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Brightcove (NASDAQ:BCOV)

February 27, 2013 4:55 pm ET

Executives

David Mendels - President, Chief Operating Officer and Director

Christopher Menard - Chief Financial Officer and Executive Vice President

Analysts

Adam H. Holt - Morgan Stanley, Research Division

Adam H. Holt - Morgan Stanley, Research Division

My name is Adam Holt, and I run the enterprise software group at Morgan Stanley in the equity research side. And I'm very excited to have our next presenter in conversation with Brightcove. And from Brightcove we have Chris Menard, the Chief Financial Officer and Dave Mendels, who's the new Chief Executive Officer. So congrats on the new seat and thank you both for coming to see us.

Question-and-Answer Session

Adam H. Holt - Morgan Stanley, Research Division

So why don't we start there? You've got your recent move, if you will, in the last few weeks. Can you talk a little bit about the change at the top?

David Mendels

Okay, sure. Thank you. So Jeremy Allaire founded the company 8 years ago. I think he had good advice and good insight that I think is kind of common, received wisdom that the person who takes the company from 0 to $100 million is not necessarily the person who could do everything from $100 million to $250 million.

We go way back. We worked together previous companies. I helped -- led the acquisition of an earlier company of his. I had experienced leading a big part of Macromedia up through $500 million in revenue and then Adobe run in $1 billion dollar business. So he brought me in as COO 3 years ago. So I've been running a lot of the operating side of the business already for 3 years, and we've been working together very closely. So it's not a huge change internally because we've been doing that.

Jeremy's staying with us as Executive Chairman. He had this vision 8 years ago now about where the industry was going in terms of online video and fundamental transformation in consumer behavior that we're really seeing today with all the devices, and it's come true. And so he's still very engaged. He's an active Executive Chairman, focused on the vision, the product strategy, key customer relationships, the public relations and the industry relations. And I'm running the day-to-day company, but it's a good partnership. It's an evolution, and I'm very excited about it.

Adam H. Holt - Morgan Stanley, Research Division

Terrific. Why don't we maybe pivot then to the market, which you just talked about, and the vision around the market. You all have been public for a little -- well, around a year, basically. We've got a year and change. And maybe you could sort of level set mark-to-market where you think we are in the opportunities set, how you're viewing the market today, penetration rate, size versus a year ago.

David Mendels

Well, we still think it's very early. A year ago in IPO process, we said we think there's a multibillion-dollar market opportunity. We still think that's the case. We think that big picture, there's still a lot of video coming online, a lot more spending on video advertising that's coming online. Brands are looking to change the way they market from paid media to owned media. So using media to create content marketing. And that we're still very early in that. And this category of online video platform is still relatively new, so a lot of people are still messing around with DIY, they're having agencies build stuff. And as they're learning about things like us, we're seeing opportunities to get in there. So we still think there's a long way to go. We look ahead, if you think long-term, is there more video coming on online or not? Is there more disruption from mobile devices? Are consumers changing their behavior in how they want to consume content? And the answer to those is all a massive growth potential for us over the next few years.

Adam H. Holt - Morgan Stanley, Research Division

Why don't we look at the enterprise opportunity. You mentioned the DIY approach. What do you think shakes loose the DIY to move to your approach? Do you think that's just a matter of time? Is there sort of a critical mass from a customer reference point perspective? How do you think about really freeing that transition up?

David Mendels

Sure. Well, an inflection started a couple of years ago, really with the introduction of things like the iPad and then all the Android devices, which started to change consumer behavior. And what happened was people who'd been going along trying to build their own suddenly realized, "Wow, this is suddenly a lot harder. It's getting more complicated, not less complicated. I have to figure out how to target all of these different devices. I have to figure out how to get advertising on these devices, how to get security on these devices." And a lot of companies, a lot of media companies and non-media companies said, "Why am I doing this? Can I outsource this?" And that's been source of our opportunity over the last few years, but we're still early in that. There's still an incredible fragmentation out there in terms of all these devices. It's still growing. Smart TVs are the next wave that people are going to struggle with and figure out, "Okay, wait a minute. I need to get help on this."

Adam H. Holt - Morgan Stanley, Research Division

And one of the things that I have a lot of conversations with investors about, I think they struggle with just a little bit to put in context what the technology options are for a large enterprise or a large media company and how you really differentiate your solutions. Can you spend a few minutes talking about that?

David Mendels

Sure. A lot of companies have started either by trying to build their own system or, in many cases, having an agency build something for them. And it's expensive, it's complicated and it's hard to keep up. The platforms are changing very rapidly. The protocols for video streaming have changed over the last few years. The security options have changed over the last few years. And so buying from a company like us that has plus or minus 100 people working on product, we can keep up. We can future proof them. I'll give you one example from a large consumer goods company. They had different divisions around the world. They had the French group, the British group, the U.S. group, the -- all different stuff. And each one had built micro sites. They were leaders in digital marketing. They have done a whole lot, and they had built a video player over here and another one over here with all these different rich media agencies around the world. The iPad came out and they're, like, "Well, let's make it all work on HTML5 now." And they realized they couldn't, right? Because it wasn't one player, and it wasn't a vendor. It was like 10, 20 different little custom pieces of software all over the place. And so they came to us that we were able to give them a complete system that gave them a way to manage their content in each one of those things as well as share content across it, a way to control their brand so they can get consistent look and feel of their players across, a way to improve the quality, a way to reach all the different devices which they weren't able to reach, and it's a huge ROI versus DIY. We also compete against a range of different smaller private companies as well, and we differentiate on a number of things, but probably the biggest single variable ties back to the biggest single opportunity, which is our focus across device playback. It sounds simple, but when you try and get a video to play back on Android 2.2 and Android 3 and Android 4 and iOS and a TV with advertising, a pre roll, a mid roll, a post roll with an overlay with analytics, it's a pretty hard problem. And we've really invested in that, and I think we're clear leader in the market, and it's one of the reasons that people choose us.

Adam H. Holt - Morgan Stanley, Research Division

And if you look at the different segments of your business right now, I've been focusing on sort of the higher end. Can you talk about the demand trends you're seeing between traditional enterprise customers like Morgan Stanley, who's doing more video. In fact, you guys, I actually started to do videos where we embed them with some of our research reports.

David Mendels

We're happy to help you with that, by the way.

Adam H. Holt - Morgan Stanley, Research Division

And then on the other side, you've got more traditional media coverage. Can you talk a little bit about the demand trends on both sides?

David Mendels

Sure. I mean, we think that there's big opportunities on both sides, digital media and digital marketing is the way we think about it. And there's fundamental trends involved. In the digital media side, it's consumer behavior and more video going over the Internet and new monetization strategy. On the digital marketing side, it's been moved from paid and earned media to paid, earned and owned media where people are using content to engage the audience and creating their own channels and always engaging the audience and using that to drive search. So there's fundamental positive trends on both. In terms of where we are this year, we did shift a little bit of our resources to focus more in on media right now. Not a right turn for the company, but just a shift a little bit. We've always been strong with media. It's about 40% of our revenue. And we decided we were seeing a lot of opportunities at the high end of media where people are making that move from DIY. Last year, we had success with companies like some big parts of NBC Corporation, big parts of Viacom, and we decided to focus a little bit more on that. So we invested a little bit more in the vertical sales team for digital media. We're investing with some features for digital media around things like advertising and DRM. But we still see good trends on both sides of the fence.

Adam H. Holt - Morgan Stanley, Research Division

And how would you characterize the spending environment on the media side?

David Mendels

It is -- I think that people are wary, but the digital businesses are often the fastest growing part of what they're doing. We sell -- it's not just about broadcast. We sell a lot, for example, in the newspapers. And obviously, a lot of newspapers are struggling and have been struggling for some time. But within that, they're seeing some of the fastest growth from video on their websites. We've had great results with companies like the New York Times Company, the Gannett Company, et cetera. And so what the value proposition we offer is we can help them lower their costs if they're trying to build a whole bunch of stuff, and we can help them better monetize their properties by getting a better video experience on their site, getting that to work across all their stuff. So while spending is tough and everyone in media's struggling a little bit with business models and all the changes that are going on, on the other hand, the value proposition we bring is positive to that, and so things are fairly stable.

Adam H. Holt - Morgan Stanley, Research Division

And then if you could talk about maybe the other side of the marketplace. Another initiative for you is getting into the mid-market, expanding the kinds of companies you can get to. Can you talk a little bit about what you've done there and how your progress has been?

David Mendels

Sure. So we've got over 6,000 customers now. It's a very, very wide range. We've always believed that every professional online property in the world, every professional app in the world is going to need video. Video is just a great way to communicate. So whether you're a banking institution or a media company or a church, there's power in using video. And so we've been very successful with a strategy like that. And we have a volume business and a premium business. The volume business, customers could come in and buy on a self-service basis. That's a very competitive space. It's been a good space for us, but what it -- the role it serves for us is primarily it's a feeder for that premium business. So we bring customers in, and then we're able to upgrade them over time. They might come in just because they need a micro site or a project or a campaign, but then we can get them up later on to a full Enterprise edition. So that takes a customer from maybe a couple of hundred bucks a month to $10,000-plus a year. We did 160 of those last year, of those upgrades, which is about a 25% increase year-on-year. So it's a really nice feeder for us, and that's going to continue, I think.

Adam H. Holt - Morgan Stanley, Research Division

If you look at the -- one of the other initiatives, the Zencoder initiatives, can you talk about what you've done there and how that's expanding your market opportunity?

David Mendels

Sure. We're really excited about Zencoder. Zencoder is a San Francisco-based start-up we acquired last July. Great group of people, really hot software guys here in San Francisco. We felt they were the technical leader in cloud encoding. It plays 2 roles at least for the company. One is there's a standalone opportunity in cloud encoding to disrupt the traditional hardware-software approach to encoding video. When I say encoding video, I mean basically converting it from one format to all the different formats you need for play out. The way people have done this traditionally is they buy a bunch of servers and they buy a bunch of software. And then they have a fundamental problem from day 1, which is at any given point, they're either underutilizing that server farm or they have a bottleneck, right? Because it's a peaks and valley kind of thing. People don't have a constant stream. And so it's perfect for the cloud because you can scale up and scale down, and we can offer really good economics. And what the Zencoder guys have done and now we've done together is be able to do that with the quality and performance people got in the old way. So there's a standalone opportunity. It's a couple of hundred million dollars. We're excited. The other thing is it takes our suite, we put it in our suite and it makes it more competitive. We do have competitors, and so being able to go in and say we have the highest quality, fastest performance encoding as part of our suite is a really powerful thing, too. So there's a couple of different ways to help.

Adam H. Holt - Morgan Stanley, Research Division

And just on that latter point, because that's a little bit harder for us to sort of quantify. Can you talk to where you think you're seeing win rates change or what you're -- how you would characterize the actual and practice benefit?

David Mendels

So it's a little bit early. We have won some customers because we can bring the 2 together, but we haven't got the full suite completely integrated yet. We're working on that, so that's something that's still work in progress in terms of rolling out to all our customers. But there are a bunch of used cases we've been able to leverage Zencoder to win deals that we wouldn't have won otherwise. So too soon to talk about how win rates have changed. I can point -- we do have numerous examples for us where we're seeing more wins because of it, but we're going to see that accelerate as we get it fully integrated.

Adam H. Holt - Morgan Stanley, Research Division

So -- and then actually, I'll get to the other piece which you made news on today, which is around the IPO, the App Cloud was a part of -- sort of the upside case, if you will. Maybe walk through what you announced today on the App Cloud and why you announced it.

Christopher Menard

Sure. So the idea behind the App Cloud was that there's this fundamental challenge that all of our customers are having about, how do you create these great experiences across devices in an economical scalable way? And we had the hypothesis that I think is a very good hypothesis around using a hybrid technology -- HTML, JavaScript -- to build those apps and deliver that. What we found over the last 2 years is a couple of things. One is the market from a technology direction. From a problem space direction, the whole problem of mobile delivery is still a huge problem, and it's one we're incredibly focused on. So there's no change from a strategy level. From a technical platform level, we found that hybrid approach wasn't quite the right approach. We were seeing pushback on it from customers. Facebook famously came out and said, "We don't like this approach. We're building everything native now." But then on top of that, specifically as it related to video, we found there are things we just couldn't do well in terms of, like for example, getting pre rolls and mid-roll advertising to play inside of video inside of a hybrid app. And so we started to build a native strategy as well. And we've got traction with it with a couple of great customers. We're really excited about it. So we just decided that's not a battle we need to fight. It's not a -- we're not in a technical platform battle. We're in a battle to solve problems for our customers and delivering video to all of their devices, and we're able to do that now.

Adam H. Holt - Morgan Stanley, Research Division

Do you think that if Windows Phone had substantially more market share or RIM was stabilized from a market share perspective, that there would be a greater need for that independent sort of abstraction layer or is that not the case or the wrong way of thinking about the market?

David Mendels

No. That's a valid hypothesis. I think that the more fragmentation there is, the more demand there becomes for abstraction layers. At the same time, the more platforms you try to abstract, the more technical challenges you run into. And when you're trying to do things that are really tweaky, to be honest, like get advertising to run inside a video on a mobile device, when you're bringing together multiple parties -- you've got ad, tech vendors and us -- it's going to be hard to do that. And so, at least for now we think that we're taking the right opportunity. We can still integrate our native player with other technologies. We're not saying that we have a one size fits all approach to everything, but I think we've taken the right approach for now.

Adam H. Holt - Morgan Stanley, Research Division

I guess another question is that part of the hypothesis had also been that it was cost prohibitive. In some cases, it was $300,000, $400,000, $500,000 to build a native app. Doing that a number of different times across multiple different applications, that could be very expensive. Have you seen the cost of developing those mobile applications go down to the point where it's no longer an issue, or is that just now part of the cross that people have to bear to get the kind of functionality that they need?

David Mendels

It's a little bit of both. So I think people have gotten more efficient of building their apps. But the cost of hiring people with that skill set, native co-development for iOS and native co-development for Android, is higher. There's no doubt. And so it is a cross to bear. We thought that would move faster than it did, but it is still fairly expensive to do that. We're going to help lower the cost by having this reusable video component that pre-integrates a lot of the key technologies people need around analytics and audience measurement and advertising quality and the like. And so that's going to help lower the cost for parts of the development. But you're right that ultimately, right now, the market has, I wouldn't say settled on, but still is biased towards in terms of what people are buying the native solution, which still remains more expensive. There's no doubt.

Adam H. Holt - Morgan Stanley, Research Division

If I were to go back to video for a minute. One of the -- because we we're just talking about value proposition. And one of the other sort of interesting things about video is in addition to the fact that it's a great technology and it's easy to consume a lot of content, but you also get tangible ROI in your marketing dollars. And I guess my question is, you've now been public a year, you've got more brand awareness, have you also seen the ROI cases evolve to the -- where they're easier from a selling perspective than they were 12, 18 months ago?

David Mendels

We keep building out good customer case studies. The interesting thing is video is a piece of a problem, right? So if you're a marketer, you have a campaign, let's say you're doing an e-mail newsletter. We have real ROI case studies that those kinds of things get higher open rates with video and you get higher click through. In the e-commerce space, we have some real ROI case studies where e-commerce vendors who use us and others get higher close rates, conversion rates when they have video on the product page, but they also get lower return rates. So there is some great data out there. We've got good case studies, but you got to look at a lot of different sub-verticals within that because the metrics are really different, depending on which one you're looking at.

Adam H. Holt - Morgan Stanley, Research Division

Chris, I'm going to pivot to you for a minute. So first, starting with the App Cloud announcement, based on the -- my understanding, there is no impact to the numbers, is that correct?

Christopher Menard

There's no change in guidance because of the App Cloud announcement.

Adam H. Holt - Morgan Stanley, Research Division

Okay, so the natural follow-up -- and this is obviously a public forum, so I don't what you're comfortable saying. But there was some revenue in our models. Does that imply that you're more comfortable with the core business in the trajectory there?

Christopher Menard

Yes, I think that's fair. I think the guidance we've put out encompassed what we think is going to run off from App Cloud and then the rest of it, Video Cloud and Zencoder. And on the expense side, most of those resources will be redeployed to other R&D initiatives.

Adam H. Holt - Morgan Stanley, Research Division

Okay, and did you -- just to be perfectly clear. Did you contemplate that you were going to get out of the App Cloud business when you gave the guide? Or subsequently, now that you're out of the App Cloud business, the implication is the other part of the business is stronger?

Christopher Menard

We've been talking about it for the last couple of weeks, and we only guided about a month ago. So we had an idea this was potentially coming when we gave the guidance.

Adam H. Holt - Morgan Stanley, Research Division

Got it. And then the second sort of follow-up question is can you maybe, just like you did a few weeks ago, set the table for the coming year? What you're seeing? How you view this year unfolding? What the key drivers are?

Christopher Menard

Sure. So I think we have the same amount of visibility this year that we've had the last couple of years. We haven't changed our forecast and methodology. So we come into the year, we can see 70% of the revenue, and that's a combination of backlog that's about to expire or unwind and also the renewals that we always discount back to historical levels. Coming into the first quarter, we have visibility into 90%, so really strong visibility. I think when we look at some of the other factors that we saw last year, as we've talked about a lot, last year, we saw our big jump in overage revenue, and we saw that jump up, really, in Q1 of last year and then kind of level off throughout the year. We've talked about for this year, we're expecting overages to remain steady that we've talked about in the last Q3, Q4 time period. Anywhere between $1.4 million, $1.5 million of overage per quarter. And then when you take a look at the year as we move forward, there are some things that we think we could do to help accelerate revenue a little bit more. So for example, in quarters where we get off and we beat the guidance, we get off to what I like to call a fast start or a hot start. Remember, we take revenue on a daily basis. So the more orders we can bring in, in month 1 and month 2 in a full quarter, we pick up the incremental revenue within that quarter. Because like just about any other software company, most of our deals come in the last 2 weeks. We also forecast revenue based on historical renewal rates. And so as you know, our historical revenue retention rate is somewhere between 92%, 94%. But we've seen quarters where we can beat that and do 97%. In fact, we did that twice last year. And so we can get the renewal or the retention rate back up that could generate some incremental revenue. As David pointed out, we're also planning to increase the quota-carrying sales ads by between 15% or 20% this year. And so in our models, we definitely plan on those people generating some incremental bookings and hence revenue. But if we can find some all stars, that might help to move the bar a little bit more, especially in the back half of the year. And then finally, we're really excited about Zencoder. It's been everything we wanted to do, but we're up 2 quarters in so far. And so with the new live offering coming out and the traction we're seeing in the incremental pipeline, I'm hopeful that we can get some extra revenue there somewhere in the back half.

Adam H. Holt - Morgan Stanley, Research Division

And remind us how material Zencoder is.

Christopher Menard

They did about $2 million of total revenue last year. About $1 million of that landed on our books because of the timing of the acquisition. And when we announced the deal, we said we felt we could double that this year. And we haven't updated or given anything else on that.

Adam H. Holt - Morgan Stanley, Research Division

Okay, and then going back to the point about your front-end loading the quarters, how do you that in practice?

Christopher Menard

What's that part again?

Adam H. Holt - Morgan Stanley, Research Division

To try to front-end load the quarters, you get them a little bit more -- improving the area. How do you do that?

Christopher Menard

To be honest, I don't have a lot of control. You have to kick in the sales guys and sign deals earlier, but it's not like we close nothing in the first couple of months. And so you just hope that some of your bigger transactions come in earlier or if there's a transaction that you can't get on those last couple of days of the previous quarter, that you can get it right away in the next quarter. So remember, under our model, there's no reason to give a big incremental discount on the last 2 days of a quarter just to bring a deal in. Because that's revenue you'll probably never get back. And so when I have those conversations with the sales guys, they say, "We need an extra 10% discount to bring this deal in." I say, "Why are we stuck?" And they say, "We're stuck in purchasing, but an extra 10% will get it this quarter." I say, "Will we get it next quarter?" They say yes. For that conversation, you always say, "Okay, I'll take it next quarter because I'd rather have the incremental 10% revenue than the booking in the previous quarter."

Adam H. Holt - Morgan Stanley, Research Division

And on the cost side, you also laid out a plan where there's some aggressive investments around some of the new growth areas. You touched on the sales, the hiring piece, but can you also walk through where you're investing in the first half?

Christopher Menard

Sure. I think we're continuing to invest obviously in sales and marketing as a whole, mostly right now in people. When I look at last year, we grew sales and marketing expense by about 20%, 21%, but it was really a lot more around marketing programs, telequalifiers, teleprospectors, not necessarily people who carry the quota. We're continuing to invest in R&D in absolute dollars. And what you're starting to see is it's coming down as a percentage of revenue, but it doesn't mean we're not pumping more money into R&D as we try to put out new product and new initiatives. G&A, it's still going up a little bit because it's that first full year public, but it's really just the annualization of what we've invested in last year and this year getting stocks compliant. And then on the flipside, on gross margin, we're actually trying to get the gross margins up higher. So we're trying to figure out ways to be more efficient in the cost of license and more efficient in Professional Services.

Adam H. Holt - Morgan Stanley, Research Division

Got it. All right. With that, we've got time for more 1, maybe 2 questions, from the audience if there are any. No questions in the audience. So why don't I -- I'll follow up with another sort of related question, the Zencoder. Is that the kind of deal we should expect you all to do from an acquisition perspective, smaller key technology plug-in? Or is there a scenario where you all would go out and try to acquire customers?

David Mendels

I think that we theoretically could do either. We have been more focused -- we're not doing lots of acquisitions. We're not set up with huge pile of cash to go do that. So our primary focus and interest has been on looking for those kinds of tuck-ins of key technologies that's going to let us sell more, provide a more complete solution, provide a more differentiated solution. So we really like that model, and I think there may be other opportunities to do that. Would we look at opportunities to acquire customers? Sure. But there's nothing to announce today and it's not a primary focus. That's the way we think about it.

Adam H. Holt - Morgan Stanley, Research Division

Got it. And I guess my last question unless -- are there any other questions on the floor? There are not. How do we think about long-term margins? Obviously, you're a high-growth company. You're in invest mode right now. But how do we think about the 3 to 5 year margin profile?

Christopher Menard

Sure. I think there's a couple of big milestones. In fact, Q4 we hit the first one. We generated cash flow for the first time.

David Mendels

Absolutely.

Christopher Menard

And one of the things that we said last year when we were on the roadshow was in the fourth quarter of this year, '13, that we would turn that corner and go into non-GAAP op income profitable. And we said that again on the conference call. So I think once we turn the corner, as long as we still see good revenue growth, it's not like we're going to go from break-even to 10% margins. I expect it will increase by 200 to 400 basis points a year, so kind of a slow and steady path, to eventually an operating income of 20%.

Adam H. Holt - Morgan Stanley, Research Division

Okay. Terrific. With that, we're about out of time. Thanks very much, guys.

David Mendels

Thank you.

Christopher Menard

Thank you.

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