ServiceSource International, Inc.
Q1 2015 Earnings Call Transcript

Published: 7 May 2015

[Operator:]

Good day, everyone, and welcome to the ServiceSource first quarter 2015 earnings release conference call. [Operator instructions.] Eric Bylin from investor relations will be opening today's call. Eric, please go ahead.

[Eric 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 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 discussed. Please refer to the documents that 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. Please note that we reference non-GAAP revenue, which excludes the impact of the haircut to deferred revenue from our acquisition of Scout, as required by purchase accounting. The remainder of our non-GAAP metrics do not include noncash expenses related to stock-based compensation, the amortization of internally developed software, amortization of intangibles acquired from the acquisition of Scout, acquisition-related costs, and noncash interest expense related to the issuance of convertible notes. 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.

[Christopher Carrington:]

Thank you, Eric. Good afternoon, and thank you for joining the ServiceSource Q1 fiscal 2015 earnings call. I am joined on the call by Bob Pinkerton, our new chief financial officer, and Simon Biddiscombe. Today, I’ll provide you a brief summary of our Q1 2015 financial results, share some updates on the business, and then turn the call over to Bob, who will cover our financials in more detail. We will then open the line for Q&A. I’m pleased to share that ServiceSource exceeded our financial expectations across all key metrics in Q1. Our revenue came in at $66.3 million, above the high end of our guidance, which led to outperformance of EBITDA and earnings per share. Our managed services teams drove higher than expected renewals across the majority of our customers, resulting in increased revenues and gross margins for ServiceSource. Additionally, we were more effective at managing our people and expenses in the quarter, driving lower than expected operating expenses. On the customer front, we are seeing strong indicators of success from our renewed focus on customer-centricity. For example, our largest customer, VMware, recently renewed and extended its contract through the end of 2017. In addition, our customer churn returned to historical norms, coming in at 11% annualized in Q1. As I discussed in our last earnings call, ServiceSource is in the midst of a turnaround, and we are making solid progress on key initiatives that I will update you on momentarily. The first step is putting the right long term team in place, and I am pleased with the progress to date. In the past month, we have announced the addition of three new executive vice presidents. Bob Pinkerton has joined as our new, permanent chief financial officer; Greg Hopkins was announced as our new chief customer officer; and I introduced a new executive role to the company, naming Joe Kovach as chief transformation officer. Bob, Greg, and Joe are proven leaders in the services and technology space and are very experienced in turnarounds. I’m delighted to add them to the team and feel their decision to join ServiceSource at this juncture is further validation of the opportunity ahead of us. In driving the turnaround of our business, we have spoken about five key initiatives we are focused on improving. I will now speak to each of the five. Number one, growing new sales ACV across both business units. Q1 was active once again for new ACV sales and expansions of existing relationships. In the quarter, we signed 17 contracts, including eight managed services, eight in cloud and business intelligence, and one that spanned both. This total represents two new logos and 15 expansions. When I joined in December, my desire was to have a single executive who would be responsible for not only sales and marketing but also our entire customer lifecycle from initial prospect through to customer for life. To fit this framework, Greg Hopkins has joined the company to serve as chief customer officer. Greg has over 25 years of leading both installed base relationships and new logo sales across large, global companies. I am confident that in the coming quarters, he will drive new relationships for ServiceSource as well as expand existing relationships. As we announced, Ashley Johnson will transition this role to Greg and provide assistance through the end of Q2. I would like to thank Ashley for her four and a half years of service and most importantly, bringing the company’s focus back onto our customers. We wish Ashley the best in her pursuit of new accomplishments in the next stage of her career. Initiative number two is focused on improving our execution in managed services to reduce our cost to serve and increase our gross margin. This quarter, we piloted the redesign of two different business processes and the evaluation of several technologies that will further automate our selling environment. These pilots proved to us that we can and will drive significant efficiencies within our managed services business. Our new chief transformation officer, Joe Kovach, will increase our focus on execution against these plans to lower the cost to serve. Our investments in this transformation will accelerate through the remainder of the year and we will continue to [audio drops out]… gross margin as investments increase and cost savings are generated. However, I remain confident that we will see a sustainable, positive impact to the business in 2016 and beyond, both in terms of our performance for our customers and our cost to serve. Initiative number three is our continued investment in our cloud solutions. We see our technology and analytics as an integral differentiator for ServiceSource. We have positive traction with our new CSM app, including securing multiple wins, and we are on track to deliver two more new apps in 2015 to help customers manage and improve direct and channel renewals. As a point of interest, we are using our own customer success app within our own account management teams to drive insights and drive actions for managing our customer relationships. We have continued to build new functionality within our enterprise Renew platform as we invest to support installations with several key customers. In short, we continue our progress in this period of transition for cloud and business intelligence. Initiative number four is aligning the operating expenses of the business model more closely with our revenues. We have made solid progress each quarter to reduce our overall cost structure and that has resulted in operating expenses 20% below where they were a year ago. We will continue to take a hard look at our operating expenses related to noncustomer facing activities and we believe we can continue to make progress in reducing our overall SG&A and enhance our operations to demonstrate leverage in our overall business model. And initiative number five, customer-centricity, remains core to our turnaround. We have made substantial progress transforming ServiceSource into a more customer centric organization. On a weekly basis, the entire leadership team, including myself, reviews the key customer health metrics using our own Customer Success application. This process represents a new level of discipline and a commitment by the executive leadership team to engage our employees to focus on customer relationships and the results we drive on their behalf. Our reconstituted account management teams drive the conversations that allow us to quickly implement appropriate changes to improve in-quarter customer satisfaction across a number of KPIs. The result has been significant improvements across our customer relationships in 2015, as evidenced by our rapidly improving churn rate and strong expansion activity in Q1. Our commitment to the chief customer officer role will further drive the cultural transformation required to maintain our leadership position in the recurring revenue management industry. This is yet another reason why I’m so excited that Greg Hopkins elected to join the ServiceSource team. And with that, I’ll turn it over to Bob.

[Bob Pinkerton:]

Thank you, Chris. Today we’ll share our Q1 2015 financial results, give some color on the drivers of our business, and provide guidance for the second quarter of 2015. 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. In Q1, we delivered better than expected results across our key metrics, including revenue, gross margin, operating expenses, and profitability. This was mainly driven by strong performance in managed services across the majority of our customers. We also continued to benefit from the cost reductions from prior quarters, along with cost management activities that were ongoing throughout the quarter. Importantly, we returned to historic levels of churn, which came in at 11% annualized in Q1, a considerable improvement from the last two quarters. This improvement was due principally to progress we continue to make in our customer-centric approach to the business. This result bodes well for our efforts to stabilize the business, and we continue to believe that, from a churn perspective, the worst is behind us. Now turning to the results, our non-GAAP revenue was $66.3 million, a decrease of 1.4% from the prior year. Non-GAAP gross margin was 34.1%, up 2.1 percentage points year over year. I’ll now turn to our business segment view, starting with managed services. Q1 revenue from managed services was $58 million, down 0.9% year over year, but above our guidance due to strong production by the selling teams, including overperformance on several accounts that wound down during the quarter. Non-GAAP gross margin for managed services was 29.2%, down 1.9 percentage points from a year ago due to lower revenue and increased spend on investments. In cloud and business intelligence, we have chosen to combine our reporting for subscription and professional services and not break out revenue and cost detail for each. We believe this presentation better reflects the underlying operations of the business. For cloud and business intelligence, Q1 non-GAAP revenue was $8.3 million, down $400,000 from last year. Non-GAAP gross margin for cloud and business intelligence was 67.9%, up 30 percentage points from a year ago as a result of lower professional services costs combined with lower infrastructure costs. Moving on to profitability, our non-GAAP operating costs were below expectations for the quarter at $23.9 million, down $6.1 million from last year due to cost control actions in the back half of 2014. Operating expenses were down across the board through the reduction of sales and marketing and R&D headcount. As a result, adjusted EBITDA for the first quarter was positive $739,000, significantly better than our guidance of a loss of $4 million to $7 million. Our non-GAAP net loss in the first quarter was $729,000 or a loss of $0.01 per share, better than the $0.07 loss a year ago. Now turning to a brief review of the balance sheet and cash flow metrics. DSOs in Q1 were 88 days, up from 85 days in the prior quarter. Cash flow from operations was negative $3.7 million. Capex was $2.7 million, which included $1.5 million in capitalized development resulting in free cash flow of negative $5.3 million after adjusting for foreign exchange. We subsequently ended the quarter with $211.1 million of cash, equivalents, and investments. Turning now to guidance for the second quarter of 2015, on our last earnings call, we communicated that we expected Q2 revenues to decline from Q1, driven primarily by one customer which terminated a subscription to our legacy platform in cloud and business intelligence and reduced the scope of its managed services engagement. Consistent with this, we expect consolidated revenue for Q2 in the range of $56 million to $60 million on a non-GAAP basis. We expect consolidated non-GAAP gross margins in the range of 21% to 24% in the second quarter, down from 30% in the year ago quarter, driven by lower revenues and incremental technology investments we are making, in particular with our large customers, and the reduced cloud intelligence revenue. We are forecasting non-GAAP operating expenses in Q2 of approximately $25 million. As we have mentioned, the total cost of our revenue and operating expenses are expected to come in around the $70 million quarterly run rate we talked about last quarter. As a result, in Q2, we expect an adjusted EBITDA loss in the range of $8 million to $11 million and a non-GAAP loss in the range of $6.5 million to $8 million, or a loss of $0.08 to $0.09 per share. We assume a basic share count of 86 million shares and a normalized tax rate of 40%. In our business segments, we expect managed services revenue of $51.5 million to $55 million, reflecting a decrease of 6% to 12% year over year and a non-GAAP gross margin of 22% to 24%. For cloud and business intelligence, we expect revenue of $4.5 million to $5 million, down 35% to 42% year on year, with non-GAAP gross margin of approximately 15% to 24%. We do not expect cloud and business intelligence revenue to grow materially through the rest of 2015 off the Q2 level. We are expecting free cash flow to come in at negative $5 million to $8 million. And with that, I’ll hand it back to Chris.

[Christopher Carrington:]

Thank you, Bob, and welcome to the team. Since our last call, I’ve spent considerably more time with our employees and customers. I see the great work being done by our existing teams and the additions to the leadership team will only accelerate the transformation we have begun. ServiceSource is the clear and undisputed leader in recurring revenue management, a rapidly growing market opportunity. I am increasingly confident we can produce the meaningful change necessary to return to growth and profitability. We are seeing strong indicators that our continued focus on customer-centricity is making a difference with customers, including a considerable decrease in customer churn in Q1. ServiceSource continued signing new logos and expanded our relationships with existing customers. I am confident the new additions to the team will only strengthen the momentum we are building. I am excited about the opportunities ahead of us as we continue to improve the performance of the business and invest in our people, processes, and technologies to drive success for our customers and ultimately drive long term shareholder value. And with that, we will open the line for questions.

[Operator:]

[Operator instructions.] Our first question comes from the line of Jennifer Lowe of Morgan Stanley.

[Jennifer Lowe:]

My first question, if I can drill into the guidance a little bit and specifically for the guidance that Q3/Q4 won’t grow much from Q2. And I’m assuming that’s quarter over quarter. I’m trying to reconcile that with it sounds like certainly more upbeat commentary around churn returning to more normal levels. And it sounds like Q1 deal signings was back to a healthier level as well. So can you just sort of speak through the moving parts there? Is there more revenue that rolls off in Q3 and Q4 that you need to refill the bucket on? Or is it going to take longer to see some of the improvements in the new signings, roll into revenue. Is it conservatism? Could you just provide a little more context there?

[Christopher Carrington:]

I think just a slight clarification and then I’ll turn it over to Bob. But I think there’s an interpretation there of flattening revenues across the rest of the year, across our business. And the reality, just to clarify, we were really referring to our cloud and business intelligence segment. That’s where we provide the insight of flat revenues across the rest of the year.

[Bob Pinkerton:]

So with that comment from Chris, we’re still committed to cloud and business intelligence, but as we look at where we are from a funnel perspective, etc., we believe that C&BI will continue to be flat for the rest of the year. With all that said, we believe it’s a critical differentiator for us as it relates to the entire business. It’s vital for our large clients, and it’s important for us to make those investments in that technology platform. I think you can recognize from our bringing on Greg Hopkins that that particular business has not had an experienced sales leader for the last nine months or so. We believe that C&BI, that 2015’s going to be a transitional year.

[Jennifer Lowe:]

And maybe just finishing up that last point, you noted that you made three senior hires in the last month, which is certainly pretty busy. But at this point, are all the key senior business leaders in place, and now it’s just getting them out there and executing? Or are there any more key hires that still need to be made?

[Christopher Carrington:]

Yeah, really excited to have added Bob and Greg and Joe to the team. As I committed to the Street back during earnings call in February, I was taking 100 days to really circle the globe, meet all of our employees, meet our customers, and truly get a sense and understanding for what additional talent I thought could be utilized here at ServiceSource. So this past month saw the execution of that plan and bringing on three seasoned executives who have a lot of experience in the technology and services area, as well as within turnarounds. I think as to the question am I done adding executives, we do have one open search that is out there. It’s publicly disclosed. And that is an ongoing search for a chief human resource officer. And so I’ll just clarify to that point. Certainly I think any CEO’s role, as one of the most important things to be doing, is evaluating talent outside the company and as we grow as a company, looking to attract that talent into the company. But CHR officer position is the one that’s open today.

[Operator:]

Our next question comes from Ed Maguire with CLSA.

[Ed Maguire:]

I would just be interested in a bit of color on some of the new bookings that you discussed. It sounds like it’s one of the most healthy bookings quarters in quite some time. Was there anything notable about either the verticals or the types of customers that you were able to book?

[Christopher Carrington:]

Really this represents the second quarter in a row now where we, I think, have had healthy new bookings, signings in both our manned services business as well as cloud and business intelligence. And I think it represents really how our message is coming together as a company of having, once again, two competencies, but one company in the market, one single voice. And I think that clarity is providing both existing customers and new prospective customers the insight they need to make a decision about partnering with ServiceSource for the long term. I think one other point to make is the reality, what I was most excited about within this past quarter, is really the number of expansions as I mentioned in my earnings comments. We had 15 expansions in addition to the two new logos. But the expansions really start to represent the beginning of the results of the customer-centricity that we launched now about four months ago. And I think it reflects the ongoing confidence of our current customers to see a turnaround in process and to want to be a part of that and continue to partner with ServiceSource. So really excited about that, and then I think that exclamation mark is certainly we look forward to continuing this trend of strong new ACV now that Greg Hopkins is on board. And although just a couple of weeks, he’s making a big difference already, and I look forward to seeing his contribution and the contribution of the rest of the team going forward.

[Ed Maguire:]

And just a follow up, just contrasting the managed services outlook with the cloud and BI business. Managed services seem to be the area of the business that’s struggling, but it seems like you’re having the most success in turning things around there. What do you see as the market landscape competitively for managed services? And has there been a change in how your customers are viewing the managed services offering from you? And ultimately, how you’re prioritizing that against the cloud and BI, because it sounds like that’s a lesser priority for you guys at this point.

[Christopher Carrington:]

I guess let me start with the second part first, and just clarify that cloud and business intelligence is not a lesser priority for us whatsoever. Cloud and business intelligence - Bob even mentioned this in his comments - continues to be a critical differentiator for us in two aspects. First, in the aspect that we’re now starting to, I’d say, utilize more of our own technology more and more across the enterprise. And it truly makes a difference for our own employees as well as for the service capability we can provide to our clients. And then second, it continues to be a business within our business that we have optimism on, in believing that it will continue to grow. 2015 is clearly the transition year we talked about last quarter and this quarter as we introduced the concept of lightweight apps on top of a Salesforce One compliant ecosystem, as well as continuing to invest in our large enterprise software Renew system. So I just want to clarify that comment, that it’s a less focus for us, because it’s not. As to the first part of your question, as to managed services, although it seemed to be the problem, I think it was, once again, as we talked last quarter, maybe seemed to be the result of a lack of focus and investment over a previous year, year and a half. And I think we’ve started to rebalance that investment and focus from the leadership team, and I think we’re seeing early results and gains upon that. I would also suggest to you, while we actually released it earlier this week in a press release, we had really pulled together our messaging coming out of Q4 and Q1 around the concept of revenue lifecycle management. And this is a concept and a science that’s really evolving that is capturing the attention of a lot of our current customers and future prospects. And you know, just in short, revenue lifecycle management, RLM, that’s not a product, that’s not a technology, or it’s not just an outcome. But revenue lifecycle management is really a methodology to analyze a company’s revenue lifecycle across its initial sale, onboarding, adoption, upsell, cross sell, retention, renewals. And this is becoming increasingly important as more and more technology companies move from on-prem solutions to cloud-based subscription solutions and they realize the economics of customer relationships can no longer be captured at point of sale, but are captured across the lifecycle of a customer relationship. And so ServiceSource is becoming ever so more important because now, instead of just touching a client once a year, we’re being asked to support their client relationships across the entire year. And I think that represents a big growth opportunity for us going forward.

[Operator:]

[Operator instructions.] As there appear to be no further questions in queue at this time, I’d like to turn the call back over to Chris Carrington for any closing remarks.

[Christopher Carrington:]

Thank you. I just want to thank everyone for their questions today and participating today. We’re excited about Q1 results and we look forward to updating you on the progress in the coming 90 days. Thanks, everyone.