UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

(Mark One)

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended July 31, 2008

 

or

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT

 

  For the Transition Period from              to              

 

Commission File Number 001-31756

 

Argan, Inc.

(Exact Name of Registrant as Specified in Its Charter)

Delaware		13-1947195
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

 

One Church Street, Suite 401, Rockville Maryland 20850

(Address of Principal Executive Offices) (Zip Code)

(301) 315-0027

(Registrant’s Telephone Number, Including Area Code)

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(Former Name, Former Address and Former Fiscal Year,

if Changed since Last Report)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes þ No o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):

Large accelerated filer o Accelerated filer o Non-accelerated filer o Smaller reporting company þ

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ 

Indicate the number of shares outstanding of each of the Registrant’s classes of common stock, as of the latest practicable date: Common Stock, $0.15 par value, 13,415,451 shares at September 2, 2008.

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ARGAN, INC. AND SUBSIDIARIES 

INDEX

 

		Page No.
PART I.	FINANCIAL INFORMATION	3
Item 1.	Financial Statements (unaudited)	3
	Condensed Consolidated Balance Sheets – July 31, 2008 and January 31, 2008	3
	Condensed Consolidated Statements of Operations for the Three and Six Months Ended July 31, 2008 and 2007	4
	Condensed Consolidated Statements of Cash Flows for the Six Months Ended July 31, 2008 and 2007	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operation	18
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	27
Item 4.	Controls and Procedures	27
PART II.	OTHER INFORMATION	28
Item 1.	Legal Proceedings	28
Item 1A.	Risk Factors	29
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	30
Item 3.	Defaults upon Senior Securities	30
Item 4.	Submission of Matters to a Vote of Security Holders	30
Item 5.	Other Information	30
Item 6.	Exhibits	30
SIGNATURES		31
CERTIFICATIONS

 

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Options		Shares			Weighted- Average Exercise Price			Weighted- Average Remaining Contract Term (Years)			Weighted- Average Fair Value
Outstanding, January 31, 2008			426,000		$	6.07
Granted			120,000		$	12.05
Exercised			(88,000	)	$	6.14
Forfeited or expired			(1,000	)	$	7.87
Outstanding, July 31, 2008			457,000		$	7.62			7.6		$	4.35
Exercisable, July 31, 2008			232,000		$	4.19			6.2		$	2.40
Exercisable, January 31, 2008			235,000		$	4.16			6.9		$	2.19

 

The weighted-average grant date fair value amount per share for stock options awarded during the six months ended July 31, 2008 was $6.68.

Compensation expense amounts relating to vesting stock options were $391,000 and $86,000, respectively, in the three months ended July 31, 2008 and 2007 and were $788,000 and $100,000, respectively, in the six months ended July 31, 2008 and 2007. At July 31, 2008, there was $625,000 unrecognized compensation cost related to stock options granted under the Option Plan. The end of the period over which the compensation expense for these awards is expected to be recognized is June 2009. The total intrinsic value of the stock options exercised during the six months ended July 31, 2008 was approximately $798,000. The aggregate intrinsic value amount for exercisable stock options at July 31, 2008 was approximately $2,851,000.

The fair value of each stock option granted in the six months ended July 31, 2008 was estimated on the date of award using the Black-Scholes option-pricing model based on the following weighted average assumptions.

		2008			2007
Computed expected income tax (expense) benefit		$	(1,368,000	)	$	234,000
State income taxes, net			(150,000	)		(203,000	)
Permanent differences			(144,000	)		(24,000	)
		$	(1,662,000	)	$	7,000

As of July 31, 2008 and January 31, 2008, accrued expenses included income tax amounts currently payable of approximately $498,000 and $1,003,000, respectively.

The Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of SFAS No. 109” (“FIN 48”), on February 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes,” and prescribes a recognition threshold and measurement process for financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. There was no material effect on the Company’s consolidated financial statements as a result of adopting this standard.

NOTE 13 - TERMINATED CONSTRUCTION CONTRACT

 

Under the terms of an amended agreement with a customer covering the engineering, procurement and construction of an ethanol production facility (the “EPC Agreement”), March 19, 2008 was the deadline for the customer to obtain financing for the completion of the project. Financing was not obtained and the EPC Agreement was terminated. GPS continues to cooperate with the customer in its efforts to obtain financing. GPS is uncertain as to the ultimate resolution of this matter. As of July 31, 2008 and January 31, 2008, the Company’s consolidated balance sheets included assets and liabilities related to the terminated construction contract. The Company has classified these assets and liabilities as current assets and current liabilities in the accompanying condensed consolidated balance sheets due to the expectation that the assets will be realized and the liabilities will be extinguished. Although cash may be required to make payment on accounts payable to project subcontractors that are included in the condensed consolidated balance sheet at July 31, 2008, GPS does not anticipate any losses to arise from the resolution of this EPC Agreement. No net revenues were recorded in the six months ended July 31, 2008 related to this project.

NOTE 14 - LEGAL CONTINGENCIES

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 current claims and proceedings will have a material effect on the Company’s consolidated financial statements other than the matters discussed below.

Western Filter Corporation Litigation

On March 22, 2005, WFC filed a civil action against the Company, and its executive officers. The suit was filed in the Superior Court of the State of California for the County of Los Angeles. WFC purchased the capital stock of the Company's wholly owned subsidiary, Puroflow Incorporated, pursuant to the terms of the Stock Purchase Agreement dated October 31, 2003. WFC alleged that the Company and its executive officers breached the Stock Purchase Agreement between WFC and the Company and engaged in misrepresentations and negligent conduct with respect to the Stock Purchase Agreement. WFC sought declaratory relief, compensatory and punitive damages in an amount to be proven at trial as well as the recovery of attorney's fees. This action was removed to the United States District Court for the Central District of California. The Company and its officers deny that any breach of contract or that any misrepresentations or negligence occurred on their part.

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This case was scheduled for trial on April 10, 2007. On March 15, 2007, the District Court granted the Company and its executive officers' motion for summary judgment, thereby dismissing WFC's lawsuit against the Company and its executive officers in its entirety. WFC appealed the District Court’s decision. The parties filed their appellate briefs and oral arguments occurred on June 3, 2008. On August 25, 2008, the Ninth Circuit Court of Appeals reversed the summary judgment decision and remanded the case back to the District Court.

 

The Company has reviewed WFC’s claims and continues to believe that they are without merit. The Company intends to continue vigorously defending this litigation. It is possible, however, that the ultimate resolution of the WFC litigation could result in a material adverse effect on the results of operations of the Company for a particular future reporting period. The Company’s condensed consolidated balance sheet at July 31, 2008 included an amount in accrued expenses reflecting the Company’s estimate of the amount of future legal fees that it expects to be billed in connection with the completion of this litigation.

 

Kevin Thomas Litigation

On August 27, 2007, Kevin Thomas, the former owner of VLI, filed a lawsuit against the Company, VLI and the Company’s Chief Executive Officer (the “CEO”) in the Circuit Court of Florida for Collier County. The Company acquired VLI by way of merger on August 31, 2004. Mr. Thomas alleges that the Company, VLI and the CEO breached various agreements regarding his compensation and employment package that arose from the acquisition of VLI. Mr. Thomas has alleged contractual and tort-based claims arising from his compensation and employment agreements and seeks rescission of his covenant not to compete against VLI. The Company, VLI and the CEO deny that any breach of contract or tortious conduct occurred on their part. The Company and VLI have also asserted four counterclaims against Mr. Thomas for breach of the merger agreement, breach of his employment agreement, breach of fiduciary duty and tortious interference with contractual relations because Mr. Thomas violated his non-solicitation, confidentiality and non-compete obligations after he left VLI. The Company intends to vigorously defend this lawsuit and prosecute its counterclaims.

 

Although the Company has reviewed the claims of Mr. Thomas and believes that they are without merit, the Company’s condensed consolidated balance sheet at July 31, 2008 included an amount in accrued expenses reflecting the Company’s estimate of the amount of future legal fees that it expects to be billed in connection with this matter. It is possible however, that the ultimate resolution of the litigation with Mr. Thomas could result in a material adverse effect on the results of operations of the Company for a particular future reporting period.

On March 4, 2008, Vitarich Farms, Inc. (“VFI”) filed a lawsuit against VLI and its current president in the Circuit Court of Florida for Collier County. VFI, which is owned by Kevin Thomas, supplied VLI with certain organic raw materials used in the manufacture of VLI products. VFI has asserted a breach of contract claim against VLI and alleges that VLI breached a supply agreement with VFI by acquiring the organic products from a different supplier. VFI also asserted a claim for defamation against VLI’s president alleging that he made false statements regarding VFI’s organic certification to one of VLI's customers. VLI and its president filed their Answer and Affirmative Defenses on May 8, 2008. VLI and its president deny that VLI breached any contract or that its president defamed VFI. The defendants intend to continue to vigorously defend this lawsuit. The Company’s condensed consolidated balance sheet at July 31, 2008 included an amount in accrued expenses reflecting the Company’s estimate of the amount of future legal fees that it expects to be billed in connection with this matter.

On March 4, 2008, Mr. Thomas filed a lawsuit against VLI's president in the Circuit Court of Florida for Collier County. Mr. Thomas has filed this new lawsuit against VLI’s president for defamation. Mr. Thomas alleges that VLI’s president made false statements to third-parties regarding Mr. Thomas' conduct that is the subject of counterclaims by the Company and VLI in the litigation matter discussed above and that these statements have caused him damage to his business reputation. VLI’s president filed his answer with the court on May 8, 2008. VLI’s president denies that he defamed Mr. Thomas and intends to continue to vigorously defend this lawsuit.

NOTE 15 - RELATED PARTY TRANSACTIONS

 

The Company leased administrative, manufacturing and warehouse facilities for VLI from an individual who was the former officer and shareholder of VLI. The lease costs through March 2007, the date of his employment termination, were considered related party expenses. The total prior year expense amount under this arrangement of $45,000 was recorded in the quarter ended April 30, 2007.

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The Company 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. Last year, VLI made $47,000 in purchases under the supply agreement through March 2007, the date on which the former officer and shareholder of VLI was terminated.

 

The Company also sold its products in the normal course of business to an entity in which the former shareholder of VLI had an ownership interest. VLI had approximately $117,000 in prior year net revenues related to this entity through the aforementioned termination in March 2007 which were recorded in the quarter ended April 30, 2007; this amount was collected.

NOTE 16 - SEGMENT REPORTING AND MAJOR CUSTOMERS

 

The Company’s three reportable segments are power industry services, nutritional products and telecommunications infrastructure services. The Company conducts these operations through its wholly owned subsidiaries - GPS, VLI and SMC, respectively. 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, technologies and services. 

Three Months Ended July 31, 2008		Power Industry  Services			Nutritional Products			Telecom Infrastructure Services			Other			Consolidated
Net revenues		$	70,639,000		$	2,226,000		$	2,233,000			—		$	75,098,000
Cost of revenues			63,108,000			2,395,000			1,875,000			—			67,378,000
Gross profit			7,531,000			(169,000	)		358,000			—			7,720,000
Selling, general and administrative expenses			1,579,000			799,000			408,000			1,230,000			4,016,000
Impairment losses of VLI			—			1,946,000			—			—			1,946,000
Income (loss) from operations			5,952,000			(2,914,000	)		(50,000	)		(1,230,000	)		1,758,000
Interest expense			(92,000	)		(16,000	)		—			—			(108,000	)
Interest income			390,000			—			—			42,000			432,000
Equity in the net loss of unconsolidated subsidiary			(165,000	)		—			—			—			(165,000	)
Income (loss) before income taxes		$	6,085,000		$	(2,930,000	)	$	(50,000	)	$	(1,188,000	)		1,917,000
Income tax expense															(1,111,000	)
Net income														$	806,000
Amortization of purchased intangibles		$	355,000		$	21,000		$	26,000		$	—		$	402,000
Depreciation and other amortization		$	51,000		$	149,000		$	141,000		$	3,000		$	344,000
Goodwill		$	18,476,000		$	—		$	940,000		$	—		$	19,416,000
Total assets		$	130,399,000		$	4,980,000		$	4,243,000		$	30,373,000		$	169,995,000
Fixed asset additions		$	40,000		$	75,000		$	31,000		$	—		$	146,000

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Three Months Ended July 31, 2007		Power Industry  Services			Nutritional Products			Telecom Infrastructure Services			Other			Consolidated
Net revenues		$	45,599,000		$	5,036,000		$	2,502,000		$	—		$	53,137,000
Cost of revenues			40,590,000			4,122,000			1,858,000			—			46,570,000
Gross profit			5,009,000			914,000			644,000			—			6,567,000
Selling, general and administrative expenses			2,553,000			1,015,000			340,000			865,000			4,773,000
Income (loss) from operations			2,456,000			(101,000	)		304,000			(865,000	)		1,794,000
Interest expense			(155,000	)		(30,000	)		—			—			(185,000	)
Interest income			657,000			—			—			—			657,000
Income (loss) before income taxes		$	2,958,000		$	(131,000	)	$	304,000		$	(865,000	)		2,266,000
Income tax expense															(932,000	)
Net income														$	1,334,000
Amortization of purchased intangibles		$	1,695,000		$	304,000		$	26,000		$	—		$	2,025,000
Depreciation and other amortization		$	41,000		$	149,000		$	126,000		$	4,000		$	320,000
Goodwill		$	16,476,000		$	6,565,000		$	940,000		$	—		$	23,981,000
Total assets		$	116,531,000		$	14,850,000		$	4,484,000		$	2,689,000		$	138,554,000
Fixed asset additions		$	—		$	39,000		$	85,000		$	—		$	124,000

Six Months Ended July 31, 2008		Power Industry  Services			Nutritional Products			Telecom Infrastructure Services			Other			Consolidated
Net revenues		$	114,647,000		$	4,625,000		$	4,232,000			—		$	123,504,000
Cost of revenues			101,684,000			4,718,000			3,649,000			—			110,051,000
Gross profit			12,963,000			(93,000	)		583,000			—			13,453,000
Selling, general and administrative expenses			3,420,000			1,515,000			751,000			2,341,000			8,027,000
Impairment losses of VLI			—			1,946,000			—			—			1,946,000
Income (loss) from operations			9,543,000			(3,554,000	)		(168,000	)		(2,341,000	)		3,480,000
Interest expense			(195,000	)		(33,000	)		—			—			(228,000	)
Interest income			894,000			—			—			42,000			936,000
Equity in the net loss of unconsolidated subsidiary			(165,000	)		—			—			—			(165,000	)
Income (loss) before income taxes		$	10,077,000		$	(3,587,000	)	$	(168,000	)	$	(2,299,000	)		4,023,000
Income tax expense															(1,662,000	)
Net income														$	2,361,000
Amortization of purchased intangibles		$	1,079,000		$	43,000		$	52,000		$	—		$	1,174,000
Depreciation and other amortization		$	99,000		$	297,000		$	283,000		$	4,000		$	683,000
Fixed asset additions		$	89,000		$	131,000		$	44,000		$	—		$	264,000

 

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Six Months Ended July 31, 2007		Power Industry  Services			Nutritional Products			Telecom Infrastructure Services			Other			Consolidated
Net revenues		$	88,953,000		$	9,985,000		$	4,631,000			—		$	103,569,000
Cost of revenues			83,835,000			8,288,000			3,701,000			—			95,824,000
Gross profit			5,118,000			1,697,000			930,000			—			7,745,000
Selling, general and administrative expenses			5,105,000			2,185,000			698,000			1,346,000			9,334,000
Income (loss) from operations			13,000			(488,000	)		232,000			(1,346,000	)		(1,589,000	)
Interest expense			(316,000	)		(61,000	)		—			(1,000	)		(378,000	)
Interest income			1,266,000			—			10,000			3,000			1,279,000
Income (loss) before income taxes		$	963,000		$	(549,000	)	$	242,000		$	(1,344,000	)		(688,000	)
Income tax benefit															7,000
Net loss														$	(681,000	)
Amortization of purchased intangibles		$	3,428,000		$	609,000		$	52,000		$	—		$	4,089,000
Depreciation and other amortization		$	94,000		$	293,000		$	249,000		$	8,000		$	644,000
Fixed asset additions		$	4,000		$	124,000		$	96,000		$	—		$	224,000

During the three and six months ended July 31, 2008, the majority of the Company’s net revenues related to engineering, procurement and construction services provided by GPS to the power industry. Total net revenues from power industry services accounted for approximately 94% and 93% of consolidated net revenues for the periods, respectively. The Company’s most significant current year customer relationships included two power industry service customers which accounted for approximately 52% and 42%, respectively, of consolidated net revenues for the current quarter, and approximately 43% and 49%, respectively, of consolidated net revenues year to date. VLI, which provides nutritional and whole-food supplements as well as personal care products to customers in the global nutrition industry, accounted for approximately 3% and 4% of consolidated net revenues for the three and six months ended July 31, 2008. SMC, which provides infrastructure services to telecommunications and utility customers as well as to the federal government, accounted for approximately 3% of consolidated net revenues for both the three and six month periods ended July 31, 2008.

NOTE 17 - SUBSEQUENT EVENT

On September 4, 2008, one of the major subcontractors on the terminated construction contract discussed in Note 13 filed a third-party complaint against GPS in the United States District Court for the Eastern District of Virginia seeking payment of certain amounts for equipment plus interest. GPS believes that the condensed consolidated balance sheet at July 31, 2008 includes all amounts owed under the subcontractor agreement and intends to vigorously defend this lawsuit.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion summarizes the financial position of Argan, Inc. and its subsidiaries as of July 31, 2008, and the results of operations for the three and six months ended July 31, 2008 and 2007, and should be read in conjunction with (i) the unaudited condensed consolidated financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q and (ii) the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the fiscal year ended January 31, 2008 that was filed with the Securities and Exchange Commission on April 24, 2008 (the “2008 Annual Report”).

Cautionary Statement Regarding Forward Looking Statements 

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for certain forward-looking statements. We have made statements in this Item 2 and elsewhere in this Quarterly Report on Form 10-Q that may constitute “forward-looking statements”. The words “believe,” “expect,” “anticipate,” “plan,” “intend,” “foresee,” “should,” “would,” “could,” or other similar expressions are intended to identify forward-looking statements. These forward-looking statements are based on our current expectations and beliefs concerning future developments and their potential effects on us. There can be no assurance that future developments affecting us will be those that we anticipate. All comments concerning our expectations for future revenues and operating results are based on our forecasts for our existing operations and do not include the potential impact of any future acquisitions. These forward-looking statements involve significant risks and uncertainties (some of which are beyond our control) and assumptions. They are subject to change based upon various factors including, but not limited to, the risks and uncertainties described in Item 1A of our 2008 Annual Report and Item 1A in Part II of this Quarterly Report on Form 10-Q. Should one or more of these risks or uncertainties materialize, or should any of our assumptions prove incorrect, actual results may vary in material respects from those projected in the forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Introduction

Argan, Inc. (the “Company,” “we,” “us,” or “our”) conducts operations through our wholly-owned subsidiaries, Gemma Power Systems, LLC and affiliates (“GPS”) that we acquired in December 2006, Vitarich Laboratories, Inc. (“VLI”) that we acquired in August 2004, and Southern Maryland Cable, Inc. (“SMC”) that we acquired in July 2003. Through GPS, we provide a full range of development, consulting, engineering, procurement, construction, commissioning, operations and maintenance services to the power generation market for a wide range of customers including public utilities, independent power project owners, municipalities, public institutions and private industry. 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. Each of the wholly-owned subsidiaries represents a separate reportable segment - power industry services, nutritional products and telecommunications infrastructure services, respectively.

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make use of estimates and assumptions that affect the reported amount of assets and liabilities, net revenues, expenses, and certain financial statement disclosures. We believe that the estimates, judgments and assumptions upon which we rely are reasonable based upon information available to us at the time that these estimates, judgments and assumptions are made. Estimates are used for, but not limited to, the Company’s accounting for revenue recognition, allowance for doubtful accounts, inventory obsolescence, goodwill and other intangible assets with indefinite lives, long lived assets, contingent obligations, and deferred taxes. Actual results could differ from these estimates.

New Accounting Pronouncements

In May 2008, the Financial Accounting Standards Board (the “FASB”) issued Statement of Financial Accounting Standards No. 162, “The Hierarchy of Generally Accepted Accounting Principles.” This statement identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with U.S. GAAP (the “GAAP Hierarchy”) and mandates that the GAAP Hierarchy reside in the accounting literature as opposed to the audit literature. This pronouncement will become effective 60 days following approval by the SEC. We do not believe this pronouncement will impact our consolidated financial statements.

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In April 2008, the FASB issued FASB Staff Position (“FSP”) FAS 142-3, “Determination of the Useful Life of Intangible Assets.” This FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets.” (“SFAS No. 142”) and intends to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset under FASB Statement of Financial Accounting Standards No. 141R (see description below) and other U.S. generally accepted accounting principles. This FSP is effective for our interim and annual financial statements beginning in the fiscal year commencing February 1, 2009. We do not expect the adoption of this FSP to have a material impact on our consolidated financial statements.

In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, “Disclosures about Derivative Instruments and Hedging Activities - An Amendment of FASB Statement No. 133.” This new standard requires enhanced disclosures about an entity’s derivative and hedging activities with the intent of improving the transparency of financing reporting as the use and complexity of derivative instruments and hedging activities have increased significantly over the past several years. Currently, we use interest rate swap agreements to hedge the risks related to the variable interest paid on our term loans. The current effects of our hedging activities are not significant to our consolidated financial statements. However, the new standard will require us to provide an enhanced understanding of 1) how and why we use derivative instruments, 2) how we account for derivative instruments and the related hedged items, and 3) how derivatives and related hedged items affect our financial position, financial performance and cash flows. Adoption of this new accounting standard will first be required for our consolidated financial statements covering the quarter ending April 30, 2009.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141R, “Business Combinations” (“SFAS No. 141R”) which replaces SFAS No. 141 and provides greater consistency in the accounting and financial reporting of business combinations. SFAS No. 141R requires the acquiring entity in a business combination to recognize all assets acquired and liabilities assumed in the transaction, establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed, establishes principles and requirements for how an acquirer recognizes and measures any non-controlling interest in the acquiree and the goodwill acquired, and requires the acquirer to disclose the nature and financial effect of the business combination. Among other changes, this statement also requires that “negative goodwill” be recognized in earnings as a gain attributable to the acquisition, that acquisition-related costs are to be recognized separately from the acquisition and expensed as incurred and that any deferred tax benefits resulted in a business combination are recognized in income from continuing operations in the period of the combination. For us, SFAS No. 141R will be effective for business combinations occurring subsequent to January 31, 2009. The accounting for future acquisitions, if any, may be affected by certain new requirements of this pronouncement that will be evaluated at that time.

In December 2007, the FASB also issued Statement of Financial Accounting Standards No. 160, “Noncontrolling Interests in Consolidated Financial Statements,” that establishes accounting and reporting standards for minority interests in consolidated subsidiaries. This standard will be effective for us on February 1, 2009, and its adoption would not affect our current consolidated financial statements.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” This standard permits companies to measure many financial instruments and certain other items at fair value at specified election dates. The provisions of this new standard were effective for us beginning February 1, 2008 and did not have a significant impact on the consolidated financial statements.

In September 2006, the FASB issued Statement of Financial Accounting Standard No. 157, “Fair Value Measurements.” This standard defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. Certain provisions of this standard relating to financial assets and financial liabilities were also effective for us beginning February 1, 2008; they did not have a significant impact on the consolidated financial statements. Adoption of the other provisions of this new standard relating primarily to nonfinancial assets and nonfinancial liabilities will first be required for our consolidated financial statements covering the quarter ending April 30, 2009. The significant nonfinancial items included in our consolidated balance sheet include property and equipment, goodwill and other purchased intangible assets. Adoption of the new provisions is not expected to have a significant impact on our consolidated financial statements.

Recent Events

Construction Projects and Backlog. In May 2008, the Company announced that GPS signed an engineering, procurement and construction agreement with Pacific Gas & Electric Company (“PG&E”) in the amount of $336 million for the design and construction of a natural gas-fired power plant in Colusa, California. This energy plant will be a 640 megawatt combined cycle facility and construction is expected to be completed in the summer of 2010. GPS commenced activity on this project in the fourth quarter ended January 31, 2008 under an interim notice to proceed that it received from PG&E in December 2007.

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In July 2008, the Company announced that GPS signed an engineering, procurement and construction agreement and received a limited notice to proceed from Competitive Power Ventures Inc. (“CPV”) to design and build the Sentinel Power Project. This project, valued at $211 million, consists of eight simple cycle gas-fired peaking plants with a total power rating of 800 megawatts to be located in southern California. The first phase of the project, including the construction of five units, is expected to be completed in the summer of 2010. The second phase includes the construction of the remaining three units and is expected to be completed in the spring of 2011. CPV has a power supply agreement with Southern California Edison covering five of the units.

The addition of these contracts increased our energy-plant construction contract backlog to approximately $530 million at July 31, 2008. The construction contract backlog of GPS was $122 million at January 31, 2008.

Under the terms of an amended agreement with a customer covering the engineering, procurement and construction of an ethanol production facility (the “EPC Agreement”), March 19, 2008 was the deadline for the customer to obtain financing for the completion of the project. Financing was not obtained and the EPC Agreement was terminated. GPS continues to cooperate with the customer in its efforts to obtain financing. GPS is uncertain as to the ultimate resolution of this matter. As of July 31, 2008 and January 31, 2008, our condensed consolidated balance sheets included assets and liabilities related to the terminated construction contract. We have classified these assets and liabilities as current assets and current liabilities in the accompanying condensed consolidated balance sheets due to the expectation that the assets will be realized and the liabilities will be extinguished. Although cash may be required to make payment on accounts payable to project subcontractors that are included in the condensed consolidated balance sheet at July 31, 2008, GPS does not anticipate any losses to arise from the resolution of this EPC Agreement. No net revenues were recorded in the six months ended July 31, 2008 related to this project.

Investment in Unconsolidated Subsidiary. In June 2008, the Company announced that GPS had entered into a business partnership with Invenergy Wind Management LLC, for the design and construction of wind farms located in the United States and Canada. The business partners each own 50% of a new company, Gemma Renewable Power, LLC (“GRP”). The Company expects that GRP will provide engineering, procurement and construction services for new wind farms generating electrical power including the design and construction of roads, foundations, and electrical collection systems, as well as the erection of towers, turbines and blades. It is expected that GRP will also assist with some of the ongoing servicing of the wind farms. During the start-up phase of this new business and pursuant to the formation document, GPS has contributed $600,000 cash to GRP. In accordance with the equity method of accounting for unconsolidated subsidiaries, the condensed consolidated statements of operations for the three and six months ended July 31, 2008 include our share of the net loss incurred to date by GRP in the amount of approximately $165,000.

Performance of VLI. VLI continued to report operating results that were below expected results. The loss of major customers and the reduction in the amounts of orders received from currently major customers have caused net revenues to continue to decline and this business to operate at a loss. VLI is actively pursuing opportunities to expand the volume of business related to current customers and secure business from new customers. However, there is no assurance that business will improve. Accordingly, during the current quarter, we conducted analyses in order to determine whether additional impairment losses have occurred related to the goodwill and the long-lived assets of VLI. The assessment analyses indicated that the carrying value of the business exceeded its fair value, that the carrying values of VLI’s long-lived assets were not recoverable and that the carrying values of the long-lived assets exceeded their corresponding fair values. As a result, VLI recorded impairment losses related to goodwill, other purchased intangible assets, and fixed assets in the amounts of $921,000, $86,000 and $939,000, respectively, that were included in the condensed consolidated statements of operations for the three and six months ended July 31, 2008. These adjustments eliminated the remaining carrying value of VLI’s goodwill and reduced the carrying values of VLI’s other purchased intangible assets and fixed assets to approximately $8,000 and $135,000, respectively.

Legal Matters. As described in Item 1 of Part II of this Form 10-Q and in Note 14 to the condensed consolidated financial statements, Vitarich Farms, Inc. (“VFI”) filed a lawsuit against VLI and its current president in March 2008. VFI, which is owned by Kevin Thomas, the former owner of VLI, supplied VLI with certain organic raw materials used in the manufacture of VLI's products. VFI has asserted a breach of contract claim against VLI and alleges that VLI breached a supply agreement with VFI by acquiring the organic products from a different supplier. VFI also asserted a claim for defamation against VLI’s president alleging that he made false statements regarding VFI’s organic certification to one of VLI's customers. In March 2008, Mr. Thomas filed a lawsuit against VLI's president for defamation. The Company, VLI and VLI’s president deny all of the new allegations and intend to vigorously defend these lawsuits.

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As described in Item 1 of Part II of this Form 10-Q and in Note 14 to the condensed consolidated financial statements, in March 2007, the United States District Court for the Central District of California granted our motion for summary judgment, thereby dismissing the civil action brought by Western Filter Corporation (“WFC”) relating to WFC’s purchase of the capital stock of Puroflow Incorporated (“Puroflow”), formerly our wholly-owned subsidiary. WFC appealed the District Court’s decision. On August 25, 2008, the Ninth Circuit Court of Appeals reversed the summary judgment decision and remanded the case back to the District Court. We continue to believe that WFC’s claims are without merit and intend to continue to defend this litigation vigously. It is possible, however, that the ultimate resolution of the WFC litigation could result in a material adverse effect on the results of operations of the Company for a particular future reporting period. The Company’s condensed consolidated balance sheet at July 31, 2008 included an amount in accrued expenses reflecting the Company’s estimate of the amount of future legal fees that it expects to be billed in connection with the completion of this litigation.

Comparison of the Results of Operations for the Three Months Ended July 31, 2008 and 2007

The following schedule compares the results of our operations for the three months ended July 31, 2008 and 2007. Except where noted, the percentage amounts represent the percentage of net revenues for the corresponding period.

 

		Three Months Ended July 31,
		2008						2007
Net revenues
Power industry services		$	70,639,000			94.1	%	$	45,599,000			85.8	%
Nutritional products			2,226,000			2.9	%		5,036,000			9.5	%
Telecommunications infrastructure services			2,233,000			3.0	%		2,502,000			4.7	%
Net revenues			75,098,000			100.0	%		53,137,000			100.0	%
Cost of revenues **
Power industry services			63,108,000			89.3	%		40,590,000			89.0	%
Nutritional products			2,395,000			107.6	%		4,122,000			81.9	%
Telecommunications infrastructure services			1,875,000			84.0	%		1,858,000			74.3	%
Cost of revenues			67,378,000			89.7	%		46,570,000			87.6	%
Gross profit			7,720,000			10.3	%		6,567,000			12.4	%
Selling, general and administrative expenses			4,016,000			5.4	%		4,773,000			9.0	%
Impairment losses of VLI			1,946,000			2.6	%		—			—	%
Income from operations			1,758,000			2.3	%		1,794,000			3.4	%
Interest expense			(108,000	)		*			(185,000	)		*
Interest income			432,000			*			657,000			1.2	%
Equity in the net loss of unconsolidated subsidiary			(165,000	)		*			—			—	%
Income from operations before income taxes			1,917,000			2.6	%		2,266,000			4.3	%
Income tax expense			(1,111,000	)		(1.5	)%		(932,000	)		(1.8	)%
Net income		$	806,000			1.1	%	$	1,334,000			2.5	%

 

* Less than 1%.

 

** The percentage amounts for cost of revenues represent the percentage of net revenues of the applicable segment.

The following analysis provides information as to the results of our operations for the three month periods ended July 31, 2008 and 2007. As analyzed below, we reported net income of $806,000 for the three months ended July 31, 2008, or $0.07 per diluted share. For the three months ended July 31, 2007, we reported net income of $1.3 million, or $0.12 per diluted share.

Net Revenues. Net revenues increased by approximately 41.3% in the three months ended July 31, 2008 compared with the three months ended July 31, 2007 due to an increase in the net revenues of GPS, partially offset by a 55.8% reduction in the net revenues of VLI and 10.8% reduction in the net revenues of SMC.

The business of GPS represented 94.1% of consolidated net revenues for the quarter ended July 31, 2008. This business represented 85.8% of consolidated net revenues for the quarter ended July 31, 2007. The two significant customers of the power industry services business for the current quarter represented approximately 55.1% and 44.6% of the net revenues of this business segment for the current quarter, respectively, and represented approximately 51.8% and 42.1% of our consolidated net revenues for the current quarter, respectively. The net revenues were boosted in the current quarter by the effect of equipment purchases occurring during the early portion of the power plant project.

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The four significant customers of the power industry services business for the quarter ended July 31, 2007 represented approximately 91.7% of its net revenues for the quarter ended July 31, 2007. The net revenues for these four customers represented approximately 26.7%, 22.3%, 21.5% and 8.2% of the Company’s consolidated net revenues for the three months ended July 31, 2007, respectively.

The net revenues from the sale of nutritional products by VLI were $2.2 million for the three months ended July 31, 2008, and represented 2.9% of consolidated net revenues. The net revenues from the sale of nutritional products were $5.0 million for the three months ended July 31, 2007. This amount represented 9.5% of consolidated net revenues for the prior-year period. The decrease in the net revenues of nutritional products of $2.8 million, or 55.8%, primarily was due to the loss of several customers and declines in the sales of products to most of VLI’s largest current customers.