Logo of jester cap with thought bubble.

Image source: The Motley Fool.

Cornerstone OnDemand, Inc.  (NASDAQ:CSOD)
Q2 2019 Earnings Call
Aug. 05, 2019, 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 Second Quarter 2019 Earnings Conference Call. [Operator Instructions]

And now I'd like to introduce your host for today's program, Jason Gold, Cornerstone's Vice President of Finance and Corporate Development. Please go ahead, sir.

Jason Gold -- Vice President of Finance and Corporate Development

Thank you. Good afternoon, everyone, and welcome to Cornerstone OnDemand's Second Quarter 2019 Earnings Call. The format of today's call will be similar to last quarter. Since we published a shareholder letter with a lot of information about our Q2 results and our updated outlook, Adam's and Brian's prepared remarks today will be relatively short, which should give us plenty of time for Q&A.

In the letter, we've also outlined our Investor Relations calendar for the quarter, including when we plan to enter our quiet period, so if you'd like to participate in any of our scheduled events please feel free to reach out. Our press release and shareholder letter were both furnished with the SEC in a Form 8-K. You can access the shareholder letter, press release and related investor materials, including detailed financials, on our Investor Relations website.

As a reminder, today's call is being recorded, and a replay will be made available following the conclusion of the call. Our discussion will include forward-looking statements, including, but not limited to statements regarding 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 10-Q and 10-K as well as subsequent periodic filings with the SEC.

During the call, we will be referring to both GAAP and non-GAAP financial measures. All financial figures discussed today are non-GAAP unless we state that the measure is a GAAP number. Reconciliation of our GAAP to non-GAAP information is provided in our shareholder letter and in the press release.

With that as a backdrop, I'd like to turn the call over to Adam.

Adam Miller -- Founder and Chief Executive Officer

Thanks, Jason, and thanks to everyone who joined us today. Q2 marked the best second quarter we've had in the Company's history. And when looking at the first half of the year overall, we feel good about our position, and we are raising our financial outlook accordingly. I remain incredibly proud of our team for what they've accomplished and how they have thrived through this transition, which they've done while simultaneously increasing the size of our competitive moat.

To that point on competitive positioning, we talked about this a little on the last quarter's call, and again on the Analyst Day we had a Convergence in June, but it's so core to the fundamental story of Cornerstone that I think it's worth repeating. The combination of our Learning Suite and our emerging content offering is starting to create a flywheel effect which we believe will distance us from our traditional competitors.

One of our greatest assets is a scale we've developed over the years. Over the past 12 months, we've had over 550 million online course registrations on our platform. Think about that amount of data and what it provides, particularly since the related user data and content metadata flows through our system. We know which of those courses are the most popular, not only overall, but also by geography, by industry and by job function. It provides us with an extremely valuable repository of anonymized data, and when matched up with the data we have from our Performance Suite, we have the ability to serve this relevant content that drives employee engagement, reduces turnover and improves productivity. These are the things that all our clients want.

With the skills divide making news almost every week, the need for companies to rescale and upscale their workforces has never been greater. Think about how prevalent things like AI, machine learning and cloud computing have become in today's world, and then compare that to the number of workers that possess the requisite skills in these areas and you'll soon realize how the skills divide is becoming a burning issue for companies all around the globe. Our solutions actively address this issue. And now when we walk into a sales meeting and we are asked to present our vision, these clients see that we not only have the right products and strategy, but we're the only company that's properly positioned to execute on that strategy by leveraging our scale, our distribution and our data while simultaneously providing content subscriptions globally.

As we pointed out last quarter, we think that having a compelling content offering will act as a propellant for our overall business. It's the injection of this content into our massive install base and the scale that brings that is enabling us to tell a story to our clients that is truly differentiating and helping us win. This strategy drove strong performances around the globe and across our product suites.

During the second quarter, we had some notable wins at organizations like the US Postal Service, CB Richard Ellis and Lockton. Our US commercial sales team had a particularly strong Q2, and our strategic accounts team closed the first multimillion-dollar deal of our proprietary content subscription, Cornerstone Content Anytime. The feedback we received at Convergence, our annual client conference in June, made me feel even better about our strategic positioning and the opportunity that sits before us as a leader in both learning and talent management. Because of that and our performance in the first half of this year, I am even more enthusiastic about our business today than I've been. The onus is really on us to deliver, while the road may not always be linear, and we'll surely encounter some minor bumps along the way, our strategy is clear, and I'm really excited about it.

Before I turn things over to Brian, I want to comment about our philosophy and our plan to achieve the Rule of 40 in 2020. We believe our ability to continue driving operational efficiency while simultaneously capitalizing on our growth opportunities is the foundation for creating long-term shareholder value. Over the last several months, we have discussed our aspiration to achieve the Rule of 40 next year in 2020. We no longer consider this goal an aspiration, it is now our expectation. Although things may change along the way, today, we see a clear path and are feeling increasingly confident about our ability to achieve the Rule of 40, which in 2020 will have an unlevered free cash flow margin be a somewhat stronger contributor to this metric than constant currency subscription revenue growth.

In the shareholder letter we published earlier today, we detailed some of the operational efficiency initiatives that are driving our margin expansion over the next 18 months. Our team has really stepped up and found ways to become more efficient in almost every corner of our business. There's always more that we can do, but I believe we have an excellent plan in place, and I'm confident in our ability to deliver on that plan.

I'll now turn the call over to Brian to provide a few comments on our financials.

Brian Swartz -- Chief Financial Officer

Thanks, Adam, and good afternoon, everyone. Since we've provided a very thorough overview of the quarter and our updated guidance in the shareholder letter, I am going to keep my comments brief. As you can see, we had a strong second quarter, and we feel good about our performance. Accordingly, we chose to raise our full year financial guidance on all metrics; ARR, revenue, profit and cash flow.

A few key financial highlights. In Q2, subscription revenue was $133 million, representing 16% year-over-year growth or 17% on a constant-currency basis. This constant-currency year-over-year growth rate was better than the midpoint of our Q2 guidance by about 130 basis points. Operating income was nearly $17 million, representing an approximate 12% operating margin or an improvement of 175 basis points over the prior year. There were a few timing-related expense items that fell into Q2 that we budgeted to come in, in the second half of the year. Since they are timing-related, they won't occur in the second half. Additionally, we have raised our full year constant currency or currency-neutral operating income guidance at the midpoint by $1.2 million. This amount is adversely impacted by $700,000 in currency headwind for a net increase of $500,000.

Regarding our cash flow guidance for the second half, we expect a more back-end-loaded year than we had in 2018, so 2019 will be more in line with our historical trends. Please note that we expect higher capex in Q3 of this year, which will further exacerbate the comparison to 2018's linearity. While these quarterly variations create the optics of a back-end-loaded year, we are confident in our ability to meet these forecasts.

Regarding currency impacts on our guidance, you'll notice in our shareholder letter that in keeping with our practice over the last few quarters, we have disaggregated our updated financial guidance into changes that result from movements in currency from changes which are operational in nature. As you can see, changes in the spot rate, most notably the British pound, have moved considerably from where they were when we initially gave guidance about six months ago. It's also worth pointing out that we have provided new FX sensitivity disclosures so you have a better understanding of the magnitude of currency changes depending on whether the transactions are tied to the British pound or the euro.

Finally, in the spirit of full transparency, I'd also like to point out that R&D expenses declined by a few million dollars sequentially, which is atypical for our business. While there were some operational items that drove this, namely costs associated with transitioning our tech stack into the public cloud, which could result in some quarter-to-quarter variability on a prospective basis. We also chose to more appropriately classify an immaterial dollar amount into cost of revenue that was previously classified in R&D. Obviously, this has no impact on our operating income or cash flow.

Like Adam, I am very proud of the team for what we've accomplished in Q2, and I am excited about what lies ahead. Although we still have a lot of the year left in front of us, the first half has been our strongest on record, and I feel good about the strength of our team and the opportunity ahead.

With that, we will now take your questions.

Questions and Answers:

Operator

Certainly [Operator Instructions] Our first question comes from the line of Chris Merwin from Goldman Sachs. Your question, please.

Kevin Kumar -- Goldman Sachs -- Analyst

Hi. This is Kevin Kumar on for Chris. Thanks for taking my questions. For federal, you mentioned US Postal Service was one of the deals. It sounds like it was a relatively large deal. Can you talk about the federal pipeline more broadly and how's that looking for Q3?

Adam Miller -- Founder and Chief Executive Officer

Yes. We're feeling good about our federal business. We've had very good momentum over the last couple of years in federal, and that continues through today. So we're feeling good about our relationships with our existing clients and the growth opportunities there as well as the new business opportunities we're seeing as well. We already have seen good opportunities in Q3, and we'll continue to see that going into the future.

Operator

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

Mike -- Barclays -- Analyst

Hey, this is Mike [Phonetic] on for Raimo. Just had a quick question on the partner relationships that you guys are working through. It seems like you -- I saw on the shareholder letter you were talking about the best practices evaluation of the partner operating model. Could you go into a little bit more detail on that and what's going on in that end?

Adam Miller -- Founder and Chief Executive Officer

Sure. So what we did is we brought in some help from the outside and analyzed our entire structure in operating with our partner ecosystem. So everything from how we organize our alliances team to how we interact with our partners, to how we deal with things like service delivery, advisory work, delivery assurance, quality control, partner audit, certification, partner enablement, all of which we have been doing, but we had to make guesses back 18 months ago when we first moved to this new services model, where our partners did the vast majority of the service work.

And so 18 months later, we feel good about the partners that we have in place. We feel good about the work they have done. We feel good about the relationships we've established, and we really want to drive efficiency in our model, particularly the back-office components there, and that's exactly what we did. So we did the study over a close to six-month period and reviewed the results of that study and made some changes which result in real efficiency in the business.

Operator

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

Mark Murphy -- JP Morgan -- Analyst

Yeah. Thank you. You mentioned that you had the best second quarter for new sales in the Company's history. And I just wanted to clarify, Brian, is that a reference to the new subscription bookings? And if so, did you consider listing the constant currency ARR or subscription revenue guidance by 1 bp more than you are for the year? Or was it -- is it a case where that -- kind of that strength was apparent in the pipeline and you had sort of seen this developing coming into Q2?

Brian Swartz -- Chief Financial Officer

Well, so, Mark, I hope I understand your question. I mean, first of all, the reference to the best quarter is measured basically on new ARR, new ACV basis, right? It's bookings -- new bookings in the quarter, and it was the best first half in the Company's history. So that's what we mean by that from a pure metric perspective. In terms of how that flows through to our guidance, be it last quarter or this quarter. We obviously take that into account and flow it through in subscriptions. There's other things that impact that as well, whether it's currency rates, it's renewal rates and otherwise, but all of that has reflected in whatever guidance we give at any point in time. Obviously, the guidance we have today reflects all of that performance.

Operator

Thank you. Our next question comes from the line of Nandan Amladi from Guggenheim. Your question, please.

Nandan Amladi -- Guggenheim -- Analyst

Yeah. Good afternoon. Thanks for taking my question. So with the big push on the content side now in your sales efforts, how much emphasis are you continuing to place on recruiting and your expanding talent management suite?

Adam Miller -- Founder and Chief Executive Officer

So these are both very important parts of our business, whether we're talking about sales of our performance suite, which still remain extremely strong; the Recruiting Suite, which we're seeing very good opportunity for and continue to see pipeline growth for; or Cornerstone HR, they are all important components of how we go-to-market. Content, obviously, is the big incremental upside to all of that, and so that's why we've been calling out content specifically. But today, if you look at our software business, about half of our business is the Learning Suite and about half are the other talent management components. And that's remained true and will be true into the future. Content is incremental to all of the software.

Operator

Thank you. Our next question comes from the line of Scott Berg from Needham. Your question, please.

Scott Berg -- Needham -- Analyst

Hi, Adam and Brian, thanks for taking my questions and congrats on a good quarter. I guess my question, Adam, is around that first multimillion-dollar Content Anywhere [Phonetic] transaction that you discussed. Is there anything that's unique about that deal outside of maybe just the sheer number of seats that were a part of that to drive this level of spend?

Adam Miller -- Founder and Chief Executive Officer

Yeah. It was actually a combination both of the size of the account and the fact that they bought multiple subscriptions. So as you know, Content Anytime now is five separate subscription offerings, everything from professional skills and digital fluency, to sales and customer relationships in modern compliance. And we have, in that particular case, seen the purchase of multiple Content Anytime subscriptions, which increases the size of the deal, obviously. So we're feeling good about the Content Anytime business specifically and the content business generally, and it's just another proof point of our progress.

Operator

Thank you. Our next question comes from the line of Corey Greendale from First Analysis. Your question, please.

Corey Greendale -- First Analysis -- Analyst

Hi. Good afternoon and thanks for taking my question. Actually, I'm going to try to sneak in a two-part. First, on the enhanced -- or the continued guidance on the Rule of 40, I just want to make sure that when you say you expect more of the contribution to come from free cash flow margin than subscription revenue growth that, that is intended to be consistent with what you communicated at the Investor Day.

And the second part of my question is just on the content as you are sort of getting traction there. If you could just elaborate a bit.? Talking to some content partners or potential content partners, one of the questions I hear is about data you're sharing back with the content partners. And as you're getting data, are you now or is there a potential to share data or the metadata with your partners in a way that can help them improve their content? Or is it really -- is that not the idea and idea is just to pick -- find the best combinations?

Brian Swartz -- Chief Financial Officer

Yeah. Corey, it's Brian. I'll take part one and then I'll hand over part two to Adam. So to answer your question on the Rule of 40, it is consistent. We have consistently said that we expect to achieve the Rule of 40 in a balanced way. We are feeling more confident now. As you can see in the shareholder letter we published today, we laid out a variety of kind of operational levers for us to get there. We spent a lot of time over the course of the last quarter really fine-tuning the operational plans and the cost based plan to enable us to achieve the Rule of 40 given our current ARR guide for this year. So that's roughly mid-teens, as you can see, give or take maybe a little bit higher. We are basically planning on being able to achieve the targets that we talked about next year through bottom-line free cash flow or unlevered free cash flow performance.

Obviously, we're continuing to strive for higher revenue and subscription revenue growth, and we believe the market opportunity is very strong, as we talked about on the call, particularly with content next year and in the coming years. But we are feeling even more confident now than we did at our Analyst Day.

Adam Miller -- Founder and Chief Executive Officer

And with regard to the data around content, we are going to be sharing that with our content partners. Part of the benefit of working with Cornerstone is going to be a suite of tools that we're providing for the content providers to help them optimize their individual businesses as well as obviously support Cornerstone's overall content business. So the data has been put into a system that allows us to visualize the data both for internal consumption as well as to provide the content partners with their own provider portal to manage that data and leverage that data for improving their own business.

Operator

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

Brad Sills -- Bank of America -- Analyst

Oh! Great. Hey, guys, thanks for taking my question. Just wanted to ask about content again, just on any use cases or domains that you've seen some success in. Any themes here that are emerging as to use cases or domains?

Adam Miller -- Founder and Chief Executive Officer

Actually, it is very broad, or horizontal is probably the best way to talk about it. Virtually every business, every organization -- it's not limited to companies or corporations, but any organization needs to train its people. And those people typically need to be trained in a variety of areas, depending on what particular job they have. So some content is functionally specific, other content is based on the level of the employee. Obviously, entry-level employees don't need management or leadership development. By the same token, senior employees don't need some of the basic time management or professional skills that entry-level employees need, because hopefully they already have it. And our content offerings allow for all of that disparate subject matter.

And that's one of the things that's compelling about Content Anytime is that you're able to handle the breadth of content required by an organization irrespective of your size and irrespective of your geography. So downmarket, Content Anytime is compelling because you don't have the people internally that are able to do that kind of work for you to do the curation, build the content, to enter into these agreements or even optimize how the employee learning paths are operating.

By the same token, upmarket, you have a different level of complexity, being a multinational, having lots of employees at different levels of skill, different functional requirements, different potentially industry requirements, combined with just breadth of subject matter which makes curation more difficult.

So our Content Anytime offering works both downward and upmarket. We've seen that clearly now, the price points vary depending on if you're upmarket or downmarket. Obviously, large enterprises have lower prices per seat than small companies do. And the ASPs vary for each sale predominantly because big clients have big volumes. And even if the price per seat is lower, the total volume is going to be a lot higher, so those deals tend to be bigger or like this multimillion-dollar deal we just had.

By contrast, you'll have deals downmarket that are much smaller, low volume but high price points per seat. And there are also very nice opportunities for us, albeit not multimillion-dollar deals. So we think we have a very interesting offering that's quite compelling to many, many different kinds of clients and is quite accretive for us overall.

Operator

Thank you. [Operator Instructions] Our next question comes from the line of Rishi Jaluria from D.A. Davidson. Your question, please.

Hannah Rudoff -- D.A. Davidson -- Analyst

Hi, guys. This is Hannah on for Rishi. Thank you for taking my question today. On the last call, Adam, I believe you mentioned that there's still room for improvement with regards to returns on marketing spend and positioning in the market. With Heidi, you've recently hired as the Chief Marketing and Strategy Officer, what would you say are her three top priorities in the near term?

Adam Miller -- Founder and Chief Executive Officer

Great question. I would say number one is branding, so establishing our positioning in the market, assuring that we have consistent messaging and that we're positioning things properly vis-a-vis both the competition, but also based on market demand, product market fit and where we see the most opportunity. So that's number one.

Number two, I would say is blocking and tackling, ensuring that our marketing team globally is operating as a single global organization. We see a lot of room for efficiency by operating some functions more centrally, others more decentrally or locally, and that makes us more efficient in our spend overall.

And the third is related to our analyst relationships. So not the financial analyst community but the industry analysts and influencer community which has a major impact on demand-generation and our ability to compete effectively. And that's something where Heidi has an enormous advantage, having been in the space for over two decades and having personal relationships with many of these analysts and influencers. So I would say that's Top 3. The list is longer than three, but those are the Top 3.

And then I'll answer more broadly. While we have had tremendous success in improving sales productivity over the last 18 months, we are by no means finished, and we think there's opportunity to continue to drive sales productivity and cost efficiencies throughout sales and marketing, making us more efficient as a business overall in driving incremental margin improvement.

Operator

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

Pat Walravens -- JMP Securities -- Analyst

Oh! Great. Thank you and congratulations. So Adam, it's interesting to me that last week, Pluralsight, which has sort of a technology skills focus for learning, had pretty disappointing results, and yet your Content Anywhere is so strong. I hope you can help us figure out why that might be?

Adam Miller -- Founder and Chief Executive Officer

So I am not going to comment on Pluralsight. Obviously, very good company, good business. They've done many things extremely well. What I will say is that their offering is very specific. So they are very focused on development and engineering, whereas Content Anytime, as I mentioned earlier, is a very broad offering. So it's applicable to any group of people, any business, any organization, any size and any geography. And so that gives us a very horizontal opportunity that allows us to sell into different markets at different times and different geographies at different times and gives us much better portfolio diversification for that business, which I think is one of the keys to our success. It also allows us to leverage our scale. The fact that we are large and have global distribution, allows us to have that kind of offering.

But we're not seeing anything concerning in content at all, and I think again part of that has to do with the breadth of our offering and the fact that we're able to sell through the global distribution we've already established into any market segment anywhere in the world. Like we're still bullish on content, generally.

Operator

Thank you. Our next question is a follow up from the line of Chris Merwin from Goldman Sachs. Your question, please.

Chris Merwin -- Goldman Sachs -- Analyst

Okay. Great. Thanks very much for having us back on. Just wanted to ask about, I think in the shareholder letter, you called it out as having its best first half ever. We've heard other companies so far this running cycle talking about pressure there. So just curious if it is really strong execution, if you did see any lull in demand at all. That is obviously a great first half, so just curious if you could speak to the climate there?

Adam Miller -- Founder and Chief Executive Officer

Yeah. So obviously, Brexit is top of mind for everybody in Europe and all throughout EMEA. We were severely impacted by Brexit last time around, and so we wanted to make sure we didn't repeat that mistake. We are much better diversified throughout Europe and throughout EMEA generally. We have much lower concentration risk in any single market. We are better set up from an accounting and currency perspective, all of which makes us more confident about the opportunity in Europe.

We're also not seeing any slowdown in any particular market or geography, and we're not seeing any headwinds at this time. That's not to say if there's a hard Brexit that there won't be any impact. I imagine there could be collateral damage, but we are not seeing anything at this time. We feel very good about that business. We have a strong pipeline in EMEA, and obviously an excellent first half of the year.

Operator

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

Adam Miller -- Founder and Chief Executive Officer

Thank you all for your questions and for your participation on today's call. As always, I want to especially thank our global team for the great work they have done as Cornerstone continues its drive to rescale the global workforce for the future. Thank you for attending.

Operator

[Operator Closing Remarks]

Duration: 32 minutes

Call participants:

Jason Gold -- Vice President of Finance and Corporate Development

Adam Miller -- Founder and Chief Executive Officer

Brian Swartz -- Chief Financial Officer

Kevin Kumar -- Goldman Sachs -- Analyst

Mike -- Barclays -- Analyst

Mark Murphy -- JP Morgan -- Analyst

Nandan Amladi -- Guggenheim -- Analyst

Scott Berg -- Needham -- Analyst

Corey Greendale -- First Analysis -- Analyst

Brad Sills -- Bank of America -- Analyst

Hannah Rudoff -- D.A. Davidson -- Analyst

Pat Walravens -- JMP Securities -- Analyst

Chris Merwin -- Goldman Sachs -- Analyst

More CSOD analysis

Transcript powered by AlphaStreet

This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see our Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.