Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Organization and Nature of Operations
PROS Holdings, Inc., a Delaware corporation, through its operating subsidiaries (collectively, the "Company"), provides artificial intelligence ("AI") solutions that power commerce in the digital economy by providing fast, frictionless and personalized buying experiences. PROS solutions enable dynamic buying experiences for both business-to-business ("B2B") and business-to-consumer ("B2C") companies across industry verticals. Companies can use the Company's selling, pricing, revenue optimization and eCommerce solutions to assess their market environments in real time to deliver customized prices and offers. The Company's solutions enable buyers to move fluidly across its customers’ direct sales, online, mobile and partner channels with personalized experiences regardless of which channel those buyers choose. The Company's decades of data science and AI expertise are infused into its solutions and are designed to reduce time and complexity through actionable intelligence. The Company provides standard configurations of its software based on the industries it serves and offers professional services to configure these solutions to meet the specific needs of each customer.
2. Summary of Significant Accounting Policies
Basis of presentation
The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles in the United States ("GAAP") for interim financial reporting and applicable quarterly reporting regulations of the Securities and Exchange Commission ("SEC"). In management's opinion, the accompanying interim unaudited condensed consolidated financial statements include all adjustments necessary for a fair statement of the financial position of the Company as of March 31, 2020, the results of operations for the three months ended March 31, 2020 and 2019, cash flows for the three months ended March 31, 2020 and 2019, and stockholders' equity for the three months ended March 31, 2020 and 2019.
Certain information and disclosures normally included in the notes to the annual financial statements prepared in accordance with GAAP have been omitted from these interim unaudited condensed consolidated financial statements pursuant to the rules and regulations of the SEC. Accordingly, these unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2019 ("Annual Report") filed with the SEC. The unaudited condensed consolidated balance sheet as of December 31, 2019 was derived from the Company's audited consolidated financial statements but does not include all disclosures required under GAAP.
Certain prior year amounts have been reclassified for consistency with the current year presentation. This reclassification had no effect on the reported results of operations. License revenue and license cost of revenue are now combined with subscription revenue and subscription cost of revenue, respectively.
Changes in accounting policies
There have been no material changes in the Company’s significant accounting policies and their application as compared to the significant accounting policies described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, except for the Company's adoption of certain accounting standards described in more detail under "Recently adopted accounting pronouncements" in this Note 2 below.
Fair value measurement
The Company's financial assets that are included in cash and cash equivalents and that are measured at fair value on a recurring basis consisted of $239.0 million and $273.1 million at March 31, 2020 and December 31, 2019, respectively, and were invested in treasury money market funds. The fair value of the treasury money market funds is determined based on quoted market prices, which represents level 1 in the fair value hierarchy as defined by ASC 820.
Trade and other receivables
Trade and other receivables are primarily comprised of trade receivables, net of allowance for doubtful accounts, contract assets and unbilled receivables. The Company records trade accounts receivable for its unconditional rights to consideration arising
from the Company's performance under contracts with customers. The Company's standard billing terms are that payment is due upon receipt of invoice, payable generally within thirty to sixty days. The carrying value of such receivables, net of the allowance for doubtful accounts, represents their estimated net realizable value. When developing its estimate of expected credit losses on trade and other receivables, the Company considers the available information relevant to assessing the collectability of cash flows, which includes a combination of both internal and external information relating to past events, current conditions, and future forecasts as well as relevant qualitative and quantitative factors that relate to the environment in which the Company operates.
Contract assets represent conditional rights to consideration that have been recognized as revenue in advance of billing the customer. Unbilled receivables represent unconditional rights to consideration arising from contingent revenue that have been recognized as revenue in advance of billing the customer.
There are no comparable recent events that provide guidance as to the effect of the spread of COVID-19 as a global pandemic. As a result, the impact of COVID-19 is highly uncertain and subject to change. The Company does not yet know the full extent of the impact from COVID-19 to the Company's business operations or the global economy as a whole; however, the impact could have an adverse effect on the Company's customers and inherently the related receivables.
Deferred costs
Sales commissions earned by the Company's sales representatives are considered incremental and recoverable costs of obtaining a customer contract. Sales commissions are deferred and amortized on a straight-line basis over the period of benefit, which the Company has determined to be five to eight years. The Company determined the period of benefit by taking into consideration its customer contracts, expected renewals of those customer contracts (as the Company currently does not pay an incremental sales commission), the Company's technology and other factors. The Company also defers amounts earned by employees other than sales representatives who earn incentive payments under compensation plans that are also tied to the value of customer contracts acquired. Deferred costs were $20.5 million and $21.2 million as of March 31, 2020 and December 31, 2019, respectively. Amortization expense for the deferred costs was $1.4 million and $1.1 million for the three months ended March 31, 2020 and 2019, respectively.
Deferred implementation costs
The Company capitalizes certain contract fulfillment costs, including personnel and other costs (such as hosting, employee salaries, benefits and payroll taxes), that are associated with arrangements where professional services are not distinct from other undelivered obligations in its customer contracts. The Company analyzes implementation costs and capitalizes those costs that are directly related to customer contracts, that are expected to be recoverable, and that enhance the resources which will be used to satisfy the undelivered performance obligations in those contracts. Deferred implementation costs are amortized ratably over the remaining contract term once the revenue recognition criteria for the respective performance obligation has been met and revenue recognition commences. Deferred implementation costs were $4.1 million and $4.4 million as of March 31, 2020 and December 31, 2019, respectively. Amortization expense for the deferred implementation costs was $0.5 million and $0.2 million for the three months ended March 31, 2020 and 2019, respectively. Deferred implementation costs are included in prepaid and other current assets and other assets, noncurrent in the unaudited condensed consolidated balance sheets. Amortization of deferred implementation costs is included in cost of subscription and cost of services revenues in the accompanying unaudited condensed consolidated statements of comprehensive income (loss).
Recently adopted accounting pronouncements
In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("Topic 326"), in order to improve financial reporting of expected credit losses on financial instruments and other commitments to extend credit. Topic 326 requires that an entity measure and recognize expected credit losses for financial assets held at amortized cost and replaces the incurred loss impairment methodology in current GAAP with a methodology that requires consideration of a broader range of information to estimate credit losses. The Company adopted Topic 326 as of January 1, 2020 using the modified retrospective method and there was no material impact on the Company's unaudited condensed consolidated financial statements as of the adoption date. The Company recognized a $2.6 million provision for credit losses in the first quarter of 2020 representing the Company’s estimate of additional allowance for doubtful accounts related to trade receivables due to increased credit risk from uncertain economic conditions caused by COVID-19.
Recently issued accounting pronouncements not yet adopted
With the exception of the new standards discussed above, there have been no other recent accounting pronouncements or changes in accounting pronouncements during the three months ended March 31, 2020, as compared to the recent accounting pronouncements described in the Company's Annual Report, that are of significance or potential significance to the Company.
3. Deferred Revenue and Performance Obligations
Deferred Revenue
For the three months ended March 31, 2020 and 2019, the Company recognized approximately $47.7 million and $38.3 million, respectively, in each case of revenue that was included in the deferred revenue balances at the beginning of the respective periods and primarily related to subscription services, maintenance and support, and services.
Performance Obligations
As of March 31, 2020, the Company expects to recognize approximately $391.0 million of revenue from remaining performance obligations. The Company expects, based on the terms of the related, underlying contractual arrangements, to recognize revenue on approximately $191.6 million of these performance obligations over the next 12 months, with the balance recognized thereafter. However, as a result of uncertain economic conditions caused by COVID-19, the amount of revenue recognized from the Company's contractual remaining performance obligations could vary and be less than what the Company expects as revenue recognized could be delayed or not occur depending on the ongoing impact of COVID-19.
4. Disaggregation of Revenue
Revenue by Geography
The geographic information in the table below is presented for the three months ended March 31, 2020 and 2019. The Company categorizes geographic revenues based on the location of the customer's headquarters. Because the Company's contracts are predominately denominated in U.S. dollars, it has limited exposure to foreign currency exchange risk as discussed under "Foreign Currency Exchange Risk" of Part I, Item 3 below.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
2020
|
|
2019
|
(in thousands)
|
Revenue
|
|
Percent
|
|
Revenue
|
|
Percent
|
United States of America
|
$
|
21,800
|
|
|
33
|
%
|
|
$
|
19,780
|
|
|
35
|
%
|
Europe
|
19,930
|
|
|
30
|
%
|
|
17,287
|
|
|
31
|
%
|
The rest of the world
|
24,581
|
|
|
37
|
%
|
|
19,064
|
|
|
34
|
%
|
Total revenue
|
$
|
66,311
|
|
|
100
|
%
|
|
$
|
56,131
|
|
|
100
|
%
|
5. Leases
The Company has operating leases for data centers, computer infrastructure, corporate offices and certain equipment. These leases have remaining lease terms ranging from 1 year to 13 years. Some of these leases include options to extend for up to 15 years, and some include options to terminate within 1 year.
In February 2020, the Company entered into an agreement with a computer infrastructure vendor which resulted in future consideration to be paid by the Company for services provided. The Company accounted for this agreement as an operating lease and in result obtained a $1.5 million right-of-use asset in exchange for a new lease liability of the same amount at lease inception.
As of March 31, 2020, the Company did not have any finance leases.
Supplemental information related to leases was as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
2020
|
|
2019
|
Cash paid for amounts included in the measurement of lease liability:
|
|
|
|
Operating cash flows from operating leases
|
$
|
1,627
|
|
|
$
|
1,016
|
|
As of March 31, 2020, maturities of lease liabilities were as follows (in thousands):
|
|
|
|
|
|
Year Ending December 31,
|
|
Amount
|
Remaining 2020
|
|
$
|
5,567
|
|
2021
|
|
9,080
|
|
2022
|
|
8,447
|
|
2023
|
|
4,880
|
|
2024
|
|
4,930
|
|
2025 and thereafter
|
|
34,072
|
|
Total operating lease payments
|
|
66,976
|
|
Less: Imputed interest
|
|
(23,703
|
)
|
Less: Anticipated lease incentive
|
|
(14,207
|
)
|
Total operating lease liabilities
|
|
$
|
29,066
|
|
6. Earnings per Share
The following table sets forth the computation of basic and diluted earnings per share for the three months ended March 31, 2020 and 2019:
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
(in thousands, except per share data)
|
2020
|
|
2019
|
Numerator:
|
|
|
|
Net loss
|
$
|
(22,735
|
)
|
|
$
|
(16,917
|
)
|
Denominator:
|
|
|
|
Weighted average shares (basic)
|
43,102
|
|
|
37,623
|
|
Dilutive effect of potential common shares
|
—
|
|
|
—
|
|
Weighted average shares (diluted)
|
43,102
|
|
|
37,623
|
|
Basic loss per share
|
$
|
(0.53
|
)
|
|
$
|
(0.45
|
)
|
Diluted loss per share
|
$
|
(0.53
|
)
|
|
$
|
(0.45
|
)
|
Dilutive potential common shares consist of shares issuable upon the exercise of stock options, settlement of stock appreciation rights ("SARs"), and the vesting of restricted stock units ("RSUs") and market stock units ("MSUs"). Potential common shares determined to be antidilutive and excluded from diluted weighted average shares outstanding were approximately 1.6 million and 2.0 million for the three months ended March 31, 2020 and 2019, respectively. In addition, potential common shares related to the convertible notes determined to be antidilutive and excluded from diluted weighted average shares outstanding were 2.2 million for the three months ended March 31, 2020.
7. Noncash Share-based Compensation
The Company's 2017 Equity Incentive Plan (as amended and restated, the "2017 Stock Plan") was approved by stockholders in May 2017 and reserved an aggregate amount of 2,500,000 shares for issuance. In May 2019, the shareholders approved an amendment to the 2017 Stock Plan which increased the aggregate amount of shares for issuance to a total of 4,550,000. As of March 31, 2020, 2,010,087 shares remain available for issuance under the 2017 Stock Plan.
The following table presents the number of shares or units outstanding for each award type as of March 31, 2020 and December 31, 2019, respectively, (in thousands):
|
|
|
|
|
|
|
|
Award type
|
|
March 31, 2020
|
|
December 31, 2019
|
Restricted stock units (time-based)
|
|
1,534
|
|
|
1,893
|
|
Restricted stock units (performance-based)
|
|
190
|
|
|
114
|
|
Stock appreciation rights
|
|
32
|
|
|
65
|
|
Market stock units
|
|
157
|
|
|
267
|
|
During the three months ended March 31, 2020, the Company granted 459,499 RSUs (time-based) with a weighted average grant-date fair value of $66.22 per share. The Company also granted 76,200 performance-based RSUs ("PRSUs") with a weighted average grant-date fair value of $54.23 to certain executive employees during the three months ended March 31, 2020. These PRSUs vest on January 13, 2023 and the actual number of PRSUs that will be eligible to vest is based upon achievement of certain internal performance metrics, as defined by each award's plan documents or individual award agreements. The maximum number of shares issuable upon vesting is 200% of the PRSUs initially granted. The Company did not grant any stock options, SARs or MSUs during the three months ended March 31, 2020.
Share-based compensation expense is allocated to expense categories on the unaudited condensed consolidated statements of comprehensive income (loss). The following table summarizes share-based compensation expense included in the Company's unaudited condensed consolidated statements of comprehensive income (loss) for the three months ended March 31, 2020 and 2019:
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
2020
|
|
2019
|
Share-based compensation:
|
|
|
|
Cost of revenue
|
$
|
524
|
|
|
$
|
538
|
|
Operating expenses:
|
|
|
|
Selling and marketing
|
1,866
|
|
|
1,400
|
|
General and administrative
|
2,450
|
|
|
2,812
|
|
Research and development
|
1,507
|
|
|
1,296
|
|
Total included in operating expenses
|
5,823
|
|
|
5,508
|
|
Total share-based compensation expense
|
$
|
6,347
|
|
|
$
|
6,046
|
|
At March 31, 2020, the Company had an estimated $62.9 million of total unrecognized compensation costs related to share-based compensation arrangements. These costs will be recognized over a weighted average period of 3.0 years.
The Company's Employee Stock Purchase Plan ("ESPP") provides for eligible employees to purchase shares on an after-tax basis in an amount between 1% and 10% of their annual pay: (i) on June 30 of each year at a 15% discount of the fair market value of the Company's common stock on January 1 or June 30, whichever is lower, and (ii) on December 31 of each year at a 15% discount of the fair market value of the Company's common stock on July 1 or December 31, whichever is lower. An employee may not purchase more than $5,000 in either of the six-month measurement periods described above or more than $10,000 annually. During the three months ended March 31, 2020, the Company issued 26,774 shares under the ESPP. As of March 31, 2020, 113,477 shares remain authorized and available for issuance under the ESPP. As of March 31, 2020, the Company held approximately $0.7 million on behalf of employees for future purchases under the ESPP, and this amount was recorded in accrued payroll and other employee benefits in the Company's unaudited condensed consolidated balance sheet.
8. Convertible Senior Notes
The following is a summary of the Company's convertible senior notes as of March 31, 2020 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Date of Issuance
|
|
Unpaid Principal Balance
|
|
Net Carrying Amount
|
|
Contractual Interest Rates
|
|
|
|
Current
|
|
Noncurrent
|
|
1% Convertible Notes due in 2024 ("2024 Notes")
|
May 2019
|
|
$
|
143,750
|
|
|
$
|
—
|
|
|
$
|
112,406
|
|
|
1%
|
The 2024 Notes, along with the previously issued convertible notes with original due dates in 2019 and 2047 (the "2019 Notes" and "2047 Notes," and together with the 2024 Notes, collectively, the "Notes"), are general unsecured obligations and rank senior in right of payment to all of the Company's indebtedness that is expressly subordinated in right of payment to the Notes, rank equally in right of payment with all of the Company's existing and future liabilities that are not so subordinated, are effectively junior to any of the Company's secured indebtedness to the extent of the value of the assets securing such indebtedness and are structurally subordinated to all indebtedness and other liabilities of the Company's subsidiaries (including trade payables but excluding intercompany obligations owed to the Company or its subsidiaries). The 2019 Notes and 2047 Notes were settled as of December 31, 2019 and no longer remain outstanding.
Interest related to the 2024 Notes is payable semi-annually in arrears on May 15 and November 15 of each year, commencing on November 15, 2019. The 2024 Notes mature on May 15, 2024, unless redeemed or converted in accordance with their terms prior to such date.
Each $1,000 of principal of the 2024 Notes will initially be convertible into 15.1394 shares of the Company’s common stock, which is equivalent to an initial conversion price of approximately $66.05 per share. The initial conversion price for the 2024 Notes is subject to adjustment upon the occurrence of certain specified events.
As of March 31, 2020, the 2024 Notes are not yet convertible and their remaining term is approximately 49 months.
As of March 31, 2020 and December 31, 2019, the fair value of the principal amount of the 2024 Notes was $121.5 million and $163.2 million, respectively. The estimated fair value was determined based on inputs that are observable in the market or that could be derived from, or corroborated with, observable market data, including the Company's stock price and interest rates, which represents level 2 in the fair value hierarchy.
In accounting for the transaction costs for the 2024 Notes issuance, the Company allocated the costs incurred to the liability and equity components in proportion to the allocation of the proceeds from issuance to the liability and equity components. Issuance costs attributable to the liability component, totaling $3.4 million for the 2024 Notes are being amortized to expense over the expected life of the notes using the effective interest method. Issuance costs attributable to the equity component related to the conversion option, totaling $1.1 million for the 2024 Notes were netted with the equity component in stockholders' equity.
The 2024 Notes consist of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
March 31, 2020
|
|
December 31, 2019
|
Liability component:
|
|
|
|
Principal
|
$
|
143,750
|
|
|
$
|
143,750
|
|
Less: debt discount and issuance cost, net of amortization
|
(31,344
|
)
|
|
(33,046
|
)
|
Net carrying amount
|
$
|
112,406
|
|
|
$
|
110,704
|
|
|
|
|
|
Equity component(1)
|
$
|
32,883
|
|
|
$
|
32,883
|
|
|
|
(1)
|
Recorded within additional paid-in capital in the unaudited condensed consolidated balance sheet. As of March 31, 2020 and December 31, 2019, it included $32.9 million related to the 2024 Notes, which was net of $1.1 million issuance cost in equity.
|
The following table sets forth total interest expense recognized related to the Notes (in thousands):
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
2020
|
|
2019
|
Coupon interest
|
$
|
360
|
|
|
$
|
1,250
|
|
Amortization of debt issuance costs
|
156
|
|
|
365
|
|
Amortization of debt discount
|
1,546
|
|
|
2,741
|
|
Total
|
$
|
2,062
|
|
|
$
|
4,356
|
|
Note Hedge and Warrant Transactions
Concurrently with the offering of the 2019 Notes, the Company entered into separate convertible note hedge (the "Note Hedge") and warrant (the "Warrant") transactions. Taken together, the purchase of the Note Hedge and the sale of the Warrant were intended to offset any actual dilution from the conversion of the 2019 Notes and to effectively increase the overall conversion
price of the 2019 Notes from $33.79 to $45.48 per share. The Warrant was not part of the 2019 Notes or Note Hedge. Both the Note Hedge and Warrant were recorded as part of additional paid-in capital.
As of December 31, 2019, the Note Hedge was settled through certain note hedge termination agreements and exercise of any remaining Note Hedge. In 2019, the Company entered into certain warrant termination agreements which terminated certain of the Warrants that were entered into by the Company in connection with the offering of the 2019 Notes. The remaining Warrants expire in August 2020 and, if exercised, will settle on a net share basis.
Capped Call Transactions
In May 2019, in connection with the offering of the 2024 Notes, the Company entered into privately negotiated capped call transactions (collectively, the "Capped Call") with certain option counterparties. The Capped Call transactions cover, subject to customary anti-dilution adjustments, the number of shares of the Company’s common stock initially underlying the 2024 Notes, at a strike price that corresponds to the initial conversion price of the 2024 Notes, also subject to adjustment, and are exercisable upon conversion of the 2024 Notes. The Capped Call transactions are intended to reduce potential dilution of the Company's common stock and/or offset any cash payments the Company will be required to make in excess of the principal amount upon any conversion of 2024 Notes, and to effectively increase the overall conversion price of the 2024 Notes from $66.05 to $101.62 per share. As the Capped Call transactions meet certain accounting criteria, they are recorded in stockholders’ equity and are not accounted for as derivatives. The cost of the Capped Call was $16.4 million and was recorded as part of additional paid-in capital.
9. Commitments and Contingencies
Litigation
In the ordinary course of business, the Company regularly becomes involved in contract and other negotiations and, in more limited circumstances, becomes involved in legal proceedings, claims and litigation. The outcomes of these matters are inherently unpredictable. The Company is not currently involved in any outstanding litigation that it believes, individually or in the aggregate, will have a material adverse effect on its business, financial condition, results of operations or cash flows.
Purchase commitments
In the ordinary course of business, the Company enters into various purchase commitments for goods and services.
In March 2019, the Company entered into a noncancelable agreement with a computing infrastructure vendor that amended the existing agreement dated June 2017. The amended agreement expires in March 2022. The purchase commitment as of March 31, 2020 was $58.4 million for the remaining period through the expiration of the agreement.