Perion Network Ltd (PERI) 2012 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Perion third-quarter 2012 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 November 1, 2012.

With us today from Perion we have Josef Mandelbaum, CEO, and Jacob Kaufman, CFO. I will now hand the call over to Jeff Stanlis of Hayden IR for the Safe Harbor information. Mr. Stanlis, please go ahead.

Thank you, and we appreciate the attention of everyone who is joining us today. On today's call, management will be reviewing the financial results and business highlights of the third quarter and first nine months of 2012. A press release detailing the results is available on the Company's website at www.Perion.com.

Before we begin, I would like to read the following Safe Harbor statement. Today's discussion will include 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 Factors and elsewhere in the Company's annual report on Form 20-F. These may cause actual results, performance or achievements to be materially different from any future results, performances 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'll turn the call over to Josef Mandelbaum, Chief Executive Officer. Josef, congratulations on the record financial results.

Thank you, Jeff, and good morning, everyone. Welcome to our third-quarter earnings call. Before I begin my remarks, I would like to take a minute to wish all of our customers and investors on the East Coast a speedy recovery from Superstorm Sandy. Our thoughts and prayers are with all of you.

As Jeff mentioned, this was a record quarter for us, with strong organic growth in both revenue and profitability. Today, I'd like to focus my comments on a review of our record third-quarter and first nine month results and to highlight some of our exciting initiatives for the remainder of the year. I'll then turn over the call to Yacov for more details regarding the financial results, before opening up the call for questions.

This quarter was a phenomenal quarter for us in every aspect of our business, and I am proud to report this was the 27th consecutive quarter of growth for the Company on a year-over-year basis. The accelerating growth in revenues and profitability stemmed from two major factors. The first is the continued success of our Smilebox acquisition, and the second is the result of improvements we have made in our backend systems and media buying capabilities. Given these improvements, we have also increased our spending on customer acquisition this quarter, which will fuel incremental growth in future quarters.

As you can see, our scaling efforts are starting to pay off in terms of increased profitability, as customer acquisition investments made in recent months have had a faster payback with a higher ROI, or return on investment, than those made previously. We expect this trend to continue for the remainder of the year and into 2013.

As we saw this momentum, we revised our guidance upward in early September for the second time this year. On a non-GAAP basis, we now expect revenues for the full year to reach approximately $55 million, up from our original guidance of $48 million to $50 million, with EBITDA of approximately $12 million compared to our original guidance of $8.5 million to $10 million. As for net income, we now expect 2012 net income to be approximately $9 million or $0.90 per share compared to our original guidance of $7 million to $8 million.

Based on the first nine months, we are well on our way to achieving this new and increased guidance and our metrics across the board are improving. Non-GAAP revenues in the third quarter increased by 81% year-over-year to a record $16.3 million and increased 32% on a sequential basis from the second quarter of 2012. The sequential growth was driven by the improvements in our search business we talked about on our second-quarter earnings call. We significantly enhanced our backend systems, enabling us to better track our marketing efforts, improved our ROI, as well as the lifetime value of our users.

In addition, Smilebox grew revenues on a year-over-year basis by 30% in the quarter, with a continually improving EBITDA margin reaching 20% this quarter. As we celebrate the first anniversary of the acquisition, we are proud to say Smilebox has been exactly the acquisition we thought it would be. It has significantly enhanced our premium revenue, providing a stable recurring revenue stream that has helped us diversify our revenue base, providing a larger, profitable platform for growth.

Equally exciting are the investments we are making for the future. These are strategic long-term investments, meant to advance our product offering and their appeal to consumers, thus creating significant value for our Company over the next few years. I'd like to highlight two of these initiatives, our IncrediMail iPad product and our Smilebox iPhone product.

We are very excited about our new IncrediMail unified messaging app as it truly takes a unique and revolutionary approach to e-mail and text-based communication, from Gmail to Facebook and from Twitter to Yahoo Mail. An initial beta version of our product should be ready later this month. This product is initially focusing primarily on user adoption. However, we have built in the ability to monetize once we reach scale with in-app purchases and advertising. As you all know, both of these methods are proven business models and growing very fast in the mobile space.

As part of the groundwork for future monetization, we have recently signed up with Apple's iAd, Google's AdMob and Millennial Media on the mobile advertising front and already are partnered with Apple for in-app purchases.

We have also recently launched a new version of our Smilebox app and it has been getting very positive reviews. We made major improvements in sharing, collage-making and click personalization features, such as filters, based on our user feedback. We have over 700,000 installs to date and are looking to rapidly expand our user base. Similar to our IncrediMail product, we will monetize this app at the appropriate time through advertising and in-app purchases.

Now, I'd like to turn the call over to Yacov, who will review the financials in greater detail.

Thank you, Josef. As in prior quarters, we will be analyzing our results on a non-GAAP basis, which better conveys the operational state of the business. There is a detailed reconciliation to GAAP results in the financial tables of the earnings press release.

As Josef just mentioned, revenues this quarter were a record $16.3 million, up 32% from previous quarter and up 81% from the third quarter of 2011. In the first nine months of 2012, revenues increased 55% to a record $39.8 million, compared to $25.7 million in the first nine months of 2011. The record $39.8 million in revenues for the nine-month period of 2012 has already surpassed total revenues for the entire year of 2011.

Search-generated revenues for the quarter were $10.9 million, an 82% increase from $6 million in the third quarter of 2011, and up by 70% sequentially from $6.4 million in the second quarter of this year. Product and other advertising sales were $5.4 million in the third quarter of 2012, growing 78% from the third quarter last year. In the first nine months of this year, product and other advertising revenues grew 153% to $17 million from $6.7 million in the same period last year. This demonstrates one of the strengths of our businesses, which is having multiple revenue streams that provide for consistent growth.

As we mentioned in previous calls, since the Smilebox acquisition, there is a difference between GAAP and non-GAAP revenues. This difference has decreased over the years since the acquisition, having amounted to less than $100,000 this quarter, although totaling almost $1 million in the first nine months of 2012. As we are now a full year post acquisition, the difference in revenues stemming from this acquisition will no longer continue.

Gross profit in the third quarter of 2012 was $15.5 million, up 35% sequentially and up 84% from the third quarter of 2011. The gross profit margin increased to 94% from 93% in the third quarter of 2011. The difference between GAAP and non-GAAP revenues together with $0.3 million in amortization of intangible assets provided for the $0.3 million difference between GAAP and non-GAAP gross profit in this quarter.

With gross margins exceeding 90%, we maintain a compelling business model. This level of profitability is a key reason we are investing in marketing and customer acquisition to accelerate our top-line growth and subsequently increase profitability. In the first nine months of 2012, gross profits increased 53%, reaching $37.2 million or 93% of revenues, compared to $24.3 million or 94% of revenue in the first nine months of 2011.

Research and development expenses for the third quarter of this year were $2.7 million compared to $2.5 million last quarter and compared to $1.7 million in the third quarter of 2011. The increase year-over-year was primarily due to the acquisition of Smilebox and the development efforts related to its mobile product. We expect R&D expenses as a percentage of sales to remain at the current level in coming quarters.

Sales and marketing expenses in the third quarter of 2012, excluding customer acquisition for us, were $1.8 million compared to $0.7 million in the third quarter last year, when we acquired Smilebox, and $1.4 million in the second quarter of 2012. The changes are primarily due to the sales and marketing expenses from Smilebox.

In the third quarter of 2012, we invested $5.8 million in customer acquisitions compared to $3.9 million last quarter and $2.6 million in the third quarter of 2011. The increase was in conjunction with the improvements and the return on investments as we improved backend systems and had a better focused methodology. Typically, only half the return on investments are received in the quarter in which the investment is made. So in this case, we expect to see the remaining return on investment primarily in the fourth quarter of this year and the beginning of next year.

In the first nine months of 2012, customer acquisition costs were $12.4 million compared to $4.9 million in the first nine months of 2011. We believe this important investment will enable us to continuously grow our search revenues, and as I mentioned, we are already seeing a return on this expenditure. Since the third quarter of 2011, we have been ramping up this investment in order to accelerate our growth. We will continue to increase our customer acquisition investment. However, as a result of investments already made, we expect profits to increase despite the increased investments.

General and administrative expenses was $1.4 million in the third quarter of 2012, similar to last quarter and the same quarter last year. Our ability to maintain this level of G&A has significantly reduced the G&A expense as a percentage of sales to 9% in the third quarter of 2012, down from 16% in the third quarter of last year. The difference between GAAP and non-GAAP operating expenses in the third quarter of 2012 was $0.4 million, including $0.2 million of share-based compensation and $0.2 million for amortization of acquired intangible assets. In the third quarter of 2011, these expenses totaled $1.1 million, attributable to share-based compensation and acquisition expenses related to Smilebox.

In the third quarter of 2012, EBITDA was $3.8 million, a 71% increase compared to the third quarter last year, despite the $3.2 million increase in customer acquisition costs as the return on this investment started to take effect. In the first nine months of 2012, EBITDA was $9.1 million, increasing 9% from $8.3 million in the first nine months of 2011, despite the $7.4 million increase in customer acquisition costs.

In the third quarter, non-GAAP net income was $2.6 million or $0.26 per share compared to $1.8 million or $0.18 per share in the third quarter of 2011. As a result of a 44% increase in net income in the third quarter, in the first nine months of 2012, net income reached $6.7 million, similar to the first nine months of 2011. Earnings per share was $0.66 per share in the first nine months of 2012 compared to $0.67 per share in the first nine months of 2011. We expect the year-over-year increase experienced in the third quarter to continue in the fourth quarter, and as a result, full-year net income for 2012 should be higher than 2011.

In the first nine months of 2012, GAAP cash flow from operations was $4.5 million compared to $5.4 million in the first nine months of 2011. The decrease in year-to-date cash flow from operations is primarily due to the increase in search revenues receivable, coupled with the investment in customer acquisition costs. As of September 30, 2012, we had cash and cash equivalents of approximately $17.9 million.

As we look forward to year end, we believe that Perion will report year-over-year improvements in all key financial metrics, including cash flow from operations, throughout the rest of 2012.

With that, I'd like to open the call to questions.

(Operator Instructions) Jay Srivatsa, Chardan Capital Markets.

Thanks for taking my question. Good performance, Yacov and Josef. I wanted to ask you a couple of questions related to the acquisition costs, the customer acquisition costs. Clearly, you are seeing some good return on investment, but the costs have been significantly higher than last year, year-to-date. So as you look ahead, maybe you can highlight to us what are specific areas that you've used that investment to give you the increase in rate of return.

First of all, thanks for joining, Jay. Good to hear you on the phone. The answer is we basically on the marketing side take a mixture approach of marketing to hopefully maximize the return, and we will do basically two different things. To put it simply, we do a shotgun approach and a rifle approach.

On the shotgun approach, it is pretty much trying to get mass volume. We will buy a lot of display inventory on -- random inventory in different sites, which brings clickthrough and it's a volume game. And you are paying X amount, usually a lower number, to bring in a certain number of consumers and those consumers then convert. That's number one in terms of how we attract users.

We also do things where we bundle our software with other people's software so we can actually try to help them get free software, and we take over. And we use search on that basis as well, which increases the lifetime value.

The second that we do is you do very targeted or rifle approach advertising, and that is to get specific people, primarily, for example for our subscription businesses, Smilebox and IncrediMail, where we will actually try to buy very targeted inventory, whether it is on Facebook with geo targeting or demographic targeting, whether that specific websites that are very appropriate to the users we are trying to get at. And those two things combined, while they are two completely different economics in terms of the cost per thousand that we pay, the end economics end up being very similar in terms of the return we get. Some are a little bit longer term, we see good return, but probably less churn; some a little higher churn, but we still see good ROI on that.

Everything I just said is enabled by the fact that the investment we made in the backend systems enables us to actually optimize this on a channel and a campaign basis. So we do this in, for example, Brazil, I do it in Germany, I do it in the United States. We test a lot of campaigns and channels and we basically optimize by throwing out the bad and focusing on the good, scaling it as much as we can until we start seeing the return going down, which is the law of diminishing returns applies everywhere.

So that is the approach we take, is two from a marketing standpoint, a shotgun and a rifle approach. Both of them are anchored in the analytics of the backend systems to help us optimize the marketing spend and the return we get.

All right. Talking about the backend system, where are you at in terms of further improvements? Have you identified certain areas that you think could give you a more fundamental change in your approach as you look at more opportunities ahead?

Yes. We think, at least, that's the exciting thing about the story about Perion, is that we still have a lot of room for growth. Primarily, because, as I think I've told you and other people on the phone, we still have -- we've done a good job in the backend systems. We still have a way to go.

We are not -- we have areas we have identified we think we can improve upon. But they are not overnight fixes, so it takes some time. And I think it's a journey; it's never a destination. And on the journey, I would say we are probably halfway there on the journey. And we expect next year to continue to invest in that, to tweak and improve the systems and look for opportunities to do major leaps forward if possible.

All right. In terms of Google, I missed the first part of your prepared remarks. Were you able to share with us what percentage of your revenues was from Google?

Search in total was about 82% of growth, and it represented approximately 67% of our revenues this quarter.

It appears that the speaker has disconnected. One moment please while we get the speakers to reconnect. Thank you for waiting. The speakers are back in the call.

Let me ask the question again. The question was what portion of your revenues was Google.

As I said, in the third quarter of 2012, search-generated revenues represented 67% of our revenues, and for the most part, that is Google.

Okay. I know you are coming up on renewal of the contract with Google pretty soon. Josef, what level of confidence do you have in terms of the renewal and what are some of the challenges ahead?

I am extremely confident we will get a renewal. I do not see any reason at this point in time why we would not. We have had conversations already with Google, and from everybody I've spoken to at Google, I don't think it will be an issue.

In terms of what challenges would be ahead, in general, what Google is doing in the marketplace is they are continually, every year, trying to make sure that the user experience is protected and that -- there are people in the marketplace who are aggressive and try to trick the user. We are not one of those companies. We never have been. We don't intend to be. So we fully agree with Google's efforts. We assist them in any way we can. And we don't think there will be meaningful impact on us, because most of these things that they are going to change on a policy basis either we are hopefully complying with already or we would agree with and to change, because it is for the benefit of the consumer.

Fair enough. Last question for me. You've done a great job of the acquisition of Smilebox. As you look at 2013, where do you see the growth? Is it going to be organic or are you seeing further opportunities for acquisitions?

We think two things. One, our organic growth, I think as people can see today, is certainly picking up. And again, after the investments we've made, it is improving and we expect that to continue in Q4, we expect it to continue obviously in 2013. So the percentage -- I don't know the exact percentage, but a large percentage of it should be coming organically.

In addition, we are seeing -- we have a very good pipeline of acquisition opportunities, and we are going to be aggressive. The issue always is it takes two to tango, but we believe there will be opportunities for us in the near future and hopefully in 2013 as well.

And as I mentioned, Jay, on the phone, the one thing I can promise is that any acquisition we do in the near term and in 2013, it will be accretive from day one.

Thank you. Keep up the good work.

Jared Schramm, ROTH Capital.

Congratulations on the strong quarter. Looking at the growth in customer acquisition costs, obviously we saw a nice improved ROI on that metric. On a high level, where do you see customer acquisition costs grow over the next year? And kind of a tangent to that point as well, how are you looking to balance increasing customer acquisition costs along with product development?

We would expect customer acquisition costs next year, frankly, to grow as fast as we can, but we're certainly going to be aggressive as long as we see the returns we are seeing. And we think there is room for improvement on those returns. As we optimize our systems we expect to be aggressive. What we've done historically and you'll continue to see from us is that we do it prudently. So we're going to do things in a way that we think is healthy for the long-term benefits of the Company, as opposed to just a quick land grab, so to speak, for revenues.

And that leads into the second part of your question, which is we're going to balance it out by two things. One is we are making organic investments in future products, primarily on mobile, but also improving our existing desktop products. And number two is we are starting to look at acquisitions in the future, 2013 or beyond, as a way of helping us grow and balance out our revenues as we go forward.

Okay. You mentioned previously on another question about being aggressive as far as acquisitions are concerned. Is there a particular space you're looking to focus on more than another right now? And if so, just maybe a high-level idea on what kind of concept those would be entailed with?

I would say that we look at it in probably two different categories, Jared. I want to be -- I want to answer your question, but I am going to be a little bit general, because obviously sensitive (multiple speakers).

Understood.

But here's what we look at. We look at one category which is scale and technology. We think there is opportunities in the marketplace to buy companies that can improve our scale, which is significant in terms of a lot of other aspects, which we can go into in greater detail. But they include scale of revenues, buying power, purchasing power, negotiating power with marketing partners, which improves my margins with regards to scale. You also -- negotiating power with partners such as Google and others, as well as the backend systems and scale of efficiencies. So we think on the technology side and the scale side, there is opportunities in the marketplace there.

And the second place we are looking into is it different product verticals. And those verticals range, again, focusing on everyday type of use categories that either actively or passively the consumer needs. And we are focusing on everyday type of categories, like e-mail communication or photos as examples because we believe in the long term the more someone uses our products, the more loyal they will become. And to be candid, I wish it was my idea, but Procter & Gamble kind of did it 100 years ago; proven very successful. And we are looking at those two general categories.

Obviously, in the everyday product categories, it can include a lot of different categories, whether it is privacy or security or whether it is to-do lists and task management and so on and so forth. But we believe there was opportunities out there. We are seeing a good pipeline of companies, and as I mentioned before, we are very confident we can do it in a way where it is accretive from day one.

Lastly, the big increase in search revenue on a year-over-year basis, how would you say you are seeing the competitive market today versus even two quarters ago or a year ago?

It is a great question. On the competitive side -- I think I said it maybe two or three earnings called ago -- what we saw probably last year was a separation of the men from the mice, where you saw the bigger guys pushing the gas pedal harder and growing faster. And a lot of the smaller guys couldn't keep up, and because of that their margin pretty much imploded, which makes it very difficult to kind of play the game of buying a customer and then making money on the other side. And I think that is continuing today.

We are seeing the bigger people are just growing faster, and the overall search market is certainly growing. There is no question about that. And we are seeing that benefit. I think Google announced their earnings last week or two weeks ago, and their overall search revenues are growing. In fact, their partners' share of their search revenues grew faster than their organic share, and we are part of that -- this whole ecosystem is part of the partner share.

And I think you are seeing that is what -- that is the dynamics in the marketplace. Obviously, what we are trying to do is make sure we are part of the men and not the mice. And we think we are well on our way of proving that, and we were very confident we will be one of those players in the future.

Okay. And lastly, I think Yacov mentioned that you expect net income for full 2012 to be higher than it was in 2011. Is that correct?

Yes.

Okay. Congratulations again on the very strong quarter.

Thanks, Jared.

Dov Rozenberg, Clal.

Thanks, and congratulations on the great results. You mentioned a change in strategy in media buying. I want to know if you can elaborate a little bit on that, and is that new partners or -- and is that something that you can see improving more ahead?

Nice to have you on the phone. The change in strategy is more reflective of really scale. We believe we have been prudent to wait until we have the backend systems to really help us scale the business, so we do it in a way where actually we can make money. And we believe we are at that point; the inflection point happened sometime towards the end of Q2.

And the specific answer to the question is yes, we see a lot of opportunity for growth in the marketplace. It is competitive. There is no question about that. But there actually, when you look at -- as I mentioned earlier, there aren't that many big players. There are a lot of little guys, but the little guys are losing steam. So we believe we actually are in a very good position where we don't have a lot of saturation from our standpoint, and we can grow at, we believe, an accelerated pace going forward, 2013 and beyond.

Thanks. And as far as mobile, you mentioned your iPad to iPhone product. I was wondering what roadmap you have for mobile. You said the beta version should be out by the end of the month. You have plans for Android also, for any other mobile platforms?

Yes, I think what you will see going forward in the future, 2013 and beyond, from us -- we started this year's -- we are making investments to mobile. We believe, as I think everybody on the phone I'm sure believes, hopefully believes, it will be the predominant way which people access their data, the web will be ultimately mobile smart phones and/or tablets, in addition to -- not replacing, but in addition to the desktop.

So our roadmap is to start primarily with Apple products, for obvious reasons, especially they have the -- one of the largest penetrations, but more importantly, of people who actually download and monetize, as opposed to other platforms which may have wider distribution but don't monetize as well. That's number one.

We would follow that primarily with Android type of products, whether that be Nexus or other. It could be Kindle Fire. And then we would probably follow very closely on that. We are waiting to see what happens, but we believe the Microsoft Surface could have some good potential. The Windows phone still is lagging, so there's not an urgency, but we believe that our roadmap will eventually take us there, as well.

Right. Do you have any timeline, meaning when you expect to move the beta to actually (multiple speakers) after or when --

I would expect us to have Android products next year for sure. I'm not going to commit to the Surface, but it is very possible. But for sure, Android products for our existing products, we should have Android applications out next year as well.

All right. Thank you very much.

Aram Fuchs, Fertilemind Capital.

I was wondering if you can talk about a few things on the balance sheet. Where are you comfortable with your working capital going forward? It has been in the negative zone at the end of the year. Now it is nicely positive. You do have that long-term debt. Maybe you could just talk about how you look at the balance sheet.

We feel comfortable with working capital that can support the business we're looking at. As Josef mentioned earlier, we are looking to ramp up our customer acquisition costs, which are forward-looking in their expenditure, meaning that you can have the expense before the revenue. So therefore, we are going to need the sufficient working capital to support that.

In addition, as you rightly mentioned, what we did was increased our working capital also by the bank long-term debt that we took. So that gave us some more flexibility.

So you ask which -- the working capital that we would feel comfortable with would be the working capital sufficient to support our growth right now. And right now, it is more than sufficient. We actually expect it to continue growing positively going forward.

Just -- so quantifying that, when you say growing positively, you think the working capital will grow, the cash current assets will increase faster than current liabilities?

We are expecting cash flow from operations to be positive going forward. How we utilize that will be a fact of our growth and how we use it.

Okay. Related to that, your purchase of plant and equipment doubled. Do we flatline that $447,000 roughly $0.5 million, going forward? And is that -- what is that for? Is that office equipment, servers, or what is the delta there?

Most of the investment is actually to support the backend systems that we are continuously working on. Frankly, in the past, in 2010, 2011, we had let that go a little bit low and we did increase that investment in the first part of 2012. I don't expect that to have a dramatic effect on our cash flow going forward.

Backend systems for ROI calculations is usually just in-house software development and labor, right? It wouldn't be in that line or am I missing something?

Servers, et cetera.

Okay. And then on your monetization strategies for mobile, is this going to be similar to the desktop IncrediMail, where you are going to be selling templates and things like that, or is there another strategy?

I think, as I mentioned -- and thanks for being on the call today. We appreciate it. We are going to -- first of all, anybody who says today they know exactly how to monetize mobile in the long run, I would question that. I'm not going to sit here and tell you I know exactly.

What I can tell you is in the 20 years of being in the technology business, advertising, premium revenue, transaction revenue and now search have always been available to monetize applications. So we are focusing first and foremost on growth.

The answer to the specific question is we will have in-app purchases, like on the desktop, probably not subscription-based, but in-app purchases for our products. We tested it on Smilebox. We took it down now, but we did test it on Smilebox, and we did test it in one of our initial photo e-mail apps earlier this year, just to see if it works, and we actually got some good feedback and actually good response.

On advertising, as we mentioned, we signed up with three different providers, and if we have scale, you can make money off of advertising. What is not clear yet to me is whether we can make money off of search revenue on the mobile phone. And to be candid, I don't think that is clear to anybody yet. But I do expect over the next few years that will open up as well. But I believe through advertising and in-app purchases alone, it could be a very attractive model for us.

But as I mentioned in my remarks, we are taking a long-term view on this. So I don't expect, for example, 2013 to have really any meaningful revenues in mobile.

Got it. The basic search business of getting the homepage or the search box in the browser is not applicable in mobile yet. That is effectively what you are saying, right?

Today on mobile, the people who control that are Apple and Google.

Right, right.

We will see how long that will last, but today, that is what they are doing.

Okay. And then on Smilebox specifically, you said you were gingerly testing search as a revenue stream, or you said that the last couple of quarters. You didn't mention that this quarter. Are those tests going on, or are they -- or are you content with the results of the tests and you're moving forward aggressively with that? Can you talk about that?

I'm not exactly sure, but I think -- I'll try to answer the question. If I don't, please ask it again. We have added search to the free version of Smilebox, when you download it for free. And we are continually doing that. We are not testing -- the only testing we are doing now is just optimize, which we do on an overall basis for Perion, not specific to Smilebox. So it is working well, and we are now monetizing the free users of Smilebox.

Okay, good. So you are content with the results. You had mentioned before that you were just doing that a little more conservatively because of the --

Sorry, I misunderstood your question. You are talking about the existing customer base who we had on Smilebox that we tried to monetize to them search.

Right.

Sorry. I misunderstood the question. We are walking gingerly. We are not being aggressive about that at this point in time. We are looking at in the future, but we are walking gingerly.

We don't feel the need, frankly, to be piggish here and potentially alienate customers. So we are doing some tests, as I mentioned. We've had, as you can expect, some interesting results that we're going to analyze before we make any future decisions.

However, I think the important point is that Smilebox is doing great without that. So that also weighs into our factor of how aggressive we should be.

Right, okay. Then you mentioned that in any business, you eventually meet the point where marginal costs meet the marginal return. In the search business, it is sometimes quite surprising when you reach that point. I'm wondering if there are any sort of subcategories, either by geography or by media buying, vertical, like banners or remnant or text or anything, where you are sort of seeing that you've reached that point.

Today the answer is no. We don't see that today. And really, the simple reason -- by the way I agree with you -- it sometimes does sneak up on you. The advantage of being in the business for a long time is it is happened before. So hopefully, I will be on the lookout.

The simple reason is, we are still a relatively -- we are growing, but I would say a small, midsize player. So the saturation, frankly, that other people have in the marketplace, we are not even close. You have people out there, competitors, who are spending -- we just spent in the first nine months -- was it $12.4 million in media buying? We've got people who spend that in a month. And by the way, not one competitor, but we're talking, at least that I know of, probably eight to 10 competitors who are spending that type of money.

So we think we have a pretty good headroom of growth ahead of us. Clearly, the backend systems we mentioned beforehand will enable us hopefully to be on the lookout, so that when we do hit the law of diminishing returns, which happens to every company, you begin to optimize more what you have. And obviously, our subscription businesses, our investment in mobile, other acquisitions will help us do that.

Great. Thanks for your time.

Kenneth Miller, Nokomis Capital.

Hello, gentlemen. First, I'd like to echo the congratulations, Josef, not just for this quarter, but for doing exactly what you said you were going to do when you took over at Perion. I think we are really starting to see some great results from it.

Thanks, Kenny.

I wanted to ask about your guidance. If I'm doing the math correctly, it implies your revenue is going to be down a little bit -- flat to down in the fourth quarter, when the fourth quarter is usually strong for search. What is going on with that? Is there some search revenue that is not recurring in the fourth quarter, or other reasons for a revenue decline in the fourth quarter?

No, there are no reasons for revenue decline in the fourth quarter. We feel very strongly that we are well on our way of achieving those revenues of the guidance we discussed. It's already November, and our feeling was, to be candid, that this far in, we had just raised guidance a little while ago, that at the end of the year, we expect, as Yacov said in his remarks and my remarks, continued growth in the trend. And as you said, if you can do the math, I believe you will see the results.

Okay. And what led to the especially strong search revenue? How much of this was from monetizing Smilebox users for the first time and how much was from customer acquisition and how much was maybe from price or usage increases? It seems like a really incongruously strong one-quarter growth in search.

Basically, it does break down to those three things you mentioned, Smilebox, increased media buying and improvements in our systems. The large majority of that came from improvement in our systems. Smilebox clearly contributed. Last year, we didn't have Smilebox search revenue at all for the third quarter and this year we did, so there is no question that helped.

We obviously increased our media buying by $2 million, but as Yacov said, only roughly half of that hits the quarter we are in. So -- but it helped, obviously, because we increased media buying.

But the large portion, Kenny, came from what we described in our second earnings call, which is we -- because of the analytic systems we finally got live and working January/February timeframe in a meaningful way -- I mean, we're working on it for almost two years now -- but in a meaningful way, it highlighted some of the opportunities for improvement that, frankly, we weren't aware of on a mean basis. So when you go into the granular analytics, you find a lot of things out, and those are things we started improving. And when we started improving that, we saw a radical improvement in the numbers.

One of the examples I gave last quarter, for example, was Chrome and Firefox, as you look at -- we saw in our analytics that the lifetime value on those two browsers -- users with those two browsers was lower than on Internet Explorer. There really wasn't any good reason why, and we started investigating it; we found a few technical issues which were depressing the lifetime value and the amount of time we held onto users on those two browsers. We subsequently fixed it, and the results speak for themselves. That's just one example.

We found four or five different things, mostly technical issues that were hard to see on an aggregate basis; when we had these systems, enabled us to see it on a few levels deeper, which clearly helped us in the end of the second quarter and clearly for the full third quarter. And as I mentioned in response to your earlier question, we expect it to continue in the fourth quarter.

Okay, that makes sense. A couple questions for Yacov. First, what is your long-term EBITDA margin target, and when do you kind of -- when are you kind of targeting to achieve it? Obviously, this business was running in the high 40%s before in terms of EBITDA margin, but that was probably when it wasn't investing enough in systems and improving its business. You've taken down the margin quite a bit, but we are starting to see the ramp in revenue. Can you give me some longer-term thoughts on where you think your EBITDA margin should be once you are running the business like you want to, and what kind of time frame you think that is?

I think that 25% EBITDA margin is a good go, and I think we can maintain that. The main challenge going forward would be maintaining that kind of a margin on accelerated growth, and despite our investments in customer acquisition, which, as I said, is very forward-looking. So I think 25% is something that we would try to attain.

Okay, and last quick question. It seems like taxes picked up. What should we think about as a prospective going-forward tax rate?

Regretfully, this is a rather sporadic expenditure and it's very difficult to see how it is going to come through in each quarter. I think -- on average, I think what we've been seeing is that it's -- we're about 25% to 30%. We would expect in the long term that it would go lower than that. We are suffering from different situations with regard to our tax shelter. But I think going forward, our regulatory tax rate would be about 20%, and I would expect that to come anywhere near between 25% or around that.

Last quick question. Presumably, Smilebox is growing very well. Are you going to owe the earnout payment, which I think is about $6.5 million, in the fourth quarter?

No. We have paid everything we are going to pay to Smilebox. They did not hit the last earnout statement. And we expected that when we structured the deal, so it was not a surprise to us. And I don't know if it was a surprise to the investors and founder, but it wasn't a surprise to us. So we are very happy with the acquisition and we fully paid it off.

So there is no more Smilebox, there is no more contingent consideration or Smilebox earnout payments to be made?

Zero.

So cash should just be building steadily from here with your free cash flow?

Correct. Subsequent to what Yacov said about investments in media buying or future acquisitions, yes.

Understood. That's all I have. Thanks very much, gentlemen.

(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.Perion.com. Mr. Mandelbaum, please go ahead with your concluding statement.

Thank you. This was a great time for Perion as we are beginning to reap the benefits of our investments over the past two years. We still have more to do to improve our business and there will be challenges ahead. However, the great results we have achieved, including 55% top-line growth year to date, with improved profitability, have been accomplished without yet reaching our full potential. I believe this is still unmet opportunity -- sorry -- I believe this still unmet opportunity is the exciting part of the Perion story.

Over the next few quarters, we will continue to focus on revenue growth, while expanding our profitability, primarily in our core subscription and search business. We will continue to invest in the future, primarily in mobile-related areas, and we will continue to aggressively pursue acquisition opportunities to expand our portfolio of products and/or our backend systems and scale.

In summary, this was an exceptional quarter for Perion, and I want to take this opportunity to thank all of our employees in Tel Aviv and Seattle for all the hard work. Thank you, and have a great day.

Thank you. This concludes the Perion third-quarter 2012 results conference call. Thank you for your participation. You may go ahead and disconnect.