ ------------ ------------
Loss from operations (145,000) (146,000) (791,000) (3,146,000)
Interest expense 205,000 34,000 364,000 64,000
Other expense (income), net 1,000 (8,000) 1,926,000 (63,000)
------------ ------------ ------------ ------------
Loss before income taxes (351,000) (172,000) (3,081,000) (3,147,000)
Income tax benefit 64,000 29,000 386,000 893,000
------------ ------------ ------------ ------------
Net loss $ (287,000) $ (143,000) $ (2,695,000) $ (2,254,000)
============ ============ ============ ============
Basic and diluted loss per share: $ (0.08) $ (0.06) $ (0.81) $ (1.13)
============ ============ ============ ============
Weighted average number of shares outstanding - basic
and diluted 3,814,000 2,354,000 3,314,000 1,987,000
============ ============ ============ ============
See Accompanying Notes
4
ARGAN, INC.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
Nine Months Ended
October 31,
2005 2004
============ ============
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (2,695,000) $ (2,254,000)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Depreciation and amortization 721,000 349,000
Amortization of purchase intangibles 1,272,000 406,000
Impairment loss on goodwill and intangibles -- 1,942,000
Deferred income taxes (430,000) (934,000)
Non-cash loss on liability for derivative financial instruments 1,930,000 --
Gain on sale of property and equipment (33,000) (4,000)
Changes in operating assets and liabilities:
Accounts receivable, net (578,000) (219,000)
Receivable from affiliated entity, net (63,000) (15,000)
Escrowed cash 304,000 --
Estimated earnings in excess of billings (25,000) 208,000
Inventories, net 1,090,000 (31,000)
Prepaid expenses and other current assets 110,000 (230,000)
Accounts payable and accrued expenses 298,000 (1,445,000)
Billings in excess of estimated earnings -- 32,000
Due to affiliates 65,000 (38,000)
Other 9,000 (14,000)
------------ ------------
Net cash provided by (used in) operating activities 1,975,000 (2,247,000)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of Vitarich Laboratories, Inc. (426,000) (6,650,000)
Purchase of investments -- (9,000,000)
Redemptions of investments -- 12,000,000
Purchases of property and equipment (955,000) (123,000)
Proceeds on sale of property and equipment 70,000 11,000
------------ ------------
Net cash used in investing activities (1,311,000) (3,762,000)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercised stock options -- 11,000
Proceeds from line of credit 2,500,000 2,569,000
Proceeds from long-term debt 8,000 --
Principal payments on long-term debt (531,000) (1,091,000)
Principal payments on line of credit (2,781,000) --
Payment to former stockholder on loan to Vitarich Laboratories, Inc. -- (507,000)
------------ ------------
Net cash (used in) provided by financing activities (804,000) 982,000
------------ ------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (140,000) (5,027,000)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 167,000 5,212,000
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 27,000 $ 185,000
============ ============
See Accompanying Notes
5
ARGAN, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1- ORGANIZATION AND BASIS OF PRESENTATION
NATURE OF OPERATIONS
Argan, Inc. (AI or the Company) conducts its operations through its wholly owned
subsidiaries Vitarich Laboratories, Inc. (VLI) which it acquired in August 2004
and Southern Maryland Cable, Inc. (SMC) which it acquired in July 2003. Through
VLI, the Company develops, manufactures and distributes premium nutritional
supplements, whole-food dietary supplements and personal care products. Through
SMC, the Company provides telecommunications infrastructure services including
project management, construction and maintenance to the Federal Government,
telecommunications and broadband service providers, as well as electric
utilities primarily in the Mid-Atlantic region.
AI was organized as a Delaware corporation in May 1961.
The Company operates in two reportable segments. (See Note 9)
MANAGEMENT'S PLANS, LIQUIDITY AND BUSINESS RISKS
As of October 31, 2005, the Company had an accumulated deficit of $8.2 million.
At October 31, 2005, the Company had $2.5 million available under its revolving
line of credit with the Bank of America, N.A. (the Bank). The Company operates
in two distinct markets. The market for nutritional products is highly
competitive and the telecom and infrastructure services industry is fragmented
and also very competitive. The successful execution of the Company's business
plan is dependent upon the Company's ability to continue integrating 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 as well
as 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 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. (See Notes 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 the $1 million provided that such payment would not put the Company in
default of its current financing arrangement with the Bank. (See Note 6)
On April 8, 2005, the Company renewed its line of credit with the Bank,
extending the maturity date to May 31, 2006. The maximum 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) The Company was in
compliance with the aforementioned financial covenants at October 31, 2005.
6
During the nine months ended October 31, 2005, the Company had positive cash
flows from operations of $1,975,000. 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 does not reflect any adjustments should the Company
be unable to meet its future operating cash needs in the ordinary course of
business. The Company continues to take various actions to align its cost
structure to appropriately match its expected revenues, including limiting its
operating expenditures and controlling its capital expenditures. Any future
acquisitions, other significant unplanned costs or cash requirements may require
the Company to raise additional funds through the issuance of debt and equity
securities. There can be no assurance that such financing will be available on
terms acceptable to the Company, or at all. If additional funds are raised by
issuing equity securities, significant dilution to the existing stockholders may
result.
BASIS OF PRESENTATION
The condensed consolidated balance sheet as of October 31, 2005 and the
condensed consolidated statements of operations for the three and nine months
ended October 31, 2005 and 2004 and cash flows for the nine months ended October
31, 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 October 31, 2005 and the results of its
operations and its cash flows for the periods presented. The Company prepares
its interim financial information using the same accounting principles as it
does for its annual financial statements.
These financial statements do not include all disclosures associated with annual
financial statements and, accordingly, should be read in conjunction with the
footnotes contained in the Company's consolidated financial statements for the
year ended January 31, 2005, together with the independent registered public
accounting firm's report, included in the Company's Annual Report on Form
10-KSB/A, as filed with the Securities and Exchange Commission. The results of
operations for any interim period are not necessarily indicative of the results
of operations for any other interim period or for a full fiscal year.
NOTE 2 - 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. The Company also restated inventory
and cost of goods sold for the quarter ended April 30, 2005 related to an error
in inventory valuation accounting.
The impact of the restatements are detailed in the Company's Form 10-KSB/A in
Note 2 and in Form 10-QSB/A in Note 2 both filed with the Securities and
Exchange Commission on December 2, 2005. Refer to accompanying Notes 4 and 5 for
a description of the aforementioned transactions with MSR and Thomas which
resulted in the restatements.
7
NOTE 3 - SIGNIFICANT ACCOUNTING POLICIES
Property and Equipment - The Company recorded net gains of $33,000 and $55,000
on disposal of equipment which resulted in a decrease in selling, general and
administrative expenses during the nine months and three months ended October
31, 2005.
Inventories - Inventories are stated at the lower of cost or market (net
realizable value). Cost is determined on the first-in, first-out (FIFO) method.
Appropriate consideration is given to obsolescence, excessive inventory levels,
product deterioration, and other factors in evaluating net realizable value.
Inventories at October 31, 2005 consist of the following:
Raw materials $ 2,245,000
Work-in process 131,000
Finished goods 263,000
------------
$ 2,639,000
============
Earnings 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 and warrants were not included in the weighted
average number of shares outstanding during the three and nine months ended
October 31, 2005 and 2004 due to the Company's net loss and because the market
price of the Company's stock was significantly below the respective exercise
prices for the stock options and warrants.
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 income or expense, net. The determination of fair value
for 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 associated in net sales were $116,000
and $47,000 for the nine and three months ended October 31, 2005 and $25,000 for
the nine and three months ended October 31, 2004. Costs associated with shipping
goods to customers which aggregate $116,000 and $39,000 are accounted for as
part of selling expenses for the nine and three months ended October 31, 2005
and $24,000 for nine and three months ended October 31, 2004.
Reclassifications - Certain amounts in the prior year financial statements have
been reclassified for comparability with the presentation in the current year
financial statements.
The Pro Forma disclosures required by Statement of Financial Accounting
Standards No. 148 "Accounting for Stock Based Compensation" are reflected below:
8
Pro Forma Disclosures
For the three months ended October 31,
2005 2004
============ ============
Net loss, as reported $ (287,000) $ (143,000)
Add: Stock based compensation recorded
in the financial statements -- --
Deduct: Total stock-based employee compensation
expense determined under fair value based methods 12,000 5,000
------------ ------------
Pro forma net loss $ (299,000) $ (148,000)
============ ============
Basic and diluted per share:
Basic and diluted - as reported $ (0.08) $ (0.06)
============ ============
Basic and diluted - pro forma $ (0.08) $ (0.06)
============ ============
Pro Forma Disclosures
For the nine months ended October 31,
2005 2004
============ ============
Net loss, as reported $ (2,695,000) $ (2,254,000)
Add: Stock based compensation recorded
in the financial statements -- --
Deduct: Total stock-based employee compensation
expense determined under fair value based methods 38,000 25,000
------------ ------------
Pro forma net loss $ (2,733,000) $ (2,279,000)
============ ============
Basic and diluted per share:
Basic and diluted - as reported $ (0.81) $ (1.13)
============ ============
Basic and diluted - pro forma $ (0.82) $ (1.15)
============ ============
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 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 standard and is continuing its analysis of 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 adopt SFAS No. 151 on February 1, 2006. The Company
has not determined the impact of adopting the new standard and is continuing its
analysis of the impact.
9
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 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 contained provisions for the 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 were met.
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 July 5, 2005, the Company and Thomas entered into an agreement (Earn Back
Agreement) concerning the calculation of Additional Consideration due Thomas. In
the Earn Back Agreement, the Company agreed to pay Thomas $594,000 in a
subordinated note and 77,000 shares of common stock with a fair value of $5.50
per share utilizing the quoted market price on July 5, 2005. The $1,015,000 of
Additional Consideration has been recorded by the Company as additional purchase
consideration and an increase in goodwill. The amount of Additional
Consideration due in shares of the Company's common stock aggregating 77,000
shares with a fair value of approximately $422,000 is reflected as long-term
debt due to former owner of Vitarich Laboratories, Inc. In addition, if certain
inventory considered to be an overstock for purchase accounting at the time of
the acquisition was reduced to normal levels of usage by November 30, 2005,
Thomas would be paid an additional $264,000, one-half in a subordinated note and
one-half in common stock. The Company has not accrued any additional amount due
Thomas at October 31, 2005.
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. The subordinated note carries an interest rate of
10% with interest paid in arrears on October 1, 2005, January 1, 2006, April 1,
2006, July 1, 2006 and at maturity on August 1, 2006. During the nine and three
months ended October 31, 2005, the Company incurred $92,000 and $68,000 in
interest expense for the subordinated debt.
10
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 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 per share less
any shares already issued. 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
Kevin Thomas of $614,000 at January 31, 2005. The liability for derivative
financial instrument was subject to adjustment for changes in fair value
subsequent to its issuance. The Company recorded a loss of $1,587,000 in other
expense, net and net loss for the subsequent changes in fair value. The
liability for derivative financial instruments aggregating $2,702,000 was
settled in a non-cash transaction by the issuance of 535,052 shares of the
Company's common stock on September 1, 2005.
The Company's accounting for the acquisition of VLI and the 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
$12,375,000, $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 $972,000,
$467,000 and $420,000 at October 31, 2005 for PF, NCR and NCA, respectively.
At the date of acquisition, the Company identified a preacquisition contingency
with respect to approximately $264,000 for certain inventory items and reduced
VLI's valuation by that amount. The Company has been monitoring the sales level
of the specific inventory items during the allocation period (since the date of
acquisition). Based on the additional sales performance information regarding
this inventory, the Company reversed the preacquisition contingency and recorded
a decrease to Goodwill and an increase in Inventory of $264,000 during the three
months ended July 31, 2005.
The following unaudited pro forma statement of operations of the Company for the
three and nine months ended October 31, 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.
11
Three Months Ended Nine Months Ended
October 31, 2004 October 31, 2004
---------------- ----------------
Pro Forma Statement of Operations
Net sales $ 6,202,000 $ 18,098,000
Cost of sales 4,450,000 13,678,000
---------------- ----------------
Gross profit 1,752,000 4,420,000
Selling, general and
administrative expenses 1,716,000 4,938,000
Impairment loss -- 1,942,000
---------------- ----------------
Income (Loss) from operations 36,000 (2,460,000)
Other expense, net (48,000) (50,000)
---------------- ----------------
Loss before income tax benefit (12,000) (2,510,000)
Income tax benefit 5,000 714,000
---------------- ----------------
Net loss $ (7,000) $ (1,796,000)
================ ================
Loss per share -- $ (0.50)
================ ================
Weighted average shares outstanding 3,588,000 3,588,000
================ ================
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, 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 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 upon
issuance was accounted for as a liability for 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 fair value
adjustment loss of $343,000 was recorded during the nine months ended October
31, 2005 and included in other expense net and net loss. The liability
aggregating $482,000 was settled in a non-cash transaction by the issuance of
95,321 shares of the Company's common stock on August 13, 2005.
The Company retained Investor under a consulting arrangement to assist in
identifying and meeting potential equity investors. Under this consulting
arrangement, the Company paid the Investor $100,000 during the nine months ended
October 31, 2005.
The Company leases administrative, manufacturing and warehouse facilities from
individuals who are officers of SMC and VLI. The total expense under these
arrangements were $75,000 and $222,000 for the three and nine months ended
October 31, 2005 and $40,000 and $79,000 for the three and nine months ended
October 31, 2004.
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 $68,000 and $146,000, respectively, in purchases under the
supply agreement during the three and nine months ended October 31, 2005. No
purchases were made by the Company during the three and nine months ended
October 31, 2004.
12
At October 31, 2005, the Company has accrued $112,000 for reimbursement to
Thomas for certain leasehold improvements which he constructed in the building
that the Company leases from Thomas.
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 $129,000 and $430,000 and $130,000
and $130,000, respectively, in sales with this entity for the three and nine
months ended October 31, 2005 and 2004. At October 31, 2005, the affiliated
entity owed $175,000 to VLI, net of an allowance for doubtful accounts of zero
which the Company had reduced from $120,000 during the three months ended
October 31, 2005 due to collections of aged receivables.
NOTE 6 - DEBT
In April 2005, the Company agreed to amend the existing financing arrangements
with the Bank. Under this arrangement, the Company has a revolving line of
credit of $4.25 million and a term loan with an original balance of $1.2
million. 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 October 31, 2005, the Company had
$300,000 outstanding under the term note and $1,378,000 outstanding under the
revolving line of credit with $2.5 million of additional availability.
The financing arrangements amended on April 8, 2005 provide for the measurement
at Argan's fiscal year end and at each of Argan's fiscal quarter ends 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 and requiring a pro forma fixed charge coverage ratio of not
less than 1.25 to 1. 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 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. The Company was in compliance with the aforementioned financial covenants
at October 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 and non-cash deferred
loan issuance cost 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,
yielding aggregate proceeds of $999,998. The Shares were issued pursuant to the
exemption provided by Section 4(2) of the Securities Act of 1933, as amended.
The Investor is an entity controlled by Daniel Levinson, a director of the
Company. (See Note 4) 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 previously issued. Any additional
shares issued would effectively reduce the Investor's purchase price per common
share as set forth in the Subscription Agreement.
13
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. During the nine
months ended October 31, 2005, the Company recorded a fair value adjustment loss
of $343,000 which is recorded in other expense and net loss. The liability
aggregating $482,000 was settled in a non-cash transaction by the issuance of
95,321 shares of the Company's common stock on August 13, 2005.
NOTE 8 - INCOME TAXES
The Company had an effective income tax benefit rate of 18% and 13% for the
three and nine months ended October 31, 2005. The effective income tax benefit
rate changed during the three months ended October 31, 2005 resulting in an
increase in income tax benefit of $25,000. During the nine months ended October
31, 2005, the Company recorded the $1,930,000 valuation loss for the liability
for derivative financial instruments as other expense which is treated as a
permanent difference for income tax reporting purposes. This permanent
difference reduced our income tax benefit rate from 38% to 13% for the nine
months ended October 31, 2005. The Company had an effective tax benefit rate of
17% and 28%, respectively, for the three and nine months ended October 31, 2004.
During the nine months ended October 31, 2004, the Company recorded a $740,000
impairment of goodwill which is treated as a permanent difference for tax
reporting purposes. This permanent difference reduced our effective income tax
benefit rate from 38% to 28% for the nine months ended October 31, 2004.
NOTE 9 - 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 assess 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/A and Note 3 in this filing. Summarized
financial information concerning the Company's operating segments is shown in
the following tables:
14
For the Nine Months
Ended October 31, 2005
Telecom
Nutraceutical Infrastructure
Products Services Other Consolidated
-------------- -------------- -------------- --------------
Net sales $ 13,337,000 $ 7,804,000 $ -- $ 21,141,000
Cost of sales 10,111,000 6,100,000 -- 16,211,000
-------------- -------------- -------------- --------------
Gross profit 3,226,000 1,704,000 -- 4,930,000
Selling, general and administrative
expenses 3,341,000 1,128,000 1,252,000 5,721,000
-------------- -------------- -------------- --------------
(Loss) income from operations (115,000) 576,000 (1,252,000) (791,000)
Interest expense 238,000 43,000 83,000 364,000
Other (income) expense, net -- (2,000) 1,928,000 1,926,000
-------------- -------------- -------------- --------------
(Loss) income before income taxes ($ 353,000) $ 535,000 $ (3,263,000) (3,081,000)
============== ============== ============== --------------
Income tax benefit 386,000
--------------
Net loss $ (2,695,000)
==============
Depreciation and amortization $ 267,000 $ 300,000 $ 154,000 $ 721,000
============== ============== ============== ==============
Amortization of intangibles $ 1,194,000 $ 78,000 -- $ 1,272,000
============== ============== ============== ==============
Goodwill $ 12,375,000 $ 940,000 -- $ 13,315,000
============== ============== ============== ==============
Total Assets $ 21,314,000 $ 5,281,000 $ 3,127,000 $ 29,722,000
============== ============== ============== ==============
For the Nine Months
Ended October 31, 2004
Telecom
Nutraceutical(1) Infrastructure
Products Services Other Consolidated
------------ ------------ ------------ ------------
Net sales $ 2,767,000 $ 5,718,000 $ -- $ 8,485,000
Cost of sales 1,825,000 4,873,000 -- 6,698,000
------------ ------------ ------------ ------------
Gross profit 942,000 845,000 -- 1,787,000
Selling, general and administrative
expenses 580,000 1,279,000 1,132,000 2,991,000
Impairment loss -- 1,942,000 -- 1,942,000
------------ ------------ ------------ ------------
Income (loss) from operations 362,000 (2,376,000) (1,132,000) (3,146,000)
Interest expense 25,000 36,000 3,000 64,000
Other income -- 5,000 58,000 63,000
------------ ------------ ------------ ------------
Income (loss) before income
taxes $ 337,000 $ (2,407,000) $ (1,077,000) (3,147,000)
============ ============ ============ ------------
Income tax benefit 893,000
------------
Net loss $ (2,254,000)
============
Depreciation and amortization $ 40,000 $ 287,000 $ 22,000 $ 349,000
============ ============ ============ ============
Amortization of intangibles $ 266,000 $ 140,000 -- $ 406,000
============ ============ ============ ============
Goodwill $ 6,441,000 $ 940,000 -- $ 7,381,000
============ ============ ============ ============
Total Assets $ 19,174,000 $ 5,361,000 $ 799,000 $ 25,334,000
============ ============ ============ ============
(1) Operating results of VLI are included since date of acquisition, August
31, 2004.
15
For the Three Months
Ended October 31, 2005
Telecom
Nutraceutical Infrastructure
Products Services Other Consolidated
------------ ------------ ------------ ------------
Net sales $ 4,085,000 $ 3,048,000 $ -- $ 7,133,000
Cost of sales 3,146,000 2,285,000 -- 5,431,000
------------ ------------ ------------ ------------
Gross profit 939,000 763,000 -- 1,702,000
Selling, general and administrative
expenses 1,062,000 382,000 403,000 1,847,000
------------ ------------ ------------ ------------
(Loss) income from operations (123,000) 381,000 (403,000) (145,000)
Interest expense 106,000 19,000 80,000 205,000
Other expense, net 1,000 -- -- 1,000
------------ ------------ ------------ ------------
(Loss) income before income taxes $ (230,000) $ 362,000 $ (483,000) (351,000)
============ ============ ============ ------------
Income tax benefit 64,000
------------
Net loss $ (287,000)
============
Depreciation and amortization $ 101,000 $ 102,000 $ 96,000 $ 299,000
============ ============ ============ ============
Amortization of intangibles $ 398,000 $ 26,000 -- $ 424,000
============ ============ ============ ============
Goodwill $ 12,375,000 $ 940,000 -- $ 13,315,000
============ ============ ============ ============
Total Assets $ 21,314,000 $ 5,281,000 $ 3,127,000 $ 29,722,000
============ ============ ============ ============
For the Three Months
Ended October 31, 2004
Telecom
Nutraceutical(1) Infrastructure
Products Services Other Consolidated
------------ ------------ ------------ ------------
Net sales $ 2,767,000 $ 2,083,000 $ -- $ 4,850,000
Cost of sales 1,825,000 1,658,000 -- 3,483,000
------------ ------------ ------------ ------------
Gross profit 942,000 425,000 -- 1,367,000
Selling, general and administrative
expenses 580,000 452,000 481,000 1,513,000
Impairment loss -- -- -- --
------------ ------------ ------------ ------------
Income (loss) from operations 362,000 (27,000) (481,000) (146,000)
Interest expense 25,000 9,000 -- 34,000
Other income -- -- 8,000 8,000
------------ ------------ ------------
Income (loss) before income taxes $ 337,000 $ (36,000) $ (473,000) (172,000)
============ ============ ============
Income tax benefit 29,000
------------
Net loss $ (143,000)
============
Depreciation and amortization $ 40,000 $ 96,000 $ 13,000 $ 149,000
============ ============ ============ ============
Amortization of intangibles $ 266,000 $ 26,000 -- $ 292,000
============ ============ ============ ============
Goodwill $ 6,441,000 $ 940,000 -- $ 7,381,000
============ ============ ============ ============
Total Assets $ 19,174,000 $ 5,361,000 $ 799,000 $ 25,334,000
============ ============ ============ ============
(1) Operating results of VLI are included since date of acquisition, August
31, 2004.
16
NOTE 10 - CONTINGENCIES
On October 31, 2003, the Company 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 if a breach of the representations and warranties made by the Company in
connection with that sale should occur. 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.
WFC filed a civil action against Argan, Inc. on March 22, 2005. The suit was
initially filed in the Superior Court of the State of California for the County
of Los Angeles. The complaint asserts seven claims against the Company: (1)
breach of contract; (2) intentional misrepresentation; (3) concealment and
non-disclosure; (4) negligent misrepresentation; (5) false promise; (6)
negligence; and (7) declaratory disclosure as well as negligent
misrepresentations against the Company's executive officers.
WFC alleges substantial damages. This action was removed to the United States
District Court for the Central District of California. On June 30, 2005, WFC
filed its Second Amended Complaint. The Company filed its Motion to Dismiss the
Complaint on July 27, 2005. The District Court denied the Company's Motion to
Dismiss on November 18, 2005. The Company will file its Answer and Special
Defenses. The Company has reviewed WFC's complaint and believes that most 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
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 that may result from this
matter for which the Company has recorded an accrual at October 31, 2005 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.
17
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.
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. The Company also restated inventory
and cost of goods sold for the quarter ended April 30, 2005 related to an error
in inventory valuation accounting.
The impact of the restatements are detailed in the Company's Form 10-KSB/A in
Note 2 and in Form 10-QSB/A in Note 2 both filed with the Securities and
Exchange Commission on December 2, 2005. Refer to accompanying Notes 4 and 5 for
a description of the aforementioned transactions with MSR and Thomas which
resulted in the restatements.
RECENT EVENTS
Earn Back Agreement
On July 5, 2005, the Company and Thomas entered into an agreement (Earn Back
Agreement) concerning the calculation of Additional Consideration due Thomas. In
the Earn Back Agreement, the Company agreed to pay Thomas $594,000 in a
subordinated note and 77,000 shares of common stock with a fair value of $5.50
per share utilizing the quoted market price on July 5, 2005. The $1,015,000
payment has been recorded by the Company as additional purchase consideration
and an increase in goodwill. The amount of Additional Consideration due in
shares of the Company's common stock aggregating 77,000 shares with a fair value
of approximately $422,000 is reflected as long-term debt due to former owner of
Vitarich Laboratories, Inc. In addition, if certain inventory considered to be
an overstock for purchase accounting at the time of the acquisition was reduced
to normal levels of usage, Thomas would be paid an additional $264,000 one-half
in a subordinated note and one-half in common stock. The Company has not accrued
any additional amount due Thomas at October 31, 2005.
18
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, yielding aggregate proceeds of $999,998. The Shares were issued
pursuant to the exemption provided by Section 4(2) of the Securities Act of
1933, as amended. The Investor is an entity controlled by Daniel Levinson, a
director of the Company.
Pursuant to the Subscription Agreement, the Company has agreed to issue
additional shares of our common stock to Investor in accordance with the
Subscription Agreement 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.
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 have been accounted for as liability for 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
fair value adjustment loss of $343,000 was recorded during the nine months ended
October 31, 2005 and included in other expense, net and net loss. The liability
aggregating $482,000 was settled in a non-cash transaction by the issuance of
95,321 shares of the Company's common stock on August 13, 2005.
Subordination of Certain Debt
On January 31, 2005, the Company entered into a Debt Subordination Agreement
("Subordination Agreement") with Kevin J. Thomas ("Thomas"), Southern Maryland
Cable, Inc., a wholly owned subsidiary of the Company ("SMC," and together with
the Company, the "Debtor") and Bank of America, N.A. ("Lender") to reconstitute
as subordinated debt certain additional cash consideration ("Additional Cash
Consideration") that Debtor will owe to Thomas in connection with the Merger
Agreement.
Debtor entered into a certain Financing and Security Agreement dated as of
August 19, 2003, as amended, with Lender whereby Lender extended to Debtor
certain loans. On August 31, 2004, with the consent of Lender, the Debtor
entered into an Agreement and Plan of Merger (the "Merger Agreement"), whereby
the Company acquired all of the common stock of Vitarich Laboratories, Inc.
("Vitarich") by way of merger of Vitarich with and into a wholly-owned
subsidiary of the Company, with Vitarich (now VLI) as the surviving company.
Pursuant to the Merger Agreement, Thomas (who was a shareholder of Vitarich) is
entitled to receive from Debtor, subject to certain conditions, Additional Cash
Consideration as provided in the Merger Agreement.
Pursuant to the Subordination Agreement, Debtor and Thomas have agreed to
reconstitute the Additional Cash Consideration as subordinated debt and in
furtherance thereof, the Company has agreed to execute and deliver to Thomas a
Subordinated Promissory Note in an amount equal to the amount that would
otherwise be due Thomas as Additional Cash Consideration under the Merger
Agreement. Accordingly, under the Subordination Agreement, Debtor subordinated
all of the Junior Debt (as such term is defined in the Subordination Agreement)
to the full extent provided in the Subordination Agreement, and Thomas
transferred and assigned to Lender all of his rights, title and interest in the
Junior Debt and appointed Lender as his attorney-in-fact for the purchases
provided in the Subordination Agreement for as long as any of the Superior Debt
remains outstanding. Except as otherwise provided in the Subordination Agreement
and until such time that the Superior Debt is satisfied in full, Debtor shall
not, among other things, directly or indirectly, in any way, satisfy any part of
the Junior Debt, nor shall Thomas, among other things, enforce any part of the
Junior Debt or accept payment from Debtor or any other person for the Junior
Debt or give any subordination in respect of the Junior Debt.
19
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 reconstituting such additional cash consideration as
subordinated debt. Pursuant to the Letter Agreement, the Company agreed to issue
additional shares to Thomas upon the earlier of (i) Company's issuance of
additional shares of common stock at a price per share less than $7.75; 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 closing stock for the thirty days ended
July 31, 2005, if the price were below $7.75 per share. The concessions given to
Kevin Thomas pursuant to the Letter Agreement are being accounted for as a
derivative financial instrument under EITF 00-19. The Company recorded a
liability for a derivative financial instrument of $1,115,000, deferred loan
commitment charge of $501,000 and compensation expense of $614,000 at January
31, 2005. The derivative financial instrument is subject to adjustment for
changes in fair value subsequent to issuance. A fair value adjustment of
$1,587,000 was recorded during the nine months ended October 31, 2005, and
included in other expense and net loss. The liability aggregating $2,702,000 was
settled in a non-cash transaction by issuance of 535,052 shares of the Company's
common stock on September 1, 2005.
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 provides for the measurement of
certain financial covenants at the end of Argan's fiscal quarters and year-end
including requiring the ratio of debt to pro forma earnings before interest,
taxes, depreciation and amortization (EBITDA) not to exceed 2.5 to 1 and
requiring a pro forma fixed charge coverage ratio of not less than 1.25 to 1.
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. The Company was in compliance with the aforementioned financial covenants
at October 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 deferred loan
issuance cost amortization.
Western Filter Corporation Litigation
On October 31, 2003, the Company 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 if a breach of the representations and warranties made by the Company in
connection with that sale should occur. 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.
20
WFC filed a civil action against Argan, Inc. on March 22, 2005. The suit was
initially filed in the Superior Court of the State of California for the County
of Los Angeles. The complaint asserts seven claims against the Company: (1)
breach of contract; (2) intentional misrepresentation; (3) concealment and
non-disclosure; (4) negligent misrepresentation; (5) false promise; (6)
negligence; and (7) declaratory disclosure as well as negligent
misrepresentations against the Company's executive officers.
WFC alleges substantial damages. This action was removed to the United States
District Court for the Central District of California. On June 30, 2005, WFC
filed its Second Amended Complaint. The Company filed its Motion to Dismiss the
Complaint on July 27, 2005. The District Court denied the Company's Motion to
Dismiss on November 18, 2005. The Company will file its Answer and Special
Defenses. The Company has reviewed WFC's complaint and believes that most 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.
We are a holding company with no operations other than our investments in VLI
and SMC. At October 31, 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.
21
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.
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 which is generally when
orders are shipped. 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.
22
The timing of billing to customers varies based on individual contracts and
often differs from the period of revenue recognition. Estimated earnings in
excess of billings totaled $348,000 at October 31, 2005.
Contract costs are recorded when incurred and include direct labor and other
direct costs combined with allocations of operational indirect costs. Management
periodically reviews the costs incurred and revenue recognized from contracts
and adjusts recognized revenue to reflect current expectations. Provisions for
estimated losses on incomplete contracts are provided in full in the period in
which such losses become known.
Inventories
Inventories are stated at the lower of cost or market (net realizable value).
Cost is determined on the first-in first-out (FIFO) method. Appropriate
consideration is given to obsolescence, excessive inventory levels, product
deterioration and other factors in evaluating net realizable value.
Impairment of Long-Lived Assets
Long-lived assets, consisting primarily of property and equipment, are reviewed
for impairment whenever events or changes in circumstances indicate that the
carrying amount should be assessed pursuant to SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." We determine impairment by
comparing the carrying value of these long-lived assets to the undiscounted
future cash flows expected to result from the use of these assets. In the event
we determine that an impairment exists, a loss would be recognized based on the
amount by which the carrying value exceeds the fair value of the assets, which
is generally determined by using quoted market prices or valuation techniques
such as the discounted present value of expected future cash flows, appraisals,
or other pricing models as appropriate.
Impairment of Goodwill
In accordance with SFAS No. 142, we will conduct annually on November 1, a
review of our goodwill and intangible assets with an indefinite useful life to
determine whether their carrying value exceeds their fair market value. Should
this be the case, a detailed analysis will be performed to determine if the
goodwill and other intangible assets are impaired. We will also review the
finite intangible assets when events or changes in circumstances indicate that
the carrying amount may not be recovered.
We will test for impairment of Goodwill and indefinite lived intangible assets
more frequently if events or changes in circumstances indicate that the asset
might be impaired.
Contractual Customer Relationships ("CCR's")
The fair value of the Contractual Customer Relationships (CCR's) was determined
at the time of the acquisition of SMC by discounting the cash flows expected
from SMC's continued relationships with three customers - General Dynamics
Corp., Verizon Communications and Southern Maryland Electric Cooperative.
Expected cash flows were based on historical levels, current and anticipated
projects and general economic conditions. In some cases, the estimates of future
cash flows reflect periods beyond those of the current contracts in place. The
expected cash flows were discounted based on a rate that reflects the perceived
risk of the CCR's, the estimated weighted average cost of capital and SMC's
asset mix. We are amortizing the CCR's over a seven year weighted average life
given the long standing relationships SMC has with Verizon and SMECO.
Trade Name
The fair value of the SMC Trade Name was estimated using a relief-from-royalty
methodology. We determined that the useful life of the Trade Name was indefinite
since it is expected to contribute directly to future cash flows in perpetuity.
The Company has also considered the effects of demand and competition including
its customer base. While SMC is not a nationally recognized Trade Name, it is a
regionally recognized name in Maryland and the Mid-Atlantic region, SMC's
primary region of operations.
23
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.
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 income or 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 $116,000 and $47,000 for the nine and three months
ended October 31, 2005 and $25,000 for the nine and three months ended October
31, 2004. Costs associated with shipping goods to customers which aggregate
$116,000 and $39,000 are accounted for as part of selling expenses for the nine
and three months ended October 31, 2005 and $24,000 for the nine and three
months ended October 31, 2004.
24
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 October 31, 2005, we have cumulatively recorded a net operating loss carry
forward aggregating $254,000 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.
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 contained provisions for the 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 were met.
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 estimated value of $2.1 million or $6.00 per share utilizing
the quoted market price on February 28, 2005.
On July 5, 2005, the Company and Thomas entered into an agreement (Earn Back
Agreement) concerning the calculation of Additional Consideration due Thomas. In
the Earn Back Agreement, the Company agreed to pay Thomas $594,000 in a
subordinated note and 77,000 shares of common stock with a fair value of $5.50
per share utilizing the quoted market price on July 5, 2005. The $1,015,000 of
Additional Consideration has been recorded by the Company as additional purchase
consideration and an increase in goodwill. The amount of Additional
Consideration due in shares of the Company's common stock aggregating 77,000
shares with a fair value of approximately $422,000 is reflected as long-term
debt due to former owner of Vitarich Laboratories, Inc. In addition, if certain
inventory considered to be an overstock for purchase accounting at the time of
the acquisition was reduced to normal levels of usage, Thomas would be paid an
additional $264,000, one-half in a subordinated note and one-half in common
stock. The Company has not accrued any additional amount due Thomas at October
31, 2005.
25
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. The subordinated note carries an interest rate of
10% with interest paid in arrears on October 1, 2005, January 1,2006, April 1,
2006, July 1,2006 and at maturity on August 1, 2006. During the nine and three
months ended October 31, 2005, the Company incurred $92,000 and $68,000 in
interest expense for the subordinated 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 into 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 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 Investor 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 per share less
any shares previously issued. The concessions given to Kevin 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 Kevin Thomas of $614,000 at January 31, 2005. The liability for
derivative financial instrument was subject to adjustment for changes in fair
value subsequent to its issuance. The Company recorded losses of $1,587,000 in
other expense, net and net loss for the subsequent changes in fair value. The
liability for derivative financial instruments aggregating $2,702,000 was
settled in a non-cash transaction by the issuance of 535,052 shares of the
Company's common stock on September 1, 2005.
The Company's accounting for the acquisition of VLI and the 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
$12,375,000, $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 $972,000,
$467,000 and $420,000 at October 31, 2005 for PF, NCR and NCA, respectively.
26
At the date of acquisition, the Company identified a preacquisition contingency
with respect to approximately $264,000 in a specific inventory category and
reduced VLI's valuation by that amount. The Company has been monitoring the
sales level of the specific inventory category during the allocation period
(since the date of acquisition). Based on the additional sales performance
information regarding this inventory, the Company has reversed the
preacquisition contingency and recorded a decrease to Goodwill and an increase
in Inventory of $264,000 during the three months ended July 31, 2005.
Results of Operations
The following summarizes the results of our operations for the three and nine
months ended October 31, 2005 compared to the pro forma results for the three
and nine months ended October 31, 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 Nine Months Ended
October 31, October 31,
Statements of Operations 2005 2004 2005 2004
------------ ------------ ------------ ------------
(Pro forma) (Pro forma)
Net sales $ 7,133,000 $ 6,202,000 $ 21,141,000 $ 18,098,000
Cost of sales 5,431,000 4,450,000 16,211,000 13,678,000
------------ ------------ ------------ ------------
Gross profit 1,702,000 1,752,000 4,930,000 4,420,000
Selling general and
administrative expenses 1,847,000 1,716,000 5,721,000 4,938,000
Impairment loss -- -- -- 1,942,000
------------ ------------ ------------ ------------
(Loss) income from operations (145,000) 36,000 (791,000) (2,460,000)
Other expense, net (206,000) (48,000) (2,290,000) (50,000)
------------ ------------ ------------ ------------
Loss from operations
before income taxes (351,000) (12,000) (3,081,000) (2,510,000)
Income tax benefit 64,000 5,000 386,000 714,000
------------ ------------ ------------ ------------
Net loss $ (287,000) $ (7,000) $ (2,695,000) $ (1,796,000)
============ ============ ============ ============
Results of Operations for the Three Months Ended October 31, 2005 Compared to
the Pro Forma Results of Operations for the Three Months ended October 31, 2004
Net sales
Net sales were $7,133,000 for the three months ended October 31, 2005 compared
to pro forma net sales of $6,202,000 for the three months ended October 31,
2004. The increase of $931,000 or 15% is due primarily to an increase of
$965,000 at SMC in sales volume. SMC experienced a $475,000 increase in activity
with one customer under time and materials arrangements. Sales volume for
infrastructure services provided to SMC's customers under fixed-price contracts
was also a significant source of the sales increase. VLI experienced relatively
flat sales volume as compared to the same period one year ago due primarily to
the impact of hurricane Wilma. VLI lost more than one week's production due to
lack of electric power and water.
27
Cost of sales
For the three months ended October 31, 2005, cost of sales was $5,431,000 or 76%
of net sales compared to $4,450,000 or 72% of pro forma net sales for the three
months ended October 31, 2004. SMC had above average margins for the
aforementioned customer under time and materials arrangements. SMC experienced
decreased costs as a percent of net sales as the volume and number of
fixed-priced contracts increased during the three months ended October 31, 2005.
SMC's improved margin performance was offset by VLI which had increased cost of
sales as a percentage of net sales due to increased pricing of raw materials and
the impact of hurricane Wilma. VLI is in the process of examining its vendor
costs and will be repricing its product offerings with the expectation to return
to historical levels of margins.
Selling general and administrative expenses
Selling, general and administrative expenses were $1,847,000 or 26% of net sales
for the three months ended October 31, 2005 compared to $1,716,000 or 28% of pro
forma net sales for the three months ended October 31, 2004, an increase of
$131,000. VLI has been aggressively seeking to diversify its customer base which
resulted in a $94,000 increase in selling costs for the three months ended
October 31, 2005 related to increased staffing and related costs to support the
marketing program. During the three months ended October 31, 2005, the Company
reduced its allowances for doubtful accounts by $107,000 to reflect improved
collections of aged receivables. In addition, Argan incurred costs associated
with the restatement of its financial statements for the Company's Form 10-KSB/A
for January 31, 2005 and Form 10-QSB/A for April 30, 2005. In addition, the
Company recorded net gains of $55,000 on disposal of equipment which resulted in
a decrease in selling, general and administrative expenses for the three months
ended October 31, 2005.
Other expense, net
We had other expense, net of $206,000 for the three months ended October 31,
2005 compared to pro forma other expense, net of $48,000 for the three months
ended October 31, 2004. The Company incurred $207,000 in interest expense during
the three months ended October 31, 2005 due, in large part, to the amortization
of bond issuance cost for subordinated debt and interest due Thomas on the
subordinated debt that the Company owes Thomas.
Income tax benefit
We had an effective income tax benefit rate of 18% for the three months ended
October 31, 2005 compared to a 42% pro forma income tax benefit rate for the
three months ended October 31, 2004. During the nine months ended October 31,
2005, the Company recorded the $1,930,000 valuation loss for the liability for
derivative financial instruments as other expense which is treated as a
permanent difference for income tax reporting purposes. This permanent
difference reduced our annual income tax benefit rate from 38% to 13%. The
Company recorded an 18% effective income tax benefit rate for the three months
ended October 31, 2005 to "true-up" to the annual effective income tax benefit
rate of 13%.
Results of Operations for the Nine Months Ended October 31, 2005 Compared to the
Pro Forma Results of Operations for the Nine Months ended October 31, 2004
Net Sales
Net sales were $21,141,000 for the nine months ended October 31, 2005 compared
to pro forma net sales of $18,098,000 for the nine months ended October 31,
2004. The increase of $3,043,000 or 17% is due primarily to increases of
$2,086,000 and $957,000 in sales volume at SMC and VLI, respectively. SMC
experienced $760,000 of its increased sales volume from infrastructure services
provided to customers under fixed-price contracts. In addition, one customer
under time and materials arrangements increased sales activity with SMC by
$554,000. VLI's sales increase would have been greater had the impact of
hurricane Wilma not closed VLI for more than one week because of lack of
electric power and water.
28
Cost of sales
For the nine months ended October 31, 2005, cost of sales was $16,211,000 or 77%
of net sales compared to $13,678,000 or 76% of pro forma net sales for the nine
months ended October 31, 2004. SMC experienced decreased costs as a percent of
net sales as the sales volume and number of fixed-priced contracts increased
during the nine months ended October 31, 2005 allowing SMC to more effectively
utilize its technical and project management teams. In addition, the
aforementioned SMC customer under time and materials arrangements experienced
above average margins. VLI's margins were slightly below historical levels due
to increased raw material costs. VLI is in the process of examining its vendor
costs and is repricing its product offerings with the expectation to return to
historical margin levels.
Selling general and administrative expenses
Selling, general and administrative expenses were $5,721,000 or 27% of net sales
for the nine months ended October 31, 2005 compared to $4,938,000 or 27% of pro
forma net sales for the nine months ended October 31, 2004, an increase of
$783,000. Argan retained MSR for a fee of $100,000 to assist in identifying
sources of additional equity investors. VLI has been aggressively seeking to
diversify its customer base which resulted in approximately an $160,000 increase
in selling costs for staff salaries and other costs to support the marketing
program. During the nine months ended October 31, 2005, the Company reduced its
allowance for doubtful accounts by $81,000 to reflect improved collections of
aged receivables. In addition, VLI has upgraded its senior management team which
resulted in increased salaries as well as placement, relocation and severance
costs of $125,000. Argan incurred substantial costs in the restatements of its
financial statements for the Company's Form 10-KSB/A for January 31, 2005 and
Form 10-QSB/A for April 30, 2005. In addition, the Company recorded net gains of
$33,000 on disposal of equipment which resulted in a decrease in selling,
general and administrative expenses for the nine months ended October 31, 2005.
Impairment of Goodwill and Intangibles
During the nine months ended October 31, 2004, the Company determined that both
events and changes in circumstances with respect to its business climate would
have significant effect on its future estimated cash flows. During the nine
months ended October 31, 2004, SMC had a customer contract terminated which had
historically provided positive margins and cash flows. In addition, SMC
experienced revenue levels well below expectations for its largest fixed priced
contract customer. As a consequence, SMC has reduced its future expectations of
cash flows. As a result of these events, the Company believed that there was an
indication that its intangible assets not subject to amortization might be
impaired. The Company determined the fair value of its Goodwill and Trade Name
and compared it to its respective carrying amounts. The carrying amounts
exceeded the Goodwill and Trade Name's respective fair values by $740,000 and
$456,000, respectively, which the Company recorded as an impairment loss for the
nine months ended October 31, 2004.
During the nine months ended October 31, 2004, the Company terminated a customer
contract. The impact of the termination indicated that its Contractual Customer
Relationships carrying amount was not fully recoverable. Accordingly, the
Company determined the fair value of the CCR's and compared it to its carrying
amount. The Company recorded an impairment loss of $746,000 by which the CCR's
carrying amount exceeded its fair value.
Other expense, net
We had other expense, net of $2,290,000 for the nine months ended October 31,
2005 compared to pro forma other expense, net of $50,000 for the nine months
ended October 31, 2004. The fair value loss for the liability for derivative
financial instruments of $1,930,000 was realized during the nine months ended
October 31, 2005. The Company's interest expense increased to $364,000 due to
interest on subordinated debt of $92,000 and $126,000 in amortization of
issuance cost for subordinated debt.
29
Income tax benefit
We had an effective income tax benefit rate of 13% for the nine months ended
October 31, 2005 compared to a 28% pro forma income tax benefit rate for the
nine months ended October 31, 2004. During the nine months ended October 31,
2005, the Company recorded the $1,930,000 loss for the liability for derivative
financial instruments as other expense which is treated as a permanent
difference for income tax reporting purposes. This permanent difference reduced
our effective income tax benefit rate from 38% to 13% for the nine months ended
October 31, 2005. We recorded a $740,000 impairment of goodwill for the nine
months ended October 31, 2004 which is treated as a permanent difference for
income tax reporting purposes. This permanent difference reduced our effective
income tax benefit rate from 38% to 28% for the nine months ended October 31,
2004.
RELATED PARTY TRANSACTIONS
We retained MSR under a consulting arrangement to assist in identifying and
meeting potential equity investors. Under this consulting arrangement we paid
the MSR $100,000 during the nine months ended October 31, 2005.
We lease administrative, manufacturing and warehouse facilities from individuals
who are officers of SMC and VLI. The total expense under these arrangements were
$75,000 and $222,000 for the three and nine months ended October 31, 2005 and
$40,000 and $79,000 for the three and nine months ended October 31, 2004.
We also entered into a supply agreement with an entity owned by the former
shareholder of VLI whereby the supplier committed to sell to us and we committed
to purchase on an as-needed basis, certain organic products. VLI made $68,000
and $146,000 in purchases under the supply agreement during the three and nine
months ended October 31, 2005. No purchases were made by the Company during the
three and nine months ended October 31, 2004.
At October 31, 2005, we accrued $112,000 for reimbursement to Thomas for certain
leasehold improvements which he constructed in the building that we lease from
Thomas.
We also sell our 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 $129,000 and $430,000 in sales to this entity
for three and nine months ended October 31, 2005. At October 31, 2005, the
affiliated entity owed $176,000 to VLI, net of an allowance for doubtful
accounts of zero which the Company reduced from $120,000 during the three months
ended October 31, 2005 due to collections of aged receivables.
LIQUIDITY AND CAPITAL RESOURCES
Cash Position and Indebtedness
We had negative working capital of approximately $1.3 million at October 31,
2005. We had cash and cash equivalents of $27,000 and $2.5 million available
under credit facilities.
Working capital decreased by $2.8 million to negative working capital of $1.3
million at October 31, 2005 from $1.5 million in working capital at January 31,
2005. This decrease was primarily due to $3,292,000 in subordinated debt due to
former owner of Vitarich Laboratories, Inc. which is due August 1, 2006, an
increase in accounts receivable of $578,000 and decrease in liability for
derivative financial instruments of $1,254,000. The Company had a loss before
taxes of $3,081,000 for the nine months ended October 31, 2005. The Company's
non-cash expenses included in the determination of loss before income taxes
included the non-cash loss on liability for derivative financial instruments of
$1,930,000, $1,272,000 for amortization of purchase intangibles and $721,000 for
depreciation and other amortization.
30
Cash Flows
Net cash provided by operations for the nine months ended October 31, 2005 was
$1,975,000 compared with $2,247,000 of cash used in operations for the nine
months ended October 31, 2004 due to improved performance of SMC operations.
During the nine months ended October 31, 2005, the Bank released $304,000 in
escrows to us (see discussion below). During the nine months ended October 31,
2005, net cash used for investing activities was $1,311,000 compared to net cash
used in investing activities of $3,762,000 for the nine months ended October 31,
2004. During the nine months ended October 31, 2005, we had cash of $955,000
used in the purchase of property and equipment and $426,000 used to pay $275,000
in additional consideration in the purchase of VLI as well as other acquisition
costs of $151,000. During the nine months ended October 31, 2004, the Company
used cash of $6,650,000 in the acquisition of VLI. During the nine months ended
October 31, 2004, we had cash of $3,000,000 provided by the sale of investments
net of purchases. During the nine months ended October 31, 2004 we used cash to
purchase property and equipment of $123,000.
For the nine months ended October 31, 2005, net cash used by financing
activities was $804,000. We had $982,000 in cash provided by financing
activities for the nine months ended October 31, 2004. During the nine months
ended October 31, 2005 and 2004, we used cash of $531,000 and $1,091,000 to pay
down term-debt. During the nine months ended October 31, 2004, we increased our
net draw in excess of payments on our line of credit by $2,569,000 primarily to
assume debt on the acquisition of VLI.
In April 2005, we agreed to amend the existing financing arrangements with the
Bank. Under this arrangement, the Company has a revolving line of credit of
$4.25 million and a term loan with an original balance of $1.2 million. 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 October 31, 2005, the
Company had $1,378,000 outstanding under the revolving line of credit and
additional availability of $2.5 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.
The amended financing arrangements provide for the measurement of certain
financial covenants at each of Argan's fiscal quarter and year end including
requiring the ratio of debt to pro forma earnings before interest, taxes,
depreciation and amortization (EBITDA) not to exceed 2.5 to 1 and requiring pro
forma fixed charge coverage ratio not less than 1.25 to 1. 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. The Company was in compliance with the aforementioned financial covenants
at October 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 deferred loan
issuance cost amortization.
31
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 nine months ended October 31, 2005, we provided nutritional and
whole-food supplements as well as personal care products to customers in the
global nutrition industry and services to telecommunications and utilities
customers as well as to the Federal Government, through a contract with General
Dynamics Corp. (GD). Certain of our more significant customer relationships are
with 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 22%, 12% and 6% of consolidated net sales during the
nine months ended October 31, 2005. SMECO and GD accounted for approximately 12%
and 10% of consolidated net sales during the nine months ended October 31, 2005.
Combined TVC, RRC, SMECO, GD, and C accounted for approximately 62% of
consolidated net sales during the nine months ended October 31, 2005.
Seasonality
The Company's telecom infrastructure services operations are expected to have
seasonally weaker results in the first and fourth quarters of the year, and may
produce stronger results in the second and third quarters. This seasonality is
primarily due to the effect of winter weather on outside plant activities as
well as reduced daylight hours and customer budgetary constraints. Certain
customers tend to complete budgeted capital expenditures before the end of the
year, and postpone additional expenditures until the subsequent fiscal period.
IMPACT OF CHANGES IN ACCOUNTING STANDARDS
In December 2004, the Financial Accounting Standards Board issued FASB Statement
No. 123 (revised 2004), Share-Based Payment ("SFAS 123(R)"). SFAS 123(R)
supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees and amends FASB Statement No. 95, Statement of Cash Flows.
SFAS 123(R) requires all share-based payments to employees, including grants of
employee stock options, to be recognized in the income statement based on their
fair values. Pro forma disclosure is no longer an alternative. We will adopt
SFAS 123(R) on February 1, 2006. We have not determined the impact of adopting
the new standard and are still evaluating the impact.
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 standard and is continuing its
analysis of the impact.
32
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 in the application of
first-in, first-out (FIFO) inventory 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, 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.
33
PART ll
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On October 31, 2003, the Company 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 if a breach of the representations and warranties made by the Company in
connection with that sale should occur. 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.
WFC filed a civil action against Argan, Inc. on March 22, 2005. The suit was
initially filed in the Superior Court of the State of California for the County
of Los Angeles. The complaint asserts seven claims against the Company: (1)
breach of contract; (2) intentional misrepresentation; (3) concealment and
non-disclosure; (4) negligent misrepresentation; (5) false promise; (6)
negligence; and (7) declaratory disclosure as well as negligent
misrepresentations against the Company's executive officers.
WFC alleges substantial damages. This action was removed to the United States
District Court for the Central District of California. On June 30, 2005, WFC
filed its Second Amended Complaint. The Company filed its Motion to Dismiss the
Complaint on July 27, 2005. The District Court denied the Company's Motion to
Dismiss on November 18, 2005. The Company will file its Answer and Special
Defenses. The Company has reviewed WFC's complaint 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 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 October 31,
2005 that may result from this matter for which the Company has recorded an
accrual is not ascertainable, the Company believes that any amounts exceeding
the aforementioned accrual should not materially affect the Company's financial
condition. It is possible, however, that the ultimate resolution of WFC's claim
could result in a material adverse effect on the Company's results of operations
for a particular reporting period.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
34
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
a) Exhibits:
Exhibit No. Title
Exhibit 10.25 Subordinated Term Note (Earnback Obligations)
as of November 30, 2005 between Argan, Inc.
and Kevin J. Thomas
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
35
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 14, 2005 By: /s/ Rainer Bosselmann
-------------------------------------------------
Rainer Bosselmann
Chairman of the Board and Chief Executive Officer
December 14, 2005 By: /s/ Arthur F. Trudel
-------------------------------------------------
Arthur F. Trudel
Chief Financial Officer
36