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ARI NETWORK SERVICES INC /WI - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
(Edgar Glimpses Via Acquire Media NewsEdge) 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, 2012 and 2011, 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 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 our annual report on Form 10-K for the
year ended July 31, 2012, under "Item 1A. Risk Factors," 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 of Business
ARI Network Services, Inc. ("ARI" or the "Company") is a leader in creating,
marketing, and supporting solutions that enhance revenue and reduce costs for
our customers. Our innovative, technology-enabled solutions connect the
community of consumers, dealers, distributors, and manufacturers to help them
efficiently service and sell more whole goods, parts, garments, and accessories
("PG&A") in selected vertical markets worldwide that include power sports,
outdoor power equipment, marine, and appliances. We estimate that more than
22,000 equipment dealers, 140 manufacturers, and 195 distributors worldwide
leverage our technology to drive revenue, gain efficiencies and increase
customer satisfaction.
Our Solutions
Today, we generate revenue from three primary categories of technology-enabled
solutions: (i) electronic catalogs for publishing, viewing and interacting with
PG&A information from Original Equipment Manufacturers ("OEMs"), aftermarket
manufacturers and distributors; (ii) websites with eCommerce capabilities
designed to leverage leads for sales of whole goods and sales of PG&A through
the sites and provide information to consumers in dealers' local areas; and
(iii) lead generation and management products and services designed to help
dealers generate sales of whole goods and PG&A through efficient marketing of
their products.
Electronic Catalogs
Our electronic catalog solutions, which encompass our PartSmart®, PartSmart
Web™, PartStream™ and other various catalog products, leverage our
industry-leading content database to allow distributors and dealers to view and
interact with this information to efficiently support the sales and service of
equipment. We believe that our catalog solution is the fastest and most
efficient in the market, as it allows multi-line dealers to quickly access data
for any of the brands serviced from within the software, allowing the dealer's
parts and service operations to more quickly service and sell to its customers.
We derived approximately 58% of our revenues from our electronic catalog
services in the first quarter of fiscal 2013.
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Website Solutions
Our eCommerce enabled website solutions, which are tailored to the vertical
markets we serve, provide consumers with information about the dealership and
its product lines and allow consumers to purchase OEM or aftermarket PG&A
through the dealers' website 24 hours a day, 7 days a week. Our website
solutions include WebSiteSmart Pro®, eXceleratePro™, eXceleratePro™ 2, and
LeadStorm™. We also offer a mobile solution that allows some dealers' websites
to be fully functional on smart mobile phones. Website services accounted for
approximately 26% of revenues in the first quarter of fiscal 2013.
Lead Management Product
Our award-winning SaaS solution, Footsteps™, is designed to efficiently manage
and nurture generated leads, increasing conversion rates and ultimately
revenues. Footsteps™ connects equipment manufacturers with their dealer channel
through lead consolidation and distribution, and allows the dealers to handle
leads more efficiently and professionally through marketing automation and
business management system integration. The product provides a complete database
of customers and prospects, and manages the dealer to customer relationship from
generating email campaigns and automated responses, to providing sales teams
with a daily follow-up calendar and reminder notices. We derived approximately
4% of our revenues from Footsteps™ in the first quarter of fiscal 2013.
Lead Generation Service
Our web-based lead generation service, SearchEngineSmart™, generates increased
traffic to dealers' stores and websites through optimization of the dealers'
paid search engine marketing campaigns, which include optimization for results
in our dealers' local areas. We derived approximately 5% of our revenues from
lead generation services in the first quarter of fiscal 2013.
Other Services
We also offer a suite of complementary solutions, which include software and
website customization services, website hosting, and document transfer and
communication services. On a combined basis, these other services accounted for
approximately 7% of revenue in the first quarter of fiscal 2013.
Further information regarding our service offerings can be accessed at the
Company's website at www.arinet.com, or in our Annual Report on Form 10-K for
the year ended July 31, 2012. Please note that we are not including the
information contained on or available through our website as a part of, or
incorporating such information by reference into, this quarterly report on Form
10-Q.
Our Strategy
ARI's goal is to drive increased value to our shareholders through sustained
double digit revenue and earnings growth. We believe that execution of the
following fundamental strategic pillars will enable us to continue to provide
our customers with the innovative solutions and value-added services they have
come to expect, which will ultimately drive the long-term growth and
profitability our shareholders expect.
Nurture and retain existing customers through world-class customer service and
value-added product feature updates
In fiscal 2012, we deployed a brand new, state-of-the-art call center to support
our inside sales, customer service, technical support, and renewal teams. The
call center was designed to drive increased efficiencies and activity levels
within these groups, and includes the display of continuous, real time sales and
support metrics throughout the call center. We will continue to leverage our
relationships with existing customers and closely monitor and manage the level
of customer churn. In fiscal 2012, our rate of customer churn improved by 19%
over fiscal 2011 and we have seen an additional improvement of 21.2% in the
first quarter of fiscal 2013, compared to the same period last year.
Drive organic growth through innovative new service offerings, differentiated
content and geographic expansion
As a subscription-based, recurring revenue business, the most important drivers
of future growth are adding new customers, increasing the level of our recurring
revenue ("RR") and reducing the rate of customer churn. We define RR as products
and services which are SaaS or DaaS-based and renewable, including license fees,
maintenance fees, catalog subscription fees and hosting fees. In the first
quarter of fiscal 2013 our RR increased 8.9% overall, and RR on our three core
recurring products -
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catalog, website, and lead management - increased 9.5%. This increase was the
result not only of the improvement in customer churn rates discussed above, but
was also driven by progress we made with respect to our organic growth strategy,
which includes the following critical objectives:
· Develop and deploy innovative new solutions. We have resources assigned to each
of our core products who continue to research and develop new value-added
features and functionality in our existing products. The introduction of new
solutions, upgrades to existing products, and new feature sets are all designed
to grow our average revenue per dealer ("ARPD"), an important measure for a
subscription-based business, and the increase in our customer base serves to
quickly compound the benefits of an increased ARPD.
· Expand geographically. Currently, only a small percentage of our revenues are
generated from international operations. Our OEM customers have stated
objectives to drive growth internationally, with a focus on the "BRIC"
countries of Brazil, Russia, India, and China. We must continue to support our
OEM customers with products and content for these markets. During the first
quarter of fiscal 2013, we expanded our content offerings in the international
outdoor power market. We began to upgrade our product roadmaps to allow us to
rapidly deploy our products in these markets in a scalable and efficient
manner.
· Differentiate our content. We believe that we have the largest library of
whole goods and PG&A content data 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 growth we expect. We strive to deliver more
value to our customers through enrichment of our content. Content enrichment
can take several forms, including the incorporation of user reviews and
feedback into our existing content, further enhancing content provided to us by
our OEM customers, and creating new forms of content that further our
customers' ability to efficiently service and sell more whole goods and PG&A.
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 the systems, saving our
customers valuable time and eliminating redundant data entry. We currently have
integration capabilities with over 90 DMS's (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
Historically, acquisitions have been a significant driver of ARI's growth. Since
2007, the Company has successfully closed six strategic acquisitions while
reviewing, and ultimately deciding not to pursue, a multitude of others. Our
2009 acquisition of Channel Blade Technologies ("Channel Blade") and our 2008
acquisition of the electronic parts catalog and eCommerce assets of Info Access
expanded not only our product offerings but the number of markets we serve. As a
result of those acquisitions, ARI is the market leader in the marine, RV and
appliance markets. Although we believe organic growth will be the primary driver
of our business for the foreseeable future, we will continue to evaluate
acquisitions that are in alignment with our core strategy.
On August 17, 2012 we successfully acquired substantially all of the assets of
Ready2Ride, Inc. ("Ready2Ride"), the first-to-market and leading provider of
aftermarket fitment data to the powersports industry. The acquisition of
Ready2Ride is directly aligned with our strategy to further differentiate our
content.
On November 28, 2012, the Company purchased the assets of the Retail Services
Division of Fifty Below Sales & Marketing, Inc. ("50 Below"), a leading provider
of eCommerce websites in the powersports, automotive tire and wheel aftermarket,
medical equipment and pool and spa industries. We expect that the acquired
business will add over 3,000 new dealers to our customer base and accelerate our
entry into new, high growth markets, including the automotive aftermarket,
specifically automotive tire and wheel dealers.
Sales, Marketing and Support Teams
We organize our sales and marketing programs into three distinct sales channels
and two geographic regions: North America and Europe.
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Sales Channels
We go to market utilizing sales teams determined through a combination of
customer, product, and geographic market. Our field sales personnel focus on
building relationships with manufacturers and distributors, while our inside,
telephone-based sales team focuses on selling to dealers. The dealer sales team
located in the US is further divided by product (catalog sales versus other
products and services) and we also have an international sales team in The
Netherlands. We are also in the process of enhancing our core products to allow
for online customer self-service sales capabilities.
Marketing
Our marketing strategy is designed to drive knowledge of our value proposition
into the markets we serve. We use a variety of marketing programs to target and
build relationships with our prospective and current customers and partners. Our
primary marketing activities include:
" participation in dealer meetings, trade shows and industry events to create
awareness, build our lead database and develop relationships;
" search engine marketing and online and print direct marketing to generate
awareness and action;
" ongoing website development to educate prospects and provide product
information, testimonials, live demonstrations and marketing collateral;
" email and phone campaigns used to capture leads;
" use of customer testimonials; and
" sales tool kits and field marketing training to enable our sales organization
to more effectively develop leads and close transactions.
Customer Service and Support
Customer support is a critical part of our strategy as it is essential to
retaining our existing customer base and reducing the level of customer
churn. We maintain customer support operations in each of the Company's four
locations. Our support representatives are available via telephone or email. We
also maintain a customer satisfaction and renewal team that focuses on
proactively reaching out to customers to ensure that our customers are satisfied
and are receiving the most value possible from their spend with ARI.
Our Competitive Strengths
Market Leader in Core Verticals
We believe that we are one of the leaders in each of our core vertical markets
and also believe we are the market leader in the outdoor power, marine, and
appliance markets. Our direct relationships with approximately 19,000 dealers,
140 manufacturers, and 195 distributors allow us to cost-effectively leverage
our published catalog content into a large and diversified customer base and to
launch new product enhancements and technology-enabled solutions to this
customer base.
Breadth and Depth of Published Content
The breadth and depth of our catalog content, as well as our ability to enhance
and efficiently publish manufacturers' PG&A data as it becomes available,
provides ARI with a critical competitive advantage. Our electronic catalog
content enables multi-line dealers to easily access catalog content for multiple
manufacturers using a single software platform. This advantage, which saves our
customers significant time, provides "stickiness" to our catalog customer base
that allows us to efficiently and cost effectively nurture our existing
customers while devoting resources to develop new products and services,
enabling us to grow our overall customer base.
Recurring Revenue Model
Approximately 84% of our revenue is subscription-based and recurring
revenue. The majority of our customers are on contracts of twelve months or
longer, and these contracts typically auto-renew for additional twelve month
terms. This provides us with advanced visibility into our future revenues and
opportunities to sell additional services to our customers. Our recurring
revenue model also emphasizes the importance of maintaining a low rate of
customer churn, one of the key drivers of any recurring revenue,
subscription-based business.
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Our recurring revenue model, when combined with low rates of customer churn,
significantly reduces the cost to maintain and nurture our customer base. This
in turn frees up resources to enhance our existing products and work toward new
revenue generating product innovations. Additionally, a substantial portion of
our electronic catalog business is focused on our customers' service and repair
operations. This allows our revenues to remain strong even in a down economy, as
consumers tend to repair, rather than buy new equipment during a challenging
economy.
Suite of Products Covers Entire Sales and Service Cycle
Our suite of dealer products and services and eCommerce capabilities enhance our
customers' front office operations by covering the entire sales cycle, from lead
generation and lead management to sales of PG&A to the consumer, both in-store
and online, and our electronic catalog products allow dealers to efficiently
service and repair equipment.
We believe that our competitive advantages will enable us to compete effectively
and sustainably in our core markets, although given the current pace of
technological change, it is possible that unidentified competitors could emerge,
existing competitors could merge and/or obtain additional capital, thereby
making them more formidable, or new technologies could come on-stream and
potentially threaten our position.
Our Markets and the Challenges We Face
Competition for our products and services varies by product and by vertical
market. We believe that no single competitor today competes with us on every
product and service in each of our industry verticals. In electronic catalogs,
we compete primarily with Snap-on Business Solutions, which designs and delivers
electronic parts catalogs, accessory sales tools, and manufacturer network
development services, primarily to the automotive, power sports, outdoor power,
construction, agriculture and mining markets. In addition, there is a variety of
smaller companies focused on one or two specific industries.
In lead management, websites and eCommerce, our primary competitor is
PowerSports Network, owned by Dominion Enterprises. Competition for our website
development services also comes from in-house information technology groups that
may prefer to build their own web-based proprietary systems, rather than use our
proven industry solutions. There are also large, general market eCommerce
companies, such as IBM, which offer products and services that could address
some of our customers' needs. These general eCommerce companies do not typically
compete with us directly, but they could decide to do so in the future. We
believe we maintain a competitive advantage in our core vertical markets given
the breadth and integration of our published content into our catalog, lead
management and website products.
Several of the markets we serve, including power sports, marine, and RV, are
closely aligned with the state of the economy, given the "luxury" nature of the
products in those verticals. In fiscal 2010 we experienced an increase in
customer churn in these markets due to manufacturer bankruptcies, dealer
closures, and extreme cost reduction measures by our dealers. Our customer churn
rates improved in these markets in over the past two years as the effects of the
economy began to lessen in those markets. It is also important to note that the
impacts of a difficult economic environment are somewhat softened by the
consumers' willingness in a down economy to repair existing equipment rather
than purchase new equipment, which serves to amplify the importance of our
published parts content provided to customers via our catalog parts lookup
products and our website products.
Summary of Operating Results
The revenue growth momentum achieved in fiscal 2012 continued into the first
quarter of fiscal 2013, as total revenues in the quarter grew 9.8% over the same
period last year. This growth is a direct result of the continued execution of
ARI's growth strategy. One component of this strategy is to execute synergistic
acquisitions. We recently executed two acquisitions directly tied to this
strategy, as previously discussed. Although we believe these acquisitions will
immediately increase our revenues and will significantly enhance our operating
income and EBITDA in fiscal 2014, non-recurring costs associated with these
acquisitions will continue into our third fiscal quarter and will impact our
operating results for the full 2012 fiscal year.
· Total revenue increased 9.8% or $532,000 for the three month period ended
October 31, 2012, compared to the same period last year. Recurring revenue
increased 8.9% or $402,000 for the three months ended October 31, 2012,
compared to the same period last year. We achieved organic revenue growth of
approximately 7.4% for the quarter, compared to last year, excluding revenues
from the Ready2Ride acquisition, which were included in catalog revenue.
· Operating income decreased $193,000 for the three months ended October 31,
2012, compared to the same period last year. This decline is largely due to
acquisition-related costs of approximately $250,000 for legal fees and travel
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expenses, partially offset by a sales tax credit of $89,000 included in general
and administrative expense, as well as integration costs related to the
Ready2Ride acquisition.
· Net income decreased $159,000 for the quarter, compared to the same period last
year, due to the decrease in operating income and the tax effect of the
decrease in earnings.
· Cash flows from operations decreased 39.0% or $326,000 for the quarter ended
October 31, 2012, compared to the same period last year. We utilized the cash
generated from operations as well as additional financing to invest in two
acquisitions, product development and our technology infrastructure.
We expect continued improvements in revenue for the remainder of fiscal 2013,
relative to fiscal 2012, as we execute our strategies aimed at double digit
revenue growth, but anticipate a year over year decline in earnings as we
integrate the acquisitions and make investments in our infrastructure to support
more rapid revenue growth.
Revenue
The following table summarizes our recurring and non-recurring revenue by major
product category:
Three months ended October 31 Percent
2012 2011 Change
Catalog
Recurring revenue $ 3,321 $ 3,092 7.4 %
Non-recurring revenue 137 222 (38.3) %
Total catalog revenue 3,458 3,314 4.3 %
Percent of revenue recurring 96.0 % 93.3 %
Website
Recurring revenue 1,259 1,081 16.5 %
Non-recurring revenue 264 242 9.1 %
Total website revenue 1,523 1,323 15.1 %
Percent of revenue recurring 82.7 % 81.7 %
Lead management
Recurring revenue 212 205 3.4 %
Non-recurring revenue 45 51 (11.8) %
Total lead management revenue 257 256 0.4 %
Percent of revenue recurring 82.5 % 80.1 %
Lead generation
Recurring revenue - - - %
Non-recurring revenue 307 192 59.9 %
Total lead generation revenue 307 192 59.9 %
Percent of revenue recurring - % - %
Other
Recurring revenue 147 159 (7.5) %
Non-recurring revenue 250 166 50.6 %
Total catalog revenue 397 325 22.2 %
Percent of revenue recurring 37.0 % 48.9 %
Total
Recurring revenue 4,939 4,537 8.9 %
Non-recurring revenue 1,003 873 14.9 %
Total revenue $ 5,942 $ 5,410 9.8 %
Percent of revenue recurring 83.1 % 83.9 %
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Total revenue increased 9.8% or $532,000 for the three months ended October 31,
2012, compared to the same period last year. Recurring revenue increased 8.9% or
$402,000 for the three months ended October 31, 2012, compared to the same
period last year. This increase in revenue is attributed to new sales, recurring
revenue from the Ready2Ride acquisition and continued decline in the Company's
rate of customer churn, which has collectively led to continued growth in its
recurring revenue. Given that a substantial portion of the Company's revenue is
subscription-based, monthly recurring revenue ("MRR") is one of the performance
indicators the Company closely monitors, as it is the key driver of future
revenue growth.
Catalog
Catalog revenue is generated from catalog subscriptions, software license fees,
license renewal fees, software maintenance and support fees and professional
services related to data conversion. Revenue from the acquired Ready2Ride
business is included in Catalog revenue. Catalog, which continues to be the
Company's largest source of revenue, increased 4.3% or $144,000 for the three
months ended October 31, 2012, compared to the same period last year, primarily
due to revenue from the Ready2Ride customers. We expect to see year over year
growth in catalog revenue for the remainder of fiscal 2013.
Website
Website revenue is generated from one-time set-up fees and recurring
subscription fees on our website products, as well as transaction fees from
customers' online sales generated via the websites. Website revenue increased
15.1% or $200,000 for the three month period ended October 31, 2012, compared to
the same period last year. Recurring website revenue grew 16.5% for the three
months ended October 31, 2012, compared to the same period last year due to an
increase in the number of new websites. Non-recurring website revenue increased
9.1% for the three months ended October 31, 2012, compared to the same period
last year. As the Company continues to focus on MRR growth, including the
anticipated addition of revenue from the 50 Below acquisition, it expects total
website revenue to continue to show double digit growth for the remainder of
fiscal 2013, over the previous year, and for these products to be a long-term
source of growth for the Company.
Lead Management
Lead management revenue is generated from one time set-up fees and recurring
subscription fees for the use of the Company's Footstepsä products. Revenue from
lead management products for the three months ended October 31, 2012 was
$257,000, consistent with revenue for the same period last year. The majority of
lead management revenue is recurring in nature and increased 3.4% for the three
months ended October 31, 2012, compared to the same period last year. The
Company deployed early new editions of its Lead Management product, Footsteps
Channel Connect™, which offers the product's base functionality at a low price
with the option to upgrade to additional functionality, to a select number of
customers. Our product development staff is incorporating the customer feedback
into new releases of the product, which is expected to drive growth in fiscal
2013.
Lead Generation
Lead generation revenue is realized from the sale of the Company's
SearchEngineSmartä ("SES") service and is non-recurring. Revenue from the
Company's lead generation services increased 59.9% or $115,000 for the three
month period ended October 31, 2012, compared to the same period last year due
to revenue from several new larger customers. Revenue from the Company's lead
generation services does not directly contribute to MRR growth, but contributes
to MRR growth in the lead management and website services.
Other Revenue
Other revenue primarily consists of professional services related to software
customization, website hosting fees, and revenue generated from other products
that are ancillary to our three core offerings. Other revenue increased 22.2%
or $72,000 for the three months ended October 31, 2012, compared to the same
period last year, primarily due to a large professional services contract with a
major customer. Management anticipates that other revenue will fluctuate based
on the timing of professional fees related to software customization.
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Cost of Revenue
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 directly attributable to the services we provide our customers.
The table below breaks out cost of revenue into each of these three categories:
Percent of Percent of
2012 Revenue 2011 Revenue
Net revenues $ 5,942 $ 5,410
Cost of revenues:
Amortization of
capitalized software
costs 396 6.7 % 335 6.2 %
Direct labor 448 7.5 % 384 7.1 %
Other direct costs 564 9.5 % 417 7.7 %
Total cost of
revenues 1,408 23.7 % 1,136 21.0 %
Gross profit $ 4,534 76.3 % $ 4,274 79.0 %
Gross profit was $4,534,000 or 76.3% of revenue for the three months ended
October 31, 2012, compared to $4,274,000 or 79.0% of revenue for the same period
last year. This decline in gross profit margin was primarily attributed to: (i)
an increase in SES and professional services revenues, which have a much lower
margin than our other core products; and (ii) an increase in website and lead
management software amortization. The Company expects fluctuations in gross
margin from quarter to quarter and year over year based on the mix of products
sold, but expects its gross margins to improve over time as we focus our sales
efforts on the higher margin, recurring revenue products.
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Gross Margins
The following table summarizes our gross profit and gross margin percentage by
major product category:
Three months ended October 31 Percent
2012 2011 Change
Catalog
Revenue $ 3,458 $ 3,314 4.3 %
Cost of revenue 477 489 (2.5) %
Gross profit 2,981 2,825 5.5 %
Gross margin percentage 86.2 % 85.2 %
Website
Revenue 1,523 1,323 15.1 %
Cost of revenue 262 332 (21.1) %
Gross profit 1,261 991 27.2 %
Gross margin percentage 82.8 % 74.9 %
Lead management
Revenue 257 256 0.4 %
Cost of revenue 167 111 50.5 %
Gross profit 90 145 (37.9) %
Gross margin percentage 35.0 % 56.6 %
Lead generation
Revenue 307 192 59.9 %
Cost of revenue 271 140 93.6 %
Gross profit 36 52 (30.8) %
Gross margin percentage 11.7 % 27.1 %
Other
Revenue 397 325 22.2 %
Cost of revenue 231 64 260.9 %
Gross profit 166 261 (36.4) %
Gross margin percentage 41.8 % 80.3 %
Total
Revenue 5,942 5,410 9.8 %
Cost of revenue 1,408 1,136 23.9 %
Gross profit $ 4,534 $ 4,274 6.1 %
Gross margin percentage 76.3 % 79.0 %
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Catalog
Catalog gross profit margin increased from 85.2% for the three months ended
October 31, 2011 to 86.2% for the three months ended October 31, 2012. The
increase in margin is due to the cost savings realized for catalog replication
and shipping as a result of our new internet updating capabilities used by more
than 90% of our catalog customers. The Company expects catalog margins to
gradually improve over time as the growth in recurring revenue has little
incremental cost.
Website
Website gross profit margin increased from 74.9% for the three months ended
October 31, 2011 to 82.8% for the same period this year. The improvement in
website gross margin is primarily due to an increase in recurring revenue with
relatively little incremental cost. The Company expects to see continued
improvements in gross margin as we focus on increasing recurring revenue and
streamlining operations.
Lead Management
Lead management gross profit margin decreased from 56.6% for the three months
ended October 31, 2011 to 35.0% for the same period this year. The decline in
gross profit margin is primarily due to an increase in software amortization of
our newly enhanced lead management products.
Lead Generation
Lead generation gross profit margin decreased from 27.1% for the three months
ended October 31, 2011 to 11.7% for the same period this year primarily due to
several larger contracts with volume discounts. The Company expects fluctuations
in lead generation gross margin from quarter to quarter.
Other Revenue
Gross profit margin on other revenue declined for the three months ended October
31, 2012, compared to the same period last year primarily due to the increase in
professional services revenue, which has a lower margin than our other
products. The Company expects fluctuations in gross margin on other revenue,
depending on the mix of products and services sold.
Operating Expenses
The following table summarizes our unaudited operating expenses by expense
category:
Percent of Percent of Percent
2012 Revenue 2011 Revenue Change
Sales and marketing $ 1,046 17.6 % $ 1,033 19.1 % 1.3 %
Customer operations and
support (1) 1,008 17.0 % 846 15.6 % 19.1 %
Software development and
technical support (2) 577 9.7 % 388 7.2 % 48.7 %
General and administrative
(3) 1,320 22.2 % 1,108 20.5 % 19.1 %
Depreciation and
amortization (4) 280 4.7 % 403 7.4 % (30.5) %
Net operating
expenses $ 4,231 71.2 % $ 3,778 69.8 % 12.0 %
(1) Net of capitalized software development costs of $8 and $26 in fiscal 2012
and 2011, respectively.
(2) Net of capitalized software development costs of $359 and $440 in fiscal 2012
and 2011, respectively.
(3) Net of capitalized software development costs of $25 in fiscal
2011.
(4) Exclusive of amortization of software products of $396 and $335 in fiscal
2012 and 2011, respectively, which are included in cost of revenue.
Net operating expenses increased 12.0% or $453,000 for the three month period
ended October 31, 2012, compared to the same period last year. The increase was
largely due to legal fees related to the Company's latest acquisitions and the
operating expenses of the newly acquired Ready2Ride business.
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Sales and Marketing Expenses
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. Marketing programs consist of lead
generation and direct marketing, advertising, events and meeting costs, public
relations, brand building and product management activities. Sales and marketing
expenses increased 1.3% or $13,000 for the three months ended October 31, 2012,
compared to the same period last year as a result of the addition of sales and
marketing personnel related to the Ready2Ride acquisition. Sales and marketing
expenses, as a percentage of revenue, decreased from 19.1% for the first quarter
of fiscal 2012 to 17.6% for the same period this year. We anticipate that sales
and marketing will continue to be one of our largest expenses, as we intend to
continue to invest in sales and marketing to grow our customer base and expand
relationships with our existing customers during the remainder of fiscal
2012. However, management expects sales and marketing costs to decline as a
percentage of revenue in future years.
Customer Operations and Support
Customer operations and support expenses are composed of our customer hosting
operations, software maintenance agreements for our core network, and personnel
and related costs for operations and support employees. Customer operations and
support costs increased 19.1% or $162,000 for the three months ended October 31,
2012, compared to the same period last year, due to the expansion of our
operations and support team, including those supporting our Ready2Ride
customers. Management expects customer operations and support to continue to be
higher than the previous year for the remainder of fiscal 2013, but to decline
as a percentage of revenue in future years.
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
are typically capitalized as software product costs and amortized over the
estimated useful lives of the product; (ii) professional services performed for
customers related to software customization projects are classified as cost of
revenue; and (iii) all other activities are considered operating expenses and
included within the software development and technical support operating expense
category.
The table below summarizes our internal software development and technical
support spending:
Three months ended October 31 Percent
2012 2011 Change
Total software development and
technical support costs $ 1,417 $ 1,263 12.2 %
Less: amount capitalized as
software development (392) (491) (20.2) %
Less: direct labor classified
as cost of revenues (448) (384) 16.7 %
Net software development and
technical support
costs classified as operating
expenses $ 577 $ 388 48.7 %
The Company increased total software development and technical support costs by
12.2% or $154,000 for the three months ended October 31, 2012, compared to the
same period last year, which is consistent with the strategy to release new
products, create enhancements to existing products, offer expanded data content
and deliver superior services and technical support to our customers.
During the first quarter of fiscal 2013, the Company capitalized $392,000 of
software development labor and overhead, versus $491,000 for the same period
last year. The Company deployed several new editions of its lead management
product FootSteps™, which enable customers to add feature upgrades and grow with
the product over time during fiscal 2012. The Company is working on several new
enhancements expected to be released in the upcoming quarters, which it
anticipates will increase future revenue for the Company.
Page 29
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Management expects total spending for software development and technical support
to increase for the remainder of fiscal 2013 as we integrate our newly acquired
technology with the look and feel of the Company's other product offerings and
continue to focus on our core strategy of product enhancement and innovation.
The Company expects fluctuations in the amount of software development and
technical support costs classified as operating expenses from period to period,
as the mix of research and prototype work versus capitalized software
development and professional services activities will change, even if total
software development and technical support departmental costs were to remain
relatively constant.
General and Administrative
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. General and administrative costs increased 19.1% or $212,000, for the
three month period ended October 31, 2012, compared to the same period last
year. This increase was primarily due to legal fees and travel of approximately
$250,000 related to the Ready2Ride and 50 Below acquisitions, offset in part by
a credit of $89,000 for the reduction a sales tax provision related to a sales
tax audit which has been resolved. As a percentage of revenue, general and
administrative expenses increased from 20.5% for the three months ended October
31, 2011 to 22.2% for the same period this year. Management expects general and
administrative expenses to increase as a result of the acquisitions but to
decrease as a percentage of revenue compared to the previous year in the latter
half of fiscal 2013.
Depreciation and Amortization
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 assets are a component of cost of
revenue. Depreciation and amortization expense decreased 30.5% or $123,000 for
the three months ended October 31, 2012, compared to the same period last year
as intangible assets related to an earlier acquisition have become fully
amortized and older technology related to our infrastructure is getting replaced
by newer cloud-based technology which is classified in general and
administrative expense. Management expects depreciation and amortization expense
to increase over the previous year for the remainder of fiscal 2013 as a result
of amortization of acquisition related intangible assets and our new cloud-based
infrastructure.
Interest Expense
Interest expense increased slightly from $62,000 for the three months ended
October 31, 2011 to $68,000 for the same period this year. Management expects
interest expense to increase for the remainder of fiscal 2013, compared to the
previous year, as a result of additional debt to finance the Company's
acquisitions.
Other Income (Expense)
Other income (expense) consists of foreign currency exchange rate gains and
losses, interest income and other gains or losses. Other income decreased from
$6,000 for the three months ended October 31, 2011 to $4,000 for the same period
this year.
Income Taxes
The Company has net deferred tax assets of $5,024,000, primarily consisting of
net operating loss carryforwards and book to tax timing 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. This does not represent a current cash obligation, as we continue to
have net operating loss carryforwards to offset taxable income.
The Company recorded income tax expense of $126,000 during the three months
ended October 31, 2012, compared to $168,000 for the same period last year. The
decrease in income tax expense was due to the decline in income before
tax. Income tax expense may vary from period to period as the Company continues
to evaluate the valuation allowance against net deferred tax assets on a
semi-annual basis.
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Liquidity and Capital Resources
The following table sets forth, for the periods indicated, certain cash flow
information derived from the Company's financial statements:
Three months ended October
31 Percent
2012 2011 Change
Net cash provided by
operating activities $ 509 $ 835 (39.0) %
Net cash used in investing
activities (2,526) (538) (369.5) %
Net cash provided by (used
in) financing activities 932 (438) 312.8 %
Effect of foreign currency
exchange rate
changes on cash (4) 5 (180.0) %
Net change in cash $ (1,089) $ (136) (700.7) %
Cash at end of period $ 261 $ 1,350 (80.7) %
Net cash provided by operating activities decreased 39.0% or $326,000 over the
same period, primarily due to the decline in earnings, which was driven by
acquisition-related costs.
Cash used in investing activities increased $1,988,000 in the first quarter of
fiscal 2013, compared to the same period last year. The Company invested more
than $920,000 in the Ready2Ride acquisition in August 2012 and an additional
$900,000 deposit on the 50 Below acquisition, which closed in November 2012. ARI
also invested $381,000 in equipment and technology for our new cloud-based
infrastructure and $396,000 on enhancements to our software products. We will
continue to invest cash in the business for the development of new products and
upgrades to existing products.
The Company had net cash provided by financing activities of $932,000 for the
three months ended October 31, 2012 compared to net cash used in financing
activities of $438,000 for the same period last year. The Company borrowed an
additional $1,000,000 of debt from Fifth Third to partially fund its
acquisitions.
In connection with the Company's acquisition of the 50 Below assets, the Company
issued a Secured Non-Negotiable Subordinated Promissory Note dated as of
November 28, 2012 (the "Note") issued to Michael D. Sifen, Inc. (the "Holder"),
an affiliate of an existing shareholder of the Company, in aggregate principal
amount of $3.5 million. Interest accrues on the outstanding unpaid principal
under the Note from and after November 7, 2012 until November 28, 2013 at a rate
of 10.0% per annum, and at a rate of 14.0% per annum thereafter. Accrued
interest only will be payable quarterly commencing on February 28, 2013 and
continuing on each May 31st, August 31st, November 30th and February 28th
thereafter until May 28, 2016, at which time all accrued interest and
outstanding principal will be due and payable in full. The Note may be prepaid
in part or in full at any time without premium or penalty. The Note contains
negative covenants relating to, among other things, the Company's incurrence of
future indebtedness and liens and the making of dividends and distributions upon
shares of the Company's capital stock, as well as customary events of default.
The Company also entered into the Second Amendment to Loan and Security
Agreement with Fifth Third Bank, effective as of November 28, 2012. Under
amendment, Fifth Third consented to the acquisition of the 50 Below assets and
the related transactions and provided waivers of certain provisions of the
Credit Facilities, subject to certain terms and conditions. Such terms and
conditions include, among others, amendments to the fixed charge coverage ratio
(1.00x for the four fiscal quarter period ending January 31, 2013) and senior
leverage (maximum senior funded debt to EBITDA) ratio (1.75x for the fiscal
quarter ending January 31, 2013) financial covenants and the addition of a
maximum total funded debt to EBITDA ratio financial covenant (2.50x for the four
fiscal quarter period ending January 31, 2013); amendment of the revolving loan
and term loan maturity dates from July 27, 2014 to December 15, 2013; and other
customary terms and conditions.
The Company was in compliance with the financial covenants contained in the
Fifth Third credit facilities during the quarter ended October 31, 2012, and
expects to remain in compliance with the amended financial covenants in the
foreseeable future.
Management believes that current cash balances and its ability to generate cash
from operations, as well as the existing availability under our line of credit
with Fifth Third, are sufficient to fund our needs over the next twelve months.
Page 31
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Off-Balance Sheet Arrangements
The Company has no significant 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.
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