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Executives

Denise Garcia – ICR

Ron Frankel – President and CEO

Bill Stuart – CFO

Analysts

Jason Helfstein – Oppenheimer

Edward Williams – BMO Capital Markets

[Gord Talpez] – Stifel Nicolaus

Leo Kulp – Citi

Nat Schindler – Bank of America Merrill Lynch

Synacor (SYNC) Q3 2012 Earnings Call October 24, 2012 5:00 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the Synacor 2012 third quarter earnings call. [Operator Instructions].

I would now like to turn the call over to Denise Garcia. Please go ahead, ma'am.

Denise Garcia

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

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

I'm pleased we had another solid quarter. Our third quarter revenue grew 18% to $28.3 million from $24 million in the same period last year. Adjusted EBITDA was $2.2 million for the quarter compared to adjusted EBITDA of $2.5 million in the third quarter of 2011. Revenue from our display advertising business grew 59% over the same quarter last year, from $5.5 million to $8.8 million, and increased 7% from $8.2 million in the second quarter of 2012. We continue to make great strides in our direct advertising sales in the major verticals such as finance, autos, insurance and travel.

Search revenue was $14.5 million, a 10% increase from the same period last year, a 16% sequential decrease from Q2 2012 due to typical summertime search seasonality. Subscription-based revenue was $5.1 million, a decrease of 3% from the third quarter 2011 and a 6% sequential decrease, mainly due to non-recurring activity during both of the previous quarters.

Our revenue mix continues to diversify with display advertising revenue representing greater than 30% of our total revenue for the first time. Search represented 51% third quarter revenue, in part due to the impressive growth we experienced in display advertising combined with third quarter search seasonality. Seasonal trends aside, we anticipate our revenue mix to continue to diversify over time, and we're pleased with Synacor's most recent display advertising results.

Also we expect continued growth in our display advertising business as we make more of our inventory available to local resellers. In this regard, we expanded our partnership with Comcast Spotlight, which enables local marketers to efficiently reach multichannel video subscribers, both on television and online through one sales team. Under the agreement, Comcast Spotlight will have the ability to sell advertising inventory on Synacor-managed start pages in areas where Comcast Spotlight also sells local spot television advertising on behalf of television service providers.

We also announced a partnership with MTC Media. As part of the partnership, MTC Media will sell regional advertising inventory of Synacor's start pages, in conjunction with MTC's existing broad portfolio of multichannel operator web properties to ensure that advertisers can reach their customers easily and effectively.

On the customer front, we are kicking out the fourth quarter with a new launch announcement. On October 1, we launched the start page and email for dishNET, the broadband ISP service of DISH Networks. We are excited to have been chosen by DISH.

In terms of users, we ended the third quarter with an average of 20.2 million unique visitors per month, an increase of 1.6% over the second quarter with an average of 19.9 million. Year over year, our unique visitors per month grew 44% from an average of 14.1 million in the third quarter of 2011. We feel good about our user base and our ability to continue monetizing the asset as we head into the fourth quarter.

As a technology company, we are always innovating. As you know, we're at the cutting-edge of TV Everywhere authentication and Synacor is a leader in the market with nearly 40 pay TV operators utilizing our authentication technology to enable consumers to access content from providers such as HBO Go, Turner, Hulu and Fox. The 2012 Summer Olympics showcased the value consumers receive from their pay TV subscription and accelerated awareness of TV Everywhere to an all-time high. We expect this awareness and growing interest in TV Everywhere to spur consumer adoption, particularly as consumers increase the number of connected devices they use to access their content.

We are currently working with a number of our current customers to expand their existing TV Everywhere offering as well as continuing to talk to potential customers in the pipeline.

I want to take a moment to describe how excited I am about our new Cloud ID offering. Cloud ID with social log-in gives Synacor customers the flexibility to offer their consumers access to TV Everywhere content via their favorite social log-ins, like Facebook, Twitter and Google. As a leader in the space, we are proud to be the first to feature social log-in for TV Everywhere.

We also remain on track to rollout our multi-device start pages and cloud-based experiences later this year and early 2013 based on technology we gave in Carbyn acquisition earlier this year. These multi-device products will incorporate TV Everywhere with a range of cloud services and exciting user experience, and will further extend our presence on multiple devices including tablets, smartphones and connected TVs. In this regard, our customer Toshiba is leading the charge. Together, we expect to launch Windows 8, Tiles, Cloud ID and a new multi-device Carbyn-based user experience for Toshiba devices this quarter.

We're excited about our technology, our new partnerships and multiple growth opportunities. We are well-positioned to enable our customers to become the primary media source for their consumers, single place where consumers get all of their media online. We're just beginning to scratch the surface of our potential as consumers increase their adoption of mobile and connected devices.

With that, I'll turn the call over to Bill who will walk you through our third quarter financials. 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 third quarter key metrics, according to Comscore, Synacor engaged 20.2 million average unique visitors per month, an increase of 44% from 14.1 million unique visitors in the third quarter of 2011 and up slightly from the 19.9 million in the previous quarter. Search queries were 234 million for the third quarter, an increase of 15% from the 203 million search queries in the third quarter of 2011 and down from 238 million in the previous quarter, consistent with our seasonality expectations we set on our Q2 earnings call. Synacor delivered almost 11.6 billion advertising impressions, 51% growth over 7.7 billion in the third quarter of 2011 and 13% growth over the previous quarter.

As a result, third quarter revenue grew 18% to $28.3 million from $24 million in the same period last year. Adjusted EBITDA was $2.2 million for the quarter compared to adjusted EBITDA of $2.5 million in the third quarter of 2011. Net income was $700,000 compared to $1.5 million in the third quarter of 2011. Diluted earnings per share or EPS was $0.02.

Net income includes stock-based compensation expense of $500,000 or $0.02 per share in the third quarter of 2012 and $200,000 or $0.01 per share in the third quarter of 2011. Included in our net income is a tax benefit of $40,000 for the third quarter of 2012 which includes the final benefits from the research and development tax credits we discussed during our previous calls. The diluted EPS calculation for the third quarter of 2012 is based on 30 million weighted average fully diluted common shares outstanding.

Turning to costs and expenses, cost of revenue remained within our historical range. We continue to expect cost of revenue as a percentage of revenue to remain at approximately 55%. Total operating expenses, excluding stock-based compensation and depreciation, were $10.4 million for the quarter or 37% of revenue compared to $8.7 million or 36% 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 costs associated with being a public company. Sales and marketing continues to show operating leverage over the prior year, declining by two percentage points, while R&D increased one percentage point as we continue to invest in product development and enhancements to our platform, continuing to create a more engaging user experience.

For the third quarter of 2012, further reinforcing the strength of our financial model, Synacor generated $5 million in cash from operating activities compared to $2.8 million in the third quarter of 2011. The company ended the quarter of -- third quarter 2012 with $38.7 million in cash and cash equivalents compared to $35.1 million at the end of the prior quarter.

I would like to finish our call with our thoughts regarding guidance for the fourth quarter and full year 2012. Based solely on seasonality, our fourth quarter has historically been our largest quarter in terms of revenue and we expect a record quarter this year. Given the uncertainty in the timing of our new customer launches and the resulting impact on volume, along with user trends over the year, we feel it's prudent to revise guidance and widen our range.

For the fourth quarter, we expect revenue within the range of $31 million to $33 million, with adjusted EBITDA in the range of $2.9 million to $3.9 million. As a result, we expect to finish the year with revenue in the range of $120.8 million to $122.8 million. We also expect adjusted EBITDA for the year to be in the range of $11 million to $12 million.

We are also providing guidance on additional line items as follows. For depreciation, we expect a range between $1 million and $1.2 million for the fourth quarter and between $3.7 million and $3.9 million for the full year. For stock-based compensation, we expect a range between $600,000 and $700,000 for the fourth quarter and $2.1 million and $2.2 million for the full year.

For other income and expense, we expect approximately $100,000 in expense for the fourth quarter. For income tax expense in the fourth quarter, we expect our tax rate to be approximately 40% as the work associated with the R&D tax credit is now finalized. As a reminder, the majority of this tax expense is non-cash, as we have a balance of $5.5 million of deferred tax assets which we will partially use in 2012 and in the future to offset tax liabilities.

For weighted average fully diluted shares outstanding utilizing the treasury shares method, we expect our share count to be approximately 30.5 million shares for the fourth quarter.

In closing, our third quarter results delivered on our expectations, producing our eighth consecutive quarter of positive adjusted EBITDA results. Based on our pipeline, we are well-positioned to capitalize on the foundation we have built as a leading providing of start pages, TV Everywhere solutions, and cloud services that deliver on behalf of our customers pay TV content and services to consumers anywhere, anytime, on any device. We expect Carbyn and our Cloud ID management offerings, specifically our social log-in capability, will greatly accelerate the usage of TV Everywhere cross-device, continuing to enhance the consumer experience and our positioning in this rapidly-growing market.

Thank you, and we'll now open the line to your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions].

The first question comes from Jason Helfstein from Oppenheimer.

Jason Helfstein – Oppenheimer

Hey. Thanks, guys. So, question, I mean it looks like clearly that there's a way to drive the advertising business. I mean, you concede in your number that may be volatile quarter to quarter, but I guess, and we're thinking about the subscriber-based services revenues, right, the growth continue to decelerate on a year-over-year basis. And I think a lot of us are looking for some pretty significant acceleration next year in that number. You kind of talked about pipeline, talked about the social log-in. I mean, how much confidence do you have in meaningfully accelerating that subscriber-based number next year or, you know, it doesn’t make sense to have a more prudent outlook. And then just a follow-up question on the browser issues afterwards.

Bill Stuart

So, at this point, we wouldn't be providing any guidance out beyond the fourth quarter. We have had some lumpiness in the subscription revenue based business, and it's -- it would be associated with some project-related NREs that we've had with customers that have contributed to that lumpiness. And this may happen -- may continue to happen from time to time given the nature of some of our subscription business. Ron?

Ron Frankel

And Jason, the TV Everywhere authentication part of this is driving our customers to also, we think, want to deliver more online services, generally to their customer base. So we see increased energy around other types of products that would complement the video viewing experience. We believe we'll be an important part of that. I think that's what we think about how that grows. Timing is a little more difficult to predict.

Jason Helfstein – Oppenheimer

So, is it fair to say -- just let me ask this one more detail. So, is it fair to say, you meet with a customer, you show them a solution, they say, wow, we like this. They start to talk about implementation. And then they say, wow, we also want to do this and we also want to do that. And in fact really what's happening, it's really pushing out the deployment because they are looking for larger solutions. Is that a fair assessment?

Ron Frankel

Not so much larger solutions as more content services for their consumers.

Jason Helfstein – Oppenheimer

Okay.

Ron Frankel

So there -- so when you think about subscription services, it's add-on services like email and security on the application. That's TV Everywhere, which is in a sense a -- not so much subscription but recurring fee base. And then it's services that also carry a recurring fee. And I think you'll see us make some announcements over the next few months about these sorts of services that we think can have the potential, but again difficult to describe timing, you know, some significant upside opportunity.

Jason Helfstein – Oppenheimer

So when you think about the deceleration into the fourth quarter, is that more towards the advertising side or the subscriber-based service side? And then if it is on the advertising side, is it still some issues you're having with Internet Explorer?

Ron Frankel

No, I think we've stabilized in that regard. I think the upside in the fourth quarter is more meaningfully growth in usage. And the traffic-based revenue is [a flow from that].

Jason Helfstein – Oppenheimer

Okay.

Ron Frankel

Both increased CPMs, traditionally, seasonally, we see both increased CPMs and increased RPMs -- CPMs on the advertising side, RPMs on the search side for all of the traffic-based revenues. So we don’t think we're going to see -- we think much of that growth is really already embedded in the increases in traffic that the internet, broadly speaking, feels over the course of the fourth quarter.

Jason Helfstein – Oppenheimer

Okay. So basically we should walk away saying, any weakness in the fourth quarter [is disproportionately] driven by subscriber-based services?

Ron Frankel

Any weakness, I'm not sure --

Jason Helfstein – Oppenheimer

Weakness. Well, I mean, in other words, like you're narrowing the guidance for the year and it's basically the fourth quarter. So what is driving that narrow, you know, that $31 million to $32 million versus numbers that other people might have that's higher than that is subscriber-based services, is that what you're saying?

Ron Frankel

I think coming off of a base of -- so, when we -- I think coming off of the base of $28.2, we're seeing very nice growth in the fourth quarter. The question the range is larger because in the fourth quarter there's a range in which the CPMs and RPMs may grow too. And so we're really focused on those things, as well as launch of a new customer that we anticipate this quarter that will drive some of that range. And so we're very focused on it being a record quarter, we haven't even seen a $31 million quarter yet. So for us, the fourth quarter will be a record quarter. And the question is where in the range we will end up in the quarter.

Jason Helfstein – Oppenheimer

Okay.

Bill Stuart

Subscriber-based revenue there would be very little changed from the third to the fourth quarter, we'd expect.

Ron Frankel

Right.

Jason Helfstein – Oppenheimer

Okay, got it. Thank you very much.

Operator

[Operator Instructions]. The next question comes from Edward Williams from BMO Capital Markets.

Edward Williams – BMO Capital Markets

I just had a quick question on dishNET. Can you provide some more color on the deal? I'm not sure if, you know, does it include subscriber-based revenues beyond email? And just what your general expectations are. Don't know if you can give any color from the initial sign-on.

Ron Frankel

Yeah, we can't share, we're obviously under NDA, it's really for DISH to share their subscriber results. But we're very happy that we're expanding our relationship with DISH. And it is a full new rollout for us, which we're very excited about.

The DISH results are taken into account in the range we've described in the fourth quarter. I expect long term that will continue to be a really important cash flow for us.

Bill Stuart

And was that -- what was this separate question about email?

Edward Williams – BMO Capital Markets

I'm sorry? I'll go back in the queue for my next question.

Operator

The next question comes from Tom Roderick from Stifel Nicolaus.

[Gord Talpez] – Stifel Nicolaus

It's [Gord Talpez] on for Tom. I was hoping you could talk a bit about the sequential decline in search revenue in Q3 versus the relative stability in the number of search queries. Is this just a function of seasonality in which you expect the revenue per search to kind of tick back up in Q4, or something substantial sort of changed in terms of your relationships out there? Thank you.

Ron Frankel

No, nothing -- no fundamental change, very typical seasonality. We'll see increases in revenue per search in the fourth quarter.

[Gord Talpez] – Stifel Nicolaus

Okay, good, perfect. And then one more question here, how much work have guys done to sort of quantify the potential impact from the launch of Windows 8 and Internet Explorer 10 with unified search, and then additionally the launch of Safari 6 I believe, which also had unified search. You talked about it last quarter. I wonder if you've kind of gone granular in terms of your internal sort of analysis with regard to the impact from those two launches.

Ron Frankel

Yeah, there are a number of techniques that we have and will continue to deploy that will help us in both of those rollouts. In addition with Windows 8, we are rolling out Tiles. So there are other ways to [jazz in] into the experience. And the first customer will be launched, Toshiba, here in the fourth quarter. And this is an effort that we are focused on and we feel very good about our current position.

[Gord Talpez] – Stifel Nicolaus

Perfect. And then just one last question if I might. Olympics obviously, you know, a big theme last quarter. Potential impact, obviously a bit muted as expected. But in terms of exposure, have you seen any sort of impact from that in terms of sort of new pipeline, new customer interest, anything of that sort? Thank you guys.

Ron Frankel

Sure. As a practical matter, it raised the exposure of TV Everywhere. I think that there was a lot of interest. I think that programmers generally are accelerating their interest and getting online and getting their consumers online. I think there's much more conversation about the way consumers will enjoy those experiences. And I've got to tell you, I think what we're doing in the mobile devices and in the -- and with Windows 8 are right on in terms of the way the distributors and the programmers will come together to deliver a holistic TV Everywhere experience online and to multiple devices. So I'm very excited about this part. For us this is a great area of opportunity. We continue to gain traction.

[Gord Talpez] – Stifel Nicolaus

Perfect. Thank you.

Operator

Your next question comes from Leo Kulp from Citi.

Leo Kulp – Citi

Hi, guys. Could you talk a little bit about the pipeline and what you're seeing on the consumer electronics and if you're making much progress there?

Ron Frankel

I can't really speak to the pipeline, unfortunately. We have said in this earnings announcement that we are -- launch it. We do have some new customer launches this month. But I can't speak to the specifics of those launches.

Leo Kulp – Citi

Okay. Thanks.

Operator

Your next question comes from Nat Schindler from Merrill Lynch.

Nat Schindler – Bank of America Merrill Lynch

Yes, hi. Can you guys talk a little bit about the history with DISH and really how long that sales cycle was for getting that relationship to where it was? And also, can you reconcile a little bit, I'm looking at your guidance, you're taking down your guidance on revenue yet you're including what I will consider at least the beginning of a major new customer win in October. I'm trying to reconcile that difference. With the growth rate at the midpoint of your guidance, this is somewhere around 11% for the fourth quarter. Could you just give us a little bit more understanding on that and maybe a discussion on how the revenue traditionally ramps for a new customer win?

Ron Frankel

Well, there are a number of factors. And so ramping has to do with rate of marketing, et cetera, and so, you know, and adoption. And so these are open items. And so we don't know the exact impact today. We just know long term it should be a very good impact.

So we're being a bit muted, a bit conservative in the way that we forecast, which is one of the reasons that we increased the range. And we talked about launching DISH October 1 and we also talked about some other new customer launches where the timing may have a variable rate of impact on this current quarter, fourth quarter's results. So that's -- those are the reasons that we've actually widened the range this quarter, Nat. We're just being really conservative and thoughtful as we move forward.

Nat Schindler – Bank of America Merrill Lynch

All right. Thank you.

Ron Frankel

Yes.

Operator

At this time there are no further questions. I would now like to turn the call back over to Ron Frankel.

Ron Frankel

On behalf of the Synacor team, I just want to thank all of you for participating in our third quarter conference call. Please have a great evening and enjoy yourselves. Thanks so much.

Bill Stuart

Thank you.

Operator

Ladies and gentlemen, that does conclude the conference for today. Again, thank you for your participation. You may all disconnect. Have a good day.

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