Cornerstone OnDemand, Inc. (CSOD) Q3 2018 Earnings Conference Call Transcript

Cornerstone OnDemand, Inc. (CSOD)
Q3 2018 Earnings Conference Call
Nov. 7, 2018, 5:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

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

Jennifer Gianola -- Vice President of Investor Relations

Good afternoon, everyone, and welcome to Cornerstone OnDemand's third quarter 2018 earnings conference call. As always, today's call will begin with Adam Miller, Chief Executive Officer, who will provide an overview of our performance, and then Brian Swartz, Chief Financial Officer, will review some key financial results for the quarter, which ended on September 30, 2018. Later, we will conduct a question-and-answer session.

By now, you should have received a copy of our press release, which was released after the market closed today and was furnished with the SEC on Form 8-K. You can also access the press release and related investor materials, including detailed financials on our investor relations website. We have also shared a copy of the prepared remarks on our investor relations website for your review. As a reminder, today's call is being recorded, and a replay will be made available following the conclusion of the call.

Our discussion will include forward-looking statements, including, but not limited to statements regarding the expected performance of our business, our future financial and operating performance, including our GAAP and non-GAAP guidance, strategy, long-term growth, and overall future prospects.

Forward-looking statements involve risks, uncertainties, and assumptions. These risks, uncertainties, and assumptions, as well as other factors that could cause actual results to differ materially from those contained in our forward-looking statements, are included in our most recent Form 10-K and subsequent periodic filings with the SEC.

During the call, we will be referring to both GAAP and non-GAAP financial measures. All financial figures discussed today are non-GAAP unless we state that the measure is a GAAP measure. The reconciliation of our GAAP to non-GAAP information is provided in the press release and our website. Please note that we have made some changes to our disclosures, in part due to the new ASC 606 revenue recognition standard. All financial figures discussed today are on ASC 606 basis unless we state the value is on ASC 605 basis. Please refer to our press release and the Supplemental Financial Deck on our Investor Relations website for a summary of changes to the non-GAAP financial measures. With that, I will turn the call over to Adam.

Adam Miller -- Founder and Chief Executive Officer

Today marks one year since we first announced our strategic plan to transform Cornerstone into an industry-leading, high-margin growth company. We highlighted a five-point plan which included Cornerstone exiting the enterprise service delivery business and improving our margin profile, focusing on annual recurring revenue, introducing new recurring revenue streams, bolstering management, and strengthening our corporate governance.

I am extremely pleased to report one year later that we have successfully executed against our plan and the results have been quite strong. We have successfully moved our enterprise service delivery business to our global partner ecosystem. We now have over 440 certified consultants who have completed more than 1,000 product certifications to date, and we have successfully reduced our non-recurring services sales by over 60%.

We are on track to nearly double profitability from last year, and we expect to move from 6% operating margins in 2017 to almost 12% operating margins in 2018. In Q3, we had 13% operating margins. Also, Q3 marked our first-ever quarter of GAAP operating profitability.

In the last three years, we have seen sales and marketing spend drop from 54% to 35% of revenue, or 38% if you exclude certain reallocations in Q3 which Brian will discuss later. This over 1,500 basis point improvement is primarily due to improvements in sales productivity. As measured by ARR per rep, sales productivity was up over 50% year-over-year for the first nine months of 2018.

At the same time, we have seen our sales growth accelerate. Recurring sales grew over 30% through the first nine months of the year. Subscription revenue for the third quarter came in at $119 million, ahead of guidance and representing year-over-year growth of 18%. Year-to-date, subscription revenue saw year-over-year growth of 19%.

We have introduced new recurring revenue streams and leveraged our leadership position in learning to build a burgeoning content business. Content sales in the first nine months have already eclipsed our content sales for all of last year, and we are continuing to invest in the content arena to step-up our momentum. We also strengthened our management team and our Board to help us scale, and that has undoubtedly contributed to our continued success.

Now let's discuss our strong Q3 in more detail. In the third quarter, we expanded our organically grown client base to more than 3,400 enterprise and mid-market organizations from all over the world. New client additions include: U.S. Xpress Enterprises, Valeo Management Services in France, SBS Transit in Singapore, the 4th largest consumer cooperative in the UK, F5 Networks, Henkel AG & Co. in Germany, one of the largest banks in South Africa, Sun Life Financial in Canada, IRPC in Thailand, and Pioneer Natural Resources, among many more. Our client base includes global leaders across nearly every vertical, which has enabled us to build one of the largest subscriber bases of any software provider in the world with more than 38 million subscribers.

Our solid performance in Q3 was driven by our focus on recurring revenue with contributions across many teams. Our public sector team, which now includes federal, state and local, K12, higher ed, and healthcare sales, had another great quarter. Our largest wins in the quarter came from our federal team, delivering both new wins and upsells to existing clients including the United States Census Bureau, United States Postal Service, United States House of Representatives, and the Social Security Administration.

On the new client front, the Social Security Administration replaced its on-premise instance of SumTotal with Cornerstone's Learning suite. They chose to deploy Cornerstone across 90,000 employees and contractors due to our cloud-based, modern, and robust learning offering. The U.S. House of Representatives chose to replace its homegrown, on-premise platform with Cornerstone's Learning and Recruiting suites. They were looking for a FedRamp certified, unified talent management offering.

Within our existing client base, we also had success selling additional recruiting licenses to the U.S. Postal Service and the U.S. Census Bureau, as both organizations ramp for incremental hiring in the near future. Other public sector wins included the Virginia Department of Environmental Quality; and the County of Placer, California; Texas Tech University; and the University of Denver; and The Children's Hospital of Alabama; Appalachian Regional Healthcare; and Baptist Health System. Our recent wins in public sector have been driven by the momentum we have built up in that vertical over the past few years, and we believe Cornerstone is well positioned as this sector continues to transition to the cloud.

On the commercial side, the client sales team continued to outperform despite the massive transition that team in particular faced as we moved one-time services from our paper to our partners. We had hypothesized that our sales teams would have more time to sell recurring business if they no longer spent time on one-time services. That hypothesis has proved accurate. As we exited enterprise delivery services, the client sales team has been able to dedicate more time educating our installed base about new and existing products.

As a result, we have seen an uptick in clients adding new recurring solutions, such as our Customer Support Packages and Content Anytime subscriptions, as well as expanding their Cornerstone human capital management footprint. For example, in the third quarter the world's largest package delivery company, which has been using our Learning and Performance suites, added an entirely new population of 100,000 seasonal drivers to their Cornerstone Learning suite to reduce instructor-led training and accelerate the speed to market for new drivers.

Another cross-sell included a global medical device manufacturer using our Cornerstone Learning that outgrew their home-grown performance tool. In Q3, they doubled their Cornerstone footprint with the addition of our Performance suite due to our unified talent management platform, the alignment between learning and performance, and our ability to integrate with numerous vendors.

Abroad, we saw continued success in EMEA, with the second-largest number of new client wins in any Q3 in history. Momentum in the region has spanned across all products in our human capital management offering. With our European Learning clients, we have continued to see strong demand for the Content Anytime Offering, due to our multi-language capabilities. With our Recruiting suite, we have seen increased adoption over the past 12 months with 30% growth in the number of EMEA recruiting clients year-over-year.

Last but not least, the Cornerstone HR product has continued to see strong attach in Europe and in Q3 we more than doubled the total number of Cornerstone HR clients in EMEA relative to the prior year. Driven by continued adoption of the Cornerstone offering, our EMEA clients have an extensive Cornerstone footprint, with nearly 80% using two or more products and more than half using three or more products.

Moving on to the bottom line, we continued to see improvements in profitability, and as I mentioned, we achieved our first ever quarter of GAAP operating profitability. Non-GAAP operating income for the quarter was $18 million or 13% in operating margin. Through the first nine months of the year, we generated $44 million in operating income, resulting in an 11% operating margin. Much of this progress can be attributed to continued improvement in sales rep productivity.

Additional benefits to the bottom line have continued to be realized through our Operational Excellence initiatives. First, we achieved more than $10 million in life-of-contract cost reductions and avoidance through the first nine months of this year, due to competitive bidding and negotiations by our strategic sourcing team. Second, we realized early savings from our software rationalization initiative, and believe we will capture as much as $1.5 million in run-rate savings over the next two years from this effort.

Third, we recently announced that we will be opening our second largest U.S. office in Silicon Slopes near Salt Lake City, Utah. We believe the addition of this office, which will support the expansion of several of our U.S.-based teams, gives us the opportunity to manage growth in a cost-effective manner. While we have already seen substantial margin improvements from these initiatives, we believe there are incremental efficiencies to be gained through further strategic sourcing, automation, and process improvement initiatives.

Even with all of this change and strong business results, our focus on innovation has remained steadfast. After making substantial improvements to our Recruiting Suite through the first half of the year, in September we doubled-down on Recruiting with the acquisition of Workpop. With Workpop, we are able to solve a huge pain point for our clients with high volumes of entry-level and hourly employees. We believe Workpop's deep domain expertise, outstanding product design capabilities, and recruiting application focused on retail environments will help make this expanded solution a reality and can accelerate our momentum in recruiting while expanding our opportunity in retail, manufacturing, and healthcare.

Like Recruiting, we see significant upside in the Content area. According to Training Industry, the global market for third-party online training is over $25 billion. We have continued to see strong demand for our content offerings, and the Content team closed our second largest content win in history, enabling Content sales through the first nine months of 2018 to exceed Content sales for the full year of 2017. In addition, we had a renewal of Content Anytime with a leading French bank that converted their one-year trial into a three-year contract and expanded their Content Anytime user population.

To capitalize on the momentum we have seen in the Content business, I am pleased to announce today that we have entered into a definitive agreement to acquire Grovo, the global leader in microlearning content. Microlearning, which is a name for short-form content which teaches a single concept in three to five minutes, has become increasingly popular in workplace training because of its accessibility, engagement levels, and effectiveness.

The acquisition of Grovo came at a fortuitous time for them and us, and we believe it provides Cornerstone with four key value drivers. First, Grovo has a robust library of 2,500 top-rated microlearning courses. This library will now only be available through Cornerstone. This makes our Content Anytime subscriptions more exclusive and creates additional barriers to entry for others trying to replicate our content strategy.

Second, Grovo provides us with a limited content production capability that allows us to capitalize on our relationships with global thought leaders to create unique training titles to supplement our content subscriptions. The vast majority of the curated content in our subscriptions will remain sourced from our content partner ecosystem.

Third, Grovo differentiates our Learning Suite with their Grovo Create Tool. In order to efficiently build their content, Grovo developed the Create Tool to streamline their own content production. We plan to offer the Create Tool to our clients directly, which will allow them to develop high-quality, proprietary training content for their employees. We know this has real value for our Learning clients because of the many inquiries we've received for such a solution over the years.

Fourth, from a financial standpoint, it represents an opportunity to improve our unit economics on content. Grovo has been a key partner in our Content Anytime offering, and upon completion of this acquisition, we will recapture their content royalties.

We remain laser-focused on delivering value through our human capital management software and content subscription offerings and are not planning to embark on any type of transformation into a content creation company. Neither our content strategy nor this acquisition is expected to adversely impact our highly capital-efficient business model. We will continue to partner with the top e-learning providers in the world to offer highly curated modern content subscriptions for our clients.

To that end, today we released several new subscriptions for our Content Anytime service beyond our popular Content Anytime Essentials offering, including thematic subscriptions for compliance and digital transformation and regional subscriptions for France, Germany, and Spain. Over time, we plan to add more subscriptions, including those focused on specific industries and job functions. All of these subscriptions are expected to include content from a wide variety of e-learning providers. We believe the combination of our state-of-the-art Learning Suite, our Content Anytime subscription service, and the acquisition of Grovo will provide increased competitive differentiation to drive further attach of our Learning and Content offerings into the future.

Our commitment to product innovation has continued to generate significant recognition from leading industry analysts. Last month we were recognized as a "Leader" in Gartner's Talent Management Suites for the fifth consecutive time due to our completeness of vision and ability to execute. For the third consecutive time, Gartner also recognized Cornerstone as the leading vendor with the best "ability to execute."

In October, Fosway recognized Cornerstone as the clear "Strategic Leader" in their Talent Management 9-Grid for the fourth consecutive time, ahead of SAP, Oracle, Saba, SumTotal, and TalentSoft. Fosway also advanced Cornerstone's position as a "Core Challenger" in their 9-Grid for HCM due to continued improvement in both performance and potential. Cornerstone was also recognized numerous times in the quarter for our corporate culture and our leadership in the HR space.

With that, I'd like to turn it over to Brian to discuss our third quarter financial performance and our outlook in more detail.

Brian Swartz -- Chief Financial Officer

Thanks, Adam, and good afternoon, everyone. As Adam discussed, we are very pleased with our team's strong execution against an ambitious strategic plan over this past year.

Before I discuss our Q3 financial results and updated outlook, I'd like to spend a moment summarizing our acquisition announcement today. We signed a definitive agreement to acquire Grovo for $24 million in cash this quarter, subject to customary closing adjustments. While from an accounting perspective Grovo is not material to Cornerstone, we do expect it to enhance the momentum we have achieved in our content business.

Furthermore, although we have not incorporated Grovo into our updated guidance, other than ARR, we expect to capture meaningful synergies as a result of the acquisition, while ensuring we maintain the core capabilities of the business. Accordingly, excluding the impacts of purchase accounting, we do expect Grovo to provide positive operating income in 2019 and beyond.

Now on to our Q3 performance. We grew subscription revenue by 18% year-over-year; nearly doubled our EPS to $0.23 per share compared to $0.12 per share in the prior year. In addition, the third quarter marked our first quarter of GAAP operating profitability in Cornerstone's history. Although there is still work to be done to achieve our long-term goals, we are pleased with our performance thus far in 2018.

In the third quarter, total revenue came in at $134 million, representing year-over-year growth of 10%. Remember that our overall revenue growth is adversely impacted by our intentional reduction of services revenues. Our focus is on annual recurring revenue or ARR, and we are pleased with our progress year-to-date. Accordingly, we're raising our full year guidance which I will discuss shortly.

Subscription revenue exceeded the high end of our guidance range by $2 million, coming in at $119 million, or a year-over-year increase of 18%. Under ASC 605, subscription revenue growth was 19% year-over-year. This outperformance was primarily related to better linearity in the quarter. Services revenue in Q3 came in at $15 million, representing a 27% decrease year-over-year.

A few other key Q3 metrics: The size of our client base increased to 3,428, representing 65 net new client additions during the quarter. Additionally, we remain keenly focused on maintaining our industry-leading dollar-based retention rates through disciplined operating procedures around renewals and maintaining strong client satisfaction. We added more than 1.8 million net users during the quarter, bringing our user base to approximately 38.5 million users.

As I discussed last quarter, we expect our revenue growth to become less correlated to user growth as we move forward due to selling multiple suite offerings, several product add-ons including Content and Cornerstone HR, and having a very large and diversified installed client base. Accordingly, while every user represents a tremendous future opportunity for Cornerstone, user growth is only part of today's growth story. For that reason, while we will continue to disclose user counts periodically, we will no longer consider user count to be a key metric and will therefore not be disclosing it on a quarterly basis following our Q4 2018 earnings call. For financial modeling purposes, we recommend you use ARR, the same metric we use internally, to model the business.

Finally, we had 1,892 employees as of September 30th, representing a 3% decrease over the prior year. Our gross margin improved to 74% in the third quarter, up 50 basis points from the prior year. The improvement in gross margin was driven by a higher mix of subscription revenue.

With respect to operating expenses for the quarter, during the quarter we completed certain aspects of our strategic transformation plan to position us for long-term growth. The completion of this phase resulted in a reallocation of certain resources. The primary reallocation resulted in some sales and marketing headcount that were moved into research and development activities to better align the organization with their updated job functions. This had the impact of reducing sales and marketing, and increasing research and development, both as a percentage of revenue, by approximately 3 percentage points on a non-GAAP basis and 4 points on a GAAP basis. Sales and marketing expense was 35% of revenue in the quarter.

Continuing down the P&L, R&D was 12% of revenue, up 100 basis points from the prior year. I'd like to point out that R&D expense, including capitalized software development costs for the quarter, was $23 million or 17% of revenue, compared to 15% in the prior year. This increase was primarily driven by the reallocation of resources I just discussed, as well as continued investment in product development.

In the third quarter, G&A was 13% of revenue, in line with the prior year. We expect to see G&A optimization over time as our operational excellence initiatives are fully implemented. Overall, this resulted in a Q3 operating income of $18 million or a 13% margin, which represents a 700 basis point improvement from the prior year's operating margin of 6%. This is largely driven by leverage in sales and marketing.

Additionally, I am very pleased to report that GAAP operating income was $2 million in the quarter, marking our first ever quarter of GAAP operating profitability. Net income for the quarter was $15 million or $0.23 per diluted share, up 102%, compared to $7 million or $0.12 per share in the prior year. It's also worth noting that our 2021 convertible note is not dilutive to our share count in EPS calculation until we generate roughly $170 million in net income.

With regard to cash flow, unlevered free cash flow improved year-over-year by $16 million to $32 million in the third quarter, representing an unlevered free cash flow margin of 24%. We exceeded our expectations on quarterly cash flow, primarily due to timing, driven by billing and collection process improvements.

Now let's turn to the balance sheet. We continue to maintain a well-capitalized balance sheet. As of September 30th, we had $393 million of cash and investments. Additionally, we had $288 million in carrying value of debt. As a reminder, we used approximately $253 million of cash and investments to pay off our 2018 convertible notes that came due on July 1, 2018.

Back in November of 2017, our Board of Directors authorized a $100 million share repurchase program. In the third quarter, we repurchased approximately 300,000 shares totaling $16 million. From inception through last Friday, we repurchased 2.1 million shares at an average cost of about $43 per share, for a total of $91 million.

Now let's turn to our 2018 outlook and our first look at 2019, which has been developed using the best information we have as of today. Please note we have included a "Supplemental Financial Deck" on our investor relations website to help you follow along as I discuss our updated guidance. As a reminder, all guidance assumes ASC 606, but you can view the ASC 605 guidance for comparative purposes in the supplemental deck.

Our current guidance assumes a U.S. dollar to British pound exchange rate of 1.27 to 1 and a U.S. dollar to euro exchange rate of 1.13 to 1. If the U.S. dollar were to change by 5%, the impact is approximately $7 million to ARR and $2 million to revenue. As I mentioned earlier, I encourage you to reference our supplemental financial deck as I discuss the following guidance. I would also like to point out that with the exception of ARR, the financial impacts from the Grovo acquisition are excluded from our updated guidance, as we are working to quantify the impacts of purchase accounting.

For the fourth quarter of 2018, we expect total revenue in the range of $128 to $131 million and subscription revenue in the range of $119 to $122 million. At the midpoint, this represents approximately 13% reported growth and 15% constant currency growth. On an ASC 605 basis, these growth rates are approximately 1 percentage point higher.

Regarding full year revenue guidance, we are raising our currency neutral guidance range to $529 to $532 million, which increases the midpoint by $8 million. On a reported basis, those numbers are impacted by $1 million of currency headwinds, resulting in an increase to the midpoint of $7 million for an expected reported range of $528 to $531 million.

We are raising our currency-neutral, full-year subscription revenue guidance range to $467 to $470 million, which increases the midpoint by $6 million. On a reported basis, those numbers are also impacted by $1 million of currency headwinds, resulting in an increase to the midpoint of $5 million, for an expected reported range of $466 to $469 million. At the midpoint, this represents approximately 18% reported growth and 17% constant currency growth. On an ASC 605 basis, these growth rates are approximately 2 percentage points higher at 20% and 19%, respectively.

As we continue to move service projects to our partners in Q4, we believe services revenue in Q4 will be just under $10 million, resulting in full-year services revenue of $62 million, down about 25% year-over-year. We expect to begin 2019 on a normalized quarterly run rate of services revenue.

Moving on to ARR, as I mentioned earlier, our ARR guide includes the best estimate of Grovo's ARR at the end of 2018. Given the strength in new ARR so far this year, and including the $9 million benefit from Grovo, we are raising our currency-neutral, full-year ARR guide range to $507 to $517 million, which increases the midpoint by $20 million. On a reported basis, those numbers are impacted by $4 million of currency headwinds, resulting in an increase in the midpoint of $16 million for an expected reported range of $503 to $513 million. At the midpoint, this represents approximately 16% reported growth and 17% constant currency growth. Grovo's acquisition positively impacted these growth rates by about 2 percentage points.

Please note the separate Grovo ARR disclosure is one-time in nature, and we will not disclose it on an ongoing basis. As you think about modeling our business in 2019 and beyond, please be mindful that our strong performance through the first nine months of 2018 included some large-deal execution. We had more than two times the number of seven-figure deals through the first nine months of 2018, relative to a year ago.

Moving on to profitability, we are raising our 2018 operating income to a range of $61 to $64 million, which increases the midpoint by $2 million. This results in an operating margin of 11-12%. For Q4, we expect operating income to be in line with Q3 of 2018 operating income of $18 million.

Regarding cash flow, for the full year 2018, we are raising our unlevered free cash flow guidance range to $59 to $63 million, which increases the midpoint by $2 million. Please note this excludes $14 million of cash interest expense. Assuming services revenue is down 25% by the end of 2018, this amounts to an unlevered free cash flow margin of 11% to 12%. We expect this margin to increase at a faster rate than operating income in the years ahead as our services revenues begin to normalize.

For Q4, we expect unlevered free cash flow to be in line with Q3 of 2018 unlevered free cash flow at around $31 million.

Now I would like to provide some preliminary thoughts for 2019. We expect to continue to grow ARR in 2019. As I mentioned earlier, it is important to acknowledge that 2018 New ARR has been more concentrated up-market than in prior years, which could impact the amount of New ARR growth in 2019.

We expect 2019 subscription revenue growth to be in the mid-teens and service revenue of $5 to $10 million per quarter. Service revenue would, therefore, represent about mid-to-high single digits, as a percentage of total revenue. The decline in services revenue from 2018 to 2019 will continue to impact our total revenue growth, but not our subscription revenue growth. Assuming mid-teens subscription revenue growth and services of about 5% of total revenue, we would expect 2019 total revenue growth of about 7%. As a reminder, during the transition of moving services to our partners, it's important to focus on subscription revenue growth instead of total revenue growth.

We expect continued improvement in operating and unlevered free cash flow margins that will be enabled by continued improvements in sales efficiency and our operational excellence initiatives. With respect to longer-term margin targets, we remain on track to achieve the Rule of 40, which we define as the sum of annual revenue growth and unlevered free cash flow margin by 2020, resulting in roughly $150 million of unlevered free cash flow, or approximately $2.00 per diluted share.

Lastly, I'd like to announce that we plan to attend several upcoming investor conferences this quarter, including the Credit Suisse Annual Technology, Media and Telecom Conference, the Wells Fargo Tech Summit, and the Barclays Technology, Media and Telecom Conference. If you would like to participate in any of those meetings, please reach out to our Investor Relations team.

In summary, we are quite pleased with our 2018 performance and look forward to a strong 2019. With that, I'll turn it back to Adam.

Adam Miller -- Founder and Chief Executive Officer

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

Questions and Answers:

Operator

Thank you, sir. Ladies and gentlemen, if you have a question at this time, please press * then 1 on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the # key. To prevent any background noise, we ask that you please place your line on mute once your question has been stated. Our first question comes from the line of Scott Berg of Needham. Your line is open.

Scott Berg -- Needham & Co. -- Analyst

Hi, everyone. Congrats on taking my questions. It's a very good quarter here. I've got a couple of things. Brian, we'll start with you. Your comments on the 7-figure deals that were up materially year-over-year versus '17 and that's expected going forward. I guess is that a question or a comment that '17 is drastically outperforming, or is this really more a normalized level, and '17 was underperforming relative to the '18 results?

Brian Swartz -- Chief Financial Officer

No, so I would say it is certainly an anomaly. We've had great success this year, Scott, and we're really pleased with that, but there is more concentration upmarket. Now, there's a lot of big logos out there and opportunity that we still have, but obviously, when you have a higher level of concentration, it could impact the compare for next year and expectations around growth for next year. So we've got to get through Q4. We'll look at what pipelines look like next year.

As a reminder, in the near-term financial guidance right now, our 2018 guidance, we do not assume large deals close. That's something I've consistently done here for the last 4 to 6 quarters, plus. So we are very targeted on big deals, and there are lots of opportunity there, but it is important for all of our investors and for everyone to understand that there is more concentration this year than there was last year.

Scott Berg -- Needham & Co. -- Analyst

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

Adam Miller -- Founder and Chief Executive Officer

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

Scott Berg -- Needham & Co. -- Analyst

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

Adam Miller -- Founder and Chief Executive Officer

Thank you.

Brian Swartz -- Chief Financial Officer

Thank you.

Operator

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

Brad Sills -- Bank of America Merrill Lynch -- Analyst

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

Adam Miller -- Founder and Chief Executive Officer

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

Brad Sills -- Bank of America Merrill Lynch -- Analyst

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

Adam Miller -- Founder and Chief Executive Officer

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

Brad Sills -- Bank of America Merrill Lynch -- Analyst

Great. Thanks, Adam.

Adam Miller -- Founder and Chief Executive Officer

Thank you.

Operator

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

Alex Zukin -- Piper Jaffray -- Analyst

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

Brian Swartz -- Chief Financial Officer

Alex, it's Brian. Obviously, this is a big topic. It's come up three times in a row here. Let me just try to be very clear. All we're trying to do is be very transparent. We've had a very strong year. We've had a lot of success upmarket. We continue to believe there are further opportunities to have that kind of ongoing success, but it's also important for everyone to understand that our guidance philosophy, the philosophy that I've laid out for the last year, doesn't contemplate very, very large deal execution consistently quarter after quarter after quarter, and year after year.

We're simply trying to be transparent and relatively conservative. We would hope to exceed those numbers and be able to outperform and continue to have the same kind of year in 2019 that we're having in 2018 on a large-deal basis, but you obviously won't know that until you get into that year and into those respective quarters. That's all we're trying to tell. It's not a timing issue around deals this year. Q3, Q4, Q2, there's still deals in the pipeline, as Adam mentioned, both in Q4, Q1, Q2, and Q3 of next year, and we're excited about performing against all of that.

Adam Miller -- Founder and Chief Executive Officer

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

Alex Zukin -- Piper Jaffray -- Analyst

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

Brian Swartz -- Chief Financial Officer

On the first question with respect to billing, we said, as I said three quarters ago, at our analyst day, we talked extensively about this. It's not a metric that we are commenting on. It's not a metric we consider a key metric right now while we're going through our transition. The reason why is we are intentionally, as everyone knows, moving our services business and services revenue to our partners in our deferred revenue number, which is a component or the change in deferred revenue, which is a component of the billings calculation, are the billings associated with services.

Until we fully normalize our services revenue on a year-over-year basis, which will likely happen in 2020, it's a metric that I would not encourage anyone to focus on. We obviously watch it internally. But it's not a key metric from the standpoint of running the business. The right metric is ARR, which we obviously talk about every quarter, and we provide guidance on each quarter for the full-year and report on at the end of the year. That's how I would think about it. It's just a function of how the services are unwinding, and it's all being done, like I said, intentionally as we exit the services business.

With respect to the Content question, Alex, if I understood the question correctly, obviously we are expecting continued strong growth in our Content business. They've had a great year thus far this year. As Adam talked about in his prepared remarks, we have rolled out as of today, new subscription offerings under Cornerstone Content Anytime. Obviously the Grovo acquisition today, we're very excited about bringing that team on board and really enhancing the offerings overall. We do expect continued strong growth from that side of the business, and we'll talk more about it obviously in the coming quarters.

Alex Zukin -- Piper Jaffray -- Analyst

Great. Thanks, guys, for taking the questions.

Adam Miller -- Founder and Chief Executive Officer

Thank you.

Operator

Thank you. Again, ladies and gentlemen, if you have a question at this time, please press * then 1 on your touchtone telephone. Our next question comes from the line of Justin Furby of William Blair Company. Your question, please.

Justin Furby -- William Blair -- Analyst

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

Adam Miller -- Founder and Chief Executive Officer

Thanks, Justin. From a percent of sales perspective, I would say midmarket is relatively small at this point. It's about 10% of New ARR coming into the business now on an annual basis. With regard to optimization of midmarket, we're seeing a lot of opportunity in all segments -- SMB, midmarket, enterprise, and strategic, both on the commercial side and on the public sector front.

What we are looking at doing is expanding our capabilities in SMB. We're having a lot of success with inside sales, which are obviously less expensive and more cost-efficient. We are raising the bar for our inside sales team, and we are consolidating our midmarket in enterprise management teams to enable more efficiency going into 2019.

We are on track with midmarket this year. We are hitting targets. We are hitting targets really across all teams, and so we see a lot of opportunity. We're also seeing that down market, our service inclusive pricing has gotten a lot of traction, and that allows us to roll in non-enterprise service projects as part of the implementation. Remember, these are very short implementations. They're done by our team. They're done very quickly, and they're rolled into the overall price that brings up the ASP, and it brings up the total contract value for those smaller deals.

All of that has worked very successfully, as well as the client success packages being attached for that segment, and content being attached to that segment. Overall, we've seen good ASP growth and good progress in that midmarket segment, which to us today is 500 to 5,000 employees. We think there's an opportunity to continue to drive that business in a more efficient way.

Justin Furby -- William Blair -- Analyst

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

Brian Swartz -- Chief Financial Officer

Let me handle the latter question, Justin. At the end of the year, obviously once Q4 is over, we'll try to get some commentary on our new ARR trends, not just by team, but also by product, including content. Obviously, we've given some commentary in the first three quarters of this year. They've already beat last year's number. Obviously, they have a strong pipeline for Q4, and we've got to see how they execute, but they are definitely growing faster than the overall growth rate of the business. And we think over time, we can certainly maintain that, both given the size of that business today, but more importantly, the market is so much bigger.

As Adam mentioned, it's a $25+ billion market relative to the market for our existing products. We believe it's a very unique offering. With the acquisition today, I think our competitive moat grows, and it just enhances the competitive advantages that we have relative to other competitors [inaudible] subscription-based offerings. We'll look to -- no promises -- give some more commentary and a breakdown of the composition of the sales on the Q4 call, and that's how we think about it going into 2019.

Justin Furby -- William Blair -- Analyst

Okay. Then Adam, on the go-to-market?

Adam Miller -- Founder and Chief Executive Officer

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

Justin Furby -- William Blair -- Analyst

Okay, great. Thanks very much, guys. Nice quarter.

Brian Swartz -- Chief Financial Officer

Thank you.

Adam Miller -- Founder and Chief Executive Officer

Thanks.

Operator

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

Patrick Walravens -- JMP Securities -- Analyst

Oh, great. Thank you very much, and congratulations. So I guess I have two. The first one is, Adam, what's happening competitively? How have things evolved with Workday and with their learning product?

Adam Miller -- Founder and Chief Executive Officer

I'd say competitively, the situation has been fairly the same. We haven't seen a lot of changes in the competitive landscape. There are not new entrants. We've seen some further consolidation, for example, Saba bought Lumesse. All of that makes for a fairly static competitive environment, which is good for us. I would also say that our moves, both on the Learning and Recruiting front have put us in a very strong position going forward.

On the Learning side in particular, since you brought up Workday Learning, the availability of our Learning experience platform and the continued investment into that Learning experience platform, combined with our whole Content Anytime subscription strategy, combined with now the acquisition of Grovo makes us the clear leader in learning, and further distances us from the competition. Not limited to Workday, but certainly including Workday.

And so we're feeling very good about our positioning in the Learning space, and we think our investments in Recruiting, in particular, the acquisition of Workpop, and the improvements we've made to the Recruiting product, the investments we've made in engineering around Recruiting, all position us very well for that market going forward as well. We're feeling good both about Recruiting and Learning going forward.

Justin Furby -- William Blair -- Analyst

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

Adam Miller -- Founder and Chief Executive Officer

What I heard recently from another CEO, which I think is a right way to think about it, is it's not just how fast you can grow, but how long you can grow. We're looking at, as you know, the Rule of 40, where we expect to attain the Rule of 40, which is a combination of revenue growth and free cash flow margin by 2020. We think we're very much on track for that. We've taken a balanced approach to the Rule of 40, and we think we're on track to achieve that. You've seen significant gains in profitability.

You've also seen us be able to sustain revenue growth even with the transformation we've made. We think there's obviously upside both in Recruiting and especially in Learning when you take Content into consideration. We also, as Brian mentioned, have effectively expanded our TAM, all of which puts us in a strong position for long-term growth and effective, long-term execution.

Justin Furby -- William Blair -- Analyst

Great. Thank you.

Operator

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

Corey Greendale -- First Analysis Securities Corp. -- Analyst

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

Adam Miller -- Founder and Chief Executive Officer

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

It's also worth mentioning that Content is a little bit like the life sciences business, in that people pick their spots. For example, we have a healthcare Content Anytime subscription we're working on. There are a number of healthcare providers we're in discussions with or we've already partnered with. And the content that we'll have from Grovo has nothing to do with that type of content. But the top content providers out there are highly specialized, Pluralsight being a great example of that.

We believe we can retain these partnerships and, in fact, even grow these partnerships as we pick our lanes and continue to operate efficiently, effectively growing the pie for everybody, and I think becoming an even better partner for the content providers that we work with.

Brian Swartz -- Chief Financial Officer

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

Corey Greendale -- First Analysis Securities Corp. -- Analyst

Got it. Then my quick follow-up question is, clearly the first order of shifting services work to third parties is working in terms of freeing up your rep time. Can you just talk about the other piece of it, how much you're seeing partners beginning to refer business to you and also how those implementations are going? Are the partners, are they syncing as well as you were doing when you were doing the implementation services internally?

Adam Miller -- Founder and Chief Executive Officer

I'll do that in reverse order. The implementations are going as well as they have gone in the past. I think we have very consistent service delivery now. In part, because you have to remember most of the people that were on our service delivery team are now working for our partners and are part of that delivery ecosystem that we have today. So it's literally the same people delivering the service work.

On the second order benefit of moving the service work to our partners, we are starting to see the benefit. We have not seen the full extent of the benefit. I believe there's a lot more opportunity in 2019 and beyond, as we continue to build out the practices at these partners, but we already have seen some of the benefit. Some of the larger deals we've brought in, some of the larger deals we're working on have absolutely come from our partners, and we are working on these opportunities in teams with our partner ecosystem. So, we believe we'll continue to see that benefit, and that benefit should grow over time, particularly upmarket.

Corey Greendale -- First Analysis Securities Corp. -- Analyst

Great, thanks. Congratulations on the progress.

Adam Miller -- Founder and Chief Executive Officer

Thank you.

Operator

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

Adam Miller -- Founder and Chief Executive Officer

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

Operator

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

Duration: 64 minutes

Call participants:

Adam Miller -- Founder and Chief Executive Officer

Brian Swartz -- Chief Financial Officer

Jennifer Gianola -- Vice President of Investor Relations

Scott Berg -- Needham & Co. -- Analyst

Brad Sills -- Bank of America Merrill Lynch -- Analyst

Alex Zukin -- Piper Jaffray -- Analyst

Justin Furby -- William Blair -- Analyst

Corey Greendale -- First Analysis Securities Corp. -- Analyst

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