Cyren Ltd.
Q1 2013 Earnings Call Transcript

Published: 16 May 2013

[Operator:]

Greetings and welcome to the Commtouch 2013 First Quarter Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Monica Gould, Investor Relations for Commtouch. Thank you, Ms. Gould. You may now begin.

[Monica Gould:]

Thank you Melissa and welcome to Commtouch’s First Quarter 2013 Financial Results Conference Call. I would like to remind everyone that the Safe Harbor statement issued in today’s press release also covers the content of this conference call. With me on the call today are Mr. Shlomi Yanai, Chief Executive Officer; and Mr. Brian Briggs, Chief Financial Officer. I would now like to hand the call over to Mr. Shlomi Yanai.

[Shlomi Yanai:]

Thank you, Monica. Good morning everyone and thank you for joining us. Q1 was a significant quarter for Commtouch, with revenue growth of 34% year over year and 17% sequentially. This growth in our overall results were in line with our expectations and were a direct result of our execution on our previously discussed strategy. Commtouch reached a significant milestone during the first quarter of 2013 and a transformation to a full Cloud-based security service provider with the introduction of our first new Cloud-based offering. We launched our private label Email Security-as-a-Service solution at the end of January, marking a major step in the long-term strategic plan we outlined 12 months ago. We are seeing very good demand from both new and existing customers for this service, as well as two other solutions we introduced during the first quarter, which I will elaborate on later. We initiated a major effort to integrate the two acquisitions we completed last quarter FRISK and Eleven, while at the same time streamlining the business to achieve cost synergies. I’m pleased to report that integration is proceeding smoothly and we completed two key elements in the process with the creation of one global sales and marketing organization and a unified engineering group. Our efforts to eliminate redundancies yield 15% headcount reduction and we have other initiatives planned for the second quarter, including integration and westernization of G&A functions. Those actions put us on track to meet profitability target as we outlined at the beginning of this year and we expect the integration process to be largely completed by the first quarter. I would like to provide a little more color on our product introductions and customer wins before turning the call over to Brian to discuss the financial results. We launched the Commtouch private label Email SaaS platform, our first major release in a series of planned Cloud-based product introductions. This solution combines premium protection against email-based threats such as spam, phishing and malware, with maximum cost-efficiency and minimum time to market. The platform delivers market-leading malware detection at a competitive price point, streamline utilization, and delivers Quality of Service. As a result, our solution helps vendors and service providers grow revenue and market share, reduce churn and improve customer satisfaction. Our second new product launch is our Mobile Security Service for Android, which represents the first ever malware detection solution that offers cloud-assisted antivirus and Web security services for Android, delivered through a single, easy to integrate client SDK. This solution offers a very large market opportunity for Commtouch with more than 400 million Android devices in use around the globe. Our third product introduction during the first quarter was our Cloud-assisted on-premise Email Security for service providers, which augments existing market-leading messaging security suite and cloud-assisted malware detection services which Commtouch has. This solution enables customers to improve email Quality of Service while reducing the cost of delivery. We are delighted by the reception of our new products have received in the market from both new and existing customers. Our broadened product portfolio is enabling us to extend our addressable market by creating a market share with existing customers as well as expanding our reach to new customers, including resellers, distributors, hosting providers and mobile application developers. During the quarter, we began to develop a channel strategy aimed at existing and expanding our opportunity with these customers and are pleased to report that we already closed our first Private Label hosting provider win. The strength of our product portfolio was recognized by the industry leading information security research and advisory guide at the RSA Conference in the first quarter. Info Security Products Guide awarded top honors to Commtouch across all our product categories. We remain on track with our plans to launch our new cloud-based Web security solutions and our Advanced Persistent Threat Detection Service in the second half of 2013. The successful rollout of our new solutions, combined with our planned product introductions give us confidence in our full year guidance of $34 million to $45 million in GAAP revenue. During the quarter, we gained new customers, both in the U.S and internationally. In addition to our new customer wins, we also continue to expand our relationship with existing customers. for example NETGEAR, a global networking equipment vendor which has been a long time Commtouch customer for all our email and web security solutions, recently integrated our Antivirus services into its ReadyNAS line of Network Attached Storage products SMBs and enterprises. In summary, I’m very pleased with the progress we have made executing on our strategic initiatives. We are bringing to market a suite of leading edge Cloud-based services that would significantly expand Commtouch’s addressable market and position the company from a best-in-class embedded malware detection service provider to a supplier of complete Cloud-based Security-as-a-Service solution. We have moved very quickly to integrate our recent acquisitions and eliminate redundancy and are on track to meet the profitability targets that we outlined at the beginning of the year. Our pores in executing on those fronts provide us with confidence in our strategy and growth objectives, which will enable Commtouch to deliver long term shareholder value. With that, I will hand over to Brian to further elaborate on the quarterly results. Brian, please go ahead.

[Brian Briggs:]

Thank you, Shlomi and hello everyone. I will now provide you with a summary of our first quarter 2013 results. For the more detailed results, please refer to the press release we issued earlier today. In addition, please note that we compile our financials under U.S GAAP, which includes non-operating expenses. In order to better analyze our business performance, I will also discuss certain financial metrics on a non-GAAP basis excluding these non-operating items. You can refer to today’s press release for a full reconciliation of our GAAP and non-GAAP results. GAAP revenue for the first quarter of 2013 was $7.9 million, up 17% sequentially from Q4 of 2012 and up 34% from a year ago. The acquisitions of Eleven and FRISK accounted for the majority of the revenue increase. Both acquisitions were included for the full quarter in Q1 which was only a partial quarter in Q4 2012. Non-GAAP revenues for the first quarter totaled $8.1 million compared to $7.0 million for the sequential fourth quarter of 2012 and $5.9 million in the first quarter of 2012. Non-GAAP includes the full book value of deferred revenue amassed from the two acquisitions completed during the fourth quarter. Our GAAP and non-GAAP gross margin for the quarter was 78% and 81% respectively. First quarter gross margin reflects our post acquisition mix of business. Gross margin decline primarily related to the acquisition of Eleven, which has gross margins of roughly 75% which are below the gross margin percentages generated by the historical Commtouch business. We continue to anticipate a gradual improvement in gross margins over time as we realize efficiencies from our ongoing integration and streamlining processes. GAAP operating expenses for the quarter were $7.2 million, compared to $6.4 million in Q4 2012 and $3.7 million in the first quarter of 2012. Non-GAAP operating expenses for the quarter were $6.4 million, compared to $5.2 million for Q4 2012 and $3.3 million for the first quarter last year. The rise in operating expenses reflect the full quarter impact of the two acquisitions we completed in the fourth quarter. Additionally, we incurred increased expenses from the previously announced high level investment in sales and marketing as we drilled out a worldwide revenue generating organization. As previously discussed, we also invested more heavily in engineering to drive the development and the launches of Commtouch’s SaaS offerings. We expect operating expenses to gradually decrease as we complete the integration process and begin to realize the benefits of our rationalization efforts. The detailed analysis showing the difference between GAAP operating expense and non-GAAP operating expenses is included in our press release. During the first quarter, the company specifically recognized expenses totaling approximately $300,000 related to integration, severance and streamlining. We incurred additional costs associated with our integration efforts during the quarter, primarily related to the 15% reduction in headcount. Most of the employees impacted by this reduction were given notice rather than severance, therefore under GAAP we cannot identify these costs as being acquisition related. First quarter GAAP net loss and earnings per diluted share data include the impact of the aforementioned costs. We anticipate additional outlays related to these activities in the second quarter and expect to realize the full benefits from these efforts in the second half of 2013. First quarter GAAP net loss was $1.3 million or a loss of $0.05 per basic share, compared to net income of $1.2 million or earnings of $0.05 per diluted share in first quarter of 2012. First quarter 2013 data includes the aforementioned integration costs. Our first quarter non-GAAP net income was $72,000 or $0.00 per diluted share, including the aforementioned integration costs, compared to $1.6 million or $0.06 per diluted share in the first quarter of 2012. The differences between GAAP and non-GAAP net income are included in our press release. The primary differences include intangible amortization, stock-based compensation, adjustments to deferred revenue, adjustments to earn-out obligations, executive terminations and other acquisition related costs. Now turning to the balance sheet; our net cash at the end of the quarter stood at $4.9 million, compared to $5.1 million as of December 31, 2012. Cash usage during the first quarter included integration and severance costs associated with the two acquisitions completed during the fourth quarter of 2012. Subsequent to quarter end, we strengthened our balance sheet with the addition of a line of credit with two large Israeli banks. During the first quarter, cash used for operating activities was $151,000. Total deferred revenues as of March 31, 2013 were $7.3 million, up 45% compared to $5 million at the end of the fourth quarter 2012. The rise of deferred revenue is primarily driven by customer prepayments on contract renewals. Moving now to our financial outlook; based on the company’s current expectations, we are reiterating guidance for the full year 2013. We continue to anticipate full year 2013 GAAP revenue will be between $34.0 million and $35.0 million, an increase of approximately 42% to 46% compared to the prior year. As a reminder, our GAAP and non-GAAP net income guidance includes a higher level of sales and marketing expense relative to 2012 in support of our new Cloud-based offerings. Full year 2013 GAAP net income is expected to be greater than $2.0 million and non-GAAP net income greater than $3.5 million. The company expects to recognize additional expenses related to its recently completed acquisitions, primarily associated with integration and streamlining expenses during the second quarter of 2013. The impact of these expenses is reflected in the aforementioned full year 2013 net income guidance. With these integration and streamlining expenses addressed in the first half of the year and cost efficiency efforts in place, we project profitability to improve measurably in the second half of 2013 and be much more reflective of a baseline profitability of the core business. Please also note as a Safe Harbor, any outlook we presented is as of today and we do not undertake an obligation to update estimates in the future. At this point I’d like to turn the call back to Shlomi for closing remarks.

[Shlomi Yanai:]

Thank you very much, Brian. In conclusion, we continue to execute on our growth strategy and made great progress to date by delivering our next generation mobile and Security-as-a-Service growth engines in the first quarter. Those milestones provide us with increased confidence in our ability to deliver future growth. And with that, we would be happy to take your questions. Operator, please proceed with the Q&A.

[Operator:]

(Operator Instructions) Gentlemen, our first question comes from the line of Jay Srivatsa with Chardan Capital Markets. Please proceed with your question, your line is live.

[Jay Srivatsa:]

Shlomi, in terms of starting to realize the synergies of the integration of some of the businesses that you acquired, where are you at in terms of trying to start to benefit from the acquisition? Are you expecting more growth in the coming quarters or are you seeing pretty good traction already?

[Shlomi Yanai:]

Hi Jay. Thank you very much for joining us in the question. So the integration is moving very smoothly. When it comes to benefit from the business, as you can see from Q1 numbers, obviously the numbers are as we expected and those reflect growth also from the businesses we acquired. What we started to do in Q1 very aggressively is market and sell our Private Label mail SaaS services around the globe and we already had wins with that business. One of them is (inaudible). There were additional ones and we anticipate in the next quarters and this was part of our guidance was more growth and acceleration of growth thanks to those acquisitions.

[Jay Srivatsa:]

In terms of the Security-as-a-Service offering, obviously something new to the firm. What kind of response have you heard so far from some of the people you’ve talked to and how optimistic are you that that will start to contribute materially this year?

[Shlomi Yanai:]

When it comes to the confidence and the attraction, so when we started to market those obviously we started with the mail services we have right now and we’re also engaging partners on the web services which are a much faster growing market these days. On both we have major attraction. On the mail as a service we have a few customers already on board and a major program and prospects that we are engaged with this quarter and the next quarters. So we are confident it will contribute this year to our revenues. Obviously our revenues as you know have -- because it’s all subscription based, the contracts are multi-year. so the contribution is such, you see the impact especially growing, but still we know we’re going to have impact this year already. The good news with this business is the deals we close on this front because of the nature of the private label service and because we’re offering a complete, ready to use offering, those are not required time to sell by the vendors as it was with our detection services. For revenue customer joined, we see the recognition there and a lot of the services very fast. So we have a very high confidence there. We have high attraction. By the way a lot of the attraction is not necessarily in U.S. It’s internationally and on the web services we already have two design partners. Obviously if we launch those in the second half of the year, we’re already testing the system and have the design partners that are starting to close.

[Jay Srivatsa:]

And then last question for me is on your mobile initiative related to the Android platform. I guess the question is, how flexible is your software app to the mobile platform and as you work on the Android side of it, what are some of the challenges you’re facing in terms of tailoring the software to the mobile platform?

[Shlomi Yanai:]

So the offering on the Android was launched during the quarter. Our main focus and effort obviously was surrounding the biggest asset we have as a company, which is our malware detection services. We had to establish 18 months ago already and dedicated that just to detect the malware on the Android and learn this space which is a bit different than just the detection services we had before in the mail and web front. So we extended our detection capabilities on web and mail. We have dedicated teams for specific Android related malware. The application itself with the endpoint the bundle both web security and antivirus was already launched. It’s much more complete. It’s not an STK. To call it STK is a bit underestimating it. It’s much more ready to use by software developers. We were surprised from the attraction there, mainly surrounding new audiences we didn’t sell or didn’t obtain before which are a mobile application developers and big hosts that enable you to download application to your Android as part of the service. If it’s banking or if it’s any application you can think of. So we see opportunity there and acceptance of the solution we delivered already is high and we see opportunity there as we move forward. For us it’s a literal extension of our detection services. We sold for multiple end points and enable vendor service providers to have complete detection services we’ve already case and mobile device is literal extension and we’ll continue and focus on that.

[Operator:]

Our next question comes from the line of Ken Nagy with Zacks Investment Research. Please proceed with your question, your line is live.

[Ken Nagy:]

Congratulations on a strong quarter. Just curious, with the new product launches, is there a ramping up period with regard to margins or do they contribute right away? Thanks.

[Brian Briggs:]

Ken, this is Brian. I think you’ll see that the margins will start to ramp up right away, but obviously if we get more subscriptions, more people on board with that, the overall dollars of margins will become more meaningful. But the infrastructure that we have in place will allow the margins to start immediately, but obviously as we ramp up the volume that’s when you start to see the dollars of margin dropping through the bottom line.

[Operator:]

(Operator Instructions) Our next question comes from the line of Gunnar Hansen with Sidoti & Company. Please proceed with your question, your line is live.

[Gunnar Hansen:]

Just trying to get a better sense of some of the organic growth there. Brian, do you by any chance have the exact contribution from some of the acquisitions here in the quarter?

[Brian Briggs:]

I don’t have that broken out completely that way. I would say that very comfortably, I think that the majority of the growth was giving a slow quarter impact to the two acquisitions. Again as we talked about in the release and in the call, a lot of first quarter was investing and getting the sales and marketing organization going worldwide. So I would say the minority part of the growth quarter over quarter came from organic.

[Gunnar Hansen:]

And I guess just staying in line with some of the investment in sales and marketing in there globally, are you guys adding to that organization or is it just more of a transformation and a restructuring?

[Shlomi Yanai:]

Thanks for joining us. It’s both. What we did with the -- we started last year by establishing the team that is focused on sales operations and supporting our existing customers and making sure they’re more successful to completely eliminate churn and reduce significantly the churn and enable our customers to grow their business. And what we focused in the last six months is really on what we call the hunter side of the house. We completely redistributed our sales team in Europe, in the States. Also presence the support the Far East, both getting closer to the end customers and to the prospect. We obviously added through this process additional resources, both in sales and marketing. You can see by our numbers it’s significant investments for us. So there was a lot of new headcounts that joined the team. So it’s both.

[Gunnar Hansen:]

And I think you guys also mentioned just some of the headcount reduction, I think 15% since December. What I guess are reasons of the business as you guys were able to make some of those reductions in?

[Brian Briggs:]

The 15% we talked about in the call is net obviously of the increases that Shlomi just talked about. So the two big areas or the biggest area I guess that we completed and talked about was the integration of the engineering teams worldwide and we were able to see a fairly significant reduction in headcount there by finding out where best practices were and integrating that across the organization. So that would be the biggest individual area where we saw that happen. As Shlomi pointed out in the second quarter here, we anticipate spending more time looking at the G&A side of the equation and understanding what is needed to fully run the combined organization.

[Gunnar Hansen:]

So will there be further reductions in research and development or is this is a fairly consistent run rate for you guys going forward?

[Shlomi Yanai:]

No. this is a -- as we said also earlier we completed the reorganization there and we do not anticipate any additional reductions. We want to keep the investment there. Obviously there was a lot of opportunities for us when you think about the different types of business that we acquired and the similarity to some of the pieces that compensate the space enable us to have those synergies in those fronts. But overall our investment this year is much more significant than it was last year and we are going to maintain the expense level we have going in the meantime as we operate.

[Gunnar Hansen:]

Last question here, just with some of the guidance, any kind of breakdown in terms of U.S versus international sales and where you guys see the most growth coming from?

[Brian Briggs:]

No. We haven’t disclosed that yet and I don’t think we’ll do that at this point in time.

[Operator:]

Our next question comes from the line of Dick Mills with [RAMCO] Management. Please proceed with your question, your line is live.

[Dick Mills:]

I’m more interested in some details of the financial statement under the revenues and operating expenses. It’s nice to see revenues increase, but when the cost of revenues consistently year after year increases over the increase in revenue, that’s concerning. And particularly I’m interested in sales and marketing or the sales force. are they on a commission base or are they salaried people? And please explain what the huge increase in general and administrative cost happens to be. Thank you.

[Brian Briggs:]

Yes. I’ll cover off those questions for you, Dick. This is Brian. The sales force predominantly is on a combination of salary and commission with very specific quarters and very specific deliverables that they have to produce in order to achieve their conversation targets. So yes, everything is aligned there. Again I think what you see is because of the longer term nature of the sales cycle and the way the revenue flows in from those long term contracts that you see certainly a leading indicator of an investment in sales and marketing before you see the ramp on related revenue. I think that’s consistent with what was going to the market and what you’re seeing in the financial statements. On the general administrative side, certainly again as we talked about in the call here today, that has not been an area yet that we’ve done a complete integration and taken out any redundancies and streamlined that process, but it something that’s currently underway and we expect to complete over the course of the next quarter or so. There are also some fairly significant non-GAAP items in the G&A expense that’s broken out in the press release as far as executive terminations and amortization of intangibles and some of those stock compensation items and so on. So when you look at it on a GAAP basis, it’s significantly higher obviously than what the ongoing run rate basis of the business is.

[Operator:]

Our next question comes from the line of George Melas with MKH Management. Please proceed with your question, your line is live.

[George Melas:]

Great progress in the strategy. I have two questions. One of them is product related. The web security product that you should be launching in the second half of 2013, how much does it leverage some of the infrastructure that you got from Eleven? To what extent are you able to leverage some of what they have? And the second question relates to the deferred revenue. Brian, you mentioned that in your remarks it was a huge increase. Is it primarily related to Eleven or is there something else there?

[Brian Briggs:]

So I’ll answer the second question first, George and thank you for those questions. I’ll hand over to Shlomi for the product question. No, that was primarily related to the historical Commtouch business and certain renews. Customers who made the decision as part of their renewal and part of our negotiation to make some prepayments to us. So that was the main driver of the increase in deferred revenue during the first quarter.

[George Melas:]

So let me just elaborate a little bit on that. In the previous March quarter, in March 2012, deferred revenue barely moved, barely increased that quarter. So that seems like a very significant event of people renewing and people who had maybe not renewed before renewing now. Can you give us a little more color --

[Shlomi Yanai:]

Yes, definitely. So you definitely nailed it down. As we shared last year we added a lot of new customers to our customer base. We had a significant year on the booking side and on our execution. Some of those customers we added at the beginning of the year, some of them just renewed after 12 months of working with our products and services and those were significant renewals that we also negotiated obviously on the terms to be more long term, multi-year renewals and not just annual as sometimes happened with the initial contracts. And this is a direct result of that. So does it make sense or?

[George Melas:]

Yeah. It seemed significant to me.

[Shlomi Yanai:]

Yeah. It’s significant for us as well by all means. It was just reinforcing the great year we had last year with those renewals and we anticipate more of those as we move forward by all means. On your first question on the web to highlight, so we started the development of the web security services in the Cloud a while back before we acquired Eleven and the development of that continued. We leverage from Eleven infrastructure a lot of components. There were some significant elements that we decided to leverage and integrate with our development efforts. So this gave us a lot of opportunity and confidence in some of the cost pieces and infrastructure pieces when we developed the web services. So to your question, yes, we leveraged some pieces from Eleven. A lot of the other pieces were developed organically and the launch is targeted still for the second half of the year as was originally planned.

[Operator:]

There are no further questions at this time. I would like to turn the floor back over to Mr. Yanai for any closing comments or remarks you may have.

[Shlomi Yanai:]

I would like to thank you all for joining us today and for your continued support and interest in Commtouch. I look forward to updating to you all on our next conference call. Thank you and have a great day.

[Operator:]

Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time and we thank you all for your participation. Good day.