Synchronoss Technologies Management Discusses Q3 2013 Results - Earnings Call Transcript

Synchronoss Technologies (NASDAQ:SNCR)

Q3 2013 Earnings Call

November 04, 2013 4:30 pm ET

Executives

Lawrence R. Irving - Chief Financial Officer, Executive Vice President and Treasurer

Stephen G. Waldis - Founder, Executive Chairman, Chief Executive Officer, Member of Key Employee Stock Options Committee and Member of Business Development Committee

Analysts

Tom M. Roderick - Stifel, Nicolaus & Co., Inc., Research Division

Nandan Amladi - Deutsche Bank AG, Research Division

Shyam Patil - Wedbush Securities Inc., Research Division

Michael B. Nemeroff - Crédit Suisse AG, Research Division

William V. Power - Robert W. Baird & Co. Incorporated, Research Division

John F. Bright - Avondale Partners, LLC, Research Division

Gray Powell - Wells Fargo Securities, LLC, Research Division

James Moore - FBR Capital Markets & Co., Research Division

Paul B. Thomas - Goldman Sachs Group Inc., Research Division

Sterling P. Auty - JP Morgan Chase & Co, Research Division

Tavis C. McCourt - Raymond James & Associates, Inc., Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter 2013 Synchronoss Technologies, Inc. Earnings Conference Call. My name is Cristal, and I will be your operator for today. [Operator Instructions]

I would now like to turn the conference over to your host today, Mr. Stephen Waldis, Chairman and CEO. Please proceed, sir.

Lawrence R. Irving

Okay. Well, this is Larry Irving, and thank you. Good afternoon, and welcome to the Synchronoss Third Quarter 2013 Earnings 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. With me on the call is Steve Waldis, Founder and CEO.

During the call, we will make statements related to our business that may be considered forward-looking statements under federal security 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 those listed in our SEC filings, including our most recently filed annual report on Form 10-K and our quarterly report on Form 10-Q.

With that, I will turn the call over to Steve, and I'll come back a bit later to provide some further details regarding our financials and our forward-looking outlook. Steve?

Stephen G. Waldis

Great. Thank you, Larry. Good afternoon, and thanks for joining us on our call today to review our third quarter financial results, which were consistent with our expectations on both the top and bottom line. Our non-GAAP revenues were $90.3 million, representing 30% growth on a year-over-year basis, and we delivered a non-GAAP operating margin of 23% and a non-GAAP EPS of $0.34, which was at the high end of our guidance range.

Now the investments that we're making in both our Activation Services and Cloud Services businesses are delivering positive results that we believe will position Synchronoss for continued growth. In particular, we remain encouraged by the performance of our Cloud Services offering, in which we generated 55% year-over-year growth in the third quarter, and it's set to accelerate here in Q4.

Now there are several key highlights for our personal cloud offering during the third quarter. Our customers are rolling out more visible marketing promotions and expanding their free storage offerings, which are focused on driving further increases and adoption rates as we head into 2014. And we have completed almost all of our initial personal cloud rollouts, including our Personal Cloud Platform, to all 16 of our target markets at Vodafone.

Now as we've discussed on our calls for the last year, we have always expected 2013 to be a year in which mobile operators continue to fine-tune their go-to-market strategies for personal cloud services in order to deliver a world-class customer experience and maximize adoption rates. In the last 2 quarters, our customers have learned quite a bit about where their subscribers are demanding and how these subscribers are utilizing the personal cloud.

Early industry data is showing that subscribers adopting our personal cloud software ultimately become more valuable subscribers to our mobile operator customers. These subscribers have a tendency to buy more comprehensive 4G data plans as the ability to sync and store data becomes truly easy in mobile, fueled by the proliferation of 4G connectivity that is growing nationwide and globally every day; they buy more family share plans, with the average personal cloud subscriber using at least 2 devices to connect, sync and back up their content from the device to the cloud; and they become more loyal customers, as the personal cloud convenience and security levels lead to lower churns rates that drive significant savings to our mobile operator customers.

And as a result of our early implementations and market data, our customers are planning to drive greater adoption via the increased amount of storage they provide subscribers for free by rewarding subscribers who buy and subscribe to larger 4G data plan networking offers. Most of our customers have recently moved to at least 5 gigabytes of free usage as part of their ongoing marketing promotions, and we believe this long-term trend will be towards even higher amounts in the future. The recent step-up in offerings, both here in the U.S. and in Europe, from our customers, is an exciting development because it shows their commitment to providing their subscribers a more comprehensive cloud solution.

Now Verizon's commitment to the cloud, in partnership with Synchronoss, was further reinforced by our enhanced and extended relationship through a new 5-year agreement. This agreement includes a meaningful increase in minimums, along with greater expectations and visibility into the future volumes. We believe this new agreement provides us with an opportunity for strong growth over time and assumes that personal cloud will be a very key part of the communication strategy for customer acquisition and retention in the coming years. I'm also pleased to share that our current deployments and new agreements put us on track to exceed the projected run rate that we discussed last year, which was that our business at Verizon would be at least $70 million annual run rate exiting first quarter of 2014.

Now our current visibility and commitments across all of our customers provided us with the confidence to pull in future CapEx investments into 2013 in order to support our future growth and gain quicker operational and cost efficiencies. Now as we've discussed in the past, we only make CapEx investments when we have a high level of confidence and visibility in future volume levels.

Now in addition to the progress on our personal cloud offer, we're also making significant progress building out our new business cloud. I'm pleased to share with you that an early adopter of our business cloud offering will be Vodafone. Our business cloud will target small to midsized business customers who rely on mobile operators to provide much of their basic communication needs, including voice, Internet connectivity and networking. We believe the need for an end-to-end platform that provides their employees with business productivity tools are required to succeed in today's mobile environment.

Now mobile operators will be able to deliver a wide range of benefits to their small and medium business customers, such as allowing customers to bring their own device to work while the business controls its data; data can be synced across user devices and fully searchable and accessible; users can edit and comment documents from their mobile devices and tablets and allow groups to edit, update and tag work in progress, which will foster better employee collaboration and productivity; and all while the business IT administrators retain control of end-user management, access control, storage allocation to ensure consistent and secure user experience.

Now we see the business cloud as a significant market opportunity that has the potential, over time, to be as large as our business cloud (sic) [personal cloud] opportunity. Now we remain on track to move into production with our business cloud platform in early 2014, and we are excited at some of the early but positive discussions with other mobile operators on how the business cloud can help them secure more customers.

Now turning to our Activation business. We had another solid quarter. The combination of upgrade promotions now being offered by operators, along with the positive impact of family share plans, is driving solid transaction volumes with our mobile operator customers. Now during the third quarter, we also had another successful release of the latest iPhone devices, both the iPhone 5S and 5C.

Now one of the highlights of the third quarter was signing of a new 3-year deal with AT&T. Now similar to our last contract with AT&T, it covers all the existing areas that we are working on together and provides a framework that is conducive to expanding our relationship over time. The primary changes to the contract related to putting in place terms for new transaction types that we have on-boarded to our platform since we signed our last agreement in 2009.

Now we've also updated our service level agreements to better align with the natural changes in the business over time. And in terms of pricing, we had some transactions that went down in price while other transactions went up in price, but the near-term revenue impact from this new agreement is not meaningful to our overall results. We are excited to have extended our relationship with AT&T and see great opportunities to continue to drive meaningful top line growth with new technology and new service offerings.

And we're also excited to announce today that we'll soon be introducing a powerful new extension to the Synchronoss core Activation Services called integrated life. With our integrated life capabilities, we will bring a powerful point of distinction to the marketplace. Whether we're talking about a desktop computer or an automobile, we believe that technologies deliver greater value, utility and power when they're working together. So after years of activating mobile phone devices on mobile networks around the world, it's only logical that we become the key to activating your automotive, your home appliances or even ensuring your physical activity can be monitored properly.

Our integrated life platform will enable all these types of devices, and eventually even more, to be connected to a mobile operator's network, ensuring they're always on and able to work together. Now we're pleased to announce that we have an agreement with a major Tier 1 customer to deploy our integrated life platform, and we intend to showcase our capabilities and some exciting new connected devices at both CES and Mobile World Congress in early 2014.

In summary, we're pleased with the momentum of both our Cloud Service and Activation business, we are encouraged with the adoption trends we're seeing in our personal cloud deployments, and we expect to see strong growth next year as we realize the benefit of more substantial marketing programs being executed across all of our customers. At the same time, we're expanding our value proposition and addressable market opportunities with the introduction of our business cloud and the integrated life platform. We believe Synchronoss is well positioned at the center of multiple powerful industry growth drivers, and we're excited about our future.

With that, let me turn the call over to Larry.

Lawrence R. Irving

Well, thanks, Steve. I would like to begin with a review of our third quarter financial results and finish with our outlook for the fourth quarter and full year of 2013.

Our top line performance is being driven by our cloud platform beginning to ramp across our portfolio of customers, in addition to continued solid growth from our Activation Services. We're also very pleased to have recently put in place multiyear contract extensions with our 2 largest customers, AT&T and Verizon, which further reinforces the significant value that Synchronoss is delivering to our customers. These agreements and their associated minimums provide enhanced visibility to revenues for both AT&T and Verizon for the next couple of years.

The growing commitments from our customers, combined with the momentum of our business, provides us with the confidence to continue to invest in our growth initiatives, in addition to pulling forward some CapEx investments that Steve noted earlier. This is an exciting time in the development of the mobile carrier cloud market, and we believe Synchronoss is well positioned to be a primary beneficiary as it scales in the years ahead.

With that overview, let me provide additional details on our third quarter financial performance, starting with the income statement. GAAP revenues were $89.7 million for the third quarter. Non-GAAP revenue, after adding back $558,000 of deferred revenue write-downs from certain acquisitions, was $90.3 million, which was in line with our guidance and up 30% on a year-over-year basis.

Our non-GAAP cloud revenue in the third quarter was $26.9 million, which represented 30% of our total revenue and year-over-year growth of 55%. Our cloud revenue growth was driven by scaling of our Personal Cloud Platform deployments with major Tier 1 customers, including Verizon Wireless, Vodafone, Telefonica and AT&T. We are pleased with the performance of this business, and we expect increased marketing programs from our customers heading into the holiday season, along with our offering being rolled out to additional devices, all of which will drive further increases in customer adoption.

Our non-GAAP Activation Services revenue was $63.4 million for the third quarter, representing 70% of our total revenue and year-over-year growth of 22%. Activation revenue growth in the quarter was largely attributable to strong performance at AT&T due to a positive impact of new device upgrade programs and family share plans, the launch of the iPhone and solid activity in our broadband business.

Further on revenue mix, we saw an increase in our recurring revenue sources to 77% of our third quarter non-GAAP revenue, up from 72% in the third quarter of 2012. Revenue from professional services and licenses declined to 23% of revenue in the third quarter from 28% in the year-ago period. This mix shift largely reflects the fact that we have more cloud service deployments moving into production, along with data storage requirements, adoption rates and volume levels that are in the early stages of ramping.

Turning to cost and expenses. We will review our numbers both on a GAAP and non-GAAP basis. There is a full reconciliation table between the 2 in our earnings release, which can be located under the Investor Relations section of our website. Non-GAAP gross profit in the quarter was $53.9 million, or a gross margin of 60%, which was comparable gross margin to the year-ago quarter. Non-GAAP SG&A was $11.6 million or 13% of non-GAAP revenue, which was up from 11% compared to the year-ago quarter and flat compared to the prior quarter. R&D was $14.7 million or 16% of non-GAAP revenue, which is consistent with the year-ago period and down from 17% last quarter.

Non-GAAP income from operations was $21 million in the third quarter, representing an operating margin of 23%, consistent with our expectations and down from a 27% operating margin in the year-ago quarter. We are pleased with our ability to deliver solid profitability while making significant investments in our personal cloud, business cloud and integrated life platforms, all of which will help drive future revenue growth.

Our non-GAAP tax rate for the quarter was 34%, which led to a non-GAAP EPS of $0.34, up from $0.28 in the year-ago period and at a high end of our guidance. The number of weighted average shares for the quarter was 40.1 million, up from 38.9 million in the year-ago quarter. On a GAAP basis, third quarter gross profit was $51.6 million, income from operations was $8.8 million and GAAP fully diluted earnings per share was $0.09.

Looking at our cash. Total cash, cash equivalents and marketable securities was $50.8 million, down $10.2 million from $61 million at the end of last quarter. We generated $2.5 million in adjusted cash flow from operations for the quarter. Non-GAAP cash from operations excludes the payments for additional purchase price for acquisition or renounce [ph] and the excess tax benefit of exercising of stock options. Cash flow in the quarter was negatively impacted by the timing of the new agreements we entered into with AT&T and Verizon, which impacted the timing of both invoicing and cash collections. We do expect our cash flow will normalize in the fourth quarter. During the quarter, we entered into a 5-year $100 million credit facility that gives us increased financial flexibility and further strengthens an already strong balance sheet.

Capital expenditures were $17.5 million, bringing year-to-date CapEx to $55.2 million. Capital expenditures are above our historical average, as we have received materially higher minimum commitments from our customers than we had originally anticipated. In the fourth quarter, we intend to continue making substantial investments in our infrastructure to support the increased storage requirements of our personal cloud customers, as well as prepare for the deployment of the business cloud in the first quarter of 2014.

We now expect capital expenditures of $72 million to $74 million for the full year of 2013. This includes approximately $15 million to $20 million of capital expenditures that we were originally expecting to make in 2014, but we pulled them in 2013 based on the increased commitments we have received from our customers. As we've noted in the past, we have a history of being prudent in the deployment of capital for CapEx, always doing our best to ensure that customers are committed to scaling their relationships with Synchronoss in order for us to justify ramping investments. As such, our decision to accelerate certain CapEx investments demonstrates our confidence in the programs we are executing against.

We believe the investments we are making in our infrastructure this year can support substantial future adoption growth in our cloud business, and our current expectation is for our capital expenditures in 2014 to be in line with or below our typical 8% to 10% of revenue. This level does not assume an incremental significant expansion of scope of any of our existing customer relationships or signing a transformational new customer, both of which would obviously have a positive impact on revenue over time if they were to occur.

With that, let me turn to the guidance, starting with the fourth quarter. For the fourth quarter of 2013, we are targeting non-GAAP revenues in the range of $94 million to $97 million, which represents year-over-year growth of approximately 27% to 31%. From a profitability perspective, we are targeting non-GAAP gross margins in the 61% to 62% range. We expect to generate non-GAAP operating margins of approximately 25% to 26%. We expect non-GAAP EPS of approximately $0.38 to $0.41, assuming a tax rate of approximately 34% and a diluted share count of approximately 41 million shares.

Taking our 9-month actual results along with our fourth quarter guidance, this translates into full year results as follows: We are increasing the low end and midpoint of our revenue guidance, leading to a full year non-GAAP revenue of approximately $349 million to $352 million, which compares to our prior guidance of $345 million to $352 million. From a profitability perspective, we expect full year non-GAAP gross margins in the 61% range, along with a non-GAAP operating margin of approximately 23%. We're narrowing our non-GAAP EPS range to $1.31 to $1.34, assuming a 34% estimated full year tax rate and a diluted share count of approximately 40 million shares.

We are very pleased with how Synchronoss' business has progressed over the course of 2013, which is supported by the fact that our updated non-GAAP revenue guidance of $349 million to $352 million compares favorably to our initial guidance of $330 million to $350 million. Looking at this from a detail perspective, we are extremely pleased with the rollout of our personal cloud deployment to date. We are seeing marketing programs move from pilots to more aggressive nationwide and global rollouts.

We're seeing meaningful increases in minimum commitments from our customers, and we're increasing the mix of our total revenue coming from recurring sources. All of these factors bode well for cloud growth in 2014 and beyond and are supported by the fact that we are tracking to exit 2013 with a higher level of subscription revenue than we initially anticipated from our cloud offerings.

As compared to our expectations coming into 2013, we expect recurring revenues from our cloud offerings to exceed our projections, while we expect to see less professional services than initially expected, due primarily to the fact that the software assets acquired from NewBay at the end of last year were integrated very effectively within our technology cloud stack in 2013. The net result is strong full year cloud growth in the mid-40% range, which includes expected cloud year-over-year revenue growth of approximately 60% in the second half of 2013. As we look ahead, the trend of our personal cloud revenues and the introduction of the business cloud platform give us confidence that we are on track to generate strong growth in 2014.

Our Activation Services revenue has been a strong performer all year, and we are optimistic about our fourth quarter outlook in this area as well. For the full year, our Activation Services revenue is tracking above our high-end range of guidance provided at the beginning of the year.

So in summary, Synchronoss delivered solid performance across both our businesses during the third quarter, and we are optimistic that we are expanding our set of activation and cloud service solutions that position us well going forward. We remain confident in our ability to capitalize on the substantial market opportunity we address and to grow Synchronoss into a substantially large and more profitable company over time.

With that, let me turn it back to the operator, and we'll begin our QA. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Tom Roderick with Stifel.

Tom M. Roderick - Stifel, Nicolaus & Co., Inc., Research Division

So maybe I could start with talking -- or asking a question a little bit here about the Verizon relationship. And in particular, you highlighted an extension of that for 5 years. Can you discuss what, if any, sort of pricing concessions you had to give up to achieve some of that visibility as far as the 5-year agreement? And when you talk about better top line visibility, can you give a sense as to what that means? Are you getting commitments on a subscriber level, on a pricing level? Just any further detail you can get, since it seems like you're getting better visibility out of this relationship than you might typically get on the activation side.

Stephen G. Waldis

Yes. Tom, this is Steve. So the general extension of the agreement, really, the pricing remained as we previously had it. The bigger initiatives and changes were around the commitment for the minimums on a go-forward and a visibility into the outer years. If you recall, in the cloud business, our software is in the hands of, obviously, their end subscribers, and so it's really important to partner with us so that we have accurate time to make the right investments to ensure that experience can be as pleasurable and as scalable as possible. And so the additional new marketing promotions, as well as the future outward look of the cloud, required higher minimum commitments, and so we adjusted it accordingly so that the partnership can generate the results that everybody intends to see over the next few years.

Tom M. Roderick - Stifel, Nicolaus & Co., Inc., Research Division

Great. Maybe second question, this is more broadly speaking around the transactional business itself. If I look at cloud, it looks like it was relatively flat quarter-on-quarter. But it does sound there's some puts and takes relative to the transactional business line inside of that growing faster while pro serve's shrinking. Can you break apart the cloud, in particular, as it relates to what sort of growth you may be seeing on the transactional side? And then, I guess, the secondary question around that is, was there any sort of meaningful license revenue this quarter that should be called out, like we had in some of the past quarters?

Stephen G. Waldis

Tom, let me take the first part. I'll let Larry address on the license side; I'm not sure. As you recall, the first half of this year, we had a lot of deployments that were taking place across the personal cloud. And a lot of that services revenue -- this is kind of a transitioning quarter, where the service revenues are going down and these personal cloud productions that we spoke about last quarter are ramping up. And as I indicated in my script, you'll see the output of that and the acceleration here in Q4. And the combination of the success of the personal cloud rollouts and a lot of the technology integration that we were able to capitalize -- and NewBay got us through these personal cloud deployments a lot quicker, especially in Europe, and put us more into the transactional flow on a go-forward basis. I think some of the proof points, besides this quarter going up, I kind of shared a little bit on the call of the run rates for Verizon that will be a little bit ahead of where we anticipated for sure at the end of Q1.

Tom M. Roderick - Stifel, Nicolaus & Co., Inc., Research Division

Okay, great. And last one for me was just around the recent change from Verizon. It looks like they upped their free service to run 5 gigabit -- run 5 gig in terms of customers who have downloaded the app. What does that mean as far as any sort of rev share for paid services programs? Does that impact you on the pricing that you see from Verizon? Is in a reflection of any change in the relationship? Just anything you can add to offer regarding that change in their service is great.

Stephen G. Waldis

Yes, sure, Tom. I mean, certainly can't provide any color around Verizon, and particularly in terms of their marketing presence in the market. But I can say, from a more generic perspective, across the industry, what we're seeing is that the cloud and the personal operator's role of it is really being deployed, I think, effectively in the sense that they're looking to get -- these customers that are signing up are more profitable, bigger data consumers for the carriers. They have a tendency, when they have additional storage, to drive more revenue-based services. And the carriers, with their family share plans, across the market, are enabling more devices. The more devices will store, more of those devices will also become more integrated across the network. All of those lead to lower churn rates that we're seeing and better-paying and higher ARPU type of customers. And so ultimately, what we're seeing is a trend across the industry for that to happen on a continual basis. As it relates to Synchronoss, in a generic sense, nothing has really changed in our model in the sense that we scale by the number of subscribers, the number of devices the subscribers have and then the amount of storage allocated or used by those subscribers. And that model has stayed pretty consistent across our base.

Operator

Our next question comes from the line of Nandan Amladi with Deutsche Bank.

Nandan Amladi - Deutsche Bank AG, Research Division

Steve, question on the Vodafone business cloud. You talked about document sharing. Obviously, storing the documents is something that you have already been doing at Verizon. But as you get into BYOD and document sharing across teams, are you building those capabilities in your own product? Or are you licensing your third-party document management type platform and MDM platform, potentially?

Stephen G. Waldis

Sure. So from the first part, obviously, we haven't broken out all the different components yet of the business cloud. You'll see more of that coming later in the year. I will tell you that the collaboration capabilities that we have certainly are things that, when you look at small to midsized business customers, especially the segment that we're going after, it's really important that, that not only be shared, which you can get from multiple services, but you can do it in a very secure and integrated fashion. And that's one of the big advantages, obviously, that we bring in to companies like Vodafone and others, where we kind of provide that over-the-top capabilities but we're integrating it into their network for the security and for the ease of use that these small to medium-sized businesses count on for these operators every day.

Nandan Amladi - Deutsche Bank AG, Research Division

Okay. And a quick follow-up, how portable is that solution for the U.S. market?

Stephen G. Waldis

We built the solution independent of a particular customer in hand. So we believe that it's very -- I think it's a great niche opportunity for both the U.S., as well as markets around the world. And we see it very portable in these various different markets, especially for those customers that we define are in that 99 to maybe 250 to 300 users, where they typically don't have large IT groups. They rely very heavily on the operators for things like data center, PBX, and they view cloud as another kind of utility they can add on to that carrier capabilities. And so we've built it in a very similar fashion like we've done personal cloud, where we believe that the device settings, backups and the ability to make the information very secure and very integrated across the enterprise is a smart thing to do, and I think the operators, as well as Synchronoss, think that the market has some good potential going forward.

Operator

Our next question comes from the line of Shyam Patil with Wedbush Securities.

Shyam Patil - Wedbush Securities Inc., Research Division

Just wanted to ask a follow-up on Verizon with the minimums. I think the last time you guys disclosed minimums, you said it was something like $200 million over 5 years. Just wondering kind of how we should think about this one in the context of the previous one? And then, Steve, you also mentioned the run rate expands beyond the -- or has the potential to expand beyond the $70 million. Maybe if you could just talk a little bit about how we should think about the magnitude of the upside to that as well.

Stephen G. Waldis

Sure, Shyam. So I think the main component of it is, obviously, we haven't broken out on a go-forward basis, obviously, on Verizon, with the implication -- clearly, we wanted to circle back with the data point that we gave you guys a year ago, just to show you the success that we're having. And again, as I'd said earlier, it's really around getting better visibility within this customer base and how it's going to roll out, both in the number of devices, the amount of storage, how the marketing plans are going to be utilized. As we had said at the beginning of the year, this was going to be a year of really tweaking different marketing programs, and we did see that across almost all of our customers, not just here in the U.S., but very different ways of how to make the cloud a very strategic part of the communications rollout for our operators. And so the combination of those things really led us to make sure that when the volume of projected uptick and the volume of storage -- we obviously need time to prepare for that. Larry talked a little bit about some of the CapEx expenditures we're making in general, and that was really the bigger focus of the agreement that we had in place is to really make sure that we had enough ample time to build out and support it and then work very closely with our partners to ensure we can deliver a great experience.

Shyam Patil - Wedbush Securities Inc., Research Division

Great. And then on the integrated life initiative that you mentioned in your script, it certainly seems like the world is moving in that direction. Can you just talk a little bit about how the activations will work, what kind of devices you're thinking about, when you expect to move into production with a live customer and how we should think about the economics?

Stephen G. Waldis

Yes. So we saw, with family share connected devices, kind of what's that next generation after the tablet. And when we look at it, there's 3 or 4 different industries that really lend itself to be very connected on wide area networks. And it's logical, obviously, for Synchronoss to have a very compelling play, given our footprint in our core activation products today. And so we see it really in 3 or 4 areas. Certainly, automotive is a big area, and you'll see us discuss some of that later this year; second area, certainly, is in the health and wellness, particularly wearable devices that you see there on the market today -- I think when you look forward to next-generation devices, I think you can see so many new applications for those devices to stay connected; and home security and the connection of your home security over these wide area networks; and then lastly, probably a little bit slower to develop, given a lot of the regulation that exists there, but in the health care. And so really, what Synchronoss is doing is really trying to put -- as our integrated life platform calls for, is really being the glue to not only connecting these multiple devices, but we also see to start to leverage some of the cloud capabilities that we've already done on the personal cloud side because being able to store certain bits of information, whether it's for a wearable device or an automotive car or a home security system, and be able to project that across devices in ways that consumers want it, in a more contextual sense, we think will be an interesting market. Now I will tell you the volumes will probably be, here, like we saw initially with tablets, will take some time to develop. But we think once consumers get used to the concept of being connected, most mobile devices will almost be assumed to be some connected into an actual wide area network.

Operator

Our next question comes from the line of Michael Nemeroff with Crédit Suisse.

Michael B. Nemeroff - Crédit Suisse AG, Research Division

How much of a step-down should we think about with stemming from the PS in terms of the results over the next couple of quarters? And should we expect that, going forward, that reduction in PS? And also, should we expect to or model a higher gross margin as a result of that?

Lawrence R. Irving

Mike, this Larry. The way I would think about professional services is pretty consistent with what we've said in the past. There's always going to be a certain element of professional services in the business that we do for the carriers because that's -- in effect, that's a way the carriers like to deal. It does fluctuate from one quarter to the next, but over an extended period of time, let's just say a 12-month period, we do expect professional services to be roughly 20% to 25% of our revenue base. So that still remains the same. It's just that this particular quarter, it's much less, and it will vary from one quarter to another.

Michael B. Nemeroff - Crédit Suisse AG, Research Division

Is that why there was a sequential decline from Q2 to Q3 in the cloud services revenue last year?

Lawrence R. Irving

Well, we don't break out the different types of revenues for the different groups of activation or cloud. But yes, clearly, the professional service was down from Q3 to Q2, and a lot of it had to do with the cloud side.

Michael B. Nemeroff - Crédit Suisse AG, Research Division

Okay. And then, Steve, on the ASP this quarter, did you mention in your prepared remarks whether the ASP remained at or above the median that we've previously discussed, the $1 to $5 range?

Stephen G. Waldis

Yes. Mike, I did not update it. But basically, the trends still look the same as we discussed before, where they're kind of tailing more towards the higher end than the lower end of that $1 to $5 range, and that trend pretty much stayed consistent during the quarter.

Operator

Our next question comes from Will Power with Robert Baird.

William V. Power - Robert W. Baird & Co. Incorporated, Research Division

I guess a couple of questions. I guess a bit of a follow-on, just on the cloud front, just want to make sure I'm clear. So as I look at the cloud revenue in Q3 versus Q2, can you give us any sense for what the transactional growth was sequentially? I mean, it sounds like professional services was down. Maybe let's start with that, and then a couple of other questions.

Stephen G. Waldis

Yes. So essentially, if you look back on Q2, we had quite a number of implementations going on at the time, and those have gone into production. And now that they're in production, they're in the early stages of ramping those transactions forward. And you'll start to see some of that acceleration, as I indicated, here in Q4. And so the bigger driver was we had an enormous amount of personal cloud deployments, both here in the U.S. and in Europe and in multiple countries, going down. As that wound down -- for a couple of reasons: one, we completed the jobs that we need to do to get the platforms up and running; two, we actually found that we could get a lot more leverage in the assets that we acquired, specifically NewBay, in terms of some of the integration that we have. And the combination of those 2 elements allowed us -- as you saw, we were probably ahead of schedule in terms of some of the deployments that we had discussed going into the year. So that's kind of behind us. On a go-forward basis, to Larry's point, we'll always have some new services because there's always new data classes and new things that are being added to the platform. But I think very rarely do we have that many going on at the same time. That being said, as we move forward, especially with some of the new marketing promotions that you're seeing being rolled out in the market, you're going to start to see the adoption of the transactional subscriber stuff really start to take off.

William V. Power - Robert W. Baird & Co. Incorporated, Research Division

Okay. And maybe as a follow-up to that, then. Yes, Steve, you talked a little bit about the expected increase in marketing advertising dollars. Has that, in fact, started today? And is that in 1 or 2 carriers, or is that across each of your kind of cloud customers? And maybe just speak to, generally, the visibility and, I guess, confidence you have that you're really going to see that, either here in Q4 and/or continuing it into '14?

Stephen G. Waldis

Well, we certainly from -- each of the different carrier deployments that we have are all in different phases, some more mature, some more nascent. We're seeing it varies by country, Will, and varies by market. But most are offering at least a minimum both here in the U.S. of 5 gig and -- which in the past was lower numbers, and most of the operators, as well, are rolling it out as part of -- in some instances, in some countries, part of different data plans and absorbing.

William V. Power - Robert W. Baird & Co. Incorporated, Research Division

Okay. All right. Maybe just a final question on that. So as you look at expected further, I guess, sequential growth in the cloud business in Q4, I mean, is that principally transaction or are there any new -- or are you expecting a step-up in professional services from something new?

Lawrence R. Irving

Look, Will, there's definitely going to be a step-up in transactions. There's -- the growth -- as Steve pointed out, you're seeing a lot more marketing programs, you're seeing adoption come up. So I think it's fair to say that our subscription base of our revenues are going to -- or our transactional base is going to continue to increase. That being said, I do expect to have some professional services in Q4 as well. So -- but I think the real answer to your question is both are going to go up.

Operator

Our next question comes from the line of John Bright with Avondale Partners.

John F. Bright - Avondale Partners, LLC, Research Division

Steve, Larry, when we're talking about a pull-forward on the CapEx, where is the majority of that going when we think about the 2 new products you talked about, integrated life, business cloud, versus -- is it more personal cloud and then maybe some in Activation? Where's the majority of the pull-forward going?

Lawrence R. Irving

Well, it's definitely the personal cloud. There's been a large investment in the personal cloud as it relates to a lot of what you've heard and seen and what we've talked about today. So that's one piece of it. There is a -- as we move here into the fourth quarter, some investments that are going to be made on the business side of it as well. As it relates to activation, there is definitely upgrades that we do on a year-to-year basis. Certainly, we just had a launch -- the iPhone launch that we prepared for that as well. So -- but the majority of the CapEx that we've talked about and a lot of bringing forward from the previous year -- for next year bringing into this year is coming from the personal cloud side of the business.

John F. Bright - Avondale Partners, LLC, Research Division

Likely to coincide with the increased marketing that I think we've talked about around storage? 5 gig mentioned in the call. Has there been any discussion about the firmware, particularly at Verizon?

Stephen G. Waldis

The continued initiative of getting on the devices, whether it's on the actual firmware of the device or the app, really varies by device to device. But one of the bigger drivers, clearly, was around how they want to position those market -- those offers in the market and then the amount of storage that they want to agree to give their customers. And keep in mind, Synchronoss also has an embedded base of customers, which would also be eligible for those increased storage -- free storage requirements as well. So it's a combination of all those 3 things and customers' willingness to give us visibility and commitment into the minimums that drove a lot of what Larry is referring to on the CapEx side.

John F. Bright - Avondale Partners, LLC, Research Division

On the -- a new AT&T contract question. If I recall, it's affected the August-September time frame. Thus, any pricing has been reflected for a couple of months in this quarter and within guidance, so any impact there might have been to pricing was reflected in those 2 data points. Correct?

Stephen G. Waldis

That's correct, John. In fact, I tried to indicate in the script that we don't see any material near-term changes based on the pricing. As I've said, some transactions went up, some went down. We adjusted, primarily, a lot of the service-level agreements that we had with our operators, given that some of the transactions had been in place since 2009. And we continue to see great opportunities within AT&T to expand that business.

John F. Bright - Avondale Partners, LLC, Research Division

Larry, you've been great with guidance as long as I've been covering the stock. And in this particular case, what we see in front of us are some meaningfully increased expectations for marketing going to take place. This is more of a qualitative question on how you went about thinking about the, I guess, penetration that might take place because of the increased marketing that's coming forward when you were putting together your guidance. Can you give us any sense there?

Lawrence R. Irving

Well, the process that we go through hasn't really changed. I mean, we actually look through and work with our customers to kind of get a good feel for what they believe that business is going to look like. Certainly, when we come into an earnings call, we do have some visibility and some commitments for the quarter, so we have some pretty good idea of what the quarter is going to look like. But clearly, it's really a partnership with our customer, making sure that we have a good feel for what they believe and, certainly, using our understanding as well in coming up with our guidance.

Operator

Our next question comes from the line of Gray Powell with Wells Fargo.

Gray Powell - Wells Fargo Securities, LLC, Research Division

Can you talk about where you're at with AT&T on the cloud side? And is it safe to assume that's probably 12 to 18 months behind where you are with Verizon?

Stephen G. Waldis

Yes, sure. Gray, this Steve. So when we talked about AT&T initially, we had said that this is more of an incremental opportunity. There are some incumbent providers that exist there today, and so we were piloting certain elements of the transactions. As it relates to the progress at AT&T, we've definitely moved out of the pilot phase. We're actually being shipped on the firmware of devices. We're probably up to about a half -- about a dozen or so devices. We'll ship probably a few hundred thousand transactions this quarter just on new devices that will be shipped. But it's incremental in the sense that, where Verizon is much more of a holistic personal cloud approach, as well as Vodafone and others, there are certain different, I'll call it, connected clouds, and so we see the opportunity over time, like we've done successfully, to expand. We're optimistic, based upon the new relationship that we've got with AT&T and our new agreement, as well as some of the success we've had out of the gate here with some of these initial transactions that we're supporting.

Gray Powell - Wells Fargo Securities, LLC, Research Division

Got it. And then, as you scale the Vodafone contract from 2 to -- I believe it's 16 countries, I mean, do you see the potential for them to become a 10%-plus customer?

Stephen G. Waldis

I think, over time. Again, I think Vodafone and that region in general, as you know, is more decentralized across countries. So the marketing that's done is done on a per-country basis, where here in the U.S., typically, the operators should do it more of a nationwide program. So depending upon the certain territories or countries you support, it varies in terms of the type of volume. I think that it would take -- in the longer term, we see no reason why it won't be an integral part of the cloud business over there at Vodafone. But it will take some time to develop, and I think that, that will go on probably into early parts of '14, especially in certain some of the -- in certain regions and countries that we support there. But it has all the elements, and I think that they are looking at it in the way in which the successful operators have looked at it with us in the past as a -- as not only a great retention tool, but an ability to drive more desirable data network customers on their network.

Gray Powell - Wells Fargo Securities, LLC, Research Division

Got it, got it. And then one last one, if I may, just a detail question. You said 60% cloud revenue growth in the second half of the year. You did 55% in the third quarter, and I think you made the comment for an acceleration. So is it safe to assume that you're talking something north of 60%, like more like 65% growth on cloud in Q4, give or take?

Lawrence R. Irving

Yes. So we said approximately 60%. And just to be clear, that's taking the second half of this year and comparing with the second half of last year. So -- but, certainly, it's basically north of the 60% that I gave you of approximate...

Operator

Our next question comes from the line of Daniel Ives with FBR Capital Markets.

James Moore - FBR Capital Markets & Co., Research Division

This is Jim Moore in for Dan. Just a follow-up on the CapEx discussion for next year, as you're pulling some forward to this year. I'm just wondering where you're at, at this point on the business cloud investments. And as a follow-up to that, what kind of traction are you guys seeing internationally, aside from Vodafone, in business cloud?

Stephen G. Waldis

So there -- as Larry said, the majority of the CapEx was associated with personal cloud. There is some of the investment there, certainly, for business cloud. I would say that we're -- it's early on, but we're excited at the opportunities we see, both here in the U.S. as well as abroad, in terms of our ability to really go after that segment of small business customers at these operators. We think it's a good opportunity to add value that the operator -- these customers look heavily on the operators. It has the right price points. The functionality and integration that we've done, especially at Vodafone, is really reusable. So we think all those things bode well for that market. Now that being said, it will take some time to develop, just like personal cloud did, but we're excited to have kind of an anchor client there, and we want to continue to blow that market out over the next few years. But I think it's going to take some time in '14 to really get the right operators on board, but I will tell you, the early discussions we've had have been very favorable.

Lawrence R. Irving

And just to add a little bit more color on that CapEx in the fourth quarter as it relates to the business cloud, so certainly, that's one of the items that we brought back -- forward into 2013 versus the first quarter of 2014. So that's one of the elements of some of that CapEx that we brought forward.

Operator

Our next question comes from the line of Paul Thomas with Goldman Sachs.

Paul B. Thomas - Goldman Sachs Group Inc., Research Division

With the 5 gigabyte now being the free level of storage, can you talk about how that decision was driven? Were there any early signs that the 0.5 gig level was not being adopted as planned? Was there some testing at 5 versus -- or 0.5 gig versus 5 gig that drove the change?

Stephen G. Waldis

I think more generically, again, across our customer base, since most of our customers are at 5 gig -- I know you're referring to, I think, Verizon just went to 5 gig a few days ago. Overall, I think the operators are starting to get data back from the customers around what would make them good cloud customers and what do they like to do, and they start to compare a lot of attributes to those customers. And I think what was happening across the board was that the more storage that you give, the more likely they will use your other services and really become kind of integrated with that experience because once you start introducing family shares, 9 out of 10 of these family shares today have at least 2 ecosystems associated with it. It's either Android and iOS or Windows and iOS. And so the ability to tie the devices in and the customer -- lower churn rates all contributed to factors across the board at a generic level that drove the increase in storage -- and ultimately, the industry. The industry in whole, when it comes to storage, clearly, today, is at least 5 to 10 gig.

Paul B. Thomas - Goldman Sachs Group Inc., Research Division

Okay. That makes sense. And then, can you give a little more color on the sequential growth we can expect for cloud in 4Q? Transaction revenue is going to be above sort of the prior annual guidance range. How much lower are you expecting cloud to be? I guess the math looks like $34 million to $35 million would be cloud revenue in 4Q if you were at the low end of the $112 million annual range you guys have given in the past. Is that kind of the right range? Is it lower than that?

Lawrence R. Irving

I mean, you're doing the math based on the data that I gave you, and I think that's a fair calculation to do. It will be in a range in that neighborhood, if not more. But just think of it -- if you look at last year's second half of cloud revenue and you look at this year's projection of 60% -- approximately 60% growth from last year, you can get kind of a rough idea what we're thinking about for cloud in the second half of this year.

Paul B. Thomas - Goldman Sachs Group Inc., Research Division

Okay. Then I guess that revenue in 4Q, $2 million [ph], we think of that as mostly guaranteed at this point based on minimums and forecast in professional services?

Lawrence R. Irving

Well, there is definitely professional services in the mix.

Paul B. Thomas - Goldman Sachs Group Inc., Research Division

Right. So I guess I'm asking the confidence level in reaching that range. I mean, we talked before about the transaction revenue growth you'd have to get to reach that range. Is that what you're seeing right now coming from the carriers?

Lawrence R. Irving

Yes. So it goes back to your previous question. We look at what we've got from our customers, kind of the -- what we've got in the hopper already, and that's how we come up with the guidance. So yes, when we provide guidance, we feel pretty confident with what we provide.

Stephen G. Waldis

One of the drivers to add to that, Paul -- this is Steve -- is just as our customers commit, because our -- again, I can't emphasize enough, our software is in the hands of their subscribers. They'll raise their minimum commitments to us, which gives us the confidence in those numbers. And so when they commit to those minimums that drives a lot of the CapEx spend, that gives us the visibility, I think, you're looking for.

Operator

Our next question comes from the line of Sterling Auty with JPMorgan.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

Just one question, one follow-up. On the renewals, can you give any even qualitative discussion? You mentioned the increased minimums. But are there either price or volume escalators over the period?

Stephen G. Waldis

So typically, in our contracts, everything's typically time sensitive, period-wise. So most of the -- as it relates to the AT&T contract, we certainly relook at all our transactions, and we put a determination. What really drives it is the service level that the customer wants to work on with us based upon the channel we're supporting. Service levels, for lack of a better word, could be more gold in nature, silver, bronze, et cetera, so they'll drive it. And then for certain periods, there's always tapers or volume discounts, the more volume they drive in the current period. As it relates to our cloud renewals, particularly Verizon, it's mostly around volumes and the commitments of infrastructure that we would need, obviously, to support those volumes going forward. The original pricing that was set up, I guess, maybe a year ago now, really hasn't changed, and it contemplates higher volumes and tapers as well.

Lawrence R. Irving

Yes. I mean, certainly, I would just think of the minimums as kind of the floor going forward.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

Okay. And then Larry, on the EPS guidance for the fourth quarter, is there any incremental expenses from these renewals that maybe came in? Or thinking about the pull-forward in CapEx, is there going to be a higher depreciation that maybe weighs on EPS or even some variable expense from commissions on getting the deals closed?

Lawrence R. Irving

Well, yes. I mean, you're seeing a couple of things. One is you're seeing depreciation expenses, as a percentage of our business, continue to increase. Some of what we put and spent money on is in construction of projects, and we haven't even begun to realize some of that depreciation on that CIP part of it. But the maintenance agreements associated with this CapEx is actually being expensed. So those are all elements that are factored into our guidance. But as I mentioned, our op income, okay, is roughly going to -- non-GAAP operating income is going to be roughly around 25%, 26%. So we factored all those things in the mix when we came up with our guidance.

Operator

Our next question comes from the line of Tavis McCourt with Raymond James.

Tavis C. McCourt - Raymond James & Associates, Inc., Research Division

Larry, just wanted to confirm the increase in DSOs was primarily related to the contract extensions, so we should expect those to come down a bit in Q4. Is that right?

Lawrence R. Irving

Yes. So yes, that's exactly right, Tavis. I mean, we had the 2 new contracts coming in place. Obviously, I mean, when you deal with these carriers, when you have new contracts, it does slow down the process of the payment and even the invoices. So yes, it has an impact here in Q3 that we believe will correct itself here in Q4.

Tavis C. McCourt - Raymond James & Associates, Inc., Research Division

And also, when you look at kind of the big ramp in cloud revenues expected in the fourth quarter, fair to say most of that is going to be recurring?

Lawrence R. Irving

The recurring revenue is continuing to increase. As I said before, Tavis, there's a certain amount of professional services that will vary from one quarter to the next. But when I look over an extended period of time, I do believe that to be somewhere in the neighborhood of about 20% to 25% of our total revenues. With the carriers, you really don't know exactly when that CapEx is going to come in, so you factor that in. But the big point here is that the recurring base of that revenue is increasing and continues to increase.

Tavis C. McCourt - Raymond James & Associates, Inc., Research Division

Got you. And then in terms of the gross margin differential between some of the recurring business and nonrecurring, the mix went up quite a bit this quarter sequentially, I think, the recurring. But the gross margins were kind of flat or slightly down. Is that an indication that the gross margin profile on those 2 segments is relatively similar?

Lawrence R. Irving

I think there's a number of different drivers that impact our gross margins, and it will vary from a couple hundred basis points each quarter, but some of the things that are changing and dragging down our overall margins is the investments in the infrastructure that we're making. And so that's being offset with some of the additional revenues and the increased recurring base of our revenue. So as that continues to grow, our margins will continue to increase. But right now, we've got some very large investments in the infrastructure. I mentioned some of the maintenance agreements around that CapEx. That's dragging down the margins as well. So that's what's really holding it down, but if you think about what we're saying here in Q4, we're expecting that to go up 1 percentage point or 2, so we do see that scale moving. But at the same time, we're making investments that's kind of offsetting some of that growth.

Tavis C. McCourt - Raymond James & Associates, Inc., Research Division

Understood. And then, Steve, one for you. The new services in Activation, are these going to be revenues generated from carriers or device manufacturers? I'm a little confused in terms of how that revenue model works. And are these services that will be kind of -- if the goal is to replace internal systems, or are there existing third-party vendors that you think are kind of subpar that you can displace in the market?

Stephen G. Waldis

So I think in this scenario -- it's a good question. It's mostly greenfield opportunities because, obviously, it's the devices that are coming on the market. I would say the lion's share of the transactions will be in our typical model, meaning that the carrier will use our platform, will sign up deals with device manufacturers, albeit -- whether it's automotive companies, whether it's wearables, you name it. And we would transact that no different than we do today. That being said, there could be instances -- like we support, for example, OEMs directly today in the market, so there could be a capability that an OEM would come to us and ask us to process his integrated device or her integrated device over a bunch of carriers, in which they would be the client at the end of the day. But very much like our Activation business today, my assumption is the lion's share would be the operators.

Operator

And with that being the final question, I would like to turn the call back over to Steve Waldis for his closing remarks.

Stephen G. Waldis

Great. I'd like to thank everybody for joining us on our Q3 2013 conference call, and we look forward to talking to all of you soon. Thank you.

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Synchronoss Tech (SNCR): Q3 EPS of $0.34 in-line. Revenue of $90.3M (+30% Y/Y) beats by $0.22M. (PR)