UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended April 30, 2006
or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number 001-31756
Argan, Inc.
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(Exact name of small business issuer as specified in its charter)
Delaware 13-1947195
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(State or other jurisdiction of incorporation (IRS Employer Identification No.)
or organization)
One Church Street, Suite 302, Rockville MD 20850
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(Address of principal executive offices)
(301) 315-0027
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(Issuer's telephone number)
N/A
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(Former name, former address and former fiscal year,
if changed since last report)
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 |_|
Indicate by check mark whether the Registrant is a shell company (as defined in
Rule 12b-2) of the Exchange Act). Yes |_| No |X|
Common Stock, par value $.15 per share, outstanding at June 8, 2006: 4,574,010.
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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 (unaudited)......................................3
Condensed Consolidated Balance Sheets - April 30, 2006 and January 31, 2006...3
Condensed Consolidated Statements of Operations for the Three Months
Ended April 30, 2006 and 2005....................................4
Condensed Consolidated Statements of Cash Flows for the Three Months
Ended April 30, 2006 and 2005.....................................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...............................................28
PART II. OTHER INFORMATION...................................................28
Item 1. Legal Proceedings....................................................28
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds..........29
Item 3. Defaults Upon Senior Securities......................................29
Item 4. Submission of Matters to a Vote of Security Holders..................29
Item 5. Other Information....................................................29
Item 6. Exhibits.............................................................29
SIGNATURES....................................................................30
================================================================================
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ARGAN, INC.
Condensed Consolidated Balance Sheets
(Unaudited)
April 30, January 31,
2006 2006
============ ============
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 93,000 $ 5,000
Accounts receivable, net of allowance for doubtful accounts
of $86,000 at 4/30/2006 and $50,000 at 1/31/2006 4,390,000 3,351,000
Receivable from affiliated entity 146,000 157,000
Escrowed cash 300,000 300,000
Estimated earnings in excess of billings 170,000 675,000
Inventories, net of reserves of $83,000 at 4/30/2006 and $95,000
at 1/31/06 3,270,000 3,410,000
Prepaid expenses and other current assets 482,000 458,000
------------ ------------
TOTAL CURRENT ASSETS 8,851,000 8,356,000
------------ ------------
Property and equipment, net of accumulated depreciation of
$1,636,000 at 4/30/2006 and $1,418,000 at 1/31/2006 3,349,000 3,324,000
Issuance cost for subordinated debt 129,000 257,000
Other assets 36,000 46,000
Contractual customer relationships, net 1,768,000 1,894,000
Trade name 224,000 224,000
Proprietary formulas, net 611,000 726,000
Non-compete agreement, net 1,200,000 1,290,000
Goodwill 7,505,000 7,505,000
------------ ------------
TOTAL ASSETS $ 23,673,000 $ 23,622,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 3,484,000 $ 3,205,000
Due to affiliates -- 121,000
Accrued expenses 2,143,000 1,801,000
Billings in excess of cost and earnings 31,000 --
Deferred income tax liability 25,000 49,000
Line of credit 993,000 1,243,000
Current portion of long-term debt 270,000 421,000
------------ ------------
TOTAL CURRENT LIABILITIES 6,946,000 6,840,000
------------ ------------
Deferred income tax liability 1,603,000 1,618,000
Deferred rent 12,000 10,000
Long-term debt 152,000 176,000
Subordinated note due former owner of Vitarich Laboratories, Inc. 3,292,000 3,292,000
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 -3,817,243 shares
issued at 4/30/2006 and 1/31/2006 and 3,814,010
shares outstanding at 4/30/2006 and 1/31/2006 572,000 572,000
Warrants outstanding 849,000 849,000
Additional paid-in capital 25,336,000 25,336,000
Accumulated deficit (15,056,000) (15,038,000)
Treasury stock at cost: - 3,233 shares at 4/30/2006 and 1/31/2006 (33,000) (33,000)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 11,668,000 11,686,000
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 23,673,000 $ 23,622,000
============ ============
See Accompany Notes
3
ARGAN, INC.
Condensed Consolidated Statements of Operations
(Unaudited)
Three months ended April 30,
2006 2005
=========== ===========
Net sales
Nutraceutical products $ 5,829,000 $ 4,728,000
Telecom infrastructure services 3,133,000 2,428,000
----------- -----------
Net Sales 8,962,000 7,156,000
Cost of sales
Nutraceutical products 4,386,000 3,430,000
Telecom infrastructure services 2,323,000 1,907,000
----------- -----------
Gross profit 2,253,000 1,819,000
Selling, general and administrative expenses 1,976,000 1,840,000
----------- -----------
Income (loss) from operations 277,000
(21,000)
Interest expense 261,000 56,000
Other income, net 2,000 27,000
----------- -----------
Income (loss) from operations before income taxes 18,000
(50,000)
Income tax provision (benefit) 36,000
(28,000)
----------- -----------
Net loss $ (18,000) $ (22,000)
=========== ===========
Basic and diluted loss per share -- $ (0.01)
=========== ===========
Weighted average number of shares outstanding - basic and diluted 3,814,000 2,992,000
=========== ===========
See Accompany Notes
4
ARGAN, INC.
Condensed Consolidated Statements of Cash Flows
(unaudited)
Three Months Ended
April 30,
2006 2005
=========== ===========
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (18,000) $ (22,000)
Adjustments to reconcile net loss to net cash provided by (used in) operating
activities:
Depreciation and amortization 376,000 195,000
Amortization of purchase intangibles 331,000
424,000
Deferred income taxes (39,000) (30,000)
Unrealized gain on liability for derivative financial instruments -- (23,000)
Gain on sale of property and equipment (2,000) --
Changes in operating assets and liabilities:
Accounts receivable, net (1,039,000) (800,000)
Receivable from affiliated entity 11,000 (22,000)
Estimated earnings in excess of billings 505,000 (42,000)
Inventories, net 140,000 312,000
Prepaid expenses and other current assets (24,000) (58,000)
Accounts payable and accrued expenses 620,000 60,000
Billings in excess of estimated earnings 31,000 6,000
Due to affiliates (121,000) (47,000)
Other 12,000 23,000
----------- -----------
Net cash provided by (used in) operating activities 783,000 (24,000)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (273,000) (118,000)
Proceeds from sale of property and equipment 3,000 --
----------- -----------
Net cash used in investing activities (270,000) (118,000)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from escrowed cash -- 304,000
Proceeds from line of credit 1,605,000 600,000
Proceeds from long-term debt -- 8,000
Payments on line of credit (1,855,000) (598,000)
Principal payments on long-term debt (175,000) (232,000)
----------- -----------
Net cash (used in) provided by financing activities (425,000) 82,000
----------- -----------
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 5,000 167,000
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 88,000 (60,000)
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 93,000 $ 107,000
=========== ===========
See Accompany Notes
5
ARGAN, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1- ORGANIZATION
NATURE OF OPERATIONS
Argan, Inc. ("AI" or the "Company") conducts its operations through its wholly
owned subsidiaries Vitarich Laboratories, Inc. ("VLI") which it acquired in
August 2004 and Southern Maryland Cable, Inc. ("SMC") which it acquired in July
2003. Through VLI, the Company develops, manufactures and distributes premium
nutritional supplements, whole-food dietary supplements and personal care
products. Through SMC, the Company provides telecommunications infrastructure
services including project management, construction and maintenance to the
Federal Government, telecommunications and broadband service providers, as well
as electric utilities primarily in the Mid-Atlantic region.
AI was organized as a Delaware corporation in May 1961 and operates in two
reportable segments. (See Note 9)
MANAGEMENT'S PLANS, LIQUIDITY AND BUSINESS RISKS
As of April 30, 2006, the Company had an accumulated deficit of $15.1 million.
At April 30, 2006, the Company had $3.3 million available under its revolving
line of credit with the Bank of America, N.A. (the Bank). The Company operates
in two distinct and separate reportable segments. The market for nutritional
products is highly competitive and the telecom and infrastructure services
industry is fragmented, but also very competitive. The successful execution of
the Company's business plan is dependent upon the Company's ability to integrate
acquired businesses and their related assets into its operations, its ability to
increase and retain its customers, the ability to maintain compliance with
significant government regulation, the ability to attract and retain key
employees and the Company's ability to manage its growth and expansion, among
other factors.
On May 4, 2006, the Company completed a private offering of 760,000 shares of
common stock at a price of $2.50 per share for aggregate proceeds of $1.9
million. The Company used $1.8 million of the proceeds to pay down an equal
notional amount of the subordinated note due the former owner of VLI. The
remainder of the proceeds was used for general corporate purposes. (See Notes 5
and 7)
The Company's line of credit was due to expire on May 31, 2006. On May 5, 2006,
the Company renewed its line of credit with the Bank, extending the maturity
date to May 31, 2007. Concurrent with the renewal, the Bank has agreed to
provide a new $1.5 million term loan facility (New Term Loan) designed to
refinance a portion of the existing subordinated note with the former owner of
VLI that had an outstanding balance of $3,292,000 at April 30, 2006. The Company
must be in compliance with its debt covenants to draw on the New Term Loan. (See
Note 6)
The financing arrangement with the Bank requires the Company to comply with
certain financial covenants. At January 31, 2006, the Company failed to comply
with financial covenants requiring that the ratio of debt to pro forma earnings
before interest, taxes, depreciation and amortization not exceed 2.5 to 1 and
requiring a pro forma fixed charge coverage ratio of not less than 1.25 to 1.
The Bank waived the failure for the measurement period ended January 31, 2006.
For future measurement periods, the Bank revised the definitions of certain
components of the financial covenants to specifically exclude the impact of
VLI's impairment loss at January 31, 2006.
6
The subordinated debt due the former owner of VLI was originally due on August
1, 2006. On May 5, 2006, the Company entered into an agreement with the former
owner of VLI to delay the timing of the payment on the subordinated debt to
August 1, 2007. The former owner of VLI will be paid prior to this date if the
Company were to raise additional equity having an aggregate purchase price of
more than $1 million. The Company also has the option to draw on the
aforementioned New Term Loan to pay the former owner of VLI if the Company is in
compliance with their debt covenants. (See Note 6)
Management believes that capital resources available under its renewed line of
credit combined with cash generated from the Company's operations is adequate to
meet the Company's future operating cash needs. Accordingly, the carrying value
of the assets and liabilities in the accompanying balance sheet do not reflect
any adjustments should the Company be unable to meet its future operating cash
needs in the ordinary course of business. The Company continues to take various
actions to align its cost structure to appropriately match its expected
revenues, including limiting its operating expenditures and controlling its
capital expenditures. Any future acquisitions, other significant unplanned costs
or cash requirements may require the Company to raise additional funds through
the issuance of debt and equity securities. There can be no assurance that such
financing will be available on terms acceptable to the Company, or at all. If
additional funds are raised by issuing equity securities, significant dilution
to the existing stockholders may result.
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation - The condensed consolidated balance sheet as of April 30,
2006 and the condensed consolidated statements of operations and cash flows for
the three months ended April 30, 2006 and 2005, respectively, are unaudited. In
the opinion of management, the accompanying financial statements contain all
adjustments, which are of a normal and recurring nature, considered necessary to
present fairly the financial position of the Company as of April 30, 2006 and
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, 2006, together with the independent registered public
accounting firm's report, included in the Company's Annual Report on Form
10-KSB, as filed with the Securities and Exchange Commission. The results of
operations for any interim period are not necessarily indicative of the results
of operations for any other interim period or for a full fiscal year.
Reclassifications - Certain amounts in the prior year financial statements have
been reclassified to conform with the presentation in the current year financial
statements.
Inventories - Inventories are stated at the lower of cost or market (net
realizable value). Cost is determined on the first-in, first-out (FIFO) method.
Appropriate consideration is given to obsolescence, excessive inventory levels,
product deterioration, and other factors in evaluating net realizable value.
Inventories at April 30, 2006 consist of the following:
Raw materials $ 2,930,000
Work-in process 278,000
Finished goods 145,000
-----------
3,353,000
Less: Reserves (83,000)
-----------
Inventories, net $ 3,270,000
===========
7
The Company entered into an agreement with one of its major customers, whereby
the customer made an advanced payment to the Company for a significant portion
of raw material at cost. The raw material is held at the Company's premises and
is used in the production of product for the customer. The Company is accounting
for this as an inventory financing arrangement and recognizes revenue from the
sale of the raw material when the finished product is shipped to the customer.
At April 30, 2006, the Company had customer deposits and inventories related to
this arrangement of $463,000.
Earnings Per Share - Income per share is computed by dividing net income (loss)
by the weighted average number of common shares outstanding for the period.
Dilutive earnings per share represent net income divided by the weighted average
number of common shares outstanding inclusive of the effects of dilutive
securities. Outstanding stock options and warrants for the purchase of shares of
common stock were not included in the weighted average shares outstanding during
the three months ended April 30, 2006 and 2005 because the market price of the
Company's common stock was significantly below the exercise prices for the stock
options and warrants and as such were antidilutive.
Seasonality - The Company's telecom infrastructure services operations are
expected to have seasonally weaker results in the first and fourth quarters of
our 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 Option Plans - Prior to February 1, 2006, the Company measured
compensation costs for stock based compensation plans using the intrinsic value
method of accounting as prescribed in Accounting Principles Board Opinion No. 25
"Accounting for Stock Issued to Employees" ("APB No. 25") and related
interpretations. In electing to follow APB No. 25 for expense recognition
purposes for the three months ended April 30, 2005, the Company has provided
below the expanded disclosures required under Statement of Financial Accounting
Standards No. 148 "Accounting for Stock Based Compensation" ("SFAS No. 148") for
stock-based compensation granted including, if materially different from
reported results, disclosure of pro forma net income and net income per share
had compensation expense relating to grants been measured under the fair value
recognition provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123"). All options issued and outstanding at April 30,
2005 had an exercise price greater than the market price of the Company's stock
on the date of grant. The fair value of the options granted have been estimated
at the date of grant using a Black-Scholes option-pricing model. Option
valuation models require the use of subjective assumptions and changes in these
assumptions can materially impact the fair value of the options.
The following table illustrates the effect on net loss and net loss per share if
the Company had applied the fair value recognition provisions of SFAS No. 123 to
options granted and unvested under the Plan for the three months ended April 30,
2005. For purposes of this pro forma disclosure, the value of options is
estimated using a Black-Scholes option-pricing formula and amortized over the
options' vesting periods.
8
Pro Forma Disclosures
For the three months ended April 30, 2005
Net loss, as reported $(22,000)
Add: Stock based compensation recorded
in the financial statements --
Deduct: Total stock-based employee compensation
expense determined under fair value based methods 20,000
--------
Pro forma net loss $(42,000)
========
Basic and diluted per share:
Basic and diluted - as reported $ ( 0.01)
========
Basic and diluted - pro forma $ ( 0.01)
========
NOTE 3 - STOCK BASED COMPENSATION
At April 30, 2006, the Company has a stock option plan which was established in
August 2001 (Plan). Under the Plan, the Company's Board of Directors may grant
stock options to officers, directors and key employees. The Plan was amended in
April 2003 to authorize the grant of options for up to 250,000 shares of common
stock.
Prior to February 1, 2006, the Company accounted for the Plan under the
recognition and measurement provisions of Accounting Principles Board Opinion
No. 25 "Accounting for Stock Issued to Employees ("APB No. 25"), and related
interpretations, as permitted by Statements of Financial Accounting Standards
("SFAS") No. 123, "Accounting for Stock Based Compensation ("SFAS No. 123"). No
stock-based employee compensation cost was recognized in the Statement of
Operations for the three months ended April 30, 2005, as all options granted
under the Plan had an exercise price equal to or greater than the market value
of the underlying common stock on the date of grant. Effective February 1, 2006,
the Company adopted the fair value recognition provisions of SFAS No. 123(R),
"Share-Based Payment" (SFAS No. 123(R)), using the modified-prospective
transition method. Under that transition method, compensation cost recognized in
the three months ended April 30, 2006 includes: (a) compensation cost for all
share-based payments granted prior to, but not yet vested as of February 1,
2006, based on grant date fair value estimated in accordance with the original
provisions of SFAS No. 123 and (b) compensation cost for all share-based
payments granted on or subsequent to February 1, 2006, based on the grant-date
fair value estimated in accordance with the provisions of SFAS No. 123(R).
Results for prior periods have not been restated.
As a result of adopting SFAS No. 123(R) on February 1, 2006, the Company's
income before income taxes for the three months ended April 30, 2006, was
approximately $11,000 lower than if it had continued to account for share based
compensation under APB No. 25. Basic and diluted net income per share for the
three months ended April 30, 2006 would have been the same as if the Company had
not adopted SFAS No. 123(R).
Stock options granted may be "Incentive Stock Options" ("ISOs") or "Nonqualified
Stock Options" (NSOs"). ISOs have an exercise price at least equal to the
stock's fair market value at the date of grant, a ten-year term and vest and
become fully exercisable one year from the date of grant. NSOs may be granted at
an exercise price other than the stock's fair market value at the date of grant
and have up to a ten-year term, and vest and become fully exercisable as
determined by the Board.
9
The fair value of each option award is estimated on the date of grant using a
Black-Scholes option-pricing formula that uses the assumptions noted in the
table and discussion that follows:
Three Months Ended April 30,
2006 2005(1)
============== ==============
Dividend yield -- --
Expected volatility 58% --
Risk-free interest rate 5.12% --
Expected life in years 5 --
(1) No options were granted during the three months ended April 30, 2005.
A summary of option activity under the Plan as of April 30, 2006, and changes in
the period then ended is presented below:
Weighted-
Weighted- Average
Average Remaining Aggregate
Exercise Contract Term Intrinsic
Shares Price Value
---------- ------------- ------------- --------------
Outstanding at beginning of period 73,000 $ 7.84 -- --
Granted 50,000 $ 2.15 -- --
Exercised --
Forfeited or expired --
----------
Outstanding at end of period 123,000 $ 5.53 7.6 $ 274,000
==========
Vested or expected to vest at end of 123,000 $ 5.53 7.6 $ 274,000
period
Exercisable at end of period 58,000 $ 7.86 6.4 $ 186,000
The weighted average grant date fair value of options granted during the three
months ended April 30, 2006 was $1.17. No options were granted during the three
months ended April 30, 2005.
No options were exercised during the three months ended April 30, 2006 and 2005.
At April 30, 2006, there was $61,000 of total unrecognized compensation cost
related to stock options issued under the Plan. That cost is expected to be
recognized during the next six months which represents the vesting period of
options granted during the six months ended April 30, 2006.
A summary of the status of the Company's nonvested shares as of April 30, 2006,
and changes during the three months then ended, is present below:
Aggregate
Intrinsic
Shares Value
------------- -----------
Nonvested at beginning of period 16,000 $ 1.95
Granted 50,000 $ 1.17
Vested -- --
Forfeited -- --
------------- -------------
Nonvested at end of period 66,000 $ 1.35
=============
10
The fair value of nonvested shares is determined based on the opening trading
price of the Company's shares on the grant date. The weighted average grant date
fair value of shares granted during the three months ended April 30, 2006 was
$1.17. As of April 30, 2006, there was $61,000 of total unrecognized
compensation cost related to nonvested share-based compensation arrangements
under the Plan. The cost is expected to be recognized over the next six months.
No shares vested during the three months ended April 30, 2006.
In connection with the Company's private placement in April 2003, the Company
issued warrants to purchase shares of the Company's common stock at a price of
$7.75 per share with a ten year term. 180,000 of the warrants were granted to
three individuals who became the executive officers of the Company upon
completion of the offering. In addition, MSR Advisors, Inc. (MSR) received
warrants to purchase 50,000 shares of the Company's stock. A director of the
Company is the Chief Executive Officer of MSR. The fair value of the warrants of
$849,000 was recognized as offering costs. All warrants are exercisable.
At April 30, 2006, there were 353,000 shares of the Company's common stock
reserved for issuance upon exercise of stock options and warrants.
NOTE 4- SUMMARY OF INTANGIBLE ASSETS
The Company's intangible assets consist of the following at April 30, 2006.
Gross SMC VLI Net
Estimated Carrying Accumulated Impairment Impairment Carrying
Useful Life Amount Amortization Loss(1) Loss(2) Amount
-------------- -------------- ----------------- --------------- ---------------- ----------------
Goodwill Indefinite $14,055,000(3) -- 740,000(1) 5,810,000(2) $ 7,505,000
Contractual
Customer
Relationships 5-7 years 3,600,000 1,086,000 746,000(1) -- 1,768,000
Proprietary
Formulas 3 years 2,500,000 1,202,000 -- 687,000(2) 611,000
Non-Compete
Agreement 5 years 1,800,000 600,000 -- -- 1,200,000
Trade Name Indefinite 680,000 -- 456,000(1) -- 224,000
-------------- ----------------- --------------- ---------------- ----------------
$22,635,000 $ 2,888,000 1,942,000(1) $ 6,497,000(2) $ 11,308,000
============== ================= =============== ================ ================
(1) During the twelve months ended January 31, 2005, the Company recorded an
impairment loss with respect to goodwill and intangibles at SMC.
(2) During the twelve months ended January 31, 2006, the Company recorded an
impairment loss with respect to goodwill and proprietary formulas at VLI.
(3) Amounts recorded as goodwill are not deductible for tax reporting purposes.
Amortization expense for the three months ended April 30, 2006, aggregated
$126,000, $115,000 and $90,000 for Contractual Customer Relationships,
Proprietary Formulas and Non-Compete Agreement, respectively.
NOTE 5 - RELATED PARTY TRANSACTIONS
On May 4, 2006, the Company completed a private offering of 760,000 shares of
common stock at a price of $2.50 per share for aggregate proceeds of $1.9
million. The Company used $1.8 million of the proceeds to pay down an equal
notional amount of the subordinated note due Kevin Thomas ("Thomas").The
remainder of the proceeds was used for general corporate purposes.
One of the investors, MSRI SBIC, L.P., which acquired 240,000 shares in the
offering, is controlled by Daniel Levinson, a director of the Company. In
addition, James Quinn, a director of the Company acquired 40,000 shares for his
own account.
On January 28, 2005, the Company sold and issued to MSR I SBIC, L.P., a Delaware
limited partnership ("Investor"), 129,032 shares of common stock of the Company
pursuant to a Subscription Agreement between the Company and Investor
("Subscription Agreement"). These Shares were issued at a purchase price of
$7.75 per share, yielding aggregate proceeds of $999,998 (See Note 7). These
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 the Company's common stock to Investor in accordance with the
Subscription Agreement under certain conditions upon the earlier of (i) the
Company's issuance of additional shares of common stock having an aggregate
purchase price of at least $2,500,000, at a price per share less than $7.75
subject to certain exclusions, or (ii) ninety percent of the average bid price
of the Company's common stock for the thirty days ended July 31, 2005 if the
price was less than $7.75, less the 129,032 shares previously issued. The
Company settled the liability for issuance of additional shares in a non-cash
transaction at July 31, 2005 with the issuance of 95,321 shares of the Company's
common stock.
The provision in the Subscription Agreement which allows the Investor to receive
additional shares under certain conditions represents a derivative under
Statement of Financial Accounting Standards No. 133 "Accounting for Derivative
Instruments and Hedging Activities." Accordingly, $139,000 of the proceeds
received at issuance was accounted for as a liability for a derivative financial
instrument. This liability relates to the obligation to issue Investor
additional shares under certain conditions. The derivative financial instrument
was subject to adjustment for changes in fair value subsequent to issuance.
During the three months ended April 30, 2005, the Company recorded a fair value
adjustment of a $1,000 gain which is recorded in other income, net.
On January 31, 2005, the Company entered into a debt subordination agreement
with Thomas, the former owner of VLI, for the cash portion of the additional
consideration the Company owes Thomas. The subordinated debt had an original
maturity of August 1, 2006 and had an interest rate of 10%. On May 5, 2006, the
Company entered into an extension with Thomas of the maturity date of the
subordinated note to August 1, 2007.
On January 28, 2005, the Company entered into a Letter Agreement with Thomas in
consideration for his agreement to delay the timing of the payment of contingent
cash consideration and for entering into a Debt Subordination Agreement
(Subordination Agreement), reconstituting such additional cash consideration as
subordinated debt. The Letter Agreement includes certain concessions to Thomas
allowing him to receive additional consideration based on the market price of
the Company's common stock. The concessions provide that in addition to
providing Thomas additional shares if the Company issued additional shares at a
price less than $7.75, if the Company did not issue additional shares at a price
less than $7.75 per share, then the Company would issue additional shares to
Thomas based on the average closing price of the Company's common stock for the
30 days ended July 31, 2005, if the price was below $7.75 per share less
1,173,147 shares previously issued. These concessions allowing Thomas to receive
additional shares under certain conditions represent a freestanding financial
instrument and were accounted for in accordance with EITF 00-19 "Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in a
Company's Own Stock."
12
At issuance, $501,000 of the charge related to the liability for derivative
financial instruments was recorded as deferred issuance cost for subordinated
debt which will be amortized over the life of the subordinated debt. The
amortization of the deferred loan issuance cost increases the Company's interest
expense through August 1, 2007, the maturity date of the note, and reduces net
income. The derivative financial instrument was subject to adjustment for
changes in fair value subsequent to issuance. The fair value adjustment of a
$22,000 gain during the three months ended April 30, 2005 was reflected as a
change in liability for the derivative financial instruments and as a credit to
the Company's other expenses or income and net loss. The liability for the
derivative financial instrument was settled as a non-cash transaction by the
issuance of 535,052 shares of the Company's common stock on September 1, 2005.
The Company leases administrative, manufacturing and warehouse facilities from
individuals who are officers of SMC and VLI. The total expense under these
arrangements was $76,000 and $69,000 for the three months ended April 30, 2006
and 2005, respectively.
The Company has 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 $17,000 and $24,000 in purchases under the supply agreement
during the three months ended April 30, 2006 and 2005, respectively.
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. VLI had
approximately $129,000 and $149,000 in sales with this entity for three months
ended April 30, 2006 and 2005, respectively. At April 30, 2006, the affiliated
entity owed $146,000 to VLI.
NOTE 6 - DEBT
In May 2006, the Company agreed to amend the existing financing arrangements
with the Bank of America (Bank). Under this arrangement, the Company has a
revolving line of credit of $4.25 million in maximum availability and a term
loan with an original balance of $1.2 million. The May 2006 amendment extended
the expiration of the revolving line of credit to May 31, 2007. 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 (Borrowing Base). The aforementioned term note remains in
effect and the final monthly scheduled payment of $33,000 is due on July 31,
2006. As of April 30, 2006, the Company had $100,000 outstanding under the term
note. At April 30, 2006, the Company also had $993,000 outstanding under the
revolving line of credit at an interest rate of 8.2% with $3.3 million of
additional availability under its Borrowing Base.
The amended financing arrangements provides for a new $1.5 million term loan
facility (New Term Loan). The proceeds of the New Term Loan are designated to
refinance a portion of the existing subordinated note with Thomas that at April
30, 2006 had an outstanding balance of $3,292,000. Advances under the New Term
Loan are subject to the Company being in compliance with its debt covenants with
the Bank. The New Term Loan will be repaid in thirty-six equal monthly principal
payments and bears interest at LIBOR plus 3.25%. If the Company draws on the New
Term Loan, the Company's Borrowing Base will be reduced by $750,000 for maximum
availability under the revolving line of credit.
The financing arrangements provide for the measurement at the Company's fiscal
year end and at each of the Company'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 (with the next measurement date on July 31, 2006) and requiring a pro forma
fixed charge coverage ratio of not less than 1.25 to 1 (with the next
measurement date on July 31, 2006). The amended financings also require that the
Company meet minimum EBITDA covenants equal to or exceeding (on a rolling four
quarter basis) $1.2 million for July 31, 2006, $1.3 million for October 31, 2006
and $1.8 million for January 31, 2007 and for each successive quarter end
thereafter. The Bank's 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.
13
The amended financing arrangements contains a subjective acceleration clause
which allows the Bank to declare amounts outstanding under the financing
arrangement due and payable if certain material adverse changes occur. We
believe that we will continue to comply with our financial covenants under our
financing arrangement. If our performance does not result in compliance with any
of our financial covenants, or if the Bank seeks to exercise its rights under
the subjective acceleration clause referred to above, we would seek to modify
our financing arrangement, but there can be no assurance that the Bank would not
exercise their rights and remedies under our financing arrangement including
accelerating payment of all outstanding senior and subordinated debt due and
payable.
NOTE 7 - PRIVATE OFFERINGS OF COMMON STOCK
On May 4, 2006, the Company completed a private offering of 760,000 shares of
common stock at a price of $2.50 per share for aggregate proceeds of $1.9
million. The Company used $1.8 million of the proceeds to pay down an equal
notional amount of the subordinated note due Kevin Thomas. The remainder of the
proceeds was used for general corporate purposes.
One of the investors, MSRI SBIC, L.P., which acquired 240,000 shares in the
offering, is controlled by Daniel Levinson, a director of the Company. In
addition, James Quinn, a director of the Company acquired 40,000 shares for his
own account.
On January 28, 2005, the Company sold and issued to MSR I SBIC, L.P., a Delaware
limited partnership ("Investor"), 129,032 shares of the Company's common stock,
pursuant to a Subscription Agreement between the Company and Investor
("Subscription Agreement"). These shares were issued at a purchase price of
$7.75 per share, yielding aggregate proceeds of $999,998. These shares were
issued pursuant to the exemption provided by Section 4(2) of the Securities Act
of 1933, as amended. The Investor is an entity controlled by Daniel Levinson, a
director of the Company. (See Note 5) Pursuant to the Subscription Agreement,
the Company has agreed to issue additional shares of the Company's 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, less the 129,032
shares previously issued. The Company settled the liability for issuance of
additional shares in a non-cash transaction at July 31, 2005 with the issuance
of 95,321 shares of the Company's common stock.
The provision in the Subscription Agreement which allows the Investor to receive
additional shares under certain conditions represents a derivative under
Statement of Financial Accounting Standards No. 133 "Accounting for Derivative
Instruments and Hedging Activities." Accordingly, at January 31, 2005, $139,000
of the proceeds was accounted for as a liability for a derivative financial
instrument. This liability related to the obligation to issue Investor
additional shares under certain conditions. The derivative financial instrument
was subject to adjustment for changes in fair value subsequent to issuance.
During the three months ended April 30, 2005, the Company recorded a fair value
adjustment of a $1,000 gain which is recorded in other income, net.
14
NOTE 8 - INCOME TAXES
The Company had an effective income tax rate of 200% for the three months ended
April 30, 2006 and an effective income tax benefit rate of 56% for the three
months ended April 30, 2005. During the three months ended April 30, 2006, the
Company's effective income tax rate was increased by the impact of the
amortization of issuance cost for subordinated debt which is treated as a
permanent difference for income tax reporting purposes. During the three months
ended April 30, 2005, the Company's income tax benefit rate was increased by the
impact of the fair value adjustment for liability for derivative instruments
which is a permanent difference for income tax reporting purposes.
NOTE 9 - SEGMENT REPORTING
The Company has two reportable operating segments. Operating segments are
defined as components of an enterprise about which separate financial
information is available that is evaluated regularly by the chief operating
decision maker, or decision making group, in deciding how to allocate resources
and assessing performance.
The Company's two operating segments are nutraceutical products and telecom
infrastructure services. The Company conducts its operations through its wholly
owned subsidiaries - VLI and SMC. The "Other" column includes the Company's
corporate and unallocated expenses.
The Company's operating segments are organized in separate business units with
different management, customers, technology and services. The respective
segments account for the respective businesses using the accounting policies in
Note 2 to the Company's Form 10-KSB and Note 2 in this filing. Summarized
financial information concerning the Company's operating segments is shown in
the following tables:
For the Three Months
Ended April 30, 2006
Telecom
Nutraceutical Infrastructure
Products Services Other Consolidated
------------- -------------- --------- ------------
Net sales $ 5,829,000 $ 3,133,000 $ -- $ 8,962,000
Cost of sales 4,386,000 2,323,000 -- 6,709,000
------------- -------------- --------- ------------
Gross profit 1,443,000 810,000 -- 2,253,000
Selling, general and administrative
expenses 1,087,000 414,000 475,000 1,976,000
------------- -------------- --------- ------------
Income (loss) from operations 356,000 396,000 (475,000) 277,000
Interest expense 127,000 19,000 115,000 261,000
Other income, net -- 2,000 -- 2,000
------------- -------------- --------- ------------
Income (loss) before income taxes $ 229,000 $ 379,000 $(590,000) 18,000
= =========== = =========== ========= ------------
Income tax provision 36,000
------------
Net loss $ (18,000)
============
Depreciation and amortization $ 134,000 $ 112,000 $ 130,000 $ 376,000
============= ============== ========= ============
Amortization of intangibles $ 305,000 $ 26,000 $ 331,000
============= ============== ========= ============
Goodwill $ 6,565,000 $ 940,000 -- $ 7,505,000
============= ============== ========= ============
Total assets $ 17,959,000 $ 5,165,000 $ 549,000 $ 23,673,000
============= ============== ========= ============
Fixed asset additions $ 96,000 $ 177,000 -- $ 273,000
============= ============== ========= ============
15
For the Three Months
Ended April 30, 2006
Telecom
Nutraceutical Infrastructure
Products Services Other Consolidated
------------- -------------- --------- ------------
Net sales $ 4,728,000 $ 2,428,000 $ -- $ 7,156,000
Cost of sales 3,430,000 1,907,000 -- 5,337,000
------------- -------------- --------- ------------
Gross profit 1,298,000 521,000 -- 1,819,000
Selling, general and administrative
expenses 1,086,000 354,000 400,000 1,840,000
------------- -------------- --------- ------------
Income (loss) from operations 212,000 167,000 (400,000) (21,000)
Interest expense (income) 58,000 11,000 (13,000) 56,000
Other income, net -- 2,000 25,000 27,000
------------- -------------- --------- ------------
Income (loss) before income taxes $ 154,000 $ 158,000 $(362,000) (50,000)
============= ============== ========= ============
Income tax benefit (28,000)
------------
Net loss $ (22,000)
============
Depreciation and amortization $ 77 ,000 $ 98,000 $ 20,000 $ 195,000
============= ============== ========= ============
Amortization of intangibles $ 399,000 $ 25,000 -- $ 424,000
============= ============== ========= ============
Goodwill $ 11,339,000 $ 940,000 -- $ 12,279,000
============= ============== ========= ============
Total assets $ 23,817,000 $ 5,204,000 $ 928,000 $ 29,949,000
============= ============== ========= ============
Fixed asset additions $ 106,000 $ 12,000 -- $ 118,000
============= ============== ========= ============
NOTE 10 - CONTINGENCIES
On September 17, 2004, Western Filter Corporation (WFC) notified the Company
that WFC believes that the Company breached certain representations and
warranties under the stock purchase agreement dated October 31, 2003 by and
between AI and WFC ("Stock Purchase Agreement"). WFC asserts damages in excess
of the $300,000 escrow which is being held by a third party in connection with
the Stock Purchase Agreement.
On March 22, 2005, WFC filed a complaint in Los Angeles Superior Court alleging
the Company and its executive officers, individually, committed breach of
contract, intentional misrepresentation, concealment and non-disclosure,
negligent misrepresentation and false promise. WFC seeks declaratory relief and
compensatory and punitive damages in an amount to be proven at trial as well as
the recovery of attorney's fees.
Although the Company has reviewed WFC's claim and believes that substantially
all of the claims are without merit, at April 30, 2006, the Company has recorded
an accrual related to this matter of $360,000 for estimated payments and legal
fees related to the claims of WFC that it considers to be probable and that can
be reasonably estimated. Although the ultimate amount of liability that may
result from this matter 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. The Company
will vigorously contest WFC's claim.
16
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.
GENERAL
Argan, Inc. (the "Company," "we," "us," or "our") 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.
RECENT EVENTS
Private Offering of Common Stock
On May 4, 2006, the Company completed a private offering of 760,000 shares of
common stock at a price of $2.50 per share for aggregate proceeds of $1.9
million. The Company used $1.8 million of the proceeds to pay down an equal
notional amount of the subordinated note due Kevin Thomas. The remainder of the
proceeds was used for general corporate purposes.
One of the investors, MSRI SBIC, L.P., which acquired 240,000 shares in the
offering, is controlled by Daniel Levinson, a director of the Company. In
addition, James Quinn, a director of the Company acquired 40,000 shares for his
own account.
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 Agreement
and Plan of Merger dated August 31, 2004 as amended, by and among the Company,
AGAX/VLI Acquisition Corporation, a subsidiary of the Company, VLI and Thomas
("Merger Agreement").
17
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 purposes
provided in the Subordination Agreement for as long as any of the Superior Debt
(as such term is defined in the Subordination Agreement) 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.
The subordinated debt due the former owner of VLI was originally due on August
1, 2006. On May 5, 2006, the Company entered into an agreement with the former
owner of VLI to delay the timing of the payment on the subordinated debt to
August 1, 2007. The former owner of VLI will be paid prior to this date if the
Company were to raise additional equity having an aggregate purchase price of
more than $1 million. The Company also has the option to draw on the New Term
Loan (as defined below) to pay the former owner of VLI if we are in compliance
with our debt covenants with the Bank of America, N.A.
Amendment of Financing Arrangements
In May 2006, the Company agreed to amend the existing financing arrangements
with the Bank of America, N.A. (Bank). Under this arrangement, the Company has a
revolving line of credit of $4.25 million in maximum availability and a term
loan with an original balance of $1.2 million. The May 2006 amendment extended
the expiration of the revolving line of credit to May 31, 2007. Under the
amended financing arrangements, amounts outstanding under the revolving line of
credit and the three-year note bear interest at LIBOR plus 3.25% and 3.45%
respectively. Availability on a monthly basis under the revolving line is
determined by reference to accounts receivable and inventory on hand which meet
certain Bank criteria (Borrowing Base). The aforementioned three-year note
remains in effect and the final monthly scheduled payment of $33,000 is due on
July 31, 2006. As of April 30, 2006, the Company had $100,000 outstanding under
the term note. At April 30, 2006, the Company also had $993,000 outstanding
under the revolving line of credit at an interest rate of 8.2% with $3.3 million
of additional availability under its Borrowing Base.
The amended financing arrangements provides for a new $1.5 million term loan
facility (New Term Loan). The proceeds of the New Term Loan are designated to
refinance a portion of the existing subordinated note with Kevin Thomas that at
April 30, 2006 had a current outstanding balance of $3,292,000 which is due on
August 1, 2007. Advances under the New Term Loan are subject to the Company
being in compliance with its debt covenants with the Bank. The New Term Loan
will be repaid in thirty-six equal monthly principal payments and bears interest
at LIBOR plus 3.25%. If the Company draws on the New Term Loan, the Company's
Borrowing Base will be reduced by $750,000 for maximum availability under the
revolving line of credit.
The amended financing arrangements provides for the measurement of certain
financial covenants including requiring the ratio of debt to pro forma earnings
before interest, taxes, depreciation and amortization (EBITDA) not to exceed 2.5
to 1 (with the next measurement date being July 31, 2006) and requiring pro
forma fixed charge coverage ratio not less than 1.25 to 1 (with the next
measurement date being July 31, 2006). The amended financings also require that
the Company meet minimum EBITDA covenants equal to or exceeding (on a rolling
four quarter basis) $1.2 million for July 31, 2006, $1.3 million for October 31,
2006 and $1.8 million for January 31, 2007 and for each successive quarter end
thereafter. The Bank's 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.
18
The amended financing arrangement contains a subjective acceleration clause
which allows the Bank to declare amounts outstanding under the financing
arrangement due and payable if certain material adverse changes occur. We
believe that we will continue to comply with our financial covenants under our
financing arrangement. If our performance does not result in compliance with any
of our financial covenants, or if the Bank seeks to exercise its rights under
the subjective acceleration clause referred to above, we would seek to modify
our financing arrangement, but there can be no assurance that the Bank would not
exercise their rights and remedies under our financing arrangement including
accelerating payment of all outstanding senior and subordinated debt due and
payable.
HOLDING COMPANY STRUCTURE
We intend to make additional acquisitions and/or investments. We intend to have
more than one industrial focus and to identify those companies that are in
industries with significant potential to grow profitably both internally and
through acquisitions. We expect that companies acquired in each of these
industrial groups will be held in separate subsidiaries that will be operated in
a manner that best provides cashflow and value for the Company.
We are a holding company with no operations other than our investments in VLI
and SMC. At April 30, 2006, 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 of these products have garnered honors including the
National Nutritional Foods Association's prestigious Peoples Choice Awards for
best products of the year in its respective category.
We provide nutrient-dense, super-food concentrates, vitamins and supplements.
Our customers include health food store chains, mass merchandisers, network
marketing companies, pharmacies and major retailers.
We intend to enhance our position in the fast growing global nutrition industry
through our innovative product development and research. We believe that we will
be able to expand our distribution channels by providing continuous quality
assurance and by focusing on timely delivery of superior nutraceutical products.
We are focused on efficiently utilizing the strong cash flow potential from
manufacturing nutritional products. To ensure that working capital is
effectively allocated, we closely monitor our inventory turns as well as the
number of days sales that we have in our accounts receivable.
TELECOM INFRASTRUCTURE SERVICES
We currently provide inside plant, premise wiring services to the Federal
Government and have plans to expand that work to commercial customers who
regularly need upgrades in their premise wiring systems to accommodate
improvements in security, telecommunications and network capabilities.
We continue to participate in the expansion of the telecommunications industry
by working with various telecommunications providers. We are actively pursuing
contracts with a wide variety of telecommunications providers. We provide
maintenance and upgrade services for their outside plant systems that increase
the capacity of existing infrastructure. We also provide outside plant services
to the power industry by providing maintenance and upgrade services to
utilities.
19
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 2
contained in the Company's consolidated financial statements for the year ended
January 31, 2006 included in the Company's Annual Report contained in Form
10-KSB, as filed with the Securities and Exchange Commission describes the
significant accounting policies and methods used in the preparation of our
consolidated financial statements. Estimates are used for, but not limited to
our accounting for revenue recognition, allowance for doubtful accounts,
inventory valuation, long-lived assets and deferred income taxes. Actual results
could differ from these estimates. The following critical accounting policies
are impacted significantly by judgments, assumptions and estimates used in the
preparation of our consolidated financial statements. If future conditions and
results are different than our assumptions and estimates, materially different
amounts could be reported.
Revenue Recognition
Vitarich Laboratories, Inc.
We manufacture products for our customers based on their orders. We typically
ship the orders immediately after production keeping relatively little on-hand
as finished goods inventory. We recognize customer sales at the time title and
the risks and rewards of ownership passes to our customer which is generally
when orders are shipped. Sales are recognized on a net basis which reflect
reductions for certain product returns and discounts. Cost of goods sold and
finished goods inventory sold include materials and direct labor as well as
other direct costs combine with allocations of indirect operational costs.
Southern Maryland Cable, Inc.
We generate revenue under various arrangements, including contracts under which
revenue is based on a fixed price basis and on a time and materials basis.
Revenues from time and materials contracts are recognized when the related
service is provided to the customer. Revenues from fixed price contracts,
including a portion of estimated profit, are recognized as services are
provided, based on costs incurred and estimated total contract costs using the
percentage of completion method.
The timing of billing to customers varies based on individual contracts and
often differs from the period of revenue recognition. Estimated earnings in
excess of billings and billings in excess of estimated earnings totaled $170,000
and $31,000, respectively, at April 30, 2006.
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.
20
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, Including Definite Lived Intangible 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 whether any
impairment exists by comparing the carrying value of these long-lived assets to
the undiscounted future cash flows expected to result from the use of these
assets. In the event 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.
Goodwill and Other Indefinite Lived Intangible Assets
In connection with the acquisitions of VLI and SMC, the Company has substantial
goodwill and intangible assets including contractual customer relationships,
proprietary formulas, non-compete agreements and trade names. In accordance with
SFAS 142 "Goodwill and Other Intangible Assets," the Company reviews for
impairment, at least annually, goodwill and intangible assets deemed to have an
indefinite life.
Goodwill impairment is determined using a two-step process. The first step of
the goodwill impairment test is to identify a potential impairment by comparing
the fair value of a reporting unit with its carrying amount, including goodwill.
The estimates of fair value of a reporting unit, generally a Company's operating
segment, is determined using various valuation techniques, with the principal
techniques being a discounted cash flow analysis and market multiple valuation.
A discounted cash flow analysis requires making various judgmental assumptions,
including assumptions about future cash flows, growth rates and discount rates.
Developing assumptions for the Company's entrepreneurial business requires
significant judgment and to a great extent relies on the Company's ability to
successfully determine trends with respect to customers, industry and regulatory
environment. The assumptions, including assumptions about future flows and
growth rates, are based on the Company's budget and business plans as well as
industry trends with respect to customers and other manufacturers' and
distributors' sales and margins. The Company reviews trends for publicly traded
companies which either compete with the Company to provide services or the types
of products the Company produces or are users of the types of services and
products provided by the Company. Changes in economic and operating conditions
impacting these assumptions could result in goodwill impairment in future
periods. Discount rate assumptions are based on the Company's subjective
assessment of the risk inherent in the respective reporting units. Risks which
the Company faces in its business include the public's perception of our
integrity and the safety and quality of our products and services. In addition,
in the industries that we operate we are subject to rapidly changing consumer
demands and preferences. The Company also operates in competitive industries. We
are not assured that customers or potential customers will regard our products
and services as sufficiently distinguishable from our competitors' product and
service offerings. If after taking into consideration industry and Company
trends, the fair value of a reporting unit exceeds its carrying amount, goodwill
of the reporting unit is not deemed impaired and the second step of the
impairment test is not performed. If the carrying amount of a reporting unit
exceeds its fair value, the second step of the goodwill impairment test compares
the implied fair value of the reporting unit's goodwill with the carrying amount
of that goodwill. If the carrying amount of the reporting unit's goodwill
exceeds the implied fair value of that goodwill, an impairment loss is
recognized in an amount equal to that excess. The implied fair value of goodwill
is determined in the same manner as the amount of goodwill recognized in a
business combination. Accordingly, the fair value of the reporting unit is
allocated to all of the assets and liabilities of that unit (including any
unrecognized intangible assets) as if the reporting unit had been acquired in a
business combination and the fair value of the reporting unit was the purchase
price paid to acquire the reporting unit.
21
The Company will test for impairment of Goodwill and other intangible assets
more frequently if events or changes in circumstances indicate that the asset
might be impaired.
Contractual Customer Relationships
Southern Maryland Cable, Inc. - 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. (GD), Verizon Communications (VZ) and
Southern Maryland Electric Cooperative (SMECO). 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. While SMC's relationship with GD
is relatively recent, SMC has performed work for VZ and SMECO for approximately
twenty years and ten years, respectively. The long-term relationship with VZ and
SMECO affected the discount rate used to discount 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.
Vitarich Laboratories, Inc. - The fair value of the Contractual Customer
Relationships at VLI (VCCR's) was determined at the time of the acquisition of
VLI by identifying long established customer relationships in which VLI has a
pattern of recurring purchase and sales orders. The Company estimated expected
cash flows attributable to these existing customer relationships factoring in
market place assumptions regarding future contract renewals, customer attrition
rates and forecasted expenses to maintain the installed customer base. These
cash flows were then discounted based on a rate that reflects the perceived risk
of the VCCR's, the Company's estimated weighted average cost of capital and
VLI's asset mix. VLI has had a relationship of five years or more with most if
its currently significant customers. We are amortizing VCCR's over a five year
life based on our expectations of continued cash flows from these relationships
and our history of maintaining relationships.
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 the Mid-Atlantic region, SMC's primary region of
operations.
We are using the relief-from-royalty method described above to test the trade
name for impairment annually on November 1 and on an interim basis if events or
changes in circumstances between annual tests indicate the trade name might be
impaired.
Proprietary Formulas
The Fair Value of the Proprietary Formulas (PFs) 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 PFs, the
estimated weighted average cost of capital and VLI's asset mix. We are
amortizing the PFs over a three year life based on the estimated contributory
life of the proprietary formulations utilizing estimated historical product
lifecycles and changes in technology.
22
Non-Compete Agreement
The fair value of the Non-Compete Agreement (NCA) was determined at the time of
acquisition of VLI by discounting the estimated reduction in the cash flows
expected if one key employee, the former sole shareholder of VLI, were to leave.
The key employee signed a non-compete clause prohibiting the employee from
competing directly or indirectly for five years. The estimated reduced cash
flows were discounted based on a rate that reflects the perceived risk of the
NCA, the estimated weighted average cost of capital and VLI's asset mix. We are
amortizing the NCA over five years, the length of the non-compete agreement.
Derivative Financial Instruments
The Company accounts for derivative financial instruments in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 133 "Accounting for
Derivative Instruments and Hedging Activities" and Emerging Issues Task Force
Issue No. 00-19, "Accounting for Derivative Financial Instruments Indexed to,
and Potentially Settled in a Company's Own Stock." The derivative financial
instruments are carried at fair value with changes in fair value recorded as
other expense, net. The determination of fair value for our derivative financial
instruments is subject to the volatility of our stock price as well as certain
underlying assumptions which include the probability of raising additional
capital.
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.
Western Filter Corporation Litigation
On September 17, 2004, Western Filter Corporation ("WFC") notified the Company
that WFC believes that the Company breached certain representations and
warranties under the stock purchase agreement dated October 31, 2003 by and
between Argan, Inc. and WFC ("Stock Purchase Agreement"). WFC asserts damages in
excess of the $300,000 escrow which is being held by a third party in connection
with the Stock Purchase Agreement.
On March 22, 2005, WFC filed a complaint in Los Angeles Superior Court alleging
the Company and its executive officers, individually, committed breach of
contract, intentional misrepresentation, concealment and non-disclosure,
negligent misrepresentation and false promise. WFC seeks declaratory relief and
compensatory and punitive damages in an amount to be proven at trial as well as
the recovery of attorneys' fees.
Although the Company has reviewed WFC's claim and believes that substantially
all of the claims are without merit, at April 30, 2006, the Company had an
accrual related to this matter of $360,000 for estimated payments and legal fees
related to the claims of WFC that it considers to be probable and that can be
reasonably estimated. Although the ultimate amount of liability that may result
from this matter 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. The Company will vigorously
contest WFC's claim.
23
Results of Operations for the Three Months Ended April 30, 2006 Compared to the
Results of Operations for the Three Months ended April 30, 2005
Three Months Ended
April 30,
2006 2005
Statement of Operations
Net sales
Nutraceutical products $ 5,829,000 $ 4,728,000
Telecom infrastructure services 3,133,000 2,428,000
----------- -----------
Net Sales 8,962,000 7,156,000
----------- -----------
Cost of sales
Nutraceutical products 4,386,000 3,430,000
Telecom infrastructure services 2,323,000 1,907,000
----------- -----------
Gross profit 2,253,000 1,819,000
Selling general and administrative expenses 1,976,000 1,840,000
----------- -----------
Income (loss) from operations 277,000 (21,000)
Interest expense 261,000 56,000
Other income, net 2,000 27,000
----------- -----------
Income (loss) from operations before income taxes 18,000 (50,000)
Income tax provision (benefit) 36,000 (28,000)
----------- -----------
Net loss $ (18,000) $ (22,000)
=========== ===========
Net sales
Net sales of nutraceutical products were $5,829,000 for the three months ended
April 30, 2006 compared to net sales of nutraceutical products of $4,728,000 for
the three months ended April 30, 2005, an increase of $1,101,000 or 23%. The
increase in net sales of nutraceutical products was due primarily to increased
sales to several of our largest customers, TriVita Corporation (TVC) and Rob
Reiss Companies (RRC) as well as to two new customers.
Net sales of telecommunications infrastructure services were $3,133,000 for the
three months ended April 30, 2006 compared to net sales of telecommunications
infrastructure services of $2,428,000 for the three months ended April 30, 2005,
an increase of $705,000 or 29%. The increase is due primarily to increased sales
to VZ, SMECO and Electronic Data Systems Corp. (EDS) which offset the decline in
business with GD whose contract with SMC was completed last year.
Cost of sales
For the three months ended April 30, 2006, cost of sales for nutraceutical
products was $4,386,000, or 75% of net sales for nutraceutical products compared
to $3,430,000 or 73% of net sales of nutraceutical products for the three months
ended April 30, 2005. VLI experienced a higher percentage of cost of sales
during the three months ended April 30, 2006 due to increased costs of
non-nutritional materials whose cost was affected by the rise in oil prices. VLI
has begun to pass along price increases during the three months ended April 30,
2006. In addition, during the three months ended April 30, 2006, VLI outsourced
certain manufacturing processes at higher costs which it had originally planned
to perform in-house at lower costs.
24
For the three months ended April 30, 2006, cost of sales for telecommunications
infrastructure services were $2,323,000 or 74% of net sales of
telecommunications infrastructure services compared to $1,907,000 or 79% of net
sales of telecommunications infrastructure services. SMC experienced improved
percentage margin performance due primarily to more effective utilization of
construction personnel and equipment assigned to VZ and SMECO as the net sales
to both customers increased.
Selling general and administrative expenses
Selling, general and administrative expenses were $1,976,000 or 22% of net sales
for the three months ended April 30, 2006 compared to $1,840,000 or 26% of net
sales for the three months ended April 30, 2005, an increase of $136,000. SMC
increased its selling, general and administrative expenses by $60,000 due to the
hiring of additional sales support personnel. In addition, corporate expenses as
a percentage of net sales increased from 6% to 7% due to increased corporate
costs due to higher professional accounting services.
Interest Expense
We had an increase of interest expense to $261,000 for the three months ended
April 30, 2006 from $56,000 for the three months ended April 30, 2005 due
primarily to the interest expense for subordinated debt of $82,000 and
amortization of issuance cost for the subordinated debt of $129,000 for the
three months ended April 30, 2006.
Other income, net
We had other income, net of $2,000 for the three months ended April 30, 2006
compared to other income, net of $27,000 for the three months ended April 30,
2005.
Income tax (benefit) provision
The Company's effective income tax rate was 200% for the three months ended
April 30, 2006 compared to a 56% effective income tax benefit rate for the three
months ended April 30, 2005.
During the three months ended April 30, 2006, the Company's effective income tax
rate was increased by the impact of the amortization of issuance cost for
subordinated debt which is treated as a permanent difference for income tax
reporting purposes.
For the three months ended April 30, 2005, the Company's effective income tax
benefit rate was increased by the impact of the fair value adjustment for
liability for derivative financial instruments which is a permanent difference
for income tax reporting purposes.
LIQUIDITY AND CAPITAL RESOURCES
Cash Position and Indebtedness
We had $1.9 million in working capital at April 30, 2006, including $93,000 of
cash and cash equivalents. In addition we had $3.3 million available under
credit facilities.
Working capital increased by $400,000 to $1.9 million at April 30, 2006 from
$1.5 million at January 31, 2006. Components of the Company's cash flow provided
by operations during the three months ended April 30, 2006 contributed to the
increase in working capital. Estimated earnings in excess of billings decreased
by $505,000, inventories decreased by $140,000, accounts payable and accrued
expenses increased by $620,000 which was offset, in part by the increase in
accounts receivable of $1,039,000. The Company had income before taxes of
$18,000 for the three months ended April 30, 2006. The Company's non-cash
expenses included in the determination of income before taxes included $331,000
for amortization of purchase intangibles and $376,000 for depreciation and
amortization.
25
Cash Flows
Net cash provided by operations for the three months ended April 30, 2006 was
$783,000 compared with $24,000 of cash used in operations for the three months
ended April 30, 2005 due to the improved financial performance of both SMC and
VLI. For the three months ended April 30, 2006, SMC had income from operations
of $396,000 compared to income from operations of $167,000 for the three months
ended April 30, 2005. Net sales from VZ increased by $830,000 due to SMC
reestablishing a contractual relationship with VZ which had been previously
discontinued. In July 2004, SMC lost a significantly profitable contract with
VZ. In September 2005, SMC commenced work on an underground telecommunications
infrastructure services contract with VZ which had been previously awarded to a
third party which did not perform to VZ's satisfaction. In addition, SMC
experienced strong revenue growth from SMECO. During the three months ended
April 30, 2006, VLI had income from operations of $356,000 compared to income
from operations of $212,000 for the three months ended April 30, 2005. VLI
experienced strong revenue growth from two of its most significant customers,
TVC and RRC as well as from two new customers.
During the three months ended April 30, 2006, accounts receivable used cash of
$1,039,000. Strong revenue performance at both SMC and VLI resulted in the
substantial increase in accounts receivable. During the three months ended April
30, 2006, estimated earnings in excess of billings, inventories, net and
accounts payable and accrued expenses provided cash flow of $505,000, $140,000
and $620,000, respectively. Improved processing of invoices reduced SMC's
estimated earnings in excess of billings. VLI exercised tighter controls over
inventory levels as it experienced strong revenue growth. Accounts payable and
accrued expenses increased as SMC experienced substantial increase in work
performed by subcontractors which resulted in increased amounts payable to
subcontractors at April 30, 2006. Since subcontractors are paid on terms
consistent with SMC's terms with its customers, subcontractors are not paid
until invoices are paid by our customers which contributes to a higher level of
accounts payable.
During the three months ended April 30, 2006, net cash used for investing
activities was $270,000 compared to net cash used for investing activities of
$118,000 for the three months ended April 30, 2005. SMC paid for new drilling
equipment and trucks to respond to opportunities for additional customer work.
For the three months ended April 30, 2006, net cash used by financing activities
was $425,000 compared to cash provided by financing activities of $82,000 for
the three months ended April 30, 2005. The change in net cash provided during
the three months ended April 30, 2005 to net cash used during the three months
ended April 30, 2006 is due to payments made on the line of credit and the term
loan by the Company during the three months ended April 30, 2006 from cash
provided by operating activities. During the three months ended April 30, 2005,
the Bank of America, N.A. released $304,000 in previously escrowed funds in
accordance with the amended financing arrangements of April 2005 which offset
the net paydown of the Company's line of credit and long term debt.
In May 2006, the Company agreed to amend the existing financing arrangements
with the Bank of America, N.A. (Bank). Under this arrangement, the Company has a
revolving line of credit of $4.25 million in maximum availability and a term
loan with an original balance of $1.2 million. The May 2006 amendment extended
the expiration of the revolving line of debt to May 31, 2007. Under the amended
financing arrangements, amounts outstanding under the revolving line of credit
and the three-year note bear interest at LIBOR plus 3.25% and 3.45%,
respectively. Availability on a monthly basis under the revolving line is
determined by reference to accounts receivable and inventory on hand which meet
certain Bank criteria (Borrowing Base). The aforementioned three-year note
remains in effect and the final monthly scheduled payment of $33,000 is due on
July 31, 2006. As of April 30, 2006, the Company had $100,000 outstanding under
the term note. At April 30, 2006, the Company also had $993,000 outstanding
under the revolving line of credit at an interest rate of 8.2% with $3.3 million
of additional availability under its Borrowing Base.
26
The amended financing arrangements provides for a new $1.5 million term loan
facility (New Term Loan). The proceeds of the New Term Loan are designated to
refinance a portion of the existing subordinated note with Kevin Thomas that had
at April 30, 2006 an outstanding balance of $3,292,000 which is due on August 1,
2007. Advances under the New Term Loan are subject to the Company being in
compliance with its debt covenants with the Bank. The New Term Loan will be
repaid in thirty-six equal monthly principal payments and bear interest at LIBOR
plus 3.25%. If the Company draws on the New Term Loan, the Company's Borrowing
Base will be reduced by $750,000 for maximum availability under the revolving
line of credit.
The amended financing arrangements provides for the measurement of certain
financial covenants including requiring the ratio of debt to pro forma earnings
before interest, taxes, depreciation and amortization (EBITDA) not to exceed 2.5
to 1 (with the next measurement period of July 31, 2006) and requiring pro forma
fixed charge coverage ratio not less than 1.25 to 1 (with the next measurement
period of July 31, 2006). The amended financing arrangements also provide a
requirement that the Company meet minimum EBITDA covenants equal to or exceeding
(on a rolling four quarter basis) $1.2 million for July 31, 2006, $1.3 million
for October 31, 2006 and $1.8 million for January 31, 2007 and for each
successive quarter end thereafter. 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 amended financing arrangement contains a subjective acceleration clause
which allows the Bank to declare amounts outstanding under the financing
arrangement due and payable if certain material adverse changes occur. We
believe that we will continue to comply with our financial covenants under our
financing arrangement. If our performance does not result in compliance with any
of our financial covenants, or if the Bank seeks to exercise its rights under
the subjective acceleration clause referred to above, we would seek to modify
our financing arrangement, but there can be no assurance that the Bank would not
exercise their rights and remedies under our financing arrangement including
accelerating payment of all outstanding senior and subordinated debt due and
payable.
At April 30, 2006, the Company was in compliance with the covenants of its
amended financing arrangements.
Management believes that cash generated from the Company's operations combined
with capital resources available under its renewed line of credit is adequate to
meet the Company's future operating cash needs. Any future acquisitions, other
significant unplanned costs or cash requirements may require the Company to
raise additional funds through the issuance of debt and equity securities. There
can be no assurance that such financing will be available on terms acceptable to
the Company, or at all. If additional funds are raised by issuing equity
securities, significant dilution to the existing stockholders may result.
Customers
During the three months ended April 30, 2006, 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
Electronic Data Systems Corp. (EDS). Certain of our more significant customer
relationships are with TriVita Corporation (TVC), Rob Reiss Companies (RRC),
Verizon Communications, Inc. (VZ), Southern Maryland Electrical Cooperative
(SMECO), EDS, CyberWize.com, Inc. (C), and Orange Peel Enterprises, Inc. (OPE).
TVC, RRC, C and OPE are VLI customers. SMC's significant customers are VZ, SMECO
and EDS. TVC, RRC, C and OPE accounted for approximately 22%, 13%, 6% and 5% of
consolidated net sales during the three months ended April 30, 2006. VZ, SMECO
and EDS accounted for approximately 11%, 11% and 6% of consolidated net sales
during the three months ended April 30, 2006. Combined TVC, RRC, VZ, SMECO, EDS,
C and OPE accounted for approximately 74% of consolidated net sales during the
three months ended April 30, 2006.
27
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
ITEM 3. CONTROLS AND PROCEDURES
(a) Disclosure Controls and Procedures
As of the end of the period covered by this report, the Company carried out an
evaluation, under the supervision and with the participation of the Company's
management, including Chief Executive Officer and Chief Financial Officer, of
the effectiveness of the design and operation of the Company's disclosure
controls and procedures (as defined in Rule 13a-15 of the Securities Exchange
Act of 1934). Based on that evaluation, our Chief Executive Officer and Chief
Financial Officer have concluded that the Company's current disclosure controls
and procedures are effective in timely alerting them of material information
relating to the Company that is required to be disclosed by the Company in the
reports it files or submits under the Securities Exchange Act of 1934.
(b) Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Rules 13a-15(f)
under the Securities Exchange Act of 1934 and for the assessment of the
effectiveness of internal control over financial reporting.
Changes in Internal Control Over Financial Reporting
There have been no changes in the Company's internal control over financial
reporting that occurred during the quarter ended April 30, 2006 that have
materially affected, or are reasonably likely to materially affect the Company's
internal control over financial reporting.
PART ll
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On September 17, 2004, Western Filter Corporation (WFC) notified the Company
that WFC believed that the Company breached certain representations and
warranties under the stock purchase agreement dated October 31, 2003 by and
between Argan, Inc. and WFC ("Stock Purchase Agreement"). WFC asserts damages in
excess of the $300,000 escrow which is being held by a third party in connection
with the Stock Purchase Agreement.
28
On March 22, 2005, WFC filed a complaint in Los Angeles Superior Court alleging
the Company and its executive officers, individually, committed breach of
contract, intentional misrepresentation, concealment and non-disclosure,
negligent misrepresentation and false promise. WFC seeks declaratory relief and
compensatory and punitive damages in an amount to be proven at trial as well as
the recovery of attorneys' fees.
Although the Company has reviewed WFC's claim and believes that substantially
all of the claims are without merit, as of April 30, 2006, the Company had an
accrual related to this matter of $360,000 for estimated payments and legal
expenses related to the claim of WFC that it considers to be probable and that
can be reasonably estimated. Although the ultimate amount of liability that may
result from this matter 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. The Company
will vigorously contest WFC's claim.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
Exhibit No. Title
----------- -----
Exhibit: 31.1 Certification of Chief Executive Officer, pursuant to
Rule 13a-14(c) under the Securities Exchange Act of 1934
Exhibit: 31.2 Certification of Chief Financial Officer, pursuant to
Rule 13a-14(c) under the Securities Exchange Act of 1934
Exhibit: 32.1 Certification of Chief Executive Officer, pursuant to 18
U.S.C. Section 1350
Exhibit: 32.2 Certification of Chief Financial Officer, pursuant to 18
U.S.C. Section 1350
29
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto, duly
authorized.
ARGAN, INC.
June 13, 2006 By: /s/ Rainer Bosselmann
---------------------------------------
Rainer Bosselmann
Chairman of the Board and Chief
Executive Officer
June 13, 2006 By: /s/ Arthur F. Trudel
---------------------------------------
Arthur F. Trudel
Chief Financial Officer
30