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Cornerstone OnDemand, Inc. (NASDAQ:CSOD)

Q2 2013 Earnings Conference Call

August 6, 2013 5:00 PM ET

Executives

Perry Wallack – Chief Financial Officer

Adam L. Miller – Founder and Chief Executive Officer

Analysts

Mark R. Murphy – Piper Jaffray, Inc.

Michael Nemeroff – Credit Suisse Securities, LLC

Brendan J. Barnicle – Pacific Crest Securities LLC

Patrick Walravens – JMP Securities

Rick G. Sherlund – Nomura Securities International, Inc.

Justin A. Furby – William Blair & Co. LLC

Scott Berg – Northland Capital Markets

Frank Robertson – Goldman Sachs

Operator

Good day, ladies and gentlemen and welcome to Cornerstone OnDemand Second Quarter 2013 Earnings Conference Call. At this time all participants are in a listen-only mode. Later we will conduct the question-and-answer session and instructions will be given at that time. As a reminder, this conference call is being recorded.

I’d now like to turn the conference over to Perry Wallack, CFO for Cornerstone OnDemand.

Perry Wallack

Good afternoon everyone. This Perry Wallack, CFO of Cornerstone OnDemand and welcome to our second quarter 2013 earnings conference call. Today’s call will begin with Adam providing a brief overview of our company and our performance over the second quarter and then I will review some key financial results for the quarter which ended June 30, 2013. Later, we will conduct a question-and-answer session.

By now, you should have received the copy of our press release, which was released after the market close today and will be furnished with the SEC on Form 8-K. You can also access the press release and the detailed financials on our Investor Relations website. As a reminder, today’s call is being recorded and a replay will be made available following the conclusion of the call.

During the call, we will be referring to both GAAP and non-GAAP financial measures. The reconciliation of our GAAP to non-GAAP information is provided in the press release and on our website. All of the financial measures that we will discuss today are non-GAAP, unless we state that the measure is a GAAP number. Any non-GAAP outlook we provide has not yet been reconciled with the comparable GAAP outlook, because, among other things, we cannot reliably estimate our future stock-based compensation expenses, which are dependent on our future stock price.

Our discussion will include forward-looking statements such as statements regarding our business strategy, demand for our products, certain projected financial results and operating metrics, product development, customer satisfaction and retention, customer attrition rate, market or business growth, our revenue run rate, investment activity in our business, visibility into our business model and results, the effective capitalized development costs, spending on R&D, professional services and other aspects of our business, our appraisal of our competitors and their products, and our ability to compete effectively.

Words such as expect, believe, anticipate, plan, illustrate, intent, estimate and other similar words are also intended to identify such forward-looking statements. Forward-looking statements involve risks, uncertainties and assumptions. If any of the risks or uncertainties materialize or any of the assumptions proved incorrect actual results could differ materially from those expressed or implied by the forward-looking statements we make. These risks, uncertainties, assumptions as well as other information on potential factors that could affect our financial results are included in today’s press release, the Risk Factors section of our most recent Form 10-K, and subsequent periodic fillings with the SEC.

With that, I will turn the call over to Adam.

Adam L. Miller

Thanks Perry, and thank you to everyone joining us today. In a quarter that saw many software companies come up short, Cornerstone recorded one of its best performances to date. And I’m excited to share some of the highlights of the quarter with all of you today.

GAAP revenue for the second quarter came in at a record $44.3 million, representing a year-over-year increase of 66%. And bookings came in at a record $48.9 million representing a year-over-year increase of 55%. Our client base once again saw the addition of a diverse group of the leading organizations across various industries and geographies, taking our enterprise and midmarket client count to over 1,400.

Our newest clients include one of the world’s premier investment banks, a Fortune 500 sporting goods retailer, one of Canada’s largest retailer chains, one Spain’s largest insurers, a leading Argentinean temporary agency, and the Internets leading travel website to sight just a few.

Last quarter, I spoke at the way about the rising average selling prices or ASPs that we were seeing in all areas of the business. And in the second quarter, we saw this trend continue, resulting in enterprise and mid-market ASPs that were more than 20% above the 2012 levels through the first six months of this year. As more and more organizations think strategically and holistically about talent management, we believe there is a significant opportunity for our ASPs to continue to grow higher in the years to come.

To ensure that we are well positioned to capture this opportunity, we are investing more than ever in innovation across the talent management continuum. Well for our time, our goal is to be considered one of the best B2B software companies in the world. We have clearly crossed that milestone and today are focused on continuously finding new ways to set the bar higher, as we now aim to become one of the best technology companies in the world.

As I spoke about during our annual client conference in June, work is changing. This includes who we work with, where we work from and how we work. The makeup of the global workforce is going through an evolution with people seeking to work much later until their lives combined with motivated millennials becoming a more significant piece of the pie.

This is the way to changing workforce demands within organizations all over the world, with things like career progression, mobility, and ongoing training and development becoming the most critical drivers of employee engagement. Additionally, because more and more people today are telecommuting, effective virtual collaboration and the ability to learn on your own schedule are both becoming increasingly important?

With the proliferation of mobile devices in flex time, people are working wherever they want.

Finally, with the consumerization of the enterprise, how we work is also changing. The line is clearly blurred between what devices and apps we use for personal versus bigger issues. As a result, our expectations about how our applications will look and work are clearly changing. While enterprise software is historically focused on functional sufficiency, we are seeing a clear shift towards a more spherically posing and intuitive user experience.

What this means is that, today the employee and end-user rather than the company must be at the core of what we do. As we began working on the enhancements offered to the most recent product release, we considered all of this and set out to reimagine the way people work.

The first thing we did was spend a significant amount of time doing a deep dive to evaluate all of the leading consumer applications on the Internet, so that we could better understand what features and functions, we needed to bring into our solutions and sometimes add things like predictive search and text capabilities. It’s now work much like Google and Kayak. We also incorporated social reviews similar to what you might find in Yelp, into our already management solution with both pull-push recommendations for full recommendations for similar training based on the course we’re considering, much like you would expect to find in Amazon today.

The next thing we did was adopt Steve Jobs mantra of simplicity through complexity and export ways to eliminate redundancies in our product design and streamline everything while continuing to increase the depth of our functionality behind the scenes. It has lead to the creation of what we call the Universal profile, which was designed to reconcile the entire application. The universal profile takes the best of social networking and allows employees to see everything about themselves in one place, connections, skills, interests, their team, their career preferences and much more and it goes beyond just biographical information.

What we sought to do was employee comsumerisation, in a way that really impacts how employees work. So the universal profile also allows you to manage all of your actions as well as those of your team. This includes things like training, goal setting, performance reviews, compensation tasks, competency assessments, and even the giving and receiving of feedback to enable fully social performance management.

We also incorporated the concept of game application into our solution by giving users who are providing feedback, the ability to assign badges to the points associated with them. Organizations will be able to allow their users to redeem the points from these badges for gifts or money. So we now have a performance product that has all of the functionality of a traditional performance management system, as well as a full range of social performance capabilities, which we believe no other vendor offers today.

We also launched an all new Connect, which is our enterprise social networking tool. Many of you may not know this, but we were actually the first ones in our space to recognize the importance of enterprise social networking. And initially we came out with Connect, as part of our suite back in 2007.

Admittably, however, we did not maintain cutting edge standards around social networking due to other priorities, consequently as the technology evolved over the past five years, our enterprise social networking products well behind.

The likes of Facebook and Twitter on the consumer side changed peoples expectations with respect to social. In recognizing that, we decided to go back to the joint board.

With the completely redesigned Connect, we intend to reclaim the mantle in this area by taking social productivity to the next level. We want Connect to be as much about management as it is about social collaboration. Managers can use Connect to manage their teams and teams can use Connect to manage their projects. And because we organically build all of these new tools, it’s seamlessly embedded with Cornerstone’s learning, performance and recreating clouds.

We not only plan to more aggressively self connect with our other products, but we also expect to sell it on a standalone basis. We were off to a good start because approximately a quarter of our clients already have Connect.

While we have continued to innovate, we believe that the competitive environment has also become increasingly favorable to us. I’ve said in the past that the massive consolidation space is to improve our advantage. At the most basic level, we’ve been able to substantially enhance and expand our talent management solution making it now highly differentiated, it’s the leading best of bridge solution, while our acquired competitors have focused on trying to integrate the products with their new parents. But we believe there is something deeper going on in our space.

Following the acquisitions, the acquired company has began to transform in many of the key people who made this company successful and competitive leave for greener pastures. Atrophy powers the exodus and the competitors significantly weaken. This happened over the last year with Huawei. But success to remain relatively independent and largely in tact. That was until last quarter.

In May, SuccessFactors’ CEO left SAP, not only he was the leader and a worthy competitor, but he was also the visionary behind the product and that their best salesman. It has been announced that their sales and service teams now report to the [Areva] management team and SuccessFactors’ tech team now reports to the core SAP tech group. We believe it will be a few more quarters to see the full impact, but the exodus has begun.

From today, we believe the momentum in quarter is stronger than ever. After over two years as a public company, not only have we maintained industry leading growth quarter-after-quarter, but we have done so while strengthening long-term position, fortifying our product and our services superiority.

Our ongoing focus on the success of our clients has kept our retention rate amongst the highest in SaaS. And this combination of growth and retention helped us increase our user count over 12 million users in the second quarter, which continues to represent one of the largest cloud subscriber basis in the world.

And with that, I’d like to turn it back over to Perry.

Perry Wallack

Thanks, Adam. Before I get to the financial results of our second quarter of 2013, I’d like to remind everyone again that the financial figures I discuss today are non-GAAP unless I stated the measure is a GAAP number. We talk about non-GAAP numbers for the following reasons; non-GAAP financial measures exclude certain items that we believe are not good indicators of Cornerstone’s current or future operating performance.

For the periods we will discuss today, these items include expenses related to stock-based compensation and related employer payroll taxes, amortization of intangible assets, acquisition costs, adjustments in taxes related to acquisition adjustments and amortization of debt discount and issuance costs. But prior period this may also include adjustments to our revenue due to the write-down of differed revenue related to our acquisition of Sonar Limited in April 2012. You can find the reconciliation of GAAP to non-GAAP results in today’s earnings release.

As Adam said, we had a great quarter. Second quarter GAAP revenue and bookings grew at 66% and 55% respectively on a year-over-year basis. As this indicates for the past several years, this growth has continued as we have scaled the business due to our leading market position and talent management, as well as the strong demand for talent management across geographies, verticals and segments.

Our GAAP revenue for the second quarter was $44.3 million. Our revenue results for the second quarter represent year-over-year increase of 66% on a GAAP basis and 62% on a non-GAAP basis. Our GAAP revenue exceeded the midpoint of our second quarter 2013 guidance of $42 million by $2.3 million or 5%.

As we may have highlighted in the past, our revenue depends on among other things, the timing of when consulting services are delivered to our clients by both our services organization and third-party implementation partners. Total bookings which we define as gross revenue plus change in differed revenue were $48.9 million for the second quarter, representing a 55% year-over-year increase over second quarter 2012 bookings of $31.5 million.

As you think about our bookings growth, I’d like to remind you that our bookings can vary on a quarterly basis depending on the nature and timing of the invoicing for new clients, existing clients and renewals. The size of our client base excluding CSB and CFS clients increased from 1,001 clients as of June 30, 2012 to 1,411 as of June 30, 2013, representing 410 client additions and 31% year-over-year growth. On a sequential basis, versus the first quarter of 2013, we added 94 clients during the quarter, again excluding CSB and CFS clients.

Our user base increased from approximately 11 million users as of March 31, 2013 to approximately 12.3 million users as of June 30, 2013, which represents the addition of approximately 1.3 million users during the second quarter or 11% sequential growth. As we have mentioned in the past, our user additions can vary from quarter-from-quarter based on the size and number of clients that go live on our solution in a given quarter.

Our gross profit for the second quarter of 2013 was $32 million, compared to $20.4 million in 2012, reflecting an increase of approximately $11.7 million from 57%. Our gross margin for the second quarter of 2013 was 72.2%. As a reminder, we do not expect to always have sequential improvements in our gross margins from quarter-to-quarter.

In addition to continued investment in our software, network infrastructure and services organization to support our growth we use third-parties to perform implementations. The timing of these investments and use of third-parties to perform implementations can effect our margins on a quarter-to-quarter basis.

We anticipate that for the full year 2013, our gross margins will nominally improve over 2012 gross margins. This is principally due to the increased use of third-parties to assist with the timely implementation of our increasing numbers of new clients.

Now let’s turn to our operating expenses. Sales and marketing expense was $24.2 million representing a year-over-year increase of $7.5 million, or 45%. This increase was principally driven by increased headcount across our sales and marketing organizations as well as increased sales commissions. As a percentage of revenue, sales and marketing expense was 55% compared to 61% in the same period in 2012.

R&D expense was $4.8 million representing a year-over-year increase of $1.6 million or 48%. The increase in R&D expense can be attributed to increased headcount related to our continued investments in product development. As a percentage of revenue, R&D expense was 11% in the second quarter compared to 12% in the same period in 2012.

G&A expense was $6 million representing a year-over-year increase of $1.5 million or 34%. The increase in G&A expense can be attribute to increased headcount, legal fees, accounting fees, audit fees and increased overhead to support the growth of the company in both domestic and international markets.

As a percentage of revenue, G&A expense represented 13.6% of revenue for the quarter compared to 16.4% in 2012. As a percentage of revenue operating expenses were 79% in the second quarter compared to 89% in the same period in 2012, which represents a year-over-year improvement of approximately 10%.

We believe that this operating margin improvement when considered with our industry leading revenue and bookings growth speaks of the strength in our overall business model and our ability to have a very high margin, high growth business over the long-term.

Operating loss for the second quarter was $3 million compared to an operating loss of $4.1 million for the second quarter of 2012. Net loss for the second quarter was $3.5 million or a net loss of $0.07 per share based on a weighted average shares outstanding of 51.2 million shares compared to a net loss of $4.7 million or a net loss of $0.09 per share based on a weighted average shares outstanding of 49.8 million shares in the second quarter of 2012.

With regarding to cash flow, our cash flow from operating activities was negative $1.4 million compared to negative $5.3 million in the second quarter of 2012. As we have communicated in the past, collections and DSOs fluctuate significantly during the year and are therefore best reviewed on an annual basis.

Let me now turn to the balance sheet. As of June 30, 2013 our total cash and accounts receivable balance was approximately $334.4 million. Our total cash and cash equivalents were $290.3 million as of June 30, 2013, an increase of $213.8 million compared to our cash and cash equivalents balance at December 31, 2012. The increase in cash and cash equivalents was principally driven by our June 2013 issuance of $253 million of five-year convertible notes, which yielded approximately $220 million in cash net of the related word and hedge transactions, as well as underwriters, legal and accounting fees.

On a GAAP basis, our deferred revenue balance was $95 million as of June 30, 2013 compared to $90.5 million as of March 31, 2013 and $60.7 million as of June 30, 2012, representing a sequential increase of 5% and a year-over-year increase of 57% respectively.

With respect to headcount, we added 82 employees during the second quarter of 2013, bringing our total headcount to 881 employees as of June 30, 2013. This total headcount number represents a sequential increase of 10%, and a year-over-year increase of 35% respectively.

I’d now like to discuss our outlook for the third quarter of 2013 and the full-year of 2013, which falls under the Safe Harbor provisions for forward-looking statements outlined at the start of the call and it’s based on preliminary assumptions, which are subject to change over time.

Given the strength of our business this past quarter, for the full-year of 2013, we are raising our previous GAAP revenue guidance from a range of $181 million to $183 million to a range of $183.5 million to $185.5 million. At the midpoint, this revised range suggests 56% growth over 2012 GAAP revenue of $117.9 million.

For the third quarter of 2013, we currently expect GAAP revenues to range from $47.5 million to $48.5 million. At the midpoint, this range represents 56% growth over the third quarter of 2012 GAAP revenues of $30.8 million.

With respect to non-GAAP net income or loss, we are adjusting our prior guidance from a loss of approximately $9 million to a loss for the full-year of 2013 of approximately $11 million. This implies a non-GAAP loss of $0.21 per share based on a full-year weighted average share count of approximately 51.3 million shares. This $2 million increase in net loss is attributable to interest expense on our convertible debt offering.

Turning to cash flow, for the full-year of 2013, we are maintaining our full year guidance as previously communicated for non-GAAP cash flows provided by operating activities of approximately $18 million. As was the case in the prior year, we are choosing to continue to reinvest a portion of our top line overachievement back into the business to drive further growth in the future.

In conclusion, I would like to reiterate how pleased we are with our second quarter performance. The momentum of the business has continued and our ability to maintain industry leading revenue and bookings growth rates at increasing levels of scale, all while expanding our operating margins also continues.

And with that I would like to turn it back over to Adam.

Adam L. Miller

Thanks Perry. So today, our solution is improving, our global distribution capabilities are expanding, and our competition is weakening. In other words, our momentum is continuing.

In closing, I’d like to express my gratitude to the incredible team here at Cornerstone for getting us to where we are. While there have been many drivers of our success, the biggest without a doubt are people and our culture, that many of our clients including our most recent additions choose to partner with us because of this very reason and that makes us extremely proud.

We’ve built a truly unique company and I am excited about the road ahead. We will now take your questions.

Question-and-Answer Session

Operator

Yes, thank you. (Operator Instructions) And will go first to Mark Murphy with Piper Jaffray.

Mark R. Murphy – Piper Jaffray, Inc.

Yes, thank you and congratulations on the revenue and billings, acceleration here in Q2. Adam, I wanted to start by asking you, you’ve spoken in the past about an opportunity of approximately $400 million potential global feeds. And it looks like Cornerstone has over $13 million of them and I think $350 million are still up for grab, it is a Greenfield opportunity. The question is should we be thinking of those $400 million feeds as a static number or is that more of a moving target. When you think through population growth, more knowledge workers, more internet connectivity, more mobility et cetera, do you think that that’s something that’s over time is going to develop into something more a like $500 million feed opportunity?

Perry Wallack

Yeah, or more. I think all of the things you described are correct. You also can take into account that would be extended enterprise model. In some cases we could hit the exact same person from multiple places both where you work maybe where you go to school and perhaps based some other non-linear extrapolation of how you’re associating. So, trade associations at your end, places that you take training or generally gather a partner.

So we think there is upside for that number, but it the same time we think, if you just focus on $300 million which is what we think is a very defensible number, and a very clear aspirational target for us. If we were to maintain even in our current market share, we are looking at 6 times growth of the business and we think we’re gaining market share.

Mark R. Murphy – Piper Jaffray, Inc.

And Adam, as a follow-up, I’m curious about the pricing dynamic. We feel like we have seen evidence of surprisingly from pricing for Cornerstone even in some of the largest take-offs, across all of the partner interviews that we do. And so I am wondering if you were to consider what a typical customer is paying to subscribe to your product suite and then you compare that to their annual spend on all of the employee labor within the business, how do you think that looks? In other words, what are they spending to optimizing all that labor expense and could that math actually argue for a price increase in terms of list prices, at some point especially while you have the competitive landscape here apparently in disarray?

Adam L. Miller

Mark, I can answer that question so many different ways. Let me start by saying that Cornerstone typically cause give or take the cost of lunch for an employee. So we are talking about really a true fraction of their expense obviously depends on what type of worker, what industry they are in and what their pay package is overall, but generally are expense relative to the payroll spread is minute, we are talking about basis points, not percentages.

The other factor here is that our industry overall and I am talking about talent management in general had started from very low price points. So when I walk around the floor of Dreamforce for example, and look at the ecosystem at Salesforce.com with many new cloud vendors emerging, using very point things in that case in the sales area, they are charging multiples of what we charge for our suite. In many cases, they are charging per month when we are charging per year. And as a result, I think there is lot’s of opportunity to keep growing price points particular as the competition shrinks as we move down market and there is more of a Greenfield opportunity and as we expand our product footprint to include more products upfront.

And for all those things that we’re seeing here, a piece go up and I think as we have more and more proof of the kind of business impact that the Talent Management Solution offers, we’re going to also see the price points going up. But your research is correct, we have been holding fair amount of price and as a result, we become in many ways the premium provider in the space. Whereas I think a decade ago, we might a bit – we’re the lower cost providers.

Mark R. Murphy – Piper Jaffray, Inc.

I’m sorry. Go ahead.

Perry Wallack

There is definitely room for growth in ASPs and in price points proceeds. Definitely.

Mark R. Murphy – Piper Jaffray, Inc.

Thank you very much, Adam. If I may, a finally one, Perry. I wanted to ask you first off, is it possible just to ballpark maybe what percentage of bookings might have included recruiting in Q2 or is there anything material to speak of there? And then just on the topic of the magnitude of revenue upside it was – I’m surprised it’s sort of unusual and just based on your commentary, is that solely attributable to I guess, third-party services implementations or is there an element of subscription coming in above there as well?

Adam L. Miller

So, as you know Mark, we don’t breakout what we sell by product lines. Our recruiting offering is still fairly new and so we’re just starting to sell that. So I think my commentary there would it was nothing of significant materiality in the quarter.

In addition we don’t breakout our services versus our software revenue, we don’t give the detail on our bookings. What I can tell you is that from a services revenue standpoint, services revenues can and we talked about this before be a little bit lumpy based on either the size of the clients that are going live in any given quarter or the use of third-party implementation partners and us not being able to staff to the peak and needing to use partners for the flex that is required for those implementations. And so in any given quarter, we may see a little bit services revenue due to those factors.

Mark R. Murphy – Piper Jaffray, Inc.

Thank you very much.

Adam L. Miller

Sure.

Operator

And we’ll go next to Michael Nemeroff with Credit Suisse.

Michael Nemeroff – Credit Suisse Securities, LLC

Hey guys thanks for taking my questions. Just wanted to maybe ask about the International and how that trended in the quarter and what you are seeing over there in terms of momentum, hearing some signs of stabilization? And then also if I may just ask what’s your intended use of the cash that you raised with the convert? Thanks.

Adam L. Miller

First answer, is that international has trended consistent overtime. We’re in the very early days of Latin American and Asia-Pacific direct sales and services and we’ll talk more about that on our next call. But those markets are very nascent for us and still have not been a material contribution to overall results, but Europe and the rest of the world have been very consistent in growing parallel with the U.S. business.

With regard to the convert, we saw an anomalous time in the market and a window of opportunity to take capital in a very modestly dilutive very cheap way in having been at the company, Bill, Perry and I from day one, we went a long time ago that you raised money when you can, not when you needed and we saw a very significant opportunity to be opportunistic with some essentially free capital and that’s exactly what we’ve done.

So we have no near-term use, but we want to be opportunistic if over the course of the next five years, there’s acquisition opportunities or growth opportunities, where we need some excess capital that will be available to us.

Michael Nemeroff – Credit Suisse Securities, LLC

Thanks for taking my questions, guys. I will get back in the queue.

Unidentified Company Representative

Thank you.

Unidentified Company Representative

Thank you.

Operator

And we’ll go next to Brendan Barnicle with Pacific Crest Securities.

Brendan J. Barnicle – Pacific Crest Securities LLC

Thanks so much. Adam, you just saw this incredible increase in the user numbers and I know you talked about the ASP increases, but can you give us any more color on what drove that acceleration in user count? Is that more, product specific, more deal related, anything more you can give us on that would be helpful?

Adam L. Miller

So the user count have been a little bit lumpy and the reason is, we don’t count users until they go live. And so depending on the timing of go lives and the mix between Extended Enterprise and our other clouds, you end up with different numbers at any given quarter, I would say that some of what you saw in Q2 was clients from the end of 2012 going live, you saw a little bit of that. So you have that because we’re very tight in how we count this. If you’ve gone live on April 1 EBIT, let’s say you close the deal, December 31 and you went live April 1, you would not be a part of that user count until Q2, until right now.

I’d say that drives more than anything. The other is in addition, we’re going down market. We have been going up market. So we are doing more larger global deals with multinationals that have over 150,000 employees. So we now have many of those clients and those obviously create significant incremental pops to the user count.

Brendan J. Barnicle – Pacific Crest Securities LLC

Perfect. And Perry, I’m finding the guidance is a little bit of deceleration in the revenue growth in the fourth quarter. Now you got a pretty good – you got your toughest comparer in the fourth quarter. Is that what’s driving that or is it just still conservatism that you’ve build into the numbers?

Perry Wallack

Yeah, I would say that, if you’ve been watching us for the past several years that we tend to be conservative.

Brendan J. Barnicle – Pacific Crest Securities LLC

Great thanks guys.

Perry Wallack

Thank you.

Operator

We’ll go next to Pat Walravens with JMP Group.

Patrick Walravens – JMP Securities

Great, than you very much. I guess, the first question is, as we look at all these growth drivers that you got in your business, how should investors think about what kind of growth rate that you can do beyond 2013?

Perry Wallack

Part of it depends on our success expanding globally, so as I mentioned, as we get into 2014 and really 2015, how well we penetrate APAC and Lain America will become significant. Public sectors has been very lag for us. And so last year in Q3 we say very good pop in our business as you know we had very good bookings throughout the last year in Q3 at 79%. That was in part due to unexpected upside in federal business. I think we’re seeing the converse of that this year, were the federal government has essentially shutdown for business with sequestration and we’re not expecting that uplift this year in the third quarter. I think as we look in the outer years, as federal government goes back to business as usual.

We will see that resume a significant potential upside for us combined with the success we’ve had with stable or growing education business. And we’re seeing continued ability to go to down market. So as we get more successful with our small business in the market teams, we will have further ability both the grow price per se and to keep growing the business overall.

So we see lots of runway to keep growing the business. I’ve said this many time, receded a multidimensional framework, expanding internationally, expanding by segment meeting size of company and expanding by vertical, and we’re seeing the ability to continue to do that in all of three markets, in all three sectors. So we think, we can continue our industry reading growth for a while.

Patrick Walravens – JMP Securities

Okay, and then my second question is we heard from a couple of sources that one of your competitors had a pre-significant how does last week, wondering if that’s something that you can comment on?

Adam L. Miller

No, I actually….

Patrick Walravens – JMP Securities

No, I will come back on that. Thank you.

Adam L. Miller

I will say generally, we’ve seen post-acquisition many of these competitors that had have declining service levels as they become part of broader ERP suites. And that is the constant feedback we get from the market. And we believe that becomes a point of differentiation for us and that’s why you’ve seen us over the last several quarters make significant investment in our service offerings to be able to differentiate not just our product, but also on service delivery.

Patrick Walravens – JMP Securities

Great, thank you.

Operator

We’ll go next to Rick Sherlund with Nomura Securities.

Rick G. Sherlund – Nomura Securities International, Inc.

Thanks, guys. Question on the services contribution to the bookings number, actually to deferred revenues, is that a significant contributor to deferred revenues or is it mostly in the quarter or a revenue benefit?

Perry Wallack

So, we don't break things out like that Rick, what I will tell you is that we are making some efficiency changes in our services organizations and what can happen is, in any given quarter now and as much as the deal mix is more skewed down-market to mid-market we are doing the implementations a little bit faster and so deals that close earlier in the quarter we actually can get the services revenue in within that quarter, so what you may see and I'm not going to promise those deals depends on the deal mix going forward is that if we do sign amounts of smaller clients earlier in the quarter that we do have an opportunity to have more services revenue within that quarter.

And obviously, if we have more services revenue, from those customers that will affect the amount that's going to differ…

Rick G. Sherlund – Nomura Securities International, Inc.

So, last year you had a $12 million increase, sequential increase and deferrals and that gave you the 79%, 80% billings growth in year-over-year. I'm a little concerned about the OpEx going in the September quarter due to some seasonality should be expect a similar, large sequential increase in deferred in Q3 this year?

Adam L. Miller

No, so as I just said in response to past question and we saw the upside last year due to incremental sales for the federal government that we weren’t anticipating. This year we are seeing the opposite in federal sales meaning the downside case is real. And we have not performed well in federal I don't think it's specific to Cornerstone the market in general is having a difficult time, so like with federal government because of sequestration, as a result we do not expect to have that same incremental deferred booking that we had last year in Q3, but we are not making any promises about Q3 in terms of over achievement.

Rick G. Sherlund – Nomura Securities International, Inc.

And finally, if you could just talk to what you’ve seen in your pipeline following your June release and the conference, which was very positive?

Adam L. Miller

Yeah, I think it’s very consistent to what I have been saying all year, which is we are seeing true growth in global demand for talent management. We are seeing that in every market, in every segment, in every vertical. And the result of that is growing pipelines across the board.

Rick G. Sherlund – Nomura Securities International, Inc.

Thank you.

Operator

We’ll go next to Justin Furby with William Blair & Co.

Justin A. Furby – William Blair & Co. LLC

Hey, guys. Thanks for taking my questions. Congrats on the quarter. Adam, you mentioned that the exit has already begun at (inaudible) and I was wondering if you could kind of elaborate there, you are already starting to see resilience and is it on the sales side, the R&D side? And then longer term, as you think about the tailwind that presents to you with Lars’ departure, what do you think is the biggest tailwind is, is it resources that might come over to Cornerstone, is it improved win rates, is it increased sharing within SuccessFactors, existing base, what’s sort of the biggest tailwind you think – you see out of the changes that are going on over there?

Adam L. Miller

So all those things are true, but I would say honestly, the biggest tailwind is lack of focus. Meaning, we are entirely focused at specialist intelligent management and they no longer are. With regard to the management of that organization and the requirements and product about organization. So we end up being one of the only focused players left in the States. Intel management and that speaks our core constituency, which are talent management professionals and companies that are trying to improve the empowerment of their people all of which works to our advantage. We’ve seen resumes obviously in every one of these cases where the acquisition has occurred.

Wonderful senior people lead the company, you see the rest of the organization start to update their hurricane profiles and soon they are after start to leave. We saw this very clearly with Taleo after the COO left. And I think you’ll see the same thing here.

Justin A. Furby – William Blair & Co. LLC

Okay. And then on the sales hiring side, how do you go Analyst Day, it sounds like you guys were stepping on the accelerator in kind of May, early May timeframe. Can you give us an update there and what do you think, those guys become productive instead of Q4 timeframe this year or how do you they ramp?

Adam L. Miller

Yeah. So I mentioned that we were accelerating our sales hiring for the year, in the quarter. And we’ve done that, so our sales hiring has accelerated. We are not hiring more salespeople for the year, we are just hiring them sooner that we have planed to hire them. And that should result in some upside in the fourth quarter, probably will not have an impact on the third quarter.

Justin A. Furby – William Blair & Co. LLC

Okay. And then one last one you talked about febrile, but just in terms of the broader public sector that in the higher adding when we cater to all of them and say – how did that performance in Q2 and kind of, if you look at the next couple of years how meaningful the business could that be for your guys?

Adam L. Miller

So here is where I would see significant case for optimism, because we obviously have been hitting our numbers and have been overachieving, despite the fact that the federal government has the sequestration problem and as the federal government resumes business as usual, I think we’ll see even further upside in the business overall. So our non-federal public sector teams have been outperforming, it’s just the federal piece that’s been problematic and that I think it’s a macro problem, it’s not specific to us. And I know that – people in other corporations as well. So we are continuing to invest in public sector very heavily.

Justin A. Furby – William Blair & Co. LLC

Okay, great thanks very much guys. Congrats.

Adam L. Miller

Okay thank you.

Operator

We’ll go next to Scott Berg with Northland Capital Markets. Your line is open. Please go ahead.

Scott Berg – Northland Capital Markets

Sorry about that, Adam and Perry congratulations on another well executed quarter. Got a typical question to you, first of all, Adam on the cash that was raised in the quarter, obviously too early to predict how you’re going to use that, but one of the areas that we found fascinating by the Cornerstone story last two years is the organic message, how well that’s resonated with customers and we think we’ve certainly seen that from the deals come through during that period.

But assuming you make an acquisition and I know that’s in the year, how would you view those acquisitions in terms of affecting that organic story? Not that they have to, but do they have the opportunity to change that or would you ultimately look at acquisitions not to infringe upon your core product today.

Adam L. Miller

Yes, so the best example I can give you of course is on Sonar6, which was acquired in April 2011 not 2012 and in that case, we kept the product whole, we kept the team whole focused on a small business vertical which we were not active in at the time, and has given us a new vector of growth for the business, but it’s not at all impacted organic message in the enterprise, but thinking to be very attentive to that, if we made acquisition from the future and you would look for product to service offerings that are supplemental to what we do and do it infringe on the core of what we do, providing for deeper differentiation in particular segments of verticals.

Scott Berg – Northland Capital Markets

Great. And then one for Perry here, Perry, on the gross margin line, I know you send that to guide gross margins on a quarterly or even in an annual basis at times, but given that you’re into the Sonar6 acquisition, would we expect to see some leverage in that line, moving forward not looking for $4 million, $5 million, $6 million that’s obviously overnight, but even pretty stagnant in the 72 plus range, 72.5. Do we see any extradition or do they kind of outline at that for several more quarters?

Perry Wallack

Yeah. So we’re now looking out as this year yet. I think this year, we did expect a little bit of expansion in our gross margins, in the disclosure that I made earlier on the call was that we’re expecting to be about flat from last year, maybe a little bit of improvement over last year. The reason being is that we’re really using a lot more third-party implementation partners to solve the issue of really staffing to peak demand for implementations. So we want to continue to implement declines in a very timely manner and when we close deals, sort of on in any given month or at the end of a quarter, we really, really need to flex. And so in using those third-party implementation partners, the margins are a little bit lower. What I would expect is when we get around to our forecast for next year, we’ll look at the exact mix of what we’re using, and I would think that next year we would see some expansion, but no guarantees yet.

Scott Berg – Northland Capital Markets

Great. That’s all I have. I’ll turn back in queue. Thanks.

Opeartor

We’ll go next to Raimo Lenschow with Barclays Capital.

Raimo Lenschow – Barclays Capital

Hey, thanks for taking my question. And congrats on another great quarter. And quick from me, you mentioned (inaudible) problems, can you talk on what it needs for you to the slightly bigger SIs and their willingness kind of work with you, and kind of build workforce around that, that was the first question. The second question is, can you just talk a little bit about moment on the SMB business, how you’re doing there, and what’s the competitive dynamic there? Thank you.

Unidentified Company Representative

Sure. With regard to the system integrators around the world, we are seeing a changing of the dance partners. Many of those companies have been working with our competitors prior to the consolidation in our space, they have now freed up and are looking to do deals with best supreme providers. So we are very actively engaged with all of the major system integrates around the world. And that I believe longer term will be incremental upside to our business. Don’t show up that much in 2013, but 2014 and 2015, I think it could be significant contributor.

With regard to SMB, we are seeing essentially the exit of our core competition in that market. And so while there are some players left in that space, it is predominantly a Greenfield opportunity with relatively little competition, and it’s more about driving distribution.

So our challenge is how we better drive distribution, how do we drive growth, and for us we have to make decisions about where it’s most efficient to put the next sales person is it on our U.S. enterprise team, is it in a Latin American enterprise rep or an APAC rep or do we add to our small business team or mid market team, and so it varies. We make different decisions based on lots of different inputs, and we will continue to grow that team both directly and indirectly over the next year or two.

Raimo Lenschow – Barclays Capital

Thank you.

Operator

We’ll go next to Greg Dunham with Goldman Sachs.

Frank Robertson – Goldman Sachs

Hi, guys you have Frank Robertson here for Greg Dunham. Congrats on the quarter, and thanks for taking my question. I obviously want to start with, I guess if you look at the number of deals you closed in the quarter, like what percent of them included – want a more – also different color on the entire installed base and what specifically recruiting attach rates?

Unidentified Company Representative

Yeah, so we are seeing really good pick up of recruiting, particularly from new sales. We’re seeing it both in enterprise and in mid-market and we’re seeing it both domestically and internationally, so it’s been clearly our fastest adopted product offering, and we see that momentum continuing, we just training of our sales teams globally on recruiting specifically to drive incremental growth there. So we think that’s a big upside opportunity. And with regard to our average deal, we’re seeing what we’ve seen before, which is more and more of our clients are buying two or more products upfront, and specifically two or more products upfront. And I think most recently the number we gave is about 60%, and we’re seeing that consistently across-the-board. I think over time that will go off.

Frank Robertson – Goldman Sachs

Okay. And one last question, on the alliances and partnership, what percent of new business currently come from partnerships? How you think that it’s a turnover time longer term?

Adam L. Miller

Yeah, its been about 15% to 20% and that’s been pretty consistent over the last couple of years. I think it will be, that number will trend down, I don’t expect it to trend up. And it’s because of the growth of our global sales teams, as we have wider and wider direct distribution, we would expect that to be less indirect sales and more direct sales.

So I think that number will probably help around 10% or 15% over the long-term and as our mix shift to more direct.

Frank Robertson – Goldman Sachs

Great.

Adam L. Miller

Less concentration from any single partner, as we brought our partner basin as our ecosystem has grown though vertically and geographically. So we’ll see that continue to resolve.

Frank Robertson – Goldman Sachs

Thanks for taking my question.

Operator

And we’ll take our final question from Brent Thill with UBS.

Unidentified Analyst

Hi, this is Tom again for Brent Thill. Could you talk a little about the sales cycles or any trend there, whether you’re seeing acceleration and then if could maybe provide some color around large deal or so?

Adam L. Miller

What was the last part, large deal?

Unidentified Analyst

Around a large deal.

Adam L. Miller

Sure, so the sales cycle is highly dependent on the market segment as some of the deals could be issued two weeks, midmarket is anywhere from two months to pipelines, enterprise trends to be forward in a nine months at the outside. And then we have a strategic accounts team that is solely for the largest accounts in the world and that could be six to twelve months.

So we’re seeing the full spectrum deals is no difficult, no different than any typical enterprise sales team. What we’re seeing is a greater ability to onboard those reps upfront, drive them to greater productivity in the first year and ensure that all of our teams are hitting their target. So we’ve gotten better at regional distribution of targets and performance with each of our regional teams. So we have a very effective sales enablement program at the company. We use our own products internally to drive sales enablement and sales effectiveness and all of that has led to higher productivity of the reps and of the teams.

So we’re quite pleased with the direction that’s going, and we think that will continue. With regard to the larger fields out there, we are seeing many of the largest companies in the world, could we consider their talent management strategy the overall HR solutions, and we are seeing a tremendous amount of activity in that segment. So we feel the team dedicated to focusing on that segment at the same time, we continue to globally expand our enterprise team, because we’re seeing large deals not just domestically, but around the world.

Unidentified Analyst

Thank you.

Adam L. Miller

Thank you.

Operator

That concludes our question-and-answer session. I would now like to turn the call back over to the speakers for any additional or closing remarks.

Adam L. Miller

Thank you all for your participation in your questions, and we look forward to continuing to perform. Thank you.

Operator

Thank you. That does conclude our conference. You may now disconnect.

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