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Synacor Inc. (NASDAQ:SYNC)

Q2 2012 Earnings Call

July 25, 2012; 05:00 pm ET

Executives

Ron Frankel - President & Chief Executive Officer

Bill Stuart - Chief Financial Officer

Denise Garcia - ICR

Analysts

Jason Helfstein - Oppenheimer

Laura Martin - Needham & Co.

Tom Roderick - Stifel Nicolaus

Rich Tullo - Albert Fried & Co.

Nat Schindler - Bank of America/Merrill Lynch

Operator

Good day ladies and gentlemen and welcome to the Synacor 2012 second quarter earnings call.

At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session with instructions following at that time. (Operator Instructions).

And now I’ll turn the conference over to your host, Denise Garcia of ICR; please begin.

Denise Garcia

Good afternoon. Welcome to Synacor’s second quarter of 2012 earnings call. Joining me today to discuss our results are CEO, Ron Frankel and CFO, Bill Stuart.

Before we begin, I would 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 filing it makes with the Securities and Exchange Commission from time to time, including the section entitled Risk Factors and the company’s most recent 10-Q filed with the SEC on May 15, 2012.

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 in 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’m pleased to share our financial results and to provide an update on our business to our shareholders and the investment community.

Our second quarter revenue grew 58% to $30.8 million from $19.5 million in the same period last year. Adjusted EBITDA was $3.0 million for the quarter, an increase of over 100% compared to the adjusted EBITDA of $1.5 million in the second quarter of 2011.

The second quarter was the beginning of an exciting transitional period for Synacor. Regarding TV Everywhere we are very enthusiastic about our leadership position, as nearly 40 paid TV operators are utilizing our authentication technology, to enable over 25 million consumers access to NBC Universal's TV Everywhere offerings of the 2012 Summer Olympic games on multiple devices.

The authentication required by NBCU for the Olympics is a breakthrough for TV Everywhere. Its showcases the value consumers receive from their pay TV subscription and we at Synacor are delighted to play a significant leadership role. We expect our TV Everywhere offerings will contribute meaningfully to Synacor’s success over the next several years, as growing interest and usage of TV Everywhere will drive recurring fees and more traffic to the start pages we deliver for our customers.

We expect to roll out new start page and cloud based experiences in late 2012 and early 2013, based upon the technology we gain in the Carbyn acquisition earlier this year. These multi device products will incorporate TV Everywhere with a range of cloud-based services and exciting user experience and it will further extend our presence on multiple devices, including tablets, Smartphones and connect to televisions.

We also experienced a transition in the second quarter as the latest browsers combined with mobile devices give consumers a greater number of options for their search and discovery preferences. These developments have impacted the total number of unique visitors according to comScore and search queries we receive from our start pages. Our unique visitors grew 43% year-over-year; they decline 6% quarter-over-quarter. Search query grew 55% year-over-year, but declined 12% quarter-over-quarter.

We are addressing this changing environment with strategic initiatives such as TV Everywhere and new technologies such as Carbyn, both of which we expect will drive material increases in unique visitors and monetization opportunities for us on multiple devices and platforms.

Search and display advertising revenue grew 69% to $25.4 million from $15.1 million in the same period last year. Our revenue mix changed in the second quarter. We experienced greater increases in both display advertising and subscription-based revenue, while search revenue declined representing 56% of our total revenue.

Advertising impressions were up significantly on both, a year-over-year and quarter-over-quarter basis, as display-advertising revenue grew 74% year-over-year. Our direct sales team continues to bring in new advertisers across diverse verticals, including auto, finance, insurance and retail and entertainment and direct advertising CPMs are increasing.

In addition to Synacor’s own national sales force, we have engaged partners to sell our advertising inventory on a local and regional basis. The early tests are very encouraging. Our display advertising business continues to exceed our expectations.

Now lets talk a bit about subscriber-based revenue. In the second quarter subscriber-based revenue grew 22% to $5.4 million from $4.4 million in the same period last year. Looking at email and communication specifically, we continue to see solid revenue growth. We continue to deliver additional cloud based services like email and TV Everywhere to our current customer base. These additional products will also increase unique visitors and start page usage.

Synacor remains well positioned. We are witnessing a fundamental transformation in the way consumers enjoy their content. Our ability to deliver authentication for TV Everywhere and other cloud services makes us an emerging leader as consumers migrate to a consume anywhere on any device mentality and we think TV Everywhere is just the beginning. We are excited about our growth opportunities and believe we’ve just scratched the surface of our potential.

With that, I’ll turn the call over to Bill who will walk you through our financials.

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 prefer to our press release and the SEC filings for the GAAP to non-GAAP reconciliations.

Starting with our second quarter key metrics according to comScore, Synacor engaged 20 million average unique visitors per month, an increase of 43% from 14 million unique visitors in the second quarter of 2011. Search queries were 238 million for the second quarter, an increase of 55% from the 154 million search queries in the second quarter of 2011. Synacor delivered over 10 billion advertising impressions, 72% of growth over $6 billion in the second quarter of 2011.

As a result, second quarter revenue grew 58% to $30.8 million from $19.5 million in the same period last year. Adjusted EBITDA was $3 million for the quarter, an increase of over 100% compared to adjusted EBITDA of $1.5 million in the second quarter of 2011.

Net income was $1.2 million compared to $600,000 in the second quarter of 2011. Diluted earnings per share or EPS was $0.04. Net income includes stock based compensation expense of $400,000 or $0.01 per share in the second quarter of 2012 and $200,000 or $0.01 per share in the second quarter of 2011.

This also reflects a tax rate of 20% for the second quarter of 2012, which includes benefits from the research and development tax credits we discussed during our first quarter call. These benefits are associated with prior year expenses and once the tax credit analysis is completed, we will make a final tax entry in a future quarter. The diluted EPS calculation for the second quarter 2012 is based on $29.6 million weighted average fully diluted common shares outstanding.

Turning to cost and expenses, cost of revenue remained consistent with Q1 2012 at 55% of revenue. We continue to expect cost of revenue as a percentage of revenue to remain at this level going forward.

Total operating expenses, excluding stock based compensation and depreciation were $11 million for the quarter or 36% of revenue compared to $7.9 million or 41% of revenue in the same period last year.

G&A expenses as a percentage of revenue increased by one percentage point over the same quarter last year, due to cost associated with being a public company. Research and development and sales and marketing continue to show operating leverage over the prior year, declining by four and two percentage points respectively.

I would like to finish our call with our thoughts regarding guidance for the third quarter and full year 2012. As we moved from the second to third quarter, we expect to experience our typical summer quarter seasonality, where historically we have seen flat to down revenue from Q2 to Q3, adjusted for the impact of new customer additions.

For the third quarter we expect revenue in the range of $28 million to $28.5 million, with adjusted EBITDA in the range of $2 million to $2.2 million. As a result we expect to finish the year near the lower end of current guidance of $123 million to $126 million. However we do expect holiday shopping, e-commerce trends and subsequent increases in RPMs and CPMs would drive a seasonally strong fourth quarter. We also expect adjusted EBITDA for the year to be in the range of $12 million to $13 million.

We are also providing guidance on additional line items as follows. For depreciation we expect to range between $1 million and $1.2 million for the third quarter and between $3.8 million and $4.2 million for the full year. For stock based compensation, we expect to range between $550,000 and $650,000 for the third quarter and $2.2 million and $2.4 million for the full year.

For other income and expense we expect approximately $100,000 expense in the third and fourth quarter. For income tax expense, we expect our tax rate to be approximately 40% for the third and fourth quarter, as the work associated with the R&D tax credit is finalized.

As a reminder, the majority of this tax expense is non-cash taxes as we have our $6.1 million differed tax asset, which we will use throughout 2012. The weighted average fully diluted shares outstanding utilizing the treasury shares method; we expect our share count to be approximately 30 million shares.

Lastly we want to advise that our lock up will expire on Saturday, August 11, and with that being a weekend day, the shares subject to the lock up will be released for trading beginning Monday, August 13.

In closing, we now have our first full quarter as a public company successfully behind us and we remain focused on executing our growth strategies for the long term. Synacor has an enormous opportunity in front of us. With our committed and expanding customer base, exciting events like TV Everywhere, authentication for the 2012 Olympic games, world class employees and continued proliferation among could based connected devices, connected content and connected consumers, Synacor plans on capitalizing on all of the above over the second half of 2012. Thank you.

We will now open the line to your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). First question is from Jason Helfstein of Oppenheimer. Your line is open.

Jason Helfstein - Oppenheimer

Hey, thanks guys. So first, just I wanted to go through guidance. So basically I think what I’m hearing you saying is subscription based services are typically kind of flattish and potentially flattish if you haven’t added any new customers and I guess as an implication, you’re not adding any new customers for that launch, because you haven’t talked about it.

And then you highlighted what’s happening kind of with browsers and some of the devices kind of hurting UV, so that will then kind of weight on the quarter. So basically we’ll see kind of a sequentially flat subscriber base services given a slowdown in the advertising revenues and then I think it sounded like you said in the fourth quarter and into next year, based on Carbyn you’ll be launching some new products. Will those have some new revenues associated with it?

Ron Frankel

Yes, they will. But in addition, we do see subscriber base revenues. We do think we’ll be adding new subscribers in the subscriber-based revenues. I think with browsers it’s incrementally easier to search, for instance in the address bar and we are addressing that in the installation process. So we think that will also add over the next two quarters, additional capability that we are delivering to our customers.

Jason Helfstein - Oppenheimer

So in a way we are basically seeing kind of advertising gets hit, you’ll make some of the back from subscriber services and then you’ve got to figure out how to reaccelerate queries as we go into next year. Is that kind of a fair assumption?

Ron Frankel

Queries and we are also already seeing increases in CPM. So I think our advertising business actually will continue to be quite healthy.

Jason Helfstein - Oppenheimer

Okay. And then can you just go through the Olympics in a little bit more detail. I mean there’s obviously a lot of players involved here. I think we have Adobe’s invention and then I think there was a start up as well. So could you just talk about for everybody on the call, just how it kind of sets up and exactly what your role is and if you kind of successfully execute, what type of business opportunities that could open up in the future.

Ron Frankel

Yes, we have contractual relationships with our customers to help them authenticate with NBC and so that’s us working with Adobe and NBC, but representing our contractual relationship is with our customers. And in that regard we have a variable – with many of our customers we have a variable rate relationships with them, that as more TV Everywhere is used, we receive more revenue.

With regard to TV Everywhere, with regard to the opportunity today, we actually saw some lift today. Very nice activity with the US women’s soccer game playing France I believe. And so we are actually experiencing that lift right now and we are quite intrigued and it’s really quite fascinating and interesting. I think we are on the cusp of some very large developments in this area.

Jason Helfstein - Oppenheimer

And will you have an advertising opportunity for that or is it basically just authentication?

Ron Frankel

Well now the experience is also folks do come in through our various start pages, so they can not only go to nbcolympics.com directly, but they can also come in through our start pages, where we host an Olympics entry page, which does highlight the events and some other things that make it easier for consumers to navigate through many of the events. And so our customers also encourage their consumers to go through our start pages to get to the Olympics.

So we do expect to see some increased activity from the advertise, the search and advertising that come through our start pages, as a result of the NBC Olympics. We just don’t know how to quantify that at this point in time.

Jason Helfstein - Oppenheimer

So it’s fair to say your not assuming a meaningful lift in any non-contractual revenue from the Olympics at this point via advertising.

Ron Frankel

That’s correct. Yes, yes, that’s right.

Jason Helfstein - Oppenheimer

Okay. Thank you.

Operator

Thank you. Our next question is from Laura Martin of Needham and Co. Your line is open.

Laura Martin - Needham & Co.

Hi there. If I understood you right Ron, you said your click volume was up 55% year-over-year, is that what you said?

Ron Frankel

Year-over-year, yes.

Laura Martin - Needham & Co.

Yes, that’s great numbers. Those are better than Google numbers. I guess I’m wondering, are you seeing similar price pressure as Google is kind of down 18% or are you guys getting better pricing on that enhanced click through volume.

Ron Frankel

Well, interestingly our RPMs and our CPCs remain relatively consistent. We have very high, good premium demographics for search generally speaking and that part of it has actually remained quite strong.

Laura Martin - Needham & Co.

Very helpful, and we should keep modeling that. You see no change in that, so we should continue modeling it; is that what you think.

Ron Frankel

I think that’s right.

Laura Martin - Needham & Co.

Okay, great. Thanks so much.

Operator

Thank you. Our next question is from Tom Roderick of Stifel Nicolaus. Your line is open.

Tom Roderick - Stifel Nicolaus

Hi guys, good afternoon. So Ron, I was hoping you could kind of go into a little bit more depth on Q4 as the implied guidance suggest. Your expecting to see a snap back and you mentioned briefly holiday sales and traffic, sort of seasonal traffic around that as being a driver.

Can you just go into a little bit more detail, sort of where do you get some of the confidence around a snapback, particularly on the search quarry side and as it relates to the search query front where things took a turn against you this quarter, how long have you sort of seen that coming or was it just a big surprise sort of med way through the quarter type of thing. Thanks.

Ron Frankel

Yes, actually there was a round of browser upgrades during the second quarter and we began to notice in the middle of the second quarter that trend. We’ve now stabilized and we are able to address that with some installation changes and some other tips that we are utilizing with our consumers.

Generally with the fourth quarter, we have historically every quarter seen increases in RPMs, increases in CPMs and increasing search activity. Generally speaking, an increasing page view activity generally speaking. This year we also expect to see even higher CPMs, because of the traction that we are getting with our direct sales team and some deals we are putting in place with some regional and local resellers of our advertising inventory.

Tom Roderick - Stifel Nicolaus

Okay good. Can you talk a little bit more about that direct sales team, how big is that, how many bodies are you sort of looking to add to that team the next few quarters. Just some thoughts as you have them around sales capacity would be very helpful.

Ron Frankel

Would you repeat that question?

Tom Roderick - Stifel Nicolaus

Yes, just as it relates to the direct sales efforts on the advertising front, the build out of a direct sales force. Can you talk a little bit more about how big that sales force is today? What the capacity inputs you are looking to put into that model. Just trying to get a feel for as you are driving the ad rates higher here, with your own internal sales efforts, how much you are putting in to the capacity front. Thanks.

Ron Frankel

Yes, no, I think at this point in time we are pretty much built out in terms of our team. We have the capacity, we are getting a lot of the yes’s from new advertisers, which is really a great, great place to be, and then to the extent that we augment with third part ad sales teams, that’s part of our strategy.

Because we can get quite granular in terms of the geo location of our customer base, we can actually have enabled the sale of local. Now we are not going to staff local, because that wouldn’t provide leverage to us. So I think we can get a lot more leverage out of our current in house team, augmented by these external resale teams, whose deals we will announce over the next couple of months.

Tom Roderick - Stifel Nicolaus

Great. That’s it from me. Thank you guys.

Ron Frankel

Thank you.

Operator

Thank you. Our next question is from Rich Tullo of (Inaudible). Your line is open.

Rich Tullo - Albert Fried & Co.

Fried & Company, thank you very much. Two questions; did you get any revenue lift in the second quarter from the Olympics?

Ron Frankel

No, not material, no. The Olympics are just starting right now, so you can’t -- in terms of the TV Everywhere variable fees, that’s really part of the actually Olympics themselves. So no, we really did not see lift in the second quarter.

Rich Tullo - Albert Fried & Co.

So nobody was pre-signing up or anything based on…

Ron Frankel

Not material, no.

Rich Tullo - Albert Fried & Co.

I would think that you would have added those numbers in the guidance, I think it was like four million people watching the Olympics online, authenticated the last time around and the numbers should have been significantly higher. I mean is that what you are expecting.

Ron Frankel

We, honestly we are anxious to see what the numbers are. I think that if this is an important break through moment for TV Everywhere, we’ve been not focused on forecasting the revenue side of it. We’ve been very focused on building out a great service and making sure the consumers can get to it and supporting our partners in this effort. So we have not been focused on forecasting material revenue attribution at this point in time.

Bill Stuart

And trying to put any numbers on that would be at this point really just a wild guess.

Ron Frankel

Yes, too speculative. I do think there would be material contribution starting sometime next year, but we have not focused on that part.

Bill Stuart

And Rich to the point, with the announcement of NBC, that they were going to be taking the Olympics online, I’m sure that did motivate some people to start to experiment with it, but there is no way that we could quantify what that impact would be.

Rich Tullo - Albert Fried & Co.

Fair enough. Now going on to the metrics, your unique users down ticked a little bit sequentially and yet the ad impressions if I’m reading this right, picked up, is that correct.

Ron Frankel

Yes.

Rich Tullo - Albert Fried & Co.

Measuring the ad impressions pretty link is going from about 400 to 518. How is that part of them used? Is the selling effort that’s causing that or is there something else driving that, because it seems to be a little counter intuitive?

Ron Frankel

Yes, no I think we are always looking to ways to increase pages per user and we are focused on a number of techniques and we so far experimented very successfully and I think we are going to continue to focus on ways to increase usage and to drive more value to our consumers.

Rich Tullo - Albert Fried & Co.

Okay, fair enough. Thank you very much for taking my questions.

Operator

Thank you. Our next question is from Nat Schindler of Bank of America/Merrill Lynch. Your line is open.

Nat Schindler - Bank of America/Merrill Lynch

Yes hi, thank you for taking my question. Just wanted to ask a little bit if you could -- I know you probably can’t talk directly, but if you could characterize your pipeline for new customer wins and how its been changing over the last six months since going public.

Additionally, if you could go into some detail on how your top four customers have trended and how they have fallen on their maturity lines as you have discussed earlier, specifically how have the newer customers, Toshiba and Verizon been continued to grow versus older customers like Chowder and CenturyLink.

Ron Frankel

Yes, I think -- let me take that first question. I think since going public, our pipeline continues to improve. We get more calls I believe that the exposure of being a public company has helped and we have opportunity in this regard. I can’t go into really any greater detail than that at this time.

In terms of our customers, I think with some of our new customers I think we are still in a ramp period, with others I think we are in a little more stabilizing period and we continue to monitor and do and roll out new services for those customers. In addition I think we’ve been very successful at adding new services into many of our existing customers, which also we feel will drive engagement, such as email and TV Everywhere, which we continue to roll out to a number of our existing customers.

Nat Schindler - Bank of America/Merrill Lynch

Great, thank you.

Operator

Thank you. This ends the Q&A portion of today’s conference. I would like to turn the call over to Mr. Frankel for any closing remarks.

Ron Frankel

Well, on behalf of the Synacor team, we want to thank all of you for participating in our second quarter conference call. Please have a great evening and thank you very much.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program. You may now discount. Have a wonderful day.

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