Good day. Welcome to the Perion first quarter 2016 earnings conference call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Jeremy. Please go ahead, sir.
Thank you, operator, and good morning, everyone. Thank you for joining us on our first quarter earnings call. The press release detailing the 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 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, and as in prior quarters, the results reported today will be analyzed for the most part on a non-GAAP basis, which management believes better conveys the operational performance of the business. 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. I would now like to turn the call over to Josef Mandelbaum, Chief Executive Officer of Perion. Josef?
Thank you, Jeremy, and good morning, everyone. Welcome to our first quarter 2016 earnings call. This was a strong start of the year for Perion as we exceeded our revenue and EBITDA guidance. Non-GAAP revenue for the quarter was $73.1 million. EBITDA was $8.8 million. Non-GAAP net income from continuing operations was $6.7 million, with diluted earnings per share of $0.09, all better than our expectations. This is the third quarter in a row whereby our revenues increased. This is attributable to the Undertone acquisition and the relative stabilization of search revenues. To be clear, search revenue declined by 6% from the fourth quarter due to the declining remnant user base and seasonally lower RPMs.
Because most of the remnant user base has already churned, we expect quarterly search revenue to remain relatively stable at the same level as the first quarter, generating strong cash flow and EBITDA throughout 2016. Our quarterly EBITDA significantly exceeded guidance, predominantly due to our proactive decision to discontinue certain Grow Mobile activities and focus on becoming the high-impact leader for brands and publishers. As part of our focus, we decided to shut down our mobile self-serve side of the business and put up for sale our Mobile Engage business. As a result, both of these businesses have been classified as discontinued operations and netted out of our EBITDA and will cease being a drag on cash flow already in the second quarter.
We expect the cash savings of the strategic decision to yield roughly $9 million, partially offset by an approximate $6 million reduction in revenue formerly expected in the mobile self-serve and Engage business units. The social and fully managed mobile piece of our business continues to grow, and we have combined these businesses with Undertone as we see value in a broader solution to advertisers. We are already executing on some revenue synergy opportunities, including further strengthening Undertone's programmatic and mobile in-app offering, as well as adding a social solution to the mix. We believe that this provides the opportunity to bring high-impact advertising to new budget categories, particularly social and in-app. As agencies and brands look to consolidate vendors, having a cross-platform differentiated offering like we now have will be key. For example, we have a client who's a large global software company.
This customer currently purchases our high-impact cross-screen formats but has wanted to include social as part of their high-impact campaign. With our Facebook and Twitter strategic partner status, we will now be able to extend our high-impact formats to these platforms. We can also leverage our data and targeting capabilities to enhance a standard social campaign managed through our platform in conjunction with a client's high-impact campaign. These capabilities allow us to compete for social ad budgets, which, as we all know, are significant, expanding our addressable market and better serving our clients. While Undertone has grown on a year-over-year basis, in particular high-impact formats, the growth will be slightly lower than anticipated in the second quarter due to a more pronounced shift of advertising budgets to social and in-app.
We believe the strategic combination of capabilities mentioned above will help solve these issues and get us back on track to accelerating growth in the second half of the year. We continue to have a solid balance sheet with total cash of $49 million and a net financial debt position of roughly $44 million. This quarter, we also paid down over $8 million in principal of our public debt. As our results demonstrate, we are focused on execution and believe that our continuous improvement through the coming quarters will translate into increased shareholder value. As an example, this past quarter, we also completed our Smilebox cost reduction project by successfully moving the operations from Seattle to Israel and India while maintaining the same level of revenues.
We expect these types of activities to continue to provide strong profits, while at the same time diversifying our revenues, thus improving the company's risk profile. As search revenues are expected to remain relatively stable and advertising revenues grow throughout the year, predominantly in the last quarter, advertising and product revenues will contribute an increasing share of our business, accounting for approximately 50% of Perion's revenue by year-end. In summary, we remain highly profitable with strong cash flow. Given our execution of these items mentioned above, we now expect our EBITDA percentage to be at the high end of our original directional guidance of 10%-12% of revenue for the year and continue to expect year-over-year revenue growth in excess of 50%. Let me turn the call over to Yacov, who will walk through our financials. Yacov?
Thank you, Josef. Non-GAAP revenues for Perion this quarter were $73.1 million compared to $52.1 million in the first quarter last year. The increase in non-GAAP revenues was largely due to the contribution of Undertone, acquired in the fourth quarter last year. Revenues for the quarter were made up of $40.5 million from search, $28.5 million from advertising, and $4.1 million from consumer products. As can be seen in the financial reports, Perion's business has changed dramatically over the last year. This change is characterized by two major drivers. First, the shift in our search business model. Second, the acquisition of Undertone, both of which affected our revenue and cost structure. Search revenues have leveled off at the recent quarter's level. As we indicated in the past, the churning out of remnant expense-free users that were acquired in 2014 has caused a continuous decline in our profitability.
However, we expect to have substantially completed that process by the end of the second quarter, two quarters later than originally anticipated, due to the higher retention rate of these users. The combination with Undertone brought with it significant changes as well. On the one hand, it reduced our dependency on search. Already this past quarter, search revenues accounted for only 55% of revenues as compared to 82% of revenues in the first quarter of 2015. On the other hand, as is characteristic with an advertising business, sales and marketing play a much more dominant role. As a result of these two major shifts, revenues have increased over 40% and are more diversified. While CAC, media buy, marketing, and sales expenses are now 63% of revenues as compared to 38% of revenues in the first quarter of 2015.
EBITDA in the first quarter of 2016 was $8.8 million or 12% of revenues, as compared to $22.1 million or 42% of revenues in the first quarter of 2015. Last year's EBITDA benefited from the high level of expense-free remnant users, coupled with significantly reduced CAC. The unexpectedly high EBITDA this quarter benefited from the reclassification of $3.6 million to discontinued operations. However, even excluding this benefit, on a normalized basis, our EBITDA would have been $5.2 million, well above guidance. This can be credited to better efficiencies in all of our business units, as well as higher than expected RPMs this quarter in our search business. Perion's non-GAAP net income from continued operations in the first quarter of 2016 was $6.7 million, representing a 9% net profit margin, compared to $17 million or a 33% net profit margin in the first quarter of 2015.
The higher net profit in 2015 was as a result of the extraordinarily high EBITDA margin, as I described above. On a GAAP basis, we showed a net loss from continuing operations of $1.9 million or $0.02 per diluted share, and an additional loss from discontinued operations of $3.6 million or $0.05 per diluted share. The reason for the GAAP net loss this past quarter are $4.4 million amortization of acquired intangible assets, net of taxes, $1.9 million in non-cash equity compensation, $1.4 million in other non-cash expenses, and $0.9 million non-recurring cash expenses. EBITDA excluding discontinued operations better reflects how our business will look in the future. From a cash flow and net profit perspective, these operations are not expected to cause substantial losses beyond the second quarter. GAAP cash flow from continued operations in the first quarter of 2016 was $6.2 million.
As of March 31st, 2016, we had cash equivalents, and short-term deposits of $48.8 million, and working capital was $34 million. We have net financial debt of roughly $43.7 million, having paid off approximately $8 million in debt principal this past quarter and are in compliance with all of our debt covenants. This concludes my financial overview for the first quarter of 2016. Let me now share with you our financial outlook for the second quarter of 2016. In the second quarter of 2016, we expect non-GAAP revenues to be in the range of $73 million-$75 million.
EBITDA in the range of $8 million-$9 million. As Josef mentioned earlier, despite the loss of revenues from the discontinued operations, we continue to expect in excess of 50% year-over-year revenue growth, with EBITDA margins now coming in at the upper part of the 10%-12% range previously shared. With that, we will now open the call to questions. Operator?
Thank you. 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 so your signal through to our equipment. Once again, press star one to ask a question. We'll pause for a moment to allow everyone an opportunity to signal for questions. We'll take our first question from Kerry Rice with Needham.
Thanks a lot. A couple questions, mostly related to Undertone. It seemed like Undertone was really strong in Q1. Was it better than you were expecting? If so, what would you attribute that strength to? I don't know if you're starting to see any political spending or not. The second question is, you had previously talked about integrating Make Me Reach into Undertone, and I think that certainly will give you more of the social aspect that you want. Does Make Me Reach also provide you that ability to do in-app advertising, or is that something you are developing in-house or are looking for in an acquisition? Thank you.
Thanks, Kerry. Thanks for joining. I'll try to answer both questions. First, we have not benefited in Q1 from political spending. We do already see the benefits of political spending. Usually, it's more in Q3, where obviously the conventions are going to be. A little bit Q2, mostly Q3 is when we see it, so it's sort of happening all over. With regards to the performance in Q1, I think Undertone performed as expected. I don't think it was better than we expected. We had expected it was pretty much as expected. I think as Yacov mentioned, and I mentioned, the script in Q2, we're still excited about where it's going. Because actually of some social and mobile in-app inventory issues, as you know, Facebook is doing extremely well in the industry.
We were not growing as fast as we originally expected to in Q2, which is why, in answering your second question, we did make the move to combine our Grow Mobile efforts. The Grow Mobile consisted of social and mobile in-app. We're not looking to acquire anything else in mobile in-app. The social piece is the Make Me Reach piece, which you mentioned. We're in the process of doing integrations now with Undertone to really, on the sales side, figure out how to pitch it to clients and put that together. On the mobile in-app side, we already had the solution from our Grow Mobile acquisition. As Yacov mentioned, we shut down the self-serve side of the business. We still have it fully managed.
We have clients we're working with today, we have inventory, and we're looking to work together with Undertone to combine campaigns for the benefit of our clients.
Do you have a sense on maybe the completion of those integrations into Undertone? Is it ahead of Q4? Is that largely the positive impact from that won't be felt until 2017?
I think we'll start seeing some, hopefully, benefits in Q4. On the technical integration side, there isn't a whole lot we're doing at this point. It's mostly frankly, putting the campaigns together, putting the sales materials and marketing materials together, then actually managing the campaign. That we're starting to see already. We'll start probably in early Q3, start seeing some of that hit the market with our sales teams, both in MakeMeReach and Grow Mobile, as well as Undertone. I think you'll see more integration really probably into Q4 is when we start seeing some results, and obviously we're excited hopefully about 2017. What we did is we basically took the self-serve piece, which was a drag on the cash and on earnings, as well as the Mobile Engage piece, which we actually like.
We're selling it because it's a great product, and we think there's a lot of demand. It just doesn't fit with our strategy.
That's very helpful. Thank you.
Thanks, Kerry.
Moving on. We'll take our next question from Dan Kurnos from The Benchmark Company.
Benchmark Company. It would be a little bit more interesting, Josef, if it were from Benchmark Capital. In any event, good afternoon, guys. A few questions here. First on search. I'm not going to belabor the point on this one. As we think about it, we know we heard from IAC on the Google side, the removal of Right rail and some of the RPQ weakness. You did call out RPM softness in your impact here, and it sounds like the user base is somewhat stabilized. If you could give us a sense of if any of that's flowing through to Bing, because we all know you're indexed more to Bing, or if some of those changes might be coming down the pipe that could impact the search business on the go forward. Thanks.
Sure. First of all, thanks for joining, Dan. With regards to RPMs and stuff like that, the reality is, again, you have to ask Bing for more specifics because it's their business. What happens at Google doesn't impact Bing. Actually, we're pretty happy Bing's RPMs have steadily increased over the past 2 years. With regards to other changes in the industry, as we look at the search, I think most of it, as you know, we took it on the chin a year and a half ago. We've been paying for it ever since with our stock price. We think most of those changes are behind us, and we're looking forward to really a stable, as Yacov said, the old base is basically churning out. The new base we built up with premium publishers, and it's relatively stable.
Plus or minus single digits, we expect that to continue for the year. We see that. In terms of RPMs in general, as you know, Q4 for Bing, Google, and Yahoo, they're always higher because of the shopping season. Q1, it goes down a little bit from Q4. We saw in Q1 a little higher than we were expecting in Q1, it's still lower than Q4. That's not related to what Google's changes are, which they're changing the actual number of ad units on the page, which has impacted IAC, as they mentioned. It's a much smaller impact to us because, as you mentioned, we're more indexed to Microsoft than Bing.
Okay. That's helpful, Josef. Just turning over to Undertone, just a few questions. If you could talk about either some new logo wins, give us some more specific color around partner ads and size of partner ads on the go forward. I know you called out one in your initial remarks in terms of expanded business. You talked about the shift to mobile and growth. Obviously, we're seeing a lot of commentary right now around automation and particularly mobile programmatic becoming sort of the wave of the future. Just how your services particularly address that and how you guys are positioning yourselves to participate more fully in that market, please.
Yeah. I'll answer the second question first, because I think that's probably the result of the question I'm probably going to answer. The first question, I'm probably not going to give names. At least at this point in time, I'd have to double-check back if we're allowed to use names. Frankly, on the average size of the campaign, it's pretty robust. It's doing nicely. It hasn't changed materially. I know we signed up a lot of new customers, 100-plus customers this quarter, new clients that I can say. With regards to programmatic, I think that's a great question. I will say this, the high impact business is less susceptible, but still susceptible to programmatic, less susceptible than display and pre-roll video.
What we are seeing now is that the agencies and their trading desks are moving more of all the inventory, no matter what it is, through their trading desks, and therefore connected to different DSPs, whether it's DBM from Google or whether it's MediaMath or The Trade Desk or whatever the case may be. We have our own DSP on the high impact called Virtuoso that is connected already to some of the trading desks. What we do is we're pretty much agnostic. Where we can connect directly to an agency trading desk with our own platform, we're doing that. We've added some headcount there, in Israel specifically, to beef up actually our programmatic efforts and working with the DSPs and the trading desks. That's one thing we've done deliberately.
Frankly, from the Grow Mobile piece of business we shut down, it was the people that actually, a lot of the engineers were doing that already, so we moved them over to something new. With regards to private marketplaces, pretty much reserved bidding is what we'll be participating in. Unreserved bidding, we probably won't be. In other words, open RTB. It just doesn't work because the creative, for example, it has to make for a high-impact ad unit, has to be done beforehand. It's not a standard banner ad you can use and just bid on. Because of that, we're working with The Trade Desk and mostly it's reserved bidding, so all private marketplaces, and we're integrating our own platform as well as we're integrating our formats, our high-impact formats, with the DSPs I mentioned, as well as The Trade Desk directly.
We expect we're probably a quarter or two away from full coverage of all the DSPs and trading desks out there, but we're well on our way, and we have some pretty good penetration already. We think there'll be hopefully a pickup from once we're fully integrated with the DSPs and with The Trade Desk.
Got it. That's really helpful color. Just a couple more. On Grow Mobile, in the press release, you mentioned that you might look to sell some of those assets that you've discontinued. I assume it'll be for a de minimis amount, but just if you could put any color around size of asset sale that you're anticipating there. Lastly for me, obviously, Josef, look, you brought it up. The stock has been kind of languishing here. I don't think that there's a lot of faith in the long-term outlook. What's your thought here at this point? I know you stepped in a while back and purchased stock yourself. I know that you guys have not believed in buybacks historically, but this might be an opportune time to do so if you believe in the long-term strategy here.
Just any color you can give to investors on that front, I think would be helpful. Thank you.
Sure. Thank you, Dan. I was waiting for that question, thanks for getting it out of the way early. First of all, with regards to the Mobile Engage business unit. What we saw on the self-serve side is we just didn't see enough demand in the marketplace. That's not true on the Engage. It's CRM marketing automation. We actually see a lot of demand, and we actually have a really good product. It just didn't fit strategically. De minimis amounts, since you brought it up, after I brought it up, depends on your relative valuation. If you're a $1 billion in value, then it'd be de minimis amount. We're hoping, I don't know the answer. I hope we'll be able to sell it. I can't guarantee that, obviously. We are in a process today working with info and bankers.
We have some good initial interest, we'll keep everybody posted on that as we go forward. Next, with regards to the stock price and everything else. Obviously, listen, we all know and we share in shareholders' frustration. As you said, not only did I buy stock at $7, I'm suffering as others are. I actually have, obviously, options and everything else that, like all other shareholders, are hurting. I think as we look at where things are going, we believe with the Undertone acquisition, we've addressed some of the core concerns that investors had with the business, which was over-dependence on search, and a declining business in search. We think the decline business search, again, we've leveled off. The dependency on search clearly will now, hopefully, on a total basis in the year, will be at 50%.
It's still producing a lot of cash, it's still good business, we're not going to shut it down. We like the search business. We are focusing on high impact as our future, which is why we kind of merge the Grow Mobile business into that unit, in terms of giving us a fuller stack. We believe that's a good future. It's a differentiated position in the marketplace. I think the only way to win in this space, Dan, you know this probably better than others, is with scale and differentiation. None of us are going to compete with Facebook or Google, least of all us. There are verticals in the advertising ecosystem that we believe, high impact is one of them, that we can be a leader in and provide a really good business opportunity and long-term shareholder value.
With regards to buybacks and everything else, it's a great question. In general, you're right. We have not been. I would say at these prices, we certainly would consider a buyback, we actually will once we're allowed to. For those who don't know, we actually have the Israeli law, because our stock price declined, it's kind of a chicken and egg kind of thing. Because the stock price declined, if you remember in Q3, we took a write-down on the reverse merger acquisition with Conduit, where they kind of bought Perion, old Perion. When the stock price went below a certain level, obviously we took an impairment. That impairment caused our retained earnings to be negative. When you have negative retained earnings, according to Israeli corporate law, you're not allowed to do buybacks until you have a positive retained earnings.
There's a similar law in the U.S., but less restrictive, but we're an Israeli corporation at the end of the day. We will strongly consider, at these prices, I would say we probably would actually do a buyback once we are allowed to do that. If the stock price is still this low, I would agree, even myself, who's been opposed, would agree this is a good investment to make at these prices.
All right. Thank you for all of that color, Josef. Very much appreciated.
No problem. Thanks, Dan.
Again, if you'd like to ask a question, that is star one. We'll take our next question from Aram Fuchs for Fertilemind Capital.
Yes, it's Aram Fuchs. First, a question for Yacov. Yacov, can you tell us how long will these discontinued ops losses continue now that you said Grow Mobile is ensconced in Undertone? Is it all coming from the user engagement part that's being put up for sale? Please give us some specifics there.
As we mentioned in our prepared comments, it's coming from two parts of the Grow Mobile business. It's the self-serve platform, which we have discontinued, and the engaged part of the platform, which has been put up for sale. Both of those were discontinued towards the end of the first quarter. They will have a diminishing effect on our results at cash flow and net profit, in the second quarter as well, because the decision was taken at the end of the first quarter. We expect that post-second quarter, it will no longer be affecting our cash flow or net profit.
Okay. Josef, are the Undertone and Grow Mobile sales forces basically one now, and are they selling the entire combined product suite right now?
No, not yet. When we mean combining, it's really more of a portfolio approach in that. In terms of reporting, we're putting the reporting into the Undertone business unit. We're still selling the social platform and the fully managed platform as a platform sale. Undertone sells campaigns, and they sell solutions to advertisers and agencies and brands. The MakeMeReach Social and the mobile platform are selling a platform for advertisers to use to spend their money on through Facebook, Twitter, and mobile exchanges and networks. Those will always be separate because they're two separate actual sales forces.
What we're doing is we're looking to leverage the social and mobile technology for the benefit of Undertone, so that their salespeople, as an example, if you want to sell a high-impact ad unit, we can now look to potentially sell it as a campaign, which Undertone is doing today, and doing a great job at, to now reach and potentially sell that and extend it to the social through our platform, which Undertone did not have the ability to beforehand, and now we do. Mobile in-app is another good example where Undertone had mobile in-app inventory. We're now increasing that and allowing people to use the platform for balancing out performance needs with awareness needs for the brand.
We're kind of taking a multi-pronged approach to sales, where the Undertone salespeople still will focus on high impact and high-impact solutions to the brands and the agencies, and the sales force for the platform will continue, but they're both reporting up into the Undertone business unit.
Okay. The intent is not to just combine it and run it as one business. They're two related businesses reporting in to Undertone.
Yeah, long term that could change. Right now, for this year, we decided to focus on that because both businesses are, as being full swing in the middle of the year. We think there's revenue synergies and opportunities, but the full integration, we have not decided yet what that would look like or what it would be. At this point in time, we're leaving it the way it is, just with more collaboration, putting it under the Undertone business.
Okay. Regarding the buyback, just trying to get some more details. What are the hurdles you have to go through in the Israeli court system for you to get approval to do a buyback?
Well, basically, it starts off with dividends. Basically, if you do not have positive retained earnings or any distribution of dividends, it is limited by the extent you have positive retained earnings. Both the courts and other regulators deem buybacks as being dividends, and that's what this restriction's about. In order for you to be able to dividend or do buybacks, you have to have positive retained earnings. There is a limited possibility to try to distribute dividends, even if you do not have retained earnings, but as you mentioned, it has to go through a court process, and it is usually limited to companies that are not leveraged. Perion is leveraged, and therefore, the probability of us getting such consent through the court system, once they've approached all the debtors, is far-fetched, to say the least.
Okay. You're going to go through this process and ask for court approval despite the fact that you have negative retained earnings and you're leveraged, but you're hoping to get approval.
No, no. Being that, as I said, it's very far-fetched, we're not going to go through the process. It's a very, very detailed and extensive process, and we don't believe it'll be successful, therefore, we're not going to even begin it.
What I-
However, as Josef mentioned earlier, to an extent, and when we have positive retained earnings, we will recommend to the board, assuming that the stock level hasn't changed from where it is today, to in fact, institute a buyback.
Got it. That's it.
We do expect to have positive retained earnings at some point in time. It's not a farfetched.
Okay. That's the key variable that you're going to wait for.
That is correct.
Okay, great. Thanks a lot.
Thanks, Aram.
As a final reminder, that is star one if you'd like to ask a question. At this time, there are no further questions.
Okay. Well, thank you, everybody, for joining. As always, I'm thankful for the professional support and hard work of our dedicated employees. Thank you to everyone at Perion, and thank you all for joining us today. Have a nice day.
Thank you. That will conclude today's conference. We thank everyone for their participation.