ARGAN, INC. The following discussion summarizes the financial position of
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. Our forward-looking statements, including those relating to the potential effects of the COVID-19 pandemic on our business, financial position and results of operations, 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 existing operations and do not include the potential impact of any future acquisitions. Our forward-looking statements, by their nature, 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 this Quarterly Report on Form 10-Q and our Annual Report. Should one or more of these risks or uncertainties materialize, or should any of our assumptions prove to be 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.
Business Description
Argan is a holding company that conducts operations through its wholly-owned
subsidiaries, GPS, APC, SMC and TRC. Through GPS and APC, we provide a full
range of engineering, procurement, construction, commissioning, operations
management, maintenance, development, technical and consulting services to the
power generation markets, including the renewable energy sector, for a wide
range of customers, including independent power project owners, public
utilities, equipment suppliers and global energy plant construction firms. GPS
and APC represent our power industry services reportable segment. Through TRC,
the industrial fabrication and field services reportable segment provides
on-site services that support maintenance turnarounds, shutdowns and emergency
mobilizations for industrial plants primarily located in the southeast region of
the US and that are based on its expertise in producing, delivering and
installing fabricated steel components such as piping systems and pressure
vessels. Through SMC Infrastructure Solutions, the telecommunications
infrastructure services segment provides project management, construction,
installation and maintenance services to commercial, local government and
federal government customers primarily in the mid-
We may make additional acquisitions of and/or investments in companies with potential for profitable growth that reflect more than one industrial focus. We expect that they will be held in separate subsidiaries that will be operated in a manner that best provides value for our stockholders.
Overview
We have disclosed in prior filings that APC has encountered significant
operational and contractual challenges in completing the TeesREP construction
project, which is a biomass-fired power plant under construction in Teesside,
By
- 19 -
Based on analyses that have been continually updated over the last twelve
months, management currently expects that the forecasted costs for the TeesREP
project at completion will exceed projected revenues by approximately
During the fourth quarter of Fiscal 2020, APC and its customer, the engineering, procurement and construction services contractor on the TeesREP project, agreed to operational and commercial terms for the completion of the project. At the time, this framework addressed the project schedule, payment terms, the scope of the remaining effort, performance guarantees and other terms and conditions for APC to reach substantial completion of its portion of the total project. Although this negotiation returned a meaningful amount of stability to the continuation of the project efforts, the framework did not resolve significant past commercial differences which may have to be addressed through applicable dispute resolution mechanisms. Currently, it is not possible to predict precisely how, when and on what terms (if any) the past commercial differences will be resolved.
Construction on the TeesREP project was suspended on
The future identification of additional adverse impacts on APC's efforts to complete the TeesREP project, including any new problems that may arise related to the resumption of construction work before the COVID-19 outbreak is controlled and under the existing contractual structure, may result in additional losses that will be reflected in operating results when identified and quantified.
During
Due substantially to the increasing revenues of GPS, consolidated revenues for
the three months ended
As reported by the business segments, the revenue results for the three months
ended
Consolidated gross profit for the three months ended
- 20 -
We considered the unanticipated and sizable contract loss identified for the
TeesREP project to be an event which triggered our assessment of the goodwill
associated with APC and the recording of an impairment loss of
As more fully described below, the income tax benefit recorded for the three
months ended
Primarily due to the factors discussed above, the consolidated net loss
attributable to our stockholders was
Major Customer Contracts
On
At this time, for all of the contract awards with pending start dates including the two new contracts identified above, we cannot predict with certainty when the projects will commence. The start date for construction is generally controlled by the project owners.
We announced in
As announced in Fiscal 2019, GPS entered into an EPC services contract to
construct the
The aggregate rated electrical output amount for the natural gas-fired power
plants for which we have signed EPC services contracts is approximately 7.3
gigawatts with an aggregate contract value in excess of
- 21 -
We have maintained that the delays in new business awards to GPS and the project
construction starts of certain previously awarded projects relate to a variety
of factors, especially in the northeast and mid-
In
Besides the downturn in the demand for electric power during the COVID-19 outbreak in the US that is discussed below, other unfavorable factors include an increase in the amount of power generating capacity provided by renewable energy assets, improvements and decreasing prices in renewable energy storage solutions and increased environmental activism. Protests against fossil-fuel related energy projects continue to garner media attention and stir public skepticism about new pipelines resulting in project delays due to onsite protest demonstrations, indecision by local officials and lawsuits. Pipeline approval delays may jeopardize projects that are needed to bring supplies of natural gas to planned gas-fired power plant sites, thereby increasing the risk of power plant project delays or cancellations.
In the
Market Outlook
Although the total amount of electricity generated by utility-scale power
facilities in calendar year 2019 declined by 1.3% from the total amount in 2018,
the 2019 amount was the second highest total annual amount of electricity
generated by utility-scale power plants since 2010. In the reference case
included in its Annual Energy Outlook 2020 released in
Despite the overall decline in the amount of electricity generated in the US in 2019 and the increases in the amounts of electricity provided by utility-scale wind and solar power sources, the amount of electricity generated by natural gas-fired power plants rose by 7.7% during 2019, and it represented 38.4% of the total electric power generated in the US in 2019. The combined amount of power generated by the wind and the sun represented 10.8% of total utility-scale power generation in 2019. For 2018, the corresponding power shares were 35.2% and 9.9%, respectively. The amount of electricity generated from coal decreased by 15.7% in 2019 from its generation amount for 2018, and coal's share of the total, utility-scale electricity generation mix declined from 27.4% for 2018 to 23.5% for 2019. During 2019, power companies retired or converted roughly 15,100 MW of coal-fired electricity generation, reported to be enough to power about 15 million homes. That retirement capacity reduction was second only to the record 19,300 MW of capacity shut down in 2015.
- 22 -
In summary, the share of the electrical power generation mix in the US fueled by natural gas, the sun and wind continued to rise during 2019, while the share fueled by coal continued its fall. Over the ten-year period ended in 2019, the amount of electrical power fueled by natural gas in the US increased by 72% while the amount of utility-scale power generated by coal fell by 45%. This dramatic shift is a primary cause of the significant reductions in the annual power plant emissions of carbon dioxide, sulfur dioxide and nitrogen oxides over this same ten-year period.
However, reduced economic activity in the US related to the COVID-19 pandemic has caused significant changes in energy supply and demand patterns. Crude oil prices, in particular, have fallen significantly since the beginning of 2020, largely driven by reduced oil demand because of COVID-19 mitigation efforts. Despite more recent stability, crude oil prices have remained at some of their lowest levels in more than 20 years causing some uncertainty related to the future supplies and prices for natural gas.
In its Short-Term Energy Outlook released in
In the reference case of the 2020 outlook identified above, the EIA predicted that coal-fired and nuclear power generating capacity would decline by approximately 47% and 20% by 2050, respectively, representing only 13% and 12% shares of the electricity generation mix by 2050, respectively. It is important to note that most of the reduction in the coal-fired and nuclear capacity was already predicted to occur in the period 2020-2025. As a result, natural gas-fired power generating capacity was forecasted to increase by 26% over the next five years and by 67% by 2050 (before any adjustments for adverse and long-lasting effects of the COVID-19 pandemic on the demand for electricity). It is logical that this outlook represented the driver for the realization by at least certain power producers that the near-term addition of new natural gas-fired power plants to the utility-scale power generation fleet in the US is necessary. As a result, we have experienced meaningful growth in the number of new EPC service contracts awarded to us.
In our view, the competitive landscape in the EPC services market for natural gas-fired power plant construction has changed significantly. Several significant competitors have announced that they were exiting the market for a variety of reasons. Others have announced intentions to avoid entering into fixed-price contracts. While the competitive market remains dynamic, we expect that there will be fewer competitors for new gas-fired power plant EPC project opportunities in the foreseeable future.
We believe that the future long-term prospects for natural gas-fired power plant construction remain generally favorable as natural gas is the primary source for power generation in our country. Major advances in the safe combination of horizontal drilling techniques and hydraulic fracturing led to the boom in natural gas supplies which have been available at consistently low prices. The abundant availability of cheap, less carbon-intense and higher efficiency natural gas should continue to be a significant factor in the economic assessment of future power generation capacity additions. However, as identified above, stability in the availability of natural gas supplies and natural gas prices, particularly in the short-term, may be threatened due to pandemic-caused uncertainties.
Despite the pandemic, we believe that the development of natural gas-fired power generation facilities in the US should continue to provide new construction opportunities for us although, in the near term, the pace of new opportunities emerging may be restrained and the starts of awarded EPC projects may be delayed. We are committed to the rational pursuit of new construction projects and the future growth of our revenues. This may result in our decision to make investments in the development and/or ownership of new projects. Because we believe in the strength of our balance sheet, we are willing to consider certain opportunities that include reasonable and manageable risks in order to assure the award of the related EPC services contract to us. We believe that the Company has a reputation as an accomplished and cost-effective provider of EPC and other large project construction contracting services. We are convinced that the recent series of new EPC projects awarded to us confirms the soundness of our belief. With the proven ability to deliver completed power facilities, particularly combined cycle, natural gas-fired power plants, we are focused on expanding our position in the power markets where we expect investments to be made based on forecasts of electricity demand covering decades into the future. We believe that our expectations are valid and that our plans for the future continue to be based on reasonable assumptions.
- 23 -
Impacts of the COVID-19 Pandemic on Our Business Operations
The world-wide COVID-19 pandemic began to impact our businesses noticeably in
During the three month-period ended
At the time of the suspension of work on the TeesREP project, APC had completed
approximately 90% of its subcontracted work. Nonetheless, the project shutdowns
had a meaningful impact on the revenues of APC for the quarter ended
In the state of
The ultimate impacts of the health crisis and/or the executive order on the
Even before the onset of the outbreak and related restrictions, the revenues of
TRC and SMC for the first quarter of the fiscal year ending
The decline in interest rates during the pandemic period has reduced our cash
investment returns meaningfully. However, as described below, the emergency
legislation that has been enacted by the US government in response to the
COVID-19 health crisis, allows us to carryback the NOL incurred by us last year,
as determined for federal income tax reporting purposes, to our income tax
reporting year ended
The administrative and operational support staffs at the subsidiaries and
corporate headquarters have been maintained at pre-pandemic levels in general.
Substantial amounts of required duties and responsibilities, including the
timely filing of financial reports, have been fulfilled by staff members working
remotely due to pandemic restrictions imposed by local and state authorities.
Despite the migration from processes that have typically relied on the creation
and maintenance of hard-copy evidence in order to document the operation of
internal controls, we believe that our system of internal control over financial
reporting has not been fundamentally altered and that the effectiveness of the
design and operation of internal controls remained materially consistent during
the three month-period ended
- 24 -
Comparison of the Results of Operations for the Three Months Ended
We reported a net loss attributable to our stockholders of
The following schedule compares our operating results for the three months ended
Three Months Ended April 30,
2020 2019 $ Change % Change
REVENUES
Power industry services $ 48,612 $ 20,203 $ 28,409 140.6 %
Industrial fabrication and field
services 9,744 27,069 (17,325 ) (64.0 )
Telecommunications infrastructure
services 1,792 2,272 (480 ) (21.1 )
Revenues 60,148 49,544 10,604 21.4
COST OF REVENUES
Power industry services 45,710 44,526 1,184 2.7
Industrial fabrication and field
services 8,982 24,271 (15,289 ) (63.0 )
Telecommunications infrastructure
services 1,447 1,773 (326 ) (18.4 )
Cost of revenues 56,139 70,750 (14,611 ) (20.7 )
GROSS PROFIT (LOSS) 4,009 (21,026 ) 25,035 N/M
Selling, general and administrative
expenses 10,344 9,588 756 7.9
Impairment loss - 2,072 (2,072 ) (100.0 )
LOSS FROM OPERATIONS (6,335 ) (32,686 ) 26,351 80.6
Other income, net 1,088 2,252 (1,164 ) (51.7 )
LOSS BEFORE INCOME TAXES (5,247 ) (30,434 ) 25,187 82.8
Income tax benefit 4,454 521 3,933 755.9
NET LOSS (793 ) (29,913 ) 29,120 97.3
Net loss attributable to
non-controlling interests (30 ) (113 ) 83 73.5
NET LOSS ATTRIBUTABLE TO
THE STOCKHOLDERS OF ARGAN, INC. $ (763 ) $ (29,800 ) $ 29,037 97.4
N/M - Not meaningful.
Revenues
Power Industry Services
The revenues of the power industry services business increased by 140.6%, or
Industrial Fabrication and Field Services
The revenues of industrial fabrication and field services (representing the
business of TRC) provided 16.2% of consolidated revenues for the three months
ended
- 25 -
The largest portion of the revenues of TRC continues to be provided by
industrial field services. The major customers of TRC include some of
Telecommunications Infrastructure Services
The revenues of this business segment (representing the business of SMC) were
Cost of Revenues
Despite the increase in consolidated revenues for the three months ended
For the three months ended
Selling, General and Administrative Expenses
These costs were
Impairment Loss
We did not consider the unfavorable results of TRC for the quarter ended
Other Income
For the three months ended
Income Tax Benefits
We recorded a total income tax benefit for the three months ended
- 26 -
In a response to the COVID-19 health crisis, the
We estimate that our annual effective income tax rate for Fiscal 2021 before discrete items will approximate 27.8%. This tax rate differs from the statutory federal tax rate of 21% due primarily to the unfavorable effects of permanent differences relating to nondeductible travel and entertainment expenses, certain nondeductible executive compensation and interest income earned on our notes receivable from the VIE.
We recorded an income tax benefit for the three months ended
Liquidity and Capital Resources as of
At
The net amount of cash provided by operating activities for the three months
ended
A primary source of cash for the three months ended
Last year, the net amount of cash used by operating activities for the three
months ended
However, the net balance of contract assets and liabilities declined by
- 27 -
A primary source of cash required to fund operations during the three months
ended
At
Our Credit Agreement, which expires on
We have pledged the majority of our assets to secure the financing arrangements.
The Bank's consent is not required for acquisitions, divestitures, cash
dividends or significant investments as long as certain conditions are met. The
Credit Agreement requires that we comply with certain financial covenants at our
fiscal year-end and at each fiscal quarter-end, and includes other terms,
covenants and events of default that are customary for a credit facility of its
size and nature. At
In the normal course of business and for certain major projects, we may be required to obtain surety or performance bonding, to provide parent company guarantees, or to cause the issuance of letters of credit (or some combination thereof) in order to provide performance assurances to clients on behalf of one of our contractor subsidiaries.
For example, we maintain a variety of commitments that are generally made
available to provide support for various commercial provisions in our
construction contracts. For certain projects, we are required by project owners
to provide guarantees related to our services or work. If our services under a
guaranteed project would not be completed or would be determined to have
resulted in a material defect or other material deficiency, then we may be
responsible for monetary damages or other legal remedies. Certain project owners
may request that we obtain surety bonds for their benefit in connection with EPC
services contract performance obligations. As is typically required by any
surety bond, the Company would be obligated to reimburse the issuer of any
surety bond issued on behalf of a subsidiary for any cash payments made
thereunder. The commitments under performance bonds generally end concurrently
with the expiration of the related contractual obligation. Not all of our
projects require bonding. As of
When sufficient information about claims related to our performance on projects
would be available and monetary damages or other costs or losses would be
determined to be probable, we would record such guaranteed losses. As our
subsidiaries are wholly-owned, any actual liability related to contract
performance is ordinarily reflected in the financial statement account balances
determined pursuant to the Company's accounting for contracts with customers.
Any amounts that we may be required to pay in excess of the estimated costs to
complete contracts in progress as of
On behalf of APC, Argan provided a parent company performance guarantee to its
customer, the EPC services contractor on the TeesREP project, and caused the
Bank to issue letters of credit as security (see Notes 6 and 7 to the
accompanying condensed consolidated financial statements). As disclosed above,
these letters of credit represent a little over 70% of the amount of outstanding
credit under the Credit Agreement as of
We have also provided a financial guarantee on behalf of GPS to an original
equipment manufacturer in the amount of
- 28 -
We believe that cash on hand, cash that will be provided from the maturities of
short-term investments and cash generated from our future operations, with or
without funds available under our line of credit, will be adequate to meet our
general business needs in the foreseeable future. For the quarter ended
In general, we maintain significant liquid capital on our balance sheet to help ensure our ability to maintain bonding capacity and to provide parent company performance guarantees for EPC and other construction projects. Any future acquisitions, or other significant unplanned cost or cash requirement, may require us to raise additional funds through the issuance of debt and/or equity securities. There can be no assurance that such financing will be available on terms acceptable to us, or at all.
Earnings before Interest, Taxes, Depreciation and Amortization ("EBITDA")
The following table presents the determinations of EBITDA for the three months
ended
Three Months Ended
April 30,
2020 2019
Net loss, as reported $ (793 ) $ (29,913 )
Income tax benefit (4,454 ) (521 )
Depreciation 937 829
Amortization of purchased intangible assets 225 299
EBITDA (4,085 ) (29,306 )
EBITDA of non-controlling interests (30 ) (115 )
EBITDA attributable to the stockholders of Argan, Inc. $ (4,055 ) $ (29,191 ) As we believe that our net cash flow provided by or used in operations is the
most directly comparable performance measure determined in accordance with US
GAAP, the following table reconciles the amounts of EBITDA for the applicable
periods, as presented above, to the corresponding amounts of net cash flows
provided by or used in operating activities that are presented in our condensed
consolidated statements of cash flows for the three months ended
Three Months Ended
April 30,
2020 2019
EBITDA $ (4,085 ) $ (29,306 )
Current income tax benefit 12,668 780
Stock option compensation expense 642 413
Impairment loss - 2,072
Other non-cash items 328 25
Decrease (increase) in accounts receivable 14,980 (12,049 )
(Increase) decrease in other assets (13,600 ) 3,808
Decrease in accounts payable and accrued expenses (8,230 ) (10,497 )
Change in contracts in progress, net 37,484 8,372
Net cash provided by (used in) operating activities $ 40,187 $ (36,382 ) We believe that EBITDA is a meaningful presentation that enables us to assess and compare our operating cash flow performance on a consistent basis by removing from our operating results the impacts of our capital structure, the effects of the accounting methods used to compute depreciation and amortization and the effects of operating in different income tax jurisdictions. Further, we believe that EBITDA is widely used by investors and analysts as a measure of performance.
However, as EBITDA is not a measure of performance calculated in accordance with US GAAP, we do not believe that this measure should be considered in isolation from, or as a substitute for, the results of our operations presented in accordance with US GAAP that are included in our condensed consolidated financial statements. In addition, our EBITDA does not necessarily represent funds available for discretionary use and is not necessarily a measure of our ability to fund our cash needs.
- 29 -
Critical Accounting Policies
Critical accounting policies are those related to the areas where we have made what we consider to be particularly subjective or complex judgments in arriving at estimates and where these estimates can significantly impact our financial results under different assumptions and conditions. These estimates, judgments, and assumptions affect the reported amounts of assets, liabilities and equity, the disclosure of contingent assets and liabilities at the date of financial statements and the reported amounts of revenues and expenses during the reporting periods. We base our estimates on historical experience and various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets, liabilities and equity that are not readily apparent from other sources. Actual results and outcomes could differ from these estimates and assumptions.
We consider the accounting policies related to revenue recognition on long-term
construction contracts; income tax reporting; the accounting for business
combinations; the subsequent valuation of goodwill, other indefinite-lived
assets and long-lived assets; the valuation of employee stock options; and the
financial reporting associated with any significant claims or legal matters to
be most critical to the understanding of our financial position and results of
operations, as well as the accounting and reporting for special purpose entities
including joint ventures and variable interest entities. An expanded discussion
of our critical accounting policies is included in Item 7 of Part II of our
Annual Report. During the three-month period ended
Recently Issued Accounting Pronouncements
In
In 2016, the FASB also issued ASU 2016-13, Measurement of Credit Losses on
Financial Instruments. The requirements of this new standard cover, among other
provisions, the methods that businesses shall use to estimate amounts of credit
losses. As subsequently amended, the adoption of this new guidance, which became
effective for us on
There are no other recently issued accounting pronouncements that have not yet
been adopted that we consider material to our consolidated financial statements.
As required for us, we adopted ASU 2016-02, Leases, as of
© Edgar Online, source
