Andres Reiner - CEO Stefan Schulz - CFO.

Matt Van Vliet - Stifel Bhavan Suri - William Blair Scott Berg - Needham & Company Ben McFadden - Pacific Crest Securities Joe Bajen - Craig Hallum.

Good day everyone, and welcome to the PROS Holdings, Incorporated Third Quarter 2015 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Stefan Schulz, Chief Financial Officer. Please go ahead, Sir..

Thank you, operator, and good afternoon, everyone. And thank you for joining us for today's call. Joining me on today's call is Andres Reiner, President and Chief Executive Officer.

In today's conference call, Andres will provide a commentary on the third quarter, and then I will review the financial results and our outlook before we open the call to questions.

Before we begin, we must caution you that some of today's remarks, including our guidance, our strategy, our competitive position, future business prospects, revenue growth, bookings growth, market opportunities, as well as statements made during the question-and-answer session, contain forward-looking statements.

These statements are based on present information and are subject to numerous and important factors, risks and uncertainties, which could cause actual results to differ materially from the results implied by these or other forward-looking statements.

PROS does not assume any obligation to update the forward-looking statements provided to reflect events that occur, or circumstances that exist, after the date on which they are made. Additional information concerning risks and other factors that may cause actual results to differ can be found in the Company's filings with the SEC.

Also, please note that a replay of today's webcast will be available in the Investor Relations section of our website at pros.com. We encourage everyone to review this additional information.

Finally, I would like to point out that in addition to reporting financial results in accordance with Generally Accepted Accounting Principles, or GAAP, PROS reports certain financial results, as well as forward-looking guidance, on a non-GAAP basis.

A reconciliation of each non-GAAP measure to the most directly comparable GAAP measure, to the extent available without unreasonable effort, is available in the press release distributed earlier today, and in the Investor Relations section of our website. So with that, I'd like to turn the call over to Andres..

Thank you Stefan and thanks to all who're joining us on today’s call. I would like to start by recognizing our PROS team worldwide for their incredible passion and commitment to innovation and customer success.

This is the underpinning of a long term growth strategy and a key reason why customers continue to extend and expand their partnerships with PROS. Our third quarter performance reflects a long term impact to PROS when we help our customers outperform.

From a financial standpoint we closed the third quarter with 93.8 million of ARR coming in at the high end of our expectations, up 19% year-over-year. ACV came in at 4.5 million below our guidance range and up 20% year-over-year. TCV was 30.8 million within our guidance range and up 26% year-over-year.

We're pleased with the progress we've made on our long term strategy. However we were disappointed with our ACV bookings in the third quarter. Towards the end of the quarter we did not execute getting a few deals done within the timeframe we expected, and this is not acceptable.

We believe the shortfall was primarily due to sales execution as demand remains strong and the competitive environment was unchanged. We recognized that we are undergoing a complex transition and we are calibrating the business accordingly such as enhancing sales operations and strengthening the sales leadership team.

We are mutually separating with our former global sales leader and now our sales executive report directly to their comp [ph] or Chief Operating Officer. We have factored these changes into our outlook.

Turning to our overall business, our confidence in our long-term growth strategy and in particular our cloud-first strategy continued to build in the third quarter, driven by a combination of new deals added to the pipeline and the leverage shifting of perpetual opportunities to cloud. Our cloud pipelines more than doubled sequentially.

We introduced new innovations in the cloud that made a difference in winning business and bringing value to customers. Our cross-sale strategy resulted in expanded partnerships with Austrian Airlines, Avis Budget, Fonterra, and Qantas Airways among others.

I would like to share one experience that demonstrates our high ROI in cloud-first strategy helped us grow within our customer base. In a presentation at Dreamforce, a PROS customer reported an ROI of more than 20 million of incremental margin every quarter since implementing our supply-aware pricing capability.

Our teams have been working closely together on taking this even further by tightening the connection between forecasting, pricing, cording and their CRM. To that end in the third quarter the customer expanded their partnership with us by adding our cloud based price optimization and CPQ solutions integrated with their sales for CRM.

We believe our end-to-end solutions in the cloud will deliver even more value, and that no other company can offer this breadth of solutions or impact to their business. Consistent with our focus on driving continuous innovation, in the third quarter we expanded our product leadership decision with new capabilities across our solutions.

I will share a few examples. First, we introduced intelligence into our CPQ solution called fast configuration. For a sales rep putting together a quote, this innovation recommends and automates optimal products configurations in real time based on their buyer’s preferences.

Adding this capability to our already powerful science based price guidance in CPQ provides much faster, accurate and winning quotes for sales rep and a better buying experience for their customers.

The same capability can help our customers drive more business in their sales or e-commerce channel as well which we expect to be an increasingly prevalent channel for B2B companies. Second, on the airlines side we introduced new data science capabilities for Group Sales Optimizer to help airline send cover and realize additional revenue potential.

The science predicts the probability of group passenger fulfillment rates enabling airlines to better optimize capacity and performance. This was a key feature for our customers to buy Group Sales Optimizer in the third quarter from which they expect to drive significant incremental value.

Finally, our cloud-first strategy and focus on innovation also means delivering value more rapidly. As we highlighted in our cloud-first update in June we are starting to shift to monthly product recycles in the fourth quarter. We are excited to deliver faster innovation in the cloud.

Looking ahead we will continue to aggressively execute on our cloud-first strategy as investments we have made are working. Our deal activity for the year continues to outpace booking growth. Our customers are responding and realizing value fast and our innovations are setting the standard for how to help customers drive revenue and profit growth.

This is a solid foundation for our long-term growth strategy and where we believe we are in a strong position to capitalize on our large market opportunity. I will now turn the call over to Stefan so he can provide you with a review of our financial results and our outlook for the fourth quarter and full year 2015..

Okay. Thank you Andres. Before I get to my comments, I want to remind everyone that I will be discussing non-GAAP results unless otherwise noted. A full GAAP to non-GAAP reconciliation is included in our earnings release which can be found on our website in the Investor Relations section.

Additionally, we have provided a table of key metrics for this quarter and past quarters that can be found on our website in the Investor Relations section also. As Andres mentioned we made progress in our transition to a cloud-first company in the third quarter.

The two metrics we have emphasized during our cloud-first transition, ARR and ACV, were up by 19% and 20% respectively year-over-year but ACV did fall short of our expectations.

Our ARR which is composed of the committed annual value of our subscription and maintenance contracts came in at $93.8 million which was at the high end of our internal expectations and was up 19% over the third quarter of 2014. Growth in subscription ARR was the primary growth driver to our overall ARR growth rate.

Our strong ARR balance at September 30 was also supported by stronger than expected renewals.

Our ACV bookings which is composed of the annual subscription and maintenance values as well as 1/7th of the total license value of contracts signed during the given period of time was $4.5 million which was up 20% over last year, but below our guidance range.

As Andres already discussed we did not close all the deals we expected to close in the third quarter due to some sales execution challenges. We are addressing those challenges and we feel that these changes will drive better execution and allow us to capitalize on the strong demand that continues to grow for our solutions.

In the second quarter subscription ACV was the primary driver of our overall ACV growth in the third quarter. Total contract value bookings for TCV which is composed of licensed, service, maintenance and subscription bookings was $30.8 million or an increase of 26% over last year and in line with our guidance range.

As a reminder we will only provide TCV metrics through the remainder of this year. Now turning to the P&L non-GAAP revenue in the third quarter was $41.7 million, which was at the high end of our guidance. Subscription revenue was $6.9 million also at the high end of our guidance and represented a slight sequential increase.

As I've stated previously we did not expect our subscription revenue in Q3 to fully reflect the strength in our subscription bookings during the first nine months of the year. We are pleased with the momentum we're building in our subscription business and we continue to expect sequential growth for the fourth quarter and beyond.

Maintenance revenue was in line with our expectations at $15.8 million an 8% year-over-year growth. Combined subscription and maintenance revenue make up our recurring revenue. In the third quarter our recurring revenue was $22.7 million which represents 54% of total revenue, compared with 45% of total revenue in the third quarter of last year.

License revenue was $6 million and slightly below our expectations. Most of the license revenue recognized in the quarter originated from license bookings in prior quarters that were subject to percentage and completion accounting. We did close some perpetual license contracts in the third quarter but at a much lower rate than in previous quarters.

License transactions that were recognized as revenue at contract signing were less than $900,000 in the quarter which was slightly less than our expectations. Our non-GAAP EPS in the third quarter was a loss of $0.16 which was $0.04 better than the high end of our guidance. A lower level of expenses drove the improved EPS.

As we committed to you when we announced our cloud-first strategy earlier this year we have lowered our spend in non-strategic areas to reduce expenses which offset some of the lower revenue that resulted from our model change.

Now turning to cash flow, our free cash flow in the third quarter was $1.8 million and $1.7 million for the first nine months of 2015, which is better than our previous expectations. This is being driven by strong collections and the lower level of operating expenses I referenced earlier.

Now I'll discuss guidance for the fourth quarter and the full year and I'll start with our guidance for ARR. As I mentioned in the past we view growth in ARR as the best leading indicator to both degree of success in our cloud first transition and the growth in future recurring revenue.

Coming off solid cloud bookings and strong renewals through the third quarter and our expectations for the fourth quarter we are raising our year end ARR to be in the range of $99 million to $101 million. This is up from our previous guidance of $95 million to $99 million.

The increased guidance now represents a year-over-year increase of 18% at the midpoint of the range. Another key metric in our cloud-first transition is ACV. We're now expecting Q4 ACV of at least $10 million which would represent at least low single digit growth over last year. For the full year we expect ACV to be $25 million or more.

This would be at least 7% growth over last year's ACV of $23.4 million. We expect TCV to land at $53 million or more in the fourth quarter which at the low end would represent at least single digit growth over last year. For the full year we expect TCV of a $151 million which at the low end would be 15% growth over last year.

While we have the sales pipeline supporting more than this level of ACV and TCV bookings, we have a number of large opportunities that are difficult to predict and closing or not closing one opportunity can result in a wide variance to our bookings result.

We're also setting these targets with the understanding that the changes we have made to address the execution challenges we just experienced in the third quarter may not fully benefit our fourth quarter. Now turning to revenue.

As many of you know we've been pointing to the fourth quarter as the period when our subscription revenue will begin to reflect the impact from subscription bookings we've closed in previous quarters. We expect subscription revenue in the fourth quarter to land between $7.5 million and $7.9 million.

At the midpoint this will represent a sequential increase of 11% and a year-over-year increase of 10%. For the full year we expect subscription revenue between $28.7 million and $29.1 million which would be a year-over-year increase of 12% at the midpoint of guidance.

Our total revenue guidance range has been impacted by the lower ACV and TCV bookings guidance I just discussed and by the higher than expected amount of subscription bookings within our total bookings.

We are now expecting the subscription bookings to total TCV bookings mix to exceed the top end of the range of 35% to 45% we provided earlier in the year.

Because of these two factors we are estimating our fourth quarter total revenue range to be between $40.7 million and $42.7 million which will lower our total revenue guidance range to $170 million to $172 million for the year.

At the low end of this range our assumption for license revenue recognized in contracting would be less than $1 million for the fourth quarter. We realized that our revenue guidance ranges throughout 2015 have shifted several times.

The guidance shifts have mostly been due to the actual results of our cloud-first transition being different from the assumptions we made earlier in the year. While many of these differences are the result of faster adoption of our subscription offerings, the impact is lower license bookings and lower near term revenue.

We believe the life time value of subscription bookings are far better than license bookings and we are supporting the accelerated shift to subscription bookings. We are also learning more about the demand for our subscription offerings which will allow us to make better assumptions going forward in setting our revenue expectations.

Free cash flow which has been much better than forecasted year-to-date is expected to be a burn of $3 million to $5 million in the fourth quarter. This will result in a free cash flow burn of $1 million to $3 million for the full year.

Stronger than anticipated collections and expense control is driving the improved guidance from our earlier range of a $5 million to $9 million free cash flow burn for the year. Moving to EBITDA, we expect EBITDA in the fourth quarter to land between a loss of $6.2 million and $7.2 million.

For the full year, that would result in an EBITDA loss of $14.2 million to $15.2 million. Finally, even though it’s really I want to provide a few high level of updates for 2016 now that we are two quarters into our cloud-first transition.

We believe the progress we are making with our cloud-first model will continue into 2016 and subscription revenue will be the growth driver for our business going forward. Subscription revenue could grow by approximately 35% in 2016 with growth in the first quarter that is roughly equal to our fourth quarter growth rate.

The subscription revenue growth rate should accelerate in the remaining quarters throughout the year. License revenue could decline by approximately 50% to 70% as the mix of subscription bookings continues to increase. Our maintenance and services revenue lines should be relatively flat compared to 2015.

As a result of these expected trends, total revenue could be down 2% to 4% to our 2015 revenue. This is at the lower end of the range we provided at our cloud-first update. We also plan to continue making investments in our sales and our product group. This will result in higher total expenses over 2015 and will result in a free cash flow burn in 2016.

As we have communicated before, we anticipate that free cash flow burn could be as much as $30 million between 2015 and 2016 and we continue to expect that level of burn during these two years. Due to our solid collection performance in 2015, most of this cash flow burn will occur in 2016.

In summary, we are making steady progress to our move to a cloud-first company. We are pleased to see that our progress is being reflected in key data points such as stronger than planned ARR, sequential and year-over-year subscription revenue growth in the fourth quarter and better than expected free cash flow.

So with that let me turn the call back to the operator for questions.

Operator?.

Thank you sir. [Operator Instructions]. And we will take our first question today from Tom Roderick with Stifel..

Yes, hi, it’s Matt Van Vliet on for Tom this afternoon. Thanks for taking my question.

I was wondering if you could talk a little bit more about some of the sales changes that you referenced given the sales execution and maybe how much of that you think has any impact from shifting to a subscription sales model and just not having the maybe management or the experience in place for selling that as a different model?.

Hi Matt, this is Andres. So mainly it’s around sales operations and just the rigor in the gross line.

I would also say that at the same time we are pushing pretty aggressively to move deals from perpetual to cloud and that’s being producing some maintaining of the sales process of which we still don’t feel that’s acceptable, but what we’ve done is we wanted to plan a little bit more sales organization or [indiscernible] to be more closely connected with each of the leaders and bring nimbleness and support through that process as well as additional executive support..

Alright, great. Thank you. .

Right..

And we will take our next question from Bhavan Suri with William Blair..

Hey guys. Thanks for taking my question.

Just as you look at this and you look at sort of the numbers for ‘16, just help me understand sort of how you thought through that guidance vis-à-vis sort of you said this year we’ve had to moderate it because of shifts, because of the newer ramp in subscription, how much sort of visibility you’ve built into that number? Give us some sort of confidence in that number given the various moving pieces here please..

Yes, Bhavan, this is Stefan.

You know we are -- as I indicated we acknowledge it's a bit early to be talking about 2016 but you know we did give some color to how we saw the model shifting in our cloud-first update back in June and because of the shift as we talked about to a higher mix of cloud booking we thought it was appropriate this time to give you an update on not just '15 but '16 as well.

And so as I, go ahead, you wanted to ask anything else on that?.

No, no, no, I think -- just agreeing with you as you go through that..

Oh, sorry. So what we thought we would do here is provide that update and so as I said in my prepared remarks, we, you know we've taken the new trends into consideration and then that's also been a factor in how we look at 2016. So that's why we decided to go ahead and provide the updates now.

As far as you know the view in terms of confidence or you know how much we already have visibility into, you know we're not really going to get into those at this point in time.

When we do give official guidance next quarter, we'll talk more about the build of that revenue stream and we'll obviously give you much more specifics around how we're thinking about 2016. .

Okay, okay. Turning to the sales challenges in the period, you know I’d love to get some color, was it competitive, was it, you sort of said sales execution but sales execution can sometimes sort of be the forecaster to a new entrant or a more complex sales process.

Just a little more color on what happened in the quarter in terms of geo or vertical, would be helpful..

Now that's a great question.

I would say that we started the quarter very strong in the first few months, actually unseasonably strong in the first few months and I would say in the last three weeks of the quarter we just -- there was a lot of deal activity and we just were not able to move the deals as fast as we like and I think it's just -- in terms of our pipeline we have a lot more activity and just having the rigor across all of the opportunities that we need to have just wasn't solid as expected.

But I would say it's not no change in the competitive environment, it's not about losing deal it's mostly shifting of deals most of which we closed close to quarter end..

One of the comment I wanted to make related to my answer you know, with the guidance -- I shouldn't say guidance, with the color that we talked about with our license revenue, you know we talked about it being more than 50% down.

I think I said 50% to 70% down, and if you think about that that is the line item that creates the most variability in our revenue in our total revenue. And with it coming down to that degree I think it's safe to assume that the variability comes down with it.

Because we're talking about much more predictable revenue streams that we're relying on in terms of our total revenue guidance..

Yes, and Stefan I think that's fair, I mean if you'd asked me before this what I thought license could be down, I’d have probably said 25%, so certainly that's pretty conservative. I get that..

And it's, to your point, it’s -- I think when we initially modeled and we talked about this at our cloud first update we were not assuming that license revenue would be down this much because we did not assume this fast of a move. And I would tell you that it's especially true with our travel business.

You know we have been in this business, the travel business for many, many years and as license company, and so we really weren't sure how fast the travel industry would adopt our cloud-first offerings and we've been very pleased with the adoption of the cloud-first offerings in that space..

One quick last one from me. You know you've had some success with the vertical approach, especially given subscription models have the faster sales cycles, things like that, take the agriculture business or so and so forth.

Any new verticals you're expanding that into and then as you think about the sales force realignment does that enter [ph] this at all or am I stretching too much here?.

So definitely industry is focusing on large enterprise and industries like you mentioned food and the consumables aftermarket, as far as high tech, you know medical devices, chemicals, those are the industries where we have a lot of depth and differentiation and that is definitely an area we're putting a lot of emphasis in.

And that's where we see -- it was great to see one of our customers in the food industry adopt our full solution stack from signal demand into supply optimization to price optimization and now CPQ. And be able to gain even more of a revenue and profit advantage through the use of the integrated offerings. Integrated natively with salesforce.com..

Got it, got it. That's it for me guys thank you..

And we'll take our next question from Scott Berg with Needham & Company..

Couple of quick ones from me is Stefan as you look at your guidance for '16 and license revenue coming down 50% to 70%, how much of that is from the model change relative to your prior expectations and how much is maybe reflective of your expectation that the sales execution challenges are just kind of maybe don’t get resolved for a couple of quarters?.

Yes I would say it’s more the former than the latter. I would tell you we do not expect to be working through sales execution challenges for the bulk of 2016. So it’s more the former of the mix shift that’s shifting between licenses to subscription bookings..

Okay, great. Then Andres you talked about your cloud pipeline doubled sequentially in the quarter over Q2.

Is any color in terms of that move? Is that more reflective of customers in the current pipeline, that were selecting a perpetual model initially making that change or is there may be a higher portion that’s reflective of new customers coming in and just saying hey we want the -- we would like the cloud model upfront?.

Yes it’s reflective of both, but definitely there is a lot of net new business coming into the pipeline that in those deals we are only selling cloud and in cloud we are seeing resonate well. But we also have opportunities that are from existing customers as well as deals that were in the pipeline before as perpetual that have since changed to cloud.

So there is a mixture of those three areas. Net new pipeline deals, that started in perpetual and are shifting to cloud and existing customers that are wanting to adopt some of our new cloud offerings..

Great. And last one from me and sorry if I am still staying on the sales execution thing, that it’s probably a top topic. You guys had some execution exercise two years ago specifically in your sales execution, deals weren’t getting across the pipelined that you thought were internal components.

How much does the challenges in the third quarter reflect similar challenges to two years ago, are they different issues, different geographies?.

I think its different issues not related. This was more blocking and tackling and I do think its part of the volume and a lot more people and the activity as well as us pushing pretty aggressively in moving from perpetual to cloud.

And naturally when you are in a sales cycle and you are moving a deal over, it just takes longer to go through that process..

Great..

But we expect that to minimize going forward..

Great. Thanks for taking my questions. I will jump back in the queue..

Thanks..

And we will take our next question from Ben McFadden with Pacific Crest Securities..

I wanted to actually go back to this execution issue. You talked about extension in some of the sales cycles, there is still confusion out there. But it seems to me like if you are shifting to a cloud-based model you should actually have an easier process to prove the value of these solutions.

So maybe you could talk about kind of were these existing perpetual deals that had to switch due to the changes that you have made or were these new deals, and kind of what’s the opportunity to improve these sales cycles as we go along with this cloud-first transition?.

Yes, now that’s a great point, Ben.

I think mainly deals that you are actually shifting from perpetual to cloud, when we are selling cloud deals from the beginning, as you said it’s a lot easier to prove the value, to see the solution, but when you are making a shift and you present a perpetual prices and then you are switching over, it just introduces a change in the sales cycle and getting customers to understand the value and the differences, plus add more complexity and time to the sales.

In either case for us it’s unacceptable to have any extension. So I just want that to be clear. And I think with better execution we don’t need to have an extension in the sales cycle times..

Okay. And then on the guidance. I mean, the ACV that didn’t really hit what you wanted to hit in the quarter, but is still above that 20% number and of course you are guiding to single-digits for ACV in Q4 and granted the comparison is significantly different.

But maybe you can kind of help us understand exactly why you are guiding to a number in that ballpark? And on that same front, those deals that were pushed in the quarter, did you see those close during the month of October or are you still seeing an extension of deals a month into the quarter?.

So Ben this is Stefan, I will take that in reverse order. So the deals that you are referring to I would say most of them have already been closed. None of them were lost or anything like that. It was simply the execution that Andres was referring to earlier.

See, as it relates to your other question around the ACV booking for Q4, our ACV metric is a metric we started providing to give additional transparency because of this cloud-first pivot, and it is a lumpy -- you know our business is lumpy and so as a result of it we have quarters where we'll do significantly better than what we thought and in quarters where we didn't quite do what we thought we could do because of one or two deals that may or may not sign in a given quarter.

So what we've done is we've looked at the fourth quarter, we've looked at the pipeline of opportunities and we feel comfortable that $10 million of ACV is something we can put out there and feel comfortable, that's something we can execute to.

But I did say there is a number of other opportunities that include larger transactions that could be closed in the quarter as well that could give us upside to that. But at this point we approach given what we experienced in Q3 given the fact that there's lumpiness in our business that's what we're comfortable in giving at this point in time..

Great guys, thanks..

[Operator Instructions] And we'll take our next question from Joe Bajen with Craig Hallum..

Hey guys, I’m here for Chad today, thanks for taking my question. Most of what I had has already been asked but I guess just one quick one. On the quarter carrying headcount of personnel, looks like sequential anyway a slight tick down, it looks like you kind slowed the cadence of net new adds over the last few quarters.

I guess looking out with new head of sales, some sales execution issues. I mean should we assume that you're kind of on a hold from a net new add standpoint over the next couple of quarters, or are you still looking at trying to grow that at least through the next two, three quarters worth of this transition, that's all from me. Thank you..

No absolutely we're continuing to add and grow the quarter carrying personnel and I would say that our sales churn rate is actually decreasing. So we feel pretty good about the sales organization that we have and the strength of the sales organization. So we'll continue to add.

What I would say is typically fourth quarter, it’s just not a good quarter to recruit in, so some of them may push to Q1, but we're going to continue to hire pretty aggressively but focus on the right talent. And what would naturally see is a big tickup in the first quarter and that's an area where we've traditionally seen the good talent.

But we're pretty aggressively hiring and we've hired close to the end of the quarter. So we're already higher than where we were at the end of Q3..

And at this time I’d like to turn the call back to Andres Reiner for closing and additional remarks..

Thank you for your participation in today's call and for your support of PROS. We believe we're well positioned to capitalize on our large market opportunities through our cloud first strategy and ongoing innovations. I'd like to thank once again our PROS team worldwide for their continued passion and commitment to innovation and customer success.

Thank you also to our customers, partners and shareholders, we look forward to speaking with you on our next call. Thank you and goodbye..

Thank you, and that does conclude today's conference, thank you for your participation..