Pros Holdings Inc (PRO) 2009 Q4 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Q4 2009 PROS Holdings Incorporated Earnings Conference Call. My name is Derrick and I'll be your operator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions). As a reminder, this call is being recorded for replay purposes.

I would like to turn the call over to your host for today, Chief Financial Officer, Mr. Charlie Murphy. Please proceed, sir.

Thank you very much, operator. 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 2009. I'm 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 full year of 2009, 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 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 forms 10-Q, 10-K and other filings with the SEC in the risk factors contained therein. 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 distributed earlier today and can also 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. With the challenging 2009 behind us, we are proud that PROS is a stronger company today than we were one year ago. We have made great progress on our strategic initiatives that will position us to serve the large long-term market opportunity or our high return-on-investment software products.

We remain focused on our strategic goals of shortest time to value, highest ROI, lowest total cost of ownership, and high customer satisfaction. We believe PROS is a stronger company due to the improvements in our product suite, real-time integrated science capabilities, release management, quality assurance, and automation of our implementation processes. In addition, our partner and influencer ecosystem continues to expand and we have a stronger balance sheet.

We are particularly pleased that we have not had a layoff and have enhanced our relative competitive position. We are pleased with our financial performance in the fourth quarter of 2009 and for the full year where we delivered a solid performance given the economic environment.

For the fourth quarter, we are reporting revenue of $16.9 million, an increase over the third quarter. Non-GAAP operating income was $3 million for the fourth quarter. EPS for the fourth quarter was $0.09, which exceeded our expectation, and full year 2009 EPS was $0.36.

PROS is a global company with revenue diversified across geographies and our target industry sectors. We believe our diversification and multiple dimensions provides us with the competitive advantage in the pricing and margin optimization market. Revenue that came from outside the US represented 58% of our 2009 revenue and 52% of our fourth quarter license and implementation revenue came from our target industry sectors of manufacturing, distribution and services.

As we have stated on our past conference calls, we believe the market for pricing and margin optimization software is still on the innovator early adopter stage, and the Gartner group has stated that market penetration is in the low single digits. We believe there are thousands of companies that have complex pricing problems and can benefit from implementing our high-value pricing and margin optimization software products. We also believe there is a multibillion dollar market opportunity.

PROS proven track record, proven processes, and proven solutions are the keys to our long-term success and drive our high level of customer satisfaction. Innovative executives are recognizing that improving pricing is one of the most strategic and powerful tools available, and it is resonating that a small improvement in price can have a large impact on operating profit.

A recent example of the increased focus on leveraging the huge investments that companies have made in ERP, SCM, CRM systems is a press release from IBM which discuss the results of a global study of more than [2,500 CIOs]. The press release stated leveraging analytics to gain a competitive advantage and improve business decision making is now the top priority for CIOs. More than four out of five survey respondents identified business intelligence and analytics. The ability to see patterns in fast amounts of data and extract actionable insights is the way they will enhance their organization's competitiveness.

In addition, a Wall Street Analyst survey revealed that 25% of CIO survey said pricing was a top IT priority, up from 16% in July of 2009. We believe more companies will turn to proven science-based pricing and margin optimization solutions in the future as the awareness of the high return on investment of pricing optimization software increases. As a leader in the pricing and margin optimization software market, we also believe PROS is in the center of this shift from current destructive pricing practices and spreadsheets to science-based pricing.

As we mentioned on our last call, the increased recognition of the value of pricing, increased analyst coverage, and third-party interest in pricing is creating a viral network interest in pricing optimization. An evolving component of our strategy has been the strengthening of our relationships with the number of companies and our partner and influencer ecosystem to increase their knowledge of PROS product offerings and the power of science-based pricing software.

Our strategic plan is focused on scalability to meet the large future market opportunity as we move from the innovator early adopter phase to mainstream, and eventually, to a must-have application. We are growing our pricing partner and influencer ecosystem as we expand our work with industry analysts, strategic consultants, technology providers and system integrators.

We have a small number of implementations where we certified third party system integrators on the configuration of our software. We are also working to lower the total cost of ownership for our customers and to enhance automation of our configuration capabilities such that a significant portion of the reduced labor content can be done by third parties or the customer.

PROS is proud to have attained gold certified status as an independent software vendor in Microsoft's Partner Program. This is a key component of our low total cost of ownership initiative and as a customer shared with us, and I quote, "The tight integration between PROS pricing software and Microsoft SQL server gives us superior application performance and cost savings on the magnitude of over $1 million."

We are continuing our focus on sales and marketing to position us to take advantage of the large long-term market opportunities as the economy improves. As we mentioned last quarter, Chris Jones recently joined PROS and serves as our Chief Sales Officer for our Manufacturing, Distribution, and Services Industry sectors.

This quarter, we are pleased to announce to have strengthened our marketing team with the addition of Tim Girgenti who serves as Chief Marketing Officer for our Manufacturing, Distribution, and Services Industry sector and leads our Corporate Marketing and Partner Program. Tim brings valuable leadership experiences of technology, company marketing executive, who will focus on increasing PROS awareness, sales support programs, and significantly increasing demand. His wealth of experience will add significant value to our marketing efforts.

To increase the awareness of our high ROI software, we're planning to participate in a number of high profile marketing events. In addition to sponsoring the Microsoft Global High Tech Summit and the National Association of Wholesalers Major Distribution Industry conference, we have a full schedule of our Regional Pricing Excellence Summits. In 2009, we had a nearly 50% increase in the number of prospects attending our events over those that attended our once-a-year Pricing Summit in Houston previously.

We plan to continue to host regional pricing excellence events around the globe, as well as in major cities in the United States, the first of which will be at the New York Stock Exchange in March entitled, "Pricing Your Way to Recovery, What Every Executive Must Know About Managing Margin in 2010." The event is endorsed by Accenture, Microsoft, and the Professional Pricing Society, and will feature presentations by pricing practitioners for major manufacturers and distributors.

We 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 26.9% of revenue for the full year. Investments in R&D have led to advances and customer-specific configuration technologies which tailor the software via configuration rather than custom coding which allows each customer to begin realizing value from the PROS software very quickly, win customer in 12 days.

Our new customers continue to uncover millions of dollars of actionable ROI in the first 30 days of an implementation. Tome to value is top priority at PROS. We are also proud that another customer had a successful production cut-over of our Scientific Analytics and Price Optimizer product in just a few months.

On the product front, our continued investment in R&D has helped to improve our product suite scalability, shortened the time to value for our customers as we provide industry-specific solutions and decreasing the time to market for new product enhancements.

In 2009, we had three releases of our Pricing Solution Suite at 100% of our customers using these products installed and available upgrade. Our continued investment in R&D, our common code platform methodology, allows us to make rapid enhancements and innovations that continually increase the return on investment for our customers.

PROS Pricing Solution Suite enables companies to unlock the value hidden in their data and increase the ROI of existing investments with real-time integrated pricing science capabilities. Innovation's aimed at improving margins, increasing pricing agility and accelerating ROI includes offline deal management through integration with Excel and -- excuse me -- real-time guidance for product complements and substitutes.

Manufacturers interested in pricing configurable and made-to-order products will benefit from our innovative modeling techniques while distributors using advances at segmentation and price guidance capabilities can realize significant basis-point improvements in margin. Additionally, market basket analyses allow both manufacturers and distributors to improve margin by identifying and recommending upsell opportunities.

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. To that end, some prospects are using a Start Smart or Proof of Value PROS engagement to provide concrete return on investment for business users to obtain financing for a production system purchase.

In one recent example of how we are helping the prospects business team, PROS conducted a five-week science study that demonstrated and estimated over $20 million of pricing profit opportunity. Our team identified pricing-based profit leaks and destructive pricing practices that cause price erosion.

CEOs, CFOs and COOs who are the ultimate decision makers for our pricing software have been focused on broadly reducing cost. In the second half of 2009, we saw sales stabilize making us incrementally more confident. Additionally, implementation projects are proceeding on schedule, and maintenance renewals continue with best-in-class maintenance renewal rates.

While sales-related activity levels continue to be good with increasing participation by prospect at our sales events and webcasts, translating this interest into bookings continues to be challenging as sales cycles continue to be long and approval processes are more rigorous.

In summary, we are pleased with our operating income and EPS for the fourth quarter and that our revenue increased sequentially in the fourth quarter of 2009 given the macroeconomy's continued pressure on our prospective and existing customers. We believe that our market leadership position, PROS will 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 product.

This achievement is the result of the hard work of 400 smart, dedicated people doing great things to bring pricing excellence and a high value to our customers. 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 2010, we intend to continue to make strategic investment while maintaining our historical track record of 10 years of profitability and positive cash flow. We will continue to be prudent about our spending in this economy. But with a strong balance sheet, we are in a unique position to invest in our products, processes, and sales and marketing to improve our relative competitive position as a leading vendor in the pricing and margin optimization market.

Now, let me turn the call over to Charlie so that he can provide you with the review of our financial results and our outlook for the first quarter of 2010.

Thanks, Bert. I will begin with a review of our financial results for the quarter and the year which ended December 31st, 2009. Then, I will provide some commentary on the balance sheet and cash flow before providing financial guidance for the first 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 fourth quarter with revenue for the quarter at $16.9 million, near the high end of our guided range for the quarter of $17 million. We're also pleased that after three quarters of decreasing revenues, fourth quarter revenue of $16.9 million was an increase over the third quarter revenue of $16.5 million. The full year, revenue was $68.8 million compared to $75.6 million in 2008.

We also have another quarter in full year of positive cash flow and we ended 2009 with a strong balance sheet. EPS for the fourth quarter of 2009 was $0.09, exceeding guidance, which I will explain, and the full year EPS was $0.36.

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.

There can be variability in license and implementation revenue from quarter-to-quarter, not as a result of seasonality but rather the implementation effort needed in relation to the contract value, the number of ongoing implementations, the number of products being deployed, and the timing of when an implementation starts or finishes. With the number of active implementations in the quarter and our subscription in the high maintenance renewal rates, we have good visibility in the near term revenue.

Maintenance revenue increased approximately $900,000 or 16.1% in the fourth quarter of 2009 and $3.4 million or 15.8% for the full year. This increase was the result of the completion of a number of implementations of our software products, following which we began to recognize maintenance and support revenue. We are pleased that our maintenance renewal rate continues in the best-in-class 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 $12.5 million for the fourth quarter of 2009 and $51 million for the year, yielding gross margins of 74.1% and 74.2% respectively. This compares to gross margins of 74.8% for the fourth quarter of 2008 and 75.3% for the year ended 2008.

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. Annual gross margins on maintenance increased from 79.9% in 2008 to 81.1% in 2009.

Non-GAAP R&D expenses of $18.5 million for year decreased approximately 3% year-over-year. During 2009 with the global recession, we closely managed operating expenses and we're able to reduce non-personnel related R&D spending by approximately $500,000 over last year. R&D for the year represented 26.9% of total revenue compared to 25.2% of total revenue in 2008. We continue to invest in our pricing and margin optimization software and product suite as part of our strategic initiatives to drive future revenues.

Non-GAAP selling, general, and administrative expenses of fourth quarter 2009 and full year were $4.8 million and $19.7 million respectively and include a $600,000 reduction in our allowance for doubtful accounts in the fourth quarter. For the full year, selling and general and administrative expenses before the reduction in the allowance was $20.3 million, an increase of approximately $400,000 or 2% from 2008. The primary drivers of the increase were reduction and non-personnel related expenses offset by an increase in sales and marketing expenses.

With the global recession in 2009, we are able to significantly reduce discretionary spending. We continue to invest in our long-term growth by maintaining our investment and highly trained personnel and modestly adding to headcount. We believe this strategy to maintain the level of profitability and positive cash flow in 2009 while keeping our focus on the longer term market opportunity was the right thing to do, and this strategy continues to guide management decisions today.

Non-GAAP operating income was $3 million for the quarter and $12.8 million for the year with non-GAAP operating margins of 17.8% and 18.7% respectively. These results were above our guidance principally as a result of the reduction of the allowance for doubtful accounts in the fourth quarter. This compares to operating income of $4.9 million in the fourth quarter of 2008 and $18 million for the year 2008 and operating margins of 24.7% and 23.8% respectively in those periods.

Continued investments in our long-term growth combined with lower full year revenue negatively impacted margins in 2009. Interest income for the year was approximately $200,000 for 2009, a decrease of $900,000 from 2008. The decrease was attributable to lower interest rates despite higher cash balances. This reduction in interest income lowered EPS by approximately $0.03 in 2009 versus 2008.

Our effective tax rate was approximately 24.4% for the fourth quarter of 2009 compared to 9% in the same period last year primarily due to the timing of the reinstatement of the research and experimentation tax credits in the fourth quarter of 2008 through the end of 2009. The full year effective tax rate was 27.1% in 2009 compared with 28.5% in 2008.

There's an item -- tax item as I mentioned. Congress recess for 2009 without extending the research and experimentation tax credit which expired on December 31st, 2009 even though there was strong bipartisan support for the credit. The credit has expired a number of times since it was originally introduced in 1981 and each time except for a brief period in 1995, that has been retroactively reinstated.

If the credit is reinstated during 2010 as we expect, and if it is retroactive in the beginning of the year, as has been the case in the past, then we'll make an accumulative adjustment in 2010 and the quarter and once the tax credit is reinstated as we did in 2008. For modeling purposes, we feel it's reasonable to use a pro forma tax rate of 30% for 2010, expect in the past 29 years of legislative experience of extending this credit will continue going forward. If it is not extended, our effective tax rate will be between 37% to 38%.

Non-GAAP net income was $2.3 million for the quarter and $9.5 million for the year compared to net income of $4.6 million for the fourth quarter of 2008 and $13.6 million for the full year of 2008. Non-GAAP net income per diluted share was $0.09 compared to $0.17 per diluted share in the fourth quarter of 2008. For the full year, net income per diluted share is $0.36 compared to $0.51 for 2008.

For the quarter ended December 31st, 2009, our income from operations in accordance with GAAP was $1.6 million. Net income in the quarter was $1.2 million or $0.04 per diluted share compared with $3.6 million or $0.14 per diluted share in the fourth quarter of 2008. For the year ended December 31st, 2009, GAAP operating income was $7.4 million compared to $13.9 million in 2008. GAAP net income in 2009 was $5.5 million or $0.21 per diluted share compared with $10.8 million or $0.40 per diluted share in 2008.

Now, moving to key balance sheet items. We ended the year with $62.4 million in cash, up from $52 million from the prior year. Total deferred revenue at the end of the year was $16.5 million, a decrease of approximately $3 million from the end of last year. Deferred revenue is not tied to total contract value; therefore is not a meaningful forward indicator of financial performance.

We continue to generate operating cash flow with approximately $6.6 million and $11.3 million of operating cash flow generated in the quarter and year respectively. Operating cash flow in the fourth quarter was very strong at 39% of revenue and 16% for the full year with significant collections expected in Q1 2010 coming in a bit earlier than anticipated. Operating cash flow in 2008 was 18% of revenue.

The strong fourth quarter cash flow contributed to gross accounts receivable at the end of the year of $13.3 million, down from $18.5 million at the end of the prior year. With the significant reduction in receivables, the allowance for doubtful accounts was reduced from $1.9 million to $1.3 million. Trade accounts receivable days sales outstanding were approximately 56 days lower than 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.

You'll notice that in our press release, we have provided disclosure of the backlog for 2009 and 2008. Backlog, which is subject to variability, at the end of 2009 was $84.3 million compared to $83.6 million at the end of 2008, an increase of 1%. A portion of our backlog as of December 31st, 2009, not reasonably expected to be recognized as revenue within the next 12 months is estimated to be $33 million.

Backlog is derived from agreements that we believe to be firm to provide software products and related implementation and maintenance services in the future. Headcount at the end of the year was 400 compared to 381 at the end of last year.

Now, let me turn to outlook. There are number of factors that impact our approach to spending in 2010. While the economy continues to be challenging, we believe our overall business is stabilizing, and there are initiatives we believe are important to position us to capture longer term market opportunities.

These include investing in our products, the addition of two senior managers, expanding our sales and marketing initiatives and our partnering programs. Additionally, retention of our highly skilled employees is a priority and by midyear, we anticipate resuming planned compensation increases and contributions to our 401(k) plan, both of which we had stopped in 2009.

Previously, we have worked with systems integrators and implementations with the customer contracting with the systems integrators for services and with PROS for installation services. In 2010, we plan on engaging system integrators directly to participate in the installation of our products as subcontractors to PROS on selective projects. Our objective is to greater worldwide scalability for installation services and to expand our partnering program. Longer term, we believe expanding our partnering program will increase our sales opportunities.

While we continue to be prudent in spending given the continued economic uncertainty, we believe the initiatives we have planned for 2010, while resulting in an increase in cost, are the right investments to position PROS for success and what we believe is a significant market opportunity. In addition, a portion of the increase from the fourth quarter to the first quarter in total spending is the normal increase in payroll taxes at the beginning of the year.

Although our revenue has declined year-over-year, we do expect Q1 2010 will be another quarter with a slight increase in sequential revenues. We will not be providing full year guidance as longer term forecasting remains considerably more challenging.

For the first quarter, we anticipate total revenue in the range of $16.9 million to $17.3 million compared to $16.9 million at the end of the fourth quarter. We are projecting non-GAAP operating income of $1.8 million to $2.2 million, and we are anticipating non-GAAP diluted earnings per share of $0.05 to $0.06 based on estimated weighted average of 27 million diluted shares outstanding and an estimated effective tax rate of 30%, assuming the R&D credit is reinstated retroactively to January 1, 2010.

The company is projecting GAAP income from operations of $300,000 to $700,000 and GAAP diluted earnings per share of $0.01 to $0.02. Non-GAAP operating income and net income for the first quarter excludes estimated non-cash stock-based compensation expense of approximately $1.5 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 help us manage the company profitability during difficult periods.

In summary, given the current economic environment, we are pleased to have achieved the high end of our EPS guidance for the fourth quarter. We continue to believe we are in a strong competitive position, and with the continued growing awareness of the benefits of high ROI price compensation 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 could take your questions.

(Operator Instructions).

I have the first question coming from the line of Tom Ernst with Deutsche Bank. Please proceed, sir.

Good afternoon, gentlemen. Thanks for taking my questions.

Hey, Tom. How are you?

Not bad and yourself?

Good.

Good. So, I guess the first observation, it's encouraging to see a backlog uptick year-on-year. You gave the long-term portion for this year. Was the long-term or did the current portion grow as well this year as well? In other words, was the long-term portion about the same size last year?

Yes, Tom, this is Charlie. Yes, we're not going back and disclosing the '08. We're going to be disclosing (inaudible - technical difficulty) and going forward, you will get the forward look. At the end of '010, we will disclose the revenue that's expected to go beyond 2011. But we're not going back.

Okay, fair enough. But my observation on an upticking backlog, understanding the deferred nature of your business model, I would walk away feeling like you've seen stability and perhaps upticking in your bookings part. I know you don't discuss bookings, but is that the right conclusion to draw here?

Yes. We -- I mean as we indicated that the business has stabilized; obviously, we weren't pleased that our revenue went down in the first and second, third quarter. But we indicated that business has stabilized. As you know, a major portion of our business comes from our backlog and another portion of the business revenue comes from new business activity.

And obviously, we were very pleased to report to our investors that the business had stabilized. We had a slight increase in the fourth quarter over the third quarter, and we're giving guidance for another slight increase in the first quarter over the fourth quarter. So, yes, absolutely, the business has stabilized and we're very pleased with that.

Okay, good. 52%of revenue came from your three-focus verticals. That's actually less by several points than last year at this time. I'm curious, what is outperforming those verticals? What's taking up the growth?

Yes. Well, the major sectors as you know are manufacturing, distribution and services. That was 52%. The other major sector is travel and transportation. Within travel and transportation, the primary revenue driver is the airline passenger market and obviously, from the numbers you can tell that airline passenger revenue was solid in 2009.

Okay. And I would assume that -- it didn't come up in this call; I assume that that's a lot of the international carriers where your strength has been historically as well?

Absolutely. As we communicated in the past, our revenue streams from the airline passenger market is dominated by international carriers, and those carriers continue to invest. We've mentioned previously that the carriers that are innovating, buying A380s and continuing to be strong in the marketplace are international carriers. The international passenger airline industry is very different than the US domestic industry.

Okay. Last question and then I'll let others ask -- what about product-wise, how are the pricing execution in analytics products doing? And you announced an AppExchange application on Salesforce recently. Is that available? Is that driving any leads or any business at this point?

Overall on product, we're extremely pleased with the strength of our product compared to one year ago. We had three major releases. As you know, we are a heavy investor in R&D. We did not have layoffs. The dominant group of employees inside PROS are in R&D science and development.

Those three major releases had significant enhancements in terms of pricing functionality. It also had built-in high performance scalability capabilities and a focus on automating out the labor of implementation. All of those things we think positions us incredibly well as we move forward to be able to scale against a very large future market opportunity.

One of the ways that we're strategically and significantly enhancing the adoption rate by sales forces and our customer base is to utilize the capabilities and tools they already had. So, we've put a lot of effort in our product development to have tightly coupled integration with spreadsheets, with BlackBerries and with Salesforce products.

We have launched partners for the Salesforce product integration and for BlackBerry, and later in the year we'll give the updates on that. But it's all part of our technology strategy to fit in with the mainstream technologies that our customers have embraced in terms of their Salesforce and automation tools.

Okay. Thank you, again.

Thank you, Tom.

Your next question comes from the line of John Diffuci with JPMorgan. Please proceed, sir.

Hi, guys. This is Giuseppe Incitti on the phone for John. Quick question, as we look at the guidance for the next quarter, and I believe you guys also commented on an increase in sales activity, is there a point -- the first quarter kind of looks similar to the fourth quarter where we were. Is there a point where you feel, and because you have such a good look at the model through the year, will this increase in sales activity will actually turn a bit?

Yes. There's two parts of that question, Giuseppe. What we've seen is a significant increase in sales activity as quantitatively measured by attendance at webinars, attendance at our summits, numbers of meetings, the interest that's being developed in the marketplace from this viral network effect of system integrators, Gartner, AMR, the strategic consultants, technology partners, it's generating a lot of activity.

Now, translating that activity into close business continues to be a challenge, long sales cycles, rigorous approval processes. But that's a great early indicator of the future market opportunity and what we hope is pent-up demand for our software products in the future. So, we're very pleased with our partner ecosystem. We're very pleased with the sales activities we've seen and the participation level in our marketing programs. But as you know, we're on a high visibility percent completion revenue recognition model. So, there's going to be a lag in revenue recognition versus bookings.

And we also believe that the market overall is going to move from that innovator early adopter phase, which is where we are now, overall in the market. It's very low penetration with single-digit percent users in our target markets of manufacturing, distribution and services. But we believe that when that market moves out of the innovator early adopter phase to mainstream, eventually must-have, we're going to be extremely well positioned to capitalize on that accelerating demand.

Great, great. Thanks, Bert.

You're welcome.

Your next question comes from the line of Tom Roderick with Thomas Weisel Partners. Please proceed.

Hi, Bert. Hi, Charlie. Good afternoon.

Hey, Tom.

Hey, Tom.

Hey, Bert, you talked -- you mentioned early on the call about the hiring of Chris Jones in the manufacturing services and distribution segment. Can you talk more specifically about any changes structurally you're making to that organization or any changes you'd like to make now that you've got a seasoned sales leader running that division? And then, with respect to some of the demands you're seeing in the pipeline around that division, anything you can comment there? Thanks.

Oh, absolutely. We're thrilled that Chris Jones has joined us. He previously was running a $600 million business division for Microsoft. He comes with a wealth of enterprise sales experience. And what Chris has really done is he's done a complete audit of our sales processes and applied those against world-class best practices. And in many areas, there's areas where we can improve in order to move towards world-class sales.

His charter is to move PROS to world-class sales and Tim Girgenti's charter is to move us to world-class marketing just like we have world-class pricing optimization products, we have world-class science, world-class total customer satisfaction. So, we brought in Chris and what he has done is taken every one of our processes and put in improvement programs. Everything from territory management, opportunity assessment, lead generation, the effective use of our strategic consulting group in identifying how we make a particular prospect, money, hard dollar return on investment.

So, what he's done is he's taken all of the processes that we had in the past and he's implied through his audit and his GAAP analysis what do we need to do to be best in class in every single area. And we're thrilled he's here; he's made a high value impact on the organization. And as you know, we've got a C-level sell and it's a team sell. So everyone, the science group, the development group, the professional services group are all benefiting from Chris's leadership.

And then, Bert, just in terms of thinking about the pipeline of opportunities and how the segment of opportunities there kind of stack up against airline and travel, any difference in either of those segments relative to which you might expect to come back first and faster?

We -- as you know, we're all statisticians and scientists here. We're always looking for metrics to give an early indicator of which one of our industry sectors are going to move from the innovator/ early adopter phase of the lifecycle into mainstream. And the penetration rate right now is so low that it's impossible to get a statistically significant indication of which one of these sectors is really going take off first. But we're monitoring closely and when we see that developed, you'll be the first to know.

Okay, thanks.

Along with all your peer group.

Thanks. Charlie, a quick one for you here. The -- nice job in the margins this quarter, nice to see them bounce off that low watermark in the third quarter. Have we seen -- have we passed the low watermark in fact? Any reason to think they kind of go lower from the level we saw here in the fourth quarter? And what needs to happen for the company to get back to above 20% margins?

I guess, first, we really want to stay away from commenting on guidance beyond the first quarter to be given. I would say that once we get the revenue back on track to where it was, let's go back to '07 and the early part of '08. We would expect margins -- margins will improve and we would expect that to hold. Our ASP is held this year. I'm referring to 2009 relative to 2008 and 2007.

So really, it's the number of deals that aren't getting down that's driving the lower revenue for us in 2009. So, my expectation is with increasing revenues, given the license components to each of our deals, I'd expect to see margins improving over time. It's a question of when.

Okay. Thanks, Charlie.

Thank you, Tom.

Your next question comes from the line of Richard Davis with Needham & Company. Please proceed, sir.

Hey, guys. It's actually [Deejay] on for Richard.

Hi, Deejay.

Deejay.

How are you doing guys?

Good.

So, Charlie, I think you mentioned a 30% tax rate for the guidance. I think the release says 32%. What's the right number there? Not that it makes a whole heck of a lot of a difference.

The right number is 30%.

Okay.

-- 32%.

Okay. And then, what level of revenue visibility do you typically have entering a given year?

I'll tell you, we're going to stay away from talking about revenue visibility because now that we've given backlog information and we've given the amount of revenue that you can defer from that backlog for the full year. We're going to stay away from inferring full year guidance to give you an answer to that question.

Got it. Okay. And then, with some of the efforts around lower total cost of ownership and expanding your third party relationships on the integration front, my question I guess has to do with the composition of the backlog. Has that changed at all since the number you reported in 2008 between product revenue and implementation services or is it largely the same make-up?

Well, the backlog is made up of maintenance and it's made up of the license and implementation contracted revenue that or the dollar amount in contracts that we expect to recognize under our high visibility percent completion model out into the future. So, it's those components.

We haven't broken out those components in the past, but you understand our business model. You understand how our go-to-market strategies are. And in a very difficult economy in 2009, we didn't dramatic -- we indicated this during the year. We haven't dramatically changed in any respect our business model. What has changed is the strength of our product, our science, our high customer satisfaction and maintenance renewal rates, our partner ecosystem and our balance sheet. All of those areas are much stronger today than they were one year ago.

Got it. Okay. And then, I guess last question we get a lot from investors and I understand the enormous opportunity that remains in the current verticals, but how broadly applicable are the pricing algorithms, say, if you were to look into go onto a financial service vertical or doing something around home loan rates and that kind of stuff? Is there a broad application for the science or is it more focused just on your five key verticals?

Yes, that's a great question. What we would say is that almost every vertical could benefit from science-based pricing optimization, the kind of capabilities that we provide in our Scientific Analytics, Price Optimizer and Deal Optimizer products.

What we have done is we looked for those industries that had exactly the pricing problems that we had solved in the past and provided a big large market opportunity. And obviously, the largest sector is manufacturing, and then within that sector you've got this great process manufacturing, and then that breaks down to industrial goods or chemicals, petroleum. Well, those industries present such a fantastic large market opportunity for us that right now we're not going to divert any resources outside of those target markets.

Clearly, we recognize there's other industries that could benefit. But right now, we're very focused. We've got a wonderful opportunity right in front of us and we're doing everything we can including industry-level solutions, industry marketing, and our new partner ecosystem which is industry driven. So, we're very pleased with what we are or where we are today and our strategy today, and you shouldn't anticipate any announcements about diverting beyond the current sectors that we're addressing.

Got it. Sounds good. Thanks a lot guys.

Thank you.

Thank you.

Your next question comes from the line of Ross MacMillan with Jefferies & Company. Please proceed.

Thanks. Hi, Bert. Hi, Charlie.

Hey, Ross.

Hey, Ross.

Hey, Charlie, you mentioned that this year you're going to basically engage with SI as directly on subcontract and you've made mention of that as you talked throughout some of the outlook for 2010. I'm just curious, what's the implication for the model? I mean, are we going to be taking out some of the lower margin implementation services and keeping more of the high margin software revenues? What is the implication for the model as you go through this change?

That's a great question. Ross, the implication early on, as we find on the script, later on we'd like to see some sales opportunities come from this initiative. But early on, it's going to be an investment on PROS's part. So essentially, we're going to be substituting our cost for a cost of bringing in SI. The SI cost will be higher than our cost. So early on, we believe it will be a modest but a modest negative impact on gross margins.

As we convert to greater participation on the sales side and driving more of the license component, our long-term strategy is that the overall revenues will go up. The mix will be richer towards license, less implementation services, and the margins will go up. Does that make sense?

Yes, absolutely. And then, a lot of companies have seen, I don't know if you want to call it a budget flush but certainly a fairly material pickup in that fourth quarter from a spending standpoint. And I guess you guys obviously don't really -- you're not beholden to quarters and your sales cycles are long and so forth. But I'm just curious as to whether you've gone back and thought about what's going on in the environment and how your business is fairing relative to that, and whether you think it's really just a timing question here that so long as the global economy continues to improve, it's just a question of time?

Yes, Ross, I would say that budget flush is not a phenomenon that we've experienced that we'd love to have it happen. But with the 10 years I've been here, there has not been --

Although we did have a lot of cash.

I was going to mention the cash, right. But budget flush on the contract side is not something that happened. I attribute it to our ASP. I will say the cash in the fourth quarter was stronger than we've expected. So, there's probably some cash coming off their balance sheets, and that has a very positive impact on Q4 which we'll probably see a little bit of a negative impact on Q1.

As far as the -- when will the economy be in a position to present itself, that's really our question. I think as the economy improves, we see ourselves getting back on track to where we were before the recession. The ROI is there. It's even stronger today. The ROI validation is greater today than it was 18 months ago. The ecosystem we have in place today is greater than it was 18 months ago.

We think the strategic initiatives that we're investing in and we'll invest in 2010 really are going to position the company very well. But the ASP relative to the economy in my view is what's withholding the revenues back. Does that make sense?

Yes, it's very helpful. Thanks.

Next question comes from the line of Nabil Elsheshai with Pacific Crest Securities. Please proceed.

Hey, guys. Thanks for taking my questions. If you look at your commentary around opportunities, the metrics you've indicated are what I would probably consider top of the funnel type of the pipeline indicators. Has that also translated into a great or a significant uptick in opportunities that are further along in the pipeline? I'm really kind of getting at is, is your coverage ratio for the same amount of revenue greater today than it was, say, 18 months ago?

Yes. Nabil, those are great questions. What we would say is the traditional approach to software sales and pipeline management has changed. And we are experiencing it and part of it is the high ASP, part of it is it's the people process as well as software decision. It's made at a C-level. It's typically outside the budget cycle that there's more rigor in the approval process. There are more approvals required.

And where -- traditionally over the decades, you would manage a software sales pipeline based on a number of very quantitative metrics -- have you eliminated the competition, do they have a budget, do you have -- are you in purchasing, and all those kinds of things.

And we've seen that even when you move through the top of the funnel down to the bottom of the funnel, you can still get a deal delayed even after you achieved all of the criteria that traditionally would say you're going to close the deal. And we have seen deals get delayed just for no other reason than a senior executive, especially a CFO might say, "I totally agree; great ROI, but we're going to just put this off for a while."

And we believe there's two things that are going to make a difference. One when C-level executives get their confidence back and they move beyond cost cutting to investment spending, and just a general new flexibility on our part to map into these new buying processes that didn't exist prior to the fourth quarter of 2008.

Okay, great. And then, I think you've tried some, at least, experimental ways to do smaller deals and kind of on-boarding or trial things. Has that had -- have you seen any uptick make above that in Q4 of this year?

Well, overall, not specifically in Q4. But we clearly recognized in the fourth quarter of 2008, we were going to have to be very flexible and we were going to have to map into how people wanted to buy even if it was a non-traditional approach.

One of the things that we've done is implemented an easy on-ramp way for a prospect to prove values called the Proof of Value Engagement with PROS where in a few weeks we'll take their data, do a scientific analysis, and then show them where the profit leaks are and where the profit opportunities are, and that's some of what's going on right now. The conversion rate is much higher on deals where you've done that proof of value engagement than where there hasn't been any proof of value engagement.

So, we're going to step up the volume on those in 2010 to help people to get over the hurdle of the CFO which is the two big hurdles are time to value -- and we deliver an incredible time to value in less than 30 days -- and number 2, are we really through people and processes going to be able to achieve this ROI? Well, if you can show them a hard ROI number based on their own data in our scientific analysis and capabilities, then that helps to get them comfortable to actually make the decision, sign a contract and get going.

The contracts we have signed and we've launched, we're getting tremendous benefit in terms of time to value and getting product implemented. And our customer satisfaction has never been higher; we have wonderful partnerships and relationships with our customers.

Okay, great. And then on the partner side, Charlie, you mentioned kind of longer term where it would potentially have an impact on license growth. Are we talking 2010 or is it further out? And do you see that channel, that partner channel being more the system integrator or do you see potentially third party ISVs as a greater opportunity?

Yes, I would say today, we're looking at the expectation being probably not early in 2010; later out and it maybe 2011. The reach that we have is a broad reach; it isn't just systems integrators. And to go back to a question that was asked earlier, I mean this is just the economy.

Well, the economy we believe certainly slowed us down. But these are the initiatives we're putting in place to help us overcome even a slow economy to be able to get a few more deals done to our ecosystem that we've been putting in place throughout 2009, and we see some early stage benefits coming from that.

But it's probably a long answer. It's -- I would say today it's too hard to make the call. I think it's going to be a combination. The ecosystem is going to help along with the little improving economy. We get the economy to kick in earlier in 2010. I've seen more deals in 2010 coming from ecosystem as it takes to 2011. It may push out to 2011.

Okay. And I guess last question -- any update on the competitive front? Is it same characters? Anybody aggressively pricing or less presence in the market?

Yes. The competitive landscape really hasn't changed. Obviously, we're public and our numbers are fully disclosed. Our competitors are private. We don't know their numbers. But we feel in a tough economy and over the last year that we're much stronger and we believe the strong gets stronger and the weak get weaker.

And so, we believe our relative competitive position is strong and we also believe that we are investing. We have the financial resources and we have the people to properly invest, and that differentiation isn't fully appreciated when you have a market that's in this innovator early adopter stage. But there's going to be a tremendous, we believe, a tremendous competitive differentiation when you start moving into the must-have phase of this market development.

Great. Thank you, guys, for taking my question.

Absolutely, Nabil. Thank you.

Your next question comes from the line of Ian Kell with Northland Securities. Please proceed.

Hey, guys. It's Chad Bennett.

Hey, Chad. How are you?

I'm doing okay. I guess a couple of questions I'll at least take a shot at. On the backlog, it's good to see the disclosure back again. If we looked back a quarter, would backlog be down year-over-year, year-to-date at the end of the September quarter or would've it still been kind of modestly up, if you guys can talk to that?

Yes.

Chad, we've historically stayed away from talking about backlog on a quarter-to-quarter basis and it gets back to that historical variability on a quarter-to-quarter basis. We thought an annual metric would be a reasonable metric to provide. At least over a period of time, you could be tracking the overall gross backlog for the company. But --

Okay.

Okay?

Yes. I guess another question I'll take a shot at, but do you expect revenue to grow year-over-year at any point this year, any quarter?

It's too early to say, Chad. We've given guidance for the first quarter. You know, obviously our revenue went down substantially from the fourth quarter of 2008 to the first to the second to the third. But it's too early to give any guidance beyond the first quarter.

Okay.

And we are pleased that of course that Q4 was over, Q3 of last year, and we see a modest increase in Q1 over Q4, but we're not giving guidance beyond Q1.

Okay. And then, speaking to the system integrator and channel initiatives you have going on in the ecosystem you're building, I know it's early, but can you talk about any type of commitments from system integrators or VARs in terms of -- I don't know what you want to do, but number of people trained on your products, number of deals or pipeline or anything like that? Is there anything quantitative you can give us or maybe where you hope to be three quarters from now?

Yes. This is a very measured program. What we have is a handful of implementations where we've worked with system integrators. We have a certification program, a training program. What we would say to you is in the fourth quarter and even in January of 2010 we have certified more people than we have combined in the entire history of the company.

Okay.

So, that's one of the metrics that we use to indicate their commitment and this is a real tangible commitment. In other words, they're sending people to our Houston corporate training center to go through five days of very rigorous training and certification, and they're doing it on their nickel. So, we see that as tangible evidence that they're serious and that we have some really substantive foundation or future relationship that's going to be beneficial to both parties.

On our technology integration, we couldn't be happier with the partnership we have with Microsoft and other technology partners. System integrators are the ones that are getting certified. We're very pleased that Gartner wrote a report last year. For the first time ever, Gartner wrote a report on the category.

So, these are very tangible manifestations of the interest in the marketplace by these third parties. And we think it bodes very well for accelerating the awareness, the understanding, and then eventually moving from the innovator phase to the mainstream application phase of the lifecycle of the category.

Got it. And on this, the VARs or SI that you're signing up, are they focused on the same verticals you guys are?

Well, absolutely, or we wouldn't sign them up.

Okay.

No, these are very big SIs. So within the SIs, they have sector groups. Typically, they'll have a pricing excellence practice that runs across all industry. But our focus is to work with them on their pricing practice experts and then the industry specialists that are in the industry target sectors that we see as our market opportunity.

Got it. One last question maybe for Charlie. What are the expectations on the sales side for headcount this year? Do we expect to add this year and any type of target there?

Yes. I'll tell you, Chad, again, we haven't been disclosing the headcount growth in sales because many times analysts will take the headcount growth and apply it with some targeted expectation of sales by person per year, and the model just hasn't work that way. But the answer is yes, we do expect to expand our sales staff somewhat during the 2010.

Okay.

Sales and marketing is one of our strategic investments that we're making.

Got it. Okay. Because I guess backward looking, nobody is extrapolating backward looking, did you add sales people in fiscal '09?

Well, our overall headcount remains flat.

Okay.

There was obviously a redistribution. We eliminated discretionary activities. We eliminated speculative activities. So, the overall headcount remains the same. But you can assume a slight increase. But you can assume that there was a redistribution across what we've communicated our strategic investment.

That's right.

Okay. Thank you, guys.

Thank you. Good to talk to you.

At this time, I'm showing no further questions in queue. I would now like to turn the call back over to your host, Mr. Bert Winemiller. Please proceed, sir.

In closing, we are pleased with our fourth quarter 2009 and full year results. And we believe the market for pricing and margin optimization software is in the innovator or early adopter stage, and there are thousands of companies that would greatly benefit from our software.

Our strategic plan is focused on scaling to meet the needs of this large long-term market opportunity. Thus, we will continue our work to grow and expand the pricing partner influencer ecosystem. We'll make strategic investments. And we appreciate very much you taking the time to listen to our call. Thank you and goodbye.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.