ARI Network Services F1Q08 (Qtr End 10/31/07) Earnings Call Transcript

Dec.17.07 | About: ARI Network (ARIS)

ARI Network Services Inc. (NASDAQ:ARIS)

F1Q08 (Qtr End 10/31/07) EarningsCall

December 17, 2007 4:30 pm ET

Executives

Brian Dearing - Chairman,President and CEO

Nancy Kafura - CorporateController

Analysts

Rob Damron - 21st Century Equity

Bob Manning

Operator

Good day, ladies and gentlemen,and welcome to this quarter one 2008 earnings release conference call.(Operator Instructions)

I would now like to turn the callover to your host, Brian Dearing. Please go ahead, sir.

Brian Dearing

Thank you, Paul. Good afternoon,ladies and gentlemen, and welcome to the conference call for ARI's firstquarter, which ended October 31, 2007. Thank you for participating. My name isBrian Dearing, Chairman and Chief Executive Officer.

With us as well or with me aswell to help answering any questions you may have are Ms. Nancy Kafura,Corporate Controller; and Ms. Diane Kurowski, Manager of Financial Reportingand Planning.

I'll begin with a brief overviewof our business and strategy to help put the financial results in context. Iwill then present some details of ARI's financial results for the quarter. Toconclude the presentation, I'll return with some additional commentary on ourbusiness during the quarter and some of our expectations for the remainder ofthe fiscal year, which ends July 31, 2008. At that point, we'll open it up forquestions.

You or your colleagues may listento a recording of this conference call and obtain a copy of the notes from ourremarks this afternoon, including tables containing the relevant financial databeginning at 6:00 pm US Central Time tomorrow, Tuesday, December 18th, byaccessing our website at www.arinet.com. The replay and notes will be availablethere until our next quarterly conference call, which is expected to be onMarch 17th, 2008, covering the second quarter of fiscal 2008, which endsJanuary 31, 2008.

The information we are presentingspeaks only as of today, and we undertake no obligation to update it. If youare listening to this presentation or reading these notes after December 17th,2007, the information may no longer be accurate.

Before we begin discussing ourresults, I'll turn it over to Nancy Kafura, Corporate Controller, for astatement concerning forward-looking statements and GAAP and non-GAAP measures.

Nancy Kafura

Thank you, Brian. Statements madeduring this conference call that are not statements of historical fact may bedeemed to be forward-looking statements, subject to protections under thefederal law, including, without limitations, statements regarding our forecastof revenues, profitability and cash. We intend words such as believes,anticipates, plans, expects, and similar expressions to identifyforward-looking statements. A number of important factors could cause our resultsto differ materially from those indicated by the forward-looking statements,including among others, those factors described under forward-lookingstatements disclosure filed as exhibit 99.1 to our Form 10-KSB for the fiscalyear ended July 31, 2007.

I also have a general commentregarding GAAP and non-GAAP measures. During this presentation, we will discussGAAP measures, such as net income, as well as certain non-GAAP measures, suchas EBITDA and earn/burn rate. We have posted on the Investor Relations tab ofour website, at www.arinet.com, a reconciliation of these non-GAAP financialmeasures to the most comparable financial measures under GAAP.

Now, I will turn things back overto Brian for a brief business and strategy overview.

Brian Dearing

Thank you, Nancy. ARI is in the business of providingtechnology-enabled services to link participants in service and distributionchannels for manufactured equipment. Today, ARI supplies two such services foruse by dealers, distributors and manufactures. One, electronic parts cataloguesor EPCs and two, marketing services for dealers, distributors and OEMs.

In addition, we also providee-Commerce and warranty management solutions. The catalog business isrelatively flat. And in the first quarter, it represented about three-quartersof our total revenue. On the other hand, marketing services, which more thanquadrupled again in the first quarter, now represents 22% of the totalbusiness.

The growth in the marketingservices business came from both organic growth, 55%, and the acquisition ofOC-Net per se, 45%. For completeness, our historical dealer and distributorbusiness contributes the remaining percentage of the business.

Our two primary market segmentsare outdoor power equipment and power sports, including motorcycles, and wealso participate in the agricultural equipment, marine, recreation vehicles,construction, and the auto and truck parts aftermarket.

The foundation of our businessmodel is recurring revenue, which today is derived primarily from annualsubscriptions to the parts and service catalogs and websites we supply todealers, which they pay for in advance. Our catalogue renewal rates remainstrong at approximately 85%. In the marketing services business, we also use asubscription model, but customers are typically invoiced monthly.

Our growth strategy is simple.Leverage our large and satisfied catalog customer base of equipment dealers,distributors, and manufacturers, by selling them additional products that helpthem to increase sales, reduce costs, and improve efficiency. The first suchadditional product set is marketing services. We expect to add others over time.

We are focused on three growthinitiatives. First, we want to maintain and enhance our current base of EPCbusiness and we are doing well on this. We are maintaining a solid renewal rateand selling some new accounts and add-on titles to build these businessesbasically flat as it is for other participants in this shared dealer segment ofthe market.

We have intensified our focus onthe OEM and distributor side of the business, both to generate revenue directlyand to create more opportunities for sponsorship within the dealer base.

Marketing services is our secondgrowth initiative and it is going very well indeed, with revenues quadruplingover last year. Our primary products in this area are an award winning websitebuilding service, professional services for large custom website projects andtechnology-enabled direct mail.

In addition to being the revenuegenerator in its own way, the professional services segment of the marketingservices business can be expected to generate product ideas for future use.

The third growth initiative ismergers and acquisitions. The OC-Net acquisition last January was a good one forus. We injected new products and talent into the organization, added keycustomers and pushed our revenue growth into double digits. Acquisitions remainan active part of strategy going forward, since we expect about half of ourgrowths to come from acquisitions overtime.

Perhaps the best news thisquarter is our recovery on the bottom line. We are nearly back to our formallevel of profitability and we anticipate getting all the way back before thefiscal year is out. The reason is that as we have repeatedly indicated, weexperienced a number of significant expenses last year that we did notanticipate would continue and indeed, they have not continued.

PartSmart has now beenstabilized. The product has been improved. The help desk is handling the calls,and management attention is no longer diverted to fixing this product in thefield. We have now turned our attention to adding compelling new capabilitiesto the product to support our first growth initiative, maintaining andenhancing our base of EPC business.

Secondly, we have reducedexpenses in a number of areas, notably including consulting. I hope thisbusiness and strategy overview has given new context for the financial results.For more details on our products or the business, please visit our website atwww.arinet.com.

Now, I will present somehighlights of the financial results. Before I start out with the financials,let me remind you that all the information I will share as well as verydetailed supplemental tables comparing the financials on a quarter, trailing toa month and consecutive quarter basis, including dollar changes andpercentages, will be included in the notes from this conference call and willbe posted on our website by tomorrow evening.

To make it easier for us toprepare these notes, the tables are collected together after the text of thecall notes. Of course, the audio of this conference will also be available,which will include the question-and-answer session. In addition, we havechanged our press release and conference call calendar to coincide with ourfiling dates. So, I would refer you to the 10QSB filed today for additionalcolor on our results.

In Q1 of fiscal 2008, we showed21% revenue growth versus Q1 of fiscal 2007, with 55% of this growth beingorganic and 45% resulting from the acquisition of OC-Net.

To clarify, we computed theorganic percentage by comparing this year's Q1 actuals to last year's Q1 proforma as if OC-Net has been included in that business at that time. Therefore,organic growth includes both pro in the business we had before and the businesswe acquired, but not the base business that we acquired.

Total revenues of $4.2 millionfor the quarter increased $721,000 or 21% compared to the same period last yearand 84,000 or 2% compared to the immediately prior fourth quarter of fiscal2007. The increase from last year was due to the increase in marketing servicesrevenues, the addition of marketing professional services and a small increasein the catalog subscription revenue. The increase from Q4 was due to the sameincreases in marketing professional services and dealer catalog subscriptions,slightly offset by a decrease in MailSmart revenue.

The total revenue of $16.1million for the trailing 12 month period increased 15% compared to the sameperiod last year, which includes three quarters of revenue from the OC-Netacquisition.

Total catalog subscriptionrevenues for the first quarter ending October 31, 2007 increased 1% versus Q1of last year, increased 2% over the prior quarter Q4 of 2007. These increaseswere due mainly to increased subscriptions to web based catalog products.

Marketing professional services,a new source of revenue for us, were $409,000 for the quarter, more than offsetting the decline in the catalog professional services. For the trailing 12month period they totaled $1 million. Marketing services revenue, that is,non-professional services fees increased $319,000 or 141 -- 147% compared to Q1of last year. For the trailing 12-month period ended October 31st, marketingservices revenue, increased $1.3 million or 202% compared to the same periodlast year.

Non-strategic dealer anddistributor communications revenues declined $35,000 or 18% versus Q1 of lastyear, approximately as we anticipated. North American revenues increased 22%,versus Q1 of last year, primarily due to the increase in the marketing servicesbusiness. For the trailing 12-month period, the increase was 15%. Internationalor rest of world revenues accounted for approximately 7% of total revenues forthe quarter.

Operating income was $237,000 forthe quarter compared to 200 -- I am sorry, $273,000 for the quarter compared to$229,000 in the first quarter of last year, and to an operating loss of a$153,000 in the fourth quarter. The increase over last year's Q1 was mainly dueto the increase in revenue partially offset by an increase in overhead costs.The increase versus Q4 was due to non-recurring expenses going away. For thetrailing 12-month period ended October 31, 2007 operating income was $209,000compared to $1.8 million for the same period last year.

The unfavorable comparison isdriven by the inclusion of Q4 and Q3 of last year, which were far lessprofitable than the prior year's Q3 and Q4 because of the non-recurringexpenses I mentioned before. Management evaluates our differed tax assets eachquarter and determines whether it is more likely than not that the company canutilize all or a portion of those deferred tax assets prior to theirexpiration.

Based on historical trends and arange of forecasts of profitability over the upcoming 12 quarters and thenmakes any adjustments. Actual taxes currently paid by the company are in a loweffective rate due to the use of these deferred tax assets, which arise cheaplyfrom net operating loss carry forwards from prior years. There is no adjustmentmade in Q1.

EBITDA for the quarter was$673,000 compared to $556,000 for last year's first quarter and $277,000 for Q4of fiscal 2007. This represents a run rate of $2.7 million, nearly returningthe company to its former level of profitability with EBITDA north of $3million. Total cash flow for the quarter ending October 31, 2007, was ageneration of cash of 25,000 versus a use of cash of $393,000 for the sameperiod last year. This is net of our debt payments.

We paid the last of the WITECHdebt on September 30th and continue to pay both the OC-Net debt and thatassociated with the $4 million, we restructured in April 2003. The finalpayment on the restructured debt is due at the end of this month, so thatchapter will be behind us.

Cash flow from operations beforechanges in working capital, a non-GAAP measure, remained positive at $683,000for the quarter and $1.8 million for the trailing 12 month period. We expectthat operating income, net income and EBITDA will continue to be positive infiscal 2008 and will improve versus last year, as the non-recurring expensesare behind us and the cost control initiatives, we have taken will enhance ourbottom line performance.

Finally, on the balance sheet. Ouraccounts receivable continues to be in excellent shape, and we are current onall our debt obligations.

Additionally, we have a continuedpositive equity balance of approximately $997,000. We achieved our objective ofdouble-digit revenue growth on the strength of the marketing services businessincluding the OC-Net acquisition and the bottom line significantly improvedversus the last half of fiscal 2007. We also continued to delever the businesspaying down debt by $400,000 during the quarter.

Finally, I would like to offerbrief perspective on ARI's valuation in the securities market. It is not clearto me that we are getting credit in the marketplace for our quiet delevering ofthe business. Theoretically, delevering should cause more of our value to flowto the shareholders in addition to reducing the risk profile of the business.

With approximately 6.7 millioncommon shares outstanding at Friday's closing price of $1.55, our market cap isabout $10.4 million. For purposes of calculating enterprise value, we estimatethat about $500,000 of our quarter-end cash balances "excess cash"meaning: cash over and above that needed for ordinary operations. Therefore,adding total debt and market cap and subtracting excess cash yields anapproximate enterprise value of $11 million, which is about 0.7 times trailingin 12 month revenues or approximately 6.1 times trailing 12 month EBITDA.

Each investor or potentialinvestor must make his or her own determination regarding whether or not ARI isfairly valued at its current share price. Though it is a much larger businessand is primarily in the auto market, the ProQuest Business Solutions unit,which is also an electronic parts catalog business was sold last year to Snap-Onfor significantly greater multiples.

I should also remind you that wehave 250,000 outstanding warrants at $1 and approximately 1.3 million optionsin the option pool, of which 983,000 are issued and outstanding at a variety ofprices, some of which are vested and most of which are currently in the moneyat Friday's closing price.

In summary, we've got a goodgrowth happening in the marketing services area, we've got some continued workto do on the cost side, and we've already aggressively begun that. We arecommitted to returning to our former level of profitability and to continuingto grow the marketing services business. We believe that building sustainableprofitable growth is the key to shareholder value.

At this time Paul, I'd like toopen it up for any questions from participants on the call.

Question-and-Answer Session

Operator

(Operator Instructions). Andwe'll go to our first caller. Please go ahead.

Rob Damron - 21st Century Equity

Rob Damron, 21st Century Equity.Hi Brian, excellent quarter. I wanted to stir it up on a couple of things.First, you did an excellent job of controlling expenses during the quarter, butobviously we saw the SG&A up this quarter versus last year. You mentionedthat, that would be increasing last quarter, but if you could talk a little bitabout: where you deployed those investments? And: have you begun to see anyreturn on those investments up to this point?

Brian Dearing

Sure. Well, first of all, we arevery pleased with the quarter, as well. With regard to SG&A, most of theincrease in SG&A was associated with the acquisition, which wasapproximately a breakeven business when we acquired it. So, most of that hasgone into the marketing services area, and we are already beginning to seereturn on that investment with some pretty strong growth coming from that area.We also had some expenses during the quarter, which were associated with aninitiative that didn't pan out, and those expenses will taper off during thesecond quarter and pretty much be gone by the third quarter. So, there is stillsome additional expense reduction that's going to show up over time.

We do not expect that everyinitiative is going to work. Certain percentages of them just don't work, andwe had one that did not perform as expected, and so we have discontinued that.

Rob Damron - 21st Century Equity

Okay. That's fair. Then I justwanted to talk about the Shopping Cart feature of the website. How has thatbeen performing? Maybe you could give us some dollars that were generated fromthat segment during the quarter and the kind of growth that you are seeing?

Brian Dearing

We don't report on thatseparately, Rob. In particular, one of the things that we want to be able todetermine ourselves is: how much of the transaction commissions are due to newsites that we've sold versus old sites that we've sold? And: how muchseasonality there is in that? We just don't have a good handle on those datayet. So, we are really not prepared to report those in any kind of systematicway. What I can tell you is, we've got customers doing well in excess of a $1million worth of business each moth. And I wish I had some better data for youand we're certainly working hard to -- sorry?

Rob Damron - 21st Century Equity

I was saying: you do take a smallpiece of those transaction dollars, is that correct?

Brian Dearing

Yes, we do. And it's not on everywebsite. Some of the website classic, WebsiteSmart classic does not have thatcharging feature, but the WebsiteSmart Pro does. And the percentage varies froma half a point all the way up to two points depending on the contract with thedealer.

So, while I am very happy aboutgetting that revenue, I would caution about making too much out of it beforewe've got some history here to let us know: just how good it is? And: how goodit's been in the past?

Rob Damron - 21st Century Equity

Okay. I mean that's fair. Andthen, just last question for me on the European business. It was nice to seesome growth there this quarter. Could you just talk about: how that isprogressing and potential return to profitability there?

Brian Dearing

Well, I continue to be broadlydisappointed with our results in that area. It's certainly the hemorrhage herehas been reduced. We've done cost control measures there. There has been aslight improvement in short-term results, but we're far from out of the woodsin that area. There is going to be some more hard work going on in that area.

You probably have noticed thatI've dropped it from the four initiatives, because I think we've got some workto do before it turns into an actual growth initiative. Right now, it is in anaccommodation state. We actually have to be able to serve customers there inorder to make the most of our USrelationships.

So, in some sense, we don't havea choice with regard to serving European customers. But it's not on a growthfooting right now, Rob.

Rob Damron - 21st Century Equity

Okay. That's helpful. Thank you.

Brian Dearing

Okay.

Operator

(Operator Instructions). Andwe'll move to our next caller. Please go ahead.

Bob Manning

This is [Bob Manning]. Theone-time costs are largely, but not completely, behind us: Any degree to whichyou can quantify that? Have we got 60% of the one-time costs behind us? Or: 80%?Or: any other number?

Brian Dearing

I'd say it's at least three quarters,because probably the biggest costs were associated with PartSmart 8, and we hadsome expensive consulting people, and they are essentially all gone now for theyear or part of the first quarter. We've also done some cost cutting in themanual data conversion area. And a lot of those costs again, we had some of theonshore costs in the first part of the first quarter, but then we transitionedto an offshore supplier manual data conversion. But that wasn't until midwaythrough the quarter.

The initiative that we wound downwas probably consuming a couple hundred grand in cash for the quarter. So,that's going to go away as well. So, I guess, may be that's a little more than75%. But I would say Bob, most of it is behind us.

Bob Manning

I am sorry. You said a couple ofhundred thousand cash in the quarter and that's going to go away, that --

Brian Dearing

It will be gone by the thirdquarter. Some of it will be gone in the second quarter.

Bob Manning

But, you did have $200,000P&L due to that in this quarter, just being reported, didn’t you?

Brian Dearing

No, it's in SG&A. That was agrowth initiative that we have funded out of SG&A.

Bob Manning

I am hearing two things, itsounds contradictory. It seems to me that you are saying that: from this oneinitiative, there was $200,000 extra SG&A in Q1, which won’t be there goingforward?

Brian Dearing

Yes. It won't be gone in Q2.

Bob Manning

Alright.

Brian Dearing

It will be gone by Q3. Yes. Iguess that may be better than I thought.

Bob Manning

Fund?

Brian Dearing

There's some more cost coming outthan I had originally thought.

Bob Manning

Okay. So, yeah, it sounds it'slittle less than -- 75% is behind us. And, of course, we may have some moregrowth initiatives in the future that will or won't work. I understand allthat.

Brian Dearing

Yeah. That's true. It probablyisn't fair to think about that as a -- to some extent that's a point in timething. We are going to start some other initiative and maybe it will work andmaybe it won't.

Bob Manning

Yeah. So, I mean: you probablyshould assume, it's in the average of $100,000 a quarter hit from new growthinitiatives, but that will be a lot more some quarters than others. Okay, butthere is something to go and there's still a fairly big hit here. Now, revenuegrowth ahead we had -- just taking 55% of 21% year-over-year, roughly we had11% or 12% organic growth versus Q1 a year ago. Is it your sense that that cankeep growing? That's higher than the growth rates we've had in the past.

Brian Dearing

It is, and of course a lot ofthat is coming from the marketing services business, which is still young. Andit's growing in size. So, picking up 10% in a given quarter is over a 100,000in new revenue. I think we can certainly keep up a very respectable growth ratewhether or not it's going to be 10% organic growth or not, that's certainly thetarget, Bob, whether or not we can sustain that, I think it remains to be same.

Bob Manning

Was there any kind ofnon-recurring stuff that made this quarter so good? We had 11% or 12% organicgrowth this quarter.

Brian Dearing

Well, not especially. The quarterwas a little bit bigger than Q4.

Bob Manning

I'm going year-over-year, yeah.

Brian Dearing

Yeah. From a revenue point ofview, it wasn't all that different from Q4, but year-over-year, obviously, wegrew both, the subscription services marketing. And, of course, ourprofessional services' marketing is a new category for us.

Bob Manning

Okay. So, bottom line is: it'sgreat! It might be a little bit better than [trend] line in that quarter. Butit looks pretty good going around. And again, it all depends here at thebeginning point and your ending point, I guess if you are looking just therevenues and you compare Q4 to Q1. Now, of these incremental revenues now,you've got a lot of costs covered. If you bring in for an extra dollar ofrevenue now, roughly: how much could come down to bottom line?

Brian Dearing

Well, it depends on what kind ofrevenue it is. Obviously, if its pro-services revenue, it's going to have laborcosts associated with it at approximately the same rate that we have on that[mortgaged] in right now. But in the -- as you add a website, those grossmargins are going to continue to improve from where they are right now, it willcertainly be a minimum of where it is right now.

Bob Manning

So averaging out over the wholebusiness again we know exactly where the gross is going to be, but 30% ofincremental revenues coming down the bottom line: is that an outrageousassumption?

Brian Dearing

I don't think that would be anoutrageous assumption, again depending on what the revenue is…

Bob Manning

Sure.

Brian Dearing

I mean: if it's all pro-servicesit will be different than, if it's all marketing subscriptions.

Bob Manning

Yeah. The number of websites thatyou are up to now?

Brian Dearing

Approximately 500, that's one ofthe things we are working to count and we'll begin reporting that soon, butapproximately 500.

Bob Manning

What's the growth rate in thatbeen recently?

Brian Dearing

Right now I don't know. All Iknow is that the sales people hit their targets for Q1. So I don't actuallyknow what the unit count rate is, it's a little difficult, because we havedifferent renewal rates among the classic customers and the new customers, someof the classic customers upgrade and we count those as a non-renewal.

Bob Manning

Okay, and are you stilloutselling the other websites by I guess you are 2 to 1 as you were: anybodycopying your architecture to reduce that huge competitive advantage?

Brian Dearing

Well, right now, our sites doseem to sell more than competitive sites, although this is a technology enabledbusiness. So, I think it's probably not wise to think that, that's not going toget copied overtime. So, the biggest advantage that we have is that we don'tmake the customer select the distributor or the OEM before they start theproduct search. And that's a significant change for the competition to make,but I think we have to anticipate that they are going to do that. We just haveto stretch our lead in every way we can, but it's probably not reasonable tothink they won't copy that.

Bob Manning

Good. Brian, thanks very much.

Brian Dearing

You're welcome Bob.

Operator

(Operator Instructions). And Mr. Dearing,there are no further questions at this time.

Brian Dearing

Okay. Thank you for participatingin the conference call everyone. As we mentioned earlier, the notes and tableswhich will appear at the end from this conference call, as well as, the audiowill be posted on our website by tomorrow evening. I refer you to our 10-Qthat's been filed today. We are adjourned.

Operator

And once again that does concludetoday's conference. We appreciate your participation and have a great day.

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