form10k.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-K
 
x   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 
For the fiscal year ended July 31, 2011

o   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.
(Name of small business issuer in its charter)
 
WISCONSIN    39- 1388360
(State or other jurisdiction of incorporation or organization)   (IRS Employer Identification No.)
 
10850 West Park Place, Suite 1200, Milwaukee, Wisconsin  53224
(Address of principal executive office)
 
Issuer's telephone number (414) 973-4300

Securities registered pursuant to Section 12(b) of the Act:  None

Securities registered pursuant to Section 12(g) of the Act:
 
Common Stock, par value $0.001 per share
(Title of Class)
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act
Yes o No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act.
Yes o No þ
 
Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 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 þ No o
 
Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
Yes þ No o  
 
Indicate by check if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (S229.405 of this chapter)  is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o
 


 
 

 
 
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 o
Accelerated filer o
Non-accelerated filer  o
Smaller reporting company þ
(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 o No þ
 
The aggregate market value of the common stock held by non-affiliates of the registrant, based on the closing price of the registrant’s common stock on January 31, 2011 as reported on the OTC bulletin board, was $4.1 million.

As of October 19, 2011, there were 7,987,944 shares of the registrant’s shares outstanding.
 
DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Definitive Proxy Statement, to be filed with the Securities and Exchange Commission no later than 120 days after July 31, 2011, for the 2011 Annual Meeting of Shareholders are incorporated by reference in Part III hereof.
 
 
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ARI Network Services, Inc.

FORM 10-K
FOR THE FISCAL YEAR ENDED JULY 31, 2011
INDEX
 
PART I
   
Page
Item 1
 
4
Item 1a
 
11
Item 2
 
15
Item 3
 
15
Item 4
 
15
PART II
Item 5
 
16
Item 6
 
17
Item 7
 
18
Item 8
 
28
Item 9
 
28
Item 9A
 
28
PART III
 
Item 10
 
30
Item 11
 
30
Item 12
 
30
Item 13
 
30
Item 14
 
30
PART IV
 
Item 15
 
31
   
33
   
34
   
35
 
 
3

 
This Annual Report on Form 10-K, including the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7, contains forward-looking statements regarding future events and our future results that are subject to the safe harbors created under the Securities Act of 1933 (the “Securities Act”) and the Securities Exchange Act of 1934 (the “Exchange Act”). All statements other than statements of historical facts are statements that could be deemed to be forward-looking statements. These statements are based on current expectations, estimates, forecasts, and projections about the markets in which we operate and the beliefs and assumptions of our management. Words such as “expects,” “anticipates,” “targets,” “goals,” “projects,” “intends,” “plans,” “believes,” “seeks,” “estimates,”  “endeavors,” “strives,” “may,” variations of such words, and similar expressions are intended to identify such forward-looking statements. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses, and other characterizations of future events or circumstances are forward-looking statements. Readers are cautioned that these forward-looking statements are only predictions and are subject to risks, uncertainties, and assumptions that are difficult to predict, estimate, or verify, including those identified below under “Item 1A. Risk Factors” and elsewhere herein. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. We undertake no obligation to revise or update any forward-looking statements for any reason.

PART I
 
Item 1. Business

Overview

ARI Network Services, Inc. (“ARI”) is a leader in creating, marketing, and supporting solutions that enhance revenue and reduce costs for our customers. Our innovative, technology-enabled solutions connect the community of consumers, dealers, distributors, and manufacturers to help them efficiently service and sell more whole goods, parts, garments, and accessories (“PG&A”) worldwide in selected vertical markets that include power sports, outdoor power equipment, marine, and appliances.  We estimate that approximately 18,000 equipment dealers, 125 manufacturers, and 150 distributors worldwide leverage our technology to drive revenue, gain efficiencies and increase customer satisfaction.

Our suite of software and SaaS solutions are designed to facilitate our customers’ operations, increasing sales through additional foot and website traffic, more effective lead management, and greater conversion rates on those leads.  To achieve this, our solutions allow our customers to: (i) efficiently market to their customers and prospects in order to drive increased traffic to their location and website; (ii) manage and nurture customers and prospects; (iii) increase revenues by selling PG&A online; (iv) increase revenues by generating leads for whole goods; and (v) increase revenues and reduce costs of our dealer customers by enhancing the productivity of our customers’ support operations, specifically with respect to the sale of manufacturers’ parts.

We were incorporated in Wisconsin in 1981.  Our principal executive office and headquarters is located in Milwaukee, Wisconsin.  The office address is 10850 West Park Place, Suite 1200, Milwaukee, WI 53224, and our telephone number at that location is (414) 973-4300. Our principal website address is www.arinet.com.

Our Solutions

Today, we generate revenue from three primary categories of technology-enabled solutions: (i) electronic catalogs for publishing, viewing and interacting with PG&A information from OEMs and distributors; (ii) lead generation and management products and services designed to help dealers generate sales of whole goods, PG&A through efficient marketing of their products; and (iii) websites with eCommerce capabilities designed to generate leads for whole goods and sales of PG&A through the sites and provide information to consumers in the dealers’ local areas.

Electronic Catalogs

Our electronic catalog solutions, which encompass our PartSmart®, PartSmart Web™ and PartStream™ products, contain enhanced data relating to manufacturers’ whole goods, and PG&A.  The solutions allow distributors and dealers to view and interact with this information to efficiently support the sales and service of equipment. We believe that we have the broadest library of available content in the vertical markets we serve, and our multi-line electronic catalog solution is the fastest and most efficient in the marketplace.  We derived 59% of our revenues from subscriptions to, and support for, our electronic catalog services in fiscal 2011.

 
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PartSmart®, our CD-based electronic parts catalog, is used by dealers worldwide in the outdoor power, power sports, marine, and agricultural equipment industries to increase productivity by significantly reducing parts lookup time.  Our PartSmart® software allows multi-line dealers to look up parts and service information for all manufacturer product lines that the dealer carries, and integrates with more than 85 of the leading dealer business management systems.  We also provide a version of our PartSmart® product to the appliance industry, known as PartSmart® IPL.

PartSmart Web™, a SaaS solution, is used by distributors and manufacturers to provide their dealers with access to parts and pricing information via the Internet.

PartStream™, a SaaS solution, is a modular, consumer-focused illustrated parts lookup application that integrates with existing dealer website platforms and shopping carts and allows consumers to quickly identify the desired part, add the part to their electronic shopping cart and check out.  It leverages ARI’s parts content, delivering it to PartStream™ users on demand from ARI servers.

Lead Generation and Management Products and Services

Our award-winning lead generation and management solutions, which encompass our Footsteps™ product and SearchEngineSmart™ service, are designed to increase traffic to dealers’ stores and websites and more efficiently manage and nurture generated leads, increasing conversion rates and ultimately revenues.  We derived 9.3% of our revenues from lead generation and management services in fiscal 2011.

Footsteps™, a SaaS solution, connects the equipment manufacturers with their dealer channel through lead consolidation and distribution, and allows dealers to handle leads more efficiently and professionally through marketing automation and business management system integration.  The product is used as a complete database of customers and prospects, and manages the dealer to customer relationship from generating email campaigns and automated responses, to providing sales teams with a daily follow-up calendar and reminder notices.

Our SearchEngineSmart™ service generates additional traffic to dealers’ stores and websites through optimization of the dealers’ paid search engine marketing campaigns, including organic optimization for local results.

Website Solutions

Our website solutions, which are tailored to the vertical markets we serve and are eCommerce enabled, provide consumers with information about the dealer and its product lines and allow consumers to purchase PG&A through the dealers’ website 24 hours a day, 7 days a week.  Our website solutions include WebSiteSmart Pro®, eXceleratePro™ and eXceleratePro™ 2, and LeadStorm™.  We also offer a mobile solution that allows dealers’ websites to be fully functional on smart mobile phones. Website services accounted for 24% of revenues in fiscal 2011.

Other Services

We also offer a suite of complementary technology-enabled solutions, which include professional services for the customization of software and website solutions; website hosting; and document transfer and communication services to customers in the manufactured equipment industry.  On a combined basis, these other services accounted for 7.9% of fiscal 2011 revenues.

Our Strategy

We believe the following strategic foundations will allow us to continue to provide our community with the innovative solutions and world class customer service they have come to expect and drive the growth and profitability our shareholders deserve.

Nurture and retain existing customers through world class customer service and product feature upgrades

We believe there is a significant opportunity to leverage our relationships with existing customers and, accordingly, we place a high degree of focus on reducing the level of customer “churn”.  In order to retain our existing customers over time, we must keep them satisfied and continuously improve upon the value the customer receives.  To this end we have made significant investments in our customer support operations, publishing, product development, and technology infrastructure during the past several years.  Additionally, we realigned internal resources to designate a team that is proactively focused on customer satisfaction and renewing customers’ subscriptions before they are set to expire.  We will continue to invest in this area as well as identify new product features designed to enhance our customers’ user experience and value.
 
 
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Drive organic growth through innovative new service offerings, differentiated content and geographic expansion

As a subscription-based, recurring revenue business, the most important drivers of future growth are: (i) increasing the level of our monthly recurring revenue (“MRR”); (ii) increasing MRR as a percentage of total revenue; and (ii) reducing the rate of our customer churn.  We discussed above our strategy for reducing our customer churn rates, and we have already seen significant improvement in these rates in fiscal 2011 and expect to see these rates continue to improve in fiscal 2012 and beyond.

The strategy we will utilize to drive increased MRR includes the following: (i) rapidly expand our base of customers and users through new innovative solutions, (ii) sell more to our existing customer base by developing and deploying “must have” new product features and upgrades; (iii) develop and deploy basic versions of our existing and new products (we refer to these as “freemium” versions), which we believe will allow us to quickly ramp up the number of users and allow us to upsell premium versions and additional features into these customers; and (iv) expand into new geographic markets.

The first three components of our organic growth strategy essentially allows us to very rapidly expand our customer and user base, and then leverage these customers and users through upsells of new innovative solutions and value-added upgrades and features of our existing solutions.   The introduction of new solutions, upgrades to existing products, and new feature sets are all designed to grow our average revenue per dealer (“ARPD”), an important measure for a subscription-based business, and the increase in our customer base serves to quickly compound the benefits of an increased ARPD.   We have made, and expect to continue to make, significant investments in our product management and development teams.  In fiscal 2011 we realigned these teams with resources assigned to each of our core products.  The teams will continue to research and develop new features and functionality in our existing products.  Additionally, we recently implemented an internal “Innovation Factory”, a team that will be solely dedicated to rapidly deploying enhancements to current products and the creation of new value-added solutions.

We believe that a significant opportunity exists to expand our services into international markets as our manufacturing customers do the same.  Currently, only a small percentage of our revenues are generated from our international operations.  One of our initiatives for fiscal 2012 is to align internal business development resources to drive additional relationships with European manufacturers and distributors.  We will also upgrade our product roadmaps to allow us to rapidly deploy those products internationally, with a focus on the “BRIC” countries of Brazil, Russia, India, and China.
Lastly, we will continue to expand and enrich what we believe to be the broadest library of available content in the vertical markets we serve.  We must continue to enhance our value proposition through enrichment of our content or this competitive advantage will begin to lose its distinction. Content enrichment can take several forms, including the incorporation of user reviews and feedback into our existing content, further enhancing content provided to us by our manufacturer customers, and creating new forms of content that further our customers’ ability b to efficiently service and sell more whole goods, PG&A.

Lead the market with open integration to related platforms

One of our strategic advantages is our focus on integrating our solutions with dealer business management systems (“DMS”) in order to pass key information, including customer and transactional data, between the systems.  We currently have integration capabilities with over 85 DMS’s and we continue to seek other strategic alliances that can be integrated with our product and service offerings.  In fiscal 2012 we plan to build a dedicated integration team to expand on the capabilities of our interface and to connect, invasively if necessary, with the top DMS providers in the vertical markets we serve.

Successfully execute acquisitions that align with our core strategy

Historically, acquisitions have been a significant driver of ARI’s growth.  Since 2007, the Company has successfully closed four strategic acquisitions while reviewing, and ultimately deciding not to pursue, a multitude of others.  Our 2009 acquisition of Channel Blade Technologies (“Channel Blade”) and our 2008 acquisition of the electronic parts catalog and eCommerce assets of Info Access expanded not only our product offerings but the number of markets we serve.  As a result of those acquisitions, ARI is the market leader in the marine, RV and appliance markets.  Although we believe organic growth will be the primary driver of our business for the foreseeable future, we will continue to evaluate acquisitions that are in alignment with our core strategy.
 
 
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Sales, Marketing and Support Teams

We organize our sales and marketing programs into three distinct sales channels and two geographic regions, including North America and Europe.

Sales Channels

We go to market utilizing three distinct sales teams, determined through a combination of customer, product, and geographic market.  Our field sales personnel focus on building relationships with manufacturers and distributors, while our inside, telephone-based sales team focuses on selling to dealers.  The dealer sales team is further divided by product (catalog sales versus other products and services) and an international sales team in The Netherlands.  We are also in the process of enhancing our core products to allow for customer self-service sales capabilities.

Marketing

Our marketing strategy is designed to drive knowledge of our value proposition into the markets we serve.  We use a variety of marketing programs to target and build relationships with our prospective and current customers and partners.  Our primary marketing activities include:

 
participation in dealer meetings, trade shows and industry events to create awareness, build our lead database and develop relationships;
 
search engine marketing and online and print direct marketing to generate awareness and action;
 
ongoing website development to educate prospects and provide product information, testimonials, live demonstrations and marketing collateral;
 
email and phone campaigns used to capture leads;
 
use of customer testimonials; and
 
sales tool kits and field marketing training to enable our sales organization to more effectively develop leads and close transactions.

Customer Service and Support

Customer support is a critical part of our strategy as it is essential to retaining our existing customer base and reducing the level of customer churn.  We maintain customer support operations in each of the Company’s four locations.  Our support representatives are available via telephone or email.  We also maintain a customer satisfaction and renewal team that focuses on proactively reaching out to customers to ensure that our customers are satisfied and are receiving the most value possible from their spend with ARI.

Our Competitive Strengths

Market Leader in Core Verticals

We believe that we are one of the leaders in each of our core vertical markets and also believe we are the market leader in the outdoor power, marine, and appliance markets.  Our direct relationships with approximately 18,000 dealers, 125 manufacturers, and 150 distributors allow us to cost-effectively leverage our published catalog content into a large and diversified customer base and to launch new product enhancements and technology-enabled solutions to this customer base.

Breadth and Depth of Published Content

The breadth and depth of our catalog content, as well as our ability to enhance and efficiently publish manufacturers’ PG&A data as it becomes available, provides ARI with a critical competitive advantage.  Our electronic catalog content enables multi-line dealers to easily access catalog content for multiple manufacturers using a single software platform.  This advantage, which saves our customers significant time, provides "stickiness" to our catalog customer base that allows us to efficiently and cost effectively nurture our existing customers while devoting resources to develop new products and services, enabling us to grow our overall customer base.
 
 
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Recurring Revenue Model

Approximately 80% of our revenue is subscription-based and recurring revenue.  The majority of our customers are on contracts of twelve months or longer, and these contracts typically auto-renew for additional twelve month terms.  This provides us with advanced visibility into our future revenues. Our recurring revenue model also emphasizes the importance of maintaining a low rate of customer churn, one of the key drivers of any recurring revenue, subscription-based businesses.  Historically, we measured customer renewal rates. Over the past year we began measuring customer churn rates.  Although similar, we believe that customer churn is a better management tool as it allows us to focus on the reasons we may lose customers and take action actions on those reasons within our control in order to reduce churn rates in the future.

Our recurring revenue model, when combined with low rates of customer churn, significantly reduces the cost to maintain and nurture our customer base.  This in turn frees up resources to enhance our existing products and work toward new product innovations.  Additionally, a substantial portion of our electronic catalog business is focused on our customers’ service and repair operations.  This allows our revenues to remain strong even in a down economy, as consumers tend to repair, rather than buy new equipment during a challenging economy.

Suite of Products Covers Entire Sales and Service Cycle

Our suite of dealer products and services and eCommerce capabilities enhance our customers' front office operations by covering the entire sales cycle, from lead generation and lead management to sales of PG&A to the consumer, both in-store and online, and our electronic catalog products allow dealers to efficiently service and repair equipment.

We believe that our competitive advantages will enable us to compete effectively and sustainably in our core markets, although given the current pace of technological change, it is possible that unidentified competitors could emerge, existing competitors could merge and/or obtain additional capital, thereby making them more formidable, or new technologies could come on-stream and potentially threaten our position.

Our Markets and the Challenges We Face

Competition for our products and services varies by product and by vertical market. We believe that no single competitor today competes with us on every product and service in each of our industry verticals. In electronic catalogs, we compete primarily with Snap-on Business Solutions, which designs and delivers electronic parts catalogs, accessory sales tools, and manufacturer network development services, primarily to the automotive, power sports, outdoor power, construction, agriculture and mining markets. In addition, there is a variety of smaller companies focused on one or two specific industries.

In lead management, websites and eCommerce, our primary competitors are PowerSports Network, owned by Dominion Enterprises, and 50 Below. Competition for our website development services also comes from in-house information technology groups that may prefer to build their own web-based proprietary systems, rather than use our proven industry solutions. There are also large, general market eCommerce companies, such as IBM, which offer products and services that could address some of our customers’ needs. These general eCommerce companies do not typically compete with us directly, but they could decide to do so in the future.  We believe we maintain a competitive advantage in our core vertical markets given the integration of our published catalog content into our lead management and website products.

Several of the markets we serve, including power sports, marine, and RV, are closely aligned with the state of the economy, given the "luxury" nature of the products in those verticals.  In fiscal 2010 we experienced an increase in customer churn in these markets due to manufacturer bankruptcies, dealer closures, and extreme cost reduction measures by our dealers.  Our customer churn rates improved in these markets in fiscal 2011 as the effects of the economy began to ease off those markets.  It is also important to note that the impacts of a difficult economic environment are somewhat softened by the consumers' willingness in a down economy to repair existing equipment rather than purchase new equipment, which serves to amplify the importance of our published parts content provided to customers via our catalog parts lookup products and our website products.
 
 
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Intellectual Property

We rely on various intellectual property laws in the United States and other jurisdictions as well as confidentiality procedures and contractual provisions to protect our proprietary technology and our brand. We also enter into confidentiality and proprietary rights agreements with our employees, consultants and other third parties and control access to software, documentation and other proprietary information.  We have two registered trademarks in the U.S. and elsewhere: PartSmart and WebsiteSmart Pro.  We also use numerous unregistered trademarks.

Employees
 
As of July 31, 2011, we had approximately 133 employees.  Of these, 47 are involved in customer operations and support, 33 are in sales and marketing, 32 are engaged in maintaining or developing software and providing software customization services and 21 are involved in general and administration functions.  None of these employees is represented by a union.

Fiscal Year
 
ARI’s fiscal year ends on July 31st.  Any references throughout this document to fiscal 2011 or fiscal 2010 refer to the fiscal years ended July 31, 2011 and 2010, respectively.  Also note that the reference to the word “fiscal” has been removed from all tables throughout this document.

 
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Executive Officers of the Registrant

The table below sets forth the names of ARI’s executive officers as of October 19, 2011.  The officers serve at the discretion of the Board of Directors.
 
Name
 
Age
 
Capacity Served
         
Roy W. Olivier
 
52
 
President, Chief Executive Officer and Director
         
Darin R. Janecek
 
43
 
Vice President of Finance, Chief Financial Officer, Secretary and Treasurer
         
Jon M. Lintvet
 
35
 
Chief Marketing Officer

Roy W. Olivier

Mr. Olivier was appointed President and Chief Executive Officer of the Company in May 2008, after having served in the capacity of Vice President of Global Sales and Marketing of the Company since September 2006.  Prior to joining ARI in 2006, Mr. Olivier was a consultant to start-up, small and medium-sized businesses. Prior to that, he was Vice President of Sales and Marketing for ProQuest Media Solutions, a business he founded in 1993 and sold to ProQuest in 2000. Before that, Mr. Olivier held various sales and marketing executive and managerial positions with several other companies in the telecommunications and computer industries, including Multicom Publishing Inc., Tandy Corporation, BusinessLand and PacTel.

Darin R. Janecek

Mr. Janecek was appointed Vice President of Finance and Chief financial Officer of ARI in December 2010, after having served as Vice President of Finance and Director of Finance since joining the Company in May 2009.  Mr. Janecek also serves as Treasurer and Corporate Secretary.  Prior to joining ARI, Mr. Janecek served in various mergers and acquisitions, corporate strategy and analysis roles at Johnson Controls, Inc. in Milwaukee, Wisconsin, and Crowe Horwath LLP, FTI Consulting, and CNA Insurance in Chicago, Illinois.  Prior to that, he served in several corporate accounting roles in the manufacturing and health care industries.  Mr. Janecek began his career in 1991  as an auditor with Deloitte & Touche LLP.  Mr. Janecek is a certified public accountant and earned a Master of Business Administration from Loyola University, Chicago, and a Bachelor of Accounting from the University of Wisconsin - Milwaukee.

Jon M. Lintvet

Mr. Lintvet was appointed Chief Marketing Officer of ARI in October 2011.  As Chief Marketing Officer, Mr. Lintvet leads all product management, innovation and strategic marketing initiatives for ARI.  Mr. Lintvet was Chief Executive Officer of Channel Blade prior to ARI’s acquisition of the company in 2009.  Following the acquisition, Mr. Lintvet was named ARI’s Director of Business Development.  In November 2010 Mr. Lintvet was promoted to Vice President of Product.  Prior to Channel Blade Mr. Lintvet served in various product development roles at Capital One.  Mr. Lintvet earned a Bachelor of Science from Ithaca College in Ithaca, New York.

Available Information

You can obtain copies of our 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and other filings with the SEC, and all amendments to these filings, free of charge from our website at www.arinet.com as soon as reasonably practical following our filing of any of these reports with the SEC. You can also obtain copies free of charge by contacting us at our office address listed above.
 
 
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Item 1A. Risk Factors

The risks and uncertainties described below are not the only ones facing us. Other events that we do not currently anticipate or that we currently deem immaterial also may affect our results of operations and financial condition.

Continued unfavorable economic conditions or reduced investments in technology spending may harm our business.

Our business depends on the overall demand for technology services spending, and on the economic health and general willingness of our current and prospective customers to make capital commitments. If the conditions in the U.S. and global economic environment remain uncertain or continue to be volatile, or if they deteriorate further, our business, operating results and financial condition may be adversely affected. Our customers sell capital goods, some of which are considered “luxury” in nature, which are highly dependent on the disposable income of end consumers.  Continued weak or volatile economic conditions, or a reduction in consumer spending may weaken our customers’ demand for electronic catalogs, websites, lead management or other technology-enabled services, or their general information technology spending, which would likely harm our business and operating results in a number of ways, including longer sales cycles, potential lower prices for our services, reduced sales, and reduced subscription renewal rates.

We may become liable to our customers and lose customers if we have defects or disruptions in our service or if we provide poor service.

Because we deliver some of our technology as a service, errors or defects in the software applications underlying our service, or a failure of our hosting infrastructure, may make our services, in particular our eCommerce services, unavailable to our customers. Since our customers use our eCommerce services to facilitate their sales, any errors, defects, disruptions in service or other performance problems with our services, whether in connection with the day-to-day operation of our services, upgrades or otherwise, could damage our customers’ businesses.

Despite the implementation of security measures, the core of our network infrastructure is vulnerable to unauthorized access, computer viruses, equipment failure and other disruptive problems, including the following:

 
we and our users may experience interruptions in service as a result of the accidental or intentional actions of Internet users, current and former employees or others;
 
unauthorized access may jeopardize the security of confidential information stored in our computer systems and our customers’ computer systems, which may result in liability to our customers and also may deter potential customers;
 
we may face liability for transmitting viruses to third parties that damage or impair their access to computer networks, programs, data or information;
 
there may be a systemic failure of Internet communications, leading to claims associated with the general unavailability of some of our products; or
 
eliminating computer viruses and alleviating other security or technical problems may require interruptions, delays or cessation of service to our customers.
 
If we have any errors, defects, disruptions in service or other performance problems with our services, customers could elect not to renew, or delay or withhold payment to us, we could lose future sales or customers may make claims against us, which could result in an increase in our provision for doubtful accounts, an increase in collection cycles for accounts receivable or litigation costs.

Our core markets and verticals are competitive, and if we do not compete effectively, our operating results may be harmed.

The markets for electronic catalog, websites, lead management and other technology-enabled services targeted at the equipment industry are competitive, and the eCommerce area, specifically, is rapidly changing with relatively low barriers to entry. With the introduction of new technologies and market entrants, we expect competition to remain intense. In addition, increased competition generally could result in reduced sales, reduced margin or the failure of our services to achieve or maintain more widespread market acceptance. Competition in our market is based principally upon service breadth and functionality; service performance, security and reliability; ability to tailor and customize services for a specific company, vertical market or industry; ease of use of the service; speed and ease of deployment, integration and configuration; total cost of ownership, including price and implementation and support costs; professional services implementation; strength of customer relationships; and financial resources of the vendor. To compete effectively, we also must be able to more frequently update our services to meet market demand.

Our principal competitors include Snap-on Business Solutions, 50 Below, and Powersports Network, owned by Dominion Enterprises. Some of our actual and potential competitors enjoy competitive advantages over us, such as greater name recognition within our target vertical markets, larger marketing budgets, as well as substantially greater financial, technical and other resources. If we are not able to compete effectively, our operating results will be harmed.
 
 
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The impact of negative factors on the business may not be immediately reflected in our financial results.

Because we recognize subscription revenue over the term of the applicable agreement, the lack of subscription renewals or new service agreements may not be reflected immediately in our operating results. The majority of our revenue in any given period is attributable to service agreements entered into during previous periods. A decline in new or renewed service agreements in any one period will not be fully reflected in our revenue in that period but will harm our revenue in future periods. As a result, the effect of significant downturns in sales and market acceptance of our services in a particular period may not be fully reflected in our operating results until future periods. Our subscription model also makes it difficult for us to rapidly increase our revenue through additional sales in any period, because revenue from new customers must be recognized over the applicable subscription term.
 
Our operating results may fluctuate from quarter to quarter.

We expect that a portion of our revenue in the future will be derived from non-recurring fee income, which consists primarily of revenues from professional services such as software customization and training, software sales and one-time network installation fees.  The timing of receipt of this revenue is dependent upon several factors that we cannot predict.  These factors include:

 
the time required to close large license fee and development agreements, which can be delayed due to customer requirements and decision-making processes;
 
the seasonality of certain sectors of the equipment industry in which we operate;
 
delays in the introduction of new products or services and their acceptance by customers; and
 
delays in delivering customized software to our customers.

Our costs are not entirely predictable and may vary from quarter-to-quarter due to acquisitions or non-recurring expenditures.  Cash flows may also vary from quarter to quarter, depending on the timing of disbursements and customer payments, which exhibit considerable seasonality. These fluctuations may make period-to-period comparisons of our results of operations more complex.

Changes in financial accounting standards or practices may cause adverse, unexpected financial reporting fluctuations and harm our operating results.

A change in accounting standards or practices could harm our operating results and may even affect our reporting of transactions completed before the change is effective. New accounting pronouncements and varying interpretations of accounting pronouncements have occurred and may occur in the future. Changes to existing rules or the questioning of current practices may harm our operating results or the way we conduct our business and may increase our compliance costs.

Our business could suffer if we are unable to protect our intellectual property rights or are liable for infringing the intellectual property rights of others.

We regard our trademarks, proprietary technology and similar intellectual property as critical to our success, and we rely upon trademark law, trade secret protection, and confidentiality and license agreements with our employees, strategic partners, and others to protect our proprietary rights, but these measures can have only limited effectiveness. Prevalent use of the Internet has also increased the ease with which third parties can distribute our intellectual property without our authorization.

We intend to pursue the registration of our material trademarks as necessary. We may not be entitled to the benefits of any such registration until such registration takes effect. In addition, effective protection may not be available in every country in which our products are available. Further, we may be subject to claims in the ordinary course of our business, including claims of alleged infringement of the trademarks, copyrights and other intellectual property rights of third parties by us and our licensees.

Other parties may assert claims of infringement of intellectual property or other proprietary rights against us. These claims, even if without merit, could require us to expend significant financial and managerial resources. Furthermore, if claims like this were successful, we might be required to change our trademarks, alter our content, products or services, or pay financial damages, any of which could substantially increase our operating expenses. We also may be required to obtain licenses from others to refine, develop, market and deliver new services. We may be unable to obtain any needed license on commercially reasonable terms or at all, and rights granted under any licenses may not be valid and enforceable. In the future we could be subject to legal proceedings and claims from time to time in the ordinary course of our business, including claims of alleged infringement of trademarks and other intellectual property rights of third parties by us and our licensees. Any such claims could have a material adverse effect on our business, financial condition and operating results.
 
 
12


We are dependent on our management and employees.

We are dependent on the services of our executive officers and other key employees. There can be no assurance, however, that we can obtain executives of comparable expertise and commitment in the event of death, disability, or voluntary departure of one of our executive officers or other key employees, or that our business would not suffer material adverse effects as the result of the death, disability, or voluntary departure.  Further, the loss of the services of any one or more of these employees could have an adverse effect on our business. In addition, we will also need to attract and retain other highly skilled technical and managerial personnel for whom competition is intense. If we are unable to do so, our business, results of operations and financial condition could be materially adversely affected.

Our common stock has a very limited trading market.

Our common stock is traded on the OTC bulletin board, which typically provides less liquidity than the NASDAQ or any other national securities exchange. In addition, trading in our common stock has historically been extremely limited. Because of the thinness of the market for our stock, the price of our common stock may be subject to manipulation.  This limited trading may adversely affect the liquidity of our common stock, not only in terms of the number of shares that can be bought and sold at a given price, but also through delays in the timing of transactions and reduction in security analysts’ and the media’s coverage of us. As a result, there could be a larger spread between the bid and the ask prices of our common stock and an investor may not be able to sell shares of our common stock when or at prices you desire.

Our shareholder rights plan may permit our board to block a takeover attempt and adversely affect the value of our common stock.

Our board of directors adopted a shareholder rights plan and declared a dividend of an associated right, which together are expected to have the effect of deterring any takeover of the Company that is not preceded by board approval of the proposed transaction.  The existence of such shareholder rights plan may deter potential tender offers for our common stock or other acquisition offers and may have the effect of delaying or preventing a change of control.

We may not be able to identify, acquire and successfully integrate acquisitions.

A key component of our growth strategy has been and will continue to be acquisitions and other business development opportunities that solidify or accelerate our market position in our core offerings and vertical markets.  The successful implementation of this strategy depends upon our ability to identify suitable acquisition candidates, acquire such businesses on acceptable terms, finance the acquisition and integrate their operations successfully into ARI. There can be no assurance that such candidates will be available or, if such candidates are available, that the price will be attractive or that we will be able to identify, acquire, finance or integrate such businesses successfully. In addition, in pursuing such acquisition opportunities, we may compete with other entities with similar growth strategies; these competitors may be larger and have greater financial and other resources than ARI. Competition for these acquisition targets could also result in increased prices of acquisition targets and/or a diminished pool of companies available for acquisition.

The successful integration of these acquisitions also may involve a number of additional risks, including: (i) the inability to retain the clients of the acquired business; (ii) the lingering effects of poor client relations or service performance by the acquired business, which also may taint our existing business; (iii) the inability to retain the desirable management, key personnel and other employees of the acquired business; (iv) the inability to fully realize the desired efficiencies and economies of scale; (v) the inability to establish, implement or police ARI’s existing standards, controls, procedures and policies on the acquired business; (vi) diversion of management attention; and (vii) exposure to client, employee and other legal claims for activities of the acquired business prior to acquisition. In addition, any acquired business could perform significantly worse than expected.

The inability to identify, acquire, finance and successfully integrate acquisitions could have a material adverse effect on ARI or its estimated or desired business, income, growth or other condition and results.

Future acquisitions may result in dilution to existing shareholders.

The timing, size and success of acquisition efforts and any associated capital commitments cannot be readily predicted. Future acquisitions may be financed by issuing shares of common stock, cash, or a combination thereof.  To the extent our common stock is used for all or a portion of the consideration to be paid for future acquisitions, dilution may be experienced by existing stockholders.
 
 
13


We face risks with our international strategy.

Our business strategy includes increasing our presence in the non-U.S. equipment markets.  This strategy presents a number of special risks, including:

 
managing more geographically diverse operations;
 
dealing with currency fluctuations;
 
the increased costs of operation;
 
only having a small number of employees in these markets;
 
our dependence on value-added resellers and contractors to sell and service our products;
 
a much smaller and more concentrated current customer base; and
 
the assumption that U.S. international policy will remain favorable towards the countries in which we sell our products and services.

Our historical losses have resulted in our weak balance sheet.

While we have been profitable in recent years, we have experienced net losses in numerous fiscal years since our organization in 1981, resulting in an accumulated deficit of $89.1 million at July 31, 2011.  We may not be able to maintain profitability or increase profitability in the future.  As a result of our historical losses, our financial position has been weakened, and our ability to finance our growth is constrained.

We will require a significant amount of cash to service our indebtedness.  Our ability to generate cash depends on certain factors beyond our control.

Our ability to make principal and interest payments on our indebtedness and to fund planned capital expenditures and product development efforts will depend on our ability to generate cash in the future. Our future operating performance and financial results will be subject, in part, to factors beyond our control, including dealer bankruptcies in the vertical markets we serve, and general economic, financial and business conditions. We cannot assure that our business will generate sufficient cash flow from operations or that future financing facilities will be available to us in an amount sufficient to enable us to pay our indebtedness or to fund our other liquidity needs.

If we are unable to generate sufficient cash flow to service our debt, we may be required to:

 
refinance all or a portion of our debt or obtain additional financing, neither of which can be assured;
 
sell some of our assets or operations;
 
reduce or delay capital expenditures, research and development efforts and acquisitions; or
 
revise or delay our strategic plans.

If we are required to take any of these actions, it could have a material adverse effect on our business, financial condition and results of operations. In addition, we cannot assure that we would be able to take any of these actions, that these actions would enable us to continue to satisfy our capital requirements or that these actions would be permitted under the terms of our various debt instruments.

 
14


Item 2. Properties

The table below summarizes ARI’s current facilities.  Management believes that the Company’s current facilities are suitable and sufficient to support present operations.
 
Description of Use
 
Location
 
Square
Footage
 
Lease
Expiration
 
Operating
Segment
                 
Corporate headquarters
 
Milwaukee, WI
    16,300  
July 2021
 
North America
                   
Product development and professional services team
 
Cypress, CA
    6,000  
July 2013
 
North America
                   
Marine and RV sales and support
 
Virginia Beach, VA
    9,800  
April 2014
 
North America
                   
European sales and support
 
Leiden, The Netherlands
    200 m 2
April 2015
 
Netherlands

Item 3. Legal Proceedings

None.

Item 4. [Removed and Reserved for Future Use]
 
 
15


PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

ARI’s common stock is currently quoted on the OTC bulletin board under the symbol ARIS.  The following table sets forth the high and low sales price for the periods indicated.  OTC  bulletin board quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily reflect actual transactions.
 
Fiscal Quarter Ended:
 
High
   
Low
 
             
10/31/2009
  $ 1.07     $ 0.55  
1/31/2010
  $ 1.10     $ 0.63  
4/30/2010
  $ 1.00     $ 0.70  
7/31/2010
  $ 0.84     $ 0.61  
10/31/2010
  $ 0.75     $ 0.31  
1/31/2011
  $ 0.75     $ 0.45  
4/30/2011
  $ 0.80     $ 0.47  
7/31/2011
  $ 0.99     $ 0.48  

As of October 19, 2011, there were approximately 671 holders of record of ARI common stock.  We have not paid cash dividends to date and have no current intention to pay cash dividends.

During fiscal 2011, the Company did not repurchase any of its equity securities.
 
 
16


Item 6. Selected Financial Data

The following tables set forth certain financial information with respect to the Company for each of the previous five fiscal years, which includes information derived from ARI’s audited financial statements and notes thereto for fiscal 2011 and fiscal 2010.  The reports, thereon, of Wipfli LLP are included elsewhere in this report. The selected financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the aforementioned Financial Statements and Notes.  All amounts are in thousands, except per share data.
 
Statement of Income
 
   
2011
   
2010
   
2009
   
2008
   
2007
 
                               
Net revenue
  $ 21,334     $ 21,484     $ 17,560     $ 16,917     $ 15,435  
Gross profit
    16,927       17,131       14,160       14,046       12,716  
Gross margin
    79.3 %     79.7 %     80.6 %     83.0 %     82.4 %
Net operating expenses
    15,194       16,626       13,051       13,225       12,551  
Operating income
    1,733       505       1,109       821       165  
Other expense
    (332 )     (630 )     (221 )     (28 )     (60 )
Income (loss) from continuing operations before provision for income taxes
    1,401       (125 )     888       793       105  
Income tax benefit (expense)
    1,017       1,294       (123 )     590       (4 )
Income from continuing operations
    2,418       1,169       765       1,383       101  
Discontinued operations
    25       (392 )     (341 )     -       -  
Net income
  $ 2,443     $ 777     $ 424     $ 1,383     $ 101  
                                         
Earnings per share:
                                       
Income from continuing operations:
                                       
Basic
  $ 0.31     $ 0.15     $ 0.11     $ 0.21     $ 0.02  
Diluted
  $ 0.31     $ 0.15     $ 0.11     $ 0.20     $ 0.02  
                                         
Net income:
                                       
Basic
  $ 0.31     $ 0.10     $ 0.06     $ 0.21     $ 0.02  
Diluted
  $ 0.31     $ 0.10     $ 0.06     $ 0.20     $ 0.02  
 
Other Financial Data
 
   
2011
   
2010
   
2009
   
2008
   
2007
 
                               
Amortization of capitalized software products
  $ 1,127     $ 1,054     $ 876     $ 764     $ 800  
Depreciation and amortization
    1,688       1,640       1,054       727       631  
Capital expenditures
    670       541       636       119       639  
Software development costs capitalized
    1,741       1,340       759       524       358  
 
 
17

 
Balance Sheet Data
 
   
As of July 31st
 
   
2011
   
2010
   
2009
   
2008
   
2007
 
Cash and cash equivalents
  $ 1,134     $ 938     $ 650     $ 1,086     $ 1,050  
Working capital deficit
    (2,998 )     (3,692 )     (4,246 )     (5,475 )     (5,221 )
Net capitalized software product costs
    2,815       2,395       2,397       1,596       1,606  
Total assets
    21,099       19,777       18,607       12,193       9,927  
                                         
Current portion of debt and lease obligations
    1,289       1,217       726       1,471       1,031  
Long term debt and lease obligations
    4,293       5,338       5,115       349       484  
Total shareholders' equity
    7,831       5,219       4,187       2,896       718  
 
Cash flow Data
 
   
2011
   
2010
   
2009
   
2008
   
2007
 
Net cash provided by (used for):
                             
Operating activities
  $ 3,471     $ 1,624     $ 2,745     $ 2,027     $ 1,144  
Investing activities
    (2,293 )     (1,891 )     (2,219 )     (1,651 )     (2,174 )
Financing activities
    (977 )     550       (968 )     (353 )     (1,491 )

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our results of operations and financial condition should be read together with our audited consolidated financial statements for fiscal 2011 and fiscal 2010, including the notes thereto, which appear elsewhere in this Annual Report on Form 10-K.  This discussion contains forward-looking statements, which as previously identified are subject to the safe harbors created under the Securities Act and Exchange Act.

Overview

Our fiscal 2011 financial results were some of the best in the Company’s history.  We more than tripled our operating income and net income; more than doubled our cash generated from operations; paid down nearly $1 million of debt; and increased our investment in product development.  We believe these results are the culmination of various critical initiatives of the past several years.  In April 2009 we acquired Channel Blade and fiscal 2011 was the first full year we experienced the efficiencies that resulted from that acquisition.  At the end of fiscal 2010 we underwent a workforce reduction and business improvement initiative designed to help the Company streamline its operations and focus on our core offerings of electronic catalogs, lead generation and management, and eCommerce websites.  As part of this initiative in July 2010 we divested ARI F&I Services LLC (“AFIS”), our non-strategic dealer outsourced finance and insurance operation, and in March 2011 we divested our non-strategic electronic data interchange business devoted to the agricultural chemicals industry (“AgChem EDI”).

We generated net income of $2,443,000, or $0.31 per share in fiscal 2011, compared to net income of $777,000, or $0.10 per share, in fiscal 2010.  The significant improvement in earnings is attributable to several factors, including:
 
 
(i)
Operating expenses declined by $1,432,000, or 8.6%, in fiscal 2011, resulting from our fiscal 2010 fourth quarter workforce reduction and business improvement initiative, for which we incurred a $437,000 charge in the fiscal 2010 fourth quarter, and from our continuing efforts to reduce costs and achieve operational efficiencies throughout the organization.
 
 
(ii)
In fiscal 2010 we incurred losses from our discontinued AFIS operation, net of tax benefits, of $392,000.  These losses did not reoccur in fiscal 2011.
 
 
(iii)
We recorded a gain on the sale of our AgChem EDI business of $433,000.

These factors were partially offset by both an increase in interest expense in fiscal 2011 and a reduction in the amount of tax benefit realized, each of which will be discussed below.
 
 
18


Despite a slight decline in revenue and gross profit, operating income increased to $1,733,000 in fiscal 2011 from $505,000, driven solely by the reduction in operating expenses discussed above.

At July 31, 2011, we had cash balances of $1,134,000, versus $938,000 at July 31, 2010.  Furthermore, our total outstanding debt, which includes amounts due under our line of credit, capital lease obligations, and term note, was $5,582,000 at July 31, 2011, nearly a $1,000,000 decline from the $6,555,000 outstanding at July 31, 2010.  These favorable results were due to significant growth in cash generated from operations, which resulted from our strategy of focusing on growing our core recurring revenue base and generating technological and operating efficiencies throughout our business.

Net Revenues and Gross Margins

The table below summarizes the Company’s net revenues, gross profit and gross margin by major product category for fiscal 2011 and fiscal 2010.
 
   
2011
   
2010
   
Percent Change
 
Catalog
                 
Revenue
  $ 12,649     $ 12,474       1.4 %
Cost of revenue
    1,546       1,621       -4.6 %
Gross profit
    11,103       10,853       2.3 %
Gross margin percentage
    87.8 %     87.0 %        
Website
                       
Revenue
    5,025       5,305       -5.3 %
Cost of revenue
    1,120       1,012       10.7 %
Gross profit
    3,905       4,293       -9.0 %
Gross margin percentage
    77.7 %     80.9 %        
Lead generation and management
                       
Revenue
    1,982       2,044       -3.0 %
Cost of revenue
    1,078       983       9.7 %
Gross profit
    904       1,061       -14.8 %
Gross margin percentage
    45.6 %     51.9 %        
Other
                       
Revenue
    1,678       1,661       1.0 %
Cost of revenue
    663       737       -10.0 %
Gross profit
    1,015       924       9.8 %
Gross margin percentage
    60.5 %     55.6 %        
Total
                       
Revenue
    21,334       21,484       -0.7 %
Cost of revenue
    4,407       4,353       1.2 %
Gross profit
  $ 16,927     $ 17,131       -1.2 %
Gross margin percentage
    79.3 %     79.7 %        

Total revenues for the fiscal year ended July 31, 2011 were $21,334,000 compared to $21,484,000 for the same period last year, a decline of 0.7%.  Our fiscal 2011 revenues were negatively affected by the loss of non-cash deferred revenues related to the Channel Blade acquisition and the loss of revenues from our divested Agchem EDI business.  Excluding the impact of these items, we experienced revenue growth of 4.0% for fiscal 2011, as shown in the table below (in thousands).
 
   
2011
   
2010
   
Percent Change
 
                   
Revenue as reported
  $ 21,334     $ 21,484       -0.7 %
Non-cash deferred revenue
    (49 )     (801 )     -93.9 %
AgChem EDI revenue
    (275 )     (481 )     -42.8 %
Revenue, adjusted
  $ 21,010     $ 20,202       4.0 %
 
 
19

 
The non-cash deferred revenues represent the amortization of a deferred revenue liability recorded at the time we acquired Channel Blade.  As of July 31, 2011, this liability was fully amortized and these revenues will not recur in the future.  As previously discussed, we divested our AgChem EDI business in March 2011.  We recognized $275,000 of revenues related to this business in fiscal 2011 prior to the divestiture, compared to revenues of $481,000 for the full fiscal year 2010.

New sales, although down from fiscal 2010, remain strong and in fiscal 2011 we realized a significant improvement in our customer churn rates, both of which served to increase our MRR year over year by more than 30%.  Given that a substantial portion of our revenues are subscription-based, MRR and churn are two performance indicators we closely monitor, as they represent the most significant drivers of future revenue growth.

Catalog

Catalog revenues are generated from software license fees, license renewal fees, software maintenance and support fees, catalog subscription fees, and professional services related to data conversion.  Catalog revenues increased 1.4% in fiscal 2011, compared to fiscal 2010, resulting from improvements in our customer churn rates and new catalog sales. Management expects catalog subscriptions to remain the Company’s most significant source of revenues and anticipates modest growth in this category for the foreseeable future.

Website

Website revenues are generated from set-up and recurring subscription fees on our website products, as well as transaction fees from our customers’ online sales generated via the websites.  Website revenues decreased 5.3% in fiscal 2011, compared to fiscal 2010.  This decrease in revenue was due to the decline in non-cash deferred revenues previously discussed.  All of these revenues were recorded in the website category.  Excluding the recognition of these non-cash revenues, revenues from our website products increased 10.5%.  Furthermore, the non-cash, non-recurring revenues in fiscal 2010 were replaced with cash-generating MRR in fiscal 2011.  We expect to see continued sales growth in fiscal 2012 from our website products and for these products to be a long-term source of growth for the Company.

Lead Generation and Management

Lead generation revenues are realized from the sale of our SearchEngineSmartä product, while lead management revenues are generated from set-up and subscription fees for the use of the Company’s Footstepsä product. Lead generation and management revenues decreased 3.0% in fiscal 2011, when compared to fiscal 2010.  As previously discussed, the marine market was hard hit by the economy and we experienced an increase in customer churn rates on our Footstepsä product in the latter half of fiscal 2010 due to the bankruptcies of several large marine manufacturers.  This churn had a negative impact on fiscal 2011 revenues.  Management expects our Footstepsä product to be a significant driver of future growth for the Company, and anticipates the launch of a new platform of this product in fiscal 2012.

Other Revenues

Other revenues primarily consist of professional services related to software customization and website hosting fees, but also include revenues generated from other products that are ancillary to our three core offerings.  Revenues from our divested AgChem EDI business were also included within this category.  Other revenues increased 1.0% in fiscal 2011 compared to fiscal 2010.  The main driver of this increase was a contracted website customization project with a large manufacturer in the power sports industry, offset in part by the loss of revenues related to our divested Agchem EDI business.  Management anticipates that other revenues will fluctuate based on the timing of professional fees related to software customization, which tend to be opportunistic in nature.

Cost of Revenues, Gross Profit and Gross Margin

We classify as cost of revenues those costs that are directly attributable to the provision of services to our customers. These costs include:
 
Software amortization, which represents the periodic amortization of costs for internally developed or purchased software sold to our customers;

Direct labor, used in the provision of catalog and marketing professional services; and

Other direct costs, which represent amounts paid to third party vendors directly attributable to the services we provide our customers.
 
 
20


The table below breaks out fiscal 2011 and fiscal 2010 cost of revenues into each of these three expense categories (in thousands):
 
   
2011
   
Percent of Revenue
   
2010
   
Percent of Revenue
 
                         
Net revenues
  $ 21,334           $ 21,484        
Cost of revenues:
                           
Amortization of capitalized software costs
    1,127       5.3 %     1,054       4.9 %
Direct labor
    1,272       6.0 %     1,395       6.5 %
Other direct costs
    2,008       9.4 %     1,904       8.9 %
Total cost of revenues
    4,407       20.7 %     4,353       20.3 %
Gross profit
  $ 16,927       79.3 %   $ 17,131       79.7 %

Overall gross profit was $16,927,000, or 79.3 % of revenue, in fiscal 2011, versus $17,131,000, or 79.7% of revenue, in fiscal 2010.  There was an increase in software amortization costs, as we began to amortize several new releases of our core products in fiscal 2011.  We also experienced an increase in other direct costs related to royalties for the rights to sell certain catalog content.  Overall gross margin was 79.3% in fiscal 2011, which was less than half of one percentage point lower than fiscal 2010.  Management expects to see improvements in gross margin over time as we grow our subscription-based recurring revenues, which typically have a higher margin than our other products and services.

Operating Expenses

The table below summarizes the Company’s operating expenses by expense category for fiscal 2011 and fiscal 2010 (in thousands):
 
   
2011
   
Percent of Revenue
   
2010
   
Percent of Revenue
   
Percent Change
 
Sales and marketing
  $ 4,272       20.0 %   $ 4,786       22.3 %     -10.7 %
Customer operations and support (1)
    3,439       16.1 %     3,469       16.1 %     -0.9 %
Software development and technical support (2)
    1,543       7.2 %     1,415       6.6 %     9.0 %
General and administrative
    4,252       19.9 %     4,879       22.7 %     -12.9 %
Restructuring
    -       0.0 %     437       2.0 %     n/a  
Depreciation and amortization (3)
    1,688       7.9 %     1,640       7.6 %     2.9 %
Net operating expenses
  $ 15,194       71.2 %   $ 16,626       77.4 %     -8.6 %
 
 
(1) 
Net of capitalized software development costs of $191 and $81 in fiscal 2011 and fiscal 2010, respectively.
 
(2) 
Net of capitalized software development costs of $1,474 and $1,247 in fiscal 2011 and fiscal 2010, respectively.
 
(3) 
Exclusive of amortization of software products of $1,127 and $1,054 in fiscal 2011 and fiscal 2010, respectively, which are included in cost of revenue.
 
Net operating expenses were $15,194,000 in fiscal 2011, a decrease of $1,432,000, or 8.6%, from fiscal 2010.  As part of our strategy to streamline the business and focus on our three core offerings, we undertook a workforce reduction and business improvement initiative, which included the divestiture of AFIS, the write off of certain assets related to non-core operations, and a small headcount reduction in July 2010.  We incurred a charge of $437,000 in fiscal 2010 related to this initiative.  This initiative, coupled with the economies realized from the Channel Blade acquisition and a continued focus on cost reduction and operational efficiencies, is reflected in the decrease in net operating expenses in fiscal
2011.
 
 
21


Sales and Marketing Expenses

Sales and marketing expenses consist primarily of personnel and related costs, including sales commissions, for our sales and marketing employees, and also include the cost of marketing programs and trade show attendance. Marketing programs consist of lead generation and direct marketing, advertising, events and meeting costs, public relations, brand building and product management activities. Sales and marketing expenses decreased 10.7% in fiscal 2011, when compared to fiscal 2010.  As a percentage of revenue, sales and marketing expenses declined from 22.3% in fiscal 2010 to 20.0% in fiscal 2011, driven in part by a reduction in commission expense that resulted from the previously-mentioned sales decline.

We measure the returns realized through our sales teams with the customer acquisition cost (“CAC”) ratio, one of Bessemer Venture Partners’ “6C’s of Cloud Finance.”  We experienced an improvement in our CAC ratios during fiscal 2011, compared to the same period last year, which means that we are generating more margin for each sales and marketing dollar spent.  These improvements in CAC were achieved by refining our sales incentive programs to better align them with our core strategy of MRR growth, as well as achieving operating efficiencies and close management of discretionary sales and marketing spending.  Sales and marketing will continue to be one of our largest expenses, as we intend to continue to invest in sales and marketing to grow our customer base and expand relationships with our existing customers.  However, management expects sales and marketing costs to gradually decline as a percentage of revenues over time.

Customer Operations and Support

Customer operations and support expenses are composed of server room operations, software maintenance agreements for our core network, and personnel and related costs for our operations and support employees.  Customer operations and support costs remained relatively the same in fiscal 2011, compared to last year.  Management expects customer operations and support costs to decline as a percentage of revenue in future years as we continue to consolidate our data centers into one centralized facility, while retaining the appropriate backup facilities.

Software Development and Technical Support

Our software development and technical support staff have three essential responsibilities for which the accounting treatment varies depending upon the work performed: (i) costs associated with internal software development efforts are typically capitalized as software product costs and amortized over the estimated useful lives of the product; (ii) professional services performed for customers related to software customization projects are classified as cost of revenues; and (iii) all other activities are considered operating expenses and included within the software development and technical support operating expense category.

The table below summarizes the breakdown of our total software development and technical support spending (in thousands):
 
   
2011
   
2010
   
Percent Change
 
                   
Total software development and technical support costs
  $ 4,480     $ 4,138       8.26 %
Less: amount capitalized as software development
    (1,665 )     (1,328 )     25.38 %
Less: direct labor classified as cost of revenues
    (1,272 )     (1,395 )     -8.82 %
Net software development and technical support costs classified as operating expenses
  $ 1,543     $ 1,415       9.05 %

We increased our total software development and technical support costs by $330,000, or 7.95%, in fiscal 2011, compared to the same period last year, which is consistent with our strategy to release new products and enhancements to existing products. We expect fluctuations in the amount of software development and technical support costs classified as operating expenses from period to period, as the mix of development and customization activities will change based on customer requirements, even if total software development and technical support departmental costs remain relatively constant.

During fiscal 2011, we capitalized $1,665,000 of software development labor and overhead, versus $1,340,000 last year.  As discussed earlier, we completed several significant product upgrades and enhancements during fiscal 2011 and are working on several new enhancements expected to be released in the upcoming quarter, which we anticipate will increase future revenues for the Company.  Management expects total spending for software development and technical support to continue to increase in fiscal 2012 as we continue to focus on our core strategy of product enhancement and innovation.
 
 
22


General and Administrative

General and administrative expenses primarily consist of personnel and related costs for executive, finance, human resources and administrative personnel, legal and other professional fees and other corporate expenses and overhead.  General and administrative costs declined $627,000, or 12.9%, in fiscal 2011.  As a percentage of revenue, general and administrative expenses declined from 22.7% in fiscal 2010 to 19.9% in fiscal 2011.

This improvement can be attributed to the various cost reduction and business improvement initiatives implemented over the last several years as well as efficiencies realized from the integration of the Channel Blade operations.  Management expects general and administrative expenses to remain relatively flat in fiscal 2012 and to continue to decline, as a percentage of revenues, in fiscal 2012 and beyond as the business continues to grow and the Company leverages its reduced cost structure.

Depreciation and Amortization

Depreciation and amortization expenses consist of depreciation on fixed assets, which are composed of leasehold improvements and information technology assets, and the amortization of acquisition-related intangible assets. Costs associated with the amortization of software assets are a component of cost of revenues.  Depreciation and amortization expense remained relatively flat in fiscal 2011.

Restructuring

As discussed previously, in July 2010 the Company undertook a workforce reduction and business improvement initiative, which included the divestiture of AFIS, the write off of certain assets related to non-core operations, and a headcount reduction.  The Company incurred restructuring charges of $437,000 related to this initiative.  The results of operations of AFIS were reclassified as a discontinued operation in the Company’s consolidated financial statements.  All remaining payment obligations related to severance and net future lease costs were paid in fiscal 2011.

Interest Expense

Interest expense was $790,000 in fiscal 2011, versus $649,000 in fiscal 2010.  On April 27, 2010, the interest rate on our term note, which resulted from the April 2009 acquisition of Channel Blade, increased from 10% to 14%.  Management expects a significant reduction in interest expense beginning in fiscal 2012.  On July 27, 2011 we entered into a Loan and Security Agreement (described in Note 4 to the consolidated financial statements) with Fifth Third Bank (“Fifth Third”), the proceeds of which were used to pay off the Channel Blade note in full. The note bears interest at a rate based on the one, two, three or six month LIBOR (as selected by the Company on the last business day of each month) plus 4.0%, and matures on July 27, 2014.  The effective interest rate on the note was 4.21% at July 31, 2011.
 
Income Taxes

As of July 31, 2011, we had unused net operating loss carryforwards (“NOLs”) for federal income tax purposes of $13,092,000 expiring between 2012 and 2030, and as such generally only incur alternative minimum taxes.

We performed an assessment as of July 31, 2011 of the likelihood that the remaining NOLs included in our net deferred tax assets will be realized from future taxable income.  The assessment resulted in a change in estimate of $1,967,000 less tax expense, or $0.25 per basic and diluted common share. This change was due to an improvement in our forecasted U.S. net income before taxes and a change in our tax strategy related to the treatment of capitalized software product costs.  Refer to Note 11 of the consolidated financial statements for further discussion.
 
 
23


Discontinued Operations

On July 27, 2010 we sold AFIS, which offered dealer finance and insurance services, to F&I Smart LLC, recording a loss on the divestiture of $1,000.  The results of operations of AFIS have been reflected as a discontinued operation in our consolidated financial statements for all periods presented.  The results of operations of AFIS were previously reported within the United States business segment.  The following table summarizes the results of operations of AFIS, included in discontinued operations for the fiscal years ended July 31 (in thousands):
 
   
2011
   
2010
 
             
Revenues
  $ -     $ 136  
Cost of sales
    -       13  
Operating expenses
    -       776  
Operating loss
    -       (653 )
Gain (loss) on sale
    40       (1 )
Income tax benefit (provision) (1)
    (15 )     262  
Net gain (loss)
  $ 25     $ (392 )
 
 
(1) 
Net of recorded deferred income tax asset valuation allowance

Liquidity and Capital Resources

The following table sets forth, for the periods indicated, certain cash flow information derived from the Company’s financial statements (in thousands):
 
   
2011
   
2010
   
Percent Change
 
Net cash provided by operating activities
  $ 3,471     $ 1,624       113.7 %
Net cash used in investing activities
    (2,293 )     (1,891 )     21.3 %
Net cash provided by (used in) financing activities
    (977 )     550       -277.6 %
Effect of foreign currency exchange rate changes on cash
    (5 )     5       -200.0 %
                         
Net change in cash
  $ 196     $ 288       -31.9 %
                         
Cash at end of period
  $ 1,134     $ 938       20.9 %
 
Cash

At July 31, 2011, the Company had cash balances of $1,134,000, compared to $938,000 at July 31, 2010.  Total cash flows declined from $288,000 in fiscal 2010 to $196,000 in fiscal 2011, as we used our increased cash flows from operations to pay down nearly $1,000,000 in debt and continue to invest in product development.

Net cash provided by operations more than doubled in fiscal 2011, compared to fiscal 2010, due to several factors:
 
 
(i)
a greater portion of our revenues in fiscal 2011 resulted in cash collected, as the $801,000 of revenues recognized in fiscal 2010 related to the amortization of the deferred revenue liability incurred with the acquisition of Channel Blade were non-cash revenues;
 
 
(ii)
our accounts receivable collections have improved as we expanded our efforts and made process improvements in this area;
 
 
(iii)
we sold the AFIS business, which generated pre-tax operating losses of $654,000 in fiscal 2010;
 
 
(iv)
our operating expenses continued to decline as we focus on efficiencies throughout the organization; and
 
 
(v)
the Channel Blade acquisition has been fully integrated into the organization.

 
24

 
We invested more cash into the business in fiscal 2011 than we did in fiscal 2010.  Fiscal 2011 cash used in investing activities was $2,293,000, compared with $1,891,000 in fiscal 2010.  We continue to invest cash in the business, primarily for the development of new products and upgrades of existing products, as well as upgrading our technology infrastructure as part of our efforts to consolidate our data centers.  These efforts will result in our primary data center being located in a Tier III (as defined by the Uptime Institute's tier classification system) hosted facility in Madison, Wisconsin with one internally-hosted backup data center.  Although we will continue to invest in the business, management expects cash used in investing activities to fluctuate from period to period based on the level of software development activities as well as the timing of other capital expenditures.

We used cash for financing activities of $977,000 in fiscal 2011; in fiscal 2010 we generated cash from financing activities of $550,000.  We used a significant portion of the cash generated from operating activities in fiscal 2011 to pay down outstanding debt.

Management believes that current cash balances and its ability to generate cash from operations, as well as the existing availability under the Company’s line of credit with Fifth Third, are sufficient to fund the Company’s needs over the next twelve months.

Debt

On July 9, 2004, we entered into a line of credit agreement with JPMorgan Chase, N.A. (the “Chase Line”) which, as amended, permitted us 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 was at least 85%) minus $75,000, up to $2,000,000.  The agreement bore interest at 1% per annum above the prime rate plus an additional 3%, at the bank’s option, upon the occurrence of any default under the note.  There was $1,025,000 outstanding on the Chase Line at July 31, 2010 and the line was paid in full and terminated on July 27, 2011.
 
On July 27, 2011, ARI entered into a Loan and Security Agreement (the “Agreement”) with Fifth Third, filed as exhibit 10.1 on the Company’s Form 8-K on July 28, 2011.  Pursuant to the terms of the Agreement, Fifth Third extended to the Company credit facilities consisting of a $1,500,000 revolving credit facility (the “Revolving Loan”) and a $5,000,000 three year term loan facility (the “Term Loan”).  Each of the credit facilities bears interest at a rate based on the one, two, three or six month LIBOR (as selected by the Company on the last business day of each month) plus 4.0% (effective rate of 4.21% at July 31, 2011).  In connection with this Agreement, the Chase Line and all other banking relationships between ARI and JP Morgan Chase, N.A. were terminated.  There was $245,000 outstanding on the Revolving Loan as of July 31, 2011.
 
The Agreement contains covenants that restrict, among other things and subject to certain conditions, the ability of the Company to incur new debt, create liens on its assets, make certain investments, enter into merger transactions, issue capital securities and make distributions to its shareholders.  Financial covenants include a minimum fixed charge coverage ratio, as defined in the Agreement, of 1.2, and a senior leverage (maximum senior funded indebtedness to EBITDA) ratio, as defined in the Agreement, of 2.0.  The Agreement also contains customary events of default which, if triggered, could result in an acceleration of the Company’s obligations under the Agreement.  The Credit Facilities are secured by a first priority security interest in substantially all assets of the Company and by a first priority pledge of all outstanding equity securities of each of the Company’s domestic subsidiaries and 65% of outstanding equity securities of the Company’s foreign subsidiary.
 
Long-term debt consisted of the following at July 31, 2011 and 2010 (in thousands):
 
   
2011
   
2010
 
             
Notes payable :
           
Channel Blade Technologies
  $ -     $ 5,000  
Fifth Third Bank
    5,000       -  
Total long-term debt
    5,000       5,000  
Less current maturities
    (917 )     -  
Long-term debt, non-current
  $ 4,083     $ 5,000  
 
Principal and interest on the new Term Loan will be repaid in fixed monthly principal installments of $83,333 plus accrued but unpaid interest on the unpaid principal balance commencing on September 1, 2011 through July 1, 2014, with a final balloon payment due July 27, 2014.  Mandatory prepayments of the Credit Facilities will be required in the amount of 50% of the Company’s excess cash flow for the six-month periods ending January 31, 2012 and July 31, 2012 and for each fiscal year thereafter.  Excess cash flow is defined as the remainder of net income plus interest, taxes, depreciation and amortization expense for such period, minus cash taxes paid, capital expenditures incurred, capitalized software costs and scheduled payments of principal and interest charges.
 
 
25


Acquisitions

Since 1995 the Company has had a formal corporate 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, nine business acquisitions and one software asset acquisition have been completed.  All of these acquisitions have been fully integrated into the Company’s operations.

On April 27, 2009, the Company acquired substantially all of the assets of Channel Blade Technologies, the leading provider of websites, lead management and marketing automation solutions in the marine and RV markets. Consideration for the acquisition included approximately $500,000 in cash, 615,385 shares of the Company’s common stock at a market price of $0.75 per share, $765,000 of assumed liabilities and a $5,000,000 note payable.  The Company included the results of operations of Channel Blade in its consolidated financial statements for all periods presented.

On April 17, 2009, AFIS acquired the assets of Powersports Outsourcing Group, valued at approximately $85,000, in partial satisfaction of its debt to ARI of approximately $185,000, $149,000 of which we purchased from Keybank National Association on April 16, 2009.  PSOG, located in Schenectady, NY and then led by Mark L. Taylor, had been offering outsourced F&I services to power sports, marine and RV customers in the Northeast United States since 1998.  In connection with the acquisition, AFIS entered into a three year employment agreement with Mr. Taylor to serve as Director of F&I Business Development. Effective March 8, 2010, ARI and Mr. Taylor terminated the employment agreement and entered into an arrangement pursuant to which Mr. Taylor continued to provide any necessary transitional services to the Company for six months following the effective date.  This agreement has expired.

On July 27, 2010, ARI sold all of the equity interests in AFIS to F&I Smart LLC (the “Subject Interests”) in a membership interest sale agreement.  The sales price of the Subject Interests is a contingent amount based on dealer revenue beginning July 28, 2010 and ending on August 28, 2013.  We have not accrued for any future contingent proceeds as we are not able to estimate the amounts at this time.  The Company recognized a $1,000 loss on the sale of AFIS in the fourth quarter of fiscal 2010.

Critical Accounting Judgments

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 (“GAAP”). The preparation of financial statements in conformance with GAAP requires estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The SEC has defined a company’s critical accounting policies as the ones that are most important to the portrayal of a company’s financial condition and results of operations, and which require the company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain.  Based on this definition, we have identified as the most critical accounting policies and judgments those addressed below.  We also have other key accounting policies, which involve the use of estimates, judgments, and assumptions that are significant to understanding our results.  For additional information, refer to Note 1 of the consolidated financial statements, which appear elsewhere within this report on Form 10-K.  Although we believe that our estimates, assumptions, and judgments are reasonable, they are based upon information currently available.  Actual results may differ significantly from these estimates under different assumptions, judgments, or conditions.

Revenue Recognition

Arrangements that include professional services are evaluated to determine whether those services are essential to the functionality of other elements of the arrangement. Types of services that are considered essential include customizing complex features and functionality in a product’s base software code or developing complex interfaces within a customer’s environment. 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 in the period the amount is determined.

Allowance for Doubtful Accounts

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 estimates a reserve for most amounts due over 90 days, unless there is reasonable assurance of collectability. 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.
 
 
26


Impairment of Long-Lived Assets

Equipment and leasehold improvements, capitalized software product costs and other identifiable assets are reviewed for impairment annually, or 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. During fiscal 2011 and fiscal 2010, the Company disposed of equipment and leasehold improvements with a cost basis of $371,000 and $1,220,000, respectively and recorded a loss on disposal of $0 and $10,000, respectively.

In fiscal 2010, the Company incurred an impairment charge of $48,000 on capitalized software, with a cost basis of $208,000, which was disposed of, and an additional impairment charge of $141,000 on assets that are still in use.  These impairment charges are included in restructuring costs on the statement of operations.  The Company did not incur any software impairment charges in fiscal 2011.

Deferred Income Taxes

The tax effect of the temporary differences between the book and tax basis of assets and liabilities and the estimated tax benefit from tax net operating losses is reported as deferred tax assets and liabilities in the balance sheet. An assessment of the likelihood that net deferred tax assets will be realized from future taxable income is performed. Because the ultimate realizability of deferred tax assets is highly subject to the outcome of future events, the amount established as a valuation allowance is considered to be a significant estimate that is subject to change in the near term. To the extent a valuation allowance is established or there is a change in the allowance during a period, the change is reflected with a corresponding increase or decrease in the tax provision in the statement of income.  We recognized a tax benefit of $1,017,000 and $1,294,000 from continuing operations in fiscal 2011 and fiscal 2010, respectively, both of which primarily resulted from a change in our estimated tax valuation allowance.

Stock-Based Compensation

The Company uses 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 of operations is based on awards ultimately expected to vest, the amount has been reduced for estimated forfeitures based on our historical experience.  Management reviews the critical assumptions used in the Black-Scholes model each quarter and adjusts those assumptions when necessary.

Goodwill and Other Intangible Assets

As fully described in note 1 to the Consolidated Financial Statements, we periodically review the carrying value of goodwill to determine whether an impairment may exist.  We determined that there is a single reporting unit for the purpose of goodwill impairment tests.  We estimate the fair value of the reporting unit using various valuation techniques, with our primary techniques being a discounted cash flow valuation and control premium adjusted market capitalization. There are many estimates and assumptions involved in preparing a discounted cash flow analysis, including estimating future operating results, selecting a weighted average cost of capital to discount estimated future cash flows, anticipated long-term growth rates, and future profit margins.

Estimating the fair value of a reporting unit is an inherently subjective process.  Changes in assumptions, estimates, and other inputs could result in the indication of potential impairment of a portion of the recorded goodwill.  Management believes the assumptions, estimates, and other inputs used reflect their best efforts and are appropriate for valuing the reporting unit.  Our goodwill impairment test indicated that goodwill was not impaired in fiscal 2011 or fiscal 2010.

Impairment tests are also performed for those intangible assets with estimable useful lives if circumstances warrant a review.  Due to the restructuring in the fourth quarter of fiscal 2010, the Company performed an impairment test on intangible assets with definite lives using estimated future cash flows from these assets for the remainder of their useful lives in fiscal 2010.  There were no impairments to intangible assets with estimable useful lives as a result of this test.  There were no circumstances to warrant a review of intangible assets with estimable useful lives in fiscal 2011.

Earn-out Receivable

As part of the purchase price for the disposition of a component of the business, we recorded an earn-out receivable with anticipated payments to ARI annually over a four-year period following the closing date. The earn-out was recorded at fair value, which was the estimated future receipts less an imputed discount, based on the present value of the estimated earn-out payments, discounted at an imputed interest rate at the time the note is issued and any subsequent changes in prevailing interest rates shall be ignored.  Imputed interest is amortized to interest income over the life of the earn-out.
 
 
27


Quarterly Financial Data

The following table sets forth the unaudited results of operations for each of the eight quarterly periods ended July 31, 2011, prepared on a basis consistent with the audited financial statements, reflecting all normal recurring adjustments that are considered necessary. The quarterly information is as follows (in thousands, except per share data):
 
   
1st Quarter
   
2nd Quarter
   
3rd Quarter
   
4th Quarter
 
   
2011
   
2010
   
2011
   
2010
   
2011
   
2010
   
2011
   
2010
 
Net revenues
  $ 5,324     $ 5,437     $ 5,238     $ 5,334     $ 5,354     $ 5,352     $ 5,418     $ 5,361  
Gross margin
    4,157       4,486       4,152       4,361       4,259       4,232       4,359       4,052  
Income from continuing operations
    99       325       123       339       516       155       1,680       350  
Discontinued operations
    -       (163 )     -       (163 )     25       (129 )     -       63  
Net income (loss)
  $ 99     $ 162     $ 123     $ 176     $ 541     $ 26     $ 1,680     $ 413  
                                                                 
Basic and diluted income from continuing operations per common share:
                                                               
Basic
  $ 0.01     $ 0.04     $ 0.02     $ 0.04     $ 0.07     $ 0.02     $ 0.21     $ 0.05  
Diluted
  $ 0.01     $ 0.04     $ 0.02     $ 0.04     $ 0.07     $ 0.02     $ 0.21     $ 0.05  
                                                                 
Basic and diluted net income per common share:
                                                               
Basic
  $ 0.01     $ 0.02     $ 0.02     $ 0.02     $ 0.07     $ 0.00     $ 0.21     $ 0.05  
Diluted
  $ 0.01     $ 0.02     $ 0.02     $ 0.02     $ 0.07     $ 0.00     $ 0.21     $ 0.06  

Off-Balance Sheet Arrangements
 
ARI has no significant off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on its financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Item 8. Financial Statements and Supplementary Data

Reference is made to the consolidated financial statements, the reports thereon and the notes thereto commencing after the signature page of this Report, which are incorporated herein by reference.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

Item 9A. Controls and Procedures
 
Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act, as amended, is recorded, processed, summarized, and reported within the required time periods and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure.

As required by Rule 13a-15 under the Exchange Act, we have completed an evaluation, under the supervision and with the participation of our management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness and the design and operation of our disclosure controls and procedures as of July 31, 2011.  Based upon this evaluation, our management, including the Chief Executive Officer and the Chief Financial Officer, has concluded that our disclosure controls and procedures were effective as of July 31, 2011.
 
 
28


Management’s Annual Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Under the supervision and with the participation of our management, including our Chief Executive Officer and the Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control over Financial Reporting – Guidance for Smaller Public Companies issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under this framework, our management concluded that our internal control over financial reporting was effective as of July 31, 2011.

This Annual Report on Form 10-K does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Internal control over financial reporting was not subject to attestation by our independent registered public accounting firm pursuant to the amendments to Rule 2-02(f) of Regulation S-X that exempt us from this attestation requirement based on our status as a non-accelerated filer.  We are required to provide only management’s report in this Annual Report on Form 10-K.

Changes in Internal Controls

There were no changes to the Company’s internal control over financial reporting during the year ended July 31, 2011 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Limitations on Effectiveness of Controls and Procedures

Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include, but are not limited to, the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
 
 
29


PART III

Item 10. Directors, Executive Officers, and Corporate Governance

Information required by Item 10 of Part III is included in our Proxy Statement relating to our 2011 Annual Meeting of Shareholders, and is incorporated herein by reference.

Item 11. Executive Compensation

Information required by Item 11 of Part III is included in our Proxy Statement relating to our 2011 Annual Meeting of Shareholders, and is incorporated herein by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Information required by Item 12 of Part III is included in our Proxy Statement relating to our 2011 Annual Meeting of Shareholders, and is incorporated herein by reference.

Item 13. Certain Relationships and Related Transactions

Information required by Item 13 of Part III is included in our Proxy Statement relating to our 2011 Annual Meeting of Shareholders, and is incorporated herein by reference.

Item 14. Principal Accounting Fees and Services

Information required by Item 14 of Part III is included in our Proxy Statement relating to our 2011 Annual Meeting of Shareholders, and is incorporated herein by reference.
 
 
30

 
PART IV
 
Item 15. Exhibits
 
2.1
Asset Purchase Agreement dated March 1, 2011 between ARI Network Services, Inc. and Globalrange Corporation, incorporated herein by reference to Exhibit 2.1 to the Form 8-K filed on March 4, 2011.
 
3.1
Articles of Incorporation of the Company, as amended, incorporated herein by reference to Exhibit 3.1 of the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended April 30, 1999.
 
3.2
Articles of Amendment of the Company, incorporated herein by reference to Exhibit 3.2 of Form 8-K filed on August 18, 2003.
 
3.3
By-laws of the Company incorporated herein by reference to Exhibit 3.1 of the Company’s Registration Statement on Form S-l (Reg. No. 33-43148).
 
4.2
The Company agrees to furnish to the Commission upon request copies of any agreements with respect to long term debt not exceeding 10% of the Company’s consolidated assets.
 
10.1
Rights Agreement dated as of August 7, 2003, between the Company and American Stock Transfer & Trust Company, as Rights Agent, incorporated herein by reference to Exhibit 10.1 of Form 8-K filed on August 18, 2003.
 
Summary of Executive Bonus Arrangements (Fiscal 2011).
 
10.3
Credit Agreement dated July 9, 2004 between the Company and Bank One, NA,  incorporated by reference to exhibit 10.14 of the Company’s Form 10-K for the year ended July 31, 2004.
 
10.4
Amendment to Credit Agreement dated February 15, 2005, between the Company and JPMorgan Chase Bank, NA, successor by merger to Bank One, NA.,  incorporated herein by reference to Exhibit 10.14 of the Company’s Form 10-KSB for the fiscal year ended July 31, 2005.
 
10.5
Continuing Security Agreement dated July 9, 2004, between the Company and JPMorgan Chase Bank, NA, successor by merger to Bank One, NA., incorporated by reference to Exhibit 10.15 of the Company’s Form 10-KSB for the year ended July 31, 2004.
 
10.6
Line of credit note dated July 9, 2004 by the Company for $500,000, incorporated by reference to exhibit 10.16 of the Company’s Form 10-KSB for the year ended July 31, 2005.
 
10.7
Note Modification Agreement dated February 15, 2005 to the Line of Credit Note dated July 9, 2004 by the Company for $500,000, incorporated herein by reference to Exhibit 10.17 of the Company’s Form 10-KSB for the fiscal year ended July 31, 2005.
 
10.8
Note Modification Agreement dated October 26, 2006, to the Line of Credit Note dated July 9, 2004 by the Company for $1,000,000, incorporated herein by reference to Exhibit 10.1 of the Company’s Form 8-K filed on October 31, 2006.
 
10.9
Note Modification Agreement dated April 25, 2006 to the Line of Credit Note dated July 9, 2004 by the Company for $500,000, incorporated herein by reference to Exhibit 10.16 of the Company’s Form 10-KSB for the fiscal year ended July 31, 2006.
 
10.10
First Amendment to Rights Agreement dated November 10, 2005, between the Company and American Stock Transfer & Trust Company, as Rights Agent, incorporated by reference to Exhibit 10.1 of Form 8-K filed on November 14, 2005.
 
10.11
Amendment to Credit Agreement dated May 10, 2007, between the Company and JP Morgan Chase Bank, NA, successor by merger to Bank One, NA, incorporated by reference to the Company’s Form 10-QSB for the quarter ended April 30, 2007.
 
10.12
Note Modification Agreement dated May 10, 2007, between the Company and JP Morgan Chase Bank, NA, successor by merger to Bank One, NA, incorporated by reference to the Company’s Form 10-QSB for the quarter ended April 30, 2007.
 
10.13
Note Modification Agreement dated April 25, 2008, between the Company and JP Morgan Chase Bank, NA, successor by merger to Bank One, NA., incorporated by reference to the Company's Form 10-K for the fiscal year ended July 31, 2008.
 
10.14
Credit Agreement Amendment dated April 6, 2009, incorporated by reference to Form 10-Q for the quarter ended April 30, 2009.
 
10.15
Credit Agreement Amendment dated April 8, 2010, between the Company and JP Morgan Chase Bank, NA, incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed on June 18, 2010.
 
10.16*
Change of Control Agreement dated September 13, 2006 between the Company and Roy W. Olivier, incorporated by reference to Exhibit 10.3 of the Company’s Form 10-QSB for the quarter ended October 31, 2007.
 
10.17*
Employment Agreement dated May 1, 2008 between the Company and Roy W. Olivier, incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K filed on May 2, 2008.
 
 
 
31

 
Amendment to Change of Control Agreement dated May 2, 2008, by and between ARI Network Services, Inc. and Roy W. Olivier.
 
10.19*
Employment Agreement dated December 10, 2010 between Darin R. Janacek and the Company, incorporated herein by reference to Exhibit 10.1 to the Form 8-K filed on December 16, 2010.
 
10.20*
Change of Control Agreement dated December 10, 2010 between Darin R. Janacek and the Company, incorporated herein by reference to Exhibit 10.2 to the Form 8-K filed on December 16, 2010.
 
10.21*
ARI Network Services, Inc. 2010 Equity Incentive Plan, incorporated herein by reference to Exhibit 10.1 to the Form 8-K filed on December 22, 2010.
 
10.22*
ARI Network Services, Inc. 2000 Employee Stock Purchase Plan, as Amended and Restated November 4, 2010, incorporated herein by reference to Exhibit 10.2 to the Form 8-K filed on December 22, 2010.
 
10.23
Loan and Security Agreement dated as of July 27, 2011 by and between ARI Network Services, Inc. and Fifth Third Bank, incorporated herein by reference to Exhibit 10.1 to the Form 8-K filed on July 28, 2011.
 
10.24
Membership Interests Security Agreement dated as of July 27, 2011 by ARI Network Services, Inc. to and in favor of Fifth Third Bank, incorporated herein by reference to Exhibit 10.2 to the Form 8-K filed on July 28, 2011.
 
Subsidiaries of the Company.
 
Consent of Wipfli LLP.
 
24.1
Powers of Attorney appear on the signature page hereof.
 
Section 302 Certification of Chief Executive Officer.
 
Section 302 Certification of Chief Financial Officer.
 
Section 906 Certification of Chief Executive Officer.
 
Section 906 Certification of Chief Financial Officer.
 

*Indicates Management Contract or Compensatory Plan or Agreement.
 
 
32


SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 31st day of October 2011.
 
ARI NETWORK SERVICES, INC.
 
By:   /s/ Roy W. Olivier
Roy W. Olivier
President and Chief Executive Officer
 
By:   /s/ Darin R. Janecek
Darin R. Janece
Vice President of Finance and Chief Financial Officer

KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Roy W. Olivier and Darin R. Janecek, his true and lawful attorney-in-fact and agent with full power of substitution and resubstitution, for him and his name, place and stead, in any and all capacities, to sign any and all amendments to this report and to file the same with all exhibits thereto, and other documents in connection therewith, with the Commission, granting unto said attorney-in-fact and agent full power and authority to do and perform each act and thing requisite and necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorney-in-fact and agent, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
 
/s/ Brian E. Dearing   October 31, 2011
Brian E. Dearing  
Chairman of the Board  
   
/s/ Roy W. Olivier October 31, 2011
Roy W. Olivier  
Director  
   
/s/ Gordon J. Bridge     October 31, 2011
Gordon J. Bridge  
Director  
   
/s/ Ted C. Feierstein    October 31, 2011
Ted C. Feierstein  
Director  
   
/s/ William C. Mortimore   October 31, 2011
William C. Mortimore  
Director  
   
/s/ P. Lee Poseidon October 31, 2011
P. Lee Poseidon  
Director  
 
 
33


Report of Wipfli LLP,
Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders
ARI Network Services, Inc.

We have audited the accompanying consolidated balance sheets of ARI Network Services, Inc. and Subsidiaries (the Company) as of July 31, 2011 and 2010 and the related consolidated statements of income, shareholders’ equity and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of July 31, 2011 and 2010 and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States.
 
/s/ Wipfli LLP
Milwaukee, Wisconsin
October 31, 2011

 
34


Consolidated Financial Statements
 
ARI Network Services, Inc.
Years ended July 31, 2011 and 2010
 
 
35

 
ARI Network Services, Inc.
Consolidated Balance Sheets
(Dollars in Thousands, Except per Share Data)
 
   
July 31
2011
   
July 31
2010
 
Current assets:
           
Cash and cash equivalents
  $ 1,134     $ 938  
Trade receivables, less allowance for doubtful accounts of $383 and $565 at July 31, 2011 and 2010, respectively
    1,179       1,359  
Work in process
    169       133  
Prepaid expenses and other
    802       481  
Deferred income taxes
    2,693       2,600  
Total current assets
    5,977       5,511  
Equipment and leasehold improvements:
               
Computer equipment and software for internal use
    2,304       1,883  
Leasehold improvements
    558       506  
Furniture and equipment
    2,000       1,970  
      4,862       4,359  
Less accumulated depreciation and amortization
    2,988       2,433  
Net equipment and leasehold improvements
    1,874       1,926  
Capitalized software product costs:
               
Amounts capitalized for software product costs
    16,693       15,919  
Less accumulated amortization
    13,878       13,524  
Net capitalized software product costs
    2,815       2,395  
Deferred income taxes
    2,607       1,616  
Other long term assets
    346       63  
Other intangible assets
    2,041       2,827  
Goodwill
    5,439       5,439  
Total assets
  $ 21,099     $ 19,777  
 
See accompanying notes
 
 
36

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

   
July 31
2011
   
July 31
2010
 
Current liabilities:
           
Current borrowings on line of credit
  $ 245     $ 1,025  
Current portion of long-term debt
    917       -  
Accounts payable
    561       490  
Deferred revenue
    5,282       5,270  
Accrued payroll and related liabilities
    1,264       1,322  
Accrued taxes
    106       60  
Other accrued liabilities
    473       844  
Current portion of capital lease obligations
    127       192  
Total current liabilities
    8,975       9,203  
Non-current liabilities:
               
Long-term debt
    4,083       5,000  
Long-term portion of accrued compensation
    -       17  
Capital lease obligations
    210       338  
Total non-current liabilities
    4,293       5,355  
Total liabilities
    13,268       14,558  
                 
Shareholders' equity:
               
Cumulative preferred stock, par value $.001 per share, 1,000,000 shares authorized; 0 shares issued and outstanding at July 31, 2011 and 2010, respectively
    -       -  
Junior preferred stock, par value $.001 per share, 100,000 shares authorized; 0 shares issued and outstanding at July 31, 2011 and 2010, respectively
    -       -  
Common stock, par value $.001 per share, 25,000,000 shares authorized; 7,901,774 and  7,768,921 shares issued and outstanding at July 31, 2011 and 2010, respectively
    8       8  
Common stock warrants and options
    1,092       983  
Additional paid-in capital
    95,834       95,748  
Accumulated deficit
    (89,064 )     (91,507 )
Other accumulated comprehensive loss
    (39 )     (13 )
Total shareholders' equity
    7,831       5,219  
Total liabilities and shareholders' equity
  $ 21,099     $ 19,777  
 
See accompanying notes
 
 
37

 
ARI Network Services, Inc.
Consolidated Statements of Income
(Dollars in Thousands, Except per Share Data)
 
   
2011
   
2010
 
Net revenue
  $ 21,334     $ 21,484  
Cost of revenue
    4,407       4,353  
Gross profit
    16,927       17,131  
Operating expenses:
               
Sales and marketing
    4,272       4,786  
Customer operations and support
    3,439       3,469  
Software development and technical support (net of capitalized software product costs)
    1,543       1,415  
General and administrative
    4,252       4,879  
Restructuring
    -       437  
Depreciation and amortization (exclusive of amortization of software product costs included in cost of revenue)
    1,688       1,640  
Net operating expenses
    15,194       16,626  
Operating income
    1,733       505  
Other income (expense):
               
Interest expense
    (790 )     (649 )
Gain on sale of a component of the business
    433       -  
Other, net
    25       19  
Total other income (expense)
    (332 )     (630 )
Income (loss) from continuing operations before provision for income tax
    1,401       (125 )
Income tax benefit (expense)
    1,017       1,294  
Income from continuing operations
    2,418       1,169  
Discontinued operations, net of tax
    25       (392 )
Net income
  $ 2,443     $ 777  
                 
Income from continuing operations per common share:
               
Basic
  $ 0.31     $ 0.15  
Diluted
  $ 0.31     $ 0.15  
                 
Net income per common share:
               
Basic
  $ 0.31     $ 0.10  
Diluted
  $ 0.31     $ 0.10  
 
See accompanying notes
 
 
38

ARI Network Services, Inc.
Consolidated Statements of Shareholders' Equity
(Dollars in Thousands)
 
                                 
Other
       
   
Common Stock
               
Accumulated
   
Total
 
   
Shares Issued
   
Par
   
Warrants &
   
Paid-in
   
Accumulated
   
Comprehensive
   
Shareholders'
 
   
and Outstanding
   
Value
   
Options
   
Capital
   
Deficit
   
Income (Loss)
   
Equity
 
Balance July 31, 2009
    7,693,510     $ 8     $ 816     $ 95,681     $ (92,284 )   $ (34 )   $ 4,187  
                                                         
Stock-based compensation
    -       -       167       -       -       -       167  
Issuance of common stock under company 401(k) plan
    58,332       -       -       52       -       -       52  
Issuance of common stock under executive bonus plan
    10,495       -       -       10       -       -       10  
Issuance of common stock under stock purchase plan
    6,584       -       -       5       -       -       5  
Subtotal
    75,411       -       167       67       -       -       234  
                                                         
Net Income
    -       -       -       -       777       -       777  
Foreign currency translation adjustments
    -       -       -       -       -       21       21  
Comprehensive income
    -       -       -       -       777       21       798  
Balance July 31, 2010
    7,768,921     $ 8     $ 983     $ 95,748     $ (91,507 )   $ (13 )   $ 5,219  
                                                         
Stock-based compensation
    -       -       109       -       -       -       109  
Issuance of common stock under company 401(k) plan
    86,739       -       -       60       -       -       60  
Issuance of common stock under executive bonus plan
    33,140       -       -       20       -       -       20  
Issuance of common stock under stock purchase plan
    12,174       -       -       5       -       -       5  
Issuance of common stock from exercise of stock options
    800                       1                       1  
Subtotal
    132,853       -       109       86       -       -       195  
                                                         
Net Income
    -       -       -       -       2,443       -       2,443  
Foreign currency translation adjustments
    -       -       -       -       -       (26 )     (26 )
Comprehensive income
    -       -       -       -       2,443       (26 )     2,417  
Balance July 31, 2011
    7,901,774     $ 8     $ 1,092     $ 95,834     $ (89,064 )   $ (39 )   $ 7,831  
 
Shareholders' Equity includes cumulative preferred stock, par value $.001 per share, 1,000,000 shares authorized; 0 shares issued and outstanding for all periods presented.
 
Shareholders' Equity includes junior preferred stock, par value $.001 per share, 100,000 shares authorized; 0 shares issued and outstanding for all periods presented.
 
See accompanying notes
 
 
39

 
ARI Network Services, Inc.
Consolidated Statements of Cash Flows
(Dollars in Thousands)
 
   
2011
   
2010
 
Operating activities
           
Net income
  $ 2,443     $ 777  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Amortization of software products
    1,127       1,054  
Impairment of software products
    -       189  
Amortization of interest income related to present value of earnout
    (19 )     -  
Depreciation and other amortization
    1,688