Ladies and gentlemen, thank you for standing by. Welcome to the Perion second quarter 2012 results conference call. All participants are present in listen-only mode. Following management's formal presentation, instruction will be given for the question and answer session. For operator assistance during the conference, please press star zero. As a reminder, this conference is being recorded August 8th, 2012. With us today from Perion, we have Josef Mandelbaum, CEO, and Yacov Kaufman, CFO. I will now hand the call over to Brett Maas of Hayden IR for the safe harbor information. Mr. Maas, would you like to begin?
Thank you. We appreciate the attention of everyone who is joining us today. On today's call, management will be reviewing the financial results and business highlights of the second quarter and first half of 2012. 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 revise any forward-looking statements to reflect future events or circumstances. With that, I'll turn the call over to Josef Mandelbaum, Chief Executive Officer. Josef, the call is yours.
Thank you, Brett. Good morning, everyone. Welcome to our second quarter earnings call. This morning, I'd like to focus my comments on a review of our record second quarter and first half results and to highlight some of our exciting initiatives for the remainder of the year. I will then turn the call over to Yacov for more details regarding the financial results before opening up the call to questions. The second quarter was another great quarter for the company and the 26th consecutive quarter of growth on a year-over-year basis. After a lot of hard work and investment in our back-end systems, as well as refining and optimizing our media buying capabilities, we seem to have hit an inflection point with our search business in the middle of the second quarter. We are very optimistic that this trend will continue in the second half of 2012 and beyond.
Therefore, we are increasing our non-GAAP guidance for 2012 to the range of $50 million-$52 million in revenue and $10.5 million-$11.5 million in EBITDA. Non-GAAP revenues in the second quarter increased by 53% year-over-year to $12.3 million, primarily as a result of an increase in product and advertising revenues. Our product-focused strategy enables us to continue to communicate with our users while increasing their lifetime value to Perion. Search revenue was up 15% compared to the previous quarter as a result of steps taken to recapture the monetization of our existing users and better protect the monetization of our new users. In addition, we have significantly enhanced our ability to track our marketing efforts and rapidly adjust our programs to maximize their effectiveness. This, in turn, has dramatically improved the return on our investment.
We are pleased to report that as a result of these efforts, June was a record revenue month for us, and we see that trend continuing into the third and fourth quarters. As I've mentioned all along, building the proper fundamentals takes time and discipline, though we have made significant progress over the last year, enabling us to scale the business and accelerate growth. More exciting news for us this quarter continues to come from Smilebox, as it grew revenues by 30% in the quarter and continues to be cash flow positive and profitable with an 18% EBITDA margin this quarter. Smilebox has been exactly the acquisition we thought it would be. It has significantly enhanced our premium revenue, providing a stable recurring revenue stream, and has helped us diversify our revenue base, providing a larger, profitable platform for growth.
We have also strategically positioned ourselves to address the new mobile and tablet platforms. We have begun and intend to further develop and offer a range of iPhone, iPad, Android, Windows Mobile/Surface products over time to answer the increasing penetration demands of our primary target audience. We believe this is of critical importance to Perion and one that will serve as a basis for our growth in the future as mobile devices, and especially tablets, are an ideal platform for our products and consumers. While we already have a few mobile products, including Smilebox Mobile, we need to do more now to establish a leadership position with our audience. I'm excited to announce that we expect to launch a revolutionary new email app that, for the first time, will make your email enjoyable. We expect to launch for the iPad later this year.
We'll also be releasing major upgrades to our photo offering on mobile platforms. We look to add additional products over the coming quarters. As we look ahead to the coming quarters, we expect significant growth in revenues and profits resulting from the investments we've made to date. Now, I would like to turn the call over to Yacov. Yacov?
Thank you, Josef. As in prior quarters, we will be analyzing our results on a non-GAAP basis, which better conveys the operational state of the business. There is a detailed reconciliation to GAAP results in the financial tables of the earnings press release. Revenues this quarter were $12.3 million, up 9% from the previous quarter and up 53% from the second quarter of 2011.
In the first half of 2012, revenues increased 41%, from $16.7 million in the first half of 2011 to $23.6 million in the first half of 2012. The increase was due to product sales increasing four-fold, partially offset by a small decrease in search-generated revenues experienced in the first quarter of 2012 and since remedied. In fact, late in the quarter, we experienced a sharp acceleration in search revenue. Search revenue for the month of June was up 76% compared to May this year, and up 67% compared to June of 2011. This improvement in search revenue gives us ample optimism for the second half of this year and was a key factor in our increased guidance. This quarter's revenues included $6.4 million in search-generated revenues and a dramatic increase in product sales from $1.2 million in the second quarter of 2011 to $5.1 million this past quarter.
As Josef mentioned, this growth is primarily attributed to our Smilebox product. Product sales grew four-fold from $2.5 million in the first six months last year to $10 million in the first six months of 2012. This demonstrates one of the strengths of our business, having multiple revenue streams providing for consistent growth. As we mentioned in previous calls, since the Smilebox acquisition, there is a difference between GAAP and non-GAAP revenues. This quarter, it amounted to $0.3 million and was $0.9 million in the first half of 2012. This difference will gradually decrease through the next quarter of 2012, one year post the closing of the acquisition. Gross profit in the second quarter of 2012 was $11.5 million, up 10% sequentially and up 51% from the second quarter of 2011.
The gross profit margin remained healthy at 93% this last quarter, compared to 94% in the second quarter of 2011. The $0.3 million difference between GAAP and non-GAAP revenues, together with the $0.3 million in amortization of intangible assets, provided for the $0.6 million difference between GAAP and non-GAAP gross profit in this quarter. With gross margins exceeding 90%, we maintain a compelling business model. This level of profitability is a key reason we are investing in marketing and customer acquisition to accelerate our top-line growth and subsequently increase profitability. In the first six months of 2012, gross profit increased 38%, reaching $22 million, or 93% of revenues, compared to $15.9 million, or 95% of revenues, in the first half of 2011.
Research and development expenses for the second quarter of this year were $2.4 million, compared sequentially to $2.6 million in the first quarter and compared to $1.4 million in the second quarter of 2011. The increase year-over-year was primarily due to the acquisition of Smilebox and the development efforts related to its mobile product. We expect R&D expenses as a % of sales to remain at the current level in coming quarters. Sales and marketing expenses in the second quarter of 2012, excluding customer acquisition costs, were $1.3 million, compared to $0.9 million in the second quarter last year, prior to that Smilebox acquisition, and $1.4 million in the first quarter of 2012. The changes are primarily due to the sales and marketing expenses from Smilebox.
In the second quarter of 2012, we invested $3.9 million in customer acquisition, compared to $2.6 million last quarter and $1.7 million in the second quarter of 2011. The increase was in conjunction with the improvement in the return on investment and the enhancement of our back-end systems, as mentioned by Josef. Typically, over half the return on investment is received in the quarter the investment is made. In this case, we expect to see the remaining return on investment primarily in the third and fourth quarter of this year. In the first half of 2012, our CAC expense was $6.5 million, compared to $2.3 million in the first half of 2011. We believe this important investment will enable us to continuously grow our revenues. As I mentioned, we are already enjoying the fruits of this expenditure.
Since the first quarter of last year, we have been ramping up this investment, increasing it almost three-fold year-over-year, in order to accelerate our growth. We plan on continuing to increase our CAC investment. However, as a result of investments already made, we expect profits to increase despite the increased investment. G&A was $1.4 million in the second quarter of 2012, similar to the previous quarter and in the second quarter of 2011. Our ability to maintain this level of G&A has significantly reduced the G&A expense as a % of sales from 18% in the second quarter of 2011 to 12% in the second quarter of this year. GAAP operating expenses in the second quarter of 2012 included $0.2 million in share-based compensation and $0.5 million for amortization of acquired intangible assets, which were adjusted for in the non-GAAP numbers.
In the second quarter of 2011, these expenses totaled $0.5 million, attributable to share-based compensation and acquisition expenses related to Smilebox. In the second quarter of 2012, EBITDA was $2.7 million, increasing 13% compared to the second quarter of last year, despite the $2.3 million increase in customer acquisition costs as the return on this investment started to take effect. In the first half of 2012, EBITDA was $5.3 million, decreasing $0.8 million from $6.1 million in the first half of 2011, primarily due to the $4.2 million increase in CAC. Specifically, the $3.3 million customer acquisition cost for search-generated revenues this quarter created a $1.5 million negative EBITDA in the 2012 period, all of which and more are expected to be covered already in the third quarter of this year.
While EBITDA increased year-over-year, due to a $0.3 million increase in finance expenses, net income in the second quarter of 2012 decreased year-over-year by $0.1 million and was $1.8 million, or $0.18 per share. The increase in finance expenses was associated primarily with the bank debt drawn down at the beginning of this quarter. In the first half of 2012, net income was $4 million, or $0.40 per share, compared to $4.9 million or $0.48 per share in the first half of 2011. In the first half of 2012, GAAP cash flow from operations was $2.5 million compared to $4.1 million in the first half of 2011. The decrease in year-to-date cash flow from operations compared to the first half of last year is primarily due to the increase in search revenues receivable, coupled with the investment in customer acquisition costs.
As of June 30th, 2012, we had cash and cash equivalents of approximately $16.3 million. Looking forward, we believe that Perion will report sequential and year-over-year improvements in all key financial metrics, including cash flow from operations, throughout the rest of 2012. With that, I'd like to open the floor to questions.
Thank you. Ladies and gentlemen, at this time, we will begin the question and answer session. If you have a question, please press star one. If you wish to cancel your request, please press star two. If you are using speaker equipment, kindly lift the handset before pressing the numbers. Your questions will be pulled in the order they are received. Please stand by while we pull for your question. The first question is from Jared Schramm of Roth Capital Partners. Please go ahead.
Congratulations on the quarter.
Thanks, Jared.
Turning to R&D spend, Josef, I think you mentioned that it will be constant at current levels. Was that an absolute dollar amount, or is that a percentage of revenue?
That was as a percentage of revenue. We are continuing our R&D expense. As we mentioned earlier in the call, we are also focusing now on the mobile platforms and the iPad. We see it increasing nominally, but as a percentage of sales, we expect it to remain what it is today.
Okay. I'll turn to CAC. You seem to be getting more efficient there as well in the quarter. Growth in that metric, can we kind of anticipate the same level of growth we've been seeing the last several quarters here on a year-over-year basis as you really ramp up and leverage the back-end assets you've built up the last year?
Yes, I believe we expect to see the same type of growth. Frankly, I think we think we're going to get a little stronger growth in the back half of the year.
Okay. Turning to customer acquisition, with the efficiencies there, does it make sense to even ramp that up a little more aggressively than we've been seeing?
Well, frankly, we're doing this very prudently. In other words, we're leveraging our new capabilities in the back-end systems. However, we do wish also to increase our profitability so that we will be accelerating our growth, but we will be increasing our profitability as well.
Okay. I think you mentioned Smilebox, you saw 30% year-over-year revenue growth and now at an 18% EBITDA margin. Obviously, this appears to have been a great success from the initial date of acquisition. Just some high-level thoughts on where Smilebox stands today versus expectations originally. Secondly, how many of these Smilebox-type acquisitions are you currently looking at in the marketplace today?
Sure. Let's address the first part of the question. Smilebox today is doing, I'd say, slightly better than our initial predictions when we bought the company. I think we fairly well understood what we were buying and how we could enhance it and continue to grow and lift the profits. I think to say that it was a big surprise to us, it wasn't. I think, and potentially to some of our investors, it was a big surprise, but to us, we're actually very happy with it and what we've accomplished there. Frankly, we see it continuing as we go forward.
I think the opportunity for Smilebox in the photo space, there's a lot happening today in activity. We think the monetization will lag that activity as we go forward, but we're in a good position for a company of our size to get our share of that market spend. With regards to other companies, we believe there's a very good pipeline of companies out there that are similar to Smilebox. We have a good pipeline of our own. We're aggressively pursuing deals that make sense. I think the one thing we would say that would be a difference between what we did with Smilebox is we're focusing obviously a little bit more on a future acquisition or acquisitions we do, that they will be accretive and profitable from day one. Whereas Smilebox.
Because we knew it so intimately well, we knew we could turn it around very quickly, which we did. Going forward, we believe it's a little more prudent, given our current levels of cash and the current state of the business, to focus on similar types of businesses in terms of the state of the business of a Smilebox, with profitability already in hand so that it can be accretive from day one.
With these future acquisitions, would they be roughly the same size as Smilebox or smaller?
I think they'll be in a range, frankly, between the size of Smilebox, maybe a little bit bigger, to $5 million to the range of a Smilebox or a little bigger, in that range. We're comfortable in that range, and obviously, we would look to use a combination of our equity and our stock and our cash prudently. We're going to make sure, as I mentioned, it's going to be accretive from day one.
Okay. Well, congratulations on the quarter and the progress. Thank you.
Thank you. Thanks, Jared.
The next question is from Firia Gor of Ion. Please go ahead.
Good afternoon, and great results, guys.
Thank you.
Maybe you can give us some more color about the search side of the business, maybe about some color about the competition, about how aggressive peers are on the bidding side on advertising and buying media, and maybe some color about how did you manage to grow so fast in May, and the returns you expect. Thank you.
Sure. Thanks for joining the call. If I understood the question, it's a three-part question, so I'll answer the first part. What do we see in the marketplace with regards to competition? I think you're specifically on pricing competition. There is no question in the past, frankly, three or four quarters, that the industry has heated up, and there's been a lot of activity in the search-generated distribution business model. Because of that, there clearly is upward pricing pressure that will ultimately lower the ROI on a lot of different players in the industry. We're seeing that in certain places. Obviously, the more sophisticated systems you have allows you to better adapt and to have better results. I think I'll comment because you made a comment that it seems like we've grown it so quickly.
I would say actually that it's taken us time, through investments in the back-end systems, to actually get us to the place we're at now. I think we said it all along. It's a marathon. It takes time to build up the systems and make it scalable. I think what we're seeing now is the fruits of our labor. We've hit an inflection point where we think our systems, while not perfect, are much better than they were before, which allows us to compete favorably in that competitive landscape. That's number one. Number two, color on the media buying. I think as Yacov mentioned before, we're really striving. First of all, I think we've grown media buying significantly. Since when I joined the company, they were doing about $1.5 million-$1.8 million for the year. As you can see, in Q2 alone, we doubled that.
We think we're making good progress on the media buying efforts. We'll continue to do that as we look to leverage our systems and investments we made. We're going to balance it out with making sure that we also increase profitability as we go forward. We believe that's the prudent way of running the business, and not just running to frankly, get any dollar at any cost going forward. We're not looking to do that at this point in time. We think there's enough growth, and with good discipline, that we can make some good revenue growth as well as profits. Lastly, which is expected returns. In this business, what you see, I can summarize it on a global basis, but it's really misleading.
There are certain countries where your acquisition cost is very low, but your ROI is frankly above 200%, and there are other countries where your amount of revenue you get may be much higher, but your ROI is lower. You're always looking to balance out those two things as you go forward. The systems we built actually allow us the visibility on a country basis, on a campaign basis, on a daily basis, to look to optimize the revenue trade-off with profitability and return on investment trade-off. We're very optimistic and confident that what we have, we're just getting to the tip of the iceberg, and we think we can increase that as we go forward.
Frankly, there's a lot of optimization on the other end, both in buying media, looking to buy in better places, more targeted places, sometimes more global shotgun approach where you buy a bulk of media to get a number of downloads, as well as optimization on the search results page. There is a lot of work to be done there as well, which really can increase the amount of revenue you get per click on a paid sponsored link. We're doing both, and we're seeing very good returns, and we expect that to continue.
Okay. Very encouraging. Thank you very much.
Thank you.
The next question is from Aaron Fuchs of First Mile Mind Capital. Please go ahead.
Hi. I have a couple questions here. The expense reduction on G&A, just curious what brought that on, and why you think that-
That is near permanent.
First of all, hi, Aaron. Thanks for joining the call. To your question, actually, It's been stable now for a number of quarters. We see that as quite an achievement because what we've been successful in doing is scaling the business once we've already created the foundation for accommodating a larger business. Basically what happened was, is when Josef first joined the company, he said, "We have to strengthen management, and we have to strengthen the basis for creating a larger and more comprehensive business." That has been about $1.4 million, ever since the fourth quarter 2011 or so. There was a slight reduction compared to last year. Last year, we did have some other expenses with regard to compensation, and there was some overlap with some of the transition we did.
We believe that we'll be able to maintain more or less this level that we have today.
Okay. There was a drop from Q1 to Q2, right? It was $2 million Q1, 1.5-
Q1 and Q2. Q1, our non-GAAP G&A expense in Q1 was $1,450,000, and this quarter is $1,420,000. It was really very close. The main difference when you're looking at the six-month numbers is because of what was happening last year that was just slightly higher, that's all.
Okay. Can you remind us, what was the business purpose for changing some of these subscriptions to a more permanent sale? How did that help the customer or the company?
Sure.
Can you talk about that?
Yeah, sure. Basically, what the company was transitioning from an open-ended service commitment to more of a product model. That is, if I sell somebody a license fee, a perpetual license fee, rather than refer to that as a subscription, which means an ongoing relationship between the customer and our servers and the dependency of the customer on our infrastructure. What we did was we moved the product to that it should be local on the consumer's computer so that the consumer is no longer dependent on us, and the product is all by the consumer. That model enables us also to discontinue an ongoing dependency, which we believe is both good for the consumer and good for us financially.
Just to add one more thing, Aaron. From the consumer standpoint, first of all, we've heard only positive feedback on the changes, and really just sped up their experience because now everything's local, and they get all the content, and they can do it much quicker in a better experience. It did have both a consumer benefit as well as a financial benefit.
Okay. Josef, you mentioned that you're looking forward to this launch of what you call revolutionary iPad app. Obviously, email and applications in general are moving from a basic desktop to something that accesses data from the cloud and is available on different devices. In that context, can you tell us why you think this is revolutionary?
Sure. First of all, it's interesting you bring up the point, Aaron, actually the world is moving more back to what people call desktop, our desktop in credibility today is just an app. Everything is based in the cloud. It's just a conduit to allow you to access your data. It's totally synced. We have new versions on the desktop that are IMAP-compatible, which means it's synchronous compatibility with your Gmail or your Yahoo or Hotmail or what have you. It just automatically does that. It's all cloud-based, but the way you access it, frankly, is on your desktop. We think the world is moving towards applications, as you said, which, frankly, plays to our strength.
We're an internet software type of company that knows how to build applications where X% is resident on someone's local hardware, could be your phone, could be your tablet, could be your desktop. A lot of the data is stored in the cloud, whether it's by us or somebody else, and we let you access it. We actually think the world moving towards that is actually great for us as a company because it takes advantage of our skill sets, but also the consumers get much more used to downloading applications, which both we think will have a benefit, maybe a couple of years from now, but a benefit on the desktop as the Mac moves to an App Store on the desktop, as Windows Metro moves to an app model on their deskto
p.
People will be much more used to, in fact, we think the downloading of apps will increase, which I think allows us, with our products, to have a leg up, so to speak. It puts us in a unique position. The uniqueness of the email iPad app that we'll be launching in a few months, hopefully, is really the way we're rethinking how you interact with email. The only way you're really going to see that is when you see the product, which at this point in time, we're not prepared to show. It's still under wraps. Internally, we're very excited about it, and we've done some usability testing with consumers, and they're very excited about it. We think that it really changes the paradigm of how someone interacts with email, and frankly, other communications. You also get Facebook messages in there.
Eventually, we'll obviously hook it up as well with Twitter and other forms of communication as well. We're excited about that. To be candid, you got to wait a little bit and see, we're very excited about the opportunity.
Okay. When you called it an email app in the press release, it sounds like it'll be more a multi-faceted communications hub.
Correct.
Okay.
Yeah, it was harder to write down the press release, a multi-faceted communications hub.
Right.
Is that what you-
Let me follow up with you.
What does that mean?
Okay. One more question on the presentation of your results. You didn't mention subscribers. You used to mention that. Is there a particular reason why you decided to not quantify the subscriber count?
No, happy to do that now. Just a matter of what we put in, what we didn't put in the presentation as we go forward. The subscriber count went up to roughly 413,000.
No, went up to actually over half a million. We had half a million subscribers.
The number continues to trail upwards. Obviously, most of the increase coming from Smilebox. Actually, Josef was correct. It's 413,000 subscribers that we had in this quarter.
Okay. Okay, you started moving into debt this quarter. I'm just curious what you think you're comfortable with in terms of working capital. Remind us that the debt terms are just a fixed rate over LIBOR, and that becomes fixed once you draw it down, right?
That's correct. With regards to working capital, as you can see, the debt is so structured that most of it's long-term, so that we have very positive working capital. Also going forward, this quarter, we believe, was an anomaly. Because of our ramped-up growth, our cash flow from operations was negligible. Going forward, we expect to have positive cash flow from operations in the coming quarters so that we see our working capital increase.
If I can add just a little color to yourself and people on the phone. To be a little more specific, as our systems are ramping up, I think we mentioned this in our last phone call, we did a lot of testing starting March, April, and beginning of May. Actually, a lot of our customer acquisition costs was back-end loaded in the second quarter, which is why that had the impact Yaacov just mentioned. On a steady-state basis, you won't see that. Since we were more conservative at the beginning of the quarter and towards the end of Q1, as who remembers, we were much more aggressive in the second half of the quarter, which led to the higher expenditure in that second half.
Okay, then one last question. This term, search revenue receivable, that's not a receivable in the conventional sense. You're saying if the revenue comes in as predicted according to your model, right?
No, not at all. Listen, this is traditional as it comes. Google and other search providers owe us that money contractually. That's a real receivable. What happens is that as your search revenues grow, when you have the end of the month cutoff, your revenues and your trade receivables increase dramatically. We had $2 million of search-generated revenues in June alone. Okay? Our receivables are increasing.
Okay, it is in this trade receivable line under current assets.
Yeah.
That's correct.
That's part of it. Okay. I'll follow up offline with my question. Okay, great. Thanks a lot for your time.
Thanks, Aaron.
If there are any additional questions, please press star one. If you wish to cancel your request, please press star two. Please stand by while we pull for more questions. There are no further questions at this time. Before I ask Mr. Mandelbaum to go ahead with his closing statement, I would like to remind participants that a replay of this call will be available in three hours on the company website at www.perion.com. Mr. Mandelbaum, would you like to make your concluding statement?
Yes, thank you. As some of you may recall, this earnings call marks my second anniversary with the company. As I look back on the past two years, I am very proud of what we have accomplished. The foundation of our business is stronger today than it ever has been. Specifically, we have reignited growth and will have increased revenues roughly 80% by the end of the fiscal year, maintained 20-plus% EBITDA margins while investing in improving our infrastructure as well. In addition, we have added management talent and depth, strengthened our Google partnership, successfully increased media buying with a positive ROI, and diversified our revenues with our highly successful Smilebox acquisition.
We also have a number of exciting growth catalysts ahead of us in the next few quarters, including the resurgence of our search revenue, which we believe will continue to grow and is sustainable, and the introduction of some new tablet and mobile applications that we are confident will strike a chord with consumers. Lastly, I would like to thank the entire Perion team in Tel Aviv and Seattle for another great quarter and their unyielding dedication and focused effort in delivering the results Yaacov and I just mentioned. Thank you very much, and have a nice day.
Thank you. This concludes the Perion second quarter 2012 results conference call. Thank you for your participation. You may go ahead and disconnect.