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Synacor, Inc. (NASDAQ:SYNC)

Q2 2013 Results Earnings Call

August 6 2013 5:00 PM ET

Executives

Denise Garcia - ICR, IR

Ron Frankel - President and CEO

Bill Stuart - Chief Financial Officer

Analysts

Jed Kelly - Oppenheimer

Edward Williams - BMO Capital Markets

Rich Tullo - Albert Fried

Operator

Good day, ladies and gentlemen, and thank you for your patience. You’ve joined Synacor’s 2013 Second 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 be given at that time. (Operator Instructions)

As a reminder, this conference maybe recorded. I would now like to turn the call over to your host, Denise Garcia with ICR. Ma’am, you may begin.

Denise Garcia

Thank you. Good afternoon. Welcome to Synacor’s second 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 the 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-Q filed with the SEC on May 14, 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’ll turn the call over to Ron Frankel, Synacor’s President and CEO.

Ron Frankel

Thanks, Denise, and welcome to today’s conference call. I wanted to take a moment and express my views of Synacor’s position in the marketplace and the excitement that I feel about our prospects as a company.

2013 is the transition year. A year in which we are investing in products which our customers and prospects demand, these products deliver compelling experiences for smartphones, tablets and desktop and laptop computers.

I believe our financial performance in 2013 is not a reflection of current state of our prospects. Our sales pipeline is strong and I believe the combination of our strong pipeline and new products will return Synacor to growth in 2014.

Now let me take you through our financial results for the second quarter of 2013 and an update on our business.

Looking more closely, our results were in line with the guidance we shared on our first quarter call. Revenue for the second quarter was $26.7 million versus $30.8 million in the same quarter of 2012. Adjusted EBITDA was $1 million compared to adjusted EBITDA of $3 million in the second quarter of 2012.

Looking more closely at the different components of our revenue, display advertising totaled $7.7 million for the quarter, compared to $8.2 million in the second quarter of last year. Search revenue was $13.7 million in the second quarter, compared to $17.3 million in the same quarter last year.

Continue to feel the effects of Windows 8 on PCs in our OEM business. This has decreased the volume of impressions and searches we monetize with these customers, resulting in a decrease in display and search revenue for our OEM customers.

Typical, second quarter seasonality also impacted search and display revenue. Subscription-based revenue was $5.3 million, compared to $5.4 million in the second quarter of 2012.

I want to elaborate a bit on the opportunities we have with our device manufacturer customers and prospects. While, Windows 8 has affected our current PC business with these OEMs, we have significant opportunity supporting their Android, tablet and smartphone offerings.

Our tablet-based browser startpages are performing well and we are investing in Android products for both tablets and smartphone. I believe the growth of Android and our relationships with device manufacturers has put us in great position to drive in this newly emerging ecosystem.

I have mentioned investment a couple of times. I want to describe how we are developing. We have recently expanded our technology and engineering talent in Boston. We expect to have a team of 25 engineers, project managers and product developers there by year end, focusing on our innovative Cloud ID and Social Login project -- products for TV Everywhere. This talent will augment the excellent team we have working on these products in our Buffalo headquarters.

These products have won a number of industry awards demonstrating our leadership in TV Everywhere and Cloud ID. Synacor’s Cloud ID, Social Login solution received the TV of Tomorrow Leadership Award for the most significant technology product. Same product was awarded TMC Cable Spotlight Product of the Year and CableFAX Best of the Web Award as the best TV Everywhere technology.

As the innovator in the space, Synacor’s was also recently invited to showcase its Cloud ID, Social Login and TV Everywhere products at Google’s Developer Sandbox at Google I/O ‘13. This is recognition of the important role we are playing in the TV Everywhere ecosystem. I’m personally proud of our team from their hard work and the accolades these products have received.

Most importantly, is our customer response, I’m happy to say, we have added DISH Network as a customer for Cloud ID and Social Login. We are also increasing the size of carbon technology team in Toronto, focusing on mobile products for tablets and smartphones with a particular emphasis on Android.

Our customers and prospects are excited about both browser startpage and native Android launcher opportunities with us. With estimates of nearly 1.5 billion devices being sold worldwide in 2013, they rely on us to address their challenges around browser-based and pre-loaded launcher start experience.

There significant demand for our new products among consumer electronics manufacturers and wireless carriers. We believe Synacor can become an indispensable partner, helping our customers advance their mobile experiences.

Our focus on multiple platforms has positioned us well for international where android devices have significant market share. In China, our China joint venture is progressing nicely.

We’ve also established the presence in Latin America by signing Grupo TV Cable, Ecuador. Ecuador is largest MSO for consumer startpage and e-mail products. We are excited about the global opportunity for our products.

Let’s come back to our sales pipeline and timing as it relates to new customers. As I have said, we have an exceptionally strong pipeline with multiple large projects and we are currently making the product and personnel investments required to support them.

However, the timing of their launches is difficult to predict and we currently estimate, they will begin to contribute revenue near the end of 2013 or first half of ’14 rather than in the second half of 2013 as we discussed in last quarter’s earnings call.

As a result, we are lowering our 2013 guidance to a range of $108 million to $112 million in revenue. Adjusted EBITDA will be reduced accordingly to a range of $3 million to $5 million.

This is the transitional year for Synacor, year that I believe does not reflect the true potential of Synacor and assuming the conversion of our customer pipeline, I believe we will return to growth in 2014.

With that, I’ll turn the call over to Bill and then we can open the call for questions. Bill?

Bill Stuart

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 second quarter key metrics according to comScore, Synacor engaged 19.7 million average unique visitors per month consistent with the 19.9 million average unique users in the same quarter last year and down 3% from the 20.3 million in the previous quarter.

Search queries were 177 million for the second quarter, a decrease of 26% from the 238 million search queries in the second quarter of 2012 and down 16% from 212 million in the previous quarter. We delivered 10.3 billion advertising impressions, consistent with the second quarter of 2012 and the 10% decrease from the previous quarter.

As Ron mentioned earlier, we continue to feel the effects of Windows 8 on new PCs affecting our OEM business which has decreased the volume of impressions and searches we monetize.

As a result, second quarter revenue decreased 13% to $26.7 million from $30.8 million in the same period last year. Adjusted EBITDA was $1 million for the quarter, compared to adjusted EBITDA of $3 million in the second quarter of 2012.

Net income for the quarter was a loss of $637,000, compared to a profit of $1.2 million in the second quarter of 2012. Diluted earnings per share, or EPS was a loss of $0.02, compared to a profit of $0.04 in the second quarter of 2012.

Net income includes stock-based compensation expense of $617,000, or $0.02 per share in the second quarter of 2013 and $425,000, or $0.01 per share in the second quarter of 2012. The diluted EPS calculation for the second quarter of 2013 is based on $27.3 million weighted average fully diluted common shares outstanding.

Turning to costs and expenses, cost of revenue as a percentage of revenue was 52% for the second quarter. We expect cost of revenue to be approximately 55% going forward which is within our historical range.

Total operating expenses, excluding stock-based compensation and depreciation were $11.8 million for the quarter or 44% of revenue, compared to $11 million, or 36% of revenue in the same period last year.

R&D as a percentage of revenue increased by 7 percentage points over the same quarter last year, due largely to our continued investment in product and talent.

G&A expenses as a percentage of revenue increased by 1 percentage points over the same quarter last year. Sales and marketing as a percentage of revenue was flat compared to the same quarter last year.

In the second quarter, we generated $500,000 in cash from operating activities compared to generating $400,000 in the second quarter of 2012. We ended the quarter with $37.7 million in cash and cash equivalents compared to $35.1 million in the second quarter 2012.

I would like to finish our call with our thoughts regarding guidance for the third quarter and full year 2013. For the third quarter, we expect revenue within the range of $25 million to $26 million with adjusted EBITDA in the range of negative $300,000 to positive $300,000.

For the third 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. For depreciation we expect to range between $1.1 million and $1.3 million. For stock-based compensation we expect to range between $650 and $750,000. For other income expense we expect approximately $50,000 in expense.

For income tax expense, given we are forecasting a net loss we are not likely to incur any federal income tax expense. As a reminder, the majority of our tax expense is non-cash taxes as we have a balance of $4.7 million in deferred tax asset. For weighted average fully diluted shares outstanding utilized in the treasury shares method, we expect our share count to be approximately $28 million.

At this point, we continue to expect depreciations, stock-based compensation shares outstanding to increase slightly as the year progresses with other income and expense remaining relatively constant -- consistent.

For the full year, we are adjusting our guidance to $108 million to $112 million in revenues. Our expectations for adjusted EBITDA are $3 million to $ 5 million, taking it to consideration the lower revenue guidance and the investments we are making to better position the company to deliver on those key opportunities in the pipeline.

Lastly, regarding the prospects of leveraging our 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 $37 million of cash in the bank and additional financing available to us, we are well positioned to act strategically.

In closing, our second quarter results delivered on expectations. We remained confident about our future and our market opportunity and look forward over the course of 2013 and into 2014 to continue to build Synacor for the long term.

Thank you. And we’ll now open the line to your questions. Operator?

Question-and-Answer Session

Operator

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

Jed Kelly - Oppenheimer

Hey guys. Good afternoon. This is Jed Kelly on for Jason. Just real quick run overall, just kind of an overall view of the business for 2014. Where do you see most of the growth coming from? Would it be from OEMs? Would it be more international based? Would it be more subscription? Can you just touch on, like, what aspect you see most of the growth coming from and then my other question, can you just briefly touch on why display was down year-to-year, more insight?

Ron Frankel

With regard to the customers mix, I think we’re seeing demand as we did show our products across the board. And so I’m really taking -- I'm really heartened by that response in the market place. And what I’m focused on is investing to make sure that we have the products available in the marketplace.

I think their early returns on our mobile products show significant monetization opportunities, traffic monetization opportunities on those platforms. So I’m pretty bullish, excited about that part of it. Of course, timing is little hard to predict. And I have said that and so we’re going to -- we're trying to be careful about that.

In terms of display advertising, I think it’s really just the number of impressions that we’re selling ads on. One of our customers is actually paying us fees instead of selling some of the inventory because they wanted some of the inventory for some internal folks. So there is a combination -- reduction in OEM traffic. It is also a primary reason for reduction display advertising.

Jed Kelly - Oppenheimer

Okay. And then is there any way you could touch on like what percentage your revenue is coming from mobile products?

Ron Frankel

It’s still small. I mean, we really only have mobile with Toshiba on the tablet. But we love the numbers that are coming from that part of it. But I think with our new carbon based, it’s -- we have the tremendous potential in this area.

Jed Kelly - Oppenheimer

All right. Thank you.

Operator

Thank you. Our next question comes from Tom Roderick of Stifel. Your question please.

Unidentified Analyst

Hey guys. It’s [Gord Talpez] on for Tom. So I was hoping you could elaborate a bit on the new customer rollouts and what maybe causing that pushback into the end of the year, early next year. Is it the adoption of your newer products and kind of the working bits that go to that or just kind of difficulty in timing new customer wins?

Ron Frankel

I think it’s really a combination. I mean, from my perspective, we have -- it's now three platforms. So desktop, laptop, historically, we’ve been focused primarily on desktop laptop. But now it’s desktop laptop and then you really separate that between touch and non-touch. And then you go to the tablet which is touch and of course smartphone with different form factors.

So our launches are more complicated but also more excited. And so I’m really looking forward to it. Really honest, I just want to make sure it’s done really well. Well from a quarterly financial performance perspective, obviously I’d like to see the revenues sooner. I’m really focusing in getting the products right, making sure we’re doing the right kind of launches for these customers, long-term customers and so that’s really our primary focus.

Unidentified Analyst

In the past, with regards to Windows 8, you’ve talked about something that you can do to kind of combat the attrition that you’ve seen from that rollout. And you talked specifically about Windows 8 specific applications. Is that still a strategy that you guys are trying to employ or is that some of you are kind of looking into the future, maybe a little bit of elaboration on that would be helpful?

Ron Frankel

Well, it is interesting because I think on the Windows 8 side, it really primarily affects our OEM customers, not our MSO and telco customers. And I think there is a lot more that they are doing but also it’s their proliferation into multiple devices. And the growth of Android on all of their other devices as a percentage of total devices shift compared to PC. And the early data is very good for us with our Toshiba tablets.

And so for us, I think it’s focusing in on that Android opportunity is really a great place for us to play. And I think it’s one that they have a tremendous amount of respect in us to provide solutions for them.

Unidentified Analyst

Sure. And with regard to Android, are you doing native app development yet for Android or is it still very much a browser-based HTML file approach kind of what we see with carbon historically?

Ron Frankel

Yeah. First product that will be carbon browser based, but you’ll see us involved in some native applications absolutely.

Unidentified Analyst

Okay. Thank you very much.

Ron Frankel

Thank you.

Operator

(Operator Instructions) Our next question comes from Edward Williams of BMO Capital Markets. Your question please.

Edward Williams - BMO Capital Markets

Hi, good afternoon. Just a couple of quick questions for you guys. First of all, if we’ve to look at your levels of R&D spending and some of your operating expenses in general, should we look at kind of the levels in the second quarter and go forward from there or can you give us any clarity as to what variability maybe in some of those line items?

Bill Stuart

Yeah. In fact, hi -- yeah, this is Bill. I’d expect R&D would move up over the course of the year whereas the others are going to remain essentially flat. Again I’d expect that over the third and fourth quarter.

Edward Williams - BMO Capital Markets

Okay. And is that -- are we going to see that trend continually rollout into Boston or are we going to see leveling off of R&D?

Ron Frankel

Largely driven by the rollout, the addition of people in Boston and in Toronto and in fact I would expect that would continue at least through the end of this year and then maybe into next year as well assuming that we’re successful with the opportunities in the pipeline.

Edward Williams - BMO Capital Markets

Okay. And then, Ron, can you talk a little about the difference in the usage and what you’re seeing on mobile at this stage relative to desktop and laptop?

Ron Frankel

Well, interestingly our early data suggest that we’re seeing much more searches and more usage on tablet than we’ve seen historically in the desktop, laptop setting which is great and maybe testimony to the fact that it’s harder to switch and also testimony to maybe quality of the experiences as well and some of the advantages that we have in that regard on the tablet.

Edward Williams - BMO Capital Markets

Okay. All right. Great. Thank you.

Ron Frankel

Thank you.

Operator

Thank you. Our next question comes from Rich Tullo of Albert Fried. Your line is open.

Rich Tullo - Albert Fried

The step up in R&D expenses as well as your commentary on the pipeline would lead me to believe that the pipeline is somewhat firm. Synacor had signed contracts, are you in pitching process, if you’re in a pitching process, are you one of two prospects or you responding to requests for the proposals?

Ron Frankel

Rich, I’d love to give you more detail on the exact specific status, but I can’t at this time. As soon as I’m able, of course we will announce the relevant customer outcomes.

Rich Tullo - Albert Fried

Okay. And in terms of the M&A market, it sounds like you’re more of a buyer of the M&A than the seller of M&A?

Ron Frankel

Yeah. I think we are not -- we’re focused primarily on growing the company. I think that’s really are our principal objective.

Rich Tullo - Albert Fried

And do you think that’s possible, if a situation would arise where Synacor can grow faster under the umbrella and taking advantage of certain synergies from a larger company, is that something you’ll consider?

Ron Frankel

Well, like I mean our -- we’re stewards. So we represent shareholder interest. So obviously anything that maximizes shareholder value, we have a fiduciary responsibility to look at. Having said, that you’re not spending any time on it.

Rich Tullo - Albert Fried

Fair enough. And one last kind of…

Bill Stuart

If I can clarify when Ron says, we’re not spending any time that’s on the sale side if you will, where we spend our time looking at some acquisitions that we think would fit with the company strategically so that has a buyer if you will.

Rich Tullo - Albert Fried

Fair enough. And like let say some 2015, ‘16, ‘17, what percentage of revenue from either search display or in total do you think you’ll derive from non-PC-based platforms as compared to today?

Ron Frankel

Rich, that’s a very good question. I think that there are tremendous opportunities. When I talk about a billion and a half devices and I look at our customers like Lenovo and Toshiba and others in the pipeline. I just think that there is a huge opportunity for us in this area. And think we could see easily more than 50% of our total searches and advertising impressions on mobile devices and devices of a wide range of sort.

I mean the proliferation of these devices and the requirements for the kinds of experiences that we’re creating is growing tremendously and think about all kinds of different venues. I mean cars, walls, just -- it’s very interesting. And so I can really think we’re in the middle of tremendous opportunity and I for one remain very excited about it.

Rich Tullo - Albert Fried

Fair enough. Thank you very much.

Bill Stuart

Thank you, Rich.

Operator

Thank you, sir. And ladies and gentlemen, that does conclude the Q&A portion of our call and Synacor’s 2013 second quarter earnings call. At this time, you may disconnect your lines. Have a great day.

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