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PROS Holdings, Inc. (NYSE:PRO)

Morgan Stanley Technology, Media & Telecom Conference Call

February 28, 2013 7:15 PM ET

Executives

Charles Murphy – CFO

Andres Reiner – President and CEO

Analysts

Adam Holt – Morgan Stanley

Adam Holt – Morgan Stanley

Thank you all for coming. We’re going to be not quite at the end of the afternoon but we’re getting close. And we’ve got an old friend in PROS Holdings, which is a company I used to cover when I was back at JP Morgan. So, thank you all so much for coming.

Why don’t we start with maybe a general question, which is, for the level set for the audience, maybe talk about what you’re seeing in the marketplace right now and how you think about the demand drivers heading into account with their team? Okay.

Charles Murphy

Yes sure. Thank you, thanks Adam for having us here. In terms of the demand drivers what are we seeing is, the – it’s been very obvious over the past couple of years that there are so much broad recognition that data driven decisions and company should invest in big data are able to really outperform their competition. And we see that to continue the demand to be driven by this broad recognition of that fact. Gardner a report out last year, where they said the company should invest in big data and analytics, could achieve up to 20% improvements over the competition for every – every available financial metric. That type of data and the continued adoption of our technology, we think is, will continue to drive demand for our solutions.

I’d like to add one more comment I guess, is really public in 2007. There is very little of those being written about the space, the rent. We’re essentially creating the space on the B2B side of our business. And today, of course as much more that’s being publicized about the company’s utilization to beat data to optimize sales effectiveness. And we’re very pleased with that. And we are actually and I think like 24 or 40, how many publications we had last year.

Andres Reiner

Over 40, about 45.

Charles Murphy

About 45 publications last year had the prosthesis on them, compared to 21 publications a year before that. And if you go back to public there’s really nothing that all being written about the space. So, one of the drivers really is that the awareness that this technology exists and the adoption rates are increasing and we’re very pleased with them.

Adam Holt – Morgan Stanley

If you were to, why don’t we sort of look at the fourth quarter results and talk about, what some of the key highlights were? Now, we’re sort of half way through the first quarter, want to maybe set the landscape for calendar ‘13 as well?

Charles Murphy

Sure. We ended the year 2012 on a very, very good position. I think that those of you who have seen our announcement, we actually ended up with backlog revenue which is a metric use of sort of how much revenue we’re going to recognize in 2013. About $108 million and that’s of a total backlog of $145 million. So, going into this year, we already have approximately $108 million revenue to be recognized which we think is terrific. If you look at that as a percentage, our overall guidance for the year, which is about 22% to 23% revenue growth, that $108 million represents 75% of our revenue guidance for this year is already booked.

So, we ended the year very strong, we’re very pleased with that. Some other metrics that we discussed on the call were that we had more new customer acquisitions in 2012 with that than prior years. Typically our business model and it’s been very strong this way, we have great sell-back into our existing customer base. And that continues today but in ‘12 we actually saw more new customer acquisition, which is a great sign for us, effective, not in the sense of trend but that is the trend, it really gets to as the market moving, what’s the momentum in the marketplace.

Adam Holt – Morgan Stanley

Why do you think you had such an up-tick in customer wins in 2012?

Charles Murphy

I think it gets back the awareness. We’ve been investing there in the last three years. And our sales and our marketing programs to help create awareness in the marketplace. And with that awareness we’re seeing the adoption rates increasing. And to add to that we’re also seeing something that didn’t exist five six years ago, and that is success cases. There are just so many more success stories out there about companies who are making hundreds of millions of dollars of additional revenue and margin and they’re talking a little bit more about what they did in the past.

Adam Holt – Morgan Stanley

Can you maybe walk us through some of your customer success cases and some of the reference points that might be driving that adoption?

Charles Murphy

Sure, I’ll give you an example of a company that’s a large electronics distributor. They actually started with PROS in the beginning of 2009, so it’s a very difficult time. They had experienced a couple of years of declining margins, and they turned to PROS because their VP of Sales who actually led this project, who led this initiative looked at its business and said his sales team is really struggling to get the – to really win in the market, to get the prices and the value that they felt that they deserved.

So, they worked with us, we applied our data science technology to look at patterns and their customer buying patterns and preferences. And with that in about six months, they’re able to actually raise their margins by 230 basis points in a six-month period. And now they continue to outperform their competition. And how that worked was by looking at the patterns, we were able to recommend and prescribe on a deal by deal basis, every time their sales rep created a new deal, we were recommending products and prices unique to that individual customer that gave the sales rep the confidence to negotiate, and gave them the highest probability of winning business.

And again, they were operating at about 200 basis points level of margin and they more than doubled that in about six months. So that’s a case that goes back quite a ways. But even just last year, we had a customer – another customer in the services business, was active, was basically acted as a reference customer PROS. The individual doing the background check goes and meets with this customer and asks, what kind of ROI have you seen from PROS? They had only been a customer for us for two years and they said, we’ve generated over $200 million in benefit in the first two years.

So, those kinds of stories and case studies did not exist five, six years ago, that’s driving demand. We’re seeing a lot more interest in demand because those stories are more frequently told.

Adam Holt – Morgan Stanley

We do lots of work in the field around, data and analytics and data related technologies and things. But as I think about your offering, I mean, you will have very deep analytics, you’ve got very significant amount of subject matter expertise. Can you talk about from a customer perspective where they typically draw the line between maybe some off the shelf stuff to maybe a little bit more horizontal and the deep analytics that you all have?

Charles Murphy

Yeah, that’s a great question. When we go into a customer, we often times are replacing a BI tool that’s used just a reporting tool to show where opportunities may exist. The cut line is when they really want to operationalize the data when they want to go from just seeing some information insights to executing on them. So, an example would be, with issues and example both the pricing example and the sales execution example.

Our analytics engine will identify opportunities for the price you could look at and identify pricing opportunities and recommend price changes based on segments. That price can then take from that system in the same level that they can execute price changes across a million skews at the push of a button all in real time, in the same technology where those insights are lifted.

And again, now a sales rep, you will use the exact same solution when they go out to create a deal and they’ll begin negotiating, it’s in the same system where those insights existed so that the analytics will not just uncover opportunities but will prescribe an action and the system exists to execute on that. That’s really the cut line, when companies are ready to move from just information to real action and execution.

Adam Holt – Morgan Stanley

And in practice from a sales model perspective, are you typically responding to RFPs or are you typically having to sort of drive demand yourself?

Charles Murphy

I’d say it’s a combination of both but dip typically as RFPs are actually a result of the demand and the awareness that’s being created in the marketplace.

Adam Holt – Morgan Stanley

And if you look at your vertical markets right now, how are you – why do you spread across different verticals?

Charles Murphy

So, the four main industries are manufacturing, distribution, services and travel, kind of in the broad categories, that’s in really broad. But in reality we’re an over 30 sub industries. So we’re very, very well distributed across a wide range of verticals, all using the same products, same platform. So, for example, a chemical customer is using the exact same product that a medical device distributor is using. There is no custom code for each individual industry.

What we’re able to do is because the product is configurable we can actually have the solution configured for an industry specific requirement without releasing a new set of code. So, the loss of scale is very quickly over those 30 sub industries, even just in 2005 we’re in only seven industries to give you an example.

Adam Holt – Morgan Stanley

So, that leads to your next question, which is, if you look at the – you grew 20 plus percent on the most recent quarter. You’ve substantially expanded your industry footprint. But could you grow another 20% just in your four core industries or do, is it the growth really dependent on entrance in the new markets at this point?

Charles Murphy

No, it’s not really dependent on new markets, it’s really the industries we’re in and we’re very pleased to – just to mention we’re in over 30 industries today. So we really don’t need to expand beyond, when we actually what we need to do is keep some back into our existing customer base, expanding in the industries that we’re in with the footprint that we have, so we feel very comfortable about our growth opportunities.

We’ve said that we believe we can do 20% plus growth for the next several years. And that’s really on the B2B side of our business, manufacturing, distribution and services. As Gartner, said that this market is still less than 5% penetrated and that’s in the industries that we serve. So there is still tremendous amount of runway for us.

Adam Holt – Morgan Stanley

Remind me what the concentration is of your four core verticals versus the rest?

Charles Murphy

That’s B2B…

Adam Holt – Morgan Stanley

That’s actually, if you were to look at your core verticals, what percentage of revenues those are versus the other verticals?

Andres Reiner

Yeah, we actually don’t report by vertical but manufacturing is our largest vertical and that’s been tested by the sheer size of the number of manufacturing companies both here in the United States and in Europe. And then within manufacturing, I guess you could…

Charles Murphy

Yeah, you break down after that. But if you’re taking up a level, if you take manufacturing, distribution, services and travel, we call manufacturing distribution services are B2B industries and travel to B2C. Last year, really for the first time, last year we saw from a revenue standpoint the B2B industries, we’re bigger mix of revenue than B2C. And that’s what we want to see, that’s the high growth market, that’s the high growth opportunities. The B2B to revenue was up 40% last year.

Adam Holt – Morgan Stanley

That’s what I was trying to get at is basically because the mix of the growth is between the two.

Charles Murphy

Yeah, yeah.

Adam Holt – Morgan Stanley

Got it. And you added, I believe 30, you grew 36% in your sales organization last year. Can you talk about how you’re allocating that incremental resource against these two opportunities, is that kind of splitting on that, how would you think about that?

Charles Murphy

Yeah, it’s split predominantly on the B2B side of our business, the manufacturing, distribution and services. And some of it what we did last year, it’s predominantly the largest piece is in the United States and North America. Although we did expand in Europe as well last year, we actually expanded not just sales but our entire workforce by 40% last year. So, we’re seeing good results out of Europe, but the real growth for 2012 was more US centric because that’s where we put most of our efforts within US.

Adam Holt – Morgan Stanley

Okay. And you had 40% growth in the B2B side last year, if you had 36% increase in capacity as well, should we expect that capacity kind of attracted the growth in that market again for calendar ‘13.

Charles Murphy

That’s a good proxy part, yes. And we said on our call, we expect that the B2B growth in 2013 is quite going to be up the same as less than ‘12 which is 40%, and then the B2C side of our business which is the predominantly the travel side, with the single digit revenue growth as it was in 2012.

Adam Holt – Morgan Stanley

Okay. And how much, what’s the sort of macro background that you’re assuming underpinning those growth rates?

Andres Reiner

The macro I think it’s back to how under-penetrated the B2B side of the business is, as Gartner says, and the industries that we serve is less than 5% of the companies in the technology today, so that’s the fundamental of underpinning of why we expect to continue experience very good growth in the B2B side of our business.

Charles Murphy

And maybe to add to that, if you think about the last couple of years haven’t been the greatest economy we’ve seen in a long time. Yeah, the last two years we did increase our L&I revenue 75%, total revenue 60% over the last two years. As the economy strengthens, which we don’t know is going to happen obviously but the economy strengthens, we feel good about where we’re going. We also have a number of customers who have turned to PROS when things have been tough, look to us as way of get out of their margin compression.

Adam Holt – Morgan Stanley

Do you feel like based on the data set that you all have that you get from customers and the travel industry and in terms of the industries that you are in, do you actually have a fairly good proxy for leading indicators for demand?

Andres Reiner

For our own demand, their data forecasting our demands?

Adam Holt – Morgan Stanley

Well, no, so, I mean, effectively you’re sitting on tons and tons of data and you’re running at what say tons and tons of data sets, there is a very good proxy for the macro and for what spending intentions are going to look like on what the consumer and the business side. So, I mean, do you feel like you’re able to leverage that effectively into a better predictive model?

Charles Murphy

We do forecast, if you think about from an airline standpoint, we absolutely do forecast demand for bookings on a flight but we’re well far out, long way out.

Adam Holt – Morgan Stanley

Right.

Charles Murphy

We do that every day. And it does take into account the macro factors of what they anticipate passenger loads to be. But we don’t apply that necessarily to forecasting demand for our business of what’s going to happen, again I think it goes back to – we have seen in the last couple of years, the right growth in the pipeline that we expect to see as a result of the investments we’re making, we’ve seen the early stage lead generations, the accounts at an early stage have doubled in the last year. So, we are looking at other indicators for our demand at a macro level for us. But hope that answers your question.

Adam Holt – Morgan Stanley

Yeah, yeah. Have you seen any change in the time to ramp the people that you brought on from the sales perspective?

Andres Reiner

It’s still around nine months to get the sales people effective, I don’t think that’s really changed very much. The sales cycles haven’t changed that much, they’re still around 11 months.

Adam Holt – Morgan Stanley

And as you think about the 20% plus growth target, is that an organic target or do you think you need to do acquisitions to compliment your?

Andres Reiner

No, that number is an organic number, yeah. When we’re talking, we’re talking organic growth.

Adam Holt – Morgan Stanley

And as you look at the other elements of the model, you’ve also talked about margins, basically 2013 a little bit of an investment here. Can you talk about where those investments are going?

Charles Murphy

Sure. Really what we’re doing is extending on initiatives that we’ve already proven to be successful. What we feel like the results for 2012 and our competence in 2013, we are directly related to investments we made in sales and marketing and creating border awareness, putting feed on the street. Being able to drive really industry specific thought leadership and content and configuration. Some of the areas that we will continue to invest in, these are proven ROI on these initiatives and that’s where we will continue to focus.

Adam Holt – Morgan Stanley

And that tells to the next question which is, how are you thinking about your strategic priorities for calendar ‘13?

Charles Murphy

Sales and marketing growth awareness. By far, we are in a really nice position from, at least I know as the Chief Marketing Officer, as we’ve got tremendous product. We have got really, really, really strong customers with really great customer reference-ability. We’ve got a great service organization. What we need to do, our number one mission is really driving awareness of adoption, the market is still less than six years old. So what we’re – and we’re thrilled to see the growth over the last couple of years. But we’re still early stage in seeing that growth.

Adam Holt – Morgan Stanley

So, effect of the year, your capacity constraint?

Charles Murphy

I think we’ve got the right pace of investment from the market momentum that we’re seeing. I wouldn’t say we’re capacity constraint, I mean, distribution well distribution has always better for us. But the markets for the B2B side, is predominantly in the United States which we’ve got good coverage in and Europe and we’re expanding a bulk of those geographical territory.

Adam Holt – Morgan Stanley

Have you seen anything change on the competitive front in the last several years?

Charles Murphy

No, we actually haven’t. The only change is there were two primary competitors, company called Vendetta, here in the West Coast, there is a company called Zillionth in Austin, Texas. The only change we’ve really is seen is that Zillionth seems have gone more to mid-market with more of a services offering. We don’t see them as much in a competitive set, now as we used to when we were public. And Vendetta we continue to see essentially in every deal.

Adam Holt – Morgan Stanley

And no change out of SAP or IBM?

Charles Murphy

No.

Andres Reiner

Vendetta has a reseller range with SAP, but 60% of our customers in the B2B side use SAP and we’ve got the highest level of certifications as far as integration with SAP, we’ve got fantastic customer references that are SAP customers, so we’re doing very well in that front.

Adam Holt – Morgan Stanley

And that you all, you talked about Zillionth sort of taking a mid-market pivot. You all have also rolled out a specialized sales organization for the mid-market. Can you talk about A, the dynamics of that market and how they’re different? And B, what kind of success you’ve had there?

Andres Reiner

Sure.

Charles Murphy

So, I should back up and mention that. We started seeing demand out of mid-sized companies a while ago. And the reality is that, the enterprise solution really didn’t scale to the mid-sized companies. So we built a mid-market product from the ground up on the salesforce.com platform. We did not take the enterprise product and try to rapture it down, we didn’t think that it was the right way to go. So, we built a solution that could scale to the market. We built it on the salesforce.com platform so it’s really a solution that’s designed, it’s according, its sales effectiveness and coating solution for the salesforce.com customer in the $100 million to $500 million range.

Same type of profile to kind of – targeting at the B2B companies, manufacturing, distribution services, and we’re very early stage, very early days in that market. We’ve invested last year in really creating awareness and seeding the market. We do have customers on the solution and we’re pleased to see how well it’s working. But it’s a really early market. That’s a market that has not really been served before, so it’s like we winded the clock from where we were six years ago on the enterprise side. And the problems they have are the same problems, it’s just really tailing the solution to scalp of that.

Adam Holt – Morgan Stanley

Got it. I’m going to shift to a couple of product questions here. But before I do that I want to make sure that we offer the opportunity to ask any questions to the audience as well. Jim?

Question-and-Answer Session

Unidentified Analyst

You mentioned scaling of the sales force, so I’m just curious since you have the opportunity to accelerate investments in the sales force, can you get the same ROI with the increased sales force investment, or do you think that it may take longer for encouraging customers that’s real mature enough to get value out of the applications that you offer?

Charles Murphy

Yeah. First I would say, I think we’re expanding our sales force comments of what we see in our pipe. So, as we’re measuring our pipe and look at the growth in our pipe, in the low to the high pipe, we’re trying to make sure we’re very closely tracked the sales requirements that are needed to support that type. So, we’re very metrics driven in that regard.

We don’t believe in just taking sales people and putting them out there without summing up those metrics behind us, it’s really going to benefit us. So, we’re investing much more this year as we did last year, with even more this year. And lead generation for example, so as we bring in the sales people, they’re not deciding this time with pipe to make sure they’re effective. We still have long sales cycles, the question was asked, it’s on the 11-month sales cycle, we just have to very judicious about how we bring people in otherwise we’re just going to have more churn on the sales organization that we like.

So, I think we’ve got a good handle on this, we’ve got a great Chief Sales Officer in the company, that’s been here over three years. And I think we’ve got the right tempo on that sales growth, does that answer the question? Okay.

Unidentified Analyst

I would like to understand a little bit upon on your services business. I’m sure your implementation requires effort integrating into your systems etcetera. What are your gross margin, and I don’t want to be that precise but generally what are your gross margins for your services business? I then have a follow-up?

Andres Reiner

Yeah.

Charles Murphy

The overall gross margins for the company was 72%. And since our license is bundled in with our services as far as revenue recognition, the margins that we report and the margins on the license and implementation and the margins on maintenance, and the composition is 80% margins on maintenance and that’s been pretty consistent over the years, 72% in the aggregate and I think the weight of that is probably 60% something on the license and services. But we actually don’t split out the services component. We do say that approximately 50% of our contracts of services and 50% of license.

Unidentified Analyst

Also a little bit on your B2C space, the investments you’re making in that area, is that a growth area, what growth have you seen in the last two, three years? Thank you.

Charles Murphy

Yeah, on the B2C side of our business, it’s predominantly airline centric. We do have some hotels, some cruise that’s been on the LN centric. And we’ve been saying single-digit revenue growth in that B2C business over the last couple of years. And we expect to see a single-digit again this year. We are making investments, one thing that PROS did very, very well in the early days is filled out terrific products, we’re very proud of being a product company. And we’ve got the best breed products in the airline space for optimizing that revenue for airlines.

So, we continue to invest in that and we get payback on that because customers come back to us for license and additional applications from us. We have P3, P4, P5, P6, OND1, OND2, OND3, so we keep innovating and going back out with new products to sell back into our existing customer base. And we also have new customer acquisitions each year but it’s not a lot because it’s a mature statement and it’s a small market. Unlike the B2B side which is a very immature market and a very, very large market opportunity for us. Is that helpful? Yeah, okay.

Adam Holt – Morgan Stanley

Good. Time for one more quickly one in the back.

Unidentified Analyst

Hi, given you’re already analyzing pricing, you probably have announced a data to look at adjacent markets with forecasting etcetera. Are you doing any other products outside pricing and other optimization products?

Andres Reiner

I think the way I’ll answer that is, our customers have been telling us for a while that we’re far more than pricing, pricing company, pricing as really just a sales motion, it’s a sales lever. So we have customers who are using analytics to really optimize sales performance, identifying, looking within the territory and identifying opportunities accounts that they should go pursue and opportunities most likely to close.

We’ve been recommending compliments and substitutes on deals for a lot – for a number of years now. So, I’m not sure if that’s how specific you’ve met with pricing. So, we’ve been doing more than pricing for quite a while. Because it’s the data, so you’re absolutely right. It’s the same set of data, with that data, once if you start looking for patterns, we are able to apply that, those insights into different areas like offer combinations, and opportunities. So, I’m not sure if that’s what you were driving towards.

Yeah, we discern for example willingness to pay, which obviously helps in negotiation. We can provide our customers with our products is called deal optimizer. And that particular product will allow our customer to be able to negotiate much more effectively as they are trying to close deals. And they can see the stretch price, they can see the floor price before the sales people, as much more and to that really work on tuition, I suppose to now they’re giving guidance, we actually guide them this is what the price should be for that specific customer for that specific product in real time, so this is an example of a closer to pricing, which is you’re referring to, as opposed to science of the analytics, it’s more visualization looking for profit, looking for opportunities. Price optimizer and other product that we have is here to as allowing companies with thousands of skews, thousands of customers to be able to get price list out effectively.

Charles Murphy

And an example of that, to get your point as we released a new product last year called rebate optimizer. This is built on the same set of data and now it’s about instead of optimizing a product, it’s optimizing your rebate programs.

Unidentified Analyst

If I may ask a follow-on question, like let’s take an example, since the customer and they are using a pricing for poly-ethane. But if they won’t use the same mechanism to the same or different polymers, would they have to buy, how does the licensing remain actually to work?

Andres Reiner

Licensing is really based on revenue under management. And so, if your question is, are customers able to use the product to solve other problems in their business, that we do have cases where our customers have been able to do that. We have a customer using, it’s really – they’re taking all the margin that all of the pocket margin information that comes out of the waterfall, the price of waterfall now and since they are using that margin information to negotiate on procurement side. So they’re using it to solve other problems, same thing on sales performance. So, yes, our customers are able to do that.

Adam Holt – Morgan Stanley

All right. We’re out of time. Thanks guys.

Andres Reiner

That was great, that was quick.

Charles Murphy

Thank you.

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