Good day everyone. Welcome to the Perion second quarter 2017 earnings conference call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Angie Geffen, Investor Relations. Please go ahead, ma'am.
Thank you, operator. Good morning, everyone. Thank you for joining us on our second quarter 2017 earnings call. 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 headings "Risk Factors" and elsewhere in the company's annual report on the Form 20-F that may cause actual results, performance, or achievements to be materially different from 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.
In addition, as in prior quarters, the results reported today will be analyzed both on a GAAP and non-GAAP basis. We will be referring to adjusted EBITDA when mentioning EBITDA in our comments. 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. With me on the call today are Doron Gerstel, Perion's Chief Executive Officer, Ofir Yaakovion, Chief Financial Officer, Mike Pallad, President of Undertone, and Mike Glover, General Manager of our Search business. I would now like to turn the call over to Doron Gerstel. Doron, the call is yours.
Thank you, Angie. Good morning, everyone. In my first 100 days as CEO, I've confirmed that the core assets and underlying business opportunities that attracted me to accept my position with Perion are firmly in place. Further, we have identified the issues that are impacting our financial results and near-term prospect. On today's call, I would like to present my findings for my first 100 days and details of the action I've taken and will take to address the issues we identified. As I mentioned during our last earnings call, all of the actions we are taking are in support of the three overarching priorities. One. Drive our long-term organic growth. Second. Maximize our technology asset to differentiate and enhance our solution offering. Third. Optimize our cost structure. When I arrived at Perion, the company had a holding company structure to support an M&A-driven growth strategy.
As a result, the organization heavily invested in corporate functions that would be needed to support an integrated acquisition on a go-forward basis. The company also had siloed technology as a result of this structure, and a business unit with decentralized support functionality. As one of my first actions, I announced the appointment of Ofir Yaakovion as Perion's new CFO. Ofir has significant public company experience and expertise in driving operational enhancement and cost optimization efforts. Under his leadership, Perion has begun implementing a cost optimization plan that we expect will result in reduction of our corporate expense over the next 12 months and lower our corporate cost by a minimum of $6 million in 2018.
During the second quarter, we unified our engineering function under the leadership of Miki Kolko, Perion's CTO, which will allow us to better allocate resources to strengthen our core technology and enhance our suite of solutions, both of which are key catalysts to reignite organic growth. Our ability to grow is contingent upon our ability to integrate and leverage our technology assets for maximum throughput for our clients. Over the years, Perion has acquired unique and compelling technology that has been managed as individual assets rather than consolidated into synergistic offerings. We promote Chris Hanger to be Perion's new Senior Vice President of Product Management to drive our new holistic approach. I strongly believe that deploying a one-company approach will open up additional opportunities for us to cross-sell to existing customers while also offering broader, more comprehensive solutions to new customers.
This effort will allow us to reduce our customer acquisition and media buying costs. On the search side of our business, the performance in the second quarter highlights the attractive margin profile of this business. Despite a decline in search revenues due to one-time network cleanup, we generated solid profitability as a result of the mix between our syndication business and search tail, with the tail performing better than expected. As one of the last remaining players of meaningful size in this space, we believe there are new opportunities for growth where we can leverage our position and strategic partnership with Bing to resume growth with increased profitability and cash flow. We see a significant opportunity to strategically leverage our relationship with Microsoft Bing, our largest partner, to increase our search business internationally and advance our participation in mobile.
During the second quarter, we appointed Mike Glover as General Manager of our Search business as part of strategic efforts to rejuvenate this business. Mike is an experienced leader in the search field, and he brings strong relationships in the industry. He understands and believes in the search media market, and is committed to evolving Perion as a search industry leader. Under Mike's leadership and working with our network of high-quality publishers, we believe we can substantially increase the value we add to Bing and other partners. On the advertising side of the business, I found that Undertone is strategically well-positioned in the growth areas of advertising with a strong portfolio of world's leading brands as customers and differentiated offerings. Increasingly, brands are seeking higher levels of quality with their advertisements, and this strongly benefits Undertone. To support our organic growth strategy, we have implemented sales-first approach to our business.
This means that every decision that we make will be based on their impact to drive revenues. In doing so, we reviewed the existing engineering project to prioritize them for their immediate impact on the company revenue. We expect to see revenues from this initiative as early as Q4. As we announced earlier today in our press release, subsequent to the end of the quarter, we promoted Mike Pallad, Undertone's Chief Revenue Officer, to President of Undertone. Mike will be replacing Rob Schwartz, who has stepped down from this role to pursue other opportunities after a transition period. I'd like to thank Rob for his service and wish him well in his future endeavors. His contributions to Undertone will benefit the business for years to come. I'd also like to congratulate Mike on his promotion.
Mike joined Undertone in 2016 from Apple, where he held key sales management roles for Apple Music and iAd. Mike's promotion is aligned with our sales-first approach, and I have confidence that in his new role, he will advance efforts to strengthen Undertone sales team, enhance our core brand, and play a key role in the diversification and expansion of Undertone business. At this time, I would like to break here and let Mike say a few words. When he is finishing, I will continue with my prepared remarks. Mike?
Doron, thank you. I appreciate the kind words and the confidence that you have in me. I'm very excited about this opportunity. During my time here at Undertone, I've seen this company continually adapt to the ever-changing landscape of the ad tech industry. Undertone has always been seen as a leader in delivering outstanding, engaging creatives as we've continually advanced our capabilities in providing full service solutions that brings exceptional value to the top brands and agencies that we work with across the globe. I'm thrilled to be working even closer with the talented team here at Undertone. I look forward to continuing to innovate and leverage our technology to bring even more value to our customers. With this, again, Doron, thank you, and we'll turn it back over to you.
Thank you, Mike, and good luck. During the second quarter of 2017, revenues of our advertising business unit were up both sequentially and 9% year-over-year basis. To complement our core agency business, we have begun launching new business initiatives and are working to unify our internal technologies to drive new incremental advertising revenue streams to help improve our visibility and diversify our business. Our recently announced collaboration with the Associated Press is a great example of a business initiative we are doing to diversify our advertisement business to complement our traditional agency stream of business. Undertone will work with AP to create the first to market sponsorship opportunity around the iconic AP Top 25 College Football Poll. Our social collaboration with Cycle brings premium, engaging brand content, and impactful social inventory to Undertone clients.
An important additional business initiative that enhances Undertone offering and allow us to capture a larger share of our clients' ad budget is the integration of the MakeMeReach social media platform. During the second quarter, MakeMeReach, one of the Facebook leading marketing partners in Europe, announced their partnership with Snapchat. This new integration will allow our clients to run campaigns on Snapchat and benefit from the expertise of our team on this rapidly growing mobile platform. Being recognized as a Snapchat partner marks a new milestone for MakeMeReach and for Perion as a whole. Further to our successful partnership with Facebook, Twitter, and Instagram, we can now deliver the ultimate social media ad management platform, creating a stronger synergy among Perion business division in the process.
I will now turn the call to Ofir to discuss our second quarter 2017 financial performance in more detail. Ofir?
Thank you, Doron. On a personal note, I'm excited to join Perion. This is my first earning call with the company, and I share Doron's optimism on the business. Revenue for Perion in the second quarter of 2017 were $69.7 million, comprised of $35.3 million of advertising revenues and $34.4 million of search and other revenues. Revenues were up 12% from $62 million in the previous quarter, and down 11% from $78 million in the second quarter last year. This decrease was due to our search and other revenues declining 24%, which was partially offset by an increase in advertising revenues of 9% compared to the second quarter of 2016. The decline in search was mainly due to transition effort to add new publisher to offset the expected decline due to cleanup of our existing network. In addition, legacy search products continue their natural churn as expected.
The increase in advertising revenue was primarily related to our programmatic business and increased volume from some of our top brands. Search and other revenue represented 49% of revenues for the second quarter of 2017, with advertising contributing 51% of revenues. This is compared to the second quarter of 2016, where search contributed 58% and advertising contributed 42%. Customer acquisition costs and media buy in the second quarter of 2017 were $33.8 million or 48% of revenues, compared to $34.8 million or 45% of revenue in the second quarter of 2016. The increase is attributed to both of our business line. In our advertising business, we are carefully evaluating our media buying costs and working to optimize these expenses and improve our margins. In the search business, traffic acquisition cost as percentage of revenue increased as our legacy products continued their churn.
During the second quarter of 2017, we determined that the carrying value of our Undertone business exceeded its fair value and therefore recorded a non-recurring non-cash goodwill and other intangible assets impairment charge of $43.8 million. We remain optimistic about Undertone and believe that with the new leadership and the new business initiatives we are implementing to complement our core agency business, we will see accelerated growth and improved visibility in this compelling business. On GAAP basis in the second quarter of 2017, we reported a net loss of $36 million or $0.46 per diluted share, inclusive of the $43.8 million goodwill and other intangible assets impairment charge. This is compared to a net income of $585,000 or $0.01 per diluted share in the second quarter of 2016.
Perion's non-GAAP net income in the second quarter of 2017 was $4.2 million or $0.05 earning per share compared to $6.8 million or $0.08 earning per share in the second quarter of 2016. Adjusted EBITDA in the second quarter of 2017 was $7 million compared to $10.8 million in the second quarter of 2016. Cash flow from operation in the second quarter of 2017 was $3.6 million and $11.8 million in the first six months of 2017 compared to $4.3 million in the second quarter of 2016 and $7.9 million in the first half of 2016. As of June 30th, 2017, we had cash equivalent and short-term deposits of $22.4 million and net debt of $42.7 million, and we are in compliance with all of our financial covenants associated with our debt. This conclude my financial overview for the second quarter of 2017.
With that, I will now turn the call back to Doron for closing comments.
Thank you, Ofir. We see a significant opportunity to organically grow our business over the next several years. The targeted initiatives that we began implementing in the second quarter to reignite growth and optimize expenses are advancing, and we will continue in the second half of 2017 and into 2018. I would now like to open the call to questions.
Thank you, sir. If you'd like to ask a question, please signal at this time 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, that is star one if you'd like to ask a question. We'll first go to Dan Kurnos with The Benchmark Company.
Great. Thanks. Good morning. Just real quickly on search. Obviously, that's sort of down sequentially again here. Just curious, we saw some pretty decent results actually from IAC, although most of that's coming out of their O&O portfolio. They've done a lot of stuff on the mobile side in search. Obviously, being leveraged to Bing rather than Google and having still mostly or all entirely affiliate business is going to continue to make that challenging. Can you just talk about a little bit more where the potential areas for upside, what kind of initiatives you have there to at least stabilize it as a cash flow backdrop?
Right. Mike, are you on the call, Mike Glover?
Yes, I am.
Okay. I'd like to address this question to Mike Glover, who is the General Manager of our search business, and he was the President of InfoSpace. That was a major player in this domain. Mike?
I know Mike very well. I covered Blucora and InfoSpace for a long time. How's it going, Mike?
Hey, going well. Thank you. Look, going forward, our plans are to begin to invest in the business. We've been harvesting the revenue and maintaining existing partner base, which is fairly narrow, and in terms of the product, distributed very narrow as well. I think we'll invest more in custom search. We'll invest more in the mobile business. We are limited geographically by being with Bing as our primary partner. It gives us a good asset base to start to develop those products, having overlay over the U.S. and Western Europe still gives you from an RPM, CPC basis, the ability to leverage some pretty good economics as we develop the product.
As we put the product around and start to show growth, I think it'll give us an opportunity to add additional monetization opportunities into the network, as well as to begin to develop some owned and operated property, which will give us more control and more expertise in the search business, similar to some of the activities that we did or that I did previously at InfoSpace.
Got it. That's helpful. Thanks, Mike. Doron, back to Undertone and the rest of the business. It was actually a decent quarter for advertising. Interesting that you guys commented, I think Ofir commented that programmatic was a big driver of that. I'm curious, one of the things that we're seeing now in general, from ad agencies, is a desire for larger national buys on a programmatic basis, and typically those have historically had lower CPMs. I'm just wondering how you guys are balancing new business initiatives, and your sort of direct-to-agency push now, versus sort of what looks to be more of a required or a greater demand on the programmatic side of the ledger from the agencies themselves.
All right. I will handle it to Mike Pallad, but I want to say just a few words about it. I think that we are bringing on the fact that on the programmatic, we're trying to basically mix two worlds here. One is very much the push or the desire of the brand, even though it's done through the agency to push quality. Us with our high impact ads and a very high publishers network, we definitely provide the quality that the brand is seeking. When it comes to get this quality into the programmatic world, we basically combined the two, I think, into our favorite. Mike, you want to add few things on us and programmatic?
Sure. Agreed, Doron. As it pertains to programmatic, we continue to see growth, both sequentially quarter-to-quarter, as well as significant growth year-over-year with Q2. We want to be a company that's kind of agnostic to how people want to transact with us, whether it's a brand or agency. If programmatic is the way that they want to transact, we feel, as Doron was speaking to, we have a competitive advantage, based off our quality, our transparency, as well as the engaging ads and proprietary ad units. From a direct standpoint, and then making sure that we're also offering a portfolio of products and solutions that go beyond programmatic pipes, that's when our premium content alliances come in, such as how we're leveraging the MakeMeReach platform, and new recently announced partnerships with the Associated Press in premium content social providers like .
Got it. Okay. That's helpful color. I appreciate that. Just high level, maybe either for Ophir or Doron, just kind of giving the pace of play here, in terms of results. I know you didn't give real official guidance, but just can you give us high level, just sort of acceleration, how we should expect things to sort of trend over the next several quarters, both for search and Undertone? For Doron, just from a capital allocation standpoint, as you right-size the business, understanding you have some organic investment to make, just how you think about either tuck-ins or implementing or augmenting the product portfolio. Thank you.
Right. First and foremost, three months on the CEO chair, I think that we're definitely trying as much as we can to leverage on previous acquisition, trying very much to look inside and trying to get in to find those assets, technology assets, and get them into one kind of holistic solution. We start seeing some traction in this direction, and I think Undertone growth is a great result. We are planning to do so even in the Search, and I hope that in the next call I even can announce that this technology integration will allow us for the first time to combine the Undertone and Search to a one integrated service. That will be a great news that we are working on it right now. I think that we all understand that's why we announced the Sales First Initiative. We prioritize everything that we're doing it.
We have 100 engineers. We have a solid group of product management. All is very much tuned in order to increase sales as part of this program. On one hand, I'm very optimistic. On the other hand, we need to understand that I'm here to turn this ship and showing substantial growth. I think it will come. The question is how long need to be the runway? We've seen some results even in this quarter, and I'm hoping to see better results on the next quarter. We are in the right track.
Okay. Once again, it's star one if you'd like to ask a question. We'll move on to Kerry Rice with Needham.
Thanks. Three questions if I may. Back to Search, and you talked about a network cleanup. Can you talk about the impact there in the sense of a monetary one? If we add that back, how much do you think was taken out of Search from that cleanup? The second question is on Undertone. Can you talk a little bit more about the social aspects of MakeMeReach? How big is that contribution today? Where do you think it can get to be as a percentage of advertising? Then, there was some discussion, and there has been ongoing discussion about reducing the cost structure. Any thoughts, any more maybe details around that? It seems like overall cost structure, excluding the impairment charge, actually went up in Q2. How far do we think that can come down in Q3 or maybe second half of 2017? Thank you.
Right. Okay. Thank you. In terms of Undertone and MakeMeReach, I will talk about the search and the cost optimization later. One of the main key performance indicator that we put in place when it comes to measure the Undertone success and the progress has to do with the average in-session order. In other words, on a given RFP that we're getting from the agency, how we able to optimize our outcome. There is no doubt that in today's budget allocation, brands, if it's done through the agency or if it's done direct, social media is a substantial element into it. The fact that we integrated MMR, social media ad placement platform into our offering, that's a great addition to our ability to offer enhanced solution other than what we offer today. That's complimentary.
This is definitely needed, and that's definitely growing aspect of the overall RFPs or the demands that we're getting from the clients. We see it growing quarter over quarter over quarter. That's on the social media and MMR. I must say that the integration has to do with the data, it has to do with the format, it has to do with a lot of things that currently we add to this, where our customer and agency sees a great added value compared to other platform that exists there. On the cost structure, we are very detailed in our plan. The plan that we presented, what we able to share with the public is the overall, the $6 million. Some of it we already implemented, and some of it we definitely going to implement. Overall, I think it's an aggressive target.
For a good reason, we are not touching anything that has to do with our sales force, our engineering or product. This is all has to do with corporate structure, the cost optimization is very much narrow to this expense. We are doing everything that we can to expedite it, to enjoy the full benefit of this effort beginning of 2018. That's quite a process. As far as the network cleanup, that's equivalent to $25 million compared to last year. That has to do with our relationship with Bing, which is very much based on the fact that we are one major partner that we need to follow their compliance in a rigid way. I can say that that's something that we need to do based on their request, this is something that we are doing.
I'm sorry, could you repeat the impact to revenue on that? I didn't hear it very well. Sorry.
The impact on revenue on an annual basis, this cleanup is equivalent to $25 million, 2017 to 2016.
Okay, I appreciate that. Maybe one final just follow-up. On the other, do you guys feel comfortable disclosing what other revenue was of search and other?
When it comes to Smilebox, that's in the neighborhood of $16 million. When it comes to MMR, we have it as part of the advertisement number, and it's very difficult to distinguish between the MMR platform and the advertisement since it's all being a one solution for us.
Thank you.
You're welcome.
One more time, that is star one if you'd like to ask a question. We'll pause for just a moment. We did have a question queue up. I'll take that from Aaron Fuchs with Brittle Mind Capital.
Yes, it's Aaron Fuchs.
Hi, Aaron.
I was wondering, you have these different assets and the search was organic, then MMR and Undertone were purchased. I was wondering, I thought the goal was to eventually sort of create one platform which you could then market to the clients of those unique assets and build a defensible moat that way. On this call, it sounds like you have each business moving separately. Is that fair to say, or have we just not gotten started on seeing if you can combine the assets in a unique way?
Yeah. That's a good question. Thank you. First of all, we need to look in what is possible, and we need to integrate it, whether it makes sense from our customer perspective. We are definitely see a great integration that is happening as we speak between MMR and Undertone. When it comes to the integration between search and Undertone, I think that's a tough call. We are working right now on a very interesting concept where we are trying to combine the assets, not to a story, not to one platform, because that's not the direction, but basically taking core technologies from one and core technologies from the other, then develop unique product offering in the market. That's the integration. We don't want to force to something which is not real. We definitely want to take something which is holding water from a business standpoint.
This will be a sort of take the social media buying from MMR and sort of offer it to Undertone agencies, is that basically it?
Yeah. As I mentioned before, that's an easy story because the point here is that what we are facing is a budget allocation from the brand through the agency. They're trying to maximize this budget and provide maximum business outcome as a result. What we are doing, we are offering our advertisement network, and we basically said that additional component in this and complementary to what Undertone is doing is that we very much would love, we offering to publish it or the advertisement and part of our offering is do it on a social media. The way for us and the platform that we are using in order to deploy those assets into social media, if it's Facebook or Snapchat or Instagram, is by using MMR.
That's the vehicle, and once it's integrated, it provide a better higher ROI for our customer that are looking to optimize their budget for a single brand awareness campaign.
Right. Okay, great. Thank you very much then.
You're welcome.
It looks like we have no further questions at this time.
First, thanks for joining. I appreciate it. In summary, after completing my first 100 days, I believe that we now have all necessary components to move the company forward. We have identified our strategy, we have established a comprehensive plan, we completed assembling the right leadership team, and most importantly, we have ensured that all pioneers are aligned, excited about the direction, and executing the plan. Thank you very much, guys, for joining.
That does conclude today's call. We thank everyone again for their participation.