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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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(XX) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
for the fiscal year ended July 31, 2002
or
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
From the transition period from ............... to ...............
Commission File No. 0-19608
ARI NETWORK SERVICES, INC.
(Exact name of registrant as specified in its charter)
Wisconsin 39-1388360
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
11425 West Lake Park Drive 53224-3025
Milwaukee, Wisconsin (zip code)
(Address of principal executive offices)
Registrant's telephone number, including area code (414) 973-4300
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.001 PAR VALUE
(TITLE OF CLASS)
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 12 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 90 days.
YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_____]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
YES [ ] NO [X]
As of October 15, 2002, aggregate market value of the Common Stock held by
non-affiliates (based on the closing price on the NASDAQ bulletin board) was
approximately $1.0 million.
As of October 15, 2002, there were 6,329,301 shares of Common Stock of the
registrant outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Definitive Proxy Statement, to be filed with the Securities and
Exchange Commission no later than 120 days after July 31, 2002, for the 2002
Annual Meeting of Shareholders are incorporated by reference in Part III hereof.
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ITEM 1. BUSINESS
BUSINESS OVERVIEW
ARI Network Services, Inc. (the "Company" or "ARI") is a leading provider of
electronic catalog-enabled business solutions for sales, service and life cycle
product support in the manufactured equipment market. We focus our sales and
marketing on the U.S., Canadian, European and Australian manufactured equipment
industry (the "Equipment Industry"), providing direct sales and service in North
America and operating through a combination of direct sales and service and
value-added sales and service agents elsewhere. Sales in these markets are
driven by dealers' and other servicing agents' need for technical parts and
service information needed to perform repair, warranty, and maintenance
services. The Equipment Industry is made up of separate sub-markets in which the
manufacturers often share common distributors, retail dealers and/or service
points. These sub-markets include: outdoor power, recreation vehicles,
motorcycles, marine, construction, power sports, floor maintenance, auto and
truck parts aftermarket and others. By "Equipment" we mean capital goods which
are repaired rather than discarded when broken and for which the repairs are
generally performed by a distributed network of independent dealers and/or
repair shops. The Equipment Industry has been a growing percentage of our
revenue over the past three years, representing 83% of fiscal 2002 revenue. We
expect the Equipment Industry to continue to be the Company's largest Industry
in fiscal 2003, and expect to expand into other sub-markets within the Equipment
Industry which have similar electronic catalog-related business needs.
Our products and services enable Equipment Industry manufacturers to automate
business communications with their worldwide distributors, dealers, and service
points. We supply three types of software and services: robust Web and CD-ROM
electronic parts catalogs, template-based website services and transaction
services. The electronic cataloging products and services enable partners in a
service and distribution network to look up electronically technical reference
information such as illustrated parts lists, service bulletins, price files,
repair instructions and other technical information regarding the products of
multiple manufacturers. The template-based website service makes it easy for a
dealer to create a professional web presence and optionally to conduct
electronic business with its customers. The transaction services allow the
manufacturers and their distribution and service partners to exchange electronic
business documents such as purchase orders, invoices, warranty claims, and
status inquiries. Our products and services use the Internet for data transport
and a combination of the World-Wide Web and CD-ROM technology for user
interfaces and data presentation. The primary product line is electronic
catalogs; the other products are supplementary offerings that leverage our
position in the catalog market.
Our sales and marketing activities are focused primarily on Equipment Industry
manufacturers that sponsor our products and services to their dealers,
distributors and/or service points. These manufacturers have the financial
capability and business power to implement an automation strategy throughout
their service and distribution networks. We believe that the implementation of
our products can reduce internal costs for manufacturers and increase loyalty
and productivity in the service and distribution network as well as end-customer
satisfaction. In addition to software licenses and support services, a typical
implementation for a given manufacturer will involve professional services for
project management, software customization and continuing catalog updates. Once
manufacturer sponsorship is obtained, we also develop a direct business
relationship with the distributors, dealers, and service points for software and
services.
An important aspect of our business is the relationships we have developed with
over 100 dealer business management system providers through our COMPASS
Partners(TM) program. A dealer business management system is used to manage
inventory, maintain accounting records, bill customers and focus marketing
efforts. Our software's ability to interface with these systems provides the
end-user with a more robust, informative, and cost-effective solution.
Our customer base currently comprises approximately 100 lines of manufactured
equipment in approximately a dozen different sub-markets of the Equipment
Industry, as well as over 25,000 dealers, distributors, and repair facilities in
more than 100 countries. No single customer accounted for 10% or more of our
revenues in fiscal 2002.
As part of our historical business practice, we continue to provide electronic
directory and transaction services, to the U.S. and Canadian agribusiness
industry, which accounted for 11% of our total revenue in fiscal 2002. During
fiscal 2002, we also provided on-line information management services to the
non-daily newspaper publishing industry, which accounted for 6% of our total
revenue in fiscal 2002. The contract with the non-daily newspaper publishing
industry expired in February 2002.
2
Our executive offices are located at 11425 West Lake Park Drive, Milwaukee,
Wisconsin 53224 and our telephone number at that location is (414) 973-4300. ARI
is a Wisconsin corporation, incorporated in 1981. We maintain a website at
http://www.arinet.com(TM), which is not part of this report.
MISSION AND STRATEGY
Our mission is to be the leading provider of electronic catalog-enabled business
solutions for sales, services and product support in selected manufacturing
industry segments to primarily those with shared distribution channels and
service networks. Our vision is that whenever a manufacturer in one of our
target markets distributes technical parts and service information
electronically to a distributor, dealer or service location, it will use at
least some of our products and services to do so. To achieve this vision, our
strategy is to concentrate on a few vertical markets, and to be the leading
provider of electronic catalog products and services. After establishing a
position in a market, we will then bring other products and services to bear in
order to expand our presence and solidify our competitive position. Our goal is
to provide a complete array of high-quality electronic catalog-enabled software
and services that industry participants will adopt and use effectively.
Our strategy includes driving growth in our targeted markets through three
distinct programs: (i) sales; (ii) strategic alliances; and (iii) acquisitions.
Our external sales team focuses on large manufacturers and distributors in the
targeted industry sectors, while internal telesales representatives sell to
dealers and small to medium sized distributors. The alliance strategy includes
three parts: (i) manufacturer sales partners; (ii) COMPASS partners; and (iii)
non-US sales and service agents. We have relationships with Click Commerce,
Commercial Communications, Inc. and others under which they sell or co-market
our catalog products and services as part of their total offering. We are
actively cultivating relationships with other potential manufacturer sales
partners. Through our COMPASS Partners program, we have a strategic alliance
relationship with over 100 companies that provide complementary software and
services to distributors and dealers in our targeted industries. Outside of
North America, we sell to manufacturers directly, but use local agents to
provide sales and support to dealers. We also selectively seek to acquire
businesses with market positions in our targeted markets, additional products
that we can provide to our customer base, and development talent to supplement
our current staff.
Through our sales, alliance and acquisition programs, we expect to expand our
business both by growing market share in our current Equipment sectors and by
entering new sectors.
3
PRODUCTS AND SERVICES
We offer three basic kinds of services to our customers in the Equipment
Industry: (i) electronic catalogs for publishing and viewing technical reference
information about the equipment, (ii) website services which allow a dealer to
create a website using a series of templates and (iii) electronic communications
for exchanging documents such as purchase orders, invoices, and warranty claims.
The following table shows the software products and services that we offer, a
brief description of the products and the industries where they are currently in
use.
ELECTRONIC CATALOG PRODUCTS AND SERVICES
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PRODUCT OR SERVICE DESCRIPTION PRIMARY INDUSTRY/MARKET
--------------------------- ------------------------------------------------------- -------------------------------------
PartSmart(TM) Electronic parts catalog for equipment dealers Equipment - all sub-markets except
RV and manufactured housing
--------------------------- ------------------------------------------------------- -------------------------------------
EMPARTweb(TM) Web based electronic parts catalog based upon the Equipment - outdoor power, auto and
EMPART database technology truck parts after market, marine
and motorcycle
--------------------------- ------------------------------------------------------- -------------------------------------
EMPARTviewer(TM) Electronic parts catalog viewing software Equipment - RV and manufactured
housing only
--------------------------- ------------------------------------------------------- -------------------------------------
EMPARTpublisher(TM) Electronic parts catalog creation software used to Equipment - all sub-markets
produce catalogs for viewing on EMPARTweb, PartSmart,
and EMPARTviewer
--------------------------- ------------------------------------------------------- -------------------------------------
Electronic publishing Project management, data conversion, editing, Equipment - all sub-markets
services production, and distribution services for
manufacturers who wish to outsource catalog
production operations
--------------------------- ------------------------------------------------------- -------------------------------------
EMPARTweb(TM) Add-on product to Empartweb that facilitates order Equipment - all sub-markets
Shopping Cart taking from the catalog
--------------------------- ------------------------------------------------------- -------------------------------------
Gardenpart.com(TM)/ Integrated multi-manufacturer catalog and ordering Equipment - all sub-markets
EMPARTweb(TM)Portal system for the web
--------------------------- ------------------------------------------------------- -------------------------------------
Professional services Project management, software customization, roll-out Equipment - all sub-markets
management, and help desk support services
--------------------------- ------------------------------------------------------- -------------------------------------
WEBSITE SERVICES
-------------------------------------------------------------------------------------------------------------------------
PRODUCT OR SERVICE DESCRIPTION PRIMARY INDUSTRY/MARKET
--------------------------- ------------------------------------------------------- -------------------------------------
WebSite Smart(TM) Template-based software to create customized dealer Equipment - outdoor power, power
websites and conduct business electronically sports
--------------------------- ------------------------------------------------------- -------------------------------------
ELECTRONIC COMMUNICATIONS PRODUCTS AND SERVICES
-------------------------------------------------------------------------------------------------------------------------
PRODUCT OR SERVICE DESCRIPTION PRIMARY INDUSTRY/MARKET
--------------------------- ------------------------------------------------------- -------------------------------------
TradeRoute(R) Document handling and communications for product Equipment - Outdoor power and RV
ordering, warranty claims and other business documents
--------------------------- ------------------------------------------------------- -------------------------------------
As part of our historical business practice, we continue to provide electronic
directory and transaction services to the U.S. and Canadian agribusiness
industry. These products and services are expected to continue to be a declining
percentage of the Company's total revenue over time.
4
ACQUISITIONS
Since December 1995, ARI has had a business development program aimed at
identifying, evaluating and closing acquisitions which augment and strengthen
our market position, product offerings, and personnel resources. Since the
program's inception, more than 350 acquisition candidates have been evaluated,
resulting in four completed acquisitions. The following table shows selected
information regarding these acquisitions:
Acquisition Date Acquired Company and Location Description of Acquired Company
------------------------- --------------------------------------------- --------------------------------------
November 4, 1996 cd\*.IMG, Inc. ("CDI") CDI developed the Plus1(R)
New Berlin, WI electronic parts catalog which
featured parts information from over
20 manufacturers in the outdoor
power, marine, motorcycle and power
sports industries and was replaced
with the Partsmart electronic
catalog.
September 30, 1997 Empart Technologies, Inc. ("EMPART") EMPART provided us with the
Foster City, CA EMPARTpublisher and EMPARTviewer
software.
September 15, 1998 POWERCOM-2000 ("POWERCOM"), a subsidiary of POWERCOM provided electronic catalog
Briggs & Stratton Corporation and communication services to a
Colorado Springs, CO number of manufacturers in North
America, Europe, and Australia in
the outdoor power, power tools, and
power sports industries.
May 13, 1999 Network Dynamics Incorporated ("NDI") NDI provided us with the PartSmart
Williamsburg, VA electronic catalog which was used by
over 10,000 dealers to view catalogs
from 50 different manufacturers in 6
sectors of the Equipment Industry.
COMPETITION
Competition for ARI's products and services in the Equipment Industry varies by
product and by sub-market. No single competitor today competes with us in each
of our targeted vertical Equipment Industry sub-markets. In electronic catalog
software and services, our direct competitors include ProQuest and Enigma which
provide electronic service catalogs in the motorcycle, marine, and auto markets,
and a variety of small companies focused on specific industries. Many of these
smaller companies may also represent acquisition targets for us. There are also
other companies that provide more general catalog services such as Saqqara
Systems, Inc. and Requisite Technology, Inc. that may in the future directly
compete with us in our target markets. In addition, there are also a number of
larger companies which have targeted Web-based catalogs for procurement, such as
Ariba, Commerce One, and i2 Technologies, Inc., which could expand their
offerings to address the needs of our markets and become competitors in the
future. WebSite Smart(TM) has many competitors, including PowerSports Network,
Inc. and many internet service providers. In the communications part of our
business, the primary competition comes from in-house information technology
groups who may prefer to build their own Web-based proprietary systems, rather
than use our industry-common solutions. There are also large, general market
e-Commerce companies like SBC Technologies, which offer products and services
which could address some of our customers' needs. These general e-Commerce
companies do not typically compete with us directly, but they could decide to do
so in the future. These companies may also represent alliance partner
opportunities for us. In addition, as in the catalog side of our business, there
are a variety of small companies focused on specific industries which compete
with us and which may also represent acquisition targets. Another potential
source of competition in the future is the group of companies
5
attempting to build so-called "net communities," such as Chemdex or VerticalNet,
which could expand their offerings to target our served markets. Finally, given
the current pace of technological change, it is possible that as yet
unidentified well-capitalized competitors could emerge, that existing
competitors could merge and/or obtain additional capital thereby making them
more formidable, or that new technologies could come on-stream that could
threaten our position.
ARI's primary competitive advantages are (i) our focus on our target markets and
the industry knowledge and customer relationships we have developed in those
target markets, (ii), our robust electronic parts catalog software products, and
(iii) our relationships with over 100 dealer business management system
providers. When combined with products and services that are designed for our
targeted industries, we believe that our competitive advantages will enable us
to compete effectively and sustainably in these markets.
EMPLOYEES
As of October 15, 2002, we had 87 full-time equivalent employees. Of these, 13
are engaged in maintaining or developing software and providing software
customization services, 19 are in sales and marketing, 18 are engaged in catalog
creation and maintenance or database management, 30 are involved in customer
implementation and support and 7 are involved in administration and finance.
None of these employees is represented by a union.
ITEM 2. PROPERTIES
ARI occupies approximately 17,000 square feet in an office building in
Milwaukee, Wisconsin, under a lease expiring June 30, 2009. This facility houses
our headquarters and server room. In Colorado Springs, Colorado, we occupy
approximately 5,500 square feet of office space under a lease expiring January
31, 2006. In Williamsburg, Virginia we occupy approximately 5,100 square feet of
office space under a lease that expires October 1, 2004. In the Netherlands we
occupy approximately 450 square feet of office space under a month-to-month
lease.
ITEM 3. 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 none of the defendants has filed an
answer. On November 1, 2002, prior to the Company's filing of the Complaint, the
Company received a letter from Rose Glen's counsel stating that no such
agreement exists and that Rose Glen had sold its interest in the Debenture and
related securities and assigned its rights and obligations on or around
September 27, 2002.
6
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
EXECUTIVE OFFICERS OF THE REGISTRANT
The table below sets forth the names of ARI's executive officers as of October
15, 2002. The officers serve at the discretion of the Board.
Name Age Capacities in Which Serving
---- ---- ----------------------------
Brian E. Dearing 47 Chairman of the Board of Directors, CEO and President
Timothy Sherlock 50 CFO, Secretary, Treasurer and Vice President of Finance
John C. Bray 45 Vice President of New Market Development
Michael E. McGurk 54 Vice President of Technology Operations
Frederic G. Tillman 40 Vice President of Technology Development
Jeffrey E. Horn 40 Vice President of North American Sales
BRIAN E. DEARING. Mr. Dearing, Chief Executive Officer and a director since 1995
and Chairman of the Board of Directors since 1997, is CEO and President. Prior
to joining ARI, Mr. Dearing held a series of electronic commerce executive
positions at Sterling Software, Inc. in the U.S. and in Europe. Prior to joining
Sterling in 1990, Mr. Dearing held a number of marketing management positions in
the EDI business of General Electric Information Services from 1986. Mr. Dearing
holds a Masters Degree in Industrial Administration from Krannert School of
Management at Purdue University and a BA in Political Science from Union
College.
TIMOTHY SHERLOCK. Mr. Sherlock was appointed Chief Financial Officer, Secretary,
Treasurer and Vice President of Finance in April 2001. Prior to joining ARI, Mr.
Sherlock was CFO and vice president of finance and administration for Catalyst
International, Inc., a warehouse management software specialist. Before joining
Catalyst in 1999, he held a series of progressively more responsible finance
positions at Rennaissance Learning (RLRN), a leading educational software firm
based in Wisconsin Rapids, Wis. culminating in his appointment as vice
president, secretary and CFO. His early career included a variety of financial
management positions at Cray Research, Inc., Eagan, Minn., from 1983 to 1995.
Mr. Sherlock, a Certified Public Accountant, received a BA in business
administration from the College of St. Thomas, St. Paul, Minn.
JOHN C. BRAY. Mr. Bray was appointed Vice President of Sales in September 1996
and became Vice President of New Market Development in March 2002. Prior to
joining ARI, Mr. Bray was Manager of Global Internet Sales and Consulting at GE
Information Services (GEIS) in Rockville, Maryland. Before joining GEIS, Mr.
Bray had a six year sales career at AT&T, culminating in his appointment as
Regional Vice President of Sales for AT&T's EasyLink Services, marketing
electronic commerce services. He holds a BA in marketing from the University of
Iowa.
MICHAEL E. MCGURK. Mr. McGurk was appointed Vice President of Technology in
January 1997 and became Vice President of Technology Operations in August 1999.
Prior to joining ARI, Mr. McGurk developed and operated a large format printing
services business for customers involved in business process re-engineering
projects. Before opening the printing service, Mr. McGurk had a twelve year
career in information technology management at various divisions of General
Electric, including GE Medical Systems, GE Corporate and GE Aircraft Engines.
Mr. McGurk's early career included sales and technology positions at Cullinet
and CinCom Systems. Mr. McGurk holds an MBA and BS from Miami University in
Ohio.
FREDERIC G. TILLMAN. Mr. Tillman was appointed Vice President of Technology
Development in August 1999. He joined ARI in September 1998 as part of the
acquisition of Powercom where he had been Vice President of Software
Development. Prior to joining Powercom in May 1998, Mr. Tillman was Director of
New Product Development for ADAC Healthcare Information Systems in Houston,
Texas, a producer of information systems for hospital laboratories and radiology
departments. Before joining ADAC in 1990, Mr. Tillman spent six years at General
7
Dynamics as a software engineer. Mr. Tillman holds an MBA from Texas Christian
University and a BS in Computer Science from Oklahoma State University.
JEFFREY E. HORN. Mr. Horn joined ARI in December 2000 as Director of U.S. Sales.
In September 2002, Mr. Horn was appointed Vice President of North American
Sales. Before joining ARI, Mr. Horn held sales executive positions for a number
of technology-based companies with the responsibility of establishing,
maintaining and expanding customer relationships in the technology marketplace.
Prior to joining ARI, Mr. Horn was Director of Sales, North America for
CyberShift, Inc., Parsippany, New Jersey, a division of Amano-Blick
International. Before joining CyberShift in 1995, Mr. Horn was National Accounts
District Manager for Automatic Data Processing, Milwaukee, Wisconsin, and
District Sales Manager for Kronos Incorporated, Houston, Texas. Mr. Horn holds a
BA in business administration from the University of North Texas.
PART II
ITEM 5. MARKET FOR COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
ARI's common stock is currently quoted on the NASDAQ Over the Counter Bulletin
Board ("OTCBB") under the symbol ARIS. The following table sets forth the high
and low closing sales price for the periods indicated. OTCBB quotations reflect
inter-dealer prices, without retail mark-up, mark-down or commission and may not
necessarily reflect actual transactions.
Fiscal Quarter Ended High Low
October 31, 2000 ........ $2.594 $1.750
January 31, 2001 ........ $2.250 $0.938
April 30, 2001 .......... $1.625 $0.688
July 31, 2001 ........... $1.050 $0.220
October 31, 2001 ........ $0.320 $0.180
January 31, 2002 ........ $1.000 $0.200
April 30, 2002 .......... $0.800 $0.310
July 31, 2002 ........... $0.510 $0.300
As of October 25, 2002, there were approximately 234 holders of record of the
Company's common stock. The Company has not paid cash dividends to date and has
no present intention to pay cash dividends.
8
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth certain financial information with respect to the
Company as of and for each of the five years in the period ended July 31, 2002,
which was derived from audited Financial Statements and Notes thereto of ARI
Network Services, Inc. Audited Financial Statements and Notes as of July 31,
2002 and 2001 and for each of the three years in the period ended July 31, 2002,
and the report of Ernst & Young LLP thereon are included elsewhere in this
Report. The selected financial data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Financial Statements and Notes thereto included elsewhere
herein.
STATEMENT OF OPERATIONS DATA:
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED JULY 31
--------------------------------------------------------------------
2002 2001 2000 1999 1998
-------- -------- -------- -------- --------
Subscriptions, support and other services revenues $ 8,915 $ 9,985 $ 9,743 $ 8,616 $ 5,811
Software license and renewal revenues 2,721 3,266 1,289 2,822 1,431
Professional services revenues 2,227 2,526 2,272 1,450 722
-------- -------- -------- -------- --------
Total revenues 13,863 15,777 13,304 12,888 7,964
Operating expenses:
Cost of subscriptions, support and other
services sold 387 1,740 1,415 1,431 1,327
Cost of software licenses and renewals sold (1) 1,523 3,137 3,614 2,543 1,333
Cost of professional services sold 738 1,359 1,965 1,234 407
Depreciation and amortization (exclusive of
amortization of software products included in
cost of sales) 223 1,517 1,778 1,773 1,021
Customer operations and support 1,220 1,597 2,048 1,017 708
Selling, general and administrative 6,835 8,790 8,214 6,995 4,586
Software development and technical support 2,056 3,317 2,779 2,786 2,198
Restructuring and other charges (2) -- 7,766 -- -- --
-------- -------- -------- -------- --------
Operating expenses before amounts
capitalized 12,982 29,223 21,813 17,779 11,580
Less capitalized portion (717) (1,972) (1,729) (1,802) (1,546)
-------- -------- -------- -------- --------
Net operating expenses 12,265 27,251 20,084 15,977 10,034
-------- -------- -------- -------- --------
Operating income (loss) 1,598 (11,474) (6,780) (3,089) (2,070)
Other income (expense) (1,410) (1,551) (822) (326) (70)
-------- -------- -------- -------- --------
Net income (loss) $ 188 $(13,025) $ (7,602) $ (3,415) $ (2,140)
======== ======== ======== ======== ========
Weighted average diluted common shares outstanding 6,238 6,175 6,002 5,061 4,119
Basic and diluted net income (loss) per share $ 0.03 $ (2.11) $ (1.27) $ (0.67) $ (0.52)
SELECTED BALANCE SHEET DATA:
(IN THOUSANDS)
Working capital (deficit) $ (8,713) $ (9,696) $ (4,680) $ (3,476) $ 762
Capitalized software development (net) (3) 3,066 3,961 11,901 14,052 9,122
Total assets 6,374 7,060 18,488 20,438 12,808
Current portion of long-term debt and capital
lease obligations 3,691 3,608 933 713 58
Total long-term debt and capital lease obligations 26 251 2,695 3,511 1,653
Total shareholders' equity (deficit) (5,606) (5,850) 7,159 9,756 8,962
(1) Includes amortization of software products of $1,612, $3,178, $3,224,
$2,057 and $1,121.
(2) See note 3 to the financial statements.
(3) Fiscal 1999 includes a reclassification of $5,208 from goodwill as a
result of the finalization of the purchase price allocation for the NDI
acquisition.
9
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
SUMMARY
ARI achieved its first full year of profitable operations, with earnings
increasing from a net loss of $13,025,000 for the fiscal year ended July 31,
2001 to net income of $188,000 for the fiscal year ended July 31, 2002. The
increase in earnings was due to the one-time charges to earnings in fiscal 2001
associated with the Company's restructuring and the cost reductions in fiscal
2002 as a result of the restructuring. Total revenue declined 12% during fiscal
2002 compared to fiscal 2001, while recurring revenues in the Equipment Industry
grew 3%. The decline in revenue was primarily due to the expected decline in the
Company's non-strategic product revenues and a decline in new customer
customization revenues in the Company's strategic product lines. Management
expects the Company to continue to generate enough cash to fund operations,
investment and pay down debt in fiscal 2003, but given the problematic outlook
for the economy, profitability is not assured. In the event the Company is not
successful in its lawsuit regarding the Debenture, management expects the
Company would be able to pay the Debenture in full over several years but it
cannot pay it in full at this time. See "Liquidity and Capital Resources".
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.
10
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.
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
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 Equipment Industry has been a growing percentage of our revenue
over the past five years, representing approximately 83% of the Company's total
revenue in fiscal 2002. The Company's strategic focus is electronic catalog and
related products in the Equipment Industry, which represents approximately 77%
of the Company's total revenue in fiscal 2002.
11
The following tables set forth, for the periods indicated, certain revenue
information derived from the Company's financial statements:
REVENUE BY INDUSTRY SECTOR
(IN THOUSANDS)
YEAR ENDED JULY 31
----------------------------------------------------------------------------
INDUSTRY SECTOR: PERCENT PERCENT
2002 2001 CHANGE 2001 2000 CHANGE
------- ------- ------- ------- ------- -------
EQUIPMENT INDUSTRY
North American
Recurring $ 7,881 $ 7,715 2% $ 7,715 $ 5,219 48%
Non-recurring 2,298 3,014 (24)% 3,014 2,245 34%
------- ------- ------- -------
Subtotal 10,179 10,729 (5)% 10,729 7,464 44%
Non-North American
Recurring 1,039 981 6% 981 402 144%
Non-recurring 294 350 (16)% 350 619 (43)%
------- ------- ------- -------
Subtotal 1,333 1,331 0% 1,331 1,021 30%
Total Equipment Industry
Recurring 8,920 8,696 3% 8,696 5,621 55%
Non-recurring 2,592 3,364 (23)% 3,364 2,864 17%
------- ------- ------- -------
Subtotal 11,512 12,060 (5)% 12,060 8,485 42%
NON-EQUIPMENT INDUSTRY
Recurring 2,343 3,686 (36)% 3,686 4,483 (18)%
Non-recurring 8 31 (74)% 31 336 (91)%
------- ------- ------- -------
Subtotal 2,351 3,717 (37)% 3,717 4,819 (23)%
TOTAL REVENUE
Recurring 11,263 12,382 (9)% 12,382 10,104 23%
Non-recurring 2,600 3,395 (23)% 3,395 3,200 6%
------- ------- ------- -------
Grand Total $13,863 $15,777 (12)% $15,777 $13,304 19%
======= ======= ======= =======
REVENUE BY PRODUCT IN THE EQUIPMENT INDUSTRY
(IN THOUSANDS)
YEAR ENDED JULY 31
----------------------------------------------------------------------------
PRODUCT: PERCENT PERCENT
2002 2001 CHANGE 2001 2000 CHANGE
------- ------- ------- ------- ------- -------
EQUIPMENT INDUSTRY
Catalog and related
Recurring $ 8,258 $ 7,482 10% $ 7,482 $ 4,390 70%
Non-recurring 2,464 3,067 (20)% 3,067 1,596 92%
------- ------- ------- -------
Subtotal 10,722 10,549 2% 10,549 5,986 76%
Communications
Recurring 662 1,214 (45)% 1,214 1,231 (1)%
Non-recurring 128 297 (57)% 297 1,268 (77)%
------- ------- ------- -------
Subtotal 790 1,511 (48)% 1,511 2,499 (40)%
------- ------- ------- -------
Total Equipment Industry $11,512 $12,060 (5)% $12,060 $ 8,485 42%
======= ======= ======= =======
12
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. Recurring revenues
decreased in fiscal 2002, compared to the prior year, due to decreases in the
non-equipment industry revenues and increased in fiscal 2001, compared to the
prior year, primarily due to increases in Equipment Industry revenues. Recurring
revenue, as a percentage of total revenue, increased from 76% in fiscal 2000 and
78% in fiscal 2001 to 81% in fiscal 2002 primarily due to increases in the
customer base in the Equipment Industry. Management believes a ratio 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 or year to year.
Non-recurring revenues are derived from initial software licenses and
professional service fees. Non-recurring revenues decreased in fiscal 2002,
compared to the prior year, primarily due to a decrease in large customization
projects in the Equipment Industry. Non-recurring revenues increased in fiscal
2001, compared to fiscal 2000, due to increased catalog license revenue in the
Equipment Industry. Management believes that non-recurring revenues in the
Equipment Industry will increase slightly during fiscal 2003.
Equipment Industry
The Equipment Industry comprises several vertical markets including outdoor
power, recreation vehicles, motorcycles, marine, construction, power sports,
floor maintenance, auto and truck parts aftermarket and others. 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 additional products and services in these markets
and then expand to other similar markets in the future.
North American
Recurring revenues in the North American Equipment Industry increased
in fiscal 2002 and fiscal 2001, compared to the prior year, primarily
due to an increase in the base of catalog customers. Non-recurring
revenues in the North American Equipment Industry decreased in fiscal
2002, compared to the prior year, primarily due to a decrease in major
software customization projects. Non-recurring revenues in the North
American Equipment Industry increased in fiscal 2001, compared to the
prior year, primarily due to increased software and professional
services sold to new and existing manufacturing customers.
Non-North American
Recurring revenues in the non-North American Equipment Industry
increased in fiscal 2002 and fiscal 2001, compared to the prior year,
primarily due to an increase in the base revenue of catalog customers.
Non-recurring revenues in the non-North American Equipment Industry
decreased in fiscal 2002, compared to the prior year, primarily due to
a decrease in major software customization projects. Non-recurring
revenues in the non-North American Equipment Industry decreased in
fiscal 2001, compared to the prior year, primarily due to lower new
software licenses because of the decline in the manufacturing sector of
the economy.
Catalog and Related Products
Revenues from the Company's catalog and related products in the
Equipment Industry increased in fiscal 2002 and fiscal 2001, compared
to the prior year, primarily due to an increase in the Company's base
of electronic catalog customers and an increase in the volume of
catalogs purchased by dealers. Management expects recurring and
non-recurring catalog and related revenues to increase in both the
North American and non-North American Equipment Industry in fiscal 2003
and beyond, as the Company continues to focus attention and resources
on its catalog products.
Communications Products
Revenues from the Company's communications products decreased in both
fiscal 2002 and fiscal 2001, compared to the prior year, primarily due
to a decline in new product licenses and software customizations in
fiscal 2001 and a decline in the base of communications customers. The
Company has focused the
13
business primarily on its catalog products. Management expects revenues
from communications products will be a declining percentage of total
revenue in fiscal 2003.
Non-Equipment Industry Business
The Company's business outside of the Equipment Industry includes sales of
database management services to the agricultural inputs industry and, for fiscal
2000 and part of fiscal 2001, the railroad industry, electronic communications
services to the agricultural inputs industry, and, for fiscal 2000, fiscal 2001
and part of fiscal 2002, the on-line provision of information for republication
to the non-daily newspaper publishing industry. Both recurring and non-recurring
revenues in this business have decreased from the prior year in fiscal 2002 and
in fiscal 2001. Our five-year contract with the Association of American
Railroads expired in December 2000 and our five-year contract with the
Associated Press, expired in February 2002. Revenue from these contracts was
approximately $0.9 million in fiscal 2002.
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
financial statements.
COST OF PRODUCTS AND SERVICES SOLD AS A PERCENT OF REVENUE BY REVENUE TYPE
(IN THOUSANDS)
YEAR ENDED JULY 31
-------------------------------------------------------------------------------
PRODUCT: PERCENT PERCENT
2002 2001 CHANGE 2001 2000 CHANGE
------- ------- ------- ------- ------- -------
Subscriptions, support and other services
fees
Revenue $ 8,915 $ 9,985 (11)% $ 9,985 $ 9,743 2%
Cost of revenue 387 1,740 (78)% 1,740 1,415 23%
Cost of revenue as a percent of revenue 4% 17% 17% 15%
Software licenses and renewals
Revenue 2,721 3,266 (17)% 3,266 1,289 153%
Cost of revenue 1,523 3,137 (51)% 3,137 3,614 (13)%
Cost of revenue as a percent of revenue 56% 96% 96% 280%
Professional services
Revenue 2,227 2,526 (12)% 2,526 2,272 11%
Cost of revenue 738 1,359 (46)% 1,359 1,965 (31)%
Cost of revenue as a percent of revenue 33% 54% 54% 86%
Total
Revenue $13,863 $15,777 (12)% $15,777 $13,304 19%
Cost of revenue 2,648 6,236 (58)% 6,236 6,994 (11)%
Cost of revenue as a percent of revenue 19% 40% 40% 53%
Cost of subscriptions, support and other services consists primarily of
telecommunication costs, catalog replication and distribution costs and
royalties on revenues in the newspaper publishing industry (non-equipment). Cost
of subscriptions, support and other services fees as a percentage of revenue
decreased significantly in fiscal 2002, compared to the prior year, primarily
due to the elimination of revenues and related royalties in the newspaper
publishing industry, which have a lower margin than other revenues in this
category, and the favorable settlement of a reserve for royalties in the
newspaper publishing industry. Cost of subscriptions, support and other services
fees as a percentage of revenue remained relatively the same in fiscal 2001,
compared to the prior 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, now that the royalties from revenues in the
newspaper publishing industry are no longer being incurred.
Cost of software licenses and renewals consists primarily of amortization of
software products, royalties and software distribution costs. Cost of software
license and renewals as a percentage of revenue decreased significantly
14
in fiscal 2002, compared to the prior year, primarily due to lower software
amortization costs as a result of the restructuring in the fourth quarter of
fiscal 2001 and the elimination of royalties associated with the NDI
acquisition. Cost of software licenses and renewals as a percentage of revenue
decreased in fiscal 2001, compared to the prior year, due to lower software
license and renewal revenues but constant software product amortization costs,
which are fixed regardless of the level of sales. Management expects gross
margins from software licenses and renewals to 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 in
fiscal 2002 and fiscal 2001, compared to the prior year, primarily due to
significant decreases in communication software customizations, which have low
or negative margins and an increase in catalog production revenue as the Company
converted several NDI contracts from a fixed price to a time and materials
price. Management expects gross margins on 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 financial statements:
OPERATING EXPENSES
(IN THOUSANDS)
YEAR ENDED JULY 31
----------------------------------------------------------------------------
PERCENT PERCENT
2002 2001 CHANGE 2001 2000 CHANGE
-------- -------- ------- -------- -------- --------
Cost of products and services sold $ 2,648 $ 6,236 (58)% $ 6,236 $ 6,994 (11)%
Customer operations and support 1,220 1,597 (24)% 1,597 2,048 (22)%
Selling, general and administrative 6,835 8,790 (22)% 8,790 8,214 7%
Software development and technical support 2,056 3,317 (38)% 3,317 2,779 19%
Depreciation and amortization (exclusive
of amortization of software products included
in cost of products and services sold) 223 1,517 (85)% 1,517 1,778 (15)%
Restructuring and other charges -- 7,766 (100)% 7,766 -- n/a
Less capitalized portion (717) (1,972) (64)% (1,972) (1,729) 14%
-------- -------- -------- --------
Net operating expenses $ 12,265 $ 27,251 (55)% $ 27,251 $ 20,084 36%
======== ======== ======== ========
Net operating expenses decreased significantly in fiscal 2002, compared to the
prior year, as a result of cost reductions associated with the Company's
restructuring and increased in fiscal 2001, compared to the prior year,
primarily due to restructuring and other charges.
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 decreased in fiscal 2002,
compared to the prior year, primarily due to the cost reductions associated with
the Company's restructuring. Customer operations and support costs decreased in
fiscal 2001, compared to the prior year, primarily due to cost reductions in
catalog data maintenance and directory services. Management expects these costs
to remain more or less at the same level in fiscal 2003.
Selling, general and administrative expenses ("SG&A") decreased in fiscal 2002,
compared to the prior year, primarily due to the cost reductions associated with
the Company's restructuring. SG&A increased in fiscal 2001, compared to the
prior year, primarily due to the hiring of additional upper level finance, sales
and marketing personnel. SG&A, as a percentage of revenue, was 49% in fiscal
2002, 56% in fiscal 2001 and 62% in fiscal 2000. Management expects SG&A to
decline as a percentage of revenues in the future.
15
The Company's technical staff (in-house and contracted) is allocated between
software development and technical support and software customization services
for customer applications. Therefore, management expects fluctuations between
software customization services and development expenses from quarter to
quarter, as the mix of development and customization activities will change
based on customer requirements. During fiscal 2002, our technical resources were
primarily focused on enhancements to our CD-ROM and Web-based catalog products
and on-going catalog updates. During fiscal 2001, our technical resources were
focused primarily on a new release of TradeRoute(R), a major customization
project of our Web-based catalog for a customer in the auto parts aftermarket
industry and on-going catalog data updates. During fiscal 2000, our technical
resources were focused primarily on customization projects for our TradeRoute(R)
customers and development of Web-based communications and cataloging software.
We expect our technical resources to continue to focus on software
customization, catalog data updates and development of catalog software in
fiscal 2003, although the mix may fluctuate quarter to quarter based on customer
requirements. We expect software customization and development expenses to
remain more or less at the same level during fiscal 2003.
Depreciation and amortization expenses decreased significantly in fiscal 2002,
compared to fiscal 2001 and fiscal 2000, primarily due to the write-off of the
Company's communications platform as a result of the restructuring in July 2002.
Depreciation and amortization, as a percentage of total revenue, was 2% in
fiscal 2002, 10% in fiscal 2001 and 13% in fiscal 2000. Management expects
depreciation and amortization expenses to remain more or less at the same level
in fiscal 2003.
In the fourth quarter of fiscal 2001, management commenced a restructuring
designed to refocus resources from the Company's communication products to the
Company's core catalog products, which contribute greater cash margins, in order
to reach sustainable cash generation and earnings. During the quarter ended July
31, 2001, the Company incurred non-cash impairment charges of $7,333,000 for the
write-off of long-lived assets related to our network platform and communication
software and $433,000 in accrued restructuring expense related to severance and
future minimum lease payments. By the end of October 2001, the Company had
reduced its number of full-time equivalent employees to 101 from 137 prior to
the restructuring and eliminated all but a few contract staff. The reductions
have not had a material adverse effect on the Company's competitiveness or
operations and the restructuring positioned the Company to show a quarterly
profit for the entire year in fiscal 2002.
Capitalized development costs represented 35% of software development and
support expense in fiscal 2002, compared to 59% in fiscal 2001 and 62% in fiscal
2000. Capitalized expenses decreased in fiscal 2002, compared to fiscal 2001 and
fiscal 2000, as a percentage of software development and technical support,
because the Company's development resources were focused on software
customization projects and catalog data updates, both of which are expensed.
OTHER ITEMS
Interest expense decreased $152,000 in fiscal 2002, compared to the prior year,
as the Company paid off $808,000 of debt principal. Interest expense increased
$794,000 in fiscal 2001, compared to the prior year, due to the Debenture and
additional financing by the Company under its RFC facility. The Company expects
interest expense to decrease in fiscal 2003, as the Company continues to pay
down principal balances. See "Liquidity and Capital Resources".
The Company had net income of $188,000 in fiscal 2002, an improvement of
$13,213,000 over the prior year, primarily due to cost reductions associated
with the restructuring. Earnings decreased $5,423,000 in fiscal 2001, compared
to the prior year, primarily due to the write-off of impaired assets and the
accrual of related expenses in the Company's restructuring. Management expects
earnings to be near break-even in fiscal 2003, assuming that the Company's debt
can be restructured, although there can be no assurance that this will occur.
See "Liquidity and Capital Resources".
16
LIQUIDITY AND CAPITAL RESOURCES
The following table sets forth, for the periods indicated, certain cash flow
information derived from the Company's financial statements.
CASH FLOW INFORMATION
(IN THOUSANDS)
YEAR ENDED JULY 31
-----------------------------------------------------------------------
PERCENT PERCENT
2002 2001 CHANGE 2001 2000 CHANGE
------- ------- ------- ------- ------- -------
Net cash provided by (used in) operating activities
before changes in working capital $ 3,034 $ 401 657% $ 401 $(2,316) 117%
Net cash used in investing activities (1,058) (1,977) 46% (1,977) (1,792) (10)%
------- ------ ------- -------
Subtotal 1,976 (1,576) 225% (1,576) (4,108) 62%
Effect of net changes in working capital (391) 2,084 (119)% 2,084 1,153 81%
------- ------ ------- -------
Net cash provided by (used in) operating and
investing activities $ 1,585 $ 508 212% $ 508 $(2,955) 117%
======= ======= ======= =======
Net cash provided by (used in) operating activities before changes in working
capital increased in fiscal 2002, compared to the prior year, due to cost
reductions associated with the Company's restructuring. Net cash provided by
(used in) operating activities before changes in working capital increased in
fiscal 2001, compared to the prior year, due to increased revenues and tight
cost controls.
Net cash used in investing activities decreased in fiscal 2002, compared to the
prior year, due to cost reductions in the communications software development
area associated with the Company's restructuring. Net cash used in investing
activities increased in fiscal 2001, compared to the prior year, due to
increased costs attributable to the development of the Company's Web-based
communications and catalog software and a new release of the Company's
TradeRoute(R) software.
The effect of net changes in working capital is dependent on the timing of
payroll and other cash disbursements and may vary significantly from year to
year. In fiscal 2002, the change in working capital was negative, compared to a
substantial positive number in the prior year, primarily due to decreases in
accrued payroll related expenses, accrued royalties and other accruals. In
fiscal 2001, cash provided by working capital was higher, compared to the prior
year, primarily due to intensive collection efforts on past due accounts
receivables and an increase in deferred revenue as sales increased.
At July 31, 2002, the Company had cash and cash equivalents of approximately
$879,000 compared to approximately $313,000 at July 31, 2001.
17
The following table sets forth, for the periods indicated, certain information
related to the Company's debt derived from the Company's audited financial
statements.
DEBT SCHEDULE
(IN THOUSANDS)
JULY 31 JULY 31 NET
2002 2001 CHANGE
------- ------- -------
Debt to Shareholder:
Current portion of line of credit $ -- $ 200 $ (200)
Current portion of notes payable 56 333 (277)
Long-term portion of notes payable -- 56 (56)
Debt discount (common stock warrants) (6) (41) 35
------- ------- -------
Total Debt to Shareholder 50 548 (498)
Subordinated Debenture:
Notes payable* 4,000 4,000 --
Debt discount (common stock warrants and options) (588) (1,373) 785
------- ------- -------
Total Subordinated Debenture 3,412 2,627 785
Other Debt:
Current portion of notes payable other 78 275 (197)
Long-term notes payable other -- 78 (78)
------- ------- -------
Total Other Debt 78 353 (275)
------- ------- -------
Total Debt $ 3,540 $ 3,528 $ 12
======= ======= =======
* 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 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 "Item 3 - 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.
18
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. During fiscal 2002, the Company incurred
approximately $29,832 of interest with respect to its borrowings from WITECH.
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 $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 the 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 October
15, 2002, the balance of the RFC Facility was $522,000.
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 increased
from negative $6,743,000 in fiscal 2001 to positive $3,458,000 in fiscal 2002,
primarily due to the cost reductions associated with the Company's
restructuring. EBITDA decreased from negative $1,807,000 in fiscal 2000 to
negative $6,743,000 in fiscal 2001 primarily due to restructuring and other
charges, partially offset by increased revenues and cost controls over cash
expenditures. Management believes that EBITDA will be positive in fiscal 2003,
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-K are forward looking statements
including revenue growth, future cash flows and cash generation and sources of
liquidity. Expressions such as "believes," "anticipates," "expects," and similar
expressions are intended to identify such forward looking statements. Several
important factors can cause actual results to materially differ from those
stated or implied in the forward looking statements. Such factors include, but
are not limited to the factors listed on exhibit 99.1 of the Company's annual
report on Form 10-K for the year ended July 31, 2002, which is incorporated
herein by reference.
19
QUARTERLY FINANCIAL DATA
The following table sets forth the unaudited operations data for each of the
eight quarterly periods ended July 31, 2002, prepared on a basis consistent with
the audited financial statements, reflecting all normal recurring adjustments
that are considered necessary. The quarterly information is as follows (in
thousands):
1st 2nd 3rd 4th
------------------ ------------------ ------------------ ------------------
2002 2001 2002 2001 2002 2001 2002 2001
------- ------- ------- ------- ------- ------- ------- -------
Net revenues $ 3,820 $ 4,142 $ 3,318 $ 4,086 $ 3,408 $ 3,876 $ 3,317 $ 3,673
Gross profit 3,007 2,300 2,801 2,460 2,677 2,499 2,730 2,282
Net income (loss) 63 (1,522) 34 (1,216) 18 (1,502) 73 (8,785)
Basic and diluted
net income (loss) per share $ 0.01 $ (0.25) $ 0.01 $ (0.20) $ 0.00 $ (0.24) $ 0.01 $ (1.42)
ITEM 7A. 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 October 15, 2002. As a result,
ARI believes that the market risk relating to interest rate movements is
minimal.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ARI's Financial Statements and related notes for the fiscal years ended July 31,
2002, 2001 and 2000 together with the report thereon of ARI's independent
auditors, Ernst & Young LLP, are attached hereto as Exhibit A-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF ARI
Information regarding the directors of ARI and compliance with Section 16(a) of
the Exchange Act is included in ARI's definitive 2002 Annual Meeting Proxy
Statement, and is incorporated herein by reference. See "Election of Directors"
and "Section 16(a) Beneficial Ownership Reporting Compliance." Information with
respect to ARI's executive officers is shown at the end of Part I of this Form
10-K.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding Executive Compensation, Employment Agreements,
Compensation of Directors, Employee Stock Options and other compensation plans
is included in ARI's definitive 2002 Annual Meeting Proxy Statement, and is
incorporated herein by reference. See "Executive Compensation" and "Election of
Directors".
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding beneficial ownership of ARI's common stock and common
stock authorized for issuance under equity compensation plans is included in
ARI's definitive 2002 Annual Meeting Proxy Statement and is
20
incorporated herein by reference. See "Security Ownership of Certain Beneficial
Owners" and "Equity Compensation Plan Information".
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information related to Certain Relationships and Related Transactions is
included in ARI's definitive 2002 Annual Meeting Proxy Statement, and is
incorporated herein by reference. See "Certain Transactions".
ITEM 14. CONTROLS AND PROCEDURES
In the quarter ended July 31, 2002, there were no significant changes in ARI's
internal controls or in other factors that could significantly affect these
controls, including any corrective actions with regard to significant
deficiencies and material weaknesses. Management periodically reviews ARI's
internal controls for effectiveness and plans to conduct quarterly evaluations
of its disclosure controls and procedures.
PART IV
ITEM 14. FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES, EXHIBITS AND
REPORTS ON FORM 8-K
(a)1.
FINANCIAL STATEMENTS
Report of independent auditors on Financial Statements and Financial Statement
Schedule.
Balance sheets - July 31, 2002 and 2001.
Statements of operations for each of the three years in the period ended July
31, 2002.
Statements of shareholders' equity (deficit) for each of the three years in the
period ended July 31, 2002.
Statements of cash flows for each of the three years in the period ended July
31, 2002.
Notes to financial statements - July 31, 2002.
The Financial Statements are located immediately following the signature pages.
(a)2.
FINANCIAL STATEMENT SCHEDULES
Schedule II
Valuation and qualifying accounts for the years ended July 31, 2002, 2001, and
2000.
The Financial Statement Schedule is located immediately following the Financial
Statements. All other schedules to which provision is made in the applicable
accounting regulation of the Securities and Exchange Commission are not required
under the related instructions or are inapplicable, and therefore have been
omitted.
(a)3.
EXHIBITS:
See (c) below.
21
(b) REPORTS ON FORM 8-K:
There were no reports on Form 8-K filed for the three months ended July 31,
2002.
(c)
EXHIBITS:
EXHIBIT
NUMBER DESCRIPTION
------- -----------
3.1 Articles of Incorporation of the Company, as amended, incorporated herein by reference to Exhibit 3.1
of the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended April 30, 1999.
3.2 By-laws of the Company incorporated herein by reference to Exhibit 3.1 of the Company's Registration
Statement on Form S-1 (Reg. No. 33-43148).
4.1 The Company agrees to furnish to the Commission upon request copies of any agreements with respect to
long term debt not exceeding 10% of the Company's consolidated assets.
10.1* 1991 Stock Option Plan, as amended, incorporated herein by reference to Exhibit 10.2 of the Company's
Form 10-Q for the quarter ended January 31, 1999.
10.2* 1993 Director Stock Option Plan, as amended, incorporated herein by reference to Exhibit 10.3 of the
Company's Form 10-Q for the quarter ended January 31, 1999.
10.3* 2000 Stock Option Plan, incorporated herein by reference to Exhibit 10.3 of the Company's Annual
Report on Form 10-K for the fiscal year ended July 31, 2000.
10.4 Loan Agreement by and between the Company and WITECH Corporation dated October 4, 1993, incorporated
herein by reference to Exhibit 10.10 of the Company's Form 10-K for the fiscal year ended July 31,
1993.
10.5 Amendment to Loan Agreement dated May 19, 1994 between the Company and WITECH Corporation,
incorporated herein by reference to Exhibit 10.22 of the Company's Registration Statement on Form S-3
(Reg. No. 33-75760).
10.6 Amendment No. 2 to Loan Agreement dated July 28, 1994 between the Company and WITECH Corporation,
incorporated herein by reference to Exhibit 10.22 of the Company's Registration Statement on Form S-1
(Reg. No. 33-80914).
10.7 Consent and Amendment No. 3 to Loan Agreement dated December 2, 1994 between the Company and WITECH
Corporation, incorporated herein by reference to Exhibit 10.1 of the Company's Form 10-Q for the
quarter ended October 31, 1994.
10.8 Amendment No. 4 to Loan Agreement dated October 18, 1995 between the Company and WITECH Corporation,
incorporated herein by reference to Exhibit 10.14 of the Company's Form 10-K for the fiscal year ended
July 31, 1995.
10.9 Amendment No. 5 to Loan Agreement dated December 20, 1995 between the Company and WITECH Corporation,
incorporated herein by reference to Exhibit 10.31 of the Company's Form 10-K for the fiscal year ended
July 31, 1996.
10.10 Amendment No. 6 to Loan Agreement dated January 23, 1996, between the Company and WITECH Corporation,
incorporated herein by reference to Exhibit 10.32 of the Company's Form 10-K for the fiscal year ended
July 31, 1996.
10.11 Amendment No. 7 to Loan Agreement dated April 20, 1996 between the Company and WITECH Corporation,
incorporated herein by reference to Exhibit 10.1 of the Company's Form 10-Q for the quarter ended
April 30, 1996.
10.12 Amendment No. 8 to Loan Agreement dated May 31, 1996 between the Company and WITECH Corporation,
incorporated herein by reference to Exhibit 10.2 of the Company's Form 10-Q for the quarter ended
April 30, 1996.
10.13 Amendment No. 9 to Loan Agreement dated November 5, 1996, between the Company and WITECH Corporation,
including Forms of Amended and Restated Commitment Warrant and Usage Warrant, incorporated herein by
reference to Exhibit 10.1 of the Company's Form 10-Q for the quarter ended October 31, 1996.
10.14 Amendment No. 10 to Loan Agreement dated May 30, 1997, between the Company and WITECH Corporation,
incorporated herein by reference to Exhibit 10.1 of the Company's Form 10-Q for the quarter ended
April 30, 1997.
22
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.15 Amendment No. 11 to Loan Agreement dated January 21, 1998 between the Company and WITECH Corporation,
incorporated herein by reference to Exhibit 10.1 of the Company's Form 10-Q for the fiscal quarter
ended April 30, 1998.
10.16 Amendment No. 12 to Loan Agreement dated May 27, 1998 between the Company and WITECH Corporation
incorporated herein by reference to Exhibit 10.1 of the Company's Form 10-Q for the fiscal quarter
ended April 30, 1998.
10.17 Amendment No. 13 to Loan Agreement dated September 14, 1998 between the Company and WITECH Corporation
incorporated herein by reference to Exhibit 10.16 of the Company's Form 10-K for the fiscal year ended
July 31, 1998.
10.18 Consent of WITECH Corporation, dated September 15, 1998, incorporated herein by reference to Exhibit
10.1 of the Company's Form 10-Q for the fiscal quarter ended October 31, 1998.
10.19 Amendment No. 14 to Loan Agreement dated January 29, 1999, between the Company and WITECH Corporation,
incorporated herein by reference to Exhibit 10.1 of the Company's 10-Q for the fiscal quarter ended
January 31, 1999.
10.20 Consent of WITECH Corporation, dated April 19, 1999, incorporated herein by reference to Exhibit 4.1
of the Company's Form 10-Q for the fiscal quarter ended April 30, 1999.
10.21 Amendment No. 15 to Loan Agreement dated September 23, 1999, between the Company and WITECH
Corporation, incorporated herein by reference to Exhibit 10.20 of the Company's Form 10-K for the
fiscal year ended July 31, 1999.
10.22 Amendment No. 16 to Loan Agreement dated December 21, 1999 between the Company and WITECH Corporation,
incorporated herein by reference to Exhibit 10.1 of the Company's Form 10-Q for the fiscal quarter
ended January 31, 2000.
10.23 Amendment No. 17 to Loan Agreement dated July 9, 2001 between the Company and WITECH Corporation,
incorporated herein by reference to Exhibit 10.23 of the Company's Form 10-K for the fiscal year ended
July 31, 2001.
10.24 Amendment No. 18 to Loan Agreement dated October 22, 2001 between the Company and WITECH Corporation,
incorporated herein by reference to Exhibit 10.24 of the Company's Form 10-K for the fiscal year ended
July 31, 2001.
10.25 Receivables Sales Agreement, dated September 28, 1999, between the Company and RFC Capital
Corporation, incorporated herein by reference to Exhibit 10.21 of the Company's Form 10-K for the
fiscal year ended July 31, 1999.
10.26 Amendments to Receivables Sales Agreement dated September 25, 2002 and October 31, 2002 between the
Company and RFC Capital Corporation.
10.27* Form of Change of Control Agreement between the Company and each of Brian E. Dearing, John C. Bray,
Michael E. McGurk, Frederic G. Tillman, Timothy Sherlock and Jeffrey E. Horn, incorporated herein by
reference to Exhibit 10.25 of the Company's Form 10-K for the fiscal year ended July 31, 1999.
10.28* Deferred Compensation Plan, incorporated herein by reference to Exhibit 10.26 of the Company's Form
10-K for the fiscal year ended July 31, 1999.
10.29* Deferred Bonus Plan, incorporated herein by reference to Exhibit 10.27 of the Company's Form 10-K for
the fiscal year ended July 31, 1999.
10.30 Preferred Stock Purchase Agreement dated July 15, 1997, between the Company and WITECH Corporation,
incorporated herein by reference to Exhibit 10.1 of the Company's Registration Statement on Form S-2
(Reg. No. 333-31295) filed on July 15, 1997.
10.31 Securities Purchase Agreement, dated as of April 25, 2000, by and among the Company and RGC
International Investors, LDC, incorporated herein by reference to Exhibit 99.1 of the Company's Report
on Form 8-K filed May 2, 2000.
10.32 Convertible Subordinated Debenture dated as of April 27, 2000, incorporated herein by reference to
Exhibit 99.2 of the Company's Report on Form 8-K filed May 2, 2000.
10.33 Stock Purchase Warrant dated as of April 27, 2000, incorporated herein by reference to Exhibit 99.3 of
the Company's Report on Form 8-K filed May 2, 2000.
10.34 Investment Option dated as of April 27, 2000, incorporated herein by reference to Exhibit 99.4 of the
Company's Report on Form 8-K filed May 2, 2000.
10.35 Registration Rights Agreement, dated as of April 27, 2000, by and among the Company and RGC
International Investors, LDC, incorporated herein by reference to Exhibit 99.5 of the Company's Report
on Form 8-K filed May 2, 2000.
10.36 Complaint filed by the Company with the Milwaukee County Circuit Court on November 8, 2002.
23.1 Consent of Ernst & Young LLP.
24.1 Powers of Attorney appear on the signature page hereof.
23
EXHIBIT
NUMBER DESCRIPTION
------- -----------
99.1 Forward-Looking Statements Disclosure.
99.2 Section 906 Certification of Chief Executive Officer.
99.3 Section 906 Certification of Chief Financial Officer.
* Management Contract or Compensatory Plan.
24
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of
Milwaukee, State of Wisconsin on this 13th day of November 2002.
ARI NETWORK SERVICES, INC.
By: /s/ Brian E. Dearing
--------------------------------
Brian E. Dearing,
Chairman, President & CEO
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Brian E. Dearing and Timothy Sherlock,
his true and lawful attorney-in-fact and agent with full power of substitution
and resubstitution, for him and his name, place and stead, in any and all
capacities, to sign any and all amendments to this report and to file the same
with all exhibits thereto, and other documents in connection therewith, with the
Commission, granting unto said attorney-in-fact and agent full power and
authority to do and perform each act and thing requisite and necessary to be
done, as fully to all intents and purposes as he might or could do in person,
hereby ratifying and confirming all that said attorney-in-fact and agent, or his
substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed by the following persons in the capacities and on
the dates indicated.
SIGNATURE TITLE DATE
/s/ Brian E. Dearing Chairman, President, CEO & Director November 13, 2002
------------------------------ (Principal Executive Officer)
Brian E. Dearing
/s/ Timothy Sherlock Chief Financial Officer, Secretary, November 13, 2002
------------------------------- Treasurer & VP of Finance
Timothy Sherlock (Principal Financial and Accounting Officer)
/s/ Gordon J. Bridge Director November 13, 2002
------------------------------
Gordon J. Bridge
/s/ Ted C. Feierstein Director November 13, 2002
------------------------------
Ted C. Feierstein
/s/ Richard W. Weening Director November 13, 2002
---------------------------
Richard W. Weening
25
================================================================================
CERTIFICATIONS
I, Brian E. Dearing, certify that:
1. I have reviewed this annual report on Form 10-K of
ARI Network Services, Inc.;
2. Based on my knowledge, this annual 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 annual report;
and
3. Based on my knowledge, the financial statements, and
other financial information included in this annual
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 annual report.
Date: November 13, 2002
By: /s/ Brian E. Dearing
---------------------------------
By: Brian E. Dearing
Title: Chairman, President and CEO
I, Timothy Sherlock, certify that:
1. I have reviewed this annual report on Form 10-K of
ARI Network Services, Inc.;
2. Based on my knowledge, this annual 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 annual report;
and
3. Based on my knowledge, the financial statements, and
other financial information included in this annual
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 annual report.
Date: November 13, 2002
By: /s/ Timothy Sherlock
--------------------------------
By: Timothy Sherlock
Title: Chief Financial Officer,
Secretary, Treasurer, and
VP of Finance
26
FINANCIAL STATEMENTS
ARI Network Services, Inc.
Years ended July 31, 2002, 2001 and 2000
ARI Network Services, Inc.
Financial Statements
Years ended July 31, 2002, 2001 and 2000
CONTENTS
Report of Independent Auditors ............................... 1
Financial Statements
Balance Sheets ............................................... 3
Statements of Operations ..................................... 5
Statements of Shareholders' Equity (Deficit) ................. 6
Statements of Cash Flows ..................................... 8
Notes to Financial Statements ................................ 10
Report of Ernst & Young LLP, Independent Auditors
To the Board of Directors and Shareholders
ARI Network Services, Inc.
We have audited the accompanying balance sheets of ARI Network Services, Inc.
(the Company) as of July 31, 2002 and 2001, and the related statements of
operations, shareholders' equity (deficit) and cash flows for each of the three
years in the period ended July 31, 2002. Our audits also included the financial
statement schedule listed in the Index at Item 14(a). These financial statements
and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of the Company at July 31, 2002
and 2001, and the results of its operations and its cash flows for each of the
three years in the period ended July 31, 2002, in conformity with accounting
principles generally accepted in the United States. Also, in our opinion, the
related financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.
1
The accompanying financial statements have been prepared assuming the Company
will continue as a going concern. As more fully described in Note 2, the Company
has a working capital deficiency and a shareholders' deficit. In addition, the
Company's convertible Debenture is a current obligation and the Company does not
have long-term credit availability. The Debenture contains a provision which
states that the holder can accelerate maturity if the Company's common stock is
not listed on a particular exchange. The Company's common stock is not so
listed. These conditions raise substantial doubt about the Company's ability to
continue as a going concern. Management's plans in regard to these matters are
also described in Note 2. The financial statements do not include any
adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
may result from the outcome of this uncertainty.
Milwaukee, Wisconsin
September 19, 2002, except
for Note 11 as to which the
date is November 12, 2002
2
ARI Network Services, Inc.
Balance Sheets
(Dollars in Thousands, Except Per Share Data)
JULY 31
2002 2001
------- -------
ASSETS
Current assets:
Cash $ 879 $ 313
Trade receivables, less allowance for doubtful accounts of
$140 in 2002 and $757 in 2001 1,743 2,084
Prepaid expenses and other 84 140
------- -------
Total current assets 2,706 2,537
Equipment and leasehold improvements:
Computer equipment 4,394 4,394
Leasehold improvements 73 239
Furniture and equipment 1,292 1,000
------- -------
5,759 5,633
Less accumulated depreciation and amortization 5,262 5,293
------- -------
Net equipment and leasehold improvements 497 340
Other assets 105 222
Capitalized software product costs 23,585 23,399
Less accumulated amortization 20,519 19,438
------- -------
3,066 3,961
------- -------
$ 6,374 $ 7,060
======= =======
3
JULY 31
2002 2001
--------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Line of credit payable to shareholder $ -- $ 200
Current portion of note payable to shareholder 50 333
Current portion of notes payable (Note 5) 3,490 2,902
Accounts payable 927 1,074
Deferred revenue 4,619 4,811
Accrued payroll and related liabilities 1,140 1,364
Other accrued liabilities 1,042 1,376
Current portion of capital lease obligations 151 173
--------- ---------
Total current liabilities 11,419 12,233
Note payable to shareholder -- 15
Notes payable -- 78
Other long-term liabilities 535 426
Capital lease obligations 26 158
--------- ---------
Total noncurrent liabilities 561 677
Commitments (Note 6)
Shareholders' equity (deficit):
Cumulative preferred stock, par value $.001 per share,
1,000,000 shares authorized; 20,350 shares issued and
outstanding -- --
Common stock, par value $.001 per share, 25,000,000 shares
authorized; 6,329,301 and 6,184,281 shares issued and
outstanding in 2002 and 2001, respectively 6 6
Common stock warrants and options 2,459 2,459
Additional paid-in capital 91,853 91,797
Accumulated deficit (99,924) (100,112)
--------- ---------
Total shareholders' equity (deficit) (5,606) (5,850)
--------- ---------
$ 6,374 $ 7,060
========= =========
See accompanying notes.
4
ARI Network Services, Inc.
Statements of Operations
(Dollars in Thousands, Except Per Share Data)
YEAR ENDED JULY 31
2002 2001 2000
-------- -------- --------
Net revenues:
Subscriptions, support and other services fees $ 8,915 $ 9,985 $ 9,743
Software licenses and renewals 2,721 3,266 1,289
Professional services 2,227 2,526 2,272
-------- -------- --------
13,863 15,777 13,304
Operating expenses:
Cost of products and services sold:
Subscriptions, support and other services
fees 387 1,740 1,415
Software licenses and renewals 1,523 3,137 3,614
Professional services 738 1,359 1,965
-------- -------- --------
2,648 6,236 6,994
Depreciation and amortization (exclusive of
amortization of software products included in cost
of products and services sold) 223 1,517 1,778
Customer operations and support 1,220 1,597 2,048
Selling, general and administrative 6,835 8,790 8,214
Software development and technical support 2,056 3,317 2,779
Restructuring and other charges -- 7,766 --
-------- -------- --------
Operating expenses before amounts capitalized 12,982 29,223 21,813
Less capitalized portion (717) (1,972) (1,729)
-------- -------- --------
Net operating expenses 12,265 27,251 20,084
-------- -------- --------
Operating income (loss) 1,598 (11,474) (6,780)
Other income (expense):
Interest expense (1,435) (1,587) (793)
Other, net 25 36 (29)
-------- -------- --------
(1,410) (1,551) (822)
-------- -------- --------
Net income (loss) $ 188 $(13,025) $ (7,602)
======== ======== ========
Basic and diluted net income (loss) per share $ .03 $ (2.11) $ (1.27)
======== ======== ========
5
See accompanying notes.
ARI Network Services, Inc.
Statements of Shareholders' Equity (Deficit)
(Dollars in Thousands)
Number of Shares Issued
and Outstanding
-------------------------------
Preferred Stock Common Stock
--------------- ------------
Balance July 31, 1999 20,350 5,097,432
Issuance of common stock in connection
with acquisitions -- 550,019
Issuance of common stock as payment on
line of credit -- 195,122
Issuance of common stock for professional
services received -- 58,270
Issuance of common stock under stock purchase
plan and from exercise of stock options -- 267,427
Issuance of common stock warrants and options
in connection with notes payable -- --
Net loss -- --
--------- ---------
Balance July 31, 2000 20,350 6,168,270
Issuance of common stock under stock
purchase plan -- 16,011
Stock compensation expense -- --
Net loss -- --
--------- ---------
Balance July 31, 2001 20,350 6,184,281
Issuance of common stock under stock
purchase plan -- 39,064
Issuance of common stock as contribution to
401(k) plan -- 105,956
Capital contribution -- --
Net income -- --
--------- ---------
Balance July 31, 2002 20,350 6,329,301
========= =========
See accompanying notes.
6
Common Stock
to be Issued Par Value Common
---------------------- ---------------------- Stock Additional
Number of Preferred Common Warrants Paid-in Accumulated
Shares Amount Stock Stock and Options Capital Deficit
--------- ---------- ---------- --------- ----------- ---------- -----------
Balance July 31, 1999 550,019 $ 2,406 $ -- $ 5 $ -- $ 86,830 $ (79,485)
Issuance of common stock in connection
with acquisitions (550,019) (2,406) -- 1 -- 2,405 --
Issuance of common stock as payment on
line of credit -- -- -- -- -- 1,000 --
Issuance of common stock for professional
services received -- -- -- -- -- 211 --
Issuance of common stock under stock
purchase plan and from exercise of
stock options -- -- -- -- -- 1,335 --
Issuance of common stock warrants and
options in connection with notes payable -- -- -- -- 2,459 -- --
Net loss -- -- -- -- -- -- (7,602)
--------- --------- ---------- --------- --------- --------- --------
Balance July 31, 2000 -- -- -- 6 2,459 91,781 (87,087)
Issuance of common stock under stock
purchase plan -- -- -- -- -- 14 --
Stock compensation expense -- -- -- -- -- 2 --
Net loss -- -- -- -- -- -- (13,025)
--------- --------- ---------- --------- --------- --------- --------
Balance July 31, 2001 -- -- -- 6 2,459 91,797 (100,112)
Issuance of common stock under stock
purchase plan -- -- -- -- -- 14 --
Issuance of common stock as contribution to
401(k) plan -- -- -- -- -- 38 --
Capital contribution -- -- -- -- -- 4 --
Net income -- -- -- -- -- -- 188
--------- --------- ---------- --------- --------- --------- ---------
Balance July 31, 2002 -- $ -- $ -- $ 6 $ 2,459 $ 91,853 $ (99,924)
========= ========= ========== ========= ========= ========= =========
See accompanying notes.
7
ARI Network Services, Inc.
Statements of Cash Flows
(In Thousands)
YEAR ENDED JULY 31
2002 2001 2000
-------- -------- --------
OPERATING ACTIVITIES
Net income (loss) $ 188 $(13,025) $ (7,602)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Amortization of network platform -- 604 656
Amortization of software products 1,612 3,178 3,224
Amortization of goodwill 15 658 658
Amortization of debt discount and deferred financing fees 973 963 284
Depreciation and other amortization 208 255 464
Restructuring and other charges -- 7,766 --
Stock compensation expense -- 2 --
Issuance of common stock as contribution to 401(k) plan 38 -- --
Net change in receivables, prepaid expenses and other
current assets 397 1,167 (90)
Net change in accounts payable, deferred revenue, accrued
liabilities and long-term liabilities (788) 917 1,243
-------- -------- --------
Net cash provided by (used in) operating activities 2,643 2,485 (1,163)
INVESTING ACTIVITIES
Purchase of equipment and leasehold improvements (341) (5) (63)
Software product costs capitalized (717) (1,972) (1,729)
-------- -------- --------
Net cash used in investing activities (1,058) (1,977) (1,792)
FINANCING ACTIVITIES
Borrowings (repayments) under line of credit (200) 200 (1,000)
Borrowings under notes payable -- -- 4,000
Payments of capital lease obligations and notes payable (786) (942) (690)
Debt issuance costs incurred (51) (30) (254)
Proceeds from issuance of common stock and capital contribution 18 14 1,335
-------- -------- --------
Net cash provided by (used in) financing activities (1,019) (758) 3,391
-------- -------- --------
Net increase (decrease) in cash 566 (250) 436
Cash at beginning of year 313 563 127
-------- -------- --------
Cash at end of year $ 879 $ 313 $ 563
======== ======== ========
Cash paid for interest $ 394 $ 532 $ 437
======== ======== ========
See accompanying notes.
8
ARI Network Services, Inc.
Statements of Cash Flows (continued)
(In Thousands)
YEAR ENDED JULY 31
2002 2001 2000
------ ------ ------
NONCASH INVESTING AND FINANCING ACTIVITIES
Capital lease obligations incurred for --
Computer equipment $ 24 $ 154 $ 328
Issuance of common stock as payment on line of credit -- -- 1,000
Conversion of line of credit to notes payable to shareholder -- -- 1,000
Issuance of common stock warrants and options -- -- 2,459
Issuance of common stock for professional services:
Computer equipment -- -- 85
Deferred financing costs -- -- 126
See accompanying notes.
9
ARI Network Services, Inc.
Notes to Financial Statements
July 31, 2002
1. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
ARI Network Services, Inc. (the Company) operates in one business segment and
provides technology-enabled business solutions that connect manufacturers in
selected industries with their service and distribution networks. Disaggregated
operating expense information is not provided to the chief operating decision
maker of the Company. The Company focuses on the U.S., Canadian, European and
Australian manufactured equipment industry. The Company provides both electronic
catalog and transaction services, enabling partners in a service and
distribution network to electronically look up parts, service bulletins and
other technical reference information, and to exchange electronic business
documents such as purchase orders, invoices, warranty claims and status
inquiries. The Company's customers are located primarily in the United States,
Europe and Canada. Transaction gains and losses that arise from exchange rate
fluctuations on transactions denominated in a currency other than the U.S.
dollar are included in the results of operations as incurred. Transaction gains
and losses were insignificant in each of the periods reported.
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 is recognized ratably over the
period the maintenance is provided. Revenue from catalog subscriptions is
recognized over the subscription term.
Revenue from software licenses in multiple element arrangements is recognized
ratably over the contractual term of the arrangement. The Company considers all
arrangements with payment terms extending beyond 12 months and other
arrangements with payment terms longer than normal not to be fixed or
determinable. If the fee is not fixed or determinable, revenue is recognized as
payments become due from the customer. 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.
10
ARI Network Services, Inc.
Notes to Financial Statements (continued)
1. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Arrangements that include professional services are evaluated to determine
whether those services are essential to the functionality of other elements of
the arrangement. Types of services that are considered essential include
customizing complex features and functionality in the products' base software
code or developing complex interfaces within a customer's environment. 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 uncertainty on the ability and intent of the reseller
to sell such software independent of their payment to the Company.
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 that affect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates.
EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements are stated at cost. Depreciation and
amortization are computed under the straight-line method for financial reporting
purposes and under accelerated methods for income tax purposes. Depreciation and
amortization have been provided over the estimated useful lives of the assets as
follows:
Years
-----
Computer equipment 2 - 7
Leasehold improvements 7
Furniture and equipment 2 - 5
11
ARI Network Services, Inc.
Notes to Financial Statements (continued)
1. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CAPITALIZED SOFTWARE PRODUCT COSTS
Certain software development costs are capitalized when incurred. Capitalization
of these costs begins upon the establishment of technological feasibility. The
establishment of technological feasibility and the ongoing assessment of
recoverability of software costs requires considerable judgment by management
with respect to certain external factors, including, but not limited to,
technological feasibility, anticipated future gross revenues, estimated economic
life and changes in software and hardware technologies. Note 3 further describes
certain capitalized software development costs written down to net realizable
value in 2001.
The annual amortization of software products is the greater of the amount
computed using: (a) the ratio that current gross revenues for the network or a
software product bear to the total of current and anticipated future gross
revenues for the network or a software product, or (b) the straight-line method
over the estimated three-year economic life of the product. Amortization starts
when the product is available for general release to customers.
All other software development and support expenditures are charged to expense
in the period incurred.
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.
Such analyses necessarily involve judgment. The Company evaluated the ongoing
value of its long-lived assets as of July 31, 2002 and 2001, and the impact on
the Company's results of operations for the year ended July 31, 2001, is
described in Note 3.
DEFERRED FINANCING COSTS
Costs incurred to obtain long-term financing are included in other assets and
are amortized using the interest method over the term of the related debt.
12
ARI Network Services, Inc.
Notes to Financial Statements (continued)
1. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CAPITALIZED INTEREST COSTS
In 2002, 2001 and 2000, interest costs of $63,000, $180,000 and $76,000,
respectively, were capitalized and included in the capitalized software product
costs.
COMPREHENSIVE INCOME (LOSS)
Net income (loss) for 2002, 2001 and 2000 is the same as comprehensive income
(loss) defined pursuant to Statement of Financial Accounting Standards (SFAS)
No. 130, "Reporting Comprehensive Income."
NET INCOME (LOSS) PER SHARE
The numerator for the calculation of basic and diluted earnings per share is net
income (loss) in each year. The following table sets forth the computation of
basic and diluted weighted-average shares used in the per share calculations:
2002 2001 2000
--------- --------- ---------
Denominator for basic net income (loss) per
share - weighted-average shares outstanding 6,215,000 6,175,000 6,002,000
Effect of dilutive options 23,000 -- --
--------- --------- ---------
Denominator for diluted net income (loss) per
share 6,238,000 6,175,000 6,002,000
========= ========= =========
Options that could potentially dilute net income
(loss) per share in the future that are not
included in the computation of diluted net
income (loss) per share, as their impact is
antidilutive -- 17,000 57,000
========= ========= =========
During 2001 and 2000, options and warrants were antidilutive due to the net
losses incurred in those years.
RECLASSIFICATIONS
Certain 2001 amounts were reclassified to conform to the 2002 presentation.
13
ARI Network Services, Inc.
Notes to Financial Statements (continued)
1. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ACCOUNTING PRONOUNCEMENTS
SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," has been applied prospectively for transfers of
financial assets occurring after April 1, 2001. SFAS No. 140 replaces SFAS No.
125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities." The Company recognizes the transactions
discussed in Note 5 as secured borrowings.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," which addresses financial accounting and
reporting for the impairment or disposal of long-lived assets and supersedes
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of," and the accounting and reporting
provisions of Accounting Principles Board (APB) Opinion No. 30, "Reporting the
Results of Operations," for a disposal of a segment of business. SFAS No. 144 is
effective for fiscal years beginning after December 15, 2001. The Company will
adopt SFAS No. 144 as of August 1, 2002, and it does not expect that the
adoption of the statement will have a significant impact on the Company's
financial position and results of operations.
2. LIQUIDITY AND MANAGEMENT'S PLAN
As further discussed in Note 5, the Company's convertible Debenture is a current
obligation and the Company does not have long-term credit availability. See Note
11 for management's efforts to uphold a stand-still and buy-back agreement with
the holder of the Debenture.
The Company has implemented a series of reductions in its work force and other
strategies to reduce its cash expenditures, as further described in Note 3.
Management believes the cash flows from the Company's operations in fiscal 2003
will fund its operations and that other strategic or financing options will
provide the Company with the ability to meet its cash flow obligations.
Accordingly, the financial statements have been prepared on the basis of a going
concern, which contemplates realization of assets and satisfaction of
liabilities in the normal course of business.
14
ARI Network Services, Inc.
Notes to Financial Statements (continued)
3. RESTRUCTURING AND OTHER CHARGES
In July 2001, the Board of Directors authorized management to restructure the
Company and discontinue certain noncatalog software products and related
services. Revenue generated from noncatalog product lines was approximately $5.3
million in 2001. The Company discontinued or transitioned certain of these
product lines to other service providers during fiscal 2002. The Company may
sell certain discontinued product lines in the future. The Company's actions
resulted in a work force reduction of approximately 15%, mainly consisting of
software development and support personnel. The Company communicated all
severance benefits to the 18 affected employees before July 31, 2001.
Additionally, an impairment charge of $7,333,000 was recorded in July 2001
related to long-lived assets for the noncatalog product lines. The Company
estimated undiscounted cash flows expected over the remaining amortization
period of the long-lived assets. Immediately before recording the impairment
charge, the carrying value of goodwill and capitalized software development
costs related to discontinued product lines was $1,203,000 and $6,130,000,
respectively. The discontinued product lines were expected to generate minimal
or negative cash flows (including any estimated sales proceeds) through their
expected date of discontinuance, and, accordingly, the Company recorded an
impairment charge to write off the carrying value of the assets.
The restructuring and impairment charges were determined based upon formal plans
approved by the Company's Board of Directors in July 2001. No significant
additional restructuring charges were recognized in fiscal 2002.
Restructuring and other charges recorded in the statement of operations during
the fourth quarter of fiscal 2001 are as follows (in thousands):
Employee termination costs $ 130
Noncancellable operating agreements 303
Asset impairment charges 7,333
------
$7,766
======
At July 31, 2001, no payments had been made for any of the restructuring costs.
During 2002, payments of $130,000 were made for the restructuring costs.
At July 31, 2002, other accrued liabilities and other long-term liabilities
include accrued restructuring costs of $69,000 and $234,000, respectively. At
July 31, 2001, these amounts were $130,000 and $303,000, respectively.
15
ARI Network Services, Inc.
Notes to Financial Statements (continued)
4. LINE OF CREDIT AND NOTE PAYABLE TO SHAREHOLDER
At July 31, 1999, the Company had a $3,000,000 revolving line-of-credit
agreement with a shareholder that was to expire on December 31, 2001. On
September 30, 1999, the Company and the shareholder restructured and amended the
line-of-credit agreement in order to reduce the line of credit from $3,000,000
to $1,000,000, establish a $1,000,000 term loan payable and convert $1,000,000
of the line of credit into 195,122 shares of common stock.
On October 22, 2001, the Company and the shareholder amended the agreement to
waive the restrictive covenant requiring maintenance of a minimum level of net
worth at July 31, 2001, and through July 31, 2002, and to increase the interest
rates on borrowings.
The term loan is payable in equal monthly installments over three years
commencing November 1, 1999, and bears interest at prime (4.75% at July 31,
2002) plus 4%. The line of credit expired December 31, 2001.
In connection with the amendment in September 1999, the Company issued a warrant
to purchase 30,000 shares of the Company's common stock at $4 per share. These
warrants are exercisable at any time through September 2006 and were initially
valued at $105,000 for financial statement purposes. The value allocated to the
warrants, which reduced the carrying value of the debt, was measured at the date
of grant because the number of shares was fixed and determinable. The value was
determined based upon a Black-Scholes option pricing model with the following
assumptions: risk-free interest rate of 6%, dividend yield of 0%, expected
common stock market price volatility factor of .72 and an expected life of the
warrants of six years. The debt discount is being amortized straight-line over
the three-year term of the debt. The unamortized balance of the debt discount at
July 31, 2002, was $6,000. The entire agreement is secured by substantially all
assets of the Company other than accounts receivable securitized under the
receivable sale agreement described in Note 5.
16
ARI Network Services, Inc.
Notes to Financial Statements (continued)
5. NOTES PAYABLE
Notes payable consist of the following at July 31 (in thousands):
2002 2001
------- -------
Term loan $ 78 $ 172
Note payable to bank, paid in 2002 -- 167
Convertible subordinated debenture 4,000 4,000
Less debt discount for convertible subordinated debenture (588) (1,373)
Other -- 14
------- -------
3,490 2,980
Less current maturities 3,490 2,902
------- -------
$ -- $ 78
======= =======
On April 27, 2000, the Company issued RGC International Investors, LDC (RGC):
(i) a convertible subordinated debenture (the Debenture) for $4,000,000, (ii)
warrants to purchase 600,000 shares of common stock at $6 per share (the
Warrants), and (iii) an investment option to purchase 800,000 shares of common
stock at $6 per share (the Investment Option). The Investment Option expired on
October 27, 2001, and the Warrants expire on April 27, 2005. The value allocated
to the Warrants and Investment Option, which reduced the carrying value of the
debt, were measured at the date of grant because the number of shares was fixed
and determinable. The value was determined based upon a Black-Scholes option
pricing model with the following assumptions: risk-free interest rate of 6%,
dividend yield of 0%, expected common stock market price volatility factor of
..80, an expected life of the Investment Option of eighteen months and an
expected life of the Warrants of five years. A debt discount was recorded for
the fair value of the Warrants and Investment Option of $2,354,000. The debt
discount is being amortized straight-line over the three-year term of the debt.
The Debenture bears interest at 7% and is convertible into common stock at $4
per share. The Company can require RGC to convert the amount owed under the
Debenture into common stock at $4 per share provided that the closing bid price
of the Company's common stock has been greater than $6.60 for 20 consecutive
trading days.
17
ARI Network Services, Inc.
Notes to Financial Statements (continued)
5. NOTES PAYABLE (CONTINUED)
Under the terms of the Debenture and the related Investment Option and Warrants,
the Debenture is convertible and the Investment Option and Warrants are
exercisable by RGC only to the extent that the number of shares of common stock
issuable, together with the number of shares of common stock owned by RGC and
its affiliates, generally would not exceed 4.9% of the Company's outstanding
common stock at the time of conversion or exercise. In certain circumstances
where the Company has the right to force conversion of the Debenture and
exercise of the Investment Option, RGC's percentage ownership may exceed 4.9%
but cannot exceed 9.9%.
As part of the consulting fee paid in conjunction with obtaining the RGC
financing, the Company issued warrants for the purchase of 8,000 shares of its
common stock at $7.03 per share. These warrants expire on April 27, 2005.
The terms of the Debenture require the Company to maintain the listing of its
common stock on Nasdaq, the Nasdaq Small Cap Market, the New York Stock Exchange
or the American Stock Exchange. The Company's common stock is not so listed on
any of these markets. Under the terms of the Debenture, this condition allows
RGC to make a demand for the Company to redeem the Debenture at 130% of the
outstanding principal and accrued interest balances as well as to increase the
stated interest rate from 7% to 17%. As further described in Note 11, on
November 11, 2002, the Company received a purported demand for immediate
payment. The Company intends to vigorously contest the validity of this demand.
The Debenture is classified as current in the accompanying balance sheet.
On September 28, 1999, the Company commenced funding under a three-year
Receivable Sale Agreement (the RFC Agreement) with RFC Capital Corporation (RFC)
pursuant to which RFC has agreed to loan amounts to the Company based on a
security interest in certain receivables generated by the Company in the
ordinary course of the Company's business. The RFC Agreement allows for RFC to
loan up to $3,000,000 of the Company's eligible receivables. Under the
Agreement, RFC loans 90% of the eligible receivables from the Company from time
to time upon presentation thereof for a value equal to approximately the net
value of such receivables. Net value is designed to yield RFC an effective rate
of 11.5% plus allow RFC to retain a holdback of 5% in the face amount of the
receivables, net of collections, against future collection risk. To comply with
SFAS No. 140, the Company recognizes these transactions as secured borrowings.
At July 31, 2002 and 2001, a secured borrowing of $360,000 and $469,000,
respectively, is included in accounts payable. For the years ended July 31, 2002
and 2001, the Company incurred $55,000 and $98,000, respectively, of financing
expense relating to this agreement.
18
ARI Network Services, Inc.
Notes to Financial Statements (continued)
5. NOTES PAYABLE (CONTINUED)
Under the RFC Agreement, the Company performs certain servicing, administrative
and collection functions with respect to the secured receivables. Also, pursuant
to the terms of the RFC Agreement, the Company has granted to RFC a security
interest in and to the Company's U.S. receivables not sold to RFC and the
Company's customer base, excluding non-U.S. customers, relating to the
generation of such accounts receivable.
6. CAPITAL AND OPERATING LEASES
The Company leases office space and certain office equipment under operating
lease arrangements expiring through 2009. The Company is generally liable for
its share of increases in the landlord's direct operating expenses and real
estate taxes. Total rental expense for the operating leases was $756,000 in
2002, $787,000 in 2001 and $616,000 in 2000.
Rent expense for the Company's corporate office is recognized on a straight-line
basis over the lease term, which differs from the pattern of payments required
by the lease. Other long-term liabilities includes $125,000 of deferred rent at
July 31, 2002.
Minimum lease payments under remaining capital and operating leases are as
follows (in thousands):
Fiscal year ending Capital Leases Operating Leases
------------------- -------------- -----------------
2003 $ 163 $ 636
2004 22 615
2005 8 519
2006 -- 423
2007 -- 300
Thereafter -- 579
----- ------
Total minimum lease payments 193 $3,072
======
Amounts representing interest and taxes 16
-----
Present value of minimum capital lease payments 177
Less amounts payable in one year 151
-----
$ 26
=====
19
ARI Network Services, Inc.
Notes to Financial Statements (continued)
7. SHAREHOLDERS' EQUITY
Preferred Stock
At July 31, 2002, the Company has 20,350 shares of Series A Preferred Stock
outstanding. The shares are entitled to cumulative annual dividends equal to the
product of $100 and prime plus 2% payable quarterly, as and when declared by the
Board of Directors. The Company may redeem outstanding shares at any time at the
redemption price of $100 per share plus accrued and unpaid dividends.
In the event of liquidation or dissolution of the Company, the holders of shares
of Series A Preferred Stock shall be entitled to receive $100 per share plus
accrued and unpaid dividends before any distribution is made to the holders of
common stock. Accumulated dividends in arrears at July 31, 2002, are $1,254,000.
8. STOCK PLANS
Employee Stock Purchase Plans
The Company's 1992 Employee Stock Purchase Plan had 62,500 shares of common
stock reserved for issuance, and all 62,500 shares have been issued.
The Company's 2000 Employee Stock Purchase Plan has 75,000 shares of common
stock reserved for issuance, and 39,061 of the shares have been issued as of
July 31, 2002. All employees of the Company, other than executive officers, with
six months of service are eligible to participate. Shares may be purchased at
the end of a specified period at the lower of 85% of the market value at the
beginning or end of the specified period through accumulation of payroll
deductions.
1991 Stock Option Plan
The Company's 1991 Stock Option Plan was terminated August 14, 2001, except as
to outstanding options. Options granted under the 1991 Plan may be either: (a)
options intended to qualify as incentive stock options under Section 422 of the
Internal Revenue Code of 1986, as amended (the Code), or (b) nonqualified stock
options.
20
ARI Network Services, Inc.
Notes to Financial Statements (continued)
8. STOCK PLANS (CONTINUED)
Any incentive stock option that was granted under the 1991 Plan could not be
granted at a price less than the fair market value of the stock on the date of
grant (or less than 110% of the fair market value in the case of holders of 10%
or more of the voting stock of the Company). Nonqualified stock options were
allowed to be granted at the exercise price established by the Stock Option
Committee, which could be less than, equal to or greater than the fair market
value of the stock on the date of grant.
Each option granted under the 1991 Plan is exercisable for a period of ten years
from the date of grant (five years in the case of a holder of more than 10% of
the voting stock of the Company) or such shorter period as determined by the
Stock Option Committee and shall lapse upon the expiration of said period, or
earlier upon termination of the participant's employment with the Company.
At its discretion, the Stock Option Committee may require a participant to be
employed by the Company for a designated number of years prior to exercising any
options. The Committee may also require a participant to meet certain
performance criteria, or that the Company meet certain targets or goals, prior
to exercising any options.
Changes in option shares under the 1991 Plan are as follows:
2002 2001 2000
----------------------------- --------------------------- ----------------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
-------- ---------- -------- --------- -------- -----------
Outstanding at the
beginning of the year 544,431 $6.67 513,220 $7.20 675,849 $5.58
Granted -- -- 106,000 2.33 181,950 8.36
Exercised -- -- -- -- (223,136) 1.89
Forfeited (73,343) 5.58 (74,789) 4.33 (121,443) 9.63
-------- ----- -------- ----- -------- -----
Outstanding at the end of
the year 471,088 $6.83 544,431 $6.67 513,220 $7.20
======== ===== ======== ===== ======== =====
Exercisable 394,870 $5.70 368,849 $5.63 308,774 $7.55
======== ===== ======== ===== ======== =====
Available for grant -- 40,999 72,210
======== ======== ========
The weighted-average contractual life of options outstanding at July 31, 2002,
was 6.5 years. The range of exercise prices for options outstanding at July 31,
2002, was $2.00 to $15.48.
21
ARI Network Services, Inc.
Notes to Financial Statements (continued)
8. STOCK PLANS (CONTINUED)
2000 Stock Option Plan
The Company's 2000 Stock Option Plan (2000 Plan) has 450,000 shares of common
stock authorized for issuance. Options granted under the 2000 Plan may be
either: (a) options intended to qualify as incentive stock options under Section
422 of the Code, or (b) nonqualifed stock options.
Any incentive stock option that is granted under the 2000 Plan may not be
granted at a price less than the fair market value of the stock on the date of
the grant (or less than 110% of the fair market value in the case of a
participant who is a 10% shareholder of the Company within the meaning of
Section 422 of the Code). Nonqualified stock options may be granted at the
exercise price established by the Stock Option Committee.
Each incentive stock option granted under the 2000 Plan is exercisable for a
period of not more than ten years from the date of grant (five years in the case
of a participant who is 10% shareholder of the Company). Nonqualified stock
options do not have this restriction.
Eligible participants include current and prospective employees, nonemployee
directors, consultants or other persons who provide services to the Company and
whose performance, in the judgment of the Stock Option Committee or management
of the Company, can have a significant affect on the success of the Company.
Changes in option shares under the 2000 Plan are as follows:
2002 2001
---------------------------- ----------------------------
Weighted- Weighted-
Average Average
Exercise Exercise
Options Price Options Price
-------- ------------ -------- -------------
Outstanding at the beginning of the
year 301,125 $1.23 -- $ --
Granted 144,100 0.32 320,400 1.24
Forfeited (32,750) 1.31 (19,275) 1.34
-------- ----- -------- -----
Outstanding at the end of the year
412,475 $0.91 301,125 $1.23
======== ===== ======== =====
Exercisable 202,150 $1.08 63,781 $1.35
======== ===== ======== =====
Available for grant 37,525 148,875
======== ========
22
ARI Network Services, Inc.
Notes to Financial Statements (continued)
8. STOCK PLANS (CONTINUED)
The weighted-average contractual life of options outstanding at July 31, 2002,
was 8.7 years. The range of exercise prices for options outstanding at July 31,
2002, was $0.22 to $1.75.
1993 Director Stock Option Plan
The Company's 1993 Director Stock Option Plan (Director Plan) has 150,000 shares
of common stock reserved for issuance to nonemployee directors. Options under
the Director Plan are granted at the fair market value of the stock on the grant
date.
Each option granted under the Director Plan is exercisable one year after the
date of grant and cannot expire later than ten years from the date of grant.
Changes in option shares under the Director Plan are as follows:
2002 2001 2000
--------------------------- -------------------------- -------------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
-------- ---------- -------- ---------- -------- -------------
Outstanding at the
beginning of the year 113,640 $ 5.20 119,586 $ 5.69 107,379 $ 4.88
Granted -- -- 13,379 2.01 42,261 8.41
Exercised -- -- -- -- (11,509) 3.23
Forfeited (34,381) 6.18 (19,325) 6.04 (18,545) 7.51
-------- ---------- -------- ---------- -------- ----------
Outstanding at the end of
the year 79,259 $ 4.78 113,640 $ 5.20 119,586 $ 5.69
======== ========== ======== ========== ======== ==========
Exercisable 79,259 $ 4.78 101,201 $ 5.60 80,890 $ 4.20
======== ========== ======== ========== ======== ==========
Available for grant 59,232 24,851 18,905
======== ======== ========
The weighted-average contractual life of options outstanding at July 31, 2002,
was 5.6 years. The range of exercise prices for options outstanding at July 31,
2002, was $1.78 to $17.00.
23
ARI Network Services, Inc.
Notes to Financial Statements (continued)
8. STOCK PLANS (CONTINUED)
As permitted by SFAS No. 123, "Accounting for Stock-Based Compensation," the
Company follows APB Opinion No. 25, "Accounting for Stock Issued to Employees,"
in accounting for its stock option plans. Had the Company accounted for its
stock option plans based upon the fair value at the grant date for options
granted under the plan based on the provisions of SFAS No. 123, the Company's
pro forma net loss and pro forma net loss per share would have been as follows
(for purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period):
YEAR ENDED JULY 31
2002 2001 2000
--------- --------- ---------
Pro forma net loss (in thousands) $ (546) $ (13,950) $ (8,647)
Pro forma diluted net loss per share $ (0.09) $ (2.26) $ (1.44)
The weighted-average fair value of the options granted in 2002, 2001 and 2000
was $0.31, $1.49 and $7.76, respectively.
Pro forma information regarding net loss and net loss per share is required by
SFAS No. 123, and has been determined as if the Company had accounted for its
employee stock options using a Black-Scholes option pricing model with the
following assumptions: risk-free interest rates ranging from 4% to 6%, dividend
yield of 0%; expected common stock market price volatility factors ranging from
..6 to 1.3 and an expected life of the options of ten years.
During 2001, 6,000 of the stock options granted were to a nonemployee in
exchange for services. No performance commitment existed at the date of grant
for the nonemployee options granted. At each reporting period, the Company
records compensation expense for the fair value of the options as calculated
using the Black-Scholes method. Compensation expense is being recorded over the
period of the service agreement.
24
ARI Network Services, Inc.
Notes to Financial Statements (continued)
9. INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and income tax purposes. Significant components of the Company's
deferred tax liabilities and assets as of July 31 are as follows (in thousands):
2002 2001
-------- --------
Deferred tax assets:
Net operating loss carryforwards $ 28,290 $ 30,650
Deferred revenue 1,800 1,880
Goodwill 920 1,010
Other 480 720
-------- --------
Total deferred tax assets 31,490 34,260
Valuation allowance for deferred tax assets (30,600) (33,700)
-------- --------
Net deferred tax asset 890 560
Deferred tax liabilities:
Software product costs (800) (250)
Other (90) (310)
-------- --------
Net deferred taxes $ -- $ --
======== ========
As of July 31, 2002, the Company has unused net operating loss carryforwards for
federal income tax purposes of $70,489,000 expiring in 2003 through 2021.
In addition, the Company has unused net operating loss carryforwards for federal
income tax purposes of $2,038,000 expiring between 2012 and 2014, of which not
more than $116,000 annually can be utilized to offset taxable income. Use of the
net operating loss carryforwards is restricted under Section 382 of the Code
because of changes in ownership in 1997.
A reconciliation between income tax expense and income taxes computed by
applying the statutory federal income tax rate to net income (loss) is as
follows (in thousands):
2002 2001 2000
------- ------- -------
Computed income taxes at 34% $ 64 $(4,429) $(2,585)
Permanent items 222 451 435
Change in valuation allowance (286) 3,978 2,150
------- ------- -------
Income tax expense $ -- $ -- $ --
======= ======= =======
25
ARI Network Services, Inc.
Notes to Financial Statements (continued)
9. INCOME TAXES (CONTINUED)
During 2002 and 2001, $6,132,000 and $3,917,000, respectively, of net operating
loss carryforwards expired. These net operating loss carryforwards had been
fully reserved.
10. EMPLOYEE BENEFIT PLAN
The Company has a qualified retirement savings plan (the 401(k) Plan) covering
its employees. Each employee may elect to reduce his or her current compensation
by up to 15%, up to a maximum of $11,000 in calendar 2002 (subject to adjustment
in future years to reflect cost of living increases) and have the amount of the
reduction contributed to the 401(k) Plan. Company contributions to the 401(k)
Plan are at the discretion of the Board of Directors. During 2002, the Company
issued 105,959 shares of common stock as a discretionary contribution to the
401(k) Plan. The Company did not make any contribution to the 401(k) Plan in
2001 or 2000.
11. SUBSEQUENT EVENTS
On August 28, 2002, 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 Debenture in return for an immediate
payment of $500,000 by the Company and an option to buy back the Debenture 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 a stand-still and buy-back
agreement between the Company and RGC. 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
significantly impact the Company's results of operations in fiscal 2003.
26
Schedule II
ARI NETWORK SERVICES, INC.
VALUATION AND QUALIFYING ACCOUNTS
Years ended July 31, 2002, 2001, and 2000
(Dollars in Thousands)
ADDITIONS
(REDUCTIONS)
BALANCE AT CHARGED TO BALANCE
BEGINNING EXPENSE AT END
DESCRIPTION OF YEAR (INCOME) DEDUCTIONS OF YEAR
-------------------------------------------------------------------------------
Allowance for doubtful accounts-
accounts receivable:
2002 $757 $(131) $486 (A) $140
==== ===== ==== ====
2001 $697 $ 532 $472 (A) $757
==== ===== ==== ====
2000 $278 $ 668 $249 (A) $697
==== ===== ==== ====
(A) Uncollectible accounts written off, net of recoveries.