ServiceSource International, Inc.
Q2 2021 Earnings Call Transcript

Published: 29 Jul 2021

[Operator:]

Good day and thank you for standing by and welcome to the Second Quarter 2021 Earnings Conference Call. I would now like to hand the conference over to Elise Brassell, Head of Corporate Communications.

[Elise Brassell:]

Thank you, operator. We appreciate everyone joining us today and welcome to ServiceSource’s earnings call to discuss our results for the second quarter ended June 30, 2021. On the call today are Gary Moore, ServiceSource’s Chairman and CEO and Chad Lyne, our CFO. As a reminder, our SEC filings and the earnings release we issued yesterday after market close are available on our website at www.ir.servicesource.com. In addition, we have posted earnings slides to accompany our comments today. Shortly after this call, we will post an audio replay and a copy of our prepared remarks to our website.

[Gary Moore:]

Thank you, Elise and welcome everyone to our earnings conference call for the second quarter of 2021. It’s a pleasure to be speaking with you today and to update you on the progress we are making. Our second quarter results highlight areas of acceleration in the business and we expect our trajectory to continue to improve in the coming quarters. We are confident in our strategy, our capabilities and are squarely aligned to our clients’ most pressing challenges and opportunities, and our focused execution is driving stronger outcomes. Last quarter, we spoke about the lingering headwinds caused by COVID-19 and I would be remiss if I did not acknowledge that it continues to have an impact in particular markets and geographies. Uncertainty persists, particularly in foreign markets, but on balance, the tone, commentary and outlooks from our clients has shifted more to the positive. And within the small-to-midsize segment that we primarily address for our clients, we are seeing encouraging signs that companies within this tier appear to be on relatively stronger footing compared to the start of the year. We believe we stand to benefit as our clients and their customers continue to regain confidence. The work we have done over the course of the past 2 years has improved our ability to be more responsive to the needs of the markets we serve. We have enhanced our solution suite and go-to-market strategy to be more focused and effective. We have transformed our delivery model to be virtual-first and more digitally enabled. We have streamlined our organization for greater speed and accountability. And we have invested meaningful time, resources and capital to strengthen the foundation of the company to allow it to grow and scale more efficiently over the long-term.

[Chad Lyne:]

Thank you, Gary. It’s good to catch up with everyone today and thank you for joining us. When we spoke with you at the beginning of the year, we shared our expectation that the first half of 2021 would have more pronounced challenges from a year-over-year comparison standpoint, with a return to growth in the back half of this year. The dynamics we spoke about and first half cadence largely trended as we expected, if not a bit more favorably. With two quarters under our belt, we are encouraged by the headway we are making in the business and our stronger positioning to capitalize on a large and growing opportunity for our solutions. Now, let’s turn to our Q2 results. Revenue of $46.3 million was down $1.3 million, or 2.8% year-over-year, marking a sizable shift from the 10.2% year-over-year contraction we reported last quarter. Consistent with Q1, the new logos we won in FY 2020 contributed approximately 3% to our second quarter revenue. The single large client headwind that we have spoken about in past quarters continued to weigh on our results as we have not yet lapped the tougher compare. If you exclude that client from both periods, revenue in Q2 would have shown nominal year-over-year growth. This is also the first time since 2018 where we can report top line growth from Q1 to Q2, which tends to be a seasonally softer quarter. On a sequential quarter-over-quarter basis, revenue was up 2.9%. Walking down the P&L, our second quarter non-GAAP cost of revenue was $33.2 million and non-GAAP gross profit was $13.1 million, or a margin of 28.4% of revenue, down $1.2 million or approximately 180 basis points year-over-year. As we previewed in our May call, non-GAAP gross profit margins were impacted by higher recruiting and personnel-related expenses as we added approximately 150 employees in the quarter to support new program launches and expansions, including the examples Gary shared in his remarks.

[Operator:]

Thank you. And our first question comes from Josh Vogel from Sidoti. Your line is now open.

[Josh Vogel:]

Thanks. Good afternoon, Gary and Chad. A couple high level ones first, if I may. I was just, when we think about the marketplace and the opportunity out there, seeing other companies and peers are talking about how larger enterprises are increasingly turning to outsourcing for a whole host of services. So, I was just thinking outside of your traditional small and midsized segment, can you talk about what you are seeing in the marketplace and are you actively going after larger client sets at all?

[Gary Moore:]

Hi, Josh. This is Gary. Yes, I mean, clearly, there is opportunity that we talked about some near-term opportunity that we did not close in Q2, but hope that we will close here in Q3 and hopefully early in Q3. A couple of those are the larger clients that deals don’t necessarily start as the large deals, but if you look at our portfolio today, we already have the largest enterprise tech companies and some of the healthcare in our portfolio. So, I would just say that the opportunities continue. I think that the fact that we have expanded 3 of our top 10 with $1 million plus run-rate revenue opportunity is a good sign of that. So, there are still headwinds. I think, not the concern, but I think while we have growing optimism, we still know that there is a tough road ahead in the marketplace, not the least of which is pushed on by uncertainty around tax rates here in the U.S. COVID, just a number of different things that aren’t put to bed yet. So I would say that, from our point of view, we are very pleased with the pipeline that we have. And some of those clients are ones that heretofore weren’t that interested in outsourcing, but they see the opportunity to really accelerate their internal sales as well as utilize ServiceSource to drive not only customer success, but also go after untouched areas of their market opportunity. Let me let Chad add a couple of things here. He is also very, very close to this.

[Chad Lyne:]

Yes, no, thanks, Gary. And Josh thanks for the question. I think maybe the only clarification to that I would add to your question is that as you think about our client base, by and large, all of that is what we would define as enterprise clients, so whether it’s a $50 billion in revenue company or a $1 billion in revenue company, most of those are enterprise clients. But I think as we talk about SMB or the SMB tiers, that’s the cohort of customers that we are serving on our clients’ behalf, so just wanted to clean up that distinction between those two. But as Gary said as we look at the marketplace in size that we see an opportunity of upwards of 300 to 400 companies that are squarely within our TAM, companies with $500 billion plus of ARR and again, more companies moving towards subscription based models and recurring revenue streams, where solutions are really resonating and with our current client base of new approximately 40 still see plenty of headroom there to run and penetrate within that market, while still growing and selling more into our current book of installed base clients like we highlighted on the call earlier. So, I would say generally would agree with your thesis and what you are hearing from other companies that by and large, with the recovery in the economy, with companies growing on stronger footing, I think they are being the arbiter and looking more aggressively at outsourcing when we have seen that in our pipeline and some of the wins that we highlighted this quarter. So, to Gary’s point, there is still a lot of uncertainty out there, but do feel good generally about the tone and the commentary and the broader velocity that we are seeing in the marketplace.

[Josh Vogel:]

Thank you for the clarification and really good insights there. I guess, even to your point about general uncertainty out there as the Delta variant makes its way around the world, there is a prevailing theme. I know, we are still kind of early on in the earnings season here, but a prevailing theme is talking about a sense of urgency or pent-up demand with clients and their agendas today. So, I want you to get a sense of what you are seeing in your dialogue with clients and are you – and is this resulting in any notable compression in the sales pipeline as well as following a signed contract that the time it takes to ramp obviously talking about on new business?

[Gary Moore:]

Yes. So no, we are optimistic to be clear about that. We – our pipeline is as strong as it’s ever been in terms of opportunity. We have multiple pursuits underway. We have been very fortunate to in Q2 sign yet another new logo and the expansions that we talked about. I think the opportunity we have is being driven, but based on our performance we have an all-time high and net promoter score is up 17 points and that’s a record high. The customer performance targets and the focus that might not and then the delivery team has put on that is really yielding dividends for us from an expansion point of view as well as continued getting performance hit. So I think the confidence in the long-term and our ability to continue to return to growth has strengthened. And again, I keep underlining there are some still – some variables out there and some things that could hit us. But I think we feel very strongly about the opportunity and that opportunity is increasing.

[Josh Vogel:]

Thank you. It actually leads into my next question. And your commentary about returning to growth, can you maybe ballpark for me the level of year-to-year growth we could see in the back half of the year and while you are doing it, can you remind me what drove the strong results in Q4 last year, and given that it makes for a tougher comp? And you think you will see your growth in Q4 as well. And it’s basically implying a meaningful lift from Q2 levels.

[Gary Moore:]

Yes. Go ahead Chad.

[Chad Lyne:]

After you, Gary.

[Gary Moore:]

No, go ahead.

[Chad Lyne:]

Okay. Josh, I think, we would try to avoid putting specifics on it as you think about Q3 and Q4. But just to kind of point back to what we did talk about coming into the year, as we set up the context that we thought the first half would be a tougher compare. One, because of some of the churn that we had late last year that would start to roll through from a revenue standpoint, the one large client headwind that we mentioned. And then maybe coming back to your first question, did see a strong recovery in enterprise IT spending early this year. But we knew that it would take or we suspected, it would take a number of quarters for that level of confidence in discretionary IT spend if you will, to come back into the SMB tiers that we serve. So, we have seen that level of strengthening that did contribute to some of the good progress that we made in Q2, but our view on the full year is still consistent with what we shared in February and May that we do expect to return to growth in the second half of this year. And obviously pushing as hard as we can and being prudent about doing smart deals, doing the right deals and executing on our install base, we have to pull that sooner rather than later. So, that’s probably about as specific as I want to get with that one, Josh. But I think our objective is not even just this year or the next few quarters. But doing things that are going to set us up to deliver on our long-term target model, which I think as you know, we have talked for a while now, by returning the business on a consistent, sustainable basis, to show 10% plus year-over-year growth. So, we think that the groundwork that we have laid over the past 2 years, the investments that we have made in the business, the better results we are driving for clients, better retention of our employees, all those different levers are putting us in that right direction and pleased with the shape and shift of the revenue trajectory that we have seen so far and look forward to that continuing up into the right.

[Josh Vogel:]

I appreciate that. And I knew you aren’t going get too specific, but I couldn’t control myself, I had to ask. So, I got one last one here. The slide and your comments around the gross margin, there is some pressure there tied to the higher recruiting and personnel related expenses. Was that it or was the mix have any play in it? And then just lastly, how should we think about the gross margin profile of the business once you see some leverage from the recent investments, and a return to top line growth?

[Chad Lyne:]

Yes, I can start off here.

[Gary Moore:]

I will let you finish this Chad. But I don’t think, well, I have said that incorrectly. Our long-term view has not changed. The long-term model that we laid out there and our ability to grow 10% plus, and drive 38% plus gross margins, non-GAAP gross margin, and drive either side in the 10% to 12% range, once we get to a higher revenue rate. We still believe strongly in that. And I think as we look at the impacts of this last quarter, some of that impact really came from the fact that we have signed some business, we did some very fast ramping. We – Chad mentioned, the one client where we more than tripled the amount of people we had on it. We were able to do that in a very short timeframe. But a lot of those expenses were ahead of where we started receiving revenue because of that fast ramp. And we had a couple of those. So, I am comfortable with making that kind of bet, because it’s long-term high value revenue. Chad?

[Chad Lyne:]

Yes. Only a couple points I would add to that Josh is, Q2 does tend to be one of our seasonally softer quarters, both from a revenue standpoint and a margin standpoint. If you look back 2 years, Q2 of 2019, was about 28.9%. So, we are 50 basis points below that and about 30 basis points below what we got in Q1 of this year. So, we are mindful of it. I know that we do have a lot of wood to chop and are focused on the lever for pulling to set us up to get to that 38% that Gary mentioned. But a couple of the pieces there that that drove the marking this time Gary hit on the ramping that we undertook in the quarter. I think that will continue to put a bit of a drag on GP margins as we look over the next quarter or two quarters and again, good problem to have because we are driving growth and expansion. And so, we are going to make those investments to launch clients in green and set them up for Clients for Life where that you turned on that investment upfront is well worth it. So, we will continue to do that. The other pieces that are contributing to that a bit as you think through the year-over-year compare as well is last year, we had a grant from the Government of Singapore that on the full year was bought north of $1 million of a good guide from the expense standpoint. That’s largely gone down now as you know, as COVID has moved into the background a bit. So, we had about 100,000 of Singapore grant recognized in the first half of this year, compared to about 400,000 last year. So, that’s a bit of the headwind. And then the third piece, we have mentioned it briefly in my prepared remarks is FX has clearly been a headwind in the business as well from an expense standpoint. Our revenue is fairly naturally hedged as we do billing invoice, predominantly in USD, but given the scope of our international operations in eight different countries, a good amount of our expense obviously does have some exposure to ForEx, or FX swings and so. As we have seen strengthening of the euro, the British pound, etcetera, compared to where it was in the first half of last year. That’s had about a $1.4 million impact across both cost and revenue and backs in Q2.

[Josh Vogel:]

Alright, great. I appreciate all those data points. Well, thank you for taking my questions. And I look forward to chatting with you guys soon.

[Gary Moore:]

Thanks, Josh.

[Josh Vogel:]

I appreciate it.

[Operator:]

Thank you for your question. And I am showing me no further questions. I would now like to turn the call back to Gary Moore for closing remarks.

[Gary Moore:]

Hey. Thank you, Justin. I really appreciate it. I will be brief in closing here. As you heard in my earlier remarks, and as highlighted in the financial results that Chad shared, we believe we are nearing an inflection point in the business based on three key points and I would like to cover those. First, we are going after a large and attractive market opportunity. Our solutions are squarely aligned to the needs in this market. And what we have to offer is a growing importance for high growth companies like the examples I shared earlier on the call. Second, the changes and forward focused investments we have made during the past 2 years are resulting in stronger and more consistent execution throughout business. As we said last quarter, it will take time for this to fully realize in our financial profile. But our results in Q2 are a good indicator of that positive shift. And third, the outcomes of our teams are driving and the relationships we have built are positioning us as a strategic partner with our clients. While these companies each have their own unique challenges and opportunities, we are doing a better job earning their trust to support their most important objectives and strategic priorities. So, we are pleased with our gains through the first half of the year and remain super focused on the progress we need to achieve in the quarters to come. So, thank you to our stockholders for your continued support on our transformation journey. We look forward to speaking with many of you in the coming weeks. With that Justin, you may end the call.

[Operator:]

Thank you, sir. This concludes today’s conference call. Thank you for participating. You may now disconnect.