ServiceSource International, Inc.
Q1 2020 Earnings Call Transcript

Published: 8 May 2020

[Operator:]

Ladies and gentlemen, thank you for standing by. And welcome to the ServiceSource First Quarter 2020 Earnings Call [Operator Instructions]. Please be advised that today’s conference isbeing recorded [Operator Instructions].I would now like to hand the conference over to your speaker today, Chad Lyne, Executive Vice President of Strategy, Corporate Development and IRO. Thank you. Please go ahead, sir.

[Chad Lyne:]

Thank you, operator and good day, everyone. Thank you for joining us, and welcome to ServiceSource’s first quarter earnings call to discuss our results for the quarter ended March 31, 2020. On the call today are Gary Moore, ServiceSource’s Chairman and CEO and Rich Walker, our CFO.As a reminder, our SEC filings and the earnings release we issued yesterday after market close, are available on our Web site 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 reply of this call and a copy of our prepared remarks to our Web site.Before we begin, I would like to remind you that during the call, we will make projections or forward-looking statements that involve risks related to future events. All statements made during the call reflect our views as of today, May 8, 2020 and are based upon the information currently available to us. All projections and forward-looking statements should be considered in conjunction with the cautionary statements in the earnings press release and the risk factors included in our SEC filings, including our report on Form 10-K. These documents contain and identify important factors that could cause actual events and results to materially differ from those contained in our projections and forward-looking statements, and we disclaim any duty to revise or update any forward-looking statements.In addition, during the call, we will also be discussing certain non-GAAP financial measures, which we believe provide additional information to enhance the understanding of how management assesses the operating performance of the business. The reconciliation of the GAAP and non-GAAP measures can be found in the earnings release that accompany this call.And with that, I’ll turn the call over to Gary.

[Gary Moore:]

Thank you, Chad. And welcome everyone, to our earnings conference call for the first quarter of 2020.Before diving in here, we would just like to offer our heartfelt sympathy to those who have been personally affected by the COVID-19 pandemic, as well as to express our deepest appreciation to the healthcare workers, first responders and others who are on the front lines of this battle. All of us are clearly dealing with unprecedented times, but we are incredibly proud of how the ServiceSource team has rallied together to support each other. Our priority has been and will continue to be on the safety, health and wellbeing of our employees around the world, while ensuring we fulfill our brand promise and deliver on behalf of the clients who have entrusted us with their business.As you see in our results, we executed well against the things within our control and delivered solid financial performance for the first quarter. In the past few weeks, however, things outside our control, like the duration or severity of the crisis, the timing or magnitude of the economic impact and whether or how these factors will affect our clients and their customers, have created a higher degree of uncertainty and a potentially wider range of outcomes.As a result and inline with our commitment to transparency, we believe it is prudent to withdraw contextual outlook that we previously provided for the full year. Our business remained strong and resilient, and we are confident in our ability to execute to our internal objectives and priorities. We will continuously monitor the environment we are in and revisit our outlook once we feel there is a greater clarity and visibility.Moving on to the rest of our agenda for today's call, I plan to cover a couple of topics with you. First, I will be share an update on the activities and actions we have taken in response to COVID. And then I will go onto our accomplishments during Q1, and the demonstrable progress we continue to make across the organization. I will then hand the call over to Rich to provide a deeper review of our financial results, before I close this out and open the call for questions.Starting first with what I am sure is top of mind for many of you is what we've done to position the company in what is obviously a fluid and dynamic environment. Our proactive efforts throughout Q1 enabled us to mitigate risks or disruption to the business to care for our employees and to sustain the mission-critical work we do for our clients. Beginning early in February, we formed a COVID security and incident response team and properly began testing our business continuity plan.In close collaboration with our clients, we began taking action in early March, we made rapid wholesale changes to our infrastructure, systems, processes and policies to enable an entirely virtual operating model. Within a matter of days and prior to government restrictions and lockdown, we successfully transitioned our entire global workforce to 100% remote work-from-home environment.For our clients, our dedication allowed them to have a strong close to their month or quarter. We have heard a lot of positive feedback from our clients and believe we have earned goodwill due to how we supported them and their customers. It goes without saying that there is nothing usual about the current environment, but our proactive and early response allowed us to effectively maintain business as usual in the first quarter and we continue to recruit on board, train and operate through our new model. Recognizing that many companies are facing very pronounced disruptions, we feel very fortunate that we've been able to maintain full delivery capability for our clients and that our employees can continue to earn a living in an environment that is safest for them, their families and their communities.With that context, I will now speak to our typical Q1 activities and highlights. We are proud of how well our teams executed to deliver financial results above our internal expectations during what has been a challenging period. As we discussed on our February call, we anticipated a tougher year-over-year revenue comparable given the actions we took last year to optimize and right-size our portfolio. We knew we would continue to face a top-line trade off as we ramp new revenue, while rolling off more revenue from churned or proactively exited engagements.That said, we managed well through these cross currents in the first quarter, generating revenue of $50.1 million, down less than 10% from Q1 of last year. In anticipation of the lower revenue base, we demonstrated rigorous cost management and expense discipline to drive non-GAAP gross profit margin expansion year-over-year and maintain positive, albeit modest adjusted EBITDA in the quarter.And as we've discussed in the past, we have not backed off from the targeted investments we are making throughout the business that align to our longer-term strategic roadmap. We will continue to reduce spend in some areas in order to fund priority initiatives that we believe will strengthen our value proposition, further differentiate our offerings and enhance our client relationships and outcome.Moving on from the financials, we continued the progress and momentum from last year on our four transformational pillars of inspire success, impact scale, ignites sales and innovate solutions. First on our people. We are seeing the benefit from our investments in talent acquisition, training, leadership development and culture, employee loyalty and retention, continued to show strong gains, with average tenure now at 3.1 years, up approximately 25% from the same period last year. And with a more tenured and experienced workforce, we are realizing improvements in productivity and efficiency. Revenue per employee is up nearly 9% year-over-year, while total headcount is down 17%.Shifting to the delivery organization. We made extensive changes last year to simplify, streamline and strengthen core aspects of our business. The impact on our operations continues to be encouraging. We are demonstrating more agility, responsiveness and client centricity that is earning us a seat at the table as a strategic enabler and trusted partner. Our teams are showing up differently and we are seeing improvements in several key areas as a result. Q1 was expected to be our single largest quarter this year in terms of contracts coming up for renewal. With approximately $55 million expiring in the quarter, we successfully renewed or extended approximately 95% of the contract value. So, it's been a great start to the year there.And then looking at our largest relationships, on a trailing 12 month basis, we grew revenue with six of our top 10 clients. Excluding the impact from one top 10 client where we are currently seeing some pronounced contraction as they re-prioritize some of their go-to-market spend, the other nine clients collectively grew approximately 4.8% on a trailing 12 month basis.On the sales front, we remain focused on improving our pipeline size, quality and diversity and velocity. We've made a good amount of progress here but still have more to go to get the growth engine firing on all cylinders. That said, the traction we are seeing so far this year is encouraging. If you recall, we find a total of three new logos throughout all of fiscal 2019 year. Year-to-date today, we have already won three new logos. On our February call, we mentioned an early Q1 win with Absolute, the leader in endpoint resilience software, which we are now in the process of ramping.In April, we welcomed two additional brands to our client roster, PTC, a leading provider of digital transformation software solutions for global manufacturers and Firefly Educate, a leading provider of IT training, programs and educational content. From an installed base perspective, we closed multiple expansion wins, signing incremental business with four of our top five clients.In summary, we are encouraged by what has been a relatively strong start to the year. We saw continued progress and momentum building off of the foundational heavy lifting we did last year. The underlying fundamentals of the business are healthy, the work we do on behalf of our clients is relevant and important, our business model is resilient and we are executing from a position of relative strength with a well-capitalized and healthy balance sheet.With that, I will turn the call over to Rich to walk you through our financials and then I will come back to close this out before we open it up for Q&A. Rich?

[Rich Walker:]

Thank you, Gary and good morning to everyone. As highlighted in Gary's remarks, we are proud of how we executed in the quarter, not just in terms of our financial results but also more holistically in how we supported our clients and employees through the evolving uncertainty of the COVID impact.Many of the initiatives and actions we undertook last year were key enablers to allowing us to adopt and pivot our business to operate in the current environment. Although, global macro uncertainty remained high, we believe we are well positioned to build a stronger and more valuable company through this period.There are three things I plan to cover with you today; first, I'll walk you through the P&L highlights and year-over-year comparisons to Q1 of last year; second, I will review key balance sheet, cash flow and liquidity items; and third, I'll provide some perspective on what we're seeing in the current environment in light of COVID, and our decision to withdraw the full year contextual outlook that we shared with you in February. With that backdrop, let's move into the Q specifics.In the first quarter, we generated revenue of $50.1 million, down $5.4 million or 9.7% year over year. The entirety of this variance is tied to logos that were churned or proactively exited in 2018 or 2019. We generated $5.4 million of revenue from these logos in Q1 of last year, but had zero revenue contribution in Q1 of 2020.As Gary mentioned in his commentary and as we've shared transparently with you during the past year, where appropriate we are willing to make a near-term revenue trade-off in order to optimize our portfolio. This is allowing us to free up capacity and resources to support new scopes of work in higher growth areas, which are in the sweet spot of our growth strategy and that we believe can be more margin accretive overtime. Although, we estimate most of the rationalization work is now behind us rather than front of us, we anticipate facing similarly challenging year-over-year comparables for a couple more quarters.Shifting to cost of revenue and gross profit. Our non-GAAP cost of revenue was $34.3 million, favorably down $4.2 million or 10.8% year-over-year. Our focus on expense management, productivity, utilization and spans of control allowed us to generate non-GAAP gross profit of $15.9 million and a margin of 31.6% of revenue, an improvement of 80 basis points from the first quarter 2019.Moving further down to P&L, you will see that we remained vigilant at managing our expense base. Our objective is to be responsive to our current top line profile, while also ensuring we continue to invest appropriately in the initiatives, programs, technologies and teams that we believe will position us for return to long-term sustainable growth.Our non-GAAP operating expenses in the first quarter of this year were $17.3 million, favorably down approximately $800,000 or roughly 4.5% from last year's Q1. From a bottom line standpoint, we generated adjusted EBITDA of approximately $140,000 or 0.3% of revenue compared to approximately $950,000 and 1.7% of revenue in the first quarter of 2019.Now let me turn to the balance sheet and cash flow highlights. Our balance sheet and liquidity profile remained strong. DSOs came in at 78 days, favorably down five days on a year-over-year basis. Cash flow from operations was negative $5.7 million compared to positive $2.1 million in Q1 of 2019, primarily driven by shifts in working capital. CapEx inclusive of capitalized internally developed software was $1.6 million this quarter, a reduction of approximately 46% from the $2.9 million spent in last year's Q1. Free cash flow was negative $7.2 million this quarter compared to approximately negative $800,000 in Q1 of 2019.We entered this year with $29.4 million of cash, cash equivalents and restricted cash on the balance sheet. As you saw in our earnings press release and the 10-Q we filed yesterday, we made a decision in March to further enhance our balance sheet and liquidity. We thought it was prudent to take advantage of our access to our $40 million revolving line of credit, given some of the volatility we were seeing in the broader credit markets.We drew down $27 million through six month borrowing on this line to bring our cash, cash equivalents and restricted cash balance at quarter end to $49.5 million. Although, we do not currently anticipate any needs or uses for this capital, given the uncertainty of COVID's impacts on the economy or financial markets, we felt it was a wise course of action to preemptively strengthen an already solid cash and liquidity position.So to summarize our Q1 financials, we had a nice start to the year with good execution throughout the business, and we are positioned with the strong balance sheet to continue to invest in our strategic priorities. Now, let me take a step back to cover in more detail Gary's earlier comments about our decision to withdraw our directional full year outlook, as well as some broader context and what we are seeing as we look forward.We want to be clear that although the COVID pandemic has created multiple areas of uncertainty for all companies, we remain confident in the underlying fundamentals of our business. In good times, driving recurring revenue, investing in customer success and ensuring high renewal rates, are all important mandates to the clients we serve. In the challenging environments that many companies are currently facing, these priorities take on even greater importance, visibility and criticality. Given our domain expertise and the scope of our capabilities and solution suite, we believe we are well positioned with a very strong platform to help our clients best navigate through the challenges they are now encountering.As you would expect, there are various factors and circumstances outside our control that may limit our visibility in the current environment. The dynamic and rapidly evolving nature of the pandemic and any resulting downstream impact it may have on our clients and their end users remains unclear. Global GDP and technology spending forecasts are being been revised downward, and many of our larger publicly traded clients have withdrawn their revenue and earnings guidance.On the other hand, we're excited and encouraged as we see areas of growth and heightened demand from clients in sectors like collaboration, cyber security and cloud workloads. We have analyzed and modeled a variety of upside and downside scenarios to our original outlook. To put it simply and transparently, at this point in time, we don't have enough clarity to either lower, maintain or raise the expectation we had coming into the year.As you can appreciate, new information and data emerges on a near real time basis and we will evaluate and assess these inputs as they become available. Once we get greater clarity on the economic recovery, the outlook for the technology industry as a whole and the trajectory for our clients specifically, we anticipate providing a subsequent update to our full year financial expectations on our Q2 call.With that, let me pass the call back over to Gary.

[Gary Moore:]

Thank you, Rich. We are pleased with what we are seeing in the business. We executed and delivered well in Q1, particularly since we accomplished what we did even as we pivoted the entire organization to a new distributed work from home model. We are extremely proud of the level of interaction and engagement of the teams, the speed of decision making and everyone's relentless focus on driving exceptional outcomes for our clients. So in a word, a public thanks and appreciation to our people for doing a great job, taking care of our business and our clients during this time.The COVID pandemic may have served as a catalyst to change where or how we do things, but it hasn't changed who we are as a company, our value proposition in the marketplace, or near term priorities or long term strategy. Our strategic focus and vision remains the same. We will continue to build upon the stronger foundation we've established as we strive to create a growing profitable and more valuable company that we are all proud of.Although, there's a high degree of uncertainty in the broader environment, we have tremendous confidence in the health, strength and resilience of our business across both intermediate and longer term horizons. We believe we have the right priorities and are doing the right things throughout the business to ensure we are prepared and positioned to come through this period even stronger.With that operator, please open the call to questions.

[Operator:]

Thank you [Operator Instructions]. Our first question comes from Zach Cummins with B. Riley FBR. Your line is open.

[Zach Cummins:]

Hi, good morning everyone. I hope everyone is staying healthy and surviving these unprecedented times. But congrats just first off on the strong quarter here, given all the changes that you saw beginning in March. But Gary, can you talk about the retention metric in the quarter? It’s very impressive considering all the changes in the environment. Maybe can you speak to how that compared to internal expectations and what really drove the key strong performance there in this quarter?

[Gary Moore:]

Thanks by the way, Zach, for your comments. Look, I'm sure we're getting some lift from just what's going on with COVID-19, but we've done a lot of things. I think Patricia and her team, HR and then the leaders around the world, we've invested pretty heavily in leadership and development. I think the work that's been done relative to the amount of training that we're giving people, the amount of the way we're looking at trying to reward people for doing the job that they have, I think has really helped. And we don't have turnover where we'd like to get it, but we are making significant progress. I think the opportunity to continue to have the right people join the company, to give them superior training and give them opportunity for growth is what's really exciting people.

[Zach Cummins:]

And then I guess just during the start of Q2, I mean, through April and the first week here in May. Can you just describe what you're seeing in the market thus far? Are customers kind of starting to get their bearings and then react to the current market environment? Or kind of what are you seeing across your broad base of clients?

[Gary Moore:]

I think, again, these are certainly not usual times as I mentioned in my comments, but I think the approach that we're taking is across really three areas. The broader macro, I think GDP impact in Q1 in the primary regions where we operate, and there is an -- I expect that in Q2 and I think our customers feel the same way, the global GDP outlook for FY20 is going to continue to reset lower. That causes people who want to pause. But from a client point of view, I think you have to remember that our clients are very large, well-capitalized and resilient enterprises. Most of them have been through this stuff before.I think if you just look at the top 10 of our clients, they have $0.5 trillion in revenue, so that’s staying power, I'll just leave it with that. Also, I think it's important that we've built really durable relationships with those clients. And we've been with them through various economic and business cycles and this one's tough. But again, our top 10 clients have been with us for an average of 10 years.I think many tech companies are facing reduced sales in their pipeline. I think the new booking metrics are impacting things like cancellation of events, conferences and those kinds of things. But I think it's placing an even greater emphasis on protecting their base, focusing on renewals and customer success. Remember when I was running services at Cisco and went through the 2’08 and 2’09, we had six or seven quarters where hardware sales were really stifled, and the services business continued to grow, continued to deliver high profitability and guide us through that, and so that's what we do for our clients. So, we feel very good about how we're positioned.We have seen some heightened demand for RFPs. We've seen some companies that are benefiting from the work from home trend. There's a lot of investment right now being made in collaboration tools, cyber security, visualization, cloud computing, et cetera. So, it's not like we're in the hospitality industry or some of the others that have just really been hit hard. I think the outlook for the fiscal year and our clients become less certain that's for sure. I think approximately half of our publicly traded clients have withdrawn their guidance.And to be clear, the overall business is going to be questionable. So as one of the reasons we decided to withdraw our contractual guidance, because we saw our clients doing that. But their customers and their end users, I think it's still too early to draw any conclusions on, on the trend lines. I think as a general rule, we only have a great deal of exposure to some of the harder hit markets that I mentioned, like retail, travel and hospitality. I think from a software stats and hardware products point of view, what we support operationally is mission critical to those companies.So, we'll see U.S. discretionary spend. But on the other hand, I don't see a significant reduction, at least short term. I think the pockets of demand and weakness around SMB market can state local governments, for clients will -- it's just too early to tell. I think all we can do is focus on the things that we can control and make sure that every day we're focused on delivering 100% for our clients and that's what we're doing.

[Rich Walker:]

As we said in the script, we're running virtually real time scenarios, different potential outcomes. We know what key metrics are monitoring that are going to be leading indicators. And we're going to have immediate visibility. But more importantly, we know what levers we will pull, when we need to pull and to navigate through.

[Zach Cummins:]

And Gary, I know you mentioned in your script that you had, excluding one client, your top 10 clients, are doing actually relatively well, I think growing over 4% on a trailing 12 month basis. But can you speak to the one top 10 client that you're seeing interaction with at the moment. Can you provide any more insight as to what's really going on in that situation?

[Gary Moore:]

Yes, we don’t really get into detail about specific clients. But look, when you have a large client and their market is changing, they're shifting what they're selling to some degree and they've been on a path to shift the way that they go to market with some of the work that we were doing for them. We've also signed expansions with them. So it's not like they're going away, but they shifted some pretty significant business over the last year and we've signed some additional business with them, and the additional business hasn't caught up to what's gone away. But again, there's still some very strong client of ours. We have a great relationship with them. And I think we will continue to win business there.

[Zach Cummins:]

And in terms of the new logo, and impressive to see that you're signing basically -- potentially the same amount of logos here in 2020 that you did in all of 2019. I mean, can you give us an update on the expected ramp time of some of these new logo wins? It sounds like you're making some progress on the absolute software deal. Just kind of the expectations and then when you're starting to recognize revenue from some of these new logos?

[Gary Moore:]

So yes, I think Denzil and Peter Flynn and the sales team have really focused heavily on expansions of existing clients, as well as really attacking the new logos. I think you remember last year in the second half of the year, we made that a big focus. It’s paying dividends, obviously. I think the ramp will, a couple of them are already live, but live with a slower ramp to get to full volumes. A lot of these clients are growing very fast. So we knew that going in that the initial revenue might be lower than where we expect to be but we'll see.I think the opportunity for us to continue to grow those over multiple years is really high. And so, our job now is to make sure that we ramp them up, turn them on live. And between our professional services team and the delivery organization, they've done an incredible job of getting people. By the way, we hired over 85 people in the quarter and trained them. So we moved from a hiring and training point of view completely virtual, really impressive by our HR team.

[Zach Cummins:]

And then final question for me, just maybe geared more towards Rich. What's really the approach that cost and expenses here versus the investment? It sounds like you're continuing to invest in some of your key areas that can drive some of this long-term value as you've laid out in some of your longer term targets. Can you give a little more detail into areas where you're going to continue to invest and in some other areas in the business where you can potentially extract some costs as you get more visibility into the environment?

[Rich Walker:]

I would tell you, I think there's more to go. And [Technical Difficulty] the progress we’ve made and seen some nice improvements, I think there's incremental progress in both cost of revenue and in the OpEx environment. In all of 2019, we reduced our CapEx by almost [17%]. We continued that trend specifically in the first quarter, lowering OpEx almost $1 million or just under 5%.If you look at what we did over two year horizon, Q1 of 2018, we said about $11 million lower. So good progress to this point. But the combination of some improved productivity, very pleased particularly at the gross margin level, the ability to increase our year over year gross margins by 80 basis points. Headcount is 17% lower, revenue per employee is 9% higher. And to your point, we’re still investing in the business. We have particularly in cost of revenue a lot of incremental technology licenses that are going through.So the combination of prudent and balancing when we make the investment and still delivering a positive return, we’re satisfied and pleased to see some of those results. But as we’ve talked about what we’re building to, it’s an even higher margin profile, both at the gross margin and at the EBITDA line.

[Operator:]

Thank you. And I’m showing no further questions at this time. Ladies and gentlemen, this conclude today’s conference call. Thank you for participating. You may now disconnect.