Synchronoss Technologies, Inc. Q3 2008 Earnings Call Transcript

Synchronoss Technologies, Inc. (NASDAQ:SNCR)

Q3 2008 Earnings Call

November 5, 2008 4:30 pm ET

Executives

Stephen G. Waldis - Chief Exec. Officer, Pres

Lawrence R. Irving CPA - Chief Financial Officer

Analysts

Tom Roderick - Thomas Weisel Partners

Analyst for Shyan Patil - Raymond James

Operator

Good day ladies and gentlemen and welcome to the third quarter 2008 Synchronoss Technologies Incorporated Earnings Call. (Operator Instructions) I would now like to turn the presentation over to Mr. Larry Irving, Chief Financial Officer Advisor.

Lawrence R. Irvin

Good afternoon and welcome to the Synchronoss third quarter 2008 earnings conference call. We will be discussing the results announced in the press release issued after the market closed today. Again, I am Larry Irving, Chief Financial Officer of Synchronoss Technologies. With me on the call is Steve Waldis, President and CEO.

During this call, we will make statements related to our business that may be considered forward-looking statements under Federal Securities Laws. These statements reflect our views only as of today and should not be reflected upon as representing our views as of any subsequent date. These statements reflect our current views regarding the future and are subject to a variety of risks and uncertainties that could cause actual results to differ materially from expectations. For a discussion of the material risks and other important factors that could affect our actual results, please refer to our SEC filings.

With that I will turn the call over to Steve and I will come back a bit later to provide some further details regarding our financials and our forward outlooks.

Stephen G. Waldis

Good afternoon and thank you for joining us on our call to review our third quarter results. We continue to focus on executing against our long-term growth initiatives, including expanding our relationship with AT&T and onboarding our newer service providers, such as Sprint.

And I am pleased to share that during the third quarter we have made steady progress against both of these goals and we completed the first acquisition of the company’s history and Wisor Telecom at the end of Q3.

From a high-level perspective, the increasingly challenging macroeconomic environment had had a negative impact on transactions volumes across our collective customer base during the quarter. However, progress against our growth initiatives, some which are actually positively influenced by the current economic environment, helped to return the company to sequential growth during the third quarter and we currently expect to continue to deliver sequential growth in our seasonally strong fourth quarter as well.

Now, let me provide a summary review of our third quarter financial performance, followed by an update on key business development activities.

Starting with the third quarter results, we reported revenues of $26.3 million, up from $24.3 million in the second quarter and marking a return to sequential growth. From a profitability perspective, we generated a non-GAAP operating margin of 20%, leading to a non-GAAP EPS of $0.11, which was within our guidance range for the quarter.

We ended the quarter with a very strong balance sheet. Our cash was approximately $73.0 million with essentially no debt and we have generated approximately $18.0 million in cash flows from operations through the first nine months of 2008.

Now, turning to our business operations and beginning with our largest customer, AT&T. During the quarter our core AT&T revenue, which excludes revenue associated with the iPhones, grew 16% on a year-over-year basis and 7% on a sequential basis. On a year-to-date basis our core AT&T revenue was up 11% on a year-over-year basis. We believe this is the best measure of the underlying growth in this segment of our business.

We also continue to make solid progress on newer initiatives that we have discussed on recent calls in regards to our expansion within AT&T. We continue to deploy our convergence in our platform for converged, wire-line services for AT&T commerce channel. Once this is completed, we will manage all wire-line consumer transactions over the Web, as we currently do with AT&T mobility. These transactions include DSL, high-speed data, as well as complex service bundles.

And today we also are announcing the latest version of our platform, which we are referring to as ConvergenceNow Plus. This platform is focused on supporting and enabling different types of emerging devices to be activated and supported on multiple networks. With ConvergenceNow Plus we are moving beyond just transactions around the ordering and activation process, but extending our platform into account management and life cycle management.

In doing so, we will be expanding the types of transactions our platforms can manage. Examples of some of these new transactions include credit card transactions, inventory management of emerging devices, trouble picketing of devices and installation, and product catalogue capabilities for devices, to mention a few.

We plan to begin to support a specific AT&T device transaction this quarter and we expect that we will be able to share more details on this specific device and service transaction on our next quarter’s call.

As we have highlighted in the past, both in our relationship with Brightpoint and Nokia, we believe the market for merging devices has the potential to grow rapidly in the years ahead. We are focused on aggressively pursuing opportunities to manage all kinds of devices from smartphones to consumer electronics to machine-to-machine.

Our acquisition of Wisor and their North American e-phonic footprint will also enable many more automated transactions for even more devices. And as major service providers open their networks and more devices offer advanced wireless capabilities, we believe Synchronoss is well positioned, based on our highly differentiated platform and our relationship with tier-1 carriers and device manufacturers.

In addition, we are actively exploring additional ways that Synchronoss can add value to AT&T in the years ahead and continue to believe there is a good opportunity to continue to expand what has already been firmly established as a model relationship for our company.

Growing our business outside of AT&T remains a top, strategic priority for Synchronoss as well. We have a number of irons in the fire with new programs and customers that we believe have significant long-term potential but which will take time to ramp.

I will start by providing our latest business update regarding our relationship with Sprint. As we have discussed on previous calls over the course of 2008, Sprint has been educating its numerous internal initiatives and undergoing a material amount of internal organizational change. This has led to a much more measured pace relative to our relationship.

Last quarter we commented that we are starting to see a more focused effort and internal priority relative to improving the customer experience, which is encouraging as it relates to our relationship. This trend has continued since our last call.

There are factors beyond our control, such as client-specific, industry-specific, or even economic-related that can cause customers to change their plans and that would impact our outlook. However, there has recently been greater specificity regarding plans for Synchronoss and other key technologies related to Sprint’s customer services initiatives.

The current plan calls for spring to significantly increase the number of transactions managed by Synchronoss this quarter as compared to the just-completed third quarter. We expect to continue scaling in the first half of 2009.

Now, if you can look at increased transactions going into the fourth quarter, it is still not close to what we believe our long-term opportunity is. But we believe it is evidence that Synchronoss is viewed as an important in their overall ecosystem heading into 2009.

Again, customer timetables can change as they are managing numerous vendor relationships and these changes are beyond our control. As evidence, the timetable I just shared is a bit more stretched out than we had anticipated six months ago. However, the positive side is that the number of transactions we are processing is growing, starting this quarter, and this our greatest clarity on our opportunity we have had since initiating our relationship with Sprint.

It is also worth noting that we have also recently been awarded a contract to support Sprint Zone. This relationship gives us further penetration at spring and our position within our existing cable MSO customers.

As we discussed last quarter, we believe our relationships with the top cable MSO companies provide us with opportunities to leverage both past and current investment as they prepare for the WiMax joint initiative between Clearwire and Sprint.

We continue to take on additional transactions with both Comcast and Time Warner Cable. Most notably, during the fourth quarter we will go into full production with TWC.com, as we have mentioned on previous calls, in which we are supporting their national e-commerce channel related to video, broadband, telephony transactions sold on the Web.

And finally, with respect to our continuing relationship with Vodafone, last quarter we highlighted the fact that their acquisition of Arcor and Synchronoss’ early discovery phase was going to be extended. We continue to have our staff engaged on site and we are currently involved in two paid engagements, one being the evaluation of Vodafone’s online channel for consumer customers, and the second effort focused on the evaluation of Vodafone’s activations related to prophesies for their multi-national enterprise customers.

These initial paid engagements are purely on a professional services level and from our perspective we took a step forward, but it’s a small step, to be candid. The combination of the complexity involved, the structure of the decision-making cycles of Vodafone, and the uncertain macroeconomic climate lead us to believe that this process will take some time.

Ultimately, the potential outcomes at Vodafone are the same as we discussed last quarter. We could start a trial of our platform, we could agree to terms and begin an aggressive ramp in early 2009, or we could fail to reach a long-term commitment altogether.

We continue to believe that between Vodafone and Nokia, whose U.S. deployment via our Brightpoint relationship has gone well, and other opportunities we are pursuing, we are well positioned to establish a solid international reference account.

These are strategic engagements which means they are lengthy sales and decisions cycles and as we have proven with our customers such as AT&T and Time Warner Cable, the positive aspect is that once our relationships are established, they tend to be long term and grow over time.

I would like to finish with some brief words around our acquisition of privately held Wisor Telecom, which was completed during the end of Q3. They provide software and service solutions that enable clients to manage, execute, and provision with their end customers with automation order accuracy. It expands our customer technology footprint, and particularly to related service provider-to-service provider automation.

Now there were three key reasons why we believe Wisor was a good fit for Synchronoss. The first, with the addition of Wisor solutions, Synchronoss gains additional automated transactions and our technology footprint will now cover a much more increased footprint for all the major carriers in the U.S. we believe the significant expansion of our platform’s carrier integration capabilities has potential to drive higher automation rates in a shorter period of time for our customers.

This is important, as well, as we grow our emerging device initiative to offer more devices across more service providers of multiple network technologies.

Secondly, the strength of Wisor’s technology solution and domain expertise has been validated by its Bluechip client base, which includes Sprint, Verizon Wireless, Embark, Time Warner Telecom, Global Crossing, and British Telecom, to name a few.

And third, Wisor’s global capabilities team brings significant expertise to the table. We believe the integration of Wisor and its global R&D facility into Synchronoss’ overall operations will provide an opportunity for the company to realize synergies and cost efficiencies in all these areas.

In summary, our third quarter performance was in line with our expectations and showed improvement from the second quarter. We similarly expect our fourth quarter to be an improvement over the third quarter as we continue to make progress on new transaction types and programs.

Most significant from a long-term perspective, however, is to continue the value of our relationship with our largest customer and we are taking steps forward with early-stage initiatives.

With that, let me turn it back over to Larry.

Lawrence R. Irvin

I would like to provide additional details on the third quarter performance, in addition to our guidance for the fourth quarter and full year 2008.

Starting with the income statement, revenues were $26.3 million, which was an increase of 8% on a sequential basis. The third quarter marked a return to sequential growth at Synchronoss and if we were to exclude the impact of the acquired revenue in the prior period, our total revenues were up approximately 16% on a year-over-year basis.

Our overall AT&T revenue represented 66% of our total revenues compared to 67% in the previous quarter and 78% in the third quarter of 2007. The revenue from our other customers represented the remaining 34% of our total, up from 33% in the previous quarter and 22% in the third quarter of 2007.

Revenue from our customers outside of AT&T grew 16% on a year-over-year basis and 10% sequentially.

From a revenue mix perspective, 80% of our third quarter revenue came from transactions processed. The remaining 20% was generated from professional services and subscription services. Turning to costs and expenses, we will review them on a GAAP and non-GAAP basis. There is a reconciliation table between the two in our earnings release. Our non-GAAP results exclude stock-based compensation expenses.

Non-GAAP gross profit in the quarter was $13.1 million representing a non-GAAP gross margin of 50%.

Turning to operating expenses, non-GAAP R&D expenses came in at $2.5 million, or 9% of revenue, while non-GAAP SG&A expenses were $3.8 million, or 14% of revenue. Depreciation was $1.6 million, or 6% of revenue.

Non-GAAP income from operations came in at $5.2 million, representing a non-GAAP operating margin of 20% and compares to $10.3 million in the year-ago period.

The company’s tax rate for the quarter was 41.6%, leading to a non-GAAP EPS of $0.11.

And it should be noted that on October 3, 2008, the United States Congress passed the Emergency Economic Stabilization Act of 2008. As part of this act, the R&D tax credit has been extended for 2008 and 2009. As a result, I expect the company’s effective tax rate to be favorably impacted for 2008.

We are currently evaluating the impact of this change, but I expect our full-year effective rate to be reduced by as much as 200 basis points and recorded in the fourth quarter.

On a GAAP basis, including stock-based compensation expense of $1.7 million, the resulting GAAP income from operations and net income for the quarter was $3.5 million and $2.3 million respectively.

The resulting GAAP diluted earnings per share was $0.07.

Looking at our cash, total cash, cash equivalents, and marketable securities totaled $73.3 million at the end of the third quarter. During the quarter approximately $17.0 million in cash was used for the acquisition of Wisor Telecom and $13.0 million was used to repurchase our common stock. This was partially offset by $8.6 million in cash flow from operations during the third quarter. On a year-to-date basis the company has generated $18.1 million in cash from operations.

Before discussing the 2008 guidance I would like to touch on our thoughts regarding the impact of Wisor Telecom. The acquisition took place at the end of the quarter and had a nominal impact on our results. We have been aggressively integrating their operations and technology into our ConvergenceNow platform.

In doing so we are transitioning their model from what has historically been a license- and subscription-based model to a Synchronoss traditional model. Our primary objective with the Wisor acquisition was to acquire their carrier integration capabilities, complementary customer footprint, and global development capabilities that we expect to increasingly leverage over time with our current customers and future prospects.

Overall we expect Wisor’s contribution to be less than 5% of Synchronoss’ total revenue, however, moving forward we will not be breaking out Wisor’s individually as we will not be tracking them as an individual entity or product internally.

Now let me turn to guidance for the quarter and the full year 2008. For the fourth quarter we expect total revenues in the range of $30.0 million to $32.0 million. We are optimistic that our revenues will grow solidly on a sequential basis in our fourth quarter based on our typical year-end seasonality albeit less than what we have seen prior years because solid visibility in programs with AT&T and Time Warner Cable that Steve mentioned, which are set to begin ramping.

That said, we expect the increasingly challenging macroeconomic to continue to have a negative impact on transaction volumes for our customers.

With our fourth quarter and full-year revenue guidance toward the lower end of our previous expectations, it is important to note that we are confident about the prospects of both our existing accounts and new accounts. We are continuing to invest in our platform to support new opportunities such as deploying the consumer wire line program with AT&T, enhancing ConvergenceNow Plus for emerging devices, and continue investments for volume upticks expected at Time Warner Cable and Sprint, to name a few. These upfront investments are required to drive higher automation rates as quickly as possible in 2009 and we expect to gain leverage off these investments over time.

We also continue to aggressively pursue international opportunities. We are making progress against our goal of putting our platform in place this quarter as many programs as possible across our customer base. This will not only help take us through this more challenging economic period but it will also position us well for improved new revenue growth and profitability when the economy improves and volumes across our highly automated programs down step to normal levels.

That said, we remain committed to our R&D and salesman marketing initiatives. As a result we expect our gross margins to remain at the low 50% range as we ramp many of these new initiatives leading to a non-GAAP operating margin between 18% to 20% in the fourth quarter.

We currently estimate non-GAAP EPS between $0.11 and $0.13. Our EPS forecast assumes a tax rate of 40% and 31.1 million shares outstanding. As just mentioned, our fourth quarter and full-year debt does not at this point take into consideration the cumulative impact of the recently enacted R&D tax credit as we are still evaluating the impact on our overall tax rate.

Based on the third quarter results and the fourth quarter guidance, our full year 2008 guidance translates to a range of approximately $110.0 million to approximately $112.0 million. From a profitability perspective we expect to deliver non-GAAP EPS of $0.48 to $0.50 for 2008.

In addition to strong non-GAAP operating margins in the 22% range, we currently expect shares outstanding of approximately 32.2 million, which is reduced from our previous expectations of 32.5 million, primarily as a result of the execution of our share buyback program.

We continue to use our strong cash position and cash flow capabilities of the company to enhance shareholder value.

In summary, we are pleased that Synchronoss returned to sequential growth in the third quarter and we expect to do so again in the fourth quarter. Longer term, we have a strong market position, tier-1 customer base, and a balance sheet to execute our strategies.

With that let me turn it over to begin the Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Tom Roderick - Thomas Weisel Partners.

Tom Roderick - Thomas Weisel Partners

I was hoping you would go into a little more detail on the zone deal on the Zone deal on the WiMax side and then with respect to the more broadly spoken relationship with Spring, can you get into a little bit of detail in terms of what types of transactions you expect to support and what changes are taking place organizationally that are driving those ahead for you?

Stephen G. Waldis

From an organizational perspective there has certainly been momentum as Sprint kind of reorganizes from a management execution perspective, when obviously has had a positive impact in focus and direction for us.

Let me answer the Zone part of it. It is an initial contract. It is not large in size but it is giving us an opportunity to understand how we might be able to add value in processing transactions associated with the Clearwire WiMax arrangement. We can’t get into a lot of specificity around the transaction but it is an opportunity to demonstrate that we are expanding our relationship with Sprint as a whole.

As it relates to Sprint in our current efforts to grow our transactions, we have had some positive results, both in focus in Q3 as well as our ability to make some material impact changes and so as we start in the fourth quarter we will be increasing the number of transactions that we are supporting. It is essentially very similar to our model that we discussed earlier. Obviously it’s not where we want to be in our end state but we are pleased with the results that we are getting more transactions and moving in the direction now that was a little bit faster than it was on our previous calls.

Tom Roderick - Thomas Weisel Partners

And then I want to just dive into your comments in terms of expecting transactions to slow a little bit as you look into the coming quarters. I know it’s probably too early to have a lot of visibility into 2009, but as we look at the core business right now growing about 16%, I think you said about 16% year-on-year, can you just give us a sense as to how you expect in the third quarter for year-on-year growth rates to evolve over the next few quarters so we can have a good sense of where to model for 2009.

Stephen G. Waldis

We haven’t done a lot of bottoms-up exercise in terms of where we see that in 2009. I will tell you that in our preexisting programs that are embedded in the channels pretty much across our base, we have seen customers forecast being in the lower end of our range and numbers really seem to be exceeding the range. And that obviously has a two-fold effect for us on the negative side. One is obviously the revenue. But two, those are typically high-ex margin transactions, they are the most automated.

But what I referred to earlier, which has been a positive impact is there has also been, as you know in our model, a desired to on board transactions quicker because of the reduction that customers can get by putting them on to us. And that allows us to have the future growth but out of the gate that does impact the margins. Those transactions have a tendency to engage to be less automated than they will be if they’re in state.

So we have those two factors. I think the growth initiatives are helping us keep the sequential growth. I think that, as Larry pointed out, when the economy turns around and customers can get back into either solidly in exceeding or increasing their arranges, and that’s also going to have not just a revenue but a good margin uplift as well.

Operator

Your next question comes from Shyan Patil - Raymond James.

Analyst for Shyan Patil - Raymond James

Given that the e-commerce channel is typically seen as the fastest growth and the highest margin channel, what kind of interest are you seeing from carriers, even as spending is not that great right now?

Stephen G. Waldis

Our model has opportunities to drive higher RPU and higher revenue for customers so that part of it and the current economic condition is not favorable, but what we are seeing is by moving transactions into an automated state or through the West, some of the work that we had mentioned with AT&T to move a lot of the wire line bundles on line and automated, that definitely has a bottom line savings. And so with those types of existing programs that you can drive higher automation, the economic benefit would have a positive uplift for us.

Analyst for Shyan Patil - Raymond James

And can you talk about the cost structure in terms of fixed versus variable costs and how quickly the costs could be projected into potential revenue in that?

Stephen G. Waldis

I think the biggest leverage in our model has always been around the margins and how quickly we automate transactions. And so effectively, what ends up happening, to the extent that we start to automate these transactions, we are able to reduce the manual labor that we have associated with handling those transactions. And that’s pretty much the adjustment that we end up with in our bottom line.

So we have very good flexibility in terms of driving that to the extent that we can drive automation. So I would think that that’s pretty much the biggest variable cost that we have, is driving automation to eliminate some of the manual costs that we have in the model.

In terms of other fixed costs, they’re not really a very heavy fixed cost of business. Most of our business is labor-intensive, other than the technology that we have built already. So I would say it’s pretty solid in terms of being a very variable business. And we can adjust up and down as we feel appropriate, based on the market conditions.

Analyst for Shyan Patil - Raymond James

And how are you thinking about 2009 at this point? What are the biggest variables that will affect how you plan for 2009?

Stephen G. Waldis

It’s early yet to be thinking of 2009. Obviously in our model we do get expectations from our customers in terms of the volume transactions that they are seeing 2009. So it’s a little premature for us to give a good feel to that. It’s really going to be driven by the macroeconomic environment in terms of how much volume we see.

What we are doing, as you can see in the investments that we are making, is putting as many of our platforms across as many of our customers as we can, so as that volume starts to come in, we are able to benefit from that stream of transactions.

Operator

There are no further questions in queue.

Stephen G. Waldis

Thank everybody for joining us this afternoon and we look forward to continuing with you in the future.

Operator

This concludes today’s conference call.

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