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Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

Form 10-Q

 

QUARTERLY REPORT UNDER SECTION 13 OR 15(d)

OF THE SECURITIES ACT OF 1934

 

For the Quarter Ended June 30, 2004

 

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 an accelerated filer (as described in Exchange Act Rule 12b-2).

Yes x    No ¨

 

On July 31, 2004, approximately 63,088,636 shares of the registrant’s common stock were issued and outstanding.

 



Table of Contents

ARIBA, INC.

 

INDEX

 

          Page
No.


PART I.

   FINANCIAL INFORMATION     

Item 1.

   Financial Statements    3
     Condensed Consolidated Balance Sheets as of June 30, 2004 and September 30, 2003 (Unaudited)    3
     Condensed Consolidated Statements of Operations for the three and nine month periods ended June 30, 2004 and 2003 (Unaudited)    4
     Condensed Consolidated Statements of Cash Flows for the nine month periods ended June 30, 2004 and 2003 (Unaudited)    5
     Notes to the Condensed Consolidated Financial Statements (Unaudited)    6

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    22

Item 3.

   Quantitative and Qualitative Disclosures About Market Risk    54

Item 4.

   Controls and Procedures    55

PART II.

   OTHER INFORMATION     

Item 1.

   Legal Proceedings    57

Item 2.

   Changes in Securities and Use of Proceeds    59

Item 3.

   Defaults Upon Senior Securities    59

Item 4.

   Submission of Matters to a Vote of Securities Holders    60

Item 5.

   Other Information    60

Item 6.

   Exhibits and Reports on Form 8-K    61
     SIGNATURES    62

 

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PART I:    FINANCIAL INFORMATION

 

Item 1.    Financial Statements

 

ARIBA, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

(unaudited)

 

    

June 30,

2004


    September 30,
2003


 

ASSETS

                

Current assets:

                

Cash and cash equivalents

   $ 110,193     $ 70,819  

Short-term investments

     13,659       56,323  

Restricted cash

     45,190       1,123  

Accounts receivable, net of allowance for doubtful accounts of $1,364 and $1,356 as of June 30, 2004 and September 30, 2003, respectively

     17,125       8,669  

Prepaid expenses and other current assets

     14,440       10,747  
    


 


Total current assets

     200,607       147,681  

Property and equipment, net

     19,052       21,767  

Long-term investments

     26,029       78,329  

Restricted cash, net of current portion

     27,312       28,579  

Goodwill, net

     190,710       181,033  

Other intangible assets, net

     5,635        

Other assets

     2,202       1,741  
    


 


Total assets

   $ 471,547     $ 459,130  
    


 


LIABILITIES AND STOCKHOLDERS’ EQUITY

                

Current liabilities:

                

Accounts payable

   $ 10,464     $ 10,767  

Accrued compensation and related liabilities

     25,093       26,674  

Accrued liabilities

     80,950       35,513  

Restructuring obligations

     10,533       13,764  

Deferred revenue

     49,595       57,470  
    


 


Total current liabilities

     176,635       144,188  

Restructuring obligations, less current portion

     27,181       34,112  

Deferred revenue, less current portion

     27,247       43,954  
    


 


Total liabilities

     231,063       222,254  
    


 


Minority interests

     20,500       20,019  

Commitments and contingencies (Note 3)

                

Stockholders’ equity:

                

Common stock (1)

     92       90  

Additional paid-in capital (1)

     4,511,696       4,501,424  

Deferred stock-based compensation

     (4,421 )     (314 )

Accumulated other comprehensive income

     2,187       2,856  

Accumulated deficit

     (4,289,570 )     (4,287,199 )
    


 


Total stockholders’ equity

     219,984       216,857  
    


 


Total liabilities and stockholders’ equity

   $ 471,547     $ 459,130  
    


 



(1)   Reflects the Company’s one-for-six reverse stock split effected July 1, 2004.

 

See accompanying notes to condensed consolidated financial statements.

 

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ARIBA, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

 

    

Three Months Ended

June 30,


   

Nine Months Ended

June 30,


 
     2004

    2003

    2004

    2003

 

Revenues:

                                

License

   $ 15,148     $ 16,597     $ 47,890     $ 64,963  

License—related party

     327       4,691       2,201       14,523  

Maintenance and service

     36,870       34,146       109,562       94,805  

Maintenance and service—related party

     638       1,129       2,069       3,275  
    


 


 


 


Total revenues

     52,983       56,563       161,722       177,566  
    


 


 


 


Cost of revenues:

                                

License

     744       1,784       2,421       3,663  

Maintenance and service

     14,553       11,889       42,053       33,942  

Amortization of acquired technology

     340             340       4,000  
    


 


 


 


Total cost of revenues

     15,637       13,673       44,814       41,605  
    


 


 


 


Gross profit

     37,346       42,890       116,908       135,961  
    


 


 


 


Operating expenses:

                                

Sales and marketing

     22,621       19,199       65,449       60,320  

Research and development

     13,811       13,123       38,932       40,955  

General and administrative

     6,650       8,745       16,114       29,578  

Amortization of other intangible assets

     149             225       113,464  

Stock-based compensation (1)

     771       364       1,639       1,836  

Restructuring and integration costs

     1,820       5,350       (97 )     5,350  
    


 


 


 


Total operating expenses

     45,822       46,781       122,262       251,503  
    


 


 


 


Loss from operations

     (8,476 )     (3,891 )     (5,354 )     (115,542 )

Interest income

     695       1,163       2,527       4,105  

Interest expense

     (2 )     (74 )     (7 )     (87 )

Other income (loss)

     30       97       (26 )     494  
    


 


 


 


Net loss before income taxes and minority interests

     (7,753 )     (2,705 )     (2,860 )     (111,030 )

Provision (benefit) for income taxes

     174       (116 )     (353 )     327  

Minority interests in net income (loss) of consolidated subsidiaries

     (296 )     858       (136 )     2,335  
    


 


 


 


Net loss

   $ (7,631 )   $ (3,447 )   $ (2,371 )   $ (113,692 )
    


 


 


 


Net loss per share—basic and diluted (2)

   $ (0.17 )   $ (0.08 )   $ (0.05 )   $ (2.57 )
    


 


 


 


Weighted average shares used in computing net loss per share—basic and diluted (2)

     45,454       44,500       45,256       44,239  
    


 


 


 



(1)   For the three and nine month periods ended June 30, 2004 and 2003, stock-based compensation expense (benefit), net of the effects of cancellations, is attributable to various operating expense categories as follows (in thousands):

 

     Three Months
Ended June 30,


    Nine Months Ended
June 30,


 
         2004    

       2003    

        2004    

       2003    

 

Cost of revenues

   $ 71    $ (42 )   $ 225    $ (751 )

Sales and marketing

     478      239       1,078      1,446  

Research and development

     98      26       126      258  

General and administrative

     124      141       210      883  
    

  


 

  


Total

   $ 771    $ 364     $ 1,639    $ 1,836  
    

  


 

  


(2)   Reflects the Company’s one-for-six reverse stock split effected July 1, 2004.

 

See accompanying notes to condensed consolidated financial statements.

 

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ARIBA, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

    

Nine Months Ended

June 30,


 
     2004

    2003

 
Operating activities:                 

Net loss

   $ (2,371 )   $ (113,692 )

Adjustments to reconcile net loss to net cash used in operating activities:

                

Provision (recovery) of doubtful accounts

     18       (1,317 )

Depreciation and amortization

     5,699       126,350  

Stock-based compensation

     1,639       1,836  

Minority interests in net loss (income) of consolidated subsidiaries

     (136 )     2,335  

Changes in operating assets and liabilities:

                

Accounts receivable

     (6,624 )     (2,294 )

Prepaid expenses and other assets

     (3,708 )     6,190  

Accounts payable

     (648 )     1,653  

Accrued compensation and related liabilities

     (2,608 )     (5,415 )

Accrued liabilities

     39,062       (3,610 )

Restructuring obligations

     (10,162 )     (10,595 )

Deferred revenue

     (24,887 )     (33,945 )
    


 


Net cash used in operating activities

     (4,726 )     (32,504 )
    


 


Investing activities:                 

Purchases of property and equipment, net

     (2,056 )     (2,218 )

Sales/purchases of investments, net

     93,620       16,023  

Business combinations, net of cash acquired

     (10,864 )     (3,272 )

Allocations from (to) restricted cash, net

     (42,800 )     1,498  
    


 


Net cash provided by investing activities

     37,900       12,031  
    


 


Financing activities:                 

Repayments of lease obligations

           (1,376 )

Proceeds from issuance of common stock

     4,908       6,163  
    


 


Net cash provided by financing activities

     4,908       4,787  
    


 


Net increase (decrease) in cash and cash equivalents

     38,082       (15,686 )

Effect of foreign exchange rate changes on cash and cash equivalents

     1,292       718  

Cash and cash equivalents at beginning of period

     70,819       86,935  
    


 


Cash and cash equivalents at end of period

   $ 110,193     $ 71,967  
    


 


 

See accompanying notes to condensed consolidated financial statements.

 

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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 all non-payroll goods and services required to run their business. The Company refers to these non-payroll expenses as “spend.” The Company’s solutions, which include software applications, services and network access, are designed to provide enterprises with technology and business process improvements to better manage their spending and, in turn, save money. The Company’s software applications 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. These goods and services include commodities, raw materials, operating resources, services, temporary labor, travel, maintenance, repair and operations equipment.

 

The Company was incorporated in Delaware in September 1996 and currently markets its products and related services in North America, Europe, Latin America, the Middle East, Asia and Australia primarily through its direct sales force and indirectly through resellers.

 

Basis of presentation

 

The unaudited condensed consolidated financial statements 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, 2004. Certain information and note disclosures normally included in 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 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/A for the year ended September 30, 2003 filed on May 14, 2004 with the Securities and Exchange Commission (“SEC”).

 

Reclassifications

 

Certain reclassifications, none of which affected net loss or net loss per share, have been made to prior period amounts to conform to the current period presentation. Specifically, the Company reclassified amortization of acquired technology of zero and $4.0 million for the three and nine month periods ended June 30, 2003, respectively, from amortization of other intangible assets in operating expenses to cost of revenues. In addition, the Company began separately disclosing minority interests in net income (loss) of consolidated subsidiaries which had been included as other income, net in prior years.

 

Use of estimates

 

The preparation of condensed 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. For example, actual sublease income attributable to the consolidation of excess

 

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facilities might deviate from the assumptions used to calculate the Company’s accrual for lease abandonment costs and litigation settlement amounts may differ from estimated amounts. Actual experience in the collection of accounts receivable considered doubtful may differ from estimates used to develop allowances due to changes in the financial condition of customers or the outcomes of collection efforts.

 

Adoption of accounting standards

 

In December 2003, the Company adopted Staff Accounting Bulletin No. 104 (SAB 104), Revenue Recognition in Financial Statements, which revises or rescinds portions of the interpretative guidance included in Topic 13 of the codification of staff accounting bulletins. The principal revisions related to the rescission of material no longer necessary because of the private sector developments in U.S. generally accepted accounting principles. The adoption of SAB 104 did not have a material impact on the Company’s financial position, results of operations or cash flows.

 

In March 2004, the EITF reached consensus on Issue 03-01 (EITF 03-01), The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. EITF 03-01 includes new guidance for evaluating and recording impairment losses on debt and equity investments, as well as new disclosure requirements for investments that are deemed to be temporarily impaired. The accounting guidance provided in EITF 03-01 is effective for reporting periods beginning after June 15, 2004, while the disclosure requirements for debt and equity securities accounted for under FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, are effective for annual periods ending after December 15, 2003. The Company does not expect that the adoption of EITF 03-01 will have a material impact on its financial position, results of operations or cash flows.

 

Revenue recognition

 

As of June 30, 2004, the Company’s spend management applications fell into three solution sets: the Ariba Analysis Solution, the Ariba Sourcing Solution, and the Ariba Procurement Solution. Ariba Enterprise Sourcing, which was introduced in late fiscal year 2001, is derived from the Company’s Dynamic Trade and Sourcing applications, which are still available as separate products. The modules that make up the Ariba Analysis Solution and the Ariba Sourcing Solution can be deployed as hosted or installed applications. In addition, the Ariba Workforce and Ariba Marketplace products are also available as hosted applications. The Company’s spend management applications will be expanded in July 2004 as a result of the Company’s merger with FreeMarkets, Inc. (“FreeMarkets”).

 

The Company licenses its products through its direct sales force and indirectly through resellers. 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 cancellation have expired. The Company generally recognizes revenue on sales to resellers upon sell-through to the end-user. Collectibility of receivables is assessed based on the reseller’s ability to pay. Commissions/fees paid to partners under co-sale arrangements are included as cost of license revenues at the time of sale, when the liability is incurred and reasonably estimable. The products are licensed under either a perpetual license or under a time-based license. Access to the Ariba Supplier Network is available to Ariba customers as part of their maintenance agreements for certain products.

 

The Company recognizes revenue in accordance with Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended by SOP 98-4 and SOP 98-9, and SEC SAB 104. The Company recognizes revenue when all of the following criteria are met: persuasive evidence of an arrangement exists; delivery of the product has occurred; services are not considered essential; the fee is fixed or determinable; and collectibility is probable. Payment terms are considered extended when greater than 20% of an arrangement fee is due beyond twelve months from delivery. If fees are not “fixed or determinable”, revenue is recognized when due and payable. In arrangements where at least 80% of fees are due within one year or less from delivery, the entire arrangement fee is considered fixed or determinable and revenue is recognized when the remaining basic revenue recognition criteria are met. If collectibility is not considered probable at the inception of the arrangement, the Company does not recognize revenue until the fee is collected.

 

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The Company recognizes revenue using the residual method pursuant to the requirements of SOP 97-2, as amended by SOP 98-9. Under the residual method, revenue is recognized in a multiple element arrangement when Company-specific objective evidence of fair value exists for all of the undelivered elements in the arrangement, but does not exist for one of the delivered elements in the arrangement. The Company allocates revenue to each undelivered element in a multiple element arrangement based on its respective fair value. The Company’s determination of the fair value of each element in multi-element arrangements is based on vendor-specific objective evidence (VSOE). The Company limits its assessment of VSOE for each element to either the price charged when the same element is sold separately or the price established by management, having the relevant authority to do so, for an element not yet sold separately.

 

Revenue allocated to maintenance and support is recognized ratably over the maintenance term (typically one year) and revenue allocated to training and other services is recognized as the services are performed. Revenue from hosting services is recognized ratably over the term of the arrangement. The proportion of total revenue from new license arrangements that is recognized upon delivery may vary from quarter to quarter depending upon the relative mix of types of licensing arrangements and the availability of VSOE of fair value for undelivered elements.

 

Certain of the Company’s perpetual and time-based licenses include the right to unspecified additional products. The Company recognizes revenue from perpetual and time-based licenses that include unspecified additional software products ratably over the longer of the term of the time-based license or the period of commitment to such unspecified additional products.

 

Under the terms of the Company’s agreements with Softbank, Softbank was required to make scheduled quarterly cash payments through June 30, 2004 for the purchase of licenses and maintenance services at agreed prices for resale through September 30, 2004. Softbank’s minimum payment obligations were non-cancelable and non-refundable, and Softbank would have been obligated to make additional payments to the extent that sublicense sales exceed scheduled payment amounts. Revenues under the Company’s agreements with Softbank were recognized based on the lesser of cumulative ratable revenue on a subscription basis or cumulative cash received. The term of the subscription period used was based on the resale period plus twelve months to cover the maximum term of maintenance commitments thereafter. However, in June 2003 we commenced an arbitration proceeding against Softbank for their failure to meet contracted revenue commitments. In June 2004, the Company entered into a binding agreement with Softbank setting forth the material terms under which the Company and Softbank will settle their dispute. The terms of the settlement agreement will be effected by definitive agreements to be negotiated and entered into by Ariba and Softbank. See Note 8 for further discussion.

 

Arrangements that include consulting services are evaluated to determine whether the services are essential to the functionality of other elements of the arrangement. When services are not considered essential, the revenue allocable to the services is recognized separately from the software, provided VSOE of fair value exists. If the Company provides consulting services that are considered essential to the functionality of the software products, both the software product 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 percentage of completion method based on the ratio of direct labor hours incurred to date to total projected labor hours except in limited circumstances where completion status cannot be reasonably estimated, in which case the completed contract method is used.

 

The Company’s customers include certain suppliers from whom, on occasion, the Company has purchased goods or services for the Company’s operations at or about the same time the Company has licensed its software to these organizations. These transactions are separately negotiated at terms the Company considers to be arm’s-length. To the extent that the fair value of either the software sold or the goods or services purchased in concurrent transactions cannot be reliably determined, revenues and cost of the goods or services acquired are recorded at the net cash received or paid. Revenues for the three and nine month periods ended June 30, 2004 and 2003 were not affected by such transactions.

 

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Equity instruments received in conjunction with licensing transactions are recorded at their estimated fair market value and included in the measurement of the related license revenue in accordance with EITF No. 00-8, Accounting by a Grantee for an Equity Investment to Be Received in Conjunction with Providing Goods and Services. For the quarters ended June 30, 2004 and 2003, the Company recorded revenue of $399,000 and $428,000, respectively, based on equity instruments received in such transactions, and for the nine month periods ended June 30, 2004 and 2003, the Company recorded revenue of $1.2 million and $1.3 million, respectively, based on equity instruments received in such transactions. These transactions were originated in fiscal year 2000.

 

Deferred revenue includes amounts received from customers for which revenue has not been recognized that generally results from deferred maintenance and support, consulting or training services not yet rendered and license revenue deferred until all requirements under 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 SOP 97-2 are satisfied. Deferred revenue excludes contract amounts for which payment has yet to be collected. Likewise, accounts receivable exclude amounts due from customers for which revenue has been deferred.

 

Stock-based compensation

 

The Company accounts for its employee stock-based compensation plans in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees, and Financial Accounting Standards Board Interpretation No. 44 (FIN 44), Accounting for Certain Transactions Involving Stock Compensation—an Interpretation of APB Opinion No. 25, and complies with the disclosure provisions of SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of FASB Statement No. 123. Accordingly, no compensation cost is recognized for any of the Company’s fixed stock options granted to employees when the exercise price of the option equals or exceeds the fair value of the underlying common stock as of the grant date for each stock option. The Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123 and EITF No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services. Deferred employee stock-based compensation is included as a component of stockholders’ equity and is being amortized by charges to operations over the vesting period of the options and restricted stock consistent with the method described in Financial Accounting Standards Board Interpretation No. 28 (FIN 28), Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans.

 

Had compensation cost been recognized based on the fair value at the date of grant for options granted and Employee Stock Purchase Plan issuances, the Company’s pro forma net loss and net loss per share for the three and nine month periods ended June 30, 2004 and 2003 would have been as follows (in thousands, except per share amounts):

 

    

Three Months Ended

June 30,


   

Nine Months Ended

June 30,


 
     2004

    2003

    2004

    2003

 

Reported net loss

   $ (7,631 )   $ (3,447 )   $ (2,371 )   $ (113,692 )

Add back employee stock-based compensation expense included in reported net loss

     771       364       1,639       1,836  

Less employee stock-based compensation expense determined under fair value based method

     (6,968 )     (9,144 )     (23,941 )     (26,568 )
    


 


 


 


Pro forma net loss

   $ (13,828 )   $ (12,227 )   $ (24,673 )   $ (138,424 )
    


 


 


 


Reported basic and diluted net loss per share

   $ (0.17 )   $ (0.08 )   $ (0.05 )   $ (2.57 )
    


 


 


 


Pro forma basic and diluted net loss per share

   $ (0.30 )   $ (0.27 )   $ (0.55 )   $ (3.13 )
    


 


 


 


 

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Note 2—Goodwill and Other Intangible Assets

 

Business Combinations

 

Softface, Inc.

 

On April 15, 2004, the Company completed the acquisition of Softface, Inc. (“Softface”), a privately held company headquartered in Walnut Creek, California. Softface is a spending performance management company offering data enrichment solutions complementary to Ariba’s products. The total purchase price was $8.1 million, consisting of upfront cash payments of $3.3 million, payments of $3.4 million deferred for up to twelve months due to delayed payment terms or general representations and warranties, $169,000 of acquisition costs and $1.2 million of assumed liabilities. Of the total purchase price, $722,000 was allocated to net tangible assets acquired, and the remainder was allocated to other intangible assets, including existing software technology ($4.9 million), customer relationships ($100,000), order backlog ($100,000), and goodwill ($2.3 million). Other intangible assets are being amortized over their estimated useful lives of six months to three years. Pro forma financial information has been excluded as the information is considered immaterial.

 

Alliente, Inc.

 

On January 13, 2004, the Company completed the acquisition of Alliente, Inc. (“Alliente”), a privately held company headquartered in Colorado Springs, Colorado. Alliente provides procurement outsourcing services to companies based on Ariba technology. The total purchase price was approximately $10.0 million, consisting of cash payments of $9.0 million, $183,000 of acquisition costs and $790,000 of assumed liabilities. Of the total purchase price, $1.5 million was allocated to net tangible assets acquired, and the remainder was allocated to other intangible assets, including customer relationships ($1.0 million), trade name/trademark ($100,000), and goodwill ($7.4 million). Other intangible assets are being amortized over their estimated useful lives of three years. Pro forma financial information has been excluded as the information is considered immaterial.

 

Amortization of other intangible assets was $489,000 and $565,000 for the three and nine month periods ended June 30, 2004, respectively, related to the Company’s acquisitions of Alliente and Softface, of which $340,000 was classified as cost of revenues for each of the three and nine month periods ended June 30, 2004. Amortization of other intangible assets was zero and $117.5 million for the three and nine month periods ended June 30, 2003, respectively, of which $4.0 million was classified as cost of revenue for the nine months ended June 30, 2003.

 

The table below reflects changes or activity in the balances related to goodwill from September 30, 2003 through June 30, 2004 (in thousands):

 

     Net
carrying
amount


 

Goodwill balance as of September 30, 2003

   $ 181,033  

Add: goodwill related to Alliente

     7,565  
    


Goodwill balance as of March 31, 2004

     188,598  

Add: goodwill related to Softface

     2,321  

Less: goodwill adjustment for Alliente

     (209 )
    


Goodwill balance as of June 30, 2004

   $ 190,710  
    


 

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The table below reflects changes or activity in the balances related to other intangible assets from September 30, 2003 through June 30, 2004 (in thousands):

 

     Gross
carrying
amount


   Accumulated
amortization


    Net
carrying
amount


Other Intangible Assets balance as of September 30, 2003

   $    $     $

Additions:

                     

Customer relationships

     1,100      (160 )     940

Trade name/trademark

     100      (15 )     85

Existing software technology

     4,900      (340 )     4,560

Order backlog

     100      (50 )     50
    

  


 

Other Intangible Assets balance as of June 30, 2004

   $ 6,200    $ (565 )   $ 5,635
    

  


 

 

Amortization of other intangible assets balance as of June 30, 2004 for the remainder of fiscal year 2004 and for fiscal years 2005, 2006 and 2007 is anticipated to total $558,000, $2.0 million, $2.0 million and $1.0 million, respectively.

 

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 the Company’s headquarters. The operating lease term commenced on January 2001 through April 2001 and ends on January 24, 2013. Minimum monthly lease payments are approximately $2.4 million and escalate annually, with the total future minimum lease payments amounting to $293.4 million over the remaining lease term. As part of this lease agreement, the Company is required to hold certificates of deposit, totaling $26.3 million as of June 30, 2004, as a form of security through fiscal year 2013. Also, the Company is required by other lease agreements to hold an additional $1.6 million of standby letters of credit, which are cash collateralized. These instruments are issued by its banks in lieu of a cash security deposit required by landlords for domestic and international real estate leases. The total cash collateral of $27.9 million is classified as restricted cash on the Company’s condensed consolidated balance sheet as of June 30, 2004.

 

Future minimum lease payments and sublease income under noncancelable operating leases for the next five years and thereafter are as follows as of June 30, 2004 (in thousands):

 

Year Ending June 30,


   Lease
Payments


   Sublease
Income


2005

   $ 38,168    $ 17,895

2006

     37,035      18,245

2007

     34,620      17,941

2008

     33,897      2,760

2009

     34,835     

Thereafter

     134,618     
    

  

Total

   $ 313,173    $ 56,841
    

  

 

Of the total operating lease commitments as of June 30, 2004 noted above, $111.7 million is for occupied properties and $201.5 million is for abandoned properties, which are a component of the restructuring obligation. Future minimum lease payments and sublease income under noncancelable operating leases for the remainder of fiscal year 2004 are $9.7 million and $4.4 million, respectively.

 

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Restructuring and integration costs

 

In connection with its merger with FreeMarkets (see Note 9), the Company recorded a charge to operations of $480,000 and $807,000 in the quarters ended March 31, 2004 and June 30, 2004, respectively, for acquisition-related integration costs. These charges include the cost of actions designed to improve the Company’s post-merger competitiveness, productivity and future operating results and primarily relate to workforce severance and related benefits and to professional fees.

 

In fiscal year 2001, the Company initiated a restructuring program to align its expense and revenue levels. As part of this program, the Company restructured its worldwide operations including a worldwide reduction in workforce and the consolidation of excess facilities.

 

The following table details accrued restructuring and integration obligations and related activity for the nine months ended June 30, 2004 (in thousands):

 

     Severance
and
benefits


    Lease
abandonment
costs


    Other
integration
costs


    Total
restructuring
and integration
costs


 

Accrued restructuring obligations as of September 30, 2003

   $ 67     $ 47,809           $ 47,876  

Cash paid

     (2 )     (3,882 )           (3,884 )
    


 


 


 


Accrued restructuring obligations as of December 31, 2003

   $ 65     $ 43,927     $     $ 43,992  

Cash paid

           (2,748 )           (2,748 )

Total charge (benefit) to operating expense

           (2,397 )     480       (1,917 )
    


 


 


 


Accrued restructuring obligations as of March 31, 2004

   $ 65     $ 38,782     $ 480     $ 39,327  

Cash paid

             (2,742 )     (691 )     (3,433 )

Total charge to operating expense

     473       1,013       334       1,820  
    


 


 


 


Accrued restructuring obligations as of June 30, 2004

   $ 538     $ 37,053     $ 123     $ 37,714  
    


 


 


       

Less: current portion

                             10,533  
                            


Accrued restructuring obligations, less current portion

                           $ 27,181  
                            


 

Severance and benefits costs

 

Severance and benefits primarily include involuntary termination and health benefits, outplacement costs and payroll taxes.

 

Lease abandonment costs

 

Lease abandonment costs incurred to date relate to the abandonment of leased facilities in Mountain View and Sunnyvale, California, Tampa, Florida, Alpharetta, Georgia, Lisle, Illinois, Chicago, Illinois, Burlington, Massachusetts, Florham Park, New Jersey, Dallas, Texas, Hong Kong and Singapore. Total lease abandonment costs include lease liabilities offset by estimated sublease income. The estimated net costs of abandoning these leased facilities, including remaining lease liabilities offset by estimated sublease income, were based on market trend information analyses.

 

As of June 30, 2004, $37.1 million of lease abandonment costs, net of anticipated sublease income of $190.4 million, remains accrued and is expected to be paid by fiscal year 2013. In the quarter ended June 30, 2004, the Company revised its original estimates and expectations for its corporate headquarters and field offices disposition efforts. This revision was a result of changed estimates of sublease commencement dates and rental

 

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rate projections to reflect continued declines in market conditions in the commercial real estate market in Northern California. Based on these factors and using market trend information analyses provided by a commercial real estate brokerage firm retained by the Company, an additional charge to lease abandonment costs of $1.0 million was recorded in the quarter ended June 30, 2004. During the quarter ended March 31, 2004, the Company recorded a benefit to operating expense totaling $2.4 million primarily as a result of entering into a sublease agreement which was not anticipated in previous estimates of the restructuring obligation.

 

Actual sublease payments due to the Company under noncancelable subleases of excess facilities totaled $56.8 million as of June 30, 2004, 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, 2004, 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 of the Company’s Sunnyvale, California headquarters as of June 30, 2004 by approximately $7.7 million.

 

Other integration costs

 

Other integration costs for the three-month periods ended March 31, 2004 and June 30, 2004 consist primarily of professional fees incurred in connection with integration planning for the Company’s merger with FreeMarkets, which was consummated on July 1, 2004.

 

Other arrangements

 

Other than the obligations identified above, the Company does not have commercial commitments under lines of credit, standby repurchase obligations or other such debt arrangements. The Company has no 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, 2004.

 

Litigation

 

IPO Class Action Litigation

 

Between March 20, 2001 and June 5, 2001, a number of purported shareholder class action complaints were filed in the United States District Court for the Southern District of New York against the Company, certain of its former officers and directors (the “Individual Defendants”) and three of the underwriters of its initial public offering (“IPO”). These actions purport to be brought on behalf of purchasers of the Company’s common stock in the period from June 23, 1999, the date of its IPO, to December 23, 1999 (or in some cases, to December 5 or 6, 2000), and make certain claims under the federal securities laws, including Sections 11 and 15 of the Securities Act and Sections 10(b) and 20(a) of the Exchange Act, relating to its IPO.

 

On June 26, 2001, these actions were consolidated into a single action bearing the title In re Ariba, Inc. Securities Litigation, 01 CIV 2359. On August 9, 2001, that consolidated action was further consolidated before a single judge with cases brought against additional issuers (who numbered in excess of 300) and their underwriters that made similar allegations regarding the IPOs of those issuers. The latter consolidation was for purposes of pretrial motions and discovery only. On February 14, 2002, the parties signed and filed a stipulation dismissing the consolidated action without prejudice against the Company and certain Individual Defendants, which the Court approved and entered as an order on March 1, 2002. On April 19, 2002, the plaintiffs filed an amended complaint in which they dropped their claims against the Company and the Individual Defendants under Sections 11 and 15 of the Securities Act, but elected to proceed with their claims against such defendants under Sections 10(b) and 20(a) of the Exchange Act.

 

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The amended complaint alleges that the prospectus pursuant to which shares of common stock were sold in the Company’s IPO, which was incorporated in a registration statement filed with the SEC, contained certain false and misleading statements or omissions regarding the practices of the Company’s underwriters with respect to their allocation to their customers of shares of common stock in the Company’s IPO and their receipt of commissions from those customers related to such allocations. The complaint further alleges that the underwriters provided positive analyst coverage of the Company after the IPO, which had the effect of manipulating the market for its stock. Plaintiffs contend that such statements and omissions from the prospectus and the alleged market manipulation by the underwriters through the use of analysts caused the Company’s post-IPO stock price to be artificially inflated. The actions seek compensatory damages in unspecified amounts as well as other relief.

 

On July 15, 2002, the Company and the Individual Defendants, along with other issuers and their related officer and director defendants, filed a joint motion to dismiss based on common issues. On or around November 18, 2002, during the pendency of the motion to dismiss, the Court entered as an order a stipulation by which all of the Individual Defendants were dismissed from the case without prejudice in return for executing a tolling agreement. On February 19, 2003, the Court rendered its decision on the motion to dismiss, granting a dismissal of the remaining Section 10(b) claim against the Company without prejudice. Plaintiffs have indicated that they intend to file an amended complaint.

 

On June 24, 2003, a special litigation committee of the Company’s Board of Directors approved a Memorandum of Understanding (the “MOU”) reflecting a settlement in which the plaintiffs agreed to dismiss the case against the Company with prejudice in return for the assignment by the Company of claims that the Company might have against its underwriters. No payment to the plaintiffs by the Company was required under the MOU. After further negotiations, the essential terms of the MOU were formalized in a Stipulation and Agreement of Settlement, which has been executed on behalf of the Company and the Individual Defendants. The settling parties filed formal motions seeking preliminary approval of the proposed settlement on June 25, 2004. The underwriter defendants, who are not parties to the proposed settlement, filed a brief objecting to the settlement’s terms on July 14, 2004. There can be no assurance that the proposed settlement will be approved by the Court. In the event that the settlement is not approved by the Court, the Company intends to defend against these claims vigorously. As of June 30, 2004, no amount is accrued as a loss is not considered probable and estimable.

 

Restatement Class Action Litigation

 

Beginning January 21, 2003, a number of purported shareholder class action complaints were filed in the United States District Court for the Northern District of California against the Company and certain of its current and former officers and directors, all purporting to be brought on behalf of a class of purchasers of the Company’s common stock in the period from January 11, 2000 to January 15, 2003. The complaints bring claims under the federal securities laws, specifically Sections 10(b) and 20(a) of the Exchange Act, relating to the Company’s announcement that it would restate certain of its consolidated financial statements, and, in the case of two complaints, relating to its acquisition activity and related accounting. Specifically, these actions allege that certain of the Company’s prior consolidated financial statements contained false and misleading statements or omissions relating to its failure to properly recognize expenses and other financial items, as reflected in the then proposed restatement. Plaintiffs contend that such statements or omissions caused the stock price to be artificially inflated. Plaintiffs seek compensatory damages as well as other relief.

 

In a series of orders issued by the Court in February and March, 2003, these cases were deemed related to each other and assigned to a single judge sitting in San Jose. On July 11, 2003, following briefing and a hearing on related motions, the Court entered two orders that together (1) consolidated the related cases for all purposes into a single action captioned In re Ariba, Inc. Securities Litigation, Case No. C-03-00277 JF, (2) appointed a lead plaintiff, and (3) approved the lead plaintiff’s selection of counsel. On September 15, 2003, the lead plaintiff filed a Consolidated Amended Complaint, which restated the allegations and claims described above and added a claim pursuant to Section 14(a) of the Exchange Act, based on the allegation that the Company failed to disclose

 

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certain payments and executive compensation items in its January 24, 2002 Proxy Statement. On November 17, 2003, defendants filed a motion to dismiss the action for failure to state a claim, which was fully briefed and set for hearing on March 29, 2004. Prior to the hearing, the parties stipulated that, in lieu of proceeding to a hearing on defendants’ motion, plaintiff would withdraw its complaint and file a further amended complaint by April 16, 2004 and plaintiff did so on that date. Defendants’ motion to dismiss plaintiff’s further amended complaint was filed on June 18, 2004. A hearing on Defendants’ motion to dismiss is scheduled for October 29, 2004. This case is still in its early stages. The Company intends to defend against these claims vigorously. As of June 30, 2004, no amount is accrued as a loss is not considered probable and estimable.

 

Restatement Shareholder Derivative Litigation

 

Beginning January 27, 2003, several shareholder derivative actions were filed in the Superior Court of California for the County of Santa Clara against certain of the Company’s current and former officers and directors and against the Company as nominal defendant. These actions were filed by stockholders purporting to assert, on the Company’s behalf, claims for breach of fiduciary duties, aiding and abetting, violations of the California insider trading law, abuse of control, gross mismanagement, waste of corporate assets, unjust enrichment, and contribution and indemnification. Specifically, the claims were based on the Company’s acquisition activity and related accounting implemented by the defendants, the alleged understatement of compensation expenses as reflected in the Company’s then proposed restatement, the alleged insider trading by certain defendants, the existence of the restatement class action litigation, in which the Company is alleged to be liable to defrauded investors, and the allegedly excessive compensation paid by the Company to one of its officers, as reflected in its then proposed restatement. The complaints sought the payment by the defendants to the Company of damages allegedly suffered by the Company, as well as other relief.

 

These actions were assigned to a single judge sitting in San Jose. On May 7, 2003 following briefing and hearing on related motions, the court issued an order that (1) consolidated the cases for all purposes into a single action captioned In re Ariba, Inc. Shareholder Derivative Litigation, Lead Case No. CV 814325, and (2) appointed lead plaintiffs’ counsel. Pursuant to that order, plaintiffs filed an amended consolidated derivative complaint on May 28, 2003. The amended consolidated complaint restates the allegations, causes of action and relief sought as pleaded in the original complaints, and adds allegations relating to the Company’s April 10, 2003 announcement of the restatement of certain financial statements and also adds a cause of action for breach of contract. On October 28, 2003, the Company filed a demurrer, joined by the individual defendants, seeking dismissal of the action for failure to comply with applicable pre-litigation demand requirements. Following a hearing on the Company’s demurrer, the court issued a ruling on January 6, 2004 granting the Company’s demurrer and giving plaintiffs 60 days to file an amended complaint. The parties have since stipulated to extend this date to September 10, 2004. This case is still in its early stages. The Company intends to vigorously defend against the claim that plaintiffs should be excused from any pre-litigation demand requirements based on allegations that its Board of Directors could not have fairly evaluated any pre-litigation demand and thus that such demand would have been futile. As of June 30, 2004, no amount is accrued as a loss is not considered probable and estimable.

 

On March 7 and March 21, 2003, respectively, two shareholder derivative actions were filed in the United States District Court for the Northern District of California against certain of the Company’s current and former officers and directors and against the Company as nominal defendant. These actions were filed by shareholders purporting to assert, on behalf of the Company, claims for violations of the Sarbanes-Oxley Act, violations of the California insider trading law, breach of fiduciary duties, misappropriation of information, abuse of control, gross mismanagement, waste of corporate assets and unjust enrichment. Specifically, the claims were based on the Company’s announcements that it intended to and/or had restated certain financial statements and on alleged insider trading by certain defendants. The complaints sought the payment by the defendants to the Company of damages allegedly suffered by the Company, as well as other relief.

 

By orders issued by the Court on May 27 and June 23, 2003, these two derivative cases were deemed related to each other and to the securities class actions pending before the same court as now consolidated into In re

 

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Ariba, Inc. Securities Litigation, Case No. C-03-00277 JF, and accordingly these two derivative actions were assigned to the same judge sitting in San Jose assigned to that action. On June 23, 2003, following submission of a related stipulation of the parties, the Court issued an order that (1) consolidated the two derivative cases for all purposes into a single action captioned In re Ariba, Inc. Derivative Litigation, Case No. C-03-02172 JF, and (2) appointed lead plaintiffs’ counsel. In accordance with that order, plaintiffs filed an amended consolidated derivative complaint on June 26, 2003. The amended consolidated complaint restates the allegations, causes of action and relief sought as pleaded in the original complaints. On September 18, 2003, defendants filed a motion to dismiss or stay the action pending resolution of the parallel state court derivative litigation. Following a hearing on this motion on November 10, 2003, the Court issued a ruling on November 13, 2003 denying the motion but granting defendants’ alternative request for a stay of the action in light of the related securities class action litigation. Accordingly, this action is now stayed until the Court has determined the viability of the federal securities claim in the related action. This case is still in its early stages. The Company intends to vigorously defend against the claim that plaintiffs should be excused from any pre-litigation demand requirements based on allegations that its Board of Directors could not have fairly evaluated any pre-litigation demand and thus that such demand would have been futile. As of June 30, 2004, no amount is accrued as a loss is not considered probable and estimable.

 

General

 

The Company is also subject to various claims and legal actions arising in the ordinary course of business. One example is the Company’s dispute with Softbank. See Note 8 for further discussion. As another example, on December 28, 2001, BCE Emergis, Inc., a distributor in Canada of certain of the Company’s products, filed a lawsuit against the Company. In April 2004, the Company settled its litigation with BCE Emergis, resulting in a $2.4 million and $3.4 million reclassification of deferred revenue and other liabilities, respectively, to accrued liabilities and a $3.0 million charge to operating expense in the quarter ended March 31, 2004. The distribution of the settlement totaling $8.8 million was made in the quarter ended June 30, 2004. Additionally, on May 26, 2004, the Company was sued for patent infringement by ePlus, Inc. in an action filed in the U.S. District Court for Eastern District of Virginia. The complaint alleges that the Company directly or indirectly infringes three patents through the sale of unspecified “Enterprise Spend Management” products. Plaintiff seeks an injunction and damages in an unspecified amount. The Company is unable to assess the outcome of the litigation, which is at an early stage.

 

The Company has accrued for estimable and probable losses in its consolidated financial statements for those matters where it believes that the likelihood that a loss has occurred is probable and the amount of loss is reasonably estimable. There can be no assurance that existing or future litigation arising in the ordinary course of business or otherwise will not have a material adverse effect on the Company’s business, consolidated financial position, results of operations or cash flows or that the amount of accrued losses is sufficient for any actual losses that may be incurred.

 

Indemnification

 

The Company sells software licenses and services to its customers under contracts which the Company refers to as Software License and Service Agreements (each an “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, expense, 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 modify it to make it non-infringing. If the Company cannot address the infringement by replacing the product or services, or modifying the product or services, the Company is allowed to cancel the license or services and return the fees paid by the customer. The Company requires its employees to sign a proprietary information and inventions assignment agreement, which assigns the rights in its employees’ development work to the Company.

 

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To date, the Company has not had to reimburse any of its customers for any losses related to these indemnification provisions and no material claims asserted under these indemnification provisions are outstanding as of June 30, 2004. For several reasons, including the lack of prior indemnification claims and the lack of a monetary liability limit for certain infringement cases under the SLSA, the Company cannot determine the maximum amount of potential future payments, if any, related to such indemnification provisions. There can be no assurance that potential future payments will not have a material adverse effect on the Company’s business, financial position, results of operations or cash flows.

 

Note 4—Minority Interests in Subsidiaries

 

As of June 30, 2004, minority interests of approximately $20.5 million are recorded on the Company’s condensed consolidated balance sheet in order to reflect the share of the net assets of Nihon Ariba K.K. and Ariba Korea, Ltd. held by minority investors. In addition, the Company reduced consolidated net loss by approximately $296,000 and $136,000 for the quarter and nine months ended June 30, 2004, respectively, representing the minority interests’ share of net loss of these majority-owned subsidiaries. For the quarter and nine months ended June 30, 2003, the Company increased consolidated net loss by approximately $858,000 and $2.3 million, respectively, representing the minority interests’ share of net income of these majority-owned subsidiaries.

 

Note 5—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 one operating segment, enterprise spend management solutions. The Company markets its products in the United States and in foreign countries through its direct sales force and indirectly through resellers. The Company’s chief operating decision maker evaluates resource allocation decisions and the performance of the Company based upon revenue recorded in geographic regions and does not receive financial information about expense allocations on a disaggregated basis.

 

Information regarding revenues for the three and nine month periods ended June 30, 2004 and 2003, and long-lived assets (excluding goodwill) by geographic area as of June 30, 2004 and September 30, 2003, is as follows (in thousands):

 

     Three Months Ended
June 30,


   Nine Months Ended
June 30,


     2004

   2003

   2004

   2003

Revenues:

                           

United States

   $ 41,490    $ 38,359    $ 119,549    $ 120,140

Japan

     1,563      6,083      6,801      19,890

Other international

     9,930      12,121      35,372      37,536
    

  

  

  

Total

   $ 52,983    $ 56,563    $ 161,722    $ 177,566
    

  

  

  

 

     June 30,
2004


   September 30,
2003


Long-Lived Assets:

             

United States

   $ 24,687    $ 21,250

International

     1,406      1,097
    

  

Total

   $ 26,093    $ 22,347
    

  

 

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Approximately 1.8% and 10.2% of total revenues for the three months ended June 30, 2004 and 2003, respectively, and 2.6% and 10% of total revenues for the nine months ended June 30, 2004 and 2003, respectively, were from entities affiliated with Softbank, a related party. See Note 8 for additional information. Revenues are attributed to countries based on the location of the Company’s customers. The Company’s other international revenues were derived from sales in Europe, Canada, Asia, Australia and Latin America. The Company had net liabilities of $1.4 and $6.0 million related to its international locations as of June 30, 2004 and September 30, 2003, respectively.

 

Note 6—Stockholders’ Equity

 

Reverse Stock Split

 

On July 1, 2004, the Company effected a one-for-six reverse split of its outstanding common stock. As the reverse stock split occurred after the quarter ended June 30, 2004 but before the release of the quarterly report in which these Condensed Consolidated Financial Statements are contained, the information contained herein gives retroactive effect to the reverse stock split for all periods presented.

 

Common Stock Repurchase Program

 

The Company’s Board of Directors has authorized the repurchase of up to $50 million of its currently outstanding common stock. Stock purchases under the common stock repurchase program may be made periodically in the open market based on market conditions. Through June 30, 2004, there were no stock repurchases under this program.

 

Warrants

 

In March 2000, in connection with a sales and marketing alliance agreement with a third party, the Company issued an unvested warrant to purchase up to 571,429 shares of the Company’s common stock at an exercise price of $525.00 per share. Of the total shares underlying the warrant, 528,572 shares have expired unexercised and 42,857 shares remain unvested as of June 30, 2004. These unvested shares, if they remain unvested, will expire on a quarterly basis through March 2005. The business partner can partially vest in this warrant each quarter upon attainment of certain periodic milestones related to revenue targets. The warrant generally expires as to any earned or earnable portion when the milestone period expires or eighteen months after the specific milestone is met. During the quarters ended June 30, 2004 and 2003, the business partner did not vest in any shares of this warrant and no business partner warrant expense was recorded for these quarters. No amounts related to the unvested warrants are reflected in the accompanying condensed consolidated financial statements.

 

In connection with the purchase of Goodex AG in January 2003, the Company issued a warrant to purchase 83,333 shares of Company common stock at an exercise price of $18.78 per share, vesting of which was contingent upon achievement of certain revenue milestones through December 31, 2003. As of December 31, 2003, the warrant had not vested and the possibility of its vesting ceased. The warrant expired unexercised in July 2004.

 

Deferred stock-based compensation

 

During the nine month period ended June 30, 2004, the Company granted 281,704 shares of restricted common stock to executive officers and certain employees, resulting in additional deferred stock-based compensation of $5.5 million. This amount will be amortized in accordance with FIN 28 over the vesting periods of the individual restricted common stock grants, which are between eighteen months to five years.

 

During the quarters ended June 30, 2004 and 2003, the Company recorded $771,000 and $364,000 of stock-based compensation expense, respectively. During the nine month periods ended June 30, 2004 and 2003, the

 

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Company recorded $1.6 million and $1.8 million of stock-based compensation expense, respectively. As of June 30, 2004, the Company had an aggregate of approximately $4.4 million of deferred stock-based compensation remaining to be amortized.

 

Comprehensive loss

 

SFAS No. 130, Reporting Comprehensive Income, establishes standards of reporting and displaying 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 (loss) but rather are recorded directly in stockholders’ equity. The components of comprehensive loss for the three and nine month periods ended June 30, 2004 and 2003 are as follows (in thousands):

 

    

Three Months Ended

June 30,


   

Nine Months Ended

June 30,


 
     2004

    2003

    2004

    2003

 

Net loss

   $ (7,631 )   $ (3,447 )   $ (2,371 )   $ (113,692 )

Unrealized gain (loss) on securities

     (1,063 )     51       (1,344 )     (331 )

Foreign currency translation adjustments

     (596 )     290       675       719  
    


 


 


 


Comprehensive loss

   $ (9,290 )   $ (3,106 )   $ (3,040 )   $ (113,304 )
    


 


 


 


 

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

 

The components of accumulated other comprehensive income as of June 30, 2004 and September 30, 2003 are as follows (in thousands):

 

     June 30,
2004


    September 30,
2003


Unrealized gain (loss) on securities

   $ (284 )   $ 1,060

Foreign currency translation adjustments

     2,471       1,796
    


 

Accumulated other comprehensive income

   $ 2,187     $ 2,856
    


 

 

The Company has gross unrealized losses on securities as of June 30, 2004 comprised of $24,000 on US Treasury obligations, $128,000 on Federal agency non-mortgage-backed securities and $162,000 on corporate bonds. Because the Company has the ability and intent to hold these investments until a recovery of fair value, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at June 30, 2004.

 

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Note 7—Net Loss Per Share

 

The following table presents the calculation of basic and diluted net loss per common share for the three and nine month periods ended June 30, 2004 and 2003 (in thousands, except per share data):

 

    

Three Months Ended

June 30,


   

Nine Months Ended

June 30,


 
     2004

    2003

    2004

    2003

 

Net loss

   $ (7,631 )   $ (3,447 )   $ (2,371 )   $ (113,692 )
    


 


 


 


Weighted-average common shares outstanding

     45,746       44,680       45,450       44,515  

Less: Weighted-average common shares subject to repurchase

     (292 )     (180 )     (194 )     (276 )
    


 


 


 


Weighted-average common shares used in computing basic and diluted net loss per common share

     45,454       44,500       45,256       44,239  
    


 


 


 


Net loss per common share—basic and diluted

   $ (0.17 )   $ (0.08 )   $ (0.05 )   $ (2.57 )
    


 


 


 


 

For the three months ended June 30, 2004 and 2003, 8.5 million and 8.2 million weighted-average potential common shares, respectively, 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, 2004 and 2003, 8.1 million and 7.8 million weighted-average potential common shares, respectively, are excluded from the determination of diluted net loss per share, as the effect of such shares is anti-dilutive. Further, the potential common shares for the each of the three and nine month periods ended June 30, 2004 exclude 126,190 shares, and the potential common shares for the each of the three and nine month periods ended June 30, 2003 exclude 204,726 shares, which would be issuable under certain warrants contingent upon completion of certain milestones.

 

The weighted-average exercise price of stock options outstanding for the three months ended June 30, 2004 and 2003 was $19.46 and $20.82, respectively. The weighted-average exercise price of stock options outstanding for the nine months ended June 30, 2004 and 2003 was $19.50 and $20.82, respectively. The weighted average repurchase price of unvested restricted stock was $0.00 for each of the three and nine month periods ended June 30, 2004 and 2003. The weighted average exercise price of warrants outstanding was $525.00 for each of the three and nine month periods ended June 30, 2004 and 2003.

 

Note 8—Related Party Transactions

 

Strategic Relationships

 

In fiscal year 2001, the Company sold approximately 41% of its consolidated subsidiary, Nihon Ariba K.K., and approximately 42% of its consolidated subsidiary, Ariba Korea, Ltd., to Softbank Corp., a Japanese corporation and its subsidiaries (collectively, “Softbank”). An affiliate of Softbank also received the right to distribute the Company’s products from these subsidiaries in their respective jurisdictions. Related to transactions with Softbank, the Company recorded license and maintenance revenues of $965,000 and $5.8 million for the quarters ended June 30, 2004 and 2003, respectively, and $4.3 million and $17.8 million for the nine month periods ended June 30, 2004 and 2003, respectively, including license and maintenance revenues recognized pursuant to a long-term revenue commitment.

 

The Company’s strategic relationship with Softbank has not performed to its expectations. In June 2003, the Company commenced an arbitration proceeding against Softbank for failing to meet contractual revenue commitments. In response, Softbank filed a counterdemand alleging breach of fiduciary duty, breach of the implied covenant of good faith and fair dealing and fraud related to both the Company’s Japanese and Korean subsidiaries. In November 2003, the arbitration panel dismissed the Korea related claims on jurisdictional grounds and entered an interim award requiring Softbank to make a $26.6 million interim payment, which includes interest, and to make future payment commitments on an interim basis. The panel ordered that these

 

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payments may only be used for the purpose of conducting Nihon Ariba’s business and will be subject to the panel’s final award, which may require repayment of the interim payments. In January 2004, Softbank re-filed its claims related to Korea in a separate arbitration proceeding in San Francisco, California, and we filed our defenses and counterdemand in that proceeding in March 2004. Softbank has made three interim payments under the interim award totaling $43.4 million, including $9.7 million paid in April 2004. In connection with the arbitration proceeding, these funds are recorded in the period received as an increase to restricted cash and accrued liabilities. For any interim payment ultimately retained by Nihon Ariba, 35% will be payable as royalty to the Company under its intercompany agreement and may be subject to a 10% Japanese withholding tax while the remainder will be locally taxable income to Nihon Ariba subject to an effective income tax rate of approximately 40%.

 

On June 16, 2004, the Company entered into a binding agreement with Softbank setting forth the material terms under which the Company and Softbank will settle the dispute. Under the terms of the agreement, Ariba will acquire all of Softbank’s equity interests in Nihon Ariba K.K. and Ariba Korea Ltd., and will return to Softbank certain disputed interim payments Softbank has made in connection with the Nihon Ariba K.K. related arbitration proceedings. In addition, Softbank will purchase a license for certain Ariba software products for use by Softbank, and its affiliates for their own benefit and for the benefit of unaffiliated third-party customers in Japan. The terms of the settlement agreement will be effected by definitive agreements to be negotiated and entered into by the Company and Softbank.

 

Executive Agreements

 

In fiscal year 2001, the Company entered into an agreement with Robert Calderoni, its CEO, pursuant to which he is entitled to receive annual cash payments from the Company to compensate him for income tax incurred as a result of loan forgiveness and cash payments. As a result, the Company incurs additional compensation expense averaging approximately $267,000 per quarter through the quarter ending December 2004.

 

Note 9—Subsequent Event – Merger with FreeMarkets, Inc.

 

On July 1, 2004, the Company completed its merger with FreeMarkets, a publicly held company headquartered in Pittsburgh, Pennsylvania. FreeMarkets provides companies with software, services and information for global supply management. The merger is expected to create a comprehensive Spend Management company by bringing together the Company’s Spend Management technology with FreeMarkets’ sourcing and services expertise.

 

Pursuant to the merger, former stockholders of FreeMarkets became entitled to receive 0.375 shares of the Company’s common stock (after giving effect to the one-for-six reverse stock split effected on July 1, 2004) and $2.00 cash for each outstanding share of FreeMarkets common stock held by them.

 

The total estimated purchase price of approximately $547.4 million consists of (i) approximately $89.6 million of cash, (ii) $364.4 million of the Company’s common stock (based on the issuance of approximately 16.8 million shares of Ariba common stock), (iii) the assumption of approximately 10.6 million FreeMarkets stock options with a fair value of $86.9 million, and (iv) other estimated acquisition related expenses of approximately $6.5 million, consisting primarily of payments to financial advisors and other professional fees. For the purposes of this purchase price calculation, the deemed fair value of the Ariba common stock shares issued in the merger is $21.70 per share which is equal to Ariba’s average closing price per share as reported on The Nasdaq National Market for each trading-day during the period beginning two days before and ending two days after January 23, 2004, the merger announcement date, as adjusted for the one-for-six reverse stock split effected on July 1, 2004. The estimated purchase price will be allocated to the assets acquired and liabilities assumed based on their estimated fair values on the acquisition date.

 

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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 (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). 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 the 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” and the risks discussed in our other Securities and Exchange Commission (“SEC”) filings, including our Annual Report on Form 10-K/A as filed with the SEC on May 14, 2004 (the “Form 10-K/A”) and our Amendment No. 4 to our Registration Statement on Form S-4 as filed with the SEC on May 14, 2004 (the “Registration Statement”) relating to our merger with FreeMarkets, Inc. (“FreeMarkets”).

 

Recent Events

 

On July 1, 2004, we completed our merger with FreeMarkets, a publicly held company headquartered in Pittsburgh, Pennsylvania. FreeMarkets provides companies with software, services and information for global supply management. Pursuant to the merger, former stockholders of FreeMarkets became entitled to receive 0.375 shares of our common stock and $2.00 cash for each outstanding share of FreeMarkets common stock held by them. See note 9 of Notes to Condensed Consolidated Financial Statements.

 

On July 1, 2004, we effected a one-for-six reverse split of our outstanding common stock.

 

On April 15, 2004, we completed the acquisition of Softface, Inc. (“Softface”), a privately held company headquartered in Walnut Creek, California. Softface is a spending performance management company offering data enrichment solutions. The total purchase price was $8.1 million, consisting primarily of cash.

 

On January 13, 2004, we completed the acquisition of Alliente, Inc. (“Alliente”), a privately held company headquartered in Colorado Springs, Colorado. Alliente provides procurement outsourcing services to companies based on Ariba technology. The total purchase price was approximately $10.0 million, consisting of cash payments of $9.0 million, $183,000 of acquisition costs and $790,000 of assumed liabilities.

 

Overview of Business

 

Ariba provides Spend Management solutions that allow enterprises to manage efficiently the purchasing of all non-payroll goods and services required to run their business. We refer to these non-payroll expenses as “spend.” Our solutions, which include software applications, services and network access, are designed to provide enterprises with technology and business process improvements to better manage their spending and, in turn, save money. Our software applications 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. These goods and services include commodities, raw materials, operating resources, services, temporary labor, travel, maintenance, repair and operations equipment.

 

Ariba Spend Management applications and services are offered through six solution sets, each designed to address a business process related to enterprise spending.

 

    Ariba Strategy Solution—helps organizations define their spend management vision and develop a program that aligns their strategy and resources.

 

    Ariba Visibility Solution—provides organizations with a comprehensive set of products and services to enhance spend visibility across the purchasing lifecycle.

 

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    Ariba Sourcing Solution—allows companies to identify top suppliers across a broad range of categories to negotiate procurement terms, leverage and aggregate spend, implement best practices and manage procurement contracts.

 

    Ariba Procurement Solution—delivers flexible applications and services to enhance requisitioning and procurement capabilities for handling every aspect of spend.

 

    Ariba Supplier Management Solution—provides organizations with a broad set of products and services to support supplier interaction and performance throughout the spend management lifecycle.

 

    Ariba Managed Services—allow procurement organizations to outsource tactical procurement activities and the entire management of spend categories.

 

Our software applications were built to leverage the Internet and provide enterprises with real-time access to their business data and their business partners. They are designed to integrate with all major platforms and can be accessed via web browser. 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 customers with their business partners and suppliers to exchange product and service information as well as a broad range of business documents, such as purchase orders and invoices. Over 80,000 suppliers of a wide array of goods and services are connected to the Ariba Supplier Network. As a result, our customers can connect once to the Ariba Supplier Network and access many suppliers simultaneously.

 

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, and procurement outsourcing services. All of these additional offerings together with the Ariba Supplier Network are designed to improve the return on investment our customers receive through the use of our software applications.

 

We were incorporated in Delaware in September 1996 and from that date through March 1997 were in the development stage, conducting research and developing our initial products.

 

Overview of Quarter Ended June 30, 2004 and Outlook for Fiscal Year 2004

 

Overall, we reported results for the quarter ended June 30, 2004 that were within our expectations at the beginning of the quarter. Total revenues of $53.0 million for the quarter were 6% less than those for the quarter ended June 30, 2003, but in line with our guidance. Total revenues were negatively affected by the falloff in revenues from our strategic relationship with Softbank, but positively affected by our recent acquisitions of Alliente and Softface.

 

License revenues of $15.5 million for the quarter were 27% less than those for the quarter ended June 30, 2003, but slightly higher than our expectations. The decline in license revenues was primarily due to the falloff in revenues from Softbank.

 

Maintenance and service revenues of $37.5 million for the quarter were 6% higher than those for the quarter ended June 30, 2003, and reflect our continuing investment in our services business, including our recent acquisition of Alliente. We believe that our service offerings will continue to play an important role in our Spend Management solutions.

 

Gross margin for the quarter was approximately 70%. Our merger with FreeMarkets is expected to lower overall gross margins, as the FreeMarkets business had lower overall gross margins and we will be required to amortize certain acquired technology and customer contracts intangible assets to cost of revenues. In addition, we anticipate that gross margins will decline somewhat in future quarters to the extent that maintenance and service revenues increase as a percentage of total revenues.

 

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Total expenses, including cost of revenues, of $61.5 million for the quarter were in line with our expectations at the beginning of the quarter. However, we expect total expenses to increase in future quarters, primarily due to our recent acquisitions of Alliente, Softface, and FreeMarkets, as well as due to integration and other costs relating to our acquisition activity.

 

Net loss for the quarter was $7.6 million, or $0.17 per share, which was in line with our expectations at the beginning of the quarter. Net loss for the quarter ended June 30, 2003 was $3.4 million, or a loss of $0.08 per share.

 

Cash, cash equivalents, investments and restricted cash were $222.4 million at June 30, 2004, which was down $22.4 million from $244.8 million at March 31, 2004. Included in the total cash balance is $43.4 million in restricted cash relating to Softbank, which is offset by an equal current liability. Excluding the cash relating to Softbank, our total cash balance at June 30, 2004 was $179.0 million.

 

During the quarter, we received $9.7 million in restricted cash from an interim payment from Softbank, and made payments of $8.8 million for a legal settlement and $6.7 million for acquisition-related activity, including integration expenses. Other uses of cash during the quarter included payments of lease obligations, insurance premiums, advertising, foreign exchange, and general operations.

 

We expect several factors will cause our total cash balance at September 30, 2004 to decline significantly, including: (1) cash acquired through our merger with FreeMarkets, net of cash paid to FreeMarkets stockholders, (2) integration and other merger-related expenses, (3) our proposed settlement with Softbank, and (4) ongoing lease-loss payments and other operating expenses. In addition, our Board of Directors has extended our authorization to repurchase up to $50 million of our outstanding common stock, and any actions taken to repurchase shares of our outstanding common stock will reduce our cash balance.

 

Total deferred revenue declined by $5.6 million during the quarter to $76.8 million at June 30, 2004. The decrease in deferred revenue is principally due to recognition of more revenue from contracts entered into during prior periods than new deferrals originating in the current period quarter. We anticipate that our deferred revenue balance will decline at a slower rate in future quarters and that license revenues in future quarters will generally be more dependent upon revenues from new software license agreements entered into during those quarters. This trend may vary in any given quarter to the extent that we defer recognition of revenues for significant sales transactions.

 

Our outlook for the balance of fiscal 2004 has been adjusted to reflect our recent merger with FreeMarkets. As a result, we expect total revenues and expenses to increase significantly in the quarter ending September 30, 2004 relative to our recently reported quarters. In addition, we expect to incur substantial expenses related to the merger with FreeMarkets, including restructuring and severance payments, which will cause us to report a significant net loss in the quarter ending September 30, 2004. We also expect that goodwill on our balance sheet will increase substantially and we will be required to amortize acquired intangibles due to the merger with FreeMarkets. We believe that our success in the remainder of fiscal year 2004 will be substantially influenced by our ability to fully integrate our recent acquisitions of Alliente, Softface and FreeMarkets and our ability to maintain tight control over expenses and cash.

 

Longer term, our merger with FreeMarkets and our related restructuring program over the next few quarters are designed to yield better operating results in fiscal year 2005 and beyond. More specifically, we believe there are opportunities to generate ongoing cost reductions through identified cost synergies and to increase our quarterly revenues through cross-selling efforts, which should help improve our operating results.

 

We believe that key risks include our success in integrating our recent acquisitions, particularly our merger with FreeMarkets, market acceptance of spend management solutions as a standalone market category, our success in growing our sales channels in Europe and Japan, the overall level of information technology spending,

 

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potential declines in average selling prices as our newer products generally have lower list prices than our more established products, and the potential adverse impacts resulting from the restatement of our consolidated financial statements and related regulatory inquiries and legal proceedings.

 

Our prospects must be considered in light of the risks encountered by companies at an early stage of development, particularly given that we operate in new and rapidly evolving markets, have completed several acquisitions and face an uncertain economic environment. We may not be successful in addressing such risks and difficulties. See “Risk Factors” for additional information.

 

Dispute with Softbank

 

Our strategic relationship with Softbank has not performed to our expectations. In June 2003, we commenced an arbitration proceeding in San Francisco, California against Softbank for failing to meet contractual revenue commitments. We believe that Softbank’s failure to meet contractual revenue commitments was affected at least in part by the significant decline in information technology spending following formation of the strategic relationship in October 2000.

 

In response to our arbitration demand, Softbank filed a counterdemand alleging breach of fiduciary duty, breach of the implied covenant of good faith and fair dealing and fraud related to both of our Japanese and Korean subsidiaries. In November 2003, the arbitration panel dismissed the Korea related claims on jurisdictional grounds and entered an interim award requiring Softbank to make a $26.6 million interim payment, which includes interest, and to make future payment commitments on an interim basis. The panel ordered that these payments may only be used for the purpose of conducting Nihon Ariba’s business and will be subject to the panel’s final award, which may require repayment of the interim payments. In January 2004, Softbank re-filed its claims related to Korea in a separate arbitration proceeding in San Francisco, California, and we filed our defenses and counterdemand in that proceeding in March 2004.

 

Softbank has made three interim payments under the interim award totaling $43.4 million, including $9.7 million paid in April 2004. In connection with the arbitration proceeding or additional rulings regarding the disposition of the interim award proceeds, interim payments received from Softbank have been recorded in the period received as an increase to restricted cash and accrued liabilities.

 

On June 16, 2004, we entered into a binding agreement with Softbank setting forth the material terms under which Ariba and Softbank will settle the dispute. Under the terms of the agreement, we will acquire all of Softbank’s equity interests in Nihon Ariba K.K. and Ariba Korea Ltd., and will return to Softbank certain disputed interim payments Softbank has made in connection with the Nihon Ariba K.K. related arbitration proceedings. In addition, Softbank will purchase a license for certain of our software products for use by Softbank, and its affiliates for their own benefit and for the benefit of unaffiliated third-party customers in Japan. The terms of the settlement agreement will be effected by definitive agreements to be negotiated and entered into by Ariba and Softbank. There is no assurance we can achieve a mutually satisfactory resolution of our dispute with Softbank. We do not have similar long-term revenue commitments with any other customer. Accordingly, we do not believe that the factors giving rise to the dispute, which are unique to the Softbank relationship, are likely to affect anticipated revenues from other customers.

 

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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, reflects 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/A and the Registration Statement. The information contained below is in thousands, except per share data. The per share information contained below reflects the one-for-six reverse stock split of our common stock effected July 1, 2004.

 

    

Three Months Ended

June 30,


   

Nine Months Ended

June 30,


 
     2004

    2003

    2004

    2003

 

Revenues:

                                

License

   $ 15,148     $ 16,597     $ 47,890     $ 64,963  

License—related party

     327       4,691       2,201       14,523  

Maintenance and service

     36,870       34,146       109,562       94,805  

Maintenance and service—related party

     638       1,129       2,069       3,275  
    


 


 


 


Total revenues

     52,983       56,563       161,722       177,566  
    


 


 


 


Cost of revenues:

                                

License

     744       1,784       2,421       3,663  

Maintenance and service

     14,553       11,889       42,053       33,942  

Amortization of acquired technology

     340             340       4,000  
    


 


 


 


Total cost of revenues

     15,637       13,673       44,814       41,605  
    


 


 


 


Gross profit

     37,346       42,890       116,908       135,961  
    


 


 


 


Operating expenses:

                                

Sales and marketing

     22,621       19,199       65,449       60,320  

Research and development

     13,811       13,123       38,932       40,955  

General and administrative

     6,650       8,745       16,114       29,578  

Amortization of other intangible assets

     149             225       113,464  

Stock-based compensation

     771       364       1,639       1,836  

Restructuring and integration costs

     1,820       5,350       (97 )     5,350  

Total operating expenses

     45,822       46,781       122,262       251,503  
    


 


 


 


Loss from operations

     (8,476 )     (3,891 )     (5,354 )     (115,542 )

Interest income

     695       1,163       2,527       4,105  

Interest expense

     (2 )     (74 )     (7 )     (87 )

Other income (loss)

     30       97       (26 )     494  
    


 


 


 


Net loss before income taxes and minority interests

     (7,753 )     (2,705 )     (2,860 )     (111,030 )

Provision (benefit) for income taxes

     174       (116 )     (353 )     327  

Minority interests in net income (loss) of consolidated subsidiaries

     (296 )     858       (136 )     2,335  
    


 


 


 


Net loss

   $ (7,631 )   $ (3,447 )   $ (2,371 )   $ (113,692 )
    


 


 


 


Net loss per share—basic and diluted

   $ (0.17 )   $ (0.08 )   $ (0.05 )   $ (2.57 )
    


 


 


 


Weighted average shares used in computing net loss per share—basic and diluted

     45,454       44,500       45,256       44,239  
    


 


 


 


 

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Comparison of the Three and Nine Month Periods Ended June 30, 2004 and 2003

 

Revenues

 

Please refer to Note 1 of Notes to our Condensed Consolidated Financial Statements and “Application of Critical Accounting Policies and Estimates” for a description of our accounting policy related to revenue recognition.

 

License

 

Total license revenues for the quarter ended June 30, 2004 were $15.5 million, a 27% decrease from license revenues of $21.3 million for the quarter ended June 30, 2003. The decrease is primarily attributable to a decline of $4.4 million in license revenues from our Softbank relationship. Total license revenues for the nine months ended June 30, 2004 were $50.1 million, a 37% decrease from license revenues of $79.5 million for the nine months ended June 30, 2003. This decrease is primarily attributable to a $12.3 million decline in license revenues from our Softbank relationship and a decrease of $20.1 million from the recognition of previously deferred license revenues.

 

For the quarter and nine months ended June 30, 2004, a majority of license revenues were from license arrangements recognized on a non-ratable basis (such as recognition upon entering into the license, recognition on a percentage of completion basis, or contingency-based recognition), whereas for comparable periods in the prior year, the majority of license revenues were from arrangements recognized on a ratable basis over the term of the arrangement. This reflects the effects of the decline in Softbank revenues and decline in the base of large licenses, principally new customer Ariba Buyer sales, recognized on a ratable basis. In the future, we believe that license revenues in any quarter will be increasingly dependent on new customer licenses entered into in that quarter rather than amortization or recognition of license revenues deferred in prior quarters.

 

We recognized license revenues of $327,000 and $4.7 million for the quarters ended June 30, 2004 and 2003, respectively, and $2.2 million and $14.5 million for the nine months ended June 30, 2004 and 2003, respectively, from transactions involving Softbank, a related party. Of these amounts, zero and $4.7 million for the quarters ended June 30, 2004 and 2003, respectively, and $1.4 million and $14.1 million for the nine months periods ended June 30, 2004 and 2003, respectively, were pursuant to a long-term revenue commitment. Total Softbank-related license revenues represented 0.6% and 8.3% of license revenues for the quarters ended June 30, 2004 and 2003, respectively, and 1.4% and 8.2% of license revenues for the nine month periods ended June 30, 2004 and 2003, respectively. Revenues under our agreement with Softbank are recognized based on the lower of cumulative ratable revenue or cumulative cash received.

 

In June 2003, we commenced an arbitration proceeding against Softbank for failing to meet contractual revenue commitments. See “Dispute with Softbank” and “Risk Factors—Our Business May be Seriously Harmed If We Are Unable to Satisfactorily Resolve Our Dispute with Softbank” herein. Softbank has made three interim payments under the interim award totaling $43.4 million, including $9.7 million paid in April 2004. On June 16, 2004, we entered into a binding agreement with Softbank setting forth the material terms under which the companies will settle the dispute. Under the terms of the agreement, we will acquire all of Softbank’s equity interests in Nihon Ariba K.K. and Ariba Korea Ltd., and will return to Softbank certain disputed interim payments Softbank has made in connection with the Nihon Ariba K.K. related arbitration proceedings. In addition, Softbank will purchase a license for certain of our software products for use by Softbank, and its affiliates for their own benefit and for the benefit of unaffiliated third-party customers in Japan. The terms of the settlement agreement will be effected by definitive agreements to be negotiated and entered into by Ariba and Softbank For any interim payment ultimately retained by Nihon Ariba, 35% will be payable as royalty to us under our intercompany agreement and may be subject to a 10% Japanese withholding tax while the remainder will be locally taxable income to Nihon Ariba subject to an effective income tax rate of approximately 40%. Softbank is not contractually required to make any additional revenue payments in connection with our 2001 strategic relationship.

 

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Maintenance and service

 

Total maintenance and service revenues for the quarter ended June 30, 2004 were $37.5 million, a 6% increase over maintenance and service revenues of $35.3 million for the quarter ended June 30, 2003. This change was comprised of a $1.8 million increase in service revenues from $16.8 million for the quarter ended June 30, 2003 to $18.6 million for the quarter ended June 30, 2004, and a $500,000 increase in maintenance revenues from $18.4 million for the quarter ended June 30, 2003 to $18.9 million for the quarter ended June 30, 2004. Service revenues for the quarter ended June 30, 2004 included $2.5 million from the operations of Alliente.

 

Total maintenance and service revenues for the nine months ended June 30, 2004 were $111.6 million, a 14% increase over maintenance and service revenues of $98.1 million for the nine months ended June 30, 2003. This change was comprised of a $11.4 million increase in service revenues from $41.9 million for the nine months ended June 30, 2003 to $53.3 million for the nine months ended June 30, 2004, and a $2.1 million increase in maintenance revenues from $56.2 million for the nine months ended June 30, 2003 to $58.3 million for the nine months ended June 30, 2004. Service revenues for the nine months ended June 30, 2004 included $5.0 million from the operations of Alliente.

 

Cost of Revenues

 

License

 

Cost of license revenues for the quarter ended June 30, 2004 was $744,000, a 58% decrease from cost of license revenues of $1.8 million for the quarter ended June 30, 2003. The decrease is primarily a result of a decrease in partner co-sale commissions of approximately $914,000.

 

Cost of license revenues for the nine months ended June 30, 2004 was $2.4 million, a 34% decrease from cost of license revenues of $3.7 million for the nine months ended June 30, 2003. This decrease is primarily due to a decrease in product royalties of $1.5 million resulting from a decline in the number of products shipped during the nine months ended June 30, 2004 compared to the nine months ended June 30, 2003 and a decrease in partner co-sale commissions of approximately $1.1 million. This decrease was primarily offset by an increase in warranty expense during the nine months ended June 30, 2004 of $1.3 million resulting from a reversal during the nine months ended June 30, 2003.

 

Maintenance and service

 

Cost of maintenance and service revenues for the quarter ended June 30, 2004 was $14.6 million, a 22% increase over cost of maintenance and service revenues of $11.9 million for the quarter ended June 30, 2003. The increase is primarily a result of additional personnel costs of $3.2 million associated with increased levels of resources needed to support higher services revenues, due in part to our acquisition of Alliente, which resulted in increased services personnel.

 

Cost of maintenance and service revenues for the nine months ended June 30, 2004 was $42.1 million, a 24% increase over cost of maintenance and service revenues of $33.9 million for the nine months ended June 30, 2003. The increase is a result of additional personnel-related costs of $7.9 million associated with higher levels of service revenues, due in part to our acquisitions of Alliente and Goodex AG.

 

Amortization of acquired technology

 

Amortization of acquired technology represents the amortization of the other intangible assets allocated to technology in our fiscal year 2000 acquisitions of TradingDynamics, Tradex and SupplierMarket and our fiscal year 2004 acquisition of Softface. This expense amounted to $340,000 for each of the quarter and nine months ended June 30, 2004, and zero and $4.0 million for the quarter and nine months ended June 30, 2003, respectively.

 

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Operating Expenses

 

Sales and marketing

 

Sales and marketing expenses include costs associated with our sales and product marketing personnel and consist primarily of compensation and benefits, commissions and bonuses, promotional and advertising expenses, and travel and entertainment expenses, and also include the provision for doubtful accounts.

 

Sales and marketing expenses for the quarter ended June 30, 2004 were $22.6 million, an 18% increase from sales and marketing expenses of $19.2 million for the quarter ended June 30, 2003. This increase is primarily attributable to an increase in personnel costs totaling $1.9 million due to additional headcount resulting from our acquisition of Alliente during the quarter ended March 31, 2004, as well as an increase in marketing costs of $1.4 million relating principally to our advertising campaign for fiscal year 2004.

 

Sales and marketing expenses for the nine months ended June 30, 2004 were $65.4 million, a 9% increase over sales and marketing expenses of $60.3 million for the nine months ended June 30, 2003. This increase is primarily attributable to increased costs, as described above, for the quarter ended June 30, 2004, an increase in bad debt expense during the nine months ended June 30, 2004 due to the reversal of $1.3 million during the nine months ended June 30, 2003, and an increase in legal fees of $1.0 million, net of reimbursements, related to litigation costs.

 

Research and development

 

Research and development expenses include 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 include employee compensation and benefits, consulting costs and the cost of software development tools and equipment.

 

Research and development expenses for the quarter ended June 30, 2004 were $13.8 million, a 5% increase from research and development expenses of $13.1 million for the quarter ended June 30, 2003. This increase is primarily attributable to increases in globalization costs of $775,000 and software costs of $397,000 offset by a reduction in personnel related costs totaling $371,000.

 

Research and development expenses for the nine months ended June 30, 2004 were $38.9 million, a 5% decrease from research and development expenses of $41.0 million for the nine months ended June 30, 2003. The decrease is primarily attributable to decreases in compensation of $1.2 million and a reduction in depreciation expense of $1.1 million, as our equipment is nearing the end of its estimated useful life. To date, all software development costs have been expensed in the period incurred.

 

General and administrative

 

General and administrative expenses include costs for executive, finance, human resources, information technology, legal and administrative support functions.

 

General and administrative expenses for the quarter ended June 30, 2004 were $6.7 million, a 24% decrease from general and administrative expenses of $8.7 million for the quarter ended June 30, 2003. This decrease is primarily due to a reduction in expenses in the current quarter of $2.3 million related to our fiscal year 2003 accounting review compared to the quarter ended June 30, 2003.

 

General and administrative expenses for the nine months ended June 30, 2004 were $16.1 million, a 46% decrease from general and administrative expenses of $29.6 million for the nine months ended June 30, 2003. This decrease is primarily due to a reduction of expense associated with our fiscal year 2003 accounting review of $9.6 million, a decrease in compensation and benefit costs of $1.5 million related in part to a decrease in

 

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headcount, an decrease of $1.1 million due to a favorable outcome of a state sales tax audit, and a decrease in facilities related costs resulting from a $2.3 million benefit related to a bankruptcy settlement of a former sub-tenant, partially offset by increases in legal fees of $1.5 million. Although we believe the expenses associated with our fiscal 2003 internal accounting review are substantially complete, we may continue to incur significant fees and expenses relating to our ongoing regulatory and legal proceedings, including but not limited to litigation relating to the recent restatement of our consolidated financial statements.

 

Amortization of other intangible assets

 

Amortization of other intangible assets was $489,000 and $565,000 for the three and nine months ended June 30, 2004, respectively, related to our acquisitions of Alliente and Softface, of which $340,000 was classified as cost of revenues for each of the three and nine months ended June 30, 2004. Amortization of other intangible assets was zero and $117.5 million for the three and nine months ended June 30, 2003, respectively. For the nine months ended June 30, 2003, $4.0 million was classified as cost of revenues. As of June 30, 2004, we had $5.6 million of unamortized other intangible assets.

 

Stock-based compensation

 

We recognized deferred stock-based compensation associated with stock options granted to employees at prices below market value on the date of grant, stock options issued to certain employees in conjunction with the consummation of the TradingDynamics and SupplierMarket acquisitions in fiscal year 2000 and the issuance of restricted shares of common stock to certain senior executives, officers and employees. These amounts are included as a component of stockholders’ equity and are charged to operations over the vesting period of the options or the lapse of restrictions for the restricted stock, consistent with the method described in Financial Accounting Standards Board Interpretation No. 28 (FIN 28), Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans. Stock-based compensation expense is presented as a separate line item in our Condensed Consolidated Statements of Operations, net of the effects of reversals related to terminated employees for cancellation of unvested stock options previously amortized to expense under FIN 28. For the quarters and nine month periods ended June 30, 2004 and 2003, stock-based compensation expense, net of the effects of cancellations, is attributable to various operating expense categories as follows (in thousands):

 

    

Three Months Ended

June 30,


   

Nine Months Ended

June 30,


 
     2004

   2003

    2004

   2003

 

Cost of revenues

   $ 71    $ (42 )   $ 225    $ (751 )

Sales and marketing

     478      239       1,078      1,446  

Research and development

     98      26       126      258  

General and administrative

     124      141       210      883  
    

  


 

  


Total

   $ 771    $ 364     $ 1,639    $ 1,836  
    

  


 

  


 

During the nine month period ended June 30, 2004, we granted 281,704 shares of restricted common stock to executive officers and certain employees, resulting in additional deferred stock-based compensation of $5.5 million. This amount will be amortized in accordance with FIN 28 over the vesting periods of the individual restricted common stock grants, which are between eighteen months to five years.

 

During the quarters ended June 30, 2004 and 2003, we recorded $771,000 and $364,000 of stock-based compensation, respectively. During the nine months ended June 30, 2004 and 2003, we recorded $1.6 million and $1.8 million of stock-based compensation expense, respectively. As of June 30, 2004, we had an aggregate of approximately $4.4 million of deferred stock-based compensation remaining to be amortized through fiscal year 2009. We will incur additional stock-based compensation expense, over the near term and perhaps for much longer, as a result of our merger with FreeMarkets on July 1, 2004.

 

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Restructuring and integration costs

 

In connection with our merger with FreeMarkets we recorded a charge to operations of $480,000 and $807,000 in the quarters ended March 31, 2004 and June 30, 2004 respectively, for acquisition-related integration costs. These charges include the cost of actions designed to improve our post-merger competitiveness, productivity and future operating results and primarily relate to workforce severance and related benefits and to professional fees.

 

In fiscal year 2001, we initiated a restructuring program to align our expense and revenue levels. As part of this program, we restructured our worldwide operations including a worldwide reduction in workforce and the consolidation of excess facilities.

 

The following table details accrued restructuring and integration obligations and related activity for the nine months ended June 30, 2004 (in thousands):

 

     Severance
and
benefits


    Lease
abandonment
costs


    Other
integration
costs


    Total
restructuring
and integration
costs


 

Accrued restructuring obligations as of September 30, 2003

   $ 67     $ 47,809           $ 47,876  

Cash paid

     (2 )     (3,882 )           (3,884 )
    


 


 


 


Accrued restructuring obligations as of December 31, 2003

   $ 65     $ 43,927     $     $ 43,992  

Cash paid

           (2,748 )           (2,748 )

Total charge (benefit) to operating expense

           (2,397 )     480       (1,917 )
    


 


 


 


Accrued restructuring obligations as of March 31, 2004

   $ 65     $ 38,782     $ 480     $ 39,327  

Cash paid

             (2,742 )     (691 )     (3,433 )

Total charge to operating expense

     473       1,013       334       1,820  
    


 


 


 


Accrued restructuring obligations as of June 30, 2004

   $ 538     $ 37,053     $ 123     $ 37,714  
    


 


 


       

Less: current portion

                             10,533  
                            


Accrued restructuring obligations, less current portion

                           $ 27,181  
                            


 

Severance and benefits costs

 

Severance and benefits primarily include involuntary termination and health benefits, outplacement costs and payroll taxes.

 

Lease adandonment costs

 

Lease abandonment costs incurred to date relate to the abandonment of leased facilities in Mountain View and Sunnyvale, California, Tampa, Florida, Alpharetta, Georgia, Lisle, Illinois, Chicago, Illinois, Burlington, Massachusetts, Florham Park, New Jersey, Dallas, Texas, Hong Kong and Singapore. Total lease abandonment costs include lease liabilities offset by estimated sublease income. The estimated net costs of abandoning these leased facilities, including remaining lease liabilities offset by estimated sublease income, were based on market trend information analyses.

 

As of June 30, 2004, $37.1 million of lease abandonment costs, net of anticipated sublease income of $190.7 million, remains accrued and is expected to be paid by fiscal year 2013. In the quarter ended June 30, 2004, we revised our original estimates and expectations for our corporate headquarters and field offices disposition efforts. This revision was a result of changed estimates of sublease commencement dates and rental rate

 

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projections to reflect continued declines in market conditions in the commercial real estate market in Northern California. Based on these factors and using market trend information analyses provided by a commercial real estate brokerage firm retained by us, an additional charge to lease abandonment costs of $1.0 million was recorded in the quarter ended June 30, 2004. During the quarter ended March 31, 2004, we recorded a benefit to operating expense totaling $2.4 million primarily as a result of entering into a sublease agreement which was not anticipated in previous estimates of the restructuring obligation.

 

Actual sublease payments due to us under noncancelable subleases of excess facilities totaled $52.4 million as of June 30, 2004, 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, 2004, particularly if actual sublease income is significantly different from current estimates. These differences could have a material adverse effect on our 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 of our Sunnyvale, California headquarters as of June 30, 2004 by approximately $7.7 million.

 

Other integration costs

 

Other integration costs for the three-month periods ended March 31, 2004 and June 30, 2004 consist primarily of professional fees incurred in connection with integration planning for our merger with FreeMarkets which was consummated on July 1, 2004.

 

Interest income

 

Interest income for the quarter ended June 30, 2004 was $695,000, a 40% decrease from interest income of $1.2 million for the quarter ended June 30, 2003. Interest income for the nine months ended June 30, 2004 was $2.5 million, a 38% decrease from interest income of $4.1 million for the nine months ended June 30, 2003. These decreases are primarily attributable to lower invested cash, cash equivalents and investment balances as well as a change in mix to lower interest bearing accounts.

 

Other income (expense)

 

Other income (expense) consists of realized gains and losses on investments and foreign exchange currency fluctuations. Other income for the quarter ended June 30, 2004 was $30,000 compared to $97,000 of other income for the quarter ended June 30, 2003. The net change is primarily attributable to realized gains on investments and losses due to international currency fluctuations.

 

Other expense for the nine months ended June 30, 2004 was $26,000, compared to $494,000 of other income for the nine months ended June 30, 2003. The net change is primarily attributable to realized losses on investments offset by gains due to international currency fluctuations.

 

Minority interests

 

In December 2000, our consolidated subsidiary, Nihon Ariba K.K., issued and sold approximately 41% of its common stock for cash consideration of approximately $40.0 million to Softbank, a Japanese corporation and its subsidiaries (collectively, “Softbank”). In April 2001, Nihon Ariba K.K. issued and sold an additional 2% of its common stock for cash consideration of approximately $4.0 million to third parties. Prior to the transactions, we held 100% of the equity of Nihon Ariba K.K. in the form of common stock. Nihon Ariba K.K.’s operations consist of the marketing, distribution, service and support of our products in Japan.

 

As of June 30, 2004, minority interest of approximately $17.6 million is recorded on the condensed consolidated balance sheet in order to reflect the share of the net assets of Nihon Ariba K.K. held by minority

 

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investors. We recognized $303,000 as the minority interest’s share of Nihon Ariba K.K.’s loss for the quarter ended June 30, 2004 and recognized $884,000 as the minority interest’s share of Nihon Ariba K.K.’s income for the quarter ended June 30, 2003, respectively. We recognized $130,000 as the minority interest’s share of Nihon Ariba K.K.’s loss for the nine months ended June 30, 2004 and $2.4 million as the minority interest’s share of Nihon Ariba K.K.’s income for the nine months ended June 30, 2003.

 

In April 2001, our consolidated subsidiary, Ariba Korea, Ltd., issued and sold approximately 42% of its common stock for cash consideration of approximately $8.0 million to Softbank and its affiliate. Prior to the transaction, we held 100% of the equity of Ariba Korea, Ltd. in the form of common stock. Ariba Korea, Ltd.’s operations consist of the marketing, distribution, service and support of our products in Korea.

 

As of June 30, 2004, minority interest of approximately $2.9 million is recorded on the condensed consolidated balance sheet in order to reflect the share of the net assets of Ariba Korea, Ltd. held by minority investors. We recognized $7,000 as the minority interest’s share of Ariba Korea, Ltd.’s income for the quarter ended June 30, 2004 and recognized $26,000 for the minority interest’s share of Ariba Korea, Ltd.’s loss for the quarter ended June 30, 2003, respectively. We recognized $5,000 and $91,000 as the minority interest’s share of Ariba Korea, Ltd.’s loss for the nine months ended June 30, 2004 and 2003, respectively.

 

Liquidity and Capital Resources

 

As of June 30, 2004, we had $123.9 million in cash, cash equivalents and short-term investments, $26.0 million in long-term investments and $72.5 million in restricted cash, for total cash and investments of $222.4 million, and $24.0 million in working capital. All significant cash, restricted cash and investments are held in accounts in the United States except for approximately $43.6 million and $6.9 million held by Nihon Ariba K.K. and Ariba Korea, Ltd, respectively, our majority-owned subsidiaries in Japan and Korea, respectively. Repatriation of cash held in these foreign accounts may be subject to foreign withholding taxes at rates ranging from 10% to 16.5%. As of September 30, 2003, we had $127.1 million in cash, cash equivalents and short-term investments, $78.3 million in long-term investments and $29.7 million in restricted cash, for total cash and investments of $235.1 million, and $3.5 million in working capital.

 

The decrease in total cash, cash equivalents, investments and restricted cash of $12.7 million in the nine months ended June 30, 2004 is primarily attributable to a legal settlement matter involving a marketing alliance partner of approximately $8.8 million, $15.3 million of expenditures for integration and direct acquisition costs related to our recently completed acquisitions and net cash paid related to our abandoned real estate obligations of approximately $9.4 million. These decreases were partially offset by interim payments totaling $43.4 million received in connection with the Softbank arbitration proceeding. Interim payments received from Softbank pursuant to the arbitration proceeding may only be used for the purpose of conducting Nihon Ariba’s business of which certain amounts will be repaid to Softbank upon execution of definitive settlement agreements. As a result, we will not be able to retain all of the interim payments. Excluding the interim payments, we would have had $179.0 million in cash, cash equivalents, investments and remaining restricted cash as of June 30, 2004, a decrease of $56.1 million from September 30, 2003.

 

The increase in working capital of $20.5 million at June 30, 2004 compared to September 30, 2003 is primarily attributable to an increase in our accounts receivable and prepaid expenses and other current assets and to a reduction in accrued compensation, the current portion of deferred revenues and restructuring obligations and accounts payable, offset by an increase in accrued liabilities.

 

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Net cash used in operating activities was approximately $4.7 million for the nine months ended June 30, 2004, compared to $32.5 million of net cash used in operating activities for the nine months ended June 30, 2003. Net cash used in operating activities for the nine months ended June 30, 2004 is primarily attributable to the following:

 

    an increase in accrued liabilities of $39.1 million which principally relates to the interim payments received from Softbank totaling $43.4 million, partially offset by the payment of $8.8 million related to the settlement of a litigation matter involving a market alliance partner;

 

    an increase in accounts receivable of $6.6 million primarily due to timing of collections;

 

    an increase in prepaid expenses and other current assets of $3.7 million, which principally relates to prepaid acquisition costs related to our recently completed merger with FreeMarkets;

 

    a decrease in deferred revenue of $24.9 million principally due to recognition of more revenue from contracts entered into during prior periods than new deferrals originating in the current period quarter, to lower than expected sales in our software business, and to a reduction of deferred revenues of approximately $2.4 million related to the settlement of a litigation matter;

 

    a decrease in restructuring obligations of $10.2 million due to rent paid for abandoned properties; and

 

    a decrease in accrued compensation and related liabilities of $2.6 million comprised primarily of reduced accruals for commissions and bonuses totaling $3.4 million, partially offset by an increase of $1.8 million related to our employee stock purchase plan.

 

Excluding the $43.4 million interim payments from Softbank, our operating activities would have used $48.1 million in net cash rather than using $4.7 million in cash. To the extent that deferred revenues continue to decline, operating cash flows will be reduced.

 

Net cash provided by investing activities was approximately $37.9 million for the nine months ended June 30, 2004, compared to $12.0 million of net cash provided by investing activities for the nine months ended June 30, 2003. Net cash provided by investing activities for the nine months ended June 30, 2004 is primarily attributable to net sales of our investments, which was partially offset by the allocation of the interim payments received in connection with the Softbank arbitration proceeding to restricted cash and by our acquisitions of Alliente and Softface.

 

Net cash provided by financing activities was approximately $4.9 million for the nine months ended June 30, 2004, compared to $4.8 million of net cash provided by financing activities for the nine months ended June 30, 2003. Net cash provided by financing activities for the nine months ended June 30, 2004 is primarily attributable to proceeds from the issuance of stock under the Employee Stock Purchase Plan and exercise of stock options.

 

Contractual obligations

 

Our primary contractual obligations are under our operating leases and a letter of credit which are discussed below.

 

In March 2000, we entered into a facility lease agreement for approximately 716,000 square feet in four office buildings and an amenities building in Sunnyvale, California for our headquarters. The operating lease term commenced on January 2001 through April 2001 and ends on January 24, 2013. Minimum monthly lease payments are approximately $2.4 million and escalate annually, with the total future minimum lease payments amounting to $293.4 million over the remaining lease term. As part of this lease agreement, we are required to hold certificates of deposit totaling $26.3 million as of June 30, 2004, as a form of security through fiscal year 2013. Also, we are required by other lease agreements to hold an additional $1.6 million as standby letters of credit, which are cash collateralized. These instruments are issued by its banks in lieu of a cash security deposit required by landlords for domestic and international real estate leases. The total cash collateral of $27.9 million is classified as restricted cash on our condensed consolidated balance sheet as of June 30, 2004.

 

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Future minimum lease payments and sublease income under noncancelable operating leases for the next five years and thereafter are as follows as of June 30, 2004 (in thousands):

 

Year Ending June 30,


   Lease
Payments


   Sublease
Income


2005

   $ 38,168    $ 17,895

2006

     37,035      18,245

2007

     34,620      17,941

2008

     33,897      2,760

2009

     34,835     

Thereafter

     134,618     
    

  

Total

   $ 313,173    $ 56,841
    

  

               

 

Of the total operating lease commitments as of June 30, 2004 noted above, $111.7 million is for occupied properties and $201.5 million is for abandoned properties, which are a component of the restructuring obligation. Future minimum lease payments and sublease income under noncancelable operating leases for the remainder of fiscal year 2004 are $9.7 million and $4.5 million, respectively.

 

Other arrangements

 

Other than the obligations identified above, we do not have commercial commitments under lines of credit, standby repurchase obligations or other such debt 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. We do not have any material noncancelable purchase commitments as of June 30, 2004.

 

Common stock repurchase program

 

Our Board of Directors has authorized the repurchase of up to $50 million of our currently outstanding common stock to reduce the dilutive effect of our stock option and purchase plans. Stock purchases under the common stock repurchase program may be made periodically in the open market based on market conditions. Through June 30, 2004, there were no stock repurchases under this program. Cash flows from operations and existing cash balances may be used to repurchase our common stock in the future.

 

Anticipated cash flows

 

We expect to incur significant operating expenses, particularly research and development and sales and marketing expenses, for the foreseeable future in order to execute our business plan. We anticipate that such operating expenses, as well as planned capital expenditures, will constitute a material use of our cash resources. As a result, our net cash flows will depend heavily on the level of future sales, the impact of our merger with FreeMarkets, integration and merger-related expenses, our proposed settlement with Softbank, our ability to manage infrastructure costs, the outcome of our subleasing activities related to the costs of abandoning excess leased facilities, the use of cash under our stock repurchase program and the level of expenditures relating to our recently completed accounting review and ongoing regulatory and legal proceedings.

 

Although 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 expenditure requirements for at least the next twelve months, given the significant changes in our business and results of operations in the last twelve to eighteen months, the fluctuation in cash, cash equivalents and investments balances may be greater than presently anticipated. See “Risk Factors.” After the next twelve months, we may find it necessary to obtain additional funds. In the event additional funds are required, we may not be able to obtain additional financing on favorable terms or at all.

 

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Application of Critical Accounting Policies and Estimates

 

This information should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in our Form 10-K/A and the Registration Statement.

 

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 condensed 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 condensed consolidated financial statements, areas that are particularly significant for us include revenue recognition policies, the assessment of recoverability of goodwill, restructuring obligations related to abandoned operating leases and contingencies related to the collectibility of accounts receivable, warranty costs and pending litigation. These critical accounting policies and estimates, their related disclosures and other accounting policies, methods and estimates have been reviewed by us and our audit committee.

 

Revenue recognition

 

Our revenues are principally derived from licenses of our products, from maintenance and support contracts and from the delivery of implementation, consulting and training services. Our products are licensed under a perpetual license model or under a time-based license model. Access to the Ariba Supplier Network is available to our customers as part of their maintenance agreements for certain products.

 

We recognize revenue in accordance with Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended by SOP 98-4 and SOP 98-9, and Staff Accounting Bulletin (SAB) 104. We generally recognize revenue when all of the following criteria are met as set forth in paragraph 8 of SOP 97-2: (1) persuasive evidence of an arrangement exists, (2) delivery has occurred, (3) services are not considered essential, (4) the fee is fixed or determinable and (5) collectibility is probable.

 

One of the critical judgments we make is the assessment that “collectibility is probable.” Our recognition of revenue is based on our assessment of the probability of collecting the related accounts receivable balance on a customer-by-customer basis considering past payment history and credit history. The timing or amount of revenue recognition may have been different if different assessments of the probability of collection had been made at the time the transactions were recorded in revenue. In cases where collectibility is not deemed probable, revenue is recognized at the time collection becomes probable, which is generally upon receipt of cash.

 

Another critical judgment involves when fees are “fixed or determinable”. We consider payment terms where 80% of arrangement fees are due within twelve months from delivery to be normal. Payment terms are considered extended when greater than 20% of an arrangement fee is due beyond twelve months from delivery. If fees are not “fixed or determinable,” revenue is recognized when due and payable. In arrangements where at least 80% of fees are due within one year or less from delivery, the entire arrangement fee is considered fixed or determinable and revenue is recognized when the remaining basic revenue recognition criteria are met.

 

We recognize revenue using the residual method pursuant to the requirements of SOP 97-2, as amended by SOP 98-9. Under the residual method, revenue is recognized in a multiple element arrangement when Ariba specific objective evidence of fair value exists for all of the undelivered elements in the arrangement, but does not exist for one of the delivered elements in the arrangement. We allocate revenue to each undelivered element in a multiple element arrangement based on its respective fair value, with the fair value determined by the price charged when that element is sold separately, or the price established by management, having the relevant authority to do so. We defer revenue for the fair value of its undelivered elements, such as maintenance and

 

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professional services, and recognize revenue for the remainder of the arrangement fee attributable to the delivered elements (i.e., software products) when the basic criteria in SOP 97-2 have been met. As such, discounts, if any, are allocated to the license element and no discount is applied to undelivered elements. Our determination of the fair value of each element in multi-element arrangements is based on vendor-specific objective evidence (VSOE). We limit our assessment of VSOE for each element to either the price charged when the same element is sold separately or the price established by management, having the relevant authority to do so, for an element not yet sold separately.

 

Accounting for multiple elements under SOP 97-2 may result in significant deferrals of license revenue from the date of license delivery, the precise timing of which may be uncertain. The classification of deferred revenues between current and non-current is based on the determination as to whether the recognition will occur within the next twelve months or thereafter. The actual timing of revenue recognition will depend on when the four basic revenue recognition criteria are met and can vary based on the timing of product acceptance, delivery of specified upgrades, completion of services, delivery of future products available under options and many other factors. While it may be difficult to predict the timing of revenue recognition, in most cases the determination of when revenue recognition is appropriate is not subject to significant judgment.

 

Allowance for doubtful accounts receivable

 

We maintain an allowance for doubtful accounts at an amount we estimate to be sufficient to provide for actual losses resulting from collecting less than full payment on our receivables. A considerable amount of judgment is required when we assess the realizability of receivables, including assessing the probability of collection and the current credit-worthiness of each customer. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, an additional provision for doubtful accounts might be required. In cases where we are aware of circumstances that may impair a specific customer’s ability to meet its financial obligations, we record a specific allowance against amounts due, and thereby reduce the net recognized receivable to the amount we reasonably believe will be collected. For the remaining customers, we recognize allowances for doubtful accounts based on the length of time the aggregate receivables are outstanding, the current business environment and historical experience. Alternatively, if the financial condition of our customers were to improve such that their ability to make payments was no longer considered impaired, we would reduce related estimated reserves with a credit to the provision for doubtful accounts.

 

Recoverability of goodwill

 

On June 30, 2004 we had $190.7 million of goodwill on our condensed consolidated balance sheet. Of this amount, $9.7 million resulted from the acquisition of Alliente and Softface in the second and third quarters of fiscal year 2004, respectively, and approximately $181.0 million resulted from acquisitions completed in fiscal year 2000. Our net assets as of June 30, 2004 were $220.0 million and our market capitalization as of that date was $546.3 million.

 

Our merger with FreeMarkets on July 1, 2004 is expected to result in additional estimated goodwill of between $350 million and $370 million, which would result in estimated aggregate goodwill of between $540 million and $560 million as of September 30, 2004.

 

We regularly 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 net assets for a sustained period. Based upon our net assets as of June 30, 2004, anticipated operating results for the quarter ended September 30, 2004 and the impact of our merger with FreeMarkets, if the price of our common stock

 

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were to be below a price currently estimated to be between $10.10 and $10.40 per share for a sustained period, thereby resulting in our market capitalization being below net assets, we would be required to complete an analysis of the recoverability of our goodwill. Our stock price is highly volatile and it has experienced significant declines in fiscal year 2004, and our common stock has recently been trading below this threshold. Depending on market conditions and other factors, we may determine that an impairment review is necessary and assess whether the goodwill carrying value is considered recoverable.

 

When management determines that an impairment review is necessary based upon the existence of one or more of the above indicators of impairment, we must determine if the carrying amount of our reporting unit level exceeds the “fair value” of the reporting unit level (we have only one reporting unit, specifically the license, implementation and support of our software applications), based on quoted market prices of our common stock, which would indicate that goodwill may be impaired. If we determine that goodwill may be impaired, we compare the “implied fair value” of the goodwill, as defined by SFAS No. 142, to its carrying amount to determine the impairment loss, if any. We have recorded significant impairment charges for goodwill and other intangible assets in the past, and to the extent that events or circumstances cause our assumptions to change, additional charges may be required which could be material.

 

Lease abandonment costs

 

We initially recorded a significant restructuring charge in the third quarter of fiscal year 2001 upon abandoning certain operating leases as part of a program to restructure our operations and related facilities. In the quarters ended June 30, 2004, 2003 and 2002, we revised our estimates and expectations for our corporate headquarters and field offices disposition efforts as a result of changed estimates of sublease commencement dates and rental rate projections to reflect continued declines in market conditions in the commercial real estate market in Northern California. Lease abandonment costs for the abandoned facilities were estimated to include remaining lease liabilities and brokerage fees offset by estimated sublease income. Estimates related to sublease costs and income are based on assumptions regarding the period required to locate and contract with suitable sub-lessees and sublease rates which were achieved using market trend information analyses provided by a commercial real estate brokerage firm retained by us. Each reporting period we review these estimates, and to the extent that our assumptions change, the ultimate restructuring expenses for these abandoned facilities could vary significantly from current estimates. During the quarter ended June 30, 2004, we recorded an additional charge to operating expense totaling $1.0 million primarily as a result of changed estimates of sublease commencement dates and rental rate projections to reflect continued declines in market conditions in the commercial real estate market in Northern California During the quarter ended March 31, 2004, we recorded a benefit to operating expense totaling $2.4 million, primarily as a result of entering into a sublease agreement which was not anticipated in previous estimates of the restructuring obligation.

 

Actual sublease payments due to us under noncancelable subleases of excess facilities totaled $56.8 million as of June 30, 2004, and the remainder of anticipated sublease income of $133.6 million represents our 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, 2004, particularly if actual sublease income is significantly different from current estimates. These differences could have a material adverse effect on our 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 of our Sunnyvale, California headquarters as of June 30, 2004 by approximately $7.7 million.

 

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The following table details accrued lease abandonment costs and related activity from September 30, 2003 through June 30, 2004 (in thousands):

 

     Lease
abandonment
costs


 

Accrued restructuring obligations as of September 30, 2003

   $ 47,809  

Cash paid

     (3,882 )
    


Accrued restructuring obligations as of December 31, 2003

     43,927  

Cash paid

     (2,748 )

Adjustments

     (2,397 )
    


Accrued restructuring obligations as of March 31, 2004

     38,782  

Cash paid

     (2,742 )

Total charge to operating expense

     1,013  
    


Accrued restructuring obligations as of June 30, 2004

   $ 37,053  

Less: current portion

     9,872  
    


Accrued restructuring obligations, less current portion

   $ 27,181  
    


 

As of June 30, 2004, we had contractual commitments of $201.5 million for abandoned properties.

 

Warranty costs

 

Warranty cost accruals are established for specific product performance issues that are determined to require engineering and consulting efforts outside the normal scope of maintenance support. Historically, our warranty expense has principally related to Ariba Buyer Version 7.0 that affected a number of new customers and existing customers upgrading in early fiscal year 2001. We estimate warranty costs based on an evaluation of affected customers and remediation efforts required. These estimates are reassessed on a quarterly basis and adjusted as warranty issues are resolved or estimates change. Actual costs may vary from estimates due to unique features of individual customer information technology environments or changes in customer deployment plans or integration requirements, and whether or not customers require individualized remediation solutions or adopt new version releases or interim upgrades that may address performance issues. For example, during fiscal years 2003 and 2002, license warranty accruals totaling approximately $1.6 million and approximately $600,000, respectively, were reversed as reductions to cost of license revenues as a result of actual costs being less than those originally estimated and accrued in fiscal year 2001 in connection with Ariba Buyer Version 7.0.

 

Legal contingencies

 

We are subject to various claims and legal actions. We have accrued for estimated losses in accordance with GAAP for those matters where we believe that the likelihood that a loss has occurred is probable and the amount of loss is reasonably estimable. Although we currently believe that we have properly accrued for estimable and probable losses regarding the outcome of outstanding legal proceedings, claims and litigation involving us, litigation is inherently uncertain, and there can be no assurance that existing or future litigation will not have a material adverse effect on our business, results of operations or financial condition or that the current amount of accrued losses is sufficient for any actual losses that may be incurred.

 

Risk Factors

 

In addition to other information in this Form 10-Q, the following risk factors should be carefully considered in evaluating us and our business because such factors may have a significant impact on our business, operating results and financial condition. As a result of the risk factors set forth below and elsewhere in this Form 10-Q, including in “Overview of Quarter Ended June 30, 2004 and Outlook for Fiscal Year 2004,” and the risks

 

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discussed in our other SEC filings, including our Form 10-K/A and the Registration Statement, actual results could differ materially from those projected in any forward-looking statements.

 

We Have a Relatively Limited Operating History and Compete in New and Rapidly Evolving Markets. These Factors Make Evaluation of Our Future Prospects Difficult.

 

We were founded in September 1996 and have had a relatively limited operating history. Our limited operating history makes an evaluation of our future prospects very difficult. We introduced our first product, Ariba Buyer, in June 1997 and introduced additional products thereafter, partly as a result of acquisitions. We repositioned our product offerings as the Ariba Spend Management solution in September 2001, and introduced additional applications in 2002 and 2003. As we adjust to evolving customer requirements and competitor pressures, we may be required to further reposition our product and service offerings and introduce new products and services.

 

A Continued Slowdown in Information Technology Spending May Adversely Impact Our Business.

 

Our business has been adversely impacted by the decline in information technology spending in recent years. The majority of our business continues to be from sales of the Ariba Buyer product and related products and services to a relatively small number of customers each quarter. A continued slowdown could adversely impact our business in a number of ways including longer sales cycles, lower average selling prices and reduced bookings and revenues.

 

Our Merger with FreeMarkets Is Subject to a Number of Risks.

 

On July 1, 2004, we completed our merger with FreeMarkets, which provides companies with software, services and information for global supply management. Our merger with FreeMarkets is subject to a number of risks. These include risks that are disclosed in the Registration Statement under “Risk Factors—Risks Related to the Merger” and elsewhere. Among other things, achievement of the expected benefits of the merger, including cost savings, will depend on successfully:

 

    integrating the operations and personnel of the two geographically separate companies;

 

    offering the complementary products and services of each company to the other company’s existing customers; and

 

    developing new products and services that utilize the assets of both companies.

 

In addition, the merger could adversely affect our financial results, adversely affect our stock price or result in lost revenues and business opportunities as a result of customer confusion. If any of these or other risks relating to the merger occur, our business and prospects may be seriously harmed.

 

Our Spend Management Solutions are at a Relatively Early Stage of Development. They May Not Achieve Continued Market Acceptance.

 

Spend management software applications and services are at a relatively early stage of development. We introduced our initial Ariba Spend Management solutions in September 2001, and we have recently introduced several new products that have achieved limited deployment, including Ariba Analysis in November 2002, Ariba Contracts and Ariba Invoice in April 2002 and Ariba Category Management in March 2003. These products may be more challenging to implement than our more established products, as we have less experience deploying these applications. Our success depends on widespread customer acceptance of spend management solutions, including customer acceptance of standalone solutions from vendors like Ariba, rather than solutions from enterprise resource planning software vendors and others that are part of a broader enterprise application solution. For example, enterprise resource planning (ERP) vendors, including Oracle, SAP and PeopleSoft, could bundle spend management solutions with their existing ERP solutions and offer these spend management

 

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solutions 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 had an accumulated deficit of approximately $4.3 billion as of June 30, 2004, including cumulative charges for the amortization of goodwill and other intangible assets and the impairment of goodwill and other intangible assets totaling approximately $3.7 billion. We may incur significant losses in the future for a number of reasons, including the following:

 

    adverse economic conditions, in particular declines in information technology spending;

 

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

 

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

 

    failure to achieve and implement growth initiatives designed in part to offset declines in revenue from our strategic relationship with Softbank and from prior year contracts;

 

    failure to effectively redeploy internal resources to enhance our marketing, sales and service programs;

 

    failure to successfully grow our sales channels in Europe and Japan;

 

    increased reliance on hosted solutions and subscription offerings that result in lower near-term revenues from customer deployments;

 

    failure to maintain tight control over costs;

 

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

 

    the impact of our merger with FreeMarkets.

 

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

 

Our quarterly operating results have varied significantly in the past and will likely vary significantly in the future. We believe that period-to-period comparisons of our results of operations may not be meaningful and should not be relied upon as indicators of future performance trends.

 

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 timing mix 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;

 

    increased dependence on the number of new customer contracts in the current quarter, including follow-on contracts from existing customers, rather than on contracts entered into in prior quarters;

 

    increased dependence on generating revenues from new revenue sources;

 

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    delays in recognizing revenue from licenses of software products;

 

    changes in the mix of types of licensing arrangements and related timing of revenue recognition;

 

    the impact of recent declines in our deferred revenue;

 

    changes in our product line and customer demand resulting from our acquisition of FreeMarkets; and

 

    the impact of the restatement of our consolidated financial statements and our ongoing legal proceedings on customer demand.

 

Risks Related to Expenses

 

    unanticipated costs resulting from the redeployment of internal resources to expand marketing, sales and service programs;

 

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

 

    the level of expenditures relating to the restatement of our consolidated financial statements and our ongoing legal proceedings;

 

    changes in our pricing policies and business model, including increased reliance on hosted solutions and the implementation of programs to generate revenue from new sources;

 

    costs associated with the acquisition and integration of FreeMarkets into Ariba, including the amortization of other intangible assets and stock-based compensation expense;

 

    the failure to adjust our workforce to changes in the level of our operations; and

 

    the loss of key personnel.

 

Our Business Could Be Seriously Harmed if We Fail to Retain Our Current Key Personnel and Attract Additional Key Personnel.

 

Our future performance depends on the continued service of our senior management, product development and sales personnel, in particular Robert M. Calderoni, who was elected President and Chief Executive Officer in October 2001 and Chairman of the Board of Directors in July 2003. We do not carry key person life insurance. The loss of the services of one or more of our key personnel could seriously harm our business. In addition, our success depends on our continuing ability to attract, hire, train and retain a selected number of highly skilled managerial, technical, sales, marketing and customer support personnel. Our ability to retain key employees may be harder, given adverse changes in our business in recent years. In addition, new hires frequently require extensive training before they achieve desired levels of productivity. Competition for qualified personnel is intense, and we may fail to retain its key employees or to attract or retain other highly qualified personnel.

 

Our Revenues in Any Quarter Depend on a Relatively Small Number of Relatively Large Orders and Our Sales Cycles Are Long and Can Be Unpredictable. As a Result, Revenues in Any Quarter May Be Difficult to Predict and Unreliable as Indicators of Future Performance Trends.

 

Our quarterly revenues are especially subject to fluctuation because they depend on the sale of relatively large orders for our products and related services. For example, between three and eight individual customers represented at least 50% of our license revenues for each of the quarters ended June 30, 2004, March 31, 2004, December 31, 2003, September 30, 2003, June 30, 2003, March 31, 2003, and December 31, 2002. In addition, many of these relatively large orders are realized at the end of the quarter. As a result of this concentration and timing, our quarterly operating results, including average selling prices, may fluctuate significantly if we are unable to complete one or more substantial sales in any given quarter.

 

As discussed in “Risk Factors—Our Business May be Seriously Harmed if We Are Unable to Satisfactorily Resolve Our Dispute with Softbank,” we are in the process of negotiating the definitive agreement with Softbank

 

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under which we will settle our dispute with Softbank. The resolution of this dispute could affect the level of revenues realized by us in any given quarter. In addition, our sales cycles are long and can be unpredictable. See “Risk Factors—Implementation of Our Products by Large Customers Is Complex, Time Consuming and Expensive. We Frequently Experience Long Sales and Implementation Cycles. These Factors May Increase Our Operating Costs and Delay Recognition of Revenues.”

 

We May Continue to Depend on Ariba Buyer for a Substantial Portion of Our Business for the Foreseeable Future. Price Declines or the Failure to Achieve Broad Market Acceptance of Ariba Buyer Could Adversely Impact Our Business.

 

We anticipate that revenues from Ariba Buyer and related products and services will continue to constitute a substantial portion of our revenues for the foreseeable future. For example, we recognized 52%, 54%, and 59% of total revenues from Ariba Buyer licenses and related maintenance in the three and nine months ended June 30, 2004, and the fiscal year ended September 30, 2003, respectively. If we experience price declines or fail to achieve broad market acceptance of Ariba Buyer, our business could be seriously harmed.

 

An Increased Demand for Hosted Solutions by Customers May Result in Lower Near-Term Revenues.

 

We license our spend management solutions directly to our customers and also host these solutions for our customers. Because we generally charge lower up front fees to customers that obtain hosted solutions, our near-term revenues may decline if our customers increasingly rely on hosted solutions rather than directly licensing solutions from us.

 

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 Unreliable Indicators 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. We anticipate that license revenues in future quarters will generally be more dependent on revenues from new customer contracts entered into in those quarters rather than from amortization or recognition of license revenues deferred in prior quarters.

 

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.

 

As a Result of Our Merger With FreeMarkets, We Will be Subject to a Number of Risks That May Have Affected FreeMarkets’ Business and Operations Before the Merger.

 

The business and operations of FreeMarkets before our merger with them was subject to a number of risks that will affect our combined business after the merger. These include risks that were disclosed in “Risk Factors—Risks Related to FreeMarkets” and elsewhere in the Registration Statement as well in FreeMarkets’ filings with the SEC. Among this risks are the following:

 

    customers may buy self-service products, rather that more costly technology enhanced services, which could adversely affect revenue;

 

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    the sales cycle for products and services that we now offer is long and uncertain and factors outside of our control may affect purchase decisions for those products and services;

 

    revenues and fee from products and services that we now offer are concentrated and the loss of any significant customer may significantly reduce revenues and fees from those products and services;

 

    customers may not purchase products and services that we now offer unless those products and services generate significant savings for these customers; and

 

    revenues and gross margins may be impaired unless short-term agreements lead to long-term customer relationships.

 

Failure or Circumvention of Our Controls and Procedures Could Seriously Harm Our Business.

 

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 other than inconsequential error or fraud 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 other than inconsequential error or fraud could seriously harm our business and results of operations.

 

Failure to Raise Required Additional Capital on Acceptable Terms, If At All, Could Seriously Harm Our Business and Dilute the Percentage Ownership of Our Stockholders.

 

Although our existing cash, cash equivalents and investment balances together with our anticipated cash flow from operations should be sufficient to meet our anticipated working capital and operating resource expenditure requirements for at least the next 12 months, given the significant changes in our business and results of operations in the last 12 to 18 months, the fluctuation in cash, cash equivalents and investments balances may be greater than presently anticipated. After the next 12 months, we may need to raise additional funds and we cannot be certain that we will be able to obtain additional financing on favorable terms, if at all. Our inability to raise funds on acceptable terms, if and when needed, could seriously harm our business. In addition, if we raise funds through the issuance of additional shares, our current stockholders’ percentage ownership of Ariba would be reduced.

 

Implementation of Our Products by Large Customers Is Complex, Time Consuming and Expensive. We Frequently Experience Long Sales and Implementation Cycles. These Factors May Increase Our Operating Costs and Delay Recognition of Revenues.

 

Ariba Buyer, Ariba Enterprise Sourcing and our other products are complex applications that are generally deployed with many users. Implementation of these applications by buying organizations is complex, time consuming and expensive. In many cases, our customers must change established business practices. Customers must generally consider a wide range of other issues before committing to purchase our products and services, including product benefits, ease of installation, ability to work with existing computer systems, ability to support a larger user base, reliability and return on investment. Furthermore, 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.

 

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

 

We depend on suppliers joining the Ariba Supplier Network. Any failure of suppliers to join the Ariba Supplier Network in sufficient numbers, or of existing suppliers to maintain their participation in the Ariba

 

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Supplier Network, would make the network less attractive to buyers and consequently other suppliers. 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 (services that provide electronic product indices) and other content aggregation tools (software tools that allow users to aggregate information maintained in electronic format). Our inability to access and index these catalogs and services would result in our customers having fewer products and services available to them through our solution, which would adversely affect the perceived usefulness of the Ariba Supplier Network.

 

Failure to Establish and Maintain Strategic Relationships with Third Parties Could Seriously Harm Our Business.

 

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.

 

Our Business May Be Seriously Harmed if We Are Unable to Satisfactorily Resolve Our Dispute with Softbank.

 

We also have strategic relationships with Softbank and its affiliates, as a minority stockholder of our Japanese and Korean subsidiaries, Nihon Ariba K.K. (“Nihon Ariba”) and Ariba Korea, Ltd., respectively, from which they derived license and maintenance revenues of $965,000 and $5.8 million for the quarters ended June 30, 2004 and 2003, respectively, and $4.3 million and $17.8 million for the nine months ended June 30, 2004 and 2003, respectively, including license and maintenance revenues recognized pursuant to a long-term revenue commitment. These amounts represent 1.8% and 10.2% of total revenues for the quarters ended June 30, 2004 and 2003, respectively, and 2.6% and 10.0% of total revenues for the nine months ended June 30, 2004 and 2003, respectively.

 

Our strategic relationship with Softbank has not performed to our expectations. In June 2003, we commenced an arbitration proceeding in San Francisco, California against Softbank for failing to meet contractual revenue commitments. In response to our arbitration demand, Softbank filed a counterdemand alleging breach of fiduciary duty, breach of the implied covenant of good faith and fair dealing and fraud related to both of our Japanese and Korean subsidiaries. In November 2003, the arbitration panel dismissed the Korea related claims on jurisdictional grounds and entered an interim award requiring Softbank to make a $26.6 million interim payment, which includes interest, and to make future payment commitments on an interim basis. The panel ordered that these payments may only be used for the purpose of conducting Nihon Ariba’s business and will be subject to the panel’s final award, which may require repayment of the interim payments. In January 2004, Softbank re-filed its claims related to Korea in a separate arbitration proceeding in San Francisco, California, and we filed our defenses and counterdemand in that proceeding in March 2004.

 

Softbank has made three interim payments under the interim award totaling $43.4 million, including $9.7 million in April 2004. There is no assurance we can achieve a mutually satisfactory resolution of our dispute with Softbank. In connection with the arbitration proceeding, these funds are recorded in the period received as an increase to restricted cash and accrued liabilities.

 

On June 16, 2004, we entered into a binding agreement with Softbank setting forth the material terms under which Ariba and Softbank will settle the dispute. Under the terms of the agreement, we will acquire all of Softbank’s equity interests in Nihon Ariba K.K. and Ariba Korea Ltd., and will return to Softbank certain disputed interim payments Softbank has made in connection with the Nihon Ariba K.K. related arbitration proceedings. In addition, Softbank will purchase a license for certain of our software products for use by

 

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Softbank, and its affiliates for their own benefit and for the benefit of unaffiliated third-party customers in Japan. The terms of the settlement agreement will be effected by definitive agreements to be negotiated and entered into by Ariba and Softbank.

 

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. The intensity of competition has increased and is expected to further increase in the future. This increased competition has resulted in price reductions and 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, scope and breadth of the products and services they offer. In addition, because spend management is a relatively new software category, we expect additional competition from other established and emerging companies. 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, Cap Gemini Ernst & Young, Deloitte Consulting and Bearing Point, are generally not subject to confidentiality or non-compete agreements that restrict such competitive behavior. Also, there are consulting companies that offer services that may compete with parts of our offering. We could also face competition from other companies who introduce Internet-based spend management solutions.

 

Many of our current and potential competitors, such as enterprise resource planning software vendors including Oracle, SAP and PeopleSoft, 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 potential customers and have extensive knowledge of our industry. In the past, 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 compete successfully against our current and future competitors.

 

Our Acquisitions Are, and Any Future Acquisitions Will Be, Subject to a Number of Risks.

 

On January 13, 2004, we acquired Alliente, Inc., a privately held company that provides procurement outsourcing services to companies based on Ariba technology. Alliente derived, and the Alliente business continues to derive, a substantial majority of its revenue from a single customer, and the loss of this customer could have a very significant negative effect on the Alliente business. Furthermore, the acquisition of Alliente could have the effect of straining or damaging our strategic relationships with certain consulting firms which also offer outsourcing services. On April 15, 2004, the Company completed the acquisition of Softface, Inc. (“Softface”), a privately held company headquartered in Walnut Creek, California. Softface is a spending performance management company. See Note 2 of Notes to Condensed Consolidated Financial Statements for further discussion on these acquisitions.

 

On July 1, 2004, we completed our merger with FreeMarkets. See Note 9 of Notes to Condensed Consolidated Financial Statements for further discussion.

 

In addition, our acquisitions of Alliente, Softface and FreeMarkets are, and any future acquisitions will be, subject to a number of additional risks, including:

 

    the diversion of management time and resources;

 

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

 

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    the potential disruption of our ongoing businesses;

 

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

 

    unanticipated expenses related to integration of the acquired company;

 

    difficulties in 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; and

 

    potential unknown liabilities associated with acquired businesses.

 

See “Risk Factors—Risks Related to the Merger” in the Registration Statement and “Risk Factors—Our Merger with FreeMarkets is Subject to a Number of Risks” above for additional information about risks relating to our merger with FreeMarkets.

 

If We Fail to Develop Products and Services on a Timely and Cost-Effective Basis, or If Our Products 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.

 

For example, the introduction of Version 7.0 of Ariba Buyer was delayed significantly in the first quarter of fiscal year 2001, and we have experienced delays in the introduction of other products and releases in the past. If new releases of our products or potential new products are delayed, we could experience a delay or loss of revenues and customer dissatisfaction.

 

New Versions and Releases of Our Products May Contain Errors or Defects, Which Could Harm Our Business.

 

Ariba Buyer, Ariba Enterprise Sourcing and our other products are complex. They may contain undetected errors or failures when first introduced or as new versions are released. This may result in loss of, or delay in, market acceptance of our products. We have in the past discovered software errors in our new releases and new products after their introduction. We have experienced delays in product release, lost revenues and customer frustration during the periods required to correct these errors. We may in the future discover errors and additional limitations in new releases or new products after the commencement of commercial shipments.

 

Litigation Regarding Our IPO Could Seriously Harm Our Business.

 

Between March 20, 2001 and June 5, 2001, a number of purported shareholder class action complaints were filed in the United States District Court for the Southern District of New York against Ariba, certain of our former officers and directors (the “Individual Defendants”) and three of the underwriters of our initial public offering (“IPO”). These actions purport to be brought on behalf of purchasers of our common stock in the period from June 23, 1999, the date of our IPO, to December 23, 1999 (in some cases, to December 5 or 6, 2000), and make certain claims under the federal securities laws, including Sections 11 and 15 of the Securities Act and Sections 10(b) and 20(a) of the Exchange Act, relating to our IPO.

 

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On June 26, 2001, these actions were consolidated into a single action bearing the title In re Ariba, Inc. Securities Litigation, 01 CIV 2359. On August 9, 2001, that consolidated action was further consolidated before a single judge with cases brought against additional issuers (who numbered in excess of 300) and their underwriters that made similar allegations regarding the IPOs of those issuers. The latter consolidation was for purposes of pretrial motions and discovery only. On February 14, 2002, the parties signed and filed a stipulation dismissing the consolidated action without prejudice against Ariba and certain Individual Defendants, which the Court approved and entered as an order on March 1, 2002. On April 19, 2002, the plaintiffs filed an amended complaint in which they dropped their claims against Ariba and the Individual Defendants under Sections 11 and 15 of the Securities Act, but elected to proceed with their claims against such defendants under Sections 10(b) and 20(a) of the Exchange Act.

 

The amended complaint alleges that the prospectus pursuant to which shares of common stock were sold in our IPO, which was incorporated in a registration statement filed with the SEC, contained certain false and misleading statements or omissions regarding the practices of our underwriters with respect to their allocation to their customers of shares of common stock in our IPO and their receipt of commissions from those customers related to such allocations. The complaint further alleges that the underwriters provided positive analyst coverage of Ariba after the IPO, which had the effect of manipulating the market for our stock. Plaintiffs contend that such statements and omissions from the prospectus and the alleged market manipulation by the underwriters through the use of analysts caused our post-IPO stock price to be artificially inflated. Plaintiffs seek compensatory damages in unspecified amounts as well as other relief.

 

On July 15, 2002, Ariba and the Individual Defendants, along with other issuers and their related officer and director defendants, filed a joint motion to dismiss based on common issues. On or around November 18, 2002, during the pendency of the motion to dismiss, the Court entered as an order a stipulation by which all of the Individual Defendants were dismissed from the case without prejudice in return for executing a tolling agreement. On February 19, 2003, the Court rendered its decision on the motion to dismiss, granting a dismissal of the remaining Section 10(b) claim against Ariba without prejudice. Plaintiffs have indicated that they intend to file an amended complaint.

 

On June 24, 2003, a special litigation committee of our Board of Directors approved a Memorandum of Understanding (the “MOU”) reflecting a settlement in which the plaintiffs agreed to dismiss the case against us with prejudice in return for the assignment by us of claims that we might have against our underwriters. No payment to the plaintiffs by us was required under the MOU. After further negotiations, the essential terms of the MOU were formalized in a Stipulation and Agreement of Settlement, which has been executed on our behalf and on behalf of the Individual Defendants. The settling parties filed formal motions seeking preliminary approval of the proposed settlement on June 25, 2004. The underwriter defendants, who are not parties to the proposed settlement, filed a brief objecting to the settlement’s terms on July 14, 2004. There can be no assurance that the proposed settlement will be approved by the Court. In the event that the settlement is not approved by the Court, we intend to defend against these claims vigorously.

 

Defending against securities class action relating to our IPO may require significant management time and, regardless of the outcome, result in significant legal expenses. If our defenses are unsuccessful or we are unable to settle on favorable terms, we could be liable for large damages that could seriously harm our business and results of operations.

 

Litigation Arising Out of the Restatement of Our Consolidated Financial Statements Could Seriously Harm Our Business.

 

Beginning January 21, 2003, a number of purported shareholder class action complaints were filed in the United States District Court for the Northern District of California against us and certain of our current and former officers and directors, all purporting to be brought on behalf of a class of purchasers of our common stock in the period from January 11, 2000 to January 15, 2003. The complaints bring claims under the federal securities

 

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laws, specifically Sections 10(b) and 20(a) of the Exchange Act, relating to our announcement that we would restate certain of our consolidated financial statements, and also, in the case of two complaints, relating to our acquisition activity and related accounting. Specifically, these actions allege that certain of our prior consolidated financial statements contained false and misleading statements or omissions relating to our failure to properly recognize expenses and other financial items, as reflected in the then proposed restatement. Plaintiffs contend that such statements or omissions caused our stock price to be artificially inflated. Plaintiffs seek compensatory damages as well as other relief.

 

In a series of orders issued by the Court in February and March, 2003, these cases were deemed related to each other and assigned to a single judge sitting in San Jose. On July 11, 2003, following briefing and a hearing on related motions, the Court entered two orders that together (1) consolidated the related cases for all purposes into a single action captioned In re Ariba, Inc. Securities Litigation, Case No. C-03-00277 JF, (2) appointed a lead plaintiff, and (3) approved the lead plaintiff’s selection of counsel. On September 15, 2003, the lead plaintiff filed a Consolidated Amended Complaint, which restated the allegations and claims described above and added a claim pursuant to Section 14(a) of the Exchange Act, based on the allegation that we failed to disclose certain payments and executive compensation items in our January 24, 2002 Proxy Statement. On November 17, 2003, defendants filed a motion to dismiss the action for failure to state a claim, which was fully briefed and set for hearing on March 29, 2004. Prior to the hearing, the parties stipulated that, in lieu of proceeding to a hearing on defendants’ motion, plaintiff would withdraw its complaint and file a further amended complaint by April 16, 2004 and plaintiff did so on that date. Defendants’ motion to dismiss plaintiff’s further amended complaint is due to be filed on June 18, 2004. This case is still in its early stages. We intend to defend against these claims vigorously.

 

Beginning January 27, 2003, several shareholder derivative actions were filed in the Superior Court of California for the County of Santa Clara against certain of our current and former officers and directors and against us as nominal defendant. The actions were filed by stockholders purporting to assert, on our behalf, claims for breach of fiduciary duties, aiding and abetting, violations of the California insider trading law, abuse of control, gross mismanagement, waste of corporate assets, unjust enrichment, and contribution and indemnification. Specifically, the claims were based on our acquisition activity and related accounting implemented by the defendants, the alleged understatement of compensation expenses as reflected in our then proposed restatement, the alleged insider trading by certain defendants, the existence of the restatement class action litigation, in which we are alleged to be liable to defrauded investors, and the allegedly excessive compensation paid by us to one of our officers, as reflected in our then proposed restatement. The complaints sought the payment by the defendants to Ariba of damages allegedly suffered by it, as well as other relief.

 

These actions were assigned to a single judge sitting in San Jose. On May 7, 2003 following briefing and hearing on related motions, the court issued an order that (1) consolidated the cases for all purposes into a single action captioned In re Ariba, Inc. Shareholder Derivative Litigation, Lead Case No. CV 814325, and (2) appointed lead plaintiffs’ counsel. Pursuant to that order, plaintiffs filed an amended consolidated derivative complaint on May 28, 2003. The amended consolidated complaint restates the allegations, causes of action and relief sought as pleaded in the original complaints, and adds allegations relating to our April 10, 2003 announcement of the restatement of certain financial statements and also adds a cause of action for breach of contract. On October 28, 2003, we filed a demurrer, joined by the individual defendants, seeking dismissal of the action for failure to comply with applicable pre-litigation demand requirements. Following a hearing on our demurrer, the court issued a ruling on January 6, 2004 granting our demurrer and giving the plaintiffs 60 days to file an amended complaint. The parties have since stipulated to extend this date to May 14, 2004. This case is still in its early stages. We intend to vigorously defend against the claim that plaintiffs should be excused from pre-litigation demand requirements based on allegations that our Board of Directors could not have fairly evaluated any pre-litigation demand and thus that such demand would have been futile.

 

On March 7 and March 21, 2003, respectively, two shareholder derivative actions were filed in the United States District Court for the Northern District of California against certain of our current and former officers and

 

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directors and against us as nominal defendant. These actions were filed by shareholders purporting to assert, on our behalf, claims for violations of the Sarbanes-Oxley Act, violations of the California insider trading law, breach of fiduciary duties, misappropriation of information, abuse of control, gross mismanagement, waste of corporate assets and unjust enrichment. Specifically, the claims were based on our announcements that we intended to and/or had restated certain financial statements and on alleged insider trading by certain defendants. The complaints sought the payment by the defendants to Ariba of damages allegedly suffered by Ariba, as well as other relief.

 

By orders issued by the Court on May 27 and June 23, 2003, these two derivative cases were deemed related to each other and to the securities class actions pending before the same court as now consolidated into In re Ariba, Inc. Securities Litigation, Case No. C-03-00277 JF, and accordingly these two derivative actions were assigned to the same judge sitting in San Jose assigned to that action. On June 23, 2003, following submission of a related stipulation of the parties, the Court issued an order that (1) consolidated the two derivative cases for all purposes into a single action captioned In re Ariba, Inc. Derivative Litigation, Case No. C-03-02172 JF, and (2) appointed lead plaintiffs’ counsel. In accordance with that order, plaintiffs filed an amended consolidated derivative complaint on June 26, 2003. The amended consolidated complaint restates the allegations, causes of action and relief sought as pleaded in the original complaints. On September 18, 2003, defendants filed a motion to dismiss or stay the action pending resolution of the parallel state court derivative litigation. Following a hearing on this motion on November 10, 2003, the Court issued a ruling on November 13, 2003 denying the motion but granting defendants’ alternative request for a stay of the action in light of the related securities class action litigation. Accordingly, this action is now stayed until the Court has determined the viability of the federal securities claim in the related action. This case is still in its early stages. We intend to vigorously defend against the claim that plaintiffs should be excused from pre-litigation demand requirements based on allegations that our Board of Directors could not have fairly evaluated any pre-litigation demand and thus that such demand would have been futile.

 

Litigating existing and potential securities class actions and shareholder derivative actions relating to the restatement of our consolidated financial statements will likely require significant attention and resources of management and, regardless of the outcome, result in significant legal expenses. In the case of the securities class actions, if our defenses were ultimately unsuccessful, or if we were unable to achieve a favorable settlement, we could be liable for large damages awards that could seriously harm our business, results of operations and financial condition.

 

The SEC Inquiry Regarding the Restatement Could Seriously Harm Our Business.

 

The SEC has commenced an informal inquiry regarding the circumstances leading up to the restatement of our consolidated financial statements. Responding to any such review could require significant diversion of management’s attention and resources in the future. For example, if the SEC elects to pursue an enforcement action, the defense against this type of action could be costly and require additional management resources. If we are unsuccessful in defending against any such enforcement action, we may face civil or criminal penalties or fines that could seriously harm our business and results of operations.

 

We have in the past been, and are now, subject to claims arising out of various aspects of our business operations, including, but not limited to, claims relating to intellectual property, employment, and breach of contract. For instance, in May 2004, we were sued for alleged patent infringement by ePlus, Inc. based on the sale of unspecified “Enterprise Spend Management” products. We are unable to assess the likely outcome of this litigation, which is at an early stage. We are at risk of future litigation relating to our business operations, which could be costly and time consuming. Any such litigation, particularly if adversely resolved, could seriously harm our business.

 

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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 our Sunnyvale, California headquarters. Moreover, we have from time to time revised our assumptions and expectations regarding lease abandonment costs, resulting in additional charges. For example, in the quarters ended June 30, 2004 and 2003, we revised our estimates and expectations for our corporate headquarters and field offices disposition efforts, resulting in additional charges to operating expense of $1.0 million and $5.4 million, respectively. Additionally, in the quarter ended March 31, 2004, we recorded a benefit to operating expense totaling $2.4 million primarily as a result of entering into an unanticipated sublease agreement which was not estimated into the restructuring obligation. Each reporting period we review these estimates, and to the extent that our assumptions change, the ultimate restructuring expenses for these abandoned facilities could vary significantly from current estimates. For example, as of June 30, 2004, 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 of our Sunnyvale, California headquarters by approximately $7.7 million. 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.

 

On June 30, 2004 we had $190.7 million of goodwill on our condensed consolidated balance sheet. Of this amount, $9.7 million resulted from the acquisition of Alliente and Softface in the second and third quarters of fiscal year 2004, respectively, and approximately $181.0 million resulted from acquisitions completed in fiscal year 2000. Our net assets as of June 30, 2004 were $220.0 million and our market capitalization as of that date was $546.3 million.

 

Our merger with FreeMarkets on July 1, 2004 is expected to result in additional estimated goodwill of between $350 million and $370 million, which would result in estimated aggregate goodwill of between $540 million and $560 million as of September 30, 2004.

 

We regularly 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 net assets for a sustained period. Based upon our net assets as of June 30, 2004, anticipated operating results for the quarter ended September 30, 2004 and the impact of our merger with FreeMarkets, if the price of our common stock were to be below a price currently estimated to be between $10.10 and $10.40 per share for a sustained period, thereby resulting in our market capitalization being below net assets, we would be required to complete an analysis of the recoverability of our goodwill. Our stock price is highly volatile and it has experienced significant declines in fiscal year 2004, and our common stock has recently been trading below this threshold. Depending on market conditions and other factors, we may determine that an impairment review is necessary and assess whether the goodwill carrying value is considered recoverable.

 

When management determines that an impairment review is necessary based upon the existence of one or more of the above indicators of impairment, we must determine if the carrying amount of our reporting unit level exceeds the “fair value” of the reporting unit level (we have only one reporting unit, specifically the license, implementation and support of our software applications), based on quoted market prices of our common stock, which would indicate that goodwill may be impaired. If we determine that goodwill may be impaired, we compare the “implied fair value” of the goodwill, as defined by SFAS No. 142, to its carrying amount to determine the impairment loss, if any. We have recorded significant impairment charges for goodwill and other

 

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intangible assets in the past, and to the extent that events or circumstances cause our assumptions to change, additional charges may be required which could be material.

 

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

 

We warrant the performance of the Ariba Supplier Network’s availability to 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.

 

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;

 

    loss of a major customer or 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-based 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 a company following periods of volatility in the market price of its securities. We have recently experienced significant volatility in the price of our stock. 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.

 

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 only three patents issued in the United States and 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 the Ariba Supplier Network, because the validity, enforceability and type of protection of proprietary rights in Internet-related industries are uncertain and evolving.

 

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In the quarter ended March 31, 2000, we entered into an intellectual property agreement with IBM under which, among other things, each party granted to the other party a perpetual cross-license to certain of the other party’s patents which were issued at the time of the agreement or which were issued based on applications filed within three years after the agreement. Among other things, the cross-license allows each party to make, use, import, license or sell certain products and services under such patents of the other party. As such, the agreement forecloses each party from trying to enforce such patents against the other party by claiming that the other party’s products and services violated the patents.

 

There has been a substantial amount of litigation in the software industry and the Internet industry regarding 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 system 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, in significant part because of our strategic relationship with Softbank which is now the subject of a significant dispute discussed in “Risk Factors—Our Business May Be Seriously Harmed if We Are Unable to Satisfactorily Resolve Our Dispute with Softbank.” 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;

 

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

 

    political instability.

 

These risks could prevent or impede our planned efforts to grow our sales channels in Europe and Japan.

 

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

 

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minimize the impact of changes in foreign currency exchange rates on earnings. We utilize forward contracts to hedge trade and intercompany receivables and payables. All hedge contracts are marked to market through operations each period. There can be no assurance that our hedging strategy will be successful and that currency exchange rate fluctuations will not have a material adverse effect on our operating results.

 

We Have Implemented Certain Anti-Takeover Provisions That Could Make it More Difficult for a Third Party to Acquire Us.

 

Provisions of our amended and restated certificate of incorporation and bylaws, including certain anti-takeover provisions, as well as provisions of Delaware law, could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders.

 

Item 3.    Quantitative and Qualitative Disclosures About Market Risk

 

Foreign Currency Risk

 

We develop products in the United States and market our products in the United States, 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-US sales are priced in currencies other than the U.S. dollar, a strengthening of the dollar may reduce the level of reported revenues. If any of the events described above were to occur, our net sales could be seriously impacted, since a significant portion of our net sales are derived from international operations. For the quarters ended June 30, 2004 and 2003, approximately 22% and 32%, respectively, of our total net sales 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.

 

The following table provides information about our foreign exchange forward contracts outstanding as of June 30, 2004 (in thousands):

 

          Contract Value

   

Unrealized

Gain (Loss)

in USD


 
     Buy/Sell

   Foreign
Currency


   USD

   

Foreign Currency

                            

British Pounds

   Sell    $ 250    $ 453     $ (4 )

Swiss Francs

   Sell    $ 750    $ (595 )   $ 6  

Euro

   Sell    $ 5,250    $ 6,304     $ (91 )

 

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, 2004.

 

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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 $600,000. 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.

 

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 such as debt, equity or both. We do 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.

 

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,
2005


    Year Ending
June 30,
2006


    Year Ending
June 30,
2007


    Year Ending
June 30,
2008


   Year Ending
June 30,
2009


   Thereafter

   Total

 

Cash equivalents

   $ 63,188     $     $     $    $    $    $ 63,188  

Average interest rate

     0.84 %                                0.84 %

Investments

   $ 15,445     $ 16,505     $ 36,836                    $ 68,786  

Average interest rate

     3.20 %     3.15 %     2.05 %                    2.57 %
    


 


 


 

  

  

  


Total investment securities

   $ 78,633     $ 16,505     $ 36,836     $    $    $    $ 131,974  
    


 


 


 

  

  

  


 

As of June 30, 2004, these amounts exclude equity investments totaling $796,000 and uninvested cash of $90.4 million, of which $43.4 million represents funds received from Softbank and $27.9 million represents letters of credit for our real estate obligations, which are both classified as restricted cash on our condensed consolidated balance sheets.

 

Item 4.    Controls and Procedures

 

We evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2004, 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 Securities and Exchange Commission 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.

 

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Disclosure controls and procedures means controls and other procedures that are designed to ensure that information required to be disclosed in the reports the 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 included, without limitation, controls and procedures designed that such 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.

 

Based upon the controls evaluation, our CEO and CFO have concluded that, subject to the limitations noted above, as of June 30, 2004 our disclosure controls and procedures are effective to ensure that material information relating to the company and our consolidated subsidiaries is made known to management, including the CEO and CFO, particularly during the period when our periodic reports are being prepared.

 

No change in our internal control over financial reporting occurred during the quarter ended June 30, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. Internal control over financial reporting means a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

 

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PART II:    OTHER INFORMATION

 

Item 1.    Legal Proceedings

 

IPO Class Action Litigation

 

Between March 20, 2001 and June 5, 2001, a number of purported shareholder class action complaints were filed in the United States District Court for the Southern District of New York against Ariba, certain of its former officers and directors (the “Individual Defendants”) and three of the underwriters of its initial public offering (“IPO”). These actions purport to be brought on behalf of purchasers of Ariba’s common stock in the period from June 23, 1999, the date of its IPO, to December 23, 1999 (or in some cases, to December 5 or 6, 2000), and make certain claims under the federal securities laws, including Sections 11 and 15 of the Securities Act and Sections 10(b) and 20(a) of the Exchange Act, relating to its IPO.

 

On June 26, 2001, these actions were consolidated into a single action bearing the title In re Ariba, Inc. Securities Litigation, 01 CIV 2359. On August 9, 2001, that consolidated action was further consolidated before a single judge with cases brought against additional issuers (who numbered in excess of 300) and their underwriters that made similar allegations regarding the IPOs of those issuers. The latter consolidation was for purposes of pretrial motions and discovery only. On February 14, 2002, the parties signed and filed a stipulation dismissing the consolidated action without prejudice against Ariba and certain Individual Defendants, which the Court approved and entered as an order on March 1, 2002. On April 19, 2002, the plaintiffs filed an amended complaint in which they dropped their claims against Ariba and the Individual Defendants under Sections 11 and 15 of the Securities Act, but elected to proceed with their claims against such defendants under Sections 10(b) and 20(a) of the Exchange Act.

 

The amended complaint alleges that the prospectus pursuant to which shares of common stock were sold in Ariba’s IPO, which was incorporated in a registration statement filed with the SEC, contained certain false and misleading statements or omissions regarding the practices of Ariba’s underwriters with respect to their allocation to their customers of shares of common stock in Ariba’s IPO and their receipt of commissions from those customers related to such allocations. The complaint further alleges that the underwriters provided positive analyst coverage of Ariba after the IPO, which had the effect of manipulating the market for its stock. Plaintiffs contend that such statements and omissions from the prospectus and the alleged market manipulation by the underwriters through the use of analysts caused Ariba’s post-IPO stock price to be artificially inflated. The actions seek compensatory damages in unspecified amounts as well as other relief.

 

On July 15, 2002, the Company and the Individual Defendants, along with other issuers and their related officer and director defendants, filed a joint motion to dismiss based on common issues. On or around November 18, 2002, during the pendency of the motion to dismiss, the Court entered as an order a stipulation by which all of the Individual Defendants were dismissed from the case without prejudice in return for executing a tolling agreement. On February 19, 2003, the Court rendered its decision on the motion to dismiss, granting a dismissal of the remaining Section 10(b) claim against the Company without prejudice. Plaintiffs have indicated that they intend to file an amended complaint.

 

On June 24, 2003, a special litigation committee of the Company’s Board of Directors approved a Memorandum of Understanding (the “MOU”) reflecting a settlement in which the plaintiffs agreed to dismiss the case against the Company with prejudice in return for the assignment by the Company of claims that it might have against its underwriters. No payment to the plaintiffs by Ariba was required under the MOU. After further negotiations, the essential terms of the MOU were formalized in a Stipulation and Agreement of Settlement, which has been executed on behalf of the Company and the Individual Defendants. The settling parties filed formal motions seeking preliminary approval of the proposed settlement on June 25, 2004. The underwriter defendants, who are not parties to the proposed settlement, filed a brief objecting to the settlement’s terms on July 14, 2004. There can be no assurance that the proposed settlement will be approved by the Court. In the event that the settlement is not approved by the Court, the Company intends to defend against these claims vigorously.

 

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Restatement Class Action Litigation

 

Beginning January 21, 2003, a number of purported shareholder class action complaints were filed in the United States District Court for the Northern District of California against us and certain of our current and former officers and directors, all purporting to be brought on behalf of a class of purchasers of our common stock in the period from January 11, 2000 to January 15, 2003. The complaints bring claims under the federal securities laws, specifically Sections 10(b) and 20(a) of the Exchange Act, relating to our announcement that we would restate certain of its consolidated financial statements, and, in the case of two complaints, relating to our acquisition activity and related accounting. Specifically, these actions allege that certain of our prior consolidated financial statements contained false and misleading statements or omissions relating to its failure to properly recognize expenses and other financial items, as reflected in the then proposed restatement. Plaintiffs contend that such statements or omissions caused the stock price to be artificially inflated. Plaintiffs seek compensatory damages as well as other relief.

 

In a series of orders issued by the Court in February and March, 2003, these cases were deemed related to each other and assigned to a single judge sitting in San Jose. On July 11, 2003, following briefing and a hearing on related motions, the Court entered two orders that together (1) consolidated the related cases for all purposes into a single action captioned In re Ariba, Inc. Securities Litigation, Case No. C-03-00277 JF, (2) appointed a lead plaintiff, and (3) approved the lead plaintiff’s selection of counsel. On September 15, 2003, the lead plaintiff filed a Consolidated Amended Complaint, which restated the allegations and claims described above and added a claim pursuant to Section 14(a) of the Exchange Act, based on the allegation that Ariba failed to disclose certain payments and executive compensation items in its January 24, 2002 Proxy Statement. On November 17, 2003, defendants filed a motion to dismiss the action for failure to state a claim, which was fully briefed and set for hearing on March 29, 2004. Prior to the hearing, the parties stipulated that, in lieu of proceeding to a hearing on defendants’ motion, plaintiff would withdraw its complaint and file a further amended complaint by April 16, 2004 and plaintiff did so on that date. Defendants’ motion to dismiss plaintiff’s further amended complaint was filed on June 18, 2004. A hearing on Defendants’ motion to dismiss is scheduled for October 29, 2004. This case is still in its early stages. We intend to defend against these claims vigorously.

 

Restatement Shareholder Derivative Litigation

 

Beginning January 27, 2003, several shareholder derivative actions were filed in the Superior Court of California for the County of Santa Clara against certain of our current and former officers and directors and against us as nominal defendant. These actions were filed by stockholders purporting to assert, on our behalf, claims for breach of fiduciary duties, aiding and abetting, violations of the California insider trading law, abuse of control, gross mismanagement, waste of corporate assets, unjust enrichment, and contribution and indemnification. Specifically, the claims were based on our acquisition activity and related accounting implemented by the defendants, the alleged understatement of compensation expenses as reflected in our then proposed restatement, the alleged insider trading by certain defendants, the existence of the restatement class action litigation, in which we are alleged to be liable to defrauded investors, and the allegedly excessive compensation paid by us to one of our officers, as reflected in its then proposed restatement. The complaints sought the payment by the defendants to us of damages allegedly suffered by us, as well as other relief.

 

These actions were assigned to a single judge sitting in San Jose. On May 7, 2003 following briefing and hearing on related motions, the court issued an order that (1) consolidated the cases for all purposes into a single action captioned In re Ariba, Inc. Shareholder Derivative Litigation, Lead Case No. CV 814325, and (2) appointed lead plaintiffs’ counsel. Pursuant to that order, plaintiffs filed an amended consolidated derivative complaint on May 28, 2003. The amended consolidated complaint restates the allegations, causes of action and relief sought as pleaded in the original complaints, and adds allegations relating to our April 10, 2003 announcement of the restatement of certain financial statements and also adds a cause of action for breach of contract. On October 28, 2003, we filed a demurrer, joined by the individual defendants, seeking dismissal of the action for failure to comply with applicable pre-litigation demand requirements. Following a hearing on our demurrer, the court issued a ruling on January 6, 2004 granting our demurrer and giving plaintiffs 60 days to file

 

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an amended complaint. The parties have since stipulated to extend this date to September 10, 2004. This case is still in its early stages. We intend to vigorously defend against the claim that plaintiffs should be excused from pre-litigation demand requirements based on allegations that our Board of Directors could not have fairly evaluated any pre-litigation demand and thus that such demand would have been futile.

 

On March 7 and March 21, 2003, respectively, two shareholder derivative actions were filed in the United States District Court for the Northern District of California against certain of our current and former officers and directors and against us as nominal defendant. These actions were filed by shareholders purporting to assert, on our behalf, claims for violations of the Sarbanes-Oxley Act, violations of the California insider trading law, breach of fiduciary duties, misappropriation of information, abuse of control, gross mismanagement, waste of corporate assets and unjust enrichment. Specifically, the claims were based on our announcements that we intended to and/or had restated certain financial statements and on alleged insider trading by certain defendants. The complaints sought the payment by the defendants to Ariba of damages allegedly suffered by us, as well as other relief.

 

By orders issued by the Court on May 27 and June 23, 2003, these two derivative cases were deemed related to each other and to the securities class actions pending before the same court as now consolidated into In re Ariba, Inc. Securities Litigation, Case No. C-03-00277 JF, and accordingly these two derivative actions were assigned to the same judge sitting in San Jose assigned to that action. On June 23, 2003, following submission of a related stipulation of the parties, the Court issued an order that (1) consolidated the two derivative cases for all purposes into a single action captioned In re Ariba, Inc. Derivative Litigation, Case No. C-03-02172 JF, and (2) appointed lead plaintiffs’ counsel. In accordance with that order, plaintiffs filed an amended consolidated derivative complaint on June 26, 2003. The amended consolidated complaint restates the allegations, causes of action and relief sought as pleaded in the original complaints. On September 18, 2003, defendants filed a motion to dismiss or stay the action pending resolution of the parallel state court derivative litigation. Following a hearing on this motion on November 10, 2003, the Court issued a ruling on November 13, 2003 denying the motion but granting defendants’ alternative request for a stay of the action in light of the related securities class action litigation. Accordingly, this action is now stayed until the Court has determined the viability of the federal securities claim in the related action. This case is still in its early stages. We intend to vigorously defend against the claim that plaintiffs should be excused from pre-litigation demand requirements based on allegations that our Board of Directors could not have fairly evaluated any pre-litigation demand and thus that such demand would have been futile.

 

General

 

We are also subject to various claims and legal actions arising in the ordinary course of business. One example is our dispute with Softbank, which is discussed in “Risk Factors—Our Business May be Seriously Harmed If We Are Unable to Satisfactorily Resolve Our Dispute with Softbank.”

 

Ariba has accrued for estimable and probable losses in its consolidated financial statements for those matters where it believes that the likelihood that a loss has occurred is probable and the amount of loss is reasonably estimable. There can be no assurance that existing or future litigation arising in the ordinary course of business or otherwise will not have a material adverse effect on our business, consolidated financial position, results of operations or cash flows or that the amount of accrued losses is sufficient for any actual losses that may be incurred.

 

Item 2.    Changes in Securities and Use of Proceeds

 

Not applicable.

 

Item 3.    Defaults Upon Senior Securities

 

Not applicable.

 

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

 

The Company held its annual meeting of stockholders in New York, New York on June 28, 2004. The following information gives effect to the one-for-six reverse split effected July 1, 2004. Of the 45,756,945 shares outstanding as of the record date, 33,295,406 shares were present or represented by proxy at the meeting. At the meeting, the following actions were voted upon:

 

a. Approval of the issuance of shares of Ariba common stock pursuant to the Agreement and Plan of Merger and Reorganization by and among Ariba, Fleet Merger Corporation and FreeMarkets, Inc.

 

     FOR

   AGAINST

   ABSTAIN

     11,896,657    814,363    434,028

 

b. Approval of two proposed alternative amendments to the Company’s Amended and Restated Certificate of Incorporation to enable the Company to effect a reverse stock split of the Company’s issued and outstanding Common Stock in a ratio of 1-for-5 or 1-for-6.

 

     FOR

   AGAINST

   ABSTAIN

     31,677,301    1,535,828    82,276

 

c. To elect the following two directors to serve for terms ending upon the 2007 Annual Meeting of Stockholders or until their successors are duly elected and qualified:

 

     FOR

   WITHHELD

    

Thomas F. Monahan

   31,735,037    1,560,368     

Richard F. Wallman

   31,735,037    1,560,368     

 

The continuing directors with terms ending upon the 2005 Annual Meeting of Stockholders are Robert M. Calderoni and Robert E. Knowling, Jr. The continuing director with a term ending upon the 2006 Annual Meeting of Stockholders is Richard A. Kashnow.

 

d. To ratify the appointment of KPMG LLP as the Company’s independent public accountants for the fiscal year ending September 30, 2004:

 

     FOR

   AGAINST

   ABSTAIN

     31,786,978    1,294,753    213,673

 

e. Granting the proxies discretionary authority to adjourn the annual meeting, including for purposes of soliciting additional votes:

 

     FOR

   AGAINST

   ABSTAIN

     32,015,218    825,935    454,252

 

f. Granting the proxies discretionary authority to vote upon such matters as may properly come before the meeting or any adjournment or postponement of the meeting:

 

     FOR

   WITHHELD

    
     27,076,564    2,239,697     

 

Item 5.    Other Information

 

Not applicable.

 

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Item 6.    Exhibits and Reports on Form 8-K

 

(a)    Exhibits

 

31.1   

Certification of Chief Executive Officer.

31.2   

Certification of Chief Financial Officer.

32.1   

Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


*   Incorporated by reference.

 

(b)    Reports on Form 8-K

 

A current report on Form 8-K was filed with the Securities and Exchange Commission on April 27, 2004 to announce our earnings for the second quarter of fiscal year 2004.

 

A current report on Form 8-K was filed with the Securities and Exchange Commission on June 22, 2004 to report on a binding agreement that we entered into with Softbank Corp. setting forth the material terms under which the companies would settle their previously-announced dispute related to Nihon Ariba K.K., Ariba’s majority-owned Japanese subsidiary, and Ariba Korea, Ltd., Ariba’s majority-owned Korean subsidiary.

 

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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 13, 2004

 

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EXHIBIT INDEX

 

Exhibit
No.


  

Exhibit Title


31.1   

Certification of Chief Executive Officer.

31.2   

Certification of Chief Financial Officer.

32.1   

Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


*   Incorporated by reference.

 

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