Good day, everyone, and welcome to the ServiceSource Second Quarter 2014 Earnings Results Conference Call. This call is being recorded. With us today from the company is Mike Smerklo, the Chairman and Chief Executive Officer; Ashley Johnson, the Chief Financial Officer; Eric Bylin from Investor Relations. At this time, I would like to turn the call over to 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 today with you, 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. Please refer to the documents we have filed with the SEC. These documents contain and identify important factors that could cause the 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. 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 it over to Mike.

Thanks, Eric, and welcome to the call. As you've seen in today's press release, this was a challenging quarter. Ashley will share more of the financial details, but I want to start by providing some perspective on what we've uncovered in the last 90 days and then move quickly to our plan for ensuring growth and profitability in our business. On almost all counts, this was one of the toughest quarters in my 12-year history running ServiceSource, particularly when I consider our outlook just 180 days ago. That said, we did have some positive highlights in the quarter. We added more than $3 million in new subscription revenue, including some great competitive wins from our Scout product line. We also signed a number of expansions with our existing managed services customers. The trend of customer expansion has been consistent and in the past 5 years, our average contract size per customer logo has increased by approximately 60%. We also signed a large new deal with a Fortune 100 company, our largest new contract in the last year. I applaud our sales team on their execution this quarter. But as the results show, both our top line and our margins were challenged this quarter, and we recognize the need to take immediate action. However, I want to emphasize that ours is a complex, global business and restructuring it will take time. 90 days ago we acknowledged a slowing ACV trend, and we attributed this trend to our unbundling strategy and hybrid go-to market approach. We also discussed the fundamental differences between our managed service pay-for-performance business and our SaaS product business, and the difference of go-to-market motions required for each. We also acknowledge our underinvestment over the last 3 years in our Managed Services business. Before I share our plan, I…

Thanks, Mike. I'd like to take a moment to give some commentary on our Q2 results, as well as provide an update to our guidance. As we provided previously, there are slides posted to our website with the details for our guidance as well as GAAP to non-GAAP reconciliations. 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 compensations, the amortization of internally developed software, the amortization of intangibles acquired from Scout, acquisition-related costs and noncash interest expense related to the issuance of convertible notes. As always, you can find a reconciliation of GAAP to non-GAAP metrics in today's press release and on the Investor Relations section of our website. Now let me turn to our Q2 financials. As you have seen, Q2 results were below our expectations across most key metrics. And as Mike noted, we attribute the further deterioration of our financials to the challenges of our hybrid operating model and unbundling strategy. Starting with bookings, while we don't provide a numerical update for Managed Services ACV on a quarterly basis, we did add several new accounts to our portfolio this quarter, including the largest new customer additions in over a year. Of the new business we added, approximately 50% came from our existing customers through expansions and approximately 50% was from new logos. We also added more than $3 million of new SaaS subscription ARR in the quarter. Our ACV churn rate in Q2 remained in line with our historical target of an annualized 90% ACV dollars retention. Turning to revenue. Non-GAAP revenue was $66.3 million, reflecting a decrease of 2% over prior year. This…

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

I'm going to jump into the strategic -- the outcome of the strategic review in the SaaS, but maybe before we get into that, I just wanted to quickly touch on -- I think, earlier in the comments, there was a couple of remarks, one, about some contracts in the Managed Services business that were taken in-house; and then, two, I think there's also comment around reduction in scope a little bit for some of the subscription contracts that had been signed a while back. So I just wanted to drill into those 2 quickly to better understand some of the dynamics there and whether that's tied to sort of uncertainty around the -- what the strategic review outcome would be or if there's other factors in play there that we should be thinking about.

Jennifer, thanks for the questions. Primarily, as we've talked about in the past, on ACV churn, typically we're not losing to competitive situations but rather a customer making the decision to pull the operations back in-house and away from ServiceSource. And so that's -- and as I mentioned, the last 2 quarters have been in line with our annualized expectations of a 90% retention rate. So -- and we had talked about previously that internationally, since it's a smaller book of business, when that happens, it has a large impact. So that's what that referenced. In terms of the reductions in scope for subscription contracts, those are primarily related to some of the earlier deployment of Renew OnDemand where we've scoped back with the customer, the deployment, and it's a small handful.

Great. And then, I understand sort of the reluctance to commit to a timeline on some of the realignment that needs to happen currently, but maybe just a couple questions on that. One, has any of this started yet? Or does the clock effectively start today on getting people sorted into new roles potentially? And then two, and related to that, as you think about some of the components that are involved with breaking the sales force into 2 and getting them trained appropriately in the field. That just as a first step, is that something that's sort of mapped out in terms of the timeline on that specific action? Or is that sort of open ended in terms of when roles will actually get assigned and people will be out productive in the field along with the new lines of alignment?

Yes, Jen, it's Mike. I would say that we have a massive sense of urgency, obviously, given what we've talked about financially. We need to make impact change as quickly as possible. We also acknowledge it's a huge transition, so what I would say is we started a strategic review 90 days ago and just to give you more color, it has been very comprehensive. We've done everything from looking at what the real root cause analysis are to our challenges. We started with a belief that it was showing up in go-to market. What we revealed was much more significant, as we talked about. We also did competitive and a market-sizing assessment. We've done a full benchmarking of the businesses. We developed a path forward, and we've done high-level org design all in the last 90 days. We've also gone through this restructuring plan. We've done -- began to communicate it internally. We've developed milestones and metrics for the plan. We've also engaged a professional project manager and a PMO firm to help us through this change. In terms of the org changes, we have begun to announce them and communicate them at the highest level immediately. We've also begun in terms of cost rationalization as quickly as we can. We've launched the president -- the search for the president of Managed Services and made some other org changes. So we're moving at a swift pace or as swift as possible and really the next 90 days, about implementation across the board. To your other question though, on the sales part, one of the things that we're mindful of is this isn't as simple as just saying, hey, we're going to have 2 sales force and you're on Team A or Team B. The complications come in to how do we have unique value propositions that are tied to each selling motion, how do we have a rework of the value statements and the contractual and statement of work we mentioned a couple of times. And then, working through rules of engagement between the 2 sales forces. So that's going to take some time. What we commented on is that we will run the teams jointly through Q3 and into Q4 as not to disrupt any customer-facing or ACV acquisition activities. We're just going to try and start moving the new relationships into 1 of the 2 buckets. So I would expect the ultimate goal here is to do as much as we can, certainly on the cost side with a massive sense of urgency, and then look on the go-to market and customer-facing side to implement the changes we can immediately, but really start to look to begin the new year with all of that in line from top to bottom. So that's the framework we're working on, but there's no shortage of urgency across the board here.

Our next question comes from the line of Scott Berg from Northland Capital.

Mike and Ashley, several questions here for you. Let's start off with the lack of -- or the underperformance of the Managed Service revenue in the quarter. Can you talk about, was that purely because of lower close rates or was it a combination of other items like you mentioned, maybe a customer pulling some business in-house during the quarter?

Yes, Scott, what we've really seen on the Managed Services business, it's interesting, I guess, if there's any good news here, which is hard to find, we've looked at the performance in the quarter as also part of the overall market assessment. We're not seeing a major change in the competitive dynamics, if you will, that would impact close rates. So in some regards, I struggle to call that good news. What the reality means is that it's internal execution. We saw areas where we just didn't close the business on time, the level that we had expected or had historically and we also saw other inefficiencies in the business. So some of this comes from the ACV additions in 2013 and Q1. Some of it comes from ramping new business and churn, but I would say the bigger part of the miss really came from our own internal performance, us not executing at the level that we know we can and that we've done historically. That's really driving the miss and obviously, have been putting pressure on the rest of the year in Managed Services.

Then, can you help us understand the delta between when you gave guidance in end of April or early May relative to where the quarter came in at? Because my assumption was, obviously, you'd already seen some issues in the execution of that business in Q1, and I thought the guidance was kind of a worst case scenario, kind of using those -- the execution in Q1 as kind of the new baseline. What's the delta between when you gave that guidance and what was reported in the quarter?

Really, Scott, it was just a further deterioration in the performance as opposed to a stabilization or even improvement that we, frankly, expected to see just coming into the quarter and having identified some of the issues, believing that we could at least stabilize it. And the fact of the matter is the underinvestment that the operations have had over these past several years means that we're not going to be able to brute force our way out of this.

Okay. I also saw the 8-K release that Jay Ackerman is leaving the organization. I guess, can you talk about why he left? Was it his own decision or was that a higher-level decision by you all? And then, what does that mean for the sales teams moving forward? It sounds like there's going to be separate teams, but there's -- there'll be no one single head of sales anymore, it sounds like.

Yes. So first of all, Jay's had an incredible valuable -- value to our organization, and we're working through this in a mutually professional way. What the result of this is -- of this whole strategy and the whole leadership team was involved, including members like Jay that will -- that were impacted by it, but we worked on this together and said what's the best path forward and came up with this restructuring plan across the 5 components I measured, the first one being that we really moved to separate business units. What that means then is, there are a handful of functions that were global and span both business units as they were before, that simply don't have a place in the new organization structure. So in cases like that, we're working through a very measured transition and in doing so in a mutually agreeable time frame. So I want to make sure that everyone understands that this is done with some folks that have had huge impact for us, individuals like Jay have done great work for us over multiple years, but when you move to a 2-business unit model, where there's roles that were across both in global roles, we just don't have a need for them anymore. We will move forward with the approach to have separate sales, separate solution-based marketing and separate customer, what we called customer success or customer-facing customer account management roles within each business unit. And so, the only thing that will be shared at the corporate level will be the 4 functions that I mentioned in the script. Everything else will be distributed to the business unit.

Okay. And then last question for me, Ashley, on the cash burn in the quarter. Free cash flow burn of $20 million to $24 million sounds quite high even with your recent execution issues. Can you maybe detail a little bit more, is it purely just the carried run rates of cost in the last quarter relative to the new revenues? Or is there going to be, I don't know, higher level of severance costs maybe then, what I'm thinking at the present time? Just trying to understand how we get to that $20-plus million because it seems like a big difference in where you've been recently.

It is a big difference. And it relates to the fact that we have run rate costs that we can't take out of the business as quickly as we're seeing the revenue come down, and we are obviously moving quickly to realign our cost structure, as I detailed earlier. But the fact of the matter is, in Q3, we're not going to be able to cut costs quickly enough to counteract the decline in revenue, and that's the impact on cash. Q3 is typically a tough quarter for collections anyway given our international business. And so, that compounds the matter.

Our next question comes from the line of Ed Maguire from CLSA.

I was wondering in your -- it's obviously a lot of information to sort through that you've gone through over the last 90 days, but what have you learned about the quality of contracts in your underlying Managed Services business. Was there -- have you discovered anything about some of the prior MSS business that you've done that was a disconnect from what you're believing before? And I guess, that leads to the question whether you were -- whether the SaaS business, in effect, was cannibalizing itself? Would just be curious as to -- because there had been -- I know you, in the past, have had -- there had been some issues with just the nature of the underlying business that you guys were executing against. And sometimes you've had some changes in the customers -- your client's mix as well. So I'd be curious to get any color on that.

Yes, it's -- and you hit upon what I'd say the progression in the last 90 days. We came into it realizing there was a slowdown in go-to market and challenging in our customer messaging. When we dug deeper and really did a root cause and discovered as running these 2 businesses in a hybrid fashion, not just selling a hybrid solution, but running in a hybrid fashion, really became clear and speaks to what you're alluding to. The root cause, if you really dig in -- and this shows up in gross margins, it shows up in cash burn expectations that Ashley had out is -- it's really three-fold. One, we have this underinvestment Managed Services, we've talked about it in the past but it really has put our cost to serve at a much higher rate -- higher level than it should be. So when we were signing new managed service customers, our expectations around profitability may have been off in our modeling because we had historically been able to drive cost out of Managed Service at a pretty aggressive rate. When you take 3 years off from investment, that clearly is going to take a pause and we've got to begin an aggressive process, it's 1 of the 5 steps I laid out, to get Managed Services back on track. So I think that's the first aspect of it. But tied into that, when we went forward with this market message, it became very clear that we were putting, because we're trying to get the SaaS business off the ground, an unintended consequence was that we commoditized the market message for the BPO business. And what that meant is we were putting less emphasis on our core value proposition there, so we were signing up for maybe higher levels of performance or not defining scope as well as we should. So therefore, we've had headcount go up or it turned into a headcount play as we've seen headcount go up and cost to serve go up trying to live up to unrealistic expectations. And then, the third one is just making sure, as we've gone through this transition, because we've had vagueness around this, as we've called it out several times, a statement of work, without these clear definitions, we've had to throw bodies at things to bridge the gap in both professional and managed services. And so, it really is -- you asked a super question, but the core issue is deeper than go-to market, it's the 3 things I highlighted. And I think why, as disappointing as it is to be here today, the plan forward is so comprehensive is because it really takes and attacks these root causes that I've just discussed.

Great. And just when you look at -- attacking the cost structure here, I mean, it sounds like you feel that the underinvestment in technology has really been at the core. And I know that every situation is different, but I mean do you feel that, that it's going to be technology that's going to allow you to really take cost, that investing is going to allow you to create more process automation and efficiency? Or was there an organizational issue where you just may not have had the right people in the right roles doing the right things?

It's a little bit of both. And one of the things that you'll hear us saying more overtly than we have in the past, is the term BPO or business process outsourcing, that's what the Managed Service business is. We know how to run that business because we've done it successfully for a long period of time. Unfortunately, with these businesses, as I know, because 12 years here, is that they are incredibly detail-oriented, and there is no one single solution. It really does come down to the value proposition, how you manage your workforce, not only in what the tools you give them, but where they sit and how you continue to source talent, how you manage processes, not just are they automated but are they repeatable and do they show up specifically in statement of work? Are you able to provide -- automate as much as you can? And then, do you have the right contracting structure, meaning do you have very tight statement of works, so that if there is change orders or change in the customer environment, you're able to recoup the cost for it. That unfortunately -- and then, of course, leadership, too. So those are the cornerstones of the BPO business. Admittedly, we've lost our way over the last couple of years without investment. And that's what we're setting about to change. I believe if there's good news, we know what to do. The bad news is, none of those things can be changed overnight. We're in the market for new leadership. I think we're going to get some great additions there. But at the end of the day, you can't take 3 years off and expect to turn that around in short order. So it's going to take time.

Our next question comes from the line of Albert Tukin [ph] from William Blair. Bhavan Suri - William Blair & Company L.L.C., Research Division: It's Bhavan here. So just following up on Ed's questions here. When you look at the gross margin of Managed Services business, even prior to the launch of Renew or even conversations around Renew, those have trended down. And then, Mike you spoke a little bit about commoditization. I know you're talking about messaging. But it sounds like there's sort of commoditization on the services side. And I guess, I'm just trying to contrast that with your comment that there's no competition. So help me sort of understand what was going -- gross margin coming down before you started focusing on Renew 3 years ago, 4 years ago, and then sort of comment around commoditization.

Thanks, Bhavan. In terms of prior to the launch of the Renew strategy, we had one customer, frankly, back in those days some that operated at higher gross margins because, frankly, we did a different array of services for them. And when that customer was acquired, that impacted our overall gross margins. So that's the downward trend that you see before the launch of the Renew strategy, and it was really a separate issue that I'd kind of put to one side. Overall, though, as you said, the reason for moving into the market with Renew was a customer-driven strategy, customers asking for this and also a business model strategy of saying we wanted to have the ability to offer 2 different ways of solving this recurring revenue management problem and that SaaS business should bring higher margins as well. So you're right in that it was a downward trend, but I'd put that in a separate category, unrelated to what Mike was referring to on the commoditization of the message. So Mike, do you want to take the second point?

Yes, Bhavan, if you think about it this way, we were going out historically with a bundled message. It was black box but we were able to talk about a business outcome and talk about multiple facets of that. If you go back and look at when we went public NRS 1, we had a very comprehensive story around our Managed Services. The good news is, that those core tenets and value proposition are still in place. But when I look at our over rotation, that's what I'll call it, in the last 18 months, we started to talk about Renew, which is a phenomenal SaaS product, but when we started to move -- the pendulum swung all the way over to Renew, Renew, Renew, what you are left with in the unbundling, as an unintended consequence, is a more of a bodies for hire mentality, and that's never been our tenet. We've never hung our hat on that. We've always talked about it being comprehensive, but that's what started to show up in our pricing margin. And that's -- when I think about the future state and while I am -- I believe this is the right path for the business is, you can get back to a comprehensive value proposition for the Managed Services business and you can let the technology solution be sold in a stand-alone fashion and you can let buyers line up for what works better for their business. But that does not mean -- in the corporate message is the same, but you do not go-to market with à la carte approach, which we've done in the past. Bhavan Suri - William Blair & Company L.L.C., Research Division: And then, when you look at the core platform, it obviously supports the Managed Services business and then sort of your SaaS, pure SaaS customers and hopefully, there's cross-sell or whatever. But when you look about the Managed Services business still running on Renew, how do you guys, in the go forward sort of reorg, think about managing that? Because obviously, your SaaS customer want feature functionality, but obviously running a lot of customers on the Managed Services platforms drives a lot of enhancements too. How does that work in the new organization and sort of how do you deal with the pull and pull -- the push and pull between those 2 sort of -- demands from those 2 organizations? How are you guys thinking about that?

It's a super question. What we're thinking about, and this is one of the details to work through, you've just hit upon one of the more of the complexities of the go-forward plan. But I believe the best way to solve this is, is for the SaaS division, Cloud & Business Intelligence, to look at Managed Services as it's, one of or its largest customer. And so you define -- the way you interact between the business units is similar to how you'd interact with an external customer. That means you have to find scope. You have ProServ, you have UAT, you have different signoffs for the Managed Service like you would for any other customer, and you drive each other in a supportive way. But I think by having a commercial relationship or commercial approach between the 2, you'll get the best of both. And I think it's very important over time for Managed Services to be able to highlight that they use Renew, but they're going to do a whole host of things to add on to it to differentiate the value proposition, and similarly to have the SaaS division to be able to sell it on a standalone basis. So that's one of the complexities we're working through in the next 2 quarters. Bhavan Suri - William Blair & Company L.L.C., Research Division: One quick one on professional services. Obviously, the professional services business has been a little bit of a challenging business and as you look at the core of what you do, there's a significant portion of professional services that is involved in taking the various data elements contracts -- contracts, contract databases, renewals, CRM systems, whatever and integrating that into the Managed Services business and into Renew. And so where do you think professional services falls there? Where do you think the pricing for that -- because remember when you brought sort of some of the new sales structures over about 2 years ago, you guys didn't charge for professional services and you started charging for professional services, which is a positive. But help us understand how that looks going forward, too, given the split of the businesses?

Yes, let me -- I'll give you the high-level org component and then add on to the financial component if necessary. This is one more example of where this is all gotten muddied below the go-to market and the value proposition line. What we will set up for is have ProServ be just like any other SaaS business, have it charge market rates for -- to bring onboard customers and integrate them as need be. That's part of Cloud & Business Intelligence, and that has commercial requirements like you would for a SaaS business at that size. On the flip side, as you know, BPO businesses have something called a PMO or a customer onboarding component. And we are reestablishing that in the BPO business and that is -- takes everything from changed management, staffing, location, training, as part of the BPO offering. But the biggest point is, you draw the line between what the customer is asking you to do. In a BPO business, you're trying to get the customer live as quickly as possible and handle change management, that's PMO. On the SaaS side, that's about technology migrations, customization as need be and integration, that's professional services and we need to find a way to charge market rates for that as the product becomes more mature.

Yes, just following on, on that, Bhavan. If you think about it, when you're doing a technical systems implementation, you're defining what's included in that and what's not included in that in a very specific way. So what is the environment look like that you're integrating to, what are the requirements then and the hours needed to perform that work and the scope is very bound. On a Managed Services side, it's really more about managing the transfer of the activity from inside the 4 walls of the company over to ServiceSource, and that's a different set of activities. If you start bundling in the outcome of what's going to happen when Managed Services is up and running into the professional services engagement, that's when you start to get very unclear about actually what's captive inside that statement of work and what's really outside of the scope of that. And that's the crossover between those 2 functions is really where you started to see significant scope creep, therefore, a challenge for us on cost management, and even beyond that, just a challenge on managing customer expectations and ultimately, customer sat. So that is [indiscernible] just we have. Bhavan Suri - William Blair & Company L.L.C., Research Division: So having run, and you guys know my background, I've run a professional services business and a software business. But I guess, at a high level strategically, so doesn't it even make sense to keep the 2 businesses together?

You mean, from a corporate perspective? Bhavan Suri - William Blair & Company L.L.C., Research Division: Yes.

I think there's some really good news. As I mentioned, this review was exhaustive and probably the most positive -- again, it is not a day to be talking about positives other than the plan forward and what we learned around the market. The assessment helped us understand that there's still is a big need for recurring revenue management solutions. The importance of what we do and the growth we're going to need is only going up. So that's good news. It also helped validate that there are really, as we put up on the slides, there are 2 different types of buyers. There's an outcome buyer, and there's a technology buyer. Our belief is that we can serve both, but we just have to be more distinct in it. And we do think there's a real benefit by having a thin line, if you will, at the corporate layer, and that will be shared functions that don't add double cost, but HR, finance, corporate IT, and G&A, and then corporate messaging and marketing. So I think, there is a real benefit to having both businesses. The key, though, is lining up to what the buyer's needs are and then having every aspect of your delivery, say it again, every aspect of your delivery lined up to what you agreed with the customer. And that's where we, I think, had really lost our way.

[Operator Instructions] And this does conclude the question-and-answer session of today's program. I'd like to hand the program back for any further remarks.

Thanks, everyone. We appreciate the time today, and we will look forward to answer any questions as they come up in the follow-up sessions. Thank you.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.