<TABLE>
<CAPTION>
<S> <C>
Securities and Exchange Commission
Washington, DC 20549
----------------------------------
Form 10-Q
Quarterly Report pursuant to Section 13 or 15(d)
of the securities exchange act of 1934
For the quarterly period ended September 30, 1999 Commission file number: 0-25326
Ariel Corporation
(exact name of registrant as specified in its charter)
Delaware 13-3137699
(State of incorporation) (IRS employer identification number)
2540 Route 130
Cranbury, New Jersey 08512
(Address of principal executive offices)
609-860-2900
(Telephone number, including area code)
--------------------------------------------
Indicate by check mark whether the Issuer (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 ( X ) No ( )
State the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Common Stock, $.001 par value 9,760,150 shares outstanding
as of September 30, 1999
Documents Incorporated by Reference: None
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
Ariel Corporation
Index
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
A. Consolidated balance sheets as of September 30, 1999 and December 31, 1998
B. Consolidated statements of operations for the three and nine months ended
September 30, 1999 and 1998
C. Consolidated statements of cash flows for the nine months ended September 30, 1999 and 1998.
D. Notes to consolidated financial statements
</TABLE>
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Part II. Other Information
Item 1. Legal proceedings - None
Item 2. Changes in Securities - None
Item 3. Defaults upon senior securities - None
Item 4. Submissions of matters to a vote of shareholders - None
Item 5. Other Information - None
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits - Exhibit 27 - Financial Data Schedule (Filed
Electronically)
b) Reports on Form 8-K - None.
<PAGE>
PART I. - FINANCIAL INFORMATION
ITEM I. - FINANCIAL STATEMENTS
ARIEL CORPORATION
BALANCE SHEETS
(Unaudited)
<TABLE>
<CAPTION>
<S> <C> <C>
September 30, December 31,
1999 1998
------------ ------------
ASSETS
CURRENT ASSETS:
CASH AND CASH EQUIVALENTS ................................................ $ 6,152,272 $ 17,996,575
ACCOUNTS RECEIVABLE, NET OF ALLOWANCE FOR DOUBTFUL
ACCOUNTS OF $1,565,866 IN 1999 AND $1,460,855 IN 1998 .............. 3,191,526 3,593,709
OTHER RECEIVABLES ........................................................ 838,344 1,378,781
INVENTORIES, NET ......................................................... 1,978,500 2,857,326
PREPAID EXPENSES ......................................................... 411,668 449,691
------------ ------------
TOTAL CURRENT ASSETS ................................ 12,572,310 26,276,082
EQUIPMENT, NET OF ACCUMULATED DEPRECIATION
AND AMORTIZATION .................................................... 1,176,393 1,365,354
INTANGIBLE ASSETS ............................................................... 248,285 997,225
GOODWILL ........................................................................ 3,816,791 4,344,374
OTHER ASSETS .................................................................... 618,495 699,345
------------- ------------
TOTAL ASSETS .................................................................... $ 18,432,274 $ 33,682,380
============= ============
LIABILITIES & STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
ACCOUNTS PAYABLE ......................................................... $ 1,529,864 $ 2,679,548
ACCRUED EXPENSES ......................................................... 2,834,502 5,388,661
CURRENT PORTION OF LONG-TERM DEBT ........................................ 3,872,467 5,480,430
ROYALTIES PAYABLE ........................................................ 42,021 95,410
--------- ----------
TOTAL CURRENT LIABILITIES ........................... 8,278,854 13,644,049
LONG-TERM DEBT .................................................................. 29,912 332,834
STOCKHOLDERS' EQUITY
PREFERRED STOCK, $.001 PAR VALUE:
AUTHORIZED - 2,000,000 SHARES
ISSUED AND OUTSTANDING - NONE
COMMON STOCK, $.001 PAR VALUE:
AUTHORIZED - 20,000,000 SHARES
ISSUED AND OUTSTANDING - 9,760,150 AT SEPTEMBER 30, 1999
AND 9,760,150 AT DECEMBER 31, 1998 ............. 9,760 9,760
ADDITIONAL PAID-IN CAPITAL ............................................... 33,302,342 33,302,342
UNREALIZED GAIN / (LOSS) ON FOREIGN CURRENCY TRANSLATION ................. (291,980) 31,272
ACCUMULATED DEFICIT ...................................................... (22,896,614) (13,637,877)
TOTAL STOCKHOLDERS' EQUITY .......................... 10,123,508 19,705,497
---------- ----------
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY ................................. $ 18,432,274 $ 33,682,380
============ ============
The accompanying notes are an integral part of the financial statements
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
ARIEL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<S> <C> <C> <C> <C>
Three Months Ended September 30, Nine Months Ended September 30,
1999 1998 1999 1998
============== ============== ============== ==============
SALES ............................................... $ 2,869,593 $ 3,180,252 $ 8,694,254 $ 13,568,059
COST OF GOODS SOLD .................................. 1,133,081 1,802,570 3,654,950 7,951,014
------------ ------------ ------------ ------------
GROSS PROFIT ................................. 1,736,512 1,377,682 5,039,304 5,617,045
EXPENSES:
SALES AND MARKETING ............................ 1,102,758 1,257,027 4,258,553 3,679,971
GENERAL AND ADMINISTRATIVE ..................... 1,723,805 3,402,922 5,370,956 6,440,794
RESEARCH AND DEVELOPMENT ....................... 1,425,861 1,847,725 4,230,325 5,618,925
RESTRUCTURING CHARGE ........................... 369,528 0 369,528 0
------------ ------------ ------------
TOTAL OPERATING EXPENSES ................... 4,621,952 6,507,674 14,229,362 15,739,690
------------ ------------ ------------ ------------
LOSS FROM OPERATIONS ......................... (2,885,440) (5,129,992) (9,190,058) (10,122,645)
INTEREST INCOME ..................................... 85,384 140,399 378,734 180,607
INTEREST EXPENSE .................................... (119,899) (939,599) (411,950) (1,217,001)
GAIN ON SALE OF ASSETS .............................. 0 29,537,896 0 29,537,896
OTHER INCOME / (EXPENSE) ............................ (64,038) 72 (35,463) 52,728
------------ ------------ ------------ ------------
INCOME / (LOSS) BEFORE INCOME TAXES ........... (2,983,993) 23,608,776 (9,258,737) 18,431,585
PROVISION FOR INCOME TAXES .................... 0 368,632 0 368,632
------------ ------------ ------------ ------------
NET INCOME / (LOSS) .......................... ($ 2,983,993) $ 23,240,144 ($ 9,258,737) $ 18,062,953
------------ ------------ ------------ ------------
OTHER COMPREHENSIVE INCOME / (LOSS), NET OF TAX:
FOREIGN CURRENCY TRANSLATION ADJUSTMENTS ...... 81,807 0 (213,346) 0
============ ============ ============ ============
COMPREHENSIVE INCOME / (LOSS) . (2,902,186) 23,240,144 (9,472,083) 18,062,953
============ ============ ============ ============
BASIC EARNINGS / (LOSS) PER SHARE ............ (0.31) 2.39 (0.95) 1.86
============ ============ ============ ============
DILUTED EARNINGS / (LOSS) PER SHARE .......... (0.31) 2.36 (0.95) 1.84
============ ============ ============ ============
BASIC WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING 9,760,150 9,742,926 9,760,150 9,728,223
============ ============ ============ ============
EFFECT OF DILUTIVE OPTIONS ................... 0 123,314 0 74,157
DILUTED WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING 9,760,150 9,866,240 9,760,150 9,802,380
============ ============ ============ ============
The accompanying notes are an integral part of the financial statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
ARIEL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<S> <C> <C>
For The Nine Months Ended September 30,
1999 1998
============== ==============
Cash flows from operating activities:
Net Loss .............................................................................. ($ 9,258,737) $ 18,062,953
Adjustments to reconcile net loss to net cash used in
operating activities:
Gain/(loss) on disposal of assets ......................... 60,911 (29,537,896)
Depreciation and amortization ............................. 693,552 913,641
Amortization of goodwill & intangibles .................... 764,312 0
Amortization of debt issuance costs ....................... 32,181 48,629
Provision for doubtful accounts ........................... 284,829 724,268
(Benefit from) / provision for inventory obsolescence ..... (28,706) 225,000
Non-Cash compensation expense ............................. 0 83,115
(Increase) decrease in assets:
Accounts receivable ....................................... 452,799 (3,202,582)
Inventories ............................................... 897,992 (779,711)
Other assets .............................................. 171,636 (119,351)
Increase (decrease) in liabilities:
Accounts payable and accrued expenses ..................... (3,466,637) 437,425
Royalties payable, related parties ........................ (53,389) (2,406)
------------ ------------
Net cash used in operating activities ................................................. (9,449,257) (13,146,915)
------------ ------------
Cash flows from investing activities:
Net proceeds from sale of assets .......................... 0 31,187,253
Purchase of equipment ..................................... (509,711) (415,437)
------------ ------------
Net cash (used in) provided by investing activities ................................... (509,711) 30,771,816
------------ ------------
Cash flows from financing activities:
Proceeds from debt financing .............................. 0 4,500,000
Principal payments on long-term debt ...................... (174,537)
Principal payments on short-term debt ..................... (1,927,501) (2,000,000)
Proceeds from exercise of common stock options and warrants 0 2,010,915
------------ ------------
Net cash (used in) provided by financing activities ................................... (1,927,501) 4,336,378
------------ ------------
Effect of exchange rate changes on cash ............................................... 42,166 0
Net increase (decrease) in cash ....................................................... (11,844,303) 21,961,279
Cash and cash equivalents, beginning of year .............. 17,996,575 2,645,864
============ ============
Cash and cash equivalents, end of period .............................................. $ 6,152,272 $ 24,607,143
============ ============
The accompanying notes are an integral part of the financial statements.
</TABLE>
<PAGE>
Ariel Corporation
Notes to Financial Statements
(Unaudited)
1. Basis of Presentation
The financial statements included herein have been prepared by the Company,
pursuant to the Rules and Regulations of the Securities and Exchange Commission.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to such rules and regulations. The
financial statements should be read in conjunction with the financial statements
and notes thereto included in the Company's Form 10-K for the year ended
December 31, 1998.
As of September 30, 1999, the Company had working capital of $4,293,456,
including cash and cash equivalents of $6,152,272. The Company expects to incur
costs and expenses in excess of expected revenues during the ensuing twelve
months as the Company continues to execute its business strategy in the Internet
Service Provider (ISP) and Original Equipment Manufacturer (OEM) markets. There
is no assurance that the Company will generate sufficient cash flow from
operations to liquidate liabilities as they come due. In the event that the
Company is unable to liquidate its liabilities, it may delay or eliminate some
expenditures and planned operations may be scaled back. Accordingly the Company
expects that it will need additional funds to meet obligations through the next
twelve months and will seek to raise such amounts through a variety of options
including expected future cash from operations, borrowings, proceeds from equity
or debt financing and scaling back operations. Additional funding may not be
available when needed or on terms acceptable to the Company, which could have a
material adverse effect on its business, financial condition, and results of
operations. The financial statements do not include any adjustments that might
result from the outcome of these uncertainties.
In the opinion of the management of the Company, the accompanying unaudited
financial statements contain all adjustments, consisting of normal recurring
accruals, necessary to present fairly the financial position of the Company as
of September 30, 1999 and the results of operations for the three and nine
months ended September 30, 1999 and 1998. The results for interim periods are
not necessarily indicative of results for the full year.
2. Inventories, net of allowance:
Inventories, net of allowance, consists of the following:
September 30, December 31,
1999 1998
------------- ------------
Component Materials.............. $ 783,755 $1,040,115
Work-in process.................. 322,369 1,536,870
Finished Goods.................... 872,376 280,341
------- -------
$1,978,500 $2,857,326
========== ==========
<PAGE>
3. Debt
As of September 30, 1999 the Company had total debt of $3,902,379
consisting of notes due to Transamerica Business Credit Corporation's Technology
Finance Division of Farmington Connecticut of $3,610,928 and acquired foreign
debt of $291,451.
Under its credit facility with Transamerica, outstanding debt of $3,610,928
as of September 30,1999 consisted of a $2,411,091 Term Loan payable quarterly in
arrears over twenty consecutive quarters commencing October 1, 1998, and
$1,199,837 drawn against a revolving note. The Revolver matures on June 12, 2000
and can be extended for two additional periods of one year each. Amounts drawn
under the Revolver are based on a formula of eligible accounts receivable and
inventory. Approximately $1,115,164 of the Revolver balance was paid in July and
August as the Company had insufficient eligible accounts receivable and
inventory to support amounts drawn. As of September 30, 1999 the Company had
sufficient eligible accounts receivable and inventory to support the revolver
balance of $1,199,837.
The interest rate in effect under the Revolver is based on prime rate plus
2.50% and is payable monthly in arrears. The interest rate in effect on the term
loan at September 30, 1999 was 12.099%.
Payment terms for the term loan are as follows:
October 1, 1999 through September 30, 2000 $490,161
October 1, 2000 through September 30, 2001 $552,214
October 1, 2001 through September 30, 2002 $622,122
October 1, 2002 $746,594
--------
Total $2,411,091
==========
On May 14, 1999 the Company executed an amendment to its agreement with
Transamerica that included a waiver for certain financial covenants the Company
was not in compliance with as of December 31, 1998 and March 31, 1999 and
amended covenants for 1999 and 2000. With the execution of this amendment all
previous financial covenants have been waived. Amended covenants consist of the
following:
o As of June 30, 1999 working capital shall be no less than $8,000,000.
The ratio of current assets to current liabilities shall not be less
than 1.50 to 1.00. Tangible net worth shall not be less than
$7,000,000.
o As of September 30, 1999 working capital shall be no less than
$6,000,000. The ratio of current assets to current liabilities shall
not be less than 1.50 to 1.00. Tangible net worth shall not be less
than $5,000,000.
o As of December 31, 1999 working capital shall be no less than
$8,000,000. The ratio of current assets to current liabilities shall
not be less than 1.75 to 1.00. Tangible net worth shall not be less
than $6,500,000.
o Gross Profit Margins for the year ending December 31, 1999 shall not
be less than 35%.
o Net losses before taxes for the year ending December 31, 1999 are not
to exceed $10,000,000.
o Net losses before taxes for the year ending December 31, 2000
are not to exceed $ 0.
<PAGE>
As of September 30, 1999 the Company is in compliance with these covenants.
Portions of the term note due beyond one year were classified as long term for
purposes of computing working capital and current ratio covenants. Due to the
uncertainty of attaining future covenants all Transamerica debt is reflected as
a current liability as of September 30, 1999.
On October 18, 1999 the Company executed a further amendment to the credit
agreement that substantially reduces the amended financial covenants that the
Company must be in compliance with as of and for the year ending December 31,
1999. The only financial covenants which remain are as follows:
o As of December 31, 1999, working capital shall be no less than $2,000,000.
o The ratio of current assets to current liabilities shall not be less than
1.25 to 1.00.
o Tangible net worth shall not be less than $2,000,000.
o Gross profit margins for the year ending December 31, 1999 shall not be
less than 35%.
The amendment also eliminates financial covenants thereafter.
4. Segment Data
Segments are comprised of European and North American operations. The
accounting policies of the segments are the same as those described in the
"Summary of Significant Accounting Policies" in Note 1 of the Company's Form
10K. Segment profit includes operating expenses directly attributable to the
segment including administrative, selling, marketing, research and development
costs and taxes. Certain expenses managed outside the reportable segments are
excluded. Costs excluded from segment profit include charges for in-process
technology and costs related to mergers and acquisitions. The Company does not
include intercompany transfers between segments for management reporting
purposes.
On November 23, 1998 the Company acquired all of the outstanding stock of
SCii Telecom, SA, in Paris France. As a result of the acquisition, the Company
now reports segments on a geographic basis. European operations did not qualify
as a reportable segment as of December 31, 1998, therefore, there is no
comparable segment information presented.
<TABLE>
<CAPTION>
<S> <C> <C>
Summary information by segment as of and for the three and nine months
ending September 30, 1999 is as follows:
For the three months For the nine months
NORTH AMERICA: ending September 30, 1999 ending September 30, 1999
--------------------------- ---------------------------
Revenues from external customers $2,835,559 $8,353,273
Intersegment revenues 14,068 19,318
Segment loss (2,293,294) (7,186,087)
Segment assets 13,126,204 13,126,204
EUROPE:
Revenues from external customers $34,034 $340,981
Intersegment revenues -0- -0-
Segment loss (689,421) (2,069,097)
Segment assets 5,306,069 5,306,069
A reconciliation of the Company's segment losses to the corresponding
consolidated amounts for the three and nine months ending September 30, 1999 is
as follows:
Segment loss ($2,982,715) ($9,255,184)
Margins on intersegment revenues (1,278) (3,553)
============== =============
Net loss ($2,983,993) ($9,258,737)
============== =============
</TABLE>
5. Restructuring Charge
With the Company's decision to focus on the ISP market and in combination
with its newly created sales channel through KeyLink Systems, the Company
terminated the employment agreement of Brian Hoerl, its Vice-President of OEM
Sales and entered into a termination agreement with Mr. Hoerl effective August
20, 1999. Two additional field sales-reps were also terminated in the third
quarter of 1999. As a result, the Company recorded a restructuring charge of
$369,528, which reflects severance and related benefits payments, of which
$47,576 was paid as of September 30, 1999. The remaining amounts are expected to
be paid over a six month period ending March 31, 2000.
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
COMPARISON OF RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
relationship that certain items of the Company's results of operations bear to
total sales.
<TABLE>
<CAPTION>
<S> <C> <C>
Nine months Ended
September 30,
1999 1998
------------- ----------
Sales 100% 100%
Cost of goods sold 42 59
----------- ----------
Gross profit 58 41
Expenses
Sales and marketing 49 27
General and administrative 62 48
Research and development 49 41
Restructuring Charge 4 -
----------- ----------
Total Operating Expenses 164 116
Loss from operations (106) (75)
Interest income 4 1
Interest expense (5) (9)
Gain on sale of assets * 218
Other (expense) income * 1
----------- ----------
Income / (Loss) before income taxes (107) 136
Provision for income taxes - (3)
=========== ==========
Net Income / (Loss) (107)% 133%
=========== ==========
* Total is less than 1%
<PAGE>
</TABLE>
Three months ended September 30, 1999 as compared to three months ended
September 30, 1998
Sales
Worldwide sales were $2,869,593 for the three months ended September 30,
1999, a decrease of $310,659 compared to sales of $3,180,252 for the three
months ended September 30, 1998. Domestic sales were $2,776,644 for the three
months ended September 30, 1999 compared to $2,544,862 for the three months
ended September 30, 1998, a decrease of $231,782. This decrease is attributable
to a decrease in sales to PC manufacturers. Such decreases were partially offset
by sales to internet service providers (ISPs) and other end users as the Company
continues to execute its business strategy of shifting to ISP markets.
International sales were $92,949 for the third quarter of 1999 including
U.S. exports of $58,915 and sales from European operations of $34,034. This as
compared to $635,390 for the third quarter of 1998. The decrease is attributable
to a reduction in demand by an OEM customer for our Audio Mixing Product which
the Company no longer actively markets. A reduction in demand for T1-Modem+
products due to the release of the RS2000 also contributed to the decline.
Gross Profit
Gross profit increased by $358,830 to $1,736,512 for the three months ended
September 30, 1999 from $1,377,682 for the three months ended September 30,
1998. Gross profit margin was 61% for the three months ended September 30, 1999
compared to 43% for the three months ended September 30, 1998. The increase in
gross profit as a percent to sales reflects an improved mix of sales
concentrated in original equipment manufacturers (OEM) as compared to
lower-margin PC manufactures. OEM gross profits are higher as the Company is
able to charge premiums for engineering for specific customer applications.
Sales and marketing
Sales and marketing expenses were $1,102,758 or 38% of sales for the three
months ended September 30, 1999 compared to $1,257,027 or 40% of sales for the
three months ended September 30, 1998, a decrease of $154,269. Salaries and
related expenses decreased $113,544 as a result of the Company's decision to
restructure its sales department and streamline its internal sales force (see
Note 5 "Restructuring Charges"). As such, the Company has refocused its sales
efforts from PC manufacturers and PC equipment suppliers to the ISP market and
in August 1999 entered into an arrangement with KeyLink Systems to distribute
the Company's products. A reduction in commissions of $80,019, due to lower
sales, contributed to the overall reduction in Sales and Marketing expenses.
Such decreases in employee related expenses were offset by an increase of
$44,717 in trade show costs as the Company introduced its PowerPopTM
architecture to ISPs and continues its efforts to penetrate the ISP market.
<PAGE>
General and administrative
General and administrative expenses were $1,723,805 for the three months
ended September 30, 1999 compared to $3,402,922 for the three months ended
September 30, 1998. The decrease of $1,679,117 is primarily due to non-recurring
bonuses paid in September 1998 of $1.1million in connection with the sale of the
Company's Communications Systems Group (CSG) in that month. Additionally, a
provision for doubtful accounts was recognized in September 1998 for Hayes
Microcomputer, Inc. and its affiliates when Hayes filed for bankruptcy
protection. Accordingly, provisions for doubtful accounts decreased by
approximately $600,000 as compared to the three months ending September 30,
1998.
Research and Development
Research and development expenses were $1,425,861 or 50% of sales for the
three months ended September 30, 1999 compared to $1,847,725 or 58% of sales for
the three months ended September 30, 1998, a decrease of $421,864 or 23%.
Expenses declined by $462,236 from the same period last year due to the sale of
the Company's CSG group to Cabletron in September 1998. These decreases were
offset by an increase in research and development of $62,514 resulting from
investments in products and technologies at the Company's European subsidiary,
SCii Telecom, SA.
Restructuring Charge
With the Company's decision to focus on the ISP market and in combination
with its newly created sales channel through KeyLink Systems, the Company
terminated the employment agreement of Brian Hoerl, its Vice-President of OEM
Sales and entered into a termination agreement with Mr. Hoerl effective August
20, 1999. Two additional field sales-reps were also terminated in the third
quarter of 1999. As a result, the Company recorded a restructuring charge of
$369,528, which reflects severance and related benefits payments, of which
$47,576 was paid as of September 30, 1999. The remaining amounts are expected to
be paid over a six month period ending March 31, 2000.
Tax Provision
As of December 31, 1997, the Company had available, for income tax
reporting purposes, unused federal and state net operating loss carryforwards of
approximately $24.5 million and $24.8 million, respectively. These losses will
expire through the years 2012 and 2004 respectively. Under certain Alternative
Minimum Tax rules, these losses can be used to offset up to 90% of the Company's
taxable gain. Therefore, a provision for income taxes of $368,632 was recognized
in the three months ending September 30, 1998.
The provision was computed using an effective rate of two percent of net
income before tax for the nine months ending September 30, 1998. The effective
rate is based on an Alternative Minimum Tax rate of 20% applied to 10% of nine
months income before taxes. Remaining federal and state loss carryforwards are
approximately $6.4 million and $6.7 million respectively. There was no provision
for taxes for the same period in 1999.
<PAGE>
Nine months Ended September 30, 1999 as Compared to Nine months Ended
September 30, 1998
Sales
Worldwide sales were $8,694,254 for the nine months ended September 30,
1999, a decrease of $4,873,805 compared to sales of $13,568,059 for the nine
months ended September 30, 1998. Domestic sales were $7,880,355 for the nine
months ended September 30, 1999 compared to $12,240,787 for the nine months
ended September 30, 1998, a decrease of $4,414,325. Approximately $3.2 million
of this decrease is attributable to a decrease in sales to Compaq, a major PC
Integrator customer. Compaq has discontinued its networking group and as a
result, the Company expects 1998 sales to PC integrators to be a significant
part of its 1999 sales variances from the previous year. A reduction in
T1-Modem+ sales to OEM customers accounted for an additional decrease of $1.1
million.
International sales were $813,899 for the first nine months of 1999
including U.S. exports of $472,918 and sales from European operations of
$340,981. This as compared to $1,327,272 for the same period of 1998. The
decrease is attributable to a reduction in demand by an OEM customer for our
Audio Mixing Product, as well as a reduction in demand for T1-Modem+ products
due to the release of the RS2000. Such decreases are partially offset by sales
from the Company's European subsidiaries of $340,981.
Gross Profit
Gross profit decreased by $577,741 or 10% to $5,039,304 for the nine months
ended September 30, 1999 from $5,617,045 for the nine months ended September 30,
1998. Gross profit margin was 58% for the nine months ended September 30, 1999
compared to 41% for the nine months ended September 30, 1998. The increase in
gross profit margin as a percent of sales reflects the continued shift in
product mix from lower margin shipments to PC integrators to shipments to OEM
customers that carry higher gross margins.
Sales and marketing
Sales and marketing expenses were $4,258,553 or 49% of sales for the nine
months ended September 30, 1999 compared to $3,679,971 or 27% of sales for the
nine months ended September 30,1998. The increase of $578,582 reflects
incremental spending in 1999 of $507,917 for advertising, trade shows and
marketing programs related primarily to the launch of the Company's ISP PowerPoP
architecture and $322,324 for European operations. Such increases were offset by
decreases in commissions of $152,793 due to lower sales volume. Salaries and
related expenses decreased $113,544 as a result of the Company's decision to
restructure (see Note 5 "Restructuring Charges") its sales department and
streamline its internal sales force. The Company has refocused its sales efforts
from PC manufacturers to the ISP market and in August 1999 entered into an
arrangement with KeyLink Systems to distribute the Company's products.
General and administrative
General and administrative expenses were $ 5,370,956 for the nine months
ended September 30, 1999 compared to $6,440,794 for the nine months ended
September 30, 1998. The decrease of $1,069,838 is primarily due to non-recurring
bonuses paid in September 1998 of $1.1million in connection with the sale of the
Company's CSG group in that month and a reduction in staff salaries as a result
of the sale. Additionally, a provision for doubtful accounts was recognized in
September 1998 for Hayes Microcomputer, Inc. and its affiliates when Hayes filed
for bankruptcy protection. Accordingly, provisions for doubtful accounts
decreased by approximately $600,000 as compared to the nine months ending
September 30, 1998. Such decreases were partially offset by $527,737 in general
and administrative expenses related to the Company's European subsidiaries
including costs related to establishing a wholly owned German subsidiary, Ariel
Deutschland, GmbH.
<PAGE>
Research and Development
Research and development expenses were $4,230,325 or 49% of sales for the
nine months ended September 30, 1999 compared to $5,618,925 or 41% of sales for
the nine months ended September 30, 1998, a decrease of $1,388,600 or 25%.
Expenses declined by $2,869,773 from the same period last year due to the sale
of the Company's CSG group to Cabletron in September 1998. These decreases were
offset by an increase in research and development of $606,576 resulting from
investments in products and technologies at the Company's European subsidiary,
SCii Telecom, SA. Additionally, expenses increased due to bonuses paid to
certain engineers in conjunction with employment contracts of approximately
$715,000.
Restructuring Charge
With the Company's decision to focus on the ISP market and in combination
with its newly created sales channel through KeyLink Systems, the Company
terminated the employment agreement of Brian Hoerl, its Vice-President of OEM
Sales and entered into a termination agreement with Mr. Hoerl effective August
20, 1999. Two additional field sales-reps were also terminated in the third
quarter of 1999. As a result, the Company recorded a restructuring charge of
$369,528, which reflects severance and related benefits payments, of which
$47,576 was paid as of September 30, 1999. The remaining amounts are expected to
be paid over a six month period ending March 31, 2000.
Tax Provision
A provision for income taxes of $368,632 was recognized for the nine months
ending September 30, 1998. No provision was recognized for the six months ending
June 30, 1998 due to losses reported for that period. There was no provision for
taxes for the nine months ending September 30, 1999.
<PAGE>
Liquidity and Capital Resources
The Company maintains a credit facility with Transamerica Business Credit
Corporation's Technology Finance Division, of Farmington, Connecticut. Currently
the Company has a five-year, $3 million term loan and a $4 million revolving
credit facility ("Revolver"). As of September 30, 1999, there was $2,411,091
outstanding under the term loan and $1,199,837 under the Revolver. (See Note 3
to the Financial Statements.)
The Company took down the term loan on June 12, 1997 when it signed the
agreement. Term loan payments of principal and interest are due in arrears in
twenty consecutive quarterly installments, payable on the first day of each
calendar quarter commencing October 1, 1997. The interest rate under the term
loan is based on the weekly average of the interest rate on five year U.S.
Treasury Securities for stated periods plus an agreed upon number of additional
basis points. At September 30, 1999, the interest rate in effect was 12.099%.
The Revolver provides for up to $4.0 million in advances based on a formula
of eligible accounts receivable and inventory. Amounts drawn under the Revolver
mature on June 12, 2000. Eligibility is computed monthly and amounts drawn that
are not supported by the formula are to be repaid at that time. Accordingly, the
Revolver balance is reflected as a current liability on the balance sheet. The
interest rate in effect under the Revolver is based on the prime rate plus 2.50%
and is payable monthly in arrears.
In addition, the credit agreement includes a material adverse effect
clause, whereby Transamerica can accelerate the due date of the loan if certain
changes in conditions (financial or otherwise) are deemed to have a material
adverse effect on the Company or its ability to meet its obligations.
On May 14, 1999 the Company executed an amendment to its agreement with
Transamerica that included a waiver for certain financial covenants the Company
was not in compliance with as of December 31, 1998 and March 31, 1999 and
amended covenants for 1999 and 2000. With the execution of this amendment all
previous financial covenants have been waived. Amended covenants consist of the
following:
o As of June 30, 1999 working capital shall be no less than $8,000,000.
The ratio of current assets to current liabilities shall not be less than
1.50 to 1.00. Tangible net worth shall not be less than $7,000,000.
o As of September 30, 1999 working capital shall be no less than $6,000,000.
The ratio of current assets to current liabilities shall not be less than
1.50 to 1.00. Tangible net worth shall not be less than $5,000,000.
o As of December 31, 1999 working capital shall be no less than $8,000,000.
The ratio of current assets to current liabilities shall not be less than
1.75 to 1.00. Tangible net worth shall not be less than $6,500,000.
o Gross Profit Margins for the year ending December 31, 1999 shall not be
less than 35%.
o Net losses before taxes for the year ending December 31, 1999 are not to
exceed $10,000,000.
o Net losses before taxes for the year ending December 31, 2000 are not to
exceed $ 0.
As of September 30, 1999 the Company is in compliance with these covenants.
Portions of the term note due beyond one year were classified as long term for
purposes of computing working capital and current ratio covenants. Due to the
uncertainty of attaining future covenants all Transamerica debt is reflected as
a current liability as of September 30, 1999.
<PAGE>
On October 18, 1999 the Company executed a further amendment to the credit
agreement that substantially reduces the amended financial covenants that the
Company must be in compliance with as of and for the year ending December 31,
1999. The only financial covenants that remain are as follows:
o As of December 31, 1999, working capital shall be no less than $2,000,000.
o The ratio of current assets to current liabilities shall not be less than
1.25 to 1.00.
o Tangible net worth shall not be less than $2,000,000.
o Gross profit margins for the year ending December 31, 1999 shall not be less
than 35%.
The amendment also eliminates financial covenants thereafter.
During the nine months ended September 30, 1999, there was a net decrease
in cash and cash equivalents of $11,844,303. At September 30, 1999, cash and
cash equivalents amounted to $6,152,272. Working capital amounted to $4,293,456
at September 30, 1999 as computed with all Transamerica debt reflected as a
current liability. This as compared to $12,632,033 at December 31, 1998.
Net cash used in operating activities for the nine months ended September
30, 1999 amounted to $9,449,257. The negative cash flows from operations were
due, in part, to the Company's net loss of $9,258,737 which was offset by
non-cash expenditures related to depreciation, amortization, reserves and
allowances of $1,774,874. Other operating cash uses included decreases in
accounts payable and accrued liabilities of $3,466,637 as the Company paid down
obligations of its subsidiary and accrued costs related to the sale of CSG and
executive bonuses. Such decreases were partially offset by increases in
operating cash due to reduced inventory and accounts receivable of $897,992 and
$452,799, respectively.
Net cash used in investing activities for the nine months ended September
30, 1999 amounted to $509,711 due to the purchases of computer and peripheral
equipment related to engineering staff and final test and assembly in
manufacturing.
Net cash used in financing activities for the nine months ended September
30, 1999 amounted to $1,927,501, reflecting principal payments on debt including
$1,115,164 against the Revolver.
The Company expects to incur costs and expenses in excess of expected
revenues as the Company continues to execute its business strategy in the
Internet Service Provider (ISP) and Original Equipment Manufacturer (OEM)
markets. There is no assurance that the Company will generate sufficient cash
flow from operations to liquidate liabilities as they come due. In the event
that the Company is unable to liquidate its liabilities, it may delay or
eliminate some expenditures and planned operations may be scaled back.
Accordingly the Company expects that it will need additional funds to meet
obligations through the next twelve months and will seek to raise such amounts
through a variety of options including expected future cash from operations,
borrowings, proceeds from equity or debt financing and scaling back operations.
Additional funding may not be available when needed or on terms acceptable
to the Company, which could have a material adverse effect on our business,
financial condition and results of operations.
<PAGE>
Year 2000 Disclosure
Overview
Until recently, many computer programs were written using two digits rather
than four digits to define the applicable year in the twentieth century. Such
software may recognize a date using "00" as the year 1900 rather than the year
2000. We have defined, assessed and converted or replaced various internal
computer programs and systems to ensure that our information technologies are
year 2000 compliant. This process and the testing of our critical systems for
year 2000 compliance were completed as of September 30, 1999. While year 2000
costs are not expected to be material to our financial position or any year's
results of operations, we cannot assure you that this will be the case.
Non-information technology systems, which include embedded technology such
as micro-controllers used in fax machines, photocopiers, telephone switches,
security systems and other common devices, may also be affected by the year 2000
problem. We are currently assessing the potential effect, if any, and the cost
of remediating the year 2000 problem with respect to our office and facilities
equipment.
State of readiness
While we have not tested all the products we have sold in the past, we test
our current products for year 2000 readiness, and because these products do not
utilize date codes, we believe that these products are year 2000 compliant.
However, due to the fact that these products interact with third party vendor
products and operate on computer systems not under our control, it is not
possible to be completely certain that all of the possible year 2000 problems
have been foreseen. We have not tested software provided by, nor sought
certifications from, third parties bundling software with our products. Our
reasonably likely worst case year 2000 scenario would be that these products and
bundled software from third parties fail in the year 2000, resulting in a
decreased demand for our products and damage to our brand. In the event of a
year 2000 failure, we would devote the necessary resources to correct it.
Because we do not believe our products are date code sensitive and because of
our skilled in-house developers and our relationships with the third parties
whose software we bundle with our products, we believe we will be able to
respond promptly to any failures that occur. The costs of such response and the
diversion of resources, however, could have a material adverse effect on our
business, results of operation and financial condition.
Bundled third party applications and software components
We have bundled third party applications and software components with a
limited number of our products. To date, we have made no assessment, and have no
knowledge, of year 2000 readiness of third parties whose products are bundled
with ours. We intend to contact these third parties and remedy problems on a
case-by-case basis as problems arise. Because we believe that the costs
associated with the failure of third party products will not be material to our
business, results of operations or financial condition, we do not intend to
expend resources to seek out and correct problems before they arise.
Accordingly, there is a possibility that some of our customers may experience
difficulties related to third party software, which may affect the performance
of our products and may lead to adverse results such as an unusually high number
of calls to our technical support department or other unusual requests for
information or assistance. Responding to these requests may divert resources
from pursuing our business strategy. Moreover, failure of applications bundled
with our products may reduce the value of our products, decrease or delay
revenues, tarnish our brand, give rise to breach of warranty claims or divert
resources, any of which could materially adversely affect our business, results
of operations and financial condition.
<PAGE>
Third party suppliers
We are seeking certification from contract manufacturers, component
suppliers and external systems providers regarding year 2000 compliance of their
systems, products and processes. Accordingly, we have initiated communications
with these suppliers to determine whether their operations and products and
services are year 2000 compliant. A survey of our major suppliers has revealed
that 82% have compliance programs in place and are, or will be, year 2000
compliant in a timely manner.
Contingency plans
Our contingency plans are based on the responses to our inquiries that we
have received from our suppliers and external system providers regarding year
2000 compliance of their systems, products and processes and are largely
dependent on the ability of the systems vendors and suppliers to put in place
alternative resources in the event their processes and systems fail as a result
of year 2000 issues. Depending on the systems affected, these plans could
include:
o accelerated replacement of affected equipment or software;
o short-term to medium-term use of backup equipment and software;
o increased work hours for our personnel; and
o use of contract personnel to correct, on an accelerated schedule,
any year 2000 issues that arise or to provide manuals (workarounds) for
information systems.
The implementation of any of these contingency plans could have a material
adverse effect on our business, results of operations and financial condition.
Costs
To date, we have not expended a material amount of capital resources on
year 2000 compliance and do not anticipate future expenditures to be material to
our business, results of operations and financial condition. We have not hired
additional personnel to specifically address our year 2000 compliance issues,
and presently, we do not expect to do so.
Recovery under existing insurance policies should be available depending
upon the circumstances of a year 2000 related event and the type of facility
involved. Generally, no recovery would be available in the event of an orderly
shutdown which does not result in damage to one of our facilities. Potential
recoveries in the event of facility damage, including business interruption,
would be subject to deductibles in place under these policies.
The above expectations are subject to uncertainties. For example, if we
have not identified or fixed all year 2000 problems in our critical operations,
or if we are affected by the inability of suppliers or major customers to
continue operations due to a year 2000 problem, our results of operations could
be materially impacted.
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The results of our operations and the valuation of some of our assets and
liabilities are sensitive to changes in the general level of interest rates in
the United States and foreign exchange rate fluctuations.
Interest rate risk
Our interest income is sensitive to changes in the general level of
interest rates in the United States, as our investments are in United States
dollar cash equivalents and short-term instruments.
Our interest expense is sensitive to changes in the general level of
interest rates in the United States, because the computation of interest due on
our debt in the United States is based on key interest rate indicators used in
the United States such as the prime rate.
Foreign exchange risk
We currently have foreign subsidiaries that conduct and report their
operations in local currency. The primary foreign currency is the French Franc.
Other currencies include the British Pound and the German Deutschmark. On
January 1, 1999, eleven member countries (including France and Germany) of the
European Union established fixed conversion rates between their existing, or
local, currencies and one common currency, the euro. The euro trades on currency
exchanges and may be used in business transactions. Conversion to the euro
eliminates currency exchange risk between the participating member countries.
Due to the limited contribution of our foreign subsidiaries to our results
of operations, the short-term nature of our cash equivalents, investments and
debt, we do not believe we have material market risk exposure.
Part II. Other Information
Item 1. Legal proceedings - None
Item 2. Changes in Securities - None
Item 3. Defaults upon senior securities - None
Item 4. Submissions of matters to a vote of shareholders - None
Item 5. Other Information - None
Item 6. Exhibits and Reports on Form 8-K
a)Exhibits - Exhibit 27 - Financial Data Schedule (Filed Electronically)
b) Reports on Form 8-K - None.
<PAGE>
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
Ariel Corporation
------------------
Registrant
/S/ JOHN R. LOPRETE
-------------------------
John R. Loprete
Vice President of Finance and
Principal Accounting Officer
Date: November 15, 1999
<PAGE>
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