Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Ariba Inc. (NASDAQ:ARBA)

F2Q08 (Qtr End 3/31/08) Earnings Call

April 24, 2008 5:00 am ET

Executives

John Duncan - Director of IR and Corporate Finance

Bob Calderoni - Chairman and CEO

Jim Frankola - CFO

Analysts

Greg Dunham - Deutsche Bank

Peter Goldmacher - Cowen & Co.

Pat Walravens - JMP Securities

Nathan Schneiderman - Roth Capital Partners

Brad Reback - Oppenheimer & Co.

Robert Breza - RBC Capital Markets

Brad Whitt - Broadpoint Capital

Richard Williams - Cross Research

Operator

Greetings, ladies and gentlemen and welcome to Ariba's Second Quarter Earnings 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, Mr. John Duncan, Director of Investor Relations and Corporate Finance for Ariba. Thank you, you may begin.

John Duncan

Good afternoon and welcome, everyone, to Ariba's conference call to discuss results for the second quarter of fiscal year 2008. In today's call, we will make reference to supplemental presentation slides with our prepared remarks. To access these slides, please log on to the Investor Relations section of our website at www.ariba.com.

Our speakers for the call today are Bob Calderoni, our Chairman and Chief Executive Officer, and Jim Frankola, our Chief Financial Officer. For those on the call accessing the supplemental information, please now advance to Slide 2.

Before we begin, I will read the Safe Harbor statement. Statements that could [ph] be - 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 Management's intentions, hope, beliefs, plans, expectations or strategies for the future. These statements are subject to various risks and uncertainties, and actual results could differ materially from the company's current expectations. These risks and uncertainties are discussed in the company's SEC filings, including our most recent report on Form 10-Q filed on February 6, 2008 for the year ended December 31, 2007.

During the course of this call, we will reference historical non-GAAP financial measures. 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 2008 revenues, expenses and net income. We are unable to reconcile this forward-looking non-GAAP financial information to the corresponding forward-looking GAAP measures, because we are unable to estimate without unreasonable efforts certain forward-looking GAAP revenue and expense items.

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

Jim Frankola

Thanks, John. Good afternoon everyone, and thank you for joining us today. Overall, we were very pleased with our performance in the second quarter. Here are some highlights. Ariba's 2Q results came in at the high end of our expectations. Non-GAAP revenue was $82.8 million versus a guidance of $80 million to $83 million. Non-GAAP EPS was $0.09 versus guidance of $0.05 to $0.09. We continue to see strong demand for our subscription software products across all market segments; from the mid market to the largest companies in the world.

During the quarter we closed 13 software deals greater than $1 million; all of them were subscription software. In fact, we signed the largest subscription software transaction in Ariba's history. Please now refer to slide 3. Once again, we saw strong growth in our backlog. This is the 13th consecutive quarter that we have posted an increase. Our total subscription software backlog, including Procuri, now stands at $201 million, and our 12 month backlog is $101 million, which represents 98% and 89% year-over-year growth rates. Even without the impact of Procuri, we still posted a very healthy 64% annual growth in total backlog and a 61% growth in 12 month backlog.

We had outstanding growth in subscription software revenue, driven by organic growth, a strong quarter for the network, and the Procuri acquisition. Continued strong cash collections coupled with tight expense management resulted in cash flow from operations before the impact of lease loss payments, Procuri, and Sky [ph] settlement of $17 million for the quarter. We released Ariba 9s5, the fifth version of our on-demand product this quarter, which puts Ariba's on-demand offerings on par with our CD-based products. This is the milestone that marks our successful transformation to an on-demand company. Finally, we closed 226 transactions, added 22 new name accounts, and signed 135 on-demand deals and closed 20 deals over $1 million in value.

Now let me turn to more specific financial results for the March quarter. Total revenues were $80.5 million for the second quarter. Including a $2.3 million purchase accounting adjustment against Procuri's revenue stream. Non-GAAP revenues were $82.8 million and came in at the high end of our guidance range. Please refer to Slide 4. On a GAAP basis, subscription and maintenance revenue was $46.8 million with maintenance revenue of $18.2 million and subscription software revenue of $28.6 million. On a non-GAAP basis, subscription and maintenance revenue was $49.1 million, slightly above our guidance. Non-GAAP subscription software revenues came in at $30.8 million, up 97% year-over-year on a reported basis or 57% on an organic basis, excluding the effects of the Procuri acquisition.

Please refer to Slide 5. In Q2, we reported $7 million of network software revenue, of which $5 million came from the Supplier Membership Program. Importantly, we have seen no change in churn rates of suppliers, as we have implemented our new pricing structure. We believe this stability in renewal rates, validates the tremendous value the Ariba network provides. Given these renewal rates, backlog and pipeline, we are on track to almost double our network software revenue from $13 million in 2007 to $25 million in 2008.

Service and other revenue, including license revenue of $1.4 million, came in at $33.7 million, compared to our guidance of $32 million to $34 million. We also continue to improve our operating margins. Overall, non-GAAP gross margin increased to 61% this quarter, and we are now on track to beat our full year target of 60%. As we noted previously, the transformation of our business to higher growth, higher margin subscription software is driving these margin increases. Looking at total expenses on a GAAP basis including cost of revenue were $93 million. Included in these GAAP results were a $4.9 million charge for the amortization of intangible assets, an $11 million charge for stock-based compensation, and a $690,000 charge related to the Procuri integration.

Excluding these items, non-GAAP expenses were $76 million for the quarter. As a result, GAAP net loss for the third quarter was $12 million or $0.16 a share. On a non-GAAP basis, we had positive net income of $7 million or $0.09 a share, which was at the high end of our guidance range of $0.05 to $0.09 per diluted share. Included in these non-GAAP expenses were $1.5 million of IT-related litigation expenses in Q2.

Moving to the balance sheet; cash, cash equivalents and investments at the end of Q2 were $125 million, which was down $3 million from $128 million at the end of Q1. We generated positive cash flow from operations of $1.5 million. Excluding cash used for Procuri-related activities, the Sky settlement and lease losses, our cash flow from operations was $17 million for the quarter. These cash flows are significant and are a measure of our success in expanding both revenue and margins as we complete our transition to a profitable, high-growth subscription software company. Our DSO declined to 33 days, down one day from the previous quarter.

I'd like to also provide some color on our cash balances in light of recent credit market conditions. The $125 million cash balance is comprised of the following: $103 million in cash and equivalents, including $30 million of restricted cash. This cash is invested in bank deposits and AAA-rated money market funds. In addition, we have $22 million in long-term investments, which are invested in auction rate securities. All of these amounts are had in AAA rated variable rate debt instruments, and are backed by federally guaranteed student loans or by commercial debt. These option rate securities are not liquid right now, and we have reclassified them as long-term assets. This is a very complex area. Slides 9 through 14 in the investor slide deck provide additional details on our auction rate securities and how we value them.

I'd also like to update you on another positive development in our real estate situation. During Q2, Motorola renewed their lease and agreed to sublet two floors until 2013. I'd like to note that market rates have improved since the original lease was signed back in 2004. We now have 75% of the campus either occupied or leased through the remaining term of our master lease. The local real estate market is still active, and I anticipate additional subleases over the course of 2008. Please see slide 18 -- sorry, 15 through 18 for further information. Finally in terms of headcount, Ariba ended the March quarter with approximately 1,744 employees, down from 1,800 at the end of December. We ended the quarter with 117 quota carrying sales reps, up 17 from the beginning of our fiscal year.

Now let's turn to our outlook for the June quarter and the rest of fiscal year 2008. As I noted above, we continue to see strong demand for Ariba's Spend Management Solutions. Now that our on-demand products have similar functionality as our CD-based products, we feel the Ariba offering is even more competitive in today's difficult economic environment. As we've said before, although we are not immune to the macroeconomic climate, Ariba has two strategic benefits that most technology companies do not have, the unique combination of what we sell and how we deliver value.

First, we sell spend management solutions. That is technology and services to help companies save money. Second, we deliver those solutions in an on-demand approach that significantly lowers our customers' total cost of ownership, reduces their risk of technology adoption, and reduces their time to achieve return on investment. We believe these strategic benefits, coupled with our successful execution of our major business initiatives will position us to achieve our long-term financial objectives of non-GAAP gross margins of 60% to 65%, non-GAAP operating and net income margins of approximately 15%, and cash flow from operations before lease losses of approximately 20% of revenue.

Please see Slide 6. Focusing now on the fiscal year 2008, we are reiterating the guidance we provided on our last earnings call. That is total non-GAAP revenue is expected to be between $330 million and $335 million, and non-GAAP EPS of approximately $0.45. Please now refer to Slide 7. This is a slide that outlines cash flow projections. Turning to the cash flow outlook, with our strong first-half performance on cash flow, we are tracking towards the high end of our guidance of $50 million to 55 million of cash flow from operations before lease-loss payments, Sky settlement, and Procuri-related integration charges.

Focusing on the near term for the June quarter, we expect the following non-GAAP revenue, expense, and net income performance. We anticipate total non-GAAP revenues in the $83 million to $86 million range, with subscription and maintenance revenues between $49 million and $50 million, including roughly $31 million to $32 million for subscription software and $18 million for maintenance; services and other revenues in the $34 million to $36 million range.

Now that perpetual license revenue is an insignificant portion of Ariba's revenue mix, I will not provide guidance on a go-forward basis. We anticipate that license revenue will range from $1 million to $1.5 million for the next several quarters. I will disclose actual perpetual license revenue for the remainder of 2008, and beginning in fiscal year '09, we will no longer provide this metric. There will be approximately a $2 million purchase accounting adjustment to Procuri's revenue stream. Thus, GAAP revenues are expected to be between $81 million and $84 million for the quarter.

With respect to the rest of the P&L, we expect total non-GAAP operating costs and expenses to be $75 million to $76 million. Contained within this expense are, cost of revenues of $31 million to $32 million, R&D of roughly $12 million, sales and marketing of approximately $25 million. Please note, sales and marketing expenses will be seasonally high this quarter, due to Ariba LIVE and other marketing activities; G&A of approximately $8.5 million, which includes roughly $1.5 million of IP-related litigation expenses; and a net benefit of approximately $1.5 from interest income and exchange gains net of taxes. Note that we have factored in the decline in market interest rates into our forecast.

On a non-GAAP basis, we expect positive net income of approximately $8 million to $11 million or $0.10 to $0.13 based on 83 million diluted shares outstanding. In addition, we expect to record expenses of $10 million for stock-based compensation, $5 million for amortization of intangible assets, and $1 million for integration-related restructuring charges. As a result, we expect to generate a GAAP net loss of $7 million to $10 million or a loss of $0.09 to $0.13 per share.

Overall, it was another excellent quarter for Ariba. In addition to the business transformation that Bob will describe, I am pleased that we can mark this quarter as the one where we have completed the transformation of Ariba into an on-demand company. It has been a long, hard journey; but Ariba has emerged as a stronger, more flexible and dynamic company, and we are extremely excited about the many opportunities that lay in front of us.

With that, let me turn the call over to Bob.

Bob Calderoni

Thanks, Jim, and thank you for joining us this afternoon. I'm also very pleased with our results this quarter and the continued progress we have made towards our goals for the full year. This quarter we had solid performance across the board. We saw record bookings for subscription software, while non-GAAP subscription software revenue and subscription software backlog both nearly doubled compared to year-ago levels, fueled by strong organic growth. And we saw particular strength in both the U.S. and the Asia-Pac markets, with North America scoring the single largest subscription software deal in Ariba's history.

When we met last quarter, I indicated that recent results suggested our transformation to an on-demand company was nearly complete. I can assure you today we are not resting on our laurels, and we continue to be very focused on execution. It's clear we have passed through the transition phase and we are entering the growth phase for subscription and on-demand software, and our performance this quarter further validates this and it positions us extremely well going into the second half of 2008 and then into 2009.

Today, we already see strong signs that our acquisition of Procuri is already contributing in numerous ways, despite this being just our first quarter following the acquisition. Overall, things are progressing well on the Procuri front, and we are ahead of schedule. In fact, this quarter we did 47 deals with legacy Procuri customers, which represented a combination of either new deals, renewals or extensions of existing programs. This included a three-year renewal for 1500 users for use of both our on-demand sourcing and contract management solutions at one of the largest Dow industrial companies.

We are also seeing success transitioning legacy Procuri customers to the Ariba platform and upselling them. For example, Norway-based [Kongsberg] transitioned from using only Procuri TotalSource solution to a three-year subscription for Ariba Sourcing, Spend Visibility contracts, and Supplier Performance Management. We've also seen some success cross-selling Ariba services into Procuri accounts, and this is just in our first quarter following the acquisition. Overall, company-wide we signed 135 on-demand deals this quarter, including 19 on-demand deals with new customers. It is important to note that our on-demand growth is not only being driven by expansion into our mid-market, but large enterprises are increasingly embracing our on-demand solution as well.

In fact, we signed 13 software deals greater than $1 million, and all of them were for subscription software. This includes the largest subscription software deal in our history, a five-year full-suite deal with one of the largest food service companies in the world. I think the deal was additionally significant and that it was a direct replacement and a win against SAP, and included significant commitment to managing supplier relationships and millions of annual transactions through the Ariba supplier network. One of our goals with on-demand was to penetrate large ERP accounts, and we are doing well on this front. For example, this quarter we had a win at a customer that already purchased all of Oracle's suite of procurement applications, but they still chose Ariba on-demand for its complete source-to-pay platform.

In another case, a large information service company that was in the process of standardizing on SAP for its back-end solutions elected to subscribe to Ariba on-demand Procure-To-Pay solution because of our ability to rapidly deploy and deliver quick cost-savings results. We have a number of other customers that are connecting directly from the ERP procurement implementations to the Ariba supplier network to quickly enable their suppliers, and when we set out on our on-demand mission, I'll remind you our goal was to create an opportunity where we would co-exist with the ERP solutions as opposed to being positioned in an us or them scenario. The experience we've had and the success we have had growing our business these past few quarters clearly signals that the strategy is working.

Another area where we target growth is with our channel strategy. In December, I laid out for you our renewed focus on developing a successful channel eco system. We expanded our channels program and we put forth a strategy to drive more demand for our on-demand solutions through a broader network of channel partners. Well, I am happy to report that Ariba's channel strategy is already taking hold and there are several near-term opportunities in front of us. To date, we've already added six new strategic channel partners, companies like Aon Corporation, CCP Global, the Shelby Group, Keane and Wipro. These deals added over $3 million in committed bookings and contract values. But the commitments are really just a down payment on what we jointly expect to be a much larger, future opportunity.

In addition to these deals, we have a number of additional significant channel partnerships that I hope to share with you in a not too distant future. The final area of growth I want to discuss is the Ariba supplier network. As I've stated before, the network is a core growth engine and strategic asset for the future of this market. Last year, hundreds of buying organizations conducted more than $110 billion worth of goods and services with more than 168,000 global suppliers on our network. That's anywhere from 5 to 10 times the size and volume of any competing network. Participation and volume in this network is growing in the double-digit level each year, and we are on track to nearly double our network software revenue here in 2008.

From a business perspective, buying organizations, who are using the network, have higher retention and loyalty rates than our customers that do not leverage the network. So we are looking to get more and more customers hooked on the network. From a supplier point of view, we have excellent retention as well, we are seeing renewal rates with suppliers at the same 92% rate as we always have, and I think this is an important fact since we recently changed our business model for the network. And with the key renewal months of November and December behind us, I am pleased to say our renewals and our supplier business this year are as strong as ever.

What's even more encouraging is that there has been a significant improvement in the rate at which new supplier relationships are joining and paying on the network. All these factors demonstrate that the network continues to outpace the industry in terms of adding value to inner enterprise commerce relationships, but we are not content with stopping here. In fact, we are going to double down on this investment to expand the participation, the value, and the utility of our network.

On-demand has made it easier for customers to get to the network and easier for us to get more customers using the network. Coming up at Ariba (inaudible) in a few weeks, I hope to share more on our plans to drive additional services via the network for both existing Ariba software companies and companies that may not be current customers. We are planning to expand ways for buyers and suppliers to collaborate over the network, such as buyer supplier, matching and discovery services, and we plan to enhance community aspects on the network such as buyer/seller ratings and market intelligence services. All of this is going to enhance the value that our buyers and sellers derive from the network, as well as add additional the [buyer] revenue streams for us.

Before I conclude, let me give a few comments on the macroeconomic environment. We are not immune to a recessionary environment, but as you know I spend a great deal of my time with our customers and our prospects, and I have yet to see or hear customers pulling back from current planned investments and spend management, which I find very encouraging. Instead of a pullback, what I do see is that the pressures in the market today are actually playing to Ariba's strengths, and that has to be one of the reasons why we just experienced a record quarter in our software bookings.

Companies today are facing two macro trends. The first is rapid and widespread inflation; the second being slower growth. Both of these factors are causing companies to realize they need to focus on reducing costs, and spend management today is one of if not the best opportunity to reduce cost. This heightened focus on cost reduction requires companies to embrace spend management as a strategic initiative, and I see that pretty much happening all over.

One way to illustrate this is the fact that we had several transactions this quarter in the financial services sector, including wins at BNP Paribas, National City and GMAC, and we even did some work for Bear Stearns this quarter. And this is not just limited to financial companies. Companies in many verticals are feeling the macro pressures, and we are getting good traction in the automotive sector, the manufacturing sector and in retail sectors, with wins at companies like Nissan, Michelin and Kroger, amongst many others.

I believe this demonstrates that companies recognize that cutting costs takes more than just turning off the spigot. On-demand is also a strength of ours that is aiding us in today's market. A Forrester Research study recently of more than 1,000 companies found that on-demand software as a service solution adoption claimed 33% year-over-year. The weak economy helps as on-demand provides the flexibility and the speed that companies need to quickly deploy solutions and start to realize immediate cost savings. And our complementary service is also key to our growth, and I believe another strength that is playing well in the current environment.

Our global services business is up with particularly high demand for strategic sourcing and spend management services, which has been trending up for some time now. And this has proven to be a good entry point for us. In fact, several of our $1 million plus software deals this quarter were expansion sales at accounts that we first penetrated with sourcing services just a few quarters ago. So I continue to be very pleased with the progress we are making on all of our growth initiatives. Our subscription software business continues to grow with solid, if not impressive increases in both the revenues and backlog. Our investment in Procuri and our channel program are contributing positively, and the Ariba network has become a significant contributor to both revenue and growth.

So let me reiterate that with the momentum we have built over the past few quarters, coupled with the shift in attitudes favoring on-demand solutions, I believe Ariba is well-positioned for continued high margin growth. This has led us to forecast strong operating profitability for the full-year of '08, with significant sequential increases in each of our remaining two quarters. We had a strong second quarter. We anticipate an even stronger third quarter, and we've reaffirmed the full-year forecast which implies we expect a very strong Q4 on both the top and the bottom line.

I believe the run rate that we will exit the year at will provide a solid foundation for a very good 2008; that will be up significantly versus what will be an already good 2008. I am confident we have the right strategy. I'm equally confident we have the right solutions and leadership, and most of all I am confident we have a plan and a path to achieve our goals and objectives for the year.

So with that, let me turn the call over to your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question is from Greg Dunham with Deutsche bank.

Greg Dunham - Deutsche Bank

Thank you very much. I really just want to first hit on the million dollar deal. This is the most million dollar deals you've had since fiscal Q4 in 2006. In this economy, I am a little surprised at the number of large deals. Could you talk about the buying trends of some of your larger customers, and specifically is this a one-time thing you're seeing, or are you seeing a general trend here?

Bob Calderoni

I have been seeing a general trend in our pipeline for a few quarters now. You know, the programs and the projects that we have been talking to our customers with have been rather large typically three-year deals, versus maybe a couple of years ago customers were more in a trial stage. So rather than one year programs, we are seeing more three-year programs, and also broader programs. Rather than one module, we're seeing multiple modules. I think it's a combination of the maturity of our products. Again, we've had five releases over the past two years, and today we now have an on-demand set of products equivalent to our CD products, and I think it is also a contributor from the current macro environment as well.

Greg Dunham - Deutsche Bank

Okay, that helps. And then, Jim, you mentioned getting closer to the higher end of that cash flow range for the year. A, what gives you the visibility of that and how confident are you that you can get there? And then I have a follow-up question on the maintenance line real quick.

Jim Frankola

Okay. Obviously, being halfway through the year and closing a quarter with $17 million of cash flow from operations before the adjustment items, it allows me to put a fair chunk of that cash flow target in the bag, so to speak. And then, quite frankly, the rest of it is math. So we are still tracking to the $0.45, which is $37 million of non-GAAP net income. I am getting more and more confident on the working capital benefit of the subscription model. We still collect significant amounts; on average $5 million or $6 million of cash collections in excess of revenue each and every quarter.

Now there's some seasonal inflows and outflows to that, but it's that cash collection in excess of revenue, the working capital benefit of the model, which as I go through the year gives me more and more confidence that we will be tracking toward the high end of that cash range.

Greg Dunham - Deutsche Bank

Okay. And then just one question quickly on maintenance. It was actually down sequentially this quarter. I know that has happened in the past. Anything that I should read into that?

Jim Frankola

No. Maintenance, we have some slight upticks and downticks each quarter because we don't begin to recognize maintenance revenue until we collect the cash. Overall, we're still tracking well north of a 95% renewal rate. Several of the past few quarters have been in the 98%, 99%. We actually had 100% renewal rate of maintenance. So I expect maintenance revenues to be very stable with just a slight 1% or 2% decline over time.

Greg Dunham - Deutsche Bank

All right. Thank you very much.

Operator

The next question is from Peter Goldmacher with Cowen & Co.

Peter Goldmacher - Cowen & Co.

Hi guys. I want to ask a quick clarifying question. Jim, I understood you to say you had 13 deals greater than $1 million; software deals greater than $1 million. And then later did you say there were 20 deals greater than $1 million? Is that all-in deals?

Jim Frankola

Yes, all-in 20 deals north of $1 million. The software component only north of $1 million was 13.

Peter Goldmacher - Cowen & Co.

Okay, great. Can you talk a little bit about the one big deal that Bob mentioned I think 12 times; word on the street that that was an eight figure deal. If it's a five-year duration, can you give us a little insight into how you are invoicing for it? And what I am really getting at is, it was a nice quarter, and I am trying to get a sense of how much this quarter was impacted by how much you were able to bring in this quarter and get recognized in deferred revenue in this quarter.

Bob Calderoni

It was a large transaction. It was a five-year transaction. It was significant both in terms of the length of the contract and also in the size of the commitment they make to us, because they're using pretty much the entire suite of our products, on-demand products. As far as impact in the current quarter, there's no revenue. I think the answer, Jim, is zero revenue. He shook his head yes if you couldn't see. It is zero revenue in the current quarter, Peter.

Jim Frankola

And Peter, given the size of this deal and the complexity, the revenue ramp-up over the next quarter or two will be less than a typical deal. So the revenue recognition on this one will lag slightly behind, obviously, the bookings and the backlog growth.

Peter Goldmacher - Cowen & Co.

Okay. And then did you invoice -- if it was a five-year deal, did you invoice -- are you invoicing it annually?

Jim Frankola

I'm not going to get into the discussions on any invoicing on any individual customer contract.

Peter Goldmacher - Cowen & Co.

Okay. So what's your average invoice duration and has that changed through the subscription business?

Jim Frankola

Most of our deals, the subscription software component is invoiced upfront annually. We do have some that are invoiced on other terms. Services components are generally invoiced on a -- closer to an as-delivered basis.

Peter Goldmacher - Cowen & Co.

Okay and then just a quick update on Emptoris.

Bob Calderoni

I think we are in the early stages still. The case is set for trial in October. I think that's pretty well confirmed. We remain pretty confident in our position here and feel good about all of the, you know, the pretrial decisions and pretrial actions that are taking place seem to reinforce our position.

Peter Goldmacher - Cowen & Co.

Okay. Thanks, guys.

Jim Frankola

Thanks Peter.

Operator

The next question is from Pat Walravens with JMP Securities.

Pat Walravens - JMP Securities

Great, thank you. First of all, congratulations. Secondly, would you have still been happy with the bookings had that big deal not closed in the quarter?

Bob Calderoni

Yes.

Pat Walravens - JMP Securities

You would have? Okay, good. Are there more like that out there?

Bob Calderoni

There's more large deals out there. I mean we just had -- remember we had 13 software deals this quarter greater than $1 million. One of them was the biggest we ever had. So even without that, it would have been 12 deals larger than $1 million. I look at the pipeline and I look at the number of transactions that we're working on with customers north of $1 million, and I feel pretty good about it. So even if we didn't close this deal, I think I would feel equally good about the business.

Pat Walravens - JMP Securities

And can you describe a little bit, I mean sort of where the lead came from? So how did the deal evolve to allow this company to have sort of this level of confidence?

Bob Calderoni

This company that what?

Pat Walravens - JMP Securities

In your mega-deal, let's call it that.

Bob Calderoni

Oh that one. Well, I don't think we're too hard to find, pat. When you are interested in procurement software, you are interested in anything to do around spend management or connecting with suppliers, if you are not thinking of talking to Ariba, you are not doing your job out there. So we have been working with this customer for quite some time, and they're in the food service industry. They have thousands and thousands of locations that they manage for their customers, and they buy lots of things in each of these small locations. And it was a very complex supply chain operation for them, and I think we were in the end -- not only in the end but very early in the project, I think we were really the only legitimate provider that could meet their needs. It was not competitive very early in the cycle.

Pat Walravens - JMP Securities

Interesting. And then, Jim, I think this is for you. I think you gave us the percentage growth, but could you just give us the subscription backlog number without Procuri?

Jim Frankola

Well, let me give you these numbers. The total backlog number is 101 for 12 months and 202 for the total backlog. The Procuri component of each of those was 15 million for the 12-month piece and 34 million for the full-year piece.

Pat Walravens - JMP Securities

Okay.

Jim Frankola

And then back those out.

Pat Walravens - JMP Securities

Okay. Thanks very much.

Jim Frankola

By the way, on slide 3 on the website, they're also noted there.

Pat Walravens - JMP Securities

Okay. Thank you.

Operator

Your next question is from Nathan Schneiderman with Roth Capital Partners.

Nathan Schneiderman - Roth Capital Partners

Hi, thanks very much. Hi, Bob; hi, Jim. Once again, congratulations, great job.

Bob Calderoni

Thank you.

Nathan Schneiderman - Roth Capital Partners

Jim you just gave us the Procuri numbers that were part of backlog. What was it the prior quarter?

Jim Frankola

Zero. So we did not enter Procuri into our accounting system until this quarter. The deal closed on December 17th, so there was no backlog in the previous quarters' numbers.

Nathan Schneiderman - Roth Capital Partners

Okay. Ex the additional lift from Procuri and let's say ex the -- can you share with us the exact dollar size of that large deal?

Bob Calderoni

No, we won't go into --.

Nathan Schneiderman - Roth Capital Partners

Will it be disclosed in your Q?

Jim Frankola

No.

Nathan Schneiderman - Roth Capital Partners

Okay.

Bob Calderoni

And we have had a number of large deals. This just happened to be larger than any of the other large deals, but it is not something that rises to the level where it has to be -- it is that significant that it has to be spelled out as a single deal.

Nathan Schneiderman - Roth Capital Partners

The suggestion that the network revenue was going to come in at $25 million versus $12 million, I remember you talking about some different numbers; if I recall, a $15 million target for this year. It may have just been the supplier fees, but how does that $25 million number compare with your prior expectation?

Jim Frankola

That $25 million is slightly higher than our prior expectations. The supplier membership fee component of that $25 million will be roughly $17 million. So we started out this year thinking that the supplier membership fees will be roughly $15 million of revenue for 2008. They're now tracking closer to $17 million.

Nathan Schneiderman - Roth Capital Partners

Ex the Procuri contribution to subscription backlog and let's X out the mega-deal as well; did the subscription numbers come in much higher than you were expecting or more along -- more so in line?

Jim Frankola

It was still a very good quarter. If you look at our organic growth in backlog, 12 month backlog organically grew I think about $6 million. The total backlog grew like $22 million organically. Those numbers are consistent where we would like to see growth in this business. So they represent very large year-over-year growth rates. They represent healthy bookings. We still, obviously, would always like to do better, but we are quite pleased with the results.

Bob Calderoni

And let me just help, maybe address where you and some of the other questions are going. This was not a one-deal quarter. Again, we did 13 million dollar deals. One was the -- you always have the largest, but this was the largest ever. We'd done 12 without it. If you look at the number of software deals over a million that we have done over the past year, I think we have averaged somewhere around four or five per quarter. So this was -- I would say this was a pretty broad-based strong quarter; not any single deal.

Nathan Schneiderman - Roth Capital Partners

Understood. I guess where I was going with this is it looks like even adjusting for these factors, subscription revenue or subscription backlog was higher than you were looking for, that network expectation is higher. Why did you not want to raise the revenue outlook here? Are you just going conservative or is there something else you are seeing that is holding you back?

Bob Calderoni

You know, it was less than a year ago; in August last year, Jim and I put out the guidance for '08 at -- I forget the specific revenue number, but the 335'ish kind of revenue for the year, $0.45 and $50'ish million of cash flow. When we put that out, we put that as a stake in the ground. That's what we are driving this organization to. Every 90 days, we assess where we are at. We revalidate our plan going forward and we tweak whatever we need to tweak to stay on track to those numbers.

We feel good about those numbers. We are reiterating those numbers, but we are sticking with those numbers until we hit them and then we're going to put out new numbers. But with all of that said, we feel very good about the business this quarter. We feel very good about the business the last two quarters, and we feel pretty good about what's in front of us to make that a reality in the next two quarters. Our goal is to meet or beat internally.

Nathan Schneiderman - Roth Capital Partners

Super. Final question for --.

Jim Frankola

Let me just add one more thing from a numbers standpoint. With the very large number of large deals, so not just the mega-deal but we had a number of deals north of $1 million. With those deals often comes complexity. They're bundled transactions. As such, the rev-rec rules will often prevent you from recognizing revenue as quickly as a $100,000 simple on-demand software deal. So part of what's going on is you see a very large addition to the total backlog that reflects the value of the transaction. The 12 month backlog grew at a lower rate, especially for the next quarter or two, because the revenue associated with some of these large deals isn't going to come in Q3 and Q4 quite as fast as you would see typically. So that's another reason why the very strong booking this quarter is not translating into faster revenue growth in Q3 and Q4.

Nathan Schneiderman - Roth Capital Partners

Got it. Final question for you, Jim. Last quarter on the call, you said you were pretty comfortable that in Q4 you would hit a 13% plus operating margin; that you would see sequential improvements in that margin going into 2009. Is that still your belief?

Jim Frankola

We're still tracking to a Q4 operating margin, somewhere in that 13%, 14%, 15% or so. And yes, I think as Bob said, that's going be the foundation for our '09 performance.

Nathan Schneiderman - Roth Capital Partners

Okay. Thanks a lot. Congrats again.

Operator

The next question is from Brad Reback with Oppenheimer & Co.

Brad Reback - Oppenheimer & Co.

Hey guys how are you?

Bob Calderoni

Hi Brad

Brad Reback - Oppenheimer & Co.

On the quota carrying reps, you have added a handful again; I guess another six sequentially and up from the beginning of the year. How aggressively will you continue to add, and is that just something we should expect going forward here to support the growth in the business?

Bob Calderoni

You know, I think we have been pretty consistently adding for the past -- actually, a little more than a year, and we are kind of within that level where we want to be right now. And we want to -- I think we want to let some of these adds that we've had season for another quarter or two. So I think you will probably see us move plus or minus a couple from where we are right now for the next two quarters. And when you are adding resources as rapidly as where every now and again you have to pause, let them season, and then start adding more again. So we will look to add more in '09.

Brad Reback - Oppenheimer & Co.

Great, and on the subscription renewal rates, have you guys seen any change, any improvement or any delta post Procuri getting the product roadmap set going forward?

Jim Frankola

Yes. What I would say is, it takes several quarters after a contract is up for renewal until you can actually measure the renewal rates. So, for example, on the network with the big class of renewals in November, now that we are several months beyond that, we can sit there and say we had a 92% renewal rate, which is very similar to what we have seen in previous years. So the network renewal rates are stable.

The Procuri renewal rates, the first crop that we did in the first quarter as an emerged company are tracking very well. Overall renewal rates measured over the past few quarters, they're still tracking at that 82% annualized value, and that's where we think we have -- we are not satisfied with that performance, and we think we have some upside as we execute to the model to increase that renewal rate.

Bob Calderoni

That's definitely a focus item of ours internally, and we're taking some operational steps to do things that we think could help drive that renewal rate up. We think that's a source of growth as much as new business is.

Brad Reback - Oppenheimer & Co.

And that is somewhat of an '09 event, Bob?

Bob Calderoni

I hope to see some -- we're certainly targeting internally to see results from our investments sooner than that. You know, you can't work on -- what we have learned is you can't work on a renewal at the renewal date. You really have to put some operational things in place to make sure that you identify customers that aren't getting enough usage out of your software, and those are the ones that don't renew.

If you got a stale project out there, you want to get in early enough so you can influence it. So the investments we've made have been operational investments to do things like that, and that does take a little bit of seasoning. So I don't expect much improvement this year, but it should start to pay dividends a few quarters from now.

Brad Reback - Oppenheimer & Co.

And final question, I'm assuming from the solid results on the network that the ASN dedicated sales force is doing pretty well out there still.

Bob Calderoni

They're doing pretty well. I think it is an area that we could do better on, quite honestly. We went from having a single sales force a year ago to this year having a few product-focused sales organization. We believe that's the right thing to do, but I don't think we have got that completely nailed yet. It is a little -- any time you change a sales organization, it could be a little disruptive and you don't get the productivity that you ultimately can. So I think there's room for improvement even there, even though we are doing okay right now. I don't want to say good because I know some of our guys are listening.

Brad Reback - Oppenheimer & Co.

Excellent. Thanks a lot.

Operator

The next question is from Robert Breza with RBC Capital Markets.

Robert Breza - RBC Capital Markets

Hi, good afternoon. Just a quick question. As you look at the headcount, if I wrote the numbers down correctly going from 1800 down to 1744, I was wondering if you could talk about the reduction in heads. Is that mostly on the Procuri side, and then where do you think headcount kind of ends up, and would you say the integration that leads from a headcount perspective is over? Thanks.

Jim Frankola

What I would say is that the headcount reductions you see come from both Procuri and Ariba heritage employees. We peaked at 1800. I think we'll see some continued declines in headcount as we execute our announced synergy strategies, offset by the fact that we have rapidly growing elements in our business that we will continue to fund as they grow. And that's on the network side and subscription software side, and many of our services businesses now are showing some good growth signs. So I anticipate to see probably a slight decline in that number over the next quarter, and then gradually ticking back up again.

Bob Calderoni

Our Chief Operating Officer, Kent Parker is a lean process guru, and in the last few months now that his role has been expanded, he's leading an operational excellence program inside, and we are looking at every one of our internal processes and looking to see where we could streamline the process and get more efficient in a variety of different ways. He's early in that program, but we think there's a number of opportunities for further efficiency later on in '08, and we will probably be in a position to talk more about it when we talk about the '09 plan later in the summer out there. But we are certainly looking for margin expansion opportunities by just being a lot more efficient in everything we do internally.

Robert Breza - RBC Capital Markets

Sounds great. That's it for me. Thank you.

Operator

The next question is from Brad Whitt with Broadpoint Capital.

Brad Whitt - Broadpoint Capital

Hey, guys, thanks for taking my question. Jim, I think if I heard you correctly, the subscription component guidance is $31 million to $32 million next quart?

Jim Frankola

Yes.

Brad Whitt - Broadpoint Capital

And you did $30.8 million this quarter?

Jim Frankola

Yes.

Brad Whitt - Broadpoint Capital

It seems like with the, you know, big ups -- big increases in your backlog that would be more than just kind of flattish next quarter.

Jim Frankola

Part of it is when you look at the network revenues, specifically the SMP, supplier membership program revenues; they went from $3 million in Q1 to $5 million in Q2. And part of that $5 million is a catch-up due to the fact that revenue gets hung up until we collect the cash. That's worth about $600,000. So if I were to normalize my March results, my March results are really closer to $30 million of subscription software revenue, growing to $31 million to $32 million next year, which is consistent with the nature of the bookings that we got in the quarter and especially with some of these larger deals not showing up in revenue quite as fast as I will say some of the smaller deals.

Brad Whitt - Broadpoint Capital

Okay, that's helpful. And just a clarification on how you define software deals. I am assuming you are adding up all of the years of the contracts when you say they're over $1 million. So if it's a three-year deal, you have three years -- it is not $1 million per year.

Jim Frankola

Correct.

Bob Calderoni

Correct.

Brad Whitt - Broadpoint Capital

Bob, you talked a little bit about the Procuri customer that did a three-year renewal, 1500 users.

Did they renew on Procuri or did they renew on Ariba?

Bob Calderoni

In that particular case, they renewed that specific solution on the Procuri solution. They will ultimately -- I believe they will ultimately migrate to the Ariba solution, but because their renewal came up so quickly after the acquisition, their project planning just didn't allow them to be in a position to do that. But many of the other customers that have renewals later in the cycle, I think they are likely just to use that renewal period as a jump-off period and go to Ariba.

Now with that one customer that renewed on a Procuri platform, that customer is also looking at some additional modules that Procuri did not offer with Ariba, and that would be obviously Ariba software in that case. And I fully expect that customer within that three-year period would be migrating to Ariba software anyway, just they weren't ready to do it right now.

Brad Whitt - Broadpoint Capital

Okay. And then another question; can you comment a little bit on your release that you are expecting, the on-premise release for later this summer? And curious as to whether or not you think that's going to drive more implementation-type services.

Bob Calderoni

Yes, so there are a number of customers that have CD customers that have been waiting for this release, and they're actively talking to us now about upgrades. So we do see that fueling some growth in our implementation services business. You know, by the time we sign -- the product will be available in the summer. We will probably be signing those deals beginning this summer and in the September quarter, and probably start to see the revenue of that if not in the September quarter, certainly in the December quarter.

Brad Whitt - Broadpoint Capital

Okay. Thanks for taking my questions.

Jim Frankola

Thanks, Brad.

Operator

(Operator Instructions). The next question is from Richard Williams with [Cross Research].

Richard Williams - Cross Research

Thanks for taking my question. Very nice to see the accelerating results, guys.

Bob Calderoni

Thanks, Richard.

Richard Williams - Cross Research

Could you break out for us the North American, EMEA and APAC results in sales?

Jim Frankola

Yes. From a bookings standpoint, North America and Asia did pretty well this quarter. So North America was about two-thirds of our bookings, Asia was about 12%; EMEA was a little bit less than 20% this quarter. From a revenue standpoint, revenue is a lagging indicator. It doesn't change very often. North America about 65%, Europe in the low 20s, Asia about 7%, and a couple of our corporate businesses make up the balance.

Richard Williams - Cross Research

Okay. What were the ASN revenues in this quarter?

Jim Frankola

The total network revenues this quarter were $7 million, of which the supplier membership fees made up $5 million of that.

Richard Williams - Cross Research

Okay. And did you see any significant impact in cash earnings from lower interest rates in the marketplace?

Jim Frankola

Yes, our interest income this quarter fell modestly, and we expect that to continue to decline slightly over the next quarter.

Richard Williams - Cross Research

And what kind of interest rate do you get off of auction rate securities at the moment?

Jim Frankola

Our auction rate securities have an average interest rate about 3.6% of face value.

Richard Williams - Cross Research

Wow, that's not bad compared to maybe 1.25% for two of those.

Jim Frankola

Yes.

Richard Williams - Cross Research

Okay. Thanks very much and congrats on the quarter.

Bob Calderoni

Great. Thanks, Richard.

Jim Frankola

Thanks, Richard.

Operator

At this time, there are no further questions in queue. I would like to turn the call back over to management for closing remarks.

Bob Calderoni

Thank you, Joe. This is Bob. I just wanted to remind everybody we have got lots of IR activities coming up in the May/June quarter combination of numerous conferences on both East Coast and West Coast. We also have our Ariba LIVE event, which I know many of you attend in a few weeks. I look forward to seeing you there and also at some of the other IR activities we have coming up. And we are looking forward to continued progress on many of the trends we've established these first two quarters, and wrapping up a very, very strong second half of '08, with good momentum into '09. So I appreciate everyone being on the call and see you in the next few weeks. Take care.

Operator

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Ariba Inc. F2Q08 (Qtr End 3/31/08) Earnings Call Transcript
This Transcript
All Transcripts