As filed with the Securities and Exchange Commission on October 30, 2007.

Registration No. 333-145077

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

AMENDMENT NO. 4

TO

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

Synacor, Inc.

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 October 30, 2007

 

Synacor, Inc.

 

 

 

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

Deutsche Bank Securities	Bear, Stearns & Co. Inc.

Thomas Weisel Partners LLC

Canaccord Adams

Montgomery & Co.

	•	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

	•	180,000 restricted shares of common stock sold to our chief financial officer in April 2007 for $1.39 per share, which are subject to the Company’s right of repurchase upon termination of service;
	•	2,879,889 shares of common stock issuable upon exercise of options outstanding as of September 30, 2007 at a weighted average exercise price of $2.26 per share;
	•	598,292 shares of common stock issuable upon exercise of warrants outstanding as of September 30, 2007 at an exercise price of $1.17 per share;
	•	185,399 shares of common stock reserved as of September 30, 2007 for future issuance under our 2006 Stock Plan; and
	•	1,500,000 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.

														Nine Months Ended
		Year Ended December 31,												September 30,
		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			$	18,775			$	27,811
Costs and expenses:
Cost of sales(1)			1,244				7,781				15,327				10,548				15,132
Research and development(1)(2)(3)			1,385				2,802				4,546				3,219				5,162
Sales and marketing(2)(3)			1,426				2,434				4,413				3,006				5,038
General and administrative(1)(2)(3)			1,072				1,892				3,933				2,792				3,523
Depreciation and amortization			191				177				465				321				900
Total costs and expenses			5,318				15,086				28,684				19,886				29,755
Loss from operations			(2,933	)			(746	)			(2,357	)			(1,111	)			(1,944	)
Loss on extinguishment of debt			—				—				(32	)			—				—
Other income			27				93				279				46				467
Interest expense			(77	)			(117	)			(132	)			(111	)			(138	)
Loss before income taxes			(2,983	)			(770	)			(2,242	)			(1,176	)			(1,615	)
Provision for income taxes			—				—				14				—				10
Net loss		$	(2,983	)		$	(770	)		$	(2,256	)		$	(1,176	)		$	(1,625	)
Net loss per common share, basic and diluted		$	(36.27	)		$	(9.20	)		$	(18.83	)		$	(11.17	)		$	(4.87	)
Weighted average number of common shares outstanding — basic and diluted			82,260				83,630				119,815				105,262				333,454

(1)	Exclusive of depreciation and amortization shown separately.

(2)	Includes stock-based compensation expense as follows:

														Nine Months Ended
		Year Ended December 31,												September 30,
		2004				2005				2006				2006				2007
														(unaudited)
		(in thousands)
Research and development			—				—				—				—				23
Sales and marketing			—				—				—				—				21
General and administrative			—				—				58				26				127
Total stock-based compensation expense		$	—			$	—			$	—			$	26			$	171

(3)	Amounts for the years ended December 31, 2004, 2005, and 2006 have been restated to appropriately allocate the expense for employee bonuses in each period to research and development, sales and marketing, and general and administrative expense. (See Note 14 to the consolidated financial statements.)

	•	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 this 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
										September 30,
										2007
		As of																Pro
		December 31,												Pro				Forma As
		2005				2006				Actual				Forma				Adjusted
										(unaudited)				(unaudited)				(unaudited)
		(in thousands)
Consolidated Balance Sheet Data:
Cash and cash equivalents		$	2,721			$	15,293			$	10,747			$	10,747
Trade receivables, net			2,067				4,102				5,161				5,161
Property and equipment, net			1,190				4,315				5,191				5,191
Total assets			6,243				24,212				24,978				24,978
Long-term notes payable, capital lease obligations and other long-term liabilities			934				1,297				2,120				2,120
Convertible preferred stock			11,187				28,432				28,432				—
Total stockholders’ equity			2,554				17,608				16,184				16,184

 

RISK FACTORS

 

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 nine months ended September 30, 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. Our Google-related revenues, which consist of the portion of the payment from the sponsor that Google shares with us, accounted for approximately 49.7% of our net sales in 2006 and 45.1% of our net sales in the nine months ended September 30, 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 each of 2006 and the nine months ended September 30, 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. For example, net sales attributable to two customers, Charter Communications Inc., or Charter, and Time Warner (pursuant to the Adelphia legacy agreement only), together accounted for approximately 53% of our net sales for the year ended December 31, 2006, with net sales attributable to each of these customers accounting for more than 20% in such period. In addition, net sales attributable to Charter, Time Warner (pursuant to the Adelphia legacy agreement only) and Embarq Corporation, or Embarq, together accounted for approximately 61% of our net sales for the nine months ended September 30, 2007, with net sales attributable to two of these customers each accounting for more than 20% in such period and net sales attributable to the third customer accounting for more than 15%. Net sales attributable to these customers includes the subscriber-based revenues earned directly from them, as well as the search and advertising revenues earned from third parties, such as Google, based on traffic generated from their websites.

 

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 September 30, 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 September 30, 2007 was $16.2 million, or approximately $1.34 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 12,059,316 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 September 30, 2007, options to purchase 2,879,889 shares of our common stock with a weighted average exercise price of approximately $2.26 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. Additionally, as of September 30, 2007, 180,000 restricted shares of common stock sold to our chief financial officer in April 2007 for $1.39 per share were outstanding, and also are not included in the 12,059,316 shares indicated above.

 

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 have applied to list our common stock 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.

 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

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.

 

USE OF PROCEEDS

 

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. These purposes may include expansion of our sales and marketing activities through hiring additional personnel or funding new marketing initiatives. They may also include investments in research and development projects that our management and technical staff may wish to pursue in the future to enhance our product offerings. In addition, the net proceeds may be used to pursue other corporate opportunities that arise in the future.

 

We may also use a portion of the net proceeds to expand our current business through acquisitions of other companies, assets, products or technologies that enhance or add functionality to our solution, further solidify our market position or allow us to offer complementary services and products. However, we do not have agreements or commitments for any specific acquisitions at this time.

 

The principal purpose of this offering is to create a public market for our common stock, and we have not yet determined the specific uses of the net proceeds from this offering. Therefore, we 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.

 

DIVIDEND POLICY

 

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.

 

CAPITALIZATION

 

The following table sets forth our capitalization as of September 30, 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 September 30, 2007 would be $      , $      , $      , $      and           shares, respectively.

This table excludes the following shares:

 

 

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

 

DILUTION

 

Our pro forma net tangible book value as of September 30, 2007 was $16.2 million, or approximately $1.34 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 12,059,316 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 September 30, 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 September 30, 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 September 30, 2007, there were options outstanding to purchase a total of 2,879,889 shares of common stock at a weighted average exercise price of $2.26 per share, 180,000 restricted shares of common stock, and warrants to purchase 598,292 shares of common stock at an exercise price of $1.17 per share. To the extent outstanding options are exercised, restrictions lapse, and outstanding warrants are exercised, there will be further dilution to new investors. For a description of our equity plans, please see “Management—Equity Benefit Plans.”

 

SELECTED CONSOLIDATED FINANCIAL DATA

 

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 nine months ended September 30, 2006 and 2007 and as of September 30, 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 nine months ended September 30, 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 nine months ended September 30, 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.

 

 

 

 

 

 

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

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 172 at September 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.

 

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 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 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 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, or a cost per click basis, which means that an advertiser pays only when a subscriber clicks on one of its advertisements.

 

As with search, we 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 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 September 30, 2007, we derived net sales from over 30 customers, a substantial portion of which comes from a small number of them. Net sales attributable to two customers, Charter and Time Warner (pursuant to the Adelphia legacy agreement only), together accounted for approximately 53.0% of our net sales for the year ended December 31, 2006, with net sales attributable to each of them accounting for more than 20% in such period. In addition, net sales attributable to Charter, Time Warner (pursuant to the Adelphia legacy agreement only) and Embarq together accounted for approximately 61% of our net sales for the nine months ended September 30, 2007, with net sales attributable to two of these customers each accounting for more than 20% in such period and net sales attributable to the third customer accounting for more than 15%. Net sales attributable to these customers includes the subscriber-based revenues earned directly from them, as well as the search and advertising revenues earned from third parties, such as Google, based on traffic generated from their websites.

 

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 vendors, as well as the rates charged for these services when sold separately to similarly situated customers. 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 collection of our calculated revenues is probable.

 

Revenue Sharing

 

As discussed above, we pay our customers a portion of the revenue generated from search and advertising. This revenue consists of the consideration we receive from our advertising partners in connection with traffic supplied by the applicable customer. 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 September 30, 2007, we had approximately $35.2 million of federal and approximately $21.0 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 $10,000 as of September 30, 2007.

 

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. We adopted FIN 48 effective as of January 1, 2007. The adoption of FIN 48 did not have a material impact on our consolidated results of operations and financial condition. Our federal and New York tax returns, constituting the returns of our major taxing jurisdictions, are subject to examination by the taxing authorities for all open years as prescribed by applicable statute. No waivers have been executed that would extend the period subject to examination beyond the period prescribed by statute. We classify any interest and penalties related to income taxes as a component of income tax expense.

 

As of September 30, 2007, we have recognized tax benefits related to temporary uncertain tax positions identified upon initial adoption in our NOL of approximately $231,000. This benefit had no impact on our effective rate due to the full valuation allowance. We anticipate further changes in our uncertain tax positions due to adjustments in timing differences in the next three months. Any change is not anticipated to have a material effect on the financial statements due to anticipated offsetting changes in the valuation allowance.

 

Stock-Based Compensation

 

Accounting Treatment for Options Prior to January 1, 2006.  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.

 

Accounting Treatment for Options Beginning January 1, 2006.  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 prospective transition method and, therefore, have not restated results for prior periods. Under this transition method, stock-based compensation expense is recorded only for stock-based awards granted after the date of adoption.

 

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, as described in more detail below. Beginning May 1, 2006, we determined the fair value of our common stock after considering valuations prepared for our board of directors by Empire Valuation Consultants, LLC, or Empire, and Anvil Advisors, or Anvil, each an unrelated valuation specialist as defined under the American Institute of Certified Public Accountants Practice Guide, Valuation of Privately-Held Company Equity Securities Issued as Compensation, or the Practice Guide.

 

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, the risk-free interest rate and expected dividend yield. 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 volatilities of the public company 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 6.25 years. The expected term is estimated by using the actual contractual term of the awards and the length of time for the employees to exercise the awards. 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. A 4.5% annual forfeiture rate estimate was used for the stock-based compensation expense recorded for 2006 and the nine months ended September 30, 2007. 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 nine months ended September 30, 2007.

 

Determination of Common Stock Fair Value before May 2006.  Prior to May 2006, we determined the fair value of our common stock in connection with option grants based on several factors, including the price at which shares of our convertible preferred stock had been

sold to investors, the liquidation preferences, dividend rights, voting control and other preferential rights attributable to our then outstanding convertible preferred stock and our limited operating history and uncertain prospects. We also based our determination on developments in our business, such as the hiring of key personnel, the status of our sales efforts and revenue growth. In addition, we took into account the illiquid nature of our common stock and the likelihood of achieving a liquidity event, such as an initial public offering or sale of the company.

 

Determination of Common Stock Fair Value by Valuations Beginning in May 2006.  In May 2006, in accordance with Section 409A of the Internal Revenue Code and the proposed regulations issued by the Internal Revenue Service thereunder, our board of directors received the first contemporaneous valuation of our common stock from Empire, which we refer to as the May 2006 valuation, and the board utilized the value determined in that report to set the exercise price and common stock fair value assumption of options granted from May 2006 through August 2006. In October 2006, Empire prepared another valuation, which we refer to as the October 2006 valuation, and the board utilized the value determined in that report to set the exercise price of options granted from December 2006 through May 2007. In July 2007, Empire prepared a third valuation, which we refer to as the July 2007 valuation, and the board utilized the value determined in that report to set the exercise price of options granted in July, August and September 2007. Our management also considered the May 2006 valuation and October 2006 valuation when determining the fair value of our common stock for purposes of SFAS 123R in connection with options granted from May through December 2006.

 

In the May 2006 valuation and the July 2007 valuation, Empire used the discounted future cash flow method to estimate the enterprise value of Synacor on the applicable valuation date, and applied the guideline company method as a reasonableness check. Then Empire used the company security valuation method to allocate the enterprise value of Synacor among its various classes of equity, thereby deriving a fully marketable value per share for the common stock.

 

In the October 2006 valuation, Empire elected not to use the discounted future cash flow method or guideline company method because, shortly before the valuation date, we sold shares of our Series C preferred stock to investors, and Empire believed that such transaction was a preferable indicator of Synacor’s value. Empire used the price per share of Series C preferred stock to imply a post-money enterprise value of Synacor and thereafter allocated that enterprise value using the company security valuation method.

 

The discounted future cash flow method uses cash flows as a basis to forecast the cash flows that a company will generate and then calculates an aggregate present value for the future cash flows using a required rate of return known as the discount rate. The discount rate reflects current rates of return seen in the public capital markets plus a number of company-and industry-specific factors. The cash flow projections used in connection with Empire’s valuations were based on management’s projections through 2010.

 

The guideline company method uses the pricing multiples of selected public companies with business and financial risks that are comparable to the company being valued to derive a market value for the company under analysis. Companies whose markets, customer bases, operations and financial condition were sufficiently similar to Synacor were examined to test the reasonableness of the enterprise value of Synacor derived with the discounted future cash flow method.

 

The company security valuation method may be used to allocate a company’s enterprise value based on the rights and attributes of the company’s various equity classes. This method considers many aspects of venture financing such as the capital structure of the company, seniority of securities, future financing needs, the time to the liquidation event and company-specific volatility. In addition, the valuation determined under the company security valuation method varies depending upon the term of the option, among other things. Because shares of our

preferred stock have different rights upon an initial public offering and a sale of our company, Empire applied the company security valuation method to both scenarios and then computed a weighted average of the results based on the relative probability of each occurring.

 

Once Empire determined a fully marketable value per share for the common stock based on the methods described above, an appropriate discount for lack of marketability of the common stock was then deducted from this fully marketable value to arrive at the fair market value per share of common stock. The lack-of-marketability discount is influenced by factors including dividend history, ownership rights, information access and reliability, future financing and timing of exit events, lack of historic trading activity of the stock, existence of restrictive shareholder agreements, and overall priority and timing of any contingent financial claims.

 

In connection with the preparation of our consolidated financial statements for the six months ended June 30, 2007 and our condensed consolidated financial statements for the nine months ended September 30, 2007, we engaged Anvil to assist management in estimating the fair value of our common stock for purposes of SFAS 123R in connection with options granted during that period. In a valuation report dated September 2007, which we refer to as the September 2007 valuation, and a valuation report dated October 2007, which we refer to as the October 2007 valuation, Anvil retrospectively valued our common stock at prices ranging from $1.51 per share to $7.86 per share across nine different valuation dates. Those dates were February 7, April 3, April 19, May 1, May 31, July 31, August 2, September 14 and September 29 and corresponded to the dates on which we granted options or sold restricted shares.

 

In the September 2007 valuation and the October 2007 valuation, Anvil estimated the enterprise value of our company on each applicable valuation date using the discounted future cash flow method and the guideline company method and then computing a weighted average of the two based on the likelihood of an initial public offering. As an initial public offering became more likely, the guideline company method was given greater weight. Then Anvil used the company security valuation method to allocate the enterprise value of our company among its various classes of equity to derive a fully marketable value per share for the common stock. Anvil applied an appropriate discount for lack of marketability to this fully marketable value to arrive at the fair value per share of common stock.

 

The difference between the exercise price of the options and our estimate of the fair value has been factored into the SFAS 123R compensation expense. Our estimates of the fair value used to compute the stock-based compensation expense for financial reporting purposes may not be reflective of the fair value that would result from the application of other valuation methods, including accepted valuation methods for tax purposes.

Summary of Option Grants and Other Equity Awards.  We made the following option grants to employees during the period from January 1, 2006 to September 30, 2007:

 

 

 

 

 

In addition to the option grants listed in the foregoing table, we sold 180,000 restricted shares of common stock to our chief financial officer under our 2006 Stock Plan on April 19, 2007 at a price of $1.39 per share. Management’s estimate of the fair value of our common stock on that date, after considering the September 2007 valuation, was $1.66 per share. The fair value is recorded in stock-based compensation expense over the vesting term.

 

Subsequent to September 30, 2007, we have not granted options to purchase common stock.

 

We estimated the fair value of our common stock on May 3, 2006 based on the contemporaneous May 2006 valuation, and we continued to use the same estimate for the grants on June 2, 2006 and August 1, 2006 because there had been no changes in our valuation assumptions sufficient to warrant an adjustment. In the May 2006 valuation, Empire used a discount rate of 25% in its discounted future cash flow analysis, and the estimated time to stockholder liquidity was 1.75 years. Based on a sample of comparable publicly-traded companies, company-specific volatility was determined to be 70%, and the lack-of marketability discount was 20%. Management determined that the probabilities of an initial public offering and a sale of the company were equal, and thus equal weight was given to each scenario.

 

We based our estimate of the fair value of our common stock on December 15, 2006 in part on the October 2006 valuation from Empire, which we requested Empire to prepare because we had recently completed a private placement of shares of our Series C preferred stock. In making our estimate, we also considered that the sale of such preferred shares increased the liquidation preferences ahead of the common stock in our capital structure and that our former chief financial officer, Robert Rusak, resigned in November 2006. The estimated time to stockholder liquidity in the October 2006 valuation increased to 3 years because management determined that, with the proceeds from the Series C financing, Synacor could remain private for a longer period of time. For similar reasons, the probabilities of an initial public offering and a sale of the company shifted to 7% and 93%, respectively. The company-

specific volatility decreased to 52% because the volatility of the comparable publicly-traded companies decreased. A discount rate of 25% was used for the discounted future cash flow analysis, and the lack-of-marketability discount was 20%.

 

Our estimate of the fair value of our common stock on February 7, 2007 was based principally on the September 2007 valuation. We also considered that, in February 2007, we were told that revenue from our contract with Susquehanna Communications would end in April 2007 as a result of its acquisition by Comcast. In the September 2007 valuation, the estimated time to stockholder liquidity decreased to 2 years because our board of directors and management had begun to reconsider a possible initial public offering. The company-specific volatility decreased to 49% because the volatility of the comparable publicly-traded companies decreased. A discount rate of 25% was used for the discounted future cash flow analysis, and the lack-of-marketability discount was 20%. The probabilities of an initial public offering and a sale of the Company were 25% and 75%, respectively.

 

We based our estimate of the fair value of our common stock on April 3 and April 19, 2007 primarily on the September 2007 valuation. For the sale of restricted shares on April 19, 2007, we also considered that we hired a new chief financial officer with prior public company experience on that date. According to the September 2007 valuation, the fair value of our common stock increased primarily because of a rise in the valuation and trading multiples of the comparable publicly-traded companies. This rise in multiples increased the calculated enterprise value under both the discounted future cash flow method and the guideline company method. The estimated time to stockholder liquidity as of April 3 and April 19 was 1.75 years and 1.5 years, respectively. The company-specific volatility was 48% on April 3 and 46% on April 19. A discount rate of 25% was used in the discounted future cash flow analysis. The lack-of-marketability discount was 20%. The probabilities of an initial public offering and a sale of the Company were 25% and 75%, respectively.

 

Our estimate of the fair value of our common stock on May 1, 2007 was based on the September 2007 valuation. The fair value increased primarily because the likelihood of an initial public offering was greater and, as a result, the guideline company method was given greater weight in calculating our enterprise value. The discounted future cash flow method and guideline company method were weighted 33% and 67%, respectively, whereas prior to May 1, 2007 they had been weighted 67% and 33%, respectively. For similar reasons, the lack-of-marketability discount was reduced from 20% to 15%, and the estimated time to stockholder liquidity decreased to 1.25 years. The company-specific volatility was 44%, and a discount rate of 25% was used in the discounted future cash flow analysis. The probabilities of an initial public offering and a sale of the Company were 50% and 50%, respectively.

 

The estimate of the fair value of our common stock on May 31, 2007 was based on the September 2007 valuation and reflected our initial discussions with investment bankers about our initial public offering. Fair value as calculated in the September 2007 valuation increased primarily as a result of a change in management’s financial projections. Those projections, which contained more favorable projections of EBITDA than prior projections, caused the enterprise value determined using the discount future cash flow method to be greater. In addition, due to our ongoing preparations for an initial public offering, the estimated time to stockholder liquidity decreased to one year, and the weightings given to the discounted future cash flow method and the guideline company method shifted to 20% and 80%, respectively. The company-specific volatility was 44%, and a discount rate of 25% was used in the discounted future cash flow analysis. The probabilities of an initial public offering and a sale were 50% and 50%, respectively. The lack-of-marketability discount was 15%.

 

Our estimate of the fair value of our common stock on July 31 and August 2, 2007 was based on the October 2007 valuation and took into account our engagement of investment banks to underwrite our initial public offering in June 2007. Fair value as calculated in the

October 2007 valuation increased primarily as a result of the increased probability of an initial public offering, which caused the estimated time to stockholder liquidity to decrease to nine months and the weightings given to the discounted future cash flow method and the guideline company method to shift to 10% and 90%, respectively. The company-specific volatility was 47%, and a discount rate of 25% was used in the discounted future cash flow analysis. The probabilities of an initial public offering and a sale of the Company were 70% and 30%, respectively. The lack-of-marketability discount was reduced to 10%.

 

We based our estimate of the fair value of our common stock on September 14, 2007 on the October 2007 valuation and the fact that we filed a registration statement for our initial public offering on August 2, 2007. Fair value as calculated in the October 2007 valuation increased primarily as a result of the increased probability of an initial public offering, which further reduced the estimated time to stockholder liquidity to three months. The weightings given to the discounted future cash flow method and the guideline company method remained 10% and 90%, respectively. The company-specific volatility was 50%, and a discount rate of 25% was used in the discounted future cash flow analysis. The probabilities of an initial public offering and a sale of the Company were 80% and 20%, respectively. The lack-of-marketability discount was reduced to 5%.

 

The estimate of the fair value of our common stock on September 29, 2007 was based on the October 2007 valuation and the fact that we appointed Jeffrey Mallet, former President and Chief Operating Officer of Yahoo! Inc., to our board of directors on September 29, 2007. Fair value as calculated in the October 2007 valuation was higher principally because of an increase in the pricing multiples of comparable companies used in the guideline company method. The estimated time to stockholder liquidity remained three months, and the weightings given to the discounted future cash flow method and the guideline company method remained 10% and 90%, respectively. The company-specific volatility was 52%, and a discount rate of 25% was used in the discounted future cash flow analysis. The probabilities of an initial public offering and a sale of the Company were shifted to 90% and 10%, respectively. The lack-of-marketability discount remained 5%.

 

Aggregate Intrinsic Values of Options.  Assuming the sale of shares contemplated by this offering is consummated at $      per share, which is the midpoint of the range of the initial public offering prices listed on the cover page of this prospectus, the aggregate intrinsic values of vested and unvested options to purchase shares of our common stock outstanding as of September 30, 2007 would be $      million and $      million, respectively. However, the amount of any additional value that would be added to the shares of our common stock cannot be measured with precision or certainty.

 

As of September 30, 2007, the unrecognized compensation expense related to unvested stock-based awards granted prior to that date, for which vesting is probable, was approximately $3.1 million. These expenses are expected to be recognized over a weighted average period of 3.4 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.

 

Empire and Anvil provided their reports with respect to the valuation of our common stock to management. Management is responsible for the financial statements included in this prospectus.

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 Nine Months Ended September 30, 2006 and 2007

 

Net Sales.  Our total net sales increased by approximately $9.0 million, or 48%, to approximately $27.8 million for the nine months ended September 30, 2007 from approximately $18.8 million for the same period in 2006.

 

Subscriber-based net sales increased approximately $3.2 million, or 33%, to approximately $12.9 million in the nine months ended September 30, 2007 from approximately $9.7 million for the same period in 2006. The increase was driven almost exclusively by the addition of new customers during the period.

 

Search and advertising net sales increased by approximately $5.8 million, or 64%, to approximately $14.9 million for the nine months ended September 30, 2007 from approximately $9.1 million for the same period in 2006, primarily as a result of increases in the traffic on our customers’ portals, as measured by the number of subscriber clicks on sponsored links, or paid clicks, and the number of display advertising impressions. The total number of paid clicks increased by 4% during the period. The increase in paid clicks accounted for approximately 62% of the increase in search and advertising net sales, while the increase in display advertising impressions accounted for approximately 38%. Prices for our services and products in the nine months ended September 30, 2007 did not change materially from the same period in 2006.

Cost of Sales.  Cost of sales consists of revenue-sharing costs, vendor content acquisition costs and infrastructure costs. Revenue-sharing 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 $4.6 million, or 44%, to approximately $15.1 million for the nine months ended September 30, 2007 from approximately $10.5 million for the same period in 2006. The increase was proportional to the increase in our net sales and was largely driven by additional revenue-sharing costs, which accounted for approximately 61% of the increase in cost of sales; additional vendor content acquisition costs, which accounted for approximately 27% of the increase; and an increase in various support costs, which accounted for approximately 12% of the increase. Cost of sales as a percentage of net sales declined to 54% of sales in the nine months ended September 30, 2007 from 56% of net sales in the nine months ended September 30, 2006.

 

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, bonuses and related costs for personnel associated with research and development activities.

 

Research and development expenses increased by approximately $2.0 million, or 63%, to approximately $5.2 million for the nine months ended September 30, 2007 from approximately $3.2 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 increased to 19% in the nine months ended September 30, 2007 as compared to 17% for the nine months ended September 30, 2006.

 

Sales and Marketing Expenses.  Sales and marketing expenses consist primarily of salaries, bonuses, benefits and commissions 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 $2.0 million, or 67%, to approximately $5.0 million for the nine months ended September 30, 2007 from approximately $3.0 million for the same period in 2006. This increase was largely driven by the hiring of a new direct salesperson and additional marketing personnel, which accounted for approximately 66% of the increase, and the launch of new marketing programs during the last half of 2006 and during the nine months ended September 30, 2007, which accounted for approximately 34% of the increase. Sales and marketing headcount increased by approximately 57% during the period.

 

General and Administrative Expenses.  General and administrative expenses consist primarily of salaries, bonuses 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 $0.7 million, or 25%, to approximately $3.5 million for the nine months ended September 30, 2007 from approximately $2.8 million for the same period in 2006. The following factors contributed to the increase in general and administrative expenses:

 

 

 

These factors were offset by a decrease of 6% related to other various general and administrative expenses. Administrative headcount increased by approximately 29% during the period. As a percentage of sales, general and administrative expenses declined to 13% in the nine months ended September 30, 2007 from 15% in the same period in 2006 as sales growth outpaced spending during the nine months ended September 30, 2007 as compared to the same period in 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 $579,000 to approximately $900,000 for the nine months ended September 30, 2007 from approximately $321,000 for the same period in 2006 due principally to our acquisition of additional equipment to support the addition of both new customers and increased personnel.

 

Other Income.  Other income consists primarily of interest income on cash deposits. Other income increased to approximately $467,000 for the nine months ended September 30, 2007 from approximately $46,000 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 $138,000 for the nine months ended September 30, 2007 from approximately $111,000 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 nine months ended September 30, 2006 and 2007. We have a deferred income tax asset at September 30, 2007 of approximately $13.7 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 September 30, 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 nine months ended September 30, 2007 was approximately $1.6 million, which was approximately $449,000 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. This increase was largely driven by the addition of new customers, which accounted for approximately 44% of the increase, and

an expansion in the number of our existing customers’ subscribers, which accounted for approximately 56% of the increase.

 

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. This increase was primarily a result of increases in the number of paid clicks and the number of display advertising impressions. The total number of paid clicks increased by approximately 101% during the period. The increase in paid clicks accounted for approximately 97% of the increase in search and advertising net sales, while the increase in display advertising impressions accounted for approximately 3%. Prices for services and products in 2006 did not change materially from 2005.

 

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 additional revenue-sharing costs, which accounted for approximately 76% of the increase in cost of sales, and additional vendor content acquisition costs, which accounted for approximately 24% of the increase in cost of sales.

 

Research and Development Expenses.  Research and development expenses increased by approximately $1.7 million, or 61%, to approximately $4.5 million in 2006 from approximately $2.8 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 17% in 2006 from 20% in 2005.

 

Sales and Marketing Expenses.  Sales and marketing expenses increased by approximately $2.0 million, or 83%, to approximately $4.4 million in 2006 from approximately $2.4 million in 2005. This increase was primarily a result of the hiring of our vice president of marketing and other marketing personnel, which accounted for approximately 47% of the increase, and the launch of new marketing programs during the second half of 2006, which accounted for approximately 27% of the increase. Sales and marketing headcount increased by approximately 60% from 2005 to 2006. Other various sales and marketing expenses accounted for the remaining 26% of the increase.

 

General and Administrative Expenses.  General and administrative expenses increased by approximately $2.0 million to approximately $3.9 million in 2006 from approximately $1.9 million in 2005 and increased to 15% of net sales in 2006 from 13% of net sales in 2005. This increase was due largely to the following factors: additional headcount, which accounted for approximately 68% of the increase; occupancy expenses resulting from the relocation of our corporate headquarters, including higher rent and build-out costs, which accounted for approximately 9% of the increase; increased audit fees, which accounted for approximately 6% of the increase; recruiting expenses for key personnel, which accounted for approximately 5% of the increase; and the establishment of an allowance for doubtful accounts, which accounted for approximately 12% of the increase. Administrative headcount increased by approximately 45% from 2005 to 2006.

 

Depreciation and Amortization.  Depreciation and amortization for 2006 increased to approximately $465,000 from approximately $177,000 in 2005. This increase was principally due to our acquisition of additional computing equipment, including a network operating center, for approximately $2.1 million, to support new customers and growth in our existing customers’ subscriber bases. We also acquired computing equipment for approximately $1.5 million during the period 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 in subscriber-based net sales was largely driven by the addition of new customers, which accounted for approximately 75% of the increase, and an expansion in the number of our existing customers’ subscribers, which accounted for approximately 25% of the increase.

 

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. The increase in paid clicks accounted for approximately 99% of the increase in search and advertising net sales, while the increase in display advertising impressions accounted for approximately 1%. Prices for our services and products in 2005 did not change materially from 2004.

 

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 greater rate than net sales primarily because of additional revenue-sharing costs, which accounted for approximately 61% of the increase in cost of sales, and additional vendor content acquisition costs, which accounted for approximately 39% of the increase.

 

Research and Development Expenses.  Research and development expenses increased by approximately $1.4 million, or 100%, to approximately $2.8 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 20% of sales in 2005 from 58% in 2004.

 

Sales and Marketing Expenses.  Sales and marketing expenses increased by approximately $1.0 million, or 71%, to approximately $2.4 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 17% of net sales in 2005 from 60% of net sales in 2004 due to the growth in net sales.

 

General and Administrative Expenses.  General and administrative expenses increased by approximately $0.8 million to approximately $1.9 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 13% of net sales in 2005 from 45% 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.