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 April 30, 2002
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________________ to ___________________
Commission file number 000-19608
ARI Network Services, Inc.
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(Exact name of registrant as specified in its charter.)
WISCONSIN 39-1388360
------------------------------- ----------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
330 E. Kilbourn Avenue, Milwaukee, Wisconsin 53202
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(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 June 12, 2002 there were 6,223,342 shares of the registrant's shares
outstanding.
ARI NETWORK SERVICES, INC.
FORM 10-Q
FOR THE THREE MONTHS ENDED APRIL 30, 2002
INDEX
PART I - FINANCIAL INFORMATION
Page
Item 1 Financial statements
Condensed balance sheets - April 30, 2002 and July 31, 2001 3-4
Condensed statements of operations for the three and nine
months ended April 30, 2002 and 2001 5
Condensed statements of cash flows for the nine months ended
April 30, 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
Signatures
2
ARI NETWORK SERVICES, INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(Unaudited)
ASSETS APRIL 30 JULY 31
2002 2001
------- -------
Current assets:
Cash $ 1,343 $ 313
Trade receivables, less allowance for doubtful accounts of $502
at April 30, 2002 and $757 at July 31, 2001 1,358 2,084
Prepaid expenses and other 45 140
------- -------
Total current assets 2,746 2,537
Equipment and leasehold improvements:
Computer equipment 4,394 4,394
Leasehold improvements 239 239
Furniture and equipment 1,024 1,000
------- -------
5,657 5,633
Less accumulated depreciation and amortization 5,445 5,293
------- -------
Net equipment and leasehold improvements 212 340
Goodwill, less accumulated amortization of $64 at April 30,
2002 and $54 at July 31,2001 5 15
Deferred financing costs, less accumulated amortization of $298 at
April 30, 2002 and $203 at July 31, 2001 112 207
Capitalized software development 24,116 23,533
Less accumulated amortization 20,777 19,572
------- -------
Net capitalized software development 3,339 3,961
------- -------
TOTAL ASSETS $ 6,414 $ 7,060
======= =======
3
ARI NETWORK SERVICES, INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(Unaudited)
LIABILITIES AND SHAREHOLDERS' DEFICIT APRIL 30 JULY 31
2002 2001
--------- ---------
Current liabilities:
Current portion of notes payable to shareholder $ 152 $ 333
Current portion of notes payable 3,312 2,902
Current portion of line of credit to shareholder - 200
RFC financed receivables facility 660 469
Accounts payable 353 482
Deferred revenue 4,668 4,811
Accrued payroll and related liabilities 1,355 1,487
Other accrued liabilities 1,102 1,499
Current portion of capital lease obligations 175 173
--------- ---------
Total current liabilities 11,777 12,356
Long term liabilities:
Notes payable to shareholder - 15
Notes payable 8 78
Capital lease obligations 47 158
Accrued restructuring costs 303 303
--------- ---------
Total long term liabilities 358 554
Shareholders' deficit:
Cumulative preferred stock, par value $.001 per share, 1,000,000 shares
authorized; 20,350 shares issued and outstanding at April 30, 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 April 30, 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 (99,997) (100,112)
--------- ---------
Total shareholders' deficit (5,721) (5,850)
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT $ 6,414 $ 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 NINE MONTHS ENDED
APRIL 30 APRIL 30
2002 2001 2002 2001
-------- -------- -------- --------
Net revenues:
Subscriptions, support and other services fees $ 2,106 $ 2,515 $ 6,789 $ 7,617
Software licenses and renewals 637 823 2,128 2,424
Professional services 665 538 1,629 2,063
-------- -------- -------- --------
3,408 3,876 10,546 12,104
Operating expenses:
Cost of products and services sold:
Subscriptions, support and other services fees 30 579 181 1,269
Software licenses and renewals * 435 529 1,254 2,403
Professional services 266 269 626 1,173
-------- -------- -------- --------
731 1,377 2,061 4,845
Depreciation and amortization (exclusive of amortization of
software products included in cost of products and
services sold) 55 382 162 1,152
Customer operations and support 308 423 902 1,236
Selling, general and administrative 1,657 2,407 5,174 6,840
Software development and technical support 457 955 1,644 2,630
-------- -------- -------- --------
Operating expenses before amounts capitalized 3,208 5,544 9,943 16,703
Less capitalized portion (153) (556) (583) (1,496)
-------- -------- -------- --------
Net operating expenses 3,055 4,988 9,360 15,207
-------- -------- -------- --------
Operating income (loss) 353 (1,112) 1,186 (3,103)
Other expense:
Interest expense (342) (366) (1,082) (1,133)
Other, net 7 (24) 11 (4)
-------- -------- -------- --------
Total other expense (335) (390) (1,071) (1,137)
-------- -------- -------- --------
Net income (loss) $ 18 $ (1,502) $ 115 $ (4,240)
======== ======== ======== ========
Average common shares outstanding 6,223 6,184 6,201 6,174
Basic and diluted net income (loss) per share $ 0.00 ($ 0.24) $ 0.02 ($ 0.69)
======== ======== ======== ========
See notes to unaudited condensed financial statements.
* Includes amortization of software products of $410, $764, $1,205 and $2,436
and excludes other depreciation and amortization shown separately.
5
ARI NETWORK SERVICES, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
APRIL 30
2002 2001
------- -------
OPERATING ACTIVITIES
Net income (loss) $ 115 $(4,240)
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Amortization of network platform - 428
Amortization of software products 1,205 2,436
Amortization of goodwill 10 493
Amortization of deferred financing costs and debt discount 710 713
Depreciation and other amortization 152 231
Net change in receivables, prepaid expenses and other
current assets 821 757
Net change in accounts payable, deferred revenue,
accrued liabilities and RFC financed receivables facility (610) 1,129
------- -------
Net cash provided by operating activities 2,403 1,947
INVESTING ACTIVITIES
Purchase of equipment and leasehold improvements - (33)
Software product costs capitalized (583) (1,496)
------- -------
Net cash used in investing activities (583) (1,529)
FINANCING ACTIVITIES
Repayments under line of credit (200) -
Payments under notes payable (471) (628)
Payments of capital lease obligations (133) (112)
Debt issuance costs incurred - (39)
Proceeds from issuance of common stock 14 14
------- -------
Net cash used in financing activities (790) (765)
------- -------
Net increase (decrease) in cash 1,030 (347)
Cash at beginning of period 313 563
------- -------
Cash at end of period $ 1,343 $ 216
======= =======
Cash paid for interest $ 372 $ 420
======= =======
NONCASH INVESTING AND FINANCING ACTIVITIES
Capital lease obligations incurred for:
Computer equipment $ 24 $ 154
See notes to unaudited condensed financial statements.
6
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
APRIL 30, 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 nine months ended April 30, 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 $1,226,000 at April 30,
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 April 30, 2002 decreased $468,000 or 12%
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 101% from a net loss of $1,502,000, or $0.24 per
share for the quarter ended April 30, 2001 to net income of $18,000 or $0.00 per
share for the quarter ended April 30, 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 we may incur net losses 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 electronic catalog technology-enabled
business solutions for sales, service and life cycle product support in the
manufactured equipment market. The Company currently serves approximately 100
lines of manufactured equipment and 25,000 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, until February
28,2002, publishing. As the Company focuses on its core businesses in the
Equipment industry, revenues in the non-equipment industry are expected to
continue to decline 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 NINE MONTHS ENDED
INDUSTRY SECTOR APRIL 30 PERCENT APRIL 30 PERCENT
2002 2001 CHANGE 2002 2001 CHANGE
------- ------- ------- -------
EQUIPMENT INDUSTRY
North American
Recurring $ 1,994 $ 1,835 9% $ 5,877 $ 5,616 5%
Non-recurring 681 1,002 (32%) 1,841 2,576 (29%)
------- ------- ------- -------
Subtotal 2,675 2,837 (6%) 7,718 8,192 (6%)
Non-North American
Recurring 202 248 (19%) 680 795 (14%)
Non-recurring 103 48 115% 226 255 (11%)
------- ------- ------- -------
Subtotal 305 296 3% 906 1,050 (14%)
Total Equipment Industry
Recurring 2,196 2,083 5% 6,557 6,411 2%
Non-recurring 784 1,050 (25%) 2,067 2,831 (27%)
------- ------- ------- -------
Subtotal 2,980 3,133 (5%) 8,624 9,242 (7%)
NON-EQUIPMENT INDUSTRY
Recurring 428 743 (42%) 1,914 2,815 (32%)
Non-recurring - - - 8 47 (83%)
------- ------- ------- -------
Subtotal 428 743 (42%) 1,922 2,862 (33%)
TOTAL REVENUE
Recurring 2,624 2,826 (7%) 8,471 9,226 (8%)
Non-recurring 784 1,050 (25%) 2,075 2,878 (28%)
------- ------- ------- -------
Grand Total $ 3,408 $ 3,876 (12%) $10,546 $12,104 (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 80% for the nine months
ended April 30, 2002 compared to 76% 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 compared to last year.
Equipment Industry
The Equipment Industry comprises several vertical markets including outdoor
power, recreation vehicles, motorcycles, auto and truck parts after-market, 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 76% for the nine months ended
April 30, 2001 to 82% for the nine months ended April 30, 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 year over year decline in
non-Equipment Industry revenues.
North American
Recurring revenues in the North American Equipment Industry increased for
the three and nine month periods ended April 30, 2002, compared to the same
periods last year, primarily due to the increase in the base revenue from
the Company's catalog products. Non-recurring revenues in the North American
Equipment Industry decreased for the three and nine month periods ended
April 30, 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 nine month periods ended April 30, 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 increased for the three month period ended April
30, 2002, compared to the same period last year, primarily due to an
increase in new customer contracts.
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 until February 28,
2002 and until December 31, 2000, database management services to the railroad
industry. Revenues in the non-Equipment Industry decreased for the three and
nine month periods ended April 30, 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 and newspaper publishing businesses. 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
depended 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
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 NINE MONTHS ENDED
APRIL 30 PERCENT APRIL 30 PERCENT
2002 2001 CHANGE 2002 2001 CHANGE
----------- ----------- ----------- ---------
Subscriptions, support and other
services fees
Revenue $ 2,106 $ 2,515 (16%) $ 6,789 $ 7,617 (11%)
Cost of revenue 30 579 (95%) 181 1,269 (86%)
Cost of revenue as a percent of revenue 1% 23% 3% 17%
Software licenses and renewals
Revenue 637 823 (23%) 2,128 2,424 (12%)
Cost of revenue 435 529 (18%) 1,254 2,403 (48%)
Cost of revenue as a percent of revenue 68% 64% 59% 99%
Professional services
Revenue 665 538 24% 1,629 2,063 (21%)
Cost of revenue 266 269 (1%) 626 1,173 (47%)
Cost of revenue as a percent of revenue 40% 50% 38% 57%
Total
Revenue $ 3,408 $ 3,876 (12%) $ 10,546 $ 12,104 (13%)
Cost of revenue 731 1,377 (47%) 2,061 4,845 (57%)
Cost of revenue as a percent of revenue 21% 36% 20% 40%
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 nine month periods ended April 30, 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
license and renewals decreased for the three and nine month periods ending April
30, 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. Cost of software licenses and renewals as a percentage
of revenue increased slightly for the three month period ended April 30, 2002,
compared to the same period last year, and decreased for the nine month period
ended April 30, 2002, compared to the same period last year. Gross margins from
software licenses and renewals will fluctuate from quarter to quarter based on
the level of revenue, while costs remain relatively the same as amortization of
software is not related to the level of revenue generated from software license
and renewals.
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 nine month periods ended April 30, 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 NINE MONTHS ENDED
APRIL 30 PERCENT APRIL 30 PERCENT
2002 2001 CHANGE 2002 2001 CHANGE
-------- -------- -------- --------
Cost of products and services sold $ 731 $ 1,377 (47%) $ 2,061 $ 4,845 (57%)
Customer operations and support 308 423 (27%) 902 1,236 (27%)
Selling, general and administrative 1,657 2,407 (31%) 5,174 6,840 (24%)
Software development and technical
support 457 955 (52%) 1,644 2,630 (37%)
Less capitalized portion (153) (556) (72%) (583) (1,496) (61%)
Depreciation and amortization 55 382 (86%) 162 1,152 (86%)
-------- -------- -------- --------
Net operating expenses $ 3,055 $ 4,988 (39%) $ 9,360 $ 15,207 (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
nine month periods ended April 30, 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 nine month periods ended April 30, 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 57% for the nine
month period ended April 30, 2001 to 49% for the nine month period ended April
30, 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 nine month
periods ended April 30, 2002, compared to the same periods last year, primarily
due to the reduction of resources 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 35% of software development and
technical support for the nine month period ended April 30, 2002, compared to
57% 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
nine month periods ended April 30, 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 from a loss of $4,240,000 for the nine month period ended
April 30, 2001, to net income of $115,000 for the nine month period ended April
30, 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 nine month period ended
April 30, 2002, compared to the same period last year because the Company paid
off $806,000 of debt and capital lease obligations since April 30, 2001.
Non-cash interest expense of approximately $615,000 was incurred for each of the
nine month periods ended April 30, 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 an
important 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 NINE MONTHS ENDED
APRIL 30 PERCENT APRIL 30 PERCENT
2002 2001 CHANGE 2002 2001 CHANGE
------- ------- ------- -------
Net cash provided by operating activities
before changes in working capital $ 720 $ (119) 705% $ 2,192 $ 61 3493%
Net cash used in investing activities (153) (579) 74% (583) (1,529) 62%
------- ------- ------- -------
Subtotal 567 (698) 181% 1,609 (1,468) 210%
Effect of net changes in working capital 399 343 16% 211 1,886 (89%)
------- ------- ------- -------
Net cash provided by operating and
investing activities $ 966 $ (355) 372% $ 1,820 $ 418 335%
======= ======= ======= =======
Net cash provided by operating activities before changes in working capital
increased significantly for the three and nine month periods ended April 30,
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 nine month periods ended April 30, 2002,
compared to the same periods last year, primarily due to decreased costs
attributable to the Company's restructuring. 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 continue to be positive
for the remainder of the fiscal year ended July 31, 2002 and beyond, however,
there can be no assurance that this result will be ultimately achieved.
At April 30, 2002, the Company had cash of approximately $1,343,000 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)
APRIL 30 JULY 31
2002 2001 NET
(UNAUDITED) (AUDITED) CHANGE
------- ------- -------
Debt to Shareholder:
Current portion of line of credit $ - $ 200 $ (200)
Current portion of notes payable 167 333 (166)
Long-term portion of notes payable - 56 (56)
Debt discount (common stock warrants) (15) (41) 26
------- ------- -------
Total Debt to Shareholder 152 548 (396)
Subordinated Debenture:
Notes payable * 4,000 4,000 -
Debt discount (common stock warrants and options) (784) (1,373) 589
------- ------- -------
Total Subordinated Debenture 3,216 2,627 589
Other Debt:
Current portion of notes payable other 96 275 (179)
Long-term notes payable other 8 78 (70)
------- ------- -------
Total Other Debt 104 353 (249)
------- ------- -------
Total Debt $ 3,472 $ 3,528 $ (56)
======= ======= =======
* 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 June 12,
2002 there was $111,000 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 can be extended, although there can
be no assurance that this will occur. As of June 7, 2002, the balance of the RFC
Facility was $156,000.
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 2003 if 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 could 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 $481,000 for the nine month period ended April 30, 2001 to $2,564,000 for
the nine month period ended April 30,2002 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 and beyond, 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 projected 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.
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: June 14, 2002 /s/ Brian E. Dearing
-----------------------------------------
Brian E. Dearing, Chairman of the Board
/s/ Timothy Sherlock
-----------------------------------------
Timothy Sherlock, Chief Financial Officer
17