Pros Holdings Inc

NYSE:PRO

Earnings Call Transcript 2017-Q4

[Operator]

Greetings and welcome to PROS Holdings, Inc. Fourth Quarter 2017 Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Stefan Schulz. Thank you. You may begin.

[Stefan Schulz, EVP and CFO]

Thank you, operator. Good afternoon everyone and thank you for joining us. With me on today's call is Andres Reiner, President and Chief Executive Officer. Before we begin, note that some of the information we will discuss during this call will consist of forward-looking statements including without limitation our guidance, our strategy, future business prospects, revenue, margin, and market opportunities.

Actual results could differ materially from our current forecast. Please refer to the risks and uncertainties as well as other factors described in our filings with the SEC for more information.

PROS assumes no obligation to update any forward-looking statements to reflect future events or circumstances. Also during the call, we will discuss financial results in accordance with Generally Accepted Accounting Principles or GAAP as well as certain financial results and 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 on the press release distributed earlier today and in the Investor Relations section of our website at pros.com. A replay of today's call is also available there, and we encourage everyone to review this additional information.

So, with that, I will turn the call over to Andres.

[Andres Reiner, President and CEO]

Thank you, Stefan and good afternoon everyone and thank you for joining us on today's call. I'd like to start by thanking our global team for their commitment to our mission of helping customers outperform. We believe our customers are single biggest opportunity to outpace our competition in the future is to redefine how to sell.

Companies are seeing radical changes in buying preferences in recent years. U.S. consumers now make more than half of their purchases online, more than 40% buy from smart devices. This shift in consumer buying preferences continues to shape the expectations of for B2B buyers who now see digital, social, and mobile as a new storefront.

They expect to move seamlessly across channels with personalized offers and fair prices to be available whenever they choose to purchase. This shift in buyer expectations creates an incredible opportunity for us. We see tomorrow outperformers as those companies who realized their customer buying experience must be frictionless, personalized, simple, and digital. And our vision is to be the artificial intelligence platform to power smarter e-commerce.

Like to take a moment how this vision translates into reality for customers. Pictures sales reps starting her morning by accessing more opportunities detection solutions from her smart device. Monet or AI personal assistant tells the sales rep opportunities for the day. The sales rep accepts an opportunity and Monet immediately creates an offer with real-time market competitive pricing in our Smart CPQ solution.

The sales rep presents the offer and her customers can go online at any time to complete the purchase. With an e-commerce portal powered by PROS, the buyer is able to see the same offer, customize it further, and immediately get updated pricing to complete the purchase.

Monet then notifies the sales rep that this is opportunity has closed. With our technology, this company gives us customers to personalize, consistent, and fluid experience across channels, while empowering our sales rep with the tools they need to grow their business.

As company assumes us to make changes like this and buying experience, we believe we have tremendous opportunity to transform how company sell, grow, and outperform. The combination of this large market opportunity in our incredible team executing on our strategy led us to accomplish great things in 2017.

At the beginning of last year, we committed to driving more consistency, productivity, and skill in our business. And I'm pleased to report that we delivered in all three areas. We created more consistency in how we deliver revenue.

In 2017, recurring revenue represented 77% of our revenue mix compared to 70% the year before. We improved sales productivity, which drove about a 30% increase in deal volume year-over-year with less than a 20% increase in quota-carrying personnel in the same period. And we added scale to our business by growing 17 data centers globally. Our extended cloud footprint enabled us to support our growth as we increased our number of cloud customers by more than 50% year-over-year.

Our focus on consistency, productivity and scale drove our exceptional financial performance in 2017. We're pleased to report that we increased annual recurring revenue by 31% year-over-year and grew full year subscription revenue by 59% in 2017, exceeding the high end of guidance on both metrics.

We also achieved two important milestones in our cloud transformation in Q4. We saw subscription revenue overtake maintenance as the largest contributor to total revenue. And we generated positive free cash flow within the quarter.

In 2018, we are committed to continue to drive growth and skill in our business by focusing on four strategic pillars: innovation, migrations, operational efficiency, and market adoption. So, I'd like to share a few highlights from each of these areas.

First, innovation is a hallmark of who we are as a company. And we see our modern commerce innovations are easy as a key component to realizing our long-term growth goals. Our strategy is to create a AI solutions that enable our customers to deliver personalized and consistent offers and pricing across all channels.

Now, I'd like to give you an example of the new PROS customers who started their journey to accomplish this last quarter. AirPlus, a business travel management solution provider, has a strategy to grow by expanding into a small and medium businesses. AirPlus plans to serve these customers by bringing together best-of-breed [ph] technologies to provide a robust, seamless into an e-commerce solution on Microsoft Azure.

To realize their vision, AirPlus will leverage grow Smart CPQ for Microsoft Dynamics to deliver personalized offers and dynamic pricing directly to their customers online. We see AirPlus as an incredible example of our company leveraging our solutions and partnerships to create a winning omnichannel experience.

And we are excited to bring this vision to a broader market now that we have been selected as one of the first partners to showcase our AI innovations in Microsoft Technology Centers globally. These centers are designed to educate customers on technology solutions that will fast-track their digital transformation and will feature our Smart CPQ solution for the manufacturing industry as a critical component to how manufacturers modernize your sales experience in the digital era. We see this as an incredible opportunity to spotlight how our solutions are uniquely tailored to meet the needs of customers and our target industries.

Second, we're focused on scaling our business by migrating more for customers to the cloud. Our strategy is to use our latest innovation to attract customers to the cloud. And I'm incredibly excited by what we have created to accomplish this. For example, our next-generation pricing guidance solution is revolutionizing how customers use our product and set a new standard of what customers expect in the market.

Customers now have transparency to our science and flexibility to dynamically adjust to their markets. We're already seeing our customers are embracing this innovation and expected to be one of the many pull factors that will drive customers to move to the cloud.

Modern commerce innovations like these have inspired more than two dozen customers who migrate already. And we expect to build on that momentum in 2018 with our migration program.

Third, we see a strong opportunity to improve our profitability by driving further efficiencies across our business. For example, we are designing our latest innovations to fully leverage the benefits of the cloud, allowing us to reduce cost in ways like scaling compute elastically.

As customers continue to adopt these cloud innovations, we have the opportunity to further improve for subscription gross margins and leverage the global infrastructure that we have in place.

Finally, we're focused on further refining our sales and marketing strategy to accelerate market adoption. I'm pleased to welcome Celia Fleischaker to our team as Chief Marketing Officer as we continue to strengthen our leadership team driving these efforts. This year, Celia's focus will be enhancing our digital strategy and driving our demand generation to help us capitalize on the large market opportunity in front of us.

As we enter 2018, we're energized and motivated by the large market opportunity in front of us, confident that we have the right team and strategy in place to carry out our vision of being the AI platform to power smarter e-commerce.

We like to thank our employees, customers, partners and shareholders for their support for this past year. I look forward to another strong year in 2018.

With that, I'd like to turn the call over to Stefan to comment on our financial performance.

[Stefan Schulz, EVP and CFO]

Thank you, Andres. I too would like to begin by thanking our team for their contributions last year and throughout our cloud transition. We've driven an incredible amount of change and are a much stronger company today because of it.

In the early stage of our cloud transition, we laid the foundation to become a cloud company by transforming our organization, products, and infrastructure. In the middle stage, we began truly operating as a cloud company driving improvements in how we do business.

Now, as we enter the final stage, we can see the strong cumulative impact we've made on our business. We've reduced our cap [ph] ratio by about 40%, we've driven close to a 200% increase in product releases, and we've reduced our average B2B implementation time by about 50%.

Thanks to these tremendous improvements, we delivered on a commitment that we made two and a half years ago that 2017 will be an inflection point in our financials. In Q1, we returned to year-over-year revenue growth. In Q3, we saw subscription ARR overtake maintenance ARR. And in Q4, as Andres mentioned earlier, we broke in positive free cash flow.

We created a strong momentum in our business as we enter the final stages of our shift to the cloud, and we will continue to emphasize operational efficiency as we make further investments in our future growth.

As we complete our transition to the cloud, we are increasing our focus on migrating our customer base. I would like to take a few moments to comment on the impact that we expect this to have on our financials.

As we put our program into action in 2018, we anticipate that the migrations will cause a mid-single-digit decline in maintenance revenue, which will convert into subscription revenue at roughly a 2x multiple. We expect migrations to contribute up to $5 million in subscription revenue for the full year.

Please note that we expect maintenance revenue to decline in the high single-digits in total this year due to the combination of migrations and churn, typically in our business. Our 2017 renewal rate remained better than 95%. Looking ahead to future years, we expect the impact of migrations to increase as we build momentum in our program.

Now, moving on to our fourth quarter and full year results. We finished the fourth quarter with a $160.6 million of ARR, up 31% year-over-year on a combined basis. When excluding the impact of Vayant, ARR was $152.5 million, exceeding the $147 million to $149 million guidance that we set before the acquisition. Subscription ARR continues to be the primary driver of overall ARR growth.

Total revenue for the fourth quarter was up sequentially and came in above guidance at $46.3 million. For the full year, total revenue was $168.8 million, up 10% year-over-year and also ahead of our expectations, mostly due to stronger subscription revenue. Services revenue was down slightly year-over-year, as we continue to focus on reducing our implementation times and getting customers to value quicker.

Subscription revenue was $19.1 million in the fourth quarter, up 74% year-over-year due to strong bookings throughout the year and solid execution in professional services implementations.

Q4 represented the first quarter that subscription revenue overtook maintenance revenue in our financials and became the largest line item in our revenue streams. This occurred in less than three years after announcing our move to cloud and is the result of our complete commitment to the new model from day one. Full year subscription revenue was up 59% on a combined basis and 50% organically.

Subscription and maintenance revenue combined make up our recurring revenue. For the full year, our recurring revenue was 77% of our total revenue as it compared to 70% in 2016. This puts us ahead of our schedule to achieve our long-term target of better than 85% recurring revenue mix.

As a reminder, we continue to break out of the recurring portion of our deferred revenue to facilitate the calculation of our trailing 12-month calculated billings. This metric generally tracks with ARR and can be calculated directly from our public disclosures. We believe these metrics are indicative of our intrinsic growth rate as we go through this cloud transition. At the end of the fourth quarter, the recurring portion of deferred revenue was $80.3 million and trailing 12-month calculated billings was up 23% year-over-year.

Moving on to margins, Q4 gross margins were 64%, which represents a three percentage point increase sequentially, mostly driven by improved subscription margins. This was achieved as a result of several initiatives that we've discussed on previous calls, including consolidating onto a primary cloud provider and renegotiating better terms with that provider. We view this as solid progress towards achieving our long-term gross margin target range of between 69% and 72%.

Now, turning to free cash flow, in Q4, we generated $3.6 million in free cash flow, which was ahead of our expectations due to strong collections at the end of the quarter. For the full year 2017, our free cash flow burn was $29.5 million and we exited the year with a total cash and investments balance of $160.5 million.

From an overall balance sheet perspective, we are pleased to have exited the fourth quarter with an increase to both our cash in investments as well as our deferred revenue positions, while lowering our accounts receivable balance. Overall, we're pleased with our financial results and believe that we are well-positioned to create more leverage in our business in 2018.

Now, turning to guidance, I will start with the first quarter and then move to the full year. For the first quarter, we expect subscription revenue to be in the range of $19.1 million to $19.6 million, up 58% over the first quarter of 2017 at the midpoint.

We expect total revenue to be in the range of $45.6 million to $46.6 million, a 15% year-over-year increase at the midpoint driven by our strong improvement in subscription revenue.

We expect our adjusted EBITDA loss for the first quarter to be in the range of $5.8 million to $6.8 million. With an estimated non-GAAP tax rate of 32% in the first quarter, we anticipate a non-GAAP loss per share between $0.19 and $0.21 per share based on an estimated $32.3 million basic shares outstanding.

Please note that on a GAAP and cash basis, the tax Cut and Jobs Act of 2017 will not have an economic benefit on our current business due to the NOLs that we've accumulated during our cloud transition.

And now for full year guidance, we anticipate subscription revenue for the full year will be between $90 million and $91 million. Note that we expect our subscription revenue growth rate to have about a 4% headwind due to the impact of 606, the revenue recognition accounting standard. This requires us to recognize recurring term license previously reported as subscription revenue as a combination of license and maintenance revenue.

We expect total revenue for 2018 to be between $187 million and $190 million, a 12% increase over 2017 at the midpoint driven primarily from increased subscription revenue. Please note, we expect the impact of 606 on total revenue in 2018 to be immaterial.

Now, while on the topic of 606, I wanted to highlight that our modified approach causes a small adjustments to retained earnings at the beginning of 2018 that will be unwound over the next several years.

Now, moving on to free cash flow. We estimate our free cash flow burn for the full year will be between $2 million and $5 million, a $26 million improvement over 2017 at the midpoint. Now, this is slightly less than the year-over-year improvement we projected last quarter since we improved our 2017 baseline with stronger than expected fourth quarter cash collections. This strong improvement in cash and will largely be attributable to the leering effect of the subscription model as we approach our third year anniversary as a cloud company.

Please not there are some seasonality in cash flow and first quarter cash outlays are higher due to payments related to prior year performance bonuses and the other special events.

We estimate that our full year adjusted EBITDA will be a loss between $25 million and $27 million, which is a $7.7 million improvement at the midpoint over 2017. From a cloud-metric standpoint, we expect ARR for 2018 to be between $186 million and $189 million.

Overall, we're very pleased with the fourth quarter and full year performance. The work that we've done to move our business to cloud has made us a stronger company and we are seeing the benefits in our financials.

We entered the year confident in our ability to achieve our long-term growth and probability goals and we remain committed to creating value for our customers and shareholders. We are grateful for your support at PROS and we look forward to 2018.

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

[Operator]

Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions]

And our first question is from Scott Berg from Needham & Company. Please go ahead.

[Scott Berg, Needham & Company]

Hi everyone and congrats on a good quarter. Couple of quick ones for me.

[Andres Reiner, President and CEO]

Thank you, Scott.

[Scott Berg, Needham & Company]

Yes, first of all, Andres, I expect a lot of activity over the last three or four months on the improvement of demand for B2B e-commerce websites. And I know it's part of a thing, you all have discussed multiple times over the last couple of years, but it seems like it's finally "caching on." And the commentary that we have heard is these customers want to rush to these websites, buy these shopping carts to provide the functionality online as you talk about to kind of individualized part of the experience, but pricing is always the biggest sticking point. They don't only realize that how important pricing is. And you guys have kind of naturally brought in. But what are you seeing in that theme right now relative to maybe 12 or 18 months ago, and your expectations on the demand drivers here in the near-term?

[Andres Reiner, President and CEO]

Yes, Scott. You're absolutely right. What we're seeing is e-commerce is thoughtful mine. And I think a lot of companies are thinking obviously on the tools to help sales, drive better execution around deal quoting, but they are thinking beyond that in how they're going to power a digital experience.

And really how they're going to power not just omnichannel, but this -- what we call channel fluidity. It's being able for customer to start through an e-commerce and be able for a sales rep to take that opportunity and help complete that opportunity, letting our customers drive through whatever channel they choose, but still the sales organization being able to support that sales motion.

And like you said, one of the two important components that we have power with AI in that work stream is; one, the personalization, how we're creating the right offices that make sense to that customer; and two, what is the real-time price that's tied to that customer's willingness to pay. Because if you don't have a real-time market price, you're not going to win those deals, those customers are going to go elsewhere.

So, a lot more conversations with our customers on how do they drive that digital selling experience. And how do they use -- how do they have that digital and e-commerce help support their sales motion, rather than just be separate channel. And there's a lot of excitement and we feel we're uniquely positioned to capitalize on that market opportunity.

[Scott Berg, Needham & Company]

Thank you. Very helpful. And I think kind of the follow-up to that, at least on the sales sized. You talked about productivity improving year-over-year at a much faster rate than the growth in your sales capacity.

How do we think about sales capacity growth going forward in 2018 relative to your current ARR guidance of 17%? And I guess that's an initial view and it can change next quarter or two. But how should we think about what you growing those capacity needs?

[Andres Reiner, President and CEO]

Yes, so we're -- first of all, we're really pleased with their sales productivity. Our sales performance and sales productivity as I commented in my prepared remarks. We saw a 30% increase in the volume with about an 18% increase in quota-carrying personnel, which made our cap [ph] ratios improved by 40%. So, I think those are an awesome accomplishment by our team.

As we look into 2018, we're seeing about the same 18% quota-carrying increase in the year and maintaining that. We still -- we had an incredible year in driving sales execution and improving productivity, but we're still focused on driving even further productivity improvements.

[Scott Berg, Needham & Company]

Got it. And last -- one last quick one for me, Stefan. Your adjusted EBITDA guidance is just a little bit lower than I think we in consensus were, which I believe assumes a little bit higher spend level. Is there something may be in the Vayant acquisition or some other, I don't know, conservatives and some of your numbers that might be driving that current guidance?

[Stefan Schulz, EVP and CFO]

No, not really. It's not really attributable to Vayant, Scott. It really is a function of the continued increases in cost associated with driving additional revenue. I mean if you looked at operating expenses, for example, we're going to actually be holding those operating expenses relatively flat, maybe up a couple of three percentage points. It really is going to be driven by the cost of goods that goes with the increase in sales. And that's going to be in the driver to the EBITDA.

But overall, we're actually pleased with the progress we're making from the scale and efficiency standpoint to add to Andres's comments. And we feel like there is still more to come and we'll be focused on generating more of those as we go through 2018 and into 2019 as well.

[Scott Berg, Needham & Company]

Thank you. Very helpful. I'll jump back in the queue.

[Andres Reiner, President and CEO]

Thank you.

[Stefan Schulz, EVP and CFO]

Thank you.

[Operator]

Our next question is from Jackson Ader from JPMorgan. Please go ahead.

[Jackson Ader, JPMorgan]

Thanks for taking my question guys. Actually if I can just pull you back off of the last question, if our expectation is for operating expenses to be roughly flat and sales rep are expected to grow again around 18%, new Chief Marketing Officer who certainly will be asking for a larger budget. Where should we expect some of the other operating expenses to either decline or where will you fund some of these other investments from?

[Stefan Schulz, EVP and CFO]

Yes, so that's a great question. And first of all, I'll tell you that some of the savings are going to be in the G&A line. We continuously look at ways in which we could process the business and operate the business more effectively. And I think if you look at our history, we've shown that we're able to do that not only in G&A, but we've done that in selling and marketing.

In addition, some of those, the new hires that we're talking about from a quota-carrying perspective are going to be a part of some of the changes that Tom is making as our new Head of Sales and we're going to be looking at some inside sales capabilities that will be a further refinement in investment to what we've been doing in the past. So, some of the sales headcount are going to be coming at relatively lower cost associated with the travel that will now have to occur and things of that nature.

So, we're looking at ways in which we can take the existing cost structure we have, lower it, at the same time, looking at ways we can add people. We're doing that in efficiency -- in efficient manners as well.

We also have some of the development capacity that we have. We're leveraging the capacity and experience we have in Bulgaria, which also does save us a little money. And those are some of the things that we're looking at holistically as a business.

So, even though we're investing and growing the business, we're doing it in a way that not necessarily requiring us to spend the representative dollars that you might think otherwise. So, it's a number of different initiatives. It's been something that we look into every year and this year is no different.

[Jackson Ader, JPMorgan]

Okay. Understood. And then just may be a quick follow-up for you Andres. If I look at some of the numbers organically, ARR has grown about 25% for the last couple of years, excluding Vayant. So, 17% projected growth with the same kind of sales rep increases. I guess where my -- not necessarily missing something, but there does seem to be a little bit of a mismatch of growth rates looking forward versus looking backward. So, what should we be looking out for in 2018?

[Andres Reiner, President and CEO]

Well, I would tell you, still we're very early in the year. We feel very good about our overall sales momentum. I think last year was another great year and we ended back on two back-to-back record quarters. And I think it's very early in the year and we want to put a guide that we feel confident in.

But overall, I will tell you we're pretty pleased with the growth rates that we've achieved and we are very pleased with all areas around our demand, whether it be our overall pipeline growth has grown much more than our overall bookings growth. So, overall, we feel very good about our growth rates looking into 2018.

[Jackson Ader, JPMorgan]

Okay, sounds good. Thank you.

[Andres Reiner, President and CEO]

Yes.

[Operator]

Our next question is from Nandan Amladi from Deutsche Bank. Please go ahead.

[Nandan Amladi, Deutsche Bank]

Hi, good afternoon. Thanks for taking my question. So, this is our two-part question. You talk a little bit about migrations, you said about two dozen migrations have already taken place. What is the mix between B2B and airlines, because the airlines are just starting this time a year ago. And I think Stefan guided to high single-digit percentage decline in maintenance. What pace does that translate to in terms of customer mix?

[Andres Reiner, President and CEO]

Yes, so Nandan, you could definitely travel in our airline business, started to migrate from the very early. If you remember, we talked about very early in our transition about Etihad Airways as being one of the first.

And when you look at our business where we had over 97% of work business that's cloud and you know that our travel business is predominantly existing, you're able to see that in the numbers we are actually able and been migrated airlines. I also talked about Korean airline last quarter of many.

So, overall, I would say, look, we're pleased across both B2B and across the travel. If anything early on in our Cloud-First, we were concerned that maybe airlines will take longer to serve global deployments real-time. But overall, we've seen really a pull factor from all the innovations that we've done in the new real-time capabilities or shopping in merchandising now that airlines are wanting to adopt these capabilities and move to the cloud. So, I would say it's been balanced across both B2B and travel.

[Nandan Amladi, Deutsche Bank]

And how much of the migration is sort of capitalized by the Vayant offering? I'm assuming Vayant is only deployed as a cloud option?

[Andres Reiner, President and CEO]

Yes, so Vayant is not included in any of the migrations because that was part in cloud from the very beginning and that's not tied to any of our customers. So, the -- over two dozen migrations is pure PROS customers that have migrated to the cloud.

[Nandan Amladi, Deutsche Bank]

Okay. Thank you.

[Andres Reiner, President and CEO]

Your other question on the maintenance line, some of the maintenance that's coming off is going to take a little bit longer because some of this migrations that have happened that have signed when they go live is when you will actually see the subscription coming up in the maintenance being moving out. And as you would imagine in some, the time for migrating is verifying the two systems, because these are mission-critical, can vary.

[Nandan Amladi, Deutsche Bank]

Thank you. Very helpful.

[Andres Reiner, President and CEO]

Okay.

[Operator]

Our next question is from Tom Roderick from Stifel. Please go ahead.

[Matthew Van Vliet, Stifel, Nicolaus & Company]

Yes, hi, Matt Van Vliet on for Tom. Thanks for taking my question. I guess just looking at the Vayant acquisition, where are you in terms of consolidating that sort of within the cohesive go-to-market platform? And maybe how that aspect of the business sort of performed in the fourth quarter for you?

[Andres Reiner, President and CEO]

Yes, I will tell you that the Vayant acquisition has performed extremely well from an integration perspective. I would tell you we have more conviction than ever from a organizational or in integration, I would say, it's fully integrated from a sales, from a product innovation, from a support, cloud ops, every area of the business is been integrated into one and it's been -- they have been an amazing team. And I'd say this is much on their our team as our team on really embracing the PROS culture as being part of one.

And I would tell you that our sales team -- PROS sales team has been able to sell Vayant solution in both quarters that we found the business, which is a true testament. It's a -- finally a real task that we were able to cross-sell.

So, overall, we're very pleased with how it's performing and the overall market response, I would tell you a lot of our customers are really excited about the shopping and merchandise capabilities.

[Matthew Van Vliet, Stifel, Nicolaus & Company]

And then as you look towards the migrations that you've done so far and what's sort of in the pipeline for 2018, is there much of a mix that's different than your overall business in terms of geography? Is there any issue in the EU with GDPR standards or other privacy issues right now?

[Andres Reiner, President and CEO]

Yes, that's a great question. So, overall, a part of us laying the foundation over the last several years has been around placing all -- now we've talked about 17 data centers across the world from Asia-Pac to EMEA to Americas to ensure that we can serve all of our customers in their local zones.

And I would tell you, we've been working on GDPR from the very beginning and we are prepared for GDPR. And we've seen a very good option our cost rest of world, Europe, and Americas.

If anything, I would tell you that, Europe and rest of world where we thought maybe would lag, we haven't seen a lag. We've seen them wanted to adopt our technologies in all those regions.

[Matthew Van Vliet, Stifel, Nicolaus & Company]

And then last question. With some of the Smart CPQ integrations, you're talking about on the partnership side and a lot of AI-based capabilities that you have sort of have engrained in the product for a while and are certainly a huge buzz that's out there right now.

Where do you guys stand in the overall products, lifecycle or capabilities relative to some of the newer products coming out to market that are accounting machine learning in AI, but maybe don't have it as much of their overall history? How are you able to sell that aspect and really differentiate the product?

[Andres Reiner, President and CEO]

Yes, I would say we're light years ahead. I think it's not even close. I think there's a lot of companies talking about it. There's very few that actually have proof points of customers actually making money from AI machine learning.

We have a phenomenal science organization that's been innovating in algorithms for decades and they're always ahead. And I would tell you that's an area that is natural to us. It's an area that we've -- we've really innovative over decades across many different industries, many different problem areas and creating it in a way that you can actually drive these predictions for real-time, mission-critical decisions in a way that they produce reliable results.

And I think that's part of our true differentiation and that's part of what makes really PROS special. So, I think anytime we can compete on AI and machine learning, that's a great opportunity for us.

[Matthew Van Vliet, Stifel, Nicolaus & Company]

Great. Thank you.

[Andres Reiner, President and CEO]

Thank you.

[Operator]

[Operator Instructions]

And our next question is from Joe Fadgen from Craig-Hallum. Please go ahead.

[Joe Fadgen, Craig-Hallum]

Hey guys. On here for Chad. Thanks for taking the question. A couple for me probably more for Stefan. On free cash flow for the year, $2 million to $5 million burn, you talked I think this call and in previous calls that Q1 was probably going to be a little bit steeper burn than the rest of the year.

But given that you're approach in breakeven, I mean do you think there's -- I mean how likely is it that you effectively burned cash that in Q1 in a more or less breakeven as soon as Q2 and then Q3 and Q4, is it more of a -- you probably burn cash Q1, Q2 and maybe Q3 and then have a stronger Q4?

And then on the subscription business, looks like you had a nice bump here in the gross profit or gross margin line a little bit over 60 here. Should we expect low to mid-60s kind of improving throughout 2018?

[Stefan Schulz, EVP and CFO]

Yes, so let me go -- I'll go in order you asked that question. So, first of all, free cash flow. Yes, so in our guidance of $2 million to $5 million burn, yes, we do expect to burn cash in Q1 and even a slight burn in Q2. So, it's really more of a one half, two-half kind of way of thinking about it. And I would tell you that in the first half we'll be a net burn in cash and in the second half, it will be a net generator of cash.

And -- no that should be the mark where you see us more consistently generating cash flow. And we'll be able to withstand seasonality in spin patterns much better than we are right now. Because as I said in my prepared remarks, some of our seasonality in spin patterns are causing us to spend more than we collect in certain quarters. And I do suspect that will become less and less of an issue as we move beyond this year.

As it relates to your second question around the subscription line item, yes, you're right, we did see a nice increase in our subscription revenue line and our total revenue line, because of some of the go lives that we have talked about earlier in the year. And to your point, that did drive a nice increase in the quarter for us from a subscription gross margin perspective.

And yes, we do -- if you think about from the year perspective, then you look at where we landed for the year in subscription gross margins, we landed somewhere in the 59% range for our subscription gross margins and I would tell you that will increase next year thinking in the terms of 300 basis points somewhere in that neighborhood. You should see us getting into the low 60s on the subscription gross margin line as we continue to make the improvements that we've been highlighting this quarter and in previous quarters.

[Joe Fadgen, Craig-Hallum]

Okay. That will be all for now. Thanks guys.

[Stefan Schulz, EVP and CFO]

Thank you.

[Andres Reiner, President and CEO]

Thank you.

[Operator]

Thank you. This concludes the question-and-answer session. I'd like to turn the floor back over to management for any closing comments.

[Andres Reiner, President and CEO]

Thank you for your participation in today's call. We come to 2018 with great moment and we're confident that we will continue to drive growth and scale in our business. Once again, I would like to thank our incredible PROS team for their commitment to helping our customers outperform.

Now, I would also like to thank our customers, partners, and shareholders for your continued support. Finally, I'd like to invite you to our Annual Outperform Conference, which will be held on May 15th through the 17th in Houston, Texas. Thank you and good bye.

[Operator]

This concludes today's teleconference. Thank you for your participation. You may disconnect your lines at this time.