Pros Holdings Inc (PRO) 2007 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2007 PROS Holdings Incorporated Earnings Conference Call. My name is Karen, and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question and answer session towards the end of this conference.

(OPERATOR INSTRUCTIONS)

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Mr. Charlie Murphy, Chief Financial Officer. Please proceed.

Thank you, Karen. Good afternoon, everyone, and thank you for joining us today for the PROS Holdings financial results conference call for the fourth quarter and full year of 2007. This is Charlie Murphy, I'm 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 fourth quarter and year ended December 31, 2007. 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 in 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 different materially from those projected in the forward-looking statements. Please refer to our prospectus, Form 10-Q and other filings with the SEC and the risk factors contained herein.

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.

Thank you, Charlie. And thanks to those of you listening to our call this afternoon. We are pleased that we have exceeded our financial targets in the fourth quarter of 2007, reporting the strongest quarter and year in PROS' history. These results are validation of PROS' proven business model of delivering high return on investment, pricing and revenue optimization software products to our customers and our high visibility revenue model.

PROS' proven track record, proven processes and proven solutions are the keys to our success, and drive our high level of customer satisfaction. The fourth quarter of 2007 marked record revenue, record operating income and positive operating cash flow. Market momentum continues to build for pricing and revenue optimization software products, and PROS continues to capitalize on that momentum.

We are seeing increasing adoption of pricing optimization software products across all of our target industries. Our revenue is diversified geographically across our five target vertical markets, and between business-to-business and business-to-consumer pricing solutions.

We have successfully executed our growth strategy and enhanced our market position of unparalleled experience and expertise in developing high performance, real-time, dynamic pricing technology, embedding world-leading science in our software products, and providing an impressive return on investment to our customers by implementing pricing excellence best practice and PROS' pricing and revenue optimization software.

We believe that the pricing and revenue optimization software industry is still in its early stage, and that PROS is in the center of this shift to science-based pricing from spreadsheets and the current destructive pricing practices. The momentum we built earlier in the year, as a leader in the pricing optimization market, continued in the fourth quarter.

In accordance with our revenue recognition policy, PROS does not recognize any revenue at contract signing. License and implementation revenue is bundled together with revenue recognized using percent completion over the implementation period. Our high visibility revenue model gives us 70% visibility into our revenue target at the beginning of the year, and 90% visibility into our quarterly revenue target at the beginning of a quarter.

Our fourth quarter revenue of $17.8 million was a record, and was up 35% year-over-year. Our full year revenue of $62.1 million was also up 35% year-over-year. Stronger than anticipated revenue drove non-GAAP earnings that were also above plan at $0.15 per diluted share for the quarter, and $0.46 per diluted share for the year.

Bookings for 2007 came in above our expected range of $42 million to $44 million. During the fourth quarter, we saw the factors that have been driving our growth all year continue with the mix of business and some project implementations accelerated, driving higher revenues and profits.

CEOs and CFOs are starting to recognize that traditional pricing strategies, such as cost plus and match the competition, cause unnecessary discounting and destructive pricing practices. The message that a small improvement in pricing can have a large impact on operating profit is resonating with executives who recognize that pricing is one of the most strategic and powerful tools available to them. As executives face market challenges, the innovators will continue to embrace pricing optimization.

PROS' high performance, real-time, dynamic pricing products deliver all the relevant pricing information that a sales person needs to effectively negotiate a transaction at the time the price is quoted and the sales transaction is actually made, which is very different from static retail pricing.

PROS provides the pocket price, pocket margin, customer willingness to pay, customer cost to serve, win-loss ratios, market price, stretch price and all of the other relevant information so our customers can maximize revenue and profitability by using optimized prices. PROS' software products dynamically price millions of individual transactions every day.

PROS' customer base is made up of blue chip customers in each of our target industries, manufacturing, distribution, services, hotel, cruise and airline. While these diverse industries provide a wide range of business-to-business and business-to-consumer products and services, what they have in common is the need to individually price each transaction optimally and dynamically, and to have visibility in the profit leaks from pricing.

PROS is a global company with revenue diversified across geography and our target industries. 63% of our 2007 revenue came from outside the United States. 57% of our 2007 license and implementation revenue came from manufacturing, distribution and services.

During 2007, we signed contracts in each of our target industries. As you know, we do not disclose the number of contracts and the contract dollar amounts. The timing, amount and scope of these contracts drive very different future revenue streams. During 2007, many PROS' customers have achieved significant milestones through implementing PROS' pricing optimization. I'd like to share with you some of those customer milestones.

Clariant, a global specialty chemicals manufacturer based in Basel, Switzerland that does $6.6 billion in revenue, has four divisions, 25 business units, hundreds of thousands of products and over 1200 sales representatives, completed a global deployment of PROS' Pricing Analytics and Execution software products.

U.S. Food Service, a $25 billion food service distributor with a very complex pricing environment, consisting of 3 million SKUs, 400 million transactions, 1.3 million customers and 15,000 sales representatives, successfully implemented Pricing Analytics in 2007 and is in the process of implementing Pricing Execution.

Johns Manville, a leading manufacturer of premium building and specialty products with annual sales in excess of $2.5 billion, operating 46 plants in North America, Europe and China, and has over 9,000 total employees, completed a global deployment of PROS' Pricing Analytics. The Vice President of Marketing stated, PROS' analytics gives us visibility we have never had before into the impact of our pricing actions and insight regarding our customers' purchase behavior, allowing us to make better pricing decisions.

Outrigger Hotels and Resorts deployed the PROS' Hotel Revenue Optimization System and a senior executive with Outriggers said, after careful review of the solutions available in the marketplace, Outrigger chose PROS for its advanced forecasting and optimization capabilities.

The Dollar Thrifty Group is implementing a PROS' Pricing and Fleet Optimization System. A senior Dollar Thrifty Group executive said, the competitive climate continues to demand that we grow revenues while reducing costs. The Dollar Thrifty Group must continue to innovate. We selected PROS based on the strength of the Company's full suite of optimization products.

Finally, Emerald Performance Materials is implementing PROS' Pricing Analytics. Tom Holleran, Emerald's CEO, said, we are partnering with PROS because they are a proven leader in pricing science and a significant source of pricing best practices and software tools. PROS' Pricing Analytic software stops price-based profit leaks by finding the negative pocket margin customers and products. These tools have identified millions of dollars of improved operating profit opportunities for PROS' customers.

As we look to 2008, our growth strategy is to further penetrate our five critical target vertical markets, to sell additional products to existing customers, extend our pricing thought leadership through science innovation and extend our technology leadership through product innovations.

We continue to see large opportunities for our suite of pricing and optimization software within our five target vertical markets. And the number of sales opportunities at new customers continues to expand. We believe our continuing investments in sales and marketing and research and development will bring us new opportunities.

We are thrilled with our fourth quarter and 2007 results. This achievement is the result of the hard work of over 300 employees at PROS who are smart, dedicated people doing great things to bring pricing excellence and high value to our customers. Also, we have a very experienced management team. We feel good about our future prospects and are confident we can capitalize on the market momentum we are experiencing.

Now, let me turn the call over to Charlie so that he can provide you with a review of our financial results and our outlook for 2008.

Thanks, Bert. PROS had a solid Q4 and a full year 2007 from a financial perspective, as well as a business perspective. I will begin with a review of our statement of operations for the quarter and the year, which ended December 31st. Then I will provide some commentary on the balance sheet, [and] cash flow items, before providing you with financial guidance for the first quarter and for the full year of 2008.

As Bert indicated, we are very pleased with our performance in the fourth quarter and for the year. Revenue for the fourth quarter of 2007 and the full year came in at $17.8 million and $62.1 million, respectively, which is up 35% for both the quarter-over-quarter and year-over-year periods, and was approximately $500,000 above the high point of the quarter's guidance range we provided in our last call.

As previously discussed, there can be variability in revenue from quarter to quarter, not as a result of seasonality, but rather the timing of when an implementation starts or finishes, the implementation effort needed and the contract size. In the fourth quarter, the mix of business and some project implementation accelerations contributed to exceeding the guidance. We're very pleased.

I'll be discussing the statement of operations information 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. In accordance with our revenue recognition policy, PROS does not recognize any revenue at contract signing, license and implementation revenue is bundled together, with revenue recognized using percentage of completion over the implementation period.

Within revenue, license and implementation revenue was $12.6 million for the fourth quarter of 2007 and $43.2 million for the full year, or 71% and 70% of total revenue, respectively. This is up 40% over the fourth quarter of 2006, and 46% year-over-year, respectively.

Maintenance and support, which makes up the balance of revenue, was $5.2 million for the fourth quarter of 2007 and $18.9 million for the year, up 23% over the fourth quarter of 2006 and 15% year-over-year, respectively.

Our revenue is diversified geographically across our five target vertical markets, and between B-to-B and B-to-C pricing and revenue optimization solutions. Our revenue generated outside the United States remains strong at approximately 63% in 2007. In addition, approximately 57% of license and implementation revenue was in manufacturing, distribution and services in 2007.

On a non-GAAP basis, gross profit was $13.1 million and $44.4 million for the fourth quarter 2007 and the full year, respectively, yielding gross margins of 73.6% and 71.5%, respectively. This compares to gross margins of 67.1% for the fourth quarter of 2006, and 66.1% of year ended 2006. We are pleased with the improvements in gross margins.

Improvements on our implementation processes and the continue standardization of our products have contributed to improving license and implementation margins. As previously communicated, gross margins may vary from period to period, depending on factors such as the amount of implementation services required to deploy our products relative to the total contracted price.

Margins have been improving. However, our 2008 guidance is not based on the rate of increasing margins experienced in 2007 because, while the overall trend for gross margins are up, we can't be certain that the previously-mentioned factors, which contributed to 2007 gross margins will have as much of an impact in 2008.

Non-GAAP R&D expense was $4.2 million for the quarter, and $16.3 million for the year, up 28.1% over the fourth quarter and 57.7% year-over-year, respectively, as we continue to invest in our pricing and revenue optimization software products suite. R&D for the year represented 26.3% of total revenue, compared to 22.4% of total revenue in 2006.

R&D spending started accelerating in 2006 following the increase in market momentum experienced in 2005, to take advantage of the growing market opportunity for pricing and revenue optimization products. We expect R&D spending will increase in future periods.

Non-GAAP selling, general and administrative expenses for the fourth quarter of 2007 and the full year were $4.5 million and $15.5 million, respectively, and were up 38.9% over the fourth quarter of 2006, and 16.8% year-over-year. SG&A expenses increased for the year largely due to increased marketing and personnel expenses and some public company costs we are now incurring.

We expect SG&A costs will continue to increase in future periods with higher SOX compliance costs in 2008, a full year of other public company costs, and increases in sales and marketing to take advantage of the growing market opportunity for our products.

Non-GAAP operating income was $4.4 million for the quarter, and $12.6 million for the year with non-GAAP operating margins of 25% and 20.3%, respectively. These results are above our previous guidance.

Revenue exceeded the high point of our quarter guidance by approximately $500,000 contributing approximately 2.5% to the increase in operating income. Expenses were lower than expected which contributed 4% to the increase in operating income. Included in the 4% was a one-time item equal to 2%. This compares to operating income of $2.4 million in the fourth quarter of 2006 and $6.8 million for the year, and operating margins of 18.1% and 14.8%, respectively, in those periods.

In absolute dollars, operating income increased $5.8 million, for the 2007 year over 2006 or 85%. The improvement in non-GAAP operating income from a year ago was principally attributable to higher gross margins.

On a non-GAAP basis, other income and expense was a net inflow of $1.2 million for the year ended 2007, primarily interest on our cash balances. Note that our GAAP interest expense for the year includes the expensing in the third quarter of $397,000 of deferred financing cost in connection with repayment of a debt facility that has been retired.

Our non-GAAP effective tax rate is 19.7% and 20.3% in the fourth quarter of 2007 and for the full year, respectively, compared to 19.7% for the fourth quarter and year ended 2006. Excluded in our non-GAAP tax expense for the year is a benefit recorded in the third quarter of 2007 of $1.1 million, due to the reversal of a valuation allowance previously recorded against our deferred tax assets. Our effective tax rate, historically, has been lower than the statutory rate of 35%, largely due to the application of general business tax credits.

While the non-GAAP effective tax rate for the year was 20.3% for 2007 and 19.7% for 2006, as we discussed in our last call, we expect that 2008, our effective tax rate will increase to approximately 28%. This is due to the utilization of research and experimentation tax credit carry forwards in 2007, and to the higher levels of pre-tax income in relationship to research and experimentation credits earned going forward.

There is another item -- another tax item, to mention. Congress recessed for 2007 without extending the R&E tax credit which, therefore, expired on December 31, 2007, even though there was a strong bipartisan support for the credit. The credit has expired a number of times since it was originally enacted in 1981, and each time, except for a brief period in 1995, it has been retroactively reinstated.

If the tax credit is reinstated during 2008, as we expect, and if it is retroactive to the beginning of the year, as has been the case in the past, then we'll make accumulative adjustment in the quarter in which the law was reinstated. For modeling purposes, we feel it's reasonable to use a pro forma tax rate of 28% for 2008, expecting the past 26 years of experience of extending this credit will continue going forward. If it is not extended, our effective tax rate will be 35%.

Non-GAAP net income was $4 million for the quarter and $11 million for the year, compared to net income of $2.3 million for the fourth quarter 2006 and $7 million for the full year of 2006. Non-GAAP net income per diluted share exceeded guidance and was $0.15, compared to $0.11 per diluted share in the fourth quarter of 2006. For the full year, net income per diluted share was $0.46, compared to $0.32 for 2006.

2006 reflects a lower pre-IPO share count of 21.1 million shares for the quarter, and 20.6 million shares for the year. 2006 earnings per diluted share for the fourth quarter and year would have been $0.08 and $0.28 using the post-IPO 2007 weighted average shares outstanding for comparability.

The previous information has been reported on our non-GAAP operating results because we believe that excluding certain non-cash items, such as stock-based compensation, deferred financing costs, the reversal of a valuation allowance against deferred tax assets and other one-time items, provides you the best indicator of the health of the overall business. Also, this is how we measure the success of the business internally.

That said, we appreciate that investors also need to analyze our results on a GAAP basis. So, we have provided a reconciliation of the GAAP results and non-GAAP results as part of the earnings release.

For the quarter ended December 31st, our income from operations, in accordance with GAAP, was $3.8 million, compared with $2.4 million for the same period in 2006. Net income in the quarter was $3.5 million or $0.13 per diluted share, compared with $2.3 million or $0.11 per diluted share in the fourth quarter of 2006.

The year ended December 31st, GAAP operating income was $11 million, compared to $6.8 million in 2006. GAAP net income in 2007 was $10.5 million or $0.45 per diluted share, compared with $7 million or $0.32 per diluted share in 2006.

Moving to our balance sheet, we ended the year with cash and equivalents of $44.4 million. Accounts receivable at the end of the year were $14.9 million, unchanged from the prior quarter. Trade accounts receivable days of sales outstanding were approximately 70 days, which is in line with our typical DSOs. Accounts receivable balances can vary in a quarter based on the timing of invoicing and milestone billings under our contracts, which may vary from quarter to quarter.

Total deferred revenue at the end of the year was $26.1 million, compared to $26.2 million at the end of last year. As with receivables and cash flow, deferred revenue can fluctuate on a quarter-to-quarter basis depending on the timing for milestone billings under our contracts. Because deferred revenue is not tied to total contract value, we do not believe it is a meaningful forward indicator.

Let me turn to cash flows. Our operating cash flow in the fourth quarter was $3.3 million. For the year, operating cash flow was $10 million, compared to $13.5 million in 2006. As with receivables, there is variability in cash flow as it is impacted by the timing of invoicing for milestone billings under our contracts which can result in some quarter-to-quarter lumpiness.

Capital expenditures for the year were $1.7 million, which included expenditures to expand our existing facility. For the year ended 2007, we exceeded the high end of our bookings guidance range of $42 million to $44 million. Overall headcount at the end of the year was 342, compared to 300 a year ago, as we continue to increase staffing throughout the organization in order to support our continued growth.

Now, let me turn to our guidance for the first quarter of 2008 and full year. For the first quarter of 2008, PROS anticipates total revenue in the range of $17.5 million to $17.8 million, representing a growth rate of 31% from 2007 at the mid-point of our guided range.

We are projecting non-GAAP operating income of $3.2 million to $3.4 million. And we are anticipating non-GAAP net income of $2.6 million to $2.8 million and non-GAAP diluted earnings per share of $0.10, based on estimated fully diluted share count of 26.8 million shares and an effective tax rate of 28%. The 2007 earnings per diluted share for the first quarter would have been $0.09 using 2008 weighted average shares outstanding.

Non-GAAP operating income and net income for the first quarter excludes estimated FAS 123-R stock option expense of approximately $800,000. For the full year 2008, we expect total revenue in the range of $76 million to $78 million, or growth rate at the mid-point of 24% compared to the prior year. We are projecting non-GAAP operating income of $14.9 million to $15.7 million. We are projecting non-GAAP net income of $12 million to $12.6 million, and non-GAAP diluted earnings per share of $0.45 to $0.47.

Non-GAAP operating income and net income for the year excludes estimated FAS 123-R stock option expense of approximately $3.6 million. Diluted shares outstanding at the end of the year are estimated at 27 million. The 2007 non-GAAP earnings per diluted share for the full year would have been $0.40 using estimated 2008 weighted average shares outstanding.

As a public company for the full year, we'll be incurring public company costs including higher audit and legal fees, Director's compensation, Director's and Officer's insurance and SOX compliance cost. These costs have been factored into the operating income guidance I just provided.

The first quarter and full year guidance is based on our current expectations. Our full year bookings forecast for 2008, is a range of $53 million to $55 million. Our bookings forecast does not include maintenance revenue.

With that, let me turn the call back to the Operator so that we can take questions. Operator?

(OPERATOR INSTRUCTIONS)

And your first question comes from the line of Adam Holt with JP Morgan. Please proceed.

Hi, guys, and congratulations on the quarter.

Thank you.

Thank you.

I had a couple of questions about the assumptions underpinning the revenue and bookings guidance for 2008. First of all, can you talk a little bit about sort of the direct sales assumptions and your plans for expanding direct sales to underpin the bookings guidance? And then, also, can you talk a little bit about what your expectations are for the macro environment as well as any other assumptions that drive that number for next year.

Absolutely.

That's fine. That's fine. Yes, regarding the headcount, we had mentioned, I think on previous calls, that from a sales standpoint, we generally don't break out headcount for the entire organization. But we have communicated that the sales group, which really consists of all areas. It includes the sales personnel, solutions consultants, business development and marketing.

We had 29 people at the end of the 2006 and we just finished 2007 a little over 40 individuals in that group. And we've also indicated in the past, we continue to expect we'll be increasing the sales group. And currently, we're on target with our plan for headcount for this group during the first quarter of this year.

Yes, Adam, that's a great question. 2007 was a terrific year. The Company exceeded our expectations in all areas. And we really felt a lot of momentum building through the year, where we exited 2007, our market position very strong. We believe our competitive position is improving. As you know, the sales are at the CEO, COO level.

And the overall trend toward adopting analysis and pricing optimization software was clearly accelerating through 2007 because of it improves profitability and it has a relatively short payback period. We do recognize the general sense of caution about the economy. We haven't seen any recognizable change in the demand for our high return on investment products. We haven't seen any indication of a slowdown.

As you know, we're very rigorous and very thorough and we have numerous metrics that we use to monitor and assess the business. We look at all of these metrics and try to anticipate what could happen. And we believe the momentum is building and our confidence and optimism about growth prospects in the future is high.

Now, that said, while we have not seen any economic impact, it is possible that customers and prospects could slow the sales process if economic conditions don't show some signs of improving. And we've taken this into account on our full year guidance. Our high visibility revenue model gives us tremendous visibility. And we're looking at the near term with great confidence. But we're very aware of the economic conditions and the concern that executives have.

So, to kind of summarize, we haven't seen any slowdown in our business. All the metrics we use to monitor our business would indicate a positive outlook for the future. But we are cognizant that there's this looming economic issue out there. And so we're taking that into consideration.

And if I could just ask a couple of follow ups on the top line trajectory. So, presumably, as with previous bookings guidance, we should expect that there are not any materially large deals in that guidance.

And then, secondarily, you talked a little bit about deferred revenue and the relationship with revenue as it not being entirely indicative or directionally accurate as an indicator. However, how should we be thinking sort of generally about deferred revenue next year? Should it grow roughly in line with revenue? Should it grow roughly in line with bookings? How should we be thinking about that?

I think let's talk about the deferred revenue first. 2007's deferred revenue relative to the yearend 2006 was basically flat all year long. And the reason for that, I think as we explained before, is that in 2006, we had some very unusual situations where we were able to do some billings on some contracts that were closed that drove the cash flow from operations in the fourth quarter of 2006 above 50%.

Therefore, it also drove the deferred revenue up substantially into an abnormally high deferred revenue net worth at the end of 2006. So, all through 2007, the comparisons really didn't make much sense. They didn't relate to each other. In fact, if I backed off the 2006 yearend deferred revenue number, kind of normalized it, you would have seen a nice growth in deferred revenue in 2007 over 2006.

That gets to why it's really difficult at comparability, 'cause you can get these contracts -- between the contracts closing and the timing of the milestone billings, you can really get some movements from one quarter to the next and, in this case, year-over-year.

Going through 2007, I would expect we're going to see the same thing. I think you're going to see one quarter, you're going to see some variability in deferred revenue where it's moving up, perhaps on an accelerated rate. Then another quarter, it moves down. And it really does get to how much is the initial payment on a contract that's closed which has a lot of variability in it and what are the timing of the milestone payments, which has variability as well. So, it's just not a good indicator of our forward business.

Yes, the deferred revenue is not tied to the total contract value. And it's not tied to anything internally that we would use as a metric on the margins related to that particular business. So, and we don't see that changing. There's just no relationship between deferred revenue and our overall strength of the business.

Adam, regarding big deals, I know you're referring to the situation a couple of years ago. There are no big deals of that order of magnitude that we have in our plan nor would we put big deals in a plan.

Terrific. Thank you.

And your next question comes from the line of Thomas Ernst with Deutsche Bank. Please proceed.

Yes. Actually, this is Greg Dunham on behalf of Tom. Looking at the income statement, the mix of license revenues has increased steadily over the past few quarters and was a little higher than we were expecting. Should we expect this trend to continue? Or, how should we expect looking forward in '08?

You're referring to the mix of license versus maintenance revenue?

Yes.

Yes. Well, I think, as we've said in the past, the maintenance revenue has been lagging the growth in license implementation revenue. And that's been true for an extended period of time now. I think, going forward, what you'd expect is to continue to see growth in license and implementation. But I think you'd expect to see some more maintenance growth. So the disparity between the two, although will continue to be disparate, license implementation will grow faster, will narrow a bit.

Okay. That helps. And then on the operating expense side, because really I want to get to the margin targets you've set for next year. I mean, are you expecting the significant portion of the increase to be more in SG&A due to the SOX and increased sales and marketing, more so than the R&D?

Both areas will increase in spending. The R&D will increase as well as the SG&A. The reason I emphasized the SG&A is because we do have a full year of SOX costs. We do have a full year of public company costs, and sales and marketing continues to be an area that, obviously, we're emphasizing as we go through 2007 and 2008. But both areas will increase. Relative percentage increases, I'd agree with you, likely sales and marketing over sales marketing, SG&A over R&D.

Okay. Thank you very much.

And your next question comes from the line of Tom Roderick with Thomas Weisel. Please proceed.

Hi, guys. Good afternoon.

Hey, Tom.

Hey, I just want to follow up on Greg's question there just a minute ago. You indicated with respect to your margin targets for next year, you've also outperformed handily your last couple quarters on your margin targets. What would need to happen from either a gross margin or operating expense standpoint next year to continue to exceed?

Is it your view that the profitability of certain contracts has just hit a level that's not necessarily sustainable for the near future? Or, are you just trying to be a little bit conservative in your view towards that?

Tom, I think that's a good question. I think we'd first like to start with is that we continue to see a big market opportunity ahead of us in pricing revenue optimization, the ah ha moment where the CEO says they really need this application. So, we're going to continue to invest as we go through 2008 in all areas of the Company.

So, we're not necessarily trying to drive to an operating margin number that would be at the expense of taking advantage of the big market opportunity ahead of us. So, when you say what is it, it's the opportunity -- I think, if anything, it would be sales. Can we perhaps drive sales to a higher level, which we're not suggesting we put the guidance out there. But we are planning on spending to take advantage of the opportunity.

Yes, we're getting, as we have mentioned in the past, as we continue to penetrate our target industries, we get more efficient, more effective. We're able to capitalize on our platform, our pricing solution suite platform. And that leverages very effectively into driving incremental value for our customers. Plus, we're implementing tools and capabilities within the platform to facilitate a quicker time to value and more automate the implementation process. So, we're going to continue to do all of those things.

But what we've communicated to our investors consistently is there's a big market opportunity out in front of us. And we don't want to be squeezing cost to chase margins at the expense of doing the R&D investment, the sales and marketing investment to capitalize on that big opportunity.

Great. Thanks, Bert. And I want to follow up just with a quick question here. You indicated you are getting more efficient and more effective in some of these new verticals that you've been targeting. Can you just give a little bit more anecdotal evidence or any numbers that you can share around the vertical breakout this quarter as evidence of what's going on in some of your newer vertical efforts?

That's a great question. We wanted to share some of the customer milestones and I had quite a few more that I wanted to share. But I was advised that it would take up too much time on the call. But, we're seeing momentum in every one of our target markets.

And I specifically mentioned manufacturers, both process and discrete. I mentioned a large distribution company. So, we're seeing that the innovator, the early movers, the first movers in these markets fully appreciate pricing excellence. They look at innovation as a way to mitigate the risk of a macro economic challenge and we've seen this quite often.

So, what we would say to you is over the course of the year, we were very pleased with the momentum and the increased penetration we got across all of our target markets. That said, quarter-to-quarter, it can vary a little bit. There's different adoption rates. But we're focusing on all of those.

We have professional services, experienced staff now in every one of those industries. We have industry domain experts that provide the capabilities to configure our software in the optimal way for each one of those industries. We have scientists now that are focused on specific industry-related science implementations and configuration.

So, we feel good about the target industries that we selected a number of years ago. We have a good blue chip customer base in each of those industries. And we're continuing to see momentum in every industry. So, we're very pleased with where we are.

Bert, any target to exact new verticals in 2008?

Not while I'm CEO. Not in 2008 or not any time soon. And the reason, very simply, is that the kind of problems we solve, the high performance, real-time, dynamic pricing for sales forces, contract negotiations, single transaction deals, multiple transaction deals, e-commerce transactions, where you have to supply an optimized price in 200 milliseconds.

All of the things that we do particularly well, from a high performance technology standpoint and from a science standpoint, those pricing problems are the problems that the CEOs and CFOs in manufacturing, distribution and services have and been recognized in hotel, cruise and airline. So, we see a big market opportunity.

There's just -- there's over 800 manufacturers, 500 million and up in the United States. The penetration is virtually nil. All of these companies are using spreadsheets. So we see a very big opportunity in front of us. And down the road, when we're a $10 billion company, maybe we'll entertain a new industry, but not any time soon.

Okay. Thanks. That's great.

And your next question comes from the line of Richard Davis with Needham & Company. Please proceed.

Hey, thanks very much. So, you're spending more on R&D, so imagine if I'm a sales person for you, what kind of new versions, modules or upgrades should I be expecting to come down the pipe that'll help me make my quota and help me make Club?

There you go, Richard. We -- that's a great question. The way the platform is architected is with a single set of source code that can be configured for each customer. And we actually create data like pocket margin, pocket price, win-loss ratios, willingness to pay, that doesn't exist in any other systems.

So, what we've built is this platform and our development team and our science team have worked cooperatively to facilitate what we call our time to marketing initiative which means new releases are coming out every three or four months.

Now, these new releases will involve enhancements to analytics; enhancements to execution; enhancements to the optimization and the science capabilities; statistical analysis, even more innovative market segmentation, customer profiling.

So, there are lots of things that are coming out on a regular basis. But the way to think about it it's a platform release of new capabilities that are made available to all of our customers across these industries because they're all in need of solving the same kind of pricing problems.

Now, for our sales force and our domain experts in every industry, what happens is our product management group, and we pride ourselves on world-class product management and our time-to-market initiative, they have a very rigorous process that takes into account current users. We have a User Advisory Board.

Internal tools that can help us with time-to-value and then the highest value features and functions that are being requested by the marketplace and by our existing customers and that all goes through a scrum process, daily scrums and release scrums, that then is sorted out to a value versus effort set of ratios in terms of what's coming out in the next release.

Now, once that decision is made, then that is communicated to all of our sales people. And, of course, they're constantly standing up and giving development standing ovations and doing cartwheels, recognizing that what we have is terrific and delivers a high return on investment. But it's consistently being enhanced and it's being enhanced in a way that the benefits of those enhancements can be realized by all of our customers across all of our industries.

I think that's one of the areas that is truly unique to PROS, a really powerful capability of PROS that we can leverage our single source code platform development with new releases coming out every three or four months across our entire customer base. That is a very powerful capability.

And I actually think you're right 'cause I talked to a bunch of the other companies in your space. And I think that's an accurate assessment. So, thanks very much. I'm all set.

Okay. Great, Richard.

Again, to ask a question, please press star one. And your next question comes from the line of Nabil Elsheshai from Pacific Crest Securities. Please proceed.

Hey, guys, thanks for taking my call. Quick question on kind of your commentary on the macro and your assumptions. You're saying you're being conservative. Last time we went through a downturn, you guys were much less diversified.

Do you view that as a good guide? Or, do you think price optimization has reached another level of adoption where maybe things won't be as bad this time? And then kind of, is there any color you can give us on your assumptions in terms of being conservative in terms of -- I don't know if you're talking about win rates changing or something like that?

Yes, Nabil, that's a great question. Well, we have a very experienced management team that has managed through economic cycles, at PROS and long before PROS, although we wouldn't call post-9/11 an economic cycle. That was a terrible tragic event that affected all of us.

Sure.

Now, I think, to answer your question and to understand the kind of metrics that we use, when we're looking into a year, we're looking at our maintenance component where we have a world-class renewal rate of 96% and annual increases, price increases on that maintenance. We also have our license and implementation revenue. But one-third of that license and implementation revenue comes from our existing customers.

Yes.

It's either incremental scope for an existing product they have or a new product that's going in. Well, once they deployed their first product, once deployed, stays deployed, very sticky, high return on investment. Then they become committed to the additional extension of that product and to new divisions, new geography or a new product.

And the sales cycle is really just part of -- it's like an extension of the project plan of the initial product deployment. So, one-third of our revenue comes from our existing customers and it's just a planned further implementation of PROS' software products throughout their enterprise.

Now, the other two-thirds is the new name business. And that's where we're focusing very -- our sales effort -- first of all, the add-on business into our existing customer base is part of our professional services team's responsibility because they already have the relationship with the customer.

Now, new name business is the responsibility of our sales team and that's outside quota-carrying sales territory professionals that are just superb in pricing excellence; inside sales people, a marketing team, a sales solutions group with industry expertise. They're focused on the new name business. We have a very specific and finite target market. And we know every company in those markets. We already have a database with all of those. We market to those companies. We have webinars. We've got our pricing summit coming up in April.

So, what we're doing is we're monitoring the activity of the suspects in a very quantitative, with detailed statistics. What's going on in the suspect community? Then, based on very specific quantifiable metrics, how do they move to a C prospect. Then a B prospect; then to an A prospect and then to a forecastable prospect.

So, as we're monitoring all these metrics, we're able to clearly see, in a quantifiable way, how is that sales pipeline developing over time and how does it look relative to the past. And what we communicated in our script was that all the metrics we see would indicate that we're not experiencing a macro economic slowdown at this time.

Now, we have had customers that has been counter to doom and gloom economy where innovator CEOs say, hey, I got to do something. I'm not just going to take less volume and deep discount. I actually want to segment my market. I want to find the pocket price. I want to find ways to improve and consequently, we need price optimization. We've had a number of CEOs that looked at it as a way to mitigate the risk of macro economic conditions.

What we do is we look at all of that. We analyze it. We take all of the metrics and then we say well, how does each one of these revenue components look. We take our high visibility revenue model. We do a statistical analysis.

And then we come up with what we think is prudent for the business and that management has confidence that we're going to be able to deliver and that we effectively communicate to the investment community. And that's exactly what we did at the IPO. It's what we did at the secondary, and it's what we're doing on this call.

Okay. Thank you. And then if I could flip to the implementation and license margins real quick. So, obviously, you guys have said you don't expect the same rate of increase. But you've been at 73%, I think the last two quarters. If you look at the utilization within the services folks, is that a sustainable level of margins? Or, are we talking about increasing off of there? Or, are we talking more kind of the 70% that you had for the full year?

We are going to be increasing the professional services group to work on the implementations. We're doing that. We're increasing staffing across the entire organization. So, we are doing that. In the first quarter of 2008, a little more pressure comes in because expenses do go up in the first quarter of the year compared to the fourth quarter for us.

I'm sure for other companies, as well, because there are some expenses, costs, such as just employer's share of Social Security taxes and such. It many not sound like much, but it's actually a substantial increase because basically for a company like PROS at our average compensation, those taxes are finished by the time we get into the fourth quarter of this year.

Or, if not, they're substantially finished by the fourth quarter of this year. So, we do get some added pressure on our operating margins in the first quarter of the year compared to, say, the fourth just because of things like taxes, whether it's FICA, SUTA taxes. Those increases do put some additional pressure on the first quarter of the year for us.

But, beyond that, I think the margin improvements have been very good, not just this year, last year. And we do expect to see some improvements in margins. But we want to be very cautious and guarded about expecting the kind of improvements we experienced in '07 to continue in '08.

Okay. Thank you very much.

Thank you.

There are no additional questions at this time. I would now like to turn the call over to your host for today.

Well, thank you all for participating. We're thrilled with our results. We look forward to 2008, and we look forward to meeting you at Investor conferences, or if you attend our PROS Pricing Excellence Summit in April. So, thank you very much, and we'll see you soon. Bye.

Bye.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.