Rainmaker Systems Inc. Q4 2008 Earnings Call Transcript

Executive

Jim Byers - IR

Michael Silton - President and CEO

Steve Valenzuela - SVP- Finance and CFO

Analysts

Jonathan Maietta - Needham & Company

Jeff Van Rhee - Craig-Hallum Capital Group

Nathan Schneiderman - Roth Capital Partners

Rainmaker Systems Inc. (RMKR) Q4 2008 Earnings Call February 19, 2009 4:30 PM ET

Welcome to the Rainmaker Systems fiscal 2008 fourth quarter and year-end financial results conference call. During today's presentation all parties will be in a listen-only mode. Following the presentation the conference will be opened for questions. (Operator Instructions) This conference call is being recorded today, Thursday February 19, 2009.

I would like now to turn the conference over to Mr. Jim Byers of MKR Group. Please go ahead, sir.

Jim Byers

Thank you, operator. Good afternoon, everyone, and thank you for joining us today for Rainmaker Systems fiscal 2008 fourth quarter and year-end conference call.

On line today is Michael Silton, Rainmaker's Chief Executive Officer, and Steve Valenzuela, Rainmaker's Chief Financial Officer. Steve will begin by reviewing Rainmaker's fourth quarter and fiscal 2008 financial results. Michael will then review recent business highlights before turning the call over for Q&A.

Before we begin, let me note that during today's call management will make forward-looking statements. All such forward-looking statements are based on information available to Rainmaker as of this date and they assume no obligation to update any such forward-looking statements. These statements are not guarantees of future performance and actual results could differ materially from current expectations.

Among the important factors which could cause actual results to differ materially from those in the forward-looking statements are general market conditions, the current very difficult macroeconomic environment and its impact on our business as our clients are reducing their overall marketing spending.

And our clients' customers are reducing their purchase of service contracts, high degree of uncertainty and our limited visibility due to economic conditions, our ability to execute our business strategy, our ability to integrate acquisitions without disruption to our business, the effectiveness of our sales team and approach, our ability to target, analyze and forecast the revenue to be derived from a client and the costs associated with providing services to that client, the date during the course of a calendar year that a new client is acquired, the length of the integration cycle for new clients and the timing of revenues and costs associated therewith.

Our client concentration given that we are currently dependent on a few significant client relationships, our ability to expand our channel hosted contract solution and drive adoption of the solution by resellers, potential competition in the marketplace, the ability to retain and attract employees, market acceptance of our service programs and pricing options.

Our ability to maintain our existing technology platform and to deploy new technology, our ability to sign new contracts and control expenses, the possibility of the discontinuation and our realignment of some client relationships, the financial condition of our clients' businesses and other factors detailed in Rainmaker's filings with the Securities and Exchange Commission including our filings on Forms 10K and 10Q.

With that said, I will now like to turn the call over Steve Valenzuela, Rainmaker's Chief Financial Officer. Steve.

Steve Valenzuela

Good afternoon. We reported net revenue of $13.4 million in the fourth quarter compared to net revenue of $20.1 million in the fourth quarter of 2007 and $14.5 million in the third quarter of 2008. Excluding Dell, fourth quarter $2008 revenue was down 11% from the same quarter last year and down 7% from the preceding quarter.

Revenue for 2008 was $66.3 million compared to $73.5 million in 2007. Excluding Dell, revenue for 2008 was $60.3 million up 16% from 2007. The economic downturn is having a direct impact on our business, as many of our clients are reducing their overall marketing spend, including with Rainmaker.

We have seen significant cutbacks by some of our clients and may see further reductions. Marketing budget cuts impacted our lead development business at the end of the third quarter and the impact continued in the fourth quarter, partially offset by new client wins.

In the fourth quarter as the economy began to effect buy decisions, we began to see the impact on service contract sales, as more of our clients and customers have postponed or foregone renewals of some of their service contracts. Contract sales were less impacted by lead development, but there was a financial impact and we saw it in Q4.

In training sales we have strong bookings in the quarter. Contract sales revenue excluding Dell was approximately $4.4 million in the fourth quarter, down 1% from the same quarter last year and down 14% from the preceding quarter.

Lead development revenue was approximately $7.9 million in the fourth quarter, down 18% from the same quarter last year and down 3% sequentially. And training sales revenue was $1.1 million in the fourth quarter, up 2% from the same quarter last year and up 6% sequentially.

Gross margin was 34% in the fourth quarter of 2008, compared to 48% in the fourth quarter of 2007 and 34% in the prior quarter of 2008. Fourth quarter 2008 gross margin includes severance and facility closure cost of $212,000. Excluding these costs, gross margin in the fourth quarter would have been 36%.

GAAP net loss for the fourth quarter of 2008 was $20.3 million, or a loss $1.05 per share compared to GAAP net income of $221,000 or $0.01 per diluted share for the fourth quarter of 2007, and a GAAP net loss of $6.1 million or a loss of $0.32 per share in the third quarter of 2008. GAAP net loss includes non-cash impairment charges for goodwill and intangible assets of $13.7 million and a $749,000 write-down of our minority investment in a private company.

The non-cash goodwill and intangible asset impairment charges are based on a combination of factors, including the current economic environment and the company's market valuation. Also included in the fourth quarter GAAP net loss are severance costs of $565,000 and facility closure costs of $181,000, related to our action to reduce our cost structure.

Non-GAAP net loss for the fourth quarter of 2008 was $4.3 million or a loss of $0.22 per share. Fourth quarter non-GAAP net loss excludes the aforementioned impairment charges on goodwill and intangible assets and write-down in our minority investments and also excludes stock-based compensation costs of $583,000, amortization of intangible assets from acquisitions of $711,000 and facility closure costs of $181,000.

As of December 31st, our remaining balance of goodwill is $3.5 million and intangible assets is $1.6 million, after these write-downs. As a result of the write-down the amortization of intangible assets will be approximately $300,000 per quarter beginning in Q1 '09.

Turning to our balance sheet, at December 31, 2008 we had cash and cash equivalents of $20 million compared to$23.2 million at the end of last quarter. We continue to conservatively invest our cash in government money market accounts and have not been exposed to auction rate securities or commercial debt obligations.

We have a low debt balance of only $4.3 million at December 31, which includes $3 million from a line of credit, which will be repaid over the next 36 months. The remaining balance of the debt reflects the deferred payment of our acquisition of CAS Systems, which will be repaid over the next year.

Net cash used for operations was approximately $2.5 million in the fourth quarter. Capital equipment purchases in the fourth quarter were $639,000, down from $1.9 million in the third quarter. We expect capital equipment purchases to be significantly lower going forward.

To update you on our share repurchase programs, which we launched in the third quarter of 2008, we repurchased approximately $272,000 of our common stock in the fourth quarter of 2008. Since inception of the program to December 31, we have repurchased approximately $512,000 of our common stock. Going forward, we plan to continue our share repurchase program.

Accounts receivables DSOs were 33 days at December 31, compared to 38 days in September 30, reflecting strong collections.

Now, turning to our forward outlook for 2009: Given the uncertainties in the economic environment and its direct impact on our customers, and their overall marketing spending going forward, we are not providing revenue guidance for the full year, until visibility in our business and the overall economy improves.

We have taken significant actions to reduce our cost structure and we believe we will be close to achieving our goal of positive cash flow in the first quarter and we are focused on achieving positive cash flow for fiscal year 2009.

I would now turn the call over to Michael to discuss business highlights for the quarter. Michael?

Michael Silton

Thank you, Steve. As we announced on our last call, given the downturn in the economy, we changed our priority to managing for positive cash flow from our previous revenue orientation.

As Steve has noted, we have already taken significant steps to better align our cost structure with revenue. We have made substantial reductions in cost, and we continue to be focused on managing the business for cash flow.

But the impact of the economic downturn is clearly creating challenges in the near-term, at the same time we continue to win new business. This includes both new customer signings and renewals, and expansions of the existing programs. However, the total value and pace of the new business has not been enough to offset the decline in revenue from our established programs.

These are difficult times, and things may get worse before they get better. But the strength in our business model and our ability to deliver revenue for our clients is reflected in our new customer signings and continued work with major clients. We believe we are well positioned to resume a path of overall growth when conditions stabilize and we remained focus on executing for our customers.

In the fourth quarter, lead development was the most impacted and was down 18% year-over-year. Contract sales, was down 1% year-over-year, and trading sales was up 2% year-over-year. But spending on marketing services is down. Our clients still seek to reach their revenue targets and are especially focused on getting the most revenue they can from their existing customers, particularly in times like this when attracting new customers can be challenging.

Rainmaker sales and marketing execution services and our software-as-a-service solutions, including contract sales and training sales are helping them get the most from their customer base. In a difficult economy, efficiency and return on investment are especially important to companies, and our hosted applications and services offer a particularly compelling value proposition.

To give an example, our data shows that as the economy has worsened, fewer people are showing up for on-site classroom training at our clients. But the number of people that are taking e-Learning online classes from our clients is growing dramatically.

Rainmaker’s ViewCentral platform for training sales is helping companies adapt to these changes and still drive the most revenue by enabling them to offer e-Learning in place of classroom training to maximize their available revenue.

Despite the challenging environment, we continue to win new business in all of our product lines and sign numerous, new and expanded business agreements during the quarter. And our pipeline has significant opportunities in each of our product lines.

As companies began to cut back on their marketing spend, our lead development business was quick to feel the impact near the end of the third quarter, and this impact continued in Q4, as large corporations continued to evaluate and cut back their budgets. At the same time, we saw some new business activity during the quarter to partially offset the declines, including new clients engaging in pilot programs for our lead development solution and a few of our larger existing clients expanding the reach of their existing programs.

We signed a new lead development agreement with a nationwide office products company for an outbound business-to-business program. Our Fortune 50 global software client awarded an expansion of our long-term partnership to include demand generation in North America and support their event recruitment business, displacing one of their current private company vendors.

We were also awarded a significant expansion of our agreement with our Fortune 500 global network computing client that extends its program to include coverage of the Asia Pacific region.

Other recently signed lead development agreements include a renewed agreement with a nationwide wireless services provider, a new agreement with a global marketing services company, a new client in education and career services provider, a new pilot program with a financial services company and an expanded agreement with a database software provider.

Turning to contract sales, we began to see the impact of the economic downturn on our contract sales business in the fourth quarter, as more of our clients and customers began to hold back on discretionary spending and postpone or forego renewals on some of their service contracts. At the same time however, we continued to win new business.

During the quarter, we added as a new client a Fortune 500 global telecom services provider. We were awarded an extension of our contract sales agreement with our Fortune 50 hardware client to provide a comprehensive resale channel contract sale solutions supported by our hosted technology.

And our Fortune 500 global desktop and notebook computer manufacturer client awarded an extension of its program for hosted channel contract sales to enhance the success of its channel partners and deliver revenue across multiple channels.

Moving to training sales, we had strong bookings in training sales in the fourth quarter, including a three-year agreement with a new client, Lawson Software, a global enterprise business software provider. A two year new client agreement with a global enterprise management solutions company, BMC Software, a renewal for three years of our agreement with business software client TIBCO Software; a renewal of our agreement with a data management software company; a renewed agreement with a data integration software company; a new client agreement with an IT solutions company; a renewal of our agreement with a nationwide document management company; and a two year extension of our agreement with a global media business information client.

In conclusion, while the impact of the economic downturn is clearly creating challenges in the near-term, we continue to win new business and have a strong pipeline with significant opportunities across all of our product lines. We are in a strong position to weather current conditions and resume a path of overall growth when conditions stabilize and see opportunities to emerge as an even stronger company.

We have taken significant steps to better align our cost structure and return to positive cash flow. With a strong financial position and a substantial base of industry leading customers, we are focused on executing for our clients and are confident about the future.

This concludes the prepared remarks section of our call. Operator, if you please open the call to questions.

Question-and-Answer Session

Operator

Thank you, sir. We will now begin the question-and-answer session. (Operator Instructions) Our first question comes from the line of Jon Maietta with Needham & Company. Please go ahead.

Jonathan Maietta - Needham & Company

Thank you very much. Hey, Michael, hey, Steve. First question I had was yeah, tough economic backdrop for everybody. Do you think you could take some share in this market both in the lead development side as well as contract sales and training sales for that matter?

Michael Silton

Yes, absolutely, and when I talked about emerging as a stronger company out of this, I see some definite opportunities. We talked about one of the deals, where one of our clients moved business away from a private company to us. Our public company stature, our balance sheet and execution we are doing, is helping us move business away from those kinds of situations. And so, we are seeing more and more of the kind of competitive takeaways.

If you look at our pipeline, in all three of the product lines, there are significant opportunities of competitive takeaways, predominantly from private companies, but also from other market players that just don’t have the same degree of technology.

As you know, we made fairly significant investment in our technology over the last year and half, and where we’re seeing growth from clients especially in the lead development area, which has traditionally been more transitory, is from those customers that have adopted our web-enabled technology and as that's kind of being scaled across the globe, we are seeing strength.

So the investments we've made in technology and globalization over the last couple of years and our public company stature are helping us win some competitive takeaways. And if you look at it, the deals that we're winning out there and the New Year starting off with a growing pipeline right now, I'd say are predominantly competitive takeaways moving them to new generations of approaches or away from smaller competitors.

Jonathan Maietta - Needham & Company

Okay. And Michael, could you talk a little bit about, I guess coming out of the December quarter, going through January and up to this point in February, what have you seen in terms of customer demand patterns or the different sides of the business? Has it been up and down from week-to-week or is there any discernable patterns there?

Michael Silton

Well, volatility is probably the best way of describing the pattern. There is no question that large companies are continuing to evaluate their budget and we were continuing to see some cut-backs in those area. The real question is when is the pace of the new business going to offset those kinds of declines and when is that environment going to stabilize?

We don't need a growing economy but we need at least a point where the larger companies have kind of reset to the lower expectations of the economy and are kind of moving forward from there. And then our competitive takeaways can get us back to growth. I don't know when that's going to happen anymore than anybody else does about the economy.

I will say that although the first few weeks were certainly challenging in this quarter, the pipeline of new activity has actually surprised me on the upside and we'll see how they all turn out over the coming months. But we're seeing more and more people get more aggressive now about doing something new.

Jonathan Maietta - Needham & Company

Okay. And then Steve, with regard to kind of cash breakeven, roughly what revenue level would get through there, given where the cost infrastructure stands today?

Steve Valenzuela

Well we made significant cuts from Q4 – in Q4 actually, and so the Q4 results you don't see the full impact of that, because Q4 again includes about $565,000 of costs related to severance, also $181,000 of costs related to the facility closure.

So going forward, taking into account about a third cut in operating expenses. Taking into account, we won't have those reoccurring costs, we are positioned well to achieve cash flow positive.

Part of the challenges of volatility in terms of revenue, we don't have the full visibility as to this point as to what the revenue level will be going forward, and so we're being careful with our spending as much as we possibly can to get the cash flow positive. We're focused on achieving cash flow positive for Q1 and for the fiscal year.

We said on the call that we believe we'll be close to achieving cash flow positive in Q1, but I can't tell you at what revenue level or how close we will be. Clearly we are very focused on achieving that cash flow positive and we have the ability to adjust our cost structure within some time elements -- some reasonable time element.

As you saw in Q4, we made two reductions in Q4. We did that in a timely sequence, so that we would be able to adjust for the first reduction and then the second reduction, so that we would not impact our clients.

Jonathan Maietta - Needham & Company

Got it, okay. Then just -- the last question I had was, Steve, you had mentioned CapEx down substantially in this calendar year. Should we think about it being at half the level it was in '08 or just directionally if you could help me out a little bit there?

Steve Valenzuela

You bet. Yeah if you look at '06, we've talked a little bit about in FY '06 how we're really kind of modeling with our goal to get back to more of those levels. In '06, we spent about $1.6 million in CapEx for the whole year, and we would certainly expect the '09 CapEx spending to be below that amount.

Jonathan Maietta - Needham & Company

Okay.

Steve Valenzuela

And also in '06 we generated $10.5 million of operating cash flow and free cash flow of $8.9 million, taking into account the CapEx. So we've shown our ability to drive a lot of cash flow into the business and we believe we have the opportunity to do that again. It's just a matter of exactly when the timing of that would occur.

Jonathan Maietta - Needham & Company

Got it. Thank you.

Steve Valenzuela

Thank you.

Operator

Thank you. (Operator Instructions) Our next question comes from the line of Jeff Van Rhee with Craig-Hallum Capital Group. Please go ahead.

Jeff Van Rhee - Craig-Hallum Capital Group

Great. Thank you. Hi, guys. And a couple of questions, first, I guess, would you -- kind of a follow-up on the last question to understand, when you say you are targeting cash flow breakeven in Q1 - what that really means. Can you maybe give us a chronology of the reductions that you've already made and what kind of annualized savings you expect those cuts to ultimately drive for the '09 year?

Steve Valenzuela

Sure, so we made two separate reductions in the fourth quarter, a total of about a third reduction in our operating spending in the fourth quarter. Some of that occurred about midway in the fourth quarter and the rest of it was toward the end of the fourth quarter. So that's why the fourth quarter doesn't show the full impact of that. But we said we took out about a third of operating expenses, from a cash operating expense for a deal.

And if you look at the third quarter kind of as a gauge, if you take our cash operating expenses for the third quarter of 2008, take out depreciation, stock comp and amortization of intangibles, it was about $8.6 million in cash operating expenses, not counting cost of sales, right. And so, we are targeting a reduction. We made a reduction of about a third from that $8.6 million.

Jeff Van Rhee - Craig-Hallum Capital Group

Okay. And that’s very helpful, thank you. And then also if you would, touch on the debt. You went through it a little quicker than I was able to get it down. In terms of the debt, what’s in there, when it's due, how much it took down, what the terms are, etcetera?

Steve Valenzuela

Sure, you bet. So, we have debt on our balance sheet, relatively small amount of debt of $4.3 million, about $3 million of that is relating to a term loan that we took down from our line of credit. It will be repaid over three years and the interest rate on that is about 6%. And it’s a fully amortized fixed rate loan. And that will be starting to be repaid in January.

The remaining one-third relates to acquisition of CAS Systems, which we completed in January of 2007. Part of that acquisition provided for deferred payment over the next three years. We did make one of those payments in 2008. We made another payment in January of 2009 for about $670,000. The final payment will be made in January of 2010.

Jeff Van Rhee - Craig-Hallum Capital Group

Okay. That’s…

Steve Valenzuela

That’s at about 5.2% fixed interest rate.

Jeff Van Rhee - Craig-Hallum Capital Group

Okay. And the $3 million term loan from the line of credit. When did you take that down?

Steve Valenzuela

We took that down in the fourth quarter. And the repayment starts in January of 2009.

Jeff Van Rhee - Craig-Hallum Capital Group

I guess, just specifically in Q4 was it at the end of the quarter, early in the quarter?

Steve Valenzuela

It was actually in two pieces, we took $2 million down earlier, and then we took $1 million down in the fourth quarter, later in the fourth quarter.

Jeff Van Rhee - Craig-Hallum Capital Group

Okay. Alright, great. And then, lastly just in terms of cash flow on the balance sheet. I know there is some working capital play, particularly on the contract sales side. In terms of the cash balance, whether that cash is due to partners, or due to customers I should say?

Steve Valenzuela

Well one thing to look at our balance sheet, you see that the cash did come down but also accounts payable came down significantly. So of the amount of cash that we have on the balance sheet, the amount that's sitting in accounts payable, that's due to partners is a couple of million dollars.

Jeff Van Rhee - Craig-Hallum Capital Group

Okay, maybe two million dollars. Okay, great. Thank you.

Steve Valenzuela

Thank to you.

Operator

Thank you. Our next question comes from the line of Nathan Schneiderman with Roth Capital Partners. Please go ahead.