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ARI Network Services, Inc. (NASDAQ:ARIS)

F3Q08 Earnings Call

June 16, 2008 4:30 pm ET

Executives

 

Brian E. Dearing - Chairman

Roy W. Olivier – President and Chief Executive Officer

Nancy Kafura - Corporate Controller

Analysts

Bob Manning

 

Operator

Good day everyone and welcome to the ARI Network Services Third Quarter Fiscal Year 2008 Earnings Conference Call. Just as a reminder, today’s call is being recorded. Now for opening remarks and introductions, I would like to turn the call over to your host, Mr. Brian Dearing. Please go ahead, sir.

Brian E. Dearing

Good afternoon, ladies and gentlemen, and welcome to the conference call for ARI’s third quarter, which ended April 30, 2008. Thank you for participating.

My name is Brian Dearing, Chairman of the Board of Directors, Chief Corporate Development and Strategy Officer, and Acting Chief Financial Officer. Also presenting during this call is Mr. Roy. W. Olivier, newly appointed President and Chief Executive Officer. With us to help answer any questions you may have are Ms. Nancy Kafura, Corporate Controller, and Ms. Diane Kurowski, Interim Vice President of Finance and Administration.

Roy will begin with a brief overview of our business and strategy to help put the financial results in context. I will then present some details of ARI’s financial results for the quarter. To conclude the presentation Roy will provide some additional commentary regarding our expectations for the remainder of the fiscal year, which ends July 31, 2008. At that point we will open it up for questions.

You or your colleagues may listen to a recording of this conference call and obtain a copy of the notes from our remarks this afternoon, including tables containing the relevant financial data, beginning at 6:00 pm CT tomorrow, Tuesday, June 17, 2008, by accessing our website at www.arinet.com. The replay and notes will be available there until our next quarterly conference call, which is expected to be on October 29, 2008, covering the fourth quarter of fiscal 2008 which ends July 31, 2008.

The information we are presenting speaks only as of today and we undertake no obligation to update it. If you are listening to this presentation or reading these notes after June 16, 2008, the information may no longer be accurate.

Before we begin discussing our results, I will turn it over to Nancy Kafura, our Corporate Controller, for a statement concerning forward-looking statements and GAAP and non-GAAP measures.

Nancy Kafura

Thank you, Brian.

Statements made during this conference call that are not statements of historical fact may be deemed to be forward-looking statements subject to protections under federal law, including without limitation, statements regarding our forecasts of revenues, profitability and cash. We intend words such as believes, anticipates, plans, expects, and similar expressions to identify forward-looking statements. A number of important factors could cause our results to differ materially from those indicated by the forward-looking statements, including among others, those factors described under Forward-Looking Statements Disclosure filed as exhibit 99.1 to our Form 10-KSB for the fiscal year ended July 31, 2007.

I also have a general comment regarding GAAP and non-GAAP measures. During this presentation we will discuss GAAP measures such as Net Income, as well as certain non-GAAP measures such as EBITDA and Earn/Burn Rate. We have posted on the Investor Relations tab of our website at www.arinet.com a reconciliation of these non-GAAP financial measures to the most comparable financial measures under GAAP.

Now I will turn things over to Roy for a brief business and strategy overview.

Roy W. Olivier

Thank you, Nancy.

First of all, let me tell you how excited I am to be leading ARI for its next phase of profitable growth. I see a tremendous opportunity before us. We undertook the recent leadership change to accomplish two key objectives:

First, we wanted to improve our execution on both the organic and acquisition fronts by splitting the responsibilities. Although Brian and I will be certainly be joined at the hip, in terms of strategy, I will be focusing primarily on driving profitable growth out of the current operations while Brian will be focused on strategic growth through acquisitions.

Second, we wanted to change up our leadership style to re-energize the operation. Over the next several quarters we expect the benefits of the dual-focus approach will become readily apparent.

Now for the business overview. ARI is in the business of providing technology-enabled services that connect participants in the service and distribution channels for manufactured equipment. Today, ARI derives its revenue primarily from two such services for use by dealers, distributors, and manufacturers: number one, electronic parts catalogs, or EPCs; and number two, marketing services for dealers, distributors, and OEMs. In addition, we also provide e-commerce and warranty management solutions.

The shared dealer segment of the worldwide EPC market is not growing. Our revenues in that space decreased slightly for both the three- and nine-month period ending April 30, 2008, due to the non-renewal of two significant OEM customers who had purchased in bulk on behalf of their dealers. For the first nine months of the year the EPC represented about 74% of our total revenue.

On the other hand, our marketing services business, which grew more than 25% in the third quarter, now represents 23% of our total business. Year-to-date about half the growth of the marketing services business came from organic growth and about half from the acquisition of OC-Net per se. For completeness, our historical dealer and distributor communications business constitutes the remaining 4% of the business.

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

The foundation of our business model is reoccurring revenue, which today is derived primarily from annual subscriptions both to the parts and service catalogs and to the websites we supply to dealers, which they often pay for in advance. Our dealer CD catalog renewal rates remain strong at approximately 89%. In the marketing services business, we also use a subscription model, but customers typically pay monthly. We also enjoy a high renewal rate for our websites marked Pro Product at approximately 90%.

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 help them increase sales, reduce costs and improve efficiency. The first such additional product set is marketing services. We continue to add others over time.

We will continue to be focused on three growth initiatives:

First, we want to maintain and enhance our current base of EPC business, and we are doing well on this. We are maintaining a solid dealer renewal rate and selling some new accounts, though this business has declined a bit. To enable us to maintain this business, we have intensified our focus on the OEMs and distributors, both to generate revenue directly and to create more opportunities for sponsorship within the dealer base.

Our catalog revenue actually declined slightly for the quarter due to the defection of two bulk-deal OEMs, although we are working hard to salvage as much of that business as possible by selling directly to their dealers. Because the overall shared dealer segment of the EPC market is not growing, we can expect to see slight increases or decreases on quarterly revenue going forward as competition intensifies and price pressure continues.

Marketing services is our second growth initiative, and it continues to go well, with year-to-date revenues more than doubling over last year, with about half of that being organic growth. Our primary products in this area are an award-winning website-building service, professional services for large custom website projects, and technology-enabled direct mail.

In addition to being a revenue-generator in its own right, the professional services segment of the marketing services business can be expected to generate product ideas for future use. In fact, the WebsiteSmart Pro Product itself grew out of a pro services engagement.

The third growth initiative is mergers and acquisitions. The OC-Net acquisition last January was a good one for us: we injected new products and talent into the organization, added key customers, and pushed our revenue growth into double digits. Acquisitions remain an active part of our strategy going forward, since we expect to see a significant portion of our growth come from acquisitions over time.

Perhaps the best news this quarter is our continued recovery on the bottom line after a difficult second half of fiscal year 2007. We are nearly back to our former level of profitability, and we anticipate getting all the way back on a run rate basis before the fiscal year is out.

The reason is that, as we have repeatedly indicated, we experienced a number of significant expenses last year that we did not anticipate would continue, and indeed, they have not continued. In particular, PartSmart has now been stabilized. The product has been improved, the helpdesk is handling the calls, and management attention is no longer diverted to fixing this product in the field.

We have now turned our attention to adding compelling new capabilities to the product, such as thumbnails and internet updating, to support our first growth initiative, maintaining and enhancing our base of EPC business.

Second, we have reduced expenses in a number of areas, notably including consulting. We expect to continue to focus on cost control going forward, especially as the business recession looms.

I hope this business strategy overview has given you the context for the financial results Brian is about to present. For more details on our products, or the business, please visit our website at www.arinet.com.

Now I will turn it over to Brian to present some highlights of the financial results.

Brian E. Dearing

Thanks, Roy.

Let me remind you that all of the information I will share, as well as a very detailed supplemental tables set comparing the financials on a quarter, year-to-date, trailing twelve-month, and consecutive quarter basis, including dollar changes and percentages, will be included in the notes from this conference call and will be posted on our website by tomorrow evening.

To make it easier for us to prepare these notes, the tables are collected together after the text of the call notes. Of course, the audio of this conference call will also be available, which will include the question and answer session. In addition, our press release and conference call calendar coincides with our filing dates, so I would refer you to the 10-Q filed today for additional color on our results.

In Q3 of fiscal 2008 we showed 1% revenue growth versus Q3 of 2007, with 100% of that growth being organic. To clarify, we compute the organic percentage by comparing this year’s actuals to last year’s pro forma, as if OC-Net had been included in the business at that time. Therefore, organic growth includes both growth in the business we had before the acquisition and growth in the business we acquired, but not the base business that we acquired. On a year-to-date basis the revenue growth was 12%, with 50% of that growth being organic.

Total revenues of $4.2 million for the quarter increased $57,000, or 1%, compared to the same period last year and declined slightly, 2%, compared to the immediately prior second quarter. For the nine months ended April 30, 2008, total revenues increased $1.3 million, or 12%. Total revenue of $16.7 million for the trailing twelve-month period increased 14%, compared to the same period last year.

The increase from last year in each case was due primarily to the increase in marketing services revenues and to the addition of marketing professional services, partly offset by a decrease in both catalog subscription and catalog professional services revenues. The decline from last quarter also included a slight decline in marketing professional services, which we expect to fluctuate somewhat quarter-to-quarter.

Total catalog subscription revenues for the third quarter ended April 30, 2008, decreased 2% versus Q3 of last year and 3% over the prior quarter, Q2 of fiscal 2008. On a year-to-date basis the decrease was 2%. These decreases were due mainly to the non-renewal of two significant OEM bulk deal subscriptions, though we continue to sell directly to their dealers.

Marketing professional services increased 62% for the quarter compared to last year’s third quarter, more than offsetting the decline in catalog professional services. For the trailing twelve-month period the increase was $1.3 million.

Marketing services revenue, i.e., subscriptions and other non-professional services fees, increased $52,000, or 10%, compared to Q3 of last year. For the nine-month period ended April 30, 2008, marketing services revenue increased $657,000, or 63%, compared to the same period last year.

Underneath this number is an important change in sales mix in favor of websites marked Pro, which has greater recurring characteristics and is more profitable than MailSmart. Although total marketing services revenue in the quarter grew 10%, website revenues increased 52%.

Non-strategic dealer and distributor communications revenues increased slightly over Q3 of last year due to the settlement of an outstanding receivable, but decreased for the nine-month period, approximately as we expected.

North American revenues overall increased 3% versus Q3of last year, primarily due to the increase in the marketing services business. For the nine-month period the increase was 13%, and for the trailing twelve-month period the increase was 16%.

International, or rest of world, revenues accounted for approximately 6% of total revenue for the quarter and year-to-date. Rest of world revenues declined 20% compared to Q3 of fiscal 2007 due to the lack of new manufacturer titles, offset slightly by an increase in subscription revenues caused by delays in fiscal 2007 of two manufacturer renewals. For the trailing twelve-month period the decrease was 9%.

Operating income was $427,000 for the quarter, up from a loss of $172,000 in the third quarter of last year, and up from $357,000 in the second quarter of this year. These increases were mainly due to the increases in revenue and reductions in expenses related to computer support and The Netherlands operation. For the nine-month period ended April 30, 2008, operating income was $1.1 million, up from $318,000 for the same period last year.

Management evaluates our deferred tax assets each quarter and determines whether it is more likely than not that the company can utilize all or a portion of those deferred tax assets prior to their expiration based on historical trends and a range of forecasts of profitability over the upcoming 12 quarters, and then makes any adjustments. Actual taxes currently paid by the company are at a low effective rate due to the use of these deferred tax assets, which arise chiefly from net operating loss carry-forwards from prior years. There was no adjustment made in Q3.

EBITDA, a non-GAAP measure, for the quarter was $799,000, up from $260,000 for last year’s third quarter, and up from $750,000 for the immediately prior quarter, Q2 of this year. On a year-to-date basis EBITDA increased from $1.4 million to $2.2 million. For the balance of the year, we anticipate that EBITDA will increase, so that we will exceed $3M annually on a run rate basis.

Total cash flow for the quarter ended April 30, 2008, was a generation of cash of $483,000, improved from a use of cash of $171,000 for the same period last year. This figure includes our debt payments and the OC-Net acquisition last year. We paid the last of our $4.4 million in debt we restructured in April 2003 on December 31. The only remaining non-trade debt is related to the OC-Net acquisition.

Cash flow from operations before changes in working capital, a non-GAAP measure, remained positive at $796,000 for the quarter, $2.3 million for the nine-month period year-to-date, and $2.6 million for the trailing twelve-month period.

We expect that operating income, net income, and EBITDA will continue to be positive in fiscal 2008 and improve versus. last year, as the non-recurring expenses are behind us and the cost control initiatives we have taken should enhance our bottom-line performance.

On the balance sheet, our accounts receivable continues to be in excellent shape and we are current on all our debt obligations. Additionally, our positive shareholder’s equity balance continues to improve, and is now approximately $1.8 million.

Finally, I’d like to offer a brief perspective on ARI’s valuation in the securities market. It is not clear to me that we are getting credit in the marketplace for our continued de-levering of the business. Theoretically, de-levering should cause more of our value to flow to the shareholders, in addition to reducing the risk profile of the business.

With approximately 6.7 million common shares outstanding, at last Monday’s 20-day moving average price of $1.50, our market cap is about $10.1 million. For purposes of calculating enterprise value, we estimate that about $500,000 of our quarter-end cash balance is excess cash, meaning cash over and above that needed for ordinary operations.

Therefore, adding total debt to market cap and subtracting excess cash yields an approximate enterprise value of $10.1 million, which is about 0.6x trailing twelve-month revenues, or approximately 4.1x trailing twelve-month EBITDA.

Each investor, or potential investor, must make his or her own determination regarding whether or not ARI is fairly valued at its current share price.

Though it was a much larger acquisition and is primarily in the auto market, the ProQuest business solutions unit, which is also an electronic parts catalog business, was sold a little over a year ago to Snap-On for significantly greater multiples.

I should remind you that we have 250,000 outstanding warrants at $1 and approximately 1.8 million options in the option pool, of which approximately 1.0 million are issued and outstanding at a variety of prices, some of which are vested and many of which are currently in the money at today’s closing price.

Now I will turn it back over to Roy for some final commentary.

Roy W. Olivier

Thank you, Brian.

In summary, we achieved our objective of double-digit revenue growth year-to-date on the strength of the marketing services business, including the OC-Net acquisition, and the bottom line is improved significantly versus the first half of FY2007. We also continued to de-lever the business, paying down debt significantly during the quarter.

A brief word about the economy. We do anticipate that we will have a recession, and that it may have actually already begun. Of course, we will continue to manage our expenses, but I should emphasize that the recession should not be bad news for ARI.

First of all, much of our business is tied to repair, which, if anything, is even more important during a recession, as customers keep their current units in operation longer, rather than purchasing new ones.

Second, although there will definitely be pressure on new sales in the marketing area, stronger dealers and OEMs can be expected to increase their marketing expenditures in order to take market share from weaker players.

Third, our reoccurring revenue business model and improving cash position may present ARI with unique opportunities to acquire assets, negotiate long-term relationships on favorable terms with vendors and customers, and put more pressure on weaker competitors. We are evaluating our options in each of these areas.

In summary, we’ve got good growth happening in the marketing services area and we continue to manage the cost side. We see opportunities in the current economic climate and we are working hard to make the most of them. We are committed to returning to our former level of profitability and we continue to grow the marketing services business. We believe that building sustainable, profitable growth is the key to long-term shareholder value.

At this time, Paula, we would like to open it up to any questions from participants on the call.

Question-and-Answer Session

 

Operator

(Operator Instructions) We will go to our first question.

Bob Manning

This is Bob Manning. You’ve done a great job in maintaining revenues, keeping expenses down, and the environment is not really the most conducive to make all that easy. But the thing that I think would be very helpful to your stock price, if there really were visible growth ahead. And I think it has to be said that it seems the easy picking in the website product has kind of been done so we’re looking to that fairly marginal growth, it seems, looking ahead to the existing business. Maybe I’m wrong.

I would just like, and I know we’ve got the acquisitions which you’re on the prowl for and have done a good job on in the past, but is there anything in line, in prospect, that can make the organic growth of the business look like it might accelerate?

Brian E. Dearing

Yes. Let me give sort of a general overview and then let me turn it over to Roy for some additional commentary.

Let me focus on each aspect of the business individually.

In the catalog area I think we can probably squeeze a little bit out of that by repurposing some of the content or use by people that aren’t using it now. And example of that is to allow people to use the content on an on-demand basis. Today they have to subscribe for a year, but if a customer, a dealer for example, is not regularly servicing a given manufacturer’s line, they may want to only subscribe for the period of time that they are conducting some special service. So we would like to be able to extend the reach of the content by allowing shorter subscription periods for people to kind of have a bit of an impulse buy, if you will.

And also to reach some markets that we’re not reaching. We essentially don’t participate at all in the Asian market. Even though we have exclusive content. So we have the exclusive content for Harley Davidson, and there’s 100+ Harley Davidson dealers in Japan; we don’t do business with any of them.

So I think while it would be incorrect to look to the catalog business as a source of tremendous growth going forward, it would also be wrong to conclude that that business has to decline or even remain flat. And given that’s it’s approximately a $12 million business, every point in that business is an interesting amount of money. So we haven’t sort of thrown in the towel in that area.

In the marketing area, there are a couple of things. First of all, we masked the growth in the website business, which grew by over 50%, because we had a mix change. We deliberately sent our sales force forth on a mission to sell websites instead of direct mail.

And for us, that’s better, in terms of profitability and it’s a recurring revenue stream, as well. But because they kind of substituted in those sales, it looked as if the marketing services revenue did not increase as much as the website revenue did. So, it’s actually a little better than it looks because we forced our sales team to change what they’re selling.

Second of all, there is an opportunity within the current customer base to unbundled the services. Historically, we have had a one-size-fits-all pricing philosophy where we said, “You buy the service from us and you get everything. There’s not way to buy less, there’s no way to buy more.” We are the only player in the market that does it that way.

Basically, everybody else has an a la carte service and they’re getting, some of those competitors are getting a lot more per customer than we’re getting. Now, are we going to get all the way to 2x-3x the level of revenue? Probably not. But there is substantial revenue growth from the current customer base that can be obtained with additional price or service offerings.

We’ve been spending the last, probably six months, retooling the applications to provide for that capability. Obviously we have to have, the software has to be instrumented to capture those data and then our billing system has to be set up to bill for them, so there’s some internal growth, I think, available in terms of greater revenue per customer, going forward.

The other thing, obviously, is additional markets. You know, we’ve focused on power and power sports. There are other people that are in the website business in agriculture and construction, for example, and so we’re kind of turning our attention to some of those additional markets to generate some growth.

So, I guess the net-net here, Bob, is that we’re not ready to throw in the towel on organic growth. Obviously maintaining a doubling pace is probably beyond our reach, but I don’t think we should have difficulty maintaining a double-digit growth rate in that segment over a significant period of time.

Let me ask Roy to add some additional comments here.

Roy W. Olivier

Well, I think the other area that we can expect to see growth is in additional content, where we’re adding other content, whether it’s websites more pro content or catalogue content that we’re selling into the dealer base. There are specific manufacturers, for example, that we do not resell today, like BMW, Triumph, and Ducati, which are targets for us moving forward.

In addition to that, other services, for example, in the marketing services group we are putting together some packages to provide a new service to dealers that will improve their search engine results for their website and drive more business to them. And that product we can sell to ARI customers as well as non-ARI customers.

So there will be a few more products that will help us drive organic growth over the next few months, as well.

Operator

It appears there are no further questions in the queue.

Brian E. Dearing

Thank you everyone for participating in this conference call. As we mentioned earlier, the notes and tables, which will appear at the end, from this conference call, as well as the audio, will be posted on our website by tomorrow evening. I also refer you to our 10-Q, filed earlier today. We are adjourned.

Operator

This concludes today’s conference call. You may now disconnect.

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