SeaChange International, Inc. (NASDAQ:SEAC)
F3Q09 Earnings Call
November 25, 2008 5:00 pm ET
Martha Schaefer - Director, Investor Relations
Kevin Bisson - Chief Financial Officer
Bill Styslinger - President and Chief Executive Officer
Yvette Kanouff - Chief Strategy Officer
Tony Kelly – Managing Director ODG
Greg Mesniaeff - Needham & Company
Blair King - Avondale Partners
John [Zarrow] – BCM
Todd Cooper – Stevens Inc.
I would like to welcome everyone to the SeaChange third quarter fiscal 2009 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions)
Ms. Schaefer, you may begin your conference.
Good afternoon everyone and thank you for joining us today. We'll be discussing the financial results for our third quarter of our fiscal year 2009. Our press release went out a short time and is available on our website on the Investor Relations page.
Before we begin, I would 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 but are subject to a number of risks and uncertainties that may cause actual results to differ.
These risks are outlined in our SEC filings included in our Annual Report on Form 10-K filed April 14, 2008. Any forward-looking statements should be considered in light of these factors. Any redistribution, retransmission, or rebroadcast of this presentation in any form without the express written consent of SeaChange International is prohibited.
Our format today will be as follows: Kevin Bisson, our CFO, will review our financial performance. Then Bill Styslinger, our CEO, will provide an overview of the quarter. We also have Tony [Kelly] with us today from our U.K. office. Tony will be giving you more details on our acquisition of Mobix which was announced today as well. Following our prepared remarks we will be happy to take your questions. At this point I’d like to hand the call over to you Kevin.
Thanks Martha. Good afternoon everyone. Turning to our third quarter results for fiscal 2009 revenue for the third quarter amounted to $51.8 million which was $2.8 million or 6% higher than total revenue of $49 million generated in the third quarter of last year. From an operating segment perspective, revenue from our software segment for the third quarter was $37.6 million which was $8.4 million or 29% higher than revenue of $29.2 million for the third quarter fiscal 2008. The year-over-year increase in revenue was due primarily to higher Comcast software upgrade revenue, or what we refer to as subscription revenue, derived from the completion of the VOD products and services contract extension with Comcast which extends the contract through the end of calendar 2009.
By signing the contract extension in the third quarter which was retroactive to January 1 of this year, the company was able to record revenue for work performed in the first half of this year as well as for the third quarter. In addition, software segment revenue in the third quarter benefited from higher advertising insertion revenue due to continued increases in high definition television channel requirements for several North American service providers. Software services revenue increased significantly in this year’s third quarter compared to the third quarter of last year due to the completion of several large projects from the U.S. based cable television provider that had been initiated in prior quarters.
Our service and storage segment generated $10.4 million in revenue for the third quarter which was $5.7 million lower than revenue of $16.1 million recorded in the third quarter of last year. For the first nine months of fiscal 2009 revenue in the service and storage segment was $35.9 million which was $1.2 million lower than revenue for the first nine months of fiscal 2008. As such, the decline in third quarter service and storage revenue compared to last year’s third quarter is largely a function of the timing of VOD service orders for this historically lumpy business in fiscal 2009 compared to fiscal 2008 given the comparable nine month revenue amounts between years.
Service and storage revenue for the third quarter was comprised largely of VOD server shipments to North American based MSO’s during the quarter along with related customer maintenance revenue.
The media services segment had revenue for the third quarter of $3.9 million which was $100,000 higher than revenue of $3.8 million generated in the third quarter of fiscal 2008. The increase in media services revenue between years was due mainly to revenues from recent telecom customer contract wins in Greece and Turkey as well as professional services revenue from a customer in Brazil. These revenue increases were essentially offset by the impact of the weakening British pound compared to the U.S. dollar during the third quarter of this year compared to last year’s third quarter.
At constant foreign exchange rates, year-over-year media services revenue would have increased by approximately $500,000 or 13%.
Geographically, revenue for the third quarter fiscal 2009 included 74% in North America, 19% in Europe, Middle East, and Africa, 5% in Asia Pacific and 2% in Latin America. Consistent with prior quarters, Comcast and Virgin Media were 10% or greater customers in the third quarter of fiscal 2009.
Revenue for the first nine months of fiscal 2009 amounted to $147.9 million which was $15.8 million or 12% higher than the $132.1 million of revenue generated in the first nine months of fiscal 2008. Revenue growth in the first nine months of this fiscal year was driven mainly by increased VOD and advertising insertion software license revenue from several large, U.S. based cable television customers and higher VOD software, professional services and maintenance revenue tied to increased year-over-year VOD software deployments.
Total gross margin of 54.3% for the third quarter was 4.8 points higher than the total gross margin of 49.5% for the third quarter fiscal 2008. Looking at gross margin by operating segment, software segment gross margin of 61.7% for the third quarter of fiscal 2009 was 6.1 points higher than software gross margin of 55.6% for the third quarter of last year. The increase in software segment gross margin was due to increased software subscription revenue much of which was in connection with the extension of the Comcast agreement during this year’s third quarter. Software subscription revenue not only carries margins that are accretive to overall software segment margins but the retroactive nature of the Comcast contract extension allowed the company to bill several quarters of revenue in the third quarter while incurring one quarter’s worth of expenses for work related to customer commitments. Hence, driving higher gross margins.
Service and storage gross margin of 42.9% for the third quarter of fiscal 2009 was 5.4 points lower than gross margin of 48.3% for the third quarter of fiscal 2008. The decrease in gross margin for the service and storage segment between years was due primarily to a higher proportion of this year’s third quarter service and storage revenue being broadcast product revenue which carries lower gross margins than VOD servers.
Media services gross margin of 13.9% for the third quarter was 6.1 points higher than gross margin of 7.8% for the third quarter of last year. The year-over-year increase in media services gross margin was due mainly to higher margins from ODG’s Greek telecom customer and higher margins from a Brazilian customer due to the timing of costs incurred on the professional services contract with this customer compared to when the revenue was recognized.
Total gross margin for the first nine months of fiscal 2009 was 51.1% which was 7.8 points higher than gross margins of 43.3% for the first nine months of last year. Last year’s first nine month results included approximately $4.8 million of expenses related to certain manufacturing and service related cost reduction actions that were taken in last year’s second quarter. The impact of those cost reduction actions lowered last year’s nine-month gross margin by 3.7 points. The increase in gross margin for the first nine months of fiscal 2009 compared to the first nine months of fiscal 2008 was due primarily to a larger proportion of higher margin, Axiom related and advertising insertion software revenue as well as improvement in manufacturing costs between years tied partially to material cost savings as well as savings generated from last year’s cost reduction efforts.
Operating expenses for the third quarter amounted to $23.2 million which was $2 million higher than the $21.2 million of operating expenses incurred in the third quarter of last year. The increase in operating expenses in this year’s third quarter compared to last year’s third quarter reflect primarily higher selling expenses resulting from higher sales commissions and higher headcount related expenses. In addition, increased G&A expenses caused by higher legal fees and higher ODG G&A expenses were partially offset by lower amortization of intangibles due to the sale of the company’s equity interest in [Film Flex] in the fourth quarter of last year.
For the first nine months of fiscal 2009 operating expenses were $69.3 million which was $2.5 million higher than the $66.8 million of operating expenses incurred in the first nine months of fiscal 2008. Higher selling expenses due to higher sales commissions, increased travel costs and higher headcount related expenses were partially offset by lower amortization of intangibles from last year’s [Film Flex] transaction as noted earlier.
Net income for the third quarter of fiscal 2009 was $3.4 million which was $100,000 higher than the $3.3 million of net income generated in the third quarter of last year. The corresponding earnings per share for the third quarter of fiscal 2009 was $0.11 per share which was consistent with the earnings per share recorded in the third quarter of fiscal 2008.
For the first nine months of fiscal 2009 net income was $5.2 million compared to a net loss of $9.1 million in the first nine months of last year. The corresponding earnings per share for the first nine months fiscal 2009 was $0.17 per share as compared to a $0.31 per share loss for the first nine months of fiscal 2008. Expenses related to the cost reduction actions implemented in last year’s second quarter increased 2008’s nine month net loss and net loss per share by $6 million and $0.20 per share respectively.
Turning to the balance sheet, the company ended the third quarter with cash and investments of $79.7 million which was $1.6 million higher than the $78.1 million of cash and investments at July 31 of this year. Cash flow for the third quarter of $1.6 million was driven by $6.8 million of cash flow from operations as measured by the quarter’s net income and adding back $3.4 million of non-cash depreciation, amortization, and stock based compensation expense.
Offsetting this source of cash was $2.8 million of capital expenditures and a $1.9 million increase in inventory due principally to a higher than normal inventory build to satisfy previously shipped product awaiting customer acceptance as well as anticipated fourth quarter customer orders.
I’ll now turn it over to Bill.
Thank you Kevin. Good evening everyone. Our third quarter financial results continued the fiscal 2009 trend of improving financial performance for SeaChange. Third quarter revenues of $51.8 million were 6% higher than last year’s third quarter which was by the way the highest quarter for all of last year. More importantly we generated record gross margins of 54% of the third quarter. This provides further evidence to the margin expansion potential of our products and services.
Combining the quarter’s margin strength with our continued focus on controlling growth of operating expenses we were able to more than double sequentially our net income in this year’s third quarter to $3.3 million.
In addition, we further strengthened our balance sheet by generating cash in the quarter leaving us with nearly $80 million and of course no debt. Our strong balance sheet is particularly important during this time of tight credit as it affords the company the opportunity to make selective investments to expand our business. A little later we will discuss one such investment we announced today, the acquisition of Mobix Interactive.
I will spend the next several minutes discussing highlights of our financial performance for the quarter as well as commentary regarding our financial guidance for the fourth quarter. I will then turn the call over to Tony Kelly, Managing Director of ODG, and our media services operation in London. Tony will provide an in-depth description of Mobix and the strategic rationale for this acquisition.
Our software operating segment had a robust quarter with revenues of nearly $38 million which was up 29% from comparable revenues last year. As Kevin mentioned earlier our VOD software business had very strong top line performance assisted by the renewal of the Comcast mass to purchase agreement. This has enabled the company to book significant software services upgrade revenue during the quarter. The company’s signing of this contract extension is more than a financial benefit during the quarter. The [reason] SeaChange is one of Comcast’s preferred sources for video on demand software, hardware, and services. SeaChange initially rolled out its VOD systems to Comcast in 2003 and continues to work closely with Comcast to offer the best quality experience for Comcast video on demand users.
With the Comcast contract extended through 2009 the company will continue working collaboratively with Comcast as it rolls out its next generation on demand platform. Our VOD software business continued to benefit from active deployments at Cox. During the third quarter we converted an additional three sites through a competitive product Axiom. In addition we licensed additional Axiom software for VOD stream expansion at four sites and converted Axiom in the third quarter or in earlier quarters this year.
Over the last four quarters we have converted nine of Cox’s sites to Axiom based VOD software as part of Cox’s plan to standardize its VOD software platform with SeaChange. We expect to license more active software in the fourth quarter through a combination of site conversions of competitive software and expansions of sites that have been converted in prior quarter’s or would be converted this quarter.
Software revenue growth in the quarter compared to last year was helped by an increase in advertising insertion revenues similar to the last several quarters. The company saw a substantial demand for insertion software driven by increased numbers of high definition television channels by North American service providers. While we saw sequential and year-over-year reductions in service and storage revenue and in a traditionally lumpy business segment, we had significant sales in the quarter. The company further strengthened its position with a large Canadian MSO with a sizeable VOD service shipment during the quarter through a combination stream expansion.
In addition we shipped during the third quarter first VOD server and software products to a medium sized domestic cable television provider to displace one of our larger competitors. This win, combined with the Motorola layoffs in its [broadbox] operation further expands the leadership position of our new storage and flash server products.
Our media services business segment in the third quarter results begin to display the geographical diversification of its customer base. During the quarter ODG generated revenue from contracts from customers based in Greece, Turkey, and Brazil. In addition, ODG doubled the year-over-year contribution they received from the content services it provides to its German joint venture with the Telemunchen group.
ODG’s strategy of migrating its content aggregation success in the U.K. to other regions is beginning to bear fruit. However, the financial crisis that has dominated the news globally has had an impact on ODG relative to the weakening British pound. In fact, while media services revenues have been essentially flat in this year’s third quarter compared to the same quarter last year if one was to maintain constant exchange rates media services revenue would have been up by 50% compared to last year. Media services revenue is expected to improve further as contracts at telecom operators in Greece and Turkey continue to wrap up. New contracts are in the pipeline and are being finalized and ODG is beginning to consolidate Mobix’s financial results, all of which Tony will discuss momentarily.
The operating leverage of our business has never been more apparent than in our third quarter where our record contribution of revenue from our software business set another record gross margin of 54% for the company for the quarter. While we are quite proud of the 62% gross margin generated by our software business in particular in the third quarter, what was equally important was the 42% gross margin in our service and storage business unit in the quarter despite a 30% sequential drop in revenue.
Continued manufacturing cost containment and a solid base of recurring maintenance revenue derived from our industry leading installed base of video service helped cushion the reduction in revenue. The drop through in gross margin combined with the company’s continued emphasis on operating expense containment led to our fifth consecutive quarter of profitability and improved earnings growth since the beginning of this fiscal year.
Turning to our guidance for the remainder of fiscal 2009. We continue to expect top line growth will be 10% higher for fiscal 2009 compared to fiscal 2008. Revenue guidance for the remainder of the fiscal year is driven by our expectation of continued spending from North American cable and Telco operators on VOD software products. Two, continued high levels of advertising insertion shipments to satisfy increased high definition television channel requirements. Increased VOD and broadcast revenues from customers outside North America, particularly Europe.
Similar to previous quarters we expect the company to be profitable for the fourth quarter driven by VOD and advertising insertion margin strength and containing of operating expenses. Before I turn things over to Tony, I want to make a few comments about the prospects for SeaChange while in the midst of a very difficult financial period.
My point is not to provide specificity as to how we view our fiscal 2010 which begins on February 1 of next year. We can’t at this time because our customers are still fine-tuning their operating and capital budgets. My points is to express the belief that the fundamentals in our industry continue to support the rapid expansion of time-shifted television. My belief stems from our basic thesis to investors that as more and more content migrates to VOD SeaChange prospers through its leading position in the industry.
If you look at our customer’s VOD activity, the movement of content to VOD continues to ramp up. Both Comcast and Verizon are unwavering in their commitment to provide more than 1,000 HD VOD titles by year end with more available in 2009. Comcast’s Project Infinity with the goal of increasing the number of movies on demand by a factor of five continues to progress. Cox followed up its success with My Primetime offering of Cox ABC primetime programs on demand by replicating this service with NBC and Fox. Cox now offers My Primetime in four cities. Furthermore, Verizon is now beginning to offer ABC’s video services on demand.
These developments point to rapid service provider movement towards accommodating time-shifted television which positions SeaChange for long-term revenue growth, margin expansion and cash generation.
I will now turn it over to Tony Kelly who will discuss the reasons for our acquisition of Mobix.
Good evening everyone. I just want to tell you a little bit about the reason for our acquisition of Mobix Interactive. A little bit about the market first.
As mobile networks and handsets mature, and unlimited data plans proliferate, mobile video will become one of the fastest growing markets in video consumption. The mobile video market according to Price Waterhouse Coopers is expected to grow at a compound rate of 29% to reach $3.9 billion by 2012. SeaChange and ODG are recognized as a strategic necessity to participate in this rapidly expanding arena as many of our new and existing customers move to offer these expanded services.
ODG’s recently signed contracts to aggregate IPTV content services with telephone operators like Telecom Austria, [Helena] Telecom in Greece and Turk Telecom are either just starting or are about to launch over the next six months. All of these companies are aggressively tackling the IPTV space but also have significant mobile operations and we believe they will want to offer a single-branded singular service across all platforms.
The acquisition of Mobix Interactive enables SeaChange to extend its offerings of real three screens, triple play solution and become the only independent VOD player actively delivering content across all platforms.
A little bit about Mobix. London based Mobix was founded in 2002 and has become a leading provider of mobile video and TV services to mobile network operators and media owners. It has built a mobile, video and TV platform, Adrenaline, that is provides as a managed service to enable network operators to deploy mobile video and TV services to their users. It also provides services to media companies and mobile handset manufacturers wanting to deploy mobile video and TV content under their own brand name. The Adrenaline platform enables both operators and media companies to monetize video in a number of ways including the real time insertion of video advertising which can be targeted to particular users, an area that is obviously expected to grow in the coming years.
Today, Mobix customers who include O2 and three in the U.K. and Vodacom in South Africa reach over 50 million mobile users and it delivers over 20,000 hours of mobile video each month with approximately 30 employees headed by an experienced management team. It is a company that has meaningful growth opportunities and one that can deliver other benefits to ODG and SeaChange including the following: Speed to market is really important. The acquisition of Mobix will not only avoid the substantial cost to develop comparable solutions and client relationships but will also remove the years of development time needed to get to the level Mobix is at today.
The integration of the Mobix business means ODG will be the only VOD Service Company delivering content, cable, IPTV, mobile and internet platforms, thereby creating a unique market position and strategic advantage for ODG and SeaChange. There are cross-selling opportunities. The acquisition broadens SeaChange and ODG’s customer base and creates valuable cross-sale opportunities. We believe Mobix services have the potential to be sold to a host of ODG’s customers through our own mobile platforms and we also believe that ODG services and content have the potential to be sold to Mobix customers.
Cost synergies. Most of the mobile content consumed today has been of the short-form nature, between 1-5 minutes in length. Much of this content includes high volumes of music content, already acquired and processed by ODG for many of its clients today. In addition, the new Mobix services launching later this year will be centered on subscription video on demand services and will change the genre mix allowing for longer form content such as full-length TV episodes to be made available. ODG is again already processing and acquiring this content for a number of its TV platforms.
ODG therefore confidently believes there are synergistic savings to be made across the businesses in the areas of content acquisition, content processing and in the creation of retail marketing tools such as [box] channels, etc.
Strategically, this acquisition offers SeaChange the ability to create a set of platform tools under a differentiable media services brand. If broadband operators focus on mobile delivery to complement fixed line and online delivery, SeaChange will be able to offer a comprehensive service platform. Development time and costs associated with integrated mobile features to our market leading VOD software, Axiom, can be reduced or removed as Adrenaline contains similar components employed within the Axiom family of products.
In particular, it will enable consolidation of product management including [ingest] and trans coding, advertising campaign management, advertising insertion and subscriber management system integration.
Finally, the Adrenaline platform contains some of the components employed with an ODG VOD content rights software manager, VZ, which allows for consolidation of functional development and the ability for the creation of a single platform that can deliver content to both mobile and fixed line platforms.
I’ll turn the call back to you now Bill.
I think we are now ready for question.
(Operator Instructions) The first question comes from Greg Mesniaeff - Needham & Company.
Greg Mesniaeff - Needham & Company
I was hoping you could give us a little more color on the upgrade of the installed base of your older VOD servers with the Axiom platform, particularly beyond Cox and Comcast which you have already mentioned.
Specifically you want to know what the status is.
Greg Mesniaeff - Needham & Company
If you can give us some color as to where some of your MSO customers are in their upgrade time line for Axiom if that is possible?
It is moving along very well. We signed up several more upgrade customers. I’d like to be able to list who they are but I’m not sure we have made public announcements on them. Within North America we have moved beyond the ones you knew of and several more. Then we have a few more in the process of signing up that we plan to complete soon and so I think that growth is steady and especially as we add more and more features to move to more of a content distribution network as we add more content management functions and more advertising functions and network PDR support, some of these really big things, I think some of the operators are really seeing the value to sign up for upgrades. So that is continuing on.
Greg Mesniaeff - Needham & Company
As far as your ICM customers are some of them new customers that were not previously customers of your older product?
We do continue to sign up new customers as well, but there are separate efforts. One is which trying to take existing customers and have them continue to pay for upgrades so they can see an ongoing value of new releases and paying for new releases. The other is signing up new customers to do both purchase a license as well as be ongoing upgrades.
I’d like to point out there aren’t many accounts that aren’t our accounts in the U.S.
The next question comes from Blair King - Avondale Partners.
Blair King - Avondale Partners
On this Mobix thing perhaps there is a way to extrapolate exactly what it might mean in terms of your business, in terms of the SeaChange business not just over the next year but over the coming years in terms of how you segregate it and where it fits into the puzzle and what the revenue opportunities look like and how you think of the cost structure of adding that business into the mix over the next couple of years.
Certainly having Tony Kelly on the call should give you an indication that it will be part of our media services business segment. More specifically it would fall under ODG. I think from a revenue perspective we would look at Mobix as potentially being the size from a top line perspective the size of ODG over the next years given all the potential growth Tony talked about in his remarks. I don’t know if that answers all your questions. If it doesn’t.
Blair King - Avondale Partners
Should we expect an incremental increase in operating expenses any time soon?
Yes, obviously we are in the midst of beginning the integration of the two companies. There will be some integration costs associated with that which I would characterize more as one-time. We will incur probably some this quarter and in the first quarter of next year. But by and large I think the cost we will be incurring on that business in total will be third-party costs at Mobix as opposed to other costs. I think characterizing the business as similar to ODG in terms of a cost structure and so forth is probably comparable at this point.
Just to be clear, the revenues now are fairly small in the $3-4 million range annually. So we are talking about a great deal of growth in the coming years. We are hoping to have this thing turn profitable either towards the end of next year or the following year for sure.
Blair King - Avondale Partners
I wanted to dive a little more deeper on your comment on the Primetime television shows being more available on demand and ask you is there any evidence that statistically reveals an increase in usage or frequency of usage among the VOD users as Primetime content is made available?
Yes there is but we are not free to disclose that.
Blair King - Avondale Partners
I know Warner Brothers has been making new release movies available on demand and seemingly the release window has been shrinking. I think that Warner Brothers is doing that via the Internet but I was wondering if there is any comment on the day and date topic.
We are obtaining the licenses from a lot of content from Warner Brothers for a number of territories and it is true to say that Warner’s is an example of one of the studios that is making selective content available day on day on video on demand in a number of places. That is having a very significant impact on the usage from the customer base for that particular content. As a result of that we have seen a number of other studios reducing their windows as well which is all good news to video on demand since it makes it a more popular pass down and an easier way for consumers to consume media entertainment. That has been a reality now for four months time. That has been rippling around the world starting in the U.S. but it has moved to the U.K., Germany and a few of the other major markets. It is not just on the internet, it is day on day on video on demand as well.
The next question comes from John [Zarrow] – BCM.
John [Zarrow] – BCM
I have to ask the question that is out there in the world today. I’m just curious what you guys are seeing out there. Given how your business is and it is much more of a long tail, are you seeing any type of push back or people trying to delay or holding?
No we haven’t. In fact I have been kind of bullish on our go forward outlook. We have the fortunate advantage of having much of our revenue being recurring and that is increasing. You heard about the content increasing and that is positive for us. We have more and more multi-year purchase agreements with committed purchases. We have great relationships. So I’m feeling pretty good about the quarter and next year despite all the difficult circumstances for everybody else.
John [Zarrow] – BCM
How about just on contracts in general. Obviously you are increasing the international contracts and things like that. Are you seeing just people not so much pushing back but just taking a little bit longer?
No, we haven’t seen much change in our business at all.
The next question comes from Todd Cooper – Stevens Inc.
Todd Cooper – Stevens Inc.
Given the Comcast deal in the quarter should we expect gross margins to fall back to the more historical 50% type range?
I think that we will approach our norm going forward but I think that they will be healthy going forward as well. Your statement I couldn’t argue with.
We are lumpy by quarter in our businesses. We see that but we see also a general improvement.
Todd Cooper – Stevens Inc.
As software picks up as a percentage of revenue?
Yes and as we further diversify accounts and geographies and products.
Todd Cooper – Stevens Inc.
Bill can you comment on any progress you have made in adding additional customers like Turk Telecom where you are the primary integrator rather than a third-party participant?
We have one more in the works. Hopefully we will be able to tell you something about it in the next 90 days.
There are no further questions at this time.
Let me finish by reiterating my comments on performing well in the next quarter, next year and beyond. Despite the general global downturn, the reasons are these; more content, more HD and more Primetime and time shifted. We have an increasing amount of recurring revenues and they make up about half our quarterly revenue. We have multi-year contracts with committed purchasing and most importantly our positioning in more of our accounts continues to improve. Our accounts are happy and doing well with us. Thank you for calling in tonight. I look forward to having another good report for you in about 90 days. Have a good evening.
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