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Edited Transcript of SYNC earnings conference call or presentation 14-Nov-17 10:00pm GMT

Q3 2017 Synacor Inc Earnings Call

Buffaclo Nov 23, 2017 (Thomson StreetEvents) -- Edited Transcript of Synacor Inc earnings conference call or presentation Tuesday, November 14, 2017 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Himesh Bhise

Synacor, Inc. - CEO, President and Director

* Matthew Wolfrom

Synacor, Inc. - VP of Corporate Communications

* William J. Stuart

Synacor, Inc. - CFO and Corporate Secretary

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Conference Call Participants

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* George Frederick Sutton

Craig-Hallum Capital Group LLC, Research Division - Partner, Co-Director of Research & Senior Research Analyst

* Laura Anne Martin

Needham & Company, LLC, Research Division - Senior Analyst

* Mark Nicholas Argento

Lake Street Capital Markets, LLC, Research Division - Head of Capital Markets & Senior Research Analyst

* Michael Patrick Graham

Canaccord Genuity Limited, Research Division - MD and Senior Equity Analyst

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Presentation

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Operator [1]

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Good afternoon. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Synacor Third Quarter 2017 Earnings Conference Call. (Operator Instructions) Mr. Matt Wolfrom, you may begin your conference.

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Matthew Wolfrom, Synacor, Inc. - VP of Corporate Communications [2]

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Thank you, and good evening. Welcome to Synacor's Third Quarter 2017 Financial Results Conference Call. Joining me today to discuss Synacor's results are CEO, Himesh Bhise; and CFO, Bill Stuart.

Before we begin, I would like to take this opportunity to remind you that during the course of this call management will make forward-looking statements, which are subject to various risks and uncertainties. Actual results may differ materially from the results predicted and reported results should not be considered as an indication of future performance. Further information on these and other factors that could affect the company's financial results is included in 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'll turn the call over to Himesh.

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Himesh Bhise, Synacor, Inc. - CEO, President and Director [3]

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Thank you, Matt, and welcome, everyone, to today's conference call. This evening, we will share with you our third quarter 2017 results. I'm pleased to report that we delivered strong financial performance, achieving our revenue and adjusted EBITDA guidance and reporting GAAP net profit. We delivered 14% year-over-year revenue growth and $1.8 million of adjusted EBITDA. Three key takeaways from the call today. First, Synacor generated significant revenue growth and increased operating leverage that grow profitability. Second, we continue to see strong market validation of Synacor products with several customer renewals and wins in the quarter. And third, I'd like to highlight our recurring revenue software platforms that serve as an excellent foundation for high-margin growth.

Let's begin with takeaway #1. Synacor generated significant revenue growth and increased operating leverage that drove profitability. Our third quarter revenue grew 14% year-over-year to $36.3 million, and adjusted EBITDA rose to $1.8 million from $0.2 million a year ago. We reported GAAP net income for the first time in nearly 4 years. Our net income was $0.3 million compared to a net loss of $3.4 million a year ago.

Importantly, along with the revenue growth, we also demonstrated operating leverage that drove profitability. Our third quarter revenue increased 14% or by about $4.5 million year-over-year, and $1.6 million of that over 1/3 drops to incremental adjusted EBITDA profitability. We expect to continue delivering strong financial growth in the fourth quarter.

Takeaway #2. We continue to see strong market validation of Synacor products with several customer renewals and wins in the quarter. We launched a new portal experience for WOW! a top 10 operator. We renewed and extended our WOW! relationship that covers portal, advertising and e-mail services. We continue to work closely with AT&T. We again delivered strong user engagement metrics, and we grew material revenue with the ATT.net portal. We added several Pay TV operators to our advanced cloud-based identity management platforms. These operators include WOW! and NorthwesTel, which is a wholly owned subsidiary of Bell Canada. We added to a growing list of e-mail customers in the enterprise and government markets. These include a Southeast Asia Government Ministry and India government research lab and an Africa government information technology authority.

And we added over 50 channel partners certified to sell Synacor enterprise products, growing the existing base to more than 1,900 partners around the world.

And now, let me turn the call over to Bill, to share our financial results in more detail, before I close with the third takeaway regarding our recurring revenue software platforms. Bill?

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William J. Stuart, Synacor, Inc. - CFO and Corporate Secretary [4]

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Thank you, Himesh. Before I discuss our results, I wanted to remind everyone that our non-GAAP financial measures exclude stock-based compensation expenses. Please refer to our press release and SEC filings for the GAAP to non-GAAP reconciliations.

In the third quarter of 2017, Synacor delivered revenue of $36.3 million, meeting the company's financial guidance, an increase of 16% over the second quarter of 2017 and 14% over the third quarter of 2016. Our adjusted EBITDA was $1.8 million, also meeting guidance. As Himesh noted, we were GAAP profitable for the first time in nearly 4 years with net income of $300,000.

Looking more closely at the different components of our revenue. Search revenue was $6.1 million, up from $3.3 million in the prior year third quarter and $5 million in the second quarter. Advertising revenue was $16.6 million versus $15.2 million in the third quarter of 2016, and $13 million in the second quarter of this year.

Recurring and fee-based revenue was $13.6 million versus $13.2 million in the same quarter last year and $13.2 million in the second quarter. Cost of revenue was 49% versus 46% in the third quarter a year ago. This resulted in an implied gross margin of 51% in the third quarter of 2017.

Total operating expenses, excluding stock-based compensation of $605,000 in depreciation and amortization of $2.6 million were $16.8 million for the third quarter or 46% of revenue compared with $16.9 million or 53% of revenue in the same period last year, which reinforces Himesh's earlier point regarding increased operating leverage in the business. As a percentage of revenue and excluding stock-based compensation expense, depreciation and amortization, technology and development expenses were 18%, sales and marketing expenses were 17% and G&A expenses were 12%.

Synacor's GAAP net income was $300,000 or $0.01 per share. As Himesh mentioned, this was the first profitable quarter since Q4 of '13. This compares with a net loss of $3.4 million or $0.11 per share in the third quarter of 2016, and a net loss of $3.3 million or $0.09 per share in the second quarter of 2017. Net income includes $2.6 million in depreciation and amortization in the third quarter of 2017 versus $2.4 million in the third quarter of 2016, and stock-based compensation expense of $605,000 or $0.02 per share in the third quarter of '17 compared with $680,000 or $0.02 per share in the third quarter of 2016.

The net income in the third quarter of 2017 includes a $1.9 million gain on the sale of an investment. The EPS calculation for the third quarter of 2017 and third quarter of 2016 is based on 39.9 million fully diluted and 38.3 million weighted average common shares outstanding, respectively.

Adjusted EBITDA was $1.8 million, which as noted met our guidance range and was significantly improved from $0.2 million a year ago and $0.2 million in the second quarter. The reconciliation of GAAP net income to adjusted EBITDA is included in our earnings release.

We ended the quarter with $22.9 million in cash and cash equivalents compared to the $23 million at the prior quarter end. Based on information available as of today, November 14, we are providing financial guidance for the fourth quarter of 2017. For the fourth quarter, we expect revenue within the range of $46 million to $51 million, net income of negative $1.8 million to $0.5 million, and adjusted EBITDA of $2 million to $4 million. Adjusted EBITDA excludes stock-based compensation expense of $600,000 to $700,000, depreciation and amortization of $2.6 million to $2.8 million, and tax interest expense and other income and expense were approximately $300,000. We expect approximately 39 million weighted average shares outstanding in the fourth quarter.

We expect revenue and adjusted EBITDA for the full year to be within the previously reported ranges and revenue narrowed to $140 million to $145 million, and for adjusted EBITDA a range of $0.8 million to $2.8 million. We expect a net loss of $9.1 million to $11.4 million for 2017. Adjusted EBITDA excludes stock-based compensation expense of $2.5 million to $2.6 million, depreciation and amortization of $9.6 million to $9.8 million, gain on investment of $1.9 million and tax interest expense, capitalized software impairment, gain on investment and other income and expense of approximately $1.7 million.

Himesh?

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Himesh Bhise, Synacor, Inc. - CEO, President and Director [5]

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Thank you, Bill. Synacor is delivering solid growth. We are executing our 4-pillar growth strategy, increasing value for our current customers; innovating on our product platforms; winning new customers; and extending into international and enterprise markets, which brings me to takeaway #3. Our recurring revenue software platforms serve as an excellent foundation for high-margin growth. Synacor's fee-based revenue was $13.6 million in Q3, and represented 37% of our total revenue in the quarter. Software and services primarily includes our Zimbra branded e-mail and collaboration platform, a leading open source-based e-mail platform that powers about 500 million mailboxes worldwide; and Cloud ID, our cloud-based identity management platform, a leading single sign-on platform that can authenticate about 90 million Pay TV households in the U.S. Our fee-based business grew 3% year-over-year, but we believe this is a platform that can grow more significantly. These software platforms add strength to Synacor's overall business. We believe we are well positioned in the market and we are investing in product and sales.

Our customers are diversified across 100 service providers and 3,500 enterprises and government organizations around the world. Sales leverage a growing channel network and asset of more than 1,900 value-added resellers and hosting providers. And over 90% of this fee-based revenue is recurring and it is high margin.

As we move into the balance of 2017 and look ahead to 2018, we are excited by our growth prospects. We look forward to reporting further progress when we speak with you on our year-end call in March. We'll now open the line to your questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of George Sutton from Craig-Hallum.

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George Frederick Sutton, Craig-Hallum Capital Group LLC, Research Division - Partner, Co-Director of Research & Senior Research Analyst [2]

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I wondered if you could talk about your stated goal of $300 million, $330 million in 3 years. That wasn't talked about on tonight's call, I just want to make sure that is still part of the presentation.

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Himesh Bhise, Synacor, Inc. - CEO, President and Director [3]

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Perfect. Thanks for the question, George. $330 million, $300 million still remains our goal. As I think about it, and, I guess, what you're asking for is the real -- the primary variables that really determine how we get there. I think there are 3 of them. One, AT&T still has a potential to be $100 million opportunity. Clearly, that depends on AT&T's business priorities and how they need to balance engagement and monetization.

Second, as we talked about on this call and we mentioned before, we have a strong pipeline of organic growth opportunities through our core portal advertising e-mail, video businesses. And as you know, larger opportunities have longer sales cycles. So sitting here today it's hard to predict exactly when these will pop. But clearly, we're excited about our organic sales pipeline. And finally, disciplined M&A that accelerates our growth strategy plays a role in achieving our goal. And our acquisitions to date, when I think about Zimbra and Technorati, they've both been successful, and this gives us the confidence to pursue additional opportunities. So while we will have the $330 million, $300 million goal in mind everyday as we operate the business, we will continue to provide the quarterly and annual guidance on these calls as we typically do.

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George Frederick Sutton, Craig-Hallum Capital Group LLC, Research Division - Partner, Co-Director of Research & Senior Research Analyst [4]

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Right. And I wondered if you could just give us any sense of a timeline from the AT&T side in terms of their potential interest in focusing more on monetization?

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Himesh Bhise, Synacor, Inc. - CEO, President and Director [5]

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George, we continue to have an excellent relationship with AT&T. We're working together to build consumer engagement on ATT.net, which is AT&T's current focus. And those consumer engagement efforts are going well, and we do expect increased monetization in 2018.

We're excited by the potential of a long-term relationship with AT&T, and we will monetize the platform in line with their goals.

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George Frederick Sutton, Craig-Hallum Capital Group LLC, Research Division - Partner, Co-Director of Research & Senior Research Analyst [6]

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Perfect, if I could just lastly relative to the M&A strategy. Are there the Zimbras and Technoratis out there and by those, I mean, pretty big cloud names who have had a lot of investment put in them, but are available for a relatively small price?

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Himesh Bhise, Synacor, Inc. - CEO, President and Director [7]

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We believe so, George, and we hope so, and we've been clearly talking to a lot of companies that could accelerate our efforts in video, in advertising, and can leverage, I think, the platform and credibility we have built, whether that's channel-based, leveraging our partner network or cloud-based, leveraging our operating scale. So I'm certainly excited by the prospect that those companies exist. Clearly, again, a lot of things have to fall in place as it relates to M&A. And I think as you know from our track record, we tend to be very disciplined about this and clearly, anything we look at got to help accelerate our growth.

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Operator [8]

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

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Laura Anne Martin, Needham & Company, LLC, Research Division - Senior Analyst [9]

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Maybe first is, could you give us a little more granularity on the $1.9 million gain, please? What is that?

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William J. Stuart, Synacor, Inc. - CFO and Corporate Secretary [10]

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That was an investment that we had made a few years ago for $1 million in the company that did business under the name, The Experience Engine. And the premise behind that was they brought experience in dealing with connecting customers to mobile devices. So it was an opportunity to build on that relationship. And they were acquired by a company called accesso in the U.K. and that generated a gain of about $2 million. We got $2.6 million in cash and stock this quarter, in the third quarter that is. And we also would have there's additional approximately $0.5 million that would be payable in 18 months.

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Laura Anne Martin, Needham & Company, LLC, Research Division - Senior Analyst [11]

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Okay. That's like the earn-out or whatever. Okay.

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William J. Stuart, Synacor, Inc. - CFO and Corporate Secretary [12]

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Yes, now it's actually a holdback. A typical thing like this with the private company is holdback by for indemnification claims. So we've discounted that. The net of all of that is it represents a $1.9 million gain that we recognized in the third quarter.

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Laura Anne Martin, Needham & Company, LLC, Research Division - Senior Analyst [13]

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So we shouldn't expect to see the other $500,000 in 18 months. You already put that this into this number, discounted that?

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William J. Stuart, Synacor, Inc. - CFO and Corporate Secretary [14]

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Well, yes. In terms of any recognizable gain, that could change between now and then, but the cash would actually be -- if it's to be paid, it would be paid in 18 months.

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Laura Anne Martin, Needham & Company, LLC, Research Division - Senior Analyst [15]

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Okay, cool. And then your gross margins went from 54% to 51% year-over-year and yet a lot of our -- I think a lot our growth is coming from these cloud services and Zimbra, which have higher margins. So I'm curious as to why we have a 300 basis point decline in gross margins year-over-year?

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Himesh Bhise, Synacor, Inc. - CEO, President and Director [16]

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So Laura, this quarter, our search and advertising business grew by about 23% year-over-year. And as you know, that tends to be lower margin. And so given the preponderance of that revenue and the fact that AT&T revenues started ramping up as well, we kind of saw a pretty high revenue growth from typically lower gross margin revenue line. Our fee-based business grew 3%, so less obviously, even though exactly as you say, it has very high margin, 90% of it is recurring, it's a strong foundation. And as we accelerate growth in that, which we are hoping to do based on the investments we're making, it will have the margin -- positive margin impact that you're describing.

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Laura Anne Martin, Needham & Company, LLC, Research Division - Senior Analyst [17]

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Okay, cool. And then one of the awesome things about the AT&T deal was they gave you mobile capability. Have you got any new clients as a result of that extra excellence and credibility now on the mobile side?

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Himesh Bhise, Synacor, Inc. - CEO, President and Director [18]

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So it has certainly been extremely helpful for us, as we have renewed and extended current deals. And I think we've been announcing those along the way. Material larger new customers that are in our pipeline just tends to have longer sales cycle and those things started kicking of this year. And so we're optimistic, but nothing to report today.

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Laura Anne Martin, Needham & Company, LLC, Research Division - Senior Analyst [19]

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Okay. And then my last question is just an observation. So you renewed WOW! and it sounds like that was also an expansion into some new services in addition to renewal, right?

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Himesh Bhise, Synacor, Inc. - CEO, President and Director [20]

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Yes.

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Laura Anne Martin, Needham & Company, LLC, Research Division - Senior Analyst [21]

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Okay. And then my -- and so in all the rest of the new business that I think you talked about in your prepared remarks were offshore, and so I'm wondering about the economics of offshore deals and what you're selling offshore versus the U.S. deals?

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Himesh Bhise, Synacor, Inc. - CEO, President and Director [22]

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Our international business today is almost entirely our Zimbra-based e-mail and collaboration platform. So our -- and it's sold through our partner network, again, largely speaking. So those are the kinds of deals we're talking about. Each individual deal tends to be pretty small, but overall they are software-based deals with high margins.

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Operator [23]

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Your next question comes from the line of Michael Graham from Canaccord.

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Michael Patrick Graham, Canaccord Genuity Limited, Research Division - MD and Senior Equity Analyst [24]

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I just want to ask a couple. First on AT&T. Maybe just an update in terms of, I think, last quarter you had talked about how there were certain types of ads that were on some of your other portals, I think down towards the bottom of the pages where those were some of the ads that were deemed to be, may be favoring monetization over engagement. And therefore, the emphasis on engagement precipitated the need to kind of take some of those ads out. I was just wondering, you mentioned in the press release that engagement from AT&T was improving. Can you put in more color around that, like are there goals in place or targets where everyone will feel more comfortable with increased monetization? And can you just give us an update in terms of like how the discussion is going in terms of possibly adding new ads units or just anything else you can share on that front?

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Himesh Bhise, Synacor, Inc. - CEO, President and Director [25]

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Thanks for the question, Michael. I will reiterate that our relationship with AT&T is really strong. And I think as we talked about on the last call and for your question today, there are different facets of what it means to operate a portal in concept with them. Clearly, as you've stated, their goal is engagement, which is captured by metrics like time spent per visit on the site by customer satisfaction scores and kind of the kinds of traffic that they can drive, and then clearly there is levels of monetization based on many units.

The teams work extremely closely together on an hourly and daily basis. They are tied at the hip. And so are closely monitoring all of those metrics. The specific metrics are obviously AT&T's proprietary metrics for them to share directly, which I cannot. But I could speak to the fact that things like customer satisfaction, things like customer engagement are all trending extremely positive, and as a combined team, we are proud of what we've accomplished. That is still the priority for AT&T, even though we believe there is upsides to be had in the future. The specific monetization examples, I mean, the kinds of things we've talked about are the number of paid content modules on the page and where you locate them. The total amount of advertising inventory, whether there is an opportunity for another 350 units just to make something up or adding something in an article page or using video to drive more engagement and more monetization, the kinds of programmatic portals we use to define the quality and the type of advertising that we actually serve on the page. And all of these things are things that we are engaging in discussion with them. They are very positively received. I think it is -- I think monetization helps both AT&T and Synacor, clearly. But at the end of the day, we anticipate a long and fruitful relationship with AT&T and have to follow their lead on how they balance engagement and monetization.

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Operator [26]

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Your next question comes from the line of Mark Argento from Lake Street Capital.

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Mark Nicholas Argento, Lake Street Capital Markets, LLC, Research Division - Head of Capital Markets & Senior Research Analyst [27]

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Just wanted to drill down a little bit more on some potential growth opportunities on the more recurring revenue side. Zimbra apparently is performing well. Cloud ID, could you drill down a little bit as to how fast that business is growing. Obviously with the move to OTT and CTV, the opportunity to grow that business more aggressively. Maybe you could help us think through that little bit.

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Himesh Bhise, Synacor, Inc. - CEO, President and Director [28]

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Sure. Mark, thank you for the question. And clearly, to your point, we today bundle Cloud ID and Zimbra into the fee-based revenue line item in our report. So let me speak to it at the aggregate level, and then provide, maybe some of the texture you're looking for in terms of growth opportunities we see across both of those areas.

What I wanted to convey during the call, just to recap a little bit, is that these software platform businesses provided really strong foundation for us as a company, right? They delivered $13.6 million of revenue. It was 38% of our overall revenue. Over 90% of it is recurring and it's high margin. And that to me is a quality of business and size of revenue stream that is comparable with many of the mid cap, small cap software vendors and companies that exist today.

So just this piece of our business, I believe, compares very favorably with many other companies that we've seen in the market, that serve enterprise markets.

The reason we believe that we can drive accelerated growth is because we have been declaring wins in the area. We've been declaring wins, we talked about several new advanced Cloud ID wins in the service provider space, and we announced several new enterprise wins and government wins for Zimbra around the world. You kind of pair that with the fact that we continue to invest in the channel. So 1,900 partners worldwide selling our products, I consider to be a really strong asset that we can leverage in many ways. And what we have been doing this year is continue to invest in each of these product lines. We've been driving things like hardening APIs and building microservices to drive a faster pace of innovation, kind of leveraging the open source community. We've been focused on things like configurability and scalability, as we take things like data access and security really seriously, and believe it's a strong way we differentiate these products.

So going forward, we feel there is an opportunity for Zimbra in areas like open source and kind of growing enterprise presence, growing cloud base presence. We believe there are opportunities in identity management to continue to serve Pay TV operators really well, to expand into the programmer and the content provider space, building on what we've done with HBO. And certainly, there are much broader applications for single sign-on that we are beginning to explore. So again, an area that is contributing strong margins today, contributing strong recurring revenues today. The growth is about 3%, so not bad, but certainly, we have higher aspirations.

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Mark Nicholas Argento, Lake Street Capital Markets, LLC, Research Division - Head of Capital Markets & Senior Research Analyst [29]

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Got it. You guys do business with Roku or any of the other, kind of, OTT platforms? Obviously, Roku has been on a tear recently given the results and the demand that they are seeing for their products and the move to cord cutting. How much exposure, if any, do you guys have there any of the -- kind of the OTT platforms at this point, not just the HBO guys, but guys who are on the actual platform like a Roku?

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Himesh Bhise, Synacor, Inc. - CEO, President and Director [30]

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Got it. Single sign-on across content providers on "TV-based hardware platforms" is a really strong application of our Cloud ID platform. And we are approaching that very broadly. The one that we have talked about before in the past and is us being able to enable single sign-on on Apple TV and Apple's platform for several Pay TV operators today. So that's a direct visible public application of what we can do, but you can generalize that used case across hardware platforms.

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Mark Nicholas Argento, Lake Street Capital Markets, LLC, Research Division - Head of Capital Markets & Senior Research Analyst [31]

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All right. Got it. And then just last, back on AT&T. So obviously, you guys made a pretty significant investment both in monetary time, opportunity cost, capital. Do you guys -- in that agreement, is there any kind of minimum? So you guys don't get "hold my bag here" just because the AT&T wants to roll slower, they have other priorities now? Is there any kind of true-ops of minimums or how do we -- how should we feel about opportunity that actually turn that from an ROI negative to reach a breakeven or positive over the next 6 to 12 months?

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Himesh Bhise, Synacor, Inc. - CEO, President and Director [32]

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Right. You should believe and expect that we are already driving margins from our AT&T business. I mean, that should be a reasonable assumption that you can make based on the incremental revenues we are driving and that we operate the business thoughtfully.

The specifics of it, obviously, are kind of really dependent on how AT&T kind of manages their business and draws a balance between engagement and monetization. So I think it's reasonable for you to expect that at certain levels around where we are today, we are profitable. And as the business kind of gets closer to the $100 million mark that we all are aspiring to, there is significant upside for us when we get there.

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Operator [33]

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There are no further questions at this time. I will turn the call over to Himesh Bhise for closing remarks.

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Himesh Bhise, Synacor, Inc. - CEO, President and Director [34]

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Thank you, operator, and thank you, everyone, for being on the call. I look forward to updating you again on our next quarterly earnings call. But in the meantime, we hope to see some of you at the Craig-Hallum Alpha Select Conference in New York on Thursday. Thank you and have a good evening.

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Operator [35]

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This concludes today's conference call. You may now disconnect.