Argan, Inc. — Form 10-Q summary
Business context and reporting period. This unaudited filing covers the quarter and six months ended July 31, 2012, the second quarter of Argan’s fiscal 2013. Continuing operations comprise power industry services, principally Gemma Power Systems (GPS), and telecommunications infrastructure services through Southern Maryland Cable (SMC). Power services generated about 93% of six-month continuing revenue. The prior-year comparison reflects a transition between major power projects; substantial work on current projects began later.
Key financial metrics
| Metric | Three months ended July 31, 2012 | Six months ended July 31, 2012 |
|---|---|---|
| Revenue from continuing operations | $82.6 million, versus $26.3 million | $146.3 million, versus $42.3 million |
| Gross profit / margin | $12.9 million / 15.6%, versus $4.6 million / 17.6% | $23.0 million / 15.7%, versus $8.5 million / 20.2% |
| Operating income / margin | $9.6 million / 11.6%, versus $2.3 million / 8.6% | $16.7 million / 11.4%, versus $3.4 million / 8.1% |
| Income from continuing operations | $6.0 million, versus $1.5 million | $10.5 million, versus $2.3 million |
| Net income attributable to Argan shareholders | $6.2 million; diluted EPS $0.45, versus $2.1 million and $0.15 | $10.6 million; diluted EPS $0.76, versus $2.7 million and $0.20 |
| Operating cash flow | Not separately reported for the quarter | $33.5 million, versus $21.2 million |
Cash and cash equivalents were $186.8 million at July 31, up from $156.5 million at January 31. Working capital was $84.5 million. Six-month investing cash outflow was $3.8 million, primarily property and equipment purchases; financing cash inflow was $0.6 million. No bank borrowings were outstanding. The revolving facility provided up to $4.25 million through May 2013; the company was in compliance with its financial covenants. Total liabilities were $133.0 million, principally current operating and contract-billing liabilities, rather than funded debt.
Material changes and operating performance
- Revenue increased sharply year over year: about 214% for the quarter and 246% for the six-month period. Power revenue growth was driven principally by construction activity on the Sentinel gas-fired project; SMC revenue also increased, including work on Maryland’s broadband network.
- Margins were mixed. Operating margins improved as SG&A fell as a share of revenue, but gross margin declined versus prior-year periods. Management attributed the six-month comparison partly to prior-year final incentive fees on completed projects and the current-period $1.6 million Altra-related cost charge.
- Construction backlog declined from $415 million at January 31 to $286 million at July 31. More than 95% of current backlog related to Sentinel and a 49.9-megawatt Texas biomass project. Sentinel was 53% complete; management said it contributed over 59% of current-year power-segment revenue.
- Six-month operating cash flow benefited from working-capital movements, including increases in accounts payable and accrued expenses ($16.3 million) and billings in excess of costs and estimated earnings ($12.3 million). Receivables increased and used $6.0 million of cash. Customer retainages in receivables were about $19.0 million.
Outlook, risks and unusual items
- Management expected higher revenue and favorable profit results for fiscal 2013 than fiscal 2012, while describing forecasting visibility as unusually limited. It anticipated that weak power demand, financing constraints, regulatory uncertainty and intense, low-margin competition would limit new project opportunities. Management said it would prioritize completing current work, controlling costs and conserving cash.
- Argan consolidated two Moxie gas-plant development entities as variable interest entities. GPI had advanced about $3.1 million; the amended agreement contemplated loans up to $9 million, potentially $10 million with board approval. Repayment and possible EPC awards depend on project development, permits, financing and other milestones. Unsuccessful development could result in a significant loan write-off.
- The Altra matter resulted in a $1.6 million net charge to cost of revenues in the quarter. GPS paid DCR $1.875 million in August 2012, partly offset by a $275,000 payment from Delta-T’s parent. Related court hearings remained scheduled regarding a former counsel’s charging lien and a subcontractor’s motion concerning dismissals.
- A former subsidiary, VLI, faced TBN litigation alleging damages exceeding $42 million. In August 2012 the court ordered TBN to pay a $295,000 sanction; failure to pay by the stated deadline could lead to dismissal, but payment, bonding or appeal could allow the case to continue. Argan said the outcome and potential damages could not be estimated reliably and that an adverse resolution could materially affect future results.
- Revenue and earnings are concentrated in a small number of projects and customers. One customer accounted for about 62% of second-quarter continuing revenue. Fixed-price construction estimates, project execution, customer collections, litigation and VIE exposure are important sources of uncertainty.
- The filing reports effective disclosure controls and no material change in internal control over financial reporting during the quarter. Management stated that no material revisions had been made to the risk factors in its latest annual report.
Important facts for investors to verify
- Whether Sentinel and the Texas biomass project meet schedule, cost and completion expectations, and how much of backlog converts to revenue.
- Backlog replenishment and customer/project concentration, including the continuation and economics of Maryland broadband work.
- Cash conversion: the extent to which reported operating cash flow depends on customer billing milestones, payables and contract advances, and collection of retainages.
- Progress on Moxie permits, financing and project ownership; additional advances, potential EPC awards and recoverability of GPI’s loans.
- Resolution of the Altra-related hearings and TBN litigation, including any further costs, recoveries or changes in accrued legal expenses.