As filed with the Securities and Exchange Commission on August 2, 2007.

Registration No. 333-          

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

 

 

SYNACOR, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

40 La Riviere Drive, Suite 300

Buffalo, NY 14202

(716) 853-1362

(Address, including zip code and telephone number, including area code, of registrant’s principal executive offices)

 

 

 

 

Ron Frankel

President and Chief Executive Officer

40 La Riviere Drive, Suite 300

Buffalo, NY 14202

(716) 853-1362

(Name, address, including zip code and telephone number, including area code, of agent for service)

 

 

 

Copies to:

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

 

 

 

 

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, as amended, check the following box.  o

 

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of earlier effective registration statement for the same offering.  o

 

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o

 

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o

 

 

CALCULATION OF REGISTRATION FEE

 

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 

 

 

Subject to Completion, Dated          , 2007

 

Synacor, Inc.

 

 

 

		Per Share				Total
Public offering price		$				$
Underwriting discounts and commissions		$				$
Proceeds, before expenses, to Synacor, Inc.		$				$

Thomas Weisel Partners LLC

Canaccord Adams

Montgomery & Co., LLC

 

PROSPECTUS SUMMARY

	•	Enhance our technology platform;
	•	Increase subscriber penetration of paid and packaged online services and products;
	•	Increase usage and revenue from traffic generated by our services and products;
	•	Broaden our customer base;
	•	Expand our international operations; and
	•	Increase support for new digital platforms and technologies.

	•	We have a limited operating history and may not be able to achieve operational or financial success;
	•	We have a history of significant net losses and may not be profitable in future periods;
	•	Any loss of, or diminution in, our business relationship with Google could materially and adversely affect our financial performance;

	•	A loss of any significant customer could negatively affect our financial performance;
	•	Our business could suffer if we do not continue to obtain high-quality content at a reasonable cost;
	•	The loss of key officers or an inability to attract and retain qualified personnel could harm our business; and
	•	We may not effectively manage growth in our business.

Common stock offered by Synacor		shares
Common stock to be outstanding after this offering		shares
Use of proceeds		We intend to use the net proceeds from this offering for working capital and other general corporate purposes. We may also use a portion of the net proceeds to acquire other businesses, products or technologies. We do not have agreements or commitments for any specific acquisitions at this time. See “Use of Proceeds.”
Dividend policy		We do not anticipate paying cash dividends for the foreseeable future. See “Dividend Policy.”
Proposed Nasdaq Global Market symbol		SYNC

	•	2,354,720 shares of common stock issuable upon exercise of options outstanding as of March 31, 2007 at a weighted average exercise price of $0.94 per share;
	•	598,292 shares of common stock issuable upon exercise of warrants outstanding as of March 31, 2007 at an exercise price of $1.17 per share;
	•	11,032 shares of common stock reserved as of March 31, 2007 for future grant under our 2000 Stock Plan;
	•	587,897 shares of common stock reserved as of March 31, 2007 for future grant under our 2006 Stock Plan; and
	•	shares of common stock reserved for future issuance under our 2007 Equity Incentive Plan, which will become effective on the effective date of the registration statement of which this prospectus is a part.

	•	the automatic conversion of all outstanding shares of our preferred stock into 11,596,759 shares of common stock concurrently with the closing of the offering;
	•	the filing of our amended and restated certificate of incorporation and the adoption of our amended and restated bylaws immediately prior to the closing of this offering; and
	•	no exercise by the underwriters of their option to purchase up to an additional           shares from Synacor in the offering.

														Three Months Ended
		Year Ended December 31,												March 31,
		2004				2005				2006				2006				2007
														(unaudited)
		(in thousands except share and per share data)
Consolidated Statements of Operations Data:
Net sales		$	2,385			$	14,340			$	26,327			$	5,866			$	8,677
Costs and expenses:
Cost of sales(1)			1,244				7,781				15,327				3,453				5,116
Research and development			1,361				2,615				4,274				990				1,359
Sales and marketing			1,400				2,214				3,939				714				1,655
General and administrative(1)			1,122				2,299				4,679				913				1,230
Depreciation and amortization			191				177				465				78				273
Total costs and expenses			5,318				15,086				28,684				6,148				9,633
Loss from operations			(2,933	)			(746	)			(2,357	)			(282	)			(956	)
Loss on extinguishment of debt			—				—				(32	)			—				—
Other income			27				93				279				22				180
Interest expense			(77	)			(117	)			(132	)			(37	)			(44	)
Loss before income taxes			(2,983	)			(770	)			(2,242	)			(297	)			(820	)
Provision for income taxes			—				—				14				—				—
Net loss		$	(2,983	)		$	(770	)		$	(2,256	)		$	(297	)		$	(820	)
Net loss per common share, basic and diluted		$	(36.27	)		$	(9.20	)		$	(18.83	)		$	(3.39	)		$	(4.32	)
Weighted average number of common shares outstanding — basic and diluted			82,260				83,630				119,815				87,582				189,948

(1)	Exclusive of depreciation and amortization shown separately.

	•	on an actual basis;
	•	on a pro forma basis to give effect to the automatic conversion of all outstanding shares of preferred stock into common stock concurrently with the closing of this offering; and
	•	on a pro forma as adjusted basis to give effect to (i) the conversion of all outstanding shares of preferred stock into common stock concurrently with the closing of the offering and (ii) the receipt of the estimated net proceeds from the sale of           shares of common stock offered by us in this offering at an assumed initial public offering price of $      , which is the midpoint of the range of the initial public offering price listed on the cover page of this prospectus, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us, and the filing of our amended and restated certificate of incorporation immediately prior to the closing of this offering.

										As of
										March 31,
										2007
										(unaudited)
		As of																Pro
		December 31,												Pro				Forma As
		2005				2006				Actual				Forma				Adjusted
		(in thousands)
Consolidated Balance Sheet Data:
Cash and cash equivalents		$	2,721			$	15,293			$	12,711			$	12,711
Trade receivables, net			2,067				4,102				4,872				4,872
Property and equipment, net			1,190				4,315				5,040				5,040
Total assets			6,243				24,212				23,565				23,565
Long-term notes payable and capital lease obligations			934				1,297				1,522				1,522
Convertible preferred stock			11,187				28,432				28,432				—
Total stockholders’ equity			2,554				17,608				16,820				16,820

 

Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors and all other information contained in this prospectus before deciding to invest in our common stock. If any of the following events actually occur or risks actually materialize, our business, financial condition or results of operations could be materially and adversely affected. In that case, the trading price of our common stock could decline, and you might lose some or all of your investment.

 

Risks Related to Our Business

 

We have a limited operating history and may not be able to achieve operational or financial success.

 

We have only a limited history of generating revenues, and the future revenue potential of our business is uncertain. As a result of our short operating history, we have limited financial data that can be used to evaluate our business and assess our future prospects. Any evaluation of our business and our prospects must be considered in light of our limited operating history, which may not be indicative of future performance, and the risks and uncertainties encountered by companies in our stage of development. As an early stage company, we face increased risks, uncertainties, expenses and difficulties. To address these risks and uncertainties, we must do the following:

 

 

We may be unable to accomplish one or more of these objectives, which could cause our business to suffer. In addition, accomplishing these objectives might be very expensive, which could adversely impact our operating results and financial condition.

 

We have a history of significant net losses and may not be profitable in future periods.

 

We have incurred significant losses since inception, including a net loss of $3.0 million in 2004, a net loss of $0.8 million in 2005 and a net loss of $2.3 million in 2006. Due to increased

expenses, our net loss for the three months ended March 31, 2007 exceeded our net loss for the comparable period in 2006, and our net loss for the year ending December 31, 2007 may exceed our net loss for 2006. Our expenses will continue increasing as we implement initiatives designed to grow our business, including, among other things, the development and marketing of new services and products, licensing of content, expansion of our infrastructure, international expansion and general and administrative expenses associated with being a public company. If our revenues do not sufficiently increase to offset these expected increases in operating expenses, we will continue to incur significant losses and will not become profitable. Our revenue growth in recent periods should not be considered indicative of our future performance. In fact, in future periods, our revenues could decline. Accordingly, we may not be able to achieve profitability in the future. Any failure to achieve profitability may materially and adversely affect our business, results of operations and financial condition, as well as the trading price of our common stock.

 

Our quarterly revenues and operating results can fluctuate, and if we fail to meet or exceed the expectations of securities analysts or investors, our stock price and the value of your investment could decline substantially.

 

As a result of our limited operating history and the rapidly changing nature of the markets in which we compete, our quarterly revenues and operating results are likely to fluctuate from period to period. These fluctuations may be caused by a number of factors, many of which are beyond our control, including:

 

 

Because the market for our services and products is relatively new and rapidly changing, it is difficult to predict future financial results. For these reasons, you should not rely on period-to-period comparisons of our financial results, if any, as indications of future results. Our future operating results could fall below the expectations of securities analysts or investors and significantly reduce the trading price of our common stock. Fluctuations in our operating results will likely increase the volatility of our stock price.

 

Google accounts for a significant portion of our revenue, and any loss of, or diminution in, our business relationship with Google could materially and adversely affect our financial performance.

 

We leverage traffic on our customers’ websites to generate search and advertising revenues, a substantial portion of which are derived from text-based links to advertisers’ websites as a result of Internet searches. We have a revenue-sharing relationship with Google, under which we typically include a Google-branded search tool on customer portals. When a subscriber makes a search request using this tool, we deliver it to Google. Google returns search results to us that include advertiser-sponsored links. If the subscriber clicks on a sponsored link, Google receives payment from the sponsor of that link and shares a portion of that payment with us. We then typically share a portion of that payment with the applicable customer. Google-related revenues accounted for approximately 49.7% of our net sales in 2006 and 46.3% of our net sales in the three months ended March 31, 2007. Our agreement with Google, which was renewed in July 2006, expires in July 2008, unless we and Google mutually elect to renew it. If advertisers were to discontinue their usage of Internet search, if Google’s revenues from search-based advertising were to decrease, if our share of Google’s revenues were to be reduced, or if our agreement with Google were to be terminated for any reason or renewed on less favorable terms, our revenues could be materially and adversely affected.

 

Most of our customers are MSOs and Telcos, and consolidation within the cable and telecommunications industries, or migration of MSO and Telco subscribers from one broadband service provider to another, could adversely affect our business.

 

Our net sales from MSOs and Telcos, including our search and advertising revenue generated by the traffic on these customers’ websites, accounted for more than 83% of our net sales in 2006 and more than 81% of our net sales in the three months ended March 31, 2007. The cable and telecommunications industries have experienced consolidation over the past several years, and we expect that this trend will continue. As a result of consolidation, some of our customers may be acquired by companies with which we do not have existing relationships and which may have relationships with one of our competitors or may have the in-house capacity to perform the services we provide. As a result, such acquisitions could cause us to lose customers and the associated subscriber-based and search and advertising revenues. For example, in April 2006, Comcast Corporation, or Comcast, completed its acquisition of Susquehanna Communications, which subsequently ended its relationship with us as a customer in April 2007. In addition, in July 2006, Time Warner Cable Inc., or Time Warner, and Comcast announced that they completed the acquisition of substantially all of the assets of Adelphia Communications Corp., or Adelphia. In connection with the acquisition, we entered into a new agreement with Time Warner, under which we agreed that we will continue providing Adelphia subscribers who became Time Warner subscribers the same services that such subscribers had been receiving under our agreement with Adelphia prior to the acquisition. We refer to this agreement as the Adelphia legacy agreement. Our revenues from the traffic associated with the former Adelphia subscribers have, however, declined significantly and we expect revenues associated with this traffic to continue to decline or cease in the near term.

 

Consolidation may also require us to reduce prices as a result of enhanced customer leverage. We may not be able to offset the effects of any price reductions, and we may not be

able to expand our customer base to counter any revenue declines resulting from the loss of customers or subscribers.

 

MSO and Telco subscribers may become dissatisfied with their current broadband service provider and may switch to another provider. In the event that there is substantial subscriber migration from our existing customers to service providers with which we do not have a relationship, the fees that we receive on a per-subscriber basis, and the related search and advertising revenues generated by these customers’ websites, could decline.

 

A loss of any significant customer could negatively affect our financial performance.

 

We derive a substantial portion of our net sales from a small number of customers. When combined with the search and advertising revenue associated with traffic generated from their websites, net sales from two customers, Charter Communications Inc., or Charter, and Time Warner (pursuant to the Adelphia legacy agreement only), together accounted for approximately 45.8% of our net sales for the three months ended March 31, 2007 and approximately 53.0% of our net sales for the year ended December 31, 2006, with each of these customers accounting for more than 10.0% in each such period. Our contracts with these and other customers are generally long-term contracts, with a term of approximately two to three years. If any one of these key contracts is not renewed or otherwise is terminated, or if revenues from these significant customers decline because of competitive or other reasons, our revenues would decline and our ability to achieve or sustain profitability would be impaired. In addition to loss of subscriber-based revenues, including portal and paid content sales, we would also lose significant revenues from the related search and advertising services that we provide on these customers’ websites. We must maintain our key customer relationships, but we cannot assure you that we will be successful in doing so.

 

Our agreements with some of our customers and content providers contain penalties for non-performance and fixed payments, which could limit our ability to improve our financial performance.

 

We have entered into service level agreements with most of our customers. These agreements generally call for specific system “up times” and 24 hours per day, seven days per week support and include penalties for non-performance. We may be unable to fulfill these commitments due to circumstances beyond our control, which could subject us to substantial penalties under those agreements, harm our reputation and result in a reduction of revenues or the loss of customers, which would have an adverse effect on our business.

 

Moreover, certain of our agreements with customers and content providers require us to make fixed payments to them. The aggregate amount of such fixed payments for the years ending 2007, 2008 and 2009 are approximately $7.1 million, $6.5 million and $1.6 million, respectively. We are required to make these fixed payments regardless of the achievement of any revenue objectives or subscriber or usage levels. If we do not achieve our financial objectives, these contractual commitments would constitute a greater percentage of our revenue than originally anticipated and affect our profitability.

 

Our sales cycles in contracting with new customers are long and unpredictable, which makes it difficult to project when we will obtain new customers and when we will generate additional revenues and cash flows from those customers.

 

We market our services and products directly to broadband service providers, including MSOs, Telcos and ISPs. New customer relationships typically take time to finalize. Due to operating procedures in many organizations, a significant time period may pass between selection of our services and products by key decision-makers and the signing of a contract. The length of time between the initial customer sales call and the realization of significant

sales is difficult to predict and can range from several months to several years. As a result, it is difficult to predict when we will obtain new customers and when we will begin to generate revenues and cash flows from these potential new customers.

 

Our sales growth will be adversely affected if we are unable to expand the breadth of our services and products or to introduce new services and products on a timely basis.

 

To retain our existing customers, attract new customers and increase overall revenues, we must continue to develop and introduce new services and products on a timely basis and continue to develop additional features to our existing product base. If our existing and prospective customers do not perceive that we will deliver our services and products when we promise to do so, and if they do not perceive our services and products to be of sufficient value and quality, we may lose the confidence of our existing customer base and fail to increase sales to these existing customers, and we may not be able to attract new customers, each of which would adversely affect our operating results.

 

We rely on our management team and need additional personnel to expand our business, and the loss of key officers or an inability to attract and retain qualified personnel could harm our business.

 

We depend on the continued contributions of our senior management and other key personnel, especially Ron Frankel, our chief executive officer, Eric Blachno, our chief financial officer, George Chamoun, our senior vice president, and Ross Winston, our chief technology officer. The loss of the services of any of our executive officers or other key employees could harm our business. All of our executive officers and key employees are at-will employees, which means they may terminate their employment relationship with us at any time.

 

Our future success also depends on our ability to identify, attract and retain highly skilled technical, managerial, finance, marketing and creative personnel. We face intense competition for qualified individuals from numerous technology, marketing and media companies, and we may incur significant costs to attract them. We may be unable to attract and retain suitably qualified individuals, or we may be required to pay increased compensation in order to do so. If we are unable to attract and retain the qualified personnel we need to succeed, our business would suffer.

 

Volatility or lack of performance in the trading price of our common stock following the consummation of this offering may also affect our ability to attract and retain our key employees. Many of our senior management personnel and other key employees have become, or will become, vested in a substantial amount of stock or stock options. Employees may be more likely to leave us if the shares they own or the shares underlying their options have significantly appreciated in value relative to the original purchase prices of the shares or the exercise prices of the options, or if the exercise prices of the options that they hold are significantly above the trading price of our common stock. If we are unable to retain our employees, our business, operating results and financial condition would be harmed.

 

We depend on third parties for content that is critical to our business, and our business could suffer if we do not continue to obtain high-quality content at a reasonable cost.

 

We license the content that we aggregate on our customers’ portals from numerous third-party content providers, and our future success is highly dependent upon our ability to maintain and enter into new relationships with these and other content providers. In the future, some of our content providers may not give us access to high-quality content or may increase the royalties, fees or percentages that they charge us for their content, which could have a

material negative effect on our operating results. Our rights to the content that we offer to our customers and their subscribers are not exclusive, and the content providers could license their content to our competitors. Our content providers could even grant our competitors exclusive licenses. In addition, our customers are not prohibited from entering into content deals directly with our content providers. Any failure to enter into or maintain satisfactory arrangements with content providers would adversely affect our ability to provide a variety of interesting services and products to our customers. Our reputation and operating results could suffer as a result, and it may be more difficult for us to develop new relationships with potential customers. Our costs as a percentage of revenues may also increase due to price competition.

 

System failures or capacity constraints could harm our business and financial performance.

 

The provision of our services and products depends on the continuing operation of our information technology and communications systems. Any damage to or failure of our systems could result in interruptions in our service. Interruptions in our service could reduce our revenues and profits, and our reputation could be damaged if people believe our systems are unreliable. Our systems are vulnerable to damage or interruption from snow storms, terrorist attacks, floods, fires, power loss, telecommunications failures, computer viruses, computer denial of service attacks or other attempts to harm our systems and similar events. Our data center is also subject to break-ins, sabotage and intentional acts of vandalism and to potential disruptions if the operators of the facility have financial difficulties. Although we maintain insurance to cover a variety of risks, the scope and amount of our insurance coverage may not be sufficient to cover our losses resulting from system failures or other disruptions to our online operations. For example, the limit on our business interruption insurance is approximately $1.0 million. Any system failure or disruption and any resulting losses that are not recoverable under our insurance policies may materially harm our business, operating results and financial condition.

 

Although we regularly back-up our systems and store these system back-ups in a site located in the greater Buffalo, New York area, we do not have full second-site redundancy. If we were forced to rely on our system back-ups, we would experience significant delays in restoring the functionality of our customers’ websites and could experience loss of data, which would harm our business and our operating results.

 

Our services and products may become less competitive or even obsolete if we fail to respond to technological developments.

 

Our future success will depend, in part, on our ability to modify or enhance our services and products to meet customer and subscriber needs, to add functionality and to address technological advancements that would improve their performance. For example, if our services and products do not adapt to the increasing video usage on the Internet or to take into account evolving developments in social networking, then they could begin to appear obsolete.

 

To remain competitive, we will need to develop new services and products and adapt our existing ones to address these and other evolving technologies and standards. However, we may be unsuccessful in identifying new opportunities or in developing or marketing new services and products in a timely or cost-effective manner. In addition, our product innovations may not achieve the market penetration or price levels necessary for profitability. If we are unable to develop enhancements to, and new features for, our existing services and products or if we are unable to develop new services and products that keep pace with rapid technological developments or changing industry standards, our services and products may become obsolete, less marketable and less competitive, and our business will be harmed.

We must effectively manage growth in our business.

 

To date, we have expanded our business through organic growth. We expect to continue to grow organically, and we may also grow through strategic acquisitions in the future. This growth has placed, and may continue to place, significant demands on our management and our operational and financial infrastructure. Our ability to manage our growth effectively and to integrate new technologies and acquisitions into our existing business will require us to continue to expand our operational, financial and management information systems and to continue to retain, attract, train, motivate and manage key employees. Continued growth could strain our ability to:

 

 

Managing our growth will require significant expenditures and allocation of valuable management resources. If we fail to achieve the necessary level of efficiency in our organization as it grows, our business, operating results and financial condition would be harmed.

 

Expansion into international markets, which is an important part of our strategy, but where we have limited experience, will subject us to risks associated with international operations.

 

We plan to expand our product offerings internationally, particularly in Europe and, over the long term, in Asia and Latin America. We have limited experience in marketing and operating our services and products in international markets, and we may not be able to successfully develop our business in these markets. Our success in these markets will be directly linked to the success of relationships with potential customers, content partners and other third parties.

 

As the international markets in which we plan to operate continue to grow, competition in these markets will intensify. Local companies may have a substantial competitive advantage because of their greater understanding of and focus on the local markets. Some of our domestic competitors who have substantially greater resources than we do may be able to more quickly and comprehensively develop and grow in the international markets. International expansion may also require significant financial investment including, among other things, the expense of developing localized products, the costs of acquiring foreign companies and the integration of such companies with our operations, expenditure of resources in developing customer and content relationships and the increased costs of supporting remote operations.

 

Other risks of doing business in international markets include the increased risks and burdens of complying with different legal and regulatory standards, difficulties in managing and staffing foreign operations, recruiting and retaining talented direct sales personnel, limitations on the repatriation of funds and fluctuations of foreign exchange rates, varying levels of Internet technology adoption and infrastructure, and our ability to enforce contracts in foreign jurisdictions. In addition, our success in international expansion could be limited by barriers to international expansion such as tariffs, adverse tax consequences and technology export controls. If we cannot manage these risks effectively, the costs of doing business in some international markets may be prohibitive or our costs may increase disproportionately to our revenues.

We may expand our business through acquisitions of, or investments in, other companies or new technologies, which may divert our management’s attention or prove not to be successful.

 

Although we have no present understandings, commitments or agreements to pursue acquisitions of other businesses, we may decide to do so in the future. Future acquisitions could divert management’s time and focus from operating our business. In addition, integrating an acquired company, business or technology is risky and may result in unforeseen operating difficulties and expenditures, including, among other things:

 

 

In addition, a significant portion of the purchase price of companies we may acquire may be allocated to acquired goodwill and other intangible assets, which must be assessed for impairment at least annually. In the future, if our acquisitions do not yield expected returns, we may be required to take charges to our earnings based on this impairment assessment process, which could harm our operating results.

 

Future acquisitions could result in potentially dilutive issuances of our equity securities, including our common stock, or the incurrence of debt, contingent liabilities, amortization expenses or acquired in-process research and development expenses, any of which could harm our financial condition and operating results. Future acquisitions may also require us to obtain additional financing, which may not be available on favorable terms or at all.

 

Our business depends, in part, on our ability to protect and enforce our intellectual property rights.

 

The protection of our intellectual property is critical to our success. We rely on copyright and trademark enforcement, contractual restrictions and trade secret laws to protect our proprietary rights. We have entered into confidentiality and invention assignment agreements with our employees and contractors, and nondisclosure agreements with certain parties with whom we conduct business to limit access to and disclosure of our proprietary information. However, if we are unable to adequately protect our intellectual property, our business may suffer from the piracy of our technology and the associated loss in revenue. Other parties may also independently develop similar or competing products that do not infringe upon our intellectual property rights, and that are similar or superior to our technology.

 

Protecting against the unauthorized use of our intellectual property and other proprietary rights is expensive, difficult and, in some cases, impossible. Litigation may be necessary in the future to enforce or defend our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. Such litigation could be costly and divert management resources, either of which could harm our business. Furthermore, many of our current and potential competitors have the ability to dedicate substantially greater resources to enforce their intellectual property rights than we do. Accordingly, despite our efforts, we may not be able to prevent third parties from infringing upon or misappropriating our intellectual property.

Any claims from a third party that we are infringing upon its intellectual property, whether valid or not, could subject us to costly and time-consuming litigation or expensive licenses or force us to curtail some services or products.

 

Companies in the Internet and technology industries own large numbers of patents, copyrights, trademarks and trade secrets and frequently enter into litigation based on allegations of infringement or other violations of intellectual property rights. As we face increasing competition, the possibility of intellectual property rights claims against us grows. Our technologies may not be able to withstand any third-party claims or rights against their use. Any intellectual property claims, with or without merit, could be time-consuming, expensive to litigate or settle and could divert management resources and attention. An adverse determination also could prevent us from offering our services and products to others and may require that we procure substitute products or services for our customers.

 

In the case of any intellectual property rights claim, we may have to pay damages or stop using technology found to be in violation of a third party’s rights. We may have to seek a license for the technology, which may not be available on reasonable terms and may significantly increase our operating expenses. The technology also may not be available for license to us at all. As a result, we may also be required to develop alternative non-infringing technology, which could require significant effort and expense. If we cannot license or develop technology for the infringing aspects of our business, we may be forced to limit our service and product offerings and may be unable to compete effectively. Any of these consequences could harm our operating results.

 

We are not currently subject to any legal proceedings with respect to our intellectual property; however, we may from time to time become a party to various legal proceedings with respect to our intellectual property arising in the ordinary course of our business.

 

Any unauthorized disclosure or theft of private information we gather could harm our reputation and subject us to claims or litigation.

 

We collect, and have access to, personal information of subscribers, including names, addresses, account numbers, credit card numbers and email addresses. Unauthorized disclosure of personally identifiable information regarding website visitors, whether through breach of our systems by an unauthorized party, employee theft or misuse, or otherwise, could harm our business. If there were an inadvertent disclosure of personally identifiable information, or if a third party were to gain unauthorized access to the personally identifiable information we possess, our operations could be seriously disrupted and we could be subject to claims or litigation arising from damages suffered by subscribers or our customers. In addition, we could incur significant costs in complying with the multitude of state, federal and foreign laws regarding the unauthorized disclosure of personal information. Finally, any perceived or actual unauthorized disclosure of the information we collect could harm our reputation, substantially impair our ability to attract and retain customers and have an adverse impact on our business.

 

We may require additional capital to grow our business, and this capital may not be available on acceptable terms or at all.

 

We have historically relied on outside financing, principally equity investments by venture capital investors, which are a substantial majority of our existing stockholders, and, to a lesser degree, cash flows from operations to fund our operations, capital expenditures and expansion. In the future, the operation of our business and our growth strategy may require significant additional capital, especially if we were to accelerate our expansion and acquisition plans. If the cash generated from operations and from this offering are not sufficient to meet our capital requirements, we will need to seek additional capital, potentially through debt or equity financings, to fund our growth. We may not be able to raise needed capital on terms

acceptable to us or at all. Financings, if available, may be on terms that are dilutive or potentially dilutive to our stockholders, and the prices at which new investors would be willing to purchase our securities may be lower than the initial public offering price, in which case our existing stockholders would suffer substantial dilution. The holders of new securities may also receive rights, preferences or privileges that are senior to those of existing holders of our common stock. If new sources of financing are required but are insufficient or unavailable, we could be required to delay, abandon or otherwise modify our growth and operating plans to the extent of available funding, which would harm our ability to grow our business.

 

Changes in, or interpretations of, accounting rules and regulations, including recent rules and regulations regarding expensing of stock options, could result in unfavorable accounting charges and make attracting and retaining personnel more difficult.

 

We prepare our financial statements to conform to accounting principles generally accepted in the United States, or GAAP. These accounting principles are subject to interpretation by the Financial Accounting Standards Board, or FASB, the Securities and Exchange Commission, or SEC, and other regulatory bodies. A change in accounting principles could have a significant effect on our reported results and might affect our reporting of transactions completed before a change is announced. For example, we have used stock options as a fundamental component of our employee compensation packages. We believe that stock options directly motivate our employees to maximize long-term stockholder value and, through the use of vesting, encourage employees to remain in our employ. Several regulatory agencies and entities have made regulatory changes that could make it more difficult or expensive for us to grant stock options to employees. For example, the FASB released Statement of Financial Accounting Standards, or SFAS 123R, “Share-Based Payments,” which required us to record a charge to earnings for employee stock option grants beginning in January 2006. We may, as a result of these changes, incur increased compensation costs or change our equity compensation strategy, which could make it more difficult to attract, retain and motivate employees. Any of these factors could materially and adversely affect our business, operating results and financial condition.

 

Investors could lose confidence in our financial reports, and the trading price of our common stock may be adversely affected, if our internal controls over financial reporting are found by management or by our independent registered public accounting firm not to be adequate or if we disclose material weaknesses in those controls.

 

Effective internal controls are necessary for us to provide reliable financial reports and prevent fraud. In addition, Section 404 of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, will require us to evaluate and report on our internal control over financial reporting and have our independent registered public accounting firm attest to our evaluation beginning with our Annual Report on Form 10-K for the year ending December 31, 2008. We are in the process of preparing and implementing an internal plan for compliance with Section 404 and strengthening and testing our system of internal controls to provide the basis for our report. The process of implementing our internal controls and complying with Section 404 will be expensive and time consuming, and will require significant attention of management. We cannot be certain that these measures will ensure that we implement and maintain adequate controls over our financial processes and reporting in the future. Even if we conclude, and our independent registered public accounting firm concurs, that our internal control over financial reporting provides reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles, because of its inherent limitations, internal control over financial reporting may not prevent or detect fraud or misstatements. Failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations.

If we or our independent registered public accounting firm discover a material weakness in our internal control over financial reporting, the disclosure of that fact, even if quickly remedied, could reduce the market’s confidence in our financial statements and harm our stock price.

 

In addition, a delay in compliance with Section 404 could subject us to a variety of administrative sanctions, including ineligibility for short form resale registration, action by the SEC, the suspension or delisting of our common stock from The Nasdaq Global Market and the inability of registered broker-dealers to make a market in our common stock, which would further reduce the trading price of our common stock and could harm our business.

 

Completion of our initial public offering may limit our ability to use our net operating loss carryforwards.

 

As of December 31, 2006, we had substantial federal and state net operating loss, or NOL, carryforwards. Under the provisions of the Internal Revenue Code of 1986, as amended, substantial changes in our ownership may limit the amount of NOL carryforwards that we can utilize in the future to offset taxable income. We believe that, as a result of this initial public offering, it is possible that a change in our ownership will be deemed to have occurred. If such a change in our ownership is deemed to occur, our ability to use our NOL carryforwards in any fiscal year may be limited under these provisions.

 

Risks Related to Our Industry

 

The growth of the market for our services and products depends on the continued growth of the Internet as a medium for content, advertising, commerce and communications.

 

Expansion in the sales of our services and products depends on the continued acceptance of the Internet as a platform for content, advertising, commerce and communications. The acceptance of the Internet as a medium for such uses could be adversely impacted by delays in the development or adoption of new standards and protocols to handle increased demands of Internet activity, security, reliability, cost, ease-of-use, accessibility and quality-of-service. The performance of the Internet and its acceptance as such a medium has been harmed by viruses, worms, and similar malicious programs, and the Internet has experienced a variety of outages and other delays as a result of damage to portions of its infrastructure. If for any reason the Internet does not remain a medium for widespread content, advertising, commerce and communications, the demand for our services and products would be significantly reduced, which would harm our business.

 

The growth of the market for our services and products depends on the development and maintenance of the Internet infrastructure.

 

Our business strategy depends on continued Internet and broadband access growth. Any downturn in the use or growth rate of the Internet or broadband access would be detrimental to our business. If the Internet continues to experience significant growth in number of users, frequency of use and amount of data transmitted, the Internet infrastructure might not be able to support the demands placed on it and the performance or reliability of the Internet may be adversely affected. The success of our business therefore depends on the development and maintenance of a sound Internet infrastructure. This includes maintenance of a reliable network backbone with the necessary speed, data capacity and security, as well as timely development of complementary products, such as routers, for providing reliable Internet access and services. Consequently, as Internet usage increases, the growth of the market for our products depends upon improvements made to the Internet as well as to individual customers’ networking

infrastructures to alleviate overloading and congestion. In addition, any delays in the adoption of new standards and protocols required to govern increased levels of Internet activity or increased governmental regulation may have a detrimental effect on the Internet infrastructure.

 

A substantial portion of our net sales are derived from search and advertising, so that our net sales might decline if advertisers do not continue their usage of the Internet as an advertising medium.

 

We have derived and expect to continue to derive a substantial portion of our net sales from search-based and other advertising on our customers’ websites. However, the prospects for continued demand and market acceptance for Internet advertising are uncertain. If advertisers do not continue to increase their usage of the Internet, our revenue might stagnate or decline. Advertisers that have traditionally relied on other advertising media may not advertise on the Internet. Most advertising agencies and potential advertisers, particularly local advertisers, have only limited experience advertising on the Internet and devote only a small portion of their advertising expenditures to online advertising. As the Internet evolves, advertisers may find online advertising to be a less attractive or effective means of promoting their services and products than traditional methods of advertising and may not continue to allocate funds for Internet advertising. Many historical predictions by industry analysts and others concerning the growth of the Internet as a commercial medium have overstated the growth of the Internet and you should not rely upon them. This growth may not occur or may occur more slowly than estimated.

 

Most of our search revenues are based on the number of paid “clicks” on sponsored links that are included in search results generated from our customers’ websites. Generally, each time a subscriber clicks on a sponsored link, the search provider that provided the commercial search result receives a fee from the advertiser who paid for such commercial click and the search provider pays us a portion of that fee and we, in turn, typically share a portion of the fee we receive with our customer. If an advertiser receives what it perceives to be a large number of clicks for which it needs to pay, but that do not result in a desired activity or an increase in sales, the advertiser may reduce or eliminate its advertisements through the search provider that provided the commercial search result to us. This may lead to a loss of revenue to our search providers and consequently to lesser fees paid to us, which could have a material negative effect on our financial results.

 

We cannot assure you that market prices for online advertising will not decrease due to competitive or other factors. In addition, if a large number of Internet users use filtering software programs that limit or remove advertising from the users’ view, advertisers may perceive that Internet advertising is not effective and may choose not to advertise on the Internet. Moreover, there are varying standards for the measurement of the effectiveness of Internet advertising, and no single standard may develop sufficiently to support online advertising as a significant advertising medium. If no such standards develop, advertisers may be reluctant to transition to the Internet from conventional media.

 

The market for Internet-based services and products in which we operate is highly competitive, and if we cannot compete effectively, our sales may decline and our business may be harmed.

 

Competition in the market for Internet-based services and products in which we operate is intense and involves rapidly-changing technologies and customer and subscriber requirements, as well as evolving industry standards and frequent product introductions. Our primary competitors include broadband service providers with internal information technology staff capable of developing similar solutions in-house and Yahoo! Inc., or Yahoo!, InfoSpace, Inc., or InfoSpace, Ask.com, a wholly-owned business of IAC/InterActiveCorp, or Ask, Google, AOL

LLC, or AOL, and MSN, a division of Microsoft Corporation, or Microsoft. Advantages of some of our existing and potential competitors’ over us include the following:

 

 

If we are unable to compete effectively or we are not as successful as our competitors in our target markets, our sales could decline, our margins could decline and we could lose market share, any of which would materially harm our business, operating results and financial condition.

 

Subscriber tastes continually change and are unpredictable, and our sales may decline if we fail to enhance our service and content offerings to achieve continued subscriber acceptance.

 

Our business depends on aggregating and providing services and content that our customers will place on their websites, including news, entertainment, sports and other content that subscribers find engaging, and value-added services and paid content that subscribers will buy. We must continue to invest significant resources in licensing efforts, research and development and marketing to enhance our service and content offerings, and we must make decisions about these matters well in advance of product releases to implement them in a timely manner. Our success depends, in part, on unpredictable and volatile factors beyond our control, including subscriber preferences, competing content providers and portals and the availability of other news, entertainment, sports and other services and content. If our services and content are not responsive to the requirements of our customers or the preferences of their subscribers, or the services and content are not brought to market in a timely and effective manner, our business, operating results and financial condition would be harmed. Even if our services and content are successfully introduced and initially adopted, a subsequent shift in the preferences of our customers or their subscribers could cause a decline in our services and content’s popularity that could materially reduce our revenues and harm our business, results of operations and financial condition.

 

Government regulation of the Internet continues to evolve, and new laws and regulations could significantly harm our financial performance.

 

Today, there are relatively few laws specifically directed towards conducting business over the Internet. We expect more stringent laws and regulations relating to the Internet to be enacted. The adoption or modification of laws related to the Internet could harm our business, operating results and financial condition by, among other things, increasing our costs and administrative burdens. Due to the increasing popularity and use of the Internet, many laws

and regulations relating to the Internet are being debated at the international, federal and state levels, which are likely to address a variety of issues such as:

 

 

Several federal laws that could have an impact on our business have been adopted. The Digital Millennium Copyright Act of 1998 is intended to reduce the liability of online service providers of third-party content, including content that may infringe copyrights or rights of others. The Children’s Online Privacy Protection Act imposes additional restrictions on the ability of online services to collect user information from minors. In addition, the Protection of Children from Sexual Predators Act requires online service providers to report evidence of violations of federal child pornography laws under certain circumstances.

 

Laws and regulations regarding user privacy and information security impact our business because we collect and use personal information regarding the users of our customers’ websites. We use this information to deliver more relevant content and services and provide subscribers with a personalized online experience. We share this information on an aggregate basis with our partners and, subject to confidentiality agreements, to prospective partners and sponsors. Laws such as the CAN-SPAM Act of 2003 or other user privacy or security laws could restrict our and our customers’ ability to market products to their subscribers, create uncertainty in Internet usage and reduce the demand for our services and products or require us to redesign our customers’ Internet portals.

 

We could find it costly for us to comply with existing and potential laws and regulations, and they could harm our marketing efforts and our attractiveness to advertisers by, among other things, restricting our ability to collect demographic and personal information from subscribers or to use or disclose that information in certain ways. If we were to violate these laws or regulations, or if it were alleged that we had, we could face private lawsuits, fines, penalties and injunctions and our business could be harmed. Even though we believe we meet the safe harbor requirements of the Digital Millennium Copyright Act, we could be exposed to copyright actions, which could be costly and time-consuming to defend.

 

Finally, the applicability to the Internet and other online services of existing laws in various jurisdictions governing issues such as property ownership, sales and other taxes, libel and personal privacy is uncertain. Any new legislation or regulation, the application of laws and regulations from jurisdictions whose laws do not currently apply to our business, or the application of existing laws and regulations to the Internet and other online services could also

increase our costs of doing business, discourage Internet communications, reduce demand for our services, and expose us to substantial liability.

 

Risks Related to this Offering and Ownership of Our Common Stock

 

Our existing stockholders will continue to have substantial control over us after this offering, which could limit your ability to influence the outcome of key corporate decisions, such as an acquisition of our company.

 

Following the consummation of this offering, our directors, executive officers and holders of more than 5% of our common stock, together with their affiliates, will beneficially own, in the aggregate, approximately     % of our outstanding common stock, or     % if the underwriters exercise their over-allotment option in full. As a result, these stockholders, if they act together, would have the ability to control the outcome of matters submitted to our stockholders for approval, including the election of directors and any merger, consolidation or sale of all or substantially all of our assets. In addition, these stockholders, if they act together, would have the ability to control the management and affairs of our company. Accordingly, this concentration of ownership might harm the trading price of our common stock by:

 

 

Future sales of our common stock may cause the trading price of our common stock to decline.

 

If our existing stockholders, particularly our directors, their affiliated venture capital funds and our executive officers, sell substantial amounts of our common stock in the public market, or are perceived by the public market as intending to sell, the trading price of our common stock could decline below the initial public offering price. Based on shares outstanding as of March 31, 2007, upon completion of this offering, we will have outstanding           shares of common stock (or           shares if the underwriters exercise their over-allotment option in full). Of these shares, only the shares of common stock sold in this offering will be immediately freely tradable, without restriction, in the public market, except for those shares held by “affiliates,” as that term is defined in Rule 144 under the Securities Act of 1933, as amended, or the Securities Act.

 

Our directors, executive officers, holders of substantially all of our common stock and holders of options and warrants to purchase our stock have agreed with the underwriters, subject to certain exceptions, not to dispose of or hedge any of their common stock or securities convertible into or exchangeable or exercisable for shares of common stock for a period through the date that is 180 days after the date of this prospectus, except with the prior written consent of Deutsche Bank Securities Inc. In addition, substantially all of the holders of our common stock and options to purchase our common stock have previously entered into agreements with us not to sell or otherwise transfer any of their common stock or securities convertible into or exchangeable for shares of common stock for a period through the date 180 days after the date of this prospectus.

 

The 180-day restricted period under the agreements with the underwriters described in the preceding paragraph will be automatically extended if: (1) during the last 17 days of the 180-day restricted period we release earnings results or material news or a material event relating to us occurs; or (2) prior to the expiration of the 180-day restricted period, we

announce that we will release earnings results during the 16-day period following the last day of the 180-day period, in which case the restrictions described in the preceding paragraph will continue to apply until the expiration of the 18-day period beginning on the release of the earnings results or material news or the occurrence of a material event relating to us.

 

Upon the expiration of the contractual lock-up agreements pertaining to this offering 180 days from the date of this prospectus, or such longer period described above, up to an additional           shares will be eligible for sale in the public market,           of which will be held by directors, executive officers and other affiliates and will be subject to volume limitations under Rule 144 under the Securities Act and, in certain cases, various vesting agreements. Some of our existing stockholders have demand and piggyback rights to require us to register with the Securities and Exchange Commission, or SEC, up to 11,671,891 shares of our common stock, subject to contractual lock-up agreements. See “Description of Capital Stock—Registration Rights” for more information. If we register any of these shares of common stock, the stockholders would be able to sell those shares freely in the public market.

 

In addition, the shares that are either subject to outstanding options or that may be granted in the future under our 2007 Equity Incentive Plan, and the shares that are subject to outstanding warrants, will become eligible for sale in the public market to the extent permitted by the provisions of various vesting agreements, the contractual lock-up agreements and Rules 144 and 701 under the Securities Act.

 

After this offering, we intend to register the shares of our common stock that we may issue under our equity plans. Once we register these shares, they can be freely sold in the public market upon issuance, subject to any vesting or contractual lock-up agreements.

 

If any of these additional shares described are sold, or if it is perceived that they will be sold, in the public market, the trading price of our common stock could decline. For additional information, see “Shares Eligible for Future Sale.”

 

Some provisions of our certificate of incorporation, bylaws and Delaware law may discourage, delay or prevent a merger or acquisition that you may consider favorable or prevent the removal of our current board of directors and management.

 

Our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that may discourage, delay or prevent a merger or acquisition that you may consider favorable or prevent the removal of our current board of directors and management. We have a number of anti-takeover devices in place that will hinder takeover attempts, including:

 

 

 

These provisions and other provisions in our charter documents could discourage, delay or prevent a transaction involving a change in our control. Any delay or prevention of a change of control transaction could cause stockholders to lose a substantial premium over the then-current trading price of their shares. These provisions could also discourage proxy contests and could make it more difficult for you and other stockholders to elect directors of your choosing or to cause us to take other corporate actions you desire.

 

In addition, we are subject to Section 203 of the Delaware General Corporation Law, which, subject to some exceptions, prohibits “business combinations” between a Delaware corporation and an “interested stockholder,” which is generally defined as a stockholder who becomes a beneficial owner of 15% or more of a Delaware corporation’s voting stock, for a three-year period following the date that the stockholder became an interested stockholder. Section 203 could have the effect of delaying, deferring or preventing a change of control that our stockholders might consider to be in their best interests. See “Description of Capital Stock—Anti-Takeover Effects of Our Certificate of Incorporation and Bylaws and Delaware Law.”

 

We have not paid cash dividends on our capital stock and we do not expect to do so in the foreseeable future.

 

We have not historically paid cash dividends on our capital stock. We anticipate that we will retain all future earnings and cash resources for the future operation and development of our business, and as a result, we do not anticipate paying any cash dividends to holders of our capital stock for the foreseeable future. Any future determination regarding the payment of any dividends will be made at the discretion of our board of directors and will depend on our financial condition, results of operations, capital requirements, general business conditions and other factors that our board may deem relevant. Consequently, investors must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investment. Investors seeking cash dividends should not invest in our common stock.

 

We will have broad discretion in the use of the net proceeds from this offering and may fail to apply these proceeds effectively.

 

Our management will have broad discretion in the application of the net proceeds that we will receive from this offering, including for working capital, possible acquisitions and other general corporate purposes. We cannot specify with certainty the actual uses of the net proceeds that we will receive from this offering. You may not agree with the manner in which our management chooses to allocate and spend the net proceeds. Pending their use, we may invest the net proceeds from this offering in a manner that does not produce income or that loses value. The failure by our management to apply these funds effectively could harm our business and financial condition.

 

Purchasers in this offering will suffer immediate and substantial dilution.

 

The initial public offering price of our common stock is substantially higher than the net tangible book value per share of our common stock outstanding immediately after this offering. Our pro forma net tangible book value as of March 31, 2007 was $16.8 million, or approximately $1.43 per share. Our pro forma net tangible book value per share represents the amount of our total tangible assets reduced by the amount of our total liabilities and divided

by 11,800,955 shares of common stock outstanding after giving effect to the automatic conversion of all outstanding shares of preferred stock into shares of common stock upon the closing of this offering. Investors who purchase our common stock in this offering will pay a price per share that substantially exceeds the pro forma net tangible book value per share of our common stock. If you purchase our common stock in this offering, you will experience immediate and substantial dilution of $      in the net tangible book value per share of our common stock, based upon the initial public offering price of $      per share, which represents the mid-point of the range set forth on the cover page of this prospectus. Investors who purchase our common stock in this offering will have purchased     % of the shares outstanding immediately after the offering, but will have paid     % of the total consideration for those shares. If previously granted options or warrants are exercised, additional dilution will occur. As of March 31, 2007, options to purchase 2,354,720 shares of our common stock with a weighted average exercise price of approximately $0.94 per share were outstanding. In addition, as of the date of this prospectus, warrants to purchase an aggregate of 598,292 shares of our common stock with an exercise price of $1.17 were outstanding. Exercise of these options and warrants will result in additional dilution to purchasers of our common stock in this offering.

 

An active market for our common stock may not develop, which could make it difficult for you to sell your shares of common stock and could have a material adverse effect on the value of your investment.

 

Prior to this offering, there has been no public market for shares of our common stock. We plan to submit an application to have our common stock approved for listing on The Nasdaq Global Market under the symbol “SYNC.” However, we cannot assure you that an active public trading market for our common stock will develop on that exchange or elsewhere or, if developed, that any market will be active or sustained. Accordingly, we cannot assure you of the liquidity of any such market, your ability to sell your shares of common stock or the prices that you may obtain for your shares of common stock. As a result, you could lose all or part of your investment.

 

The trading price and volume of our common stock is likely to be volatile, and you might not be able to sell your shares at or above the initial public offering price.

 

Even if an active trading market develops, the trading price of our common stock may be highly volatile and could be subject to wide fluctuations. In addition, the trading volume in our common stock may fluctuate and cause significant price variations to occur. If the trading price of our common stock declines significantly, you may be unable to resell your shares at or above your purchase price. We cannot assure you that the trading price of our common stock will not fluctuate or decline significantly in the future. Some of the factors that could negatively affect our share price or result in fluctuations in the price or trading volume of our common stock include:

 

 

 

In addition, if the market for technology stocks or the stock market in general experiences loss of investor confidence, the trading price of our common stock could decline for reasons unrelated to our business, operating results or financial condition. The trading price of our common stock might also decline in reaction to events that affect other companies in our industry even if these events do not directly affect us. Some companies that have had volatile market prices for their securities have had securities class actions filed against them. A suit filed against us, regardless of its merits or outcome, could cause us to incur substantial costs and could divert management’s attention.

 

If securities or industry analysts do not publish research or reports about our company, our stock price and trading volume could decline.

 

The trading market for our common stock will depend in part on the research and reports that securities or industry analysts publish about us or our business. We do not currently have and may never obtain research coverage by securities and industry analysts. If no securities or industry analysts commence coverage of our company, the trading price for our stock would be negatively impacted. In the event we obtain securities or industry analyst coverage, if one or more of the analysts who cover us downgrade our stock or publish inaccurate or unfavorable research about our business, our stock price would likely decline. If one or more of these analysts cease coverage of our company or fail to publish reports on us regularly, demand for our stock could decrease, which might cause our stock price and trading volume to decline.

 

We will incur increased costs and demands upon management as a result of complying with federal securities laws and regulations applicable to public companies, which could adversely affect our financial performance.

 

As a public company, we will be subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act, the Sarbanes-Oxley Act and the rules and regulations of The Nasdaq Global Market. The Sarbanes-Oxley Act, as well as rules subsequently implemented by the SEC and The Nasdaq Global Market, imposes additional requirements on public companies, including enhanced corporate governance practices. For example, the Nasdaq listing requirements require that listed companies satisfy certain corporate governance requirements relating to independent directors, audit committees, distribution of annual and interim reports, stockholder meetings, stockholder approvals, solicitation of proxies, conflicts of interest, stockholder voting rights and codes of business conduct.

 

The requirements of these rules and regulations will increase our legal, accounting and financial compliance costs, will make some activities more difficult, time-consuming and costly and may also place undue strain on our personnel, systems and resources. Our management and other personnel will need to devote a substantial amount of time to these requirements. These rules and regulations will also make it more difficult and more expensive for us to maintain directors’ and officers’ liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to maintain coverage. If we are unable to maintain adequate directors’ and officers’ insurance, our ability to recruit and retain qualified directors, especially those directors who may be considered independent for purposes of Nasdaq rules, and officers will be significantly curtailed.

 

This prospectus includes forward-looking statements that reflect our current views with respect to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to differ materially from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. Words such as, but not limited to, “believes,” “expects,” “anticipates,” “estimates,” “intends,” “plans,” “targets,” “likely,” “may,” “might,” “will,” “would,” “should,” “could,” and similar expressions or phrases identify forward-looking statements. Forward-looking statements include, but are not limited to, statements about:

 

 

Any forward-looking statements contained in this prospectus are based upon our historical performance and our current plans, estimates and expectations. The inclusion of this forward-looking information should not be regarded as a representation by us, the underwriters or any other person that the future plans, estimates or expectations contemplated by us will be achieved. All forward-looking statements involve risks, assumptions and uncertainties. The occurrence of the events described, and the achievement of the expected results, depend on many factors, some or all of which are not predictable or within our control. Actual results may differ materially from expected results. See “Risk Factors” and elsewhere in this prospectus for a more complete discussion of these risks, assumptions and uncertainties and for other risks and uncertainties. These risks, assumptions and uncertainties are not necessarily all of the important factors that could cause actual results to differ materially from those expressed in any of our forward-looking statements. Other unknown or unpredictable factors also could harm our results. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this prospectus might not occur. Except as required by law, we undertake no obligation to update publicly or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

We estimate that our net proceeds from the sale of the           shares of common stock that we are offering will be approximately $      , assuming an initial public offering price of $      per share, which is the midpoint of the range of the initial public offering price listed on the cover page of this prospectus, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. If the underwriters’ option to purchase additional shares in this offering is exercised in full, we estimate that our net proceeds will increase by approximately $     .

 

We intend to use the net proceeds to us from this offering for working capital and other general corporate purposes, which may include expansion of our sales and marketing activities, investment in research and development to enhance our product offerings and other corporate opportunities that may arise in the future.

 

We may also use a portion of the net proceeds to expand our current business through acquisitions of other businesses, products or technologies. However, we do not have agreements or commitments for any specific acquisitions at this time.

 

We have not yet determined the specific uses of the net proceeds from this offering and, therefore, cannot specify with certainty the amounts to be used for each of the purposes discussed above. The amounts and timing of any expenditures will vary depending on the amount of cash generated by our operations, competitive and technological developments and the rate of growth of our business. As a result, we will have broad discretion in applying the net proceeds from this offering, and investors will be relying on our judgment regarding the application of these net proceeds.

 

Pending the use of the net proceeds from this offering, we intend to invest the net proceeds in short-term investment-grade, interest-bearing securities.

 

We have never declared or paid cash dividends on our capital stock. We currently intend to retain all future earnings and cash resources for the future operation and development of our business and do not anticipate paying any cash dividends for the foreseeable future. Any future determination to declare cash dividends will be made at the discretion of our board of directors and will depend on our financial condition, results of operations, capital requirements, general business conditions and other factors that our board of directors may deem relevant.

 

The following table sets forth our capitalization as of March 31, 2007:

 

 

You should read this table in conjunction with “Selected Consolidated Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus.

 

 

If the underwriters’ option to purchase additional shares in the offering were exercised in full, pro forma as adjusted cash and cash equivalents, additional paid-in capital, total stockholders’ equity (deficit), total capitalization and shares issued and outstanding as of March 31, 2007 would be $      , $      , $      , $      and           shares, respectively.

This table excludes the following shares:

 

 

See “Management—Equity Benefit Plans” for a description of our equity plans.

 

Our pro forma net tangible book value as of March 31, 2007 was $16.8 million, or approximately $1.43 per share. Our pro forma net tangible book value per share represents the amount of our total tangible assets reduced by the amount of our total liabilities and divided by 11,800,955 shares of common stock outstanding after giving effect to the automatic conversion of all outstanding shares of preferred stock into shares of common stock upon the closing of this offering.

 

Net tangible book value dilution per share to new investors represents the difference between the amount per share paid by purchasers of shares of common stock in this offering and the pro forma net tangible book value per share of common stock immediately after completion of this offering. After giving effect to our sale of           shares of common stock in this offering at an assumed initial public offering price of $      per share, which is the midpoint of the range of the initial public offering price listed on the cover page of this prospectus, and after deducting estimated underwriting discounts and commissions and estimated offering expenses, our pro forma net tangible book value as of March 31, 2007 would have been $      million, or $      per share. This represents an immediate increase in pro forma net tangible book value of $      per share attributable to new investors and an immediate dilution in pro forma net tangible book value of $      per share to purchasers of common stock in this offering, as illustrated in the following table:

 

 

If the underwriters exercise in full their option to purchase additional shares of our common stock in this offering, the pro forma net tangible book value per share after the offering would be $      per share, the increase in pro forma net tangible book value per share to existing stockholders would be $      per share and the dilution to new investors purchasing shares in this offering would be $      per share.

 

Each $1.00 increase (decrease) in the assumed initial public offering price of $      per share would increase (decrease) our pro forma net tangible book value by $      million, or $      per share, the increase in pro forma net tangible book value attributable to new investors by $      per share and the dilution in pro forma net tangible book value per share to purchasers of common stock in this offering by $      per share, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting an assumed underwriting discount and estimated offering expenses we must pay.

 

The following table presents on a pro forma basis as of March 31, 2007, after giving effect to the automatic conversion of all outstanding shares of preferred stock into common stock upon completion of this offering, the differences between the existing stockholders and the

purchasers of shares in the offering with respect to the number of shares purchased from us, the total consideration paid and the average price paid per share:

 

 

As of March 31, 2007, there were options outstanding to purchase a total of 2,354,720 shares of common stock at a weighted average exercise price of $0.94 per share. To the extent outstanding options are exercised, there will be further dilution to new investors. For a description of our equity plans, please see “Management—Equity Benefit Plans.”

 

You should read the following selected consolidated historical financial data below in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements, related notes and other financial information included in this prospectus. The selected consolidated financial data in this section is not intended to replace the consolidated financial statements and is qualified in its entirety by the consolidated financial statements and related notes included in this prospectus.

 

We derived the selected consolidated financial data for the years ended December 31, 2004, 2005 and 2006 and as of December 31, 2005 and 2006 from our audited consolidated financial statements and related notes, which are included in this prospectus. We derived the selected consolidated financial data for the years ended December 31, 2002 and 2003 and as of December 31, 2002, 2003 and 2004 from our audited consolidated financial statements and related notes, which are not included in this prospectus. The selected consolidated financial data for the three months ended March 31, 2006 and 2007 and as of March 31, 2007 are derived from our unaudited condensed consolidated financial statements and related notes included elsewhere in this prospectus. The unaudited condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and include, in the opinion of management, all adjustments, which include only normal recurring adjustments, that management considers necessary for the fair presentation of the financial information set forth in those statements. Historical results are not necessarily indicative of future results and the results for the three months ended March 31, 2007 are not necessarily indicative of the results to be expected for the year ending December 31, 2007.

 

The pro forma basic and diluted net loss per common share data for the year ended December 31, 2006 and the three months ended March 31, 2007 reflect the conversion of all of our outstanding shares of preferred stock into 11,596,759 shares of common stock in connection with this offering. See Note 1 of Notes to Consolidated Financial Statements for an explanation of the method used to determine the number of shares used in computing pro forma basic and diluted net loss per common share.

 

 

 

 

 

The following discussion of our results of operations and financial condition should be read in conjunction with the information set forth in “Selected Consolidated Financial Data” and our consolidated financial statements and the notes thereto included in this prospectus. This discussion contains forward-looking statements based upon our current expectations, estimates and projections that involve risks and uncertainties. Actual results could differ materially from those anticipated in these forward-looking statements due to, among other considerations, the matters discussed under “Risk Factors” and “Special Note Regarding Forward-Looking Statements.”

 

Overview

 

We provide an Internet platform and a portfolio of digital content and services that enable broadband service providers, such as MSOs, Telcos and ISPs, to create a compelling online experience for their subscribers. Our technology platform is used to create customized Internet portals and includes integration infrastructure, subscriber personalization capabilities, a content management and delivery system and a customer-branded video player and toolbar. Our platform also aggregates free and paid value-added services and digital content, including video, from third-party providers to create a customized and branded Internet portal solution. We deliver a seamless subscriber experience by integrating these services and products with existing customer billing and management systems, thereby allowing our customers to extend their brands and enhance their subscriber relationships. We believe our solution assists our customers in promoting subscriber retention, increasing ARPU and cultivating new revenue streams.

 

We were originally formed as a New York corporation in January 1998 with the name Chek, Inc. Chek, an Internet messaging technology provider, designed and managed a proprietary messaging platform that supported the hosting of branded e-mail and time management applications. In December 2000, Chek acquired MyPersonal through a recapitalization and stock swap and changed its name to CKMP, Inc. MyPersonal developed white label Internet community portals and built and managed a flexible platform for delivering content-rich, branded portals to affinity groups with a focus on the educational marketplace. In July 2001, CKMP, Inc. changed its name to Synacor, Inc., and in November 2002, Synacor re-incorporated under the laws of the State of Delaware. MyPersonal remained a subsidiary of Synacor until May 2007 when it was dissolved.

 

Trends in Our Business

 

The cable and telecommunications industries have experienced considerable merger and acquisition activity over the past several years, and we expect that this trend will continue. Business combinations in these industries affect us because some of our customers may acquire or be acquired by other companies, which may have pre-existing in-house capabilities or relationships with our competitors to provide the services and products that we now provide. In some cases, acquisitions have adversely affected our business. For example, in April 2007, Susquehanna Communications ended its relationship with us as a customer following its April 2006 acquisition by Comcast. In other cases, merger and acquisition activity in the cable and telecommunications industries has presented us with opportunities for growth. For example, in 2006, Time Warner and Comcast acquired substantially all of Adelphia’s assets; and although our revenues from Adelphia subscribers have declined significantly following the acquisition, we are now providing Time Warner with premium content for its high speed Internet service, Roadrunner. In addition, in 2007 our customer NTL Incorporated, or NTL, merged with Telewest Global, Inc., or Telewest, and Virgin Mobile Holdings

(U.K.) plc, or Virgin Mobile. VirginMedia Inc., the successor to NTL, expanded the use of our platform beyond NTL’s subscriber base to Telewest subscribers.

 

During 2004, 2005 and 2006, we benefited significantly from the application of search and advertising technologies to subscriber traffic generated by our customers’ websites. Not only did our search and advertising revenues increase in dollar amount and as a percentage of net sales, but also these revenues enabled our service and product offerings to become profit centers for many of our customers through revenue-sharing arrangements with them. During those three years, the growth in our search and advertising revenues was significantly greater than the growth in our subscriber-based revenues. That growth was principally based on two factors: the initial rollout of search and advertising technologies across our network of customer websites; and improvement in the techniques we use to generate revenue from the traffic generated by these websites. While we anticipate continued growth in search and advertising revenues, we believe that the rate of growth will be more in line with that of our subscriber-based revenues principally due to two factors: we are beyond the initial rollout phase for search and advertising; and future growth will more likely result from increases in subscribers of existing and new customers, as well as continued improvements in our ability to monetize traffic.

 

We continue to invest in building employee and systems infrastructures to support our growth and develop and promote our services and products, which may cause our operating margins to decrease. We have experienced, and expect to continue to experience, growth in our operations as we acquire new customers, as our existing customers acquire new subscribers and as we increase our presence in international markets. Our full-time employee headcount has increased from 28 at December 31, 2003 to 165 at June 30, 2007, which has required us to make substantial investments in property and equipment. In addition, our capital expenditures have grown from approximately $750,000 in 2005 to approximately $3.6 million in 2006. We expect to continue to make significant capital expenditures in 2007 related to our information and technology infrastructure. We also expect that our research and development expenses will rise in 2007 as we continue to develop our technology platform, primarily as a result of additional increases in headcount. As a result, the growth rate of our costs and expenses may exceed the growth rate of our revenues in 2007.

 

Once we become a public company, we will incur significant legal, accounting and other costs that we have not previously incurred as a private company. The Sarbanes-Oxley Act of 2002 and related rules of the SEC and The Nasdaq Global Market regulate corporate governance practices of public companies. We expect that compliance with these public company requirements, including ongoing costs to comply with Section 404 of the Sarbanes-Oxley Act, which includes documenting, reviewing and testing our internal controls over financial reporting, will significantly increase our general and administrative costs. These costs will also include the costs of our independent registered public accounting firm to issue an opinion on the effectiveness of our internal control over financial reporting on an annual basis beginning with the year ending December 31, 2008. We also may incur higher costs for director and officer liability insurance.

 

Our Net Sales

 

We derive our net sales from two categories: subscriber-based revenues and revenues generated from search and advertising activities.

 

Subscriber-Based Revenues

 

We define subscriber-based revenues as fees and subscription amounts that we receive from our customers. These fees and subscription amounts are for subscriber-based activities, including the use of our proprietary technology platform and the use of, or access to, value-

added services and paid content. Our technology platform is used to create customized Internet portals and includes integration infrastructure, subscriber personalization capabilities, a content management and delivery system and a customer-branded video player and toolbar. Value-added services include hosted email services, which are designed to meet both consumer and small business client needs, and online security services, such as anti-virus protection, firewall and intrusion detection and pop-up blockers. Paid content includes premium online offerings from third parties, such as games and streaming and downloadable music and movies.

 

Monthly subscriber levels typically form the basis for calculating and generating subscriber-based revenues. They generally are determined by multiplying a per-subscriber per-month fee by the number of subscribers applicable to the particular services being offered or consumed. In certain cases, we charge a fixed monthly fee for specific services provided to the customer to form a base fee for the customer, in addition to the per-subscriber fees.

 

Subscriber-based revenues are recognized on a monthly basis as the applicable services or content is consumed by, or made available to, subscribers. We generally determine subscriber levels in conjunction with our customers. Several methodologies may be used to determine the number of subscribers in a particular month, including, for example, the number of subscribers on a particular day of the month or the average number of subscribers during the month. We typically follow the methodology our customers use to determine their own subscriber levels, and we then reconcile those levels with our own databases to determine the accurate subscriber levels for billing purposes. Our processes for determining subscriber levels are consistent across all of our subscriber-based services, including use of the technology platform, value-added services and paid content.

 

Search and Advertising Revenues

 

We use Internet search and advertising technologies to generate revenue from the traffic generated by our customers’ Internet portals. In the case of searches, we have a revenue-sharing relationship with Google, pursuant to which we typically include a Google-branded search tool on our customers’ portals. When a subscriber makes a search request using this tool, we deliver it to Google. Google returns search results to us that include advertiser-sponsored links. If the subscriber clicks on a sponsored link, Google receives payment from the sponsor of that link and shares a portion of that payment with us. We then typically share a portion of that payment with the applicable customer. We recognize our revenue share from Google monthly.

 

We generate advertising revenue when subscribers view or click on a text or display advertisement that we delivered. We typically recognize the revenue monthly from our advertising network partners, who manage the placement of advertising into our customers’ websites and other web pages that we control. Depending on the relationship between our advertising network partners and their advertisers, the revenue may be calculated on a cost per impression basis, which means the advertiser pays based on the number of times its advertisements appear, a cost per click basis, which means that an advertiser pays only when a subscriber clicks on one of its advertisements, or another methodology agreed upon by our partners and us.

 

As with search, we generally pay a share of the advertising revenue to those customers of ours who make their web sites available for the delivery of these advertisements. The revenue-sharing amounts to be paid by us generally take the form of variable payments based on a percentage of our advertising revenues and are paid monthly or quarterly in arrears. Revenue-sharing amounts are expensed as incurred.

Recent Net Sales Growth

 

Our total net sales grew from approximately $2.4 million in the year ended December 31, 2004 to approximately $26.3 million in the year ended December 31, 2006. The growth in net sales was due, in large part, to growth in our customer base and development of our portfolio of digital content and services. Net sales growth in 2006 was also due to the organic growth of our existing customers’ subscriber base and our improved ability to generate additional revenue from those subscribers.

 

Customers

 

As of March 31, 2007, we derived net sales from over 30 customers, a substantial portion of which comes from a small number of them. When combined with the search and advertising revenue associated with traffic generated from their websites, net sales from two customers, Charter and Time Warner (pursuant to the Adelphia legacy agreement only), together accounted for approximately 45.8% of our net sales for the three months ended March 31, 2007 and approximately 53.0% of our net sales the year ended December 31, 2006, with each of them accounting for more than 10.0% in each such period.

 

Critical Accounting Policies

 

The preparation of our financial statements requires us to make estimates, assumptions and judgments that affect the amounts reported in our financial statements and the accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates. While our significant accounting policies are described in more detail in the notes to our consolidated financial statements included in this prospectus, we believe the following accounting policies to be the most critical to the judgments and estimates used in the preparation of our consolidated financial statements.

 

Revenue Recognition

 

We recognize net sales in accordance with SEC Staff Accounting Bulletin No. 104, Revenue Recognition, or SAB 104. SAB 104 requires that four basic criteria must be met prior to revenue recognition: (1) persuasive evidence of an arrangement exists, (2) delivery has occurred or the services have been rendered, (3) the fee is fixed and determinable and (4) collection of the resulting receivable is reasonably assured.

 

Certain of our arrangements contain multiple elements, consisting of the various services we offer. Multiple element arrangements typically consist of the use of our technology platform to deliver an Internet portal combined with the delivery of our value-added services and paid content. These arrangements are accounted for in accordance with Emerging Issues Task Force Issue No. 00-21, Revenue Arrangements with Multiple Deliverables, or EITF 00-21. In such arrangements, we have historically determined that each of the services made available to our customers constitutes a separate unit of accounting pursuant to the guidance set forth in EITF 00-21. In accordance with EITF 00-21, arrangement consideration is allocated to each unit based on its relative fair value. We have historically concluded that the stated rates charged for our services have been an accurate reflection of their fair values based on our own market knowledge and that of our customers and partners. Accordingly, we have utilized these stated rates for the purposes of allocating arrangement consideration to each of the accounting units. Although our process for the determination of stated rates is generally consistent among our various customer arrangements, our identification of accounting units and their relative fair value is separately made for each of our customer arrangements. Applicable revenue recognition criteria are separately considered for each unit of accounting once it and its relative fair value have been defined.

The terms of our arrangements with our customers, Google and our advertising network partners are specified in written agreements. These written agreements constitute the persuasive evidence of the arrangements with our customers that are a pre-condition to the recognition of revenue. The evidence used to document that delivery or performance has occurred generally consists of third-party communication of either numbers of subscribers or the revenue generated in a reporting period. Occasionally, a customer will notify us of subsequent adjustments to previously reported subscriber data. These adjustments, once accepted by us, will result in adjustments to net sales and cost of sales. The historical occurrences of such adjustments, and the amounts involved, have not been significant.

 

Although prices used in our revenue recognition formulas are generally fixed pursuant to the written arrangements with our customers, Google and our advertising network partners, the number of subscribers or the amount of search and advertising revenues that are subject to our pricing arrangements are not known until the reporting period has closed. Although this data is, in most cases, available prior to the completion of our periodic financial statements, this data may need to be estimated. When made, these estimates are based upon our historical experience with the relevant party. Adjustments to these estimates have historically not been significant. The receipt of this volume data also serves to verify that we have appropriately satisfied our obligation to our customers for that reporting period.

 

Pursuant to the terms of our customer contracts, we commence the accrual of net sales for our services once the contract has been signed, its terms reviewed and understood, the service, content or both have been made available to the customer and reliable information as to the number of subscribers using the service is made available to us.

 

We undertake an evaluation of the credit-worthiness of both new and, on a periodic basis, existing customers. Based on these reviews and our strong history of collections, we have determined that that collection of our calculated revenues is probable.

 

Revenue Sharing

 

As discussed above, we generally pay our customers a portion of the revenue generated from search and advertising. In accordance with Emerging Issues Task Force Issue No. 99-19, Reporting Revenue Gross as a Principal Versus Net as an Agent, the revenue derived from these arrangements that involve traffic supplied by customers is reported on a gross basis because we are the primary obligor in the arrangements, are involved in the determination of the service specifications, have discretion in supplier selection and bear credit risk.

 

Income Taxes

 

We account for income taxes using the liability method in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, or SFAS 109. We estimate our income tax liability through calculations we perform for the determination of our current income tax liability, together with assessing temporary differences resulting from the different treatment of items for income tax and financial reporting purposes. These differences result in deferred income tax assets and liabilities, which are recorded on our balance sheet. Management then assesses the likelihood that deferred income tax assets will be recovered in future periods. In assessing the need for a valuation allowance against the net deferred income tax asset, we consider factors such as future reversals of existing taxable temporary differences, taxable income in prior carryback years, if carryback is permitted under the tax law, tax planning strategies and future taxable income exclusive of reversing temporary differences and carryforwards. To the extent that we cannot conclude that it is more likely than not that the benefit of such assets will be realized, we establish a valuation allowance to adjust the net carrying value of such assets.

To date, we have recorded a full valuation allowance against our gross deferred income tax assets, principally NOL carryforwards, due to uncertainty regarding our ability to generate future taxable income. Any deferred income tax benefit or provision to date has been offset by changes in the valuation allowance against our deferred income tax assets. To the extent we determine that all or a portion of our valuation allowance is no longer necessary, we will recognize an income tax benefit in the period such determination is made for the reversal of the valuation allowance. Once the valuation allowance is eliminated, its reversal will no longer be available to offset our current income tax provision. These events could have a material impact on our reported results of operations.

 

As of December 31, 2006, we had approximately $33.1 million of federal and approximately $18.9 million of state NOL carryforwards, which begin to expire in 2018. The NOLs are subject to change of control limitations that generally restrict the utilization of the NOLs on an annual basis. Due to the uncertainty as to our ability to generate sufficient taxable income in the future and utilize the NOLs before they expire, we have recorded a valuation allowance to reduce the net deferred income tax asset to zero. Our tax provision includes only the net income tax expense attributable to our operations outside of the United States, which was $14,000 in 2006.

 

In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, or FIN 48, an interpretation of SFAS 109. This interpretation clarifies the accounting for income taxes by prescribing that a company should use a more-likely-than-not recognition threshold based on the technical merits of the tax position taken. Tax provisions that meet the more-likely-than-not recognition threshold should be measured as the largest amount of tax benefits, determined on a cumulative probability basis, which is more likely than not to be realized upon ultimate settlement in the financial statements. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting for interim periods, disclosure and transition, and explicitly excludes income taxes from the scope of Statement of Financial Accounting Standards No. 5, Accounting for Contingencies. FIN 48 is effective for fiscal years beginning after December 15, 2006, and was adopted by us on January 1, 2007. As of March 31, 2007, we had gross unrecognized tax benefits of approximately $300,000, which may reduce our NOLs in the future. We file income tax returns in the U.S. federal jurisdiction and various states and foreign jurisdictions. For income tax returns filed by us, we are no longer subject to U.S. federal, state and local tax examinations by tax authorities for years before 2002, although carryforward tax attributes that were generated prior to 2002 may still be adjusted upon examination by tax authorities if they either have been or will be utilized. It is our policy to recognize interest and penalties related to income tax matters in income tax expense.

 

Stock-Based Compensation

 

Prior to January 1, 2006, we accounted for stock option grants in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, or APB 25, and complied with the disclosure provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock Based Compensation, or SFAS 123, as amended by Statement of Financial Accounting Standards No. 148, Accounting for Stock Based Compensation—Transition and Disclosure, or SFAS 148. Under APB 25, deferred stock-based compensation expense is recorded for the intrinsic value of options (the difference between the deemed fair value of our common stock and the option exercise price) at the grant date and is amortized ratably over the option’s vesting period.

 

On January 1, 2006, we adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123R, Share-Based Payment, or SFAS 123R, which requires us to measure the cost of employee services received in exchange for an award of equity instruments, based on the fair value of the award on the date of grant, and to recognize the cost over the period during which the employee is required to provide services in exchange for

the award. We adopted SFAS 123R using the modified prospective transition method and, therefore, have not restated results for prior periods. Under this transition method, stock-based compensation expense is recorded for the unvested portion of previously issued awards that remain outstanding at January 1, 2006 using the same estimate of grant date fair value and the same attribution method used to determine the pro forma disclosure under SFAS 123.

 

Subsequent to the adoption of SFAS 123R, we estimate the fair value of our stock-based awards on the date of grant using the Black-Scholes option-pricing model. The determination of fair value using the Black-Scholes model requires a number of complex and subjective variables. One key input into the model is the estimated fair value of our common stock on the date of grant. For periods prior to May 1, 2006, we performed an internal valuation analysis to determine the fair value of our common stock in connection with granting stock options to employees. This analysis used our projected future cash flows, discounted at a rate that reflects both our weighted average cost of capital and the lack of liquidity of our stock, and an implied market value analysis based on the stock price performance of our most comparable public peers (as determined by management) within the Internet service provider enabler industry. Beginning May 1, 2006, we determined the fair value of our common stock with the assistance of valuations by an unrelated valuation specialist. The valuations used valuation methods commonly used in the valuation of private company equity securities for purposes of estimating the fair value of their common stock.

 

Other key variables in the Black-Scholes option-pricing model include the expected volatility of our common stock price, the expected term of the award and the risk-free interest rate. We determined that, as a private company, it was not practicable to estimate the volatility of our stock price, based on our low frequency of price observations. Therefore, expected volatilities were based on a volatility factor computed based upon an external peer group analysis of publicly traded companies based in the United States within a predetermined market capitalization range. The analysis provided historical and implied volatilities of the public comparables and developed an estimate of constant expected volatility for us. The expected term for options prior to January 1, 2006 is 10 years. For options granted subsequent to December 31, 2005, the expected term is 6.5 years consistent with the simplified method. The risk free interest rate was based on the implied yield available at the time the options were granted on U.S. Treasury zero coupon issues with a remaining term equal to the expected term of the option. The expected dividend yield is 0% for all periods presented, based upon our historical practice of electing not to declare or pay cash dividends on our common stock. In addition, under SFAS 123R, we are required to estimate forfeitures of unvested awards when recognizing compensation expense. If factors change and we employ different assumptions in the application of SFAS 123R in future periods, the compensation expense we record may differ significantly from what we have recorded during 2006 and the three months ended March 31, 2007.

 

As of December 31, 2006, the unrecognized compensation expense related to unvested stock-based awards granted prior to that date, for which vesting is probable, was approximately $241,000. These expenses are expected to be recognized over a weighted average period of 1.6 years.

 

We expect stock-based compensation expense to increase in absolute dollars as a result of the adoption of SFAS 123R as options that were granted at the beginning of 2006 and beyond vest and we continue to grant new options to employees. The actual amount of stock-based compensation expense we record in any fiscal period will depend on a number of factors, including the number of shares subject to the stock options issued, the fair value of our common stock at the time of issuance and the expected volatility of our stock price over time.

Results of Operations

 

The following table sets forth selected consolidated statements of operations data as a percentage of total net sales for each of the periods indicated.

 

 

 

 

Comparison of Three Months Ended March 31, 2006 and 2007

 

Net Sales.  Our total net sales increased by approximately $2.8 million, or 48%, to approximately $8.7 million for the three months ended March 31, 2007 from approximately $5.9 million for the same period in 2006. Subscriber-based net sales increased approximately $0.8 million, or 24%, to approximately $4.1 million in the three months ended March 31, 2007 from approximately $3.3 million for the same period in 2006. The increase was largely driven by the addition of new customers and an increase in the number of our existing customers’ subscribers. Search and advertising net sales increased by approximately $2.0 million, or 80%, to approximately $4.6 million for the three months ended March 31, 2007 from approximately $2.5 million for the same period in 2006, primarily as a result of increases in the traffic on our customers’ portals, the number of searches, the revenue per search and the number of display advertising impressions.

 

Cost of Sales.  Cost of sales consists of revenue-share costs, vendor content acquisition costs and infrastructure costs. Revenue-share and vendor content acquisition costs may be based on a percentage of our revenue, on a fixed fee schedule, on the number of subscribers per month or any combination of the foregoing. Percentage of revenue arrangements are expensed as incurred based on the revenue earned during the relevant accounting period. Fixed fee arrangements are expensed ratably over the term of the contract or on a forecasted per subscriber use basis. Fees based on the number of subscribers are expensed based on the

number of subscribers having access to the specific content during the relevant accounting period.

 

Our cost of sales increased by approximately $1.7 million, or 48%, to approximately $5.1 million for the three months ended March 31, 2007 from approximately $3.5 million for the same period in 2006. The increase was proportional to the increase in our net sales and reflected increased revenue sharing, vendor content acquisition and various support costs necessary to meet the larger sales volume. Cost of sales as a percentage of net sales also remained consistent at 59%.

 

Research and Development Expenses.  Research and development expenses include costs incurred for product development, including the development of and enhancements to our technology platform and related infrastructures, and customer and content integration. These expenses consist primarily of compensation and related costs for personnel associated with research and development activities.

 

Research and development expenses increased by approximately $0.4 million, or 37%, to approximately $1.4 million for the three months ended March 31, 2007 from approximately $1.0 million for the same period in 2006. The increase was due primarily to increased headcount to support new product initiatives and customer deployments. As a percentage of net sales, research and development expenses declined to 16% of sales in the three months ended March 31, 2007 from 17% of net sales in the three months ended March 31, 2006.

 

Sales and Marketing Expenses.  Sales and marketing expenses consist primarily of salaries, benefits, commissions and bonuses paid to our direct sales and marketing personnel, as well as costs related to advertising, industry conferences, promotional materials and other sales and marketing programs. We expense advertising as incurred.

 

Sales and marketing expenses increased by approximately $941,000 to approximately $1.7 million for the three months ended March 31, 2007 from approximately $0.7 million for the same period in 2006 primarily as a result of the hiring of a new direct salesperson and additional marketing personnel and the launch of new marketing programs during the last half of 2006 and the first quarter of 2007.

 

General and Administrative Expenses.  General and administrative expenses consist primarily of salaries and related expenses for executive management, finance, accounting, human resources and other administrative functions, as well as professional fees, overhead, rent and expenses incurred for general corporate purposes.

 

General and administrative expenses increased by approximately $317,000, or 35%, to approximately $1.2 million for the three months ended March 31, 2007 from approximately $0.9 million for the same period in 2006 due largely to higher rent and occupancy expenses for our new headquarters, increased audit fees and additional headcount in our finance and human resources departments. As a percentage of sales, general and administrative expenses declined to 14% of net sales in the three months ended March 31, 2007 from 16% of net sales in the same period in 2006 as sales growth outpaced spending for the first quarter of 2007 as compared to the first quarter of 2006.

 

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

 

Depreciation and amortization increased by approximately $195,000 to approximately $273,000 for the three months ended March 31, 2007 from approximately $78,000 for the same period in 2006 due principally to our acquisition of additional equipment to support the addition of new customers.

Other Income.  Other income consists primarily of interest income on cash deposits. Other income increased to approximately $180,000 for the three months ended March 31, 2007 from approximately $22,000 for the same period in 2006 due largely to the investment of the proceeds from the sale of Series C preferred stock in October 2006.

 

Interest Expense.  Interest expense increased to approximately $44,000 for the three months ended March 31, 2007 from approximately $37,000 for the same period in 2006 primarily as a result of additional capital lease obligations.

 

Provision for Income Taxes.  We have incurred operating losses since our inception and, consequently, did not incur any federal or state income taxes for the three months ended March 31, 2006 and 2007. We have a deferred income tax asset at March 31, 2007 of approximately $13.8 million, resulting primarily from NOLs. Due to uncertainty as to our ability to generate sufficient taxable income in the future to utilize these deferred tax assets, we have recorded a valuation allowance for their full amount at March 31, 2007. We do not anticipate recording significant tax benefits or provisions in the near future.

 

Net Loss.  Based on the factors described above, our net loss for the three months ended March 31, 2007 was approximately $820,000, which was approximately $523,000 greater than our net loss for the same period in 2006.

 

Comparison of Years Ended December 31, 2005 and 2006

 

Net Sales.  Our total net sales increased by approximately $12.0 million, or 84%, to approximately $26.3 million in 2006 from approximately $14.3 million in 2005. Subscriber-based net sales increased approximately $3.9 million, or 43%, to approximately $12.9 million in 2006 from approximately $9.0 million in 2005. The increase was largely driven by the addition of new customers and an increase in the number of our existing customers’ subscribers. Search and advertising net sales increased by approximately $8.1 million to approximately $13.4 million in 2006 from approximately $5.3 million in 2005, primarily as a result of increases in the traffic on our customers’ portals, the number of searches, the revenue per search and the number of display advertising impressions.

 

Cost of Sales.  Cost of sales increased by approximately $7.5 million to approximately $15.3 million in 2006 from approximately $7.8 million in 2005. Cost of sales also increased as a percentage of net sales to 58% in 2006 from 54% in 2005. Cost of sales increased at a rate greater than the growth of net sales primarily because of an increase in revenue-share costs and vendor content acquisition costs.

 

Research and Development Expenses.  Research and development expenses increased by approximately $1.7 million, or 63%, to approximately $4.3 million in 2006 from approximately $2.6 million in 2005, primarily as a result of increased headcount to support new product initiatives and customer deployments. As a percentage of net sales, research and development expenses declined to 16% in 2006 from 18% in 2005.

 

Sales and Marketing Expenses.  Sales and marketing expenses increased by approximately $1.7 million, or 78%, to approximately $3.9 million in 2006 from approximately $2.2 million in 2005, primarily as a result of the hiring of our Vice President of Marketing and other marketing personnel and the launch of new marketing programs during the second half of 2006.

 

General and Administrative Expenses.  General and administrative expenses increased by approximately $2.4 million to approximately $4.7 million in 2006 from approximately $2.3 million in 2005 and increased to 18% of net sales in 2006 from 16% of net sales in 2005. The increase was due largely to additional headcount, increased occupancy expenses resulting from the relocation of our corporate headquarters, including higher rent and build-out costs,

increased audit fees, increased recruiting expenses for key personnel, and the establishment of an allowance for doubtful accounts.

 

Depreciation and Amortization.  Depreciation and amortization for 2006 increased to approximately $465,000 from approximately $177,000 in 2005 due principally to our acquisition of additional computing equipment to support new customers and growth in our existing customers’ subscriber bases, including a network operating center. We also acquired computing equipment to accommodate our increased headcount.

 

Loss on Extinguishment of Debt.  We recognized an approximately $32,000 loss on extinguishment of debt in 2006 attributable to our early repayment of notes payable with the proceeds from the sale of our Series C preferred stock. The notes were originally due in November 2007 and were repaid in October 2006.

 

Other Income.  Other income increased to approximately $279,000 in 2006 from approximately $93,000 in 2005 due largely to the investment of the proceeds from the sale of Series C preferred stock in October 2006.

 

Interest Expense.  Interest expense increased to approximately $132,000 in 2006 from approximately $117,000 in 2005, primarily as a result of additional capital lease obligations.

 

Provision for Income Taxes.  We did not accrue federal or state income taxes for 2005 or 2006. We did, however, accrue approximately $14,000 of income tax expenses for 2006 related to foreign income taxes. We had a deferred income tax asset at December 31, 2006 of approximately $13.8 million, resulting primarily from stock and other compensation expense and NOLs. Due to uncertainty as to our ability to generate sufficient taxable income in the future to utilize these deferred tax assets, we have recorded a valuation allowance for their full amount at December 31, 2006. We do not anticipate recording significant tax benefits or provisions in the near future.

 

Net Loss.  Based on the factors described above, our net loss for 2006 was approximately $2.3 million, which was $1.5 million greater than our net loss in 2005.

 

Comparison of Years Ended December 31, 2004 and 2005

 

Net Sales.  Our total net sales increased by approximately $12.0 million to approximately $14.3 million in 2005 from approximately $2.4 million in 2004. Subscriber-based net sales increased to approximately $9.1 million in 2005 from approximately $2.2 million in 2004. The increase was largely driven by the addition of new customers and an increase in the number of our existing customers’ subscribers. Search and advertising net sales increased to approximately $5.3 million in 2005 from approximately $0.2 million in 2004. The significant increase occurred because 2005 was the first year in which we made search advertising technologies widely available on our customers’ websites.

 

Cost of Sales.  Cost of sales increased by approximately $6.5 million to approximately $7.8 million in 2005 from approximately $1.2 million in 2004. Cost of sales also increased as a percentage of net sales to 54% in 2005 from 52% in 2004. Cost of sales increased at a rate greater than the growth of net sales primarily because of an increase in revenue-share costs and vendor content acquisition costs.

 

Research and Development Expenses.  Research and development expenses increased by approximately $1.3 million, or 92%, to approximately $2.6 million in 2005 from approximately $1.4 million in 2004, primarily as a result of the hiring of additional technical and engineering personnel. As a percentage of net sales, research and development expenses declined to 18% of sales in 2005 from 57% in 2004.

 

Sales and Marketing Expenses.  Sales and marketing expenses increased by approximately $0.8 million, or 58%, to approximately $2.2 million in 2005 from approximately

$1.4 million in 2004, primarily as a result of the addition of client services personnel. As a percentage of net sales, sales and marketing expenses declined to 15% of net sales in 2005 from 59% of net sales in 2004 due to the growth in net sales.

 

General and Administrative Expenses.  General and administrative expenses increased by approximately $1.2 million to approximately $2.3 million in 2005 from approximately $1.1 million in 2004, largely because of the hiring of additional personnel in our finance and human resources departments. As a percentage of net sales, general and administrative expenses declined to 16% of net sales in 2005 from 47% of net sales in 2004 due to growth in net sales.

 

Depreciation and Amortization.  Depreciation and amortization decreased to approximately $177,000 in 2005 from approximately $191,000 in 2004 due to an increase in the useful lives of certain assets, principally computing equipment, which was partially offset by the acquisition of additional equipment.

 

Other Income.  Other income increased to approximately $93,000 in 2005 from approximately $27,000 in 2004 due largely to increased invested cash and cash equivalents balances. Those balances were higher as a result of the sale of shares of our Series B preferred stock in October 2004.

 

Interest Expense.  Interest expense increased to approximately $117,000 in 2005 from approximately $77,000 in 2004, primarily as a result of additional capital lease obligations.

 

Provision for Income Taxes.  We did not incur federal or state income taxes for 2004 or 2005. We had a deferred income tax asset at December 31, 2005 of approximately $13.2 million, resulting primarily from stock and other compensation expense and NOLs. Due to uncertainty as to our ability to generate sufficient taxable income in the future to utilize these deferred tax assets, we have recorded a valuation allowance for their full amount at December 31, 2005. We do not anticipate recording significant tax benefits on provisions in the near future.

 

Net Loss.  Based on the factors described above, our net loss for 2005 was approximately $0.8 million, which was approximately $2.2 million, or 74%, less than our net loss in 2004.

Quarterly Results of Operations

 

The following tables set forth selected unaudited quarterly consolidated statement of operations data for each of the quarters indicated. The consolidated financial statements for each of these quarters have been prepared on the same basis as the audited consolidated financial statements included in this prospectus and, in the opinion of management, include all adjustments necessary for the fair presentation of the consolidated results of operations for these periods. You should read this information together with our consolidated financial statements and related notes included elsewhere in this prospectus. These quarterly operating results are not necessarily indicative of the results for any future period.

 

 

 

 

Over the nine quarters presented in the table above, net sales have generally increased due primarily to the addition of new customers and an increase in the number of subscribers of our existing customers. As the number of our customers’ subscribers increased, the subscriber-based fees we earned for the use of our technology platform, value-added services and paid content also increased. A larger number of subscribers also resulted in greater traffic on customers’ web sites, which resulted in increased search and advertising revenue for us. In addition, we increased the revenue generated per subscriber by selling increasing amounts of value-added services and paid content.

 

Cost of sales as a percentage of net sales increased in each of the quarters in 2005 from 41% to 64% as we expanded our portfolio of value-added services and paid content to sell to subscribers. Cost of sales as a percentage of net sales then leveled off at 59% for the first two quarters of 2006. It decreased to 52% in the third quarter of 2006 because non-recurring engineering fees, or NREs, contributed to an increase in our net sales for that quarter. The NREs were fees for professional services that we rendered to a customer on a special project basis in connection with enhancements to the customer’s portal and premium content delivery system. Cost of sales as a percentage of net sales then increased to 63% in the fourth quarter

before returning to 59% in the first quarter of 2007. The increase in the fourth quarter was due to the cessation of the NREs upon completion of the special project and increased contractual commitments to customers.

 

On an absolute basis, total expenses from operations increased significantly in each of the nine quarters presented due primarily to increased cost of net sales and increased headcount. Additional sales and marketing expenses related to the launch of new marketing campaigns also drove the increases in the fourth quarter of 2006 and the first quarter of 2007.

 

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, cash from short-term borrowings and the net proceeds from this offering are insufficient to fund our future activities, we may need to raise additional funds through public or private equity offerings or debt financings.

 

Since our inception, we have funded our operations and met our capital expenditure requirements primarily with venture capital funding. In four separate issuances of preferred stock, from Series A in November 2002 to Series C in October and November 2006, we have raised approximately $28.9 million from institutional investors. The proceeds from all of these issuances have been used for general business purposes, with the exception of the Series C preferred stock offering, a portion of which was used to repay approximately $700,000 of notes payable. Each share of preferred stock is convertible into common stock at the respective conversion ratio for each series of preferred stock at any time, subject to adjustment triggered by changes in our capitalization such as a stock split. Conversion is automatic in the event of a public offering of common stock at a price per share representing a post-offering valuation (on a fully diluted basis) of at least $150.0 million with gross proceeds of at least $25.0 million. This conversion of all our outstanding series of preferred stock is expected to take place upon consummation of this offering.

 

As of March 31, 2007, we had approximately $12.7 million of cash and cash equivalents. We have invested a substantial portion of our available funds in money market funds for which credit loss is not anticipated. The primary objective of our investment activities is to preserve principal while maximizing income received from our investments.

 

We believe that our existing cash and cash equivalents and the net proceeds from this offering will be sufficient to meet our anticipated working capital and capital expenditure requirements for at least the next 12 months.

 

Cash Flows

 

Operating Activities

 

We have historically experienced negative cash flows from operating activities as we continue to expand our business and build our infrastructure. Cash flows from operations will continue to be affected primarily by the extent to which we increase personnel, primarily in research and development and sales and marketing, to grow our business. Our largest source of cash flows from operating activities is cash collections from customers. Our primary uses of cash from operating activities are for revenue-share and content acquisition costs, personnel related expenditures, facilities expenses and research and development costs to support our sales growth.

 

Net cash used in operating activities was approximately $2.0 million for the three months ended March 31, 2007 as compared to approximately $0.5 million for the same period in 2006,

for an increase of approximately $1.5 million. The increase was primarily attributable to increased trade receivables corresponding with the increase in our net sales, combined with headcount increases that resulted in increased payroll accruals. We also experienced an increase in unearned revenues as of March 31, 2007 as compared to March 31, 2006.

 

Net cash used in operating activities was approximately $1.9 million for the year ended December 31, 2006 as compared to approximately $1.2 million for the year ended December 31, 2005, for an increase of approximately $0.7 million, or 58%. The increase was primarily attributable to increased trade receivables corresponding with increased sales volumes for 2006.

 

Net cash used in operating activities was approximately $1.2 million for the year ended December 31, 2005 as compared to approximately $2.5 million for the year ended December 31, 2004, for a decrease of approximately $1.3 million, or 52%. The decrease was primarily the result of increased sales volume, combined with expenses for 2005 that were a lower percentage of net sales as compared to expenses in 2004.

 

We have incurred losses from operations during each of the last three years as a result of our continued research and development and sales and marketing activities. We anticipate continued losses from operations in the near future until our development efforts result in significant revenues and operating income.

 

Investing Activities, Including Capital Expenditures

 

For the three months ended March 31, 2007, net cash used in investing activities was approximately $0.4 million, as compared to net cash used in investing activities for the three months ended March 31, 2006 of approximately $0.2 million, representing an increase of approximately $0.2 million. The increase was largely due to increased purchases of property and equipment. We anticipate continuing to expend significant amounts for fixed assets in the near future as we continue to invest in equipment necessary for our research and development activities. We anticipate approximately $1.7 million, including amounts we expect to finance, of capital expenditures in 2007.

 

For the year ended December 31, 2006, net cash used in investing activities was approximately $1.9 million as compared to net cash used in investing activities of approximately $0.5 million for the year ended December 31, 2005, for an increase of approximately $1.4 million. Similarly, net cash used in investing activities for the year ended December 31, 2005 represented an increase of approximately $0.2 million, or 67%, over net cash used in investing activities of approximately $0.3 million for the year ended December 31, 2004. In each year, the increase was largely due to increased purchases of property and equipment, primarily computer hardware.

 

Financing Activities

 

We have entered into a credit agreement with Bridge Bank, pursuant to which we can borrow under a revolving credit line of $1.5 million until February 2009. Borrowings under the revolving line of credit accrue interest at the prime rate plus a margin of 0.75% and must be repaid by February 2009. The credit agreement contains provisions that allow Bridge Bank to accelerate repayment of the borrowings on the revolving credit line upon occurrence of a material adverse change as defined in the agreement. The credit agreement also contains certain financial performance and reporting covenants. There were no outstanding borrowings under the revolving credit line as of March 31, 2007.

 

For the three months ended March 31, 2007, net cash used in financing activities was approximately $0.2 million as compared to approximately $44,000 for the three months ended

March 31, 2006, for an increase of approximately $156,000. This increase was largely due to payments on increased capital lease obligations.

 

For the year ended December 31, 2006, net cash provided by financing activities was approximately $16.4 million as compared to net cash used in financing activities of approximately $90,000 for the year ended December 31, 2005. This increase was primarily due to the receipt of gross proceeds of approximately $17.2 million from the sale of our Series C preferred stock in the fourth quarter of 2006. The primary use of cash for financing activities in the year ended December 31, 2005 was to repay capital lease obligations and notes payable.

 

For the year ended December 31, 2005, net cash used in financing activities was approximately $90,000 as compared to net cash provided by financing activities of approximately $5.5 million for 2004. This change was primarily due to the receipt of gross proceeds of approximately $5.5 million from the sale of our Series B preferred stock in 2004.

 

Quantitative and Qualitative Disclosures about Market Risk

 

Our cash, cash equivalents and short-term investments as of March 31, 2007 consisted primarily of money market funds. Our primary exposure to market risk is interest income sensitivity, which is affected by changes in the general level of U.S. interest rates, particularly because the majority of our investments are in short-term marketable securities. The primary objective of our investment activities is to preserve principal while maximizing the income we receive from our investments. Due to the short-term duration of our investment portfolio and the low risk profile of our investments, an immediate 10% change in interest rates would not have a material effect on the fair market value of our portfolio. In general, money market funds are not subject to market risk because the interest paid on such funds fluctuates with the prevailing interest rate.

 

Contractual Obligations

 

The following table describes our long-term contractual obligations and commitments as of December 31, 2006:

 

 

Contractual Commitments

 

Contractual commitments include fixed payments that we are required to make to certain of our customers and content providers pursuant to our agreements with them. These payments are typically made on monthly or quarterly basis and are not contingent on the achievement of any revenue objectives or subscriber or usage levels.

 

Operating and Capital Lease Obligations

 

Our principal lease commitments consist of obligations under leases for office space and computer and telecommunications equipment. We finance the purchase of some of our computer equipment under a capital lease arrangement over a period of 36 months. The capital lease obligations shown above include the current portion of our liabilities and imputed interest.

Purchase Obligations

 

Our purchase orders are normally based on our current needs and are fulfilled by our vendors within short time horizons. We do not have significant agreements specifying minimum quantities or set prices that exceed our expected requirements in the short-term. We also enter into contracts for outsourced services; however, the obligations under these contracts are not significant and the contracts generally contain clauses allowing for cancellation without significant penalty.

 

Off-Balance Sheet Arrangements

 

As of March 31, 2007, we did not have any off-balance sheet arrangements.

 

Recently Issued Accounting Pronouncements

 

In June 2006, the FASB issued FIN 48, which clarifies the accounting for uncertainty in income taxes and reduces the diversity in current practice associated with the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return by defining a more-likely-than-not threshold regarding the sustainability of the position. Effective January 1, 2007, we adopted FIN 48. Based upon our analysis, we believe that all of our open tax positions are more-likely-than-not to be sustained upon examination. Additionally, we have determined that the amount of tax benefits recognized in the Company’s financial statements at January 1, 2007 are already reflective of the largest amount that is greater than 50 percent likely of being recognized upon the ultimate settlement with a taxing authority. Accordingly, the adoption of FIN 48 had no impact on our consolidated financial statements.

 

In September 2006, the SEC issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, or SAB 108. SAB 108 provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of determining whether the current year’s financial statements are materially misstated. SAB 108 became effective for us in 2006 and its adoption did not have a material impact on our consolidated financial statements.

 

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements, or SFAS 157. SFAS 157 provides guidance for using fair value to measure assets and liabilities. SFAS 157 serves to clarify the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect that fair-value measurements have on earnings. SFAS 157 is to be applied whenever another standard requires or allows assets or liabilities to be measured at fair value. We will be required to adopt SFAS 157 effective January 1, 2008. We are currently evaluating the impact that the adoption of SFAS 157 will have on our consolidated financial statements.

 

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115, or SFAS 159. SFAS 159 provides entities with an option to choose to measure eligible items at fair value at specified election dates. If elected, an entity must report unrealized gains and losses on the item in earnings at each subsequent reporting date. The fair value option may be applied instrument by instrument, with a few exceptions, such as investments otherwise accounted for by the equity method, is irrevocable (unless a new election date occurs), and is applied only to entire instruments and not to portions of instruments. We will be required to adopt SFAS 159 effective January 1, 2008. We are currently evaluating the impact that the adoption of SFAS 159 will have on our financial statements.

 

We provide an Internet platform and a portfolio of digital content and services that enable broadband service providers, such as MSOs, Telcos and ISPs, to create a compelling online experience for their subscribers. Our platform is used to create customized Internet portals and includes integration infrastructure, subscriber personalization capabilities, a content management and delivery system and a customer-branded video player and toolbar. Our platform also aggregates free and paid digital content and value-added services, including video, from third-party providers to create a customized and branded Internet portal solution. We deliver a seamless subscriber experience by integrating these services and products with existing customer billing and management systems, thereby allowing our customers to extend their brands and enhance their subscriber relationships. We believe our solution assists our customers in promoting subscriber retention, increasing ARPU and cultivating new revenue streams.

 

Industry Background

 

Growth of the Internet and Broadband Access

 

The Internet has emerged as a global digital medium for content, communications, advertising and commerce. According to IDC, the number of households with Internet access in 2006 was approximately 72.3 million in the United States and 306.7 million globally. The U.S. consumer Internet access market has evolved from a market in which the Internet was primarily accessed through narrowband or dial-up access to one in which consumers are able to access the Internet through a variety of high-speed or broadband access technologies. IDC estimates that the number of broadband Internet subscribers in the United States will increase from 56.3 million in 2006 to 91.5 million in 2011, while the total number of broadband subscribers globally will increase from 232.7 million in 2006 to 386.6 million in 2011. At the same time, IDC projects that narrowband subscribers in the United States will decrease from 21.2 million in 2006 to 7.8 million in 2011. In addition, as broadband access speeds, particularly download speeds, continue to increase, the overall quality of the subscriber’s online experience will improve significantly and subscribers will access and consume an increasing amount of digital content that requires higher bandwidth.

 

The broadband Internet access market in the United States consists primarily of MSOs, offering cable modem-based broadband Internet access, and Telcos, offering digital subscriber line, or DSL-based broadband Internet access. A range of new technologies and providers are also emerging that represent future broadband access alternatives. These new technologies include various fixed-line and wireless Internet access standards, such as Metro Ethernet Internet Access, or MEIA, WiMax, fixed wireless, satellite, broadband over power lines and Wi-Fi. The table below provides recent IDC U.S. subscriber projections for categories of Internet access technologies.

 

U.S. Broadband Services Subscriptions by Technology, 2006-2011

 

 

 

Source: IDC, 2007

 

New and Increasing Competition for Broadband Access Subscribers

 

The broadband access market has become increasingly competitive in recent years due to the commoditization of Internet access, pricing pressure, evolving consumer demand and the advent of competing new access technologies. Against this backdrop and in an attempt to increase sales, customer loyalty and differentiation, MSOs and Telcos have expanded beyond traditional core service offerings of television and voice, respectively, to offer “triple-play” (fixed-line voice, television and broadband Internet access) and, in some cases, “quadruple-play” (fixed-line voice, television and broadband Internet access plus mobile communications) packages of services, which has put MSOs and Telcos in direct competition with one another. At the same time, Internet media and technology companies such as AOL, Google, Microsoft and Yahoo! have assembled large, loyal online audiences, powerful brands and growing suites of digital content and service offerings, are competing against traditional media and telecommunications companies for consumer loyalty and spending, and are emerging as a potential competitive threat for incumbent MSOs and Telcos. These competitive dynamics are further pressuring broadband service providers to evolve from being providers of basic voice, television and Internet access services to becoming integrated providers of digital content and service offerings.

 

Higher Demand for Digital Content and Services

 

The rapid increase in Internet usage has been characterized by the growing adoption of online communications, e-commerce and digital content and services. The Internet has become an important consumption and distribution platform for digital content and services, with Internet users spending increasing amounts of time and money online and engaging in a broad range of activities including entertainment, social networking, shopping and commerce. According to Frost & Sullivan, the U.S. residential online paid content and services market, which includes music, online games and video, is projected to grow from $3.1 billion in 2006 to $8.8 billion in 2011. Content providers, including television networks, music labels, movie studios, newspapers and other traditional and new media companies have recognized the growth potential of the Internet as an additional, important distribution channel for their content. As a result, they are increasingly focused on marketing their vast libraries of content through the Internet by developing focused online and digital marketing strategies.

 

Increased Importance of Internet Advertising and Search

 

As digital media consumption, commerce and overall usage grow across the Internet, advertisers are shifting a greater proportion of their marketing budgets online. According to IDC, online advertising spending in the United States reached $16.9 billion in 2006, an increase of 35% versus 2005, and is projected to increase to $31.4 billion by 2011, including online search advertising revenues of $10.1 billion. Online search and display advertising have emerged as the largest components of online advertising, in large part because they allow advertisers to reach a targeted audience. Internet companies, such as Google and Yahoo!, have taken advantage of the strong growth in search-based advertising spending by forming advertising syndication networks that have acquired a sizeable share of the Internet search volume. The syndication network model has created opportunities for Internet sites with strong web traffic to partner with online advertising networks to monetize their traffic using many forms of advertising, including banners, animation, streaming video, special effects and user interactivity.

 

Emergence of the Digital Home and Access to On-Demand, Cross-Platform Digital Media

 

The proliferation of broadband Internet access has fundamentally changed the way that consumers access and interact with media content and Internet-based services. Consumers can now access the Internet from a range of different devices including personal computers,

television sets, personal multimedia players and mobile phones. They are increasingly using these devices to get on-demand access, and to download, consume, transport and share music, video, games and other content. As a result, there is an emerging trend towards convergence of digital media within the residence. For broadband service providers, the challenge is no longer about owning the viewership of one device, but rather to “own the digital home.” They are responding to this trend by expanding their offerings beyond their traditional focus areas. Telcos and MSOs have invested heavily over the past decade to upgrade their existing telecommunications and cable networks to support enhanced voice communications, digital television programming and broadband Internet access, and are offering bundled packages of services and content in an attempt to cross-sell services and products to existing customers.

 

Advances in home networking technologies and the increased adoption of new media are helping accelerate the emergence of the digital home. Consumers are increasingly using their home networks to access multimedia, such as streaming video, music and online content from multiple platforms, including personal computers, stereos, home theater systems and a variety of Internet-enabled networked devices. The network-enabled personal computer has become a center for media, entertainment, communication and social interaction, with user-generated content, email, instant messaging and social networking proliferating alongside professionally-created content and media. The television has also evolved to become a digital entertainment hub, enabling consumers to access a broad range of on-demand programming through the set top box. IDC forecasts that the number of network-enabled video devices, one of the key building blocks of this “digital home,” will grow from 1.6 million units in the United States in 2006 to 45.3 million units in 2011, a CAGR of 96%. The market for digital home services, such as digital television services delivered over the Internet, or IPTV, is also expected to grow rapidly. According to eMarketer, the worldwide number of IPTV subscribers is projected to increase from 4.9 million in 2006 to 41.1 million in 2011, a CAGR of 53%.

 

Challenges for Broadband Service Providers

 

Differentiating Service Offerings in a Highly Competitive Environment

 

In order to maintain and grow their subscriber bases and effectively compete in the current environment, broadband service providers are seeking to provide a differentiated solution—in particular, compelling digital content and value-added online services—that can help promote subscriber retention and increase their ARPU. The increasing consumption of new media segments, such as the Internet, has prompted broadband service providers to begin extending their subscriber offerings to include a variety of online services. In doing so, broadband service providers have found it difficult to differentiate themselves and move from providing core Internet access to becoming relevant to the subscriber’s online experience, as this requires competing with well-established Internet portals and online content providers. To succeed in this highly competitive environment, broadband service providers need to deliver a subscriber experience that is simple, personalized, engaging and valuable. As a result, broadband service providers seek to offer a broad portfolio of digital content and services coupled with personalization and other advanced features bundled into an integrated offering.

 

Offering a Compelling Suite of Digital Content and Services

 

Because broadband service providers have not traditionally focused on providing online content and services, they may not have the expertise required to provide a seamless user experience integrating a broad range of online offerings. Constantly changing subscriber needs and tastes and rapidly evolving technology, coupled with the difficulty of delivering a digital media experience, create technical and management challenges for companies seeking to deliver these offerings. For example, while MSOs have benefited from a broad network of relationships with media companies, they have not historically been able to couple online

media offerings with their television offerings. In addition, although MSOs have been successful in delivering content to subscribers, they do not generally have the necessary expertise or relationships to enable them to aggregate and deliver online content in packages that subscribers perceive as valuable. The volume of content offerings available on the Internet presents an added challenge as subscribers now have a greater variety of choices online than those offered through traditional media such as television and radio.

 

Integrating Existing Subscriber Management and Billing Systems

 

To provide a seamless online experience for their subscribers, it is important for broadband service providers to achieve integration at the user interface by making content and subscriptions customizable across different platforms, and at the back-end by synchronizing subscriber management and billing systems and processes. Because the back-end processes for traditional versus online services vary considerably, they require a high degree of customization to achieve integration across systems. Broadband service providers require a carrier-grade Internet platform that easily interacts with existing systems and reduces information technology, or IT, and other operational costs. In order to implement efficient and flexible solutions on a timely basis, broadband service providers must either use solutions from third-party vendors or develop their own solutions. As the Internet evolves and new online technologies emerge, broadband service providers that choose to develop their own solutions will increasingly face challenges in keeping up with the technological changes required to deliver online solutions while continuing to maintain integration with the rest of their IT systems.

 

Acquiring Technical Expertise and Experience

 

We believe that most broadband service providers lack the necessary expertise to develop and deploy a technology platform that can efficiently deliver a wide range of online content and services to their subscribers. This is due, in part, to their focus on network infrastructure, their core competency, which prevents them from dedicating the resources necessary to develop a scalable technology platform capable of delivering an integrated, cost-effective package of online content and services to multiple devices. To achieve these capabilities, broadband service providers would need to invest significant capital to acquire or build a technology platform, train specialized personnel and conduct the ongoing research and development required to keep up with technological advances.

 

Extending and Strengthening Brand

 

Broadband service providers are challenged to extend and strengthen their brand beyond the core Internet access market. We believe that providing a compelling online experience is critical to strengthening relationships with subscribers and building and extending a brand identity as the media provider to the digital home. Established portal providers typically insist on co-branding or their own branded solution in order to promote their own brands, which limits the flexibility offered to the broadband service providers and makes it more difficult for them to build and maintain a strong brand image. While this approach provides the broadband service providers with a broad roster of digital content and services, it can also result in dilution to their brand in the online domain.

 

Increasing Presence in the Digital Home

 

With the growing importance of the converged digital home that utilizes access to triple- and quadruple-play services, broadband service providers must respond to consumer demand for on-demand access to digital content and services across various media platforms. In order to build upon their existing subscriber touch points and gain further penetration and presence in the digital home, broadband service providers will need to deploy a scaleable technology platform that can provide digital content and services across multiple devices and platforms

including personal computers, television sets, personal multimedia players and mobile phones. In addition, as new consumption patterns emerge, broadband service providers will need the capability to bundle and cross-sell emerging forms of bandwidth-intensive media and communication services across the converging digital home platforms.

 

The Synacor Solution

 

We provide an Internet platform and a portfolio of digital content and services that enable broadband service providers to create a compelling online experience for their subscribers. Our solution provides our customers with the following key benefits:

 

Differentiation of Broadband Service Providers’ Offerings

 

Our platform enables broadband service providers, domestic and international, to differentiate their offerings by packaging and customizing a wide variety of free and paid digital content and value-added services for their subscribers. These offerings are incorporated in a customer-branded, or “white label,” Internet portal and a comprehensive content management and delivery solution that enables our customers to aggregate and deliver content and service offerings from diverse sources. All of these offerings can be accessed through a single user interface, thus creating a unified and cohesive online experience.

 

Access to a Diverse Portfolio of Digital Content and Services

 

We have an extensive network of relationships with digital content and service providers. We believe that our content and service providers value the new channels of distribution that our technology platform and customer relationships open to them, giving us an advantage when acquiring content and services. By combining our technology platform with our portfolio of digital content and services, we enable our customers to flexibly package content and services for their subscribers, which allows them to differentiate their brand and respond to changing subscriber needs. In addition, we create customized bundles of digital content and service offerings, which we make available to our customers’ subscribers. Our portfolio of digital content and services includes the following categories: news; weather; family; games; music; video; entertainment; sports; lifestyle products; email; and security. We regularly evaluate our offerings to deliver customer and subscriber value and to enable our customers to build a large, loyal and engaged online audience.

 

Ability to Integrate Different Technologies

 

Our technology is built on a standards-based platform, which is designed for interoperability with our customers’ and our content providers’ internal and other third-party systems. In addition, most of our deployments with both broadband service providers and content providers involve complex applications that are integrated into their content management and delivery, billing, service management, customer care and other core systems. This approach provides a unified and cohesive user experience for subscribers, which is an important component of building subscriber loyalty and improving the “stickiness” of our customers’ websites—meaning that they increase the likelihood that the customers’ portals will remain their subscribers’ homepage. Due to our automated sign-on and authentication process and integration with content providers, subscribers are able to access proprietary third-party content from within the customer-branded portal with a single sign-on and consolidated billing. Furthermore, recognizing the need for flexibility, we offer our customers the choice of either a hosted on-demand solution or a non-hosted on-site application, as well as a number of integration methodologies. Our scalable infrastructure also enables us to maintain performance levels as our customers’ subscriber bases develop, media content file sizes increase and overall online consumption of digital media continues to grow.

Focus and Expertise in Delivering Services and Content

 

Our focus and expertise have enabled us to improve significantly the performance and reliability of the solutions we offer our customers, and our singular focus on developing an Internet platform and providing a portfolio of digital content and services allows us to rapidly and efficiently deploy our solutions. In addition, the size of our customer base, together with their associated subscriber footprint and the depth of our technology expertise, provides us with the ability to continually develop and refine our solutions in a way that may not be feasible for many of our customers on a stand-alone basis. We have a diversified and growing customer base of broadband service providers consisting mainly of MSOs, Telcos and ISPs. As of March 31, 2007, our services and products were deployed at over 30 broadband service providers, whom we believe, based upon our own internal estimates, had over 21.0 million broadband Internet subscribers, over 5.0 million narrowband Internet subscribers and over 33.0 million household television subscribers in the United States and the United Kingdom.

 

Support for Online Branding Strategies of Broadband Service Providers

 

We believe that building brand loyalty is a primary objective of broadband service providers. Our white label solutions assist our customers in strengthening their online brands while enhancing their subscriber relationships. With co-branded solutions, the solution provider could have different and competing objectives. For example, the co-brand vendor may promote its own brand at the expense of the broadband service provider’s brand. In contrast, our objective is to work with our customers on a collaborative basis and help them strengthen their online brand awareness among their subscribers. We believe that our solution offers broadband service providers the ability to develop a direct communication channel with their subscribers that they previously did not have, which helps to improve subscriber satisfaction and loyalty.

 

Enhanced Customer Presence in the Digital Home

 

Our solution offers our customers the ability to extend their presence in the digital home by providing them with a flexible technology platform that scales across multiple devices, including personal computers, television sets, personal multimedia players and mobile phones. Customers can incorporate a selection of digital content and services into multiple devices as they expand their triple- and quadruple-play offerings. In addition, as new consumption trends emerge in the future, we plan to enhance our platform so that it can aggregate, customize and deliver emerging forms of bandwidth-intensive media and communications services.

 

Strategy

 

Our goal is to accelerate the growth of our business and to achieve long-term profitability. In order to achieve this goal, we seek to:

 

Enhance Our Technology Platform

 

We continue to enhance our technology platform and regularly introduce new features and services to improve subscribers’ online experience. For example, we are developing new personalization features that will allow subscribers to drag and drop components, insert and remove a wide variety of components, and generally make their homepage their “dashboard” for digital content and services. By providing a higher degree of customization and enhancing the features and functionality of our solution, we believe our customers will benefit from improved subscriber satisfaction and loyalty.