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EX-32.2 - EX-32.2 - ARI NETWORK SERVICES INC /WIaris-20170131xex32_2.htm
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EX-31.2 - EX-31.2 - ARI NETWORK SERVICES INC /WIaris-20170131xex31_2.htm
EX-31.1 - EX-31.1 - ARI NETWORK SERVICES INC /WIaris-20170131xex31_1.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549



FORM 10-Q



(Mark One)



(X)QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934



For the quarterly period ended January 31, 2017



( )TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934



For the transition period from                                      to                                          

 

Commission file number 000-19608

ARI Network Services, Inc.

(Exact name of registrant as specified in its charter)





 

 

WISCONSIN

 

39-1388360

(State or other jurisdiction of incorporation or organization)

 

(IRS Employer Identification No.)



10850 West Park Place, Suite 1200, Milwaukee, Wisconsin  53224

(Address of principal executive offices)

(414) 973-4300

(Registrant's telephone number, including area code)



Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES        NO  



Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (S232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

YES        NO  



Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):





 

 

 

 

 

Large accelerated filer

 

Accelerated filer

 

Non-accelerated filer

 

Smaller reporting company

 

(Do not check if a smaller reporting company)

 

 

 

 

 



Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES        NO  



As of March  8, 2017, there were 17,528,259 shares of the registrant’s common stock outstanding.




 

 

ARI Network Services, Inc.



FORM 10-Q

FOR THE THREE MONTHS ENDED JANUARY 31, 2017

INDEX



 

 





 

Page



 

 

PART I             FINANCIAL INFORMATION

Item 1

Consolidated Financial Statements

Item 2

Management’s Discussion and Analysis of Financial Condition and Results of Operations

18 

Item 3

Quantitative and Qualitative Disclosures about Market Risk

29 

Item 4

Controls and Procedures

29 

PART II           OTHER INFORMATION

Item 1

Legal Proceedings

30 

Item 1A

Risk Factors

30 

Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

30 

Item 3

Defaults upon Senior Securities

30 

Item 4

Mine Safety Disclosures

30 

Item 5

Other Information

30 

Item 6

Exhibits

30 

Signatures

 

31 



 







2


 

 

PART I.   FINANCIAL INFORMATION

Item 1.   Consolidated Financial Statements

3


 

 



 

 

 

 

 

 



 

 

 

 

 

 

ARI Network Services, Inc.

Consolidated Balance Sheets

(Dollars in Thousands, Except per Share Data)



 

 

 

 

 

 



 

(Unaudited)

 

(Audited)



January 31

 

July 31



 

2017

 

2016

ASSETS

 

 

 

 

 

 

Cash and cash equivalents

 

$

4,555 

 

$

5,118 

Trade receivables, less allowance for doubtful accounts of $225

 

 

 

 

 

 

  and $211 at January 31, 2017 and July 31, 2016, respectively

 

 

2,660 

 

 

1,942 

Work in process

 

 

145 

 

 

132 

Prepaid expenses and other

 

 

695 

 

 

781 

Deferred income taxes

 

 

2,827 

 

 

3,182 

Total current assets

 

 

10,882 

 

 

11,155 

Equipment and leasehold improvements:

 

 

 

 

 

 

Computer equipment and software for internal use

 

 

3,648 

 

 

3,575 

Leasehold improvements

 

 

724 

 

 

639 

Furniture and equipment

 

 

2,643 

 

 

2,544 

          Total equipment and leasehold improvements

 

 

7,015 

 

 

6,758 

Less accumulated depreciation and amortization

 

 

(4,649)

 

 

(4,237)

Net equipment and leasehold improvements

 

 

2,366 

 

 

2,521 

Capitalized software product costs:

 

 

 

 

 

 

Amounts capitalized for software product costs

 

 

27,801 

 

 

24,774 

Less accumulated amortization

 

 

(20,893)

 

 

(19,743)

Net capitalized software product costs

 

 

6,908 

 

 

5,031 

Deferred income taxes

 

 

968 

 

 

1,112 

Other intangible assets

 

 

10,225 

 

 

7,890 

Goodwill

 

 

28,034 

 

 

21,634 

Total non-current assets

 

 

48,501 

 

 

38,188 

Total assets

 

$

59,383 

 

$

49,343 



LIABILITIES

 

 

 

 

 

 

Current portion of long-term debt

 

$

2,921 

 

$

2,417 

Current portion of contingent liabilities

 

 

206 

 

 

331 

Accounts payable

 

 

1,150 

 

 

718 

Deferred revenue

 

 

5,329 

 

 

6,763 

Accrued payroll and related liabilities

 

 

2,308 

 

 

1,817 

Accrued sales, use and income taxes

 

 

336 

 

 

297 

Other accrued liabilities

 

 

1,641 

 

 

677 

Current portion of capital lease obligations

 

 

50 

 

 

50 

Total current liabilities

 

 

13,941 

 

 

13,070 

Long-term debt

 

 

13,319 

 

 

6,658 

Long-term portion of contingent liabilities

 

 

1,420 

 

 

60 

Capital lease obligations

 

 

39 

 

 

63 

Other long-term liabilities

 

 

142 

 

 

166 

Total non-current liabilities

 

 

14,920 

 

 

6,947 

Total liabilities

 

 

28,861 

 

 

20,017 



 

 

 

 

 

 

SHAREHOLDERS' EQUITY

 

 

 

 

 

 

Cumulative preferred stock, par value $.001 per share, 1,000,000 shares authorized; 0 shares issued and outstanding at January 31, 2017 and July 31, 2016, respectively

 

 

 —

 

 

 —

Junior preferred stock, par value $.001 per share, 100,000 shares authorized; 0 shares issued and outstanding at January 31, 2017 and July 31, 2016, respectively

 

 

 —

 

 

 —

Common stock, par value $.001 per share, 25,000,000 shares authorized; 17,526,856 and  17,310,763 shares issued and outstanding at January 31, 2017 and July 31, 2016, respectively

 

 

17 

 

 

17 

Additional paid-in capital

 

 

115,957 

 

 

115,364 

Accumulated deficit

 

 

(85,452)

 

 

(86,050)

Other accumulated comprehensive income

 

 

 —

 

 

(5)

Total shareholders' equity

 

 

30,522 

 

 

29,326 

Total liabilities and shareholders' equity

 

$

59,383 

 

$

49,343 



See accompanying notes







4


 

 















 

 

 

 

 

 

 

 

 

 

 

ARI Network Services, Inc.

Consolidated Statements of Operations

(Dollars in Thousands, Except per Share Data)

(Unaudited)



 

 

 

 

 

 

 



Three months ended January 31

 

Six months ended January 31



2017

 

2016

 

2017

 

2016

Net revenue

$

13,244 

 

$

11,752 

 

$

25,516 

 

$

23,489 

Cost of revenue

 

2,603 

 

 

2,064 

 

 

4,892 

 

 

4,133 

Gross profit

 

10,641 

 

 

9,688 

 

 

20,624 

 

 

19,356 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

Sales and marketing

 

2,822 

 

 

2,748 

 

 

5,509 

 

 

5,513 

Customer operations and support

 

2,885 

 

 

2,428 

 

 

5,640 

 

 

4,874 

Software development and technical support (net of capitalized software product costs)

 

1,560 

 

 

1,319 

 

 

2,816 

 

 

2,574 

General and administrative

 

1,964 

 

 

1,730 

 

 

3,906 

 

 

3,515 

Depreciation and amortization (exclusive of amortization of software product costs included in cost of revenue)

 

738 

 

 

590 

 

 

1,313 

 

 

1,199 

Net operating expenses

 

9,969 

 

 

8,815 

 

 

19,184 

 

 

17,675 

Operating income

 

672 

 

 

873 

 

 

1,440 

 

 

1,681 

Other income (expense):

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

(218)

 

 

(120)

 

 

(326)

 

 

(232)

Other, net

 

 

 

 —

 

 

 

 

(8)

Total other income (expense)

 

(217)

 

 

(120)

 

 

(324)

 

 

(240)

Income before provision for income tax

 

455 

 

 

753 

 

 

1,116 

 

 

1,441 

Income tax expense

 

(213)

 

 

(305)

 

 

(518)

 

 

(604)

Net income

$

242 

 

$

448 

 

$

598 

 

$

837 



 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

Basic

 

17,468 

 

 

17,188 

 

 

17,446 

 

 

17,170 

Diluted

 

18,002 

 

 

17,695 

 

 

17,956 

 

 

17,655 



 

 

 

 

 

 

 

 

 

 

 

Net income per common share:

 

 

 

 

 

 

 

 

 

 

Basic

$

0.01 

 

$

0.03 

 

$

0.03 

 

$

0.05 

Diluted

$

0.01 

 

$

0.03 

 

$

0.03 

 

$

0.05 



 

 

 

 

 

 

 

 

 

 

 

See accompanying notes



 

 

 

 

 

 

 

 

 

 

 

Consolidated Statements of Comprehensive Income

(Dollars in Thousands)

(Unaudited)



Three months ended January 31

 

Six months ended January 31



2017

 

2016

 

2017

 

2016

Net income

$

242 

 

$

448 

 

$

598 

 

$

837 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

 

 

 

 

 

 

(1)

Total other comprehensive income (loss)

 

 

 

 

 

 

 

(1)

Comprehensive income

$

247 

 

$

449 

 

$

603 

 

$

836 



 

 

 

 

 

 

 

 

 

 

 



                             See accompanying notes





5


 

 

ARI Network Services, Inc.

Consolidated Statements of Cash Flows

(Dollars in Thousands)

(Unaudited)





 

 

 

 

 

 

 

 



 

 

Six months ended January 31

 



 

 

2017

 

2016

 



Operating activities:

 

 

 

 

 

 

 



Net income

 

$

598 

 

$

837 

 



Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 



Amortization of software products

 

 

1,150 

 

 

1,040 

 



Amortization of deferred loan fees and imputed interest expense

 

 

35 

 

 

19 

 



Depreciation and other amortization

 

 

1,310 

 

 

1,199 

 



Gain on change in fair value of earn-out receivable and payable

 

 

 -

 

 

 



Provision for bad debt allowance

 

 

(6)

 

 

78 

 



Deferred income taxes

 

 

499 

 

 

592 

 



Stock based compensation

 

 

323 

 

 

203 

 



Net change in assets and liabilities:

 

 

 

 

 

 

 



Trade receivables

 

 

171 

 

 

(166)

 



Work in process, prepaid expenses and other

 

 

113 

 

 

107 

 



Accounts payable

 

 

377 

 

 

 



Deferred revenue

 

 

(1,482)

 

 

(1,207)

 



Accrued payroll and related liabilities

 

 

606 

 

 

144 

 



Accrued taxes and other accrued liabilities

 

 

121 

 

 

93 

 



Net cash provided by operating activities

 

$

3,815 

 

$

2,951 

 



Investing activities:

 

 

 

 

 

 

 



Purchase of equipment, software and leasehold improvements

 

 

(117)

 

 

(324)

 



Cash paid for net assets related to acquisitions

 

 

(10,205)

 

 

 -

 



Cash paid for contingent liabilities related to acquisitions

 

 

(191)

 

 

(322)

 



Software development costs capitalized

 

 

(1,087)

 

 

(827)

 



Net cash used in investing activities

 

$

(11,600)

 

$

(1,473)

 



Financing activities:

 

 

 

 

 

 

 



Payments on long-term debt

 

$

(935)

 

$

(530)

 



Borrowings under long-term debt

 

 

8,081 

 

 

 -

 



Payments of capital lease obligations

 

 

(24)

 

 

(121)

 



Proceeds from exercise of common stock options and warrants

 

 

103 

 

 

56 

 



Net cash provided by (used in) financing activities

 

$

7,225 

 

$

(595)

 



Effect of foreign currency exchange rate changes on cash

 

 

(3)

 

 

(1)

 



Net change in cash and cash equivalents

 

 

(563)

 

 

882 

 



Cash and cash equivalents at beginning of period

 

 

5,118 

 

 

2,284 

 



Cash and cash equivalents at end of period

 

$

4,555 

 

$

3,166 

 



Cash paid for interest

 

$

200 

 

$

227 

 



Cash paid for income taxes

 

$

63 

 

$

43 

 



 

 

 

 

 

 

 

 



See accompanying notes







6


 

 

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. 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 25,000 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 dealer (“Auto”), market under the “Auction123, an ARI Company” brand name, the customers in the automotive tire and wheel aftermarket (ATW) under the “TCS Technologies, an ARI Company” brand name; and we service the automotive aftermarket (AA) market under the “DCi, an ARI Company” brand name.

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; Weston, Florida; Leiden, The Netherlands; and Gurgaon, India. 

Basis of Presentation

These consolidated financial statements include the consolidated financial statements of ARI and its wholly-owned subsidiaries, 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 2017, for example, refer to the fiscal year ending July 31, 2017, and references to fiscal 2016 refer to the fiscal year ended July 31, 2016.  

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.

7


 

 

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 or six months ended January 31, 2017 or 2016.  

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 for 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 the 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.

8


 

 

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 or six months ended January 31, 2017 or 2016 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):





 

 

 

 

 

 

 

 



 

 

Six months ended January 31

 



 

 

2017

 

2016

 



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

 

 

 -

 

 

36 

 



Accrued liabilities assumed in connection with acquisitions

 

 

 -

 

 

58 

 



Hold back and working capital adjustment incurred in connection with acquisition

 

 

858 

 

 

 -

 



Contingent liabilities incurred in connection with acquisition

 

 

1,410 

 

 

(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 using 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 January 31

 

Six months ended January 31

 



 

 

2017

 

2016

 

2017

 

2016

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 



Net income

 

$

242 

 

$

448 

 

$

598 

 

$

837 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 



Weighted-average common shares outstanding

 

 

17,468 

 

 

17,188 

 

 

17,446 

 

 

17,170 

 



Effect of dilutive stock options and warrants

 

 

534 

 

 

507 

 

 

510 

 

 

485 

 



Diluted weighted-average common shares outstanding

 

 

18,002 

 

 

17,695 

 

 

17,956 

 

 

17,655 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 



Net income per share

 

 

 

 

 

 

 

 

 

 

 

 

 



Basic

 

$

0.01 

 

$

0.03 

 

$

0.03 

 

$

0.05 

 



Diluted

 

$

0.01 

 

$

0.03 

 

$

0.03 

 

$

0.05 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 



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

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

9


 

 



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 included credit facilities consisting of a $3,000,000 revolving credit facility with a maturity date of November 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 Auction 123, Inc. (“Auction 123”), the Company entered into the Second Loan Modification Agreement with SVB.  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 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 4.75% at January 31, 2017, based upon a prime rate of 3.75%.





 

 



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 commenced on February 1, 2017 through November 1, 2018; $487,500 commencing on February 1, 2019 through November 1, 2019; and $650,000 commencing on February 1, 2020 through August 1, 2021.  All remaining principal in respect of the term loan 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

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 $67,000 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 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 commenced on December 29, 2015. The payments are subject to acceleration upon certain Events of Default, as defined in the TCS Notes. 

10


 

 

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. The principal amount of the DCi Note was reduced by approximately $64,000 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 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 were interest only payments, and payments of principal and interest commenced on October 13, 2016. The payments are subject to acceleration upon certain Events of Default, as defined in the DCi Note. 

The Company did not trigger any Events of Default and was in compliance with its debt covenants as of January 31, 2017. The following table sets forth certain information related to the Company’s long-term debt as of January 31, 2017 and July 31, 2016 (in thousands): 



 

 

 

 

 

 



January 31

 

July 31

 



2017

 

2016

 

Notes payable principal

$

16,393 

 

$

9,168 

 

Less debt issuance costs

 

(153)

 

 

(93)

 

Less current maturities

 

(2,921)

 

 

(2,417)

 

Notes payable - non-current

$

13,319 

 

$

6,658 

 



 

 

 

 

 

 

Minimum principal payments due on the SVB Term Note, the TCS Notes and the DCi Note as of January 31, 2017 were 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

$

650 

 

$

488 

 

$

313 

 

$

1,451 

 

 

2018

 

1,300 

 

 

1,014 

 

 

645 

 

 

2,959 

 

 

2019

 

1,625 

 

 

262 

 

 

671 

 

 

2,558 

 

 

2020

 

2,275 

 

 

 —

 

 

 —

 

 

2,275 

 

 

2021

 

2,600 

 

 

 —

 

 

 —

 

 

2,600 

 

 

2022

 

4,550 

 

 

 —

 

 

 —

 

 

4,550 

 

 



$

13,000 

 

$

1,764 

 

$

1,629 

 

$

16,393 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 















4. Contingent Liabilities 



Consideration for the November 1, 2016 acquisition of Auction 123 included a contingent earn-out purchase price. The earn-out is contingent upon the attainment of revenue goals related to specific customers, which is measured on the two subsequent anniversaries and paid in quarterly installments. The fair value of the earn-out was originally estimated at $1,410,000 and has a maximum payout of $1,500,000.    



Consideration for the September 2014 TCS acquisition included 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.  The first quarterly payment of $120,905 commenced on December 31, 2015On March 7, 2016, the TCS Asset Purchase Agreement was amended in relation to the contingent earn-out, whereas,  the Company made the remaining three quarterly payments of $120,905, followed by four quarterly payments of $70,000, which commenced on December 31, 2016.

The following table shows changes in the earn-out payable related to the TCS and Auction acquisitions (in thousands):



 

 

 

 

 



Six months ended January 31



2017

 

2016

Beginning balance

$

391 

 

$

1,116 

Additions

 

1,410 

 

 

 -

Adjustments

 

 -

 

 

(62)

Payments

 

(191)

 

 

(382)

Imputed interest recognized

 

16 

 

 

14 

Gain on change in fair value of earn-out

 

 -

 

 

Ending balance

$

1,626 

 

$

694 

    Less current portion

$

(206)

 

$

(470)

Ending balance, long-term

$

1,420 

 

$

224 



 

 

 

 

 

11


 

 



The following table shows the remaining estimated payments of contingent liabilities related to the TCS and Auction 123 acquisitions at January 31, 2017, (in thousands) for the fiscal years ending July 31:



 

 

 

 

 

 



2017

$

140 

 

 

 



2018

 

633 

 

 

 



2019

 

750 

 

 

 



2020

 

188 

 

 

 



Total estimated payments

 

1,711 

 

 

 



Less imputed interest

 

(85)

 

 

 



Present value of contingent liabilities

$

1,626 

 

 

 



 

 

 

 

 

 



















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 January 31, 2017 and 2016 (in thousands): 



 

 

 

 

 

 

 

 

 

 

 

 



 

 

Six months ended January 31, 2016

Wtd. avg.

 



 

 

Cost

 

Accumulated

 

Net

remaining

 



Customer relationships

 

Basis

 

Amortization

 

Value

life

 



Beginning balance

 

$

11,947 

 

$

(4,418)

 

$

7,529 

 

 



Activity

 

 

(220)

 

 

(565)

 

 

(785)

 

 



Ending balance

 

$

11,727 

 

$

(4,983)

 

$

6,744 

12.13

 



 

 

 

 

 

 

 

 

 

 

 

 



Other intangibles

 

 

 

 

 

 

 

 

 

 

 



Beginning balance

 

$

3,203 

 

$

(616)

 

$

2,587 

 

 



Activity

 

 

(467)

 

 

(204)

 

 

(671)

 

 



Ending balance

 

$

2,736 

 

$

(820)

 

$

1,916 

8.92

 



 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



Total intangibles

 

 

 

 

 

 

 

 

 

 

 



Beginning balance

 

$

15,150 

 

$

(5,034)

 

$

10,116 

 

 



Activity

 

 

(687)

 

 

(769)

 

 

(1,456)

 

 



Ending balance

 

$

14,463 

 

$

(5,803)

 

$

8,660 

11.42

 



 

 

 

 

 

 

 

 

 

 

 

 



 

 

Six months ended January 31, 2017

Wtd. avg.

 



 

 

Cost

 

Accumulated

 

Net

remaining

 



Customer relationships

 

Basis

 

Amortization

 

Value

life

 



Beginning balance

 

$

11,727 

 

$

(5,558)

 

$

6,169 

 

 



Activity

 

 

2,540 

 

 

(376)

 

 

2,164 

 

 



Ending balance

 

$

14,267 

 

$

(5,934)

 

$

8,333 

11.92

 



 

 

 

 

 

 

 

 

 

 

 

 



Other intangibles

 

 

 

 

 

 

 

 

 

 

 



Beginning balance

 

$

2,739 

 

$

(1,018)

 

$

1,721 

 

 



Activity

 

 

690 

 

 

(519)

 

 

171 

 

 



Ending balance

 

$

3,429 

 

$

(1,537)

 

$

1,892 

9.93

 



 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



Total intangibles

 

 

 

 

 

 

 

 

 

 

 



Beginning balance

 

$

14,466 

 

$

(6,576)

 

$

7,890 

 

 



Activity

 

 

3,230 

 

 

(895)

 

 

2,335 

 

 



Ending balance

 

$

17,696 

 

$

(7,471)

 

$

10,225 

11.55

 



 

 

 

 

 

 

 

 

 

 

 

 

















6Stock-based Compensation Plans 



The Company uses the Black-Scholes model to value stock options granted. Volatility is calculated as managements 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.  

12


 

 

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. The Company recognized stock option compensation expense of $2,000 and $40,000 during the six months ended January 31, 2017, and 2016, respectively. There was approximately $15,000 and $82,000 of total unrecognized compensation costs related to non-vested options granted under the Company’s stock option plans as of January 31, 2017 and 2016, 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:  



 

 

 

 

 

 

 



 

 

Six months ended January 31,

 

 



 

 

2017

 

 



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

 

$

46,000 

 

 

 

 

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 except 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 six months ended January 31, 2017 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

 

(9,250)

 

 

1.88 

 

n/a

 

 

n/a

Forfeited

 

(125)

 

 

1.94 

 

n/a

 

 

n/a

Outstanding at 1/31/2017

 

375,375 

 

$

1.45 

 

1.42 

 

$

1,445,209 

Exercisable at 1/31/2017

 

375,375 

 

$

1.45 

 

1.42 

 

$

1,445,209 



 

 

 

 

 

 

 

 

 

 



The range of exercise prices for options outstanding under the 2000 Plan was $0.49 to $1.85 at January 31, 2017.



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 and January 2017. The 2010 Plan is the successor to the Company’s 2000 Plan. There are 3,050,000 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 appreciation rights (“SARs), and shares of common stock. Up to 2,725,000 of the shares authorized for issuance under the 2010 Plan may be used for common stock, restricted stock or restricted stock unit awards.

13


 

 

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 six months ended January 31, 2017 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

 

(13,750)

 

 

2.88 

 

n/a

 

 

n/a

Forfeited

 

(13,750)

 

 

3.31 

 

n/a

 

 

n/a

Outstanding at 1/31/2017

 

330,126 

 

$

2.47 

 

6.36 

 

$

934,613 

Exercisable at 1/31/2017

 

281,376 

 

$

2.33 

 

6.23 

 

$

836,526 



 

 

 

 

 

 

 

 

 

 



The range of exercise prices for options outstanding under the 2010 Plan was $0.59 to $3.54 at January 31, 2017.

Changes in the 2010 Plan's non-vested option shares included in the outstanding shares above during the six months ended January 31, 2017 were as follows:



 

 

 

 

 

 

 

 

 

 



 

Number of
Options

 

Wtd. Avg.
Exercise Price

 

 

 

 

 

Non-vested at 7/31/2016

 

70,000 

 

$

3.29