SEC Company Response from ARKONA INC (CIK 0000925662) — Nov 7, 2005
ARKONA INC (CIK 0000925662)
Date: Nov. 7, 2005 · CIK: 0000925662 · Accession: 0000931731-05-000209
AI Filing Summary & Sentiment
File numbers found in text: 000-24372
Letter
November 7, 2005 FILED VIA EDGAR AS CORRESPONDENCE AND SENT VIA FEDERAL EXPRESS Mr. Stephen Krikorian Accounting Branch Chief Securities and Exchange Commission Room 4561 Washington, D.C. 20549
Re: Arkona, Inc. Form 10-KSB for the fiscal year ended March 31, 2005 Filed July 14, File No. 000-24372
Dear Mr. Krikorian:
As outside U.S. securities counsel for Arkona, Inc. ("Arkona" or the "Company"), we are writing in response to your letter to the Company dated September 23, 2005 (your "Letter"). Each of our responses is based solely on information we have been provided by Arkona, and all representations and commitments are those of Arkona. For clarity, each of our responses is preceded by a bolded restatement of your request (provided that we have broken up your request number 12 into separate questions in order to ensure that we have responded to all subquestions). Throughout this response, references to a "[year] fiscal year" refer to this fiscal year ended March 31 of the year in question.
Background Information
Many of the questions in your letter relate to how the Company has accounted for revenues and expenses associated with the Company's primary product, its Arkona Dealer Management Software ("ADMS") and a related adjustment reflected in Note 15 of the financial statements included in the Company's Form 10-KSB for fiscal year 2005 (the "2005 10-KSB"). In order to facilitate the answers that follow, and avoid needless repetition, the following paragraphs in this "Background Information" section provide certain background information about the Company and certain of its accounting policies.
Prior to November 2000, the Company was a development stage company in the process of developing a "database updating" software product called Universal Update. In November 2000, the Company acquired substantially all of the assets of Ensign Information Systems, Inc. ("Ensign"), which was in the business of providing back office management software for automobile dealerships and similar entities. This business quickly became the primary business of the Company. Based upon its interpretation of the books and records of Ensign, the Company determined to allocate $305,682 of the purchase price to technology rights costs associated with the predecessor to the ADMS software The Company
<PAGE> Stephen Krikorian November 7, 2005 Page 2
booked an asset (such asset, the "Acquired Software Asset") in that amount and began amortizing the asset over two years. By the early part of fiscal 2003, the Company had amortized an aggregate of $229,262 of the Acquired Software Asset, leaving a remainder of $76,420. The Company ceased amortizing the asset at that point based upon its determination that, because the Acquired Software Asset had an indefinite life, it was no longer subject to amortization, but, under FASB 142, was subject to annual impairment testing. The Company has continued to test the Acquired Software Asset annually and believes that no impairment has occurred.
Between November 2000 and the end of fiscal year 2003, the Company expensed all costs associated with software development. In fiscal 2004, the Company determined that it could capitalize certain software development expenses. Some of these capitalized software development expenses related to various enhancements and add-ons to the ADMS software; however, most of the capitalized software development expenses related to OEM manufacturer integration software. It has become increasingly important for automobile dealerships to be able to communicate electronically with the OEM (such as Ford, GM, Toyota, etc.). With proper connections and communications software, much of the ordering of parts and inventory, and the making of reports to the OEM, can be done automatically by computers communicating directly with computers. Unfortunately, each OEM has a different interface and integration process. Establishing an interface between an OEM and the ADMS (referred to as OEM integration) typically involves the creation of a special software program for the interface. Creation and refinement of this special software program requires the expenditure of a significant amount of time by software engineers at the Company and the OEM. To date, the Company has integrated with 26 of the 38 major automobile OEMs.
As noted above, at or about the beginning of fiscal 2004, the Company determined, with the input of the Chief Financial Officer, outside auditors and board of directors, that it should capitalize some of the costs associated with the OEM integration process in accordance with SFAS No. 86. The Company determined that, in light of the foundation of experience and core software it and the various OEMs had developed with respect to the software for interfacing with the OEM, substantially all of the engineering costs associated with developing software for each additional OEM were occurring after the establishing of the technical feasibility but prior to completion of the OEM integration. Consistent with this determination, the Company capitalized an aggregate of $384,398 and $378,400 in software development costs in fiscal 2004 and 2005, respectively. (This asset is hereinafter referred to as the "OEM Software Asset").
On or about April 11, 2005, the Company hired a new Chief Financial Officer. As part of his effort to understand how these capitalized assets were determined, he reviewed the records of the Company related to the capitalization of software, requested records from the Company's independent auditors (which had at one time assisted with the development of certain work papers and records) and discussed the issue with the independent auditors. The process ended in what now appears to be a mistaken determination that the Acquired Software Asset and the OEM Software Asset had the same origins - i.e. they both represented the capitalization of OEM integration costs - and, accordingly, should be consolidated (as consolidated the "Consolidated Software Asset") and amortized together beginning with the completion of the first OEM integration in May 2002.
<PAGE>
Stephen Krikorian November 7, 2005 Page 3 The determination was made, after consultation with the independent auditors, to restate the capitalization and amortization of the Consolidated Software Asset as set forth in the following table:
---------------------------------- ---------------------- ---------------------- As Restated in the Software Costs As Initially Reported 2005 10-KSB ---------------------------------- ---------------------- ---------------------- Balance 03/31/00 $ - $ - ---------------------------------- ---------------------- ---------------------- Additions $ 305,682 $ 305,683 ---------------------------------- ---------------------- ---------------------- Amortization $ (63,684) $ - ---------------------------------- ---------------------- ---------------------- Balance 03/31/01 $ 241,998 $ 305,683 ---------------------------------- ---------------------- ---------------------- Additions $ - $ - ---------------------------------- ---------------------- ---------------------- Amortization $ (152,841) $ - ---------------------------------- ---------------------- ---------------------- Balance 03/31/02 $ 89,157 $ 305,683 ---------------------------------- ---------------------- ---------------------- Additions $ - $ - ---------------------------------- ---------------------- ---------------------- Amortization $ (12,737) $ (39,739) ---------------------------------- ---------------------- ---------------------- Balance 03/31/03 $ 76,420 $ 265,944 ---------------------------------- ---------------------- ---------------------- Additions $ 384,398 $ 357,312 ---------------------------------- ---------------------- ---------------------- Amortization $ - $ (63,073) ---------------------------------- ---------------------- ---------------------- Balance 03/31/04 $ 460,818 $ 560,183 ---------------------------------- ---------------------- ---------------------- Additions $ 378,400 $ 378,400 ---------------------------------- ---------------------- ---------------------- Amortization $ (134,034) $ (134,034) ---------------------------------- ---------------------- ---------------------- Balance 03/31/05 $ 705,184 $ 804,549 ---------------------------------- ---------------------- ----------------------
This table reflects four key steps. The first was the reversal of $229,262 in amortization expense originally recorded in fiscal years 2001, 2002 and 2003 with respect to the $305,682 Acquired Software Asset. The basis for the reversal was the mistaken belief that these expenses should be grouped with the OEM integration software and, accordingly, should be amortized (not over two years as previously reported) but over five years beginning with the Company's first announced completion of OEM integration software in May 2002. The second was the capitalization of OEM integration expenses for periods beginning in fiscal 2004. As stated above, the Company determined to capitalize OEM integration expenses beginning in fiscal 2004; there appears to be no change in the underlying factual circumstances between fiscal 2002 and 2004. The third was the development of amortization schedules with respect to the Consolidated Software Asset and the application of those schedules to periods following the completion of the first OEM integration in May 2002. The basis for this was the new Chief Financial Officer's belief that the Consolidated Software Asset costs should have been allocated to completed OEM integrations and amortized on a straight line basis over the expected life of the asset. The fourth was a decrease, from $384,398 to $357,312 in the amount of software development costs capitalized during fiscal 2004. The basis for this was the consistent capitalization of only salaries and outside consultant costs associated with the OEM integration process.
In the process of preparing a response to your Letter, the new Chief Financial Officer conducted a more thorough inquiry into the origins of the Acquired Software Asset, the OEM Software Asset, the ADMS software, the OEM integration process and related items. Although this inquiry confirmed most of the Company's prior determinations, it has led to a determination by the Company (with the approval of the Company's board of directors and independent auditors) that a second correction is required, in part reversing some of the adjustments reflected on the 2005 10-KSB. <PAGE>
Stephen Krikorian November 7, 2005 Page 4 In order to ensure accuracy, the Company is still confirming and testing its conclusions and does not expect to be able to file a planned Amendment No. 1 on Form 10-KSB/A for the year ended March 31, 2005 (the "2005 10-KSB Amendment") for approximately one week. At this point, however, the Company expects new adjustments to capitalization and amortization, as set forth below:
---------------------------------- ---------------------- ---------------------- As Reported in the To be Reported in the Acquired Software Asset 2005 10-KSB 2005 10-KSB Amendment ---------------------------------- ---------------------- ---------------------- Balance 03/31/00 $ - $ - ---------------------------------- ---------------------- ---------------------- Additions $ - $ 305,682 ---------------------------------- ---------------------- ---------------------- Amortization $ - (63,684) ---------------------------------- ---------------------- ---------------------- Balance 03/31/01 $ - 241,998 ---------------------------------- ---------------------- ---------------------- Additions $ - $ - ---------------------------------- ---------------------- ---------------------- Amortization $ - $ (152,841) ---------------------------------- ---------------------- ---------------------- Balance 03/31/02 $ - $ 89,157 ---------------------------------- ---------------------- ---------------------- Additions $ - $ - ---------------------------------- ---------------------- ---------------------- Amortization $ - $ (12,737) ---------------------------------- ---------------------- ---------------------- Balance 03/31/03 $ - $ 76,420 ---------------------------------- ---------------------- ---------------------- Additions $ - $ - ---------------------------------- ---------------------- ---------------------- Amortization $ - $ - ---------------------------------- ---------------------- ---------------------- Balance 03/31/04 $ - $ 76,420 ---------------------------------- ---------------------- ---------------------- Additions $ - $ - ---------------------------------- ---------------------- ---------------------- Amortization $ - $ - ---------------------------------- ---------------------- ---------------------- Balance 03/31/05 $ - $ 76,420 ================================== ====================== ======================
---------------------------------- ---------------------- ---------------------- As Reported in the To be Reported in the OEM Software Asset 2005 10-KSB 2005 10-KSB Amendment ---------------------------------- ---------------------- ---------------------- Balance 03/31/00 $ - $ - ---------------------------------- ---------------------- ---------------------- Additions $ 305,683 119,165 ---------------------------------- ---------------------- ---------------------- Amortization $ - $ - ---------------------------------- ---------------------- ---------------------- Balance 03/31/
Show Raw Text
<DOCUMENT>
<TYPE>CORRESP
<SEQUENCE>1
<FILENAME>filename1.txt
<TEXT>
November 7, 2005
FILED VIA EDGAR AS CORRESPONDENCE AND SENT VIA FEDERAL EXPRESS
Mr. Stephen Krikorian
Accounting Branch Chief
Securities and Exchange Commission
Room 4561
Washington, D.C. 20549
Re: Arkona, Inc.
Form 10-KSB for the fiscal year ended March 31, 2005 Filed July 14,
2005
File No. 000-24372
Dear Mr. Krikorian:
As outside U.S. securities counsel for Arkona, Inc. ("Arkona" or the
"Company"), we are writing in response to your letter to the Company dated
September 23, 2005 (your "Letter"). Each of our responses is based solely on
information we have been provided by Arkona, and all representations and
commitments are those of Arkona. For clarity, each of our responses is preceded
by a bolded restatement of your request (provided that we have broken up your
request number 12 into separate questions in order to ensure that we have
responded to all subquestions). Throughout this response, references to a
"[year] fiscal year" refer to this fiscal year ended March 31 of the year in
question.
Background Information
Many of the questions in your letter relate to how the Company has
accounted for revenues and expenses associated with the Company's primary
product, its Arkona Dealer Management Software ("ADMS") and a related adjustment
reflected in Note 15 of the financial statements included in the Company's Form
10-KSB for fiscal year 2005 (the "2005 10-KSB"). In order to facilitate the
answers that follow, and avoid needless repetition, the following paragraphs in
this "Background Information" section provide certain background information
about the Company and certain of its accounting policies.
Prior to November 2000, the Company was a development stage company in
the process of developing a "database updating" software product called
Universal Update. In November 2000, the Company acquired substantially all of
the assets of Ensign Information Systems, Inc. ("Ensign"), which was in the
business of providing back office management software for automobile dealerships
and similar entities. This business quickly became the primary business of the
Company. Based upon its interpretation of the books and records of Ensign, the
Company determined to allocate $305,682 of the purchase price to technology
rights costs associated with the predecessor to the ADMS software The Company
<PAGE>
Stephen Krikorian
November 7, 2005
Page 2
booked an asset (such asset, the "Acquired Software Asset") in that amount and
began amortizing the asset over two years. By the early part of fiscal 2003, the
Company had amortized an aggregate of $229,262 of the Acquired Software Asset,
leaving a remainder of $76,420. The Company ceased amortizing the asset at that
point based upon its determination that, because the Acquired Software Asset had
an indefinite life, it was no longer subject to amortization, but, under FASB
142, was subject to annual impairment testing. The Company has continued to test
the Acquired Software Asset annually and believes that no impairment has
occurred.
Between November 2000 and the end of fiscal year 2003, the Company
expensed all costs associated with software development. In fiscal 2004, the
Company determined that it could capitalize certain software development
expenses. Some of these capitalized software development expenses related to
various enhancements and add-ons to the ADMS software; however, most of the
capitalized software development expenses related to OEM manufacturer
integration software. It has become increasingly important for automobile
dealerships to be able to communicate electronically with the OEM (such as Ford,
GM, Toyota, etc.). With proper connections and communications software, much of
the ordering of parts and inventory, and the making of reports to the OEM, can
be done automatically by computers communicating directly with computers.
Unfortunately, each OEM has a different interface and integration process.
Establishing an interface between an OEM and the ADMS (referred to as OEM
integration) typically involves the creation of a special software program for
the interface. Creation and refinement of this special software program requires
the expenditure of a significant amount of time by software engineers at the
Company and the OEM. To date, the Company has integrated with 26 of the 38 major
automobile OEMs.
As noted above, at or about the beginning of fiscal 2004, the Company
determined, with the input of the Chief Financial Officer, outside auditors and
board of directors, that it should capitalize some of the costs associated with
the OEM integration process in accordance with SFAS No. 86. The Company
determined that, in light of the foundation of experience and core software it
and the various OEMs had developed with respect to the software for interfacing
with the OEM, substantially all of the engineering costs associated with
developing software for each additional OEM were occurring after the
establishing of the technical feasibility but prior to completion of the OEM
integration. Consistent with this determination, the Company capitalized an
aggregate of $384,398 and $378,400 in software development costs in fiscal 2004
and 2005, respectively. (This asset is hereinafter referred to as the "OEM
Software Asset").
On or about April 11, 2005, the Company hired a new Chief Financial
Officer. As part of his effort to understand how these capitalized assets were
determined, he reviewed the records of the Company related to the capitalization
of software, requested records from the Company's independent auditors (which
had at one time assisted with the development of certain work papers and
records) and discussed the issue with the independent auditors. The process
ended in what now appears to be a mistaken determination that the Acquired
Software Asset and the OEM Software Asset had the same origins - i.e. they both
represented the capitalization of OEM integration costs - and, accordingly,
should be consolidated (as consolidated the "Consolidated Software Asset") and
amortized together beginning with the completion of the first OEM integration in
May 2002.
<PAGE>
Stephen Krikorian
November 7, 2005
Page 3
The determination was made, after consultation with the independent
auditors, to restate the capitalization and amortization of the Consolidated
Software Asset as set forth in the following table:
---------------------------------- ---------------------- ----------------------
As Restated in the
Software Costs As Initially Reported 2005 10-KSB
---------------------------------- ---------------------- ----------------------
Balance 03/31/00 $ - $ -
---------------------------------- ---------------------- ----------------------
Additions $ 305,682 $ 305,683
---------------------------------- ---------------------- ----------------------
Amortization $ (63,684) $ -
---------------------------------- ---------------------- ----------------------
Balance 03/31/01 $ 241,998 $ 305,683
---------------------------------- ---------------------- ----------------------
Additions $ - $ -
---------------------------------- ---------------------- ----------------------
Amortization $ (152,841) $ -
---------------------------------- ---------------------- ----------------------
Balance 03/31/02 $ 89,157 $ 305,683
---------------------------------- ---------------------- ----------------------
Additions $ - $ -
---------------------------------- ---------------------- ----------------------
Amortization $ (12,737) $ (39,739)
---------------------------------- ---------------------- ----------------------
Balance 03/31/03 $ 76,420 $ 265,944
---------------------------------- ---------------------- ----------------------
Additions $ 384,398 $ 357,312
---------------------------------- ---------------------- ----------------------
Amortization $ - $ (63,073)
---------------------------------- ---------------------- ----------------------
Balance 03/31/04 $ 460,818 $ 560,183
---------------------------------- ---------------------- ----------------------
Additions $ 378,400 $ 378,400
---------------------------------- ---------------------- ----------------------
Amortization $ (134,034) $ (134,034)
---------------------------------- ---------------------- ----------------------
Balance 03/31/05 $ 705,184 $ 804,549
---------------------------------- ---------------------- ----------------------
This table reflects four key steps. The first was the reversal of
$229,262 in amortization expense originally recorded in fiscal years 2001, 2002
and 2003 with respect to the $305,682 Acquired Software Asset. The basis for the
reversal was the mistaken belief that these expenses should be grouped with the
OEM integration software and, accordingly, should be amortized (not over two
years as previously reported) but over five years beginning with the Company's
first announced completion of OEM integration software in May 2002. The second
was the capitalization of OEM integration expenses for periods beginning in
fiscal 2004. As stated above, the Company determined to capitalize OEM
integration expenses beginning in fiscal 2004; there appears to be no change in
the underlying factual circumstances between fiscal 2002 and 2004. The third was
the development of amortization schedules with respect to the Consolidated
Software Asset and the application of those schedules to periods following the
completion of the first OEM integration in May 2002. The basis for this was the
new Chief Financial Officer's belief that the Consolidated Software Asset costs
should have been allocated to completed OEM integrations and amortized on a
straight line basis over the expected life of the asset. The fourth was a
decrease, from $384,398 to $357,312 in the amount of software development costs
capitalized during fiscal 2004. The basis for this was the consistent
capitalization of only salaries and outside consultant costs associated with the
OEM integration process.
In the process of preparing a response to your Letter, the new Chief
Financial Officer conducted a more thorough inquiry into the origins of the
Acquired Software Asset, the OEM Software Asset, the ADMS software, the OEM
integration process and related items. Although this inquiry confirmed most of
the Company's prior determinations, it has led to a determination by the Company
(with the approval of the Company's board of directors and independent auditors)
that a second correction is required, in part reversing some of the adjustments
reflected on the 2005 10-KSB.
<PAGE>
Stephen Krikorian
November 7, 2005
Page 4
In order to ensure accuracy, the Company is still confirming and
testing its conclusions and does not expect to be able to file a planned
Amendment No. 1 on Form 10-KSB/A for the year ended March 31, 2005 (the "2005
10-KSB Amendment") for approximately one week. At this point, however, the
Company expects new adjustments to capitalization and amortization, as set forth
below:
---------------------------------- ---------------------- ----------------------
As Reported in the To be Reported in the
Acquired Software Asset 2005 10-KSB 2005 10-KSB Amendment
---------------------------------- ---------------------- ----------------------
Balance 03/31/00 $ - $ -
---------------------------------- ---------------------- ----------------------
Additions $ - $ 305,682
---------------------------------- ---------------------- ----------------------
Amortization $ - (63,684)
---------------------------------- ---------------------- ----------------------
Balance 03/31/01 $ - 241,998
---------------------------------- ---------------------- ----------------------
Additions $ - $ -
---------------------------------- ---------------------- ----------------------
Amortization $ - $ (152,841)
---------------------------------- ---------------------- ----------------------
Balance 03/31/02 $ - $ 89,157
---------------------------------- ---------------------- ----------------------
Additions $ - $ -
---------------------------------- ---------------------- ----------------------
Amortization $ - $ (12,737)
---------------------------------- ---------------------- ----------------------
Balance 03/31/03 $ - $ 76,420
---------------------------------- ---------------------- ----------------------
Additions $ - $ -
---------------------------------- ---------------------- ----------------------
Amortization $ - $ -
---------------------------------- ---------------------- ----------------------
Balance 03/31/04 $ - $ 76,420
---------------------------------- ---------------------- ----------------------
Additions $ - $ -
---------------------------------- ---------------------- ----------------------
Amortization $ - $ -
---------------------------------- ---------------------- ----------------------
Balance 03/31/05 $ - $ 76,420
================================== ====================== ======================
---------------------------------- ---------------------- ----------------------
As Reported in the To be Reported in the
OEM Software Asset 2005 10-KSB 2005 10-KSB Amendment
---------------------------------- ---------------------- ----------------------
Balance 03/31/00 $ - $ -
---------------------------------- ---------------------- ----------------------
Additions $ 305,683 119,165
---------------------------------- ---------------------- ----------------------
Amortization $ - $ -
---------------------------------- ---------------------- ----------------------
Balance 03/31/