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Synacor, Inc. (NASDAQ:SYNC)

Q1 2013 Earnings Conference Call

May 7, 2013 17:00 ET

Executives

Denise Garcia - ICR

Ron Frankel - President and Chief Executive Officer

Bill Stuart - Chief Financial Officer

Analysts

Jason Helfstein - Oppenheimer

Gur Talpaz - Stifel

Tom Andrews - BMO Capital Markets

Rich Tullo - Albert Fried

Operator

Good day, ladies and gentlemen, and welcome to the Synacor 2013 First Quarter Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference call is being recorded.

I would now like to turn the call over to your host, Denise Garcia from ICR. Please go ahead.

Denise Garcia - ICR

Good afternoon. Welcome to Synacor’s first quarter earnings call. Joining me today to discuss Synacor’s results are CEO, Ron Frankel and CFO, Bill Stuart.

Before we begin, I’d like to take this opportunity to remind you that during the course of this call management will make forward-looking statements which are subject to various risks and uncertainties. Actual results may differ materially from the results predicted and reported results should not be considered as an indication of future performance. Further information on these and other factors that could affect the company’s financial results is included in filings it makes with the Securities and Exchange Commission from time-to-time, including the section entitled Risk Factors in the company’s most recent 10-K filed with the SEC on March 26, 2013.

Also I’d like to remind you that during the course of this conference call we will discuss non-GAAP measures in talking about the company’s performance. Reconciliations to the most directly comparable GAAP financial measures are provided in the tables in the press release. This conference call is also being broadcast on the internet and is available through the Investor Relations section of the Synacor website.

And now, I will turn the call over to Ron Frankel, Synacor’s President and CEO.

Ron Frankel - President and Chief Executive Officer

Thanks, Denise, and welcome to today’s conference call. I am pleased to share our financial results for the first quarter of 2013 and to provide an update on our business to our shareholders and the investment community.

Our results this quarter were in line with the guidance we shared on our fourth quarter call. First quarter revenue was slightly above the midpoint at $29.1 million versus $30.7 million in the same quarter of 2012. Adjusted EBITDA was at the midpoint of guidance at $1.8 million compared to adjusted EBITDA of $3 million in the first quarter of 2012. Looking more closely at the different components of our revenue, display advertising grew 19% over the same quarter last year to $8.3 million from $6.9 million.

Search revenue was $15.8 million in the first quarter, a 16% decrease from $18.8 million in the same quarter last year. Both search and display advertising were down 11% quarter-over-quarter due in large part to seasonality and maturation of some of our customer relationships. Subscription based revenue was $5.1 million a 3% increase compared to $4.9 million in the first quarter of 2012. I am very encouraged on a separate not I am very encouraged by our large pipeline and our conversations have been sufficiently significant that we become – we have begun to invest resources to support select large prospects.

We make those investments in confidence I am also very enthusiastic about our new product pipeline both customers and prospects alike are excited about our lead into mobile and touch screen enabled devices. I am confident our investments into these products will produce great results as we move into 2014 and beyond. On one hand we are excited about our new customer prospects the strength of our customer pipeline and our new products. But on the other hand we are experiencing lower search volume as we continued through this transitional year. It is these trends that have made realizing certain of these key initiatives important to achieving our revenue and EBITDA goals for this year.

Bill will discuss further the guidance later on the call. Recently we announced and important expansion in our relationship with one of our key customers Verizon. We are now offering Verizon to start page users access to TV shows and movies from one online destination, TV Everywhere website which we power. We are very excited by to the more deeply partnering with Verizon as they build out a world class TV Everywhere offering for their consumers. We also continue to build momentum with Synacor’s cloud ID Social Login service, the first service connecting social ids to TV everywhere.

We are pleased to announce that we now have several service providers offering their subscribers social login as a means to simultaneously authenticate for TV Everywhere content when logging into Facebook, Twitter or Google. So, fun, friction-free way to access content, a move we are will help to accelerate consumer adoption of TV Everywhere.

And I’d like to provide an update on international initiatives. During the first quarter, we established a joint venture in China with Maxit Technology, a leading provider of targeting and analytic software delivered in partnership with China Unicom and China Telecom. Over 0.5 billion consumers are online in China representing a significant growth opportunity to expand the reach of our solutions, for operators and consumers, electronics companies who are there. Dr. Sean Wang, the former CEO of Maxit Technology is leading the joint venture. We are excited to work with Sean and we are very encouraged by our early progress.

Lastly regarding the prospects of leveraging cash position and balance sheet to explore strategic acquisitions and partnerships, we continue to evaluate our options and business opportunities to return value to our shareholders. With more than $40 million in cash and additional financing available to us, we are well positioned to act strategically. With that after I will turn the call over Bill and then we’ll open to your questions. Bill?

Bill Stuart - Chief Financial Officer

Thanks Ron. Before I discuss our results I want to remind everyone that our non-GAAP financial measures exclude stock-based compensation expenses. Please refer to our press release and SEC filings for the GAAP to non-GAAP reconciliations. Starting with our first quarter key metrics according to comScore, Synacor engaged 20.3 million average unique visitors per month consistent with total unique users in the previous quarter and a 5% descriptive decrease from 21.3 million unique users in the same quarter last year.

Search queries were 212 million for the first quarter, a decrease of 22% from the 271 million search queries in the first quarter of 2012 and down 6% from 225 million in the previous quarter primarily due to first quarter seasonality.

Synacor delivered level 11.5 billion advertising impressions, an increase of 35% over 8.5 billion in the first quarter 2012 and a 2% decrease over the first quarter – over the previous quarter also a result of first quarter seasonality. As a result first quarter revenue decreased 5% to $29.1 million from $30.7 million in the same period last year. Adjusted EBITDA was $1.8 million for the quarter compared to adjusted EBITDA of $30 million in the first quarter of 2012.

Net income for the quarter was $27,000 compared to $1.2 million in the first quarter of 2012. Diluted earnings per share, or EPS was breakeven. Net income includes stock-based compensation expense of $562,000, or $0.02 per share in the first quarter of 2013 and $558,000 or $0.02 per share in the first quarter of 2012. The diluted EPS calculation for the first quarter of 2013 is based on $28.2 million weighted average fully diluted common shares outstanding.

Turning to costs and expenses, cost of revenue as a percentage of revenue remained within our historical range at 54% for the first quarter. We continue to expect cost of revenue to remain at approximately 55% going forward. Total operating expenses, excluding stock-based compensation and depreciation, were $11.6 million for the quarter or 40% of revenue compared to $10.9 million, or 36% of revenue in the same period last year.

G&A expenses as a percentage of revenue increased by 2 percentage points over the same quarter last year. Sales and marketing continued to show operating leverage over the prior year, declining by 0.5 percentage point, while R&D increased 3 percentage points. In the first quarter, we used $700,000 in cash from operating activities compared to generating $800,000 in the first quarter of 2012. This was mainly due to timing of payables and receivables and accrued expenses. We ended the quarter with $40.2 million in cash and cash equivalents compared to $33.1 million in the first quarter of 2012.

I would like to finish our call with our thoughts regarding guidance for the second quarter and full year 2013. For the second quarter, we expect revenue within the range of $26.5 million to $27.5 million with adjusted EBITDA in the range of $800,000 to $1.2 million. For the second quarter, we are also providing guidance on additional line items as follows. For operating expenses, we expect to range between $11 million and $12 million. We are continuing plans to increase staff in our technology centers in Toronto and Boston related to the initiatives, Ron discussed earlier.

For depreciation, we expect to range between $1.1 million and $1.3 million. For stock-based compensation, we expect to range between $600,000 and $700,000. For other income and expense, we expect approximately $50,000 in expense. For income tax expense, we would expect a tax rate approximately 45%. As a reminder, the majority of this tax expense is non-cash taxes as we have a balance of $4.5 million of deferred tax assets. For weighted average fully diluted shares outstanding utilizing the treasury shares method, we expect our share count to be approximately 29 million. At this point, we continue to expect depreciation, stock-based compensation, and shares outstanding to increase slightly as the year progresses with other income and expense and tax rates remaining relatively consistent.

For the full year we reaffirm our guidance of $122 million to $126 million in revenue. Note that our revenue expectations contemplate successfully implementing or realizing some of the new customer and product initiatives that are underway which give us more encouragement going forward. Regarding our expectations for adjusted EBITDA, again referring back to Ron’s comments, we are reducing guidance to $8 million to $10 million taking into consideration the investments we are and will continue to make in the next several quarters to better position the company to deliver in those key opportunities in the pipeline.

In closing, our first quarter results delivered on our expectations. We remain confident about our future and our market opportunity and look forward over the course of 2013 or beyond to continue to build Synacor for the long-term. Thank you. We’ll now open the line to your questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Jason Helfstein from Oppenheimer. Your line is open.

Jason Helfstein - Oppenheimer

Thanks. Hey guys, can you hear me?

Ron Frankel

Yeah.

Jason Helfstein - Oppenheimer

Thanks. So, a few questions, so first as far as the slowdown in search how much of that was in the quarter? How much of that was due to Google policy changes versus just actual traffic reduction? And then can you just talk about, are you seeing any impact of the browser update, I know there is an IE 10 update recently, which did a homepage takeover and kind of how you are dealing with that with your MSO partners? Thanks.

Ron Frankel

The policies that are out of our toolbars and that are affecting some of the guys like some of the folks that do toolbar downloads etcetera. Those policies do not really apply to us. So, no I think that reduction in search for us is more about the OEM second tab pages where we don’t get search from those pages. With regards to – what was the last part of the question Jason?

Jason Helfstein - Oppenheimer

Well, just about there was another browser update I think IE 10?

Ron Frankel

Yeah, no we haven’t – we have not detected any fact of any recent browser updates and actually are making good progress with our customers in addressing those kinds of issues.

Jason Helfstein - Oppenheimer

Will there be more proactive in front of those changes basically?

Ron Frankel

Yeah, well there are a number of techniques that can be used to drive consumers. And I think that one of the byproducts of what we are doing TV Everywhere is that our customers are more willing to for instance do device detection to set homepages or become more visible to their customers. Either device detection in which case you can message click here to see your new media options, set homepage if it’s a laptop, work more on the installation processes in on-boarding. Our customers are becoming much more proactive. I think we will see the benefit of that over the next few quarters in that regard.

Jason Helfstein - Oppenheimer

And then just one more follow-up on the reduced EBITDA guidance, would you say that’s more driven by R&D or more driven by higher investments in selling and then would you expect a big payoff on that in 2014?

Ron Frankel

Well, we do have a very strong pipeline at this point in time. It is causing us to do two things. One is to invest in the selling process, and two, to invest to accelerate the pace of delivery on our new products. And so the – it’s really those two elements.

Jason Helfstein - Oppenheimer

Okay, thank you.

Operator

Our next question comes from Tom Roderick with Stifel. Your line is open.

Gur Talpaz - Stifel

Yeah, it’s Gur for Tom. So, with this Verizon expansion, I was hoping you could perhaps elaborate on how it’s expected to impact the model and how we might see it totally flow through in terms of upside over the next few quarters?

Ron Frankel

I think we don’t quite yet have – we don’t have a lot of visibility at this point in time except that if an expansion of our relationship and will ultimately drive more viewer ship as well as a fee element. And we haven’t shared those models with you guys at this point in time.

Gur Talpaz - Stifel

Well, basically what I am getting I think if I look at your guidance you are calling for a pretty meaningful ramping in the back half in the revenue, you talked about a pretty steady pipeline I want to know what sort of gives you confidence in achieving that outlook just given sort of the ramp you are sort of alluding to in your guidance?

Bill Stuart

The first off I commented related to Verizon, we wouldn’t expect to see a lot of revenue coming from that particular part of the relationship. The – I’m looking at the guidance for the year as Ron described earlier on a call it really is a – the expectations that we have associated with the opportunities that we are working including to some extent the work other works that we are doing with Verizon to drive more revenue with existing customers but a big opportunity with some other customers in the pipeline.

Ron Frankel

Yeah, I think there are really two key elements to this. One is we do have some significant opportunities in the pipeline. And two is the pace of rollout of our new products, and so both of these elements are important elements of the – of our forecast.

Gur Talpaz - Stifel

Got it and then just maybe going one step further you announced the Lenovo deal last quarter, so a nice win, you also talked about carbon rollout at Toshiba perhaps you would give us an update on both of those? Thank you very much.

Ron Frankel

Yeah, I think there is strong interest on the part of both of those companies to take us out globally. And one of the byproducts of our China opportunity is the opportunity to expand globally especially with a Lenovo. And I think that we have significant opportunities there we are still primarily U.S. and for PC is primarily on the second tab. Our early results on tablet are excellent. We were seeing much greater search and discovery activity and monetization with our tablet products now it’s just a question getting them out there on a lot of machines which seems very good, very, very positive early traction.

Gur Talpaz - Stifel

Got it. Thank you very much.

Bill Stuart

Okay and Gur thanks very much. I am sorry about that I mistook your program, your associate there Tom.

Gur Talpaz - Stifel

That’s okay.

Operator

Our next question comes from Edward Williams with BMO Capital Markets. Your line is open.

Tom Andrews - BMO Capital Markets

Hi guys, its Tom Andrews standing in for Edward tonight. Just a couple of questions if I may I may have missed it early in the call but did you give a breakdown on revenue between search advertising and display advertising?

Bill Stuart

Yes, we did actually I think we just talked about the search and display total. We did, so yeah hold on let me just.

Tom Andrews - BMO Capital Markets

Sure.

Bill Stuart

Yeah I was just turning back into the script search revenue was $15.8 million in the first quarter and display advertising was $18 million – excuse me $8.3 million in the first quarter.

Tom Andrews - BMO Capital Markets

Great. Thanks for that. You had just mentioned the strength that you are seeing in tablet, is that – are you seeing equivalent strength in any kind of a smartphone platform as well. And can you also just talk about what kind of CPM trends you are seeing out there in the market right now?

Ron Frankel

Yeah, so let me take the first one, smartphone we don’t have enough experience yet. We are just now rolling out with CenturyLink and it’s very, very early days. So, we really have a little experience in that area. On CPMs our e-CPMs are stable. At the margin, our video CPMs are very good and improving. They are already very good and then we are also getting some more multimedia cross media display with video elements and we are seeing very nice CPM growth in that area. But overall because we have a large tail of remnant the CPMs are relatively stable.

Tom Andrews - BMO Capital Markets

Okay, thank you very much.

Operator

Our next question comes from Rich Tullo with Albert Fried. Your line is open.

Rich Tullo - Albert Fried

Hey guys. You said that the early results on the tablet are excellent where is this product is going to be deployed, is it going to be deployed at the MSO level, is it going to happen in-store or is that going to be user generative?

Ron Frankel

Well, so there are a number use cases and the data I quoted on the tablet relates to our OEM customers. With regard to our MSO customers there are really a few use cases on the tablet, it’s been sort of spread use cases. Today tablets are been used as a media in the home, smartphones not so much really video viewing on smartphones has really come down significantly.

In the home tablet, our customers are becoming a little more aggressive or a lot more aggressive actually and being able to present a media either search and discovery it media experience on the tablet. And so they want to promote that experience. And so they advice the methodologies associated with device detection when they come on to WiFi network, you can do some messaging. Also with regard to their laptops in their house there is a greater desire to set homepage because it also drives more sampling of the off television media experiences that our MSO and Telco customers want to drive throughout their household. I think it’s becoming a much more central effort than in the past because I think they ultimately see some of it online over the top players somewhat competitive that’s not – yeah, it’s somewhat competitive in time.

Rich Tullo - Albert Fried

Okay. And as we discussed guidance it appears to be a nice hockey stick from what we are seeing, how much is – are the new initiatives reflected in the range of guidance, between the low end of the range and the high end of the range, as well as the little spike in R&D and spending that we saw this quarter in G&A, is that related to support these new customer initiatives that will hopefully onboard in the second half of the year?

Ron Frankel

Yes, the increase in spending is associated with pipeline and new product development.

Bill Stuart

Yes, the question I think Rich had was regarding G&A, Rich?

Rich Tullo - Albert Fried

Yeah.

Bill Stuart

Yes, that had more to do with the typical expenses in the first quarter such as the preparation of the proxy, the 10-K and also in the first quarter here, the expenses – legal expenses associated with the setup of the joint venture in China. The overall expenses would increase, and as Ron alluded to earlier when talking about these initiatives in spending in sales and marketing associated on the front end, and then over the course of the year continuing to ramp up in spending and R&D.

Rich Tullo - Albert Fried

And one last additional question, if you may, as we think about the potential for new customer relationships, are we thinking about expansion within the current platform of clients, or are we thinking about completely new customer relationships?

Ron Frankel

Primarily new customer relationships.

Rich Tullo - Albert Fried

Good enough. Thank you very much.

Ron Frankel

You are welcome. Thank you.

Operator

This concludes our Q&A session. I will turn it back to Ron Frankel for closing remarks.

Ron Frankel - President and Chief Executive Officer

Thank you very much for everybody attending, and love you all to have a great evening on behalf of the Synacor team. Thank you for attending.

Operator

Ladies and gentlemen, thank you for participating in today’s program. This concludes the program, you may all disconnect.

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