Sunday, November 6, 2011

Pros Holdings ( NYSE - PRO ) -- Pricing Software Leader Accelerates Growth

Pros Holdings (PRO $16.25) reported excellent on target Q3 results.  Earnings (excluding non cash stock option expense) advanced 83% to $.11 a share.  Sales climbed 34% to $25.2 million.  The company still sells its software exclusively on a perpetual license basis.  The target market at this point remains large Fortune 500 type customers, with a particular emphasis on international airlines and other customers with a high number of variable pricing transactions.  Most U.S. airlines operate their own internally developed pricing schemes.  Initial selling prices approach $1.0 million and sometimes expand from there as customers extend the technology to additional business units.  Maintenance contracts, which provide the latest software updates when they become available, are 15%-20% of the current selling price.  In the September period more than 95% of the maintenance contracts that came up for renewal were continued.  Incoming orders demonstrated greater end market diversification.  More industries are adopting pricing (revenue management) software to enhance profitability in a slow growth environment.  Pros already is the industry leader and appears to be lenghtening its advantage by boosting R&D and marketing.  The company is developing specialized applications for niche markets.  It also has boosted the sales force by 50% this year.

Momentum is likely to continue in Q4.  We estimate full year earnings will rise 40% to $.35 a share.  Revenues appear headed for the $96 million mark (+29%).  Pros is rolling the dice a bit with respect to 2012.  The company does have several large companies nipping at its heels in the pricing space, including Oracle and Accenture.  Those behemoths are validating the technology among a far greater customer base than Pros addressed in the past.  So the company plans to keep spending at an elevated level next year to retain its competitive lead and capture a lot of new business.  All that spending is likely to prevent margins from expanding, however.  Pros also is launching a cloud based computing service aimed at smaller mid-market customers in 2012.  That initiative is likely to crimp profitability further.  Gross margins on incremental sales remain unusually high, so Pros will have plenty of latitude to work with.  Despite the escalated spending plan our estimates reflect a modest improvement in 2012 pretax margins.  If economic conditions contract in any serious manner, though, the leverage process could shift into reverse.  With the P/E multiple already at a steep valuation the stock could be a volatile performer if economic conditions deteriorate.

We estimate 2012 sales will improve 20%-30% to $115-$125 million.  Earnings could end up in the $.40-$.50 a share range.  The long term outlook remains bright.  Economic growth in Japan, the United States, and Europe is likely to remain muted for several years.  But corporate income promises to stay robust.  So companies will have an incentive to apply pricing technology to their relatively slow growing operations.  And they'll have the cash to pay for it.  Penetration of the mid-market segment promises additional leverage.  Sales to emerging markets promise to reinforce the long term trend.

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