SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended January 31, 2002
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 000-19608
ARI Network Services, Inc.
(Exact name of registrant as specified in its charter.)
WISCONSIN 39-1388360
------------------------------- ---------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
330 E. Kilbourn Avenue, Milwaukee, Wisconsin 53202
--------------------------------------------------
(Address of principal executive office)
Registrant's telephone number, including area code (414) 278-7676
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of The Securities Exchange Act of 1934 during
the preceding 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 ninety days.
YES X NO
-------- --------
As of March 13, 2002 there were 6,223,342 shares of the registrant's shares
outstanding.
1
ARI NETWORK SERVICES, INC.
FORM 10-Q
FOR THE THREE MONTHS ENDED JANUARY 31, 2002
INDEX
PART I - FINANCIAL INFORMATION
Page
----
Item 1 Financial statements
Condensed balance sheets - January 31, 2002 and
July 31, 2001 3-4
Condensed statements of operations for the three and six months
ended January 31, 2002 and 2001 5
Condensed statements of cash flows for the six months ended
January 31, 2002 and 2001 6
Notes to unaudited condensed financial statements 7
Item 2 Management's discussion and analysis of financial condition and results
of operations 7-15
PART II - OTHER INFORMATION
Item 3 Defaults upon senior securities 16
Item 4 Submission of matters to a vote of security holders 16
Signatures
2
ARI NETWORK SERVICES, INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(Unaudited)
ASSETS JANUARY 31 JULY 31
2002 2001
------ -------
Current assets:
Cash $ 490 $ 313
Trade receivables, less allowance for doubtful accounts of $601
at January 31, 2002 and $757 at July 31, 2001 1,978 2,084
Prepaid expenses and other 108 140
------- -------
Total current assets 2,576 2,537
Equipment and leasehold improvements:
Computer equipment 4,394 4,394
Leasehold improvements 239 239
Furniture and equipment 1,000 1,000
------- -------
5,633 5,633
Less accumulated depreciation and amortization 5,394 5,293
------- -------
Net equipment and leasehold improvements 239 340
Goodwill, less accumulated amortization of $60 at January 31,
2002 and $54 at July 31, 2001 9 15
Deferred financing costs, less accumulated amortization of $266 at
January 31, 2002 and $203 at July 31, 2001 144 207
Capitalized software development 23,963 23,533
Less accumulated amortization 20,367 19,572
------- -------
Net capitalized software development 3,596 3,961
------- -------
TOTAL ASSETS $ 6,564 $ 7,060
======= =======
3
ARI NETWORK SERVICES, INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(Unaudited)
LIABILITIES AND SHAREHOLDERS' DEFICIT JANUARY 31 JULY 31
2002 2001
-------- ---------
Current liabilities:
Current portion of notes payable to shareholder $ 199 $ 333
Current portion of notes payable 3,121 2,902
Current portion of line of credit to shareholder -- 200
Accounts payable 770 951
Deferred revenue 4,982 4,811
Accrued payroll and related liabilities 1,463 1,487
Other accrued liabilities 1,193 1,499
Current portion of capital lease obligations 84 173
--------- ---------
Total current liabilities 11,812 12,356
Long term liabilities:
Notes payable to shareholder -- 15
Notes payable 30 78
Capital lease obligations 158 158
Accrued restructuring costs 303 303
--------- ---------
Total long term liabilities 491 554
Shareholders' deficit:
Cumulative preferred stock, par value $.001 per share, 1,000,000 shares
authorized; 20,350 shares issued and outstanding at January 31, 2002 and
July 31, 2001 -- --
Common stock, par value $.001 per share, 25,000,000 shares authorized;
6,223,342 and 6,184,281 shares issued and outstanding at January 31, 2002
and July 31, 2001, respectively 6 6
Common stock warrants and options 2,459 2,459
Additional paid-in-capital 91,811 91,797
Accumulated deficit (100,015) (100,112)
--------- ---------
Total shareholders' deficit (5,739) (5,850)
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT $ 6,564 $ 7,060
========= =========
See notes to unaudited condensed financial statements.
Note: The balance sheet at July 31, 2001 has been derived from the audited
balance sheet at that date but does not include all of the information and
footnotes required by accounting principles generally accepted in the United
States for complete financial statements.
4
ARI NETWORK SERVICES, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JANUARY 31 JANUARY 31
2002 2001 2002 2001
------- ------- ------- --------
Net revenues:
Subscriptions, support and other services fees $ 2,228 $ 2,550 $ 4,683 $ 5,102
Software licenses and renewals 671 842 1,491 1,601
Professional services 419 694 964 1,525
------- ------- ------- --------
3,318 4,086 7,138 8,228
Operating expenses:
Cost of products and services sold:
Subscriptions, support and other services fees (58) 317 151 690
Software licenses and renewals * 423 907 819 1,874
Professional services 152 402 360 904
------- ------- ------- --------
517 1,626 1,330 3,468
Depreciation and amortization (exclusive of amortization of
software products included in cost of products and
services sold) 53 370 107 770
Customer operations and support 291 409 594 813
Selling, general and administrative 1,660 2,200 3,517 4,433
Software development and technical support 541 830 1,187 1,675
------- ------- ------- --------
Operating expenses before amounts capitalized 3,062 5,435 6,735 11,159
Less capitalized portion (172) (508) (430) (940)
------- ------- ------- --------
Net operating expenses 2,890 4,927 6,305 10,219
------- ------- ------- --------
Operating income (loss) 428 (841) 833 (1,991)
Other expense:
Interest expense (411) (396) (740) (767)
Other, net 17 21 4 20
------- ------- ------- --------
Total other expense (394) (375) (736) (747)
------- ------- ------- --------
Net income (loss) $ 34 $(1,216) $ 97 $ (2,738)
======= ======= ======= ========
Average common shares outstanding 6,197 6,168 6,190 6,168
Basic and diluted net income (loss) per share $ 0.01 ($ 0.20) $ 0.02 ($ 0.44)
======= ======= ======= ========
See notes to unaudited condensed financial statements.
* Includes amortization of software products of $405, $793, $795 and
$1,672 and excludes other depreciation and amortization shown separately
5
ARI NETWORK SERVICES, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED
JANUARY 31
2002 2001
------- -------
OPERATING ACTIVITIES
Net income (loss) $ 97 $(2,738)
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Amortization of network platform -- 286
Amortization of software products 795 1,672
Amortization of goodwill 6 329
Amortization of deferred financing costs and debt discount 473 476
Depreciation and other amortization 101 155
Net change in receivables, prepaid expenses and other
current assets 138 239
Net change in accounts payable, deferred revenue and
accrued liabilities (340) 1,304
------- -------
Net cash provided by operating activities 1,270 1,723
INVESTING ACTIVITIES
Purchase of equipment and leasehold improvements -- (10)
Software product costs capitalized (430) (940)
------- -------
Net cash used in investing activities (430) (950)
FINANCING ACTIVITIES
Repayments under line of credit (200) --
Payments under notes payable (388) (405)
Payments of capital lease obligations (89) (82)
Debt issuance costs incurred -- (39)
Proceeds from issuance of common stock 14 --
------- -------
Net cash used in financing activities (663) (526)
------- -------
Net increase in cash 177 247
Cash at beginning of period 313 563
------- -------
Cash at end of period $ 490 $ 810
======= =======
Cash paid for interest $ 267 $ 291
======= =======
NONCASH INVESTING AND FINANCING ACTIVITIES
Capital lease obligations incurred for:
Computer equipment $ -- $ 141
See notes to unaudited condensed financial statements.
6
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
JANUARY 31, 2002
1. BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared and reviewed
in accordance with accounting principles generally accepted in the United States
for interim financial information. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States for fiscal year end financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results for the
three and six months ended January 31, 2002 are not necessarily indicative of
the results that may be expected for the fiscal year ending July 31, 2002. For
further information, refer to the financial statements and footnotes thereto
included in the Company's annual report on Form 10-K for the year ended July 31,
2001.
2. BASIC AND DILUTED NET INCOME (LOSS) PER SHARE
The weighted average number of shares outstanding used to calculate basic and
diluted earnings per share result in the same earnings per share amount.
3. PREFERRED STOCK
The Series A preferred stock accrues dividends on a quarterly basis,
cumulatively, at a rate per annum equal to the product of the stated value
thereof and 2% above the prime rate (minimum dividend rate of 10% and maximum of
14%). All Series A preferred stock must be redeemed at $100 per share plus
accrued and unpaid dividends prior to any payment of dividends on, or
repurchases by the Company of, the Company's common stock. Prior to August 1,
2002, dividends, if declared by the Board of Directors, can be paid in either
cash or additional shares of Series A preferred stock. The total amount of
dividends in arrears on the Series A preferred stock is $1,160,000 at January
31, 2002.
4. NOTES PAYABLE
The convertible debentures, issued on April 27, 2000, and accrued interest
thereon are convertible into common stock at a rate of $4 per share, subject to
certain adjustments. Concurrent with the issuance of the debentures, the Company
issued the investors 600,000 common stock purchase warrants expiring April 27,
2005 and 800,000 investment options which expired October 27, 2001. Each of the
warrants are exercisable for one share of common stock at a price of $6 per
share. The warrants and options, which were originally estimated to have a value
of $2,354,000, less accumulated amortization, reduce the carrying amount of the
debt.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Total revenue for the quarter ended January 31, 2002 decreased $768,000 or 19%
compared to the same period last year, primarily due to the expected decline in
non-Equipment Industry revenue and a decrease in new customers in the Equipment
Industry. Earnings improved 103% from a net loss of $1,216,000, or $0.20 per
share for the quarter ended January 31, 2001 to net income of $34,000 or $0.01
per share for the quarter ended January 31, 2002. Management believes that, due
to the restructuring in the fourth quarter of fiscal 2001 which focused the
Company on our core catalog business and reduced both cash and non-cash expenses
to bring them in line with our revenues, we will continue to generate enough
cash from operations to fund investment and debt, although earnings may be
negative for the remainder of fiscal 2002. See "Forward Looking Statements."
7
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
General
The Company's discussion and analysis of its financial condition and results of
operations are based upon its financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires the Company to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. On an on-going basis, the Company evaluates its estimates,
including those related to customer contracts, bad debts, intangible assets,
financing instruments, restructuring and other accrued revenues and expenses.
The Company bases its estimates on historical experience and on various other
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions.
The Company believes the following critical accounting policies affect its more
significant judgments and estimates used in the preparation of its financial
statements.
Revenue Recognition
Revenue for use of the network and for information services is recognized in the
period such services are utilized. Revenue from annual or periodic maintenance
fees, license and license renewal fees and catalog subscription fees is
recognized ratably over the period the service is provided. Arrangements that
include acceptance terms beyond the Company's standard terms are not recognized
until acceptance has occurred. If collectibility is not considered probable,
revenue is recognized when the fee is collected. Arrangements that include
professional services are evaluated to determine whether those services are
essential to the functionality of other elements of the arrangement. When
professional services are not considered essential, the revenue allocable to the
professional services is recognized as the services are performed. When
professional services are considered essential, revenue under the arrangement is
recognized pursuant to contract accounting using the percentage-of-completion
method with progress-to-completion measured based upon labor hours incurred.
When the current estimates of total contract revenue and contract cost indicate
a loss, a provision for the entire loss on the contract is made. Revenue on
arrangements with customers who are not the ultimate users (resellers) is
deferred if there is any contingency on the ability and intent of the reseller
to sell such software to a third party.
Bad Debt
The Company maintains allowances for doubtful accounts for estimated losses
resulting from the inability of its customers to make required payments. The
Company currently reserves for most amounts due over 90 days, unless there is
reasonable assurance of collectability. If the financial condition of the
Company's customers were to deteriorate, resulting in an impairment of their
ability to make payments, additional allowances may be required.
Use of Estimates
The preparation of the Company's financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions about accrued expenses, including
royalties and other contingent expenses that affect the amounts reported in the
financial statements and accompanying notes. Actual results could differ from
those estimates.
Debt Instruments
The Company valued a debt discount for Common Stock Warrants and Options granted
in consideration for the RGC Debenture and the WITECH Facility using the Black
Scholes valuation method. Non-cash interest expense is recorded for the
amortization of the debt discount over the term of the debt.
Impairment of Long-Lived Assets
Equipment and leasehold improvements, capitalized software development costs and
goodwill are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount may not be recoverable. If the sum of the
expected undiscounted cash flows is less than the carrying value of the related
asset or group of assets, a loss is recognized for the difference between the
fair value and carrying value of the asset or group of assets.
8
REVENUES
The Company is a leading provider of technology-enabled business solutions for
sales, service and life cycle product support in the manufactured equipment
market. The Company currently serves over 100 manufacturers and 20,000 dealers
in more than 100 countries in 12 segments of the worldwide manufactured
equipment market including outdoor power, recreation vehicles, auto and truck
parts aftermarket, marine, construction, power sports, floor maintenance and
others. The Company supplies three types of software and services: robust Web
and CD-ROM electronic parts catalogs, transaction services and template-based
website services. The Company's primary business is electronic cataloging; the
others are complementary businesses that leverage our catalog position.
The Company also has a supplemental business that provides e-Commerce services
to certain non-equipment industries including agribusiness and publishing. As
the Company focuses on its core businesses in the Equipment industry, revenues
in the non-equipment industry are expected to decline significantly during
fiscal 2002.
Management reviews the Company's recurring vs. non-recurring revenue in the
aggregate and within the North American Equipment, Non-North American Equipment
and non-Equipment markets.
The following table sets forth, for the periods indicated, certain revenue
information derived from the Company's unaudited financial statements.
REVENUE BY INDUSTRY SECTOR
(IN THOUSANDS)
THREE MONTHS ENDED SIX MONTHS ENDED
INDUSTRY SECTOR JANUARY 31 PERCENT JANUARY 31 PERCENT
2002 2001 CHANGE 2002 2001 CHANGE
------ ------ -------- ------ ------ ---------
EQUIPMENT INDUSTRY
North American
Recurring $1,919 $2,150 (11%) $3,883 $3,781 3%
Non-recurring 423 699 (39%) 1,160 1,574 (26%)
------ ------ ------ ------
Subtotal 2,342 2,849 (18%) 5,043 5,355 (6%)
Non-North American
Recurring 260 269 (3%) 478 547 (13%)
Non-recurring 25 80 (69%) 123 207 (41%)
------ ------ ------ ------
Subtotal 285 349 (18%) 601 754 (20%)
Total Equipment Industry
Recurring 2,179 2,419 (10%) 4,361 4,328 1%
Non-recurring 448 779 (42%) 1,283 1,781 (28%)
------ ------ ------ ------
Subtotal 2,627 3,198 (18%) 5,644 6,109 (8%)
NON-EQUIPMENT INDUSTRY
Recurring 691 888 (22%) 1,486 2,072 (28%)
Non-recurring -- -- -- 8 47 (83%)
------ ------ ------ ------
Subtotal 691 888 (22%) 1,494 2,119 (29%)
TOTAL REVENUE
Recurring 2,870 3,307 (13%) 5,847 6,400 (9%)
Non-recurring 448 779 (42%) 1,291 1,828 (29%)
------ ------ ------ ------
Grand Total $3,318 $4,086 (19%) $7,138 $8,228 (13%)
====== ====== ====== ======
9
Recurring revenues are derived from catalog subscription fees, software
maintenance and support fees, software license renewals, network traffic and
support fees and other miscellaneous subscription fees. Non-recurring revenues
are derived from initial software licenses and professional services fees.
Recurring revenue, as a percentage of total revenue, was 82% for the six months
ended January 31, 2002 compared to 78% for the same period last year. Management
believes that the relationship of approximately three quarters recurring revenue
to one quarter non-recurring revenue establishes an appropriate level of base
revenue while the Company continues to add new sales to drive future increases
in recurring revenue. If the manufacturing sector of the economy improves in the
future, the percentage of recurring revenue may be slightly lower, indicating a
higher amount of new business. This ratio is expected to fluctuate from quarter
to quarter and year to year, depending on the size and timing of new business.
Management expects the Equipment Industry revenues to increase and non-Equipment
Industry revenues to decrease resulting in decreased total revenues for the
remainder of fiscal 2002.
Equipment Industry
The Equipment Industry comprises several vertical markets including outdoor
power, recreation vehicles, motorcycles, auto and truck parts after-market,
manufactured housing, farm equipment, marine, construction, power sports, floor
maintenance and others primarily in the U.S., Canada, Europe and Australia.
Management's strategy is to expand the Company's electronic parts catalog
software and services business with manufacturers and distributors and their
dealers in the existing vertical markets, add supplemental products for existing
customers, and then expand to other similar markets in the future. Revenues in
the Equipment Industry increased, as a percentage of total revenues, from 74%
for the six months ended January 31, 2001 to 79% for the six months ended
January 31, 2002. Management expects revenues in the Equipment Industry to
increase for the remainder of fiscal 2002, as management continues to focus
attention and resources in this industry, but not at a rate sufficient to offset
the decline in non-Equipment Industry revenues.
North American
Recurring revenues in the North American Equipment Industry decreased for
the three month period ended January 31, 2002, compared to the same period
last year, primarily due to the decline in the base of customers of the
Company's communications product. Non-recurring revenues in the North
American Equipment Industry decreased for the three and six month periods
ended January 31, 2002, compared to the same periods last year, due to fewer
new customer contracts because of the decline in the manufacturing sector of
the economy.
Non-North American
Recurring revenues in the Non-North American Equipment Industry decreased
for the three and six month periods ended January 31, 2002, compared to the
same periods last year, primarily due to the loss of a major customer in the
agricultural equipment market. Non-recurring revenues in the Non-North
American Equipment Industry decreased for the three and six month periods
ended January 31, 2002, compared to the same periods last year, primarily
due to the decrease in sales to new customers.
Non-Equipment Industry
The Company's business outside of the Equipment Industry includes sales of
database management services and electronic communications services to the
agricultural inputs industry, the on-line provision of information for
republication to the non-daily newspaper publishing industry and until December
31, 2000, database management services to the railroad industry. Revenues in the
non-Equipment Industry decreased for the three and six month periods ended
January 31, 2002, compared to the same periods last year, due to the Company's
focus in the Equipment Industry and the non-renewal of the railroad industry
business. Management expects revenues in the non-Equipment Industry will decline
significantly for the remainder of fiscal 2002. The Company's five-year contract
with the Associated Press, on which its business in the non-daily newspaper
publishing industry depends and which represented approximately $1.5 million in
revenue on an annual basis, expired on February 28, 2002.
10
COST OF PRODUCTS AND SERVICES SOLD
The following table sets forth, for the periods indicated, certain revenue and
variable cost of products and services sold information derived from the
Company's unaudited financial statements.
COST OF PRODUCTS AND SERVICES SOLD AS A PERCENT OF REVENUE BY REVENUE TYPE
(IN THOUSANDS)
THREE MONTHS ENDED SIX MONTHS ENDED
JANUARY 31 JANUARY 31
PERCENT PERCENT
2002 2001 CHANGE 2002 2001 CHANGE
------ ------ -------- ------ ------ ---------
Subscriptions, support and other
services fees
Revenue $ 2,228 $2,550 (13%) $4,683 $5,102 (8%)
Cost of revenue (58) 317 (118%) 151 690 (78%)
Cost of revenue as a percent of
revenue (3%) 12% 3% 14%
Software licenses and renewals
Revenue 671 842 (20%) 1,491 1,601 (7%)
Cost of revenue 423 907 (53%) 819 1,874 (56%)
Cost of revenue as a percent of
revenue 63% 108% 55% 117%
Professional services
Revenue 419 694 (40%) 964 1,525 (37%)
Cost of revenue 152 402 (62%) 360 904 (60%)
Cost of revenue as a percent of
revenue 36% 58% 37% 59%
Total
Revenue $ 3,318 $4,086 (19%) $7,138 $8,228 (13%)
Cost of revenue 517 1,626 (68%) 1,330 3,468 (62%)
Cost of revenue as a percent of
revenue 16% 40% 19% 42%
Cost of subscriptions, support and other services fees consists primarily of
telecommunications and catalog replication and distribution costs and royalties
on revenues in the publishing industry. Cost of subscriptions, support and other
services fees as a percentage of revenue decreased significantly for the three
and six month periods ended January 31, 2002, compared to the same periods last
year, primarily due to the reduction of an accrual for royalties related to the
settlement of a contract in the publishing industry. Management expects gross
margins, as a percent of revenue from subscriptions, support and other services
fees, to be relatively consistent from quarter to quarter, once the royalties
from revenues in the publishing industry are no longer being incurred.
Cost of software licenses and renewals consists primarily of amortization of
software products, royalties and software distribution costs. Cost of software
licenses and renewals as a percentage of revenue decreased for the three and six
month period ended January 31, 2002, compared to the same periods last year,
primarily due to lower software amortization costs as a result of the
restructuring in the fourth quarter of fiscal 2001 and the sale of software
licenses with no associated royalties. Management expects gross margins from
software licenses and renewals to fluctuate from quarter to quarter based on the
mix of products and services sold.
Cost of professional services consists of customization and catalog production
labor. Cost of professional services as a percentage of revenue decreased for
the three and six month periods ended January 31, 2002, compared to the same
periods last year, primarily due to a decrease in communication software
customization, which has a lower margin. Management expects cost of professional
services to fluctuate from quarter to quarter depending on the mix of services
sold and on the Company's performance towards the contracted amount for
customization projects.
11
OPERATING EXPENSES
The following table sets forth, for the periods indicated, certain operating
expense information derived from the Company's unaudited financial statements.
OPERATING EXPENSES
(IN THOUSANDS)
THREE MONTHS ENDED SIX MONTHS ENDED
JANUARY 31 PERCENT JANUARY 31 PERCENT
2002 2001 CHANGE 2002 2001 CHANGE
------- ------- ------- --------
Cost of products and services sold $ 517 $ 1,626 (68%) $ 1,330 $ 3,468 (62%)
Customer operations and support 291 409 (29%) 594 813 (27%)
Selling, general and administrative 1,660 2,200 (25%) 3,517 4,433 (21%)
Software development and technical
support 541 830 (35%) 1,187 1,675 (29%)
Less capitalized portion (172) (508) (66%) (430) (940) (54%)
Depreciation and amortization 53 370 (86%) 107 770 (86%)
------- ------- ------- --------
Net operating expenses $ 2,890 $ 4,927 (41%) $ 6,305 $ 10,219 (38%)
======= ======= ======= ========
Customer operations and support consists primarily of data center operations,
software maintenance agreements for the Company's core network and customer
support costs. Customer operations and support costs decreased for the three and
six month periods ended January 31, 2002, compared to the same periods last
year, primarily due to the cost reductions associated with the Company's
restructuring. Management expects customer operations and support costs to
continue to be lower than last year for the remainder of fiscal 2002 due to the
cost containment efforts instituted by the restructuring.
Selling, general and administrative expenses ("SG&A") decreased for the three
and six month periods ended January 31, 2002, compared to the same periods last
year, primarily due to the cost reductions associated with the Company's
restructuring. SG&A, as a percentage of revenue, decreased from 54% for the six
month period ended January 31, 2001 to 49% for the six month period ended
January 31, 2002. Management expects costs in SG&A to continue to be lower than
last year for the remainder of fiscal 2002 due to the cost containment efforts
instituted by the restructuring.
The Company's technical staff (in-house and contracted) performs both software
development and technical support and software customization and data conversion
services for customer applications. Therefore, management expects fluctuations
between software customization and data conversion services and development and
technical support expenses quarter to quarter, as the mix of development and
customization activities will change based on customer requirements. Software
development and technical support costs decreased for the three and six month
periods ended January 31, 2002, compared to the same periods last year,
primarily due to the reduction of resources related to the Company's
communications products as a result of the restructuring. Management expects
software development and technical support costs to continue to be lower than
the previous year for the remainder of fiscal 2002 due to the cost containment
efforts instituted by the restructuring.
Capitalized software product costs represented 36% of software development and
technical support for the six month period ended January 31, 2002, compared to
56% for the same period last year. Management expects capitalized software
product costs to fluctuate from quarter to quarter depending on the deployment
of the Company's resources between early stage research, software development
available for capitalization, data conversion, customer customizations and
maintenance and technical support.
Depreciation and amortization expense decreased significantly for the three and
six month periods ended January 31, 2002, compared to the same periods last
year. Management expects depreciation and amortization to continue to be
significantly lower than the previous year for the remainder of fiscal 2002 due
to the write-off of long-lived assets related to the Company's network platform
at the end of fiscal 2001.
12
OTHER ITEMS
Earnings improved 104% from a loss of $2,738,000 for the six month period ended
January 31, 2001, to net income of $97,000 for the six month period ended
January 31, 2002. The substantial improvement in earnings is attributable to the
restructuring, which focused the Company on its core catalog business and
reduced both cash and non-cash expenses to bring them in line with our revenues.
Interest paid or accrued for payment decreased for the six month period ended
January 31, 2002, compared to the same period last year, because the Company
paid off $1,132,000 of debt and capital lease obligations since January 31,
2001. Non-cash interest expense of approximately $410,000 was incurred for each
of the six month periods ended January 31, 2001 and 2002 due to debt discount
amortization for the Debenture sold to RGC in April 2000.
Since December 1995, the Company has had a formal and aggressive business
development program aimed at identifying, evaluating and closing acquisitions
that augment and strengthen the Company's market position, product offerings,
and personnel resources. Since the program's inception, four acquisitions have
been completed, all of which were fully integrated into the Company's operations
prior to fiscal year 2000. The business development program is still a strong
component of the Company's growth strategy.
LIQUIDITY AND CAPITAL RESOURCES
The following table sets forth, for the periods indicated, certain cash flow
information derived from the Company's unaudited financial statements.
CASH FLOW INFORMATION
(IN THOUSANDS)
THREE MONTHS ENDED SIX MONTHS ENDED
JANUARY 31 JANUARY 31 PERCENT
2002 2001 2002 2001 CHANGE
----- ------- ------- ------- -------
Net cash provided by operating activities
before changes in working capital $ 728 $ 183 298% $ 1,472 $ 180 718%
Net cash used in investing activities (172) (500) 66% (430) (950) 55%
----- ------- ------- -------
Subtotal 556 (317) 275% 1,042 (770) 235%
Effect of net changes in working capital (54) 1,130 (105%) (188) 1,543 (112%)
----- ------- ------- -------
Net cash provided by operating and
investing activities $ 502 $ 813 (38%) $ 854 $ 773 10%
===== ======= ======= =======
Net cash provided by operating activities before changes in working capital
increased for the three and six month periods ended January 31, 2002, compared
to the same periods last year, due to the reduction in cash expenses related to
the Company's restructuring. Net cash used in investing activities decreased for
the three and six month periods ended January 31, 2002, compared to the same
periods last year, primarily due to decreased costs attributable to the
development of the Company's communications software. The effect of net changes
in working capital is dependent on the timing of payroll and other cash
disbursements, accruals and the timing of invoices and may vary significantly
from quarter to quarter. Management expects the summation of cash provided by
operating activities and used in investing activities to be positive for the
fiscal year ended July 31, 2002, however, there can be no assurance that this
result will be ultimately achieved.
At January 31, 2002, the Company had cash of approximately $490,000 compared to
approximately $313,000 at July 31, 2001.
13
The following table sets forth, for the periods indicated, certain information
related to the Company's debt derived from the Company's unaudited financial
statements.
DEBT SCHEDULE
(IN THOUSANDS)
JANUARY 31 JULY 31
2002 2001 NET
(UNAUDITED) (AUDITED) CHANGE
----------- --------- ------
Debt to Shareholder:
Current portion of line of credit $ -- $ 200 $(200)
Current portion of notes payable 222 333 (111)
Long-term portion of notes payable -- 56 (56)
Debt discount (common stock warrants) (23) (41) 18
------- ------- -----
Total Debt to Shareholder 199 548 (349)
Subordinated Debenture:
Notes payable* 4,000 4,000 --
Debt discount (common stock warrants and options) (981) (1,373) 392
------- ------- -----
Total Subordinated Debenture 3,019 2,627 392
Other Debt:
Current portion of notes payable other 102 275 (173)
Long-term notes payable other 30 78 (48)
------- ------- -----
Total Other Debt 132 353 (221)
------- ------- -----
Total Debt $ 3,350 $ 3,528 $(178)
======= ======= =====
* The debenture includes a condition which was in default due to the
Company's delisting from Nasdaq, which gives RGC the right to call the
debenture, although they have not actually done so.
On April 27, 2000, the Company issued and sold pursuant to a Securities Purchase
Agreement, dated as of April 25, 2000, by and among the Company and RGC
International Investors, LDC (the "Investor"), (i) a convertible subordinated
debenture in the amount of $4,000,000 due on April 27, 2003 (the "Debenture"),
and convertible into shares of the Company's common stock, (ii) warrants to
purchase 600,000 shares of Common Stock (the "Warrants"), and (iii) an
investment option to purchase 800,000 shares of Common Stock (the "Investment
Option"). The Investment Option expired on October 27, 2001 and the Warrants
expire on April 27, 2005. The Debenture is convertible into Common Stock at $4
per share and the Warrants are exercisable at $6 per share. The Company is
required to maintain listing of its common stock on the Nasdaq National Market,
the Nasdaq Small Cap Market, the New York Stock Exchange or the American Stock
Exchange; failure to meet this requirement results in the Debenture becoming
fully due at 130% of principal and accrued interest, as well as an increase in
the interest rate from 7% to 17%. At any time after October 27, 2000, the
Company can require the Investor to convert the amount owed under the Debenture
into Common Stock at $4.00 per share provided that: (i) the closing bid price of
the Common Stock has been greater than $6.60 for twenty (20) consecutive trading
days and (ii) the Company's resale registration statement has been effective for
at least three (3) months. As long as $500,000 or more principal amount of the
Debenture is outstanding, the Company agreed not to: (i) pay any dividends or
make any other distribution on our common stock, other than stock dividends and
stock splits; (ii) repurchase or redeem any shares of our capital stock, except
in exchange for common stock or preferred stock; (iii) incur or assume any
liability for borrowed money, except our existing debt, debt from a bona fide
financial lending institution, indebtedness to trade creditors, borrowings used
to repay the debenture, indebtedness assumed or incurred in connection with the
acquisition of a business, product, license or other asset, refinancing of any
of the above, and indebtedness that is subordinate to the debenture; (iv) sell
or otherwise dispose of assets outside the normal course of business, except the
sale of a business, product, license or other asset that our board of directors
determines is in the best interests of us and our shareholders, and sales of
assets with a value not exceeding $500,000 in any 12-month period following the
issuance of the debenture; (v) lend money or make advances to any person not in
the ordinary course of business, except loans to subsidiaries or joint ventures
approved by a majority of our independent directors, guarantee another person's
liabilities, except, among other things, guarantees made in connection with the
acquisition of a business, product, license or other asset.
The Company was delisted on July 7, 2001 from the NASDAQ National Market System
but is currently listed on the NASDAQ Bulletin Board Market. The delisting
resulted in a default condition on the RGC debenture, which gives RGC the right
to accelerate the Debenture, although they have not actually done so. If the
Company is unable to negotiate a new debenture or obtain waivers from the
Investor, shareholders could be materially and adversely affected.
ARI has a term loan with WITECH for an original principal amount of $1.0 million
payable in equal monthly principal installments over three years, commencing
November 1, 1999 and which bears interest at prime plus 4.0%. As of March 13,
2002 there was $194,000 outstanding under the WITECH term loan. The only
financial covenant was that ARI maintained a net worth (calculated in accordance
with accounting principles generally accepted in the United States) of at least
$1 million. This net worth covenant was waived as of July 31, 2001 and for the
fiscal year ended July 31, 2002.
14
On September 28, 1999, ARI and RFC Capital Corporation ("RFC") executed a
Receivables Sales Agreement (the "Sale Agreement") establishing a $3.0 million
working capital facility (the "RFC Facility"). The three-year Sale Agreement
allows RFC to purchase up to $3.0 million (the "Purchase Commitment") of ARI's
accounts receivable. The Purchase Commitment may be increased in increments of
$1.0 million upon mutual agreement and a payment by ARI of $10,000 for each $1.0
million increase. Under the Sale Agreement, RFC purchases 90% of eligible
receivables. In connection with the Sale Agreement ARI was required to pay a
Commitment Fee of $45,000 on September 28, 1999, $30,000 on September 28, 2000,
and $15,000 on September 28, 2001. In addition, ARI is obligated to pay a
monthly program fee equal to the greater of (a) $3,000 or (b) the amount of the
purchased but uncollected receivables times the prime rate plus 2%. ARI may
terminate the Sale Agreement prior to three-year term by paying 2.0% of the
Purchase Commitment during the second year, and 1.0% of the Purchase Commitment
during the third year. The RFC Facility expires on September 28, 2002. RFC has
indicated to the Company that the Facility will be extended, although there can
be no assurance that this will occur. As of March 13, 2002, the balance of the
RFC Facility was $650,000.
Management believes that funds generated from operations and the RFC Facility
will be adequate to fund the Company's operations, investments and debt payments
through fiscal 2002 if the RFC Facility is extended and the Debenture is
successfully renegotiated or the necessary waiver is obtained from RGC. If
management is unable to renegotiate the Debenture or obtain the necessary
waiver, the Company will remain in default and owe in excess of $5 million,
which would have a material adverse effect on the Company. The Company does not
expect to be in a position to pay back the Debenture if it is accelerated or at
the scheduled maturity date. Management has restructured the Company to reduce
cash overhead by over $2 million in fiscal 2002. Management is also continually
analyzing its anticipated cash flows under a variety of growth scenarios ranging
from modest contraction to modest growth. Management believes that, provided the
defaults can be cured, either (i) sufficient cash can be generated from the
business to fund operations and a modest level of investment or (ii) that the
cash profile of the business can be further restructured to be self-funding,
although there can be no assurance that these efforts will be successful.
The Company believes that earnings before interest, taxes, depreciation and
amortization ("EBITDA") is generally accepted as providing useful information
regarding a company's ability to service and/or incur debt. EBITDA increased
from $471,000 for the six month period ended January 31, 2001 to $1,739,000 for
the six month period ended January 31,2002 primarily due to reductions in cash
expenses as a result of the restructuring. Management believes that EBITDA will
continue to be positive for the remainder of fiscal 2002, although there can be
no assurance that this will occur.
The Company has included data with respect to EBITDA because it is commonly used
as a measurement of financial performance and by investors to analyze and
compare companies on the basis of operating performance. EBITDA is not a
measurement of financial performance under accounting principles generally
accepted in the United States and should not be considered an alternative to
operating income, as determined in accordance with accounting principles
generally accepted in the United States, as an indicator of our operating
performance, or to cash flows from operating activities, as determined in
accordance with generally accepted generally accepted in the United States, as a
measure of our liquidity. EBITDA is not necessarily comparable with similarly
titled measures for other companies.
FORWARD LOOKING STATEMENTS
Certain statements contained in this Form 10-Q are forward looking statements
including revenue growth, future cash flows and cash generation and sources of
liquidity. Expressions such as "believes," "anticipates," "expects," and similar
expressions are intended to identify such forward looking statements. Several
important factors can cause actual results to materially differ from those
stated or implied in the forward looking statements. Such factors include, but
are not limited to the factors listed on exhibit 99.1 of the Company's annual
report on Form 10-K for the year ended July 31, 2001.
15
PART II - OTHER INFORMATION
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
(a) See Part I, Item 2 Management's discussion and analysis of financial
condition and results of operation under liquidity with respect to
information of the Company's violation of requirements of its debenture with
RGC International Investors, LDC.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Company held its 2001 Annual Meeting of Shareholders on December 13,
2001. The meeting was adjourned because there was not a quorum of votes and
reconvened on January 31, 2002 to report the results of the shareholder
votes.
(b) Votes cast for the ratification of the appointment of Brian E. Dearing to
serve as director until the 2004 Annual Shareholder's Meeting were as
follows:
For 3,359,054
Against 0
Abstained 82,212
Broker Non-Vote 0
Votes cast for the ratification of the appointment of Richard W. Weening to
serve as a director until the 2004 Annual Shareholder's meeting were as
follows:
For 3,368,391
Against 0
Abstained 72,875
Broker Non-Vote 0
Directors whose terms of office continue past the 2001 Annual Meeting of
Shareholders are: Gordon J. Bridge, Ted C. Feierstein, Steven M. Katz
and D. Bruce Merrifeld, Jr.
(c) Votes cast to ratify the appointment of Ernst & Young LLP as the Company's
auditors for the year ending July 31, 2002 were as follows:
For 3,402,256
Against 15,355
Abstained 23,655
Broker Non-Vote 0
16
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ARI Network Services, Inc.
(Registrant)
Date: March 17, 2002 /s/ Brian E. Dearing
-------------------------------
Brian E. Dearing, Chairman
of the Board
/s/ Timothy Sherlock
-------------------------------
Timothy Sherlock, Chief
Financial Officer
17