Castlight Health, Inc.
Q3 2016 Earnings Call Transcript

Published: 3 Nov 2016

[Operator:]

Good evening. My name is Ruth, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Castlight Health's Q3 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. Seth Teich, Vice President, Financial and Corporate Planning, you may begin your conference.

[Seth Teich:]

Good afternoon and welcome to Castlight's conference call to discuss our financial results for the third quarter ended September 30, 2016. Joining me today are Giovanni Colella, Castlight's Co-Founder and Chief Executive Officer; and John Doyle, our President and Chief Operating Officer. Our CFO, Siobhan Nolan Mangini, will not be on the call today, as she is on maternity leave with her two newest additions to her family. We're all extremely happy for Siobhan and her family, and look forward to having her back with us shortly. In terms of the structure of today's call, Gio and John will offer their prepared remarks, and then we will open up the call to take your questions. Our press release was issued after the close of market today, and is posted on our web site where this call is being simultaneously webcast. We're also providing an accompanying PowerPoint presentation that may be accessed on our web site, 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 2016. These statements are made as of today and reflect management's current views and expectations, and are subject to various risks, uncertainties and assumptions. 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 our any forward-looking statements. We will provide guidance on today's 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 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. A reconciliation to comparable GAAP metrics on a historical basis can be found in the earnings release dated November 2, 2016 which is available on our web site and as an exhibit to the Form 8-K filed with the SEC just before this call. With that, I'd like to turn the call over to Gio. Gio?

[Giovanni M. Colella:]

Okay. Good afternoon and thank you, Seth. Thanks, everyone, for joining us on the call to review our third quarter results. Revenue and profitability for the third quarter were consistent with the direction we provided on last quarter's call. We are very pleased that Castlight reached $100 million annualized revenue run rate during the quarter. This is a significant milestone for the company that I'm incredibly proud of, and we believe we have only scratched the surface of our long-term potential. We also reduced our operating loss to its lowest level in four years, as we continued to make significant progress against our goals of bringing our business to cash flow breakeven by mid-2017, which is now just a few quarters away. We believe we remain on track to deliver against our financial guidance for 2016 and I remain confident in Castlight's future. As we have discussed previously, 2016 is a transition year for Castlight as we focus on putting in place the foundation to drive growth from $100 million to $500 million in revenue. This year has been about evolving our business to address the needs of mainstream buyers. Our top-two priorities in this regard have been to establish a blended sales model that leverages channel partners to drive the front part of the sale process and to build upon our leadership position in transparency with the successful expansion of our health benefits platform. With respect to our new channel-led sales strategy, we have consistently said that it would take time for us to ramp this initiatives, but we are very confident that we're moving in the right direction. Over the last few quarters, we have learned a lot in collaboration with Anthem. We increasingly expect this relationship to benefit our business tremendously. We also have continued to invest in expanding set of relationships with large consulting firms and regional brokers, that are helping to broaden awareness of the Castlight brand and the future set. Finally, we expect that our partnership with SAP will offer another potential source of growth in the future. During the third quarter, we were pleased to see increased velocity in new customer logos. We added 14 net new customers, including new Fortune 500 customers, such as Kraft Heinz and Tractor Supply. Our continued traction with some of the largest companies in the U.S. is evidence of the strength of our technology and the power of our vision. Increasingly, we are seeing customers turn to Castlight as the health benefits platform that they want to expand from in the future. So far this year, more than 80% of our new customers have subscribed to our full platform solution, which is a combination of our employer-facing functionality, Castlight Action, with our core transparency capabilities. We believe there's a need among large employers to put in place a comprehensive, cloud-based platform that addresses a broad range of health benefits challenges, including low employee engagement and underutilized employer health benefits. The market is highly fragmented today, with a dizzying number of point solution providers under the umbrella of healthcare, benefits, wellness and related areas. We increasingly hear from customers that they do not want to deal with 10, 15 different vendors and neither do their employees. We believe the ultimate winners in the employer benefit market will be the player that offers a wide range of solutions that streamline and simplify healthcare for employers and the employees. Today, Castlight has built a natural platform to drive utilization across multiple solutions. We are already seeing this, as we have introduced new offerings such as Action and Elevate, and we're highly focused on further expanding our offerings to drive even higher levels of engagement and program utilization for our customers. We also believe that we have a substantial data advantage over other players in the market. Castlight's data spans all major medical carriers, pharmacy benefit managers, and a broad range of other sources, combined with HR and search data. In addition, we're building out a powerful distribution model that will allow Castlight to quickly bring to market new solutions that integrate with and enhance our health benefits platform. I want to thank all our customers, partners and employees for their dedication to Castlight. We remain laser focused on driving innovation in the health benefits industry, and helping to improve the quality of care employees receive and at the same time, helping employers better manage one of their most significant and fastest-growing areas of spend. With that, let me turn the call over to John.

[John C. Doyle:]

Thanks, Gio. To start, we are beginning to see clear results from several key initiatives that we have prioritized over the last year to improve Castlight's business fundamentals. Overall, we think our foundation for long-term growth is stronger than ever. To recap some of the highlights briefly, new logo velocity is improving with growing leverage from channel partners. A large majority of new customers are buying our full platform solution. Implementation timelines are condensing. We hit our long-term target for non-GAAP gross margins ahead of schedule in Q3. Our non-GAAP net loss in the third quarter was 66% smaller than in the year-ago period. And, we remain on track to reach cash flow breakeven in the middle of next year with more than $100 million in cash on hand when we get there. As fundamentals improve, we are also aiming to drive higher levels of ARR growth. We think we are headed in the right direction on that front as well. As Gio said, we added 14 net new logos during the third quarter, which was a significant jump from four net new logos added in the first six months of the year. We saw good success signing mid-size customers during Q3, which is a key customer segment for us to penetrate over time. Overall, Castlight is steadily building our business and now has 209 customers and annualized revenue run rate above $100 million, and ARR of $118 million. One point to emphasize again, as we did on our Q2 call, is that as our channel strategy matures the seasonality of new sales that we've seen in past years is shifting. Our sales cycles are increasingly linked to those of our channel partners, which is leading to reduced concentration of new bookings in any one quarter relative to the others. The bottom line is that quarter-to-quarter bookings will fluctuate. We expect to see more enterprise deals with large employers during the fourth quarter and we feel good about our sales momentum as we finish 2016 and begin planning for 2017. Of the channel relationships we've built so far, our partnership with Anthem has the greatest potential to drive growth in the near term. During 2016, we devoted significant R&D capacity to the development of a white label medical cost and quality estimator solution that we began rolling out to Anthem customers in October. This first wave was quite successful. Over the next two years, we expect to deploy this solution across Anthem's entire commercial book of business. As we have described in the past, the primary growth opportunity for Castlight in our collaboration with Anthem does not come from medical cost and quality transparency. For us, the success of the Anthem relationship from a growth perspective is tied to sales of our more comprehensive health benefits platform to Anthem customers. This channel partnership is showing promise and we're working with Anthem to extend it further. For Anthem's national customers, we expect our health benefits platform solution will soon be packaged with Anthem's overall value proposition at the initial point of sale or renewal, rather than being sold as a separate upsell from Castlight. In other words, our intention is for the Castlight platform to be marketed and sold as an Anthem employee engagement offering starting in Q1 2017. We think this streamlined go-to-market approach will meaningfully improve pipeline conversion and platform adoption among Anthem's large employer customers. Outside of the Anthem channel, we will continue to market and sell Castlight independently as before. Alongside our work to drive channel leverage, from a product standpoint, we have placed enormous focus on driving greater value for customers from their data. Specifically, our health benefits platform uses advanced analytics and personalized digital marketing techniques to segment employees by their healthcare needs and connect them with the right care at the right time. In this way, we enable employers to drive greater utilization of the benefits and programs that make up the core of their benefits strategy. Products like Castlight Action and Elevate for behavioral health are great examples of this. We have launched more than 10 customers on Castlight Action, and engagement with targeted communications has been well above benchmarks. Most importantly, many users who received Action communications have made better healthcare decisions. For example, we have seen greater utilization of physical therapy, more cancer screenings and significantly higher enrollment in employer-sponsored maternity programs among these populations. All of this adds up to fewer unnecessary procedures and better outcomes for employees and their families. These are exactly the kinds of results companies are looking to achieve when they deploy Castlight's health benefits platform. Over time, we expect the growth of our installed base, combined with greater adoption of our platform solutions, will yield increased net dollar retention. For 2016, we continue to expect to achieve net dollar retention of approximately 100%. So far this year, we've renewed or committed eight of the 10 largest accounts in this year's renewal cohort and we expect the remaining two to renew during Q4. As we work to drive sales growth, we believe that it is also critical for us to ensure that Castlight is in a strong financial position, and we've made great progress on this front. As Siobhan is not with us today, I will provide the summary of our third quarter financial performance and our full-year 2016 guidance. Total revenue for the third quarter was $25.5 million, an increase of 31% compared to the same period in 2015. Subscription revenue represented 94% of total revenue in Q3. Reported revenue is a function of completed implementations and in the third quarter, we deployed 10 new customers, and completed 25 cross-sell product implementations. Non-GAAP gross margin was 72% in the third quarter, a meaningful increase from 59% in the third quarter of 2015, and 66% in the previous quarter. We expect gross margins to fluctuate on a quarter-to-quarter basis. But as we look ahead to next year and beyond, we feel good about our ability to maintain non-GAAP gross margins within our long-term target range of 70% to 75%. Total non-GAAP operating expenses for the quarter were $23.9 million, down 13% versus Q3 2015, and 9% sequentially. This represented the fifth consecutive quarter in which we've lowered our quarterly non-GAAP operating expenses from the peak level in the second quarter of 2015. Two important points need to be made to put this performance in further perspective. First, over this same five-quarter period, we have actually increased our quarterly investments in R&D by 24% as we continue to be highly focused on innovation and the expansion of our health benefits platform. Second, while we have reduced quarterly operating expenses by 16% since second quarter of 2015, we have increased our quarterly revenue run rate by 38% over the same period. Our non-GAAP operating loss was $5.5 million in the third quarter, which is 65% lower than the $15.9 million non-GAAP operating loss we reported for the third quarter of 2015 and approximately 50% lower than Q2. We ended Q3 2016 with $116.4 million in cash and marketable securities. Cash used in operations was $9.4 million in the third quarter, including almost $3 million related to our previously disclosed legal settlement and various restructuring expenses. We are on track to reach cash flow breakeven in the middle of 2017 with a healthy cash balance on hand at that time. With that, let me turn to our outlook for the full-year 2016. We remain comfortable with our revenue guidance range of $99 million to $102 million for the full year. We are tracking to the midpoint of that range, which implies year-over-year revenue growth in Q4 in the mid-30% range, and sequential revenue growth in the mid-teens. This would be the highest level of sequential revenue growth in a year and a half, and it's something we have solid visibility into based on completed implementations. It's also worth pointing out that we expect approximately $1.4 million of our Q4 subscription revenue to be non-recurring in nature, primarily associated with the expirations of the initial terms of several large customer contracts. As we look at expenses and profitability, we expect operating expenses to increase slightly in the fourth quarter as we add resources to support our go-to-market and product development efforts. Even so, we expect to meaningfully outperform our previous guidance ranges for a non-GAAP operating loss of $40 million to $42 million for the year, and a non-GAAP net loss of $0.40 to $0.42 per share based on 100 million to 101 million weighted average basic and diluted shares outstanding. Finally, we continue to expect cash used in operations to be in the low-$40 million range for the full year 2016. In summary, we believe our business is in a very strong position. We're growing revenue at a solid pace and have initiatives in flight to deliver improved sales results over time. In Q3, not only did we cross the $100 million mark in terms of our annualized revenue run rate, but that revenue is coming from a broader set of products and a larger number of customers than ever before. We believe we are very well positioned strategically to build a big business as we continue to expand our health benefits platform, and as we realize the long-term payback on the efforts and investments made in the build-out of our partner ecosystem over the course of 2016. Everything we've accomplished to date and all of the value we expect to create for customers and shareholders in the future depends on the excellence and commitments of everybody at Castlight. I want to thank every one of our fellow Castlighters for their tireless dedication to delivering great products that make healthcare work better for our customers and their employees and families. With that, we will open the call to questions.

[Operator:]

We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Adam Borg from Stifel. Your line is open.

[Adam C. Borg:]

Great. Thanks much for taking the questions. I guess just two to start off. On SAP, maybe just a bigger update on the status of where we are with the relationship and where is the alliance agreement? Is it in place and, if not, when do we expect it to be?

[Giovanni M. Colella:]

Yes, this was SAP? I'm sorry you went in and out. So thank you, this is Gio, and thank you very much for the question. So, we're still working through the best approach and the impact of SAP on the long term. We are developing a multi-branch business alliance, which will include two components. One is the participation into SAP's Connected Health platform and the second part is the distribution of Castlight by SAP's HCM business, which means SuccessFactors. These two deals, these two relationships will provide us a new distribution, marketing channel, complementary go-to-market relationship with Anthem. So, we'll expand quite a bit our distribution in the healthcare ecosystem and the access to new data sets and ecosystem relationships. So, I am personally involved in both of these relationships, both of these discussions. We're very pleased where we are today and we will update you as soon as we have something material to inform you about. I just want to remind you that SAP made an $18 million investment in Castlight earlier this year, and they're very committed to their investment.

[John C. Doyle:]

And, Adam, to give you timing, we're expecting the staging of these relationship to be such that Anthem will be an important contributor to growth in the first half of the year. And then, we'll see SAP and our relationship there layering in in the second half of the year.

[Adam C. Borg:]

Perfect. That's really helpful. And I guess, just as a follow-up, I'm really pleased to hear about the 80% of the new customers this year getting the full platform. As you have this broader conversation, what is that doing, if anything, to sales cycles? Thanks.

[John C. Doyle:]

Yes. Great question. This has been a very exciting shift in the market. I think in many ways the market is moving towards us. And when I say that, I'm referring to this platform value proposition, which really is something we're hearing about broadly in the channel. We're hearing about it in prospect conversations. And the value proposition to these large organizations that are, frankly, overwhelmed trying to manage a complex array of programs and technologies and looking for a way to deliver, A, a more robust, united experience to their employees, so to integrate all of those programs and technologies, and then more effectively engage folks with those programs and technologies. It's an intuitive and growing specific demand from these employers. So, the expansion of our value proposition has met the market, I think, at a really interesting moment. And so, the need to evangelize new functionality, for example, as we might have with transparency years ago hasn't been a real challenge here. It's a pretty exciting moment.

[Adam C. Borg:]

Great. Thanks so much.

[John C. Doyle:]

Sure.

[Operator:]

Your next question comes from the line of Brian Peterson from Raymond James. Your line is open.

[Brian Peterson:]

Thanks for taking the question and congrats to Siobhan. That's great news to hear. So I just wanted to follow-up on Adam's question. So with the 80% buying the complete suite of products, I'm curious if that changes implementation times or processes at all. I know in the past maybe it would be medical, in pharmacy and in dental. But, are these customers turning everything live on at one particular juncture? Or is it still a gradual roll-out of products?

[John C. Doyle:]

Great question, Brian. And one of the other exciting things that we've – that the team has achieved this year is not just condensing implementation timelines, but allowing us to launch multiple products on the platform in parallel. And so, when a new customer signs a Castlight Engage agreement, the default is that we would launch the entire program at the same time. As you know, historically, launch timelines have averaged about six months. They've been between three and nine months on medical. And I think that's still a reasonable target. But, now, that applies broadly across these platform implementations.

[Brian Peterson:]

Got it. Okay. In a follow-up, I just wanted to understand the difference between the net customer adds, 14, that was great, and the deferred revenue which obviously was great. But, I would have thought that that would have led to a bigger increase in ARR, which was only up about $300,000 sequentially. So, is there a churn dynamic or is there something going on? I just figured that would increase a little bit more quarter-over-quarter.

[John C. Doyle:]

Right. So, I think when we think about Q3, the first thing to focus on is we're super pleased to see the improved logo velocity. I mentioned in my remarks, we had four net new logos in the first half of the year, moving to 14 in Q3. And where that came from is directly responsive to your question. So, we saw a much healthier uptake among mid-sized customers, coming from our broker channel in particular. Those tend to be smaller deals and so, the way you're going to see ARR moving as that customer segment begins to gain momentum for us is for us to get to a healthy blend of mid-sized logos and the large enterprise customers that historically have been core customer segment for Castlight. And we are making terrific progress on both fronts and I make that comment with respect to the enterprise customers because, as we look ahead into Q4, we're seeing good momentum with those large employers that have been the bread and butter for the business historically. So, I do think we're going to be in a good place there. More importantly, since you asked the question about ARR, we're feeling very good about the foundation that we've got now for a higher level of ARR growth going forward. We'll probably see growth in the teens as we exit Q4, but we do expect to return to a higher level of ARR growth in 2017. And that comes from these initiatives that we've mentioned, some of which we talked about in the script. And I want to focus in on what we're looking to do with Anthem, which I think is an important change. So in particular, what we said is that we're going to packaging Castlight's Engage platform with Anthem's renewals and new business in 2017. And what that means at the ground level is that instead of taking a warm lead and then asking a customer to transition from an Anthem sales process into a Castlight sales process, their Anthem sales process will now include our full platform solution. And that's a very exciting change that we think is part of the reason we're going to see a different level of ARR growth next year. And so we are – it's an exciting moment. As I said, the market moving our direction and I think these channel relationships are really maturing. So, excited to go forward here.

[Brian Peterson:]

That sounds great, John. I'm excited to hear about what Anthem can bring for you guys next year. Just curious, because I'm not as exposed to their business; do they have any seasonality to their bookings with renewals and new customers? Is it weighted towards any particular quarter? Any sense for that?

[John C. Doyle:]

Part of the reason – it's a great question, and I think one broad comment is what we're seeing in the pipeline is continued kind of quarter-to-quarter volatility, particularly with these bigger deals that we use to drive ARR growth. But, overall, a more muted volatility. So you don't see that concentration in any one quarter that we had previously been seeing in Q3. And we actually previewed that, if you remember, on our Q2 call. So this was something we were expecting. It's not a hindsight reflection. And so, when you look ahead at how the channels impact our business, as we're planning for 2017 with our channel partners, Anthem included, the cadence is significantly heavier in Q1 from a proposal standpoint. So, a lot of new business getting pitched to customers by consultants and health plans in Q1; Castlight expecting to be right there with them in those proposals and then deals beginning to close in Q2 in their business, more so than holding until Q3 as we've seen previously. And so, as we work more closely with the channel, again, I don't expect to see the same level of concentration in any one quarter. But if there's anything we are expecting, based on the early planning, it's a bit more shift into Q2 from what we might have seen in Q3 previously.

[Brian Peterson:]

Understood. Thanks, John.

[John C. Doyle:]

Thanks, Brian.

[Operator:]

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

[Richard Collamer Close:]

Great. Thank you. Congratulations on the progress there. I just want to make sure I'm understanding the improvement in the implementation times and also, I appreciate the sales cycle commentary. Can you just give us a – what it was maybe a year ago, both on sales cycle and implementation and then where it stands after the third quarter that you just reported?

[John C. Doyle:]

Absolutely. And I think what's important to say here is, in particular, when we talk about sales cycles, what we're seeing there are very quick anecdotes that we hadn't been seeing at all before. So we're starting to see in our channel relationships, occasionally deals closing in the quarter that weren't even in the pipeline coming into the quarter. And that a year ago, is something we were never seeing.

[Richard Collamer Close:]

Okay.

[John C. Doyle:]

So in terms of averages, we're still planning on a 12-month sales cycle in our own plans. But particularly, as the channel relationship with Anthem gets stood up in the way I was just describing when Brian asked the question, I think that we see an opportunity there certainly to improve. And then on the implementation side, the team's done a terrific job. What we were seeing a year ago was some of the upsell products taking north of a year, in some cases, as we were standing up new data partners and so forth, and we're just not seeing that at all. In fact, we had one customer we signed late last quarter, a very large employer, who we deployed on the platform in a four-month timeframe, and that was a complex launch. And again, it's an anecdote. But it's an anecdote that did not exist at all a year ago. And I think it's representative of all of the products that we now sell getting into a more routine cadence for implementation. And so our confidence level around delivering on the timelines we're committing and on the visibility of the revenue that we're talking to you about is really at a high point relative to any time in the company's history right now.

[Richard Collamer Close:]

That's great. Thank you. With respect to the gross margin, I just want to go back to something you commented in your prepared remarks, I believe it was. Obviously, strong performance on that gross margin in the quarter. But then you said it could, in not too many words, that it could bounce around a little bit quarter-to-quarter. Just if you could walk through that and maybe exactly what drives that bouncing around?

[John C. Doyle:]

Yes. And to be clear from a planning perspective, I'm not sure if we used the phrase bouncing around, but I understand your question. So we do expect it to move from quarter-to-quarter. And the main reason that would occur is that in particular, when we have a concentration of really big customer launches, the level of configuration that we will do for some of those big customers can drive extra cost of goods in a given quarter relative to another. And we often kind of fill those needs with engineering resource that would be kind of dedicating some hours, for example, to a given implementation. It doesn't happen a ton, but when it does happen, it results in a shift of R&D dollars into cost of goods and then that turns right back around the next quarter when the trend flips and so that's what can drive the volatility.

[Richard Collamer Close:]

One of my final questions here would be on the Anthem understanding pitch in the first quarter, deals close in the second quarter, so is that more of a revenue contributor then into 2018? Is that how we should think about that?

[John C. Doyle:]

I think that's the right base case. So the cadence of their business is exactly what you're suggesting. So proposals in Q1, deals in Q2 and those deals are typically for, in this case, 1/1/18 launches. Keep in mind, we are continuing in the rest of our business to sell and launch product in the same way we have historically and will continue to see situations where businesses, for example, want to be launching Castlight at open enrollment which is typically in the fourth quarter. It's part of the reason you've seen the revenue growth accelerate for us in the later part of the year this year. And we do expect to see that kind of dynamic happening.

[Richard Collamer Close:]

Final question would be, you stated in your outlook that you expect to notably outperform, I guess, or outperformed the guidance operating income and whatnot. But why not go ahead and update your guidance if you're going to outperform?

[John C. Doyle:]

We're very focused, as we said, on the Q2 call, on setting expectations on an annual basis and then giving kind of clear commentary about how we're tracking to those expectations rather than kind of moving numbers around on a quarter-to-quarter basis. And so, totally understand the question, but what I think we can offer that's helpful to you in terms of developing your own expectations is, we are still on track for cash flow breakeven middle of next year and we intend to be making progress towards that goal over the next several quarters. And so wouldn't expect, for example, our net loss to be increasing, if that's helpful.

[Richard Collamer Close:]

Yes, thanks. Congratulations.

[John C. Doyle:]

Thanks a lot.

[Giovanni M. Colella:]

Thank you.

[Operator:]

Your next question comes from the line of Robert Jones with Goldman Sachs. Your line is open.

[Robert Patrick Jones:]

Great. Thanks for the questions. John, I just want to go back to the ARR comments. I appreciate the optimism on the growth going forward. But I guess I'm still a little confused on how 14 net new adds would only add what appears to be around $300,000 in ARR. Can you maybe just walk through – maybe help us understand a little bit of how the new wins impacted ARR? And then I suspect maybe the renewals of some of the large legacy clients might also have an impact on this metric.

[John C. Doyle:]

Sure. So the critical thing goes back to one of the answers I was giving before. But if I elaborate a little bit, it probably gets you what you're looking for. So the mid-size customers that we signed brought the average size of deals we did in the quarter to less than half of the employee count that we'd seen historically in other quarters. And so, when you think about what that means from a deal size perspective, it was a pretty significant one quarter shift. And so, the reason I offered the commentary about the current quarter and the mix we're seeing in the current quarter is that we don't view that Q3 change in mix as a durable change in the business that we should be using for expectations going forward. We actually see it as a very healthy sign that the company is gaining traction in that mid-sized customer market. And when we think about getting ARR growth to higher levels going forward, it really does require that market to come to life, in addition to the enterprise sale, and so we're super pleased about that. In terms of what the number would have been on a gross basis, churn has been the other variable there and is in line with our expectations for the year. We came into the year with $110 million in ARR. So churn, even in the single digit percentages which is the target for us in a given quarter, can make a difference when deal sizes are lower than they are typically, and that's what we saw in the third quarter. Again, commenting on this quarter and then looking forward, we feel good about where we are ending the year. And more importantly, as we look forward into 2017 and beyond, the foundation for growth, Bob, is really quite strong. So that's where our optimism is coming from.

[Robert Patrick Jones:]

Okay. That's helpful. And then I guess just a follow-up around that. You talked about having a lot of success on the renewal side, 8 of 10 renewals this year so far and the expectation to renew the other two in 4Q. How does that play into the ARR metric? And I guess within that, anything you can comment on as far as how those renewal re-pricings went compared to the original pricing of those contracts?

[John C. Doyle:]

Yes, sure. So we're very pleased that our customers have been renewing so consistently and particularly our larger customers. And remember, these folks mostly signed transparency contracts three years ago. And I think we've all seen that the transparency market, in isolation, has evolved pretty significantly over that period of time. And so, what we've been super pleased about is, as we've been making the transition to a platform model, we've had an opportunity to get these customers onto a footprint that gives us a great opportunity to grow those relationships over time. And we've shown that we can build and launch new products and deploy those new products with our customers. And so, there were several cases in these renewals where we're able to be aggressive in spots, if it's necessary, to get that platform and optimize for customer lifetime value. And that's a very – I'm glad you raised it, it's a super important point. A year ago that really wasn't an option we had in the business because we hadn't proven out, A, the platform value proposition, or B, our ability to launch new products like Action and Elevate and see uptake. We see penetration of Action now at almost 20% just three quarters after that product was launched. We have more than 40% of our customers with three or more Castlight products. And so, our confidence level around the platform we're getting into this installed base, again, is at a peak. And that gives us a tremendous ability from a competitive standpoint to be aggressive and go after logos, and that's why we're as excited as we are.

[Robert Patrick Jones:]

Got it. Got it. Okay, thanks so much.

[John C. Doyle:]

Thanks, Bob.

[Operator:]

The next question comes from the line of Frank Sparacino from First Analysis. Your line is open.

[Frank Sparacino:]

Hi, guys. Just two questions from me. Maybe, John, just can you clarify a little bit more of what you talked about in terms of the $1.4 million in Q4 of nonrecurring, what that relates to?

[John C. Doyle:]

Absolutely, Frank. So, when we set up revenue recognition on a new contract, from time to time, we will have a term in those contracts that says there's a certain amount of revenue associated with when and if available functionality. When those kinds of provisions are in contracts, we defer the revenue associated with that functionality. In most cases, we end up delivering it, and we record revenue from the time that when-and-if capability is delivered. In some cases, there happened to be a concentration of them reaching the expiration their first term in the last quarter – sorry, in the fourth quarter, in some cases the when-and-if technology isn't something we launch. And it doesn't change the overall economic value of the contract for Castlight. And so, as a result, from an accounting perspective, we recognize all of that deferred revenue when the obligation to deliver expires.

[Frank Sparacino:]

Thank you. And just last from me, I know you aren't going to give 2017 guidance at this stage. But your comment, John, earlier around ARR exiting the year somewhere mid-teens comparable to where we're at today was just the likely revenue growth for 2017, given implementation cycles will probably be difficult to change that one way or another meaningfully. But is there anything I'm not interpreting correctly there?

[John C. Doyle:]

It's an important question. You're right. We're not, in particular, given the shifts in seasonality that we're seeing and the changes in implementation timelines and so forth, it would be premature to give full year 2017 guidance today. In terms of expectations, we did say that ARR, as you said, would be teens growth rate exiting the year and that we expect to get that to a higher level for all the reasons we've talked about on the call. It's important to point out that the ARR growth rate doesn't necessarily translate into the topline growth rate, certainly not in the short-term, because of the ARR backlog, if you will, that we've already built up. And so, we have some flexibility to get that growth rate going again. And with Anthem coming online and SAP coming online next year, we're excited about that. In terms of your question about implementation timelines and how much can we impact that, I think some of the anecdotes that I talked about earlier are not individual examples. We've had a number of customer situations where the time from signing to launch is well shorter than six months. And so, I think the business is moving into a different place in terms of our ability to impact current year growth rates. And so, very important to note, this business can do a lot better than teens growth rates on a topline perspective. We have been in a transition period and I think we're in good shape to get ARR back to the growth rates that we think are achievable. And in the meantime, I think topline is going to be healthy.

[Frank Sparacino:]

Great, thank you.

[John C. Doyle:]

Thanks a lot.

[Operator:]

Your next question comes from the line of Charles Rhyee from Cowen and Company. Your line is open.

[Charles Rhyee:]

Thanks for taking my question. Just another question on Anthem, I guess. When you guys are going to market, when Anthem's going to market to clients now, is the platform for Castlight included? Is it already bundled into the offering that they're presenting to clients, or is it an option that they can select from a menu? And then, is it like a technical sales person that's joining them in the pitch, or you're brought in if they've expressed interest? Thanks.

[John C. Doyle:]

Yes, right, it's important because this is exactly where the change is happening from 2016 to 2017. So, in 2016, you could think of it as more a part of an a la carte set of third party offerings as the way it looks to a prospect. So imagine you're an HR buyer. You sign a contract with Anthem for your health plan business, and some of the other programs that they would be offering through Anthem, and you do that deal as part of one big contract. And then your Anthem rep says, we're also partnered with Castlight on some technologies, engagement technologies that can really improve the value you get from our overall relationship, let me connect you with the Castlight sales rep. And then you go into what looks like, frankly, our traditional selling cycle. We're doing all of the selling. We're doing all the technical demos. We're doing contracting on our paper. Now, in a few cases this year, we actually mentioned one of them on last quarter's call, we have had situations, and just a few, where the process actually looked different and the Anthem rep packaged Castlight in on Anthem paper. Those were some of the fastest deals we got done this year. So, as we were working with Anthem on 2017 and the best way to deliver an engagement platform to their employer base, our strategy is going to be packaging as the default. So, instead of the a la carte offering and the handoff to Castlight sales, the engagement offering will be part of that base Anthem relationship. And the reason that works, just to be clear, Anthem is very focused on price to value with its customer base, and making sure that every piece of technology and program that they're offering to customers is driving good value for that customer. And so, just as a practical matter, when we deploy the Engage platform, what Anthem is able to deliver to their customer is much better engagement with a whole slew of ancillary programs, whether it's telehealth programs or it's a maternity care program, or any number other things that make the spend overall more efficient for the employer. That is what is possible when you package in Engage and that's what makes it possible for us to build our business in that way. So, it's a pretty exciting change and one of the many reasons that we feel like we're set up for a great 2017.

[Charles Rhyee:]

And so just a follow up, is the Anthem salesforce fully trained on all the variations to the offering and so they can offer a more customized solution? Or is it kind of like an off-the-shelf kind of product, and what about customization from the customer end?

[John C. Doyle:]

We will continue to have our direct sales capability and our solutions consultant capabilities. It's super important to be very clear that this evolution is not shifting where the emphasis is in terms of communicating our value proposition. We own that communication. But, in terms of the way that looks to the customer is Castlight at the table with their Anthem rep who, to your point, will be much better prepared from a sales enablement standpoint in 2017 than they were in 2016. Heading into 2016, we'd only just signed the relationship. So, not only were we in a very different posture in terms of taking warm leads, but it was just a lot to imagine that you could get an entire Anthem sales force fully trained. We did training, but now we have the benefit of a full year of a lot more interaction and those Anthem folks receiving a second year of sales enablement on Castlight and, importantly, having sales of Castlight built into their incentives the same way that all of their other programs are. So it really, from a sales motion perspective within Anthem, should be kind of very low friction which is what we're trying to accomplish as a partnership here.

[Charles Rhyee:]

Thanks. And my last question then, is that the way we think about SAP then? We're going to be ramping up SAP next year, but probably the real benefit is, as SAP's sales force has more interaction and comfort with Castlight, the real benefit is probably the year after? And I'll stop there, thank you.

[Giovanni M. Colella:]

So let me break down this question in two parts. In terms of the real benefit, we should – we're pretty confident that we'll start seeing benefit by mid-year 2017 from a business standpoint. From an engagement and sales force go-to-market, we're still in the process of working with SAP to define that. So, I'm not going to comment too much on that. What I am going to say is that the framework we want to work under is the same that John has very well outlined for Anthem, in which we are still part of the relationship with the client.

[John C. Doyle:]

Charles, I think you...

[Charles Rhyee:]

Great, thank you.

[John C. Doyle:]

Yes, Charles, one quick addendum. I think in terms of timing, it will also be similar, as Gio was saying, to the way Anthem has rolled out. So while we think there will be an impact in second half of the year, I think it's reasonable to imagine that going through a full cycle gets us better momentum in the 2018 sales season.

[Charles Rhyee:]

Great, thanks a lot.

[John C. Doyle:]

Thank you for the question.

[Operator:]

There are no further questions at this time. I turn the call back over to Giovanni Colella, Co-Founder and CEO.

[Giovanni M. Colella:]

Thank you very much, all of you, for joining us today. I again want to thank our dedicated employees for working tirelessly to transform the way employees and their families make healthcare decisions. We are proud of our progress, and we look forward to continuing the dialog with you, including at the upcoming Stifel Healthcare Conference in New York. Have a great afternoon.

[Operator:]

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