PROS HOLDINGS, INC. The terms "we," "us," "PROS" and "our" refer toPROS Holdings, Inc. and all of its subsidiaries that are consolidated in conformity with generally accepted accounting principles inthe United States . This management's discussion and analysis of financial condition and results of operations should be read along with the unaudited condensed consolidated financial statements and unaudited notes to unaudited condensed consolidated financial statements included in Part I, Item 1 ("Interim Condensed Consolidated Financial Statements (Unaudited)"), as well as the audited consolidated financial statements and notes to consolidated financial statements and management's discussion and analysis of financial condition and results of operations set forth in our Annual Report.
Q1 2023 Financial Overview
In the first quarter of 2023, we continued to grow our subscription revenue. For the three months endedMarch 31, 2023 , our subscription revenue increased 15% and total revenue increased 10% for the three months endedMarch 31, 2023 , each as compared to the same period in 2022. Recurring revenue (which consists of subscription revenue and maintenance and support revenue) as a percentage of total revenue accounted for 84% and 85% of total revenue for the three months endedMarch 31, 2023 and 2022, respectively. Our gross revenue retention rates remained above 93% during the trailing twelve months endedMarch 31, 2023 . Cash used in operating activities was$6.1 million for the three months endedMarch 31, 2023 , as compared to$11.0 million for the three months endedMarch 31, 2022 . The improvement was primarily attributable to increased cash collections during the period and a lower annual incentive payment in 2023 as compared to prior year. Free cash flow is a key metric to assess the strength of our business. We define free cash flow, a non-GAAP financial measure, as net cash provided by (used in) operating activities, excluding severance payments, less capital expenditures, purchases of other (non-acquisition-related) intangible assets and capitalized internal-use software development costs. We believe free cash flow may be useful to investors and other users of our financial information in evaluating the amount of cash generated by our business operations. Free cash flow used during the three months endedMarch 31, 2023 was$4.5 million , compared to$11.5 million for the three months endedMarch 31, 2022 . The improvement was primarily attributable to increased cash collections during the period and a lower annual incentive payment in 2023 as compared to prior year. The following is a reconciliation of free cash flow to the most comparable GAAP measure, net cash used in operating activities (in thousands): Three Months Ended
2023 2022
Net cash used in operating activities
Severance 3,170 - Purchase of property and equipment (1,546) (461) Free Cash Flow$ (4,519) $ (11,475)
Factors Affecting Our Performance
Key factors and trends that have affected, and we believe will continue to affect, our operating results include:
•Macroeconomic Environment. We believe the combination of increased inflation, rising interest rates, volatile capital and financial markets, supply chain disruptions, tight labor markets, pricing volatility, theRussia -Ukraine conflict, and other macroeconomic conditions increases corporate focus on profitable growth. Despite this challenging environment, we remain confident in our ability to help optimize shopping and selling experiences for our customers. For example, pricing volatility and inflation are catalysts for demand for our price management and optimization solutions. Uncertain macroeconomic and industry conditions in countries and regions in which we operate create a challenging selling environment for large enterprise technology deployment and we believe in the near term will lead new customers to increasingly emphasize smaller scope initial purchases with faster implementations. While our recurring revenue and earnings are relatively predictable as a result of our subscription-based business model, the broader implications of these macroeconomic events on our business, results of operations, cash flows and overall financial position, particularly in the long term, remain uncertain. Under this model, our lower subscription bookings during the pandemic has adversely impacted our subscription revenue growth rates due to the timing lag between subscription 15 -------------------------------------------------------------------------------- Table of Contents bookings and the revenue recognized on those bookings. However, despite the impact of the pandemic on our prior revenue growth rates, we had double digit growth for both subscription revenue and total revenue in the first quarter of 2023. For a full discussion on the risks and uncertainties to our business, please see the "Risk Factors" section in our Annual Report. •Profitable Growth as a Priority. We believe our market opportunity is large and underpenetrated and intend to continue investing in our business to create awareness for our solutions, acquire new customers, and expand within our existing customer base globally, while focusing on cash flow and profitability. We intend to continue investing for growth and also seek opportunities to mitigate the growth in our costs and reduce our existing cost structure. We also plan to continue investing in product development to enhance our existing technologies, including initiatives to accelerate customer time-to-value, improve efficiency, provide out-of-the-box integration with third-party commerce solutions and develop new applications and technologies. •Travel Industry Recovering. Despite operational headwinds and regional variances in the timing of travel restrictions being lifted, the travel industry, particularly the airline industry, continues to recover from the unprecedented disruption caused by the pandemic. While global capacity has not fully returned to pre-pandemic levels, demand for air travel continues to increase as restrictions have been lifted. Travel inNorth America has led this recovery withAsia Pacific lagging, particularly asChina has only recently lifted international travel restrictions. TheInternational Air Transport Association is forecasting airline industry profitability in 2023 with certainU.S. -based airlines already publicly reporting profitable quarters. Still, the rate of airline industry recovery could be impacted negatively if inflation impacts consumer disposable income or limits business travel. Despite geographic variation, we expect airlines to increasingly prioritize technology investments as travel returns to pre-COVID levels. •Digital Purchasing Driving Technology Adoption. We believe the long-term trends toward digital purchasing by both consumers and corporate buyers will increasingly drive demand for technology that provides fast, frictionless and personalized buying experiences across direct sales, partner, online, mobile and emerging channels. Buyers often prefer not to interact with sales representatives as their primary source of research, and increasingly prefer to buy online when they have already decided what to buy. For example, in the airline industry, the pandemic accelerated a long-term trend towards direct booking channels, and we anticipate airlines continuing to invest in technology, including mobile device-enabled solutions, to enhance their ability to capture a greater percentage of bookings through their own channels such as their websites. We believe companies must adopt technologies which power these types of experiences across sales channels as they modernize their sales process to compete in digital commerce. Increasingly, companies are looking to AI to deliver actionable insights from their data, improve and customize their offerings and drive process efficiencies. Our AI-powered solutions enable buyers to move fluidly and with personalized experiences across our customers' sales channels, and our digital offer marketing solutions help our customers drive their buyers directly into their direct selling channels. •Cloud Migrations. As we continue to migrate our on-premises customers from our legacy licensed solutions to our current cloud solutions, we expect our future maintenance and support revenue to continue to decline and subscription revenue to increase. We continue to encourage our customers to migrate to our cloud solutions as we have announced end of support dates for certain of our on-premises solutions. 16 -------------------------------------------------------------------------------- Table of Contents Results of Operations
The following table sets forth certain items in our unaudited condensed
consolidated statements of comprehensive loss as a percentage of total revenues
for the three months ended
Three Months Ended March
31,
2023 2022
Revenue:
Subscription 76 % 73 %
Maintenance and support 8 12
Total subscription, maintenance and support 84 85
Services 16 15
Total revenue 100 100
Cost of revenue:
Subscription 19 21
Maintenance and support 3 3
Total cost of subscription, maintenance and support 22 24
Services 18 17
Total cost of revenue 40 41
Gross profit 60 59
Operating Expenses:
Selling and marketing 36 38
Research and development 30 37
General and administrative 19 22
Impairment of fixed assets - 2
Total operating expenses 85 99
Convertible debt interest and amortization (2) (2)
Other income (expense), net 2 (1)
Loss before income tax provision (26) (43)
Income tax provision - -
Net loss (26) % (43) %
Revenue:
Three Months Ended March 31, Variance
(Dollars in thousands) 2023 2022 $ %
Subscription $ 55,969 $ 48,765 $ 7,204 15 %
Maintenance and support 5,712 7,855 (2,143) (27) %
Total subscription, maintenance and support 61,681 56,620 5,061 9 %
Services 11,501 9,872 1,629 17 %
Total revenue $ 73,182 $ 66,492 $ 6,690 10 %
Subscription revenue. Subscription revenue increased primarily due to an
increase in new and existing customer subscription contracts and a recovery of
approximately
Maintenance and support revenue. Maintenance and support revenue decreased
primarily as a result of existing maintenance customers migrating to our cloud
solutions and, to a lesser extent, customer maintenance churn. We expect
maintenance revenue to continue to decline as we continue to migrate maintenance
customers to our cloud solutions.
Services revenue. Services revenue increased primarily as a result of higher
sales of professional services related to our subscription contracts and
follow-on professional services to existing customers. Services revenue varies
from period to period depending on different factors, including the level of
professional services required to implement our solutions, the timing of
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services revenue recognition on certain subscription contracts and efficiencies
in our solutions implementations requiring less professional services during a
particular period.
Cost of revenue and gross profit:
Three Months Ended March 31, Variance
(Dollars in thousands) 2023 2022 $ %
Cost of subscription $ 14,093 $ 13,779 $ 314 2 %
Cost of maintenance and support 2,282 2,167 115 5 %
Total cost of subscription, maintenance and support 16,375 15,946 429 3 %
Cost of services 13,167 11,415 1,752 15 %
Total cost of revenue 29,542 27,361 2,181 8 %
Gross profit $ 43,640 $ 39,131 $ 4,509 12 %
Cost of subscription. Cost of subscription increased slightly primarily due to
increased infrastructure cost to support our current subscription customer base
and higher employee-related costs mainly due to increase in headcount. The
increase was partially offset by a decrease in amortization expense for
intangible assets and internal-use software. Our subscription gross profit
percentages were 75% and 72% for the three months ended March 31, 2023 and 2022,
respectively.
Cost of maintenance and support. Cost of maintenance and support remained
relatively unchanged. Maintenance and support gross profit percentages were 60%
and 72% for the three months ended March 31, 2023 and 2022, respectively. The
decrease in gross profit percentages was primarily due to lower maintenance and
support revenue as we continue to migrate customers to our subscription
solutions and the cost of maintenance and support being relatively fixed.
Cost of services. Cost of services increased primarily due to higher personnel
costs to support the increase in our services revenue during the period.
Services gross profit percentages were (14)% and (16)% for the three months
ended March 31, 2023 and 2022, respectively. Services gross profit percentages
vary period to period depending on different factors, including the level of
professional services required to implement our solutions, the utilization of
our employees and our effective man-day rates.
Operating expenses:
Three Months Ended March 31, Variance
(Dollars in thousands) 2023 2022 $ %
Selling and marketing $ 26,010 $ 25,287 $ 723 3 %
Research and development 22,291 24,467 (2,176) (9) %
General and administrative 14,135 14,329 (194) (1) %
Impairment of fixed assets - 1,551 (1,551) (100) %
Total operating expenses $ 62,436 $ 65,634 $ (3,198) (5) %
Selling and marketing expenses. During the three months ended March 31, 2023 ,
selling and marketing expenses increased primarily due to an increase in sales
and marketing initiatives and travel expenses. The increase was partially offset
by a decrease in employee-related costs mainly due to organizational changes.
Research and development expenses. Research and development expenses decreased
primarily due to a decrease in noncash share-based compensation and contractors
expense. The noncash share-based compensation was higher in prior year mainly
due to the acceleration of equity awards related to the retirement of a senior
officer in the first quarter of 2022.
General and administrative expenses. General and administrative expenses remained relatively consistent with prior year.
Impairment of fixed assets. During the three months endedMarch 31, 2023 and 2022, we recorded zero and$1.6 million impairment charge related to fixed assets, respectively. The 2022 impairment resulted from changes to our intentions for these assets in connection with a new agreement with a software vendor. 18 -------------------------------------------------------------------------------- Table of Contents Non-operating expenses: Three Months Ended March 31, Variance (Dollars in thousands) 2023 2022 $ % Convertible debt interest and amortization$ (1,576) $ (1,576) $ - - % Other income (expense), net$ 1,451 $ (418) $ 1,869 (447) %
Convertible debt interest and amortization. Convertible debt expense for the
three months ended
Other income (expense), net. The change in other income (expense), net for the three months endedMarch 31, 2023 , primarily related to higher interest income and to a smaller extent due to the impact of foreign currency fluctuations.
Income tax provision:
Three Months Ended March 31 , Variance
(Dollars in thousands) 2023 2022 $ % Effective tax rate (0.4) % (0.5) % n/a n/a Income tax provision
Income tax provision. The tax provision for the three months ended
Our effective tax rate was (0.4)% and (0.5)% for the three months endedMarch 31, 2023 and 2022, respectively. The income tax rate varies from the 21% federal statutory rate primarily due to the valuation allowances on our deferred tax assets. While our expected tax rate would be 0% due to the full valuation allowance on our deferred tax assets, the income tax provision and related effective tax rates is due to foreign income and withholding taxes. Jurisdictions with a projected loss for the year where no tax benefit can be recognized due to the valuation allowances on our deferred tax assets are excluded from the estimated annual federal effective tax rate. The impact of such an exclusion could result in a higher or lower effective tax rate during a particular quarter depending on the mix and timing of actual earnings versus annual projections.
Liquidity and Capital Resources
At
Our principal sources of liquidity are our cash and cash equivalents. In addition, we could access capital markets to supplement our liquidity position. Our material drivers or variants of operating cash flow are net income (loss), noncash expenses (principally share-based compensation, intangible amortization and amortization of debt issuance costs) and the timing of invoicing and cash collections from our customers. Our operating cash flows are also impacted by the timing of payments to our vendors and the payments of other liabilities. We believe our existing cash and cash equivalents will provide adequate liquidity and capital resources to meet our operational requirements, anticipated capital expenditures and coupon interest payments for our Notes for the next twelve months. Our future working capital requirements depend on many factors, including the operations of our existing business, growth of our customer subscription services, future acquisitions we might undertake, expansion into complementary businesses, timing of adoption and implementation of our solutions and customer churn. Capital markets have tightened recently in response to the macroeconomic environment making new financing more difficult and/or expensive and we may not be able to obtain such financing on terms acceptable to us or at all. During the first quarter of 2023, the financial markets experienced disruption due to certain bank failures. We have not experienced any material impact from the disruption but will continue to monitor the situation and take action accordingly. Our 2024 Notes, with a principal amount of$143.8 million , mature onMay 15, 2024 , unless redeemed or converted in accordance with their terms prior to such date. 19
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The following table presents key components of our unaudited condensed consolidated statements of cash flows for the three months endedMarch 31, 2023 and 2022: Three Months Ended March 31, (Dollars in thousands) 2023 2022 Net cash used in operating activities$ (6,143) $ (11,014) Net cash used in investing activities (1,546) (461) Net cash (used in) provided by financing activities (3,573) 1,231 Cash and cash equivalents (beginning of period) 203,627 227,553 Cash and cash equivalents (end of period)$ 192,376 $ 217,393 Operating Activities Net cash used in operating activities for the three months endedMarch 31, 2023 was$6.1 million . The$4.9 million improvement over last year was primarily attributable to increased cash collections during the period and a lower annual incentive payment in 2023 as compared to prior year.
Investing Activities
Net cash used in investing activities for the three months endedMarch 31, 2023 was$1.5 million . The increase was due to higher capital expenditures, primarily related to third-party software license renewal, in 2023 as compared to the same period in prior year. Financing Activities
Net cash used in financing activities for the three months ended
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material. We do not have any relationships with unconsolidated entities or financial partnerships, such as variable interest entities, that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Contractual Obligations and Commitments
Other than changes described in Note 9 above, there have been no material changes to our contractual obligations and commitments disclosed in our Annual Report.
Recent Accounting Pronouncements
See "Recently issued accounting pronouncements not yet adopted" in Note 2 above for discussion of recent accounting pronouncements including the respective expected dates of adoption, if any.
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Critical accounting policies and estimates
Our consolidated financial statements are prepared in accordance with GAAP.
The preparation of these consolidated financial statements requires us to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues, costs and expenses, and related disclosures. Actual
results could differ from those estimates. The complexity and judgment required
in our estimation process, as well as issues related to the assumptions, risks
and uncertainties inherent in determining the nature and timing of satisfaction
of performance obligations and determining the standalone selling price of
performance obligations, affect the amounts of revenue, expenses, unbilled
receivables and deferred revenue. Estimates are also used for, but not limited
to, receivables, allowance for credit losses, operating lease right-of-use
assets and operating lease liabilities, useful lives of assets, depreciation,
income taxes and deferred tax asset valuation, valuation of stock awards, other
current liabilities and accrued liabilities. Numerous internal and external
factors can affect estimates. Our critical accounting policies related to the
estimates and judgments are discussed in our Annual Report under management's
discussion and analysis of financial condition and results of operations.
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