AVG Technologies' (AVG) CEO Gary Kovacs on Q2 2014 Results - Earnings Call Transcript

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 |  About: AVG Technologies (AVG)
by: SA Transcripts

AVG Technologies NV (NYSE:AVG)

Q2 2014 Earnings Conference Call

July 30, 2014 5:00 PM ET

Executives

Erica Abrams – IR, The Blueshirt Group

Gary Kovacs – CEO

John Little – CFO

Analysts

Melissa Gorham – Morgan Stanley

Gregg Moskowitz – Cowen & Co

Fred Grieb – Nomura Securities

Hamed Khorsand – BWS Financial

Michael Kim – Imperial Capital

Pat Walravens – JMP Investments

Operator

Good day everyone. Welcome to the AVG second quarter 2014 financial results conference. (Operator Instructions)

At this time for opening remarks, I would like to turn things over to Ms. Erica Abrams. Please go ahead, ma’am.

Erica Abrams

Thank you, Callie. Thank you all for joining us for AVG's second quarter of fiscal 2014 financial results conference call. Joining me on the call today are Gary Kovacs, CEO; and John Little, CFO of AVG.

Before we get started today, I would like to remind you that this call is being webcast and recorded. The webcast can be accessed live on the Investor Relations section of our website and via replay on our website shortly after the conclusion of the call. The website can be accessed at investors.avg.com.

On this call today we will provide you with details about our performance in Q2 of fiscal 2014. Some of our comments may include forward-looking statements such as statements regarding our outlook for fiscal 2014.

These forward-looking statements are based on certain assumptions and are subject to a number of risks and uncertainties. Actual results may vary materially. Please refer to the section entitled forward-looking statements in our earnings release and read the risk factors included in our filings with the SEC, most recently our 20-F filed on March 25th.

I would also like to point out that the results reported today include certain non-GAAP financial measures, and that the numbers discussed on this call will be non-GAAP unless stated otherwise. We provide non-GAAP financial measures because we believe that they are the most valuable way to review our core operating results. We have provided a reconciliation of non-GAAP measures to their comparable GAAP measures in our earnings release, which is available on our website and has also been filed on form 6-K.

The forward-looking statements and risks stated on this conference call are based on current expectations as of today, and AVG assumes no obligation to update or revise them, whether as a result of new developments or otherwise.

Now I'll turn the call over to Gary Kovacs for his remarks.

Gary Kovacs

Thank you, Erica. Hello, everybody, and thank all of you for joining us today as we report second quarter 2014 results. On the call today I will give you a high-level summary of our financial performance as well as some context around them and provide more details about the strategic progress we are making in each of our business areas. I will then turn the call over to John Little, our Chief Financial Officer, for a more detailed review of the financials and our outlook for the remainder of 2014.

So turning to the results, revenue for the second quarter was $88 million and earnings per share were $0.47. Within these result, we posted double digit growth in subscription revenue while we continued to see the expected decline in platform revenues that we talked about in the last two quarters.

Let me start by putting these results in context. Overall we are executing a very substantial pivot from a PC based single product company to a multiple product mobile and cloud based security solution provider. Now we started this pivot at the beginning of the year and there are two parts to the execution plan. The first of course is that we must continue to manage our current desktop and search platform business very closely. This means crisp execution while closing managing costs. To this end, we performed well in the quarter particularly given the dynamics of the desktop and search markets overall.

In the desktop market we are seeing an increasingly competitive environment, particularly relative to standalone antivirus products and given the quality of free alternatives, including our own. In our search platform business, we continue to manage access [ph] from third party search distribution and believe we have now established the new base for the remaining organic search business. I will talk more about this later.

The second part of our pivot is to leverage our existing assets to accelerate into our strategic initiatives. This is particularly important given that consumers are increasingly shifting their views to multiple platforms which is exactly why we are investing in product innovation across devices and specifically focusing on rolling out AVG Zen to a broad set of customers while building deep partnerships through open mobile ecosystem to increase our global distribution opportunities. In these areas, we made great progress this quarter.

Now let me talk about these further in the context of our business segments. First, subscription revenue increased double digits year-over-year reflecting the continued strength in consumer renewals as well as growth from Managed Workplace within our SMB segment. In our consumer business overall, the contribution slowed this quarter consistent with the overall slowing of the consumer desktop market. In light of this, however, we managed our business very well by continuing to deliver solid profitability and focusing a lot of energy on the rollout of AVG Zen as I outlined at the beginning of the call. The core strategy of AVG Zen remains to drive higher customer engagement and greater lifetime value by providing an integrated set of security products and services across devices, data and people. Put another way, AVG Zen is designed to make it much, much simpler for users to secure their worlds by discovering and deploying multiple AVG products and services across multiple platforms. The AVG Zen initiative continues to gain traction and we expanded further into our new subscriber base throughout the quarter. Our target remains to rollout AVG Zen to a 100% of our new traffic by mid September of this year and following this milestone, we plan to convert the majority of the existing users to AVG Zen by the end of the year. This plan is tracking well and we will continue to monitor and report on our progress throughout the coming quarters.

Turning to mobile, we experienced a significant increase in user numbers adding 4 million subscribers in the quarter to now reach 85 million worldwide. Mobile user growth and product innovation continued to be our primary focus. In the quarter, we added important new products to our iOS and android mobile platform including AVG Vault, which is an application that encrypts personal data on the mobile device. I’m even more excited about the partnerships we’re building throughout the mobile ecosystem and in particular we recently signed and delivered agreements with both Amazon and Yahoo. And with Amazon we delivered our first two products, our core antivirus and our alarm clock product for the new Amazon Fire Phone. This is a pretty important achievement for AVG and one that validates the significant effort we’re making to infuse more mobile D&A throughout the company and innovate along with our partners. These two partnerships are only part of a growing network of partnerships which will deliver organic growth throughout our mobile offerings during the next couple of years. Now this is significant for many reasons, first of all brand. With these partnerships, AVG has attracted broad range of distribution channels, partners and named brand OEMs, which will create its own momentum with other players in the industry and also drives brand awareness with potential customers. As I mentioned earlier, also validates our core value proposition as we now count global technology leaders like Google, Yahoo, Qualcomm, Samsung and now Amazon among our partners. Second, users. We believe that through the distribution, brand and innovation power of these companies we can drive and enhance user growth directly and indirectly. And finally revenue. While it’s early in our revolution into mobile, we are increasing our presence in opportunity dramatically and we’ll rely on these multiple distribution channels to convert this opportunity into revenue over time. In addition to the partnerships that I talked about, we also made significant progress in our objective to establish our broader distribution footprint in Latin America and specifically in Brazil, which is now the country with the fifth largest population on the planet and one of the fastest growing new Internet populations in the world. I’m pleased to announce that we acquire a small technology integrator and distributor in Brazil that would help us not only accelerate our presence on the ground in that region but deliver new products through that presence.

Turning to the SMB business, we continue to see the steady progress of the strategic investments we have been making. These include the build-out of a cloud infrastructure needed to more aggressively address the software-as-a-service opportunity in front of us. We are also making further product investments to better and enable our SMB partners including our resellers and integrators to serve our collective users. More about this will be detailed in the coming months. Annualized monthly recurring revenue from our software as a service products increased to approximately $17 million in the second quarter from approximately $15 million in the prior quarter. Now as we continue to put the building blocks in place, we believe the SMB market for our offerings remains strong and we expected to continue its double-digit growth.

Finally turning to our platform business, we are excited to announce a renewed partnership with Yahoo, which expands our relationship across mobile devices in global locations and extends the term another three-four years. Revenues from Yahoo increased approximately overall 50% of platform revenues in the second quarter. As many of you would have heard already, Yahoo recently reconfirmed their commitment to search and building on this both parties were in a position to renew the contract early and we did. We are pleased with both the terms and the long-term stability and choice this contract brings to our platform business. Now while we executed well on the platform business, there continued to be secular challenges in both the third party and organic search business that you are well aware of due to significant changes in Google guidelines, which we have discussed in the past.

However we believe Q2 to be the low in our platform revenue and expect to see improvements into the second half of 2014. In summary I am pleased with the quarter as we continue to optimize our existing business well and leverage these core assets to invest in strategic initiatives that will enable our future. While we are at the early stages of our evolution I am confident we have the right plan in front of us and that AVG is well positioned for a strong and sustainable future in this very important and growing market.

With that let me now turn the call over to John Little.

John Little

Hello everybody. In Q2 we delivered total revenue of $88 million and earnings per share of $0.47. Our subscription contributed $68.3 million, or 78% of total revenues. Our platform business contributed 19.8 million.

Free cash flow was $19.1 million, or 36% per share and cash conversion was 22%.

Turning to more detail of our second quarter performance. Subscription revenue increased 12% over the prior year to $68.2 million with the gross margin of 90%. In our subscription revenues, both consumer and SMB segments grew nicely. Consumer subscription revenue grew by 8% to $53.8 million. While we saw a solid renewal activity, we experienced slower bookings related to first purchases across the old desktop product. We have modelled this to continue through Q4 and therefore now expect total subscription revenue growth to be approximately 10% for the year. SMB revenue increased 30% to $14.4 million as a result of that continuing transition to the cloud-based model. SMB showed strong growth in annualized monthly recurring revenue, which increased 15% sequentially to $16.9 million.

In our platform business, revenue was $19.8 million, down sequentially as expected. Yahoo and Google each contributed approximately half of platform revenues demonstrating the diversification strategy that we have been focused on as well as allowing us options for our franchise for customers within our platform revenue stream. Organic search revenues were $13.5 million in Q2, which is down year-over-year as compared to $30.1 million in Q2 2013 when we had a very strong quarter. This decline reflects the full impact of Google guideline changes that have altered the landscape for everyone in the industry. Overall, we saw the number of searches decline to approximately 800 million in the second quarter of 2014 as compared to 900 million in the prior quarter.

Turning to user details, total active users were 182 million and mobile users reached 85 million. Pages account rounded down to approximately 15 million as a number of low value license in developing markets expired and we did not renew the distribution relationships in these markets.

Operating income for the second quarter was $28.6 million and operating margin 33%, once again above our target margin. We’re focused on managing operations and expenses overall to maximize investment in growth areas of SMB, multi device and particularly Zen. For example, in the second quarter, we have consolidated our Australian consumer operations reflecting changes in our more mature PC market. As we look across segments on our operating income basis, the consumer business contributes to $35.9 million or 49% margin. We continue to manage the SMB business for future software as a service growth and consequently generated $1.2 million over operating income profit at a margin of 8% in that business in the quarter. We have $8.5 million of [ph] central cost representing approximately 17% of OpEx. Operating margins in the consumer business expanded by more than 300 basis year-over-year driven by the increased focus on our more profitable subscription business and that continued exit from the third-party search distribution.

Interest and other expense in the quarter was approximately $400,000 as compared to $1.9 million a year ago. Finally, net income was $24.7 million at a margin of 28%.

Turning to the balance sheet, deferred revenue at June 30th was $196 million, down slightly from the prior quarter and up 4% compared to the prior quarter second quarter. Deferred revenue reflects softer than expected bookings in the consumer business as we discussed earlier. Cash and cash equivalents totaled $45.1 million at June 30th, have to repay then the remaining $5 million of our expending debt.

Turning to cash flow, we generated approximately $19.1 million of free cash flow in the quarter. This was negatively impacted by a $4.2 million movement in working capital, yet to date, we have generated $49.1 million of free cash flow at a margin of 27%. We repurchased an additional 424,000 shares in the quarter at a cost of $9.2 million under our anti-diluted share repurchase program. We paid $3 million in taxes to the quarter. Interest paid was $100,000 compared to the prior year of $700,000 primarily due to lower debt levels.

Turning to our outlooks for the remainder of 2014, we expect overall revenue to grow sequentially from Q2 levels with platform revenue stabilizing or increasing complemented by ongoing but relatively small increases in subscription. In addition, we are planning for increases in the contribution from the SMB business as we continue to transition to the best model. Our original guidance for the year was for the revenue of $365 million to $405 million and we’re now refining our guidance after completing the second quarter. Based on the developments we’ve seen to date, we expect revenue to be at the low end of that range. We expect that EPS to come in the middle of the original range of $1.80 to $2.10 for the year.

We look forward to talking to you all soon. And now back to Gary for some closing remarks.

Gary Kovacs

Thank you John. Let me reiterate our vision. AVG will provide the security services and solutions across devices, data and people to make it simple to discover and deploy on any platform.

We are well on our way to becoming the online security company and in this leveraging our brand and the trust that we have gained from protecting our customers over the past 20 years and now extending that protection to their much broader security needs across multiple platforms. We announced the pivot of beginning of the year and we are executing in that pivot today.

I’m encouraged by our progress in the first half of 2014 and we have more to go. The pivot we have made to date is very significant and we have executed well and I would like to thank all of our stakeholders for the contribution to the success today.

We will remain focus on both our core business and driving as hard as possible on our strategic initiatives and I look forward to reporting on our further success in the coming quarters.

Thank you again for joining us and I will now close the formal part of the call and turn it over to the operator for any questions. Operator, please go ahead.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll go first to Melissa Gorham with Morgan Stanley.

Melissa Gorham – Morgan Stanley

Hi, thanks for taking my call on my question. A question for Gary and potentially John too. I just have a question on your commentary for slower booking credits seen [ph] in the subscription business. I’m just wondering if you could maybe provide a little bit more color on what was driving that specifically what change in this quarter. I know that you mentioned increased competition and maturity of the business. On the other hand, you’re ruling out year’s end product, which I think should help on subscription as I was just wondering if you could provide more color on that.

John Little

I’ll start Melissa and then Gary will come in and comment. We saw, as we said, solid renewal activity across everything that. So what we’re looking at is slow booking related to first purchases. There’s nothing specific that we want to call out. I think it was generally across all desktop products and I would refer back as you said to the increased competition that Gary was talking to across the industry and also with free products. What that meant was that we saw a slightly reduced conversion rates on a couple of ad campaigns and so we took that and as you know we modelled what we can see. So we have reflected that in a modelling that we’ve done for the second half of the year and therefore that’s where we come out to bring news to the lower end of the guidance. I think those are probably the main point to say about what did happen. They also make the points out, but I think we have said that we were not anticipating material revenue from our Zen for this calendar year and the material revenue with significant revenue would be coming next year. So those would be my comment and now probably over to Gary for some additional color.

Gary Kovacs

Yeah, I think John you covered most of the key points. The market is in an interesting state now where antivirus as a single product is important, however alone people have it broadened by the definition of security that they expect companies to provide protection for. And that is precisely the reason why we’ve launched AVG Zen, which has a much broader solution set than pure antivirus for protection from malware and that’s taking some time for us to roll out as we have communicated in the past and that we were managing very thoughtfully. And the reason we want to manage that is just so that we roll it out and learn from their early rollouts so that we can make the medium- to long-term rollout as big as success as it can be. So that market for AVG continues to consolidate we see a lot of competition and those are really some of the factors that you are seeing in these results right now.

Melissa Gorham – Morgan Stanley

Okay, great. And then it’s just a question on the mobile users. 85 million users is definitely impressive. Just wondering if any of those users are actually contributing revenue or what the contribution for mobile from a revenue perspective is? And then as you start to get Zen kind of through the installed base, do you think if that net adds for the mobile users, it’s going to start to accelerate and then decelerate a little bit this quarter?

John Little

So I think you’ve got two elements to say that. One is that the revenue from mobile remains negligible and again that’s something that we would see in the future coming, as you say, from Zen. In terms of the overall products there’s no doubt in our mind it’s back to the existence of the multi platform and the multiple products on those platforms that Zen represents will lead to better user retention and also as Gary just referred to [ph] more on ramp and more opportunities for user acquisitions. In terms of just the overall evidence that we have for that, it simply what’s going on in our mobile products right now we see much higher retention for the users who have more than one product as you might expect and that penetration of devices continues to accelerate. When we start to reporting it, clearly it was one application per device. Right now, it’s 1.08 applications for device and it’s continued to go up sequentially every quarter. That drives lifetime and ultimately as we monetize we’ll drive lifetime value.

Gary Kovacs

Just a couple of thoughts on that. We expect the number of AVG products for user to grow on this continued path even more significantly, as of course we at Zen are able to fuel future products. So we have two paths to the rollout, number one the rollout of Zen across our new and then existing users and of course then the alignment of all of our products to the Zen interface, and so as we’ve reported earlier that that’s going to take that time for us to do that in a measured and effective way. So we’ll continue to report on those metrics. On the monetization in the user growth, I’m actually pleased with the user growth. There’s a number of things that.. the market moves up and down based on that and that is some of the marketing of different players in the market place and so overall we want to see that number continue to move up and that has. The other thing that we’re going to continue to do is do little trial experiments of monetization because there’s always a balance between when you monetize and when you go for users and we still think this market in the early stages and the revenue pools are just forming. So attracting and growing the user base is a premium today. So we want to push only when we think we can grab material revenue from the revenue pool that’s forming in. That’s the experiments we’ll do, but as John mentioned those are not a material part of anything we’re reporting now. So overall I think it was a good number.

Melissa Gorham – Morgan Stanley

Okay, great. Thank you.

Operator

We’ll hear next from Matthew [ph] with Goldman Sachs.

Unidentified Analyst

Hi, this is James [ph] for Matt. Could you talk about the platform business now that it’s kind of reset the base as you look at it throughout rest of this year? And then what happens with the platform business now with the Yahoo agreement in the out years?

Gary Kovacs

Well, the platform business that we’ve talked about over the past two quarters has undergone substantial change mostly driven by the Google guideline changes that changed the perimeters by which we can offer some of the toolbar campaigns and offers that we previously did and the others in the industry did. And those guideline changes have reduced of course the yield that we expect from our campaigns. So we made a strategic decision last year to not do some more aggressive tactics to offset that declining yield. We just didn’t think that they were in-furnished [ph] to use reason enough they’ll represent the brand well and that decision turns out to be quite precious and valuable. But we also communicated that we’re going to soft-line the contracts meaning honor the ones we had, not go for any new ones and that it would take about a half a year for us to really see where the bottom of that business because of those changes is. So that’s where we now see, we’re at that bottom. To the rest of your question, which is what’s the organic growth? With the Yahoo deal, we now have another search provider that we can send traffic to and ultimately they have been there and we’ll continue to be a great partner. The terms of that deal, of course we can’t disclose, but the length is good in the terms we really think we got to a fair place with Yahoo. So we’ll start to see that revenue sequentially grow. It’s too early to predict exactly the specifics of what, but we’ll start to see that sequentially grow and we also have the opportunity to move traffic to other providers to optimise both the revenue and the experience for a user. So I think we can see a good building place from here and that’s the outlook for the rest of the year and out years.

Unidentified Analyst

Okay, thank you. As you think of your free cash flow generation, do you see opportunities to potentially have introduced greater leverage into the business or increase the buybacks?

Gary Kovacs

Certainly that we’ve said in the past that there is identified organic, so inorganic growth opportunities as we talked on previous calls. And given the use of free cash flow, we think an opportunity to use to fund such inorganic opportunities through leverage would be very sensible. We do not, however, foresee utilizing any debts so raised in order to accelerate buybacks. We have used that. We regard that as an anti-diluted program, it’s ongoing at the moment, and so I think you can expect that to continue at the pace which is being set out and I think we’ve made public the various arrangements that we have on that.

Unidentified Analyst

Okay, thank you.

Operator

We’ll now go to Gregg Moskowitz with Cowen & Co.

Gregg Moskowitz – Cowen & Co

Okay, thank you very much and good afternoon. Gary, you mentioned that this quarter first time purchases where we set across are all desktop products and you touched on antivirus. Where there any changes in the PC optimisation market as it relates to TuneUp.

Gary Kovacs

Yes. Generally, on that platform, PCs kind of were a little bit of a mixed bag this year as an industry. So some PC segments grew in the enterprise and some in the consumer continues to trail off in terms of the rates of growth. So for our customers in our market that we saw antivirus, there is a continued move to free. The fact that we’re continuing to see robust set of pay that is a sentiment to the value of the product, but the free [ph] and the competition is pretty intense out there. We see similar sets of dynamics, if you will, in the optimisation space but there is more opportunity and in the enterprise business of course we don’t participate and that’s not a core focus for us but the reasons that we’d talked about in the past, but we think that there was some new marketing techniques and tactics that we can use to further the optimisation business and we’re going to be trying a lot of those in the coming quarters. One positive to note on that, Gregg, I mean we did talk about that. You’re exactly right that it is dealt with the focus on the solid renewal activities. You know we have switched the TuneUp product onto the auto renewal and as we’ve talked about it pretty decently we’ve seen a pretty significant increase in the renewal rates since we did that and that is now starting to become a more material part of that overall renewal revenue. So that’s a pretty positive move to go along of course with the core AV product also being on auto renewal.

Gregg Moskowitz – Cowen & Co

Okay, great. And then, John, in terms of paid users the decline in this quarter you talked about that number of low value licenses in emerging markets had expired and were not renewed. Has that effect really been more or less kind of turnout or are we sort of dealing with a clean number at 15 million or are there some other distribution relationships or geographic areas that you might look to to reduce as well going forward? Thank you.

John Little

No. We think that’s the clean number and we’re not looking at anything specifics to reduce from that, Gregg.

Gregg Moskowitz – Cowen & Co

That’s great. Thanks very much.

Operator

We’ll now go to Fred Grieb with Nomura.

Fred Grieb – Nomura Securities

Hi, guys. First just kind of going back to subscription business again, is it possible for the subscription business going forward to grow kind of outside of the SMB business or are we going to be relying on the SMB business to grow the subscription of renews and potentially facing declining growth in the consumer fees?

Gary Kovacs

No, we expect that to grow in both businesses. In fact, that’s a core anchor to present strategy. The share represent which we’ve seen play out in parts of the industry is linking some of these answers together. In core AV people, we expect to be pushed to free, but it’s only one of the features, if you will, of a much broader securities that our users are now asking for. And as you extend many more products delivered in a consistent way and across multiple devices, we know this industry introduced a new aggravation point of kind of charge people too many little times and that introduces the opportunity to charge on subscription for something like AVGs and it just handles it all across all your platforms and that is entirely the design point of that product, which all other products are tucked in to. So we expect to see that become a core part of our strategy of Zen. On the SMB business, that subscription revenue continues to grow as reported. We’re making some product investment saves in the use and looking field of our current product as well as the tools that we provide to our resellers and integrators to be able to drive that subscription revenue even further. So those are the two points that we’re going after.

Fred Grieb – Nomura Securities

Got you. I guess I want to make sure I understand the dynamics on the consumer fees. You’re expecting growth both in number of paid users as well as in cabin [ph] ASP for that business?

Gary Kovacs

Yeah, ASP or average rate.. the revenue per user. Yes, we would expect growth. As we said we are not forecasting any material contribution from that this year, but that certainly is where the product is designed to go after.

Fred Grieb – Nomura Securities

Got you. And then when you saw active users declined quarter-over-quarter in this quarter, is that something that we may see in Q3 and Q4 as well or do we think that this is kind of a new base there?

Gary Kovacs

I think there are two factors that are driving the downturn in that. We continue to see the exit from the first half of the distribution business and that is bringing use as down. We still allow our continued intake [ph] fees that effectively we still got $5 million coming from that business and so that’s still a pretty significant number of uses, which need to continue to run out. And then we continue on the activity that we have been doing as we transitioned to the Zen platform of just aggressively looking for revenue from usage about old versions and old products where there is no Zen capability on the machines that we’re looking at. So those two factors I think would expect to drive that to continue to be flat or slightly declining, but I think that overall again we would expect the mobile user number to be the area of growth there. And generally in terms of the pages as we’re looking at towards the end of this year, we’re just again with rounding differences that I think probably will be around about that $15 million paid user account until the end of the year. One thing to just flag up to everybody thought that as Zen comes in we’re going to start thinking about additional counting ways to look at this because that’s going to provide devices per Zen customer and devices per Zen account. And so I think as that becomes more firm or solid, then we will start to report some other additional matrix on those and I want to try and make sure those are as helpful as possible for guiding the business forward. So that’s something you can expect to make [ph] from us probably not next quarter but let’s say maybe Q4 earnings call, we’ll talk about that.

Fred Grieb – Nomura Securities

Okay, great. Thanks a lot.

Operator

And next is from BWS Financial. We’ll go to Hamed Khorsand.

Hamed Khorsand – BWS Financial

Hi, guys. Just a first question here is can you decide for if any of the user who asked this quarter is really if it’s generally people just don’t like the Zen product and they want to try something else that’s free?

Gary Kovacs

No impact of that we’re seeing. The losses are being entirely unrelated to that, Hamed. So no correlation at all.

Hamed Khorsand – BWS Financial

Okay, And then do you think that some of the impact could be from..I’ve always seen it’s from some of the larger industry but really just from the refreshed cycle that occurred in the PC industry in this past quarter? It sounds like you guys are more countered to it. The older PC is the more like what people use your products. So does that have an impact in refreshing the PC?

Gary Kovacs

As we look into that and we have a number of thoughts about that, but I think if you look at the world, well people talking about the refreshed cycle, the focus of the refreshed cycle has been on the enterprise and SMB markets. So both of those are not really how a free market.. enterprise we don’t play in the tool. So as we look at those, we don’t see that particular cycle as impacting it significantly at the moment and specifically we’ll refer you to some other comments that people have made that say that the consumer PC business for them remains challenging, which is you correctly say those represent an opportunity for us as a replacement product than for the older machines.

Hamed Khorsand – BWS Financial

Okay. I remember asking this question last call about what was going on to your assumptions at the high point of your last revenue guidance and now I imposed the question as to what could be happened that you guys actually missed numbers? What’s the assumptions you guys are taking into consideration that you’re confident and then you’ll hit the low end of that range now?

Gary Kovacs

Yeah. The assumptions that we made going into the last which we stated in the context or the reason why we provided it a broad range was we needed to weigh three changes that we didn’t. Frankly, we hadn’t seen enough of a pattern to be able to comfortably predict. The first is house search and the changes in the search market are going to play out. Understand I think and everybody does, there are significant changes in the search market. We got well ahead of those changes and we took the strategic direction that we announced last year to exit the third party business mostly. I’m just going to reiterate from here because the yield were dropping and companies that were competing in this space were starting to do very deceptive things to drive increased traffic and our view was this is not a sustainable business, we do not want to play in that, we want to stay court to the part of search which is the reason we got into business which is associated to our product which is the organic search. So the third party search we just decided to exit. There was a fairly substantial top line hit and we had a series of contracts that we had to understand how they would trail off and how we could land. Along with that, of course when Google makes guideline changes as they did when they changed from an opt out which means a person has to consciously uncheck a box, to an opt in which means they have to consciously check a box, the yield associated with that drops. We had some models and a number of different models to predict exactly what that drop was, but frankly until you see actually what happens the models are just that model.

So the good news is in parts of our models we’re fairly close to in a number of scenarios where we’re now guiding, but we needed to see that in action. The other piece along with the guideline changes they have been continuing the browsing [ph] continuing to make technical changes as to how toolbars are introduced in the browsers. [Thus so what’ [ph], the meaning of that means that how you distributed toolbar may not be true on your web property and every time there’s another stop for user to make it introduces another potential off wrap [ph]. We want to understand those changes. So that kind of is the search business. On the desktop business, what we saw and what we reported on and are confirming here is the PC markets evolving. Certainly not going away, it’s still a very important part of the user landscape, but the reliance on the PC market as a sole platform is obviously dwindling. The funny part of that is in mobile, the revenue pull. How people pay other than advertising hasn’t really formed yet, but there are some experiments that are starting to show some interesting promise and the third piece of course is the role of AVG Zen and we wanted to see the early results, we wanted to see the uptake, we wanted to see exactly what our users were doing if they were interested in another platforms and as I reported last quarter reiterating here, we’re pleased with the early results but it’s certainly. So you modelled all those. We wanted to set arrange and we wanted to then refine that range midyear, which we have done and we feel comfortable now that we understand the elements of the model and barring anything else that’s unforeseen or significant. Of course, we’re very comfortable with that guidance.

John Little

So two things that add to that question, just mathematically demonstrable from this, the subscription business is driven by the deferred revenue. As you go through the year, the proportion of that deferred revenue that you’ve got visibility of increases and so that gives us a lot of confidence and increasing confidence with everything quarter of what the subscription revenue is going to do for the year. You then also got the points that Gary made around the amount of the search that we had targeted for the year and those points are playing out in the models as Gary said. So both of those things add to the certainty that we have for the remaining part of the year that we will come in as we estimate right now at the low end of the rate.

Hamed Khorsand – BWS Financial

Okay, thanks very much. Thank you.

Gary Kovacs

Thank you.

Operator

We’ll hear now from Michael Kim with Imperial Capital.

Michael Kim – Imperial Capital

Hi, guys. Could you explain a little bit on what’s driving the SMB growth and update on the build-up of sales and channel team, how much of the growth is driven by North America versus some of the build-out in the near [ph] region?

Gary Kovacs

The primary factor is that it’s a market growing with a strong need. These people in small and medium business worlds rely on their technology around the business and they have been exposed and so we are serving a very vital need and strong driver of success continues to be the development of our channel, which is expectedly the route to market, the integrators and SMB resellers. So in North America we have had a number of good advancements in developing that channel and that’s what increasing the growth. I’d say it’s Europe remains a largely untapped market for us and one that we are focused to execute against and are beginning those now. So it’s not affected into our model but it’s not important and we see certainly growth from that in the out periods, I guess. And so these are the two things. Of course along with that, we continue to evolve the product, we continue to evolve the looking field and the usability of the product. Those are very concrete things but they are not as easy to measure the direct impact that are needed. So those are the two sets of investments we’re making.

John Little

In terms of the teams, we continue to build up the Europe team, but we’ve also taken an initiative to accelerate the highs within the U.S.-North America environment because we have seen that as a continuing opportunity for us to take market shares. So that’s another initiative that we put in place and we will be focused on in the second half.

Michael Kim – Imperial Capital

Can you provide a metric on the number of integrators and reseller partners you have or what the growth look like in the quarter?

Gary Kovacs

We haven’t broken that out. The number that we’re focused on is the annualized months of recurring revenue. We may annually, I think we talked about the number of resellers and providers that we have during this, but I think the overall number to focus on is the annualized monthly recurring revenue where again we saw 15% sequential growth.

Michael Kim – Imperial Capital

Okay, great. Thank you very much.

Gary Kovacs

Welcome.

Operator

(Operator Instructions) We’ll move on to Pat Walravens with JMP Investments.

Pat Walravens – JMP Investments

Great, thank you. John, let’s start through the free cash flow conversion, that dropped from 39% to 27% in the first half versus last year. Should we expect that lower free cash flow conversion rate to continue?

John Little

I think that we said at the beginning of the year that we would expect the free cash flow conversion to be more in line with the operating income conversion. So I think you should be looking for around about that sort of 30% level is the target that we’re looking at. And obviously as you rightly say last year extremely strong for the reasons that we talked about previously and the..

Pat Walravens – JMP Investments

Okay, that would still suggest a pretty meaningful improvement in the back half because you did 22 this quarter.

John Little

Yeah, we did 22 and we said that was impacted by working capital.

Pat Walravens – JMP Investments

Okay.

John Little

Yeah, exactly right. Clearly, we haven’t guided to overall free cash flow across on a quarterly basis ever because of that movement there and I think we did say that as we see initiatives coming in and we will reserve the right to invest in those to accelerate future growth but again, if we are seeing those we will be calling the map and to explain them where that money is being spent.

Pat Walravens – JMP Investments

And then, big picture here, to the extent possible it would be nice to avoid a negative revision on revenue for next year, so where should investors sort of set their expectations for growth for next year? Maybe what's a nice conservative way to think about it?

John Little

We will start to give guidance for 2015 as we get later in the year.

Pat Walravens – JMP Investments

Are you comfortable saying whether you think you will grow or not?

John Little

I think that I will repeat my commence that we will start go give guidance later in the year for 2015.

Pat Walravens – JMP Investments

And then what is going on with your relationship with and your ability to provide services for Apple devices as opposed to Android, because the Android stuff is great and the Apple stuff is pretty limited.

Gary Kovacs

So our relationship with Apple is the same, unfortunately as everybody else which is we are bound by the Apple licensing terms and conditions which are much more restrictive and probably more impactfully by their technology restrictions which are much more restrictive than Android and this is true on both the Mac, desktop platform as well as on the iOS based devices. So what that means is we just don’t have access to all the functions to be able to provide as richer solution set as we would like. This is the good news, it’s just reality that everybody is impacted and affected by this. So what our strategy will continue to remain is we can buy as richer set of services as we can, Apple iOS devices – Apple and their iOS devices continue to be important for us to acquire users and are critical as we expand Zen to all of our user – all parts of our user’s lives because many have either Macs or iOS devices and we have to include them, so in that context there is – there is an expectation of the same richness and I think people have a pretty set of expectations but it has to include the Apple devices. So that’s where we are and where we are going to go and we think that’s us, but I sure wish Apple would open up more other technology platform.

Pat Walravens – JMP Investments

When will we see the Apple support for Zen? I notice I got it to work with my Mac but then it doesn't actually show up. It made an effort.

John Little

But I would like to dive a little deeper with that at another time but it’s – so we have Zen enabled, our cleaner product, we have AVG Zen for the desktop coming out in the next version in September and the same for iOS devices. So the function and breathe will also increase. And we will continue to push on it but those are the times when you can expect the next revisions.

Operator

Thank you everyone. A replay of today’s call will be available starting today July 30 at 7PM Central Standard Time and available through August 6 at 7PM Central Standard Time. You may access the replay information by dialing 888-203-1112 or 719-457-0820 and entering access code 2290282. That does conclude today’s conference, again thank you all for joining us today.

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