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UNITED STATESSECURITIES AND EXCHANGE COMMISSION   FORM 10-QSB (X)     QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 For the quarterly period ended April 30, 2004 OR ( )    TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 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   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 twelve 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 ninety days. YES (X)     NO ( ) Transitional Small Business Disclosure Format (check one). YES ( )     NO  (X) As of June 10, 2004, there were 5,923,034 shares of the registrants shares
outstanding. 1




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ARI Network Services, Inc. FORM 10-QSB FOR THE THREE MONTHS ENDED APRIL 30, 2004 INDEX PagePART I - FINANCIAL INFORMATIONItem 1
    Financial statementsCondensed balance sheets  April 30, 2004 and July 31, 2003
    
    3-4Condensed statements of operations for the three and nine months ended April 30, 2004 and 2003
    
    5Condensed statements of cash flows for the nine months ended April 30, 2004 and 2003
    
    6Notes to unaudited condensed financial statements
    
    7-8Item 2
Managements discussion and analysis of financial condition and results of operations
    
    9-17Item 3
    Controls and procedures
    
    17PART II - OTHER INFORMATIONItem 2
    Changes in securities and small business issuer purchases of equity securities
    
    17Item 6
    Exhibits and reports on Form 8-K
    
    18Signatures
    19Payment of Deferred Compensation AgreementPayment of Deferred Compensation AgreementPayment of Deferred Compensation AgreementCertification of Chief Executive OfficerCertification of Chief Financial OfficerCertification of Chief Executive OfficerCertification of Chief Financial Officer
 2




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ARI Network Services, Inc. 
 Balance Sheets  (In thousands, except share and per share data)  (Unaudited)
 April 30
    
    July 312004
    
    2003ASSETSCurrent assets:Cash
    
    $
    2,747
    
    
    $
    2,120Trade receivables, less allowance for doubtful accounts of $110
at April 30, 2004 and $98 at July 31, 2003
    
    
    856
    
    
    
    1,088Prepaid expenses and other
    
    
    137
    
    
    
    115Total current assets
    
    
    3,740
    
    
    
    3,323Equipment and leasehold improvements:Computer equipment
    
    
    4,480
    
    
    
    4,475Leasehold improvements
    
    
    73
    
    
    
    73Furniture and equipment
    
    
    1,473
    
    
    
    1,3726,026
    
    
    
    5,920Less accumulated depreciation and amortization
    
    
    5,584
    
    
    
    5,474Net equipment and leasehold improvements
    
    
    442
    
    
    
    446Other assets
    
    
    16
    
    
    
    0Capitalized software product costs
    
    
    10,075
    
    
    
    9,602Less accumulated amortization
    
    
    9,044
    
    
    
    7,721Net capitalized software product costs
    
    
    1,031
    
    
    
    1,881Total Assets
    
    $
    5,229
    
    
    $
    5,650
 3




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##### Table of Contents



ARI Network Services, Inc.
Balance Sheets(In thousands, except share and per share data)(Unaudited) April 30
    
    July 312004
    
    2003LIABILITIES AND SHAREHOLDERS EQUITY (DEFICIT)Current liabilities:Current portion of notes payable
    
    $
    1,000
    
    
    $
    400RFC financed receivables facility
    
    
    
    
    
    
    346Accounts payable
    
    
    196
    
    
    
    401Deferred revenue
    
    
    5,364
    
    
    
    5,280Accrued payroll and related liabilities
    
    
    955
    
    
    
    1,088Other accrued liabilities
    
    
    709
    
    
    
    601Current portion of capital lease obligations
    
    
    12
    
    
    
    20Total current liabilities
    
    
    8,236
    
    
    
    8,136Long term liabilities:Notes payable (net of discount)
    
    
    3,623
    
    
    
    3,769Other long term liabilities
    
    
    553
    
    
    
    559Capital lease obligations
    
    
    5
    
    
    
    16Total long term liabilities
    
    
    4,181
    
    
    
    4,344Shareholders equity (deficit):Cumulative preferred stock, par value $.001 per share,
1,000,000 shares authorized; 0 and 20,350 shares issued and
outstanding at April 30, 2004 and July 31, 2003, respectively
    
    
    
    
    
    
    Common stock, par value $.001 per share, 25,000,000 shares
authorized; 5,921,034 and 6,645,191 shares issued and outstanding
at April 30, 2004 and July 31, 2003, respectively
    
    
    5
    
    
    
    6Common stock warrants and options
    
    
    36
    
    
    
    141Additional paid-in-capital
    
    
    93,616
    
    
    
    94,295Accumulated deficit
    
    
    (100,845
    )
    
    
    (101,272
    )Total shareholders equity (deficit)
    
    
    (7,188
    )
    
    
    (6,830
    )Total Liabilities and Shareholders Equity (Deficit)
    
    $
    5,229
    
    
    $
    5,650
 See notes to unaudited condensed financial statements. Note: The balance sheet at July 31, 2003 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
    
    Nine months endedApril 30
    
    April 302004
    
    2003
    
    2004
    
    2003Net revenues:Subscriptions, support and other services fees
    
    $
    2,263
    
    
    $
    2,137
    
    
    $
    6,812
    
    
    $
    6,168Software licenses and renewals
    
    
    590
    
    
    
    608
    
    
    
    1,783
    
    
    
    1,713Professional services
    
    
    505
    
    
    
    509
    
    
    
    1,341
    
    
    
    1,5213,358
    
    
    
    3,254
    
    
    
    9,936
    
    
    
    9,402Operating expenses:Cost of products and services sold:Subscriptions, support and other services fees
    
    
    98
    
    
    
    152
    
    
    
    382
    
    
    
    453Software licenses and renewals *
    
    
    470
    
    
    
    455
    
    
    
    1,390
    
    
    
    1,328Professional services
    
    
    306
    
    
    
    242
    
    
    
    646
    
    
    
    586874
    
    
    
    849
    
    
    
    2,418
    
    
    
    2,367Depreciation and amortization (exclusive of
amortization of software products included in
cost of products and services sold)
    
    
    38
    
    
    
    52
    
    
    
    110
    
    
    
    164Customer operations and support
    
    
    249
    
    
    
    290
    
    
    
    823
    
    
    
    912Selling, general and administrative
    
    
    1,696
    
    
    
    2,157
    
    
    
    5,212
    
    
    
    5,359Software development and technical support
    
    
    399
    
    
    
    363
    
    
    
    1,102
    
    
    
    1,239Operating expenses before amounts capitalized
    
    
    3,256
    
    
    
    3,711
    
    
    
    9,665
    
    
    
    10,041Less capitalized portion
    
    
    (144
    )
    
    
    (86
    )
    
    
    (331
    )
    
    
    (369
    )Net operating expenses
    
    
    3,112
    
    
    
    3,625
    
    
    
    9,334
    
    
    
    9,672Operating income
    
    
    246
    
    
    
    (371
    )
    
    
    602
    
    
    
    (270
    )Other expense:Interest expense
    
    
    (55
    )
    
    
    (291
    )
    
    
    (200
    )
    
    
    (970
    )Other, net
    
    
    (11
    )
    
    
    8
    
    
    
    25
    
    
    
    (34
    )Total other expense
    
    
    (66
    )
    
    
    (283
    )
    
    
    (175
    )
    
    
    (1,004
    )Net income (loss)
    
    $
    180
    
    
    $
    (654
    )

    
    $
    427
    
    
    $
    (1,274
    )Average common shares outstanding:Basic
    
    
    5,861
    
    
    
    6,581
    
    
    
    5,812
    
    
    
    6,449Diluted
    
    
    6,115
    
    
    
    6,581
    
    
    
    6,066
    
    
    
    6,449Net income (loss) per share:Basic
    
    $
    0.03
    
    
    $
    (0.10
    )
    
    $
    0.07
    
    
    $
    (0.20
    )Diluted
    
    $
    0.03
    
    
    $
    (0.10
    )
    
    $
    0.07
    
    
    $
    (0.20
    )
 See notes to unaudited condensed financial statements.  *
    
    Includes amortization of software products of $435, $440, $1,323 and
$1,304 and excludes other depreciation and amortization shown separately 5




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ARI Network Services, Inc. 
 Statements of Cash Flows  (In thousands)
(Unaudited)
 Nine months endedApril 302004
    
    2003Operating activitiesNet income (loss)
    
    $
    427
    
    
    $
    (1,274
    )Adjustments to reconcile net income (loss) to net cash provided
by operating activities:Amortization of software products
    
    
    1,323
    
    
    
    1,304Amortization of deferred financing costs, debt discount and
excess carrying value over face amount of notes payable
    
    
    (42
    )
    
    
    701Depreciation and other amortization
    
    
    110
    
    
    
    164Interest expense converted to subordinated debt
    
    
    
    
    
    
    229Stock issued as consideration to vendor
    
    
    
    
    
    
    44Stock issued as contribution to 401(k) plan
    
    
    37
    
    
    
    Net change in receivables, prepaid expenses and other
current assets
    
    
    215
    
    
    
    403Net change in accounts payable, deferred revenue,
accrued liabilities and other long term liabilities
    
    
    (370
    )
    
    
    194Net cash provided by operating activities
    
    
    1,700
    
    
    
    1,765Investing activitiesPurchase of equipment and leasehold improvements
    
    
    (106
    )
    
    
    (42
    )Purchase of assets related to acquisitions
    
    
    (108
    )
    
    
    Software product costs capitalized
    
    
    (331
    )
    
    
    (369
    )Net cash used in investing activities
    
    
    (545
    )
    
    
    (411
    )Financing activitiesBorrowings under notes payable
    
    
    
    
    
    
    58Payments under notes payable
    
    
    (500
    )
    
    
    (634
    )Payments of capital lease obligations
    
    
    (19
    )
    
    
    (125
    )Debt issuance costs incurred
    
    
    (20
    )
    
    
    Proceeds from issuance of common stock
    
    
    11
    
    
    
    44Net cash used in financing activities
    
    
    (528
    )
    
    
    (657
    )Net increase in cash
    
    
    627
    
    
    
    697Cash at beginning of period
    
    
    2,120
    
    
    
    879Cash at end of period
    
    $
    2,747
    
    
    $
    1,576Cash paid for interest
    
    $
    353
    
    
    $
    65Noncash investing and financing activitiesCapital lease obligations incurred for computer equipment
    
    $
    
    
    
    $
    15Issuance of common stock in connections with deferred
executive compensation
    
    
    130
    
    
    
    Issuance of common stock in connection with acquisitions
    
    
    37
    
    
    
    Issuance of common stock in connection with restructuring of debt
    
    
    
    
    
    
    36Conversion of accrued interest to subordinated debt
    
    
    
    
    
    
    493Exchange of equity to debt
    
    
    1,000
    
    
    
    
 See notes to unaudited condensed financial statements. 6




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Notes to Condensed Financial Statements
(Unaudited)
April 30, 2004 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 months ended April 30, 2004 are not necessarily
indicative of the results that may be expected for the fiscal year ending July
31, 2004. For further information, refer to the financial statements and
footnotes thereto included in the Companys annual report on Form 10-K for the
year ended July 31, 2003. 2. BASIC AND DILUTED NET INCOME (LOSS) PER SHARE Basic net income(loss) per common share is computed by dividing net
income(loss) 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 effect of dilutive
stock options and warrants on net loss per common share is antidilutive in
fiscal 2003 and therefore not computed. The following table is a
reconciliation of the weighted average number of common shares and equivalents
outstanding (in thousands), which are used in the calculation of basic and
diluted net income (loss) per common share for the periods indicated. Three months ended
    
    Nine months endedApril 30
    
    April 302004
    
    2003
    
    2004
    
    2003Weighted average common shares outstanding
    
    
    5,861
    
    
    
    6,581
    
    
    
    5,812
    
    
    
    6,449Dilutive effect of stock options and warrants
    
    
    254
    
    
    
    
    
    
    
    254
    
    
    
    Diluted weighted average common shares outstanding
    
    
    6,115
    
    
    
    6,581
    
    
    
    6,066
    
    
    
    6,449
 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
    
    Nine months endedApril 30
    
    April 302004
    
    2003
    
    2004
    
    2003Net income (loss), as reported
    
    $
    180
    
    
    $
    (654
    )
    
    $
    427
    
    
    $
    (1,274
    )Stock-based compensation using the
fair value method
    
    
    (20
    )
    
    
    (21
    )
    
    
    (59
    )
    
    
    (60
    )Pro forma net income (loss)
    
    $
    160
    
    
    $
    (675
    )
    
    $
    368
    
    
    $
    (1,334
    )Net income (loss) per shareBasic - as reported
    
    $
    0.03
    
    
    $
    (0.10
    )
    
    $
    0.07
    
    
    $
    (0.20
    )Basic - pro forma
    
    $
    0.03
    
    
    $
    (0.10
    )
    
    $
    0.06
    
    
    $
    (0.21
    )Diluted - as reported
    
    $
    0.03
    
    
    $
    (0.10
    )
    
    $
    0.07
    
    
    $
    (0.20
    )Diluted - pro forma
    
    $
    0.03
    
    
    $
    (0.10
    )
    
    $
    0.06
    
    
    $
    (0.21
    )
 4. NOTES PAYABLE On April 27, 2000, the Company issued and sold to RGC International Investors,
LDC (RGC) (i) a convertible subordinated Debenture (the Debenture) in the
amount of $4,000,000 due on April 27, 2003, (ii) warrants to purchase 600,000
shares of Common Stock at a price of $6 per share (the Warrants) expiring
April 27, 2005, and (iii) an Investment Option to purchase 800,000 shares of
Common Stock at a price of $6 per share (the Investment Option) which expired
on October 27, 2001. In September 2002, RGC transferred the Debenture and the Warrants to ARI
Network Services Partners (which is not in any way affiliated with the
Company), Dolphin Offshore Partners, LP and SDS Merchant Fund, LP. (the
Transferees). 7




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On April 24, 2003, the Company restructured the foregoing instruments. In
exchange for the Debenture and the Warrants, the Company issued to a group of
investors affiliated with the Transferees (collectively, the New Holders), in
aggregate, $500,000 in cash, new unsecured notes in the amount of $3.9 million
(the New Notes) and new warrants for 250,000 common shares, exercisable at
$1.00 per share (the New Warrants). In addition, the Transferees assigned to
the Company all their rights and claims against RGC. The interest rate on the
New Notes is the prime interest rate plus 2%. The New Notes 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 New 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 New Holders, has the right to appoint one designee
to the Companys Board of Directors. The original Warrants and Investment
Options were estimated using a Black Scholes valuation model to have a value of
$2,354,000, and the New Warrants were estimated to have a value of $36,000, of
which the unamortized amount reduces the carrying amount of the debt. In accordance with SFAS No. 15, Accounting by Debtors and Creditors for
Troubled Debt Restructurings, the exchange of the Debenture plus accrued
interest and the Warrants for $500,000 in cash, the New Notes and the New
Warrants was accounted for as a troubled debt restructuring and no gain was
recorded. Instead the liability in excess of the future cash flows to the New
Holders, which was originally approximately $322,000, remains on the balance
sheet as a long term debt and is being amortized as a reduction of interest
expense over the life of the New 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 in $50,000 quarterly installments through
September 30, 2007, at the prime interest rate plus 2%. 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 rest of the 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. 8




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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS Results of Operations Total revenue for the quarter ended April 30, 2004 increased $104,000 or 3%
compared to the same period last year, primarily due to an increase in
recurring revenues from the Companys catalog products in the Equipment
Industry. Earnings increased from a net loss of $654,000, or $0.10 per share
for the quarter ended April 30, 2003 to net income of $180,000 or $0.03 per
share for the quarter ended April 30, 2004. Management believes that the
Company will have modest revenue growth and continue to be profitable for the
remainder of fiscal 2004, although there can be no assurance that this will
occur. See Forward Looking Statements. 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. 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. 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. 9




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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. 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 catalog-enabled business
solutions for sales, service and life cycle product support in the manufactured
equipment market. The Company currently provides 76 catalogs of manufactured
equipment for 60 manufacturers to over 24,000 dealers in more than 100
countries in 12 segments of the worldwide manufactured equipment market
including outdoor power, power sports, recreation vehicles, auto and truck
parts aftermarket, marine, construction, floor maintenance and others.
Collectively, dealers and distributors have over 88,000 catalog subscriptions.
The Company supplies three types of software and services: robust Web and
CD-ROM interactive electronic parts catalogs, template-based website services
and 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 April 30, 2004) Distinct
    
    DistinctDistinct
    
    
    
    
    
    Distributors
    
    DealersCatalogs
    
    Manufacturers
    
    Subscriptions
    
    (Estimated)
    
    (Estimated)North American
    
    
    69
    
    
    
    52
    
    
    
    70,744
    
    
    
    117
    
    
    
    18,899Non-North American
    
    
    71
    
    
    
    8
    
    
    
    17,929
    
    
    
    17
    
    
    
    6,000Included in both Regions
    
    
    (64)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    76
    
    
    
    60
    
    
    
    88,673
    
    
    
    134
    
    
    
    24,899
 Catalog
    
    =
    
    A separately sold and/or distributed parts catalog. A
manufacturer may have more 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 directory and transaction services to the U.S. and Canadian
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 2004. 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
    
    
    
    
    
    Nine months endedApril 30
    
    Percent
    
    April 30
    
    Percent2004
    
    2003
    
    Change
    
    2004
    
    2003
    
    ChangeIndustry Sector:Equipment IndustryNorth AmericanRecurring
    
    $
    2,495
    
    
    $
    2,313
    
    
    
    8
    %
    
    $
    7,278
    
    
    $
    6,398
    
    
    
    14
    %Non-recurring
    
    
    439
    
    
    
    449
    
    
    
    (2
    %)
    
    
    1,174
    
    
    
    1,262
    
    
    
    (7
    %)Subtotal
    
    
    2,934
    
    
    
    2,762
    
    
    
    6
    %
    
    
    8,452
    
    
    
    7,660
    
    
    
    10
    %Non-North AmericanRecurring
    
    
    250
    
    
    
    264
    
    
    
    (5
    %)
    
    
    834
    
    
    
    748
    
    
    
    12
    %Non-recurring
    
    
    34
    
    
    
    42
    
    
    
    (20
    %)
    
    
    168
    
    
    
    193
    
    
    
    (13
    %)Subtotal
    
    
    284
    
    
    
    306
    
    
    
    (7
    %)
    
    
    1,002
    
    
    
    941
    
    
    
    6
    %Total Equipment IndustryRecurring
    
    
    2,745
    
    
    
    2,577
    
    
    
    7
    %
    
    
    8,112
    
    
    
    7,146
    
    
    
    14
    %Non-recurring
    
    
    473
    
    
    
    491
    
    
    
    (4
    %)
    
    
    1,342
    
    
    
    1,455
    
    
    
    (8
    %)Subtotal
    
    
    3,218
    
    
    
    3,068
    
    
    
    5
    %
    
    
    9,454
    
    
    
    8,601
    
    
    
    10
    %Non-equipment IndustryRecurring
    
    
    140
    
    
    
    176
    
    
    
    (20
    %)
    
    
    482
    
    
    
    755
    
    
    
    (36
    %)Non-recurring
    
    
    
    
    
    
    10
    
    
    
    (100
    %)
    
    
    
    
    
    
    46
    
    
    
    (100
    %)Subtotal
    
    
    141
    
    
    
    186
    
    
    
    (25
    %)
    
    
    482
    
    
    
    801
    
    
    
    (40
    %)Total RevenueRecurring
    
    
    2,885
    
    
    
    2,753
    
    
    
    5
    %
    
    
    8,594
    
    
    
    7,901
    
    
    
    9
    %Non-recurring
    
    
    473
    
    
    
    501
    
    
    
    (6
    %)
    
    
    1,342
    
    
    
    1,501
    
    
    
    (11
    %)Grand Total
    
    $
    3,358
    
    
    $
    3,254
    
    
    
    3
    %
    
    $
    9,936
    
    
    $
    9,402
    
    
    
    6
    %
 Revenue by Product in the Equipment Industry
(In thousands) Three months ended
    
    
    
    
    
    Nine months endedApril 30
    
    Percent
    
    April 30
    
    Percent2004
    
    2003
    
    Change
    
    2004
    
    2003
    
    ChangeProduct:Equipment IndustryCatalog and relatedRecurring
    
    $
    2,669
    
    
    $
    2,475
    
    
    
    8
    %
    
    $
    7,789
    
    
    $
    6,819
    
    
    
    14
    %Non-recurring
    
    
    456
    
    
    
    480
    
    
    
    (5
    %)
    
    
    1,318
    
    
    
    1,432
    
    
    
    (8
    %)Subtotal
    
    
    3,125
    
    
    
    2,955
    
    
    
    6
    %
    
    
    9,107
    
    
    
    8,251
    
    
    
    10
    %CommunicationsRecurring
    
    
    76
    
    
    
    102
    
    
    
    (25
    %)
    
    
    323
    
    
    
    327
    
    
    
    (1
    %)Non-recurring
    
    
    17
    
    
    
    11
    
    
    
    55
    %
    
    
    24
    
    
    
    23
    
    
    
    4
    %Subtotal
    
    
    93
    
    
    
    113
    
    

    
    (18
    %)
    
    
    347
    
    
    
    350
    
    
    
    (1
    %)Total Equipment Industry
    
    $
    3,218
    
    
    $
    3,068
    
    
    
    5
    %
    
    $
    9,454
    
    
    $
    8,601
    
    
    
    10
    %
 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 86% for the nine months ended April 30, 2004 compared to 84% for
the same period last year. Management believes that the relationship of
approximately three quarters recurring revenue to one quarter non-recurring
revenue establishes an appropriate level of base revenue while the Company
continues to add new sales to drive future increases in recurring revenue. If
the manufacturing sector of the economy improves in the future, the percentage
of recurring revenue may be slightly lower, indicating a higher amount of new
business. 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, auto and truck
parts after-market, farm equipment, marine, construction, floor maintenance and
others primarily in the U.S., Canada, Europe and Australia. Managements
strategy is to expand the Companys electronic parts catalog software and
services business with manufacturers and distributors and their dealers in the
existing vertical markets, 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 91% for
the nine months ended April 30, 2003 to 95% for the nine months ended April 30,
2004. North American Recurring revenues in the North American Equipment Industry increased for the
three and nine month periods ended April 30, 2004, 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. Non-recurring
revenues in the North American Equipment Industry decreased for the three and
nine month periods ended April 30, 2004, compared to the same periods last
year, primarily due to fewer large customization projects because of the
decline in the manufacturing sector of the economy. Non-North American Recurring revenues in the non-North American Equipment Industry decreased for
the three month period ended April 30, 2004, compared to the same period last
year, primarily due to the loss of a major customer representing
approximately $25,000 a quarter. Recurring revenues in the non-North
American Equipment Industry increased for the nine month period ended April
30, 2004, compared to the same period last year primarily due to fluctuations
in USD revenue because of the euro exchange rate. Non-recurring revenues in
the non-North American Equipment Industry decreased for the three and nine
month periods ended April 30, 2004, compared to the same periods last year,
primarily due to fewer customization projects. Management expects revenues
in the Non-North American Equipment Industry to continue at the same level or
to decline for the remainder of fiscal 2004, until the economy improves. Catalog and Related Products Recurring revenues from the Companys catalog and related products in the
Equipment Industry increased for the three and nine month periods ended
April 30, 2004, 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. Management expects
recurring catalog and related revenues to continue at the same level or
higher in the North American Equipment Industry for the remainder of fiscal
2004, as the Company continues to focus attention and resources on its
catalog products, but non-recurring catalog and related revenue growth may be
delayed until the economy improves. Communications Products Revenues from the Companys communications products decreased for the three
month period ended April 30, 2004, compared to the same period last year,
primarily due to fluctuations in network traffic revenues and remained
relatively the same for the nine month period ended April 30, 2004, 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 2004. Non-Equipment Industry Business The Companys business outside of the Equipment Industry includes sales of
database management and electronic communication services to the agricultural
inputs industry. Revenues in this business have decreased for the three and
nine month periods ended April 30, 2004, 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 and expire 12




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##### Table of Contents



each December. 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 2004. 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
    
    
    
    
    
    Nine months endedApril 30
    
    Percent
    
    April 30
    
    Percent2004
    
    2003
    
    Change
    
    2004
    
    2003
    
    ChangeSubscriptions, support and other services feesRevenue
    
    $
    2,263
    
    
    $
    2,137
    
    
    
    6
    %
    
    $
    6,812
    
    
    $
    6,168
    
    
    
    10
    %Cost of revenue
    
    
    98
    
    
    
    152
    
    
    
    (36
    %)
    
    
    382
    
    
    
    453
    
    
    
    (16
    %)Cost of revenue as a percent of revenue
    
    
    4
    %
    
    
    7
    %
    
  
    
    
    
    
    6
    %
    
    
    7
    %Software licenses and renewalsRevenue
    
    
    590
    
    
    
    608
    
    
    
    (3
    %)
    
    
    1,783
    
    
    
    1,713
    
    
    
    4
    %Cost of revenue
    
    
    470
    
    
    
    455
    
    
    
    3
    %
    
    
    1,390
    
    
    
    1,328
    
    
    
    5
    %Cost of revenue as a percent of revenue
    
    
    80
    %
    
    
    75
    %
    
  
    
    
    
    
    78
    %
    
    
    78
    %Professional servicesRevenue
    
    
    505
    
    
    
    509
    
    
    
    (1
    %)
    
    
    1,341
    
    
    
    1,521
    
    
    
    (12
    %)Cost of revenue
    
    
    306
    
    
    
    242
    
    
    
    26
    %
    
    
    646
    
    
    
    586
    
    
    
    10
    %Cost of revenue as a percent of revenue
    
    
    61
    %
    
    
    48
    %
    
  
    
    
    
    
    48
    %
    
    
    39
    %TotalRevenue
    
    $
    3,358
    
    
    $
    3,254
    
    
    
    3
    %
    
    $
    9,936
    
    
    $
    9,402
    
    
    
    6
    %Cost of revenue
    
    
    874
    
    
    
    849
    
    
    
    3
    %
    
    
    2,418
    
    
    
    2,367
    
    
    
    2
    %Cost of revenue as a percent of revenue
    
    
    26
    %
    
    
    26
    %
    
  
    
    
    
    
    24
    %
    
    
    25
    %
 Cost of subscriptions, support and other services fees consists primarily of
telecommunications and catalog replication and distribution costs. Cost of
subscriptions, support and other services fees as a percentage of revenue
decreased for the three and nine month periods ended April 30, 2004, compared
to the same periods last year primarily due to increased catalog subscriptions
and decreased telecommunications costs and distribution costs related to
shipping updated catalog subscriptions. 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, royalties and software distribution costs. Cost of software
license and renewals as a percentage of revenue increased for the three month
period ended April 30, 2004, compared to the same period last year, and
remained relatively the same for the nine month period ended April 30, 2004,
compared to the same period last year, primarily due to fluctuations in
revenues from software licenses and renewals while software amortization costs
increased slightly. 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 decrease significantly in the fourth
quarter, as the initial software product cost of PartSmart acquired in fiscal
1999, becomes fully amortized. Amortization expense for PartSmart was
$346,000 in the third quarter and will be approximately $110,000 in the fourth
quarter. Cost of professional services consists of customization and catalog production
labor. Cost of professional services as a percentage of revenue increased for
the three and nine month periods ended April 30, 2004, compared to the same
periods last year, primarily due to an increase in catalog production of data
bases requested by dealers that are not billed to the manufacturer on a time
and materials basis (revenues from these databases are included in
subscriptions, support and other services fees) and, for the nine month
periods, the reversal of an accrual for contracted project work in excess of
the contract amount in the first quarter of fiscal 2003. 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
    
    
    
    
    
    Nine months endedApril 30
    
    Percent
    
    April 30
    
    Percent2004
    
    2003
    
    Change
    
    2004
    
    2003
    
    ChangeCost of products and services sold
    
    $
    874
    
    
    $
    849
    
    
    
    3
    %
    
    $
    2,418
    
    
    $
    2,367
    
    
    
    2
    %Customer operations and support
    
    
    249
    
    
    
    290
    
    
    
    (14
    %)
    
    
    823
    
    
    
    912
    
    
    
    (10
    %)Selling, general and administrative
    
    
    1,696
    
    
    
    2,157
    
    
    
    (21
    %)
    
    
    5,212
    
    
    
    5,359
    
    
    
    (3
    %)Software development and technical support
    
    
    399
    
    
    
    363
    
    
    
    10
    %
    
    
    1,102
    
    
    
    1,239
    
    
    
    (11
    %)Less capitalized portion
    
    
    (144
    )
    
    
    (86
    )
    
    
    67
    %
    
    
    (331
    )
    
    
    (369
    )
    
    
    (10
    %)Depreciation and amortization
    
    
    38
    
    
    
    52
    
    
    
    (27
    %)
    
    
    110
    
    
    
    164
    
    
    
    (33
    %)Net operating expenses
    
    $
    3,112
    
    
    $
    3,625
    
    
    
    (14
    %)
    
    $
    9,334
    
    
    $
    9,672
    
    
    
    3
    %
 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 nine month periods ended April 30, 2004, compared to the same periods last
year primarily due to reduced server room and software maintenance costs.
Management expects customer operations and support costs to continue at
relatively the same level for the remainder of fiscal 2004. Selling, general and administrative expenses (SG&A) decreased significantly
for the three month period ended April 30, 2004, compared to the same period
last year, primarily due to decreased legal fees. SG&A decreased slightly for
the nine month period ended April 30, 2004, compared to the same period last
year, primarily due to increased legal fees in the second and third quarter of
fiscal 2003 related to the Companys lawsuit to enforce the buy-back agreement
and the first quarter of fiscal 2004 related to the option exchange program and
the WITECH equity buy-back agreement. SG&A, as a percentage of revenue,
decreased slightly from 57% for the nine month period ended April 30, 2003 to
52% for the nine month period ended April 30, 2004. Management expects SG&A
costs as a percentage of revenue to decline for the remainder of fiscal 2004
due to a reduction in legal fees. 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 month period ended April 30, 2004, compared to the same period last
year, primarily due to increased consulting labor related to software
development of the Companys catalog products. Software development and
technical support costs decreased for the nine month period ended April 30,
2004, compared to the same period last year, primarily due to temporarily open
positions. Management expects software development and technical support costs
to increase slightly for the remainder of fiscal 2004. Capitalized software product costs represented 30% of software development and
technical support for the nine month periods ended April 30, 2004 and 2003.
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 increase for the remainder of fiscal
2004, because of planned allocation of resources towards product development
investments. Depreciation and amortization expense decreased for the three and nine month
periods ended April 30, 2004, compared to the same periods last year as some
computer equipment became fully depreciated. Management expects depreciation
and amortization to continue at relatively the same level for the remainder of
fiscal 2004. Other Items Earnings increased from a net loss of $1,274,000 for the nine month period
ended April 30, 2003, to net income of $427,000 for the nine month period
ended April 30, 2004. The increase in earnings is primarily due to the
increase in revenues and the decrease in interest expense. Management expects
to continue to generate positive earnings and cash flows for the remainder of
fiscal 2004, 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. Interest paid or
accrued for payment was approximately $242,000 and $269,000 for the nine month
periods ended April 30, 2004 and 2003, respectively. In addition,
approximately $42,000 of excess debt principal was amortized to offset interest
expense for the nine month period ended April 30, 2004 and approximately
$701,000 of non-cash interest expense was incurred for the nine month period
ended April 30, 2003 due to amortization of debt discount related to the
Debenture and shareholder note. On November 19, 2003, pursuant to its option exchange program, the Company
accepted for cancellation old options to purchase 319,186 shares of common
stock, representing approximately 29% of the shares of common stock underlying
all old options that were eligible for exchange in the offer. Subject to and
in accordance with the terms of the offer, the Company issued, on the new
option grant date, May 21, 2004, new options to purchase 245,944 shares of the
Companys common stock in exchange for the old 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 previously been reselling the
VertX software under the brand name WebsiteSmart. The acquisition did not
have a material impact on the Companys financial statements for the nine
months ended April 30, 2004. The Company expects to realize modest synergies
in both revenues and costs during the remainder of fiscal 2004. 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 endedApril 30
    
    Percent
    
    April 30
    
    Percent2004
    
    2003
    
    Change
    
    2004
    
    2003
    
    ChangeNet cash provided by operating activities
    
    $
    443
    
    
    $
    1,037
    
    
    
    (57
    %)
    
    $
    1,700
    
    
    $
    1,765
    
    
    
    (4
    %)Net increase (decrease) in receivables, prepaid expenses
and other current assets
    
    
    272
    
    
    
    (326
    )
    
    
    183
    %
    
    
    (215
    )
    
    
    (403
    )
    
    
    47
    %Net (increase) decrease in accounts payable, deferred revenue
and accrued liabilities
    
    
    (75
    )
    
    
    (409
    )
    
    
    82
    %
    
    
    370
    
    
    
    (194
    )
    
    
    291
    %Net cash provided by operating activities
before changes in working capital
    
    
    640
    
    
    
    302
    
    
    
    112
    %
    
    
    1,855
    
    
    
    1,168
    
    
    
    59
    %Net cash used in investing activities
    
    
    (173
    )
    
    
    (125
    )
    
    
    (38
    %)
    
    
    (545
    )
    
    
    (411
    )
    
    
    (33
    %)Earn/burn rate
    
    $
    467
    
    
    $
    177
    
    
    
    164
    %
    
    $
    1,310
    
    
    $
    757
    
    
    
    73
    %
 Net cash provided by operating activities decreased for the nine month period
ended April 30, 2004, compared to the same period last year, primarily due to
components of working capital. Net cash used in investing activities increased
for the nine month period ended April 30, 2004, compared to the same period
last year, primarily due to the software purchased in the Companys
acquisition. 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. Management
expects cash provided from operations and investments before changes in working
capital (earn/burn rate) to be positive for the remainder of fiscal 2004,
although there can be no assurance that this result will be ultimately
achieved. At April 30, 2004, the Company had cash of approximately $2,747,000 compared to
approximately $2,120,000 at July 31, 2003. 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) April 30
    
    July 312004
    
    2003
    
    Net(Unaudited)
    
    (Audited)
    
    ChangeNote payable to WITECH:Current portion of note payable
    
    
    200
    
    
    
    
    
    
    
    200Long term portion of note payable
    
    
    500
    
    
    
    
    
    
    
    500Total note payable to WITECH
    
    
    700
    
    
    
    
    
    
    
    700Notes payable to New Holders:Current portion of notes payable
    
    
    800
    
    
    
    400
    
    
    
    400Long term portion of notes payable
    
    
    2,900
    
    
    
    3,500
    
    
    
    (600
    )Total face value of notes payable to New Holders
    
    
    3,700
    
    
    
    3,900
    
    
    
    (200
    )Carrying value in excess of face amount of notes payable
    
    
    250
    
    
    
    302
    
    
    
    (52
    )Debt discount (common stock warrants and options)
    
    
    (27
    )
    
    
    (33
    )
    
    
    6Total carrying value of notes payable to New Holders
    
    
    3,923
    
    
    
    4,169
    
    
    
    (246
    )Receivables financing
    
    
    
    
    
    
    346
    
    
    
    (346
    )Total debt and receivables financing
    
    $
    4,623
    
    
    $
    4,515
    
    
    $
    108
 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 in quarterly installments of $50,000 and bearing interest at prime plus
2%. The note does not contain any financial covenants. On April 24, 2003, the Company restructured previously outstanding securities
which were then held by New Holders. The interest rate on the new notes is
prime plus 2%. Collectively, the new notes 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 new
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 New Holders, has the right to appoint one designee to the
Companys Board of Directors. On September 28, 1999, ARI and RFC Capital Corporation (RFC) executed a
Receivables Sales Agreement (the Sale Agreement). The initial three-year
Sale Agreement allowed RFC to purchase up to $3.0 million of ARIs accounts
receivable. Under the Sale Agreement, RFC purchased 90% of eligible
receivables. The Sale Agreement expired on November 28, 2003 and was not
renewed. Management does not believe this will materially impact its ability
to fund operations in fiscal 2004. Management believes that funds generated from operations will be adequate to
fund the Companys operations, investments and debt payments through fiscal
2004. 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
    
    
    
    
    
    Nine months endedApril 30
    
    Percent
    
    April 30
    
    Percent2004
    
    2003
    
    Change
    
    2004
    
    2003
    
    ChangeNet income (loss)

    
    $
    180
    
    
    $
    (654
    )
    
    
    128
    %
    
    $
    427
    
    
    $
    (1,274
    )
    
    
    134
    %Plus: Interest
    
    
    55
    
    
    
    291
    
    
    
    (81
    %)
    
    
    200
    
    
    
    970
    
    
    
    (79
    %)Amortization of software products
    
    
    435
    
    
    
    440
    
    
    
    (1
    %)
    
    
    1,323
    
    
    
    1,304
    
    
    
    1
    %Other depreciation and amortization
    
    
    38
    
    
    
    52
    
    
    
    (27
    %)
    
    
    110
    
    
    
    164
    
    
    
    (33
    %)Earnings before interest, taxes, depreciation and
amortization
    
    $
    708
    
    
    $
    129
    
    
    
    449
    %
    
    $
    2,060
    
    
    $
    1,164
    
    
    
    77
    %
 16




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##### Table of Contents



Earnings before interest, taxes, depreciation and amortization (EBITDA)
increased for the three and nine month periods ended April 30, 2004, compared
to the same periods last year, primarily due to the increase in revenue and a
decrease in overhead expenses, primarily third quarter legal expense.
Management believes that EBITDA will continue to increase over last year for
the remainder of fiscal 2004, although there can be no assurance that this will
occur. This Managements Discussion and Analysis of Financial Condition and Results of
Operations 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 generally accepted accounting principles. 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
cash flows. 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 certain 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-K for the year ended July 31, 2003, 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. 
 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 April 30, 2004. 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 fiscal quarter ended April 30, 2004 that have materially affected,
or are reasonably likely to materially affect, ARIs internal control over
financial reporting. 
 PART II  OTHER INFORMATION 
 ITEM 2. CHANGES IN SECURITIES AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY
SECURITIES During the quarter ended April 30, 2004, except as noted below, the Company did
not sell any equity securities which were not registered under the Securities
Act or repurchase any of its equity securities. On April 2, 2004, the Company settled $260,961 of deferred compensation owed to
three executive officers. The settlement was paid one-half in cash and
one-half in stock. The stock was priced at $1.60 per share, the average of
the closing bid and asked prices of the Companys common stock on the date of
settlement. A total of 81,550 shares of stock were issued. The transaction was exempt from registration under the Securities Act pursuant
to Section 4(2) thereof. Each of the executive officers provided investment
representations, and the stock certificates bear a restrictive legend. 17




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##### Table of Contents



ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 10.1 Payment of Deferred Compensation agreement dated April 2, 2004 ,
between the Company and Mr. Brian Dearing. 10.2 Payment of Deferred Compensation agreement dated April 2, 2004 ,
between the Company and Mr. John Bray. 10.3 Payment of Deferred Compensation agreement dated April 2, 2004 ,
between the Company and Mr. Michael McGurk. 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. (b) Reports on Form 8-K On February 26, 2004, ARI furnished a Form 8-K (dated February 26, 2004)
with respect to Item 12. 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: June 14, 2004
    
    /s/ Brian E. DearingBrian E. Dearing, Chairman of the Board and Chief Executive Officer/s/ Timothy SherlockTimothy Sherlock, Chief Financial Officer
 19