ServiceSource International, Inc.
Q1 2016 Earnings Call Transcript

Published: 10 May 2016

[Operator:]

Good day everyone and welcome to the ServiceSource First Quarter 2016 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 today. Before we begin, I'd like to remind you that during the course of this webcast and call we may make projections or forward-looking statements that 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. We caution you that such statements are just projections and actual events and results may materially differ from what we discuss. Pleased to 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, each income statement metric discussed will be non-GAAP. For all these non-GAPP measures, we direct your attention to a reconciliation between 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:]

Thanks Eric. Good afternoon and thank you for joining the ServiceSource Q1 FY 2016 earnings call. I'm joined on the call by Bob Pinkerton, our Chief Financial Officer. Today, I will provide you a brief summary of our Q1 2016 financial results, share some updates on the business and the results we delivered for our customers, and then turn the call over to Bob who will cover our financials in more detail. We will then open the call for Q&A. The first quarter of 2016 provided a solid start to the year as our results were better than guidance across revenue, gross margin, operating expenses, and EBITDA. Q1 represents our fifth consecutive quarter of increasing gross margins year-over-year and continued cost controls in our operating expenses contributed to positive EBITDA for the quarter. For Q1 2016, revenues were $59.8 million, gross margin was 34.5%, and EBITDA was positive $250,000. Continuing the momentum from 2015, we closed 15 new transactions in Q1 across four of our five targeted verticals and held churn to the low end of industry norms. The transactions in Q1 reflect the trust we have established with our clients. Our deals were larger and closed faster than they did in Q1 2015. Combining larger deals with low churn, we achieved our largest quarterly positive increase in ACV since Q2 of 2014. I’d look back over the past years customer centricity initiative and clearly see the difference in the health of our customer base. As I mentioned last quarter, we have less than 10% of the recurring revenue opportunity amongst our current clients and are keenly focused on penetrating the 90% that remains in-house. This quarter’s sales results reflect the success of our progress against our goal to grow to 20% of our existing clients’ recurring revenue. Given the strong start to the year, we remain confident in our full year guidance of increasing revenue, expanding gross margins, improved EBITDA, and 10% ACV growth. Before I turn the call over to Bob, I would like to take a couple of minutes and provide some additional insight as to why our efforts and outcomes are so important in the eyes of our clients. Our revenue as a service platform is the essence of a customer success solution. It maximizes customer lifetime economics by supporting the relationship our clients have with their customers including both channel partners and direct end customers. By combining our highly trained sales professionals with time proven processes and powered by a combination of proprietary and third-party software, we delivered revenue to our clients last year that totaled $8.4 billion. And while our sweet spot is the B2B midmarket for transactions from $1000 and $1 million, our recent investments and capabilities have allowed ServiceSource to increasingly go up market into more strategic enterprise accounts and down market into small businesses to more efficiently chase the tail and pursue smaller deals profitably. I'd like to share four quick recent examples of the significant results we drive for our clients. The first two show how our teams can grow opportunities when we move upmarket into strategic relationships and the second two are examples of how chasing the tail more efficiently leads to greater customer success for our clients. As a part of a recent land and expand campaign for a SaaS client, two of our North American customer success managers or CSMs started with a pilot that produced a $7,000 monthly revenue stream and turned it into a multi-year contract worth $4.3 million to our client. In the process, our CSM's work closely with the client to deliver on all the end customers’ needs, from technical troubleshooting to countless quotations. Managing weekly calls throughout the one-year pilot, our CSM deployed a full suite of our own services, including enablement, adoption, upsell, and cross sell to execute a three-year deal, which was one of the biggest upsells the client had in its fiscal year. Not to be outdone, a team of ServiceSource customer success managers engaged on a multimillion dollar renewal opportunity for a large hardware client and turned it into a $34 million transaction. Upon first investigating the assets, our CSM's quickly realized that there was a far greater potential to this complex transaction. The team spent several months significantly growing the renewal opportunity by understanding usage patterns and digging through the despaired data files to view original orders sold years ago across multiple geographies, all the while staying tightly engaged with the client. Through court adjustments, re-pricings, and the creation of new service plans to address the needs of the end customer, our team secured this mammoth opportunity by consolidating almost 120,000 assets across three continents. This transaction literally helped our client meet their quarterly target and create a prominent exposure for ServiceSource within the client. On the other end of the spectrum, we have seen some very small opportunities turning to significant wins. As you know, we recently opened the Philippines Revenue Delivery Center and have immediately rolled out the latest generation of our revenue as a service platform. In doing so, we can more efficiently go after the tail and we have had some fantastic early successes. I will share two of those with you now. Last month, one of our customer success managers in the Philippines was working on a large SaaS client and identified a potential renewal for a license that was about to expire. The initial opportunity totaled $65, but our CSM was able to grow this into a $22,782 contract. Prior to opening in the Philippines and deploying new technologies, a $65 opportunity would be below the threshold of what we could pursue. However, this savvy CSM leveraging our technology platform quickly examined hundreds of unrelated records and consolidated several soon to be expired licenses across a large enterprise into an annual renewal that was far greater than originally envisioned. In yet another great example utilizing our platform, a customer success manager in the Philippines examined an account of a prominent SaaS client and identified a number of expired licenses. Each individually small from a customer, our client had considered lost. Technically, this opportunity, expired licenses is worth zero dollars to us and to the client, but our CSM, through diligent research, proven methodologies, in depth salesmanship was able turn these licenses into a $50,675 deal. In this example, our CSM built a proposal and worked with the end customer to overcome resistance to more than $9,000 in reinstatement fees on his way to closing this deal. Needless to say, the client was thrilled to receive the revenue, but also appreciated the return of a lost customer. The conclusion of these four examples and the millions of other transactions worked on in the past year alone is that our clients are truly able to tie recurring revenue, including renewals, subscriptions, upsell, cross-sell results, directly to the relationship they have with ServiceSource. As we strengthen our delivery engine with continued investments in our revenue as a service platform, namely billing our new revenue delivery centers, deploying enhanced technologies, and investing in more innovative training for our customer success managers, our ability to outperform our client’s expectations will only grow. Because of this, we remain confident we are only scratching the surface of the revenue management industry and we have a long path in front of us from which to grow. In closing, we are delivering outcomes on behalf of our clients, while increasing employee productivity and controlling the cost to do so. Additionally, we are making the investments in the way we operate to strengthen our value proposition and drive operational excellence. By working closely with our clients, we are building deeper relationships and opening up opportunities to expand the business they entrust to us. I remain confident ServiceSource is on track to achieve our full year guidance of topline revenue growth, increasing gross margins, improved EBITDA, and 10% ACV growth. And with that, I will now turn the call over to Bob Pinkerton, our Chief Financial Officer. Bob?

[Bob Pinkerton:]

Thank you, Chris. Today I will share our Q1 2016 financial results, give some color on the drivers of our business, and provide guidance for the second quarter of 2016. 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. During my comments today, any income state results or projections I refer to will be non-GAAP. In Q1, our revenue came in above the high-end of guidance and we were able to control our cost of revenue and operating expenses, which led to better-than-expected profitability. Also as Chris mentioned, churn came in towards the lower end of the industry norms. I’m pleased to see our teams continue to outperform our expectations in delivering revenue for clients, controlling spend, and executing on initiatives that deliver distinct ROI for the business. Now turning to results. A bit better than expectations our revenue was $59.8 million, a decrease of 10% from the prior year. Gross margin was 34.5%, up 40 basis points year-over-year. Our operating expenses came in below guidance for the quarter at $22 million, down 7.8% or $1.9 million year-over-year, due principally to continued discipline around controlling spend. Adjusted EBITDA for the first quarter was $250,000 below the $740,000 from the prior year, but better than our guidance of a loss of $1.5 million to $4.5 million. Our net loss in the first quarter was $500,000 or a loss of $0.01 per share. Now turning to a brief review of the balance sheet and cash flow metrics. DSOs in Q1 were 83 days, up from 78 days in the fourth quarter of 2015. Cash flow provided by operations was $1.7 million. CapEx was $5.3 million, which included $3 million in capitalized development resulting in negative free-cash flow $4.5 million after adjusting for foreign-exchange. With respect to our stock buyback program, in Q1, we repurchased 1.8 million shares for a total spend of $7.2 million not including commissions equating to an average price of $3.94 per share. Our share repurchase program accelerated buying activity in Q1 as a decline in our stock price drove accelerated purchases. We subsequently ended the quarter with $198.3 million of cash, equivalents and investments down $10.4 million from Q4. Turning now to guidance for the second quarter of 2016, we expect revenue for Q2 in the range of $58.5 million to $61.5 million. We expect gross margins in the range of 32.5% to 35.5% in the second quarter, compared to 33.9% in the year ago quarter. We are forecasting operating expenses in Q2 of approximately $24 million, a sequential increase of around $2 million, due principally to increased spend on technology and infrastructure investments that include employ related cost and spend in our new centers. As result, in Q2, we expect an adjusted EBITDA loss of between $500,000 to $3.5 million and a net loss in the range of $1 million to $3 million or a loss of $0.01 to $0.03 per share. We assume a basic share count of 86.5 million shares and a normalized tax rate of 40%. We are expecting free cash flow to come in at negative $6 million to negative $9 million for Q2. And with that let’s open up for questions.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from Ed Maguire from CLSA. Your line is open.

[Ed Maguire:]

Hi good afternoon everyone. It's good to see some progress in yield and performance. Could you elaborate a bit more on what some of the investments in 2Q were going to be comprised of?

[Chris Carrington:]

Yeah, I think I will start Ed, and Bob and then you can pick up. Ed good to hear you and thanks for joining the call. Many investments in Q2 will be a continuation from Q1, which primarily included system migrations from the multiple platforms we’ve had in the past to our latest revenues and service RLM platform. That's one of the investments. Second one is, we’ve been consolidating multiple data warehouses into a single data warehouse, which will enable us to give better business insights and analytics to our customers. And then the third one is, we’re adding more automation to our revenue delivery centers allowing us to continue to drive greater productivity and improved training.

[Bob Pinkerton:]

Yes, thanks Chris. I would say again as Chris highlighted there Ed, from our backgrounds you know getting the training and recruiting machines, humming is a real critical way for us to get, you know, knowledge transfer, standardize processes across the organization, and continue to improve margins. Again that's a classic example of us investing to spend money now to drive margins now and in the future.

[Ed Maguire:]

Great. It seems you're having some success as well with reducing the churn, could you comment on what you see as the quality of the underlying base of your ACV contracts and whether you're seeing any shift in the dynamics among some of the larger customers in terms of either opportunities or headwinds that may advance or hinder your goal for a 10% ACV growth this year?

[Chris Carrington:]

Yeah, absolutely Ed. Great question. I think as it relates to the customer base as a whole, once again, I feel really confident that our investments, you know our customer centricity initiative from last year and continuing on this year has really stabilized our client base as a whole. It's really, the client base as a whole is much healthier this year as compared to where we were last year. I think number two, the results and outcomes we are generating for the clients are continuing to improve year-over-year. So, one of the things that’s contributing to our expansions with our clients is that we’re driving better results and better outcomes for them. So, I think that's a strength. I think as far as the shift in dynamics is this one we’ve really been, kind of you know, quietly suggesting over the past year, which is this big shift in the global marketplace from a world of perpetual licenses to one of a subscription-based economy. One where increasingly the concept of customer success is pretty critical to our clients’ future with their customers. And that's really all around this concept that originally at the point of, you know of original sale, 80% of economics of that relationship was recognized, and then ServiceSource tended to follow up on 15% to 20% in the maintenance payments. In today's world with the subscription-based economy, the reality is, very little is recognized upfront and most of the revenue is recognized over the lifetime value of that customer relationship, which could be four, five, six years and more. And because subscription renewals tend to be much shorter, maybe month-to-month, quarter-to-quarter or one year as compared to four or five years, it becomes really imperative for our clients to focus on customer success and that's really where ServiceSource shines. So more and more we’re starting to increase the number of activities we provide on behalf of our customers where we're getting involved on activation, un-boarding, adoption, we are starting to do more cross-sell/upsell plays, which generates more revenue for us as well as these other activities and of course then we feed right back into the backend of naturally extending the client relationship. So, I think these really start to act as a tailwind at our back as it relates to pushing us forward and starting to see real revenue growth.

[Bob Pinkerton:]

And Ed, I’m sorry, if I could add to this, recognize the net ACV growth that we are forecasting is a combination of closing new ACV and managing churn. We were pleased with the performance of Q1 on both fronts and we’re maintaining our view of the 10% full-year growth.

[Ed Maguire:]

Great. And this last question has to do with hires, I mean it seems you're putting some new infrastructure in to ensure that you manage and train people. Could you comment, at least, on the current mix of your workforce whether you – where you feel you have the appropriate resources and what you may do to ensure that you have kind of the proper balance of costs and talent in different regions?

[Chris Carrington:]

Yeah great. Thanks Ed for that and for your questions today as a whole. Clearly, two of the big investments we made in the past year or specifically in the past six months was the opening of Philippines and the opening of Bulgaria, specifically Sofia, Bulgaria. In both those, it was about providing this access to new talent, new markets with available talent. So, clearly the Philippines was all about English support, where Sofia was all about multilingual EMEA support. And these really well positions us for our growth in front of us associated with the Revenue Lifecycle Management we’ve been talking about. And I think it starts to balance our workforce. Somebody had asked me last quarter were we intending to close any of our centers, and that's not the case whatsoever. In fact, we just filled up our Liverpool Center, so we’re looking for some additional growth there, and we are starting to get full in our Denver Center again. So, we’re actually growing into our footprint very nicely and I think we're really well-balanced in our footprint globally.

[Ed Maguire:]

Great. Thank you.

[Chris Carrington:]

Absolutely.

[Operator:]

Thank you. Our next question comes from Tim Klasell with Northland. Your line is open.

[Tim Klasell:]

Yeah, good afternoon guys. Just a quick question on the churn, obviously that's very important. Was there maybe an unusually low number or maybe even a higher number, maybe can speak to that, your number of contracts that were for renewal this last quarter?

[Chris Carrington:]

That's great insight Tim. Actually, I would say it was our typical average quarter as far as number of contracts that were expiring and the opportunity to either extend those or lose those. What we really experienced is the ability to extend the vast majority of those. And in some cases actually, you know grow them significantly. We had very few contracts that came to an end. So that really contributed to the low end of the churn that we experienced in this quarter.

[Tim Klasell:]

Okay great, great. You know obviously currency swings have settled down here recently, but that never holds for long. How should we think about the currency exposure on the expense side going forward, because obviously Sofia and the Philippines have currencies that aren't widely traded out there? How should we think about that?

[Chris Carrington:]

Yeah, great question Tim. We manage, you know currency, obviously we've got revenue of variety of currencies and we have expensive volume currencies. We are inherently using some natural hedging as we look at the exposure we have. As we looked at building out Sofia in particular, we spend a fair amount of energy looking at, you know, kind of our views of expense base relative to currency exposure and we were managing that. You know, we will continue to hold the currency swings, should not have any meaningful impact on our P&L or balance sheet.

[Tim Klasell:]

Okay great. Thank you that's very helpful.

[Operator:]

Thank you. Our next question comes from Patrick Walravens with JMP Securities. Your line is open.

[Matt Carletti:]

Hi, thanks for taking my question, it's actually Matt on for Pat. I wanted to just maybe get you guys's take on what you are seeing more generally in the competitive environment, have you seen any shifts lately and any broader trends you are seeing within the marketplace in general. Thank you.

[Chris Carrington:]

Yeah, I think that as I alluded to in our opening remarks, Matt, we are seeing real positive trends in our sales engine, in the fact that our transactions are getting larger. That the deals are closing quicker. I seem to recall about a year ago right after Greg Hopkins had joined, that, I suggested to everyone it takes about 12 months to 18 months to really rebuild the sales engine and effective outside sales engine. And I think Greg has really done a great job with his team. I think we’re right on track and we are really starting to see the momentum of new growth coming in. As Bob alluded to, when we say net, our net ACV increased most significantly for a number of quarters. It was not only that low churn, but it was really that contribution of a sales number that was significantly larger than Q1 in 2015. So, I think the trend I’d really say is not only our internal capability to expand revenues, but really the markets interest in the value proposition we’re taking to them, especially around the area of customer success. I think that's become a really hot topic. I was recently at an Executive Roundtable with about 30 other C-Suite Executives from the technology industry and I promise I didn't see this answer, but the question was asked to the room as to what the number one topic was on their mind. And we had been talking about everything from the upcoming political race to activist, investors, everything. And at the end of the day, the number one topic on everyone's mind was the concept of customer success around this, this shift from perpetual licensing to the subscription-based economy. So, I think it just plays right into our hand. We were clearly the recurring revenue pioneer, some 17 years ago now. And we're clearly the emerging leader in customer success of having a complete platform that encompasses people processing technologies. So, really excited about where we are and where we are headed.

[Matt Carletti:]

Perfect. Thank you very much.

[Operator:]

Thank you. I'm showing no further questions at this time. I'd like to turn the call back to Chris Carrington for closing remarks.

[Chris Carrington:]

Thank you and thanks for everyone's interest in this quarter. We're very pleased with what we accomplished. I’m very proud of the overall team of not only what we accomplished in Q1 2016, but over the last five quarters. And I think we’re right on track with where we wanted to be. I think for the investors as a whole, I'd remind everyone that we’re uniquely positioned in the marketplace. A company that has the luxury to exclusively focus on revenue generation on behalf of our clients and with that recurring revenue pioneer and emerging leader in the customer success, I think we’re unique in the marketplace. So a great investment thesis right there. We have a large total adjustable market. We talked about that a little last time. Were only 10% penetrated within our current clients, and our goal is not only to get to 20% penetration with our existing 78 clients, but also to really start growing within logos. I think we've done all the right activities as it relates to seeking the marketplace and I feel very, very confident that we'll be able to announce the logos in the second quarter. And with that, I thank everyone once again and thanks for your time and interest.

[Operator:]

Ladies and gentlemen thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.