CYREN Ltd. - Quarter Report: 2019 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2019

OR

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                       to                     

Commission file number: 000–26495

CYREN LTD.

(Exact name of Registrant as specified in its charter)

Registrant’s telephone number, including area code 011–972–9–863–6888

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒  No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒  No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes ☐  No ☒

Securities registered pursuant to Section 12(b) of the Act:

Indicate the number of shares outstanding of each issuer’s classes of common stock, as of the latest practicable date: 54,511,307 ordinary shares as of July 31, 2019.

Table of Contents

CYREN LTD.

CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF June 30, 2019

($USD in thousands, except share and per share amounts)

(Unaudited)

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

CYREN LTD.

CONDENSED CONSOLIDATED BALANCE SHEETS

($USD in thousands, except share and per share amounts)

(Unaudited)

The accompanying notes are an integral part of the interim consolidated financial statements.

CYREN LTD.

CONDENSED CONSOLIDATED BALANCE SHEETS

($USD in thousands, except share and per share amounts)

(Unaudited)

The accompanying notes are an integral part of the interim consolidated financial statements.

CYREN LTD.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

($USD in thousands, except share and per share amounts)

(Unaudited)

The accompanying notes are an integral part of the interim consolidated financial statements.

CYREN LTD.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

($USD in thousands, except share and per share amounts)

(Unaudited)

The accompanying notes are an integral part of the interim consolidated financial statements.

CYREN LTD.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY 

($USD in thousands, except share and per share amounts)

(Unaudited)

The accompanying notes are an integral part of the interim consolidated financial statements.

CYREN LTD.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

($USD in thousands, except share and per share amounts)

(Unaudited)

The accompanying notes are an integral part of the interim consolidated financial statements.

CYREN LTD.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

($USD in thousands, except share and per share amounts)

(Unaudited)

The accompanying notes are an integral part of the interim consolidated financial statements.

CYREN LTD.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

($USD in thousands, except share and per share amounts)

(Unaudited)

Cyren Ltd. (henceforth “Cyren”) was incorporated under the laws of the State of Israel on February 10, 1991 and its legal form is a company limited by shares. Cyren listed its shares to the public on July 15, 1999 under the name Commtouch Software Ltd. and changed its legal name to Cyren Ltd. in January 2014. Cyren and its subsidiaries, unless otherwise indicated will be referred to in these consolidated financial statements as the “Company”.

The Company is engaged in developing and marketing information security solutions for protecting web, email and mobile transactions. The Company sells its cloud-based solutions worldwide, in both embedded and Security-as-a-Service models, to Original Equipment Manufacturers (“OEMs”), service providers and enterprises. The Company operates in one reportable segment, which constitutes its reporting unit.

The accompanying consolidated balance sheet as of June 30, 2019, the consolidated statements of operations, the consolidated statements of comprehensive loss and the statement of changes in shareholders’ equity for the three and six months ended June 30, 2019 and 2018, as well as the consolidated statements of cash flows for the six months ended June 30, 2019 and 2018, are unaudited. These unaudited interim consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”) and applicable rules and regulations of the Securities and Exchange Commission regarding interim financial reporting. In management’s opinion, the unaudited interim consolidated financial statements include all adjustments of a normal recurring nature necessary for the fair presentation of the Company’s financial position as of June 30, 2019, as well as its results of operations for the three and six months ended June 30, 2019 and 2018. The results of operations for the three and six months ended June 30, 2019 are not necessarily indicative of the results to be expected for the year ending December 31, 2019 or for other interim periods or for future years.

CYREN LTD.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

($USD in thousands, except share and per share amounts)

(Unaudited)

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates, judgments and assumptions. The Company’s management believes that the estimates, judgments and assumptions used are reasonable based upon information available at the time they are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the interim consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. On an ongoing basis, the Company’s management evaluates estimates, including those related to fair value and useful lives of intangible assets, fair value of earn-out liabilities, valuation allowance on deferred tax assets, income tax uncertainties, fair values of stock-based awards, other contingent liabilities and estimates used in applying the revenue recognition policy. Such estimates are based on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities.

The accompanying unaudited interim financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”) on March 29, 2019.

There have been no changes in the significant accounting policies from those that were disclosed in the audited consolidated financial statements for the fiscal year ended December 31, 2018 included in the 2018 Form 10-K.

In June 2018, the FASB issued ASU No. 2018-07, “Compensation – Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting.” These amendments expand the scope of Topic 718, Compensation - Stock Compensation (which currently only includes stock-based payments to employees) to include stock-based payments issued to nonemployees for goods or services. Consequently, the accounting for stock-based payments to nonemployees and employees will be substantially aligned. This ASU supersedes Subtopic 505-50, Equity - Equity-Based Payments to Non-Employees. Adoption of this standard had an immaterial impact on the Company’s consolidated financial statements.

CYREN LTD.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

($USD in thousands, except share and per share amounts)

(Unaudited)

In February 2016, the FASB issued ASU 2016-02, “Leases”, on the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e., lessees and lessors). The new standard supersedes the lease requirements in Accounting Standards Codification (ASC) Topic 840, “Leases” and requires lessees, to classify leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease, respectively. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for in a manner similar to the accounting under existing guidance for operating leases today. The new standard requires lessors to account for leases using an approach that is substantially equivalent to existing guidance for sales-type leases, direct financing leases and operating leases. The Company adopted ASU 2016-02 as of January 1, 2019, using the modified retrospective approach. For additional information regarding the Company's accounting for leases, please refer to Note 3.

In January 2017, the FASB issued ASU 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. ASU 2017-04 eliminates step two of the goodwill impairment test and specifies that goodwill impairment should be measured by comparing the fair value of a reporting unit with its carrying amount. Additionally, the amount of goodwill allocated to each reporting unit with a zero or negative carrying amount of net assets should be disclosed. ASU 2017-04 is effective for annual or interim goodwill impairment tests performed in fiscal years beginning after December 15, 2019, and early adoption is permitted. The Company is currently assessing the impact of the adoption of this standard on its consolidated financial statements and footnote disclosures.

In August 2018, the FASB issued ASU No. 2018-15, Customer’s Accounting for implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (“ASU 2018-15”). ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The update to the standard is effective for interim and annual periods beginning after December 15, 2019, with early adoption permitted. Entities can choose to adopt the ASU 2018-15 prospectively or retrospectively. The Company is currently assessing the impact of the adoption of this standard on its consolidated financial statements and footnote disclosures.

CYREN LTD.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

($USD in thousands, except share and per share amounts)

(Unaudited)

The Company adopted the new standard as of January 1, 2019, using the modified retrospective approach. The modified retrospective approach provides a method for recording existing leases at adoption and in comparative periods that approximates the results of a full retrospective approach. The Company has elected to utilize the available package of practical expedients permitted under the transition guidance within the new standard which does not require it to reassess the prior conclusions about lease identification, lease classification and initial direct costs.

In addition, the Company has elected the short-term lease exception for leases with a term of 12 months or less. As part of this election it will not recognize right-of-use assets and lease liabilities on the balance sheet for leases with terms less than 12 months.

Some leases include one or more options to extend the lease. The exercise of options to extend the lease is typically at the Company’s sole discretion; therefore, the majority of renewals to extend the lease terms are included in our right of use assets and lease liabilities as they are reasonably certain of exercise. The Company regularly evaluates the renewal options, and, when it is reasonably certain of exercise, it will include the renewal period in its lease term. Lease modifications result in remeasurement of the lease liability. 

The right-of-use asset and lease liability are initially measured at the present value of the lease payments, discounted using the interest rate implicit in the lease or, if that rate cannot be readily determined, the Company’s incremental borrowing rate based on the information available at the date of adoption in determining the present value of the lease payments.

Some of the real estate leases contain variable lease payments based on an index or rate. Variable lease payments based on an index or rate are initially measured using the index or rate in effect at lease adoption. Additional payments based on the change in an index or rate are recorded as a period expense when incurred. 

CYREN LTD.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

($USD in thousands, except share and per share amounts)

(Unaudited)

The Company has various operating leases for office space, vehicles that expire through 2030. Below is a summary of our operating right-of-use assets and operating lease liabilities as of June 30, 2019:

The short-term lease liabilities are included within accrued expenses and other short-term  liabilities in the consolidated balance sheet.

Minimum lease payments for our right of use assets over the remaining lease periods as of June 30, 2019, are as follows:

Premises rent expense was $496 and $452 for the three months ended June 30, 2019 and 2018, respectively and $963 and $893 for the six months ended June 30, 2018.

As of June 30, 2019, the Company had an additional operating lease that had not yet commenced in the amount of $3,675. This operating lease will commence in the first quarter of 2020 with a lease term through 2029.

The weighted average remaining lease terms and discount rates for all of operating leases were as follows as of June 30, 2019:

CYREN LTD.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

($USD in thousands, except share and per share amounts)

(Unaudited)

In connection with specific research and development, the Company received $3,699 of participation payments from the IIA through June 30, 2019. In return for the IIA’s participation in this program, the Company is committed to pay royalties at a rate of 3.5% of the program’s developed product sales, up to 100% of the amount of grants received plus interest at annual LIBOR rate. The Company’s total commitment for royalties payable with respect to future sales, based on IIA participations received, net of royalties paid or accrued, totaled $2,780 and $2,734 as of June 30, 2019 and December 31, 2018 respectively.

CYREN LTD.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

($USD in thousands, except share and per share amounts)

(Unaudited)

The vendor is claiming license fees of approximately $3,150 and an injunction relief ordering the Company and/or its customers to delete any remaining data and to cease from utilizing such data.

The Company denies all claims and has filed a Statement of Defense on November 15, 2017. Pretrial was scheduled for May 15, 2018. In accordance with the court’s recommendation from November 28, 2017, the parties agreed to examine a non-binding mediation process and have appointed a mediator. The parties agreed to conduct a third-party audit of the Company’s databases in the scope of the mediation and the audit is currently being conducted. At this early stage, the Company is unable to make any estimations as to the outcome of this litigation.

In September 2018 and January 2019, the same vendor filed a lawsuit against two of the Company’s customers in the United States. The vendor alleges that the clients misappropriated the vendor’s trade secrets and is seeking injunctive relief and monetary damages in an amount to be determined. Both customers have contended that the allegations relate to the services they receive from the Company, and the Company has agreed to indemnify both clients against these claims. As such, the Company has taken over the representation in these lawsuits. At this early stage, the Company is unable to make any estimations as to the outcome of these litigations.

Ordinary shares confer upon their holders the right to receive notice to participate and vote in general shareholder meetings of the Company and to receive dividends, if declared.

On December 5, 2018 the Company issued $10,000 aggregate principal amount of convertible notes in a private offering. The notes are unsecured, unsubordinated obligations of Cyren and carry a 5.75% interest rate, payable semi-annually in (i) 50% cash and (ii) 50% cash or ordinary shares at Cyren’s election. The notes have a 3-year term and are expected to mature in December 2021, unless converted in accordance with their terms prior to maturity. The notes have a conversion price of $3.90 per share. The conversion price may be subject to adjustment using a weighted average ratchet mechanism based on the size and price of future equity offerings and the total shares outstanding. In addition, the notes would be subject to immediate conversion upon any change in control in the Company (or subject to repayment if the price in the change in control transaction is less than the conversion price). The Company incurred interest expense for the six months ended June 30, 2019 of $282. In June 2019, the Company paid the first of the semi-annual interest payments totaling, $287, of which $215 was paid in cash and the remaining portion through the issuance of 35,950 shares.

CYREN LTD.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

($USD in thousands, except share and per share amounts)

(Unaudited)

In 1996, the Company adopted the 1996 CSI Share Option Plan for granting options to its U.S. employees and consultants to purchase ordinary shares of the Company, which was replaced in 2006 by the 2006 U.S. Share Option Plan. Until 1999, the Company issued options to purchase ordinary shares to its Israeli employees pursuant to individual agreements. In 1999, the Company approved the 1999 Section 3(i) stock option plan for its Israeli employees and consultants, (which was amended in 2003 and renamed the “Amended and Restated Israeli Share Option Plan”). On December 22, 2016, the Company’s shareholders approved a new stock option plan - the 2016 Equity Incentive Plan (the “Equity Incentive Plan”). This plan, along with its respective Israeli appendix, has replaced all existing employee and consultants stock option plans which have terminated.

The Equity Incentive Plan allows for the issuance of Restricted Share Units (“RSUs”), as well as options. The options and RSUs generally vest over a period of four years. Options granted under the Equity Incentive Plan generally expire after six years from the date of grant. Options and RSUs cease vesting upon termination of the optionee’s employment or other relationship with the Company. The per share exercise price for options shall be no less than 100% of the fair market value per ordinary share on the date of grant. Any options and RSUs that are canceled or not exercised within the option term become available for future grant.

As of June 30, 2019, an aggregate of 306,493 ordinary shares of the Company are available for future grant under the Equity Incentive Plan. At the Company’s Annual Meeting on July 30, 2019, our shareholders approved an increase in the number of Ordinary Shares reserved for issuance under the 2016 Equity Incentive Plan and its respective Israeli Appendix to a total of 11,200,000.

In 1999, the Company adopted the 1999 Directors Share Option Plan, and in 2008 shareholders approved an extension of the term of this plan through July 13, 2019. On December 15, 2006, the plan was extended through 2016. On December 22, 2016, the Company’s shareholders approved a new stock option plan - the 2016 Non-Employee Director Equity Incentive Plan (the “Non-Employee Director Plan”). This plan, along with its respective Israeli appendix, has replaced all existing Directors stock option plans which have terminated.

The Non-Employee Director Plan allows for the issuance of Restricted Share Units (“RSUs”), as well as options. Each option and RSU granted under the Non-Employee Plan generally vests over a period of four years. Each option has an exercise price equal to the fair market value of the ordinary shares on the grant date of such option. Options granted under the Non-Employee Director Plan generally expire after six years from the date of grant. Options and RSUs cease vesting upon termination of the relationship with the Company.

As of June 30, 2019, an aggregate of 170,214 ordinary shares of the Company are still available for future grant to non-employee directors. At the Company’s Annual Meeting on July 30, 2019, our shareholders approved an increase in the number of Ordinary Shares reserved for issuance under the Non-Employee Director Plan and its respective Israeli Appendix to a total of 1,150,000 Ordinary Shares.

CYREN LTD.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

($USD in thousands, except share and per share amounts)

(Unaudited)

As of June 30, 2019, the Company had $2,293 of unrecognized compensation expense related to non-vested stock options granted to employees and directors, expected to be recognized over a remaining weighted average period of 3.21 years.

CYREN LTD.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

($USD in thousands, except share and per share amounts)

(Unaudited)

The options vest and become exercisable at a rate of 1/16 of the options every three months.

As of June 30, 2019, the Company had approximately $2,137 of unrecognized compensation expense related to RSUs, expected to be recognized over a weighted average period of 3.32 years.

CYREN LTD.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

($USD in thousands, except share and per share amounts)

(Unaudited)

Summary information about geographic areas:

ASC 280, “Segment Reporting,” establishes standards for reporting information about operating segments. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The Company manages its business on the basis of one reportable segment and derives revenues from licensing of software and sales of professional services, maintenance and technical support (see note 1 for a brief description of the Company’s business). The following is a summary of revenues within geographic areas:

CYREN LTD.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

($USD in thousands, except share and per share amounts)

(Unaudited)

During the quarter ended June 30, 2019, 20% of the Company’s revenues were derived from customer A. During the quarter ended June 30, 2018, 21% of the Company’s revenues were derived from customer A.

- - - - - - - - - - - - -

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the information contained in our consolidated financial statements and the notes thereto. The following discussion and analysis includes forward-looking statements that involve certain risks and uncertainties, including, but not limited to, those described in Item 1A. Risk Factors in our most recent Annual Report on Form 10-K (the “2018 Annual Report”). Our actual results may differ materially from those discussed below. See “Special Note Regarding Forward-Looking Statements” below.

Overview

Purpose built for the cloud, Cyren is an early pioneer and leading innovator of SaaS security solutions that protect businesses and their employees and customers from threats on the web, in email and on mobile devices. Our mission is to protect people and organizations from cyber threats when they use the internet.

Cyren’s cloud-first approach to security sets us apart from other vendors in the market. Cyren is an internet security company that is delivering security results that are disrupting legacy vendors and appliance-based solutions. Our security solutions are architected around the fundamental belief that internet security is a race against time – and the cloud best enables the speed, sophistication and advanced automation needed to detect and block threats as they emerge on the internet.

Cyren’s security cloud delivers faster detection and protection, with SaaS security solutions that inspect web and email traffic before it reaches a user’s browser or inbox – often identifying and blocking threats in just seconds. Our SaaS solutions are easy to deploy and manage, delivering critical security and faster innovation, for a low total cost of ownership.

Cyren’s cloud security services are sold into two markets:

Key Opportunities and Challenges

Threat Landscape

Over the last several years, possibly the greatest magnitude of significant incidents directly related to malware and cyber threats have occurred since the advent of the internet. From election hacks to global ransomware attacks and cyber breaches, malware threats are at an all-time high. Today, no item or user connected to the internet is immune to attack. While many businesses are still exploring effective security measures, cybercriminals are “all in”, creating dangerous new tools to target companies, governments, and private citizens. We need to be mindful that the world has changed; hyper-evasive malware and threat distribution via HTTPS are growing rapidly, mobile devices are increasingly targets, and Internet of Things (IoT) devices, from refrigerators to televisions, are an inviting new vector for criminal attacks. 

Cloud and Mobility

Businesses are going through a massive change in their IT strategies as they look to drive more business value, agility, and better customer experiences, while cloud and mobility are becoming increasingly important, as evidenced by the following trends:

These are some of the reasons why we believe Cyren’s vision for 100% cloud security is compelling to IT security teams looking to protect their businesses in today’s cloud-centric mobile-first world.

Investments in Operations, Research and Development and Sales and Marketing

Our cost of revenues, research and development (“R&D”) expenses, and sales and marketing expenses are all significant contributing factors to our operating losses. Nonetheless, we expect to increase our investments in all three areas in order to grow our revenues. Over time, we expect that our utilization of our cloud infrastructure will increase and provide the opportunity for improved gross margins. Our investments in R&D are required in order to enhance and improve our solutions. In the future, we expect to lower the rate of R&D investment as a percentage of revenue, and we will be able to drive more revenue from existing solutions rather than by adding new solutions. The return on our sales and marketing investment is tied to attracting new customers and enhancing our business with existing customers, thereby lowering the overall sales and marketing costs as a percent of revenues. Finally, we continue to increase our headcount to support the growth of the business, but we expect that reducing the historical rate of headcount growth will be key in improving our gross and operating margins over time.

Growing Our Enterprise SaaS Business

Although all of our services are subscription services, our Enterprise Security-as-a-Service offerings on the CCS platform are typically invoiced up front for an annual contract amount, or the full multi-year contract amount, at the start of the term. As a result, this business is expected to provide a larger immediate contribution to cash flow and better return on investment. As this enterprise business grows as a portion of our overall revenues, we expect to increase deferred revenue and our operating results and cash flow to improve, which will make us less reliant on other sources of capital in the future.

Components of our Operating Results

Revenue

We derive revenues from the sale of real-time cloud-based services for each of Cyren’s email security, web security, antimalware and advanced threat protection offerings.

We sell all of our solutions as subscription services, either through OEMs and service providers, which are considered Cyren customers, or as complete security services directly, or indirectly via our partners, to enterprises.

Cost of Revenues

Personnel costs, which consist of salaries, benefits, bonuses and stock-based compensation for employees that operate our network and provide support services to our customers, as well as data center costs, are the most significant components of our cost of revenues. Other costs include third party contractors, royalties for use of third-party technologies, amortization of intangibles and depreciation of data center equipment. We expect these costs to continue to increase in absolute dollars as we continue to invest in enhancing our cloud infrastructure and our support services.

Operating Expenses

Our operating expenses consist of R&D, sales and marketing, and general and administrative expenses. Personnel costs, which consist of salaries, benefits, bonuses, and stock-based compensation, are the most significant component of our operating expenses. Operating expenses also include allocated overhead costs for facilities, IT and depreciation. We expect operating expenses to increase in absolute dollars as we continue to grow.

Research and Development. R&D expense consists primarily of personnel costs, outsourced engineering and threat analysis services. We believe these investments are crucial for our ability to continue to enhance the functionality of our services, as well as to develop and introduce new services to the market. We expect R&D expenses to continue increasing in absolute dollars as we continue to invest in our service offerings. Development costs related to internal use technology that supports our security services are capitalized on the balance sheet, while other development costs are expensed as they are incurred.

Sales and Marketing. Sales and marketing expenses primarily include personnel costs, sales commissions, marketing activities, and travel associated with sales and marketing. We market and sell our services worldwide through our sales organization and distribution channels. We capitalize sales commissions paid to internal sales personnel and amortize these expenses over an estimated period of benefit that reflects the expected future revenue streams. We expect our sales and marketing expenses to continue to increase in absolute dollars as we continue to enhance our sales and marketing teams to support our further growth. Our sales personnel are typically not immediately productive, and therefore the increase in expenses we incur when adding personnel is not immediately accompanied by increased revenue and in some cases may not result in increased revenue if these new sales personnel are unsuccessful in becoming productive.

General and Administrative. General and administrative expenses consist primarily of personnel costs, audit fees, legal expenses, recruiting expenses and other general operating costs. We expect our general and administrative expenses to continue to grow in absolute dollars as we continue our operational growth.

Other Income (Expense), net

Other income (expense), net consists primarily of capital gain or loss from the sale of assets.

Financial Expenses, net

Financial expenses, net consist mainly of foreign exchange gains and losses, interest expense on our outstanding debt and interest income earned on our cash and cash equivalents.

Tax Benefit

Our tax benefit is derived primarily from income taxes in foreign jurisdictions in which we conduct business. We estimate income taxes in each of the jurisdictions in which we operate. This process involves determining income tax expense together with calculating the deferred income tax expense related to temporary differences resulting from the differing treatment of items for tax and accounting purposes. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. These temporary differences result in deferred tax assets and liabilities, which are included net as applicable within our balance sheets. For most of our recent years, we have incurred operating losses in Israel and the U.S., where we have recorded a full valuation allowance against our deferred tax assets in those jurisdictions.

RESULTS OF OPERATIONS

The following table sets forth financial data for the three and six months ended June 30, 2019 and 2018. Percentages may not add due to rounding.

Three and Six Months Ended June 30, 2019 Compared to the Three and Six Months Ended June 30, 2018

Revenues. Revenues for the three and six months ended June 30, 2019 increased $0.5 million, or 6%, and $2.5 million or 15%, respectively, as compared to the corresponding periods last year. The increase was primarily driven by contract expansions with a large Threat Intelligence customer which was signed during the fourth quarter of 2018, as well as new and upsell contracts in the enterprise business during the second half of 2018. These increases were offset by a small number of customer terminations in the Threat Intelligence and enterprise businesses, but overall contract renewal rates were consistent with prior periods.

Cost of Revenues. Cost of revenues for the three and six months ended June 30, 2019 increased $0.2 million, or 4%, and $0.8 million or 11%, respectively, as compared to the corresponding periods last year.

For the three months ended June 30, 2019 cost of revenues represented 39% of revenue, compared to 40% during the prior year, and accordingly gross margins for the period were 61% for the three months ended June 30, 2019 compared to 60% for the same period in the prior year. For the six months ended June 30, 2019 cost of revenues represented 40% of revenue, compared to 42% during the prior year, and accordingly gross margins for the period were 60% for the six months ended June 30, 2019 compared to 58% for the same period in the prior year. The increase in cost of revenues is the result of continued investment in our global network and data centers, as well as additional payroll expense in our Support and Operations groups compared to the prior year. During the period, there was a slight decrease in amortization of capitalized development expenses for the three and six months ended June 30, 2019 to $0.8 million from $0.9 million and to $1.6 million from $1.8 million during the prior year.

Operating Expenses. Overall operating expenses for the three and six months ended June 30, 2019 increased $0.6 million, or 6%, and $1.5 million or 8%, respectively, as compared to the corresponding periods last year.

Operating expenses for the three months ended June 30, 2019 represented 106% of revenue, compared to 105% during the prior year. For the six months ended June 30, 2019, operating expenses represented 107% of revenue, compared to 114% during the prior year. The increase in operating expenses was primarily due to an increase in employee headcount, captured in cost of revenues and operating expenses, which totaled 265 employees at the end of June 30, 2019, compared to 251 employees at the end of June 30, 2018.

Research and Development, Net. Research and development expenses, net increased $0.6 million, or 17%, and $1.5 million, or 21%, respectively, for the three and six months ended June 30, 2019, as compared to the corresponding periods last year. R&D expense, net for the three months ending June 30, 2019 represented 44% of revenue, compared to 40% a year ago. For the six months ending June 30, 2019, R&D expense, net represented 44% of revenue compared to 42% a year ago. The increase in R&D expense is primarily driven by increased employee headcount, higher payroll and an increase in outsourced development compared to the same period in 2018. Capitalization of technology development decreased to $0.7 million for the three months ended June 30, 2019 from $0.8 million for the three months ended June 30, 2018 and to $1.4 million from $1.6 million for the six months ended June 30, 2019.

Sales and Marketing. Sales and marketing expenses decreased $0.5 million, or 12%, and $0.8 million, or 9%, respectively, for the three and six months ended June 30, 2019, as compared to the corresponding periods last year. Sales and marketing expense for the three months ending June 30, 2019 represented 37% of revenue, compared to 44% a year ago. For the six months ending June 30, 2019, sales and marketing expense represented 38% of revenue compared to 49% a year ago. The decrease in sales and marketing expense was due to a reduction of overall sales and marketing headcount from 57 employees to 56 employees at the end of the second quarter 2019, as well as a reduction in overall marketing spend related to advertising and industry trade shows.

General and Administrative. General and administrative (G&A) expenses increased $0.5 million, or 23%, and $0.8 million, or 21%, respectively, for the three and six months ended June 30, 2019, as compared to the corresponding periods last year. G&A expense for the three months ending June 30, 2019 represented 25% of revenue, compared to 21% a year ago. For the six months ending June 30, 2019, sales and marketing expense represented 25% of revenue compared to 24% a year ago. The increase in G&A expense is mainly due to an increase in legal costs, as well as additional executive compensation related to the CEO transition that occurred during the second quarter of 2019.

Other Income (Expense), Net. Other income, net for the six months ended months ended June 30, 2019 was $0.2 million, compared to an expense of $0.0 million for corresponding periods last year. During the first quarter of 2019, we reached a financial settlement with the former shareholders of eleven related to the legal dispute regarding the amount and timing of the earn-out payments related to the acquisition of eleven (the “eleven settlement”). Since the financial settlement was less than the accrued interest and the unpaid earn-out consideration on the Company’s balance sheet, the difference was reflected as other income during the period. For additional information, please refer to Note 3 of the consolidated financial statements included elsewhere in this quarterly report on Form 10-Q (the “Quarterly Report”).

Financial Expense, Net. Financial expenses, net, increased $0.2 million, or 163%, and $0.2 million, or 228%, respectively, for the three and six months ended June 30, 2019, as compared to the corresponding periods last year. The increase in expense is due mainly to an increase in interest expenses associated with the convertible notes issued in December 2018, the associated interest expense for the three and six months ended June 30, 2019 was $0.1 million and $0.3 million. For additional information, please refer to Note 4 of the consolidated financial statements included elsewhere in this Quarterly Report. In addition, during the three and six months ended June 30, 2019 we also recorded expense of $0.2 million and $0.1 million resulting from the effect of foreign currency exchange rate fluctuation.

Effective Corporate Tax Rates

Corporate tax rates and real capital gains tax in Israel were 23% for the three months ended June 30, 2019 and 2018.

Our German subsidiary is subject to German tax at a consolidated rate of approximately 30%.

Other non-Israeli subsidiaries are taxed according to the tax laws in their respective countries of residence.

We do not provide deferred tax liabilities when we intend to reinvest earnings of foreign subsidiaries indefinitely. As of June 30, 2019, there are no undistributed earnings of foreign subsidiaries. 

We may currently qualify as an “industrial company” within the definition of the Law for the Encouragement of Industry (Taxation) and, as such, we may be eligible for certain tax benefits, including, inter alia, special depreciation rates for machinery, equipment and buildings, amortization of patents, certain other intangible property rights and deduction of share issuance expenses.

Net Operating Loss Carry-Forwards

As of December 31, 2018, Cyren’s net operating loss carryforwards for tax purposes amounted to $80.1 million and capital loss carryforwards of $17.8 million which may be carried forward and offset against taxable income in the future, for an indefinite period.

As of December 31, 2018, the U.S. subsidiary had net operating loss carryforwards of $40.3 million for federal tax purposes and $8.8 million for state tax purposes. These losses may offset any future U.S. taxable income of the U.S. subsidiary and will expire in the years 2019 through 2038.

On December 24, 2017, a “change in the respective ownership” event occurred upon the completion of a tender offer of our ordinary shares by an entity controlled by funds affiliated with Warburg Pincus LLC (“Warburg Pincus”), and in accordance with the relevant provisions of the Internal Revenue Code 382 of 1986 and similar state provisions. Therefore, our utilization of U.S. net operating losses are subject to substantial annual limitations. Management believes that the annual limitations will result in the partial expiration of net operating losses before utilization.

Management currently believes that based upon its estimations for future taxable income, it is more likely than not that the deferred tax assets regarding the loss carryforwards will not be utilized in the foreseeable future. Thus, a valuation allowance was provided to reduce deferred tax assets to their realizable value.

LIQUIDITY AND CAPITAL RESOURCES

We finance our operations primarily from our cash and cash equivalents and cash from operations. As of June 30, 2019 and December 31, 2018, we had approximately $12.4 million and $17.6 million of cash and cash equivalents, respectively.

Our future capital requirements will depend on many factors, including, but not limited to our growth, market acceptance of our offerings, the timing and extent of spending to support our efforts to develop our platform and the expansion of sales and marketing activities. We may be required to seek additional equity or debt financing. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, financial condition and results of operations could be adversely affected.

Outlook

During 2019, we expect to continue to incur capital expenditures associated with R&D and data center infrastructure.  We generated a loss of $4.6 and $9.1 million for the three and six months ending June 30, 2019 and negative cash flow of $0.5 million from operating activities in the six months ending June 30, 2019, and have an accumulated deficit of $222.5 million as of June 30, 2019. We are planning to finance our operations from our existing and future working capital resources and to continue to evaluate additional sources of capital and financing. However, there is no assurance that additional capital and/or financing will be available to us, and even if available, whether it will be on terms acceptable to us or in amounts required. Accordingly, our Board approved a contingency plan, to be effected if needed, in whole or in part, at its discretion, to allow us to continue our operations and meet our cash obligations. The contingency plan consists of cost reduction, which include mainly the following steps: reduction in consultants’ expenses, headcount, compensation paid to key management personnel and capital expenditures. We and the Board believe that our existing capital resources and other future measures that may be implemented, if so required, will be adequate to satisfy our expected liquidity requirements for at least twelve months from the filing date of this Quarterly Report.

Cash Flows from Operating Activities

Cash used in operating activities was $0.5 million for the six months ended June 30, 2019 as compared to $3.3 million for the six months ended June 30, 2018. The decrease in cash usage of $2.6 million was primarily due to one large 36-month and one large 12-month prepayment from two of Cyren’s largest Threat Intelligence customers during the first and second quarters of 2019, respectively. The prepayments are reflected on the balance sheet as an increase in short-term and long-term deferred revenue.

Cash Flows from Investing Activities

Cash used in investing activities was $2.4 million for the six months ended June 30, 2019 as compared to $3.3 million for the six months ended June 30, 2018. The decrease of $0.9 million was primarily due to a decrease in capital expenditures compared to the same period a year ago.

Cash Flows from Financing Activities

Cash used in financing activities was $2.2 million for the six months ended June 30, 2019 as compared to $0.3 million for the six months ended June 30, 2018. The increase of $1.9 million was primarily due to a payment of $2.7 million in conjunction with the eleven settlement which occurred in the first quarter of 2019. The eleven settlement was offset by an increase in 2019 of $0.2 million generated from the exercise of stock options in the period.

Working Capital

As of June 30, 2019, and 2018, we had positive working capital of $1.1 million and $5.7 million, respectively. The decrease in working capital during the three months ended June 30, 2019 as compared to the prior year is primarily due to our negative cash flow from operations and lower amounts of capital raised during the fourth quarter of 2018 compared to amounts of capital raised during the fourth quarter of 2017.

Convertible Notes

On December 5, 2018, we issued an aggregate $10.0 million principal amount of convertible notes in a private placement (the “Notes”) to affiliates of an existing minority institutional shareholder. The Notes are unsecured, unsubordinated obligations of Cyren and carry a 5.75% interest rate, payable semi-annually in (i) 50% cash and (ii) 50% cash or ordinary shares at Cyren’s election. The Notes have a 3-year term and mature in December 2021, unless converted in accordance with their terms prior to maturity. The Notes have a conversion price of $3.90 per share, which may be subject to adjustment using a weighted average ratchet mechanism based on the size and price of future capital raises and the total shares outstanding. In addition, the Notes would be subject to immediate conversion upon any change in control in the Company (or subject to repayment if the price in the change in control transaction is less than the conversion price). The Company incurred interest expense for the six months ended June 30, 2019 of $0.3 million. In June 2019, the Company paid the first of the semi-annual interest payments totaling, $0.3 million, of which $0.2 was paid in cash and the remaining portion through the issuance of 35,950 shares.

Earn-Out Consideration

In conjunction with the 2012 acquisition of eleven, we entered into an earn-out agreement with the former shareholders that would pay additional consideration based on the revenue performance for the years ending 2012-2015. Subsequently in 2014, we had a legal dispute regarding the amount and timing of the earn-out payments and had entered into arbitral proceedings with the former shareholders of eleven. On March 9, 2017, we received the arbitral judgement. Pursuant to the judgement, the earn-out consideration balance was increased to reflect additional legal expenses and interest expenses covering the period up to December 31, 2016. During 2017 and 2018, we continued to accrue interest on the unpaid earn-out consideration balance. Such interest is reflected in the consolidated statements of operations under financial expenses, net. In May 2018, we made a partial payment of the earn-out consideration to five of the six former shareholders, in an amount of $0.6 million. The earn-out consideration balance presented on our balance sheet as of December 31, 2018 reflected the complete remaining liability relating to the earn-out, including accrued interest. In February 2019, the parties agreed to resolve all pending claims, and on February 28, 2019, we paid approximately $2.7 million to settle the earn-out consideration in full. For additional information, please refer to Note 3 of the consolidated financial statements included elsewhere in this Quarterly Report.

Registration Statements

In connection with a previously disclosed private placement in November 2017 in which we issued approximately 10.6 million ordinary shares to an entity controlled by funds affiliated with Warburg Pincus, we and Warburg Pincus entered into a registration rights agreement which, among other things, provides Warburg Pincus with three demand registration rights, piggyback and shelf registration rights. The demand registration rights may be exercised starting August 6, 2018, subject to certain customary blackout periods. In addition, as of November 6, 2019, at the request of Warburg Pincus, we will be required to file a shelf registration statement covering the sale of Warburg Pincus’s shares.

On September 21, 2018 we filed a shelf registration statement on Form F-3 with the Securities and Exchange Commission (“SEC”), which we intend to convert to a Form S-3 during the third quarter of 2019. This registration statement enabled us to issue debt securities, ordinary shares, warrants or subscription rights up to an aggregate amount of $50 million. Under the rules governing shelf registration statements, once we convert the registration statement on Form F-3 to a registration statement on Form S-3, we will thereafter be able to file a prospectus supplement with the SEC which describes the amount and type of securities being offered each time we issue securities under the registration statement. No securities were issued under the registration statement on Form F-3 from September 21, 2018 through the date of the filing of this Quarterly Report.

Off-Balance Sheet Arrangements

As of June 30, 2019, we did not have any off-balance sheet arrangements. 

Critical Accounting Policies and Estimates

Our significant accounting policies are discussed in Note 2. Significant Accounting Policies to our consolidated financial statements included in the Company’s Form 10-K filed with the Securities and Exchange Commission on March 29, 2019. There have been no significant changes to these policies for the six months ended June 30, 2019, except as described in Note 2. Significant Accounting Policies to our condensed consolidated financial statements are included elsewhere in this Quarterly Report. The critical accounting policies requiring estimates, assumptions, and judgements that we believe have the most significant impact on our consolidated financial statements are described in Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our 2018 Annual Report.

Recent Accounting Pronouncements

Please refer to Note 2. Significant Accounting Policies to our condensed consolidated financial statements included elsewhere in this Quarterly Report for a full description of recent accounting pronouncements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not required for smaller reporting companies.

Special Note Regarding Forward-Looking Statements

This Quarterly Report contains “forward-looking statements” within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. These statements concern expectations, beliefs, projections, plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. We urge you to consider that statements which use the terms “anticipate,” “believe,” “expect,” “plan,” “intend,” “estimate”, “will” and similar expressions are intended to identify forward-looking statements. Specifically, this Quarterly Report contains forward-looking statements regarding:

These forward-looking statements reflect our current views about future events and are subject to risks, uncertainties and assumptions. We wish to caution readers that certain important factors may have affected and could in the future affect our actual results and could cause actual results to differ significantly from those expressed in any forward-looking statement. The most important factors that could prevent us from achieving our goals, and cause the assumptions underlying forward-looking statements and the actual results to differ materially from those expressed in or implied by those forward-looking statements include, but are not limited to, the following: