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SYNC > SEC Filings for SYNC > Form 10-Q on 15-Nov-2012All Recent SEC Filings

Show all filings for SYNACOR, INC.

Form 10-Q for SYNACOR, INC.


15-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This quarterly report on Form 10-Q contains "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. In addition, we may make other written and oral communications from time to time that contain such statements. Forward-looking statements include statements as to industry trends and future expectations of ours and other matters that do not relate strictly to historical facts. These statements are often identified by the use of words such as "may," "expect," "believe," "anticipate," "intend," "could," "estimate," or "continue," and similar expressions or variations. These statements are based on the beliefs and assumptions of our management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. These forward-looking statements include statements in this Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations." Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled "Risk Factors" included elsewhere in this Form 10-Q and in our other Securities and Exchange Commission filings, including our Annual Report on Form 10-K for the fiscal year ended December 31, 2011. Furthermore, such forward-looking statements speak only as of the date of this report. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and related notes thereto appearing elsewhere in this Form 10-Q and with the consolidated financial statements and notes thereto and management's discussion and analysis of financial condition and results of operation appearing in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.

Overview

We are a leading provider of authentication and aggregation solutions for delivery of online content and cloud-based services. We deliver our solutions as a set of services through our hosted and managed platform, enabling cable, satellite, and telecom service providers and consumer electronics manufacturers to provide the online content and cloud-based services that their consumers increasingly demand. Our platform allows our customers to package a wide array of online content and cloud-based services with their high-speed Internet, communications, television and other offerings. Our customers offer our services under their own brands on Internet-enabled devices such as PCs, tablets, smartphones and connected TVs.

We generate revenue from search and display advertising and by charging subscriber-based fees for cloud-based services and products delivered through our platform. Our results are driven primarily by our customer mix, the product and service mix preferences of those customers and the pricing of those products and services. We generate the majority of our revenue from search and display advertising on the Internet websites we operate for our customers, which we refer to as our startpages, which comprise consumer-facing components of our platform. Adding new customers with large consumer bases and expansion of our relationships with existing customers have resulted in an increasing shift in our revenue mix towards search and display advertising revenue. In addition, as new customers adopt our startpages, and as their respective consumers' use of our startpages ramps up as described below, our growth is increasingly driven by search and display advertising revenue. These increases are largely driven by our model of sharing a portion of this search and advertising revenue with our customers. As we expand our cloud-based services offerings, we expect to generate increased subscriber-based revenue from our customers.

As more consumers use our startpages and as consumers spend more time on these startpages, we have a greater number of opportunities to deliver advertisements. During the three and nine months ended September 30, 2012, search and display advertising revenue was $23.3 million and $74.5 million, a growth of 24% and 55% over $18.7 million and $48.0 million for the three and nine months ended September 30, 2011. Over the same periods, our unique visitors increased by 44% and 55%, our search queries increased by 15% and 48% and our advertising impressions increased by 51% and 57%. We expect consumer engagement on our startpages to continue to grow in the future as our customers deliver more services through these startpages.

Our subscriber-based revenue consists of fees charged for the use of our proprietary technology platform and for the use of, or access to, cloud-based services, such as e-mail, TV Everywhere, security, online games, music and other value added services and paid content. During the three and nine months ended September 30, 2012, subscriber-based revenue was $5.1 million and $15.3 million, a decrease of 3% and an increase of 9% from $5.2 million and $14.1 million during the three and nine months ended September 30, 2011. We believe there are opportunities to generate additional sources of


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subscriber-based revenue, such as fees for TV Everywhere authentication and the introduction of new cloud-based services. We believe that the variety of subscriber and cloud-based services and the introduction of new services will also drive increased search and display advertising revenue.

As new customers introduce our startpages to their consumers, usage of our platform and our revenue from these startpages tends to increase over time. There are a variety of reasons for this ramp-up period. For example, a new customer may migrate its consumers from its existing platform to our platform over a period of time. Moreover, a new customer may initially launch a selection of our services and products, rather than our entire suite of offerings, and subsequently broaden their service and product offerings over time. When a customer launches a new service or product, marketing and promotional activities may be required to generate awareness and interest among consumers. Search and display advertising revenue typically grows significantly during the first one to three years after a customer launch, although there can be notable variances from customer to customer. Thereafter, changes in revenue tend to mirror changes in the consumer base of the applicable customer.

For the three and nine months ended September 30, 2012, we derived revenue from over 45 customers, with revenue attributable to four customers, CenturyLink, Inc. or CenturyLink (including revenue attributable to Qwest Communications International, Inc. or Qwest, which merged with CenturyLink in April 2011), Toshiba America Information Systems, Inc., or Toshiba, Charter Communications Inc., or Charter, and Verizon Corporate Services Group, Inc., or Verizon, together accounting for approximately 71% and 73% of our revenue for the three and nine months ended September 30, 2012, or $20.2 million and $65.5 million, respectively. Two of these customers accounted for 20% or more of revenue in such periods, and revenue attributable to each of the other two customers accounted for more than 10% in both periods. Revenue attributable to our customers includes the subscriber-based revenue earned directly from them, as well as the search and display advertising revenue generated through our relationships with our search and display advertising partners (such as Google, Inc., or Google, for search advertising and advertising networks, advertising agencies and advertisers for display advertising). This revenue is attributable to our customers because it is produced from the traffic on the startpages we operate for them. These partners provide us with advertisements that we then deliver with search results and other content on our startpages. Since our search advertising partner, Google, and our advertising network partners generate their revenue by selling those advertisements, we create a revenue stream for these partners. In the three and nine months ended September 30, 2012, search advertising through our relationship with Google generated approximately 51% and 57% of our revenue, or $14.5 million and $50.8 million (all of which was attributable to our customers).

The initiatives described below under "Key Initiatives" are expected to contribute to our ability to maintain and grow profitability via increases in advertising revenue, increases in customers and our consumer reach, and increases in availability of products across more devices. We expect the period in which we experience a return on future investments in each of these initiatives to differ. For example, more direct advertising at higher cost-per-thousand impressions (referred to as cost per mille, or CPM) would be expected to have an immediate and direct impact on profitability while expansion into international markets may require an investment that involves a longer term return.

Key Initiatives

We are focused on several key initiatives to drive our business:

add new, and expand our offerings with current, cable, telecom, satellite and consumer electronics customers to increase our consumer reach;

continue to expand our offerings of, and invest in, cloud-based services such as e-mail and TV Everywhere and increase the number of customers using our TV Everywhere authentication platform;

enhance our direct advertising sales effort to increase the CPMs derived from advertising;

extend the availability of our existing and new products and services to additional devices including tablets and smartphones;

expand our presence into international markets; and

invest in and acquire new technologies and products.

Key Business Metrics

In addition to the line items in our financial statements, we regularly review a number of business metrics related to Internet traffic and search and display advertising to evaluate our business, determine the allocation of resources and make decisions regarding business strategies. We believe disclosing these metrics is useful for investors and analysts to


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understand the underlying trends in our business. The following table summarizes our key business metrics, which are unaudited, for the three and nine months ended September 30, 2011 and 2012:

                                 Three Months Ended September 30,           Nine Months Ended September 30,
                                     2011                 2012                 2011                 2012
Key Business Metrics:
Unique Visitors (1)                  14,069,737           20,241,871           13,250,013           20,487,594
Search Queries (2)                  203,335,131          233,767,194          503,476,341          742,893,799
Advertising Impressions (3)       7,682,888,761       11,634,386,253       19,461,422,855       30,457,542,583

Notes:

(1) Reflects the number of unique visitors to our startpages computed on an average monthly basis during the applicable period.

(2) Reflects the total number of search queries during the applicable period.

(3) Reflects the total number of advertising impressions during the applicable period.

Unique Visitors

We define unique visitors as consumers who have visited one of our startpages at least once during a particular time period. We rely on comScore to provide this data. comScore estimates this data based on the U.S. portion of the Internet activity of its worldwide panel of consumers and its proprietary data collection method.

Search Queries

We define search queries as the number of instances in which a consumer entered a query into a search bar on our platform during a particular time period. We rely on reports from our search partner, Google, to measure the number of such instances.

Advertising Impressions

We define advertising impressions as graphical, textual or video paid advertisements displayed to consumers on our platform during a particular time period. We rely on reports from technology and advertising partners, including DoubleClick (a division of Google), to measure the number of advertising impressions delivered on our platform.

Components of our Results of Operations

Revenue

We derive our revenue from two categories: revenue generated from search and display advertising activities and subscriber-based revenue, each of which is described below. We record our search and display advertising revenue on a gross basis, which includes the net amount received from Google under our agreement with them. The following table shows the revenue in each category, both in amount and as a percentage of revenue, for the three and nine months ended September 30, 2011 and 2012.

                                          Three Months Ended September 30,             Nine Months Ended September 30,
                                            2011                   2012                  2011                   2012
                                                   (in thousands)                               (in thousands)
Revenue:
Search and display advertising         $        18,722        $        23,255       $        48,040        $        74,474
Subscriber-based                                 5,232                  5,071                14,075                 15,329

Total revenue                          $        23,954        $        28,326       $        62,115        $        89,803

Percentage of revenue:
Search and display advertising                      78 %                   82 %                  77 %                   83 %
Subscriber-based                                    22                     18                    23                     17

Total revenue                                      100 %                  100 %                 100 %                  100 %


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Search and Display Advertising Revenue

We use Internet search and display advertising to generate revenue from the traffic on our startpages.

In the case of search advertising, we have a revenue-sharing relationship with Google, pursuant to which we include a Google-branded search tool on our startpages. When a consumer makes a search query using this tool, we deliver the query to Google and they return search results to consumers that include advertiser-sponsored links. If the consumer clicks on a sponsored link, Google receives payment from the sponsor of that link and shares a portion of that payment with us, which we in turn share with the applicable customer. The net payment we receive from Google is recognized as revenue.

We generate display advertising revenue when consumers view or click on a text, graphic or video advertisement that was delivered on one of our startpages. We fill our advertising inventory with advertisements sourced by our direct sales force, independent advertising sales representatives and advertising network partners. Revenue may be calculated differently depending on our agreements with our advertisers or the agreements between our advertising network partners and their advertisers. It may be calculated on a cost per impression basis, which means the advertiser pays based on the number of times its advertisements appear, or a cost per action basis, which means that an advertiser pays when a consumer performs an action after engaging one of its advertisements. Historically, only a small percentage of our display advertising revenue has been calculated on a cost per action basis.

Subscriber-Based Revenue

We define subscriber-based revenue as subscription fees and other fees that we receive from our customers for the use of our proprietary technology platform and the use of, or access to, e-mail, TV Everywhere, security, games and other services, including value added services and paid content. Monthly subscriber levels typically form the basis for calculating and generating subscriber-based revenue. They are generally determined by multiplying a per-subscriber per-month fee by the number of subscribers using the particular services being offered or consumed. In other cases, the fee is fixed. We recognize revenue from our customers as the service is delivered.

Costs and Expenses

Cost of Revenue

Cost of revenue consists of revenue sharing, content acquisition costs and co-location facility costs. Revenue sharing consists of amounts accrued and paid to our customers for the traffic on their websites resulting in the generation of search and display advertising revenue. The revenue-sharing agreements with our customers are primarily variable payments based on a percentage of the search and display advertising revenue. Content acquisition agreements may be based on a fixed payment schedule, on the number of subscribers per month, or a combination of both. Fixed-payment agreements are expensed over the term defined in the agreement. Agreements based on the number of subscribers are expensed on a monthly basis. Co-location facility costs consist of rent and operating costs for our data center facilities.

Research and Development

Research and development expenses consist primarily of compensation-related expenses incurred for the development of, enhancements to, and maintenance and operation of our technology platform and related infrastructure.

Sales and Marketing

Sales and marketing expenses consist primarily of compensation-related expenses to our direct sales and marketing personnel, as well as costs related to advertising, industry conferences, promotional materials, and other sales and marketing programs. Advertising cost is expensed as incurred.


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General and Administrative

General and administrative expenses consist primarily of compensation-related expenses for executive management, finance, accounting, human resources and other administrative functions.

Depreciation

Depreciation includes depreciation of our computer hardware and software, furniture and fixtures, leasehold improvements, and other property, and depreciation on capital leased assets.

Other Income (Expense)

Other income (expense) consists primarily of interest income earned and foreign exchange gains and losses.

Interest Expense

Interest income (expense) primarily consists of expenses associated with our long-term debt, capital leases, and amortization of debt issuance costs.

Provision for Income Taxes

Income tax expense consists of federal and state income taxes in the United States and taxes in certain foreign jurisdictions.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these condensed consolidated financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and the related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. Our estimates form the basis for our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

An accounting policy is considered to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimate that are reasonably likely to occur, could materially impact the condensed consolidated financial statements. We believe that our critical accounting policies reflect the more significant estimates and assumptions used in the preparation of the condensed consolidated financial statements.

For a discussion of our critical accounting policies and estimates, see "Critical Accounting Policies and Estimates" included in our Annual Report on Form 10-K for the year ended December 31, 2011 under the caption Management's Discussion and Analysis of Financial Condition and Results of Operations. We have made no significant changes to our critical accounting policies and estimates from those described in our Annual Report on Form 10-K for the year ended December 31, 2011.

Recent Accounting Pronouncements

For information with respect to recent accounting pronouncements and the impact of these pronouncements on our consolidated financial statements, see Note 1, The Company and Summary of Significant Accounting Policies, in the notes to the condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.

Adjusted EBITDA

To provide investors with additional information regarding our financial results, we have disclosed within this Quarterly Report on Form 10-Q adjusted EBITDA, a non-GAAP financial measure. We have provided a reconciliation below of adjusted EBITDA to net income (loss), the most directly comparable GAAP financial measure.

We have included adjusted EBITDA in this Quarterly Report on Form 10-Q because it is a key measure used by our management and board of directors to understand and evaluate our core operating performance and trends, to prepare and approve our annual budget and to develop short- and long-term operational plans. In particular, the exclusion of certain expenses in calculating adjusted EBITDA can provide a useful measure for period-to-period comparisons of our core business. Additionally, adjusted EBITDA is a key financial measure used by the compensation committee of our board of directors in connection with the payment of bonuses to our executive officers. Accordingly, we believe that adjusted EBITDA provides useful information to investors and others in understanding and evaluating our operating results in the same manner as our management and board of directors.


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Our use of adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:

although depreciation is a non-cash charge, the assets being depreciated may have to be replaced in the future, and adjusted EBITDA does not reflect capital expenditure requirements for such replacements or for new capital expenditure requirements;

adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;

adjusted EBITDA does not consider the potentially dilutive impact of equity-based compensation;

adjusted EBITDA does not reflect tax payments that may represent a reduction in cash available to us; and

other companies, including companies in our industry, may calculate adjusted EBITDA differently, which reduces its usefulness as a comparative measure.

Because of these limitations, you should consider adjusted EBITDA alongside other financial performance measures, including various cash flow metrics, net income and our other GAAP results. The following table presents a reconciliation of adjusted EBITDA to net income for each of the periods indicated:

                                             Three Months Ended September 30,                 Nine Months Ended September 30,
                                               2011                     2012                   2011                     2012
                                                      (in thousands)                                  (in thousands)
Reconciliation of Adjusted EBITDA:
Net income                               $          1,485         $            652       $          2,188         $          3,025
Provision (benefit) for income taxes                   49                      (40 )                   55                      660
Interest expense                                       13                       72                     64                      208
Other (income) expense                                 19                      (25 )                   18                       (7 )
Depreciation                                          673                      981                  1,950                    2,696
Stock-based compensation                              232                      520                    640                    1,503

Adjusted EBITDA                          $          2,471         $          2,160       $          4,915         $          8,085

The following tables set forth our results of operations for the periods presented in amount and as a percentage of revenue for those periods. The period to period comparison of financial results is not necessarily indicative of future results.

                                          Three Months Ended September 30,             Nine Months Ended September 30,
                                             2011                  2012                  2011                  2012
                                                   (in thousands)                              (in thousands)
Revenue                                 $        23,954       $        28,326       $        62,115       $        89,803
Costs and operating expenses:
Cost of revenue (1)                              12,814                15,792                32,872                49,432
Research and development (1)(2)                   4,950                 6,218                14,270                18,629
Sales and marketing (2)                           2,127                 2,000                 5,811                 6,776
General and administrative (1)(2)                 1,824                 2,676                 4,887                 8,384
Depreciation                                        673                   981                 1,950                 2,696

Total costs and operating expenses               22,388                27,667                59,790                85,917

Income from operations                            1,566                   659                 2,325                 3,886

Other income (expense)                              (19 )                  25                   (18 )                   7
Interest expense                                    (13 )                 (72 )                 (64 )                (208 )

Income before income taxes                        1,534                   612                 2,243                 3,685
Provision (benefit) for income taxes                 49                   (40 )                  55                   660

Net income                              $         1,485       $           652       $         2,188       $         3,025

Notes:
. . .
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