Cornerstone OnDemand, Inc.
Q1 2017 Earnings Call Transcript

Published: 3 May 2017

[Operator:]

Good day, ladies and gentlemen, and welcome to Cornerstone OnDemand's First Quarter 2017 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 Alexandra Geller, Manager of Investor Relations for Cornerstone OnDemand. Please begin.

[Alexandra Geller:]

Good afternoon, everyone, and welcome to Cornerstone OnDemand first quarter 2017 earnings conference call. As always, today's call will begin with Adam Miller, Chief Executive Officer, who will provide a brief overview of our performance. And then Brian Swartz, Chief Financial Officer will review some key financial results for the quarter, which ended on March 31, 2017. 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. 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 our business strategy, demand for our products, both in the United States and internationally, certain projected financial results and operating metrics, product development, and the benefit of such developed products, client satisfaction and retention, client attrition rate, market or business growth, our revenue run rate, investment activity in our business, visibility into our business model and results. The effect of capitalized development costs, spending on R&D, professional services and other aspects of our business, our appraisal of our competitors and their products, and our ability to compete effectively. Forward-looking statements involve risks, uncertainties and assumptions. If any of the risks or uncertainties materialize or any of the assumptions prove incorrect, actual results could differ materially from those expressed in or implied by the forward-looking statements we make. These risks, uncertainties, assumptions, as well as other information on potential factors that could affect our financial results are included in today's press release and the Risk Factors section of 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 number. The reconciliation of our GAAP to non-GAAP information is provided in the press release and on our website. With that, I will turn the call over to Adam.

[Adam Miller:]

Thanks, Alex, and thank you to everyone for joining us today. The first quarter of 2017 represented a good start to the year, driven by solid performances in multiple geographies and segments. First quarter revenue reached a record $112 million, representing 17% growth on a constant currency basis. In addition, we continue to see improvements in profitability, and for the first time ever achieved first quarter profitability with nearly $5 million in net income. The demand environment for what we do remained strong, and in the first quarter we expanded or organically grown client base to 3,000 enterprise and mid-market organizations across the globe. Once again new client additions include some of the world's leading companies, such as Visa, AEG Worldwide, one of the world's largest suppliers of technology and services, The American Heart Association, one of the world's leading integrated electricity and gas operators, Singapore Airlines, a leading French multinational automobile manufacturer, the Panda Restaurant Group, the largest U.S. car rental company, the U.S. Census Bureau, one of the largest construction companies in Europe, the seventh largest U.S. airline, a Fortune 500 French multinational IT consulting corporation, the New York City Housing Authority and the second largest bank in Singapore among many others. In Q1, we continued to grow our user base, adding more than 1.1 million net users. This amounts to a total user base of over 31 million users representing one of the largest subscriber bases of any software provider in the world. As we have grown we have maintained a 95% average dollar retention rate since 2002, excluding incremental up-sells and cross-sells. In March, Cornerstone was once again named the leader in the 2017 Gartner Magic Quadrant for Talent Management Suites. Cornerstone has maintained its position in the leader quadrant every year since the Gartner report was introduced, making this the fourth consecutive year in which Cornerstone has received the leadership recognition in talent management. Our dominance in this space has allowed us to maintain consistent growth in our core business. And in the first quarter we saw return to strong performances across Europe. Although we had seen a slowdown in Europe in the second half of 2016, resulting from Brexit, our expectation was that European operations would stabilize in 2017, supported in part by a recent announcement that we're opening new data centers in both Frankfurt and Paris in early 2018. While we're only one quarter in, we saw early signs of improvement with the largest volume of new European client wins in any first quarter in the company's history, many of which stemmed from Continental Europe. France, in particular, has become a very strong market for us and we expect that both France and Germany could see improvement in win rates as a direct result of our data center investments in these regions. In addition to new client wins in the quarter, the European region was very successful in cross-selling our human capital management suite to existing clients. One such cross-sell took place with BBVA, one of the largest banks in Spain. They started out as a learning client in 2013, and in Q1, they expanded their reach to include the full Cornerstone HCM platform. It shows us to engage and maintain their global workforce due to the synergies with their existing LMS, the speed of implementation, our product roadmap and our commitment to continued innovation for all talent related processes. And most importantly, because employees are at the center of everything we do. Moving on to business in the U.S., I'm pleased to report that we recently brought on Gene Gainey to head our enterprise sales team with nearly 30 years in sales including 8 years at Learn.com and then Taleo. Gene has deep expertise both in human capital management and in leading enterprise sales teams. He has a proven history of accelerating sales and we are excited to have Gene on board to further drive expansion in the U.S. strategic and enterprise segments. We also have good momentum in several other business segments. The APJ's region had its best quarter ever with significant wins in Singapore and Hong Kong. The public sector had its second strongest quarter ever, led by a landmark federal deal as well several wins by our education and our state and local teams. Although these emerging areas do not represent a majority of our business today, we remain very bullish about their long-term opportunity. We still have work to do with our U.S. mid-market business, which has been an area of challenge for us over the past two years. But I'm pleased to report that, in Q1, we saw the highest percentage of mid-market teams achieve quota that we've seen in the past two years. This is a clear sign of improved efficiency and better execution, led by more tenured reps, the appropriate management layer now in place and our revised packaging and pricing. Despite this progress in the first quarter, there is still a long way to go. So we are maintaining our reduced 2017 mid-market growth expectations that we discussed on the last earnings call. Long-term, we remain excited about the opportunity in the mid-market, which represents 150 million of the 400 million global available seats for what we do. As I mentioned, Cornerstone once again achieved profitability in Q1, driven by the continued success of our ongoing operational excellence initiatives. From automation to strategic sourcing to process improvement, we've found multiple ways to drive margin expansion. One of our biggest near-term opportunities is around delivery through what we've called program accelerate. We believe this initiative, with its many sub-projects, could decrease our average implementation time by up to 50%. And this goal is validated by our initial success with this program. Right now, we're working on automating the loading of data with Edge transform, which will further streamline the implementation process for us and our clients. In most implementations, especially our larger enterprise implementations, the loading of data has been the long straw in the process. So dramatic reductions in integration project timelines substantially impacts both the overall duration of new client deployments and our internal costs associated with those deployments. Couple that with the ability for us to reduce lower margin outsourcing of service projects and you begin to understand our enthusiasm in this area. Over our last several calls, I spoke about many of our newer products, including Cornerstone HR. Our product lineup has grown substantially over the last decade, as we've continued to innovate and address the entire employee lifecycle for our clients. While our ability to cross-sell is well-proven, at the beginning of this year, we decided that our salespeople actually had too many different products to sell. So we've consolidated our dozens of products into four primary product suites

[Brian L. Swartz:]

Thank you, Adam, and good afternoon, everyone. As Adam highlighted, we are pleased with our performance in the first quarter. In the first quarter, billings were $90 million, which represents a year-over-year increase of 7% or 6% on a constant currency basis. We had stronger than anticipated performance in Q1, driven by early signs of recovery in our European business and significant wins in the U.S. public sector. As a reminder, we had a particularly tough year-over-year compare in Q1 of this year, as we did about 18% of our 2016 billings in the first quarter of last year, when we normally do approximately 15%. In the first quarter, revenue exceeded the high-end of our guidance range by $1 million, coming in at $112 million, a year-over-year increase of 12%, or 17% on a constant currency basis. The split between subscription and services revenue was 83% and 17%, respectively. As we have commented in the past, the subscriptions and services revenue mix on an annual basis has been roughly 80/20, but may vary by a few percentage points on a quarterly basis principally due to the timing of services revenue recognition. A few other key metrics on our Q1 performance, the size of our client base increased to 2,998 as of March 31, representing 80 net client additions during the quarter. And our user base increased to more than 31 million users, representing 1.1 million new user additions during the quarter. Finally, we added 36 net new employees bringing us to 1,859 employees at the end of the quarter, which represents an 11% increase over the prior year, and 2% sequentially. Our gross margin was 72.6% in the first quarter, up 90 basis points from the prior year. This improvement is largely a result of less outsourcing to third-parties. With respect to operating expenses for the quarter, we continue to demonstrate improved efficiency with sales and marketing expense. Sales and marketing expense was 45% of revenue during the quarter, down 600 basis points year-over-year. This continue to be largely driven by the optimized deployment of our sales head count across various teams as well as the impact of the commission planned changes we made in early 2016. R&D expense was 10% of revenue or 80 basis points more than the prior year, principally as a result of increased investment in head count to support our product development efforts. G&A expense was flat year-over-year at 13% of revenue. Overall, this resulted in an operating margin of 4.4% for the quarter, which represents an improvement of 550 basis points from our operating margin of negative 1.1% in the prior year. Driven in part by our improved focus on controlling operating expenses, net income for the quarter was approximately $4.8 million or $0.08 per diluted share, compared to a net loss of $300,000 in the prior year. As Adam mentioned, this is the first Q1 in the company's history in which we have reported net income, and it highlights our commitment to continued improvement in profitability. Also as a reminder, for EPS purposes, our share count of approximately 57 million increases to approximately 62 million in quarters in which we report a profit. With regard to cash flow, free cash flow, which we define as operating cash flow less capitalized software and capital expenditures, improved year-over-year by $5 million to negative $16 million. Now let's turn to the balance sheet, we continue to maintain a well-capitalized balance sheet. As of March 31, our total cash and investments balance was approximately $331 million. Additionally, as of March 31, we had $241 million in carrying value of long-term debt. Our deferred revenue balance was $260 million as of March 31, compared to $237 million in the prior year, representing a year-over-year increase of 10%. Now let's discuss our outlook for 2017, which has been developed using the best information we have as of today. Please note that all guidance assumes a U.S. dollar to British pound exchange rate of $1.28 to £1, up from $1.25 on our last earnings call. Due solely to the appreciation of the British pound, we are raising our previously communicated full-year 2017 revenue guidance from a range of $475 million to $485 million to a range of $477 million to $487 million. At the midpoint of $482 million, this represents approximately 14% growth, or 16% on a constant currency basis, over our 2016 revenue of $423 million. If the British pound were to change by 5%, the approximate impact on our full-year revenue will be about $5 million. For the second quarter of 2017, we currently expect revenue between $115 million to $118 million. At the midpoint, this represents 9% growth, or 13% constant currency growth year-over-year. Regarding billings, we are maintaining our full-year 2017 billings expectation of growth in the low-to-mid teens. We expect second quarter billings seasonality to be about 21% of the full year. With respect to profitability, we are very pleased with our Q1 performance and expect to be profitable in each of the remaining quarters of 2017. As a result of our outperformance in Q1, we are adjusting our previously communicated guidance for full-year operating margins from 5% to 6% to approximately 6%. As I mentioned on our last quarterly call, starting this quarter, we will only be providing guidance for operating margin and we'll no longer guide to net income in order to better align with the manner in which we discuss our long-term margin expectations. Regarding cash flow, for the full-year 2017, we are maintaining our previously communicated guidance of free cash flow margin of 6% to 7%. With respect to our long-term margin targets, we remain committed to achieving operating margins of at least 10% by 2018 and free cash flow margin targets of at least 16% by 2019. Finally, I'd like to mention that we intend to file our Form 10-Q for the first quarter later this week. Additionally, you may have noticed that we filed an amendment to our 2016 Form 10-K yesterday in lieu of filing our proxy statement. The reason is we are pleased to announce that our board is in the final stage of an extensive, professionally supported Director search. Accordingly, we intend to file the proxy statement for our upcoming shareholder meeting in the coming days, as soon as the search has formerly concluded. And with that, I'd like to turn the call back over to Adam.

[Adam Miller:]

Thanks, Brian, and thank you to everyone joining us today. As always, I especially want to thank our global team for all their great work to help 31 million people around the world to realize their potential. We will now take your questions.

[Operator:]

Certainly. Our first question comes from the line of Scott Berg from Needham. Your question please?

[Scott Berg:]

Hi, Adam and Brian. Thanks for taking my questions. My first question would be on Europe in particular. Adam, you'd mentioned in your remarks, or maybe it was Brian, some of the performance was based on slow at least recovery in Europe. Want to better understand what you're seeing there, what should our expectations be like in terms of when that – those sales cycles normalize and just kind of the general view there and how it's changed?

[Adam Miller:]

Yeah. I mean the way I would characterize it is Europe, for many years, has been a very stable part of our business, which had pretty consistent growth and relatively strong performance across the region, not just in one spot in Europe, but really across the entire European continent. And last year, because of Brexit we saw an anomaly. Last year, we had a very bad year for the full year in Europe, and, in particular, in the second half of 2016. And we suspected that with Brexit settling down with the addition of future datacenters being announced in both Frankfurt and Paris, we would see a return to some level of normality in Europe and that's exactly what we've seen. So we are back to, I think, the typically strong performance we see in that region.

[Scott Berg:]

Great. And my follow-up question would be around the competitive environment. Every call or meeting I have on you guys certainly brings up Workday somewhere as I'm sure you guys hear it as well. Interesting in the quarter our checks did showed that Workday did seem to slow some sales cycles for you, but the positive is pretty brief overall, commentary suggested that the customers looked at the product and said, not for us, we definitely want to go with Cornerstone, better product. Want to understand what you're seeing there in that competitive dynamic and if you're seeing in different than what our work suggested?

[Adam Miller:]

No. Our primary competition remains the same. Our number one competitor remains SAP and has been for many years now. There are, obviously, new entrants into the space in each of the segments we compete in in learning, in performance, in recruiting and even in HR where you have venture-backed companies emerging, but they tend to be smaller players that have a relatively small footprint and tend to work down market, don't affect our enterprise business. With regard to Workday we've seen no significant impact from Workday, there is no real change over the last couple of years. As you know, several years ago, they were a partner of ours, we haven't been partners for a couple of years now and there is no real change in the market, because of them. And the last is, as I talked about on the prior call we see still our legacy competitors out there in the market often competing exclusively on price, and with our new packaging and pricing I talked about on our last call, we're now much more competitive against those players as well. We are the number one player in the space. And as a result, most of the competition is targeting us specifically, but as you could see from the results we're back in business and doing well.

[Operator:]

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

[Alex J. Zukin:]

Hey, guys. Thanks for taking my question. So maybe one for Adam. Adam, where were you, I'd say – it sounds like there have been some improvements both on large deal activity and across the European geography. I'm curious if you can call out any positive momentum in North America or Asia Pac that you saw in the quarter. And also, I guess, maybe for Brian, the implied billings guide for 2Q looks like it's about 3% growth. Meaning that in order to hit your, call it, mid-teens billings targets for the year, the back half assumes a pretty significant acceleration, not that this wasn't the case before, but I guess what incrementally that you saw in the quarter gives you the confidence to be able to hit those numbers in the back half of the year?

[Brian L. Swartz:]

Yeah. Let me – Alex, it's Brian. Let me go ahead and answer the second question and then I'll hand it over to Adam on the first. I mean, I think when we think about our full year, it's obviously early in the year. We had a good Q1 as reported in the billings number. We exceeded our expectations, exceeded what we had talked about a couple of months ago, which is all positive. I think as we look to the full year, given where we're at in the year, we're kind of on-track with where our original plan was. We had no major kind of large eight figure deals that were necessarily moved from one quarter to another that happened in Q1, but we had a lot of large deals in general that happened earlier in the year that we had expected. Hence, the better performance in Q1 and the implied guidance for Q2 that I mentioned on the call. So, in general, I think the big – the takeaway is we had a good solid start to the year, Q1 was better than we expected, and our full-year plans are kind of right on-track. So with that I'll hand it over to Adam.

[Adam Miller:]

And then with regard to performance outside of Europe, Asia had their best quarter ever, so that was particularly strong. And in the U.S., the team I'd highlight is probably the federal team. We've done very well with government business, the new administration. There are changes, obviously, in personnel, changes in spending patterns, and we're seeing an opening of that market. So we've done quite well in government in the U.S.

[Alex J. Zukin:]

Got it. And then maybe just a quick follow-up. Just given kind of the billings growth rates in the first half of the year, given the improving environment that you seem to be seeing both from a sales execution perspective as well as, I guess, globally, is there any way for us to get some kind of color on the differential between kind of your bookings growth at this point that gives you the confidence for the back half and really beyond that, given kind of the toughness last year or any kind of commentary that you can give around that metric?

[Adam Miller:]

Well, the main thing, I would say, if you look at our bookings growth and our revenue growth in Q1, obviously, we have extremely tough compare. Q1 2016 was an extremely good quarter for us and from a seasonality perspective somewhat anomalous from any other year with regard to Q1. If you look at the second half of 2016 by comparison you have a relatively easy comp. And so we think that there is reasons to feel good about the opportunity going into the second half of the year.

[Alex J. Zukin:]

Perfect. Thank you, guys.

[Operator:]

Thank you. Your next question comes from the line of Jesse Hulsing from Goldman Sachs. Your question please.

[Jesse Hulsing:]

Yeah. Thank you. Adam, it sounds like you're cautiously optimistic on the mid-market business and you might be starting to see a turn there. I guess, one, what else needs to happen for your full-year forecast for that business to be taken up? And I guess I'm curious to drill down a little bit into the impact that your new pricing and packaging had on win rates and momentum there?

[Adam Miller:]

Yeah. So, pricing and packaging has been good. We're very focused on efficiency of the team as a whole and in particular of individual rep performance and sub-team performance within that group. So we're seeing very good trends in that area. We want to see that continue. There is also the question of pipeline. As you know, the mid-market business' sales cycle is much shorter than in the enterprise business. So the pipeline has much higher velocity. And as a result, it's often hard to predict what a Q4 pipeline is going to look like in Q1 of the year. You tend to turn over the pipeline much faster than in enterprise. And so we're also very focused on pipeline building, both from a marketing perspective, so traditional lead generation as well as from a rep and alliance perspective. So looking at outbound calling programs, partnerships, building our capacity with those partners, and continuing to maintain and even improve win rates across the board.

[Jesse Hulsing:]

And a quick follow-up to that. I guess, on a quarter-over-quarter basis because the sales cycles are longer, are you seeing what you want to see out of the pipeline in that mid-market business?

[Adam Miller:]

Well, no salesperson ever thinks the pipeline is good enough.

[Jesse Hulsing:]

Fair enough.

[Adam Miller:]

Say it's good enough, but again, we have a lot of initiatives around building pipeline for mid-market. And that's something we talked about couple quarters ago and something that's been continuing.

[Jesse Hulsing:]

Great. Thanks, Adam.

[Operator:]

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

[Brad Sills:]

Hey, guys. Thanks for taking my question. Wanted to ask, Adam, about Link, I know you've talked about some bigger deals for Link in Europe as kind of that presentation layered a glue composite HR apps across desperate core HR systems, just curious how do that business track this core, are you seeing traction there?

[Adam Miller:]

Yeah. So as I talked about last call we're now calling a LinkCornerstone HR and it's the fourth suite that I talked about today. We are seeing good traction particularly in EMEA, but really internationally around the world. We're seeing a real need for multinational corporations to have some way to tie their data together in what we describe is the hub model, BBVA is one example of that, a large bank in Spain that had exactly this issue built by acquisition, lots of different systems around the world needing to somehow centralize the data even while they administered it in a very decentralized approach. And so we continue to build out Cornerstone HR. We have a lot of very impressive clients already, but there is a very big market opportunity there. And I think we're just at the tip of the iceberg in terms of what we can do in that segment.

[Brad Sills:]

Great. Thanks. And then maybe just one on the sales leverage that you're seeing sales and marketing, a nice step up year-over-year as a percentage of revenue, what are some of the initiatives there Brian, that you have undertaken that are starting to generate the productivity improvement that you're seeing?

[Brian L. Swartz:]

Yeah, Brad. It's a lot of what we've talked about on the prior calls, there is nothing new or significant, quite frankly, it's just a focus in efficiency and optimization, Adam commented specifically in the mid-market, I mean we're real pleased in Q1, we had the largest number of mid-market teams achieve quota than – individual sub teams within the segment team achieve quota than we have in the last two years. So it's been very focused on that and it's just appropriate allocation of head count by segment and looking at team performance and teams that are performing well, investing in them more. Those that aren't, better understanding that before we invest more. So it's a lot of the same stuff we have talked about over the last several calls.

[Brad Sills:]

Great. Thanks, Brian.

[Operator:]

Thank you. Our next question comes from the line of Pat Walravens from JMP Securities. Your question please.

[Mathew Spencer:]

Yeah. Hi. This is Matt Spencer on for Pat. Thank you very much for taking my question. I guess, if you could just talk a little bit about your different modules and where you are seeing the most momentum maybe in the enterprise and then on the mid-market? Thank you.

[Adam Miller:]

Yeah. So, again, we've really reconciled the entire platform into four primary suites, learning, performance, recruiting and HR. The highest penetration rates remain in learning with about 85% penetration, followed by performance then recruiting and really at its inception is Cornerstone HR. So we're seeing tremendous greenfield opportunity there. We continue to sell by industry. So different industries tend to adopt certain products more than others. It tends to vary a little bit by size of the company and slightly by region, so for example Cornerstone HR is much more prevalent or in demand in Europe whereas learning is still the primary focus in Asia. And so it depends on the part of the world, depends on the industry, but we really teach the reps to be able to sell all four products or all four product suites equivalently.

[Mathew Spencer:]

That's helpful. Thank you very much.

[Adam Miller:]

Thank you.

[Operator:]

Thank you. Our next question come from the line of Michael Nemeroff from Credit Suisse. Your question please.

[Michael Nemeroff:]

Thanks for taking my questions, guys. Most of them have been already asked. But, Adam, as you focus, it seems like you're focusing a little bit more on the profitability, and obviously, it's coming through in the numbers. What do you think is the right organic constant currency growth rate on a normalized basis, take out the tough compares, the easy compares, over the next couple of years what do you think the appropriate growth rate is of the business? And then, I'm surprised nobody asked about this, on the proxy – the delayed proxy, I'm just curious on that Director search, are any of the candidates you're looking at being proposed by existing shareholders, and just get a little clarity on what the delay is and where you stand on that? Thanks very much.

[Adam Miller:]

Yeah. So with regard to the second question on the Director search, we – the search has been conducted by the board of directors. We hired a professional executive search firm, one of the largest in the world to facilitate the search with us. We are at the final stages of that search that's why there has been a delay at the proxy, and you will have more information about that ideally within the week. With regard to growth rates and profitability, the way we think about it really is around this concept of the Rule of 40 and we have been targeting a balanced approach to the Rule of 40 with on the one hand continued growth and on the other, increasing margins particularly around operating margin and free cash flow. And we think there's multiple levers for that not just sales and marketing, we think there is room for improvement around cost of sales, upping our gross margin, there is also opportunity within G&A as we automate more and more of our back office functions. So that's the approach we're taking.

[Michael Nemeroff:]

And do you care to hazard maybe a number on that growth rate given all those – given the focus on the leverage in the model?

[Brian L. Swartz:]

Yeah. Michael, it's Brian. I mean we haven't commented specifically on a number. What we have said and I think you know this but just to make sure it's clear, I mean the concept of the Rule of 40, our composite Rule of 40 in 2017 is, obviously, lower based on the guidance of where it was in 2016, but that is because what we've said which is we believe in the future we can reaccelerate the revenue growth. We haven't said to exactly what level or when for that matter, but certainly as we look at fiscal 2018, 2019, 2020, and some of the investments we're making today we'll constantly view it and make some adjustments in a balanced way to optimize around 40. So that's how we think about it.

[Michael Nemeroff:]

Thanks, guys.

[Adam Miller:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Samad Samana from Stephens Inc. Your question please.

[Samad Samana:]

Hi, there. Thanks for taking my questions and nice quarter. Brian, since I've asked it before when it didn't look so great, I'm curious, you saw year-over-year net customer growth grow for the first time since 2Q 2015, which is obviously a positive. Should we assume that that means that churn in the mid-market has gone or is there some sort of acceleration in the mid-market at least in terms customer growth, maybe help understand that trend and I have a follow-up.

[Brian L. Swartz:]

Yeah. So a couple of things, with respect to churn specifically we did see some elevated levels of churn that we talked about three quarters ago now mid last year, they were at the very low end of the mid-market, very low annual base line amounts like less than $10,000 per client, we actually have done some things operationally to better support that market segment. So we are seeing some improvements there just in terms of unit count, in terms of number of churned clients. In terms of growth of actual logos, again, we talk about it or report it on a net basis, but we did see some nice traction in Q1 on a gross basis relative to what we've seen in the last couple of quarters, and that's what you're, obviously, in the net number between the two of them.

[Samad Samana:]

Great. And then, when I think about just in terms of hiring, the margin efficiencies are looking very good, but as you think about demand and Adam mentioning demand has improved, now that your post – the data center is getting announced et cetera. How should we think about sales organization hires or should we just continue to think about efficiency is driving the growth there versus actual bodies?

[Brian L. Swartz:]

Yeah. I mean the way we – this goes to my comments a little bit earlier on the question, the earlier questions one I mean when we think about sales and marketing whether it's individual's quota capacity performance or sales and marketing as a percentage of revenue. Today, we actually have roughly the same number, of plus or minus of reps around the world, that are generating sales for us. Those reps actually have better tenure than they did 12 months ago, so by definition our quota capacity on the street is bigger. And so there is still lot of opportunity, it's all about balancing, if we get to a point in certain geography, certain segments, where we believe there is more opportunity, we'll increase that, just as we've reduced it in certain other segments, for example, the mid-market last year. So it's just looking at each one of those segments and teams individually and making sure that we have the right level of investment in each one of them. But today, we do have like I said, roughly the same number of reps with higher overall quota capacity for the company.

[Samad Samana:]

That's helpful. Thanks again and congrats again.

[Brian L. Swartz:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Raimo Lenschow from Barclays. Your question please.

[Raimo Lenschow:]

Hey, thanks for taking my question, and congrats on the quarter as well. A quick one, Adam, can you talk towards Cornerstone HR? Is that – is the current sales force equipped to sell it or you need to have changes there because it's a slightly more strategic discussion, it's a slightly different buying center depending on the size of the customer. Can you talk to what's that please? Thank you.

[Adam Miller:]

Yeah. I mean, obviously, it depends on your perspective, whether it's more or less strategic than talent management. I would argue that our sales force is well equipped. Having said that, we are supplementing our sales force with subject matter experts. So we have a business consulting team that works on both pre-sales and post-sales engagements and that team now has HRIS expertise as part of that group. They support the sales force. Some of our solution consultants and some of our sales people have come from traditional core HR companies. And there is a lot of human capital management experience in the company at large. So, I'd say, we're actually quite well equipped for handling it.

[Raimo Lenschow:]

Perfect. And can you just talk about sales cycles, length of sales cycles in terms of how you have to kind of plan for the business and build the business as you kind of broaden your footprint around Cornerstone HR?

[Adam Miller:]

Yeah. So we haven't seen major changes in sales cycles, enterprise sales cycles still are six to nine months, strategic sales cycles often longer, mid-market sales cycles significantly shorter. So we are seeing the ability to stay within those broad ranges. Having said that, depending on how large a purchase we're talking about and in particular how many different product suites are part of that initial platform by, we'll dictate in many ways how long the sales cycle is going to take. So if it's even a mid-market client but they're buying everything that will take longer than perhaps an enterprise client buying only the performance suite. And so we do see differentiation depending on the scope of the sale, but generally it hasn't had a meaningful impact on the overall sales cycles.

[Raimo Lenschow:]

Perfect. Thank you.

[Operator:]

Thank you. Our next question comes from the line of Mark Murphy from JPMorgan. Your question please.

[Pinjalim Bora:]

Thank you. This is Pinjalim sitting in for Mark. Thanks for taking my question. I just want to double click on the federal deal that you said. You said it's a landmark deal. Any way to quantify that or also in terms of modules, maybe how many modules it included? And do you think the FedRAMP certification you had beginning of last year, is that helping in that area?

[Adam Miller:]

Yeah. So FedRAMP definitely has been very helpful to our government business in general and our federal business specifically. The deal we're talking about – the Census deal is mostly focused on recruiting, although the scope is beyond just recruiting and is a multi-year deal that will actually get much larger over time. So as you can imagine they're starting to hire up for the 2020 census and as that happens the scope of the deal gets much larger. So we think this is a really nice deal in the federal space, obviously, supplements some of the other business we have in the federal space like U.S. Treasury, the SBA, HUD and the like. And we think we could continue to build our business there.

[Pinjalim Bora:]

Okay. I'm assuming it's nowhere near in terms of size like the U.S. Treasury deal. Is that correct?

[Adam Miller:]

No. Over time it will be bigger than the Treasury deal.

[Pinjalim Bora:]

Well. Okay. And in terms of the – I think you said you have a new head of sales for the enterprise and the strategic side of business and also you mentioned some of the changes in the products packaging. Do you anticipate any major changes in the sales force in the next six months to eight months?

[Adam Miller:]

No. And thank you for bringing it up, because I want to just address that point. I think there were some rumors circulating about major changes in our entire sales management organization. That did not happen. This was somebody who was running our U.S. enterprise team as distinct from our Chief Sales Officer or our General Managers of Europe or Asia. And he left specifically because he wanted to run the sales team. He wanted to run the entire corporate team. And obviously we have people in those positions. So it was a very amicable departure. He actually left because of training that we gave him that encouraged him to take the next leadership move. And it's something we think is very important, ongoing development of people. And we don't expect significant changes in our sales organization. In fact, we are quite stable now relative to the last couple of years. We're now five months into the year and extremely stable relative to 2016, 2015 even, I would argue 2014. And that I think speaks volumes to the organization we've established and the leadership that's in place.

[Pinjalim Bora:]

Okay. That's all – one more if I can squeeze in. The PS mix seems quite a bit different from previous time. I think it's been about 1 point, maybe plus/minus the 20, maybe 1 or 2 points, but this time it seems more like 3 points. Is there something going on? Do we expect maybe a large go-live towards the end of the year or something like that?

[Adam Miller:]

No. There is nothing like that in the numbers. Do keep in mind it's roughly been about 80%/20% for the last several years. Obviously, the bigger we get, the recurring portion of the base will increase. So the 80% should go up over time holding all variables constant. As I said in the last few calls, we did have a higher proportion of new sales and services last year. So that kind of kept it more at the 80%/20% level recently, but I would certainly expect over time – again it depends what happens with new sales and how many of those are services versus recurring or software. But over time, there would be a natural increase in the 80% number and I think you just kind of saw that in Q1. But I think there is a lot of variability quarter-to-quarter. You really have to look at it more annually on an LTM basis and trend it out. But that's what happened at least in Q1.

[Operator:]

Thank you. Our next question comes from the line of Justin Furby from William Blair. Your question please.

[Justin A. Furby:]

Thanks, guys. Adam, you called out in your prepared remarks a lot of big logos in the quarter, federal sounds more encouraging. And, I think, other bright spots as well, Europe, Asia. And I guess I'm just trying to reconcile that with the billings result this quarter that guide for Q2 as well. Then I know you have a tough compare. But it seems like – trying to bridge single-digit billings growth in the first half of this year versus what it looked like a year ago it sounds like there are other components there. So can you help bridge it? And then, Brian, can you remind us on the mechanics around services and how they impact both billings as well as deferred revenue? Thanks.

[Adam Miller:]

Yeah. So part of it was the amount of upfront payments. So, for example, the Census deal had a very small upfront payment, so it doesn't show up really in the billings, it's more of the un-billed backlog. We also, obviously, do not have a full recovery of mid-market, and some of the other businesses just performed as expected. Also if you were to normalize the Q1 billings growth year-over-year, you would see that the billings growth was actually pretty solid, relative to where we've been or where expectations have been. Having said that, we want to be conservative about the full year, it's only Q1, Q1 tends to be relatively small portion of our overall business. And we don't want to overweight success in Q1, as indicative of definitive success for the full year. So we want to be conservative.

[Adam Miller:]

Yeah. Then Justin to address your second question, if I understood it correctly, and if I didn't, please correct me. So services, in general, we generally bill clients upfront. So if you take our year – year one is generally when they have the most services around deployments, implementations and integrations. We generally will bill pretty consistently for the software upfront, in year one, services oftentimes will happen as the services occur through the implementation period. So they clearly impact revenue, they – once we bill and they sit in deferred revenue. And then as we deliver those services, the deferred revenue is recognized as revenue. So there is, obviously, a lot of moving parts there on all the various orders we have not just on new logos but also on account management in our client sales organizations to keep clients CSAT scores high and keep clients happy, we have incremental services and obviously modules that we sell them. But mechanically that's how it works through the billings revenue and deferred revenue.

[Operator:]

Thank you. Our next question comes from the line of Corey Greendale from First Analysis. Your question please. Corey, you might have your phone on mute.

[Corey Greendale:]

I did, I apologize. Thank you for taking my question. My question, Adam, is about the redesign of the learning experience, the consumerization that you mentioned. Just want to understand, is that a redesign of the core LMS or is that more for kind of only informal learning? Do you see that as a separate SKU or all customers are going to be on the new experience and what's involved in implementing that?

[Adam Miller:]

Yeah. So all customers will be on the new experience. This is something that is the next evolution of our learning management system. As you know, our LMS is the number one learning solution in the world. We have the most market share and the largest distribution of e-learning in the world. And consumers standards have changed, so we are adopting our system to matches new consumer standards. It will be discussed and demoed in June at Convergence. And then the initial release will be in August followed by another release in October. The modernized approach to learning, includes not only visualization of the learning paths and how people are learning and functionalities similar to Spotify around things like curated list, but also fully embedding machine learning. So taking all the experience we have now in big data and artificial intelligence and embedding it into our learning management solution. So we think this is the next logical step in this industry and some clients, not our accounts, some companies are assuming that they need to go out and buy different systems to handle some of this. We think we have a real advantage with now 31 million users to establish a really interesting repository of the world's learning content and personally – personalize it for the end user to meet their career aspirations and to help them with their jobs, and ultimately that help people realize their potential. So this is a really big initiative for us something we're really excited about and I think, keeps us in that pole position within the learning space as we done...

[Corey Greendale:]

I look forward to seeing you. Thank you for taking the question.

[Adam Miller:]

Thank you.

[Operator:]

Thank you. And this does conclude the question-and-answer session of today's program. I would like to hand the program back to Adam Miller for any further remarks.

[Adam Miller:]

Just want to say thank you to everyone joining us today. And I hope to see you at Convergence in June.

[Operator:]

Thank you ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.