Good day, ladies and gentlemen, and welcome to the ServiceSource Third Quarter 2013 Earnings Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Ms. Anne Bawden. You may begin.

Thank you. Good afternoon, everyone, and thank you for joining us for ServiceSource's Third Quarter 2013 Earnings Call. Joining me on the call today is our Chairman and CEO, Mike Smerklo; and Chief Financial Officer, Ashley Johnson. Before we begin, I'd like to remind you that during the course of this call, we may make projections or forward-looking statements that reflect our views as of today and are based upon 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 updates in the future. 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 we have filed with the SEC. These documents contain and identify important factors that could cause actual results to differ materially 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 our reconciliations 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.

Thank you, Anne, and good afternoon to all of you on today's call. I'd like to start my comments by saying that overall, I was pleased with our performance in the quarter. We delivered solid growth, profitability and cash flow, and our financial results met or exceeded the upper end of our guidance. Total revenue in the third quarter was $66.5 million, non-GAAP gross margins were 43%, adjusted EBITDA was $5.3 million and our free cash flow was approximately $2 million. Turning to ACV. We closed new business in 4 of our 5 target markets, with both new logos and expansions, including 2 notable SaaS wins, one of which, Workday, we announced earlier in the quarter. In addition to several new customer signings, we added 3 subscription customers to Renew OnDemand. And our first Renew OnDemand customer, Dell, went live in another theater, making this a true global deployment for ServiceSource. We're 9 months into a significant strategic shift in unbundling our business, and there's been some great progress to date. Recurring revenue is now a category far more recognizable than 1 year ago. It's no longer only for startups, but big multibillion-dollar companies realizing the power of this extremely profitable revenue stream. We have reinvented our brand with a new logo, new website, along with enhanced value proposition all tied into leading with Renew OnDemand. And we now have 10 customers live on Renew OnDemand across the globe. Subscription bookings cost $30 million in the quarter and are approximately $33 million 1 month into the fourth quarter. This represents year-over-year bookings growth of over 300%. The continued strength of our subscription bookings is driving dramatic growth in the cloud and data services side of our business, with both improved cash flows and higher margins. And finally, with the launch…

Great. Thanks, Mike. Good afternoon, everyone. As you heard from Mike, Q3 was a quarter of solid progress for our business. I'd now like to take a few minutes to walk through our financial results from the third quarter and provide context and guidance for the fourth quarter, as well as full year of fiscal 2013. As a reminder, non-GAAP metrics do not include noncash expenses related to stock-based compensation, the amortization of internally developed software and non-cash interest expense related to the issuance of convertible notes. 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. To begin, let me take you through some of the numbers. Revenue for the third quarter totaled $66.5 million, at the upper end of our guidance and reflecting growth of 13% year-over-year. Revenue in North America grew 20% year-over-year, as new business that landed in region late last year and early in 2013 moved beyond the early ramp phases of deployment. International regions grew more slowly, based primarily on quarterly seasonality. In addition, in Asia, we saw one large customer move away from a pay-per-performance model that skewed heavily to Q3 to a more ratable subscription model that now includes Renew OnDemand. GAAP gross margins were 40%, slightly down from 42% from Q3 2012, as scale and outperformance in our managed services business was offset by the increased professional services expenses incurred in the quarter. Non-GAAP gross margins were 43% at the high end of guidance, and down approximately 1 percentage point year-over-year. Moving to operating expenses. Sales and marketing was relatively flat year-over-year and down quarter-over-quarter, primarily due to lower sales commissions offset by increased marketing spend. R&D expenses increased year-over-year, as we are no longer capitalizing R&D expenses…

Thanks, Ashley. We continue to be optimistic about the growth potential for our business. I want to personally thank the entire ServiceSource organization working incredibly hard across the globe. We're still in the early stages of what we believe is a major transformative opportunity, and I'm confident that we have the right strategy, team and product in place to see it to success. As we build on this solid foundation, we also look to ways that we can further inflect our growth curve in the SaaS space through strategic acquisitions and partnerships. We raised $150 million of convertible debt in Q3, bringing our cash balance to almost $280 million and added new senior member to our team to run corporate business development, with an eye towards pursuing these kinds of opportunities to drive higher growth and accelerate our market capture. I look forward to sharing more on our strategy for growth at our Analyst Day on November 21 on the last day of Dreamforce in San Francisco. Information and registration information is located on the IR portion of our website. And with that, we'll now open the line up for questions. Operator?

[Operator Instructions] Our first question comes from Mr. Ed Maguire with CLSA.

I was wondering if you could just discuss a bit about your success in converting the Renew OnDemand pipeline into paid engagements. How many of those are brand new customers, and what kind of success are you having with your managed service customers moving them to Renew OnDemand?

Thanks, Ed. Well, so we felt really good about the progress made in Q3. As we highlighted, we added some really great names and we had one name that came in, as we mentioned, just at the end of October, which was Google. So some really exciting progress there, and it was a good blend of both new and existing customers. So a lot of progress as evidenced by the number, first time we've given this out is 300% year-over-year growth in bookings, so very good progress there. As it relates to our managed service customers, we continue to approach them with updating them on Renew OnDemand, showing them the product and functionalities and giving them the choice to move some of their business there or expand their footprint with us in that regard. So I'd say it's really early days with that, early -- good progress, but we're just starting to put those efforts in place. And we think that's going to be a really strong part of our story for 2014.

Great. And just a follow-up for Ashley. You discussed the -- your decision to discontinue capitalizing software and hiring engineers. Could you just -- I'd love a little bit more color in terms of how the change in the expense profile is tying into some of the hiring initiatives you have, at least in the engineering organization. Or are you going to continue the plan to staff up in engineering and discontinue use of outside contractors?

Thanks, Ed. So since basically, midway through Q4 last year, we've not been capitalizing R&D and safety net through our financials this whole year. In terms of whether we're going to use third-party contractors or internal developers, it's frankly a combination of both. So we will continue to supplement the internal teams with outside contractors. But the focus really beginning in Q3 was to ramp up our internal hiring to build out the engineering team.

And our next question comes from Ms. Jennifer Lowe with Morgan Stanley.

Mike, I just wanted to follow up quickly on sort of the commentary, I guess, this is in Ashley's prepared remarks as well, around sort of the more conservative stance on ACV growth. And it sounded like the takeaway was that the pipeline is good, the customer sat is good and it's really just getting the execution model right. But putting that against the context of the execution in the sales force has been kind of a work in progress for a few quarters now. Is this just a matter of continuing to refine the model there or is this something that the strategy that you've been sort of working on over the last couple of quarters maybe isn't showing the way you'd hoped and now there might need to be a change in strategy? I guess, I'm just trying to clarify, is this a matter of tightening up the execution with what you're doing already or is there going to be more material changes than that?

Yes. Thanks, Jen. I would say, when we look back at Q3, it was really around close rates on the dollar, not the unit level. But when we reflect back, we had come off of 4 quarters, the previous 4 quarters had been the highest revenue -- or highest ACV obtained that we've ever had in our history. So there'd been a lot of great work there. We knew that coming into Q3, with the unbundling and the enterprise SaaS solution, combined with what we said 90 days ago, that Q3 is always a hard quarter to predict. There's just a lot going on. And I think most technology companies see that same level of unpredictability in the quarter. I think all of those came to fruition in Q3. And so what we saw was, on a unit basis, the close rate was in line with where it had been in Q1 and Q2, so that's good news. We signed some great customers both on the Renew side and overall. But the dollar ACV was down from what we expected. If there's any good news around that, and this is where I speak to the strategy, no planned change in strategy because the deals really slipped. They weren't lost. And our focus right now is on executing in Q4 and continuing to drive those close rates up.

Okay, great. And then just one more for me. I know you -- that there was a mention of a customer in Asia that had sort of shifted from a pay-per-performance to a ratable model and then that also included Renew OnDemand. And I just -- I guess, there are 2 questions there. One, I want to clarify, was the Renew OnDemand component incremental to the existing deal or did you see them bring business back in-house with Renew OnDemand that had been managed service before? And sort of broadening it out to the extent that there was a change in that relationship on that front, is that something that you think could happen on a broader base or is this sort of unique to this particular customer? I'm just trying to get some good -- to understand that dynamic a little better.

Yes, sure. So this was an example where we had a managed services relationship with that customer, and we had mutually decided that we needed to reduce the scope. What was exciting was that we were able to engage with them in a conversation around Renew OnDemand, and they really saw an opportunity for that within their business. So there was a reduction in overall scope or ACV that's reflected in our net ACV. But importantly, we moved them to a subscriptions model, which we, frankly, think is stickier and better-margin business for us. So again, as I said, that was a customer that happened to have a fiscal year end in Q3, so the year-over-year compare is particularly pronounced in Q3. But nonetheless, we think, in general, it's reflective of the power of Renew OnDemand. In these situations, we can have a conversation with customers and really let them be the guiding light as to which solution is more appropriate for them, maintain that customer and, frankly, do so with a stickier solution.

Our next question comes from Mr. Scott Berg with Northland Capital Markets.

I guess, a couple of my questions -- or, Mike, can you talk about the new service center in Japan a little bit more in terms of, it's up and running now and what maybe our expectations are for how that can expand your presence over there?

Absolutely. We are live. And a reminder, this is largely focused on the selling services, part of our managed service operations. We are able to bring over customers that were already live in Singapore, over into Japan to provide language coverage there. I think it's really off to a good start, and you're not going to see that reflected in 2013. For now, it's about establishing the footprint, servicing the customers in Japan and then starting to ramp up our sales and ACV obtainment in 2014. I do think the -- I know the initial focus will be on the selling services part. But having just been over there a few weeks ago, I think the opportunity for Renew OnDemand over time, as we build up our presence, build up our sales force and obviously get more referenceability around the product, I think longer term, there's a huge opportunity for Renew OnDemand as well. So I'd say it's off to a good start, with a lot of focus on execution there for 2014.

Okay, great. And then I don't know how much details you can give us on the Google win necessarily, but that's not exactly a company that I would, off the top of my head, put into your target market given the rest of the types of customers that you work with today. But can you give us any sense on maybe what they specifically would be using their Renew OnDemand product for?

Well, we went through this Scott -- I don't want to -- we've done a pretty good job, I think, of not going into extensive detail with any specific customer, and it's just recently signed. But I would say -- and a reminder it's a Q4 deal, so when we give the numbers, it was the add-on. I think it's consistent with what we're seeing across the marketplace, which is there's a significant opportunity for recurring revenue management. There is a big gap for systems here or solutions here, and Renew OnDemand fits very nicely into existing investments that companies have made and also, to me, underscores just the quality of companies that we're working with. And if you would have told me 1 year ago, when we were getting ready to roll this out, that we would be sitting here 12 months later or 9 months into this and have 300% year-over-year growth and have wins, with not just the likes of Google, which, as you referenced, is a really a challenging company to sell technology into, given their leadership position. But if you add that on to folks like PerkinElmer, Workday, Dell, Bazaarvoice, Aspect to name some of the other -- to give you a list of the companies we called out before, I think it really just underscores the market opportunity we have in front of us and the opportunity we have to execute into it.

Okay, great. And then the last question for me is, on your sales force today, obviously, both you and Ashley I think talked a little bit about the sales execution components. But are you looking to still add headcount to your sales team here, maybe in fourth quarter or the first part of '14? Or is this more of just working through the current excess capacity that you have?

No. We'd definitely be adding. We've mentioned last quarter that we were, given the record ACV in the first half of the year in Q1 and Q2, we did get a little bit -- we were digesting a bit of that, and didn't do as much hiring as we had wanted to. We ramped those efforts back up in Q3, put some offers out to some great candidates and we'll continue to do that in Q4. Our stated goal was to get to a 10% net add on the sales force. I don't know if we'll get exactly there, but we'll be pretty close. Maybe plus or minus on either side of that, but pretty close to it. We really feel that Q3 was a timing issue. We feel good about the pipeline in Q4 and certainly carry over that optimism into 2014.

Our next question comes from Mr. Mark Murphy with Piper Jaffray.

Mike, I'm curious about any data points thus far. In terms of the effectiveness of Renew OnDemand, you've shown historically the ability to increase the customer's maintenance renewal rates, I think by 12 points or even more than that on average, with your managed service. And so I'm just wondering thus far, I know it's early, I think you said you have 10 customers live. But where you do have data points, what is the level of improvement that customers are realizing when they're using their in-house renewal staff in conjunction with Renew OnDemand?

Yes. So it is early, Mark, and we are -- we're talking about customers live and then we've got to get the usage, the adoption, training, change in management, all of that in place. And that really speaks to this white glove approach. But our target and our studies would indicate that we can drive -- our historic average has been actually a 15-percentage-point improvement in renewal rates. We have highlighted and believe that Renew OnDemand will drive about half of that, so we think, just on the pure technology alone, you should be able to get to 6 to 8 percentage-point improvements. But the other parts that we're really seeing an equal draw to is around automation and taking out a lot of manual work. We've indicated, we've done some analysis that would suggest that anywhere between 20% to 30% of a sales rep's time can be spent on administrative task. And so what I love about the value proposition is we can talk about the improvement in renewal rates, but we can also talk about an improvement in efficiency, 20% to 30% to 40% of administrative task being removed. And that will show up in not just higher revenue, but better sales force efficiency, perhaps higher quotas or lower sales headcount. And so it's all of the metrics that we're tracking. And as we're rolling this out for customers, that's where we're maniacally focusing on as we get through the second half of this year and early into next year.

And then, Ashley, I wanted to ask you, if you could clarify maybe what is going into the bookings, this closure that you're giving and how is it calculated and maybe what's not going into it. I think what I'm thrown off by is that I had thought the Dell deal was booked in Q3 of last year, and I guess, that being an ultra megadeal for the Renew OnDemand component, then I was -- it wasn't clear to me how the bookings there would have grown 300% year-over-year. So is that -- are you strictly talking about the cumulative bookings level or is that in-quarter bookings? And that -- or are you annualizing or is it total contract value?

So we're looking at cumulative booking. This is for only the subscription part of the business, so it doesn't include any managed services, data services or professional services. And it is the non-terminable portion of the contract. So what we're looking at is the subscriptions that are guaranteed per the contract, whether that's -- on average, it's been about 2 years. But to the extent that there are any termination rights or things like that within the contract, then we wouldn't include beyond the date where a termination clause could take effect. So really, we're trying to look at the most airtight view of subscription bookings. But it is, on average, a 2-year number, so a multiyear number.

And the Dell deal that I'm thinking of, if I'm recalling this correctly, that, that was -- that was indeed closed Q3 of last year?

That's correct. And remember that when we talked about the magnitude of that deal, it also incorporated managed services that we're doing on their behalf.

Right. Okay, got it. Okay. Ashley, I was wondering if you could also repeat the -- a comment towards the end, I just didn't catch all of it. You had said something about 13% to 15% growth, I think, for the core business or organically in 2014. Was that -- are you talking exclusive or inclusive of Renew OnDemand revenue contributions when you gave that range?

That's for the overall business. So it's a preliminary look at our revenue growth for 2014.

Okay. And then could you tell us where did you end up in terms of quota-carrying sales reps as of the end of Q3?

Yes. We were roughly flat, Mark. We had a couple of folks that we added on and moved some folks around. So we ended about flat, which was really where we thought we would be, and then we added a couple of folks who accepted offers that didn't start yet. So you should look at it about flat from quarter-over-quarter, new adds coming on in the quarter and continue hiring throughout the year.

[Operator Instructions] Our next question comes from Mr. Patrick Walravens with JMP Securities.

It's Pete Lowry actually in for Patrick. I guess back to Jennifer's questions, ACV reflects signed business. And you've talked to some extent about the pipeline. But maybe you could just give a little bit more detail about just qualitatively, how satisfied you are with the pipeline currently, the overall health of the pipeline?

Yes. As I mentioned, we gave some statistics in the call to indicate what we're seeing which is positive. So we've seen a significant uptick in terms of demonstrations, leads coming into the business and active sales pipeline activity, so not just the early stage work but progressing forward. So feel good about that. What we highlighted was -- and Q3 is always a tough quarter to predict, was just the close rates on a dollar basis coming down. So as I mentioned, the unit basis was signed, it was the dollar basis, and that was deals slipping. So I don't think we have -- we, like anybody else, can always use more pipeline. But I don't think we have a market demand or interest. I think we've done a really good job this year of stimulating and ramping that up -- machine up. I think it's just a matter of getting one through a quarter that always is hard to predict, some digestion given all of the business we had signed in the previous 4 quarters, and then executing on it. So I think that's really where we are as a business. But of the factors going into it, I would not say pipeline is a major concern for us right now.

Okay, great. And then, I guess, Asia. Apart from the one customer that produced scope and/or switched to Renew OnDemand, several companies have had weakness in the APJ region, what we did you see apart from that one customer in the region?

Yes, I would think very similar -- the one of the things we have -- we're a little bit different than most companies is there's a law of small numbers, right? I mean, that's a small part of our business. We talked about the customer that transitioned over to Renew, which is net positive overall in terms of that part of our business. But I think we're seeing -- we saw a little bit of slowed down decision-making and a little bit of confusion in the marketplace, I would say, outside of ServiceSource. So I think consistent with what you've heard from other companies, but for us, it's such a -- it's a relatively small part of our business, less than 10% that things can move around and perhaps make it seem more than it appears.

I'm not showing any further questions at this time. Please proceed with any further remarks.

Thank you, everyone, for taking the time. We look forward to seeing you at Analyst Day here in a couple of weeks.