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SYNACOR, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) 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, 2013 (as amended). 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, 2013 (as amended). Overview We are a leading provider of start experiences (startpages and homescreens), TV Everywhere, Identity Management (IDM) and various cloud-based services across multiple devices for cable, satellite, telecom and consumer electronics companies. For these customers, we are also a leading provider of authentication and aggregation solutions enabling the delivery of personalized online content. Our technology allows our customers to package a wide array of personalized 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 services and products delivered through our start experiences. 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 our start experiences, which comprise consumer-facing components of our technology. Adding new customers with large consumer bases and expansion of our relationships with existing customers have historically resulted in an increasing shift in our revenue mix towards search and display advertising revenue. Growth in our business (through growth in search and display advertising revenue) is dependent on new customers adopting our solutions and their respective consumers' use of our start experiences ramping up as described below. Increases in search and display advertising revenue 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 and value added services offerings, we expect to generate increased subscriber-based revenue from our customers. For the three and six months ended June 30, 2014, search and display advertising revenue was $18.5 million and $38.4 million, a decrease of 13% and 16% compared to $21.4 million and $45.5 million for the three and six months ended June 30, 2013. Over the same periods, our unique visitors decreased by 9% and 6%, respectively, our search queries decreased by 27% for both periods, and our advertising impressions decreased by 14% and 20%, respectively. Search revenue decreased by $2.6 million and $5.4 million for the three and six months ended June 30, 2014 compared to the same periods ended June 30, 2013. We believe a material portion of the decrease in revenue was due to the placement of our start experiences on the second tab of the default Windows 8 Internet browser by our consumer electronics customers. In addition, and to a lesser extent, we believe the decrease was due to lower search activity associated with the increased usage of other devices such as tablets and smartphones generally across the consumer base. We anticipate that search activity will increase on smartphones and tablets in the future and, although our search queries have decreased, we believe that our continuing investment in mobile products, such as our acquisitions of Carbyn and Teknision, will allow us to compete more effectively for search activity on smartphones and tablets. Display advertising revenue decreased by $0.3 million and $1.6 million for the three and six months ended June 30, 2014 compared to the same periods ended June 30, 2013 as a result of pricing changes in one of our customer contracts, another customer's implementation of more secure webmail, which affected our ability to insert display advertising on that customer's webmail site, and operational changes in practices and policies for display advertising. We anticipate video advertising may become an increasing percentage of our advertising revenue which may also serve to increase our advertising 15-------------------------------------------------------------------------------- Table of Contents cost per thousand impressions (referred to as cost per mille, or CPMs). We also anticipate that the signing, and launching, of new customers and our mobile product initiatives may help add new search and display advertising revenue in future years. Our subscriber-based revenue consists of fees charged for the use of our proprietary technology and for the use of, or access to, services, such as e-mail, security, TV Everywhere, online games, music and other value added services and paid content. During the three and six months ended June 30, 2014, subscriber-based revenue was $5.7 million and $11.0 million, increases of 7% and 6% compared to $5.3 million and $10.4 million for the three and six months ended June 30, 2013. This increase is primarily driven by growth in adoption of our TV Everywhere services by our customers. We believe there are opportunities to generate new sources of subscriber-based revenue, such as the introduction of new value added services, including those delivered on smartphones and tablets. We believe that the variety of value added services and the introduction of new value added services will also drive increased search and display advertising revenue. As we obtain new customers and those new customers introduce our start experiences to their consumers, we expect that usage of our solutions and our revenue from our start experiences 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 technology to our technology 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 six months ended June 30, 2014, we derived revenue from over 50 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), Charter Communications Inc., or Charter, Verizon Corporate Services Group, Inc., or Verizon, and Toshiba America Information Systems, Inc., or Toshiba, together accounting for approximately 65% and 66% of our revenue for the three and six months ended June 30, 2014, or $15.8 million and $32.5 million, respectively. One of these customers accounted for 20% or more of revenue in such periods, and revenue attributable to each of the other three customers accounted for more than 10% in such 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 our start experiences. These partners provide us with advertisements that we then deliver with search results and other content on our start experiences. 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 six months ended June 30, 2014, search advertising through our relationship with Google generated approximately 46% and 49% of our revenue, or $11.1 million and $24.0 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 revenue and return to profitability via increases in advertising revenue, increases in customers and our consumer reach, including international customers and consumers, 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 CPMs 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. We intend to utilize a portion of our cash and cash equivalents to improve our ability to achieve consistent profitability in the future by enhancing our technology and our systems capabilities to more efficiently support our customers, develop new products and features and report upon, analyze and manage the financial performance of the business. Key Initiatives We are focused on several key initiatives to drive our business: • add new customers, and expand our existing offerings with current cable, telecom, satellite and consumer electronics customers, in order to increase our consumer reach; • continue to expand our offerings of, and invest in, mobile technology and cloud-based services such as e-mail and TV Everywhere and increase the number of customers using our TV Everywhere technology; 16-------------------------------------------------------------------------------- Table of Contents • extend the availability of our existing and new products and services to additional devices including tablets and smartphones; • enhance our direct advertising sales effort to increase the CPMs derived from advertising; • 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 consolidated 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 understand the underlying trends in our business. The following table summarizes our key business metrics, which are unaudited, for the three and months ended June 30, 2013 and 2014: Three Months Ended June 30, Six Months Ended June 30, 2013 2014 2013 2014 Key Business Metrics: Unique Visitors (1) 19,686,182 17,932,647 19,973,574 18,810,423 Search Queries (2) 177,025,185 129,546,784 388,669,982 283,370,361 Advertising Impressions (3) 10,292,927,243 8,897,558,466 21,775,961,313 17,484,367,947 Notes: (1) Reflects the number of unique visitors to our start experiences 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 start experiences 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 start experiences 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 start experiences 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. 17-------------------------------------------------------------------------------- Table of Contents The following table shows the revenue in each category, both in amount and as a percentage of revenue, for the three and six months ended June 30, 2013 and 2014: Three Months Ended June 30, Six Months Ended June 30, 2013 2014 2013 2014 (in thousands) (in thousands) Revenue: Search and display advertising $ 21,399 $ 18,521 $ 45,485 $ 38,429 Subscriber-based 5,309 5,670 10,366 11,010 Total revenue $ 26,708 $ 24,191 $ 55,851 $ 49,439 Percentage of revenue: Search and display advertising 80 % 77 % 81 % 78 % Subscriber-based 20 23 19 22 Total revenue 100 % 100 % 100 % 100 % Search and Display Advertising Revenue We use Internet search and display advertising to generate revenue from the traffic on our start experiences. • 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 start experiences. 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 a Synacor-operated start experience. We fill our advertising inventory with advertisements sourced by our direct salesforce, 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, or on a fixed fee basis. Historically only a small percentage of our display advertising revenue has been calculated on a cost per action basis or fixed fee 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 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 the start experiences we operate for them that results 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 18-------------------------------------------------------------------------------- Table of Contents Research and development expenses consist primarily of compensation-related expenses incurred for the development of, enhancements to, and maintenance and operation of our technology 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. 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, as well as depreciation on capital leased assets. Other (Expense) Income Other (expense) income consists primarily of interest income earned and foreign exchange gains and losses. Interest Expense Interest expense primarily consists of expenses associated with our capital leases. Benefit for Income Taxes Income tax benefit consists of federal and state income taxes in the United States and taxes in certain foreign jurisdictions. Loss in Equity Interest Loss in equity interest represents our percentage share of losses in investments in entities in which we can exercise significant influence, but do not own a majority equity interest or otherwise control. 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, 2013 (as amended) 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, 2013 (as amended). 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 loss, the most directly comparable GAAP financial measure. 19-------------------------------------------------------------------------------- Table of Contents 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. 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 U.S. 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 loss and our other U.S. GAAP results. The following table presents a reconciliation of adjusted EBITDA to net loss for each of the periods indicated: Three Months Ended June 30, Six Months Ended June 30, 2013 2014 2013 2014 (in thousands) (in thousands) Reconciliation of Adjusted EBITDA: Net loss attributable to Synacor, Inc. $ (637 ) $ (1,868 ) $ (610 ) $ (3,924 ) Provision for income taxes (204 ) (641 ) (186 ) (1,325 ) Interest expense 43 23 101 111 Other 8 (6 ) 15 (14 ) Depreciation 1,138 1,117 2,268 2,175 Stock-based compensation 617 847 1,179 1,528 Loss on equity interest - 344 - 590 Gain on sale of domain - (1,000 ) - (1,000 ) Adjusted EBITDA $ 965 $ (1,184 ) $ 2,767 $ (1,859 ) 20-------------------------------------------------------------------------------- Table of Contents Results of Operations 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 June 30, Six Months Ended June 30, 2013 2014 2013 2014 (in thousands) (in thousands) Revenue $ 26,708 $ 24,191 $ 55,851 $ 49,439 Costs and operating expenses: Cost of revenue (1) 14,017 13,146 29,781 27,022 Research and development (1)(2) 7,336 7,120 14,201 14,612 Sales and marketing (2) 2,147 2,457 4,277 4,594 General and administrative (1)(2) 2,957 3,499 6,101 6,598 Depreciation 1,138 1,117 2,268 2,175 Gain on sale of domain - (1,000 ) - (1,000 ) Total costs and operating expenses 27,595 26,339 56,628 54,001 Loss from operations (887 ) (2,148 ) (777 ) (4,562 ) Other (expense) income (8 ) 6 (15 ) 14 Interest expense (43 ) (23 ) (101 ) (111 ) Loss before income taxes and equity interest (938 ) (2,165 ) (893 ) (4,659 ) Benefit for income taxes (204 ) (641 ) (186 ) (1,325 ) Loss in equity interest - (344 ) - (590 ) Net loss (734 ) (1,868 ) (707 ) (3,924 ) Net loss attributable to noncontrolling interests 97 - 97 - Net loss attributable to Synacor, Inc. $ (637 ) $ (1,868 ) $ (610 ) $ (3,924 ) Notes:(1) Exclusive of depreciation shown separately. (2) Includes stock-based compensation as follows: Three Months Ended June 30, Six Months Ended June 30, 2013 2014 2013 2014 (in thousands) (in thousands)Research and development $ 281 $ 375 $ 542 $ 702 Sales and marketing 76 125 152 233 General and administrative 260 347 485 593 $ 617 $ 847 $ 1,179 $ 1,528 21-------------------------------------------------------------------------------- Table of Contents Three Months Ended June 30, Six Months Ended June 30, 2013 2014 2013 2014 Revenue 100 % 100 % 100 % 100 % Costs and operating expenses: Cost of revenue (1) 52 54 53 55 Research and development (1) 27 29 25 30 Sales and marketing 8 10 8 9 General and administrative (1) 11 14 11 13 Depreciation 4 5 4 4 Gain on sale of domain - (4 ) - (2 ) Total costs and operating expenses 103 109 101 109 Loss from operations (3 ) (9 ) (1 ) (9 ) Other (expense) income - - - - Interest expense - - - - Loss before income taxes and equity interest (4 ) (9 ) (2 ) (9 ) Benefit for income taxes (1 ) (3 ) - (3 ) Loss in equity interest - (1 ) - (1 ) Net loss (3 ) (8 ) (1 ) (8 ) Net loss attributable to noncontrolling interests - - - - Net loss attributable to Synacor, Inc. (2 )% (8 )% (1 )% (8 )% Note: (1) Exclusive of depreciation shown separately. Comparison of the Three and Six Months ended June 30, 2013 and 2014 Revenue Six Months Ended Three Months Ended June 30, June 30, 2013 2014 % Change 2013 2014 % Change (in thousands) (in thousands) Revenue: Search and display advertising $ 21,399 $ 18,521 (13 )% $ 45,485 $ 38,429 (16 )% Subscriber-based 5,309 5,670 7 10,366 11,010 6 Total revenue $ 26,708 $ 24,191 (9 ) $ 55,851 $ 49,439 (11 ) Percentage of revenue: Search and display advertising 80 % 77 % 81 % 78 % Subscriber-based 20 23 19 22 Total revenue 100 % 100 % 100 % 100 % Three months ended 2013 compared to 2014. Revenue decreased by $2.5 million, or 9%, compared to the same period in 2013. Search revenue decreased by $2.6 million. We believe a material portion of the decrease was due to the placement of our start experiences on the second tab of the default Windows 8 Internet browser by our consumer electronics customers. In addition, and to a lesser extent, we believe the decrease was due to lower search activity associated with the increased usage of other devices such as tablets and smartphones generally across the consumer base. Display advertising revenue decreased by $0.3 million as a result of one of our customer's implementation of more secure webmail, which affected our ability to insert display advertising on that customer's webmail site, and operational changes in practices and policies for display advertising. Subscriber-based revenue increased $0.4 million, or 7% compared to the same period in 2013 mainly due to growth in adoption of our TV Everywhere service by our customers. Six months ended 2013 compared to 2014. Revenue decreased by $6.4 million, or 11%, compared to the same period in 2013. Search revenue decreased by $5.4 million. We believe a material portion of the decrease was due to the placement of our start experiences on the second tab of the default Windows 8 Internet browser by our consumer electronics customers. In addition, and to a lesser extent, we believe the decrease was due to lower search activity associated with the increased usage of other devices such as tablets and smartphones generally across the consumer base. Display advertising revenue decreased by $1.6 million as a result of pricing changes in one of our customer contracts, anot 22-------------------------------------------------------------------------------- Table of Contents her customer's implementation of more secure webmail, which affected our ability to insert display advertising on that customer's webmail site, and operational changes in practices and policies for display advertising. Subscriber-based revenue increased $0.6 million, or 6% compared to the same period in 2013 mainly due to growth in adoption of our TV Everywhere service by our customers. Cost of Revenue Six Months Ended Three Months Ended June 30, June 30, 2013 2014 % Change 2013 2014 % Change (in thousands) (in thousands) Cost of revenue $ 14,017 $ 13,146 (6 )% $ 29,781 $ 27,022 (9 )% Percentage of revenue 52 % 54 % 53 % 55 % Three months ended 2013 compared to 2014. Our cost of revenue decreased by $0.9 million, or 6% for the three months ended June 30, 2014 compared to the same period in 2013. The decrease in our cost of revenue was driven by a decrease in revenue-sharing costs due to decreased search and display advertising. Cost of revenue as a percentage of revenue increased slightly, from 52% to 54%, due to certain fixed costs. Six months ended 2013 compared to 2014. Our cost of revenue decreased by $2.8 million or 9% for the six months ended June 30, 2014 compared to the same period in 2013. The decrease in our cost of revenue was driven by a decrease in revenue-sharing costs due to decreased search and display advertising. Cost of revenue as a percentage of revenue increased slightly, from 53% to 55%, due to certain fixed costs. Research and Development Expenses Six Months Ended Three Months Ended June 30, June 30, 2013 2014 % Change 2013 2014 % Change (in thousands) (in thousands) Research and development $ 7,336 $ 7,120 (3 )% $ 14,201 $ 14,612 3 % Percentage of revenue 27 % 29 % 25 % 30 % Three months ended 2013 compared to 2014. Research and development expenses decreased by $0.2 million, or 3%, compared to 2013. Six months ended 2013 compared to 2014. Research and development expenses increased by $0.4 million, or 3%, compared to 2013. The fluctuation in each period is primarily due to employee-related costs as a result of changes in headcount that support new product initiatives, maintenance of current products and services, and infrastructure. Sales and Marketing Expenses Six Months Ended Three Months Ended June 30, June 30, 2013 2014 % Change 2013 2014 % Change (in thousands) (in thousands) Sales and marketing $ 2,147 $ 2,457 14 % $ 4,277 $ 4,594 7 % Percentage of revenue 8 % 10 % 8 % 9 % Three months ended 2013 compared to 2014. Sales and marketing expenses increased by $0.3 million or 14% compared to 2013. Six months ended 2013 compared to 2014. Sales and marketing expenses increased by $0.3 million or 7% compared to 2013. The increase in each period is primarily due to an investment in market research with a third party consultant during the second quarter of 2014. 23-------------------------------------------------------------------------------- Table of Contents General and Administrative Expenses Six Months Ended Three Months Ended June 30, June 30, 2013 2014 % Change 2013 2014 % Change (in thousands) (in thousands) General and administrative $ 2,957 $ 3,499 18 % $ 6,101 $ 6,598 8 % Percentage of revenue 11 % 14 % 11 % 13 % Three months ended 2013 compared to 2014. General and administrative expenses increased by $0.5 million or 18% compared to 2013. Six months ended 2013 compared to 2014. General and administrative expenses increased by $0.5 million or 8% compared to 2013. The increase in each period is due to increases in legal and professional fees and costs associated with the Company's transition to a new CEO. Depreciation Three Months Ended June 30, Six Months Ended June 30, 2013 2014 % Change 2013 2014 % Change (in thousands) (in thousands)Depreciation $ 1,138 $ 1,117 (2 )% $ 2,268 $ 2,175 (4 )% Percentage of revenue 4 % 5 % 4 % 4 % The decrease in depreciation was nominal for the three months ended June 30, 2014 compared to the three months ended June 30, 2013. Depreciation for the six months ended June 30, 2014 decreased $0.1 million, or 4% compared to 2013. This minor decrease was primarily driven by the timing of purchases of assets such as computer equipment and development costs to support our investment in new projects, as well as timing of new projects being placed into service. Gain on sale of domain Three Months Ended June 30, Six Months Ended June 30, 2013 2014 % Change 2013 2014 % Change (in thousands) (in thousands) Gain on sale of domain $ - $ 1,000 100 % $ - $ 1,000 100 % Percentage of revenue - % 4 % - % 2 % The gain on sale of domain amounted to $1.0 million for the three and six months ended June 30, 2014, which was equal to the sale price. The sale was unique to the second quarter of 2014 and no such transactions occurred in the comparative periods. Other (expense) income Three Months Ended June 30, Six Months Ended June 30, 2013 2014 % Change 2013 2014 % Change (in thousands) (in thousands) Other (expense) income $ (8 ) $ 6 175 % $ (15 ) $ 14 193 % Our other (expense) income consists mainly of interest income coupled with foreign currency transaction losses related to our international operations. 24-------------------------------------------------------------------------------- Table of Contents Interest Expense Three Months Ended June 30, Six Months Ended June 30, 2013 2014 % Change 2013 2014 % Change (in thousands) (in thousands) Interest expense $ 43 $ 23 (47 )% $ 101 $ 111 10 % Our interest expense consists mainly of interest due on our capital lease obligations, for which the fluctuation in the three and six months ended June 30, 2014 to the comparative periods is nominal. Benefit for Income Taxes Three Months Ended June 30, Six Months Ended June 30, 2013 2014 % Change 2013 2014 % Change (in thousands) (in thousands) Benefit for income taxes $ 204 $ 641 214 % $ 186 $ 1,325 612 % Our income tax benefit increased for both the three and six month periods ended June 30, 2013 and June 30, 2014. The increase in deferred tax benefit for each period is attributable to increases in our taxable losses for the corresponding periods. Loss in Equity Interest Three Months Ended June 30, Six Months Ended June 30, 2013 2014 % Change 2013 2014 % Change (in thousands) (in thousands) Loss in equity interest $ - $ (344 ) (100 )% $ - $ (590 ) (100 )% In 2013 we entered into a Joint Venture Agreement pursuant to which we own 50% of the outstanding common stock and 100% of the preferred shares of Synacor China, Ltd., or the JV Company. For the three and six months ended June 30, 2014, we recorded our share of the losses of the JV Company of $0.3 million and $0.6 million, respectively. Liquidity and Capital Resources Our primary liquidity and capital resource requirements are for financing working capital, investing in capital expenditures such as computer hardware and software, supporting research and development efforts, introducing new technology, enhancing existing technology and marketing our services and products to new and existing customers. To the extent that existing cash and cash equivalents, cash from operations and cash from short-term borrowings are insufficient to fund our future activities, we may need to raise additional funds through public or private equity offerings or debt financings. In September 2013, we entered into a Loan and Security Agreement, or Loan Agreement, with Silicon Valley Bank, or Lender. The Loan Agreement provides for a $10.0 million secured revolving line of credit with a stated maturity of September 27, 2015. The credit facility is available for cash borrowings, subject to a formula based upon eligible accounts receivable. As of June 30, 2014, due to the operation of the borrowing formula, $7.2 million was available under the revolving credit line, with no outstanding borrowings. Borrowings under the Loan Agreement bear interest, at our election, at an annual rate of either 0.50% above the "prime rate" as published in The Wall Street Journal or LIBOR for the relevant period plus 3.00%. For LIBOR advances, interest is payable (i) on the last day of a LIBOR interest period or (ii) on the last day of each calendar quarter. For prime rate advances, interest is payable (a) on the first day of each month and (b) on each date a prime rate advance is converted into a LIBOR advance. We paid a commitment fee of $50,000 upon the closing of the facility, and must pay quarterly, in arrears, an unused facility fee of 0.50% per annum of the average unused portion of the facility (as determined by the Lender). Additionally, if we terminate the facility prior to the first anniversary of the effective date, we must pay the Lender a termination fee of $100,000 unless the facility is replaced with a new facility from the Lender. 25-------------------------------------------------------------------------------- Table of Contents Our obligations to the Lender are secured by a first priority security interest in all our assets, including our intellectual property. The Loan Agreement contains customary events of default, including non-payment of principal or interest, violations of covenants, material adverse changes, cross-default, bankruptcy and material judgments. Upon the occurrence of an event of default, the Lender may accelerate repayment of any outstanding balance. The Loan Agreement also contains certain financial covenants and other agreements that are customary in loan agreements of this type, including restrictions on paying dividends and making distributions to our stockholders. As of June 30, 2014, we were in compliance with the covenants and anticipate continuing to be so. Under the terms of our joint venture agreement with the JV Company, we have agreed, upon the satisfaction of certain conditions, to provide approximately $0.5 million in additional funding to the JV Company over the remainder of the two year period following the initial investment through the purchase of non-voting, non-convertible Series A preferred shares of the JV Company. As of June 30, 2014, we had approximately $25.7 million of cash and cash equivalents and money market funds. We did not have any short-term or long-term investments. We believe that our existing cash and cash equivalents, along with cash flows from operations and availability under our revolving credit line, will be sufficient to meet our anticipated working capital, capital lease payment obligations, JV Company funding obligations and capital expenditure requirements for at least the next 12 months. |