Cyren Ltd.
Q2 2015 Earnings Call Transcript

Published: 17 Aug 2015

[Operator:]

Good day and welcome to the CYREN Second Quarter 2015 Earnings Conference Call Webcast. Today's conference is being recorded. At this time, I would like to turn the conference over to Brad Nelson with KCSA Strategic Communications. Please go ahead.

[Brad Nelson:]

Thank you and welcome to our conference call to discuss CYREN's second quarter 2015 financial results. This call is being broadcast live and can be accessed on the Investor Relations section of the CYREN website. Before we begin, please let me remind you that during the course of this conference call, CYREN's management may make forward-looking statements. These forward-looking statements are based on current expectations, that are subject to a number of risks and uncertainties that may cause actual results to differ materially from expectations. These risks are outlined in the Risk Factors section of our SEC filings, including our prospectus filed on August 12, 2015. Any forward-looking statements should be considered in light of these factors. Please also note as a Safe Harbor, any outlook we present is as of today and management does not undertake any obligation to revise any forward looking statements in the future. Also during the course of this conference call, we may discuss non-GAAP measures when talking about the company's performance. Reconciliations to the most directly comparable GAAP financial measures are provided in the tables in the earnings press release issued today and available on the Investor Relations section of our website. These financial measures are included for the benefit of investors and should be considered in addition to and not instead of GAAP measures. With me on the call today are Mr. Lior Samuelson, CYREN's Chairman and Chief Executive Officer and Mr. Mike Myshrall, Chief Financial Officer. With that, I would now like to hand the call over to Lior.

[Lior Samuelson:]

Thank you, Brad, and thank you for joining me today as we discuss CYREN’s 2015 second quarter results and provide an operational and business update following the completion of our recent capital raise. On our last earnings call, we discussed CYREN’s evolution, our transition from being a detection technology provider to one of the world's top security companies, enhancing our cloud-based CYREN WebSecurity platform, to provide the most sophisticated cyber security protection capabilities in the industry, scaling our go-to-market strategy to best position us to drive customer wins and continuing innovation in new approaches to cyber security solutions. During the second quarter, we increased the speed of our accomplishments. Last week, we successfully completed an underwritten public offering of our common shares with total gross proceeds of $12.6 million. The offering roadshow was an overwhelming success, [indiscernible] dozens of institutional investors and the deal was heavily over-subscribed. The successful completion of this public offering shows that CYREN story is resonating with investors and the market views our business model favourably. We took advantage of this opportunity to raise money because we are seeing increased demand for our product offerings, particularly CYREN WebSecurity. While our balance sheet is sound, we have significant investor interest, and felt now was an appropriate point in our company’s trajectory to tap the capital markets. The proceeds will allow us to accelerate R&D and hire additional sales professionals to meet the increased demand for CWS. The security industry continues to shift from hardware to software, cloud solutions and from traditional detection methods to more sophisticated automatic cyber solutions. We have positioned CYREN to be a major player in the changing landscape of the security industry and CYREN WebSecurity is appealing to customers, while seeking to replace their expensive and cumbersome secure web gateway appliances with a cloud based solution. Enterprise customers are beginning to realize the appliance based security cannot protect today’s mobile workforce. We are very bullish about the prospects of CYREN WebSecurity and have some important wins and a large and growing pipeline. As an example, during the quarter we signed WiFi SPARK, a CWS customer. WiFi SPARK operates over 100,000 access points across Europe and has integrated CYREN WebSecurity to provide secure browsing to its enterprise customers, hotspot owners and visitors. The integration utilizes CYREN’s DNS-based policy enforcement feature and validates the market’s interest in this solution. We also won several new accounts in the US and Asia who are currently rolling out CYREN WebSecurity. These wins include several multi-year contracts with enterprise customers and security solution providers ranging in size from several hundred seats to several thousand seats. As the interest of CWS continues to grow, we’re continuing to build out our sales force in order to meet this demand. As we told the investors during the roadshow part of the proceeds from the capital raise will go toward adding additional sales people. This is consistent with our previous stated strategy to ramp up our direct enterprise sales efforts that were begun earlier this year. We continue to validate the superiority of our detection technology both in our embedded business as well as our new offerings. As an example, during the quarter Intel Security, McAfee, renewed [and added] [ph] to our already significant relationship. We continue to see an increased strength of our customers who are interested in components of our cyber intelligence solution. As an example, during the quarter Securepoint has expanded their relationship with us by buying our Malware Attack Detection and IP Reputation services. And Cyveillance has entered a new contract for CYREN Phishing Intelligence. We are increasing the speed of innovation and our development efforts are focused on further enhancing CYREN WebSecurity as well as the rollout of our cyber security solution called Cyber Threat Protection. Cyber Threat Protection will be released later this year, first as an add-on module for CWS and separately as a standalone solution in 2016. Cyber Threat Protection will leverage CYREN’s superior real time protection, industry leading security data and intelligent analytics to protect customers against advanced cyber attacks. It will be sold as an extra component to CWS at potentially double the average selling price over current CWS pricing. During the quarter, we announced a key component of the Cyber Threat Protection solution. The CYREN Next Generation Sandbox service, which uniquely harnesses the power of automated, multi-layered sandboxing array capabilities that rely on global cyber intelligence, instead of traditional human analysis or reactive procedures initiated due to customer infection or attack. The tool is unique in the industry in that it can decide what to do with suspicious resources before the threats can impact a single customer. No other security vendor is able to do this, making the Sandbox a truly first for the industry. Most importantly, CYREN is able to consistently identify and protect against more new and unknown threats sooner than any other competitor security vendor. Gartner recently identified network based sandboxing as an emerging requirement for security solutions though most vendors like a cloud based solution. In support of our constant innovation, in June, we were awarded a government grant of approximately $930,000 from the Office of Chief Scientist at the Ministry of Economy of Israel. The grant is part of OCS’ KIDMA program to advance the cyber security industry in Israel and will offset our R&D costs and the development of our cyber threat protection platform. The funding allows us to expedite the launch of this platform and specifically address detection, remediation of advanced threats that have already breached the security perimeter. The recent development on the sales front, our growing pipeline and R&D accomplishments enhanced our confidence that our CWS and Cyber cloud offerings will compose the majority of our quarterly revenue by early 2017. As this new cloud business becomes a more material piece of the quarterly business, we will communicate meaningful targets and metrics against which to track our progress. With that, I’d like to hand the call over to Mike to further elaborate on the results. Mike?

[Michael Myshrall:]

Thank you, Lior and good morning everyone. I will now provide you with a summary of our second quarter 2015 results. For the more detailed results, please refer to the press release we issued earlier today which is posted on our website. In addition, please note that we compile our financials under US GAAP, including non-operating items. In order to better analyze our business performance, I will also discuss certain financial metrics on a non-GAAP basis, which excludes those 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 second quarter of 2015 was $6.7 million, compared to $7 million in the first quarter of 2015 and $8.3 million a year ago. Non-GAAP revenues for the second quarter totaled $6.8 million compared with $7 million last quarter and $8.3 million in the second quarter of 2014. As we detailed on the last earnings call, the reduction in revenue over the past several quarters has been driven primarily by the weakness of the euro over the trailing 12 months; a few customer agreements that were not renewed at the end of their terms along with some weakness in customer reporting of traditional anti-spam services. However we believe the revenue base in the embedded OEM business is stable and we will remain between $6.5 million and $7.5 million in upcoming quarters. Our GAAP gross margin for the quarter was 69% compared with 71% for the previous quarter and 75% in the second quarter of 2014. Non-GAAP gross margin for the quarter was 72% compared with 74% during the previous quarter and 79% a year ago. The reduction in gross margins is solely a function of reduced revenue for the period while the operating cost base remains relatively flat. GAAP operating expenses for the second quarter were $5.2 million, continuing an improvement from $6.4 million last quarter and $8.1 million in the second quarter of 2014. The reduction in GAAP operating expenses was mainly due to a decline in R&D costs which decreased to $1.8 million from $3.1 million for the same period last year. This decline is due to the net capitalization of some software development costs amounting to approximately $0.5 million, the OCS grant that Lior previously discussed which amounted to approximately $0.5 million, as well as the appreciation of the US dollar versus the euro and Shekel. Technology capitalization is a new adjustment that has been added to the GAAP and non-GAAP reconciliation table in our earnings release. Also, within operating expense, G&A expense for the quarter totaled $1.3 million compared to $1.9 million during Q2 2014. The decline is primarily the result of a one-time settlement of $0.6 million received from a former customer which reduced G&A expenses for the quarter. Settlement agreements are adjusted from non-GAAP expenses as explained in the non-GAAP reconciliation of the earnings release. Non-GAAP operating expenses for the quarter were $6 million compared with $5.9 million last quarter and $7.5 million for the second quarter of 2014. Second quarter GAAP net loss was $0.6 million or a loss of $0.02 per basic and diluted share compared to a loss of $2 million or a loss of $0.08 per basic and diluted share in the second quarter of 2014. Our second quarter non-GAAP net loss was $1.2 million or a loss of $0.04 per basic and diluted share compared to a non-GAAP net loss of $1.1 million or $0.04 per diluted share in the second quarter of 2014. The reconciliation between GAAP and non-GAAP net income is included in our press release. Now turning to the balance sheet. Our cash balance at the end of the quarter stood at $7.9 million compared to $8.5 million as of March 31. Operating cash flow for the second quarter was $0.3 million in line with operating cash flow from a year ago but up substantially from an operating cash burn of $2 million during the last quarter. Net cash usage for the quarter was $0.6 million, down dramatically from the $2.6 million cash burn during the first quarter of 2015. The cash position as of June 30, 2015 does not reflect the proceeds raised from the public share offering which was priced last week. As Lior mentioned, the share offering was very well received and heavily over-subscribed and the $12.6 million gross proceeds of the offering will result in approximately $11.5 million of additional cash after expenses. We believe this additional cash will help allow CYREN to invest incrementally in sales and R&D and propel the company to profitability by early 2017. We sold 7.7 million shares in the public offering, including the underwriters’ over-allotment option bringing the current total as standing share count to 39.1 million shares. At this point, I would like to open up the lines for Q&A.

[Operator:]

[Operator Instructions] And we will take our first question from Lisa Thompson of Zacks Investment Research.

[Lisa Thompson:]

I just have a couple of questions on things like the R&D grant, looks like you took $0.5 billion of that, are you going to take the other $0.4 million in this quarter?

[Lior Samuelson:]

No, the remaining amount will be spread through Q3 and Q4 but since we received the notice of the grant during the second quarter, we were able to take basically Q1 and Q2 expenses both in the second quarter.

[Lisa Thompson:]

And then I noticed one bright spot is that your bookings are up. Can you talk a little bit about where the new orders are coming in from specifically versus revenues?

[Michael Myshrall:]

Sure. So our bookings have increased both on the embedded OEM side as well as the CWS side. And in the embedded OEM business, as we talked about we renewed McAfee for another three year term which was at an incremental amount over previous year’s. We had also signed a couple of contracts related to our cyber intelligence fees. And so I think what we are seeing is increased demand for our advanced malware and phishing intelligence solutions in the OEM business. On the CWS side, we made good traction as well, both with re-sellers and direct to enterprise accounts. Lior did reference the WiFi SPARK deal which is a relatively large operator throughout Europe but we had a number of other enterprise customers both in Asia and the US who signed up for CWS as well.

[Lisa Thompson:]

And as far as the WiFi SPARK deal, how is that contract, is that multiyear or how do you get paid off for that, the usage or dollar amount?

[Michael Myshrall:]

It’s a combination of usage as they put more of their access points on to our network and sell our security solutions through their network, and we should see their – the revenue contribution from that contract increase. Initially it came with several enterprise accounts that are already signed on to the CWS platform but we would anticipate that we would grow that relationship over the next two years.

[Lisa Thompson:]

Okay. So these people – what do they do – they have stores or something like Starbucks or what do you mean by enterprise accounts?

[Michael Myshrall:]

They provide Wi-Fi services to both public Wi-Fi networks as well as private Wi-Fi networks which are corporate customers who outsource their operation of Wi-Fi infrastructure to WiFi SPARK. So you can think of it as a large enterprise that has a campus environment or guest Wi-Fi access point that they want secured, they could use our CYREN WebSecurity technology to secure that infrastructure.

[Lisa Thompson:]

Are there other companies like that out there that you can target?

[Michael Myshrall:]

Yes. We have several initiatives ongoing both in Europe as well as the US to target the Wi-Fi and public network infrastructure and we think that there is good opportunity there.

[Lisa Thompson:]

And what’s your best guess on sequential revenue growth?

[Michael Myshrall:]

So as I mentioned in the financial section, we do anticipate that the embedded OEM business will remain stable in the $6.5 million to $7.5 million quarterly revenue range and as we add additional CWS customers on top of that, that will be incremental on top of the OEM embedded business.

[Lisa Thompson:]

Okay, so we have a good shot at it then. Great, thank you, that’s all my questions.

[Operator:]

And we will go next to JD Padgett of ALMAK Capital.

[J.D. Padgett:]

A couple of quick questions. One is, I know coming out of Q4, you had talked about some incremental new wins on the embedded side and expectation that might ramp in the second half. Is that still your expectation or are there some incremental headwinds that have since popped up for that business?

[Michael Myshrall:]

No, so the bookings that we did announce in fourth quarter did start to have an impact both in Q1 and in Q2. So for instance, the Dell SonicWALL deal that we announced earlier in Q1 was the deal that was announced – or actually closed in the fourth quarter and that started to generate revenue in the second quarter. There were some other bookings that happened in the fourth quarter that have started to recognize revenue at the end of Q2 and into Q3. So we do believe that there will be a more positive impact in the second half of the year from some of those bookings that closed in Q4.

[J.D. Padgett:]

I guess that’s kind of consistent with your expectation that the revenues would be in the $6.5 million to $7.5 million range or kind of at the lower end of that now, so maybe we see some continued lift through the next couple quarters?

[Michael Myshrall:]

Yes, that’s our expectation.

[J.D. Padgett:]

And then what’s the expectation with respect to CWS? Will that be a needle mover at all this year or really more for 2016?

[Lior Samuelson:]

It’s Lior. I think it will be a needle mover. I mean I like the way you’ve phrased it. We are seeing – there is a lot of traffic in our network from trials, I think that -- we see that the – so there will be an impact this year but clearly the big impact from this -- big sort of basically trials and backlog in pipe will probably – I will guess, the big one will actually be in 2016, I think. But we will see some this year as well.

[J.D. Padgett:]

Did I ask kind of a naïve question as well, with CWS how do the customers utilize that, so they adopt that within their networks and then all of their internal users, do they need to then just log in to a site that you manage, then to secure all of their resources or what’s the layman explanation?

[Lior Samuelson:]

That’s okay. I am glad you asked the question. Fundamentally the way that most people basically secure their web browsing today, which you know is sort of one of the main ways that people get infected is through appliances, to a fundamentally get appliance and the entry to let’s say to an enterprise, if you are a bank or variety or multi-facility enterprise, you’ve got to have multiple boxes and then the traffic, they see it flows through the box. And what happens today is you have a mobile workforce, I mean you take your laptop or iPad home or people moving around all the time, working from home, and as a result, the boxes can no longer protect you, and also – so what happens is that when you sign up to our service, because we provide the service through the cloud every time you open your device, whatever the device is, then you surf all the browsing you do is through our cloud infrastructure. I mean so you open a device, no matter where you are and you will surf the web, you browse the web through our cloud and we provide you we will refer to as a clean pipe.

[J.D. Padgett:]

So it is logging into your infrastructure to –

[Lior Samuelson:]

You don’t have to – well, you don’t have to log in, once you initiate the service, that’s basically automatic. You just – all the browsing, all your activity in the Internet goes through our network.

[J.D. Padgett:]

And what’s the method of authentication for the people coming to your cloud then?

[Michael Myshrall:]

So there is two levels of authentication. Number one from a user standpoint, as Lior mentioned, once you authenticate once to the service, you’re recognized to our service and so you don’t have to log in ever again, any time you open that browser it knows that you are already registered with our service and your traffic goes through our infrastructure. On the incoming side, the way our technology works is that we leverage our embedded building blocks, our OEM building blocks that we’ve licensed to other partners, our anti-malware, our anti-spam, our URL filtering, our anti-phishing technologies and basically we run the websites through those engines to clean them of any potential malware or any potential infections. So from a security standpoint, you are utilizing all of our fundamental underlying technologies to make sure that you receive both a secure and clean pipe.

[J.D. Padgett:]

And then a final question from me, the customer settlement. Could you provide any background about that? Was that a customer that maybe could have contributed revenue in the second quarter and then sold away and just reached some settlement agreement with you or is that not correct?

[Lior Samuelson:]

No, that’s actually a longstanding issue that dates back several years and we finally resolved that in the second quarter where they paid us about $600,000.

[Operator:]

And we’ll go next to Reuben Gaz with Opus Capital.

[Reuben Gaz:]

Thank you for taking my questions. First question, what I have is for CWS, how many customers you have now approximately?

[Lior Samuelson:]

So we have several tens of thousands of people on the network right now and growing.

[Reuben Gaz:]

And if I understand correctly, you mentioned that early in 2017, majority of your revenues will be from CWS? So --

[Lior Samuelson:]

Sorry, go ahead.

[Reuben Gaz:]

So first, did I get it right?

[Lior Samuelson:]

Yes.

[Reuben Gaz:]

Okay. Does it mean then that basically today you are running your embedded service between – around $7 million, let’s call it per quarter – does it mean that it would double by 2017, if you embedded stays about the same and now in 2017 majority would be from your cloud service so that means your revenue would double?

[Lior Samuelson:]

That’s correct. I do want to make one comment, I apologize but everything we do today including our embedded business, everything is done through our cloud. So we are a totally cloud company, have been for quite a while.

[Reuben Gaz:]

So but still assumption, which I mentioned before is correct, right --?

[Lior Samuelson:]

That’s correct.

[Reuben Gaz:]

And in terms of competitive situation [indiscernible] your competitors in cloud in AWS business for you?

[Lior Samuelson:]

So I think that – if you are looking about sort of cloud services, I think it’s probably Zscaler which is a private company. OpenDNS which does mostly DNS but it was acquired by Cisco a few weeks ago.

[Reuben Gaz:]

So that’s very limited number of competitors right, that you have?

[Lior Samuelson:]

Well, I mean I think that if you think about the cloud, I mean clearly we believe that a lot of other people analysts believe that there is going to be – that there is a – there will be and there is a shift to home appliances to the cloud, there are not too many cloud players out there. We are one of the few that are totally cloud service. I do think that there are other people out there that today provide appliance based security. Websense and Blue Coat and people like that who are – that provide web gateway but they do not provide the best arenas web gateway to in the cloud.

[Reuben Gaz:]

And how many people approximately you have in R&D working on CWS?

[Lior Samuelson:]

If you think about it, we are really an R&D company. I mean since that’s our foundation, we start out and still continue to be basically a detection technology supplier to some of the biggest companies in the world and the best security companies in the world. So I would say about half of the people in the company are R&D people.

[Reuben Gaz:]

And you could do it with like around $2 million per quarter in R&D budget.

[Lior Samuelson:]

So there were a couple of entries from an accounting standpoint that made the numbers a little confusing on an R&D standpoint. The few items that have brought the R&D expense on a quarterly basis have brought the R&D expense down, our number one that we’ve capitalized some of our R&D expense so that had an impact of about $0.5 million in the quarter. And the second was the OCS grant that was referenced earlier that also offset the expenses by about $0.5 million. But if you were to look at the R&D expenses on a non-GAAP basis, it’s approximately $2.2 million on a quarterly basis. And I think that’s a truer reflection of the expense in R&D.

[Reuben Gaz:]

And my last question if I may. What is that you feel is the competitive differentiation of your CWS service comparing to a bigger player like Zscaler or OpenDNS?

[Lior Samuelson:]

I mean I don’t want to single out any other competitor but I will tell you what we think are competitive advantages and how we differentiate ourselves today and in the future. One is that as I mentioned a few minutes ago, we are really a detection technology company, and we have a very sophisticated detection engines and algorithms that are we believe second to none, not only in the quality of the detection, but also the number of engines that we have. We do everything ourselves, we buy no detection from anybody else. So whether it’s anti-malware, anti-spam, URL filtering, phishing, whatever we have all that, that we’ve developed ourselves, that’s one. The second thing is that we basically conduct about 17 billion security transactions in the cloud every day, and as a result, we have a huge database, I mean absolutely huge database that allows us on a second-by-second, millisecond to millisecond day to day basically improve continuously our detection and also see real time where all the attacks come from. So we have visibility that few people in the industry have.

[Operator:]

And we will take a follow up question from JD Padgett of ALMAK Capital.

[J.D. Padgett:]

Hi, just one quick follow up. The outlook for the embedded OEM business over the next couple of years, is it correct to think that would maintain at stable or does that begin to decline as you ramp CWS, just trying to get some idea about how to think about that?

[Lior Samuelson:]

Historically we have had a very good renewal rate in that business, of approximately 90%. We plan to maintain that revenue stream in that same $6.5 million to $7.5 million for the foreseeable future. So our goal is to hold on to the vast majority of those revenues even if CWS begins to ramp.

[J.D. Padgett:]

Is there any dynamic where those customers potentially don’t like that you are moving into position to be more competitive with them or CWS and therefore don’t renew or anything like that?

[Lior Samuelson:]

We don’t think so. It’s a pretty rationale market.

[Operator:]

And we will go next to Chad Bennett of Craig Hallum.

[Chad Bennett:]

Hey guys, good morning. So can you talk about the demand or the pipeline growth that you are seeing and kind of – as you get your cyber threat product out, do you think that significantly enhances the pipeline or accelerates the pipeline? I guess what I am viewing that is – I would imagine the hottest part of the security market is more on kind of the cyber threat side, and do you think that you are seeing some customers – potential customers hold off until your threat product comes out?

[Lior Samuelson:]

So let me start with the latter part of your question. So I think that – so we are not seeing people sort of holding off and I think it’s part, I think, of – what we are seeing, what the industry sees, as I mentioned earlier, sort of a transition or shift from appliances to cloud based services. We do think that – when our cyber intelligence module is added to CWS that, it will enhance our competitive position in the market measurably. So we think that’s going to happen and that as we mentioned, that will happen toward the end of this year. So I think that’s going to happen. What we are seeing is we started really sort of the direct to enterprise efforts maybe about two and half months ago, two, two and a half months ago, and everyday we are seeing more and more interested parties and more and more people that want to test the products. So we don’t have enough information to forecast yet but it sure feels good.

[Chad Bennett:]

Do you – I guess the early enterprise customers that you talked about, what forced them to move to you guys and what today – I assume they have some type of web gateway security technology in place, and what do they move from?

[Lior Samuelson:]

So I think there’s really perhaps maybe four elements that I think are important. One is, I think, when you move from our appliance to the cloud, one, I think it’s the lifetime costs of the service to clients and we don’t have to replace appliances. Two, I think the mobile workforce, working from home, taking your laptop around, your iPad, your cellphone has become quite important to a lot of enterprises. Three, I think that the overall detection, I think, is superior if you use the cloud service, and four, I think the user experience of going to the cloud is just a better user experience for the person who browses. It’s basically seamless, you basically get securely in a seamless manner.

[Chad Bennett:]

And then what are they replacing – your early wins, what do they have before you?

[Lior Samuelson:]

Well, they are replacing basically appliances, Websense appliance is an example.

[Chad Bennett:]

And then last one from me, Lior, what do you think with the additional capital where are you at today and with from a quota bearing standpoint for CWS on a sale sub-account basis and where would you hope to be, pick your timeframe, two quarters from now?

[Lior Samuelson:]

So I think that, right now we are – our total sales force is about in the mid 20s. We’re probably going to enhance it this year, say by probably 20% to 25% and I would say that by the end of 2016 probably almost double it, so that’s kind of really our plan. End of Q&A

[Operator:]

And that concludes today’s question and answer session. At this time I will turn the call back to management for any additional or closing remarks.

[Lior Samuelson:]

Well, thank you all for joining us. I think that with the increasing sophistication of the cyber criminal tactics and more complex distribution methods, and bigger volume of attacks, enterprise data is more vulnerable than ever. So we believe that the opportunities that exist for us at CYREN are greater than ever before and that we are very well positioned to become a leader in the security industry in the future. Thank you.

[Operator:]

And this concludes today’s CYREN second quarter 2015 earnings conference call webcast. We thank you for your participation. You may now disconnect.