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 October 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
---------------- ----------------
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)
11425 W. Lake Park Drive, Milwaukee, Wisconsin 53224
----------------------------------------------------
(Address of principal executive office)
Registrant's telephone number, including area code (414) 973-4300
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
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YES NO X
As of December 10, 2002 there were 6,438,625 shares of the registrant's shares
outstanding.
ARI NETWORK SERVICES, INC.
FORM 10-Q
FOR THE THREE MONTHS ENDED OCTOBER 31, 2002
INDEX
PART I - FINANCIAL INFORMATION
Page
----
Item 1 Financial statements
Condensed balance sheets - October 31, 2002 and July 31, 2002 3-4
Condensed statements of operations for the three months ended
October 31, 2002 and 2001 5
Condensed statements of cash flows for the three months ended
October 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 8-15
Item 3 Quantitative and qualitative disclosures about market risk 15
Item 4 Controls and procedures 15
PART II - OTHER INFORMATION
Item 1 Legal proceedings 16
Item 3 Defaults upon senior securities 16
Item 6 Exhibits and reports on Form 8-k 16
Signatures
Certifications
2
ARI NETWORK SERVICES, INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(Unaudited)
ASSETS OCTOBER 31 JULY 31
2002 2002
---------- ----------
Current assets:
Cash $ 701 $ 879
Trade receivables, less allowance for doubtful accounts of $146
at October 31, 2002 and $140 at July 31, 2002 1,563 1,743
Prepaid expenses and other 131 84
---------- ----------
Total current assets 2,395 2,706
Equipment and leasehold improvements:
Computer equipment 4,394 4,394
Leasehold improvements 73 73
Furniture and equipment 1,295 1,292
---------- ----------
5,762 5,759
Less accumulated depreciation and amortization 5,321 5,262
---------- ----------
Net equipment and leasehold improvements 441 497
Other assets 73 105
Capitalized software product costs 23,745 23,585
Less accumulated amortization 20,938 20,519
---------- ----------
Net capitalized software product costs 2,807 3,066
---------- ----------
TOTAL ASSETS $ 5,716 $ 6,374
========== ==========
3
ARI NETWORK SERVICES, INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(Unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) OCTOBER 31 JULY 31
2002 2002
---------- ----------
Current liabilities:
Current portion of notes payable to shareholder $ -- $ 50
Current portion of notes payable 3,665 3,490
RFC financed receivables facility 580 360
Accounts payable 567 293
Deferred revenue 4,346 4,619
Accrued payroll and related liabilities 1,094 1,140
Other accrued liabilities 928 1,042
Current portion of capital lease obligations 151 116
---------- ----------
Total current liabilities 11,419 11,022
Long term liabilities:
Capital lease obligations 14 26
Other long term liabilities 535 531
---------- ----------
Total long term liabilities 545 561
Shareholders' equity (deficit):
Cumulative preferred stock, par value $.001 per share,
1,000,000 shares authorized; 20,350 shares issued and
outstanding at October 31, 2002 and July 31, 2002 -- --
Common stock, par value $.001 per share, 25,000,000 shares
authorized; 6,329,301 shares issued and outstanding
at October 31, 2002 and July 31, 2002 6 6
Common stock warrants and options 2,459 2,459
Additional paid-in-capital 91,853 91,853
Accumulated deficit (100,169) (99,924)
---------- ----------
Total shareholders' equity (deficit) (5,851) (5,606)
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) $ 5,716 $ 6,374
========== ==========
See notes to unaudited condensed financial statements.
Note: The balance sheet at July 31, 2002 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
OCTOBER 31
2002 2001
------- -------
Net revenues:
Subscriptions, support and other services fees $ 1,991 $ 2,455
Software licenses and renewals 557 820
Professional services 507 545
------- -------
3,055 3,820
Operating expenses:
Cost of products and services sold:
Subscriptions, support and other services fees 189 209
Software licenses and renewals * 425 396
Professional services 150 208
------- -------
764 813
Depreciation and amortization (exclusive of amortization of
software products included in cost of products and
services sold) 59 54
Customer operations and support 310 303
Selling, general and administrative 1,514 1,857
Software development and technical support 475 646
------- -------
Operating expenses before amounts capitalized 3,122 3,673
Less capitalized portion (160) (258)
------- -------
Net operating expenses 2,962 3,415
------- -------
Operating income 93 405
Other expense:
Interest expense (335) (329)
Other, net (3) (13)
------- -------
Total other expense (338) (342)
------- -------
Net income (loss) $ (245) $ 63
======= =======
Average common shares outstanding 6,329 6,184
Basic and diluted net income (loss) per share $ (0.04) $ 0.01
======= =======
See notes to unaudited condensed financial statements.
* Includes amortization of software products of $419 and $390 and excludes
other depreciation and amortization shown separately
5
ARI NETWORK SERVICES, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
OCTOBER 31
2002 2001
------- -------
OPERATING ACTIVITIES
Net income (loss) $ (245) $ 63
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Amortization of software products 419 390
Amortization of goodwill -- 3
Amortization of deferred financing costs and debt discount 237 237
Depreciation and other amortization 59 51
Net change in receivables, prepaid expenses and other
current assets 133 500
Net change in accounts payable, deferred revenue,
accrued liabilities and long term liabilities (491) (634)
------- -------
Net cash provided by operating activities 112 610
INVESTING ACTIVITIES
Purchase of equipment and leasehold improvements (3) --
Software product costs capitalized (160) (258)
------- -------
Net cash used in investing activities (163) (258)
FINANCING ACTIVITIES
Repayments under line of credit -- (102)
Payments under notes payable (80) (221)
Payments of capital lease obligations (47) (45)
------- -------
Net cash used in financing activities (127) (368)
------- -------
Net decrease in cash (178) (16)
Cash at beginning of period 879 313
------- -------
Cash at end of period $ 701 $ 297
======= =======
Cash paid for interest $ 29 $ 118
======= =======
See notes to unaudited condensed financial statements.
6
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
OCTOBER 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 months ended October 31, 2002 are not necessarily indicative of the
results that may be expected for the fiscal year ending July 31, 2003. 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,
2002.
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 $1,303,000 at October
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.
5. SUBSEQUENT EVENTS
On August 28, 2002, RGC, International Investors, LDC (RGC) orally offered to
enter into an eight month "stand-still" agreement with the Company under which
RGC would not exercise any claimed acceleration rights under the Company's
convertible subordinated Debenture due in 2003 (Debenture) in return for an
immediate payment of $500,000 by the Company and an option to buy back the
Debenture and all other securities sold to RGC for $1 million at any time during
the eight-month stand-still period. On September 13, 2002, the Company accepted
RGC's offer.
On November 1, 2002, the Company received a letter from RGC's legal counsel
stating that no such stand-still agreement exists and that RGC had sold its
interest in the Debenture and assigned its rights and obligations on or around
September 27, 2002.
The Company filed a lawsuit on November 8, 2002 against RGC and three alleged
transferees of the Debenture to enforce the terms of the stand-still and
buy-back agreement. RGC denies that any such agreement exists. An agent for the
alleged transferees of the Debenture has contacted the Company with demands that
are inconsistent with the terms of the stand-still and buy-back agreement and
has submitted a purported demand to accelerate the maturity of the Debenture.
The Company intends to vigorously contest the validity of this demand. The
pending litigation and the purported demand may have a significant impact on the
Company's results of operations in fiscal 2003.
7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Total revenue for the quarter ended October 31, 2002 decreased $765,000 or 20%
compared to the same period last year, primarily due to the expected decline in
non-Equipment Industry revenue and a decrease in new sales in the Equipment
Industry. Earnings decreased from net income of $63,000, or $0.01 per share for
the quarter ended October 31, 2001 to a net loss of $245,000 or $0.04 per share
for the quarter ended October 31, 2002. Management believes that, due to cost
containment efforts, the Company will continue to generate enough cash from
operations to fund operations, investments and debt payments in fiscal 2003,
provided the Debenture is satisfactorily resolved and/or restructured. The
Company may incur net losses for the remainder of fiscal 2003 and the results of
the lawsuit regarding the debenture may have a significant impact on earnings.
See "Liquidity and Capital Resources" and "Forward Looking Statements."
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 Debts
The Company maintains an allowance 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 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.
8
Impairment of Long-Lived Assets
Equipment and leasehold improvements and capitalized software product costs 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.
REVENUES
The Company is a leading provider of electronic catalog-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,
template-based website services and communication or transaction services. The
Company's primary product line is electronic cataloging the other products are
supplementary offerings that leverage its position in the catalog market.
As part of its historical business practice, the Company continues to provide
electronic directory and transaction services to U.S. and Canadian agribusiness
industry. 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 2003.
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 industries and by product category within the Equipment
Industry.
The following tables set 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
INDUSTRY SECTOR: OCTOBER 31 PERCENT
2002 2001 CHANGE
------ ------ -------
EQUIPMENT INDUSTRY
North American
Recurring $1,938 $1,964 (1%)
Non-recurring 448 737 (39%)
------ ------
Subtotal 2,386 2,701 (12%)
Non-North American
Recurring 273 218 25%
Non-recurring 47 98 (52%)
------ ------
Subtotal 320 316 1%
Total Equipment Industry
Recurring 2,211 2,182 1%
Non-recurring 495 835 (41%)
------ ------
Subtotal 2,706 3,017 (10%)
NON-EQUIPMENT INDUSTRY
Recurring 349 803 (57%)
Non-recurring -- -- --
------ ------
Subtotal 349 803 (57%)
TOTAL REVENUE
Recurring 2,560 2,985 (14%)
Non-recurring 495 835 (41%)
------ ------
Grand Total $3,055 $3,820 (20%)
====== ======
9
REVENUE BY PRODUCT IN THE EQUIPMENT INDUSTRY
(IN THOUSANDS)
THREE MONTHS ENDED
PRODUCT: OCTOBER 31 PERCENT
2002 2001 CHANGE
------ ------ -------
EQUIPMENT INDUSTRY
Catalog and related
Recurring $2,114 $1,945 9%
Non-recurring 485 777 (38%)
------ ------
Subtotal 2,599 2,722 (5%)
Communications
Recurring 97 237 (59%)
Non-recurring 10 58 (83%)
------ ------
Subtotal 107 295 (64%)
------ ------
Total Equipment Industry $2,706 $3,017 (10%)
====== ======
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 84% for the three
months ended October 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 2003 compared to the
prior year.
Equipment Industry
The Equipment Industry has been a growing percentage of the Company's revenue
over the past five years and is composed of 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 79%
for the three months ended October 31, 2001 to 89% for the three months ended
October 31, 2002.
North American
Recurring revenues in the North American Equipment Industry decreased
marginally for the three month period ended October 31, 2002, compared
to the same period last year, primarily due to a decrease in the base
revenue from the Company's communication products. Non-recurring
revenues in the North American Equipment Industry decreased for the
three month period ended October 31, 2002, compared to the same period
last year, primarily due to fewer new customer contracts and
customization projects because of the decline in the manufacturing
sector of the economy.
Non-North American
Recurring revenues in the non-North American Equipment Industry
increased for the three month period ended October 31, 2002, compared
to the same period last year, primarily due to an increase in the base
revenue of catalog customers. Non-recurring revenues in the non-North
American Equipment Industry decreased for the three month period ended
October 31, 2002, compared to the same period last year, primarily due
to less revenue from new customer contracts.
10
Catalog and Related Products
Recurring revenues from the Company's catalog and related products in
the Equipment Industry increased for the three month period ended
October 31, 2002, compared to the same period last year, primarily due
to an increase in the Company's base revenue of catalog customers and
an increase in the volume of catalogs purchased by dealers. Management
expects recurring catalog and related revenues to continue at the same
level or higher in both the North American and non-North American
Equipment Industry for the remainder of fiscal 2003, as the Company
continues to focus attention and resources on its catalog products, but
that non-recurring catalog and related revenue growth may be delayed
until the economy improves.
Communications Products
Revenues from the Company's communications products decreased for the
three months ended October 31, 2002, compared to the same period last
year, primarily due to a decline in the base revenue of communications
customers. The Company has focused the business primarily on its
catalog products. Management expects revenues from communications
products will be a declining percentage of total revenue for the
remainder of fiscal 2003.
Non-Equipment Industry Business
The Company's business outside of the Equipment Industry includes sales of
database management and electronic communication services to the agricultural
inputs industry and, for part of fiscal 2002, the on-line provision of
information for republication to the non-daily newspaper publishing industry.
Revenues in this business have decreased for the three months ended October 31,
2002, compared to the same period last year. The Company's five-year contract
with the Associated Press expired in February 2002. Revenue from this contract
was approximately $384,000 for the three months ended October 31, 2001.
Management expects revenue from its database management services to the
agricultural inputs industry, which is approximately $500,000 on an annual
basis, to decline significantly in the second half of fiscal 2003 due to
competitive pressure.
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
OCTOBER 31 PERCENT
2002 2001 CHANGE
------ ------
Subscriptions, support and other services fees
Revenue $1,991 $2,455 (19%)
Cost of revenue 189 209 (9%)
Cost of revenue as a percent of revenue 10% 9%
Software licenses and renewals
Revenue 557 820 (32%)
Cost of revenue 425 396 7%
Cost of revenue as a percent of revenue 76% 48%
Professional services
Revenue 507 545 (7%)
Cost of revenue 150 208 (28%)
Cost of revenue as a percent of revenue 30% 38%
Total
Revenue $3,055 $3,820 (20%)
Cost of revenue 764 813 (6%)
Cost of revenue as a percent of revenue 25% 21%
11
Cost of subscriptions, support and other services fees consists primarily of
telecommunications and catalog replication and distribution costs and, during
fiscal 2001, royalties on revenues in the publishing industry. Cost of
subscriptions, support and other services fees as a percentage of revenue
increased 1% for the three month period ended October 31, 2002, compared to the
same period last year. Management expects gross margins, as a percent of revenue
from subscriptions, support and other services fees, to be relatively consistent
from quarter to quarter.
Cost of software licenses and renewals consists primarily of amortization of
software products, royalties and software distribution costs. Cost of software
license and renewals as a percentage of revenue increased for the three month
period ended October 31, 2002, compared to the same period last year, primarily
due to lower software license revenues. 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 month period ended October 31, 2002, compared to the same period last
year, primarily due to a decrease in software customization, which has a lower
margin, and an increase in data conversion revenue, which has a higher 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.
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
OCTOBER 31 PERCENT
2002 2001 CHANGE
------ ------
Cost of products and services sold $ 764 $ 813 (6%)
Customer operations and support 310 303 2%
Selling, general and administrative 1,514 1,857 (18%)
Software development and technical support 475 646 (26%)
Less capitalized portion (160) (258) (38%)
Depreciation and amortization 59 54 9%
------ -----
Net operating expenses $2,962 $3,415 (13%)
====== ======
Customer operations and support consists primarily of server room operations,
software maintenance agreements for the Company's core network and customer
support costs. Customer operations and support costs remained relatively the
same for the three month period ended October 31, 2002, compared to the same
period last year. Management expects customer operations and support costs to
continue at relatively the same level for the remainder of fiscal 2003.
Selling, general and administrative expenses ("SG&A") decreased for the three
month period ended October 31, 2002, compared to the same period last year,
primarily due to cost reductions. SG&A, as a percentage of revenue, increased
slightly from 49% for the three month period ended October 31, 2001 to 50% for
the three month period ended October 31, 2002. Management expects costs in SG&A
to continue to be lower than last year for the remainder of fiscal 2003 due to
the cost containment efforts instituted by the Company.
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 month period
ended October 31, 2002, compared to the same period last year, primarily due to
the reduction of resources. Management expects software development and
technical support costs to continue to be lower than the previous year for the
first six months and remain constant for the balance of fiscal 2003.
12
Capitalized software product costs represented 34% of software development and
technical support for the three month period ended October 31, 2002, compared to
40% 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 increased slightly for the three month
period ended October 31, 2002, compared to the same period last year. Management
expects depreciation and amortization to continue at relatively the same level
for the remainder of fiscal 2003.
OTHER ITEMS
Earnings decreased from net income of $63,000 for the three month period ended
October 31, 2001, to a net loss of $245,000 for the three month period ended
October 31, 2002. The decrease in earnings is primarily due to the reduction in
revenue, which was only partially offset by cost reductions. Management expects
operating income and cash to be positive, but earnings to remain negative for
the remainder of fiscal 2003.
Interest paid or accrued for payment increased from $124,000 for the three month
period ended October 31, 2001, to $130,000 for the three month period ended
October 31, 2002. Non-cash interest expense of approximately $205,000 was
incurred for each of the three month periods ended October 31, 2001 and 2002 due
to amortization of debt discount related to the Debenture.
Since December 1995, the Company has had a formal 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
OCTOBER 31 PERCENT
2002 2001 CHANGE
------ ------
Net cash provided by operating activities
before changes in working capital $ 470 $ 744 (37%)
Net cash used in investing activities (163) (258) 37%
----- -----
Subtotal 307 486 (37%)
Effect of net changes in working capital
(358) (134) (167%)
----- -----
Net cash provided by (used in) operating
and investing activities $ (51) $ 352 (114%)
===== =====
Net cash provided by operating activities before changes in working capital
decreased for the three month period ended October 31, 2002, compared to the
same period last year, due to the reduction in revenue. Net cash used in
investing activities decreased for the three month period ended October 31,
2002, compared to the same period last year, due to decreased capitalized
software costs. 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 before changes in working
capital and used in investing activities to continue to be positive for the
remainder of the fiscal year ended July 31, 2003, although there can be no
assurance that this result will be ultimately achieved.
At October 31, 2002, the Company had cash of approximately $701,000 compared to
approximately $879,000 at July 31, 2002.
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)
OCTOBER 31 JULY 31
2002 2002 NET
(UNAUDITED) (AUDITED) CHANGE
----------- ----------- -----------
Debt to Shareholder:
Current portion of notes payable -- 56 (56)
Debt discount (common stock warrants) -- (6) 6
----------- ----------- -----------
Total Debt to Shareholder -- 50 (50)
Subordinated Debenture:
Notes payable * 4,000 4,000 --
Debt discount (common stock warrants and options) (389) (588) 199
----------- ----------- -----------
Total Subordinated Debenture 3,611 199 3,412
Other Debt:
Current portion of notes payable other 54 78 (24)
----------- ----------- -----------
Total Other Debt
54 78 (24)
----------- ----------- -----------
Total Debt $ 3,665 $ 3,540 $ 125
=========== =========== ===========
* The Debenture requires the Company 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 and that failure to meet this
requirement allows the original holder to accelerate the Debenture at 130% of
principal and accrued interest, and to increase the interest rate from 7% to
17%. The Company's common stock is not so listed.
On April 27, 2000, the Company issued and sold pursuant to a Securities Purchase
Agreement, dated as of April 25, 2000, (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. 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.
As set forth in "Part II, Item 1 - Legal Proceeding," the Company has filed a
lawsuit in Milwaukee County Circuit Court against the original holder of the
Debenture and three alleged transferees to enforce the terms of a stand-still
and buy-back agreement between the Company and the original holder of the
Debenture. The original holder of the Debenture denies that any such agreement
exists. An agent for the alleged transferees of the Debenture has contacted the
Company with demands that are wholly inconsistent with the terms of the
stand-still and buy-back agreement and has submitted a purported demand to
accelerate the maturity of the Debenture. The Company intends to vigorously
contest the validity of this demand. In the event that the Company is not
successful in its lawsuit, management expects that the Company would be able to
pay the Debenture in full over several years but it cannot pay it in full at
this time. The pending litigation and the purported demand may have a
significant impact on the Company's results of operations in fiscal 2003.
During fiscal 2002, the Company had a term loan and a revolving line of credit
with WITECH Corporation. The term loan was initially for $1.0 million, payable
in equal monthly installments over three years, and the revolving line of credit
was for a maximum of $1.0 million. The interest rate on the term loan was at
prime plus 4.0% and on the revolving line of credit was prime plus 3.25%. The
revolving line of credit terminated on December 31, 2001 and the term loan was
repaid in full on October 1, 2002.
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 three-year Sale Agreement allows RFC to purchase
up to
14
$3.0 million of ARI's accounts receivable. 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%. The Sale Agreement has been extended through January 28, 2003. If the
Sale Agreement is not renewed beyond the current expiration date, ARI's primary
source of additional liquidity will no longer be available to it. In addition,
the most recent extension provides that any attempt by the holder of the
Debenture to accelerate the obligation shall be deemed an event of default under
the Sale Agreement. As noted above, the Company has received a purported demand
for immediate payment of the Debenture, but intends to vigorously contest the
validity of this demand. If the Company loses the source of liquidity under the
Sale Agreement and is unable to replace it, ARI's financial condition and
capital resources would be significantly and adversely affected. As of December
10, 2002, the balance of the RFC Facility was $549,000.
Management believes that funds generated from operations and the Sales Agreement
will be adequate to fund the Company's operations, investments and debt payments
through fiscal 2003, provided the Debenture is satisfactorily resolved and/or
restructured and the Sale Agreement renewed.
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 decreased
from $836,000 for the three month period ended October 31, 2001 to $568,000 for
the three month period ended October 31, 2002, primarily due to the decrease in
revenue. Management believes that EBITDA will continue to be positive in fiscal
2003 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 an alternative to cash flows from operating activities, as
determined in accordance with accounting principles generally accepted in the
United States, or 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, 2002, which
is incorporated herein by reference.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ARI is subject to market risks pertaining to interest rate movements and
collectibility of accounts receivable. ARI's only expenses subject to interest
rate risk are (i) interest expense on the WITECH Term Loan and (ii) monthly
program fees owed with respect to the Sale Agreement. See "Liquidity and Capital
Resources". The WITECH Term Loan, which bore interest tied to prevailing market
rates, was paid in full as of October 15, 2002. The monthly program fees under
the Sale Agreement are also tied to prevailing market interest rates. An
increase or decrease of one percent in the prime interest rate would affect
ARI's net income by approximately plus or minus $5,000, annualized, based on the
outstanding balances under the Sale Agreement at December 10, 2002. As a result,
ARI believes that the market risk relating to interest rate movements is
minimal.
ITEM 4. CONTROLS AND PROCEDURES
An evaluation was performed under the supervision and with the participation of
management, including the Chief Executive Officer (CEO) and Chief Financial
Officer (CFO), of the effectiveness of the design and operation of the Company's
disclosure controls and procedures within 90 days before the filing date of this
quarterly report. Based on that evaluation, management, including the CEO and
CFO, concluded that the disclosure controls and procedures of the Company are
adequate and effective. There have been no significant changes in the Company's
internal controls or in other factors that could significantly affect these
controls subsequent to the evaluation, including any corrective actions with
regard to significant deficiencies or material weaknesses.
15
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On November 8, 2002, the Company filed a complaint (the "Complaint") in the
Milwaukee County Circuit Court, Milwaukee, WI, against RGC International
Investors, LDC ("Rose Glen"), ARI Network Services Partners (which is not in any
way affiliated with the Company), Dolphin Offshore Partners, LP and SDS Merchant
Fund, LP. Rose Glen is the original purchaser of the Company's outstanding
convertible subordinated Debenture due 2003 (the "Debenture") and the other
defendants are alleged transferees of the Debenture. Taglich Brothers, Inc. is
the agent for the three alleged transferees.
The Complaint alleges that on August 28, 2002, Rose Glen orally offered to enter
into an eight month "stand-still" agreement with the Company under which Rose
Glen would not exercise any claimed acceleration rights under the Debenture. On
August 28, 2002, Rose Glen orally offered to enter into this eight month
"stand-still" in return for an immediate payment of $500,000 by the Company.
Rose Glen also offered to give the Company an option to buy back the Debenture
and all other securities sold to Rose Glen in return for a payment of $1 million
at any time during the eight month stand-still period. Rose Glen subsequently
confirmed the offer in writing. The Company accepted Rose Glen's offer on
September 13, 2002.
The Complaint further alleges that Rose Glen was apparently shopping the
Debenture behind the Company's back. Although Rose Glen verbally confirmed the
agreement with the Company, Rose Glen later changed its position and informed
the Company it would not live up to the terms of the agreement. Rose Glen then
told the Company that it had sold the Debenture. The Company has now been
contacted by Taglich Brothers, Inc., on behalf of three alleged transferees,
which is making demands that are wholly inconsistent with the agreement and
which has submitted a purported demand to accelerate the maturity of the
Debenture. The Company intends to vigorously contest the validity of this
demand.
The Complaint alleges, among other things, claims for a declaratory judgment,
breach of contract, specific performance and breach of the covenant of good
faith and fair dealing. The Complaint requests, among other things, damages and
specific performance of the agreement.
The Complaint was only recently filed and, as of December 13, 2002, none of the
defendants had filed an answer.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
See Item 1 - Legal proceedings with respect to information concerning a
purported demand to accelerate the maturity of the Company's Debenture.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 2000 Stock Option Plan, as amended
99.1 Section 906 certification of Chief Executive Officer
99.2 Section 906 certification of Chief Financial Officer
(b) Reports on Form 8-K
There were no reports on Form 8-K filed for the quarter ended
October 31, 2002.
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: December 16, 2002 /s/ Brian E. Dearing
-----------------------------------------
Brian E. Dearing, Chairman of the Board
/s/ Timothy Sherlock
-----------------------------------------
Timothy Sherlock, Chief Financial Officer
17
CERTIFICATIONS
I, Brian E. Dearing, certify that:
1. I have reviewed this quarterly report on Form 10-Q of ARI Network
Services, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this quarterly
report; and
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly
present in all material respects the financial condition, results
of operations and cash flows of the registrant as of, and for, the
periods presented in this quarterly report.
4. The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)
for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the
period in which this quarterly report is being prepared.
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior
to the filing date of this quarterly report (the
"Evaluation Date"); and
c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors ( or
persons performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors and material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role
in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant
changes in internal controls or in other factors that could
significantly affect internal controls subsequent to the date of
our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: December 16, 2002
/s/ Brian E. Dearing
----------------------------------
By: Brian E. Dearing
Title: Chairman, President and CEO
18
I, Timothy Sherlock, certify that:
1. I have reviewed this quarterly report on Form 10-Q of ARI Network
Services, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this quarterly
report; and
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly
present in all material respects the financial condition, results
of operations and cash flows of the registrant as of, and for, the
periods presented in this quarterly report.
4. The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)
for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the
period in which this quarterly report is being prepared.
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior
to the filing date of this quarterly report (the
"Evaluation Date"); and
c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors ( or
persons performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors and material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role
in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant
changes in internal controls or in other factors that could
significantly affect internal controls subsequent to the date of
our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: December 16, 2002
/s/ Timothy Sherlock
------------------------------------------
By: Timothy Sherlock
Title: Chief Financial Officer, Secretary,
Treasurer, and VP of Finance
19
EXHIBIT INDEX
EXHIBIT
NO. DESCRIPTION
------- -----------
10.1 2000 Stock Option Plan, as amended
99.1 Section 906 certification of Chief Executive Officer
99.2 Section 906 certification of Chief Financial Officer