Perion Network Ltd (PERI) 2011 Q2 法說會逐字稿

Ladies and gentlemen thank you for standing by. Welcome to the IncrediMail Second Quarter 2011 Results Conference Call.

All participants are at present in listen-only mode. Following Management's formal presentation, instructions will be given for the question and answer session. (Operator Instructions). As a reminder, this conference is being recorded August 15, 2011.

With us today from IncrediMail we have Josef Mandelbaum, CEO, and Yacov Kaufman, CFO. I will now hand the call over to Rob Fink of KCSA for the Safe Harbor information.

Thank you Rachael. And thank you all for joining us today for the IncrediMail Second Quarter 2011 Results Call. In addition to the audio portion of the call, you are invited to follow an accompanying slide presentation that can be found by visiting the investor relations section of IncrediMail's website at IncrediMail-Corp.com.

Before I turn the call over to the Company's CEO Mr. Josef Mandelbaum, I would like to read the following Safe Harbor statement. This conference call contains statements that can constitute forward-looking statements. These statements reflect the Company's current views with respect to future events.

These forward-looking statements involve known and unknown risks, uncertainties and other factors including those discussed under the heading Risk Factor and elsewhere in the Company's Annual Report on Form 20-F that may cause actual results, performance or achievements to be materially different from any future results, performance or achievements anticipated or implied by these forward-looking statements. The Company does not undertake to revise any forward-looking statements to reflect future events or circumstances.

With that, I will turn the call over to Josef. Josef, the call is yours.

Thank you Rob. Welcome everybody. Before I start discussing the strong results of the second quarter, I would like to focus on our recent acquisition of Smilebox which was announced on August 1. As a reminder, I will begin by reviewing our growth strategy, and in that context explain why we think Smilebox is such an exciting opportunity for our Company.

Since joining IncrediMail as CEO last August, I have discussed a vision to shift the Company's focus towards growth by building a portfolio of simple, safe, useful digital consumer products to help make our consumer's life, everyday life, easier and more enjoyable.

As many of you know, we began this effort by conducting an extensive consumer research study which served as a basis for developing our overall strategy and roadmap for both IncrediMail the product and IncrediMail the Company. Over the last year we have executed on our plans to focus the Company and our consumer, better understand their needs and create the infrastructure necessary to implement our strategy and properly prepare for accelerated growth. We have also begun investing in customer acquisition efforts, and with the acquisition of Smilebox we have executed on the fourth leg of our growth plan -- extending our product portfolio.

Smilebox addresses four key objectives of our strategy. Number one, it fits into a product category that was identified in our consumer research as an area of opportunity frequently used by our target demographics. Number two, Smilebox is a high-quality consumer product that diversifies our portfolio of products.

Number three, Smilebox diversifies our revenue mix with over 90% of its sales being subscription-based. And lastly, number four, as a young and growing Company we believe a two times revenue multiple is a good value and a good use of our cash. With that in mind, let me elaborate in more detail on each of these points to give you a better feel for what we bought and why we're confident that this will be a good acquisition for the Company and our shareholders.

Smilebox shares a similar demographic to IncrediMail as -- and the product fits into a category that was specifically identified in our consumer research as frequently used by our target demographic of second-wave adopters on a weekly and monthly basis. In fact, 70% of our consumers responded that they share photos, but they find it difficult to do so especially when it comes to creating something unique, creative and special.

Based on the research we conducted in five different countries, our target demographic represents an addressable market of 228 million potential users. While there are many photo sharing sites and big players in this space, no one is purely focused on serving the needs of our demographic and that is where we see an opportunity.

Product diversity is also another key accomplishment of this acquisition. One of the first things identified upon joined the Company was an opportunity to diversify our portfolio with high-quality products that interest and engage consumers. If real value is provided to consumers, the product and subsequent business model have real staying power.

Smilebox is a high-quality product that has garnered many awards and a very loyal fan base. It has a Mac and PC downloadable version and it is scheduled to release a mobile version in the next few months. Smilebox has over 250,000 followers in their Facebook community, over 15 million installs to date and 300,000 new installations every month.

In addition, a differentiator in this acquisition versus others is the geographic makeup of Smilebox's customer base. Roughly 80% of Smilebox users are based in the US, and American users are the highest revenue per search value which provides us with a great opportunity to leverage our monetization expertise and implement a search model to accelerate future growth.

Additionally, because the IncrediMail customer base is currently only 20% to 25% US-based, it provides the opportunity to leverage the IncrediMail international footprint to broaden Smilebox's reach. The expected change to product mix is dramatic.

In the first half of 2011, 93% of our sales, product and search were connected to our e-mail client and less than 7% to other products. In 2012, we expect only 70% of our sales will come from our e-mail clients while 30% of our sales are expected to come from other products. This newly diversified model puts the Company on much more solid footing and enhances the possibility for growth going forward.

In addition to Product diversity, the acquisition also diversifies our revenue mix. On my first earnings call one year ago, I said that while IncrediMail might have problems to address -- like all companies -- Google wasn't one of them. I'm happy to say I was right about the prediction and our Google partnership has never been stronger.

At the same time our dependency on search revenue, which currently accounts for our most 80% of our revenue, was somewhat troubling. And I announced I wanted to grow premium revenue to create a better balance for the Company. Smilebox generates over 90% of its revenue from subscriptions, which in addition to being high-quality and -- are more predictable due to their deferred nature.

For our first acquisition we felt it was important to focus on a Company that could provide a better balance in our revenue mix and Smilebox certainly accomplishes. So that whereas in the first half of 2011 prior to the acquisition, almost 80% of IncrediMail revenues came from search, looking forward to 2012 we expect that less than 60% of our consolidated sales will come from search with a full 34% coming from product sales.

Now allow me to give you some details the economics of the transaction. First, we said all along that we would be disciplined and look to make an acquisition at or below current trading multiples, and we accomplished this by paying roughly 2 times revenue multiple for Smilebox. Our revenue before -- our revenue multiple before the market correction, an announcement of this transaction was 2.2 times revenue. Recent Internet transactions were sold at three to four times revenue, so we feel pretty good about the price we paid for a fast-growing business in a fast-growing category.

Smilebox had been growing the topline by more than 35% each year for the past few years. And it is expected to do the same in 2011, driven by the strong user base and subscriber growth. In 2012, the first full year after the acquisition, we expect Smilebox to continue its revenue growth and generate $15 million in cash sales.

Our ability to leverage our search monetization expertise to Smilebox's premium model is expected to accelerate revenue growth and profitability by capitalizing on the premium US-focused installed base. In addition, the [Internet] was structured in such a manner that the revenue multiple will essentially be a constant at each stage of the payment schedule, assuming that Smilebox hits their milestones and performance criteria.

The basic components of the earnout include EBITDA threshold, revenue targets and benchmarks for the number of installs. Smilebox's EBITDA performance and profitability are important to us, which is why it is one of the earnout components. We expect EBITDA margins to be in the 25% range as the business matures and synergies are fully realized.

Furthermore, while we stated in the acquisition press release that we expect Smilebox to be EBITDA accretive by the second half of 2012, from a non-US GAAP standpoint we actually expect Smilebox to be EBITDA accretive well before then.

The accounting for this acquisition is such that while cash sales have been and are expected to continue to increase, US GAAP accounting takes a significant bite out of deferred revenue in the first 12 months post-acquisition. In non-accounting lingo, due to the fact that we cannot recognize the deferred revenue already created, and the fact that we must defer all new subscriptions going forward, our GAAP revenues and EBITDA will be lower than normal for the next year as the loss of high-margin deferred revenue significantly impacts the bottom line.

This is purely an accounting issue and does not at all reflect the health or profitability of the business. We will disclose these differences every quarter and we should see this issue dissipate over the 12 months after the acquisition, and in the end, disappear as existing deferred revenue is replaced by new deferred revenue. Therefore, from a business standpoint and on non-GAAP numbers, we expect the acquisition to be accretive well before the second half of 2012.

We also indicated in the acquisition press release the gross amount of the first payment is $25 million. However, the cash impact is expected to be closer to $23 million. In addition to this upfront payment, two payments totaling as much as another $15 million could be paid based on future performance and milestones.

Frankly, if Smilebox achieve the goals we defined and we pay the full $15 million in additional payments, we will be very happy as its contribution to the Company will be obvious to all and will more than justify the additional payments.

We're very excited about this acquisition and pleased with the opportunity presents. I would like to thank our acquisition and post-merger integration team for doing such a good job to date. And I have full confidence in the team we assembled over the past year, and believe that the integration and post-merger execution will go well.

I would also like to thank Andrew Wright, the CEO of Smilebox, for all of his efforts and welcome Andrew and the whole of Smilebox team to the IncrediMail family.

With that, would like now to move on to review the financial highlights of our second quarter.

We are very happy with the continued revenue growth on a year-over-year basis reaching $8.1 million in the second quarter, growing from $7.2 million in the second quarter of 2010 and generating net income of over $2.2 million, or more than 27% of net profit margin.

Some of the highlights of the second quarter included the official launch of PhotoJoy, the integration of Facebook into our IncrediMail product, the addition of Rajiv Jain as our CTIO, further improvements to the infrastructure to help scale the business, and the implementation of the previously announced Google terms and condition changes. Now that all of the changes of been completed, we're happy to report that our new deal with Google performed and continues to perform better than last year.

Our main operational objective for the remainder of the year is the successful integration of Smilebox. We need to ensure that the business continues to grow by not getting in the way of its execution, while at the same time looking for synergies between the companies to accelerate growth and profitability.

It has been my experience for the biggest challenge in acquisitions is the execution in the actual merger of two companies, [coachers] and teams. We have assembled a strong and experienced team which I am confident will ensure a smooth transition and integration. We intend to move one of our senior executives to Seattle to join Andrew as his Chief Operating Officer to help the Smilebox team and to ensure successful meshing of our companies.

I would now like to turn the call over to Yacov for more details on the financial results of this quarter.

Thank you Josef. As Josef has already mentioned, this has been a very busy quarter. Revenues this quarter were $8.1 million, bringing revenues to a total of $16.7 million for the first half of 2011, reflecting 18% growth year over year.

Gross profits also continued to grow, from $6.8 million in the second quarter of 2010 to $7.6 million this past quarter, maintaining a gross profit margin of 94% and validating our growth-focused strategy.

Research and development expenses for the second quarter were $1.5 million, similar to those in the second quarter of last year, and were 18% as a percentage of sales compared to 21% in the second quarter last year. Sales and marketing expenses for the second quarter of 2011 were $2.6 million compared to $1.2 million in 2010, with virtually the entire increase coming from customer acquisition costs on which I will elaborate on shortly.

General and administrative expenses were $1.9 million in the second quarter of 2011 compared to $0.8 million in the second quarter of 2010. This increase for the most part stems from the broader and more experienced management team created over the past year including the addition of Josef as our CEO, a corporate development department, in-house General Counsel and a seasoned CTIO. These costs are largely being offset Company-wide by other reductions in expenses, including the outsourcing of our QA to India and an overall reduction in headcount.

In addition, there are increased costs in G&A due to the approval for the first time of a formal compensation plan for the Company that has increased the stock option expense and bonus accrual for the Company, accounting for $0.2 million per quarter. This increase also includes $0.2 million of acquisition related costs. We expect the lion's share of acquisition expenses to be in the next quarter.

As I mentioned earlier, the increase in sales and marketing expenses was attributable to the ramping up of our customer acquisition costs. These investments totaled $1.7 million in the second quarter, increasing $1.3 million compared to the second quarter of 2010.

While we continue to fine-tune our media buying program, as we expected, our overall initial effort has been mixed. Some of the campaigns are clearly ROI positive while others are not. And some require more time to evaluate their return.

To optimize our efforts in the third quarter we will continue to refine and adjust our spending accordingly. Our goal remains the same -- to increase revenues and customer engagement through customer acquisition marketing. And I am confident that as we continue to learn, we will get even better at maximizing our ROI.

We expect these expenses to increase in the third quarter, and to the extent that this effort is successful, increase even more so in the fourth quarter this year. If we maximize our ROI, a large amount of the return on these investments will come in 2012 as we have previously indicated.

This quarter we benefited from both a nonrecurring tax credit as well as an ongoing lower effective tax rate, resulting in a net tax credit of $0.1 million. We expect our effective tax rate to level out at approximately 18% of pretax income.

Net income in the second quarter of 2011 after all the investments mentioned above was a robust $2.2 million, or $0.22 per diluted share compared to $2.3 million or $0.23 per diluted share in 2010. Comparing the first six months of 2011 to the same period last year, revenues increased 18%, reaching $16.7 million in the first six months of 2011 compared to $14.2 million in the same period last year.

We continue to enjoy a high 95% gross profit margin, with gross profits of $15.9 million in the first half of 2011 increasing from $13.4 million in the first half of 2010. R&D expense remains relatively stable, decreasing as a percentage of sales to 20% in the first half of 2011 compared to 22% in the 2010 period.

As customer acquisition costs continued to ramp up and totaled $2.3 million in the first half of 2011, up $1.4 million compared to the same period in 2010, sales and marketing expenses increased as well and were $4.1 million in the first half of 2011 compared to $2.6 million in the 2010 period.

The investment in management expertise, systems and procedures mentioned earlier carried through since the end of 2010 as well as the transaction-related costs in the latter part of the second quarter is reflected in the increased level of G&A, reaching $3.5 million in the first half of 2011 compared to $1.7 million in the same period last year. As we have witnessed in the last few quarters, except for transaction-related costs expected in the coming quarter, we believe G&A has pretty much leveled out at the current rate.

Net income in the first half of 2011 was $5.5 million or [$0.54] per diluted share, compared to $4.4 million and $0.45 per diluted share in the first half of 2010.

In the first half of 2011, cash generated from operations totaled $4.1 million. And as of June 30, 2011 we had cash, cash equivalents and investments of approximately $31 million, which is more than sufficient for us to close on our recent Smilebox acquisition.

Our receivables are exceptionally high. And we're expecting a considerable amount of them to turn into cash in the latter part of this year. As a result, we expect cash from operations in the second half of 2011 to reach approximately $6 million.

In addition to the sizable cash flow being generated from operations, we're close to finalizing debt financing that will provide us additional liquidity and flexibility so that we can remain opportunistic on all fronts. We will keep you posted as we finalize the terms and conditions of that debt.

As to in the coming quarters, we expect to consolidate Smilebox into our numbers immediately after closing, which is currently expected to be no later than the end of the third quarter. As Josef mentioned earlier, currently almost all of Smilebox's revenues are from premium product subscriptions. As such, ongoing sales are deferred over the period of the subscription.

However, at the point of acquisition, all deferred revenues are recognized prior to the acquisition, deleting on a GAAP basis the existing [tail] of deferred revenues for the coming 12 months. Our consolidated revenues and resulting profits will be lowered due to the GAAP treatment of deferred revenue accounting during this transition period. I'll expand on that when reviewing the actual numbers next quarter.

After closing, once the accounting treatment of the acquisition is finalized we will update guidance for 2011. In the meantime, to provide you with some context for the remainder of the year, the fourth quarter is Smilebox's strongest. And their growth this year, as Josef mentioned, is tracking to previous years at 35% plus on a year-over-year basis.

Our existing business is performing at a run rate in line with our previously stated guidance. And we expect the third quarter to be similar to that of the second in terms of results. Furthermore, the third quarter will be a pivotal one in terms of evaluating the return we expect to get from our increased customer acquisition efforts.

With that said, I would now like to turn the call back over to Josef for closing remarks before opening the call to questions.

Thank you Yacov. This week marks my one year anniversary at IncrediMail. Looking back on the year, I'm proud of the progress we've made in taking the Company to the next level.

We have significantly enhanced our personnel by attracting high-level talent to key management positions. Conducting consumer research is the backbone of our new strategy. Reduced costs through outsourcing and a reduction overall headcount, developed new administrative processes to ensure the business can scale, and invested in enhancing our infrastructure and building out new systems to enable us to track and measure our marketing efforts.

In addition, we signed a new two-year deal with Google, improved the quality and relevance of our flagship product IncrediMail, launched a new product with PhotoJoy and established a Labs Group to increase our product pipeline over time. Finally, we completed our first acquisition with Smilebox. Clearly a lot has happened over the course of the year and I can confidently say, a year later, we're a stronger Company.

Since this is a journey, there is always more to do. But I feel confident we're on the right path and we have the right team to execute and build on our momentum. Thank you very much for your time. We will now open up the line for questions. Operator?

(Operator Instructions) Nick Halen, Sidoti & Co.

First question I had, I was just wondering if you could give us a little bit more details on what exactly Smilebox's products are. And are they kind of standalone products you guys are going to incorporate, or is it something that can be used in conjunction with your existing e-mail product?

It's a stand-alone product. We may market it ultimately to our members and to our existing client base, but it is a stand-alone product.

Essentially what it does is it allows you to take your photos, wherever they may be, and basically create a unique creation out of it that you can then -- which helps you connect with family and friends in a really simple easy-to-use fashion. As they like to say, it puts a smile on everybody's heart. So basically it's like a slide show with really creative content, with music in the background that you can share on Facebook, you can share via e-mail, you can share via Smilebox.

And essentially they have a significant amount of people using it today. As we mentioned, over 15 million installs to date, and it really fits in the photo sharing/photo personal expression bucket.

Okay. Now, like you said, that seems to have a very strong presence in the US. I believe you said about 80% of revenues within the US. I was just wondering what -- outside of the US, where do they currently have some operations? And I guess where do you expect to be able to market this and grow out these products internationally?

Great question. In the research, here's the good news. I mentioned it before. There's like 228 million people who use photos in some fashion online every week or every month.

I think today they have UK, Germany and France if I'm not mistaken. They just started some of that, so it is really fledgling at this point in time. One of the things we think we can bring to the table is our expertise.

I would expect going to countries that have strong Internet presence. Obviously a presence of a large portion of our audience is online. So, again, Western Europe is a good example where the demographics are such that it is an aging population which fits into us very nicely. And a lot of people are getting online now faster because broadband penetration in Europe has accelerated over the past couple of years. So we will try to make a push for that over time.

I will say it's not the first thing we're going to be doing, because we really want to make sure we do this right. And we help Smilebox accomplish their immediate goals and then we will look to plan with them how we leverage IncrediMail's footprint on one side, and how we leverage their US presence for IncrediMail and search on the other side.

Okay. Just lastly, can you give us a little bit of an update on how your existing product line has been performing? Obviously revenues growing and everything like that, but I was just wondering any products in particular that are in your existing portfolio that have shown some pretty good strength recently?

The only one we've really launched -- and since in the past is really PhotoJoy. IncrediMail itself is still holding its own. The installed base -- overall our installed base went up a little bit; I think $6.8 million from the $6.6 million. To remind everybody, we stopped talking about Hi-Yo, which is a previous product we discounted. So that is going okay.

And on photo joy PhotoJoy, what we're seeing so far is that the usage of PhotoJoy is actually exceeding our expectations. And as Yacov said earlier in the call, we're still really monitoring the revenue generation on an ROI positive basis as we [spin] some media around PhotoJoy to help launch it.

And also measuring it, it's really too early to tell from that standpoint. We're making money on the -- revenues on it. But really as it grows, we'll hopefully by Q3 have more information; as Yacov said, it is going to be a really telling quarter for us in terms of how fast we can scale PhotoJoy with regards to getting a positive return on our marketing spending.

PhotoJoy today, although we're making some additions, is not viral like IncrediMail or that Smilebox is, as a matter of fact, as well. We're adding some components in the next quarter to PhotoJoy to allow you to share via e-mail, share via Facebook and other social networks. Also we have a mobile and iPad version of PhotoJoy that will be coming out.

So we're really investing a little bit in it to get to the next level. We hope we will be able to leverage that. Ideally, over time, the Smilebox audience and the PhotoJoy audience -- since they're both photo-centric products -- I hope [we'll] be able to cross market over time [with that]. It's not the immediate thing we're going to be doing, but we are certainly looking at that in the future.

Great, thank you.

Jay Kumar, Midsouth Investment Fund.

Hey guys, I've got a question about customer acquisition costs. What is that? And how do you see that playing out over the next two quarters?

Well, first of all, I'll explain what it is. Basically a customer acquisition cost is -- we would go to let's say Google or Bing. And when someone is searching on a word, let's say for free e-mail or for putting animations in e-mail, we would look to buy placement on Google or Bing, like everyone else in the world is doing, to get a high placement. So when someone clicks on it, they come to our website and download our product.

We would also do that for example for display ads. It could be on Facebook or it could be on Yahoo. But we do a display ad and hopefully someone clicks on it and they download our product.

We pay the media, right? So, we pay for the advertising and then we track all the way back so when someone downloads it, who uses it, how much money we're making from them. And then we can basically see over time -- right, these things take a while -- how much revenue we've got, we received from that customer versus how much we paid for them up front.

I think as Yacov mentioned earlier and on the previous calls, the accounting for that is -- you expense the marketing expense right away. And the revenue you recognize as you get the revenue, which is why there is a lag, as we discussed earlier in previous phone calls.

We see it in Q3 being similar to, maybe slightly larger than the spend in Q2. And we hope things go well. Then Q4 will be slightly larger than we saw in Q3.

We have discussed earlier and we said previously that we are targeting the $6 million or so range for the year to spend. At this point in time I think we're tracking towards that. But we're being cautious because, as Yacov said, we've seen good results but I can't say we've seen good results from every campaign we have done, which we didn't expect and frankly no one could expect. There's no one in the world who does that.

As we learn, we're learning which campaigns to focus on and grow, and which campaigns to cut off so that we don't lose a lot of money from them. As Q3 starts rolling out and we see it concluding, we will then see a much better feel for how some of those campaigns are doing that we started in Q2. And that will give us confidence to continue the spending or to pull back on some of the spending.

(inaudible), Union Bank.

Congratulations [on] your results. I want to ask, how much money does it cost to get a customer?

We don't disclose those numbers in terms of what we spend in general. But I can tell you geographically basically the US, Canada and the UK have the highest customer acquisition cost. If you look at other companies in the space, I think some of them may disclose it. I don't know. But it is similar because we're fighting in a market where, I don't care if somebody is downloading an e-mail client or frankly a wig, right, a virtual wig. Someone is still paying the money to somebody and we compete with everybody from that perspective.

If you go to Third World countries, like -- well, [not] Third World -- to lower -- to rest of the world countries like India or Brazil, for example, your customer acquisition cost is probably one-fifth to one-sixth of what it is; maybe less so, that of in the US and the UK. What we try to do is balance out obviously.

And consequently, the revenue you get from Brazil and India is also much less than what you get from the US and the UK. So we're trying to balance out where we spend the money and looking for the best return on an absolute basis, as well as looking for where the highest revenue growth potential is. And we're trying to give a balance in there, so can get a really good mix of the spend.

If I may add to that, this is one of the reasons why the testing process is taking so much time. In other words, we have to be able to test multiple channels, different words, different display ads. And we have to do that in multiple geographies, so we have to see in which countries can we spend as much. And then we have to compare that to the revenues, and in each one of the specific cases, find an ROI positive traffic. So that is why the testing period is taking such a long time.

You don't disclose the numbers, but you can get a range of the numbers?

Well, frankly, the range anywhere from $0.01 or $0.02 to $2.00 or $3.00. So the range is tremendous. Again, our focus is constantly matching the cost to what we believe would be the return on that investment.

So, in some countries, in some places, the numbers are extremely high, like I said. In other places, like Josef mentioned, they could be extremely low. So the range is actually extremely broad.

So how many customers do you have today?

We have about 6.8 million installed base today.

Okay. Thank you.

You're welcome. Thank you.

(Operator Instructions). There are no further questions at this time. Before I ask Mr. Mandelbaum to go ahead with his closing statement, I would like to remind participants that a replay of this call will be available in three hours on the Company website at www.IncrediMail.com. Mr. Mandelbaum, would you like to make your concluding statement?

Sure. Thank you Rachael. Thank you all once again for joining our conference call today.

I hope you will agree these are really exciting times ahead of us, as we look to close on our first acquisition and we look to continue the momentum we have that we have built up over the past year. We look forward to speaking with you in future quarters and updating you on our progress. Thank you and have a nice day.

Thank you. This concludes the IncrediMail Second Quarter 2011 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.