##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB (Mark One) þ
    
    QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended January 31, 2005 OR 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. 
 (Exact name of small business issuer as specified in its charter.) WISCONSIN
    
    39- 1388360(State or other jurisdiction of
incorporation or organization)
    
    (IRS Employer Identification No.)
 11425 W. Lake Park Drive, Milwaukee, Wisconsin 53224 
  Issuers telephone number (414) 973-4300 Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the
Exchange Act during the past 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 þ      NO o As of March 10, 2005, there were 6,005,707 shares of the registrants shares outstanding. Transitional Small Business Disclosure Format (check one). YES o NO þ   1




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ARI Network Services, Inc. FORM 10-QSB FOR THE THREE MONTHS ENDED JANUARY 31, 2005 INDEX  
 PagePART I  FINANCIAL INFORMATIONItem 1
    
    Financial statementsCondensed balance sheets  January 31, 2005 and July 31, 2004
    
    
    3-4Condensed statements of operations for the three and six months ended January 31, 2005 and 2004
    
    
    5Condensed statements of cash flows for the six months ended January 31, 2005 and 2004
    
    
    6Notes to unaudited condensed financial statements
    
    
    7-8Item 2
    
    Managements discussion and analysis or plan of operation
    
    
    9-17Item 3
    
    Controls and procedures
    
    
    17PART II  OTHER INFORMATIONItem 2
    
    Unregistered sales of equity securities and use of proceeds
    
    
    17Item 4
    
    Submission of matters to a vote of Security Holders
    
    
    17Item 6
    
    Exhibits
    
    
    18Signatures
    
    
    19CertifictionCertificationCertificationCertification
  2




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ARI Network Services, Inc. 
 Balance Sheets
 (In thousands, except share and per share data)
 (Unaudited)
 January 31
    
    
    July 312005
    
    
    2004ASSETSCurrent assets:Cash
    
    $
    3,326
    
    
    $
    3,357Trade receivables, less allowance for doubtful accounts of $83
at January 31, 2005 and $44 at July 31, 2004
    
    
    729
    
    
    
    1,121Prepaid expenses and other
    
    
    101
    
    
    
    187Total current assets
    
    
    4,156
    
    
    
    4,665Equipment and leasehold improvements:Computer equipment
    
    
    4,751
    
    
    
    4,607Leasehold improvements
    
    
    73
    
    
    
    73Furniture and equipment
    
    
    1,500
    
    
    
    1,4916,324
    
    
    
    6,171Less accumulated depreciation and amortization
    
    
    5,753
    
    
    
    5,630Net equipment and leasehold improvements
    
    
    571
    
    
    
    541Other assets
    
    
    38
    
    
    
    15Capitalized software product costs
    
    
    10,949
    
    
    
    10,203Less accumulated amortization
    
    
    9,507
    
    
    
    9,233Net capitalized software product costs
    
    
    1,442
    
    
    
    970Total Assets
    
    $
    6,207
    
    
    $
    6,191
 3




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##### Table of Contents



ARI Network Services, Inc.
Balance Sheets(In thousands, except share and per share data)(Unaudited) January 31
    
    
    July 312005
    
    
    2004LIABILITIES AND SHAREHOLDERS EQUITY (DEFICIT)Current liabilities:Current portion of notes payable
    
    $
    1,000
    
    
    $
    1,000Accounts payable
    
    
    248
    
    
    
    260Deferred revenue
    
    
    5,302
    
    
    
    5,453Accrued payroll and related liabilities
    
    
    805
    
    
    
    951Accrued sales, use and income taxes
    
    
    168
    
    
    
    489Other accrued liabilities
    
    
    641
    
    
    
    564Current portion of capital lease obligations
    
    
    5
    
    
    
    10Total current liabilities
    
    
    8,169
    
    
    
    8,727Long term liabilities:Notes payable (net of discount)
    
    
    2,762
    
    
    
    3,306Accrued payroll and related liabilities
    
    
    568
    
    
    
    495Other long term liabilities
    
    
    211
    
    
    
    211Capital lease obligations
    
    
    2
    
    
    
    3Total long term liabilities
    
    
    3,543
    
    
    
    4,015Shareholders equity (deficit):Cumulative preferred stock, par value $.001 per share,
1,000,000 shares authorized; 0 shares issued and outstanding
at January 31, 2005 and July 31, 2004, respectively
    
    
    
    
    
    
    Common stock, par value $.001 per share, 25,000,000 shares
authorized; 6,005,707 and 5,923,034 shares issued and outstanding
at January 31, 2005 and July 31, 2004, respectively
    
    
    5
    
    
    
    5Common stock warrants and options
    
    
    36
    
    
    
    36Additional paid-in-capital
    
    
    93,722
    
    
    
    93,625Accumulated deficit
    
    
    (99,268
    )
    
    
    (100,217
    )Total shareholders equity (deficit)
    
    
    (5,505
    )
    
    
    (6,551
    )Total Liabilities and Shareholders Equity (Deficit)
    
    $
    6,207
    
    
    $
    6,191
 See notes to unaudited condensed financial statements. Note: The balance sheet at July 31, 2004 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. 4




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ARI Network Services, Inc. 
 Statements of Operations
 (In thousands, except per share data)
 (Unaudited)
 Three months ended
    
    
    Six months endedJanuary 31
    
    
    January 312005
    
    
    2004
    
    
    2005
    
    
    2004Net revenues:Subscriptions, support and other services fees
    
    $
    2,422
    
    
    $
    2,260
    
    
    $
    4,824
    
    
    $
    4,549Software licenses and renewals
    
    
    558
    
    
    
    604
    
    
    
    1,134
    
    
    
    1,193Professional services
    
    
    324
    
    
    
    429
    
    
    
    621
    
    
    
    8363,304
    
    
    
    3,293
    
    
    
    6,579
    
    
    
    6,578Operating expenses:Cost of products and services sold:Subscriptions, support and other services fees
    
    
    233
    
    
    
    129
    
    
    
    426
    
    
    
    284Software licenses and renewals *
    
    
    145
    
    
    
    458
    
    
    
    299
    
    
    
    920Professional services
    
    
    48
    
    
    
    149
    
    
    
    130
    
    
    
    340426
    
    
    
    736
    
    
    
    855
    
    
    
    1,544Depreciation and amortization (exclusive of
amortization of software products included in
cost of products and services sold)
    
    
    69
    
    
    
    37
    
    
    
    123
    
    
    
    72Customer operations and support
    
    
    257
    
    
    
    291
    
    
    
    519
    
    
    
    574Selling, general and administrative
    
    
    1,745
    
    
    
    1,758
    
    
    
    3,454
    
    
    
    3,516Software development and technical support
    
    
    445
    
    
    
    362
    
    
    
    866
    
    
    
    703Operating expenses before amounts capitalized
    
    
    2,942
    
    
    
    3,184
    
    
    
    5,817
    
    
    
    6,409Less capitalized portion
    
    
    (144
    )
    
    
    (123
    )
    
    
    (306
    )
    
    
    (187
    )Net operating expenses
    
    
    2,798
    
    
    
    3,061
    
    
    
    5,511
    
    
    
    6,222Operating income
    
    
    506
    
    
    
    232
    
    
    
    1,068
    
    
    
    356Other expense:Interest expense
    
    
    (47
    )
    
    
    (64
    )
    
    
    (91
    )
    
    
    (145
    )Other, net
    
    
    10
    
    
    
    7
    
    
    
    22
    
    
    
    36Total other expense
    
    
    (37
    )
    
    
    (57
    )
    
    
    (69
    )
    
    
    (109
    )Income before provision for income taxes
    
    
    469
    
    
    
    175
    
    
    
    999
    
    
    
    247Income tax expense
    
    
    (14
    )
    
    
    
    
    
    
    (50
    )
    
    
    Net income
    
    $
    455
    
    
    $
    175
    
    
    $
    949
    
    
    $
    247Average common shares outstanding:Basic
    
    
    5,974
    
    
    
    5,780
    
    
    
    5,958
    
    
    
    5,788Diluted
    
    
    6,445
    
    
    
    6,039
    
    
    
    6,429
    
    
    
    6,047Net income per share:Basic
    
    $
    0.08
    
    
    $
    0.03
    
    
    $
    0.16
    
    
    $
    0.04Diluted
    
    $
    0.07
    
    
    $
    0.03
    
    
    $
    0.15
    
    
    $
    0.04
 See notes to unaudited condensed financial statements.   *
    
    Includes amortization of software products of $133, $445, $274 and $888 and excludes other
depreciation and amortization shown separately 5




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ARI Network Services, Inc. 
 Statements of Cash Flows
 (In thousands)
 (Unaudited)
 Six months endedJanuary 312005
    
    
    2004Operating activitiesNet income
    
    $
    949
    
    
    $
    247Adjustments to reconcile net income to net cash provided by
Operating activities:Amortization of software products
    
    
    274
    
    
    
    888Amortization of deferred financing costs, debt discount and
excess carrying value over face amount of notes payable
    
    
    (42
    )
    
    
    (29
    )Depreciation and other amortization
    
    
    123
    
    
    
    72Stock issued as contribution to 401(k) plan
    
    
    37
    
    
    
    37Net change in receivables, prepaid expenses and other
current assets
    
    
    453
    
    
    
    487Net change in accounts payable, deferred revenue,
accrued liabilities and other long term liabilities
    
    
    (480
    )
    
    
    (445
    )Net cash provided by operating activities
    
    
    1,314
    
    
    
    1,257Investing activitiesPurchase of equipment and leasehold improvements
    
    
    (153
    )
    
    
    (77
    )Purchase of assets related to acquisitions
    
    
    
    
    
    
    (108
    )Software product costs capitalized
    
    
    (746
    )
    
    
    (187
    )Net cash used in investing activities
    
    
    (899
    )
    
    
    (372
    )Financing activitiesPayments under notes payable
    
    
    (500
    )
    
    
    (250
    )Payments of capital lease obligations
    
    
    (6
    )
    
    
    (16
    )Debt issuance costs incurred
    
    
    
    
    
    
    (20
    )Proceeds from issuance of common stock
    
    
    60
    
    
    
    4Net cash used in financing activities
    
    
    (446
    )
    
    
    (282
    )Net increase (decrease) in cash
    
    
    (31
    )
    
    
    603Cash at beginning of period
    
    
    3,357
    
    
    
    2,120Cash at end of period
    
    $
    3,326
    
    
    $
    2,723Cash paid for interest
    
    $
    131
    
    
    $
    112Cash paid for income taxes
    
    $
    55
    
    
    $
    Noncash investing and financing activitiesIssuance of common stock in connection with acquisitions
    
    $
    
    
    
    $
    37Exchange of equity to debt
    
    
    
    
    
    
    1,000
 See notes to unaudited condensed financial statements. 6




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Notes to Condensed Financial Statements
(Unaudited)
January 31, 2005 1. BASIS OF PRESENTATION The accompanying unaudited financial statements have been prepared in accordance with accounting
principles generally accepted in the United States for interim financial information. Accordingly,
they do not include all of the information and footnotes required by accounting principles
generally accepted in the United States for fiscal year end financial statements. In the opinion
of management, all adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation have been included. Operating results for the three and six months ended January
31, 2005 are not necessarily indicative of the results that may be expected for the fiscal year
ending July 31, 2005. For further information, refer to the financial statements and footnotes
thereto included in the Companys annual report on Form 10-KSB for the year ended July 31, 2004. 2. BASIC AND DILUTED NET INCOME PER SHARE Basic net income per common share is computed by dividing net income by the weighted average number
of common shares outstanding during the period. Diluted net income per common share is computed by
dividing net income by the weighted average number of common shares outstanding during the period
and reflects the potential dilution that could occur if all of the Companys outstanding stock
options and warrants that are in the money were exercised (calculated using the treasury stock
method). The following table is a reconciliation of the weighted average number of common shares
and equivalents outstanding in the calculation of basic and diluted net income per common share (in
thousands) for the periods indicated. Three months ended
    
    
    Six months endedJanuary 31
    
    
    January 312005
    
    
    2004
    
    
    2005
    
    
    2004Weighted average common shares outstanding
    
    
    5,974
    
    
    
    5,780
    
    
    
    5,958
    
    
    
    5,788Dilutive effect of stock options and warrants
    
    
    471
    
    
    
    259
    
    
    
    471
    
    
    
    259Diluted weighted average common shares outstanding
    
    
    6,445
    
    
    
    6,039

    
    
    
    6,429
    
    
    
    6,047
 3. STOCK-BASED COMPENSATION The Company has stock-based compensation plans. SFAS No. 148 Accounting for Stock-Based
Compensation  Transition and Disclosure requires companies with stock-based compensation plans to
disclose the pro forma effect of stock-based compensation on earnings and earnings per share. The
following table sets forth the effect on earnings and earnings per share (in thousands, except per
share data) of stock-based compensation had the cost been determined based upon the fair value at
the grant date for awards under the plan using the Black-Scholes valuation method. Three months ended
    
    
    Six months endedJanuary 31
    
    
    January 312005
    
    
    2004
    
    
    2005
    
    
    2004Net income, as reported
    
    $
    455
    
    
    $
    175
    
    
    $
    949
    
    
    $
    247Stock-based compensation using the
fair value method
    
    
    (89
    )
    
    
    (18
    )
    
    
    (136
    )
    
    
    (35
    )Pro forma net income
    
    $
    366
    
    
    $
    157
    
    
    $
    813
    
    
    $
    212Net income per shareBasic  as reported
    
    $
    0.08
    
    
    $
    0.03
    
    
    $
    0.16
    
    
    $
    0.04Basic  pro forma
    
    $
    0.06
    
    
    $
    0.03
    
    
    $
    0.14
    
    
    $
    0.04Diluted  as reported
    
    $
    0.07
    
    
    $
    0.03
    
    
    $
    0.15
    
    
    $
    0.04Diluted  pro forma
    
    $
    0.06
    
    
    $
    0.03
    
    
    $
    0.13
    
    
    $
    0.04
 4. NOTES PAYABLE On April 24, 2003, the Company restructured its debt. In exchange for its previously outstanding
securities, the Company issued to a group of investors, in aggregate, $500,000 in cash, unsecured
notes in the amount of $3.9 million and warrants for 250,000 common shares, exercisable at $1.00
per share. The interest rate on the notes is the prime interest rate plus 2% (effective rate of
7.25% as of January 31, 2005). The notes (in aggregate) are payable in $200,000 quarterly
installments commencing March 31, 2004 through December 31, 2005 and $300,000 quarterly
installments commencing March 31, 2006 until paid in full. The notes do not contain any financial
covenants, but the Company is restricted from permitting certain liens on its assets. In addition,
in the event of payment default that is not cured within ninety (90) days, Taglich Brothers, Inc.,
one of the note holders, has the right to appoint one designee to the Companys Board of Directors.
The warrants were estimated to have a value of $36,000, of which the unamortized amount reduces
the carrying amount of the debt. 7




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In accordance with SFAS No. 15, Accounting by Debtors and Creditors for Troubled Debt
Restructurings, the exchange of the previously outstanding securities for $500,000 in cash, the
notes and the warrants was accounted for as a troubled debt restructuring and no gain was recorded.
Instead the liability in excess of the future cash payments, which was originally approximately
$322,000, remains on the balance sheet as long term debt and is being amortized as a reduction of
interest expense over the life of the notes. On August 7, 2003, the Company purchased from WITECH Corporation 1,025,308 shares of the Companys
common stock, 30,000 common stock warrants and 20,350 shares of series A Preferred Stock for
$200,000 at closing and an $800,000 promissory note which is payable quarterly through September
30, 2007, at the prime interest rate plus 2% (effective rate of 7.25% as of January 31, 2005). 5. SHAREHOLDER RIGHTS PLAN On August 7, 2003, the Company adopted a Shareholder Rights Plan designed to protect the interests
of common shareholders from an inadequate or unfair takeover, but not affect a takeover proposal
which the Board of Directors believes is fair to all shareholders. Under the Shareholder Rights
Plan adopted by the Board of Directors, all shareholders of record on August 18, 2003 received one
Preferred Share Purchase Right for each share of common stock they owned. These Rights trade in
tandem with the common stock until and unless they are triggered. Should a person or group acquire
more than 10% of ARIs common stock (or if an existing holder of 10% or more of the common stock
were to increase its position by more than 1%), the Rights would become exercisable for every
shareholder except the acquirer that triggered the exercise. The Rights, if triggered, would give
the other shareholders the ability to purchase additional stock of ARI at a substantial discount.
The rights will expire on August 18, 2013, and can be redeemed by the Company for $0.01 per Right
at any time prior to a person or group becoming a 10% shareholder. 6. CLAIM FOR INDEMNIFICATION The Company recently received a letter on behalf of one of its customers asserting a warranty claim
and/or a claim for indemnity with respect to a complaint filed against the customer for patent
infringement in the United States District Court for the Eastern District of Texas. In connection
with the case, the customer has identified three other suppliers as potential indemnitors as well.
The customer is one of several primarily large, multinational corporate defendants alleged to have
violated patents purporting to cover an Electronic Proposal Preparation System (U.S. Patent No.
5,615,342) and/or Computer-Assisted Parts Sales Method (U.S. Patent No. 5,367,627). The customer
has denied any and all allegations of patent infringement in the lawsuit. If the Company can assist
its customer in its defense, management intends to do so. At the same time, ARI denies any
responsibility, warranty or indemnification to the customer with respect to the complaint and
intends to vigorously defend itself in this matter should that become necessary. 8




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MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATION Results of Operations Total revenue increased marginally from $3,293,000 for the three months ended January 31, 2004 to
$3,304,000 for the three months ended January 31, 2005 and from $6,578,000 for the six months ended
January 31, 2004 to $6,579,000 for the six months ended January 31 2005. The limited change
consisted of an increase in recurring revenues from the Companys catalog products in the North
American sector of the Equipment Industry, offset by a decrease in revenues from the Non-North
American sector of the Equipment Industry and the Non-equipment Industry. Earnings increased from
$175,000, or $0.03 per share for the quarter ended January 31, 2004 to $455,000 or $0.08 per share
for the quarter ended January 31, 2005 and from $247,000 or $0.04 for the six months ended January
31, 2004 to $949,000 or $0.16 per share for the six months ended January 31, 2005 primarily due to
decreased software amortization expense. Management believes that the Company will have modest
revenue growth and continue to be profitable for the remainder of fiscal 2005. Critical Accounting Policies and Estimates General The Companys discussion and analysis of its financial condition and results of operations are
based upon its financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States. The preparation of these financial statements
requires the Company to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.
On an on-going basis, the Company evaluates its estimates, including those related to customer
contracts, bad debts, capitalized software product costs, financing instruments, revenue
recognition and other accrued expenses. The Company bases its estimates on historical experience
and on various other assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions and are subject to change in the near term. The Company believes the following critical accounting policies affect its more significant
judgments and estimates used in the preparation of its financial statements. Revenue Recognition Revenue for use of the network and for information services is recognized in the period such
services are utilized. Revenue from annual or periodic maintenance fees, license and license
renewal fees and catalog subscription fees is recognized ratably over the period the service is
provided. Arrangements that include acceptance terms beyond the Companys standard terms are not
recognized until acceptance has occurred. If collectibility is not considered probable, revenue is
recognized when the fee is collected. Arrangements that include professional services are
evaluated to determine whether those services are essential to the functionality of other elements
of the arrangement. When professional services are not considered essential, the revenue allocable
to the professional services is recognized as the services are performed. When professional
services are considered essential, revenue under the arrangement is recognized pursuant to contract
accounting using the percentage-of-completion method with progress-to-completion measured based
upon labor hours incurred. When the current estimates of total contract revenue and contract cost
indicate a loss, a provision for the entire loss on the contract is made. Revenue on arrangements
with customers who are not the ultimate users (resellers) is deferred if there is any contingency
on the ability and intent of the reseller to sell such software to a third party. Bad Debts The Company maintains an allowance for doubtful accounts for estimated losses resulting from the
inability of its customers to make required payments. The Company currently reserves for most
amounts due over 90 days, unless there is reasonable assurance of collectibility. If the financial
condition of the Companys customers were to deteriorate, resulting in an impairment of their
ability to make payments, additional allowances may be required. Use of Estimates The preparation of the Companys financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates and assumptions about
accrued expenses that affect the amounts reported in the financial statements and accompanying
notes. Actual results could differ from those estimates and are subject to change in the near term. Impairment of Long-Lived Assets Equipment and leasehold improvements and capitalized software product costs are reviewed for
impairment whenever events or changes in circumstances indicate that the carrying amount may not be
recoverable. If the sum of the expected undiscounted cash flows is less than the carrying value of
the related asset or group of assets, a loss is recognized for the difference between the fair
value and carrying value of the asset or group of assets. 9




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Debt Instruments The Company valued debt discounts for Common Stock Warrants and Options granted in consideration
for Notes Payable using the Black-Scholes valuation method. Non-cash interest expense is recorded
for the amortization of the debt discount over the term of the debt. Stock-Based Compensation The Company accounts for its employee stock option plans under the recognition and measurement
principles of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees, and related Interpretations. Under APB Opinion No. 25, no stock-based compensation is
reflected in net income (loss), as all options granted under the plans had an exercise price equal
to the market value of the underlying common stock on the date of grant and the related number of
shares granted is fixed at that point in time. Revenues The Company is a leading provider of electronic parts catalogs and related technology and services
to increase sales and profits for dealers in the manufactured equipment market. The Company
currently provides 82 catalogs of manufactured equipment from 69 manufacturers to over 28,000
dealers in more than 100 countries in 12 segments of the worldwide manufactured equipment market
including outdoor power, power sports, recreation vehicles, marine, construction, floor
maintenance, agricultural equipment, auto and truck parts after-market, and others, primarily in
North America, Europe and Australia. Collectively, dealers and distributors have over 88,000
catalog subscriptions. The Company supplies three types of software and services: (1) robust Web
and CD-ROM interactive electronic parts catalogs, (2) integrated marketing services including
template-based website services and technology-enabled direct mail services and (3) communication
or transaction services. The Companys primary product line is electronic cataloging; the other
products are supplementary offerings that leverage its position in the catalog market. The following table sets forth certain Catalog, Customer and Subscription information by region
derived from the Companys financial and customer databases. The number of distinct distributors
and dealers is estimated because some subscriptions are distributed by third parties (including
manufacturers), which may or may not inform ARI of the distributors and/or dealers to which the
subscriptions are distributed. Because the estimating methodology is still being refined,
comparisons to prior quarters may or may not be indicative of business trends. Catalog, Customer and Subscription Information by Region
(As of January 31, 2005) Distinct
    
    
    DistinctDistinct
    
    


    
    
    Distributors
    
    
    DealersCatalogs
    
    
    Manufacturers
    
    
    Subscriptions

    
    
    (Estimated)
    
    
    (Estimated)North American
    
    
    74
    
    
    
    58
    
    
    
    71,782
    
    
    
    103
    
    
    
    19,399Non-North American
    
    
    69
    
    
    
    11
    
    
    
    16,677
    
    
    
    22
    
    
    
    8,633Included in both Regions
    
    
    (61
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    82
    
    
    
    69
    
    
    
    88,459
    
    
    
    125
    
    
    
    28,032
 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
    
    =
    
    A single catalog 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.
 As part of its historical business practice, the Company continues to provide electronic
transaction services to the North American agribusiness industry. As the Company focuses on its
core businesses in the Equipment industry, the percentage of revenues coming from the non-equipment
industry is expected to continue to decline during fiscal 2005. Management reviews the Companys recurring vs. non-recurring revenue in the aggregate and within
the North American Equipment, non-North American Equipment and non-Equipment industries and by
product category within the Equipment Industry. 10




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##### Table of Contents



The following tables set forth, for the periods indicated, certain revenue information derived from
the Companys unaudited financial statements. Revenue by Industry Sector
(In thousands) Three months ended
    
    
    
    
    
    
    Six months endedJanuary 31
    
    
    Percent
    
    
    January 31
    
    
    Percent2005
    
    
    2004
    
    
    Change
    
    
    2005
    
    
    2004
    
    
    ChangeIndustry Sector:Equipment IndustryNorth AmericanRecurring
    
    $
    2,673
    
    
    $
    2,428
    
    
    
    10
    %
    
    $
    5,165
    
    
    $
    4,783
    
    
    
    8
    %Non-recurring
    
    
    315
    
    
    
    369
    
    
    
    (15
    %)
    
    
    710
    
    
    
    735
    
    
    
    (3
    %)Subtotal
    
    
    2,988
    
    
    
    2,797
    
    
    
    7
    %
    
    
    5,875
    
    
    
    5,518
    
    
    
    6
    %Non-North AmericanRecurring
    
    
    203
    
    
    
    289
    
    
    
    (30
    %)
    
    
    427
    
    
    
    584
    
    
    
    (27
    %)Non-recurring
    
    
    
    
    
    
    66
    
    
    
    (100
    %)
    
    
    
    
    
    
    134
    
    
    
    (100
    %)Subtotal
    
    
    203
    
    
    
    355
    
    
    
    (43
    %)
    
    
    427
    
    
    
    718
    
    
    
    (41
    %)Total Equipment IndustryRecurring
    
    
    2,876
    
    
    
    2,717
    
    
    
    6
    %
    
    
    5,592
    
    
    
    5,367
    
    
    
    4
    %Non-recurring
    
    
    315
    
    
    
    435
    
    
    
    (28
    %)
    
    
    710
    
    
    
    869
    
    
    
    (18
    %)Subtotal
    
    
    3,191
    
    
    
    3,152
    
    
    
    1
    %
    
    
    6,302
    
    
    
    6,236
    
    
    
    1
    %Non-equipment IndustryRecurring
    
    
    113
    
    
    
    141
    
    
    
    (20
    %)
    
    
    277
    
    
    
    342
    
    
    
    (19
    %)Non-recurring
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Subtotal
    
    
    113
    
    
    
    141
    
    
    
    (20
    %)
    
    
    277
    
    
    
    342
    
    
    
    (19
    %)Total RevenueRecurring
    
    
    2,989
    
    
    
    2,858
    
    
    
    5
    %
    
    
    5,869
    
    
    
    5,709
    
    
    
    3
    %Non-recurring
    
    
    315
    
    
    
    435
    
    
    
    (28
    %)
    
    
    710
    
    
    
    869
    
    
    
    (18
    %)Grand Total
    
    $
    3,304
    
    
    $
    3,293
    
    
    
    0
    %
    
    $
    6,579
    
    
    $
    6,578
    
    
    
    0
    %
 Revenue by Product in the Equipment Industry
(In thousands) Three months ended
    
    
    
    
    
    
    Six months endedJanuary 31
    
    
    Percent
    
    
    January 31
    
    
    Percent2005
    
    
    2004
    
    
    Change
    
    
    2005
    
    
    2004
    
    
    ChangeProduct:Equipment IndustryCatalog and relatedRecurring
    
    $
    2,758
    
    
    $
    2,603
    
    
    
    6
    %
    
    $
    5,357
    
    
    $
    5,120
    
    
    
    5
    %Non-recurring
    
    
    315
    
    
    
    434
    
    
    
    (27
    %)
    
    
    710
    
    
    
    862
    
    
    
    (18
    %)Subtotal
    
    
    3,073
    
    
    
    3,037
    
    
    
    1
    %
    
    
    6,067
    
    
    
    5,982
    
    
    
    1
    %CommunicationsRecurring
    
    
    118
    
    
    
    114
    
    
    
    4
    %
    
    
    235
    
    
    
    247
    
    
    
    (5
    %)Non-recurring
    
    
    
    
    
    
    1
    
    
    
    (100
    %)
    
    
    
    
    
    
    7
    
    
    
    (100
    %)Subtotal
    
    
    118
    
    
    
    115
    
    
    
    3
    %
    
    
    235
    
    
    
    254
    
    
    
    (7
    %)Total Equipment Industry
    
    $
    3,191
    
    
    $
    3,152
    
    
    
    1
    %
    
    $
    6,302
    
    
    $
    6,236
    
    
    
    1
    %
 11




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##### Table of Contents



Recurring revenues are derived from catalog subscription fees, catalog data update fees,
software maintenance and support fees, software license renewals, network traffic and support fees
and other miscellaneous subscription fees. Non-recurring revenues are derived from initial software
licenses and professional services fees. Recurring revenue, as a percentage of total revenue, was
89% for the six months ended January 31, 2005 compared to 87% for the same period last year. This
ratio is expected to fluctuate from quarter to quarter and year to year, depending on the nature,
size and timing of new business. Equipment Industry The Equipment Industry has been a growing percentage of the Companys revenue over the past five
years and is composed of several vertical markets including outdoor power, power sports,
motorcycles, recreation vehicles, marine, construction, floor maintenance, agricultural equipment,
auto and truck parts after-market and others primarily in North America, Europe and Australia.
Managements strategy is to expand the Companys electronic parts catalog software and services
business with dealers in the existing vertical markets and the manufacturers and distributors whose
products they sell and service, add supplemental products for existing customers, and then expand
to other similar markets in the future. Revenues in the Equipment Industry increased, as a
percentage of total revenues, from 95% for the six months ended January 31, 2004 to 96% for the six
months ended January 31, 2005. North American Recurring revenues in the North American Equipment Industry increased for the three and six
month periods ended January 31, 2005, compared to the same periods last year, primarily due to
an increase in the base revenue of subscription renewals from the Companys catalog products and
services. Non-recurring revenues in the North American Equipment Industry decreased for the
three and six month periods ended January 31, 2005, compared to the same periods last year,
primarily due to fewer large customization projects as the Company sells a larger number of
smaller deals, requiring less customization. Non-North American Recurring revenues in the non-North American Equipment Industry decreased for the three and six
month periods ended January 31, 2005, compared to the same periods last year, primarily due to
the loss of a customer in the power generation market and the discontinuation of a legacy
microfiche publishing application. Non-recurring revenues in the non-North American Equipment
Industry decreased for the three and six month periods ended January 31, 2005, compared to the
same periods last year, primarily due to no new sales. Management expects revenues in the
Non-North American Equipment Industry to continue at the same level or to improve slightly for
the remainder of fiscal 2005, as the Company invests in a new dealer-centric model similar to
that used in its North American operations, and expects to show more significant improvements in
fiscal 2006. Catalog and Related Products Recurring revenues from the Companys catalog and related products in the Equipment Industry
increased for the three and six month periods ended January 31, 2005, compared to the same
periods last year, primarily due to an increase in the Companys base revenue from new catalog
customers and an increase in the volume of catalogs purchased by dealers. Non-recurring
revenues from the Companys catalog and related products in the Equipment Industry decreased for
the three and six month periods ended January 31, 2005, compared to the same periods last year,
primarily due to less professional service revenues from customization projects. Management
expects recurring catalog and related revenues, which have a higher margin than revenues from
professional services, to continue to increase in the North American Equipment Industry, and
non-recurring catalog and related revenues in this industry to continue at relatively the same
level for the remainder of fiscal 2005. Communications Products Revenues from the Companys communications products increased for the three month period ended
January 31, 2005, compared to the same period last year, primarily due to fluctuations in
network traffic revenues and decreased for the six month period ended January 31, 2005, compared
to the same period last year. The Company has focused the business primarily on its catalog
products. Management expects revenues from communications products will be a declining
percentage of total revenue for the remainder of fiscal 2005. Non-Equipment Industry Business The Companys business outside of the Equipment Industry includes sales of electronic communication
services to the agricultural inputs industry. Revenues in this business have decreased for the
three and six month periods ended January 31, 2005, compared to the same periods last year because
an industry association introduced a competitive offering to our database management services. As
a result, many of the agricultural inputs industry participants did not renew their contracts for
database management services, which were approximately $500,000 on an annual basis. The Company
continues to provide electronic communication services to the agricultural inputs industry, but
management expects these revenues, as a percentage of total revenues, to continue to decline for
the remainder of fiscal 2005. 12




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##### Table of Contents



Cost of Products and Services Sold The following table sets forth, for the periods indicated, certain information regarding revenue
and cost of products and services sold which is derived from the Companys unaudited financial
statements. Cost of Products and Services Sold as a Percent of Revenue by Revenue Type(In thousands) Three months ended
    
    
    
    
    
    
    Six months endedJanuary 31
    
    
    Percent
    
    
    January 31
    
    
    Percent2005
    
    
    2004
    
    
    Change
    
    
    2005
    
    
    2004
    
    
    ChangeSubscriptions, support and other services fees
Revenue
    
    $
    2,422
    
    
    $
    2,260
    
    
    
    7
    %
    
    $
    4,824
    
    
    $
    4,549
    
    
    
    6
    %Cost of revenue
    
    
    233
    
    
    
    129
    
    
    
    81
    %
    
    
    426
    
    
    
    284
    
    
    
    50
    %Cost of revenue as a percent of revenue
    
    
    10
    %
    
    
    6
    %
    
    
    
    
    
    
    9
    %
    
    
    6
    %Software licenses and renewals
Revenue
    
    
    558
    
    
    
    604
    
    
    
    (8
    %)
    
    
    1,134
    
    
    
    1,193
    
    
    
    (5
    %)Cost of revenue
    
    
    145
    
    
    
    458
    
    
    
    (68
    %)
    
    
    299
    
    
    
    920
    
    
    
    (83
    %)Cost of revenue as a percent of revenue
    
    
    26
    %
    
    
    76
    %
    
    
    
    
    
    
    26
    %
    
    
    77
    %Professional services
Revenue
    
    
    324
    
    
    
    429
    
    
    
    (24
    %)
    
    
    621
    
    
    
    836
    
    
    
    (26
    %)Cost of revenue
    
    
    48
    
    
    
    149
    
    
    
    (68
    %)
    
    
    130
    
    
    
    340
    
    
    
    (62
    %)Cost of revenue as a percent of revenue
    
    
    15
    %
    
    
    35
    %
    
    
    
    
    
    
    21
    %
    
    
    41
    %Total
Revenue
    
    $
    3,304
    
    
    $
    3,293
    
    
    
    0
    %
    
    $
    6,579
    
    
    $
    6,578
    
    
    
    0
    %Cost of revenue
    
    
    426
    
    
    
    736
    
    
    
    (42
    %)
    
    
    855
    
    
    
    1,544
    
    
    
    (45
    %)Cost of revenue as a percent of revenue
    
    
    13
    %
    
    
    22
    %
    
    
    
    
    
    
    13
    %
    
    
    23
    %
 Cost of subscriptions, support and other services fees consists primarily of reseller fees,
telecommunication costs, catalog production, replication and distribution costs. Cost of
subscriptions, support and other services fees as a percentage of revenue increased for the three
and six month periods ended January 31, 2005, compared to the same periods last year primarily due
to an increase in catalog production and replication costs absorbed by the Company as part of a
strategy to acquire additional catalog titles to sell to dealers. Management expects gross
margins, as a percent of revenue from subscriptions, support and other services fees, to vary
slightly from quarter to quarter, depending on the timing of catalog update shipments. Cost of software licenses and renewals consists primarily of amortization of software products,
software royalties and reseller commissions. Cost of software license and renewals as a percentage
of revenue decreased significantly for the three and six month periods ended January 31, 2005,
compared to the same periods last year, primarily due to lower software amortization costs, as the
software product costs of PartSmartTM, acquired in fiscal 1999, became fully amortized in
May, 2004. Gross margins from software licenses and renewals will fluctuate from quarter to
quarter based on the level of revenue, while costs remain relatively the same as amortization of
software is not related to the level of revenue generated from software license and renewals.
Management expects software amortization costs to increase slightly from the current level for the
remainder of the year as the Company releases new products, but still be well below last year. Cost of professional services consists of customization and catalog production labor. Cost of
professional services as a percentage of revenue decreased for the three and six month periods
ended January 31, 2005, compared to the same periods last year, primarily due to the
reclassification of catalog production labor that is not directly billed to the manufacturer to
cost of subscriptions, where the Company realizes revenue for this service. These costs had
previously not been segregated from catalog production labor which was billed to the manufacturer.
Management expects cost of professional services to fluctuate from quarter to quarter depending on
the mix of services sold and on the Companys performance towards the contracted amount for
customization projects. 13




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##### Table of Contents



Operating Expenses The following table sets forth, for the periods indicated, certain operating expense information
derived from the Companys unaudited financial statements. Operating Expenses(In thousands) Three months ended
    
    
    
    
    
    
    Six months endedJanuary 31
    
    
    Percent
    
    
    January 31
    
    
    Percent2005
    
    
    2004
    
    
    Change
    
    
    2005
    
    
    2004
    
    
    ChangeCost of products and services sold
    
    $
    426
    
    
    $
    736
    
    
    
    (42
    %)
    
    $
    855
    
    
    $
    1,544
    
    
    
    (45
    %)Customer operations and support
    
    
    257
    
    
    
    291
    
    
    
    (12
    %)
    
    
    519
    
    
    
    574
    
    
    
    (10
    %)Selling, general and administrative
    
    
    1,745
    
    
    
    1,758
    
    
    
    (1
    %)
    
    
    3,454
    
    
    
    3,516
    
    
    
    (2
    %)Software development and technical support
    
    
    445
    
    
    
    362
    
    
    
    23
    %
    
    
    866
    
    
    
    703
    
    
    
    23
    %Less capitalized portion
    
    
    (144
    )
    
    
    (123
    )
    
    
    17
    %
    
    
    (306
    )
    
    
    (187
    )
    
    
    64
    %Depreciation and amortization
    
    
    69
    
    
    
    37
    
    
    
    86
    %
    
    
    123
    
    
    
    72
    
    
    
    71
    %Net operating expenses
    
    $
    2,798
    
    
    $
    3,061
    
    
    
    (9
    %)
    
    $
    5,511
    
    
    $
    6,222
    
    
    
    (11
    %)
 Customer operations and support consists primarily of server room operations, software
maintenance agreements for the Companys core network and customer support costs. Customer
operations and support costs decreased for the three and six month periods ended January 31, 2005,
compared to the same periods last year primarily due to reduced customer operations and support
costs for the agricultural inputs industry and continued server room cost reductions. Management
expects customer operations and support costs to continue at relatively the same level for the
remainder of fiscal 2005. Selling, general and administrative expenses (SG&A) decreased slightly for the three and six
month periods ended January 31, 2005, compared to the same periods last year, primarily due to
decreased legal fees in the first quarter and the reduction of an accrual for costs related to a
sales tax audit, offset by increased consulting costs related to Sarbanes-Oxley 404 compliance.
SG&A, as a percentage of revenue remained approximately the same at 53% for the six month periods
ended January 31, 2004 and January 31, 2005. Management expects SG&A costs as a percentage of
revenue to increase compared to the previous year for the remainder of fiscal 2005 due to
investments in new product marketing and the reorganizing of the non-North American business. The Companys technical staff (in-house and contracted) performs both software development and
technical support and software customization and data conversion services for customer
applications. Therefore, management expects fluctuations between software customization and data
conversion services and development and technical support expenses quarter to quarter, as the mix
of development and customization activities will change based on customer requirements. Software
development and technical support costs increased for the three and six month periods ended January
31, 2005, compared to the same periods last year, primarily due to temporarily open positions in
the first quarter of fiscal 2004 and a shift in resources from cost of sales to software
development in the first quarter of fiscal 2005. Management expects software development and
technical support costs to continue to be higher than the previous year for the remainder of fiscal
2005 as we invest in new products. Capitalized software product costs represented 35% of software development and technical support
for the six month periods ended January 31, 2005, compared to 27% for the same period last year.
Capitalized software product costs fluctuate from quarter to quarter depending on the deployment of
the Companys resources between early stage research, software development available for
capitalization, data conversion, customer customizations and maintenance and technical support.
Management expects that capitalized software product costs will continue to be higher than the
previous year for the remainder of fiscal 2005, because of planned product development investments. Depreciation and amortization expense increased for the three and six month periods ended January
31, 2005, compared to the same periods last year as the Company made investments in computer
equipment. Management expects depreciation and amortization to continue to be higher than the
previous year for the remainder of fiscal 2005. Other Items Net income increased from $247,000 for the six month period ended January 31, 2004, to $949,000 for
the six month period ended January 31, 2005. The increase in net income is primarily due to the
decrease in software amortization expense. Management expects to continue to generate positive
earnings and cash flows for the remainder of fiscal 2005, although there can be no assurance that
this will occur. 14




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##### Table of Contents



Interest expense includes both cash and non-cash interest. Cash interest paid or accrued for
payment was approximately $133,000 and $174,000 for the six month periods ended January 31, 2005
and 2004, respectively. In addition, approximately $42,000 and $29,000 of excess debt principal, a
non-cash item, was amortized to offset interest expense for the six month periods ended January 31,
2005 and 2004, respectively. On November 19, 2003, pursuant to its option exchange program, the Company accepted for
cancellation options to purchase 319,186 shares of common stock, representing approximately 29% of
the options that were eligible for exchange in the offer. Subject to and in accordance with the
terms of the offer, the Company issued, on May 21, 2004, replacement options to purchase 245,944
shares of the Companys common stock in exchange for the options cancelled in the offer. Acquisitions Since December 1995, the Company has had a formal business development program aimed at
identifying, evaluating and closing acquisitions that augment and strengthen the Companys market
position, product offerings, and personnel resources. Since the programs inception, five
acquisitions have been completed, four of which were fully integrated into the Companys operations
prior to fiscal year 2000. On October 27, 2003, the Company acquired the technology and customer base of VertX Commerce
Corporation (VertX). ARI had been reselling the VertX software under the brand name
WebsiteSmartÔ. The acquisition did not have a material impact on the Companys financial
statements. The business development program is still an important component of the Companys long-term growth
strategy and the Company expects to continue to pursue it aggressively. Liquidity and Capital Resources The following table sets forth, for the periods indicated, certain information reconciling
earn/burn rate to the Companys unaudited financial statements. Earn/Burn Rate(In thousands) Three months ended
    
    
    
    
    
    
    Nine months endedJanuary 31
    
    
    Percent
    
    
    January 31
    
    
    Percent2005
    
    
    2004
    
    
    Change
    
    
    2005
    
    
    2004
    
    
    ChangeNet cash provided by operating activities
    
    $
    579
    
    
    $
    1,189
    
    
    
    (51
    %)
    
    $
    1,314
    
    
    $
    1,257
    
    
    
    5
    %Less: Net increase (decrease) in receivables, prepaid
expenses and other current assets
    
    
    (31
    )
    
    
    (338
    )
    
    
    91
    %
    
    
    (453
    )
    
    
    (487
    )
    
    
    7
    %Net (increase) decrease in accounts payable, deferred
revenue and accrued liabilities
    
    
    88
    
    
    
    (208
    )
    
    
    142
    %
    
    
    480
    
    
    
    445
    
    
    
    8
    %Net cash used in investing activities
    
    
    (228
    )
    
    
    (183
    )
    
    
    (25
    %)
    
    
    (899
    )
    
    
    (372
    )
    
    
    (142
    %)Earn/burn rate
    
    $
    408
    
    
    $
    460
    
    
    
    (11
    %)
    
    $
    442
    
    
    $
    843
    
    
    
    (48
    %)
 Net cash provided by operating activities increased slightly for the six month period ended
January 31, 2005, compared to the same period last year, primarily due to the increase in net
income and decreased for the three month period ended January 31, 2005, compared to the same period
last year, primarily due to components of working capital. The effect of net changes in working
capital is dependent on the timing of payroll and other cash disbursements, accruals and the timing
of invoices and may vary significantly from quarter to quarter. Net cash used in investing
activities increased for the three and six month periods ended January 31, 2005, compared to the
same periods last year, primarily due to the acquisition of software purchased from a third party
in the first quarter of fiscal 2005 that will be incorporated into a new ARI product and increased
in-house capitalized software product costs. Management expects the earn/burn rate to continue to
be less than the prior year for the remainder of fiscal 2005, as the Company invests in marketing
and the development of new software products. At January 31, 2005, the Company had cash of approximately $3,326,000 compared to approximately
$3,357,000 at July 31, 2004. 15




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##### Table of Contents



The following table sets forth, for the periods indicated, certain information related to the
Companys debt derived from the Companys unaudited financial statements. Debt Schedule(In thousands) January 31
    
    
    July 312005
    
    
    2004
    
    
    Net(Unaudited)
    
    
    (Audited)
    
    
    ChangeNote payable to WITECH:Current portion of note payable
    
    
    200
    
    
    
    200
    
    
    
    Long term portion of note payable
    
    
    350
    
    
    
    450
    
    
    
    (100
    )Total note payable to WITECH
    
    
    550
    
    
    
    650
    
    
    
    (100
    )Notes payable to New Holders:Current portion of notes payable
    
    
    800
    
    
    
    800
    
    
    
    Long term portion of notes payable
    
    
    2,300
    
    
    
    2,700
    
    
    
    (400
    )Total face value of notes payable to New Holders
    
    
    3,100
    
    
    
    3,500
    
    
    
    (400
    )Carrying value in excess of face amount of notes payable
    
    
    134
    
    
    
    182
    
    
    
    (48
    )Debt discount (common stock warrants and options)
    
    
    (22
    )
    
    
    (26
    )
    
    
    4Total carrying value of notes payable to New Holders
    
    
    3,212
    
    
    
    3,656
    
    
    
    (444
    )Total debt
    
    $
    3,762
    
    
    $
    4,306
    
    
    $
    (544
    )
 On April 24, 2003, the Company restructured its debt. In exchange for previously outstanding
debt and securities, the Company issued to a group of investors, in aggregate, $500,000 in cash,
unsecured notes in the amount of $3.9 million and warrants for 250,000 common shares, exercisable
at $1.00 per share. The interest rate on the notes is prime plus 2% (effective rate of 7.25% as of
January 31, 2005). The notes (in aggregate) are payable in $200,000 quarterly installments
commencing March 31, 2004 through December 31, 2005 and $300,000 quarterly installments commencing
March 31, 2006 until paid in full. The notes do not contain any financial covenants, but the
Company is restricted from permitting certain liens on its assets. In addition, in the event of
payment default that is not cured within ninety (90) days, Taglich Brothers, Inc., one of the note
holders, has the right to appoint one designee to the Companys Board of Directors. The warrants
were estimated to have a value of $36,000, of which the unamortized amount reduces the carrying
amount of the debt. On August 8, 2003, the Company repurchased from WITECH Corporation 1,025,308 shares of Common
Stock, a warrant to purchase 30,000 shares of Common Stock at $.24 per share, and 20,350 shares of
Series A Preferred Stock with an approximate face value plus accrued and undeclared dividends of
$3.5 million. The Company paid $200,000 in cash and issued a four-year note for $800,000, payable
quarterly and bearing interest at prime plus 2% (effective rate of 7.25% as of January 31, 2005).
The note does not contain any financial covenants. On July 9, 2004, the Company entered into a line of credit with Bank One, N.A. which permits the
Company to borrow an amount equal to 80% of the book value of all eligible accounts minus $75,000,
up to $500,000, and bears interest at prime rate. Eligible accounts include certain non-foreign
accounts receivable which are less than 90 days from the invoice date. The line of credit
terminates July 9, 2005, and is secured by substantially all of the Companys assets. The line of
credit limits repurchases of common stock, the payment of dividends, liens on assets and new
indebtedness, and requires the Company to meet minimum net worth and debt service coverage
financial covenants. As of March 10, 2005, the Company had not borrowed on the line of credit. Management believes that funds generated from operations will be adequate to fund the Companys
operations, investments and debt payments for the foreseeable future, although additional financing
may be necessary if the Company were to complete a large acquisition or to make a large investment
in its business. 16




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##### Table of Contents



The following table sets forth, for the periods indicated, certain information reconciling earnings
before interest, taxes, depreciation and amortization to the Companys unaudited financial
statements. Earnings before Interest, Taxes, Depreciation and Amortization
(in thousands) Three months ended
    
    
    
    
    
    
    Six months endedJanuary 31
    
    
    Percent
    
    
    January 31
    
    
    Percent2005
    
    
    2004
    
    
    Change
    
    
    2005
    
    
    2004
    
    
    ChangeNet income
    
    $
    455
    
    
    $
    175
    
    
    
    160
    %
    
    $
    949
    
    
    $
    247
    
    
    
    284
    %Plus: Interest
    
    
    47
    
    
    
    64
    
    
    
    (27
    %)
    
    
    91
    
    
    
    145
    
    
    
    (37
    %)Amortization of software products
    
    
    133
    
    
    
    445
    
    
    
    (70
    %)
    
    
    274
    
    
    
    888
    
    
    
    (69
    %)Other depreciation and amortization
    
    
    69
    
    
    
    37
    
    
    
    86
    %
    
    
    123
    
    
    
    72
    
    
    
    71
    %Income tax expense
    
    
    14
    
    
    
    
    
    
    
    100
    %
    
    
    50
    
    
    
    
    
    
    
    100
    %Earnings before interest, taxes, depreciation and
amortization
    
    $
    718
    
    
    $
    721
    
    
    
    (0
    %)
    
    $
    1,487
    
    
    $
    1,352
    
    
    
    10
    %
 Earnings before interest, taxes, depreciation and amortization (EBITDA) decreased marginally, for
the three month period ended January 31, 2005, compared to the same period last year. EBITDA
increased for the six month period ended January 31, 2005, compared to the same period last year,
primarily due to the reduction in operating expenses net of capitalized software product costs in
the first quarter of fiscal 2005. Management believes that EBITDA will continue at the same level
for the remainder of fiscal 2005, as the Company invests in the future. This Managements Discussion and Analysis or Plan of Operation discloses EBITDA (earnings before
interest and other taxes, depreciation and amortization) and cash from operations and investment
before changes in working capital (earn/burn rate), each of which may be considered a non-GAAP
financial measure. Generally, a non-GAAP financial measure is a numerical measure of a companys
performance, financial position or cash flows that either excludes or includes amounts that are not
normally excluded or included in the most directly comparable measure calculated and presented in
accordance with accounting principles generally accepted in the United States. In order to fully
assess the Companys financial results, management believes that EBITDA and earn/burn rate are
appropriate measures of evaluating operating performance and liquidity, respectively. EBITDA is a
commonly used measurement of financial performance. In addition, management believes EBITDA is
helpful in understanding period-over-period operating results separate and apart from items that
may, or could, have a disproportionate impact on the Companys results of operations in any
particular period. The Company believes that cash from operations and investment before changes in
working capital items (earn/burn rate) is helpful in determining and measuring the amount of cash
generated from the Companys business, separate and apart from changes caused by changes in working
capital items, which, over several periods, tend to offset each other. However, these measures
should be considered in addition to, and not as a substitute for operating income, cash flows or
other measures of financial performance prepared in accordance with generally accepted accounting
principles and may not necessarily be comparable to similarly titled measures of other companies. Forward Looking Statements Certain statements contained in this Form 10-QSB are forward looking statements including revenue
growth, future cash flows and cash generation and sources of liquidity. Expressions such as
believes, anticipates, expects, and similar expressions are intended to identify such forward
looking statements. Several important factors can cause actual results to materially differ from
those stated or implied in the forward looking statements. Such factors include, but are not
limited to the factors listed on exhibit 99.1 of the Companys annual report on Form 10-KSB for the
year ended July 31, 2004, which is incorporated herein by reference. The forward-looking
statements are made only as of the date hereof, and the Company undertakes no obligation to
publicly release the result of any revisions to these forward-looking statements. 17




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##### Table of Contents



ITEM 3. CONTROLS AND PROCEDURES ARI maintains a set of disclosure controls and procedures that are designed to ensure that
information required to be disclosed by it in the reports filed by it under the Securities Exchange
Act of 1934, as amended (Exchange Act) is recorded, processed, summarized and reported within the
time periods specified in the SECs rules and forms. ARI carried out an evaluation, under the
supervision and with the participation of its management, including its Chief Executive Officer and
its Chief Financial Officer, of the effectiveness of the design and operation of its disclosure
controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based on that evaluation,
ARIs Chief Executive Officer and its Chief Financial Officer concluded that ARIs disclosure
controls and procedures are effective as of January 31, 2005. There have been no changes in ARIs internal control over financial reporting identified in
connection with the evaluation discussed above that occurred during the quarter ended January 31,
2005 that have materially affected, or are reasonably likely to materially affect, ARIs internal
control over financial reporting. 
 PART II  OTHER INFORMATION 
 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS During the quarter ended January 31, 2005, the Company did not sell any equity securities
which were not registered under the Securities Act or repurchase any of its equity securities. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS  (a)
    ARI held its 2004 Annual Meeting of Shareholders on December 9, 2004.(b)
    Votes cast for the election of William C. Mortimore to serve as director until the 2007
Annual Shareholders Meeting were as follows: For
    
    
    5,626,172Withheld authority to vote for
    
    
    29,304
  (c)
    Votes cast for the election of Richard W. Weening to serve as director until the 2007 Annual
Shareholders Meeting were as follows: For
    
    
    4,843,174Withheld authority to vote for
    
    
    812,302
  (d)
    Votes cast to ratify the appointment of Wipfli LLP as ARIs auditors for the year ending July
31, 2005 were as follows: For
    
    
    5,622,454Against
    
    
    11,253Abstained
    
    
    21,769
 
 ITEM 6. EXHIBITS 31.1 Section 302 Certification of Chief Executive Officer.
31.2 Section 302 Certification of Chief Financial Officer.
32.1 Section 906 Certification of Chief Executive Officer.
32.2 Section 906 Certification of Chief Financial Officer. 18




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##### Table of Contents



SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized. ARI Network Services, Inc.
(Registrant)Date:
    
    March 17, 2005
    
    /s/ Brian E. DearingBrian E. Dearing, Chairman of the Board and Chief Executive Officer/s/ Timothy SherlockTimothy Sherlock, Chief Financial Officer
 19