1
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, 1999
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)
330 E. Kilbourn Avenue, Milwaukee, Wisconsin 53202
(Address of principal executive office)
Registrant's telephone number, including area code (414) 278-7676
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of The Securities Exchange Act of
1934 during the preceding twelve months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past ninety days.
YES (check mark) NO
As of May 31, 1999 there were 5,097,432 shares of the registrant's Common Stock
outstanding.
1
2
ARI NETWORK SERVICES, INC.
FORM 10-Q
FOR THE THREE MONTHS ENDED APRIL 30, 1999
INDEX
PART I - FINANCIAL INFORMATION
Page
----
Item 1 Financial statements
Condensed balance sheets - April 30, 1999 and July 31, 1998. 3
Condensed statements of operations for the three and nine
months ended April 30, 1999 and 1998. 4
Condensed statements of cash flows for the nine months
ended April 30, 1999 and 1998. 5
Notes to unaudited condensed financial statements. 6
Item 2 Management's discussion and analysis of financial condition
and results of operations. 7-14
PART II - OTHER INFORMATION
Item 2 Changes in securities and use of proceeds. 15
Item 6 Exhibits and reports on Form 8 K . 15
Signatures 16
2
3
ARI NETWORK SERVICES, INC.
CONDENSED BALANCE SHEETS
(Amounts in thousands, except per share and share data)
April 30, 1999 April 30, 1999
(Unaudited) (Audited)
-------------- --------------
ASSETS
Current assets:
Cash $ 32 $ 194
Trade receivables, less allowances for doubtful accounts of $291 at
April 30, 1999 and $185 at July 31, 1998 3,078 2,643
Prepaid expenses and other 282 118
-------- --------
Total current assets 3,392 2,955
Equipment and leasehold improvements:
Network system hardware 3,826 3,778
Leasehold improvements 239 239
Furniture and equipment 845 485
-------- --------
4,910 4,502
Less accumulated depreciation and amoritzation 4,457 4,107
-------- --------
Net equipment and leasehold improvements 453 395
Goodwill, net of accumulated amortization 2,935 336
Network system:
Network platform 11,467 11,467
Industry-specific applications 21,779 19,906
-------- --------
33,246 31,373
Less accumulated amortization 24,064 22,251
-------- --------
Net network system 9,182 9,122
-------- --------
Total Assets $ 15,962 $ 12,808
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabiliities:
Notes payable $ 13 $ 28
Accounts payable 1,041 581
Unearned revenue 3,008 776
Accrued payroll and related expenses 804 620
Other accrued expenses 229 158
Current portion of capital lease obligations 15 30
-------- --------
Total current liabilities 5,110 2,193
Line of credit payable to shareholder 2,950 1,620
Capital lease obligations 25 33
Shareholders' equity:
Preferred stock, par value $.001 per share, 1,000,000 shares authorized;
20,350 and 20,000 shares issued and outstanding at April 30, 1999 and
July 31, 1998, respectively 0 0
Common stock, par value $.001 per share, 25,000,000 shares authorized;
5,097,432 and 4,247,460 shares issued and outstanding at April 30, 1999
and July 31, 1998, respectively 5 4
Additional paid-in capital 86,829 85,028
Accumulated deficit (78,957) (76,070)
-------- --------
Total shareholders' equity 7,877 8,962
-------- --------
Total liabilities and shareholders' equity $ 15,962 $ 12,808
======== ========
See notes to unaudited condensed finanacial statements.
3
4
ARI NETWORK SERVICES, INC.
CONDENSED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share and share data)
(Unaudited)
THREE MONTHS NINE MONTHS
ENDED ENDED
APRIL 30 APRIL 30
1999 1998 1999 1998
------ --------- ------- --------
Net revenues:
Network and other services $1,520 $ 1,400 $ 6,068 $ 4,050
Software and development 1,472 317 2,530 1,469
------ -------- ------- -------
Total net revenues 2,992 1,717 8,598 5,519
Operating expenses:
Variable cost of products and services sold (exclusive of
depreciation and amortization shown below):
Network and other services 372 315 1,100 964
Software and development 464 169 1,200 481
------ -------- ------- -------
Total variable cost of products and services sold 836 484 2,300 1,445
Depreciation and amortization 873 535 2,586 1,553
Network operations 193 176 566 559
Selling, general and administrative 1,791 1,230 5,204 3,634
Network construction and expansion 531 521 2,040 1,694
------ -------- ------- -------
Operating expenses before amounts capitalized 4,224 2,946 12,696 8,885
Less capitalized expenses* (418) (362) (1,426) (1,094)
------ -------- ------- -------
Total operating expenses 3,806 2,584 11,270 7,791
------ -------- ------- -------
Operating loss (814) (867) (2,672) (2,272)
Interest and other expense (75) (28) (215) (84)
------ -------- ------- -------
Net loss $ (889) $ (895) $(2,887) $(2,356)
====== ======== ======= =======
Average common shares outstanding 5,097 4,247 4,950 4,076
Basic and diluted net loss per share $(0.17) $ (0.21) $ (0.58) $ (0.58)
* In accordance with FASB 86, includes a portion of network and product
development expense and other operating expenses directly related to the
development process.
See notes to unaudited condensed financial statements.
4
5
ARI NETWORK SERVICES, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)
NINE MONTHS
ENDED
APRIL 30
1999 1998
------- ----------
OPERATING ACTIVITIES
Net loss $(2,887) $ (2,356)
Amortization of network platform 521 521
Amortization of industry specific applications 1,292 731
Amortization of goodwill 424 74
Depreciation and other amortization 349 227
Net change in operating assets 135 243
Net change in operating liabilities 277 (311)
------- ---------
Net cash provided (used) by operating activities 111 (871)
INVESTING ACTIVITIES
Purchase of equipment and leasehold improvements (47) (84)
Industry specific application costs capitalized (1,426) (1,094)
Other (124) 10
------- ---------
Net cash used by investing activities (1,597) (1,168)
FINANCING ACTIVITIES
Borrowings under line of credit 1,330 559
Payment of capital lease obligations (23) (3)
Proceeds from issuance of common stock 17 1,496
------- ---------
Net cash provided by financing activities 1,324 2,052
------- ---------
Net increase (decrease) in cash (162) 13
Cash at beginning of period 194 64
------- ---------
Cash at end of period $ 32 $ 77
======= =========
Cash paid for interest $ 215 $ 84
======= =========
NONCASH INVESTING AND FINANCING ACTIVITIES
Capital lease obligations incurred for:
Furniture and equipment $ - $ 30
Issuance of common stock for acquisition 1,785 654
See notes to unaudited condensed financial statements.
5
6
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
APRIL 30, 1999
1. BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles 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 nine months ended
April 30, 1999 are not necessarily indicative of the results that may be
expected for the fiscal year ending July 31, 1999. 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, 1998.
2. BASIC AND DILUTED NET LOSS PER SHARE
Dilutive earnings per share is not shown as the impact is antidilutive.
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 par 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 par 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 $388,000 at April 30, 1999.
4. ACQUISITIONS
On September 15, 1998, the Company acquired certain assets used in the
operation of Briggs & Stratton Corporation's Powercom business through the
issuance of 840,000 shares of its common stock at $2.125 per share and the
assumption of certain liabilities of the Powercom business. The acquisition
has been accounted for under the purchase method; accordingly, its results are
included in the financial statements of the Company from the date of
acquisition. As a result of the purchase price allocation, based on a final
determination of the fair value of assets acquired and liabilities assumed, the
Company recognized goodwill of $2,918,000, which is being amortized over five
years.
The following unaudited pro forma results of operations for the three and nine
months ended April 30, 1999 and 1998 assume the acquisition of the Powercom
business occurred at the beginning of each period presented:
THREE MONTHS ENDED NINE MONTHS ENDED
APRIL 30 APRIL 30
(IN THOUSANDS) (IN THOUSANDS)
1999 1998 1999 1998
------ ------- ------- -------
Net revenues $2,992 $ 2,331 $ 9,024 $ 7,493
Net loss (889) (1,424) (2,887) (3,811)
Net loss per share (0.17) (0.28) (0.58) (0.75)
This pro forma information does not purport to be indicative of the results
that actually would have been obtained if the combined operations had been
conducted during the periods presented and is not intended to be a projection
of future results.
On May 13, 1999, the Company acquired Network Dynamics Incorporated ("NDI"), a
privately held company based in Williamsburg, VA. NDI is a leading provider of
e-catalog and e-commerce software and services with customers in several of the
Company's targeted manufactured equipment market segments. The acquisition was
structured as a merger pursuant to which the Company will issue approximately
550,000 shares of its common stock in exchange for all of the outstanding
shares of common stock of NDI. It is anticipated that the ARI shares
6
7
will be issued on or about June 30, 1999 when the closing balance sheet has
been completed. The acquisition will be accounted for under the purchase
method; accordingly, its results will be included in the financial statements
of the Company from the date of acquisition. As a result of the purchase price
allocation, and subject to a final determination of the fair value of assets
acquired and liabilities assumed, the Company anticipates that it will
recognize goodwill of approximately $4,500,000, which will be amortized over
five years.
5. REVENUE RECOGNITION
As of August 1, 1998, the Company adopted AICPA Statement of Position 97-2 (SOP
97-2), Software Revenue Recognition, which is effective for transactions that
the Company enters into in fiscal 1999. Prior years are not restated. The
adoption of SOP 97-2 did not have a material impact on the Company's financial
statements.
6. UNEARNED REVENUE
The increase in unearned revenue for the nine months ended April 30, 1999
compared to the same period last year was primarily due to unearned annual
maintenance contracts acquired as part of the Powercom acquisition which will
be recognized ratably over one to three years.
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Total revenue for the quarter ended April 30, 1999 increased $1,275,000 or 74%
compared to the same period last year, representing the Company's thirteenth
consecutive quarter of year-over-year revenue improvement. Approximately half
of the increase was attributable to the Powercom acquisition and half from
internal growth. Management expects revenue for the full year to increase by
more than 50% over fiscal 1998. Earnings before interest, taxes, depreciation
and amortization ("EBITDA") also showed year over year improvement for the
tenth consecutive quarter. EBITDA for the third quarter was positive $59,000,
compared to a negative $332,000 during the third quarter of last year. Through
the first nine months EBITDA totaled a negative $86,000, compared to a negative
$719,000 during the first nine months of last year. Although non-cash
amortization expenses relating to the introduction of new products and the
Company's September 15, 1998 acquisition of the Powercom division of Briggs &
Stratton Corporation ("Powercom") increased by $338,000 (see "Other Items"),
net loss showed a slight improvement for the quarter ended April 30, 1999
compared to the same period last year. Management believes that the Company
will continue to achieve improvements in EBITDA for the remainder of fiscal
1999 but that, due to amortization of goodwill from its acquisitions, full
profitability will not be achieved until the second half of fiscal 2000.
Should the Company complete additional acquisitions, non-cash amortization of
goodwill could further delay full profitability. See "Forward Looking
Statements."
REVENUES
The Company provides Internet e-commerce solutions for shared service and
distribution networks. The Company's strategy is to build sustainable
recurring revenues in selected vertical markets from each of its primary
services and software products. Accordingly, management reviews the Company's
recurring vs. non-recurring revenue in the aggregate and within each industry
sector.
7
8
The following table sets forth, for the periods indicated, certain revenue
information derived from the Company's unaudited financial statements.
THREE MONTHS ENDED NINE MONTHS ENDED
APRIL 30 APRIL 30
(IN THOUSANDS) (IN THOUSANDS)
PERCENT PERCENT
1999 1998 CHANGE 1999 1998 CHANGE
------ ------ ------- ------ ------ -------
INDUSTRY SECTOR
Equipment Industry
Recurring $ 732 $ 165 344% $2,021 $ 453 346%
Non-recurring 881 224 293% 2,453 973 152%
------ ------ ------ ------
Subtotal 1,613 389 315% 4,474 1,426 214%
Agribusiness Industry
Recurring 664 561 18% 1,935 1,635 18%
Non-recurring 109 181 -40% 453 689 -34%
------ ------ ------ ------
Subtotal 773 742 4% 2,388 2,324 3%
Transportation Industry
Recurring 209 190 10% 601 567 6%
Non-recurring 22 36 -39% 44 117 -62%
------ ------ ------ ------
Subtotal 231 226 2% 645 684 -6%
Publishing Industry
Recurring 353 333 6% 1,030 983 5%
Non-recurring - (3) 100% 1 12 -92%
------ ------ ------ ------
Subtotal 353 330 7% 1,031 995 4%
Other Revenue
Recurring 20 30 -33% 53 90 -41%
Non-recurring 2 - 100% 7 - 100%
------ ------ ------ ------
Subtotal 22 30 -27% 60 90 -33%
Total Revenue
Recurring 1,978 1,279 55% 5,640 3,728 51%
Non-recurring 1,014 438 132% 2,958 1,791 65%
------ ------ ------ ------
Grand Total $2,992 $1,717 74% $8,598 $5,519 56%
====== ====== ====== ======
The Company derives its recurring revenues from maintenance and support fees,
transaction fees, software license renewals, subscription fees, and network
traffic fees. Recurring revenue, as a percentage of total revenue, was 66% for
both the three and nine month periods ended April 30, 1999. Management
believes a relationship of approximately two thirds recurring revenue to one
third non-recurring revenue is desirable in order to establish an appropriate
level of base revenue while continuing to add new sales to drive future
increases in recurring revenue. This revenue mix may fluctuate from quarter to
quarter. Recurring revenues increased for the three and nine month periods
ended April 30, 1999 compared to the same periods last year primarily due to
growth in the manufactured equipment industry (the "equipment industry").
Equipment industry revenue growth was driven, in part, by the September 15,
1998 acquisition of Powercom and by the Company's continuing penetration of the
recreational vehicle market segment. See "Other Items."
Non-recurring revenues are derived from initial software license fees and
professional services fees. The increase in non-recurring revenues for the
three and nine month periods ended April 30, 1999 compared to the same periods
last year was due primarily to increased customization fees in the equipment
industry. See "Other Items."
8
9
Equipment Industry
Over the last two years, the Company has focused its attention on the equipment
industry as its primary growth opportunity. During this period, the Company's
sales effort and its acquisition program has been primarily directed toward
increasing the Company's base of business in this industry. Management has
targeted approximately 36 vertical markets within the equipment industry that
management believes have shared service and distribution networks that would
derive substantial benefit from the Company's electronic commerce products and
services. To date, the Company has customers in about one third of these
markets including recreational vehicle, outdoor power equipment, construction,
farm equipment, floor maintenance, warehouse equipment, outboard marine,
manufactured housing, power tools, diesel truck, motorcycle, and power
generation.
Revenues from the equipment industry are derived from software license fees,
maintenance and support fees, electronic catalog subscription fees, network
traffic fees and professional services fees. Recurring revenues in the
equipment industry increased substantially for the three and nine month periods
ended April 30, 1999 compared to the same periods last year primarily due to
increased maintenance and support and to revenues from Powercom. Non-recurring
revenues in the equipment industry also increased for the three and nine month
periods ended April 30, 1999 compared to the same periods last year due to
increased professional services and development fees as the Company continued
its drive to penetrate the recreational vehicle (RV) market and other segments
of the equipment industry. As of April 30, 1999, the Company had signed
contracts with seven of the leading RV manufacturers and had expressions of
interest from several others. Management expects total revenues in the
equipment industry will continue to increase for the remainder of fiscal 1999.
Agribusiness Industry
The agribusiness industry is composed of several vertical markets comprising
businesses which supply inputs to the agricultural industry including
agricultural and specialty chemicals, livestock pharmaceuticals, fertilizer,
feed and seed. Revenues from the agribusiness industry are derived from
software license fees, maintenance and support fees, network traffic fees and
professional services fees. Recurring revenues increased, while non-recurring
revenues decreased in the agribusiness industry for the three and nine month
periods ended April 30, 1999 compared to the same periods last year. This was
primarily due to the recurring traffic fees generated from a major sales force
automation customer when non-recurring customization of their software was
completed in the fourth quarter of fiscal 1998. Management expects that
revenues in the agribusiness industry will continue at approximately the same
level for the remainder of this fiscal year. Management expects that gross
margins from this industry will continue at a rate that makes this business
attractive for the Company. . See "Forward Looking Statements."
Transportation Industry
Revenues from the transportation industry are derived from maintenance and
support fees, transaction fees and professional services fees charged to the
Association of American Railroads ("AAR") for the creation and maintenance of
the Customer Identification File ("CIF"), an industry wide shared database of
ship to and bill to locations. Recurring revenues in the transportation
industry increased slightly for the three and nine month periods ended April
30, 1999 compared to the same periods last year due to growth in recurring
maintenance and support fees as the CIF increased in size. As expected,
non-recurring revenues in the transportation industry decreased for the three
and nine month periods ended April 30, 1999 compared to the same periods last
year when the Company undertook some special systems development and
modification projects on behalf of the AAR. Management expects that revenues
in the transportation industry will continue at approximately the same level
for the remainder of this fiscal year. Management expects that gross margins
from this industry will continue at a rate that makes this business attractive
for the Company. See "Forward Looking Statements."
Publishing Industry
Revenues from the publishing industry are derived from connect time fees, photo
traffic fees, subscription fees and service initiation fees charged to the
Company's Newsfinder(R) customers. Through Newsfinder(R), the Company manages
the approximately 20,000 news stories per week output from the Associated
Press, providing access through the World Wide Web and on a dial-up basis to
approximately 800 publishers with more than 1,300 weekly and monthly
newspapers. Revenues in the publishing industry remained consistent with the
three and nine month periods ended April 30, 1999 compared to the same periods
last year. Management expects that revenues in the publishing industry will
continue at approximately the same level for the remainder of this fiscal year.
Management expects that gross margins from this industry will continue at a
rate that makes this business attractive for the Company. See "Forward Looking
Statements."
9
10
OPERATING EXPENSES
The following table sets forth, for the periods indicated, certain operating
expense information derived from the Company's unaudited financial statements.
THREE MONTHS ENDED NINE MONTHS ENDED
APRIL 30 APRIL 30
(IN THOUSANDS) (IN THOUSANDS)
PERCENT PERCENT
1999 1998 CHANGE 1999 1998 CHANGE
------ ------ ------- ------- ------- -------
OPERATING EXPENSES:
Variable cost of products and services sold (exclusive
of depreciation and amortization shown below) $ 836 $ 484 73% $ 2,300 $ 1,445 59%
Network operations 193 176 10% 566 559 1%
Selling, general & administrative 1,791 1,230 46% 5,204 3,634 43%
Network construction and expansion 531 521 2% 2,040 1,694 20%
------ ------ ------- -------
Gross cash expenses 3,351 2,411 39% 10,110 7,332 38%
Depreciation and amortization 873 535 63% 2,586 1,553 67%
Less capitalized expenses (418) (362) 15% (1,426) (1,094) 30%
------ ------ ------- -------
Met operating expenses $3,806 $2,584 47% $11,270 $ 7,791 45%
====== ====== ======= =======
The increase in operating expenses for the three and nine month periods ended
April 30, 1999 compared to the same periods last year was primarily due to cash
expenditures and non-cash amortization of software and goodwill, all of which
increased substantially as a result of the Powercom acquisition completed on
September 15, 1998. The revenue increase from the Powercom acquisition exceeded
the increase in cash expenditures but was not enough to cover the increase in
noncash amortization of goodwill from the acquisition and the increase in
software amortization. See "Other Items."
Variable cost of products and services sold consists primarily of royalties,
telecommunications, data processing, software customization labor and temporary
help fees. Variable cost of products and services sold as a percentage of
revenue was 27% and 26% for the nine months ended April 30, 1999 and 1998,
respectively. Management expects gross margins in future quarters to continue
to fluctuate based on the mix of products and services sold.
The Company's technical staff (in-house and contracted) is allocated between
research and development and software customization services for customer
applications. Therefore, management expects fluctuations between software
customization services (a variable cost of products and services sold) and
development expenses quarter to quarter, as the mix of development and
customization activities will change based on customer requirements. For the
nine months ended April 30, 1999, the Company's technical resources were
focused primarily on the development and customization of the TradeRoute(TM)
software and the development of a World Wide Web version of the Company's
electronic catalog for implementation in the construction and heavy equipment
industry under the Company's contract with the Construction Industry
Manufacturers Association (CIMA) and the Associated Equipment Distributors
(AED).
Network operations consists primarily of data center operations, software
maintenance for the Company's core network and customer support costs. Network
operations expense remained relatively flat for the first three quarters after
decreasing significantly during fiscal 1998, despite increases in revenue.
The 10% increase for the three months ended April 30, 1999 compared to the same
period last year was due to increased technical support costs attributable to
the Powercom acquisition. Management expects these costs to remain relatively
flat for the remainder of the fiscal year.
The increase in selling, general and administrative expenses for the three and
nine month periods ended April 30, 1999 compared to the same periods last year
was due primarily to the addition of the Company's new Colorado Springs offices
and other expenses arising out of the Powercom acquisition. See "Other Items."
The increase in depreciation and amortization expense for the three and nine
month periods ended April 30, 1999 compared to the same periods last year was
due primarily to amortization of the Company's new products for the equipment
industry and
10
11
increased goodwill amortization resulting from the Powercom acquisition. The
Company recorded $2,918,000 in goodwill as a result of the acquisition and is
amortizing this asset over five years. Management expects to add approximately
$225,000 per quarter in additional depreciation and amortization expense as a
result of the acquisition of Network Dynamics Incorporated which closed May 13,
1999. See "Forward Looking Statements." See "Other Items."
OTHER ITEMS
Interest expense increased $47,000 and $131,000 for the three and nine month
periods ended April 30, 1999 compared to the same periods last year. The
increase reflects additional borrowing by the Company under its line of credit
with WITECH. Interest expense will fluctuate depending on the use and timing
of financing through lines of credit and/or additional equity financing.
Net loss decreased $6,000 and increased $531,000, respectively for the three
and nine month periods ended April 30, 1999 compared to the same period last
year. The nine month increase was due primarily to non-cash amortization
expenses resulting from the Powercom acquisition and from amortization of
completed software products which were offset by improved revenues. Earnings
before interest, taxes, depreciation and amortization (EBITDA) improved to
positive $59,000 for the three months ended April 30, 1999 from negative
$332,000 for the same period last year. For the first nine months of the
current fiscal year, EBITDA improved to negative $86,000 from negative $719,000
over the same period last year. On a rolling four quarter basis, EBITDA was
positive $705,000 for the period ended April 30, 1999, compared to negative
$636,000 for the same period last year. As a result of non-cash amortization
charges resulting from the Company's acquisition program, management has
revised its goal for full sustainable profitability from the fourth quarter of
fiscal 1999 to the second half of fiscal 2000. However, as the Company
continues its strategic acquisition program, non-cash amortization of goodwill
from the Company's acquisitions may cause net losses to continue beyond fiscal
2000. Management expects EBITDA to turn positive during the fourth quarter of
this year and to remain positive in the future. See "Forward Looking
Statements."
The Company is using both internal and external resources to reprogram or
replace, test and implement its software and operating equipment for year 2000
modifications. Management estimates that the total cost of the year 2000
program will be approximately $450,000. Included in this estimate is
approximately $100,000 which management added to the Company's year 2000
program costs because of its recent acquisition of Powercom. No specific
estimate has been made of the additional costs that will be incurred as a
result of the NDI acquisition; however, based upon the relative size of
Powercom and NDI and the nature of NDI's operations, management does not
anticipate that the additional costs associated with NDI will exceed $100,000.
The Company is in the compliance development phase of its year 2000 program as
it relates to its non-Powercom and non-NDI businesses. The Company is in the
inventory phase of its year 2000 program as it relates to the Powercom business
which management expects to complete by June 30, 1999 and in the assessment
phase as it relates to the NDI business which management expects to complete
July 31, 1999. These costs are being funded with cash from operations and with
the Company's lines of credit. See "Liquidity and Capital Resource." As of
April 30, 1999, the Company has incurred approximately $240,710 relating to all
phases of the year 2000 program.
BUSINESS DEVELOPMENT:
Since December 1995, the Company has had a formal business development program
aimed at identifying, evaluating, and closing acquisitions which would augment
and strengthen the Company's market position, product offerings, and personnel
resources. To date, over 200 potential acquisition targets have been
considered, resulting in four acquisitions. The program is intended to remain
active indefinitely. The Company has engaged Tucker Anthony Cleary Gull, an
investment banking firm, to help expand and accelerate the program.
CD\*.IMG, INC. ("CDI")
On November 4, 1996, the Company completed the acquisition of CDI, located in
New Berlin, Wisconsin, in a stock for stock transaction. CDI was in the
business of publishing electronic parts catalogs and the software that dealers
and repair shops use to read the catalogs. CDI's operations have been
consolidated into the Company's. As a result of the acquisition, the Company
recognized goodwill in the amount of $434,000 which is being amortized over a
five year period.
EMPART TECHNOLOGIES, INC. ("EMPART")
On September 30, 1998, the Company completed the acquisition of Empart, located
in Foster City, California, in a stock for assets transaction. Empart was a
developer of software for electronic parts catalogs. Empart's products
included EMPARTpublisher(TM), which converts data from a variety of forms into
an electronic format, and EMPARTviewer(TM), a high-end configurable parts
catalog. Empart's operations were consolidated into the Company's. As a
result of the acquisition, the Company recognized goodwill in the amount of
$69,000 which is being amortized over a five year period.
11
12
POWERCOM 2000, A DIVISION OF BRIGGS & STRATTON CORPORATION ("POWERCOM")
On September 15, 1998, the Company completed the acquisition of Powercom in a
stock for assets transaction. Powercom was in the business of providing
electronic communications and cataloging software and services to manufacturers
and their distributors and dealers in the outdoor power, power sports and power
tools industries. Its major customers included Briggs & Stratton, MTD, Polaris
and Thermo King. Powercom also had been exclusively endorsed by the
Construction Industry Manufacturers Association (CIMA) and the Associated
Equipment Distributors (AED), the two leading trade associations in the
construction industry, as the vendor for the development and maintenance of a
Web based electronic catalog and electronic commerce system. As a result of
the Powercom acquisition, the Company has strengthened its position in the
outdoor power and power sports industries and has gained a strong foothold in
the construction industry. The Company also acquired an office with
approximately 20 software development professionals located in Colorado
Springs, Colorado, one of the nation's leading regions for software development
talent. As a result of the acquisition, the Company recognized goodwill in the
amount of $2,918,000 which is being amortized over a five year period.
NETWORK DYNAMICS INCORPORATED ("NDI")
On May 13, 1999, the Company acquired Network Dynamic Incorporated ("NDI"), a
privately held company based in Williamsburg, Virginia. NDI was a leading
provider of e-catalog and e-commerce software and services with customers in
several of the Company's targeted manufactured equipment market segments
including outdoor power, motorcycles, agricultural equipment, warehouse
equipment, and floor maintenance. NDI added approximately 30 major new
manufacturers as customers of the Company including Fiat New Holland, Homelite,
Jacobsen, Nissan Forklift, and Kawasaki Motorcycles. As a result of the
acquisition, the Company has further strengthened its position in outdoor power
and in the European markets where NDI provided electronic cataloging services
to The Kramp Groep and Fiat New Holland. In addition, the Company now has an
electronic catalog production facility and a staff of approximately 50
professionals based in Virginia.
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.
THREE MONTHS ENDED NINE MONTHS ENDED
APRIL 30 APRIL 30
(IN THOUSANDS) (IN THOUSANDS)
PERCENT PERCENT
1999 1998 CHANGE 1999 1998 CHANGE
------ ------ ------- ------- ------- -------
Net cash provided (used) by operating activities
before changes in working capital $ (16) $(360) 96% $ (301) $ (803) 63%
Net cash provided (used) by investing activities (403) (363) -11% (1,597) (1,168) -37%
----- ----- ------- -------
Subtotal (419) (723) 42% (1,898) (1,971) 4%
Effect of net changes in working capital (3) 354 -101% 412 (68) 706%
----- ----- ------- -------
Net cash provided (used) by operating
and investing activities $(422) $(369) -14% $(1,486) $(2,039) 27%
===== ===== ======= =======
Net cash used in operating activities before changes in working capital
decreased for the three and nine months ending April 30, 1999 due to cost
controls and increased revenues. This number may fluctuate from quarter to
quarter due to the seasonality of revenue while operating expenses remain
relatively flat. On a rolling four quarter basis, cash flow from operations
before changes in working capital was $503,000 for the period ended April 30,
1999 compared to negative $781,000 for the same period last year. Management
expects that the Company will achieve positive cash flow from operations before
changes in working capital for the fourth quarter ending July 31, 1999. See
"Forward Looking Statements."
The Company expects to continue to incur operating losses for the fiscal year
ending July 31, 1999 and there can be no assurance that profitability will be
achieved thereafter. The Company also expects to incur significant
expenditures for research and development. The Company expects to fund
research and development costs and operations for the remainder of fiscal 1999
from the Company's lines of credit described below. See "Forward Looking
Statements."
At April 30, 1999, the Company had cash and cash equivalents of approximately
$32,000 compared to approximately $194,000 at July 31, 1998.
12
13
The Company has a line of credit with WITECH (the "WITECH Line") that has been
in place since October 4, 1993. On January 29, 1999 WITECH and the Company
agreed to amend the WITECH Line, increasing the line from $2,800,000 to the
current $3,000,000 credit limit. Under the loan agreement, $1,000,000 must be
repaid out of the proceeds of any equity securities sold by the Company. The
termination date of the line of credit is December 31, 2001 and the interest
rate is prime plus 2%. In conjunction with obtaining the WITECH Line, since
1993, the Company has issued WITECH 20,350 shares of non-voting Preferred Stock
and has issued total warrants for the purchase of up to 250,000 shares of its
common stock, including warrants for the purchase of 200,000 shares at an
exercise price of $4.00 per share and warrants for a maximum of 50,000 shares
at an exercise price of $2.8125. The exercise price is reduced if the Company
issues stock at less than the then current exercise price. As of May 31, 1999
there were $3,000,000 of borrowings outstanding under the WITECH Line.
The only financial covenant in the WITECH Line is that the Company must
maintain a net worth (calculated in accordance with generally accepted
accounting principles) of at least $5.3 million. The Company has been, and is
currently, in compliance with the financial covenant in the Agreement and
currently expects to comply with such covenant or obtain any required waivers
or raise additional equity, if necessary. See "Forward Looking Statements."
In connection with the acquisition of Powercom, the Company obtained a line of
credit from Briggs & Stratton Corporation in the amount of $250,000 (the
"Briggs Line"). Borrowings under the Briggs Line are secured by certain
accounts receivable associated with the Powercom business. Borrowings under
the Briggs Line bear interest at prime plus 2%. Pursuant to an amendment dated
May 25, 1999, the Briggs Line was extended to October 31, 1999. Borrowings
under the Briggs Line must be repaid with the proceeds of equity offerings (if
any) in excess of $1,000,000 plus accrued interest under the WITECH Line. As
of May 31, 1999 there were $150,000 of borrowings outstanding under the Briggs
Line.
In connection with the acquisition of NDI, the Company assumed liabilities in
the amount of approximately $3,00,000 including unearned revenue of
approximately $1,000,000. As part of the acquisition, repayment terms for
approximately $1,300,000 of the assumed debt were agreed to by the creditors of
NDI. NDI had revenues of $2,751,000 for the twelve month period ending
December 31, 1998. It is anticipated that the net cash generated from the NDI
business together with the cost synergies made possible by the acquisition will
be more than adequate to operate the newly acquired business and repay the
restructured debt and that the NDI business as it is combined with the
Company's business will improve the Company's overall liquidity. See "Forward
Looking Statements."
Management currently believes that the financing from the WITECH Line and the
Briggs Line will be sufficient to fund operations for the remainder of fiscal
1999. However, this expectation is subject to a variety of assumptions
regarding, among other things, the timing of revenues and cash flow from new
sales, the Company's ability to control and/or reduce expenses, the timing of
the completion of software products currently under development, and the impact
of any other acquisitions. Should these assumptions prove incorrect such that
additional working capital is required, the Company believes it can be obtained
from additional borrowings and/or the sale of additional securities.
Management believes that, based on current trends, the Company will achieve
positive cash flow from operations (excluding changes in working capital items)
for the quarter ending July 31, 1999. On a long term basis, management
believes that financing for the Company's operations, as well as capital
expenditures, will come principally from cash generated from operations. See
"Forward Looking Statements." The Company currently intends to raise
additional financing during fiscal 1999 and/or fiscal 2000 in order to fund the
Company's investment requirements, including its acquisition program, and to
repay the Briggs Line and a portion of the WITECH Line. The Company has not
yet determined the terms of such financing but such financing may include
obtaining an asset backed line of credit from a bank or the sale of common
stock and/or debt securities.
FORWARD LOOKING STATEMENTS
Certain statements contained in the Management's Discussion and Analysis of
Results of Operations and Financial Condition are forward looking statements.
The forward-looking statements can generally be identified by words such as
"believes," "anticipates," "expects" or words of similar meaning.
Forward-looking statements also include statements relating to the Company's
future performance, such as future prospects, revenues, profits, EBITDA and
cash flows. 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 growth rate of the Company's
selected market segments, the positioning of the Company's products in those
segments, variations in demand for and cost of customer services and technical
support, customer adoption of Internet-enabled Windows applications and their
willingness to upgrade from earlier versions of software, the Company's ability
to release new software applications and upgrades on a timely basis, the
Company's ability to establish and maintain strategic alliances, the Company's
ability to manage its costs, the Company's ability to manage its business in a
rapidly changing environment, the Company's ability to finance capital
investments, and the Company's ability to implement its acquisition strategy to
increase growth.
13
14
Projected revenues are difficult to estimate because the Company's revenues and
operating results may vary substantially from quarter to quarter. The primary
cause of the variation is attributed to non-recurring revenues from software
license and customization fees. License fee revenues are based on contracts
signed and product delivered. Non-recurring revenues are affected by the time
required to close large license fee and development agreements, which cannot be
predicted with any certainty due to customer requirements and decision-making
processes.
Recurring revenues are also difficult to estimate. Recurring revenues from
maintenance and subscription fees may be estimated based on the number of
subscribers to the Company's services but will be affected by the renewal
ratio, which cannot be determined in advance. Recurring revenues from network
traffic fees and transaction fees are difficult to estimate as they are
determined by usage. Usage is a function of the number of subscribers and the
number of transactions per subscriber. Transactions include product ordering,
warranty claim processing, inventory and sales reporting, parts number updates
and price updates. The Company cannot materially affect or predict the volume
of transactions per customer.
Although the Company has recently introduced and plans to expand its
Internet-enabled Windows portfolio of products, the marketplace is highly
competitive and there can be no assurance that a customer will select the
Company's software and services over that of a competitor. The environment in
which the Company competes is characterized by rapid technological changes,
dynamic customer demands, and frequent product enhancements and product
introductions. Some of the Company's current and potential competitors have
greater financial, technical, sales, marketing and advertising resources than
the Company.
14
15
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On April 21, 1999, in connection with its acquisition of NDI, the Company
agreed to issue additional shares of its common stock to the shareholders of
NDI. NDI was a privately-held company based in Williamsburg, Virginia and a
leading provider of e-catalog and e-commerce software and services, with
customers in several of the Company's targeted manufactured equipment market
segments. The number of shares issued will depend on the amount of NDI
liabilities assumed as finally determined, subject to a minimum of 450,000 and
a maximum of 800,000 shares. Approximately 76% of the stock of NDI was held by
two persons.
The acquisition was completed on May 13, 1999, but the Company will not issue
the shares until the closing balance sheet is determined. At present, the
Company estimates that it will issue approximately 550,000 shares of stock.
The common stock was not sold by any form of general solicitation or general
advertising and the shares to be issued cannot be resold without registration
under the Securities Act of 1933, as amended, or an exemption therefrom. The
Company believes that the transaction was exempt from registration pursuant to
Section 4(2) of the Securities Act.
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
3.1 Articles of Incorporation, as amended
4.1 Consent of WITECH Corporation dated April 19, 1999
10.1 Amendment 1 to Revolving Credit Agreement dated May 25, 1999
27 Financial Data Schedule
b) Reports on Form 8-K. None.
15
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, 1999 /s/ Brian E. Dearing
----------------------
Brian E. Dearing, Chairman of the Board
(and acting CFO)
16