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8-K - FORM 8-K - PROS Holdings, Inc. | h72960e8vk.htm |
Exhibit 99.1
PROS Holdings Inc.
Script of Investor Teleconference
May 5, 2010
Script of Investor Teleconference
May 5, 2010
Operator
Good day, ladies and gentlemen, and welcome to the Q1 2010 PROS Holdings, Inc. Earnings
Conference Call. My name is Keyonna, and I will be your operator for today. At this time, all
participants are in a listen-only mode. Later we will conduct a question and answer session.
(Operator Instructions)
As a reminder, this conference is being recorded for replay purposes. I would now like to turn the
conference over to your host for today, Mr. Charlie Murphy, Executive Vice-President and CFO. You
may proceed.
Charlie Murphy PROS Holdings, Inc. EVP, CFO
Thank you, operator. Good afternoon, everyone, and thank you for joining us today for the PROS
Holdings financial results conference call for the first quarter of 2010. Joining me on todays
call is Bert Winemiller, PROS Chairman and Chief Executive Officer.
In todays conference call, Bert will provide a commentary on the highlights for the first quarter
of 2010, 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 todays remarks in this discussion, including statements
made during the question and answer session, contain forward-looking statements. These statements
are subject to numerous and 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 Form 10-Q, Form 10-K and other filings with the SEC
and the risk factors contained therein. Also, please note that a replay of todays webcast will be
available in the investor relations section of our website at www.prospricing.com.
I would also like to point out that the Companys use of non-GAAP financial measures is explained
in todays earnings press release and a full reconciliation between each non-GAAP measure and the
most directly comparable GAAP measure is provided in the tables accompanying the press release
distributed earlier today, and can also be found on our website in the investor relations section.
With that, I would like to turn the call over to Bert.
Bert Winemiller PROS Holdings, Inc. Chairman, CEO
Thank you, Charlie, and thanks to those of you listening to our call. With a challenging 2009
behind us, we have made great progress on our strategic initiatives that will position us to serve
the large, long-term market opportunity for our high return on investment pricing optimization
software products.
We are pleased with our financial performance in the first quarter of 2010, especially while we
continue to invest in our product and sales and marketing initiatives. For the first quarter, we
are reporting revenue of $17.3 million, which was at the high end of our guidance and was an increase over the fourth quarter. Non-GAAP operating
income was $2.2 million for the first quarter,
which was also at the top end of our guidance. I am also very pleased to report that our backlog is
up over the end of 2009.
PROS is a global company with revenue diversified across geographies and our target industry
sectors. Revenue that came from outside the US represented 56% of the first quarter 2010 revenue
and 62% of first quarter license and implementation revenue came from our target industry sectors
of manufacturing, distribution and services.
We continue to provide our customers with a high return on investment which is, in turn, helping us
to attract new customers. We also had much success with our fast time-to-value program, where we
host all of our Pricing Solution Suite customers in the initial phase of an implementation. This
allows our customers to identify millions of dollars of pricing profit opportunities in the first
30 days.
Our continuing focus on customer satisfaction and implementation success resulted in PROS being
selected as the 2010 Strategic Partner Vendor of the Year by a large distributor of office
products. Case studies like this have helped us demonstrate the high return on investment potential
for new prospects. For example, one of the largest chemical companies based in the United States
has executed a contract for the deployment of PROS Scientific Analytics with Segmentation. This is
another significant competitive win in the chemicals industry.
Many companies that understand the high return on investment that our software provides are under
pressure in this tough economy to get funding for their pricing projects. Some prospects are using
Proof of Value engagement to provide concrete ROI for business users to obtain budget authorization
for a full production system purchase. A leading industrial distributor gave PROS the go-ahead for
full implementation of Scientific Analytics, Price Optimizer and Deal Optimizer with Segmentation
and Pricing Guidance capabilities after a successful Proof of Value engagement.
A Fortune 500 distributor of health care products and services also signed to move forward on the
full installation of Scientific Analytics and Price Optimizer for its medical division after their
successful Proof of Value engagement. This is another great customer win in the health care
distribution space.
PROS provides optimized pricing guidance to the customers proprietary sales quoting system that
displays floor target, and stretch optimized prices using PROS science. Sales management utilizes
PROS Scientific Analytics to drive value realization and create peer pricing reports to ensure
adoption among the field sales organization.
We also made great progress with our partner ecosystem. Our objective is for greater worldwide
scalability, and to expand the number of PROS certified personnel. We believe expanding our
partnering program, while increasing our costs in the near term, is the right investment to
position us for longer-term success.
We recently signed a formal global alliance agreement with Deloitte Consulting, LLP and further
strengthened our technology partnerships with Microsoft, SAP and Oracle. As we mentioned on our
last call, our work with our technology partners is a key focus of our R&D spending.
With Microsoft, we now have customers in production using our integration with Microsoft SQL
Server, which helps drive low total cost of ownership for our customers. We have many customers
using our Microsoft Office Suite integration capabilities, which helps increase user adoption.
Our customers also use Microsoft reporting services to generate reports from their PROS data, and
use the integration with Microsoft Active Directory to manage their PROS user accounts and
security. Analysis Services is used for data analysis. Users are able to extract, analyze and
modify data from the PROS Pricing Optimization application using their familiar Microsoft Office
applications.
PROS is proud to have joined the SAP PartnerEdge Program for Software Solution Partners. Membership
demonstrates that PROS maintains the most up-to-date and highest SAP integration certifications,
has documented joint customer successes, and confirms that PROS solution is a high-value,
complementary solution to SAP. A significant number of our customers have integrated their PROS
solution with multiple SAP modules including ERP and CRM.
With Oracle, we have customers in production using our integration to both Oracle E-Business Suite
and Siebel CRM, allowing quote-to-order processes to be based on optimized prices.
We are continuing our focus on sales and marketing to position us to take advantage of a large,
long-term market opportunity as the economy improves. PROS is pleased with the results of our
successful pricing executive summit held at the New York Stock Exchange in March. Speakers included representatives from AMR Research,
Deloitte Consulting, Accenture, and the Professional Pricing Society. Four PROS customers shared
their real-world experiences related to the high return on investment, fast time to value, and low
total cost of ownership success they have had using PROS software.
As we mentioned last quarter, Tim Girgenti recently joined PROS and serves as our Chief Marketing
Officer for our Manufacturing, Distribution and Services industry sectors. This quarter we are
pleased to announce that we have strengthened our sales organizations strategic consulting team
with the addition of John DeCarlis, who serves as Senior Vice President of Strategic Consulting,
focusing on manufacturing, distribution and services. John was a managing partner of Strategic
Pricing Partners, a consulting firm focused on pricing strategy development, and he was also a
partner in the Pricing and Profit Optimization practice at Accenture.
We also continue to invest in people, product and processes to drive our science and product
innovation and to increase our competitive advantage, as demonstrated by our continued heavy R&D
investment which was at 28% of revenue for the first quarter of 2010. Our continued investment in
R&D has helped to improve our product suites scalability, shortened the time to value for
customers as we provide industry-specific solutions, and decreased the time to market for product
enhancements.
In summary, while sales activity continues to be high with increasing participation by prospects at
our sales events and webcasts, translating this interest into sales is challenging as sales cycles
continue to be long and approval processes are rigorous. We have responded to these market
conditions and requirements with flexible ways of doing business including Proof of Value pilots,
term licenses and other contractual arrangements where our revenue recognition is lower and longer
than our traditional percentage of completion method.
We have an experienced management team that we believe is focused on the right strategies, and we
will continue to invest appropriately to capitalize on what we believe is a fantastic long-term
market opportunity. In the remainder of 2010, we intend to continue to make strategic investments
while maintaining our historical track record of 11 years of non-GAAP profitability and positive
cash flow. We will continue to be prudent about our spending in this economy with a strong balance
sheet. We are in a unique position to invest in our products, processes, sales and marketing, and
other initiatives to improve our relative competitive position as a leading vendor in the pricing
and margin optimization market.
We are pleased with our operating income and EPS for the first quarter, and that our revenue
increased quarter-over-quarter sequentially in the first quarter of 2010.
We continue to believe that our market leadership position positions PROS to be the pricing partner
that companies turn to as market adoption increases and companies focus on setting and executing
optimal pricing strategies using science-based software products.
Now, let me turn the call back over to Charlie, so that he can provide you with a review of our
financial results and our outlook for the second quarter of 2010.
Charlie Murphy PROS Holdings, Inc. EVP, CFO
Thanks, Bert. Ill begin with a review of our financial results for the quarter ended March
31, 2010. Then, I will provide some commentary on the balance sheet and cash flow, before providing
financial guidance for the second quarter of 2010. I will be discussing our financial results on a
non-GAAP basis. Our earnings press release includes a full GAAP to non-GAAP reconciliation which
can be found on our website in the investor relations section.
As Bert stated, we are pleased with our performance in the first quarter, as revenue of $17.3
million met the high end of our revenue guidance. While revenue decreased from $18 million a year
ago, we are pleased that first quarter revenue was an increase over fourth quarter revenue of $16.9
million, representing our second quarter in a row of sequential revenue growth.
In accordance with our revenue recognition policy, PROS does not recognize any revenue at contract
signing. License and implementation fees are bundled together, and the revenue is generally
recognized on a percentage of completion basis over the implementation period. We do have
implementations where revenue is deferred and not recognized until the delivery of all products. Term license agreements, which we signed more of
over the last several quarters, are an example. With the number of active implementations in a
quarter, our term licenses and high maintenance renewal rate, we have good visibility into
near-term revenue.
Maintenance revenue increased approximately $900,000 or 14% from the first quarter of 2009. This
increase was the result of the completion of a number of implementations of our software products,
following which we begin to recognize maintenance and support revenue. We are pleased that our
maintenance and support renewal rate continues to be in the mid 90% range. Our total revenue
continues to be diversified geographically and spread across our five target vertical markets.
On a non-GAAP basis, gross profit was $12.8 million for the first quarter of 2010, yielding gross
margins of 74.1%. This is relatively consistent with gross margins of 74.3% for the first quarter
of 2009. As we have indicated in the past, license and implementation gross margins vary from
period to period depending on factors such as the amount of implementation services required to
deploy our products relative to the total contract value.
Non-GAAP R&D expenses of $4.8 million grew approximately 2% from a year ago as a percentage of
revenue, in accordance with our planned strategic initiatives to continue to invest in our product
suite. Non-GAAP selling, general and administrative expenses for the first quarter of 2010 were
$5.8 million, an increase of 19% from the first quarter of 2009 as we continue to invest in sales
and marketing talent and programs.
Non-GAAP operating income was $2.2 million for the quarter with non-GAAP operating margins of
12.6%, and were at the high end of our guidance. This compares to first quarter of 2009 operating
income of $3.8 million and operating margins of 21.1%, with the year-over-year decrease in margins
resulting from planned investments in our long-term growth combined with lower first quarter
revenue in 2010. Interest income for the quarter was approximately $11,000, down from a year ago
due to lower interest rates, despite higher cash balances.
We had a GAAP effective tax rate of 39.3% in the first quarter as the R&E tax credit has not been
reinstated, compared to an actual tax rate of 27.5% in the first quarter of last year which
included the R&E credit. Our effective federal tax rate historically has been lower than the
federal statutory rate of 35% largely due to the application of the Research and Experimentation
tax credits.
Congress recessed for 2009 without extending the Research and Experimentation tax credit which
expired on December 31, 2009, even though there was strong bipartisan support for the credit. If
the tax credit is reinstated during 2010 as we expect, and if it is retroactive to the beginning of
the year, as it has been in the past, then we will make a cumulative adjustment in 2010 in the
quarter in which the tax credit is reinstated, as we did in 2008.
For modeling purposes, we feel its reasonable to use a pro forma tax rate of 31% for 2010,
expecting the past 28 years of legislative experience of extending this credit will continue going
forward. If it is not extended, our effective tax rate is estimated to be between 35% to 37%.
Non-GAAP net income was $1.3 million for the quarter using a 39.3% tax rate, compared to net income
of $2.8 million for the first quarter of 2009 using a 27.5% tax rate and our non-GAAP net income
per diluted share was $0.05 in the first quarter of 2010. Had the R&E tax credit been reinstated
retroactively during the three months ended March 31, 2010, there would have been a $0.01 increase
to non-GAAP diluted earnings per share to $0.06 per diluted share, at the high end of our guidance
for the quarter, which did assume the tax credit would be reinstated.
For the quarter ended March 31, 2010, our income from operations, in accordance with GAAP, was
$800,000. Net income in the quarter was $5 million Im sorry, it was $0.5 million or $0.02 per
diluted share compared to $2 million, or $0.08 per diluted share in the first quarter of 2009.
Now moving to key balance sheet items. We ended the quarter with $61.6 million in cash, down from
$62.4 million from the prior quarter. Total deferred revenue at the end of the quarter was $21.7
million, an increase of approximately $2.6 million from the same period last year, and an increase
of $5.2 million over year end. Deferred revenue is not tied to total contract value, and therefore
is not a meaningful forward indicator of financial performance.
We had modestly negative cash flow from operations for the quarter of $0.4 million, reflecting the
unusually strong cash collections experienced in the fourth quarter that we discussed on our last
call.
Accounts receivable at the end of the quarter was $19 million, up from $12 million at year end
2009. At year end, receivables reflected the strong collections in the fourth quarter, and the
first quarter receivables benefited from some favorable billing terms in the quarter. Trade
accounts receivables days sales outstanding were approximately 61 days, which is in line with our
historical average.
Cash flow, accounts receivable balances and deferred revenue can vary in a quarter based on, among
other things, the timing of collections and invoicing of milestone billings under our contracts.
Headcount at the quarter end was 396, compared to 400 at the end of 2009.
Before I turn to our guidance for the second quarter, let me provide you with some additional
information regarding our assumptions. We are pleased that interest levels in our pricing and
revenue optimization solutions remain very high, and this interest was reflected in improving sales
trends. We continue to benefit from our diversification across many industries and geographies.
We not only had a year-over-year and a quarter-over-quarter increase in license deals in our newer
industries as a group, but we are seeing improvement in airline as well. Airlines, which have been
the early adopters and the most advanced users of pricing optimization software are continuing an
upgrade cycle and migrating to the most advanced pricing and optimization software available from
PROS. However, as our most sophisticated customers, airlines typically license a wider range of
products, which leads to longer implementation periods than we typically see in our other
industries.
Sales trends, combined with an improving macro environment, makes us incrementally more optimistic
than we have been in the past six months. While customer interest has been high all along through
the economic downturn, more stringent budgets made it harder for companies to acquire our big
ticket technology despite its high ROI. We responded with more flexible licensing arrangements that
included more term license deals. In addition, contract negotiations continued to be challenging
with complex terms that, in some instances, have affected the timing of revenue recognition.
While these arrangements have not impacted overall deal size or profitability, due to the nature of
these transactions we wont recognize revenue until after implementation is completed, rather than
over the implementation period on a percentage of completion basis as most of our contracts are
recognized. The result of this is we are able to close business more easily; however, revenue is
deferred until later in the contract term, primarily starting in 2011 for these contracts. While
revenue recognition is deferred, these arrangements do provide a base of backlog which will provide
revenue over a period of time and should support longer-term revenue growth.
Last quarter, we commented on initiatives that we believe are important to position us to capture
longer-term market opportunities. We continue to make these investments in product, our sales and
marketing initiatives and our partnering program. For Q1, the costs associated with our partnering
program had a minor impact on our gross margins. In the second quarter, the impact is likely
approximately a one to two point reduction in gross margins. I also commented that sometime in the
last half of the year we plan on resuming planned compensation increases and contributions to our
401k plan, both of which were stopped in 2009 and will increase overall expenses later in the year.
As we disclosed two years ago, we have been involved in a legal proceeding related to a customer
seeking early termination of a contract for one of our implementations. While litigation costs
to-date have been covered by insurance, this will change beginning in the second quarter, as we
approach a trial expected in the first quarter of 2011. In the second quarter, we expect to incur
litigation costs of approximately $1.2 million related to this suit, and increasing on a quarterly
basis as we approach trial in the first quarter of 2011. In the second quarter, we expect this
expense to have a $0.03 per share impact on our GAAP net loss.
We believe the customers attempted termination of the contract is wrongful, and we are vigorously
defending this matter and seeking payment of remaining amounts owed under the contract. Given the
inherent uncertainties in any litigation, we are unable to make any predictions as to the ultimate
outcome, and no provision for loss or other costs has been recorded. You may recall we have
approximately $4.9 million in other current liabilities on the balance
sheet related primarily to
deferred revenue on this contract. This amount will remain on the balance sheet until this matter
is resolved.
We commented on our planned investments in our long-term growth. We believe the overall increase in
spending is the right thing to do, and this strategy continues to guide management decisions.
Estimated expenses assumed in the guidance we are providing in the second quarter is $15.7 million.
We continue to experience lower interest income than we did a year ago, as a result of lower
interest rates on our cash balances, which have grown from a year ago.
With that backdrop, let me turn to our outlook. For the second quarter we are again anticipating
sequential revenue growth with total revenue in the range of $17.3 million to $17.7 million,
compared to $17.3 million in the first quarter.
We are projecting non-GAAP operating income of $1.6 million to $2 million, and we are anticipating
non-GAAP diluted earnings per share of $0.04 to $0.05 based on an estimated weighted average of
26.8 million diluted shares outstanding and an effective estimated tax rate of 31%, assuming the
R&E credit is reinstated retroactively to January 1, 2010. If the credit is not reinstated, we
expect our non-GAAP earnings per share will remain at $0.04 to $0.05.
The Company is projecting a loss from operations of $1.8 million to $1.4 million, and GAAP diluted
loss per share of $0.03 to $0.04 at a 36% tax rate. Non-GAAP operating income and net income for
the second quarter excludes estimated non-cash stock-based compensation expense of approximately
$2.1 million and litigation expense of approximately $1.2 million.
While there are no assurances that past performance can be continued, our experienced management
team, the financial strength of the Company, and our revenue recognition model helps us manage the
Company profitably during difficult periods.
Looking beyond the second quarter, while we have benefited from improved sales trends, our recent
license mix shift likely will result in a larger portion of our backlog being in deferred revenue
until implementations are complete. We believe our flexible working terms with customers has helped
close more deals. However, we do not expect our recent backlog strength to be reflected in our
revenue performance for the most part until early 2011.
In summary, given the current economic environment, we are pleased to have achieved the high end of
our revenue guidance for the first quarter. We continue to believe we are in a strong competitive
position, and with the continued growing awareness of the benefits of high ROI pricing optimization
software we remain confident that PROS has an attractive long-term growth opportunity. And, as the
economy improves, we believe we are effectively positioning the Company to take advantage of that
opportunity.
With that, let me turn the call back to the operator so we can take your questions.
Operator
(Operator Instructions)
Our first question comes from the line of John DiFucci of JPMorgan. You may proceed.
Yogesh Amle JPMorgan Investor Analyst
Hi, guys. This is Yogesh Amle for John DiFucci. Thanks, Charlie. One question I have was on
the you talked about the stream from the airline industry thats improving. Do you have any
thoughts around the consolidation thats going on, the United and the Continental merger, any
thoughts around how do you view that, and is there an impact on the Company?
Charlie Murphy PROS Holdings, Inc. EVP, CFO
Generally the Continental/United merger, its probably not unexpected; they thought about
merging a couple of years ago. We have a relationship with Continental thats been a relationship
for many, many years. I think if you look at the overall mix of our business, over 98% of our
[airline] revenue is from outside the United States.
Mergers within the United States are not expected to really have any meaningful impact on the
companys operations. These mergers also take time. Weve had instances where airlines have been
acquired, but yet theres been absolutely no impact on PROS. Im not sure how the Continental
merger may impact us, but certainly we dont expect to see an impact for the near term.
Yogesh Amle JPMorgan Investor Analyst
Got it. And just a follow-up question. You talked about the litigation expense of $1.2 million
to be factored into the second quarter. And I think you did mention that we should think about that
as increasing every quarter until as you approach the litigation date. So, any guidance on
whats the total expense around that?
Charlie Murphy PROS Holdings, Inc. EVP, CFO
Not really to total expense because its difficult to estimate that, because of the
variability as to what motions might be filed and, et cetera, as you go through the process. We
would expect a modest increase over the $1.2 million that were expecting for Q2.
Yogesh Amle JPMorgan Investor Analyst
Great. Got it. Thanks, guys.
Bert Winemiller PROS Holdings, Inc. Chairman, CEO
Thank you.
Operator
Your next question comes from the line of Tom Ernst of Deutsche Bank. You may proceed.
Nandan Amladi Deutsche Bank Analyst
Hi, good afternoon. This is Nandan Amladi on behalf of Tom. Just a couple of questions. The
sales and marketing expense you had talked about it going up, but should we expect it to stay at
a similar level as a percentage of revenue for the rest of the year?
Charlie Murphy PROS Holdings, Inc. EVP, CFO
I think what we want to do is, we want to just give the guidance for Q2 and weve given the
guidance. And we very explicitly stated that the expenses are expected to be $15.7 million for the
second quarter. And weve obviously so were continuing our investments in areas, and primarily
in sales and marketing.
So you may be able to make some of your own estimates as to how that might be split out. But we
wanted to make sure that the analysts understood very clearly that, based upon the guidance were
providing, spending for Q2 is estimated at $15.7 million. Thats non-GAAP.
Nandan Amladi Deutsche Bank Analyst
Okay. Thank you. And kind of a macro question. The recent weakness in the euro, how does that
impact your outlook for the year?
Charlie Murphy PROS Holdings, Inc. EVP, CFO
Yes, okay. Generally as far as FX lets talk about the FX component first. Historically,
weve had very minor gains and losses in FX quarter-over-quarter or year-over-year. Weve looked at
the recent impact of the euro as it stands today in the context we have today. We dont see a
significant impact in Q2. Im not sure what it might be going forward.
Obviously, any disruption in Europe could have an impact on our ability to close the deals wed
like to close in Europe, going forward.
Nandan Amladi Deutsche Bank Analyst
Right. Thank you. Thats all for me.
Operator
Our next question comes from the line of Chad Bennett of Northland Securities. You may
proceed.
Ian Kell Northland Securities Analyst
Yes, hi, guys. This is Ian sitting in for Chad today. I know last quarter you talked a little
bit about the implementations that you had going on with some of your third parties. Can you give
us an update on that? Got a few more going on now just how is that progressing?
Charlie Murphy PROS Holdings, Inc. EVP, CFO
Yes, I think the utilization of systems integrators is progressing, Id say with our
expectations. We had a few implementations in the first quarter. We continue to have a few
implementations in the second quarter. As weve gone through and looked at the analysis, we do
expect a little larger impact on our margins in the second quarter than we had in the first.
The overall impact on our margins in the first quarter from systems integrator cost was about one
percentage point. In the second quarter, that could be perhaps 1.5 percentage points, maybe two
percentage points. So the programs expanding, and its expanding at the rate that weve been
anticipating.
Ian Kell Northland Securities Analyst
Okay. All right. Good. Can we get back to the new contract terms that it sounds like youre
going about here? Any color on sort of what percentage of new deals or, how many of these new
deals are taking these different forms; and how that affects our ability to maintain sort of a
sequential growth rate going forward?
Charlie Murphy PROS Holdings, Inc. EVP, CFO
Yes, its difficult with the number of deals that are done on a quarterly basis, its
difficult to discern from one quarter to the next how many of these deals might be in the second
quarter or the third quarter then, going forward. We dont see it as a trend at this point. We just
see it as what weve experienced over the last several quarters.
So its really difficult to discern what the impact might be on the Companys near term revenue
growth. We obviously see every deal that weve closed as a good opportunity to contribute to the
long-term growth of the Company, and were very pleased with that. And were pleased with that our
sales, as I mentioned, were up licensed sales were up Q1 over Q1, and Q1 over Q4. So, were very
pleased with the direction. As far as that mix, its really difficult to comment on.
Ian Kell Northland Securities Analyst
Sure. But I mean this is not a trend, okay. But this started, shall we say, Q3? I mean, or
is this a new Q1 development?
Charlie Murphy PROS Holdings, Inc. EVP, CFO
It started in the last half of four sorry, of last year and it continued in Q1 of this
year.
Ian Kell Northland Securities Analyst
Okay. Any particular industries you see this more often? Or is this Im sure its probably
your target industries, but I mean, any one of those three in particular?
Charlie Murphy PROS Holdings, Inc. EVP, CFO
I would say no. Really, its across the board. If anything, on the airline side, a little more
weighted towards the term licenses.
Ian Kell Northland Securities Analyst
Okay. And Ill get out of the way here, but anything out of the ordinary on the maintenance
gross margin in the quarter, or thats just sort of a seasonal effect that Im missing?
Charlie Murphy PROS Holdings, Inc. EVP, CFO
Yes, I wouldnt say its seasonal effect, but we clearly made a conscious effort to increase
our spending relative to maintaining our maintenance base in the first quarter. I think a
general comment on margins for Q2, we expect the margins to be about the same in total in Q2 as
they were in Q1.
Ian Kell Northland Securities Analyst
All right. Thanks.
Bert Winemiller PROS Holdings, Inc. Chairman, CEO
Thank you.
Operator
Your next question comes from the line of Nabil Elsheshai of Pacific Crest Securities. You may
proceed.
Nabil Elsheshai Pacific Crest Securities Analyst
Hi, guys. This is Nabil for Nabil.
Bert Winemiller PROS Holdings, Inc. Chairman, CEO
Okay. Well, this is Bert and Charlie, for Bert and Charlie.
Nabil Elsheshai Pacific Crest Securities Analyst
Let me start at the high level. Leaving aside all the rev rec and term and all that, I mean,
if you look at Q1 and so far in Q2, have you seen an improvement in close rates and kind of just
general business trends? Or is it, in terms of compared to 2009, is it just as hard to get the
contracts across the finish line?
Bert Winemiller PROS Holdings, Inc. Chairman, CEO
Its still a challenge. The thing that were encouraged about and you attended the New York
Stock Exchange event theres just a lot more interest and awareness about the top line of the
P&L and the impact and power that pricing can have on margins especially.
So, were encouraged by the high level of activity. But its still difficult to get through the
sales cycle, to get budgets approved, and to get final approval for a go-forward. And thats the
reason our proof of value engagements have been successful, and were being flexible on terms and
conditions.
We want to be responsive to the prospect, customer, and what their requirements are, and we are
finding flexible ways to do business. That said, its still very good business. The ASP is still
good; the profitability is still good, but it does slow down the revenue recognition.
Nabil Elsheshai Pacific Crest Securities Analyst
Okay. Would it be fair to say that once you get somebody into a proof of value type of trial
that the close rates significantly higher than a normal sales cycle?
Bert Winemiller PROS Holdings, Inc. Chairman, CEO
Yes.
Nabil Elsheshai Pacific Crest Securities Analyst
Okay. And I think last year you guys had talked about trying different kind of size of deals
and starter packs. And it seemed to take a while for people to get some traction.
Is that just was there a time thing, or was there a different way you guys have approached that,
or is it just a matter of ? And I guess when they do those trials, do they then come back and buy
the full, on average, $2.2 million-dollar average deal, or do they start with a smaller kind of one
module type of thing?
Bert Winemiller PROS Holdings, Inc. Chairman, CEO
No, we havent seen once a company at all levels embraces the very high ROI, they decide
pricing excellence and optimized pricing is something they want to achieve, then they continue to
buy the full contract with multiple modules, and its at the same level of ASP. Its getting them
to the point where theyre comfortable making that decision.
But well offer a single module, its just thats not what they want to buy. In other words, if
they want to find pricing leaks and they want to find a negative pocket margin, customers and
products and channels, thats one step, and we can do that very effectively, and typically in 30
days with Scientific Analytics.
But they see very quickly beyond that the power of optimized price lists, the power of optimized
deals, of tracking to optimized prices throughout the entire enterprise. So even though were more
than willing to start with a phased approach and a single module as the first contract, it just
hasnt happened.
Nabil Elsheshai Pacific Crest Securities Analyst
Okay.
Charlie Murphy PROS Holdings, Inc. EVP, CFO
Nabil, Ill just mention one thing. You had mentioned 2.2. I think historically weve talked
about the average deal being 2.1, 2.2 products in a deal.
Nabil Elsheshai Pacific Crest Securities Analyst
Oh, Im sorry, yes, sorry.
Charlie Murphy PROS Holdings, Inc. EVP, CFO
The ASP averages $1.8 million.
Nabil Elsheshai Pacific Crest Securities Analyst
Right. Okay.
Charlie Murphy PROS Holdings, Inc. EVP, CFO
Thanks
Nabil Elsheshai Pacific Crest Securities Analyst
And then on the term license, I was kind of curious why, with a lot of term licenses and
perpetual models you can recognize the revenue at the beginning of the term, so why do you in these
deals what is it that is conditional that you have to wait till the end of the deal to recognize
any of the license?
Charlie Murphy PROS Holdings, Inc. EVP, CFO
Thats a great question. Yes, companies that do recognize at the beginning of the term, theyd
be on whats called 97-2 revenue recognition. Were under 81-1 percentage of completion.
So the industry or, I should say, the industry looks at PROS as saying, all right, are the services
integral to the delivery of the software? The answer for today is yes; it may not be in the future.
And as a result of that, we come under 81-1, and under 81-1 you have to defer all revenue until all
products are deployed.
Nabil Elsheshai Pacific Crest Securities Analyst
Okay.
Charlie Murphy PROS Holdings, Inc. EVP, CFO
The economics, of course, arent any different, its just how the revenue is recognized.
Nabil Elsheshai Pacific Crest Securities Analyst
Okay. What about kind of the payment and cash flow effects? It should be similar to your
current; that shouldnt change. Is that correct?
Charlie Murphy PROS Holdings, Inc. EVP, CFO
Well, no, if its a term license the payments are going to be made over the term. If its a
perpetual, the payments are going to be made over the implementation period. If that answers your
question.
Nabil Elsheshai Pacific Crest Securities Analyst
Yes. And then, just a follow-up. I guess your kind of wrap-up comments on revenue rec seemed
to indicate that we shouldnt necessarily expect to see the sequential increases on license and
implementation in the second half. Am I interpreting that correctly, or is that not what youre
trying to say?
Charlie Murphy PROS Holdings, Inc. EVP, CFO
I guess were trying to communicate that sales have been good, but when you look at sales and
you look at the other components maybe the composition of the Companys balance sheet and the size
of the receivables and the size of the deferred revenue, we dont want you to misunderstand what
that means.
That means that in this particular case, the mix is such that we see that revenue some of that
revenue being predominantly in 2011. Its too early for us to comment on Q3 or comment on Q4.
Nabil Elsheshai Pacific Crest Securities Analyst
Okay. Great. Ill jump back in the queue then, if theres time. Thanks.
Bert Winemiller PROS Holdings, Inc. Chairman, CEO
Great. Thanks, Nabil.
Operator
Our next question comes from the line of Ross MacMillan of Jefferies. You may proceed.
Ross MacMillan Jefferies & Co. Analyst
Thanks a lot. Charlie, just going back on this revenue recognition two things. How long are
the term deals? Whats the duration of these term deals? And is it really a year a year or a
year and a half, is that why we see it show up next year?
And then second of all, I guess the question is, are there any other you kind of alluded to some
other contractual terms changing which could also push revenue out, albeit that those arent
necessarily term deals? Can you elaborate on that? Thanks.
Charlie Murphy PROS Holdings, Inc. EVP, CFO
Yes, yes. First, the term deals are predominantly five-year term deals. The revenue
recognition would start once the implementation is completed. Then its recognized over the
remaining term; thats the typical term deal.
Ross MacMillan Jefferies & Co. Analyst
So just on that, the first bullet of recognition would be effectively the value that youd
have taken had you recognized revenue ratably over that implementation period?
Charlie Murphy PROS Holdings, Inc. EVP, CFO
No. All the revenue is recognized ratably over the implementation term after the
implementation is completed. Even though cash is being collected, implementation services are being
provided, the accounting does not reflect the economics.
Ross MacMillan Jefferies & Co. Analyst
So just so Im clear, five-year term takes you a year to implement. You then recognize five
years worth of revenue over the subsequent four years, ratably?
Charlie Murphy PROS Holdings, Inc. EVP, CFO
Thats correct.
Ross MacMillan Jefferies & Co. Analyst
And then the other question was on whether there are other contractual arrangements that are
also shifting some revenue out?
Charlie Murphy PROS Holdings, Inc. EVP, CFO
Yes. And thats a great, great point. The answer is yes, that it gets back to challenging
economy, difficult negotiations. I think the power may have shifted more to the customer as opposed
to the vendor.
And what weve experienced is a situation where you could have a term in the contract that
precludes revenue recognition, okay, not on a percentage of completion basis, but revenue is
recognized after the implementation is completed. Its not a term arrangement; its just a term within the contract that prohibits revenue
recognition until the implementations completed.
Ross MacMillan Jefferies & Co. Analyst
Okay. And then as you use third parties increasingly, does that move you from 81-1 to 97-2 if
youre using a third party implementation partner?
Charlie Murphy PROS Holdings, Inc. EVP, CFO
Thats a transition. Thats correct. Thats longer term, and thats the transition we expect
we will be going through. Today were using SIs, as we mentioned, a few implementations theyve
been in for training, theyre becoming more qualified in the implementation of our products.
We have SIs that have started to implement for customers outside of a relationship with us; all of
this is terrific. It really shows that weve got a true product, that its configuration and not
customization. But we as a company have to go through a transition. So over time, we may very well
get to revenue recognition at the time of contract signing not today, not this year, but at some
point.
Ross MacMillan Jefferies & Co. Analyst
Okay, thats great. And then just one other one. You mentioned, of course, that later this
year you plan to reinstate salary increases and 401k contributions. Is that likely to be a third
quarter event, or a fourth quarter event? Can you put any color to that?
Charlie Murphy PROS Holdings, Inc. EVP, CFO
Its clearly in the last half of the year. We havent picked the month that it would start. If
it helps, I can give you some idea of a range on what it would be for a quarter.
Ross MacMillan Jefferies & Co. Analyst
Yes, that would be great
Charlie Murphy PROS Holdings, Inc. EVP, CFO
Okay. It would be somewhere probably close to $400,000.
Ross MacMillan Jefferies & Co. Analyst
Okay. So if it happened midway obviously through Q3 wed have a partial quarter and then a
full quarter in Q4?
Charlie Murphy PROS Holdings, Inc. EVP, CFO
Thats correct. Yes. We havent made the decision yet, but thats correct. Think of it as
maybe $125,000 a month approximately.
Ross MacMillan Jefferies & Co. Analyst
Thats great. Very helpful. And then, just curious. You had the event here in New York in the
quarter. Do those events really build pipeline for you? Is it tangible? And, do you feel like
theres more to be done around marketing or similar, to drive more filling of the pipe and lead
generation?
Bert Winemiller PROS Holdings, Inc. Chairman, CEO
They have been incredibly successful for moving prospects faster along through the sales
cycle. But absolutely, we feel like we need to do more. Thats the reason were investing in sales
and marketing. And thats the full spectrum from lead generation, seminars, webinars, more on-site
face-to-face meetings with executives; being very active in the marketplace.
I think weve been a product driven company for the last ten years and really havent focused on
sales and marketing. Our whole focus has been on high-quality product, integrated science,
implementation success, customer satisfaction. But what were seeing is theres a lot of activity
and a lot of interest and awareness is growing.
And when that manifests itself in deals, we want to make sure that we have the sales and marketing
presence to get into the consideration set, and ultimately be selected. So we are very much focused
2010 is going to see significant sales and marketing activity, much higher than any time in our
history.
Ross MacMillan Jefferies & Co. Analyst
And just so Im clear, the SG&A that was up obviously both SG&A and R&D were up
significantly sequentially, about $1 million apiece. Were there particular kind of one-time costs
for the events in that number that you would not necessarily expect to repeat? Or, do you plan to
just hold more of these on a go-forward basis, so we should assume thats a kind of newer run rate
cost?
Bert Winemiller PROS Holdings, Inc. Chairman, CEO
Year-over-year?
Ross MacMillan Jefferies & Co. Analyst
Sequentially, just in terms of the pickup in SG&A.
Bert Winemiller PROS Holdings, Inc. Chairman, CEO
Well, the whole pickup wasnt $1 million.
Charlie Murphy PROS Holdings, Inc. EVP, CFO
No, it wasnt $1 million, no. No.
Ross MacMillan Jefferies & Co. Analyst
Okay, I must be looking at the wrong thing. But I was just curious well, maybe the real
question just simply is, was there some one-time expense in the March quarter SG&A for these
events?
Charlie Murphy PROS Holdings, Inc. EVP, CFO
No, the answer is no. But there was an event in the fourth quarter that reduced G&A expenses.
Okay, and that was a reduction in our allowance for doubtful accounts that we commented on
Ross MacMillan Jefferies & Co. Analyst
Thats right.
Charlie Murphy PROS Holdings, Inc. EVP, CFO
in the fourth quarter call.
Ross MacMillan Jefferies & Co. Analyst
Yes. That makes sense. That makes more sense now from a sequential standpoint.
Charlie Murphy PROS Holdings, Inc. EVP, CFO
Add that back add that back, Ross, for Q4. It was $600,000. You add that back to Q4
expenses and then do your comparisons.
Ross MacMillan Jefferies & Co. Analyst
Yes, that makes a lot more sense.
Charlie Murphy PROS Holdings, Inc. EVP, CFO
Okay
Ross MacMillan Jefferies & Co. Analyst
Thanks a lot.
Bert Winemiller PROS Holdings, Inc. Chairman, CEO
Thanks, Ross.
Charlie Murphy PROS Holdings, Inc. EVP, CFO
Thanks, Ross.
Ross MacMillan Jefferies & Co. Analyst
Thanks.
Operator
With no further question in the queue, I would now like to turn the call back over to Mr. Bert
Winemiller for final remarks. You may proceed.
Bert Winemiller PROS Holdings, Inc. Chairman, CEO
Thank you, operator. In closing, we are pleased with our first quarter 2010 results, and we
believe the market for pricing and margin optimization software is still in the innovator/early
adopter stage, and there are thousands of companies that would greatly benefit from our software.
We believe PROS is a stronger company today due to the continued improvements in our product suite,
science capabilities, implementation processes, sales and marketing, and we have a strong financial
balance sheet. Our strategic plan is focused on scaling to meet the needs of the large, long-term
market opportunity. Thus, we will continue to focus on our growing pricing partner and influencer
ecosystem.
Thank you very much. We appreciate you taking your valuable time to listen to our call, and we hope
to meet with you soon. Thank you.
Operator
Thank you for your participation in todays conference. This concludes the presentation. You
may now disconnect, and have a great day.