Castlight Health, Inc.
Q1 2017 Earnings Call Transcript

Published: 27 Apr 2017

[Operator:]

Good afternoon. My name is Mike and I will be your conference operator today. At this time, I would like to welcome everyone to the Castlight Health First Quarter Earnings 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. I will now turn the call over to Gary Fuges, Head of Investor Relations. You may begin your conference.

[Gary J. Fuges:]

Good afternoon and welcome to Castlight's conference call to discuss our financial results for the first quarter ended March 31, 2017. Joining me on the call are John Doyle, Chief Executive Officer; and Siobhan Nolan Mangini, Chief Financial Officer. In terms of the structure of today's call, John and Siobhan will offer their prepared remarks, and then we will open up the call to take your questions. Our press release was issued after close of market today and is posted on our website where this call is being simultaneously webcast. We are also providing an accompanying PowerPoint presentation that may be accessed on our website where it will also be posted after this call and made available for one week. This presentation contains forward-looking statements regarding our trends, our strategies, and the anticipated performance of our business, including our guidance for the full year of 2017. We may also discuss matters relating to our acquisition of Jiff, Inc., including, but not limited to, contributions that we expect Jiff's business to make the Castlight's overall performance, the anticipated benefits of the proposed transaction, anticipated future combined operations, products and services, and expected pro forma financial results of the combined business. All such statements are made as of today and reflect management's current views and expectations and are subject to various risks, uncertainties, and assumptions. Given these risks and uncertainties, you should not place undue reliance on these forward-looking statements. If this call is replayed or viewed after today, the information in the presentation may no longer be current or accurate. We disclaim any obligation to update or revise any forward-looking statements. We will provide guidance on today's call, but we will not provide any further guidance or updates to our performance during the quarter unless we do so in a public forum. Please refer to the press release and the risk factors included in the company's filings with the Securities and Exchange Commission for a discussion of important factors that may cause actual events or results to differ materially from those contained in our forward-looking statements. This presentation also includes certain non-GAAP metrics, such as non-GAAP gross margin, operating expenses, net loss and net loss per share that we believe aid in the understanding of our financial results. More information about our use of non-GAAP metrics and a reconciliation to comparable GAAP metrics on a historical basis can be found in the earnings release dated April 26, 2017, which is available on our website and as an exhibit to the Form 8-K filed with the SEC just before this call. In addition, please remember the close date of the Jiff acquisition was April 3. Accordingly, deferred revenue fair value adjustment discussed on this call is a preliminary estimate and is subject to change upon the completion of purchase price accounting. With that, I'll turn the call over to John.

[John C. Doyle:]

Thank you and good afternoon. 2017 is a pivotal year for Castlight. At the beginning of the first quarter, we announced our acquisition of Jiff and began working to capitalize on the combination as quickly as possible. Three months later, on April 3, we successfully closed the transaction, and our strong focus on integration activities this past quarter has allowed us to hit the ground running in Q2. Our new combined company is unique in its ability to help human resources leaders and employees successfully navigate the complexity of healthcare and well-being benefits and manage the overwhelming proliferation of healthcare vendors. Castlight is now the only health benefits platform that covers the full spectrum of well-being, healthcare decision support and benefits hub all in one complete package. With a comprehensive offering serving more than 240 companies, we believe we believe we put the foundation in place to achieve our financial objectives for the year. As we expected, Q1 was a seasonally light sales quarter for us again this year. Castlight's stand-alone ARR was flat sequentially at $121.5 million. Siobhan will review the quarter in greater detail, but revenue and cash used in operations were in line with our expectations and execution against our plans to drive cost synergies has us on track to achieve our goals related to substantially reducing our non-GAAP operating loss by the end of 2017. Beneath the Q1 headline performance, the platform initiatives we began in late 2015 are helping us with our 2017 goals of driving growth and mitigating churn. We added five logos in Q1, four of which were platform customers. Through the combination of new client additions and transparency client migrations, ARR from our platform business now exceeds 50% of total ARR, up from approximately 20% of our total ARR in the year-ago period. This is an important milestone for the company which we believe validates our platform strategy. Further, our combination with Jiff is already showing signs of delivering growth opportunities that are not reflected in the Q1 metrics reported today. We were pleased to see our first cross-sell of Jiff into the Castlight customer base in Q1 where Jiff successfully displaced an incumbent wellness vendor based on the power of our combined offering. Already in Q2, we've seen further validation of the combined offering with Walmart expanding their contract with us to purchase Jiff functionality. These are early proof points of the power of the Castlight and Jiff combination, which I'll speak to in greater detail shortly. Another key element of our growth strategy has been a greater focus on channels. Q1 is a critical period to be engaged with channel partners as customers begin evaluating proposals and programs for implementation in their next plan year. We are investing heavily in channel partnerships from strengthening our benefit consultant relationships to executing this year on our Anthem go-to-market initiative. Overall, we saw good channel support and further progress with Anthem. We are seeing our pipeline build and expect to see good sales yield from these efforts during the balance of the year. Ultimately, our sales plan for the year ties to the seasonality of our customers' typical buying cycles, which tend to drive our sales pipeline in Q1 and create good momentum for us, beginning in Q2. We are seeing this happen and we've seen increasing interest in the joint offering across our combined customer base and from partners and prospects. Based on the momentum in the sales pipeline, we expect to drive strong growth overall in 2017. In addition to driving sales growth, we are focused on reducing churn. We added five new logos and have seven customers churn in Q1. And as we've seen before, the losses were driven primarily by transparency-only customers. One critical focus for us has been to transition transparency customers to our platform solution because we believe the value equation for platform customers is strong and sticky and is reflected in the shifting balance of our ARR to platform customers, as I shared earlier. The churn in the first quarter was consistent with the seasonality and benefits buying, and our dollar churn is tracking to the 2017 expectations we previously discussed. Finally, in 2017, we are also focused on successfully integrating Castlight and Jiff to unlock the strategic value of the combined company. As of today, less than a month after the closing, our integrated leadership team is in place. We have identified and implemented the cost synergies needed to achieve our cash flow goals, and we are executing our plans to combine and evolve our value proposition for customers and users. From a product perspective, we are executing a phased integration plan that enables us to deliver a joint value proposition to shared customers and users right away with a plan to launch a fully integrated app during the first half of 2018. With the most comprehensive solution in the market, we will be giving employers the product they are asking for, a single app for employees to access the right benefit at the right time whether they are accessing care, managing a condition or focused on their own well-being. Our platform enables employers to deploy customized benefits, personalized content and communications, and drive engagement across their entire employee population. In this way, we save for employers while creating more engaged, healthier employees. In parallel with our efforts to re-accelerate growth, we have worked diligently to capture synergies from the acquisition as soon as possible. Prior to closing the acquisition, the integration team from both companies worked with the new leadership team to identify efficiencies in the combined business. We implemented all of the organizational adjustments and changes to our pro forma operating plan immediately after closing the acquisition. We also already combined the teams as well as our offices. The impacts of these changes on our OpEx run rate will be fully realized by the time we exit this year consistent with our plan to reach cash flow breakeven by the end of 2018. At a high level, our financial plan reflects prioritization of R&D investments needed to support the integration of our products and aggressive innovation of our platform. So this was an extremely productive quarter at Castlight. The team did a fantastic job on the merger integration tasks that were essential to keep us on track to achieve our combined goals. We also have clear plans to complete all merger-related work streams including full integration of our products by the first half of 2018 and achieve the cash flow breakeven milestone by the end of 2018. When it all comes together, I expect us to be a larger faster growing business with the most comprehensive health benefits platform in the market. When we get there, we will take an enormous step towards our ultimate objective which is to make healthcare work better for employers and our users. None of it is possible without the dedicated and talented employees who build and sell our products or who serve our customers and users or the folks in support functions who make our business run. I'm grateful to every one of them and for the opportunity to do what we do. With that, I'll turn the call over to Siobhan.

[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 I'll provide an update to our 2017 outlook. After that, we'll open up the call to questions. Please note that our Jiff acquisition closed on April 3. So Jiff's financial performance is not included in our Q1 results. First quarter financial results were largely in line with our expectations. At the end of Q1 2017, net annualized recurring revenue or ARR totaled $121.5 million, which is essentially flat from its year-end 2016 level. And we completed the quarter with 209 net signed customers. This seasonality of our ARR and new logo trends was expected due to the annual benefits decision making and buying cadence. Now over half of our Castlight's ARR is associated with customers on the full Castlight platform, and the attach rate for our Action platform product is now 27% across the Castlight customer base, up from 6% in the year-ago period. We strongly believe that our platform initiative is a key long-term driver of the business. Total revenue for the first quarter was $27.7 million, which increased 22% year-over-year and was in line with our expectations. As a reminder, we shared previously that we expected Castlight's first quarter revenues to be down sequentially given Q4 2016 included $1.7 million of non-recurring revenue and we incurred seasonally higher levels of churn at the end of the benefits year. 93% of total revenue was subscription-based. Reported revenue is a function of completed implementations, and we had a record number of customer deployments over the course of the first quarter. In particular, we built our newest products to scale, and we are now consistently seeing Castlight customers launch with multiple products simultaneously. Castlight had 65 total customer deployments in the first quarter including 18 new customers and 13 Action launches. The 18% year-over-year increase in services revenue was primarily driven by increased launch activity. Now, let's turn to our first quarter non-GAAP financials. Q1 non-GAAP gross margin was 74%, towards the high end of our 70% to 75% target range and up significantly from 63% in the year ago period. This improvement is a product of the efficiency gains associated with the investments we made last year with scaled and automated launch operations. However, we remind you that the Jiff transaction will initially result in lower gross margin for the combined company, as Jiff is in an earlier stage of launching clients during their rapid growth phase. We continue to expect gross margin to increase over time with scale just as they did with Castlight's legacy business and to reach the same long-term target range of 70% to 75%. Total non-GAAP operating expense was $26 million in Q1, down 5% year-over-year. We experienced a 15% decline in sales and marketing expense as our increased emphasis on channel partners over the past year enabled us to achieve greater efficiencies in sales and marketing. These savings were partially offset primarily by seasonal G&A expenses and one-time costs. Non-GAAP operating loss was $5.5 million in Q1, a 57% improvement year-over-year. Cash used in operations was $10.9 million including more than $4 million in one-time transaction costs associated with the Jiff deal and seasonal working capital needs. This was consistent with our expectations and led to $103.2 million in cash and marketable securities at the end of the first quarter. As Jiff's financial performance was not included in the Castlight Q1 results, I'll provide some preliminary unaudited headline metrics to assist with comparing the combined companies' performance going forward. In Q1, Jiff ended the quarter with $19 million in ARR and generated approximately $3.7 million in revenue. Please note that going forward, we do not plan to break out Castlight and Jiff's results on a quarterly basis. With that, I'll turn to our outlook for the full year 2017 and second quarter. We previously provided 2017 non-GAAP pro forma revenue guidance of $138 million to $142 million, when we announced the Jiff deal. Now that the transaction with Jiff is closed, I will also provide our 2017 GAAP revenue outlook for the combined company based on Jiff's inclusion in our financial results starting April 3. Please refer to the presentation posted on the Investor Relations section of our website for details. For the full year 2017, we expect GAAP revenue for the combined company to be in the range of $132 million to $136 million. This GAAP revenue guidance can be reconciled towards non-GAAP pro forma and revenue range above by adding the $3.7 million in revenue that Jiff generated in their first quarter, as well as the approximately $2 million impact in 2017 related to the write-down of deferred revenue associated with purchase accounting. Based on our expectations of $132 million to $136 million in GAAP revenue in 2017, we expect full year 2017 non-GAAP operating loss to be in the range of $31 million to $35 million which exclude Jiff's first quarter operating loss. This translates into a non-GAAP net loss per share of approximately $0.24 to $0.28 based on approximately 125 million to 127 million shares. We assume sequentially smaller operating losses starting in the third quarter of this year as a result of the progress we made in the first quarter identifying synergies from the Jiff transaction. Additionally, we expect to cut in half the combined companies' non-GAAP operating loss when comparing Q4 2017 to pro forma results for Q4 2016. Finally, we expect cash used in operations to be in the mid-$40 million range for the full-year 2017, including approximately $15 million in transaction cost. We remain confident that the combined company can reach cash flow breakeven by the end of 2018 with at least $60 million of cash on the balance sheet. Given Q2 will be our first quarter reporting financials in combination with Jiff, we wanted to provide a bit more detail on our expectations for the second quarter and incorporate the deferred revenue write-down outlined above. Going forward, we will return to our practice of providing annual guidance. For the second quarter of 2017, we expect quarterly revenues for the combined company of approximately $31 million, and non-GAAP operating loss of approximately $13 million, both with the level of variability. This incorporates more than $1 million of the deferred revenue write-down in the second quarter of 2017. In summary, Q1 financial performance was in line with our expectations, and we continue to make great progress with our platform initiatives. In addition, we continue to improve our ability to implement clients which improves our ARR conversion. With the close of the acquisition of Jiff, we believe we're on a track to generate a combination of a strong growth and progress towards driving to cash flow breakeven. With that, I'll now turn the call over to the operator for questions.

[Operator:]

Your first question is from Brian Essex from Morgan Stanley.

[Brian L. Essex:]

Hi. Good afternoon and thank you for taking the question. I was wondering if you could talk a little bit about Jiff and expected performance just from a seasonality perspective so that we have a little bit of insight with regard to fine-tuning our models for the rest of the year.

[Siobhan Nolan Mangini:]

Absolutely, Brian. This is Siobhan. Thanks for the question. I think one of the great things about the Jiff business model is incredibly similar to Castlight. So we're selling into the same buyer. They tend to see the same benefits year seasonality as it pertains to purchase decisions as well as implementation. So in terms of revenue contribution which I think is what your question is, they tend to see large amount of implementations in the first quarters as well as in the fourth quarters of a given year and that's what we really saw over this past quarter with Jiff and $3.7 million in revenues that they have.

[Brian L. Essex:]

Okay. And then I guess a follow-up in the first quarter's sequential decline in subscription revenue, if you could offer a little bit of color around what the dynamics were around that and how much were seasonal versus maybe attributable to those transparency only customers.

[Siobhan Nolan Mangini:]

Sure. So, there is a high degree of seasonality in terms of effective churn in our business. And so this is typically around the end of the benefit year is when our customer base tends to make decisions around terminations and churn. And so, we were expecting to see going into the first quarter the headwinds from the churn that we talked about in the last call and what we had seen in 2016. And so that was the headwind we were incurring as well as we had had $1.7 million in one-time revenues that we had had in the fourth quarter of 2016. And so it really was as we talked about the trends that we've seen in the churn in our business tends to be smaller customers, transparency-only customers and very much was in line with our expectations and was incorporated into the guidance that we shared last quarter as well.

[Brian L. Essex:]

Great. That's helpful. Thank you very much.

[Operator:]

The next question is from Brian Peterson from Raymond James.

[Brian Peterson:]

Hi, guys. Thanks for taking the question. So, just maybe a follow-up on Brian's question a bit related to Jiff. For those deals that we're talking about today with customers or opportunities that you could book maybe in the next few months, are those potentially revenue opportunities in 2017 or would that be in 2018? And how should we think about the revenue uplift for a company like Walmart versus what their existing customer economics might look like?

[Siobhan Nolan Mangini:]

Yes. Thanks, Brian. So in terms of the sales that we're seeing, Jiff has implementation timelines anywhere for effective two months up to, for larger and more complex clients, six months to nine months implementation timeline. So a high degree of variability very similar to Castlight. And so, for the most part, sales that we're seen with Jiff now are contributing to 2018 revenues now that we're in the second quarter. In relation to the Walmart question, we're really excited to be seeing early momentum with cross-sells and to have a customer like Walmart purchasing Jiff. We obviously have a high degree of economics with Walmart, and that's been disclosed in the past and this will be incremental. This was a Q2 deal, so we'll be reporting that in our Q2 ARR.

[Brian Peterson:]

Okay. Got it. And maybe just a question ore broadly on the platform versus transparency. Could you just remind us what is the delta in the PPM or customer level economics for somebody that's on a platform versus just transparency so we can kind of try to keep track of that going forward? Thank you.

[Siobhan Nolan Mangini:]

Yes. So we're in the midst. I think we've talked about this in the past – our legacy transparency business is highly variable. We typically have three-year contracts. And so, when we look back to customers in 2013 and 2014, there was a high degree of variance with customers on the transparency business. I'd say as we've seen the migration over to the platform, we have seen incremental economics. I think a point – data point that we shared in the past is in 2016, we actually saw a 20% increase on revenue proceeds and that really is as we're migrating more and more customers over to the platform and on multiple products, we're seeing that PMPM lift.

[Brian Peterson:]

Great. Thanks, Siobhan.

[Operator:]

The next question is from Richard Close from Canaccord Genuity.

[Richard Collamer Close:]

Great. Thanks for the questions. I think you talked about the deployments in the first quarter record number. I think the number was 65, and then there were some additional statistics following that. Can you just go over that again, please?

[Siobhan Nolan Mangini:]

Sure. Absolutely. I'd be happy to. So, we had 65 product deployments, 18 new customers got deployed over the course of the quarter. And what I think that points to and that we're really proud of over the past year is that we've now been able to launch customers on multiple products. So, as we've been moving over to the platform, and we're seeing the attach rate across multiple products grow, we're actually have invested in the infrastructure to launch a customer now on multiple products at the same time which is where we saw such growth in terms of the number of launches this past quarter.

[Richard Collamer Close:]

Follow-up question would be on the second quarter data points that you provided as your guidance. You said $31 million. Just want to be clear. Is that GAAP or the non-GAAP or pro forma number?

[Siobhan Nolan Mangini:]

That is GAAP.

[Richard Collamer Close:]

Okay.

[Siobhan Nolan Mangini:]

That is including our expectations around Jiff's contribution given the deal closed on April 3, and it also incorporates the deferred revenue haircut that I spoke about on the call.

[Richard Collamer Close:]

Okay. And then just as we think about the 2017 guidance and you were talking about your margin performance in the first quarter, you expect that to go down in the remaining quarters of this year because of the Jiff acquisition. Is there any ranges that you can provide us in terms of where you see the gross margin level being now with Jiff? And so, I'm just trying to get a sense on how we should think about gross margins and operating expenses now with the acquisition.

[Siobhan Nolan Mangini:]

Sure. I can provide a little more color there. So, in terms of gross margins, we do expect to see the combined company gross margins dip below the long-term range that we've been in for the past couple of quarters, the scenic drop below that 70% to 75% range. We think that we'll be able to climb back up to that long-term range in 2018, and I think, our expectations are you're going to see the same type of progression that you saw with Castlight as a stand-alone business and that we should be able to do that for Jiff. When you think about OpEx and I think that was the second part of your question, you can imagine that G&A is an area that there's natural synergies for the combined business and that we should start to see progress there in the second half of the year, and again, marching towards our long-term range of 8% to 12% of revenue by 2018. Sales and marketing is another area where there are opportunities for synergies. I mentioned we sell into the same buyer. We both have channel relationships that we should be able to leverage as well. And then, as John mentioned on the call, we will continue to invest heavily in R&D. We are very early in terms of the development of this health benefits platform and you'll continue to see aggressive investment in that area.

[Richard Collamer Close:]

Okay. Thank you.

[Operator:]

The next question is from Robert Jones from Goldman Sachs.

[Robert Patrick Jones:]

Great. Thanks for the questions. On the churn issue, I guess just wanted to get a better understanding of how you're thinking about this longer term. Is the majority of churn something you expect to cycle through at some point? Is the client base kind of the more original client base makes the decision to either stay and move on or to move off the platform, or is this something that's probably we should think about as just more normal course of business?

[John C. Doyle:]

Thanks, Bob. Certainly very much the former, and we've spent a fair amount of time on this in the past, and I would reiterate comments that we made in particular on the Q1 call where we dug into this issue quite a bit. So as you were suggesting in your question, our portfolio customers now is balanced between transparency-only customers and platform customers. And we do believe that the platform product offers a very strong and sticky value proposition to the customer and believe that what makes a lot of sense as we renew these transparency customers is for them to shift over to the platform where they continue to get the benefits of the transparency product but also then access to our well-being and healthcare navigation solutions as well. We certainly have additional transparency customers to work with on renewals during the balance of 2017, but expect to be through most of that in the early part of next year, and then expect to see a significant decrease in churn.

[Robert Patrick Jones:]

Got it. And then I guess, John, just thinking about Jiff, some of Jiff's channel partners, curious if you could maybe just give an update on any early conversations or strategies maybe that you guys have thought through in leveraging folks like Towers Watson and Mercer from the Jiff side.

[John C. Doyle:]

We've had a bunch of conversations there. As you know, channels are a big focus for the business. On the Castlight side, the emphasis has definitely been on our alignment and partnership with Anthem, which we're making great progress with. And then, as we combine with Jiff, to your point, they've done a great job historically building close relationships in the consultant community. And so, Derek and I have been meeting with their partners and expanding on those relationships, and we've got leadership in place to expand those dialogues and feel good about the support we're getting in the market. As we think about the growth that we can drive for the balance of this year and then into 2018 all of those partners, we think are going to make a significant contribution.

[Robert Patrick Jones:]

Got it. Thanks so much.

[John C. Doyle:]

Thanks, Bob.

[Operator:]

The next question is from Jeff Captain from Stifel.

[Jeff Captain:]

Hey, guys. Thanks for taking the question. Just want to follow up on the partner channel, I guess. Just curious if you have any update around the SAP relationship.

[John C. Doyle:]

Sure, Jeff. So we had hoped I think as you noted to get the SAP relationship completed in the first half of this year, we've pushed that out. Today, we extended the timeline that we have to get that relationship solidified to the later part of this year. And so, teams are working actively on doing that. In the meantime, as I was just saying, the focus for the business and we really just scratched the surface here, is driving this relationship with Anthem which incorporates elements of Castlight's legacy products as well as the products that Jiff brings to the combined business. And we see an enormous opportunity there with Anthem where our strategic alignment is incredibly strong. And so, that's really where the focus is in addition to those consultant relationships that I just talked about. And we feel like we're setup well from a channel perspective to drive growth in the foreseeable future.

[Jeff Captain:]

Got it. Great. Thanks a lot.

[Operator:]

The next question is from Jamie Stockton from Wells Fargo.

[Jamie Stockton:]

Yes. Good evening and thanks for taking my questions. I guess maybe good afternoon there. I guess maybe first on Jiff. The Walmart deal, is it correct to assume that that applies to the $25 million kind of burnout target from an ARR standpoint for them?

[Siobhan Nolan Mangini:]

Yes. It does.

[Jamie Stockton:]

Okay. And then maybe just as far as the environment is concerned, maybe not recently, but especially kind of late last year, early this year, some other benefit technology companies were talking about repeal and replace noise and it having some impact on benefit decisions the companies were making. Can you talk about whether or not you guys have seen any of that in the marketplace as when repeal and replace seem to fold, did the marketplace seem to accelerate, just any color there would be great.

[John C. Doyle:]

Sure. And then – in my new role, as you can imagine, I'm spending a lot more time with customers and partners in the field and talking about range of topics. It's actually not the AHCA and the repeal and replace dynamic earlier in Q1 really wasn't at all a focus of those conversations. Folks are much more focused on things that have been longer-term issues that I think are just becoming more and more acute. So, obviously, escalating costs, an explosion of healthcare and healthcare technology vendors and programs that they'd like to deploy but that can get very confusing and overwhelming to manage for their employee base. And just the amount of money, frankly, that's being wasted and spent on inefficient and poor quality of care, in many cases. And fortunately, for us, those are the issues that I think we're going to – we address head on with the combination of Jiff and Castlight, and so that's been the focus of these conversations, much more so than the political environment.

[Jamie Stockton:]

Okay. That's great. And maybe just one more quick one as a follow-up to Richard's question just to make sure that everybody is modeling this the right way. Does the $31 million revenue guidance for Q2 being a GAAP number mean that you guys aren't – you're just not going to talk about a non-GAAP revenue number and nobody needs to model a non-GAAP revenue number, you'll make some adjustment below the revenue line for the deferred revenue?

[Siobhan Nolan Mangini:]

That's the intent, exactly.

[Jamie Stockton:]

Okay. That's great. Thank you.

[John C. Doyle:]

Thank you.

[Operator:]

The next question is from Frank Sparacino from First Analysis.

[Frank Sparacino:]

Hi, guys. Just two questions from me. First, Siobhan, on the ARR for Jiff, the $19 million, can you tell us what the year-ago figure was?

[Siobhan Nolan Mangini:]

I don't actually have that. I'm sorry. I can tell you at the of 2016, they were at $17 million in ARR. So there's a $2 million increase over this past quarter.

[Frank Sparacino:]

And secondly, maybe this is best for John. In terms of the two companies coming together now, if I look at the org chart, we have some fair number of new faces in some fair – in some important roles particularly on the sales side of things. So, John, wanted to get your sense as to how much – just how much disruption has there been, will there be sort of in the next couple of months and sort of how you feel right now about the sales side of things.

[John C. Doyle:]

Yes. Thanks. So headline, I feel great about where we are on the sales side. I think your question suggests – there's no question that when you bring two companies together and in particular merge leadership teams, you're going to have some amount of people learning to work with each other and bringing in new practices and so forth. But we really have blended the teams and made a very concerted effort to ensure that our top folks in all of the teams around the business are – that we're communicating regularly, that they're feeling excited about the business, excited about the go-forward team and the opportunity that we've created by combining the businesses. I think also in the case of each of the individual leaders including Mike Leonard on the sales side, very experienced people who know this healthcare and healthcare technology ecosystem extremely well. And so I think in addition to all of the efforts that we've been making to get folks working together as quickly as possible, we also have the benefit, as Siobhan was alluding to earlier, of having worked in a very much overlapped ecosystem in terms of partners and customers and buyers, and so much, much less disruption in our sales motion than you might otherwise imagine. So, I'm really excited about where we are and optimistic about the balance of the year.

[Frank Sparacino:]

If I could just throw in one more, on the Walmart side, I'd be curious if you can give us some details on the competitive environment there and maybe how that sales process went from kind of start to finish and what you think maybe that tells you as you look at cross-sell opportunities sort of going forward.

[John C. Doyle:]

Let me – so, I'll answer really the second part of that question. And I think a couple of the cross-sells we saw in Q1 are consistent with a pattern that's emerging in the pipeline and that I think we'll see over the balance of the year. Our hypothesis when we merged Jiff and Castlight was that the combination of wellness and healthcare decision support and the benefit hub functionality available in one relationship would not only be a big benefit to employers from an administrative and value perspective, but also a much better experience for end users and, therefore, more engaging and effective at the end of the day, and controlling the escalation of cost and driving benefit utilization. And the cross-sell dynamic is validating that, for sure. We saw a really strong build of cross-sell pipeline in the first quarter. We're seeing deals advancing pretty rapidly here in the second quarter, and that's really gratifying. Having said that, as I've said multiple times, stretching back more than a year, we're at the very beginning at Castlight of an enormous long-term opportunity. We have 240 customers but ultimately, there are 1,000s of large businesses in the United States that could derive a lot of value from the products we build. And so from that perspective, while I'm pleased with the cross-sell activity, we're certainly going to expand those relationships aggressively. We are continuing to focus from a strategic perspective on driving new logo acquisition because, ultimately, strategically, we think that platform, that large installed base over time is essential to achieving our long-term goals. And so as we move forward through the year, we really are focused on both.

[Frank Sparacino:]

Thank you.

[John C. Doyle:]

Thanks, Frank.

[Operator:]

The next question is from Steve Halper from Cantor Fitzgerald.

[Steven Halper:]

Yes. Hi. Thanks for taking the question. I just wanted to clarify the non-GAAP earnings guidance or loss per share guidance. Will that include a deferred revenue adjustment?

[Siobhan Nolan Mangini:]

Yes. So it will be GAAP revenue and then our operating expenses are non-GAAP and that's really taking into account transaction costs, stock-based compensation and the like. But it will take into account the deferred revenue haircut.

[Steven Halper:]

Okay. And how long will we see the deferred revenue add-back?

[Siobhan Nolan Mangini:]

It will be primarily through 2017, and the majority, as I mentioned is actually in the second quarter of this year. And then, we'll see a little bit in the third quarter and the fourth quarter of this year.

[Steven Halper:]

Okay. So, GAAP revenue and the deferred add-back. Okay. So just when you think about the Jiff combination, you talked a little bit about some gross margin pressure at least in the short term. But when you think about cost rationalization between the two companies, can you break down between cost of goods sold or gross – and operating expenses where the synergies would come from over time?

[Siobhan Nolan Mangini:]

Sure. So when we think about synergies, where we expect to see the most is really in operating expenses, as I mentioned. We were – I think we've made great progress. One of the many things that we did this past quarter was really set the combined business up to capture those synergies in the second half of this year, and where you're going to see the most savings is, as you would expect, G&A. As I mentioned to some degree in sales and marketing, and this is, as I mentioned, we're selling into the same buyer and have a similar target market, so both sales and marketing efforts and then, I would say less so on the R&D side. When it comes to servicing customers, Jiff is still very much in its early days of launching the servicing customers. And so, we're going to continue to invest there and get that infrastructure into place.

[Steven Halper:]

Great. And how long does that take in terms of integration process?

[Siobhan Nolan Mangini:]

Well, I think it will take us through the balance of this year. Our hope is that we'll be in the long-term target range of 70% to 75% gross margins in 2018.

[Steven Halper:]

Great. Thank you so much.

[John C. Doyle:]

Thanks, Steve.

[Operator:]

The next question is from Charles Rhyee from Cowen & Company.

[Charles Rhyee:]

Yes, hey, thanks for taking the questions. Just wanted to clarify just real quickly on the deferred revenue, again. So when you talked about the second quarter being the biggest amount, is the $1.9 million that you kind of used pro forma for the first quarter, is it greater that amount – is that the right number to use, or is it more or less than that number?

[Siobhan Nolan Mangini:]

It is less, so it's over $1 million will be – is our expectation, I would say. We just closed the deal obviously on April 3, but our expectation is the haircut will be over $1 million in the second quarter. And then, you can imagine the balance of that around $2 million haircut being split over the remainder of the year in the third quarter and fourth quarter and a tiny amount in 2018.

[Charles Rhyee:]

Okay. That's helpful. And then you talked about 93% of your business subscription revenue. Is the other 7%, the variability that – what drives the variability for the other 7% for you? And then is that similar for Jiff? Like, how much visibility does Jiff have into their revenue for the full-year?

[Siobhan Nolan Mangini:]

Yes. So maybe I'll start there. I think one of the highly complementary things about our businesses is we both have SaaS subscription business models with the same seasonality. And so we tend to have, as I mentioned, similar implementation timeframes. And so, when we're thinking about revenue and revenue visibility, we do have a high degree of visibility into our businesses because of the SaaS subscription model. When you're talking about the other 7% of revenues, that's really it's professional services items. So, this is the fees that we're charging to implement and launch a customer, have communication services to make employees aware of the offering. And that is very much tied to the launch activities of the business. And so, it's similar in terms of its visibility and predictability to the SaaS subscription model. It just is shorter in tenure because it's actually linked to the initial implementation and subscription of the initial contract.

[Charles Rhyee:]

Okay. That's helpful. And then, John, you just mentioned earlier driving logo acquisition is a key focus for you. I'm just curious how – when – I guess the question is that as your channel partner relationships gain more traction, how much direction or how much ability do you have to really drive logo growth if it's sold through a channel partner? And I guess another way to ask the question is what do you expect sort of your mix in terms of sales – I know Anthem is just ramping up, but as we think out a little bit longer between your channel partners and through consultants, what do you kind of think the mix will be between direct sales and the channel partner sales? Thanks.

[John C. Doyle:]

Thanks, Charles. I think it's important, first of all, to describe again what – how our channel relationships work because they're really I would say robust lead generation sources in most cases where we're still taking a very direct role in the sales process itself which I think is critical for making sure that we are doing a complete job communicating value proposition and tailoring our solution for individual customers. We're also, obviously, partnering with those channel folks, consultants, and health plan partners in the customer dialog so that their – as they're building strategy for the customer, we are right there with them making sure that the technology solution is supporting that strategy. But it's not as if there's a large – we expect a large percentage of the business to just be order taking on our end and the channels actually out there doing the selling. As the relationships evolve over time, we may see more of the effort being undertaken in the channel. But for the foreseeable future, there's big involvement from the direct team in almost every deal. Now, that said, to answer the question about balance, I think very soon the large majority of our deals are going to be channel deals, whether through Anthem or the consultants. That's essentially the pattern we're already beginning to see, and it presents a much more comprehensive and coordinated solution to the customer. And so I think it's in everybody's interest to have that alignment working well, starting in the sales cycle.

[Charles Rhyee:]

Okay. Thank you. That's helpful. Thank you.

[John C. Doyle:]

Thanks. Thanks.

[Operator:]

The next question is from Richard Close from Canaccord Genuity.

[Richard Collamer Close:]

Yes. Thanks. John, you talked about the Walmart cross-sell with Jiff. Are there any proof points in terms of cross-sell of Castlight into the Jiff customer base, or can you give us some description of how those conversations are going?

[John C. Doyle:]

Sure. So no examples from Q1. And as you know, Jiff has a much smaller installed base than Castlight does. And so I think the nearest-term opportunity in terms of growing at our scale is definitely the reverse situation. That said, as we're blending the sales teams, I said we're hitting the ground running in Q2, and what that means is we're enabling the teams to sell and support each other in sales cycles for both products in each other's customer bases. One exciting thing that came out of not only one of the examples in Q1 but I think we're seeing more and more in these cross-sell opportunities with Jiff and it's worth mentioning is that historically Castlight has not really had access to the wellness wallet in the market. And with Jiff as part of the overall solution, when we go in now and pitch either Jiff alone or Jiff and Castlight together, one of the things we're doing and have done is displacing existing wellness vendors, in particular because with this combined solution, we're now the only vendor out there that's able to power that wellness experience and personalize it using claims data which, over time, I think employers agree is going to be a huge differentiator for us. And so important part of that cross-sell story. So thanks for the question.

[Richard Collamer Close:]

Ok. Thank you.

[Operator:]

And the next question is from Jamie Stockton from Wells Fargo.

[Jamie Stockton:]

Yes. Just one quick follow-up on that comment you just made, John. If we looked at your customer base today, is there a ballpark percentage or number that you could tell us have an existing wellness solution that is comparable to Jiff that you feel like could be displaced if you make the right pitch?

[John C. Doyle:]

Right. So wellness is a very highly penetrated category. So the large majority of our customer base offer a wellness solution to their population. And, again, I think as you kind of dig in to what we're observing in the pipeline, and I mentioned that the kind of great reception we're seeing to Jiff in our portfolio, I think that's a reflection of the fact that these buyers, almost all, have some kind of budget allocated to the space and have been looking for more effective ways to deliver wellness. Jiff had already been having a lot of success in those head-to-head competitive situations. And I think now with the addition of the power of our data infrastructure and platform and the promise of combining these two products over time, and I think consolidating healthcare decision support and wellbeing and healthcare navigation from a roadmap perspective it's just an incredibly powerful value proposition that lands right on top of what a lot of market is thinking about today. And so, I think we're really well-positioned on that wellness competitive front.

[Jamie Stockton:]

All right. Thanks.

[John C. Doyle:]

Thanks a lot.

[Operator:]

There are no further questions at this time. I will now turn the call back over to John Doyle, CEO, for closing remarks.

[John C. Doyle:]

Thank you. Thanks, everyone, for joining us today. I think as we've talked about on the call, we're in a terrific position to make 2017 absolutely Castlight's best year yet. We appreciate your interest in Castlight and hope to see many of you at upcoming investor conferences in May and June. Have a super day.

[Operator:]

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