ARIBA INC - 10-Q Quarterly Report

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 ¨

The number of shares outstanding of the registrant’s common stock as of April 30, 2005 was 66,112,891.

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

Ariba, Inc., along with its subsidiaries (collectively referred to herein as the “Company”), provides spend management solutions that allow enterprises to efficiently manage the purchasing of non-payroll goods and services required to run their business. The Company refers to these non-payroll expenses as “spend.” The Company’s solutions include software applications, professional services and network access. They are designed to provide enterprises with technology and business process improvements to better manage their corporate spend 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 and equipment.

The Company was incorporated in Delaware in September 1996, and from that date through March 1997 was in the development stage, conducting research and developing its initial products. In March 1997, the Company began selling its products and related services, and now markets them globally through its direct sales force and indirect sales channels.

The unaudited condensed consolidated financial statements of the Company reflect all adjustments (all of which are normal and recurring in nature) that, in the opinion of management, are necessary for a fair presentation of the interim periods presented. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for any subsequent quarter or for the entire year ending September 30, 2005. Certain information and note disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted under the Securities and Exchange Commission’s rules and regulations. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto, together with management’s discussion and analysis of financial condition and results of operations, presented in the Company’s Annual Report on Form 10-K for the year ended September 30, 2004 filed on December 14, 2004 with the Securities and Exchange Commission (“SEC”), as amended on January 28, 2005.

As a result of the merger with FreeMarkets, Inc. (“FreeMarkets”) on July 1, 2004, the Company re-aligned its business model. Accordingly, the Company has made certain reclassifications to prior year amounts to conform to the current year presentation, none of which affected net (loss) income or net (loss) income per share. Specifically, the Company has reclassified its revenues and cost of revenues into license, subscription and maintenance and services and other. In addition, the Company reclassified non-chargeable time of consultants previously recorded in sales and marketing expenses to cost of revenues to conform to FreeMarkets’ prior classification. The Company also made various adjustments that impacted other line items in the Statements of Operations. The following table reflects the effect of all of these reclassifications for the three and six months ended March 31, 2004 (in thousands):

The Company also reclassified deferred rent obligations on its headquarters in California from current to long-term liabilities in the amount of $18.0 million as of September 30, 2004.

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported results of operations during the period. Actual results could differ from those estimates. For example, actual sublease income 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.

The carrying value of the Company’s financial instruments, including cash and cash equivalents, investments, accounts receivable and accounts payable approximates fair value. Financial instruments that subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents, investments and trade accounts receivable. The Company maintains its cash and investments with high quality financial institutions and limits its investment in individual securities based on the type and credit quality of each such security. As it relates to trade accounts receivable, the Company performs ongoing credit evaluations of its customers, and maintains allowances for potential credit losses.

No customer accounted for more than 10% of total revenues for the three and six months ended March 31, 2005 and 2004. In addition, no customer accounted for more than 10% of net accounts receivable as of March 31, 2005. Visteon accounted for 12% of net accounts receivable as of September 30, 2004, the Company’s most recent fiscal year end.

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), Share-Based Payment (SFAS No. 123R). SFAS No. 123R will require the Company to measure all employee stock-based compensation awards using a fair value method and record such expense in the consolidated financial statements. SFAS No. 123R is effective beginning in the Company’s first quarter of fiscal year 2006. The adoption of SFAS No. 123R will have a material impact on the Company’s consolidated financial position and results of operations. If the Company had applied the provisions of SFAS No. 123R for the three and six months ended March 31, 2005, the pro forma impact would have been as disclosed below in “Stock-Based Compensation”.

In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment of Accounting Principles Board (“APB”) Opinion No. 29, Accounting for Nonmonetary Transactions. SFAS No. 153 addresses the measurement of exchanges of nonmonetary assets and redefines the scope of transactions that should be measured based on the fair value of the assets exchanged. SFAS No. 153 is effective for nonmonetary asset exchanges beginning in the Company’s third quarter of fiscal year 2005. The adoption of SFAS No. 153 is not expected to have a material effect on the Company’s consolidated financial position, results of operations or cash flows.

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

The Company licenses its products through its direct sales force and indirectly through resellers. 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 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 or 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 is reasonably estimable. Access to certain functionality on the Ariba Supplier Network is available to Ariba licensees 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, Staff Accounting Bulletin (SAB) 104 and Emerging Issues Task Force (EITF) 00-21, Revenue Arrangements with Multiple Deliverables. The Company recognizes revenue when all of the following criteria are met: persuasive evidence of an arrangement exists; delivery of the product has occurred; 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. In these scenarios, fees are not “fixed or determinable”, and therefore revenue is recognized when fees are due and

payable. In arrangements where at least 80% of license 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, provided that any accompanying services are not considered essential to the functionality of the software products. If collectibility is not considered probable at the inception of the arrangement, the Company does not recognize revenue until the fee is collected.

The Company allocates and recognizes revenue on contracts that include software 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 defers revenue for the fair value of its undelivered elements (e.g., subscription and maintenance and services) and recognizes revenue for the remainder of the arrangement fee attributable to the delivered elements (i.e., software product) when the basic criteria in SOP 97-2 have been met. Where the contract does not include software, the Company allocates revenue to each element in a multiple element arrangement based on its respective fair value. The Company’s determination of the fair value of each element in a multiple element arrangement involving software is based on vendor-specific objective evidence (VSOE), which is limited to the price when sold separately. For all other transactions not involving software, fair value is determined using the price when sold separately or other methods allowable under EITF 00-21.

Revenue allocated to maintenance and support is recognized ratably over the maintenance term (typically one year). Revenue from hosting and sourcing solutions services is recognized ratably over the term of the arrangement as the access is provided over the related contract period. Revenue allocated to software implementation, process improvement, training and other services is recognized as the services are performed. 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. In addition, certain of the Company’s contracts include performance incentive payments based on market volume and/or savings generated, as defined in the respective contracts. Revenue from such arrangements is recognized as those thresholds are achieved.

Arrangements that include consulting services, such as system implementation and process improvement, are evaluated to determine whether the services are essential to the functionality of the software products. 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 six months ended March 31, 2005 and 2004 were not affected by such transactions.

Deferred revenue includes amounts received from customers for which revenue has not been recognized, and 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, SAB 104 or EITF 00-21 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.

The Company issues stock options to its employees and outside directors, as well as provides employees the right to purchase common stock pursuant to various stock options and employee stock purchase plans. The Company accounts for stock-based compensation under the intrinsic value method of accounting as defined by APB Opinion No. 25, Accounting for Stock Issued to Employees and FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation—an Interpretation of APB Opinion No. 25. The Company applies 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. Deferred stock-based compensation is included as a component of stockholders’ equity and is amortized by charges to operations over the vesting period of the options and restricted stock. For pro forma disclosures, the estimated fair value of options is amortized using the accelerated expense attribution method over the vesting period, and the estimated fair value of stock purchases is amortized over the six-month purchase period. This method is consistent with FASB Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans. The following table illustrates the effect on net (loss) income and net (loss) income per share if the Company had accounted for its stock option and stock purchase plans under the fair value method of accounting (in thousands, except per share amounts):

The Company estimates the fair value of options using the Black-Scholes option pricing model, which was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. Option valuation models require the input of several assumptions, including the expected stock price volatility. The Company’s options have characteristics significantly different from those of traded options, and

changes in the input assumptions can materially affect the fair value estimates. The fair value of options granted and the option component of the employee purchase plan shares were estimated at the date of grant using the Black-Scholes option pricing model and the following assumptions:

On July 1, 2004, the Company completed its merger with FreeMarkets, a publicly held company headquartered in Pittsburgh, Pennsylvania, for a total purchase price of $549.5 million. The merger was accounted for using the purchase method of accounting, and accordingly, the purchase price was allocated to the assets acquired and liabilities assumed based on their estimated fair values on the acquisition date. The purchase price allocation related to the FreeMarkets merger was final as of September 30, 2004, except for the resolution of certain tax related pre-acquisition contingencies that may result in an adjustment to goodwill in the future period the contingency is resolved.

Since July 1, 2004, the results of operations of FreeMarkets have been included in the Company’s consolidated statements of operations. The following unaudited pro forma financial information is presented to reflect the results of operations for the three and six months ended March 31, 2004 as if the merger with FreeMarkets had occurred on October 1, 2003, which was the beginning of the Company’s 2004 fiscal year. The pro forma financial information includes $4.1 million and $10.3 million of nonrecurring charges incurred by FreeMarkets for the three and six months ended March 31, 2004, respectively.

These pro forma results have been prepared for comparative purposes only and do not purport to be indicative of what operating results would have been had the merger actually taken place on October 1, 2003, and may not be indicative of future operating results (in thousands, except per share amounts):

For the three and six months ended March 31, 2005, foreign currency translation resulted in a $267,000 decrease and a $890,000 increase, respectively, in the goodwill related to the January 2003 acquisition of Goodex AG, a foreign-based entity. Also, the Company recorded a $1.2 million increase to goodwill due to the closure of an excess legacy FreeMarkets facility in March 2005. Although no goodwill impairment was recorded during the three and six months ended March 31, 2005 and 2004, there can be no assurance that future goodwill impairments will not occur.

Identifiable intangible assets as of March 31, 2005 (and their related useful lives) consist of the following (in thousands):

Amortization of other intangible assets for the three and six months ended March 31, 2005 totaled $5.5 million and $11.0 million, respectively. Amortization of other intangible assets for each of the three and six months ended March 31, 2004 was $76,000, related to customer relationships acquired in the acquisition of Alliente. Amortization of $5.3 million and $10.0 million related to the excess fair value of the Visteon in-place contract over current fair value, the Visteon contract and related customer relationship, other contracts and related customer relationships and existing software technology was recorded as cost of revenues in the three and six months ended March 31, 2005, respectively. Amortization of $213,000 and $398,000 related to trademarks and other contracts and related customer relationships was recorded as operating expense in the three and six months ended March 31, 2005, respectively. Amortization of $568,000 related to the excess fair value of the Visteon in-place contract over current fair value was recorded as a reduction of revenues in the six months ended March 31, 2005.

In March 2000, the Company entered into a facility lease agreement for 716,000 square feet in four office buildings and an amenities building in Sunnyvale, California for its headquarters. The operating lease term commenced in 2001 and ends in January 2013. The Company occupies 191,200 square feet in this facility, and currently subleases two and one-half buildings totaling 442,600 square feet to third parties. These subleases expire between July 2007 and August 2008. The remaining 82,200 square feet is available for sublease. Minimum monthly lease payments are $2.9 million and escalate annually, with the total future minimum lease payments amounting to $308.6 million over the remaining lease term. As part of this lease agreement, the

Company is required to hold certificates of deposit, totaling $31.3 million as of March 31, 2005, as a form of security through fiscal year 2013. Also, the Company is required by other lease agreements to hold an additional $2.3 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 $33.6 million is classified as restricted cash on the Company’s condensed consolidated balance sheet as of March 31, 2005.

The Company also occupies 108,900 square feet of office space in Pittsburgh, Pennsylvania under a lease covering 182,000 square feet that expires in May 2010. The remaining 73,100 square feet is available for sublease. This location consists principally of the Company’s services organization and administrative activities.

The Company leases certain equipment, software and its facilities under various noncancelable operating and immaterial capital leases with various expiration dates through 2013. Gross operating rental expense was $12.8 million and $11.5 million for the three months ended March 31, 2005 and 2004, respectively, and $25.8 million and $23.9 for the six months ended March 31, 2005 and 2004, respectively. This expense was reduced by sublease income of $4.0 million and $5.0 million for the three months ended March 31, 2005 and 2004, respectively, and $8.4 million and $12.2 million for the six months ended March 31, 2005 and 2004, respectively.

The following table summarizes future minimum lease payments and sublease income under noncancelable operating leases as of March 31, 2005 (in thousands):

Of the total operating lease commitments noted above, $115.1 million is for occupied properties and $235.9 million is for abandoned properties, which are a component of the restructuring obligation.

The Company recorded a charge to operations of $2.3 million and $4.1 million for the three and six months ended March 31, 2005, respectively. The charge in the three months ended March 31, 2005 was primarily for a $1.6 million adjustment to the Company’s restructuring obligation related to a prior period. The Company assessed its findings using the guidance in SAB 99, and concluded that the amount of the error was immaterial to the prior period. The remaining charge in the three and six months ended March 31, 2005 was for restructuring and integration costs in connection with the merger with FreeMarkets in order to improve the Company’s post-merger competitiveness, productivity and future operating results. These charges primarily relate to severance and related benefits for terminated employees and legal and consulting fees. The Company also recorded a $1.2 million adjustment to the restructuring obligation due to the closure of an excess legacy FreeMarkets facility in March 2005. The restructuring costs incurred are considered part of the purchase price of FreeMarkets and have been recorded as an adjustment to goodwill.

In fiscal years 2002 and 2001, the Company carried out a restructuring program to align its expense and revenue levels. As part of these programs, the Company restructured its operations, which included a reduction in its global workforce and the consolidation of excess facilities. In addition, the Company carried out another restructuring program in fiscal year 2004 to realign its business model concurrent with the FreeMarkets merger, and assumed FreeMarkets’ restructuring obligations on July 1, 2004.

The following table details accrued restructuring obligations and related restructuring activity through March 31, 2005 (in thousands):

Severance and benefits primarily include involuntary termination and health benefits, outplacement costs and payroll taxes for sales and marketing, engineering and general and administrative personnel. During the three and six months ended March 31, 2005, an additional $390,000 and $1.6 million, respectively, of severance and benefits were recorded due to the continued reduction of its workforce as a result of the merger with FreeMarkets.

Lease abandonment costs incurred to date relate primarily to the abandonment of leased facilities in Mountain View and Sunnyvale, California and Pittsburgh, Pennsylvania. Total lease abandonment costs include lease liabilities offset by estimated sublease income, and were based on market trend information analyses. As of March 31, 2005, $59.5 million of lease abandonment costs remain accrued and are expected to be paid by fiscal year 2013.

The Company’s lease abandonment accrual is net of $162.5 million of estimated sublease income. Actual sublease payments due under noncancelable subleases of excess facilities totaled $47.3 million as of March 31, 2005, 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 March 31, 2005, particularly if actual sublease income is significantly different from current estimates. These differences could have a material adverse effect on the Company’s operating results and cash position. For example, a reduction in assumed market lease rates of $0.25 per square foot per month for the remaining term of the lease, with all other assumptions remaining the same, would increase the estimated lease abandonment loss on the Company’s Sunnyvale, California headquarters and its other principal office in Pittsburgh, Pennsylvania as of March 31, 2005 by $8.1 million.

Other integration costs for the three and six months ended March 31, 2005 totaled $306,000 and $935,000, respectively, and consists primarily of legal and consulting fees incurred in connection with integration activity related to the Company’s merger with FreeMarkets.

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 March 31, 2005.

During 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 and FreeMarkets, and against certain of their respective former officers and directors (“Individual Defendants”) and certain of the underwriters of their respective initial public offerings (the “IPOs”). These actions purport to be brought on behalf of purchasers of the Company’s and FreeMarkets’ common stock during certain time periods commencing with their respective IPOs, and made 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. These actions were later consolidated into actions relating to each IPO, and were then further consolidated (for pretrial purposes) with cases brought against in excess of 300 additional issuers and their underwriters that made similar allegations. During the course of pre-trial proceedings, the plaintiffs have dismissed their claims against all of the Individual Defendants without prejudice in return for executing a tolling agreement by the Individual Defendants, and they have also dismissed without prejudice their claims against the Company under Section 11 of the Securities Act. Plaintiffs seek compensatory damages in unspecified amounts as well as other relief.

In June 2003, the Company and FreeMarkets each approved a Memorandum of Understanding (“MOU”) reflecting a settlement in which plaintiffs agreed to dismiss with prejudice the case against the Company and FreeMarkets in return for the assignment by the Company and FreeMarkets, respectively, of claims that each might have against its respective underwriters. No payment is required under the MOU. The settling parties filed formal motions seeking preliminary approval of the proposed settlement reflected in the MOU 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. The Court granted preliminary approval of the settlement on February 15, 2005, and a final fairness hearing on the settlement has been scheduled for January 2006.

In the meantime, the plaintiffs and underwriters have continued to litigate the consolidated action. The litigation is proceeding through the class certification phase by focusing on six cases chosen by the plaintiffs and underwriters. Neither the Company nor FreeMarkets is a focus case.

There can be no assurance that the preliminary approval of the settlement will be finalized at the fairness hearing. As of March 31, 2005, no amount is accrued as a loss is not probable or estimable.

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 Ariba as nominal defendant. The actions were subsequently consolidated into a single action. The 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 (which was dismissed with prejudice on March 16, 2005), and the allegedly excessive compensation paid by Ariba to one of its officers, as reflected in the Company’s then proposed restatement. The complaints sought the payment by the defendants to Ariba of damages allegedly suffered by it, as well as other relief.

Plaintiffs filed an Amended Consolidated Derivative Complaint in May 2003 adding allegations relating to the Company’s April 10, 2003 announcement of the restatement of certain financial statements and also adding a cause of action for breach of contract, and filed a Second Amended Consolidated Derivative Complaint in September 2004. The Company filed a demurrer to the second amended complaint in November 2004. A hearing on the demurrer is scheduled for May 10, 2005.

In March 2003, 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. The actions were subsequently consolidated into a single action. These actions were filed by shareholders purporting to assert, on the Company’s 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 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.

Plaintiffs filed an Amended Consolidated Derivative Complaint on June 26, 2003. In November 2003 the Court granted a stay of the action in light of the related securities class action litigation, which was later dismissed with prejudice on March 16, 2005. Accordingly, this action is currently stayed. As of March 31, 2005, no amount is accrued as a loss is not probable or estimable.

Litigating existing and potential shareholder derivative actions and securities class actions will likely require significant attention and resources of management and, regardless of the outcome, result in significant legal expenses. If the Company’s defenses are ultimately unsuccessful in these actions, or if it is unable to achieve a favorable settlement, the Company could be liable for large damages awards that could seriously harm its business, results of operation and financial condition.

On September 16, 2004, a purported shareholder class action was filed against the Company and the individual board members of the FreeMarkets Board of Directors in Delaware Chancery Court by stockholders who held FreeMarkets common stock from January 23, 2004 through July 1, 2004. The complaint alleges various breaches of fiduciary duty and a violation of the Delaware General Corporation Law on the part of the former FreeMarkets board members in connection with the merger between the Company and FreeMarkets, which was consummated on July 1, 2004. The plaintiff in this action contends, among other things, that the FreeMarkets board members breached their fiduciary duties to FreeMarkets’ common stockholders by negotiating the merger with the Company so as to provide themselves with downside protection against a decline in the Company’s market price through a beneficial option exchange formula while failing to provide the common stockholders protection in the event of a drop in the price of the Company’s stock, by contractually obligating themselves to recommend unanimously that FreeMarkets’ stockholders approve the merger, by failing to disclose to FreeMarkets’ stockholders certain material information before the merger closed, and by breaching their duties of loyalty to the common stockholders in various other respects. As FreeMarkets’ corporate successor, the Company is alleged to be liable for the FreeMarkets board members’ violation of the Delaware General Corporation Law. Plaintiff seeks disgorgement of benefits by the individual defendants, as well as monetary and rescissory damages from all of the defendants, jointly and severally.

The defendants’ Motion to Dismiss the complaint was submitted to the Delaware Chancery Court on February 4, 2005, and full briefing is expected to be completed within the next 90 days. As of March 31, 2005, no amount is accrued as a loss is not probable or estimable.

Defending against class action litigation relating to the Company’s merger with FreeMarkets may require significant management time and, regardless of the outcome, result in significant legal expenses. If the Company’s defenses are unsuccessful or it is unable to settle on favorable terms, the Company could be liable for a large damages award that could seriously harm its business and results of operations.

Beginning in April 2001, eleven securities fraud class action complaints were filed against FreeMarkets and two of its executive officers in the United States District Court for the Western District of Pennsylvania. The complaints, all of which assert the same claims, stem from FreeMarkets’ announcement on April 23, 2001 that, as a result of discussions with the SEC, it was considering amending its fiscal year 2000 financial statements for the purpose of reclassifying fees earned by FreeMarkets under a service contract with Visteon. All of the cases have been consolidated into a single proceeding. On March 10, 2004, the Court certified the case as a class action. The certification order is now on appeal to the United States Court of Appeals for the Third Circuit. Although the case is in the discovery phase, only a limited amount of discovery has been taken. The Company believes that the Plaintiffs’ allegations are without merit and it intends to continue to defend these claims vigorously. As of March 31, 2005, no amount is accrued as a loss is not probable or estimable.

Defending against the FreeMarkets securities class action litigation may require significant management time and, regardless of the outcome, result in significant legal expenses. If the Company’s defenses are

unsuccessful or it is unable to settle on favorable terms, the Company could be liable for a large damages award that could seriously harm its business and results of operations.

In addition, the Company has been or is subject to various claims and legal actions arising in the ordinary course of business. For instance, in the three months ended March 31, 2005, the Company paid $37.0 million to settle a lawsuit brought by ePlus, Inc. alleging that three of its products, Ariba Buyer, Ariba Marketplace and Ariba Category Procurement, infringed patents held by them. In addition, the Company is a defendant in a case pending in the United States District Court for the Northern District of California wherein the plaintiff alleges various contract and tort causes of action. A case management conference in that case is set for June 2005, at which a trial date should be selected. The Company is also a defendant in a case pending in state court in Hillsborough County, Florida, wherein the plaintiffs allege various contract and tort causes of action. That case is set for trial in June 2005. 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.

The Company sells software licenses and services to its customers under contracts that the Company refers to as Software License and Service Agreements (“SLSA”). Each SLSA contains the relevant terms of the contractual arrangement with the customer, and generally includes certain provisions for indemnifying the customer against losses, expenses and liabilities from damages that may be incurred by or awarded against the customer in the event the Company’s software or services are found to infringe upon a patent, copyright, trade secret, trademark or other proprietary right of a third party. The SLSA generally limits the scope of remedies for such indemnification obligations in a variety of industry-standard respects, including but not limited to certain product usage limitations and geography-based scope limitations, and a right to replace an infringing product or 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 also requires its employees to sign a proprietary information and inventions assignment agreement, which assigns the rights in its employees’ development work to the Company.

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 are outstanding as of March 31, 2005. 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, consolidated financial position, results of operations or cash flows.

As of March 31, 2005 and September 30, 2004, minority interests of $141,000 and $19.5 million, respectively, are recorded on the condensed consolidated balance sheets in order to reflect the share of the net

assets of Nihon Ariba K.K. (“Nihon Ariba”) and Ariba Korea Ltd. (“Ariba Korea”) held by minority investors. In addition, the Company increased consolidated net loss by $2,000 and reduced consolidated net loss by $253,000 for the three months ended March 31, 2005 and 2004, respectively, and increased consolidated net loss by $18,000 and reduced consolidated net income by $160,000 for the six months ended March 31, 2005 and 2004, respectively, representing the minority interests’ share of net income or loss of these majority-owned subsidiaries.

In October 2004, the Company purchased the 41% interest in Nihon Ariba and the 42% interest in Ariba Korea held by Softbank Corp., a Japanese corporation, and its subsidiaries (collectively “Softbank”) for $3.5 million. See Note 9 for a discussion of the Softbank settlement agreement. The Company purchased an additional 2% interest in Nihon Ariba held by various shareholders. These transactions resulted in a $733,000 and $19.5 million reduction to minority interests during the three and six months ended March 31, 2005, respectively.

On July 1, 2004, the Company effected a one-for-six reverse split of its outstanding common stock. The information contained herein gives retroactive effect to the reverse stock split for all periods presented.

In October 2002, the Company’s Board of Directors authorized the repurchase of up to $50.0 million of its common stock. In July 2004, the Board of Directors approved an extension of this stock repurchase program. Under the extended program, the Company may repurchase up to $50.0 million of its common stock from time to time, expiring after eighteen months, in compliance with the SEC’s regulations and other legal requirements and subject to market conditions and other factors. Stock purchases under the common stock repurchase program may be made periodically in the open market based on market conditions. During the year ended September 30, 2004, the Company repurchased and retired 806,000 shares of common stock at an average price of $7.97 per share for a total of $6.4 million. There were no shares of common stock repurchased during the three and six months ended March 31, 2005.

During fiscal year 2004 and the six months ended March 31, 2005, the Company granted 365,000 and 2.1 million shares, respectively, of restricted common stock to executive officers and certain employees. Net deferred stock-based compensation of $5.8 million was recorded during fiscal year 2004 and $22.4 million was recorded during the six months ended March 31, 2005. These amounts will be amortized in accordance with FASB Interpretation No. 28 over the vesting periods of the individual restricted common stock grants, which are between eighteen months and five years. During the three months ended March 31, 2005 and 2004, the Company recorded $4.3 million and $838,000 of stock-based compensation expense, respectively. During the six months ended March 31, 2005 and 2004, the Company recorded $8.7 million and $868,000 of stock-based compensation expense, respectively. As of March 31, 2005, the Company had an aggregate of $19.2 million of deferred stock-based compensation remaining to be amortized.

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

The following table summarizes information about stock options outstanding as of March 31, 2005:

SFAS No. 130, Reporting Comprehensive Income, establishes standards of reporting and display of comprehensive income and its components of net income and other comprehensive income. Other comprehensive income refers to revenues, expenses, gains and losses that are not included in net income but rather are recorded directly in stockholders’ equity. The components of comprehensive (loss) income for the three and six months ended March 31, 2005 and 2004 are as follows (in thousands):

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

The components of accumulated other comprehensive income as of March 31, 2005 and September 30, 2004 are as follows (in thousands):

The Company has gross unrealized losses of $682,000 on its investments as of March 31, 2005. Because the Company has the ability and intent to hold these investments until a recovery of fair value, which may be at maturity, the Company does not consider these investments to be other-than-temporarily impaired as of March 31, 2005.

In March 2005 and December 2004, the Company hedged the net assets of Ariba Korea and Nihon Ariba, respectively, using foreign currency forward contracts (Korean Won and Japanese Yen) to offset the translation and economic exposures related to the Company’s investments in these subsidiaries. The change in fair value of the forward contracts attributable to the changes in forward exchange rates (the effective portion) is reported in stockholders’ equity to offset the translation results on the net investments. The Korean Won and Japanese Yen investment hedges minimize currency risk arising from net assets held in Korean Won and Japanese Yen as a result of the Softbank settlement in October 2004. The notional amount of the Korean Won and Japanese Yen investment hedges were 2.0 billion Korean Won ($2.0 million) and 3.0 billion Japanese Yen ($28.3 million) as of March 31, 2005. The unrealized net gain on the investment hedges reported in stockholders’ equity was $973,000 as of March 31, 2005

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

For the three months ended March 31, 2005 and 2004, 10.5 million and 3.0 million weighted-average potential common shares, respectively, are excluded from the determination of diluted net (loss) income per share, as the effect of such shares is anti-dilutive. For the six months ended March 31, 2005 and 2004, 9.4 million and 2.8 million weighted-average potential common shares, respectively, are excluded from the determination of diluted net (loss) income per share, as the effect of such shares is anti-dilutive. Further, the potential common shares for each of the three and six months ended March 31, 2005 and 2004 exclude 86,000 and 140,000 shares, respectively, which would be issuable under certain warrants contingent upon completion of certain milestones.

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 makers 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 indirect sales channels. The Company’s chief operating decision makers evaluate 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.

The Company’s license revenues are derived from a similar group of software applications that are sold individually or in combination. Subscription revenues consist mainly of fees for software access subscription and hosted software services. Maintenance revenues consist primarily of Ariba Buyer and Ariba Sourcing product maintenance fees. Services and other revenues consist of fees for implementation services, consulting services, managed services, training, education, premium support and other miscellaneous services. Revenues by similar product and service groups are as follows (in thousands):

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

Revenues are attributed to countries based on the location of the Company’s customers. The Company’s international revenues were derived primarily from sales in Europe and Asia. The Company had net assets of $44.9 million and $40.7 million related to its international locations as of March 31, 2005 and September 30, 2004, respectively.

In fiscal year 2001, the Company entered into an agreement with Robert Calderoni, its CEO, pursuant to which he was 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 incurred additional compensation expense averaging $267,000 per quarter through the quarter ended December 31, 2004.

The Company entered into an agreement with another executive officer in October 2001 which provided for an unsecured loan in the amount of $1,500,000. The principal amount of the loan was to become payable in full immediately after termination of the individual’s employment for any reason other than a termination by the Company without cause. Further, the agreement provided that the loan would be forgiven over three years based on continued service. This loan was fully forgiven in October 2004.

The Company entered into an agreement with a third executive officer in April 2002 which provided for two unsecured loans, the first in the amount of $600,000 and the second in the amount of $400,000. The principal amounts of the loans were to become immediately payable in full if the individual’s employment terminated. These loans were fully forgiven in December 2004.

The Company recorded the principal amounts of these loans as an operating expense in fiscal year 2002 based upon its assessment at that time that recoverability of the loans in the event of the employees’ termination prior to the expiration of the related forgiveness periods was remote.

In fiscal year 2001, the Company sold 41% of its consolidated subsidiary, Nihon Ariba, and 42% of its consolidated subsidiary, Ariba Korea, to Softbank. A subsidiary of Softbank also received the right to distribute the Company’s products from these subsidiaries in their respective jurisdictions. The Company recorded license and maintenance revenues of $255,000 and $408,000 in the three months ended March 31, 2005 and 2004, respectively and $1.2 million and $3.3 million in the six months ended March 31, 2005 and 2004, respectively, related to transactions with Softbank, including license and maintenance revenues recognized pursuant to their long-term revenue commitment.

In June 2003, the Company commenced an arbitration proceeding against Softbank for failing to meet its contractual revenue commitments. In response to Ariba’s 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 Nihon Ariba and Ariba Korea.

The Company’s agreements with Softbank required Softbank to be current with its revenue commitments before arbitration could proceed. Pursuant to the arbitration proceeding, Softbank made three interim payments totaling $43.4 million from October 2003 through April 2004, representing the aggregate quarterly payments owed to Nihon Ariba plus interest. The arbitration panel stipulated that the payments were subject to possible return to Softbank depending on the outcome of the arbitration. These funds were recorded in the period received as an increase to restricted cash and current accrued liabilities.

In October 2004, the Company entered into a definitive agreement with Softbank settling their dispute. Under the terms of the agreement, the Company acquired Softbank’s 41% interest in Nihon Ariba and its 42% interest in Ariba Korea for $3.5 million, as well as returned to Softbank $43.0 million of the interim payments made by Softbank pursuant to the arbitration proceeding. In addition, Softbank paid $20.0 million for a new three-year term license of certain Ariba software products for use by Softbank and its affiliates and for the benefit of unaffiliated third-party customers in Japan. The net cash outflow from these transactions was $26.5 million.

The settlement agreement resulted in the elimination of Softbank’s minority interests of $18.8 million from the Company’s consolidated balance sheets. A total of $37.0 million was recorded as “Deferred income—Softbank.” As the Company was unable to determine the respective fair value of the amounts that related to Softbank’s software license, related maintenance and the settlement of the Company agreements with Softbank, the $37.0 million will be recognized ratably as “Other income—Softbank” over the three-year software license term. The $37.0 million of deferred income is comprised of the following: $20.0 million from the software license; the $15.3 million difference between the $18.8 million in carrying value of the minority interests and the $3.5 million paid to acquire those interests; and $1.7 million in fair value adjustments, primarily related to deferred revenue, from the acquisition of Softbank’s minority interests. The Company also made a provision for taxes of $4.8 million in the three-month period ended December 31, 2004 as a result of the settlement. The Company recorded $2.8 million in income related to the Softbank settlement in the three months ended March 31, 2005. As of March 31, 2005, deferred income—Softbank was $34.1 million.

The information in this discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such statements are based upon current expectations that involve risks and uncertainties. Any statements contained herein that are not statements of historical facts may be deemed to be forward-looking statements. For example, words such as “may”, “will”, “should”, “estimates”, “predicts”, “potential”, “continue”, “strategy”, “believes”, “anticipates”, “plans”, “expects”, “intends” and similar expressions are intended to identify forward-looking statements. Our actual results and the timing of certain events may differ significantly from the results discussed in 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 SEC filings, including our Annual Report on Form 10-K filed with the SEC on December 14, 2004 and amended on January 28, 2005.

Ariba provides Spend Management solutions that allow enterprises to efficiently manage the purchasing of non-payroll goods and services required to run their business. We refer to these non-payroll expenses as “spend.” Our solutions, which include software applications, services and network access, are designed to provide enterprises with technology and business process improvements to better manage their spend 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 and equipment.

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 a web browser. In addition to application software, Ariba Spend Management solutions include implementation and strategic consulting services, education and training, commodity expertise, decision support services, benchmarking services, low-cost country sourcing and procurement outsourcing services. Ariba Spend Management solutions also integrate with and leverage the Ariba Supplier Network. The Ariba Supplier Network is a scalable Internet infrastructure that connects our 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 100,000 suppliers, offering a wide array of goods and services, are connected to the Ariba Supplier Network.

Ariba Spend Management solutions are organized around six key areas of spend management, allowing organizations to take a step-by-step approach with technology and services that work together. Through its solution offerings, Ariba helps customers to: (1) develop a strategy for spend management, (2) aggregate spend data and gain visibility into current spending and opportunities for savings, (3) develop sustainable sourcing savings and competencies, (4) automate procurement, establish best practices and drive compliance, (5) manage global connectivity and supplier performance, and (6) outsource certain spend management processes or entire functions.

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

We have aligned our business model with the way we believe customers want to purchase and deploy spend management solutions. Customers may generally subscribe to our software products and services for a specified term, purchase a perpetual software license and/or pay for services on a time-and-materials basis, depending upon their business requirements. Our revenue is comprised of license fees, subscription and maintenance fees, and services and other fees. License revenue consists of fees charged for the use of our software products under perpetual or term agreements. Subscription and maintenance revenue consists of fees charged for hosted software solutions, fees for product updates and product support, and fees paid by suppliers for access to the Ariba Supplier Network. Services and other revenue consists of fees for implementation services, consulting services, managed services, training, education, premium support and other miscellaneous services.

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

These different revenue streams also carry different gross margins. Revenue from license fees tends to be high-margin revenue, and gross margins are often greater than 90%. Revenue from subscription and maintenance fees also tends to be higher-margin revenue, but not quite as high as license fees, with gross margins typically in the 75% to 80% range. License, subscription and maintenance fees are generally based on software products developed by us, which carry minimal marginal cost to reproduce and sell. Revenue from labor-intensive services and other fees tends to be lower-margin revenue, with gross margins typically in the 15% to 30% range. Our overall gross margins could fluctuate from period to period depending upon the mix of revenue. For example, a period with a higher mix of license revenue versus services revenue would drive overall gross margin higher and vice versa.

Several major factors had a significant impact on our business during the second quarter of fiscal year 2005. Most notable was our merger with FreeMarkets on July 1, 2004 and our acquisitions of Alliente and Softface in the first half of fiscal year 2004. The business combinations from fiscal year 2004 added to our software and services capabilities and increased our revenues. We also experienced organic growth in our services revenues, as our business model continues to shift from software sales to providing comprehensive solutions including both software applications and strategic services. Partially offsetting these positive factors was the falloff in revenue from our strategic relationship with Softbank and the continued difficult selling environment for enterprise software applications. In summary, these and other factors caused our revenues to increase by 45% from $56.0 million in the second quarter of fiscal year 2004 to $81.3 million in the same period of fiscal year 2005.

More specifically, license revenues of $12.6 million were down 21% compared to the second quarter of fiscal year 2004, primarily due to the difficult selling environment, particularly for large enterprise software deals, and a shift from perpetual software licenses to more subscription and hosted term licenses. Subscription and maintenance revenues of $31.2 million were up 45% compared to the second quarter of fiscal year 2004, primarily due to the addition of software subscription revenues from FreeMarkets, while maintenance revenues were relatively flat. Finally, services and other revenues of $37.4 million were up 102% compared to the second quarter of fiscal year 2004, primarily due to the addition of service revenues from FreeMarkets, as well as organic growth of the Ariba services organization. While the addition of the subscription and services business from FreeMarkets increased our reported revenues on a year-over-year basis, this revenue stream has been declining, and we expect this trend to continue for at least the next few quarters.

As a result of these trends, we experienced a significant shift in our revenue mix, with license revenues contributing 16% of total revenues compared to 28% in the second quarter of fiscal year 2004, subscription and maintenance revenues contributing 38% of total revenues in the second quarter of fiscal year 2005 and 2004, and services and other revenues contributing 46% of total revenues compared to 33% in the second quarter of fiscal year 2004. Since the cost of software license revenues is typically much lower than the cost of services revenues, the shift in our revenue mix contributed to a decline in our gross margin for the quarter to 45% compared to 62% in the second quarter of fiscal year 2004. Also contributing to the decline in our gross margin was a charge of $5.3 million for the amortization of acquired technology.

Operating expenses increased to $43.5 million compared to $37.1 million in the second quarter of fiscal year 2004. The increase in operating expenses can primarily be attributed to the additional operating infrastructure from FreeMarkets, Alliente and Softface, as well as to increased charges for stock-based compensation and post-merger integration activity. In sum, our total expenses, including cost of revenue and other items, increased to $88.2 million compared to $56.8 million in the second quarter of fiscal year 2004, which caused a net loss of $6.9 million compared to $831,000 in the second quarter of fiscal year 2004.

As a result of our merger with FreeMarkets, we expect total revenues and expenses to increase significantly during fiscal year 2005 relative to fiscal year 2004. In addition, we have incurred and expect to incur additional expenses related to the merger, including restructuring and severance payments and the amortization of acquired intangible assets. These restructuring activities have helped to lower our cost of revenue, sales and marketing, research and development, and general and administrative expenses to $84.6 million for the quarter ended March 31, 2005 from $89.1 million for the quarter ended September 30, 2004 (the first full quarter of combined operations after the merger with FreeMarkets).

While we have realized cost synergies from our merger with FreeMarkets, our revenues have declined sequentially from the first quarter to the second quarter of fiscal year 2005. We believe the sequential decline in our revenue was due to several factors, including (1) a difficult spending environment for enterprise software vendors, (2) a shift in our mix of software revenue from perpetual licenses to subscription and hosted term licenses, and (3) the decline in our subscription services business and lower utilization levels for our field delivery team. In addition, while cross-selling to the legacy Ariba and FreeMarkets customer bases has had a positive impact on our business, it has been slower to develop than we had originally anticipated.

We believe that many of these trends may continue, and our current expectation is that revenues may again decline sequentially in the third quarter of fiscal year 2005. Based on the anticipated lower level of revenues, we expect to take additional restructuring actions over the next few quarters in an attempt to further reduce our cost structure.

We believe that our success for the remainder of fiscal year 2005 will depend largely on our ability to stabilize our base of revenues and capture further cost savings through our restructuring efforts. To stabilize our

revenues, we will need to (1) drive greater acceptance of our spend management solutions, (2) continue to capitalize on cross-selling opportunities from our merger with FreeMarkets, and (3) develop new revenue streams, such as procurement outsourcing, low-cost country sourcing services and fees from the Ariba Supplier Network.

We believe that key risks to our future revenues include: our ability to realize our cross-selling objectives; our ability to renew ratable revenue streams without substantial declines from prior arrangements, including subscription software, software maintenance and subscription services; our ability to generate organic growth; the market acceptance of spend management solutions as a standalone market category; the overall level of information technology spending; and potential declines in average selling prices. We believe that key risks to our future operating profitability include: our ability to maintain or grow our revenues; a shift in our mix of revenues from higher margin license fees to lower margin services and other fees; our success in integrating our recent business combinations, particularly our merger with FreeMarkets; our ability to maintain utilization of our services organization; and the potential adverse impacts resulting from legal proceedings. Our prospects must be considered in light of the risks encountered by companies at a relatively early stage of development, particularly given that we operate in new and rapidly evolving markets, 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.

The following table sets forth statements of operations data for the periods indicated (in thousands, except per share data). The data has been derived from the unaudited Condensed Consolidated Financial Statements contained in this Form 10-Q which, in the opinion of our management, reflect all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial position and results of operations for the interim periods presented. The operating results for any period should not be considered indicative of results for any future period. In addition, the results of operations for the three and six months ended March 31, 2005 include the effects of the FreeMarkets merger on July 1, 2004. This information should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in our Form 10-K for the fiscal year ended September 30, 2004 filed with the SEC on December 14, 2004 and amended on January 28, 2005.

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

Total license revenues for the three months ended March 31, 2005 were $12.6 million, a 21% decrease from the $15.9 million for the three months ended March 31, 2004. Total license revenues for the six months ended March 31, 2005 were $29.7 million, a 14% decrease from the $34.6 million for the six months ended March 31, 2004. These declines in revenue are attributable to the continued difficult selling environment for enterprise software applications and a shift from perpetual license sales to more subscription and hosted term license software sales. 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 on revenues from licenses entered into in prior quarters.

Our backlog is the value of software license contracts entered into by us with customers or resellers for which no revenue or deferred revenue has been recognized. In the quarter ended March 31, 2005, our backlog remained relatively consistent compared to December 31, 2004. We do not believe that backlog is a meaningful indicator of future revenues in any particular period for the following reasons: many of the contracts representing our backlog are cancelable or subject to performance conditions, a substantial portion of our license revenues in any period are realized from contracts entered into in that period, and an increasing portion of our revenues are realized from our services business.

Subscription and maintenance revenues for the three months ended March 31, 2005 were $31.2 million, a 45% increase over the $21.5 million recorded in the three months ended March 31, 2004. Subscription revenues for the three months ended March 31, 2005 were $11.8 million, a 511% increase over the $1.9 million for the three months ended March 31, 2004, primarily attributable to an expansion of our product lines as a result of our merger with FreeMarkets and the sale of more hosted term licenses. Maintenance revenues for the three months ended March 31, 2005 were $19.4 million, relatively consistent with the $19.6 million for the three months ended March 31, 2004.

Subscription and maintenance revenues for the six months ended March 31, 2005 were $62.7 million, a 44% increase over the $43.6 million for the six months ended March 31, 2004. Subscription revenues for the six months ended March 31, 2005 were $23.4 million, a 454% increase over the $4.2 million for the six months ended March 31, 2004, primarily attributable to an expansion of our product lines as a result of our merger with FreeMarkets. Maintenance revenues for the six months ended March 31, 2005 were $39.2 million, relatively consistent with the $39.4 million for the six months ended March 31, 2004. We expect our merger with FreeMarkets will continue to result in increased subscription and maintenance revenues in fiscal year 2005 as compared to fiscal year 2004.

Services and other revenues for the three months ended March 31, 2005 were $37.4 million, a 102% increase over the $18.5 million for the three months ended March 31, 2004. The increase in services and other revenues is due to $16.1 million from services revenues added as a result of our merger with FreeMarkets and $1.9 million from organic growth.

Services and other revenues for the six months ended March 31, 2005 were $75.8 million, a 148% increase over the $30.5 million for the six months ended March 31, 2004. The increase in services and other revenues is due to $33.2 million from services revenues added as a result of our merger with FreeMarkets, $9.6 million from organic growth and $2.4 million from Ariba Managed Services added as a result of our acquisition of Alliente in the second quarter of 2004. We are continuing to invest in our services business which we believe is strategic to selling our spend management solutions. We anticipate that services and other revenues will represent an increasing portion of total revenues in fiscal year 2005, partly due to the inclusion of the results of operations of FreeMarkets for a full fiscal year.

Cost of license revenues consists of product, delivery and royalty costs. Cost of license revenues for the three months ended March 31, 2005 was $1.1 million, a 386% increase from the $217,000 for the three months ended March 31, 2004. This increase is primarily due to a $722,000 increase in royalties due to third parties.

Cost of license revenues for the six months ended March 31, 2005 was $1.7 million, a 10% increase from the $1.6 million for the six months ended March 31, 2004. This increase is primarily due to a $379,000 increase in royalties due to third parties, partially offset by a decrease of $271,000 in co-sale and reseller fees.

Cost of subscription and maintenance revenues consists of labor costs for implementation and services, hosting services, technical support, facilities and equipment costs. Cost of subscription and maintenance revenues for the three months ended March 31, 2005 was $7.1 million, a 32% increase over the $5.4 million for the three months ended March 31, 2004. This increase is the result of a $1.7 million increase in the cost of subscription services, primarily due to the inclusion of the results of operations of FreeMarkets in the current period.

Cost of subscription and maintenance revenues for the six months ended March 31, 2005 was $14.4 million, a 33% increase over the $10.8 million for the six months ended March 31, 2004. This increase is the result of a $3.6 million increase in the cost of subscription services, primarily due to the inclusion of the results of operations of FreeMarkets in the current period.

Cost of services and other revenues consists of labor costs for consulting services, training personnel, facilities and equipment costs. Cost of services and other revenues for the three months ended March 31, 2005 was $31.6 million, a 102% increase over the $15.6 million for the three months ended March 31, 2004. The increase is a result of additional personnel costs associated with our merger with FreeMarkets and organic growth, all of which resulted in increased services personnel.

Cost of services and other revenues for the six months ended March 31, 2005 was $61.4 million, a 138% increase over the $25.8 million for the six months ended March 31, 2004. The increase is a result of additional personnel costs associated with our acquisition of Alliente, the merger with FreeMarkets and organic growth,

both of which resulted in increased services personnel. We anticipate that cost of services and other revenues will increase significantly in fiscal year 2005 as compared to fiscal year 2004, primarily due to the inclusion of the results of operations of FreeMarkets for a full fiscal year.

Amortization of acquired technology and customer intangible assets represents the amortization of the costs allocated to technology and customer relationships in our fiscal year 2004 business combinations with Alliente, Softface and FreeMarkets. This expense amounted to $5.3 million and $10.0 million for the three and six months ended March 31, 2005, respectively.

Our gross margin for the three months ended March 31, 2005 was 45% compared to 62% for the three months ended March 31, 2004, and our gross margin for the six months ended March 31, 2005 was 48% compared to 65% for the six months ended March 31, 2004. This change primarily reflects the shift in our revenue mix to revenues with lower gross margins as a result of the merger with FreeMarkets. We anticipate that our gross margin may decline further in the future to the extent that subscription and maintenance and services revenues increase as a percentage of total revenues.

Sales and marketing includes costs associated with our sales, marketing and product marketing personnel, and consists primarily of compensation and benefits, commissions and bonuses, promotional and advertising and travel and entertainment expenses related to these personnel, as well as the provision for doubtful accounts. Sales and marketing expenses for the three months ended March 31, 2005 were $19.3 million, a 5% decrease from the $20.4 million for the three months ended March 31, 2004. This decrease is primarily due to decreased legal costs of $5.5 million related to the settlement of a litigation matter involving a marketing alliance program partner in the three months ended March 31, 2004, partially offset by increased compensation and benefits expense of $2.5 million due to the 32% increase in average headcount primarily due to the merger with FreeMarkets and by increased bad debt expense in the amount of $1.1 million due to a deterioration in the aging of our accounts receivable.

Sales and marketing expenses for the six months ended March 31, 2005 were $44.0 million, a 30% increase over the $33.9 million for the six months ended March 31, 2004. This increase is primarily due to the following: (1) increased compensation and benefits expense of $6.6 million resulting from a 33% increase in average headcount, primarily due to the merger with FreeMarkets; (2) increased bad debt expense in the amount of $1.8 million due to a deterioration in the aging of our accounts receivable; (3) increased travel costs of $1.4 million from the increase in headcount; and (4) increased advertising costs of $1.1 million.

Research and development includes costs associated with the development of new products, enhancements of existing products for which technological feasibility has not been achieved, and quality assurance activities, and primarily includes employee compensation and benefits, consulting costs and the cost of software development tools and equipment. Research and development expenses for the three months ended March 31, 2005 were $12.3 million, a 4% decrease from the $12.8 million for the three months ended March 31, 2004. This decrease is primarily attributable to a slight decrease in facilities and equipment expense of $374,000, primarily due to a decrease in depreciation expense as office equipment reaches its maximum depreciable lives.

Research and development expenses for the six months ended March 31, 2005 were $24.7 million, which is relatively consistent with the $25.1 million recorded in the six months ended March 31, 2004.

General and administrative includes costs for executive, finance, human resources, information technology, legal and administrative support functions. General and administrative expenses for the three months ended March 31, 2005 were $7.9 million, a 61% increase from the $4.9 million for the three months ended March 31, 2004. This increase is primarily due to the following: (1) increased compensation and benefits of $1.5 million relating to an increase in average headcount, primarily due to the merger with FreeMarkets; and (2) increased legal expenses of $2.6 million primarily related to a patent infringement case settled in February 2005. For further discussion, see Note 4 to the unaudited Condensed Consolidated Financial Statements.

General and administrative expenses for the six months ended March 31, 2005 were $16.5 million, a 75% increase from the $9.5 million for the six months ended March 31, 2004. This increase is primarily due to the following: (1) increased compensation and benefits of $2.4 million relating to an increase in average headcount, primarily due to the merger with FreeMarkets; and (2) increased legal expenses of $4.3 million primarily related to a patent infringement case settled in February 2005. For further discussion, see Note 4 to the unaudited Condensed Consolidated Financial Statements.

During the three months ended March 31, 2005, we recorded $2.8 million of income from the settlement with Softbank entered into in October 2004. The $37.0 million of deferred income recorded upon the settlement of the Softbank agreement is being recognized into income, starting in January 2005, over the remaining term of the three year license. For further discussion, see Note 9 to the unaudited Condensed Consolidated Financial Statements.

Amortization of other intangible assets was $213,000 and $398,000 for the three and six months ended March 31, 2005, respectively, which consisted of trademarks acquired from our merger with FreeMarkets, our acquisitions of Softface and Alliente and our acquisition of the minority interests of Nihon Ariba and Ariba Korea from Softbank. Amortization of other intangible assets was $76,000 for each of the three and six months ended March 31, 2004, which consisted of trademarks acquired from our acquisition of Alliente. We anticipate amortization of other intangible assets will remain relatively consistent in the near term.

We recognized deferred stock-based compensation associated with stock options issued to employees in conjunction with the consummation of our acquisitions 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 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 FASB 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.

During the three and six months ended March 31, 2005, we granted 69,000 and 2.1 million shares, respectively, of restricted stock to executive officers and certain employees. Net deferred stock-based compensation of $22.4 million was recorded during the six months ended March 31, 2005. This amount will be amortized in accordance with FIN 28 over the vesting periods of the individual restricted common stock grants, which are between two to three years. During the three months ended March 31, 2005 and 2004, we recorded $4.3 million and $838,000 of stock-based compensation expense, respectively. During the six months ended

March 31, 2005 and 2004, we recorded $8.7 million and $868,000 of stock-based compensation expense, respectively. As of March 31, 2005, we had an aggregate of $19.2 million of deferred stock-based compensation remaining to be amortized.

We recorded a charge to operations of $2.3 million and $4.1 million during the three and six months ended March 31, 2005 for restructuring and integration costs in connection with our merger with FreeMarkets in order to improve our post-merger competitiveness, productivity and future operating results. The charge in the three months ended March 31, 2005 was primarily for a $1.6 million adjustment to our restructuring obligation related to a prior period. We assessed our findings using the guidance in SEC Staff Accounting Bulletin No. 99, and concluded that the amount of the error was immaterial to the prior period. The remaining charges for the three and sixth months ended March 31, 2005 primarily relate to severance and related benefits for terminated employees and consulting fees. During the three months ended March 31, 2004, we recorded a benefit to operating expense of $1.9 million primarily as a result of entering into a sublease agreement which was not anticipated in previous estimates of the restructuring obligations.

We recorded a $37.0 million provision related to the settlement of our patent infringement litigation during the six months ended March 31, 2005. For further discussion, see Note 4 to the unaudited Condensed Consolidated Financial Statements.

Interest and other income, net for the three months ended March 31, 2005 was $640,000, a 33% decrease from the $953,000 recorded in the three months ended March 31, 2004. The decrease is primarily attributable to a 30% decrease in average cash and cash equivalents, investments and restricted cash, primarily due to the settlement of patent litigation with ePlus in February 2005 and the merger with FreeMarkets in July 2004. Interest and other income, net for the six months ended March 31, 2005 was $3.3 million, an 84% increase over the $1.8 million recorded in the six months ended March 31, 2004. The increase is primarily attributable to an increase in realized foreign currency transaction gains in the amount of $1.1 million on accounts receivable billed from Ariba, Inc. in foreign currencies to customers headquartered in foreign countries and foreign currency transaction gains in the amount of $331,000 on intercompany transactions. The foreign currency transaction gains are primarily due to the U.S. dollar weakening against the Euro and the British Pound in the six months ended March 31, 2005.

Provision for income taxes for the three months ended March 31, 2005 was $224,000, compared to a benefit of $255,000 for the three months ended March 31, 2004. Provision for income taxes for the six months ended March 31, 2005 was $5.0 million, compared to a benefit of $527,000 for the six months ended March 31, 2004. The increase in the six months ended March 31, 2005 is primarily attributable to the $4.8 million tax effect related to the buy-out of the minority interests from Softbank in October 2004.

In the three months ended March 31, 2005, we purchased an approximate 2% minority interest in Nihon Ariba held by minority shareholders. In October 2004, we purchased the 41% interest in Nihon Ariba and the 42% interest in Ariba Korea held by Softbank for $3.5 million. These transactions resulted in a $733,000 and $19.5 million reduction to minority interests during the three and six months ended March 31, 2005, respectively.

We increased consolidated net loss by $2,000 and decreased consolidated net loss by $253,000, representing the minority interests’ share of Nihon Ariba’s and Ariba Korea’s income (loss) for the three months ended March 31, 2005 and 2004, respectively. We increased consolidated net loss by $18,000 and reduced net income by $160,000 representing the minority interests’ share of Nihon Ariba’s and Ariba Korea’s income for the six months ended March 31, 2005 and 2004, respectively.

As of March 31, 2005, we had $120.6 million in cash, cash equivalents and investments and $33.6 million in restricted cash, for total cash, cash equivalents and investments of $154.2 million. Our working capital on March 31, 2005 was $18.5 million. All significant cash, cash equivalents and investments are held in accounts in the United States except for $50.0 million held by our majority-owned subsidiaries in Japan and Korea. Repatriation of cash held in Korea may be subject to foreign withholding taxes at a rate of 11%. As of September 30, 2004, we had $140.9 million in cash, cash equivalents and investments and $72.5 million in restricted cash, for total cash, cash equivalents and investments of $213.4 million. Our working capital on September 30, 2004 was $33.1 million.

The decrease in total cash, cash equivalents, investments and restricted cash of $59.2 million in the six months ended March 31, 2005 is primarily attributable to the cash outflow of $37.0 million associated with the ePlus settlement in February 2005 and the $26.5 million associated with the Softbank settlement in October 2004. The net cash outflow to Softbank is comprised of the following: (1) repayment of $43.0 million of the interim payments received in connection with the Softbank arbitration proceedings, which represented the amounts owed to Ariba for software and support under the strategic relationship with Softbank; (2) payment of $3.5 million to buy out Softbank’s minority interests in Nihon Ariba and Ariba Korea; and (3) $20.0 million received from Softbank for a three year software license of the Ariba Sourcing and Ariba Analysis product lines. Excluding the ePlus and Softbank settlements, total cash and investments increased $4.3 million primarily due to proceeds from the issuance of common stock from stock option exercises and the employee stock purchase plan in the amount of $9.0 million, partially offset by capital expenditures of $3.6 million.

Net cash used in operating activities was $62.3 million for the six months ended March 31, 2005, compared to $12.3 million of net cash provided by operating activities for the six months ended March 31, 2004. Cash flows from operating activities decreased a total of $74.6 million due to the following:

Net cash provided by investing activities was $44.4 million for the six months ended March 31, 2005, compared to net cash used in investing activities of $25.1 million for the six months ended March 31, 2004. The

increase in net cash provided by investing activities for the six months ended March 31, 2005 is primarily attributable to the net Softbank activity of $69.9 million described above and the $8.3 million used to acquire Alliente in the six months ended March 31, 2004, partially offset by the $4.2 million used to acquire minority interests in the six months ended March 31, 2005 and reduced proceeds from sales of marketable securities, net of purchases.

Net cash provided by financing activities was $9.0 million for the six months ended March 31, 2005, compared to net cash provided by financing activities of $4.8 million for the six months ended March 31, 2004. Net cash provided by financing activities in both periods is attributable to the issuance of common stock from stock option exercises and from the employee stock purchase plan.

Our primary contractual obligations are from operating leases for office space and letters of credit related to those leases. See Note 4 to the unaudited Condensed Consolidated Financial Statements for a discussion of our lease commitments and letters of credit.

Other than the lease commitments and letters of credit discussed in Note 4 to the unaudited Condensed Consolidated Financial Statements, we do not have commercial commitments under lines of credit, standby repurchase obligations or other such debt arrangements. We do not have any material noncancelable purchase commitments as of March 31, 2005. There have been no material changes in our contractual obligations and commercial commitments during the quarter ended March 31, 2005 from those presented in our Annual Report on Form 10-K filed with the SEC on December 14, 2004 and amended on January 28, 2005.

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

We believe our existing cash and cash equivalents and investment balances, together with anticipated cash flow from operations, should be sufficient to meet our working capital and operating resource requirements for at least the next twelve months. However, given the significant changes in our business and results of operations in the last twelve to eighteen months, the fluctuation in cash and investment 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.

Our condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Accounting policies, methods and estimates are an integral part of the preparation of consolidated financial statements in accordance with GAAP and, in part, are

based upon management’s current judgments. Those judgments are normally based on knowledge and experience with regard to past and current events and assumptions about future events. Certain accounting policies, methods and estimates are particularly sensitive because of their significance to the consolidated financial statements and because of the possibility that future events affecting them may differ markedly from management’s current judgments. While there are a number of accounting policies, methods and estimates affecting our consolidated financial statements, areas that are particularly significant include:

These critical accounting policies and estimates, their related disclosures and other accounting policies, methods and estimates have been reviewed by our senior management and audit committee. These policies and our practices related to these policies are described in Note 1 to the Condensed Consolidated Financial Statements and in our Annual Report on Form 10-K filed with the SEC on December 14, 2004 and amended on January 28, 2005.

In addition to other information in this Form 10-Q, the following risk factors should be carefully considered in evaluating Ariba 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 the sections titled “Overview of Quarter Ended March 31, 2005” and “Outlook for Fiscal Year 2005,” and the risks discussed in our other SEC filings, actual results could differ materially from those projected in any forward-looking statements. See Note 4 to the unaudited Condensed Consolidated Financial Statements for a discussion of risks related to litigation proceedings.

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

Spend management software applications and services are at a relatively early stage of development. 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 recent product releases and upgrades integrating functionality acquired in our recent merger with FreeMarkets. These products may be more challenging to implement than our more established products, as we have less experience deploying these applications. The markets in which we compete are characterized by rapid technological change, evolving customer needs and frequent introductions of new products and services. As we adjust to evolving customer requirements and competitive pressures, we may be required to further reposition our product and service offerings and introduce new products and services. We may not be successful in developing and marketing such product and service offerings, or we may experience difficulties that could delay or prevent the development and marketing of such product and service offerings, which could have a material adverse effect on our business, financial condition or results of operations.

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

Our business depends on the overall demand for enterprise software and services and on the economic health of our current and prospective customers. Weak global economic conditions in recent years and the related decline in information technology spending has hurt our business. Continued weak economic conditions, or a

continued reduction in information technology spending even if economic conditions improve, could adversely impact our business in a number of ways including longer sales cycles, lower average selling prices and reduced bookings and revenues.

On July 1, 2004, we completed our merger with FreeMarkets, which provides enterprises with software, services and information for global supply management. Our merger with FreeMarkets is subject to a number of risks. Among other things, achievement of the expected benefits of the merger, including cost savings, will depend on successfully:

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 Success Depends on Market Acceptance of Standalone Spend Management Solutions.

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

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

We have a significant accumulated deficit as of March 31, 2005, resulting in large part from cumulative charges for the amortization and impairment of goodwill and other intangible assets. We may incur significant losses in the future for a number of reasons, including those discussed in subsequent risk factors and the following:

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

Our quarterly operating results have varied significantly in the past and will likely continue to vary significantly in the future. 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:

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

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

Our License Revenues in Any Quarter May Fluctuate Because We Depend on a Relatively Small Number of Relatively Large Orders.

Our quarterly license 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 quarter in each of our last two fiscal years. 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.

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

Our sales cycles are long and can be unpredictable. The purchase of our products is often discretionary and generally involves a significant commitment of capital and other resources by a customer. It frequently takes several months to finalize a sale and requires approval at a number of management levels within the customer organization. The implementation and deployment of our products requires a significant commitment of resources by our customers and third parties and/or professional services organizations.

An Increased Demand for Term Licenses and Subscriptions or Hosted Applications by Customers May Result in Deferral of Revenues and Cash Payments from Customers.

Customers may purchase a perpetual license for our software or purchase the software for a specified period of time through a term license or a subscription. If an increasing portion of customers choose term licenses or subscriptions, we may experience a deferral of revenues and cash payments from customers. Similarly, if an increasing portion of customers request application hosting services, we may experience a deferral of revenues and cash payments from customers.

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. License revenues in recent and future quarters have generally been more dependent on revenues from new customer contracts entered into in those quarters rather than from the amortization or recognition of license revenues deferred in prior quarters.

Revenues From Our Ariba Sourcing Solution (Which Includes the Service Formerly Known as FullSource) Could Be Negatively Affected if Customers Elect to Purchase Our Self-Service Products Rather Than Our Technology-Enhanced Services.

Revenue from our full-service sourcing services offering (formerly known as FullSource) has been declining as existing customers renew contracts for lower dollar volumes and/or purchase our lower-priced self-service technologies (such as Ariba QuickSource). We have several large multi-year contracts for these technology-enhanced services, many of which will come up for renewal during fiscal year 2005. If these customers do not renew their contracts upon expiration, or if they elect to use one of our lower-cost self-service solutions, our future revenues may decrease.

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

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

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

Because we are a publicly-traded company, we are subject to certain federal, state and other rules and regulations, including rules and regulations recently adopted in response to laws adopted by Congress, such as the Sarbanes-Oxley Act of 2002. Compliance with these evolving regulations is costly and requires a significant diversion of management time and attention, particularly with regard to our disclosure controls and procedures and our internal control over financial reporting. Although we have reviewed our disclosure and internal controls and procedures in order to determine whether they are effective, our controls and procedures may not be able to prevent other than inconsequential errors 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 errors or fraud could seriously harm our business and results of operations.

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

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

If a Sufficient Number of Suppliers Do Not Join and Maintain Their Participation In the Ariba Supplier Network, Particularly in Light of Our Recently-Implemented Program to Charge Our Higher Transaction Volume Suppliers for Access to the Network, It May Not Attract a Sufficient Number of Buyers and Other Sellers Required to Make the Network Successful.

In order to provide buyers on the Ariba Supplier Network an organized method for accessing goods and services, we rely on suppliers to maintain web-based product catalogs, indexing services and other content aggregation tools. Any failure of suppliers to join the Ariba Supplier Network in sufficient numbers, or of existing suppliers to maintain their participation in the Ariba Supplier Network, would make the network less attractive to buyers and consequently other suppliers. We recently implemented a program to begin charging select suppliers for access to the Ariba Supplier Network, which could make it less attractive for suppliers to join

or maintain their participation in the network. Our inability to access and index these catalogs and services provided by suppliers would result in our customers having fewer products and services available to them through our solutions, which would adversely affect the perceived usefulness of the Ariba Supplier Network.

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

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

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

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

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

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

Many of our current and potential competitors, such as enterprise resource planning software vendors including Oracle and SAP, have longer operating histories, significantly greater financial, technical, marketing and other resources, significantly greater name recognition and a larger installed base of customers than us. These vendors could also introduce spend management solutions that are included as part of broader enterprise application solutions at little or no cost. In addition, many of our competitors have well-established relationships with our current and potential customers and have extensive knowledge of our industry. In the past, we have lost potential customers to competitors for various reasons, including lower prices and incentives not matched by us. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address customer needs. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly increase their market share. We also expect that competition will increase as a result of industry consolidations. As a result, we may not be able to compete successfully against our current and future competitors.

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

We completed our merger with FreeMarkets on July 1, 2004, and we acquired Softface on April 15, 2004 and Alliente on January 13, 2004. Our acquisitions of Alliente, Softface and FreeMarkets are, and any future acquisitions will be, subject to a number of additional risks, including:

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.

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

The SEC Inquiry Regarding the Restatement of Certain of Our Financial Statements During Fiscal Year 2003 Could Seriously Harm Our Business.

In fiscal year 2003, the SEC commenced an informal inquiry regarding the circumstances leading up to the restatement in fiscal year 2003 of our consolidated financial statements for the fiscal years ended September 30, 2000 and 2001 and the quarters ended December 31, 1999 through June 30, 2002. 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 are subject to pending litigation that could seriously harm our business. See Note 4 of Notes to unaudited Consolidated Condensed Financial Statements.

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

We have recorded significant restructuring charges in the past relating to the abandonment of numerous leased facilities, including most notably our Sunnyvale, California headquarters. Moreover, we have from time to time revised our assumptions and expectations regarding lease abandonment costs, resulting in additional charges. In addition, we have assumed abandoned leases and related costs as part of our merger with FreeMarkets.

We review these estimates each reporting period, and to the extent that our assumptions change, the ultimate restructuring expenses for these abandoned facilities could vary significantly from current estimates. For example, a reduction in assumed market lease rates of $0.25 per square foot per month for the remaining term of the lease, with all other assumptions remaining the same, would increase the estimated lease abandonment loss on our Sunnyvale, California headquarters and our other principal office in Pittsburgh, Pennsylvania as of March 31, 2005 by $8.1 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 expect to take additional restructuring actions over the next few quarters that will result in additional restructuring charges in fiscal 2005.

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

On March 31, 2005 we had $576.8 million of goodwill on our consolidated balance sheet. We review goodwill for impairment annually and more frequently if events and circumstances indicate that the asset may be impaired and that the carrying value may not be recoverable. Factors we consider important that could trigger an impairment review include, but are not limited to, significant underperformance relative to historical or projected future operating results, significant changes in the manner of use of the acquired assets or the strategy for our overall business, significant negative industry or economic trends, a significant decline in our stock price for a sustained period, and decreases in our market capitalization below net assets for a sustained period. Our stock price is highly volatile and has experienced significant declines since January 2004. Although no goodwill impairment has been recorded for the three and six months ended March 31, 2005 and 2004, we have recorded significant impairment charges for goodwill and other intangible assets in the past and there can be no assurances that future goodwill impairments will not occur.

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:

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

In the past, securities class action litigation has often been brought against companies following periods of volatility in the market price of their securities. We have 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 twelve patents issued in the United States, but may not develop other proprietary products that are patentable. Despite our efforts, we may not be able to adequately protect our proprietary rights, and our competitors may independently develop similar technology, duplicate our products or design around any patents issued to us. This is particularly true because some foreign laws do not protect proprietary rights to the same extent as those of the United States and, in the case of the Ariba Supplier Network, because the validity, enforceability and type of protection of proprietary rights in Internet-related industries are uncertain and evolving.

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. For example, in the three months ended March 31, 2005 we paid $37.0 million to ePlus to settle a lawsuit alleging that three of our products, Ariba Buyer, Ariba Marketplace and Ariba Category Procurement, infringe patents held by a third party. It is possible that in the future other third parties may claim that we or our current or potential future products infringe their intellectual property rights. We expect that software product developers and providers of electronic commerce solutions will increasingly be subject to infringement claims, and third parties may claim that we or our current or potential future products infringe their intellectual property. Any claims, with or without merit, could be time-consuming, result in costly litigation, cause product shipment delays or require us to enter into royalty or licensing agreements. Royalty or licensing agreements, if required, may not be available on terms acceptable to us or at all, which could seriously harm our business.

We must now, and may in the future have to, license or otherwise obtain access to intellectual property of third parties. For example, we are currently dependent on developers’ licenses from enterprise resource planning, database, human resource and other 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. 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:

For international sales and expenditures denominated in foreign currencies, we are subject to risks associated with currency fluctuations. We hedge risks associated with foreign currency transactions in order to minimize the impact of changes in foreign currency exchange rates on earnings. We utilize forward contracts to hedge trade and intercompany receivables and payables. 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.

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

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

We develop products primarily in the United States of America and India and market our products in the United States of America, Latin America, Europe, Canada, Australia, Middle East and Asia. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. Since the majority of our non-U.S. sales are priced in currencies other than the U.S. dollar, a strengthening of the dollar may reduce the level of reported revenues. If any of the events described above were to occur, our net sales could be seriously impacted, since a growing portion of our net sales are derived from international operations. For the three months ended March 31, 2005 and 2004, 30% and 27%, respectively, and for the six months ended March 31, 2005 and 2004, 29% and 28%, 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 March 31, 2005 (in thousands):

The unrealized gain represents the difference between the contract value and the market value of the contract based on market rates as of March 31, 2005.

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 $425,000. 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.

In January 2005 and December 2004, we hedged the net assets of Ariba Korea and Nihon Ariba, respectively, using foreign currency forward contracts (Korean Won and Japanese Yen) to offset the translation and economic exposures related to our investments in these subsidiaries. The change in fair value of the forward contract attributable to the changes in forward exchange rates (the effective portion) is reported in stockholders’ equity to offset the translation results on the net investments. The Korean Won and Japanese Yen investment

hedges minimize currency risk arising from net assets held in Korean Won and Japanese Yen as a result of the Softbank settlement in October 2004. The notional amount of our investment hedges were 2.0 billion Korean Won ($2.0 million) and 3.0 billion Japanese Yen ($28.3 million) as of March 31, 2005. The unrealized net gain on the investment hedges reported in stockholders’ equity was $973,000 as of March 31, 2005.

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

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

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).

The table above does not include uninvested cash of $52.0 million held as of March 31, 2005, of which $42.0 million represents funds held by Nihon Ariba, our majority owned subsidiary in Japan. Total cash, cash equivalents, investments and restricted cash as of March 31, 2005 was $154.2 million.

We evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of March 31, 2005, the end of the period covered by this report on Form 10-Q. This evaluation (the “controls evaluation”) was done under the supervision and with the participation of management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”). Rules adopted by the SEC require that we disclose the conclusions of the CEO and the CFO about the effectiveness of our disclosure controls and procedures based upon the controls evaluation.

Disclosure controls and procedures means controls and other procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act, such as this report on Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in the

SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure 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 March 31, 2005 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 March 31, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. However, we recently relocated to our Pittsburgh office a number of functions and processes previously performed in our Sunnyvale office that are part of our internal control over financial reporting, and there can be no assurance that this relocation will not adversely 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.

The litigation discussion set forth in Note 4 of Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q is incorporated herein by reference.

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)


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


		Page No.
PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements (unaudited)	3

	Condensed Consolidated Balance Sheets as of March 31, 2005 and September 30, 2004	3

	Condensed Consolidated Statements of Operations for the three and six months ended March 31, 2005 and 2004	4

	Condensed Consolidated Statements of Cash Flows for the six months ended March 31, 2005 and 2004	5

	Notes to Condensed Consolidated Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	25

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	47

Item 4.	Controls and Procedures	48

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings	50

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	50

Item 3.	Defaults Upon Senior Securities	50

Item 4.	Submission of Matters to a Vote of Security Holders	50

Item 5.	Other Information	50

Item 6.	Exhibits	50

	SIGNATURES	51


	March 31, 2005			September 30, 2004
*ASSETS*
Current assets:
Cash and cash equivalents	$	67,338		$	74,031
Short-term investments		31,306			37,227
Restricted cash		1,996			45,623
Accounts receivable, net of allowance for doubtful accounts of $3,341 and $3,933 as of March 31, 2005 and September 30, 2004, respectively		45,262			48,071
Prepaid expenses and other current assets		11,337			10,795

Total current assets		157,239			215,747

Property and equipment, net		20,744			21,909
Long-term investments		21,938			29,676
Restricted cash, less current portion		31,580			26,862
Goodwill		576,817			574,679
Other intangible assets, net		51,482			62,249
Other assets		2,787			2,767

Total assets	$	862,587		$	933,889

*LIABILITIES AND STOCKHOLDERS’ EQUITY*
Current liabilities:
Accounts payable	$	15,116		$	15,433
Accrued compensation and related liabilities		26,709			31,171
Accrued liabilities		25,468			69,570
Restructuring obligations		17,042			16,825
Deferred revenue		40,997			49,664
Deferred income—Softbank		13,403			—

Total current liabilities		138,735			182,663
Deferred rent obligations		22,049			21,406
Restructuring obligations, less current portion		43,393			41,042
Deferred revenue, less current portion		23,522			22,858
Deferred income—Softbank, less current portion		20,664			—

Total liabilities		248,363			267,969

Minority interests		141			19,547

Commitments and contingencies (Note 4)

Stockholders’ equity:
Common stock		132			125
Additional paid-in capital		4,993,902			4,963,002
Deferred stock-based compensation		(19,182	)		(5,959	)
Accumulated other comprehensive income		5,303			1,634
Accumulated deficit		(4,366,072	)		(4,312,429	)

Total stockholders’ equity		614,083			646,373

Total liabilities and stockholders’ equity	$	862,587		$	933,889


	Three Months Ended March 31,						Six Months Ended March 31,
	2005			2004			2005			2004
Revenues:
License	$	12,615		$	15,940		$	29,737		$	32,742
License—Softbank (Note 9)		—			—			—			1,874
Subscription and maintenance		30,969			21,121			61,472			42,165
Subscription and maintenance—Softbank (Note 9)		255			408			1,180			1,431
Services and other		37,429			18,539			75,808			30,527

Total revenues		81,268			56,008			168,197			108,739

Cost of revenues:
License		1,054			217			1,748			1,584
Subscription and maintenance		7,116			5,396			14,352			10,780
Services and other		31,617			15,632			61,385			25,793
Amortization of acquired technology and customer intangible assets		5,281			—			9,981			—

Total cost of revenues		45,068			21,245			87,466			38,157

Gross profit		36,200			34,763			80,731			70,582

Operating expenses:
Sales and marketing		19,349			20,353			44,022			33,908
Research and development		12,260			12,784			24,662			25,061
General and administrative		7,918			4,921			16,532			9,464
Other income—Softbank		(2,795	)		—			(2,795	)		—
Amortization of other intangible assets		213			76			398			76
Stock-based compensation(1)		4,278			838			8,656			868
Restructuring and integration		2,282			(1,917	)		4,099			(1,917	)
Litigation provision		—			—			37,000			—

Total operating expenses		43,505			37,055			132,574			67,460

(Loss) income from operations		(7,305	)		(2,292	)		(51,843	)		3,122
Interest and other income, net		640			953			3,255			1,771

Net (loss) income before income taxes and minority interests		(6,665	)		(1,339	)		(48,588	)		4,893
Provision (benefit) for income taxes		224			(255	)		5,037			(527	)
Minority interests in net income (loss) of consolidated subsidiaries		2			(253	)		18			160

Net (loss) income	$	(6,891	)	$	(831	)	$	(53,643	)	$	5,260

Net (loss) income per share—basic	$	(0.11	)	$	(0.02	)	$	(0.85	)	$	0.12

Net (loss) income per share—diluted	$	(0.11	)	$	(0.02	)	$	(0.85	)	$	0.11

Weighted average shares—basic		63,518			45,313			63,113			45,156

Weighted average shares—diluted		63,518			45,313			63,113			46,409


	Three Months Ended March 31,				Six Months Ended March 31,
	2005		2004		2005		2004
Cost of revenues	$	1,360	$	115	$	2,513	$	154
Sales and marketing		1,731		619		3,844		599
Research and development		475		28		920		29
General and administrative		712		76		1,379		86

Total	$	4,278	$	838	$	8,656	$	868


	Six Months Ended March 31,
	2005			2004
Operating activities:
Net (loss) income	$	(53,643	)	$	5,260
Adjustments to reconcile net (loss) income to net cash from operating activities:
Provisions for (recovery of) doubtful accounts		1,612			(190	)
Depreciation		4,724			3,434
Amortization of intangible assets		10,965			76
Stock-based compensation		8,656			868
Minority interests in net income of consolidated subsidiaries		18			160
Changes in operating assets and liabilities, net of effects of acquisitions:
Accounts receivable		1,171			(3,027	)
Prepaid expenses and other assets		459			(1,979	)
Accounts payable		(317	)		1,219
Accrued compensation and related liabilities		(4,855	)		(5,376	)
Accrued liabilities		(43,661	)		39,837
Restructuring obligations		1,383			(9,029	)
Deferred revenue		(5,945	)		(18,967	)
Deferred income—Softbank		17,115			—

Net cash from operating activities		(62,318	)		12,286

Investing activities:
Purchases of property and equipment		(3,603	)		(1,260	)
Sales of investments, net of purchases		13,336			17,365
Business combinations, net of cash acquired		—			(8,251	)
Acquisition of minority interest		(4,235	)		—
Allocation from (to) restricted cash, net		38,909			(32,912	)

Net cash from investing activities		44,407			(25,058	)

Financing activities:
Proceeds from issuance of common stock		9,028			4,756

Net cash from financing activities		9,028			4,756

Effect of foreign exchange rate changes on cash and cash equivalents		2,190			2,317

Net change in cash and cash equivalents		(6,693	)		(5,699	)
Cash and cash equivalents at beginning of period		74,031			70,819

Cash and cash equivalents at end of period	$	67,338		$	65,120


	Three Months Ended March 31, 2004						Six Months Ended March 31, 2004
	As Previously Reported			As Reclassified			As Previously Reported			As Reclassified
Cost of revenues	$	16,249		$	21,245		$	29,177		$	38,157
Sales and marketing	$	25,289		$	20,353		$	42,828		$	33,908
Research and development	$	12,844		$	12,784		$	25,121		$	25,061
General and administrative	$	5,401		$	4,921		$	9,944		$	9,464
Restructuring and integration	$	(2,397	)	$	(1,917	)	$	(2,397	)	$	(1,917	)


	Three Months Ended March 31, 2004			Six Months Ended March 31, 2004
Total net revenues	$	86,005		$	172,277
Net loss	$	(13,929	)	$	(16,416	)
Net loss per share—basic and diluted	$	(0.22	)	$	(0.26	)
Weighted average shares—basic and diluted		62,108			61,952


Identified Intangible Assets	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount		Statements of Operations Classification
Existing software technology (18 months)	$	10,400	$	(4,315	)	$	6,085	Cost of revenue
Order backlog (6 months)		100		(100	)		—	Operating expense
Visteon contract and related customer relationship (4 years)		3,206		(601	)		2,605	Cost of revenue
Excess fair value of Visteon in-place contract over current fair value (10 months)		1,894		(1,700	)		194	Revenue and cost of revenue
Other contracts and related customer relationships (3-4 years)		51,081		(10,019	)		41,062	Cost of revenue and operating expense
Trademarks (5 years)		1,800		(264	)		1,536	Operating expense

	$	68,481	$	(16,999	)	$	51,482


Period Ending September 30,	Lease Payments		Contractual Sublease Income
2005	$	24,584	$	9,177
2006		48,202		18,707
2007		43,703		14,676
2008		44,043		4,755
2009		44,999		—
Thereafter		145,502		—

Total	$	351,033	$	47,315


	Severance and benefits			Lease abandonment costs			Leasehold impairments			Other integration costs			Total restructuring and integration costs
Accrued restructuring obligations as of September 30, 2003	$	67		$	47,809		$	—		$	—		$	47,876
Cash paid		(5,153	)		(11,696	)		—			(2,560	)		(19,409	)
Total charge to operating expense		3,402			7,710			2,885			2,806			16,803
Asset impairment applied to asset balances		—			—			(2,885	)		—			(2,885	)
Restructuring obligation assumed under purchase acquisition		4,813			10,669			—			—			15,482

Accrued restructuring obligations as of September 30, 2004		3,129			54,492			—			246			57,867
Cash paid		(3,801	)		(10,128	)		—			(1,181	)		(15,110	)
Total charge to operating expense		1,578			1,593			—			935			4,106
Purchase accounting adjustment		—			1,185			—			—			1,185
Sublease early payment from tenant		—			12,387			—			—			12,387

Accrued restructuring obligations as of March 31, 2005	$	906		$	59,529		$	—		$	—			60,435

Less: current portion														17,042

Accrued restructuring obligations, less current portion													$	43,393


	Six Months Ended March 31, 2005
	Number of Options		Weighted-Average Exercise Price
Outstanding at beginning of period	13,103,476		$	20.03
Granted	1,241,531		$	10.72
Exercised	(952,332	)	$	5.57
Forfeited	(1,634,767	)	$	24.84

Outstanding at end of period	11,757,908		$	19.59

Exercisable at end of period	6,909,065		$	23.03


	Options Outstanding				Options Exercisable
Range of Exercise Prices	Number of Options	Weighted- Average Remaining Contractual Life (years)	Weighted- Average Exercise Price		Number of Options	Weighted- Average Exercise Price
$ 0.01—$ 10.43	2,638,151	7.48	$	7.68	942,665	$	4.90
$10.44—$ 16.62	3,458,265	8.23	$	13.73	1,440,492	$	14.34
$16.63—$ 20.52	2,600,521	7.33	$	18.37	1,918,613	$	18.13
$20.53—$ 28.88	2,496,176	6.36	$	25.54	2,152,078	$	25.86
$28.88—$733.50	564,795	5.60	$	90.51	455,217	$	95.30

$ 0.01—$733.50	11,757,908	7.34	$	19.59	6,909,065	$	23.03


	March 31, 2005			September 30, 2004
Unrealized loss on securities	$	(682	)	$	(359	)
Foreign currency translation adjustments		5,012			1,993
Net investment hedge gains		973			—

Accumulated other comprehensive income	$	5,303		$	1,634


	March 31, 2005		December 31, 2004
Long-Lived Assets:
United States	$	20,080	$	20,578
International		2,854		3,501

Total	$	22,934	$	24,079


	Buy/Sell	Contract Value			Unrealized Gain in USD
	Buy/Sell	Foreign Currency	USD		Unrealized Gain in USD
*Foreign Currency*
Brazilian Real	Buy	500	$	173	$	13
Euro	Sell	3,000		4,005		113

Total			$	4,178	$	126


	Year Ending March 31, 2006			Year Ending March 31, 2007			Year Ending March 31, 2008			Year Ending March 31, 2009		Year Ending March 31, 2010		Thereafter		Total
Cash equivalents	$	15,446		$	—		$	—		$	—	$	—	$	—	$	15,446
Average interest rate		2.66	%		—			—			—		—		—		2.66	%
Investments	$	32,176		$	18,443		$	36,182			—		—		—	$	86,801
Average interest rate		1.84	%		2.53	%		2.20	%		—		—		—		2.14	%

Total investment securities	$	47,622		$	18,443		$	36,182		$	—	$	—	$	—	$	102,247



10.1		Settlement and License Agreement, dated February 12, 2005, by and between ePlus, Inc. and the Registrant.

10.2		Ariba Bonus Plan, North America, as adopted by the Compensation Committee of the Registrant.

10.3		Notice of Stock Option Grant and Stock Option Agreement under the Ariba, Inc. 1999 Directors’ Stock Option Plan, as granted by the Registrant to Robert Johnson on January 24, 2005.

10.4		Notice of Stock Option Grant and Stock Option Agreement under the Ariba, Inc. 1999 Equity Incentive Plan, as granted by the Registrant to Robert Johnson on January 24, 2005.

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.


Exhibit No.		Exhibit Title

10.1		Settlement and License Agreement, dated February 12, 2005, by and between ePlus, Inc. and the Registrant.

10.2		Ariba Bonus Plan, North America, as adopted by the Compensation Committee of the Registrant.

10.3		Notice of Stock Option Grant and Stock Option Agreement under the Ariba, Inc. 1999 Directors’ Stock option Plan, as granted by the Registrant to Robert Johnson on January 24, 2005.

10.4		Notice of Stock Option Grant and Stock Option Agreement under the Ariba, Inc. 1999 Equity Incentive Plan, as granted by the Registrant to Robert Johnson on January 24, 2005.

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.