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Q3 2019 · Earnings Call Transcript

Oct 30, 2019

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the ServiceSource Third Quarter 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, Chad Lyne, Head of Investor Relations. Please go ahead, sir.

Chad Lyne

Thank you, Michelle, and good day, everyone. Thank you for joining us, and welcome to ServiceSource’s third quarter earnings call to discuss our results for the quarter ended September 30, 2019.

As a reminder, a copy of our earnings release has been posted on the Investor Relations section of our website at www.ir.servicesource.com. On the call today is 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 and 10-Q. 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 third quarter 2019 earnings conference call. As you saw in the release and the 10-Q we filed yesterday after market close, we had a solid quarter.

Our teams performed with a high level of focus, rigor and discipline, which translated into stronger sequential results throughout the business. Relative to the second quarter of this year, we grew revenue 2% and expanded non-GAAP gross profit 240 basis points while prudent operating expense management in all areas of the company allowed us to drive positive adjusted EBITDA of $1.1 million.

We still have more work to do, but we are pleased with the commitment of our teams and the important progress that is being made. Over the past three quarters, we’ve enacted a series of strategic changes and tactical realignments in the organization to improve our execution and strengthen our brand promise to our client.

Our end-to-end engagement model and global account management investment are bearing fruit as we delivered positive outcomes for our clients this quarter and generated year-over-year growth at the majority of our largest relationship. From a go-to-market and sales standpoint, we also made good strides.

We saw encouraging progress in the sales pipeline, stronger bookings activity, up sales and expansion with several key accounts, and the signing of a $2 million new logo win for a global security software provider. Allow me to share a little more context behind the new logo wins as it offered validation of our strategy, the differentiation of our CJX solution suite and the alignment of our value proposition to a large and growing market opportunity.

As you would expect, I’ve been spending a significant amount of my time with senior executives and our clients and prospects across the C-Suite. The priorities are the same.

One, a desire to grow closer to their customers through data-driven insights; two, a need to digitally transform their B2B customer engagement model and innovate their customer experience; and three, a mandate to globally scale their go-to-market activities more efficiently and effectively. Our proven ability to address these priorities is why our top 10 clients have partnered with ServiceSource for an average of 10 years, and it’s the reason this $1 billion security company chose to align with us as the key enabler for their ongoing transformation to a software services and recurring revenue model.

They were seeking to unify customer engagement activities that were previously spread across multiple partners. We designed and deployed a fully integrated customer journey experience solution across the full ILAER continuum of identifying, land, adopt, expand and renew.

ServiceSource will now have full end-to-end accountability for their entire IoT North America book of business. It’s a great competitive win over two established incumbents and a real testament to the value and differentiation of our integrated CJX solution suite.

Shifting gears, I will now touch on the four transformation pillars behind the vision, strategy, execution and metrics framework that we have discussed with you throughout the course of the year. As a refresh, these pillars are; inspire success, which is focused on our people and culture; impact scale, which is focused on our operating model; innovate solutions, which is focused on new offerings and capabilities; and ignite sales, which is focused on value-enhancing growth.

First, on the inspire success pillar. We ended Q3 with approximately 3,400 employees globally with an average tenure of 2.7 years with the company.

We have rationalized our headcount by nearly 13% over the course of the past three quarters, but importantly, we have been able to take these thoughtful actions while maintaining our culture and continuing to invest in the teams and people we are retaining. As we have talked about in the past, we continue to see heightened competition for talent in some of our locations due to historically tight labor market, and we will continue to execute a number of initiatives to ensure we can continue to attract, engage, develop and retain a high-performance workforce.

On the impact scale front, we made further progress bringing greater standardization and consistency through our operating and engagement model. We are driving greater alignment across teams and functions, which is resulting in better performance and outcomes for our clients.

We generated year-over-year revenue growth from six of our top 10 clients in the third quarter with 2.1% cumulative trailing 12-month revenue growth across these top 10. Q3 was also our largest quarter from a contract renewal standpoint, and we continue to perform well relative to our internal churn expectation.

On a year-to-date basis, we renewed or extended more than 75% of the value that was up for renewal, and we were able to improve client health and renewed several engagements that were facing discrete challenges in previous quarters. Turning to the innovate solutions pillar, our IT and engineering teams continue to make progress on our digital transformation road map and the refactoring of our tech stack.

Year-to-date, these efforts have enabled us to reduce our non-GAAP R&D expense by more than 20%, but as we have previously discussed, the true benefit of the company won’t be realized until next year when we expect enhanced automation and digitization to improve various cost levers and unit economic metrics in the business. In this pillar, we are also focused on bringing to market new digital solutions that naturally expand our suite of capabilities and enhance our client value proposition.

In September, we announced the launch of a new digital commerce capability that offers clients a unique single source solution for both automated and human-assisted transactions. This allows us to unlock additional revenue opportunity in customer segments we historically haven’t served while also enabling us to more profitably transact higher volume, lower value, long tail commerce for our clients.

Finally, on the ignite sales pillar. We have room to go to improve our velocity but we are pleased with the turnaround progress we have made since Q2.

As a result of the decisive correction of action we took as part of our go-to-market organizational realignment in the third quarter, we had a marked improvement in our win rates and a 60%-plus quarter-over-quarter increase in bookings, including the new logo wins I spoke to previously. So in summary, in Q3, we were able to make important headway on our strategic initiatives and delivered well against our expectations.

While we are encouraged by a quarter of demonstratable execution, our teams are 100% focused on driving the further improvements that are required to build and enhance value for our stakeholders. With that, let me turn the call over to Rich Walker, our CFO, to review our financial results.

Rich?

Rich Walker

Thank you, Gary, and good morning, everyone. We are pleased by the results we delivered in the third quarter and the disciplined execution and operational rigor that allowed us to exceed our expectations, but I will reiterate Gary’s remarks that we remain keenly focused on the longer-term journey in front of us.

For today’s call, I’ll be reviewing our third quarter results and comparing to both third quarter of 2018 for a year-over-year view as well as to the second quarter of 2019 for a sequential view of the progress we are making. At the top line, revenue was $53.4 million, down $3.8 million or 6.6% compared to the same period in 2018.

Approximately $3.5 million of the negative variance was from three logos that were in the third quarter of 2018 that had zero contribution to this year’s third quarter. On a sequential basis, revenue was up $1 million or 2% driven by strong performance at our top 10 clients, including ongoing expansion with the cloud client that we announced earlier this year.

By region, NALA revenue for the third quarter of 2019 was $32.2 million or 6.2% of total revenue compared to $34.3 million in the prior year period. Sequentially, NALA revenue was up from $29.6 million in the second quarter of 2019.

EMEA revenue for the third quarter of 2019 was $12.9 million or 24.2% of total revenue compared to $13.8 million in the prior year period and $18.4 million in the second quarter of 2019. APJ revenue was $8.3 million or 15.6% of total revenue compared to $9.1 million in the prior year period and $9.4 million in the second quarter of 2019.

Turning to expenses and margin, our non-GAAP cost of revenue in the third quarter was $36.7 million, down $1.7 million or 4.4% year-over-year and down $600,000 sequentially as we maintain the disciplined approach to improving all areas of our cost structure. Non-GAAP gross profit in the third quarter was $16.7 million or 31.3% of revenue, a decrease of $2.1 million and 160 basis points year-over-year.

On a sequential basis, non-GAAP gross profit was up $1.6 million, and margins were up 240 basis points compared to the second quarter of 2019. Non-GAAP operating expenses in the third quarter were $17.3 million or 32.4% of revenue, down $500,000 or 2.6% year-over-year and down $700,000 or 3.8% sequentially.

The combination of tight spend management across cost of revenue and operating expenses resulted in adjusted EBITDA in the third quarter of $1.1 million. Year-over-year, adjusted EBITDA was down $2 million while sequentially, we had a $1.6 million improvement from the second quarter of 2019.

We maintained a strong debt-free balance sheet in the third quarter with cash, cash equivalents and restricted cash of $25.4 million. We had $43.8 million of net accounts receivable and DSOs were 74 days, down three days year-over-year.

Cash flow generated by operations in the third quarter was $500,000, and CapEx was $3.1 million, including $1.2 million of capitalized internally developed software costs, resulting in negative free cash flow of $2.6 million. However, excluding the impact of a onetime legal settlement related to a four-year-old lawsuit, free cash flow was positive $600,000.

In closing, given our performance year-to-date, current conditions in the markets we serve and ongoing actions to optimize our portfolio, we affirm the full year financial outlook we provided on August 7, 2019. On the top line, we are continuing to take a measured and methodical approach to renegotiate or unwind engagements that are not aligned to our longer-term priorities.

And on the expense side, our leaders are executing with an ROI-first mind- set. We continue to serve as good stewards of our capital, reducing or eliminating lower return spend to free up internal investment capacity for higher return opportunities.

As we demonstrated in the third quarter, we are holding ourselves accountable to enhance performance and execution over a near-term horizon. At the same time, we continue to organize and operate with an unwavering focus on our multiyear objectives, which we believe will allow for the compounding of shareholder value over time.

With that, Michelle, please open the call to questions.

Operator

[Operator Instructions] Our first question comes from the line of Zach Cummins with B. Riley FBR.

Your line is open. Please go ahead.

Zach Cummins

Hi, Good morning, Gary and Rich.

Gary Moore

Hi, Zach.

Rich Walker

Hi, Zach.

Zach Cummins

Good. How are you?

Just starting off, Gary, with the bookings performance. It seems like it was really a nice sequential pick up from – especially from Q2.

So can you talk a little bit more about some of the changes, especially in the leadership and kind of your go-to-market approach that helped drive that better performance here?

Gary Moore

Yes. I think you will remember, I was not very pleased with where we were going in Q4.

Q1 showed a little bit of rebound. Q2 was a disappointment.

We make changes at the very top of the company relative to sales. We promoted two excellent sales leaders.

We divided them between going after new logos, new accounts, hunting, if you will. And then we took the global account managers, and that team then rolled in the other sales leader to focus on our accounts.

Those moves alone are showing tremendous, tremendous results in terms of a relationship. We stepped up our activity relative to our executive sponsors.

They are much more engaged with a process and methodology today. So I just feel we’re executing as a team.

It’s not sales and then delivery. It’s an integrated go-to-market sales and delivery, working very closely together.

We moved sales responsibility under Denzil Samuels, I mentioned that last quarter. Denzil also has marketing alliances and the channels, if you will.

So we have a lot more to go relative to the things that we’re doing, but I’m very pleased with the progress we made, especially that new logo in the quarter.

Zach Cummins

Got it. That’s helpful.

And then Rich, after a really strong Q3 or pretty solid Q3 results here, I was just curious in terms of maintaining the full year guidance. I mean can you talk about a little bit of the rationale behind that?

I think if you’re maintaining the full year guidance, it’s essentially implying that 4Q revenue is going to decline now on a sequential basis, and then there’s going to be an adjusted EBITDA loss in Q4 if 4Q guidance is the implication.

Rich Walker

Yes. Obviously, Zach, our objective is to meet or exceed our expectations and our guidance.

We always take a measured and balanced view of where we are in market, where our clients, where our customer opportunities are. We don’t give quarterly guidance.

We look at the full year. We continue to balance with scales of where we make investments and where we continue to execute.

We’re going to continue to do all of that through the balance of the year. So leaving guidance where it was, we thought is an accurate reflection of where the market is and where we’re focused.

Zach Cummins

Got it. That’s helpful.

And then, Gary, can you talk about the renewal performance in Q3? It seems like 75% of the business was renewed year-to-date.

I think there was a little bit of a sequential tick down from what you did in the first half of the year. So could you just talk about how that performed versus your expectations?

And maybe what were some of the factors that could have driven that number a little bit lower from first half to – now to – here to Q3?

Gary Moore

Yes. Zach, I – first off, it’s not – the number is not a surprise.

It was in line with what we were expecting for Q3. And the numbers – the 75% is not reflective of churn.

It only reflects what was up for renewal in the quarter and what we did against that. And we still have some pending that could improve that number.

So I think again, no surprise. I feel very good about how we’re engaging with the clients well ahead of time.

And I think as we continue to work and make progress, you’ll see that what we’re able to do in Q1, Q2 and where – I believe we’ll end up relative to Q3 in terms of churn. Again, it’s only 45% of our revenue for the whole year that’s up for renewal, so we’re not losing a ton of business there.

And so I feel very good. I don’t know how much more to add to that, Zach.

Hopefully, that gives you a clear picture. But the key point is it’s not churn.

It’s not reflective of the churn in the quarter.

Zach Cummins

Got it. That’s helpful.

And then I think you mentioned in your commentary that a majority of the renewal work was out of the way in Q3. So can you give any sort of context of kind of what’s up ahead of you here in Q4, a little more context to how you’re feeling as you’re moving forward on those renewals here towards the end of this year?

Gary Moore

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Zach Cummins

Yes. Maybe I misunderstood a portion of the commentary.

It seemed like, at least from some of the comments, that it sounded like a majority of the renewal work that was on the slate here in the second half was happening in Q3 or has already happened in Q3. Is that kind of an accurate reflection in terms of what’s still left to be renewed here in Q4?

And how you’re feeling as you get towards those towards the end of this year?

Gary Moore

Yes. So first half of the year was a one-third of the 45%.

The second half is two-third, and Q3 was – is the biggest of all of those.

Zach Cummins

Got it. And just – yes, that’s helpful.

And just one last question for me. Rich, in terms of managing cost, it seems like you’ve done a really great job this year in terms of really being stringent with cost management here, especially in the near term.

So can you just give a little more context in how you’re thinking about this going forward and whether there are certain areas for investment versus if there’s potential areas where you could even squeeze additional costs out of this model?

Rich Walker

Yes. Very much so.

First of all, it’s really all of the key leaders in the business and even the next line leaders, Zach, that are really embracing kind of what we call an ROI-focused approach. So we’re inspecting where we’re spending money in the near-term, what we’re trying to enable longer-term, and everything starts with how we’re supporting the clients.

We went into the year with a commitment to our technology investments. We’ve made the progress we expected there.

That’s driving our dependency on third-party contractors. It’s simplifying our technology stack, providing good management reporting internally.

Proverbially, what’s measured is managed. All of our P&L leaders are doing a superb job of understanding their investments, what the return in payback is to support clients.

And it’s just good hygiene, Zach, just constantly getting into the detail, making difficult decisions, trade-offs in the near term or longer term, and the teams are executing. We’re seeing sequential cost reductions.

We haven’t even seen and won’t until we get into 2020 some of the benefits of the automation. So it’s just good blocking and tackling in some respects.

Zach Cummins

Got it. That’s helpful.

Well. Thanks again for taking my questions.

And congrats on the strong results here in Q3.

Gary Moore

Thanks, Zach. Really appreciate it.

Operator

And that does conclude today’s Q&A portion, and I would like to hand the conference over back to Mr. Gary Moore for any further remarks.

Gary Moore

Thanks, Michelle. I – again, I just want to reiterate, we’re in this for the long term, and we’re focused on a number of things.

We’re very proud of the progress we’ve made year-to-date, and we’re focused on a very strong close for Q4. And as I pointed out during the call, there’s a lot of things going on in the market that could affect that.

So I feel very good about the reaffirmation of our guide for the full year. So thank you all very much.

We appreciate your support.

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.

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