Cornerstone OnDemand, Inc.
Q3 2016 Earnings Call Transcript

Published: 4 Nov 2016

[Operator:]

Good day, ladies and gentlemen, and welcome to the Cornerstone OnDemand Third Quarter 2016 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. I'd like to turn the call over to host, Alexandra Geller, Manager of Investor Relations. Please go ahead.

[Alexandra Geller:]

Good afternoon, everyone, and welcome to Cornerstone OnDemand third quarter 2016 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 September 30, 2016. 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, certain projected financial results and operating metrics, product development, 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 reduction of DSOs, 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. Excluding revenue, all financial figures discussed today are non-GAAP. 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. I'm pleased to report that we significantly exceeded expectations in several areas in the third quarter, most notably, revenue and profitability. Revenue reached another record high, coming in at $108 million, representing 30% year-over-year growth on a constant currency basis, and net income for the quarter was $6.9 million, well ahead of where we had anticipated being at this point in the year, and demonstrating the success of our focus on operational excellence and margin expansion. While the fundamentals of our business, including demand for our solutions, customer satisfaction with existing products and the initial positive response we've been seeing to new products remain strong, we identified three challenges that impact our near-term growth outlook. First, we experienced slight delays in Q3 with nearly all UK-based prospects and many others in the broader European Union, largely driven by Brexit and related concerns about data security and privacy given the uncertainty around what the EU will look like in the future. As a reminder, our European data centers are in the UK. Second, while we believe our strong international business is a tremendous long-term asset, Cornerstone's global exposure has been a near-term headwind. As Brian outlined last quarter, about a third of our revenue comes from outside the US and flows through our UK subsidiary, which has a functional currency of the British pound. As a result, because of Brexit, the continued devaluation of the British pound against the U.S. dollar will continue to put pressure on our revenue. And third, while we exceeded our expectation in other areas of the business, we saw slower progress from our national accounts team, which focuses on the upper-mid-market segment, than we had hoped by this point in the year, especially given the changes we've implemented over the past year. While issues related to Brexit and foreign exchange remain largely beyond our control, we can address our challenges in the mid-market. We've decided to eliminate our national accounts team and consolidate our national and major accounts efforts into a single mid-market sales team to drive efficiency. While we understand that our focus on efficiency may cause us to trade off some near-term growth, we believe it will set us up to achieve even stronger gains in profitability, without sacrificing our outstanding long-term growth opportunities. Now, onto the highlights of the quarter. We have continued to grow our user base, adding almost 1.4 million net users in Q3, reaching nearly 28 million total users. This represents one of the largest subscriber bases of any software provider in the world in a market where we believe there is still significant opportunity for growth. As we have grown, we've maintained excellent client satisfaction, which has enabled us to achieve 95% dollar retention on average since 2002, excluding upsells. We fully expect our dollar retention rate to remain at an industry-leading level, again, in 2016. Our success up-market has continued unabated through the first nine months of the year. The third quarter was no exception, with a number of notable large client additions, including the World Bank Group, Unipol Gruppo, Panasonic Corporation of North America, GEMA, the U.S. Securities and Exchange Commission, one of the largest banks in Spain, the Central Bank of Norway, one of the largest casino operators in the world, Hammerson plc, and a large accounting firm in India, among many others. We continued to see even more opportunity for growth in the enterprise base. We also saw particular success in pharmaceuticals, adding a Fortune 100 pharmacy benefit management organization, a large French life sciences company, and India's largest pharma company, to our customer list. In the last couple of years, since we verticalized our approach to healthcare and life sciences, we've consistently secured the world's largest life sciences companies as Cornerstone clients due to our solution's unique ability to meet the sophisticated compliance requirement within that space. Today, healthcare and life sciences is one of our fastest growing and most penetrated verticals. Another strong performer during the quarter was client sales, which has exceeded expectations every quarter this year, and which we expect will remain a key driver of our continued growth. As our clients continue to pursue a more integrated approach to managing their people, we believe our land-and-expand strategy continues to have tremendous potential. One such client is one of the largest food distributors in the U.S. who became a Cornerstone client in August 2013 by purchasing learning. After a successful implementation, they added compensation just five months later. Over the next two years, they added more learning users and purchased performance, while also engaging our services organization to perform a handful of projects to enable them to maximize the utility of their Cornerstone products. When they renewed their contract with us this August, they also purchased recruiting and onboarding for their entire organization, taking our footprint with them to five products from just one in only three years. As we have continued to enhance our existing products and add new products, the installed base opportunity has become increasingly compelling. With respect to products, we've been increasing our investment in Cornerstone HCM, leveraging our solid foundation as the world's number one talent management system and supplementing it with Cornerstone Link, our new employee self-service and people administration tool, which we first unveiled at Cornerstone Convergence in May. We believe Cornerstone HCM opens up growth opportunities for us in three ways. The first is with smaller mid-market companies who have grown out of using payroll as the primary means for tracking employee data, but cannot afford a full HRIS. We solve this issue for them by offering a cost effective interim solution, akin to how NetSuite served as a bridge between QuickBooks and Oracle Financials early on. Second, many of our multinational clients have many HRIS systems, sometimes approaching 20 or 30 different systems often driven by acquisitions made over time. These companies often want to implement a new enterprise HRIS system, but that can be expensive, time consuming and disruptive. These clients are already using Cornerstone organization-wide to manage their talent, so adding Link in Cornerstone Analytics becomes much easier as a cost effective alternative to centralize the global data across the enterprise by leveraging our solution as a hub for their various HRIS spokes. Third, there are many large companies that want to replace their very old HRISs, but cannot afford to upgrade them. Cornerstone HCM allows those companies to modernize their existing systems by overlaying them with our modern people administration solutions and cutting-edge talent management. Since convergence, we've seen strong traction in this area. We already have sold a number of Link deals in the mid-market segment, resulting in significantly higher ASPs. And we are really starting to see strong momentum with large clients in EMEA. With the addition of Link for clients with multiple HRIS systems provides as much needed solution for their global HCM strategy. As our profitability demonstrates, we also continue to focus on operational excellence. After building out our operations function last year, we have made great strides across a number of different initiatives including decreasing our sales and marketing spend on an expedited timeline. We continue to analyze our cost structure and find opportunities to drive leverage in our business model, including through a reduction in services outsourcing, improved strategic sourcing, increased business automation and improved sales efficiency. These initiatives have contributed to the significant improvement in margins that we've already seen in the business. I now like to turn it over to Brian to discuss our financial performance in more detail.

[Brian L. Swartz:]

Thanks, Adam, and good afternoon, everyone. I'd like to start by summarizing our quarterly financial performance. Then I'll spend some time talking about our enhanced focus on operational excellence and the balance between revenue growth and profitability. And then, I'll conclude by providing an update to our 2016 outlook. In the third quarter, revenue was $108 million, representing a year-over-year increase of 23% or 30% on a constant currency basis. The outperformance of nearly $3 million above the high-end of our guidance range was largely attributed to strong execution by our services team. And the split between subscription and services revenue was consistent with historical trends at 80.1% and 19.9%. Additionally, during the first nine months of 2016, due largely to our continued success at the top-end of the market, for new sales, we experienced a higher percentage of services revenue, relative to total deal size. In the third quarter, our constant currency billings increased 9% year-over-year, while our reported billings of $107 million increased 3%. It's important to note that the reported billings number was materially impacted by the continued devaluation of the British pound during the quarter. This is evidenced by calculating billings using the cash flow method, which adjust for a portion of the devaluation impact and results in $110 million in billings for the quarter. A few other key metrics, the size of our client base increased to 2,805 as of September 30, representing 75 net new client additions during the quarter, and our user base increased to 27.7 million users, representing nearly 1.4 million net user additions. Additionally, we added 66 employees, bringing us to 1,788 employees at the end of the quarter. Our total employees increased 11% year-over-year and 4% sequentially. Our gross margin was 72.2% in the third quarter, down 70 basis points from 72.9% in the prior year. The reduction was due to a slightly higher percentage of services revenue during the quarter. With respect to operating expenses, as a result of our continued execution across various operational excellence initiatives, we again demonstrated improved efficiency. Most notably, sales and marketing expense was 44% of revenue during the quarter, down 980 basis points year-over-year. We also saw a small reduction in R&D expense, which was down 80 basis points to 9% of revenue, while G&A expense saw a slight increase of 100 basis points to 13% of revenue. Together, this resulted in an operating margin of 6.4% for the quarter, which represents a 900-basis point improvement from negative 2.5% in the prior year. We're extremely pleased with this performance and particularly with our continued improvement in sales and marketing. Just nine months into our three-year margin improvement plan, we have already achieved a high-end of the sales and marketing expense range two years ahead of schedule. Driven by our operating expense improvement, I'm pleased to report we once again came in substantially ahead of our profitability expectations for Q3. Net income for the quarter was approximately $6.9 million or $0.11 per diluted share compared to a net loss of $3.2 million or $0.06 per share in the prior year. With respect to cash flow, free cash flow, which we define as operating cash flow less capitalized software and capital expenditures, was $7.8 million in the third quarter of 2016 compared to negative $3.8 million in the third quarter of 2015. Now, let's turn to the balance sheet. We continue to maintain a well capitalized balance sheet. As of September 30, our total cash and investment balance was approximately $311 million. Additionally, as of September 30, we had $236 million in carrying value of long-term debt. Our deferred revenue balance was $235 million as of September 30, 2016 compared to $206 million as of September 30, 2015, representing a year-over-year increase of 14%. Before talking about our outlook, I'd like to take a minute to discuss our enhanced focus on operational excellence. Cornerstone's growth from start-up to public company has been nothing short of spectacular. Given the tremendous value our products deliver to our clients every single day, along with the hundreds of millions of people in the global workforce who have yet to use a SaaS-based human capital management solution, there is a very long tail of opportunity for us that I believe will extend for many decades. With that said, based on my observations over the past couple of months, I also believe that in order to optimize the efficiency of our business, we need to operate differently from how we have in the past. It has become clear to me that the different regions, segments and verticals that comprise our total addressable market all mature at different paces, largely beyond our control. We have invested in many of these areas and given them time to demonstrate their near-term potential. So we must now take our learnings from these investments and tighten our focus. In order for Cornerstone to truly achieve operational excellence, we must hold ourselves accountable for underperformance and that is exactly what we intend to do going forward. In some cases, that may result in a complete restructuring of a team such as what we are doing with our mid-market sales organization. Ultimately, I am confident this more disciplined approach will allow us to achieve the right balance of growth and profitability with the goal of maximizing shareholder value over time. Now, let's turn to our outlook, which incorporates the best information we have as of today and may change in the future as we gain additional insight into our fourth quarter operating results. Please note that all guidance assumes a U.S. dollar to British pound exchange rate of $1.22 to £1, which is down about 6% from $1.3 on our last earnings call. Principally due to the continued devaluation of the British pound, we are lowering our previously communicated full year 2016 revenue guidance from a range of $424 million to $428 million to a range of $422 to $424 million. At the midpoint of $423 million, this represents 30% constant currency growth over our 2015 revenue of $340 million and 25% growth on a reported basis. If the British pound were to further depreciate by 5%, the approximate impact on our full year revenue would be about $2 million. This implies that, for the fourth quarter, we currently expect revenue between $108 million and $110 million. Regarding billings for the year, as a result of the further devaluation of the British pound, which impacts the fourth quarter by about $6 million, the restructuring of the mid-market team and the uncertainty in the UK and the European Union resulting from Brexit, we are lowering our expectations. We now expect that our third quarter billings of $107 million will represent about 24.5% give or take of full year billings compared to 23% that I mentioned on our prior earnings call. It's important to note that at the current FX rate, the year-over-year growth rate between the reported and constant currency billings will be larger in the fourth quarter than they were in the third quarter due to the continued strengthening of the U.S. dollar compared to the British pound since September 30. With respect to net income, given our strong performance in Q3, we are raising our full year net income guidance from $500,000 to $2.5 million. As a reminder, for EPS purposes, our share account of approximately 56 million increases to approximately 61 million in quarters in which we report a profit. Now, let's turn to cash flow. For the full year 2016, we are reducing our previously communicated free cash flow guidance of approximately $27 million to $10 million. This reduction in free cash flow is primarily a function of timing and due to three items. First, despite our expected increase in net income, I have elected to make certain one-time working capital adjustments, which will impact cash by approximately $10 million. Second, we saw increased payment terms given to clients signed late in Q3 which will result in some cash collections being pushed into 2017. And third, the continued devaluation of the British pound will also impact free cash flow by approximately $4 million. Despite these three items, we have and will continue to operate much more efficiently than we have in the past as shown by our significantly improved profitability. Consequently, we remain confident that we can achieve and we'll try to exceed our 2018 operating margin target of 10% and our free cash flow margin target of 16%. Although, we would typically provide some color on 2017 at this time, since I'm relatively new to the CFO role and given our focus on finding the right balance between revenue and profitability, we will provide our initial 2017 outlook on our next earnings call. And with that, I'll turn the call back to Adam.

[Adam Miller:]

Thanks, Brian. To wrap up, I want to reiterate that strong fundamentals have driven the results we reported today. At the same time, we are reacting decisively to the exogenous factors that have created headwinds for us in the market. I want to thank our global team for their dedication to helping nearly 28 million people to realize their potential. We will now take your questions.

[Operator:]

Thank you. Our first question comes from Scott Berg from Needham. Your line is open.

[Scott Berg:]

Hi, Adam and Brian. Thanks for taking my questions. I have a couple here for you. First off, Brian, going back to your last comments there around payment term changes in the third quarter. Can you help us quantify kind of what that looked like either on a magnitude basis or how it impacted billings in the quarter?

[Brian L. Swartz:]

Yeah, Scott. Nice to hear from you. Thanks for the question. First of all, we're going to try to limit everyone's questions to one question, so please try to do that. With respect to the extended payment terms, it had a mild impact on some deals that we did in late Q3, which, as I mentioned in the script, will push the timing of those cash collections into 2017. With respect to upfront billings rate, it was pretty consist with what we saw in the first half of this year, down slightly year-over-year, but pretty consistent with what we saw in the first half of this year.

[Operator:]

Thank you. Our next question comes from Brent Thill from UBS. Your line is open.

[Brent Thill:]

Thanks. Adam, just on the mid-market, you've been working on this for quite some time. What is, in your opinion, not firing at the level that you'd like there and I'm curious how long you think it's going to take to pull this back into where you'd like to see it? Is this a multi-quarter initiative, is this one quarter out? And Brian, if you can remind us the percent of the revenue that's derived from this particular sector; I think the last account we had was close to 35% to 40% of revenue, is that kind of a fair change for the mid-market business as a percent of revenue?

[Adam Miller:]

Yes. So, this is something that is already underway. It will happen very quickly. And we think it boils down to the fact that when we split up these teams, we put the reps in a position where either they were doing a lot of small deals with no chance at a home run, or they were working on very large deals with no chance of momentum, no singles or doubles for them. And so, we think by putting the territories back together, putting the teams back together and streamlining that organization, it allows us to have, number one, much better efficiency, on the productivity side and the cost side, and number two, much better productivity for the reps. So the reps have a greater ability to consistently perform and to hedge their portfolio, mixing both small and large deals in their pipelines. And that is what we saw back in 2012 and 2013 when the teams were structured that way.

[Brian L. Swartz:]

And Brent, its Brian, just to follow up on the second part. We have not broken out – we have never broken out actually the actual segmentation of our clients. As you know, we are primarily an enterprise upper market business. But we haven't provided the exact breakdown of what percentage of revenue is in mid-market.

[Brent Thill:]

Thanks.

[Operator:]

Thank you. Our next question comes from Mark Murphy with JPMorgan. Your line is open.

[Unknown Speaker:]

Hi, Adam. Thanks for taking my question. I'm sitting in for Mark here, Benjamin. We actually heard from a few of your partners that there has been a surge of deals in the learning and the recruiting space of late. In learning, obviously, we know that you're the leader, but in recruiting, seems like it's a very crowded space with a lot of smaller players. How do you view that market from relative to your opportunities and have you seen any deals where you have actually led with recruiting as of now? Any color would be great. Thanks.

[Adam Miller:]

Yeah. So, as you know, if you've been covering the ATS market for a while, Taleo and Kenexa dominate the enterprise segment. Between them, they have probably 80% plus market share in that segment, at least at their peak. And because they were both acquired a couple of years ago, many of those deals are back out for renewal. And that's created a pretty large opportunity in the enterprise segment for recruiting. So, our focus has been upper market in recruiting. Having said that, there are many smaller players now in the recruiting space with the advent of social recruiting, machine learning-based recruiting, chat box and the like, all of which have certain strong functional feature sets in various specific areas. But those are narrow solutions, they're not enterprise class. And we do not see them in these larger competitions. Now, what's changed is that, historically, we've sold recruiting as part of our overall talent platform. And more recently, particularly in certain segments, we have been able to lead with recruiting or do recruiting-only deals, so stand-alone ATS replacement deals in the enterprise. And today, recruiting represents about 20% of our client base from a perpetration perspective. That's up significantly from a couple of years ago. And we continue to see good momentum in the recruiting area. So, we continue to invest in that product set.

[Unknown Speaker:]

Thank you.

[Operator:]

Our next question comes from Michael Nemeroff with Credit Suisse. Your line is open.

[Adam Miller:]

Mike, I don't know if you're on mute. We can't hear you. Michael Nemeroff - Credit Suisse Securities (USA) LLC (Broker) Can you hear me?

[Brian L. Swartz:]

Yes.

[Adam Miller:]

Yeah. Michael Nemeroff - Credit Suisse Securities (USA) LLC (Broker) Okay. Thanks. Yeah. So, Brian, I'm curious. I know you haven't guided for 2017 – operational excellence initiatives that you talked about, I'm curious, what kind of expectations you would like investors to have in terms of cash flow or free cash flow?

[Brian L. Swartz:]

Yeah. And I think, Michael, the way we're viewing it right now, we laid out, as you know, about six months ago, some long-term margins targets for 2018. We are still focused on hitting those. We're actually focused on exceeding them. From the standpoint of where exactly we think 2017 will land at this point, just given some of the changes and, quite frankly, Q4 is generally a time when most companies do budget. It's obviously our biggest quarter is seasonally in the sector, and then all the other decisions we're doing around the focus around growth and profitability, we're just not prepared to comment today on what to expect in 2017. But we are standing by the 2018 long-term targets. And our profitable is getting much stronger, so our free cash flow should grow nicely over time as well. Michael Nemeroff - Credit Suisse Securities (USA) LLC (Broker) Okay. And then – I'm sorry. I joined the call a little bit late, but when I looked at the numbers, the sales and marketing expense this quarter was down substantially, but the guidance implied that there's a pretty significant ramp back up. Could you explain that? I'm sorry if I missed that earlier.

[Brian L. Swartz:]

Yeah. Well, we didn't guide exactly to the sales and marketing for Q4. So, in general, because of some of the pressure from currency, we obviously lowered our revenue by about $3 million. The profit is up $2 million. We weren't explicit on where that would come out quarter to quarter. But we do expect that to have a pretty substantial savings on just operating expenses in general. Michael Nemeroff - Credit Suisse Securities (USA) LLC (Broker) Okay. Thanks for taking my questions.

[Operator:]

Our next question comes from Jesse Hulsing with Goldman Sachs. Your line is open.

[Jesse Hulsing:]

Yeah. Thank you. Adam, you mentioned some challenges in Europe that were Brexit related and it sounded like having data centers in the UK was one of the issues. And I'm wondering what steps you're taking to help ease those concerns of your European customers. And I guess, looking at how Q4 has started in Europe, are you starting to see improvement in the close rate there? Thank you

[Adam Miller:]

Yeah. So, specifically around data privacy and data security, we have extensive experience in this area. We have a chief data privacy officer, a chief information security officer. We have teams dedicated not only to technology operations, but also specifically to data security and privacy. And the issue has to do with just the unknown in the European Union. And as you saw this morning, even Brexit itself is unclear. So, there's much confusion, and I would describe it simply to say that it's elongated sales cycles. So we are able to overcome it. We do have plans if necessary to open up the data center in Continental Europe to alleviate any concerns from the EU. But, right now, nothing has been decided as far as both Brexit and the interrelationship between the EU and the UK post Brexit if it occurs. As a result, we have not made any decision yet on what to do there. And the clients accept that and understand it, it just takes longer to explain. And so something that was very simple and a non-issue pre-Brexit has become a major point of discussion post-Brexit, elongating sales cycles. And we've seen that very clearly both in the Continental European prospect deals and amongst our UK opportunities. So, we're seeing the impact of Brexit on both sides of the EU at this point. And I do believe it is a short-term phenomenon. And these deals are not being closed. It's not that we're losing the deals, they're just getting delayed. And so I think it will come back and the long-term will be fine.

[Jesse Hulsing:]

Got it. And then just a quick follow-up for Brian along the same thread. Is there – have you guys tried to quantify what the impact was from that? Because it sounds like – that's a big chunk of business for you. It sounds like it could've been many deals. I'm wondering if it was single-digits millions of dollars type of impact or bigger or lesser or any help around that would be helpful. Thank you.

[Adam Miller:]

Let me answer that. As you know, Europe represents about 30% of our business, and I have felt strongly that our global diversification and percent of international business, about a third of our business today is outside the U.S., are extremely strong assets of the business, particularly over the long term. I would say relative to any other public SaaS company, we have been very strongly diversified internationally. But, of course, in the near term, it's become a liability with Brexit. So that's impacted both our ability to sell in that EU part of the market and it's impacted overall currency rate, so that impacts both revenue and deferred revenue as well as cash flow. And it's worth mentioning that within Europe, which is 30% of our revenue, the UK has been the strongest market historically. So, it's a more exaggerated impact than it should otherwise have in the case of Cornerstone relative to other companies that are out there.

[Jesse Hulsing:]

Thank you.

[Operator:]

Our next question comes from Samad Samana with Stephens. Your line is open.

[Samad Samana:]

Thanks for taking my question. I kind of wanted to follow up a little bit on that. Can you – it seems like the billings implied guidance for next quarter is slightly down actually year-over-year. Can you give us how much of that impact is due to Brexit versus national accounts versus FX, so we can have an idea of the magnitude of each issue impacting billings? And then just generally, what does the 4Q large deal pipeline look like?

[Brian L. Swartz:]

Yeah. So, a couple of things; in terms of breaking them down into different components, Samad, it's hard to do. We haven't done that. But here's what I can do to help you. The implied guidance does the math if you do the math on my comments – my prepared remarks. It does indicate that on a reported basis we're down slightly, flat to slightly down. But, remember, there's a big currency impact there. And on a constant currency basis, the difference between the reported and the constant currency growth year-over-year in Q4 will actually be bigger than it was in Q3 based on the guidance, because since September 30, the pound has weakened more. Now, that changed this morning, obviously, but who knows where the quarter will end. So, keep that in mind as the difference between reported and constant currency growth when you're comparing year-over-year growth Q3 to Q4. With respect to breaking it down specifically between the components, we haven't done that, but you can certainly make some conclusions or draw some conclusions on your own. But it will at least help you – tell you where we expect the overall growth to be in Q4.

[Samad Samana:]

And then just as a quick follow-up if I could, the users per client continues to grow nicely, but the net adds is tracking lower than levels seen last year. Could you just help us maybe understand is it just larger clients where you're narrowing your focus or is there some churn at smaller clients? Just help us to understand that number.

[Adam Miller:]

So, our client adds have grown sequentially and part of this, again, is the impact of the mid-market issues we've had as most of the client adds we've had historically when those numbers were quite high, it was lower mid-market client adds. And so, as we restructure that group, I think those numbers will come back up. But, generally, our retention has remained very strong and our growth up-market has remained quite strong. So, I wouldn't overly look at the unit metric, but it has improved sequentially quarter-over-quarter.

[Samad Samana:]

Great. Thanks for taking my questions.

[Brian L. Swartz:]

Can I make one comment? Just to elaborate that to help you, Samad, and everyone else. I think just to help break down the different components, I did mention in the call that with respect to billings in Q4 that the FX impact was $6 million, and then with the balance to the other major ones that we talked about, obviously, the major components just being kind of the UK slowdown or elongated sales cycle and then the impact of big markets. They're about 50/50 in terms of balance between the two if you're looking to where things were previously and where they will settle for Q4 now.

[Operator:]

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

[Alex J. Zukin:]

Hey, guys. Thanks for taking my question. So, Brian, maybe on the current quarter, if I look at the deferred revenue delta between kind of what you reported and the estimate about $8 million, how does that break down in terms of the mid-market team versus the international component? And in your mind, does that – I know you don't want to comment on how that changes the long-term growth rate, but given those two uncertainties and kind of given where growth has been, is there at least any kind of color you guys can provide on a high level about the intermediate growth pace of the company now?

[Brian L. Swartz:]

So, I'm sorry. I just want to make sure I understand the beginning part of your question. You mentioned something – are you talking about the current quarter Q3, are you talking about Q4, and then you mentioned...

[Alex J. Zukin:]

Yeah, I'm talking about Q3. The deferred revenue in Q3, the breakdown of that kind of the mid-market team effect versus the international effect.

[Brian L. Swartz:]

Well, for Q3, the reported billings – total billings was about $107 million. I'm sorry – $107 million, which is impacted by currency. So, in fact, I think I made a comment that if you look at the cash flow method, its closer to $110 million, which is pretty much in line with kind of what I talked about on the last call. So I'm not sure what you mean by the breakdown between the mid-market with respect to Q3.

[Alex J. Zukin:]

Yeah, I guess, I still don't understand. I still don't see how that $8 million delta, from a deferred revenue perspective, where you came in versus where you had been expecting is kind of all currency? I guess maybe how much of the delta above and beyond FX was due to the deals getting delayed or going through? We can take it offline.

[Adam Miller:]

Yeah, if you look at the billings, the $107 million on a constant currency basis would've been $110 million, $111 million is where the Street was. So we are basically exactly in line with billings and, obviously, beat with both revenue and earnings. So, these impacts are really future impacts...

[Brian L. Swartz:]

Right.

[Adam Miller:]

...which is what we've been talking about.

[Alex J. Zukin:]

Okay. Understood.

[Operator:]

Thank you. Our next question comes from Brad Sills with Bank of America. Your line is open.

[Brad Sills:]

Hey, guys. Thanks for taking my question. Wonder if you could comment a little bit on how the enterprise versus strategic accounts group performed this quarter and then any commentary on how that's tracking for Q4.

[Adam Miller:]

Yeah. So, specifically, the enterprise team has been our backbone from the beginning, and continues to be a very strong performer, obviously, through this year and also all of last year. We also are seeing great results from our client sales organization. The issue for us has specifically been mid-market as well as the impact of Brexit. So, strategic account, specifically, has had a very strong first half of the year and, probably, will end the year quite well. But we did have a big opportunity that is coming later in the year than might otherwise have occurred. I think we thought it could pull into Q3, but will end up most likely being in Q4.

[Brad Sills:]

Great. Thank you.

[Adam Miller:]

And we continue to do a number of eight-figure deals, and I think we'll have more in the pipeline in the future.

[Brad Sills:]

Excellent. Thank you.

[Operator:]

Our next question comes from Raimo Lenschow with Barclays. Your line is open.

[Raimo Lenschow:]

Thanks for taking my question and well done on the performance on the profitability side and the cash flow side. Brian, you talked about the changes you wanted to do in the organization around that. Can you just elaborate a little bit? Is that kind of – do you have to think about dynamic budgeting, what other guys are doing to kind of run the business more dynamic in terms of where the investments are going in and where you're not going to invest? Thank you.

[Brian L. Swartz:]

Yeah. It's a good question. The way we think about is we want a healthy balance between revenue and profitability fundamentally. And I'll give you a perfect example of what I mean by that. It relates to the changes in our cash flow guidance for this year. So my philosophy on cash flow is pretty simple. We should pay our vendors when we say we're going to pay our vendors and we should expect that our clients are going to pay us when they say they're going to pay us. So, as a result of that, we're not going to do things at year-end that just don't create long-term value for the business, right? And you can see historically, there have been obviously a lot of movements in our working capital in Q4 and, I think, taking some of that out of the business and focusing on the long term is what creates value over time, right? It's not short-term changes to cash flow. So that's an example of at least the way we think about it. I think, looking throughout the rest of the organization around optimizing efficiency, we don't want to invest just for growth just for growth sake; we want to invest in profitable growth. We want to do it in a consistent way. As we see market opportunity, we'll put capital to work to capture that market opportunity, but not overload the market so that we can't capture the market opportunity in a consistent way. So that's how we think about it. That's how we're going to be focused on building the plans for 2017 and beyond.

[Raimo Lenschow:]

Okay. Perfect. Thank you.

[Operator:]

Thank you. Our last question comes from Justin Furby with William Blair. Your line is open.

[Vinay Mohan:]

Hey. This is actually Vinay in for Justin. I got a question on the mid-market and then a quick follow-up. Any commentary on the partnership with ADP and sort of with what happened in the mid market, how that played out, whether it contributed, benefited at all? And then I had a quick follow-up on percentage of new business that you're selling back into the base and any additional color there? Thanks.

[Adam Miller:]

Actually, going back to a single mid-market team helped the relationship with ADP because we had a support team, created a little bit of confusion between where referred deals would flow. I would say the partnership probably worked more effectively when we had a single team. And I think we'll go back to that. So, ADP, amongst other partners, will help us continue to build our pipelines, and our mid-market pipelines are significantly stronger than they were in the past. So, we think going forward, the combination of a single team and the stronger pipelines will lead to good results.

[Vinay Mohan:]

And then a quick follow-up on the percentage of new business that you saw selling back into the base and sort of any commentary on what kind of module you're adding back both for enterprise and, I guess, mid-market at well? Thanks.

[Adam Miller:]

Yeah. So, client sales have been very effective over the last year since we've moved to immediate transference of account to the client sales organization upon the closing of the deal. That's been a very effective approach for us. That team has done quite well all throughout the year. And we expect to continue to grow. It's one of the reasons we've continued to invest in the product area. And we have seen very good adoption of recruiting, along with not just the ATS product, but the entire suite, including onboarding. And we now are seeing our deals getting expanded into full human capital management deals with the addition of Link, which we launched back in May. The adoption's been quite good of Link, combined with analytics and our talent suite really provides the full human capital management solution to our clients. That does elongate the sales cycle, so it does have some impact on the timing of deals. But it also increases the size of those deals, and so that patience is warranted to get those larger opportunities. They're also higher margin deals because same amount of effort goes into closing that deal, but it ends up with a higher ASP. So we are looking forward to the client sales team continuing to perform and continuing to execute across our entire product platform.

[Vinay Mohan:]

Awesome. Thanks.

[Operator:]

This ends our Q&A session. I'll turn it back to Adam Miller, Chief Executive Officer, for closing remarks.

[Adam Miller:]

Thank you all for joining the call today and we look forward to seeing you out at conferences and in the field soon. Thank you.

[Operator:]

Ladies and gentlemen, thanks for participating in today's program. This concludes the program. You may all disconnect.