ServiceSource International, Inc.
Q4 2019 Earnings Call Transcript

Published: 20 Feb 2020

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the ServiceSource Fourth Quarter and Full Year 2019 Earnings Conference Call. [Operator Instructions] Please be advised that today’s conference is being recorded. [Operator Instructions]I would now like to hand the conference over to your speaker today Mr. Chad Lyne, Head of Investor Relations. 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 fourth quarter earnings call to discuss our results for the quarter and full year ended December 31, 2019. As a reminder, the earnings release we issued yesterday after market close that accompanies this call and webcast has been posted on Investor Relations section of our website at www.ir.servicesource.com. On today's call we will is review ServiceSource’s performance for Q4 and the full year 2019 and provide our thoughts as we look forward to fiscal 2020. On the call 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. 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 earnings conference call. 2019 was a foundational period for ServiceSource marking the first full year under a new executive leadership team. You may recall my comments from this time last year as I framed a multi-year transformational journey to enhance our client relationship and outcomes to improve our execution and consistency and to strengthen our financial performance.I would also share that there were no quick fixes and very little low hanging fruit to achieve those objectives. Over the course of the past year we have focused on making needed changes big and small throughout the business. We simplified and standardized our operating model, realigned teams and resources to our strategic priorities and rationalize non-core revenue streams were appropriate. While also making substantial forward focus growth and transformational investments.We continue to expect the impact of these actions to roll through the P&L in the coming quarters. But I am pleased to share that we are seeing major and meaningful progress across the company. We are regaining momentum in the marketplace with a stronger value proposition and more clear competitive differentiation. We are earning greater trust and loyalty from our clients through targeted investments and our people, processes and technology.And we're doing a better job of more consistently fulfilling our brand promise of trusted business outcomes delivered. While there is much more progress to be made one year into this journey we believe we have established a more solid foundation that we can continue to build upon. Throughout the organization our teams are fully committed to our strategic roadmap and are aligned to delivering on our value creation priorities and objectives.With that as a backdrop let's dive into the results. As I've done in the past I will provide some brief financial highlights for the quarter and the full year and then I will update you on the four key execution pillars that we have consistently spoken to. I will then share a strategic framework and tactical focus areas for the coming year. Then I will turn the call over to Rich for a deeper review of our financials and commentary on our initial 2020 expectations.First on the numbers. In the fourth quarter of 2019, we generated revenue of $54.9 million and adjusted EBITDA of $2.7 million or 5% of revenue. For the full year our revenue was $216.1 million adjusted EBITDA was $4.2 million and we generated positive free cash flow of $2.3 million.If you recall our outlook call for year-over-year revenue contraction of 10% to 12% which equated to $212.1 million at the midpoint. We also anticipated delivering approximately breakeven adjusted EBITDA. So I am very proud of how our teams executed over the course of the year to deliver financial outcomes that exceeded these expectations by approximately $4 million at the top and bottom line.Underpinning these financial results are the collective efforts of our people in 11 offices around the world these talented professionals work together across every department to advance the strategic priorities within our four transformational pillars. As a refresher we call that our inspire success pillar is focused on our human capital and culture. Our impact scale pillar is focused on our end-to-end operating model. Our ignite sales pillar is focused on landing and expanding client relationships and our innovate solutions pillar is focused on advancing our capabilities and suite of offerings.We were able to make forward strides throughout the year on each of these pillars. In areas where we weren't seeing the velocity or results we expected we adapted and made changes as needed in order to course-correct.Touching on the first inspire success pillar. We believe our people to be the greatest asset and central to the success of ServiceSource and our clients. Technology and data expertise are critical enablers for us but the quality and expertise of our people is foundational. We ended the year with just over 3,200 employees globally with Q4, 2019 marking the first time in several years where we generated a year-over-year increase in our revenue per employee unit economics and although our attrition rates aren't where we want them yet we saw strong gains in our employee satisfaction and loyalty metrics compared to last year with average employee tenure increasing to 2.9 years.On the culture front we remain committed to creating an environment that supports personal and professional growth, that incentivizes and rewards high performance and that promotes trust, diversity and inclusion.We advanced our gender equality initiative with women now representing approximately one-third of our leadership ranks, up from less than 20% in the prior year. We're also extremely proud of how we promoted and supported efforts to give back to the communities in which we operate. With our employees collectively volunteering more than 13,000 hours of their time during the year supporting many charitable causes and community organizations. These initiatives are very important in recruiting, developing and retaining the highly skilled workforce that our clients rely on.Moving to the impact scale pillar, our clients entrust us with their most valuable resource, their customers and their revenue. We believe the structural and operational changes we made this year and which we will continuously improve upon going forward have enabled us to be better stewards of that client trust. I talk a lot internally with my team about how value is often lost in the scenes due to organizational silos and handoff across departments and functions. In 2019 we made a great deal of progress closing these things as we set our sights on getting the right people in the right roles and focus on the right things.The feedback we are hearing from our clients gives us confidence that we are in fact becoming a more client-centric company that is better and easier to do business with. Our deployment of a more standardized end-to-end operating model allowed us to improve the predictability and consistency of outcomes we delivered for our clients and our performance with our installed base pairs as well. We grew the combined revenue from our top 10 clients by 1.1% in 2019 with year-over-year expansion from five of them.Furthermore, our teams executed well on contracts that faced expiration during the year as we mitigated areas of churn risk and successfully renewed or extended approximately 84% of the value that was up for renewal in 2019.On the innovate solutions pillar we rationalized our internal tech stack and made significant transformational investments to standardize around the salesforce.com platform and ecosystem.We successfully reduced our third-party vendor and consultant footprint and lowered our total research and development spend inclusive of capitalized internally developed software cost by more than 35% year-over-year. Importantly, this allowed us to free up capacity and redirect resources to bring new capabilities to market.While we are still in the early days of beta test and pilots with select clients we are excited about the future potential things like our innovative Click To Renew capability, our digital commerce solution and our CRM system administration as a service offering.Finally, on the ignite sales pillar we continuing our progress rebuilding the growth engine after a disappointing first half of 2019. Following our go to market realignment and sales leadership changes we made midway through the year. We are seeing tangible results and improvements in our pipeline, quality, commercial discipline, sales execution and new logo opportunity set.In addition to the cybersecurity new logo win that we shared with you on our Q3 call we've added two more marquee clients to our roster. In late Q4 we won business with Okta, a leading cloud platform for enterprise identity management who awarded us a multi-year customer success contract. Okta engaged us to drive faster speeds of value for its customers with a variety of high touch customer success motions including on-boarding and adoption calls, proactive health checks and monitoring and periodic business and customer outcome reviews.In addition, to Okta we also announced earlier this month that Absolute the leader in endpoint resilient software entered into a new agreement with us where together we will drive higher levels of customer success for Absolute’s mid-market commercial customers as an integrated component of Absolute’s customer experience initiatives ServiceSource will augment and support Absolute’s internal go to market teams to empower improved recurring revenue retention and annual contract value expansions across the company's product suite. As these recent wins highlight our focus on a line with category leaders and innovators and the high-growth cloud and software subscription market is bearing fruit.As we look forward to 2020 we will continue to talk about these four key transformational pillars. Our leadership team recently completed our annual long term strategic planning process and we agreed that these pillars were instrumental in aligning the entire organization around shared objectives and metrics in 2019. More importantly, however, they remain in the right areas of priority for this year as well. We believe if we execute well against these pillars that we will be positioned to provide greater value and better outcomes to our clients, more rewarding careers and growth opportunities for employees and a financial profile and trajectory that builds value over time for our stockholders.With that let me turn the call over to Rich Walker, our CFO to reveal our financial results in more detail. Rich?

[Rich Walker:]

Thank you and good morning to everyone. I will first review our fourth quarter financials and then we'll cover the full year results. I will also provide some context to how we're thinking about 2020 and the general cadence we expect to see during the year. We will then open the call for questions before Gary closes this out with some concluding remarks. As Gary highlighted at the outset of the call, we ended the year on a positive note with strong execution throughout the business translating into financial results that surpassed our expectations.Our delivery teams generated higher conversion rates and drove greater productivity on our commission-based pay-for-performance engagements, which yielded upside incremental revenue with a high contribution margin in the quarter. Our ongoing cost discipline and more streamlined expense base allowed that revenue to cascade favorably through the P&L while our tight focus on working capital efficiency and prudent capital allocation drove positive free cash flow and a stronger balance sheet with cash accretion for the full year.Turning to the specifics. In the fourth quarter we generated revenue of $54.9 million, down $6.6 million or 10.7% compared to the same period in 2018. More than 90% of the year-over-year variance was tied to logos that were exited or churned between the comparable periods with the remainder due to the net difference from contractions, expansions and new logo ramps.On a regional basis NALA revenue for the fourth quarter of 2019 was $30.7 million or 56% of revenue compared to $36.2 million and 59% of revenue in the prior year period. EMEA revenue was $15.8 million or 29% of revenue compared to $16.6 million and 27% of revenue in the prior year period. APJ revenue was $8.3 million and 15% revenue compared to $8.7 million and 14% of revenue in the prior year period. On a year-over-year basis for the fourth quarter NALA revenue contracted approximately 15%. EMEA contracted approximately 5% and APJ contracted approximately 4% principally due to the geographic mix and concentration in NALA for programs that were unwound during the year.Moving the cost of revenue and gross profit, our non-GAAP cost of revenue was $36.2 million in the fourth quarter of 2019 favorably down $3.3 million or 8.4% year-over-year. The targeted actions we took throughout the year to right-size production capacity and infrastructure enabled us to generally reduce our cost of revenue in line with the lower revenue profile. That said some of the savings were partially offset by increased technology license costs flowing through the P&L compared to prior years. From a margin standpoint our non-GAAP gross profit in the fourth quarter was $18.7 million or 34% of revenue down slightly by a 180 basis points year-over-year. Non-GAAP operating expenses in the fourth quarter of 2019 were $17.6 million or 32.1% of revenue were held roughly flat on a dollar basis with the prior year period.At the bottom line the fourth quarter of 2019 we generated adjusted EBITDA of $2.7 million or 5% of revenue compared to the $6.3 million and 10.3% of revenue we saw in the fourth quarter of 2018.Briefly on the balance sheet and cash flow statement we dramatically improved DSOs by 11 days year-over-year to 68 days in the fourth quarter of 2019. The combination of positive adjusted EBITDA and favorable working capital dynamics generated positive cash flow from operations of $5.2 million. CapEx was $900,000 resulting in positive free cash flow of $4.3 million in Q4.Turning now to summarize our full year 2019 results we generated revenue $216.1 million, down $22.2 million or 9.3% year-over-year. While the year-over-year contraction was primarily due to the churn we inherited from late 2018 that rolled off throughout the year we are proud of how our teams performed in 2019 to drive higher in-year retention rates than we had assumed. This combined with strong delivery execution in the second half of the year allowed us to beat the midpoint of our full year revenue outlook by $4 million.On the expense side, year-over-year we've reduced our non-GAAP cost of revenue by $7.4 million and streamlined our non-GAAP operating expenses by $5 million for a total year-over-year non-GAAP expense reduction of $12.4 million. Importantly, this is net of the meaningful investments we made in support of forward focused growth initiatives including our technology transformation and our global account management organization among others.For the full-year adjusted EBITDA was $4.2 million or 2% of revenue while down from $14.2 million and 6% of revenue in 2018, our discipline and rigor managing all aspects of the cost structure including taking thoughtful and targeted restructuring efforts were needed allowed us to nicely exceed the expectations we shared with you for an approximately breakeven year.Cash flow generated by operations during the year was $12.4 million and CapEx was $10.1 million resulting in positive free cash flow of $2.3 million marking a very strong improvement from the $11.9 million of free cash flow consumption in 2018. We had no borrowings against our $40 million revolving line of credit and accreted $1.6 million of cash during the year to exit 2019 with $29.4 million of cash, cash equivalents and restricted cash.Although we are pleased with our financial performance and results in the fourth quarter and full year 2019 we know and appreciate that we have not arrived at our destination. 2019 was a foundational year where we strengthened many fundamentals throughout the business. Yet we are mindful that it is only one mile marker on a longer multi-year transformation journey.With that in mind allow me now to spend a few minutes framing how we're thinking about fiscal 2020 and our long-term target model. Based on positive feedback from our investors we will continue the stockholder communication practices we initiated in 2019 providing an annual directional outlook for revenue and adjusted EBITDA, high level of context for our broader assumptions and anticipated cadence through the year and updates to our rolling three-year target model.Looking first to the full year 2020 we currently expect revenue to decline year-over-year in the high single digit percent range with adjusted EBITDA margins generally in line with 2019. On the revenue side it is important to clarify and keep in mind that the $216.1 million we delivered in fiscal 2019 included revenue from lower margin and suboptimal programs that we proactively exited during the year as well as revenue that was tailing on from inherited and other in-year churn. On the other side of the ledger there was revenue from new wins and expansions in 2019 that had not yet reached full ramp. Taking these two cross currents into effect a more normalized run rate view of our revenue coming into this year is approximately $20 million lower than the $216.1 million we just reported.In terms of high-level cadence through the year given the normalized run rate and typical seasonality with our clients. We're assuming first half revenue will contract in the low double-digit percent range before we return to year-over-year growth exiting the year with our new sales bookings ramped to revenue.Following along with the revenue cadence, we expect adjusted EBITDA margins to be modestly negative in the first half of the year before turning positive and accelerating in the second half of the year. Shifting now to our rolling 3-year target model.We believe the business will be in position to grow revenue 10% or more in the out year, driven by our ongoing shift to supporting companies and the higher growth cloud and software markets and our belief that we will continue to expand our share of wallet with our install base clients where we currently are underpenetrated.With targeted adjusted EBITDA margins of 10% to 12%, we believe margin expansion will be tempered a bit given rising input cost. But we do anticipate we will see good offering leverage throughout the P&L as we scale incremental revenue against our fixed and semi-variable facilities, infrastructure and SG&A overhead.While in many regards we're optimistic and are pushing to outperform both the 2020 end of 3-year target model expectations, we are also operating with a certain degree of prudence and appropriate caution given tightened broader macro volatility, increased uncertainty about potential disruptions to our clients businesses due to the Corona virus risk and ongoing M&A activity at several of our larger clients.We will also continue to be disciplined and how we manage and optimize our portfolio or similarly ensuring high standards around the margin profile in the characteristics of new business we bring in. But simply, with a more solid foundation for the company established in 2019, we will build smartly and methodically towards our multi-year vision and objectives and won’t trade-off longer-term value for short-sighted near term gains.With that operation, please open the call for questions.

[Operator:]

Thank you, Sir. [Operator Instructions] I show a first question comes from Zach Cummins from B. Riley FBR. Please go ahead.

[Zach Cummins:]

Hi, good morning Gary, and Rich. Congratulations on the solid Q4 performance.

[Gary Moore:]

Hi, Zach.

[Zach Cummins:]

Yes. I guess Rich, just starting with FY'20 guidance, you laid it out pretty well there but can you just go into some more of the puts and takes that are baked into your outlook here. It sounds like maybe in the first half of this year you're expecting some of the slower margin business to be rolling out for the P&L here and then expecting to return to some sort of growth and see the margin expansion there in the back half of this year?

[Rich Walker:]

I think I would say exactly like that we didn’t give specific point guidance, we tried to give some context to that. And I think you summarized it exactly as we thought about it.

[Zach Cummins:]

Got it, that's helpful. And then Rich, in terms of -- I mean areas to drive additional cost savings, I mean you stripped out a lot of cost share in 2019 in terms of the challenging revenue environment. But can you talk about other potential areas that you think you can drive for the leverage in the operating model in this coming year?

[Rich Walker:]

Yes. I kind of working down the P&L. I'd look first to cost to revenue. We have shared in the past probably 400 basis points of drag given excess capacity and infrastructure. We'd obviously like to fill that but we continue to manage and work at that. We've got automation opportunities to drive productivity driving more value to our clients leveraging technology to do that.I'll continue to look from an ROI base perspective that everything we're doing investing in the business. So not only enabling incremental capabilities but really inspecting what we do on an ongoing basis. So I think it's up and down the P&L Zach both areas of cost of revenue and OpEx will continue to focus.I feel great about the progress and R&D, how we call that out specifically and we'll continue to invest that way. I think all of the P&L leaders are very focused on that. Saw good leverage of that model in our fourth quarter results Zach as we continue to drive that expense base, the incremental revenue creates a lot of leverage and as we execute through the year, expect to see that same leverage again.

[Zach Cummins:]

Got it, that's helpful. And then Gary, in terms of the renewal performance, I mean really pretty solid performances this year. I mean, can you talk about some of the changes that you made within the organization to drive that improvement this year. And are there any items that I need to consider when thinking about retention in 2020 essentially because it sounds like you're going to be rolling off some of the lower margin business there in the first half of this year.

[Gary Moore:]

Yes. Look, -- as I looked at our biggest issue relative to the past. Here the company was -- churn wards exceeding the amount of new ACV being signed and the revenue that it reduced. And so, we made several changes instituting the global account managers on the top accounts driving a weekly call with all of the site leads to talk about the accounts that they're responsible for putting a lot of our customers that were listed as green, moving them to yellow, moving a bunch of yellows to red and really doing a deep dive every week to talk about what we were we going to improve performance. I think really helped, I also believe that both Debbie and Denzil put a lot of focus in the way that we organized the executive sponsorships with the amount of touch-points.I think we talked in the past in addition to the games, I go out and meet with C-Suite often. Rich has formed relationships with his counterparts of both at the CFO level as well as in procurement. And so, we're trying to open up as many touch points with our clients as we can and then we're leaning on the global account managers to really make sure that they are close to the client and looking at opportunities.That in the past maybe we want him to aware of. And that's helping us I think drive a better performance with those customers or clients of ours.

[Zach Cummins:]

Got it, that's helpful. And then Gary, just around with the top-10 customer base, I mean despite the revenue decline, this year actually you saw a 1% year-over-year increase across the top-10. So can you talk about the potential expansion opportunity there within that existing top-10 base and talk about what's your strategy here to help them navigate what's turning into a pretty challenging macro environment?

[Gary Moore:]

Yes. I think, we continue to expect better performance by the way as we go into 2020 and leveraging some of the work that we've done. That the things I just spoke about really help in my mind drive better retention and a higher success with renewals, renewing 84% was not where we wanted it to be but it was a big improvement over prior years.I think as we look at the top-10, on average they've been with us for 10 years. If you look at the five of our largest clients, they all grew and in the fourth quarter the revenue for that one large cloud client more than double. So we see continued expansion as we continue to work at a higher and higher level with our clients.Now, we're going to experience puts and takes in any given quarter in our install base but I really feel good about the portfolio that we have. And I think we have some attractive opportunities that with our new portfolio but its early days with that.

[Zach Cummins:]

Got it. And then just final question from me. In terms of the sales performance, it seems like with the new go-to market strategy, you've seen some incremental improvement here in the second half of the year.Can you talk about, I mean how are you feeling about the potential opportunities for the salesforce here as we get here in towards the end of Q1 of this year and maybe getting towards longer-term opportunities you're seeing within the pipeline?

[Gary Moore:]

Yes. So one, I think we saw in the back half for the year a good pick up, it's much stronger pipeline in the second half of the year. I think you’ll recall, we had a very rough Q2. I think overall, given that we signed three new logos last year, we had, we mentioned Okta an Absolute in our -- in the call and in our press release.I think those are indicative of the kind of high growth companies that are pushing the envelope relative to cloud and relative to software that we continue, that we can continue to offer a great value proposition to.And as long as we can do that, I think we'll start to really see results with more and more new logos while continuing to focus very heavily on the installed base and our client customer -- client portfolio.

[Zach Cummins:]

Got it, that's helpful. Well, thanks again for taking my questions this morning and best of luck in the coming quarters.

[Gary Moore:]

Zach thank you, we really appreciate that.

[Operator:]

Thank you. This concludes our Q&A session. At this time I'll like to turn the call back over to Gary Moore, ServiceSource's Chairman and CEO for closing remarks. Please go ahead, Sir.

[Gary Moore:]

Thank you, very much. I'll be brief here. I did want to close with some acknowledgements and vote of thanks to our various stakeholders, to our 3200 employees around the world. Thank you for your tireless work throughout 2019. I think you executed and delivered well against the commitments we made to each other as well as our clients and our stockholders.The clients we have that entrusted us with their business and to help them accelerate their own customer transformations. I think a big thanks to them. And then as importantly to our investors, Rich and I've spent a lot of time along with Chad, meeting with a number of our investors and the feedback, encouragement, as well as the constructive urging in some areas, I think it's been really helpful.And we look forward continuing in that dialogue as we go through 2020 and then continue to execute to our longer-term plan.Thank you, and thanks everyone.

[Operator:]

Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.