form10q.htm


UNITED STATES
 
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q


(Mark One)

x
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended January 31, 2009
 
£
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
(Address of principal executive offices)


Issuer's telephone number (414) 973-4300

Indicate by check mark whether the registrant  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES     R   NO     £

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

Large accelerated filer   £
 Accelerated filer   £
Non-accelerated filer   £
 Smaller reporting company   R
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES     £   NO      R

As of February 23, 2009, there were 7,078,125 shares of the registrant’s common stock outstanding.
 


 
 

 
 
ARI Network Services, Inc.

FORM 10-Q

FOR THE THREE AND SIX MONTHS ENDED JANUARY 31, 2009

INDEX
 

PART I - FINANCIAL INFORMATION
   
Page
     
Item 1
Financial statements
 
     
 
3
     
 
4
     
 
5
     
 
6-13
     
Item 2
13-22
 
 
 
Item 3
22
     
Item 4T
22
   
PART II - OTHER INFORMATION
 
 
 
Item 1
23
     
Item 2
23
     
Item 3
23
     
Item 4
23
     
Item 5
23
     
Item 6
23
     
 
24
 
 


ITEM 1. FINANCIAL STATEMENTS 

ARI Network Services, Inc.
Consolidated Balance Sheets
(Dollars in Thousands, Except Per Share Data)

   
(Unaudited)
   
(Audited)
 
   
January 31
   
July 31
 
   
2009
   
2008
 
ASSETS
           
Current Assets:
           
Cash
  $ 1,138     $ 1,086  
Trade receivables, less allowance for doubtful accounts of $203 and $175 at January 31, 2009 and July 31, 2008, respectively
    993       1,304  
Work in Process
    131       264  
Prepaid expenses and other
    252       392  
Deferred income taxes
    -       330  
Total Current Assets
    2,514       3,376  
Equipment and leasehold improvements:
               
Computer equipment
    5,785       5,647  
Leasehold improvements
    305       198  
Furniture and equipment
    2,886       2,842  
      8,976       8,687  
Less accumulated depreciation and amortization
    7,756       7,523  
Net equipment and leasehold improvements
    1,220       1,164  
                 
Deferred income taxes
    2,525       2,412  
Goodwill
    2,196       2,196  
Other intangible assets
    1,205       1,396  
Other long term assets
    57       53  
                 
Capitalized software product costs:
               
Amounts capitalized for software product costs
    13,554       13,209  
Less accumulated amortization
    12,032       11,613  
Net capitalized software product costs
    1,522       1,596  
Total Assets
  $ 11,239     $ 12,193  
                 
LIABILITIES AND SHAREHOLDERS' EQUITY
               
Current liabilities:
               
Current borrowings on line of credit
  $ 500     $ 700  
Current portion of notes payable
    434       676  
Accounts payable
    126       408  
Deferred revenue
    4,609       5,071  
Accrued payroll and related liabilities
    972       922  
Accrued sales, use and income taxes
    44       80  
Accrued vendor specific liabilities
    320       284  
Other accrued liabilities
    405       615  
Current portion of capital lease obligations
    95       95  
Total Current Liabilities
    7,505       8,851  
                 
Non-current liabilities
               
Notes payable
    -       116  
Long-term portion of accrued compensation
    53       97  
Capital lease obligations
    191       233  
Total Non-current Liabilities
    244       446  
                 
Shareholders' equity:
               
Cumulative preferred stock, par value $.001 per share, 1,000,000 shares authorized; 0 shares issued and outstanding at January 31, 2009 and July 31, 2008, respectively
               
Junior preferred stock, par value $.001 per share, 100,000 shares authorized; 0 shares issued and outstanding at January 31, 2009 and July 31, 2008, respectively
               
Common stock, par value $.001 per share, 25,000,000 shares authorized; 7,078,125 and 6,971,927 shares issued and outstanding at January 31, 2009 and July 31, 2008
    7       7  
Common stock warrants and options
    662       501  
Additional paid-in-capital
    95,220       95,148  
Accumulated deficit
    (92,396 )     (92,708 )
Other accumulated comprehensive (loss)
    (3 )     (52 )
Total Shareholders' Equity
    3,490       2,896  
Total Liabilities and Shareholders' Equity
  $ 11,239     $ 12,193  

See accompanying notes

Note:  The balance sheet at July 31, 2008 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.

3

 
ARI Network Services, Inc.
(Amounts in Thousands, Except Per Share Data)

   
(Unaudited)
   
(Unaudited)
 
   
Three months ended
   
Six months ended
 
   
January 31
   
January 31
 
   
2009
   
2008
   
2009
   
2008
 
                         
Revenue
  $ 3,955     $ 4,222     $ 8,124     $ 8,446  
Cost of products and services sold*
    732       780       1,461       1,527  
                                 
Gross Margin
    3,223       3,442       6,663       6,919  
                                 
Operating expenses:
                               
Depreciation and amortization+
    229       186       458       381  
Customer operations and support
    226       256       531       536  
Selling, general and administrative
    2,146       2,304       4,304       4,684  
Software development and technical support
    319       339       776       688  
                                 
Net operating expenses
    2,920       3,085       6,069       6,289  
                                 
Operating income
    303       357       594       630  
                                 
Other income (expense)
    (30 )     (27 )     (65 )     (51 )
                                 
Income before provision for income taxes
    273       330       529       579  
                                 
Income tax benefit (expense)
    (217 )     5       (217 )     (1 )
                                 
Net income
  $ 56     $ 335     $ 312     $ 578  
                                 
Average common shares outstanding:
                               
Basic
    7,049       6,656       7,011       6,645  
Diluted
    7,065       7,000       7,027       6,989  
                                 
Net income per share:
                               
Basic
  $ 0.01     $ 0.05     $ 0.04     $ 0.09  
Diluted
  $ 0.01     $ 0.05     $ 0.04     $ 0.08  

includes amortization of software products of $204, $187, $419 and $381, respectively and excludes other depreciation and amortization included in operating expenses
 
+
exclusive of amortization of software products included in cost of sales
 
See accompanying notes

4


ARI Network Services, Inc.
(Dollars in Thousands)

   
(Unaudited)
 
   
Six months ended
 
   
January 31
 
   
2009
   
2008
 
             
Operating activities
           
Net income
  $ 312     $ 578  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Amortization of software products
    419       381  
Amortization of deferred financing costs, debt discount and excess carrying value over face amount of notes payable
    8       18  
Depreciation and other amortization
    424       402  
Deferred income taxes
    217       -  
Stock based compensation related to stock options
    161       46  
Stock issued as contribution to 401(k) plan
    45       37  
Net change in assets and liabilities:
               
Trade receivables, net
    327       272  
Work in process
    133       (15 )
Prepaid expenses and other
    142       36  
Other long term assets
    (4 )     -  
Accounts payable
    (282 )     (496 )
Deferred revenue
    (462 )     (810 )
Accrued payroll related liabilities
    11       (14 )
Accrued sales, use and income taxes
    (36 )     16  
Accrued vendor specific liabilities
    36       -  
Other accrued liabilities
    (210 )     163  
                 
Net cash provided by operating activities
    1,241       614  
Investing activities
               
Purchase of equipment, software and leasehold improvements
    (244 )     (61 )
Software product costs capitalized
    (345 )     (194 )
                 
Net cash used in investing activities
    (589 )     (255 )
Financing activities
               
Repayments under line of credit
    (200 )     -  
Payments under notes payable
    (366 )     (668 )
Payments of capital lease obligations
    (42 )     (2 )
Proceeds from issuance of common stock
    19       15  
                 
Net cash used in financing activities
    (589 )     (655 )
Effect of foreign currency exchange rate changes on cash
    (11 )     7  
Net change in cash
    52       (289 )
Cash at beginning of period
    1,086       1,050  
Cash at end of period
  $ 1,138     $ 761  
Cash paid for interest
  $ 47     $ 74  
Cash paid for income taxes
  $ 28     $ 10  

See accompanying notes

5


Notes to  Consolidated Financial Statements
(Unaudited)
January 31, 2009

1.
BASIS OF PRESENTATION

The accompanying unaudited consolidated 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, 2009 are not necessarily indicative of the results to be expected for any other interim period or the full fiscal year ending July 31, 2009.  For further information, refer to the financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the fiscal year ended July 31, 2008.

The financial statements include the accounts of ARI Network Services, Inc. (the “Company”) and its wholly owned subsidiaries, ARI Europe B. V.  and ARI Outsourced F&I Center, LLC (“OFIC”). All inter-company transactions and balances have been eliminated.  Operations of OFIC were suspended in December, 2007, although the LLC remains in place and the Company may re-initiate operations at a future date.

The functional currency of the Company’s subsidiary in the Netherlands is the Euro; accordingly, monetary assets and liabilities are translated into United States dollars at the rate of exchange existing at the end of the period, and non-monetary assets and liabilities are translated into United States dollars at historical exchange rates.  Income and expense amounts, except for those related to assets translated at historical rates, are translated at the average exchange rates during the period.  Adjustments resulting from the remeasurement of the financial statements into the functional currency are charged or credited to comprehensive income.

Beginning in fiscal 2009, the Company reports revenue in total on the income statement rather than by service type, as has been done historically.  The fiscal 2008 financial statements have been restated to conform to the fiscal 2009 presentation.  For more revenue details, refer to Item 2, Management’s discussion and analysis of financial condition and results of operations.


2.             BASIC AND DILUTED NET INCOME PER SHARE

Basic net income per common share is computed by dividing net income by the basic 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 basic and diluted net income per common share for the periods indicated (in thousands, except per share data):

   
Three months ended
   
Six months ended
 
   
January 31
   
January 31
 
   
2009
   
2008
   
2009
   
2008
 
Net income
  $ 56     $ 335     $ 312     $ 578  
Weighted-average common shares outstanding
    7,049       6,656       7,011       6,645  
Effect of dilutive stock options and warrants
    16       344       16       344  
Diluted weighted-average common shares outstanding
    7,065       7,000       7,027       6,989  
Net income per share:
                               
Basic
  $ 0.01     $ 0.05     $ 0.04     $ 0.09  
Diluted
  $ 0.01     $ 0.05     $ 0.04     $ 0.08  
                                 
Options and warrants that could potentially dilute net income per share in the future that are not included in the computation of diluted net income per share, as their impact is anti-dilutive
   
1,425
      989       1,425       989  
 
3.            STOCK-BASED COMPENSATION

There were no capitalized stock-based compensation costs at January 31, 2009 or at January 31, 2008.  Total stock compensation expense recognized by the Company was approximately $85,000 and $161,000 during the three and six month periods ended January 31, 2009 and approximately $37,000 and $46,000 for the same periods last year.  As of January 31, 2009 and 2008 there was approximately $385,000 and $137,000 of total unrecognized compensation cost related to non-vested options granted under its stock option plans.
 
6

 
The Company used the Black-Scholes model to value stock options granted. Expected volatility is based on historical volatility of the Company’s stock. The expected life of options granted represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods within the contractual term of the options is based on the U.S. Treasury yields in effect at the time of grant.

As stock-based compensation expense recognized in our results for the three and six months ended January 31, 2009 is based on awards ultimately expected to vest, the amount has been reduced for estimated forfeitures based on our historical experience.

The fair value of each option grant is estimated using the assumptions in the following table:

   
Three and six months ended January 31
 
   
2009
   
2008
 
Expected life (years)
 
10 years
   
10 years
 
Risk-free interest rate
    2.6 %     4.9 %
Expected volatility
    85.0 %     120.0 %
Expected dividend yield
    0.0 %     0.0 %

Employee Stock Purchase Plans

The Company’s 2000 Employee Stock Purchase Plan has 175,000 shares of common stock reserved for issuance, and 154,322 of the shares have been issued as of January 31, 2009. All employees of the Company, other than executive officers, with six months of service are eligible to participate. Shares may be purchased at the end of a specified period at the lower of 85% of the market value at the beginning or end of the specified period through accumulation of payroll deductions, not to exceed 5,000 shares per employee per year.
 
1991 Stock Option Plan

The Company’s 1991 Stock Option Plan was terminated August 14, 2001, except as to outstanding options. Options granted under the 1991 Plan may be either: (a) options intended to qualify as incentive stock options under Section 422 of the Internal Revenue Code of 1986, as amended (the Code), or (b) nonqualified stock options.

Any incentive stock option that was granted under the 1991 Plan could not be granted at a price less than the fair market value of the stock on the date of grant (or less than 110% of the fair market value in the case of holders of 10% or more of the voting stock of the Company). Nonqualified stock options were allowed to be granted at the exercise price established by the Compensation Committee of the Board of Directors, which could be less than, equal to or greater than the fair market value of the stock on the date of grant.

Each option granted under the 1991 Plan is exercisable for a period of ten years from the date of grant (five years in the case of a holder of more than 10% of the voting stock of the Company) or such shorter period as determined by the Compensation Committee and shall lapse upon the expiration of said period, or earlier upon termination of the participant’s employment with the Company.

At its discretion, the Compensation Committee may require a participant to be employed by the Company for a designated number of years prior to exercising any options. The Committee may also require a participant to meet certain performance criteria, or that the Company meets certain targets or goals, prior to exercising any options.

7

 
Changes in option shares under the 1991 Plan:
 
   
Three Months ended
   
Three Months ended
 
   
January 31, 2009
   
January 31, 2008
 
   
Options
   
Wt-Avg Exercise Price
   
Wt-Avg Remaining Contractual Period
   
Aggregate Intrinsic Value
   
Options
   
Wt-Avg Exercise Price
   
Wt-Avg Remaining Contractual Period
   
Aggregate Intrinsic Value
 
Outstanding at the beginning of period
    63,250     $
2.31
      1.12     $ -       125,186     $ 2.30       1.64     $ -  
Granted
    -       n/a       n/a       n/a       -       n/a       n/a       n/a  
Exercised
    -       n/a       n/a       n/a       -       n/a       n/a       n/a  
Forfeited
    (26,250 )   $ 2.12       n/a       n/a       -       n/a       n/a       n/a  
Outstanding at the end of period
    37,000     $ 2.56       1.57     $ -       125,186     $ 2.30       1.39     $ -  
Exercisable at the end of period
    37,000     $ 2.56       1.57     $ -       125,186     $ 2.30       1.39     $ -  
                                                                 
   
Six Months ended
   
Six Months ended
 
   
January 31, 2009
   
January 31, 2008
 
   
Options
   
Wt-Avg Exercise Price
   
Wt-Avg Remaining Contractual Period
   
Aggregate Intrinsic Value
   
Options
   
Wt-Avg Exercise Price
   
Wt-Avg Remaining Contractual Period
   
Aggregate Intrinsic Value
 
Outstanding at the beginning of period
    93,186     $ 2.27       1.23     $ -       125,686     $ 2.30       1.89     $ -  
Granted
    -       n/a       n/a
 
    n/a       -       n/a       n/a       n/a  
Exercised
    -       n/a       n/a       n/a       -       n/a       n/a       n/a  
Forfeited
    (56,186 )   $ 2.15       n/a       n/a       (500 )   $ 4.06       n/a       n/a  
Outstanding at the end of period
    37,000     $ 2.56       1.57     $ -       125,186     $ 2.30       1.39     $ -  
Exercisable at the end of period
    37,000     $ 2.56       1.57     $ -       125,186     $ 2.30       1.39     $ -  
 
The range of exercise prices for options outstanding at January 31, 2009 and 2008 was $2.06 to $9.06.
 
1993 Director Stock Option Plan

The Company’s 1993 Director Stock Option Plan (“Director Plan”) has expired and is terminated except for outstanding options. The Director Plan originally had 150,000 shares of common stock reserved for issuance to nonemployee directors. Options under the Director Plan were granted at the fair market value of the stock on the grant date.

Each option granted under the Director Plan is exercisable one year after the date of grant and cannot be exercised later than ten years from the date of grant.
 
8

 
Changes in option shares under the Director Plan:
 
   
Three Months Ended
   
Three Months ended
 
   
January 31, 2009
   
January 31, 2008
 
   
Options
   
Wt-Avg Exercise Price
   
Wt-Avg Remaining Contractual Period
   
Aggregate Intrinsic Value
   
Options
   
Wt-Avg Exercise Price
   
Wt-Avg Remaining Contractual Period
   
Aggregate Intrinsic Value
 
Outstanding at the beginning of period
    1,313     $ 2.65       1.72     $ -       1,313     $ 2.65       2.72     $ -  
Granted
    -       n/a       n/a       n/a       -       n/a       n/a       n/a  
Exercised
    -       n/a       n/a       n/a       -       n/a       n/a       n/a  
Forfeited
    -       n/a       n/a       n/a       -       n/a       n/a       n/a  
Outstanding at the end of period
    1,313     $ 2.65       1.47     $ -       1,313     $ 2.65       2.47     $ -  
Exercisable at the end of period
    1,313     $ 2.65       1.47     $ -       1,313     $ 2.65       2.47     $ -  
                                                                 
   
Six Months Ended
   
Six Months ended
 
   
January 31, 2009
   
January 31, 2008
 
   
Options
   
Wt-Avg Exercise Price
   
Wt-Avg Remaining Contractual Period
   
Aggregate Intrinsic Value
   
Options
   
Wt-Avg Exercise Price
   
Wt-Avg Remaining Contractual Period
   
Aggregate Intrinsic Value
 
Outstanding at the beginning of period
    1,313     $ 2.65       1.97     $ -       1,313     $ 2.65       2.97     $ -  
Granted
    -       n/a       n/a       n/a       -       n/a       n/a       n/a  
Exercised
    -       n/a       n/a       n/a       -       n/a       n/a       n/a  
Forfeited
    -       n/a       n/a       n/a       -       n/a       n/a       n/a  
Outstanding at the end of period
    1,313     $ 2.65       1.47     $ -       1,313     $ 2.65       2.47     $ -  
Exercisable at the end of period
    1,313     $ 2.65       1.47     $ -       1,313     $ 2.65       2.47     $ -  
 
The range of exercise prices for options outstanding at January 31, 2009 and 2008 was $2.00 to $3.56.

2000 Stock Option Plan

The Company’s 2000 Stock Option Plan (“2000 Plan”) has 1,950,000 shares of common stock authorized for issuance. Options granted under the 2000 Plan may be either: (a) options intended to qualify as incentive stock options under Section 422 of the Code, or (b) nonqualified stock options.

Any incentive stock option that is granted under the 2000 Plan may not be granted at a price less than the fair market value of the stock on the date of the grant (or less than 110% of the fair market value in the case of a participant who is a 10% shareholder of the Company within the meaning of Section 422 of the Code). Nonqualified stock options may be granted at the exercise price established by the Compensation Committee.

Each incentive stock option granted under the 2000 Plan is exercisable for a period of not more than ten years from the date of grant (five years in the case of a participant who is 10% shareholder of the Company, unless the stock options are nonqualified), or such shorter period as determined by the Compensation Committee and shall lapse upon the expiration of said period, or earlier upon termination of the participant’s employment with the Company.
 
Eligible participants include current and prospective employees, nonemployee directors, consultants or other persons who provide services to the Company and whose performance, in the judgment of the Compensation Committee or management of the Company, can have a significant effect on the success of the Company.
 
9


Changes in option shares under the 2000 Plan during the:

   
Three Months Ended
   
Three Months ended
 
   
January 31, 2009
   
January 31, 2008
 
   
Options
   
Wt-Avg Exercise Price
   
Wt-Avg Remaining Contractual Period
   
Aggregate Intrinsic Value
   
Options
   
Wt-Avg Exercise Price
   
Wt-Avg Remaining Contractual Period
   
Aggregate Intrinsic Value
 
Outstanding at the beginning of period
    1,310,100     $ 1.52       7.44     $ 70,344       923,789     $ 1.48       6.42     $ 275,417  
Granted
    31,000     $ 0.84       -       -       35,500     $ 1.63       -       -  
Exercised
    (60,242 )   $ 0.26       -       -       -     $ -       n/a       n/a  
Forfeited
    (73,395 )   $ 1.99       -       -       (68,314 )   $ 1.14       -       -  
Outstanding at the end of period
    1,207,463     $ 1.54       7.51     $ 27,807       890,975     $ 1.52       6.43     $ 289,823  
Exercisable at the end of period
    683,752     $ 1.58       3.49     $ 25,957       732,611     $ 1.46       5.96     $ 276,774  
                                                                 
   
Six Months Ended
   
Six Months ended
 
   
January 31, 2009
   
January 31, 2008
 
   
Options
   
Wt-Avg Exercise Price
   
Wt-Avg Remaining Contractual Period
   
Aggregate Intrinsic Value
   
Options
   
Wt-Avg Exercise Price
   
Wt-Avg Remaining Contractual Period
   
Aggregate Intrinsic Value
 
Outstanding at the beginning of period
    1,380,538     $ 1.45       6.61     $ 320,062       1,013,100     $ 1.45       6.61     $ 320,062  
Granted
    89,000     $ 1.12       -       -       35,500     $ 1.63       -       -  
Exercised
    (60,242 )   $ 0.26       -       -       -     $ -       n/a       n/a  
Forfeited
    (201,833 )   $ 1.51       -       -       (157,625 )   $ 1.10       -       -  
Outstanding at the end of period
    1,207,463     $ 1.54       7.51     $ 27,807       890,975     $ 1.52       6.43     $ 289,823  
Exercisable at the end of period
    683,752     $ 1.58       3.49     $ 25,957       732,611     $ 1.46       5.96     $ 276,774  
 
 
Changes in non-vested option shares under the 2000 Plan during the:

   
Three Months Ended January 31
   
Six Months Ended January 31
 
   
2009
   
2008
   
2009
   
2008
 
   
Options
   
Wt-Avg Exercise Price
   
Options
   
Wt-Avg Exercise Price
   
Options
   
Wt-Avg Exercise Price
   
Options
   
Wt-Avg Exercise Price
 
Non-vested at the beginning of period
    493,867     $ 1.53       123,239     $ 1.85       443,335     $ 1.76       137,675     $ 1.79  
Granted
    31,000     $ 0.84       35,500     $ 1.63       89,000     $ 1.12       35,500     $ 1.63  
Vested
    -       n/a       -       n/a       -       n/a       -       n/a  
Forfeited
    (1,156 )   $ 1.74       (375 )   $ 1.80       (8,624 )   $ 1.63       (14,811 )   $ 1.29  
Non-vested at the end of period
    523,711     $ 1.49       158,364     $ 1.80       523,711     $ 1.49       158,364     $ 1.80  
 
The range of exercise prices for options outstanding at January 31, 2009 and 2008 was $0.15 to $2.735.
 
10


4.             ACQUISITIONS

On July 1, 2008, the Company acquired all of the assets related to electronic parts catalogs, electronic commerce and certification testing for service technicians of Info Access, the micropublishing division of Eye Communication Systems, Inc. (“ECSI”), of Hartland, WI.  Consideration for the acquisition included approximately $1.0 million in cash, 312,500 shares of the Company’s common stock, 125,000 of which is held in escrow based on contingent revenue retention, and notes payable of $300,000.  It was determined that as of July 31, 2008, it was more likely than not that the contingencies associated with the shares in escrow would be resolved such that the Company would be obligated to deliver such escrowed shares to ECSI in October, 2009.  Accordingly, this amount has been recorded as outstanding stock at July 31, 2008 and January 31, 2009.
 
5.             NOTES PAYABLE

The following table sets forth, for the periods indicated, certain information related to the Company’s debt derived from the Company’s unaudited balance sheet as of January 31, 2009 and audited balance sheet as of July 31, 2008.

Debt Schedule
(Dollars in thousands)

                   
   
January 31
   
July 31
   
Percent
 
   
2009
   
2008
   
Change
 
                   
Debt related to acquisition of OC-Net, Inc.:
                 
                   
Current portion of notes payable
  $ 234     $ 233       0.4 %
Long term portion of notes payable
    -       117       (100.0 )
                         
Total notes payable
    234       350       (33.1 )
Current cash earnout
    -       150       (100.0 )
Imputed interest on cash earnout/holdback
    -       (8 )     (100.0 )
Total debt related to acquisition of OC-Net
    234       492       (52.4 )
                         
Notes payable to Eye Communication Systems, Inc. - current
    200       300       (33.3 )
                         
Current borrowings on line of credit
    500       700       (28.6 )
                         
Total Debt
  $ 934     $ 1,492       (37.4 ) %

The Company issued $700,000 of notes and $400,000 of future non-interest bearing contingent payments in connection with the January 26, 2007 purchase of OC-Net, Inc.  The interest rate on the notes is prime plus 2%, adjusted quarterly (effective rate of 5.25% as of January 31, 2009).  The notes are payable in quarterly principal installments of $58,333, commencing March 31, 2007 through April 30, 2010.  The notes do not contain any financial covenants.  The Company has paid all of the future contingent payments.

In 2008, the Company issued $300,000 of notes payable in connection with the Info Access acquisition, of which $100,000 was paid on October 1, 2008 and $200,000 is due on July 1, 2009. The interest rate on the note is 6%.

6.             LINE OF CREDIT

On July 9, 2004, the Company entered into a line of credit with JPMorgan Chase, N.A. which, as since amended, permits the Company to borrow an amount equal to 80% of the book value of all eligible accounts receivable plus 45% of the value of all eligible open renewal orders (provided the renewal rate is at least 85%) minus $75,000, up to $1,500,000, and bears interest at prime rate.  Eligible accounts include certain non-foreign accounts receivable which are outstanding for fewer than 90 days from the invoice date.  The line of credit terminates July 9, 2009, 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.  The Company had $500,000 and $700,000 principal outstanding on the line of credit at January 31, 2009 and July 31, 2008.

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7.             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.             INCOME TAXES

The provision (benefit) for income taxes is composed of the following (in thousands):

   
Three months ended
   
Six months ended
 
   
January 31
   
January 31
 
   
2009
   
2008
   
2009
   
2008
 
Current:
                       
Federal - Effect
  $ 11     $ (113 )   $ 11     $ 30  
State - Effect
    2       (20 )     2       8  
Generation (utilization) of net operating loss carryforwards
    (133 )     128       (13 )     (37 )
                                 
Deferred, net
    337       -       217       -  
                                 
    $ 217     $ (5 )   $ 217     $ 1  

Provision for income taxes is an estimate based on taxes payable under currently enacted tax laws and an analysis of temporary differences between the book and tax bases of the Company’s assets and liabilities and does not represent current taxes due.  The tax effect of these temporary differences and the estimated tax benefit from tax net operating losses are reported as deferred tax assets and liabilities in the balance sheet.  An assessment is performed on a quarterly basis of the likelihood that net deferred tax assets will be realized from future taxable income.  To the extent that management believes it is more likely than not that some portion, or all, of the deferred tax asset will not be realized, a valuation allowance is established.  Because the ultimate realizability of deferred tax assets is dependent upon the outcome of future events, the amount established as a valuation allowance is a significant estimate that is subject to change quarterly.  The change in the valuation allowance during a period is reflected with a corresponding income tax provision increase or decrease in the Consolidated Statements of Income.  Because of the uncertainty of long-term future economic conditions, the estimated future utilization of deferred net tax assets is based on twelve quarters of projections. The Company had a change in its estimated valuation allowance during the quarter ended January 31, 2009, primarily due to a decrease in its projected utilization of its net operating loss carryforwards from earlier years.  The Company continues to evaluate the realizability of deferred tax assets on a quarterly basis.

The Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 48, "Accounting for  Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109" (FIN 48), on August 1, 2007. The implementation of FIN 48 did not have a significant impact on our results of operations or financial position and therefore no amounts were reserved for uncertain tax positions as of January 31, 2009 and July 31, 2008.

9.             BUSINESS SEGMENTS

The Company’s business segments are internally organized primarily by geographic location of the operating facilities.  In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 131, “Disclosures about Segments of an Enterprise and Related Information”, the Company has segregated the Netherlands operation and the U.S. operations into separate reportable segments.  (Refer to Note 1 to the financial statements, “Description of Business and Significant Accounting Policies” included in the Company’s annual report on Form 10-K for the fiscal year ended July 31, 2008, for a description of segment operations and the accounting policies for each of the segments.) We evaluate the performance of and allocate resources to each of the segments based on net income.

12


Information concerning the Company’s operating business segments for fiscal 2009 and 2008 is as follows:
 
Business Segment Information
 
(In thousands)
 
                         
   
Three months ended
   
Six months ended
 
   
January 31
   
January 31
 
Revenue
 
2009
   
2008
   
2009
   
2008
 
Netherlands
  $ 161     $ 177     $ 333     $ 338  
United States
    3,794       4,045       7,791       8,108  
Consolidated
  $ 3,955     $ 4,222     $ 8,124     $ 8,446  
                                 
Net Income (Loss)
                               
Netherlands
  $ (19 )   $ (108 )   $ (55 )   $ (177 )
United States
    75       443       367       755  
Consolidated
  $ 56     $ 335     $ 312     $ 578  
                                 
   
January 31
   
July 31
                 
Total Assets
 
2009
   
2008
                 
Netherlands
  $ 1,149     $ 1,306                  
United States
    10,090       10,887                  
Consolidated
  $ 11,239     $ 12,193                  
 
10.          RESTRUCTURING

In July, 2008, the Company announced a restructuring consolidating its data conversion operations in Virginia into its Wisconsin location and consolidating the software development operations in Colorado into its California location.  A charge of $529,000 was taken in the fourth quarter of fiscal 2008, to reflect the restructuring costs.  The following represents changes to the restructuring reserve (in thousands):

   
Balance
   
Payments
   
Balance
 
   
July 31
   
August 2008 -
   
January 31
 
   
2008
   
January 2009
   
2009
 
Severance and related benefits
  $ 292     $ (195 )   $ 97  
Net future lease costs
    204       (73 )     131  
Equipment disposition and other
    33       (29 )     4  
Total restructuring costs
  $ 529     $ (297 )   $ 232  

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Summary

The Company produced net income of $56,000 and $312,000 for the three and six months ended January 31, 2009, compared to $335,000 and $578,000 for the three and six months ended January 31, 2008.  The decrease in earnings was primarily due to income tax expense related to an increase in the valuation allowance to deferred tax assets and lower revenues.  These effects were partially offset by lower operating expenses.  Total revenue decreased 6.3% and 3.8% for the three and six month periods ended January 31, 2009, respectively, compared to the same periods last year, primarily due to a decrease in revenues from the Company’s catalog and professional services, which was substantially offset by an increase in marketing services revenue from sales of WebsiteSmart Pro™ and catalog revenue related to the July 1, 2008 Info Access acquisition.  Management expects revenue to decrease somewhat for the balance of the fiscal year, compared to the same periods in fiscal 2008.  This expectation of a continued decrease is primarily in its professional services business, as some customers delay projects due to the global economic downturn.

Management is taking prudent steps to timely align to the changing market conditions while funding the initiatives which position ARI for the future. We anticipate generating sufficient cash flow from operations to fund the Company’s needs for the foreseeable future.

For the six months ended January 31, 2009, the Company repaid $566,000 of funded debt, invested $589,000 in product development and other capital investments and increased its cash balance by $52,000.

13

 
Current Global Economic Downturn:
 
ARI provides software products, Internet websites and related professional services to customers at all levels of the value chain including equipment manufacturers, distributors and retailers.  The primary market verticals served are outdoor power, power sports, agricultural, marine, appliance and RV, as well as other equipment.  Industry trade publications are reporting that the current global economic downturn is having a substantial negative affect on the revenues, earnings and cash flow of customers within ARI’s primary markets.  These effects, should they continue, may result in a reduction in industry size, industry consolidation and a weakening in ARI’s customers’ ability to timely pay their obligations.  In turn, these results could negatively affect the base of ARI’s customers and the timing of its cash flows.

ARI sells the majority of its products on a subscription basis with terms of one or more years.  These products are considered essential to enabling more efficient operations and enhancing the sale of parts, goods and accessories throughout the channel.  The combination of these factors generally is expected to moderate the effect of the economic downturn on ARI’s revenue and earnings when compared to businesses which manufacture or distribute equipment and other capital goods.

Certain statements contained herein are forward-looking statements. The Company’s actual results may differ materially from those contained in the forward looking statements, particularly in the current weak economic environment, which has and may continue to adversely affect our operating results.  Recent turmoil in the capital and credit markets has increased the difficulty and expense of obtaining financing for many companies.  As a result, additional financing may not be available to us, and if it is, it may be dilutive to existing shareholders or may be on terms that are not favorable to us.  Management has made assumptions in its remarks that the global credit markets will not deteriorate further and acknowledges the increased uncertainty caused by the current economic environment.  See “Forward Looking Statements.”

Critical Accounting Policies and Estimates

General
Management’s discussion and analysis of the Company’s 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, equity, revenues and expenses, and related disclosure of contingent assets and