PROS Holdings, Inc.
Q2 2008 Earnings Call Transcript

Published: 21 Aug 2008

[Operator:]

Good day, ladies and gentlemen, and welcome to the second quarter 2008 PROS Holdings, Inc. earnings conference call. My name is Elisia and I’ll be your coordinator for today. At this time, all participants are in listen-only mode. We will facilitate a question-and-answer session towards the end of today's conference. (Operator instructions) I would now like to turn the presentation over to your host for today's conference, Mr. Charlie Murphy, Executive Vice President and Chief Financial Officer of PROS Holdings, Inc. Please proceed.

[Charlie Murphy:]

Thank you. Good afternoon, everyone, and thank you for joining us today for the PROS Holdings financial results conference call for the second quarter of 2008. This is Charlie Murphy, PROS’ Executive Vice President and 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 of the second quarter ended June 30, 2008. And then I will provide the review of the financial results and the outlook before we open up the call to questions. Before beginning, we must caution you that today's remarks on 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 could cause actual results to differ materially from those projected in the forward-looking statements. Please refer to our prospectus, Form 10-K and other filings with the SEC for the risk factors contained herein and other disclosures. Also, please note that a replay of today's webcast will be made 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. It also can be found on our website in the Investor Relations section. With that, I'd like to turn the call over to Bert.

[Bert Winemiller:]

Thank you, Charlie, and thanks to all of you joining us on the call today. We are pleased to announce strong results for the second quarter. We believe these results are a continuing validation of PROS’ value proposition and our high visibility revenue model and are indicative of the continuing demand we are experiencing for our products. Revenues for the second quarter of 2008 were a record $18.6 million, a 29% increase over the second quarter of 2007. License and implementation revenues were $13.4 million in the quarter, an increase of 35% from a year ago. And maintenance revenue was $5.2 million, up 16% from the second quarter of 2007. Our second quarter results are an affirmation of the value of PROS pricing and revenue optimization software as a strategic innovation for margin management and a risk mitigation initiative in a challenging economy. PROS helps us customers by providing dynamic margin optimization through real-time transaction processes at the time a price quote is made or a sales transaction is actually executed. Consistent with current economic conditions, we have recently experienced a lengthening of sales cycles in some situations. However, awareness activity metrics are high and we are very optimistic about the long-term demand for our pricing and margin optimization solutions. PROS provides standard, rigorous, pricing excellence best practices and price optimization software products. PROS customers achieve price discipline, price control and monitoring, as well as margin optimization based on all the relevant information, and most importantly current cost information. As we have stated in the past, one of the strengths is our high visibility revenue model. 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. Historically, our high visibility revenue model has given us approximately 90% visibility into our quarterly revenue target at the beginning of a quarter. As with receivables and cash flow, deferred revenue can fluctuate on a quarter-to-quarter basis depending on the timing of 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. We track numerous awareness activity metrics. These activity metrics are higher than they have ever been. We believe the recognition of the power and pricing and margin optimization continues to grow. For example, in the first half of 2008, webinar (inaudible) was up substantially, visits to our website were up substantially, and we had record attendance at the PROS Annual Pricing Excellence Summit in April in Houston. And many of the attendees on the call attended our summit. We recently announced the PROS European Pricing Forum to be held in Frankfurt, Germany in September. As a further example of these awareness statistics, in the first half of 2008 we also had strong attendance at our user advisory councils, private webcasts and face-to-face sales presentations. There is also increasing visibility of the power of pricing in the press as well as Wall Street and industry analyst reports. As Charlie will describe, we are slightly modifying our annual revenue and bookings guidance to take into account the lengthening of sales cycles due to the current economic slowdown. The net result of this modification is a 1% decrease in our growth expectations for 2008 revenue from the midpoint of our previous guidance and the allowance for a few deal delays in our bookings expectations. We are making no changes to our annual EPS guidance. In summary, we are thrilled with our second quarter outstanding results. This achievement is the result of the hard work of over 350 employees at PROS who are smart dedicated people, doing great things to bring pricing excellence best practices and high value pricing and margin optimization solutions to our customers. We feel good about our future prospects and we are confident we can capitalize on the market opportunity as more CEOs and CFOs recognize, the pricing is one of the most powerful tools available to them and the strategic importance of science-based pricing optimization in a challenging economy. I’ll now turn the call over to Charlie so he can provide you with the financial details and our outlook for the third quarter and the year 2008.

[Charlie Murphy:]

Thank you, Bert. PROS had a solid second quarter and first half of 2008. Revenue for the second quarter of 2008 came in at $18.6 million, up 29% than the second quarter of 2007 and above our guided range. As previously communicated, in accordance with our revenue recognition policy, PROS does not recognize any revenue or contract signing. License and implementation fees are bundled together and revenues recognized on a percentage of completion basis over the implementation period. This provides visibility into future quarters' revenue. 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 required, and the number of products being deployed and the contract size. Within revenue, license and implementation revenue was $13.4 million in the second quarter, or 72% of total revenue. This was an increase of approximately 35% over the second quarter of 2007. Maintenance and support revenue, which makes up the balance of revenue, was $5.2 million in the second quarter and was up approximately 16% over the second quarter of 2007. Our revenue is diversified across many dimensions, geographically, across five target vertical markets, between B2B and B2C customers. For the second quarter of 2008, our GAAP gross profit was $14 million and operating income was $3.2 million compared to a GAAP gross profit of $10.1 million and operating income of $2.0 million for the second quarter of 2007. GAAP net income was $2.2 million or $0.08 per diluted share in the second quarter at a tax rate of 36% compared to $1.3 million or $0.06 per diluted share in the second quarter of 2007 at a tax rate of 21%. Our earnings press release issued today includes a full GAAP to non-GAAP reconciliation and it can be found in the Investor Relations section of our website. The following comments on our statements of operations will refer to results on a non-GAAP basis. Gross profit on a non-GAAP basis was $14.1 million in the second quarter, resulting in gross margins of 75.8% compared to gross margins of 70.4% in the second quarter of 2007. We are pleased with the continuing improvements in gross margins on a year-over-year basis. Our gross margins benefit from the continuation of improvements in our implementation processes that continued standardization of our products and the amount of implementation services required to deploy our products relative to the contract price and the current mix of business. We can’t be certain that previously mentioned factors, which contributed to historical gross margin growth, will continue. Selling, general and administrative expenses in the second quarter were $5.1 million or approximately 27% of revenue, and increased approximately 42% from the second quarter of 2007. The quarter-over-quarter increase is primarily attributable to an increase in sales and marketing personnel and public company costs. We expect SG&A costs will continually increase in 2008 due to our continued investment in sales and marketing activities and personnel in order to extend our leadership position in this market. R&D expenses in the second quarter were $4.9 million, or approximately 26% of revenue, and increased approximately 16% from the second quarter of 2007 as we continue to make investments in our suite of pricing and revenue optimization software products. We expect to continue to invest in R&D spending in future periods. Non-GAAP operating income in the second quarter was $4.2 million, an increase of approximately 75% from a year ago and exceeded our guidance. Operating income exceeded the high end of our guidance as a result of higher than anticipated revenues, the continuation of good gross margins, and lower than expected operating expenses. Operating margins in the second quarter increased to 22.5% compared to 16.6% in the second quarter of 2007. Interest income was approximately $302,000 in the quarter compared to net interest expense of $380,000 in the second quarter of 2007. The net interest expense in 2007 included interest expense of approximately $441,000 from a $20 million credit facility we entered into in March 2007 and subsequently retired with the proceeds from the IPO. As discussed previously, Congress recessed for 2007 without extending the research and experimentation tax credit, which has bipartisan support for the credit. In May 2008, the Renewable Energy and Job Creation Act of 2008 or H.R. 6049 passed the House of Representatives and is now in the Senate. Among other legislation with this act is the R&E tax credit. Congress has adjourned for August without taking action on this legislation. Although the provisions of this tax legislation had support on both sides of Congress, there is no assurance the legislation will pass in 2008. For that reason, we will continue to provide dual guidance at the Federal effective tax rate of 35% and our pro forma non-GAAP tax rate of 28%. 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 credit is reinstated in 2008 and if it is retroactive to the beginning of the year as has been in the past, then we would make a cumulative adjustment once the credit is reinstated. If the R&E credit is passed, we believe our effective tax rate will be approximately 28%. On a pro forma basis, we are using a tax rate of 28% for the third quarter and full year guidance, expecting that the past 26 years of extending this credit will continue going forward. If it is not extended, our Federal effective tax rate would be 35%, and including state and foreign income taxes, the rate will be 36%. For the second quarter and year-to-date we are reporting actual results at the GAAP effective tax rate of 36% for Federal, state, and foreign income taxes, as the R&E credit has not been reinstated compared to an actual tax rate of 21% in the second quarter of last year. Our effective tax rate historically has been lower than the Federal statutory rate of 35%, largely due to the application of research and experimentation tax credits. The increase in our pro forma non-GAAP effective tax rate in 2008 of 28% compared to 2007 of 21% is due to the utilization of research and experimentation tax credit carry-forwards generated in the US prior to 2007 and fully utilized in 2007, and also higher levels of pretax income in relation to research and experimentation credits earned. Non-GAAP net income for the second quarter of 2008 was $2.9 million or $0.11, this is using a 36% tax rate, per diluted share exceeding our guidance. Diluted shares were 26.5 million. In the prior quarter, non-GAAP net income was $1.6 million or $0.07 per diluted share. 2007 reflects the lower pre-IPO share count of 21.8 million shares. 2007 earnings per diluted share for the second quarter would have been $0.06 compared to $0.11 in 2008 using the post IPO second quarter 2008 weighted average shares outstanding of 26.5 million shares. Had the R&E tax credit been reinstated retroactively, there would have been a 1% increase in non-GAAP diluted earnings per share to $0.12 per diluted share during the second quarter. Moving to our balance sheet. We entered the quarter with cash and equivalents of $48.8 million, up approximately $3.3 million from the first quarter. The increase is primarily attributable to operating cash flow in the quarter. Accounts receivable at the end of the quarter were $16.9 million, down approximately $2.9 million from the first quarter of 2008. Trade accounts receivable days sales outstanding of 62 days is an improvement when compared with our 2007 full year DSOs of 71 days. As we have stated in the past, accounts receivable balances can vary in a quarter based on the timing of invoicing contractual milestones, which vary from quarter to quarter. As previously discussed, during our first quarter earnings call, we had a customer action seeking to terminate a contract related to one of our implementations. In the second quarter, as a result of this action, we netted the related customer’s long-term deferred revenue, very small accounts receivable balance, and capitalized implementation cost, and classified these amounts on our balance sheet as other current liabilities. Further recognition of revenue associated with this customer has been suspended due to the uncertainty of its realization. This amount will continue to be presented as other current liabilities until the matter is resolved. We have been advised by counsel that a resolution through the courts would likely be in late 2009 or the first half of 2010. In addition, we have determined that legal cost associated with defending ourselves, except for a customary retention amount will be covered under our insurance policy. Total deferred revenue at the end of the second quarter after the aforementioned re-class was $21.1 million, an increase of approximately $1.7 million from December 31, 2007 after adjusting deferred revenue at December 31, 2007 for this contract. Total deferred revenue decreased approximately $1.7 million from March 31, 2008 after adjusting deferred revenue for the aforementioned contract. As for the accounts receivable and cash flows, deferred revenue will fluctuate quarter-to-quarter depending on the timing of contractual milestone billings. Deferred revenue balances do not correlate the total contract value, and therefore we do not believe it is a meaningful forward indicator. Turning to cash flows. Our operating cash flow for the three months ended June 30, 2008 was $3.7 million. As with receivables, there is a quarter-to-quarter variability of operating cash flow due to the variability in invoicing and subsequent collection of contractual milestones and payments to various accruals. Had the R&E tax rate been extended to January 1, estimated tax payments for the last six months would have been $600,000 less resulting in an increase of approximately 12% to the six months ended June 2008 operating cash flows. Capital expenditures for the quarter were approximately $400,000 and we expect total capital expenditures for the full year to be approximately $1.7 million. Overall headcount at the end of the quarter was 366 personnel compared to 342 at the beginning of the year, and we anticipate the continuation of increasing staffing throughout the organization to support our continued growth. Now let me turn to our guidance for the third quarter of 2008 and full year. As Bert mentioned, we have seen a lengthening of sales cycles in some situations while at the same time, we continue to experience high levels of activity around the awareness of pricing and are very optimistic about the long-term demand for our products. We have taken the lengthening of sales cycles into consideration in current revenue and bookings guidance. For the third quarter, PROS anticipates total revenue in the range of $19.1 million to $19.3 million, representing a growth rate of approximately 17% over 2007 at the midpoint of our guidance. Consistent with our historical experience, we continue to have approximately 90% of revenue visibility going into the quarter. We are projecting non-GAAP operating income of $3.4 million to $3.6 million. Also, we are anticipating non-GAAP net income of $2.6 million to $2.8 million, and non-GAAP earnings per diluted share of $0.10 to $0.11 based on estimated fully diluted share count of 26.7 million shares and using an effective tax rate of 28%. Using an effective tax rate of 36%, our earnings per diluted share would have been $0.09. Non-GAAP operating income for the third quarter excludes estimated FAS 123R stock option expense of approximately $1.1 million. For the full year 2008, we expect total revenue in the range of $75.5 million to $76.5 million, or growth rate at the midpoint of our guidance of approximately 22% over the prior year. This is a modest decrease of approximately 1% from the midpoint of our previous guidance. For the full year 2008, we are projecting non-GAAP operating income of $15.4 million to $16.1 million, which is relatively unchanged from previous guidance and represents approximately a 25% increase over 2007 at the midpoint of our guidance. We are projecting non-GAAP net income of $12.0 million to $12.6 million and maintaining our previous non-GAAP earnings per diluted share guidance of $0.45 to $0.47. Diluted shares outstanding at the end of the year are estimated at $26.7 million and the estimated pro forma effective tax rate use is 28%. Using effective tax rate of 36%, our earnings per diluted share would be $0.40 to $0.42. The 2007 non-GAAP earnings were $0.46, and would have been $0.41 using estimated 2008 weighted average shares outstanding post IPO. Non-GAAP operating income and net income for 2008 excludes FAS 123R stock option expense of approximately $4 million. We are changing our full year bookings guidance to $46 million to $51 million from our prior range of $53 million to $55 million. To give some perspective, this represents approximately two to three contracts at our average contract value. We believe we are being prudent with the guidance given the current economic environment. As always, our bookings forecast is exclusive of maintenance and support that commences at the time the implementation is completed. It is important to note that 2009 revenue growth for PROS is not solely impacted by current year bookings and 2009 bookings. Further revenue growth is also impacted by four years. Implementation durations greater than one year, maintenance growth, implementation efficiencies, and four, yearly cost of living increases from maintenance. I’ll elaborate on these points. First, implementation durations greater than one year. As I have mentioned before, PROS does not recognize any revenue or contract signing, and many contracts have implementation durations greater than one year. For example, there are three pre-2008 bookings that will generate license and implementation revenue in 2009. Second, maintenance growth. The increase in future maintenance revenue coming from completed in-process implementations. For example, maintenance growth was approximately 12% for the first six months of 2007 compared with the first six months of 2006. And this has grown to approximately 16% for the first six months of 2008 compared to first six months of 2007, a 25% increase. As implementations are completed, we expect maintenance revenue to continue to increase. The third item, implementation efficiencies. Percentage of revenue recognized from booking in a year has been increasing as a result of implementation efficiencies. This has resulted in an acceleration of a percentage of revenue recognized from contracts booked in the same year. And this trend has continued over the last four years. And fourth, annual maintenance cost of living increases. Generally there is a provision in our contracts to increase maintenance fees annually. This increases maintenance revenue each year. It is the layering effect of bookings for more than one year and maintenance growth has given PROS its high visibility revenue model. As a result of these factors and the growing awareness of the need for pricing technology at our current activity levels, we remain confident that PROS will experience good growth in the future. We are pleased with our second quarter results and we are reconfirming EPS guidance for the year of $0.45 to $0.47. With that, let me turn the call back to the operator so that we can take your questions.

[Operator:]

(Operator instructions) Your first question comes from the line of Tom Ernst with Deutsche Bank. Please proceed. Tom, your line is now open. Your next question comes from the line of Tom Roderick with Thomas Weisel Partners. Please proceed.

[Tom Roderick:]

Hi guys, thanks and good afternoon. So, I guess if we look at the results, it seems as though – and Charlie, you have just alluded to this. It seems as though the implementation periods are going well, perhaps faster than expected that’s driving upside in the margins. So I was hoping you could comment on your likelihood to be able to continue to drive some nice margin improvement or even margins above 20%. And then as you look at the pipeline out there, and obviously it’s a tough selling environment for everybody, can you comment on what’s working, what types of deals are closing in this current environment? Thanks.

[Bert Winemiller:]

Thank you, Tom.

[Charlie Murphy:]

Yes, thank you. Tom, why don’t I start with the gross margin improvements?

[Tom Roderick:]

Great.

[Charlie Murphy:]

You are absolutely right. We have seen some very nice gross margin improvements over the year. And obviously the margin improvements from the second quarter of last year to the second quarter of this year continue to be very, very good. And we are pleased – we’re pleased with that. So those margin improvements, they can vary from period to period, but they have come from – and you said it – increased implementation efficiencies has been a significant contributor to the overall margin improvements of the company. And those efficiencies have also translated into being able to get product deployed faster, which means we get more revenue sooner for each contract that we close. That’s helping us relative to what we refer to internally as the revenue coming from new business each year. And that metric has been increasing each and every year for the last solid four years. So it’s a very, very solid improvement to our margins. As far as going forward, we don’t actually give guidance on margins going forward, but at this stage here, we do expect long-term to see continued improvements and we expect the long-term to still have a positive overall impact on the company’s gross margin trends. So I think we have experienced good margins, and we’re looking forward to at least maintaining those and long-term improving on that as we go forward.

[Bert Winemiller:]

Tom, on the sales question, I think there are a couple of things that we ought to emphasize. And I’ll go back to some of my comments in my introductory remarks. I want to reemphasize that every awareness activity metric that we track – and we are all statisticians here at PROS, so we track a lot of them – is up positive and moving in the right direction. I think one of – or two of the things that I’d like to emphasize was the attendance at our Pricing Excellence Summit, and we had many of the people that are on the call here today at that summit. Once the recognition of the power of pricing is fully understood and appreciated, the momentum of a company to move forward is very, very powerful. And then the other interesting metric is visibility in the market in terms of just press coverage. AMR Research in April had a report that said thriving in a recession, value strategies at work, smart companies will be much more strategic, targeting areas that we’ll not only see them through a rough economy and help them thrive during that period but after it passes. Price optimization is a strategic opportunity. And companies need price optimization even in a down economy. McKenzie said a downturn can be a great opportunity, continue spending on long-term strategic initiatives like pricing. Gartner said, in June, the potential for pricing optimization market is significant, software solutions that systematically improve pricing practices increased margins and sales. So lots of market activity, lots of awareness that makes us particularly comfortable. Another – when you look at our 2008 statistics, our core statistics, we look at things that might show some weakening of the fundamental demand and we just don't see it. Our ASP continues to be at the same levels we've experienced historically. Our maintenance renewal rate continues to be best in class, over 95%. We had 58% of our first half bookings in manufacturing, distribution and services, which you know is our big future market opportunity. One-third of our bookings came from our existing customers which historically has been a core part of our business. So when you look at the fundamental statistics related to our core business, they are solid, they are consistent with our historical results and we feel very, very comfortable about those.

[Tom Roderick:]

Great. Last question from me, if I can just do one last quick one, maybe on the flip-side of that as you looked at a couple or three deals that perhaps slipped at the end of the quarter, what are the lessons learned from those deals? What are your customers telling you about their budgets? The deals that slipped, do you expect them to close? And what are you doing with the sales force sort of, in short tighter controls and monitoring, so that you've got a pretty good eye and maybe a little bit more conservative judgment about what types of deals will close in a given quarter? Thanks.

[Bert Winemiller:]

That's a great question. Our market position continues to remain strong and we don't see any change, any recognizable change in the fundamental demand. What we are seeing is in some cases, a lengthening of the sales cycle. It could require additional approval processes, additional scrutiny at the C-level, but we don't see a fundamental shift in the demand and that's the communication we are getting from people. It's not that they are not going to do it; it's just that they are not going to do it now. Also, it is in some cases. Obviously there is industries that are being affected by this economic downturn and then there is other industries that are doing well. Fortunately, we are very diversified across industries as you know and we are very diversified globally. 55% of our first half revenue was international, so we are diversified geographically; we are diversified by industry. But we do want to be prudent given the current economic situation and be cognize of the fact that we might have one, two or three deals postponed because of lengthening sales cycle.

[Tom Roderick:]

Okay. Great deal, thanks guys.

[Operator:]

Your next question comes from the line of Tom Ernst with Deutsche Bank. Please proceed.

[Nandan Amladi:]

Hi, this is Nandan Amladi on behalf of Tom. I wanted to ask about the verticals and geographies. I think some of it you've answered already, but what specific verticals are seeing the slowdowns in more than others and what verticals seem to be more immune? And similarly for geographies, where are you seeing more momentum versus…

[Bert Winemiller:]

That's a great question, Nandan. Across our five verticals, I mean you see a little variation but you got to remember that it somewhat varies quarter-to-quarter and that's the reason we give annual bookings because of our high ASP. I will reiterate that we had bookings in each of our five target industries. I mean you know the industries that we are in, some are more susceptible.

[Tom Ernst:]

Nandan, did anybody ask how they are keeping EPS the same with the revenue going down?

[Nandan Amladi:]

Yes, we are live Tom.

[Charlie Murphy:]

I can answer that one Tom

[Tom Ernst:]

Great, thank you. Sorry.

[Charlie Murphy:]

Good management. Tom, one thing – maybe I didn't highlight it up in the comments. One is that the second quarter, we actually exceeded our guidance by $0.02. It gives us some improvement going into the last half of the year. Second is that our expenses are less than we originally anticipated. I did mention in the comments that we did have this one customer, we have the litigation. We had expected there would be litigation cost associated with that. That was in our previous guidance. Good news, those cost except for a modest retainer are being covered our Company's insurance policies. So those costs came out of our need to provide guidance for the remainder of the year. So that helped us. And then costs were down a bit less than the second quarter, so we have got the improvement in the first half of the year and we got lower expenses in the last of the year.

[Bert Winemiller:]

And we have got a high visibility revenue model and also you've got a very experienced management team here. We have managed through cycles before and we obviously have great visibility. So if we need to make some adjustments, we know how to make them to be successful.

[Tom Ernst:]

Yes. That helps a lot. I guess the follow-up to that would be I think you've given us an outlook that leaves you flexibility, the opportunity for unknowns to come in. The question is, are you keeping a level of conservatism here as well through the remainder of the year, or we've used up kind of your powder?

[Bert Winemiller:]

I'd say, Tom, we have very rigorous fact-based, metric-based management methodology and culture here at PROS and we look at all of the facts and metrics across all of our business activities, not just bookings or sales, but everything that goes on at PROS. And we are just applying that methodology, I think you've seen a couple of things, the slight very modest decrease in revenue guidance and that's attributable to the fact that we have a high visibility revenue model and then a decrease in bookings guidance and a widening range, just to accommodate – it's only prudent to accommodate the current environment we are in. So that's what we are doing; we are just applying exactly the same prudent, rigorous, fact-based, statistics-based management methodologies that we always have here at PROS.

[Tom Ernst:]

Okay. Fantastic. I had one other question and I apologize again if the last questioners asked this. Looking into next year, I recognize you are giving guidance but perhaps it would be helpful to talk a little bit about your business model and how a little bit lower bookings target might translate into a range of growth expectation for next year?

[Charlie Murphy:]

I think we have to go back – we are not going to be able to give a range of revenue growth for 2009 at this point because we are providing guidance for 2009; it's a bit early. But let's go back to our revenue recognition model and I touched on it briefly in my comments and that is that we signed a contract, no revenues recognized. You are also pretty much aware that the duration of our implementation is going to range from six months to 24 months and even longer sometimes, so in 2009 we will be recognizing revenue on contracts we closed in 2007 and in some cases contracts even prior to 2007 if they were subscription contracts for example. So that's what gives us the revenue visibility. So it is the layering effect of contracts closed in 2007, contracts closed in 2008 and then of course there will be obviously contracts closed in 2009 that will 2009 revenue, and then it is the maintenance. The maintenance as I mentioned is up 50% for the first six months of this year compared to the first six months as far as the growth rates of the prior year. That maintenance growth we expect will continue to grow higher because the maintenance is like [ph] the implementation. So as we finish these implementations, we are just starting to recognize the revenue. The maintenance growth is coming in very nicely as a result of the layering and implementations being finished and overall maintenance composite rate of approximately 20% on the licensee. And then we do have our cost of living [ph] adjustments and maintenance each year and we also have, the point I made of, it's taking less time to implement – actually less time to complete these contracts, therefore you are getting more revenue in a year out of a contract closed in the year and that's been a metric, just like the margin metrics have been improving over the last four years, that's a metric that's improved as well over the last four years. So you got lots of factors; it’s not just the 2008 bookings and it is not just change in the guidance from one range to the other that has a significant impact in '09. It's what happened in '07. As you know, we had a very good booking year in '07. Some of that is carrying over to '09. It is the maintenance growth; it's the accelerated timing of implementations that's accelerating revenue in each contract that's booked. So we are sitting here with – I think we are pleased with the guidance we are providing as far as going into 2009.

[Tom Ernst:]

Okay. Good, that does help provide some clarity. And I guess just to summarize, clearly you have some growth drivers that helps 2009 from what's already been booked but if you are right that the bookings did need to come down from where you were, we are likely looking at a bit lower growth next year, all else being the same.

[Charlie Murphy:]

All else being the same at this time, but it is so early to make that call. My point would be, I think it is too early to make that call because we are still only in the August 1; we have good four to five months of this year to close and with all the factors I've just mentioned, sitting here today with the guidance we are currently providing, should be a good growth year next year.

[Tom Ernst:]

Okay, fantastic. Thank you.

[Charlie Murphy:]

Thank you.

[Operator:]

The next question comes from the line of Ross McMillan with Jefferies. Please proceed.

[Ross McMillan:]

Thank you. A question on competition, I know that your two major competitors are private companies but they do release I guess half-year figures and I noticed that Vendavo talked about license bookings doubling I think the first half of '08 and Zilliant don't provide bookings but they talk about 70% sales growth. So, both those numbers are ahead of your growth rate but I'm curious to get a sense for whether get a sense for any changes in win-loss ratios or anything else that might help provide some insight into those numbers in the context of your own growth?

[Bert Winemiller:]

Excellent question. As you know, we are tracking just a phenomenal set of metrics related to activity in the market and you are absolutely right. Our big opportunity is – major competition is spreadsheets but when we get into a competitive situation, 80% of the time we see Zilliant and/or Vendavo or both in the manufacturing, distribution and services markets. They are private companies. We don't have any visibility into their performance; we don't have access to any audited numbers or published numbers and we have tracked over time the marketing statements that they've made and we are just not in a position where we can verify or validate those statements with the metrics that we track. What we do know is when we are competing against them that we think we are doing very well against those competitors and we think we are substantially larger than they are and we are very comfortable. Every metric that you would use related to competition activity and PROS' strength in the market is a metric that indicates that we are the leader and we are in a strong position and the competitive landscape really hasn't changed significantly in 2008 from 2007.

[Ross McMillan:]

Okay. Great. And then just on – clearly your bookings guidance does suggest there must be a deceleration. How do you – given that your revenues are lagging relative to that bookings number, how do you address costs? Obviously you've been hiring heads in the first half of the year, do you start to adjust headcount additions already based on the modestly lowered number of deals that you expect to close or can you just help me understand kind of when you start to turn the dial on the cost side? Thanks.

[Charlie Murphy:]

As Bert mentioned before, we've got a really good metrics-based management approach here. We know the implementations that we have going forward in Q3 and Q4 and the first and second quarters of next year, so we are able to measure I think from a headcount standpoint what's it going to take on the implementation teams, that's across the company, to be able to handle those implementations. So we have got that advantage because we've got that visibility. So we can measure that. We can look at the efficiencies that we have been achieving. We have got a good handle on all that side of the business. The other side of the business is sales and marketing and this is not the time for us to be thinking about slowing down sales and marketing, so we haven't thought about moving that down at all. It's going top as we go forward into the third and fourth quarters. There is a big market opportunity out there. All the metrics are up relative to activity levels, so we are going to spending more in sales and marketing going forward. That leaves R&D and R&D as we said at the beginning of the year, we will continue to spend a bit more in R&D but as a percentage of revenue, it is coming down and that is giving us some leverage as we go forward in our model. We have said that I think in third quarter and fourth quarter of last year, we said it again this year and that is being realized. Our R&D spending is down three percentage points in the first six months of this year compared to the first six months of last year, so we have got a close watch on R&D relative to revenue. Obviously with our high visibility revenue model, we have got a good handle on revenue for Q3 and Q4 and we were able to make what we think is a very modest adjustment to the midpoint of our guidance on revenue, a little over 1% and we did that because we are really back here hopefully turning the knobs looking at our visibility model. We feel very comfortable with our ability to manage spending going forward based upon the high-visibility revenue model we have.

[Bert Winemiller:]

And we will never – we have committed to our investors from the IPO road show all the way through to every investor meeting that we've made that we are going to spend and invest appropriately to capitalize on what this big pricing and margin optimization market opportunity is out in front of us. So we are very comfortable with maintaining our EPS guidance consistent with continuing to invest in sales and marketing and R&D where it is appropriate, to take advantage of this big market opportunity.

[Charlie Murphy:]

Look at the guidance numbers we've provided for the third quarter, the full year, there is still good operating income performance in those guidance numbers.

[Ross McMillan:]

Thank you.

[Operator:]

Your next question comes from the line of Richard Davis of Needham. Please proceed.

[Richard Davis:]

Thanks. You guys were at different companies ten and eight years ago, but could you talk in kind of general terms how that recession progressed and how it affected your business and then how it feels to you that it's different or the same, I mean obviously you are much more diversified and those kind of things, but is there anything that we can clear as outsiders as to how you are handling the economic slowdown and those kind of things?

[Bert Winemiller:]

Absolutely, Richard. Great question. We were a one-industry company. We were totally centric on that industry even though we had geographic and global distribution, that was not sufficient to offset the dramatic impact to that industry as a result of 9/11. As you know, we have had nine years of profitability and cash flow, so even though it had an impact on our bookings and revenue, we still had the forward-looking visibility that Charlie talked about and the metrics management were in place back nine years ago, obviously greatly enhanced more sophisticated today. But the fundamental principles are the same and we managed through that very effectively. That was the time period when it became obvious that we needed to be focused on profitability and cash flow and diversification, and that's when we really accelerated our diversification into these other industries, that diversification and standardized product platform with a single set of source code, that's what drives our margins, our diversification by industry and our diversification by geography today. So that was a tough time. There is no question about it. But those tough times made PROS stronger and that's why we are the leader today.

[Charlie Murphy:]

Let's say one additional thing as well. During that period of time and it continues today, we expense all R&D costs, so we have a very clean balance sheet and all of those costs that we had to expense – transition from a one-industry company to a multiple-industry company were expensed and despite that because we were able to manage the business, we were able to drive profitability and good cash flow.

[Richard Davis:]

And speaking of cash flow and I may have missed it because I wasn't as fast a writer as I should be. Could you say what your operating cash flow was for this quarter?

[Charlie Murphy:]

It's $3.4 million for the quarter, about $5 million for the six months. It's about 14% of revenue for the six months.

[Richard Davis:]

Okay. And then the lasts question is, with regard to deployment cycles, you guys have become more efficient so you are able to recognize revenues more quickly. How contractually obligated are your customers to the deployment cycles that you are pursuing? In other words, could they go high – we are not having a good quarter, we want to slow down the payments to you guys – what remedies or how do you manage through that? Could you talk about that?

[Charlie Murphy:]

From a contract standpoint, it is a fixed contract. The only out is if PROS goes bankrupt and that's not realistic. So the contract is a fixed contract; they are committed; we are committed. We do occasionally experience some slowdowns and it could be for that reason or it could they have a difficulty in getting their hardware in place. So we have been through that before. At the previous economic cycle, we managed these vagaries. We believe we can manage as we go through this one as well. The best we can, we factor all conditions that we may be facing with customers in the guidance that we are providing.

[Bert Winemiller:]

I think we've communicated in the past that typically we have around 50 active projects at any one point in time. It is a broad base of active projects and if you look at them, some of them might slow down a little bit because they are doing their system integration or getting their hardware or whatever it might be but many of them accelerate because our time to value model is to show a CEO and a CFO in 30 days with a data set the negative (inaudible) margin products and customers in their business. So once they see that value proposition very quickly, that's why we deliver value very quickly and we get high visibility and then what happens is, they actually want to accelerate. So right now – and you know what's been happening to our gross margins and you know that our time to value and implementation cycles have reduced. Part of that is once you get a CEO and a CFO that understand the power of pricing, the value proposition – they don't slow down, they speed up. So we are experiencing may be a little more intensity about making sure that these projects come in on time, under budget, get it to the sales people, get it to the pricing analysts, get it to the people that are making pricing decisions, doing price quotes, especially in an economy where you've got fluctuating demand and volatile costs. And we accommodate costs in order to do margin optimization in our systems, so they are highly motivated to implement and typically whatever slowdowns we have experienced are more than offset by C-level executives wanting to accelerate implementation and get our solutions into production.

[Richard Davis:]

Got it. That's really very helpful. Thank you very much.

[Bert Winemiller:]

Thank you.

[Operator:]

(Operator instructions) And your next question comes from Nabil Elsheshai with Pacific Crest Securities. Please proceed.

[Nabil Elsheshai:]

Hi guys. I wanted to follow-up on a question I don't think you guys have finished answering, but I was wondering if you can give us some color on where you are seeing the weakness geographically and if you are seeing the delays more in the newer verticals or if you are seeing anything in the airline space?

[Bert Winemiller:]

In general, we haven't gone into detail on the bookings by industry for obvious reasons, a little lumpy and you can misread it. But, as I mentioned before, we had bookings in each of our five target industries. Our international business was still strong. Our airline business was good. We just – I mentioned 58% of first half bookings was in manufacturing and distribution and services; that's consistent. We saw no deterioration in our ASP. So it is not really – we are not seeing anything that would indicate, anything other than what you would normally expect. I mean you read the newspaper just like we do, some of the travel and transportation slowed down a little bit, but process engineering [ph] and petroleum is going gangbusters. So we just haven't – and we are still small. The category is still in its early stages. We still – our customers and buyers of pricing and margin optimization solutions are innovators for the most part in their industries and the overall penetration is low. I mean we are still replacing spreadsheets, although we have replaced our competitors in a couple of situations.

[Nabil Elsheshai:]

Okay.

[Bert Winemiller:]

But it's still early stage and there is no indication based on our awareness metrics that there is any significant change in fundamental demand either geographically or across our five target industries.

[Nabil Elsheshai:]

Okay. And Charlie, if I could just get the share count assumption you have on the guidance for the year?

[Charlie Murphy:]

Yes. Share count I believe is 26.7 million for the year, fully diluted.

[Nabil Elsheshai:]

Okay. Thank you very much.

[Bert Winemiller:]

Thank you.

[Operator:]

I'm showing you have no further questions at this time.

[Bert Winemiller:]

Well, we would like to thank everybody that joined our call today. Just to recap, we had a really super quarter. Our activity metrics are up and we are very confident about the long-term opportunity for pricing and margin optimization, and we think our products and our people are absolutely best in class, and we are going to continue to work hard to capitalize on this fantastic opportunity that we've had and to conform our commitment to our investors that we are going to continue to manage the business prudently and appropriately in order to make sure that we are the leader in the pricing and margin optimization space. So thank you very much and we look forward to visiting with you over the coming weeks in conferences and one-on-one meetings.

[Operator:]

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