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Ariba, Inc. (NASDAQ:ARBA)

F1Q12 Earnings Conference Call

January 26, 2012 5:00 PM ET

Executives

John Duncan – Director, IR

Ahmed Rubaie – Chief Financial Officer

Bob Calderoni – Chairman and Chief Executive Officer

Analysts

Peter Goldmacher – Cowen and Company

Greg Dunham – Goldman Sachs

Brad Reback – Oppenheimer

Richard Williams – Cross Research

Steve Koenig – Longbow Research

Jeff Van Rhee – Craig-Hallum

Robert Breza – RBC Capital Markets

Operator

Greetings, and welcome to the Ariba first quarter fiscal year 2012 earnings conference call. At this time all participants are in a listen-only mode. A brief 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, Vice President of Investor Relations. Thank you, Mr. Duncan, you may begin.

John Duncan

Good afternoon, and welcome everyone to Ariba's conference call to discuss the results for the first quarter of fiscal year 2012.

In today's call, we'll 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 presentation, please now advance to Slide 2.

Before we begin, I will read the Safe Harbor statement. Statements that may be made on this call and 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 Form 10-K filed on November 10, 2011.

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 financial information, including fiscal year 2011 revenues, expenses and net income.

We are unable to reconcile this forward-looking non-GAAP financial information to corresponding forward-looking GAAP measures because we are unable to estimate without unreasonable efforts certain forward-looking GAAP revenue, expense and other income 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 to review Ariba’s first quarter, which was highlighted by solid performance across all matrix. Our revenue was near the top end of our expectations with rapid growth in our network revenue and visible strength in our total subscription revenues. The strong revenue combined with our commitment to managing expenses and improving operating margins helped us exceed the high end of our non-GAAP EPS guidance.

In addition, our annualized Subscription Software backlog as well as our trailing 12 month network volumes in participation all rose strongly in the quarter. So we are very pleased with the company’s execution and strong financial performance in the first quarter particularly in light of the continued macro volatility. The expanded global region increase capabilities of the Ariba network provides us with a highly differentiated value proposition that is driving our growth and reinforcing Ariba as the clear market leader.

As adoption and spend levels continue to increase we are benefiting from a powerful network effect and our trading community is becoming increasingly vital to the way in which our customers collaborate and conduct commerce with their trading partners. We are at a very exciting point in Ariba’s history we have successfully evolved to a network company with an applications business. And we believe that we are still only in the first inning as it relates to monetizing our market opportunity.

In addition, and as I will detail out in a moment we are reiterating our expectation for strong revenue growth in fiscal 2012 despite currency headwinds, we are raising our profitability guidance for the full fiscal year, delivering on our commitment to improve operating margins while continuing to invest for tomorrow.

Now let me walk you through the highlights for the first quarter, please turn to slide three, we had another solid bookings quarter and annualized Subscription Software backlog increased to $210 million, up 27% year-over-year and up 21% organically. Our trailing 12 month network volume is approximately $219 billion up 22% organically before adding on $81 billion from b-process for a total of $300 billion. Less than four years ago we were pleased when we crossed the $100 billion milestone and now we have hit $300 billion.

Of course while the level and growth of spend on our network is tremendous we believe that we have barely scratched the surface on the trillions in addressable spend opportunity. We continue to increase penetration in our chargeable relationships rose 7000 sequentially to approximately 94,800 in the quarter, 3800 of which came from the acquisition of b-process.

Please turn to slide four, our highly profitable recurring Subscription Software revenue was $84 million for the quarter, up 67% year-over-year and up 26% organically. This was in the upper half of our guidance even after offsetting some currency headwinds in the quarter. The network revenue component showed continued strength at $41.6 million up 201% year-over-year and up 42% organically.

Meanwhile renewal rates continue to hold steady, network at around 95% and other applications around 90%. This is an indication of the business value that we are delivering to our customers all of which points to continued growth that is consistent with our medium term financial model. You will recall that our medium term financial model has total Subscription Software growing at 15% to 25% with the network component at 20% to 30%.

On to operating cash flow, we generated $12.8 million of operating cash flow before lease loss. Including lease loss of $5.6 million Q1 net cash flow was approximately $7.2 million, as a reminder our first quarter is always seasonally lower cash flow quarter as we take commissions on our seasonally strong Q4 bookings in our prior fiscal years annual bonuses. We continue to expect operating cash flow before lease loss of $108 million plus or minus $5 million for the full fiscal year. Also remember our lease loss impact in the Sunnyvale campus will disappear next January.

Now let me turn to more specific financial results for the December quarter. Please turn to slide six. Total revenue increased 39% year-over-year to $125.7 million for the first quarter, close to the high end of our previous guidance range of $124 million plus or minus 2. This is despite some currency headwind in the quarter primarily impacting our global network transaction revenues.

Subscription of maintenance revenue was $97.2 million towards the higher end of our previous guidance of $96 million plus or minus 2. Despite some currency headwinds Subscription Software revenue was $84 million also in the upper half of our guidance of $83 million plus or minus 2 and as mentioned a moment ago up 67% year-over-year and up 26% organically.

Maintenance revenue was $13.2 million slightly above our guidance of $13 million. Services and other was $28.5 million in the upper half of our previous guidance of $28 million plus or minus 1.

Turning to expenses, total operating expenses on a GAAP basis including cost of revenue for $125 million included in these GAAP results are $18.3 million for stock based compensation and $4.6 million for amortization of intangible assets. Excluding these items non-GAAP operating expenses are $102.1 million for the quarter resulting in non-GAAP operating income of $23.5 million. This represents a 49% year-over-year growth in non-GAAP operating income and approximately 19% operating margins.

The rapid growth in our non-GAAP operating income is due to a combination of strong revenue growth and over 100 basis points of operating margin expansion year-over-year. This is in line with our stated goal of lifting operating margins to a range of 19% to 20% even after announcing the acquisition of b-process.

GAAP net loss for the quarter for continuing operations was $700,000 or $0.01 per share. On a non-GAAP basis we had net income of $22.2 million or $0.23 per share coming in above the high end of our EPS range of $0.19 to $0.21 and up 27% year-over-year.

Moving on to the balance sheet, DSO was 25 days, as expected our cash balance decreased to $222.6 million mainly reflecting the b-process acquisition payment and various typically seasonal items in the quarter. Our deferred revenue was $129.1 million consistent with our expectations and up approximately $5.5 million sequentially and $4 million year-over-year.

As a reminder, our Subscription Software backlog is a better indicator than deferred revenue when it comes to analyzing the velocity and the growth trajectory of our Subscription Software business, which is close to 70% of our total business today. You will recall that our deferred revenue comprises a mix of services, which no longer gets bundled and amortized maintenance, which is declining and our accounting is based on fees already invoiced and collected.

Additionally, our recent acquisition in January and October of 2012 have resulted in a mix of monthly, quarterly, by annual and annual collections. In short, there is math and invoice duration to work out on comparing periods and I just wanted to reiterate that backlog is a better metric than deferred revenues given the mix and moving parts of our business.

Let us now look at Ariba’s outlook for fiscal year 2012. Please see slide seven. As I mentioned upfront we continue to target strong revenue growth and are raising our profitability guidance for the fiscal year. Despite increased headwinds from currency and continued macro volatility, this is a reflection of our open ended market opportunity as well as Ariba’s strong market position and business momentum not to mention our ability to navigate and execute.

We continue to expect total revenue of approximately $525 million plus or minus 5. This incorporates the year-over-year currency headwinds of roughly $5 million that primarily impacts our global network transaction revenues. We continue to expect Subscription Software revenue to be approximately $361 million plus or minus 4 or 31% year-over-year growth. At the end, we have incorporated today’s estimate of currency headwinds.

This now represents an approximately 20% constant currency organic subscription growth up slightly from our previous guidance of 19% growth. Within this we expect our network revenue to be approximately 27% constant currency organic growth up from our previous guidance of 24% growth. The international mix and respective FX impact on the network is greater due to Quadrem and b-process. The flip side of that coin is that growth is higher in the emerging markets. We still expect maintenance revenue to be approximately $49 million and services and other revenue to be approximately $115 million plus or minus 5.

On services and as we have said in the past we would expect the underline quarterly run rate to be between $27 million to $30 million and of course it will continue to be less predictable. Given our bottom line over performance in the first quarter we are raising our non-GAAP EPS guidance for the full fiscal year and now expect non-GAAP EPS to be in the range of $0.94 plus or minus $0.02, which is up from our prior guidance of non-GAAP EPS in the range of $0.92 plus or minus $0.02.

Our non-GAAP EPS guidance is based on approximately $99 million diluted shares outstanding. We remain committed to delivering a 100 basis point increase in operating margins for the year however beyond that level we remain focused on investing in the business to drive long-term growth with a particular focus on investments related to technology and innovation. We continue to estimate fiscal year ’12 operating cash flow before lease loss at $108 million plus or minus 5 representing a cash flow margin of approximately 21%.

Turning to Q2 specifically we expect the following, total revenue in the range of $128.5 million plus or minus 2, subscription and maintenance revenue of approximately $99 million plus or minus 2 including roughly $86.5 million plus or minus 2 for Subscription Software and $12.5 million for maintenance. We expect services and other revenue of approximately $29.5 million plus or minus $1 million. Note that our Q2 revenue guidance for Subscription Software has already incorporated approximately $1 million currency headwind year-over-year based on today’s estimate.

Again also the impact is on network transaction revenues. With respect to the rest of the P&L we expect total non-GAAP expenses to be approximately $106.5 million for the second quarter contained within this are cost of revenue of approximately $41 million, R&D of roughly $14 million, sales and marketing of approximately $37.5 million, G&A of roughly $11 million. In addition, we expect the net impact from interest taxes and FX of approximately $3 million in expense.

On a non-GAAP basis we expect net income of roughly $22 million plus or minus 1 or approximately $0.22 plus or minus 1. This is based on an estimated $98.5 million diluted shares outstanding. In addition, we expect to record expenses of roughly $22 million for stock based compensation and amortization of intangible assets including Quadrem and b-process. As I have done the last few quarters I thought I will give you some additional business color to help you with your models.

As I discussed with you during the last earnings call most of Quadrem’s customers are in the southern hemisphere, which generally run on a calendar year basis and start the year with their summer vacations in the January, February timeframe. So consistent with what I said last October our guidance anticipates greater sequential uptick in the second half of the fiscal year.

Moving on to the topic of integration, Quadrem is not fully integrated from a business perspective while b-process integration is well underway and our customer’s are very excited about adding e-invoicing capability in Europe. In summary, I’m very pleased with the strong start to the year and the continued momentum of our business.

The primary catalyst of our long-term growth our network business continues to increase at a robust rate and what is most exciting to us is our beliefs that we are still in the first inning of monetizing the tremendous global network opportunities in front of us. Not only that the growth of our network business enhanced Ariba’s overall subscription revenue growth and total revenue growth it also provides us with the opportunity to drive meaningful operating leverage from a long-term perspective. We saw some evidence of that leverage during the first quarter with non-GAAP EPS coming in above the high end of our expectations.

As we look ahead for the rest of the year, our sales opportunities are robust. Our competitive position continues to strengthen and we will continue to invest in the business to drive long-term growth, solidifying Ariba as the world’s largest and most global web-based commerce trading community.

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

Bob Calderoni

Thanks Ahmed, and thank you all for joining us today. I certainly am pleased with the solid performance we delivered once again with total revenue, subscription revenue, network revenue and earnings per share all at the top or in some cases ahead of guidance.

I’m also pleased with how we’ve executed against our base strategy of becoming the world’s business commerce network. And as Ahmed have indicated our core network volume continues to grow and when you include volumes from our recent acquisition of b-process our total network volume makes us the world’s largest web-based trading network for businesses by a factor of more than 3X.

Our performance here in the first quarter also reflects a diversification of our business as some software and SaaS vendors are exposed to the ups and downs in demand either because they offer only one product or focus on a single geography or if they derive revenue solely from software sales Ariba on the other hand has highly diversified solution portfolio and market coverage.

In first quarter, we saw the benefits of this with wins in the high growth emerging markets like Latin America, Brazil and India. We’ve also further penetrated our network into some non-Ariba software accounts and this is helping us to open up even more nodes at even more network volume over to above what we do in terms of new software customers.

As you know, our growth strategy is multi prompt those of you that joined us for Analyst Day a few months ago. When we shared our commerce network strategy you know we are targeting a $12 trillion opportunity of spend, which is a commerce that goes on today between the global 2000 businesses and their supply chains. We also laid out a three prompt plan for capturing the predominant share of an opportunity.

The first component of that strategy was to expand our market opportunity and the reach to geographic expansion, both of them were global direct sales coverage and to our growing eco system of partners. The goal here is pretty straight forward it’s all about market share and adding new logos around the globe and in Q1 we saw the benefit of this with wins in high growth emerging markets like Latin America, Brazil and India.

Second, we’ve increased our focus internally on customer adoption and spend penetration. A large portion of our organization today is now focused solely on customer success and enabling relationships to spend on the Ariba network. We believe we have a tremendous opportunity and an advantage in that our existing customer’s alone represent $3 trillion of spending yet we’ve only scratched the surface enabling spend in our network with about 10% spend penetration today amongst our existing customers.

As I will discuss in a moment the efforts of our customer management organization and the focus is off to a good start and I think it’s going to pay off handsomely for us over the coming years. Finally, we are also ramping up our R&D investments our focus in R&D investments is more on solutions in areas that had a big network effects, things like invoicing, discount management, Ariba discovery, receivables financing and a lots more innovation that we’ve got planned for coming releases.

Successful execution against each segment of this strategy was evident in the first quarter performance and it will be key to our continued growth consistent with our medium term financial model. Let me start with the market opportunity and expansion, we continue to execute against our strategy. This quarter we added 48 new logos in the quarter and that was up more than 50% from a year ago.

We accomplished this through channel partners like Vivo Consulting, which helped us add a new logo in Latin America and in few countries including new market for us in Columbia. This deal was a take away from SAP and (Inaudible) where we won on better functionality and some of the unique capabilities of the Ariba network including Ariba Discovery.

We also executed on our plan to expand into non-Ariba accounts it’s a unique aspect of our network model unlike other cloud vendors we continue to add new nodes independent of the enterprise software decision ArcelorMittal is one of the large steel and mining companies last quarter they selected both Ariba and Quadrem it was a joint win.

Both of our solutions directly connect more than 12 different backend systems SAP systems from around the globe from Europe to Brazil to India to our network and they are going to automate both procurement orders and invoices across their entire supply chain. It’s only the first quarter of deployment but they’ve already had a number of suppliers enabled and transacting they just went live in December. So when they are fully enabled we expect to have over 5000 suppliers and make billions of dollars in annual spend on the network.

Expansion also came in a form of a slew of competitive wins versus all of the ERP vendors. Let me give you one example for Oracle, a mid financial services firm selected Ariba over Oracle what began initially as just a focus niche invoice automation opportunity it quickly expanded to a full source to settle platform.

I think the key advantages for Ariba in this particular win were our proven cloud based delivery model but again the global reach and the coverage of the Ariba network played a very big part in that decision. Close to the 70% of that customer spend in their supply base were with suppliers that are already enabled on the Ariba network meaning we are going to get them up, running, transacting and achieving results faster than anybody else could possibly do.

We also beat out a host of niche providers this quarter I think just one example $1 billion CPG company, this company was ready to sign on we got in late actually. They were ready to sign on so a competitors procurement tool when one of our corporate sales guys learned about the opportunity and arranged for a meeting within four or five weeks we are able to get the customer to change course and select Ariba and I think that was due mostly to our proven track record to drive results and broad adoption proving I think once again that when folks are looking to drive broad spend coverage Ariba is a partner of choice.

Moving on to second prom of the strategy another area of good execution was our expanded customer management organization I spoke of earlier and that focus on customer adoption. One of our large and long time retail quarters, customers I’m sorry last quarter committed to using the Ariba network for its entire $4 billion of indirect procurement, processing for the next five years. I think this is not only a vote of confidence in our capabilities we anticipate this is going to drive significant uptick in spend through the network and supplier revenues over the next couple of years and solidifies Ariba as a core part of this retail and supply chain for the foreseeable future.

We had another win in the long-term oil and gas customer that already had a number of suppliers enabled on the network. This customer who working with or customer management organization has enhanced that plan they are committed to increasing the amount of spend and suppliers over the next couple of years. They are committed to a multi-year agreement for PO and invoice automation as well as our procurement content including catalogue management.

This one was a competitive win over SAP and some of their partners overall this customer has the potential to automate over $10 billion in annual spend over the network in the coming years obviously driving value for them, value for their suppliers and a win-win it will drive value for Ariba as well.

The final prom of the strategy is our continued focus on developing innovations that contribute enhance the network effect of our business. We continue to add value for our existing community members and attract new members at mass for example Ariba Discovery volumes and participation continues to trend out positively. Enhancements in matching and ratings in the past quarter have encouraged new participation and RFPs across the host of new categories. And over and over as we talk to both customer and we talk to suppliers the feedback we hear is that Discovery is being used more and more to find new sources of supply where to help new regions, business in new regions for those companies.

Also our network model continues to open up new channels for innovation with our growing ecosystem of partners. In the past, I’ve discussed alliances with all the software vendors this quarter we’ve aligned with ThomasNet is the online division of Thomas Publishing. ThomasNet offers really rich deep online product catalogues for more than 600,000 suppliers. We are going to connect all of those suppliers to the network and exposing those suppliers to our buyers further increasing in match rate that we will have with both existing and prospective customers and enhancing us as a place people go to find new sources of supply.

You are going to expect us to be working with other partners like ThomasNet and I think over the coming quarters you are going to hear more and more partnerships on how we are developing our network jointly with others. We believe our solid performance this quarter and our continued execution against our strategy is positioning Ariba well for continued growth. I think we are off to a good start this fiscal year. I’m even more confident in our ability to achieve our vision to lead the market into this new network economy.

With that let me open the call to your questions. Thank you.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Peter Goldmacher with Cowen and Company. Please proceed with your question.

Peter Goldmacher – Cowen and Company

Hi guys, I had two questions first for you Ahmed can you help me in your prepared comments you talked about like cash flow and deferred revenue might have been, might not be the best indicators but they are even though it’s seasonally weak, they are seasonally weaker than they have been in prior years September, December comparison.

So just a little more detail on that would be helpful and then Bob for you I would love to hear a little bit more about you have invested a lot of money in sales and marketing but it’s clear that you are deemphasizing the traditional software as a service business and you are going more active in the network business I would love to hear what the specific duties of the sales guys are that are trying to drive the network? Thanks.

Ahmed Rubaie

Okay, so let me start with the deferred revenue analysis so I think the first thing to dissect is the understand what deferred revenue comprises in addition to software and SMP, which is 70% of our business, there are services and there is maintenance. And as you know from a year and a half ago or so the new accounting rules have caused services to no longer be bundled and amortized.

So another way to say that is most new services since a year ago would actually bypass deferred revenue just by nature of their timing. Where in the past they would have added to deferred and been amortized. Maintenance itself is a declining revenue stream as you know so if you take the two of them you can work out the math and say it’s around $15 million to $20 million that would have shown up year-over-year on the deferred revenue balance on that front.

Secondly, with the addition of Quadrem and b-process, which came in late January and October the duration of our invoicing has changed also. So today, across our network revenue stream we bill monthly, quarterly, by annually and annually depending on where we use it on the network. So the duration is also having an impact. Lastly then in terms of thinking about deferred revenue I still maintain what I’ve always said and that is the backlog itself is the best indicator when it comes to our subscription revenue including the network.

Peter Goldmacher – Cowen and Company

Okay Ahmed so the invoice duration on the network is actually contracting because that would be, that would mean, that would explain deferred getting smaller or not growing the rate.

Ahmed Rubaie

That’s correct. Yep, you got that right.

Peter Goldmacher – Cowen and Company

Thank you.

Ahmed Rubaie

Now, in terms of cash flow it is Q1 is always seasonally lower if you are trying to compare this Q1 to say last Q1 I can walk you through the math as well. So I think you would agree with me that our Q4 bookings this past year were a record in our history and so as a result the commissions were a record as well we paid those out in the first quarter.

Similarly our business results organically and inorganically are also a record and in turn our bonuses to the ranking file also increase to the prior year and that was also paid out in the December quarter. So it really is, when you are thinking about cash flow that is built two items that I’m confident as it has been the case over the years that the cash flow number will increase as the year goes on and hence I’m reiterating 108 plus or minus 5 for the year.

Peter Goldmacher – Cowen and Company

Thank you.

Bob Calderoni

Peter your question regarding the sales and marketing investments traditionally prior to this year the bulk of the sales and marketing investments we made were on the traditional sales side, quarter carrying sales reps I think two years ago might have been in the 70s and are up to 125 or so quarter carrying reps. And the pay back amount invested I think it shown itself in the strength that we see in our pipeline the strength that we see in the growth rate of the business both the backlog and revenues.

With the emphasis I’m making today about the customer management organization think of it as a forming organization, traditionally where the hunting organization is where the investments were, we are now making investments in the forming side of the commercial organization. Not deemphasizing something or complementing it think of it as a complementary investment now on forming and it’s all about customer success and customer adoption.

So the individuals there will be they will be customer management executives they will have assigned territories assigned accounts, they will be measuring on things like customer success, they will be measuring on things like customer spend through the network and ultimately in supplier fees that’s how we have revenue through that adoption. So they will have bonus targets based on those types of metrics.

In the past I think we had too much balance tilted too heavily towards just forming we didn’t have enough complementary, I’m sorry hunting not in the forming. We are increasing the forming and I think given the business model that we have the two sided business model where we get we earn revenues as our customers use product I think this enhanced focus, I think is going to lean to some increases in the rate of growth we see in spending and also the rate of growth we see in supplier fees overtime.

Peter Goldmacher – Cowen and Company

And are these guys also working on getting your traditional software company to adopt the network more aggressively, how is that going?

Bob Calderoni

First of all, here is a couple of examples in my prepared remarks before where we had an existing customer that was using our product but was not using it as broadly as they could. I think we are seeing success with some of those customers as early on to where they are embracing the idea on how we can broaden the penetration and adoption of spend. And in some cases they are coming back to us and they are saying look we can put on 2, 3 $4 billion more spend we need to be able to do certain things differently than what we see today and that’s some of the R&D investment I want to make the complement.

We right now we have a long list of opportunities where with a couple of enhancement request we can bring on billions of dollars to be spend for specific customers and we have more request than we have capacity I need to increase the capacity of the R&D organizations I can do some of those things. These are the early signs of the CMO organization is we are starting to see a lot of request for enhancements to the products that are tied directly to the customer bringing new categories of spend on to the system. So it’s I think the early signs are pretty good that there is a willing customer that wants to do the same thing we want right now.

We just now need to invest more in forming and we need to invest a little more in R&D. We are shifting the investments that we used to make only in sales and marketing we are moving them to, not moving the dollars new investments are going to go not necessarily to more quarter carrying guys perhaps on this forming organization and R&D capacity.

Ahmed Rubaie

And Peter just on that in order to wrap up when Bob talked about investment that’s when there is money above and beyond what I’ve already committed to in operating margins. So we stand behind what we said we are going to do in operating margins and raise the EPS.

Peter Goldmacher – Cowen and Company

Okay, thanks guys.

Bob Calderoni

Okay, you bet.

Operator

Our next question comes from the line of Greg Dunham with Goldman Sachs. Please proceed with your question.

Greg Dunham – Goldman Sachs

Yes guys, thanks for taking my question. I also wanted to follow up on the customer success initiatives and kind of where that spending shows up on the P&L and how we should think about kind of the cost of services going forward that would be number one. Total separate question is you highlighted a number of competitive wins in the script and our research shows that the competitors frankly feel strong however there has been some investor chatter out there about increased competition in the space. And I just want to get your thoughts on that chatter out there? Thank you.

Bob Calderoni

Yeah I think the customer management organization is part of this a commercial organization so the cost of that would be in sales and marketing expenses. I will let Ahmed come back comment on services; cost of revenue I think it impacts that I will let him circle back.

Ahmed Rubaie

In a competitive environment, yeah I would say the competitive environment is comparable to what it has been in the past. We have competition on both ends of the spectrum obviously the Oracle and the SAP spectrum I think our competitive spectrum there has been and remains very strong. The differentiation in our breadth and depth of solution our differentiation is our delivery model and of course perhaps the most significant differentiation long-term is the network and the breadth of that network around the globe. So nothing is different there.

On the other end of the spectrum we have always had a mix of niche I would refer to them as providers small private companies that are narrowly focused to maybe one solution not very big I think the list of those companies changes from time to time. There is always a few out there, they are still out there. We tend to compete very well against them because it’s all about the breadth and depth of our capabilities and well we don’t win 100% of the deals we certainly win very many as evidenced by just the number of new logos we got in this quarter, which was up 55%.

But I think if I could characterize whenever one of these small niche companies win a deal it’s typically because the customer had a very narrow focus and I would refer to it more as an in house trial than a direct program. And they were really paying for a cheap in house trial.

Greg Dunham – Goldman Sachs

One follow up if you let me permit. What do you think IBM and Emptoris means for the market? What does it say about the space?

Bob Calderoni

Yeah IBM is bought a few they’ve bought a lot of software companies and generally I think they’ve got a smarter commerce strategy and I think that’s a long-term strategy to be something much broader than just a solution like Emptoris. I think it’s just a small cog in a big wheel that they have over there. Emptoris is something we’ve really haven’t seen much of Emptoris in the last couple of years.

It’s not an on demand solution; it’s basically a point solution. I don’t think it’s, I don’t think we are going to see IBM out there trying to sell a point solution. I think they are trying to build a like they did restoring commerce we just don’t see then outselling it’s all part of a big to long-term capability they are trying to build in their services organization.

Greg Dunham – Goldman Sachs

Thank you.

Operator

Our next question comes from the line of Brad Reback with Oppenheimer. Please proceed with your question.

Brad Reback – Oppenheimer

(Inaudible).

Bob Calderoni

Hi Brad.

Brad Reback – Oppenheimer

So Bob, you guys couple of times in this call have talked about increasing investment in R&D. Should we take that mean that there will be faster product releases for network services, things like Discovery coming quicker or is that around integrating which you already have?

Bob Calderoni

Well there will be I’m, it’s not necessarily going to increase the speed of the release cycles per say. There is, there might be a little bit more in each cycle but I don’t think we are releasing large quantities of innovation every six to nine months as sort of the average cycle. So I don’t see the average cycle compressing and there will be more content in each one. But actually more of it, more of the increased capacity is going to come from these customer specific enhancement requests that are tied directly to an ability to bring on some category spend and may be some particular feature unique to that customer, unique to that customer’s ability to bring out a billion or $2 billion worth of spend.

These are the types of requests that are starting to come out of the woodwork as a result of our early days of this customer management focus. So it’s going to be we refer to it as flex capacity inside the organization not release driven but very customer specific enhancement request tied to network spend penetration. So it’s a little bit different than maybe things we’ve done in the past.

Brad Reback – Oppenheimer

Okay and then one related questions. You brought up at the end of your prepared remarks the Thomson registry partnership and the opportunity for more of these. How should we think about monetization of those types of relationships?

Bob Calderoni

Well I, there is a lot of different ways I think initially what we are, we our strategies we want to be at the facto standard web-based commerce network for businesses. And in order to do that we have to be the broadest the deepest measure it a lot of ways, geographically measured by software categories, by number of suppliers. So the first thing it does is enhances our capability 600,000 suppliers. There will be a little bit of overlap with existing suppliers out of all the net increase but it will be a very significant net increase that works.

The second way we monetize is I think I used one of these examples earlier when we go on to a customer to whether it’s an existing customer or a prospective customer one of the things we talk about is looking at your existing list of suppliers and look how many of them are already on your Vivo network that’s what we refer to as the match rate. That match rate is really high and that really helps the customer CEG I’m going to be able to get up and running not necessarily the software running, running in their mind means driving a lot of spends with the process.

Pretty quickly, because many of these suppliers are already on a network again this enhances our attractiveness to those customers and it gets monetized when we sign new customers and I put more spend on. I think longer term as you know today we have a two sided business model we get revenue for our software, we get revenue from suppliers from the - our customers use of our software.

The third leg of that is a community leg and that’s when we have lots of buyers putting a lot of spends through lots of sellers we think there is a number of business models. And Ariba Discovery is one of their early ones I bet there are other business models that we put into this category called community we would be able to leverage a community. So it’s enhancing the community. So I think there is an opportunity to generate revenue in the near term based on their existing business model and I think there is a longer term opportunity as we develop community based models as well by putting more suppliers on the network.

Brad Reback – Oppenheimer

Perfect, thanks a lot.

Operator

(Operator Instructions) our next question comes from the line of Richard Williams with Cross Research. Please proceed with your question.

Richard Williams – Cross Research

Hi guys. Excuse me great quarter.

Bob Calderoni

Thank you.

Ahmed Rubaie

Thank you.

Richard Williams – Cross Research

You mentioned that there were 48 new buy side customers as I recall you around 330 total buy side customers. It seems like a lot is there anything you should be reading into that.

Bob Calderoni

The 48 were new logos not all of that buy side if you mean network nodes they are not some of this are upstream customers, which are not network nodes. But the 48 are new customer logos I think it’s up 50% from last year I don’t have the buyers.

Ahmed Rubaie

The buyers Rich 330 it’s about 380 today.

Richard Williams – Cross Research

Okay, the large deals looked a little softer in the year ago quarter. What if anything should we take away from that? Thanks.

Bob Calderoni

I think the total number of large deals 18.

Ahmed Rubaie

Down to the number this quarter 10.

Bob Calderoni

Software is 7.

Ahmed Rubaie

Software is 7 in both periods it’s all services last year as our services business is evolving from where we were doing upgrades of legacy CD customers, which have bigger deals to now mostly organization is working on assisting customers in deployment plans on the WAN product you don’t see as a bigger service deal. So the service number we would expect the number of large deals come down. The software large deals are the same year-over-year but I would also point out well we like large deals that’s not our strategy. Our strategy really is to open up new nodes start out small and then grow over time. So I would just point that out but the fact that they are lower than last year services.

Bob Calderoni

And remember Rich this is what I talked about all during last year as I kept trying to counter expectations on services. Because at the end of the day our strategic goal is to have services only be complementary to our technology and network business.

Richard Williams – Cross Research

Right and that’s why you sold off full services business.

Bob Calderoni

Yeah.

Richard Williams – Cross Research

Okay, thanks guy’s good luck.

Ahmed Rubaie

Okay Richard.

Bob Calderoni

You bet.

Operator

Our next question comes from the line of Steve Koenig with Longbow Research. Please proceed with your question.

Steve Koenig – Longbow Research

Hi guys, thanks for taking my questions.

Bob Calderoni

You bet Steve.

Steve Koenig – Longbow Research

Yeah, I would like to drill down into the whole area of having generating network business from non-Ariba software customers. As the network is clearly going to be become more and more the focus of your business? Can you just remind us maybe give us some color on things like what, how penetrated are you in terms of like what percentage of the network buyers are non-Ariba software customers today. And how do you expect that to trend overtime? And related I’m also just wondering what’s the implementation time and effort to integrate with non-Ariba procurement solutions versus Ariba how do those things compared and what’s involved in winning that kind of deal?

Bob Calderoni

Today, it’s a day that first of all your question what percent are non-Ariba software customers the number is about 20% of those on the network. I expect that number to trend up overtime as we emphasize more and more, we would love to sell our software we love for the customer to use our P to P product.

But they are already using a procurement product our goal is to get in there and use our network to extend their business process and trading community to get all spend on. And so that’s clearly, its complementary set of objectives I don’t think it’s we are deemphasizing software. But we are, be brought in the market when we felt this on the network independent software. So that’s what we are doing there.

The timeline I think it differs depending on the scope the project often times it’s an invoice automation project. Customer is already using their, they have whatever system and process they are using to manage their spend internally but the process is manually. Once it hits the edges of their four walls of their organization so invoicing is a good way of extending that process.

Those projects are usually typically measured in months, couple of months before they are up and running and the good thing is a lot of time I’ve spend is already captured in the system somewhere so we could ramp a spend and have a network what’s in the first year we can get more spend on the network than we would if we were starting from scratch with a P to P deployment.

Steve Koenig – Longbow Research

Got it. Very well thanks for your help.

Bob Calderoni

Thanks Steve.

Operator

Our next question comes from the line of Jeff Van Rhee with Craig-Hallum. Please proceed with your question.

Jeff Van Rhee – Craig-Hallum

Hey guys, just a couple of questions here. First, maybe on the network and in terms of the expected 20% to 30% growth the chargeable relationships I mean you don’t get any a lot of continuity with the introduction to b-process and Quadrem. But if you just annualize the organic growth it looks like organic billable relationship built around 14% that in relation to the 20 to 30 for the network is that how we should think about that of the increment above that either comes from prices increases or volume growth or get us in the ballpark as to how you get into that 20 to 30 range?

Bob Calderoni

Yeah, I think Jeff what you got to do is you got to look at volumes and organically that’s up 22%. You look at chargeable relationship that’s up 18% year-over-year and remember it isn’t just the number of chargeable relationship it’s the amount that goes through per chargeable relationship encamping.

So we are tracking quite well when we quote 27% constant currency organic growth. And to trace that back if you go back to the days Lehman Brothers in 2009 you will see that even in the worst case scenario where volumes didn’t stayed pretty steady and actually went down. Participation chargeable relationships both in quantity and quality went up and as a result back then the network revenue still grew at 22% year-over-year.

Jeff Van Rhee – Craig-Hallum

And then as it relates to Discovery now that you’ve been out and you’ve had some time to play with the pricing models I know you had launched the three tier model. Can you give us an update on the levels what you’ve learned about pricing, any thoughts on revenue in terms of material revenue for the Discovery product.

Bob Calderoni

Yeah we are still, we are still testing some models and we have some plans of actually we are not ready to declare what we think is the right model to monetize Discovery. We’ve got a model today in which is per RFP type of a model then we have one where this bundled number of RFPs we are looking into couple of alternatives to that because it’s still early.

We want to figure out the right model we may test a subscription based model that a little bit different not ready to really conclude on that. But we are still looking – we don’t we are not convinced yet we are ready to declare a long-term model and what’s the best way to monetize that. So we are going to test a few more things here in the next quarter or two and probably by the end of the year be ready to say this is where we are going to put our eggs in this particular model.

It’s we are not looking for it to drive a lot of revenue right now we are looking really more to get more awareness around it and we are learning we are doing a lot of focal group types of reviews with both buyers and suppliers that are using Discovery. Some of the feedback we are getting as we think we may get even more adoption if we tweak the model a little bit and that’s where we are going to experiment.

Jeff Van Rhee – Craig-Hallum

Well Bob you gave a couple of examples when you spoke earlier both in terms of enhancing sales closure in the quarter as well as increased adoption are they all related to Discovery? So what did we spend in contraction?

Bob Calderoni

Yeah, I mean there is way more RFPs, the number of RFPs all the metrics are growing in Discovery and we are intentionally not monetizing and as I said earlier in the year or towards the end of last year we are just you may see a little bit different pricing model in the next 30, 60, 90 days as we test another approach.

Jeff Van Rhee – Craig-Hallum

Okay and then just one clarification on the b-process is there any contribution from that in the short-term backlog?

Ahmed Rubaie

Pretty limited in backlog again because of their billing Jeff.

Jeff Van Rhee – Craig-Hallum

Okay, then it’s all just maybe a couple of million up to that effect.

Ahmed Rubaie

It’s that.

Jeff Van Rhee – Craig-Hallum

Okay great. Thanks guys.

Operator

Our last question comes from the line of Robert Breza with RBC Capital Markets. Please proceed with your question.

Robert Breza – RBC Capital Markets

Hi, thanks for taking my questions. I guess most of my questions have been asked just quickly on it just a few housekeeping items. One any real thought or change around tax rate and then just sure is outstanding? Thanks.

Ahmed Rubaie

Sure in terms of tax rate you know Rob I mean it’s not, it’s not meaningful enough to give you a tax rate. But I gave you the tax expense for the quarter, which is actually combined with interest income as well as FX impact it was at about $3 million and it’s a little over $11 million for the year. So that’s how I would model it. In terms of diluted shares, $99 million for the year 90.5 for Q2.

Robert Breza – RBC Capital Markets

Great. Thank you.

Operator

There are no further questions at this time. I would like to turn the floor back over to management for closing comments.

Bob Calderoni

Thanks Robin. Well thanks everyone for joining us today. We feel good about the beginning of our year here. We are looking forward to seeing many of you over the coming months between now and the next call quarter as we step up some of the IR activity we have planned. So look forward to seeing you. Take care.

Ahmed Rubaie

Thank you.

Operator

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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