ServiceSource International, Inc.
Q2 2017 Earnings Call Transcript

Published: 7 Aug 2017

[Operator:]

Good day everyone and welcome to the ServiceSource First (sic) [Second] Quarter Fiscal Year 2017 Earnings Results Conference Call. This call is being recorded. Erik Bylin from Investor Relations will open today’s call. Erik, please go ahead.

[Erik Bylin:]

Thank you, Jonathan, and thank you for joining us. Before we begin, I’d like to remind you that during the course of this webcast and call, we make projections or forward-looking statements that involve risks related to future events. We caution you that such statements are just projections and actual events and results may materially differ from what we discussed. All statements made during the course of this webcast and call reflect our views as of today and are based upon the information currently available to us. This information will likely change overtime. By discussing our current perception of our market and the future performance of our company and our solutions with you today, we are not undertaking an obligation to provide future updates. 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. Please refer to the documents we have filed with the SEC. These documents contain and identify important factors that could cause actual results to materially differ from those contained in our projections and forward-looking statements. During the course of this call, we will also be discussing certain non-GAAP financial results and projections. Unless otherwise stated, financial measures discussed in today’s remarks are non-GAA, and exclude restructuring charges. For all of these non-GAAP measures, we direct your attention to a reconciliation between the GAAP and non-GAAP measures, which can be found in today’s earnings press release, posted on the Investor Relations portion of the ServiceSource Web site. And with that, I’ll turn the call over to Chris Carrington, ServiceSource’s CEO.

[Chris Carrington:]

Thank you, Erik, and good afternoon, everyone. I appreciate you joining us for the ServiceSourceQ2 fiscal 2017 earnings call. I’m joined on the call by Bob Pinkerton, our Chief Financial Officer. As we highlighted on our earnings press release, we delivered a solid quarter on multiple fronts. Revenue was on plan. Profitability is moving in the right direction. Sales execution and momentum is encouraging, and the ongoing evolution of our solution set is resonating in the marketplace. Let me first turn to our financial results in the quarter. Q2 revenue came in at $58.3 million, at the high-end of our guidance and up 2.7% sequentially. Gross margin was 38.2%, well above the top end of our guidance. The combination of our performance by our team at the gross margin level, and continued OpEx discipline resulted in adjusted EBITDA that exceeded guidance. A $4.7 million, adjusted EBITDA increased $5.7 million over Q1. Shortly Bob will share more detail on our Q2 financial results and our outlook. But let me now briefly provide some context on our sales execution. And Q2, we closed 19 transactions spanning all of our geographic regions, including four new logo wins to mark our third consecutive quarter adding new clients to our base. All of the Q2 new logo wins are with large multi-billion dollar companies, that are market leaders in their respective industries and they each saw the value and our emerging capabilities and motions around inside sales and customer success. Let me provide some quick highlights and context on these new logo wins. For a multibillion dollar data back up and protection vendor, we will be deploying a global inside sales, customer win back and sales enablement team, spanning multiple revenue delivery centers around the world. For $2 billion plus cyber security software provider, we secured a multiyear contract for integrated inside sales, customer success and renewals management. For one of the world's largest finance and accounting software providers, we will be expanding the recurring revenue base through targeted inside sales and customer acquisition programs. And for a multibillion dollar business information services and marketing analytics company, we will be turning SMB leads and prospects into subscription customers in EMEA. As these new logo and showcase, we're seeing greater return from the investments we're making in our go-to-market activities. The sales results are also reflective of the positive outcomes that our global team delivers every day to create valuable and referenceable client relationships. The results also highlight the greater clarity where driving in the marketplace around our value proposition, solution sets, and capabilities. In the past, we may have been perceived as a market leading provider of maintenance contract renewal services for the premise-based hardware market. Today that is just one piece of a greater hole. In addition to hardware, the markets we serve are now diversified across software, cloud, medical device and diagnostic, and industrial IoT. In addition to renewals, our emerging solutions around inside sales and customer success enable our clients to engage with their customers at all points along the customer journey both presale and post sale. The unifying thread is that each of our clients chooses to partner with ServiceSource to help them more effectively and efficiently, find, convert, grow and retain their B2B customer relationships, and then to successfully turn those relationships into long-term recurring revenue growth. Our clients entrust us with their most valuable resource, their customers and their revenue. And every hour of every day our teams around the world deliver on that trust. In closing, I'd like to thank our 3,000 plus global employees for contributing to a solid quarter as we continue on our transformation and path forward. As the markets we serve and our clients need continue to evolve in a dynamic environment, we will continue to facing mix of challenges and opportunities. We remain focused and committed to grow through some of the client specific revenue headwinds we’ve encountered this year, and I'm pleased with the progress we're making the transition to our operating model as we adapt to these dynamics. With that, I'll now turn the call over to Bob, our Chief Financial Officer, to show greater detail on our financial results and outlook. Bob?

[Bob Pinkerton:]

Thank you, Chris. Today I will share our Q2, 2017 financial results and provide guidance for The third quarter and full-year of 2017. As a reminder, we’ve post a presentation on the company Web site with the details of our guidance along with a GAAP to non-GAAP reconciliation of that guidance. We do delivered a solid quarter that began to show the results of the operational changes in cost rationalization actions we took in Q2. We generated revenue with the high-end of guidance and continue to control spent, which resulted in adjusted EBITDA well above guidance and up 64% year-over-year. And with that, I'll turn to results. Revenue was $58.3 million at the high-end of our guidance, but a decrease of 6% from the prior year. Gross margin was 38.2% above the high-end of guidance, but down slightly year-over-year. Our operating expenses came in at $19.5 million, down 14% or $3.2 million year-over-year as we saw the early results of strategic actions we took to drive greater profitability. Adjusted EBITDA for the second quarter was $4.7 million or 8.1% of revenue, up $1.8 million from the prior year and well above the high-end of our guidance of $2 million. Our net income in the second quarter was $1.5 million or $0.02 per share compared to $0.01 a year-ago. Now turning to a brief review of balance sheet and cash flow metrics. DSOs in Q2 were 81 days, down from 84 days in the first quarter of 2017. Cash flow using operations was $1.5 million excluding $2.8 million in cash paid for restructuring. CapEx was $4.6 million, which included $3.2 million in capitalized development, resulting in negative free cash flow of $7 million after adjusting for foreign exchange. We subsequently ended the quarter with $179.1 million of cash equivalents and investments, down $9.9 million from Q1 largely due to the restructuring charge and changes in net working capital. With that, I'll now turn to guidance for the third quarter of 2017. We expect revenue for Q3 in the range of $55 million to $58 million, and gross margin in the range of 33.5% to 36.5%. We are forecasting third quarter operating expenses to come in between $18 million and $19 million. As a result, in Q3, we expect adjusted EBITDA between $2 million and $4 million and net income between breakeven and $2 million or $0.00 to $0.02 on a per share basis. We assume a basic share count of 89 million shares and a normalized tax rate of 40%. We are expecting free cash flow to come in between negative $1 million and negative $3 million for Q3. Moving on to full-year guidance. We are reaffirming the full-year guidance we gave last quarter with regard to revenue, gross margin, OpEx and earnings. We also still expect to be sustainably cash flow positive by the fourth quarter of this year. As we examined ACV and its relation to future revenue performance, we saw the two diverge dramatically beginning in 2017. Many of our new wins such as Inside sales, in particular, do not fit our definition of ACV. We also no longer use ACV as a key operating metrics and measurement like sales compensation are now largely tied to revenue not ACV. We feel it is no longer a cycle to provide ACV or ACV guidance as a proxy for our future revenue prospects. So we will no longer share anything value or forecast. Following this chains, similar to other publicly traded tech enabled services companies, we will continue to reporting guide to full-year revenue, gross margins, operating expenses and profitability, as well as provide quarterly affirmation of full-year guidance and/or updates based on material improvements or contractions. If we close new business wins or experienced churn of magnitude that would materially affect one of our key metrics, we will share the details of these changes on our quarterly calls, as we have done in the past. And with that, I will open up it for question.

[Operator:]

Certainly. [Operator Instructions] Our first question comes from the line of Pat Walravens from JMP Securities. Your question please. Pat Walravens Oh, great. Thank you and congrats on a -- an improvement from last quarter. So big picture, Chris, have we righted the ship? Chris Carrington Well, Patient, to your open commentary, I think it is a big improvement from where we have to report last quarter on Q1. So I feel like we’re heading in the right direction with a solid quarter, this quarter. Great -- very solid sales quarter including the four new logos and healthy balance between renewals and emerging solutions like insider sales and customer success. So, I think, our value proposition is once again resonating the marketplace and I’m looking forward to the rest of the year. Pat Walravens Okay, good. And so, how is churn this quarter? We know how it was last quarter. Bob Pinkerton Yes, sure. So Pat, this is Bob. It's similar to as we went through the analysis of the chances we’ve with respect to ACV and not tracking revenue for the year as you know, we began the year with 266.5 million of ACV, but that was disconnected to revenue guide of $238 million $243 million, and that is one of the reasons why we decided not to guide the ACV to any more churn with the same -- in the same bucket. Churn is an ACV metric. When you talk about churn on a regular quarterly basis, you’re only talking about one side of the coin. The other side of the coin is new business, and as we look at that -- what really matters is the net of new business less churn and its impact on revenue. And when in making that call to get to a revenue and P&L financial statement based guide, we felt it didn't make sense to continue to report on churn for ACV. Pat Walravens Okay. I guess, I’ve two thoughts on that. One, every SaaS company tells you, sales force calls it attrition, ultimate calls it retention, but we will put that aside for a second. So I think you guys are out of your -- you’re out of the --you’re out of consensus there. But you don’t have to give me numbers, just how was it? I mean, how happy or unhappy were you guys with where the churn was this quarter? Chris Carrington Yes, two elements. First of all, I was pleased. We came in better than expected and so we felt it was a strong quarter. I would take a shoe, Pat, to and disconnect a little bit with -- we are not a SaaS based company and the reality is the vast majority of our revenue is managed services. And as we looked at the greater number of managed services companies, they really report to a full-year revenue guide, gross margin and EBITDA, just as we’re doing now. And so, we just felt like the continuation of churn in ACV was a metric associated with the SaaS component of our business, which we stopped reporting to over a year-ago. Pat Walravens Yes, fair enough. And then, lastly, because I know this is a big one and if you don’t mind, Bob, really walking us through it. How are you guys going to deal with the convert and what kind of shape you’re into do that? Bob Pinkerton Sure. Yes, happy to. So, right now as we sit on a $179.1 million of cash and I look at my expectation to get to consistently cash flow positive by Q4 and run that those numbers out to August 1, 2018, I expect to have more than sufficient amount of cash to pay the convert off and then have liquidity to run the business. Pat Walravens Okay, great. Thank you, guys. Bob Pinkerton Thanks, Pat. Chris Carrington Thanks, Pat. I appreciate the questions.

[Operator:]

Thank you. Our next question comes from the line of Tim Klasell from Northland Securities. Your question please. Tim Klasell Yes. Hi, good afternoon, guys. Nice quarter. I’m trying to look forward a little bit here, the four new logos and maybe what you guys see in your pipeline, how does that compared to your current business? Maybe a little bit around margins, or what you think your achievable margins and how we should compare that to what your current business is, just so we can get sort of a tone of -- or a feel for direction the business is heading? Thank you. Chris Carrington Sure. So as I look at new business we are signing, we feel really positive about the fact that when we look at inside sales motions and customer success motions, they tend to lead to higher margins than our core renewals business. And see now we signed four new logos which are all had inside sales or customer success motions, we are optimistic about how that will guide our business upwards. But its early days on that and as we continue to sign more of those deals, we will have more proof points for you from market insights. Tim Klasell Okay, great. And then sort of a follow-on for the prior question around the convert, how much liquidity do you feel you need to run the business, and then obviously that begs the question of strategic thinking as far as M&A is concerned going forward, or what sort of a level do you think you need? Chris Carrington Yes, I think just our current revenue run rates, call it near $0.25 billion dollars, I think having $50 million plus of cash would be sufficient to run the business. Clearly if we were to take a strategic move, that would include an acquisition, having at that point zero net debt, we’d have options to look at traditional bank debt and/or look at another convert, but that would be on an acquisition basis only. Tim Klasell Okay. And then sort of follow-on to my first question. When you take a look at your pipeline, what are you seeing mostly, when you think of your type of customers, your hardware, your software, SaaS companies, what are you seeing in your pipeline right now? If you had a sort of, let's say, venture a guess, what will we be talking about this time next year? Chris Carrington Yes. I think we will continue to talk a lot about certainly the evolving cloud subscription industry. We had really strong traction to that this quarter representing about a -- over a third of our sales. And as we reported last quarter, our cloud and software business is now up over 57% of our total revenues. So I think that’s going to continue. We still see opportunity in helping out current clients and new clients and the traditional hardware space. And then, once again, medical device and diagnostics and IoT are emerging as well. Tim Klasell Okay, good. Thank you very much. Chris Carrington Thanks, Tim. Bob Pinkerton Thanks, Tim.

[Operator:]

Thank you. And this does conclude the question-and-answer session of today's program as well as the content. Thank you ladies and gentlemen for your participation. You may now disconnect. Good day.