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Executives

Erik Knettel - Investor Relations

Shlomi Yanai - Chief Executive Officer

Brian Briggs - Chief Financial Officer

Analysts

Jay Srivatsa - Chardan Capital Markets

Gunnar Hansen - Sidoti & Company LLC

Ken Nagy - Zacks Investment Research

Commtouch Software Ltd. (CTCH) Q4 2012 Earnings Conference Call February 20, 2013 10:00 AM ET

Operator

Greetings and welcome to the Commtouch Fourth Quarter and Full Year 2012 Earnings Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host Eric Nadel, Investor Relations for Commtouch. Thank you. Mr. Nadel, you may begin.

Erik Knettel

Thank you Melissa and welcome everyone to Commtouch’s Fourth Quarter and Full Year 2012 Financial Results Conference Call. If you have not accessed the copy of today’s earnings press release, please call Commtouch’s Investor Relations team at 1646 284 9426 or visit the Investor Relations Section of the company’s website at www.commtouch.com.

A live webcast and webcast replay of today’s call is also available on the Investor Relations website. I would like to remind everyone that the Safe Harbor statement issues in today’s press release also covers the content of this conference call. Joining us on the call today from Commtouch and management, we have Mr. Shlomi Yanai, Chief Executive Officer and Mr. Brian Briggs, Chief Financial Officer.

I would now like to hand the call over to Shlomi, Shlomi please proceed.

Shlomi Yanai

Thank you Eric. Good day everyone and thank you for joining us. I am pleased to be joined by Brian Briggs, our new Chief Financial Officer. Brian joined us in January and will follow up my opening remarks and take you through our detailed financial results.

Our Saturday call, we will work through some of our operational and performance highlights. The fourth quarter concluded 2012 with renewed revenue growth and tremendous progress on our transformation into a provider of comprehensive “security at the service” offering. As we executed on our strategic acquisition focused on accelerating the new product innovation in line with this vision.

In the fourth quarter, we successfully closed two acquisitions included our previously announced acquisition of FRISK Software International antivirus business and Eleven GmbH, a leading e-mail ‘Security-as-a-Service’ provider based in Germany and the pioneer in the field of managed email security. When combined with our significant investment in our core research and development function, those acquisitions have helped accelerate our cloud based “Security-as-a-Service” solution evolution.

The acquisition of Eleven accelerated the delivery of our “Security-as-a-Service’ quality and broadened it, enabling Commtouch to provide more OEM services and private labeled application as well as expanded our European footprint to head offices closer to many of our customers. On the new product front, Commtouch’s new e-mail “security-as-a-service” solution marks a major launch of our company related cloud based offering. We also recently launched new solutions focused on e-mail security on promise for service providers and mobile security services for android solutions, which covers strength Commtouch’s core operator. All three solutions were recently launched into the market have had a strong initial customer response. Our material progress on executing disparity and deploying our new offering are on-track and had successfully set the stage for serial double digit revenue growth in 2013.

Commtouch’s launch of our new cloud based e-mail “security-as-a-service” solution marks an important milestone in Commtouch’s strategy to provide service providers and security vendors with the ability to rapidly bring innovative cloud based “security-as-a-service” offering to the market alongside their other offerings and under their own brand providing easy and efficient access to the growing market segment. Commtouch’s e-mail “security-as-a-service” combined permanent protection against e-mail based threats such as spam, phishing and malware with maximum post efficiency and minimum time to market.

Our new mobile security service for android is the first ever OEM solution that offer cloud assist antivirus and web security services delivered through a single easy to integrate client as the gate for the popular mobile operating system. Commtouch’s lab has identified more than 360,000 security threats specific to android as of yearend. We have more than 400 million android devices around the globe, Commtouch’s addresses this best market opportunity to increase android device security with an easy-to-deploy mobile security solution that allows vendors and service providers to add security functionality to the protection of their end users.

On the new on promised e-mail security services or service providers, augment our existing market leading messaging security suite and cloud assist malware detection services for service providers environment. The service deliver additional simplified messaging security and optimization functionality enabling Commtouch to better address the requirements of any service provider that offers e-mail services to end users. The new solution leverages e-mail security technology asset which Commtouch acquires as part of its purchase of Eleven GmbH. We will be showcasing all three of those offering as well as our new complete portfolio of internet and cloud based security technologies, and the upcoming RSA conference in San Francisco from February 25th to March 1st.

On the financial front, the fourth quarter and full year 2012 marked Commtouch’s return to topline revenue growth with the full year revenue coming in line with the upper end of our guidance expectation. As acquisition related transaction and integration expenses combined with an increased investment in global business and marketing infrastructure contributed to a lower bottom line profitability year-over-year. New booking growth remains strong in the fourth quarter and for the full year. With new bookings doubling compared to the levels seen in a year ago period. This continues to provide a solid proof point that our improved execution is yielding clear results on the business generation front.

Key new client wins during the fourth quarter reflect the increase global reach of our recently extended sales and marketing efforts including key new accounts either from North America, India and China among the other global regions. Organic new booking growth combined with the synergies of our late 2012 strategic acquisition put Commtouch on-track to realize full year 2013 revenue growth in the range of 42% to 46% over 2012. We are undertaking a range of initiatives designed to optimize the integration, synergies and streamlining of our recent acquisition with a focused commitment to bottom line profitability. We also remain committed to investing in our enhanced sales and marketing platform to fully leverage the value for innovative new “securities-as-a-service” offering among customers and partners worldwide. All will continue to fund our growth for internal cash flow generation. Building on Commtouch’s progress in 2012, the focus remains on increasing our market share in the fast growing market for cloud based e-mails, web and anti-virus solutions including a significant launch of our new upcoming cloud based web security solution which is currently on-track for release during the first quarter of 2013. Based on the strength of our extended portfolio of cloud based IT security solutions and the integration of our streamlining of our recent acquisition. We are obtaining a solid foundation for growth in 2013 and beyond.

Finally, I am pleased to have Brian join me on the call today following his appointment as Commtouch’s Chief Financial Officer at the charge of 2013. Brian is proving to be a tremendous asset to the move through the process of streamlining and optimizing our most recent acquisition and establishing the structure for revenue growth with the focus on bottom line profitability. I’d like now to turn the call over to Brian who will further elaborate on the fourth quarter results. Brian, please go ahead.

Brian Briggs

Thank you Shlomi and thank you all for joining us today. In the 45 days I have been at the company, I‘ve truly been impressed with our wide range of talented professionals and our innovative service offerings which are well positioned to address some of the fastest growing segments on the IT security and cloud services market. I’d like to walk you through a summary of our fourth quarter results and some full year 2012 highlights. For more detailed results, please refer to the press release we issued earlier today.

In addition, please note that we can file our financials under U.S. GAAP which includes non-operating expenses. In order to better analyze our business performance, I will also discuss certain financial metrics on a non-GAAP basis excluding these non-operating items and you can refer to today’s press release for a full reconciliation of our GAAP and non-GAAP results. It is important to note, we have two material acquisitions closed in the fourth quarter of 2012. The first was the acquisition of FRISK Software International antivirus business which we closed on October 1, 2012. We began to integrate this FRISK into Commtouch’s quarterly results beginning in the fourth quarter of 2012. In addition, we closed the acquisition of Eleven GmbH on November 16, 2012 resulting in partial quarter contribution for the fourth quarter of 2012 results.

GAAP revenue for the fourth quarter of 2012 was $6.8 million, an increase from $5.6 million in the previous quarter and up from $6 million in the fourth quarter of 2011. Full year 2012 GAAP revenues totaled $23.9 million in line with the upper end of our guidance range and an increase of 4% compared to $23 million in 2011. Non-GAAP revenues for the fourth quarter totaled $7 million compared to $5.6 million for the sequential third quarter of 2012 and $6 million in the fourth quarter of 2011. Full year 2012 non-GAAP revenues totaled $24.1 million, an increase of 5% as compared to $23 million in 2011. Non-GAAP revenue includes the full book value of differed revenue amounts from the two acquisitions completed during the quarter versus the fair value amounts recorded through purchase accounting for GAAP purposes.

Our GAAP gross margin for the quarter was 80%, fourth quarter gross margin reflects our post acquisition mix of business. Gross margin declined primarily related to the acquisition of Eleven which has gross margins of roughly 75% which are below the gross margin percentages generated by the historical Commtouch business.

As we move through the integration and streamlining process, we anticipate that we’ll begin to see a gradual improvement in the gross margin overtime as business efficiencies are realized. GAAP operating expenses for the fourth quarter were $6.4 million compared to $4.7 million for the same period of 2011. Non-GAAP operating expenses for the quarter were $5.6 million compared to $3.2 million for the fourth quarter of last year. The rise in operating expenses was primarily attributable to the plan higher level of investment in sales, marketing and engineering expenses associated with the ongoing support of our “security-as-a-service” strategy as well as higher sales commission expense paid in the quarter associated with this significant increase in new bookings.

The higher operating expenses also reflect the impact of the two fourth quarter acquisitions prior to the integration and achievement of planned synergy. During the fourth quarter and full year, the company recognized expenses totaling $400,000 and $800,000 in the respective period related to acquisition cost. Fourth quarter and full year 2012 GAAP net income and earnings per diluted share data include the impact of the aforementioned acquisition and preliminary integration cost. Subsequent to year end, we have initiated a number of cost reduction and streamlining measures meant to optimize the combination of Commtouch’s business with our recent acquisitions of FRISK and Eleven. We expect to incur cost related to these integration measures in the first half of 2013 with savings to be realized in the second half of 2013.

Fourth quarter GAAP net loss was $500,000 where loss of $0.02 per diluted share compared to net income of $1.3 million or earnings of $0.05 per diluted share in the fourth quarter of 2011. Full year 2012 GAAP net income totaled $1.5 million or $0.06 per diluted share fourth quarter and full year 2012 data includes the aforementioned acquisition related expenses. Our fourth quarter non-GAAP net income was $267,000 or $0.01 per diluted share compared to net income of $1.7 million or $0.07 per diluted share in the fourth quarter of 2011. Full year 2012 non-GAAP net income totaled $3.9 million totaled $3.9 million or $0.16 per diluted share. This level was slightly below our expectations, primarily due to a higher level of investment in sales, marketing and engineering expenses associated with the ongoing support of our security of the service strategy rollout and the 2013 product launches among other factors.

Now, turning to the balance sheet. Our cash at year end stood at $5.1 million compared to $17.3 million as of September 30th, 2012. Cash usage during the fourth quarter included $10.2 million related to payments for business acquisitions net of cash acquired, as well as increased cash utilization for acquisition and integration costs, stock option repurchases and other factors.

During the fourth quarter, cash used for operating activities was $1.6 million, which included the acquisition-related costs and investments in engineering, sales and marketing as mentioned previously.

In May of 2012, our Board of Directors authorized the initiation of a stock repurchase program of the company’s ordinary shares in the open market, utilizing available working capital of up to $2.5 million. This action reflected the confidence the Board of Directors and management has in the long-term growth prospects of the company.

During the fourth quarter, the company repurchased approximately 105,000 shares at an aggregate cost of approximately $279,000. As of December 31st, 2012, approximately 767,000 shares have been repurchased through the program to date at an aggregate cost of approximately $1.7 million.

Deferred revenues as of December 31st, 2012 were $5 million, up 52% compared to a $3.3 million at the end of the third quarter of 2012. The increase is primarily driven by deferred revenues from the two acquired businesses.

Moving now to our financial outlook, based on the company’s current expectation, we are announcing guidance for the full-year 2013. We anticipate full-year 2013 GAAP revenue will be between $34.0 million and $35.0 million, an increase of approximately 42% to 46% compared to the full year of 2012.

GAAP and non-GAAP net income guidance includes a higher level of sales and marketing expense versus 2012 to support a strengthened global sales platform to help fully leverage the market potential for our new broadbased offerings. Full-year 2013 GAAP net income is expected to be greater than $2 million and non-GAAP net income greater than $3.5 million. The company also expects to recognize extraordinary expenses related to its previously announced acquisitions, primarily associated with related integration and streamlining expenses, totaling approximately $800,000 during the first half of 2013.

We anticipate the majority of these expenses will be recognized in the first quarter of 2013, resulting a loss for the quarter and the remaining expenses being recognized in the second quarter of 2013. The impact of these expenses is reflected in the full-year 2013 GAAP net income guidance. With these integration and streamlining expenses addressed in the first half of the year, and with our cost efficiency efforts in place, we project profitability to improve measurably in the second half of 2013 and to be much more reflective of the baseline profitability of the core business. Please also note as a Safe Harbor, the outlook we presented is as of today, and we do not undertake an obligation to update estimates in the future.

In assuming the role of Chief Financial Officer, I look forward to meeting many of you in the days and weeks ahead. Please note that I will be attending the RSA Conference in San Francisco from February 25th through March 1st. Should you be attending and wish to meet, please recap me and we can arrange some time together.

At this point, I would like to turn the call back to Shlomi for closing remarks.

Shlomi Yanai

Thank you very much, Brian. In conclusion, I believe on progress in executing on our strategic plan in 2012 and early 2013 to reflect major advancements in the transformation of Commtouch into a global leader in cloud-based security solutions, which ultimately support our ability to drive long-term growth and shareholder value. And with that, we would be happy to take your questions. Operator, please proceed with the Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Gentlemen, our first question comes from the line of Jay Srivatsa with Chardan Capital Markets. Please proceed with your question.

Jay Srivatsa - Chardan Capital Markets

Yes, thanks for taking my questions and congratulations on a good quarter and good guidance for the year, Shlomi. I have a question on cloud-based computing and the security related to that. It looks like that would be a new area for you relatively speaking. Can you give us some sense on what the competitive landscape is there on that side and how do you expect to beat some of the challenges as you attempt to penetrate that market?

Shlomi Yanai

Thank you, Jay. Thanks for joining us. So, it’s obviously a key question on our strategy, when (inaudible) on strategy and long-term growth plan. When you look today at the market, some of the recent analysts and the more people ones obviously all predict that the market will grow 20% year-over-year in the coming two years, when it comes to web security, Email Security and end point security. Those are the areas we are focusing on. We just launched Email Security. The web security will be the next service we are planning to launch. There are not too many vendors that operate on the website. Email is obviously (inaudible) service in the industry, but what’s really unique about Commtouch services is, one, the fact that we are utilizing our on-core detection capability, the unique IP we have for the last 14 years and algorithm and the way we saw for anti-spam Email Security will be the key differentiator for us in the marketplace as we just delivered the services.

Second is our go-to-market, which is all based on private labeling, and based on our knowledge and what’s available in the market, they are early vendors that private label services, this is thanks to our SaaS excellence and our cost efficiency on the infrastructure and the experience we have there that really enable us to come with this innovative business model and leverage our customers and new partners to take our service to market and be a more developed sales for us in the partnership site. So, on the competitive landscape, we are appreciating with our unique detection, our unique go-to-market, and obviously our SaaS excellence and experience in the last 40 years [ph] in this space.

We haven’t seen too many vendors of private label. We do see vendors on Email that sell directly to enterprises. Our plan is to compete in the marketplace by enabling a more service provider vendor to private label, carry build on their brand and add it as part of their core portfolio.

Jay Srivatsa - Chardan Capital Markets

All right. In terms of the announcement you have had, several partnership announcements that you have made through AVG and Openwave, can you give us some sense on when do some of these contracts start to contribute to your revenue line?

Shlomi Yanai

So, all our contract, this is something relying last year and we are sure with the market, are a three-year contract, but most of them are three-year contract, meaning there is a commitment by the customers who pay Commtouch over the three years and they are limited in place.

If you look at the specific name, the specific two names you highlighted are obviously still on the previous services. We just launched a new one, Openwave specifically as we highlighted in the press release are using our messaging suites and chose our messaging suite to be part of their offering to move forward. AVG used our messaging and more specifically our web security features, but we do see growth. When you look at our booking in 2012, which is an important point, on our core business on our cloud-based detection services, which is the core business of Commtouch where we are continuing to invest as we grow the business, and obviously those detection capabilities will be part of the complete cloud services as we move forward.

Jay Srivatsa - Chardan Capital Markets

All right. In terms of the mechanics of some of the integration of the acquisitions you have made, it looks like looking ahead to 2013, your OpEx could slightly be higher because of some of the acquisitions. What are some of the steps you are taking in terms of streamlining those businesses to potentially reduce the OpEx overtime?

Shlomi Yanai

So, obviously, we just acquired the company and we just started to look into the integration. We have the integration plans in place. We are planning to execute on those during the first quarter and will share more data as part of the Q1 results as we move forward, but the basics are, you know, integrating efficiencies on how we run operations, how we run data centers, there is G&A, and also the key areas we are looking at. Obviously, there is beyond – we are completely streamlining our sales and marketing department, engineering, but we will put more colors and details as we go through those, conclude those in the first quarter and have those executed by the end of the quarter.

Jay Srivatsa - Chardan Capital Markets

All right. Good luck.

Shlomi Yanai

Thank you very much. Thank you, Jay.

Operator

Thank you. Our next question comes from the line of Gunnar Hansen with Sidoti & Company. Please proceed with your question.

Gunnar Hansen - Sidoti & Company LLC

Hi guys. Can you talk a little bit about just some of the regional or industry-wide kind of the success you guys have had with some of the new bookings here?

Shlomi Yanai

Hi Gunnar, thanks for joining us. So, one of the things we did differently in 2012 was focusing on having a more global presence, meaning we divided our sales force to (inaudible). We realized that our customers, our existing customers are a key asset for us because all our contracts as of today are already cloud-based, all the business model, they are ready to share, our customer sells, we get more. So, we finalized a dedicated team that worked with our customers assuring they would be more successful, some of the success, obviously not in your business, but some of the success in 2012 that will reflect in our numbers as we move forward. Our existing customers being more successful, selling more, and we believe we will see much more of that coming as we move forward.

On the other side on how we deal with new business, which is where we had phenomenal success in 2012 and we doubled booking value versus the previous year. The main focus was on the new region in areas we didn’t operate before. We located our sales guys in Latin America. So, we had some deals coming from Latin America, specific in Asia-Pacific, in China, in India, we have some major new accounts. So, operationally going forward, how we work in regions we didn’t operate before and then we will also focused our go-to-market and our messaging surrounding a specific vendor guide and service providers, we can be more successful, mainly surrounding selling their services as value-added services, more and more network safety devices that realize that they can execute these value-added services to their customers, and we had a lot of success there with specific equipment and vendor.

We were successful with embedded anti-virus to very, very large service providers that’s incorporated as part of their offerings and at the same time, almost any device in the industry that has content is looking into embedding anti-virus today and we had a lot of success there. Think about hard disk storage devices, cloud-based storage infrastructure. Those are incorporating embedded anti-virus solutions like ours and became our customers. So, those are the key areas. It’s going after value-added services, new specific vendor service providers and regional presence that we didn’t before, generated a lot of new bookings, and we think we are just starting to see the growth there, and we will see more of the results coming as we go through 2013.

Gunnar Hansen - Sidoti & Company LLC

Great. And I guess just lastly, and obviously, you guys mentioned just some greater investments in sales and marketing and engineering. Could you guys give us some quantitative numbers in terms of headcount, increased headcount and things of that nature?

Shlomi Yanai

So, obviously with acquisitions, we have much more main part of the company when it comes to engineering and sales, and when we go through Q1 on fully integrating all the pieces, but today, for a company just as high-level comparisons, we doubled our sales and marketing force. In the generic front, we haven’t doubled, it’s lowering a bit, but it’s still a major investment. Mainly came through the acquisitions and organic investments we made before we started acquisitions on building our SaaS platform. But just in some color, we are entering 2013 with, I would say, more than doubled sales quota-carrying people and the former that take care of the existing numbers than we head into previous years, on a global basis.

Gunnar Hansen - Sidoti & Company LLC

Okay. And do you have a specific headcount, I guess on that?

Shlomi Yanai

It’s not – we need to look at what level we can share that and get back to you with more details.

Gunnar Hansen - Sidoti & Company LLC

All right. Great, thanks. That’s it.

Shlomi Yanai

Thank you.

Operator

Thank you. Our next question comes from the line of Ken Nagy with Zacks Investment Research. Please proceed with your question.

Ken Nagy - Zacks Investment Research

Hi, thanks for taking the question. Just curious, on the bookings, how long does it take for those bookings to become meaningful revenue?

Shlomi Yanai

So, most of our contracts, the three-year contracts, normally the way it works is the customer commit to a minimum consumption of the service each quarter. So, it’s a way committed that the first quarter after he purchased, implemented, we will start and see a recognition of revenue out of the contract. Obviously, if we close the deal before, we see it only later on the year, but those are a – if you do the math, it’s three-year contract and are starting to almost immediately impact, but on a quarterly basis. The upside we have there is obviously driving those contracts to upper levels and driving more in the short term out of those contracts, which is a dual effort.

Ken Nagy - Zacks Investment Research

Thank you.

Shlomi Yanai

You are welcome. Thank you, Ken.

Operator

Thank you, gentlemen. I would like to turn the floor back over to management for closing comments at this time.

Shlomi Yanai

I would like to thank you all for joining us today and for your continued support and interest in Commtouch. I look forward to updating to you all on our next conference call. Thank you and have a great day.

Operator

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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