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Executives

Yanki Margalit -Chairman, CEO and Founder

Aviram Shemer -CFO

Debbie Kaye - Manager, IR

Analysts

Brian Thackray - Deutsche Bank

Joel Fishbein - Lazard Capital

Manish Hemrajani - Oppenheimer

Joe Maxa - Dougherty & Co

Craig Nankervis - First Analysis

Aladdin Knowledge Systems Ltd (ALDN) Q3 2008 Earnings Call October 16, 2008 9:00 AM ET

Operator

Welcome all to the Aladdin Knowledge Systems third quarter 2008 conference call. I would like to now turn over the call to Debbie Kaye, Investor Relations Manager.

Debbie Kaye

If you have not yet received a copy of Aladdin’s third quarter 2008 earnings release, it is currently available on the company website. Today’s call is being webcast live over the Internet. A replay of this call will be made available on the Aladdin corporate website shortly after the conclusion of today’s call.

I would like to remind everyone that statements made on this call, which are not historical facts, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to known and unknown risks, uncertainties and other factors, which may cause the actual results, performance or achievements of the company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements.

Such factors include general economic and business conditions, risks relating to our recent acquisitions of Athena Smartcards, SafeWord and Eutronsec, including the failure to realize expected synergies, failure to effectively integrate these businesses into our business and increasing unexpected liabilities, the loss of market shares, changes in the level of business or anticipated business from a large customer or customers, failure to achieve anticipated customer orders, changes in the competitive landscape and other factors of which the company has little or no control. For more information please refer to the Company's filings with the SEC, which are available on the commission's website at www.SEC.gov.

Joining me on today's call are Yanki Margalit, our Chief Executive Officer, who will outline our activities in the third-quarter of 2008 and Aviram Shemer, our Chief Financial Officer, who will provide a detailed discussion of Aladdin's financial results for the third quarter and forward-looking guidance. Following their prepared remarks, Yanki and Aviram will be available to answer your questions.

At this time I would like to turn the call over to Yanki. Please go ahead.

Yanki Margalit

Today we will review the third-quarter results, and we will discuss our recent acquisitions. Aviram will provide you with a detailed look at our financial results and a discussion for the expectations of '08 in general.

We enter Q3 '08 with revenue of $31.7 million. This is a 22% increase year-over-year. For the DRM, revenues of the third-quarter were $15.7 million, slightly above the third quarter of the previous year. Enterprise Security revenues for the third quarter were a record $16 million, growing at an impressive 51% year-over-year.

Non-GAAP EPS in the third quarter was well above our expectations at $0.20. We think [so far] our third-quarter result demonstrates the success we are achieving through continued execution of our strategy. Those results are combined with our ongoing performance of our core business and our strong pipeline, [also] our confidence and our new higher outlook for the full year.

I am also excited about the success of the completion of the two acquisitions, significant acquisitions, SafeWord and Eutronsec, during the third quarter. These acquisitions have had an immediate positive impact on our earnings and have enhanced the value for our shareholders and customers.

In addition of the SafeWord product line, which we purchased for approximately $65 million in cash, its highly reliable technology for Aladdin, as well as strong market and channel presence combining eToken and SafeWord personnel, technology and partnership, all positions Aladdin as a leading strong authentication provider. We are excited to leverage SafeWord’s global presence and competitive strength to position the company for long-term success.

The addition of the ethernet-based Eutronsec extends our worldwide position as the industry leader in the areas of software protection and authentication. These acquisitions are clear examples of our disciplined strategy to investing and acquire complementary assets that enhance value for our customers and our shareholders.

Well, there's another development during the third quarter. I'm sure that most of you know that Jasmine Holding Company, an affiliate of Vector Capital, which owns SafeNet, has withdrawn its demand for the extraordinary general meeting to resolve the EGM previously scheduled for the next week is canceled. Aladdin's Board of Directors and Management Team are in ongoing discussions with Jasmine, regarding alternatives to enhance shareholders’ value throughout this process, as always. Our Board's primary focus will be to create and provide shareholder value, and this is exactly what we are focusing on right now.

I would also like to confirm an article that was published yesterday in one of the Israeli newspapers. That article has suggested that Vector made a proposal of [$14.50 to $15] to Aladdin per share, and I can confirm to you that the Board of Directors of Aladdin have confirmed such an offer from Vector. As we are in these discussions, there is no further information I can provide to you at this stage and this is important for everyone on today's call to know that we will not be commenting further on the Jasmine, Vector matter on that.

With that, and again excited with our results and happy to report them to you, I would like to turn the call to Aviram, who will give you a more detailed view of the financial results..

Aviram Shemer

I will start today's financial review with a look at the top line. Non-GAAP revenues in the third-quarter, which were a record $31.7 million, a year-over-year increase of 22%. Software DRM revenues were $15.7 million, in line with the previous year. Enterprise Security revenues were a record $16 million this quarter, a 51% increase from $10.6 million reported in the same period 2007 and accounted for 50% of total revenue.

Revenues for the third quarter included for the first time the consolidation of the SafeWord business line and Eutronsec, as well as previously consolidated Athena Smartcards. The geographic mix of the revenues during the quarter was 54% from Europe, 23% from the US, and 23% from the rest of the world.

Third-quarter gross margin was 72%. As we have said before, gross margins are influenced by the change in mix of the products we offer, our presence in emerging markets and the impact of our recently announced acquisition. We continue to work on reducing cost and expect gross margin to range between 70% and 75% going forward.

Looking at expenses now, stock-based compensation expenses totaled $713,000 in the third quarter, lowering our GAAP earnings by approximately $0.05 per diluted share. Stock-based compensation expenses increased by approximately $300,000 in the third quarter, primarily due to our option repricing program, which we announced in the beginning of the quarter.

Stock-based compensation expenses were included in the operating expense line items as follows; $31,000 in cost of revenues, $288,000 in research and development, $264,000 in sales and marketing and $140,000 in general and administrative. We expect stock-based compensation expenses to decrease in the fourth quarter to approximately $500,000.

Non-GAAP operating expenses for the quarter were $20.3 million, up 28% compared to the third quarter of 2007 and the same sequentially. R&D expenses were $6.5 million an increase of 35% compared to the third-quarter of 2007 and the same sequentially as we continue to invest in our products and solutions.

Selling and marketing expenses were $9.7 million, up 25% compared to the third quarter last year and the same sequentially. G&A expenses of $4.1 million were up 28% compared to the same period in 2007 and the same on a sequential basis.

Included in the third-quarter of 2008 operating expenses was depreciation of $960,000 and amortization of $630,000. Approximately $500,000 of this amortization expense can be attributed to our recent acquisition.

Global headcount totaled 520 employees as of September 30, 2008, an increase of 66 employees since the start of the year. Aladdin gained [55] hard-working and talented new employees throughout the acquisitions of Eutronsec and SafeWord.

The company's operating expenses reflect investments we're making in sales and marketing, R&D, our people and continued M&A activities. These investments are crucial to our building the appropriate foundation and strategy for continued growth. Looking ahead, we expect operating expenses to be higher than the third quarter as we consolidate the operations of SafeWord and Eutronsec.

Non-GAAP operating income for the quarter was $2.5 million compared to $4.3 million in operating income recorded in the third quarter of 2007. Net financial income primarily interest income [resulting] from our financial investment was $289,000 in the quarter compared to net financial income of $284,000 in the sequential quarter and $1.1 million in the year ago period.

The reduction in net financial income was primarily related to declining short term interest rate and currency exchange. We expect the fourth quarter to be lower than Q3 as a result of lower level of cash and cash equivalents. Our effective tax rate for the third quarter of 2008 was 15% in line with previous quarters. We expect our tax rate to stay in this range going forward.

Non-GAAP net income for the third quarter of 2008 totaled $2.9 million or $0.21 per basic and $0.20 per diluted share. Non-GAAP earnings per share excludes the impact of stock-based compensation expenses of approximately $700,000, fair value adjustment to acquire deferred revenues of approximately $400,000, amortization of intangibles related to the company's acquisition of approximately $630,000 and approximately $1.9 million of non-recurring legal and other expenses related to the recent unsolicited acquisition proposal and shareholders meeting expenses.

Management believes that these non-GAAP financial measures provide meaningful supplemental information regarding the company's performance, and it enhances management's and investors' ability to evaluate the company's net income and earnings per share, as well as to compare with historical net income and earnings per share performance.

A reconciliation table of our GAAP to non-GAAP financial results has been provided in today's press release for reference. The GAAP net loss for the quarter was $0.2 million or $0.02 per basic and diluted share.

Turning to the balance sheet, we finished the third quarter with $8.8 million in cash, cash equivalents and marketable securities, down approximately $84 million year-to-date due to the company's recent acquisition, which were financed with cash.

Our negative net cash flow from operating activities for the third quarter was approximately $800,000, down from $6.5 million in the year ago period. The decrease is primarily due to the decrease in the net income and our recent acquisitions. We expect to be cash flow positive in Q4 as our recent acquisitions begin to generate cash from operations. DSO in the third quarter was 58 days. Net capital expenditure for the third quarter was $1.2 million as our recent acquisitions closed in the last month of the quarter.

Finally, let me turn to our outlook for fiscal 2008, ending December 31, 2008. Based on current business conditions and expectations, Aladdin now expects its 2008 non-GAAP revenues to be between $124 million and $134 million compared to the previously reported non-GAAP range of $124 million to $132 million, provided on September 4, 2008 and as compared to the $105.9 million in revenues reported for fiscal year 2007. Non-GAAP revenue includes the fair revenue, fair value adjustment.

Aladdin expects GAAP revenues to be between $122 million and $132 million in fiscal year 2008. Fiscal year 2008 non-GAAP diluted earnings per share are expected to increase to between $0.74 and $0.84 from between $0.67 and $0.77 as previously guided.

The company reported non-GAAP earnings per diluted share of $1.21 for fiscal year 2007, which excluded stock-based compensation expense, amortization of intangible assets and the impact of the $2 million non-recurring upfront costs associated with production of video-based trainings.

Fiscal year 2008 GAAP diluted earnings per share is expected to increase to between $0.04 and $0.10 from the range of zero cents to $0.05. The company reported GAAP diluted earnings per share of $1.02 for fiscal year 2007.

That concludes our prepared remarks. We would now be happy to take your questions. As a reminder, the purpose of today’s call is to discuss our third quarter earnings result. We will not be taking questions today regarding our ongoing discussions with Jasmine Holding Company or Vector Capital.

Question-and Answer Session

Operator

(Operator Instructions) The first question is from Brian Thackray, Deutsche Bank. Please go ahead.

Brian Thackray - Deutsche Bank

Hello, good quarter.

Yanki Margalit

Thank you.

Aviram Shemer

Thank you.

Brian Thackray - Deutsche Bank

First question, Yanki, can you quantify how much contribution from SafeWord, Eutronsec and Athena was in the enterprise results?

Yanki Margalit

Sure, we will do that, but I would like to put a disclaimer here. We are going to do it for the quarter as in Q3 we had only a few weeks of that acquisition business. We are not, on a quarterly basis, going to be able to cut our sales by each and every product, however Aviram, please go ahead and provide the contribution from SafeWord and Eutronsec in the few weeks of Q3.

Aviram Shemer

Brian, SafeWord non-GAAP revenue contribution was approximately $3.3 million, and the Eutronsec contribution was approximately $300,000.

Brian Thackray - Deutsche Bank

Okay thanks you. On the gross margin front, can you just give a little bit more detail in terms of what is driving that change there? Is that something that is going to be continued going forward as we look into next year? Do you see further pressure on that coming down next year?

Aviram Shemer

It will enable us to even increase our margins next year. It is true that we are winning larger deals at lower prices, but overall we do not feel any significant price pressure in the market. We expect to be able to enhance the SafeWord margins in a significant way next year. That will start of our plan. We assume that we can reduce production for the SafeWord keys by dozens of points for next year. So overall, we are reducing our own internal production costs for our own products, for the new acquired product.

It is true that we are closing some larger deals at lower prices from time to time, but we see there is a trend and we do not anticipate cost of goods to increase next year. Contrary to that, I would suggest that Q4 was slightly on the low part of things, and we may be able to expect higher margins going forward.

Brian Thackray - Deutsche Bank

I got it. Thanks a lot. Good quarter.

Aviram Shemer

Thank you.

Operator

Thank you. The next question is from Joel Fishbein of Lazard capital. Please go ahead.

Joel Fishbein - Lazard Capital

On the SafeWord $3.3 million contribution, were there any large deals that you closed? That sound like an awfully big number for that short period of time.

Aviram Shemer

It is a big number, and yes, we had a few larger orders in that mix but that is normal. The SafeWord business is combined with online channel business, plus a few significant large accounts that we anticipate will continue and place their orders, which would not be something too out of the normal, but please bear in mind that the end of the quarter is usually more packed with business.

So what you have seen is the end of the quarter, and not the beginning of the quarter, which is, again, a bit more affecting the business. We expect that trend to continue. We expect a significant one-time order to come from the Type A customers of SafeWord going forward. We expect the general business to continue and develop. So it is not something which is totally untypical.

Joel Fishbein - Lazard Capital

I have to ask the obligatory macroeconomic question. Obviously there is a lot of uncertainty out there. You get a large portion of your revenue from Europe, and obviously that seems to be turning downward. Can you just give us a little commentary on what you are seeing out there in terms of the overall market environment in general?

Yanki Margalit

Sure. First of all we are very proud with our results given the current macroeconomic conditions, because the macro current economic conditions are not that great. We feel the pressure. We see the trends, and definitely I will discuss it on a geographic basis in a second; but definitely we feel the pressure and we are extremely proud with our results. I think that we continue to gain market share. We continue to convert customers from the competition. The huge investments we have made in R&D, in technology and products are paying off. We see the results right now.

I am especially proud with our achievements with software DRM. If you look at software DRM you see that we have been able to grow, slightly grow the business by 1.2% and given the current macro conditions, and given the fact that we believe that our competition is losing market share, the fact that our software DRM business is not shrinking, it is even slightly growing, we think that this is excellent results. Once the macro conditions become a bit better, we can, I think, accelerate growth even much further. So we are affected.

In Q3 we have seen great news coming especially from the US. You know that we are investing a lot in our US market right now. For the last two years we have hired talent, hired salespeople, increased marketing, and made some significant changes. The good news is that we have started to see results in the US in Q3. We have seen good results. I am talking about our own core business even without the additional acquisition that was again too late for us.

So, bottom line we believe that Europe continues to be a bit weaker right now, especially for Aladdin, continues to be a bit weak. We have seen a significant progress in the US. We have seen great markets internationally, and the bottom line we believe the basic demand for security is not falling apart. People need to comply. People need to secure their business. People need to go on with the projects they had started with when it comes to security. So we see great demand for our products and even given the current market conditions, we are able to grow the business, gain market share, and we are very happy with that.

Joel Fishbein - Lazard Capital

When do you think you will be able to give us some visibility into '09, putting all the pieces together and what the combined company looks like for 2009 from the revenue and profitability perspective?

Yanki Margalit

Sure. I will give you some highlights about the way we see '09 and of course we will give you more details and more numbers when we publish our Q4 results. I will have to put up a big disclaimer here, because the global market conditions are not that great, and the visibility is not that great. I would continue to be optimistic. I think, that what we are seeing right now, the pipelines that we are seeing right now, the execution that we are seeing right now is simply great. I think that we have great products and we have great demand given the current situation.

So overall we continue to anticipate growth in ‘09. We continue to anticipate cash generation in '09. We continue to anticipate higher profitability as we shared with you a couple of quarters ago; we took some very tough decisions in Q1 and Q2 to satisfy the short-term profitability to build a much larger Aladdin. We see the success of that strategy right now. We see the results. We see sales going up. We see that we continue to gain market share, and we see that profitability is coming up again.

Aladdin has the DNA of a very profitable company. The fact that we have sacrificed of our Q1, Q2 profitability to build a larger Aladdin, I think that it was a very wise move. It was the right thing to do. So looking at '09 my general anticipation right now would be to see continued growth, to see significant cash generation and to see Aladdin as a more profitable company in '09. I can tell that we see some initial pipelines developing today.

We see pipelines developing all over the markets, especially with large customers. We see some opportunities re-created with some of our largest customers today, and for the first time we are now entering Q4 with significant patent expectations for 2009. We will have some orders that we will not be able to deliver in Q4 we know that to-date. We have initial commitments for orders that will be shipped probably, partially, a small part in Q4 and the big part in '09.

So overall again I will make a big disclaimer it is a tough time, but our strategy seems to be going extremely well. We are very happy with the results. The demand for our products is increasing and today I can tell that I am quite optimistic for '09 as a whole, as well.

Joel Fishbein - Lazard Capital

It sound like you do not want to put any growth rate assumptions on '09 right now, right, in terms of…?

Aviram Shemer

I would not be able to quantify the numbers right now. I can only show the global conditions or feelings with the environment, I will not be able to quantify right now. I can maybe try and quantify the profitability level. We have a target. We want to bring Aladdin in 2010 to the normal profitability level of Aladdin, as we saw it before we made our significant investments. Aladdin enjoyed some net margins of around 15%.

So I would suggest that when we exit 2009 somewhere in 2010, we would like to see around 2010 we would like to see Aladdin again around that normal profitability level of 15%. So that is a target that we put at the start of our strategy. As far as the exact top line number, I am sorry, but it is a bit too early to discuss that.

Joel Fishbein - Lazard Capital

Okay. Thank you very much.

Aviram Shemer

Thank you.

Operator

Thank you. The next question is from Manish Hemrajani of Oppenheimer. Please go ahead

Manish Hemrajani - Oppenheimer

Good afternoon.

Yanki Margalit

Hello.

Aviram Shemer

Hello, Manish, good to hear you.

Manish Hemrajani - Oppenheimer

Yes. Can you comment on the DRM business? It seems to be a little weak this quarter. Also where do you see the business going especially in light of the macro?

Aviram Shemer

Sure. I think again, given the current market condition, I am very proud of the year end results in Q3. I do not see them as weak at all. I think that software DRM is highly affected by the global economy. We are selling to software vendors. We are selling to software developers. When they sell less software we sell less software protection. I believe that in Q3 we continued to gain significant market share, and our business has slightly grown by almost 2%. So I think that the basic strength of the business is still there. Yes, we are not able to show significant growth right now given the current market conditions, but the business continues to be very strong, and the business continues to be extremely profitable.

Our DRM business is a very profitable business. It is a long-term business. It is a business that we have invested in significantly over the last couple of years. I believe that we are going to see the results the moment the market is going to improve a bit. Right now even given those current market conditions I think that we are doing extremely well from a value creation point of view.

Manish Hemrajani - Oppenheimer

On the CIITE, do you see any contribution this quarter?

Yanki Margalit

We have good news in that we have not seen any contribution so far in '08 coming from our Indian CIITE project. I am saying it is great news because of two things; one, we are able to deliver growth, and value, and development even without that business. I think the people put too much emphasis on that business as if we are dependent on our growth on the Indian project over here. So first of all we have not seen any of this so far. All the growth that you have seen in '08 so far is net of any CIITE business.

The other part of the good news is that we have significant expectations today that the project is going to become even much larger. It is a bit too early to discuss numbers right now, but the indications that we have got today are quite positive, I am not sure that we will be able to see all of it in '08. There are issues of ramp-ups and deliveries etcetera, etcetera.. So I am not sure that we are going to see all of it in '08, but today we have very strong indications that we are going to see significant, much larger Indian business than we have seen before in the future.

Manish Hemrajani - Oppenheimer

So what is the realistic timeline when you could see a ramp up in revenue from there?

Yanki Margalit

If all goes well I think we should be seeing some part of it already in Q4 and then we will see things, if all develops well in early Q1, beginning of '09. The project as we have said many times is going exactly as we expected, exactly as people have told us before. As we told you the project we delivered some quantities and some inventory for the project by the end of '07. We waited for the next phase of deployment.

We get today very positive indications that the next phase of deployment is coming soon. As I said, we might be able to, may be able to see some income already by the end of '08. If not, we will see the majority and even much more business in '09.

Manish Hemrajani - Oppenheimer

Got it. One last one. Where are you in terms of manufacturing transition? Is that completed?

Yanki Margalit

The manufacturing transition you said?

Manish Hemrajani - Oppenheimer

Yes.

Aviram Shemer

You relate to SafeWord?

Manish Hemrajani - Oppenheimer

No, the eToken transition that you were doing in terms of the manufacturing facility.

Aviram Shemer

It is a constant process, and I believe that as of Q1 next year we will be shipping less expensive to produce units. I think we will see some of it, maybe by the end of Q4, but beginning of Q1, we are significantly reducing the cost of goods for eToken itself and also for the SafeWord product. We have been able to significantly cut production expenses for our new acquired SafeWord product line. Again, after we finish some inventories end of Q4 beginning of Q1, we will be seeing some significant cuts in production costs.

Manish Hemrajani - Oppenheimer

Can you quantify in terms of margin what the impact would be?

Aviram Shemer

It is hard to quantify because there are several issues over here, the cost of goods itself but then you have specific products for specific markets for specific quantities. I will relate to my previous statement that now that we have seen a 72% gross margin, I was asked if the number is going to decline and I said no, the number as far as I can see right now is not going to decline. Contrary to that, I think it is going to increase and that is highly related to the fact that we are as of the end of Q4 with this in production costs.

Manish Hemrajani - Oppenheimer

Thank you very much.

Aviram Shemer

Thank you.

Operator

Thank you. The next question is from Joe Maxa of Dougherty & Co. Please go ahead

Joe Maxa - Dougherty & Co

Thank you. Could you break out the net income contribution of the acquisitions?

Aviram Shemer

I am afraid we cannot do that. We do not cut the P&L by products or acquisitions or segments or whatever. I can tell you that the SafeWord acquisition so far is extremely profitable for Aladdin. It is not a coincidence that we beat Q3 expectations by $0.19 more or less. I think that right now we enjoy from an extremely profitable business, even too profitable. We intend to make some more investments in the future related to SafeWord. We need to make a few more investments.

We anticipated a 25% net operating margin business for SafeWord at our last investor conference. If you remember that, we said that we anticipated that business to be at least 25% profitable for Aladdin. In Q3 it was even way above that; if we need to make some more investments in the business, we need to create some more infrastructure for that business. Even after we make those investments we continue to anticipate at least a 25% net margin… Rather, let me be a bit more careful then to say operating margin for SafeWord going forward.

Joe Maxa - Dougherty & Co

Thank you. That is helpful. Last quarter when you had a bit of a more difficult quarter you talked about the sales cycle lengthening and taking on the closed deals. It looks like this quarter was, you maybe did not have as much of an issue with that or can you just talk about the sales cycle we would expect it to lengthen and given the environment that…?

Yanki Margalit

I would suggest we are seeing two things. First of all, yes, sales cycles continue to become longer. The environment is not easy. It is not that the environment has fixed itself and customers now want to buy. Even given the current environment I think that we are able to do much more today, and we are now operating under the assumption of longer sales cycles. So this is an assumption. This is not the macro condition. It is not that the economy has improved in Q3. It is not that we see shorter sales cycles. We see the same tough environment out there, but we are doing well.

Joe Maxa - Dougherty & Co

Okay. Aviram, can you give us an expectation for your operating expenses in the coming quarter Q4?

Aviram Shemer

Well, we expect the operating expenses to be higher since we probably will have to consolidate both SafeWord and Eutronsec for the entire quarter. In Q3 we have consolidated SafeWord only for a month and Eutronsec for half a month. I can not give you the exact number, but we expect it to be higher.

Joe Maxa - Dougherty & Co

Okay and how about the amortization and other expense line, what should we be looking at there?

Aviram Shemer

The expected amortization for Q4 would be approximately $2.8 million on the expense side.

Joe Maxa - Dougherty & Co

Okay, thank you.

Aviram Shemer

You are welcome.

Yanki Margalit

Thank you. Joe.

Operator

Thank you. The next question is from Craig Nankervis of First Analysis.. Please go ahead

Craig Nankervis - First Analysis.

Yes thank you. I have few questions Yanki. First of all, just back on the DRM business and sale cycles, I thought that 90 days ago you talked about how some DRM deals and maybe in Europe in particular got pushed out too. Did those fall in Q3, or do those continue to be pushed out trying to figure out what is going on in the business?

Yanki Margalit

For the majority of them, it is a combination. Yes, some of the deals we wanted to close in Q2 and were not closed in Q2, but rather they were closed in Q3. In general we continued to see longer sales cycles, and we also see some projects, which are being delayed right now on an indefinite time frame. Customers are telling to us that under the current market conditions they need to evaluate projects. It happens.

I am trying to make this point as clear as I can. It is not that the economy has fixed itself. We had a great quarter. We have a great pipeline. We have great expectations about the business we are going to do, because I think that the simple truth is that we have great product that customers need. The environment is tough, continues to be tough. Projects are being canceled, and delayed and we continue to see that.

Craig Nankervis - First Analysis.

Okay, but was Eutronsec all DRM contribution, or was there some authentication in that?

Yanki Margalit

Can you repeat the question, please?

Operator

Perhaps, sir, you could lift the handset instead of talking through the…

Aviram Shemer

Contribution of Eutronsec, Yanki.

Yanki Margalit

The contribution of Eutronsec in Q3 was marginal. We are talking about two weeks of business and a contribution of $300,000, mostly with software DRM.

Craig Nankervis - First Analysis.

Okay. That is helpful. Can you review the gross margin reset for your guidance, lowering the range? What the rationale is especially in light of you talking about taking out costs for the authentication side?

Yanki Margalit

We are trying to be a bit conservative here. When we look at Q4 it is hard to tell how many of our initiatives will materialize already in Q4. So when we talk about ‘08 and Q4 we try to be a bit more conservative. Talking about '09 we can be more aggressive as we know that new production facilities and reduced costs will be in place.

Craig Nankervis - First Analysis.

I see. Any comment on SafeWord account protection, SafeWord has some large accounts, some people think that they are now vulnerable given there is a transition. I wonder if you could speak to that in any particular way.

Yanki Margalit

You know, it is only natural that every time you acquire a business the competition tries to look at the customers. It’s always a vulnerable transition.

Craig Nankervis - First Analysis.

Right.

Yanki Margalit

We know that, we assumed that, we keep in good touch with our customers. We meet with them. We talk to them. I cannot tell you that we will not lose any one of our customers. I think that we are doing a great job right now in communicating with these customers, in maintaining those customers and in maintaining their needs. Do not forget that when you buy an authentication device usually you are locked to that device. It is not so easy to switch. It is a not a product you can easily switch from one vendor to another. Your infrastructure, your servers, your backend has to support the keys in the fields. So switches are not that easy. Customers know that. We know that. We do our best to maintain our customers and so far I think we are doing a great job here.

Craig Nankervis - First Analysis.

Okay, thank you. On eSafe any comments at all? I do not think we have heard anything about it so far today.

Yanki Margalit

eSafe was not doing according to our expectations in Q3. It is slightly below our expectations in Q3. One of the reasons for that is the fact that in Q3 a year ago in Q3 '07, we had a large order coming from CIITE, the Indian deal for eSafe that we were not able to repeat in Q3 of this year. So when you compare Q3 a year ago to Q3 right now for eSafe, you see a slight decline in the business. Overall, the organic business, the ongoing business has grown, and I believe that once we enhance that organic growth or the moment that we see more business coming from CIITE related to eSafe we will also see again significant growth for eSafe.

Craig Nankervis - First Analysis.

Lastly, for Aviram, I wonder if he could give us a goodwill and intangibles figure related to the acquisitions.

Aviram Shemer

Well currently all the analysis of the goodwill is not final yet. That will probably take place during the next couple of weeks. So at this stage I would prefer not to give all the information.

Craig Nankervis - First Analysis.

Okay. That does it for me. Thank you.

Aviram Shemer

Thank you, Craig.

Operator

Thank you very much. There are no further questions at this time. Before I ask Mr. Yanki Margalit to go ahead with his closing statement I would like to remind participants that a replay of this call is scheduled to begin in two hours. In the US please call 1-888-782-4291. In Israel please caught 03-925-5936. Internationally please call 9723-925-5936. Mr. Margalit, would you like to make your concluding statement?

Yanki Margalit

Thank you, everybody, for joining us today. Again, it is an exciting quarter for me. We see great results for our strategy. We see a great pipeline going forward, and we see great returns to significant profitability. I am very happy with the results and I am very happy with the continuation of this process. So thank you very much, everybody, and take care.

Operator

Thank you. This concludes the Aladdin Knowledge Systems third-quarter 2008 conference call. Thank you for your participation. You may go ahead and disconnect.

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