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SeaChange International, Inc. (NASDAQ:SEAC)

F3Q 2013 Earnings Conference Call

December 05, 2012, 08:30 AM ET

Executives

Monica Gould – IR, The Blueshirt Group

Raghu Rau – CEO

Mike Bornak – CFO

Analysts

Christopher Ferris – Noble Financial

Todd Mitchell – Brean Capital

Richard Ingrassia – ROTH Partners

Jim Roumell – Roumell Asset Management

Operator

Greetings and welcome to the SeaChange Third Quarter Fiscal Year 2013 Results. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Monica Gould, Investor Relations for SeaChange International. Thank you, Ms. Gould, you may begin.

Monica Gould

Thank you, operator. Good morning, everyone, and thank you for joining us. SeaChange released results for the third quarter of fiscal year 2013 ended October 31, 2012 yesterday after the market closed. Attached to the press release were our prepared remarks regarding the financials. If you do not have this material, please go to www.schange.com/IR to download the document. These prepared remarks will not be read on our call today.

Raghu Rau, CEO, and Mike Bornak, CFO, are joining me today. Raghu has a short introduction and a few comments. And following his remarks, we'll be happy to take your questions. This call is being webcast and will be archived on our website in the Investor Relations section.

Before Raghu begins, I'd like to remind you that the information we're about to discuss today may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on current expectations that are subject to a number of risks and uncertainties that may cause actual results to differ materially from expectations. These risks are outlined in our SEC filings including our Annual Report on Form 10-K, which was filed April 05, 2012. Any forward-looking statements should be considered in light of these factors.

Additionally, this presentation contains certain non-GAAP or adjusted financial measures as defined by the SEC. Per SEC requirements, we have provided a reconciliation of these measures to the most directly comparable GAAP measures in tables attached to the press release. Any redistribution, retransmission or rebroadcast of this presentation in any form without the expressed written consent of SeaChange International is prohibited.

And with that, I'd like to turn the call over to Raghu.

Raghu Rau

Thank you, Monica. Good morning and welcome all of you to the SeaChange third quarter earnings call. Earlier this year, I presented a SeaChange transformation strategy at the ROTH Conference in California and also walk you through that strategy during the fourth quarter fiscal year 2012 earnings call.

Considering that we have a number of new analysts covering SeaChange and a significant number of new and potential new investors, it might be appropriate for me to highlight the key elements of the strategy and our progress on execution.

The first element of our strategy was to focus on our core software business and to divest non-core assets. This was largely completed in May of this year with the sale of the Broadcast Servers and Storage business and the content services business.

The second element of our strategy was to focus intensely on our core service provider customers. This has paid us significant dividends as the world's largest operators, including Comcast, Cox Communications, Cablevision, Virgin Media, Liberty Global, Charter, Rogers, Kabel Deutschland, AT&T, Verizon to name just a few continue to trust SeaChange with their business.

An important element of our strategy is to significant lower our overall cost structure while continuing to invest significantly in innovation and R&D in the next-generation back office platform, advertising and gateway software products.

For the divestures and other cost reduction actions, we are on track to reduce our operating expenses by 15 million compared to the previous year. Our investment in R&D is continuing to deliver differentiated innovation.

In the third quarter, SeaChange was recognized in the industry with a number of prestigious awards. The Telco TV Vision Award for the Best Innovation in Customer Premises Equipment was not awarded to any of the usual suspects but to SeaChange. This could have been unthinkable even just a year ago and demonstrates the power of innovative software.

Additionally, this quarter we won an Emmy Award for Achievement in Cable Advertising. We also won the Communications Technology Platinum Award for multi-screen software innovation. We have announced design wins from major operators in the Americas and in Europe for our next-generation solutions, including from service providers that had not previously deployed SeaChange products.

Our teams have been working very hard, including many nights and weekends and through the Thanksgiving holidays to ensure that we meet our commitments to our customers and shareholders. We are becoming increasingly confident about the successful execution of our transformation strategy and the ability to grow our business profitably. This confidence is due in part to bringing in significant new talent to the company and a revised organizational structure offering greater focus and accountability on global growth and profitability.

Our balance sheet continues to be strong after buying back $5.6 million of our stock in the third quarter, utilizing $3.1 million for earn-out payments related to prior acquisitions and $800,000 in cash used for severance payments. Our cash position at the end of the quarter was $100 million.

As you will have observed from our prepared remarks, revenues for the third quarter FY '13 was $39.2 million, which was at the high end of our guidance and non-GAAP operating earnings were $0.09 per share, significantly above our guidance. Based on the momentum we are seeing, we are increasing our full year fiscal 2013 revenue and earnings guidance. We expect revenue to be in the range of $155 million to $159 million and non-GAAP earnings per share to be in the range of $0.38 to $0.41.

SeaChange remains committed to delivering shareholder value by driving improved financial performance, delivering industry-leading multi-screen video solutions will drive economic value for our customers and creating a fun place to work for our talented employees. Thank you.

With that, I'd hand you over to Monica.

Monica Gould

Thank you, Raghu. Bob, can you please give instructions for the Q&A session.

Question-and-Answer Session

Operator

Thank you. We'll now be conducting a question-and-answer session. (Operator Instructions). Our first question is from the line of Christopher Ferris with Noble Financial. Please proceed with your question.

Christopher Ferris – Noble Financial

Good morning, Raghu and Mike. Congratulations on a nice quarter.

Mike Bornak

Thank you.

Raghu Rau

Thank you very much, Chris.

Christopher Ferris – Noble Financial

You noted the success of the home gateway product and the impressive increases you've realized on the revenue side. Can you talk about what kind of percentage growth you're seeing there? And perhaps give us an update on what you think the revenue opportunity is over the next couple of years? And also how the competitive [landscape] stacks up?

Raghu Rau

Right. Compared to the previous year, we expect the gateway software business to increase in the high double-digit teen numbers. We expect continued growth in that business based on the design wins that we're seeing and the acceptance of our products. So we expect to continue with double-digit growth in that business in the foreseeable future.

Christopher Ferris – Noble Financial

Right. And when you say double-digit, I mean are we talking about 15%? Are we talking about 30%? When you say double digits, can you give us a little bit more granularity there?

Raghu Rau

Yeah. This year is very high double digits. It's higher than 75%.

Christopher Ferris – Noble Financial

Okay. Thank you very much. And just to touch on gross margins, I realized that gross margins decreased this year due to a number of factors most of which are one-time related or [weighted] to product or alignment, but how do we think about gross margins in fiscal '14 and beyond with new streamlined, video platform focused SeaChange?

Raghu Rau

Right. If you look at – you're right about the product mix. If you look at the mix between products and services, products generally have been comprising between 30% to 40% of our overall revenues. And that number has sort of been increasing quarter-on-quarter. If you look at the gross margins, the gross margins on the product can vary anything between 40% to as high as 90% based on whether it's licensing revenue. And so there's a range that you can achieve.

But however, the average is between 60% to 70%. If you look at the services business, I mean the gross margins there could be anything between 40% to 50%. And so while we can't say for sure exactly what it will be on a quarter-to-quarter basis, it depends on the product mix, I believe we can be in the – this business can be in the 55% gross margin range on a normalized basis in the future.

Christopher Ferris – Noble Financial

Okay. Thank you for that. And one last question, in your release you noted an increase in contract labor cost as you bring products to market in the fourth quarter. Does that carryover into next year as you start to rollout certain specimen of your recent customer wins and can you talk about the impact that may have on your expense line next year?

Raghu Rau

Right. When we talk about the contract labor, it's at significantly lower rates. What we're doing is using some offshore development centers to be able to have the flexible work model. So while it's incremental to the investments we make, I mean it does reduce the overall costs in our R&D headcount. And yes, that will continue to be part of our strategy going forward to lower our overall cost of R&D and increase the productivity of the R&D organization. What it also enables us to do is bring the skill levels and talent levels in a really rapid fashion which trying to do that organically and growing organically is much more difficult to do.

Christopher Ferris – Noble Financial

Thank you. I'll hang up and let someone else get in. I appreciate it.

Operator

Thank you. Our next question is from the line of Todd Mitchell with Brean Capital. Please proceed with your question.

Todd Mitchell – Brean Capital

Yeah, thank you. I'd like to ask about the home gateway business. So we've seen a pretty significant increase in the service revenues. I'm assuming that the way that business is, is that there's an element of customization and you're in that period. Can you talk about the number of customers and give us some kind of indication in terms of the pacing of actually when they roll out the actual product and you start recognizing the software revenues?

Raghu Rau

Right. We're very pleased with that business, Todd, as you know. In terms of design wins, we have contracts in place with at least two or three major customers. However, we're in engagements with several others and we think this is a very growing trend and we expect almost a very large number of operator customers of ours to eventually go the gateway software route. And we're in trials and discussions, engagements with multiple operators today. We expect to be able to sign at least five such contracts in the next several months.

Todd Mitchell – Brean Capital

Okay. And can you also let us know, are your current customers that's recognizing that you have official engagement for, are they all North American customers? And basically is there a way for us to think about that is as we look for these service providers rolling out TV everywhere and Comcast gives us an (inaudible) number, should we be thinking about as kind of a one-to-one relationship with how you're recognizing the royalties for that product?

Raghu Rau

No. The pricing model varies between customer and customer and obviously on this call I don't want to get into too much detail about the pricing. But yes, we do charge them the base – license on the bases of active subscribers to buy blocks of licenses for a certain number of subscribers. So that's how we recognize revenue. But that's only – the license in part is only one component of the overall revenue. We also have custom work where they require custom features and that's – we get NRE fees for that as well. And then the process support and maintenance and support is typically about 20% of the licensing revenue.

Todd Mitchell – Brean Capital

And all your revenue recognition right now is for North American customers?

Raghu Rau

In the fourth quarter we expect it to go international.

Todd Mitchell – Brean Capital

Great. Thank you very much.

Operator

Thank you. Our next question is from Richard Ingrassia with ROTH Partners. Please proceed with your question.

Richard Ingrassia – ROTH Partners

Thanks. Good morning, everybody.

Raghu Rau

Good morning, Rich.

Richard Ingrassia – ROTH Partners

And I apologize if you addressed these issues, I dropped off the call for a short period time, but did you say or can you say anything more specific about the latest Adrenalin design wins in North America from a November announcement?

Raghu Rau

Yes. Besides opening three major operators in the US, we have also won a major operator in North America that's in Canada and one in Central America. Unfortunately at this point of time I'm not able to disclose the names of the operator.

Richard Ingrassia – ROTH Partners

Okay, fair enough. And headcount reduction in sales obviously lowered costs this quarter. Is there more to do there in the way of reductions or potentially upgrades, if you will, on the sales force or are the changes there already done?

Raghu Rau

In terms of the cost reduction, I mean that's obviously in an ongoing effort. However, we are bringing in significant new talent. We have about 84 new hires in this year already and replacing some earlier talent. And so we are bringing in lot of new and fresh talent in all areas.

Richard Ingrassia – ROTH Partners

Okay, thank you.

Raghu Rau

To support growth in the future, but however we are going to ensure that we keep our cost commensurate with the revenues and profitability of our business.

Richard Ingrassia – ROTH Partners

Perfect. And finally just on loss and liabilities dropped pretty substantially sequentially, about 6 million. Were those earn-out paid and settled, I assume?

Raghu Rau

Yeah, that's correct.

Richard Ingrassia – ROTH Partners

Okay. Thank you. Nice quarter.

Raghu Rau

Thank you, Rich.

Operator

Thank you. Our next question is from the line of Jim Roumell of Roumell Asset Management. Please proceed with your question.

Jim Roumell – Roumell Asset Management

Thank you. Hi, Raghu.

Raghu Rau

Hi, Jim.

Jim Roumell – Roumell Asset Management

A little bit different question. You had what seemed to be a pretty big win in the legal battle with Arris in the quarter. And although the Street seemed to be expecting you to win, hence the modest reaction on the court's announcement, I'm curious as to the degree to which that – the overhang of that suit was a problem and impeded the sales process last year. And I guess just how much of a lift is this in kind of resolving this?

Raghu Rau

I would let you draw your own conclusions about that, Jim. It was a very decisive victory for us and the judge agreed with our contention that the redesign that SeaChange did, Arris was not able to prove with clear and convincing evidence that the redesign infringed upon their patents. And the judge threw out the contempt in a motion. And that was, I think, a big deal and I think potential acquires of SeaChange obviously would be very relieved to hear that news because certainly there is no overhang. But we always consistently believed that we were never infringing on Arris' patent.

Jim Roumell – Roumell Asset Management

Got it. Thanks, Raghu. Nice quarter.

Raghu Rau

Thank you, Jim.

Operator

(Operator Instructions). There are no further questions at this time. I would like to turn the floor back to management for further or closing comments.

Raghu Rau

Thank you, Rob. On behalf of SeaChange management team, thank you for your time and participation this morning. Over the coming quarters, we will look forward to reporting further progress on the execution of our transformation strategy and our commitment to deliver increased growth and profitability. Thank you.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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