Synacor (SYNC) CEO Himesh Bhise on Q2 2018 Results - Earnings Call Transcript

Synacor (NASDAQ:SYNC) Q2 2018 Results Earnings Conference Call August 1, 2018 5:00 PM ET

Executives

David Calusdian - Investor Relations, President at Sharon Merrill

Himesh Bhise - Chief Executive Officer

Tim Heasley - Chief Financial Officer

Analysts

Laura Martin - Needham

Mark Argento - Lake Street Capital Markets

Austin Moldow - Canaccord

Operator

Good afternoon. My name is Tim and I will be your conference operator today. At this time, I would like to welcome everyone to the Synacor 2018 second quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you.

Mr. David Calusdian with Sharon Merrill, you may begin the conference.

David Calusdian

Thank you and good afternoon. Welcome to Synacor's second quarter 2018 financial results conference call. Joining me today to discuss Synacor's results are CEO, Himesh Bhise and CFO, Tim Heasley. Bill Stuart is also on hand to answer questions.

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 its filings it makes with the Securities and Exchange Commission from time to time including the section entitled Risk Factors.

Also, I would like to remind you that during the course of this conference call, management 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 today's press release.

And now I will turn the call over to Himesh Bhise, Synacor's CEO.

Himesh Bhise

Thank you David and welcome everyone to today's conference call. Let me begin by welcoming Tim Heasley, Synacor's new Chief Financial Officer, to the call. Prior to joining Synacor, Tim served as a CFO or a senior finance executive at several public and private companies such as National Oak Distributors, Motus Integrated Technologies, Kaydon Corp. and Gibraltar Industries. Tim's financial acumen and previous public company experience make him a strong executive to lead Synacor's financial function. The Board and I look forward to working with him in his new capacity as CFO in executing our strategy to drive value. Tim joined us two months ago and has been working closely with Bill Stuart, our auditors and our finance teams in quickly getting up to speed with our business and our finance processes.

I will also like to take a moment to thank Bill Stuart for his many contributions to Synacor during the past seven years. We wish him the very best in his retirement. Bill is on hand today to answer questions after our prepared remarks.

On this call, we will review our financial performance for the second quarter, provide an update on our initiatives to increase near-term and long-term value and give you a deeper view into our software business. We delivered strong second quarter financial performance exceeding our revenue guidance and meeting our profit guidance. We delivered revenue of $35.9 million, a 15% increase from a year ago, exceeding our guidance for the quarter. Our adjusted EBITDA rose to $1.2 million, achieving our guidance for the quarter and rising from $0.2 million a year ago.

Today, I would like to share three key takeaways on the initiatives we teed up last quarter to drive near-term and long-term value. First, we continued our previously announced cost reduction efforts and we executed a new program that we expect will yield an additional $4 million in annualized savings. Second, we continue to deliver on customer renewals and new sales bookings. And third, our recurring and fee-based revenue grew 13% year-over-year this quarter, driven by our software platforms that we believe represent significant value for shareholders.

I will review our cost reduction efforts and provide sales updates before Tim discusses our financials. Then I will come back to talk about our recurring revenue and software business.

We expect our recent cost reduction efforts will yield an additional $4 million in annualized savings above the $4 million in savings we announced last quarter. We announced last quarter that we put in place a cost reduction program that will yield $4 million in annualized savings over the next 18 months through headcount and contractor reductions, the closing of our Toronto office and data center consolidation. In addition, we recently eliminated 30 positions. These include 15 open positions that will not be filled. We also are eliminating our San Francisco office lease expense. This will yield about $4 million in annualized savings that are incremental to the previously announced $4 million cost reduction plan, bringing the combined expected annualized savings to approximately $8 million. We remain committed to balancing investments in revenue growth with profitability and we will use some of these savings to invest in profitable near-term revenue opportunities.

Our second takeaway. We continue to develop and deliver on our sales pipeline securing several advertising and software customer renewals and wins this quarter. We renewed an expansive deal covering portal identity and email platforms with Mediacom, a top 10 video and broadband service provider in the U.S. We extended our search and advertising relationship with Google through May 2020. Google provides sponsored listings, search related services and advertising services on web portals via operator and publishers we serve. We signed a deal to upgrade Zimbra email and collaboration services for three million users in Japan. We added 110 new Zimbra enterprise and government customers in the second quarter. That makes 230 new Zimbra customer bookings in the first half of this year. Some of these new rollouts of Zimbra include Foxcraft Homes in the U.S., Bharat Heavy Electricals Ltd. in India, HIWIN in Taiwan, Skyora in the U.K. and ASAL, the Algerian Space Agency.

Now let me turn the call over to Tim to share our financial results in more detail before I close with some final thoughts on our recurring revenue and software business. Tim?

Tim Heasley

Thank you Himesh and hello everyone. I am really excited to be here today and to be working with us talented team at Synacor. I have been with the company now for two months and I am more excited now about Synacor's product platforms, the value and growth opportunities and the value potential of this business from when I started. I look forward to working with the investment community and meeting many of you in the coming months as we execute on our growth strategy and deliver on our financial goals.

I want to remind everyone that our non-GAAP financial measures exclude stock-based compensation, other income and expense and restructuring costs. Please refer to our press release and SEC filings for the GAAP to non-GAAP reconciliations.

For the second quarter of 2018, revenue increased 15% over last year to $35.9 million, exceeding the company's financial guidance. Our adjusted EBITDA was $1.2 million, which met our guidance.

Looking at the different components of our revenue. Search revenue was $4.9 million, compared with $5.0 million in the prior year's second quarter. Advertising revenue was $16.1 million, up from $13 million last year. Recurring and fee-based revenue was $14.9 million versus $13.2 million in the same quarter last year. Cost of revenue was 51% versus 46% in the second quarter a year ago, primarily related to mix due to the growth in advertising revenue. As a result, gross margin in the second quarter of 2018 was 49% versus 54% in the same quarter last year.

Total operating expenses, excluding stock-based compensation of $537,000 and depreciation and amortization expense of $2.4 million, were $16.8 million for the second quarter or 47% of revenue, compared with $16.8 million or 54% of revenue in the second quarter a year ago. As a percentage of revenue and again, excluding stock-based compensation and depreciation and amortization expense, technology and development expenses were 17% of sales. Sales and marketing expenses were 19% and G&A expenses were 11%. This compares with 22%, 19% and 13% respectively in the second quarter of 2017.

Synacor's Q2 GAAP net loss narrowed to $2.6 million or $0.07 per share, compared with a net loss of $3.3 million or $0.09 per share in the second quarter of 2017. The net loss for the second quarter of 2018 includes $2.4 million in depreciation and amortization expense versus $2.2 million in the second quarter of 2017 and stock-based compensation expense of $537,000 in the second quarter of 2018 compared with $676,000 in the second quarter of 2017. The EPS calculation for the second quarter of 2018 and 2017 is based on 38.8 million and 37.3 million weighted average common shares outstanding respectively.

Q2 adjusted EBITDA of $1.2 million, as noted, met our guidance range and improved from $0.2 million in the same quarter a year ago, primarily as a result of the higher revenue. The reconciliation of GAAP net income to adjusted EBITDA is included in our earnings release. We ended the quarter with $15 million in cash and cash equivalents, compared with $16.4 million at the prior quarter end.

Based on information available as of today, August 1, we are providing financial guidance for the third quarter and full year 2018. For the third quarter, we expect revenue to be in the range of $37 million to $39 million, a net loss of $2.2 million to $2.7 million and adjusted EBITDA of $1.5 million to $2 million. Adjusted EBITDA excludes stock-based compensation expense of approximately $600,000, restructuring cost of approximately $800,000, depreciation and amortization expense of approximately $2.5 million and tax, interest expense and other income and expense of approximately $300,000. We expect approximately 39 million weighted average shares outstanding in the third quarter.

For full year 2018, our guidance remains for revenue to be in the range of $150 million to $155 million, net loss in the range of $4.4 million to $8.6 million and adjusted EBITDA in the range of $7 million to $10 million. Adjusted EBITDA for 2018 excludes stock-based compensation expense of $2.2 million to $2.3 million, restructuring cost of approximately $1.1 million, depreciation and amortization expense of $10 million to $11.1 million and tax, interest expense and other income and expense of approximately $1.1 million.

With that, I will turn the call back over to Himesh, Himesh?

Himesh Bhise

Thank you Tim. Our recurring and fee-based revenue grew 13% year-over-year this quarter, driven by our software platforms. My final takeaway for you today is that we believe our software product lines represent significant shareholder value. Our recurring and fee-based revenue grew by 13% year-over-year to $14.9 million in the second quarter. The drivers of this growth included new subscription license and hosted services bookings from our Zimbra email and collaboration platform. In addition, we also booked revenue from our blockchain initiative. The recurring revenue component of our business grew 10% year-over-year to $11 million in the second quarter.

Given the growing importance of our software business and recurring revenue stream, we are putting in place the accounting processes to begin to formally report a few key metrics beginning next quarter. These metrics will be focused on our collaboration and identity platforms business and will include sales, renewal rates and gross margins similar to what you would expect to see from other software and SaaS companies.

Our software businesses is of significant size. Bookings are growing nicely. It has strong renewal rates and high gross margins. Our $14.9 million in fee-based and recurring revenue in Q2 includes $11 million of recurring revenue and $3.9 million of nonrecurring revenue. $2 million dollars of that $11 million recurring revenue includes license fees we are paid for our portal platform from certain operators and value-added subscriptions we selling our portals. Our Zimbra collaboration and Cloud ID platforms generated $12.8 million of revenue in the second quarter, of which $9 million was recurring and $3.8 million was nonrecurring.

Let me further describe strength we have achieved in our Zimbra collaboration and Cloud ID software platforms from our investments and our operating focus. Our Zimbra and Cloud ID software revenue grew 14.2% year-over-year and our recurring software revenue grew 12.9% year-over-year. Our software renewal rates on a dollar basis exceeded 100% this quarter with our team successfully driving upsells and longer contract extensions during the renewals process. We added 110 customers this quarter, bringing our total number of worldwide customers on Zimbra to 4,300 and the gross margin for our overall software business was about 75%.

These software platforms also create additional optionality for us. In May, we announced that Zimbra X is now in beta on the EOS.IO blockchain software protocol and we are making great strides in our development of a decentralized application of Zimbra X for EOS.IO. We are already seeing some benefit from this initiative in our revenue this quarter. While blockchain is nascent, analysts expect it to be a very large market in the next several years. We believe Zimbra is in a good position to participate in the blockchain revolution and unlock additional value for shareholders. Very simply, we believe that the demonstrated performance of our collaboration and identity platforms along with the optionality they create such as blockchain represents significant shareholder value.

Before we take your questions, let me summarize our Q2 performance and the opportunities ahead. We delivered a strong second quarter, 15% year-over-year revenue growth, exceeding our revenue guidance and achieving our guidance for both GAAP and non-GAAP profitability. We executed an additional cost reduction program that will yield approximately $4 million in annualized savings above the $4 million in savings we announced last quarter. We continue to develop and deliver on our sales pipeline, securing several advertising and software customer renewals and wins this quarter. This includes Mediacom and Google renewals and booking 110 new Zimbra customers. Our recurring and fee-based revenue grew 13% year-over-year to $14.9 million this quarter, driven by our software platforms. We are delivering on our near-term goals with an eye towards building a strong foundation for long-term profitable growth. We have made strong progress this quarter and we are excited about the opportunities ahead.

Now we will open the call to your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions]. Your first question comes from the line of George Sutton with Craig-Hallum. Your line is open.

Unidentified Analyst

Hi guys. It's Adam, on for George. Congratulations, Bill and welcome. Tim.

Tim Heasley

Thank you.

Unidentified Analyst

Yes. I want to I want to go back to the three million mailbox deal in Japan. How should we think about the impact on revenue for that?

Himesh Bhise

Our email business, as you know, has several potential revenue streams that range from license revenue to hosting revenues. As we described, we are working with our channel partners in Japan to create a hosted offering for approximately three million boxes in Japan. So the impact is already represented in our guidance. But we are particularly excited about the additional footprint presence and reputation it creates for us in that local geography.

Unidentified Analyst

Okay. Great. And then another question for you. Any thoughts about the relationship with AT&T and their recent acquisition? Do you see any opportunities to gain share with Warner Media or more headwinds with that nexus?

Himesh Bhise

Our relationship with AT&T continues to go well. The working teams are working very well together. We usually publish this number in our 10-Q, which we will be filing next week, but AT&T revenue was roughly about $10 million this quarter, right. And this compares very favorably with about $8 million in Q1 and about the same as the $10 million we booked in Q4, which is a seasonally high quarter. So again, to say, the teams are working well together, the lift is being driven by higher search and advertising RPMs, driven by various optimization tactics that we are implementing together.

Unidentified Analyst

Okay. Great. Thank you.

Operator

Your next question comes from the line of Laura Martin with Needham. Your line is open.

Laura Martin

Hi guys. Can you hear me okay? Or do I need to pickup the phone?

Himesh Bhise

No, we can hear you, Laura. Hello.

Laura Martin

Okay. That's better. Okay. Maybe a couple for, so I don't care who takes this. So cost cutting. So love this, we are going to go from $4 million of cost cutting to $8 million. So could you tell us like what's the mix of cost that you cut in the first $4 million? Give me some kind of big categories? And how that was able to double? Like what else did you find to cut? Is it more people in certain product groups? Is it buildings that you are moving out of? How did we double the cost savings? Could you talk about that first, please?

Himesh Bhise

Yes, I will, Laura. So the $4 million of annualized savings in the last call were roughly split between $2 million from data center consolidation and the rest of the $2 million was from elimination of certain lease payments for our Toronto office, a reduction of positions as well as reduction in contractor expense. So roughly think about it as $2 million and $2 million. The data center savings, this is customer related operations that take very seriously. We are very thoughtful in the way we consolidate data centers. So as we mentioned the last time, we expect that project to complete in the first quarter of next year. And so much of those data center consolidation savings will be in 2019. The rest of the savings as it relates to lease and people and contractors are well underway. These were in annualized savings numbers and we are beginning to recognize many of those savings this year.

The second crunch that we announced this quarter of $4 million was with, again, largely based on about 30 position eliminations. Of those 30, about 15 were open requisitions. So open positions that we are no longer filling and doing away with. So 15 plus 15. Plus we found a few other additional cost such as the elimination of lease in our San Francisco office. Again, those are underway. Those are annualized savings that we expect to book in the remainder of this year. We will book some restructuring expense against them. They will be annualized for next year. But I also want to reiterate that part of this is an overall refocusing. So while certainly we are very focused on profitability, we also want to make sure that we have the dry powder and the ability to invest in what we believe our strong growth opportunities and profitable growth opportunities for us as a company.

Laura Martin

Okay. Great. Super helpful. Could we talk a little bit, remind me, on blockchain, tell me how much we are investing in that this year? And what the sort of path seems forward in terms of when that turns into an economic positive NPV for the income statement on blockchain?

Himesh Bhise

Yes. Great. So let me answer the second part of your question first, because to some expanding I think that's the punch line you are looking for. I am actually really pleased to say that we are operating today in a positive NPV stand as it relates to our blockchain initiative, which is why I wanted to clear that we are able to recognize some revenue from this initiative. So the way we think about this initiative, Laura, is number one, it is a large market. It's nascent but we believe, like many analysts do, that it could grow dramatically driven by the use of blockchain to make many corporate processes and consumer processes simpler and more transparent, whether those are supply chain, digital identity, payments, smart contracts, et cetera.

Zimbra, as it turns out, given that it has its roots in open source and that the new generation of Zimbra, Zimbra X, is built in a cloud-native container-based style architecture, it makes it actually very suited for applications in the blockchain space. And we were able to get going with that initiative through the effort that we announced earlier in the quarter with EOS.IO that is one of the largest among the more successful players in that space building a software protocol and layer to enable additional distributed applications. We believe we are the first email app on blockchain. We are the first enterprise app on EOS.IO.

So while we are managing our investment in the area with some of the revenue we are beginning to realize, we are also seeing tremendous optionality for us in this space. Given that it is a nascent market, the longer-term view really depends on how we construct and participate in emerging business models. But we will have a product and we are making good progress in developing a communication and email product that works on blockchain which is, I think, more than many companies can plan.

Laura Martin

Great. Thanks so much. Appreciate the help.

Himesh Bhise

Thanks Laura.

Operator

Your next question comes from the line of Mark Argento with Lake Street Capital Markets. Your line is open.

Mark Argento

Hi guys. Good afternoon. Thanks for some of the additional color here. It's helpful. Maybe we could talk a little bit about some of the authentication, unified Id type products. It looks like, I think you said, the Zimbra recurring was $9 million overall, recurring was $11 million. So I am guessing that's roughly a $2 million business, plus or minus. Maybe you could provide a little more light there? I know it's a smaller number, but growing quickly.

Himesh Bhise

Thanks for the question, Mark. So to clarify, we are bundling the Cloud ID revenue and the Zimbra collaboration revenue into our bucket of software revenue. We believe there is strong interplay between collaboration and identity platforms, more so given our roadmap for the future than it is at this particular moment in time. But we really want to think about it as one big business rather than kind of piece those two elements apart. So overall, across both Zimbra and Cloud ID, we delivered a $12.8 million revenue business in the second quarter, of which $9 million was recurring, as you said.

We are excited about our position in the Cloud ID space. Identity is becoming central to services that consumers use as well as enterprises provide. Verified identity is a key component of the value that blockchain will ultimately provide. Our platform in the identity space is integrated with almost all PayTV households in the U.S. We have some terrific branded customers for whom we are operating at scale and with very hot, when customers have very high degree of requirements and we demonstrated our ability to continue to deliver innovations like Forever Login that we announced a few months ago. And that is generating a number of very interesting discussions for us. So we are really excited about our Cloud ID platform for the future.

Mark Argento

And the recurring revenue, I think it would be helpful, as you guys just think about how you want to recast or talk about the business in terms of calling about recurring revenues. Just so I understand, so that $9 million in recurring, is that under long-term multiyear contracts? Or how should we think of the durability of that recurring nature of that revenue?

Himesh Bhise

Got it. So again. Just so we don't lose the number, we also delivered about $2 million in recurring revenue from our core portals platforms business. Now, we are being particularly thoughtful about also presenting the software related number which is the $9 million number, but the combination is about $11 million in recurring revenue that we are generating. The length of the contracts vary, Mark. They are typically a year in length. They typically renew year-over-year. But I do believe that you should consider these fairly robust. Look at our renewals number this quarter, right. We have been talking about our renewals number being very high on prior calls and I am here talking about somewhere that is higher than 100%. And I think this reflects not only the quality of our products but how sticky they tend to be with customers. And so that's how I would have you think about the $9 million and the total of $11 million of recurring revenue.

Mark Argento

And in terms of the way you have these businesses integrated amongst each other, I am assuming and the authentication business, those standalone businesses, I am sure there is some integration and some cross-selling going on there, but you can make your argument that Zimbra and plus the Cloud ID is worth the complete value of the business times three right now. So I am just thinking about when you guys look back and you see you are refocusing the business, you thinking about the future, how much future or how do you think about the businesses should there is an opportunity to potentially unlock value here by either divesting or doing anything else structurally here to really start to tease out that value which has been obviously hidden there?

Himesh Bhise

Yes. That's a really good point, Mark and one that we have talked a lot about as a management team and a Board. I think the first point to make, just to reinforce, is with $11 million of recurring revenues in the business, with about $14.9 million of fee-based revenue, it just on an annualized basis using an y comparables of other software and recurring revenue businesses. You quickly get to the place that you got. There is significant possibility of shareholder value here that we have already delivered and we continue to grow. So in the near term, our ask is, you think about Synacor as a sum of two parts.

There is an advertising business and we are lucky enough to be a at-scale profitable advertising business. We have we ever reach of over 200 million monthly uniques. We have unique inventory we can bring to the table and we continue to grow our ad business. But we recognize that ad businesses attract certain investors at certain multiples.

Now on this other side over here, we have a software business that we have talked about being in $13 million-plus range on an annualized basis. It continues to grow. It has high gross margins, high renewal rates. And again attracts investors also who like those kinds of revenue streams at again certain kinds of multiples. And I believe, at least at this moment in time, we think about the company as the sum of those two parts.

Mark Argento

Great. That's helpful. Thanks Himesh. Bill, nice working with you. Tim, look forward to getting to know you.

Tim Heasley

Likewise. Thanks very much, Mark.

Himesh Bhise

Thanks Mark.

Operator

Your next question comes from the line of Austin Moldow with Canaccord. Your line is open.

Austin Moldow

Hi. Thanks for taking my question. I have a similar sort of big picture question as the last one, but from the other angle. Could you explain your current thought process around the search and advertising segment in general in light of what sounds like heightened emphasis on the software segment? For example, what does the pipeline look like for future business? And really what I am most curious about is, what level of investment it's getting relative to the software products?

Himesh Bhise

Thanks for the question, Austin. So let me talk a little bit about the advertising business then. And again to reiterate, we have a profitable, growing at scale advertising business. I would say, as you look around at the universe of advertising companies. I think this is a strong asset. We perform and participate similar to how you would expect other advertising companies of our scale to perform. We are being very vigilant about how we invest in that space. There are clearly opportunities that we will invest against, right. We are fully staffed on our AT&T efforts. We continue to serve our current service provider customers well. But again, if you think about innovation or a robust product roadmap and pipeline, those elements are much more visible in our software platforms. So the new features, the next-gen platforms, the cloud identity innovation, all that is resulting from the focus of resources in those areas.

Austin Moldow

Okay. Thank you.

Himesh Bhise

Thanks.

Operator

And there are no further questions at this time.

Himesh Bhise

Thank you operator and thank you everyone for being on the call. We look forward to seeing some of you at the Canaccord Genuity 38th Annual Growth Conference on August 8 and to providing additional updates on our next quarterly earnings call. Thank you and have a good evening.

Operator

This concludes today's conference call. Thank you so much for joining. You may now disconnect.