Cornerstone OnDemand, Inc.
Q3 2015 Earnings Call Transcript

Published: 8 Nov 2015

[Operator:]

Good day, ladies and gentlemen, and welcome to the Cornerstone OnDemand Third Quarter 2015 Earnings Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would like to turn the call over to your host, Mr. Perry Wallack, Chief Financial Officer. Please go ahead.

[Perry Wallack:]

Good afternoon, everyone. This is Perry Wallack, CFO of Cornerstone OnDemand, and welcome to our third-quarter 2015 earnings conference call. As always, today's call will begin with Adam providing a brief overview of our performance, and then I will review some key financial results for the quarter which ended on September 30, 2015. Later, we will conduct a question-and-answer session. By now, you should've 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 the 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 materializes or any the assumptions prove incorrect, actual results could differ materially from those expressed 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. And with that, I will turn the call over to Adam.

[Adam Miller:]

Thanks, Barry, and thank you to everyone for joining us today. Q3 marked another strong quarter for Cornerstone, and I'm pleased to update you on the business and share some insights on our longer-term growth strategy. For the third quarter, bookings after adjusting for the impact of foreign exchange came in at $106 million, representing a year-over-year increase of 29%. GAAP revenue for the third quarter came in at $87.3 million, representing a year-over-year increase of 28%. In Q3, we continued to expand our organically grown client count to more than 2,400 midmarket enterprise companies around the world, including global leaders in virtually every New client additions include Maersk, Banco Santander, Femsa, Frontier Communications Corporation, the University of Auckland, the Virginia Department of Transportation, the world's largest independent biotechnology firm and one of the top three health insurance companies in the world, to name just a few. Our success in the large-enterprise segment has continued unabated. Much of our performance in the third quarter was driven by outperformance in the enterprise segment. Working with the largest companies in the world demonstrates the strength of our platform, our ability to scale and our ability to provide world-class services. However, along with that success comes the challenge of timing service projects, which are highly dependent on the ever-changing schedule's slow-moving multinational giants. As a result, we have continued to experience quarterly variability in service revenues predominantly resulting from implementation projects associated with those large accounts. While adding more and more new clients, we remain as committed as ever to find success. For the past 12 years, we have averaged annual dollar retention of approximately 95%, and we believe we are on track to achieve industry-leading retention in 2015. This combination of growth and retention has allowed us to reach over 22 million users in the third quarter, which represents a 34% year-over-year growth in the largest user increase we have ever seen in a single quarter. As employees seek to realize their potential in today's workforce, leading organizations become increasingly focused on learning and development. While the competition is finally beginning to recognize this now, we have over 15 years and hundreds of thousands of product development hours with learning at the center of what we do. And even as a global leader, we are continuously working with our clients to ensure our solution meets their complex requirements and evolving training needs across almost every geography and vertical from financial services, technology and manufacturing to public-sector healthcare, life sciences and retail. We believe it is our focus as a specialist in the learning and talent management which enables us to lead this market. Over a decade and a half of collaborating with our large-enterprise clients in all of these verticals has enabled us to effectively build the functionality required to meet their business needs. This has not happened overnight. You can't replicate our experience simply by throwing bodies and development. It is an iterative process, and we have spent nearly 16 years honing to be the best in the world. Further validation of this came in the third quarter when Cornerstone was once again named a leader in the 2015 Gartner Magic Quadrant for Talent Management systems. In order to further distinguish us from our competition, we acquired Evolve in November of 2014. One year later, we are very pleased with the progress we have made by combining Evolve's best-in-class machine learning platform, an experienced team of data science and analytics experts with the terabytes of people data that our platform houses. While we originally expected to have one predictive analytics product, the combination of the Evolve team with our pre-existing Cornerstone reporting team has enabled us to create a full suite of analytics products. The first new analytics product was released, Cornerstone Insights, which predicts workforce outcomes and enables data-driven decisions around talent. This initial release was focused on addressing two critical issues today's organizations are facing. The first is related to the challenges organizations in highly regulated fields such as financial services, healthcare and life sciences face to mitigate the legal and regulatory compliance risks associated with mandated employee training. Through our compliance control and compliance guide dashboards, clients can better prevent the future noncompliance and identify the best prevent the future noncompliance and identify the best policy changes to increase compliance. The second helps managers identify employees who are predicted to be strong internal candidates for open positions while also promoting career mobility within an organization. Through our predictive Succession dashboard, organizations are able to drive engagement and retention of top talent. Many additional insights are expected to follow. After recently showcasing Cornerstone Insights at the HR technology conference last month, we believe that the significant global demand surrounding big data is getting even stronger. We plan to combine Cornerstone Insights with Cornerstone Reporting – with Cornerstone View, our data visualization tool expected to be released early next year, and with Cornerstone Planning, our upcoming workforce planning solution, to form our analytics suite. We believe analytics represents the fourth pillar of our talent management platform, with opportunity consistent with the other three pillars. Today, over 80% of our clients have learning, over 60% have performance, almost 20% have recruiting and now we have a greenfield opportunity with analytics. Or, put another way, over the last couple of years, we believe we have essentially doubled the market opportunity with our installed base with the introduction of our recruiting and analytics solutions while at the same time strengthening our position as a talent management leader. In addition, later this month, we expect to launch a completely new growth addition built from the ground up to provide a state-of-the-art talent management solution for small businesses. A mobile-ready, self-configurable growth addition can be deployed by a small business in under three hours. These continued product extensions, combined without our success globally, enable us to continue marching towards $1 billion in sales. And while much of what I have discussed relates to the top-line growth, we remain fully committed to financial discipline, enhancing cash flow and continued progression towards profitability. We believe we are now well within striking distance for non-GAAP profitability. And in 2016, we intend to achieve non- GAAP profitability. Central to that effort is the optimization of our sales and marketing expense in order to bring it below 50% of revenue. While we think there are tremendous opportunities for long-term growth, we intend to be discerning about the timing of our investments. Overall, we anticipate that we will grow the top line in 2016 at a rate consistent with the rate of growth in 2015 and, at the same time, enhance cash flows and operating margins meaningfully. Look out for more from us next quarter when we will provide more specific 2016 guidance. With that, I would like to turn it back over to Perry to discuss our financial platform in more detail.

[Perry Wallack:]

Thanks, Adam. Before I get to the financial results for the quarter, I would like to remind everyone that the financial figures I discuss today are non-GAAP unless I state that the measure is a GAAP number. The reconciliation of our GAAP to non-GAAP information is provided in the press release and the detailed financials on our investor relations website. As Adam highlighted, we are very pleased with our bookings performance in Q3. Meaningful wins of new clients across the world are driving growth as we continue taking market share in what we believe is a $31 billion talent management market. As a result of our confidence in the size of the market, our competitive position and the strength of our platform, as well as our ability to retain and grow our current client base, we are excited to take on the challenges necessary to achieve our next milestone of $1 billion in revenue. Now let's turn to the numbers. Bookings, which we define as revenue plus change in deferred revenue, were $103.7 million for the third quarter, representing a year- over-year increase of 26%. As we have talked about on prior calls, I would like to remind you that our bookings can vary on a quarterly basis depending on the nature and timing of invoicing for new clients, existing clients and renewals. In Q3 our average billing term was in line with our two-year historical average. However, foreign-exchange negatively impacted bookings for the headwind of $2.3 million that can be seen on the cash flow statement. If you adjust for this item, the normalized bookings for the quarter was $106 million, representing 29% year-over-year growth. GAAP revenue for the third quarter of 2015 was $87.3 million, representing a year- over-year increase of 28%. In the third quarter, our services revenue was adversely impacted by implementation delays driven by the needs of some of our large-enterprise clients. As we have noted on prior earnings calls, and as some of our SaaS peers have experienced in the last quarter, our revenue can be adversely impacted by the timing of when consulting services are delivered to new and existing clients by our services organization and implementation subcontractors. In the third quarter, one such delay came from an eight-figure deal that was signed in the second quarter of this year. This client had a significant amount of services scheduled to be performed in the third quarter but needed to postpone their implementation due to their own internal resource and strengths. As Adam mentioned, and as we have said in the past, this is merely a tiny issue. As we continue to close the largest enterprises across multiple verticals and geographies and deal sizes grow, we are taking on large service projects that may cause some variability in our service revenue. For the third quarter, the software and services revenue mix was in line with our historical averages at approximately 80% and 20%, respectively. We would like to note that we are continuing to work towards disclosing the split between software and service revenue in our filings beginning in the first quarter of 2016. Foreign exchange further impacted revenue with year-over-year headwinds of approximately $1.8 million. On an FX- adjusted basis, our GAAP revenue would have been $89.1 million, representing a year-over-year increase of over 30%. We continue to expect foreign exchange to have a drag on future revenue based on current exchange rates and market conditions. The size of our client base increased to 2,466 clients as of September 30, 2015, representing 104 net client additions for the quarter. We expect our annual dollar retention for the year to be in line with our historical average of 95%. Our user base increased to 22.2 million users as of September 30, 2015, which represents the net addition of nearly 1.8 million users for the quarter, which is a record user increase for the Company. Turning to margins, our gross margin for the third quarter of 2015 was 73%. As we noted last quarter due to increased headcount in all of our services teams, increased spending associated with third-party subcontractors used for implementations and continued investments in our network infrastructure for the full year, we expect margins to be approximately 71.5. %. Now let's turn our operating expenses. Sales and marketing represented 53% of revenue in the third quarter of 2015, remaining flat with 53% of revenue in the third quarter of 2014. R&D represents 10% of revenue in the third quarter of 2015, also in line with 10% of revenue in the third quarter of 2014. G&A represented 12% of revenue in the third quarter of 2015, up from 11% of revenue in the third quarter of 2014. Overall, this resulted in an operating margin of negative 1.8% in the third quarter of 2015, down from 0.2% in the third quarter of 2014. As we have indicated in the past, sales and marketing expense is a key driver to leveraging our model. As Adam mentioned earlier, we intend to be even more discerning in 2016 with respect to our investments in sales and marketing. Net loss for the third quarter of 2015 was $2.5 million, our net loss of $0.05 per share based on a weighted average shares outstanding of 54.3 million shares, compared to a net loss of $2.2 million, or net loss of $0.04 per share, based on a weighted average shares outstanding of 53.4 million shares in the third quarter of 2014. With regards to cash flow, cash flow from operating activities in the third quarter was $6.7 million, compared to negative $3.4 million in the third quarter of 2014. As we mentioned last quarter, we have implemented programs to reduce DSOs on a quarterly basis and believe we are on track to achieve our 2015 goals. Let me now turn to the balance sheet. As of September 30, 2015, our total cash accounts receivable in short- term and long-term investments balance was approximately $352.1 million. On a GAAP basis, our deferred revenue balance was $206 million as of September 30, 2015, compared to $189.6 million as of June 30, 2015, and a $153.3 million as of September 30, 2014, representing year-over-year increase of 34% and a sequential increase of 9%. With respect to headcount, we added 95 employees in the third quarter of 2015. As of September 30, 2015, we had 1,606 employees. This total headcount number represents the year-over-year increase of 33%, and a sequential increase of 6%. We are on track with our hiring plans for the year. I'd now like to discuss our outlook for the fourth quarter and full year of 2015, which falls under the Safe Harbor provisions for forward-looking statements outlined at the start of the call and is based on preliminary assumptions which are subject to change over time. As I touched on during my comments on our current- quarter revenue, our revenue has been adversely impacted by variability in the timing of our service delivery and by headwinds related to foreign exchange fluctuations. As a result, we are tightening our full-year 2015 GAAP revenue guidance to a range of $340.5 million to $342 million. At the midpoint of $341.25 million, this range represents while, we don't use FX-adjusted metrics internally approximately 30% growth over our 2014 GAAP revenue of $263.6 million. While we don't use FX- adjusted metrics internally, we would note that our revenue has been negatively impacted by approximately $6 million in the first nine months of 2015 due to fluctuations in foreign exchange. Our full-year guidance implies a GAAP revenue guidance range for the fourth quarter of $96.7 million to $98.2 million. With respect to full-year 2015 non-GAAP net income or loss, as a result of our foreign exchange loss for the year and the current-quarter revenue shortfall from services, we are revising our prior guidance of a loss of approximately $16 million to a loss range of $18 million to $20 million, which at the midpoint of $19 million would yield a net-loss margin of 5.6%. This is an improvement of approximately 100 basis points over the prior year. This implies a non-GAAP loss of $0.35 per share based on a full-year weighted average share count of approximately 54.1 million shares. Turning to cash flow, for the full year of 2015 we are maintaining our full-year guidance for non-GAAP cash flows provided by operating activities of approximately $43 million, which represents a 16% margin at the midpoint of the revenue guidance range. In summary, every year we have consistently produced high growth while improving cash flow margin and moving towards non-GAAP profitability. As Adam said, we anticipate we will grow the top line in 2016 at a rate consistent with the rate of growth in 2015 and enhance operating margins meaningfully. With that, I would like to turn it back over to Adam.

[Adam Miller:]

Thanks, Barry. Thank you for attending today's call, and thank you especially to our global team for continuing to help our clients and our over 22 million users around the world to realize their potential. We will now take your questions.

[Operator:]

[Operator Instructions] Our first question comes from a Mark Murphy with JP Morgan. Your line is open.

[Mark Murphy:]

Yes. Thank you very much. Adam, I'm looking at the sequential change in deferred revenue of $16 million, and it's actually the biggest number ever. If I just exclude the seasonally stronger Q4, historically, it is the biggest number ever. So, it seems as though there is a lot of strength being reflected on the balance sheet. And you did call out a number of new logos that sounded like very, very large global organizations. So I think what I don't understand is Q3 is usually actually a very soft quarter for enterprise spend. And so I'm just wondering how did you overcome the seasonal softness there? And maybe could you comment at all on how you feel about the enterprise pipeline for Q4 and beyond?

[Adam Miller:]

Yes, thanks, Mark. We are having a very good run. This is obviously a continuation of a run we've had for a long time in the enterprise segment. As you know, we have been able to push higher up into the enterprise segment, working with the larger and larger multinationals along the way. And the net result of that is strong bookings growth and also, I think, the ability to work with the biggest companies of the world. So that doesn't just speak to prior quarters, but also our ability to be perceived as real options for other big companies down the line into the future. We've seen that a little bit with some of the bigger deals we've done. As I've mentioned before, we think there's opportunities to do that in the future as well. And the only challenge with all of that is those big projects also have big implementations. And as a result, you often get variability in the implementation resulting from those projects, but they do all go live and it's just a matter of timing.

[Mark Murphy:]

Great. I wanted to ask you as well, just a quick follow-up on the platform side, we've heard a lot of feedback that you're – essentially, you are future-proofing the entire suite in a way that kind of sets you apart from the rest of industry. And so, could you remind us when is the GA expected or maybe put a finer point on that? And just how confident are you in hitting that milestone? But I think more importantly, do you envision your competitors who lack that platform capability perhaps experiencing a bit of a competitive setback or just having a tougher time next year, just given how much interest there seems to be in your platform before it's even released?

[Adam Miller:]

Yes, we have two advantages there. One obviously is the unified nature of the suite that we have today, which is – we organically built all of the products in our platform. The second is the ability to future-proof that both with our big data initiatives that I talked about, specifically the rollout of predictive analytics with Cornerstone Insights and the ability to visualize and plan around the data with you and Cornerstone Planning. In addition to that, we have the Edge platform which allows us to open up our platform to the entire ecosystem, and that's something that is a long-term project. It's well underway. We have pieces of that coming out in the near term, and we have the broader platform capabilities coming out over the next two years; will be phased out. One of the first areas we are focused on is the integration center. And I think what's truly unique about what we're doing relative to many of our larger competitors in this space is the open nature of our platform. The fact that we're opening up all the APIs, we're using a service-oriented architecture that's open and we are working with our full ecosystem on making it very easy to use Cornerstone alongside or integrated with other software solutions that are in the market.

[Mark Murphy:]

Thank you.

[Adam Miller:]

And that's been very well received.

[Mark Murphy:]

Thank you.

[Operator:]

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

[Michael Nemeroff:]

Hi, guys. Just to kind of follow up on Mark's thought, the bookings have been pretty strong. Specifically, how much did this eight-figure deal affect the services revenue in the quarter? Do you feel like you are giving yourself enough coverage on your guidance? Because this has happened before.

[Adam Miller:]

I mean, unfortunately, it's happened before, and we try to get more and more conservative about this. As you know, the revenue came in over 99% of what we had forecasted. But we need to have 100% accuracy. So those deals are difficult to predict. In that particular case, the client was ready to kick off and then a week later delayed the project by enough time that it missed that milestone for revenue recognition in the quarter. – happen for these large deals, and so we're doing a few things to offset that. The first is the creation of a dedicated strategic delivery team to work with these largest clients that we have The second is more operational control around all of our service revenue. And the third is tying the kick- off of those projects to the sales process. So, we had in the past had two distinct processes. First, you would obviously try to get the deals done, and that's where the salespeople were involved. And then you would proceed to kick off the implementation. What we are now working on is tying those pieces together so that by the time the contract is signed, it's already been agreed when the kickoff would take place. And it gets documented, making it more enforceable and easier to forecast.

[Michael Nemeroff:]

That's helpful, Adam. And just to clarify, Perry, the guidance that you provided, the tightened-up guidance, I think in your prepared remarks you said that we should expect that currency tick is going to continue to be a headwind. Just want to confirm, is the new guidance that you provided – is that with the currency impact that you told us to expect included in? Or are we going to come back in Q4 and you are going to tell us that revenue would have been $3 million or $4 million higher because of it?

[Perry Wallack:]

Well, no, we obviously bake that into our forecast. Obviously, you can only do it to a certain extent based on what the exchange rates are forecasted to do in the quarter, but it is included in that guidance.

[Michael Nemeroff:]

Okay, great. Thanks very much, guys.

[Perry Wallack:]

Thank you.

[Operator:]

Our next question comes from a Brent Thill with UBS. Your line is open.

[Brent Thill:]

The – just going back on the bookings for the quarter, Adam, Perry, I just want to be clear. If you take the services issue out, was the bookings where you guys wanted to see it in the third quarter? I guess if you could just talk about what you are seeing as you roll over. Are there any deals that slipped from Q3 to Q4 that you are expecting that -- you always have deal slips, but anything else unusual that you saw that moved around in the quarter?

[Adam Miller:]

No, if you adjusted for that services slip, A, we would have beat revenue, and, B, the bookings would have been even higher. So we had met our expectation as to where we thought we would be. And, unfortunately, that one project had a pretty big impact.

[Brent Thill:]

Okay. So it was only one project, not a string of projects.

[Adam Miller:]

It was really one implementation predominantly that impacted it.

[Brent Thill:]

Okay. And just as a follow-up from the last question, the recurring services issue, I think, has caused some investors some heartache. And is there a way that you feel that you can extinguish this going forward, or is this just something that we all have to be braced with that's just an inevitable part of the model when you think about how you are giving the guide?

[Adam Miller:]

I think there's a few things there. Number one, we have been working with our auditors to be able to disclose in our SEC filings the split between software and services. We will be able to do that beginning in Q1 of 2016, so we are very close to being able to disclose that specific split. As Perry said, it's roughly 80%/20%, but we want to be very specific about it. That will help. The operational things we're doing will help. The tying – to the sales process, I think, will give us greater assurance about what's happening. And as we grow down market, we have less variability because we are less a victim of the success we're seeing up market as a percentage of total revenue. And obviously, we're trying to incorporate this into the way we think about forecasting services specifically. So it's all of those things, but it's a multifaceted operational exercise, and we're looking at all aspects of it to make sure that we are successful.

[Brent Thill:]

Thanks for the color.

[Adam Miller:]

Thank you. Just one other point there, as Perry mentioned, it's not just us. This is something that all cloud companies are facing that deal with large-enterprise deployments. And it's a tricky problem, but something that we have a lot of experience with. And hopefully we will get better and better and better at predicting. We've gotten pretty good at predicting it; I do want to highlight that. I understand we came in under the revenue number, but it's slightly under. We were very much in line overall with where we thought we would be. We were better than expected in bookings. The challenge is that sometimes when you're dealing with these really large deals, one deal could throw off the number in a one or 2-percentage point perspective, and that has an impact obviously on the overall results.

[Brent Thill:]

Thanks.

[Operator:]

And our next question comes from a Pat Walravens with JMP Securities. Your line is open.

[Pat Walravens:]

Great thank you. Adam, I guess I have two questions. The first is I would love to hear a little bit more about the opportunity you see at the low end of the market in SMB with the new product. And then secondly, now that Workday has introduced Learning, how do you think about whether it makes sense for Cornerstone to expand into other areas like maybe payroll or core HR?

[Adam Miller:]

Yes, let me take those in order. We are launching our new Growth Edition product at the end of this month. We are very excited about it. We basically have built a new product from the ground up and have taken into account all the technology changes and consumerization expectations that happened at the low end of the market. So we have built a product that is truly mobile first in design, entirely self configurable, leveraging everything we know about learning and performance management, and can be deployed by the client themselves within three hours. So this is dramatically different not only from our existing SMB product, but from all of the major SMB products in the market today and our space, and we think could be extremely successful. We are working now with a number of potential partners because there's no way we can ourselves get all 100 million seats in the SMB space. Remember also that the price point here is about 4 times the price point for enterprise, so the per-seat value is very high. To the extent we are able to do this not just ourselves, but through third parties like some of the big payroll companies we already work with, there are really big opportunities here for that segment. So we are very bullish on it. Something we put a lot of effort into over the course for the year. You didn't see the return on that this year. It's an example of something that takes some time before you get the return. You'll start to see the return on that next year.

[Pat Walravens:]

Okay.

[Adam Miller:]

With regard to the second question on Workday, I think two points there. One, Workday doesn't even, by their own admission, have a product ready for market for another year. And then it will be a V1 product. We have been doing this now for 15 years. We have extensive experience in the learning management and are able to deal with the newest ways of doing training, but also the tried-and-true old ways of doing training and development. And this is a complex field. There are a lot of differences by industry and by geography, and the iterative process that we have gone through with our clients can't be replicated in a short period of time. So we are very comfortable with our leadership position in the space. We do think there’s an opportunity for us to keep expanding our definition of talent management. And what is needed beyond talent management for companies that are trying to manage their people, we will talk about that more on future calls. But suffice it to say that we think we're in a very good position in this area, and we are continuing to grow our footprint with our platform.

[Pat Walravens:]

That's great. Thank you.

[Adam Miller:]

Thank you.

[Operator:]

Our next question comes from a Brendan Barnicle with Pacific Crest. Your line is open.

[Brendan Barnicle:]

Thanks, so much. Adam, I just wanted to just clarify to make sure I heard right your commentary about 2016. Did you say you are planning on getting sales and marketing down to under 50% revenue for the year?

[Adam Miller:]

That’s right.

[Brendan Barnicle:]

Okay. And also, you said growth rate that would be equal to what we've seen this past year.

[Adam Miller:]

Yes, I think we can stay in the same range that we have been growing at. And as we've said before, we think we can do that not just next year but into the future.

[Brendan Barnicle:]

Terrific. And then if we look back last year, you guys identified some emerging areas that were more challenging in Latin America, the Pacific Rim. You had, I think, the public sector. The small business, you just talked about your handle a new small business solution. And you certainly – I heard some logos of some Latin American companies. Can you just comment on those? I think you had five a year ago that you talked about where we are in those individual markets.

[Adam Miller:]

A year ago, we said that these were nascent markets. We called them emerging segments for us that had relatively new teams that were building out in those markets. We said we were going to invest upfront, but it was going to take some time before we got the return. And now we are starting to see the return in all of those segments. Latin America obviously doing very well over the last couple of quarters. APAC, or Asia-Pacific, doing quite well all throughout this year, we have seen mixed results in the public sector. I think federal has still been somewhat disappointing for us. But we have had success with the rest of FLED [ph]. And SMB, we have viewed as really a two-year initiative of products coming out the end of this year. Maybe we get a little benefit at the end of the fourth quarter, but this is really a 2016 story. And the last, the fifth, being strategic accounts, which we believe will show really good returns this year. So we've had success in all of those segments. We said it was going to take some time. We have gotten that time and those teams are now performing.

[Brendan Barnicle:]

Great. And then just -- Perry, just one for you on FX. You talked about some of the headwinds we see in the fourth quarter. As you look out to next year, though, presume if rates stay where they're at, should we – are we right in assuming that you should basically see no FX headwind as we look out to next year?

[Perry Wallack:]

Yes, I think that everything resets at the end of this year. We will be giving more specific guidance, obviously, after Q4, and we will have to see exactly where everything is. But they only can go against us for so long and for so far.

[Brendan Barnicle:]

And any different thoughts on implementing more of a consistent hedging strategy?

[Adam Miller:]

Yes. We have looked at it, and there is a certain level of complexity that we haven't wanted to digest yet in the business versus the limited level of benefit that it would provide to us. But we have – we've engaged a third party and we've got everything laid out. And we constantly reassess on a quarterly basis. If you noticed this quarter, the actual drag in the PNL was only about $66,000 in the realized and unrealized loss for foreign exchange. It's just that so far this year, we are well over $3 million.

[Brendan Barnicle:]

Great. Thanks a lot.

[Operator:]

Our next question comes from Samad Samana with FBR Capital Markets. Your line is open.

[Samad Samana:]

Hi, good afternoon. A couple of questions. Coming back to next year's outlook, could you give us some color on the expected contributions from the more emerging/nascent growth opportunities versus the core enterprise business? Basically, how much do you need to maintain that 30% type of growth next year from these newer areas?

[Adam Miller:]

We are not really thinking about the business emerging versus core anymore because those businesses aren't really emerging anymore. We have seen success now in those markets. They've had time to gestate, and we are seeing results around the world. We often think about things with regard to geo, so we think about the Americas as one business unit, EMEA as the second and APAC as the third, and we will often operate our business alongside that from an investment perspective. SMB obviously has the opportunity to provide uplift next year. We don't really have significant expectations for that right now just given our historical results in SMB. But if the product proves out the way I think it could, we could have significant upside there. We are also again seeing real ability to do well up market, and that extends beyond just strategic accounts. I would also characterize that as part of our enterprise business. There are some very large enterprise deals that we do in the U.S. and around the world that are not considered part of those 150 strategic accounts. Yet, we view our capabilities up market as being very key to our continued growth, and we are seeing success all year long in that segment in very large accounts, in multiple industries and multiple geographies. So, overall, I would say we have growth opportunities in all segments, and we will continue to look for increased sales productivity across the board.

[Samad Samana:]

That's helpful. And then one more. It looks like the trailing four-quarter ARPU was down sequentially and was effectively flat year over year. Could you comment on how much of this is due to success in the enterprise where ARPU might be lower versus any changes in the pricing/discounting environment?

[Adam Miller:]

I would say that generally we've had a pretty consistent ability to raise price over time. That comes from a combination of the number of users that are different segments of our portfolios. So, whether it's up market or down market, as we have said many times before, down market we have much greater price per seat then we do up market. So if you were talking about literally the biggest companies in the world, they obviously get volume discounts that small business would not get. So the price point difference is fairly dramatic. The other is the number of products that we are able to sell per account. And we have been able to sell more products, so our ARPU goes up from that perspective. And then lastly, our revenue per user goes up when we discount less. And because of our relative strength in the market, we have been able to discount less. We also continue to train our sales force on how to effectively negotiate and hold price in competitive situations.

[Samad Samana:]

That's helpful. Thanks for taking my questions.

[Adam Miller:]

Thank you.

[Operator:]

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

[Brad Sills:]

Hi, guys. Thanks for taking my question. Just one on the success you are seeing in the enterprise segment. Any changes to the competitive environment there, or is it still a big greenfield opportunity that's driving adoption? Or have you seen a shift from greenfield more to replacement type deals?

[Adam Miller:]

Yes. We’ve always said that enterprise is not entirely greenfield. In the enterprise segment, most of our – most prospects out there have a learning management system. It might be an on-premise legacy system if they have one. Most have an applicant tracking system. Again, it might be a very old one, but they have one. And they often have some customized version of a performance management system often, again, on premise, usually customization of an ERP system they had in the past. What we see as a greenfield opportunity is the ability to go in and replace all of those systems in one fell swoop, and we've done that now many times. We're doing that with enterprises around the world across geographies, and we're doing it at scale. So these are not small businesses; these are the largest companies in the world. And they are looking for unified talent management. They are looking for a solution to effectively manage their people and help their people to realize their potential. And because they are interested in that unified talent management solution, this is why we are so bullish on analytics. Because if they are using us to manage every aspect of their people, it also makes very logical sense to extend that to include making predictions about those same people and being able to visualize and plan around the data relative to those people.

[Brad Sills:]

Got it, great. Thanks. That's very helpful color. And then on the SI channel, if you could comment a little bit, please, on how that's tracking. You signed some pretty big global SIs over the last couple of years. Maybe just some commentary on how that channel is ramping would be helpful, please. Thanks.

[Adam Miller:]

Yes. I would say at this point, we work with all of the major SIs in some capacity or another. In some cases, we have very formalized global partnerships. In others, it's more informal or even potentially regional. We have different success with different partners in different markets. So, some are influencers in certain geographies, some are very significant influencers in certain verticals and others focus on particular segments. But I would say the SI ecosystem that we have today is world-class and is influential in most deals that we do this point. So whether, they are helping inform us about the opportunity at the account, or they are somehow involved in the selection of the system, or they partner with us to do the deployment or change management resulting from the project, or we become part of a larger transformation project that perhaps they are doing, we’re getting validation from all of them and that really helps us grow the business. It's one of the reasons we have been so effective with the large enterprises.

[Brad Sills:]

Got it. Thanks, Adam.

[Adam Miller:]

Thank you.

[Operator:]

Our next question comes from Justin Furby with William Blair. Your line is open.

[Justin Furby:]

Hi guys, thanks. Sorry I joined late. A question on Europe, and then I've got a follow-up. Adam, Europe seems to be a lot of activity. And I'm curious when you look out over the next two to three years, do you think the mix of your business will look a lot more Europe-centric than it does today? And it also feels like there is maybe more efficiency going on in Europe. I would love to hear if you look at the U.S. versus Europe in terms of productivity, what that looks like. And I've got one more. Thank you.

[Adam Miller:]

I would say the mix will shift to be more and more international, not specifically more and more European. So Europe has represented about 30% of the business now for the last several years. And I suspect it will stay at 30%, but international will move from 30% to much closer to 40% and beyond as we continue to grow out APAC in Latin America.

[Justin Furby:]

Okay, and then – sorry go ahead.

[Adam Miller:]

And then in terms of productivity, I would say you do see a little more market maturity. I wouldn't necessarily call it sales maturity, but market maturity, in that you do see more European buyers buying full-suite talent management. Whereas, you will often see in the U.S. still companies willing to buy one part of the suite. So, just focusing on one pillar or one aspect of talent management. We see the same thing happening now in APAC and in Latin America, a willingness to really reevaluate their talent management strategy and look for a solution management people holistically. So we are having a lot of success in Europe, in Asia and in Latin America because of that. And the strength of our platform, our specialists focused on talent management, really gives us competitive advantage in that kind of environment. So I think you'll see the business continue to shift to be more and more international over time.

[Justin Furby:]

Got it, that's helpful. And then the midmarket – just coming back from HR tech, it feels like that's maybe an area where maybe it's a little bit more challenged. And I don't know if they are more focused and taxed on ACA, if there are other dynamics there. But are you guys still investing when you look towards the next couple of years in that market in terms of incremental sales adds? And just general, I would love to hear how it performed in Q3 and what you think going forward there. Thanks.

[Adam Miller:]

Yes, as you know, we spent a lot of time and effort going down market for a long period of time now. Particularly, down from enterprise is what we would consider midmarket. And over the last two years, we essentially segmented midmarket. We bifurcated it into what we would call upper midmarket, essentially national accounts and the lower midmarket major accounts. We have built out both of those teams. So we've made a lot of investment in that area, and we think there's room for improvement. I mean, We can continue to grow productivity in that segment. We are adding more channel partners in that segment specifically and building up our pipelines in that segment, specifically to drive more volume and more growth in that market.

[Justin Furby:]

Got it.

[Adam Miller:]

We're still bullish on it. We've got hundreds and hundreds of midmarket clients today.

[Justin Furby:]

Got it. And then you may have addressed this and somebody may have asked it, but in terms of the sales productivity and looking out to next year, just in general, when you look at some of the other companies in the space, I'm just curious why you think maybe your sales and marketing is higher relative to the growth rate. Is that a market dynamic? Is that just -- just any color there would be helpful. Thanks.

[Adam Miller:]

I think some of it was the investments we made over the last two years, which required us to seed the market. Obviously, we've all talked about this. It may have been beneficial for us to phase out those investments over time instead of doing them all at once. Because we did them all at once, we get the benefit of it starting now. But there was a lot of expense with no near- term return for a couple of years. Now that's changed. We've also learned our lesson. So, going forward, we will be phasing out our investments. We won't be making them all simultaneously, and that's why we are confident we are able to drive sales and marketing expense down as a percent of revenue.

[Justin Furby:]

Got it. Thank you.

[Operator:]

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

[Raimo Lenschow:]

Thanks for taking my question. Can you talk a little bit about what you see in the federal sector? I remember it was just Q3, and that was a couple of years ago one of the big focus areas. Any update on that one?

[Adam Miller:]

Yes. For us, it's still been somewhat disappointing. We did not have significant results in federal in Q3. So, despite our bookings over-performance, it was not a result of federal. We didn't have any success last year in federal in Q3 either, so it's relatively consistent. But we are making some changes there. We are continuing to build out the success we've had a couple of years ago in federal to ensure that we have a very strong client base in that segment, and we will continue to operate in that segment. We also were very close to finalizing our Fed ramp certification, which is something that will be relatively unique in our space. We are at literally the final stages of approval and may have a one- to two-year advantage in having Fed ramp certification before anybody else in our space, which is meaningful in that segment.

[Raimo Lenschow:]

Okay, thank you. And then the follow-up question for me was – on the midmarket initiatives that you mentioned, obviously you talked about partners, but there will obviously be investment needed. How does that fit in with the lower sales and marketing costs?

[Adam Miller:]

No, we've made the investments. The investments have already been made. This is a matter of realizing the investments that we've made and getting the returns that we expect from the segments, including on the partner side.

[Raimo Lenschow:]

Okay, perfect. Thank you.

[Operator:]

Our next question comes from Alex Zukin with Stephens. Your line is open.

[Alex Zukin:]

Hi guys, thanks taken my question. So, Just going back on the top-line growth, is it possible to get some sort of color – is it fair to assume that if you back out the services, that maybe the subscription revenue growth was at least a few points higher than what you posted in the top line? Any color there would be helpful.

[Adam Miller:]

We really don't break it out that specifically. We give the color that our software versus services percentage runs roughly at 18% and 20%. And so we probably just leave it right at that. As Adam said, we are – we are working toward being able to disclose the specific, exact percentages in Q1 of 2016. And if I gave a little bit of color on it, what I would say is that our subscription revenue was higher than what we had expected in the quarter.

[Alex Zukin:]

Got it. That's helpful. And then you guys talked about earnings profitability in 2016. And I guess first question just is that for a quarter, or are you talking about for the full year? And then maybe you can dig in around the lower sales and marketing and contrast that with how you're thinking about hiring sales reps in 2016. Because it's – you guys are talking about a very high growth rate, 30%, for not just next year but the year after that. And I'm wondering are you going to be able to hire with 15% type of growth in sales and marketing?

[Adam Miller:]

Yes, so first of all, we are talking about full-year non-GAAP profitability. We think we already getting fairly close to that, and it’s time to move over the line. So, we are forecasting full-year non-GAAP profitability next year. With regard to how we get there, the number one opportunity is the lower sales and marketing expense as a percentage of revenue while still growing the sales team. So how you do both? You have to leverage our data to make decisions about where and when to allocate incremental headcount for the sales team. So, that’s both from a global perspective. So, what part of the world? And from a segment perspective, so what team or vertical to put them on. Secondarily, we think there are opportunities to keep driving down our overall operating expenses and improve our gross margins. And so, we have recently brought in a former McKinsey partner who was focused on an operational excellence practice to run our operational excellence initiative. And we are continuing to invest in several areas to drive automation process improvement, change management and more effective utilization of our personnel across the board to drive profitability.

[Alex Zukin:]

Got it. That’s helpful. And maybe if I can just squeeze one more in. Adam, can you talk about the pipeline for large deals in the fourth quarter and maybe compare and contrast it versus this time last year?

[Adam Miller:]

The lawyers never like when I answer that question. But suffice it to say that we have seen very good pipelines in the large-enterprise segment, including strategic accounts.

[Alex Zukin:]

Perfect. Thank you, guys.

[Operator:]

Our last question comes from Scott Berg with Needham & Company. Your line is open. Q - Unidentified Analyst Hey, Adam. It’s Harry. I will leave it to one question. We will make it quick. And congrats on the continued bookings. Adam, the question is for you is we talked extensively in August about some of the process improvement changes and where you can gain those efficiencies like you just recently commented on. How much can those improvements and what you are doing with platforms simplify or make implementations of these large-scale projects go faster to maybe help reduce some of the variances that you saw in the quarter with this one deal? Or will the variance in that one customer – it’s customer-specific that the changes just won’t impact in making that more predictable?

[Adam Miller:]

Great question, so we literally just kicked off an initiative to reduce the time to implement our average enterprise implementation by 50%, which will in fact help with forecasting all types of enterprise implementations, including the largest ones. And there are process improvements we can make to make the timing of those projects more predictable. So we are very much looking at every aspect of our operation to enable Cornerstone to operate with world-class standards across the Board.

[Unidentified Analyst:]

Great. That’s all I have. Congrats again.

[Adam Miller:]

Thank you.

[Perry Wallack:]

Thank you.

[Operator:]

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

[Adam Miller:]

Thank you to everyone for joining the call, and we look forward to connecting with you soon. Thank you.

[Operator:]

Ladies and gentlemen, thank you for participating in today’s program. This concludes the program. You may all disconnect.