Cornerstone OnDemand, Inc.
Q3 2018 Earnings Call Transcript

Published: 8 Nov 2018

[Operator:]

Good day, ladies and gentlemen and welcome to Cornerstone OnDemand's Third Quarter 2018 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference call is being recorded. And now, I'll turn the call over to Jennifer Gianola, Vice President of Investor Relations for Cornerstone OnDemand.

[Jennifer Gianola:]

Good afternoon, everyone, and welcome to Cornerstone OnDemand's third quarter 2018 earnings conference call. As always, today's call will begin with Adam Miller, Chief Executive Officer, who will provide an overview of our performance; and then Brian Swartz, Chief Financial Officer, will review some key financial results for the quarter, which ended on September 30, 2018. Later, we will conduct a question-and-answer session. By now, you should have received a copy of our press release, which was released after the market closed today, and was furnished with the SEC on Form 8-K. You can also access the press release and related investor materials, including detailed financials on our Investor Relations website. We have also shared a copy of the prepared remarks on our Investor Relations website for your review. As a reminder, today's call is being recorded and a replay will be made available following the conclusion of the call. Our discussion will include forward-looking statements, including, but not limited to, statements regarding the expected performance of our business, our future financial and operating performance, including our GAAP and non-GAAP guidance, strategy, long-term growth and overall future prospects. Forward-looking statements involve risks, uncertainties, and assumptions. These risks, uncertainties and assumptions, as well as other factors that could cause actual results to differ materially from those contained in our forward-looking statements are included in our most recent Form 10-K, and subsequent periodic filings with the SEC. During the call, we will be referring to both GAAP and non-GAAP financial measures. All financial figures discussed today are non-GAAP, unless we state that the measure is a GAAP measure. The reconciliation of our GAAP to non-GAAP information is provided in the press release and our website. Please note that we have made some changes to our disclosures, in part due to the new ASC 606 Revenue Recognition Standard. All financial figures discussed today are on ASC 606 basis, unless we state the value is on ASC 605 basis. Please refer to our press release and the supplemental financial deck on our Investor Relations website for a summary of changes to the non-GAAP financial measures. With that, I will turn the call over to Adam.

[Adam Miller:]

Today marks one year since we first announced our strategic plan to transform Cornerstone into an industry-leading, high-margin growth company. We highlighted a five-point plan which included Cornerstone exiting the enterprise service delivery business and improving our margin profile, focusing on annual recurring revenue, introducing new recurring revenue streams, bolstering management and strengthening our corporate governance. I am extremely pleased to report one year later that we have successfully executed against our plan and the results have been quite strong. We have successfully moved our enterprise service delivery business to our global partner ecosystem. We now have over 440 certified consultants, who have completed more than 1,000 product certifications to-date, and we have successfully reduced our non-recurring services sales by over 60%. We are on track to nearly double profitability from last year, and we expect to move from 6% operating margins in 2017 to almost 12% operating margins in 2018. In Q3, we had 13% operating margins. Also, Q3 marked our first-ever quarter of GAAP operating profitability. In the last three years, we have seen sales and marketing spend drop from 54% to 35% of revenue, or 38% if you exclude certain reallocations in Q3, which Brian will discuss later. This over 1,500 basis point improvement is primarily due to improvements in sales productivity. As measured by ARR per rep, sales productivity was up over 50% year-over-year for the first nine months of 2018. At the same time, we have seen our sales growth accelerate. Recurring sales grew over 30% through the first nine months of the year. Subscription revenue for the third quarter came in at $119 million, ahead of guidance and representing year-over-year growth of 18%. Year-to-date, subscription revenue saw year-over-year growth of 19%. We've introduced new recurring revenue streams and leveraged our leadership position in Learning to build a burgeoning Content business. Content sales in the first nine months have already eclipsed our Content sales for all of last year, and we are continuing to invest in the Content arena to step-up our momentum. We also strengthened our management team and our board to help us scale, and that has undoubtedly contributed to our continued success. Now let's discuss our strong Q3 in more detail. In the third quarter, we expanded our organically-grown client base to more than 3,400 enterprise and mid-market organizations from all over the world. New client additions include

[Brian L. Swartz:]

Thanks, Adam and good afternoon, everyone. As Adam discussed, we are very pleased with our team's strong execution against an ambitious strategic plan over this past year. Before I discuss our Q3 financial results and updated outlook, I'd like to spend a moment summarizing our acquisition announcement today. We signed a definitive agreement to acquire Grovo for $24 million in cash this quarter, subject to customary closing adjustments. While from an accounting perspective, Grovo is not material to Cornerstone, we do expect it to enhance the momentum we have achieved in our Content business. Furthermore, although we have not incorporated Grovo into our updated guidance, other than ARR, we expect to capture meaningful synergies as a result of the acquisition, while ensuring we maintain the core capabilities of the business. Accordingly, excluding the impacts of purchase accounting, we do expect Grovo to provide positive operating income in 2019 and beyond. Now on to our Q3 performance. We grew subscription revenue by 18% year-over year, nearly doubled our EPS to $0.23 per share compared to $0.12 per share in the prior year. In addition, the third quarter marked our first quarter of GAAP operating profitability in Cornerstone's history. Although there is still work to be done to achieve our long-term goals, we are pleased with our performance thus far in 2018. In the third quarter, total revenue came in at $134 million, representing year-over-year growth of 10%. Remember that our overall revenue growth is adversely impacted by our intentional reduction of services revenues. Our focus is on annual recurring revenue, or ARR, and we are pleased with our progress year-to-date. Accordingly, we're raising our full-year guidance which I will discuss shortly. Subscription revenue exceeded the high-end of our guidance range by $2 million, coming in at $119 million, or a year-over-year increase of 18%. Under ASC 605, subscription revenue growth was 19% year-over-year. This outperformance was primarily related to better linearity in the quarter. Services revenue in Q3 came in at $15 million, representing a 27% decrease year over year. A few other key Q3 metrics. The size of our client base increased to 3,428, representing 65 net new client additions during the quarter. Additionally, we remain keenly focused on maintaining our industry leading dollar-based retention rates through disciplined operating procedures around renewals and maintaining strong client satisfaction. We added more than 1.8 million net users during the quarter, bringing our user base to approximately 38.5 million users. As I discussed last quarter, we expect our revenue growth to become less correlated to user growth as we move forward due to selling multiple suite offerings, several product add-ons including Content and Cornerstone HR, and having a very large and diversified installed client base. Accordingly, while every user represents a tremendous future opportunity for Cornerstone, user growth is only part of today's growth story. For that reason, while we will continue to disclose user counts periodically, we will no longer consider user counts to be a key metric and will therefore not be disclosing it on a quarterly basis following our Q4 2018 earnings call. For financial modeling purposes, we recommend you use ARR, the same metric we use internally, to model the business. Finally, we had 1,892 employees as of September 30, representing a 3% decrease over the prior year. Our gross margin improved to 74% in the third quarter, up 50 basis points in the prior year. The improvement in gross margin was driven by a higher mix of subscription revenue. With respect to operating expenses for the quarter, during the quarter, we completed certain aspects of our strategic transformation plan to position us for long-term growth. The completion of this phase resulted in a reallocation of certain resources. The primary reallocation resulted in some sales and marketing head count that were moved into research and development activities to better align the organization with their updated job functions. This had the impact of reducing sales and marketing and increasing research and development, both as a percentage of revenue, by approximately 3 percentage points on a non-GAAP basis and 4 points on a GAAP basis. Sales and marketing expense was 35% of revenue in the quarter. Continuing down the P&L, R&D expense was 12% of revenue, up 100 basis points from the prior year. I'd like to point out that R&D expense, including capitalized software development costs for the quarter was $23 million, or 17% of revenue, compared to 15% in the prior year. This increase was primarily driven by the reallocation of resources, I just discussed, as well as continued investment in product development. In the third quarter, G&A was 13% of revenue, in line with the prior year. We expect to see G&A optimization over time as our Operational Excellence initiatives are fully implemented. Overall, this resulted in a Q3 operating income of $18 million or a 13% margin, which represents a 700 basis point improvement from the prior years' operating margin of 6%. This is largely driven by leverage in sales and marketing. Additionally, I am very pleased to report that GAAP operating income was $2 million in the quarter, marking our first ever quarter of GAAP operating profitability. Net income for the quarter was $15 million or $0.23 per diluted share, up 102%, compared to $7 million or $0.12 per share in the prior year. It's also worth noting that our 2021 convertible note is not dilutive to our share count in EPS calculation until we generate roughly $170 million in net income. With regard to cash flow, unlevered free cash flow improved year-over-year by $16 million to $32 million in the third quarter, representing an unlevered free cash flow margin of 24%. We exceeded our expectations on quarterly cash flow, primarily due to timing, driven by billing and collection process improvements. Now let's turn to the balance sheet. We continue to maintain a well-capitalized balance sheet. As of September 30, we had $393 million of cash and investments. Additionally, we had $288 million in carrying value of debt. As a reminder, we used approximately $253 million of cash and investments to pay off our 2018 convertible notes that came due on July 1, 2018. Back in November 2017, our board of directors authorized $100 million share repurchase program. In the third quarter, we repurchased approximately 300,000 shares totaling $16 million. From inception through last Friday, we repurchased 2.1 million shares at an average cost of about $43 per share for a total of $91 million. Now let's turn to our 2018 outlook and our first look at 2019, which has been developed using the best information we have as of today. Please note we have included a supplemental financial deck on our Investor Relations website to help you follow along as I discuss our updated guidance. As a reminder, all guidance assumes ASC 606, but you can view the ASC 605 guidance for comparative purposes in the supplemental deck. Our current guidance assumes a U.S. dollar to British pound exchange rate of 1.27 to 1 and a U.S. dollar to euro exchange rate of 1.13 to 1. If the U.S. dollar were to change by 5%, the impact is approximately $7 million to ARR and $2 million to revenue. As I mentioned earlier, I encourage you to reference our supplemental financial deck, as I discuss the following guidance. I would also like to point out that with the exception of ARR, the financial impacts from the Grovo acquisition are excluded from our updated guidance as we are working to quantify the impacts of purchase accounting. For the fourth quarter of 2018, we expect total revenue in the range of $128 million to $131 million and subscription revenue in the range of $119 million to $122 million. At the midpoint, this represents approximately 13% reported growth and 15% constant currency growth. On an ASC 605 basis, these growth rates are approximately 1 percentage point higher. Regarding full-year revenue guidance, we are raising our currency neutral guidance range to $529 million to $532 million, which increases the midpoint by $8 million. On a reported basis, those numbers are impacted by $1 million of currency headwinds, resulting in an increase to the midpoint of $7 million for an expected reported range of $528 million to $531 million. We are raising our currency neutral full-year subscription revenue guidance range to $467 million to $470 million, which increases the midpoint by $6 million. On a reported basis, those numbers are also impacted by $1 million of currency headwinds, resulting in an increase to the midpoint of $5 million, for an expected reported range of $466 million to $469 million. At the midpoint, this represents approximately 18% reported growth and 17% constant currency growth. On an ASC 605 basis, these growth rates are approximately 2 percentage points higher at 20% and 19%, respectively. As we continue to move service projects to our partners in Q4, we believe services revenue in Q4 will be just under $10 million, resulting in full-year services revenue of $62 million, down about 25% year-over-year. We expect to begin 2019 on a normalized quarterly run rate of services revenue. Moving on to ARR, as I mentioned earlier, our ARR guide includes the best estimate of Grovo's ARR at the end of 2018. Given the strength in new ARR so far this year, and including the $9 million benefit from Grovo, we are raising our currency neutral full-year ARR guide range to $507 million to $517 million, which increases the midpoint by $20 million. On a reported basis, those numbers are impacted by $4 million of currency headwinds, resulting in an increase in the midpoint of $16 million for an expected reported range of $503 million to $513 million. At the midpoint, this represents approximately 16% reported growth and 17% constant currency growth. Grovo's acquisition positively impacted these growth rates by about 2 percentage points. Please note the separate Grovo ARR disclosure is one-time in nature and we will not disclose it on an ongoing basis. As you think about modeling our business in 2019 and beyond, please be mindful that our strong performance through the first nine months of 2018 included some large deal execution. We had more than two times the number of 7-figure deals through the first nine months of 2018, relative to a year ago. Moving on to profitability, we are raising our 2018 operating income to a range of $61 million to $64 million, which increases the midpoint by $2 million. This results in an operating margin of 11% to 12%. For Q4, we expect operating income to be in line with Q3 of 2018 operating income of $18 million. Regarding cash flow, for the full-year 2018, we are raising our unlevered free cash flow guidance range to $59 million to $63 million, which increases the midpoint by $2 million. Please note this excludes $14 million of cash interest expense. Assuming services revenue is down 25% by the end of 2018, this amounts to an unlevered free cash flow margin of 11% to 12%. We expect this margin to increase at a faster rate than operating income in the years ahead as our services revenues begin to normalize. For Q4, we expect unlevered free cash flow to be in line with Q3 of 2018 unlevered free cash flow at around $31 million. Now I'd like to provide some preliminary thoughts for 2019. We expect to continue to grow ARR in 2019. As I mentioned earlier, it is important to acknowledge that 2018 new ARR has been more concentrated up-market than in prior years, which could impact the amount of new ARR growth in 2019. We expect 2019 subscription revenue growth to be in the mid-teens and service revenue of $5 million to $10 million per quarter. Service revenue would therefore represent about mid-to-high single digits, as a percentage of total revenue. The decline in services revenue from 2018 to 2019 will continue to impact our total revenue growth, but not our subscription revenue growth. Assuming mid-teens subscription revenue growth and services of about 5% of total revenue, we would expect 2019 total revenue growth of about 7%. As a reminder, during the transition of moving services to our partners, it's important to focus on subscription revenue growth instead of total revenue growth. We expect continued improvement in operating and unlevered free cash flow margins that will be enabled by continued improvements in sales efficiency and our Operational Excellence initiatives. With respect to longer-term margin targets, we remain on track to achieve the Rule of 40, which we define as the sum of annual revenue growth and unlevered free cash flow margin, by 2020, resulting in roughly $150 million of unlevered free cash flow, or approximately $2 per diluted share. Lastly, I'd like to announce that we plan to attend several upcoming investor conferences this quarter, including the Credit Suisse Annual Technology, Media & Telecom Conference, the Wells Fargo Tech Summit, and the Barclays Technology, Media & Telecom Conference. If you would like to participate in any of those meetings, please reach out to our Investor Relations team. In summary, we are quite pleased with our 2018 performance and look forward to a strong 2019. With that, I'll turn it back to Adam.

[Adam Miller:]

Thanks, Brian and thank you to everyone who joined us today. At the one year mark of our strategic transformation plan, I'm incredibly pleased with our execution. We have transformed into a stronger, fitter Cornerstone, and the continued indicators of success validate the changes we have made to the business. We are excited for a solid end to the year and continued progress through 2019. We will now take your questions.

[Operator:]

Thank you, sir. Our first question comes from the line of Scott Berg of Needham. Your line is open.

[Scott Berg:]

Hi, everyone. Congrats on taking my questions. It's a very good quarter here. I've got a couple of things. Brian, we'll start with you. Your comments on the 7-figure deals that were up materially year-over-year versus 2017 and that's expected going forward. I guess, is that a question or a comment that 2017 is drastically outperforming? Or is this really more a normalized level, and 2017 was underperforming relative to the 2018 results?

[Brian L. Swartz:]

No, I mean, so I would say, it is certainly an anomaly. I mean, we've had great success this year, Scott, and we're really pleased with that, but there is more concentration upmarket. Now, there's a lot of big logos out there and opportunity that we still have, but obviously, when you have a higher level of concentration, it could impact the compare for next year and expectations around growth for next year. So, we've got to get through Q4. We'll look at what pipelines look like next year. As a reminder, in the near-term financial guidance right now, our 2018 guidance, we do not assume large deals close. That's something I've consistently done here for the last four quarters to six quarters, plus. So, we are very targeted on big deals, and there are lots of opportunity there, but it is important for all of our investors and for everyone to understand that there is more concentration this year than there was last year.

[Scott Berg:]

Got it. Then Adam, a question on the Grovo acquisition. I like this for several reasons. I'm familiar with the company. But can you help us understand maybe how much of your Content customers are currently using this product? What does the upsell opportunity look like longer-term? And do you radically expand their Content offering over time? Or you just kind of maintain where they're at today? Thank you.

[Adam Miller:]

Yeah, so Grovo today is a little over 10% of our Content business. So, it's a company we're very familiar with. It's been very popular with our client base. And as somebody who spent almost 20 years in the e-learning space, I think it's some of the best content out there. So, we're very pleased with the acquisition. We think it sets us up very well going forward with our Content Anytime strategy, and just builds on our momentum in the Content business. It also obviously helps with the margins, as we now have 100% of the Grovo Content and don't have to pay a royalty to grow up. So, it improves our economics on that part of business.

[Scott Berg:]

Got it. Helpful. Thank you for taking my questions.

[Adam Miller:]

Thank you.

[Brian L. Swartz:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Brad Sills of Bank of America Merrill Lynch. Your question, please?

[Brad Sills:]

Oh, great. Hi, guys, thanks for taking my question. I wanted to ask about sales productivity. Obviously, you've seen some real good results there. Headcount's been relatively flattish this year. How are you balancing that going forward? Are you thinking at this point with the opportunity of Cornerstone Content and HR really ramping in Europe, is there a need to hire more salespeople to drive growth, or do you feel like the team that you have, there's still more productivity gains to be had?

[Adam Miller:]

Yeah, we think there's still opportunity to gain productivity. We will keep head count relatively flat in sales going into 2019, and we'll look at opportunities to further optimize how we're allocating that head count to drive greater efficiency, improve CAC ratios, and overall better performance. And some of this is coming from just the extensive experience that Jeff Lautenbach has bringing to the sales team, Chris Wheaton from sales ops helping with optimizing the organization overall. And I think it speaks to the improvements we made both in management and the focus we have in margin improvement and productivity gains.

[Brad Sills:]

Got it. Great. And then, if I may drill into the comment on the tougher comp next year on larger deals, can we take that to mean perhaps the business is going to be more weighted towards commercial, given the success you're seeing there in commercial?

[Adam Miller:]

No, we're not really commenting on anything specific. Just we've had a very good year upmarket. We've done a large number of 7-figure deals. That doesn't mean that we don't have significant deals in the pipeline going into next year, both 7- figure deals and 8-figure deals. And so, we're looking forward to continuing to have good performance upmarket. I think Brian's just trying to highlight that there's been a little more concentration this year upmarket. And so, it does set us up for a tougher compare. Having said that, we feel pretty good about the pipeline upmarket going forward.

[Brad Sills:]

Great. Thanks, Adam.

[Adam Miller:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Alex Zukin of Piper Jaffray. Your line is open.

[Alex J. Zukin:]

Hey, guys. So, maybe just to beat the dead horse on the large deals one more time. I guess, a question emerges, given that the fourth quarter is typically a big one for you guys for big deals, the commentary intended just to set kind of a conservative posture? Or is that, that there were deals that maybe had pulled forward, signed earlier than you expected, any color around that? Then I've got a follow-up.

[Brian L. Swartz:]

Yeah, Alex, it's Brian. Obviously, this is a big topic. It's come up three times in a row here. So, let me just try to be very clear. All we're trying to do is be very transparent. We've had a very strong year. We've had a lot of success upmarket. We continue to believe there are further opportunities to have that kind of ongoing success, but it's also important for everyone to understand that our guidance philosophy, the philosophy that I've laid out for the last year, doesn't contemplate very, very large deal execution consistently quarter-after-quarter-after-quarter and year-after-year. So, we're simply trying to be transparent relatively conservative. We would hope to exceed those numbers and be able to outperform and continue to have the same kind of year in 2019 that we're having in 2018 on a large-deal basis, but you obviously don't know that until you get into that year, into those respective quarters. So, that's all we're trying to tell. It's not a timing issue around deals this year. Q3, Q4, Q2, there's still deals in the pipeline, as Adam mentioned, both in Q4, Q1, Q2, and Q3 of next year, and we're excited about performing against all that.

[Adam Miller:]

Yeah. And Alex, just on that point, we did not pull anything forward into Q3. In fact, we're feeling very good about Q4 and the pipeline going into 2019.

[Alex J. Zukin:]

Perfect. And I guess on the follow-up to that, if I look across the metrics, kind of strong beats and raises across the board. The only metric that jumps out a little bit, as being optically weak is the calculated billings metric, which seemingly is diverging increasingly from both ARR growth this year and the type of subscription revenue growth you're guiding for next year. So, maybe can you just explain why that is the case? And then of the growth that you're forecasting for subscription revenue next year, what's the anticipation? How much are you baking in from the Content business?

[Brian L. Swartz:]

Yeah. So, on the first question, with respect to billings. So, as we said, as I said, (44

[Alex J. Zukin:]

Great. Thanks, guys, for taking the questions.

[Adam Miller:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Justin Furby of William & Blair Co. (sic) [William Blair & Co.] Your question, please?

[Justin A. Furby:]

Thanks, guys, and nice quarter. I guess, maybe just to go to the other side of it, the mid-market, Adam or Brian, can you talk about what you're seeing there and the pipeline there? Remind us, if you can give a sense for how big that is as a percentage of your business? My sense is, it's come down over time, but – and I've got a quick follow-up.

[Adam Miller:]

Thanks, Justin. So, from a percent of sales perspective, I would say mid-market is relatively small at this point. It's about 10% of new ARR coming into the business now on an annual basis. With regard to optimization of mid-market, we're seeing a lot of opportunity in all segments; SMB, mid-market, enterprise, and strategic, both on the commercial side and on the public sector front. What we are looking at doing is expanding our capabilities in SMB. We're having a lot of success with inside sales, which are obviously less expensive and more cost-efficient. So, we are raising the bar for our inside sales team, and we are consolidating our mid-market and enterprise management teams to enable more efficiency going into 2019. We are on track with mid-market this year. We are hitting targets. We're hitting targets really across all teams, and so we see a lot of opportunity. We're also seeing that down market, our service-inclusive pricing has got a lot of traction, and that allows us to roll in non-enterprise service projects as part of the implementation. Remember, these are very short implementations. They're done by our team. They're done very quickly, and they're rolled into the overall price that brings up the ASP and it brings up the total contract value for those smaller deals. And all of that has worked very successfully, as well as the client success packages being attached to that segment, and content being attached to that segment. So, overall, we've seen good ASP growth and good progress in that mid-market segment, which to us today is 500 to 5,000 employees. And we think there's an opportunity to continue to drive that business in a more efficient way.

[Justin A. Furby:]

Got it. That's super helpful. And then just, Adam, on the Content side, I'm curious, in terms of where you are with ramping your reps and being able to sell that. Do you think you need to sort of change anything from a go-to-market next year as this becomes bigger? And Brian, I know you guys have given some color around the success around Content. Is there anything more you can give? I guess, you have a big Q4 and your Content sales ended up doubling this year versus last year? Is that several points, 4 or 5 points of ARR growth for you? Or any more color? Because you've given a lot of data points, but it's hard to connect them all, in terms of what it means to the business over the next year or two? Thanks.

[Brian L. Swartz:]

Yeah. So, let me handle the latter question, Justin. So, I think, at the end of the year, obviously once Q4 is over, we'll try to get some commentary on our new ARR trends, not just by team, but also by product, including Content. Obviously, we've given some commentary in the first three quarters of this year. They already beat last year's number. Obviously, they have a strong pipeline for Q4, and we got to see how they execute, but they are definitely growing faster than the overall growth rate of the business. And we think over time, we can certainly maintain that, both given the size of that business today, but more importantly, the market is so much bigger, right? As Adam mentioned, it's a $25 billion-plus market relative to the market for our existing products. We believe they're very unique offering. With the acquisition today, I think our competitive moat grows, and it just enhances the competitive advantages that we have relative to other competitors, unlike into the subscription-based offering. So, we might – we'll look to – no promises, give some more commentary on the breakdown of the composition of the sales on the Q4 call, and that's how we think about it going into 2019 and beyond.

[Justin A. Furby:]

Okay. And then Adam, on the go-to-market?

[Adam Miller:]

Yeah, from a go-to-market perspective, we're seeing good adoption by the sales force globally. We've been able to sell content all over the world. And we're selling it across all segments. So, there's always more we could do. Not every single rep has sold content, but every single team has sold content. And we continue to make it part of our training. It's a big track during our sales kickoff in January. And obviously, the acquisition of Grovo gives us more horsepower around subject matter expertise within both the sale and production of training content. So, gives us a lot of opportunity.

[Justin A. Furby:]

Okay. Great. Thanks so much, guys. Nice quarter.

[Brian L. Swartz:]

Thank you.

[Adam Miller:]

Thanks.

[Operator:]

Thank you. Our next question comes from the line of Pat Walravens of JMP Securities. Please go ahead.

[Pat Walravens:]

Oh, great. Thank you very much and congratulations. So, I guess, I have two. The first one is, Adam, what's happening competitively? What are you seeing? And how has things evolved with Workday and with their Learning product?

[Adam Miller:]

Yeah. So, I'd say, competitively, the situation has been fairly the same. We haven't seen a lot of changes in the competitive landscape. There are not new entrants. We've seen some further consolidation, for example, Saba bought Lumesse. All of that makes for a fairly static competitive environment, which is good for us. I would also say that our moves, both on the Learning and Recruiting front have put us in a very strong position going forward. So, on the Learning side, in particular, since you brought up Workday Learning, the availability of our learning experience platform and the continued investment into that learning experience platform, combined with our whole Content Anytime Subscription strategy, combined with now the acquisition of Grovo makes us the clear leader in learning, and further distances us from the competition. Not limited to Workday, but certainly including Workday. And so, we're feeling very good about our positioning in the Learning space, and we think our investments in Recruiting, in particular, the acquisition of Workpop, and the improvements we've made to the Recruiting product, the investments we've made in engineering around recruiting, all position us very well for that market going forward as well. So, we're feeling good both about Recruiting and Learning going forward.

[Pat Walravens:]

All right. Great. Thank you. And then my second question is bigger picture – a little philosophical, I guess. So, you've gone from this sort of hyper-growth in the early days to a much more balanced growth model now. And then, we'll see if things accelerate. How do you decide what the right growth rate is?

[Adam Miller:]

Yeah. So, what I heard recently from another CEO, which I think is a right way to think about it, is it's not just how fast you can grow, but how long you can grow. And we're looking at, as you know, the Rule of 40, where we expect to attain the Rule of 40, which is a combination of revenue growth and free cash flow margin by 2020. We think we're very much on track for that. We've taken a balanced approach to the Rule of 40, and we think we're on track to achieve that. You've seen significant gains in profitability. You've also seen us been able to sustain revenue growth even with the transformation we've made. We think there's obviously upside both in Recruiting and especially in Learning, when you take Content into consideration. We also, as Brian mentioned, have effectively expanded our TAM, all of which puts us in a strong position for long-term growth and effective long-term execution.

[Pat Walravens:]

Great. Thank you.

[Operator:]

Thank you. Our last question comes from the line of Corey Greendale of First Analysis. Your line is open.

[Corey Greendale:]

Great. Thank you for taking my question. So, the first question is just more strategically, on the Grovo acquisition. I understand, the positives, in terms of how other Content partners might react to that being more as a content provider versus agnostic, just kind of the strategic question how others may view it. Can you just talk about that?

[Adam Miller:]

Yeah. Great question. We are very attentive to our Content partners. We are not trying to signal a change in strategy. We will continue to curate the top Content out there from the best e-learning providers in the world. And we believe the acquisition of Grovo actually enables us to expand the pie of our Content business, which in turn increases the opportunity for our partners. So, we actually think that this deal does not compete with our partners, but rather expands the universe for our partners and the kind of revenue that's available to all of them.

[Corey Greendale:]

Okay.

[Adam Miller:]

It's also worth mentioning that Content is a little bit like the life sciences business, in that people pick their spots. So, for example, we have a healthcare Content Anytime Subscription we're working on. There are a number of healthcare content providers we're in discussions with or we've already partnered with. And the content that we'll have from Grovo has nothing to do with that type of content. But the top content providers out there today are highly specialized, Pluralsight being a great example of that. And we believe we can retain these partnerships and, in fact, even grow these partnerships as we pick our lanes and continue to operate efficiently, effectively growing the pie for everybody, and I think becoming an even better partner for the content providers that we work with.

[Brian L. Swartz:]

Yeah, Corey, it's Brian. The only thing I'd add to that, going forward, we certainly believe and expect that the third-party content will be the vast majority of the content that's offered in our various subscription offering. What we've gotten into with the Grovo acquisition and where we take it from there, will be a piece of those swim lanes, but it will not be the majority or even a large part of those swim lanes. The third-party content and that partner ecosystem is super important to be able to have a comprehensive holistic offering for our clients.

[Corey Greendale:]

Got it. And then my quick follow-up question is, clearly the first order benefit of shifting services work to third parties is working in terms of freeing up your reps time. Can you just talk about kind of the other piece of it, how much you're seeing partners gaining refer business to you and also how those implementations are going? Like are the partners – do they (58

[Adam Miller:]

Yeah, I'll do that in reverse order. The implementations are going as well as they had gone in the past. I think we have very consistent service delivery now. In part, because you have to remember most of the people that were on our service delivery team are now working for our partners and are part of that delivery ecosystem that we have today. So, it's literally the same people delivering the service work. On the second order benefit of moving the service work to our partners, we are starting to see the benefit. We have not seen the full extent of the benefit. I believe there's a lot more opportunity in 2019 and beyond, as we continue to build out the practices at these partners, but we already have seen some of the benefit. Some of the larger deals we've brought in, some of the larger deals we're working on have absolutely come from our partners, and we are working on these opportunities in teams with our partner ecosystem. So, we believe we'll continue to see that benefit, and that benefit should grow over time, particularly upmarket.

[Corey Greendale:]

Great. And congratulations on the progress.

[Adam Miller:]

Thank you.

[Brian L. Swartz:]

Thank you.

[Operator:]

Thank you. At this time, I'd like to turn the call back over to Founder and CEO, Adam Miller, for any closing remarks. Mr. Miller?

[Adam Miller:]

Thank you to everyone joining us today. As always, I want to especially thank our global team for all of their great work throughout this transition to help thousands of organizations and millions of people around the world to realize their potential. We look forward to seeing you soon at the upcoming investor conferences. Thanks, everyone.

[Operator:]

Thank you, sir. Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day. You may disconnect your lines at this time.