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Edited Transcript of CYRN.OQ earnings conference call or presentation 12-Aug-20 2:00pm GMT

Q2 2020 Cyren Ltd Earnings Call

Netanya Aug 18, 2020 (Thomson StreetEvents) -- Edited Transcript of Cyren Ltd earnings conference call or presentation Wednesday, August 12, 2020 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brett M. Jackson

CYREN Ltd. - CEO & Director

* Eric Avi Spindel

CYREN Ltd. - VP, General Counsel & Corporate Secretary

* J. Michael Myshrall

CYREN Ltd. - CFO

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Conference Call Participants

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* Chad Michael Bennett

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

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Presentation

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Operator [1]

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Greetings, and welcome to Cyren's Q2 Earnings conference call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Eric Spinder (sic) [Spindel], General Counsel. Please go ahead.

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Eric Avi Spindel, CYREN Ltd. - VP, General Counsel & Corporate Secretary [2]

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Thank you, and welcome to Cyren's Second Quarter 2020 Financial Results Conference Call. This call is being broadcast live and can be accessed on the Investor Relations section of the Cyren website.

Before we begin, please let me remind you that during the course of this conference call, Cyren's management may make forward-looking statements. These forward-looking statements are based on current expectations that are subject to a number of risks and uncertainties that may cause actual results to differ materially from expectations. These risks are outlined in the Risk Factors section of our SEC filings, including our annual report on Form 10-K filed on March 30, 2020. Any forward-looking statements should be considered in light of these risk factors. Please also note as a safe harbor, any outlook we present is as of today, and management does not undertake any obligation to revise any forward-looking statements in the future.

Also, during the course of this conference call, we may discuss non-GAAP measures when talking about the company's performance. Reconciliations to the most directly comparable GAAP financial measures are provided in the tables in the earnings press release issued today and available on the Investor Relations section of our website. These financial measures are included for the benefit of investors and should be considered in addition to and not instead of GAAP measures.

Joining me on today's call, we have Brett Jackson, Chief Executive Officer; and Mike Myshrall, Chief Financial Officer. With that, I will now hand the call over to Brett.

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Brett M. Jackson, CYREN Ltd. - CEO & Director [3]

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Thanks, Eric. I'd like to thank everyone for making time to join our call today. Cyren is now 2 quarters into the implementation of a new strategy that touches many areas of our company. Fully implementing a new strategy is clearly a time-consuming endeavor, which will span multiple quarters. While we have much work to do, and it will take time, focus and some patience to deliver the results we are aiming for, we are on track through the first half of our fiscal year.

Before I comment on specifics of our second quarter, let me remind everyone what we have set out to accomplish. We are focused on creating and driving growth as our top priority. And our new strategy gives us multiple avenues to do this, with an emphasis on growing enterprise revenues. We have reprioritized our core threat intelligence services business. This business has historically focused on an OEM market, providing threat detection services and threat intelligence to major e-mail providers, leading cybersecurity vendors as well as MSPs. We have been very successful in this market, but we will expand beyond the OEM market into what we believe is a larger enterprise market opportunity, leveraging existing technology and creating new products for enterprise customers.

In addition to our threat intelligence business initiatives, we are evolving our e-mail security business and leveraging our phishing detection and e-mail security expertise to address the large and growing problem of phishing, especially from users of Microsoft 365, the dominant e-mail platform in enterprises today. Our next-generation e-mail security product provides enterprises with phishing mitigation solution that we believe is far more effective than traditional secure e-mail gateways.

Regarding our second quarter, first and foremost, we achieved our key Q2 operational milestones related to strategy implementation. We completed the retooling of our sales force and product organizations to support our new product and associated go-to-market strategies. We delivered 2 new enterprise products in the quarter, both on schedule. Cyren Inbox Security targets e-mail-borne phishing threats faced by enterprises using Microsoft 365. Cyren Inbox Security is the first cloud-based service to combine continuous e-mail monitoring and threat detection with automated response and remediation for corporate e-mail inboxes.

Cyren Threat InDepth provides enterprise customers uniquely detailed and actionable threat intelligence that can be used by security teams, researchers and incident responders to make the right decisions more quickly. Threat InDepth is the first step in expanding Cyren's threat intelligence business into the enterprise market. We closed our first customer orders for both of our new enterprise products, providing initial validation of customer value and product market fit.

In addition to our new product development work, we have a renewed emphasis on enhancing our existing products. In the quarter, our R&D and product teams delivered key product road map enhancements to ensure that our products continue to deliver value to our customers, enabling Cyren to maximize customer satisfaction and retention. I have to express my appreciation and thanks to our team for their hard work, dedication and achievement of our Q2 objectives despite the challenges of living and working in a COVID-19-influenced environment.

Stating the obvious, we are at a relatively early stage of strategy execution. As I mentioned previously, some of the key foundational pieces are in place and we are making headway, but this is a work in progress and there is more to do. We fully appreciate the need to grow to build value for our shareholders and we believe we will get there, but it will take time to materially impact our financial results.

Lastly, while achieving growth is our priority and growth requires time and investment, we also understand that we need to continue to rationalize our cost structure, which we review on a regular basis.

I will now turn the call over to Mike, who will go through our second quarter financials.

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J. Michael Myshrall, CYREN Ltd. - CFO [4]

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Thank you, Brett, and good morning, everyone. I will now present our second quarter 2020 financial results. For more details on these results, please refer to the earnings press release that was issued earlier today and is posted on the Investor Relations section of our website and our quarterly filings on Form 10-Q.

Please note that we present our financials under U.S. GAAP accounting standards, including nonoperating expenses, and that I will discuss certain financial metrics on a non-GAAP or adjusted basis, which excludes those nonoperating items. Please refer to the table in today's earnings release for a reconciliation of our GAAP to non-GAAP results.

GAAP revenue for the second quarter of 2020 was $9.2 million compared to $9.7 million reported during the second quarter of 2019. On a constant currency basis, Q2 revenue would have been approximately $9.3 million or a decrease of 4%. The decrease in revenue year-over-year is the result of a few customer terminations in our threat intelligence business in 2019 as well as lower revenue recognition during the quarter from one of our largest customers, who recently transitioned from an annual flat fee contract to a minimum commitment contract with a variable usage component.

In addition, we discussed last year and highlighted in our 10-K annual report, during 2019, we announced the end of life of some of our legacy offerings on the Cyren Cloud Security platform, including Cyren Web Security. And the lower revenue during the period can partially be attributable to the decline of revenues associated with those products.

GAAP gross margins for the second quarter were 59% compared to 61% during Q2 2019. On a non-GAAP basis, gross margins were 66% compared to 69% during the second quarter of 2019. GAAP and non-GAAP cost of goods sold during the quarter was roughly in line with the same period as a year ago, so the reduction in gross margin is largely a function of lower revenue.

Second quarter GAAP net loss was $4.6 million, in line with the $4.6 million net loss reported during the second quarter of 2019. On a per share basis, GAAP net loss was $0.08 per basic and diluted share in both Q2 2020 and Q2 2019. On a non-GAAP basis, Cyren's second quarter net loss was $3.9 million compared to $4.1 million during the second quarter of 2019. This translates to a loss of $0.06 per basic and diluted share versus $0.08 per share in the same period last year.

As a reminder, Cyren's non-GAAP results exclude a number of noncash items, including the effect of stock-based compensation, amortization of intangible assets and capitalization of technology. Please refer to the table in our press release for a reconciliation of selected GAAP to non-GAAP measures.

GAAP operating expenses for the quarter totaled $9.8 million, down from $10.3 million during Q2 2019, a decrease of 5%. On a non-GAAP basis, total operating expenses for the quarter totaled $9.5 million, down from $10.5 million in the second quarter of 2019, a 9% decrease year-over-year.

During the quarter, GAAP R&D expense was $4.2 million compared to $4.3 million in the second quarter of 2019 but notably higher than the GAAP R&D expense of $3.3 million reported last quarter. The main reason for the increasing GAAP R&D expense during the quarter is attributed to lower R&D capitalization of technology related to our new product development efforts for Cyren Inbox Security and our Threat InDepth offerings, both of which were released ahead of schedule during the second quarter.

Since the initial R&D efforts related to those projects have largely been completed, we expect lower R&D capitalization in future quarters and therefore, GAAP R&D expense is expected to be higher during the second half of the year. On a non-GAAP basis, which excludes the effect of R&D capitalization, R&D expense for the period decreased from $4.9 million in 2019 to $4.5 million in 2020.

GAAP sales and marketing expense for the quarter was $3.1 million compared to $3.6 million during the second quarter of 2019, a decrease of 12%. Overall, sales and marketing expense represented about 34% of revenue compared to 37% of revenue a year ago. Non-GAAP sales and marketing expense was $3 million compared to $3.4 million during the second quarter of 2019.

G&A expense for the quarter was $2.5 million compared to $2.4 million during the second quarter of 2019. On a non-GAAP basis, G&A expense was $2.1 million compared to $2.2 million a year ago. We finished the quarter with 230 full-time and part-time employees in the business, down from 265 employees at the end of Q2 2019. The overall decrease in operating expenses is consistent with the reduction in headcount year-over-year.

During the quarter, we had positive operating cash flow of $2.5 million compared to operating cash flow of $0.8 million during the second quarter of 2019. During the quarter, we collected several million dollars in annual prepayments from 2 of our largest customers, which helped increase our cash balance and also increased deferred revenue from $7.2 million at the end of December 2019 to $9.7 million at the end of Q2. Overall, net cash flow for the quarter was positive $1 million, and our cash balance increased from $15.1 million at the end of the first quarter to $16.1 million at the end of the second quarter.

Our threat intelligence business renewal activity during the quarter was in line with expectations, with no significant churn during the second quarter. We had several of our long-standing threat intelligence customers renew for periods ranging from 1 to 3 years. While pricing pressure upon renewal is always a factor, 1 notable customer renewed for another year at a 15% premium and that account has now been an active customer of Cyren for over 12 years. During the quarter, our overall gross retention rate was 94%, which is above our target to keep both renewal and gross retention rates above 90%.

In 2019, we made the strategic decision to narrow down our product portfolio and focus our enterprise efforts on e-mail security and threat intelligence offerings. This included announcing the end of life for certain legacy cloud security products, including Cyren Web Security, which will wind down by the end of 2020. The decrease in revenue during the quarter is partially attributable to the expiration of these web security contracts that were not renewed due to product end of life. We expect this trend will continue over the next 2 quarters until all of these contracts have fully expired.

As Brett mentioned, during the second quarter, we released 2 enterprise products related to our new product strategy: Cyren Inbox Security and Threat InDepth. We signed multiple new contracts during the second quarter, but due to the ratable nature of our revenues, these contracts contributed very little revenue recognition into the quarter. We believe that it will take several quarters for the revenues of the new product offerings to meaningfully impact our results.

We do not believe the ongoing COVID-19 crisis had a significant impact on business operations during the second quarter. While it did take longer to close certain customer contracts and it is more challenging for our sales and marketing teams to develop new business, many of our customers have not experienced a downturn in their business and the need for cybersecurity solutions is as important as ever. We will continue to monitor the situation and the related economic impact that it may have on our business over the coming quarters.

I will now ask the operator to open up the lines for Q&A. Jerry?

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Questions and Answers

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Operator [1]

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(Operator Instructions) We have a question from Chad Bennett, Craig-Hallum.

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Chad Michael Bennett, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [2]

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So either Brett or Mike, so just on the customer -- the threat intelligent customer that changed kind of contract terms from annual flat fee to a minimum with a variable component. Kind of can you give at least maybe qualitatively how much of a change that was in terms of -- more importantly, the go forward? I assume it's somewhat of a headwind to growth, but any more color there?

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J. Michael Myshrall, CYREN Ltd. - CFO [3]

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Sure. So it was 1 of our top 5 customers that obviously is a 7 figure a year customer. They are using more of our services than they were previously. But with the variable usage nature of the contract, that means that we won't necessarily see revenues increasing from that customer until towards the end of the first contract year. So during the second quarter, we had a minor impact on revenue recognition from that customer. But overall, for the full year, we would expect that, that customer would maintain the same value.

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Chad Michael Bennett, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [4]

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Okay. So not really a headwind, too, going forward. Is that fair?

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J. Michael Myshrall, CYREN Ltd. - CFO [5]

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Well, it may take a quarter or 2 to catch up to the full value. So -- but in the first and second quarters of the contract, it was below the flat fee run rate from a year ago.

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Chad Michael Bennett, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [6]

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Right. And then maybe for Brett, can you just speak to kind of the -- Microsoft is obviously a phenomenal partner of your -- you guys. And just is there anything in terms of you can share in terms of the take rate of Cyren e-mail security and phishing products? I know phishing is relatively new, but the take rate of that within that Office 365 base at this point and kind of what you're seeing there?

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Brett M. Jackson, CYREN Ltd. - CEO & Director [7]

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Chad, the product you're referring to, Cyren Inbox Security, was just released April 27. As Mike mentioned, and I think we both mentioned, we've got some initial traction. We met our internal sales target for Q2. But I would say it's too early to know the answer to your question precisely. We expect that we will achieve a good penetration of the Microsoft market. This is a big market opportunity. Phishing is a common problem. There's 200 million Microsoft 365 inboxes. There is competition, no question. But our experience so far has been very positive with respect to the real need customers have to address phishing. So early to tell, but we'll have more data for you in future quarters as we get broader into the market.

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Chad Michael Bennett, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [8]

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And then maybe last one for me, again, probably for Mike. Mike, can you remind us from a kind of run rate standpoint, the mix of the OEM versus direct business today?

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J. Michael Myshrall, CYREN Ltd. - CFO [9]

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Yes. So the -- as of the end of the year 2019, we were at 81% in our threat intelligence OEM business and 19% on the enterprise. It's roughly still the same. We do anticipate that we're going to grow our enterprise business faster than the threat intelligence business. And so we would expect that mix to increase over time. Because we are -- because we have end of life, some of the legacy products, Cyren Web Security, which did fall under that enterprise ARR base, it has decreased a little bit, but the new CIS product and the Threat InDepth products should add to the enterprise revenue moving forward.

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Brett M. Jackson, CYREN Ltd. - CEO & Director [10]

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And I would add, as I mentioned earlier in my comments, our priority is to drive more enterprise revenue. So you may have noted that our 2 most recent product launches were enterprise -- were targeted at the enterprise, and that is our focus. We'll maintain our position in the OEM market. There's more opportunity there. But our strategic focus is to drive more enterprise revenues. And as Mike said, we'd like to see that mix change. It is hard to predict how and when it will change, but that's our focus.

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Chad Michael Bennett, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [11]

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Got it. And then maybe one last one for me. Brett, just on -- it's good to see you're already garnering some wins for the Threat InDepth product and Inbox Security on the direct enterprise side of the business. Can you just characterize from a kind of deal size, ASP standpoint, kind of I guess, what you've seen thus far? Obviously, low numbers but kind of how you think about deal size going forward for those products?

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Brett M. Jackson, CYREN Ltd. - CEO & Director [12]

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Yes. I'd rather not comment on that, Chad, until we have more data points. A lot depends on size of customers. So we are looking at our Cyren Inbox Security targeting the mid-market as well as the enterprise. And I think we want to get into the market a little bit further to see how the ASP picture looks. So too early to tell. But we'll have more data for you as we get into the -- or get through the third quarter probably. We're starting to see our first larger opportunities for Cyren Inbox Security, which I think will have an impact on ASP. So I'd rather wait to comment on that.

The Cyren Threat InDepth solution for the enterprise, we expect ASPs to be consistent with those in our OEM space. So those are typically somewhere around 7-figure ACV deals. Close to 7-figure ACV deals, could be higher, consistent with what we've seen in the OEM space.

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Chad Michael Bennett, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [13]

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Okay. Good. Fair enough. I appreciate…

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Brett M. Jackson, CYREN Ltd. - CEO & Director [14]

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Sorry. Chad, I have to correct myself. I meant to say 6 figures, not 7 figures. 6 figures.

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Operator [15]

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(Operator Instructions) Ladies and gentlemen, there are no further questions. I'd like to turn the call back over to Brett Jackson for closing remarks. Mr. Jackson?

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Brett M. Jackson, CYREN Ltd. - CEO & Director [16]

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We'd like to thank everyone for joining us on our call today and your interest in Cyren. We look forward to the second half of 2020 and keeping you updated on our progress in future quarters. Thank you.

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Operator [17]

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This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.