SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
(Amendment No. 1)
x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended January 31, 2007
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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 incorporation or organization) |
(IRS Employer Identification No.) |
50 Nagog Park, Acton, MA 01720
(Address of principal executive offices, including zip code)
(978)-897-0100
(Registrants telephone number, including area code)
Securities Registered Pursuant To Section 12(b) Of The Act:
Common Stock, $.01 par value
Securities Registered Pursuant To Section 12(g) Of The Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
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 preceding 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 of S-K is not contained herein, and will not be contained, to the best of the registrants 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. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act);
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Large accelerated filer ¨ Accelerated Filer x Non Accelerated Filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of July 31, 2006, the aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the closing price for the registrants Common Stock on the Nasdaq National Market on such date was $168,180,378. The number of shares of the registrants Common Stock outstanding as of the close of business on October 17, 2007 was 29,582,963.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the definitive Proxy Statement relating to the registrants Annual Meeting of Stockholders held on July 18, 2007 and filed on May 25, 2007 pursuant to Regulation 14A are incorporated by reference into Part III of this Annual Report on Form 10-K/A.
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PART I
Explanatory Note
SeaChange International, Inc. (the Company) is amending its Annual Report on Form 10-K for the year ended January 31, 2007 (the Original 10-K) to restate on Form 10-K/A the Companys Consolidated Balance Sheet, Consolidated Statement of Operations, Consolidated Statement of Cash Flows and Consolidated Statement of Stockholders Equity and Comprehensive Income (Loss), as of January 31, 2007 and 2006 and for each of the three years in the periods ended January 31, 2007, 2006 and 2005. The Form 10-K/A also includes the restatement of selected financial data as of and for each of the five years in the period ended January 31, 2007, as well as the restatement of quarterly results of operations for each of the two years in the period ended January 31, 2007. As to the selected financial data as of January 31, 2007 and 2006 and for the years ended January 31, 2007, 2006 and 2005 such amounts are derived from the audited financial statements included elsewhere in the Form 10-K/A. The restated selected financial data as of January 31, 2007 and 2006, and for the years ended January 31, 2007, 2006 and 2005 and the restated quarterly results of operations are unaudited and in the opinion of management, have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) and reflect all adjustments that are necessary for the fair presentation of the Companys financial position and results of operations for these periods.
As previously disclosed in the Current Report on Form 8-K dated August 31, 2007 and September 18, 2007, the Audit Committee of the Board of Directors of the Company (the Audit Committee), in consultation with the Companys management, concluded that the Consolidated Balance Sheet, Consolidated Statement of Operations, Consolidated Statement of Cash Flows and Consolidated Statement of Stockholders Equity and Comprehensive Income (Loss) as of and for the year ended January 31, 2007 contained in the Original 10-K should no longer be relied upon due to an error related to the accounting for its employee sabbatical program. The Company identified three errors, quantified them under the dual approach method and concluded that the correction of these errors through the Consolidated Statement of Operations would be material to the fiscal year ended January 31, 2007 in the aggregate. Accordingly the Company has determined to restate the consolidated financial statements for the fiscal years ended January 31, 2007, 2006 and 2005, even though the errors are not material to the Consolidated Balance Sheet, Consolidated Statement of Operations, Consolidated Statement of Cash Flows, or Consolidated Statement of Stockholders Equity and Comprehensive Income (Loss) for the fiscal years ended January 31, 2006 and 2005. A description of the 2007 restatement error and related impact on the Companys consolidated financial statements follows.
Sabbatical Leave and Retrospective Application of Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements (SAB 108)
The Companys employee sabbatical benefit entitles U.S.-based employees who achieve eight years of service to twenty days of additional paid time off. The Company had recorded expenses for this employee benefit only when employees had actually taken the sabbatical or had left the Company. Based on the terms of the Companys program, the Company should have accrued for this liability under Statement of Financial Accounting Standards (SFAS) No. 43, Accounting for Compensated Absences (SFAS 43), once an employee achieved the requisite period of service, regardless as to when the paid time off, if any, had been taken. The Company has determined that it will correct this error, along with two other errors, that were previously corrected through a $753,000 cumulative effect adjustment to decrease the accumulated deficit at February 1, 2006 in connection with the adoption of SAB 108 in the fiscal year ended January 31, 2007, in the following manner (see Note 1 to the Consolidated Financial Statement):
| A decrease to accumulated deficit of $31,000 as of February 1, 2004 reflected as a cumulative effect adjustment through a restatement of the Companys Consolidated Balance Sheet and Consolidated Statement of Stockholders Equity and Comprehensive Income (Loss) as of and for the fiscal year ended January 31, 2005. |
| An increase to net loss of $63,000, a reduction to net loss of $118,000 and a reduction to net income of $72,000 to be reflected through a restatement of its Consolidated Balance Sheet, Consolidated Statement of Operations, Consolidated Statement of Cash Flows and Consolidated Statement of Stockholders Equity and Comprehensive Income (Loss) for the fiscal years ended January 31, 2007, 2006 and 2005, respectively. |
| An increase to the basic and diluted loss per share of $.01 and a reduction to the basic and diluted loss per share of $.01 for the fiscal years ended January 31, 2007 and 2006, respectively, and no per share change in the fiscal year ended January 31, 2005. |
The impact of this restatement does not include any net tax effects as the Companys deferred tax assets are fully reserved against due to the uncertainties related to the Companys ability to generate sufficient pre-tax income for fiscal 2008 and the inability to carry back fiscal 2008 tax losses to prior years because the Company exhausted its US tax benefit carry back potential in fiscal 2007 (see Note 10).
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Impact of Restatement
The effects of this restatement on the Companys consolidated financial statements as of January 31, 2007 and 2006 and for the fiscal years ended January 31, 2007, 2006 and 2005 are described in Note 1 to the Consolidated Financial Statements included in this Amended Annual Report on Form 10-K/A.
This Annual Report on Form 10-K/A also addresses managements re-evaluation of disclosure controls and procedures and managements report on internal control over financial reporting as of January 31, 2007 resulting from its reassessment and identification of a material weakness in internal control over financial reporting related to the Companys failure to account for sabbatical leave under SFAS 43. See ITEM 9A (Controls and Procedures) for further discussion, as well as for the related attestation report of the Companys Independent Registered Public Accountants. New certifications of the principal executive officer and principal financial officer are included as exhibits to this Annual Report on Form 10-K/A.
The Company has not modified or updated the disclosures in the Original 10-K, filed on April 13, 2007, other than as required to reflect the effects of the restatement. As such, this Annual Report on Form 10-K/A does not reflect all events that have occurred since the Company filed the Original 10-K and does not modify or update those disclosures affected by subsequent events, except as specifically referenced herein. The Company has made no changes to the Items in the Original 10-K other than those described below. The Company will file an amended Quarterly Report on Form 10-Q/A for the quarterly period ended April 30, 2007 to reflect the Companys adoption of Emerging Issues Task Force (EITF) No. 06-2, Accounting for Sabbatical Leave and Other Similar Benefits Pursuant to FASB Statement No. 43, Accounting for Compensated Absences (EITF 06-2) and correction for its employee sabbatical benefit under SFAS 43, following the filing of this Annual Report on Form 10-K/A.
References to this Annual Report on Form 10-K/A shall, unless the context clearly indicates otherwise, refer to the Original 10-K, as amended by this Annual Report on Form 10-K/A. The following items have been amended as a result of the restatement and related matters:
Part I Item 1A Risk Factors
Part II Item 6 Selected Financial Data
Part II Item 7 Managements Discussion and Analysis of Financial Condition and Results of Operations
Part II Item 8 Consolidated Financial Statements and Supplementary Data
Part II Item 9A Controls and Procedures
Part IV Item 15 Exhibits and Financial Statement Schedules
Forward-Looking Statements
This Annual Report on Form 10-K/A includes certain statements of a forward-looking nature which reflect the Companys current views relating to future events, estimates 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 ITEM 1A Risk Factors below, which could cause actual events or results to differ materially from historical results or those indicated by such forward-looking statements. Any forward-looking statements included in this Annual Report on Form 10-K/A are made as of the date hereof only, based on information available to the Company as of the date hereof, and, subject to any applicable law to the contrary, the Company assumes no obligation to update any forward-looking statements. In particular, except as they may relate to matters involving the restatement, the Company has not updated any forward-looking statements contained in the Companys Original 10-K filed with the Securities Exchange Commission (SEC) on April 13, 2007. The Company can make no assurance as to the potential effects of the restatement, including the effects of any investigations, informal or otherwise, conducted by the SEC or other entities or lawsuits filed against the Company in connection therewith.
ITEM 1. | Business |
SeaChange International, Inc. (SeaChange, we or us), a Delaware corporation founded on July 9, 1993, is a leading developer, manufacturer and marketer of digital video systems and services. These products and services facilitate the management, aggregation, licensing, storage, and distribution of video, television programming, gaming and advertising content. We sell our products and services worldwide to cable system operators, including Cablevision, Comcast, Cox Communications, Virgin Media,
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Time Warner Cable and India Online Broadband; telecommunications companies, including Nippon Telephone & Telegraph (NTT), Manitoba Telecom and Verizon Communications; and broadcast television companies, including ABC Disney, CNBC UK, Ascent Media, Clear Channel, and China Central Television.
Our digital video systems are designed to enable our customers to reduce subscriber turnover and access new revenue-generating opportunities from subscribers, advertisers and electronic commerce initiatives. Using our products and services, we believe our customers can increase their revenues by offering additional services such as on demand television, which allows, for example, the operator to offer a variety of programming for viewing whenever a subscriber chooses and incorporates the ability for subscribers to pause and rewind live television shows. Our systems also allow our customers to insert advertising, known as spot advertising, into their local and on-demand programming. As on-demand continues to grow, our advertising systems will allow our customers to target advertising segments to specific subscribers in a particular geographic and/or demographic market. In addition, our systems enable broadband system operators to offer other interactive television services that allow subscribers to customize and/or dynamically interact with their television, enhancing their viewing experience.
The primary thrust of our business has been supplying systems to deliver video assets in the evolving On Demand television environment. Through acquisitions and partnerships we have expanded our products and services to address the needs of video content owners, broadcasters, and aggregators. We refer to this flow of video assets from the content owner to the subscriber as the Content Pipeline. Our products and services include middleware that drives set top box applications such as Games on Demand, hardware and software for content management and delivery systems, advertising systems to pay for content, and services that involve the acquisition and distribution of video content. We believe that the expansion of our product line will position SeaChange to support and maintain our existing customer base, take advantage of new customers entering the on-demand marketplace and to be able to enter adjacent markets.
Our core technologies provide a foundation for products and services that can be deployed in next generation systems capable of increased levels of subscriber interactivity. We have received several awards for technological excellence, including an Emmy Award in 2001 for our patented MediaCluster ® technology and an Emmy Award in 2004 for our video-on-demand system.
Since 2004, we have made a number of strategic acquisitions and investments to expand our portfolio of products and services. These acquisitions and investments position SeaChange to offer customers of our video-on-demand systems a broader set of products and services. We have expanded our product line to cover the complete Content Pipeline including middleware and applications, networking technology and media services.
Industry Background
Cable System Operators and Telecommunications Companies
The number of cable households has been estimated at 74 million in the United States and approximately 350 million worldwide. Over the last several years, cable system operators have spent billions of dollars to upgrade their networks from analog to digital, yielding a significant increase in available bandwidth, channel capacity and two-way capability. We believe this investment by the cable system operators reflects their intent to provide video-on-demand, advertising insertion, Internet access and other value-added services to their customers, that will differentiate cable system operators from competing service providers, including telecommunications companies and satellite delivery systems.
In 2001, cable system operators and telecommunications companies began the deployment of residential video-on-demand capability allowing subscribers to watch video programming at any time with pause, rewind, fast forward and a number of additional interactive capabilities. All of the top ten North American cable system operators have deployed video-on-demand services in one or more major residential markets. The various on-demand applications offered by cable system operators and, increasingly, telecommunications operators include movies-on-demand, subscription video-on-demand, such as Home Box Office (HBO), as well as news, sports, music videos, games on-demand, and time-shifted television.
Cable companies have also begun to market telephony services. In response, telecommunications operators, notably AT&T and Verizon in the U.S., have initiated efforts to provide competitive digital television services. We believe their public statements regarding further network investments and other initiatives signal their strategic intentions to become significant players in video-on-demand and other interactive television services. Elsewhere, international telecommunications companies with high-speed network capacity are actively exploring and launching similar television services.
In addition, because cable television programming is transmitted over broadband (high bandwidth networks), cable system and telecom operators have the opportunity to segment and target their programming to viewers in selected geographies. In the future, we believe that the ability of operators to target viewers will extend to individual household-level targeting of advertisements in video-on-demand applications, generating revenues which may help support the worldwide deployment and growth of video-on-demand content and services.
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Increased demand for video and audio content over the Internet will also require a substantial increase in storage capacity and bandwidth over time. We believe that cable system operators and telecommunications companies will play an integral role in providing these broadband Internet applications. We also believe that in order to offer high quality video applications over the Internet, cable system operators and telecommunications companies will need more storage and delivery systems capable of complex management and scheduling of video data streams.
Broadcast Television Companies
Both domestically and internationally, broadcast television companies face a number of new challenges to their business. In digital broadcasting, changing ownership trends, new consumer alternatives (e.g., cable television, satellite television, or Internet) and evolving viewership models (e.g., Personal Video Recorders (PVR), cell phones, Personal Digital Assistants (PDA), etc.) are creating a more complex competitive environment for our customers that calls for greater efficiencies and business innovation. We believe broadcast television companies are therefore turning away from their out-dated tape-based systems with robotic libraries, which are cumbersome and require high levels of maintenance and manual intervention.
Some television broadcasters are using digital bandwidth to originate multiple program streams. As this application further develops, television broadcasters will require more video storage and delivery systems that can effectively manage and deliver these multiple television signals. As a result, we believe that television broadcasters will continue to automate their entire programming and advertising to reduce overall operating costs and improve reliability. In the near future we expect new opportunities to emerge for broadcasters and video-on-demand operators to create new business synergies that will likely leverage digital video storage and delivery systems.
SeaChange Business Segments
Broadband
Our high-bandwidth network, or Broadband, business is the foundation of our company and includes our video-on-demand (VOD) System which digitally manages, stores and distributes digital video. Our video-on-demand system allows cable system operators and telecommunications companies to offer video-on-demand and other interactive television services, including interactive electronic advertising and retrieval of Internet content through the television. Our video-on-demand system can be deployed in either a residential environment or a commercial environment (e.g., hotels, schools, etc.) to deliver a wide variety of video services. Since 2000, we have been selected to supply our video-on-demand system in over 100 domestic and international commercial deployments of video-on-demand systems, including deployments by eight of the top 10 cable system operators in the United States, as well as large cable operators in Asia, Europe and Latin America. As of the end of the third quarter of 2006, there were approximately 30.0 million US homes that received digital cable. Approximately 25.0 million of these homes have access to video-on-demand and some research analysts are forecasting that access to video-on-demand will grow to over 40.0 million digital cable homes by the end of 2008.
Our video-on-demand platform is comprised of hardware in the form of servers that store and deliver video content, and software that manages the video assets, the network and the back-office functions of the service.
In 2006, we began selling Axiom, our video-on-demand software, independent of our VOD hardware and offering subscription services for the software in an effort to increase market share and reduce revenue volatility through more recurring revenues. By porting our software to other third party hardware platforms, we expect to increase our market share through opportunities at competitive vendors installations. In July of 2006, we announced our first software subscription service sale to Comcast. Since that time, five additional customers have purchased software subscription services.
Our Broadband business segment also includes our SPOT System for the insertion of advertisements and other short-form video into television network streams. Our advertising insertion products are available for both the traditional analog environment (the way that video signals have been transmitted for the past 60 years), and for the digital environment which provides the cable operator with a significant increase in available bandwidth, channel capacity and two-way capability. Based on currently available industry sources and our internal data, we believe our SPOT System is the leading analog video insertion system in the United States in the multichannel television market for advertisements and other short-form video. Over the last several years, our customers have begun to migrate to digital video ad insertion, and we believe our digital video ad insertion system is establishing a strong market position as well. The SPOT System automates the management and distribution process, which we believe reduces operating costs, provides high accuracy, high video image quality, and permits geographic and demographic specificity of advertisements. While the majority of our customers consist of major cable system operators and telecommunications companies in the United States, we have sold SPOT Systems to support over 55,000 channels throughout the world. Migration from the analog environment to the digital
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environment (particularly in the U.S.) has slowed demand for analog advertisement systems while accelerating demand for digital advertisement systems. In the future, we believe that our expertise in both the analog and digital advertising insertion market positions us well as the opportunities continue to develop for delivering interactive and targeted advertisements into television streams and into new media formats such as video-on-demand streams, games, and other applications.
Our middleware and application business is focused on producing set-top client middleware software products and end-to-end interactive television applications, and performing system integration and software customization services. Our middleware and applications team is comprised of engineers located in Fort Washington, PA and San Mateo, CA. Our client middleware solutions include the VODlink Platform Suite built for and deployed on common North American cable set top boxes and the TV Navigator platform deployed in Europe. We have also acquired the source code rights to technology developed by Minerva Networks which will allow us to deploy its Multiverse ® IPTV solutions in the telecom space.
Our middleware products consist of standards-based set top applications, head-end server components, software developer tools and a set of user applications. We have an open middleware architecture that can span both telecom and cable service provider deployments and is able to produce and facilitate a broad offering of applications that realize an end-to-end solution with other technologies. These include advanced asset management systems, DVD-on-Demand, switched broadcast, electronic program guides that include support for video-on-demand, subscription video-on-demand like HBO (SVOD), Personal Video Recording (PVR) and Network Personal Video Recording (nPVR), advertising insertion in video-on-demand, and the GameNow game management system and streaming game technology. SeaChange middleware is currently deployed in over 2 million homes in North America and over 3 million homes in Europe.
In June of 2005, SeaChange made an $8.2 million investment in preferred stock of Casa Systems, Inc. representing a 19.8% ownership interest. Founded in 2003, Casa is a privately held technology company that has developed next generation broadband networking devices targeted at the growing market opportunity in interactive digital video and IP services over broadband networks. Based on innovative technologies, we believe that Casas products may increase the efficiency while reducing the capital and operating expense of large scale deployments of video-on-demand, Interactive TV, Digital Video Recording (DVR), Switch Digital Video Broadcast (SDV), Video over Internet (video over IP) and broadband services.
Broadcast
Our Broadcast network business segment includes our Broadcast MediaCluster System, which allows broadcast television companies to directly transmit content, such as commercials and other programming, for broadcast television companies, to their viewers through either single, multichannel or satellite based delivery systems. We believe that our Broadcast MediaCluster System will effectively eliminate the need for analog tape libraries and provide broadcasters with the automated storage and playback features that they require and are seeking. Since 1998, we have installed our Broadcast MediaCluster System at more than 250 customer locations including network affiliates and multichannel operations in Asia, Europe and the Americas. In addition, we provide media companies, including studios, television networks, stations and cable and telecom operators, with the ability to interoperate with other devices (e.g., video editing and production equipment) within their customers enterprise as part of a client-server architecture with our SeaChange MediaClient system to support the streaming and storage requirements of digital video applications. As media companies take advantage of new video services, including video-on-demand, Internet video streaming, and High-Definition television, we believe that they will derive greater benefit from storing media in a digital format. Our MediaLibrary and MediaClient systems are designed to support the storage, streaming and conversion of digital media files for a variety of video services.
Services
SeaChange has expanded into media content services, consisting of content aggregation and distribution, through the acquisition of On Demand Group Limited (ODG), completed in September of 2005. ODG is a leader in Europe in the development and deployment of interactive media services. ODG specializes in aggregating content for video-on-demand and network video-on-demand (NVOD) platforms, and has provided services to cable operators in several countries in Europe. ODG owns 33.3 % of Filmflex Movies Limited (Filmflex), a movie video-on-demand service that supplies movies to the UK cable industry and whose other investors are the Walt Disney Company Limited and Columbia Pictures Corporation Limited. Filmflex supplies content from Warner Brothers, Paramount, Universal, MGM, and Dreamworks, as well as the studio partners that are investors in Filmflex, and the majority of the independent film distributors in the UK. ODG also sources, acquires, packages, markets and accounts for Virgin Medias (the largest cable operator in the U.K.) video-on-demand services in the areas of music, childrens, comedy and dramatic content. ODG has developed its own content rights management system and a content preparation center for incorporating video content from all of the major content suppliers around the world.
In Germany, the largest European market, ODG launched its own Pay-per-View service for Kabel Deutschland Germany (KDG) in fiscal 2007. KDG has approximately 9 million subscribers and has just begun to deploy digital services.
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We expect to transition the Pay-per-View service to a full fledged VOD service as the digital roll-out occurs. In addition, to augment the amount and variety of video content to be made available for KDGs Pay-per-View services and other prospective German service providers, ODG entered into a joint venture in fiscal 2008 with TeleMunchen Gruppe, a German media company whose activities include the production and acquisition of German-speaking feature films, television productions and classical music programs.
In addition to media content services, SeaChange installs, maintains, and supports its hardware and software products in North America, Asia, South America and Europe. We currently provide installation, maintenance and technical support services to all our Broadband and Broadcast segment customers. With the addition of our middleware software products, we are also performing system integration, software customization and other professional services. We offer maintenance and technical support to customers, agents and distributors of our products on a 24-hour, seven-day a week basis, and our systems include at least one year of warranty support. We also offer basic and advanced on-site training for our customers.
Information about our business segments is included in Managements Discussion and Analysis of Financial Condition and Results of Operations and Note 4 of the Consolidated Financial Statements.
The SeaChange Solution
We are a leading developer, manufacturer and marketer of digital video systems and services. Our digital video systems, which include hardware, such as servers, as well as operations and applications software, automate the storage, management and distribution of video content such as movies, broadcast programming, games, advertising and other video content types. We market our products and services to cable system operators, telecommunications companies and broadcast television companies, and are actively exploring the marketing of our products to new customers that are entering the video-on-demand market. Our solutions are based on the following five core areas of functionality:
| Content aggregation, management and distribution; |
| Storage and retrieval of video content to and from digital libraries; |
| Automated distribution of video streams between digital libraries by means of local and wide-area data networks; |
| Delivery of video streams over single and multiple channels; and |
| Management of video sales, scheduling, billing and execution of related business transactions and services. |
We use these core areas of functionality to provide solutions to a number of commercial markets and are focused on providing solutions to meet the opportunities presented by next-generation systems with increased levels of subscriber interactivity. Our systems are designed to provide a consistent set of features and benefits, including:
| Viewer Targeting. Our digital video products enable broadband system operators (telecom and cable television companies) to efficiently target viewers in specific demographic or geographic groups. We believe this allows operators to capitalize on new revenue-generating opportunities from subscribers and advertisers. Using our video-on-demand system, broadband operators are able to offer interactive television services to individual residences or hotel rooms and, with our advertising system, can better target advertising campaigns to consumers. |
| Scalability. Our products are scalable in both video storage and video stream capacity. Our proprietary technology, including our patented single-copy storage system, the MediaCluster system, allows a single copy of content to be streamed through all available outputs without the need for duplication of content or re-routing between servers on the system. Our storage technology and distributed architecture results in a highly scalable system that reduces operational complexity and yields storage and bandwidth efficiencies as the amount of available content and the number of subscribers increase. Our products are scalable to the needs of our customers whether operating in a single channel system concentrated in one specific zone or a system with hundreds of channels serving multiple markets and a large number of users within each market. |
| Interoperability. Our products have been designed to be compatible with a wide range of hardware systems and software applications used by broadband system operators to deliver their digital video offerings. These include set top boxes from Motorola, Scientific Atlanta, Sony, Pioneer and Pace, a variety of programming guides including TV Guide, Passport and SARA, billing systems, service delivery systems and interactive application control software. Likewise, our broadcast systems interoperate with a range of systems and applications from such companies as Adobe Systems, Apple Computer, Avid Technology, Harris, Sony, Thomson and others. |
| Automation. Our automated system allows broadband system operators to distribute and manage content without significant human intervention. We believe this automation also allows our customers to minimize operating personnel and equipment requirements resulting in lower ongoing operating costs and opportunities for new services. |
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| Reliability. Through the use of our proprietary MediaCluster technology and application software and low-cost standard computer industry components, our products are designed to be fault resilient, with no single point of failure, providing the high reliability required for television and video-on-demand operations. |
Strategy
Our strategy is to be the leading provider of video solutions to meet the growing demand for on-demand solutions in the television industry. We develop, manufacture and market digital video systems and services that include the management, aggregation, licensing, storage, and distribution of video, television, gaming and advertising content. The key elements of our strategy are to:
| Develop, Maintain and Extend Long-term Customer Relationships. We focus our product development, marketing and direct sales efforts on maintaining and extending long-term customer relationships with cable system operators, telecommunications companies and television broadcasters across the world. We have formed important relationships with customers that have grown from advertisement and other short-form video insertion to video-on-demand systems and other interactive television services, storage systems and streaming systems. We believe that the fundamental shift from broadcast to on-demand applications and the growing emphasis on interactive technologies will continue to present opportunities for us to develop, market and support solutions to our existing customers as well as to new additional markets. |
| Offer Integrated Solutions. Our customers operate complex networks that require the delivery and management of video programming across multiple channels and target zones. We believe that our integrated solutions can provide advantages in cost and implementation for digital video applications while interoperating with existing and emerging third-party equipment and software. To continue to address these needs, we intend to provide and further develop, internally and with our partners, integrated applications and support services for our customers. We believe that providing complete integrated solutions has been a significant factor in our success in the advertising and video-on-demand markets to date. |
| Establish and Maintain Technological Leadership. We believe our competitive position is dependent in large part on the features and performance of our systems. As a result, we focus our research and development efforts on introducing systems with improved hardware and software capabilities. We have been granted patents for our single-copy storage technology and have other patents pending. We have received several awards for technological excellence, including an Emmy Award in 2001 for our patented MediaCluster storage technology and a second Emmy Award in 2004 for our video-on-demand system. As of January 31, 2007, 44% of our employees were focused on research and product development efforts. |
| Provide Superior Customer Service and Support. Our products operate in customer environments where continuous operation is critical. As a result, we believe that providing a high level of service and support gives us a competitive advantage and is a differentiating factor in developing and maintaining key customer relationships. Our in-depth industry and application knowledge allows us to better understand the service needs of our customers. As of January 31, 2007, 27% of our employees were dedicated to customer service and support, including project design and implementation, maintenance, installation and training. Customers have access to service personnel via 24-hour, seven-day a week telephone support. In addition, we believe that the acquisitions and investments that have been made by us in media services and in system integration and customization services have positioned us as an integral partner with our customers to ensure optimal performance of their systems. |
Key Products and Services
SeaChange Video-On-Demand System
We have developed and are deploying a video-on-demand system to cable television companies and telecommunications companies within the Broadband segment. Our video-on-demand system consists of:
| MediaCluster video storage servers that reside at various points in a broadband network system and are used to play or stream videos as requested; |
| Axiom video operations services software to manage and control the system and to support integration with third-party systems and applications; |
| Interactive middleware software that enables cable operators outside North America to run multiple services, including high-definition television, video-on-demand, and personal video recorders on multiple platforms; |
| SPOT advertising systems hardware and software; |
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| Real-Time Record System, a time-shifting television application that enables broadcasted programming to be automatically encoded by broadband operators, with complete trick-mode functionality or video cassette recorder-like functionality; and |
| Interfaces to digital headend modulators, control systems and subscriber management systems. |
Our video-on-demand system allows our customers to offer the following interactive services to their subscribers:
| Video-on-Demand. This interactive service allows residential users and commercial users (e.g., hotel guests, academic institutions) to review lists of available movies and/or programming content, order individual movies and/or programs and view them in real-time. Using this service, subscribers gain full control over the video stream. |
| Subscription Video-on-Demand. This service provides premium channel offerings, such as those offered by HBO, Showtime or Starz, in an on-demand manner, as well as on a scheduled basis. Similar to our video-on-demand service, our subscription video-on-demand service allows subscribers to review lists of available premium channel content, order individual programs and watch them at home with full video recorder control. |
In addition, our video-on-demand system is designed to support interactive services that are being developed by broadband system operators including:
| Networked Digital Video Recording. This service provides users with interactive control over broadcasted television programming, enabling viewers to watch sports, news, and other program types with full video cassette recorder and personal video recorder-like (e.g., Tivo) control over the video stream. We enable the provision of this service through our servers and software located in broadband local transmission sites known as headends. We believe this service also has the potential to accommodate new advertising techniques, such as ad replacement or limited fast-forward functionality. |
| Targeted and Interactive Advertising. This service will support interactive advertising, or advertising where the subscriber controls the path and delivery of an advertisement, in a video-on-demand service and in other forms of programming that result in a dedicated communications link between the subscribers set top box and the video-on-demand system itself. This service will be competitive with those provided by direct marketing and direct mail firms and may allow purchases over the television, such as one might do with a web browser over the Internet. |
| DVD-on-demand. This interactive service brings DVD functionality to video-on-demand applications and provides a common standard for distributing and presenting video content. Our software tools and applications provide the capability to transform DVDs, including their menus and content chapter and options, to video-on-demand applications, which potentially offers movie studios and a variety of other video content producers the opportunity to leverage the significant DVD market. |
SeaChange SPOT System
Our family of SPOT Systems automates the complex process of advertisement and other video insertion across multiple channels and geographic zones for cable system operators and telecommunications companies primarily in the Broadband segment. Through our embedded proprietary software, our SPOT System allows cable system and telecom operators to insert local and regional advertisements and other video streams into a specific time allocated by cable television networks such as CNN, MTV, ESPN, Black Entertainment Television, Discovery Channel and Nickelodeon. The SPOT System is also capable of inserting advertising into digital cable channels and delivering targeted advertising, as well as advertising with interactive links to content on video-on-demand system, as well as to other interactive advertising systems.
The SPOT System is an integrated solution composed of hardware platforms, software applications, data networks and easy to use graphical interfaces. Our SPOT System is designed to be installed at local transmission sites, known as headends, and advertising sales business offices. Our video insertion process consists of six steps:
| Encoding. The process begins with our encoding software, which in real time transforms and compresses analog to digital short-and long-form video. |
| Storage. Our SPOT System organizes, manages and stores these video streams in a disk-based video library capable of storing thousands of advertisements. |
| Scheduling. Our advertising management software coordinates with the traffic and billing application to determine the designated time slot, channel and geographic zone for each video stream. |
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| Distribution. Our strategic digital video software then copies the video files from the master video library and distributes them over the operators data network to appropriate headends, where they are stored in video servers for future play. |
| Insertion. Following a network cue, our video switch module automatically inserts the video stream into the network feed (initiating the analog conversion, if necessary), where they are then seen by television viewers. |
| Verification. After the video streams run, our proprietary software and hardware verifies the content, accuracy, timing and placement of these video streams to facilitate proper customer billing. |
SeaChange MediaLibrary System
The SeaChange MediaLibrary is a mass storage system designed for media companies, including studios, television networks, stations and cable and telecommunications (telco) operators. The system utilizes our patented MediaCluster technology and stores any media file, independent of format and compression. This approach separates operators application decisions from their storage requirements, enabling all the client systems within a television facility, such as SeaChanges MediaClient on-air servers, non-linear editors, archives, and other media tools to share a centralized, fault-resilient online storage resource. The MediaLibrary has been deployed by a number of television operators to date and is sold in both the Broadband and Broadcast segments.
SeaChange MediaClient System
The SeaChange MediaClient is a media device equipped with product-specific video hardware and applications software. The device is designed for use by media companies, including studios, television networks, stations and cable and telecom operators, to interoperate with other devices within their customers enterprise as part of a client/server architecture. Introduced in 2004, the SeaChange MediaClient typically operates as an adjunct to the SeaChange MediaLibrary to support the streaming and storage requirements of digital video applications and is sold in both the Broadband and Broadcast segments.
We believe that as media companies take advantage of new and various video services, including video-on-demand, Internet video streaming, and High-Definition television, among others, they will derive greater benefit from the storage of media in a digital format. The MediaLibrary and the MediaClient are designed to support the storage, streaming and conversion of digital media files for a variety of video services.
SeaChange Broadcast MediaCluster System
Our Broadcast MediaCluster System is composed of multiple individual video servers arranged in a cluster acting as one system. This system is designed to provide high-quality digital based video storage and playback for use with automation systems in broadcast television stations. It product is intended to replace on-air tape decks used to store and play back advertising, movies and other programming from video tape cart systems and, in some cases, to replace the cart systems themselves. Our Broadcast MediaCluster System is designed for customers both in larger broadcast television markets, which use station automation systems, and in smaller markets, which use control software included in the system. This product is sold within the Broadcast segment.
As with the video-on-demand system in the Broadband segment, our Broadcast MediaCluster System is designed to simultaneously record, encode, store to a disk and play video content using 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. Our Broadcast MediaCluster System has features that enable the television broadcaster to have end-to-end functionality and reliability, including one feature that enables broadcasters to schedule its programming for a week of television content.
Service and Support
We install, maintain and support our hardware and software products in North America, Europe, Asia and South America. We offer basic and advanced on-site training for customer employees. We currently provide installation, maintenance and technical support to all our customers. We offer maintenance and technical support to customers, agents and distributors of our hardware, software and systems on a 24-hour, seven-day a week basis. Generally, our product sales include at least one year of free maintenance.
SeaChange has expanded into media content services, consisting of content aggregation and distribution, through the acquisition of On Demand Group Limited (ODG), completed in the third quarter of fiscal 2006. ODG is a leader in Europe in the development
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and deployment of interactive media services. ODG specializes in aggregating content for video-on-demand and network video-on-demand (NVOD) platforms, and has provided services to cable operators in more than 20 countries in Europe. ODG owns 33.3 % of Filmflex Movies Limited (Filmflex), a movie video-on-demand service that supplies movies to the UK cable industry and whose other investors are the Walt Disney Company Limited and Columbia Pictures Corporation Limited.
Customers
We currently sell our products primarily to cable system operators, broadcast and telecommunications companies.
Our customer base is highly concentrated among a limited number of large customers, primarily due to the fact that the cable, movie, broadcast, and telecommunications industries in the United States are dominated by a limited number of large companies. A significant portion of our revenues in any given fiscal period have been derived from substantial orders placed by these large organizations. In the years ended January 31, 2007, 2006 and 2005 total revenues from our five largest customers represented approximately 64%, 54% and 63%, respectively, of our total revenues. Customers accounting for more than 10% of total revenues consisted of Comcast (37%) and Virgin Media Inc. (formerly NTL Incorporated and Telewest Global, Inc. who merged during fiscal 2007) (16%) in the year ended January 31, 2007; Comcast (25%) in the year ended January 31, 2006; and Comcast (48%) in the year ended January 31, 2005. We expect that we will continue to be dependent upon a limited number of customers for a significant portion of our revenues in future periods. As a result of this customer concentration, our 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. In addition, the concentration of customers may cause variations in revenue, expenses and operating results on a quarterly basis due to seasonality of orders or the timing and relative size of orders received and shipped during a fiscal quarter.
We do not believe that our backlog at any particular time is meaningful as an indicator of our future level of sales for any particular period. Because of the nature of our products and our use of standard components, substantially the entire backlog at the end of a quarter can be manufactured and shipped to the customer before the end of the following quarter. However, because of the requirements of particular customers these orders may not be shipped or, if shipped, the related revenues may not be recognized in the ensuing quarter. Therefore, there is no direct correlation between the backlog at the end of any quarter and our total sales for the following quarter or other periods.
Selling and Marketing
We sell and market our products in the United States primarily through a direct sales organization and internationally through direct sales and independent agents and distributors, complemented by a coordinated marketing effort of our product marketing personnel. Direct sales activities in the United States are conducted from our Massachusetts headquarters and through sales representatives deployed across the country. We also market certain of our products to systems integrators and value-added resellers.
In light of the complexity of our digital video products, we primarily employ a consultative direct sales process. Working closely with customers to understand and define their needs enables us to obtain better information regarding market requirements, enhance our expertise in our customers industries, and more effectively and precisely convey to customers how our solutions address the customers specific needs. In addition to the direct sales process, customer references and visits by potential customers to sites where our products are in place are often critical in the sales process.
We use several marketing programs focused on our targeted markets to support the sale and distribution of our products. We use exhibitions at a limited number of prominent industry trade shows and conferences and presentations at technology seminars to promote awareness of us and our products. We also publish articles in trade and technical journals and promotional product literature.
Research and Product Development
Our management believes that our success will depend to a substantial degree upon our ability to develop and introduce in a timely fashion new integrated solutions and enhancements to our existing products that meet changing customer requirements in our current and new markets. We have made, and intend to continue to make, substantial investments in product and technological development. Our direct sales and marketing groups closely monitor changes in customer needs, changes in the marketplace and emerging industry standards, and are therefore better able to focus our research and development efforts to address these evolving industry requirements.
Our research and development expenditures totaled approximately $40.9 million, $34.5 million and $29.5 million for the years ended January 31, 2007, 2006 and 2005 respectively. At January 31, 2007, 360 employees were engaged in research and product
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development. We believe that the experience of our product development personnel is an important factor in our success. We perform our research and product development activities at our headquarters and in offices in Greenville, New Hampshire, Fort Washington, Pennsylvania, San Mateo, California and Shanghai, China.
Manufacturing
Our manufacturing operations are located at facilities in Acton, Massachusetts and in Greenville, New Hampshire. 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. Our 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. We rely on independent contractors to manufacture components and subassemblies to our specifications. Each of our products undergoes testing and quality inspection at the final assembly stage.
Competition
The markets in which we compete are characterized by intense competition, with a large number of suppliers providing different types of products to different segments of the markets. In new markets for our products, we compete principally based on price. In markets in which we have an established presence, we compete principally on the basis of the breadth of our products features and benefits, including the flexibility, scalability, professional quality, ease of use, reliability and cost effectiveness of our products, and our reputation and the depth of our expertise, customer service and support. While we believe that we currently compete favorably overall with respect to these factors and that our ability to provide integrated solutions to manage, store and distribute digital video differentiates us from our competitors, in the future we may not be able to continue to compete successfully with respect to these factors. In the market for long-form video products including video-on-demand, we compete with various companies offering video server platforms such as Concurrent Computer Corp., C-Cor Corporation, Motorola, Inc. (through its 2006 acquisition of Broadbus Technologies, Inc.) and Cisco Systems, Inc. (through its 2006 acquisition of Arroyo Video Solutions, Inc.). In the television broadcast market, we compete against Thomson, Omneon Video Networks, Sony Corporation and Leitch Incorporated. In the digital advertisement insertion market, we generally compete only with C-Cor Corporation. We expect the competition in each of these markets to intensify in the future as existing and new competitors with significant market presence and financial resources, including computer hardware and software companies and television equipment manufacturers, enter these rapidly evolving markets.
Many of our current and prospective competitors have significantly greater financial, technical, manufacturing, sales, marketing and other resources. As a result, these competitors may be able to devote greater resources to the development, promotion, sale and support of their products. Moreover, these companies may introduce additional products that are competitive with ours or enter into strategic relationships to offer complete solutions, and in the future our products may not be able to compete effectively with these products.
Proprietary Rights
Our success and our ability to compete are dependent, in part, upon our proprietary rights. We have been granted thirteen U.S. patents and have filed foreign patent applications related thereto for various technologies developed and used in our products. In addition, we rely on a combination of contractual rights, trademark laws, trade secrets and copyright laws to establish and protect our proprietary rights in our products. It is possible that in the future not all of these patents will be issued or that, if issued, the validity of these patents would not be upheld. It is also possible that the steps taken by us to protect our intellectual property will be inadequate to prevent misappropriation of our technology or that our competitors will independently develop technologies that are substantially equivalent or superior to our technology. In addition, the laws of some foreign countries in which our products are or may be distributed do not protect our proprietary rights to the same extent as do the laws of the United States. We have been involved in significant intellectual property litigation, and we may be a party to litigation in the future to enforce our intellectual property rights or as a result of an allegation that we infringe others intellectual property.
Employees
As of January 31, 2007, we employed 811 persons, including 360 in research and development, 218 in customer service and support, 82 in selling and marketing, 58 in manufacturing and 93 in finance and administration. We believe that our relations with our employees are good.
Geographic Information
Geographic information is included in Managements Discussion and Analysis of Financial Condition and Results of Operations and Note 4 of the Consolidated Financial Statements.
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Available Information
SeaChange is subject to the informational requirements of the Exchange Act. Therefore, SeaChange files periodic reports, proxy statements and other information with the SEC. Such reports, proxy statements and other information may be obtained by visiting the Public Reference Room of the SEC at 100 F Street, N.E., Washington, DC 20549 or by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an internet site (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding issuers that file electronically.
Financial and other information about SeaChange, including SeaChanges Code of Ethics and Business Conduct and charters for SeaChanges Audit Committee, Compensation and Option Committee and Corporate Governance and Nominating Committee, is available on our website (www.schange.com). We make available free of charge on our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information contained on our web site is not incorporated by reference into this document and should not be considered a part of this Annual Report. Our web site address is included in this document as an inactive textual reference only.
ITEM 1A. | Risk Factors |
Any statements contained in this Form 10-K/A that do not describe historical facts may constitute forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. These statements relate to future events or our future financial performance and are identified by words such as may, will, could, should, expect, plan, intend, seek, anticipate, believe, estimate, potential, or continue or other comparable terms or the negative of those terms. Forward-looking statements in this Form 10-K/A include certain statements regarding the effect of certain accounting standards on our financial position and results of operations, the effect of certain legal claims against us, projected changes in our revenues, earnings and expenses, exchange rate sensitivity, interest rate sensitivity, liquidity, product introductions, industry changes and general market conditions. Our actual future results may differ significantly from those stated in any forward-looking statements. Any such forward-looking statements contained herein are based on current expectations, but are subject to a number of risks and uncertainties that may cause actual results to differ materially from expectations. Factors that may cause such differences include, but are not limited to, the factors discussed below. Each of these factors, and others, are discussed from time to time in our filings with the SEC.
Our future success is dependent on the continued development of the video-on-demand market and if video-on-demand does not gain broad market acceptance, our business may not continue to grow.
An increasing portion of our revenue in the last year has come from sales and services related to our video-on-demand products. However, the video-on-demand market continues to develop as a commercial market and may not gain broad market acceptance. The potential size of the video-on-demand market and the timing of its development are uncertain. The success of this market requires that broadband system operators, particularly the seven largest domestic cable system operators, continue to upgrade their cable networks to support digital two-way transmission service and successfully market video-on-demand and similar services to their cable television subscribers. Some cable system operators are still in the early stages of commercial deployment of video-on-demand service to major residential cable markets and, accordingly, to date our digital video systems have been commercially available only to a limited number of subscribers. In addition, telecommunications companies have also begun to adapt their networks to support digital two-way transmission and begun marketing video-on-demand services. If cable system operators and telecommunications companies fail to make the capital expenditures necessary to upgrade their networks or determine that broad deployment of video-on-demand services is not viable as a business proposition or if our digital video systems cannot support a substantial number of subscribers while maintaining a high level of performance, our revenues will not grow as we have planned.
Because our customer base is highly concentrated among a limited number of large customers, the loss of or reduced demand of these customers could have a material adverse effect on our business, financial condition and results of operations.
Our customer base is highly concentrated among a limited number of large customers, and, therefore, a limited number of customers account for a significant percentage of our revenues in any year. In fiscal 2007 our five largest customers accounted for 64% of our revenues. Our five largest customers have accounted for approximately half to three quarters of our revenues in each of the past five years. Our largest customer has represented approximately 37% and 25% of our revenues in fiscal 2007 and fiscal 2006, respectively. We generally do not have written agreements that require customers to purchase fixed minimum quantities of our products. Our sales to specific customers tend to vary significantly from year to year depending upon these customers budgets for capital expenditures and our new product introductions. We believe that a significant amount of our revenues will continue to be derived from a limited number of large customers in the future. The loss of, or reduced demand for products or related services from, any of our major customers could have a material adverse effect on our business, financial condition and results of operations.
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Cancellation or deferral of purchases of our products could cause our operating results to be below the expectations of the public market stock analysts who cover our stock, resulting in a decrease in the market price of our common stock.
We derive a substantial portion of our revenues from purchase orders that exceed $1.0 million in value. Therefore, any significant cancellation or deferral of purchases of our products could have a material adverse effect on our business, financial condition and results of operations in any particular quarter due to the resulting decrease in revenue and gross margin and our relatively fixed costs. In addition, to the extent significant sales occur earlier than expected, operating results for subsequent quarters may be adversely affected because our operating costs and expenses are based, in part, on our expectations of future revenues, and we may be unable to adjust spending in a timely manner to compensate for any revenue shortfall. Because of these factors, in some future quarter our operating results may be below the expectations of public market analysts and investors which may adversely affect the market price of our common stock.
Timing of significant customer orders may cause our quarterly operating results to fluctuate, making period-to-period comparisons of our operating results less meaningful.
We have experienced significant variations in the revenue, expenses and operating results from quarter to quarter and these variations are likely to continue. We believe that fluctuations in the number of orders being placed from quarter to quarter are principally attributable to the buying patterns and budgeting cycles of broadband system operators, including telecommunications companies, and broadcast companies, the primary buyers of the digital video-on-demand, advertising and broadcast systems, respectively. We expect that there will continue to be fluctuations in the number and value of orders received. As a result, our results of operations have in the past and likely will, at least in the near future, fluctuate in accordance with this purchasing activity making period-to-period comparisons of our operating results less meaningful. In addition, because these factors are difficult for us to forecast, our business, financial condition and results of operations for one quarter or a series of quarters may be adversely affected and below the expectations of public market analysts and investors, resulting in a decrease in the market price of our common stock.
Due to the lengthy sales cycle involved in the sale of our products, our quarterly results may vary and should not be relied on as an indication of future performance.
Digital video-on-demand, advertising, movie and broadcast products are relatively complex and their purchase generally involve a significant commitment of capital, with attendant delays frequently associated with large capital expenditures and implementation procedures within an organization. Moreover, the purchase of these products typically requires coordination and agreement among a potential customers corporate headquarters and its regional and local operations. For these and other reasons, the sales cycle associated with the purchase of our digital video-on-demand, advertising, movie and broadcast products is typically lengthy and subject to a number of significant risks, including customers budgetary constraints and internal acceptance reviews, over which we have little or no control. Based upon all of the foregoing, we believe that our quarterly revenues and operating results are likely to vary significantly in the future, that period-to-period comparisons of our results of operations are not necessarily meaningful and that these comparisons should not be relied upon as indications of future performance.
If there were a decline in demand or average selling prices for our broadband products, including our Video-On-Demand Systems and Advertising Systems, our revenues and operating results would be materially affected.
We expect our broadband products to continue to account for a significant portion of our revenues. Accordingly, a decline in demand or average selling prices for our broadband products, 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, could have a material adverse effect on our business, financial condition and results of operations.
If we are unable to manage our growth and the related expansion in our operations effectively, our business may be harmed through a diminished ability to monitor and control effectively our operations, and a decrease in the quality of work and innovation of our employees.
Our ability to successfully offer new products and services and implement our business plan in a rapidly evolving market requires effective planning and management. We are also continuing to transition towards greater reliance on our video-on-demand products and services for an increased portion of our total revenue. In light of the growing complexities in managing our expanding portfolio of products and services, our anticipated future operations will continue to strain our operational and administrative resources. To manage future growth effectively, we must continue to improve our management, our operational controls and internal controls over financial reporting, and to integrate the businesses we have acquired and our new personnel and to manage our
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expanding international operations. A failure to manage our growth may harm our business through a decreased ability to monitor and control effectively our operations, and a decrease in the quality of work and innovation of our employees upon which our business is dependent.
Our ability to compete could be jeopardized if we are unable to protect our intellectual property rights from third-party challenges.
Our success and ability to compete depends upon our ability to protect our proprietary technology that is incorporated into our broadband and broadcast products. We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. Although we have thirteen issued patents, we cannot assure that any additional patents will be issued or that the issued patents will not be invalidated. We also enter into confidentiality or license agreements with our employees, consultants and corporate partners, and control access to and distribution of our software, documentation and other proprietary information. Despite these precautions, it may be possible for a third party to copy or otherwise misappropriate and use our products or technology without authorization, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States. We may need to resort to litigation in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. If competitors are able to use our technology, our ability to compete effectively could be harmed.
We have been and in the future could become subject to litigation regarding intellectual property rights, which could seriously harm our business and require us to incur significant legal costs to defend our intellectual property rights.
The industry in which we operate is characterized by vigorous protection and pursuit of intellectual property rights or positions, which on occasion, have resulted in significant and often protracted litigation. We have from time to time received, and may in the future receive, communications from third parties asserting infringements on patent or other intellectual property rights covering our products or processes. We have been involved in significant intellectual property litigation, and we may be a party to litigation in the future to enforce our intellectual property rights or as a result of an allegation that we infringe others intellectual property. Any parties asserting that our products infringe upon their proprietary rights would force us to defend ourselves and possibly our customers or manufacturers against the alleged infringement, as many of our commercial agreements require us to defend and/or indemnify the other party against intellectual property infringement claims brought by a third party with respect to our products. These claims and any resulting lawsuit, if successful, could subject us to significant liability for damages and invalidation of our proprietary rights. In the case of a willful infringer, any such damages may be trebled. This possibility of multiple damages serves to increase the incentive for plaintiffs to bring such litigation. In addition, these lawsuits, regardless of their success, would likely be time-consuming and expensive to resolve and would divert management time and attention away from our operations.
Although we carry general liability insurance, our insurance may not cover potential claims of this type or may not be adequate to indemnify us for all liability that may be imposed. In addition, any potential intellectual property litigation also could force us to stop selling, incorporating or using the products that use the infringed intellectual property or obtain from the owner of the infringed intellectual property right a license to sell or use the relevant technology, although this license may not be available on reasonable terms, or at all, or redesign those products that use the infringed intellectual property. If we are forced to take any of the foregoing actions, our business may be seriously harmed.
If content providers, such as movie studios, limit the scope of content licensed for use in the digital video-on-demand market, our business, financial condition and results of operations could be negatively affected because the potential market for our products would be more limited than we currently believe and have communicated to the financial markets.
The success of the video-on-demand market is contingent on content providers, such as movie studios, permitting their content to be licensed for use in this market. Content providers may, due to concerns regarding either or both marketing and illegal duplication of the content, limit the extent to which they provide content to the video-on-demand market. A limitation of content for the video-on-demand market would indirectly limit the market for our video-on-demand system which is used in connection with that market.
If we are unable to successfully introduce new products or enhancements to existing products, our financial condition and operating results may be adversely affected by a decrease in sales of our products.
Because our business plan is based on technological development of new products and enhancements to our existing products, our future success is dependent on our successful introduction of these new products and enhancements. In the future we may experience difficulties that could delay or prevent the successful development, introduction and marketing of these and other new products and enhancements, or find that our new products and enhancements do not adequately meet the requirements of the
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marketplace or achieve market acceptance. Announcements of currently planned or other new product offerings may cause customers to defer purchasing our existing products. Moreover, despite testing by us and by current and potential customers, errors or failures may be found in our products, and, even if discovered, may not be successfully corrected in a timely manner. These errors or failures could cause delays in product introductions and shipments, or require design modifications that could adversely affect our competitive position. Our inability to develop new products or enhancements on a timely basis or the failure of these new products or enhancements to achieve market acceptance could have a material adverse effect on our business, financial condition and results of operations.
Because we purchase certain material components used in manufacturing our products from sole suppliers and we use a limited number of third party manufacturers to manufacture our products, our business, financial condition and results of operations could be materially adversely affected by a failure of these suppliers or manufacturers.
Certain key components of our products are currently purchased from a sole supplier, including a computer chassis manufactured by JMR Electronics, Inc., another computer chassis manufactured by Enclosure Concepts, Inc., switching gear from EGO Systems, an interface controller video transmission board manufactured by Cyclone Microsystems, Inc., encoder and decoder hardware from Matrox and software from Ligos, Inc. and Cinegy Gmbh and certain digital video chips from Mellanox. We have in the past experienced quality control problems, where products did not meet specifications or were damaged in shipping, and delays in the receipt of these components. These problems were generally of short duration and did not have a material adverse effect on our business and results of operations. However, we may in the future experience similar types of problems which could be more severe or more prolonged. While we believe that there are alternative suppliers available for these components, we believe that the procurement of these components from alternative suppliers could take up to four months. In addition, these alternative components may not be functionally equivalent or may be unavailable on a timely basis or on similar terms. 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 our business, financial condition and results of operations.
In addition, we rely on a limited number of third parties who manufacture certain components used in our products. While to date there has been suitable third party manufacturing capacity readily available at acceptable quality levels, in the future there may not be manufacturers that are able to meet our future volume or quality requirements at a price that is favorable to us. Any financial, operational, production or quality assurance difficulties experienced by these third party manufacturers that result in a reduction or interruption in supply to us could have a material adverse effect on our business, financial condition and results of operations.
If we are unable to successfully compete in our marketplace, our financial condition and operating results may be adversely affected.
We currently compete against both computer companies offering video server platforms and more traditional analog video playback systems. In the digital advertisement insertion market, we compete against suppliers of both analog tape-based and digital systems.
Due to the rapidly evolving markets in which we compete, 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 our business, financial condition and results of operations. Many of our current and potential competitors have greater financial, selling and marketing, technical and other resources than we do. Moreover, our competitors may also foresee the course of market developments more accurately than we. Although we believe that we have certain technological and other advantages over our competitors, realizing and maintaining these advantages will require a continued high level of investment by us in research and product development, marketing and customer service and support. In the future we may not have sufficient resources to continue to make these investments or to make the technological advances necessary to compete successfully with our existing competitors or with new competitors.
If we are unable to compete effectively, our business, prospects, financial condition and operating results would be materially adversely affected because of the difference in our operating results from the assumptions on which our business model is based.
If we fail to respond to rapidly changing technologies related to digital video, our business, financial condition and results of operations would be materially adversely affected because the competitive advantage of our products relative to those of our competitors would decrease.
The markets for our 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 us or reduce the cost of existing products
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or services, any of which could enable our existing or potential customers to fulfill their video needs better and more cost efficiently than with our products. Our future success will depend on our ability to enhance our existing digital video products, including the development of new applications for our technology, and to develop and introduce new products to meet and adapt to changing customer requirements and emerging technologies. In the future, we may not be successful in enhancing our digital video products or developing, manufacturing and marketing new products which satisfy customer needs or achieve market acceptance. In addition, there may be services, products or technologies developed by others that render our products or technologies uncompetitive, unmarketable or obsolete, or announcements of currently planned or other new product offerings either by us or our competitors that cause customers to defer or fail to purchase our existing solutions.
Because our business is susceptible to risks associated with international operations, we may not be able to maintain or increase international sales of our products.
International product and service revenues ranged from 12% to 40% of our total revenues in each of the past five years. Our international operations are expected to continue to account for a significant portion of our business in the future. However, in the future we may be unable to maintain or increase international sales of our products and services. International sales are subject to a variety of risks, including:
| difficulties in establishing and managing international distribution channels; |
| difficulties in selling, servicing and supporting overseas products and in translating products into foreign languages; |
| the uncertainty of laws and enforcement in certain countries relating to the protection of intellectual property; |
| multiple and possibly overlapping tax structures; |
| currency and exchange rate fluctuations; and |
| economic or political changes in international markets. |
Our financial condition and results of operations could be materially adversely affected by the performance of the companies in which we have made and may in the future make equity investments.
As discussed in Managements Discussion and Analysis we have made equity investments in other companies, including Filmflex Movies Limited, Casa Systems, Inc., Minerva Networks, Inc. and InSite One, Inc., and we may in the future make additional investments in these and/or other companies. These investments may require additional capital and may not generate the expected rate of return that we believed possible at the time of making the investment. This may adversely affect our financial condition or results of operations. Also, investments in development-stage companies may generate other than temporary declines in fair value of our investment that would result in impairment charges.
Future acquisitions may be difficult to integrate, disrupt our business, dilute stockholder value or divert management attention.
As part of our business strategy, we have acquired and may in the future seek to acquire or invest in new businesses, products or technologies that we believe could complement or expand our business, augment our market coverage, enhance our technical capabilities or otherwise offer growth opportunities. Acquisitions could create risks for us, including:
| difficulties in assimilation of acquired personnel, operations, technologies or products which may affect our ability to develop new products and services and compete in our rapidly changing marketplace due to a resulting decrease in the quality of work and innovation of our employees upon which our business is dependent; and |
| adverse effects on our existing business relationships with suppliers and customers, which may be of particular importance to our business because our customer base is highly concentrated among a limited number of large customers, we purchase certain components used in manufacturing our products from sole suppliers and we use a limited number of third party manufacturers to manufacture our product. |
In addition, if we consummate acquisitions through an exchange of our securities, our existing stockholders could suffer significant dilution. Any future acquisitions, even if successfully completed, may not generate any additional revenue or provide any benefit to our business.
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The success of our business model could be influenced by changes in the regulatory environment, such as changes that either would limit capital expenditures by television, cable or telecommunications operators or reverse the trend towards deregulation in the industries in which we compete.
The telecommunications and television industries are subject to extensive regulation which may limit the growth of our business, both in the United States and other countries. The growth of our business internationally is dependent in part on deregulation of the telecommunications industry abroad similar to that which has occurred in the United States and the timing and magnitude of which is uncertain. Broadband system operators are subject to extensive government regulation by the Federal Communications Commission and other federal and state regulatory agencies. These regulations could have the effect of limiting capital expenditures by broadband system operators and thus could have a material adverse effect on our 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 our customers, and thereby materially adversely affect our business, financial condition and results of operations.
We may not be able to hire and retain highly skilled employees, particularly managerial, engineering, customer service, selling and marketing, finance and manufacturing personnel, which could affect our ability to compete effectively because our business is technology-based and there is a shortage of these employees within the New England area.
Our success depends to a significant degree upon the continued contributions of our key management, engineering, customer service, selling and marketing, finance and manufacturing personnel, many of whom would be difficult to replace given the shortage within the New England area of qualified persons for these positions. We do not have employment contracts with our key personnel. We believe that our future success will also depend in large part upon our ability to attract and retain highly skilled managerial, engineering, customer service, selling and marketing, finance and manufacturing personnel, as our business is technology-based. Because competition for these personnel is intense, we may not be able to attract and retain qualified personnel in the future. 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 our business, financial condition and results of operations because our business is technology-based.
We may in the future be subject to litigation or regulatory proceedings that could likely divert substantial amounts of management time from our operations and could result in significant expense and liabilities.
We may in the future be subject to litigation or regulatory proceedings, in connection with the restatement of our consolidated financial statements as of January 31, 2007 and 2006 and for the fiscal years ended January 31, 2007, 2006 and 2005, and the restatement of selected financial data as of and for each of the five years in the period ended January 31, 2007, as well as the results of operations for each of the three years in the period ended January 31, 2007. Litigation and regulatory proceedings are often costly and time-consuming, and could result in us experiencing an adverse impact in our business, results of operations, financial position and cash flows. The defense of any such actions or investigations will likely cause the diversion of managements attention and resources, and we may be required to pay damages if a proceeding is not resolved in our favor. Further, any litigation or regulatory proceedings, even if resolved in our favor, could cause us to incur significant legal and other expenses, including modifying or adopting new controls and procedures. Such events could harm our business, affect our ability to raise capital and adversely affect the trading price of our securities.
If actions taken to remediate the material weakness in our internal controls over financial reporting are insufficient or we fail to maintain all of the controls necessary for continued compliance, current stockholders and potential investors could lose confidence in our financial reporting, which would harm our business prospects and the trading price of our stock.
Management is responsible for restating and maintaining adequate internal control over financial reporting. As described below in ITEM 9A, our management has concluded that we did not maintain effective internal control over financial reporting as of January 31, 2007. Effective internal controls are necessary for us to provide reliable financial reports. If we cannot provide reliable financial reports, stockholder and investor confidence in our business and operating results could be negatively impacted. We have discovered, and may in the future discover, an area of our internal control that needs improvement. The restatement described in this Annual Report on Form 10-K/A relates to our conclusion that the Consolidated Balance Sheet, Consolidated Statement of Operations, Consolidated Statement of Cash Flows and Consolidated Statement of Stockholders Equity and Comprehensive Income (Loss) as of and for the year ended January 31, 2007 contained in the Original 10-K should no longer be relied upon due to an error related to the accounting for its employee sabbatical benefit. As a result, the Company has restated its Consolidated Balance Sheet, Consolidated
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Statement of Operations, Consolidated Statements of Cash Flows and Consolidated Statement of Stockholders Equity and Comprehensive Income (Loss), as of January 31, 2007 and 2006 and for each of the three years in the periods ended January 31, 2007, 2006 and 2005. This Form 10-K/A also includes the restatement of selected financial data as of and for each of the five years in the period ended January 31, 2007, as well as the restatement of quarterly results of operations for each of the three years in the period ended January 31, 2007. As to the selected financial data as of January 31, 2007 and 2006 and for the years ended January 31, 2007, 2006 and 2005 such amounts are derived from the audited financial statements included elsewhere in the Form 10-K/A. The restated selected financial data as of January 31, 2007 and 2006, and for the years ended January 31, 2007, 2006, 2005, 2004 and 2003 and the restated quarterly results of operations are unaudited and in the opinion of management, have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) and reflect all adjustments that are necessary for the fair presentation of the Companys financial position and results of operations for these periods.
Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate the effectiveness of our internal control over financial reporting as of each fiscal year-end. Our management has concluded that our internal control over financial reporting were not effective as of January 31, 2007 and did not provide reasonable assurance regarding the reliability of our financial reporting or the preparation of its financial statements in accordance with GAAP. In addition to the material weakness that was identified in connection with the restatement described in this Annual Report on Form 10-K/A, we may identify additional and different control deficiencies in the future that, individually or in the aggregate, could constitute one or more additional material weaknesses. Furthermore, while we are taking steps designed to remediate the material weakness that we have identified, these steps may not be adequate to fully remediate this weakness, and additional measures may be required. Our management has identified the steps it believes are necessary to address the material weakness described in ITEM 9A, and we are in the process of remediating the material weakness.
If we fail to implement and maintain the improvements in the internal control over financial reporting or encounter delays or difficulties in the implementation of these improvements in our controls, we could fail to meet our reporting obligations, and may issue financial statements in future periods that contain errors. The failure to improve internal controls over financial reporting to address the identified weakness also could cause investors to lose confidence in our reported financial information, which could have a negative impact on the trading prices of our securities. In addition, our failure to improve internal controls over financial reporting to address the identified material weakness that caused errors in the preparation of our financial statements could lead to litigation claims and/or regulatory proceedings against us. The defense of any such claims or proceedings may cause the diversion of managements attention and resources, and we may be required to pay damages if any such claims or proceedings are not resolved in our favor. Any litigation or regulatory proceeding, even if resolved in our favor, could cause us to incur significant legal and other expenses. Such events could harm our business, negatively affect our ability to raise capital and adversely affect the trading price of our securities.
ITEM 1B. | Unresolved Staff Comments |
None.
ITEM 2. | Properties |
In February 2006, we moved our corporate headquarters, which is also our principal administrative, selling, marketing, customer service and support and product development facility, to a 120,000 square foot facility in Acton, Massachusetts that was purchased in June 2005. The Acton facility replaces our previously-rented Maynard facility of approximately 105,000 square feet. We had rented the Maynard facility under a lease which expired on February 28, 2006. In addition to our Acton corporate headquarters, we own approximately 24,000 square feet of office and manufacturing space in Greenville, New Hampshire. We also lease two facilities totaling approximately 13,000 square feet in Greenville, New Hampshire that are used for the development and final assembly of our video servers. Additionally, we lease approximately 14,000 square feet of office space in Fort Washington, Pennsylvania, that is primarily used for the development of software products for companies specializing in digital video and interactive television. We also lease small research and development and/or sales and support offices in Shanghai, China, Belleville, Illinois, Reno, Nevada, San Jose, California, San Mateo, California, London, England, Valbonne, France, Singapore, Tokyo, Japan and Mumbai, India.
ITEM 3. | Legal Proceedings |
Litigation
None.
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Other Matters
We enter into agreements in the ordinary course of business with customers, resellers, distributors, integrators and suppliers. Most of these agreements require us to defend and/or indemnify the other party against intellectual property infringement claims brought by a third party with respect to our products. From time to time, we also indemnify customers and business partners for damages, losses and liabilities they may suffer or incur relating to personal injury, personal property damage, product liability, and environmental claims relating to the use of our products and services or resulting from the acts or omissions of our employees, authorized agents or subcontractors. For example, in a letter dated May 16, 2005 from Cablevision Systems Corp., in a letter dated May 19, 2005 from Time Warner Cable, Inc., and in a letter dated July 22, 2005 from Insight Communications Company, Inc., all SeaChange customers, SeaChange and other suppliers were notified that each party was served on May 3, 2005, April 25, 2005 and April 26, 2005 respectively with a complaint by Acacia Media Technologies, Corp. for allegedly infringing U.S. Patent Nos.: 5,132,992; 5,253,275; 5,550,863; and 6,144,702 by providing broadcast video and video-on-demand services to end user customers. In addition, in a letter dated August 4, 2006 from Cox Communications, Inc., in a letter dated June 29, 2006 from Time Warner Inc. and in a letter dated October 6, 2006 from Comcast Cable Communications, LLC, SeaChange and other suppliers were notified that each party was served on June 13, 2006 with a complaint by USA Video Technology Corporation for allegedly infringing U.S. Patent No. 5,130,792 by providing video-on-demand services to end use customers. These customers have requested our support under our indemnification obligations. We continue to review our potential obligations under indemnification agreements with these customers, in view of the claims made by Acacia and complaint made by USA Video Technology Corporation and the indemnity obligations to these customers from other vendors that also provided equipment and services to these customers.
We provide indemnification obligations after considering the economics of the transaction and other factors including but not limited to the liquidity and credit risk of the other party in the transaction. We believe that the likelihood is remote that any such arrangement could have a material adverse effect on our financial position, results of operation or liquidity. We record liabilities for such indemnification obligations based on the Companys best estimate of probable losses which considers amounts recoverable under any recourse provisions.
ITEM 4. | Submission of Matters to a Vote of Securities Holders |
No matters were submitted during the fourth quarter of the fiscal year ended January 31, 2007 to a vote of security holders of the Company through the solicitation of proxies or otherwise.
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PART II
ITEM 5. | Market for Registrants Common Equity and Related Stockholder Matters |
Our common stock is traded on the Nasdaq National Market under the symbol SEAC. The following table sets forth the high and low closing sale prices for the Common Stock for the periods indicated, as reported on the Nasdaq National Market.
High | Low | |||||
Three Month Period Ended: |
||||||
April 30, 2005 |
$ | 17.00 | $ | 10.04 | ||
July 31, 2005 |
10.52 | 6.84 | ||||
October 31, 2005 |
7.75 | 5.07 | ||||
January 31, 2006 |
9.22 | 5.81 | ||||
April 30, 2006 |
9.83 | 6.73 | ||||
July 31, 2006 |
7.16 | 6.03 | ||||
October 31, 2006 |
9.15 | 6.45 | ||||
January 31, 2007 |
10.63 | 8.17 |
On April 12, 2007, the last reported sale price of our common stock on the Nasdaq national market was $8.55.
We have not paid any cash dividends on our capital stock since its inception, and do not expect to pay cash dividends on our common stock in the foreseeable future. We currently intend to retain all of our future earnings for use in operations and expansion of the business.
As of April 12, 2007, we had 151 stockholders of record. We believe that the number of beneficial holders of our common stock exceeds 5,000.
Equity Compensation Plan Information
The following table provides information about the common stock that may be issued upon the exercise of options, warrants and rights under all of SeaChanges existing equity compensation plans as of January 31, 2007, including the 2005 Equity Compensation and Incentive Plan, the Amended and Restated 1995 Stock Option Plan, the 1996 Non-Employee Director Stock Option Plan and the Third Amended and Restated 1996 Employee Stock Purchase Plan.
Plan category |
Number of securities to be issued upon exercise of outstanding options, warrants and rights |
Weighted- options, warrants |
Number of securities in column (a)) |
|||||||
(a) | (b) | (c) | ||||||||
Equity compensation plans approved by security holders(1) |
5,936,735 | (2) | $ | 14.85 | 778,819 | (3) | ||||
Equity compensation not approved by security holders(4) |
160,134 | $ | 14.71 | 0 | ||||||
Total |
6,096,869 | $ | 14.85 | (5) | 778,819 |
(1) | Consists of the 2005 Equity Compensation and Incentive Plan, the Amended and Restated 1995 Stock Option Plan, the 1996 Non-Employee Director Stock Option Plan and the Third Amended and Restated 1996 Employee Stock Purchase Plan. |
(2) | Excludes the shares to be issued for the period ended May 31, 2007 under the Third Amended and Restated 1996 Employee Stock Purchase Plan, because the number of shares to be issued upon exercise of currently outstanding options thereunder cannot be determined, as it will be determined on May 31, 2007, the last day of the payment period, and will be for a maximum of 1,125 shares per eligible participant. |
(3) | As of January 31, 2007, 416,000 shares remained available for issuance under the 2005 Equity Compensation and Incentive Plan and 362,819 shares remained available for grant under the Third Amended and Restated 1996 Employee Stock Purchase Plan. As of January 31, 2007, no shares remained available for issuance under the 1996 Non-Employee Director Stock Option Plan as this plan was terminated by the Board of Directors in May 2002 and no shares remained available for issuance under the Amended and Restated 1995 Stock Option Plan as the plan was terminated following the adoption of the 2005 Equity Compensation and Incentive Plan on July 13, 2005. |
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(4) | Pursuant to the Video-on-Demand Purchase Agreement, dated as of December 1, 2000, by and between SeaChange and Comcast Cable Communications of Pennsylvania, Inc., Comcast has been issued warrants exercisable for 450,000 shares of common stock. As disclosed in SeaChanges Current Report on Form 8-K filed October 6, 2004, Comcast exercised certain of these warrants and there remains outstanding today one warrant exercisable for 160,134 shares of common stock with a per share exercise price of $14.71 and which is nonforfeitable and freely exercisable. |
(5) | Excludes the weighted average exercise price for shares to be issued under the Third Amended and Restated 1996 Employee Stock Purchase Plan, as amended, because the weighted average exercise price of currently outstanding options thereunder cannot be determined, as it will be equal to 85% of the lower of the average market price of the common stock on December 1, 2006 and May 31, 2007, the first and last business day of the applicable payment period. |
STOCK PERFORMANCE GRAPH
The following graph compares the change in the cumulative total stockholder return on SeaChanges common stock during the period from the close of trading on January 31, 2002 through January 31, 2007, with the cumulative total return on the Center for Research in Securities Prices (CRSP) Index for the Nasdaq Stock Market (U.S. Companies) and a SIC Code Index based on the SeaChanges SIC Code. The comparison assumes $100 was invested on January 31, 2002 in SeaChanges common stock at the $28.45 closing price on that date and in each of the foregoing indices and assumes reinvestment of dividends, if any.
The following graph is not soliciting material, is not deemed filed with the SEC and is not to be incorporated by reference in any filing of SeaChange under the Securities Act or the Exchange Act, whether made before or after the date hereof and irrespective of any general incorporation language in any such filing. The stock price performance shown on the following graph is not necessarily indicative of future price performance. Information used on the graph was obtained from Hemscott, Inc., Richmond, Virginia, a source believed to be reliable, but SeaChange is not responsible for any errors or omissions in such information.
Notes:
A. | The lines represent monthly index levels derived from compounded daily returns that include all dividends. |
B. | If the monthly interval, based on the fiscal year-end, is not a trading day, the preceding trading day is used. |
C. | The Index level for all series was set to 100.0 on January 31, 2002. |
ITEM 6. | Selected Financial Data (Restated) |
The following consolidated selected financial data should be read in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations and our consolidated financial statements and related notes
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included elsewhere in this Annual Report on Form 10-K/A. As previously disclosed in the Current Reports on Form 8-K filed with the SEC on August 31, 2007 and September 18, 2007, the Audit Committee of the Board of Directors of the Company (the Audit Committee), in consultation with Company management, concluded that the Companys previously issued Consolidated financial statements for the fiscal year ended January 31, 2007 should no longer be relied upon due to an error related to the accounting for its employee sabbatical benefit. As a result, the Company has restated its Consolidated Balance Sheet, Consolidated Statement of Operations, Consolidated Statement of Cash Flows and Consolidated Statement of Stockholders Equity and Comprehensive Income (Loss), as of January 31, 2007 and 2006 and for each of the three years in the periods ended January 31, 2007, 2006 and 2005. The effects of this restatement on the Companys consolidated financial statements as of January 31, 2007 and 2006 are described in Note 1 to the consolidated financial statements included in this Annual Report on Form 10-K/A. The results of operations for the fiscal year ended January 31, 2003 includes an $11.1 million charge related to the unfavorable jury verdict in connection with a patent infringement claim and income tax expense of $7.9 million primarily related to a valuation allowance against net deferred tax assets. An explanation of the determination of the number of shares used in computing net income (loss) per share for the most recent three years is given in the notes to the consolidated financial statements.
Year ended January 31, | ||||||||||||||||||||
2007 Restated (1) |
2006 Restated (1) |
2005 Restated (1) |
2004 Restated (1) |
2003 Restated (1) |
||||||||||||||||
(in thousands except per share data) | ||||||||||||||||||||
Consolidated Statement of Operations Data: |
||||||||||||||||||||
Revenues: |
||||||||||||||||||||
Product (hardware, software and systems) |
$ | 95,000 | $ | 73,516 | $ | 113,764 | $ | 112,227 | $ | 103,282 | ||||||||||
Services |
66,334 | 52,748 | 43,539 | 35,939 | 32,344 | |||||||||||||||
161,334 | 126,264 | 157,303 | 148,166 | 135,626 | ||||||||||||||||
Costs of revenues: |
||||||||||||||||||||
Product (hardware, software and systems) |
48,334 | 45,555 | 60,158 | 64,824 | 61,599 | |||||||||||||||
Services |
37,189 | 28,315 | 25,755 | 22,687 | 23,109 | |||||||||||||||
85,523 | 73,870 | 85,913 | 87,511 | 84,708 | ||||||||||||||||
Gross profit |
75,811 | 52,394 | 71,390 | 60,655 | 50,918 | |||||||||||||||
Operating expenses: |
||||||||||||||||||||
Research and development |
40,917 | 34,475 | 29,536 | 26,060 | 26,159 | |||||||||||||||
Selling and marketing |
22,383 | 18,681 | 18,069 | 16,673 | 15,725 | |||||||||||||||
General and administrative |
19,193 | 14,254 | 10,330 | 9,144 | 21,560 | |||||||||||||||
Amortization of intangibles |
5,664 | 2,201 | 1,333 | 1,599 | 1,513 | |||||||||||||||
88,157 | 69,611 | 59,268 | 53,476 | 64,957 | ||||||||||||||||
(Loss) income from operations |
(12,346 | ) | (17,217 | ) | 12,122 | 7,179 | (14,039 | ) | ||||||||||||
Interest income, net |
1,355 | 2,038 | 962 | 1,734 | 1,447 | |||||||||||||||
Impairment on investment in affiliate |
(150 | ) | | | (313 | ) | | |||||||||||||
(Loss) income before income taxes and equity income (loss) in earnings of affiliates |
(11,141 | ) | (15,179 | ) | 13,084 | 8,600 | (12,592 | ) | ||||||||||||
Income tax benefit (expense) |
1,632 | 2,941 | (3,070 | ) | (3,169 | ) | (7,925 | ) | ||||||||||||
Equity income (loss) in earnings of affiliate, net of tax |
1,272 | 39 | (148 | ) | 137 | (6 | ) | |||||||||||||
Net (loss) income |
$ | (8,237 | ) | $ | (12,199 | ) | $ | 9,866 | $ | 5,568 | $ | (20,523 | ) | |||||||
Earnings (loss) per share: |
||||||||||||||||||||
Basic |
$ | (0.29 | ) | $ | (0.43 | ) | $ | 0.36 | $ | 0.21 | $ | (0.77 | ) | |||||||
Diluted |
$ | (0.29 | ) | $ | (0.43 | ) | $ | 0.34 | $ | 0.20 | $ | (0.77 | ) | |||||||
Consolidated Balance Sheet Data (as of January 31): |
||||||||||||||||||||
Working capital |
$ | 57,820 | $ | 45,759 | $ | 126,397 | $ | 99,195 | $ | 85,435 | ||||||||||
Total assets |
199,296 | 207,797 | 212,628 | 182,579 | 171,240 | |||||||||||||||
Deferred revenue |
21,806 | 20,045 | 21,342 | 16,437 | 11,624 |
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Year ended January 31, | ||||||||||
2007 Restated (1) |
2006 Restated (1) |
2005 Restated (1) |
2004 Restated (1) |
2003 Restated (1) | ||||||
(in thousands except per share data) | ||||||||||
Long-term liabilities |
1,121 | 1,353 | | 209 | 744 | |||||
Total liabilities |
42,876 | 54,053 | 47,794 | 36,661 | 34,536 | |||||
Total stockholders equity |
156,420 | 153,744 | 164,834 | 145,918 | 136,704 |
(1) | Refer to the Explanatory Note at the beginning of this Form 10-K/A and Note 1 to the consolidated financial statements. |
ITEM 7. | Managements Discussion and Analysis of Financial Condition and Results of Operations |
You should read the following discussion and analysis together with our consolidated financial statements, related notes and other financial information appearing elsewhere in this Annual Report. As discussed above, the Company is amending its Consolidated Balance Sheet, Consolidated Statement of Operations, Consolidated Statement of Cash Flows and Consolidated Statement of Stockholders Equity and Comprehensive Income (Loss), as of January 31, 2007 and 2006 and for each of the three years in the periods ended January 31, 2007, 2006 and 2005. The Form 10-K/A also includes the restatement of selected financial data as of and for each of the five years in the period ended January 31, 2007, as well as the restatement of quarterly results of operations for each of the three years in the period ended January 31, 2007. As to the selected financial data as of January 31, 2007 and 2006 and for the years ended January 31, 2007, 2006 and 2005 such amounts are derived from the audited financial statements included elsewhere in the Form 10-K/A. The restated selected financial data as of January 31, 2007 and 2006, and for the years ended January 31, 2007, 2006 and 2005 and the restated quarterly results of operations are unaudited and in the opinion of management, have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) and reflect all adjustments that are necessary for the fair presentation of the Companys financial position and results of operations for these periods.
In addition to historical information, the following discussion and other parts of this Annual Report contain forward-looking information that involves risks and uncertainties. Our actual results could differ materially from those anticipated by such forward-looking information due to competitive factors and other factors discussed at ITEM 1A. Risk Factors and elsewhere in this Annual Report on Form 10-K/A.
Effects of the restatement on the consolidated financial statements are reflected in Managements Discussion and Analysis of Financial Condition and Results of Operations below. For a further discussion of the restatements, see the Explanatory Note at the beginning of this Form 10-K/A and Note 1 in the accompanying notes to consolidated financial statements.
Overview
We are a leading developer, manufacturer and marketer of digital video systems and services including the management, aggregation, licensing, storage, and distribution of video, television, gaming and advertisement content to cable system operators, telecommunications companies and broadcast television companies.
We have three reportable segments: Broadband, Broadcast and Services. The Broadband segment includes hardware, software and systems, such as our digital advertising and video-on-demand products that digitally manage, store and distribute digital video for cable system operators and telecommunications companies. The Broadcast segment includes products for the storage, archival, on-air playback of advertising and other video programming for the broadcast television industry. Our hardware, software and systems (product) revenues are comprised of sales originating from our Broadband and Broadcast segments. The Services segment is comprised of revenue related to professional services, media content services, installation, training, project management, product maintenance and technical support for the above products.
We have experienced fluctuations in our product revenues from quarter to quarter due to the timing of the receipt of customer orders and the shipment of those orders. The factors that impact the timing of the receipt of customer orders include among other factors:
| the customers receipt of authorized signatures on their purchase orders; |
| the budgetary approvals within the customers company for capital purchases; and |
| the ability to process the purchase order within the customers organization in a timely manner. |
Factors that may impact the shipment of customer orders include:
| the availability of material and labor to produce the product; |
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| the time required to produce and test the product before delivery; and |
| the customers required delivery date. |
The delay in the timing of receipt and shipment of any one customer order can result in significant fluctuations in our revenue reported on a quarterly basis.
Our operating results are significantly influenced by a number of factors, including the mix of products sold and services provided, pricing, costs of materials used in our products and the expansion of our operations during the fiscal year. We price our products and services based upon our costs and consideration of the prices of competitive products and services in the marketplace. The costs of our products primarily consist of the costs of components and subassemblies that have generally declined from product introduction to product maturity. As a result of the growth of our business, our operating expenses have historically increased in the areas of research and development, selling and marketing, customer service and support and administration. In the current state of the economy, we currently expect that our Broadband and Broadcast customers may still have limited capital spending budgets as we believe they are dependent on advertising revenues to fund their capital equipment purchases. Accordingly, we expect our financial results to vary from quarter to quarter, and our historical financial results are not necessarily indicative of future performance. In light of the higher proportion of our international business due, in part, to our acquisitions of the European-based businesses from Liberate Technologies and ODG in fiscal 2006, we expect movements in foreign currency exchange rates to have a greater impact on our operating results and the equity section of our balance sheet in the future.
Our ability to continue to generate revenues within the markets that our products are sold and to generate cash from operations and net income is dependent on several factors which include:
| market acceptance of the products and services offered by our customers and increased subscriber usage and demand for these products and services; |
| selection by our customers of our products and services versus the products and services being offered by our competitors; |
| our ability to introduce new products to the market in a timely manner and to meet the demands of the market for new products and product enhancements; |
| our ability to maintain gross margins from the sale of our products and services at a level that will provide us with cash to fund our operations given the pricing pressures within the market and the costs of materials and labor to manufacture our products; and |
| our ability to control operating costs given the fluctuations that we have experienced with revenues from quarter to quarter. |
Effective February 1, 2006, we adopted the provisions of SFAS No. 123 (revised 2004), Share-Based Payment (SFAS 123R) using the modified prospective transition method. In accordance with that transition method, we have not restated prior periods for the effect of compensation expense calculated under SFAS 123R. We have continued to use the Black-Scholes pricing model as the most appropriate method for determining the estimated fair value of all applicable awards. Compensation expense for all share-based equity awards is being recognized on a straight-line basis over the vesting period of the award. During fiscal 2007, total share-based compensation was $3.5 million, compared to $43,000 in fiscal 2006 which only included share-based compensation for restricted stock awards.
On January 26, 2006, the Company accelerated the vesting of certain unvested stock options with exercise prices equal to or greater than $9.00 per share that were previously awarded to its employees, including its executive officers and non-employee directors, under the Companys equity compensation plans. This decision was the principal reason for the lower stock-based compensation expense recorded in fiscal 2007 compared to the pro forma expense of $12.7 million and $9.1 million for the years ended January 31, 2006 and 2005, respectively.
As of January 31, 2007, the unrecognized stock-based compensation related to the unvested stock options was $1.5 million net of estimated forfeitures. Total unrecognized compensation cost will be adjusted for any future changes in estimated changes in forfeitures. This cost will be recognized over an estimated weighted average amortization period of 1.0 years.
In fiscal 2007, our total revenues increased 28% to $161.3 million compared to a 20% decrease in fiscal 2006 over fiscal 2005. The increase in revenues is attributable to a 29% increase in product revenues to $95.0 million in fiscal 2007 as compared to a 35% decrease in fiscal 2006 over fiscal 2005 and a 26% increase in service revenues to $66.3 million in fiscal 2007 as compared to a 21% increase in fiscal 2006 over fiscal 2005. The product revenue increase in fiscal 2007 was primarily attributable to higher revenues from video-on-demand, with total sales of $74.4 million recorded in fiscal 2007 as compared to $49.1 million in fiscal 2006. The
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product revenue increase in fiscal 2007 was primarily attributable to a $17.5 million increase in our video-on-demand software development revenues in the Broadband segment associated with the Comcast agreement executed in July 2006 and a full year of revenues from the middleware software contracts acquired from Liberate Technologies in July 2005. In addition, video-on-demand systems revenues increased by $7.8 million reflecting an increase in demand by North American cable system operators. Our advertising product revenues within the Broadband segment decreased by 31% to $10.5 million in fiscal 2007 compared to an increase of 16% in fiscal 2006 over fiscal 2005. The decrease in advertising product revenues is due to decreased order activity for customer replacement of analog advertising insertion systems with digital systems. We expect video-on-demand product revenues will increase in fiscal 2008 as compared to fiscal 2007 based upon our customers continued expansion of these systems and software in key regional domestic markets, the success of certain telephony companies in entering the video-on-demand market, and the continued deployment of video-on-demand systems and software to new customers in Asia, Europe and South America during fiscal 2008.
Our Broadcast product revenues increased by 10% to $10.1 million in fiscal 2007 compared to a decrease of 33% in fiscal 2006 over fiscal 2005. We expect sales of Broadcast products to increase in fiscal 2008 as compared to fiscal 2007 based on the expected introduction of enhancements to our existing Broadcast products.
Services revenues increased $13.6 million or 26% in fiscal 2007 compared with a 21% increase in fiscal 2006 over fiscal 2005 primarily due to a full year of ODGs media content services, or $12.9 million, recognized in fiscal 2007 in comparison to only four months, or $4.2 million, recognized in fiscal 2006 from the date of SeaChanges acquisition of ODG in September 2005. In addition, $4.0 million of the increase is attributable to the increase in video-on-demand product maintenance contracts and other technical support services from a growing installed base of VOD systems. We expect Services revenues will increase in fiscal 2008 as compared to fiscal 2007, due to an anticipated increase in the installed base of our video-on-demand systems and increased revenue at ODG tied to the expansion of its business beyond the UK.
Gross profit increased 6 percentage points to 47% in fiscal 2007 from 41% in fiscal 2006 in comparison to a 4 percentage point decrease in fiscal 2006 from fiscal 2005. Increased total revenues and increased revenues from higher margin software development contracts each contributed to the increase in gross profit. Our services gross profit was 44% in fiscal 2007 compared to 46% in fiscal 2006. We believe that competitive pressures will continue and our ability to maintain or improve gross margin will be dependent upon maintaining or increasing current levels of revenues and achieving technological advances that will further reduce material costs of sales. We expect service margins to decrease over the next several quarters due to increased headcount-related costs to service increased installed base of systems, our new products expected to be introduced in fiscal 2008 and additional costs at ODG as it expands its operations beyond the U.K.
Our operating expenses increased $18.5 million or 27% in fiscal 2007 over fiscal 2006 in comparison to a $10.3 million or 17% increase in fiscal 2006 over fiscal 2005. This increase is principally attributable to a full year of ODG operating expenses in fiscal year 2007 as compared with four months in fiscal year 2006, the hiring of additional employees to support new middleware product initiatives, a full year of amortization of intangibles for the Liberate and ODG acquisitions from the second and third quarters of fiscal 2006, respectively, and stock compensation expense of $3.1 million relating to adoption of SFAS 123R. We expect operating expenses to continue to increase in fiscal 2008 in support of increased business activity.
Equity income in earnings of affiliates was $1.3 million in fiscal 2007 in comparison to $39,000 in fiscal 2006 reflecting $1.3 million from our investment in Filmflex in fiscal 2007 compared to a loss of approximately $300,000 in fiscal 2006.
The results of our operations in fiscal 2007 were a net loss of $8.2 million or $0.29 per share as compared to net loss of $12.2 million or $0.43 per share in fiscal 2006. The primary contributors to our $9.6 million increase in cash in fiscal year 2007 were net sales and maturities of marketable securities, proceeds from the issuance of common stock relating to stock options and employee stock purchases, partially offset by our net loss adjusted for non-cash depreciation, amortization and stock compensation expense, the cash payment made to C-Cor Incorporated (as successor to nCube Corp.) in settlement of the now resolved patent infringement litigation, capital expenditures, contingent consideration cash payment for fiscal 2006 made to the sellers of ODG and changes in operating assets and liabilities. We believe there are significant uncertainties about our ability to be profitable in fiscal 2008. These uncertainties include the timing and magnitude of orders from new customers located primarily outside the United States and the timing and magnitude of orders from our largest U.S. customer who has represented 37% and 25% of our total revenues in fiscal 2007 and fiscal 2006, respectively. In addition, it is uncertain as to the extent to which our Broadcast product enhancements will be accepted in its targeted markets. There also continues to be pricing pressures from our competitors across all our product lines. Revenues for fiscal year 2008 are also dependent upon the timely introduction and customer acceptance of new products within each of our product families.
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Summary of Critical Accounting Policies; Significant Judgments and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make significant estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. These items are regularly monitored and analyzed by management for changes in facts and circumstances, and material changes in these estimates could occur in the future. Changes in estimates are recorded in the period in which they become known. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from our estimates if past experience or other assumptions do not turn out to be substantially accurate.
We believe that the accounting policies described below are critical to understanding our business, results of operations and financial condition because they involve significant judgments and estimates used in the preparation of our consolidated financial statements. An accounting policy is deemed to be critical if it requires a judgment or accounting estimate to be made based on assumptions about matters that are highly uncertain, and if different estimates that could have been used, or if changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact our consolidated financial statements. We have discussed the development, selection and application of our critical accounting policies with the audit committee of our board of directors, and our audit committee has reviewed our disclosure relating to our critical accounting policies in this Managements Discussion and Analysis of Financial Condition and Results of Operations.
Other significant accounting policies, primarily those with lower levels of uncertainty than those discussed below, are also critical to understanding our consolidated financial statements. The notes to our consolidated financial statements contain additional information related to our accounting policies and should be read in conjunction with this discussion.
Principles of Consolidation. The Company consolidates the financial statements of its wholly owned subsidiaries and all inter-company accounts are properly eliminated in consolidation. SeaChange also holds minority investments in the capital stock of certain private companies having product offerings or customer relationships that have strategic importance. The Company evaluates its equity and debt investments and other contractual relationships with affiliate companies in order to determine whether the guidelines of FASB Interpretation (FIN) No. 46, Consolidation of Variable Interest Entities (FIN 46R), as revised under FIN 46R should be applied in the financial statements. FIN 46R addresses consolidation by business enterprises of variable interest entities that possess certain characteristics. The Company has concluded that it is not the primary beneficiary for any variable interest entities as of January 31, 2007. The Companys investments in affiliates include investments accounted for under the cost method and the equity method of accounting. The investments that represent less than a 20% ownership interest of the common shares of the affiliate are carried at cost. Under the equity method of accounting, which generally applies to investments that represent 20% to 50% ownership of the common shares of the affiliate, SeaChanges proportionate ownership share of the earnings or losses of the affiliate are included in equity income (loss) in earnings of affiliates in the consolidated statement of operations.
Revenue Recognition and Allowance for Doubtful Accounts. The accounting related to revenue recognition is complex and affected by interpretations of the rules and an understanding of industry practices. As a result, revenue recognition accounting rules require us to make significant judgments. Our judgment is required in assessing the probability of collection, which is generally based on evaluation of customer-specific information, historical collection experience and economic market conditions. Revenues from sales of hardware, software and systems that do not require significant modification or customization of the underlying software are recognized when title and risk of loss has passed to the customer, there is evidence of an arrangement, fees are fixed or determinable and collection of the related receivable is considered probable. Customers are billed for installation, training, project management and at least one year of product maintenance and technical support at the time of the product sale. Revenue from these activities are deferred at the time of the product sale and recognized ratably over the period these services are performed. Revenue from ongoing product maintenance and technical support agreements are recognized ratably over the period of the related agreements. Revenue from software development contracts that include significant modification or customization, including software product enhancements, is recognized based on the percentage of completion contract accounting method using labor efforts expended in relation to estimates of total labor efforts to complete the contract. For contracts, where some level of profit is assured but the Company is only able to estimate ranges of amounts of total contract revenue and total contract cost, the Company uses the lowest probable level of profits in accounting for the contract revenues and costs. Accounting for contract amendments and customer change orders are included in contract accounting when executed. Revenue from shipping and handling costs and other out-of-pocket expenses reimbursed by customers are included in revenues and cost of revenues. Our share of intercompany profits associated with sales and services provided to affiliated companies are eliminated in consolidation in proportion to our equity ownership.
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Our transactions frequently involve the sales of hardware, software, systems and services in multiple element arrangements. Revenues under multiple element arrangements are recorded based on the residual method of accounting. Under this method, the total arrangement value is allocated first to undelivered elements, based on their fair values, with the remainder being allocated to the delivered elements. The amounts allocated to undelivered elements, which may include project management, training, installation, maintenance and technical support and hardware and software components, are based upon the price charged when these elements are sold separately and unaccompanied by the other elements. The amount allocated to installation, training and project management revenue is based upon standard hourly billing rates and the estimated time required to complete the service. These services are not essential to the functionality of systems as these services do not alter the equipments capabilities, are available from other vendors and the systems are standard products. For multiple element arrangements that include software development with significant modification or customization and systems sales where vendor-specific objective evidence of the fair value does not exist for the undelivered elements of the arrangement (other than maintenance and technical support), percentage of completion accounting is applied for revenue recognition purposes to the entire arrangement with the exception of maintenance and technical support. Where fair value of undelivered service elements has not been established, the total arrangement value is recognized over the period during which the services are performed. For transactions in which consideration, including equity instruments, is given to a customer, SeaChange accounts for the value of this consideration as an adjustment to revenue. We must apply judgment in determining all elements of the arrangement and in determining the fair value for each element.
We recognize revenue for product and services only in those situations where collection from the customer is probable. The Company performs ongoing credit evaluations of customers financial condition but generally does not require collateral. For some international customers, the Company requires an irrevocable letter of credit to be issued by the customer before the purchase order is accepted. The Company monitors payments from customers and assesses any collection issues. The Company maintains allowances for specific doubtful accounts and other risk categories of accounts based on estimates of losses resulting from the inability of the Companys customers to make required payments and records these allowances as a charge to general and administrative expenses. The Company bases its allowances for doubtful accounts on historical collections and write-off experience, current trends, credit assessments, and other analysis of specific customer situations. While such credit losses have historically been within our expectations and the allowances established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. If the financial condition of our customers were to change, additional allowances may be required or established allowances may be considered unnecessary. Judgment is required in making these determinations and our failure to accurately estimate the losses for doubtful accounts and ensure that payments are received on a timely basis could have a material adverse effect on our business, financial condition and results of operations.
Any taxes assessed by a governmental authority related to revenue-producing transactions (e.g. sales or value-added taxes) are reported on a net basis and excluded from revenues.
Inventories and Reserves for Obsolescence. Inventories are stated at the lower of cost or net realizable value. Cost is determined using the first-in, first-out (FIFO) method. Inventories consist primarily of components, subassemblies and finished products held for sale. All of our hardware components are purchased from outside vendors. We depend upon certain vendors for the manufacture of significant components for all of our products. If these vendors were to become unwilling or unable to manufacture these products in required volumes, we would have to identify and qualify acceptable alternative vendors. The inability to develop alternative sources, if required in the future, could result in delays or reductions in product shipments and thereby adversely affect our financial condition and results of operations.
Our manufacturing, finance and operations personnel monitor quarterly the inventories to determine that the carrying value is stated at the lower of cost or net realizable value. We record charges to reduce inventory to its net realizable value when an impairment is identified through the quarterly management review process. Obsolete inventory, consisting of on-hand components, subassemblies and finished products, is written down to its estimated net realizable value, if less than cost. The obsolescence evaluation is based upon assumptions and estimates about future demand and possible alternative uses and involves significant judgments. In fiscal 2007 and 2006, we recorded inventory write-downs of $1,057,000 and $988,000.
Investments in Affiliates. Investments in affiliates include equity investments accounted for under the cost method or the equity method of accounting. For investments that represent less than a 20% ownership interest of the affiliate, the investments are carried at cost. Under the equity method of accounting, which generally applies to investments that represent 20% to 50% ownership of the common stock of the affiliate, our proportionate ownership share of the earnings or losses of the affiliate is recorded as equity income (loss) in earnings of affiliates in our consolidated statement of operations. We are required to exercise judgment in determining whether an investment is more accurately reflected using the cost or equity method.
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We periodically review indicators of the fair value of our investments in affiliates in order to assess whether available facts or circumstances, both internally and externally, may suggest an other than temporary decline in the value of the investment. The carrying value of an investment in an affiliate may be affected by the affiliates ability to obtain adequate funding and execute its business plans, general market conditions, industry considerations specific to the affiliates business, and other factors. The inability of an affiliate to obtain future funding or successfully execute its business plan could adversely affect our equity earnings of the affiliate in the periods affected by those events. Future adverse changes in market conditions or poor operating results of the affiliates could result in equity losses or an inability to recover the carrying value of the investments in affiliates that may not be reflected in an investments current carrying value, thereby possibly requiring an impairment charge in the future. We record an impairment charge when we believe an investment has experienced a decline in value that is other-than-temporary.
Accounting for Acquisitions. We have completed business acquisitions that resulted in goodwill and other intangible asset balances. Our accounting for acquisitions involves judgments and estimates primarily, but not limited to: the estimates of fair values of certain acquired intangible assets which may involve projections of future revenues and cash flows, of acquired tangible acquired assets, of assumed liabilities and contingencies; and the estimated useful lives of acquired long-lived assets; and the accounting for income taxes in purchase accounting. The values we record for goodwill and other intangible assets represent fair values primarily calculated by using a discounted cash flow valuation method. Such valuations depend upon significant estimates and assumptions that are derived from information obtained from the management of the acquired businesses and our business plans for the acquired businesses or intellectual property. These estimates and assumptions used in the initial valuation of goodwill and intangible assets include, but are not limited to:
| future expected cash flows from product sales, customer contracts and acquired developed technologies and patents, |
| expected costs to complete any in-process research and development projects and commercialize viable products and estimated cash flows from sales of such products, |
| the acquired companies brand awareness and market position, |
| assumptions about the period of time over which we will continue to use the acquired products or services, and |
| discount rates. |
These estimates and assumptions may be incomplete or inaccurate because unanticipated events and circumstances may occur. If estimates and assumptions used to initially value goodwill and intangible assets prove to be inaccurate, ongoing reviews of the carrying values of such goodwill and intangible assets, as discussed below, may indicate impairment which will require us to record an impairment charge in the period in which we identify the impairment. Changes in assumptions and estimates related to acquisitions could have a material impact on our financial position or results of operations.
Valuation of Goodwill and Other Long-Lived Assets. Other long-lived assets include $30.7 million of property and equipment, $13.1 million of intangible assets and $5.0 million of purchased software for resale as of January 31, 2007. Goodwill, of $23.7 million as of January 31, 2007, was acquired primarily through the purchases of ODG and Liberate. Whereas, the intangible assets have been subject to amortization since acquisition, the software, which was acquired in fiscal 2005 and fiscal 2006, began amortization in the first half of fiscal 2007. We review goodwill for impairment annually and periodically review both goodwill and intangibles for the existence of facts or circumstances, both internal and external, which may suggest an asset is not recoverablethat is, the carrying amount of the asset exceeds the sum of the undiscounted cash flows expected to result from the assets use and eventual disposition. Factors we consider important that could trigger the impairment review include:
| significant underperformance relative to historical or projected future operating results; |
| significant negative industry or economic trends; |
| significant decrease in the market value of the long-lived asset; |
| significant adverse change to the extent or manner in which a long-lived asset is being used or in its physical condition; |
| significant adverse change in legal factors or in the business climate that could affect the value of a long-lived asset; |
| significant decline in our stock price for a sustained period; |
| significant decline in our technological value as compared to the market; and |
| a reduction in our market capitalization relative to net book value. |
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If such circumstances exist, we evaluate the carrying value of long-lived assets to determine if impairment exists based upon estimated undiscounted future cash flows over the remaining useful life of the assets and comparing that value to the carrying value of the assets. If the carrying value of the asset is greater than the estimated future undiscounted cash flows, the asset is written down to its estimated fair value. We determine the estimated fair value of the assets on a projected discounted cash flow method using a discount rate determined by management to be commensurate with the risk inherent in the current business model. In determining expected future cash flows, assets are grouped at the lowest level for which cash flows are identifiable and independent of cash flows from other asset groups. Our cash flow projections contain managements best estimates, using appropriate and customary assumptions and projections at the time. We believe there is no impairment of goodwill and other long-lived assets as of January 31, 2007.
Accounting for Income Taxes. We record income taxes using the asset and liability method. Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective income tax bases, and operating loss and tax credit carryforwards. We evaluate the weight of all available evidence to determine whether it is more likely than not that some portion or all of the deferred income tax assets will not be realized. We will record a valuation allowance if the likelihood of realization of the deferred tax assets in the future is reduced based on an evaluation of objective verifiable evidence. Significant management judgment is required in determining our income tax expense (benefit), our deferred tax assets and liabilities and any valuation allowance recorded against our deferred tax assets. We have established a valuation allowance against our deferred tax assets due to indications that they may not be fully realized. The amount of the deferred tax asset considered realizable is subject to change based on future events, including generating sufficient pre-tax income in future periods.
We maintained a full valuation allowance against our U.S. deferred tax assets primarily due to the significant historical pre-tax losses and the significant ongoing uncertainties surrounding the ability of the U.S. entity, SeaChange International, Inc., to generate pre-tax income for fiscal 2008 and thereafter. In addition, SeaChange maintains a valuation allowance for the full amount of certain foreign tax assets. At January 31, 2007, the valuation allowance was $18.7 million.
In accordance with SFAS No. 109, Accounting for Income Taxes, and SFAS No. 5, Accounting for Contingencies, we established reserves for uncertain tax positions that reflect our best estimate of the transactions and deductions that we may be unable to sustain or that we may be willing to concede as part of a broader tax settlement. We are subject to undergoing routine tax examinations by federal, state, and foreign jurisdictions. Tax authorities may challenge certain transactions and deductions we reported on our income tax returns. We do not expect the outcome of these examinations, either individually or in the aggregate, to have a material adverse effect on our financial position, results of operations, or cash flows.
Accounting for Contingencies. We are subject to certain claims and litigation, including proceedings under government laws and regulations and commercial disputes relating to our operations, including ordinary routine litigation incidental to our business. We review and determine which liabilities, if any arising from these claims and litigations could have a material adverse effect on our consolidated financial position, liquidity or results of operations. We assess the likelihood of any adverse judgments or outcomes as well as potential ranges of probable losses. Loss contingency liabilities are recorded for these contingencies based on careful analysis of each matter with the assistance of outside counsel when it is probable that a liability has been incurred and the amount of the loss is reasonably estimable. In fiscal 2003, we recorded charges of $11.1 million associated with an unfavorable jury verdict in connection with the litigation with nCube, $7.5 million of this amount was for accrued settlement costs. Our reserve at January 31, 2006, fully covered the settlement costs including interest accrued through that date. On April 6, 2006 the U.S. District Court granted nCubes motions for damages, attorneys fees, costs and interest of $8.0 million which was fully paid to C-COR Incorporated on April 20, 2006 as the successor in interest to nCube.
Foreign Currency Translation. We have determined that the functional currency of all but one of our foreign subsidiaries is the U.S. dollar. Where the U.S. dollar is designated as the functional currency of an entity, we translate that entitys monetary assets and liabilities denominated in local currencies into U.S. dollars (the functional and reporting currency) at current exchange rates, as of each balance sheet date. Nonmonetary assets (e.g., inventories, property, plant, and equipment and intangible assets) and related income statement accounts (e.g., cost of sales, depreciation, amortization of intangible assets) are translated at historical exchange rates between the functional currency (the U.S. dollar) and the local currency. Revenue and other expense items are translated using average exchange rates during the fiscal period. Translation adjustments and transactions gains and losses on foreign currency transactions, and any unrealized gains and losses on short-term inter-company transactions are included in income.
For the single foreign subsidiary where the local currency is designated as the functional currency, we translate its assets and liabilities into U.S. dollars (the reporting currency) at current exchange rates as of each balance sheet date. Revenue and expense items are translated using average exchange rates during the period. Cumulative translation adjustments are presented as a separate
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component of stockholders equity. Exchange gains and losses on foreign currency transactions and unrealized gains and losses on short-term inter-company transactions are included in income.
Off-Balance Sheet Arrangements. We have not created, and are not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital or incurring debt. Other than our equity investment in Casa Systems and Filmflex (see Note 6 included in the consolidated financial statements and Liquidity and Capital Resources), we do not have any arrangements or relationships with entities that are not consolidated into our financial statements that are reasonably likely to materially affect our liquidity or the availability of our capital resources.
Fiscal Year Ended January 31, 2007 Compared to the Fiscal Year Ended January 31, 2006
Product Revenues. Our product revenues consist of sales of hardware, software and systems from our Broadband and Broadcast segments.
Year ended January 31, | ||||||
2007 | 2006 | |||||
Broadband revenues: |
||||||
Video-on-demand revenues |
74,447,000 | 49,117,000 | ||||
Advertising revenues |
10,458,000 | 15,248,000 | ||||
Total Broadband revenues |
84,905,000 | 64,365,000 | ||||
Broadcast revenues: |
10,095,000 | 9,151,000 | ||||
Total Product revenues |
$ | 95,000,000 | $ | 73,516,000 | ||
Our total product revenues increased 29% to $95.0 million in the fiscal year ended January 31, 2007 from $73.5 million in the fiscal year ended January 31, 2006.
Revenues from the Broadband segment, which accounted for 89% of product revenues in fiscal 2007 and 88% of product revenues in fiscal 2006, increased to $84.9 million in fiscal 2007 from $64.4 million in fiscal 2006. Advertising product revenues were $10.5 million for the fiscal year ended January 31, 2007 as compared to $15.2 million for the fiscal year ended January 31, 2006. Video-on-demand product revenues increased to $74.4 million for the fiscal year ended January 31, 2007 as compared to $49.1 million for the fiscal year ended January 31, 2006. The significant increase in video-on-demand product revenues between years related to a $17.5 million increase in software development revenue in connection with the VOD Purchase Agreement with Comcast signed during the quarter ended July 31, 2006, and software development revenue derived from the middleware contracts acquired from Liberate Technologies in July 2005. The remaining $7.8 million increase in video-on-demand product revenues stemmed from increased video-on-demand systems revenue tied to higher demand for our products from North American cable systems operators. The increase in video-on-demand product revenue was partially offset by a decrease in revenues from our Advertising products due to lower order activity related to customer conversion from analog to digital advertising insertion systems.
Broadcast product revenues were $10.1 million in the fiscal year ended January 31, 2007 compared to $9.2 million in the fiscal year ended January 31, 2006, representing a 10% increase. The increase in Broadcast revenues is due primarily to a $3.6 million order from the U.S. government recorded in the second quarter of fiscal 2007 partially offset by lower year over year order activity for the remainder of this operating segment.
We expect future revenue growth, if any, to come principally from our video-on-demand products as telecommunications companies, both in North America and internationally, begin to deploy video-on-demand systems, North American cable companies continue to expand their existing deployments of video-on-demand systems, and we expand our existing product line of video-on-demand products with new hardware and software products and services.
Services Revenues. Our services revenues consist of fees for installation, training, project management, product maintenance and technical support, software development, and movie content services. Our services revenues increased 26% to $66.3 million in the year ended January 31, 2007 from $52.7 million in the year ended January 31, 2006. The growth in Services revenue is primarily attributable to a full year of ODGs media content services, or $12.9 million, recognized in fiscal 2007 in comparison to only four months, or $4.2 million, recognized in fiscal 2006 from the date of SeaChanges acquisition of ODG in September 2005. In addition, $4.0 million of the increase in Services revenues between years is attributable to the increase in video-on-demand product maintenance contracts and other technical support services from a growing installed base of VOD systems. Revenues from services are expected to continue to grow from our expanding installed base of products and additional service offerings.
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For the fiscal year ended January 31, 2007, two customers each accounted for more than 10% and collectively, accounted for 53% of our total revenues, and one customer accounted for more than 25% of our total revenues for the year ended January 31, 2006. Revenues from these customers were primarily in the Broadband segment. We believe that a significant amount of our revenues will continue to be derived from a limited number of customers.
International products and services revenues accounted for approximately 33% and 40% of total revenues in the fiscal years ended January 31, 2007 and 2006, respectively. Customers in the U.S. and United Kingdom each accounted for more than 10% and collectively accounted for 87% and 81% of total revenue in fiscal 2007 and fiscal 2006, respectively. Revenues from European customers increased to $39.7 million from $32.9 million in the fiscal years ended January 31, 2007 and January 31, 2006, respectively. The increase in European revenues was primarily attributable to U.K. customers that generated $32.9 million in revenues in the fiscal year ended January 31, 2007. The increase in revenues from the United Kingdom is primarily due to the service revenues from the video content services provided by ODG for the full fiscal year 2007 in comparison to four months from the acquisition date in fiscal 2006. In addition, the middleware software development revenues included a full year in fiscal 2007 from the contracts acquired from Liberate Technologies in comparison to six months from the acquisition date in fiscal 2006. We expect that international products and services revenues will remain a significant portion of our business in the future. Since substantially all of our product sales are made in United States dollars (USD), we have not experienced, nor do we expect to experience in the near term, any material impact from fluctuations in foreign currency exchange rates on our results of operations. With the acquisition of ODG, which has designated the Great Britain Pound (GBP) as its functional currency, their service sales, primarily payable in GBP, provide a natural hedge for payments in local currency. Thus, we do not expect to experience, nor have we experienced any material impact on our results from fluctuations in foreign currency transactions from ODG operations. However, since the ODG operation is translated to USD for reporting purposes, translation gains and losses, as a result of foreign currency rate fluctuations, are recorded in the equity section of our balance sheet. We continue to expect exposure in fluctuations in the USD/GBP exchange rate in the equity section of our balance sheet in the future.
Product Gross Profit. Costs of product revenues consist primarily of the cost of purchased material components and subassemblies, labor and overhead costs relating to the final assembly and testing of complete systems, and related expenses and labor and overhead costs related to software development contracts. Costs of product revenues increased to $48.3 million, or 51% of the related product revenues in the fiscal year ended January 31, 2007 as compared to $45.6 million or 62% of related product revenues, in the fiscal year ended January 31, 2006. In fiscal 2007, the increase in the costs of product revenues primarily reflects the increased revenues. Costs of product revenues as a percentage of revenues decreased due to the increased revenues from higher margin software development contracts. Product gross profit for the Broadband segment increased to 54% of related revenues in fiscal 2007 from 43% of related revenues in fiscal 2006. The increase in Broadband gross profit percentages is primarily due to increased revenues from higher margin software development contracts. Product gross profit for the Broadcast segment was up from 2% of related product revenues in fiscal 2006 to 9% of related product revenues in fiscal 2007.
Services Gross Profit. Cost of services revenues consist primarily of labor, materials and overhead relating to the installation, training, product maintenance and technical support, software development, project management and costs associated with providing video content services. Costs of services revenues increased 31% from $28.3 million or 54% of services revenues in the year ended January 31, 2006 to $37.2 million or 56% of services revenues in the year ended January 31, 2007, primarily due to a full year of ODG costs of services in fiscal year 2007 as compared with four months in fiscal year 2006. We expect that service gross profit percentage will decrease over the next several quarters due to increased headcount-related costs to service our increased installed base of systems, our new products expected to be introduced in fiscal 2008 and additional costs at ODG as it expands its operations beyond the U.K.
Research and Development. Research and development expenses consist primarily of the compensation of development personnel, depreciation of development and test equipment and an allocation of related facilities expenses. Research and development expenses increased from $34.5 million, or 27% of total revenues, in the fiscal year ended January 31, 2006 to $40.9 million, or 25% of total revenues, in the fiscal year ended January 31, 2007 primarily due to $3.4 million in increased salaries and benefits attributable to the hiring of additional development engineers primarily to support middleware products and stock compensation expense of $1.5 million due to adoption of SFAS 123R. We expect that research and development expenses will continue to increase in fiscal year 2008 as we continue our development of our new products and enhancements.
Selling and Marketing. Selling and marketing expenses consist primarily of compensation expenses, including sales commissions, travel expenses and certain promotional expenses. Selling and marketing expenses increased 20% from $18.7 million or 15% of total revenues in the fiscal year ended January 31, 2006 to $22.4 million, or 14% of total revenues, in the fiscal year ended January 31, 2007. This increase is primarily due to $1.7 million in increased salaries and benefits attributable to the hiring of additional sales and marketing employees, increased commissions of approximately $500,000 due to higher revenues, and stock
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compensation expense of approximately $500,000 due to adoption of SFAS 123R. We expect selling and marketing expenses to increase in fiscal 2008 as we continue to expand our product offerings and increase our selling presence in overseas markets.
General and Administrative. General and administrative expenses consist primarily of the compensation of executive, finance, human resource and administrative personnel, legal and accounting services and an allocation of related facilities expenses. In the fiscal year ended January 31, 2007, general and administrative expenses of $19.2 million, or 12% of total revenues, increased from $14.3 million, or 11% of total revenues, in the fiscal year ended January 31, 2006 due to $3.1 million attributable to a full year of ODG general and administrative expense in fiscal year 2007 as compared with four months in fiscal year 2006, $1.0 million due to the hiring of additional general and administrative employees, $1.2 million due to stock compensation expense, an increase in the bad debt provision of approximately $400,000 in fiscal 2007 in comparison with net bad debt recoveries of approximately $100,000 in fiscal 2006, all partially offset by a reduction in professional fees of approximately $700,000 some of which related to fiscal 2006 acquisitions.
Amortization of Intangibles. Amortization expense consists of the amortization of acquired intangible assets which are operating expenses and not considered costs of revenues. Amortization of intangible assets was $5.7 million in the fiscal year ended January 31, 2007 and $2.2 million in the fiscal year ended in January 31, 2006. The increase in amortization expense is attributable to the acquisitions of Liberate and ODG in the second and third quarters of fiscal 2006, respectively. The table below classifies the amortization expense by its source category, sales and marketing or general and administrative expense.
(Amounts in thousands) |
For the year ended January 31, 2007 |
For the year ended January 31, 2006 | ||||
Sales and marketing expense |
$ | 5,446 | $ | 1,948 | ||
General and administrative expense |
218 | 253 | ||||
Amortization expense |
$ | 5,664 | $ | 2,201 | ||
An additional $643,000 and $297,000 of amortization expense related to acquired technology was charged to cost of sales for the years ended January 31, 2007 and 2006, respectively.
Interest Income and Interest Expense. Interest income was $1.5 million in the fiscal year ended January 31, 2007 and $2.1 million in the fiscal year ended January 31, 2006. Interest expense was $96,000 for the fiscal year ended January 31, 2007 as compared to $30,000 for the fiscal year ended January 31, 2006. The decrease in interest income is primarily due to the decrease in marketable securities during the fiscal year ended January 31, 2007 in comparison to the fiscal year ended January 31, 2006.
Impairment on Investment in Affiliate. Impairment on investment in affiliate was a loss of $150,000 in the fiscal year ended January 31, 2007 due to the impairment of a small investment in an affiliate company and none in the fiscal year ended January 31, 2006.
Equity Income in Earnings of Affiliates. Equity income in earnings of affiliates was $1.3 million in the fiscal year ended January 31, 2007 compared with $39,000 in the fiscal year-ended January 31, 2006. The equity income in earnings of affiliates consists of our proportionate ownership share of the net income (loss) under the equity method of accounting. For fiscal 2007, the equity income in earnings of affiliates consisted of our proportionate ownership share of the earnings of Filmflex. For fiscal 2006, the equity income in earnings of affiliates consisted of our proportionate ownership share of the earnings of ODG until we purchased 100% of the company in September 2005. As part of the ODG acquisition, we increased our ownership interest to 33.3% in Filmflex for which we recorded our proportionate ownership share of its net income or loss from the acquisition date. The year over year increase in earnings from our investment in Filmflex was $1.5 million offset by the loss of approximately $200,000 from ODG in fiscal 2006 prior to our acquisition of the remaining interest in ODG.
Income Tax Benefit. Our effective tax rate and income tax benefit was 15% or $1.6 million and 19% or $2.9 million for fiscal years ended January 31, 2007 and 2006, respectively. For the fiscal year 2007, the income tax benefit was primarily attributable to $315,000 of net operating losses generated during the current fiscal year that are expected to be carried back to recover taxes paid in prior years and the change in estimate of the prior years tax provision relating to the tax benefit booked for the fiscal 2006 federal loss carryback versus the actual cash refund received of $422,000. At January 31, 2007 and January 31, 2006, we provided a valuation allowance for the full amount of net deferred tax assets recorded in the United States due to the uncertainty of realization of those assets as a result of the current fiscal years pre-tax losses and uncertainties related to our ability to generate pre-tax income for fiscal 2007 and thereafter. In addition, SeaChange maintains a valuation allowance for the full amount of certain foreign tax assets. We will continue to assess the need for the valuation allowance at each balance sheet date based on all available evidence. If we
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determine that we can generate sufficient future pre-tax income, some portion or all of the valuation allowance would be reversed and a corresponding increase in net income would be recognized.
Fiscal Year Ended January 31, 2006 Compared to the Fiscal Year Ended January 31, 2005
Product Revenues. Our product revenue consists of sales of hardware, software and systems from our Broadband and Broadcast segments.
Year ended January 31, | ||||||
2006 | 2005 | |||||
Broadband revenues: |
||||||
Video-on-demand revenues |
$ | 49,117,000 | $ | 86,879,000 | ||
Advertising revenues |
15,248,000 | 13,170,000 | ||||
Total Broadband revenues |
64,365,000 | 100,049,000 | ||||
Broadcast revenues: |
9,151,000 | 13,715,000 | ||||
Total Product revenues |
$ | 73,516,000 | $ | 113,764,000 | ||
Our total product revenues decreased 35% to $73.5 million in the fiscal year ended January 31, 2006 from $113.8 million in the fiscal year ended January 31, 2005.
Revenues from the Broadband segment, which accounted for 51% of total revenues in fiscal 2006 and 64% of total revenues in fiscal 2005, decreased from $100.0 million in fiscal 2005 to $64.4 million in fiscal 2006. Advertising product revenues were $15.2 million for the fiscal year ended January 31, 2006 as compared to $13.2 million for the fiscal year ended January 31, 2005. Video-on-demand product revenues, excluding software development revenues, decreased to $42.6 million for the fiscal year ended January 31, 2006 as compared to $86.9 million for the fiscal year ended January 31, 2005. Revenues from video-on-demand product for the fiscal year ended January 31, 2005 were increased by $1.1 million for the adjustment recorded in connection with the final agreement with Comcast (See Note 11 to Financial Statements) concerning incentive common stock purchase warrants. The decrease in Broadband revenues reflects a decline in demand by U.S. cable operators, including a significant decline in revenues from our largest U.S. customer and price decreases partially offset by increased revenues from the initial deployment of video-on-demand systems in Europe and the new middleware software revenues of $6.5 million from customer contracts acquired from Liberate Technologies. This decrease was also partially offset by an increase in revenues from our Advertising products due to an increase in demand for digital advertising systems, reflecting cable operators replacement of the analog technology with digital technology.
Broadcast product revenues were $9.2 million in the fiscal year ended January 31, 2006 compared to $13.7 million in the fiscal year ended January 31, 2005. The 33% decrease in Broadcast revenues during the fiscal year ended January 31, 2006 was primarily attributable to the delay in the introduction and initial customer acceptance of the new products.
Services Revenues. Our services revenues consist of fees for installation, training, project management, product maintenance and technical support, software development, and movie content services. Our services revenues increased 21% to $52.7 million in the year ended January 31, 2006 from $43.5 million in the year ended January 31, 2005. This increase in service revenues primarily resulted from the annual renewals of product maintenance and technical support service contracts from our expanding installed base of products and $4.2 million of revenues from ODGs video content services recorded since the acquisition of ODG in September 2005. Software development and professional services revenues from our wholly-owned subsidiary, Digital Video Arts, increased to $3.4 million in the fiscal year ended January 31, 2006 from $3.0 million in the fiscal year ended January 31, 2005.
For the fiscal years ended January 31, 2006 and 2005, one customer accounted for more than 10% of our total revenues. This customer accounted for 25% and 48% of revenues in the fiscal years ended January 31, 2006 and 2005, respectively. Revenue from this customer was primarily in the Broadband segment.
International products and services revenues accounted for approximately 40% and 22% of total revenues in the fiscal years ended January 31, 2006 and 2005, respectively. Both U.S. and United Kingdom customers accounted for more than 10% of total revenue in fiscal 2006. The U.S. was the only country to account for more than 10% of total revenues in fiscal 2005. Revenues from European customers increased from $16.7 million to $32.9 million in the fiscal years ended January 31, 2005 and January 31, 2006, respectively. The increase in European revenues was primarily attributable to U.K. customers. The increase in revenues from the United Kingdom is primarily due to the expansion of the video-on-demand system deployments by United Kingdom cable operators, software revenues generated from our U.K. customer contracts recently acquired from Liberate Technologies, and the service revenues from the video content services provided by On Demand Group since its acquisition.
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Product Gross Profit. Costs of product revenues consist primarily of the cost of purchased material components and subassemblies, labor and overhead relating to the final assembly and testing of complete systems and related expenses. Costs of product revenues decreased to $45.6 million, or a gross profit of 38% of related product revenue, in the fiscal year ended January 31, 2006 as compared to $60.2 million, or a gross profit of 47% of related product revenue, in the fiscal year ended January 31, 2005. In the fiscal 2006, the decrease in the costs of product revenues primarily reflects the decrease of the video-on-demand systems revenue. Product gross profit for the Broadband segment decreased from 49% of related revenues in fiscal 2005 to 43% of related revenues in fiscal 2006. The decrease in Broadband gross profit percentages is primarily due to lower video-on-demand product revenues offset in part by an increase in software revenues from customer contracts recently acquired from Liberate Technologies. Product gross profit for the Broadcast segment was down from 34% of related product revenues in fiscal year 2005 to 2% of related product revenues in fiscal 2006. The decrease in gross profit percentage is primarily due to lower revenues, higher discounts on certain Broadcast orders as a result of competitive pressures and the additional cost of sales necessary to enhance the performance of certain systems.
Services Gross Profit. Cost of services revenues consist primarily of labor, materials and overhead relating to the installation, training, product maintenance and technical support, software development, project management provided by us and costs associated with providing video content services. Costs of services revenues increased 10% from $25.8 million or a gross profit of 41% of services revenue in the year ended January 31, 2005 to $28.3 million or a gross profit of 46% of services revenue in the year ended January 31, 2006, primarily due to additional costs of services generated as a result of the acquisition of ODG in September 2005. The increase in services gross profit was primarily due higher revenue levels and a relatively fixed cost base and the added margin generated from the On Demand Group revenues recognized since the acquisition in September 2005.
Research and Development. Research and development expenses consist primarily of the compensation of development personnel, depreciation of development and test equipment and an allocation of related facilities expenses. Research and development expenses increased from $29.5 million, or 19% of total revenues, in the fiscal year ended January 31, 2005 to $34.5 million, or 27% of total revenues, in the fiscal year ended January 31, 2006 primarily due to the hiring of additional development engineers to support new product initiatives ($3.8 million) and additional development costs incurred by ODG ($500,000) after its acquisition date.
Selling and Marketing. Selling and marketing expenses consist primarily of compensation expenses, including sales commissions, travel expenses and certain promotional expenses. Selling and marketing expenses increased 3% from $18.1 million or 12% of total revenues, in the fiscal year ended January 31, 2005 to $18.7 million, or 15% of total revenues, in the fiscal year ended January 31, 2006. This increase is primarily due to increased tradeshow and travel expenses related to increased direct sales efforts partially offset by reduced sales commissions on lower revenues.
General and Administrative. General and administrative expenses consist primarily of the compensation of executive, finance, human resource and administrative personnel, legal and accounting services and an allocation of related facilities expenses. In the fiscal year ended January 31, 2006, general and administrative expenses of $14.3 million, or 11% of total revenues, increased from $10.3 million, or 7% of total revenues, in the fiscal year ended January 31, 2005 due to $1.1 million of higher accounting and consulting fees associated with the Companys acquisitions and investments in affiliates and compliance with Sarbanes-Oxley legislation, $1.0 million to further develop operations on a world-wide basis and particularly in China, and $900,000 additional general and administrative expenses incurred by ODG after the acquisition date. During the fourth quarter of fiscal 2006, we reversed charges related to the retirement agreement for our Chief Financial Officer due to the execution of a Management Transition Agreement which continues his employment through January 31, 2008 with no retirement benefits. The fiscal year 2006 general and administrative expenses differ from the amount reported in our earnings release, issued March 14, 2006, by an additional $209,000 of interest expense recorded in connection with our patent infringement litigation accrual.
Amortization of Intangibles. Amortization of intangible assets was $2.2 million in the fiscal year ended January 31, 2006 and $1.3 million in the fiscal year ended in January 31, 2005. This increase in amortization of intangibles is primarily due to the acquisitions of intangible assets acquired from Liberate Technologies Non-North American business in July 2005 and from the step acquisition of ODG in September 2005.
Interest Income and Interest Expense. Interest income was $2.1 million in the fiscal year ended January 31, 2006 and $1.0 million in the fiscal year ended January 31, 2005. In fiscal 2005, we recorded an $800,000 adjustment ($519,000 net of taxes) to reduce interest income to properly account for the amortization of market premiums and discounts on acquired marketable securities.
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Equity income (loss) in earnings of affiliates. Equity income in earning of affiliates was $39,000 in the fiscal year ended January 31, 2006 and equity loss in earnings of affiliates was $148,000 in the fiscal year-ended January 31, 2005. For fiscal 2006, the equity income in earnings of affiliates consisted of our proportionate ownership share of the earnings of ODG until we purchased 100% of the company in September 2005. As part of the ODG acquisition, we also increased our ownership interest to 33.3% in Filmflex for which we recorded our proportionate ownership share of its net loss since the acquisition date. For fiscal 2005, the equity loss in earnings of affiliates consisted of our proportionate ownership share of the net loss of ODG under the equity method of accounting.
Income Tax Expense (Benefit). Our effective tax rate was (19)% and 24% for fiscal years ended January 31, 2006 and 2005, respectively. For the fiscal year ended January 31, 2006, we recorded a $2.9 million income tax benefit that is primarily attributable to operating losses generated during the current fiscal year that are expected to be carried back to recover prior year taxes paid. At January 31, 2006, we provided a valuation allowance for the full amount of net deferred tax assets recorded in the United States due to the uncertainty of realization of those assets as a result of the current fiscal years pre-tax losses and uncertainties related to our ability to generate pre-tax income for fiscal 2007 and thereafter. In addition, SeaChange maintains a valuation allowance for the full amount of certain foreign tax assets. We have experienced a significant decline in product revenues since the fourth quarter of fiscal 2005, which was primarily attributable to a decline in video-on-demand systems revenues that subsequently resulted in lower gross margins and net losses. We will continue to assess the need for the valuation allowance at each balance sheet date based on all available evidence. If we determine that we can generate sufficient future pre-tax income, some portion or all of the valuation allowance would be reversed and a corresponding increase in net income would be recognized. Income tax expense of $3.1 million for fiscal year 2005 included a $2.1 million benefit primarily related to the implementation of a tax law change relating to the tax treatment of deferred revenues which resulted in the realization of an associated deferred tax asset and a corresponding valuation allowance release as SeaChange began to follow the same method for both book and tax purposes for recognizing revenue for maintenance service contracts. SeaChange had an effective income tax rate of 40% for the year ended January 31, 2005 before recording the adjustment discussed above.
Quarterly Results of Operations
The following table presents unaudited financial information for the quarterly periods in the fiscal years ended January 31, 2006 and January 31, 2007. The results for any quarter are not necessarily indicative of future quarterly results, and we believe that period-to-period comparisons should not be relied upon as an indication of future performance.
Three months ended | |||||||||||||||||||||||||||||||
April 30, As Restated |
July 31, As Restated |
October 31, As Restated |
January 31, As Restated |
April 30, As Restated |
July 31, As Restated |
October 31, As Restated |
January 31, As Restated |
||||||||||||||||||||||||
(in thousands, except per share amounts) | |||||||||||||||||||||||||||||||
Revenue |
$ | 31,512 | $ | 26,195 | $ | 35,321 | $ | 33,236 | $ | 33,241 | $ | 45,766 | $ | 42,254 | $ | 40,073 | |||||||||||||||
Gross profit |
13,526 | 9,239 | 14,716 | 14,913 | 15,434 | 23,784 | 19,525 | 17,068 | |||||||||||||||||||||||
Operating expenses |
15,663 | 16,872 | 18,263 | 18,813 | 21,485 | 22,777 | 21,820 | 22,075 | |||||||||||||||||||||||
Net (loss) income |
(665 | ) | (6,519 | ) | (2,031 | ) | (2,984 | ) | (4,329 | ) | 933 | (1,152 | ) | (3,689 | ) | ||||||||||||||||
Earnings (loss) per share - Basic |
(0.02 | ) | (0.23 | ) | (0.07 | ) | (0.11 | ) | (0.15 | ) | 0.03 | (0.04 | ) | (0.13 | ) | ||||||||||||||||
Earnings (loss) per share - Diluted |
(0.02 | ) | (0.23 | ) | (0.07 | ) | (0.11 | ) | (0.15 | ) | 0.03 | (0.04 | ) | (0.13 | ) |
We have experienced significant variations in revenues, expenses and operating results from quarter to quarter and such variations are likely to continue. A significant portion of our 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. During the fiscal 2007 quarterly periods outlined above, we experienced increases in our revenues compared to the quarterly periods in fiscal 2006 primarily related to the increase in software development revenues in fiscal 2007 in connection with the VOD purchase agreement signed with Comcast in July of 2006, the increase in video-on-demand systems revenue related to increased demand for our products from North American cable system operators and the full year impact of the ODG acquisition and Liberate middleware contracts in fiscal 2006.
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We have also experienced significant variations in our quarterly product gross profit. Changes in pricing policies, the product mix, the timing and significance of new product introductions and product enhancements, and fluctuations in the number of systems affects manufacturing efficiencies and, accordingly, gross profits. Quarterly services gross profits have historically fluctuated significantly because installation and training service revenue varies by quarter while the related costs are relatively consistent by quarter. Gross profits for fiscal 2007 were higher than quarterly gross profits for fiscal 2006 principally due to higher revenues for the reasons cited above and a greater mix of higher margin software development revenue. In addition, our gross profit for the quarter ended January 31, 2007 reflected the impact of approximately $1.0 million of fiscal year 2007 sales discounts in connection with the 18 month extension of a middleware development contract.
During the quarterly periods outlined above, we generally experienced sequential increases in our operating expenses with the exception of the third quarter of fiscal 2007 when operating expenses decreased due to the start of the reclassification to cost of goods sold of software development expenses related to the Comcast agreement. Operating expenses, also vary somewhat with the number, timing and significance of new product and product enhancement introductions by us and our competitors, increased competition, the gain or loss of significant customers, the hiring of new personnel, the acquisition of businesses, and general economic conditions. Our selling and marketing costs fluctuate from quarter to quarter as a result of commissions related to our revenues, large tradeshows that take place in the first and third quarter of the year and significant promotional costs that are incurred for new product introductions. All of the above factors are difficult for us to forecast, and these or other factors may have a materially adverse effect on our business, financial condition and results of operations for one quarter or a series of quarters. Only a small portion of our expenses vary with revenues in the short-term and there would likely be a material adverse effect on our operating results if future revenues are lower than expectations.
Based upon all of the forgoing, we believe that quarterly revenues and operating results are likely to vary significantly in the future and that period-to-period comparisons of our results of operations should not be relied upon as indications of future performance.
Liquidity and Capital Resources
Historically, we have financed our operations and capital expenditures primarily with the proceeds from sales of our common stock and cash flows generated from operations. During fiscal 2007, cash and cash equivalents increased $9.6 million from $21.6 million at January 31, 2006 to $31.2 million at January 31, 2007 largely due to cash provided by certain operating, investing, and financing activities partially offset by our net loss. Working capital increased to $57.8 million at January 31, 2007 from $45.8 million at January 31, 2006.
Net cash provided by operating activities was $488,000 for the fiscal year ended January 31, 2007 compared to net cash used in operating activities of $20.0 million for the fiscal year ended January 31, 2006. The net cash used for operating activities in the fiscal year ended January 31, 2007 was the result of a net loss of $8.2 million and the $8.0 million cash payment made to C-Cor Incorporated (as successor to nCube Corp.) in settlement of the now resolved patent infringement litigation, which was offset by the non-cash depreciation and amortization of intangible assets of $14.5 million, stock compensation expense of $3.5 million and the changes in certain operating assets and liabilities. Significant changes in operating assets and liabilities that provided cash included an income tax refund that reduced income taxes receivable by $2.4 million, and an increase in deferred revenues of $1.6 million. The significant changes in assets and liabilities that used cash from operations included an increase in inventories of $4.7 million, primarily due to inventory acquired and subsequently reclassified to fixed assets for use as research and development equipment, and a reduction in income taxes payable. The share-based compensation of $3.5 million in fiscal 2007 increased from $43,000 in fiscal 2006 and $0.0 million in fiscal 2005 due to the adoption of SFAS 123R beginning February 1, 2006.
It is typical for us to experience fluctuations in our monthly operating results primarily due to the timing of receiving customer orders and the related shipment of these customer orders. As a result of these monthly fluctuations, we may experience significant increases or decreases in our inventories as a result of the timing of the procurement of components for anticipated orders for both our product segments and increases or decreases in our accounts receivable balances and customer deposits as a result of the timing of receiving customer orders during the period and of customer payments. We expect that the video-on-demand products within the Broadband segment will continue to require a significant amount of cash to fund future product development and additional capital expenditures for engineering equipment, quality systems and customer services test systems to meet higher forecasted revenue levels.
Net cash provided by investing activities was $5.8 million for the fiscal year ended January 31, 2007 and net cash used in investing activities was $53.5 million for the fiscal year ended January 31, 2006. Investment activity for fiscal 2007 consisted primarily of $15.4 million net maturities and sales of marketable securities partially offset by capital expenditures of $7.0 million and the $3.0 million contingent consideration cash payment made to the former shareholders of ODG.
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Net cash provided by financing activities was $2.9 million for the fiscal year ended January 31, 2007 compared to $1.5 million for the fiscal year ended January 31, 2006. In fiscal 2007 and fiscal 2006, the cash provided by financing activities was comprised of proceeds from the issuance of common stock in connection with stock option exercises and the employee stock purchase plan.
In the second quarter of fiscal 2007, we renewed our revolving line of credit with Citizens Bank (a subsidiary of the Royal Bank of Scotland Group plc) through June, 2007, for the committed amount of $15.0 million. Loans made under this revolving line of credit bear interest at a rate per annum equal to the banks prime rate which was 8.25% on January 31, 2007. Borrowings under this line of credit are collateralized by substantially all of our assets. The loan agreement requires that we provide Citizens Bank with certain periodic financial reports and comply with certain financial ratios including a minimum level of earnings before interest, taxes and depreciation and amortization on a trailing twelve month basis, when amounts are outstanding under the loan agreement. As of January 31, 2007, we were not in compliance with the financial covenants but obtained a waiver from the bank for the quarter ended January 31, 2007. There are currently no amounts outstanding under the revolving line of credit.
In the third quarter of fiscal 2006, we purchased 72.4% of the outstanding capital stock of the On Demand Group Limited (ODG), a company incorporated under the laws of the United Kingdom. As a result of this purchase, we owned 100% of ODG at January 31, 2006. Under the terms of the purchase agreement, we acquired the outstanding shares in ODG we did not previously own in exchange for approximately $14.0 million in cash consideration, including transaction costs of $500,000. The purchase agreement also provides for additional contingent consideration if ODG meets certain annual performance goals related to net income over three measurement periods ending January 31, 2008. We may pay up to a maximum aggregate contingent consideration of $11.9 million (based on the exchange rate in effect at January 31, 2007), including up to 50% payable in shares of our common stock, par value $0.01 per share, with the remainder payable in cash provided that the performance goals are met. The contingent consideration is comprised of three installments, each to be made annually, beginning with the year ending January 31, 2006, for an annual baseline amount of $2.2 million, $2.3 million and $4.9 million, respectively (based on the exchange rate in effect at January 31, 2006, June 30, 2007 and January 31, 2007, respectively). These amounts are subject to upward and downward adjustment based on the actual net income related performance of ODG, as clarified in the agreement, during these periods, provided that the aggregate maximum contingent consideration payable is the sum of these baseline amounts plus a maximum of $2.6 million (based on the exchange rate in effect at January 31, 2007). The contingent consideration will be recorded as an additional cost of the purchase and recognized as goodwill if the performance measures are met by ODG and it becomes payable. On January 31, 2006, the first earnout measurement period ended, and we recorded $2.8 million (USD equivalent) of additional purchase price as goodwill based upon ODGs net income for the initial annual performance period ended January 31, 2006. In May 2006, the Company paid $3.0 million (USD equivalent at the current exchange rate) to satisfy this obligation. On June 30, 2006, SeaChange and the former stockholders of ODG amended the original purchase agreement to provide for the acceleration of the second installment of contingent consideration (for the year ended January 31, 2007) in exchange for the issuance to the sellers of 341,360 shares of SeaChanges common stock having a fair market value of $2.3 million as of the date of the amendment. Consequently, the Company recorded an additional $2.3 million of goodwill to reflect the accelerated second installment of contingent consideration.
In the second quarter of fiscal 2006, we acquired substantially all of the assets of Liberate Technologies business outside of North America. At the time of the transaction, Liberate Technologies was a leading provider of software for digital cable systems. Under the terms of the purchase agreement, we acquired certain customer contracts, patents and other intellectual property, and assumed certain limited liabilities related to Liberates business outside of North America in exchange for approximately $23.7 million in cash consideration.
In the second quarter of fiscal 2006, we purchased for $8.9 million real property located at 50 Nagog Park Drive in Acton, Massachusetts. The building on the property is approximately 120,000 square feet, and this site is our new corporate headquarters. All operations and personnel currently that were located at the facility in Maynard, Massachusetts were relocated to the new property in Acton, Massachusetts in February 2006.
In the first quarter of fiscal 2006, we entered into a Stock Purchase Agreement with InSite One, Inc. (InSite), an off-site medical imaging and data services company. As part of the agreement, we invested $2.0 million for 5.9 million shares of 8% cumulative convertible preferred stock of InSite representing approximately 11% of the total capital stock of the InSite. The preferred shares are convertible to common stock based upon defined conversion factors subject to adjustment as defined in the agreement. In fiscal 2007, we converted a note receivable of $407,000 related to an InSite One system sale to equity.
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In January 2005, we executed a Secured Loan Agreement with Casa Systems, Inc. (Casa), a Massachusetts development stage company that specializes in video-on-demand products within the telecommunications and television markets. The original total loan commitment was $1.9 million and $750,000 was drawn at the end of fiscal year 2005. During the first quarter of fiscal 2006, we increased the total loan commitment to $2.4 million, and Casa drew down the remaining $1.7 million.
In the second quarter of fiscal 2006, we invested $8.2 million in convertible preferred stock, which may convert to a 19.8% ownership interest, in Casa Systems, Inc. (Casa), a Massachusetts development stage company that specializes in video-on-demand products within the telecommunications and television markets. A portion of the purchase price was satisfied by our surrender and cancellation of the $2.5 million in principal plus accrued interest outstanding pursuant to the Secured Loan Agreement with Casa. The remainder of the purchase price was paid in cash. The investment was made for shares of Casas convertible preferred stock, convertible at our option into shares of Casas common stock on a one-to-one basis. At the time of the investment, we also entered into agreements with Casa, its stockholders and its optionholders which grant us the right of first refusal on the issuance of additional shares of Casa securities or transfers of stock or options by holders. In addition, we had a call option exercisable until January 31, 2007 to purchase all of the outstanding stock and options not owned by us for an aggregate price of $92 million. The Company did not exercise this option.
In fiscal 2005, SeaChange acquired all of the outstanding stock of ZQ Interactive, Ltd., a company incorporated in the British Virgin Islands with its principal office in Shanghai, China. According to the terms of the purchase agreement, $1.0 million was paid to the sellers at the signing of the purchase agreement and the remaining $1.0 million was to be paid to the sellers in two equal annual installments of $500,000 on the first and second anniversary dates of the signing of the purchase agreement. The final installment of $500,000 was paid in July 2006.
The following table reflects our current and contingent contractual obligations to make potential future payments as of January 31, 2007 (in thousands):
Payment due by period | ||||||||||||||
($000s) |
Total | Less than one year |
One to three years |
Three to five years |
More than Five years | |||||||||
Purchase obligations |
$ | 6,486 | $ | 6,486 | | | | |||||||
Acquisition commitments |
6,800 | 6,800 | | | | |||||||||
Studio content minimum guarantees |
3,747 | 960 | $ | 2,568 | $ | 219 | | |||||||
Non-cancelable lease obligations |
2,218 | 1,407 | 779 | 32 | | |||||||||
Total |
$ | 19,251 | $ | 15,653 | $ | 3,347 | $ | 251 | | |||||
The purchase obligations and studio content minimum guarantees include open, non-cancelable purchase commitments from our suppliers. The acquisition commitments primarily include estimated maximum additional contingent consideration obligations in the event ODG achieves specified annual performance thresholds in the future.
We believe that existing funds combined with available borrowings under the revolving line of credit and cash provided by future operating activities are adequate to satisfy our working capital, potential acquisitions and capital expenditure requirements and other contractual obligations for the foreseeable future, including at least the next 24 months.
Effects of Inflation
Our management believes that financial results have not been significantly impacted by inflation and price changes.
New Accounting Pronouncements
In February 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments an amendment of FASB Statements No. 133 and 140 (SFAS 155). SFAS 155 permits a fair value re-measurement for any hybrid financial instrument that contains an embedded derivative that would otherwise require bifurcation. This accounting standard is effective as of the beginning of fiscal years beginning after September 15, 2006. The effect of adopting SFAS 155 on our financial position and results of operations will be immaterial.
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In March 2006, the FASB issued the SFAS No. 156, Accounting for Servicing of Financial Assets, an amendment of FASB Statements No. 140 (SFAS 156). SFAS 156 requires that servicing assets and servicing liabilities be recognized at fair value, if practicable, when we enter into a servicing agreement and allows two alternatives, the amortization and fair value measurement methods, as subsequent measurement methods. This accounting standard is effective for all new transactions occurring as of the beginning of fiscal years beginning after September 15, 2006. The effect of adopting SFAS 156 on our financial position and results of operations will be immaterial.
In June 2006, the FASB issued FASB Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109. This interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprises financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. The interpretation prescribes a recognition threshold and measurement attribute for a tax position taken or expected to be taken in a tax return and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006. The Company will adopt FIN 48 as of February 1, 2007, as required. The cumulative effect of adopting FIN 48 will be recorded as an adjustment to opening retained earnings and other accounts as applicable. We are currently evaluating the effect of FIN 48 on our results of operations or financial position.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurement (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value using generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement does not require any new fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company does not expect the adoption of SFAS 157 to have a material impact on its financial statements.
In June 2006, the FASB issued EITF 06-2. A sabbatical leave is a benefit provided to employees whereby the employee is entitled to time off with pay, over and above routine vacation time, after working for a specified period of time. The Company offers an additional twenty days of sabbatical leave to U.S.-based employees upon completion of eight years of service. EITF 06-2 concluded that an employees right to a compensated absence under a sabbatical or similar benefit arrangement does accumulate pursuant to FASB Statement No. 43, Accounting for Compensated Absences and therefore, a liability should be accrued over the service period in which employees earn the right to sabbatical leave. EITF No. 06-2 requires companies to accrue the cost of such compensated absences over the requisite service period. The Task Force allows the use of one of two specified methodologies for adopting the change in accounting principle: i) a cumulative-effect adjustment to retained earnings at the beginning of the year of adoption; or ii) retrospective application to all prior periods. The Company will adopt EITF 06-2 in the first quarter of fiscal 2008 in its restated Form 10-Q/A for the period ended April 30, 2007 to be filed subsequent to filing the Form 10-K/A. The Company recorded an adjustment to the beginning balance of retained earnings resulting in an additional liability of $769,000 and a corresponding increase in the accumulated deficit of $769,000 as of February 1, 2007 as allowed by the transition provision. The impact of this adoption does not include any net tax effects as the Companys deferred tax assets are fully reserved against due to the uncertainties related to the Companys ability to generate sufficient pre-tax income for fiscal 2008 and the inability to carry back fiscal 2008 tax losses to prior years because the Company exhausted its US tax benefit carry back potential in fiscal 2007 (see Note 10).
In September 2006, the SEC released SAB 108. SAB 108 was issued in order to eliminate the diversity of practice surrounding how public companies quantify financial statement misstatements. Traditionally, there have been two widely-recognized methods for quantifying the effects of financial statement misstatements: the roll-over method and the iron curtain method. The roll-over method focuses primarily on the impact of a misstatement on the income statement, including the reversing effect of prior year misstatements, but its use can lead to the accumulation of misstatements in the balance sheet. The iron curtain method focuses primarily on the effect of correcting the period-end balance sheet with less emphasis on the reversing effects of prior year errors on the income statement. The Company previously used the roll-over method for quantifying identified financial statement misstatements.
In SAB 108, the SEC staff established an approach that requires quantification of financial statement misstatements based on the effect of the misstatements on each of the Companys financial statements and the related financial statement disclosures. This model is commonly referred to as a dual approach because it requires quantification of errors under both the iron curtain and the roll-over methods.
SAB 108 permits public companies to initially apply its provisions either by (i) restating prior financial statements as if the dual approach had always been used or (ii) recording the cumulative effect of initially applying the dual approach as adjustments to the carrying values of assets and liabilities as of the beginning of the year of adoption, February 1, 2006 for the Company, with an offsetting adjustment recorded to the opening balance of retained earnings. Due to the discovery of an error after the adoption of SAB 108, the Company is required to restate prior year financial statements using retrospective application of SAB 108, which is reflected in this Form 10-K/A.
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The Company identified three errors, quantified them under the dual approach method and concluded that the correction of these errors through the Consolidated Statement of Operations would be material to the fiscal year ended January 31, 2007 in the aggregate. Accordingly the Company has determined to restate the consolidated financial statements for the fiscal years ended January 31, 2007, 2006 and 2005, even though the errors are not material to the Consolidated Balance Sheet, Consolidated Statement of Operations, Consolidated Statement of Cash Flows, or Consolidated Statement of Stockholders Equity and Comprehensive Income (Loss) for the fiscal years ended January 31, 2006 and 2005. The Company recorded a decrease to accumulated deficit of $31,000 as of February 1, 2004 to restate its Consolidated Balance Sheet and Consolidated Statement of Stockholders Equity and Comprehensive Income (Loss) as of and for the fiscal year ended January 31, 2005. The Company also recorded an increase to net loss of $63,000, a reduction to net loss of $118,000 and a reduction to net income of $72,000 to restate its Consolidated Balance Sheet, Consolidated Statement of Operations, Consolidated Statement of Stockholders Equity and Comprehensive Income (Loss) and Consolidated Statement of Cash Flows for the fiscal years ended January 31, 2007, 2006 and 2005, respectively.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. We are currently evaluating the impact of adopting SFAS 159 on our financial statements.
ITEM 7A. | Quantitative and Qualitative Disclosures about Market Risk |
We face exposure to financial market risks, including adverse movements in foreign currency exchange rates and changes in interest rates. These exposures may change over time as business practices evolve and could have a material adverse impact on our financial results. Our primary exposure has historically been associated with product sales arrangements denominated in the local currency where the functional currency of the foreign subsidiary is the U.S. dollar (as most of our revenues are in U.S. dollars) and operating expenses in Europe and Asia. In light of the higher proportion of our international businesses due, in part, to the recent acquisitions of European-based business from Liberate Technologies and ODG, we expect the risk of any adverse movements in foreign currency exchange rates to have a greater impact on our operating results in the future. Historically, we have not hedged specific currency exposures as gains and losses on foreign currency transactions have not been material to date. At January 31, 2006 and January 31, 2007, we had $0 outstanding related to variable rate U.S. dollar denominated debt. As there were no amounts outstanding at January 31, 2006 and 2007 related to variable rate debt, there was no interest rate exposure.
The carrying amounts reflected in the consolidated balance sheet of cash and cash equivalents, short-term marketable securities, trade receivables and trade payables approximate fair value at January 31, 2007 due to the short maturities of these instruments. We maintain investment portfolio holdings of various issuers, types, and maturities. Our cash and marketable securities include cash equivalents, which we consider to be investments purchased with original maturities of three months or less. Given the short maturities and investment grade quality of the portfolio holdings at January 31, 2007, a sharp rise in interest rates should not have a material adverse impact on the fair value of our investment portfolio. Additionally, our long term marketable investments, which are carried at the lower of cost or market, have fixed interest rates, and therefore are not subject to any interest rate exposure. As a result, we do not currently hedge these market risk exposures. At January 31, 2007, we had $11.2 million in short-term marketable securities and $12.9 million in long-term marketable securities.
ITEM 8. | Financial Statements and Supplementary Data |
The Companys Financial Statements and Schedules, together with the independent registered public accounting firm reports thereon, appear at pages 55 through 90 of this Form 10-K/A. The supplementary financial information required by Item 302 of Regulation S-K is included in this Annual Report under Item 7.
ITEM 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
On October 12, 2006, PricewaterhouseCoopers LLP was dismissed as the independent registered public accounting firm of the Company. The dismissal of PricewaterhouseCoopers LLP was approved by the Companys Audit Committee.
The reports of PricewaterhouseCoopers LLP on the Companys financial statements as of and for the fiscal years ended January 31, 2005 and 2006 did not contain an adverse opinion or a disclaimer of opinion, and were not qualified or modified as to uncertainty, audit scope or accounting principle.
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During the Companys fiscal years ended January 31, 2005 and 2006 and through October 12, 2006 there were no disagreements with PricewaterhouseCoopers LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which, if not resolved to the satisfaction of PricewaterhouseCoopers LLP, would have caused them to make reference to the subject matter of the disagreement in connection with their reports on the financial statements for such years. During the Companys fiscal years ended January 31, 2005 and 2006 and through October 12, 2006 there were no reportable events as defined in Item 304(a)(1)(v) of Regulation S-K.
Effective as of October 17, 2006, the Companys Audit Committee engaged Grant Thornton LLP as its new independent registered public accounting firm to audit the Companys financial statements for the Companys fiscal year ending January 31, 2007. The decision to engage Grant Thornton LLP as the Companys independent registered public accounting firm was the result of a competitive selection process.
Prior to the engagement of Grant Thornton LLP, neither the Company nor anyone on behalf of the Company consulted with Grant Thornton LLP during the Companys fiscal years ended January 31, 2005 and 2006 and through October 17, 2006, in any manner regarding: (A) either the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that might be rendered on the Companys financial statements, and neither was a written report provided to the Company nor was oral advice provided that Grant Thornton LLP concluded was an important factor considered by the Company in reaching a decision as to the accounting, auditing, or financial reporting issue, or (B) the subject of either a disagreement or a reportable event, as defined in Item 304(a)(1)(iv) and (v), respectively, of Regulation S-K.
ITEM 9A. | Controls and Procedures |
(A) Evaluation of Disclosure Controls and Procedures (Restated)
The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Companys filings with the SEC is recorded, processed, summarized and reported within the time period specified in the SECs rules and forms, and that such information is accumulated and communicated to management, including the Companys Chief Executive Officer (CEO) and Chief Financial Officer (CFO), as appropriate, to allow timely decisions regarding required disclosure based on the definition of disclosure controls and procedures as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act). In designing and evaluating disclosure controls and procedures, the Company has recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply judgment in evaluating the cost-benefit relationship of possible controls and procedures.
In connection with the restatement of its financial statements related to accounting for the Companys sabbatical benefit, the Company reevaluated its disclosure controls and procedures. The evaluation was performed under the supervision and with the participation of Company management, including William C. Styslinger, III our Chief Executive Officer (CEO), and Kevin M. Bisson, our Chief Financial Officer (CFO), to assess the effectiveness of the design and operation of its disclosure controls and procedures (as defined under the Exchange Act). Based on that evaluation, the Companys management, including its CEO and CFO, concluded that the Companys disclosure controls and procedures were not effective as of January 31, 2007 because of a material weakness in its internal controls over financial reporting.
(B) Report of Management on Internal Control over Financial Reporting (Restated)
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control system was designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Our internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors, and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
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Our management assessed the effectiveness of our internal control over financial reporting as of January 31, 2007 and determined that our internal controls over financial reporting were not effective. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal ControlIntegrated Framework.
After the Company filed its Original Form 10-K for the year ended January 31, 2007, the Company identified an error in the Companys previously issued consolidated financial statements and concluded that the financial statements included in the Original Form 10-K should be restated, as discussed in Note 1 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K/A.
The Company determined that this error resulted from a material weakness in the operating effectiveness of the Companys internal controls over financial reporting relative to its accounting for its sabbatical benefit. As a result, the Company has restated its original assessment of the effectiveness of internal controls over financial reporting relative to its accounting for its sabbatical benefit in this Annual Report on Form 10-K/A. The Company did not have the appropriate procedures and documentation in place to properly evaluate its liability to its employees under the sabbatical benefit. As a result, the Company did not record an accrual for the vested and unused sabbatical benefit as required by SFAS 43.
The certifications of our principal executive officer and principal financial officer required in accordance with Rule 13a-14(a) under the Exchange Act are attached as exhibits to this Annual Report on Form 10-K/A. The disclosures set forth in this Item 9A contain information concerning the evaluation of our disclosure controls and procedures, and changes in our internal control over financial reporting, referred to in paragraph 4 of those certifications. Those certifications should be read in conjunction with this Item 9A for a more complete understanding of the matters covered by the certifications.
Our managements assessment of the effectiveness of the Companys internal control over financial reporting as of January 31, 2007 has been audited by Grant Thornton LLP, an independent registered public accounting firm, as stated in their report which appears herein on Form 10-K/A.
(C) Changes in Internal Control over Financial Reporting (Restated)
For the fiscal year ended January 31, 2007, the Company did not make any material changes to internal controls over financial reporting.
Remediation of Material Weakness
The Company expects to implement additional changes to its infrastructure and related processes that it believes will strengthen its internal control over financial reporting. These include:
| Increased review and timely identification of new accounting pronouncements; |
| Ongoing implementation of control enhancements to improve the timeliness and accuracy of transaction reporting for employee benefits. |
The Company expects to test the effectiveness of the changes described above during fiscal 2008, and will design and implement additional changes to remediate the material weakness which existed as of January 31, 2007.
The Company is currently implementing enhanced controls intended to address the material weakness in its internal control over financial reporting and to remedy the ineffectiveness of its disclosure controls and procedures. The changes in the Companys internal control over financial reporting are expected to remediate the material weakness and certain of these remedial measures will require some time to be fully implemented or to take full effect. While this implementation phase is underway, we are continuing to rely on extensive manual procedures.
The Company is designing its internal controls over financial reporting to provide reasonable assurances of achieving these objectives. For the reasons described above, the Company has concluded that its internal controls over financial reporting did not provide such reasonable assurances as of January 31, 2007. The Company also believes that a control system addressing internal control over financial reporting, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must include an assessment of the costs and related risks associated with the control and the purpose for which it was intended. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues including instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and breakdowns can occur because of simple errors or mistakes. Additionally, controls can be circumvented by the individual acts of some person, by collusion of two or more people, or by management override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its
44
stated goals under all potential future conditions. Over time, the Companys internal control systems, as it develops them, may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected and could be material and require a restatement of our financial statements. There were no changes during the fiscal year ended January 31, 2007 in the Companys internal controls over financial reporting which have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
(D) Audit Report of the Registered Public Accounting Firm
45
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and
Stockholders of SeaChange International, Inc.
We have audited managements assessment, included in ITEM 9A. Controls and Procedures- Report of Management on Internal Control Over Financial Reporting (Restated), that SeaChange International, Inc. and subsidiaries (a Delaware Corporation) (collectively the Company) did not maintain effective internal control over financial reporting as of January 31, 2007, because of the effect of the material weakness identified in managements assessment based on the criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on managements assessment and an opinion on the effectiveness of the Companys internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating managements assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A companys internal control over financial reporting is a process designed by, or under the supervision of, the companys principal executive and principal financial officers, or persons performing similar functions, and effected by the companys board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
A material weakness is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weakness has been identified and included in managements assessment. As of January 31, 2007, the Company did not maintain effective controls related to its sabbatical benefit. The Company did not have the appropriate procedures and documentation in place to properly evaluate its liability to its employees under the sabbatical benefit. As a result, the Company did not record an accrual for the vested and unused sabbatical as required by Statement of Financial Accounting Standards (SFAS) No. 43, Accounting for Compensated Absences.
This material weakness resulted in a material error and the related restatement of the consolidated financial statements of the Company as of and for the year ended January 31, 2007. This material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the consolidated financial statements as of and for the year ended January 31, 2007, of the Company and this report does not affect our report dated April 13, 2007 (except for Notes 1 and 11 and Schedule II, as to which the date is October 19, 2007), which expressed an unqualified opinion on those financial statements.
In our opinion, managements assessment that the Company did not maintain effective internal control over financial reporting as of January 31, 2007, is fairly stated, in all material respects, based on the criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also in our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of January 31, 2007, based on the criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
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We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of SeaChange International, Inc. and subsidiaries as of January 31, 2007 and the related consolidated statements of operations, changes in stockholders equity and comprehensive income (loss), and cash flows for the year ended January 31, 2007 and our report dated April 13, 2007, except for Notes 1 and 11 and Schedule II, as to which the date is October 19, 2007, expressed an unqualified opinion on those financial,
/s/ GRANT THORNTON LLP |
Boston Massachusetts |
April 13, 2007 (except for the effects of the restatement as discussed in Notes 1 and 11 and Schedule II, as to which the date is October 19, 2007) |
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ITEM 9B. | Other Information |
None.
PART III
ITEM 10. | Directors, Executive Officers and Corporate Governance of the Registrant |
Information concerning the directors of SeaChange is hereby incorporated by reference from the information contained under the heading Election of Directors in SeaChanges definitive proxy statement related to SeaChanges Annual Meeting of Stockholders to be held on or about July 18, 2007 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 SeaChange is hereby incorporated by reference to the information contained under the headings Occupations of Directors and Executive Officers, and Section 16(a) Beneficial Ownership Reporting Compliance, Availability of Corporate Governance Documents and Audit Committee in our Definitive Proxy Statement.
ITEM 11. | Executive Compensation |
Information concerning executive compensation is hereby incorporated by reference to the information contained under the headings Compensation and Other Information Concerning Directors and Officers, Compensation of Directors, Compensation and Option Committee Report, Compensation Committee Interlocks and Insider Participation and Options and Stock Plans in the Definitive Proxy Statement.
ITEM 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
Information concerning security ownership of certain beneficial owners and management is hereby incorporated by reference to the information contained under the headings Securities Ownership of Certain Beneficial Owners and Management and Equity Compensation Plan Information in the Definitive Proxy Statement.
ITEM 13. | Certain Relationships and Related Transactions, and Director Independence |
Information concerning certain relationships and related transactions is hereby incorporated by reference to the information contained under the heading Certain Relationships and Related Transactions and Determination of Director Independence in the Definitive Proxy Statement.
ITEM 14. | Principal Accountant Fees and Services |
Information concerning Principal accountant fees and services is hereby incorporated by reference to the information contained under the heading Ratification of Appointment of Independent Registered Public Accounting Firm in the Definitive Proxy Statement.
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PART IV
ITEM 15. | Exhibits and Financial Statement Schedules. |
(a)(1) INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS
The following Consolidated Financial Statements of the Registrant are filed as part of this Annual Report on Form 10-K/A:
Page | ||
54-55 | ||
Consolidated Balance Sheet as of January 31, 2007 (Restated) and 2006 (Restated) |
56 | |
57 | ||
58 | ||
59 | ||
60 |
(a)(2) INDEX TO FINANCIAL STATEMENT SCHEDULE
The following Financial Statement Schedule of the Registrant is filed as part of this report:
Page | ||
Schedule II - Valuation and Qualifying Accounts and Reserves (Restated) |
94 |
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/A.
(b) EXHIBITS
The Company hereby files as part of this Form 10-K/A the Exhibits listed in Item 15 (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, Room 1024, N.W., Washington, D.C. 20549. 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.
(c) FINANCIAL STATEMENT SCHEDULES
The Company hereby files as part of this Form 10-K/A the consolidated financial statements schedule listed in Item 15 (a) (2) above, which is attached hereto.
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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: October 19, 2007
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 Kevin M. Bisson, 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/A 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 William C. Styslinger, III |
President, Chief Executive Officer, Chairman of the Board and Director (Principal Executive Officer) |
October 19, 2007 | ||
/s/ KEVIN M. BISSON Kevin M. Bisson |
Chief Financial Officer, Senior Vice President, Finance and Administration, Treasurer and Secretary (Principal Financial and Accounting Officer) |
October 19, 2007 | ||
/s/ MARTIN R. HOFFMANN Martin R. Hoffmann |
Director | October 19, 2007 | ||
/s/ CARMINE VONA Carmine Vona |
Director | October 19, 2007 | ||
/s/ THOMAS F. OLSON Thomas F. Olson |
Director | October 19, 2007 | ||
/s/ MARY PALERMO COTTON Mary Palermo Cotton |
Director | October 19, 2007 |
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EXHIBIT INDEX
Exhibit No. | Description | |
2.1 | Agreement for the Purchase and Sale of Share Capital of The ON Demand Group Limited, dated as of September 23, 2005, by and among the Company, Anthony Kelly, Andrew Birchall and the other parties set forth on the signature pages thereto (filed as Exhibit 2.1 to the Companys Current Report on Form 8-K previously filed September 29, 2005 with the Commission (File No. 000-21393) and incorporated herein by reference). | |
2.2 | Variation Agreement, dated as of June 30, 2006, by and among the Company, Anthony Kelly, Andrew Birchall and the others set forth on the signature pages thereto, to that certain Agreement for the Sale and Purchase of Share Capital of On Demand Group Limited (filed as Exhibit 2.1 to the Companys Current Report on Form 8-K previously filed July 6, 2006 with the Commission (File No. 000-21393) and incorporated herein by reference). | |
3.1 | Amended and Restated Certificate of Incorporation of the Company (filed as Exhibit 3.3 to the Companys Registration Statement on Form S-1 previously filed on November 4, 1996 with the Commission (File No. 333-12233) and incorporated herein by reference). | |
3.2 | Certificate of Amendment, filed May 25, 2000 with the Secretary of State in the State of Delaware, to the Amended and Restated Certificate of Incorporation of the Company (filed as Exhibit 4.1 to the Companys Quarterly Report on 10-Q previously filed on December 15, 2000 with the Commission (Filed No. 000-21393) and incorporated herein by reference). | |
3.3 | Amended and Restated By-laws of the Company (filed as Exhibit 3.5 to the Companys Registration Statement on Form S-1 previously filed on November 4, 1996 with the Commission (File No. 333-12233) and incorporated herein by reference). | |
4.1 | Specimen certificate representing the Common Stock (filed as Exhibit 4.1 to the Companys Registration Statement on Form S-1 previously filed on November 4, 1996 with the Commission (File No. 333-12233) and incorporated herein by reference). | |
4.2 | Amended and Restated Certificate of Incorporation of the Company (filed as Exhibit 3.3 to the Companys Registration Statement on Form S-1 previously filed on November 4, 1996 with the Commission (File No. 333-12233) and incorporated herein by reference). | |
4.3 | Certificate of Amendment, filed May 25, 2000 with the Secretary of State in the State of Delaware, to the Amended and Restated Certificate of Incorporation of the Company (filed as Exhibit 4.2 to the Companys registration statement on Form S-3 previously filed on December 6, 2000 with the Commission (Filed No. 333-51386) and incorporated herein by reference). | |
10.1 | 2005 Equity Compensation and Incentive Plan (filed as Appendix A to the Companys Proxy Statement on Schedule 14A previously filed May 27, 2005 with the Commission (File No. 000-21393) and incorporated herein by reference). | |
10.2 | Form of Restricted Stock Unit Agreement pursuant to the Companys 2005 Equity Compensation and Incentive Plan (filed as Exhibit 10.1 to the Companys Current Report on Form 8-K previously filed December 14, 2005 with the Commission (File No. 000-21393) and incorporated herein by reference). | |
10.3 | Form of Incentive Stock Option Agreement pursuant to the Companys 2005 Equity Compensation and Incentive Plan (filed as Exhibit 10.3 to the Companys Annual Report on Form 10-K previously filed on April 17, 2006 with the Commission (File No. 000-21393) and incorporated herein by reference). | |
10.4 | Form of Non-Qualified Stock Option Agreement pursuant to the Companys 2005 Equity Compensation and Incentive Plan (filed as Exhibit 10.4 to the Companys Annual Report on Form 10-K previously filed on April 17, 2006 with the Commission (File No. 000-21393) and incorporated herein by reference). | |
10.5 | Amended and Restated 1995 Stock Option Plan (filed as Annex B to the Companys Proxy Statement on Form 14a previously filed on May 31, 2001 with the Commission (File No. 000-21393) and incorporated herein by reference). | |
10.6 | Form of Incentive Stock Option Agreement pursuant to SeaChanges Amended and Restated 1995 Stock Option Plan (filed as Exhibit 99.1 to the Companys Current Report on Form 8-K filed on October 6, 2004 with the Commission (File No. 000-21393) and incorporated herein by reference). | |
10.7 | Form of Non-Qualified Stock Option Agreement pursuant to SeaChanges Amended and Restated 1995 Stock Option Plan (filed as Exhibit 99.2 to the Companys Current Report on Form 8-K filed on October 6, 2004 with the Commission (File No. 000-21393) and incorporated herein by reference). | |
10.8 | Form of Lockup Agreement (filed as Exhibit 10.1 to the Companys Current Report on Form 8-K previously filed February 1, 2006 with the Commission (File No. 000-21393) and incorporated herein by reference). | |
10.9 | 1996 Non-Employee Director Stock Option Plan (filed as Exhibit 10.2 to the Companys Registration Statement on Form S-1 previously filed on November 4, 1996 with the Commission (File No. 333-12233) and incorporated herein by reference). |
51
Exhibit No. | Description | |
10.10 | Third Amended and Restated 1996 Employee Stock Purchase Plan of the Company (filed as Appendix A to the Companys Definitive Proxy Statement filed on Schedule 14A previously filed on May 24, 2006 with the Commission (File No. 000-21393) and incorporated herein by reference). | |
10.11 | Loan and Security Agreement, dated as of October 22, 2001, by and between Citizens Bank of Massachusetts and the Company (filed as Exhibit 10.1 to the Companys Quarterly Report on Form 10-Q previously filed on December 13, 2001 with the Commission (File No. 000-21393) and incorporated herein by reference). | |
10.12 | Amendment No. 1, dated as of June 14, 2002, by and between the Company and Citizens Bank of Massachusetts, to that certain Loan and Security Agreement, dated as of October 22, 2001, by and between the Company and Citizens Bank of Massachusetts (filed as Exhibit 10.1 to the Companys Quarterly Report on Form 10-Q previously filed on September 13, 2002 with the Commission (File No. 000-21393) and incorporated herein by reference). | |
10.13 | Amendment No. 2, dated as of April 21, 2003, between the Company and Citizens Bank of Massachusetts, to that certain Loan and Security Agreement, dated as of October 22, 2001 by and between the Company and Citizens Bank of Massachusetts (filed as Exhibit 10.7 to the Companys Annual Report on Form 10-K previously filed on May 1, 2003 with the Commission (File No. 000-21393) and incorporated herein by reference). | |
10.14 | Amendment No. 3, dated as of December 1, 2003, between the Company and Citizens Bank of Massachusetts, to that certain Loan and Security Agreement, dated as of October 22, 2001 by and between the Company and Citizens Bank of Massachusetts (filed as Exhibit 10.1 to the Companys Quarterly Report on Form 10-Q filed on December 15, 2003 with the Commission (File No. 000-21393) and incorporated herein by reference). | |
10.15 | Amendment No. 8, dated as of April 14, 2006, between the Company and Citizens Bank of Massachusetts, to that certain Loan and Security Agreement, dated as of October 22, 2001, by and between the Company and Citizens Bank of Massachusetts (filed as Exhibit 10.15 to the Companys Annual Report on Form 10-K previously filed on April 17, 2006 with the Commission (File No. 000-21393) and incorporated herein by reference). | |
10.16 | License Agreement dated May 30, 1996 between Summit Software Systems, Inc. and the Company (filed as Exhibit 10.7 to the Companys Registration Statement on Form S-1 previously filed on November 4, 1996 with the Commission (File No. 333-12233) and incorporated herein by reference). | |
10.17 | Lease Agreement dated May 28, 1998 between Robert Quirk, Trustee of Maynard Industrial Properties Associates Trust and the Company (filed as Exhibit 10.3 to the Companys Annual Report on Form 10-K previously filed on March 24, 1999 with the Commission (File No. 000-21393) and incorporated herein by reference). |
52
Exhibit No. | Description | |
10.18 | Change-in-Control Severance Agreement, dated as of July 30, 2004, by and between the Company and William L. Fiedler (filed as Exhibit 10.1 to the Companys Quarterly Report on Form 10-Q filed on September 9, 2004 with the Commission (File No. 000-21393) and incorporated herein by reference). | |
10.19 | Change-in-Control Severance Agreement, dated as of July 30, 2004, by and between the Company and Ira Goldfarb (filed as Exhibit 10.2 to the Companys Quarterly Report on Form 10-Q filed on September 9, 2004 with the Commission (File No. 000-21393) and incorporated herein by reference). | |
10.20 | Change-in-Control Severance Agreement, dated as of July 30, 2004, by and between the Company and Bruce Mann (filed as Exhibit 10.3 to the Companys Quarterly Report on Form 10-Q filed on September 9, 2004 with the Commission (File No. 000-21393) and incorporated herein by reference). | |
10.21 | Change-in-Control Severance Agreement, dated as of July 30, 2004, by and between the Company and William C. Styslinger, III (filed as Exhibit 10.4 to the Companys Quarterly Report on Form 10-Q filed on September 9, 2004 with the Commission (File No. 000-21393) and incorporated herein by reference). | |
10.22 | Change-in-Control Severance Agreement, dated as of March 13, 2006, by and between the Company and Kevin Bisson (filed as Exhibit 10.1 to the Companys Current Report on Form 8-K previously filed March 9, 2006 with the Commission (File No. 000-21393) and incorporated herein by reference). | |
10.23 | Change-In-Control Agreement, dated as of May 31, 2006, by and between the Company and Randy Banton (filed as Exhibit 10.1 to the Companys Current Report on Form 8-K previously filed June 19, 2006 with the Commission (File No. 000-21393) and incorporated herein by reference). | |
10.24 | Change-in-Control Severance Agreement, dated as of December 11, 2006, by and between SeaChange and Yvette Kanouff (filed as Exhibit 10.1 to the Companys Current Report on Form 8-K previously filed December 14, 2006 with the Commission (File No. 000-21393) and incorporated herein by reference). | |
10.25 | Change-in-Control Severance Agreement, dated as of December 11, 2006, by and between SeaChange and Steven M. Davi (filed as Exhibit 10.2 to the Companys Current Report on Form 8-K previously filed December 14, 2006 with the Commission (File No. 000-21393) and incorporated herein by reference). | |
10.26 | Management Transition Agreement, dated as of January 30, 2006, by and between the Company and William L. Fiedler (filed as Exhibit 10.2 to the Companys Current Report on Form 8-K previously filed February 1, 2006 with the Commission (File No. 000-21393) and incorporated herein by reference). | |
10.27 | Executive Services Agreement, dated as of September 23, 2005, by and between On Demand Management Limited and Andrew Birchall (filed as Exhibit 10.1 to the Companys Current Report on Form 8-K previously filed September 29, 2005 with the Commission (File No. 000-21393) and incorporated herein by reference). | |
10.28 | Executive Services Agreement, dated as of September 23, 2005, by and between On Demand Management Limited and Anthony Kelly (filed as Exhibit 10.2 to the Companys Current Report on Form 8-K previously filed September 29, 2005 with the Commission (File No. 000-21393) and incorporated herein by reference). | |
21.1* | List of Significant Subsidiaries. | |
23.1* | Consent of Grant Thornton LLP. | |
23.2* | Consent of PricewaterhouseCoopers LLP. | |
24.1 | Power of Attorney (included on signature page). | |
31.1* | Certification Pursuant to Rule 13a-14(a) of the Exchange Act, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2* | Certification Pursuant to Rule 13a-14(a) of the Exchange Act, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1* | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
32.2* | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
* | Provided herewith. |
53
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and
Stockholders of SeaChange International, Inc.
We have audited the accompanying consolidated balance sheet of SeaChange International, Inc. and subsidiaries (a Delaware corporation) (collectively the Company) as of January 31, 2007, and the related consolidated statements of operations, stockholders equity and comprehensive income (loss), and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of SeaChange International, Inc. and subsidiaries as of January 31, 2007, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.
Our audit was conducted for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. Schedule II is presented for purposes of additional analysis and is not a required part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic consolidated financial statements taken as a whole.
As discussed in Notes 1 and 11 to the consolidated financial statements, the Companys consolidated financial statements as of and for the year ended January 31, 2007 have been restated.
As discussed in Note 5 to the consolidated financial statements, the Company changed its method of accounting for stock-based payments as of February 1, 2006.
As discussed in Notes 1 and 11 to the consolidated financial statements, the Company adopted SEC Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Qualifying Misstatements in Current Year Financial Statements.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Companys internal control over financial reporting as of January 31, 2007, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated April 13, 2007, except for Notes 1 and 11 and Schedule II, as to which the date is October 19, 2007, expressed an unqualified opinion on managements assessment of the effectiveness of the Companys internal control over financial reporting and an adverse opinion on the effectiveness of the Companys internal control over financial reporting because of the existence of a material weakness.
/s/ GRANT THORNTON LLP |
Boston, Massachusetts |
April 13, 2007 (except for the effects of the restatement as discussed in Notes 1 and 11 and Schedule II, as to which the date is October 19, 2007) |
54
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of SeaChange International, Inc.: In our opinion, the consolidated balance sheet as of January 31, 2006 and the related consolidated statements of operations, of stockholders equity and of cash flows for each of two years in the period ended January 31, 2006 present fairly, in all material respects, the financial position of SeaChange International, Inc. and its subsidiaries at January 31, 2006, and the results of their operations and their cash flows for each of the two years in the period ended January 31, 2006, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule for each of the two years in the period ended January 31, 2006 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 1 to the consolidated financial statements, the Company has restated its consolidated financial statements for the fiscal years ended January 31, 2007, 2006 and 2005.
PricewaterhouseCoopers LLP
Boston, Massachusetts
April 17, 2006, except for Note 1, as to which the date is October 19, 2007
55
CONSOLIDATED BALANCE SHEET
(in thousands, except share and per share data)
January 31, 2007 Restated (1) |
January 31, 2006 Restated (1) |
|||||||
Assets |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 31,179 | $ | 21,594 | ||||
Restricted cash |
| 500 | ||||||
Marketable securities |
11,231 | 14,596 | ||||||
Accounts receivable, net of allowance for doubtful accounts of $466 at January 31, 2007 and $405 at January 31, 2006 |
28,854 | 30,109 | ||||||
Unbilled receivables |
5,562 | 4,363 | ||||||
Inventories, net |
19,350 | 19,922 | ||||||
Income taxes receivable |
409 | 2,781 | ||||||
Prepaid expenses and other current assets |
2,990 | 4,594 | ||||||
Total current assets |
99,575 | 98,459 | ||||||
Property and equipment, net |
30,720 | 27,191 | ||||||
Marketable securities |
12,885 | 24,689 | ||||||
Investments in affiliates |
14,312 | 12,812 | ||||||
Intangible assets, net |
13,054 | 18,904 | ||||||
Goodwill |
23,726 | 20,379 | ||||||
Other assets |
5,024 | 5,363 | ||||||
Total assets |
$ | 199,296 | $ | 207,797 | ||||
Liabilities and Stockholders Equity |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 10,003 | $ | 10,016 | ||||
Income taxes payable |
941 | 2,843 | ||||||
Accrued litigation reserve |
| 7,986 | ||||||
Other accrued expenses |
6,623 | 9,084 | ||||||
Customer deposits |
2,016 | 2,170 | ||||||
Deferred revenues |
21,806 | 20,045 | ||||||
Deferred tax liabilities |
366 | 556 | ||||||
Total current liabilities |
41,755 | 52,700 | ||||||
Deferred tax liabilities, long-term |
1,121 | 1,353 | ||||||
Total liabilities |
42,876 | 54,053 | ||||||
Commitments and contingencies (Note 12) |
||||||||
Stockholders equity: |
||||||||
Convertible preferred stock, $0.01 par value 5,000,000 shares authorized, none issued or outstanding |
| | ||||||
Common stock, $0.01 par value; 100,000,000 shares authorized; 29,345,103 and 28,451,930 shares issued and outstanding at January 31, 2007 and 2006, respectively |
293 | 285 | ||||||
Additional paid-in capital |
184,976 | 176,238 | ||||||
Accumulated deficit |
(30,424 | ) | (22,187 | ) | ||||
Accumulated other comprehensive income (loss) |
1,575 | (592 | ) | |||||
Total stockholders equity |
156,420 | 153,744 | ||||||
Total liabilities and stockholders equity |
$ | 199,296 | $ | 207,797 | ||||
(1) | Refer to Note 1 to the consolidated financial statements. |
The accompanying notes are an integral part of these consolidated financial statements.
56
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands, except per share data)
Fiscal Year ended January 31, | ||||||||||||
2007 Restated (1) |
2006 Restated (1) |
2005 Restated (1) |
||||||||||
Revenues: |
||||||||||||
Products |
$ | 95,000 | $ | 73,516 | $ | 113,764 | ||||||
Services |
66,334 | 52,748 | 43,539 | |||||||||
161,334 | 126,264 | 157,303 | ||||||||||
Costs of revenues: |
||||||||||||
Products |
48,334 | 45,555 | 60,158 | |||||||||
Services |
37,189 | 28,315 | 25,755 | |||||||||
85,523 | 73,870 | 85,913 | ||||||||||
Gross profit |
75,811 | 52,394 | 71,390 | |||||||||
Operating expenses: |
||||||||||||
Research and development |
40,917 | 34,475 | 29,536 | |||||||||
Selling and marketing |
22,383 | 18,681 | 18,069 | |||||||||
General and administrative |
19,193 | 14,254 | 10,330 | |||||||||
Amortization of intangible assets |
5,664 | 2,201 | 1,333 | |||||||||
88,157 | 69,611 | 59,268 | ||||||||||
(Loss) income from operations |
(12,346 | ) | (17,217 | ) | 12,122 | |||||||
Interest income |
1,451 | 2,068 | 1,004 | |||||||||
Interest expense |
(96 | ) | (30 | ) | (42 | ) | ||||||
Impairment on investment in affiliate |
(150 | ) | | | ||||||||
(Loss) income before income taxes and equity income (loss) in earnings of affiliate |
(11,141 | ) | (15,179 | ) | 13,084 | |||||||
Income tax benefit (expense) |
1,632 | 2,941 | (3,070 | ) | ||||||||
Equity income (loss) in earnings of affiliate, net of tax |
1,272 | 39 | (148 | ) | ||||||||
Net (loss) income |
$ | (8,237 | ) | $ | (12,199 | ) | $ | 9,866 | ||||
Earnings (loss) per share: |
||||||||||||
Basic |
$ | (0.29 | ) | $ | (0.43 | ) | $ | 0.36 | ||||
Diluted |
$ | (0.29 | ) | $ | (0.43 | ) | $ | 0.34 | ||||
Weighted average common shares outstanding: |
||||||||||||
Basic |
28,857 | 28,303 | 27,640 | |||||||||
Diluted |
28,857 | 28,303 | 29,053 | |||||||||
(1) | Refer to Note 1 to the consolidated financial statements. |
The accompanying notes are an integral part of these consolidated financial statements.
57
CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY AND COMPREHENSIVE INCOME (LOSS)
(in thousands, except share data)
Common Stock | |||||||||||||||||||||||||||||
Number of |
Par value |
Additional paid-in capital |
Accumulated Restated (1) |
Deferred stock-based compensation |
Accumulated Restated (1) |
Total (Restated (1) |
Comprehensive income (loss) |
||||||||||||||||||||||
Balance at January 31, 2004, as originally reported |
27,279,365 | $ | 273 | $ | 165,410 | $ | (19,393 | ) | $ | | $ | (403 | ) | $ | 145,887 | ||||||||||||||
Cumulative effect of restatement on prior periods (see Note 1) |
| | | 31 | | | 31 | ||||||||||||||||||||||
Balance at January 31, 2004, as Restated |
27,279,365 | $ | 273 | $ | 165,410 | $ | (19,362 | ) | $ | | $ | (403 | ) | $ | 145,918 | ||||||||||||||
Issuance of common stock pursuant to exercise of stock options |
562,528 | 6 | 4,529 | | | | 4,535 | ||||||||||||||||||||||
Issuance of common stock in connection with the employee stock purchase plan |
107,579 | 1 | 1,344 | | | | 1,345 | ||||||||||||||||||||||
Issuance of common stock in connection with Comcast stock warrant exercise |
225,474 | 2 | 3,143 | | | | 3,145 | ||||||||||||||||||||||
Tax benefit from stock options |
| | 29 | | | | 29 | ||||||||||||||||||||||
Change in unrealized gain on marketable securities, net of tax |
| | | | | 78 | 78 | $ | 78 | ||||||||||||||||||||
Translation adjustment |
| | | | | (82 | ) | (82 | ) | (82 | ) | ||||||||||||||||||
Net income |
| | | 9,866 | | | 9,866 | 9,866 | |||||||||||||||||||||
Comprehensive income |
$ | 9,862 | |||||||||||||||||||||||||||
Balance at January 31, 2005, as Restated |
28,174,946 | 282 | 174,455 | (9,496 | ) | | (407 | ) | 164,834 | ||||||||||||||||||||
Issuance of common stock pursuant to exercise of stock options |
73,012 | 1 | 364 | | | | 365 | ||||||||||||||||||||||
Issuance of common stock in connection with the employee stock purchase plan |
203,972 | 2 | 1,376 | | | | 1,378 | ||||||||||||||||||||||
Issuance of restricted stock units |
| | 818 | | (818 | ) | | | |||||||||||||||||||||
Amortization of unearned compensation on restricted stock units |
| | | | 43 | | 43 | ||||||||||||||||||||||
Adjustment for equity method loss incurred during lag period |
| | | (492 | ) | | | (492 | ) | ||||||||||||||||||||
Change in unrealized loss on marketable securities, net of tax |
| | | | | (101 | ) | (101 | ) | $ | (101 | ) | |||||||||||||||||
Translation adjustment |
| | | | | (84 | ) | (84 | ) | (84 | ) | ||||||||||||||||||
Net loss |
| | | (12,199 | ) | | | (12,199 | ) | (12,199 | ) | ||||||||||||||||||
Comprehensive loss |
$ | (12,384 | ) | ||||||||||||||||||||||||||
Balance at January 31, 2006, as Restated |
28,451,930 | $ | 285 | $ | 177,013 | $ | (22,187 | ) | $ | (775 | ) | $ | (592 | ) | $ | 153,744 | |||||||||||||
Issuance of common stock pursuant to exercise of stock options |
266,074 | 2 | 1,587 | | | | 1,589 | ||||||||||||||||||||||
Issuance of common stock in connection with the employee stock purchase plan |
250,082 | 2 | 1,354 | | | | 1,356 | ||||||||||||||||||||||
Issuance of common stock pursuant to vesting of restricted stock units |
35,657 | | | | | | | ||||||||||||||||||||||
Issuance of common stock pursuant to second earnout for ODG acquisition (Note 7) |
341,360 | 4 | 2,283 | | | | 2,287 | ||||||||||||||||||||||
Stock-based compensation expense |
| | 3,514 | | | | 3,514 | ||||||||||||||||||||||
Change in unrealized loss on marketable securities, net of tax |
| | | | | 254 | 254 | $ | 254 | ||||||||||||||||||||
Translation adjustment |
| | | | | 1,913 | 1,913 | 1,913 | |||||||||||||||||||||
Net loss |
| | | (8,237 | ) | | | (8,237 | ) | (8,237 | ) | ||||||||||||||||||
Reversal of unearned compensation upon adoption of SFAS 123R |
| | (775 | ) | | 775 | | | |||||||||||||||||||||
Comprehensive loss |
$ | (6,070 | ) | ||||||||||||||||||||||||||
Balance at January 31, 2007, as Restated |
29,345,103 | $ | 293 | $ | 184,976 | $ | (30,424 | ) | $ | | $ | 1,575 | $ | 156,420 | |||||||||||||||
(1) | Refer to Note 1 to the consolidated financial statements. |
The accompanying notes are an integral part of these consolidated financial statements.
58
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
Year ended January 31, | ||||||||||||
2007 Restated (1) |
2006 Restated (1) |
2005 Restated (1) |
||||||||||
Cash flows from operating activities: |
||||||||||||
Net (loss) income |
$ | (8,237 | ) | $ | (12,199 | ) | $ | 9,866 | ||||
Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities: |
||||||||||||
Depreciation |
7,799 | 6,642 | 5,917 | |||||||||
Amortization of intangibles and capitalized software |
6,655 | 2,498 | 1,333 | |||||||||
Inventory valuation charge |
1,057 | 988 | 842 | |||||||||
Allowance for doubtful accounts receivable |
403 | 100 | 200 | |||||||||
Amortization of premiums on marketable securities |
(1 | ) | 260 | 947 | ||||||||
Tax benefit from stock options |
| | 29 | |||||||||
Equity (income) loss in earnings of affiliates |
(1,273 | ) | (39 | ) | 148 | |||||||
Elimination of intercompany earnings in investments in affiliates |
148 | | | |||||||||
Stock-based compensation |
3,514 | 43 | | |||||||||
Loss on investment in affiliates |
150 | | | |||||||||
Deferred income taxes |
(493 | ) | (110 | ) | | |||||||
Changes in operating assets and liabilities: |
||||||||||||
Accounts receivable |
1,056 | (3,978 | ) | (8,449 | ) | |||||||
Unbilled receivables |
(1,199 | ) | (3,951 | ) | (210 | ) | ||||||
Inventories |
(4,652 | ) | (5,366 | ) | (3,569 | ) | ||||||
Income taxes receivable |
2,372 | 1,304 | (4,079 | ) | ||||||||
Prepaid expenses and other assets |
1,293 | (7,232 | ) | (1,491 | ) | |||||||
Accounts payable |
(67 | ) | (1,769 | ) | 8,312 | |||||||
Income taxes payable |
(1,950 | ) | (952 | ) | 1,239 | |||||||
Accrued litigation reserve |
(7,986 | ) | 305 | 77 | ||||||||
Accrued expenses |
243 | 3,105 | (705 | ) | ||||||||
Customer deposits |
(154 | ) | 2,005 | (236 | ) | |||||||
Deferred revenues |
1,623 | (1,680 | ) | 4,904 | ||||||||
Other |
187 | | | |||||||||
Net cash provided by (used in) operating activities |
488 | (20,026 | ) | 15,075 | ||||||||
Cash flows from investing activities: |
||||||||||||
Purchases of property and equipment |
(7,079 | ) | (13,424 | ) | (3,944 | ) | ||||||
Purchases of marketable securities |
(32,267 | ) | (24,786 | ) | (9,592 | ) | ||||||
Proceeds from sale and maturity of marketable securities |
47,692 | 25,488 | 8,918 | |||||||||
Acquisition of businesses and payment of contingent consideration, net of cash acquired |
(3,045 | ) | (31,260 | ) | (1,124 | ) | ||||||
Release (deposit) of restricted cash |
500 | 500 | (1,000 | ) | ||||||||
Investments in affiliates |
| (10,743 | ) | (1,000 | ) | |||||||
Repayment of (loan to) affiliate |
| 750 | (750 | ) | ||||||||
Net cash provided by (used in) investing activities |
5,801 | (53,475 | ) | (8,492 | ) | |||||||
Cash flows from financing activities: |
||||||||||||
Repayments of obligations under capital lease |
| (209 | ) | (399 | ) | |||||||
Proceeds from issuance of common stock, net of issuance costs |
2,947 | 1,743 | 5,880 | |||||||||
Net cash provided by financing activities |
2,947 | 1,534 | 5,481 | |||||||||
Effect of exchange rate changes on cash |
349 | | | |||||||||
Net increase (decrease) in cash and cash equivalents |
9,585 | (71,967 | ) | 12,064 | ||||||||
Cash and cash equivalents, beginning of period |
21,594 | 93,561 | 81,497 | |||||||||
Cash and cash equivalents, end of period |
$ | 31,179 | $ | 21,594 | $ | 93,561 | ||||||
Supplemental disclosure of cash flow information: |
||||||||||||
Income taxes paid |
$ | 1,846 | $ | 405 | $ | 6,551 | ||||||
Interest paid |
96 | 30 | 42 | |||||||||
Supplemental disclosure of non-cash activities: |
||||||||||||
Transfer of items originally classified as inventories to equipment |
4,167 | 4,237 | 3,196 | |||||||||
Transfer of items originally classified as equipment to inventories |
| 11 | 188 | |||||||||
Issuance of equity for ODG contingent consideration (Note 7) |
2,287 | | | |||||||||
Conversion of note receivable to equity related to investment in affiliate (Note 6) |
407 | | | |||||||||
Issuance of note payable for acquisition of business |
| | 1,000 | |||||||||
Issuance of common stock in connection with warrant exercise |
| | 3,145 |
(1) | Refer to Note 1 to the consolidated financial statements. |
The accompanying notes are an integral part of these consolidated financial statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. | Nature of Business |
SeaChange International, Inc. (SeaChange or the Company), headquartered in Acton, Massachusetts, is a leading developer, manufacturer and marketer of digital video systems and services including the management, aggregation, licensing, storage and distribution of video, television, gaming and advertising content to cable system operators, telecommunications companies and broadcast television companies. Through January 31, 2007, substantially all of SeaChanges revenues were derived from the sale of hardware, software and systems and related services and movie content to cable system operators, broadcast and telecommunications companies located in the United States of America and internationally.
Restatement of Previously Issued Financial Statements
Subsequent to the filing of the Companys Annual Report on Form 10-K for the year ended January 31, 2007, the Audit Committee of the Board of Directors of the Company, in consultation with Company management, concluded that due to an accounting error related to accounting for the Companys sabbatical benefit, certain of the Companys previously issued consolidated financial statements would need to be restated. The Company identified three errors, quantified them under the dual approach method and concluded that the correction of these errors through the Consolidated Statement of Operations would be material to the fiscal year ended January 31, 2007 in the aggregate. Accordingly the Company has determined to restate the consolidated financial statements for the fiscal years ended January 31, 2007, 2006 and 2005, even though the errors are not material to the Consolidated Balance Sheet, Consolidated Statement of Operations, Consolidated Statement of Cash Flows, or Consolidated Statement of Stockholders Equity and Comprehensive Income (Loss) for the fiscal years ended January 31, 2006 and 2005. A description of the 2007 restatement error and related impact on the Companys consolidated financial statements follows.
The Companys employee sabbatical benefit entitles U.S.-based employees who achieve eight years of service to twenty days of additional paid time off. The Company had recorded expenses for this employee benefit only when employees had actually taken the sabbatical or had left the Company. Based on the terms of the Companys program, the Company should have accrued for this liability under Statement of Financial Accounting Standards (SFAS) No. 43, Accounting for Compensated Absences, once an employee achieved the requisite period of service, regardless as to when the paid time off, if any, had been taken. The Company has determined that it will correct this error, along with two other errors that were previously corrected through a $753,000 cumulative change adjustment to decrease the accumulated deficit at February 1, 2006 in connection with the adoption of Staff Accounting Bulletin (SAB) 108, Considering the Effect of Prior Year Misstatements When Quantifying Misstatements in the Current Year (SAB 108) in the fiscal year ended January 31, 2007 (See Note 11), in the following manner:
| A decrease to accumulated deficit of $31,000 as of February 1, 2004 reflected as a cumulative effect adjustment through a restatement of the Companys Consolidated Balance Sheet and Consolidated Statement of Stockholders Equity and Comprehensive Income (Loss) as of and for the fiscal year ended January 31, 2005. The cumulative adjustment resulted from an increase to inventory of $323,000 to reflect labor and overhead costs that had, in the past, been treated as period costs and had not been capitalized as a component of inventory and an increase to accrued expenses of $292,000 to reflect the sabbatical liability which should have been accrued for in previous years. |
| An increase to net loss of $63,000, a reduction to net loss of $118,000 and a reduction to net income of $72,000 to be reflected through a restatement of its Consolidated Balance Sheet, Consolidated Statement of Operations, Consolidated Statement of Cash Flows and Consolidated Statement of Stockholders Equity and Comprehensive Income (Loss) for the fiscal years ended January 31, 2007, 2006 and 2005, respectively. The increase to net loss of $63,000 in 2007 resulted from an increase to accrued liabilities of $63,000 to reflect the sabbatical liability which should have been accrued for during the year. The reduction to net loss of $118,000 in 2006 resulted from an increase to inventory of $300,000 to reflect labor and overhead costs that had, in the past, been treated as period costs and had not been capitalized as a component of inventory and an increase to accrued expenses of $182,000 to reflect the sabbatical liability which should have been accrued for during the year. The reduction to net income of $72,000 in 2005 resulted from an increase to accrued expenses of $202,000 to reflect the sabbatical liability which should have been accrued for during the year and a decrease to accumulated other comprehensive income (loss) of $130,000 to reflect a realized gain which should have been recognized in fiscal 2005. |
| An increase to the basic and diluted loss per share of $.01 and a reduction to the basic and diluted loss per share of $.01 for the fiscal years ended January 31, 2007 and 2006, respectively, and no per share change in the fiscal year ended January 31, 2005. |
The impact of this restatement does not include any net tax effects as the Companys deferred tax assets are fully reserved against due to the uncertainties related to the Companys ability to generate sufficient pre-tax income for fiscal 2008 and the inability to carry back fiscal 2008 tax losses to prior years because the Company exhausted its US tax benefit carry back potential in fiscal 2007 (see Note 10).
60
As described above, the Company is required to retrospectively apply SAB 108 to its previously identified two errors and unwind the cumulative effect transition adjustment previously recorded in fiscal 2007. In the fiscal 2007 Original Form 10-K, the Company elected the prospective transition method of SAB 108, quantified the two errors under the roll-over method and concluded they were immaterial, individually and in the aggregate. Inventory was increased by $623,000 to reflect labor and overhead costs that had, in the past, been treated as period costs and had not been capitalized as a component of inventory. Accumulated other comprehensive income (loss) was decreased by $130,000 to reflect a realized gain which should have been recognized in fiscal 2005.
Impact of Restatements
The following summarizes the effects of the restatements on net (loss) income on each annual period and beginning retained earnings:
Fiscal Year ended January 31, | ||||||||||||
2007 | 2006 | 2005 | ||||||||||
Net (loss) income as previously reported |
$ | (8,174 | ) | $ | (12,317 | ) | $ | 9,938 | ||||
Pre tax restatement adjustments: |
||||||||||||
Sabbatical leave |
(63 | ) | (182 | ) | (202 | ) | ||||||
Capitalization of labor and overhead to inventory |
| 300 | | |||||||||
Other comprehensive income |
| | 130 | |||||||||
Net (loss) income, as restated |
$ | (8,237 | ) | $ | (12,199 | ) | $ | 9,866 | ||||
The table below sets forth the effect of the restatement adjustments on the applicable line items within the Companys Consolidated Balance Sheet for the year ended January 31, 2007:
|
| |||||||||||
As Previously Reported |
Restatement Adjustments |
As Restated | ||||||||||
Liabilities and Stockholders Equity |
||||||||||||
Current liabilities: |
||||||||||||
Other accrued expenses |
$ | 5,884 | $ | 739 | $ | 6,623 | ||||||
Total current liabilities |
41,016 | 739 | 41,755 | |||||||||
Total liabilities |
42,137 | 739 | 42,876 | |||||||||
Accumulated deficit |
(29,685 | ) | (739 | ) | (30,424 | ) | ||||||
Total stockholders equity |
$ | 157,159 | $ | (739 | ) | $ | 156,420 |
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The table below sets forth the effect of the restatement adjustments on the applicable line items within the Companys Consolidated Statement of Operations for the year ended January 31, 2007:
As Previously Reported |
Restatement Adjustments |
As Restated | ||||||||||
Costs of revenues: |
||||||||||||
Products |
$ | 48,316 | $ | 18 | $ | 48,334 | ||||||
Services |
37,169 | 20 | 37,189 | |||||||||
85,485 | 38 | 85,523 | ||||||||||
Gross profit |
75,849 | (38 | ) | 75,811 | ||||||||
Operating expenses: |
||||||||||||
Research and development |
40,914 | 3 | 40,917 | |||||||||
Selling and marketing |
22,413 | (30 | ) | 22,383 | ||||||||
General and administrative |
19,141 | 52 | 19,193 | |||||||||
Amortization of intangible assets |
5,664 | | 5,664 | |||||||||
88,132 | 25 | 88,157 | ||||||||||
Loss from operations |
(12,283 | ) | (63 | ) | (12,346 | ) | ||||||
Loss before income taxes and equity loss in earnings of affiliate |
(11,078 | ) | (63 | ) | (11,141 | ) | ||||||
Net loss |
$ | (8,174 | ) | $ | (63 | ) | $ | (8,237 | ) |
The table below sets forth the effect of the restatement adjustments on the applicable line items within the Companys Consolidated Statement of Cash Flows for the year ended January 31, 2007:
As Previously Reported |
Restatement Adjustment |
As Restated | ||||||||||
Cash flows from operating activities: |
||||||||||||
Net loss |
$ | (8,174 | ) | $ | (63 | ) | $ | (8,237 | ) | |||
Adjustments to reconcile net loss to net cash provided by operating activities: |
||||||||||||
Changes in operating assets and liabilities: |
||||||||||||
Accrued expenses |
180 | 63 | 243 | |||||||||
Net cash provided by operating activities |
$ | 488 | $ | | $ | 488 |
The table below sets forth the effect of the restatement adjustments on the applicable line items within the Companys Consolidated Balance Sheet for the year ended January 31, 2006:
As Previously Reported |
Restatement Adjustment |
As Restated | ||||||||||
Assets |
||||||||||||
Current assets: |
||||||||||||
Inventories, net |
$ | 19,299 | $ | 623 | $ | 19,922 | ||||||
Total current assets |
97,836 | 623 | 98,459 | |||||||||
Total assets |
$ | 207,174 | $ | 623 | $ | 207,797 | ||||||
Liabilities and Stockholders Equity |
||||||||||||
Current liabilities: |
||||||||||||
Other accrued expenses |
$ | 8,408 | $ | 676 | $ | 9,084 | ||||||
Total current liabilities |
52,024 | 676 | 52,700 | |||||||||
Total liabilities |
53,377 | 676 | 54,053 | |||||||||
Accumulated deficit |
(22,264 | ) | 77 | (22,187 | ) | |||||||
Accumulated other comprehensive income |
(462 | ) | (130 | ) | (592 | ) | ||||||
Total stockholders equity |
153,797 | (53 | ) | 153,744 | ||||||||
Total liabilities and stockholders equity |
$ | 207,174 | $ | 623 | $ | 207,797 |
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The table below sets forth the effect of the restatement adjustments on the applicable line items within the Companys Consolidated Statement of Operations for the year ended January 31, 2006:
As Previously Reported |
Restatement Adjustments |
As Restated | ||||||||||
Costs of revenues: |
||||||||||||
Products |
$ | 45,858 | $ | (303 | ) | $ | 45,555 | |||||
Services |
28,275 | 40 | 28,315 | |||||||||
74,133 | (263 | ) | 73,870 | |||||||||
Gross profit |
52,131 | 263 | 52,394 | |||||||||
Operating expenses: |
||||||||||||
Research and development |
34,378 | 97 | 34,475 | |||||||||
Selling and marketing |
18,646 | 35 | 18,681 | |||||||||
General and administrative |
14,241 | 13 | 14,254 | |||||||||
Amortization of intangible assets |
2,201 | | 2,201 | |||||||||
69,466 | 145 | 69,611 | ||||||||||
Loss from operations |
(17,335 | ) | 118 | (17,217 | ) | |||||||
Loss before income taxes and equity loss in earnings of affiliate |
(15,297 | ) | 118 | (15,179 | ) | |||||||
Net loss |
$ | (12,317 | ) | $ | 118 | $ | (12,199 | ) | ||||
The table below sets forth the effect of the restatement adjustments on the applicable line items within the Companys Consolidated Statement of Cash flows for the year ended January 31, 2006:
|
| |||||||||||
As Previously Reported |
Restatement Adjustment |
As Restated | ||||||||||
Cash flows from operating activities: |
||||||||||||
Net loss |
$ | (12,317 | ) | $ | 118 | $ | (12,199 | ) | ||||
Adjustments to reconcile net loss to net cash used in operating activities: |
||||||||||||
Changes in operating assets and liabilities: |
||||||||||||
Inventories |
(5,066 | ) | (300 | ) | (5,366 | ) | ||||||
Accrued expenses |
2,923 | 182 | 3,105 | |||||||||
Net cash used in operating activities |
$ | (20,026 | ) | $ | | $ | (20,026 | ) | ||||
The table below sets forth the effect of the restatement adjustments on the applicable line items within the Companys Consolidated Balance Sheet for the year ended January 31, 2005:
|
| |||||||||||
As Previously Reported |
Restatement Adjustment |
As Restated | ||||||||||
Accumulated deficit |
(9,455 | ) | (41 | ) | (9,496 | ) | ||||||
Accumulated other comprehensive loss |
(277 | ) | (130 | ) | (407 | ) | ||||||
Total stockholders equity |
$ | 165,005 | $ | (171 | ) | $ | 164,834 |
63
The table below sets forth the effect of the restatement adjustments on the applicable line items within the Companys Consolidated Statement of Operations for the year ended January 31, 2005:
As Previously Reported |
Restatement Adjustments |
As Restated | ||||||||||
Costs of revenues: |
||||||||||||
Products |
$ | 60,141 | $ | 17 | $ | 60,158 | ||||||
Services |
25,705 | 50 | 25,755 | |||||||||
85,846 | 67 | 85,913 | ||||||||||
Gross profit |
71,457 | (67 | ) | 71,390 | ||||||||
Operating expenses: |
||||||||||||
Research and development |
29,424 | 112 | 29,536 | |||||||||
Selling and marketing |
18,053 | 16 | 18,069 | |||||||||
General and administrative |
10,323 | 7 | 10,330 | |||||||||
Amortization of intangible assets |
1,333 | | 1,333 | |||||||||
59,133 | 135 | 59,268 | ||||||||||
Income from operations |
12,324 | (202 | ) | 12,122 | ||||||||
Income before income taxes and equity income in earnings of affiliate |
13,286 | (202 | ) | 13,084 | ||||||||
Income tax expense |
(3,200 | ) | 130 | (3,070 | ) | |||||||
Net income |
$ | 9,938 | $ | (72 | ) | $ | 9,866 |
The table below sets forth the effect of the restatement adjustments on the applicable line items within the Companys Consolidated Statement of Cash Flows for the year ended January 31, 2005:
As Previously Reported |
Restatement Adjustment |
As Restated | ||||||||||
Cash flows from operating activities: |
||||||||||||
Net income |
$ | 9,938 | $ | (72 | ) | $ | 9,866 | |||||
Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||||||
Changes in operating assets and liabilities: |
||||||||||||
Accrued expenses |
(907 | ) | 202 | (705 | ) | |||||||
Net cash provided by operating activities |
14,945 | 130 | 15,075 | |||||||||
Cash flows from investing activities: |
||||||||||||
Proceeds from sale and maturity of marketable securities |
9,048 | (130 | ) | 8,918 | ||||||||
Net cash used in investing activities |
$ | (8,362 | ) | $ | (130 | ) | $ | (8,492 | ) |
2. | Summary of Significant Accounting Policies |
Significant accounting policies followed in the preparation of the accompanying consolidated financial statements are as follows:
Principles of Consolidation
The Company consolidates the financial statements of its wholly owned subsidiaries and all inter-company accounts are eliminated in consolidation. SeaChange also holds minority investments in the capital stock of certain private companies having product offerings or customer relationships that have strategic importance. The Company evaluates its equity and debt investments and other contractual relationships with affiliate companies in order to determine whether the guidelines of FASB Interpretation (FIN) No. 46, Consolidation of Variable Interest Entities,, as revised under FIN 46R should be applied in the financial statements. FIN 46R addresses consolidation by business enterprises of variable interest entities that possess certain characteristics. A variable interest entity (VIE) is defined as an entity in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. The primary beneficiary is required to consolidate the financial position and results of the VIE. Since the adoption of FIN 46R in the
64
first quarter of fiscal 2005, the Company concluded that FIN 46R has not required the consolidation of any affiliate company. The Company has concluded that it is not the primary beneficiary for any variable interest entities during the fiscal year ended January 31, 2007.
The Companys investments in affiliates include investments accounted for under the cost method and the equity method of accounting. The investments that represent less than a 20% ownership interest of the common shares of the affiliate are carried at cost. Under the equity method of accounting, which generally applies to investments that represent 20% to 50% ownership of the common shares of the affiliate, SeaChanges proportionate ownership share of the earnings or losses of the affiliate are included in equity income (loss) in earnings of affiliates in the consolidated statement of operations.
Revenue Recognition and Allowance for Doubtful Accounts
Revenues from sales of hardware, software and systems that do not require significant modification or customization of the underlying software are recognized when title and risk of loss has passed to the customer, there is evidence of an arrangement, fees are fixed or determinable and collection of the related receivable is considered probable. Customers are billed for installation, training, project management and at least one year of product maintenance and technical support at the time of the product sale. Revenue from these activities are deferred at the time of the product sale and recognized ratably over the period these services are performed. Revenue from ongoing product maintenance and technical support agreements are recognized ratably over the period of the related agreements. Revenue from software development contracts that include significant modification or customization, including software product enhancements, is recognized based on the percentage of completion contract accounting method using labor efforts expended in relation to estimates of total labor efforts to complete the contract. For contracts, where some level of profit is assured but the Company is only able to estimate ranges of amounts of total contract revenue and total contract cost, SeaChange uses the lowest probable level of profits in accounting for the contract revenues and costs. Accounting for contract amendments and customer change orders are included in contract accounting when executed. Revenue from shipping and handling costs and other out-of-pocket expenses reimbursed by customers are included in revenues and cost of revenues. SeaChanges share of intercompany profits associated with sales and services provided to affiliated companies are eliminated in consolidation in proportion to our equity ownership.
SeaChanges transactions frequently involve the sales of hardware, software, systems and services in multiple element arrangements. Revenues under multiple element arrangements are recorded based on the residual method of accounting. Under this method, the total arrangement value is allocated first to undelivered elements, based on their fair values, with the remainder being allocated to the delivered elements. Where fair value of undelivered service elements has not been established, the total arrangement value is recognized over the period during which the services are performed. The amounts allocated to undelivered elements, which may include project management, training, installation, maintenance and technical support and certain hardware and software components, are based upon the price charged when these elements are sold separately and unaccompanied by the other elements. The amount allocated to installation, training and project management revenue is based upon standard hourly billing rates and the estimated time required to complete the service. These services are not essential to the functionality of systems as these services do not alter the equipments capabilities, are available from other vendors and the systems are standard products. For multiple element arrangements that include software development with significant modification or customization and systems sales where vendor-specific objective evidence of the fair value does not exist for the undelivered elements of the arrangement (other than maintenance and technical support), percentage of completion accounting is applied for revenue recognition purposes to the entire arrangement with the exception of maintenance and technical support. For transactions in which consideration, including equity instruments, is given to a customer, SeaChange accounts for the value of this consideration as an adjustment to revenue.
SeaChange recognizes revenue for product and services only in those situations where collection from the customer is probable. The Company performs ongoing credit evaluations of customers financial condition but generally does not require collateral. For some international customers, SeaChange requires an irrevocable letter of credit to be issued by the customer before the purchase order is accepted. The Company monitors payments from customers and assesses any collection issues. The Company maintains allowances for specific doubtful accounts and other risk categories of accounts based on estimates of losses resulting from the inability of the Companys customers to make required payments and records these allowances as a charge to general and administrative expenses. SeaChange bases its allowances for doubtful accounts on historical collections and write-off experience, current trends, credit assessments, and other analysis of specific customer situations.
Any taxes assessed by a governmental authority related to revenue-producing transactions (e.g. sales or value-added taxes) are reported on a net basis and excluded from revenues.
Concentration of Credit Risk
Financial instruments which potentially expose SeaChange to concentrations of credit risk include cash equivalents, investments in treasury bills, certificates of deposits and commercial paper, auction rate securities, trade accounts receivable, accounts payable
65
and accrued liabilities. The Company restricts its cash equivalents and investments in marketable securities to repurchase agreements with major banks and U.S. government and corporate securities which are subject to minimal credit and market risk. For trade accounts receivable, SeaChange evaluates customers financial condition, requires advance payments from certain of its customers and maintains reserves for potential credit losses. At January 31, 2007 and 2006, SeaChange had an allowance for doubtful accounts of $466,000 and $405,000, respectively, to provide for potential credit losses. Such losses have not exceeded managements expectations to date.
The following table summarizes revenues by significant customer where such revenue exceeded 10% of total revenues of the fiscal year. Revenues from significant customers were generated in the Broadband segment.
Year ended January 31, | |||||||||
2007 | 2006 | 2005 | |||||||
Customer A |
37 | % | 25 | % | 48 | % | |||
Customer B |
16 | % | | |
At January 31, 2007, one customer accounted for 42% of SeaChanges gross accounts receivable balance. At January 31, 2006, one customer accounted for 20%, a second customer accounted for 17% and a third customer accounted for 11% of SeaChanges gross accounts receivable balance.
Use of Estimates
The preparation of these financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities. On an ongoing basis, management evaluates these estimates and judgments, including those related to revenue recognition, valuation of inventory and accounts receivable, valuation of investments and income taxes, stock-based compensation, sabbatical leave, software development costs eligible for capitalization, goodwill, intangible assets and related amortization. The Company bases these estimates on historical and anticipated results and trends and on various other assumptions that the Company believes are reasonable under the circumstances, including assumptions as to future events. These estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. By their nature, estimates are subject to an inherent degree of uncertainty. Actual results may differ from managements estimates.
Cash Equivalents and Marketable Securities
SeaChanges investment portfolio consists of investments classified as cash equivalents, short-term marketable securities and long-term marketable securities. All highly liquid investments with an original maturity of three months or less when purchased are considered to be cash equivalents. All cash equivalents are carried at cost, which approximates fair value. SeaChanges marketable securities are classified as available for sale and are reported at fair value. Any unrealized gains or losses are included in stockholders equity as a component of accumulated other comprehensive loss. Any realized gains or losses would be shown in the accompanying consolidated statements of operations in other income or expense. The cost basis, aggregate fair value and unrealized gains and losses for SeaChanges cash equivalents, short- and long-term marketable securities portfolio is shown below (in thousands).
Cost | Fair Market Value |
Unrealized Gain (Loss) |
||||||||
January 31, 2007: |
||||||||||
Cash |
$ | 30,491 | $ | 30,491 | $ | | ||||
Cash equivalents |
688 | 688 | | |||||||
Cash and cash equivalents |
31,179 | 31,179 | | |||||||
US government agency issues |
10,210 | 10,212 | 2 | |||||||
Corporate debt securities |
18 | 18 | | |||||||
State and municipal obligations |
1,001 | 1,001 | | |||||||
Marketable securitiesshort-term |
11,229 | 11,231 | 2 | |||||||
US government agency issues |
10,965 | 10,929 | (36 | ) | ||||||
Corporate debt securities |
1,936 | 1,956 | 20 | |||||||
Marketable securitieslong-term |
12,901 | 12,885 | (16 | ) | ||||||
Total cash equivalents and marketable securities |
$ | 55,309 | $ | 55,295 | $ | (14 | ) | |||
January 31, 2006: |
||||||||||
Cash |
$ | 18,258 | $ | 18,258 | $ | |
66
Cost | Fair Market Value |
Unrealized Gain (Loss) |
||||||||
Cash equivalents |
3,336 | 3,336 | | |||||||
Cash and cash equivalents |
21,594 | 21,594 | | |||||||
US government agency issues |
8,308 | 8,293 | (15 | ) | ||||||
Corporate debt securities |
2,225 | 2,203 | (22 | ) | ||||||
State and municipal obligations |
4,100 | 4,100 | | |||||||
Marketable securitiesshort-term |
14,633 | 14,596 | (37 | ) | ||||||
US government agency issues |
22,984 | 22,749 | (235 | ) | ||||||
Corporate debt securities |
1,936 | 1,940 | 4 | |||||||
Marketable securitieslong-term |
24,920 | 24,689 | (231 | ) | ||||||
Total cash equivalents and marketable securities |
$ | 61,147 | $ | 60,879 | $ | (268 | ) | |||
Inventories and Reserves for Obsolescence
Inventories are stated at the lower of cost or net realizable value. Cost is determined using the first-in, first-out (FIFO) method. Inventories consist primarily of components and subassemblies and finished products held for sale. All of SeaChanges hardware components are purchased from outside vendors.
The costs and net realizable value of inventories are reviewed quarterly. SeaChange records charges to reduce inventory to its net realizable value when an impairment is identified through the quarterly review process. For inventory that has been written down to its net realizable value, the reserve is released upon sale or disposal of this inventory.
Property and Equipment
Property and equipment consists of land and buildings, office and computer equipment, leasehold improvements, demonstration equipment, deployed assets and spare components and assemblies used to service SeaChanges installed base.
Demonstration equipment consists of systems manufactured by SeaChange for use in marketing and selling activities. Property and equipment are recorded at cost and depreciated using the straight-line method over their estimated useful lives. Leasehold improvements are amortized over the shorter of their estimated useful lives or the term of the respective leases using the straight-line method. Deployed assets consist of movie systems owned and manufactured by SeaChange that are installed in a hotel environment. Deployed assets are depreciated over the life of the related service agreements. Capitalized service and spare components are depreciated over the estimated useful lives using the straight-line method. Maintenance and repair costs are expensed as incurred. Significant improvements are capitalized and depreciated. Upon retirement or sale, the cost of the assets disposed of, and the related accumulated depreciation, are removed from the accounts, and any resulting gain or loss is included in the determination of net income.
Costs associated with software developed or obtained for internal use are capitalized when the Company has completed the preliminary project stage and has determined that the project will be completed and used to perform the function intended. Capitalization of such costs ceases when the project is substantially complete and ready for its intended purpose. Post-implementation training, maintenance and other operating costs are expensed as incurred. At each of the years ended January 31, 2007 and 2006, $1.9 million of internal use software costs were capitalized. Accumulated amortization related to these internal use software costs at January 31, 2007 and 2006 were $1.7 million and $1.1 million, respectively. The related amortization expense was $633,000 and $612,000 for fiscal years ended January 31, 2007 and 2006, respectively.
Investments in Affiliates.
Investments in affiliates include equity investments accounted for under the cost method or the equity method of accounting. For investments that represent less than a 20% ownership interest of the affiliate, the investments are carried at cost. Under the equity method of accounting, which generally applies to investments that represent 20% to 50% ownership of the common stock of the affiliate, SeaChanges proportionate ownership share of the earnings or losses of the affiliate is recorded as equity income (loss) in earnings of affiliates in the consolidated statement of operations.
The Company periodically review indicators of the fair value of the investments in affiliates in order to assess whether available facts or circumstances, both internally and externally, may suggest an other than temporary decline in the value of the investment. The carrying value of an investment in an affiliate may be affected by the affiliates ability to obtain adequate funding and execute its business plans, general market conditions, industry considerations specific to the affiliates business, and other factors. SeaChange records an impairment charge when management believes an investment has experienced a decline in value that is other-than-temporary.
67
Business Combinations
The Company accounts for business acquisitions in accordance with SFAS No. 141, Business Combinations, which requires that the purchase method of accounting be used for all business combinations. The Company determines and records the fair values of assets acquired and liabilities assumed as of the dates of acquisition.
Goodwill and Intangible Assets
SeaChange evaluates goodwill for impairment on, at least, an annual basis. SeaChange evaluates the recoverability of goodwill annually, in the second quarter for goodwill associated with the Broadband segment (primarily the goodwill associated with the acquisition of the non-North American assets of Liberate Technologies) and in the third quarter for goodwill associated with the Services segment (primarily the goodwill associated with the acquisition of the On Demand Group Ltd and for the related equity method goodwill associated with Filmflex). The Broadband and Services segments were determined to be the applicable reporting units for the goodwill impairment analyses. Goodwill is evaluated more frequently if events or changes in circumstances, such as declines in sales, earnings or cash flows or material adverse changes in the business climate, indicate that the carrying value of goodwill might be impaired. Goodwill is considered to be impaired when the net book value of a reporting unit exceeds its estimated fair value. Fair values are primarily determined using a discounted cash flow methodology. The determination of discounted cash flows is based on SeaChanges strategic plans and future forecasts. SeaChange completed the annual impairment tests of goodwill associated with the Broadband and Services segments and determined that no adjustment was required to the carrying value of goodwill based on the analyses performed at those times or at January 31, 2007. However, there can be no assurance that goodwill will not become impaired in future periods.
Intangible assets consist of customer contracts, completed technology, patents and trademarks and are reported as part of the Broadband and Services segments. The intangible assets are amortized to cost of sales and operating expenses, as appropriate, on a straight-line or accelerated basis in order to reflect the expected pattern and period that the assets will be consumed.
Software Development Costs
SeaChange develops software for resale in markets that are subject to rapid technological change, new product development and changing customer needs. The time period during which software development costs can be capitalized from the point of reaching technological feasibility until the time of general product release is very short, and consequently, the amounts that could be capitalized are not material to the Companys financial position or results of operations. Software development costs relating to sales of software requiring significant modification or customization are charged to costs of product revenues.
SeaChange also purchases software for resale and capitalizes those costs associated with projects that meet technological feasibility. At the end of each of the fiscal years ended January 31, 2007 and 2006, $5.2 million of purchased software costs were capitalized. Amortization expense is recorded over the period of economic consumption or the life of the agreement whichever results in the higher expense, starting with the first shipment of the product to a customer. The related amortization expense was $346,000 and $0 for fiscal years ended January 31, 2007 and 2006, respectively.
Long-lived Assets
SeaChange evaluates property and equipment, intangible assets and other long-lived assets on a regular basis for the existence of facts or circumstances, both internal and external that may suggest an asset is not recoverable. Factors SeaChange considers important that could trigger the impairment review include:
| significant underperformance relative to historical or projected future operating results; |
| significant negative industry or economic trends; |
| significant decrease in the market value of the long-lived asset; |
| significant adverse change to the extent or manner in which a long-lived asset is being used or in its physical condition; |
| significant adverse change in legal factors or in the business climate that could affect the value of a long-lived asset; |
| significant decline in our stock price for a sustained period; |
| significant decline in our technological value as compared to the market; and |
| a decline in the Companys market capitalization relative to net book value. |
If such circumstances exist, SeaChange evaluates the carrying value of long-lived assets to determine if impairment exists based upon estimated undiscounted future cash flows over the remaining useful life of the assets and compares that value to the carrying value of the assets. If the carrying value of the assets is greater than the estimated future undiscounted cash flows, the assets are
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written down to their estimated fair value. SeaChange determines the estimated fair value of the assets on a projected discounted cash flow method using a discount rate determined by management to be commensurate with the risk inherent in the current business model. In determining expected future cash flows, assets are grouped at the lowest level for which cash flows are identifiable and independent of cash flows from other asset groups. SeaChanges cash flow estimates contain managements best estimates, using appropriate and customary assumptions and projections at the time.
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statements carrying amounts of existing assets and liabilities and their tax bases. Deferred tax assets and liabilities are measured using enacted statutory tax rates in effect in the year in which the differences are expected to reverse. A deferred tax asset is established for the expected future benefit of net operating loss and credit carryforwards. A valuation reserve is required, if, based upon available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.
SeaChange does not provide for U.S. federal and state income taxes on the undistributed earnings of its non-U.S. subsidiaries that are considered indefinitely reinvested in the operations outside the U.S.
Income taxes payable includes uncertain tax positions taken that could be challenged by taxing authorities. These probable exposures result from the varying application of statutes, rules, regulations and interpretations. The Companys estimate of the value of its tax contingencies contains assumptions based on past experiences and judgments about potential actions by taxing jurisdictions.
Stock-based Compensation
On February 1, 2006, SeaChange adopted SFAS No. 123 (revised 2004), Share-Based Payment (SFAS 123R), which requires the measurement and recognition of compensation expense for all stock-based awards made to employees and directors including stock options, employee stock purchases under a stock purchase plan, and non-vested share awards (restricted stock units) based on estimated fair values. SFAS 123R supersedes the Companys previous accounting under Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). The Company adopted the provisions of SFAS 123R using the modified prospective transition method beginning February 1, 2006, the first day of the first quarter of fiscal 2007. In accordance with that transition method, the Company has not restated prior periods for the effect of compensation expense calculated under SFAS 123R. The Company has continued to use the Black-Scholes option pricing model for determining the estimated fair values of all applicable awards. The determination of the fair value of stock-based awards on the date of grant using an option pricing model is affected by the historical price of the Companys stock as well as key assumptions including the expected life of the award, the expected stock price, volatility over the term of the award and actual and projected exercise behaviors. For all awards the Company has recognized stock compensation expense using a straight-line amortization method over the vesting period of the award. As SFAS 123R requires that stock-based compensation expense be based on awards that ultimately vest, estimated share-based compensation for fiscal 2007 has been reduced for estimated forfeitures.
Foreign Currency Translation
SeaChange has determined that the functional currency of all but one of its foreign subsidiaries is the U.S. dollar. Where the U.S. dollar is designated as the functional currency of an entity, SeaChange translates that entitys monetary assets and liabilities denominated in local currencies into U.S. dollars (the functional and reporting currency) at current exchange rates, as of each balance sheet date. Nonmonetary assets (e.g., inventories, property, plant, and equipment and intangible assets) and related income statement accounts (e.g., cost of sales, depreciation, amortization of intangible assets) are translated at historical exchange rates between the functional currency (the U.S. dollar) and the local currency. Revenue and other expense items are translated using average exchange rates during the fiscal period. Translation adjustments and transactions gains and losses on foreign currency transactions, and any unrealized gains and losses on short-term inter-company transactions are included in income.
For the single foreign subsidiary where the local currency is designated as the functional currency, we translate its assets and liabilities into U.S. dollars (the reporting currency) at current exchange rates as of each balance sheet date. Revenue and expense items are translated using average exchange rates during the period. Cumulative translation adjustments are presented as a separate component of stockholders equity. Exchange gains and losses on foreign currency transactions and unrealized gains and losses on short-term inter-company transactions are included in income.
The aggregate foreign exchange transaction losses were $314,000, $339,000 and $133,000 for the years ended January 31, 2007, 2006 and 2005, respectively.
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Comprehensive Income (Loss)
SeaChange presents accumulated other comprehensive income (loss) and total comprehensive income (loss) in the Statement of Stockholders Equity. Total comprehensive income (loss) consists primarily of net income (loss) cumulative translation adjustments and unrealized gains and losses on marketable securities, net of income tax.
Advertising Costs
Advertising costs are charged to expense as incurred. Advertising costs were $313,000, $273,000 and $224,000 for the years ended January 31, 2007, 2006 and 2005, respectively.
Earnings (Loss) Per Share
Earnings (loss) per share are presented in accordance with SFAS No. 128, Earnings Per Share, which requires the presentation of basic earnings (loss) per share and diluted earnings (loss) per share. Basic earnings (loss) per share is computed by dividing earnings (loss) available to common shareholders by the weighted-average shares of common stock outstanding during the period. For the purposes of calculating diluted earnings (loss) per share, the denominator includes both the weighted average number of shares of common stock outstanding during the period and the weighted average number of potential common stock, such as stock options and restricted stock, calculated using the treasury stock method.
For the fiscal years ended January 31, 2007 and 2006, 6,177,411 and, 6,551,857, respectively, of common shares issuable upon the exercise of stock options are anti-dilutive because SeaChange recorded a net loss for the periods and, therefore, have been excluded from the diluted loss per share computation. For the fiscal year ended January 31, 2005, 2,220,000 of common shares issuable upon the exercise of stock options are anti-dilutive and have been excluded from the diluted earnings per share computation as the exercise prices of these common shares were above the market price of the common stock for the periods indicated.
Below is a summary of the shares used in calculating basic and diluted earnings (loss) per share for the periods indicated:
Year Ended January 31, | ||||||
2007 | 2006 | 2005 | ||||
Weighted average shares used in calculating earnings (loss) per shareBasic |
28,857,000 | 28,303,000 | 27,640,000 | |||
Dilutive common stock equivalents |
| | 1,413,000 | |||
Weighted average shares used in calculating earnings (loss) per shareDiluted |
28,857,000 | 28,303,000 | 29,053,000 | |||
New Accounting Pronouncements
In February 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments an amendment of FASB Statements No. 133 and 140 (SFAS 155). SFAS 155 permits a fair value re-measurement for any hybrid financial instrument that contains an embedded derivative that would otherwise require bifurcation. This accounting standard is effective as of the beginning of fiscal years beginning after September 15, 2006. The effect of adopting SFAS 155 on the Companys financial position and results of operations will be immaterial.
In March 2006, the FASB issued the SFAS No. 156, Accounting for Servicing of Financial Assets, an amendment of FASB Statements No. 140 (SFAS 156). SFAS 156 requires that servicing assets and servicing liabilities be recognized at fair value, if practicable, when we enter into a servicing agreement and allows two alternatives, the amortization and fair value measurement methods, as subsequent measurement methods. This accounting standard is effective for all new transactions occurring as of the beginning of fiscal years beginning after September 15, 2006. The effect of adopting SFAS 156 on the Companys financial position and results of operations will be immaterial.
In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 (FIN 48). This interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprises financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. The interpretation prescribes a recognition threshold and measurement attribute for a tax position taken or expected to be taken in a tax return and also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006. The Company will adopt FIN 48 as of February 1, 2007, as required. The cumulative effect of adopting FIN 48 will be recorded as an adjustment to opening retained earnings and other accounts as applicable. The Company is currently evaluating the effect of FIN 48 on the Companys results of operations or financial position.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurement (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value using generally accepted accounting principles, and expands disclosures about fair
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value measurements. This Statement does not require any new fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company does not expect the adoption of SFAS 157 to have a material impact on its financial statements.
In June 2006, the FASB issued Emerging Issues Task Force (EITF) No. 06-02, Accounting for Sabbatical Leave and Other Similar Benefits Pursuant to FASB Statement No. 43, Accounting for Compensated Absences (EITF 06-02). A sabbatical leave is a benefit provided to employees whereby the employee is entitled to time off with pay, over and above routine vacation time, after working for a specified period of time. The Company offers an additional twenty days of sabbatical leave to U.S.-based employees upon completion of eight years of service. EITF 06-02 concluded that an employees right to a compensated absence under a sabbatical or similar benefit arrangement does accumulate pursuant to FASB Statement No. 43, Accounting for Compensated Absences, and therefore, a liability should be accrued over the service period in which employees earn the right to sabbatical leave. The Company adopted EITF 06-02 in the first quarter of fiscal 2008 in its restated Form 10-Q/A for the period ended April 30, 2007, to be filed subsequent to filing the Form 10-K/A, and recorded a cumulative effect of change in accounting principle totaling $769,000 as of February 1, 2007. The impact of this adoption does not include any tax effects as the Companys deferred tax assets are fully reserved against due to the uncertainties related to the Companys ability to generate sufficient pre-tax income for fiscal 2008 and the inability to carry back fiscal 2008 tax losses to prior years because the Company exhausted its US tax benefit carry back potential in fiscal 2007 (see Note 10).
In September 2006, the SEC staff released SAB 108. SAB 108 was issued in order to eliminate the diversity of practice surrounding how public companies quantify financial statement misstatements. Traditionally, there have been two widely-recognized methods for quantifying the effects of financial statement misstatements: the roll-over method and the iron curtain method. The roll-over method focuses primarily on the impact of a misstatement on the income statement, including the reversing effect of prior year misstatements, but its use can lead to the accumulation of misstatements in the balance sheet. The iron curtain method focuses primarily on the effect of correcting the period-end balance sheet with less emphasis on the reversing effects of prior year errors on the income statement. The Company previously used the roll-over method for quantifying identified financial statement misstatements.
In SAB 108, the SEC staff established an approach that requires quantification of financial statement misstatements based on the effect of the misstatements on each of the Companys financial statements and the related financial statement disclosures. This model is commonly referred to as a dual approach because it requires quantification of errors under both the iron curtain and the roll-over methods.
SAB 108 permits public companies to initially apply its provisions either by (i) restating prior financial statements as if the dual approach had always been used or (ii) recording the cumulative effect of initially applying the dual approach as adjustments to the carrying values of assets and liabilities as of the beginning of the year of adoption, February 1, 2006, for the Company, with an offsetting adjustment recorded to the opening balance of retained earnings. The Company has applied the provisions of SAB 108 using retrospective application as of February 1, 2004, as discussed in Note 11 to the Companys consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact of adopting SFAS 159 on its financial statements.
3. | Consolidated Balance Sheet Detail |
Inventories consist of the following:
January 31, | ||||||
2007 | 2006 As Restated | |||||
Components and assemblies |
$ | 11,825,000 | $ | 14,078,000 | ||
Finished products |
7,525,000 | 5,844,000 | ||||
$ | 19,350,000 | $ | 19,922,000 | |||
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Property and equipment consist of the following:
Estimated useful life (years) |
January 31, | |||||||||
2007 | 2006 | |||||||||
Land |
$ | 3,063,000 | $ | 283,000 | ||||||
Buildings |
20 | 12,509,000 | 2,150,000 | |||||||
Office furniture and equipment |
5 | 2,320,000 | 2,204,000 | |||||||
Computer equipment, software and demonstration equipment |
3 | 43,833,000 | 38,467,000 | |||||||
Deployed assets |
2-7 | 3,280,000 | 3,405,000 | |||||||
Service and spare components |
5 | 6,796,000 | 5,516,000 | |||||||
Leasehold improvements |
1-7 | 1,511,000 | 2,694,000 | |||||||
Automobiles/truck |
5 | 649,000 | 635,000 | |||||||
Construction in progress |
| 10,347,000 | ||||||||
73,961,000 | 65,701,000 | |||||||||
Less - Accumulated depreciation and amortization |
(43,241,000 | ) | (38,510,000 | ) | ||||||
$ | 30,720,000 | $ | 27,191,000 | |||||||
Construction in progress at January 31, 2006 included $8.9 million of real property located at 50 Nagog Park in Acton, Massachusetts which was purchased in the second quarter of fiscal 2006. The building has approximately 120,000 square feet, and as of mid-February 2006, became the Companys new corporate headquarters. All operations and personnel that were located at the facility in Maynard, Massachusetts were relocated to the new property in Acton, Massachusetts in February 2006. All related construction in progress balances were capitalized, primarily to the buildings category, during fiscal 2007.
Depreciation and amortization expense of fixed assets was $7,799,000, $6,642,000 and $5,917,000 for the years ended January 31, 2007, 2006 and 2005, respectively. At both January 31, 2007 and 2006 SeaChange had no assets under capital lease.
Other accrued expenses consist of the following:
January 31, | ||||||
2007 As Restated |
2006 As Restated | |||||
Accrued consideration payable to former shareholders in ODG |
$ | | $ | 2,804,000 | ||
Other accrued expenses |
6,623,000 | 6,280,000 | ||||
$ | 6,623,000 | $ | 9,084,000 | |||
This balance is net of a reclassification of the value-added tax (VAT) payable amount against the VAT receivable balance. The right of offset exists between these VAT amounts with the net balance being either a receivable or payable from the appropriate tax authorities. Reclassification of the VAT payable balance has been made to conform the January 31, 2006 balance to the current period presentation.
4. | Segment Information and Significant Customer Information (Restated) |
SeaChange has three reportable segments: Broadband, Broadcast and Services. The Broadband segment develops, markets and sells products to digitally manage, store and distribute digital video for cable system operators and telecommunications companies. The Broadcast segment develops, markets and sells products for the storage, archival, on-air playback of advertising and other video programming for the broadcast television industry. The Services segment provides installation, training, project management, product maintenance and technical support services, and software development, for all of the above products, and movie content services. SeaChange measures profitability of the segments based on their respective gross profit. There were no inter-segment sales or transfers. The following summarizes the revenues and cost of revenues by reportable segment:
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Year ended January 31, | |||||||||
2007 As Restated |
2006 As Restated |
2005 As Restated | |||||||
Revenues: |
|||||||||
Broadband hardware, software and systems |
$ | 84,905,000 | $ | 64,365,000 | $ | 100,049,000 | |||
Broadcast hardware, software and systems |
10,095,000 | 9,151,000 | 13,715,000 | ||||||
Services |
66,334,000 | 52,748,000 | 43,539,000 | ||||||
$ | 161,334,000 | $ | 126,264,000 | $ | 157,303,000 | ||||
Costs of revenues: |
|||||||||
Broadband hardware, software and systems |
$ | 39,082,000 | $ | 36,608,000 | $ | 51,038,000 | |||
Broadcast hardware, software and systems |
9,252,000 | 8,947,000 | 9,120,000 | ||||||
Services |
37,189,000 | 28,315,000 | 25,755,000 | ||||||
$ | 85,523,000 | $ | 73,870,000 | $ | 85,913,000 | ||||
Gross profit: |
|||||||||
Broadband hardware, software and systems |
$ | 45,823,000 | $ | 27,757,000 | $ | 49,011,000 | |||
Broadcast hardware, software and systems |
843,000 | 204,000 | 4,595,000 | ||||||
Services |
29,145,000 | 24,433,000 | 17,784,000 | ||||||
$ | 75,811,000 | $ | 52,394,000 | $ | 71,930,000 | ||||
SeaChange does not measure the assets allocated to the segments, other than the goodwill and intangible assets in connection with its acquisitions. The following table summarizes intangible assets, net and goodwill by reportable segment:
January 31, 2007 |
January 31, 2006 | |||||
(in thousands) | ||||||
Goodwill and Intangible Assets |
||||||
Broadband |
$ | 19,282 | $ | 23,711 | ||
Services |
17,498 | 15,572 | ||||
Total |
$ | 36,780 | $ | 39,283 | ||
The following summarizes revenues by customers geographic locations:
Fiscal Year ended January 31, | |||||||||
2007 | 2006 | 2005 | |||||||
Revenues: |
|||||||||
United States of America |
$ | 107,950,000 | $ | 75,817,000 | $ | 122,245,000 | |||
United Kingdom |
32,936,000 | 26,988,000 | 6,043,000 | ||||||
Canada and South America |
7,446,000 | 9,733,000 | 9,238,000 | ||||||
Europe and Middle East (excluding the United Kingdom) |
6,723,000 | 5,896,000 | 10,694,000 | ||||||
Asia/Pacific and other international locations |
6,279,000 | 7,830,000 | 9,083,000 | ||||||
$ | 161,334,000 | $ | 126,264,000 | $ | 157,303,000 | ||||
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The following summarizes fixed assets, net by geographic locations:
January 31, 2007 |
January 31, 2006 | |||||
(in thousands) | ||||||
Fixed assets, net |
||||||
United States of America |
$ | 27,619 | $ | 25,444 | ||
United Kingdom |
802 | 317 | ||||
Europe and Middle East (excluding the United Kingdom) |
125 | 205 | ||||
Asia/Pacific and other international locations |
2,174 | 1,225 | ||||
Total |
$ | 30,720 | $ | 27,191 | ||
5. | Stock-Based Compensation and Stock Incentive Plans |
Effective February 1, 2006, SeaChange adopted on a modified prospective basis the provisions of the Financial Accounting Standards Boards SFAS 123R, which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors including employee stock options, restricted stock units and employee stock purchases related to SeaChanges Employee Stock Purchase Plan (ESPP) based on estimated fair values. Accordingly, stock-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized as expense on a straight-line basis over the employees requisite service period. SeaChange has applied the provisions of SAB No. 107, Share-Based Payment, (SAB 107) in its adoption of SFAS 123R.
Impact of the Adoption of SFAS 123R
Under the modified prospective transition method, SeaChange recognized stock-based compensation expense during the year ended January 31, 2007 for: (a) ESPP awards from offering periods that began on December 1, 2005, June 1, 2006 and December 1, 2006 and ended on May 31, 2006, November 30, 2006 and May 31, 2007, respectively, (b) stock options and restricted stock units granted prior to, but not yet vested as of February 1, 2006, based on the grant date fair value estimated in accordance with the disclosure provisions of SFAS 123, and (c) stock options and restricted stock units granted subsequent to February 1, 2006, based on the grant date fair value, estimated in accordance with the provisions of SFAS 123R. Under the modified prospective transition method, results for prior periods are not restated. The adoption of SFAS 123R did not affect the accounting for stock-based compensation expense related to restricted stock units. The fair value of a restricted stock unit is the market value of a share of the Companys common stock on the date of grant of the restricted stock unit. This fair value is amortized on a straight-line basis over the related vesting period of the restricted stock unit.
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The estimated fair value of SeaChanges stock-based awards, less expected forfeitures, is amortized over the awards vesting period on a straight-line basis. The effect of recording stock-based compensation for the year ended January 31, 2007 was as follows:
Year Ended January 31, 2007 |
||||
(Amounts in thousands, except per share amounts) |
||||
Stock-based compensation expense by type of award: |
||||
Stock options |
$ | 2,179 | ||
Restricted stock units |
625 | |||
Performance-based restricted stock units |
248 | |||
Employee Stock Purchase Plan |
462 | |||
Total stock-based compensation |
3,514 | |||
Less: Tax effect on stock-based compensation |
| |||
Net effect on net loss |
$ | 3,514 | ||
Effect on net loss per share |
||||
Basic |
$ | (0.12 | ) | |
Diluted |
$ | (0.12 | ) |
Since additional option grants are expected to be made each year and options vest over several years, the effects of applying SFAS 123R for recording stock-based compensation for the year ended January 31, 2007 are not indicative of future amounts.
The following table presents stock-based compensation expenses included in the Companys Consolidated Statement of Operations:
Year Ended January 31, 2007 | |||
(Amounts in thousands) | |||
Cost of product revenue |
$ | 109 | |
Cost of service revenue |
216 | ||
Research and development expense |
1,551 | ||
Sales and marketing expense |
470 | ||
General and administrative expense |
1,168 | ||
Income tax benefit |
| ||
Total stock-based compensation expense |
$ | 3,514 | |
SeaChange estimates the fair value of stock options, including rights granted under the ESPP, using the Black-Scholes valuation model. Key input assumptions used to estimate the fair value of stock options include the exercise price, the expected option term, the risk-free interest rate over the options expected term, the expected annual dividend yield and the expected stock price volatility. The expected option term was determined using the simplified method for plain vanilla options as allowed by SAB 107. The expected stock price volatility was established using a blended volatility, which is an average of the historical volatility of SeaChanges common stock over a period of time equal to the expected term of the stock option, and the average volatility of SeaChanges common stock over the most recent one-year and two-year periods. Estimates of fair values are not intended to predict actual future events or the value ultimately realized by the persons who receive equity awards.
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The fair value of each option grant was estimated on the grant date using the Black-Scholes option-pricing model with the following assumptions:
Year ended January 31, 2007 | ||||||
Options | ||||||
Range | Weighted Average |
ESPP | ||||
Expected term (in years) |
4 5 | 4.5 | 0.5 | |||
Expected volatility |
51% 58% | 56% | 45% | |||
Risk-free interest rate |
4.4% 5.1% | 4.7% | 4.6% | |||
Expected dividend yield |
0% | 0% | 0% |
Pro Forma Information Under SFAS 123
Prior to February 1, 2006, SeaChange accounted for its stock plans under the provisions of APB 25 and provided pro forma disclosures as though the fair value method was reported in accordance with SFAS No. 123, Accounting for Stock-Based Compensation, (SFAS 123), as amended by SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, An Amendment of SFAS No. 123. The effects of applying SFAS 123 in this pro forma disclosure are not indicative of future amounts.
The pro forma information for the years ended January 31, 2006 and 2005 was as follows:
(Amounts in thousands, except share amounts) |
Year ended January 31, 2006 As Restated |
Year ended January 31, 2005 As Restated |
||||||
Net (loss) income, as reported |
$ | (12,199 | ) | $ | 9,866 | |||
Add: Stock-based compensation under APB No. 25, net of related tax effect |
34 | | ||||||
Less: Stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects |
(12,688 | ) | (9,100 | ) | ||||
Pro forma net (loss) income |
$ | (24,853 | ) | $ | 766 | |||
Basic (loss) earnings per share |
||||||||
As reported |
$ | (0.43 | ) | $ | 0.36 | |||
Pro forma |
$ | (0.88 | ) | $ | 0.03 | |||
Diluted (loss) earnings per share |
||||||||
As reported |
$ | (0.43 | ) | $ | 0.34 | |||
Pro forma |
$ | (0.88 | ) | $ | 0.03 |
The fair value of SeaChanges stock-based awards granted during the years ended January 31, 2006 and 2005 was estimated on the grant date using the Black-Scholes option pricing model with the following weighted-average assumptions:
Year Ended January 31, 2006 |
Year Ended January 31, 2005 | |||
Expected term (in years) |
5.6 |