Castlight Health, Inc.
Q1 2018 Earnings Call Transcript

Published: 11 May 2018

[Operator:]

Good afternoon. My name is Sheryl, and I will be your conference operator today. At this time, I would like to welcome everyone to the Castlight Health Q1 2018 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you. Gary Fuges, Head of Investor Relations, you may begin your conference.

[Gary J. Fuges:]

Good afternoon, and welcome to Castlight Health first quarter 2018 conference call. Joining me on the call today are John Doyle, Chief Executive Officer, and Siobhan Nolan Mangini, Chief Financial Officer. John and Siobhan will offer their prepared remarks and then we will open the call to take your questions. Our press release, webcast and PowerPoint presentation are available on our website. This call contains forward-looking statements regarding our trends, our strategies and the anticipated performance of our business, including our guidance for the full year of 2018, timing of cash flows and non-GAAP operating breakeven, future cash position and the expected impact of changes of certain accounting standards. These statements are made as of May 10, 2018 and reflect management's views and expectations at that time and are subject to various risks, uncertainties and assumptions. If the call is replayed after May 10, 2018, the information in the call may no longer be current or accurate. We disclaim any obligation to update or revise any forward-looking statements. We provide guidance on this call, but we will not provide any further guidance or updates on our performance during the quarter unless we do so in a public forum. Please refer to the company's May 10, 2018 press release and the risk factors included in the company's filings with the Securities and Exchange Commission for discussion of important factors that may cause actual events or results to differ materially from those contained in our forward-looking statements. Our presentation also includes certain non-GAAP metrics, such as non-GAAP gross profit margin, operating expenses, operating loss and net loss per diluted share that we believe aid in the understanding of our financial results. A reconciliation to comparable GAAP metrics on a historical basis can be found in the Appendix section of our earnings release filed before this call. Finally, note that the company adopted the requirements of the ASC 606 accounting standard as of January 1, 2018, utilizing a full retrospective method, which required the company to recast the prior reporting periods presented. Adoption of the new standard resulted in changes to our county policies for revenue recognition, contract balances, deferred revenue, and deferred contract costs, which consists of deferred commissions and deferred professional services costs. We have published a supplemental presentation on our Investor Relations website that illustrates the impact of ASC 606 on our historical financial statements. With that, I'll now turn the call over to John Doyle, CEO of Castlight. John?

[John C. Doyle:]

Good afternoon, and thank you for joining us on the call today. At Castlight, we believe that as individuals take more direct responsibility for their healthcare, they'll increasingly rely on technologies like ours that integrate, personalize, and simplify the fragmented healthcare ecosystem. By making it as easy as humanly possible to navigate healthcare in this way, we effectively guide people to high value resources that can save money and improve health. Castlight made a major leap forward on this front in Q1 with the first wave of launches of Anthem Engage, our first joint care guidance and wellbeing product partnered with one of the largest health plans in the United States. This was an incredibly exciting milestone for us. I'll provide more color on the successful delivery of Engage and why we see it as foundational to the launch of our Castlight Complete offering later this year. I'll also discuss our progress on 2018 priorities related to growth, customer health and financial sustainability. Next, Siobhan will review our Q1 financial results and 2018 outlook and then we'll finish with Q&A. We ended the quarter with $164 million in annualized recurring revenue or ARR. This represented a 17% increase year-over-year on a pro forma basis. Importantly, we continued to increase the share of ARR that is tied to our platform solutions. We did this through sales of new platform business, cross-sales of wellbeing into legacy care guidance clients, and the continued focus on converting the remaining transparency customers to the platform. As a result of these efforts, transparency-only ARR now represents just 19% of total ARR, and we are on track to hit our target of less than 15% on this metric by year-end. We believe it is increasingly evident that our platform solution with its large number of integrations, breadth of solutions, and improved value equation for customers creates a strong foundation for customer relationships to endure. Accordingly, we continue to expect churn to improve over time. As I said, the big milestone at Castlight in Q1 was our delivery of Anthem Engage on January 1 on time and at scale. The highlights are impressive. We launched more than 800,000 lives across more than 20 individual employers. We also deployed a lighter weight version of Engage to fully insure large group populations in California and Colorado. Right away, we've seen user satisfaction with Engage that compares favorably to well-known consumer digital applications outside of healthcare, and we've quickly demonstrated the power of combining wellbeing and care guidance in a single app. For example, Engage customers that deployed care guidance and wellbeing, including our incentives layers saw 2x to 3x increases in utilization compared to those without combined wellbeing and care guidance functionality. And this increase in utilization led rapidly to measurable results, including a significant increase in the number of members closing gaps in care that we identified and addressed with targeted outreach through Engage. We believe the results to-date and the opportunity ahead for Engage offer early validation of our decision to collaborate closely with a partner that brings scale, a broad scope of health care capabilities and a strong strategic commitment to best-in-class consumer digital solutions. This is becoming an efficient growth vector for us and one that enables us to serve segments of the employer market that have been difficult for us to sell to in the past. With good progress on platform penetration and the successful launch of Engage in Q1, we are also focused on selling and launching Castlight Complete, which will deliver all of our personalized health navigation functionality and ecosystem integrations in a single user experience. Good uptake of Complete during our peak selling season, which runs through the end of Q3, is foundational to driving healthy top-line growth next year. We are on track for the initial launches of Complete later this year, and we are excited about the opportunity these launches represent to drive more value than ever before for our customers and users. Castlight Complete offers customers a platform through which they can assemble, integrate, personalize and deploy best-of-breed digital health solutions through a single vendor. As we talk to customers and other stakeholders, it is powerful to observe how uniformly they see the value of this platform approach to delivering health benefits. And we believe the opportunity is significant. As of Q1, just 12% of our customers had purchased third-party ecosystem solutions through Castlight. Ultimately, we think all of our customers can benefit from leveraging their relationships with us to bring their own benefit strategies to life with the most innovative solutions in the market. The pace and substance of innovation at Castlight have never been higher, and this has required high levels of R&D investment. With non-GAAP R&D expense increasing more than 40% year-over-year in Q1, our commitment to innovation is unmistakable. As we have increased R&D investments, we have sustained our march towards financial sustainability by closely managing investments in other areas. As a result, we are on track to hit our Q4 cash flow breakeven target, which will be another great milestone for the business this year. So we got off to a solid start in the first quarter of 2018 with good execution against our key goals for the period. In particular, I want to congratulate our teams for achieving the highest level of launch activity in our history in Q1, which Siobhan will say more about in her remarks. Their commitments to delivering great products that drive real results are inspiring to all of us and are already yielding the biggest improvements in user satisfaction and behavior change that we've ever seen in such a short period. We look forward to more of the same with an intense commitment at Castlight to get better at everything we do, every time we do it. I'll now turn the call over to Siobhan, who will discuss our Q1 financial results and full-year 2018 outlook in detail.

[Siobhan Nolan Mangini:]

Thanks, John. Good afternoon, everyone. And let me also thank all of you for joining us on today's call. I'll start by reviewing our Q1 results and then discuss our 2018 outlook. After that, we'll open up the call to questions. As a reminder, the Jiff acquisition closed on April 3, 2017. And as a result, Jiff's financial performance is included in our reported results starting in Q2 2017. Also, please note that all of the numbers included in the press release and on today's call are based on the ASC 606 accounting standard, which we adopted on a fully retrospective basis starting in Q1. As illustrated in the supplemental presentation available on our IR website, 606 had a relatively small impact on our financials, including no impact on cash flow. Q1 was a good start to the year, as our financial performance tracked our overall expectations for 2018 revenue, non-GAAP operating loss, and cash used from operations. As John shared, net annualized recurring revenue or ARR totaled $163.9 million at the end of Q1. ARR increased sequentially by approximately $700,000, which was in line with expectations given Q1 is a seasonally slow quarter for growth. We closed the quarter with approximately 250 signed customers, of which over 30% are Fortune 500 companies. While we are still early in the renewal cycle in 2018, we are pleased to see four legacy transparency customers migrate to the Castlight platform as we continue to improve the quality of our book of business. At the end of Q1, platform customers accounted for 81% of total ARR. Total revenue for the first quarter was $36.5 million, which increased 32% year-over-year on a reported basis. Subscription revenue was 90% of total revenue and increased 27% year-over-year. Reported revenue is a function of completed implementations, and we had a record quarter in Q1, launching 29 new customers in the quarter and 26 cross-sell products. Services revenue increased 93% year-over-year, which reflects revenues from launching customers, the Anthem local fees, as well as an approximately $500,000 onetime revenue increase associated with the development of the Anthem local product that we launched in January. As a result of this, we expect professional services revenue to decline quarter-over-quarter in Q2. Now let's turn to our first quarter non-GAAP financials. Q1 non-GAAP gross margin was 63% compared to 68% in the prior quarter and 74% a year ago. As I mentioned in our last call, we expected gross margin to dip sequentially as we invested in both professional services and our user support teams to ensure the success of the record number of launches we had in the first quarter. From here, we continue to expect gross margins to improve sequentially starting in Q2. Total non-GAAP operating expense in the first quarter was $30.7 million, which increased 19% year-over-year compared to Q1's 32% revenue growth over the same period. As in prior quarters, we continue to remain disciplined in our operating expenses, driving sales and marketing and G&A to their long-term targets by year-end. We're investing more aggressively in R&D to drive ongoing innovation. Q1 non-GAAP operating loss was $7.7 million, which reflects solid revenue and operating expense performance partially offset by the expected sequential dip in gross margin. We ended the quarter with $74.6 million of cash, cash equivalents and marketable securities. Cash used in operations was approximately $90 million in Q1, which was in line with our expectation that the majority of cash usage in 2018 would occur in Q1 due to the timing of our 2017 annual bonus payment and other cash usage that are typically front-end loaded in our fiscal year. Additionally, as a reminder, due to several customer pre-payments, cash from operations in Q4 2017 was better than expected. We continue to remain on track to be breakeven on a cash flow from operations basis in Q4. With that, I'll now discuss our outlook for 2018. We are reiterating the guidance ranges we initially provided on our February call. We continue to expect 2018 revenue between $150 million and $155 million; non-GAAP operating loss between $15 million and $20 million; and non-GAAP loss per share of $0.11 to $0.15 based on 137 million to 138 million shares. Finally, we expect 2018 cash used in operations to be in the mid $20 million range. In summary, Q1 was a solid quarter of execution across our strategic initiatives for customer growth and health, innovation and sustainability. In particular, the successful launch of Anthem Engage at scale with such positive user feedback provides us with early insight into the power of a single integrated health navigation platform. I want to take a moment to thank Castlight's employees for their hard work and to our shareholders, customers, partners and users for their support on this journey. Thank you. Operator, we'll now take questions.

[Operator:]

Our first question comes from the line of Steven Halper of Cantor Fitzgerald. Please go ahead. Your line is open.

[Steven Halper:]

Hi, good afternoon. One housekeeping question and then one bigger picture question. On the housekeeping question, what was the reason for the sequential increase in the accounts receivable?

[Siobhan Nolan Mangini:]

Yes. It's a great question, Steve. So we tend to have quite a few annual and advance billings that occur at the beginning of the year. And so what you're seeing there is just billing that happened over the course of Q1 that we expect to collect in Q2.

[Steven Halper:]

Okay. And then, could you just talk about Complete a little bit? It sounds like it's a big initiative obviously and a lot of that – the launch of Complete will drive 2019 revenue growth. But what sort of validation points do you have relative to Complete? And if you could give us any sort of characterization of the pipeline for Complete, recognizing that you're not in the sort of the heavy part of the selling season yet?

[John C. Doyle:]

Yes. Thanks, Steve. I mean, first, from a product perspective, Complete is part of an evolution from the time of the merger when we brought Castlight and Jiff together, Castlight bringing care guidance capabilities, Jiff bringing wellbeing capabilities. And we've been integrating those capabilities in a phased way. So the launch of Anthem Engage in the first part of this year offers the first proof points on a number of important dimensions. One of those dimensions is that we launched that product on time and at scale, as we said, more than 800,000 users. And the work we did there and the infrastructure that's been built for the product is the infrastructure that will support the launch of Castlight Complete. So that was super. In terms of the response from users, we're also really excited there because not only are we seeing NPS in the range of consumer grade applications, but the engagement levels we're seeing, in particular, from companies that are blending the two capabilities and adding our incentives layer are much, much higher. So, for example, in the past, we've talked about engagement levels among registered users of 30% to 40% of users returning once a quarter. With Anthem Engage, we're seeing half of registered users returning once a month, which is a major leap. And if you remember the reason that we – when we brought the two companies together, we talked a lot about the episodic nature of healthcare and the opportunity to use more frequent interactions with wellbeing functionality to bring in users and give us more opportunity to help them with their healthcare decisions. And so this was really exciting. And we see both of these, the launching of the product at scale, Anthem Engage, and the response of users as important proof points, if you will, for the launch of Castlight Complete, which is essentially similar capabilities rolled out for non-Anthem populations. And so it's a really exciting start.

[Steven Halper:]

Great. Thank you.

[John C. Doyle:]

Thanks.

[Operator:]

Your next question comes from the line of Richard Close of Canaccord Genuity. Please go ahead. Your line is open.

[Richard Collamer Close:]

Great. Just on ARR and the $164 million in the quarter, can you talk to us a little bit how maybe that came in versus your internal targets?

[Siobhan Nolan Mangini:]

Sure. Richard, it's great to hear from you. This is Siobhan. So -

[Richard Collamer Close:]

Thanks.

[Siobhan Nolan Mangini:]

– absolutely, as the growth came in on plan, Q1 tends to be a very seasonally light quarter for us. The benefits leaders are typically very focused on the one-one launches. And so growth in plan and churn very much tracking to plan, as we talked about, and the same dynamics that we've been talking about over the past year plus in terms of really seeing that in the transparency side of the business and a much secure solution on the platform.

[John C. Doyle:]

And Richard, your question gives me a chance to answer the second part of Steve's question, which I missed as well.

[Richard Collamer Close:]

Okay.

[John C. Doyle:]

So Q1, as Siobhan said, played out as expected. 2019 revenue growth, as you know, depends on our performance in our peak selling season, which is Q2 and Q3. And the way to think about that is really in kind of three buckets. So in the Anthem part of the business, we have good visibility and strong confidence in the growth of that book of business relative to what we saw last year. I think the proof points from the launch of the product give us some extra momentum, and we're excited about that. Next bucket is cross-sells. Last year, we had a really significant contribution to overall bookings from cross-selling. We expect the significant contribution again this year, although sequentially a lower contribution from that bucket because cross-sells last year were – we made many to our largest customers. And so just from an opportunity standpoint, we're in a different place. And so the variability in bookings that we're going to see over the next two quarters really comes down to execution in the pipeline for Castlight Complete. As we talked about, we're excited about the proof points that we have from Anthem Engage. We're excited about how that pipeline is developing. It's too early to say where we're going to land over the next two quarters, but certainly we're going to have a much clearer, more granular update for you on the Q2 call. And I think importantly, looking ahead, and again going back to why Castlight and Jiff merged in the first place, we're seeing a very clear, growing need in the marketplace for platform solutions that consolidate ecosystem partners, both from a contractual perspective for the customer and also from a usability perspective from the user. And so, as Complete gets launched in the second half of the year, we're really excited about where we're positioned for long-term growth.

[Richard Collamer Close:]

And then a follow-up on the ARR and the sequencing as it goes, as you grow throughout the year, and then with the emergence here of the Complete offering, is there anything different in terms of how you're viewing the ability to close deals because of the new product? Does it help you close deals quicker or is there a more -- an education process with your clients? And then as that relates to that sequencing of ARR, should we see a similar type of trajectory as last year or maybe if it's quicker, see more in the second quarter versus the third quarter?

[John C. Doyle:]

Well. So last year's second quarter – and Siobhan should add in if you need to. So last year in the second quarter, we had a major contribution from some big cross-sells to major customers. And I don't think we're going to see similar activity at least at the same level with those big customers certainly. But in terms of the way Castlight Complete relates to the rest of the products, as I was saying, you really need to think about these in three buckets. Anthem sales tend to go fastest. Cross-sells are also relatively efficient because we're building on – from a sales cycle perspective because we're building on a legacy relationship and we've been able to kind of talk about the evolution of that relationship over the course of our quarterly business reviews and so forth. So we expect Castlight Complete sales cycles look more like traditional Castlight sales cycles of the past, which tend to be a year or more. And we've got a product that we're launching for the first time. So while the Anthem Engage proof points are going to be helpful, I don't expect there would be a meaningful acceleration of those sales cycles relative to, again, historical sales cycles.

[Richard Collamer Close:]

Okay. So it sounds as though maybe some bumps sequentially in ARR here in the second quarter but maybe a bigger contribution in the third quarter?

[John C. Doyle:]

Yes, that's right. And our goal just to bring it full circle is to accelerate growth in 2019 from a top-line perspective relative to what we're headed for in 2018. And Anthem and cross-sells are the foundation there. And the opportunity to outperform really comes from that period of time with Castlight Complete sales in Q2 and Q3, as you just said.

[Richard Collamer Close:]

Okay. And then my next question would be on transparency. And good to see that you're converting people over to the platform. I think CMS, if I'm not mistaken, has talked about transparency here recently, talking about getting hospital prices online. I guess I'm interested in your view maybe on some of their comments here recently and how that potentially impacts your business positively or maybe negatively.

[John C. Doyle:]

Well, so – so there's a big difference between the availability of data and the leveraging of those data to the benefit of consumers. You can think of any other industry. Let's pick travel, for example, where the prices for hotels and airlines and so forth are visible widely. Different applications use those data to create value for users. In our case, more data about pricing and the market would be a boom. Right? Because as good as we are, more data makes us better. And because transparency is increasingly an important element but incomplete element certainly when it comes to really steering users into high-value care settings, high-value benefits, high-value programs, getting better on transparency or having other organizations outside of Castlight doing a better job themselves on transparency doesn't materially impact our relative strength in the market, which we think is – which is terrific.

[Siobhan Nolan Mangini:]

And I guess I'd just add. It's kind of a sub-point to this Richard, but we did go to market this year with three packages, of which transparency is a component, but definitely not the only thing we have. And so care guidance now includes our genius capability, which is a much more proactive approach than just passively providing transparency data. And so when I was talking about migrating folks over, which we've already seen success this year in doing this, we're migrating them over to our care guidance package, of which transparency is a component but definitely not the full product anymore.

[John C. Doyle:]

Actually I want to add something else. I mean, the whole market is shifting on the point that Siobhan just made. Right? When we were selling transparency years ago as the core offering, the bias among employers or customers was we want to help educate our employees about options, but we really don't want to get into the business of being directive about what they ought to do. In that world, transparency was the entire scope, the entire need because it was all about just giving people data. Well, the evolution of our product has been a function of the evolution of the need among employers, which is now to be much more directive to use data. And in the case of Castlight, that's claims data and search data and eligibility data, many, many sources of data to figure out what giving employees based on their health profiles and the available resources through their employers and their benefits really ought to be doing. And then targeting them with personalized communications that put those resources in front of them at the moment, they need help. And that's much more what Castlight's broad product platform is about today and a reason that, as Siobhan said, transparency is just a piece.

[Richard Collamer Close:]

And my final question, John, I think you had mentioned 12% – you gave a 12% number, 12% of customers, but third party systems through Castlight. Can you just repeat that?

[John C. Doyle:]

Yes, that's exactly right. So one of the things that we do for employers is allow them to leverage their contract with us to purchase point solutions, ecosystem partners. And we now have over 50 partners covering a range of different areas. The top selling partners – and this comes out of a state of digital health report that we issued recently. I encourage everybody to get on the website and download it. But one of the things you see there is that employers tend to be focused on things like biometric screening, diabetes, EAP and things like that. While employees have a different focus, losing weight, saving for retirement, sleeping better, reducing stress, all of these are examples of ecosystem solutions that we offer for sale on Castlight paper. So when I say 12% of our customer base has purchased ecosystem solutions through us, it's exactly that set of solutions I'm talking about. And you can see easily why we expect this area of the business to be a major growth area for us in the future. For now, it's all about broadening functionality and stickiness in customer relationships.

[Richard Collamer Close:]

Thank you very much.

[John C. Doyle:]

Thanks, Richard.

[Operator:]

And next question comes from the line of Frank Sparacino of First Analysis. Please go ahead. Your line is open.

[Frank Sparacino:]

Hi, guys.

[John C. Doyle:]

Hi.

[Frank Sparacino:]

I was hoping maybe to start, if we sort of set Anthem aside, which is obviously a key partner, any update, John, just in terms of some of the other relationships you have. And also when you look at other entities like Anthem, maybe health plan, maybe a non-health plan, but just any insight in terms of potential developments here in 2018 and how you guys are thinking about those market partners?

[John C. Doyle:]

Absolutely. I think setting Anthem aside is fine. I think it's important as a model and as an example to learn from in our business. We've been investing aggressively in our direct sales capability now for a number of years. And the market on that side of our business remains very much an innovator-dominated market from a customer perspective. Definitely from a crossing the CASM point of view, that market is not quite there yet. Whereas on the Anthem side of the business, very similar set of capabilities being sold, obviously integrated more deeply with clinical solutions in Anthem, which is really important, but we've immediately seen rapid uptake in a segment of employers that I think are squarely in an early majority population that wouldn't have been interested in Castlight previously. And what that tells us is that the evolution of the product is one element of tipping the market here, but maybe more so in our space than some others. The channel relationship is really a critical piece of getting across the CASM. And so, to your point, looking out ahead of us – and this actually I think will go beyond 2018. We're going to be looking for additional partner relationships. And I think the most natural ones would be additional health plan relationships as we build those out I think longer term. While we didn't have a very productive experience with SAP the first time around, I continue to think that the HRM vendors represent another potential channel vector in this space in the long-term. And so the answer is broadly, absolutely more interested in these kinds of relationships. For the time being, still very much focused on Anthem.

[Frank Sparacino:]

Great. And maybe one follow-up. Siobhan, when I think about the level of R&D spend today, could you help us just as we look out to the remainder of the year, obviously with Complete coming in the back half of the year, what type of trajectory we should see? But then also I'm curious as we look a little bit further out, I assume the elevated levels of R&D spend that we're seeing today will be sustained going forward. But just any thoughts around that?

[Siobhan Nolan Mangini:]

Sure. Absolutely. And it's a great question, given we continue to grow that area very aggressively, as we're driving the rest of OpEx down to their long-term target. We're still going to be growing R&D a little bit more over the rest of the year, but you are absolutely right that as we develop Complete, there begins to be efficiencies as we're driving over to a single platform that you'll start to see even towards the end of this year and the fourth quarter and then working its way through 2019. That being said, we are maintaining obviously multiple platforms right now. We have the integrated platform Castlight and then the legacy Jiff platform. We think it will take us a while to get all of the customers migrated from the legacy Jiff platform and completely off of that technology. But you can imagine ramping down costs from that all the way through 2019 until the beginning of 2020, where we hope to be able to migrate everyone over.

[Frank Sparacino:]

Great. Thank you.

[Operator:]

Your next question comes from the line of Brian Essex of Morgan Stanley. Please go ahead. Your line is open.

[Brian Essex:]

Hi, good afternoon. Thank you for taking the question. And I apologize if I missed it. Did you give a customer – like total number of customers for the quarter? And then, of those that have been new – or I guess engagement customers newly signed in the quarter, how many existing customers versus new customers ramping on Engage in terms of just trying to get an idea as you're selling in the install base, what the ramp-up spend like there?

[Siobhan Nolan Mangini:]

Sure, Brian. Let me give you a few stats and then tell me if this answers your question fully. So -

[Brian Essex:]

Sure.

[Siobhan Nolan Mangini:]

[Unknown Speaker:]

Right.

[Siobhan Nolan Mangini:]

– we did see a few Engage logos in terms of Engage contribution. I think really what will help us see the mix between the Engage – Anthem Engage channel versus the direct channel is Q2 and Q3 and what we've talked about is expecting about 40% of gross growth coming from the Anthem Engage channel and 60% coming through the direct side. Does that answer your question?

[Brian Essex:]

Got it. And – yeah. No, super. Very helpful. And then I guess given kind of the legacy install base, what is that – I get the new customary. That one is easy to understand particularly with the Anthem partnership. But I guess what is the conversation with legacy customers like to get into a more integrated offering? What can we expect for that kind of trajectory going forward? And how is that conversation materializing?

[Siobhan Nolan Mangini:]

Yes. We've put a lot of effort into that with the launch of the packages that we had at the beginning of this year. We have care guidance, wellbeing and then Complete, if you can imagine. And we've got 70%-ish by count of our customers that only have either care guidance or wellbeing. And so there is a whole strategy that's happening within our customer success teams right now of – and part of the proactive approach that I've been talking about of going out to customers, talking about Castlight Complete, and really seeing that as either a renewal opportunity or a cross-sell opportunity. And I think that there is promise there for sure. As John mentioned earlier, we saw some very, very large cross-sells happened in 2017, as we brought the companies together. So we're expecting less conversion there than what we've seen in the last year, but still that being a real opportunity for us just purely on the logos that only have one product or the other.

[John C. Doyle:]

I think one of the -

[Brian Essex:]

Got it.

[John C. Doyle:]

One of the other, Brian, important parts of that conversation is we're very focused on making sure that the migrations work well for our customers. One of the reasons that we won't complete all of the migrations until the first quarter of 2020 is that there are some customers who just don't want to migrate sooner than that. And so we're being flexible in those conversations. We think, as we launch Complete and are able to show the proof points and demo of the new products, which are super-exciting, that we're going to get – we're going to get people really comfortable with making that change. But in the meantime, we have some that prefer the extended timeline and we're absolutely willing to support that when we need to.

[Brian Essex:]

Got it. Great. And then, maybe just a quick follow-up like, how should we expect – you have a few different moving pieces relative to last year. ASC 606 one, I'm sure new product releases and amortization of capitalized software development costs playing a role there. How should we expect the trajectory of I guess gross margins particularly to track throughout the rest of the year?

[Siobhan Nolan Mangini:]

Yes, absolutely. For sure. I would say one of the things we're really proud of is just the launch activity that we had in Q1. I mentioned record number of customer launches and then just the sheer volume of lives as well, given the different components of the state as well – the California and Colorado business as well as the Anthem Engage national accounts. And so we invested very practically and aggressively into professional services as well as our customer support functions, so our call center functions, really thinking about this as just an investment in customer lifetime value, we want (38

[Brian Essex:]

Okay, great.

[Siobhan Nolan Mangini:]

In terms of the -

[Brian Essex:]

Wonderful. Thank you very much.

[Siobhan Nolan Mangini:]

Okay. Great. Are there any other -

[Brian Essex:]

Sorry.

[Siobhan Nolan Mangini:]

– questions you've had – no problem. Elsewhere, I just – you mentioned something about ASC 606. I think – is there anything else that you had questions about in terms of where that impacted the P&L?

[Brian Essex:]

Yes. I mean, maybe a little bit of color. I think it was supposed to be relatively minimal from what I understand, little bit of a tailwind in the first bit of the year and then a headwind in the tail end of the year. But it sounded like it wasn't that meaningful an impact.

[Siobhan Nolan Mangini:]

That's right. That's right. So we do have a presentation on the website that provides a lot more detail into this. But I'd say, overall, it was a minimal impact. We had a bit of a headwind actually even in Q1 as we accelerated professional services revenue into prior periods and had some level of subscription revenues that were reallocated basically across the full lifetime value of a customer. There is obviously a slight positive gross margin and operating margin impact, and that's just related to the five-year amortization of some fulfillment costs and then of commissions on sales and marketing.

[Brian Essex:]

Got it. That's helpful. Thank you.

[John C. Doyle:]

Thank you.

[Operator:]

Your next question from the line of Gene Mannheimer of Dougherty & Company. Please go ahead. Your line is open.

[Eugene Mannheimer:]

Hey, good afternoon. Congrats on a good start to the year. Just a follow-up on the last comment, Siobhan. So, are you suggesting that revenue might have looked even better if it wasn't for the SOX – or the ASC 606 impact in the quarter on the professional services line?

[Siobhan Nolan Mangini:]

I mean – so we had a fully retrospective approach. So we actually only did revenues in Q1 under ASC 606. But as we were undergoing the adoption, there was an annual fee that's in the P&L, in the materials that we attached. There is some reallocation of revenues into prior years. It's minimal. But there was a bit both on professional services as well as for subscription. It's less than 1% of revenues, just to put into perspective for 2017.

[Eugene Mannheimer:]

Okay. That's helpful. And with respect to the transparency churn, it sounds like you burned off about 2% going from 21% at year-end to 19%. Would we expect that to sort of trail off in a balanced way through the year-end or more heavy in the fourth quarter in line with the end of the benefits here?

[Siobhan Nolan Mangini:]

And this relates actually to the comment I had made earlier in terms of – our approach right now is converting transparency customers over to the platform. So we are in active discussions. Our teams are out there in the field today. They're – if we're able to get that movement in paper early, we will do so. That being said, when we look at the pattern of renewals, about two-thirds of our ARR up for renewal happens in the fourth quarter of the year. And so there is that Q4 dynamic that you're talking about. we're certainly working to try to get ahead of that and try to get these things solidified before Q4.

[Eugene Mannheimer:]

Okay. So you're trying to smooth that a little bit. Okay. And with respect to the handful of customers that put off their installs until later in the year, just to clarify, those are already included in your ARR, correct?

[Siobhan Nolan Mangini:]

Yes, they are. They were included at the end of the Q4 2017.

[Eugene Mannheimer:]

Okay. And then last question would be for me is just in terms of the cadence of the guidance. Do you expect the Q4 ramp in revenue similar to the seasonality that you saw last year as well? Is that a fair way to say it?

[Siobhan Nolan Mangini:]

Yes. And I would just say – I'd reiterate what I said last quarter. So we expected – I had said this and we've stayed (43

[Eugene Mannheimer:]

Okay. Terrific. Thank you.

[Siobhan Nolan Mangini:]

Thanks.

[John C. Doyle:]

Thank you.

[Operator:]

Your last question comes from the line of Brian Peterson of Raymond James. Please go ahead. Your line is open.

[Brian Peterson:]

Hi. Thanks for taking the question. So, first one, just on ARR. So – I think the genesis of the disclosure a few years ago was to really call out bookings momentum and how that could potentially diverge from revenue recognition. But as we see the cross-sell with Jiff and then customers migrating over to the platform, does the recognition of that ARR potentially accelerate? Because I think we were supposed to potentially use a maybe three-quarter to five-quarter timeline to see that going into revenue. Just curious if that's changed at all.

[Siobhan Nolan Mangini:]

Yes. It's a great question. It has changed, and it is a great forward-leaning metric. That's why we disclose it. This was looking at real-time where that period fails as well as notified churn. And it doesn't play through the P&L until we actually launch a customer. Historically, we've seen it around, what you said, four quarters to five quarters in advance. This year, because of the Castlight Complete dynamic, we're expecting that to elongate to about six quarters between when we announce what ARR is and what future subscription revenue would be. We do believe as soon as we get through, this is a very temporary shift of obviously reduced launches until we get the Castlight Complete integrated platform up and launched. I think what we've proven previously, and we've seen this both when we launched Action, which has now become genius, as well as Anthem Engage, is once we launch a product, it is at scale and we can launch much faster and see that ARR conversion get closer to that four-quarter to five-quarter timeframe, but we're not expecting that this year.

[Brian Peterson:]

Got it. Okay. Thanks for the clarity there. And just I think you guys gave some usage stats as it relates to the Anthem Engage channel. I'm just curious, how does that compare to the overall customer base?

[John C. Doyle:]

That's – So thanks, Brian. I mean, that's what gets us so excited is that the – the customer base usage stats that we've talked about most frequently are quarterly return visits. And those have tended to be 30% to 40% of registered users coming back at least once a quarter. And in a care guidance context, that makes a ton of sense. The typical person is getting care or consulting for care two to three times a year. So that kind of tracks. What we've seen in the first quarter with the Engage launch is half of registered users coming back monthly, which is three times – if you do the math, three times the level of engagement with Castlight that we've seen historically. And that makes a ton of sense given how deeply embedded the incentives and wellbeing capabilities are. So steps tracking, sleep tracking, food tracking, and so forth. And validates the original thesis, which was if we put these two things together, we keep Castlight top of mind. And when the rubber meets the road on a care guidance decision, we're right there to be helpful. And so we're really excited about those data.

[Brian Peterson:]

Got it. Thanks, John.

[John C. Doyle:]

Thanks a lot, Brian.

[Operator:]

I would now like to turn the call back over to John Doyle, CEO of Castlight Health, for closing remarks.

[John C. Doyle:]

Thanks, everybody, for joining us on today's call. We're really pleased with the strides we're making to deliver technology that simplifies health navigation, and we're focused on building on the foundation that we set this quarter. We look forward to seeing you at the Chardan Digital Health Conference this month and Jefferies Healthcare Conference in June. Have a super evening.

[Operator:]

This concludes today's conference call. You may now disconnect.