TEXT-S&P: Amber Holding assigned 'B' rating, stable outlook
Overview -- SumTotal Systems Inc. is issuing $540 million of credit facilities to refinance existing debt and pay a one-time dividend to its private equity sponsor, Vista Equity Partners. -- We are assigning a 'B' corporate credit rating to the parent holding company, Amber Holding Inc., a global provider of human capital management software and services. -- We are also assigning our 'B+' issue-level rating to SumTotal's proposed first-lien credit facilities ('2' recovery rating), and our 'CCC+' issue-level rating to its second-lien term loan ('6' recovery rating). -- The stable outlook reflects the company's predictable and recurring revenue base. Rating Action On Dec. 5, 2012, Standard & Poor's Ratings Services assigned its 'B' corporate credit rating to Amber Holding Inc. The outlook is stable. We also assigned a 'B+' issue-level rating to operating company SumTotal Systems Inc.'s $30 million revolving credit facility and $370 million first-lien term loan. The recovery rating on these issues is '2', indicating our expectation of substantial (70% to 80%) recovery in the event of a payment default. In addition, we assigned a 'CCC+' issue-level rating to SumTotal's $140 million second-lien term loan, with a recovery rating of '6', indicating our expectation of negligible (0% to 10%) recovery in the event of a payment default. Rationale Standard & Poor's ratings on Amber Holding, parent company of SumTotal Systems, reflect the company's "weak" business risk profile, as defined in our criteria, characterized by its modest overall position in the human capital management (HCM) software market and its "highly leveraged" financial risk profile. Offsetting some of these issues is the HCM market's critical and growing role, the company's rising position in the segment, and its highly recurring revenue base. We view the company's management and governance as "fair." SumTotal is now a global provider of strategic HCM following its diversification from providing only enterprise learning management systems to an integrated end-to-end HCM platform. The company provides integrated products in talent management, workforce management, learning management, and core human resources (HR) and payroll services to enterprise and small to midsize business (SMB) customers via on-premise, public, and private cloud solutions. The integrated HCM suite was rolled out early in 2012. The company has more than 3,500 customers and more than 43 million end users. Although revenues are heavily weighted toward North America, recurring revenues--which account for more than 70% of total revenues--are diversified among many verticals, with the largest (financial services) accounting for less than 25%. We view the company's business profile as weak, reflecting its modest overall market position in the $11 billion HCM market, competing with numerous companies, including several much larger and long-established players in selective parts of the market with greater resources. However, this is partly offset by its suite of integrated products that span the full HCM market, with opportunities for cross-selling and adding vertical functionality. We expect the HCM market to increase by the mid- to high-single-digit percentage area, as companies continue to focus on reducing costs and deploying their human capital in a more strategic fashion. While major companies such as ADP, SAP, Kronos, Oracle, and IBM have significant positions in selected parts of the market, the company's integrated suite has helped it to increase its modest overall market share and win contracts with major companies. The average tenure of its customers (including acquired customers) exceeds five years, and customer retention is approximately 95%. The top 25 customers account for approximately 20% of recurring revenues, and recurring revenues account for more than 70% of total revenues. The company's EBITDA margins have dramatically improved to near 30% at year-end 2011 from 8% in 2010 as revenue also showed dramatic growth during the period, growing to $190 million from $90 million. SumTotal has a highly leveraged financial risk structure following the transaction, and we estimate leverage will exceed 6x for 2012. We do not believe leverage will drop meaningfully over the next several years. We expect future capital expenditures to be slightly higher than historical averages at 2.5% of revenues. Revenue growth for 2012 will be restrained as the company de-emphasizes low-margin and unprofitable third-party business. After that transition, our base-case scenario assumes growth in line with the industry in the high single digits and EBITDA margins remaining near present levels. This results in leverage remaining higher than 6.0x for the next several years, unless the company allocates most free cash flow, which we estimate to be more than $30 million annually, to debt reduction. Liquidity We view Amber's liquidity as "adequate," as defined in our criteria. We expect sources of cash to exceed uses over the next 12 to 24 months. Cash sources include free cash flow and access to a $30 million revolver. Uses include working capital growth and modest capital expenditures. Loan amortization is minimal and the loans mature in 2018 and 2019. We expect cash at closing to be $25 million. Other relevant aspects of Amber's liquidity include: -- Sources of cash are likely to be above 1.2x in the next 12 to 24 months; -- Net sources are likely to be positive during the period even if EBITDA falls by 15% to 20%; -- Sufficient covenant headroom exists for EBITDA to fall by 30% without the company's breaching a covenant; -- Besides the minimal amortization, there are no debt maturities during the next 12 to 24 months; and -- We assume the company will not make any major acquisitions or dividends. -- Recovery analysis For the full recovery analysis, please see the recovery report on Amber, to be published as soon as possible following this report on RatingsDirect. Outlook The outlook is stable, reflecting the company's predictable and recurring revenue base. We could lower the rating if debt-funded acquisitions or competitive pressures were to cause margins to dip and leverage to be sustained in the mid-7x area. Alternatively, we could raise the rating if debt reduction, coupled with organic revenue growth and margin improvement that leads to EBITDA growth, resulted in leverage sustained below 5x.