ServiceSource International, Inc.
Q2 2019 Earnings Call Transcript

Published: 11 Aug 2019

[Operator:]

Good day, ladies and gentlemen, and thank you for your patience. You have joined ServiceSource's Second Quarter Earnings Call. [Operator Instructions]. As a reminder, this conference may be recorded. I would now like to turn the call over to your host, SVP, Strategy, Investor Relations, Chad Lyne. Sir, you may begin.

[Chad Lyne:]

Thank you and good day, everyone. Thank you for joining us, and welcome to ServiceSource's second quarter earnings call to discuss our results for the quarter ended June 30, 2019. As a reminder, a copy of our earnings release has been posted on the Investor Relations section of our website at www.ir.servicesource.com. On the call today is ServiceSource's Chairman and Chief Executive Officer, Gary Moore; and our Executive Vice President and Chief Financial Officer, Rich Walker.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 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 reports on Form 10-K and 10-Q. These documents contain and identify important factors that could cause results to materially differ from those contained in our projections and forward-looking statements, and we undertake no duty to revise or update any forward-looking statements.In addition, during the call, we will also be discussing certain non-GAAP financial measures and projections, which we believe provide additional information to enhance the understanding of how management assesses the operating performance of the business. You can find the reconciliation of the GAAP and non-GAAP measures in the earnings release posted on the IR portion of our website.And with that, I'll turn the call over to Gary Moore, ServiceSource's Chairman and CEO.

[Gary Moore:]

Thank you, Chad, and welcome, everyone to our second quarter 2019 earnings conference call. I will cover our results and share color on the progress we are making throughout the business in a minute. But first, let me touch on what you saw in our earnings release late yesterday. The reduction in our full year revenue outlook is clearly a disappointment, but it does not reflect upon the underlying strength of the business or the operational momentum we are seeing throughout the organization, nor does it make us question our strategy or long-term road map for what this company and team can achieve. We started taking corrective actions in the quarter and we will continue to course correct as required.As you all know, our revenue is driven by 4 factors. The first is our installed base to clients and our ability to retain and expand revenue from these relationships. On a trailing 12-month basis through Q2, we have grown our top 10 clients at a cumulative 3.6% rate. And through the first 2 quarters of the year, we have performed well on the renewal front, renewing or extending more than 85% of the value that was up for renewal. So our installed base revenue remains largely on target, and we are pleased with the results and the value we are generating for our clients. The second factor is revenue from accounts that we knew would be rolling off due to decisions that were made in Q3 and Q4 of last year, our initial outlook for the year fully factored in what we knew would be a tough year-over-year comparable from these events. So there are no surprises there.The third factor is revenue from in-year churn, which, with two quarters under our belt, is trending favorably to our plan. We are pleased to see some good progress relative to our beginning of the year assumptions, which has allowed us to apply greater scrutiny to engagements that are subscale or that have a suboptimal margin profile. As we shared with you earlier this year, we are being very methodical in having strategic discussions and renegotiating contract terms as appropriate. And where necessary, we are exiting engagements that are not mutually beneficial or commercially viable for us.So that brings us to the fourth factor, which is new sales. Our initial revenue guidance range anticipated that we would drive first half contract signing at a scale and pace that would contribute meaningful revenue in the second half of the year. Given the size and complexity of some of our deals, we expected a certain degree of quarter-to-quarter volatility. However, a slower than anticipated start in Q1 was coupled with a handful of very large deals in Q2, including a $20 million plus opportunity that was in the final stages of contracting that were either delayed or moved out of the pipeline. We can point to factors like recent activist activity for introducing uncertainty in the marketplace. But at the end of the day, we own our execution and our performance did not live up to our expectations.We have made appropriate leadership and personnel moves as well as other changes to drive greater discipline and accountability in our go-to-market teams. These changes are starting to reflect in the pipeline and sales activity. But given where we are at today, we have limited ability to favorably impact in-year revenue and are prudently adjusting our full year outlook. I also want to be perfectly clear that our performance here does not reflect in any way on the value of our solutions in the marketplace. I personally have been spending the bulk of my time in recent months with C-level executives at our clients and prospects. While they each have unique business challenges and strategic priorities, it is clear in my conversations with them that our strategy and solution are still tightly aligned to their current and emerging needs.While we are disappointed with where we now expect full year revenue to land, we remain confident in the underlying health of the company and we see many positive things taking place throughout the business. On the financial front, we are debt free, accreted cash during the quarter and had positive adjusted EBITDA year-to-date, all while continuing to push forward with our digital transformation strategy and investments, which are foundational to our longer-term strategy for profitable growth. Rich will take you through the details of our second quarter results in a moment as well as the discipline and focus that teams are driving in the business to deliver what -- our reaffirmed guidance of breakeven adjusted EBITDA for the year despite the anticipated revenue shortfall.So let me now turn to the four transformational pillars that we discussed with you on our last two calls. To remind everyone, these pillars are

[Richard Walker:]

Thank you, Gary. While we are not pleased with the softer revenue outlook and top line trajectory for the back half of the year, we have not lost sight of our longer-term goals and we remain confident that our multiyear road map and financial targets are sound and achievable. We believe we have a solid understanding of the challenges we encountered and a firm handle on the actions we are taking that we expect will improve our performance and consistency going forward. For today's call, I'll be reviewing our second quarter results and I'll also spend some time discussing our revised guidance for 2019 and the steps we are taking in the business to balance our cost structure to our current outlook while continuing to invest in support of our longer-term 2022 objectives.Turning to our results for the second quarter. Revenue was $52.4 million, down $8.8 million or 14.3% compared to the same period in 2018. Approximately $4.5 million of the negative variance was tied to last year's known churn events. Instances of year-over-year volume reductions at four installed base clients contributed to the majority of the remaining variance. By region, NALA revenue for the second quarter of 2019 was $29.6 million or 56.5% of our total and compared to $37.2 million in the prior year period. EMEA revenue was $13.4 million or 25.6% of our total and compared to $14.7 million in the prior year period. And APJ revenue was $9.3 million or 17.8% of our total and compared to $9.3 million in the prior year period.Moving to gross profit. Our non-GAAP cost of revenue in the second quarter was $37.2 million, down $2.1 million year-over-year and down $1.2 million sequentially as we reduced personnel-related costs in the face of lower revenue. Non-GAAP gross profit in the second quarter was $15.1 million or 28.9% of revenue, a decrease of $6.6 million and 670 basis points year-over-year. A meaningful driver for the year-over-year gross profit erosion was the loss of relatively higher contribution margin from the discontinued logos in 2018 that Gary mentioned earlier. Walking further down the P&L, non-GAAP operating expense in the second quarter was $18 million or 34.3% of revenue. At the individual line item level, non-GAAP sales and marketing expense was $6.8 million or 12.9% of revenue. R&D was $1.2 million or 2.3% of revenue, and general and administrative expense was $10 million or 19% of revenue. Year-over-year, we've reduced quarterly non-GAAP operating expense by 12% or $2.4 million net of investments we continue to make that underpin our multi-quarter digital transformation strategy.From a bottom line perspective, adjusted EBITDA in the second quarter was negative $500,000 compared to $3.2 million in the prior year period. Combined with our results from the first quarter, we generated positive adjusted EBITDA of $400,000 for the first half of 2019. Our non-GAAP net loss in the second quarter was $2.1 million or $0.02 per diluted share compared to non-GAAP net income of $800,000 or $0.01 per diluted share in the prior year period.Turning to select balance sheet and cash flow items. As of June 30, 2019, we had cash, cash equivalents and restricted cash of $27.9 million and we're debt free with no borrowings under the company's $40 million revolving line of credit. Importantly, we accreted $800,000 of cash in the quarter through a combination of disciplined expense management, more rigor on our working capital cycle and a sharp focus on how and where we deploy capital. We had $42.9 million of net accounts receivables and DSOs were 74 days, consistent with the prior year but a strong sequential improvement from 83 days in the first quarter. Cash flow generated by operations in the second quarter was $4.6 million and CapEx was $3.2 million, including $1.7 million of capitalized internally developed software, resulting in positive free cash flow of $1.4 million in the quarter.I want to now spend a few minutes discussing our revised outlook for the year before handing the call back over to Gary for some closing remarks. As you know, we made a decision coming into this year to steer away from short-term guidance and instead anchor our contextual guidance for the full year on 2 metrics

[Gary Moore:]

Thank you, Rich. Let me wrap up by repeating what I said at the outset of the call. We are disappointed by unacceptable performance in one area of the business, but we have made adjustments and are moving forward with renewed focus. We believe we are on the right path overall and are pleased by the broader progress and execution we are seeing throughout the organization. I will also reiterate that we are confident in our market opportunity and strategy. We are chasing a very large and underpenetrated TAM that continues to grow at an impressive rate.Several years ago, when I was President and COO at Cisco, as a client, I saw firsthand the value that ServiceSource could deliver. Its value proposition, its potential in the marketplace and its people are what interested me in joining the Board 2.5 years ago, and those same things are what attracted me to become the CEO at the end of last year.Practically every organization and corporate leader I speak to has a strategic priority to grow closer to their customers at all touch points across along the customer journey experience continuum. And in my mind, there is not a better organization than ServiceSource that can help them do this at scale globally for their B2B midmarket customers. We believe successfully executing on our strategy and delivering on this vision will create value for our clients, employees and stockholders and we remain committed to doing so.With that, operator, please open the call to questions.

[Operator:]

[Operator Instructions]. Our first question comes from the line of Zach Cummins of the B. Riley FBR.

[Zachary Cummins:]

Gary, can you talk about the $20 million deal that you mentioned? What really happened there? And is this something that was pushed out to a further period or something that's kind of gone away completely?

[Gary Moore:]

Yes. Thanks for the question. I don't think it would be appropriate to get super specific relative to the client. There were a number of deals, not just one. That one was the large one. I had met personally with the CEO of the company. The team wanted us to have the deal. We were -- I flew out to make sure that they understood my commitment to it. I walked away from that meeting feeling that we would have a signed contract and we were moving forward.After the 13D was filed with the specific language that was in there, saying that the recovery would be too long, too hard, take too much money and that the Board should immediately start process to sell the company, a number of our clients, not just this one, got fairly nervous. We were told that there was too much risk for the reward that we were going to provide to this company relative to the work that we were going to do relative to the renewals as well as their lead certifications, those kinds of things.And for the risk that was now on the business, if we were sold, it would be too much of a disruption. And it was I think as -- obviously, for that money, it was a very large deal, globally oriented with having to bring on a number of people.Well, I flew back out to meet with the CEO after that to try and see if there was anything that we could do to ease the concern there. We agreed. We shook hands and said, "Look, let's talk every quarter and see where you guys are at. And if things are settled down a year from now, let's reinitiate this." So pushed out with the -- a stretch, I would say, in terms of how long it will be. What was clear to me that it would be at least a year.We had a second deal where we had a commitment to get the deal signed in Q2. That -- again, I flew back out to another client. And after a long discussion and some pushback that they were getting internally based on, again, the 13D and our stock price, we decided to push that deal out hopefully just a quarter, but the commitment was to start -- assuming things were -- I think settled down was the words that were used. Between now and the third quarter, we would go ahead and negotiate the contract for a start date for January next year.I could go on with a couple of others where Rich has had to get on the phone with either the head of procurement or the CFO, and it's just stretched some deals out. I don't think that, that means that we won't get them, but there's a lot more scrutiny. And that's why we changed the guidance for the full year. We thought it was prudent given everything that we had seen. Not that our services and our offerings aren't valued, but there's just a lot of headwind that we hadn't counted on relative to the sales front.And again, I would underscore, all of the pillars are executing extremely well except for this one, and we are not making excuses for that. It made very -- some very senior level changes to the organization. I combined all of our go to market under one leader, so everything from marketing to sales growth as well as the global account managers under one person reporting directly to me. And he and I are working extremely closely together multiple days a week, calling on clients together, that kind of thing. Sorry for the long answers, but I won't get...

[Zachary Cummins:]

No. Not at all. It's always really helpful to get that sort of perspective. I really appreciate it. But you're actually kind of leading into my question in terms of talking about the changes to your go-to-market strategy. I mean it's all under one leader now that reports to you. How is this changing versus kind of the prior approach that you had in place?

[Gary Moore:]

I think the initial focus I had, and I think you and I spoke about this, was really from an operational point of view, getting the all 4 pillars, balancing my time between all 4 of those areas pretty evenly. And actually, from an operational point of view, working with Debbie and Rich relative to some of the operational changes we needed to make, it took a lot more of my time. So I wasn't as, I think, deeply inspecting the pipeline as maybe I should have been. And in retrospect, certainly, I should have been more deeply engaged there.I think the things that we did with the personnel move, much tighter alignment and integration between marketing and business development and outside sales and the gams, all of that is new. It used to be we had a sales organization under one leader, we had the global account managers under another leader and we had the marketing under another leader. I've consolidated all of that under one leader, Denzil Samuels, and I think that's the biggest change.I think the first thing we did was go in and cleanse the pipeline and make a more realistic assessment of the opportunities that were in there so we could have a better prediction of where things were going. We clearly are doing weekly deep dives on that. If a deal is not in Salesforce, then it doesn't get paid commission. And if it's in Salesforce, it gets a lot of scrutiny, again, on a weekly basis.So I think working to -- we continue to work to satisfy and simplify the sales pipeline work. And I think it's -- it will show good benefit. But again, we had headwinds that, quite honestly, I didn't count on. I think I need to underscore though that we're not going to engage in irrational acts to artificially fill a hole relative to revenue. We're not going to sacrifice quality for quantity and I think remain disciplined on our pricing and other contractual terms. And again, that's caused some things in the pipeline not to get closed, and I think that's in our long-term best interest.

[Zachary Cummins:]

Understood. And then, Rich, in terms of kind of looking at the cost structure here and potential areas of savings, I know you mentioned rationalization of facilities with your Denver facility, then moving to a more cost-effective office. But can you talk about other areas where you could potentially, I guess, optimize costs or kind of lower your footprint to really drive a better margin profile in the face of this declining revenue outlook?

[Richard Walker:]

Absolutely, Zach. Thanks for the question. Understood. I think all areas of the cost structure, if you look at the cost to revenue, some of the costs, the dragged costs that are tied to our frontline reps, comes out of the business, as we talked about, balancing the scales of investment. We're actually making some investment in the frontline reps and including the quality of our account management across the business.There are overheads that are allocated to cost of revenue. We talked about the overhang that's creating. We see that leverage when the business and top line grows. We see the contraction when it declines, all areas of OpEx. Sales and marketing was down 15% year-over-year. We continued to refine our marketing investment, make sure we're getting the right ROI if you look to R&D.And finally, G&A, just good cost hygiene, Zach. I think the executive team is very focused on organizing for success. We're continuing to balance the scales. We're not slowing down our technology transformation in that investment, but we are seeing some improved organizational discipline, some process discipline, and I think we're going to continue. Our outlook reflects what we've committed to for the year, reaffirmed adjusted EBITDA breakeven. And we'd certainly like to be more efficient as we move through the year.

[Operator:]

Thank you. At this time, I'd like to turn the call back over to Chairman and Chief Executive Officer, Gary Moore, for closing remarks. Sir?

[Gary Moore:]

Thank you, Rajiv. Let me just close by thanking everyone for joining the call. I'd like to especially thank our employees for their commitment to the company and the great work they're doing for our clients. I'd like to thank our clients who are on the call for the trust that they've put into us. And you have our commitment. We're not going to let you down. And for our shareholders, the support that you've given us and hopefully will continue to give us. So with that, operator, thank you very much.

[Operator:]

Thank you, sir. Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may disconnect your lines at this time.