Good day, and welcome to the Perion third quarter 2018 earnings conference call. Today's conference is being recorded. The press release detailing the financial results is available on the company's website at perion.com. Before we begin, I'd like to read the following safe harbor statement. Today's discussion will include forward-looking statements. These statements reflect the company's current views with respect to future events. These forward-looking statements involve known and unknown risks, uncertainties, and other factors, including those discussed under the heading Risk Factors and elsewhere in the company's annual report on Form 20-F that may cause actual results, performance, or achievements to be materially different in any future results, performances or achievements anticipated or implied by these forward-looking statements. The company does not undertake to update any forward-looking statements to reflect future events or circumstances.
As in prior quarters, the results reported today will be analyzed both on a GAAP and non-GAAP basis. When mentioning EBITDA, we will be referring to adjusted EBITDA. We have provided a detailed reconciliation of non-GAAP measures to their comparable GAAP measures in our earnings release, which is available on our website and has also been filed on Form 6-K. Hosting the call today are Doron Gerstel, Perion's Chief Executive Officer, Maoz Sigron, Perion's Chief Financial Officer, Mike Pallad, President of Undertone, and Mike Glover, GM of Search Business Unit. I would now like to turn the call over to Doron Gerstel. Please go ahead.
Thank you, and good morning. The headline today speaks to Perion profitability momentum and the strong financial discipline that resulted in a major financial milestone as long-term debt fell below our cash levels for the first time in four years. As of September 30th, 2018, cash and cash equivalents were $40.9 million, and we generated cash flow from operations of $28.5 million since the beginning of the year. During this period, we reduced our net debt from $60.7 million to $39.7 million, a reduction of over $20 million in nine months. With our expense restructuring effort completed, we are pivoting to the next phase of our turnaround. As you may recall from previous earning calls, the strategy that we implemented when I joined Perion as CEO in April 2017, was designed with three phases.
Phase one was cost optimization to reduce a bloated corporate structure and get our business to the right size, decrease operating costs, and strengthen Perion's financial core. Phase two is focused on differentiated technology, as technology is essential for our competitive advantage, and phase three will be focused on growth. We continue to allocate technology resources to enhance Undertone Synchronized Digital Branding platform by integrating advanced AI-based sequential messaging capabilities to retarget user according to their level of engagement. The investments we are constantly making in Undertone have been enabled by the cost optimization initiatives we put in place, which allowed us to extend our innovation runways and address the revenue headwinds we are seeing in the current programmatic environment. Advertising revenues declined in the third quarter, mainly as a result of ongoing shift to programmatic advertising and its impact on demand supply levels, which we discussed last quarter.
To be more precise, there was a continuing gap between the programmatic network who hold the inventory and the feed of our high-impact ad unit. During the third quarter, the capacity of publisher that could place our unique ad units was less than the demand we had. We had and continue to have campaigns that are not being fully delivered. We are actively working with our programmatic partners to address this issue so we can expand our available inventory to better scale our ability to deliver high-impact ad units for our customer. Our partner represent the majority of the programmatic volume, and I am confident that we will close the current gap to better serve programmatic-ready Undertone high-impact ad units in 2019.
The combination of high impact, high quality, and high engagement ad units that Undertone is known for is what brands are demanding, where the growth in the market is and where the growth will continue be. These ad units derive significantly higher campaigns ROI for our blue-chip customer and thus carry a premium margin with them. Brands need their messages to reach their consumer at the right time, in the right way, with the right story. Undertone's Synchronized Digital Branding strategy combine performance focus and award-winning creativity with AI-driven distribution and targeting to perfectly answer the brand's needs. What we launched in the beginning of the year and are continuing to build is an industry-defining combination of creativity and sequential targeting delivery.
This will keep us focused on our differentiation and reputation for leadership and quality as we adapt in real time to a programmatic world. In parallel, we continue to leverage our relationship with Bing to drive innovation and revenue as part of our ongoing effort to provide comprehensive and compelling search solution to quality publisher around the globe. Our products and engineering teams are working closely to bring an even greater added value to our partners. To drive this, we have appointed Tal Jacobson to lead our CodeFuel business unit within search. Tal has a long track record of innovation and monetization, most recently as the Chief Revenue Officer and Chief Business Development Officer at Similarweb. I am confident that he will add immense value to our team.
I also want to take this opportunity to thank Mike Glover, our former CodeFuel GM, for his dedication and ability to enhance our relationship with Bing. Mike will continue to advise the company in 2019. I will turn it over to our CFO, Maoz, to review the quarter in further detail. Maoz?
Thank you, Doron. In the third quarter of 2018, revenue for Perion total, $57.2 million, comprised of $26.2 million of advertising revenues and $31 million of search and other revenue. Revenue was down 12% from $65 million in the third quarter last year. This decrease was primarily a result of a 17% decrease in advertising revenue due to insufficient programmatic inventory to meet our demand for our programmatic high-impact ad unit, along with 7% decrease attributable to continuing decline of the long tail of our legacy sales products. Search and other revenue represented 54% of revenue for the third quarter of 2018, with advertising contributing 46%. This compared to the second quarter of 2018, when search contributed 47% and advertising contributed 53%.
Customer acquisition cost in media buying in the third quarter of 2018 was $28.8 million, or 50% of revenue, compared to $32 million, or 49% of revenue in the third quarter of 2017. This increase was primarily a result of the effect of header bidding and Chrome ad blocker on advertising. We reported net income of $2.2 million or $0.08 per diluted share for the third quarter of 2018, compared to $2.6 million or $0.10 per diluted share in the third quarter of 2017. Perion non-GAAP net income in the third quarter of 2018 was $4.3 million or $0.16 per share, compared to $4.1 million or $0.16 per share in the third quarter of 2017. Adjusted EBITDA in the third quarter of 2018 was $6.7 million, compared to $6.5 million in the third quarter of 2017.
Cash flow from operating activities for the first nine months of 2018 was $28.5 million, compared to $28.9 million for the first nine months of 2017. As of September 30, 2018, we had cash equivalent and short-term deposits of $40.9 million compared to $27.5 million as of December 31st, 2017. This concludes my financial overview for the third quarter of 2018. I will now turn the call over to the President of Undertone, Mike Pallad, for details on the business.
Great. Thank you, Maoz. I would like to take a few minutes to address some of the challenges of Undertone's advertising business, which Doron referenced earlier. Simply put, our clients want more of what we offer because it works. Undertone's effectiveness of digital spin continues to be a challenge, for marketers and agencies alike. Undertone's ability to provide a cohesive message across all screens and platforms in safe, premium environment drives the desired engagement that brands are looking for, regardless of their KPI. This is exactly is what driving our demand. We are working to ensure the demand can be completely met, ending the supply issue once and for all. To accomplish this goal, we have implemented an aggressive plan of action, three more specific initiatives, not only to drive more supply for brands, but also to enable us to offer services in an unreserved programmatic environment.
Some of these new initiatives were driven by the recent guideline changes of the Coalition for Better Ads. Motivated by these changes, we've introduced four new compliant cross-screen ad units, which allows us to scale more with our existing premium publishing network and also onboard new premium publishers, enhancing the total quality of our network. We continue to release our header bidding technologies into the marketplace, which gives us the ability to decide on specific impressions from publisher sites that best match the brand's campaign's KPI. This enables us to also see more supply from those individual publishers. Finally, the rollout of our direct server-to-server integration with our DSP partners continues to take traction. This also allows us to see more from our net new publishers, as well as our existing publisher network.
Over the next quarter and into 2019, we'll continue to release new technology solutions throughout the entire network. These advancements and continued hard work of the stellar team that we have
We're well on our way to eliminating the gap between supply and demand, as well as creating a frictionless environment for brand partners wanting to transact with us programmatically. Thank you so much, and I'll turn the call back over to Doron. Doron?
Thank you, Mike. In summary, I'm encouraged by the progress we are making, and I'm pleased with the team's execution of the turnaround strategy. Make no mistake, though, the goal here is to rejuvenate Perion long-term growth, maximize the generation of cash, and unlock value for our stakeholders. I'll be satisfied only after we have delivered each one of these primary goals. I would now like to open the call for questions. Operator?
Certainly. If you'd like to ask a question, please signal by pressing star one on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star one to ask a question. We'll pause for just a moment to allow everyone an opportunity to signal a question. We'll take our first question from Greg Gardner, from Private Investor. Greg, your line is open. Please go ahead. Caller, you may have muted yourself. Please check your mute function. Hearing no response, we'll move on. Again, that is star one if you'd like to ask a question. We'll take our next question from John Noble from Taglich Brothers.
Hello. Good morning. Actually, good afternoon in Israel. I was hoping you could talk a little about how the recent certification from Google for MakeMeReach, how that's going to benefit your platform and your clients' campaigns.
Yes. Mike, you want to take this one?
Sure. We're really excited obviously about that announcement. The MakeMeReach platform and their ability to optimize social campaigns through their existing integrations between obviously Facebook, Twitter, Instagram, and Snapchat, now added with Google, first in reporting, and as we roll out the roadmap into 2019, eventually into their ad network business and into search. This is going to add yet another major pillar in their overall platform, allowing our brands, our advertisers, to traffic, optimize, and report all within one dashboard.
If I could, last quarter, it was mentioned that there was about $2 million-$3 million in ad revenue. It was lost due to supply not meeting demand, I believe was the reason for that. I wanted to get a better handle on that. I was curious if you could talk about any progress that was being made to meet the demand from clients.
Yeah, Mike, you addressed it in detail, happy to go ahead.
Let me address it again, John, happy to discuss with you further. It was a very specific plan of attack that we implemented, and this goes back into second quarter of this year. Number one, being able to access and see more supply from our current premium publisher base. This was driven through some of the new technology enhancements that I shared, such as header bidding technologies, as well as being able to be directly integrated into our DSPs. That's more from our current base of advertisers. The format set that I spoke to earlier that we released into the market, these formats are cross-screen and also more scalable, allowing us to not only provide or see more supply from our current publishing network, but also tap into net new publishers who previously weren't part around our overall offering.
All of these things combined were actions taken to specifically address our supply issue.
Okay. Actually, I guess for Maoz, some questions just to get an idea of tax rates for 2018 and 2019, just to get an idea of the expected tax rate, Maoz, if you could address that.
Yes, of course. Thank you. In 2018, we expected to be around a 19% tax rate. Moving forward next year, it will be around between 25%-30%.
25%-30%. One more question, because I know that you've dramatically decreased your debt levels, which is very positive as far as the balance sheet is concerned. I was hoping on this call that you might be able to give me what the expected debt levels might be at the end of 2018 and 2019. I don't know if you could even break it down into both short- and long-term debt. Maoz, another question for you.
Okay. Actually, the major payment for 2018 already paid during Q1 and Q2. We're expecting an addition immaterial amount for Q4 around $2 million. We're expecting to end the year with a $38 million debt. For 2019, we're expecting to pay another $30 million, and the rest, this is around $9 million, we'll pay it in 2020.
2019, you expect debt to be down to less than $10 million? I just want to make sure I'm sure how much is going to be paid down in 2019.
Again, pay down in 2018, additional $2 million. In 2019, additional $30 million, in 2020, additional $9 million.
You're going to leave about really $8 million or $9 million at the end of 2019 on the balance sheet.
Yes, that's right.
not much. Okay, great. That's all I had. Thank you.
Thank you.
Again, that is star one if you'd like to ask a question, and again, we'll pause for a moment. Moving on, we'll take a follow-up from Greg Gardner from Private Investor.
Yes. Hi, thank you. The $30 million EBITDA guidance, $20 million is Undertone, $10 million is Search. Is that about right since Undertone was doing $20 million in 2015, 2016 on similar sales as today?
Our policy is that we're not breaking EBITDA on the different business units.
Okay.
The only thing that we are providing is top line, and we distinguish between advertisement and search.
Okay. Was the overall demand in advertising up sequentially, fulfilled plus unfulfilled, if we include both? Was there seasonality that impacted it also? I'm just wondering if sequentially, the overall demand in advertising was up.
The overall demand is definitely up. This is something that we see, especially after introducing, the beginning of the year, our new narrative, which is around Synchronized Digital Branding. We've seen it with the same brands are investing more due to this new integrated, advanced, AI-based delivery. Overall, definitely on the overall demand, we are very pleased.
The increase was not a seasonality issue. It was just pure growth.
No, we are looking at growth always from a year-over-year perspective.
Okay. The New York City staff increases during the quarter hurt your EBITDA by how much? I'm assuming it takes three to six months for the new hires to contribute to EBITDA. I was assuming that the EBITDA was hurt in the quarter by the staff increases. If that's correct, how much was the EBITDA hurt in the quarter?
I think, first of all, we need to understand that while on one hand, we are working really hard with the technology and product to allow us to serve programmatically the demand that sales are bringing in. At the same time, it takes a good six months to ramp up the new account executive. Always you need to invest before you basically able to see the results. We are very happy with the new hiring and the training process that we have at Undertone, and we have no doubt that this new hiring will definitely translate it to additional revenue in the various region.
Mm-hmm. How many staff increases were done in the quarter at Undertone?
Well, I think it's around 17 people.
Okay. Two more. The % of Undertone revenue that is software platform revenue and the % of Undertone revenue that is ad agency consulting and design revenue, what is the breakout of those two types of revenue for Undertone?
At this point, we're not providing this breakdown between software and service.
Okay. Lastly, would you discuss the basic transition that Undertone went through the last two years? Where the revenue focus switched from buy side to sell side, Revenue was impacted during that transition, The transition is complete, The demand is now increasing. Is that the short version of the transition, Would you discuss a little bit more how the-
Yes
revenue focus changed the last two years?
Yeah. Very much. Thanks for asking. I think it's a very important question to understand what Undertone went through in the last two years. For those who cover Undertone or Perion, Undertone was very much well-known of selling the high-impact format, In this regard, it was one format that was dominant, like 70% of the sales. The transition now is that Undertone transit into selling a solution, complete solution selling. In this regards, we have way more to offer to our advertiser, It's across platform, cross-channel. We have multiple format, All in all, we added a new way of delivering our ads and ads campaign, We talked about the sequential. It's a complete transition, We're glad and we're able to see, as I mentioned in our last earning call, more and more accounts that spending million dollars and more with us.
We see more and more accounts that are increasing their spend. From a renewal standpoint, we see more and more accounts or brands that are coming back to us. All in all, definitely the business KPI is very much support the new transition that Undertone has made, That's not the end of it.
Okay. Does the software platform allow a client to do self-service ad campaigns similar to The Trade Desk, where the client will actually do the ad campaign in-house self-service with the software platform?
Right. Currently, one of the things that we did strategically, we embedded MMR, MakeMeReach, our social media ad placement platform, into the offering of Undertone. Mike explained before how this platform, the MMR platform, which is a self-service platform, is being expanded and very much covers all prominent social media channels, now they cover the Google Ads as well. This is our first step in the direction of self-service, and this is being done by using MMR SaaS platform.
Okay. I'm sorry. On the $30 million of EBITDA, is approximately $25 million of the $30 million EBITDA free cash flow, roughly $0.80, $0.90, almost $1.00 a share of free cash flow?
I think that if you will look on our current free cash flow based on the first three quarter of 2018, you will see that our free cash flow is not so far from our EBITDA. If we need to say what is the expected free cash flow for 2018, it wouldn't be so far from our expecting EBITDA right now.
Okay. For 2019, if the demand is fulfilled with the higher demand, that would mean the top line would increase in 2019, there's a high incremental margin. Would the 2019 EBITDA be able to do $33 million-$35 million EBITDA, give or take, or is that too low?
It's definitely too early for us, I think we would love to talk about 2019 in our next earning call. We definitely set the foundation with what we define as phase 1 out of the three strategic phases, which has to do not just on the cost optimization, but also how we are controlling the spend and the cost, how important it's for us to operate in a lean and mean way. We definitely going to continue in this trend.
One quick last question. If the company only lists on the U.S., how much money would that save per year?
That cost us around $1 million-$2 million to have a dual listing.
That would save $1 million-$2 million a year?
Yeah.
Okay. Thank you. That was my questions.
You're welcome.
I'll now turn the call back to Doron to conclude today's call.
Yeah. Thank you guys for joining the call, and we would love to take any question that you have on a face-to-face when I'm going to be in New York soon and/or by calling us. Thank you again.
Thank you for joining our call today, and see you in the next quarter.