ServiceSource International, Inc.
Q3 2017 Earnings Call Transcript

Published: 11 Nov 2017

[Operator:]

Good day, everyone, and welcome to the ServiceSource Third Quarter 2017 Earnings Results Conference Call. This call is being recorded. Erik Bylin from Investor Relations will be opening today's call. Erik, please go ahead.

[Erik Bylin:]

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 discuss. 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 over time. 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 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-GAAP and exclude restructuring charges and one-time gains from the sale of an investment. 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 website. 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 ServiceSource Q3 Fiscal 2017 Earnings Call. I'm joined on the call by Bob Pinkerton, our Chief Financial Officer. I am pleased to report that we had a solid Q3, with the key metrics of revenue, non-GAAP gross margin, OpEx and adjusted EBITDA all beating our guidance for the quarter. Revenue was $58.1 million, and non-GAAP gross margin was 36.9%. We began to see the positive effects from the cost realignment plan that we announced earlier in the year, with Q3 OpEx of $17.7 million, which was better by nearly $2 million sequentially and by almost $4 million from the year-ago period. Flowing through to the bottom line, adjusted EBITDA of $5.7 million, or 9.9% of revenue, was up 40% year-over-year and represented the best performance from both a dollar and margin perspective since Q4 of 2013. Turning to the sales front. We continue to build momentum with solutions that are aligned with the direction the market is heading. The sales team turned in another good quarter, with wins that spanned each of our 3 geographic regions and across all of our 5 target markets. During the quarter, we closed 18 transactions comprising 15 expansions and 3 new logo wins. On a year-to-date basis through Q3, our total new logo count stands at 8, up from the 3 we'd signed during the same period last year. These expansions and new logo wins are encouraging on several fronts. First, they highlight the value we are delivering to our existing installed base clients, the strength of our relationships with them and the referenceability that they provide to new prospects. Second, they are evidence that our expanded solution set and innovative capabilities around inside sales and customer success management are unique and differentiated in the marketplace. Third, they are a validation of our go-forward vision to help our clients find, convert, grow and retain their B2B customer relationships and revenue across the entire customer journey and offer a clear sign that our multiyear transformation strategy is on the right track. Regarding our transformation strategy, we continue to execute on a number of strategic and proactive multiyear initiatives that are absolutely right for the health of the business over the long-term, despite having been dilutive to revenue and margin in the short to intermediate term. Across two major areas, our top-line has absorbed in excess of $65 million of compression since 2014. But importantly, we expect to be largely through these headwinds later in 2018. Allow me to elaborate a bit here. Two years ago, it was clear that the separate C&BI business was not going to scale profitably. We set to work embedding this technology stack into the managed services organization and then began the process of winding down the standalone business. While this ultimately improved the health of our client relationships, discontinuing C&BI has been a sustained drag on our revenue since its peak in 2014 to its effective end this year. In another strategic move, we recognized that a portion of our client portfolio needed a more cost effective delivery option in order for us to retain and grow our relationships over the long-term. To address this, we have been strategically realigning our pricing structures and rebalancing workloads to our lower cost revenue delivery centers in the Philippines and Bulgaria. Today, we are proud to employ over 600 sourcers in these offices, supporting both longstanding clients as well as recent new logo wins. While necessary for the long-term positioning of ServiceSource, these intentional global moves and pricing adjustments have had a pronounced impact to our annual revenue over the past two years. While we have faced discrete churn events this year, like the large client bankruptcy and the recent notice of termination, I share these examples of larger strategic moves to bring additional context and clarity to the more prominent pieces underlying our revenue trend. And even with sales activity that has been strong and accelerating, the difference in timing between ramping new business and the impact from these strategic shifts still nets to a revenue headwind in the interim. As we look forward a few quarters and move beyond the portfolio rebalancing and the C&BI drag, the underlying map begins to turn in our favor. With a dramatically improved cost structure and an optimized global footprint, we believe the business will grow in 2018. In closing, I am proud of what the team is accomplishing but also recognize that we have more to do to prove out the top line results that matter to us and our shareholders. We have strategically and intentionally realigned the business to be successful for the long run in the midst of a dynamic market environment. We are attracting new clients and even winning back previously lost engagements and logos, and we are being responsive and delivering increased value to the great brands we support. But until these things manifest in consistent revenue growth and the achievement of our target model, this team will not be satisfied. With that, I will now turn the call over to Bob Pinkerton, our Chief Financial Officer, to share greater detail on our financial results and outlook. Bob?

[Bob Pinkerton:]

Thank you, Chris. Today, I will share our Q3 2017 financial results and review guidance for the fourth quarter and full year 2017. As a reminder, we have posted a presentation on the company website with the details of our guidance along with a GAAP to non-GAAP reconciliation of that guidance. For Q3, revenue was $58.1 million, above the high end of our guidance but a decrease of 7% from the prior year. Gross margin was 36.9%, above the high end of guidance but down 3.6% year-over-year as we invested to ramp wins we closed in the second quarter. Our operating expenses came in at $17.7 million, an improvement of 18.2%, or almost $4 million year-over-year as we saw the strategic actions we took in Q2 drive greater profitability. This improvement reflects reductions in all OpEx categories

[Operator:]

[Operator Instructions] And our first question is from the line of Patrick Walravens with JMP Securities.

[Patrick Walravens:]

Can we start by helping understand what these 2 issues are in a little more detail?

[Chris Carrington:]

Sure, Pat.

[Patrick Walravens:]

So I'm not even sure what C&BI is. What is it?

[Chris Carrington:]

Yes. No, well, these are actually things we've been talking about for three years. C&BI was the SaaS platforms that we had in 2014 that we reported in our segment reporting, it was about $33 million. And then, at the end of '15, because it was becoming a less material part of our business, we stopped the segment reporting and at the end of this year, we finished the wind down. We have responsibility of moving clients off of those old platforms on to our new platform. So that's been the C&BI SaaS business that we inherited in 2014. And then, the -- well, my first half, did I answer your question on C&BI?

[Patrick Walravens:]

No. So -- I mean, you had -- didn't you have a bunch of companies using this software?

[Chris Carrington:]

Yes. We did. And over the past few years, we've been migrating them to a new platform. We've also been restructuring those relationships where they're not paying a SaaS subscription fee. This was our multi-year move over the past few years to move away from attempting to be a SaaS company and to be a technology enabled managed services company.

[Patrick Walravens:]

Okay. But why would that -- I mean, you guys have known this was coming. I guess, what -- something changed that has caused you to lower your guidance for the year. And you're blaming it on, in part, on C&BI. What is it about C&BI that changed?

[Chris Carrington:]

No. Well, I'll let Bob answer the lowering. What I was trying to do is trying to suggest how 2018 actually can be different and we can get back to growth. And the fact that these two macro headwinds that we faced over the last three years that we've talked about in our calls, the C&BI business, ramping that down, and then also opening the offshore centers and adjusting clients and their pricing structures. So that, I'm just trying to say, those are -- the C&BI is completely behind us now. And then, the realignment of our pricing structures, we think we're mostly through that headwind. So we think '18 can be a year we return to growth.

[Bob Pinkerton:]

And Pat, this is Bob...

[Patrick Walravens:]

So to be clear, the guidance reduction is not based on C&BI?

[Chris Carrington:]

No, it's not.

[Bob Pinkerton:]

No, it's not. And I'll walk you through the guidance reduction, right? So as we look at Q4, our current view of Q4 is lower than our prior view, at least implied in the Q3 guidance we gave last quarter, due to slower ramp in one of the large Q2 deals that we signed, slower ramp to revenue, as well as a pullback of some business from a transaction that we had in the information services sector due to a sponsor change. It's really that makes up the vast majority of the change of our view of Q4 now compared to 90 days ago.

[Patrick Walravens:]

Okay. So I guess now we can move to what's going on, on the pricing side?

[Chris Carrington:]

Yes. So once again, I wanted to just summarize why we've had challenges growing over these last 3 years. We've talked about the churn and elements like that. What one of the big buckets is, is that 18 months ago, we didn't have anyone in our offshore locations of the Philippines or Bulgaria. Today, we have 600 people, which are representative of responsibilities that have migrated from onshore markets. And typically, with those moves, we have to adjust pricing to reflect benefit to our clients who allow us to move their work to those offshore locations. So that has comprised, along with aligning our price to the value we drive that aligns to that bucket. And that's, we used to talk about it in terms of churn. And what I was once again just trying to show is we believe that's mostly behind us and then changes the perspective for 2018 and beyond, why we believe we can grow.

[Patrick Walravens:]

Okay. And Bob, so you mentioned a pullback in some business from a deal in the information services sector. I mean, what does that mean?

[Bob Pinkerton:]

Right. So we have a client whose primary business is providing information services and subscription data over the Web. It's a client that we've had for a while. We still retain this client. They pulled some business back from us that resulted in a different revenue view for Q4 than we had 90 days ago. And it was done the pullback was done primarily due to a change in sponsor there. So our sponsor had moved on, and we had a new sponsor came in that wanted to pull some business back from us and bring it in-house.

[Patrick Walravens:]

The new sponsor isn't convinced of the benefit of outsourcing it to you. Is that a fair assessment?

[Bob Pinkerton:]

In that one particular sector, that's right. We do business with a client...

[Patrick Walravens:]

Okay, thank you.

[Bob Pinkerton:]

Great

[Operator:]

Thank you. [Operator Instructions] And I'm not showing any further questions in the queue, sir. I would like to turn the call back to Chris Carrington for his final remarks.

[Chris Carrington:]

Thank you, Carmen. And yes, let me just take a minute or 2 to provide some additional color because we didn't have that many questions today. I guess I would start off by saying, look, I'd be remiss to not acknowledge that 2017 has been a difficult year for our shareholders. And for that, I personally apologize. I know that actions speak louder than words, and while progress is being made in our business, until we deliver top line revenue growth, our investors and this leadership team, frankly, will not be satisfied. That said, let me just state a few things that are less obvious. First, I'd say our client relationships are far healthier today than 3 years ago. First, as measured by the solutions we deliver; second, by the cost efficiency through which we deliver those solutions; and third, by the outcomes we generate on behalf of our clients. I would elaborate and say three years ago, we were a one solution company built around renewals. Today, we offer a breadth of solutions that span our clients' and customers' journey. Those include inside sales, customer success, revenue retention sales enablement and channel management. I'm also excited about the announcement we had this quarter of the addition of two new board members, including Madhu Ranganathan and Rich Walker. Both bring 25 years of experience that are directly related to our business. As operators of their own business, present and in the past, in areas such as AI-enabled customer engagement platforms at (24)7.ai, where Madhu works today, and the digital information insight analytics company IHS Markit, where Rich Walker had been an executive for many years. I also am very pleased with our recent simplified messaging and branding that we've launched. It's being received very positively by our clients, our prospects and our employees. Simply, we help our clients grow closer to their customers. And I think the thing that strikes me today, how it's important getting close to your customers. I can't help but point to the huge success in San Francisco this week with the Salesforce Dreamforce Conference. 170,000 people are attending that conference. I asked the question, are they there to become better users of the technology possibly? But I'd suggest that they are here to learn how to grow closer to their end customers, and the conference is jam packed with sessions all about that topic. ServiceSource is at the center of providing services and solutions that efficiently and effectively accomplish this. There is really a revolution occurring as customers move from premise-based solutions to cloud subscription models, and we are in the center of that revolution. Simply, we are in a great market. And I guess I would close by saying, speaking of markets, today in the United States alone, 1.8 million people get up and go to work, performing inside sales and customer success functions. Today, that market is less than 1% outsourced and we believe the market will grow to 5% in the next three to five years. That would be 90,000 jobs, of which today, ServiceSource has 3,200 employees that I'm incredibly proud of around the world. This is a huge market, we're well positioned, and we believe we will grow. And with that, Carmen, I'd like to thank all of our listeners and to have a great day.

[Operator:]

Thank you. And ladies and gentlemen, thank you for participating, and you may all disconnect. Have a wonderful evening.