Rimini Street, Inc. (RMNI) Q2 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Rimini Street Second Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, there will be a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to Dean Pohl, Director of Investor Relations. Sir, you may begin.

Thank you, Shannon. I’d like to welcome everyone to Rimini Street’s Second Quarter 2018 Earnings Conference Call. On the call with me today is Seth Ravin, our CEO; and Tom Sabol, our CFO. Today, we issued our second quarter 2018 earnings press release, which can be found on our website. A reconciliation of GAAP to non-GAAP financial measures has been provided in the tables following the financial statements in this press release. An explanation of these measures is also included in the press release under the heading, Non-GAAP Financial Measures. As a reminder, today’s discussion will include forward-looking statements that reflect our current outlook. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from statements made today. We encourage you to review our most recent SEC filings including our Form 10-Q for the second quarter of 2018 for a discussion of risks that may affect our results or stock price. Before taking questions, we’ll begin with prepared remarks. With that, I’d like to turn the call over to Seth.

Thank you, Dean, and thank you, everyone, for joining us to review Rimini Street’s second quarter 2018 financial results. We founded Rimini Street in 2005 to disrupt and redefine the $160 billion enterprise software support market by developing and delivering innovative, value-driven, and award-winning enterprise software support products and services, primarily through an annualized subscription model. Today, Rimini Street is the leading independent software support provider for Oracle and SAP software products. We also provide support services for IBM, Microsoft, and salesforce.com products. Our current offerings address approximately $30 billion of the $160 billion annual global enterprise software support spend. Organizations invest significant money, labor, and time in their mission-critical enterprise software systems. Rimini Street helps clients maximize the ROI and useful life of their software assets with premium support services delivered at substantial cost savings. This allows clients to focus more of their resources on innovation that drives growth and competitive advantage. To date, we estimate that we’ve saved our clients more than $3 billion. Second quarter 2018 results – For the second quarter, we generated revenue of $62.6 million, up 20% year over year and achieved our 50th consecutive quarter of revenue growth. Annualized subscription revenue was $246 million, up 18% year over year and we also recognized $1.2 million of non-subscription revenue in the quarter. Revenue retention rate for subscriptions, which is the majority of our revenue mix, remained above 90%. We ended the quarter with 1,622 active Fortune Global 100, Fortune 500, midmarket, public sector and other clients across a broad range of industries and geographies, up 21% year over year. During the quarter, we launched new products and services that expanded Rimini Street’s future market opportunities. New products and services recently launched include support for salesforce sales cloud and service cloud as well as Rimini Street Mobility, Analytics, and Advanced Database Security Solutions. Recent geographic expansions include France. Our global service delivery team closed more than 7,300 client support cases across 44 countries, delivered a gross profit of 58.4% and maintained an average client satisfaction rating of 4.8 out of 5.0 on the company’s support delivery, where 5.0 is rated as excellent. Also during the second quarter, Rimini Street was honored and recognized with many awards for outstanding service, industry leadership, and voted a top work place in the Bay area. Rimini Street was also added to the Russell 2000 Index in June of 2018. We ended the second quarter with approximately 1,075 employees, a year-over-year increase of 18%. Initiatives and investments – we believe the recently-completed refinancing of our credit facility with $140 million private placement equity transaction removes the constraints to our revenue growth by eliminating covenants on sales and marketing spend and is expected to reduce debt-related cost by approximately $95 million over the next three years. Completion of the refinancing allows us to increase our investment in global sales, marketing, and service delivery in order to drive future revenue. During the first half of 2018, we began increasing our investment in sales and marketing to support increased sales to new clients as well as sales of additional products and services to our existing clients. Now, with the previous credit facility repaid and refinanced as of July 19, 2018, we expect to further increase our investment in sales and marketing, up to 39% of revenue through the second half of 2018. This compares to 46% and 31% sales and marketing spend against revenue for 2016 and 2017, respectively, with corresponding annual revenue growth of 36% and 33%, respectively. We also plan to continue launching new products and services that expand our market opportunity and continue expanding our geographic operations to open new markets. Litigation developments – I would now like to review some recent developments in our ongoing litigation with Oracle. As discussed in previous earning calls, we have two different ongoing litigation matters with Oracle. Oracle’s litigation against Rimini Street filed in 2010, that is in the appeal stage and that is referred to as Rimini One. And Rimini Street’s litigation against Oracle, filed in 2014 that is in the pretrial stage and referred to as Rimini Two. In January 2018, the U.S. Court of Appeals for the Ninth Circuit ruled favorably for Rimini Street and its appeal of the Rimini One judgment and verdict, reversing or vacating certain awards made to Oracle during and after the 2015 trial and declaring that Rimini Street provides third-party support in lawful competition with Oracle. In all, nearly $50 million of the judgment Rimini Street previously paid to Oracle in 2016 was vacated. In the first quarter of 2018, we received a refund from Oracle of $21.5 million. On May 2, 2018, Oracle deposited $28.5 million into the Federal Court Registry, an escrow account, to be held and distributed as appropriate following a decision on Oracle’s renewed motion for attorneys’ fees. On May 31, 2018, we filed a petition with the U.S. Supreme Court seeking an additional refund of $12.8 million Rimini Street had paid to Oracle in 2016 for nontaxable cost that would not have been assessed in other court jurisdictions. Therefore, with respect to Rimini One, in addition to the $21.5 million already refunded to Rimini Street by Oracle, there is another $41.3 million that we are still aggressively pursuing for refund. We currently expect a decision on the attorneys’ fees sometime in the third quarter of 2018, but do not yet have an estimated date on when the U.S. Supreme Court may agree to hear Rimini Street’s claim let alone rule on the claim, if heard. With respect to Rimini Two , in addition to other causes of action, Rimini Street is seeking damages from Oracle for behavior that we believe was illegal and has materially impacted our new client sales since the second quarter of 2017. Oracle is also seeking damages from Rimini Street. That discovery has concluded and the case is currently in a pretrial expert witness discovery phase. Trial is not expected to proceed until 2020 or later. In summary, as we continue in fiscal 2018, our focus remains on reaccelerating billings growth. Based on our 13-year track record of sales performance, we expect our investments to lead to increased revenue-generating capacity, growth and improved operating leverage in 2019 and beyond. I will now turn the call over to Tom Sabol, our CFO.

Thanks, Seth. Let me begin with a summary of our fiscal Q2 2018 results. As Seth noted, revenue for the second quarter was $62.6 million, which represents an increase of 20% year over year. The revenue was above the high end of our guidance as a result of strong growth outside of the United States. Annualized subscription revenue was $246 million, up 18% year over year. Although our revenue is primarily subscription-based, during the second quarter we recognized approximately $1.2 million of non-subscription revenue. Clients outside of the United States constituted 37% of total revenue in the second quarter, a growth of 44% year over year. This has been and will continue to be an area of continued investment and expected growth for the company. Gross margin was 58.4% in the second quarter of 2018, down from 62.5% in the second quarter of 2017, reflecting our biannual global service delivery training conference and higher benefit costs associated with a new 10-year employee service award program. While we currently expect full year 2018 gross margin to be around 60%, we currently expect our third quarter gross margin will be in the range of 60% to 62%, taking into account additional investment costs associated with the launch of new products, services, and geographic coverage. Sales and marketing expenses increased as a percentage of revenue to 36.8% in the quarter, up from 33.8% in Q1 of 2018 and 31.4% in all of fiscal 2017. As Seth noted earlier, we currently expect to spend up to 39% of revenue on sales and marketing for all of 2018. General and administrative expenses, which excludes outside litigation costs, was 16.5% of revenue in Q2 of 2018, down from 17.2% in Q2 of 2017. Going forward, we expect G&A to continue to be a source of leverage in our model. However, as a result of being a public company, we will incur a higher professional service and additional accounting infrastructure costs over the next few quarters, which may increase G&A as a percentage of revenue in the near term. Litigation expense was $9.1 million in the second quarter of 2018. It should be noted that our outside litigation spend is not linear and can fluctuate each quarter based on litigation activities. While litigation costs are generally expected to range between $2 million and $5 million per quarter, however, we believe that like our Q2 costs, our Q3 costs will also be approximately $9 million due to specific court activities in the quarter. GAAP operating loss was $6 million in the quarter compared to operating income of $7.5 million for the same period last year. The 2017 results include a $19.3 million insurance settlement paid to Rimini Street related to the reimbursement of legal fees for the Rimini Two litigation. Non-GAAP operating income was $4.2 million in the quarter compared to $8.1 million in Q2 of 2017. Interest expense and other debt service costs were $10.7 million in the second quarter of 2018 compared to $25.4 million in the second quarter of 2017. The decrease was primarily due to the receipt of insurance settlement proceeds received in April 2017, resulting in a $4.6 million make whole interest payment and the corresponding acceleration of the write-off of amortization of debt discounts and issuance costs of $9.7 million in Q2 of 2017. A significant portion of these costs and expenses are noncash. Other income net of expenses in the quarter totaled a loss of $8.3 million as compared to a net loss of $8.1 million in the same period a year ago. The difference includes the change in embedded derivatives carrying value of approximately $6 million in Q2 of 2018, which is offset by a $7.6 million change in fair value of redeemable warrants in Q2 of 2017. In addition, in Q2 2018, we wrote off deferred financing costs of $700,000 related to unsuccessful senior debt financing and foreign exchange losses of $700,000. The credit facility cash interest and other cash fees paid in the second quarter of 2018 totaled $9.9 million compared to $10.9 million paid in the same period of the prior year, both of which include make whole interest payments on early prepayments. We had a net loss of $25.4 million in the second quarter of 2018 compared to a net loss of $25.9 million in the same period of the prior year. Non-GAAP net loss in the second quarter of 2018 was $7.8 million compared to a $16.9 million net loss in the second quarter of 2017. Net loss per share was $0.43 in Q2 of 2018 compared to a per share net loss of $1.05 in Q2 of 2017. Adjusted EBITDA for the second quarter of 2018 was $3.8 million compared to $8.9 million for the second quarter of 2017. Deferred revenue in the second quarter of 2018 was $200.4 million compared to $170.3 million in Q2 of 2017, an increase of 18% over the prior-year period and compared to $195.6 million in Q1 of 2018. We ended the quarter with $35.5 million of total cash on our balance sheet. Cash flow from operations for Q2 2018 was $8.5 million compared to operating cash flow of $28.5 million in Q2 of 2017, which included the insurance settlement of $19.3 million discussed earlier. Now with respect to our recently-announced refinancing, as disclosed on July 19, 2018, we repaid in full all obligations under our credit facility including principal, make whole interest and fees and expenses, and terminated our credit facility. This was accomplished through the payment of $132.8 million from the proceeds received from the issuance and sale of $140 million of series A convertible preferred stock and approximately 2.9 million shares of our common stock. The preferred stock will pay quarterly dividends at a cash rate of 10% and will accrue payment in kind or PIK dividends quarterly at 3%. The preferred stock converts into common stock at $10 per share and includes a three-year make whole provision during the first three years. This refinancing extended the maturity date from June 2020, under our prior credit facility, to July 2023, assuming the preferred stock is not redeemed by the company or converted into common stock before that date. After paying transaction costs, the company utilized approximately $2.7 million of its own cash to complete the closing of the refinancing. As noted by Seth, the refinancing eliminates financial and operating covenants that limited our ability to invest in growth. As a result of the payoff of the credit facility, we expect to take a noncash debt extinguishment charge of approximately $47 million to $48 million in the third quarter of 2018. Please refer to our July 19, 2018, press release and 8-K filing and our second quarter Form 10-Q for more detailed information. Now with respect to go-forward guidance, we expect revenue to be in the range of approximately $61 million to $63 million in the third quarter of 2018. In addition, the company is updating full year 2018 revenue guidance to be in the range of approximately $240 million to $250 million. And with that, operator, we’ll now take questions.

Thank you. [Operator Instructions] Your first question comes from Derrick Wood with Cowen. Your line is open.

Good afternoon, gentlemen. I wanted to start on the guidance, which was lowered for the year. And actually if I look at the midpoint of your guidance, it calls for Q3 to be down from Q2 and for Q4 to be down from Q3. That’s a pretty sharp reversal versus our expectations in the back half. So could you walk us through what’s changed in your outlook and what’s causing the contraction in the second half?

Sure, Derrick, it’s Seth. And you know I think when you look for the quarter over quarter to the third quarter, you take a look at the second quarter we had that $1.2 million of nonrecurring revenue that was recognized in the quarter from some earlier deals that had been withheld. So, that of course if you remove that from it, I think you’ll see that you could get – you do get consecutive growth quarter over quarter in the expectation, when you remove from the $1.2 million one time. Tom, you want to comment further as well?

Yes, so Derrick, the reason for taking it down and Seth can get into more of the details on the specifics, but the refinancing was delayed longer than we had thought and so some of the investments that we needed to make in sales and marketing, because of the covenant restrictions, we just weren’t able to get them in place as quickly as we would have wanted to. And because of that, we just don’t have the capacity in the sales and marketing group in the back half to where we originally thought it was going to be, to be able to drive the revenue numbers we were looking to attain. So that’s really the, you know that’s really the reason is that because of the covenant restrictions and the refinancing not closing as early as we would have thought it would have closed and really didn’t even close here in 2Q 3, that some of the hiring and stuff that we wanted to do earlier in the year had to be put off until we got the refinancing put in place. So that’s the reason for the change in guidance with regards to the back half of the year.

Okay. Did I guess, Seth, could you comment on what you’re seeing in the competitive landscape and what you’re seeing out of – I know you had an uptick in sales heads in Q1, kind of the early read with respect to ramp to productivity?

Sure, in fact, as you may remember from prior calls, we finished 2017 with 57 sales reps. We finished June 30, 2018, at 66. So I think that when you talk about growth there, that record – you know $2 million a head when these heads are fully productive after 9 months to 12 months, you’re seeing we added $18 million a quote of carrying capacity. Competition is fierce. That hasn’t changed in any particular point in our 13 years. What you’re seeing though is pretty good sales performance on the heads and when you look at quota carrying capacity, Derrick, you’re talking about us doing 90% quota-carrying capacity. So from an execution standpoint, we’re doing very well. We just simply don’t have the capacity as we talked about in these prior calls because we weren’t able to add heads. We just don’t have the capacity to do a lot more business. It takes the 9-month, 12-month, full time to really get those reps up and running. So all this new capacity, you know again $18 million of additional quota-carrying capacity added in the first half of the year, we want to beat it – as we said before, 85 heads by the end of the year. That translates when you add in all the additional hires that have to support them, inside sales reps, sales engineers. It adds up to about 45 heads that have to be hired in the back half of the year to finish up our plan. And we weren’t able to do that, as Tom said, because the deal took a lot longer to get closed than we expected on the refi and only closed in July. So now with none of the covenants in place, we can redirect budget appropriately to focus in on the reacceleration of billings.

Is the 85 heads still a target for the end of the year?

Yes, it is and I think as everybody’s well aware, in this economy, it’s pretty fierce to go out and find best talent. You know we’ve been finding it, but it is not easy to get the kind of top end reps we want. You know we raised compensation earlier in the year to make sure we have an A level player comp plan. We added draws for new hirers. So we’ve really done a lot in trying to attract the best talent. And I think we’ve done very well in what we’ve seen in the first half of the year, but as any company will tell you, it is not easy in this day in age and technology to recruit A players, get them on board, train them up for 9 months to 12 months, and then get them out there. I mean this is always represented one of the bigger challenges for us as well as any other tech company out there. But we are getting our heads filled and now that we have the budget relief to be able to go out and hire them without being under constraint, we’re going to accelerate that process.

Okay, regarding the new customers, it was a nice uptick from Q1. Any comment on the mix of kind of large deals versus small deals? I think last quarter was a good mix of large deals. Did that change this quarter? And how does the pipeline look for the second half?

I think that we’ve pretty much the same as Q1, the same mix. You know we have our mix of big, medium, and small deals. I would say the ASP is staying steady in that 200, 250K range. We certainly have some multimillion dollar deals mixed in as well. The pipeline on the back half of the year is strong. We were strong in the first half. We’ve seen – you know there were a good number of deals in the second quarter that we were hoping we would pull in early, but they’re going to close more likely on schedule in the third and the fourth quarter. A lot of paperwork to get done and I think as in so many other businesses, the nature of people is to focus in when their time is coming for a maintenance renewal, that’s when they really get focused on looking at alternatives. So one of the great challenges this business has always had and one we continue to work at which is how do you get people to focus on something months and months ahead of when it becomes a top priority for them? And that is just a continual area for the business that we see and we do manage to pull more and more deals in earlier, but in this case I think we saw a lot of deals we were hoping that we’d pull in months and months early, just couldn’t get that done with the paperwork and they’re on schedule in the Q3 and Q4 timeframe.

Okay. And then I want to go back to this, actually $1.2 million non-recurring. What was that related to? And I guess that’s not expected to be repeated in Q3?

Yes, you know we are primarily and have been almost 100% recurring revenue subscription business. We are and as we’ve been telling folks in these last calls, we do plan to do some additional consulting work that’s going to be non-recurring, that’s nip and tuck around the subscription revenues where customers have specific projects that they want us to do that are enabling projects and adjacent projects. And this is one of those cases where there was revenue related to certain tasks and projects that were completed in the third quarter and, therefore, the revenue is recognizable.

Okay. And I guess you’ve got your revenue outlook which is a bit of a deceleration in the second half, but Seth you commented on focused on reacceleration in billings in the second half. So, I don’t know, Tom, is there any more color you want to give on thoughts on billings?

So, Derrick, there is, as Seth indicated, because of the reduction in quota-carrying capacity heads from 2016 to where we were here early in 2018 and of course, while we’ve added nine people, they’re not ramped yet to the 9 months to 12 months that is needed. So, as Seth indicated, the pipeline is out there. And our view is, is that as we ramp our sales people, again we’ve been doing this for 13 years. We believe that the business is out there. We just were constrained from a sales and marketing standpoint and we would expect that billings, of course, would ramp first because of the model we have where there were primarily subscription revenue, almost exclusively. That we would see the billings increase first before the revenue, before the revenue reaccelerates. And that’s what we’re focused on doing is investing in sales and marketing, improving the growth in the billings number that will ultimately translate into revenue growth going forward.

Okay. And Tom, any – what is the balance sheet look like following the preferred financing?

Yes, so we ended up using about $2.7 million of our own cash on the refinancing. So, we didn’t add any cash to the balance sheet. All of the proceeds utilized were utilized to pay off the facility as well as the transaction related expenses. We had to put up, you know a little bit less than $3 million from our own balance sheet. So that’s really the only impact on the cash side of the business. Of course, one good news is that none of the cash going forward will be restrictive, other than a couple hundred thousand that we have with some – with a credit card program that’s restricted. But there will be no restricted cash with the new facility. The balance sheet from the standpoint of the equity, the preferred shares will be treated as mezzanine equity, so they won’t be in permanent equity. And of course we did issue, as noted, 2.9 million shares of stock, common stock as part of the deal. We will allocate the proceeds of the $140 million between the preferred and the common. And ultimately will, we’ll be able to talk about what that actual breakdown is, as we work through all the accounting entries. And there will be then some accretion in addition to the dividend going forward for the proceeds that were allocated to the common stock. The number of shares, the number of common shares will go up by approximately 2.9 million shares that were issued. And on a fully diluted basis, 14 million shares will be added for the preferred shares on a fully diluted basis when the stock is above $10 a share.

Yes, okay. Last question – yes. Last question for Seth, be curious to hear what the initial reaction or reception has been to the new sales force offering?

We said when we launched it that this was going to be one of those walk, job before you run where we would be piloting with customers and honing our – honing both the service as well as the sale pitch, getting our training in place, all of that in the back half of the year that we wouldn’t expect to have accretive revenue from it in 2018. But be well positioned with successful client references coming into 2019 to support the sales effort on a global basis. And I think we are proceeding along that path. In fact, you know we’ve hired additional staff around it. You know part of the reason you see the slight reduction in the gross margin, because of the fact that we are hiring for new products and services and we’re just at that size, Derrick, that when you add enough heads, we’re still going to be sensitive by 1% or 2%, given the kind of hiring we do. We’re just not big enough yet to where you could absorb that hiring without it really affecting margin that much. So, I think consistent with everything we said we’re doing with the investments and new products, new services, the hiring of sales and marketing, everything we’re putting in place is the rebuilding and catching up that we said we had to do from 2016, 2017, to build capacity. So it’s capacity of sales, capacity to drive service delivery, of adding new countries. All of these things are being invested in this year. You’ll start to see them as Tom was saying, come to fruition next year, first in accelerated bookings because we’ll see the results as the sales teams come on line and mature, we’ll start to see the uptick long before we’ll see the lagging revenue, right. So, I expect next – you know coming through next year will be yet still a catch up and building year. And I think it’s all in anticipation of a very large 2020.

Okay that’s helpful. Thanks, guys.

Sure.

Thanks, Derrick.

Thank you. I’m currently showing no further questions at this time. I’d like to turn the call back over to Seth Ravin for closing remarks.

Great. Well thank you very much everybody and want to thank you again for joining us for today’s call. And we look forward to talking with you again when we review the third quarter 2018 results. Thank you, everybody.

Ladies and gentlemen, this concludes today’s conference. Thanks for your participation. Have a wonderful day.