Source: The Wall Street Transcript, October 15, 2001

The Wall Street Transcript:

Can we start out with a history and overview of Prophet 21?

Chuck Boyle, president and CEO of Prophet 21, Inc.:

Prophet 21 develops enterprise software solutions, including an Internet trading network, and offers supporting professional services for durable goods distributors that enable them to increase sales and improve customer service while reducing operating costs. Ever since our founding by John and Dorothy Meggitt in 1967, Prophet 21 has positioned itself as a leader in serving the technology needs of durable goods distributors in North America. We currently have nearly 2,000 customers - each with an average of five stocking locations - that utilize Prophet 21's technology and technology services. Our core target markets include industrial, fastener, electrical, and plumbing distributors.

TWST:

And how big is the market in total?

Mr. Boyle:

The durable goods distribution market in North America encompasses nearly 40,000 prospects. This figure is based on our own, verified research.

TWST:

So you have room for growth?

Mr. Boyle:

Definitely. While we've explored opportunities beyond North America, we believe that there's more than enough market share for growth right here.

TWST:

With whom do you compete in this space?

Mr. Boyle:

Most of Prophet 21's competitors are small, privately held, very splintered companies that specialize in tight verticals. Prophet 21 has elected to go after a broader slice of the market, where our offerings are applicable to many different verticals within durable goods distribution.

TWST:

Are there no big publicly held players in this market space?

Mr. Boyle:

There really aren't. Some of the larger enterprise resource planning (ERP) players - like SAP, J.D. Edwards, and PeopleSoft - have tried to make a run at the distribution market, but the world of distribution is very complex. Just for order processing, the magnitudes of the logistics, finance, inventory management, and purchasing requirements all demand a certain level of expertise and detail that aren't available in these ERP products.

TWST:

What are the barriers to some of the bigger players coming in, given the size of the market space?

Mr. Boyle:

The main barrier is functionality. Distributors don't manufacture goods, and these bigger players tend to cater to manufacturers.

Distributors take someone else's products, add services, and deliver them to the end user. Most of the services they add are logistical. For instance, a distributor could buy a trainload of widgets and then sell them in smaller quantities to niche end users. Doing so requires a software solution that provides the capabilities to sell products in various quantities (box, palette, truckload, etc.) to each user. That kind of capability doesn't exist in the packages those other larger players bring to the market.

Also, distributors' margins are razor-thin. They survive by a complex array of pricing and inventory management, which our products help them control.

The functionality gap, more than anything else, keeps the larger ERP players from moving into the distribution industry.

TWST:

Why do distributors go outside rather than developing business solutions themselves?

Mr. Boyle:

Last year, Prophet 21 spent $8 million on research and development. It's very difficult for an individual distributor to make that kind of annual investment in a private business system. Plus, distributors' areas of expertise revolve around logistics, sales, and engineering, not information technology (IT). The vast majority of distributors feel that the more they can outsource, the better off they are. They prefer partnering with a company that has combined expertise in distribution and technology - a company like Prophet 21.

TWST:

As we look out over the next two or three years, how would you describe the strategy that Prophet 21's going to follow?

Mr. Boyle:

Prophet 21 has a very successful history of bringing enterprise software solutions and the associated professional services to distributors and that will continue well into the future.

In addition, we recently expanded our offerings to include an Internet trading network, Trading Partner Connect. Trading Partner Connect streamlines the commerce process between distributors, their manufacturers/suppliers, and customers, thereby increasing sales and improving customer service while reducing operating costs. Distributors benefit from dead stock reduction, lower costs, and access to millions of items. All this enables them to compete on a larger scale and improve customer service. They may also develop e-commerce Web sites that provide customers with on-line service as well as ordering capabilities 24 hours a day, seven days a week.

This isn't B2B magic. Distributors are by nature traders. All we've done is automate the process. Through their Prophet 21 technology our distributors can connect to Trading Partner Connect and conduct commerce directly computer-to-computer in real time. We've been able to do this in a very cost-effective manner for all parties involved. We've already experienced great success with this offering. Trading Partner Connect has amazing growth potential. It, along with our continued focus on enterprise software solutions and expanding professional services, promises to make the next three to five years very exciting for Prophet 21.

Financially, Prophet 21 is incredibly strong. We have quite a bit of available capital, close to $16 million, that we can use for investments. In addition, in the history of the organization, we've never borrowed a dime, so we're not limited like other companies with regards to making investments.

TWST:

What are your enterprise software solutions?

Mr. Boyle:

Prophet 21 offers enterprise software solutions for Microsoft Windows NT/2000 and UNIX. Prophet 21's enterprise software solutions provide organizations with powerful, highly customizable applications that streamline business processes and transaction costs to maximize profits and growth. Features include order and inventory management, purchasing, pricing and promotion, supply chain optimization, financial management, customer relationship management, business analysis and reporting, e-business, and warehouse automation. Solutions are capable of either being implemented onsite or accessed via the Internet through Prophet 21's Application Service Provider (ASP) Option.

TWST:

Why two solutions?

Mr. Boyle:

Different distributors have different needs. Some prefer the ease of use a Microsoft Windows NT/2000 solution provides, while others prefer a UNIX-based solution.

Prophet 21 CommerceCenter uses Microsoft Windows NT/2000 platform and SQL Server.

Prophet 21 Acclaim is powered by UNIX and Progress's 4GL technology.

TWST:

What are the professional services you're offering?

Mr. Boyle:

Prophet 21 Professional Services encompass several areas, including: Prophet 21 Consulting, Prophet 21 Customer Support, Prophet 21 University, and Prophet 21 Application Service Provider (ASP) Option.

We have a full array of consultants available to help our customers get the greatest return from their Prophet 21 technology investment. All of our consultants can help determine a customer's business-specific goals and streamline their daily operations. Specific services include implementation, application, technical, and e-business consulting.

Prophet 21 Customer Support provides users with access to a comprehensive solutions database 24 hours a day, seven days a week via the Web. Roughly 80 percent of the cases our customers submit to us are placed through the Web.

Prophet 21 University offers a complete suite of classroom, computer, Internet, and video courseware designed to help customers fully realize the power of their Prophet 21 solution and ensure the highest possible return on their investment.

Prophet 21 ASP Option provides an alternative for companies that would rather not license a Prophet 21 enterprise solution. Prophet 21 can also host desktop applications and all Microsoft products.

Our Professional Services offerings have been very successful in providing value to our customers and steady recurring revenue to Prophet 21.

TWST:

How do you go about promoting Trading Partner Connect?

Mr. Boyle:

Since we have such a close relationship with so many distributors, we're working within our own family of users. It hasn't been difficult for us to establish a trading network. Currently more than 100 distributors are trading goods via Trading Partner Connect, and every day that number grows.

This is successful because we focus on providing our customers with the same benefits they receive with our enterprise software. Trading Partner Connect enables them to capitalize upon more revenue opportunities, decrease their operating costs, and improve their customer service.

For example, one issue that has haunted distributors since the industry began is described as dead stock - generally, that's inventory that has not sold within a year of purchase. It takes up valuable warehouse space that could be filled by fast-moving, profitable stock. In the past, distributors with dead stock had little option but to return it (for a loss), donate it, or send it to surplus dealers for $.10 on the dollar. We recently completed a study with Trading Partner Connect where we proved that we could match distributors carrying dead stock with distributors who are actively selling the same products. Distributors can turn dead stock into cash they can use for other, more profitable purposes. And, since dead stock normally sells at $.80 on the dollar, the buying distributor can purchase it bellow his usual costs and improve his margin. It's a win-win situation and just one example of the benefits of Trading Partner Connect.

TWST:

We saw a lot of these systems develop during the height of the Internet boom 18 months ago and then fade. What's to keep yours from going the same route?

Mr. Boyle:

If you look at how the others actually came about, you had a few smart people fresh from business school that had some creative ideas. Everything was fueled more by myth than business reality. The reason Prophet 21 is successful is because we have all of the business and market elements required to make it happen, including an experienced management team.

You don't need a $100 million to create an Internet trading network. Prophet 21 employees, highly skilled people who know and understand the needs of the distribution industry, developed all of the technology for Trading Partner Connect.

Because we listen to the distributors we work with, we know what they need to drive their businesses and build those solutions into our enterprise software solutions. We did the same when developing Trading Partner Connect and made it accessible through our enterprise software solutions. Everything is completed directly from our distributors' Prophet 21 system. There is no need to enter information twice.

TWST:

It's easy to use?

Mr. Boyle:

Very easy to use. And the cost of entry is minimal also.

TWST:

If we look out over the next two or three years, what are the goals you've set for the company in terms of growth?

Mr. Boyle:

At Prophet 21, we fully expect the next several years to be ones of growth for us.

The slowing economy actually provides an opportunity for Prophet 21. Let me explain... Initially when the economy softens, business owners take a step back and examine how to best position their companies in a tighter market. The focus usually shifts to being more efficient as an organization - on minimizing their operating expenses and capitalizing on their revenue opportunities. Because Prophet 21 provides solutions that allow them accomplish those goals, we see an increase in demand for our services both from existing customers and prospects.

Moving forward, especially with respect to our continued focus on developing enterprise software and Trading Partner Connect, we feel that Prophet 21 has an excellent chance for rather dramatic growth. Trading Partner Connect itself has the potential of dominating the world of distribution. Although we're initially rolling it out to our family of users, it is designed to work with any back-end system. In the next year or two, we fully expect to invite any distributor to participate.

TWST:

You'd be able to open it up by then?

Mr. Boyle:

Technology-wise we can do that right now. We have participation from some of the largest manufacturers in North America - 3M, Henkel Loctite, Carboloy, and others. There's a list of manufacturers that have come on board Prophet 21 for Trading Partner Connect because they see it as a great value for serving their distributors and in reducing their operating costs.

TWST:

If we look longer term, what kind of growth are you capable of generating?

Mr. Boyle:

We're very optimistic with regard to our growth this year. And we expect rather dramatic growth over the next three to five years as Trading Partner Connect matures and our enterprise software offerings expand.

TWST:

As all this comes to fruition and you realize this growth, what kind of an operating margin are you capable of generating over time?

Mr. Boyle:

A few years ago, Prophet 21 recognized that our revenue from enterprise software was going to be a little slower than what we would like. But at the same time, because we had this knowledge, we chose to continue investing in research and development to put us in a strong position for the future. Now those investments are starting to pay off. Because most of our expenses revolve around human resources, once we reach a certain level we don't incur additional costs. I expect our margins to increase as our revenue increases.

TWST:

Do you have the management team in place you need?

Mr. Boyle:

Most definitely. We have a strong management team at Prophet 21. We recently streamlined our organization with regard to middle management and in doing so strengthened the company. On average, each member of the management team has 15 years of experience within the durable goods distribution industry and 20 years experience in business.

TWST:

How would you describe the culture at Prophet 21?

Mr. Boyle:

We encourage openness and input from everyone at Prophet 21. We also work very hard to hire only the brightest people who share our mission. There's no tolerance at Prophet 21 for any mediocre performance. Everyone knows it and strives to attain the highest goals.

TWST:

Do you have the balance sheet you need to support your goals?

Mr. Boyle:

Our balance sheet reflects roughly $34 million in assets, including $16 million in cash. We expect this year to continue our trend to be on the plus side with regards to cash generation. We have zero long-term debt and more than enough to invest in our initiatives moving forward.

TWST:

If you were looking at acquisitions, what would you be looking at?

Mr. Boyle:

I'd be looking at companies that are possible competitors - those that can help us expand at a rapid pace and deepen the penetration that Prophet 21 has already made within durable goods distribution in North America.

TWST:

How sensitive is this business to the economy?

Mr. Boyle:

I think all businesses are sensitive to the economy. But for us, as I've stated earlier, when people start looking at how they can improve their operations, technology like what Prophet 21 offers is something that can be a tremendous aid to them. If they're looking at how they can reduce costs associated with their business processes, that's exactly what we provide. And everything we do is geared toward helping our customers improve their bottom line. So for us, this slowness in the economy is almost an opportunity.

TWST:

How do you feel about the value the market is currently putting on Prophet 21?

Mr. Boyle:

Personally I'm biased. If you look at just the balance sheet value of Prophet 21, you would see a company that is very undervalued. But we're under-followed too. We're a small company and there's a certain amount of risk. Our float isn't where it should be for someone who is looking at getting in and out of a company rather quickly with any sizable investment. But I think the company is totally undervalued.

TWST:

Why is the company undervalued? When you talk to investors, what are they asking you? What is their concern?

Mr. Boyle:

I think the stock is undervalued because there's a lack of interest in small-cap stocks like Prophet 21. It's hard for an analyst to spend some of their valuable time writing about Prophet 21, even though we have a couple of people that do follow us and do a very nice job.

Also we only have a million and a half shares in public hands right now. And most everyone is just holding on to it, so it's hard to buy stock. I personally know of a few groups that own the majority of that million-five and they're sitting on it because they see such great potential in Prophet 21. So I think those are the market factors that are against us, small company, under-followed, and, at the same time, not a lot of liquidity out there because of the number of shares we have out.

TWST:

If you were sitting down with some potential longer-term investors, what are the two or three reasons you'd give them to take a look at your company today?

Mr. Boyle:

The first thing I'd encourage them to do is to understand what our business goals are and the markets that we serve. The world distribution is not going to go away and Prophet 21 is a solid company. The next thing I would have them look at is the actual market potential that Prophet 21 can gain through Trading Partner Connect. Long-term investors will see that Prophet 21 is really a safe bet, because of our cash position, our recurring revenue from our professional services, and our enterprise software solutions. The profits that we make with our enterprise software solutions are more than enough to fuel our investments in Trading Partner Connect. The idea of giving a large number of distributors the ability to collaborate via Trading Partner Connect and become the power to be the world's largest distributor is very compelling.

TWST:

Thank you. (TM)

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