SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
Commission File Number: 0-21393
SEACHANGE INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
Delaware 04-3197974
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
124 Acton Street, Maynard, MA 01754
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (978) 897-0100
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE
----------------------------
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceeding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [_].
As of March 23, 1998 the aggregate market value of the voting stock held by non-
affiliates of the registrant, based upon the closing price for the registrant's
Common Stock on the Nasdaq National Market on such date was $50,401,890. The
number of shares of the registrant's Common Stock outstanding as of the close of
business on March 23, 1998 was 13,595,019.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the definitive Proxy Statement in connection with the Annual Meeting
of Stockholders to be held on or about May 21, 1998 to be filed pusuant to
Regulation 14A are incorporated by reference into Part III of this Form 10-K.
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PART I
This Annual Report on Form 10-K includes certain statements of a forward-looking
nature which reflect the Company's current views relating to future events or
the future financial performance of the Company. These forward-looking
statements are only predictions and are subject to risks and uncertainties,
particularly the matters set forth in "Certain Risk Factors" below, which could
cause actual events or results to differ materially from historical results or
those indicated by such forward-looking statements.
ITEM 1. BUSINESS
SeaChange International, Inc. ("SeaChange"or the "Company") provides products
to digitally manage, store and distribute digital video for television operators
and telecommunications companies. The Company's products utilize its proprietary
distributed application software and standard industry components to automate
the management and distribution of video streams including advertisements,
movies, news and other video programming requiring precise, accurate and
continuous execution. The Company's digital video products are designed to
provide higher image quality and to be more reliable, easier to use and less
expensive than video tape-based systems. In addition, SeaChange's products
enable its customers to increase revenues by offering more targeted services
such as geography-specific spot advertising and video-on-demand movies.
SeaChange's products address a number of specific markets. The SeaChange SPOT
System is the leading digital advertisement insertion system for the
multichannel television market in terms of installations in the United States,
based on currently available industry sources and the Company's internal data.
The SeaChange SPOT System encodes analog video forms such as advertisements and
news, stores them in remote or local digital libraries, and inserts them
automatically into television network streams. The SPOT System provides high
run-rate accuracy and video image quality, permits geographic and demographic
specificity of advertisements and reduces operating costs. The Company also
sells two variants of this product-SPOT PRO which provides ad insertion
capability to small to mid-size television stations, and the SeaChange SPOT Long
Form System, a long-form video storage and delivery product for cable television
operators and telecommunications companies. The Company also sells the SeaChange
Movie System, which provides long-form video storage and delivery for the pay-
per-view movie markets and the SeaChange GuestServe System for delivering video-
on-demand and other services to hotels. The SeaChange Advertising Management
Software operates in conjunction with the SeaChange SPOT System to automate and
simplify complex sales, scheduling and billing processes for the multichannel
television market. The Company also sells its Video Server 100, which is
designed to store and distribute video streams of various lengths, and
MediaCluster, SeaChange's proprietary software technology that enables multiple
Video Server 100s to operate together as an integrated video server, to systems
integrators and value added resellers ("VARs"). In addition, the Company is
developing its Broadcast MediaCluster systems for the broadcast television
industry for storage, archiving, on-air playback of advertising and other video
programming. The Company is also developing its video-on-demand system to allow
cable television and other telecommunication companies to offer interactive
services to its subscribers.
The Company was incorporated in Delaware in July 1993.
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INDUSTRY BACKGROUND
Television operators, the largest users of professional quality video,
historically have relied on videotape technology for the storage and
distribution of video streams. These systems, which use video tapes as the
primary mechanism for the storage and distribution of video, have substantial
limitations. Video tapes and their associated playback mechanisms are subject to
mechanical failure and generational loss of video quality. Tape-based systems
also require significant manual intervention, which makes them expensive and
cumbersome to operate and also limits their flexibility for programming changes.
Finally, video tapes are bulky and have limited storage capacity.
Over the past decade, the limitations of video tape-based systems have become
increasingly apparent. Changes in government regulation and increased
competition have forced television operators to seek new revenue sources and
reduce costs. In addition, television operators are increasingly seeking to
offer new and enhanced video services while simultaneously improving the
efficiency of their operations. While video tape-based systems are sufficient
for some traditional applications, they do not meet the performance and cost
requirements of these new, targeted applications.
Cable Television Operators & Telecommunications Companies
According to industry sources, there are approximately 12,000 cable systems
currently in the United States, serving over 70 million households. In 1997, 97%
of all cable systems provided over 30 channels of programming to their
subscribers. Because cable television programming is sent over broadband lines,
operators can segment and target their programming to viewers in selected
geographies. In addition, the continuing growth in cable television's multiple
specialized programming networks, such as CNN, MTV and ESPN and other networks
such as Black Entertainment Television, the Discovery Channel and Nickelodeon,
allow advertisers to target viewers in selected demographic profiles.
Despite this advantage over television broadcasters, cable television
operators historically have not realized advertising revenues in proportion to
their share of television viewers. According to industry sources, in 1997, 46%
of all television viewers were watching cable networks, yet cable television
advertising revenue accounted for only 19.5% of the total television advertising
revenue. In addition, advertising represents the major source of revenue for
television broadcasters, while most cable television operators derive less than
5% of their gross revenue from advertising. The limitations of video tape-based
technology are a major factor which has prevented cable television operators
from historically exploiting their advantages over television broadcasters.
These systems are difficult to manage in multichannel and multi-zone
environments, resulting in relatively poor video insertion accuracy and high
operating costs.
Video-on-demand represents a new opportunity for cable television operators.
Increased channel capacity through the installation of fiber optic cables is
providing many cable television operators with the capacity to offer video-on-
demand programming capability to hotels and apartments using existing analog
set-top technology. However, wide deployment to residential subscribers is not
as practical or feasible with existing analog technology. The initial
deployment of the digital set-top which is necessary to making wide scale
video-on-demand practical, is expected in 1998.
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The recent deregulation of the United States telecommunications industry has
lowered the legal barriers to entry for telecommunications companies to enter
the multichannel video delivery market. Telecommunications companies are
attempting to capitalize on the new growth opportunities by acquiring existing
cable television operators and by leveraging their existing telephony networks
to establish new multichannel video delivery operations. However,
telecommunications companies face the same limitations as cable television
operators in cost-effectively offering targeted, value-added services with
analog tape-based systems.
Increased demand for video and audio content over the Internet will require a
substantial increase in storage capacity and bandwidth over time. The Company
believes that cable television operators and telecommunications companies will
play an integral role in providing these broadband Internet applications. The
Company also believes that in order to offer high quality video applications
over the Internet, cable television operators and telecommunications companies
will need storage and distribution products capable of complex management and
scheduling of video data streams.
Television Broadcasters
The more than 1,500 broadcast stations in the United States, including network
affiliates and independent stations, face many of the same technological issues
as cable television operators. Additionally, television broadcasters rely on
advertising for nearly all of their revenue and require high advertisement run-
rate reliability and image quality. To date, television broadcasters have
utilized tape-based systems with robotic libraries, which are cumbersome and
require high levels of maintenance and manual intervention to ensure that the
needed performance requirements are met. Also, the video tapes in these systems
need to be replaced frequently due to repeated use.
In addition, many broadcasters are contemplating the use of the cable
infrastructure for the delivery of geography-specific advertising. These
broadcasters will insert targeted advertising into their television signals and
distribute them directly, often via microwave, to cable operators' distribution
sites. If this application develops, television operators will require video
storage and delivery systems that can effectively manage and deliver multiple
television signals to targeted markets. In late 1998 several television
stations in major markets are expected to begin broadcasting Digital Television
(DTV) signals. The advent of DTV is expected to increase the demand for digital
storage, retrieval, and distribution technology.
THE SEACHANGE SOLUTION
SeaChange develops, markets and supports digital video solutions designed to
enhance its customers' ability to store, retrieve, manage and distribute short-
and long-form video streams, including advertisements, movies, news updates and
other video programming requiring precise, accurate and continuous execution.
The Company's solutions are based on five core areas of functionality: (i) real-
time conversion of analog video into digital video format; (ii) storage and
retrieval of video content to and from digital libraries; (iii) scheduled
distribution of video streams between digital libraries via local and wide area
data networks; (iv) delivery of video streams over single and multiple channels;
and (v) management of video sales, scheduling, billing and execution of related
business transactions.
SeaChange uses these core capabilities to provide solutions to a number of
commercial markets. The Company's products are designed to provide a consistent
set of features and benefits, including:
Viewer Targeting. The Company's digital video products enable television
operators to efficiently target viewers in specific demographic or geographic
groups. The ability to target selected viewers enables television operators to
increase revenues by offering more targeted services. The SeaChange SPOT
System offers this
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capability to television operators, while the SeaChange Movie System makes it
possible for television operators to offer video-on-demand movies to
individual hotel rooms or apartments.
Cost Reduction. The Company's products are designed to provide its customers
operating cost reductions as compared to analog tape-based systems due to,
among other things, the elimination of video tapes and their storage and lower
operating personnel requirements. The Company is also able to price its
products on a competitive basis by using standard operating systems and
components. The Company believes that the combination of competitive pricing
of its products and reductions in the operating costs of its customers results
in attractive pay-back periods on customers' initial capital outlay for the
Company's products.
Scalability. The Company's products are scalable to the needs of a
particular cable television operator or television broadcaster whether
operating in a single channel system concentrated in one specific zone or a
system with hundreds of channels serving multiple zones and markets. Moreover,
the Company's proprietary storage technology enables the scalability of
storage of digital video from a few minutes to hundreds of hours of video.
Reliability. The Company's products eliminate the need for traditional
mechanical tape-based systems, thereby reducing the likelihood of breakdowns.
Furthermore, through the use of redundant components and proprietary storage
technology and application software, SeaChange's products are designed to be
fault resilient, providing the high reliability required for television
operations.
Scheduling Flexibility. The digitizing and storage of video streams allows
advertisements, news updates and movies to be inserted on channels in local
communities and allows cable television operators to insert or delete video
content rapidly. This flexibility enables the provision of services such as
video-on-demand movies and provides advertisers and television broadcasters
the opportunity to insert new video content on short notice.
Video Image Quality. Because digital video streams do not degrade with
playback, image content and quality remain at the original professional level
even after multiple airings.
Ease of Use. The Company's products are simple to learn, require less
maintenance, and are less personnel intensive than analog systems. Due to
their innovative architecture, the Company's products offer a number of
features that simplify their use, including remote monitoring and service and
automated short- and long-form video distribution.
STRATEGY
SeaChange's objective is to be a leader in the emerging market for the
storage, management and distribution of professional quality digital video. The
key elements of the Company's strategy are to:
Develop Long-Term Customer Relationships. The Company is focusing its
product development, marketing and direct sales efforts on developing long-
term customer relationships with cable television operators,
telecommunications companies and television broadcasters in the United States
and internationally. The Company has formed its customer relationships by
providing software-based digital video solutions to address customers'
immediate problems, such as advertisement and other short-form video
insertion. The Company intends to continue to leverage its customer
relationships to offer new, compatible products to meet evolving market needs,
such as video-on-demand programming. The Company believes that the
fundamental shift from analog to digital video and the growing emphasis on
interactive technologies will continue to present opportunities for the
Company to develop, market and support its products to both its existing
customer base and to customers in additional markets.
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Offer Complete Solutions. SeaChange's customers operate complex networks
that require the delivery and management of video programming across multiple
channels and target zones. SeaChange believes television operators desire
complete solutions that integrate all steps of digital video delivery from
scheduling to post-air verification and billing. To address these needs,
SeaChange provides integrated applications and support services which are more
valuable to customers than individual functional products not specifically
designed to work together. The Company believes that providing complete
solutions has been a significant factor in its success and will be an
increasingly important competitive advantage.
Establish and Maintain Technological Leadership Through Software. SeaChange
believes its competitive position is dependent in large part on the features
and performance of its application and network and storage software. As a
result, the Company focuses a majority of its research and development efforts
on introducing new software applications and improving its current software.
The Company seeks to use standard hardware components wherever possible to
maintain its focus on software development.
Provide Superior Customer Service and Support. The Company's products
operate in environments where continuous operation is critical. As a result,
the Company believes that providing a high level of service and support gives
it a competitive advantage and is a differentiating factor in developing key
customer relationships. The Company's in-depth industry and application
knowledge allows it to better understand the service needs of its customers.
As of December 31, 1997, more than 30% of the Company's employees were
dedicated to customer service and support, including project design and
implementation, installation and training. In addition, using remote
diagnostic and communications features embedded in the Company's products, the
service organization has the ability to monitor the performance of customer
installations and, in most cases, rectify problems remotely. Customers have
access to service personnel via 24-hour, seven-day a week telephone support.
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PRODUCTS
SeaChange develops digital video products and related applications for the
television industry. Its products are marketed to cable television operators,
telecommunication companies, television broadcasters, systems integrators and
VARs.
SeaChange SPOT System
The SeaChange SPOT System automates the complex process of advertisement
insertion across multiple channels and geographic zones for cable television
operators and telecommunications companies. Through its proprietary software,
the SeaChange SPOT System allows cable television operators to insert local and
regional advertisements and other short-form video streams into the time
allocated for these video streams by cable television networks such as CNN, MTV,
ESPN, Black Entertainment Television, the Discovery Channel and Nickelodeon.
The SeaChange SPOT System is an integrated solution composed of software
applications, hardware platforms, data networks and easy to use graphical
interfaces. The SeaChange SPOT System is designed to be installed at local cable
transmission sites, known as headends, and advertising sales business offices.
The SeaChange video insertion process consists of six steps:
Encoding: The process begins with the SeaChange Encoding Station, which is
based on SeaChange's proprietary encoding software, where analog-based short-
and long-form video is digitized and compressed in real-time using standard
MPEG-2 hardware.
Storage: Digital video is then stored in a disk-based video library, capable
of storing thousands of spots, where the SeaChange SPOT System organizes,
manages and stores these video streams.
Scheduling: SeaChange's scheduling and management software coordinates with
the traffic and billing application to determine the designated time slot,
channel and geographic zone for each video stream.
Distribution: SeaChange's strategic digital video software then copies the
video streams from the master video library and distributes them over the
operator's data network to headends, where they are stored in video servers for
future play.
Insertion: Following a network cue, the SeaChange video switch module
automatically initiates the conversion of video streams to analog and inserts
them into the network feed, where they are then seen by television viewers.
Verification: After the video streams run, SeaChange's proprietary software
and hardware verifies the content, accuracy, timing and placement of such video
streams to facilitate proper customer billing.
SeaChange has developed two additional product offerings, the SeaChange SPOT
Long Form System ("the SeaChange SPOT LF System") and the SeaChange SPOT PRO
System, that are based on the SeaChange SPOT System technology. The SeaChange
SPOT LF System, which employs the same underlying technology and basic
functionality of the SeaChange SPOT System, is designed to be a platform for the
delivery of long-form video streams in a multichannel environment. The SeaChange
SPOT LF System is designed to permit television operators to store, manage and
distribute long-form video streams, such as movies, infomercials and other local
origination programming. The SeaChange SPOT PRO System, also employs the same
underlying technology and basic functionality of the SeaChange SPOT System and
is designed to be a platform for the delivery of advertising and other video
content in a small to mid-sized television broadcast environment.
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The selling price for all SeaChange SPOT Systems ranges from under $100,000 to
several million dollars with an average system selling price of approximately
$250,000.
SeaChange Advertising Management Software
The SeaChange Advertising Management Software (formerly Traffic and Billing
Software) is designed to permit television operators to manage advertising
sales, scheduling, packaging and billing operations. This product provides
advertising sales executives with: (i) management performance reports; (ii)
inventory tracking; and (iii) order entry, billing and accounts receivable
management. Advetising Management Software can be integrated with the SeaChange
SPOT System and is also compatible with many other advertisement insertion
systems currently in use.
Movie and Interactive Products
SeaChange GuestServe System. The SeaChange GuestServe System is a platform for
the storage and delivery of long-form video streams, particularly movies and
interactive services such as Hotel Checkout. SeaChange had worked together with
IPC Interactive Pte. Ltd. (''IPC''), a provider of video-on-demand systems, to
integrate IPC's Guestnet system and its related movie programming with the
SeaChange MediaCluster Technology. On December 10, 1997, the Company acquired
IPC. The system is designed to permit viewers in hotels and apartments to choose
particular movies on demand and also offers a variety of ancillary interactive
services, such as hotel checkout and advertisements. SeaChange is marketing the
SeaChange GuestServe System featuring movie programming to cable television
operators who package these services with their television services and sell to
hotels and apartments. The Company is currently developing other interactive
services such as Internet Access and Computer Games.
The integrated system consists of user interfaces and application hardware and
software, including set-top boxes and remote control devices, and SeaChange's
MediaCluster technology and software architecture for the delivery and storage
of movies. The video servers are installed at the cable headend and the video is
delivered over a dedicated fiber optic line. The integrated system is designed
to provide cable television operators with a new source of revenue and a
competitive advantage over the encroaching services of direct broadcast
satellite companies. The SeaChange GuestServe System has an average selling
price of approximately $1,000,000.
The SeaChange Movie System. The SeaChange Movie System provides cable
television operators, pay-per-view (PPV) movie service providers and Direct-to-
Home (DTH) providers with capability to originate multiple PPV movie channels or
any other scheduled video programming. The Movie System includes SeaChange
MediaCluster technology for storage and delivery of the video programming as
well as an MPEG-2 encoder for capturing movies from video tape, and scheduling
software and hardware to enable creating programming schedules for the PPV
channels. This system includes fault resiliency in both the video server
technology and scheduling technology so as to insure the highest levels of up
time. The SeaChange Movie System has an average selling price of approximately
$500,000.
Interactive Television. SeaChange is developing technology and product for
the Interactive Television (VOD) market. This product will work over two way
cable television systems with digital set-top boxes and will be based on
SeaChange's MediaCluster technology.
Broadcast Television Products
SeaChange plans to introduce products to the broadcast market in 1998.
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SeaChange Broadcast MediaCluster. The SeaChange Broadcast MediaCluster
System is designed to provide high quality, MPEG-2 4:2:2 based video storage and
playback for use with automation systems in broadcast television stations. This
product is intended to replace on-air tape decks used to store and play back
advertising from video tape cart systems and, in some cases, to replace the cart
systems themselves. The SeaChange Broadcast MediaCluster is designed for
customers in larger broadcast television markets which use station automation
systems or to smaller markets using control software included with the system.
The System is designed to simultaneously record, encode, store to a disk and
play video content, using SeaChange designed MPEG-2 4:2:2 compression and
decompression hardware. This product is designed to seamlessly integrate into
television broadcasters' current tape-based operations and meet the high
performance requirements of television broadcasters.
OEM Products
Video Server 100 (and variants). The Video Server 100, which is the Company's
second generation video server, is designed to store and distribute video
streams of various lengths. The Video Server 100 together with the MediaCluster
provides the base technology for all of SeaChange's digital video products. The
Video Server 100 is offered to systems integrators and VARs as a platform for
the storage and delivery of primarily short-form video in a wide range of
applications.
The Video Server 100 provides custom power and packaging and software for use
in professional video applications. It has features such as RAID and a redundant
power supply to enable the continuous uninterrupted airing of video. The Video
Server 100 uses industry standard components, which differentiates it from
various video servers based on proprietary processors and specialized hardware
components and operating systems.
MediaCluster. MediaCluster is SeaChange's proprietary software technology
that enables multiple Video Server 100s to operate together as an integrated
video server. While the Video Server 100 is the base technology for short-form
video applications, MediaCluster serves as the base technology for primarily
long-form video applications.
Through its software architecture, MediaCluster can join multiple SeaChange
Video Servers to support large-scale applications by storing large amounts of
video data and delivering multiple video streams, with no single point of
failure in the system. The Company currently has a patent application pending
for its MediaCluster technology.
The Company established a subsidiary, SeaChange Systems, Inc., at its
Greenville, New Hampshire location for the manufacture, development and OEM sale
of the Video Server 100 and MediaCluster products. Certain employees of the
Company and subsidiary have been granted stock options to acquire up to a 20%
interest in the subsidiary and the Company owns the remaining interest in the
subsidiary. The Company intends that the subsidiary will license the necessary
technology from the Company and will manufacture these products on a contract
basis for the Company. The subsidiary will have the right to sell these products
to OEM customers that do not compete with the Company. The Company intends to
provide administrative and management services and, at least initially, selling
and marketing and customer support services, to the subsidiary on a negotiated
fee basis. It is expected that the subsidiary will conduct research and
development on video server-based products, including the Video Server 100 and
MediaCluster products, and will license all developments to the Company on a
royalty-free basis. It is intended that after December, 1999, the Company will
have the right, but not the obligation, to acquire the interest from the
employees at fair market value.
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CUSTOMER SERVICE AND SUPPORT
The Company installs, maintains and supports its products in North America,
Asia, South America and Europe. Annual maintenance contracts are generally
required for the first year of a customer's use of the Company's products and
customers are billed for the initial maintenance fee at the time of the
placement of the purchase order. The maintenance contracts are renewable on an
annual basis. The Company also offers basic and advanced formal on-site
training for customer employees at the time of product installation. The Company
currently provides installation, maintenance and support to international
customers but, in the future, plans to provide such services through agents and
distributors. Pursuant to the acquisition of IPC, the Company also provides
movie content in conjunction with sales of the SeaChange GuestServe System. In
addition, as a result of the acquisition the Company acquired contracts varying
from three to five years, whereby, the Company will continue to operate IPC's
tape based systems for hotels.
The Company offers technical support to customers, agents and distributors on
a 24-hour, seven-day a week basis. Support engineers are committed to providing
a response to technical support calls within two hours. The Company's products
are designed with remote diagnostic capabilities which permit the support
engineers to immediately begin to diagnose any problems without having to travel
to the customer's location, thereby reducing both response time and cost. When
necessary, however, support engineers are dispatched to the customer's facility.
CUSTOMERS
The Company currently sells its products primarily to cable television
operators and telecommunications companies. In addition, the Company is
developing several products for television broadcasters.
The Company's customer base is highly concentrated among a limited number of
large customers, primarily due to the fact that the cable and telecommunications
industries in the United States are dominated by a limited number of large
companies. A significant portion of the Company's revenues in any given fiscal
period have been derived from substantial orders placed by these large
organizations. In 1995, 1996 and 1997, revenues from the Company's five largest
customers represented approximately 91%, 76% and 68%, respectively, of the
Company's total revenues. Customers accounting for more than 10% of total
revenues consisted of Continental Cablevision (29%), Tele-Communications, Inc.
(29%), Time Warner, Inc. (16%) and Cox Communications, Inc. (12%) in 1995; Tele-
Communications, Inc. (29%), U.S. West Media Group (17%), Comcast Corporation
(13%) and Time Warner, Inc. (12%) in 1996; and Tele-Communications, Inc. (24%),
Time Warner, Inc. (18%) and Comcast Corporation (10%) in 1997. The Company
expects that it will continue to be dependent upon a limited number of customers
for a significant portion of its revenues in future periods. As a result of this
customer concentration, the Company's business, financial condition and results
of operations could be materially adversely affected by the failure of
anticipated orders to materialize and by deferrals or cancellations of orders as
a result of changes in customer requirements or new product announcements or
introductions.
The Company believes that its backlog at any particular time is not meaningful
as an indicator of its future level of sales for any particular period. Because
of the nature of the Company's products and its use of standard components,
substantially all of the backlog at the end of a quarter can be manufactured by
the Company and is intended to be shipped by the end of the following quarter.
However, because of the requirements of particular customers, the seasonality of
the business and, in respect to certain sales, the acceptance criteria necessary
for revenue recognition, such backlog may not be shipped or, if shipped, the
related revenues may not be recognized in such quarter. Therefore, there is no
direct correlation between the backlog at the end of any quarter and the
Company's total sales for the following quarter or other periods.
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SELLING AND MARKETING
The Company sells and markets its products in the United States primarily
through a direct field sales organization and internationally primarily through
independent agents and distributors, complemented by a coordinated marketing
effort of the Company's marketing group. Direct sales activities in the United
States are conducted from the Company's Massachusetts headquarters and six field
offices. In October 1996, the Company entered into an exclusive sales and
marketing representative agreement with a private Italian company which covers
continental Europe. The Company also markets certain of its products, namely the
Video Server 100 and MediaCluster, to systems integrators and VARs. As of
December 31, 1997, the Company's selling and marketing organization consisted of
28 people.
In light of the complexity of the Company's digital video products, the
Company primarily employs a consultative direct sales process. Working closely
with customers to understand and define their needs enables the Company to
obtain better information regarding market requirements, enhance its expertise
in its customers' industries and more effectively and precisely convey to
customers how the Company's solutions address the customer's specific needs. In
addition to the direct sales process, customer references and visits by
potential customers to sites where the Company's products are in place are often
critical in the sales process.
The Company uses several marketing programs focused on the Company's targeted
markets to support the sale and distribution of its products. The Company uses
exhibitions at a limited number of prominent industry trade shows and
conferences and presentations at technology seminars to promote awareness of the
Company and its products. The Company also publishes technical articles in trade
and technical journals and product promotional literature.
RESEARCH AND PRODUCT DEVELOPMENT
Management believes that the Company's success will depend to a substantial
degree upon its ability to develop and introduce in a timely fashion new
products and enhancements to its existing products that meet changing customer
requirements in the Company's current and new markets. The Company has in the
past made, and intends to continue to make, substantial investments in product
and technological development. Through its direct sales process the Company
monitors changing customer needs, changes in the marketplace and emerging
industry standards, and is therefore better able to focus its research and
development efforts to address such evolving industry requirements.
The Company's research and development expenditures totaled approximately $2.4
million, $5.4 million and $11.8 million for the years ended December 31, 1995,
1996 and 1997, respectively. See discussion below regarding the write-off of
acquired in-process research and development in 1997. At December 31, 1997, 90
employees were engaged in research and product development. The Company believes
that the experience of its product development personnel is an important factor
in the Company's success. The Company performs its research and product
development activities at its headquarters and in offices in Greenville, New
Hampshire, Duluth, Georgia, Englewood, Colorado and Novato, California. The
Company has historically expensed its direct research and development costs as
incurred.
The Company has a variety of new products being developed and tested,
including video-on-demand products for cable television operators and
telecommunications companies, Broadcast MediaCluster systems for television
broadcasters and interactive television. There can be no assurance that the
Company will be able to successfully develop and market such products, or to
identify, develop, manufacture, market or support other new products or
enhancements to its existing products successfully or on a timely basis, that
new Company products will gain market acceptance, or that the Company will be
able to respond effectively to product announcements by competitors or
technological changes.
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ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT
In connection with the acquisition of IPC, $5,290,000 of the purchase price,
based on upon an independent appraisal, was allocated to in-process research and
development, resulting in an immediate charge to the Company's operations as of
the date of acquisition. The amount allocated to in-process research and
development represented technology which had not reached technological
feasability and did not have an alternative future use. The Company intends to
continue developing this in-process technology over the next year as a means of
increasing the marketability of the Company's movie systems.
MANUFACTURING
The Company's manufacturing operations are located at facilities in Maynard,
Massachusetts, Greenville, New Hampshire and Novato, California. The
manufacturing operations in Massachusetts consist primarily of component and
subassembly procurement, system integration and final assembly, testing and
quality control of the complete systems. The Company's operations in New
Hampshire consist primarily of component and subassembly procurement, video
server integration and final assembly, testing and quality control of the video
servers. The Company's operations in Novato, California consist primarily of
component and subassembly procurement, system integration and final assembly,
testing and quality control of the SeaChange GuestServe System. The Company
relies on independent contractors to manufacture components and subassemblies to
the Company's specifications. Each of the Company's products undergoes testing
and quality inspection at the final assembly stage.
The Company attempts to use standard parts and components available from
multiple vendors. Certain components used in the Company's products, however,
are currently purchased from a single source, including a computer chassis
manufactured by Trimm Technologic Inc., a disk controller manufactured by Mylex
Corporation, an MPEG-2 decoder card manufactured by Vela Research, Inc., set-top
boxes manufactured by IPC Corp. and an MPEG-2 encoder manufactured by
Optivision, Inc. While the Company believes that there are alternative suppliers
available for the foregoing components, the Company believes that the
procurement of such components from alternative suppliers would take anywhere
from 45-120 days. There can be no assurance that such alternative components
would be functionally equivalent or would be available on a timely basis or on
similar terms. The Company purchases several other components from a single
supplier, although the Company believes that alternative suppliers for such
components are readily available on a timely basis. The Company generally
purchases sole source or other components pursuant to purchase orders placed
from time to time in the ordinary course of business and has no written
agreements or guaranteed supply arrangements with its sole source suppliers. The
Company has experienced quality control problems and supply shortages for sole
source components in the past and there can be no assurance that the Company
will not experience significant quality control problems or supply shortages for
these components in the future. The Company has begun to increase its inventory
of these components. However, any interruption in the supply of such single
source components could have a material adverse effect on the Company's
business, financial condition and results of operations. Because of the
Company's reliance on these vendors, the Company may also be subject to
increases in component costs which could adversely affect the Company's
business, financial condition and results of operations.
COMPETITION
The markets in which the Company competes are characterized by intense
competition, with a large number of suppliers providing different types of
products to different segments of the markets. The Company currently competes
principally on the basis of: (i) the breadth of its products' features and
benefits, including the ability to precisely target viewers in specific
geographic or demographic groups, and the flexibility, scalability, professional
quality, ease of use, reliability and cost effectiveness of its products; and
(ii) the Company's reputation and the depth of its expertise, customer service
and support. While the Company believes that it currently competes favorably
overall with respect to these factors and that its ability to provide software-
based solutions to manage, store and distribute digital video differentiates the
Company from its competitors, there can be no assurance that the Company will be
able to continue to compete successfully with respect to such factors.
12
In the digital advertisement insertion market, the Company generally competes
with Channelmatic Inc., a subsidiary of Indenet, Inc., SkyConnect, Inc., Digital
Video, and other smaller suppliers of systems. In the market for NVOD and
GuestServe Movie Systems, the Company competes against various computer
companies offering video server platforms such as EMC Inc., Digital Equipment
Corporation and Silicon Graphics, Inc., and more traditional movie application
providers like The Ascent Entertainment Group, Panasonic Company, On Command,
Inc, and Lodgenet Entertainment. In addition, the SeaChange Advertising
Management Software competes against certain products of Columbine Cable
Systems, Inc., Cable Computerized Management Systems, Inc., a subsidiary of
Indenet Inc., LAN International USA, Inc., Visiontel, Inc. and various suppliers
of sales, scheduling and billing software products. In the television broadcast
market, the Company expects to compete against Tektronix, Inc., BTS Inc., a
division of Robert Bosch GmgH, Hewlett-Packard Company, Sony Corporation,
Silicon Graphics, Inc., Sun Microsystems, Inc. and ASC Incorporated. The Company
expects the competition in each of these markets to intensify.
Many of the Company's current and prospective competitors have significantly
greater financial, technical, manufacturing, sales, marketing and other
resources than the Company. As a result, these competitors may be able to devote
greater resources to the development, promotion, sale and support of their
products than the Company. Moreover, these companies may introduce additional
products that are competitive with those of the Company or enter into strategic
relationships to offer complete solutions, and there can be no assurance that
the Company's products would compete effectively with such products.
Although the Company believes that it has certain technological and other
advantages over its competitors, maintaining such advantages will require
continued investment by the Company in research and development, selling and
marketing and customer service and support. In addition, as the Company enters
new markets, distribution channels, technical requirements and levels and bases
of competition may be different than those in the Company's current markets.
There can be no assurance that the Company will be able to compete successfully
against either current or potential competitors in the future.
PROPRIETARY RIGHTS
The Company's success and its ability to compete is dependent, in part, upon
its proprietary rights. Although the Company has filed one U.S. and one foreign
patent application for its MediaCluster technology, it does not hold any issued
patents and currently relies on a combination of contractual rights, trademark
laws, trade secrets and copyright laws to establish and protect its proprietary
rights in its products. There can be no assurance that a patent will be issued
with respect to the pending application or that, if issued, the validity of such
patent would be upheld. Nor can there be any assurance that the steps taken by
the Company to protect its intellectual property will be adequate to prevent
misappropriation of its technology or that the Company's competitors will not
independently develop technologies that are substantially equivalent or superior
to the Company's technology. In addition, the laws of some foreign countries in
which the Company's products are or may be distributed do not protect the
Company's proprietary rights to the same extent as do the laws of the United
States.
The Company is also subject to the risk of adverse claims and litigation
alleging infringement of intellectual property rights of others. The Company
attempts to ensure that its products do not infringe any existing proprietary
rights of others. The Company received a letter in January 1996 stating that the
Company's video insertion system may be utilizing technology patented by a third
party. The Company did not respond to such letter and has received no further
communication from the holder of these patents. The Company does not believe
that its products infringe such patents. There can be no assurance that the
holder of these patents or other third parties will not assert infringement
claims against the Company in the future based on patents, copyrights,
trademarks or trade secrets, or that any such claims will not be successful. The
Company could incur substantial costs in defending itself and its customers
against any such claims, regardless of the merits of such claims. Parties making
such claims may be able to obtain injunctive or other equitable relief which
could effectively block the Company's ability to sell its products in the United
States and abroad, and could result in significant litigation costs and expenses
or an award of
13
substantial damages. In the event of a successful claim of infringement, the
Company and its customers may be required to obtain one or more licenses from
third parties or to develop alternative technologies. There can be no assurance
that the Company or its customers could obtain necessary licenses from third
parties at a reasonable cost or at all, or would be able to develop alternative
technologies. The defense of any lawsuit could result in time consuming and
expensive litigation, damages, license fees, royalty payments and restrictions
on the Company's ability to sell its products, any of which could have a
material adverse effect on the Company's business, financial condition and
results of operations.
A version of the SeaChange Advertising Management Software in limited
distribution was based on software the Company licensed from Summit Software
Systems, Inc. of Boulder, Colorado in May 1996. The Company has been granted a
perpetual, nonexclusive license to such software in return for the payment of an
up-front license fee and royalties for sales occurring prior to June 1998.
EMPLOYEES
As of December 31, 1997, the Company employed 264 persons, including 90 in
research and development, 83 in customer service and support, 28 in selling and
marketing, 33 in manufacturing and 30 in finance and administration. The Company
believes that its relations with its employees are good.
CERTAIN RISK FACTORS
Limited Operating History and Operating Results. The Company was founded in
July 1993 and commenced shipment of its initial products in the third quarter of
1994. Accordingly, the Company has only a limited operating history upon which
an evaluation of the Company and its prospects can be based. The Company's
prospects must be considered in light of the risks, expenses and difficulties
frequently encountered by companies in their early stage of development,
particularly companies in new and rapidly evolving markets. To address these
risks, the Company must, among other things, respond to competitive
developments, continue to attract, retain and motivate qualified persons, and
continue to upgrade its technologies and commercialize products and services
incorporating such technologies. There can be no assurance that the Company will
be successful in addressing such risks. Increases in operating expenses are
expected to continue and may result in a decrease in operating income.
Fluctuations in Quarterly Operating Results. The Company's quarterly
operating results have in the past varied and in the future will be affected by
factors such as: (i) the timing and recognition of revenue from significant
orders, (ii) the seasonality of the placement of customer orders, (iii) the
success of the Company's products, (iv) increased competition, (v) changes in
the Company's pricing policies or those of its competitors, (vi) the financial
stability of major customers, (vii) new product introductions or enhancements by
competitors, (viii) delays in the introduction of products or product
enhancements by the Company, (ix) customer order deferrals in anticipation of
upgrades and new products, (x) the ability to access a sufficient supply of sole
source and third party components, (xi) the quality and market acceptance of new
products, (xii) the timing and nature of selling and marketing expenses (such as
trade shows and other promotions), (xiii) personnel changes, (xiv) the risks
associated with international sales as the Company expands its markets, (xv) the
Company's ability to integrate the operations of acquired subsidiaries and
(xvi) economic conditions affecting the Company's customers. Any significant
cancellation or deferral of purchases of the Company's products could have a
material adverse effect on the Company's business, financial condition and
results of operations in any particular quarter, and to the extent significant
sales occur earlier than expected, operating results for subsequent quarters may
be adversely affected. The Company's expense levels are based, in part, on its
expectations as to future revenues, and the Company may be unable to adjust
spending in a timely manner to compensate for any revenue shortfall. If revenues
are below expectations, operating results are likely to be adversely affected
and net income may be disproportionately affected because a significant portion
of the Company's expenses do not vary with revenues.
Because of these factors, the Company believes that period-to-period
comparisons of its results of operations are not necessarily meaningful and
should not be relied upon as indications of future performance. Due to all of
the
14
foregoing factors, in some future quarter the Company's operating results
may be below the expectations of public market analysts and investors.
Seasonality. The Company's business has been seasonal with more orders being
placed and greater revenues being recognized in the first and second quarters
than in the third and fourth quarters. The Company believes that the
concentration of order placements in specific quarterly periods is due to
customers' buying patterns and budgeting cycles in the cable television
industry. The Company anticipates that these patterns will continue in the
future. As a result, the Company's results of operations have in the past and
likely will in the future vary seasonally in accordance with such purchasing
activity. Due to the relatively fixed nature of certain of the Company's costs
throughout each quarterly period, including personnel and facilities costs, the
decline of revenues in any quarter typically results in lower profitability in
that quarter.
Management of Growth. The Company has experienced growth in revenues and
expansion of its operations which have placed significant demands on the
Company's management, administrative and operational resources. The Company
believes that further improvements in management and operational controls are
needed, and would continue to be needed to manage any future growth. Continued
growth will also require the Company to hire more technical, selling and
marketing, support and administrative personnel, expand manufacturing and
customer service capabilities, and update or expand management information
systems. There can be no assurance that the Company will be able to attract and
retain the necessary personnel to accomplish its growth strategies or that it
will not experience constraints that will adversely affect its ability to
satisfy customer demand in a timely fashion or to satisfactorily support its
customers and operations. Also, the Company may in the future acquire
complementary service or product lines, technologies or businesses, although the
Company has no present understandings, commitments or agreements with respect to
any significant acquisitions. If the Company's management is unable to manage
growth effectively or integrate any acquisition into the Company's operations
successfully, the Company's business, financial condition and results of
operations could be materially and adversely affected.
Product Concentration. Through December 31, 1997, substantially all of the
Company's revenues were derived from the sale of the SeaChange SPOT System,
movie systems and related services. The Company's success depends in part on
continued sales of the SeaChange SPOT System, movie systems and the introduction
of new products. A decline in demand or average selling prices for the SeaChange
SPOT System or movie product lines, whether as a result of new product
introductions by others, price competition, technological change, inability to
enhance the products in a timely fashion, or otherwise, would have a material
adverse effect on the Company's business, financial condition and results of
operations.
Highly Competitive Market. The market for digital video products is highly
competitive. The Company currently competes against suppliers of both analog
tape-based and digital systems in the advertisement insertion market and against
both computer companies offering video server platforms and more traditional
movie application providers in the movie system market. When the Company
introduces products in the television broadcast market, the Company expects to
compete in that market against various computer companies offering video server
platforms and television equipment manufacturers. Due to the rapidly evolving
markets in which the Company competes, additional competitors with significant
market presence and financial resources, including computer hardware and
software companies and television equipment manufacturers, may enter those
markets, thereby further intensifying competition. Increased competition could
result in price reductions and loss of market share which would adversely affect
the Company's business, financial condition and results of operations. Many of
the Company's current and potential competitors have greater financial, selling
and marketing, technical and other resources than the Company. Moreover, the
Company's competitors may also foresee the course of market developments more
accurately than the Company. Although the Company believes it has certain
technological and other advantages over its competitors, realizing and
maintaining such advantages will require a continued high level of investment by
the Company in research and product development, marketing and customer service
and support. There can be no assurance that the Company will have sufficient
resources to continue to make such investments or that the Company will be able
to make the technological advances necessary to compete successfully with its
existing competitors or with new competitors.
15
Dependence on Emerging Digital Video Market. Cable television operators and
television broadcasters have historically relied on traditional analog
technology for video management, storage and distribution. Digital video
technology is still a relatively new technology and requires a significant
initial investment of capital. The Company's future growth will depend both on
the rate at which television operators convert to digital video systems and the
rate at which digital video technology expands to additional market segments.
There can be no assurance that the use of digital video technology will expand
among television operators or into additional markets. Any failure by the market
to accept digital video technology will have a material adverse affect on the
Company's business, financial condition and results of operations.
Risks Associated with Expansion into New Markets. To date the Company's
products have been purchased primarily by cable television operators and
telecommunications companies. The Company's success depends in part on the
penetration of new markets. In particular, the Company plans to introduce
several products for use by television broadcasters. These broadcast products
will be directed toward a market that the Company has not previously addressed.
There can be no assurance that the Company will be successful in marketing and
selling these new products to customers in the broadcast television market. Any
inability of the Company to penetrate this new market would have a material
adverse effect on the Company's business, financial condition and results of
operations.
Risk of New Product Introductions. The Company's future success requires
that it develop and market additional products that achieve significant market
acceptance and enhance its current products. The Company has recently introduced
a new product which enables television operators to provide video-on-demand and
scheduled playback services to hotels and apartments. The success of this
product may depend in part on relationships with movie content providers. There
can be no assurance that the Company will not experience difficulties that could
delay or prevent the successful development, introduction and marketing of this
and other new products and enhancements, or that its new products and
enhancements will adequately meet the requirements of the marketplace and
achieve market acceptance. Announcements of currently planned or other new
product offerings may cause customers to defer purchasing existing Company
products. Moreover, there can be no assurance that, despite testing by the
Company, and by current and potential customers, errors or failures will not be
found in the Company's products, or, if discovered, successfully corrected in a
timely manner. Such errors or failures could cause delays in product
introductions and shipments, or require design modifications that could
adversely affect the Company's competitive position. The Company's inability to
develop on a timely basis new products, enhancements to existing products or
error corrections, or the failure of such new products or enhancements to
achieve market acceptance could have a material adverse effect on the Company's
business, financial condition and results of operations.
Rapid Technological Change. The markets for the Company's products are
characterized by rapidly changing technology, evolving industry standards and
frequent new product introductions and enhancements. Future technological
advances in the television and video industries may result in the availability
of new products or services that could compete with the solutions provided by
the Company or reduce the cost of existing products or services, any of which
could enable the Company's existing or potential customers to fulfill their
video needs better and more cost efficiently than with the Company's products.
The Company's future success will depend on its ability to enhance its existing
digital video products, including the development of new applications for its
technology and to develop and introduce new products to meet and adapt to
changing customer requirements and emerging technologies. There can be no
assurance that the Company will be successful in enhancing its digital video
products or developing, manufacturing and marketing new products which satisfy
customer needs or achieve market acceptance. In addition, there can be no
assurance that services, products or technologies developed by others will not
render the Company's products or technologies uncompetitive, unmarketable or
obsolete, or that announcements of currently planned or other new product
offerings by either the Company or its competitors will not cause customers to
defer or fail to purchase existing Company solutions. The failure of the Company
to respond to rapidly changing technologies related to digital video could have
a material adverse effect on the Company's business, financial condition and
results of operations.
16
Significant Concentration of Customers. The Company's customer base is
highly concentrated among a limited number of large customers, primarily due to
the fact that the cable television and telecommunications industries in the
United States are dominated by a limited number of large companies. A fairly
limited number of customers account for a significant percentage of the
Company's revenues in any year. In 1995, 1996 and 1997, revenues from the
Company's five largest customers represented approximately 91%, 76% and 68%,
respectively, of the Company's total revenues. In each of 1995 and 1996, four
customers each accounted for more than 10% of the Company's revenues and in 1997
three customers accounted for more than 10% of the Company's revenues, two of
which accounted for more than 10% of the Company's revenues in 1995, 1996 and
1997. The Company generally does not have written continuing purchase agreements
with its customers and does not have any written agreements that require
customers to purchase fixed minimum quantities of the Company's products. The
Company's sales to specific customers tend to vary significantly from year to
year depending upon such customers' budgets for capital expenditures and new
product introductions. In addition, the Company derives a substantial portion of
its revenues from products that have a selling price in excess of $150,000. The
Company believes that revenue derived from current and future large customers
will continue to represent a significant proportion of its total revenues. The
loss of, or reduced demand for products or related services from, any of the
Company's major customers could have a material adverse effect on the Company's
business, financial condition and results of operations.
Dependence on Sole Source Suppliers and Third Party Manufacturers. Certain
key components of the Company's products are currently purchased from a sole
supplier, including a computer chassis manufactured by Trimm Technologic Inc., a
disk controller manufactured by Mylex Corporation, an MPEG-2 decoder card
manufactured by Vela Research, Inc. and an MPEG-2 encoder manufactured by
Optivision, Inc. The Company does not have material written supply agreements
with these or any of its suppliers. The Company has in the past experienced
quality control problems, where products did not meet specifications or were
damaged in shipping, and delays in the receipt of such components. These
problems were generally of short duration and did not have a material adverse
effect on the Company. However, the Company may in the future experience similar
types of problems which could be more severe or more prolonged. The inability to
obtain sufficient key components as required, or to develop alternative sources
if and as required in the future, could result in delays or reductions in
product shipments which, in turn, could have a material adverse effect on the
Company's business, financial condition and results of operations. Moreover, the
Company relies on a limited number of third parties who manufacture certain
components used in the Company's products. While to date there has been suitable
third party manufacturing capacity readily available at acceptable quality
levels, there can be no assurance that such manufacturers will be able to meet
the Company's future volume or quality requirements or that such services will
continue to be available to the Company at favorable prices. Any financial,
operational, production or quality assurance difficulties experienced by such
third party manufacturers that result in a reduction or interruption in supply
to the Company could have a material adverse effect on the Company's business,
financial condition and results of operations.
Regulation of Telecommunications and Television Industries. The
telecommunications and television industries are subject to extensive regulation
in the United States and other countries. The Company's business is dependent
upon the continued growth of such industries in the United States and
internationally. Although recent legislation has lowered the legal barriers to
entry for telecommunications companies into the United States multichannel
television market, there can be no assurance that such telecommunications
companies will successfully enter this or related markets. Moreover, the growth
of the Company's business internationally is dependent in part on similar
deregulation of the telecommunications industry abroad and there can be no
assurance that such deregulation will occur. Television operators are also
subject to extensive government regulation by the Federal Communications
Commission (''FCC'') and other federal and state regulatory agencies. These
regulations could have the effect of limiting capital expenditures by television
operators and thus could have a material adverse effect on the Company's
business, financial condition and results of operations. The enactment by
federal, state or international governments of new laws or regulations, changes
in the interpretation of existing regulations or a reversal of the trend toward
deregulation in these industries could adversely affect the Company's customers,
and thereby materially adversely affect the Company's business, financial
condition and results of operations.
17
Lengthy Sales Cycle. Digital video products are relatively complex and their
purchase generally involves a significant commitment of capital, with attendant
delays frequently associated with large capital expenditures and implementation
procedures within an organization. Moreover, the purchase of such products
typically requires coordination and agreement among a potential customer's
corporate headquarters and its regional and local operations. For these and
other reasons, the sales cycle associated with the purchase of the Company's
digital video products is typically lengthy and subject to a number of
significant risks, including customers' budgetary constraints and internal
acceptance reviews, over which the Company has little or no control. Based upon
all of the foregoing, the Company believes that the Company's quarterly
revenues, expenses and operating results are likely to vary significantly in the
future, that period-to-period comparisons of its results of operations are not
necessarily meaningful and that, in any event, such comparisons should not be
relied upon as indications of future performance.
Dependence on Key Personnel and Hiring of Additional Personnel. The
Company's success depends to a significant degree upon the continued
contributions of its key management, engineering, selling and marketing and
manufacturing personnel, many of whom would be difficult to replace. The Company
does not have employment contracts with its key personnel. The Company believes
its future success will also depend in large part upon its ability to attract
and retain highly skilled managerial, engineering, selling and marketing,
finance and manufacturing personnel. Competition for such personnel is intense,
and there can be no assurance that the Company will be successful in attracting
and retaining such personnel. The loss of the services of any of the key
personnel, the inability to attract or retain qualified personnel in the future
or delays in hiring required personnel, particularly software engineers and
sales personnel, could have a material adverse effect on the Company's business,
financial condition and results of operations.
Dependence on Proprietary Rights. The Company's success and its ability to
compete is dependent, in part, upon its proprietary rights. The Company relies
primarily on a combination of patent, copyright, trademark and trade secret
laws, as well as confidentiality procedures and contractual provisions to
protect its proprietary rights. There can be no assurance that such measures
will be adequate to protect the Company's proprietary rights. The Company
attempts to ensure that its products and technology do not infringe the
proprietary rights of third parties. The Company received a letter in January
1996 stating that the Company's video insertion system may be utilizing
technology patented by a third party. The Company did not respond to such letter
and has received no further communication from the holder of these patents. The
Company does not believe that its products infringe the patents mentioned in
such letter. However, there can be no assurance that the holder of these patents
or other third parties will not assert infringement claims against the Company
in the future or that any such claim will not be successful.
Risks Associated with International Sales. Prior to 1996, the Company
derived no significant revenues from international operations. International
sales accounted for approximately 5% and 12% of the Company's total revenues in
the years ended December 31, 1996, and 1997, respectively. The Company expects
that international sales will account for a significant portion of the Company's
business in the future. However, there can be no assurance that the Company will
be able to maintain or increase international sales of its products.
International sales are subject to a variety of risks, including difficulties in
establishing and managing international distribution channels, in servicing and
supporting overseas products and in translating products into foreign languages.
International operations are subject to difficulties in collecting accounts
receivable, staffing and managing personnel and enforcing intellectual property
rights. Other factors that can also adversely affect international operations
include fluctuations in the value of foreign currencies and currency exchange
rates, changes in import/export duties and quotas, introduction of tariff or
non-tariff barriers and economic or political changes in international markets.
Concentration of Ownership. The Company's officers, directors and their
affiliated entities, and other holders of 5% or more of the Company's
outstanding capital stock, together beneficially owned approximately 64% of the
outstanding shares of Common Stock of the Company as of March 23, 1998. As a
result, such persons will have the ability to elect the Company's directors and
to determine the outcome of corporate actions requiring stockholder approval,
irrespective of how other stockholders of the Company may vote. This
concentration of ownership may have the effect of delaying or preventing a
change in control of the Company which may be favored by a majority of the
remaining stockholders, or cause a change of control not favored by the
Company's other stockholders.
18
ITEM 2. PROPERTIES
The Company's corporate headquarters, which is also its principal
administrative, selling and marketing, customer service and support and product
development facility, is located in Maynard, Massachusetts and consists of
approximately 44,000 square feet under a lease which originally expired on March
31, 1998, however, the lease term has been extended to July 31, 1998 with a
revised annual base rent of $342,000. The Company is currently negotiating a
lease for premises for its principal facility and anticipates that space under
terms acceptable to the Company will be available as needed. The Company leases
a facility of approximately 9,000 square feet in Greenville, New Hampshire that
is used for the development and final assembly of its video servers. The Company
leases a facility of approximately 29,000 square feet in Novato, California that
is principally used for product development and customer support. The Company
also leases small research and development and sales and support offices in
Atlanta, Georgia, Englewood, Colorado, Burlingame, California and St. Louis,
Missouri. The Company believes its existing and planned facilities are adequate
for its current needs and that suitable additional or substitute space will be
available as needed.
ITEM 3. LEGAL PROCEEDINGS
From time to time, the Company is involved in litigation relating to claims
arising out of its operations in the normal course of business. The Company
believes that it is not currently involved in any legal proceedings the
resolution of which, individually or in the aggregate, would have a material
adverse effect on the Company's business, financial condition or results of
operation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
No matters were submitted during the fourth quarter of the fiscal year ended
December 31, 1997 to a vote of security holders of the Company through the
solicitation of proxies or otherwise.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq National Market under the
symbol "SEAC." Public trading of the Common Stock commenced on November 5,
1996. Prior to such date, there was no public market for the Common Stock. The
following table sets forth the high and low sale prices for the Common Stock for
the periods indicated, as reported on the Nasdaq National Market.
YEAR ENDED DECEMBER 31, 1997 High Low
----------- ---------
First Quarter $33.00 $12.13
Second Quarter $28.25 $16.75
Third Quarter $29.38 $13.75
Fourth Quarter $14.75 $ 6.38
YEAR ENDED DECEMBER 31, 1996
Fourth Quarter (from November 5, 1996) $39.50 $17.38
On March 23, 1998, the last reported sale price of the Common Stock on the
Nasdaq National Market was $7.50. As of March 23, 1998, there were
approximately 162 stockholders of record of the Company's Common Stock, as shown
in the records of the Company's transfer agent. The Company believes that most
of its stock (other than shares held by its officers and directors) is held in
street names through one or more nominees. The Company has not paid any cash
dividends on its capital stock since its inception, and does not expect to pay
cash dividends on its Common Stock in the foreseeable future. The Company
currently intends to retain future earnings for use in the operation and
expansion of the business.
19
ITEM 6. SELECTED FINANCIAL DATA
The consolidated statement of operations data for the period from July 9, 1993
(inception) through December 31, 1993 and each of the four years ended December
31, 1994, 1995, 1996 and 1997 and the consolidated balance sheet data at
December 31, 1993, 1994, 1995, 1996 and 1997 are detailed below. The following
selected consolidated financial data should be read in conjunction with the
Company's consolidated financial statements and related notes thereto and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included in Item 7.
PERIOD FROM
JULY 9, 1993
(INCEPTION) YEAR ENDED
THROUGH DECEMBER 31,
DECEMBER 31, ------------------------------------
1993 1994 1995 1996 1997
--------------- ------- ------- ------- ---------
(in thousands, except per share data)
Consolidated Statement of Operations Data:
Revenues
Systems.......................................................... $ -- $5,037 $21,999 $45,745 $60,414
Services......................................................... -- 116 1,204 3,521 7,473
Other............................................................ 213 537 -- -- --
------ ------ ------- ------- -------
213 5,690 23,203 49,266 67,887
------ ------ ------- ------- -------
Costs of revenues
Systems.......................................................... -- 3,406 14,917 27,133 34,740
Services.......................................................... -- 176 1,641 4,030 7,607
Other............................................................. 112 304 -- -- --
------ ------ ------- ------- -------
112 3,886 16,558 31,163 42,347
------ ------ ------- ------- -------
Gross profit......................................................... 101 1,804 6,645 18,103 25,540
------ ------ ------- ------- -------
Operating expenses
Research and development............................................ 43 885 2,367 5,393 11,758
Selling and marketing............................................... 16 443 1,609 4,254 6,049
General and administrative.......................................... 59 273 858 2,064 3,744
Write-off of acquired in-process research and development.......... -- -- -- -- 5,290
------ ------ ------- ------- -------
118 1,601 4,834 11,711 26,841
------ ------ ------- ------- -------
Income (loss) from operations........................................ (17) 203 1,811 6,392 (1,301)
Interest income, net................................................. (1) 7 113 353 657
------ ------ ------- ------- -------
Income (loss) before income taxes.................................... (18) 210 1,924 6,745 (644)
Provision for income taxes........................................... -- 55 713 2,483 1,776
------ ------ ------- ------- -------
Net income (loss).................................................... $ (18) $ 155 $ 1,211 $ 4,262 $(2,420)
====== ====== ======= ======= =======
Basic earnings (loss) per share (1).................................. $ (.05) $ .09 $ .33 $ .82 $ (.24)
====== ====== ======= ======= =======
Diluted earnings (loss) per share (1)................................ $ (.05) $ .02 $ .11 $ .36 $ (.24)
====== ====== ======= ======= =======
December 31,
-------------------------------------------------------
1993 1994 1995 1996 1997
---------- ---------- --------- --------- ---------
(IN THOUSANDS)
Consolidated Balance Sheet Data:
Working capital................................................ $ 90 $ 154 $ 3,493 $26,593 $24,490
Total assets................................................... 228 3,494 13,595 46,035 51,950
Long-term liabilities.......................................... 125 -- -- -- --
Deferred revenue............................................... 72 152 767 2,192 3,851
Total liabilities.............................................. 246 2,977 8,644 14,205 17,468
Redeemable convertible preferred stock......................... -- -- 4,008 -- --
Total stockholders' equity (deficit)........................... (18) 517 943 31,830 34,482
- --------------
(1) For an explanation of the determination of the number of shares used in
computing earnings (loss) per share see Notes to Consolidated Financial
Statements.
20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
Company's Consolidated Financial Statements and the related notes thereto
included elsewhere in this Annual Report on Form 10-K. The following discussion
contains certain trend analysis and other statements of a forward-looking nature
relating to future events or the future financial performance of the Company.
Readers are cautioned that such statements are only predictions and that actual
results or events may differ materially. In evaluating such statements, readers
should specifically consider the risk factors set forth in this Annual Report on
Form 10-K, particularly the matters set forth under the caption "Certain Risk
Factors," in Item 1 "Business", which could cause actual results to differ
materially from those indicated by such forward-looking statements.
OVERVIEW
The Company shipped its first digital video insertion product, the SeaChange
SPOT System, in the third quarter of 1994. Through December 31, 1997,
substantially all of the Company's revenues were derived from the sale of
digital video insertion systems, movie systems and related services primarily to
cable television operators and telecommunications companies in the United States
and internationally. In 1997, the Company derived revenues from the sales of
movie systems, a new version of which was introduced in the quarter ended
September 30, 1997. Revenues from the sale of systems is recognized upon
shipment provided that there are no uncertainties regarding customer acceptance
and collection of the related receivables is probable. If such uncertainties
exist, such as performance criteria beyond the Company's standard terms and
conditions, revenue is recognized upon customer acceptance. Installation and
training revenue is deferred and recognized as these services are performed.
Revenue from technical support and maintenance contracts is deferred and
recognized ratably over the period of the related agreements, generally twelve
months. Customers are billed for installation, training and maintenance at the
time of the product sale.
The Company's business has been seasonal with more customer orders being placed
and greater revenues being generated in the first and second quarters than in
the third and fourth quarters. The Company believes that this pattern of order
placements in specific quarterly periods is due to cable television customers'
buying patterns and budgeting cycles. Many television operators want new video
insertion systems to be operational in the second half of the year in order to
be able to respond to higher seasonal advertising demand from their customers in
this period. The Company expects that these patterns will continue and that, at
least in the near future, the Company's revenues and results of operations will
reflect these seasonal variations.
The Company's results are significantly influenced by a number of factors,
including the Company's pricing, the costs of materials used in the Company's
products and the expansion of the Company's operations. The Company prices its
products and services based on its costs as well as the prices of competitive
products and services in the marketplace. The costs of the Company's products
primarily consist of the costs of components and subassemblies. The costs of
such materials have generally declined over time. As a result of the expansion
of the Company's operations, operating expenses of the Company have increased in
the areas of research and development, selling and marketing, customer service
and support and general and administration.
On December 10, 1997, the Company acquired all of the outstanding capital stock
of IPC Interactive Pte. Ltd. ("IPC"). IPC, together with the Company's
centralized video server platform, provides interactive television network
systems to the hospitality and commercial property markets. Additionally, IPC
deploys and operates its interactive network television systems at customer
locations and charges fees for providing services and content, primarily movies.
The transaction was accounted for under the purchase method and, accordingly,
the results of operations of the Company include the operating results of IPC
from the date of acquisition. IPC was renamed GuestServe Networks.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated the percentage of total
revenues represented by certain items reflected in the Company's Consolidated
Statement of Operations. Gross profit shown for systems and services revenues at
the bottom of the table is stated as a percentage of related revenues.
Year ended December 31,
1995 1996 1997
REVENUES
Systems 94.8 % 92.9 % 89.0 %
Services 5.2 7.1 11.0
-----------------------------
100.0 100.0 100.0
-----------------------------
COST OF REVENUES
Systems 64.3 55.1 51.3
Services 7.1 8.2 11.2
-----------------------------
71.4 63.3 62.5
-----------------------------
Gross profit 28.6 36.7 37.5
-----------------------------
Operating expenses
Research and development 10.2 10.9 17.3
Selling and marketing 6.9 8.6 8.9
General and administrative 3.7 4.2 5.5
Write-off of acquired in-process
research and development -- -- 7.8
-----------------------------
20.8 23.7 39.5
-----------------------------
Income (loss) from operations 7.8 13.0 (2.0)
Interest income, net .5 .7 1.0
-----------------------------
Income (loss) before income
taxes 8.3 13.7 (1.0)
Provision for income taxes 3.1 5.0 2.6
-----------------------------
Net income (loss) 5.2 % 8.7 % (3.6)%
=============================
Gross profit
Systems 32.2% 40.7% 42.5%
Services (36.4)% (14.5)% (1.8)%
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
REVENUES
Systems. The Company's systems revenues consist of sales of its digital video
insertion and movie system products. Systems revenues increased 108% from $22.0
million in 1995 to $45.7 million in 1996, and increased 32% to $60.4 million in
1997. The increased systems revenues in 1996 reflect the Company's introduction,
in January 1996, of the second generation of its digital video insertion system
which significantly improved the scalability and performance of the Company's
products, and the subsequent increase in the number of systems sold. The
increased systems revenues in 1997 compared to 1996 resulted from the increase
in the number of the Company's digital video insertion systems sold to
television operators primarily in the United States and the sale of
approximately $4.4 million of movie systems compared to $232,000 in 1996. The
Company expects the sales of its digital ad insertion products to decrease in
1998 as compared to the $55.7 million in 1997, primarily due to an anticipated
decrease in spending by U.S. cable operators on these products and the slowness
in the development of international demand for such products. The Company
anticipates that future growth in systems revenue will come from its movie
system products, a new version of which was introduced in the quarter ended
September 30, 1997, and its broadcast products, which are expected to be
introduced in 1998.
For the years ended December 31, 1995, 1996 and 1997, certain customers
accounted for more than 10% of the Company's total revenues. Individual
customers accounted for 29%, 29%, 16% and 12% of total revenues in 1995, 29%,
17%,13% and 12% of total revenues in 1996 and 24%, 18% and 10% of total revenues
in 1997. The Company believes that revenues from current and future large
customers will continue to represent a significant proportion of total revenues.
International sales accounted for approximately 5% and 12% of total revenues in
the years ended December 31, 1996 and 1997, respectively. The Company expects
that international sales will continue to increase as a percentage of the
Company's business in the future. Prior to 1996, the Company had no significant
international sales. As of December 31, 1997, all sales of the Company's
products were made in United States dollars. The Company does not expect to
change this practice significantly in the foreseeable future. Therefore, the
Company has not experienced, nor does it expect to experience in the near term,
any material impact from fluctuations in foreign currency exchange rates on its
results of operations or liquidity. If this practice changes in the future, the
Company will reevaluate its foreign currency exchange rate risk.
Services. The Company's services revenues consist of fees for installation,
training and product maintenance and technical support services. The Company's
services revenues increased 193% from approximately $1.2 million in 1995 to $3.5
million in 1996, and increased 112% to $7.5 million in 1997. These increases in
services revenues primarily resulted from the increase in product sales and
renewals of maintenance and support contracts related to the growing installed
base of systems. Service and content revenues resulting from the acquisition of
IPC were not significant in 1997.
GROSS PROFIT
Systems. Costs of systems revenues consist primarily of the cost of purchased
components and subassemblies, labor and overhead relating to the final assembly,
testing and quality control of complete systems and related expenses. Costs of
systems revenues increased 82% from $14.9 million in 1995 to $27.1 million in
1996, and increased 28% to $34.7 million in 1997. The increases in costs of
systems revenues primarily reflect the overall growth in systems sales including
the increase in movie system sales in 1997, partially offset by the change in
product mix upon the introduction of the second generation video insertion
product in January 1996 and the decreasing costs of various components.
Systems gross profit as a percentage of systems revenues was 32.2%, 40.7% and
42.5% in 1995, 1996 and 1997, respectively. The increases in systems gross
profit in 1996 and 1997 resulted from lower costs of certain purchased
components and subassemblies for systems, the Company achieving certain
manufacturing efficiencies as a result of increased volume of systems and from
design improvements in the second generation video insertion product. The
increases in 1996 and 1997 were partially offset by increases of approximately
$694,000 and $1.7 million in the Company's inventory valuation allowance,
respectively. The Company evaluates inventory levels and expected usage on a
periodic basis and provides a valuation allowance for estimated inactive,
obsolete and surplus inventory.
Services. Costs of services revenues consist primarily of labor, materials and
overhead relating to the installation, training and product maintenance and
technical support services provided by the Company. Costs of services revenues
increased 146% from approximately $1.6 million in 1995 to $4.0 million in 1996,
and increased 89% to $7.6 million in 1997, primarily as a result of the costs
associated with the Company building a service organization to support the
installed base of digital ad insertion systems and movie systems. Costs of
services exceeded services revenues by 36.4%, 14.5% and 1.8% in 1995, 1996 and
1997, respectively. Improvements in the services negative gross profit in 1996
and 1997 reflected the increase in the installed base of systems under service
contracts.
RESEARCH AND DEVELOPMENT. Research and development expenses consist primarily
of compensation of development personnel, depreciation of equipment and an
allocation of related facilities expenses. Research and development expenses
increased 128% from approximately $2.4 million in 1995 to $5.4 million in 1996,
and increased 118% to $11.8 million in 1997. The increases in the dollar amounts
were primarily attributable to the hiring and contracting of additional
development personnel. All internal software development costs to date have been
expensed by the Company. The Company expects that research and development
expenses will continue to increase in dollar amount as the Company continues its
development of new and existing products.
SELLING AND MARKETING. Selling and marketing expenses consist primarily of
compensation expenses, including sales commissions and travel expenses,
depreciation of equipment and certain promotional expenses. Selling and
marketing expenses increased 164% from approximately $1.6 million in 1995 to
$4.3 million in 1996, and increased 42% to $6.0 million in 1997. The increases
in the dollar amounts were attributable to the hiring of additional selling and
marketing personnel, expanded promotional activities, increased international
selling efforts and an increase in commissions relating to increased revenues.
The Company expects that selling and marketing expenses will continue to
increase in dollar amount as the Company hires additional personnel and expands
selling and marketing activities in 1998.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist
primarily of compensation of executive, finance, human resource and
administrative personnel, legal and accounting services and an allocation of
related facilities expenses. General and administrative expenses increased 140%
from $858,000 in 1995 to approximately $2.1 million in 1996, and increased 81%
to approximately $3.7 million in 1997. The increases in the dollar amounts were
primarily attributable to increased staffing and related costs to support the
Company's growth and expenses associated with being a public company. The
Company believes that its general and administrative expenses will continue to
increase as a result of an expansion of the Company's administrative staff to
support its growing operations.
WRITE-OFF OF ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT. In connection with
the acquisition of IPC the Company acquired certain technology which can be used
with the Company's video server technology to provide interactive television
network systems to the hospitality and commercial property markets. As discussed
in Note 3 to the consolidated financial statements, the Company recorded a
charge to operations of $5,290,000 for the write-off of in-process research and
development, the value of which was determined based upon an independent
appraisal. In addition, the Company recorded intangible assets of $1,635,000
which included approximately $850,000 of software. Of the acquired technology,
the capitalized amount reflects the allocation of the purchase price to the
software technology deemed technologically feasible, including the operating
system and software for the distribution of movies over the network. Acquired
technology included in the in-process write-off reflects the purchase price
allocated to technology currently under development and not considered
technologically feasible at the time of the acquisition and did not have an
alternative future use, including software to provide certain new interactive
features and functions over the network. The Company intends to continue
developing this in-process technology over the next year as a means of
increasing the marketability of its movie systems.
INTEREST INCOME. Interest income was approximately $113,000, $353,000 and
$657,000 in 1995, 1996 and 1997, respectively. The increase in interest income
primarily resulted from interest earned on a higher invested balance primarily
due to the net proceeds of $24.1 million from the initial public offering of the
Company's common stock in November 1996.
PROVISION FOR INCOME TAXES. The Company's effective tax rates were 37.1% and
36.8% in 1995 and 1996, respectively. The Company's effective tax rate for 1997
was significantly impacted by the write-off of the acquired in-process research
and development which, due to the tax-free nature of the transaction to IPC
stockholders, is not deductible for tax purposes by the Company. Accordingly, in
1997 the Company recorded a tax provision of approximately $1.8 million despite
a book pre-tax operating loss. Through the first three quarters of 1997, the
Company's effective tax rate was 38%.
The Company had net deferred tax assets of $575,000 and $1,091,000 at December
31, 1996 and 1997, respectively. The Company has made the determination that it
is more likely than not that it will realize the benefits of the net deferred
tax assets. As a result of the acquisition of IPC, the Company acquired deferred
tax assets of $3.4 million, consisting primarily of net operating loss
carryforwards. As discussed in Note 5 of the consolidated financial statements,
the Company maintains a full valuation allowance on the acquired net deferred
tax assets.
QUARTERLY RESULTS OF OPERATIONS
The following table presents certain unaudited quarterly information for the
eight quarters ended December 31, 1997. Gross profit shown for systems and
services revenues at the bottom of the table is stated as a percentage of
related revenues. This information is derived from unaudited financial
statements and has been prepared on the same basis as the Company's audited
financial statements which appear elsewhere in this Annual Report on Form 10-K.
In the opinion of the Company's management, this data reflects all adjustments
(consisting only of normal recurring adjustments) necessary for a fair
presentation of the information when read in conjunction with the Company's
Consolidated Financial Statements and Notes thereto. The results for any quarter
are not necessarily indicative of future quarterly results of operations, and
the Company believes that period-to-period comparisons should not be relied upon
as an indication of future performance.
QUARTERLY FINANCIAL DATA (UNAUDITED)
Quarter Ended
March 31, June 30, Sept. 30, Dec. 31, March 31, June 30, Sept. 30, Dec. 31,
1996 1996 1996 1996 1997 1997 1997 1997
(in thousands)
REVENUES
Systems $ 9,684 $13,222 $11,738 $11,101 $16,796 $20,184 $13,188 $10,246
Services 545 903 1,188 885 1,256 1,668 2,063 2,486
--------------------------------------------------------------------------------------------
10,229 14,125 12,926 11,986 18,052 21,852 15,251 12,732
--------------------------------------------------------------------------------------------
COSTS OF REVENUES
Systems 6,342 8,088 6,665 6,038 9,457 11,079 7,889 6,315
Services 729 1,087 1,055 1,159 1,386 1,622 1,953 2,646
--------------------------------------------------------------------------------------------
7,071 9,175 7,720 7,197 10,843 12,701 9,842 8,961
--------------------------------------------------------------------------------------------
Gross profit 3,158 4,950 5,206 4,789 7,209 9,151 5,409 3,771
--------------------------------------------------------------------------------------------
Operating expenses
Research and development 992 994 1,256 2,151 2,416 2,750 3,159 3,433
Selling and marketing 755 1,155 1,125 1,219 1,268 1,842 1,431 1,508
General and administrative 294 568 648 554 930 866 792 1,156
Write-off of acquired and
in-process research and
development -- -- -- -- -- -- -- 5,290
--------------------------------------------------------------------------------------------
2,041 2,717 3,029 3,924 4,614 5,458 5,382 11,387
--------------------------------------------------------------------------------------------
Income (loss) from
operations 1,117 2,233 2,177 865 2,595 3,693 27 (7,616)
Interest income, net 48 52 37 216 200 187 136 134
--------------------------------------------------------------------------------------------
Income (loss) before
income taxes 1,165 2,285 2,214 1,081 2,795 3,880 163 (7,482)
Provision (benefit) for
income taxes 446 882 788 367 1,062 1,475 61 (822)
--------------------------------------------------------------------------------------------
Net income (loss) $ 719 $ 1,403 $ 1,426 $ 714 $ 1,733 $ 2,405 $ 102 (6,660)
============================================================================================
Basic earnings (loss)
per share $ .20 $ .32 $ .29 $ .09 $ .19 $ .24 $ .01 $ (.61)
Diluted earnings (loss)
per share $ .06 $ .12 $ .12 $ .06 $ .13 $ .18 $ .01 $ (.61)
Gross profit
Systems 34.5% 38.8% 43.2% 45.6% 43.7% 45.1% 40.2% 38.4%
Services (33.7)% (20.5)% 11.2% (31.0)% (10.4)% 2.8% 5.3% (6.4)%
The Company has experienced significant variations in revenues, expenses and
operating results from quarter to quarter and such variations are likely to
continue. A significant portion of the Company's revenues have been generated
from a limited number of customers and it is difficult to predict the timing of
future orders and shipments to these and other customers. Customers can cancel
or reschedule shipments, and development or production difficulties could delay
shipments.
The Company has also experienced significant variations in its quarterly gross
margins. In the third quarter of 1995, the Company decreased the selling price
of its first generation SeaChange SPOT digital video insertion system in
anticipation of the introduction of the second generation system in the first
quarter of 1996. This price reduction had a negative impact on the Company's
systems gross margins in the first and second quarters of 1996. In the third and
fourth quarters of 1997, the decrease in the number of systems sold affected the
Company's ability to achieve manufacturing efficiencies and, accordingly, the
gross profit was negatively impacted. Quarterly services gross margins have
historically fluctuated significantly because installation and training service
revenue varies by quarter, while the related costs are relatively consistent by
quarter.
Operating expenses also vary with the number, timing and significance of new
product and product enhancement introductions by the Company and its
competitors, increased competition, changes in pricing policies by the Company
or its competitors, the gain or loss of significant customers, the hiring of new
personnel and general economic conditions. All of the above factors are
difficult for the Company to forecast, and these or other factors may materially
adversely effect the Company's business, financial condition and results of
operations for one quarter or a series of quarters. Only a small portion of the
Company's expenses vary with revenues in the short-term and there would likely
be a material adverse effect on the operating results of the Company if future
revenues are lower than expectations.
Based upon all of the foregoing, the Company believes that quarterly revenues
and operating results are likely to vary significantly in the future and that
period-to-period comparisons of its results of operations are not necessarily
meaningful and should not be relied upon as indications of future performance.
LIQUIDITY AND CAPITAL RESOURCES
From inception through November 1996, the Company funded its operations
primarily through cash provided by operations and the private sale of equity
securities. In November 1996, in connection with the initial public offering of
the Company's common stock, the Company received net proceeds of $24.1 million.
Cash, cash equivalents and marketable securities decreased $11.1 million from
$23.4 million at December 31, 1996 to $12.3 million at December 31, 1997.
Working capital decreased from approximately $26.6 million at December 31, 1996
to approximately $24.5 million at December 31, 1997.
Net cash provided by operating activities was approximately $2.8 million for the
year ended December 31, 1995. Net cash used in operating activities was
approximately $1.9 million and $9.2 million for the years ended December 31,
1996 and 1997, respectively. The net cash used in operating activities in 1997
was the result of the net loss adjusted for noncash expenses including
depreciation, amortization, deferred income taxes and write-off of acquired in-
process research and development and the changes in certain assets and
liabilities, net of the effect of the acquisition of IPC. The significant net
changes in assets and liabilities that used cash in operations include increases
in accounts receivable and inventories and decreases in accounts payable and
customer deposits. The net increase in accounts receivable in 1997 of
approximately $4.4 million is attributable to the decrease in customer deposits,
which represent advance payments from customers and the 6% increase in revenues
in the fourth quarter of 1997 compared to the same period in 1996. The net
increase in inventories in 1997 of approximately $7.1 million is attributable to
lower than anticipated system sales in the fourth quarter of 1997 and additional
inventories to support the Company's current and anticipated revenue from
existing and new product lines and to service the growing installed base of
systems. The net decrease in customer deposits in 1997 of approximately $3.3
million is the result of the timing, volume and size of customer orders.
Net cash used in investing activities was approximately $659,000, $3.2 million
and $10.8 million for the years ended December 31, 1995, 1996 and 1997,
respectively. Investment activity consisted primarily of capital expenditures
related to the acquisition of computer equipment, office furniture, and other
capital equipment required to support the expansion and growth of the business.
In addition, in 1997 the marketable securities increased $9.3 million, net of
sales and maturities of $9.0 million and the Company acquired approximately
$665,000 of cash, net of transaction costs, related to the acquisition of IPC.
Net cash provided by financing activities was approximately $3.2 million and
$22.3 million for the years ended December 31, 1995 and 1996, respectively. Net
cash used in financing activities was approximately $454,000 for the year ended
December 31,1997. In 1995, the cash provided by financing activities included
$4.0 million received in connection with the issuance of the Series B
Convertible Redeemable Preferred Stock, partially offset by a $795,000 cash
outlay related to loans to stockholders. In 1996, the cash provided by financing
activities consisted primarily of net proceeds of $24.1 million from the initial
public offering of the Company's common stock in November 1996 offset by the
purchase of $2.0 million of treasury stock. In 1997, the cash used in financing
represented repayment of IPC's line of credit of approximately $700,000 and
payment of loans to related parties of approximately $437,000, offset by
$683,000 received in connection with the issuance of common stock pursuant to
both the exercise of stock options and purchases under the employee stock
purchase plan.
The Company has a $6.0 million revolving line of credit with a bank which
expires in September 1998. Borrowings under the line of credit are secured by
substantially all of the Company's assets. Loans made under the revolving line
of credit will bear interest at a rate per annum equal to, at the Company's
option, the bank's base rate or LIBOR, plus an applicable margin. The loan
agreement relating to the line of credit requires that the Company provide the
bank with certain periodic financial reports and comply with certain financial
ratios. As of December 31, 1997, the Company had not borrowed against the line.
The Company believes that existing funds together with available borrowings
under the line of credit agreement are adequate to satisfy its working capital
and capital expenditure requirements for the foreseeable future.
The Company also believes that "Year 2000" conversion costs will not be
significant. The Company's business and operating systems were installed in 1996
and necessary Year 2000 conversion requirements will be achieved through routine
upgrades and maintenance to these systems. These upgrades are expected to be
completed by the end of 1998.
The Company had no material capital expenditure commitments as of December 31,
1997.
NEW ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS
128) which changes the method of calculating earnings per share. SFAS 128
requires the presentation of "basic" earnings per share and "diluted" earnings
per share. Basic earnings per share is computed by dividing the net income
available to common shareholders by the weighted average number of shares
outstanding. For purposes of calculating diluted earnings per share the
denominator includes both the weighted average number of shares of common stock
outstanding and potential common stock, such as stock options. Earnings per
share for all periods presented have been restated to comply with SFAS 128.
In February 1998, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 98 (SAB 98), which supersedes SAB 83 and provides new guidance for
the calculation of earnings per share in an initial public offering. SAB 98 is
effective upon a Company's adoption of SFAS 128 and impacts the Company's
calculation of earnings per share for fiscal periods prior to the Company's
initial public offering in November 1996, and for the year ended December 31,
1996. Earnings per share amounts for these periods have been restated to comply
with SAB 98.
In October 1997, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants (AcSEC) issued Statement of Position
97-2 "Software Revenue Recognition" (SOP 97-2), which will become effective with
respect to all reporting periods subsequent to January 1, 1998. Management does
not expect SOP 97-2 to have a material effect on the Company's results of
operations as the Company's revenue recognition policy is substantially
consistent with the provisions of SOP 97-2.
In June 1997, the FASB issued Statement of Financial Accounting Standards No.
130, "Reporting Comprehensive Income" (SFAS 130) and Statement of Financial
Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and
Related Information" (SFAS 131). SFAS 130 establishes standards for reporting of
comprehensive income and its components in the consolidated financial
statements. SFAS 131 establishes standards for reporting information on
operating segments in interim and annual financial statements. Both SFAS 130 and
SFAS 131 will become effective for the Company beginning in 1998 and will
require additional financial statement disclosures only.
EFFECTS OF INFLATION
Management believes that financial results have not been significantly impacted
by inflation and price changes.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's Financial Statements and Schedules, together with the auditors'
reports thereon, appear at pages F-1 through F-12, and S-1 through S-2,
respectively, of this Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information concerning the directors of the Registrant is hereby incorporated
by reference from the information contained under the heading " Election of
Directors" in the Registrant's definitive proxy statement related to the
Registrant's 1997 Annual Meeting of Stockholders which will be filed with the
Commission within 120 days after the close of the fiscal year (the "Definitive
Proxy Statement").
Certain information concerning directors and executive officers of the
Registrant is hereby incorporated by reference to the information contained
under the heading "Occupations of Directors and Executive Officers" in the
Registrant's Definitive Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation is hereby incorporated by
reference to the information contained under the heading "Compensation and Other
Information Concerning Directors and Officers" in the Definitive Proxy
Statement.
21
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGMENT
Information concerning security ownership of certain beneficial owners and
management is hereby incorporated by reference to the information contained
under the heading "Securities Ownership of Certain Beneficial Owners and
Management" in the Definitive Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning certain relationships and related transactions is
hereby incorporated by reference to the information contained under the heading
"Certain Relationships and Related Transactions" in the Definitive Proxy
Statement.
22
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS
The following Consolidated Financial Statements of the Registrant are filed as
part of this report:
Page
-------
Report of Independent Accountants F-1
Consolidated Balance Sheet as of December 31, 1996 and 1997 F-2
Consolidated Statement of Operations for the years ended December 31, 1995, 1996 and 1997 F-3
Consolidated Statement of Stockholders' Equity for the years ended December 31, 1995, 1996 and 1997 F-4
Consolidated Statement of Cash Flows for the years ended December 31, 1995, 1996 and 1997 F-5
Notes to Consolidated Financial Statements F-6
(a)(2) INDEX TO FINANCIAL STATEMENT SCHEDULES
The following Financial Statement Schedule of the Registrant is filed as part
of this report:
Page
-------
Schedule I - Report of Independent Accountants on Financial Statement Schedule S-1
Schedule II - Valuation and Qualifying Accounts and Reserves S-2
Schedules not listed above have been omitted because the information requested
to be set forth therein is not applicable or is shown in the accompanying
Consolidated Financial Statements or notes thereto.
(a) (3) INDEX TO EXHIBITS
See attached Exhibit Index of this Annual Report on Form 10-K.
(b) REPORTS ON FORM 8-K
On December 10, 1997 the Company filed a current report on Form 8-K
announcing that the Company had acquired all of the outstanding stock of IPC
Interactive Pte. Ltd. pursuant to a Stock Purchase Agreement by and among the
Company and the parties listed therein.
(c) EXHIBITS
The Company hereby files as part of this Form 10-K the Exhibits listed in Item
14(a)(3) above. Exhibits which are incorporated herein by reference can be
inspected and copied at the public reference facilities maintained by the
Securities and Exchange Commission (the "Commission"), 450 Fifth Street, N.W.,
Washington, D.C., 20549 and at the Commission's regional offices located at
Seven World Trade Center, 13th Floor, New York, New York 10048, and at the
Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661.
Copies of such material can also be obtained from the Public Reference Section
of the Commission, 450 Fifth Street, N.W., Washington, D.C., 20549, at
prescribed rates. In addition the Company is required to file electronic
versions of certain of these documents with the Commission through the
Commission's Electronic Data Gathering, Analysis and Retrieval (EDGAR) system.
The Commission maintains a World Wide Web site at http://www.sec.gov that
contains the report, proxy and information statements and other information
regarding registrants that file electronically with the Commission. The Common
Stock of the Company is traded on the Nasdaq National Market. Reports and other
information concerning the Company may be inspected at the National Association
of Securities Dealers, Inc. 1735 K Street, N.W., Washington, D.C. 20006.
(d) FINANCIAL STATEMENT SCHEDULES
The Company hereby files as part of this Form 10-K the consolidated financial
statements schedules listed in Item 14(a)(2) above, which are attached hereto.
23
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, SeaChange International, Inc. has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: MARCH 31, 1998
SEACHANGE INTERNATIONAL, INC.
by: /s/ William C. Styslinger, III
----------------------------------
William C. Styslinger, III
President, Chief Executive Officer,
Chairman of the Board and Director.
POWER OF ATTORNEY AND SIGNATURES
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints William C. Styslinger, III and Edward J.
McGrath, jointly and severally, his attorney-in-fact, each with the power of
substitution, for him in any and all capacities, to sign any amendments to this
Report on Form 10-K and to file same, with exhibits thereto and other documents
in connection therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming all that each of said attorneys-in-fact, or his
substitute or substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE(S) DATE
- ---------------------------------------- -------------------------------------- -------------------------
/s/ William C. Styslinger, III President, Chief Executive Officer, March 31, 1998
- ---------------------------------------- Chairman of the Board and Director
William C. Styslinger, III (Principal Executive Officer)
/s/ Joseph S. Tibbetts, Jr. Vice President, Finance and March 31, 1998
- ---------------------------------------- Administration, Chief Financial
Joseph S. Tibbetts, Jr. Officer and Treasurer (Principal
Financial and Accounting Officer)
/s/ Martin R. Hoffmann Director March 31, 1998
- ----------------------------------------
Martin R. Hoffmann
/s/ Edward J. McGrath Director March 31, 1998
- ----------------------------------------
Edward J. McGrath
/s/ Paul Saunders Director March 31, 1998
- ----------------------------------------
Paul Saunders
/s/ Carmine Vona Director March 31, 1998
- ----------------------------------------
Carmine Vona
24
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION PAGE
- ------------ ----------------------------------------------------------------- ----
3.1 Amended and Restated Certification of Incorporation (incorporated
by reference to the Registrant's Annual Report on Form 10-K filed
March 28, 1997).
3.2 Amended and Restated By-laws of the Company (incorporated by
reference to the Registrant's Annual Report on Form 10-K filed
March 28, 1997).
4.1 (1) Form of Stock Restriction Agreement (incorporated by reference to
Exhibit 4.3 to the Registrant's Registration Statement on Form
S-1, Registration No. 333-12233).
4.2 (1) Form of Stock Restriction Agreement Admendment (incorporated by
reference to Exhibit 4.4 to the Registrant's Registration
Statement on Form S-1, Registration No. 333-12233).
10.1 (1) Amended and Restated 1995 Stock Option Plan (incorporated by
reference to Exhibit 10.1 to the Registrant's Registration
Statement on Form S-1, Registration No. 333-12233).
10.2 (1) 1996 Non-Employee Director Stock Option Plan (incorporated by
reference to Exhibit 10.2 to the Registrant's Registration
Statement on Form S-1, Registration No. 333-12233).
10.3 Lease Agreement dated March 10, 1995 between Thomas B. O'Brien,
Trustee of Jelric Realty Trust u/d/t dated 9/18/68 and the Company
(incorporated by reference to Exhibit 10.3 to the Registrant's
Registration Statement on Form S-1, Registration No. 333-12233).
10.4 Sublease Agreement dated March 19, 1996 between IPL Systems, Inc.
and the Company (incorporated by reference to Exhibit 10.4 to the
Registrant's Registration Statement on Form S-1, Registration No.
333-12233).
10.5 Indenture of Lease dated October 1, 1995 between Alden T.
Greenwood and the Company (incorporated by reference to Exhibit
10.5 to the Registrant's Registration Statement on Form S-1,
Registration No. 333-12233).
10.6 (1) Letter Agreement dated as of June 12, 1996 between Joseph S.
Tibbetts, Jr. And the Company (incorporated by reference to
Exhibit 10.6 to the Registrant's Registration Statement on Form
S-1, Registration No. 333-12233).
10.7 License Agreement dated May 30, 1996 between Summit Software
Systems, Inc. and the Company (incorporated by reference to
Exhibit 10.7 to the Registrant's Registration Statement on Form
S-1, Registration No. 333-12233).
10.8 Loan and Security Agreement, dated September 25, 1996, between the
Company and BayBank, N.A. (incorporated by reference to Exhibit
10.8 to the Registrant's Registration Statement on Form S-1,
Registration No. 333-12233).
10.9 Working Capital Line of Credit-Master Note dated September 25,
1996, between the Company and BayBank, N.A. (incorporated by
reference to Exhibit 10.9 to the Registrant's Registration
Statement on Form S-1, Registration No. 333-12233).
10.10 Equipment Line of Credit-Master Note dated September 25, 1996,
between the Company and BayBank, N.A. (incorporated by reference
to Exhibit 10.10 to the Registrant's Registration Statement on
Form S-1, Registration No. 333-12233).
10.11 Sales and Marketing Representative Agreement dated October 11,
1996, between the Company and Media Power S.n.c. (incorporated by
reference to Exhibit 10.11 to the Registrant's Registration
Statement on Form S-1, Registration No. 333-12233).
10.12* Second Amendment To Loan and Security Agreement, dated September
24, 1997 between the Company and BankBoston, N.A.
10.13 Stock Purchase Agreement, dated December 10, 1997, by and among
the Company, IPC Interactive Pte. Ltd. and the shareholders of IPC
Interactive Pte. Ltd. (incorporated by reference to the Exhibits
to the Company's Report on Form 8-K dated December 10, 1997).
10.14 Registration Rights Agreement, dated December 10, 1997, by and
among the Company, IPC Interactive Pte. Ltd. and the shareholders
of IPC Interactive Pte. Ltd. (incorporated by reference to
25
the Exhibits to the Company's Report on Form 8-K dated December
10, 1997).
10.15 Escrow Agreement, dated December 10, 1997, by and among the
Company, IPC Interactive Pte. Ltd., the shareholders of IPC
Interactive Pte. Ltd. and State Street Bank and Trust Company
(incorporated by reference to the Exhibits to the Company's Report
on Form 8-K dated December 10, 1997).
11.1 Statement re: computation of earnings per share.
21.1* Subsidiaries of the Company.
23.1* Consent of Price Waterhouse LLP.
27.1* Financial Data Schedule (For SEC Edgar Filing Only; Intentionally
Omitted).
- -------------
* Filed herewith.
(1) Indicates a management contract or any compensatory plan or arrangement.
26
SEACHANGE INTERNATIONAL, INC.
REPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULE
To the Board of Directors of SeaChange International, Inc.
Our audits of the consolidated financial statements referred to in our report
dated January 22, 1998 appearing on page F-1 of this Form 10-K also include an
audit of the Financial Statement Schedule listed in Item 14(a) of this Form
10-K. In our opinion, this Financial Statement Schedule presents fairly, in all
material respects, the information set forth therein when read in conjunction
with the related consolidated financial statements.
PRICE WATERHOUSE LLP
Boston, Massachusetts
January 22, 1998
S-1
Schedule II
SEACHANGE INTERNATIONAL, INC.
VALUATION OF QUALIFYING ACCOUNTS AND RESERVES
Balance at Charged to
beginning of costs and Deductions Balance at end
period expenses and write-offs Other of period
------------ ------------ -------------- --------- --------------
Allowance for Doubtful Accounts:
Year ended December 31, 1995 $ -- $ 40,000 $ -- $ -- $ 40,000
Year ended December 31, 1996 $ 40,000 $ 133,000 $ -- $ -- $ 173,000
Year ended December 31, 1997 $173,000 $ 485,000 $ (174,000) $ 75,000 $ 559,000
Inventory Valuation Allowance:
Year ended December 31, 1995 $ -- $ 56,200 $ -- $ -- $ 56,200
Year ended December 31, 1996 $ 56,200 $ 693,800 $ -- $ -- $ 750,000
Year ended December 31, 1997 $750,000 $1,730,000 $(1,076,000) $100,000 $1,504,000
S-2