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Ariba 10-Q 2007
Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


Form 10-Q

 


 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2007

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period From                  to                 

Commission File Number 000-26299

 


ARIBA, INC.

(Exact name of registrant as specified in its charter)

 


 

Delaware   77-0439730
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification Number)

807 11th Avenue

Sunnyvale, California 94089

(Address of principal executive offices)

(650) 390-1000

(Registrant’s telephone number, including area code)

 


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Large accelerated filer  x            Accelerated filer  ¨            Non-accelerated filer  ¨

Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The number of shares outstanding of the registrant’s common stock as of July 31, 2007 was 78,872,885.

 



ARIBA, INC.

INDEX

 

          Page
No.
PART I. FINANCIAL INFORMATION   
Item 1.   

Financial Statements

   3
  

Condensed Consolidated Balance Sheets as of June 30, 2007 (unaudited) and September 30, 2006

   3
  

Condensed Consolidated Statements of Operations for the three and nine months ended June 30, 2007 and 2006 (unaudited)

   4
  

Condensed Consolidated Statements of Cash Flows for the nine months ended June 30, 2007 and 2006 (unaudited)

   5
  

Notes to Condensed Consolidated Financial Statements (unaudited)

   6
Item 2.   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   21
Item 3.   

Quantitative and Qualitative Disclosures About Market Risk

   32
Item 4.   

Controls and Procedures

   34
PART II. OTHER INFORMATION   
Item 1.   

Legal Proceedings

   36
Item 1A.   

Risk Factors

   36
Item 2.   

Unregistered Sales of Equity Securities and Use of Proceeds

   44
Item 3.   

Defaults Upon Senior Securities

   44
Item 4.   

Submission of Matters to a Vote of Security Holders

   44
Item 5.   

Other Information

   44
Item 6.   

Exhibits

   45
  

Signatures

   46

 

2


PART I: FINANCIAL INFORMATION

 

Item 1. Financial Statements

ARIBA, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

 

     June 30,
2007
    September 30,
2006
 
     (unaudited)        
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 23,266     $ 51,997  

Marketable securities

     121,697       86,769  

Restricted cash

     1,100       1,550  

Accounts receivable, net of allowance for doubtful accounts of $2,567 and $3,011 as of June 30, 2007 and September 30, 2006, respectively

     34,509       31,664  

Prepaid expenses and other current assets

     10,233       11,157  
                

Total current assets

     190,805       183,137  

Property and equipment, net

     19,797       19,830  

Long-term investments

     3,001       —    

Restricted cash, less current portion

     28,920       30,300  

Goodwill

     326,101       326,101  

Other intangible assets, net

     13,849       25,060  

Other assets

     3,196       2,516  
                

Total assets

   $ 585,669     $ 586,944  
                
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current liabilities:

    

Accounts payable

   $ 10,040     $ 9,863  

Accrued compensation and related liabilities

     20,075       24,694  

Accrued liabilities

     19,214       21,589  

Restructuring obligations

     19,926       14,888  

Deferred revenue

     57,849       40,035  

Deferred income—Softbank

     3,950       13,572  
                

Total current liabilities

     131,054       124,641  

Deferred rent obligations

     22,621       22,668  

Restructuring obligations, less current portion

     57,000       80,406  

Deferred revenue, less current portion

     26,960       25,641  

Deferred income—Softbank, less current portion

     —         565  
                

Total liabilities

     237,635       253,921  
                

Commitments and contingencies (Note 3)

    

Stockholders’ equity:

    

Common stock

     157       151  

Additional paid-in capital

     5,060,844       5,032,538  

Accumulated other comprehensive income

     1,367       3,475  

Accumulated deficit

     (4,714,334 )     (4,703,141 )
                

Total stockholders’ equity

     348,034       333,023  
                

Total liabilities and stockholders’ equity

   $ 585,669     $ 586,944  
                

See accompanying Notes to Condensed Consolidated Financial Statements.

 

3


ARIBA, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited; in thousands, except per share data)

 

     Three Months Ended
June 30,
    Nine Months Ended
June 30,
 
     2007     2006 (1)     2007     2006 (1)  

Revenues:

        

Subscription and maintenance

     36,613       32,270       104,851       96,703  

Services and other

     38,951       41,363       121,299       126,903  
                                

Total revenues

     75,564       73,633       226,150       223,606  
                                

Cost of revenues:

        

Subscription and maintenance

     8,490       6,894       24,534       20,359  

Services and other

     28,490       33,341       88,016       98,703  

Amortization of acquired technology and customer intangible assets

     3,356       3,696       10,786       12,005  
                                

Total cost of revenues

     40,336       43,931       123,336       131,067  
                                

Gross profit

     35,228       29,702       102,814       92,539  
                                

Operating expenses:

        

Sales and marketing

     23,389       23,518       69,461       58,601  

Research and development

     13,254       12,333       38,845       37,080  

General and administrative

     10,822       6,973       29,108       24,138  

Other income—Softbank

     (3,390 )     (3,396 )     (10,173 )     (10,190 )

Amortization of other intangible assets

     101       200       425       600  

Restructuring

     (3,805 )     24,376       (3,805 )     25,379  
                                

Total operating expenses

     40,371       64,004       123,861       135,608  
                                

Loss from operations

     (5,143 )     (34,302 )     (21,047 )     (43,069 )

Interest and other income, net

     3,456       3,138       11,462       5,974  
                                

Net loss before income taxes

     (1,687 )     (31,164 )     (9,585 )     (37,095 )

Provision for income taxes

     347       318       1,608       643  
                                

Net loss

   $ (2,034 )   $ (31,482 )   $ (11,193 )   $ (37,738 )
                                

Net loss per share—basic and diluted

   $ (0.03 )   $ (0.48 )   $ (0.16 )   $ (0.58 )
                                

Weighted average shares—basic and diluted

     70,340       65,817       69,589       65,493  
                                

(1) The Company has made certain reclassifications to prior year amounts to conform to the current year presentation, none of which affected net loss or net loss per share. See Note 1 of Notes to Condensed Consolidated Financial Statements.

See accompanying Notes to Condensed Consolidated Financial Statements.

 

4


ARIBA, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited; in thousands)

 

    

Nine Months Ended

June 30,

 
     2007     2006  

Operating activities:

    

Net loss

   $ (11,193 )   $ (37,738 )

Adjustments to reconcile net loss to net cash provided by operating activities:

    

(Recovery of) provision for doubtful accounts

     (285 )     (158 )

Depreciation

     5,186       5,926  

Amortization of intangible assets

     11,211       12,605  

Stock-based compensation

     26,259       29,910  

Restructuring

     (3,805 )     25,379  

Realized gains—currency translation adjustment (Note 4)

     (2,625 )     —    

Changes in operating assets and liabilities:

    

Accounts receivable

     (2,560 )     7,033  

Prepaid expenses and other assets

     244       (2,594 )

Accounts payable

     177       1,876  

Accrued compensation and related liabilities

     (4,619 )     (7,865 )

Accrued liabilities

     (3,323 )     (4,200 )

Deferred revenue

     19,133       11,806  

Deferred income—Softbank

     (10,173 )     (10,190 )

Restructuring obligations

     (13,662 )     (13,108 )
                

Net cash provided by operating activities

     9,965       18,682  
                

Investing activities:

    

Purchases of property and equipment

     (5,153 )     (4,239 )

Purchases of marketable securities, net of sales

     (37,929 )     (7,549 )

Allocation from restricted cash, net

     1,830       1,425  
                

Net cash used in investing activities

     (41,252 )     (10,363 )
                

Financing activities:

    

Proceeds from issuance of common stock, net

     4,309       5,059  

Repurchase of common stock

     (2,256 )     (2,025 )
                

Net cash provided by financing activities

     2,053       3,034  
                

Effect of foreign exchange rate changes on cash and cash equivalents

     503       143  
                

Net change in cash and cash equivalents

     (28,731 )     11,496  

Cash and cash equivalents at beginning of period

     51,997       60,909  
                

Cash and cash equivalents at end of period

   $ 23,266     $ 72,405  
                

See accompanying Notes to Condensed Consolidated Financial Statements.

 

5


ARIBA, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Note 1—Description of Business and Summary of Significant Accounting Policies

Description of Business

Ariba, Inc., along with its subsidiaries (collectively referred to herein as the “Company”), provides spend management solutions that allow enterprises to efficiently manage the purchasing of non-payroll goods and services required to run their business. The Company refers to these non-payroll expenses as “spend.” The Company’s solutions include software, network access, professional services and expertise. They are designed to provide enterprises with technology and business process improvements to better manage their spend and, in turn, save money. The Company’s software and services streamline and improve the business processes related to the identification of suppliers of goods and services, the negotiation of the terms of purchases, and ultimately the management of ongoing purchasing and settlement activities.

Basis of Presentation

The unaudited condensed consolidated financial statements of the Company reflect all adjustments (all of which are normal and recurring in nature) that, in the opinion of management, are necessary for a fair presentation of the interim periods presented. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for any subsequent quarter or for the entire year ending September 30, 2007. Certain information and note disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted under the Securities and Exchange Commission’s (“SEC”) rules and regulations. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto, together with management’s discussion and analysis of financial condition and results of operations, presented in the Company’s Annual Report on Form 10-K for the year ended September 30, 2006 filed on December 1, 2006 with the SEC.

Reclassifications

The Company has made certain reclassifications to prior year amounts to conform to the current year presentation, none of which affected net loss or net loss per share. Specifically, given the Company’s shift to an on-demand model and the declining amount of perpetual software revenues, the Company reclassified $651,000 and $5.4 million of license revenues in the three months ended June 30, 2006 to subscription and maintenance revenues (term component) and services and other revenues (perpetual component), respectively, and $2.7 million and $16.1 million in the nine months ended June 30, 2006, respectively. The Company reclassified $306,000 and $1.4 million of cost of revenues—license in the three and nine months ended June 30, 2006 to cost of revenues—services and other, respectively. The Company also reclassified $1.2 million and $3.1 million of compensation and benefits associated with certain employees from cost of revenues—subscription and maintenance in the three and nine months ended June 30, 2006 to sales and marketing, respectively. The following table reflects the effect of all of these reclassifications for the three and nine months ended June 30, 2006 (in thousands):

 

     Three Months Ended
June 30, 2006
   Nine Months Ended
June 30, 2006
     As Previously
Reported
   As
Reclassified
   As Previously
Reported
   As
Reclassified

Revenues—license

   $ 6,075    $ —      $ 18,832    $ —  

Revenues—subscription and maintenance

   $ 31,619    $ 32,270    $ 94,008    $ 96,703

Revenues—services and other

   $ 35,939    $ 41,363    $ 110,766    $ 126,903

Cost of revenues—license

   $ 306    $ —      $ 1,373    $ —  

Cost of revenues—subscription and maintenance

   $ 8,082    $ 6,894    $ 23,491    $ 20,359

Cost of revenues—services and other

   $ 33,035    $ 33,341    $ 97,330    $ 98,703

Sales and marketing

   $ 22,330    $ 23,518    $ 55,469    $ 58,601

 

6


Use of Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported results of operations during the reporting period. Actual results could differ from those estimates. The items that are significantly impacted by estimates include revenue recognition, the assessment of recoverability of goodwill and other intangible assets, restructuring obligations related to abandoned operating leases and contingencies related to the collectibility of accounts receivable and pending litigation.

Fair Value of Financial Instruments and Concentration of Credit Risk

The carrying value of the Company’s financial instruments, including cash and cash equivalents, investments, accounts receivable and accounts payable approximates fair value. Financial instruments that subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents, investments and trade accounts receivable. The Company maintains its cash, cash equivalents and investments with high quality financial institutions and limits its investment in individual securities based on the type and credit quality of each such security. The Company’s customer base consists of international businesses, and the Company performs ongoing credit evaluations of its customers and generally does not require collateral on accounts receivable. The Company maintains allowances for potential credit losses.

No customer accounted for more than 10% of total revenues for the three and nine months ended June 30, 2007 and 2006. In addition, no customer accounted for more than 10% of net accounts receivable as of June 30, 2007. One customer accounted for more than 10% of net accounts receivable as of September 30, 2006, the Company’s most recent fiscal year end.

Adoption of Accounting Standards

In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes. FIN 48 clarifies the accounting for uncertainty in income taxes in an enterprise’s financial statements in accordance with Statement of Financial Accounting Standard (“SFAS”) No. 109, Accounting for Income Taxes. FIN 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return and provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The provisions of FIN 48 are effective for the first quarter of fiscal year 2008 and the Company is currently evaluating the impact of this guidance on its financial position, results of operation and cash flows.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of SFAS No. 157 are effective for the fiscal year beginning October 1, 2008. The Company is evaluating the impact of the provisions of SFAS No. 157 on its financial condition, results of operations and cash flows.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No. 159 allows entities the option to measure eligible financial instruments at fair value as of specified dates. Such election, which may be applied on an instrument by instrument basis, is typically irrevocable once elected. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007, and early application is allowed under certain circumstances. The Company has not yet determined the impact this interpretation will have on its financial position, results of operation and cash flows.

 

7


Revenue Recognition

Substantially all of the Company’s revenues are derived from two sources: (i) providing software solutions on either a standalone or on-demand hosted basis and associated technical support and product updates, otherwise known as subscription and maintenance; and (ii) providing services, including implementation services, consulting services, managed services, training, education, premium support and other miscellaneous services. The significant majority of the Company’s standard end user license agreements provide for use of the Company’s software under a time-based license based on the number of users or other usage criteria. The Company licenses its software in multiple element arrangements in which the customer typically purchases a combination of some or all of the following: (i) software solutions, either on a standalone or on-demand hosted basis; (ii) a maintenance arrangement, which is generally priced as a percentage of the software license fees and provides for hosting, technical support and unspecified product updates typically over a period of one year or over the term of the license; and (iii) a services arrangement, on either a fixed fee for access to specific services over time or a time and materials basis.

The Company licenses its products through its direct sales force and indirectly through resellers. Sales made through resellers are recognized at the time that the Company has received persuasive evidence of an end user customer. The license agreements for the Company’s products generally do not provide for a right of return, and historically product returns have not been significant. The Company does not recognize revenue for refundable fees or agreements with cancellation rights until such rights to refund or cancel have expired. Direct sales force commissions are accounted for as sales and marketing expense at the time of sale, when the liability is incurred and is reasonably estimable.

The Company recognizes revenue in accordance with Staff Accounting Bulletin (“SAB”) 104, Revenue Recognition, Emerging Issues Task Force (“EITF”) 00-21, Revenue Arrangements with Multiple Deliverables, and Emerging Issues Task Force (“EITF”) 00-3, Application of AICPA Statement of Position (“SOP”) 97-2 to Arrangements That Include the Right to Use Software Stored on Another Entity’s Hardware, and SOP 97-2, Software Revenue Recognition, as amended by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions. The Company recognizes revenue when all of the following criteria are met: persuasive evidence of an arrangement exists; delivery of the product or service has occurred; the fee is fixed or determinable; and collectibility is probable. If fees are not “fixed or determinable”, revenue is recognized when fees are due and payable. If collectibility is not considered probable at the inception of the arrangement, the Company does not recognize revenue until the fee is collected.

The Company allocates revenue to each element in a multiple element arrangement based on its respective fair value. The Company’s determination of the fair value of each element in a multiple element arrangement accounted for under SOP 97-2 is based on vendor-specific objective evidence of fair value (VSOE), which is limited to the price when sold separately. VSOE or other methods of determining fair value that are allowable under EITF 00-21 are utilized for multiple element arrangements that are not subject to SOP 97-2.

Revenue from software solutions, hosting and sourcing solutions services is primarily recognized ratably over the term of the arrangement, commencing with the initial customer access date. Revenue allocated to maintenance and support is recognized ratably over the maintenance term (typically one year). Revenue allocated to software solutions implementation, process improvement, training and other services is recognized as the services are performed or as milestones are achieved or if bundled with a subscription or time-based arrangement or in circumstances where fair value cannot be established for undelivered service elements, is recognized, ratably over the term of the access agreement.

Certain of the Company’s contracts include performance incentive payments based on market volume and/or savings generated, as defined in the respective contracts. Revenue from such arrangements is recognized when those thresholds are achieved.

 

8


When revenue associated with multiple element arrangements is recognized and more than one element in an arrangement does not have fair value, the Company first allocates revenue on the statement of operations to those elements for which evidence of fair value is available.

In circumstances where the Company provides consulting services that are considered essential to the functionality of the software solutions, both the software solution revenue and service revenue are recognized under contract accounting in accordance with the provisions of SOP 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts. Revenues from these arrangements are recognized under the lesser of percentage of completion method based on the ratio of direct labor hours incurred to date to total projected labor hours or ratable over the term of the license.

Deferred revenue includes amounts received from customers for which revenue has not been recognized, and generally results from deferred subscription, maintenance and support, hosting, consulting or training services not yet rendered and license revenue deferred until all requirements under EITF 00-21 or SOP 97-2 are met. Deferred revenue is recognized as revenue upon delivery of the Company’s product, as services are rendered, or as other requirements under SAB 104, EITF 00-21 or SOP 97-2 are satisfied. Deferred revenue excludes contract amounts for which payment has yet to be collected. Likewise, accounts receivable excludes amounts due from customers for which revenue has been deferred.

Stock-Based Compensation and Deferred Stock-Based Compensation

The Company maintains stock-based compensation plans which allow for the issuance of stock options and restricted common stock to executives and certain employees. The Company also maintains an employee stock purchase plan (“ESPP”) that provides for the issuance of shares to all eligible employees of the Company at a discounted price.

Effective October 1, 2005, the Company adopted the fair value recognition provisions of SFAS No. 123R. This statement applies to all awards granted after the effective date and to modifications, repurchases or cancellations of existing awards. Additionally, under the modified prospective transition method of adoption, the Company recognizes compensation expense for the portion of outstanding awards on the adoption date for which the requisite service period has not yet been rendered based on the grant-date fair value of those awards calculated under SFAS No. 123 and SFAS No. 148. The Company amortizes the fair value of awards granted both before and after October 1, 2005 on an accelerated basis.

SFAS No. 123R requires that forfeitures be estimated over the vesting period of an award, rather than being recognized as a reduction of compensation expense when the forfeiture actually occurs.

Determining Fair Value

Valuation and amortization method. The Company estimates the fair value of stock options granted using the Black-Scholes option valuation model and a multiple option award approach. All options are amortized over the requisite service periods of the awards, which are generally the vesting periods, and are amortized using the accelerated method.

Expected term. The expected term of options granted represents the period of time that they are expected to be outstanding. The Company estimates the expected term of options granted based on historical exercise patterns, which the Company believes are representative of future behavior.

Expected volatility. The Company estimates the volatility of its common stock in the Black-Scholes option valuation at the date of grant based on historical volatility rates over the expected term, consistent with SFAS No. 123R and SAB 107.

 

9


Risk-free interest rate. The Company bases the risk-free interest rate in the Black-Scholes option valuation model on the implied yield in effect at the time of option grant on U.S. Treasury zero-coupon issues with equivalent remaining terms.

Dividends. The Company has never paid any cash dividends on its common stock and does not anticipate paying any cash dividends in the foreseeable future. Consequently, the Company uses an expected dividend yield of zero in the Black-Scholes option valuation model.

Forfeitures. SFAS No. 123R requires the Company to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. The Company uses historical data to estimate pre-vesting option forfeitures and records share-based compensation expense only for those awards that are expected to vest.

The Company granted 8,600 options in the nine months ended June 30, 2006. The fair value of options granted were estimated at the date of grant using the Black-Scholes option pricing model and the following assumptions: expected life of 2.8 years, risk-free interest rate of 4.25%, volatility of 83% and dividend yield of 0%.

The Company modified the terms of its employee stock purchase plan in August 2006 to eliminate the option component associated with the plan. The fair value of the option component of the employee purchase plan shares purchased prior to August 2006 was estimated at the date of grant using a Black-Scholes option-pricing model. The following weighted-average assumptions were used in each quarter of fiscal 2006: expected life of 1.25 years, risk-free interest rate of 4.34%, volatility of 51% and dividend yield of 0%.

During the nine months ended June 30, 2007, the Company accelerated approximately 259,000 unvested stock options, which resulted in approximately $1.0 million of compensation cost. During the three months ended June 30, 2007 and 2006, the Company recorded $170,000 and $2.6 million, respectively, of stock-based compensation expense associated with employee and director stock options and employee stock purchase plan programs. During the nine months ended June 30, 2007 and 2006, the Company recorded $2.3 million and $7.1 million, respectively, of stock-based compensation expense associated with employee and director stock options and employee stock purchase plan programs.

During the three months ended June 30, 2007 and 2006, the Company granted 175,000 shares and 333,000 shares, respectively, of restricted common stock to certain employees with a fair value of $1.7 million and $2.9 million, respectively. During the nine months ended June 30, 2007 and 2006, the Company granted 1.8 million and 3.0 million shares, respectively, of restricted common stock to certain employees with a fair value of $16.0 million and $27.1 million, respectively. These amounts will be amortized in accordance with FASB Interpretation No. 28 (“FIN 28”), Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans, over the vesting period of the individual restricted common stock grants, which are three years. During the nine months ended June 30, 2007, the Company also granted 980,000 shares of restricted common stock to executive officers and certain key employees with a fair value of $7.5 million whose vesting is contingent upon meeting a performance milestone related to subscription software revenues and is being amortized over the performance period. The fair value of each restricted share granted was calculated based on the closing stock price on the date of grant and assumes that the performance objective milestone will be achieved. If the performance objective is not achieved, any previously recognized compensation cost will be reversed. During the three months ended June 30, 2007 and 2006, the Company recorded $7.4 million and $8.7 million, respectively, of stock-based compensation expense associated with restricted stock grants. During the nine months ended June 30, 2007 and 2006, the Company recorded $22.0 million and $22.8 million, respectively, of stock-based compensation expense associated with restricted stock grants. As of June 30, 2007, there was $28.4 million of unrecognized compensation cost related to non-vested restricted share-based compensation arrangements which is expected to be recognized over a weighted-average period of 0.8 years. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures.

 

10


The Company also made a contribution to the Ariba, Inc. Employees 401(k) Savings Plan in the form of common stock with a value of $663,000 and $2.0 million in the three and nine months ended June 30, 2007, respectively.

Total stock-based compensation expense of $8.2 million and $11.4 million was recorded in the three months ended June 30, 2007 and 2006, respectively, and $26.3 million and $29.9 million was recorded in the nine months ended June 30, 2007 and 2006, respectively, to various operating expense categories as follows (in thousands):

 

     Three Months Ended
June 30,
   Nine Months Ended
June 30,
     2007    2006    2007    2006

Cost of revenues—subscription and maintenance

   $ 531    $ 662    $ 1,578    $ 1,661

Cost of revenues—services and other

     1,775      2,642      5,722      6,754

Sales and marketing

     2,550      3,950      8,657      10,013

Research and development

     1,365      1,750      4,066      4,925

General and administrative

     1,991      2,427      6,236      6,557
                           

Total

   $ 8,212    $ 11,431    $ 26,259    $ 29,910
                           

Note 2—Other Intangible Assets

The table below reflects balances related to other intangible assets as of June 30, 2007 and September 30, 2006 (in thousands):

 

    Useful Life   June 30, 2007   September 30, 2006
     

Gross

carrying

amount

 

Accumulated

amortization

   

Net

carrying

amount

 

Gross

carrying

amount

 

Accumulated

amortization

   

Net

carrying

amount

Other Intangible Assets

             

Existing software technology

  18 to 36 months   $ 10,400   $ (10,400 )   $ —     $ 10,400   $ (9,515 )   $ 885

Order backlog

  6 months     100     (100 )     —       100     (100 )     —  

Trade name/trademark

  60 months     1,800     (1,120 )     680     1,800     (847 )     953

Excess fair value of Visteon in-place contract over current fair value

  10 months     1,894     (1,894 )     —       1,894     (1,894 )     —  

Visteon contract and related customer relationship

  48 months     3,206     (2,405 )     801     3,206     (1,803 )     1,403

Other contracts and related customer relationships

  48 months     51,081     (38,713 )     12,368     51,081     (29,262 )     21,819
                                         

Total

    $ 68,481   $ (54,632 )   $ 13,849   $ 68,481   $ (43,421 )   $ 25,060
                                         

Amortization of other intangible assets for the three and nine months ended June 30, 2007 totaled $3.5 million and $11.2 million, respectively. Of these amounts, amortization of $3.4 million and $10.8 million was recorded as cost of revenues in the three and nine months ended June 30, 2007, respectively, related to the Visteon contract and related customer relationship, other contracts and related customer relationships and existing software technology. Amortization of $101,000 and $425,000 was recorded as operating expense in the

 

11


three and nine months ended June 30, 2007, respectively, related to trade name/trademark and other contracts and related customer relationships.

Amortization of other intangible assets for the three and nine months ended June 30, 2006 totaled $3.9 million and $12.6 million, respectively. Of these amounts, amortization of $3.7 million and $12.0 million was recorded as cost of revenues in the three and nine months ended June 30, 2006, respectively, related to the Visteon contract and related customer relationship, other contracts and related customer relationships and existing software technology Amortization of $200,000 and $600,000 was recorded as operating expense in the three and nine months ended June 30, 2006, respectively, related to trade name/trademark and other contracts and related customer relationships.

Note 3—Commitments and Contingencies

Leases

In March 2000, the Company entered into a facility lease agreement for approximately 716,000 square feet in four office buildings and an amenities building in Sunnyvale, California for its headquarters. The operating lease term commenced in January 2001 through April 2001 and ends in January 2013. The Company occupies approximately 191,000 square feet in this facility. As of June 30, 2007, the Company had subleases for two and one-half buildings, totaling approximately 442,600 square feet, to third parties. These subleases expire in July 2007, August 2008 and January 2013. After giving effect to the expiration of the sublease agreement in July 2007 and the amendment of another sublease agreement executed in June 2007 (see discussion under “lease abandonment and leasehold impairment costs” below), the Company has subleases for two buildings, totaling approximately 356,000 square feet to third parties. The remaining 169,000 square feet is available for sublease. Minimum monthly lease payments are approximately $3.1 million and escalate annually, with the total future minimum lease payments amounting to $226.2 million over the remaining lease term. As part of this lease agreement, the Company is required to issue standby letters of credit backed by cash equivalents, totaling $29.3 million as of June 30, 2007, as a form of security through fiscal year 2013. Also, the Company is required by other agreements to hold an additional $680,000 of standby letters of credit, which are cash collateralized. These instruments are issued by the Company’s banks in lieu of a cash security deposit required by landlords for domestic and international real estate leases. The total cash collateral of $30.0 million is classified as restricted cash on the Company’s consolidated balance sheet as of June 30, 2007.

In February 2007, the Company entered into the sixth amendment to its lease in Pittsburgh, Pennsylvania, effective January 1, 2007. This location consists principally of the Company’s services organization and administrative activities. The amendment extends the lease term for approximately 91,000 square feet of office space that the Company occupies through December 2017. Effective January 1, 2007, the Company also surrendered the abandoned space it leased and made a payment of approximately $5.4 million to the landlord concurrent with the landlord’s signing of the sixth amendment in February 2007. The difference between the Company’s lease abandonment reserve associated with this abandoned space and the payment of $5.4 million was approximately $901,000 and is being recognized as contra rent expense over the remaining term of the lease through December 2017.

The Company leases certain equipment, software and its facilities under various noncancelable operating leases with various expiration dates through 2013. Rental expense was $8.1 million and $8.2 million for the three months ended June 30, 2007 and 2006, respectively, and $24.4 million and $25.2 million for the nine months ended June 30, 2007 and 2006, respectively. This expense was reduced by sublease income of $4.1 million and $4.3 million for the three months ended June 30, 2007 and 2006, respectively, and $12.1 million and $12.9 million for the nine months ended June 30, 2007 and 2006, respectively.

 

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The following table summarizes future minimum lease payments and sublease income under noncancelable operating leases as of June 30, 2007 (in thousands):

 

Year Ending September 30,

  

Lease

Payments

  

Contractual

Sublease

Income

2007

   $ 10,885    $ 2,309

2008

     43,526      7,950

2009

     43,717      7,227

2010

     44,578      7,591

2011

     45,307      7,957

Thereafter

     74,852      11,050
             

Total

   $ 262,865    $ 44,084
             

Of the total operating lease commitments noted above, $104.2 million is for occupied properties and $158.7 million is for abandoned properties, which are a component of the restructuring obligation.

Restructuring obligations

The following table details accrued restructuring obligations and related activity through June 30, 2007 (in thousands):

 

    

Severance

and

benefits

   

Lease

abandonment

costs

   

Total

restructuring

costs

 

Accrued restructuring obligations as of October 1, 2005

   $ 1,684     $ 84,816     $ 86,500  

Cash paid

     (1,915 )     (15,140 )     (17,055 )

Total charge to operating expense

     273       26,048       26,321  

Purchase accounting adjustment

     —         (472 )     (472 )
                        

Accrued restructuring obligations as of September 30, 2006

     42       95,252       95,294  

Cash paid

     (42 )     (13,620 )     (13,662 )

Total benefit to operating expense

     —         (3,805 )     (3,805 )

Reclassification to deferred rent obligations

     —         (901 )     (901 )
                        

Accrued restructuring obligations as of June 30, 2007

   $ —       $ 76,926       76,926  
                  

Less: current portion

         19,926  
            

Accrued restructuring obligations, less current portion

       $ 57,000  
            

Severance and benefits costs

Severance and benefits costs primarily include involuntary termination and health benefits, outplacement costs and payroll taxes for terminated personnel. During the nine months ended June 30, 2006, $273,000 of severance and benefits was recorded due to the continued reduction of the Company’s workforce, primarily to better align its expenses with its revenue levels and to enable the Company to invest in certain growth initiatives.

Lease abandonment and leasehold impairment costs

Lease abandonment costs incurred to date relate primarily to the abandonment of leased facilities in Sunnyvale, California and Pittsburgh, Pennsylvania.

In June 2007, the Company entered into an amendment with Juniper Networks, Inc. (“Juniper”), the successor in interest to NetScreen Technologies, Inc. (“NetScreen”) to the sublease dated as of October 18, 2002

 

13


between the Company and NetScreen. Pursuant to the amendment, Juniper agreed to renew its sublease of approximately 177,000 square feet of space at the Company’s Sunnyvale, California headquarters through January 2013. In addition, Juniper agreed, effective no later than December 1, 2007, to lease approximately 89,000 square feet of additional space at the Company’s Sunnyvale, California headquarters through January 2013. The Company’s Chief Executive Officer, Robert Calderoni, is also on the Board of Directors of Juniper and he abstained from voting on Ariba’s Board of Directors approval of the lease agreement. Also in June 2007, the Company revised its estimates for rental rate projections and sub-lease commencement dates to reflect current market conditions primarily in the Northern California real estate market. The impact of the execution of the amendment to the sublease agreement with Juniper was a benefit to operations of approximately $7.0 million and the impact of the revised estimated rental rate projections and sub-lease commencement dates was a charge to operations of $3.2 million, resulting in a net benefit to operations of $3.8 million in the three months ended June 30, 2007.

In February 2007, the Company entered into the sixth amendment to its lease in Pittsburgh, Pennsylvania, effective January 1, 2007. The amendment extends the lease term for approximately 91,000 square feet of office space that the Company occupies through December 2017. Effective January 1, 2007, the Company also surrendered approximately 91,000 square feet of abandoned space it leased and made a payment of approximately $5.4 million to the landlord concurrent with the landlord’s signing of the sixth amendment in February 2007. The difference between the Company’s lease abandonment reserve associated with this abandoned space and the payment of $5.4 million is approximately $901,000 and is being recognized as contra rent expense over the remaining term of the lease through December 2017.

In the three months ended June 30, 2006, the Company revised its estimates for sublease rental rate projections to reflect continued soft market conditions in the Northern California real estate market and sublease commencement dates, resulting in a charge of $24.4 million. The remaining charge of $730,000 in the nine months ended June 30, 2006 was for an adjustment to the Company’s restructuring obligation related to a prior period. The cumulative understatement of expenses for periods prior to the three months ended June 30, 2006 was approximately $730,000. The Company concluded that the effect of the adjustment was not material to the current or any relevant prior period. During the nine months ended June 30, 2006, the Company also recorded a $472,000 decrease to the restructuring obligation due to the assignment of a lease of an excess legacy FreeMarkets facility. The reversal of the remaining obligation related to this facility has been recorded as a decrease to goodwill.

Total lease abandonment costs include lease liabilities offset by estimated sublease income, and were based on market trend information analyses. As of June 30, 2007, $76.9 million of lease abandonment costs remain accrued and are expected to be paid by fiscal year 2013. The Company’s lease abandonment accrual is net of $73.3 million of estimated sublease income. Actual sublease payments due under noncancelable subleases of excess facilities totaled $44.1 million as of June 30, 2007, and the remainder of anticipated sublease income represents management’s best estimates of amounts to be received under future subleases. Actual future cash requirements and lease abandonment costs may differ materially from the accrual at June 30, 2007, particularly if actual sublease income is significantly different from current estimates. These differences could have a material adverse effect on the Company’s operating results and cash position. For example, a reduction in assumed market lease rates of $0.25 per square foot per month for the remaining term of the lease, with all other assumptions remaining the same, would increase the estimated lease abandonment loss on the Company’s Sunnyvale, California headquarters by approximately $3.1 million as of June 30, 2007.

Other arrangements

Other than the obligations identified above, the Company does not have commercial commitments under standby repurchase obligations or other such debt arrangements. The Company has no other off-balance sheet arrangements or transactions with unconsolidated limited purpose entities, nor does it have any undisclosed material transactions or commitments involving related persons or entities. The Company does not have any material noncancelable purchase commitments as of June 30, 2007.

 

14


Litigation

IPO Class Action Litigation

In 2001, a number of purported shareholder class action complaints related to the Company’s and FreeMarkets’ initial public offerings (the “IPOs”) were filed in the United States District Court for the Southern District of New York against the Company and FreeMarkets, Inc. (“FreeMarkets”), and against certain of the two companies’ former officers and directors. These complaints were later consolidated into single class action proceedings related to each IPO. In June 2003, a proposed settlement was reached between plaintiffs and the Company and FreeMarkets (the individual defendants having been previously dismissed). The Company merged with FreeMarkets in July 2004. In June 2005, the underwriters filed an appeal of the District Court’s order granting class certification in the consolidated action. On December 5, 2006, the Court of Appeals issued an opinion, reversing the District Court’s order granting class certification and finding that plaintiffs cannot satisfy certain elements required for class actions. In light of the Court of Appeals’ decision, the District Court has held several conferences with the parties to discuss how the litigation will proceed. During a conference on May 30, 2007, plaintiffs orally moved for class certification based on two new proposed classes. Plaintiffs’ deadline to file their opening brief on the motion to certify the classes is September 27, 2007. On June 25, 2007, the District Court entered an order terminating the proposed settlement based on a stipulation among the parties to the settlement. The plaintiffs have indicated that they will seek to amend their allegations and file amended complaints. The parties are currently discussing further discovery that the plaintiffs seek from the underwriters and the issuers. As of June 30, 2007, no amount is accrued as a loss is not considered probable or estimable.

Litigation Relating to Alleged Patent Infringement Disclosures Involving the Company’s Chairman and Chief Executive Officer and Former President and Director

On October 31, 2005, a purported class action, alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, was filed in the United States District Court for the Eastern District of Virginia against the Company’s Chairman and Chief Executive Officer and a former president and director of the Company. That case was transferred to the United States District Court for the Northern District of California and an Amended Complaint was filed on November 30, 2006, adding the Company as a defendant. The action is brought on behalf of stockholders who purchased the Company’s stock from June 10, 2003 to February 7, 2005. A second amended complaint was filed on May 18, 2007. It alleges that the defendants artificially inflated the Company’s stock price between those dates by failing to disclose, in public statements that the Company made about its products, market position and performance, that some of those products allegedly infringed patents belonging to a third party. The defendants filed a motion to dismiss plaintiff’s second amended complaint on July 20, 2007. As of June 30, 2007, no amount is accrued as a loss is not considered probable or estimable.

Patent Litigation

In October 2006, after an unsuccessful attempt to resolve the matter by negotiation, the Company was sued by Sky Technologies, Inc (“Sky”) for patent infringement in the United States District Court for the District of Massachusetts. The Complaint (which has been amended twice to add additional patents) does not specify which products are accused or what damages are claimed. Sky has served subsequent pleadings in the case contending that the Ariba Dynamic Trade and Ariba Sourcing software products (whether hosted by Ariba for specific customers or distributed to customers for installation at their sites), as well as certain other Ariba software products when used together with Ariba Sourcing software, infringe certain claims of two of the U.S. patents owned by Sky. Sky seeks economic relief in the form of a royalty on Ariba's sale of the accused products, other Ariba software products, and sourcing services, enhancement of damages, an attorneys fee award and an injunction against further infringement. The total amount of the royalty now claimed by Sky before interest, enhancement or attorneys fees is approximately $30.8 million. The current action has been set for trial commencing on December 3, 2007. Sky previously sought to add additional claims under a certificate of correction for the third patent in suit, but on June 7, 2007 the court denied its request to amend its pleading. Sky

 

15


might seek to add those claims or other claims under other patents against Ariba in a different proceeding in the future. As of June 30, 2007, no amount is accrued as a loss is not considered probable or estimable.

General

Defending against these actions and various other claims and legal actions arising in the ordinary course of business may require significant management time and, regardless of the outcome, result in significant legal expenses. If the Company’s defenses are unsuccessful or if it is unable to settle on favorable terms, the Company could be liable for a large damages award and, in the case of patent litigation, subject to an injunction that could seriously harm its business and results of operations.

Indemnification

The Company sells software licenses, access to its on-demand offerings and/or services to its customers under contracts that the Company refers to as Terms of Purchase or Software License and Service Agreements (collectively, “SLSA”). Each SLSA contains the relevant terms of the contractual arrangement with the customer, and generally includes certain provisions for indemnifying the customer against losses, expenses and liabilities from damages that may be incurred by or awarded against the customer in the event the Company’s software or services are found to infringe upon a patent, copyright, trade secret, trademark or other proprietary right of a third party. The SLSA generally limits the scope of remedies for such indemnification obligations in a variety of industry-standard respects, including but not limited to certain product usage limitations and geography-based scope limitations, and a right to replace an infringing product or service or modify them to make them non-infringing. If the Company cannot address the infringement by replacing the product or service, or modifying the product or service, the Company is allowed to cancel the license or service and return certain of the fees paid by the customer.

To date, the Company has not had to reimburse any of its customers for any losses related to these indemnification provisions and no material customer claims for such indemnification are outstanding as of June 30, 2007.

Note 4—Stockholders’ Equity

Stock-Based Compensation Plans

A summary of the activity related to the Company’s restricted common stock is presented below for the nine months ended June 30, 2007:

 

     Nine Months Ended
June 30, 2007
     Number of
Shares
   

Weighted-
Average

Fair

Value

Nonvested at beginning of period

   7,543,632     $ 7.98

Granted

   2,757,929     $ 8.53

Vested

   (1,805,429 )   $ 9.71

Forfeited

   (431,622 )   $ 6.86
        

Nonvested at end of period

   8,064,510     $ 7.85
        

The fair value of stock awards vested was $1.8 million and $1.0 million for the three months ended June 30, 2007 and 2006, respectively and $16.0 million and $6.2 million for the nine months ended June 30, 2007 and 2006, respectively.

 

16


A summary of the activity related to the Company’s stock options is presented below:

 

    

Nine Months Ended

June 30, 2007

     Number of
Options
    Weighted-
Average
Exercise
Price
   Aggregate
Intrinsic
Value

Outstanding at beginning of period

   1,946,852     $ 11.95   

Granted

   —       $ —     

Exercised

   (453,140 )   $ 5.27   

Forfeited

   (154,221 )   $ 26.05   
           

Outstanding at end of period

   1,339,491     $ 12.58    $ 3,274,000
           

Exercisable at end of period

   1,339,491     $ 12.58    $ 3,274,000
           

The weighted-average grant date fair value of options granted during the nine months ended June 30, 2006 was $4.30. The total intrinsic value of options exercised during the three months ended June 30, 2007 and 2006 was $149,000 and $17,000, respectively, and $1.7 million and $520,000 during the nine months ended June 30, 2007 and 2006, respectively. The aggregate intrinsic value represents the total pretax intrinsic value (the difference between the Company’s closing stock price on the last trading day of the third quarter of fiscal 2007 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on June 30, 2007. This amount changes based on the fair market value of the Company’s stock.

Comprehensive Loss

SFAS No. 130, Reporting Comprehensive Income, establishes standards of reporting and display of comprehensive income and its components of net income and other comprehensive income. Other comprehensive income refers to revenues, expenses, gains and losses that are not included in net income but rather are recorded directly in stockholders’ equity. The components of comprehensive loss for the three and nine months ended June 30, 2007 and 2006 are as follows (in thousands):

 

     Three Months Ended
June 30,
    Nine Months Ended
June 30,
 
     2007     2006     2007     2006  

Net loss

   $ (2,034 )   $ (31,482 )   $ (11,193 )   $ (37,738 )

Unrealized gain on securities

     —         308       —         435  

Foreign currency translation adjustments

     187       314       517       163  

Cash flow hedge gains (losses)

     —         27       —         (14 )
                                

Comprehensive loss

   $ (1,847 )   $ (30,833 )   $ (10,676 )   $ (37,154 )
                                

The income tax effects related to unrealized gains and losses on securities and foreign currency translation adjustments are not material.

The components of accumulated other comprehensive income as of June 30, 2007 and September 30, 2006 are as follows (in thousands):

 

    

June 30,

2007

  

September 30,

2006

 

Foreign currency translation adjustments

   $ 1,367    $ 3,738  

Cash flow hedge loss

     —        (263 )
               

Accumulated other comprehensive income

   $ 1,367    $ 3,475  
               

 

17


In January 2005, the Company hedged anticipated cash flows from Ariba Korea. Ltd. (“Ariba Korea”) using foreign currency forward contracts (Korean Won) to offset the translation and economic exposures related to those cash flows. The Korean Won hedge minimized currency risk arising from cash held in Korean Won as a result of the Softbank Corp. settlement in October 2004. The change in fair value of the Korean Won forward contract attributable to the changes in forward exchange rates (the effective portion) was reported in stockholders’ equity prior to the three months ended March 31, 2007. In the nine months June 30, 2007, the Company recorded a net realized gain of $2.2 million associated with the repatriation of cash from Ariba Korea and liquidation of the Ariba Korea entity, which is comprised of a $2.5 million gain from foreign currency translation adjustments and a $285,000 realized loss on the Korean Won cash flow hedge.

In the three months ended June 30, 2007, the Company substantially liquidated FreeMarkets s.a./n.v., a former Belgium FreeMarkets entity, resulting in a $425,000 realized gain from currency translation adjustments.

Note 5—Net Loss Per Share

The following table presents the calculation of basic and diluted net loss per share (in thousands, except per share data):

 

    Three Months Ended
June 30,
    Nine Months Ended
June 30,
 
    2007     2006     2007     2006  

Net loss

  $ (2,034 )   $ (31,482 )   $ (11,193 )   $ (37,738 )
                               

Weighted-average common shares outstanding

    78,456       74,561       77,326       73,306  

Less: Weighted-average common shares subject to repurchase

    (8,116 )     (8,744 )     (7,737 )     (7,813 )
                               

Weighted-average common shares—basic and diluted

    70,340       65,817       69,589       65,493  
                               

Net loss per common share—basic and diluted

  $ (0.03 )   $ (0.48 )   $ (0.16 )   $ (0.58 )
                               

For the three months ended June 30, 2007 and 2006, 586,000 and 1.1 million weighted-average potential common shares, respectively, consisting almost entirely of outstanding options, are excluded from the determination of diluted net loss per share, as the effect of such shares is anti-dilutive. For the nine months ended June 30, 2007 and 2006, 681,000 and 1.2 million weighted-average potential common shares, respectively, consisting almost entirely of outstanding options, are excluded from the determination of diluted net loss per share, as the effect of such shares is anti-dilutive.

Note 6—Segment Information

The Company follows SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, which establishes standards for reporting information about operating segments. Operating segments are defined as components of an enterprise about which separate financial information is available that is regularly evaluated by the chief operating decision maker in deciding how to allocate resources and in assessing performance.

The Company has three geographic operating segments: North America, Europe Middle-East and Africa (“EMEA”) and Asia-Pacific (“APAC”). The segments are determined in accordance with how the chief decision maker views and evaluates the Company’s business and based on the aggregation criteria as outlined in SFAS No. 131. Future changes to this organizational structure or the business may result in changes to the reportable segments disclosed. The Company markets its products in the United States and in foreign countries through its direct sales force and indirect sales channels.

The results of the reportable segments are derived directly from the Company’s management reporting system. The results are based on the Company’s method of internal reporting and are not necessarily in

 

18


conformity with accounting principles generally accepted in the United States. Management measures the performance of each segment based on several metrics, including contribution margin. Asset data is not reviewed by management at the segment level.

Segment contribution margin includes all geographic segment revenues less the related cost of sales, direct sales and marketing expenses and regional general and administrative expenses. A significant portion of each segment’s expenses arise from shared services and infrastructure that the Company has historically allocated to the segments. These expenses include information technology services, facilities and other infrastructure costs and are generally allocated based upon headcount.

Financial information for each reportable segment was as follows for the three and nine months ended June 30, 2007 and 2006 (in thousands):

 

     Three Months Ended
June 30,
   Nine Months Ended
June 30,
     2007    2006    2007    2006

Revenue

           

—North America

   $ 46,065    $ 45,188    $ 139,302    $ 134,580

—EMEA

     15,790      15,781      48,559      50,907

—APAC

     5,937      5,573      16,778      17,622

—Corporate revenue

     7,772      7,091      21,511      20,497
                           

Total revenue

   $ 75,564    $ 73,633    $ 226,150    $ 223,606
                           

Revenues are attributed to countries based on the location of the Company’s customers, with some internal reallocation for multi-national customers. Certain revenue items are not allocated to segments because they are separately managed at the corporate level. These items include Ariba Managed Procurement Services, expense reimbursement and other miscellaneous items.

 

     Three Months Ended
June 30,
    Nine Months Ended
June 30,
     2007    2006     2007    2006

Contribution margin

          

—North America

   $ 18,498    $ 16,860     $ 56,322    $ 51,735

—EMEA

     3,700      4,005       13,077      14,924

—APAC

     1,073      (6 )     1,603      1,451
                            

Total segment contribution margin

   $ 23,271    $ 20,859     $ 71,002    $ 68,110
                            

Contribution margin is used, in part, to evaluate the performance of, and allocate resources to, each of the segments. Certain operating expenses are not allocated to segments because they are separately managed at the corporate level. These unallocated costs include marketing costs other than direct sales and marketing, research and development costs, corporate general and administrative costs, such as legal and accounting, amortization of purchased intangibles, other income—Softbank, restructuring costs, interest and other income, net and provision for income taxes.

 

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The reconciliation of segment information to the Company’s net loss before income taxes was as follows for the three and nine months ended June 30, 2007 and 2006 (in thousands):

 

     Three Months Ended
June 30,
    Nine Months Ended
June 30,
 
     2007     2006     2007     2006  

Segment contribution margin

   $ 23,271     $ 20,859     $ 71,002     $ 68,110  

Corporate revenue

     7,772       7,091       21,511       20,497  

Corporate costs, such as research and development, corporate general and administrative and other

     (39,924 )     (37,376 )     (116,327 )     (103,882 )

Amortization of acquired technology and customer intangible assets

     (3,356 )     (3,696 )     (10,786 )     (12,005 )

Other income—Softbank

     3,390       3,396       10,173       10,190  

Amortization of other intangibles

     (101 )     (200 )     (425 )     (600 )

Restructuring

     3,805       (24,376 )     3,805       (25,379 )

Interest and other income, net

     3,456       3,138       11,462       5,974  
                                

Loss before income taxes

   $ (1,687 )   $ (31,164 )   $ (9,585 )   $ (37,095 )
                                

Subscription revenues consist mainly of fees for software access subscription and hosted software services. Maintenance revenues consist primarily of Ariba Buyer and Ariba Sourcing product maintenance fees. Services and other revenues consist of fees for implementation services, consulting services, managed services, training, education, premium support, fees charged for the use of the Company’s software under perpetual agreements and other miscellaneous items. Revenues by similar product and service groups are as follows (in thousands):

 

     Three Months Ended
June 30,
   Nine Months Ended
June 30,
     2007    2006    2007    2006

Subscription revenues

   $ 18,020    $ 13,978    $ 48,851    $ 40,479

Maintenance revenues

     18,593      18,292      56,000      56,224

Services and other revenues

     38,951      41,363      121,299      126,903
                           

Total

   $ 75,564    $ 73,633    $ 226,150    $ 223,606
                           

Information regarding long-lived assets in geographic areas are as follows (in thousands):

 

    

June 30,

2007

  

September 30,

2006

Long-Lived Assets:

     

United States

   $ 17,708    $ 17,901

International

     2,089      1,929
             

Total

   $ 19,797    $ 19,830
             

Note 7—Other Income—Softbank

In June 2003, the Company commenced an arbitration proceeding against Softbank for failing to meet its contractual revenue commitments. In October 2004, the Company entered into a definitive agreement with Softbank settling their dispute. A total of $37.0 million was recorded as “Deferred income—Softbank” in connection with the settlement. As the Company was unable to determine the respective fair value of the amounts that related to Softbank’s software license, related maintenance and the Company’s prior agreements with Softbank, the $37.0 million will be recognized ratably as “Other income—Softbank” over the three-year software license term ending in October 2007. The Company also made a provision for taxes of $4.8 million in the three months ended December 31, 2004 as a result of the settlement. The Company recorded $3.4 million in income related to the Softbank agreement in each of the three months ended June 30, 2007 and 2006 and $10.2 million in each of the nine months ended June 30, 2007 and 2006. As of June 30, 2007 and September 30, 2006, deferred income related to the Softbank settlement was $4.0 million and $14.1 million, respectively.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The information in this discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such statements are based upon current expectations that involve risks and uncertainties. Any statements contained herein that are not statements of historical facts may be deemed to be forward-looking statements. For example, words such as “may”, “will”, “should”, “estimates”, “predicts”, “potential”, “continue”, “strategy”, “believes”, “anticipates”, “plans”, “expects”, “intends”, and similar expressions are intended to identify forward-looking statements. Our actual results and the timing of certain events may differ significantly from the results discussed in any forward-looking statements. Factors that might cause or contribute to such a discrepancy include, but are not limited to, those discussed under the heading “Risk Factors” in Part II of this Form 10-Q and the risks discussed in our other Securities and Exchange Commission (“SEC”) filings.

Overview of Our Business

We provide spend management solutions that allow enterprises to efficiently manage the purchasing of non-payroll goods and services required to run their business. We refer to these non-payroll expenses as “spend.” Our solutions include software, network access, professional services and expertise. They are designed to provide enterprises with technology and business process improvements to better manage their spend and, in turn, save money. Our software and services streamline and improve the business processes related to the identification of suppliers of goods and services, the negotiation of the terms of purchases, and ultimately the management of ongoing purchasing and settlement activities.

Our software is built to leverage the Internet and provide enterprises with real-time access to their business data and their business partners. Our software is designed to integrate with all major platforms and can be accessed via a web browser. Our software can be deployed as an installed application or provided as a service in an on-demand model. In addition to application software, Ariba Spend Management solutions include implementation and strategic consulting services, education and training, commodity expertise and decision support services, benchmarking services, low-cost country sourcing services and procurement outsourcing services. Ariba Spend Management solutions also integrate with and leverage the Ariba Supplier Network. The Ariba Supplier Network is a scalable Internet infrastructure that connects our buying organizations with their suppliers to exchange product and service information as well as a broad range of business documents, such as purchase orders and invoices. Over 155,000 registered suppliers, offering a wide array of goods and services, are connected to the Ariba Supplier Network.

Ariba Spend Management solutions are organized around six key functions: (1) spend visibility; (2) sourcing; (3) contract management; (4) procurement and expense; (5) invoice and payment; and (6) supplier management. Through our solution offerings, we help customers develop a strategy for spend management and enable a step-by-step approach with technology and services that work together.

Business Model

Ariba Spend Management solutions are delivered in a flexible manner, depending upon the needs and preferences of the customer. For customers seeking self sufficiency, we offer flexible, highly configurable and easy-to-use technology and related services that can be deployed behind the firewall or delivered as an on-demand service. For customers seeking expert assistance, we offer sourcing process and commodity expertise in over 400 categories of spend. Finally, for those customers seeking managed services, we offer tailored solutions to outsource processes, spend categories, or entire procurement operations.

We have aligned our business model with the way we believe customers want to purchase and deploy spend management solutions. Customers may generally subscribe to our software products and services for a specified term, purchase a perpetual software license and/or pay for services on a time-and-materials basis, depending upon their business requirements. Our revenue is comprised of subscription and maintenance fees and services

 

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and other fees. Subscription and maintenance revenue consists of fees charged for hosted on-demand software solutions, fees for product updates and support, fees paid by suppliers for access to the Ariba Supplier Network, as well as fees charged for the use of our software products under term agreements. Services and other revenue consists of fees for implementation services, consulting services, managed services, training, education, premium support, license fees charged for the use of our software products under perpetual agreements and other miscellaneous items.

Due to the different treatment of our revenue streams under applicable accounting guidance, each type of revenue has a different impact on our consolidated financial statements. Subscription fees for hosted on-demand software solutions are generally fixed for a specific period of time, and revenue is recognized ratably over the term. Therefore, a subscription license will result in significantly lower current-period revenue than an equal-sized perpetual license, but with revenue recognized in future periods. Similarly, maintenance fees are generally fixed for a specific period of time, and revenue is recognized ratably over the maintenance term. Maintenance contracts are typically entered into when new software licenses are purchased, at a percentage of the software license fee. In addition, most of our customers renew their maintenance contracts annually to continue receiving product updates and product support. Given the ratable revenue recognition and historically high renewal rates of our subscription and maintenance agreements, this revenue stream has generally been more stable over time. Finally, services revenues are driven by a contract, project or statement of work, in which the fees may be fixed for specific services to be provided over time or billed on a time and materials basis. Like subscription and maintenance fees, services fees have generally been more stable over time as revenue has been recognized over the course of the fixed time or project period. The majority of our license fees are from perpetual software license sales, which is included in services and other revenues. Revenue from these license sales is often recognized in the quarter that the software is delivered. Individual software license sales can be significant (greater than $1.0 million) and sales cycles are often lengthy and difficult to predict. As such, the timing of a few large software license transactions or the recognition of license revenue from these transactions can substantially affect our quarterly operating results.

These different revenue streams also carry different gross margins. Revenue from subscription and maintenance fees tends to be higher-margin revenue with gross margins typically around 75%. Subscription and maintenance fees are generally based on software products developed by us, which carry minimal marginal cost to reproduce and sell. Revenue from labor-intensive services and other fees tends to be lower-margin revenue, with gross margins typically in the 20% to 30% range. Our overall gross margins could fluctuate from period to period depending upon the mix of revenue.

Overview of Quarter Ended June 30, 2007

Overall, our revenues increased from $73.6 million in the three months ended June 30, 2006 to $75.6 million in the three months ended June 30, 2007, primarily due to an increase in subscription revenues of $4.0 million or 29%. Subscription revenues were $18.0 million in the three months ended June 30, 2007, as compared to $14.0 million in the three months ended June 30, 2006. This is primarily due to an overall shift over time from predominantly perpetual licenses, with upfront revenue recognition, to more subscription licenses, with revenue recognition spread out over time. This increase in subscription revenues was partially offset by a decline in services revenues of $2.4 million or 6% primarily due to reduced perpetual license revenues in the three months ended June 30, 2007. Finally, maintenance revenues of $18.6 million were relatively consistent with the three months ended June 30, 2006.

Operating expenses decreased to $40.4 million in the three months ended June 30, 2007 compared to $64.0 million in the three months ended June 30, 2006. The decrease in operating expenses is primarily attributable to a decrease in net restructuring costs of $28.2 million from the $24.4 million charge in the three months ended June 30, 2006 to the $3.8 million benefit recorded in the three months ended June 30, 2006 resulting from our execution of a sublease agreement in June 2007 and revisions of our estimates in the Northern California real estate market in fiscal years 2007 and 2006. The decrease in operating expenses in the three months ended

 

22


June 30, 2007 was partially offset by an increase in legal expenses of $2.6 million associated with litigation costs. In sum, our total net expenses, including cost of revenues and other items, decreased to $77.6 million compared to $105.1 million in the three months ended June 30, 2006, which caused a net loss for the three months ended June 30, 2007 of $2.0 million compared to $31.5 million in the three months ended June 30, 2006.

Outlook for Fiscal Year 2007

We anticipate that the shift in our software business from a perpetual model to a subscription-based model will continue during the remainder of fiscal year 2007. More specifically, we expect growth in subscription revenue in fiscal year 2007 as compared to fiscal year 2006.

We believe that our success for the remainder of fiscal year 2007 will depend largely on our ability to: (1) manage the continuing shift to an on-demand delivery model from both a product and a financial standpoint; (2) sell bundled solution offerings that include both technology and expert services; (3) renew our subscription or time-based revenues, including on-demand software fees, maintenance fees, and fees for certain services; and (4) capitalize on new revenue opportunities, such as access fees for the Ariba Supplier Network and selling on-demand spend management solutions to smaller and mid-market customers.

We believe that key risks to our revenues in fiscal year 2007 include: our ability to manage the shift from selling perpetual license software to on-demand subscription solutions; our ability to introduce additional on-demand versions of our products in fiscal year 2007; our ability to renew ratable revenue streams without substantial declines from prior arrangements, including subscription software, software maintenance, subscription services; the impact of transitioning managed procurement customers to subscription software customers; our ability to generate organic growth; our deferral of services revenues as a result of including software implementation and other services as part of a sale with our subscription software solutions; the market acceptance of spend management solutions as a standalone market category; the overall level of information technology spending; and potential declines in average selling prices. We believe that key risks to our future operating profitability include: our ability to maintain or grow our revenues; our ability to maintain adequate utilization of our services organization; and the potential adverse impacts resulting from legal proceedings. Our prospects must be considered in light of the risks encountered by companies at a relatively early stage of development, particularly given that we operate in new and rapidly evolving markets and face an uncertain economic environment. We may not be successful in addressing such risks and difficulties. See “Risk Factors” for additional information.

 

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Results of Operations

The following table sets forth statements of operations data for the periods indicated (in thousands, except per share data). The data has been derived from the unaudited Condensed Consolidated Financial Statements contained in this Form 10-Q which, in the opinion of our management, reflect all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial position and results of operations for the interim periods presented. The operating results for any period should not be considered indicative of results for any future period. This information should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in our Form 10-K for the fiscal year ended September 30, 2006 filed with the SEC on December 1, 2006.

 

     Three Months Ended
June 30,
    Nine Months Ended
June 30,
 
     2007     2006     2007     2006  

Revenues:

        

Subscription and maintenance

   $ 36,613     $ 32,270     $ 104,851     $ 96,703  

Services and other

     38,951       41,363       121,299       126,903  
                                

Total revenues

     75,564       73,633       226,150       223,606  
                                

Cost of revenues:

        

Subscription and maintenance

     8,490       6,894       24,534       20,359  

Services and other

     28,490       33,341       88,016       98,703  

Amortization of acquired technology and customer intangible assets

     3,356       3,696       10,786       12,005  
                                

Total cost of revenues

     40,336       43,931       123,336       131,067  
                                

Gross profit

     35,228       29,702       102,814       92,539  
                                

Operating expenses:

        

Sales and marketing

     23,389       23,518       69,461       58,601  

Research and development

     13,254       12,333       38,845       37,080  

General and administrative

     10,822       6,973       29,108       24,138  

Other income—Softbank

     (3,390 )     (3,396 )     (10,173 )     (10,190 )

Amortization of other intangible assets

     101       200       425       600  

Restructuring

     (3,805 )     24,376       (3,805 )     25,379  
                                

Total operating expenses

     40,371       64,004       123,861       135,608  
                                

Loss from operations

     (5,143 )     (34,302 )     (21,047 )     (43,069 )

Interest and other income, net

     3,456       3,138       11,462       5,974  
                                

Net loss before income taxes

     (1,687 )     (31,164 )     (9,585 )     (37,095 )

Provision for income taxes

     347       318       1,608       643  
                                

Net loss

   $ (2,034 )   $ (31,482 )   $ (11,193 )   $ (37,738 )
                                

Comparison of the Three and Nine Months Ended June 30, 2007 and 2006

Revenues

Please refer to Note 1 of Notes to Condensed Consolidated Financial Statements for a description of our accounting policy related to revenue recognition.

Subscription and maintenance

Subscription and maintenance revenues for the three months ended June 30, 2007 were $36.6 million, a 13% increase from the $32.3 million recorded in the three months ended June 30, 2006. Subscription revenues for the three months ended June 30, 2007 were $18.0 million, a 29% increase from the $14.0 million recorded in the three months ended June 30, 2006. The increase of $4.0 million in subscription revenues was primarily due to

 

24


growth in our on-demand software applications and the continued growth of Ariba Supplier Network revenues. Maintenance revenues for the three months ended June 30, 2007 were $18.6 million, a slight increase from the $18.3 million recorded in the three months ended June 30, 2006.

Subscription and maintenance revenues for the nine months ended June 30, 2007 were $104.9 million, an 8% increase from the $96.7 million recorded in the nine months ended June 30, 2006. Subscription revenues for the nine months ended June 30, 2007 were $48.9 million, a 21% increase from the $40.5 million recorded in the nine months ended June 30, 2006. The increase of $8.4 million in subscription revenues was primarily due to growth in our on-demand software applications the continued growth of Ariba Supplier Network revenues. Maintenance revenues for the nine months ended June 30, 2007 were $56.0 million, a slight decrease from the $56.2 million recorded in the nine months ended June 30, 2006. We anticipate that subscription revenues will increase in fiscal year 2007 compared to fiscal year 2006, partially offset by modest declines of maintenance revenues in fiscal year 2007.

Services and other

Services and other revenues for the three months ended June 30, 2007 were $39.0 million, a 6% decrease from the $41.4 million recorded in the three months ended June 30, 2006. The decrease of $2.4 million in services and other revenues is primarily attributed to a decrease in perpetual license revenues of $2.7 million in the three months ended June 30, 2007 primarily due to a shift from perpetual license sales to more subscription and hosted term license software sales.

Services and other revenues for the nine months ended June 30, 2007 were $121.3 million, a 4% decrease from the $126.9 million recorded in the nine months ended June 30, 2006. The decrease of $5.6 million in services and other revenues is primarily attributed to a decrease in perpetual license revenues of $4.5 million in the nine months ended June 30, 2007 primarily due to a shift from perpetual license sales to more subscription and hosted term license software sales and to an increase of $1.1 million in the deferral of consulting services revenues in the nine months ended June 30, 2007 due to such services being bundled with other products or services without evidence of fair value. We anticipate that services and other revenues will decrease in fiscal year 2007 compared to fiscal year 2006 due to a decrease in perpetual license revenues partially offset by an increase in managed procurement services which we anticipate will decline the three months ended September 30, 2007 due to the transition of managed procurement customers to subscription software customers.

Cost of Revenues

Subscription and maintenance

Cost of subscription and maintenance revenues consists of labor costs for hosting services and technical support, including stock compensation costs and facilities and equipment costs. Cost of subscription and maintenance revenues for the three months ended June 30, 2007 was $8.5 million, a 23% increase over the $6.9 million recorded in the three months ended June 30, 2006. This increase is primarily the result of an increase in hosted support costs associated with the overall 29% increase in subscription revenues in the three months ended June 30, 2007.

Cost of subscription and maintenance revenues for the nine months ended June 30, 2007 was $24.5 million, a 21% increase over the $20.4 million recorded in the nine months ended June 30, 2006. This increase is primarily the result of an increase in hosted support costs associated with the overall 21% increase in subscription revenues in the nine months ended June 30, 2007.

Services and other

Cost of services and other revenues consists of labor costs for consulting services, including stock compensation costs, training personnel, facilities and equipment costs. Cost of services and other revenues for the

 

25


three months ended June 30, 2007 was $28.5 million, a 15% decrease from the $33.3 million recorded in the three months ended June 30, 2006. This decrease is primarily due to the following: (1) decreased compensation and benefits expense and travel expense of $1.4 million and $751,000, respectively, due to a slight decrease in average headcount due to our re-allocation of services personnel to sales efforts in fiscal year 2007 in managing our transition to an on-demand model; (2) decreased overhead costs of $1.2 million associated with the slight decrease in average headcount, a decrease in depreciation expense as assets reach the end of their estimated useful lives and a slight decrease in rent expense; and (3) decreased stock-based compensation of $867,000 primarily due to a change in the terms of the employee stock purchase plan in August 2006 whereby the option component of the plan was eliminated (See Note 1) and a decrease in stock-based compensation expense related to restricted stock grants.

Cost of services and other revenues for the nine months ended June 30, 2007 was $88.0 million, an 11% decrease from the $98.7 million recorded in the nine months ended June 30, 2006. This decrease is primarily due to the following; (1) decreased compensation and benefits expense and travel expense of $1.8 million and $1.7 million, respectively, due to a decrease in average headcount resulting from our re-allocation of services personnel to sales efforts in fiscal year 2007 in managing our transition to an on-demand model; (2) decreased overhead costs of $4.1 million associated with the decrease in average headcount, a decrease in depreciation expense as assets reach the end of their estimated useful lives and a slight decrease in rent expense; (3) decreased temporary and contract labor costs primarily due to cost cutting efforts initiated in the current year; and (4) decreased stock-based compensation of $1.0 million primarily due to a change in the terms of the employee stock purchase plan in August 2006 whereby the option component of the plan was eliminated (See Note 1) and a decrease in stock-based compensation expense related to restricted stock grants.

Amortization of acquired technology and customer intangible assets

Amortization of acquired technology and customer intangible assets represents the amortization of the costs allocated to technology and customer relationships in our fiscal year 2004 business combinations with Alliente, Softface and FreeMarkets. This expense amounted to $3.4 million and $3.7 million in the three months ended June 30, 2007 and 2006, respectively, and $10.8 million and $12.0 in the nine months ended June 30, 2007 and 2006, respectively. The decrease in the three and nine months ended June 30, 2007 is primarily attributable to assets reaching the end of their estimated useful lives.

Gross profit

Our gross profit as a percentage of revenues for the three months ended June 30, 2007 was 47% compared to 40% for the three months ended June 30, 2006 and was 45% in the nine months ended June 30, 2007 compared to 41% for the nine months ended June 30, 2006. The increase in gross profit as a percentage of revenues was primarily due to an increase in services and other gross profit as a percentage of services and other revenues due to operational improvement in consulting and managed services. Our gross profit of services and other as a percentage of services and other revenues for the three months ended June 30, 2007 was 27% compared to 19% for the three months ended June 30, 2006 and for the nine months ended June 30, 2007 was 27% compared to 22% for the nine months ended June 30, 2006.

Operating Expenses

Sales and marketing

Sales and marketing includes costs associated with our sales, marketing and product marketing personnel, and consists primarily of compensation and benefits, commissions and bonuses, stock compensation, promotional and advertising and travel and entertainment expenses related to these personnel, as well as the provision for doubtful accounts. Sales and marketing expenses for the three months ended June 30, 2007 were $23.4 million, relatively consistent with the $23.5 million recorded in the three months ended June 30, 2006, reflecting the following: (1) increased sales commissions of $1.0 million primarily associated with sales

 

26


commission reversals of $713,000 in the three months ended June 30, 2006; and (2) increased compensation and benefits expense of $1.6 million associated with a 19% increase in average sales and marketing headcount in supporting our transition to an on-demand model. These increases were offset by a decrease in stock-based compensation expense of $1.4 million primarily due to a change in the terms of the employee stock purchase plan in August 2006 whereby the option component of the plan was eliminated (See Note 1) and a decrease in stock-based compensation expense related to restricted stock grants. The increases were also offset by a decrease in marketing expense of $1.3 million due to reduced expenses associated with our annual 2007 Ariba Live marketing event as compared to our 2006 Ariba Live marketing event.

Sales and marketing expenses for the nine months ended June 30, 2007 were $69.5 million, a 19% increase from the $58.6 million recorded in the nine months ended June 30, 2006. This increase is primarily due to the following: (1) a $4.9 million insurance reimbursement in the nine months ended June 30, 2006 related to litigation expenses which had previously been charged to sales and marketing; (2) increased sales commissions of $4.6 million primarily associated with sales commission reversals of $4.3 million in the nine months ended June 30, 2006; and (3) increased compensation and benefits expense of $4.7 million associated with a 17% increase in average sales and marketing headcount in supporting our transition to an on-demand model. These increases were partially offset by a decrease in stock-based compensation expense of $1.4 million primarily due to a change in the terms of the employee stock purchase plan in August 2006 whereby the option component of the plan was eliminated (See Note 1) and a decrease in stock-based compensation expense related to restricted stock grants. We anticipate that sales and marketing expenses will increase as a percentage of revenues in the year ending September 30, 2007 compared to the year ended September 30, 2006 as we increase personnel to support our transition to an on-demand model and as a result of non-recurring contra expense items recorded in the year ended September 30, 2006, as noted above.

Research and development

Research and development includes costs associated with the development of new products, enhancements of existing products for which technological feasibility has not been achieved, and quality assurance activities, and primarily includes employee compensation and benefits, stock compensation, consulting costs and the cost of software development tools and equipment. Research and development expenses for the three months ended June 30, 2007 were $13.3 million, a 7% increase from the $12.3 million recorded in the three months ended June 30, 2006. This increase is primarily attributable to an increase in compensation and benefits expense of $601,000 due to an 18% increase in average headcount and a $496,000 increase in consulting expense related to the continued development of our on-demand solutions in fiscal year 2007.

Research and development expenses for the nine months ended June 30, 2007 were $38.8 million, a 5% increase from the $37.1 million recorded in the nine months ended June 30, 2006. This increase is primarily attributable to an increase in compensation and benefits expense of $1.0 million or 5% due to a 15% increase in average headcount and a $587,000 in consulting expense related to the continued development of our on-demand solutions in fiscal year 2007.

General and administrative

General and administrative includes costs for executive, finance, human resources, information technology, legal and administrative support functions. General and administrative expenses for the three months ended June 30, 2007 were $10.8 million, a 55% increase from the $7.0 million recorded in the three months ended June 30, 2006. This increase is primarily due to an increase in intellectual property related legal expenses of $2.6 million associated with the patent infringement matter disclosed in Note 3 to Notes to Condensed Consolidated Financial Statements.

General and administrative expenses for the nine months ended June 30, 2007 were $29.1 million, a 21% increase from the $24.1 million recorded in the nine months ended June 30, 2006. This increase is primarily due

 

27


to an increase in intellectual property related legal expenses of $3.6 million primarily associated with the patent infringement matter disclosed in Note 3 to Notes to Condensed Consolidated Financial Statements. We anticipate that general and administrative expenses will increase in the year ending September 30, 2007 compared to the year ended September 30, 2006 due to an increase in legal expenses in fiscal year 2007.

Other income—Softbank

During each of the three months ended June 30, 2007 and 2006, we recorded $3.4 million of income from the settlement with Softbank entered into in October 2004. During each of the nine months ended June 30, 2007 and 2006, we recorded $10.2 million of income from the settlement with Softbank. The $37.0 million of deferred income recorded upon the settlement with Softbank is being recognized into income, starting in January 2005, over the remaining term of the three-year license ending in October 2007. For further discussion, see Note 7 to the Condensed Consolidated Financial Statements.

Amortization of other intangible assets

Amortization of other intangible assets was $101,000 and $200,000 for the three months ended June 30, 2007 and 2006, respectively, and $425,000 and $600,000 for the nine months ended June 30, 2007 and 2006, respectively, which consisted of amortization of trademark intangible assets acquired from our merger with FreeMarkets and our acquisitions of Softface and Alliente. We anticipate amortization of other intangible assets will remain relatively consistent in the near term.

Restructuring

We recorded a net (benefit) charge to operations of $(3.8) million and $24.4 million during the three months ended June 30, 2007 and 2006, respectively, and $(3.8) million and $25.4 million during the nine months ended June 30, 2007 and 2006, respectively. In June 2007, we entered into an amendment with Juniper Networks, Inc. (“Juniper”), the successor in interest to NetScreen Technologies, Inc. (“NetScreen”) to the sublease dated as of October 18, 2002 between Ariba and NetScreen. Pursuant to the amendment, Juniper agreed to renew its sublease of approximately 177,000 square feet of space at our Sunnyvale, California headquarters through January 2013. In addition, Juniper agreed, effective no later than December 1, 2007, to lease approximately 89,000 square feet of additional space at our Sunnyvale, California headquarters through January 2013. Also in June 2007, we revised our estimates for rental rate projections and sub-lease commencement dates to reflect current market conditions primarily in the Northern California real estate market. The impact of the execution of the sublease agreement with Juniper was a benefit to operations of approximately $7.0 million and the impact of the revised estimated rental rate projections and sub-lease commencement dates was a charge to operations of $3.2 million, resulting in a net benefit to operations of $3.8 million in the three months ended June 30, 2007.

In June 2006, we revised our estimates for rental rate projections to reflect current market conditions primarily in the Northern California real estate market and sublease commencement dates, resulting in a charge of $24.4 million. The remaining charge in the nine months ended June 30, 2006 was for severance and related benefits of $273,000 resulting from our goal to better align expenses with our revenue levels and to enable us to invest in certain strategic growth initiatives and an adjustment to our restructuring obligation of $730,000 related to a prior period. We assessed our findings using the guidance of SEC Staff Accounting Bulletin (“SAB”) No. 99, and concluded that the amount of the error was immaterial to the prior period.

Interest and other income, net

Interest and other income, net for the three months ended June 30, 2007 was $3.5 million, compared to $3.1 million recorded in the three months ended June 30, 2006. The increase is primarily attributable to a net realized gain associated with currency translation adjustments of $425,000 due to the substantial liquidation of FreeMarkets s.a./n.v., the former FreeMarkets entity in Belgium, in the three months ended June 30, 2007.

 

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Interest and other income, net for the nine months ended June 30, 2007 was $11.5 million, compared to $6.0 million recorded in the nine months ended June 30, 2006. The increase is primarily attributable to the following: (1) a net realized gain of $2.2 million associated with the repatriation of cash from Ariba Korea and the substantial liquidation of the entity in the nine months ended June 30, 2007; (2) an increase in interest income of $2.2 million due to an overall increase in the rate of return on marketable investments; and (3) a net realized gain associated with currency translation adjustments of $425,000 due to the substantial liquidation of FreeMarkets s.a./n.v., the former FreeMarkets entity in Belgium, in the three months ended June 30, 2007.

Provision for income taxes

Provision for income taxes for the three months ended June 30, 2007 was $347,000, compared to $318,000 in the three months ended June 30, 2006. Provision for income taxes for the nine months ended June 30, 2006 was $1.6 million, compared to $643,000 in the nine months ended June 30, 2006. The increase in the nine months ended June 30, 2007 is primarily attributable to an increase in foreign income taxes in the three and nine months ended June 30, 2007 related to a foreign subsidiary and an increase in withholding taxes associated with the repatriation of cash from Ariba Korea in the nine months ended June 30, 2007.

Liquidity and Capital Resources

As of June 30, 2007, we had $148.0 million in cash, cash equivalents, marketable securities and long-term investments and $30.0 million in restricted cash, for total cash, cash equivalents, marketable securities, long-term investments and restricted cash of $178.0 million. Our working capital on June 30, 2007 was $59.8 million. All significant cash, cash equivalents, marketable securities and long-term investments are held in accounts in the United States. As of September 30, 2006, we had $138.8 million in cash, cash equivalents and marketable securities and $31.8 million in restricted cash, for total cash, cash equivalents, marketable securities and restricted cash of $170.6 million. Our working capital on September 30, 2006 was $58.5 million.

The increase in total cash, cash equivalents, marketable securities, long-term investments and restricted cash of $7.4 million in the nine months ended June 30, 2007 is primarily attributable to our results of operations, excluding non-cash charges for stock compensation of $26.3 million and amortization of intangible assets of $11.2 million and non-cash income of $10.2 million from the Softbank transaction and $3.8 million benefit from restructuring. The increase in cash, cash equivalents, marketable securities, long-term investments and restricted cash in the nine months ended June 30, 2007 is also attributable to improved cash collections on outstanding accounts receivable. These increases in cash, cash equivalents, marketable securities, long-term investments and restricted cash were partially offset by a payment of $5.4 million associated with surrendering the abandoned space in Pittsburgh, Pennsylvania.

Net cash provided by operating activities was $10.0 million for the nine months ended June 30, 2007, compared to net cash provided by operating activities of $18.7 million for the nine months ended June 30, 2006. Cash flows from operating activities decreased $8.7 million primarily due to higher net loss excluding non-cash charges and a slight decline in collections on outstanding accounts receivable in the current year as compared to the prior year.

Net cash used in investing activities was $41.3 million for the nine months ended June 30, 2007, compared to net cash used in investing activities of $10.4 million for the nine months ended June 30, 2006. The decrease is primarily attributable to the increase in purchases of investments, net of sales of $30.4 million. Capital expenditures were relatively consistent in the nine months ended June 30, 2007 and 2006.

Net cash provided by financing activities was $2.1 million for the nine months ended June 30, 2007, compared to net cash provided by financing activities of $3.0 million for the nine months ended June 30, 2006. The repurchase of common stock in both periods represents shares forfeited to Ariba by employees in satisfaction of statutory tax withholding obligations incurred as a result of the vesting of restricted shares of common stock

 

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held by those employees. Proceeds from the issuance of common stock in both periods is attributed to stock option exercises and the Employee Stock Purchase Program.

Contractual obligations

Our primary contractual obligations are from operating leases for office space and letters of credit related to those leases. See Note 3 to the Condensed Consolidated Financial Statements for a discussion of our lease commitments and letters of credit.

Other than the lease commitments and letters of credit discussed in Note 3 to the Condensed Consolidated Financial Statements, we do not have commercial commitments under standby repurchase obligations or other such debt arrangements. We do not have any material noncancelable purchase commitments as of June 30, 2007. There have been no material changes in our contractual obligations and commercial commitments during the three months ended June 30, 2007 from those presented in our Annual Report on Form 10-K filed with the SEC on December 1, 2006.

Off-balance sheet arrangements

We have no off-balance sheet arrangements or transactions with unconsolidated limited purpose entities, nor do we have any undisclosed material transactions or commitments involving related persons or entities.

Anticipated cash flows

We expect to incur significant operating costs, particularly related to services delivery costs, sales and marketing, research and development and restructuring costs, for the foreseeable future in order to execute our business plan. We anticipate that such operating costs, as well as planned capital expenditures, will constitute a use of our cash resources. As a result, our net cash flows will depend heavily on the level of future sales, changes in deferred revenues, our ability to manage infrastructure costs, the outcome of our subleasing activities related to abandoned excess leased facilities and ongoing regulatory and legal proceedings.

We believe our existing cash, cash equivalents and investment balances, together with anticipated cash flow from operations, should be sufficient to meet our working capital and operating resource requirements for at least the next twelve months. See “Risk Factors.” Should we find it necessary to obtain additional funds, we may not be able to obtain additional financing on favorable terms or at all.

Application of Critical Accounting Policies and Estimates

Our condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Accounting policies, methods and estimates are an integral part of the preparation of consolidated financial statements in accordance with GAAP and, in part, are based upon management’s current judgments. Those judgments are normally based on knowledge and experience with regard to past and current events and assumptions about future events. Certain accounting policies, methods and estimates are particularly sensitive because of their significance to the consolidated financial statements and because of the possibility that future events affecting them may differ markedly from management’s current judgments. While there are a number of accounting policies, methods and estimates affecting our consolidated financial statements, areas that are particularly significant include:

 

   

Revenue recognition policies

 

   

Allowance for doubtful accounts receivable

 

   

Recoverability of goodwill

 

   

Impairment of long-lived assets

 

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Lease abandonment costs

 

   

Legal contingencies

These critical accounting policies and estimates, their related disclosures and other accounting policies, methods and estimates have been reviewed by our senior management and audit committee. These policies and our practices related to the allowance for doubtful accounts receivable, recoverability of goodwill, impairment of long-lived assets, lease abandonment costs and legal contingencies are described in Note 1 to the Condensed Consolidated Financial Statements and in our Annual Report on Form 10-K filed with the SEC on December 1, 2006. The revenue recognition policy and practices related to this policy are described below and in Note 1 of Notes to Condensed Consolidated Financial Statements:

Revenue Recognition

Substantially all of our revenues are derived from two sources: (i) providing software solutions on either a standalone or on-demand hosted basis and associated technical support and product updates, otherwise known as subscription and maintenance; and (ii) providing services, including implementation services, consulting services, managed services, training, education, premium support and other miscellaneous services. The significant majority of our standard end user license agreements provide for use of our software under a time-based license based on the number of users or other usage criteria. We license our software in multiple element arrangements in which the customer typically purchases a combination of some or all of the following: (i) software solutions, either on a standalone or on-demand hosted basis; (ii) a maintenance arrangement, which is generally priced as a percentage of the software license fees and provides for hosting, technical support and unspecified product updates typically over a period of one year or over the term of the license; and (iii) a services arrangement, on either a fixed fee for access to specific services over time or a time and materials basis.

We license our products through our direct sales force and indirectly through resellers. Sales made through resellers are recognized at the time that we have received persuasive evidence of an end user customer. The license agreements for our products generally do not provide for a right of return, and historically product returns have not been significant. We do not recognize revenue for refundable fees or agreements with cancellation rights until such rights to refund or cancel have expired. Direct sales force commissions are included as sales and marketing expense at the time of sale, when the liability is incurred and is reasonably estimable.

We recognize revenue in accordance with Staff Accounting Bulletin (“SAB”) 104, Revenue Recognition, Emerging Issues Task Force (“EITF”) 00-21, Revenue Arrangements with Multiple Deliverables, and Emerging Issues Task Force (“EITF”) 00-3, Application of AICPA Statement of Position (“SOP”) 97-2 to Arrangements That Include the Right to Use Software Stored on Another Entity’s Hardware, and SOP 97-2, Software Revenue Recognition, as amended by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions. We recognize revenue when all of the following criteria are met: persuasive evidence of an arrangement exists; delivery of the product or service has occurred; the fee is fixed or determinable; and collectibility is probable. If collectibility is not considered probable at the inception of the arrangement, we do not recognize revenue until the fee is collected.

We allocate revenue to each element in a multiple element arrangement based on its respective fair value. Our determination of the fair value of each element in a multiple element arrangement accounted for under SOP 97-2 is based on vendor-specific objective evidence of fair value (VSOE), which is limited to the price when sold separately. VSOE or other methods of determining fair value that are allowable under EITF 00-21 are utilized for multiple element arrangements that are not subject to SOP 97-2.

Revenue from software solutions, hosting and sourcing solutions services is primarily recognized ratably over the term of the arrangement, commencing with the initial customer access date. Revenue allocated to maintenance and support is recognized ratably over the maintenance term (typically one year). Revenue allocated to software solutions implementation, process improvement, training and other services is recognized as the

 

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services are performed or as milestones are achieved or if bundled with a subscription or time-based service, or in circumstances where fair value cannot be established for undelivered service elements, is recognized ratably over the term of the access agreement.

Certain of our contracts include performance incentive payments based on market volume and/or savings generated, as defined in the respective contracts. Revenue from such arrangements is recognized when those thresholds are achieved.

When revenue associated with multiple element arrangements is recognized and more than one element in an arrangement does not have fair value, we first allocate revenue on the statement of operations to those elements for which evidence of fair value is available.

In circumstances where we provide consulting services that are considered essential to the functionality of the software solutions, both the software solution revenue and service revenue are recognized under contract accounting in accordance with the provisions of SOP 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts. Revenues from these arrangements are recognized under the lesser of percentage of completion method based on the ratio of direct labor hours incurred to date to total projected labor hours or ratable over the term of the license.

Deferred revenue includes amounts received from customers for which revenue has not been recognized, and generally results from deferred subscription, maintenance and support, hosting, consulting or training services not yet rendered and license revenue deferred until all requirements under EITF 00-21 or SOP 97-2 are met. Deferred revenue is recognized as revenue upon delivery of the product, as services are rendered, or as other requirements under SAB 104, EITF 00-21 or SOP 97-2 are satisfied. Deferred revenue excludes contract amounts for which payment has yet to be collected. Likewise, accounts receivable excludes amounts due from customers for which revenue has been deferred.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Foreign Currency Risk

We develop products primarily in the United States of America and India and market our products in the United States of America, Latin America, Europe, Canada, Australia, Middle East and Asia. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. Since the majority of our non-U.S. sales are priced in currencies other than the U.S. dollar, a strengthening of the dollar may reduce the level of reported revenues. If such events were to occur, our net revenues could be seriously impacted, since a significant portion of our net revenues are derived from international operations. For each of the three and nine months ended June 30, 2007, 29% of our total net revenues were derived from customers outside of the United States. As a result, our U.S. dollar earnings and net cash flows from international operations may be adversely affected by changes in foreign currency exchange rates.

We use derivative instruments to manage risks associated with foreign currency transactions in order to minimize the impact of changes in foreign currency exchange rates on earnings. We utilize forward contracts to reduce our net exposures, by currency, related to the monetary assets and liabilities of our foreign operations denominated in local currency. In addition, from time to time, we may enter into forward exchange contracts to establish with certainty the U.S. dollar amount of future firm commitments denominated in a foreign currency. The forward contracts do not qualify for hedge accounting and accordingly, all of these instruments are marked to market at each balance sheet date by a charge to earnings. We believe that these forward contracts do not subject us to undue risk due to foreign exchange movements because gains and losses on these contracts are generally offset by losses and gains on the underlying assets and liabilities. We do not use derivatives for trading or speculative purposes. All contracts have a maturity of less than one year.

 

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The following table provides information about our foreign exchange forward contracts outstanding as of June 30, 2007 (in thousands):

 

     Buy/Sell    Contract Value   

Unrealized

Gain /(Loss) in

USD

 
        Foreign
Currency
   USD   

Foreign Currency

           

Euro

   Sell    4,500    $ 6,086    $ (12 )

British Pound

   Buy    900      1,818      0  

Japanese Yen

   Sell    125,000      1,010      0  

Switzerland Franc

   Buy    1,000      818      2  

Czech Koruna

   Buy    15,000      733      (13 )

Singapore Dollar

   Buy    900      601      (7 )
                     

Total

         $ 11,066    $ (30 )
                     

The unrealized gain (loss) represents the difference between the contract value and the market value of the contract based on market rates as of June 30, 2007.

Given our foreign exchange position, a ten percent change in foreign exchange rates upon which these forward exchange contracts are based would result in unrealized exchange gains or losses of approximately $1.1 million. In all material aspects, these exchange gains and losses would be fully offset by exchange losses or gains on the underlying net monetary exposures. We do not expect material exchange rate gains and losses from other foreign currency exposures.

Cash Flow Risk

In January 2005, we hedged anticipated cash flows from Ariba Korea, Ltd. (“Ariba Korea”) using foreign currency forward contracts (Korean Won) to offset the translation and economic exposures related to those cash flows. The Korean Won hedge minimized currency risk arising from cash held in Korean Won as a result of the Softbank Corp. settlement in October 2004. The change in fair value of the Korean Won forward contract attributable to the changes in forward exchange rates (the effective portion) was reported in stockholders’ equity. In the nine months ended June 30, 2007, the Company recorded a realized loss of $285,000 associated with the repatriation of cash from Ariba Korea.

Interest Rate Risk

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. We do not use derivative financial instruments in our investment portfolio. The primary objective of our investment activities is to preserve principal while maximizing yields without significantly increasing risk. This is accomplished by investing in widely diversified investments, consisting only of investment grade securities. We hold investments in both fixed rate and floating rate interest earning instruments, and both carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall.

Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in principal if forced to sell securities which may have declined in market value due to changes in interest rates. Our investments may fall short of expectations due to changes in market conditions and as such we may suffer losses at the time of sale due to the decline in market value. All investments in the table below are carried at market value, which approximates cost.

 

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The table below represents principal (or notional) amounts and related weighted-average interest rates by year of maturity of our investment portfolio (in thousands, except for interest rates).

 

    Year Ending
June 30,
2008
    Year Ending
June 30,
2009
    Year Ending
June 30,
2010
    Year Ending
June 30,
2011
  Year Ending
June 30,
2012
  Thereafter     Total  

Cash equivalents

  $ 10,097     $ —       $ —       $ —     $ —     $ —       $ 10,097  

Average interest rate

    4.75 %     —         —         —       —       —         4.75 %

Investments

  $ 121,697     $ —       $ 3,001       —       —       —       $ 124,698  

Average interest rate

    5.32 %     —         5.42 %     —       —       —         5.33 %

Restricted cash

  $ 1,100     $ 1,820       —         —       —     $ 27,100     $ 30,020  

Average interest rate

    4.74 %     5.04 %     —         —       —       5.02 %     5.01 %
                                                   

Total investment securities

  $ 132,894     $ 1,820     $ 3,001     $ —     $ —     $ 27,100     $ 164,815  
                                                   

The table above does not include uninvested cash of $13.2 million held as of June 30, 2007. Total cash, cash equivalents, marketable securities and restricted cash as of June 30, 2007 was $178.0 million.

 

Item 4. Controls and Procedures

Disclosure Controls and Procedures

We evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2007, the end of the period covered by this report on Form 10-Q. This evaluation (the “controls evaluation”) was done under the supervision and with the participation of management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”). Rules adopted by the SEC require that we disclose the conclusions of the CEO and the CFO about the effectiveness of our disclosure controls and internal controls based upon the controls evaluation.

Disclosure controls and procedures means controls and other procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act, such as this report on Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed such that information is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

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

 

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As of June 30, 2007, management evaluated the effectiveness of our disclosure controls and procedures and concluded those disclosure controls and procedures were not effective because of the material weakness described in Management’s Report on Internal Control over Financial Reporting in Item 9A. Controls and Procedures in our Annual Report on Form 10-K for the year ended September 30, 2006 (“Management’s Report”).

To ensure that our condensed consolidated financial statements for the three months ended June 30, 2007 are fairly presented and were prepared in accordance with U.S. generally accepted accounting principles, management has reviewed in detail all significant balance sheet accounts, as determined appropriate by our Audit Committee with the advice of our management. Consequently, management believes that the financial statements included in this report fairly represent, in all material respects, our financial condition, results of operations and cash flows for the periods presented.

Remediation of Material Weaknesses

As discussed above, as of June 30, 2007 and September 30, 2006, the Company identified several significant deficiencies in our internal control over financial reporting that resulted in adjustments and reclassifications to certain financial statement accounts. None of the internal control deficiencies was considered material individually. However, when considered in the aggregate, these control deficiencies indicate a need for more detailed analysis and documentation of balance sheet accounts and together represent a material weakness in internal control over financial reporting. We have taken steps to address this material weakness identified in the Management Report in our Annual Report on Form 10-K for the year ended September 30, 2006 and are currently evaluating whether these steps are sufficient to remediate this material weakness. We expect to have the material weakness remediated by September 30, 2007.

Changes in Internal Control Over Financial Reporting

There have been no changes in the Company’s internal control over financial reporting during the three months ended June 30, 2007 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II: OTHER INFORMATION

 

Item 1. Legal Proceedings

The litigation discussion set forth in Note 3 of Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q is incorporated herein by reference.

 

Item 1A. Risk Factors

A restated description of the risk factors associated with our business is set forth below. This description includes any material changes to and supersedes the description of the risk factors associated with our business previously disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended September 30, 2006 and our Quarterly Report on Form 10-Q for the quarter ended March 31, 2007.

We Compete in New and Rapidly Evolving Markets, and Our Spend Management Solutions Are At a Relatively Early Stage of Development. These Factors Make Evaluation of Our Future Prospects Difficult.

Spend management software applications and services are at a relatively early stage of development. For example, in September 2001, we introduced the majority of our initial Ariba Spend Management solutions and after our merger with FreeMarkets in 2004, we introduced several new products integrating functionality acquired in the merger. We also introduced on-demand versions of a number of our software products throughout fiscal year 2006 and in fiscal year 2007 and we plan to introduce additional on-demand versions of our products in the future. These new and planned products may be more challenging to implement than our more established products, as we have less experience deploying these applications. The markets in which we compete are characterized by rapid technological change, evolving customer needs and frequent introductions of new products and services. As we adjust to evolving customer requirements and competitive pressures, we may be required to further reposition our product and service offerings and introduce new products and services. We may not be successful in developing and marketing such product and service offerings, or we may experience difficulties that could delay or prevent the development and marketing of such product and service offerings, which could have a material adverse effect on our business, financial condition or results of operations.

Economic Conditions and Reduced Information Technology Spending May Adversely Impact Our Business.

Our business depends on the overall demand for enterprise software and services and on the economic health of our current and prospective customers. Weak economic conditions, or a reduction in information technology spending even with healthy economic conditions, could adversely impact our business in a number of ways including longer sales cycles, lower average selling prices and reduced bookings and revenues.

Our Success Depends on Market Acceptance of Standalone Spend Management Solutions.

Our success depends on widespread customer acceptance of standalone spend management solutions from vendors like Ariba, rather than solutions from enterprise resource planning (ERP) software vendors and others that are part of a broader enterprise application solution. For example, ERP vendors, such as Oracle and SAP, could bundle spend management modules with their existing applications and offer these modules at little or no cost. If our products and services do not achieve continued customer acceptance, our business will be seriously harmed.

We Have a History of Losses and May Incur Significant Additional Losses in the Future.

We have a significant accumulated deficit as of June 30, 2007, resulting in large part from cumulative charges for the amortization and impairment of goodwill and other intangible assets. We may incur significant losses in the future for a number of reasons, including those discussed in other risk factors and the following:

 

   

adverse economic conditions;

 

   

the failure of our standalone spend management solutions business to mature as a separate market category;

 

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declines in average selling prices of our products and services resulting from competition or the introduction of newer products that generally have lower list prices than our more established products and other factors;

 

   

failure to successfully grow our sales channels;

 

   

increased reliance on on-demand delivery of software services that result in lower near-term revenues from customer deployments;

 

   

failure to maintain control over costs;

 

   

increased restructuring charges resulting from the failure to sublease excess facilities at anticipated levels and rates;

 

   

ongoing charges related to the amortization of intangibles from our merger with FreeMarkets in July 2004; and

 

   

charges incurred in connection with any future restructurings.

Our Quarterly Operating Results Are Volatile, Difficult to Predict and May Be Unreliable as Indicators of Future Performance Trends.

Our quarterly operating results have varied significantly in the past and will likely continue to vary significantly in the future. As a result, period-to-period comparisons of our results may not be meaningful and should not be relied upon as indicators of future performance. In addition, we may fail to achieve forecasts of quarterly and annual revenues and operating results.

Our quarterly operating results have varied or may vary depending on a number of factors, including the following:

Risks Related to Revenues:

 

   

fluctuations in demand, sales cycles and average selling price for our products and services;

 

   

reductions in customers’ budgets for information technology purchases and delays in their purchasing cycles;

 

   

fluctuations in the number of relatively larger orders for our products and services;

 

   

increased dependence on relatively smaller orders from a larger number of customers;

 

   

dependence on generating revenues from new revenue sources;

 

   

delays in recognizing revenue from multiple element arrangements;

 

   

ability to renew ratable revenue streams, including subscription software, software maintenance and subscription services, without substantial declines from prior arrangements,

 

   

changes in the mix of types of customer agreements and related timing of revenue recognition; and

 

   

changes in our product line such as our release of on-demand versions of our software products throughout fiscal year 2006 and fiscal year 2007 and our planned release of additional on-demand versions in the future.

Risks Related to Expenses

 

   

our overall ability to control costs, including managing reductions in expense levels through restructuring and severance payments;

 

   

the level of expenditures relating to ongoing legal proceedings;

 

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costs associated with changes in our pricing policies and business model, including the transition to increased reliance on on-demand and managed solutions offerings and the implementation of programs to generate revenue from new sources;

 

   

costs associated with the amortization of stock-based compensation expense; and

 

   

the failure to adjust our workforce to changes in the level of our operations.

Our On-Demand Strategy Carries a Number of Risks Which May Be Harmful to Our Business.

In November 2005, we announced a new strategy to offer on-demand versions of our software products. We believe that in the future customers will increasingly move away from purchasing a perpetual license for our software in favor of purchasing the right to use the software for a specified period of time through a term license or a subscription. If an increasing portion of customers choose term or subscription licenses or application hosting services, we may experience a deferral of revenues and cash payments from customers.

In addition, our on-demand strategy carries a number of additional risks, including the following:

 

   

we may experience a delay in recognizing revenue due to the combination of multiple element arrangements, longer subscription terms and an increase in the time required to implement some on-demand services;

 

   

as a result of increased demands on our engineering organization to develop on-demand versions of our products while supporting and enhancing our existing products, we may not introduce on-demand versions of our products or enhancements to our products on a timely and cost-effective basis or at appropriate quality levels;

 

   

we may fail to achieve our targeted pricing;

 

   

we expect to experience a decrease in the demand for our implementation services to the extent fewer customers license our software products as installed applications;

 

   

we may not successfully achieve market penetration in our newly targeted markets, including target customers we characterize as middle-market companies based on their revenues;

 

   

we may have a short-term and/or long-term decrease in total revenues as a result of the transition; and

 

   

we may incur costs at a higher than forecasted rate as we expand our on-demand operations.

Our Business Could Be Seriously Harmed if We Fail to Retain Our Key Personnel.

Our future performance depends on the continued service of our senior management, product development and sales personnel. The loss of the services of one or more of these personnel could seriously harm our business. Our ability to retain key employees may be harder given that we have substantial operations in several geographic regions, including Sunnyvale, California and Pittsburgh, Pennsylvania. In addition, uncertainty created by turnover of key employees could result in reduced confidence in our financial performance which could cause fluctuations in our stock price and result in further turnover of our employees.

Our Revenues in Any Quarter May Fluctuate Significantly Because Our Sales Cycles Can Be Long and Unpredictable.

Our sales cycles can be long and unpredictable. The purchase of our products is often discretionary and generally involves a significant commitment of capital and other resources by a customer. It frequently takes several months to finalize a sale and requires approval at a number of management levels within the customer organization. The implementation and deployment of our products requires a significant commitment of resources by our customers and third parties and/or professional services organizations. As a result of the length and unpredictability of our sales cycle, our revenues in any quarter may fluctuate significantly.

 

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Revenues in Any Quarter May Vary to the Extent Recognition of Revenue is Deferred When Contracts Are Signed. As a Result, Revenues in Any Quarter May Be Difficult to Predict and are an Unreliable Indicator of Future Performance Trends.

We frequently enter into contracts where we recognize only a portion of the total revenue under the contract in the quarter in which we enter into the contract. For example, we may recognize revenue on a ratable basis over the life of the contract or enter into contracts where the recognition of revenue is conditioned upon delivery of future product or service elements. The portion of revenues recognized on a deferred basis may vary significantly in any given quarter, and revenues in any given quarter are a function both of contracts signed in such quarter and contracts signed in prior quarters. License revenues in recent and future quarters may be more dependent on revenues from new customer contracts entered into in those quarters rather than from the amortization or recognition of license revenues deferred in prior quarters.

Revenues From Our Ariba Sourcing Solution Could Be Negatively Affected if Customers Elect to Purchase Our Self-Service Products Rather Than Our Technology-Enhanced Services.

Revenue from our full-service sourcing services offering has been declining as existing customers renew contracts for lower dollar volumes and/or purchase our lower-priced self-service technologies (such as Ariba Sourcing). We have several large multi-year contracts for these technology-enhanced services, some of which will come up for renewal during the remainder of fiscal year 2007 and beyond. If these customers do not renew their contracts upon expiration, or if they elect to use one of our lower-cost self-service solutions, our future revenues may decrease.

A Decline in Revenues May Have a Disproportionate Impact on Operating Results and Require Further Reductions in Our Operating Expense Levels.

Because our expense levels are relatively fixed in the near term and are based in part on expectations of our future revenues, any decline in our revenues to a level that is below our expectations would have a disproportionately adverse impact on our operating results for that quarter.

We Are Subject to Evolving and Expensive Corporate Governance Regulations and Requirements. Our Failure to Adequately Adhere to These Requirements or the Failure or Circumvention of Our Controls and Procedures Could Seriously Harm Our Business and Results of Operations.

Because we are a publicly-traded company, we are subject to certain federal, state and other rules and regulations, including those required by the Sarbanes-Oxley Act of 2002. Compliance with these evolving regulations is costly and requires a significant diversion of management time and attention, particularly with regard to our disclosure controls and procedures and our internal control over financial reporting. Although we have reviewed our disclosure and internal controls and procedures in order to determine whether they are effective, our controls and procedures may not be able to prevent fraud or other errors in the future. Faulty judgments, simple errors or mistakes, or the failure of our personnel to adhere to established controls and procedures may make it impossible for us to ensure that the objectives of the control system are met. A failure of our controls and procedures to detect fraud or other errors could seriously harm our business and results of operations.

We Sometimes Experience Long Implementation Cycles, Which May Increase Our Operating Costs and Delay Recognition of Revenues.

Many of our products are complex applications that are generally deployed with many users. Implementation of these applications by enterprises is complex, time consuming and expensive. Long implementation cycles may delay the recognition of revenue as some of our customers engage us to perform system implementation services, which can defer revenue recognition for the related software license revenue. In addition, when we experience long implementation cycles, we may incur costs at a higher level than anticipated, which may reduce the anticipated profitability of a given implementation.

 

39


If a Sufficient Number of Suppliers Do Not Join and Maintain Their Participation In the Ariba Supplier Network, It May Not Attract a Sufficient Number of Buyers and Other Sellers Required to Make the Network Successful.

In order to provide buyers on the Ariba Supplier Network an organized method for accessing goods and services, we rely on suppliers to maintain web-based product catalogs, indexing services and other content aggregation tools. Any failure of suppliers to join the Ariba Supplier Network in sufficient numbers, or of existing suppliers to maintain their participation in the Ariba Supplier Network, would make the network less attractive to buyers and consequently other suppliers. Our inability to access and index these catalogs and services provided by suppliers would result in our customers having fewer products and services available to them through our solutions, which would adversely affect the perceived usefulness of the Ariba Supplier Network.

We Could Be Subject to Potential Claims Related to the Ariba Supplier Network.

We warrant to our customers that the Ariba Supplier Network will achieve specified performance levels to allow our customers to conduct their transactions. To the extent we fail to meet warranted performance levels, we could be obligated to provide refunds of maintenance fees or credits toward future maintenance fees. Further, to the extent that a customer incurs significant financial hardship due to the failure of the Ariba Supplier Network to perform as warranted, we could be exposed to additional liability claims.

Failure to Establish and Maintain Strategic Relationships with Third Parties Could Seriously Harm Our Business, Results of Operations and Financial Condition.

We have established strategic relationships with a number of other companies. These companies are entitled to resell our products, to host our products for their customers, and/or to implement our products within their customers’ organizations. We cannot be assured that any existing or future resellers or hosting or implementation partners will perform to our expectations. For example, in the past we have not realized the anticipated benefits from strategic relationships with a number of resellers. If our current or future strategic partners do not perform to expectations, or if they experience financial difficulties that impair their operating capabilities, our business, operating results and financial condition could be seriously harmed.

We Face Intense Competition. If We Are Unable to Compete Successfully, Our Business Will Be Seriously Harmed.

The market for our solutions is intensely competitive, evolving and subject to rapid technological change. This competition could result in further price pressure, reduced profit margins and loss of market share, any one of which could seriously harm our business. Competitors vary in size and in the scope and breadth of the products and services they offer. We compete with several major enterprise software companies, including SAP and Oracle. We also compete with several service providers, including McKinsey & Company and A.T. Kearney. In addition, we compete with smaller niche providers of sourcing or procurement products and services, including Emptoris, Ketera Technologies, Perfect Commerce, Procuri and Verticalnet. Because spend management is a relatively new software category, we expect additional competition from other established and emerging companies if this market continues to develop and expand. For example, third parties that currently help implement Ariba Buyer and our other products could begin to market products and services that compete with our products and services. These third parties, which include IBM, Accenture, Capgemini, Deloitte Consulting, BearingPoint and Unisys, are generally not subject to confidentiality or non-compete agreements that restrict such competitive behavior.

Many of our current and potential competitors, such as ERP software vendors including Oracle and SAP, have longer operating histories, significantly greater financial, technical, marketing and other resources, significantly greater name recognition and a larger installed base of customers than us. These vendors could also introduce spend management solutions that are included as part of broader enterprise application solutions at little or no cost. In addition, many of our competitors have well-established relationships with our current and

 

40


potential customers and have extensive knowledge of our industry. In the past, we have lost potential customers to competitors for various reasons, including lower prices and incentives not matched by us. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address customer needs. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly increase their market share. We also expect that competition will increase as a result of industry consolidations. As a result, we may not be able to successfully compete against our current and future competitors.

Any Future Acquisitions Will Be Subject to a Number of Risks.

Any future acquisitions will be subject to a number of risks, including:

 

   

the diversion of management time and resources;

 

   

the difficulty of assimilating the operations and personnel of the acquired companies;

 

   

the potential disruption of our ongoing business;

 

   

the difficulty of incorporating acquired technology and rights into our products and services;

 

   

unanticipated expenses related to integration of the acquired companies;

 

   

difficulties in implementing and maintaining uniform standards, controls, procedures and policies;

 

   

the impairment of relationships with employees and customers as a result of any integration of new management personnel;

 

   

potential unknown liabilities associated with acquired businesses; and

 

   

impairment of goodwill and other assets acquired.

If We Fail to Develop Products and Services on a Timely and Cost-Effective Basis, or If Our Products or Services Contain Defects, Our Business Could Be Seriously Harmed.

In developing new products and services, we may:

 

   

fail to develop, introduce and market products in a timely or cost-effective manner;

 

   

find that our products and services are obsolete, noncompetitive or have shorter life cycles than expected;

 

   

fail to develop new products and services that adequately meet customer requirements or achieve market acceptance; or

 

   

develop products that contain undetected errors or failures when first introduced or as new versions are released.

If new releases of our products or potential new products are delayed, we could experience a delay or loss of revenues and customer dissatisfaction.

Pending Litigation Could Seriously Harm Our Business.

There can be no assurance that existing or future litigation will not have a material adverse effect on our business, financial position, results of operations or cash flows, or that the amount of any accrued losses is sufficient for any actual losses that may be incurred. See Note 3 of Notes to Consolidated Financial Statements.

We May Incur Additional Restructuring Charges that Adversely Affect Our Operating Results.

We have recorded significant restructuring charges in the past relating to the abandonment of numerous leased facilities, including most notably portions of our Sunnyvale, California headquarters. Moreover, we have

 

41


from time to time revised our assumptions and expectations regarding lease abandonment costs, resulting in additional charges.

We review these estimates each reporting period, and to the extent that our assumptions change, the ultimate restructuring expenses for these abandoned facilities could vary significantly from current estimates. For example, a reduction in assumed market lease rates of $0.25 per square foot per month for the remaining term of the leases, with all other assumptions remaining the same, would increase the estimated lease abandonment loss on the vacated portions of our Sunnyvale, California headquarters by $3.1 million as of June 30, 2007. Additional lease abandonment costs, resulting from the abandonment of additional facilities or changes in estimates and expectations about facilities already abandoned, could adversely affect our operating results.

We May Incur Additional Goodwill Impairment Charges that Adversely Affect Our Operating Results.

We review goodwill for impairment annually and more frequently if events and circumstances indicate that the asset may be impaired and that the carrying value may not be recoverable. Factors we consider important that could trigger an impairment review include, but are not limited to, significant underperformance relative to historical or projected future operating results, significant changes in the manner of use of the acquired assets or the strategy for our overall business, significant negative industry or economic trends, a significant decline in our stock price for a sustained period, and decreases in our market capitalization below the recorded amount of our net assets for a sustained period. Our stock price is highly volatile and has experienced significant declines in the past. The balance of goodwill is $326.1 million as of June 30, 2007 and, there can be no assurance that future goodwill impairments will not occur.

Our Stock Price Is Highly Volatile.

Our stock price has fluctuated dramatically. There is a significant risk that the market price of our common stock will decrease in the future in response to any of the following factors, some of which are beyond our control:

 

   

variations in our quarterly operating results;

 

   

announcements that our revenues or income are below analysts’ expectations;

 

   

changes in analysts’ estimates of our performance or industry performance;

 

   

general economic slowdowns;

 

   

changes in market valuations of similar companies;

 

   

sales of large blocks of our common stock;

 

   

announcements by us or our competitors of significant contracts, acquisitions, strategic partnerships, joint ventures or capital commitments;

 

   

the loss of a major customer or our failure to complete significant license transactions;

 

   

additions or departures of key personnel; and

 

   

fluctuations in stock market prices and volumes, which are particularly common among highly volatile securities of software and Internet-related companies.

We Are at Risk of Further Securities Class Action Litigation Due to Our Stock Price Volatility.

In the past, securities class action litigation has often been brought against companies following periods of volatility in the market price of their securities. We have experienced significant volatility in the price of our stock over the past two years. We may in the future be the target of similar litigation. Securities litigation could result in substantial costs and divert management’s attention and resources, which could seriously harm our business.

 

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If the Protection of Our Intellectual Property Is Inadequate, Our Competitors May Gain Access to Our Technology, and We May Lose Customers.

We depend on our ability to develop and maintain the proprietary rights of our technology. To protect our proprietary technology, we rely primarily on a combination of contractual provisions, including customer licenses that restrict use of our products, confidentiality agreements and procedures, and patent, copyright, trademark and trade secret laws. We have 20 patents issued in the United States, but may not develop other proprietary products that are patentable. Despite our efforts, we may not be able to adequately protect our proprietary rights, and our competitors may independently develop similar technology, duplicate our products or design around any patents issued to us. This is particularly true because some foreign laws do not protect proprietary rights to the same extent as those of the United States and, in the case of our solutions, because the validity, enforceability and type of protection of proprietary rights in these technologies are uncertain and evolving. If we fail to adequately protect our proprietary rights, we may lose customers.

There has been a substantial amount of litigation in the software industry and the Internet industry regarding intellectual property rights. For example, in fiscal year 2005 we paid $37.0 million to ePlus to settle a lawsuit alleging that three of our products, Ariba Buyer, Ariba Marketplace and Ariba Category Procurement, infringed patents held by a third party. In addition, we have recently been sued by Sky Technologies, Inc. for alleged patent infringement. See “Litigation—Patent Litigation” in Note 3 of Notes to Condensed Consolidated Financial Statements. It is possible that in the future other third parties may claim that we or our current or potential future products infringe their intellectual property rights. We expect that software product developers and providers of electronic commerce solutions will increasingly be subject to infringement claims, and third parties may claim that we or our current or potential future products infringe their intellectual property. Any claims, with or without merit, could be time-consuming, result in costly litigation, cause product shipment delays or require us to enter into royalty or licensing agreements. Royalty or licensing agreements, if required, may not be available on terms acceptable to us or at all, which could seriously harm our business.

We must now, and may in the future have to, license or otherwise obtain access to intellectual property of third parties. For example, we are currently dependent on developers’ licenses from enterprise resource planning, database, human resource and other systems software vendors in order to ensure compliance of our products with their management systems. In addition, we rely on technology that we license from third parties, including software that is integrated with internally developed software and used in our software products to perform key functions. For example, we license integration software from TIBCO for Ariba Buyer. If we are unable to continue to license any of this software on commercially reasonable terms, or at all, we will face delays in releases of our software until equivalent technology can be identified, licensed or developed, and integrated into our current products. These delays, if they occur, could materially adversely affect our business.

Our Business Is Susceptible to Numerous Risks Associated with International Operations.

International operations have represented a significant portion of our revenues over the past three years. We have committed and expect to continue to commit significant resources to our international sales and marketing activities. We are subject to a number of risks associated with these activities. These risks generally include:

 

   

currency exchange rate fluctuations;

 

   

unexpected changes in regulatory requirements;

 

   

tariffs, export controls and other trade barriers;

 

   

longer accounts receivable payment cycles and difficulties in collecting accounts receivable;

 

   

difficulties in managing and staffing international operations;

 

   

potentially adverse foreign tax consequences, including withholding in connection with the repatriation of earnings;

 

43


   

the burdens of complying with a wide variety of foreign laws; and

 

   

political instability.

For international sales and expenditures denominated in foreign currencies, we are subject to risks associated with currency fluctuations. We hedge risks associated with foreign currency transactions in order to minimize the impact of changes in foreign currency exchange rates on earnings. We utilize forward contracts to hedge trade and intercompany receivables and payables. There can be no assurance that our hedging strategy will be successful or that currency exchange rate fluctuations will not have a material adverse effect on our operating results.

Anti-takeover Provisions in Our Charter Documents and Delaware Law Could Discourage, Delay or Prevent a Change in Control of Our Company and May Affect the Trading Price of Our Common Stock.

Certain anti-takeover provisions in our certificate of incorporation and bylaws and certain provisions of Delaware law may have the effect of delaying, deferring or preventing a change in control of the Company without further action by our stockholders, may discourage bids for our common stock at a premium over the market price of our common stock and may adversely affect the market price of our common stock and other rights of our stockholders.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

(c) Purchases of Equity Securities by the Issuer and Affiliated Purchasers

We have granted shares of restricted common stock that allow statutory tax withholding obligations incurred upon vesting of those shares to be satisfied by forfeiting a portion of those shares to us. The following table shows the shares acquired by us upon forfeiture of restricted shares during the quarter ended June 30, 2007.

ISSUER PURCHASES OF EQUITY SECURITIES

 

Period

   Total Number of
Shares
Purchased
  

Average Price Paid

per Share

  

Total Number of
Shares
Purchased as Part of
Publicly Announced

Plans or Programs

   Maximum Number (or
Approximate Dollar
Value) of Shares That
May Yet be Purchased
Under the Plans or
Program

April 1, 2007—April 30, 2007

   —      $ —      —      —  

May 1, 2007—May 31, 2007

   —        —      —      —  

June 1, 2007—June 30, 2007

   1,687      9.52    —      —  
                 

Total

   1,687    $ 9.52    —      —  
                 

 

Item 3. Defaults Upon Senior Securities

Not applicable.

 

Item 4. Submission of Matters to a Vote of Security Holders

Not applicable.

 

Item 5. Other Information

Not applicable.

 

44


Item 6. Exhibits

 

Exhibit
No.
  

Exhibit Title

10.45    First Amendment to Sublease, dated as of June 15, 2007, by and between Juniper Networks, Inc. and the Registrant.
10.46    Fourth Amendment to Lease, dated as of July 10, 2007, by and between Moffet Park Drive LLC and the Registrant
31.1    Certification of Chief Executive Officer.
31.2    Certification of Chief Financial Officer.
32.1    Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

45


SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

ARIBA, INC.
By:   /s/    JAMES W. FRANKOLA        
  James W. Frankola
  Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)

Date: August 8, 2007

 

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