Item 1.
Consolidated
Financial Statements
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ARI Network Services, Inc.
|
Consolidated Balance Sheets
|
(Dollars in Thousands, Except per Share Data)
|
|
|
|
|
|
|
|
|
|
(Unaudited)
|
|
(Audited)
|
|
October 31
|
|
July 31
|
|
|
2016
|
|
2016
|
ASSETS
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
5,617
|
|
$
|
5,118
|
Trade receivables, less allowance for doubtful accounts of
$175
|
|
|
|
|
|
|
and
$211
at October 31, 2016 and July 31, 2016, respectively
|
|
|
1,817
|
|
|
1,942
|
Work in process
|
|
|
73
|
|
|
132
|
Prepaid expenses and other
|
|
|
682
|
|
|
781
|
Deferred income taxes
|
|
|
2,892
|
|
|
3,182
|
Total current assets
|
|
|
11,081
|
|
|
11,155
|
Equipment and leasehold improvements:
|
|
|
|
|
|
|
Computer equipment and software for internal use
|
|
|
3,579
|
|
|
3,575
|
Leasehold improvements
|
|
|
639
|
|
|
639
|
Furniture and equipment
|
|
|
2,591
|
|
|
2,544
|
Total equipment and leasehold improvements
|
|
|
6,809
|
|
|
6,758
|
Less accumulated depreciation and amortization
|
|
|
(4,437)
|
|
|
(4,237)
|
Net equipment and leasehold improvements
|
|
|
2,372
|
|
|
2,521
|
Capitalized software product costs:
|
|
|
|
|
|
|
Amounts capitalized for software product costs
|
|
|
25,384
|
|
|
24,774
|
Less accumulated amortization
|
|
|
(20,265)
|
|
|
(19,743)
|
Net capitalized software product costs
|
|
|
5,119
|
|
|
5,031
|
Deferred income taxes
|
|
|
1,123
|
|
|
1,112
|
Other intangible assets
|
|
|
7,518
|
|
|
7,890
|
Goodwill
|
|
|
21,634
|
|
|
21,634
|
Total non-current assets
|
|
|
37,766
|
|
|
38,188
|
Total assets
|
|
$
|
48,847
|
|
$
|
49,343
|
|
LIABILITIES
|
|
|
|
|
|
|
Current portion of long-term debt
|
|
$
|
2,510
|
|
$
|
2,417
|
Current portion of contingent liabilities
|
|
|
273
|
|
|
331
|
Accounts payable
|
|
|
785
|
|
|
718
|
Deferred revenue
|
|
|
5,818
|
|
|
6,763
|
Accrued payroll and related liabilities
|
|
|
2,327
|
|
|
1,817
|
Accrued sales, use and income taxes
|
|
|
252
|
|
|
297
|
Other accrued liabilities
|
|
|
707
|
|
|
677
|
Current portion of capital lease obligations
|
|
|
50
|
|
|
50
|
Total current liabilities
|
|
|
12,722
|
|
|
13,070
|
Long-term debt
|
|
|
6,031
|
|
|
6,658
|
Long-term portion of contingent liabilities
|
|
|
—
|
|
|
60
|
Capital lease obligations
|
|
|
51
|
|
|
63
|
Other long-term liabilities
|
|
|
155
|
|
|
166
|
Total non-current liabilities
|
|
|
6,237
|
|
|
6,947
|
Total liabilities
|
|
|
18,959
|
|
|
20,017
|
|
|
|
|
|
|
|
SHAREHOLDERS' EQUITY
|
|
|
|
|
|
|
Cumulative preferred stock, par value $.001 per share, 1,000,000 shares authorized; 0 shares issued and outstanding at October 31, 2016 and July 31, 2016, respectively
|
|
|
—
|
|
|
—
|
Junior preferred stock, par value $.001 per share, 100,000 shares authorized; 0 shares issued and outstanding at October 31, 2016 and July 31, 2016, respectively
|
|
|
—
|
|
|
—
|
Common stock, par value $.001 per share, 25,000,000 shares authorized; 17,445,532 and 17,310,763 shares issued and outstanding at October 31, 2016 and July 31, 2016, respectively
|
|
|
17
|
|
|
17
|
Additional paid-in capital
|
|
|
115,571
|
|
|
115,364
|
Accumulated deficit
|
|
|
(85,694)
|
|
|
(86,050)
|
Other accumulated comprehensive income
|
|
|
(6)
|
|
|
(5)
|
Total shareholders' equity
|
|
|
29,888
|
|
|
29,326
|
Total liabilities and shareholders' equity
|
|
$
|
48,847
|
|
$
|
49,343
|
|
See accompanying notes
|
|
|
|
|
|
|
|
ARI Network Services, Inc.
|
Consolidated Statements of Operations
|
(Dollars in Thousands, Except per Share Data)
|
(Unaudited)
|
|
|
|
|
|
Three months ended October 31
|
|
|
2016
|
|
2015
|
Net revenue
|
|
$
|
12,272
|
|
$
|
11,737
|
Cost of revenue
|
|
|
2,289
|
|
|
2,069
|
Gross profit
|
|
|
9,983
|
|
|
9,668
|
Operating expenses:
|
|
|
|
|
|
|
Sales and marketing
|
|
|
2,687
|
|
|
2,765
|
Customer operations and support
|
|
|
2,755
|
|
|
2,446
|
Software development and technical support (net of capitalized software product costs)
|
|
|
1,256
|
|
|
1,255
|
General and administrative
|
|
|
1,942
|
|
|
1,785
|
Depreciation and amortization (exclusive of amortization of software product costs included in cost of revenue)
|
|
|
575
|
|
|
609
|
Net operating expenses
|
|
|
9,215
|
|
|
8,860
|
Operating income
|
|
|
768
|
|
|
808
|
Other income (expense):
|
|
|
|
|
|
|
Interest expense
|
|
|
(108)
|
|
|
(112)
|
Other, net
|
|
|
1
|
|
|
(8)
|
Total other income (expense)
|
|
|
(107)
|
|
|
(120)
|
Income before provision for income tax
|
|
|
661
|
|
|
688
|
Income tax expense
|
|
|
(305)
|
|
|
(299)
|
Net income
|
|
$
|
356
|
|
$
|
389
|
|
|
|
|
|
|
|
Weighted average common shares outstanding:
|
|
|
|
|
|
|
Basic
|
|
|
17,424
|
|
|
17,152
|
Diluted
|
|
|
17,929
|
|
|
17,604
|
|
|
|
|
|
|
|
Net income per common share:
|
|
|
|
|
|
|
Basic
|
|
$
|
0.02
|
|
$
|
0.02
|
Diluted
|
|
$
|
0.02
|
|
$
|
0.02
|
|
|
|
|
|
|
|
See accompanying notes
|
|
|
|
|
|
|
|
Consolidated Statements of Comprehensive Income
|
(Dollars in Thousands)
|
(Unaudited)
|
|
|
Three months ended October 31
|
|
|
2016
|
|
2015
|
Net income
|
|
$
|
356
|
|
$
|
389
|
Other comprehensive income (loss), net of tax:
|
|
|
|
|
|
|
Foreign currency translation adjustments
|
|
|
(1)
|
|
|
(2)
|
Total other comprehensive income (loss)
|
|
|
(1)
|
|
|
(2)
|
Comprehensive income
|
|
$
|
355
|
|
$
|
387
|
|
|
|
|
|
|
|
See accompanying notes
ARI Network Services, Inc.
Consolidated Statements of Cash Flows
(Dollars in Thousands)
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended October 31
|
|
|
|
|
2016
|
|
2015
|
|
|
Operating activities:
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
356
|
|
$
|
389
|
|
|
Adjustments to reconcile net income to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
Amortization of software products
|
|
|
522
|
|
|
496
|
|
|
Amortization of deferred loan fees and imputed interest expense
|
|
|
10
|
|
|
5
|
|
|
Depreciation and other amortization
|
|
|
575
|
|
|
610
|
|
|
Gain on change in fair value of earn-out receivable and payable
|
|
|
-
|
|
|
8
|
|
|
Provision for bad debt allowance
|
|
|
(6)
|
|
|
25
|
|
|
Deferred income taxes
|
|
|
279
|
|
|
293
|
|
|
Stock based compensation
|
|
|
149
|
|
|
115
|
|
|
Net change in assets and liabilities:
|
|
|
|
|
|
|
|
|
Trade receivables
|
|
|
131
|
|
|
(102)
|
|
|
Work in process, prepaid expenses and other
|
|
|
135
|
|
|
115
|
|
|
Accounts payable
|
|
|
67
|
|
|
71
|
|
|
Deferred revenue
|
|
|
(945)
|
|
|
(700)
|
|
|
Accrued payroll and related liabilities
|
|
|
519
|
|
|
435
|
|
|
Accrued taxes and other accrued liabilities
|
|
|
(26)
|
|
|
(25)
|
|
|
Net cash provided by operating activities
|
|
$
|
1,766
|
|
$
|
1,735
|
|
|
Investing activities:
|
|
|
|
|
|
|
|
|
Purchase of equipment, software and leasehold improvements
|
|
|
(51)
|
|
|
(167)
|
|
|
Cash paid for contingent liabilities related to acquisitions
|
|
|
(121)
|
|
|
(125)
|
|
|
Software development costs capitalized
|
|
|
(610)
|
|
|
(373)
|
|
|
Net cash used in investing activities
|
|
$
|
(782)
|
|
$
|
(665)
|
|
|
Financing activities:
|
|
|
|
|
|
|
|
|
Payments on long-term debt
|
|
$
|
(541)
|
|
$
|
(151)
|
|
|
Payments of capital lease obligations
|
|
|
(12)
|
|
|
(65)
|
|
|
Proceeds from exercise of common stock options and warrants
|
|
|
72
|
|
|
43
|
|
|
Net cash used in financing activities
|
|
$
|
(481)
|
|
$
|
(173)
|
|
|
Effect of foreign currency exchange rate changes on cash
|
|
|
(4)
|
|
|
(2)
|
|
|
Net change in cash and cash equivalents
|
|
|
499
|
|
|
895
|
|
|
Cash and cash equivalents at beginning of period
|
|
|
5,118
|
|
|
2,284
|
|
|
Cash and cash equivalents at end of period
|
|
$
|
5,617
|
|
$
|
3,179
|
|
|
Cash paid for interest
|
|
$
|
103
|
|
$
|
113
|
|
|
Cash paid for income taxes
|
|
$
|
123
|
|
$
|
13
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes
ARI Network Services, Inc.
Notes to Consolidated Financial Statements
1. Description of the Business and Significant Accounting Policies
Description of the Business
ARI Network Services, Inc. (“ARI” or “the Company”) creates software-as-a-service (“SaaS”), data-as-a-service (“DaaS”) and other solutions that help equipment manufacturers, distributors and dealers in selected vertical markets to Sell More Stuff!™ – online and in-store.
We remove the complexity of selling and servicing new and used whole goods inventory and PG&A for customers in the automotive tire and wheel aftermarket (“ATW”), automotive aftermarket parts and service (“AAPS”), powersports, outdoor power equipment (“OPE”), marine, home medical equipment (“HME”), recreational vehicles (“RV”) and appliance industries.
Our innovative products are powered by a proprietary library of enriched original equipment and aftermarket content from over
1,
8
00 manufacturers.
More than 23,500 equipment dealers, distributors and manufacturers worldwide leverage our web and eCatalog platforms to Sell More Stuff!
™
We were incorporated in Wisconsin in 1981. Our principal executive office and headquarters is located in Milwaukee, Wisconsin. The office address is 10850 West Park Place, Suite 1200, Milwaukee, WI 53224, and our telephone number at that location is (414) 973-4300. Our principal website address is
www.arinet.com
. ARI also maintains operations in Cypress, California; Floyds Knobs, Indiana; Des Moines, Iowa; Duluth, Minnesota; Wexford, Pennsylvania; Cookeville, Tennessee;
Salt Lake City, Utah;
Leiden, The Netherlands
; and
Gurgaon
, India
.
Basis of Presentation
These consolidated financial statements include the consolidated financial statements of ARI and its wholly-owned subsidiar
ies
, ARI Europe B.V.
and ARI Network Services Pvt. Ltd
.
and have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). We eliminated all significant intercompany balances and transactions in consolidation.
All
other
adjustments that, in the opinion of management, are necessary for a fair presentation
of
the periods presented have been reflected as required by Regulation S-X, Rule 10-01.
Fiscal Year
Our fiscal year ends on July 31. References to fiscal 201
7
, for example, refer to the fiscal year end
ing
July 31, 201
7
, and references to fiscal 201
6
refer to the fiscal year ended July 31, 201
6
.
Revenue Recognition
Revenues from subscription fees for use of our software, access to our catalog content, and software maintenance and support fees are all recognized ratably over the contractual term of the arrangement. The Company has customer contracts with multiple services or elements, which may be delivered at different times. The Company accounts for delivered elements in accordance with the selling price when arrangements include multiple product components or other elements and vendor-specific objective evidence exists for the value of all undelivered elements. Revenue on undelivered elements is recognized when the elements are delivered. ARI considers all arrangements with payment terms extending beyond
12
months not to be fixed or determinable and evaluates other arrangements with payment terms longer than normal to determine whether the arrangement is 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 standard terms are not recognized until acceptance has occurred. If collectability is not considered probable, revenue is recognized when the fee is collected.
For software license arrangements that do not require significant modification or customization of the underlying software, the Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collectability is probable.
Revenues for professional services to customize complex features and functionality in a product’s base software code or develop complex interfaces within a customer’s environment are recognized as the services are performed if they are determined to have standalone value to the customer or if all of the following conditions are met (i) the customer has a contractual right to take possession of the software; (ii) the customer will not incur significant penalty if it exercises this right; and (iii) it is feasible for the customer to either run the software on its own hardware or contract with another unrelated party to host the software. When the current estimates of total contract revenue for professional services and the total related costs indicate a loss, a provision for the entire loss on the contract is made in the period the amount is determined. Professional service revenues for set-up and integration of hosted websites, or other services considered essential to the functionality of other elements of the arrangement, are amortized over the term of the contract.
Revenue for variable transaction fees, primarily for use of the shopping cart feature of our websites, is recognized as it is earned.
Amounts received for shipping and handling fees are reflected in revenue. Costs incurred for shipping and handling are reported in cost of revenue.
Amounts invoiced to customers prior to recognition as revenue, as discussed above, are reflected in the accompanying balance sheets as deferred revenue.
No single customer accounted for 10% or more of ARI’s revenue during the
three
months ended
October 31
, 2016
or 201
5
.
Trade Receivables, Credit Policy and Allowance for Doubtful Accounts
Trade receivables are uncollateralized customer obligations due on normal trade terms, most of which require payment within thirty (30) days from the invoice date. Payments of trade receivables are allocated to the specific invoices identified on the customer’s remittance advice or, if unspecified, are applied to the earliest unpaid invoices.
The carrying amount of trade receivables is reduced by an allowance that reflects management’s best estimate of the amounts that will not be collected. Management individually reviews receivable balances that exceed ninety (90) days from the invoice date and, based on an assessment of current creditworthiness, estimates the portion of the balance that will not be collected. The allowance for potential doubtful accounts is reflected as an offset to trade receivables in the accompanying consolidated balance sheets.
Capitalized and Purchased Software Product Costs
Certain software development and acquisition costs are capitalized when incurred. Capitalization of these costs begins upon the establishment of technological feasibility. The establishment of technological feasibility and the on-going assessment of recoverability of software costs require considerable judgment by management with respect to certain external factors, including, but not limited to, the determination of technological feasibility, anticipated future gross revenue, estimated economic life and changes in software and hardware technologies.
The Company capitalizes software enhancements on an on-going basis and all other software development and support expenditures are charged to expense in the period incurred.
The annual amortization of software products is computed using the straight-line method over the estimated economic life of the product, which currently ranges from
2
to
14
years. Amortization starts when the product is available fo
r general release to customers.
Deferred Loan Fees and Debt Discounts
Fees associated with securing debt
are capitalized and
shown as contra-debt
, reducing the carrying amount of
long-term
debt on t
he consolidated balance sheet.
Deferred loan fees and debt discounts are amortized to interest expense over the life of the debt using the effective interest method.
Deferred Income Taxes
The tax effect of the temporary differences between the book and tax bases of assets and liabilities and the estimated tax benefit from tax net operating losses is reported as deferred tax assets and liabilities in the consolidated balance sheets. An assessment of the likelihood that net deferred tax assets will be realized from future taxable income is performed at each reporting date or when events or changes in circumstances indicate that there may be a change in the valuation allowance. Because the ultimate realizability of deferred tax assets is highly subject to the outcome of future events, the amount established as a valuation allowance is considered to be a significant estimate that is subject to change. To the extent a valuation allowance is established or there is a change in the allowance during a period, the change is reflected with a corresponding increase or decrease in income tax expense in the consolidated statements of operations.
Legal Provisions
ARI may periodically be involved in legal proceedings arising from contracts, patents or other matters in the normal course of business. We reserve for any material estimated losses if the outcome is probable and reasonably estimable, in accordance with GAAP. We had no legal provisions during the three months ended October 31, 2016 or 2015 and management believes that the results of any outstanding litigation will not have a material impact on the Company’s financial condition or results of operations.
Supplemental Cash Flow Information
The following table shows cash flow information related to non-cash investing and financing activities
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended October 31
|
|
|
|
|
2016
|
|
2015
|
|
|
Non-cash investing and financing activities
|
|
|
|
|
|
|
|
|
Issuance of common stock related to payment of contingent liabilities
|
|
$
|
-
|
|
$
|
60
|
|
|
Cashless exercise of common stock warrants
|
|
|
-
|
|
|
46
|
|
|
Current assets acquired in connection with acquisitions
|
|
|
-
|
|
|
32
|
|
|
Accrued liabilities assumed in connection with acquisitions
|
|
|
-
|
|
|
53
|
|
|
Contingent liabilities incurred in connection with acquisition
|
|
|
-
|
|
|
(62)
|
|
|
|
|
|
|
|
|
|
|
2.
Basic and Diluted Net Income per Common Share
Basic net income per common share is computed by dividing net income by the basic weighted average number of common shares
outstanding during the period.
Diluted net income per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period and reflects the potential dilution that could occur if all of ARI’s outstanding stock options and warrants that are in the money were exercised (calculated usin
g the treasury stock method).
The following table is a reconciliation of basic and diluted net income per common share (in thousands, except per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended October 31
|
|
|
|
|
2016
|
|
2015
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
356
|
|
$
|
389
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average common shares outstanding
|
|
|
17,424
|
|
|
17,152
|
|
|
Effect of dilutive stock options and warrants
|
|
|
505
|
|
|
452
|
|
|
Diluted weighted-average common shares outstanding
|
|
|
17,929
|
|
|
17,604
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.02
|
|
$
|
0.02
|
|
|
Diluted
|
|
$
|
0.02
|
|
$
|
0.02
|
|
|
|
|
|
|
|
|
|
|
|
Options and warrants that could potentially dilute net income per share in the future that are not included in the computation of diluted net income per share, as their impact is anti-dilutive
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
3.
Debt
Silicon Valley Bank
On
April 26, 2013
, the Company entered into a Loan and Security Agreement (the “Agreement”) with Silicon Valley Bank (“SVB”), pursuant to which SVB extended to the Company credit facilities consisting of a
$3,000,000
revolving credit facility with a maturity date of
April 26, 2015
and a
$4,500,000
term loan with a maturity date of
April 26, 2018
.
On September 30, 2014, in connection with the Company’s acquisition of Tire Company Solutions, LLC (“TCS”), the Company entered into the First Loan Modification Agreement (the “Modification Agreement”) with SVB, which contained substantial amendments to the terms of the Agreement.
The
Modification Agreement include
d
credit facilities consisting of a
$3,000,000
revolving credit facility with a
maturity date of
Nov
ember 30, 2016
and a
$6,050,000
term loan with a maturity date of
September 30, 2019
.
On November 1, 2016, in connection with the Company’s acquisition of
Auction123
123
,
Inc. (“Auction
123
”), the Company entered into the Second Loan Modification Agreement with SVB. See Note 8
,
Subsequent Events for details relating to the acquisition of
Auction123
and the SVB Second Loan Modification Agreement.
The term loan and any loans made under the SVB revolving credit facility accrue interest at a per
annum rate equal to the Prime R
ate plus the Applicable Margin for Prime Rate Loans set forth in the chart below based on the Total Leverage Ratio, as defined in the Modification Agreement. The Company had
$0
outstanding on the revolving credit facility and the effective interest rate was
4.00
%
at
October 31
, 2016
, based upon a prime rate of
3.50%
.
|
|
|
|
Applicable Margin
|
Total Leverage Ratio
|
for Prime Rate Loans
|
|
|
|
>= 2.50 to 1.0:
|
1.50
|
%
|
> 1.75 to 1.00 but <2.50 to 1.00:
|
1.00
|
%
|
<= 1.75 to 1.00:
|
0.50
|
%
|
Principal in respect of any loans mad
e under the revolving facility wa
s required to be paid in its entirety on or before
November
30, 2016. Princip
al in respect of the term loan wa
s required to be paid in quarterly installments on the first day of each fiscal quarter of the Company as follows:
$151,250
commenced on November 1, 2014 through August 1, 2016;
$226,875
commencing on November 1, 2016 through August 1, 2017; and
$302,500
commencing on November 1
, 2017 through August 1, 2019.
All remaining princip
al in respect of the term loan wa
s due and
payable on September 30, 2019.
The Company is permitted to prepay all of, but not less than all of, the outstanding principal amount of the term loan upon notice to SVB and, in certain circumstances, the payment of a prepayment penalty of up to
$6
1,000
.
Following July 31, 2015, the Modification Agreement require
d
the Company to make additional payments in the amount of
25%
of excess cash flow, as defined in the agreement, until the Company’s Total Leverage Ratio is less than
2.00
to 1.00.
The
Modification Agreement contained
covenants that restrict, among other things and subject to certain conditions, the ability of the Company to permit a change of control, incur debt, create liens on its assets, make certain investments, enter into merger or acquisition transactions and make distributions to its shareholders. Financial covenants include the maintenance of a minimum Total Leverage Ratio equal to or less than
3.00
to 1.00 and the maintenance of a Fixed Charge Coverage Ratio (as defined in the Modification Agreement) equal to or greater than
1.25
to 1.00.
The Total Leverage
Ratio was
1.
04
and the Fixed Charge Ratio was
1
.
9
0
for the twelve months ended
October 31
, 2016
.
The Modi
fication Agreement also contained
customary events of default that, if triggered
, could result in an acceleration of the Company’s obligations un
der the Modification Agreement.
All SVB
loans are secured by a first priority security interest in substantially all assets of the Company.
TCS Promissory Notes
In connection with the acquisition of TCS, on
September 30, 2014
, the Company issued
two
promissory notes (the “
TCS
Notes”) in the aggregate principal amount of $3,000,000 to the former owners of TCS. In February 2015, the principal amount of the
TCS
Notes was reduced by
approximately
$6
7
,
000
as a result of
post-closing adjustments to the valuation of the net assets acquired, pursuant to the terms of the asset purchase agreement.
The
TCS
Notes initially accrue interest on the outstanding unpaid principal balance at a rate per annum equal to
5.0%
; however, if any amount payable under a
TCS
Note is not paid when due, such overdue amount will bear interest at the default rate of
7.5%
from the date of such non-payment until such amount is paid in full. Accrued interest on the
TCS
Notes
is
due and payable quarterly commencing on
December 29, 2014
and continuing on each 90th calendar day thereafter, until
September 30, 2018
, at which time all accrued interest and outstanding principal balance will be due and payable in full. The first four payments due and payable under the
TCS
Notes
were
interest-
only payments, and payments of principal and interest
commence
d
on December 29, 2015. The payments are subject to acceleration upon certain Events of Default, as defined in the
TCS
Notes.
DCi Promissory Note
In connection with the acquisition of Direct Communications Inc. (“DCi”), on
July 13, 2015
, the Company issued a promissory note (the “DCi Note”) in the aggregate principal amount of $2,000,000 to
the former owners of
DCi.
T
he principal amount of the
DCi
Note w
as
reduced by
approximately
$6
4
,
00
0
as a result of
post-closing adjustments to the
estimated
valuation of the net assets acquired, pursuant to the terms of the asset purchase agreement.
The
DCi
Note initially accrues interest on the outstanding unpaid principal balance at a rate per annum equal to
4.0%
. Accrued interest on the
DCi
Note is due and payable quarterly commencing on
October 13, 2015
and continuing on each 90th calendar day thereafter, until
July 13, 2019
, at which time all accrued interest and outstanding principal balance will be due and payable in full. The first four payments due and payable under the
DCi
Note we
re interest only payments, and payments of principal and interest commence
d
on October 13, 2016. The payments are subject to acceleration upon certain Events of Default, as defined in the
DC
i
Note.
The following table sets forth certain information related to the Company’s long-term debt as of
October 31
, 2016
and July 31, 201
6
(in thousands):
|
|
|
|
|
|
|
|
October 31
|
|
July 31
|
|
|
2016
|
|
2016
|
|
Notes payable principal
|
$
|
8,626
|
|
$
|
9,168
|
|
Less debt issuance costs
|
|
(85)
|
|
|
(93)
|
|
Less current maturities
|
|
(2,510)
|
|
|
(2,417)
|
|
Notes payable - non-current
|
$
|
6,031
|
|
$
|
6,658
|
|
|
|
|
|
|
|
|
Minimum principal payments due on the SVB Term Note
,
the TCS Notes
and the DCi Note
as of October 31, 2016
we
re as follows for the fiscal years ending (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal year ending July 31:
|
SVB Term Note
|
|
TCS Notes
|
|
|
DCi Notes
|
|
|
Total Notes Payable
|
|
|
2017
|
$
|
681
|
|
$
|
728
|
|
$
|
467
|
|
$
|
1,876
|
|
|
2018
|
|
1,134
|
|
|
1,014
|
|
|
645
|
|
|
2,793
|
|
|
2019
|
|
1,210
|
|
|
261
|
|
|
671
|
|
|
2,142
|
|
|
2020
|
|
1,815
|
|
|
—
|
|
|
—
|
|
|
1,815
|
|
|
|
$
|
4,840
|
|
$
|
2,003
|
|
$
|
1,783
|
|
$
|
8,626
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4
. Contingent Liabilities
Consideration for the April 2015 TASCO
acquisition included a
$138,000
(as adjusted)
holdback
which was paid in April
2016.
Consideration for the September 2014 TCS acquisition includes a contingent earn-out purchase price, originally contingent upon the attainment of specific revenue goals. The fair value of the earn-out was originally estimated at
$711,000
.
On March 7, 2016, the TCS Asset Purchase Agreement was amended in relation to the contingent earn-out, whereas four quarterly payments of
$120,905
commenced on December 31, 2015, followed by four quarterly payments of
$70,000
,
commencing December 31, 2016.
Payments for the quarter ended October 31, 2015 included
the final earn-out payment related to the Ready2Ride acquisition, composed of
$125,000
and 15,000 shares of common stock.
The following table shows changes in the holdback and earn-out payable related to the TCS and TASCO acquisition
s
(in thousands):
|
|
|
|
|
|
|
Three months ended October 31
|
|
2016
|
|
2015
|
Beginning balance
|
$
|
391
|
|
$
|
1,116
|
Adjustments
|
|
-
|
|
|
(62)
|
Payments
|
|
(121)
|
|
|
(186)
|
Imputed interest recognized
|
|
3
|
|
|
8
|
Gain on change in fair value of earn-out
|
|
-
|
|
|
8
|
Ending balance
|
$
|
273
|
|
$
|
884
|
Less current portion
|
$
|
(273)
|
|
$
|
(639)
|
Ending balance, long-term
|
$
|
0
|
|
$
|
245
|
|
|
|
|
|
|
The following table shows the remaining estimated payments of contingent liabilit
ies related to the TCS
acquisition
at
October 31
, 2016, (in thousands):
|
|
|
|
|
|
|
|
2017
|
$
|
210
|
|
|
|
|
2018
|
|
70
|
|
|
|
|
Total estimated payments
|
|
280
|
|
|
|
|
Less imputed interest
|
|
(7)
|
|
|
|
|
Present value of contingent liabilities
|
$
|
273
|
|
|
|
|
|
|
|
|
|
|
5
. Other Intangible Assets
Amortizable intangible assets include customer relationships and other intangibles including trade names and non-compete agreements. Amortizable intangible assets are composed of the following at
October 31
, 2016
and 201
5
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended October 31, 2015
|
Wtd. avg.
|
|
|
|
|
Cost
|
|
Accumulated
|
|
Net
|
remaining
|
|
|
Customer relationships
|
|
Basis
|
|
Amortization
|
|
Value
|
life
|
|
|
Beginning balance
|
|
$
|
11,947
|
|
$
|
(4,418)
|
|
$
|
7,529
|
|
|
|
Activity
|
|
|
-
|
|
|
(285)
|
|
|
(285)
|
|
|
|
Ending balance
|
|
$
|
11,947
|
|
$
|
(4,703)
|
|
$
|
7,244
|
11.84
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other intangibles
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning balance
|
|
$
|
3,203
|
|
$
|
(616)
|
|
$
|
2,587
|
|
|
|
Activity
|
|
|
-
|
|
|
(112)
|
|
|
(112)
|
|
|
|
Ending balance
|
|
$
|
3,203
|
|
$
|
(728)
|
|
$
|
2,475
|
3.09
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total intangibles
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning balance
|
|
$
|
15,150
|
|
$
|
(5,034)
|
|
$
|
10,116
|
|
|
|
Activity
|
|
|
-
|
|
|
(397)
|
|
|
(397)
|
|
|
|
Ending balance
|
|
$
|
15,150
|
|
$
|
(5,431)
|
|
$
|
9,719
|
11.13
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended October 31, 2016
|
Wtd. avg.
|
|
|
|
|
Cost
|
|
Accumulated
|
|
Net
|
remaining
|
|
|
Customer relationships
|
|
Basis
|
|
Amortization
|
|
Value
|
life
|
|
|
Beginning balance
|
|
$
|
11,727
|
|
$
|
(5,558)
|
|
$
|
6,169
|
|
|
|
Activity
|
|
|
-
|
|
|
(263)
|
|
|
(263)
|
|
|
|
Ending balance
|
|
$
|
11,727
|
|
$
|
(5,821)
|
|
$
|
5,906
|
11.70
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other intangibles
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning balance
|
|
$
|
2,739
|
|
$
|
(1,018)
|
|
$
|
1,721
|
|
|
|
Activity
|
|
|
-
|
|
|
(109)
|
|
|
(109)
|
|
|
|
Ending balance
|
|
$
|
2,739
|
|
$
|
(1,127)
|
|
$
|
1,612
|
8.37
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total intangibles
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning balance
|
|
$
|
14,466
|
|
$
|
(6,576)
|
|
$
|
7,890
|
|
|
|
Activity
|
|
|
-
|
|
|
(372)
|
|
|
(372)
|
|
|
|
Ending balance
|
|
$
|
14,466
|
|
$
|
(6,948)
|
|
$
|
7,518
|
10.98
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6
.
Stock-based Compensation Plans
The Company uses the Black-Scholes model to value stock options granted. Volatility is calculated as management
’
s estimate of future volatility over the expected term of the option based on historical volatility of the Company’s stock. The expected life of options granted represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods within the contractual term of the options is based on the United States Treasury yields in effect at the time of grant.
Stock options granted to employees under the Company’s stock option plan typically vest
25%
on the first anniversary of the grant and
25%
on the one
-
year anniversary of each of the
three
following
years.
Stock options granted to non-employee directors under the Company’s stock option plan typically vest
50%
on the first anniversary of the grant and
50%
on the next one-
year anniversary. The Company recognizes stock option expense over the vesting period for each vesting tranche.
As recognizing stock-based compensation expense is based on awards ultimately expected to vest, the amount of recognized expense has been reduced for estimated forfeitures based on the Company’s historical experience.
T
he Company
recognized a benefi
t for stock option compensation
$5,000
in the first quarter of fiscal 2017 due to forfeitures, and expense
of
$24,000
for the
quarter
ended October 31,
201
5
.
There was approximately
$
22
,000
and
$
112
,000
of total unrecognized compensation costs related to non-vested options granted under the Company’s stock option plans as of
October 31
,
2016 and 2015
, respectively. Total unrecognized compensation cost will be adjusted for any future changes in estimated and actual forfeitures. There were
no
capitalized stock-based compensation costs during the periods presented.
The following table shows the weighted average assumptions used to estimate the fair value of options granted:
|
|
|
|
|
|
|
|
|
|
|
Three months ended October 31,
|
|
|
|
|
|
2016
|
|
|
|
Expected life (years)
|
|
|
n/a
|
|
|
|
|
Risk-free interest rate
|
|
|
n/a
|
|
|
|
|
Expected volatility
|
|
|
n/a
|
|
|
|
|
Expected forfeiture rate
|
|
|
11.1
|
%
|
|
|
|
Expected dividend yield
|
|
|
-
|
|
|
|
|
Weighted-average estimated fair value per
|
|
|
|
|
|
|
|
share of options granted during the year
|
|
|
n/a
|
|
|
|
|
Cash received from the exercise
|
|
|
|
|
|
|
|
of stock options
|
|
$
|
5,000
|
|
|
|
2000 Stock Option Plan
The Company’s 2000 Stock Option Plan (the “2000 Plan”) had
1,950,000
shares of common
stock authorized for issuance.
Each incentive stock option that was 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 a
10%
shareholder
of the Company, unless the stock options are nonqualified), or such shorter period as determined by the Compensation Committee, and shall lapse upon the expiration of said period, or earlier upon termination of the participant’s employment with the Company. The 2000 Plan expired on December 13, 2010, at which time it was terminated e
xcept for outstanding options.
While options previously granted under the 2000 Plan will continue to be effective through the remainder of their terms or until exercised, no new options may be granted under the 2000 Plan.
Changes in option shares under the 2000 Plan during the
three
months ended
October 31
, 2016
were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of
Options
|
|
Wtd. Avg.
Exercise
Price
|
|
Wtd. Avg.
Remaining
Contractual
Period
(Years)
|
|
Aggregate
Intrinsic
Value
|
Outstanding at 7/31/2016
|
|
384,750
|
|
$
|
1.46
|
|
1.89
|
|
$
|
1,408,027
|
Granted
|
|
-
|
|
|
n/a
|
|
n/a
|
|
|
n/a
|
Exercised
|
|
-
|
|
|
n/a
|
|
n/a
|
|
|
n/a
|
Forfeited
|
|
-
|
|
|
n/a
|
|
n/a
|
|
|
n/a
|
Outstanding at 10/31/2016
|
|
384,750
|
|
$
|
1.46
|
|
1.64
|
|
$
|
1,350,314
|
Exercisable at 10/31/2016
|
|
384,750
|
|
$
|
1.46
|
|
1.64
|
|
$
|
1,350,314
|
|
|
|
|
|
|
|
|
|
|
|
The range of exercise prices for options outstanding under the 2000 Plan was
$0.49
to
$
1
.
96
at
October 31
, 2016
.
2010 Equity Incentive Plan
The Board of Directors adopted the ARI Network Services, Inc. 2010 Equity Incentive Plan (as amended, the “2010 Plan”) on November 9, 2010. The plan was approved by the Company's shareholders in December 2010, and amendments to the 2010 Plan were approved by the Company’s shareholders in January 2014. The 2010 Plan is the successor to the Company’s 2000 Plan. There are
1,850,000
shares of Company common stock authorized for issuance under the 2010 Plan. Potential awards under the 2010 Plan include incentive stock options and non-statutory stock options, shares of restricted stock or restricted stock units, stock
a
ppreciation rights (“SARs), and shares of common stock. Up to
1,525,000
of the shares authorized for issuance under the 2010 Plan may be used for common stock, restricted stock or restricted stock unit awards.
The exercise price for options and SARs under the 2010 Plan cannot be less than
100%
of the fair market value of the Company’s common stock on the date of grant, and the exercise prices for options and SARs cannot be repriced without shareholder approval, except to reflect changes to the capital structure of the Company as described in the 2010 Plan. The maximum term of options and SARs under the 2010 Plan is
10
years. The 2010 Plan does not have liberal share counting provisions (such as provisions that would permit shares withheld for payment of taxes or the exercise price of stock options to be re-granted under the plan).
Changes in option shares under the 2010 Plan during the
thre
e months ended
October 31
, 2016
were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of
Options
|
|
Wtd. Avg.
Exercise
Price
|
|
Wtd. Avg.
Remaining
Contractual
Period
(Years)
|
|
Aggregate
Intrinsic
Value
|
Outstanding at 7/31/2016
|
|
357,626
|
|
$
|
2.52
|
|
6.95
|
|
$
|
930,816
|
Granted
|
|
-
|
|
|
n/a
|
|
n/a
|
|
|
n/a
|
Exercised
|
|
(1,250)
|
|
|
3.61
|
|
n/a
|
|
|
n/a
|
Forfeited
|
|
(13,750)
|
|
|
3.31
|
|
n/a
|
|
|
n/a
|
Outstanding at 10/31/2016
|
|
342,626
|
|
$
|
2.48
|
|
6.25
|
|
$
|
852,672
|
Exercisable at 10/31/2016
|
|
292,626
|
|
$
|
2.34
|
|
6.25
|
|
$
|
768,884
|
|
|
|
|
|
|
|
|
|
|
|
The range of exercise prices for options outstanding under the 2010 Plan was
$0.59
to
$3.
54
at
October 31
, 2016
.
Changes in the 2010 Plan's non-vested option shares included in the outstanding shares above during the
thre
e months ended
October 31
, 2016
were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of
Options
|
|
Wtd. Avg.
Exercise Price
|
|
|
|
|
|
Non-vested at 7/31/2016
|
|
70,000
|
|
$
|
3.29
|
|
|
|
|
|
Granted
|
|
-
|
|
|
n/a
|
|
|
|
|
|
Vested
|
|
(6,250)
|
|
|
3.20
|
|
|
|
|
|
Forfeited
|
|
(13,750)
|
|
|
3.31
|
|
|
|
|
|
Non-vested at 10/31/2016
|
|
50,000
|
|
$
|
3.29
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The weighted average remaining vesting period was
0
.
96
years at
October 31
, 2016
.
Employee Stock Purchase Plan
The Company’s 2000 Employee Stock Purchase Plan, as amended, (“ESPP”) has
575,000
shares of common stock reserved for issuance, of which
300
,
280
and
2
63
,9
74
of the shares have been issued as of
October 31
,
2016 and 2015
, respectively. All employees with at least
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, not to exceed
5,000
shares per employee per year.
The Company expensed
$1
3
,000
and
$
2
0
,000
during the three months ended
October 31
, 2016,
and
2015
related to the ESPP discount
.
Restricted Stock
Up to 1,525,000 of the shares authorized for issuance under the 2010 Plan may be granted in the form of shares of common stock, restricted stock or restricted stock units. The Company grants restricted stock to its directors as an annual retainer
,
and from time to time to directors, officers or employees as incentive compensation or as discretionary compensation in place of cash.
The Compensation Committee adopted the Long-Term Executive Bonus Plan (“LTEB”) for eligible executi
ve officers of the Company
beginning in fiscal 2013.
In March 2015, the Compensation Committee issued
550,000
shares of restricted stock under the LTEB, which will vest according to the following schedule:
|
·
|
|
30%
when the volume weighted average price of the Company’s common stock for the previous 30
-day
trading period (the “30-day VWAP”) equals or exceeds
$6.00
|
|
·
|
|
20%
when the 30-day VWAP
equals or exceeds
$7.00
|
|
·
|
|
20%
when the 30-day VWAP
equals or exceeds
$8.00
|
|
·
|
|
30%
when the 30-day VWAP
equals or exceeds
$9.00
|
Under the plan described above, a target price must be reached within a
four
-year period starting on the date of grant for any restricted stock to vest. All unvested restricted stock will be forfeited when the four-year period expires. The initial value of the common stock granted under the LTEB was approximately
$350,000
, valued using a Monte Carlo Simulation with a
46%
volatility rate and a
1.34%
risk
-
free interest rate, and is expensed over the vesting period.
Restricted stock granted under the 2010 plan during fiscal 201
7
was valued using the market price on the date of grant.
The Company recognized compensation expense of
$
142
,000
and
$
73
,000
during the three months ended
October 31
,
2016 and 2015
, respectively
,
related to
all
restricted stock.
The remaining balance of unrecognized compensation expense related to restricted stock was
$
750
,000
and
$
4
6
2
,000
at
October 31
, 2016
and 2015, respectively
.
Changes in unvested restricted shares of common stock under the 2010 Plan during the
thre
e months ended
October 31
,
2016 and 2015
were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended October 31
|
|
|
|
|
2016
|
|
2015
|
|
|
Beginning balance unvested restricted stock
|
|
657,912
|
|
671,211
|
|
|
Granted
|
|
102,720
|
|
-
|
|
|
Vested
|
|
(6,474)
|
|
(6,474)
|
|
|
Forfeited
|
|
(2,534)
|
|
(5,460)
|
|
|
Ending balance unvested restricted stock
|
|
751,624
|
|
659,277
|
|
|
|
|
|
|
|
|
7
.
Income Taxes
The provision for income taxes for the three
months ended
October 31
, 2016 and 2015 is composed of the following
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended October 31
|
|
|
|
|
|
|
|
2016
|
|
2015
|
|
|
|
|
|
Current:
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
—
|
|
$
|
—
|
|
|
|
|
|
State
|
|
|
(25)
|
|
|
(6)
|
|
|
|
|
|
Deferred, net
|
|
|
(280)
|
|
|
(293)
|
|
|
|
|
|
Income tax expense
|
|
$
|
(305)
|
|
$
|
(299)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The provision for income taxes is based on taxes payable under currently enacted tax laws and an analysis of temporary differences between the book and tax bases of the Company’s assets and liabilities, including various accruals, allowances, depreciation and amortization, and does not represent current taxes due. The tax effect of these temporary differences and the estimated benefit from tax net operating losses are reported as deferred tax assets and liabilities in the consolidated balance sheets. We have unused net operating loss carry forwards ("NOLs") for federal income tax purposes, and as a result, we generally only incur alternative minimum taxes at the federal level that are currently payable.
The Company also has NOLs related to
tax losses incurred by its Netherlands operation. Under tax laws in the Netherlands, NOLs are able to be carried forward for a period of
nine
years. The Company has determined that, consistent with prior periods, it is not likely that the net operating losses will be utilized by the Company. This conclusion was primarily based on the negative evidence of a history of losses and expired NOLs related to this entity. In the opinion of the management of the Company, there is not enough positive evidence to overcome this negative evidence. Therefore, a full valuation allowance
of $437,000 and $531,000
is recorded, resulting in
$0
net deferred tax assets related to the Netherlands operation at
October 31
, 2016 and 2015.
The Company also has an NOL related to
tax losses incurred by its India operation, which began operat
i
ons in the second quarter of fiscal 2016. Under tax laws in India, NOLs are able to be carried forward for a period of eight years. The Company has determined that it is not likely that the net operating loss will be utilized by the Company primarily based on the start-up nature of this operation. Therefore, a full valuation allowance of $61,000 was recorded, resulting in $0 net deferred tax assets related to the India operation at October 31, 2016.
As of
October 31
, 2016, the Company had accumulated NOLs for federal, state and international tax purposes of approximately
$
2
,
115
,000,
$
8
,
377
,000
and
$
1
,
9
18
,000
, respectively.
We perform an evaluation of uncertain tax positions as a component of income tax expense on an annual basis. We determined that ARI did not have any significant risk related to income tax expense and therefore
no
amounts were reserved for uncertain tax positions as of
October 31
, 2016
or
2015. We will accrue and recognize interest and penalties related to uncertain tax positions as a component of income tax expense if it becomes necessary.
Fiscal years subsequent to 2012
remain open and subject to examination by state tax jurisdictions and the United States federal tax authorities.
8. Subsequent Events
Acquisition of Auction123, Inc.
On November 1, 2016, the Company acquired substantially all of the assets of Auction123, Inc
.
(“Auction123”), a leading provider of software and services to help dealers in selected vertical markets manage and feed inventory information to online marketplaces to drive more sales and leads. Auction123 serves
several vertical markets including automotive dealers, powersports, recreational vehicles and marine.
Consideration for the acquisition (the "Company Purchase Price") included, (1) a cash payment equal to $10,5
0
0,000;
and (
2
) a contingent earn-out purchase price payable in two installments and contingent upon the attainment of specific revenue goals related to a specific customer. The earn-out has a maximum payout of $1,500,000. The purchase price will be adjusted based on the net asset value on the closing balance sheet being above or below the targeted amount.
The acquisition was funded from cash on hand and an increase in our term loan. Due to the timing of the acquisition, the opening balance sheet and pro-forma information is not complete as of the date of this report.
Loan Modification
On November 1, 2016, the Company entered into the Second Loan Modification Agreement, dated November 1, 2016, by and among SVB and the Company (the "Second Modification Agreement"). The Second Modification Agreement amends the Agreements with SVB dated April 26, 2013 and September 30, 2014.
The Second
Modification Agreement includes credit facilities consisting of $3,000,000 revolving credit facility with a
maturity date of September 30, 2018 and a $13,000,000 term loan with a maturity date of
November
1, 2021. This term loan is an amendment to the existing $6,050,000 term loan with a maturity date of September 30, 2019.
The term loan and any loans made under the SVB revolving credit facility accrue interest at a per annum rate equal to the Prime rate plus the Applicable Margin for Prime Rate Loans set forth in the chart below determined based on the Total Leverage Ratio.
|
|
|
|
Applicable Margin
|
Total Leverage Ratio
|
for Prime Rate Loans
|
> 2.50 to 1.0:
|
1.50
|
%
|
> 1.75 to 1.00 but <=2.50 to 1.00:
|
1.00
|
%
|
<= 1.75 to 1.00:
|
0.50
|
%
|
Principal in respect of any loans made under the revolving facility is required to be paid in its entirety on or before September 30, 2018. Principal in respect of the term loan is required to be paid in quarterly installments on the first day of each fiscal quarter of the Company as follows: $325,000 commenc
ing
on
February
1, 201
7
through
November
1, 2018; $487,500 commencing on
February
1, 201
9
through
November
1, 2019; and $650,000 commencing on
February
1, 20
20
through
August
1, 2021. All remaining principal in respect of the term l
oan is due and payable on November
1, 2021. The Company is permitted to prepay all of, but not less than all of, the outstanding principal amount of the term loan upon certain notice to SVB and, in certain circumstances, the payment of a prepayment penalty of up to $260,000. Following July 31, 2018, the Second Modification agreement requires the Company to make additional payments in the amount of 50% of excess cash flow until the Company’s Total Leverage Ratio is less than 2.00 to 1.00 and 25% of excess cash flow until the Company’s Total Leverage Ratio is less than 1.25 to 1.00.
The Second Modification Agreement contains covenants that restrict, among other things and subject to certain conditions, the ability of the Company to permit a change of control, incur debt, create liens on its assets, make certain investments, enter into merger or acquisition transactions and make distributions to its shareholders. Financial covenants include the maintenance of a minimum Total Leverage Ratio equal to or less than 3.00 to 1.00 through the period ending December 31, 2017 and 2.50 to 1.00 thereafter, and the maintenance of a Fixed Charge Coverage Ratio (as defined in the Agreement) equal to or greater than 1.25 to 1.00. The Agreement also contains customary events of default that, if triggered, could result in an acceleration of the Company’s
obligations under the Agreement. The loans are secured by a first priority security interest in substantially all assets of the Company.
Ite
m 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion of our results of operations and financial condition should be read together with our unaudited consolidated financial statements for the three months ended
October 31
, 2016 and 2015, including the notes thereto, which appear elsewhere in this quarterly report on Form 10-Q.
All amounts are in thousands, except per share data.
This discussion, including, wi
thout limitation, the section
titled “Summary of Operating Results”, contains forward-looking statements regarding future events and our future results that are subject to the safe harbors created under the Securities Act of 1933 (the “Securities Act”) and the Securities Exchange Act of 1934 (the “Exchange Act”). All statements other than statements of historical facts are statements that could be deemed to be forward-looking statements. These statements are based on current expectations, estimates, forecasts, and projections about the markets in which we operate and the beliefs and assumptions of our management. Words such as “expects,” “anticipates,” “targets,” “goals,” “projects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “endeavors,” “strives,” “may,” variations of such words, and similar expressions are intended to identify such forward-looking statements. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses, and other characterizations of future events or circumstances are forward-looking statements. Readers are cautioned that these forward-looking statements are only predictions and are subject to risks, uncertainties, and assumptions that are difficult to predict, estimate, or verify, including those identified in Part I, Item 1A of our annual report on Form 10-K for the year ended July 31, 2015, and elsewhere herein. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. We undertake no obligation to revise or update any forward-looking statements for any reason.
Overview
ARI Network Services, Inc. offers an award-winning suite of Lead Generation and eCommerce Websites, eCatalog Solutions, Business Management Systems and Digital Marketing Services that help dealers, equipment manufacturers and distributors in select vertical markets Sell More Stuff!™ – online and in-store. Our innovative products are powered by a proprietary library of enriched electronic product content including OEM parts, aftermarket parts, garments and accessories (PG&A) and whole goods from more than 1,800 manufacturers. Business is complicated, but we believe our customers’ technology tools don’t have to be. We remove the complexity of selling and servicing new and used whole goods inventory and PG&A. More than 23,500 equipment dealers, distributors and manufacturers worldwide leverage our solutions to Sell More Stuff!™
We go to market under the “ARI Network Services, Inc.” brand name in the powersports, outdoor power equipment (OPE), marine, home medical equipment (HME), recreational vehicles (RV) and appliance industries. We service customers in the automotive tire and wheel aftermarket (ATW) under the “TCS Technologies, an ARI Company” brand name; and we service the automotive aftermarket parts and service (AAPS) market under the “DCi, an ARI Company” brand name.
Our Solutions
Our primary solutions include: (i)
Lead Generation and eCommerce Websites,
giving
dealers and wholesalers
an online
presence optimized for today’s digital path to purchase and serving as a platform to drive in-bound lead generation and eCommerce sales; (ii)
eCatalogs
, offering access to our proprietary library of enriched electronic product content via a suite of SaaS and DaaS solutions to enable the sale of whole goods inventory and PG&A; (iii)
B
usiness Management Software
designed to streamline every aspect of a dealer’s operation, drive profitability and allow them to provide better customer service; and (iv)
Digital Marketing Services
designed to generate leads and drive traffic both to the dealer’s website and brick-and-mortar location.
Our solutions also improve our dealers’ overall customer satisfaction through a highly efficient and accurate data lookup experience at the parts counter and a quicker response time to online inquiries, both of which serve to significantly improve a customer’s overall experience with the dealer.
Our solutions are sold through our internal sales force and are composed primarily of recurring licenses and subscriptions and, in the case of business management software, perpetual licenses and maintenance contracts. Customers typically sign annual, auto-renewing contracts. Today, more than 90% of our revenues are recurring.
Lead Generation and eCommerce Websites
Our online solutions are tailored to each of the vertical markets we serve and are tightly integrated with our proprietary library of enriched electronic product content for major unit inventory and PG&A. Our website platform development teams continually innovate our platforms to keep up with the ever-evolving demands of our customers, online shoppers and search engines to ensure we can provide dealers with websites that perform well in search and convert online visits into leads, eCommerce sales and in-store visits. We offer a full menu of website add-ons, including a mobile inventory management application, third-party inventory integrations and business management integrations. Our lead generation tools are designed to efficiently manage and nurture leads through email campaigns, automated responses, sales team reminders and other lead generating activities, increasing conversion rates and ultimately revenues for our customers.
Lead Generation and eCommerce Websites are sold through our internal sales teams, which are aligned by vertical market. The sales process typically includes a live demo of the site and may include a free trial period (we refer to these as “test drives”). We typically charge monthly recurring subscription fees, and may charge a one-time set up fee to develop a new dealer website, as well as variable transaction fees. Our website solutions are typically sold under one-year, renewable contracts with monthly payment terms. We host and maintain more than 7,500 websites for dealers across all of our vertical markets.
eCatalog Platform Solutions
Our eCatalog solutions
offer access to
our
proprietary
library of
enriched
electronic
product content via a suite of SaaS and DaaS solutions including dealer-facing manufacturer parts lookup portals and parts counter solutions; consumer-facing online parts lookup; and DaaS subscription access to our content library all designed to enable the sale of
whole goods
inventory
and
PG&A.
Our eCatalog solutions are sold through our dedicated internal sales team. Fees charged for the use of our eCatalog products include a recurring license fee, subscription fees for subscribed catalogs and, in some cases, page view fees.
Business Management Software
Our business management software solutions are designed to streamline every aspect of a dealer’s operations to allow them to provide improved customer service. These products are sold through our dedicated internal sales team, and fees charged include perpetual one-time license or installation fees, maintenance and support fees, as well as hosting fees for our SaaS version. These solutions are currently only offered in the ATW aftermarket under the “TCS Technologies, an ARI Company” brand name.
Digital Marketing Services
ARI complements our suite of data-driven SaaS and DaaS solutions with digital marketing services that deliver the engaging experiences that today’s consumers expect, as well as meet the demands of leading search engines like Google. ARI’s Digital Marketing Services include search engine optimization, email marketing, search engine marketing (PPC), online reputation management and online directory management to help dealers drive more online leads, eCommerce sales and in-store traffic. Digital marketing services are sold through our dedicated internal sales team.
Other Solutions
We also offer a suite of complementary solutions, which include software, website customization, professional services and hosting services.
Our Growth Strategy
ARI’s goal is to become the leading provider of SaaS and DaaS solutions and complementary services that help our customers efficiently and effectively sell more major units, replacement parts, accessories and service – in other words, Sell More Stuff!™ Our continued goal is to grow revenues at a double-digit rate and to grow earnings through scalability. We intend to accomplish this goal by delivering our solutions to dealers, distributors, manufacturers, service providers and consumers in selected vertical markets where the finished goods are complex equipment requiring service and which are primarily sold and serviced through an independent dealer channel which typically carries multiple brands. We believe this strategy will drive increased value to our shareholders, employees and customers.
We also believe that the execution of the following strategic pillars will enable us to achieve the growth and profitability needed to drive long-term sustainable value for our shareholders:
|
·
|
|
D
rive organic growth through expanded service offerings to grow both our subscriber customer base and our average revenue per dealer;
|
|
·
|
|
D
ifferentiate our content;
|
|
·
|
|
E
xpand geographically;
|
|
·
|
|
N
urture and retain existing customers through world-class customer service and value-added product feature updates;
|
|
·
|
|
L
ead the market with open integration to related platforms; and
|
|
·
|
|
S
uccessfully execute acquisitions that align with our core strategy.
|
These strategic foundations are primarily centered on enhancing the value proposition to our customers, which will lead to additional revenues through pricing actions, product and feature upsells, reduced customer churn rates, and expansion by leveraging our core competencies in new complementary markets. Each of these strategic pillars is a long-term foundation for the Company’s growth; within each we have established near-term goals, as discussed below.
Drive organic growth through expanded service offerings to grow both our subscriber customer base and our average revenue per dealer.
As a subscription-based, recurring revenue (RR) business, the most important drivers of future growth are nurturing and defending our customer base; developing and selling additional products to our existing customer base; and acquiring new customers. We define RR as revenue from products and services which are subscription-based and
renewable, including software access fees, data content fees, maintenance fees, support fees and hosting fees. We define churn as the percentage of RR that does not renew. RR increased
7
.4%, or $7
89
,000 to 9
3
.
7
% of total revenue for the
quarter
ended
October
31, 2016, compared to the same period last year. To experience further growth in RR, we will continue to develop and deploy innovative new solutions. We have resources assigned to each of our core products that continue to research and develop new value-added features and functionality for our existing products. The introduction of new solutions, upgrades to existing products, and new feature sets are all designed to grow our subscriber base of dealers and our average revenue per dealer (ARPD), an important measure for a subscription-based business. We have recently developed a number of new features, upgrades and products, including the following:
Lead Generation and eCommerce Website Platforms
|
o
|
|
ARI Responsive Website Platform Development – we continued development and launched our next generation Responsive Design website platform, completing the first phase including advanced design capabilities, lead generation capabilities, and scalable website production tooling, among other market leading capabilities.
|
eCatalog Platforms
|
o
|
|
Data Manager RT
™
Development – We completed development and released to market our next generation of Data Manager
™
, our OEM parts product information management software. This next-generation platform provides OEMs with reduced publishing costs and time to market through real-time publishing, ensuring end users have access to the most accurate and rich part and service content across ARI’s software ecosystem.
|
|
o
|
|
PartStream
™
Development – We developed and released a comprehensive upgrade to PartStream
™
, our leading Business-to-Consumer OEM parts shopping application, that now makes the application fully Responsive – providing customers a beautiful and intuitive parts shopping experience across all devices.
|
Digital Marketing Services
|
º
|
|
Extended Digital Marketing Services Packages Available – We developed and launched extended Digital Advertising and Email Marketing packages, providing our customers with additional curated service packages that meet the demands of their unique business.
|
These product enhancements are designed to automate and enhance the marketing, sales and servicing activities for our customers in order to help them sell and service more parts, garments, accessories and whole goods.
Differentiate our content.
We believe we have the largest library of replacement part, major unit, and PG&A content in the vertical markets we serve. However, simply offering the largest content library in the markets we serve is not sufficient to drive the long-term revenue growth we desire. We strive to deliver more value to our customers through the enrichment of our content and during fiscal 2017 have made the following enhancements:
|
o
|
|
PG&A Content Addition and Expansion – We’ve secured and authored product content for two market-leading distributor catalogs in our Marine and Home Medical Equipment markets, exponentially increasing the total number or e-commerce products available to sell in those markets.
|
Enter new markets.
ARI currently maintains a significant share in our core vertical markets of OPE, powersports, marine, RV and appliances. Accordingly, we anticipate low single-digit growth in these markets. ARI maintains a lower share in our growth vertical markets of HME, ATW and AAPS. Accordingly, we anticipate double-digit growth in these markets.
As we continue to increase our share in our current markets, leveraging our technology in new and underserved markets will be important to maintaining high single digit to low double digit organic growth rates. ARI currently has more than 3,000 dealer websites in the ATW market. We estimate that the total addressable market includes approximately 18,000 dealers. Further, the broader AAPS market, which we entered via our acquisition of DCi, comprises nearly 80,000 independent service providers, more than all of our other markets combined. We intend to continue to invest heavily in this growth market, including seeking opportunities to leverage our products and services in the broader AAPS. We are one of the first website providers to service the HME market. We estimate that this market comprises nearly 25,000 service providers and believe the market to be in the early stages of eCommerce adoption.
On November 1, 2016, we acquired Auction123, Inc. (“Auction123”), which
will accelerate ARI’s growth in our existing vertical markets
, as well as
introduce ARI into the automotive dealer market
.
Auction123 has been a leader in online marketing solutions, inventory management and website development solutions for dealers in selected vertical markets. Their award-winning web-based software offers tight and seamless integration between the dealer management system (DMS), the dealer’s website, eBay Motors, Craigslist, Facebook and other third-party classified websites.
Expand geographically.
Although we maintain relationships with dealers throughout the world, we have low penetration into international markets. Growing our international business will require us to secure and publish electronic content from manufacturers outside the U.S. and make changes to our existing product suite that will allow us to rapidly deploy these products in a scalable and efficient manner without the need to have “boots on the ground” in those countries. During fiscal 2015 and 2016, we added 15 new catalog content offerings in the international outdoor power equipment market. In September 2016, we hired a general manager in the Netherlands intended to expand our European presence.
Nurture and retain existing customers through world-class customer service and value-added product feature updates.
In order to achieve sustained double-digit organic growth, we not only need to execute the growth strategies described above, we must also retain our existing customers. In a SaaS business, the cost to retain an existing customer is much less than the cost to acquire a new customer. Accordingly, customer churn is an important metric we track and manage. We experienced improvements in our churn rates the past several years as a result of strategic actions taken by the Company, all of which are designed to enhance the “stickiness” of our
product within our customers’ operations.
Our c
ustomer churn improved from 15.8
% during the twelve months ended October 31, 2015 to
14.5%
during the
same period this year.
We will continue to leverage our relationships with existing customers and closely monitor and manage the level of customer churn.
Lead the market with open integration to related platforms.
One of our strategic advantages is our focus on integrating our solutions with dealer business management systems (DMS) in order to pass key information, including customer and transactional data, between our solutions and the DMS, saving our customers valuable time and eliminating redundant data entry. We currently have integration capabilities with over 90 DMS (we refer to these relationships as “Compass Partners”), and we continue to seek other strategic alliances that can be integrated with our product and service offerings.
Successfully execute acquisitions that align with our core strategy.
S
ince 1995, we have had a formal corporate development program aimed at identifying, evaluating and closing acquisitions that align with our strategy. We focus on vertically-oriented markets with a large base of independent, multi-line dealers that sell and service complex equipment. Our strategy is to acquire companies that allow us to do one or more of the following: (i) expand our market share in existing verticals; (ii) expand into new markets that fit our desired profile; (iii) provide us with complementary products which can be cross-sold to our existing customer base; (iv) provide opportunities to cross-sell our existing products; and (v) can be integrated into our operations, thereby creating cost-saving synergies.
From the
program’s inception through
November 1, 2016
, we have closed 1
7
acquisitions. A summary of some of our most recent acquisitions is as follows:
|
|
|
|
|
|
Acquisition
|
|
Date
|
|
Strategy
|
Auction123, LLC*
|
|
November 2016
|
|
▪
|
Expand our position in the automotive industry
|
Direct Communications Inc.
|
|
July 2015
|
|
▪
|
A leading provider of electronic catalog and content in the AAPS industry
|
TASCO Corporation (and affiliated Signal
|
|
April 2015
|
|
▪
|
Extend business management software platform in the ATW market
|
Extraprise Corporation)
|
|
|
|
|
|
Tire Company Solutions, LLC
|
|
September 2014
|
|
▪
|
Consolidate website position and add new business management software
|
|
|
|
|
|
in the ATW market
|
DUO Web Solutions
|
|
November 2013
|
|
▪
|
A leading provider of social media and online digital marketing services in the
|
|
|
|
|
|
powersports industry
|
50 Below Sales & Marketing, Inc.
|
|
November 2012
|
|
▪
|
A market leader in the powersports industry
|
(Retail Division)
|
|
|
|
▪
|
Entrance into ATW and DME industries
|
|
|
|
|
▪
|
New award-winning website platform
|
Ready2Ride, Inc.
|
|
August 2012
|
|
▪
|
First of its kind aftermarket fitment data for the powersports industry
|
--------------------------------------------------------
|
|
|
|
|
|
* Acquisition completed November 1, 2016 (see Note 8, Subsequent Events).
|
|
|
|
|
|
|
Summary of Operating Results
Total revenue increased
4
.
6
%, or $
535,000, to $12
,
272
,000 for
the three months
ended
October 31
, 2016 from
$1
1
,
737
,000 for the same period last year
.
Recurring revenue increased
7
.
4
% to $1
1
,
498
,000 during the three mont
hs ended
October 31
, 2016, compared to $
10
,
709
,000 during the same period last year. Recurring revenue constituted 9
3
.
7
% of our total revenue for the
three
months ende
d
October 31
, 2016 compared to 9
1
.
2
% for the same period last yea
r. The growth in year-over-year
revenue was
entirely
organic, primarily in the lead generation and eCommerce solutions
and the digital marketing solutions
.
Operating income
de
creased
5
.
0
%, or $
40
,000, from $
808
,000 for the three mon
ths ended
October 31
, 2015 to $
768
,000 for the same period this year. Net o
perating expenses increased
4
.
0
% or $
355
,000
during the three month period ended
October 31
, 2016, compared to the same period last year, primarily due
to legal and
accounting
fees related to the Auction123 acquisition and operating expenses for the India operation, which began in the second quarter of fiscal 2016.
Net income was $
356
,000, or $0.0
2
per share, for the three months ended
October 31
, 2016, compared to $3
8
9
,000, or $0.02 per share, for the same period last year.
Cash provided by operations
increased
slightly from
$
1,735
,000 for the
three
months ended
October 31
, 201
5
to $
1
,
764
,000 for the same period
this
year.
Revenue
The following table summarizes our product revenue and RR and non-recurring revenue (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended October 31
|
|
|
|
|
2016
|
|
% of Total
|
|
2015
|
|
% of Total
|
|
% Change
|
|
|
Lead Generation and eCommerce Websites
|
|
$
|
6,268
|
|
51.1
|
%
|
|
$
|
5,868
|
|
50.0
|
%
|
|
6.8
|
%
|
|
|
eCatalog Services
|
|
|
4,430
|
|
36.1
|
%
|
|
|
4,515
|
|
38.5
|
%
|
|
(1.9)
|
%
|
|
|
Business Management Software
|
|
|
675
|
|
5.5
|
%
|
|
|
809
|
|
6.9
|
%
|
|
(16.6)
|
%
|
|
|
Digital Marketing Solutions
|
|
|
708
|
|
5.8
|
%
|
|
|
356
|
|
3.0
|
%
|
|
98.9
|
%
|
|
|
Other Revenue
|
|
|
191
|
|
1.5
|
%
|
|
|
189
|
|
1.6
|
%
|
|
1.1
|
%
|
|
|
Total revenue
|
|
$
|
12,272
|
|
100.0
|
%
|
|
$
|
11,737
|
|
100.0
|
%
|
|
4.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Recurring revenue
|
|
|
11,498
|
|
93.7
|
%
|
|
|
10,709
|
|
91.2
|
%
|
|
7.4
|
%
|
|
|
Non-recurring revenue
|
|
|
774
|
|
6.3
|
%
|
|
|
1,028
|
|
8.8
|
%
|
|
(24.7)
|
%
|
|
|
Total revenue
|
|
$
|
12,272
|
|
100.0
|
%
|
|
$
|
11,737
|
|
100.0
|
%
|
|
4.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue increased
4
.
6
% to $1
2
,
272
,000
and RR increased 7.4% to $11,498,000
for the three months ended
October 31
, 2016,
compared to the same period
last year. RR represented 9
3
.
7
% of total revenue for the first
three
months of fiscal 201
7, versus 91
.
2
% for the same period in fiscal 201
6
. We continue to focus on
maintainin
g recurring revenue of
over
90%.
Lead Generation and eCommerce Website Revenue
Our lead generation and eCommerce website solutions generate revenue from one-time setup and customization fees to develop new dealer websites, which is recognized ratably over the term of the contract, monthly recurring subscription fees and variable transaction fees. Our lead generation and eCommerce website solutions are typically sold as one year, renewable contracts with monthly payment terms. We estimate that we currently host and maintain more than 7,000 websites for dealers in all of our vertical markets. Lead generation and eCommerce website solutions have become ARI’s largest source o
f revenue and accounted for 51
.
1
% of total revenue during the
three
months ended
October 31
, 2016. Lead generation and eCommerce revenue increased
6
.
8
%
from
$
5
,
868
,000 for the three months ended
October 31
, 201
5
, to
$6,268,000 for
the same period
this
year as a result of organic growth. We anticipate that our web platforms will continue to be one of the Company’s largest source
s
of revenue growth.
eCatalog Revenue
Our eCatalog solutions generate revenue from renewable subscription fees for our software, data content, software maintenance and support fees and software customization fees. eCatalog is our second largest source of revenue, representing 3
6
.
1
% of total revenue during the
three
months ended
October 31
, 2016. eCatalog revenue de
creased
1
.
9
%
from
$4,
515
,000 during the three months ended
October 31
, 2015
to
$4,430,000 for
the same period
this
year, primarily due to
a decrease in non-recurring professional services revenue
. The catalog content provided in our eCatalog solutions helps to drive sales growth in our website and lead management solutions, as well as continuing to drive organic growth in other areas of the business.
Management expects eCatalog RR to increase at a low organic growth rate as the Company already has strong market share with this product.
Business Management Software
Revenue
Business management software revenue is generated from perpetual one-time license and installation fees for
the
software, along with recurring maintenance, support and hosting fees
for our SaaS version
.
Revenue from business management software represented 5.5% of total revenue for the three months ended October 31, 2016. B
usiness management software revenue
de
creased 1
6
.
6
%
from $
809
,000 for the three months ended
October 31
, 2015 to $
675
,000 for the same period this year.
The de
crease in business management software revenue
wa
s primarily
due to a decline in non-recurring perpetual license and professional service fees. Management expects fluctuations in non-recurring business management software revenue due to the timing of sales and professional service contracts.
Digital Marketing Revenue
Revenues from our Digital Marketing Solutions are generated from set-up fees and subscription fees for our lead generation tools through search engine optimization, social media marketing and website enhancements. We derived 5.8% of our revenues from Digital Marketing Services for the three months ended October 31, 2016. Digital mark
eting revenue increased 98.9
%, from $356,000 during the three months ended October 31, 2015 to $708,000 during the same period this year, primarily due to organic growth in RR. Management expects digital marketing revenue to continue to see
high
double digit growth in fiscal 2017 as this service offering is a relatively new offering and is complementary to our other products, allowing us to expand within our current markets and current customers.
Other Revenue
We also offer a suite of complementary solutions, which include software, professional services and hosting services. Other revenue, which is primarily non-recurring in nature, represented approximately 1.
5
% of total revenue for the three months ended October 31, 2016
, and was
relatively consistent with the same quarter last year.
Revenue from non-recurring professional services will fluctuate from period to period based on the timing of custom projects
,
which
the Company has intentionally de-emphasized these projects as it focuses more on RR.
Recurring Revenue
RR is one of the most important growth drivers of our business
and represented 93.7% of total revenue for the three months ended October 31, 2016
. Increasing the percentage of our revenues that are recurring, while at the same time reducing the rate of customer churn, enhances our ability to generate profitable growth. Our subscription-based SaaS and DaaS products generate higher margins than our non-recurring products and services, and the incremental cost of selling these products to new dealers (we refer to these as new “logos”) is relatively low. Reducing the rate of our customer churn, which is the percentage of RR that does not renew, helps drive organic growth as it allows for a greater percentage of our new logos to be incremental to the top line (versus
making up for lost logos) and also increases the base upon which we can apply price increases and sell additional products and features.
We generate RR from each of our primary product categories from monthly license, subscription, maintenance and support fees. RR increased
7
.4% from $
10
,
709
,000 during
the three months ended October 31,
2015, to $
11
,
498
,000 during
the same period this year
, primarily
due
to organic growth
in our Lead Generation and eCommerce Website and
Digital Marketing s
olutions
. We expect Lead Generation and eCommerce Website RR to continue to be our largest contributor to RR growth in fiscal 2017.
Non-recurring Revenue
Non-recurring revenue is generated from one-time perpetual license fees from our business management offerings, certain offerings within the Company’s digital marketing services, professional services related to software customization and data conversion, usage fees charged on our RR products, set-up fees and other complementary products and services. Total non-recurring revenue decreased
2
4.
7
% from $
1
,0
28
,000 during
the three months ended October 31,
2015, to $7
74
,000 during
the same period this year
, primarily due to decreased professional services
and
perpetual license revenue. Our goal is to maintain non-recurring revenue of less than 10% of total revenue, as the margins on this revenue tends to be lower than our RR products. Furthermore, non-recurring revenue must be resold each year.
Cost of Revenue and Gross Margin
We classify as cost of revenue those costs directly attributable to the provision of services. These costs include (i) software amortization, which represents the periodic amortization of costs for internally developed or purchased software sold to customers; (ii) direct labor for the provision of catalog production, product implementations and professional services revenue; and (iii) other direct costs, which represent amounts paid to third-party vendors for data royalties, as well as data conversion and replication fees directly attributable to the services we provide our customers.
The table below breaks out cost of revenue into each of these three categories (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended October 31
|
|
|
|
|
|
|
% of
|
|
|
|
|
% of
|
|
|
|
|
|
|
2016
|
|
Revenue
|
|
2015
|
|
Revenue
|
|
% Change
|
|
Net revenues
|
|
$
|
12,272
|
|
|
|
|
$
|
11,737
|
|
|
|
|
4.6
|
%
|
|
Cost of revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of capitalized software costs
|
|
|
522
|
|
4.3
|
%
|
|
|
496
|
|
4.2
|
%
|
|
5.2
|
%
|
|
Direct labor
|
|
|
785
|
|
6.4
|
%
|
|
|
642
|
|
5.5
|
%
|
|
22.3
|
%
|
|
Other direct costs
|
|
|
982
|
|
8.0
|
%
|
|
|
931
|
|
7.9
|
%
|
|
5.5
|
%
|
|
Total cost of revenues
|
|
|
2,289
|
|
18.7
|
%
|
|
|
2,069
|
|
17.6
|
%
|
|
10.6
|
%
|
|
Gross profit
|
|
$
|
9,983
|
|
81.3
|
%
|
|
$
|
9,668
|
|
82.4
|
%
|
|
3.3
|
%
|
Gross profit was $9,
983
,000 or 8
1
.
3
% of revenue for the three months ended
October 31
, 2016, compared to $
9
,
668
,000 or 8
2
.
4
% of revenue for the same period last year. Amortization of capitalized software costs as a percentage of revenue
in
creased
slightly from 4
.
2
%
for the three months ended
October 31
, 201
5
,
to 4.3% for
the same period
this
year
.
Direct labor costs as a percentage of revenue increased
22.3%
for the three months ended
October 31
, 2016, compared to the same period last year primarily due to
:
(i)
an increase in our digital marketing revenue
, which has higher direct costs than our other products
; (ii) an increase in
website implementations
; and (iii) the migration of customer websites in an effort to consolidate our customers to the product most suited to their industry
and consolidate our website platforms
. Other direct costs as a percentage of revenue
increased
slightly from 7.9%
for the
three
months ended
October 31
, 2015
,
to 8.0% for
the same period
this
year
,
primarily due to
increased third party costs associated with
our digital marketing offerings
. The Company expects fluctuations in gross margin from quarter to quarter and year over year based on the mix of products sold.
Operating Expenses
We categorize net operating expenses as follows:
|
·
|
|
Sales and marketing expenses consist primarily of personnel and related costs, including commissions for our sales and marketing employees and the cost of marketing programs and trade show attendance.
|
|
·
|
|
Customer operations and support expenses are composed of our computer hosting operations, software maintenance agreements for our core network and personnel and related costs for operations and support employees.
|
|
·
|
|
Software development and technical support expenses are composed primarily of personnel and related costs; we capitalize certain of these costs in accordance with GAAP, which is discussed below, while the remaining costs are primarily related to technical support and research and development.
|
|
·
|
|
General and administrative expenses primarily consist of personnel and related costs for executive, finance, human resources and administrative personnel, legal and other professional fees and other corporate expenses and overhead.
|
|
·
|
|
Depreciation and amortization expenses consist of depreciation on fixed assets, which are composed of leasehold improvements and information technology assets, and the amortization of acquisition-related intangible assets. Costs associated with the amortization of software products are a component of cost of revenue.
|
|
·
|
|
We allocate certain shared costs among the various net operating expense classifications. Allocated costs include facilities, insurance, internal software and telecommunications. These costs are generally allocated based on headcount, unless circumstances dictate otherwise. All public company costs, including legal and accounting fees, investor relations costs, board fees and directors and officers liability insurance, remain in general and administrative.
|
The following table summarizes our operating expenses by expense category (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended October 31
|
|
|
|
|
|
|
|
|
% of
|
|
|
|
|
% of
|
|
%
|
|
|
|
|
|
2016
|
|
Revenue
|
|
2015
|
|
Revenue
|
|
Change
|
|
|
|
Sales and marketing
|
|
$
|
2,687
|
|
21.9
|
%
|
|
$
|
2,765
|
|
23.6
|
%
|
|
(2.8)
|
%
|
|
|
|
Customer operations and support
|
|
|
2,755
|
|
22.4
|
%
|
|
|
2,446
|
|
20.8
|
%
|
|
12.6
|
%
|
|
|
|
Software development and technical support
|
|
|
1,256
|
|
10.3
|
%
|
|
|
1,255
|
|
10.7
|
%
|
|
0.1
|
%
|
|
|
|
General and administrative
|
|
|
1,942
|
|
15.8
|
%
|
|
|
1,785
|
|
15.2
|
%
|
|
8.8
|
%
|
|
|
|
Depreciation and amortization
(1)
|
|
|
575
|
|
4.7
|
%
|
|
|
609
|
|
5.2
|
%
|
|
(5.6)
|
%
|
|
|
|
Net operating expenses
|
|
$
|
9,215
|
|
75.1
|
%
|
|
$
|
8,860
|
|
75.5
|
%
|
|
4.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) Exclusive of amortization of software products of $522 and $496 for the three months ended October 31, 2016
|
|
|
|
and 2015, respectively, which are included in cost of revenue.
|
|
|
Net
operating expenses increased
4
.
0
%
,
or $
355
,000
,
for the three months ended
October 31
, 2016, compared to the same period last year. The increase in net operating expenses was primarily due to
operating costs to support our growth in revenue,
operating costs
for the new India operation and acquisition costs for the Auction123 acquisition, which was completed November 1, 2016.
Net operating expenses as a percentage of revenue decreased from 7
5
.
5
% for the
thre
e months ended
October 31
,
2015
,
to 7
5
.
1
% for the
same period this year
. Management expects net operating expenses to continue to decline as a percentage of total revenue to the extent the Company continues to leverage growth in its core RR products, as incremental costs related to these products decrease for every dollar of new revenue.
Sales and Marketing
Sales and marketing expense
decreased 2
.
8
%, or $
7
8,000
,
during the three months ended
October 31
, 2016
,
compared to the same period last year. Sales and marketing expense as a percentage of revenue decreased from 2
3
.
6
% of revenue for the
thre
e months ended
October 31
, 2015 to 2
1
.
9
% for the same period in fiscal 201
7
. This decrease is due to the growth in our RR base, which requires much less resources to renew.
Management expects sales and marketing expense as a percentage of revenue to be flat or down as RR continues to grow.
Customer Operations and Support
Customer operations and support expense increased
12
.
6
%
,
or $
3
09
,000, during the three months ended
October 31
, 2016, compared to the same period last year
,
primarily
due to
the expense
s
associated with the
India
operation. Customer operations and support expense as a percentag
e of revenue increased from
20
.
8% of revenue for the thre
e months ended
October 31
, 2015 to 2
2
.
4
% during the
same period this year
. The customer operations and support functions of an acquired business typically take longer to fully integrate due to merging software platforms, help desks and customer hosting systems in order to operate more efficiently.
Management expects customer operations and support expenses to decline as a percentage of revenue over time, to the extent we continue to integrate these areas into our operations and we supplement labor capacity in our India office, while RR continues to grow.
Software Development and Technical Support
Our software development and technical support staff have three essential responsibilities for which the accounting treatment varies depending upon the work performed: (i) costs associated with internal software development efforts (after technological feasibility is established) are capitalized as software product costs and amortized over the estimated useful lives of the product; (ii) costs for professional services performed for customers related to software customization projects are classified as cost of revenue; and (iii) all other activities, including research and development, are considered operating expenses and included within the software development and technical support operating expense category.
Software development and technical support costs were relatively the same for the three months ended October 31, 2016 and 2015. During the first quarter of fiscal 2017, we capitalized $451,000 of software development labor, overhead and interest expense, versus
$258,000 during the first quarter of fiscal 2016.
The increase was a result of two significant product initiatives that escalated in the second quarter of fiscal 2016 as well as the commencement of development work from resources in our India office.
In addition to internal capitalized software costs, we had outsourced development costs of $159,000 during the first fiscal 2017 and $115,000 during the first quarter of fiscal 2016. We devoted much of these resources to a major upgrade of our website
and e-Catalog publishing
products during both fiscal 2016 and 2017.
We expect fluctuations in the percentage of software development and technical support costs classified as operating expenses from period-to-period, based on the mix of research and prototype work versus capitalized software development and professional services activities.
General and Administrative
General and administrative expense increased 8.8%
,
or $157,000
,
during the three months ended October 31, 2016, compared to the same period last year, primarily due to legal fees and a
ccounting
fees related to the Auction123 acquisition. General and administrative expense as a percentage of revenue increased from 15.2% of revenue for the first quarter of fiscal 2016 to 15.8% for the same period in fiscal 2017. Management expects general and administrative expense as a percentage of revenue to decrease over time as we continue to scale the business, although additional acquisitions or other transactions could result in elevated general and administrative expense in future periods.
Other Income and Expense
The table below summarizes the components of other income and expenses (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Three months ended October 31
|
|
|
2016
|
|
2015
|
|
% Change
|
|
Interest expense
|
$
|
(108)
|
|
$
|
(112)
|
|
(3.6)
|
%
|
|
Other, net
|
|
1
|
|
|
(8)
|
|
(112.5)
|
%
|
|
Total other income (expense)
|
$
|
(107)
|
|
$
|
(120)
|
|
(10.8)
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense is composed of both interest paid on the Company’s debt financing arrangements and amortization of non-cash interest charges related to deferred finance costs and imputed interest on contingent liabilitie
s. Interest and other expense de
creased 1
0
.
8
%
,
or $1
3
,000
,
during the three
months ended
October 31
, 2016
,
compared to the same period last year, primarily
due to payments on our
debt obligations and contingent liabilities.
Income Taxes
The Company has net deferred tax assets of $4,
015
,000 as of
October 31
, 2016,
primarily consisting of net operating loss carryforwards (“NOLs”) and book to tax temporary differences. Income tax expense is provided for at the applicable statutory tax rate applied to current U.S. income before taxes, plus or minus any adjustments to the deferred tax assets and to the estimated valuation allowance against deferred tax assets. Income tax expense, if any, does not represent a significant current cash obligation, as we continue to have NOLs to offset substantially all of the taxable income.
We had income tax expense of $3
05
,000 during the three months ended
October 31
, 2016, compared to $2
99
,000 during the same
period
last year. We paid income taxes of $
123
,000 and $
13
,000 during the
three
months ended
October 31
, 2016 and 2015, respectively, primarily related to statutory alternative minimum taxes. Income tax expense may vary from period to period as we continue to evaluate the valuation allowance against net deferred tax assets
.
We also have NOLs related to
tax losses incurred by our
India and
Netherlands operation
s
. We have determined that, consistent with prior periods, it is not likely that the net operating losses will be utilized and therefore, a full valuation allowance is recorded, resulting in $0 net deferred tax assets related to
our international
operation
s
at
October 31
, 2016 and 2015.
Adjusted EBITDA
EBITDA is calculated as net income adjusted to exclude interest, amortization, depreciation and income tax expense.
Adjusted EBITDA further eliminates non-cash, stock-based compensation expense. Management believes Adjusted EBITDA is helpful in understanding period-over-period operating results separate and apart from non-operating expenses and expenses pertaining to prior period investing activities, particularly given the Company’s significant investments in capitalized software and its continuing efforts in completing acquisitions, which typically result in significant non-cash depreciation and amortization expense in subsequent periods. However, Adjusted EBITDA has significant limitations as an analytical tool and should only be used cautiously in addition to, and never as a substitute for, operating income, cash flows or other measures of financial performance prepared in accordance with generally accepted accounting principles and may not necessarily be comparable to similarly titled measures of other companies.
The table below presents the reconciliation of net income to EBITDA and Adjusted EBITDA (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended October 31
|
|
|
|
|
2016
|
|
2015
|
|
|
Net income
|
|
$
|
356
|
|
|
$
|
389
|
|
|
|
Interest expense
|
|
|
108
|
|
|
|
112
|
|
|
|
Amortization included in cost of sales
|
|
|
522
|
|
|
|
496
|
|
|
|
Depreciation and amortization
|
|
|
575
|
|
|
|
609
|
|
|
|
Income tax expense
|
|
|
305
|
|
|
|
299
|
|
|
|
EBITDA
|
|
$
|
1,866
|
|
|
$
|
1,905
|
|
|
|
Stock-based compensation expense
|
|
|
149
|
|
|
|
115
|
|
|
|
Adjusted EBITDA
|
|
$
|
2,015
|
|
|
$
|
2,020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
12,272
|
|
|
$
|
11,737
|
|
|
|
Adjusted EBITDA as a % of revenue
|
|
|
16.4
|
%
|
|
|
17.2
|
%
|
|
Adjusted EBITDA de
creased
0
.
2
%, from $2
,
020
,000 during the
first
quarter of fiscal 201
6
,
to $2,
0
1
5
,000 during the
first quarter of fiscal 2017
. Adjusted EBIT
DA as a percentage of revenue de
creased from 1
7
.
2
% during the
thre
e months ended
October 31
, 2015
,
to 1
6
.
4
% during the same period this year.
Management expects Adjusted EBITDA to increase in fiscal 2017, compared to the prior year, to the extent earnings increase as a result of RR growth.
Liquidity and Capital Resources
The following table sets forth certain cash flow information derived from our unaudited financial statements (in thousands):
|
|
|
|
|
|
|
|
|
|
Three months ended October 31
|
|
2016
|
|
2015
|
|
Change
|
Net cash provided by operating activities
|
$
|
1,766
|
|
$
|
1,735
|
|
$
|
31
|
Net cash used in investing activities
|
|
(782)
|
|
|
(665)
|
|
|
(117)
|
Net cash provided by (used in) financing activities
|
|
(481)
|
|
|
(173)
|
|
|
(308)
|
Effect of foreign currency exchange rate changes on cash
|
|
(4)
|
|
|
(2)
|
|
|
(2)
|
Net change in cash
|
$
|
499
|
|
$
|
895
|
|
$
|
(396)
|
Cash at end of period
|
$
|
5,617
|
|
$
|
3,179
|
|
$
|
2,438
|
We generated $
499
,000 of net cash during the
three
months ended
October 31
, 2016, compared to $
895
,000 during the same period last year. We generated net cash
from
operating activities of $
1
,
7
6
6
,000 during the
thre
e months ended
October 31
, 2016
,
compared to $
1
,
73
5
,000 during the same period last year.
Cash used in investing activities
in
creased $
117
,000 for the
thre
e months ended
October 31
, 2016, compared to the same period last year
, primarily due to
the increase in capitalized software
costs
related to the upgrades of our website platform
and e-Catalog publishing product, partially offset by lower acquired technology equipment expenditures.
We paid cash of $
121
,000
for contingent liabilities related to our acquisitions
, capitalized $
6
10
,000 of software development costs, and acquired technology equipment of $
51
,000 during the
three
months ended
October 31
, 2016. We paid cash of $
125
,000
for contingent liabilities
, capitalized $
373
,000 of software development costs,
and
acquired technology equipment of $
167
,000 during the
three
months ended
October 31
, 2015. We will continue to invest cash in the business to further our growth strategies previously discussed.
Net cash used in financing activities was $
4
8
1
,000 during the
three
months ended
October 31
, 2016, primarily to
pay down the SVB note, the TCS N
otes
, the DCi Note
and our capital lease obligations. Net cash
used in
financing activities was $
173,000 during the three
months ended
October 31
, 2015,
primarily to pay down the SVB note and capital lease obligations
.
Management believes that current cash balances and its ability to generate cash from operations are sufficient to fund our needs over the next twelve months, although additional financing may be necessary if the Company were to complete a material acquisition or to make a large investment in its business.
Debt
The Company has a Loan and Security Agreement (the “Agreement”) with Silicon Valley Bank (“SVB”), pursuant to which SVB extended to the Company credit facilities consisting of a $3,000,000 revolving credit facility with a maturity date of
Nov
ember 30, 2016 and a $6,050,000 term loan with a maturity date of September 30, 2019. In addition to this, the Company has issued several promissory notes in connection with its acquisitions. See Note 3 to the consolidated financial statements for further details. The following table
summarizes the
m
inimum principal payments due on the SVB Term Note, the TCS Notes and the DCi Note
as of October 31, 2016
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal year ending July 31:
|
SVB Term Note
|
|
TCS Notes
|
|
|
DCi Notes
|
|
|
Total Notes Payable
|
|
|
2017
|
$
|
681
|
|
$
|
728
|
|
$
|
467
|
|
$
|
1,876
|
|
|
2018
|
|
1,134
|
|
|
1,014
|
|
|
645
|
|
|
2,793
|
|
|
2019
|
|
1,210
|
|
|
261
|
|
|
671
|
|
|
2,142
|
|
|
2020
|
|
1,815
|
|
|
—
|
|
|
—
|
|
|
1,815
|
|
|
|
$
|
4,840
|
|
$
|
2,003
|
|
$
|
1,783
|
|
$
|
8,626
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In connection with the November 1, 2016 acquisition of
Auction123
123,
the Company entered into the Seco
nd Loan Modification Agreement
with SVB
, which
includes credit facilities consisting of $3,000,000 revolving credit facility with a
maturity date of September 30, 2018 and a $13,000,000 term loan with a maturity date of
November
1
, 2021. This term loan is an amendment to the existing $6,050,000 term loan with a maturity date of September 30, 2019
(see Note 8, Subsequent Events)
.
Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on its financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources.