##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-QSB
  þ
    
    QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended October 31, 2006
 o
    
    TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
 For the transition period from  to
 Commission file number 000-19608
 ARI Network Services, Inc.
  WISCONSIN
    
    39-1388360(State or other jurisdiction of
    
    (IRS Employer Identification No.)incorporation or organization)
 11425 W. Lake Park Drive, Milwaukee, Wisconsin 53224
   þ o
  o þ
   o þ




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##### 



ARI Network Services, Inc.
    PagePART I  FINANCIAL INFORMATIONItem 1 Financial statementsCondensed consolidated balance sheets  October 31, 2006 and July 31, 2006
    
    3-4Condensed consolidated statements of operations for the three
months ended October 31, 2006 and 2005
    
    5Condensed consolidated statements of cash flows for the three months ended
October 31, 2006 and 2005
    
    6Notes to unaudited condensed consolidated financial statements
    
    7-11Item 2 Managements discussion and analysis or plan of operation
    
    11-20Item 3 Controls and procedures
    
    21PART II  OTHER INFORMATIONItem 2 Unregistered sales of equity securities and use of proceeds
    
    21Item 6 Exhibits
    
    21Signatures
    
    22Summary of Non-Employee Director Compensation Arrangement302 Certification of Chief Executive Officer302 Certification of Chief Financial Officer906 Certification of Chief Executive Officer906 Certification of Chief Financial Officer
  2




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ARI Network Services, Inc.
 
 Consolidated Balance Sheets
 (In thousands, except share and per share data)
 (Unaudited)
 October 31
    
    
    July 312006
    
    
    2006ASSETSCurrent assets:Cash and cash equivalents
    
    $
    3,191
    
    
    $
    3,584Trade receivables, less allowance for doubtful accounts of $89 and
$103 at October 31, 2006 and July 31, 2006, respectively
    
    
    609
    
    
    
    885Work in Progress
    
    
    143
    
    
    
    163Prepaid expenses and other
    
    
    245
    
    
    
    254Deferred income taxes
    
    
    675
    
    
    
    675Total current assets
    
    
    4,863
    
    
    
    5,561Equipment and leasehold improvements:Computer equipment
    
    
    5,130
    
    
    
    5,084Leasehold improvements
    
    
    123
    
    
    
    116Furniture and equipment
    
    
    2,139
    
    
    
    2,0577,392
    
    
    
    7,257Less accumulated depreciation and amortization
    
    
    6,382
    
    
    
    6,275Net equipment and leasehold improvements
    
    
    1,010
    
    
    
    982Deferred income taxes
    
    
    1,419
    
    
    
    1,419Other assets
    
    
    4
    
    
    
    6Capitalized software product costs
    
    
    11,635
    
    
    
    11,557Less accumulated amortization
    
    
    10,276
    
    
    
    10,089Net capitalized software product costs
    
    
    1,359
    
    
    
    1,468Total Assets
    
    $
    8,655
    
    
    $
    9,436
 3




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##### Table of Contents



ARI Network Services, Inc.
Consolidated Balance Sheets  (In thousands, except share and per share data)  (Unaudited)
 October 31
    
    
    July 312006
    
    
    2006LIABILITIES AND SHAREHOLDERS EQUITY (DEFICIT)Current liabilities:Current portion of notes payable
    
    $
    1,400
    
    
    $
    1,400Accounts payable
    
    
    384
    
    
    
    500Deferred revenue
    
    
    4,990
    
    
    
    5,616Accrued payroll and related liabilities
    
    
    1,124
    
    
    
    1,006Accrued sales, use and income taxes
    
    
    8
    
    
    
    38Accrued vendor specific liabilities
    
    
    
    
    
    
    104Other accrued liabilities
    
    
    301
    
    
    
    254Total current liabilities
    
    
    8,207
    
    
    
    8,918Long term liabilities:Notes payable (net of discount)
    
    
    219
    
    
    
    580Long term payroll related
    
    
    202
    
    
    
    202Other long term liabilities
    
    
    43
    
    
    
    48Total long term liabilities
    
    
    464
    
    
    
    830Shareholders equity (deficit):Cumulative preferred stock, par value $.001 per share,
1,000,000 shares authorized; 0 shares issued and
outstanding at October 31, 2006 and July 31, 2006, respectively
    
    
    
    
    
    
    Common stock, par value $.001 per share, 25,000,000 shares
authorized; 6,227,335 and 6,202,529 shares issued and outstanding
at October 31, 2006 and July 31, 2006, respectively
    
    
    6
    
    
    
    6Common stock warrants and options
    
    
    62
    
    
    
    36Additional paid-in-capital
    
    
    93,883
    
    
    
    93,838Accumulated deficit
    
    
    (93,967
    )
    
    
    (94,192
    )Total shareholders equity (deficit)
    
    
    (16
    )
    
    
    (312
    )Total Liabilities and Shareholders Equity (Deficit)
    
    $
    8,655
    
    
    $
    9,436
 See notes to unaudited condensed consolidated financial statements.
 Note:
    
    The balance sheet at July 31, 2006 has been derived from the audited balance sheet at
that date but does not include all of the information and footnotes required by accounting
principles generally accepted in the United States for complete financial statements.
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ARI Network Services, Inc.
 
 Consolidated Statements of Operations
 (In thousands, except per share data)
 (Unaudited)
 Three months endedOctober 312006
    
    
    2005Net revenues:Subscriptions, support and other services fees
    
    $
    2,663
    
    
    $
    2,564Software licenses and renewals
    
    
    543
    
    
    
    518Professional services
    
    
    297
    
    
    
    4093,503
    
    
    
    3,491Cost of products and services sold:Subscriptions, support and other services fees
    
    
    272
    
    
    
    181Software licenses and renewals *
    
    
    196
    
    
    
    158Professional services
    
    
    78
    
    
    
    111546
    
    
    
    450Gross margin
    
    
    2,957
    
    
    
    3,041Operating expenses:Depreciation and amortization (exclusive of amortization of
software products included in cost of products and
services sold)
    
    
    106
    
    
    
    80Customer operations and support
    
    
    268
    
    
    
    303Selling, general and administrative
    
    
    1,985
    
    
    
    1,859Software development and technical support
    
    
    369
    
    
    
    275Net operating expenses
    
    
    2,728
    
    
    
    2,517Operating income
    
    
    229
    
    
    
    524Other income (expense):Interest expense
    
    
    (38
    )
    
    
    (49
    )Other, net
    
    
    34
    
    
    
    23Total other income (expense)
    
    
    (4
    )
    
    
    (26
    )Income before provision for income taxes
    
    
    225
    
    
    
    498Income tax benefit (provision)
    
    
    
    
    
    
    Net income
    
    $
    225
    
    
    $
    498Average common shares outstanding:Basic
    
    
    6,210
    
    
    
    6,126Diluted
    
    
    6,587
    
    
    
    6,729Basic and diluted net income per share:Basic
    
    $
    0.04
    
    
    $
    0.08Diluted
    
    $
    0.03
    
    
    $
    0.07
 See notes to unaudited condensed consolidated financial statements.
 
 *
    
    Includes amortization of software products of $187 and $145 and excludes other depreciation
and amortization shown separately 5




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ARI Network Services, Inc.
 
 Consolidated Statements of Cash Flows
 (In thousands)
 (Unaudited)
 Three months endedOctober 312006
    
    
    2005Operating activitiesNet income
    
    $
    225
    
    
    $
    498Adjustments to reconcile net income to net cash provided
by operating activities:Amortization of software products
    
    
    187
    
    
    
    145Amortization of deferred financing costs, debt discount and
excess carrying value over face amount of notes payable
    
    
    (11
    )
    
    
    (16
    )Depreciation and other amortization
    
    
    106
    
    
    
    81Stock based compensation related to stock options
    
    
    26
    
    
    
    Stock issued as contribution to 401(k) plan
    
    
    42
    
    
    
    21Net change in receivables, prepaid expenses and other
current assets
    
    
    307
    
    
    
    119Net change in accounts payable, deferred revenue,
accrued liabilities and other long term liabilities
    
    
    (716
    )
    
    
    (472
    )Net cash provided by operating activities
    
    
    166
    
    
    
    376Investing activitiesPurchase of equipment and leasehold improvements
    
    
    (134
    )
    
    
    (77
    )Software product costs capitalized
    
    
    (78
    )
    
    
    (178
    )Net cash used in investing activities
    
    
    (212
    )
    
    
    (255
    )Financing activitiesPayments under notes payable
    
    
    (350
    )
    
    
    (250
    )Proceeds from issuance of common stock
    
    
    3
    
    
    
    33Net cash used in financing activities
    
    
    (347
    )
    
    
    (217
    )Net decrease in cash
    
    
    (393
    )
    
    
    (96
    )Cash at beginning of period
    
    
    3,584
    
    
    
    3,651Cash at end of period
    
    $
    3,191
    
    
    $
    3,555Cash paid for interest
    
    $
    51
    
    
    $
    65Cash paid for income taxes
    
    $
    14
    
    
    $
    
 See notes to unaudited condensed consolidated financial statements.
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Notes to Condensed Consolidated Financial Statements
 (Unaudited)
 October 31, 2006
 1. BASIS OF PRESENTATION
    2. BASIC AND DILUTED NET INCOME PER SHARE
  Three months endedOctober 312006
    
    2005Weighted average common shares outstanding
    
    
    6,210
    
    
    
    6,126Dilutive effect of stock options and warrants
    
    
    377
    
    
    
    603Diluted weighted average common shares outstanding
    
    
    6,587
    
    
    
    6,729
 3. STOCK-BASED COMPENSATION
    7




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Three months endedOctober 31,2006
    
    2005Expected life (years)
    
    10 years
    
    10 yearsRisk-free interest rate
    
    4.88%
    
    4.00%Expected volatility
    
    124%
    
    124%Expected dividend yield
    
    0%
    
    0%
  Three months endedOctober 312005Net income as reported
    
    $
    498Stock-based compensation expense determined
under fair value based method for options
    
    
    (82
    )Pro forma net income
    
    $
    416Pro forma net income per share  basic
    
    $
    .07Pro forma net income per share  diluted
    
    $
    .06
 Employee Stock Purchase Plans
  Stock Option Plans
  1991 Stock Option Plan
   8




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Weighted-AverageWeighted-Average
    
    Remaining Contractual
    
    Aggregate IntrinsicOptions
    
    Exercise Price
    
    Period
    
    ValueOutstanding at August 1, 2006
    
    
    146,686
    
    
    $
    2.28
    
    
    
    2.85
    
    
    $
    13,125Granted
    
    
    
    
    
    
    Exercised
    
    
    
    
    
    
    Forfeited
    
    
    
    
    
    
    Outstanding at October 31, 2006
    
    
    146,686
    
    
    $
    2.28
    
    
    
    2.60
    
    
    
    Exercisable at October 31, 2006
    
    
    146,686
    
    
    $
    2.28
    
    
    
    2.60
    
    
    
    
  2000 Stock Option Plan
      Weighted-AverageWeighted-Average
    
    Remaining Contractual
    
    Aggregate IntrinsicOptions
    
    Exercise Price
    
    Period
    
    ValueOutstanding at August 1, 2006
    
    
    1,054,350
    
    
    $
    1.35
    
    
    
    7.27
    
    
    $
    814,975Granted
    
    
    50,000
    
    
    $
    2.10Exercised
    
    
    (6,250
    )
    
    $
    .28Forfeited
    
    
    (53.500
    )
    
    $
    1.38Outstanding at October 31, 2006
    
    
    1,044,600
    
    
    $
    1.39
    
    
    
    7.18
    
    
    $
    710,480Exercisable at October 31, 2006
    
    
    818,051
    
    
    $
    1.30
    
    
    
    6.79
    
    
    $
    624,157
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Weighted-Average GrantOptions
    
    Date Fair ValueNon-vested at August 1, 2006
    
    
    188,799
    
    
    $
    1.59Granted
    
    
    50,000
    
    
    $
    2.10Vested
    
    
    
    
    
    
    Forfeited
    
    
    (12,250
    )
    
    $
    1.35Non-vested at October 31, 2006
    
    
    226,549
    
    
    $
    1.72
  1993 Director Stock Option Plan
    Weighted-AverageWeighted-Average
    
    Remaining Contractual
    
    Aggregate IntrinsicOptions
    
    Exercise Price
    
    Period
    
    ValueOutstanding at August 1, 2006
    
    
    1,313
    
    
    $
    2.65
    
    
    
    3.97
    
    
    $
    152Granted
    
    
    
    
    
    
    Exercised
    
    
    
    
    
    
    Forfeited
    
    
    
    
    
    
    Outstanding at October 31, 2006
    
    
    1,313
    
    
    $
    2.65
    
    
    
    3.72
    
    
    
    Exercisable at October 31, 2006
    
    
    1,313
    
    
    $
    2.65
    
    
    
    3.72
    
    
    
    
  4. NOTES PAYABLE
    10




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5. SHAREHOLDER RIGHTS PLAN
  6. INCOME TAXES
  Three months endedOctober 312006
    
    
    2005Current:Federal
    
    $
    80
    
    
    $
    169State
    
    
    20
    
    
    
    30Deferred
    
    
    
    
    
    
    Utilization of net operating loss carryforwards
    
    
    (100
    )
    
    
    (199
    )Income tax benefit (provision)
    
    $
    
    
    
    $
    
  
 MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
 Results of Operations
   11




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Critical Accounting Policies and Estimates
 General
   Revenue Recognition
  Bad Debts
  Use of Estimates
  Legal Provisions
  Impairment of Long-Lived Assets
  Cash and Cash Equivalents
  12




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Debt Instruments
  Deferred Tax Asset
  Stock-Based Compensation
  13




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Revenues
   Catalog, Customer and Subscription Information by Region
(As of October 31, 2006)
 Distinct
    
    DistinctDistinct
    
    
    
    
    
    Distributors
    
    DealersCatalogs
    
    Manufacturers
    
    Subscriptions
    
    (Estimated)
    
    (Estimated)North America
    
    
    87
    
    
    
    67
    
    
    
    66,983
    
    
    
    92
    
    
    
    20,336Rest of World
    
    
    57
    
    
    
    10
    
    
    
    8,994
    
    
    
    58
    
    
    
    5,465Included in both Regions
    
    
    (45
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    99
    
    
    
    77
    
    
    
    75,977
    
    
    
    150
    
    
    
    25,801
 Catalog =
    
    A separately sold and/or distributed parts catalog. A manufacturer may have more than
one catalog. More than one brand or distinct product line may be included in a catalog.Distinct Manufacturer =
    
    A single independent manufacturer, not owned by another manufacturer, served by
ARI. Distinct manufacturers are included in the region they most serve even if they
have catalogs in both regions.Subscription =
    
    Catalogs subscribed to by a single dealer or distributor. A dealer or
distributor may subscribe to more than one catalog.Distinct Distributor =
    
    A single independent distributor, not owned by another distributor, served by ARI. A
distributor generally buys from manufacturers and sells to dealers.Distinct Dealer =
    
    A single independent servicing dealer, not owned by another dealer,
served by ARI.
   14




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Revenue by Geography and Service
(In Thousands)
 Three months endedOctober 31
    
    
    Percent2006
    
    
    2005
    
    
    ChangeNorth AmericaCatalog subscriptions
    
    $
    2,583
    
    
    $
    2,578
    
    
    
    0
    %Catalog professional services
    
    
    282
    
    
    
    355
    
    
    
    -21
    %Dealer marketing services
    
    
    217
    
    
    
    68
    
    
    
    219
    %Dealer & distributor communications
    
    
    198
    
    
    
    227
    
    
    
    -13
    %Subtotal
    
    
    3,280
    
    
    
    3,228
    
    
    
    2
    %Rest of the WorldCatalog subscriptions
    
    
    203
    
    
    
    214
    
    
    
    -5
    %Catalog professional services
    
    
    20
    
    
    
    49
    
    
    
    -59
    %Subtotal
    
    
    223
    
    
    
    263
    
    
    
    -15
    %Total RevenueCatalog subscriptions
    
    
    2,786
    
    
    
    2,792
    
    
    
    0
    %Catalog professional services
    
    
    302
    
    
    
    404
    
    
    
    -25
    %Dealer marketing services
    
    
    217
    
    
    
    68
    
    
    
    219
    %Dealer & distributor communications
    
    
    198
    
    
    
    227
    
    
    
    -13
    %Total
    
    $
    3,503
    
    
    $
    3,491
    
    
    
    0
    %
 North America
 Catalog Subscripitons
  Catalog Professional Services
  Dealer Marketing Services
  15




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Dealer and Distributor Communications
  Rest of the World
 Catalog Subscriptions
  Catalog Professional Services
  16




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Cost of Products and Services Sold
  Cost of Products and Services Sold as a Percent of Revenue by Revenue Type  (In thousands)
 Three months endedOctober 31
    
    Percent2006
    
    2005
    
    ChangeCatalog subscriptionsRevenue
    
    $
    2,786
    
    
    $
    2,792
    
    
    
    0
    %Cost of revenue
    
    
    296
    
    
    
    278
    
    
    
    6
    %Cost of revenue as a percent of revenue
    
    
    11
    %
    
    
    10
    %Catalog professional servicesRevenue
    
    
    302
    
    
    
    404
    
    
    
    (25
    %)Cost of revenue
    
    
    125
    
    
    
    100
    
    
    
    25
    %Cost of revenue as a percent of revenue
    
    
    41
    %
    
    
    25
    %Dealer marketing servicesRevenue
    
    
    217
    
    
    
    68
    
    
    
    219
    %Cost of revenue
    
    
    94
    
    
    
    31
    
    
    
    202
    %Cost of revenue as a percent of revenue
    
    
    43
    %
    
    
    46
    %Dealer and distributor communicationsRevenue
    
    
    198
    
    
    
    227
    
    
    
    (13
    %)Cost of revenue
    
    
    32
    
    
    
    41
    
    
    
    (22
    %)Cost of revenue as a percent of revenue
    
    
    16
    %
    
    
    18
    %TotalRevenue
    
    $
    3,503
    
    
    $
    3,491
    
    
    
    0
    %Cost of revenue
    
    
    546
    
    
    
    450
    
    
    
    21
    %Cost of revenue as a percent of revenue
    
    
    16
    %
    
    
    13
    %
     17




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Operating Expenses
  Operating Expenses  (In thousands)
 Three months endedOctober 31
    
    
    Percent2006
    
    
    2005
    
    
    ChangeCustomer operations and support
    
    $
    268
    
    
    $
    303
    
    
    
    (12
    %)Selling, general and administrative
    
    
    1,985
    
    
    
    1,859
    
    
    
    7
    %Software development and technical support
    
    
    369
    
    
    
    275
    
    
    
    34
    %Depreciation and amortization
    
    
    106
    
    
    
    80
    
    
    
    33
    %Net operating expenses
    
    $
    2,728
    
    
    $
    2,517
    
    
    
    8
    %
     Other Items
   Acquisitions
  18




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Liquidity and Capital Resources
  Cash Flow Information  (In thousands)
 Three months endedOctober 31
    
    
    Percent2006
    
    
    2005
    
    
    ChangeNet income
    
    $
    225
    
    
    $
    498
    
    
    
    (55
    %)Amortization of software products
    
    
    187
    
    
    
    145
    
    
    
    29
    %Amortization of deferred finance costs and
debt discount
    
    
    (11
    )
    
    
    (16
    )
    
    
    31
    %Depreciation and other amortization
    
    
    106
    
    
    
    81
    
    
    
    31
    %Stock based compensation related to options
    
    
    26
    
    
    
    
    
    
    
    100
    %Stock issued as contribution to 401(k) plan
    
    
    42
    
    
    
    21
    
    
    
    100
    %Net change in working capital
    
    
    (409
    )
    
    
    (353
    )
    
    
    (16
    %)Net cash provided by operating activities
    
    
    166
    
    
    
    376
    
    
    
    (56
    %)Net cash used in investing activities
    
    
    (212
    )
    
    
    (255
    )
    
    
    17
    %Net cash used in financing activities
    
    
    (347
    )
    
    
    (217
    )
    
    
    (60
    %)Net change in cash
    
    ($
    393
    )
    
    ($
    96
    )
    
    
    (309
    %)
    Debt Schedule  (In thousands)
 October 31
    
    
    July 312006
    
    
    2006
    
    
    Net(Unaudited)
    
    
    (Audited)
    
    
    ChangeNote payable to WITECH:Current portion of note payable
    
    
    200
    
    
    
    200
    
    
    
    Long term portion of note payable
    
    
    
    
    
    
    50
    
    
    
    (50
    )Total note payable to WITECH
    
    
    200
    
    
    
    250
    
    
    
    (50
    )Notes payable to New Holders:Current portion of notes payable
    
    
    1,200
    
    
    
    1,200
    
    
    
    Long term portion of notes payable
    
    
    200
    
    
    
    500
    
    
    
    (300
    )Total face value of notes payable to New Holders
    
    
    1,400
    
    
    
    1,700
    
    
    
    (300
    )Carrying value in excess of face amount of notes payable
    
    
    28
    
    
    
    42
    
    
    
    (14
    )Debt discount (common stock warrants and options)
    
    
    (9
    )
    
    
    (12
    )
    
    
    3Total carrying value of notes payable to New Holders
    
    
    1,419
    
    
    
    1,730
    
    
    
    (311
    )Total debt
    
    $
    1,619
    
    
    $
    1,980
    
    
    $
    (361
    )
 19




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Off-Balance Sheet Arrangements
  Forward Looking Statements
  20




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ITEM 3. CONTROLS AND PROCEDURES
   
 PART II  OTHER INFORMATION
 
 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  
 ITEM 6. EXHIBITS
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SIGNATURES
  ARI Network Services, Inc.
(Registrant)Date: December 15, 2006

    
    /s/ Brian E. DearingBrian E. Dearing, Chairman of the Board and Chief Executive Officer/s/ Timothy SherlockTimothy Sherlock, Chief Financial Officer
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