SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED APRIL 30, 2004 COMMISSION FILE NUMBER 001-31756
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ARGAN, INC.
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(Exact name of small business issuer as specified in its charter)
Formerly Puroflow Incorporated
DELAWARE 13-1947195
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(State or other jurisdiction of incorporation (IRS Employer identification No.)
or organization)
ONE CHURCH STREET, SUITE 302, ROCKVILLE MD 20850
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(Address of principal executive offices) (ZIP Code)
Issuer's telephone number, including area code: (301) 315-0027
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15 (d) of the Exchange Act during the past twelve months (or for such
shorter period that the Registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes |X| No [ ]
Securities registered pursuant to Section 12(b) of the Act:
Common Stock Shares outstanding
COMMON STOCK, $.15 PAR VALUE 1,803,000 AS OF JUNE 9, 2004
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Transitional Small Business Disclosure Format (Check One): Yes [ ] No |X|
ARGAN, INC.
INDEX
Page No.
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PART I. FINANCIAL INFORMATION................................................3
Item 1. Financial Statements.................................................3
Condensed Consolidated Balance Sheets - April 30, 2004 and January 31, 2004...3
Condensed Consolidated Statements of Operations for the Three Months
Ended April 30, 2004 and 2003.....................................4
Condensed Consolidated Statements of Cash Flows for the Three Months
Ended April 30, 2004 and 2003.....................................5
Notes to Condensed Consolidated Financial Statements..........................6
Item 2. Management's Discussion and Analysis or Plan of Operation...........10
Item 3. Controls and Procedures.............................................18
PART II. OTHER INFORMATION..................................................19
Item 1. Legal Proceedings...................................................19
Item 2. Changes in Securities, and Small Business Issuer Purchases of
Equity Securities...................................................19
Item 3. Defaults upon Senior Securities.....................................19
Item 4. Submission of matters to a vote of security holders.................19
Item 5. Other Information...................................................19
Item 6. Exhibits and Reports on Form 8-K....................................19
SIGNATURES...................................................................21
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2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ARGAN, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
April 30, January 31,
2004 2004
============ ============
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 2,173,000 $ 5,212,000
Investments 5,500,000 3,000,000
Accounts receivable 883,000 1,523,000
Escrowed cash 602,000 601,000
Estimated earnings in excess of billings 504,000 514,000
Prepaid expenses and other current assets 261,000 150,000
------------ ------------
TOTAL CURRENT ASSETS 9,923,000 11,000,000
------------ ------------
Property and equipment, net 1,838,000 1,913,000
Contractual customer relationships, net 1,419,000 1,476,000
Trade name 680,000 680,000
Goodwill 1,680,000 1,680,000
------------ ------------
TOTAL ASSETS $ 15,540,000 $ 16,749,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 502,000 $ 918,000
Billings in excess of estimated earnings 30,000 20,000
Accrued expenses 382,000 488,000
Deferred income tax liability, net 204,000 188,000
Current portion of long-term debt 990,000 1,092,000
------------ ------------
TOTAL CURRENT LIABILITIES 2,108,000 2,706,000
------------ ------------
Deferred income tax liability, net of current portion 826,000 1,064,000
Long-term debt 88,000 109,000
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 -1,806,046 shares
issued at April 30, 2004 and January 31, 2004 and
1,802,813 shares outstanding at April 30, 2004 and
January 31, 2004 270,000 270,000
Warrants outstanding 849,000 849,000
Additional paid-in capital 14,121,000 14,121,000
Accumulated deficit (2,689,000) (2,337,000)
Treasury stock at cost:
3,233 shares at April 30, 2004 and January 31, 2004 (33,000) (33,000)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 12,518,000 12,870,000
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 15,540,000 $ 16,749,000
============ ============
See accompanying notes.
3
ARGAN, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED APRIL 30,
2004 2003
=========== ===========
Net sales $ 1,807,000 $ --
Cost of goods sold 1,608,000 --
----------- -----------
Gross profit 199,000 --
Selling, general and administrative expenses 791,000 57,000
----------- -----------
Loss from operations (592,000) (57,000)
Interest expense 7,000 --
Other income (29,000) --
----------- -----------
Loss from continuing operations before income taxes (570,000) (57,000)
Income tax benefit (218,000) --
----------- -----------
Loss from continuing operations (352,000) (57,000)
----------- -----------
Income from discontinued operations, net of income tax
provision of $17,000 -- 83,000
----------- -----------
Net (loss) income $ (352,000) $ 26,000
=========== ===========
Basic and diluted (loss) income per share:
Continuing operations $ (0.20) $ (0.11)
=========== ===========
Discontinued operations -- $ 0.16
=========== ===========
Net (loss) income $ (0.20) $ 0.05
=========== ===========
Weighted average number of shares outstanding 1,803,000 524,000
=========== ===========
See accompanying notes.
4
ARGAN, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED
APRIL 30,
2004 2003
============ ============
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $ (352,000) $ 26,000
Adjustments to reconcile net (loss) income to net cash (used in)
provided by operating activities:
Depreciation and amortization 156,000 --
Deferred income taxes (222,000) --
Changes in operating assets and liabilities:
Accounts receivable 640,000 --
Estimated earnings in excess of billings 10,000 --
Prepaid expenses and other current assets (117,000) (6,000)
Accounts payable and accrued expenses (522,000) --
Billings in excess of estimated earnings 8,000 --
Non-cash charges and working capital changes of discontinued
Operations -- 102,000
------------ ------------
Net cash (used in) provided by operating activities (394,000) 122,000
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of investments (19,500,000) --
Redemptions of investments 17,000,000 --
Purchases of property and equipment (22,000) --
Investing activities of discontinued operations -- (53,000)
------------ ------------
Net cash used in investing activities (2,522,000) (53,000)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from private placement of common stock,
net of offering costs -- $ 10,059,000
Principal payments on credit lines (123,000) --
Financing activities of discontinued operations -- (69,000)
------------ ------------
Net cash used in financing activities (123,000) 9,990,000
------------ ------------
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 5,212,000 --
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (3,039,000) 10,059,000
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 2,173,000 $ 10,059,000
============ ============
See accompanying notes.
5
ARGAN, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION
NATURE OF OPERATIONS
Argan, Inc. (AI or the Company) conducts its operations through its wholly owned
subsidiary, Southern Maryland Cable, Inc. (SMC) which it acquired in July 2003.
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. On October 23, 2003, our
shareholders approved a plan providing for the internal restructuring of the
Company whereby AI became a holding company and its operating assets and
liabilities relating to its former Puroflow business were transferred to a
newly-formed, wholly owned subsidiary. The subsidiary then changed its name to
"Puroflow Incorporated" (PI) and AI changed its name from Puroflow Incorporated
to "Argan, Inc." At the time of the transfer, SMC was the other wholly owned
operating subsidiary.
On October 31, 2003, the Company completed the sale of PI to Western Filter
Corporation (WFC) for approximately $3.5 million in cash of which $300,000 is
being held in escrow for one year to indemnify WFC from any damages resulting
from the breach of representations and warranties under the Stock Purchase
Agreement.
After the disposition of PI, the Company operates in one reportable segment.
BASIS OF PRESENTATION
The condensed consolidated balance sheet as of April 30, 2004 and the condensed
consolidated statements of operations and cash flows for the three months ended
April 30, 2004 and 2003, 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, 2004 and the results of its
operations and its cash flows for the periods presented. The Company prepares
its interim financial information using the same accounting principles as it
does for its annual financial statements.
These financial statements do not include all disclosures associated with annual
financial statements and, accordingly, should be read in conjunction with the
footnotes contained in the Company's consolidated financial statements for the
year ended January 31, 2004, together with the auditors' 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.
In accordance with Statement of Financial Accounting Standards ("SFAS") No. 144
"Accounting for Impairment or Disposal of Long-Lived Assets," the Company
classified the operating results of PI as discontinued operations in the
accompanying financial statements.
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES
Income Per Share - (Loss) income per share is computed by dividing (loss) income
from continuing operations, income from discontinued operations and net (loss)
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income by the weighted average number of common shares outstanding for the
period. Outstanding stock options and warrants were anti-dilutive during the
three months ended April 30, 2004 and 2003 due to the Company's loss from
continuing operations.
Seasonality - The Company's telecom infrastructure services operations are
expected to have seasonally weaker results in the first and fourth quarters of
the year, and may produce stronger results in the second and third quarters.
This seasonality is primarily due to the effect of winter weather on outside
plant activities as well as reduced daylight hours and customer budgetary
constraints. Certain customers tend to complete budgeted capital expenditures
before the end of the year, and postpone additional expenditures until the
subsequent fiscal period.
Stock Issued to Employees -The Company follows Accounting Principles Board
Opinion 25, Accounting for Stock Issued to Employees, to account for stock
option plans, which generally does not require income statement recognition of
options granted at the market price on the date of issuance.
The Pro Forma disclosures required by Statement of Financial Accounting
Standards No. 148 "Accounting for Stock Based Compensation" are reflected below:
PRO FORMA DISCLOSURES
FOR THE THREE MONTHS APRIL 30,
2004
---------
Net loss, as reported $(352,000)
Add: Stock based compensation recorded in the financial statements --
Deduct: Total stock-based employee compensation expense
determined under fair value based methods (18,000)
---------
Pro forma net loss $(370,000)
=========
Basic and diluted per share:
Basic and diluted - as reported $ (0.20)
=========
Basic and diluted - pro forma $ (0.21)
=========
During the three months ended April 30, 2003, stock options issued did not have
a material effect.
NOTE 3- ACQUISITION OF SOUTHERN MARYLAND CABLE, INC.
On July 17, 2003, the Company acquired all of the common stock of SMC, a
provider of telecommunications and other infrastructure services including
project management, construction and maintenance to the Federal Government,
telecommunications and broadband service providers, as well as electric
utilities. The Company's purchase of SMC was focused on acquiring SMC's
long-standing customer relationships and its well established reputation in a
strategic geographic area, which supported the premium paid over the fair value
of the tangible assets.
The results of operations of the acquired company are included in the
consolidated results of the Company from July 17, 2003, the date of the
acquisition. The estimated purchase price was approximately $3.8 million in
cash, plus the assumption of approximately $971,000 in debt. The Company also
leases the SMC headquarters at an annual rent of $75,000 from the former owners
of SMC. The lease term is through January, 2006.
The Company acquired SMC as part of its acquisition strategy. SMC was viewed as
an attractive business because of its highly trained workforce, strong
reputation and long standing customer relationships. In addition, SMC presented
7
a strategic value because of its recent growth in the area of inside plant
premise wiring. The Company also identified several areas where significant cost
savings could be realized. The aforementioned strategic strengths of SMC
supported the premium paid over fair value of tangible assets.
The Company accounted for the acquisition of SMC using the purchase method of
accounting whereby the excess of cost over the net amounts assigned to assets
acquired and liabilities assumed is allocated to goodwill and intangible assets
based on their estimated fair values. Such intangible assets included $1,600,000
and $680,000 allocated to Contractual Customer Relationships ("CCR") and Trade
Name, respectively, and $1,680,000 to Goodwill. The Company is amortizing the
CCR over a weighted average life of seven years. Amortization expense has been
recorded since July 17, 2003 (the date of acquisition). As of April 30, 2004,
accumulated amortization was $181,000. The Trade Name was determined to have an
indefinite useful life and is not being amortized.
The following unaudited pro forma statement of operation of SMC and continuing
operations of AI does not purport to be indicative of the results that would
have actually been obtained if the aforementioned acquisition had occurred on
February 1, 2003, or that may be obtained in the future. The pro forma
presentation also excludes the discontinued operations of PI. SMC previously
reported its results of operations using a calendar year-end. No material events
occurred subsequent to this reporting period that would require adjustment to
our unaudited pro forma statement of operations. The number of shares
outstanding used in calculating pro forma earnings per share assume that the
private offering discussed in Note 6 was consummated at February 1, 2003.
Three Months Ended
April 30, 2003
------------------
Pro Forma Statement of Operation
Net sales $ 2,458,000
Cost of goods sold 1,842,000
-----------
Gross profit 616,000
Selling, general and
administrative expenses 435,000
-----------
Income from operations 181,000
Other expense (9,000)
-----------
Income from continuing operations
before income taxes 172,000
Income tax provision 69,000
-----------
Income from continuing operations $ 103,000
-----------
Income per share
- basic $ 0.06
- diluted $ 0.06
Weighted average shares
outstanding
- basic 1,798,000
- diluted 1,800,000
8
NOTE 4- DISCONTINUED OPERATIONS
On October 31, 2003, AI, as part of its plan to reallocate its capital to its
acquisition program, sold PI to WFC. The sales price of approximately $3,500,000
was satisfied in cash of which $300,000 is being held in escrow for one year to
indemnify WFC from any damages resulting from a breach of representations and
warranties under the Stock Purchase Agreement. AI recognized a gain on sale of
approximately $167,000, net of income taxes of $506,000. The Company utilized
net operating losses to offset the gain on sale and thus, has no current tax
liability. The $506,000 is the amount of the deferred tax assets related to the
PI which has been sold. In accordance with SFAS No. 144 "Accounting for the
Impairment or Disposal of Long-Lived Assets", the Company classified the
operating results of PI as discontinued operations in the accompanying
statements of operations.
The results of the discontinued operations are as follows for the three months
ended April 30, 2003.
------------------------------------------------------------------------
Net sales $ 1,690,000
Cost of goods sold 1,132,000
-----------
Gross profit 558,000
Selling, general and administrative expenses 451,000
-----------
Operating income from discontinued
operations 107,000
Other expense (7,000)
-----------
Income from discontinued operations before
income taxes 100,000
Income tax expense 17,000
-----------
Income from discontinued operations $ 83,000
===========
The Company has restated its previously issued financial statements to reflect,
as discontinued operations, the operations of its wholly owned subsidiary, PI.
Because of the reclassification of PI as discontinued operations, the Company
was required to retroactively restate its financial statements for the three
months ended April 30, 2003 according to Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets."
NOTE 5 - DEBT
In August, 2003, the Company entered into a financing arrangement with Bank of
America (" Bank") aggregating $2,950,000 in available financing in two tranches
- a revolving line of credit with $1,750,000 in availability, expiring July 31,
2004 and bearing interest at LIBOR plus 2.75%, and a three year term note with
an original outstanding balance of $1,200,000, expiring July 31, 2006 and
bearing interest at LIBOR plus 2.95%. The proceeds from the term note were used
to payoff the SMC lines of credit and for working capital. As of April 30, 2004
the Company had $900,000 outstanding under the term note. AI has not drawn on
the revolving line of credit.
9
The financing arrangement contains financial as well as nonfinancial covenants
including the ratios of debt to pro forma earnings before interest, taxes,
depreciation and amortization ("EBITDA") of 2.5 to 1, liabilities to tangible
net worth of 1.5 to 1, fixed charge coverage ratio of 1.25 to 1, as well as
requirements for bank consent for acquisitions and divestitures. The Company
pledged the majority of the Company's assets to secure the financing
arrangement. At April 30, 2004, the Company was not in compliance with the ratio
of debt to EBITDA and the fixed charge coverage ratio. The Company received a
waiver from the Bank with respect to the breach of the covenants through October
31, 2004. The Company agreed to additional covenants whereby it would maintain
at least $2 million in liquidity, increase the interest rate by 50 basis points
to LIBOR plus 3.45% and maintain positive net income during the second and third
quarters. The Company reached an agreement with the Bank to extend the financing
agreement beyond its current expiration to December 31, 2004. The Company has
classified the entire note as current. Subsequent to the sale of PI, the Company
deposited $300,000 as additional collateral in a restricted cash account with
the Bank.
NOTE 6 - PRIVATE OFFERING OF COMMON STOCK
On April 29, 2003, the Company completed a private offering of approximately
1,304,000 shares of common stock at a price of $7.75 per share. The proceeds of
the private offering were approximately $10,107,000 prior to giving effect to
offering costs of $472,000 and the proceeds which may be derived from 230,000
warrants, issued in connection with the private placement. A portion of the net
proceeds of the private placement was used in the acquisition of SMC and in
final payment of the Company's credit facility with U.S. Bancorp. The remaining
net proceeds are expected to be used for acquisitions in growth-oriented
industries and for working capital. The private offering was approved by
shareholder vote on April 15, 2003.
NOTE 7 - SUBSEQUENT EVENTS
Subsequent to April 30, 2004, the Company entered into a letter of intent with
OTC Packaging, Inc. and ProActive Labs, Inc. ("OTC") to acquire all of the
common stock of OTC. The consummation of the transaction is contingent upon the
completion of the Company's due diligence, the signing of a definitive purchase
and sale agreement, approval of both companies' board of directors and other
conditions.
Subsequent to April 30, 2004, the Company entered into a letter of intent with
Vitarich Laboratories, Inc. (VLI) to acquire all of the common stock of VLI. The
consummation of the transaction is contingent upon the completion of the
Company's due diligence, the signing of a definitive purchase and the sale
agreement, approval of both companies' board of directors and other conditions.
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
10
investments; competitive factors; business and economic conditions generally;
changes in government regulations and policies, our dependence upon third-party
suppliers; continued acceptance of our products in the marketplace;
technological changes; and other risks and uncertainties that could cause actual
events or results to differ materially from any forward-looking statement.
GENERAL
We conduct our operations through our wholly owned subsidiary, Southern Maryland
Cable, Inc. (SMC) that we acquired in July 2003. Through SMC, we provide
telecommunications infrastructure services including project management,
construction and maintenance to the Federal Government, telecommunications and
broadband service providers as well as electric utilities.
We were organized as a Delaware corporation in May 1961. On October 23, 2003,
our shareholders approved a plan providing for the internal restructuring of the
Company whereby we became a holding company, and our operating assets and
liabilities relating to our Puroflow business were transferred to a
newly-formed, wholly owned subsidiary. The subsidiary then changed its name to
"Puroflow Incorporated" and we changed our name from Puroflow Incorporated to
"Argan, Inc." At the time of the transfer, we also held another wholly owned
operating subsidiary (SMC) which we acquired in July, 2003.
On October 31, 2003, we completed the sale of Puroflow Incorporated (our new
wholly-owned subsidiary) to Western Filter Corporation (WFC) for approximately
$3.5 million in cash, of which $300,000 is being held in escrow for one year to
indemnify WFC from losses resulting from a breach of the representations and
warranties made by us in connection with that sale.
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 investment in SMC. At
April 30, 2004, there were no restrictions with respect to dividends or other
payments from SMC to Argan.
TELECOM INFRASTRUCTURE SERVICES
We currently provide inside plant, premise wiring services to the Federal
Government and have plans to expand that work to commercial customers who
regularly need upgrades in their premise wiring systems to accommodate
improvements in security, telecommunications and network capabilities.
We continue to participate in the expansion of the telecommunications industry
by working with various telecommunications providers. We provide maintenance and
upgrade services for their outside plant systems that increase the capacity of
existing infrastructure. We also provide outside plant services to the power
industry by providing maintenance and upgrade services to utilities.
11
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. We further intend to seek acquisitions to evolve into a
geographically diverse telecom and utility infrastructure services entity with a
reputation for high quality and on-time performance.
CRITICAL ACCOUNTING POLICIES
Management is required to make judgments, assumptions and estimates that affect
the amounts reported when we prepare financial statements and related
disclosures in conformity with generally accepted accounting principles. Note 1
contained in the Company's consolidated financial statements for the year ended
January 31, 2004 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,
long-lived assets and deferred income taxes. Actual results could differ from
these estimates. The following critical accounting policies are impacted
significantly by judgments, assumptions and estimates used in the preparation of
our consolidated financial statements.
REVENUE RECOGNITION
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, is recognized as services are provided,
based on costs incurred and estimated total contract costs in accordance with
Statement of Position 81-1, Accounting for Performance of Construction Type and
Certain Production-Type Contracts, 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 $504,000
and $30,000, respectively, at April 30, 2004.
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.
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets, consisting primarily of property and equipment are reviewed
for impairment whenever events or changes in circumstances indicate that the
carrying amount should be assessed pursuant to SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." We determine impairment by
comparing the carrying value of these long-lived assets to the undiscounted
future cash flows expected to result from the use of these assets. In the event
we determine that an impairment exists, a loss would be recognized based on the
12
amount by which the carrying value exceeds the fair value of the assets, which
is generally determined by using quoted market prices or valuation techniques
such as the discounted present value of expected future cash flows, appraisals,
or other pricing models as appropriate.
IMPAIRMENT OF GOODWILL
We periodically evaluate the net realizable value of intangible assets relying
on a number of factors including operating results, economic projections, and
anticipated cash flows. In connection with our acquisition of SMC, the excess of
cost over the net amounts assigned to tangible assets acquired and liabilities
assumed was allocated to goodwill and intangible assets recognized separately
such as Trade Name and Contractual Customer Relationships.
In accordance with SFAS No. 142, we will conduct annually during our fiscal
fourth quarter, a review of our goodwill and intangible assets with an
indefinite useful life to determine whether their carrying value exceeds their
fair market value. Should this be the case, a detailed analysis will be
performed to determine if the goodwill and other intangible assets are impaired.
We will review the finite intangible assets when events or changes in
circumstances indicate that the carrying amount may not be recovered.
We will test for impairment of Goodwill and indefinite lived intangible assets
more frequently if events or changes in circumstances indicate that the asset
might be impaired.
CONTRACTUAL CUSTOMER RELATIONSHIPS ("CCR's")
The fair value of the Contractual Customer Relationships (CCR's) was determined
at the time of the acquisition of SMC by discounting the cash flows expected
from SMC's continued relationships with three customers - General Dynamics,
Verizon Communications and Southern Maryland Electric Cooperative. Expected cash
flows were based on historical levels, current and anticipated projects and
general economic conditions. In some cases, the estimates of future cash flows
reflect periods beyond those of the current contracts in place. The expected
cash flows were discounted based on a rate that reflects the perceived risk of
the CCR, the estimated weighted average cost of capital and SMC's asset mix. We
are amortizing the CCR's over a seven year weighted average life given the long
standing relationships SMC has with Verizon and SMECO.
TRADE NAME
The fair value of the SMC Trade Name was estimated using a relief-from-royalty
methodology. We determined that the useful life of the Trade Name was indefinite
since it is expected to contribute directly to future cash flows in perpetuity.
The Company has also considered the effects of demand and competition including
its customer base. While SMC is not a nationally recognized Trade Name, it is a
regionally recognized name in Maryland and the mid-Atlantic region.
Using the relief-from-royalty method described above, we test the Trade Name for
impairment annually in our fiscal fourth quarter and on an interim basis if
events or changes in circumstances between annual tests indicate the Trade Name
might be impaired. Based on the annual impairment test, no impairment was
recorded.
13
DEFERRED TAX ASSETS AND LIABILITIES
We account for income taxes under the asset and liability method. The approach
requires the recognition of deferred tax assets and liabilities for the expected
future tax consequences of temporary differences between the carrying amounts
and the tax basis of assets and liabilities. Developing our provision for income
taxes requires significant judgment and expertise in Federal and state income
tax laws, regulations and strategies, including the determination of deferred
tax assets and liabilities and, if necessary, any valuation allowances that may
be required for deferred tax assets.
At April 30, 2004, we have cumulatively recorded a net operating loss carry
forward aggregating $1,044,000 which expires in 2024 and 2025.
SALE OF MANUFACTURING OPERATIONS
On October 31, 2003, as part of our plan to reallocate our capital to our
acquisition program, we sold PI to WFC. The sales price of approximately
$3,500,000 was satisfied in cash of which $300,000 is being held in escrow for
one year to indemnify WFC from any damages resulting from a breach of
representations and warranties under the Stock Purchase Agreement. We recognized
a gain on sale of approximately $167,000, net of income taxes of $506,000. We
utilized net operating losses to offset the gain on sale and thus, have no
current tax liability in connection with the sale. The $506,000 is the amount of
the deferred tax assets at the date of sale related to Puroflow (which has been
sold). In accordance with SFAS No. 144 "Accounting for the Impairment or
Disposal of Long-Lived Assets," we classified the operating results of PI as
discontinued operations in the accompanying statements of operations.
The results of the discontinued operations are as follows for the three months
ended April 30, 2003.
--------------------------------------------------------------------------
Net sales $ 1,690,000
Cost of goods sold 1,132,000
-----------
Gross profit 558,000
Selling, general and administrative expenses 451,000
-----------
Operating income from discontinued
operations 107,000
Other expense (7,000)
-----------
Income from discontinued operations
before income taxes 100,000
Income tax expense 17,000
-----------
Income from discontinued operations $ 83,000
===========
ACQUISITION OF SOUTHERN MARYLAND CABLE, INC.
We are actively pursuing acquisitions in the telecom infrastructure services
industry. On July 17, 2003, we acquired all of the common stock of SMC, a
provider of telecommunications and other infrastructure services including
14
project management, construction and maintenance to the Federal Government,
telecommunications and broadband service providers, as well as electric
utilities. Our purchase of SMC was focused on acquiring SMC's long-standing
customer relationships and its well established reputation in a strategic
geographic area, which supported the premium paid over the fair value of the
tangible assets.
The results of operations of SMC are included in the consolidated results of the
Company from July 17, 2003, the date of the acquisition. The estimated purchase
price was approximately $3.8 million in cash, plus the assumption of
approximately $971,000 in debt.
We accounted for the acquisition of SMC using the purchase method of accounting
whereby the excess of cost over the net amounts assigned to assets acquired and
liabilities assumed is allocated to goodwill and intangible assets based on
their estimated fair values. Such intangible assets include $1,600,000 and
$680,000 allocated to Contractual Customer Relationships ("CCR") and Trade Name,
respectively, and $1,680,000 to Goodwill. We are amortizing the CCR over a
weighted average life of seven years. The Trade Name was determined to have an
indefinite useful life and is not being amortized.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED APRIL 30, 2004 COMPARED TO THE
THREE MONTHS (PRO FORMA) ENDED APRIL 30, 2003
The following summarizes the actual results of our operations for the three
months ended April 30, 2004 compared to the pro forma results for the three
months ended April 30, 2003, as if the acquisition of SMC was completed on
February 1, 2003. The unaudited pro forma statements of operations do not
include the operating results of PI which have been reclassified as discontinued
operations in the condensed consolidated statements of operations (See Note 4).
The unaudited statements of operations do not purport to be indicative of the
results that would have actually been obtained if the aforementioned acquisition
and disposition had occurred on February 1, 2003, or that may be obtained in the
future. SMC previously reported its results of operations using a calendar
year-end. No material events occurred subsequent to these reporting periods that
would require adjustment to our unaudited pro forma results in the pro forma
statement of operations.
THREE MONTHS ENDED
APRIL 30,
Statements of Operations 2004 2003
----------- -----------
(Pro forma)
Net sales $ 1,807,000 $ 2,458,000
Cost of goods sold 1,608,000 1,842,000
----------- -----------
Gross profit 199,000 616,000
Selling general and
administrative expenses 791,000 435,000
----------- -----------
(Loss) income from operations (592,000) 181,000
Other income (expense) 22,000 (9,000)
----------- -----------
(Loss) income from continuing
operations before income taxes (570,000) 172,000
Provision for income tax (benefit) provision (218,000) 69,000
----------- -----------
Net (loss) income from continuing operations $ (352,000) $ 103,000
=========== ===========
Net (loss) income per share $ (0.20) $ .06
Weighted average shares
outstanding 1,803,000 1,798,000
15
We have restated our previously issued financial statements to reflect, as
discontinued operations, the disposition of our wholly owned subsidiary, PI.
Because of the reclassification of PI as a discontinued operation, we are
required to retroactively restate our financial statements for the three months
ended April 30, 2003.
As disclosed above, we acquired SMC on July 17, 2003. Because of the sale of PI,
substantially all of the Company's historical business has been reclassified as
discontinued operations. As a consequence, the Company has compared the actual
results of operations of AI for the three months ended April 30, 2004 to AI's
pro forma statement of operations for the three months ended April 30, 2003 as
presented above.
NET SALES
AI, through its wholly owned subsidiary, SMC, had net sales of $1,807,000 for
the three months ended April 30, 2004 compared to pro forma net sales of
$2,458,000 for the three months ended April 30, 2003. The decrease of $651,000
or 27% is due primarily to the decrease in volume of infrastructure services
provided to SMC's customers under fixed-priced contracts. AI expects that the
level of activity will increase under such contracts during the three months
ended July 31, 2004.
COST OF GOODS SOLD
For the three months ended April 30, 2004, cost of goods sold was $1,608,000 or
89% of net sales compared to $1,842,000 or 75% of pro forma net sales for the
three months ended April 30, 2003. Increased costs as a percent of net sales is
due to inefficiencies experienced as the Company's volume and number of
fixed-priced contracts decreased during the three months ended April 30, 2004.
AI retained its core group of technicians in anticipation of a rebound in the
level of activity under fixed-price contracts which it expects will begin in the
three months ended July 31, 2004.
SELLING GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses were $791,000 or 44% of net sales
for the three months ended April 30, 2004 compared to $435,000 or 18% of pro
forma net sales for the three months ended April 30, 2003 an increase of
$356,000. General and administrative expenses incurred for general corporate
expenses and for the new corporate management team whose efforts are focused on
expansion into infrastructure services and other industries aggregated $362,000
for the three months ended April 30, 2004 compared to $57,000 in corporate costs
from continuing operations for the three months ended April 30, 2003.
OTHER EXPENSE, NET
We had other income, net of $22,000 for the three months ended April 30, 2004
compared to pro forma other expense of $9,000 for the three months ended April
30, 2003. Other income arises from the excess of interest income on AI's cash
equivalents and short-term investments over interest expense on AI's Bank debt.
LIQUIDITY AND CAPITAL RESOURCES
At April 30, 2004 and January 31, 2004, the Company had $7,673,000 and
$8,212,000 respectively available in cash, cash equivalents and short-term
investments. On April 29, 2003, the Company completed a private offering of
16
approximately 1,304,000 shares of common stock at a price of $7.75 per share.
The net proceeds from the private placement aggregated approximately $9,634,000.
A portion of the proceeds were used in the acquisition of SMC. The Company plans
to use the remaining proceeds for acquisitions in growth-oriented industries and
for working capital.
On October 31, 2003, AI sold its subsidiary, PI, to Western Filter Corporation
(WFC). The sale price of approximately $3,500,000 was satisfied in cash of which
$300,000 is being held in escrow for one year.
Net cash used in operations for the three months ended April 30, 2004 was
$394,000 compared with $122,000 cash provided by operations for the three months
ended April 30, 2003. The decrease in cash provided by operations is primarily
due to the reduced performance of SMC's revenue with the related loss from
continuing operations.
Cash used for investing activities was $2,522,000 for the three months ended
April 30, 2004 compared to investing activities of $53,000 from the discontinued
operations for the three months ended April 30, 2003 due to net purchases of
short-term investments.
Net cash used in financing activities was $123,000 for the three months ended
April 30, 2004 compared to net cash provided by financing activities of
$9,990,000 for the same period one year ago. The aforementioned private
placement accounted for $10,059,000 of the cash provided during the three months
ended April 30, 2003.
In August, 2003, the Company entered into a financing arrangement with Bank of
America ("Bank") aggregating $2,950,000 in available financing in two tranches -
a revolving line of credit with $1,750,000 in availability, expiring July 31,
2004 and bearing interest at LIBOR plus 2.75% and a three year term note with an
original outstanding balance of $1,200,000, expiring July 31, 2006 and bearing
interest at LIBOR plus 2.95%. The proceeds from the term note were used to
payoff the SMC lines of credit and for working capital. As of April 30, 2004 the
Company had $900,000 outstanding under the term note. AI has not drawn on the
revolving line of credit.
The financing arrangement contains financial as well as nonfinancial covenants
including the ratios of debt to pro forma earnings before interest, taxes,
depreciation and amortization ("EBIDTA") of 2.5 to 1, liabilities to tangible
net worth of 1.5 to 1, fixed charge coverage ratio of 1.25 to 1 as well as
requirements for bank consent for acquisitions and divestitures. The Company
pledged the majority of the Company's assets to secure the financing
arrangement. At April 30, 2004, the Company was not in compliance with the ratio
of debt to EBITDA and the fixed charge coverage ratio financial covenants. The
Company received a waiver from the Bank with respect to the breach of these
covenants through October 31, 2004. The Company agreed to additional covenants
whereby it would maintain at least $2 million in liquidity, increase the
interest rate by 50 basis points to LIBOR plus 3.45% and maintain positive net
income during the second and third quarters. The Company reached an agreement
with the Bank to extend the financing agreement beyond its current expiration to
December 31, 2004. The Company has classified the entire note as current.
Subsequent to the sale of PI, because of the disposition of PI, the Company
deposited $300,000 as additional collateral in a restricted cash account with
the Bank.
With its present capital resources and cash flow from operations, the Company
believes it should have sufficient resources to meet its operating needs for the
next twelve months and to provide for debt maturities and capital expenditures.
17
CUSTOMERS
During the three months ended April 30, 2004, we provided services to
telecommunications and utilities customers as well as to the Federal Government,
through a contract with General Dynamics Corp. ("General Dynamics"). Certain of
our more significant customer relationships were with General Dynamics, Southern
Maryland Electrical Cooperative (SMECO) and Verizon Communications, Inc. General
Dynamics accounted for approximately 25% of consolidated net sales during the
three months ended April 30, 2004. The Federal Government, through our contract
with General Dynamics, has been a major customer for two years. SMECO accounted
for approximately 55% of consolidated net sales during the three months ended
April 30, 2004. SMECO has been a major customer for several years. Verizon
accounted for approximately 11% of consolidated net sales during the three
months ended April 30, 2004. Verizon has been a major customer for many years,
but has indicated its intention to decrease its volume of business with us. An
increase in SMECO's level of business for the twelve months ended January 31,
2005 is expected to substantially offset the Verizon decrease. Combined General
Dynamics, SMECO and Verizon accounted for approximately 91% of consolidated net
sales during the three months ended April 30, 2004.
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.
SUBSEQUENT EVENTS
Subsequent to April 30, 2004, the Company entered into a letter of intent with
OTC Packaging, Inc. and ProActive Labs, Inc. ("OTC") to acquire all of the
common stock of OTC. The consummation of the transaction is contingent upon the
completion of the Company's due diligence, the signing of a definitive purchase
and sale agreement, approval of both companies' board of directors and other
conditions.
Subsequent to April 30, 2004, the Company entered into a letter of intent with
Vitarich Laboratories, Inc. (VLI) to acquire all of the common stock of VLI. The
consummation of the transaction is contingent upon the completion of the
Company's due diligence, the signing of a definitive purchase and the sale
agreement, approval of both companies' board of directors and other conditions.
ITEM 3. CONTROLS AND PROCEDURES
The Company carried out an evaluation, under the supervision and with the
participation of the Company's Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of the Company's
disclosure controls and procedures, as of the end of the period covered by this
report. Based upon this evaluation, the Company's Chief Executive Officer and
Chief Financial Officer concluded that the Company's disclosure controls and
procedures were effective in timely alerting them to material information
required to be included in the Company's periodic SEC reports. There have been
no changes in the Company's internal control over financial reporting that
occurred during the Company's most recent fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
18
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY
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 AND REPORTS ON FORM 8-K
a) Exhibits:
EXHIBIT NO. TITLE
----------- -----
Exhibit: 31.1 Certification of Chief Executive Officer,
pursuant to Rule 13a-14(c) under the
Securities Exchange Act of 1934
Exhibit: 31.2 Certification of Chief Financial Officer,
pursuant to Rule 13a-14(c) under the
Securities Exchange Act of 1934
Exhibit: 32.1 Certification of Chief Executive Officer,
pursuant to 18 U.S.C. Section 1350
Exhibit: 32.2 Certification of Chief Financial Officer,
pursuant to 18 U.S.C. Section 1350
a) Reports on Form 8-K:
In a report on Form 8-K/A dated March 15, 2004, the Company
amended its Form 8-K dated October 23, 2003 that was filed on
November 14, 2003 reported under Item 7. "Financial Statements,
Pro Forma Financial Information and Exhibits" the correction of an
error in the calculation and classification of the deferred tax
liability associated with the intangible assets recorded in the
purchase accounting of its acquisition of Southern Maryland Cable,
Inc.
19
In a report on Form 8-K/A dated March 15, 2004, the Company
amended its Form 8-K dated July 17, 2003, that was filed on July
29, 2003, was amended by a Current Report on Form 8K/A on
September 24, 2003 and was further amended by a Current Report on
Form 8-K/A on January 27, 2004. The purpose of the amendment was
to report under Item 7. "Financial Statements, Pro Forma Financial
information and Exhibits" the correction of an error in the
calculation and classification of the deferred tax liability
associated with the intangible assets recorded in the purchase
accounting of its acquisition of Southern Maryland Cable, Inc.
20
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 9, 2004 By: /s/ Rainer Bosselmann
---------------------------------
Rainer Bosselmann
Chairman of the Board and Chief
Executive Officer
June 9, 2004 By: /s/ Arthur F. Trudel
---------------------------------
Arthur F. Trudel
Chief Financial Officer
21