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Ariba, Inc. (NASDAQ:ARBA)

F4Q09 Earnings Call

October 28, 2009 8:00 am ET

Executives

John Duncan – Director of Investor Relations

Robert M. Calderoni – Chairman of the Board & Chief Executive Officer

Ahmed Rubaie – Chief Financial Officer & Executive Vice President

Analysts

Robert Breza – RBC Capital Markets

Greg Dunham – Deutsche Bank Securities

Peter Goldmacher – Cowen & Company

Richard Williams – Cross Research

Bradley Whitt – Broadpoint AmTech

Nathan Schneiderman – Roth Capital Partners, LLC.

Jeff Van-Rhee – Craig-Hallum Capital

Curtis Shauger – Caris & Company

Brad Reback – Oppenheimer & Co.

Patrick Walravens – JMP Securities

Operator

Welcome to the Ariba fourth quarter and fiscal year 2009 earnings conference call. At this time all participants are in a listen only mode. A question and answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host John Duncan, Director of Investor Relations.

John Duncan

Welcome everyone to Ariba’s conference call to discuss the results for the fourth quarter and fiscal year 2009. In today’s call we will make references 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 presentation, please now advance to Slide Two. Before we begin I will read the Safe Harbor statements. Statements that may be made in this call and the supplemental slides that are not historical facts, may be forward-looking statements including statements regarding the company’s or managements’ 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 10Q filed on August 7, 2009 for the quarter ended June 30, 2009.

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 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 8K filed this morning.

In addition, we will reference certain forward-looking non-GAAP financial information including fiscal 2010 revenues, expenses and net income. We are unable to reconcile this forward-looking non-GAAP financial measure 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

I am pleased to report that Ariba posted a strong finish to the financial year with Q4 revenues, non-GAAP EPS and cash flow all exceeding our expectations. To recap the fiscal year, we have proactively managed our business with agility and focused execution. In the midst of the worst recession in recent history our sub software revenue grew to $151.6 million, above our guidance and 29% growth year-over-year. The continued shift in our model to higher margin recurring revenue business along with prudent cost containment allowed us to significantly improve the profitability profile of Ariba.

Non-GAAP EPS for the year came in at $0.71, above the high end of our guidance range and up 61% year-over-year. We also increased operating margins by 700 points year-over-year. Also ahead of our expectations, we generated record annual cash flow from operations, excluding lease loss and restructuring of $89 million. This translates to a 26% annual operating cash flow margin.

Let me now walk you through the highlights from the fourth quarter. Please refer to Slide Three. We increased our annualized backlog by 13% or $15 million year-over-year to $132 million despite a continued challenging market. Please go to Slide Four. We posted a 23 year-over-year increase in our non-GAAP subscription software revenue in the quarter. Non-GAAP revenue of $84.3 million and non-GAAP of $0.18, both came in ahead of our guidance range.

We had another strong cash flow quarter generating cash flow from operations excluding lease loss and restructuring of $24 million. We ended the quarter with $195 million of cash and investments representing approximately $2.20 per share. From a customer perspective, we closed 250 unique customer deals, added 40 new named accounts and signed a record 231 on demand transactions. We closed six sub software deals over $1 million, an improvement compared to four in the prior quarter although still below last year’s average of nine to 10 per quarter.

Now, let me turn to more specific financial results for the September quarter. Total revenue was $84.3 million for the fourth quarter of 2009 and as I mentioned earlier, came in ahead of our guidance range. Subscription and maintenance revenue was $67.9 million, sub software revenue came in at $41.1 million ahead of our guidance of $39 million and up 23% year-over-year. During Q4 we recognized some catch up revenue of approximately $1.5 million which drove some of the upside relative to our expectations.

Services and other revenue came in at $26.5 million at the lower end of our guidance range. As was the case for the past few quarters, we continued to see downward pressure on our services revenue. Looking at expenses, total expenses on a GAAP basis including cost of revenue were $78.7 million.

Included in these GAAP results were a $1.5 million charge for amortization of purchased technology and intangible assets and $8.7 million charge for stock-based compensation. Excluding these items, non-GAAP expenses were $68.5 million for the quarter. As a result, GAAP net income for the second quarter was $5.6 million or $0.06 per diluted share. On a non-GAAP basis we had a positive net income of $15.8 million or $0.18 per diluted share, beating the top end of our guidance range of $0.15 to $0.17.

Moving to the balance sheet, as I mentioned earlier, our balance sheet continues to strengthen. We had another terrific quarter in building up our cash position. DSO continued sequential improvement to 23 days down two days from the previous quarter. Of course, the underlying contribution to cash continues to come from sequential growth in our sub software revenues, solid expense management and strong collections activity. In the end cash, cash equivalent and investments at the end of Q4 were $195 million which was up $18 million from $177 million at the end of Q3.

Now, let’s turn to Ariba’s outlook for Q1 and fiscal year 2010. As we have done in the past, our guidance is based on our current forecast i.e. what we see and know today. Like many others, we are starting to see minor indications of some economic recovery but not enough to start incorporating new assumptions in our models. We have established our ability for agile execution and delivery of solid results in the midst of the worst recession in recent times.

In fiscal year ’09 and as we discussed a few minutes ago, we grew sub software backlog and revenue, managed the rest of the business, contained costs and conserved cash. This gives us the confidence that even without measurable economic recovery, we should be able to build on the results we have delivered in recent quarters. The balance sheet is strong and should continue strengthen. The P&L is also very healthy as we continue to shift to a highly profitable recurring revenue coupled with our proven ability to manage the bottom line.

All of this gives us the confidence to prudently resume gradual investments in the network and other areas of our business. As we discussed back with you on analyst day in the spring, we are also focused on strategic acquisitions in the next 12 months. With all of that as background let me now outline our modeling assumptions as we enter fiscal year 2010.

We expect total revenue in 2010 to be approximately $350 million plus or minus $5 million. We expect to see continued year-over-year growth in our sub software business and are forecasting full year sub software revenue of $168 million to $172 million. Note that today’s backlog represents approximately 77.5% of our sub software guidance so we have excellent visibility going in to the year.

We expect maintenance revenue to be roughly $66 million. Predicting services continues to be challenging and much like we saw in fiscal year ’09, this line item is expected to be the wildcard in our model. Based on our current outlook services and other revenue is expected to be approximately $114 million plus or minus $5 million. We will continue to focus on operating margins and anticipate non-GAAP EPS to be approximately $0.72 to $0.76 which includes approximately $0.08 of selected imprudent investments to ensure that we are capitalizing on the significant market opportunities in front of us.

This basically says that without incorporating any macroeconomic rays of hope, in fiscal 2010 we expect to once again post strong financial and operational results while simultaneously putting money back in the business. Please refer to Slides Eight and Nine. Turning to the first quarter we expect the following: total revenue in the range of $85 million plus or minus $1 million; subscription and maintenance revenue of approximately $57 million to $58 million including roughly $40.5 million for subscription software and $17 million for maintenance; and services and other revenue of $27.5 million plus or minus $1 million.

With respect to the rest of the P&L, we expect total non-GAAP operating costs and expenses to be about $69.5 million. Contained within this range are cost of revenue of approximately $30 million, R&D of roughly $9.5 million, sales and marketing of approximately $22 million, G&A roughly $7.5 million and a net charge of approximately $500,000 encompassing interest, taxes and foreign exchange impact.

On a non-GAAP basis we expect positive net income of roughly $15.5 million or approximately $0.17 to $0.19 based on 88 million diluted shares outstanding. In addition, we expect to record expenses of $12.5 million to $13.5 million for stock-based compensation and amortization of intangible assets. Turning to Slide Nine and our cash flow projections, our subscription model should continue driving strong cash flow. At this stage we expect to generate $70 million to $80 million excluding lease loss and restructuring.

To recap, we had a strong finish to fiscal 2009 and believe we have a solid financial foundation as we head in to 2010. We believe we have the right products, the right business model and the right people to continue growing our business by helping our customers strategically manage their spend. With that, let me turn the call over to Bob.

Robert M. Calderoni

As you just heard, despite what some are calling the worst business and economic environment in decades, Ariba posted solid performance both in the fourth quarter as well as for the year overall. We hit on all cylinders with strong revenue, earnings per share and cash flow at or above the top end of guidance for Q4 and for the year and we also saw a tick up in bookings in Q4 driving a resumption of sequential growth in our subscription software backlog.

I attribute a portion of our success to the disciplined management of the business and like many companies we had to make some tough decisions this year on the cost line, tightening our belt and delaying some investments yet management in the entire company remained focused on executing for both shareholders and customers. Our success in Q4 and the year reaffirmed the growing recognition that spend management is an essential competency for effectively controlling costs and managing cash.

In the past 18 months having competencies in these two areas has clearly made the difference between success and survival for many businesses and many companies and while the economy appears to be showing some early signs of recovery, companies remain cautious yet continue to invest in spend management solutions as you can see from this quarter’s results. Increasingly, even the largest enterprises are viewing SAS as the fastest, most cost-effective and risk free way to achieve such results whether you want to manage your spend or manage your customer relationships.

This shift was evident in a number of Q4 wins including a full on-demand spend management suite win at The Hartford and at AGCO and an on-demand procurement win at [inaudible], all takeaways from incumbent on premises solutions from ORACLE, SAP and Lawson all of which were costly to maintain and could not deliver the spend and savings enablement that these companies required.

Q4 continued our high volume high velocity performance where objective is to win the customer, prove our value and expand our footprint to assist in other spend and cash management areas. We added 40 new customers in Q4 continuing the recent trend of sequential growth and new customer acquisition and all told 145 new customers joined Ariba in fiscal year ’09 which is up 26% from 2008 which previously had been our highest new named customer year on record.

These new customers provide ample opportunity for future business expansions. A good example this quarter is Lifetouch. Lifetouch was a new win for our on-demand upstream solutions back in Q3. This leading photography company added both our procure to pay solution and sourcing services this quarter all within just three months of first becoming a customer. We experienced similar volume and velocity in our customer base. We had 231 on-demand transactions in the quarter. That represents a 25% increase year-over-year, all in the face of course of the difficult economic environment.

Our customers continue to expand their spend management vision and footprint with us. For example, in Europe Roche not only expanded use of its existing solutions with us but they expanded it to its newly acquired Genentech affiliate but at the same time they added new solutions in the area of sourcing and contract management companywide.

Speaking of those solutions, we broke records this year for transactions for our sourcing, contract management as well as our procure to pay products and we were at all time highs for our other solutions, all key indicators that more companies are placing a higher emphasis on spend management. Our strong renewal performance is yet another indicator that customers are recognizing the value of spend management and of Ariba. This quarter our subscription software renewal rate touched 90% continuing a trend of steady sequential improvement.

Network renewals also remained constant in the mid 90s and I believe such strong renewals are the commitment our customers are seeing in the Ariba product offering. Our network business is also showing growth with a 23% increase in network revenues for the year, right in line with our projections. This quarter we saw strong increases in the buyer side of our network adding 25 new buyers in the network from P2P, service procurement and invoice customers all of which we expect to add suppliers and transaction volumes to the network in coming quarters.

All-in-all I’m very pleased with Ariba’s strong execution not only in the fourth quarter but for the entire year particularly when you consider the tough business climate. Ariba showed impressive gains across the board in new customers, subscription software revenues, backlog, margins, earnings per share and of course cash flow. 2009 was a great year for Ariba and we expect solid results again in 2010. We’re confident enough to resume our investments and continue to deliver strong earnings even if the economy does not continue to recover.

With that, let me open the call to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Robert Breza – RBC Capital Markets.

Robert Breza – RBC Capital Markets

I’m just wondering, as you look at the cash flow outlook and the guidance, can you help us understand what you’re assuming relative to maybe some investments as it relates to the balance sheet? Specifically, you guys have made great progress with DSOs which helps a little bit but I would assume you have to make some assumptions around DSOs increasing and the impact there to cash flow? Then, maybe just as we’re talking about cash flow if you can talk a little bit about your assumptions? Deferred revenue was down a little bit this quarter relative to my expectations and maybe just comment the difference between that and what you’re seeing in your backlog?

Ahmed Rubaie

In terms of our cash flow assumptions for the current fiscal year, you’re absolutely right, the level of DSO improvements that we saw in the last couple of quarters is not sustainable or repeatable. So, when you look at reconciling last year deliver to the projection this year, and be mindful that this is the projection as we enter the year so we’ll continue to narrow that bandwidth as we go quarter-to-quarter but, as you reconcile from where we ended last year to what we’re projecting for the fiscal year 2010, recall there is an element of about $8 million of insurance proceeds that we had in the first quarter of last year.

In terms of the DSO improvement, again not all of that is sustainable. So, reconciling that you back out about $8 or $9 million from the $89, you get to $80, a little bit in terms of what is repeatable on DSO and you get to that range of $70 to $80 million. In terms of the deferred revenue piece and the backlog, at the end of the day, that’s really truly a arithmetic calculation in terms of what goes in to our final cash flow assumption. So, there’s really nothing noteworthy to discuss on that front Rob.

Operator

Your next question comes from Greg Dunham – Deutsche Bank Securities.

Greg Dunham – Deutsche Bank Securities

Looking at the on-demand metric and the maintenance business together, clearly when you look at that maintenance stream it’s been $70 million plus for the last five years so the growth in subscription revenue hasn’t come at the expense of maintenance customers switching over. However, when you look at the adoption of software as a service solutions in larger enterprises that seems to be picking up. Are you seeing legacy customers switch from old versions to SAS? And if so, are there things that you’re trying to do to encourage that? How difficult is that transition and what should investors expect going forward?

Robert M. Calderoni

Historically we have not seen any shift. You can see that by just looking at the maintenance revenue, it’s been holding relatively stable with a renewal rate in the mid 90s there. With the exception of one or two customers that migrated it largely has not happened. Now, we’re starting to see some customers talking about it and asking about it which I think would be a good thing for us and for the customer when that happens but it hasn’t happened to date and we’re really not factoring that in to any forecast for next year. So, if we do start to see migrations we would see maintenance revenue come down a little more but we would see a greater offset in subscription revenues growing even faster.

It would be a net positive contribution because in the couple of rare cases that we have actually done a conversion, every one of those conversions have been where the subscription revenue level is higher than the maintenance they were paying us for and the sample size is albeit small. But, in every case that was the answer and I expect that always to be the answer going forward. The customer gives us more revenue but see’s their total cost of ownership go down so it’s a win-win for both organizations.

Operator

Your next question comes from Peter Goldmacher – Cowen & Company.

Peter Goldmacher – Cowen & Company

I want to ask you two quick questions, can you talk a little bit more detail about what that catch up was in Q4? And also, we’ve seen your guidance on the ASN go from 30% to 20% to 25% now down to 15% annual growth. I’d like to know why we’ve seen such a dramatic down tick in guidance especially if we assume that ’09 was sort of the low point for the economy and if things just normalize or just flatten out in ’10 why we shouldn’t see better than 15% growth especially with the new products you’ve got coming out and potential price hikes?

Robert M. Calderoni

Let me take the second question and then I’ll let Ahmed follow with the question on the catch up revenue in the quarter. We had forecasted a 20% to 25% revenue growth on the network this year and we came in at 23%, in that range. We’re guiding next year to be down a little bit to 15% and I see that as an aberration. The way that we bill for the network is when the renewal period is up we look at the trailing 12 months volume and then we bill based on the 12 months trailing volume.

So, in a lot of ways the data that we are seeing where there has been a decrease in spending due to the economic drop, that’s occurred during 2009 but doesn’t get reflected in our billing until the billing cycle that we’ll start doing here in November so it’s somewhat of a lagging effect on us. That’s going to take us from what should be mid 20s again next year to only 15%. So, we’re paying in 2010 for the 2009 recession if you will.

I think long term we still see, once we get through that blip, we see the number bouncing back at least to those historical mid 20s level. We’re encouraged by the fact that this quarter and this year we had a record number of new buyers get on the network. This quarter alone we had 24 or 25 deals for either P2P product invoice or supplier connectivity, all of them will begin driving suppliers. We won’t get revenue until 2011 for it but that’s a very encouraging sign that the install base is growing nicely.

Once we get the lagging effect of this recession behind us we bounce back to mid 20s and I think there’s some opportunity – we’re not increasing prices for the current year, 2010 but there’s I’d say a good probability of there being a pricing benefit in the following year. I’m confident the 15% is a one year blip and we get back to the 25% plus levels in 2011 and better beyond that.

Ahmed Rubaie

Peter, in terms of the catch up revenue in the quarter, that was related to a few customer expansions where usage of our product was actually expanded. It’s actually a positive but it’s a onetime thing and we had that a couple of quarters ago as well.

Robert M. Calderoni

It’s retroactive when somebody goes above their capacity limits typically that’s not reported timely and every now and again we pick up a couple of customer and we have to do a retroactive billing.

Peter Goldmacher – Cowen & Company

Let me ask you one more question, you mentioned some nice wins from ORACLE, SAP and Lawson. I heard some chatter from some of the Accenture guys that you had a couple of replacements for your T&E product against Concur. Am I just hearing one off stories or is that a business you guys are going after now? Are you spending more time trying to sell the T&E products?

Robert M. Calderoni

We have a T&E offering but that’s not an area of focus for us it’s mostly within the install base where a customer already has our procurement solutions and that’s just a feature they turn on. That’s not something that we’re ramping up or gearing at. But, on the point of key wins against ORACLE and SAP and really, this is the increasing trend towards on-demand and the attractiveness of on demand. I go back to three years ago when we started this, many of us thought the whole reason to do it was to get down in to the mid market and large enterprises were not going to see the benefits or attractiveness of on-demand.

It’s actually been a pleasant surprise for everybody in this industry. Large enterprises are increasingly embracing cloud computer and SAS. There are companies that are actually pulling out something that they already own and already installed and then coming to us for an on-demand solution because it’s cheaper to switch to us than it is to upgrade what they have or finish rolling out what they started to roll out with an ERP. That is gaining momentum.

Operator

Your next question comes from Richard Williams – Cross Research.

Richard Williams – Cross Research

Just to delve a little deeper in to the network, if I’m understanding it you’re saying that you bill at the end of 12 months that occurs in the first calendar quarter for the prior year? So in other words, if ’09 had been a really good year then you’d have a big pick up in network growth in 2010, is that correct?

Robert M. Calderoni

Yes. What we do is we look at all the transaction volume between buyers and suppliers and a large percentage of our contracts with suppliers renew in the November, December, January time frame. They renew all year but more than a relative portion renew that time of the year. So, for the most part we’re going to be getting renewals here in November where we now look back at what was the trading volumes between those suppliers and their buyers for the prior 12 months. Basically, the recessionary period we just went through and then that’s what we set the billing at.

In a lot of cases we’re seeing the amount of spend between buyers and suppliers being reduced in 2009 versus 2008 as you would expect as everybody has cut cost and reduced spending in 2009. That’s going to impact supplier revenues by about 10%, somewhere in the 8% to 10% range is what the expected impact of that is.

Richard Williams – Cross Research

Help me with the offsets to it because I gather that you’ve got growth in other areas?

Robert M. Calderoni

Ordinarily we’ve modeled growth in the mid 20s is what we would say our long term trend would be and because the volumes are going to be down, that’s going to take that growth rate from 25% to 15% so it’s still growing at 15%. What’s causing that growth is we have more buyers transacting with more suppliers on the network and that’s from the expansion of how many customers are using the network, how many customers are doing business with more suppliers. So, there’s good underlying growth in some of those other metrics, it’s just the spend volumes are going to depress our growth for one year by about 10 points.

Ahmed Rubaie

In fact Richard, when we look at the chargeable relationships, the barometer, the foundation, we continue to see sequential growth every quarter including this past one. That’s truly the offset until the macroeconomic numbers come back up that’s a positive trend as we build our foundation.

Operator

Your next question comes from Bradley Whitt – Broadpoint AmTech.

Bradley Whitt – Broadpoint AmTech

One question I have concerning the $6 million software deals, I’m just curious how much of those were renewals with existing customers versus new deals?

Robert M. Calderoni

Brad, those are all new deals. When we talk about million dollar deals, we don’t count renewals in the software number.

Bradley Whitt – Broadpoint AmTech

Just so I’m clear again, on the catch up was that all maintenance or was part of that subscription and maintenance?

Ahmed Rubaie

Predominately subscription.

Operator

Your next question comes from Nathan Schneiderman – Roth Capital Partners, LLC.

Nathan Schneiderman – Roth Capital Partners, LLC.

My first question for you, I was curious on your guidance for services and other revenue that it would be at the $114 million level which looks like a nice acceleration from your current run rate so I just want to be clear on why you think that’s a likely scenario?

Robert M. Calderoni

On one hand our guidance for next year for the most part reflects more of the same in terms of an economic assumption and we’re not forecasting any uptick in the economy. Services revenue has lagged this year as you would expect as the economy went down. This quarter, I think we hit the low point of 26.5, we’re sort of forecasting Q1 for modest improvement, up $1 million at the high end of the range, possibly up as much as $2 million.

So, I’m not ready to declare back to the good old days yet but I do think we’ve hit bottom and we should start to see some sequential improvements from here and that’s what’s reflected in the guidance, a very modest sequential improvement from the run rate. We see it in Q1 and underlying that we’ve seen some really good strength in the services implementation business. We’re now up to about 50 upgrades, customers that have committed to upgrade. These are our legacy CD customers that are doing upgrades so there’s a good pipeline and backlog of that work.

That leads us to think we’re going to see some sequential uptick. Our sourcing services business, a little bit better this quarter, that’s encouraging. But, I’m not ready to say that that one is ready to turn up just yet so I think it’s the non-sourcing services piece has got a good backlog and that should give us a modest improvement. If the economy improves then I think we’re going to see that reflected in the other side of the services business and that will start trending up and I think we can do better than the guidance that we gave for 2010 but I think that’s contingent on an improvement in the economy which I don’t want to forecast.

Nathan Schneiderman – Roth Capital Partners, LLC.

You gave us the total of six seven figure software deals but what were the total number of seven figure deals?

Robert M. Calderoni

It was 15 in the current quarter.

Nathan Schneiderman – Roth Capital Partners, LLC.

What was the dollar value of domestic revenue and international revenue?

Ahmed Rubaie

The same proportion as the last few quarters so about 65% to 67% domestic, 30% to 33% international, of the 33%, 24% to 25% Europe and the rest is APAC.

Robert M. Calderoni

If I can give a little color, it was a good quarter in all of the regions, it was a particularly good quarter albeit it’s the smallest part of our business, so it was a particularly good quarter in Asia. We had a number of nice significant wins in Asia and that’s relative to the size of Asia. It was a very, very strong contribution for us. North America was up sequentially as was Europe but Asia really stood out particularly Australia. The Australian market seems to be doing pretty well and I think they’re well in to a recovery there and we’re benefitting from that recovery. A couple of large deals came out of Australia this quarter.

Nathan Schneiderman – Roth Capital Partners, LLC.

Final question for you, you gave us renewal rates of 90% for the sub software and mid 90s for the network. Could you remind us what that was in the year ago period? Then, do you expect further improvement from here and to what magnitude or do you think this it’s the right level?

Robert M. Calderoni

I don’t remember where it was exactly a year ago but I do know we started out somewhere in the low 70s at one point in time and that probably goes back two years where we started out. We’ve had a big focus on that within the company. We made some operational changes, we put together a separate renewal organization that is focused on renewals and customer satisfaction. That investment was put in place about 18 months ago and it certainly looks like its paid off.

We’re at 90%, we’re certainly striving to do better all the time on that but at 90% we’re pretty much going to be at a level where it’s going to be plus or minus a few points from here although we’ve got our team targeted to higher than that.

Operator

Your next question comes from Jeff Van-Rhee – Craig-Hallum Capital.

Jeff Van-Rhee – Craig-Hallum Capital

I have several questions, first if maybe you guys could revisit the services side. On the gross margin front a bit below where I had expected it. Can you give me some thoughts as to how that faired relative to your expectations and how you think about that gross margin level going forward?

Robert M. Calderoni

We came in at the lower end of our services guidance range and over a medium term cost is variable and we’ll manage our costs up or down. Within a 90 day short term period your cost is somewhat fixed so if you come in at the middle or high part of the range your margins are going to look better and if you come in at the lower part of your revenue range your margins is going to look lower for that period.

But, if you look over several quarters I think we’ve done a pretty good job of managing costs down as the revenue line has come down and our year-to-date margins are pretty strong. I expect the services margins to inch up a little bit as we see a sequential increase in revenues. If the revenues don’t increase then we just adjust the cost structure. You’ll see minor variations based on timing of revenue ups and downs but I think we should be able to maintain our margins over a two quarter period of time.

Jeff Van-Rhee – Craig-Hallum Capital

A couple I guess quick housekeeping items, what was the ending headcount and then also on the sales side, how many sales reps end of quarter?

Ahmed Rubaie

The ending headcount was about approximately 1,630 and the quote carrying about 86.

Jeff Van-Rhee – Craig-Hallum Capital

And thoughts there in terms of maybe forward 12 months, any thoughts on additions, deletions, whatever you think?

Robert M. Calderoni

I’ll talk about the commissioned headcount. We took that number down in 2009 as we went from a higher growth environment to a recessionary environment. We’ve been stable at 86 now for the past two quarters. I’m not ready to turn the spigots back on just yet but looking forward a full 12 months I would expect that number throughout 2010 to probably start to inch up and I’m going to time that based on – we’ll look at it every 90 days. If we continue to see further signs of a recovery, we certainly saw some this quarter, as we continue to see more we’ll start ratcheting that number up.

Jeff Van-Rhee – Craig-Hallum Capital

The last question then, the onetime catch up as it relates to the subscription revenues, you had said you had seen it previously. Just refresh us, when was that and what was the magnitude of it?

Ahmed Rubaie

It was in the first quarter and it was about $1.1 million, a similar amount.

Operator

Your next question comes from Curtis Shauger – Caris & Company.

Curtis Shauger – Caris & Company

A quick question on the backlog, in previous quarters you’ve given out a duration, if I missed it could you repeat it for me?

Ahmed Rubaie

It’s about 24 months.

Curtis Shauger – Caris & Company

So no real big change I take it?

Ahmed Rubaie

No real big change.

Robert M. Calderoni

That’s in the total backlog Curtis. The other backlog numbers Ahmed gives is an annualized backlog which would just be the 12 months one.

Curtis Shauger – Caris & Company

As far as the guidance, it would seem as though as we move through the year you’re going to try to invest where you can and I understand that a lot of the variability around professional services but is there any other areas within the company that you see – and you’ve done a fantastic job at increasing efficiencies but is there any other areas where you can see from a pure op ex side where you can get more out of the organization?

Robert M. Calderoni

I think as I said, we should see some sequential improvement in services margins as we see revenues increases so that will be a margin benefit. As we continue to drive subscription software, that’s a high margin business so our margins will continue to improve due to the mix. The guidance that we have today is not anticipating any uptick in the economy and we are going to invest $0.08 in to the business for net new investments that have revenue. It won’t contribute revenue in 2010 and even with that you can see earnings per share going up somewhat.

So, we are driving some efficiencies in other parts of the business but the rate of efficiency improvement will be less in 2010 than obviously it was in 2009 and the margin improvements is going to come more from the high margin revenue mix as we grow subscription software much faster than the rest.

Curtis Shauger – Caris & Company

One last one here, and you may have mentioned it earlier, I might have missed it but the deferred revenue was down sequentially, a bit A typical from what I understand from a Q4. Now, I know we’re kind of in between two models here. Can you give us any qualitative assessment of what the components were between your traditional maintenance base and you’re on demand subscription base?

Ahmed Rubaie

I think the way that I responded to that Curtis was it was arithmetic. So SMP was down a little bit and as a result you’re going to see a lesser input in to the number. Sub software is pretty flat so that’s basically really all the color.

Robert M. Calderoni

[Inaudible] on the balance sheet we have deferred revenue, that trended down. We gave a backlog level, that trended up. I would just remind you Curtis that on our balance sheet, deferred revenue is a subset of the backlog and the only time it shows up on our balance sheet is when we actually receive the cash. So, you’re seeing total backlogs improving because we signed a lot of business in the quarter but we didn’t receive cash yet for all of that business. That’s why you see backlog going up and deferred revenue going down. It’s more the timing of cash but overall backlogs and visibility in to the company has improved.

Operator

Your next question comes from Brad Reback – Oppenheimer & Co.

Brad Reback – Oppenheimer & Co.

Can you give us a sense how much the backlog grew year-over-year as a result of the increase in renewal rates?

Ahmed Rubaie

I don’t know that I have anything specific on the renewal rates but obviously they improved. We were in the low 80s, we improved to the high 80s low 90s. We’re at 90% right now. But, in terms of a specific dollar amount, I don’t have that for you. I can get that maybe during our on-on-one call get that for you.

Brad Reback – Oppenheimer & Co.

Bob, one for you, given that the board has been fairly generous with you guys over the years with restricted stock, there’s a fair amount of dilution that the shareholder base takes from year-to-year. Given where the balance sheet is now and your cash flow, why not use a buyback to offset some of that dilution?

Robert M. Calderoni

We feel good that we’ve got $195 million of cash and we certainly have a capital structure that gives us plenty of flexibility. We could chose to do some stock buyback but as I signaled back in the spring we’re back in the market looking at some M&A activities to compliment our current business. To start a buyback program right now in advance of driving any of those to conclusion I think might be premature. But, if we don’t use it for acquisitions we certainly have more cash than we’ll need long term and a stock buyback would be certainly a considerable use for it.

Operator

Your next question comes from Patrick Walravens – JMP Securities.

Patrick Walravens – JMP Securities

Bob, I was intrigued by the comment about the improvement in the renewals and I was wondering if you could give us some details about sort of what the new process are that you have in place versus what you did before? I know you have the team but what are they actually doing which they weren’t doing before?

Robert M. Calderoni

It’s a good question and an important part of our business. As I said over the last three years, transitioning to an on-demand company has been a perpetual learning experience for us. One of the things that we learned is that renewals is not a selling activity and that if you leave renewals out in the field with the sales force and just expect the salesman to show up on the renewal date with a piece of paper to sign you’re going to be disappointed. Renewals is a function of customer satisfaction and customer usage of the product. If you wait until the renewal period is up to find out that the customer either wasn’t using it or wasn’t satisfied for some reason, you’re going to be disappointed.

We pulled renewals out of the sales force about 18 months ago. We don’t have the salesman involved in the renewal process. We set up a separate organization. That organization is monitoring customer usage and monitoring customer issues if there are, along the way. They’re not waiting for the renewal period to come. They have a pretty good sense on whether something is going to renew long before the renewal period is up because they’re actively involved. It’s a customer satisfaction process not a selling process.

We put it in place and its worked really well not only to get the renewal rate up but we’ve obviously taken a lot of work load off of the sales force. We want the sales forced focused on generating new revenues not on maintaining old revenues and in a way we’ve taken our sales headcount from 117 at the peak to 86 but you could argue that we’ve got about 15 people in renewals that are doing some of the work that sales people use to work so we have sales capacity under the old model of more than 86 people right now as a result of it. It really is a fundamental different approach in recognizing that renewals is not a selling process that we did.

Patrick Walravens – JMP Securities

Can the renewal people do up sells? Or, who does an up sell?

Robert M. Calderoni

Renewal people can do up sells but whenever they spot and see an up sell opportunity we recognize that there is a selling activity there and they bring in a salesman and they work jointly on that.

Operator

There are no further questions at this time. I’d like to turn the floor back over to Bob Calderoni for any closing remarks.

Robert M. Calderoni

Thanks everyone for joining us today. We’re certainly pleased sitting here today in October, 2009 how the last 12 months transpired especially contrasting it to the general state of confusion most of us were in only 12 months ago. We’re certainly pleased with how the team performed this year. We feel very good about our business, we feel very good about the early signs of a recovery and some of the momentum we see building here in Q4 and we’re confident that 2010 will be a good year as well. I look forward to seeing many of you over the coming weeks and months between now and the next call.

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Source: Ariba, Inc. F4Q09 (QTR End 09/30/09) Earnings Call Transcript
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