SeaChange International Management Discusses F4Q 2013 Results - Earnings Call Transcript

SeaChange International (NASDAQ:SEAC)

F4Q 2013 Earnings Call

April 10, 2013 8:30 am ET

Executives

Monica Gould - Investor Relations, The Blueshirt Group

Raghavendra Rau - Chief Executive Officer and Director

Analysts

Michael A. Kupinski - Noble Financial Group, Inc., Research Division

Todd T. Mitchell - Brean Capital LLC, Research Division

Greg Mesniaeff - Maxim Group LLC, Research Division

Steven B. Frankel - Dougherty & Company LLC, Research Division

Richard Ingrassia - Roth Capital Partners, LLC, Research Division

John Aniblo Zaro - Bourgeon Capital Management, LLC

Michael Needleman - Preservation Asset Management

Operator

Greetings, and welcome to the SeaChange Fiscal 2013 Fourth Quarter and Full Year Results Call. [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, Kevin. Good morning, everyone, and thank you for joining us. SeaChange released results for the fourth quarter and full fiscal year 2013 ended January 31, 2013, yesterday after the market closed. Our earnings release includes prepared remarks regarding our results in the pages that follow the financial tables, along with a GAAP to non-GAAP reconciliation for each of the last 8 quarters. 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 to 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 5, 2012. Any forward-looking statement 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.

[Technical Difficulty]

Operator

We're experiencing technical difficulties. Please be patient. Thank you.

Raghavendra Rau

All right. Okay, I'm going to begin -- start from the beginning. Thank you, Monica. Good morning, and welcome to the SeaChange Fourth Quarter Earnings Call. We're very pleased with our results in the quarter, which are a testament to the significant progress we have made on our transformation strategy since it was first announced last year.

Our fourth quarter revenue grew 14% sequentially to $44.6 million and was in line with the guidance we provided.

Non-GAAP operating earnings per share on a fully diluted basis was $0.28, which significantly exceeded our guidance range of $0.18 to $0.21 per share.

The strong performance during the quarter and for the full year was driven by the sales of our new product, increased product licensing revenues and aggressive cost reduction actions led by the growth of our new products. Product revenue rose 55% sequentially to $23.6 million and represented 53% of total sales, up from 39% in the third quarter.

Our blended gross margin rose to 60% on a non-GAAP basis and was driven by higher gross margin software licensing revenue, along with other revenues that we recognized in the quarter, for which costs were incurred in prior periods. As a result, our non-GAAP operating margins increased to 21% compared to the 7% we posted in the third quarter.

On a full year basis, we reported revenue of $157.2 million, which was within our guidance range of $155 million to $159 million, and non-GAAP operating income of $15.9 million or $0.48 per share -- per diluted share, which was significantly higher than our guidance range of $0.38 to $0.41 per share.

Since we articulated our transformation strategy a year ago, it would be fitting at the end of our fiscal year 2013 to reveal the progress we have made thus far.

The first element of our strategy was to become a software-focused company. By May 2012, we successfully divested the Broadcast Servers and Storage business and the Media Services business for a purchase price of over $33 million, allowing us to focus on our core Software business.

Our focus on core service provider customers has enabled us to achieve design wins with 6 new service providers in fiscal 2013 in Europe and the Americas, as well as a number of design wins from our existing customer base.

Our focus on next-generation products has resulted in over 40 design wins for Adrenalin and the launch of Liberty Global's high-profile Project Horizon with Adrenalin.

Along with VOO, a leading service provider in Belgium, SeaChange won the 2013 Cable Europe Innovation Award for the launch of the VOOmotion service based on Adrenaline's multiscreen capabilities.

Our advertising products won an Emmy award earlier this year and we are expecting new design wins for award advertising product in Europe.

Through a combination of divestitures and non-core assets and core cost reductions, we reduced our overall headcount by 431 positions, and our overall operating expenses decreased by more than $18 million relative to fiscal 2012.

The OpEx reduction is $3 million higher than the guidance of $15 million we had given at the beginning of fiscal 2013.

Our balance sheet continues to be very strong. During the quarter, aided by strong collection efforts, we generated $19 million in operating cash flow and ended the quarter with a cash position of over $120 million.

As we enter our fiscal year 2014, we're very pleased with a double-digit revenue growth that our new products achieved last year. We now have a strong portfolio of both QAM and IP-ready offerings. With cable, telcos and mobile operators all embracing IT convergence, SeaChange now has opportunities to expand further beyond cable.

Our service-oriented architecture also enables us to incrementally add new complementary products with minimal investments.

In fiscal 2014, we fully intend to continue to execute on our transformation strategy as a software-focused company and continue to keep a low cost structure. Revenue growth will be a big area of focus for us this year. I will share with you some details of our strategic growth plan that we have already begun to implement. This plan will enable us to achieve steady, double-digit, long-term growth. The key elements of our strategic growth plan are as follows: number one, upgrade existing cable customers to the next-generation Adrenalin multiscreen video platform and Infusion Advertising Platform; Two, replace competitor legacy deployments with the best-in-class next-generation Adrenalin multiscreen video platform and Infusion Advertising Platform; three, continue design wins with service providers for our Nucleus gateway software; four, develop new related businesses in certain identified areas that can be scaled to multiple service providers in fiscal 2015 and '16. Examples of this are content management and managed services offerings; five, win a major reference account in the mobile service provider space in fiscal 2014 that can be scaled to multiple locations subsequently. We have been working hard on this for the past several months and are hoping to announce at least one design win before the end of this calendar year; six, expand within the telco IPTV service provider space. I'm pleased to let you know that Adrenalin has already been designed in by 2 telcos and we intend to build on that success; seven, expand our efforts in sales and marketing in fiscal 2014 to grow in other major geographies: Asia, Middle East and Africa. We've already begun to work with channel partners in these territories.

To summarize, in our fiscal 2014, we will continue to execute on our transformation strategy and keep a lean cost structure as we implement our strategic growth plan. We achieved double-digit growth in fiscal 2013 with our new products. We expect strong double-digit growth in fiscal 2014 with our new products. In the near term, this growth will be balanced somewhat by the decline in some of our legacy products.

As in previous years, we expect revenues in the second half to be significantly higher than in the first half. We anticipate that our first quarter fiscal year 2014 revenue will be in the range of $34 million to $36 million, and non-GAAP operating income on a fully diluted share basis will be in the range of $0.01 to $0.04 per share. We anticipate the seasonality in this year's first quarter to be more dramatic than in the prior year because of significant decline expected in this quarter of some of our legacy products, most notably video streamers. This decline will moderate in the future quarters.

On a full year basis for fiscal 2014, we anticipate that revenue will be in the range of $165 million to $175 million and non-GAAP operating income on a fully diluted share basis will be in the range of $0.53 to $0.71 per share.

In conclusion, I would like to reiterate that I am very optimistic about the customer demand for our new products. We have a large number of new product deliverables scheduled for this fiscal year with both new and existing customers, many of which require customization and localization. Our guidance reflects our desire to address this demand in a measured way and keep our costs in control to ensure both short- and long-term profitability. Thank you.

With that, I would like to hand the call back to Monica.

Monica Gould

Thank you, Raghu. We will now be happy to take your questions. Kevin, could you please provide instructions for the Q&A session?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today is coming from Michael Kupinski from Noble Financial.

Michael A. Kupinski - Noble Financial Group, Inc., Research Division

First of all, I wanted to address the margin issue in the fiscal fourth quarter in the service side. Obviously, revenues were a little weaker there, but yet expenses were up. And I was just wondering if you can address that and what your thoughts are going forward. And then secondly, your R&D expenses going forward, if you can address your thoughts about that. And then my third question would be your FTEs. I was wondering if you can give us some thoughts about your headcount in the fiscal fourth quarter and what your headcount's looking like in -- for the full year 2014?

Raghavendra Rau

All right. Let me first address the margin question. As we have explained, the margin decrease in the services business is due to the fact that the cost remained fairly constant while the service revenues came down. This is because we want to continue to keep our services people as we expand our business and build our new products. In the last quarter, new products accounted, for the first time, of almost 44% of our total product revenues and compared to over 36% for the full year. So as we expect this year, new products will be more than 50% of our overall product. So we needed to keep the services people to be able to implement many of these new products. That was the reason for the margin decline in Q4 in the services area. And the results of some product mix, the more you have install information versus higher value-added services, again, results in a margin decline. The second thing was R&D. This is another year where we'll continue to invest in R&D. It's not going to be significantly higher in absolute terms than the previous year, but maybe about $1 million more than what it was in the previous year. It will still account for in excess of 23% of our overall revenues. The third one was headcount. We continue to watch headcount. Last year, we had about a 76 headcount reduction and we expect to try and keep headcount fairly constant as we increase our overall revenues so as to be able to get greater operating leverage.

Michael A. Kupinski - Noble Financial Group, Inc., Research Division

Have you been adding headcount in your services side then? I mean, I guess I was -- I'm just curious what the headcount is doing by segment.

Raghavendra Rau

No, we haven't disclosed headcount by segment, but we have not really added in the services area. What we have done is replaced any attrition that we may have had.

Operator

Our next question today is coming from Todd Mitchell from Brean Capital.

Todd T. Mitchell - Brean Capital LLC, Research Division

You gave some color just in the last answer about the percentage of new products coming online in double digit, basically. I was wondering if you could kind of flesh that out a little bit, more specifically in terms of how it relates to the revenue breakdown between products and services. Can we expect services to kind of have a constant base and that the variability in the numbers is basically from new products coming online while the old legacy products are attritioning but are -- is a relatively constant number? Is that the way to think of this?

Raghavendra Rau

Yes, to a large extent. As I mentioned, 44% of our product revenue in Q4 was new products and this included both Nucleus, as well as -- Nucleus, our gateway software product, as well as Adrenalin. As far as the decline in legacy products and how we make up, the decline in legacy products last year was fairly significant in Axiom, came down from almost $16 million to about $4 million, almost a $12 million reduction. However, that decline is going to be moderated because we expect to sell almost the same amount as Axiom. However, the decline this year is going to be in other 2 legacy products, which is streamers and in our spot in Ad Insertion products, where we expect a decline of about $10 million. However, we are going to make up those declines by the sale of our new products. And as I mentioned earlier, we expect new products as a percentage of all of the products to be in the range of about 50% plus.

Todd T. Mitchell - Brean Capital LLC, Research Division

Okay. And as these new wins come online for new products, is there a lumpiness to recognition on -- revenue recognitions on the new products that then later smoothes itself out?

Raghavendra Rau

Yes. Last year and this year, you will continue to see some lumpiness because of the nature of when we can recognize revenue for product licensing, both for our Nucleus software as well as for Adrenalin. However, this will moderate in the future years as renewals come up and more licensing happens on a more regular basis. As we introduce these new products and as the take-up continues, there will be lumpiness based on our pricing module.

Todd T. Mitchell - Brean Capital LLC, Research Division

Okay. Last sort of question here. So if we look at the 1Q guide, can we basically assume that the revenue mix goes heavily towards the service side and the dynamic that's happening there is that there's no big deals that are being -- getting revenue recognition in the first quarter?

Raghavendra Rau

Yes, that is partly true, but the big decline is really in the video streamers in Q1 versus the previous Q1. Last Q1, we had about $4 million in streamer revenue, whereas it's fairly negligible amount this year. Though overall decline in streamers is expected to be only $6 million, therefore, you're going to see the -- most of the decline happen in Q1, but it's moderated for the next several quarters.

Todd T. Mitchell - Brean Capital LLC, Research Division

Okay. And I'm sorry, last question. Can you -- you've given growth rates for each of the 3 kind of core software businesses. Do they remain the same or -- and can you reiterate them?

Raghavendra Rau

No. We haven't given the growth rates by product. Our overall growth rate, based on the guidance range we've given, is between -- varies between, say, 6% or 7% to almost higher than 10%.

Operator

Our next question today is coming from Greg Mesniaeff from Maxim Group.

Greg Mesniaeff - Maxim Group LLC, Research Division

Raghu, I have 2 questions for you. In your discussion of your strategy, the multi-point strategy that you outlined, a significant part of it, obviously, is upgrading the installed base to next-generation software and products. Can you give us some color as to how that process occurs in terms of -- is some of that business gets ready to be replaced, does they get opened up for competitive bidding? Or is that pretty much a shoe-in opportunity for you to upgrade?

Raghavendra Rau

It's never a shoe-in opportunity, but a big advantage we have is our legacy product is working extremely well. In fact, one of our major customers, I was reviewing some stats last week, is doing, on our legacy product, about 500 million streams a month with less than 1% error rate. And so -- and the operational people in those accounts are very used to using our product. So in terms of backwards compatibility to our existing product line, we have obviously a very significant advantage besides the relationships that incumbency brings. So while it's not a shoe-in, we believe we do have the best enterprise-class solution and that's why, as I mentioned earlier in my remarks, we have won 6 new service providers and these are service providers who did not have our legacy back office platform product.

Greg Mesniaeff - Maxim Group LLC, Research Division

And assuming you have this advantage, which I'm sure you do, what kind of pricing implications does it carry for new products?

Raghavendra Rau

Yes, the price -- the new products do provide some significant additional functionality. If you take the back office platform for instance, besides providing additional functionality of the multiscreen capability, you also get centralization, regionalization so you can save on OpEx cost considerably. It's a new service-oriented architecture so you can add on, bring on third-party products more easily because of the open interfaces and some very compelling reasons for them to want to make this change.

Greg Mesniaeff - Maxim Group LLC, Research Division

But do you anticipate any aggressive pricing moves from your -- some of your customers as some of this installed base gets upgraded?

Raghavendra Rau

Yes. I mean, we always expect competition. But with the way we price and because of all this new functionality I was describing, we are able to price based on value that we generate. And as multiscreen becomes more popular, companion devices become more popular, more prevalent, advertising opportunities on these companion devices become more targeted and coordinated with what you're watching on your main screen, yes, these are all opportunities which our technology enables, creates new value for the service provider and therefore, we believe we can price based on this value. Now we always have competitive pressures.

Greg Mesniaeff - Maxim Group LLC, Research Division

One last question. One of your major competitors, Ericsson, announced the other day a fairly significant acquisition of Microsoft's Mediaroom. I was wondering if you can comment on any competitive landscape implications for you on that.

Raghavendra Rau

Right. Mediaroom was used by a few very large operators globally and -- but it was a technology, we believe, was not being supported in the future. And -- so Ericsson has bought that probably for its customer base, mainly telcos and where -- which is an area we intend to go. We believe we have a very competitive product against the Mediaroom product, and we will compete in the telco space.

Operator

Our next question is coming from Steven Frankel from Dougherty & Company.

Steven B. Frankel - Dougherty & Company LLC, Research Division

In terms of the Adrenalin business, you mentioned you had 40 wins there. Could you tell us how many of those are live today? And what's the rollout plan between now and the end of the year? Are most of those likely to be rolled out this year?

Raghavendra Rau

Well, within -- I would say within the next 18 months, all of them should be rolled out. Of the 40 wins that we have announced, we probably -- at least higher than half are already in operation. As I mentioned, most recently in August, we launched Project Horizon of Liberty Global with the SeaChange Adrenalin back office.

Steven B. Frankel - Dougherty & Company LLC, Research Division

Okay. And let's switch and talk about Nucleus. Can you give us an update there on your competitive positioning? Kind of what's the competitive environment and what's the pipeline look like in terms of potential new wins?

Raghavendra Rau

Right. In terms of the competitive landscape, I mean, we have been chosen by the world's 2 largest operators and our software has been designed in by the world's -- those 2 largest operators. Our competitors there are existing set-top box manufacturers who may want to build that themselves, though we haven't seen that in any significant form. We have at least 7 or 8 of the world's largest operators talking to us as we speak, in terms of doing proof of concepts or actually designing our product into their future roadmap. So we're very encouraged by that. We've had, as I previously mentioned, a very significant growth rate in that product line. Our challenge there, and this is what I alluded to in some of my prepared remarks, is how do we ensure that we continue to remain profitable, because while handling business that we can handle in a profitable manner so -- without increasing resources too heavily to take care of the demand over the next 1 or 2 years? So we're moderating and doing this in a really measured way and ensuring that all of the installations -- we meet all of our customer commitments.

Steven B. Frankel - Dougherty & Company LLC, Research Division

Okay. And in terms of your mix between front-half and back-half revenue, will we see a return to year-over-year revenue growth in Q2?

Raghavendra Rau

We haven't given guidance for Q2 as yet, so I don't want to go there today.

Operator

Our next question is coming from Richard Ingrassia from Roth Capital Partners.

Richard Ingrassia - Roth Capital Partners, LLC, Research Division

Raghu, can you say a little more about the effort in the mobile space, maybe scope the potential size of that business and just give us an idea of how much of your operating resources are being pulled in that direction for the sales and marketing, R&D, that sort of thing?

Raghavendra Rau

Right. The beauty of the solution is, since we're already IP ready, it's something that can go very neatly with minimal modification into the mobile space. Now why do mobile operators need this? Because mobile operators also need to have a video strategy. They need to take advantage of people watching on multiple screens and not let their subscribers be consumed by the cable operators or the IPTV service providers. So we have been working with probably one of the world's leading mobile operators and -- for the last several months, and we're really hoping that we'll be able to announce a design win before the end of this calendar year. The deal size for our mobile operator, it all depends. For just one property, could be in the $1.5 million, up to $2 million range, depending on how extensively they want to roll this out. But that's a sort of a typical start size for a very -- a fairly large operator, mobile operator.

Richard Ingrassia - Roth Capital Partners, LLC, Research Division

Okay. And then just finally, any comments on use of cash for fiscal '14?

Raghavendra Rau

Right. I have previously indicated that the cash we have and what we expect to generate this year is in excess of what we require for our operational purposes. I've also stated that we're not contemplating any large acquisitions. I expect the board will consider the possibility of reinstituting the 10b5 plan to buy back our stock in the near future as we had in the past.

Operator

[Operator Instructions] Our next question is coming from John Zaro from Bourgeon Capital.

John Aniblo Zaro - Bourgeon Capital Management, LLC

A couple of questions. One, and just a sort of clarification on my part, I guess, the first quarter guidance takes into account the fact that we're basically going to see this big -- this continued drop and sort of leveling off of the streaming products and the fact that you're trying to do, as you have in the past, trying to just smooth out these installations to make sure that you don't have any problems as you're revving them up. Doesn't have anything to do with the fact that you aren't having as many wins and design wins as you plan and anticipate, correct?

Raghavendra Rau

Right. John, you are correct on both accounts. As I mentioned, for streamers, in the first quarter of last year, streamer revenue was in excess -- product revenue was in excess of $4 million. This year, it's going to be in the hundreds of thousands.

John Aniblo Zaro - Bourgeon Capital Management, LLC

Right. And is that accelerating any worse or any different than what you thought it was going to be?

Raghavendra Rau

No, the overall decline is going to be, from about $12 million, is going to be about $6 million. So the overall decline is about $6 million, $4 million of which is seen in the first quarter. And so that will moderate in the future quarters.

John Aniblo Zaro - Bourgeon Capital Management, LLC

So that's really the only -- so that and making sure what you've been doing all along, anyway?

Raghavendra Rau

Right.

John Aniblo Zaro - Bourgeon Capital Management, LLC

So making sure that you implement each of these things so that you don't -- continue to have the 500 million-like streams with only having less than 1% errors?

Raghavendra Rau

Exactly. And so that was the second part of your original question. And clearly, what we're doing is moderating our -- the cost to ensure that we roll these out in a measured and timely way. And our demand is far greater than what we can handle at this time in terms of development and implementation.

John Aniblo Zaro - Bourgeon Capital Management, LLC

Right. And is there -- in your mind over -- if you sort of look back over the last 6 months, are you ahead of where you thought you'd be from an order standpoint? Are you behind or -- I mean, is that -- are you -- do you feel like you're on the same path or even better than you thought you'd be?

Raghavendra Rau

In some cases, I have to say we're better than what we thought we would be. But we were fairly optimistic that we were investing in the right products at the right time, and that's why we chose these 3 areas to particularly focus on.

John Aniblo Zaro - Bourgeon Capital Management, LLC

All right. Okay. Well, I mean, you've done an incredibly remarkable job turning this thing around, so hats off to you. One thing related to the -- to just the cash. I know that there was some hesitation before because of these related lawsuits and various issues that were, hopefully, in some cases, finally put to bed and also the fact that there was a final payment that you guys were getting towards the end of the year. But I'm assuming that the board and everybody is planning on trying to accelerate what they're going to do with this cash.

Raghavendra Rau

Yes. As I remarked in an answer to Richard's previous question, yes, I fully expect the board will consider the possibility of reinstituting our buyback plan.

John Aniblo Zaro - Bourgeon Capital Management, LLC

Because we pretty much -- I mean, all of the issues that were -- that I had talked about are -- have pretty much been taken care of?

Raghavendra Rau

Right.

Operator

[Operator Instructions] Our next question is coming from Michael Needleman from Preservation Asset Management.

Michael Needleman - Preservation Asset Management

I realize that you're not giving specific guidance as far as the second quarter, but I wonder whether or not you might help everyone from the standpoint of your comments on -- that revenues in the second half would be accelerating. What gives you comfort in saying that? And is that coming from the new sales in licensing that you'll be able to start to recognize? And then I have a second question as well.

Raghavendra Rau - Preservation Asset Management

Right. The answer to your question is we have a lot of visibility into the design wins we have already won, and we're in the process of collecting the requirements, ensuring that we build out, prioritize the rollout of some of these new installations. And so we're not waiting so much for design wins except in some cases, but we have a fair amount of visibility and timelines of when the development and installation is planned. So that's why we are very confident that the second half will be significantly better than the first half, like it was also in the fiscal year '13.

Michael Needleman - Preservation Asset Management

And the second question pertains to margins in regards to how you see the overall margins of your company exiting this year. I'm not looking for specific guidance. Having said that, should we think about the overall margins of the company? At what type of level exiting 2014 do you think you can possibly achieve?

Raghavendra Rau

Right. Our long-term gross margins are about 55%. Now we did achieve in Q4 really favorable product mix, 60% gross margin. I would see us being a couple of points less than the 55% for this year.

Michael Needleman - Preservation Asset Management

And the reason for that is just the way that the sequence will kind of hit in terms of software license revenue versus service revenue? Is that why you see the margins in that level?

Raghavendra Rau

Right. The big reason for the very significant increase in margin was the product mix, the mix of licensing versus hardware in the product, as well as the product of the services mix. So yes, because of those reasons, we expect it to be a little less than 55% this year. But we clearly have the ability, when all these new products are launched and licensing revenues are maintained, that we will be able to generate 55% on a normalized basis.

Operator

Thank you. If there are no further questions at this time, I'd like to turn the floor back over to management for any further or closing comments.

Raghavendra Rau

Again, I thank all of you for participating in this call, and we fully understand we're working for our shareholders and that's what we will continue to intend to do. Thank you.

Operator

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time, and have a wonderful day. We thank you for your participation today.

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SeaChange (SEAC): Q4 EPS of $0.28 beats by $0.09. Revenue of $44.6M misses by $0.09M. Shares -10% AH. (PR)