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Ariba Inc. (NASDAQ:ARBA)

F4Q08 (Qtr End 09/30/08) Earnings Call Transcript

October 23, 2008, 05:00 pm ET

Executives

John Duncan – Director of Corporate Finance and IR

Bob Calderoni – Chairman and CEO

Ahmed Rubaie – CFO

Analysts

Greg Dunham – Deutsche Bank

Peter Goldmacher – Cowen and Company

Matt Herbick [ph] – RBC Capital Markets

Sterling Auty [ph] – JP Morgan

Reno [ph] – Oppenheimer

Nathan Schneiderman – Roth Capital Partners

Brad Whitt – American Technology Research

Robert Becker – Argus Research

Operator

Greetings, ladies and gentlemen and welcome to the Ariba fourth quarter 2008 earnings conference call. (Operator instructions). It is now my pleasure to introduce your host, John Duncan, Director of Corporate Finance and Investor Relations. Thank you, you may begin.

John Duncan

Good afternoon and welcome everyone to Ariba's conference call to discuss the results of fourth quarter of fiscal year 2008. In today's call, we will make reference to supplemental presentation slides with our prepared remarks. To access these slides, please log on to the investor relations section of our website at www.ariba.com. Our speakers for the call today are Bob Calderoni, our Chairman and Chief Executive Officer and Ahmed Rubaie, our Chief Financial Officer. For those on the call accessing the supplemental information, please now advance to slide two.

Before we begin, I will read the Safe Harbor Statement. Statements that may be made in this call and in the supplemental slides that are not historical facts may be forward-looking statements, including statements regarding the Company's or Management's intentions, hopes, beliefs, plans, expectations or strategies for the future. These statements are subject to various risks and uncertainties and actual results could differ materially from the Company's current expectations. These risks and uncertainties are discussed in the Company's SEC filings, including our most recent report on Form 10-K filed on August 6, 2008, for the quarter ended June 30, 2008.

During the course of this call, we will reference historical non-GAAP financial measures. Management reviews non-GAAP financial information in evaluating Ariba's historical and projected financial performance and believes that it may assist investors in assessing its ongoing operations. The presentation of this additional information is not meant to be considered in isolation or as a substitute for or superior to measures of financial performance prepared in accordance with GAAP. For a reconciliation of historical non-GAAP to GAAP financial measures, please see the earnings press release and supplemental analysis on the investor relations section of our website at www.ariba.com or our Form 8-K filed this afternoon.

In addition, we will reference certain forward-looking non-GAAP information including fiscal 2009 revenues, expenses, and net income. We are unable to reconcile this forward-looking non-GAAP financial information to the corresponding forward looking GAAP measures because we are unable to estimate without unreasonable efforts certain forward looking GAAP revenue and expense items.

At this time, I would like to turn the call over to Ahmed Rubaie to review the financial highlights for the quarter.

Ahmed Rubaie

Thanks, John. Good afternoon, everyone and thank you for joining us today. Overall it was a great fourth quarter for Ariba. Beyond our expectations we had record subscription software bookings and backlog. Our margins expanded and our cash flow improved.

We have strong operating metrics across the board while managing the macroeconomic headwinds. Here are some highlights. Please refer to slide three. Despite the weak economic backdrop in Q4, Ariba had record sub software bookings. This drove an increase in sub software backlog for the 15th consecutive quarter.

Our 12- month backlog increased by $10 million to $117 million or up 78% year-over-year. Our on-demand strategy continues to gain momentum in the market. We saw a 243% increase in number of subscription software product deals when compared to the same quarter last year. Additionally, this quarter we saw our average contract length extend to 27 months up from 23 months last quarter.

Please now turn to slide four. We posted a 78% year-over-year increase in our subscription software revenue, which gives us one of the fastest growing software businesses today. On an organic basis without the impact of Procuri, subscription software revenues increased 44%. We met our guidance for both non-GAAP revenue and EPS. Non-GAAP revenue was $86.4 million versus guidance of $86 million to $88 million. Non-GAAP EPS also came in within our expectations at $0.15 versus guidance of $0.15 to $0.18. Our EPS would have been at the midpoint of the range but for some unusual items in the quarter, which I will cover later in the call.

We had another strong cash flow quarter generating cash flow from operations before the impact of lease loss, Procuri, and restructuring payments of $16 million for the quarter and $55 million for the year coming in at the high end of our $50 million to $55 million targeted range. We ended the quarter with $137 million of cash and investments, which was also above our expectations. Finally, we closed 224 unique customer transactions, added 33 new named accounts, signed 185 on-demand deals, and closed 26 deals over $1 million.

Now, let me turn to more specific financial results for the September quarter. Total revenues were $85.5 million for the fourth quarter of 2008, including a purchase accounting adjustment of $0.9 million. Against Procuri's revenue stream, non-GAAP revenues were $86.4 million and came in within of our guidance range. On a GAAP basis, subscription and maintenance revenue was $51 million. On a non-GAAP basis, subscription and maintenance revenue was approximately $52 million, in line with our $52 to $53 million guidance range. Non-GAAP subscription software revenues came in at $33.5 million, up 78% year-over-year on a reported basis or 44% on an organic basis.

Please go to slide five. In Q4, we recorded $7 million of network software revenue of which $5 million came from the supplier membership program. For the year we generated $26 million of network software revenue meeting our objective to double this revenue stream from the prior year. Services and other revenue came in at $34.5 including $500,000 of license revenue. As we previously discussed with you this will be the last quarter that we provide detail on our perpetual licenses since they are no longer a material part of our business.

We also continued to improve our operating margins. Overall, non-GAAP operating margins increased to 15% this quarter, which was also in line with our expectations. As we have discussed margin expansion is and will continue to be a focus area for us. During fiscal 2008 we demonstrated consistent operating margin expansion throughout the year increasing from 3% in Q1 to 6% in Q2, 10% in Q3, and now 15% in Q4. The transformation of our business is driving these margin increases as we continue to see a more favorable mix of higher margin subscriptions revenue.

Looking at expenses, total expenses on a GAAP basis including cost of revenue were $92 million. Included in these GAAP results were a $1.6 million charge for amortization of purchased technology and intangible assets, a $10 million charge for stock based compensation, a $5.1 million lease restructuring charge, and a $1.2 million severance restructuring charge primarily relating to the reorganization of our global engineering function. Excluding these items, non-GAAP expenses were $74 million for the quarter, slightly higher than our guidance of $73 million due primarily to the higher than expected legal expenses. As a result, GAAP net loss for the fourth quarter was $6 million or $0.08 a share. On a non-GAAP basis, we had positive net income of $13 million or $0.15 per diluted share. EPS came in at the lower end of our expectation due to a negative $0.03 impact from foreign exchange and incremental litigation expenses. We also had an offsetting benefit of $0.015 from a reduction of executive bonuses.

Moving on to the balance sheet, cash and cash equivalents and investments at the end of Q4 were $137 million, which was up $8 million from $129 million at the end of Q3 and $2 million above our expectations. We generated positive cash flow from operations of $10 million. Excluding cash used for restructuring charges and lease losses, cash flow from operations was $16 million. DSO improved to 30 days, down 1 day from the previous quarter.

Slides 14 through 19 in the investor slide deck provide additional details on our auction rate securities and how we value them.

Now, let's turn to Ariba's outlook for fiscal year 2009 and the December quarter.

Please see slide seven. Since we spoke to you last quarter, we had now had the opportunity to finalize our planning process. We are well positioned to get $0.70 EPS while continuing to grow our business, expand our margins, and prudently invest back in the business, against the backdrop of macroeconomic and currency uncertainty.

As you saw in our strong Q4 results, our underlying business continues to be strong and we continue to see the momentum in our subscription software business. Companies today are facing even greater pressure to cut costs and manage working capital and we are well positioned to help them. While we’re not in the business of predicting currency we are revising our revenue guidance to reflect the recent changes in foreign exchange markets. We expect the currency impact on EPS to be approximately $0.02 for the year, yet we still believe we can hit our $0.70 target.

So our FX adjusted revenue guidance for subscriptions software will be $152 million to $162 million compared to our previous guidance of $155 million to $165 million. Similarly maintenance revenue will be $69 million to $70 million compared to our previous guidance of $71 million to $72 million, and services and other revenue will be $133 million and $138 million compared to our previous guidance of $138 million to $143 million. In short and with a total FX adjustment of $10 million, we now expect our total revenues to be $355 million to $370 million for fiscal year 2009.

The currency rates will continue to move up and down. As we saw yesterday the US dollar is likely to likely to continue to strengthen given the global macroeconomic situation. Our guidance adjustments are based on mid October rates. We will continue to monitor the rates and update you as the year goes on. Our major growth driver continues to be subscription software growth. We expect growth in subscription software revenue in the range of 30% to 38% resulting in roughly $152 million to $162 million of subscription software revenue as I mentioned a few minutes ago.

We also see the continued momentum in selling more on-demand solutions and generally a more profitable mix. Margin expansion is and continues to be a focus for Ariba and as I mentioned before we continue to target $0.70 EPS for this year. In this number, we are also making a number of prudent investments to support Ariba’s future growth strategy particularly the Ariba supplier network.

To navigate the current uncertainty and continue prudent investment in the business both short and long-term we’re focused on disciplined spending across the business.

Turing to slide eight. Of course, the leverage of subscription model continues to drive strong cash flow results. We expect cash flow from operations before lease losses, Procuri, and restructuring to be $80 million to $82 million in fiscal year 2009. While we do not plan to give you guidance beyond Q1 on today’s call here are few things to keep in mind as your building your models for the year. Much as we saw in fiscal year 2008, we expect to see a continued steady increase in subscription software revenue as we go through the year.

As far as operating expenses go and as I pointed out earlier we will be making some prudent investments to support our growth in the network business which will begin in the first quarter and continue throughout the year. In total, we expect operating expenses to be rather flat with Q1 levels with sales and marketing increasing to reflect the investments we are making, offsets by declines in G&A.

Our litigation expense is expected to be the same in Q1 as it was in Q4 at $2.5 million and will taper off in future quarters. We also expect to have a net charge of $1 million per quarter and fiscal year 2009, which comprises interest, taxes, foreign exchange impact all on one line.

Now turning to Q1, we expect non-GAAP revenues in the range of $86 million to $89 million adjusted for FX. We’re investing in our network business to the tune of $0.02 in Q1, which will continue for the rest of the year. As I mentioned above the EPS will ramp up in the second half of the year, much like it did in fiscal year 2008.

Let me give you some more specific financial highlights for the quarter. Subscription and maintenance revenues between $54 million to $55 million, including roughly $35.5 million to $36.5 million for subscription software and $18 million for maintenance. Services and other revenues will be in the $32 million to $34 million range. As a reminder we will no longer breakup perpetual licenses as they are not a material factor to our overall financial results. There will be a purchase accounting adjustment of approximately $400,000 to Procuri's revenue stream, thus GAAP revenues are expected to be between $85.6 million to $88.6 million.

With respect to the rest of the P&L, we expect total non-GAAP operating costs and expenses to be about $76 million to $77 million including investments. Contained within this range are cost of revenue of roughly $31 million to $32 million, R&D of roughly $10 million, sales and marketing of approximately $24 million, G&A of $10 million, which includes roughly $2.5 million of IP and other litigation expenses, a net charge of approximately $1 million comprising of interest, taxes, and foreign exchange impact.

On a non-GAAP basis, we expect positive net income of approximately $10 million to $12 million or approximately $0.12 to $0.14 based on 86 million diluted shares outstanding. In addition, we expect to record expenses of $11 million for stock-based compensation, $1.2 million for amortization of intangible assets, and approximately $1 million for restructuring. As a result we expect to general a GAAP net loss of $2 million to $4 million or a loss of $0.03 to $0.05 per share.

To recap, we’re going into fiscal 2009 on the back of a very strong quarter and expecting to continue the momentum while prudently investing in a future. In tandem we are extra focused in keeping a lean cost structure to ensure we meet our operating margin objectives. While we cannot control the overall market conditions, we are well positioned to succeed in 2009 due to what we sell savings, and how we sell it on-demand.

And with that, let me turn the call over to Bob.

Bob Calderoni

Thanks Ahmed and I thank all of you for joining us this afternoon. I'm also pleased with the results for the fourth quarter of 2008 and I am certainly proud of the many accomplishments we made in our fiscal year 2008.

This past year has proved to be the pivotal year for us as we clearly turned the company into a fast growing subscriptions software company. We grew full-year subscription revenues into 2008 by 74%, we improved non-GAAP operating margins steadily throughout the year from 3% early in the year to 15% at the end of the year, and we integrated an acquisition as well.

Overall it was an outstanding year. We ended it with accelerating momentum right up to and including the fourth quarter as evidenced by a record quarter in subscription software bookings and a very, very strong backlog.

Before I get into a lot of details about the quarter and the great momentum we see in our business, let me touch briefly on what is top of minds for everyone and that is the current macroeconomic environment. From a bookings perspective, we have not experienced a negative impact on our business. In fact the business was stronger than we expected in Q4. This was true in total. It was true in North America. It was true in Europe and it was true in many of the most hard-pressed industry verticals.

I believe there a number of reasons for this. First reason is that we saw cost reduction and companies need that now more than ever and secondly when it comes to spend management, we’re increasingly recognized as the undisputed leader. Looking forward we continue to see strength in our software business and we expect good growth in fiscal year 2009 and we believe we’re on target to achieve the $0.70 EPS we targeted in our last earnings call.

From a sales momentum perspective, Q4 was good and better than even our high expectations. However, despite the strength we saw in terms of software bookings we came in at the low end of our EPS estimates as Ahmed pointed out, and I just want to point out we experienced two items that negatively impacted our cost. First being a net impact of currency of about $0.02 a share and the second coming from litigation costs, which are running a little bit harder than we planned as we were coming up to our trial this past week. Partially offsetting this was a benefit of $0.015 due to lower executive bonuses. Given the macro environment that we all find ourselves in coupled with the fact that we incurred some costs that were not anticipated at the beginning of the quarter, I recommend and the board approved my recommendation that I and my other section of 16 officers not take a bonus for fiscal year 2008.

While we achieved many significant milestones and overall achieved tremendous results this past year with year-over-year growth in most every metric we decided that given the current macroeconomic environment we would conserve cash and demonstrate by example of our intention to hold the line on costs going forward. This enabled us to partially offset some of the unanticipated costs incurred in the quarter and still be able to pay our bonuses for the nonexecutive employees who I believe demonstrated outstanding performance in 2008 and made significant contributions towards our many successes.

Let me now talk about the quarter and some of the trends we see and then I will circle back and give you my color of commentary on Q1 and also on the full year of 2009. First in light of the uncertainty around the world our business continues to grow. You can see that in the significant increase in our backlog from quarter-over-quarter and year-over-year and not only was it the record quarter for us in terms of subscription software bookings that the vast majority of bookings came in during the tail end of the quarter when the market was already showing signs of stress.

Second. the fundamentals of our business strategy remain strong and are possibly even more attractive today than they have ever been. In the face of the down economy companies need to cut costs and manage their cash and as a result we are seeing companies make continued significant spend management solution investments including companies in the most troubled industries like financial services and automotives. In addition, our on-demand strategy has made management accessible to a wider range of companies even at a time when IT budgets are tightening and large scale ERP and install software implementations are being put on hold.

Finally, our businesses remains very healthy. We have a strong cast position of $137 million. We have a strong backlog, good visibility for our subscription the revenues, and we’re coming into 2009 with more visibility and a stronger backlog than we entered 2008 with more of next year’s revenue already covered then we had at this point in time last year. So while other companies have piled on debt and seem to be retrenching, our strong performance will allow us to continue to invest in growing the strategic areas of our business like the network while still growing revenues, margins, and earnings per share.

As I have talked about in the past we had to go-to-market initiatives one being land and expand and the second being volume and velocity. And I think there is evidence of our success all over. First, of course, is the 78% increase in subscription software revenues that makes us amongst the fastest growing software businesses in the market today. Second, we closed 33 net new named customers this quarter, the highest ever for us and 38% higher than Q4 of last year, which was also a very strong quarter and we continue to demonstrate that spend management creates significant value, significant enough to net 26 solution deals greater than $1 million again the highest ever of which sixteen were software deals greater than $1 million, which also represents a record.

This point alone might be enough to illustrate that Ariba is part of the solution of the current economic crisis. Perhaps as more evidence I should note that several of the deals closed in the quarter with values of more than $1 million were in the financial services sector. This included a full on-demand suite deal with BB&T Bank, a Midwest regional bank, and also with SunTrust, now one of the top five or six banks in the country.

Another important trend is we’re increasingly wrapping our solutions around our ERP systems. Our on-demand solutions with superior functionality, lower total cost of ownership and speed to implementation is increasingly allowing us to win business in SAP and Oracle accounts even in situations when we’re competing against zero cost alternatives since many of these customers often own an enterprise license to the entire ERP suite. The network is playing a big role in helping us penetrate and extend the value of our ERP accounts and one example was a large multiyear win that closed this quarter in an Oracle, complete Oracle I-Procure shop [ph]. They subscribe to our invoicing and working capital management capabilities as well as Ariba network.

Another example of this trend is Apollo Group, another oracle shop that subscribed to our on-demand suite including invoicing, working capital, and supply enablement capabilities. We feel this is a right time for the Ariba network and our on-demand solutions to accelerate the time to benefit and extend the value of many company’s ERP investments. In addition to the on-demand focus, this focus enables us to extend spend management to a larger group of companies. We see that trend continuing in Q4. We saw continued growth in our midmarket business, 50% of our net new customers in the quarter were with companies with annual revenues below $5 billion, including 95 deals with companies with annual revenues below $2 billion dollars.

One midmarket deal of note was a EUR100 million manufacturer. This company subscribed to a multiyear on-demand analysis and sourcing solution earlier this year and this past quarter they came back and contracted for a $1 million in Ariba sourcing services to help them assess sourcing opportunities and drive cost reductions. All told this one midsize company believes so strongly in spend management and Ariba they are investing $1.5 million, the same levels of some of our larger enterprises.

We see many of the same trends continuing in Europe where we also closed a great quarter in our best year ever in EMEA. We had a host of wins against SAP and other regional competitors including a large deal for an on-demand sourcing and contract solution at Siemens, a net new name for us right in SAP’s backyard and an equally large transaction with Total, another large SAP customer in France.

Other significant wins in the region include on-demand sourcing and contracts at British Petroleum were we beat out both SAP and a number of smaller niche competitors. The walkaways from all of this are the following, our go to market strategy around velocity and expansion is working. We see more deals. We see more new customers and we see more big deals all at the same time. Our wraparound ERP strategy is working with countless wins in Oracle and SAP accounts and our solutions are driving value even in the face of macro downturn.

I think I will be foolish to say that we or anyone is completely immune to the current global economic situation but our success last quarter and our pipeline leads us to remain confident on the full year. We believe we have a balanced plan going forward with good growth in revenues enabling us to invest in our business approximately $0.02 per quarter for future network businesses and yet still drive to the $0.70 target that we established last quarter. We’ll start out the year with non-GAAP earnings per share in $0.12 to $0.14 as Ahmed pointed out and then show sequential improvement each quarter driven by the conclusion of our litigation pending at the end of this upcoming quarter and the leverage we get from our growing subscription software revenues each quarter and we should see a trend very much like we saw in 2008.

We are able to make these investments in our network because the fundamentals of our business remain strong, we have strong recurring revenues, a growing backlog, $137 million in cash, no debt, and we are generating cash each and every quarter. All of this is at the time when some of our competitors are taking on debt continually delivering promise to our leases and backing away from plans to get into new markets where we already have a strong foothold. With the growth in our subscription software revenue and the fact that we have a much stronger backlog and greater coverage going into 2009 than we had in 2008 coupled with our intentions to implement even tighter cost controls we can make modest investments and grow our margins in 2009 just like we did in 2008.

So in closing, I feel very good about the momentum we have built over the past few quarters and while cautious about the overall economy today I feel that our spend management message and our on-demand strategy positions Ariba well for continued growth and another very good year in 2009.

So, thank you and I will turn the call over to your questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions). Our first question is from the line of Greg Dunham with Deutsche Bank. Please go ahead with your question.

Greg Dunham – Deutsche Bank

Hi, thank you. You know, looking back, clearly the margin expansion is impressive especially when you have accelerated growth in to the mid teens as well, but I think what I most surprised that is your commentary about deal closings at the tail end of the quarter. Could you talk more specifically about that in terms of was it close rates, was it win rates, or you still seeing deals get through legal as efficiently they would have been say 6 months ago?

Bob Calderoni

You know, Greg, as you know a lot of our business closes late in the quarter and that was – remained the case here in the most recent quarter in Q4, and we felt very bullish going into the quarter, we remain bullish as the quarter progressed and with two weeks ago in September the market started melting down all around us. This is not something that occurred in October. The markets were melting down all around us in the newspaper everyday, banks were closing, and even worried that that was going to take the opportunity away and we didn’t see any change in that business at all including in the financial services sector, including in the automotive sector, including in the retail sector. And we those deals all progressed and we had better – maybe even better close rates. Our team was busy and it seemed like – you never close everything, almost everything closed that we thought we were going to close in there. So, we didn’t see any impact of anything. On the contrary it actually was stronger and we’re going into this current quarter with a good pipeline again.

Greg Dunham – Deutsche Bank

And you mentioned coverage being better than it has been in the past. Now, when you think about some of the investments that you are making, how much does your $0.70 target in your revenue target really require you to benefit from these investments in network near term?

Bob Calderoni

The investments we are making – the network is growing. So the business we have today is already growing. We expect the network to grow in the 20% to 30% range in 2009. We think there is an opportunity for that to grow even greater in 2010 and 2011 and it is going to require us to open up some new revenue streams. We’re going to make those investments in 2009 and we will see them payback for it in 2010 and 2011 and we’re able to do that Greg because we feel pretty confident in the subscription software growth that we have in our core business today. We’re going to implement some disciplined cost controls as well just to take a little bit of the pressure of the P&L. But we’re coming into 2009 with about 75 – we look at our annualized backlog it represents about 75% of our 2009 forecasted revenue. Last year we came into the year with only about 65% of the full year in backlog. So, we’re actually coming into the year with more visibility than in a year ago. The pipeline is strong, it remains strong, and we haven’t seen any slowdown in the business. And I think really comes down to it. I know this is a little bit of a surprise because we all listen to the same news reports and we all hear the same troubles out there in the market but Ariba is selling cost reduction and we are selling it on an on-demand solution where we can get time to value. We can do it without big upfront investments and customers can see rather short payback periods and I think, you know, spend management coupled with an on-demand delivery model is I think a perfect recipe for the problems many of these companies are facing.

Greg Dunham – Deutsche Bank

Okay, good. One last question if you allow me. Average term tweaked up a little bit here to 27 months. Is that due to product mix, is that more P2P or EIPP or something like that or is it more just bigger deals or different factors?

Bob Calderoni

Well we had more big deals in the quarter. Typically when you have big deals they tend to be longer deals. So having a higher mix of big deals you will see a the average term expand a little bit but, you know, we typically do either a one year or a three year deal and I think customers when they are in a kick the tires mode they tend to look at one year deals and when they are going to something serious they lock into 3 year deals. I think spend management is maturing to the point where more customers see this as, you know, something that is critical and something that they’re not just kicking the tires on, and that is why we’re seeing lot of deals. Now remember, none of that – since we talk about an annualized backlog the lengthening terms doesn’t influence the backlog, that doesn’t change an annualized backlog, just the long-term backlog. So that growth in our annualized backlog is not influenced by term. It just obviously gives us an even bigger backlog going into 2010.

Greg Dunham – Deutsche Bank

Right thank you.

Operator

Our next question is from Peter Goldmacher with Cowen and Company. Please go ahead with your questions.

Peter Goldmacher – Cowen and Company

Hi, guys. Thanks for the opportunity. Can you talk a little bit about when you give us your expectations for next year, one of the nice things about the subscription model is pretty good visibility on to the income statement but I think what everyone really cares about is your assumptions on the bookings growth. You’ve had a phenomenal year, bookings growth, I mean it is just in a great year in 2008 and I would love to know what your assumptions are apples-to-apples organic bookings growth for your guidance for 09?

Bob Calderoni

Yes, our – we have never disclosed bookings. I think you can deduce them from the – you can always get a good approximation of it from looking at the revenue and the input output on backlog to get a sense for it. But we’ve had very strong booking growth in 2008. Organically it has been strong. We have not seen it – we have not seen it deteriorate at all. In fact we’re looking at our net new bookings in the fourth quarter, the growth was significant and we don’t need that level to continue to hit the sort of numbers we are talking about in 2009. So, you know, I am hopeful we can keep the trend going as we have seen in the last several quarters, but we are not dependant upon that either.

Peter Goldmacher – Cowen and Company

Okay, and Bob as a long time Ariba guy, you were around in the good old days. Can you talk a little bit about what was going on in 2001, 2002 and the precipitous decline in IT spending and any way you can compare and contrast that with what you are seeing in the – in sort of your early quarter sales engagements if there is any sort of cold feet or any similarities between back then and today as far as customers’ ability to find the wallets?

Bob Calderoni

You know, Peter, it is really hard to draw the comparison. We’re a much different company today. The fact that we are an on-demand company versus an installed CD customer. We were typically caught in the IT shop seven years ago as all CD software companies are and today we’re not. Today we are either in the finance organization or in the procurement or operations organizations and these are the people that are charted with savings. And so they view this as critical to their meeting their objectives in 2009 or 2010 as opposed to trying to fight over an IT budget. We’re not fighting for IT budgets. So it is hard for me to draw those comparisons. Prior to becoming on-demand company my feeling was if you were a CD application company you were a dead man walking and that was the motivation to not be a CD company. So I’m glad we’re not a CD company and I probably won’t be the best person to make the comparison to 2001.

Peter Goldmacher – Cowen and Company

Okay, thanks guys.

Operator

Our next question is from Robert Breza with RBC Capital Markets. Please go ahead with your question.

Matt Herbick – RBC Capital Markets

Hello, this is an actually Matt Herbick [ph] sitting in for Rob. I apologize I may have missed it but did you give a total backlog at the end of a quarter?

Bob Calderoni

Yes we gave an annualized backlog which was –

Ahmed Rubaie

The total backlog was 236.

Bob Calderoni

It is on slide 3 Matt of the deck that we sent out. You will see it is on the right hand side corner. 236, it was up 24 million versus Q3 and up 82% from Q4 last year.

Matt Herbick – RBC Capital Markets

Great and then one last question, could you quantify the FX impact on revenue and expenses in the quarter?

Bob Calderoni

Yes, Matt it is difficult to quantity on a line item basis in the amount of time we have here. Perhaps when we have the offline conversation we can walk you through it, but let me just explain it to you at a high level. At the moment, as the dollar is strengthening, we are obviously seeing an impact on our revenue but remember the bulk of our revenue is already locked up contractually. So, the benefit we are seeing on the expense line is higher than the payment we are seeing on the revenue line. All of it is balanced then. Again it is the receivable translation because we have a lot of Euro denominated receivables on our books. So, I would have to walk you through a full calculation but the guidance we gave you is at the end of the day it is costing us about a penny in Q1.

Matt Herbick – RBC Capital Markets

Perfect. Thank you.

Bob Calderoni

For all of those items netted.

Operator

The next question is from Sterling Auty [ph] from JP Morgan. Please state your question.

Sterling Auty – JP Morgan

Hi, thanks. Hi, guys. I just want to follow on that FX question. So, are you saying that the $0.02 hit in the quarter in other income, was that on losses for hedges or was that just on translation of receivables and other balance sheet items?

Bob Calderoni

In Q4?

Sterling Auty – JP Morgan

Yes.

Bob Calderoni

In Q4 it was effectively the net of all three items, but the bulk of that amount came out of the receivables translation.

Sterling Auty – JP Morgan

Okay, and then can you compare and contrast what you are seeing out of the larger customers and smaller customers – versus smaller customers in terms of contract duration. So, we saw the bump up, is one group versus the other choosing three year or more so than the other?

Bob Calderoni

Sterling, I haven’t split the data that way to know for sure, but I think my intuition tell me that we probably would see more three-year deals with the larger companies because many of them are established companies that we may have already business with, But with that said we have many sub $5 billion companies where we are doing 3 year deals as well, but they may not be as big a differences as you think. I would have to go back and check though. We are seeing long deals on both sides but I was guessing it would be the larger companies probably a little more mix.

Sterling Auty – JP Morgan

Okay, and at this point when you are out in front of customers on this idea of a short time to value what are you actually describing to them as the payback or the return on investment period, you know, for implementing the on-demand model?

Bob Calderoni

If we are talking to them about – if we are talking to them about sourcing and contract management that is something they are deploying within weeks and if they couple that with some of our sourcing services we could identify savings for them within 60 days and they could start realizing them in the first 6 months. And I can’t imagine any sourcing initiative that we would start with a customer where in the first 6 months we would not at least recover whatever their investment is. We will probably do it in less time than that. So, we are talking about very short payback periods. On procurement to pay, there is a little bit more of a deployment time. That is from a system point of view, but by the time you drive all your business processes into that you may not be up and running on that for 4 or 5 months, but still you could generate a payback all within the first year. We are not looking at paybacks that go outside the first year on any solution.

Sterling Auty – JP Morgan

Okay and last question is what is the majority of your collection policies, in other words are you collecting mainly quarterly, monthly, or annually with your customers and for the customers and financial services in the automotive are you actually doing something different because of the tough environment for those two industries?

Bob Calderoni

Well I could take that or Ahmed could – I will take it because I have been more involved in some of the customers than Ahmed has in the first couple of months here. Know what – we typically whether it is a one-year deal or a three-year deal, we typically have payments at the beginning of the year. So if it is a three-year deal, 3 annual payments, or one-year deal, one and we typically collect that money in 30 to 45 days. We haven’t been making any concessions of any – obviously there is negotiations in every deal but we haven’t seen any change in those contractual terms and our DSOs, I believe, are about 30 days this past quarter. So, we haven’t seen any payment issues, any change on that front at all.

Ahmed Rubaie

In fact our DSOs improved by one day from the prior quarter.

Sterling Auty – JP Morgan

Right, thank you guys.

Bob Calderoni

Thank you.

Operator

The next question is from Ronald [ph] with Oppenheimer. Please go ahead with your question.

Reno – Oppenheimer

Hi, guys this is Reno [ph] for Brad. Two quick questions. One could you circle back on the investments around the network, and then two could you talk about how the renewal rates were in the quarter?

Bob Calderoni

I will do the second one first, and then I will – because the investment question might take a little longer. Renewals were strong in the quarter. Renewal rates in various parts of our business, whether it be (inaudible) remain in the mid high 90s in the supplier part of our business, for the network part of our business remain in the 90s and on the subscription software part of our business actually ticked up this quarter. That is a result of some operational changes that we have made in the business over the last 6 months. So, key area of opportunity for us we have good renewal rates but like everything there is room to improve and the renewal rates have been improving and in the fourth quarter they did improve. So, we feel good there.

On the network investments. Our network business as we reported today doubled, total network revenues versus last year. We believe in 2009, we have said something around 30% organic growth in that business. We believe that network has an even greater opportunity for us in 2010 and beyond partly by investing in some of the things we currently do in a network and partly by investing in new aspects of the network to open up to new revenue streams. So, let me split. We are diligently working to increase our network business by getting more customers to use our network. We do that by selling e-invoicing solutions and P2P solutions and that is part of our subscription business and that is growing nicely.

But the other way you grow business, on the network from the existing customer relationships is by getting them to invest – not invest, by getting them to put more spend on a network with more suppliers. We trial the program where we sent some 3 resources into a few named accounts and we worked with them sort of like engagement managers, or think of it as farmers in a farmer type of environment. And we worked with them to drive more categories of spend and more suppliers on to the network and we were getting some very significant results that it takes time before it starts showing up in S&P, but it proved to us that an investment like this would be a fantastic return. So, we are going to invest in that in 2009.

By the end of the year they will have loaded a whole bunch of suppliers on the network and that will kick our growth rate on S&P and network revenues in 2010 up. The other thing we are doing is something I have talked about before called Ariba Discovery. Ariba Discovery opens up a new line of new streams of revenues for us. We have a beta site out there today. We are register – suppliers can register and demonstrate their capabilities. It is a place where buyers could go search for those suppliers and rate those suppliers. It is a beta site.

We need to complete the work on that site and we also need to build an investment in some more marketing and business development related, because suppliers won’t go there unless buyers are searching and doing business and buyers won’t go there until there are suppliers. So, there is a little bit of a chicken and egg aspect to it, just like there is – that was the case when eBay started. People didn’t go to eBay at first when it started and you know it started growing exponentially. So, we are going to make that investment to finish the site and also to build the marketing that we need in order to bring both suppliers and buyers onto that site and we believe by the end of 2009, we will be in a position where a number of suppliers will be registering and paying us a fee to be on that site and the primary reason why suppliers will pay us a fee is because that is a place where buyers will find suppliers and suppliers will find new business. And there is plenty of Internet-based business models that are pretty lucrative.

We think we are great position today because we have 100s of customers using our applications on our network buying 100s of billions of dollars of things from suppliers and we think that is great platform to leverage this new business from. So, you guys who have followed us for a long time have known we are dropping sellers here. We have been accused of being a bunch of accountants running the business. So, we are not just blindly throwing money at this. We think we have got really good growth and really good markings in our business.

We think with $0.70 earnings next year versus $0.44 this year, we are going to deliver good growth in earnings, good growth in cash flow, good growth in cash flows, and at the same time we are ploughing back some of it, some of our earnings and cash into this new business and we still met the $0.70. So, we think it is a good balanced investment. Obviously, that gives us some (inaudible) as well as we go through the year and navigate whatever changes maybe in store in the markets as well. And it will be a net positive to EPS in 2010, that investment.

Reno – Oppenheimer

Okay, great thanks.

Operator

The next question is from Nathan Schneiderman with Roth Capital Partners. Please go ahead with your question.

Nathan Schneiderman – Roth Capital Partners

Hi, thanks very much. Hi, Bob. Hi, Ahmed.

Bob Calderoni

Hi.

Nathan Schneiderman – Roth Capital Partners

A few questions for you. I am just a little curious, maybe I missed it or maybe you can up maybe articulate it a little more directly. So, we are seeing extraordinary conditions in the global market but I am clear other than some of the adjustments due to FX, how the weakening macro conditions have affected your guidance, have they really affected it at all or if so in what areas and to what extent?

Bob Calderoni

Yes Nath, the only we really tweak the guidance for was revenue for the impact of currency translation. We just took the reported revenues, the underlying growth in the business we believe is strong. It is just going to result in a little less revenue because of foreign exchange translation. I think the numbers Ahmed went through were about –

Ahmed Rubaie

$10 million.

Bob Calderoni

$10 million less.

Ahmed Rubaie

So, the fundamentals are all the same. We took some revenue.

Nathan Schneiderman – Roth Capital Partners

Okay that is all right. Bob, I just wanted to make clear that the only real adjustment is FX, you didn’t feel the need to slow down your expectations due to macro relative to your past guidance in July?

Bob Calderoni

On July we hit $0.70 and today we are saying $0.70.

Nathan Schneiderman – Roth Capital Partners

Right, understood on EPS. Okay, I know from your comments you had good results in financials, in sectors like financial services, auto, et cetera, but what gives you confidence that some challenging in retail. And what gives you confidence some of these end markets that are under considerable challenge will not deteriorate particularly once we get through year-end budget slash or budget lift issues, why wouldn’t they. Why don’t you feel there is a significant risk if they deteriorate next year?

Bob Calderoni

You know, it is always hard to predict the future on that. So, we typically would look at you know, current trends in the business. We think that you know the business we closed towards the end of September was already in a very difficult environment. Many of the companies that we were talking to were already experiencing that. So, I think many of those sectors, I don’t think the banking sector, just started having trouble last week. They have been in – financial service has been under pressure for many months and yet we we’ve – you know, we’ve typically done about 15% of our bookings every quarter in the financial services sector and it hasn’t changed at all over the past 2 or 3 quarters. There has been no trend.

We look at the pipeline. The pipeline continues to look strong. Obviously, you can’t predict these things with a 100% certainty, but all the things we look at and the momentum we have seen in our business and the fact that we offer companies cost savings with quick payback will give us a reasonable amount of confidence. We have always said that we could operate in a down market. Obviously, this limits to how down a market could go. I think these companies are going to need to invest in cost reduction and since we can deliver that to them within month, we think we can continue to navigate through a challenging market. And the other thing Nath, I just keep pointing out is, we have got more visibility today heading into fiscal year ’09 than we had at this point last year given the strength of the backlog with those.

Nathan Schneiderman – Roth Capital Partners

Got it. What are the things you did to in your numbers as you are somewhat backend loaded in the year in terms of EPS, I was just curious if you are on track with your plan, what would you estimate operating, pro forma operating margin would be in Q1 and where you approximately end it in Q4 in order to hit your numbers?

Bob Calderoni

Let me take that one.

Ahmed Rubaie

You take that one.

Bob Calderoni

So, the plan Nath is pretty much is a very similar story to fiscal year 2008 when you say the ramp up from Q1 to Q2 to Q3 to Q4. So, it is basically around the same level of upward mobility, if you will. Looking specifically at operating margin for Q1, the pro forma is about 14%, and we expect to be at 16% for the full year.

Nathan Schneiderman – Roth Capital Partners

Okay, and then I am just curious Bob, during the last downturn, the sourcing business got hit pretty dramatically. So, we saw that in the all three markets business that you bought. It is still a meaningful part of your services and other revenue, and your guidance shows a sequential decline there. I am just curious what (inaudible) – expecting in that business and into what account – to what extent are you accounting for the potential for just reduced buying by your end-customers which could translate into lower revenue for you?

Bob Calderoni

I think in a tightened market environment if I were to say which part of our business might see a slowdown more so than the other, I would say it would be in some of the services agreements. Say, it might be tied to an upgrader that might be tied to some system project. So, we could see some variability in services going forward. The good news is that is a business that does not come with high margins, as you know. So it is going to have a muted effect on our business, and we also could reasonably quickly correct for that since that was – it was obviously work load staffing issue. So, I think we could handle some volatility in that business and right now, everything we see in our business is looking good. And we just ended the last quarter on a high note. And so we are looking forward to 2009 with – I would say we are cautiously optimistic. I don’t want to sound like we are not reading the newspapers, but we just feel that we have got enough things going for us right now to feel that we could continue to target where we are at and you know, continue to monitor the business, but it feels okay right now.

Nathan Schneiderman – Roth Capital Partners

Got it. And very last question. Just on the hiring plans. Where did you end in quota-carrying reps, where do you expect to be at the end of ’09 and there was a sequential drop in sales and marketing, what that churn or something else. Just if you could speak to the headcount area. Thanks very much.

Bob Calderoni

We ended the year with 119 quota-carrying reps that was down one from the end of the third quarter. We are probably going to stay plus or minus at that level here for the foreseeable future. We made some investments throughout 2008. So, we weren’t at a fully productive level with those 119 or 120 people. So, we expect that we are making some investments to drive productivity and we think we can navigate well into the year and hold the line at about 120 and then reevaluate at mid-year to see if we go higher at the backend of the year. Any other –

Operator

The next question is from Brad Whitt with American Technology Research. Please go ahead with your question.

Brad Whitt – American Technology Research

Hi, guys. Thanks for taking my questions. I am curious Ahmed, how much impact did foreign exchange have on your deferred revenue and your backlog?

Ahmed Rubaie

We actually don’t have that calculation. If you look at our backlog. Most of it has been locked up as to what is going on in the current year, we haven’t scheduled it out. We can take it offline and deliver that to you, Brad. Sorry.

Brad Whitt – American Technology Research

Okay, and also could you just go through the restructuring charges again, I think you said some kind of a construction with engineering group?

Bob Calderoni

Yes, we had. Our restructuring, I think that was discussed in the last earnings call. The point I was making is what remained in Q4 was about $1.2, and we abandoned one floor here in Sunnyvale and the restructuring charge for that was about $5 million.

Ahmed Rubaie

Yes, Brad, operationally what we did was we have talked about it back in the spring, late spring. We were going to – in a nutshell, we had about two-thirds of our R&D investment in North America, one-third outside of North America and today those numbers are switched. We are about one-third North America, two-thirds outside of North America. So, the restructuring charges was the severance and separation costs associated with some of the downsizing in North America and the lease was the abandonment of the space that those people used here in North America.

Brad Whitt – American Technology Research

Got you. Bob any updates on Procuri. How that is progressing and what you are seeing from that customer base regarding opportunities?

Bob Calderoni

Yes, that is progressing – that is progressing very well. Cross-sell opportunities have developed. We have got a number of Procuri customers that have come back and purchased either some of our services or some of our other modules in software. There is lot of examples of that. Plenty of examples of Procuri customers that migrated early from the Procuri platform to the Ariba platform earlier than what they would have had to. So that has been a good sign. So, overall I would say 9 months after the fact, I would say the Procuri acquisition has turned out to be as good or better than we anticipated when we did the deal and we are very happy with it. We would love to do another one just like it.

Brad Whitt – American Technology Research

Good, one final question. Bob I am sure you kind of scrubbed your financial services customer base. Are there any customers that you feel are at jeopardy or with all the mergers and acquisitions that are going on and are there any that you foresee expanding opportunities with you do to some of the activity out there?

Bob Calderoni

You think of some of the big named banks that are no longer around or no longer independent. We didn’t have any business with Lehman Brothers. So that wasn’t anything. We did have business with Merrill Lynch. There were a long time CD customer. So, we only have some maintenance revenue with them. But our agreement with Bank of America, the parent company that bought Merrill Lynch has provisions for when they do an acquisition that would have to pay for additional employees et cetera. So we don’t think there is any risk on that revenue stream there. And it is only a couple of weeks ago when the banks fell. AIG is a customer as well. They were one of the big institutions in the news.

There were also a CD maintenance customer of ours. They are obviously still there. It is not a very big revenue stream for us today, but many people believe if something happened to AIG, it would be a sale of the many of the standalone entities. Our solutions are deployed in all those entities and, you know, the license and the TSS would remain as it breaks up. If not, actually there could be some upside in revenue upon breakage, if that does get broken up. So far, I don’t have any crystal ball as to see, hopefully – these Monday mornings waking up and hearing that another bank has gone is not a pleasant way to start the week. Hopefully, we don’t have any more of those, but so far, I think so far so good. We don’t see any major risk there at all from the carnage of September.

Brad Whitt – American Technology Research

Okay, good. Thanks for taking my questions.

Bob Calderoni

Thank you.

Operator

The next question is from Robert Becker with Argus Research. Please state your question.

Robert Becker – Argus Research

Yes, thank you. Congratulations on a very good quarter.

Bob Calderoni

Thanks Robert.

Robert Becker – Argus Research

I was wondering if you could provide guidance on capital expenditures for 2009 and I was wondering if you could explain how we should think about CapEx long-term. In other words, do you need to build new data centers in order to support operations?

Bob Calderoni

I can take that Ahmed because there is an operational aspect to that. Historically, we have not had a lot of capital in this business. I think we have averaged $7 million, $8 million kind of on an annual basis in that range. I don’t see that number changing materially at all and I think it is – we are selling our solutions on – it is a true on-demand multi-tenant model that we have today. It is not capital intensive. I attribute our capital efficiency to our engineering team and specifically to our Chief Technology Officer, who I think within the engineering community is a bit of a – he is anti-capital. He is rare for an engineer, but he really drove the architecture of our solution years ago to be one that was going to have a lot of leverage and we don’t see that. This is a not a capital intensive business and it is not going to change by material sums.

Robert Becker – Argus Research

Okay, and I was wondering maybe I can go out on this one. I was wondering if you could opine on market penetration, in terms of on-demand spend management. Would you believe that say we are below 30% market penetration in all major geographies?

Bob Calderoni

I don’t think there any good credible market analysis has been done on this to answer it with quantifiable data, but I believe we have only been at this now for 2 years in the market. I don’t believe we have deep penetration yet. It is evidenced by the fact that we are increasing the number of net new customers that we are generating every quarter, and it is also evident by the fact that with existing customers, 70% of our new business every quarter is going with existing customers. So, we don’t even have penetration with the customers that we have landed. There is 8, 9, 10 different modules that we could sell and there are very few customers of ours that have bought all of it, and there is lot of customers that haven’t bought any of it yet. So, I think we are approaching any sort of a ceiling for the more than a mid-term foreseeable future.

Robert Becker – Argus Research

That is great. Well, thank you very much.

Bob Calderoni

Thank you.

Ahmed Rubaie

Thank you.

Operator

We have reached the time limit for the call. I would like to turn the call back over to Bob Calderoni for closing remarks.

Bob Calderoni

Yes, thanks for joining us this afternoon. I just wanted to close the comment by reiterating the fact that we are aware that the markets are turbulent out there but all indications in our business have been that we have a solution that is part of the solution to the customers’ problems and we think that is going to carry us through these turbulent times and we have got a good solid business and business model behind us. So, we remain confident and we will keep monitoring the business and I look forward to being back with you in 90 days. Take care.

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Source: Ariba Inc. F4Q08 (Qtr End 09/30/08) Earnings Call Transcript
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