SREV - 6.30.2015 - 10Q
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 FORM 10-Q 
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2015
OR
 
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission file number 001-35108
 SERVICESOURCE INTERNATIONAL, INC.
(Exact name of registrant as specified in our charter)
Delaware
No. 81-0578975
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)
 
 
760 Market Street, 4th floor
San Francisco, California
94102
(Address of Principal Executive Offices)
(Zip Code)
(415) 901-6030
(Registrant’s Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x   No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
¨
Accelerated filer
x
Non-accelerated filer
¨  (Do not check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
Indicate number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date:
 
Class
Outstanding as of July 31, 2015
Common Stock
86,015,532



Table of Contents

SERVICESOURCE INTERNATIONAL, INC.
Form 10-Q
INDEX
 
 
Page
No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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PART I FINANCIAL INFORMATION
 
Item 1.
Financial Statements
SERVICESOURCE INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)
 
June 30,
2015
 
December 31,
2014
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
78,045

 
$
90,382

Short-term investments
136,202

 
125,000

Accounts receivable, net
57,172

 
70,163

Deferred income taxes
390

 
398

Prepaid expenses and other
7,549

 
6,815

Total current assets
279,358

 
292,758

Property and equipment, net
25,540

 
25,658

Deferred income taxes, net of current portion
1,512

 
2,488

Goodwill and intangibles, net
10,201

 
10,957

Other assets, net
8,806

 
7,985

Total assets
$
325,417

 
$
339,846

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
1,210

 
$
2,922

Accrued taxes
1,101

 
1,721

Accrued compensation and benefits
18,957

 
20,056

Deferred revenue
7,311

 
7,018

Accrued expenses
6,383

 
8,882

Other current liabilities
2,282

 
2,569

Total current liabilities
37,244

 
43,168

Convertible notes, net
124,301

 
120,730

Other long-term liabilities
4,877

 
4,660

Total liabilities
166,422

 
168,558

Commitments and contingencies (Note 7)

 

Stockholders’ equity:
 
 
 
Common stock; $0.0001 par value; 1,000,000 shares authorized; 85,687 shares issued and 85,566 shares outstanding as of June 30, 2015; 83,928 shares issued and 83,807 shares outstanding as of December 31, 2014
8

 
8

Treasury stock
(441
)
 
(441
)
Additional paid-in capital
323,082

 
312,017

Accumulated deficit
(164,985
)
 
(141,409
)
Accumulated other comprehensive income
1,331

 
1,113

Total stockholders’ equity
158,995

 
171,288

Total liabilities and stockholders’ equity
$
325,417

 
$
339,846

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.


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SERVICESOURCE INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2015
 
2014
 
2015
 
2014
Net revenue
$
61,613

 
$
65,997

 
$
127,810

 
$
132,813

Cost of revenue
42,692

 
48,518

 
88,507

 
96,113

Gross profit
18,921

 
17,479

 
39,303

 
36,700

Operating expenses:
 
 
 
 
 
 
 
Sales and marketing
10,165

 
17,212

 
21,000

 
32,883

Research and development
4,646

 
6,881

 
9,468

 
13,597

General and administrative
10,701

 
12,256

 
22,866

 
25,121

Restructuring and other
2,988

 

 
3,739

 

Total operating expenses
28,500

 
36,349

 
57,073

 
71,601

Loss from operations
(9,579
)
 
(18,870
)
 
(17,770
)
 
(34,901
)
Interest expense and other, net
(2,739
)
 
(2,196
)
 
(4,584
)
 
(4,770
)
Loss before income taxes
(12,318
)
 
(21,066
)
 
(22,354
)
 
(39,671
)
Income tax provision
1,089

 
26

 
1,223

 
161

Net loss
$
(13,407
)
 
$
(21,092
)
 
$
(23,577
)
 
$
(39,832
)
Net loss per share, basic and diluted
$
(0.16
)
 
$
(0.25
)
 
$
(0.28
)
 
$
(0.48
)
Weighted average common shares outstanding, basic and diluted
85,072

 
82,784

 
84,665

 
82,432

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

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SERVICESOURCE INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands)
(Unaudited)
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2015
 
2014
 
2015
 
2014
Net loss
$
(13,407
)
 
$
(21,092
)
 
$
(23,577
)
 
$
(39,832
)
Other comprehensive loss, net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments
352

 
(105
)
 
105

 
334

Unrealized gain (loss) on short-term investments, net of tax
(261
)
 
120

 
113

 
99

Other comprehensive income, net of tax
91

 
15

 
218

 
433

Total comprehensive loss, net of tax
$
(13,316
)
 
$
(21,077
)
 
$
(23,359
)
 
$
(39,399
)
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

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SERVICESOURCE INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
 
Six Months Ended
 June 30,
 
2015
 
2014
Cash flows from operating activities
 
 
 
Net loss
$
(23,577
)
 
$
(39,832
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
6,783

 
6,322

Amortization of debt discount and issuance costs
3,903

 
3,636

Accretion of premium on short-term investments and other
(497
)
 
40

Deferred income taxes
980

 

Stock-based compensation
7,544

 
10,932

Restructuring and other
3,450

 

Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
11,754

 
15,504

Deferred revenue
338

 
(1,983
)
Prepaid expenses and other
(852
)
 
(45
)
Accounts payable
(2,064
)
 
1,030

Accrued taxes
(555
)
 
315

Accrued compensation and benefits
(1,570
)
 
1,936

Accrued expenses
(2,448
)
 
2,499

Other liabilities
125

 
(446
)
Net cash provided by (used in) operating activities
3,314

 
(92
)
Cash flows from investing activities
 
 
 
Acquisition of property and equipment
(5,114
)
 
(5,577
)
Restricted cash
(1,244
)
 

Cash paid for acquisition, net of cash acquired

 
(32,551
)
Purchases of short-term investments
(51,074
)
 
(46,926
)
Sales of short-term investments
40,194

 
23,134

Maturities of short-term investments
290

 
3,943

Net cash used in investing activities
(16,948
)
 
(57,977
)
Cash flows from financing activities
 
 
 
Repayment on capital leases obligations
(91
)
 
(212
)
Proceeds from common stock issuances
944

 
3,569

Net cash provided by financing activities
853

 
3,357

Net decrease in cash and cash equivalents
(12,781
)
 
(54,712
)
Effect of exchange rate changes on cash and cash equivalents
444

 
156

Cash and cash equivalents at beginning of period
90,382

 
170,132

Cash and cash equivalents at end of period
$
78,045

 
$
115,576

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

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SERVICESOURCE INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1 — Description of Business and Basis of Presentation

ServiceSource International, Inc. (together with its subsidiaries, the “Company”) is a global leader in recurring revenue management, partnering with technology and technology-enabled companies to optimize maintenance, support and subscription revenue streams, while also improving customer relationships and loyalty. The Company delivers these results via cloud-based solutions and dedicated service teams, leveraging benchmarks and best practices derived from its rich database of service and renewal behavior. By integrating software, managed services and data, the Company provides end-to-end management and optimization of the service-contract renewals process, including data management, quoting, selling and recurring revenue business intelligence. The Company receives commissions from its managed services customers based on renewal sales that the Company generates on their behalf under a pay-for-performance model, and subscription fee from customers of its cloud-based solutions. The Company’s corporate headquarters are located in San Francisco, California. The Company has offices in Colorado, Tennessee, Washington, the United Kingdom, Ireland, Malaysia, Singapore and Japan.
The accompanying unaudited interim condensed consolidated financial statements (“condensed consolidated financial statements”) include the accounts of ServiceSource International Inc. and its subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.
These condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP” or “GAAP”) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X, without audit. Accordingly, they do not include all of the information required by U.S. GAAP for annual financial statements. The unaudited condensed consolidated balance sheet as of December 31, 2014 has been derived from our audited annual consolidated financial statements included in our Annual Report on Form 10-K/A for the year ended December 31, 2014 filed with the SEC on March 17, 2015. These condensed consolidated financial statements and accompanying notes should be read in conjunction with our annual consolidated financial statements and the notes thereto for the year ended December 31, 2014, included in our Annual Report on Form 10-K/A.
In the opinion of management, these condensed consolidated financial statements reflect all adjustments, including normal recurring adjustments, management considers necessary for a fair statement of our financial position, operating results, and cash flows for the interim periods presented. Preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the Company’s condensed consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates. Also, the results for the interim periods are not necessarily indicative of results for the entire year.
Amounts shown in the Accrued liabilities and other caption in the condensed consolidated balance sheet as of December 31, 2014 have been reclassified into Accrued expenses and Other current liabilities to reflect the current period presentation. Amounts shown in the Accrued liabilities and other caption in the condensed consolidated statement of cash flows for the six months ended June 30, 2014 have been reclassified into Accrued expenses and Other liabilities to reflect the current period presentation.
Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standard Board ("FASB") issued Accounting Standard Update ("ASU") No. 2014-09, Revenue from Contracts with Customers (Topic 606), which supersedes the revenue recognition requirements in the FASB's Accounting Standards Codification ("ASC") 605, Revenue Recognition.  This ASU is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  The ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract.  In July 2015, the FASB approved a one year deferral of the effective date to December 15, 2017, and early application would be permitted, but not before the original effective date of December 15, 2016, so the effective date will be the first quarter of fiscal year 2018 using one of two retrospective application methods.  The Company has not determined the potential effects on the consolidated financial statements.

In April 2015, the FASB issued ASU No. 2015-03, Simplifying the Presentation of Debt Issuance Cost, which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The new guidance is effective for the Company beginning

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in the first quarter of fiscal year 2017, with early adoption permitted. The Company is currently evaluating the impact that adoption of ASU 2015-03 will have on its consolidated financial statements.

In April 2015, the FASB issued ASU No. 2015-05, Intangibles - Goodwill and Other - Internal-Use Software, which provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, the update specifies that the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. The update further specifies that the customer should account for a cloud computing arrangement as a service contract if the arrangement does not include a software license. ASU 2015-05 will be effective for the Company in fiscal year 2016. Early adoption is permitted. An entity can elect to adopt the amendments either (1) prospectively to all arrangements entered into or materially modified after the effective date or (2) retrospectively. The Company is currently evaluating the impact that adoption of ASU 2015-03 will have on its consolidated financial statements.
Note 2 — Cash, cash equivalents and short-term investments
Cash equivalents consist of highly liquid fixed-income investments with original maturities of three months or less at the time of purchase, including money market funds. The Company has cash and cash equivalents held on its behalf by a third party of $0.3 million and $0.9 million as of June 30, 2015 and December 31, 2014, respectively. Short-term investments consist of readily marketable securities with a remaining maturity of more than three months from time of purchase. The Company classifies all of its cash equivalents and short-term investments as “available for sale,” as these investments are free of trading restrictions. These marketable securities are carried at fair value, with the unrealized gains and losses, net of tax, reported as accumulated other comprehensive income and included as a separate component of stockholders’ equity. Gains and losses are recognized when realized. When the Company determines that an other-than-temporary decline in fair value has occurred, the amount of the decline that is related to a credit loss is recognized in earnings. Gains and losses are determined using the specific identification method. The Company’s realized gains and losses in the three and six months ended June 30, 2015 and 2014 were insignificant.
Cash and cash equivalents and short-term investments consisted of the following as of June 30, 2015 and December 31, 2014 (in thousands):
June 30, 2015
 
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Estimated
Fair Value
Description
 
Cash
$
77,755

 
$

 
$

 
$
77,755

Cash equivalents:
 
 
 
 
 
 
 
Money market mutual funds
290

 

 

 
290

Total cash and cash equivalents
78,045

 

 

 
78,045

Short-term investments:
 
 
 
 
 
 
 
Corporate bonds
53,875

 
47

 
(103
)
 
53,819

U.S. agency securities
46,806

 
131

 
(30
)
 
46,907

Asset-backed securities
22,592

 
6

 
(27
)
 
22,571

U.S. Treasury securities
12,871

 
38

 
(4
)
 
12,905

Total short-term investments
136,144

 
222

 
(164
)
 
136,202

Cash, cash equivalents and short-term investments
$
214,189

 
$
222

 
$
(164
)
 
$
214,247

December 31, 2014
 

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Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Estimated
Fair Value
Description
 
Cash
$
89,589

 
$

 
$

 
$
89,589

Cash equivalents:
 
 
 
 
 
 
 
Money market mutual funds
793

 

 

 
793

Total cash and cash equivalents
90,382

 

 

 
90,382

Short-term investments:
 
 
 
 
 
 
 
Corporate bonds
49,110

 
29

 
(120
)
 
49,019

U.S. agency securities
42,004

 
56

 
(17
)
 
42,043

Asset-backed securities
21,083

 
8

 
(34
)
 
21,057

U.S. Treasury securities
12,859

 
27

 
(5
)
 
12,881

Total short-term investments
125,056

 
120

 
(176
)
 
125,000

Cash, cash equivalents and short-term investments
$
215,438

 
$
120

 
$
(176
)
 
$
215,382

The following table summarizes the cost and estimated fair value of short-term fixed income securities classified as short-term investments based on stated maturities as of June 30, 2015:
 
 
Amortized
Cost
 
Estimated
Fair Value
 
(in thousands)
Less than 1 year
$
14,892

 
$
14,897

Due in 1 to 3 years
121,543

 
121,595

Total
$
136,434

 
$
136,492

As of June 30, 2015, the Company did not consider any of its investments to be other-than-temporarily impaired.
Note 3 — Fair value of financial instruments
The Company measures certain financial instruments at fair value on a recurring basis. The Company uses a three-tier fair value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:
Level 1 valuations are based on quoted prices in active markets for identical assets or liabilities.

Level 2 valuations are based on inputs that are observable, either directly or indirectly, other than quoted prices included within Level 1. Such inputs used in determining fair value for Level 2 valuations include quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 valuations are based on information that is unobservable and significant to the overall fair value measurement.
All of the Company’s cash equivalents and short-term investments are classified within Level 1 or Level 2.
The following table presents information about the Company’s financial instruments that are measured at fair value as of June 30, 2015 and indicates the fair value hierarchy of the valuation (in thousands):

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Total
 
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
Description
 
Cash equivalents:
 
 
 
 
 
Money market mutual funds
$
290

 
$
290

 
$

Total cash equivalents
290

 
290

 

Short-term investments:
 
 
 
 
 
Corporate bonds
53,819

 

 
53,819

U.S. agency securities
46,907

 

 
46,907

Asset-backed securities
22,571

 

 
22,571

U.S. Treasury securities
12,905

 

 
12,905

Total short-term investments
136,202

 

 
136,202

Cash equivalents and short-term investments
$
136,492

 
$
290

 
$
136,202


The Company has restricted cash of $1.2 million and $0 within Other assets, respectively as of June 30, 2015, and December 31, 2014. The restricted cash is classified within Level 1.
The following table presents information about the Company’s financial instruments that are measured at fair value as of December 31, 2014 and indicates the fair value hierarchy of the valuation (in thousands):
 
 
Total
 
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
Description
 
Cash equivalents:
 
 
 
 
 
Money market mutual funds
$
793

 
$
793

 
$

Total cash equivalents
793

 
793

 

Short-term investments:
 
 
 
 
 
Corporate bonds
49,019

 

 
49,019

U.S. agency securities
42,043

 

 
42,043

Asset-backed securities
21,057

 

 
21,057

U.S. Treasury securities
12,881

 

 
12,881

Total short-term investments
125,000

 

 
125,000

Cash equivalents and short-term investments
$
125,793

 
$
793

 
$
125,000


The convertible notes issued by the Company in August 2013 are shown on the accompanying consolidated balance sheets at their original issuance value, net of unamortized discount, and are not marked to market each period. The approximate fair value of the convertible notes as of June 30, 2015 and December 31, 2014 was $125.4 million and $111.2 million, respectively. The fair value of the convertible notes was determined using quoted market prices for similar securities, which, due to limited trading activity, are considered Level 2 in the fair value hierarchy.
The Company did not have any financial liabilities measured at fair value or any long-term debt other than the Convertible debt as of June 30, 2015 and December 31, 2014.
Note 4 — Other current liabilities
Other current liabilities balances were comprised of the following (in thousands):

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June 30,
2015
 
December 31,
2014
Accrued Interest - Convertible Notes
941

 
938

Deferred rent
705

 
855

ESPP Withholding
636

 
776

 
$
2,282

 
$
2,569

Note 5 — Credit Facility and Capital Leases
Revolving Credit Facility

On July 5, 2012, the Company, entered into a three-year credit agreement which provides for a secured revolving line of credit based on eligible accounts receivable up to $30.0 million with a $2.0 million letter of credit sublimit. On May 5, 2014, the Company entered into an amendment to the credit agreement which reduced the secured revolving line of credit to $10.0 million. The quarterly commitment fee, payable in arrears, based on the available commitments is 0.30% per annum. There were no outstanding balances on the facility as of June 30, 2015.

The letter of credit for $550,000 required under an operating lease agreement for office space at the Company’s San Francisco headquarters expired on June 1, 2015. Any outstanding loans under the credit facility bear interest, at the Company’s option, at a base rate determined in accordance with the credit agreement, minus 0.5%, or at a LIBOR rate plus 2.0%. Principal, together with all accrued and unpaid interest, was due and payable on July 5, 2015, the maturity date. At June 30, 2015, the interest rate for borrowings under the facility was 2.2%. The credit agreement contains customary affirmative and negative covenants, as well as financial covenants. The Company was in compliance with all of the covenants under the credit agreement as of June 30, 2015. The credit agreement expired on July 5, 2015.
Letter of Credit
On February 3, 2015, the Company issued a $1.2 million letter of credit in connection with a lease for a new San Francisco facility. The letter of credit is secured by $1.2 million of a money market account which is considered restricted cash.
Capital Leases
The Company has capital lease agreements that are collateralized by the underlying property and equipment and expire through September 2019. The weighted-average imputed interest rates for the capital lease agreements were 5.4% and 5.6% at June 30, 2015 and 2014, respectively.
Future minimum annual payments under capital lease obligations as of June 30, 2015 were as follows (in thousands):
 
June 30,
2015
Years Ending December 31,
 
2015 (remaining six months)
$
95

2016
120

2017
66

2018
68

2019
51

Total
$
400

Note 6 — Debt
Senior Convertible Notes
In August 2013, the Company issued senior convertible notes (the “Notes”) raising gross proceeds of $150.0 million.
The Notes are governed by an Indenture, dated August 13, 2013 (the “Indenture”), between the Company and Wells Fargo Bank, National Association, as trustee. The Notes will mature on August 1, 2018, unless earlier repurchased or converted, and

11


bear interest at a rate of 1.50% per year payable semi-annually in arrears on February 1 and August 1 of each year, commencing February 1, 2014.
The Notes are convertible at an initial conversion rate of 61.6770 of common stock per $1,000 principal amount of Notes, which represents an initial conversion price of approximately $16.21 per share of common stock, subject to anti-dilution adjustments upon certain specified events, including in certain circumstances, upon a make-whole fundamental change (as defined in the Indenture). Upon conversion, the Notes will be settled in cash, shares of the Company’s common stock, or any combination thereof, at the Company’s option.
Prior to February 1, 2018, the Notes are convertible only upon the following circumstances:
during any calendar quarter commencing after December 31, 2013, (and only during such calendar quarter), if for at least 20 trading days (whether or not consecutive) during the period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter, the last reported sale price of common stock on such trading day is greater than or equal to 130% of the applicable conversion price on such trading day;
during the five business day period after any five consecutive trading day period in which the trading price per $1,000 principal amount of the Notes for each trading day of that five consecutive trading day period was less than 98% of the product of the last reported sale price of common stock and the applicable conversion rate on each such trading day; or
upon the occurrence of specified corporate events described in the Indenture.
The Notes were not convertible at June 30, 2015 under the circumstances listed above. However, the holders of the Notes may convert their Notes at any time on or after February 1, 2018, until the close of business on the second schedule trading day immediately preceding the maturity date, regardless of the foregoing circumstances.
The holders of the Notes may require the Company to repurchase all or a portion of their Notes at a cash repurchase price equal to 100% of the principal amount of the Notes being repurchased, plus accrued and unpaid interest, if any, upon a fundamental change (as defined in the Indenture). In addition, upon certain events of default (as defined in the Indenture), the trustee by notice to the Company, or the holders of at least 25% in principal amount of the outstanding Notes by notice to the Company and the trustee, may, and the trustee at the request of such holders shall, declare 100% of the principal amount of the Notes, plus accrued and unpaid interest, if any, on all the Notes to be due and payable. In case of certain events of bankruptcy, insolvency or reorganization involving the Company, 100% of the principal of and accrued and unpaid interest on the Notes will automatically become due and payable. The Notes were not subject to repurchase at June 30, 2015.
To account for the Notes at issuance, the Company separated the Notes into debt and equity components pursuant to the accounting standards for convertible debt instruments that may be fully or partially settled in cash upon conversion. The fair value of debt component was estimated using an interest rate for nonconvertible debt, with terms similar to the Notes, excluding the conversion feature. The carrying amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated convertible feature. The excess of the principal amount of the Notes over the fair value of the debt component was recorded as a debt discount and a corresponding increase in additional paid-in capital. The debt discount is accreted to interest expense over the term of the Notes using the interest method. The amount recorded to additional paid-in capital is not to be remeasured as long as it continues to meet the conditions of equity classification. Upon issuance of the $150.0 million of Notes, the Company recorded $111.5 million to debt and $38.5 million to additional paid-in capital.
The Company incurred transaction costs of approximately $4.9 million related to the issuance of the Notes. In accounting for these costs, the Company allocated the costs to the debt and equity components in proportion to the allocation of proceeds from the issuance of the Notes to such components. Transaction costs allocated to the debt component of $3.6 million are deferred as an asset and amortized to interest expense over the term of the Notes. The transaction costs allocated to the equity component of $1.3 million were recorded to additional paid-in capital. The transactions costs allocated to the debt component were recorded as deferred offering costs in other non-current assets.
The net carrying amount of the liability component of the Notes consists of the following (in thousands):
 
June 30, 2015

 
December 31, 2014

Principal amount
$
150,000

 
$
150,000

Unamortized debt discount
(25,699
)
 
(29,270
)
Net carrying amount
$
124,301

 
$
120,730

The following table presents the interest expense recognized related to the Notes (in thousands):

12


 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
Contractual interest expense at 1.5% per annum
$
562

 
$
562

 
$
1,125

 
$
1,125

Amortization of debt issuance costs
169

 
209

 
333

 
360

Accretion of debt discount
1,816

 
1,680

 
3,571

 
3,305

Total
$
2,547

 
$
2,451

 
$
5,029

 
$
4,790


The net proceeds from the Notes were approximately $145.1 million after payment of the initial purchasers' discount and offering expense. The Company used approximately $31.4 million of the net proceeds from the Notes to pay the cost of the Note Hedges described below, which was partially offset by $21.8 million of the proceeds from the Company's sale of the Warrants also described below.
Note Hedges
Concurrent with the issuance of the Notes, the Company entered into note hedges (“Note Hedges”) with certain bank counterparties, with respect to its common stock. The Company paid $31.4 million for the Note Hedges. The Note Hedges cover approximately 9.25 million shares of the Company's common stock at a strike price of $16.21 per share. The Note Hedges will expire upon the maturity of the Notes. The Note Hedges are intended to reduce the potential dilution to the Company's common stock upon conversion of the Notes and/or offset the cash payment in excess of the principal amount of the Notes the Company is required to make in the event that the market value per share of the Company's common stock at the time of exercise is greater than the conversion price of the Notes.
Warrants
Separately, the Company entered into warrant transactions, whereby it sold warrants to the same bank counterparties as the Note Hedges to acquire approximately 9.25 million shares of the Company's common stock at an initial strike price of $21.02 per share (“Warrants”), subject to anti-dilution adjustments. The Company received proceeds of approximately $21.8 million from the sale of the Warrants. If the fair value per share of the Company's common stock exceeds the strike price of the Warrants, the Warrants will have a dilutive effect on earnings per share, unless the Company elects, subject to certain conditions, to settle the Warrants in cash.
The amounts paid and received for the Note Hedges and the Warrants have been recorded in additional paid-in capital. The fair value of the Note Hedges and the Warrants are not remeasured through earnings each reporting period.
Note 7 — Commitments and Contingencies
Operating Leases
The Company leases its office space and certain equipment under noncancelable operating lease agreements with various expiration dates through November 30, 2022. Rent expense for the three months ended June 30, 2015 and 2014 was $2.6 million and $2.4 million, respectively, and for the six months ended June 30, 2015 and 2014 was $4.8 million and $4.6 million, respectively. The Company recognizes rent expense on a straight-line basis over the lease period and accrues for rent expense incurred but not paid.
In May 2015 the Company commenced a 7-year office lease expiring in November 2022 for a new corporate headquarters in San Francisco, California to occupy 24,394 square feet of space. The table below includes approximately $13.3 million of minimum lease payments over the 7-year lease term.
Future annual minimum lease payments under all noncancelable operating leases as of June 30, 2015 were as follows (in thousands): 

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June 30, 2015
Years Ending December 31,
 
2015 (remaining six months)
$
3,722

2016
6,769

2017
6,568

2018
6,224

2019
5,131

Thereafter
12,033

Total
$
40,447



Other Contractual Obligations
In August 2013, the Company issued the Notes raising gross proceeds of $150.0 million. The Notes will mature on August 1, 2018, unless earlier repurchased or converted, and bear interest at a rate of 1.50% per year payable semi-annually in arrears on February 1 and August 1 of each year, commencing February 1, 2014.
Litigation
On July 8, 2015, a class action securities lawsuit, Weller v. ServiceSource International, Inc. et al., was filed in the U.S. District Court for the Northern District of California (“Weller Lawsuit”) against Company and Company’s former Chief Executive Officer.  The Weller Lawsuit was brought on behalf of purchasers of Company stock during the period January 22, 2014 through May 1, 2014. Plaintiffs allege that the defendants made false and misleading statements about Company’s actual and expected financial performance. Plaintiffs seek unspecified damages. The Company believes that the claims are meritless, and will vigorously defend it.
From time to time, the Company may be subject to litigation or threatened litigation arising in the ordinary course of our business. Although the results of litigation and claims cannot be predicted with certainty, the Company is currently not aware of any litigation or threats of litigation in which the final outcome could have a material adverse effect on our business, operating results, financial position, or cash flows. Regardless of the outcome, litigation can have an adverse impact on the Company because of defense and settlement costs, diversion of management resources, and other factors. The Company records a contingent liability when it is probable that a loss has been incurred and the amount is reasonably estimable in accordance with accounting for contingencies.
Note 8 — Stock-Based Compensation
The following table summarizes the consolidated stock-based compensation expense included in the condensed consolidated statements of operations (in thousands):
 
 
Three Months Ended
 June 30,
 
Six Months Ended
 June 30,
 
2015
 
2014
 
2015
 
2014
Cost of revenue
$
659

 
$
1,099

 
$
1,495

 
$
2,133

Sales and marketing
716

 
1,583

 
1,647

 
3,420

Research and development
444

 
736

 
991

 
1,437

General and administrative
1,158

 
1,932

 
3,411

 
3,942

Total stock-based compensation
$
2,977

 
$
5,350

 
$
7,544

 
$
10,932


Determining Fair Value of Stock Awards
The Company estimates the fair value of stock option awards at the date of grant using the Black-Scholes option-pricing model. Options are granted with an exercise price equal to the fair value of the common stock as of the date of grant. Compensation expense is amortized net of estimated forfeitures on a straight-line basis over the requisite service period of the options, which is generally four years. Restricted stock, upon vesting, entitles the holder to one share of common stock for each

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restricted stock unit or award and has a purchase price of $0.0001 per share, which is equal to the par value of the Company’s common stock, and vests over four years. The fair value of the restricted stock is based on the Company’s closing stock price on the date of grant, and compensation expense, net of estimated forfeitures, is recognized on a straight-line basis over the vesting period.
Option and restricted stock activity under the 2011 Plan for the six months ended June 30, 2015 was as follows (shares in thousands)
 
 
 
Options Outstanding
 
Restricted Stock
Outstanding
 
Shares and Units
Available
for Grant
 
Number
of Shares
 
Weighted-
Average
Exercise
Price
 
Number
of Shares
Outstanding — December 31, 2014
5,982

 
10,070

 
$
5.08

 
5,476

Additional shares reserved under the 2011 equity incentive plan
3,364

 

 

 

Granted
(3,497
)
 
2,689

 
4.01

 
808

Options exercised/ Restricted stock released

 
(261
)
 
5.60

 
(1,439
)
RSU shares withheld for taxes
156

 

 

 
156

Canceled/Forfeited
2,660

 
(1,666
)
 
5.60

 
(995
)
Outstanding — June 30, 2015
8,665

 
10,832

 
4.76

 
4,006

    
The weighted average grant-date fair value of employee stock options granted during the three months ended June 30, 2015 and 2014 was $1.30 and $1.59 per share, respectively and for the six months ended June 30, 2015 and 2014 was $1.30 and $2.15 per share, respectively. The unamortized grant date fair value of both stock options and restricted stock awards totaled $24.2 million at June 30, 2015.
Note 9 — Income Taxes

The Company is subject to taxation in the United States and various state and foreign jurisdictions. Earnings from non-U.S. activities are subject to local country income tax. The Company computes its quarterly income tax provision by using a forecasted annual effective tax rate and adjusts for any discrete items arising during the quarter. The primary difference between the effective tax rate and the federal statutory tax rate relates to the valuation allowances on the Company’s net operating losses and foreign tax rate differences. The Company is currently undergoing examination of the California Franchise Tax Returns relating to California state income taxes of its U.S. operating subsidiary for the years 2008 through 2010. The tax years 2008 through 2014 remain subject to examination by federal state and foreign tax authorities. The Company does not provide for federal income taxes on the undistributed earnings of its foreign subsidiaries as such earnings are to be reinvested indefinitely outside the U.S.

Consistent with the Company’s practice in prior periods for assessing realization of deferred tax assets, management believes based on the available objective evidence it is more likely than not that the tax benefits of the U.S. and Singapore losses will not be realized by the end of 2015. As a result, the Company continues to provide a valuation allowance for all U.S. federal net deferred tax assets, for all Singapore net deferred tax assets, and for substantially all of the Company’s state deferred tax assets other than those as described below.

Management assesses the available positive and negative evidence to estimate if sufficient future taxable income will be generated to use the existing deferred tax assets. A significant piece of objective negative evidence evaluated was a recent state tax law change in May 2015 that impacts the manner in which the Company apportions revenue. Such objective evidence limits the ability to consider other subjective evidence such as our projections for future growth. On the basis of this evaluation, as of June 30, 2015, a valuation allowance of $0.6 million has been recorded to record only the portion of the state deferred tax asset that is more likely than not to be realized. Note that changes in tax laws and rates may affect other deferred tax assets and liabilities recorded in the future. These changes are accounted for in the period of enactment and thus are reflected in the Company’s June 30, 2015 financial results. As a result of the recent state tax law change discussed above, the Company has also recorded approximately $0.3 million as a discrete item in our tax provision for the second quarter of 2015.

The Company’s gross amount of unrecognized tax benefits was $0.9 million as of June 30, 2015 and as of December 31, 2014, $0.1 million of which, if recognized, would affect the Company’s effective tax rate.

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Note 10 — Segment and Geographical Information
The Company’s Chief Operating Decision Maker (CODM), its Chief Executive Officer, evaluates the performance of its two operating segments based on net revenue and gross profit. Gross profit for each segment includes revenues and the related cost of revenue directly attributable to the segment. The Company does not allocate sales and marketing, research and development, or general and administrative expenses to its operating segments because management does not include the information in its measurement of the performance of the operating segments. The Company does not evaluate its operating segments using discrete asset information.
Managed Services- The Company’s managed services solution consists of end-to-end management and optimization of the recurring revenue process, including quoting, selling and business intelligence. The Company's managed services business is built on its pay-for-performance model, whereby customers pay the Company a commission based on renewal sales that it generates on their behalf. The Company’s managed services offerings include quoting and selling services, in which dedicated service teams have specific expertise in the customers’ businesses, are deployed under the Company's customers’ brands and follow a sales process tailored specifically to increase service contract renewals.
Cloud and Business Intelligence- The Company’s cloud and business intelligence solution consist of its subscription sales and professional services to deploy the Company's solutions. Subscription sales consists of selling subscriptions to Renew OnDemand and ServiceSource Revenue Analytics, both SaaS applications. The foundation of the Company’s cloud solution is Renew OnDemand, a SaaS-based renewal management system based on its data warehouse of transactional, analytical and industry data that grows with each service renewal transaction and customer. 
Summarized financial information by reporting segments based on the Company’s internal management reporting and as utilized by the Company’s CODM, is as follows (in thousands):
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2015
 
2014
 
2015
 
2014
Net Revenue
 
 
 
 
 
 
 
 
Managed Services
 
$
56,223

 
$
58,575

 
$
114,237

 
$
117,144

Cloud and Business Intelligence
 
5,390

 
7,422

 
13,573

 
15,669

 
 
61,613

 
65,997

 
127,810

 
132,813

 
 
 
 
 
 
 
 
 
Gross Profit
 
 
 
 
 
 
 
 
Managed Services
 
17,314

 
15,986

 
33,332

 
33,249

Cloud and Business Intelligence
 
1,607

 
1,493

 
5,971

 
3,451

 
 
18,921

 
17,479

 
39,303

 
36,700

 
 
 
 
 
 
 
 
 
Unallocated operating expenses
 
28,500

 
36,349

 
57,073

 
71,601

Loss from operations
 
$
(9,579
)
 
$
(18,870
)
 
$
(17,770
)
 
$
(34,901
)

The Company’s business is geographically diversified. For the six months ended June 30, 2015, 65% of our net revenue was earned in North America and Latin America (“NALA”), 24% in Europe, Middle East and Africa (“EMEA”) and 11% in Asia Pacific-Japan (“APJ”). Net revenue for a particular geography generally reflects commissions earned from sales of service contracts managed from our sales centers in that geography and subscription sales and professional services to deploy the Company's solutions. Predominantly all of the service contracts sold and managed by our sales centers relate to end customers located in the same geography. All of NALA net revenue represents revenue generated in the United States.
Summarized financial information by geographic location based on the Company’s internal management reporting is as follows (in thousands):

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Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2015
 
2014
 
2015
 
2014
Net revenue
 
 
 
 
 
 
 
NALA
$
40,859

 
$
43,140

 
$
83,049

 
$
85,958

EMEA
13,743

 
16,354

 
31,206

 
34,442

APJ
7,011

 
6,503

 
13,555

 
12,413

Total net revenue
$
61,613

 
$
65,997

 
$
127,810

 
$
132,813


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Note 11 — Restructuring and other
The Company announced at the beginning of the third quarter of 2014 a restructuring effort to better align our cost structure with current revenue levels. The restructuring plans are accounted for in accordance with ASC 420, Exit or Disposal Cost Obligations. The Company recognized restructuring and other charges of $3.0 million and $3.7 million during the three and six month periods ended June 30, 2015. Restructuring costs includes separation payments, related employee benefits and retention bonuses. Other costs include $0.6 million of severance related expenses and $2.6 million of stock based compensation related to the accelerated vesting of certain equity awards granted to the Company's former interim CFO and CEO.
Restructuring and other activities for the period ended June 30, 2015 is summarized as follows (in thousands):
 
Restructuring
 
Other
 
Total
Restructuring and other liability at December 31, 2014
$
364

 
$
251

 
$
615

Restructuring and other charges
355

 
3,384

 
3,739

Cash paid
(717
)
 
(652
)
 
(1,369
)
Acceleration of stock-based compensation expense in additional paid-in capital

 
(2,579
)
 
(2,579
)
Restructuring and other liability at June 30, 2015
$
2

 
$
404

 
$
406




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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and with our Annual Report on Form 10-K/A for the year ended December 31, 2014.
This Quarterly Report on Form 10-Q contains “forward-looking statements” that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. These forward-looking statements include, but are not limited to, statements related to changes in market conditions that impact our ability to generate service revenue on behalf of our customers; errors in estimates as to the service revenue we can generate for our customers; our ability to attract new customers and retain existing customers; risks associated with material defects or errors in our software or the effect of data security breaches; our ability to adapt our solution to changes in the market or new competition; our ability to improve our customers’ renewal rates, margins and profitability; our recurring revenue opportunity under management; our ability to increase our revenue and contribution margin over time from new and existing customers, including as a result of sales of our next-generation technology platform, Renew OnDemand, on a stand-alone subscription basis; our ability to implement Renew OnDemand, ServiceSource Revenue Analytics (formerly Scout Analytics), ServiceSource Customer Success or our other SaaS offerings; our strategy with respect to our business services and SaaS businesses, cloud offering and managed services and cost allocation and management efforts; the potential effect of mergers and acquisitions on our customer base; business strategies and new sales initiatives; technology development; protection of our intellectual property; investment and financing plans; liquidity, our leverage consisting of convertible notes and related matters concerning our note hedges and warrants; our competitive position; the effects of competition; industry environment; potential growth opportunities; and our expected benefits from the acquisition of Scout. Forward-looking statements are also often identified by the use of words such as, but not limited to, “anticipate,” “believe,” “can,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “project,” “seek,” “should,” “target,” “will,” “would,” and similar expressions or variations intended to identify forward-looking statements. These statements are based on the beliefs and assumptions of our management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section of this Quarterly Report on Form 10-Q titled “Risk Factors.” Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.
All dollar amounts expressed as numbers in this MD&A (except per share amounts) are in millions.
OVERVIEW
ServiceSource International, Inc. (NASDAQ: SREV) is the global leader in customer success and recurring revenue growth solutions across the Revenue Lifecycle. As a subset of the Customer Lifecycle Management business segment, the Revenue Lifecycle addresses critical elements of customer success, recurring revenue growth, and renewal processes, which include on-boarding, adoption, upsell, cross-sell, retention and renewals. Our solutions are designed to optimize the retention rates and recurring revenue performance for our customers to drive revenue growth and decrease churn from their own existing business-to-business ("B2B") customers.
Our solutions are comprised of managed services, cloud software and best-practice processes. In delivering our services, we leverage industry and company data, leading-edge technology and best-practices drawn from our deep database of renewal benchmarks. By integrating managed services, cloud software and data, we provide end-to-end management and optimization of the customer onboarding, adoption, subscription and service-contract renewal process.
Our managed services business leverages either a flat-rate or a pay-for-performance model whereby our customers pay us a commission based on renewal sales that we generate on their behalf. Our cloud software offerings currently include: ServiceSource Revenue Analytics (formerly Scout Analytics), Renew OnDemand and the ServiceSource Customer Success application, all of which automate and provide data-driven insights into these highly valuable but typically manual business processes. Our cloud offerings and managed services can drive higher subscription, maintenance and support revenue while improving customer retention and increasing business predictability.

The scalability of our solution enables us to sell in over 40 languages from six sales centers around the globe. Our solution is designed to optimize recurring revenue across different revenue models, distribution models, and segments, including hardware, software, SaaS, industrial systems, information and media, as well as technology-enabled health care and life sciences.

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As part of our introduction of Renew OnDemand in prior years, we had been expanding the organization, investing in our engineering and sales and marketing organization primarily in advance of our goal of an increase in revenues from both existing customers and new customers due to increased adoption of our new SaaS platform. We also acquired Scout Analytics in January 2014, believing that Scout Analytics’ new business acquisitions in the months prior to the merger demonstrated growth potential for the near term. For both SaaS platforms, we experienced a slower adoption rate than we originally planned. As a result of this slower adoption, the Company announced a restructuring plan in the third quarter of 2014, with the intention of reducing the resources to better match the expected revenues. In addition, with the incurred losses in combination with lower stock price, we performed a goodwill and long lived asset impairment analysis in the third and fourth quarters of 2014. In 2014, we recorded a goodwill and other intangible asset impairment of $25.1 million for the Cloud and Business Intelligence segment.
Key Business Metrics
In assessing the performance of our business, we consider a variety of business metrics in addition to the financial metrics discussed below under, “-Basis of Presentation.” These key metrics include recurring revenue opportunity under management and number of engagements.

Recurring Revenue Opportunity Under Management. At December 31, 2014, we estimated our opportunity under management to be over $13.5 billion. Opportunity under management is a forward-looking metric and is our estimate, as of a given date, of the value of all end customer service contracts that we will have the opportunity to service on behalf of our customers over the subsequent twelve-month period. Opportunity under management is not a measure of our expected revenue. Opportunity under management reflects our estimate for a forward twelve-month period and should not be used to estimate our opportunity for any particular quarter within that period. The value of end customer contracts actually delivered during a twelve-month period should not be expected to occur in even quarterly increments due to seasonality and other factors impacting our customers and their end customers. We estimate the value of such end customer contracts based on a combination of factors, including the value of end customer contracts made available to us by our customers in past periods, the minimum value of end customer contracts that our customers are required to give us the opportunity to sell pursuant to the terms of our contracts with them, periodic internal business reviews of our expectations as to the value of end customer contracts that will be made available to us by our customers, the value of end customer contracts included in the Service Performance Analysis (“SPA”) and collaborative discussions with our customers assessing their expectations as to the value of service contracts that they will make available to us for sale. While the minimum value of end customer contracts that our customers are required to give us represents a portion of our estimated opportunity under management, a significant portion of the opportunity under management is estimated based on the other factors described above. As our experience with our business, our customers and their contracts has grown, we have continually refined the process, improved the assumptions and expanded the data related to our calculation of opportunity under management. When estimating recurring revenue opportunity under management, we must, to a large degree, rely on the assumptions described above, which may prove incorrect. These assumptions are inherently subject to significant business and economic uncertainties and contingencies, many of which are beyond our control. Our estimates therefore may prove inaccurate, causing the actual value of end customer contracts delivered to us in a given twelve-month period to differ from our estimate of opportunity under management. These factors include:

the extent to which customers deliver a greater or lesser value of end customer contracts than may be required or
otherwise expected;
roll-overs of unsold service contract renewals from prior periods to the current period or future periods;
changes in the pricing or terms of service contracts offered by our customers;
increases or decreases in the end customer base of our customers;
the extent to which the renewal rates we achieve on behalf of a customer early in an engagement affect the amount of
opportunity that the customer makes available to us later in the engagement;
customer cancellations of their contracts with us; and
changes in our customers’ businesses, sales organizations, management, sales processes or priorities.

Our managed services revenue also depends on our close rates and commissions. Our close rate is the percentage of opportunity under management that we renew on behalf of our customers. Our commission rate is an agreed-upon percentage of the renewal value of end customer contracts that we sell on behalf of our customers.

Our close rate is impacted principally by our ability to successfully sell service contracts on behalf of our customers. Other factors impacting our close rate include: the manner in which our customers price their service contracts for sale to their end customers; the stage of life-cycle associated with the products and underlying technologies covered by the service contracts offered to the end customer; the extent to which our customers or their competitors introduce new products or underlying

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technologies; the nature, size and age of the service contracts; and the extent to which we have managed the renewals process for similar products and underlying technologies in the past.

In determining commission rates for an individual engagement, various factors, including our close rates, as described above, are evaluated. These factors include: historical, industry-specific and customer-specific renewal rates for similar service contracts; the magnitude of the opportunity under management in a particular engagement; the number of end customers associated with these opportunities; and the opportunity to receive additional performance commissions when we exceed certain renewal levels. We endeavor to set our commission rates at levels commensurate with these factors and other factors that may be relevant to a particular engagement. Accordingly, our commission rates vary, often significantly, from engagement to engagement. In addition, we sometimes agree to lower commission rates for engagements with significant opportunity under management.

In 2014, we experienced a decline in opportunity under management for our managed services business due to a number of contraction and nonrenewal by some of our customers. We expect the reduction in opportunity under management experienced in 2014 will continue to impact our 2015 revenues until we can replace this decline in opportunity under management.

Number of Engagements. We track the number of engagements we have with our customers. We often have multiple engagements with a single customer, particularly where we manage the sales of service renewals relating to different product lines, technologies, types of contracts or geographies for the customer. When the set of renewals we manage on behalf of a customer is associated with a separate customer contract or a distinct product set, type of end customer contract or geography and therefore requires us to assign a service sales team to manage the renewals, we designate the set of renewals, and associated revenues and costs to us as a unique engagement. For example, we may have one engagement consisting of a service sales team selling maintenance contract renewals of a particular product for a customer in the United States and another engagement consisting of a sales team selling warranty contract renewals of a different product for the same customer in Europe. These would count as two engagements. We had 164 and 196 engagements as of June 30, 2015 and 2014 respectively.
Factors Affecting our Performance

Sales Cycle. We sell our integrated solution through our sales organization. At the beginning of the sales process, our quota-carrying sales representatives contact prospective customers and educate them about our offerings. Educating prospective customers about the benefits of our solution can take time, as many of these prospects have not historically relied upon integrated solutions like ours for service revenue management, nor have they typically put out a formal request for proposal or otherwise made a decision to focus on this area. As part of our sales process, we utilize our solutions design team to perform a SPA of our prospect’s service revenue. The SPA includes an analysis of best practices and benchmarks the prospect’s service revenue against industry peers. Through the SPA process, which typically takes several weeks, we are able to assess the characteristics and size of the prospect’s service revenue, identify potential areas of performance improvement, and formulate our proposal for managing the prospect’s service revenue. The length of our sales cycle for a new customer, inclusive of the SPA process and measured from our first formal discussion with the customer until execution of a new customer contract, is typically longer than six months and has increased in recent periods.

We generally contract with new customers to manage a specified portion of their service revenue opportunity, such as the opportunity associated with a particular product line or technology, contract type or geography. We negotiate the engagement specific terms of our customer contracts, including commission rates, based on the output of the SPA, including the areas identified for improvement. Once we demonstrate success to a customer with respect to the opportunity under contract, we seek to expand the scope of our engagement to include other opportunities with the customer. For some customers, we manage all or substantially all of their service contract renewals.

For cloud offerings, the SPA may be more limited and focused on the benefits of the respective technology and therefore may take less time.

Implementation Cycle. After entering into an engagement with a new customer, and to a lesser extent after adding an engagement with an existing customer, we incur sales and marketing expenses related to the commissions owed to our sales personnel. The commissions are based on the estimated total contract value, with a material portion of the commission expensed upfront with the remaining portion expensed ratably over a period of twelve to fourteen months. We also make upfront investments in technology and personnel to support the engagement. These expenses are typically incurred one to three months before we begin generating sales and recognizing revenue. Accordingly, in a given quarter, an increase in new customers, and, to a lesser extent, an increase in engagements with existing customers, or a significant increase in the contract

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value associated with such new customers and engagements, will negatively impact our gross margin and operating margins until we begin to achieve anticipated sales levels associated with the new engagements, which is typically two-to-three quarters after we begin selling contracts on behalf of our customers.

Although we expect new customer engagements to contribute to our operating profitability over time, in the initial periods of a customer relationship, the near term impact on our profitability can be negatively impacted by slower-than anticipated growth in revenues for these engagements as well as the impact of the upfront costs we incur, the lower initial level of associated service sales team productivity and lack of mature data and technology integration with the customer. As a result, an increase in the mix of new customers as a percentage of total customers may initially have a negative impact on our operating results. Similarly, a decline in the ratio of new customers to total customers may positively impact our near-term operating results.

Contract Terms. Substantially all of our managed services revenue comes from our pay-for-performance model. Under our pay-for-performance model, we earn commissions based on the value of service contracts we sell on behalf of our customers. In some cases, we earn additional performance-based commissions for exceeding pre-determined service renewal targets.

Our new customer contracts typically have an initial term between two and four years. Our contracts generally require our customers to deliver a minimum value of qualifying service revenue contracts for us to renew on their behalf during a specified period. To the extent that our customers do not meet their minimum contractual commitments over a specified period, they may be subject to fees for the shortfall. Our customer contracts are cancelable on relatively short notice, subject in most cases to the payment of an early termination fee by the customer. The amount of this fee is based on the length of the remaining term and value of the contract.

We invoice our customers on a monthly basis based on commissions we earn during the prior month, and with respect to performance-based commissions, on a quarterly basis based on our overall performance during the prior quarter. Amounts invoiced to our customers are recognized as revenue in the period in which our services are performed or, in the case of performance commissions, when the performance condition is determinable. Because the invoicing for our services generally coincides with or immediately follows the sale of service contracts on behalf of our customers, we do not generate or report a significant deferred revenue balance. However, the combination of factors such as, but not limited to minimum contractual commitments, the performance improvement potential identified by our SPA process, our success in generating improved renewal rates for our customers, and our customers’ historical renewal rates, for example, help to provide us with revenue visibility, but may all affect our performance favorably or unfavorably.

M&A Activity. Our customers, particularly those in the technology sector, participate in an active environment for mergers and acquisitions. Large technology companies have maintained active acquisition programs to increase the breadth and depth of their product and service offerings and small and mid-sized companies have combined to better compete with large technology companies. A number of our customers have merged, purchased other companies or been acquired by other companies. We expect merger and acquisition activity to continue to occur in the future.

The impact of these transactions on our business can vary. Acquisitions of other companies by our customers can provide us with the opportunity to pursue additional business to the extent the acquired company is not already one of our customers. Similarly, when a customer is acquired, we may be able to use our relationship with the acquired company to build a relationship with the acquirer. In some cases we have been able to maintain our relationship with an acquired customer even where the acquiring company handles its other service contract renewals through internal resources. In other cases, however, acquirers have elected to terminate or not renew our contract with the acquired company.

Economic Conditions and Seasonality. An improving economic outlook generally has a positive, but mixed, impact on our business. As with most businesses, improved economic conditions can lead to increased end customer demand and sales. In particular, within the technology sector, we believe that the recent economic downturn led many companies to cut their expenses by choosing to let their existing maintenance, support and subscription agreements lapse. An improving economy may have the opposite effect.

However, an improving economy may also cause companies to purchase new hardware, software and other technology products, which we generally do not sell on behalf of our customers, instead of purchasing maintenance, support and subscription services for existing products. To the extent this occurs, it would have a negative impact on our opportunities in the near term that would partially offset the benefits of an improving economy.


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We believe the current uncertainty in the economy, combined with shifting market forces toward subscription-based models, is impacting a number of our customers and prospective customers, particularly in the traditional enterprise software and hardware segments. These forces have placed pressure on end customer demand for their renewal contracts and also have led to some slower decision making in general. This economic and industry environment has adversely affected the conversion rates for end customers and contracts. To the extent these conditions continue they will impact our future revenues.

In addition to the uncertainty in the macroeconomic environment, we experience a seasonal variance in our revenue typically for the third quarter of the year as a result of lower or flat renewal volume corresponding to the timing of our customers’ product sales particularly in the international regions. The impact of this seasonal fluctuation can be amplified if the economy as a whole is experiencing disruption or uncertainty, leading to deferral of some renewal decisions. As we increase our subscription revenue base, this seasonality will become less apparent. However for at least the next couple years, we would expect this pattern to continue.

Establishment of “Software-as-a-Service” Business unit. Within the software industry, there is a growing trend toward providing software to customers using a software-as-a-service (“SaaS”) model. Under this model, SaaS companies provide access to software applications to customers on a remote basis, and provide their customers with a subscription to use the software, rather than licensing software to their customers.

We have several SaaS-based applications that we develop and support: Renew OnDemand (our purpose-built offering to manage and maximize recurring revenue), ServiceSource Revenue Analytics (formerly Scout Analytics, our SaaS offering to help companies with predictive analytics for recurring revenue), and other SaaS cloud offerings such as ServiceSource Customer Success. Our research and development costs are primarily related to these SaaS based applications. We intend to maintain customer support, training and professional service organizations to support deployments of our solutions. Our current spending incorporates a level of investment required for development of our products and are targeted at improving the tools and infrastructure that will make the product easier to deploy and support in the future. We believe that the level of effort to deploy and maintain these applications will decline over time, due to product development investments made in 2014 to improve the application layer of the solutions and to improve the underlying database architecture and reduce the overall cost of our cloud infrastructure. As a result, we expect costs to decline in 2015 and rise more slowly or at the same pace as revenue growth in future years.
Basis of Presentation
Net Revenue

Substantially all of our net revenue is attributable to commissions we earn from the sale of renewals of maintenance, support and subscription agreements on behalf of our customers. We generally invoice our customers for our services in arrears on a monthly basis for sales commissions, and on a quarterly basis for certain performance sales commissions; accordingly, we typically have no deferred revenue related to these services. We do not set the price, terms or scope of services in the service contracts with end customers and do not have any obligations related to the underlying service contracts between our customers and their end customers.

We also earn revenue from the sale of subscriptions to our cloud based applications. To date, subscription revenue has been a small percentage of total revenue. We expect revenues generated from subscriptions of Renew OnDemand and ServiceSource SaaS cloud offerings to remain flat for the remainder of 2015 due to subscription losses from our initial customers. Subscription fees are accounted for separately from our managed service commissions, and they are billed in advance over a monthly, quarterly or annual basis. Subscription revenue is typically recognized ratably over the related subscription term.

We have generated a significant portion of our revenue from a limited number of customers. Our top ten customers accounted for 55% and 50% of our net revenue for the six months ended June 30, 2015 and 2014, respectively.

Effective April 2015, our largest customer reduced the scope of our managed services engagement with us and its subscription of our legacy system. Our opportunity under management reflects this reduction as of December 31, 2014.

The loss of revenue from any of our top customers for any reason, including the failure to renew our contracts, termination of some or all of our services, a change of relationship with any of our key customers or their acquisition, can cause a significant decrease in our revenue. We experienced a slight decrease in revenue in the three and six months ended on June 30, 2015 due to customer cancellation and reductions, including among some or our top customers, in excess of new customer additions and expansions for the managed services segment. The customer cancellations and reductions in the second half of

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2014 were higher than our historical rates, and we have continued to experience the effects of these cancellations and reductions on our revenue in the second quarter of 2015.

Our business is geographically diversified. Through the first half of 2015, 65% of our net revenue was earned in North America and Latin America (“NALA”), 24% in Europe, Middle East and Africa (“EMEA”) and 11% in Asia Pacific-Japan (“APJ”). Net revenue for a particular geography generally reflects commissions earned from sales of service contracts managed from our sales centers in that geography. Predominantly all of the service contracts sold and managed by our sales centers relate to end customers located in the same geography. In addition, our Kuala Lumpur location is also our global sales operations center where we have centralized, for our worldwide operations, the key contract renewal processes that do not require regional expertise, such as customer data management and quoting. We do not generate any customer revenue out of Kuala Lumpur, so it is effectively a cost center which contributes to our APJ region.
Cost of Revenue and Gross Profit

Our cost of revenue expenses include employee compensation, technology costs, including those related to the delivery of our cloud-based solutions, and allocated overhead costs. Compensation includes salary, bonus, benefits and stock-based compensation for our dedicated service sales teams. Our allocated overhead includes costs for facilities, information technology and depreciation, including amortization of internal-use software associated with our service revenue technology platform and cloud applications. Allocated costs for facilities consist of rent, maintenance and compensation of personnel in our facilities departments. Our allocated costs for information technology include costs associated with third-party data centers where we maintain our data servers, compensation of our information technology personnel and the cost of support and maintenance contracts associated with computer hardware and software. To the extent our customer base or opportunity under management expands, we may need to hire additional service sales personnel and invest in infrastructure to support such growth. We currently expect that our cost of revenue will fluctuate significantly and may increase on an absolute basis and as a percentage of revenue in the near term, including for the reasons discussed above under, “-Factors Affecting Our Performance-Implementation Cycle”. We are currently taking measures to reduce the costs to deliver our solutions and support our customer engagements, in order to improve our gross profit. Over the remaining quarters in 2015, we expect to see current cost reduction offset by investments we are making to drive further reductions to our cost to deliver and improved gross profit in 2016. We are also evaluating additional measures to further reduce our costs of revenue as opportunity under management has declined and we now are delivering our SAAS offerings on a more focused criteria than our initial engagements.

Operating Expenses

Sales and Marketing. Sales and marketing expenses consist primarily of compensation and sales commissions for our sales and marketing staff, allocated expenses and marketing programs and events. We sell our solutions through our global sales organization, which is organized across three geographic regions: NALA, EMEA and APJ. Our commission plans provide that payment of commissions to our sales representatives is contingent on their continued employment, and we recognize expense over a period that is generally between twelve and fourteen months following the execution of the applicable contract. When commissions are paid out upon contract signing and are not contingent on future payments and continued employment, we expense the sales commission upon contract signing. We currently expect sales and marketing expenses to decline in 2015 and decrease or remain flat as a percentage of revenue in future years.

Research and Development. Research and development expenses consist primarily of compensation, allocated costs and the cost of third-party service providers. We focus our research and development efforts on developing new products and related applications for revenue analytics. In connection with the development and enhancements of our SaaS cloud applications, we capitalize certain expenditures related to the development and enhancement of internal-use software related to our technology platform. We expect research and development spending to decline in 2015 and decrease or remain flat as a percentage of revenue in future years.

General and Administrative. General and administrative expenses consist primarily of compensation for our executive, human resources, finance and legal functions, and related expenses for professional fees for accounting, tax and legal services, as well as allocated expenses. We expect that our general and administrative expenses will remain flat or slightly lower on an absolute basis as we streamline our operations where possible.

Restructuring and other. Restructuring and other expenses consist primarily of employees’ severance payments, related employee benefits, retention bonuses and charges related to cancellation of contracts.

Interest expense and other, net

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Interest expense. Interest expense consists primarily of interest expense associated with our convertible debt, fees related to our credit facility, capital lease payments; accretion of debt discount; and amortization of debt issuance costs. We recognize accretion of debt discount and amortization of interest costs using the effective interest method. We expect our interest expense to increase slightly in 2015 from accretion of debt discount, amortization of deferred financing costs and contractual interest costs as a result of our August 2013 issuance of $150.0 million aggregate principal amount of convertible notes due August 2018.

Other, net. Other, net consists primarily of the interest income earned on our cash, cash equivalents and marketable securities investments and foreign exchange gains and losses. We expect other income to vary depending on the movement in foreign currency exchange rates and the related impact on our foreign exchange gain (loss) and the return of interest on our investments.

Income Tax Provision

We account for income taxes using an asset and liability method, which requires the recognition of taxes payable or refundable for the current year and deferred tax assets and liabilities for the expected future tax consequences of temporary differences that currently exist between the tax basis and the financial reporting basis of our taxable subsidiaries’ assets and liabilities using the enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in operations in the period that includes the enactment date. The measurement of deferred tax assets is reduced, if necessary, by the amount of any tax benefits that, based on available evidence, are not expected to be realized.

We evaluate our ability to realize the tax benefits associated with deferred tax assets on a jurisdictional basis. This evaluation utilizes the framework contained in ASC 740, Income Taxes, wherein management analyzes all positive and negative evidence available at the balance sheet date to determine whether all or some portion of our deferred tax assets will not be realized. Under this guidance, a valuation allowance must be established for deferred tax assets when it is more likely than not (a probability level of more than 50 percent) that they will not be realized. In assessing the realization of our deferred tax assets, we consider all available evidence, both positive and negative.

In performing our evaluation, we place significant emphasis on guidance contained in ASC 740, which states that “a cumulative loss in recent years is a significant piece of negative evidence that is difficult to overcome.”

We account for unrecognized tax benefits using a more-likely-than-not threshold for financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. We establish reserves for tax-related uncertainties based on estimates of whether, and the extent to which, additional taxes will be due. We record an income tax liability, if any, for the difference between the benefit recognized and measured and the tax position taken or expected to be taken on our tax returns. To the extent that the assessment of such tax positions change, the change in estimate is recorded in the period in which the determination is made. The reserves are adjusted in light of changing facts and circumstances, such as the outcome of a tax audit. The provision for income taxes includes the impact of reserve provisions and changes to reserves that are considered appropriate.
Results of Operations
The table below sets forth our consolidated results of operations for the periods presented. The period-to-period comparison of financial results presented below is not necessarily indicative of financial results to be achieved in future periods. 

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Three Months Ended
 June 30,
 
Six Months Ended
 June 30,
 
2015
 
2014
 
2015
 
2014
 
(in thousands)
Net revenue
$
61,613

 
$
65,997

 
$
127,810

 
$
132,813

Cost of revenue
42,692

 
48,518

 
88,507

 
96,113

Gross profit
18,921

 
17,479

 
39,303

 
36,700

Operating expenses:
 
 
 
 
 
 
 
Sales and marketing
10,165

 
17,212

 
21,000

 
32,883

Research and development
4,646

 
6,881

 
9,468

 
13,597

General and administrative
10,701

 
12,256

 
22,866

 
25,121

Restructuring and other
2,988

 

 
3,739

 

Total operating expenses
28,500

 
36,349

 
57,073

 
71,601

Loss from operations
(9,579
)
 
(18,870
)
 
(17,770
)
 
(34,901
)
Interest expense and other, net
(2,739
)
 
(2,196
)
 
(4,584
)
 
(4,770
)
Loss before income taxes
(12,318
)
 
(21,066
)
 
(22,354
)
 
(39,671
)
Income tax provision
1,089

 
26

 
1,223

 
161

Net loss
$
(13,407
)
 
$
(21,092
)
 
$
(23,577
)
 
$
(39,832
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended
 June 30,
 
Six Months Ended
 June 30,
 
2015
 
2014
 
2015
 
2014
 
(in thousands)
Includes stock-based compensation of:
 
 
 
 
 
Cost of revenue
$
659

 
$
1,099

 
$
1,495

 
$
2,133

Sales and marketing
716

 
1,583

 
1,647

 
3,420

Research and development
444

 
736

 
991

 
1,437

General and administrative
1,158

 
1,932

 
3,411

 
3,942

Total stock-based compensation
$
2,977

 
$
5,350

 
$
7,544

 
$
10,932



The following table sets forth our operating results as a percentage of net revenue:

 
Three Months Ended
 June 30,
 
Six Months Ended
 June 30,
 
2015
 
2014
 
2015
 
2014
 
(as % of net revenue)
Net revenue
100
 %
 
100
 %
 
100
 %
 
100
 %
Cost of revenue
69
 %
 
74
 %
 
69
 %
 
72
 %
Gross profit
31
 %
 
26
 %
 
31
 %
 
28
 %
Operating expenses:
 
 
 
 
 
 
 
Sales and marketing
16
 %
 
26
 %
 
16
 %
 
25
 %
Research and development
8
 %
 
10
 %
 
7
 %
 
10
 %
General and administrative
17
 %
 
19
 %
 
18
 %
 
19
 %
Restructuring and other
5
 %
 
 %
 
3
 %
 
 %
Total operating expenses
46
 %
 
55
 %
 
44
 %
 
54
 %
Loss from operations
(15
)%
 
(29
)%
 
(13
)%
 
(26
)%


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Three months ended June 30, 2015 and June 30, 2014

Net Revenue 
 
Three Months Ended
June 30,
 
 
 
 
 
2015
 
2014
 
 
 
 
 
Amount
 
% of Net Revenue
 
Amount
 
% of Net Revenue
 
Change
 
% Change
 
(in thousands)
Net revenue
 
 
 
 
 
 
 
 
 
 
 
Managed Services
$
56,223

 
91
%
 
$
58,575

 
90
%
 
$
(2,352
)
 
(4
)%
Cloud and Business Intelligence
5,390

 
9
%
 
7,422

 
10
%
 
(2,032
)
 
(27
)%
Total net revenue
$
61,613

 
100
%
 
$
65,997

 
100
%
 
$
(4,384
)
 
(7
)%

Net revenue decreased $4.4 million, or 7%, for the second quarter of 2015 compared to the second quarter of 2014. The overall decrease in revenue was due to customer cancellations and reductions in excess of new customer additions from previous quarter. Customer cancellations and reductions in the second quarter of 2015 were lower than previous quarters but continue to be slightly more than new business generated. We expect the effects of prior quarters’ cancellations and reductions on our revenue to continue through the remainder of 2015.

Managed services revenue decreased $2.4 million, or 4%, for the second quarter of 2015 compared to the second quarter of 2014 due to customer cancellations. The customer cancellations and reductions occurred primarily in the second half of 2014 and are expected to continue to impact 2015 revenue.

The $2.0 million, or 27%, decrease in revenue from our Cloud and Business Intelligence (“CBI”) for the second quarter of 2015 compared to the second quarter of 2014, was attributable to a loss of subscription revenue related to the elimination of certain services provided to one of our largest customers.
Cost of Revenue and Gross Profit 
 
Three Months Ended
June 30,
 
 
 
 
 
2015
 
2014
 
 
 
 
 
Amount
 
% of Net Revenue
 
Amount
 
% of Net Revenue
 
Change
 
% Change
 
(in thousand)
Cost of revenue
 
 
 
 
 
 
 
 
 
 
 
Managed Services
$
38,909

 
63
%
 
$
42,589

 
65
%
 
$
(3,680
)
 
(9
)%
Cloud and Business Intelligence
3,783

 
6
%
 
5,929

 
9
%
 
(2,146
)
 
(36
)%
Total cost of revenue
$
42,692

 
69
%
 
$
48,518

 
74
%
 
$
(5,826
)
 
(12
)%

 
Three Months Ended
June 30,
 
 
 
 
 
2015
 
2014
 
 
 
 
 
Amount
 
Gross Profit %
 
Amount
 
Gross Profit %
 
Change
 
% Change
 
(in thousand)
Gross profit
 
 
 
 
 
 
 
 
 
 
 
Managed Services
$
17,314

 
28
%
 
$
15,986

 
24
%
 
$
1,328

 
8
%
Cloud and Business Intelligence
1,607

 
3
%
 
1,493

 
2
%
 
114

 
8
%
Total gross profit
$
18,921

 
31
%
 
$
17,479

 
26
%
 
$
1,442

 
8
%

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The $3.7 million, or 9%, decrease in our cost of revenue for our managed services business in the second quarter of 2015 compared to 2014 reflects a $3.9 million decrease in compensation expense of managed services personnel, offset by a $1.4 million increase in temporary labor and a $1.1 million decrease in allocated overhead as a result of fewer employees driven by customer cancellations.

The $2.1 million, or 36%, decrease in our cost of revenue for our CBI business in the second quarter of 2015 compared to 2014, reflected a $1.2 million reduction in compensation expense as a result of lower headcount and a $0.7 million decrease in temporary labor and consultants, all driven by lower sales.

The increase in managed services gross profit in the second quarter of 2015 was mainly driven by the lower headcount and related personnel costs.

The increase in CBI gross profit in the second quarter of 2015 was due to cost reduction efforts related to less customer implementations of our Renew OnDemand product in the second quarter of 2015.

Operating Expenses
 
Three Months Ended
June 30,
 
 
 
 
 
2015
 
2014
 
 
 
 
 
Amount
 
% of Net Revenue
 
Amount
 
% of Net Revenue
 
Change
 
% Change
 
(in thousands)
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
Sales and marketing
$
10,165

 
16
%
 
$
17,212

 
26
%
 
$
(7,047
)
 
(41
)%
Research and development
4,646

 
8
%
 
6,881

 
10
%
 
(2,235
)
 
(32
)%
General and administrative
10,701

 
17
%
 
12,256

 
19
%
 
(1,555
)
 
(13
)%
Restructuring and other
2,988

 
5
%
 

 
%
 
2,988

 
100
 %
Total operating expenses
$
28,500

 
46
%
 
$
36,349

 
55
%
 
$
(7,849
)
 
(22
)%
Includes stock-based compensation of:
 
 
 
 
 
 
 
Sales and marketing
$
716

 
 
 
$
1,583

 
 
 
$
(867
)
 
 
Research and development
444

 
 
 
736

 
 
 
(292
)
 
 
General and administrative
1,158

 
 
 
1,932

 
 
 
(774
)
 
 
Total stock-based compensation
$
2,318

 
 
 
$
4,251

 
 
 
$
(1,933
)
 
 
Sales and marketing expenses
The $7.0 million, or 41%, decrease in sales and marketing expenses in the second quarter of 2015 resulted primarily from lower headcount and the related $3.8 million decrease in compensation expense. Lower headcount is the result of our efforts to rationalize our cost structure. Also contributing to the decrease was a $1.7 million decrease in temporary labor and consultant costs, a $0.6 million decrease in marketing programs, a $0.3 million decrease in recruiting fees and a $0.3 million decrease in travel expenses.
Research and development expenses
The $2.2 million, or 32%, decrease in research and development expense in the second quarter of 2015 was primarily due to a $1.4 million decrease in costs related to a decrease in headcount and an $0.8 million decrease in temporary labor and consulting costs, all related to efforts to reduce the level of research and development spend starting in the second half of 2014.
Internal-use software development capitalization increased by $1.6 million primarily due to new development efforts on the Customer Lifecycle products. We expect research and development spending to remain flat for the remainder of 2015 and rise more slowly or at the same pace as revenue growth in future years. We expect to capitalize internal-use software costs in the future and the amount capitalized will depend on the level of new product development.
General and administrative expenses

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The $1.6 million, or 13%, decrease in general and administrative expense in the second quarter of 2015 as compared to the second quarter of 2014 reflected a $1.6 million decrease in compensation costs, driven by lower headcount and lower stock based compensation expense, and a $0.4 million decrease in technology spending, offset by a $1.2 million reduction in overhead allocations to other departments, which is related to lower headcount and information technology spending. Also contributing to the decrease was a $0.5 million reduction in professional fees.
Restructuring and other expenses
The increase in restructuring and other expenses in the second quarter of 2015 is due to a $3.0 million charge related to employee termination costs. The charge consists primarily of stock based compensation expense related to accelerated vesting of certain equity awards granted to the Company's former interim CFO and CEO, and separation payments.
Interest expense and other, net
 
Three Months Ended
June 30,
 
 
 
 
 
2015
 
2014
 
 
 
 
 
Amount
 
% of Net Revenue
 
Amount
 
% of Net Revenue
 
Change
 
% Change
 
(in thousands)
Interest expense and other, net
$
2,739

 
4
%
 
$
2,196

 
3
%
 
$
543

 
25
%

Interest expense and other, net increased by $0.5 million, or 25%, due partially to foreign currency losses in the second quarter of 2015. Interest expense for the second quarter of 2015 as compared to the second quarter of 2014 was slightly higher due to the accretion of debt discount, the amortization of debt issuance costs and interest expense for the convertible notes.
Income Tax Provision
 
Three Months Ended
June 30,
 
 
 
 
 
2015
 
2014
 
Change
 
% Change
 
(in thousands)
 
 
 
 
Income tax provision
$
1,089

 
$
26

 
$
1,063

 
*
*Not meaningful.

For the second quarter of 2015, we recorded income tax expense of $1.0 million. The increase to the second quarter tax provision is primarily the result of a recent state tax law change in May 2015. Accordingly, a valuation allowance was recorded to reflect the portion of state deferred tax assets that are more likely than not to be realized. Tax expense for the second quarter also includes the impact to adjust other state deferred tax assets as a result of the state tax law change. The remaining portion of tax expense relates to anticipated taxes in jurisdictions where we have profitable operations, including certain U.S. state and foreign jurisdictions, offset by benefits available from foreign losses. No benefit was provided for losses incurred in the U.S. and Singapore because those losses are offset by a full valuation allowance.
For the second quarter of 2014, we recorded income tax expense of $0.1 million. This amount primarily represents anticipated taxes in jurisdictions where we have profitable operations, including certain U.S. state and foreign jurisdictions, offset by benefits available from foreign losses. No benefit was provided for losses incurred in U.S. and Singapore because those losses are offset by a full valuation allowance.

Six months ended June 30, 2015 and June 30, 2014

Net Revenue 

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Six Months Ended
June 30,
 
 
 
 
 
2015
 
2014
 
 
 
 
 
Amount
 
% of Net Revenue
 
Amount
 
% of Net Revenue
 
Change
 
% Change
 
(in thousands)
Net revenue
 
 
 
 
 
 
 
 
 
 
 
Managed Services
$
114,237

 
89
%
 
$
117,144

 
88
%
 
$
(2,907
)
 
(2
)%
Cloud and Business Intelligence
13,573

 
11
%
 
15,669

 
12
%
 
(2,096
)
 
(13
)%
Total net revenue
$
127,810

 
100
%
 
$
132,813

 
100
%
 
$
(5,003
)
 
(4
)%
Net revenue decreased $5.0 million, or 4%, in the six months ended June 30, 2015 compared to the six months ended June 30, 2014. The overall decrease in revenue was due to customer cancellations and reductions in excess of new customer additions in previous quarters. Customer cancellations and reductions in the in the six months ended June 30, 2015 were lower than previous quarters but continue to be slightly more than new business generated. We expect the effects of prior quarters’ cancellations and reductions on our revenue to continue through the remainder of 2015.
Managed services revenue decreased $2.9 million, or 2% in the six months ended June 30, 2015 compared to the six months ended June 30, 2014, and was attributable to customer cancellations and reductions in excess of new customer additions in previous quarters.
The $2.1 million, or 13% decrease in revenue from our Cloud and Business Intelligence (“CBI”) in the six months ended June 30, 2015 compared to the six months ended June 30, 2014, was primarily attributable to a loss of subscription revenue related to the elimination of certain services provided to one of our largest customers.
Cost of Revenue and Gross Profit 
 
Six Months Ended
June 30,
 
 
 
 
 
2015
 
2014
 
 
 
 
 
Amount
 
% of Net Revenue
 
Amount
 
% of Net Revenue
 
Change
 
% Change
 
(in thousand)
Cost of revenue
 
 
 
 
 
 
 
 
 
 
 
Managed Services
$
80,905

 
63
%
 
$
83,895

 
63
%
 
$
(2,990
)
 
(4
)%
Cloud and Business Intelligence
7,602

 
6
%
 
12,218

 
9
%
 
(4,616
)
 
(38
)%
Total cost of revenue
$
88,507

 
69
%
 
$
96,113

 
72
%
 
$
(7,606
)
 
(8
)%

 
Six Months Ended
June 30,
 
 
 
 
 
2015
 
2014
 
 
 
 
 
Amount
 
Gross Profit %
 
Amount
 
Gross Profit %
 
Change
 
% Change
 
(in thousand)
Gross profit
 
 
 
 
 
 
 
 
 
 
 
Managed Services
$
33,332

 
26
%
 
$
33,249

 
25
%
 
$
83

 
%
Cloud and Business Intelligence
5,971

 
5
%
 
3,451

 
3
%
 
2,520

 
73
%
Total gross profit
$
39,303

 
31
%
 
$
36,700

 
28
%
 
$
2,603

 
7
%
The $3.0 million, or 4%, decrease in our cost of revenue for our managed services business in the six months ended June 30, 2015 compared to the six months ended June 30, 2014 reflects a $3.5 million decrease in compensation expense of managed services personnel, offset by a $2.2 million increase in temporary labor, and a $1.9 million decrease in allocated overhead as a result of fewer employees driven by customer cancellations.

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The $4.6 million, or 38%, decrease in our cost of revenue for our CBI business in the six months ended June 30, 2015 compared to the six months ended June 30, 2014, reflected a $2.4 million reduction in compensation costs related to lower headcount. Also contributing to the decrease was a $1.5 million reduction in temporary labor and consultants costs and a $1.3 million reduction in information technology spending, all driven by lower sales.
Gross profit in the six months ended June 30, 2015 was slightly positive for our managed services business due to lower headcount and related personnel costs.
Gross profit in the six months ended June 30, 2015 increased for our CBI business due to continued focus on cost reductions. Also, contributing to the cost reductions were lower services cost on our new product suite.

Operating Expenses
 
Six Months Ended
June 30,
 
 
 
 
 
2015
 
2014
 
 
 
 
 
Amount
 
% of Net Revenue
 
Amount
 
% of Net Revenue
 
Change
 
% Change
 
(in thousands)
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
Sales and marketing
$
21,000

 
16
%
 
$
32,883

 
25
%
 
$
(11,883
)
 
(36
)%
Research and development
9,468

 
7
%
 
13,597

 
10
%
 
(4,129
)
 
(30
)%
General and administrative
22,866

 
18
%
 
25,121

 
19
%
 
(2,255
)
 
(9
)%
Restructuring and other
3,739

 
3
%
 

 
%
 
3,739

 
 %
Total operating expenses
$
57,073

 
44
%
 
$
71,601

 
54
%
 
$
(14,528
)
 
(20
)%
Includes stock-based compensation of:
 
 
 
 
 
 
 
Sales and marketing
$
1,647

 
 
 
$
3,420

 
 
 
$
(1,773
)
 
 
Research and development
991

 
 
 
1,437

 
 
 
(446
)
 
 
General and administrative
3,411

 
 
 
3,942

 
 
 
(531
)
 
 
Total stock-based compensation
$
6,049

 
 
 
$
8,799

 
 
 
$
(2,750
)
 
 
Sales and marketing expenses
The $11.9 million, or 36%, decreased in sales and marketing expenses in the six months ended June 30, 2015 resulted primarily from decreased compensation of $7.1 million due to lower headcount. The lower headcount period over period is the result of our efforts to rationalize our cost structure. Also contributing to the decrease was a $2.1 million decrease in temporary labor and consultant costs, a $1.0 million decrease in travel expenses, a $0.8 million decrease in marketing programs, a $0.5 million decrease in overhead allocations and a $0.4 million decrease in recruiting fees.
Research and development expenses
The $4.1 million, or 30% decrease in research and development expense in the six months ended June 30, 2015 was primarily due to a $2.7 million decreased in compensation expense and a $1.1 million decrease in temporary labor and consulting costs related to our efforts to reduce research and development spend starting in the second half of 2014.
Internal-use software development capitalization increased by $3.1 million primarily due to new development efforts on the Customer Lifecycle products. We expect research and development spending to remain flat for the remainder of 2015 and rise more slowly or at the same pace as revenue growth in future years. We expect to capitalize internal-use software costs in the future and the amount capitalized will depend on the level of new product development.
General and administrative expenses
The $2.3 million, or 9%, decrease in general and administrative expense in the six months ended June 30, 2015 reflected a $2.1 million decrease in compensation expense related to lower headcount, a $1.7 million decrease across the following: temporary labor, facilities costs, technology spending, travel, recruiting and depreciation, all offset by a $2.3 million reduction in overhead allocations to other departments. Also contributing to the decrease was a $0.6 million reduction in professional fees.

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Restructuring and other expenses

The increase in restructuring and other expenses in the six months ended June 30, 2015 is related to the Company recognizing additional employee termination related costs of $3.7 million. The charge consists primarily of stock compensation expense related to the accelerated vesting of certain equity awards granted to the Company's former interim CFO and CEO, and separation payments.
Interest expense and other, net
 
Six Months Ended
June 30,
 
 
 
 
 
2015
 
2014
 
 
 
 
 
Amount
 
% of Net Revenue
 
Amount
 
% of Net Revenue
 
Change
 
% Change
 
(in thousands)
Interest expense and other, net
$
4,584

 
4
%
 
$
4,770

 
4
%
 
$
(186
)
 
(4
)%
Interest expense and other, net decreased by $0.2 million, or 4%, partially due to foreign currency gains related to the six months ended June 30, 2015, offset by slightly higher interest expense which was due to slightly higher accretion of debt discount, the amortization of debt issuance costs and interest expense related to our convertible notes.
Income Tax Provision