PROS Holdings' (PRO) CEO Andres Reiner on Q2 2016 Results - Earnings Call Transcript

| About: PROS Holdings, (PRO)

PROS Holdings, Inc. (NYSE:PRO)

Q2 2016 Earnings Conference Call

August 02, 2016 04:45 PM ET

Executives

Andres Reiner - President and CEO

Stefan Schulz - CFO

Analysts

Bhavan Suri - William Blair

Scott Berg - Needham & Company

Ben McFadden - Pacific Crest Securities

Nandan Amladi - Deutsche Bank

Joe Fadgen - Craig-Hallum

Tim Klasell - Northland Securities

Operator

Greetings and welcome to the PROS Holdings Second Quarter 2016 Earnings 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, Mr. Stefan Schulz. Thank you. You may begin.

Stefan Schulz

Thank you, operator. Good afternoon, everyone and thank you for joining us. Joining me on today's call is Andres Reiner, President and Chief Executive Officer. In today's call, Andres will comment on the second quarter of 2016, I will review our financial results and outlook and we will then open the call to questions.

Before we begin, we must caution you that some of today's remarks, including our guidance, our strategy, our competitive position, future business prospects, revenue, bookings, market opportunities, as well as statements made during the question-and-answer session, contain forward-looking statements. These statements are based on present information and are subject to numerous and important factors, risks and uncertainties, which could cause actual results to differ materially from the results implied by these or other forward-looking statements.

PROS does not assume any obligation to update the forward-looking statements provided to reflect events that occur, or circumstances that exist, after the date on which they are made. Additional information concerning risks and other factors that may cause actual results to differ can be found in the company's filings with the SEC. Also, please note that a replay of today's webcast will be available in the Investor Relations section of our website at pros.com. We encourage everyone to review this additional information.

Finally, I would like to point out that in addition to reporting financial results in accordance with Generally Accepted Accounting Principles, or GAAP, PROS reports certain financial results, as well as 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 efforts is available on the press release distributed earlier today, and in the Investor Relations section of our website.

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

Andres Reiner

Thank you, Stefan. Good afternoon, everyone and thank you for joining us. We like to begin by recognizing our PROS team for an incredible first half of 2016. I’m proud to be part of a team so fully committed to helping customers outperform with innovations that deliver real tangible value. Over the past year, we’ve been transitioning to the cloud to deliver even more value to customers. And to execute on our commitment to expand shareholder value and now, our cloud-first strategy is driving momentum in the business. Demand continues to grow. Our land and expand business is strong and we’re making solid improvements on execution. These are the underpinnings of our strong first half of 2016 and our improved outlook for the rest of the year.

In the second quarter, ARR came in at 109.6 million, up 22% over the same period last year and above internal expectations. ACV bookings in the second quarter were 7.5 million, up 17% year-over-year and above the high end of guidance. We’re pleased that our innovations in cloud-first strategies are working. We’re now approaching an important milestone in our cloud transformation. Starting in the fourth quarter of this year, we believe we will once again start seeing sequential revenue growth. This is an incredible accomplishment by our team. In just over one year, we have principally changed the way we run our business.

Our sales organization now only goes to market with cloud solutions or new innovations are all available in the cloud and existing customers are adopting add-on solutions in the cloud and some even migrating completely.

Let me share a few data points that punctuate our progress. First, we increased our ACV bookings in the first half of 2016 by 40%, compared to the first half 2015, with subscription business being the biggest driver of growth. Second, we drove a higher mix of cloud deals. In the first half of 2016, more than 80% of all deals were cloud, compared to less than 25% in the first half of 2015. Finally, we increased our mix of recurring revenue, which was 70% at the end of the second quarter of 2016, up from 52% at the end of second quarter of 2015. These metrics not only highlight our progress, but also underscores the enthusiasm our customers have for our cloud strategy.

In the cloud model, customers can start fast, get to value quickly and then expand with more solutions. For example, last year, a B2B customer deployed our pricing solution to better manage market volatility and improved customer response times. After seeing their value expectations, the company added our Smart CPQ solution this year to give their sales reps greater confidence and success in quoting. Including full integration with salesforce and CRM and Microsoft AX ERP, they are already seeing value from our end-to-end solution.

We are excited that our cloud strategy makes our market leading innovations even more accessible and more valuable. We believe our innovation strategies at the heart of our companies are competing in today's market. The drive for better customer experience is touching nearly every industry we serve. It is why more companies are turning to PROS to enable personalized and frictionless commerce across their direct partner and e-commerce channels.

BP’s wholesale fuels divisions in Germany is a great example, their leaders recognition an opportunity to differentiate on customer experience by being the first to offer B2B e-commerce channel for wholesale fuels in Germany. The key requirement for success was first-line, customer specific pricing to harmonize with their direct sales channel. Already, you've seen PROS redirect sales, we integrated our dynamic pricing capability with their SAP hybrid e-commerce platform.

Our solution allows BP to update their pricing in real-time throughout the day to ensure they’re aligned with the market and with each customer. This personalization in simplicity has driven frequent request for more fuel volume purchases through e-commerce and help BP gain share with more new accounts. BP now expects to expand their e-commerce offering into new geographies later this year. We are proud to help BP compete and win in their market with a powerful e-commerce offering.

In the second quarter, we extended our innovation advantage with new capabilities that enable frictionless commerce and help improve customer experience. For example, we introduced a new data science innovation that gives airlines greater flexibility to adjust their loyalty strategies for every flight in real-time, providing a more personalized travel experience for customers. We also continued to strengthen our offerings through technology partnerships.

Last quarter, we announced a partnership with Icertis to deliver a lead-to-contract solution that enables frictionless commerce in the cloud. The end-to-end solution helps sales reps execute quotes and contracts with greater speed and accuracy by seamlessly integrating pricing, quoting and contracts with Microsoft dynamic CRM or salesforce.com. Our partnership with Microsoft continues to get stronger as we build upon more than a decade of innovation and collaboration.

As part of our cloud transformation, we have been working together to extend our global cloud capabilities through Microsoft Azure. I’m excited to share that we recently went live with our first Azure deployment of real-time dynamic pricing for airlines. We are leveraging two Azure cloud environments in Europe to process approximately 12 million transactions per day at less than 100 milliseconds each with better than four nines of uptime. From this data, we have also uncovered new insights about customer purchase patterns that can inform the airline strategy.

This is just one of many examples where a long-standing partnership with Microsoft is helping us deliver even more value to customers. This is an exciting time for PROS, as we align with our companies to compete in the market. And how they want to adopt software. The results for the first half provide a solid foundation for a momentum, but as results as these results were, we recognized we can improve sales productivity even further. We continue to focus on training, messaging and simplification of our packaging and believe we will continue to get stronger.

As part of these efforts to improve sales execution, we continue to elevate our field sales leadership teams and I’ve personally been working much closely with our sales leaders to drive our growth strategy. This is a top priority for me. We believe this approach is making a difference. Today, we announced that Blair Crump is pursuing other opportunities outside of PROS. We thank him for his contributions to the company over the past 2.5 years and wish him the best. We don't expect to replace the COO position in the foreseeable future, given the strength of our field sales leadership and how closely I’ve been working with the team.

As we proceed with our cloud transformation, I believe it’s best to continue leading from the front with incredible team we’ve built across sales, marketing and professional services. Overall, we had a strong second quarter and first half of 2016. We are excited this year's strategic vision continues to unfold as more companies turn data science proven solutions to help them compete on customer experience. Based on the momentum we are seeing in the business and our continued focus on execution, we are raising our outlook on ARR, ACV and subscription revenues for the year.

We’re confident we have the right people and the right strategies in place to capitalize on our market opportunity and realize our full potential. I would like to close by thanking our customers, employees, partners and shareholders for your continued support.

With that, I will now turn the call over to Stefan Schulz to review our financial results and our outlook for the third quarter and full year of 2016.

Stefan Schulz

Thank you, Andres. I would like to begin my comments by first updating you on our cloud transition and the related milestone goals we introduced last quarter. I will then provide details on the second quarter and outlook for the third quarter and full year. As Andres indicated, we have a line of sight to an important milestone for our cloud business. From the outset, we believe the cloud model would be better for customers, for PROS and for shareholders. We believe the near-term impact on revenues, EBITDA and cash flow would be temporary and ultimately offset by stable and growing base of recurring revenue.

Now, just over a year later, we are approaching the point where we expect to start seeing sequential quarterly growth in total revenue in the fourth quarter as well as an improving trend in EBITDA and free cash flow margins. We are pleased to have reached this point in our transition and give credit to our PROS team worldwide for fully committing to our cloud strategy. We also recognize that our work is not done. We’re continuing to focus on sales execution and improving our operational discipline to build upon the momentum we’ve achieved so far this year.

I’ll now update you on the two goals we introduced last quarter that are natural outcomes of a successful cloud strategy and strong indicators of long-term value creation for our customers, PROS and shareholders. The first goal relates to accelerating growth in our recurring revenue. Last quarter, I stated that we expected 20% growth in subscription revenue in 2016 at the midpoint of guidance, 40% in 2017 and further growth rate expansion in 2018. With another quarter behind us and a stronger than expected subscription revenue growth of 33%, I'm happy to say that we’re on track to achieve these targets.

Our second target was related to cash flow. We set a goal of achieving positive free cash flow in late 2017. We're still tracking to that goal with another better-than-expected free cash flow performance in the second quarter. Our free cash flow results have exceeded our expectations over the past four quarters and that has only increased our confidence towards achieving our near-term goal of positive free cash flow and our long-term goal of 20% free cash flow margins. We will provide a more detailed update to our long-term model at our Investor Day in November, which we also announced today.

I will now turn to our second quarter results. ARR came in at $109.6 million in the second quarter, up 22% over the same period last year. Growth in subscription ARR continues to be the primary driver of overall ARR growth, both sequentially and year-over-year. Our ACV bookings in the second quarter came in above the high-end of our guidance range at $7.5 million, up 17% from the second quarter of last year. Bookings from travel customers were especially strong in the second quarter and we were also pleased with the customer migration activity, which has started to occur and contributed to our upside in the first half of the year. While we are pleased with our ACV results in the second quarter, I still want to remind everyone that our ACV results can be lumpy on a quarterly basis due to the relatively low volume of transactions and the large size of our transactions.

Turning to our P&L, revenue for the second quarter was $37 million, which was above the high-end of our guidance range and a 13% decrease over last year. This decline was primarily driven by the decrease in license revenue, which was down $6.9 million from last year. Subscription revenue was $9.1 million for the quarter, well above our guidance range of $8.5 million to $8.7 million and an increase of 33% over last year. We are continuing to see the momentum build in this revenue line item, as previously booked ACV is placed into service. Maintenance revenue was $16.8 million, up 9% over last year. Combined, our subscription and maintenance revenue make up our recurring revenue, which represented 70% of total revenue in the second quarter and is a much larger component of our total revenue from last year, when recurring revenue made up only 52% of total revenue. Recurring revenue was up 17% year-over-year.

Services revenue exceeded our expectations, but was down from last year by 22%. As we've discussed in the past, the primary reasons for the services decline are the revenue deferrals from many of our travel professional services along with lower levels of professional services required from many of our SaaS implementations. Also, our total cost and expenses were lower by approximately $1.5 million from our implied guidance, as we continued to leverage investments made in previous periods and drive improvements in the business. At the same time, we continue to invest in our cloud infrastructure.

For example, in the first six months of this year, we expanded our cloud environment into Australia, Ireland and the Netherlands. Because of these continued investments in our cloud infrastructure and the fact that we are in the early quarters of our subscription revenue growth base, our subscription gross margins are in the low-60s and will likely be in that range for the next couple of quarters. Also, due to the services revenue recognition deferrals I referenced earlier, we expect to see depressed services gross margins for the next two or three quarters as well, until revenues begin to be recognized from the deferred balances. These lower gross margin amounts for subscription and services are temporary, as we execute through the early stages of our cloud-first transition and these margins will improve as we progress through this transition.

We remain confident in our long-term gross margin profile of 69% to 72%. Our free cash flow burn in the second quarter was better-than-expected at $8.5 million. This was driven primarily by another quarter of strong execution on collections as well as continued focus on expense management. For the first half of 2016, our free cash flow burn was $14.8 million, which is a lower level of burn than our initial expectations at the beginning of the year. We also expected to burn a significant amount of cash for the full year in 2016, as we migrated through the cloud-first transition. But just as we did in the first half of 2016, we are focused on minimizing the amount of free cash flow burn as much as possible for the full year and we have improved our full-year guidance as a result of this focus. We are confident that the cloud-first transition will ultimately provide us with a more consistent and stronger cash flow.

Now, turning to guidance. For the third quarter, we expect ACV bookings to be in the range of $4.5 million to $6.5 million. Based on the strength of the first half and visibility into our pipeline, we are raising our full-year guidance on ACV to $26.5 million to $28.5 million, a 28% increase over 2015 at the midpoint. With the increase in our expected ACV bookings and our strong customer retention, we are also increasing our full-year ARR guidance to $118.5 million to $120.5 million, a 22% increase over 2015 at the midpoint.

We expect subscription revenue in the third quarter between $9.3 million and $ 9.5 million. We are also raising our guidance on subscription revenue for the full year to $35.5 million to $36.5 million, a 23% increase over 2015 at the midpoint. As you can see, we are beginning to see the growth in subscription revenue that accurately reflects the momentum in our cloud-first strategy. This is what we projected would happen, and we are tracking with our growth goal.

Total revenue for the third quarter is expected to be between $35 million and $36 million. We expect the primary drivers to the year-over-year decline to be license and services revenue line items once again. We're holding our total revenue guidance for the full year at $150 million to $153 million, but expect total revenue to land in the lower end of that guidance range due to the continued expected declines in license and services revenue. We are improving our free cash flow and EBITDA guidance for the year. We are now estimating our free cash flow burn to be between $34 million and $36 million for the full year, an improvement of $1 million from prior guidance.

Lastly, we are estimating that our Q3 adjusted EBITDA to be a loss of between $13 million and $14 million. For the full year, we expect adjusted EBITDA will be a loss between $43 million to $45 million, a $1 million improvement from the guidance given last quarter. Our earnings per share loss is expected to be in the range of $0.34 to $0.36 per share in the third quarter.

Overall, we are pleased with the second quarter and the first half of 2016 and with the progress we have made. Our results reflect our continued commitment to deliver value to our customers and our shareholders through recurring revenue growth and cash flow generation, which ultimately comes from happy customers who are getting tangible value from our cloud solutions. As we look ahead, I’m confident in our outlook based on the health of our pipeline, the improvements we are seeing in execution and the strong preference for cloud offerings in the market.

We believe we are making the right investments for the long term and that we have the people, the technology, the opportunities and the customers to capture our share of the large market opportunity. We are grateful for your support and we are happy you’re joining us on our mission of helping our customers outperform.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Bhavan Suri with William Blair. Please state your question.

Bhavan Suri

Hey, guys. Thanks for taking my question and congrats. Nice job on all the metrics and certainly the raise on the recurring metrics. Just to start off first on the sales team, obviously, it feels like that you have got some cadence there, now for a couple of quarters execution, if you look at the sales team today, just some sense of what the ability for it to improve productivity looks like, so do we have to add more sales heads over the next 12 to 18 months, or is there still room for productivity with the existing salesforce and then coupled with that, maybe, just a follow-up there, on just what the pipeline looks like as you go through the back half of the year?

Andres Reiner

Great, Bhavan. Great question. In terms of sales productivity, there are four major areas we have been focusing on. One has been improving the sales organization which we’ve already done. I think I'm really proud of the great team that we have. Also, we have been focusing on training on the new products and business model, and I would say we made a significant progress I believe that our new training programs are really helping the field. The other area is looking at sales cycle time, especially around the cloud offerings and I would say this is an area that we’re starting to see early signs where these offerings, we’re selling in a faster sales cycle like you would expect in a SaaS model. I would say in this point, we’re still in the early stages, but there is still opportunity to continue to see improvements and we expect to do and the other is on land and expand, which we have made really more progress than where we probably expected and expect to continue. So I would say, we're making good progress. The solid results in Q1 and Q2 are showing that, but we expect that there is still room to improve productivity.

Bhavan Suri

Got it. And then just pipeline color Andres would be great too?

Andres Reiner

And then pipeline, I would say I feel very good about the pipeline and the pipeline growth for the second half and for next year, I feel that we are making good momentum in differentiating. I think areas around digital commerce, we’re seeing a lot of interest in the market. So being able to showcase the differentiation of our capabilities for the direct sales, the channel and e-commerce, and we are seeing that resonate with our customers and the market and how dynamic pricing is a critical capability to drive a digital commerce strategy, so we are very pleased with our pipeline growth as well.

Stefan Schulz

This is Stefan. I was just going to add to that, I think one of the other points we wanted to make is we do provide you with the number of sales, quota carrying headcount than we have and we feel like that level of headcount that we have in that area is going to be sufficient to get us to where we want to be, both for the rest of this year and getting into next year. So through the productivity things that Andres was just talking about and the steady improvement that we look forward to making, we feel like we’re in really good position to do that, which is obviously also seen in the fact that we raised our ACV numbers for the whole year this year.

Bhavan Suri

Right. That's really helpful. I guess one quick last one for me, obviously the departure of Blair comes a little bit as a surprise, just some sense of sort of how you guys are thinking about, he didn't run the sales team, but he was clearly instrumental in customer conversations and sort of morale, motivation, everything else. Sort of how you guys are sort of managing through that and sort of as you think about it, sort of, how you think about the risk of disruption there?

Andres Reiner

Yes. So I would say since the beginning of the year, I've been working very close with the field sales organization and what I would say is that we focus on, both Blair on I, on elevating the leadership team and we really like the results. And frankly, after the end of Q2, we both sat down and realized that we probably didn't need that role. So we don't expect any impact to our execution due to this. I think we had built a very strong team and that's what gave us the confidence really to raise our outlook.

Bhavan Suri

Okay, thanks, Andres. That’s it for me, guys. Congratulations. Nice job.

Operator

Our next question comes from Scott Berg of Needham & Company. Please state your question.

Scott Berg

Hi, everyone. Congrats on a very good quarter here. A couple of quick ones. First off, Stefan, can you talk about the quarter a little bit more, you certainly had some upside to your revenue expectation, but your third quarter guidance is a little bit below the street, wanted to see if some of the services performance in Q2 was pulled ahead maybe from your initial Q3 thoughts?

Stefan Schulz

Yes. So Scott, thank you for the comments. First off, as it relates to our second quarter, we were particularly pleased with how our subscription revenue business came through and you saw that in the revenue number clearly in the beat and that was one of the bigger areas that impacted our beat for total revenue. The other area was in professional services. We ended up seeing an improvement in the professional services, but still, that number is on a downward trend versus what we have seen in the past, and that's primarily because with the successful launch of our cloud-first transition, we’re seeing lower levels of attach rate and lower levels of services that are absolutely needed to get the environments up and running.

So we actually view that as a good thing, plus as we've also commented in some of our travel business, we’re in the position where we're doing work, but we’re deferring that work. So that's a little bit of the color as you saw how Q2 came together and what I will tell you is it's going to be very similar to how we are thinking about Q3 and Q4 for that matter which is more or less implied guidance that we gave as we updated the full-year as well. So as we think about Q3 and Q4, here I how I would think about it, I would think about the fact that when you bundled a license and service components of our P&L, think of those as the two most volatile areas that we have, we are basically thinking that those are going to be relatively flat to what you saw in the first half and that the level of growth that we've implied in our guidance which is getting to 150 to the 153 but obviously I made the comment that we would be towards the low end of that, would indicate that the growth that we see between the first half and the second half will come from our recurring line and more specifically our subscription line.

Scott Berg

Andres, you talked about it, and I think it was in your prepared remarks or maybe it was Stefan’s customer migration seem to be trending a little bit ahead of your expectations, where you’re had existing cloud customers come back and buy more. I wanted to see if you can add some color in terms of what you're seeing there and some of that upsell opportunity in the last six months?

Stefan Schulz

That was actually me, and it was Stefan, as I was talking about our ACV bookings in the quarter, one of the things that we saw was we actually outperformed in the ACV number in the quarter and for that matter for the first-half versus the guidance we've given. And one of the reasons for that was related to starting to see some migrations occur inside of our business. So one of the reasons we beat was because of the migration but I don’t want to overemphasize that because we are with talking about relatively small number of customers that have actually proactively came to us but just to kind of keep it in perspective, if you look at our maintenance line, you look at a subscription line both are growing, this isn’t a ground sloping that's actually taken place. We really just wanted to make you aware of it because we felt like it was a factor in the outperformance of what we saw in the second quarter and just wanted to bring that to your attention because we have been talking about the fact that a lot of the migrations are going to be trending over time and all we’re saying is we’re starting to see some of that with customers actually wanting to get to that value sooner. So we think that's a good thing but it's not a ground slope type of an event that’s occurring.

Scott Berg

I guess, last question from me really quick is, I know Andres you talked about your [indiscernible] deployments in Europe impacting a couple of customers that were moving up on your cloud platform for first time, airline certainly outperformed in the quarter but want to maybe get some additional color on your airlines customers are seeing this transition, I think that consensus would imply that you’re getting better traction there then maybe some of us would thought responsible?

Andres Reiner

I would say that airline customers have positively received the cloud transition in what I would say an indicator we talked about better than 80% of the business with cloud. And initially we were more cautious in thinking that airline may continue to adopt for petrol for a longer period of time given that many of them have been customers with us for decades, but I would say buy into division and the areas [indiscernible] pricing are areas that they see a huge benefit on us providing that on assuring driving growth capabilities. So far we are very pleased. And I think there's been an excitement around the new innovation site GSO and PAV.

Operator

Our next question comes from Ben McFadden of Pacific Crest Securities.

Ben McFadden

I want to start with just first in Q1 you gave a metric around B2B revenue optimization being more than half of the bookings, I just wanted to see if you're willing to give any color just kind of how that fell in Q2 and just as a follow-up kind of how much of that may have been driven partners versus direct sales?

Stefan Schulz

So Ben, this is Stefan, I will take a shot at that and then Andreas can add some comments if he feel to. So it relate as you know we don’t really a give a lot of color behind our differences between our B2B and B2C, we gave some color in the first quarter primarily because of the challenges that we discussed in the last half of 2015 I will say this that as we look at the mix of business we are actually pleased with the mix that we see both for the first half of the year and what we see going forward in our pipeline, so set another way, if you would ask me how I would think our business would look sitting here today halfway through the year I would say we are right on where we thought we would be in terms of the mix that is travel versus our pricing business. And then as we look forward and look at our pipeline and what we have built into our guidance, I would say the same thing that we’re actually seeing the mix that is going to play that is going to be where we thought we would be at the end of the year. I will also tell you that we‘re [Technical Difficulty] first half of this year and both groups when I say that both groups B2B and B2C are actually contributing to that growth. So that's the kind of color that we would like to provide and we see positive momentum in actually both sides of the business. Andreas just talked about some of our travel customers on the B2C but I would say tell we are seeing the same type of momentum when we look at our pipeline and where that’s going for the rest of the year as well on the B2B side.

Andres Reiner

I would add also that across geographies we've also seen strength and driving the growth from Europe, the Americas and rest of the world. So I thought [indiscernible] we are seeing pretty strong so we haven't seen an area of concern we are seeing improvements in execution around the sales organization in each area. And in terms of partner contribution Ben which you asked. I think our partner ecosystem continues to be strong especially for a size as well as technology partners we are continuing to build strength within those partnerships.

Ben McFadden

Great and then, Stefan just quickly on the per cash flow, I mean, you continue to come in well ahead of expectations, you kind of guided the cash burn down slightly, just kind of help us walk through your confidence or optimism that you can potentially come in ahead of schedule, the next quarters is out on free cash flow potentially as well especially as we look at cash collections or DSOs which continue to come in well ahead of expectation.

Stefan Schulz

Well, Ben you nailed it, that is our that is kind of our recipe for beating the numbers for the first two quarters or actually if I go back to the last four quarters we've actually been able to beat it and I would tell it's been mostly because of improvements in our cash collection area. And as we look forward that is going to be a continued theme that we are going to emphasize but obviously the low hanging fruit that you get from that does get higher into the tree at some point and it gets harder to get over or outperform I should say on the cash collection goal. But our team has a lot of momentum behind them in terms of the success that they have had and they’re continuing to push for it. So as I said in my prepared remarks Ben, I would love nothing more than to beat the guidance that we put out there. But I also want to, you know, I just also want to caution that we have had a lot of success on the cash collection side and we’ve done very well in the opportunity to do even better is getting harder and harder because well we've done such a job so far. So that's what I will give you on that but our focus is actually to minimize the amount of cash flow burn as much as possible as we go through this transition.

Operator

Our next question comes from Nandan Amladi with Deutsche Bank. Please state your question.

Nandan Amladi

So as more of your bookings are coming on the SaaS side, is there a way for us to judge what part of the land versus expand or, you know, net new versus expansion and migrations from one premise to – I know you touched a little bit on this early but trying to frame that you know looking out over the next two years.

Andres Reiner

I would say near term it’s still going to be more net new I think long-term we expect land and expand to play a bigger role and I think as we look at ‘17 and beyond we have more opportunities because reseeding new smaller opportunities that have the potential to expand and we have commented already we have seen some but I would say still in the early stages. The same thing with conversions we've seen a few conversions and successful but that is not, if we talk about our highest focus area from a sales growth it is still on net new opportunities.

Nandan Amladi

And a follow up if I might, on the professional services partnership we’ve had for implementations, as you gone from the typical sort of one year type project to cloud model, how is that community reacting to smaller scope perhaps starting out…

Andres Reiner

I think the SI community has seen the cloud shift across many sectors, so I think they are all embrace the cloud module and understand that customers want to start small and wanted to reap their value and they realized that they can’t go in with a full implementation for all of the world and a transformation initiative that customers tend to want to buy and start, prove their value but that gives them growth opportunities later to do a phase 2, 3 and 4, so I think that they are more accustomed to this model and are embracing the model.

Operator

Our next question comes from Tom Roderick with Stifel. Please state your question.

Unidentified Analyst

[indiscernible] on for Tom this afternoon, thanks for taking my question. I guess first around the sales management chain here, Blair stepping aside, I guess what has changed over the last six months or so, Andreas you talked about being a little bit more involved but from a management perspective and maybe an overall strategy perspective that you decided to take more of a hands-on approach and that is since come to the decision that maybe is the best to part ways?

Andres Reiner

We talked about really focusing on our industry strategy and really driving more consistency around weekly and monthly goals within the sales organization and I think as we looked at our processes we calibrated plus our training, there have been a lot of areas that we put efforts to really make our team members successful. And we've seen the results and I would say it’s really about elevating the great leaders that we had in the business and it really came out really after the end of Q2, Blair and I sitting down and realizing that with the involvement and how we transform our corporations and sales, and how we like the results, that role really didn't make sense anymore, so for us right now is really continuing business as usual, hoe we executed in Q1 and Q2 and we really don't expect any impact from this. I think we have an incredible team and they are improving in how they’re executing and have the utmost confidence for the team that we have.

Unidentified Analyst

And then I guess following up on some of the land and expand discussion that we've had that maybe exceeded your expectations. Has there been a greater focus from a training perspective or from an incentives perspective that has really driven that aspect of the business or is there some other factor that you guys feel and it’s really starting to give that driver?

Andres Reiner

I think it's a focus around obviously the new cloud deployment we talked about starting smaller and seems success and as customers are successful they’re expanding across other geographies or other solution. So it’s really about the cloud offerings they have been deployed during the last 18 months - 12 to 18 months where we are seeing the leads to success and continuing to expand but I would say still the sales organization is predominantly focused on net new acquisitions. But it's great to see customers being successful and that is something that we are very proud and part of mission it helping customers outperform and as they’re successful we knew that we would have opportunities to upsell.

Unidentified Analyst

And then Stefan, just digging into the model, was there anything specific on the sales and marketing alignment caused that to decline pretty substantially in this quarter but then looking forward it would appear that that's going to sort of bounce back may where we were in the first quarter given your EBITDA guidance?

Stefan Schulz

So, when you look at the first quarter, we have a number of events, we have our outperform event, we also have a worldwide kickoff that takes place in a couple of other events that actually take place. So it's more of a seasonal type of thing then it is any sort of massive change, we also did, we have a little less on the headcount side and a little bit less on the incentive side, it's more on the incentive side then on the headcount side and that's mainly because we’re deferring more of our commissions then we would have in the past. So I would say those two things are the primary of the thing, it is the events that are higher in Q1 then they would be in Q2 and because of the subscription business that we’re seeing, we’re actually seeing some more of our commissions actually get deferred and recognized together with the revenues that’s going to come in later on that's what's driving the sales and marketing line.

Operator

Our next question comes [indiscernible] JMP Securities. Please state your question.

Unidentified Analyst

So first you talked about your expectations of over the longer-term reaching 20% free cash from margin and kind of towards the end of next year heading break even on the free cash flow side. Where do you see the operating level in the model coming from both in the near term and in the longer term?

Stefan Schulz

So, first of all it's going to be time I would say that's probably the best lever we actually have which is actually getting to different, you know, getting access to the layers and layers of subscription revenue that we are working so hard to generate right now that’s going to be the number one factor that we have. The second factor is going to be, we will not be needing to make as many investments in infrastructure and people that we are making today especially on the cloud side of the equation. We're making a lot of, I made a comment about the number of data centers in the country in which we are making them available. Those are all investments that we are making now that we are going to be able to leverage in the future as we grow our business and geographies around the world. So I would say those are the two primary things that we see as adding leverage to our model. And I also comment that one of the things that we announced as well in November in New York, we are going to be doing a follow up analyst day to our cloud first analyst day we did back in June of last year. And we will provide a little more color to what those levers are and how we see those coming to fruition to drive to that not only free cash flow margin but in addition to that the overall company gross margins and how we see getting to the guidance that we put out a year ago as well.

Unidentified Analyst

With nearly a third of the revenue coming from Europe, are you seeing any kind of early signs of the impact on your business from Brexit?

Stefan Schulz

We have not seen an impact to date on Brexit, so to your point we are fairly distributed globally around the world in terms of our revenue is generated, we have about like you said about a third is from Europe and other third or so it is from the US and Americas and the rest of the world represents the other third. So fortunately for us, we are not overly dependent on one geographic versus another, but I think it's still too early to determine what exactly is going to happen as a result of that decision but it’s something we certainly keep an eye on but I'm also very happy we’re in the position we are in which is that we are not overly dependent upon one country or even one geographic for that matter.

Operator

Our next question comes from Joe Fadgen with Craig-Hallum. Please state your question.

Joe Fadgen

I’m here for Chad, thanks for taking the question. I apologize I was caught on another call and jumped over late, but I guess if you haven't mentioned already, what percentage of your sales force is today consistently closing SaaS deals and how does that changed over the last two quarters, four quarters, pick your time frame?

Andres Reiner

We talked about it in general, we have - we talked about better than 80% of the deals were closing our SaaS deals. So I would say the majority of the sales force when they are closing they’re closing SaaS. So in terms of productivity what we’ve talked about is we don't disclose the specific productivity in any given quarter but we said is we’re improving in our execution, our strong results in Q1 and Q2 are showing the improvement but we also commented there is still room for improvement and we are still focused on training enablement of the sales team to drive even better productivity.

Joe Fadgen

Your average SaaS deal size today I mean if I assume it’s trended up over the last few quarters but how does, I mean, how and can you tell us where it is or where it is maybe to kind of that overall corporate average?

Stefan Schulz

So Joe this is Stefan, I would tell you that as we look at to your point it depends on the quarter and the mix of deals that take place but the average has trended up slightly but I would tell you overall think of it as a relatively flat number like I said you can look at one quarter versus the next and very much like I would tell you ACV don't focus on one quarter versus another, I would say the same thing about average deal size because we have some transactions that can be fairly large that can skew the results one quarter versus another but overall it hasn't really changed from what we were seeing towards the end of last year.

Joe Fadgen

And then last one here, thinking now into 2017, if you want to think about like your SaaS business growing like say 20% and those are my words not yours, but growing like 20% how much visibility would you see you have until ‘17 looks like right now?

Stefan Schulz

You're referring to bookings growing at 20%?

Joe Fadgen

Bookings, revenues take your pick.

Stefan Schulz

Okay, if you look at our ACV number for the first half of this year we actually grew at 40% and when we - last quarter we talked about the subscription business being a 20% growth number of this year in total and that we actually solve that getting to 40% next year. And the reason we are able to give that visibility in the next year has a lot to do with the bookings that we are seeing this year. And so, the fact that we are seeing the 40% growth in bookings is a large contributor to how we are projecting out our visibility into subscription next year. And I will tell you there is one another ace up our sleeve if you will and that is some of the bookings that we have actually closed, we talked about this are and especially in the travel area of our business are actually deferred and their deferred until the implementations are complete and the customers are actually able to use them. And so some of the bookings that we booked to-date have actually not actually been reflected in our subscription revenue number and they will next year as we get into 2017, so that gives us confidence that we actually see have good visibility into that type of growth.

Andres Reiner

Another indicator that we choose, the AAR growth is up 22% that's also a very good indicator of what subscription and recurring revenues is going to grow next year.

Operator

[Operator Instructions] Our next question comes from Tim Klasell with Northland Securities. Please state your question.

Tim Klasell

Three quick questions, first sort of on a bigger picture, travel you said was quite strong and that you guys hit on some of the turbulence maybe over in Europe. Has travel been a leading indicator for you and your business, I mean you guys have been around for a while and been through some economic cycle has travel been a good leading indicator for the tone of your business?

Andres Reiner

I would say travel, I would say we are very diversified across industries, so not always but travel being good it’s a positive thing and we’re pleased with the results and I would say the result is partly due to a lot of the innovations that we've done around GSO and PAV and some of the new capabilities that our customers are seeing a lot of value. But that being the case, I would say we see a lot of strength in our MDS and growth opportunities and we expect that to continue to drive our growth. So we are very pleased with travel and how it is performing and we are pleased with MDS and the growth opportunities that we have there.

Tim Klasell

And then jumping over to the Azure deployment, you mentioned some of the infrastructure investments you have make in a datacenter, how do you guys look at the puts and takes of what sort of margins you get from Azure deployment versus one on your own data center, may be you can give us a little bit of a feel of which way you would prefer a customer to come onboard?

Stefan Schulz

Well, we've made a strategic decision that we are going to be moving in the Azure direction and one of the reasons for that Tim is has to do with the delivery, the reliability, the success that they’re having and it also has to do with the cost model that we are able to earn our way into as we get deeper and deeper in Microsoft in that situation. So being a datacenter provider is not in our long-term goals, it's not something that we are putting our emphasis in, we’re actually putting our emphasis in developing and innovative better technologies that actually help our customers outperform. So we think it's a great partnership that we have Microsoft where they can deliver a very reliable structure and a very good cost and we are able to focus on the things that we do well. So that's why we're doing it and I would tell you that if you were to make each decision on a stand-alone basis I think we would run ourselves crazy so we have actually looked at where we see the thing going on long long-term and where we're going to get the most leverage and the best opportunity for the buck for us going forward and that's why we choose the Azure partnership.

Tim Klasell

And then just looking on the balance sheet, short-term deferred was sequentially down and if I look back in history there is occasionally Q2s is where that’s down, can you sort of educate of what drives that and then as you begin to move more and more into the cloud will that change?

A - Stefan Schulz

So, Tim I would tell you, first off on deferred revenues and this is going to become a bigger and bigger component of things that we are going to be talking about because of the fact that our subscription business is becoming a bigger and bigger component of our deferred revenue balance. Historically we haven't talked about much because the maintenance and services was the primary driver to it. We’re actually now starting to see subscription become a bigger part of it, but the real point I wanted to make here is that I don't think you can look at short term on a stand-alone basis, you have to look at all of it combined, right because overall we’re looking at how our deferred balance grows as a total, because you can literally see a flip from long-term to short-term because of one day being either right before quarter ends or right after a quarter ends and that can skew your results quite significantly in terms of how we classify it, so really the best way to look at it is look at our total deferred put together and overall that number is growing and the reason it’s growing is because of description deferred revenue balance.

Operator

There are no further question at this time, I would like to turn the call back over to Andres Reiner for closing remarks.

Andres Reiner

Thank you for your participation in today’s call, we are pleased with our results for the second quarter and first half of 2016. We’re confident in our outlook for the rest of the year based on our momentum. We would like to thank our incredible people for their passion and commitment to helping customers outperform. I would also like to thank our customers, partners and shareholders for your continued support. We look forward to speaking with you on our next call, thank you and goodbye.

Operator

This concludes today's conference, thank you for your participation; you may disconnect your lines at this time.

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