Cornerstone OnDemand, Inc.
Q4 2017 Earnings Call Transcript

Published: 14 Feb 2018

[Operator:]

Good day, ladies and gentlemen, and welcome to Cornerstone OnDemand's Fourth 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 be given at that time. [Operator Instructions] As a reminder, today’s program is being recorded. I would now like to introduce your host for today’s program, Alexandra Geller, Manager of Investor Relations for Cornerstone OnDemand. Please go ahead.

[Alexandra Geller:]

Good afternoon, everyone, and welcome to Cornerstone OnDemand's fourth quarter and fiscal year 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 December 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 future and financial and operating performance, including our GAAP and non-GAAP guidance, business strategy, demand for our solutions, product development, client satisfaction and retention, market or business growth, 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, the use of proceeds from the sale of our convertible notes, our appraisal of our competitors and their products, our ability to compete effectively, our ability to realize potential benefits from both our recent and ongoing operational excellence and recurring revenue and margin improvement initiatives, changes to our corporate governance structure, and our proposed strategic plan to strengthen our business. 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. Please note that we have made some changes to our disclosures in part due to the new ASC 606 revenue recognition standards. 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:]

Thanks, Alex, and thank you to everyone for joining us today. I would like to start by updating you on the latest developments, the strategic plan that we first introduced on the Q3 earnings call. As it’s evolved, this plan now consists of five key components. First, a renewed focus on recurring revenue growth; second, improvement in operating margins and free cash flow; third, development of new recurring revenue streams including e-learning content subscriptions; fourth, bolstering our leadership team, and fifth, strengthening our governance to help us best execute on our strategic transformation. Regarding our first pillar, to ensure our sales teams focus their efforts exclusively on recurring revenue, as of January 1, 2018, quota credit and commissions for our sales people are now entirely based on growing recurring revenue. Quota credit and commissions for non-recurring sales have been eliminated. We believe that an individual rep can now use the incremental time and capacity that was formally spent selling services to focus their efforts on recurring revenue. Historically, we estimate that our reps spend as much as one-third of their time managing the sale of non-recurring services, which we now know didn’t add incremental value to our business and negatively impacted our rate of growth. We believe these changes align the incentives for our sales reps with our broader business objective to capture more recurring revenue and reaccelerate the growth of our business. In conjunction with these commission plan changes, and in furtherance of our focus on our recurring revenue, as of February 1 of this year, new implementations are being contracted directly by our delivery and implementation partners allowing us to shift our resources away from service delivery, which has been the least profitable part of our global operations. Because we had already established small ecosystem of partners over the last few years, and because of the partners have been asking to pay for the services directly for quite some time, the change was both achievable and well received. Since our announcement in November, our partners have sprung into action ramping up their Cornerstone practices and in some cases, such as IBM and Deloitte creating new Cornerstone practices were none have existed before. Previously, our partners had a little motivation to refer business to us due to the relatively unfavorable economics that our system of papering and then sub-contracting services imposed upon them. Now that our partners can scope the project, negotiate the terms, and keep all the revenue to have an incentive to help us sell more which can drive growth in recurring revenue. It’s important to note that these changes to our delivery organization have not and will not impact our ability to support our clients. As we have continued to invest in our global client success organization to ensure the success of our growing client roster enabling us to uphold our industry-leading dollar retention in the mid-90s. With regard to improvements in operating margin, we announced a workforce reduction in our service delivery and sales organization of approximately 6% of our global workforce in early December, which will be a significant driver of margin improvement for 2018. We also have optimized our annual budget to drive significant margin improvement. In addition, we anticipate considerable efficiencies will begin in this year and next from our ongoing strategic sourcing initiatives as well as automation and process improvement initiatives that are part of our ongoing operational excellence program. While our sales and marketing expenses have become an unfortunate anomaly over recent years, with the sales force reduction we completed in December, we expect our sales and marketing expenses and customer acquisition costs to come in line with our peers. It is worth noting that even with all of these margin improvement initiatives, we are continuing to invest in technology and client success. Our application development teams continue to grow and our core learning technology teams are the largest they have been in history. The third pillar of our plan is the development of new recurring revenue streams including leveraging our leadership position in global learning to aggressively enter the e-learning content market. I am pleased to report that in Q4, the launch of our new content subscription offering, Cornerstone Content Anytime was welcomed with strong demand. Our content sales team delivered growth of nearly 60% in annual recurring revenue from the prior year, albeit based on a relatively small scale. Going into 2018, as part of our commission plan restructure, we’ve incentivized the entire global sales team to sell content aggressively. There are four aspects that makes the training content market interesting for Cornerstone. The first is that Cornerstone’s strength in corporate learning positions us as the logical leader in the content space. Last year, over 350 million online course registrations flowed through Cornerstone. Secondly, most of our clients already have a dedicated budget for learning content. We believe organizations spend anywhere from two to five times more on learning content than they spend on their learning management systems. What makes us even more compelling is the fact that the learning management system budget and the content budget generally come from two different sources, which means that bringing content into a deal typically does not cannibalize the software spend and increases the overall size of the deal. For example, a largest content win in Q4 came from an existing Cornerstone client in France with the purchase of Content Anytime, they increased their overall Cornerstone spend by approximately 200%. Thirdly, we have the ability to create specialized solutions given our global distribution capabilities and partner ecosystem because we already help employees in virtually every industry and geography to realize their potential, we understand the unique training needs of different segments and intend to curate specific content offerings to meet those needs. Fourthly, we are well positioned to leverage the tailwinds created by the global need for life-long learning. As the relentless pace of technological change continues to impact every industry, and ultimately every job, there is a growing global need for continuous training and development to stay competitive in your industry, your career and your job. In addition to better unit economics for Cornerstone, our Content Anytime offering is creating significant value for our clients. Our one stop shop for all things learning reduces the time they spend mining for pertinent content by providing a curated library inclusive of today’s most innovative content. Moreover, the Content Anytime offering is a more cost-effective solution for clients rather than sourcing and procuring content themselves directly from multiple vendors. We are excited by the positive market reaction to our offering and believe it will not only strengthen our position as the leader in learning, but will help drive growth into the future. The content is not our only opportunity to drive more recurring revenue. In addition to our core solutions, and the continued upside opportunity around our recruiting and HR suites, we are converting some of our non-recurring services into recurring offerings. These incremental recurring offerings such as data feed connectors will further support the growth of our recurring revenue going forward. The fourth key component of our strategic plan involves leadership. We have made significant changes to our leadership team as we move to the next stage of growth for the company, in this case growing from $500 million to over $1 billion in sales. As I’ve said to our global team with each major phase of growth comes with stop of the train and at that stop, some people get off and others get on. We are saying byes to some long time executives including Kristen Helvey, Dave Carter and Frank Ricciardi who have played pivotal roles in growing Cornerstone to where it is today. On January 2nd, we appointed Jeff Lautenbach to the position of President of Global Field Operations. Jeff brings with him more than 25 years of experience at organizations such as IBM, Salesforce.com, and SAP leading sales and services teams to build and scale software businesses. Jeff was brought on to oversee Cornerstone’s worldwide sales, content and client success functions. Today, I am pleased to announce that Adrianna Burrows will be joining us as our Chief Marketing Officer. Adrianna has extensive experience in media relations, product marketing and field marketing having led teams at Stack Overflow, Microsoft, and Waggener Edstrom. We have also made changes throughout the organization and across our senior leadership team to ensure we have the right people in place to drive our transformation into a high margin growth company. The final component of the plan involves strengthening corporate governance. At the Board level, we recently announced that long tenured directors Mark Baker, Hal Burlingame, and Joe Payne will be retiring from the Board. We also announced that we will be appointing an independent director as the Chairman of the Board. We are deeply grateful for the service, dedication and significant contributions that Mark, Hal and Joe brought to Cornerstone. The nominating and corporate governance committee with input from our shareholders is actively looking for additional world-class directors for the Board. We are forever indebted to the people who made Cornerstone what it is today. As we look to the future, we believe the changes we have made have put us in a better position to successfully drive recurring revenue and margin expansion. Shifting to Q4 performance, I am very pleased to report that despite all of our changes in the last three months, we had a strong quarter to end the year, which we believe is a strong indicator that we are moving in the right direction. Fourth quarter billings came in at $185 million representing reported growth of 18% and constant currency growth of 12%. This puts full year billings squarely above the $500 million mark for the first time coming in at a record $526 million. In addition, we continued to see improvements in profitability with $27 million in operating income or 6% operating margin marking the second consecutive year of profitability with an improvement of more than 380 basis points. In the fourth quarter, we expanded our organically growing client base to more than 3200 enterprise and mid-market organizations from all over the world. New client additions include Toyota Motor North America, Tokyo Marine in Japan, PSC Group in the UK, LG Electronics, USA, Banco Bradesco in Brazil, a Fortune 500 healthcare company, Grupo DIA in Spain, one of the largest banks in the U.S., Bühler Group in Switzerland, Group Aerial in France, the world’s leading international trade association, and the School District of Philadelphia among many more. Today our client base includes global leaders in virtually every vertical, which has enabled us to build one of the largest subscriber bases of any software provider in the world. In Q4, we continued to grow our user base adding more than 1.8 million net users amounting to a total user base of more than 35 million subscribers. We continue to see strong momentum from our European business with Q4 closing the largest number of new client wins in the region’s history. As a reminder, we made the same statement just the last quarter and in Q4, we eclipse the Q3 record. This was driven by the continued adoption of the Cornerstone HR suite, as well as accelerating traction with Cornerstone Recruiting. Our performance in 2017 demonstrates that the macro challenges related to Brexit are now behind us. We ended the year with a more balanced contribution across all teams in the region including the solid come back from the UK. For the full year, the UK led the way with the largest volume of client wins followed closely by Germany, Spain and France. We believe we are well positioned to respond to the pent-up demand that stalled because of Brexit and this come back will continue to drive growth in Europe through 2018 and beyond. Speaking of come backs, North America delivered a strong second half of the year with 30% growth in new annual recurring revenue from the same period last year. Driven by the federal vertical, Q3 was our strongest quarter domestically ever with Q4 coming in at close second place. It’s worth noting that we achieved these goals despite a rightsizing of the teams during the quarter. We are pleased with the performance we saw in the second half of the year and believe the changes we made will drive strong momentum through 2018. Another strong performer for the year was client sales. In Europe, we saw accelerated growth within our installed base bolstered by sales of Cornerstone HR to our existing clients. In North America, client sales also grew its recurring revenue for the year with the majority of the largest deals expanding their Cornerstone’s footprint with the Cornerstone Recruiting suite. As you can see, the changes we have made to the business including the headcount reduction that took place in early December have not adversely impacted our business results. Transformation is never easy, but the commitment of our global team to help people realize their potential through our state-of-the-art people management solutions gives us confidence that we are making the right changes to best position Cornerstone for the future. With that, I’d like to turn it over to Brian to discuss our 2017 fourth quarter and full year financial performance, as well as our 2018 outlook in more detail.

[Brian Swartz:]

Thanks, Adam, and good afternoon, everyone. Needless to say, I firmly believe that the strategic direction and actions Adam just discussed, are the right changes for the business. Before I begin with the quarterly financial review, I'd like to discuss the financial impacts of our strategic plan and how those changes impact the financial metrics we disclosed. To best follow along, please note that we have included a document on our Investor Relations website called supplemental financial deck that will refer to throughout this discussion. As Adam just discussed, our focus in 2018 and beyond is growing recurring revenue and driving operating margins. Our subscription business is where we exercise the most control as opposed to the services business, which is heavily dictated by external factors such as our client implementation timelines. Accordingly, we will shift our financial metric disclosure to focus on recurring revenue. Our billings calculation is a combination of subscription and services billings, which as you can see denoted on Slide 5 of the supplemental deck. Given our focus on recurring revenue and the anticipated reduction in our services business, total billings is no longer relevant in the assessment of our performance and we will therefore no longer report or guide to total billings. Instead, as we move through this transition, we believe the best metrics today is the progress of our business, our subscription revenue, which we will guide to on a quarterly and annual basis and annual recurring revenue also known as ARR, which we will now disclose annually and provide guidance for on an annual basis. For clarity, annual recurring revenue is the annual runrate of recurring revenue for all existing clients at a given point in time. The difference between ARR and subscription revenue is a matter of timing. Subscription revenue begins the day we sign a contract and is recognized ratably over the lifetime of that contract. ARR shows the annual recurring revenue at a particular point in time. To give you an example, if we sign a new deal on December 30, we would only recognize two days of subscription revenue during the quarter ending December 31, whereas the ARR calculation would include the total annual recurring revenue for that deal as of December 31. Since our business is very seasonal and we tend to capture a lot of ARR in the back half of the year, this metric is best reviewed on an annual basis. This concept is depicted on Slides 3 and 4 of the supplemental deck. Our key metrics could change over time as we progress through this transition. But in the near-term, we believe these are the appropriate metrics for our business. Now on to the financial summary for the quarter. In the fourth quarter, billings, which includes both software and services, exceeded our expectations and came in at $185 million, which represents a year-over-year increase of 18% on a reported basis and 12% on a constant currency basis. The billings beat is a result of stronger than expected performance across the sales organization. For the full year, billings were $526 million, which represents a year-over-year increase of 16% on a reported basis and 11% on a constant currency basis. Annual recurring revenue as of December 31, 2017 was $439 million. Moving on to revenue. In the revenue came in at $132 million, a year-over-year increase of 21% on a reported basis and 18% on a constant currency basis. Subscription revenue came in at $106 million representing a year-over-year increase of 19% on a reported basis and 16% on a constant currency basis, in line with our internal expectations for the quarter. Services revenue on the other hand came in slightly lighter than we expected at $26 million. The completion of these remaining services and their corresponding revenue had simply been pushed to 2018. For the full year, revenue was $482 million, a year-over-year increase of 14% on a reported basis and 15% on a constant currency basis. Subscription revenue for the full year was $397 million, a year-over-year increase of 17% on a reported basis or 18% on a constant currency basis. A few other key Q4 metrics. The size of our client base increased to 3250 as of December 31, representing 104 net new client additions during the quarter. We added 1.8 million net users during the quarter bringing our user base to more than 35 million users. Finally, as a result of the headcount reductions in the fourth quarter, we ended the year with 1891 employees representing a 4% decrease from Q3, but a 4% increase over the prior year. Our annual dollar retention rate for 2017 was 93.5%, a decrease from our prior year rate of 95.1%. In any given year, there are a number of factors such as large mergers and acquisitions that can cause our annual dollar retention to fluctuate. You’ll notice that our annual dollar retention saw a similar decline in 2014 and then immediately return to 95% in the following two years. It’s worth noting that this annual dollar retention on a net basis continues to exceed 100% demonstrating that we have the ability to expand to our footprint within our installed base in addition to retaining our clients. Our gross margin was 73% in the fourth quarter, up 150 basis points from the prior year. Gross margin for the full year was 73% up 170 basis points from the prior year. This improvement is largely a result of a higher percentage of subscription revenue. With respect to operating expenses for the quarter, driven largely by reduced sales headcount, sales and marketing expense reached a record low of 41% of revenue in Q4. To give you some perspective, just two years ago, in Q4 of 2015, sales and marketing expense was 52% of revenue or 1100 basis points higher than it is today. Going forward, we expect continued improvements in sales efficiency in large part as a result of the reduction force completed in December. Continuing down the P&L, R&D expense was 10% of revenue representing a slight increase from the prior year due to increased investment in product innovation. I’d like to point out that R&D expense including capitalized software development cost for the full year of 2017 was $72 million or 15% of revenue compared to 13% in 2016. We recorded a $1.3 million write-off of capitalized software development cost in the fourth quarter impart due to changes in our service delivery model, because this is an unusual item, we have excluded it from our non-GAAP measures. In the fourth quarter, G&A improved 190 basis points from the year coming in at 12% of revenue. This improvement was largely driven by enhanced automation. We expect that these further G&A optimization as our operational excellence initiatives are fully implemented. Although excluded from our non-GAAP results, in connection with the headcount reduction that we announced in November, we recorded restructuring expense of $1.5 million in Q4 of 2017. We expect to incur an additional $3 million during the first quarter of 2018 amounting to a total restructuring expense of approximately $5 million. The corresponding cash outflow will continue throughout 2018. Overall, this resulted in an operating margin in the fourth quarter of 10%. On the last call, we indicated that any variability from the midpoint of our revenue guidance in the services revenue line item would likely flow through to the bottom-line on a dollar-for-dollar basis. For the full year, our operating margin improved 380 basis points to 5.6%. During the year, we recorded income tax expense of about $2 million, principally related to our international operations. For U.S. income tax purposes, we expect our deferred tax assets to allow us to offset any current tax liabilities related to domestic earnings for the foreseeable future. For 2018, we expect income tax expense to be slightly higher than 2017, as we continue to grow our international business. Driven in part by our continued focus on controlling operating expenses, net income for the quarter was $12 million or $0.19 per diluted share, compared to roughly breakeven in the prior year. Please note this is the first time we have achieved four consecutive quarters of profit. It also marks four consecutive quarters of year-over-year improvements in profitability. As a reminder, for EPS purposes, our weighted average diluted share count of approximately 58 million increases to approximately 63 million in quarters in which we report a profit. It’s also worth noting that our 2021 convertible note is not dilutive to EPS until we generate roughly $165 million in net income. For the full year, net income was $25 million, or $0.41 per diluted share, compared to $6 million or $0.11 per diluted share in the prior year. With regard to cash flow, unlevered free cash flow, which we define as operating cash flow, less capitalized software and capital expenditures, plus cash interest expense improved year-over-year by nearly $19 million to $46 million in the fourth quarter representing an unlevered free cash flow margin of 35%. For the full year, unlevered free cash flow exceeded our expectations at $44 million or 9% of revenue. Now let’s turn to the balance sheet. We continue to maintain a well-capitalized balance sheet. As of December 31, our total cash and investments balance was approximately $660 million. Additionally, as of December 31, we had $533 million in carrying value of debt as a result of the new convertible notes agreements with Silver Lake and LinkedIn which were completed on December 8, 2017. We intend to use approximately $253 million of our cash and investments to pay-off our existing convertible debt which is due in July of 2018. In 2017, our Board of Directors authorized a $100 million share repurchase program. The program is expected to be executed through 2019, but is not specific as to when or how many shares will be purchased. In the fourth quarter, we repurchased approximately 600,000 shares totaling nearly $23 million. Through last Friday, we repurchased in aggregate 945,000 shares at an average cost of about $36 for a total cash outlay of $34 million. Our deferred revenue balance was $326 million as of December 31, compared to $282 million in the prior year representing a year-over-year increase of 16%. In 2017, our total capital expenditures were $7 million or approximately 1% of revenue, which is low relative to our historical average of 3% to 4% of revenue. For 2018, we expect that our capital expenditures will increase to 3% to 4% of revenue as we continue to make improvements to our data infrastructure to support our client growth. This amount also includes the funding of two new European datacenters in Paris and Frankfurt. Before we turn to our 2018 outlook, I’d like to provide an update on ASC 606, which became effective for us on January 1, 2018. We have elected to adopt the new accounting standard using the modified retrospective method. Beginning on the Q1 2018 call, we will report our financial results under ASC 606 and we will also disclose our 2018 results under ASC 605, the current accounting for revenue recognition in the footnotes for comparative purposes. Please note that all guidance today is reported under ASC 606, but you can view the prior ASC 605 standard in Slides 6 and 7 of our supplemental deck for comparative purposes. Now let’s discuss our 2018 outlook, which has been developed using the best information we have as of today. Please note that our guidance assumes a US dollar to British pound exchange rate of 1.40 to 1, up from 1.32 at the time of our last earnings call. This also assumes a U.S. dollar to euro exchange rate of 1.24 to 1. Slide 7 in the supplemental deck summarizes our 2018 guidance. We have discussed at length the reasons why we are exiting the services delivery business and I want to drive home the point that our total revenue guidance reflects our best estimate as of today at to the pace that which the services revenue will roll-off to our partners. As a reminder, roughly one-third of our services business is related to technical integration projects. We will keep most of these projects and convert as we can into recurring revenue streams. We expect the remaining two-thirds of the services business to transition to our diverse ecosystem of service partners over the next several quarters. We currently believe service revenue will be down roughly 20% in the first quarter of 2018 and 50% for the full year, both on a year-over-year basis. This decline in services revenue should accelerate as we go through the year with the third and fourth quarters seem as steepest year-over-year declines. The pace of the roll-off could be materially faster or slower than today’s prediction, which would impact our total revenue, but not our subscription revenue. Assuming a 50% reduction in services revenue, we are expecting full year 2018 revenue in the range of $497 million to $507 million and full year 2018 subscription revenue in the range of $453 million to $463 million. At the midpoint of $458 million, this represents approximately 15% growth and 13% constant currency growth over our 2017 subscription revenue of $397 million. This is a slight increase from our previous guidance due to currency movements and the adoption of ASC 606. For the first quarter of 2018, we expect total revenue in the range of $126 million to $128 million and subscription revenue in the range of $111 million to $113 million. At the midpoint of $112 million for subscription revenue, this represents approximately 21% growth and 17% constant currency growth over Q1 of 2017 subscription revenue of $93 million. Regarding ARR, we expect full year 2018 ARR in the range of $475 million to $495 million. As mentioned previously, we will only disclose this metric for the full year as it’s best reviewed on an annual basis given the seasonality of our business. Moving on to profitability, we expect 2018 operating income to be in the range of $52 million to $62 million resulting in an operating margin of 10% to 12%. This slight decrease relative to our previously communicated operating margin range of 11% to 13% is due entirely to the adoption of ASC 606. Absent this accounting adjustment, there is no change to our operating profit guidance which demonstrates a 2x improvement from our profitability in 2017. Note that the pace of which services revenue rolls off should have very little impact on our dollars of operating profit, but it will impact our operating margins. For Q1, we expect operating margins to be slightly higher than Q1 of 2017. We expect Q1 to be the low point of our consolidated operating margins and then to experience a steady, but steep ramp through the remainder of 2018 as service revenues decline. For 2018, we expect first quarter interest expense to be approximately $5 million, which includes all non-cash amounts. For the full year, we expect total interest expense of $19 million which includes $14 million of cash interest. Regarding cash flow, for the full year 2018, we expect unlevered free cash flow of $50 million to $60 million assuming services revenue is down 50% by the end of 2018, this amounts to unlevered free cash flow margins of 10% to 12%. The datacenters we are building in Frankfurt and Paris should amount to roughly $5 million or 1% of free cash flow margin for the year. For Q1, we expect unlevered free cash flow to be slightly better than the prior year amount of negative $14 million. With respect to long-term margin targets, as we discussed on the last call, we believe the changes in our business will result in achieving the rule of 40 which we define as the sum of annual revenue growth and unlevered free cash flow margin by 2020. We plan to share additional details of the business drivers to achieve this goal at our upcoming Financial Analyst and Investor Day in March. Finally, I’d like to announce that we plan to attend to several upcoming investor conferences this quarter including the Goldman Sachs Technology and Internet Conference, the JMP Securities Technologies Conference, the KeyBanc Emerging Tech Conference or Summit and the Morgan Stanley TMT Conference. As I just mentioned, we will also be hosting a Financial, Analyst and Investor Day on March 13 at the Nasdaq MarketSite in New York City. You can register to attend the live event or listen to the event via the live webcast on the Events page of our Investor Relations website. In summary, we are pleased with what we were able to accomplish for the full year of 2017 led by a particularly strong second half. Although we are early in the transformation, we believe we have already made strong progress and now have the right leadership in place to best manage the successful transformation of Cornerstone. With that, I’ll turn it back to Adam.

[Adam Miller:]

Thanks, Brian, and thank you, to everyone who joined us today. We are excited about Cornerstone’s transformation and what it means for the future and we are pleased with the rapid pace of execution against our strategic plan. As always, I want to especially thank our global teams for all of their great work during this transition to help more than 35 million people around the world to realize their potential. We will now take your questions.

[Operator:]

Certainly. [Operator Instructions] Now our first question comes from the line of Scott Berg from Needham. Your question please.

[Scott Berg:]

Hi, Adam and Brian. Congrats on a good sales quarter. Lots of questions here, but I’ll start off with your guidance for ARR. You both are trying to convey, I think a pretty strong sales environment improving trends and better efficiencies there. Yet your ARR growth guidance for 2018 is only 10%. Can you help us reconcile the difference on those two areas?

[Brian Swartz:]

Yes, Scott, it’s Brian. I think you hit it right on the nail on the head. We are feeling good about the business. We are feeling good about the market opportunity and what lies ahead. Having said that, we have also and are still in the process of making a lot of changes to our business. We have new leadership throughout the company as Adam talked about. We are obviously exiting a big portion of the service delivery components of our business moving those to partners. We have less sales reps today than we did a year ago impart to drive productivity and optimization and lower tax ratios which is all the right thing to do for the business. So having said all those factors that coupled with the fact we are trying to be prudent. We are feeling good and excited about the future, but we are also trying to recognize that we want to be prudent with our outlook and be in a position where we can hopefully exceed those goals going forward. We are driving our teams obviously to much higher numbers than that and hope to execute in the coming quarters.

[Adam Miller:]

Let me just add, there is really no macro concerns. There are no market concerns. We are feeling very good about our new product introductions, about the strength of our solution, about market adoption, and about product market fit. But as Brian said, we want to be conservative. We have made mistakes in the past where we had changes going on and we were not conservative and that did not work well for us. So we’ve taken a much more modest approach.

[Scott Berg:]

Great and a brief follow-up to that if I may, Adam, is, you talked a lot about the improvements in Europe and the strength you are seeing on the sales side there. And I picked it up in my checks as well, but can you help us understand maybe what that market opportunity looks like over the next two or three years? Is this kind of because of an renewed opportunity, new opportunity there or is this going to skip?

[Adam Miller:]

No, I mean, I said, last year, I thought we were experiencing an anomaly in Europe. We had Europe being our best producing, fastest growing and most profitable business units for many years and we saw a major transition there as we moved from a non-Brexit environment to Brexit and when Brexit happened, it had a major impact on the business. Today, we are seeing a lot of opportunity post-Brexit with normalcy returning to the region. We are seeing performance across all seven of our European regions and we believe we are back to normal. So I would not say it’s changed at any point. But for Brexit, and the fact that we are opening two new datacenters, one in France and the other in Germany, certainly helps our long-term opportunity there as we continue to penetrate the market. The last point of course, is we are seeing very good traction of Cornerstone HR in Europe and we expect that that traction will only accelerate.

[Scott Berg:]

Great. Thanks for taking my questions.

[Operator:]

Thank you. [Operator Instructions] Our next question comes from the line of Brad Sills from Bank of America Merrill Lynch. Your question please.

[Brad Sills:]

Hey guys. Thanks for taking my question. Just wanted to ask strategic, it sounds like a real nice quarter for strategic deals if I am reading that properly based on the accounts you named. What do you attribute that to? I know, earlier in the year, the activity there was a little bit lighter. It sounds like you had a nice come back in the second half as you called out. Is that just better operational focus on the sales front or is something happening demand-wise?

[Adam Miller:]

I would say historically, strategic accounts do best in the second half of the year and in particular in the fourth quarter and that was true again in 2017. So, this is a little bit consistent with past practice. Having said that, as we do more of these strategic account deals, we are seeing opportunities to do even more. So, success begets success in this market and we are seeing a lot of opportunity both in Q4 of last year, but also throughout this year and I think you are going to see that trend continue this year in the strategic accounts space.

[Brad Sills:]

Great, thanks and one more if I may, just on cross-selling, it sounds like that’s kind of a new focus. You saw some progress with that motion this quarter. Is that a new focus? Am I right in saying that and so, which offerings did you see the most traction in? Thank you.

[Adam Miller:]

Yes, I wouldn't necessarily say it's a new focus. 70% of our clients have two or more products, 40% have three or more. So we’ve always been good at cross-selling and upselling. What has changed is as our client base gets larger and larger, as you could imagine our client sales team accordingly gets bigger and bigger. And so, what we are seeing now more balance between install base sales and direct sales from an overall revenue perspective and that we believe is a good thing. It allows us more stability in the business, more ability to perform consistently and of course on the install side, less competition. And so, all of that leads to better opportunity. That’s one piece of it, the other piece of it is, our products keep getting better. Our recruiting system is much stronger than it’s been in the past. Our performance system continues to be very strong. Our learning system, I would argue is better than it’s ever been and we now have a new opportunity both with Cornerstone HR and with Content. So, we are seeing more to sell. Our reps are more experienced and we have a larger installed base, all of which leads to more upsell.

[Brad Sills:]

Great, thanks, Adam.

[Operator:]

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

[Pat Walravens:]

Great, thank you. Picking one is hard, but I am going to go with LinkedIn. So in a best case scenario, Adam, what would you love to see from the LinkedIn partnership?

[Adam Miller:]

So as I mentioned before, Pat, this is a symbiotic relationship. They need our help in learning and we can help them quite a bit with Linda in LinkedIn learning and what they are doing there. Having tighter integrations on the learning side, giving them better distribution, more opportunity in the market. Conversely, they can help us on the recruiting front. They have the largest pool of candidates in the world, particularly white collar workers and having deeper integrations, better access to that candidate data gives us competitive advantage in recruiting. And so, I think we could each help the other and provide more market opportunity and as you wrote about and saw recently, we didn’t just have the investment from LinkedIn, but now true strategic partnership and there will be more announcements throughout the year as we get deeper and deeper in the relationship.

[Pat Walravens:]

Great, okay, thank you.

[Operator:]

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

[Michael Nemeroff:]

Thanks for taking my questions guys. Nice job in the quarter. Adam, one of the questions I get asked all the time from investors is whether, you’ll be able to continue to grow subscriptions at least 15% over the next few years as you transition the business? Can you break down the drivers of growth including industry growth, price per seat, new products, et cetera and can you give us a sense what you expect to be those drivers of growth to keep it at 15% at least over the next two or three years?

[Adam Miller:]

Yes, so I think there is a number of different factors at play. So one is, win rates. Our win rates have gone up year-over-year. Second is, ASPs, we saw ASPs go up meaningfully year-over-year in the fourth quarter, third is, win rates specifically around, not just learning deals, but learning plus x. So learning plus performance, learning plus recruiting which we have a pretty good track record of, but the real growth drivers are three things, particularly as it relates to recurring revenue which is where our entire focus is today. Number one, more recruiting sales to the installed base. We think our recruiting products will be best-in-class as of our May release and that’s going to allow us much more penetration of the installed base which as you know is a very big market opportunity for us. The second is content. We are seeing a really big content opportunity. We rolled out our learning experience platform in the middle of last year. We then rolled out Content Anytime subscription. At the end of last year, we’ve seen really good demand from both segments and we think we are going to be able to continue with that demand. The third is, our ability to convert some of our non-recurring revenue to recurring revenue. There is a number of service projects, particularly in the tech area that we do for clients. The truth is we probably should have been doing this on a recurring basis five or ten years ago. But we absolutely can do it now and that creates an incremental recurring revenue stream for us and one that’s both highly predictable and relatively straightforward to do, because it’s something we know the clients are adopting, it’s something we’ve been doing for many, many years and it’s simply a matter of converting the terms of the agreement for those projects. And then I’ll give you a fourth and this is the longer term opportunity for us and that’s Cornerstone HR. We are seeing really good traction in Europe. We now have over a 100 Cornerstone HR clients. The product keeps getting better with each major release and we believe this could become a large-scale incremental opportunity for us globally, not just in Europe, in 2019 and beyond.

[Michael Nemeroff:]

Great, thanks, Adam. It’s helpful.

[Adam Miller:]

Thank you.

[Operator:]

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

[Pinjalim Bora:]

Hi, this is Pinjalim sitting in for Mark. Adam, as you go hitting the ARR goal or maybe beating it, what is all of the assumption across the bigger segments like international, federal, strategic versus mid-market? I mean, where are you stacking your bets for this year among those and which could be more like wildcards?

[Adam Miller:]

Yes, so about a third of our business is international today and we think that will continue. There is upside there, particularly in Asia Pacific and Latin America, where that number could continue to creep up and we think long-term, we will be 45% to 50% of our business. But today, again, it’s about a third and we think there could be incremental upside there. The U.S. enterprise business has always been a rock for us. The exception was the first half of 2017. We talk about that later, but we clearly had an issue there in the first half of 2017. It recovered in the second half of 2017 and we expect that will continue to be a big portion of our business. Mid-market, we think has some upside opportunity. We are not forecasting the upside, but we believe that the content play specifically will do very well in our mid-market segment. We’ve seen growth opportunity there. And then, on the two extremes, strategic accounts and SMB we are seeing good traction in both areas. Like I said, we’ve consistently now done a number of eight figure deals each year. We think that will continue and the SMB market has seen really good growth albeit at a very small starting point. And the last which is most important, I think in Q3 of this past year, with public sector. We are continuing to invest in the public sector operation, both from a personnel standpoint and from a product standpoint as well as the overall technological infrastructure and we see a lot of upside from our existing clients in the Federal space organizations like the U.S. Postal Service, the Census Bureau and the SEC. And we see opportunity more broadly in government and education as well as we recently moved healthcare into the public sector organization at Cornerstone and we see a lot of upside there particularly as we combine our healthcare products with healthcare content, which we think is a really nice play for us and will result in a lot of incremental growth, both in the near-term and over the long-term.

[Pinjalim Bora:]

Okay, thanks a lot. And then I have a follow-up on the ASC 606, Brian, I would have thought that operating profit would be probably more under ASC 606 because you could capitalize the commissions, but it seems like it’s less. Could you help reconcile that?

[Brian Swartz:]

Yes. So we’ve always capitalized commission. So there is a kind of an accretive impact in the outer years, but the adjustments we’ll be making on January 1, 2018 for the adoption we’ll be putting, it’s roughly about $30 million of additional diverse commissions on our balance sheet day one. The impact of that amortization basically offsets at least for the first year, the benefit of the commission amortization on the new sales. So overtime, in the outer years, call it, two three years from now, we do expect to get one to two points of margin accretion as a result of that. But it will take time for it to fully benefit in the margin profile for us – until we get out a few more years.

[Pinjalim Bora:]

Got it. Thanks a lot.

[Brian Swartz:]

Sure.

[Operator:]

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

[Scott Wilson:]

Yes, hey guys this is Scott on for Alex. Adam, you just called out improving win rates. So maybe it’s a good time to ask about the competitive environment. So, could you maybe speak to what’s changed in the market over the last year that’s allowing for these improved win rates and maybe to the extent that there are differences in different markets. I am thinking kind of U.S. versus Europe or enterprise versus general market? Could you comment on those dynamics it’s all to be great to hear. Thanks.

[Adam Miller:]

Yes, so, maybe it’s worth answering the converse. So, we obviously had a very good back half of 2017, but a very soft first half of 2017 and even weakness in the second half of 2016. So, what happened during that twelve month period? Three things really happened. So number one, some of our partners became competitors. So you had an inversion from companies that were bringing us business to companies that were trying to take business away from us. That was a meaningful swing in the ecosystem and that was driven predominantly from the payroll companies as well as Workday. The second was the Workday effect. Workday announced a learning solution. It did in hindsight have a freezing impact on the market particularly in U.S. enterprise. We think that effect has thawed. The reason being the product is now in the market, people understand what it can and can’t do. And the hype is worn away. So that put Cornerstone back on top of the market around learning. The other thing to keep in mind is that, that impact was really focused on Workday clients in the U.S. And that’s a subset of a subset of our market. We are now seeing opportunity all around the world and even within that sub-group, because the product cannot do everything or even slightly close to what Cornerstone Learning does, it’s only applicable for various small subset of the population. And is not a meaningful impact on overall demand for Cornerstone. The third is, we did miss a product cycle as it related to Learning, particularly what people are calling learning experience and the learning experience cycle did have a big impact on us, again, for a very brief period of time. And so these were companies like degree of EdCast and Pathgather, startups that are doing work, creating a Netflix like experience for learning, but without all of the functionality in depth needed for true learning management system. As you all know, we have invested very aggressively in this area and now have a state-of-the-art solution for learning experience. We have the most data, the best machine learning and it is completely unified with the number one learning management system in the world and we just layered a subscription content offering on top of it. So we are back on top in the learning space.

[Scott Wilson:]

Very helpful. 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. I appreciate it. Brian, with the switched focus on ARR, I was wondering if you could maybe help level set us on what ARR looks like in 2016? And maybe give us an idea of how the mix looks from enterprise mid-market and SMB for ARR and what the growth rate looks like in 2017? And if you already addressed these, I am sorry, if I repeated my question.

[Brian Swartz:]

No, no. It’s a good question. It’s not been asked. Samad, I think – so, we’ve done a lot of work around analyzing our ARR and as we’ve talked about growing recurring revenue is the key for us going forward and we are going to be very focused on that metric. We’ve always tracked the metric, obviously internally and looked at it along with many other metrics as we looked in our business. What I can tell you, we are not disclosing – to answer your question directly, any ARR balance prior to December 31, 2017 and it really is just around the level of precision in the data. We’ve looked at the metric previously, but we didn’t have the right control around it to feel comfortable disclosing that with the level of accuracy that we need. What I can tell you is the implied growth at the midpoint of about 10% is the lowest as it’s been in the last few years and impart that’s for all the reasons that I mentioned on the earlier question around what’s baked into that guide and everything else. We are feeling really good about the marketplace and our product market fit, the opportunity out there, but given all the changes internally that we are making obviously to the business we are being prudent in the outlook. So, hopefully that’s helps answer the question and also give you a little background on it.

[Samad Samana:]

It’s definitely helpful. And then maybe, Adam, a follow-up for you on Cornerstone HR. Appreciate the callout on a number of customers. Could you give us maybe a general average demographic of what a C side HR seat deployment looks like versus maybe the rest of the base or the average base looking back into and again if you could give us a size of maybe the revenue installed base that they represent. That will be helpful. Thanks again for taking my questions.

[Adam Miller:]

Yes, so, a typical CHR deal actually is not typical. So it varies across industries, across segments, across markets. But they tend to be outside of the U.S. and the vast majority are in Europe. Now within that, I could tell you that the ASP of a CHR deal or a deal that includes Cornerstone HR typically is four times plus a non-Cornerstone HR deal and the reason is, most clients that are buying Cornerstone HR are investing in the full platform. So, it means that they are not just buying Cornerstone HR, they are buying learning, performance, recruiting and HR and that’s creating a very big opportunity set for us. So these are much larger deals and we think that opportunity is going to continue to grow. It also helps position us in a world where we are competing with predominantly ERPs in the high-end of the market and particularly in Europe, those ERPs are very focused on the HRIS story and more broadly the HCM, the Human Capital Management story having Cornerstone HR enables us to play in that sandbox and we are now seeing the ability to win more often than not in those deals. So, it’s positioning us very well. And we think creates a very large long-term opportunity for us.

[Operator:]

Thank you. Our final question comes from the line of Siti Panigrahi from Wells Fargo. Your question please.

[Siti Panigrahi:]

Hi, thanks for taking my question. You talked about a reduction or cost-cutting in sales and marketing and is it 5% global sales force. I am wondering what percentage of that is in sales and marketing. And then, just follow-up to like the changes you are doing, what sort of feedback you have got from the sales guys at this point? And are you making any changes to sales commission, the fact that now you are going to just focus on recurring revenue?

[Adam Miller:]

Yes, so, I’ll answer the last part first. We made a dramatic change to our sales commission plans. We are no longer commissioning our sales people. We are providing quota credit for non-recurring sales. This is a major difference from what we’ve done in the past and you would expect that would have some reaction from the sales force either positive or negative, but some reaction. And because of what we’ve done around this transition, it’s been a very positive reaction and the reason is, the overall quota goes down. Again, in the past your quota for both recurring and non-recurring sales, as you could imagine, if you eliminate the non-recurring portion, then your quota is going to be lower. The second is, we wanted to make sure that our reps were not at a loss, because of this change. So we ensure that the OTE, the on-target-earnings would remain consistent with prior years even with this change that leads to higher commission rates for the recurring portion and because of the reduction in force, most of the reps actually now have a larger territory and we now have more products for them to sell including content. So the reps are feeling very good about their opportunity this year and to give a specific anecdote, the mid-market team which has historically plugged us recently with significant turnover has been extremely stable this year and the people on that team are extremely excited about the opportunity ahead for them in large part because of the opportunity to attach content to their learning deals, which resulted a much larger ASP and a much bigger opportunity for them, especially given the new commission rates.

[Brian Swartz:]

And Siti, it’s Brian. I think the first part of your question was the breakdown of the size of the risk that we have. The risk impacted about 6% of our workforce about two-thirds of it was services-related as a result of exiting most of the services business and about a third of it was sales-related. So, that helps break it down. The other thing I do want to mention is, in my prepared remarks, I had mentioned that that risk had taken place in November. It was actually December. So I just wanted to clarify that as well.

[Siti Panigrahi:]

Appreciate the color. Thank you.

[Operator:]

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

[Adam Miller:]

Thank you to everyone for joining us today. We look forward to seeing you at the upcoming investor conferences and at our Financial Analyst and Investor Day on March 13 in New York City. Thank you.

[Operator:]

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