Eric Bylin - IR Christopher Carrington - CEO Bob Pinkerton - CFO.

Pat Walravens - JMP Securities Ed Maguire - CLSA Jeff Osher - Harvest Capital.

Good day, everyone, and welcome to the ServiceSource Second Quarter 2015 Earnings Results Conference Call. This call is being recorded. Eric Bylin from Investor Relations will be opening today's call. Eric, please go ahead..

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 any 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.

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 -- when 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 non-cash expenses related to stock-based compensation, the amortization of internally developed software, amortization of intangibles acquired from our acquisition of Scout, acquisition-related costs and non-cash 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 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..

Thanks, Eric. Good afternoon and thank you for joining the ServiceSource Q2 fiscal 2015 earnings call. I am joined on the call by Bob Pinkerton, our Chief Financial Officer.

Today, I’ll provide you a brief summary of our Q2 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 call for Q&A.

Q2 was a solid quarter as we exceeded guidance across all key financial metrics and we continue to make progress on our initiatives to transform the business back to growth and profitability. Our non-GAAP revenue came in at $61.7 and was above the high end of guidance for both managed services and cloud business intelligence.

While our revenue was down from last year, gross margins increased, operating expenses continue to decrease and adjusted EBITDA improved dramatically this quarter as compared to Q2 2014. The overall positive performance added $3.2 million in cash and short term investments to our balance sheet.

Additionally we continue to add best practices to our customer-centricity plan that led to the lowest churn since Q1 2013.

As announced during Q2 we added four new Executives to the Management Team starting with Bob Pinkerton, our Chief Financial Officer who joined April 6, Greg Hopkins, our Chief Customer Officer who joined April 20, Joe Kovach, our Chief Transformation Officer, who joined May 15 and Brian Delaney, our Chief Operating Officer who joined June 8.

I feel incredibly fortunate that such a seasoned group of Executives saw the potential in ServiceSource in fact did. I am enjoying Q3 as the first full quarter that the new Executive Team is working together and I am seeing the results of our collective team effort.

Now for an update regarding our five initiatives that are the foundation of our 2015 turnaround plan. Number one, growing new sales ACV across both business segments. Greg Hopkins, our Chief Customer Officer has completed the selection of his Leadership Team for marketing, sales and account management.

I believe that growing the topline is the longest pulling the tent during the turnaround with sustainable results usually taking root in 12 to 18 months. That said, I am pleased with some early indications of success related to our focus on topline growth. Early stage sales pipeline activity is up year-over-year.

We're seeing shorter sales cycles with higher win rates and lower push rates and our average deal size is increasing. For the quarter we had 15 transactions, all expansions will 11 managed services, two in cloud and business intelligence and two across both business segments.

Initiative number two is reducing cost to serve and increasing gross margin, Brian Delaney hit the ground running and completed the service source world tour visiting all of our worldwide locations in 50 days. Half the time that it took me. Way to go Brian, make me look bad.

Brian is driving a real sense of urgency into the position to improve results for our customers while achieving increased efficiency that contributes to the improvement of gross margin. Brian will continue to chip in investments in our people, process and technology.

We've already begun improving managed services gross margin as we invested in standardized processes, expanded the use of technology and increased discipline in our workforce management.

In fact, even against the headwind of our revenue decline in Q2 2015 as compared to Q2 2014 non-GAAP managed services gross margin improved by three percentage points to 32.1% year-over-year.

Initiative number three is continued investment in our cloud solutions, investments in our technology continue to pay off as we saw increased adoption and renewed demand in Q2. This increased adoption also drove ProServ revenues higher, which contributed to the cloud and business intelligence segment exceeding expectations during the quarter.

As we further expand revenue lifecycle management solutions, cloud and business intelligence capabilities, we'll be increasingly interwoven with managed services to support customers move to the subscription based economy.

Our technology enhances the value and stickiness of our client relationships and enables incremental growth within our strategic clients across their revenue lifecycle. We're excited to drive this approach forward with our current clients as well as our new prospects. Initiative number four is aligning operating expenses with revenues.

We continue progress on this front during Q2 2015. Non-GAAP operating expenses are down 27% from Q2 of last year and below guidance. This is further demonstration of our results to implement ROI based analysis around spend.

Bob will speak to our activities in this area in greater detail in a moment, but I remain confident the team can increase leverage in the business model in the coming quarters. Initiative number five is customer-centricity, which remains core to our turnaround.

We've been executing against our new customer-centric account management framework since March and visibility and understanding of customer satisfaction is at an all-time high. The framework includes a regimented roadmap that outlines key customer touch points throughout the quarter.

With information gathered during these touch points coupled with quantitative data about the account, we've build a predictive customer help model that will allows us to identify and address risk.

If sent sense an issue coming, we execute one of eight playbooks depending on what we're trying to solve of the playbooks we resolved today since March of this year we've experienced a 90% success rate. With this framework in place we have moved from reactive to proactive making in-quarter adjustments and getting ahead of issues.

Our improved Q2 trend was a directly result for these in-quarter adjustments. As a testament to the progress here, we've had expansion in renewals with customers that were at the risk of terminating in the last year. While we still have a long way to go the bottom line is telling.

Through the first half of 2015, we generated a positive $500,000 in adjusted EBITDA as compared to an adjusted EBITDA loss of $16.2 million from the first half of 2014. ServiceSource remains the clear leader in recurring revenue management and continues to execute on expanding the value we provide to our customers.

We've been able to build out our leadership team better than I could have envisioned and I am excited to see the progress we're making to improve our performance across all areas of the business. I remain confident that we're making the right changes and the appropriate to drive ServiceSource back to growth and profitability.

And with that I will turn it over to Bob..

Thank you, Chris. Today I’ll share our Q2 2015 financial results, give some color on the drivers of our business, and provide guidance for the third quarter of 2015. As a reminder, we've 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 Q2 with respect to guidance, we delivered better than expected results across key financial metrics including revenue, gross margin, operating expenses and profitability. We outperformed on revenue in each segment of the business and made significant progress controlling cost.

We lowered cost through increased operational discipline and cost utilization both at the cost of revenue and operating expense levels as well as through an ROI based discipline with respect to investment. From a churn perspective, in Q2 we continued to deliver churn results consistent with levels before H2 2014.

Our focus on customer success, strong performance on client engagements and improved intelligence around the business drove that improved performance. Now turning to results, our non-GAAP revenue was $61.7 million a decrease of 7% in the prior year. Non-GAAP gross margin was 33.9% up 4.1 percentage point year-over-year.

I'll now turn to our business segment views starting with Managed Services, Q2 non-GAAP revenue from Managed Services was $56.2 million down 4% year-over-year, but above our guidance as we outperformed on a number of strategic accounts and had faster than expected ramp in an expansion with the major existing accounts.

Non-GAAP gross margin from Managed Services was 32.1% up three percentage points from year ago as a result of increased operational efficiencies. Gross margin was above guidance due to the better revenue performance as well as expense management that allowed us to deliver that revenue at lower cost.

Expense management was a combination of improvements in core day to day operations as well as in management of our investments and people and technology, In Q2 as we look at the future quarters we were highly selective in how we invest in the company’s resources and this had a direct effect on gross margin.

For cloud and business intelligence Q2 non-GAAP revenue was $5.5 million down $2.2 million from last year due to the loss of a major CMBI customer as discussed in last quarter’s call. Non-GAAP gross margins for Cloud and business intelligence was 52.1% up 17.3 percentage points from year ago as a result of lower support and operational cost.

We came in above guidance due to higher revenue from professional services and the expansion with a major client as well as improved management of support and operational costs. Moving on to operating expense and profitability.

Our non-GAAP operating cost came in below expectations for the quarter at $23 million, down 27% or $8.6 million from last year's Q2 OpEx of $31.6 million. This change reflects the cost cutting measures instituted in late 2014 as well as an ongoing ROI discipline across sales and marketing, R&D and G&A.

Adjusted EBITDA for the second quarter was negative $230,000 significantly better than our guidance of a loss of $8 million to $11 million. Our non-GAAP net loss in the second quarter was $1.7 million or a loss of $0.02 per share better than the set loss a year ago.

As you should notice we came in far below the $70 million quarterly cost run rate we talked about and I want to share some perspective. We've been very clear that we're in a turnaround situation.

To that end, the new executives and the highly talented staff have come together to drive results for our customers while optimizing spend to achieve success over the long term. With respect to the run rate spend, during Q2, the ServiceSource team increased operational efficiency coupled with a tight ROI discipline spend in staffing.

Additionally, with regard to investments in the business, we were very selective in where and how we layered on the key investments that will be instrumental in the turnaround. During Q2 the ServiceSource team responded exceptionally well to this approach and this resulted in improved performance for the quarter.

It's important that we make it crystal clear that we as the Management Team are focused on the long term success of ServiceSource and our clients. With that long term view in mind, at the same time, we're working to improve the current operations of the business we're laying the groundwork for the next several years.

In that regard, we fully expect to continue to invest in the business and our clients and will likely increase the level of investments from Q2 going forward. Now turning to a brief review of the balance sheet and cash flow metrics, DSOs in Q2 were 84 days down from 88 days in the first quarter of 2015. Cash flow from operations was $5.8 million.

CapEx was $2.4 million, which included $1.6 million in capitalized development resulting in positive free cash flow of $2.7 million after adjusting for foreign exchange. We subsequently ended the quarter with $214.2 million of cash and equivalents and investments, up $3.2 million from Q1.

Turning now to guidance for the third quarter of 2015, we expect consolidated revenue for Q3 in the range of $57 million to $60 million on a non-GAAP basis. We expect non-GAAP gross margins in the range of 25% to 28% for the third quarter, compared to 27.3% in the year ago quarter.

We are forecasting non-GAAP operating expenses in Q3 of between $24 million and $25 million. As a result in Q3 we expect an adjusted EBITDA loss in the range of $5 million to $8 million and non-GAAP net loss in the range of $4 million to $6 million or a loss of $0.05 to $0.074 per share.

We assume a basic share count of 86.5 million share at a normalized tax rate of 40%. In our business segments, we expect managed services revenue of $52 million to $54.5 million reflecting a decrease of 4% to 8% year-over-year. For cloud business intelligence, we expect revenue of $5 million to $5.5 million, down 34% to 40% year-over-year.

We continue to believe cloud and business intelligence will be generally flat in the near term of the Q3 level. We're expecting free cash flow to come in at negative $7 million to negative $10 million. And with that, I’ll hand it back to Chris..

Thank Bob. I want to share how proud I am of the ServiceSource team and I look forward to the continued progress ahead of us and with that we will now open the line for questions..

[Operator instructions] Our first question comes from the line of Patrick Walravens of JMP Securities. Your line is open..

Oh! Great. Thank you and congratulations to you guys.

So I guess I have three, so the first one is you mentioned an expansion with a major existing account in this script, can you tell us more what that was about?.

Well Pat we don't -- as you know don’t typically refer to customer name. So I’ll skip on that but just share and give some color on the expansion. This is with one of our clients who uses our renewed enterprise, renew on demand software product and they've continued to accelerate adoption into their own employee usage.

And so we've expanded with them and that on the cloud and business intelligence side coupled with expansion opportunity on the Managed Service side as well as to grow with that particular client..

Okay, but it was a big one?.

Yes, it was, it was one of our larger clients..

Okay, great.

And then Chris, can you talk to us a little bit about how you view the trend in renewals and how would compare that to some of the other -- how some of the other trends and outsourcing has e played in your career so far?.

Sure, thanks Pat.

I’d say, outsourcing overall I've been certainly part of the industry its up nearly 30 years now and I go all the way back and I think about when Pro started infrastructure outsourcing in the early 60, 61 and by the end of the decade it probably had about I don’t know 3% to 4%, 5% market share by the end of the 70s it was probably at 10%, 15% by the end of the 80s is jumped up into the 30s, by the end of the 90s it has jumped up around 50 and today infrastructure is outsourced probably 85% plus.

You can take that along any other outsourced trend you could go to app management next, you can go to app development.

You can go into some of the BPO services like claims management or contact centers and all of those have followed a very typical evolution curve where outsourced partners such as ServiceSource in this case continue to grow market share over the years.

And as that relates specifically to ServiceSource and where we see ourselves in the renewal space, I think very small market share outsourced so far, I clarified it 5% and we're the leader in that space and we foresee in the coming years that only increasing as far as our potential in our target market..

I think that's really helpful.

And then Bob, one for you just how should we think about and I know you're not ready to guide for 2016, but just how should investors think about it? What you guys aspire to as we look out over the next year?.

Right, so thanks Pat. We as mentioned on the prior call and Chris has talked about since he has been here, our goal is to turn the business around, get to the point where we're in a place of revenue growth and profitability and back to kind of a gross margin level that we've experience in our past which is now going on.

So understand that as part of the turnaround team is our job to drive those things both revenue, growth and margin improvement both at the gross margin level and at the EBITDA level. So again we're not guiding out beyond Q3 here, but understanding that we're maniacally focused both on revenue growth.

You know there is a couple of new team members since our last call and also on cost control as I think it was pretty well reflected in our Q2 performance..

Okay. Thank you very much..

Thank you. Our next question comes from the line of Ed Maguire of CLSA, your question please..

Hi good afternoon. I had a question about the nature of the customers that you’re starting to see, go back and you look at some of the contracts that had built the company up until now and the opportunities that you’re seeing.

Has there any change in the types of companies and what I’m getting at is that there was some concern that as we saw the technology industry move away from products to more of software as a service that a lot of the subscription management or renewable revenue management became embedded in the business processes.

And there were a couple of wins of software as a service companies but vertical expansion was a big part of the strategy a couple of years ago and would be great to get your perspective on how you look at that, really that dynamic and how that frames your business opportunity?.

Ed thanks and that's a very insightful question about the transition and transformation of the industry we're in.

ServiceSource has had a great historic track record specifically with technology companies in the hardware space and then in the software space and grew that over the past 15 years very well and then recently in the past few years of course, the industry overall has been changing more to a subscription based economy in the cloud and thus certainly on the software side of our business, we see an increasing number of our current clients that are moving from print based licensing to cloud based licensing or subscription based licensing.

And it's a new world for them and it's candidly a new opportunity for us and if I look in the marketplace across our sales activity today, the vast majority of the conversations are around this concept that I mentioned I think on last quarter's call around that new lifecycle management.

And revenue lifecycle management really looks at the entire lifecycle of the client through a customer relationship with the company from on-boarding to adoption to cross-sell to up-sell, to renewals and then background the cycle again and what's really exciting about this for ServiceSource is it actually increases our potential to provide additional services to clients.

And so we're starting to get traction on our revenue lifecycle management deals where we're now providing services to clients in the on-boarding area on the adoption phase in the cloud, on cross-sell, up-sell and then of course continuing to support in any sort of renewal event.

So this transition actually is a great opportunity for ServiceSource to grow its capabilities and services we provide to the hundred plus relationships we have now of the marketplace.

So I see it as very favorable for us and we're getting some traction there, but that is really what has evolved, I would also suggest you although very early stages and I don't think we will see a lot of this for still some time to come.

But on the hardware side of the house, we're seeing increasing number of conversations of where physical based asset companies are looking to see if they can instead of selling that asset upfront, actually turn that into recurring revenue stream by going to a consumption based economics model or instead that stuff.

They actually get paid for that asset over the course of the lifetime into its usage. Those are really early day conversations where once again on the software side of print base licensing of the cloud that's happening real time and we're participating in that..

Right, that's helpful.

Now just in terms of cost it's a lot of progress over the last year in terms of the reduction of cost, but can you share a bit of perspective in terms of what's left to work with - -what's fixed, what's variable as you're looking at, particularly as you look at contracts where do you have make up room to drive more efficiencies out of the model and what obstacles or what fractions maybe working against you at least in the near term..

Ed I'll start and then I'll pass it over to Bob because I think he has some additional color for sure, but when you look at the P&L and there are two opportunities right, there is cost to serve and our gross margin and there is certainly our operating expenses and starting with the latter first on operating expenses as you can see, year-over-year we've had tremendous progress in the reduction of operating expenses in excess of 20% year-over-year reduction.

And we continue to believe that there are still opportunities within our operating expenses to see further reduction there.

Once again we're very customer centric in those decision evaluating each and every dollar to see if it's got any customer impact if we were to remove it, if it does we have a very ROI based discussion around whether that's going to continue or not.

So I feel very comfortable and confident that we will see continued progress in operating expenses as we take some savings out, but of course we'll look forward newer investments in the future as well. So that you'll see some variability in that, but overall I think we'll approve.

On the gross margin side, I think what's really important in this area is the announcement we made on June 8 with the announcement of Brian Delaney, our Chief Operating Officer, Brian is a very experienced leader at driving turnarounds within managed services organizations having great success formally at TeleTech and at Stream and really driving profitability and driving gross margin.

He has been on Board like 22 days in the quarter and now another month and just had great influence in the company and creating a real sense of urgency as how we can drive greater efficiency in our managed services organization and I think we’re starting to see impacts of that already. So really excited about that.

Bob do you want to?.

Sure, thanks Christ, yes I think Ed it's also really clearly a balance of, where do we - -this is not a cost reduction situation. We believe that the market that we're in there is enough opportunity that it's really about how do we invest to grow.

So that’s really kind of the primary type share over the last quarters and I think you will continue to see going forward our getting better at what we do from a cost efficiency perspective. We may -- using contractors, use more in-house intensity more per person less cost.

We're managing that, I think you will continue to see us getting better from our operational efficiencies at the gross margin level as Chris said relative to Brian, but really as we’re doing that, I think as Chris said in his script, the longest form it will take here is investing to grow the topline and getting our customers in the right place, making sure that we’re driving customers success and growing the topline of the business, because that's really where we drive the most value for ourselves and our shareholders..

Great. Thank you very much..

Thank you. [Operator Instructions] Our next question comes from the line of [Lake Larson] [ph] of Northland Securities. Your questions please..

Hey, good afternoon guys. This is Lake Larson on the call for Tim Klasell, couple of my questions have been answered already, but I did want follow up in your Q1 release there were a few risk mentioned one of them being the growth of some competitors and some potential in roads in the comparative space.

I was wondering if you had any updates on that on any of your competitors if you've seen that adversely or otherwise affecting your Q2 results here..

Lake thanks for that question, I think obviously we always keep our eyes and ears open to competitive threats and the landscape and I actually think because the improvement and the progress we've made within our own company, around our operating efficiency we're at a greater competitive advantage today than we were say even 90 days ago.

The entire market obviously for customer success across a number of different spectrums continues to grow and so while I think that represents opportunity for ServiceSource it probably represents opportunity for other companies as well as it's a very good target markets to go after..

Sure. So nothing else that we should be looking out in the meantime, all sounds good..

Yes I feel good once again where we are positioned competitively especially with the greater emphasis around revenue life cycle management where unlike just being a traditional software company or attrition services company by being able to bring the combination of both to bear for our clients, we really create a competitive differentiation in the market much to the first question that was asked today about the large enterprise client we sold.

That opportunity is created because we're able as one company to bring the benefit of both intelligent cloud solutions coupled with our managed services offerings and so as we expand in the revenue lifecycle management with on boarding with adoption, with cross sell, up-sell I really like how we're uniquely positioned in the marketplace..

Great, thank you very much..

Thank you. Our next question comes from Jeff Osher of Harvest Capital. Your question please..

Hey guys congrats on really strong execution, I guess at a higher level and I'll point to Chris to opine but just walk me through obviously there was a pretty rough stretch from a morale and retention standpoint internally through 2014 it seems to be dissipating.

Can you just maybe talk about some of the initiatives Chris that's has been so effective improving, not only internal employee retention, but also the outperformance and efficiency getting back to customer and client benchmarks.

Clearly there is something internally you guys are doing as well or at high level if you can just walk through some of those nuances that you guys have implemented?.

Sure, I think obviously in fairness to previous leadership there is a lot of change last year. 2014 was year where the company experienced three CEOs.

I came in at the tail end in December and there was a lot of additional churn in the Executive levels and candidly I think that becomes a distraction for our employees on a global basis when that volume of change is happening. As we've come into 2015 there has been additional change right.

We've brought in four new Executive Officers and additions to the Executive team is already here, but in some way that has been coming through the employees because they go okay, we're in the turnaround, we have a Leadership team in place.

The Leadership team on a regular basis now is getting out and around on a global basis as I mentioned earlier on the call today. It took me 100 days to get out and around meet all 3,000 employees in all of our locations globally. Brian Delaney did that in half the time in 50 days.

So Bob Pinkerton has gotten now, Greg Hopkins is just recently back from Europe. So our Executive leadership team is visiting with our employees as well as our customers and our prospects on a more regular basis.

I think we've gotten a little bit more clear in our aspirations of who we want to become as a company in three to five years that tends to excite employees because it gives them something to buy into, gives them confidence in the vision that we can continue to be successful once again and move forward.

And I think most importantly the leadership has been able to frame where we came from, where we are and where we are going and put in a perspective where employees once again really can understand that, digest that and be excited about the future.

So I can high, high employee engagement, I am going on, you let me to point, but I am sure really excited about the sales progress we have made in Q1 and Q2.

I think there is nothing like new sales coming into a company where employees can see growth again and we look forward to that coming on Board in H2 and into 2016 and I think the other thing we talked about it the churn level is down so dramatically, we're able to satisfy our customers, meet and exceed their expectations on a greater and greater basis and it gives employees once again the confidence that we have the ability to win with our clients and in the marketplace.

So all that added together is really the definition of what a turnaround is, what we're in the midst of, but it seems to be really taking traction with our employees..

That's great, hey really quick Bob, is EBITDA effectively less your cash interest expense on an ongoing basis, can it be roughly a rough proxy for cash from ops?.

Yes so it's a proxy for recognized at least from the cash flow statement perspective you got working capital etcetera but yes, no, it's a decent proxy for sure..

Okay. Great. Hey congrats guys, really well done..

Thank you..

Thank you..

Thank you. As there are no further questions in queue, I would like to turn the call back over to management for any closing remarks..

Well thank you for everyone's interest in ServiceSource. Really proud of the Q2 results and we're obviously midstream down now in Q3 and excited about how we move forward. So look forward to talking to you again in another quarter's time and thanks again for the call today,.

Thank you sir and thank you ladies and gentlemen and that does conclude your program. You may disconnect your lines at this time. Have a wonderful day..