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Cornerstone OnDemand, Inc. (CSOD) Q3 2020 Earnings Call Transcript

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Cornerstone OnDemand, Inc. (NASDAQ: CSOD)
Q3 2020 Earnings Call
Nov 5, 2020, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to the Cornerstone Q3 2020 Earnings Conference Call. [Operator Instructions].

I would now like to turn the conference over to your host, Mr. Jason Gold, Senior Vice President of Finance. Sir, you may begin.

Jason Gold -- Investor Relations

Thank you very much, and good afternoon, everyone, and welcome to Cornerstone's Third Quarter 2020 Earnings Call. With me today are our Chief Executive Officer, Phil Saunders; and our Interim Chief Financial Officer, Trish Coughlin. In conjunction with today's call, we published a presentation that's located on the Investor Relations section of our website. Today's press release was furnished to the SEC in a Form 8-K. Today's 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; the integration of Saba into our business and achievement of related cost synergies and efficiencies; our strategy; our long-term growth; and our 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 the measure as a GAAP number. The reconciliation of our GAAP to non-GAAP information is provided in the earnings press release and also in the presentation.

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

Phil Saunders -- Chief Executive Officer

Thank you, Jason, and thanks, everyone, for joining us today. Over the recent months, Cornerstone has experienced significant positive change. Our company continues to operate well during this bizarre new normal of COVID-19. We have continued on our path to improve the business by getting the fundamentals right. And that is by executing on our near- and long-term strategy, driving better alignment of the organization and taking a more cogent operational approach, all with a critical eye on our people and our company's culture. To be clear, our aim is to continue our focus on business improvement while actively integrating our strategic acquisition of Saba. This is an exciting time for our company. In the third quarter, we delivered total revenue of $199 million, operating income of $47 million, earnings per share of $0.51 and unlevered free cash flow of $56 million. Through our operational focus in the quarter and the continued execution of our integration and synergy plan, we generated a strong cash position, which enabled us to pay down $50 million of our Term Loan B debt instrument early in the fourth quarter. You should see this as a sign of our commitment of using cash generation to rapidly delever and allow value to accrue for our stakeholders. In the context of COVID and a massive transformation, we're pleased with these results.

We experienced modest improvement in new business wins, both from some pent-up demand and from in-period active pipeline. We're executing well on some large U.S. and EMEA enterprise opportunities where people development was of critical importance to their wider digital transformation initiatives. Our renewals, including some strategic customers in areas both affected and unaffected by COVID, progressed well and showed some improvement in the quarter. Again, this is just one quarter, and I'm not yet ready to declare victory, but it's an encouraging trajectory, and we'll track this together over the months ahead. The increased attention we have on our customers is one that is exciting and personal to us. And our customers' reception to our transformational adjustments and our strategic innovation activities is quite motivating for our team. The evidence we have for this comes directly from specific proof points in both large and small customer renewals that transpired in competitive ERP bake-offs, which we believe were directly tied to these recent strategic shifts. We also had an outstanding [customer reception] at our annual Convergence event with nearly 10,000 attendees joining us at the virtual event this year, which we think bodes well for future discussions with our customers. When looking at performance of our various theaters during the quarter, our government, U.S. enterprise and EMEA businesses did well.

In balance, our SMB business wins were respectable in the quarter with consistent win rates, yet the overall volume of active opportunities remained constrained due to the pandemic. Similarly, our APJ business and in particular Japan remained soft. We are confident these markets should remain a strategic focus area, and we have built the right partnerships with firms like IBM, Hitachi and others to serve these growth markets. But there is no denying this region has been kept in check by COVID, and consequently, our sales here were below our expectations. We continued our motions to integrate content and more specifically our Cornerstone Content Anytime offering. And it continued to prove fruitful, including early wins within the Saba customer base in all of our theaters around the world. We believe we are in the very early innings of the opportunity here. And over the next few quarters, the former Saba sales rep should be fully armed to position this offering for success within their customers. The bottom line is we see a strong opportunity here and early validation of the strategy. Our customers are recognizing the specialized value proposition that Cornerstone brings. A combination of curated partner content plus our own self-developed content is addressing our customers' needs in a highly differentiated way. We've begun to roll out the unique programs anchored by the enthusiasm we started to see for our Cornerstone Originals, micro and nano-learning content. The Grovo acquisition is proving to serve us well.

A "focus where we win" mindset is being actioned inside Cornerstone. And while we're early in the transformation process, we're off to a good start. Our ultimate scorecard is defined clearly: we want to drive value creation for all of our stakeholders. We win by creating value through our relentless focus on our customers, driving efficient growth as we advance our market impact and fueling expanded profitability. This is the new Cornerstone, and there's a legitimate enthusiasm both internally and externally about our path forward. As we follow our course of transformation and focus on strong operational principles, we continue to believe in the importance and relevance of the solutions we provide our customers and the market at large. As the COVID pandemic is part of all of our lives, both personally and professionally, I continue to be amazed how well our people and teams continue to perform, and I'm truly appreciative for them finding that balance so necessary for success. We also see the perseverance of our customers in this environment. We are working hand in hand with them, engaging with those companies who need to thrive in the critical areas where we believe we are simply better than our competitors. Companies have accelerated their digital transformation strategies and are rethinking their employee development programs. The need to move from physical classroom to virtual formats, the requirement to upskill and reskill the workforce and the desire to improve talent mobility and experiences for their people are just a sampling of certain dynamics that we believe can turn into a tailwind for our industry as we head into 2021 and beyond.

I'd now like to spend a few minutes reviewing the transformation activities we discussed last quarter and provide some insight as to how we performed on this journey during Q3. As you know from our press releases, I've made substantial leadership changes that are inextricably tied to our drive for a stronger Cornerstone. We've added three additional focus areas and related functional leaders responsible for: one, our transformation; two, customer service; and three, product leadership. These new leaders are actively driving these compelling concepts into tangible reality. As part of this wider org design initiative, we've made changes in the past 90 days to our services, delivery and support organization and adjustments to our global sales organization that we expect will drive better alignment and increase efficiency and effectiveness over time. Another transformational area for us relates to customer experience. Folks, this is more than a catchphrase for us. We've made significant changes to properly serve our customers and their 75 million users leveraging the power of our platform. As you know, we've elevated the ownership and visibility of customer support with a new executive in charge. And since making that shift, we've made tremendous change with purpose advancements in the organizational design. We've altered and enhanced the processes that align to industry best practices and our experience know-how. And we've increased investment in systems that enable a measurably improved customer support journey. These changes are significant, and they'll take some time to achieve their full impact, but know that I'm impatient and we plan to accelerate everything that's rational to get this right.

I also introduced the concept of win zones to you on our last earnings call. This approach means that we isolate those use cases and environments where we believe we perform at a higher win rate due to the differentiated assets here at Cornerstone. There's more work ahead of us for sure, but we experienced early proof points in Q3 that give us encouragement that we're on the right path. We were awarded several opportunities in heavily contested environments that had large ERP vendors at the table specifically due to the concept of knowing where we win and winning where we focus. We've experienced the success in each of our geographic theaters across multiple verticals where we're dialed into. Last quarter, we also talked about product vision and strategy. To help support those efforts, I'm thrilled to have added Ajay Awatramani to our leadership team during Q3 as our Chief Product Officer. This is and will be a strategic role for our company as we drive forward. We're off to a fast start in crystallizing our company's strategic product direction and innovation acceleration. And the anecdotal feedback from our customers has been quite positive. Equally important is Ajay and his team's focus on how best to allocate our precious talent resources to the areas that we believe drive meaningful value for our customers and ultimately for our company.

As a reference point for you, this is -- this logic is probably not terribly different from how investors approach capital allocation in their portfolios to maximize the greatest returns by putting the most capital behind the biggest and best opportunities. We believe this strategy will deliver enhanced value to our customers by further advancing our capabilities in our key market domains. We are also aligning resources to accelerate innovation for our corporate customers and their end users to a strategic -- through our strategic technical assets and massive data set. Our conviction surrounding an open architecture and enabling people development experiences in the flow of work is evidenced by our recent announcement with ServiceNow where we shared our platform interoperability plans, one example of how we can put our strategy into action. Our aim is to drive increased engagement of our users, which we believe over time can lower churn and is one element of our virtuous flywheel to success. Now let's take a moment to talk about efficient growth and the path we see to invigorating that growth here at Cornerstone as this is fundamental for us. We believe we lead the market in providing people development solutions, and we're committed to leverage our strengths to advance the people development experiences for our customers. Yes, there are COVID headwinds, and my senses will continue to contend with this reality well into 2021. But that does not relinquish our responsibility to execute the areas under our control that impact our growth. Everything we've discussed thus far in regard to our transformational actions isn't random. The strategies, steps, actions, changes are all aligned with our mission and with our purpose.

And so with this in hand, we will attack the building blocks of growth. It starts with a maniacal focus on customer retention, engage in thriving customers to renew their contracts with us. And if we're doing our job, they expand to leverage more of our capabilities. And with a sound go-to-market motion, we'll focus on and win new customers. Retention, upsell and new business in combination drives increased ARR, which, in a word, is growth. So when you hear me opine on customer experience, advancing product innovation, analyzing organizational design and focusing on win zones, it's all in the name of advancing the critical elements of driving growth. This is not novel or new to us. Through our collective experiences, we have the know-how to do this, and we believe we will. We remain confident in our drive toward $1 billion in ARR and at least 30% unlevered free cash flow margins. We discussed on our last earnings call that our core business is roughly $700 million of the $800 million we have in ARR. And this core is the area we're heavily investing in for our long-term growth and expansion. We are actively working to allocate our resources on the core to accelerate our innovation while we continue to create valuable offerings, new capabilities and seamless migration plans when sensible for our noncore business. I'd ask that you stay tuned here. Although it's early and we're still developing the official programs, we've seen anecdotal evidence of our ability to transition some of the customers using our noncore solutions over to our flagship offerings and multiple instances where we were able to simultaneously provide them an integrated content solution.

As we're driving through our Q4 -- I'm sorry, our fourth quarter and look at our full year 2020, Trish will walk you through the details, but we're expecting some of the momentum we had in Q3 to continue in Q4. We are planning our business and spend around the notion that COVID will be with us for some time. Said more directly, we do not require a major snapback in the market in order to successfully execute on our transformation. To that end, we are on track to realize the $65 million of synergies I previously shared with you. And based on actions we have taken, we expect to have this completed as we enter the new year. The guidance for full year ARR remains consistent with our last quarter's guidance. And while we are, of course, driving for growth, it is prudent to consider us tracking to about flat when compared to the pro forma combined Cornerstone and Saba $818 million we did in 2019. Before I pass to Trish, I wanted to call out our company's continued efforts world, our free development offering in Cornerstone Cares, with over 160,000 active individuals and many companies lacking current funding to take advantage of our offerings across a number of timely and relevant topics ranging from unconscious bias to interviewing skills to stress management. We've also advanced our activities with the Cornerstone Foundation with our customer and partner in Big Brothers Big Sisters, where the concept of mentoring is front and center. Our foundation provided a technology grant to Big Brothers Big Sisters as they began delivering more of their volunteer training online. By the spring of 2020, COVID-19 forced their team abruptly to convert not only their training but their entire program from a primarily in-person experience to a digital one.

With our platform, Big Brothers Big Sisters can now onboard new mentors virtually, share ideas and resources with colleagues across the country and provide training on timely topics such as social justice, working with LGBTQ youth or mental health and social isolation. These social efforts are quite personal to us here at Cornerstone, and we will continue to try and do our part in our communities in making a positive and lasting impact.

Let me now turn the floor over to Trish.

Trish Coughlin -- Interim Chief Financial Officer and Chief Accounting Officer

Thanks, Phil, and good afternoon, everyone. As Phil indicated, our Q3 results came in above the high end of the range we provided last quarter. Subscription revenue exceeded the high end of our guidance, and a higher-than-anticipated burn-off of Saba's legacy services backlog drove a meaningful outperformance on the services line relative to our expectations. In addition, our Q3 revenue absorbed the $19 million headwind due to the deferred revenue writedown relating to the Saba acquisition. The combination of stronger-than-guided subscription revenue and lower-than-planned expenses enabled us to surpass our operating income guidance by approximately $14 million. Our unlevered free cash flow of $56 million was positively impacted in part due to the timing of certain restructuring and integration expenses that we thought would happen in Q3 but which we now expect to occur in Q4 and early 2021. You'll notice that our client count declined slightly quarter-over-quarter. The decline in clients was entirely attributed to churn on our noncore segments. We experienced sequential growth in our core. We are adjusting our guidance for Q4, which, given that Q3 outperformance, drives an increase to our full year guidance for revenue and operating income. We expect our Q4 subscription revenue to be in the range of $188 million to $191 million, up from a range of $186 million to $189 million. We expect our total revenue to be in the range of $194 million to $197 million, up from a range of $193 million to $196 million.

Our Q4 revenue guidance includes a headwind of approximately $13 million due to the deferred revenue writedown. We expect our Q4 operating income to be between $35 million and $38 million, up from the $33 million implied by our prior guidance. It's worth noting that nearly $1 million of Q3's revenue outperformance on the services line carried no cost of goods sold with it, so it dropped straight through to operating income. In Q4, we anticipate transitioning the majority of Saba's remaining services backlog to our implementation partners as we transition Saba's services platform to the Cornerstone model. This will have the effect of increasing our cost of goods sold, reversing some of the benefit we enjoyed in Q3 as we have performed much of that service work internally. It's also worth noting that our updated operating income guidance takes into consideration an incremental $2 million to $3 million in operating expenses due to a recently implemented companywide bonus program tied to renewal rates. Going forward, any bonus accrual will be amortized over the course of the full year. But since we instituted this program late in 2020, the full impact of this is being felt in Q4. Continuing on to cash flow. We now expect our full year unlevered free cash flow to be between $110 million and $115 million, up from our previous range of $105 million to $115 million.

As Phil mentioned, we took the opportunity early in Q4 to pay down $50 million in principal on our outstanding Term Loan B. Under current market conditions, each $25 million in principal that we pay down should reduce our annualized interest expense by about $1 million. We are reiterating our guidance for ARR to be about flat on a year-over-year basis when compared to the 2019 pro forma Cornerstone and Saba combined figure of $818 million. Within that, we do expect our core ARR to show growth offset by declines in our noncore. This would therefore drive subscription revenue in 2021 in the low $800 million range. As a reminder, our ARR balance is determined by both new wins during the year and the ARR that churned. Phil did point out that our renewal rates are trending up, and we are cautiously optimistic about the trends we are seeing there. With that as a backdrop, I wanted to remind you that contained within our 2020 ending ARR guidance is an 8-figure expected churn from the U.S. Census Bureau. Recall that we pointed this out at the end of last year. As the Census winds down, the majority of that contract is expected to churn as a result of the end of our contract term. Absent this unusual contract, we would expect growth in our ending ARR balance. Although it remains early in our 2021 budgeting cycle, we are currently expecting low single-digit growth in our total ARR for the full year of 2021, with growth generally ramping through and weighted toward the back half of the year.

We expect declines in our noncore ARR to be more than offset by growth in our core areas. Of course, the pace of any macroeconomic or COVID-related recovery or the duration or magnitude of any continued or deepened negative impact from the pandemic are unknown, and all these factors could impact our ending ARR number. As it relates to our cost structure, we expect to have more precise guidance to share on our next earnings call. But from a framework perspective, you should think about us being able to annualize the $65 million in cost savings that we will exit 2020 with, offset by some increases due to the annual merit cycle in Q2, a resumption in travel and entertainment spending and an increase in content royalty fees as we grow our content business. This will put our cost of revenue plus operating expenses to somewhere in the range of about $650 million for 2021. From a cash flow perspective, we would expect 2021's unlevered free cash flow to be at least $185 million, which includes approximately $50 million in restructuring and integration costs, or $235 million before consideration of these onetime costs. And as Phil said, we remain confident in our ability to achieve $1 billion in ARR and 30% unlevered free cash flow margins over time.

With that, we'll now take your questions.

Questions and Answers:

Operator

[Operator Instructions] And our first question is from Rishi Jaluria of D.A. Davidson. Your question please.

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

Hi guys, this is Hannah Rudoff on for Rishi today. Thanks for taking my questions on. First question for you, Phil. I was just wondering if you could talk about if there have been any unexpected points of friction in the integration you've seen so far.

Phil Saunders -- Chief Executive Officer

So no unexpected friction points. I think it's the normal gravity of putting two companies together. As you can probably imagine, it's not the easiest thing to do from a work-from-home COVID environment. But I would say, overall, the teams have worked very, very well together, our values and goals are aligned, and I think we're doing quite well. So to answer your question specifically, no, no unexpected friction points.

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

Great. And then could you talk about Cornerstone Convergence and how pipeline was coming out of that event?

Trish Coughlin -- Interim Chief Financial Officer and Chief Accounting Officer

Sure. I mean our Convergence event, which I suspect everyone on this call knows, was virtual, and it was virtual for the obvious reasons. We were debating whether we should have it at all or not because we were, frankly, thoughtful of a platform that could withstand the volume of people. As I mentioned, we had over 10,000 active attendees in various breakouts and rooms. We have a good chunk. I don't know the exact number, to be candid, but it was in the low thousands of folks that were not customers, so prospects, which we're encouraged by, which obviously feed into our MQL or our marketing leads. And so between our existing customers, engagement and opportunities to talk to them about new things we're doing as well as new opportunities, I feel really good that it was a good use of time and obviously efficient spend.

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

Great. And then just last question. How much upside potential is there from an improving COVID environment?

Phil Saunders -- Chief Executive Officer

That's a really tricky question, and I feel like I knew the question was going to come. I think what I see in the COVID environment is actually not necessarily an uptick of ARR because of COVID. What I see is increased usage. I see the need for what we do going up on our platforms, whether it be our mobile platforms, our integrated virtual meetings, our integrated content and related amount of learning. So the sheer amount of usage is going up, which bodes well for things like customer retention and the potential for more seats and different capabilities to be adopted. So I want to be cautious on overpressing the "benefits" of the COVID environment. But I will say that we're definitely seeing the increased usage of our platforms in this environment.

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

Great, thank you.

Phil Saunders -- Chief Executive Officer

You're welcome.

Operator

[Operator Instructions] At this time, I'm showing no further questions in the queue. I'd like to turn the call back to Phil Saunders for closing remarks.

Phil Saunders -- Chief Executive Officer

Thanks very much, and thanks, everyone, for joining the call. I wish everyone safe and careful travels if you are traveling. And we're, as you can tell, pretty excited about our business and the things we're doing here, and we look forward to chatting with you again next quarter. Thanks very much, everyone.

Operator

[Operator Closing Remarks].

Duration: 26 minutes

Call participants:

Jason Gold -- Investor Relations

Phil Saunders -- Chief Executive Officer

Trish Coughlin -- Interim Chief Financial Officer and Chief Accounting Officer

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

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