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PROS Holdings Inc. (NYSE:PRO)

Q3 2008 Earnings Call

November 6, 2008 5:00 pm ET

Executives

Bert Winemiller - Chairman and Chief Executive Officer

Charlie Murphy - Chief Financial Officer

Analysts

Thomas Ernst - Deutsche Bank

Aaron Schwartz - J.P. Morgan

Gordon Hodge - Thomas Weisel Partners

Richard Davis - Needham & Company

Nabil Elsheshai - Pacific Crest Securities

Ross MacMillan - Jefferies

Operator

Good day ladies and gentlemen and welcome to the quarter three 2008 PROS Holdings Inc. earnings conference call. My name is Nora and I’ll be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions)

I would now like to turn the presentation over to your host for today’s call, Mr. Charlie Murphy, Chief Financial Officer; please proceed sir.

Charlie Murphy

Thank you very much. Good afternoon everyone and thank you for joining us today for PROS Holdings financial results conference call for the third quarter of 2008. I’m Charlie Murphy, the company’s Chief Financial Officer. Joining me on today’s call is Bert Winemiller, PROS Chairman and Chief Executive Officer.

On today’s conference call, Bert will provide a commentary on the highlights for the third quarter ended September 30, 2008 and then, I will provide the review of the financial results and our outlook before we open up the call to questions.

Before beginning, we must caution you that today’s remarks and this discussion, including statements made during the question-and-answer session contain forward-looking statements. These statements are subject to numerous important factors, risks and uncertainties, which could cause actual results to differ from the results implied by these or other forward-looking statements.

Also these statements are based solely on the present information and are subject to risks and uncertainties that can cause actual results to differ materially from those projected in the forward-looking statements. Please refer to our prospectus, the Form 10-K and other filings with the SEC for the risk factors contained herein and other disclosures.

Also, please note that a replay of today’s webcast will be available in the Investor Relations section of our website. I would also like to point out that the company’s use of non-GAAP financial measures is explained in today’s earnings press release and a full reconciliation between each non-GAAP measure and the corresponding GAAP measure is provided in the tables accompanying the press release filed earlier today and also can be found on our website in the Investor Relations section.

With that, I’d like to turn the call over to Bert.

Bert Winemiller

Thank you Charlie and thanks to those of you listening to our call this afternoon. We are pleased that we have met the high-end of our revenue target and exceeded our earnings per share target in the third quarter of 2008 and we believe that it was a solid performance given the current challenging economic environment.

These results are a validation of PROS proven business model of delivering high return on investment, pricing and margin optimization software products to our customers and our high-visibility revenue model. Our third quarter results reaffirm the value of PROS pricing and margin optimization software as a strategic innovation and a risk mitigation initiative when companies face uncertain, unpredictable demand and volatile cost. PROS proven track record, proven processes and proven solutions are the keys to our success and drive our high level of customer satisfaction.

PROS reported third quarter revenue of $19.3 million at the high-end of our guided range and a 17% increase from the third quarter of 2007. Non-GAAP operating income of $4.4 million was up 35% demonstrating the leverage in our model. Non-GAAP earnings came in at $3 million or $0.12 per share.

We continue to execute our growth strategy and enhance our market leading position of experience and expertise in developing high performance, real-time, dynamic pricing technology, embedding world-leading science in our software products and providing a high return on investment to our customers, by implementing pricing excellence best practices and PROS pricing and margin optimization software.

It’s important to recognize that the pricing optimization industry where we hold a leadership position is still in its early stage. PROS, is in the center of this shift to science-based pricing from spreadsheets and the current destructive pricing practices. We are confident that the return on investment benefits received by implementing our technology are just as important in a down-market, a challenging market, as they are in a up positive market.

CEOs and CFOs are realizing the traditional pricing strategy such as cost-plus and match the competition, cause unnecessary discounting and destructive pricing practices and are especially harmful in a challenging economy.

The natural reaction in a downturn is to retreat, cancel all new initiatives, pullback to the basics, tighten the shift, some companies even accelerate unnecessary deep discounting, but companies that focus on margin optimization during a challenging economic environment will be in a better position to remain profitable industry leaders.

In a tough economy with uncertain demand and volatile cost CFOs chose PROS to help them whether the challenge and emerge stronger. We believe that PROS is the best and safest choice for pricing and margin optimization software.

During our second quarter conference call, we believed it was prudent to lower our guidance for 2008 bookings to $46 million to $51 million; the current uncertain economic conditions make forecasting more challenging, but as of today we are reaffirming our annual bookings guidance for 2008.

We’re very pleased that we hosted our First European Pricing Form in Germany in September and it was a resounding success. We had nearly 110 days from 15 different counties participating in over 25 sessions. Some of the topics included building pricing capabilities in a global organization, value pricing and economic downturns, customers and prospects from each of our five target vertical markets were in attendance, fee notes and presentations were made by pricing practitioners, as well as industry pricing experts.

We believe the strong attendance of the European Pricing Form demonstrates that regardless of what’s happening in the global economy executives at innovative companies worldwide are recognizing the increasing value of pricing science and are looking for software-based pricing solutions to improve their bottom line.

PROS scientific analytics price optimizer and deal optimizer products were highlighted by the European Form. These high performance real-time, dynamic pricing products, deliver all of the relevant pricing information that is salesperson needs to effectively negotiate a transaction at the time the price is quoted and the sales transaction is actually made. Now, that’s very different from static retail pricing.

PROS provides pocket price, pocket margins, customer willingness to pay, customer cost to serve, win/loss ratios, market price, stretch price and all the relevant information, so that our customers can maximize margins and profitability by using optimize prices that reduced profit leaks. PROS software products optimally and dynamically price millions of individual transactions every day.

Our strategy continues to be to further penetrate our five vertical markets, continue to sell additional products to existing customers, and extent our pricing thought leadership and technology leadership through the incorporation of science and technology innovations into our products. In the third quarter, we continue to make headway in each of these areas.

Year-to-date we have achieved record revenue that is diversified across our five target vertical markets; our revenue is also diversified geographically and between B2B and B2C pricing solutions. In the third quarter, 56% of our revenue came from outside the United States. We believe PROS diversification in multiple dimensions is particularly valuable in a challenging economy.

During the third quarter, we made two significant announcements Mrs. Ellen Keszler has joined our Board of Directors and will also service a member of the Audit Committee, as well as the Nominating Governance Committee, with the addition of our newest Director of PROS Board has been expanded to eight directors, five of whom are independent.

Ellen’s leadership experience as a technology company executive and her wealth of financial experience will add significant value to the PROS Board of Directors and to our shareholders and her role as an independent director. Additionally, in late August we announced that the PROS Board of Directors had authorized a stock repurchase program for up to $15 million of PROS common stock.

The decision to implement a stock repurchase program reflects the confidence of both our Board of Directors of management in the company’s value proposition and we believe that the purchase of our own shares as a solid investment will add to long-term shareholder value.

EBIT during this time of economic uncertainty and a challenging business environment, the power of pricing continues to gain visibility in the press and with industry analyst reports. Our awareness activity metrics continue to be very healthy and we remained optimistic about the long-term demand for pricing the margin optimization solutions.

More CEOs and CFOs are recognizing that pricing is one of the most powerful tools available to them and they are recognizing the strategic importance of science based pricing to margin optimization in a challenging economy. We feel good about our future prospects and are confident we can capitalize on the future market opportunity.

Despite the current uncertain economic conditions, we are pleased with our third quarter results. This achievement is the result of the hard work of over 350 employees at PROS who are smart, dedicated people, doing great things to bring pricing excellence and pricing and margin optimization capabilities through our high-value software products to our customers.

I’ll now turn the call over to Charlie, so he can provide you with the financial details and our outlook for the fourth quarter and the year.

Charlie Murphy

Thank you, Bert. PROS had a solid third quarter. Revenue for the third quarter of 2008 came in at $19.3 million, up 17% from third quarter of 2007 and at the high-end of our guided range.

As previously communicated, in accordance with our revenue recognition policy, PROS does not recognize any revenue or contract signing. License and implementation fees are bundled together and revenue is recognized on a percentage of completion based as over the implementation period. This provides visibility into future quarters’ revenue.

There can variability in revenue from quarter-to-quarter not as result to seasonality, but rather the timing of when an implementation starts or finishes, the implementation effort required, the number of products being deployed and the contract size. Consistent with our historical experience, we believe we continue to have approximately 90% of revenue visibility going into a quarter.

Within revenue, license and implementation revenue was $13.7 million in the third quarter or 71% of total revenue. This was an increase of 18% over the third quarter of 2007. Maintenance and support revenue, which makes up the balance of revenue, was $5.6 million in the third quarter and was up 17% over the third quarter of 2007, although strength of PROS is that our revenue is diversified geographically, across our five target vertical markets, and between B2B and B2C customers.

For the third quarter of 2008, our GAAP gross profit was $14.4 million up 22% and operating income was $3.4 million up 19% compared to a GAAP gross profit of $11.8 million and operating income of $2.9 million for the third quarter 2007. GAAP net income was $2.4 million or $0.09 per diluted share in the third quarter at a tax rate of 35% compared to $3.5 million or $0.13 per diluted share in the third quarter of 2007 at a negative tax rate of 19%.

2007 tax rate reflects the benefits from research and experimentation tax credits, research and experimentation tax credit carry forwards that were fully utilized in Q3 2007 and the reversal of the valuation allowance against deferred tax assets. Now that explains the 19% negative tax rate in 2007.

Our earnings press release issued today, includes a full GAAP to non-GAAP reconciliation and can be found in the Investor Relations section of our website. The following comments on our statements of operations refer to results on a non-GAAP basis.

Gross profit was $14.6 million in the third quarter, resulting in gross margins of 75.5% compared to gross margins of 72.2% in the third quarter of 2007. We are pleased with the improvements in our gross margins on a year-over-year basis. Our gross margins benefited from the continuation of improvements in our implementation processes, the continued standardization of our products and the amount of implementation services required to deploy our products relative to the contract price and the current mix of business.

We can’t be certain that previously mentioned factors, which have contributed to historical gross margin growth, will continue. We are please with the improvements in gross margins, despite a foreign exchange loss of approximately $300,000 in the quarter that reduced gross margins by 1.5%.

Selling, general and administrative expenses in the third quarter were $5.2 million or a 27% of revenue, an increase of 19% from the third quarter of 2007. The year-over-year increase is primarily attributable to an increase in sales and marketing personnel and an increase in the provision for doubtful accounts. We expect SG&A cost will continue to increase due to our continued investment in sales and marketing activities in order to capitalize on future market opportunities.

R&D expenses in the third quarter were $4.9 million or a 25% of revenue, and increased 16% in the third quarter of 2007, as we continue to make investments in our suite of pricing and margin optimization software products. Non-GAAP operating income in the third quarter was $4.4 million and increase of 35% for the same period from a year ago and exceeded our guidance.

Operating income exceeded the high end of our guidance as a result the continuation of good gross margins and lower than expected operating expenses. Operating margins in the third quarter increased to 23% compared to 20% in the third quarter of 2007. Other income was approximately $261,000 in the quarter, compared to $492,000 in the third quarter of 2007. The decrease was attributable to a reduction in interest rates.

As we discussed on our second quarter earnings call, Congress recessed the 2007 without extending the research and experimentation tax credit. Our effective tax rate historically has been lower than the federal statutory rate of 35% largely due to the application of research and experimentation tax credits; however, we are pleased to inform you that in October, the credit was renewed retroactive to January 1, 2008 and continues through the year ended December 31, 2009, but this is consistent with the past historical experience regarding this credit.

Under GAAP, the cumulative effect of the reduction in the company’s federal tax rate for 2008 will be recorded in the fourth quarter. As such, the GAAP effective tax rate for the third quarter of 35% does not reflect the benefit of the research and experimentation credit. Since the credit was passed, we believe our non-GAAP effective tax rate with the federal state and foreign income taxes will be approximately 29% for the fourth quarter and full-year of 2008.

For our previous non-GAAP EPS guidance, we have been assuming that research and experimentation tax credit would be passed and we have been using the lower tax rate. Non-GAAP net income for the third quarter of 2008 was $3 million or $0.12 per diluted share, using a 35% tax rate exceeding guidance.

In the prior year quarter, non-GAAP net income was $3 million or $0.11 per diluted share using a 20% tax rate. The 2007 tax rate reflected benefits from our research and experimentation credits and the research and experimentation tax credit carry forwards, that were completely utilized in the third quarter of last year. Diluted share were approximately $26.3 million for the third quarter of 2007 and 2008.

Moving to our balance sheet, we entered the quarter with cash and equivalents of $48.1 million, a decrease of approximately $800,000 from the second quarter. The decrease is primarily attributable to shares repurchased in the third quarter. In Q3 we repurchased 286,000 shares and it cost us $2.7 million. As of September 30, $12.3 million remained in our repurchase authorization.

Net accounts receivable at the end of the quarter were $21.8 million, an increase of approximately $4.9 million from the second quarter of 2008. Trade accounts receivable day’s sale outstanding is 72 days, compared with our 2007 full-year day’s sales outstanding of 71 days. Additionally, we have had very good cash collection subsequent to September 30, 2008. As we have stated in the past, accounts receivable balances can vary in a quarter, based on the timing of invoicing contractual milestones, which will vary from quarter-to-quarter.

Total deferred revenue at the end of the third quarter was $23.5 million, an increase of approximately $2.3 million from June 30, 2008. As with accounts receivable and cash flows, deferred revenue will fluctuate quarter to quarter, depending on the timing of contractual milestone billings. Deferred revenue balances do not correlate to total contract value and therefore we do not believe it is a meaningful forward indicator.

Turning to cash flows; our operating cash flow for the three months ended September 30 was $2.3 million. As with receivables, there is quarter-to-quarter variability in operating cash flow due to the variability in invoicing and subsequent collection of contractual milestones and payments by various expense accruals. Had the research and experimentation credit didn’t affect all year, it would have been an approximately $800,000 increase in our year-to-date operating cash flows.

Capital expenditures for the quarter were approximately $300,000 and we expect total capital expenditures for the year to be approximately $1.5 million. Overall, headcount at the end of the quarter was $384 personnel, compared to $342 million at the beginning of the year.

Now, let me turn to our guidance for the fourth quarter of 2008 and full-year. For the fourth quarter PROS anticipates total revenue in the range of $19.6 million to $20.6 million, representing a growth rate of 13% over 2007 at the midpoint of our guidance. We are projecting non-GAAP operating income of $4.1 million to $4.5 million.

Also, we are anticipating non-GAAP net income of $3 million to $3.3 million and non-GAAP earnings per diluted share of $0.11 to $0.12 based on estimated fully diluted share count of $26.5 million shares and using an effective federal state and foreign tax rate of 29%. This 29% reflects the benefit of the research and experimentation credits. Non-GAAP operating income for the fourth quarter excludes FAS 123R stock option expense of approximately $1.1 million.

While the current economic conditions make forecasting more challenging, we are reaffirming our previous guidance for the full-year and we expect total revenue in the range of $75.5 million to $76.5 million or a growth rate at the midpoint of our guidance of 22% over the prior year. We also are reaffirming our previous guidance for bookings and our full-year booking guidance is $46 million to $51 million. As always, our booking forecast is exclusive of maintenance and support that commences at the time the implementation is completed.

For the full-year 2008, we are projecting non-GAAP operating income of $17.2 million to $17.6 million, which represents a 38% increase over 2007 at the midpoint of our guidance. We are projecting non-GAAP net income of $13 million to $13.3 million and non-GAAP earnings per diluted share guidance of $0.49 to $0.50. This is an increase in our previous guidance of $0.45 to $0.47 for the year.

Diluted shares outstanding at the end of the year are estimated at $26.5 million and the estimated effective tax rate use is the 29%. The 2007 non-GAAP earnings per diluted share were $0.46 and would have been $0.41 using the estimated 2008 post-IPO weighted average shares outstanding.

Non-GAAP operating income and net income for 2008 excludes estimated FAS 123R stock option expense of approximately $4 million. On a GAAP basis we expect our effective tax rate to be approximately 13% for the fourth quarter, obviously reflected in the cumulative adjustment of the research and experimentation credits for the year and 29% for the full-year, after giving effect to the R&D credit being recorded in fourth quarter.

Historically, revenue growth for PROS has not been solely impacted by current year bookings. Revenue growth is also impacted by four areas; (1) the duration of implementations, particularly those that exceed one year; (2) growth and maintenance revenue resulting from completed implementations; (3) enhancement efficiencies and implementation processes and (4) cost of living increase to maintenance services. I will elaborate on these points.

First, implementation durations; as I have mentioned PROS does not recognize any revenue or contract signing and many contracts have extended implementation durations, in some cases greater than one year. For example, there are pre-2008 bookings that will generate license and implementation revenue in 2009.

Second, maintenance growth; increase in future maintenance revenues coming from completing end process implementations. For example, maintenance growth was 13% for the first nine months of 2007 compared with the first nine months of 2006 and it was 16% for the first nine months of 2008 compared to the first nine months of 2007. As implementations are completed we expect maintenance revenue to continue to increase.

Third, implementation efficiencies; percentage of revenue recognized from bookings in the year has been increasing as a result of greater implementation efficiencies. This has resulted in an acceleration of the percentage of revenue recognized from contracts booked in the same year.

Last, annual maintenance cost of living increases; generally there was a provision in our contracts to increase maintenance fees annually. This increases maintenance revenue each year.

It is the layering effect of bookings for more than one year and maintenance growth that has given PROS its high visibility revenue model. As a result of these factors and the growing awareness of the need for pricing technology in current activity levels, we remain confident that PROS has an attractive long-term opportunity.

There was tightened uncertainty regarding future expectations given the current economic environment. The company has been in business for over 20 years. The PROS management team has experienced challenging periods in the past and the company remained profitable and achieved positive cash flow during those periods. While there are no assurances that past performance can be continued, our experienced management team, the financial strength of the company and its high visibility revenue model is particularly helpful during such periods.

With that, let me turn the call back to the operator, so that we can take your questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Thomas Ernst - Deutsche Bank.

Thomas Ernst - Deutsche Bank

First question, I guess the gross margin performance, especially in light of an FX hit, is surprising and that it continues to be strong and expanding, what is driving this? Is there a mix issue that you’re getting more licensed consistent with time? What’s happening to service margins within that blended revenue item you report?

Charlie Murphy

Yes, Tom this is Charlie. We don’t get into and of course in our guidance we don’t get into that level of detail, but let me give you some color on this. Clearly, we benefit from increasing maintenance and maintenance carries the higher gross margin component between license implementation and maintenance is higher and I think generally the mix between license implementation really hasn’t changed very much.

I think we’re really confound to is that the company’s were able to maintain a prudent cost structure as we’re gone into this period of Q3 and as we go into Q4. Obviously historically we had good margin improvements as well, but I think it’s a combination of that margin improvement on maintenance; the prudence, I think we’ve demonstrated coming into the third quarter and going forward and again the growth in overall revenue. I think we’ve tried to do a good job of keeping our overall cost under control.

Thomas Ernst - Deutsche Bank

What’s happening to your implementation and consulting services margins? I know you don’t disclose them, but is there an expanding trend there?

Charlie Murphy

What I would say is that, it’s really difficult to carve out all of those components internally, but we do believe that overall since I made a comment that the implementation timelines are coming down, because it’s becoming increasingly more efficient to deploy our products, that has two benefits. One, it allows to get more revenue from a contract earlier and if you could do that then obviously there’s some benefit to the margins as well.

Thomas Ernst - Deutsche Bank

Okay and perhaps expanding on this. You mentioned one of this, I think it was the third of your four areas that explain why revenue growth in difference from the bookings from the enhancement of implementation efficiencies. How are you able to do this and I guess that the primary thing I’m interested in first is this something that’s driven by customer demand; in other words, is this something that might reverse itself in a weak macro were the customers want to implement much slower or is this something you’ve been driving clearly to your own implementation methodologies?

Bert Winemiller

Yes, Tom this is Bert. Our own implementation methodologies have become more and more efficient over the last two years and when we are in the road show with the IPO, we said that we will continue to invest not only on the integration of science into our products and the pricing functionality, but also in the ability to get time to value quicker for our customers.

Now, the time to value faster is partly a result of some of the capabilities we built into our software to implement, configure more efficiently, more effective in a shorter period of time than we were able to do previously. So, those implementation efficiencies have had a very positive impact on our gross margins and we’re going to continue.

We’re an R&D company, we’re a technology company, we’re a science company, but we’re not investing in R&D in just one area; we’re investing in R&D in all of these areas and we also recognize that customers are under incredible pressure and its uncertain economic environment and they want results fast.

So, we have implemented some advanced capabilities to configure our software in a much shorter period of time, than we were doing even six or 12 months ago and now we actually have some implementations where the first identification of price-based profit leaks are actually taking place in an actionable form within 30 days. So, there is a benefit and time-to-value, but there’s also a benefit in implementation efficiencies.

Thomas Ernst - Deutsche Bank

I guess one more to prove that further; is the improvement primarily system and technology driven or is this training and people cumulative experience driven and I’m trying to get of how sticky you feel with those improvements in implementation efficiency are; even if perhaps people leave or if these are things you can extent further with technology.

Bert Winemiller

It’s all of the above; it’s all of the above. If your software is easier to implement, it’s easier to get value quicker, then it’s easier to trying to get users up to speed. If it’s easier for PROS professional services to implement our real-time integrated science capabilities with advance science segmentation, the advanced price optimization guidance that we provide, all of those things comes together. So, it’s not one thing, it’s the total package that’s driving time-to-value with quicker implementation as more efficient.

Thomas Ernst - Deutsche Bank

Okay, if you permit, I’ll ask one more question in a different direction and then I’ll let others go. What is your expansion plans today? You mentioned the headcount 384, but are you hiring in this environment and the flipside of that question is, how quickly do you think you can control costs if demand slows even further than you think it might?

Bert Winemiller

Okay, Tom good questions. Are we hiring? Yes, we’ve continued some headcount of growth as we go into the fourth quarter of this year. The growth for the first nine months of the year, you’ve got these numbers in different leases; it’s approximately 12% headcount growth for the year.

Going into the fourth quarter that’s slowing down, we’re not going to maintain that level of headcount growth going into the fourth quarter. We want to be prudent as we move to the end of the year; that’s the headcount growth piece of it. What was the second part of your question again?

Charlie Murphy

It’s our ability to manage…

Bert Winemiller

Our ability to manage, yes okay Tom. This gets back to the high visibility revenue model and of course as you know we’ve got 40 to 50 implementations going on at anyone particular point in time. All of those implementations are reviewed every month by our accounting group, along with the professional services team and we monitor each of these projects very, very carefully. So, if we see these projects for any reason slowing down and we haven’t yet, that would show up obviously in our revenue reorganization; we have that visibility and we’ll be able to act accordingly.

Operator

Your next question comes from Aaron Schwartz - J.P. Morgan.

Aaron Schwartz - J.P. Morgan

I just had a sort of high level question, but when you’re out talking to customers, I assume those customers right now are very focused on the expense side and remove the cost from their model and I’m just wondering if you have to make a change in your marketing to really take the eyes, move them from expenses to the pricing or revenue line or if you’ve taken a change in strategy about doing that?

Bert Winemiller

Aaron, that’s a great question. What we would say to you is, there is more emphasis on margin optimization and cost of capital and cash ramification of deals than there might have been, say two years ago. So, when you think about pricing, you don’t think about it as just the list price, but you think about all of the components and the price waterfall, all down to pocket margin.

What we’re seeing is, CFOs in particular, where they’re face with this uncertain demand, non-forecastable demand, volatile costs; what they’re really looking for is advanced science based pricing optimization or margin optimization from PROS that will allowed them without wholesale changes in their pricing processes, to implement the proper price in order to optimize margin, but absolutely the focuses on margin taken into account volatility of cost and the cost of capital and cash flow are much more sensitive in terms of the criteria that CFOs are looking at vis-à-vis, what was going on two years ago.

Aaron Schwartz - J.P. Morgan

Okay, and if we look at the verticals that you’re exposed to, certainly some are probably in a little better health than others and I’m just wondering sort of, if you look at sort of repositioning some of your sales and marketing folks on the verticals that are little healthier; one, if that is going on, sort of how quickly can you do that; just to sort of optimize the yield that you have out of your spend?

Charlie Murphy

Aaron, that’s a great question. I think that’s answered better in terms of where we are in the lifecycle of the category. I mean we’re still dealing with innovators; we’re still dealing with the first movers, where that the CEOs and CFOs that get it and understand the power of pricing and margin optimization are our buyers, that who are selling to, but 98%, 99% of the companies who are out there are still using spreadsheets.

So, we are so early stage in terms of the penetration of these industries and they’re still is a continuing demand from the innovators and first movers, that we don’t see any industry shift in terms of what’s happening in our market today.

We think all of these industries need it. We think that it will be a must-have application, sometime down the road, three to five years, but right now the innovators and first movers, even in the face of a challenging economy, are looking at margin optimization and how to capitalize on pocket margins without wholesale, a tax on their pricing policies, that they actually end up, being detrimental to their overall business strategy.

Aaron Schwartz - J.P. Morgan

Okay and last question from me. I was just wondering if you could provide some color on sort of the assumptions you’re making in terms of mix new verse maybe installed base sales going forward. I mean does that change as the environment gets a little tougher and then also sort of the implications on margins there?

Charlie Murphy

I think for the third quarter and year-to-date, it hasn’t changed and historically it’s been one-third of our sales are back into our existing customer base; approximately two-thirds are into the new customers. We haven’t seen a change in that for the first nine months of this year. You can add variability from quarter-to-quarter, but we haven’t seen that, we haven’t seen the change.

Operator

Your next question comes from Tom Roderick - Thomas Weisel Partners.

Gordon Hodge - Thomas Weisel Partners

This is actually Gordon for Tom. So, guys you got a lot of software companies there that are missing pretty dramatically, showing a lot of signs of slowdown. How are you guys able to maintain the bookings guidance and the revenue guidance; especially, given the fact that you guys do you sell big deals? I understand the visibility, but the bookings guidance is sort of a surprise to me.

Charlie Murphy

I think its outstanding executive management.

Gordon Hodge - Thomas Weisel Partners

I’ll support that.

Charlie Murphy

No listen, yes that’s a great question. Listen, we’re monitoring as you know, we’re at bunch of quants here and we monitor all the statistics and metrics in our business. We’re scrutinizing every aspect of our business, even greater than we did in the past and what we are constantly looking for are any indicators of softening that would obligate us to change our guidance.

I think the other thing is if you go back at the end of the second quarter, we felt based on the commitments we have made during the IPO and throughout our history as a public company to be transparent and to tell our investors anything that we saw that might be an indicator or change our forward-looking outlook.

What we did was we analyzed the situation; we decided it would be prudent to change and lower our annual bookings guidance at that time. When we looked at it and when we analyzed it, we analyzed all of the statistics and the facts and the metrics we had at that time, we lowered our guidance and we also had an eye to being prudent so that we wouldn’t have a continuous lowering of guidance quarter-after-quarter-after-quarter.

What we will tell you are that exactly we anticipated based on that facts at that time; we thought we are going too happened. So, now we are reaffirming our annual bookings guidance for the year. Obviously long-term we think this is a huge market and with a great opportunity; we are continuing to invest in R&D; we are continuing to integrate science into our products.

We think and we believe that we are extending our leadership and pricing the margin optimization capabilities and even in a down market there are going to be CEO’s and CFOs to recognize that they need pricing and margin optimization and we think we are the best and safest provider and we can do the best job of being their long-term partner to help them achieve pricing excellence.

Gordon Hodge - Thomas Weisel Partners

Along those lines are you seeing any sort of change from your competition? Are they getting more aggressive out there with pricing? Any sort of change in that dynamics?

Bert Winemiller

We really haven’t seen a change in the competitive landscape. I would say that if anything, there’s more sensitivity on buyers today, the financial viability, the financial strength of PROS and the fact that we are public company and we adhere to good governance. I mean we are absolutely committed to best practice in terms of good governance and transparency and that’s very much appreciated by CEOs and CFOs when they are making a decision on a long-term partner.

Gordon Hodge - Thomas Weisel Partners

Then one final question from me; during the last slowdown you sort of changed your strategy; you didn’t change it, but you diversified and you went after some new verticals. Do you have any plans sort of as we kind of encounter some more economic slowdown; targets some of these new verticals; do you see any opportunity to go after some new markets here?

Bert Winemiller

No. We got a big opportunity right in front of us. The last thing we’re going to do is distract ourselves.

Operator

Your next question comes from Richard Davis - Needham & Company.

Richard Davis - Needham & Company

If we’re in the early adopter face, if you’re believer in Jeffrey more and things like that you have to cross the chasm; are we close to the chasm, miles from the chasm, minutes from the chasm?

Charlie Murphy

If I could forecast future Richard, I mean we don’t know. We just know that there’s a lot of activity; there’s lots of CEOs and CFOs who did it, but where we are in that particular spectrum, we don’t know.

Richard Davis - Needham & Company

So then I’ll make the second part of this question harder and as you know that I’ve written about this, so with regard to ’09, I know you didn’t guide it in like that, do have at least a sense of abandoning of high, low or anything like that, that you’ll be willing to talk about in terms of the outlook, at least in your opinion obviously we’ll make our own judgment, but do you have any thoughts there?

Charlie Murphy

Richard, it’s just too early for us to be talking the 2009. The first time we plan on giving guidance, we’ll report the year-end results which will be in February ‘09.

Operator

Your next question comes from Nabil Elsheshai - Pacific Crest Securities.

Nabil Elsheshai - Pacific Crest Securities

I got a follow-up on the kind of bigger picture question, so when you guys lowered your guidance since then obviously some things have changed, we’ve heard from other software companies that maybe things got worse, a lot worse in October. If you were to look at your longer-term pipeline, have you seen changes in that and in the past you’ve given more qualitative commentary about levels of interest and webinar attendance and those types of things, any commentary you could give this time?

Bert Winemiller

Nabil, absolutely, you’re on the right subject. What we have experienced, over the life, history of the company is long sales cycles, and it’s a big ticket and our ASP is high, it takes a commitment on the part of the company in terms of process, implementation of science-based pricing, a complete rethink as they abandon spreadsheet, so we’ve always have long sales cycles.

While we have the experience, starting in 2005 up to and including 2008 is an increasing demand and an increasing awareness of the power of pricing. If we look at it over the long-term, we would say every indicator, every metric, our European form, the number of people that are here in the building or conference rooms are busy, all of those kind of indicators and if we didn’t listen to CNN and all of those cable channels, it would be hard to translate what’s going out in the economy to what we see in terms of tactical activity everyday.

Now that said, we still know that there is an increasing scrutiny and a more intense approval process on deals than there was a year ago in 2007. If things remained the same then you would say, all looks great. If things get more intense there is more levels of approval than the sales cycles can change, but if you look at the facts, the way we’re look at it right now with the metrics, we’re very comfortable with where we are; we’re very pleased with our results year-to-date and we are reaffirming our booking guidance for 2008.

Nabil Elsheshai - Pacific Crest Securities

You probably can’t comment on this, but any update on the lawsuit, the deal that was delayed or potentially cancelled?

Bert Winemiller

I can give you an update. It’s going to be a protracted long legal process. I think the last time we talked about this, we don’t expect much to happen from the substance standpoint until the fourth quarter of 2009 and perhaps going into 2010. As of today, other than just by passing documents back and forth to the standard legal process, there’s really nothing to comment on.

Operator

(Operator Instructions) Your next question comes from Ross MacMillan - Jefferies.

Ross MacMillan - Jefferies

So, Charlie you are guiding upon revenues and I think your gross margin Ex CFX would have been up sequentially as well and it sounded like you were decelerating hiring into Q4. You’re kind of guiding down sequentially in operating income, can you just kind of square the circle for me on that? Thanks.

Charlie Murphy

The operating income guidance that we provided and we’ll just get back to the numbers here. I guess when you’re saying we are decelerating the operating income guidance itself…

Ross MacMillan - Jefferies

Well, the range is 4.1 to 4.5, so I guess at the midpoint or higher it’s inline with last quarter, but revenues were up and your gross margins seem to be moving in the right direction as well sequentially and your hiring is slowing; I just thought you’d get more leverage I guess than that what you’re guiding to?

Charlie Murphy

I guess that’s not the way the numbers are rolling out, their rolling out to what we’ve guided.

Ross MacMillan - Jefferies

Okay, and the FX impact on gross margin, was that when you said a 1.5% impact, is that sequentially or year-over-year?

Charlie Murphy

That was within the quarter.

Ross MacMillan - Jefferies

Its 1.5 percentage point, so that’s what it has to normalize to, that’s what I should think about?

Charlie Murphy

It was 1.5 in the quarter.

Ross MacMillan - Jefferies

And from an FX standpoint overall, we’re moving from a period of weak dollar comparable to stronger dollar comparables. How should we think about that and I guess specifically, I don’t know if I’ve asked this before, but have you had a benefit from FX as we looked backward over the last few quarters; it could be materially or how should we think about that? Thanks.

Charlie Murphy

Historically, if you were back to 2007, it’s a non-issue it’s nothing. Historically, we have not had many contracts denominated in currencies other than US dollars. We happened to have coming into this year, a couple of contracts that were denominate in euros and through the first half of the year, there is really no material impact at all. There is a little gain in the first quarter a little loss in the second quarter.

As you may know what happened is that as the financial crisis really hit very hard in the third quarter, there was a run to the US dollar and the yen and across the board other currencies just came down and the US dollars strengthened as did the yen. So this question is are we at the bottom; are we strengthened as much as we’re going to strengthen? I don’t know, I’m not a forecaster of foreign exchange rates, but as you know it was a precipitous strengthening of the US dollar in the third quarter and that continues somewhat through the fourth quarter today.

Ross MacMillan - Jefferies

So, if guess the question is if rates stayed the same, let’s see from now, we’d still have a negative impact in Q4, because I think on average the rate is probably stronger for the dollar that of today than it was for the average rates to Q3?

Charlie Murphy

To the extent, yes that’s true and that has been taken into consideration in the guidance…

Ross MacMillan - Jefferies

That probably helps to explains some of the original question.

Charlie Murphy

Okay.

Ross MacMillan - Jefferies

Last one, just on the EPS, just to be clear; the non-GAAP EPS change reflects the adjustment through the prior quarters for the ROE credit, that’s right?

Charlie Murphy

Well, no the non-GAAP EPS from a guidance standpoint is at 29% for the fourth quarter.

Ross MacMillan - Jefferies

For the full-year though?

Charlie Murphy

And for the full-year it’s 29%.

Ross MacMillan - Jefferies

So, we should go back and restate the prior quarters of that rate; is that the way to get to that full-year number?

Charlie Murphy

It was 28%, just about 30% in the third quarter and 29% in the fourth and so on…

Operator

I’d now like to turn the call over to Bert Winemiller, Chairman and CEO for closing remarks.

Bert Winemiller

We know there were a lot of calls tonight and we really appreciate you taking the time to get an update from PROS. We’re obviously pleased with our results and if you have any follow-up questions feel free to call Charlie or Bert at anytime. We want to be as transparent, as open with our investors as we possibly can.

Also for the employees that are on the call, we want to thank all of our employees for just the outstanding job they are doing in delivering value to our customers. Thank you.

Operator

Thank you. Ladies and gentlemen, this now concludes your presentation. You may now disconnect. Have a great day.

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Source: PROS Holdings Inc. Q3 2008 Earnings Call Transcript

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