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Executives

Monica Gould – IR

Shlomi Yanai – CEO

Brian Briggs – CFO

Analysts

Jay Srivatsa – Chardan Capital Markets

Jay Srivatsa – Chardan Capital

George Melas – MKH Management

Commtouch Software Ltd. (CTCH) Q3 2013 Earnings Call November 14, 2013 10:00 AM ET

Operator

Greetings, and welcome to the Commtouch 2013 Third Quarter 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, Ms. Monica Gould, Investor Relations for Commtouch. Thank you, Ms. Gould. You may now begin.

Monica Gould

Thank you and welcome to the Commtouch’s Third Quarter 2013 Financial Results Conference Call. I would like to remind everyone that the Safe Harbor statement issued in today’s press release also covers the contents of this conference call. With me on the call today are Mr. Shlomi Yanai, Chief Executive Officer; and Mr. Brian Briggs, Chief Financial Officer.

Before we begin, I wanted to note some of the investment conferences that Commtouch will be participating in over the next couple of months. These include the LD Micro Conference in Los Angeles on December 4; the Imperial Capital Security Conference in New York on December 12; the Needham Growth Conference in New York on January 16 and the Noble Financial Conference in South Florida on January 20. With that, I would now like to hand the call over to Mr. Shlomi Yanai.

Shlomi Yanai

Thank you, Monica. Good day everyone and thank you for joining us. Commtouch delivers a solid third quarter performance with revenue growth of 44% year-over-year to $8 million and a significant improvement in margins and non-GAAP profitability.

Total results were in line with our expectations and included a good performance in our Core Detection Services Business and further attraction [ph] of our new Cloud-based offerings that were launched earlier this year.

The third quarter was also our strongest booking quarter of the year marked by increased growth in new deal bookings and growing demand for our Detection Services including our new mail SaaS platform.

In addition to our early success in launching new products, we also continue to execute on our strategy of expanding our customer base into new segments including hosting providers and mobile application developers.

During the quarter, we added web.com to our growing base of hosting provider customers. Web.com is integrating our inbound and outbound anti-spam protection and virus outbreak detection services into its email infrastructure.

We serve millions of small business customers. We are pleased with the continued demand for new product offerings by both new and existing customers and look forward to introducing our Cloud-based web security as a service platform in the fourth quarter.

Our Web SaaS offering is a key element of our strategy to transform Commtouch from a best-in-class embedded malware detection service provider to a supplier of complete cloud-based security as a service solution.

Our Web SaaS offering was designed to be easy to use and provisions and was developed on our market leading security detection platform. This solution has been in better testing with key customers and the initial feedback has been very positive.

During the third quarter, we make excellent progress in expanding our global sales and marketing organizations to support the rollout of the new cloud-based offerings. Most notably, Joy Nemitz joined the company as our new Chief Marketing Officer. Joy brings significant software and cloud experience to Commtouch and we are thrilled to welcome her to the team.

In addition, we continued our sales build out in Asia Pacific where we expect strong demand for our new Web SaaS offerings. Specifically, we added [ph] a new Vice President of Sales in Singapore and a new Sales Director in India.

I’m also pleased to report that we have finished the main portion of the integration of the two acquisitions we completed in the fourth quarter of last year and our recent streamlining efforts have result margin improvements in the third quarter.

We will continue to expand our product portfolio to accelerate the company top-line growth and increase our addressable market. As part of those new product initiatives our research and development efforts for our best protection spread [ph] detection services remain on track to release in the coming months.

I remain very encouraged by the demand of our new – we are seeing for our new products in the marketplace and the solid performance of our Core Detection business. This, along with our upcoming product launches, give us confidence in our strategy to transform the company and position Commtouch for long term profitable growth.

With that I will hand over the call to Brian to properly elaborate on the quarterly results. Brian, please go ahead.

Brian Briggs

Thank you, Shlomi and hello everyone. I will now provide you with a summary of our third quarter 2013 results. For the more detailed results, please refer to the press release we issued earlier today.

In addition, please note that we compile 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. You can refer to today’s press release for a full reconciliation of our GAAP and non-GAAP results.

GAAP revenue for the third quarter of 2013 was $8 million, up 44% s from year ago. The Q4 2012 acquisitions of our German and Icelandic operations accounted for the majority of the year-over-year revenue increase. Non-GAAP revenues for the third quarter totaled $8.1 million compared to $8.2 million for the sequential second quarter of 2013 and $5.6 million in the third quarter of 2012.

Non-GAAP revenue includes the full book value of deferred revenue amounts from the two acquisitions completed during the fourth quarter of 2012. Our recently completed integration and streamlining efforts have yielded substantial improvements in our gross and operating margin performance.

Our GAAP gross margin for the quarter improved 33 basis points sequentially to 79% while our non-GAAP gross margin rose approximately 130 basis points from the second quarter to 82%. GAAP operating expenses for the third quarter were $6.8 million down from the $7 million in Q2 of 2013 and compared to $4.6 million in the third quarter of 2012.

Non-GAAP operating expenses for the quarter were $6.0 million, down from $6.4 million in Q2 2013 and compared to $3.9 million for the third quarter of last year. A detailed analysis showing the difference between GAAP operating expenses and non-GAAP operating expenses is included in our press release.

Third quarter GAAP net loss was $0.9 million or a loss of $0.03 per basic share compared to net income of $19,000 or earnings of zero cents per diluted share in the third quarter of 2012. Our third quarter non-GAAP net income was $0.3 million or $0.01 per diluted share compared to $0.7 million or $0.03 per diluted share in the third quarter of 2012.

The differences between GAAP and non-GAAP net income are included in our press release. The primary differences include intangible amortization, stock-based compensation, adjustments to earn-out obligations, reorganization expenses, adjustments to deferred revenue, deferred tax benefits and customer contract settlement agreements.

Now turning to the balance sheet, our net cash at the end of the quarter stood at $4.0 million compared to $5.1 million as of December 31, 2012. Net cash usage from operating activities was $1 million for the quarter compared to cash usage of $1.4 million in Q3 2012.

After the end of the quarter the company executed a new credit facility with the U.S. based financial institution for a line of credit up to $7.5 million. This facility replaces the precious line of credit that was outstanding as of September 30, 2013.

Total deferred revenues as of September 30, 2013 were $6.3 million up 26% compared to the $5.0 million at the end of the third quarter of 2012. The rise in deferred revenue is primarily driven by customer prepayments on contract renewals.

Moving now to our financial outlook, based upon the company’s current expectations, we are reaffirming our guidance for the full year of 2013. We continue to expect 2013 revenue in the range of $32.0 million to $33.0 million an increase of approximately 34% to 38% compared to the prior year. Full year 2013 GAAP net loss is expected to be less than $2 million and non-GAAP net income is expected to greater than $1.5 million.

Please also note as a Safe Harbor any outlook we presented is as of today and we do not undertake an obligation to update estimates in the future. At this point, I would like turn the call back to Shlomi for closing remarks.

Shlomi Yanai

Thank you, Brian. And with that, we’d be happy to take your questions. Operator, please proceed for the questions and answers.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen we will now be conducting the question-and-answer session. (Operator Instructions) Thank you, the first question is from Jay Srivatsa of Chardan Capital Markets, please go ahead.

Jay Srivatsa – Chardan Capital Markets

Yes, thanks for taking my question. Shlomi, in terms of the product launch that’s coming up for the Cloud-based product, given that the reception from the customers is administered in [ph] low positive, when do you expect to start to see maturing revenues from this rollout and how does it – how does it transform the business going forward?

Shlomi Yanai

Hey Jay, thank you for joining us today. Thank you for your question. So, our plans – the Web SaaS is in beta, we have a prospects and customers that are both in different regions. And the difference between the Web SaaS services that are complete Cloud services and ready to use and white labeled versus what Commtouch used to do is that the customers’ ability to adopt and roll those and generate revenues out of those is almost immediate.

Unlike in the past when we use to close deals and it was the time between closing the deal until we can recognize and roll the business.

So our expectations in Q1 and to start and see customer names, we have customers don’t beat up performing [ph] into customers and starting to see the initial revenue signs towards the end of the quarter.

Jay Srivatsa – Chardan Capital Markets

Okay and in terms of fiscal ‘14 here without getting into numbers, you need some good acquisitions which I believe are pretty much done and obviously are strengthening your bench in terms of management that’s come in. What is your view on fiscal ‘14? Where do you see yourself as a company as you look at next year, both competitively as well as those in the broad scheme of things related to revenue and earnings growth?

Shlomi Yanai

So 2014 is going to be the year when Commtouch will become a new company. It’s not a different company, but it’s a company with new services, with new offerings, with a completely different opportunity on the available market that we are addressing and also on the growth opportunity.

At the end of this year, we’ll launch the new services and next year when we go to market, we’ll still go for the section services we have and complete in the cloud not only mail SaaS but also the Web SaaS that we see a major demand in the marketplace. So the company is going to be a different company from our perspective and the ability to generate revenue and growth, execution to give [ph], provide any projections, but obviously when we built the business we were assuming that the current business is in place. It’s stable. And the new business will help us to really accelerate and transform the company on the financial side to a completely new place.

Jay Srivatsa – Chardan Capital

All right. And in terms of the mobile side, I know there were some efforts earlier on in the year. Can you give us an update on where you are related to the mobile part? And how do you hope to continue to focus on that as you focus on the website’s part of the business?

Shlomi Yanai

Yes, definitely. So the mobile part has two parts in our business, there is a detection services, when we empower a vendor, an application developers to add a mobile security. We released earlier this year a solution for android both for security and moral detection which is very, very unique in the marketplace and we are starting to gain more and more prospects and customers that are using these detection services and the OEM services we have there.

The second part, we’re investing a lot when we talk about the Web services in the cloud, Web security services. The core piece of those solution is support from mobile devices, the ability to support roaming the employees, mobile devices, bring your own devices, corporate devices, board security and no matter where those devices and where the employees around the world or in the office. And this is a core element of our development effort as we move forward. And this will be a core element of the release of those new services when we launched them at the end of the year and at the beginning of next year.

Jay Srivatsa – Chardan Capital

All right. Last question for me, Brian, in terms of OpEx given the increase in headcount, what does it do with the OpEx going forward? And how do they model out next year?

Brian Briggs

So I think it’s going to be two pieces, Jay. I think the ongoing business, I think you’ll see the operating expenses overall have come down a bit as we’ve integrated the business together. I think that kind of steady state is where you’re looking at as you go forward.

I think the other component of it which, again, we haven’t completed budgeting processes or thoughts for 2014 as, again, how aggressively we continue to invest in the go-to-market strategy and the support around the Web SaaS business. But certainly the – any investment – any incremental investment we make in 2014 into that would be tied to expectations of revenue impact as well. So I think on the base side, you’re going to see a consistent level, but again, it would really dependent on what our decisions are over the next month or two here as we finalize our 2014 budget regarding the amount of incremental investment we make.

Jay Srivatsa – Chardan Capital

Thank you.

Shlomi Yanai

Thank you, Jay.

Operator

Thank you. (Operator Instructions) Thank you. The next question comes from George Melas of MKH Management. Please go ahead.

George Melas – MKH Management

Good morning, guys. A very encouraging news about the straight [ph] running of the cost and also the upcoming launch of the Web SaaS product. Shlomi, you talked a little bit about a strong booking in the quarter. I imagined that has no Web SaaS. And can you give us a little bit more color on the bookings?

Shlomi Yanai

Yes, definitely. Thank you, George. So there are two pieces. As we’ve shown in the previous quarters, we had a ramp up in the sale structure and building our sales teams throughout the year. So in 2013, we started the year with a very minimal force out there and we went very fast and focused on building a salesforce.

The good news is it’s already done – almost done with this task and we have a very strong salesforce distributed around the globe. This immediately reflected with the results on the booking side and our focus also on telling specifically our URLs technology to specific segments on imbedded AV and also our on dollar spend [ph] things like web.com and we have additional ones that we succeeded to close.

And there is also – we see demand for the mail SaaS both in Europe and outside Europe doing all the fronts. There is no specific area that I can point versus the other in the detection services that is growing. This is around the booking side.

There is not Web SaaS, obviously the services are not out. It’s only beta n the appendix that we have for beta customers. We will be able to recognize revenue only in Q1 when it’s becoming GA and then we would be able to transform those beta customers into real customers and get recognized revenue.

George Melas – MKH Management

Okay great. And how is the salesforce organized? Does everybody sell everything or do you have some kind of specialization?

Shlomi Yanai

So our salesforce is built from a three team which is different than what we have in the past. We have teams in the Americas. We have a team in Europe. And we have a team now in APAC. We have an executive running each one of the teams. And the sales team is distributed in different countries to really support our existing customers and new business opportunities.

There is no specific specialty. All the sales team we have is focused on being able to close deals with large services providers, holsters, vendors or distributors. It’s a senior business/sales guys with a rich experience. So those guys are ready also with the Web SaaS and getting trained to push that to all the things we described.

George Melas – MKH Management

Okay great. And on the Web SaaS you have some beta customers. Are they in all three – all three geographies or are you focusing somewhere?

Shlomi Yanai

So not yet in all the geographies. We’re mainly in US and Europe now. But as we speak we are expanding that. We have a funnel of beta all over. What we are doing is because it’s beta, we are really pasting how we distribute that to make sure we are successful with the different customers based on their needs and probably wanted to become the general available GA. We will push it around the globe to our multiple customers and prospects.

George Melas – MKH Management

Okay great. Okay, thank you very much.

Shlomi Yanai

Thank you, George.

Operator

Thank you. (Operator Instructions) The next question is from Jay Srivatsa of Chardan Capital, please go ahead.

Jay Srivatsa – Chardan Capital

Yes, thanks. Shlomi, just a follow up, in terms of the appointments you’ve made in India and Singapore, help us understand what you see the opportunity there in terms of the product? And is it related to Web SaaS or is it your traditional business that you’re hoping to expand? Can you give us a little bit more detail on the appointment you’ve made there?

Shlomi Yanai

Definitely. Thank you for your question, Jay. That’s a great one. So Commtouch historically our business was spread almost equally around the globe. I would say that between Europe and the Americas, we had the majority of the business obviously. But in China specifically, in India, in Southeast Asia, we have a lot of customers and those were supported remotely.

Historically I feel that 12 months ago, most of our sales guides were distributed – were centralized in Tel Aviv or in our office in Palo Alto. We completely changed that moving the sales guys to be closer to the customers, realizing there is opportunity to upscale and grow the consumption of our detection services within our customer base and close more deals. And there’re more opportunities in those regions mainly in Asia Pacific with our detection services.

If you think about Taiwan, for example, if you think about Singapore, India there’re are a lot of large service providers, holsters and also manufacturers of network equipment, security equipment. And it is our – the key target for us is the detection services.

When you look into the future for the Web SaaS, those markets mainly in Asia Pacific, around the globe, small and mid-sized organization that’s our key target to consume, the Web SaaS that was designed to be very simple to use, told audiences are buying from distributors, channels primarily in those regions. And our goal is really to paint a trait the small, mid-size organizations in those regions, in Asia Pacific specifically to your question for distribution, channel and vendors and service providers that would be serving those – into [ph] specific region.

We definitely see a good opportunity there and where we position vendors and customers and new prospects as we’re starting to gain for demand for the services.

Jay Srivatsa – Chardan Capital

Thank you.

Shlomi Yanai

Thank you, Jay.

Operator

Thank you. We have no further questions in the queue at this time. I’ll return the floor back over to management for any closing remarks.

Shlomi Yanai

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

Operator

Thank you. Ladies and gentlemen, this concludes today’s teleconference. You may disconnect your lines at this time and thank you for your participation.

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