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SeaChange International, Inc. (NASDAQ:SEAC)

February 25, 2014 5:00 pm ET

Executives

Monica Gould

Raghavendra Rau - Chief Executive Officer and Director

Anthony C. Dias - Chief Financial Officer, Chief Accounting Officer, Senior Vice President of Finance & Administration and Treasurer

Analysts

Todd T. Mitchell - Brean Capital LLC, Research Division

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

Hamed Khorsand - BWS Financial Inc.

Russell Anmuth

Operator

Greetings, and welcome to the SeaChange Preliminary Fourth Quarter and Full Year Fiscal 2014 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Monica Gould, Investor Relations for SeaChange. Thank you. You may now begin.

Monica Gould

Thank you, Shay, and thank you for joining us on short notice. Today, SeaChange announced preliminary results for its fourth quarter and full year fiscal 2014. The purpose of today's call is to provide some additional perspective on these results. Further details will be provided when the company announce its final results in a regularly scheduled earnings conference call in early April.

With me on the call today are Raghu Rau, Chief Executive Officer; and Tony Dias, Chief Financial Officer. As a reminder, today's discussion may include forward-looking statements as that term is defined in the Private Securities Litigation Reform Act regarding preliminary fourth quarter and full year fiscal 2014 results. Future events and the future financial performance of the company that are based on certain assumptions and that are subject to a number of risks and uncertainties. Actual events and results may differ materially from these expectations. Please refer to SeaChange's SEC filings for a discussion of risk factors that could cause actual results to differ materially from those discussed today. The statements being made today are as of February 25, 2014, and the company disclaims any duty to update them. Now I will turn the call over to Raghu.

Raghavendra Rau

Thank you, Monica, and good afternoon, everyone.

On today's call, we will cover our anticipated fourth quarter performance and provide a preliminary outlook for fiscal 2015.

We continue to expand the new product revenue from our next-generation multi-screen television, advertising and video gateway software platforms. During the fourth fiscal quarter, new product revenue grew to over 2/3 of total product revenue, up from 45% in the third quarter of fiscal 2014. However, delays in expected orders from customers, primarily in the Americas, combined with continued delays in final product acceptance, caused our fourth quarter results to fall short of the guidance that we provided on our fiscal year 2014 third quarter earnings call on December 5, 2013. Although we indicated that these issues affected our initial fourth quarter guidance during our December call, the magnitude of this impact was greater than we had anticipated. This was due to our customer concentration and the timing of our sales, wherein many sales occur towards the end of a quarter.

Despite this disappointing fourth quarter performance, I am pleased to report that based on our progress to date, we now expect to receive, in the first half of fiscal 2015, all of the customer acceptances that were missed in the fourth quarter. We also expect to receive, over the course of fiscal 2015, the majority of the orders we had anticipated earlier. These are short-term challenges, reflecting the timing issue between when legacy revenue falls off and when new product revenue begins to ramp more substantially. We remain encouraged by the continued market traction for our new products, which accounted for over 2/3 of our total product revenue in the fourth quarter. We are also enthusiastic about our new customer opportunities before us.

Notably, in the current quarter, we achieved our fifth design win for our Nucleus video gateway software with the new European video service provider, as well as a new design win for the Adrenalin multi-screen television platform with the same customer. We achieved acceptance of another Adrenalin deployment by a new customer in the Scandinavian region. And we received an order from a large North American customer to upgrade from its legacy Axiom video and demand platform to Adrenalin.

More recently, in the first quarter, we reached an agreement with another top-tier set-top box vendor to put our Reference Design Kit-based gateway software to their set-top box. Also, we received an order in the first quarter to upgrade a large North American service provider from its legacy SeaChange advertising platform to the new Infusion Advertising Platform.

As I have mentioned previously, we are in the midst of a 3-year transition from being primarily a hardware, media services and legacy software vendor to become a supplier of next-generation, multi-screen video software and services to the service provider sector. With the start of our new fiscal year on February 1, 2014, we have now entered what we believe to be the final year of this transition, after which, legacy product declines are unlikely to be material.

As I mentioned on our third quarter earnings call, we have several customers that are concurrently rolling out multiple SeaChange products and other customers who are evaluating products to add to their initial scope. The complexity of these rollouts, combined with the extended decision-making process on new products, has resulted in continued delays in revenues. We expect that we will continue to experience increased lead times and customer orders and acceptances during this transition. This trend, combined with significant declines in sales of our legacy products, suggests that revenues are likely to grow only in the second half of fiscal 2014 -- sorry, second half of fiscal 2015, and remain flat to down for the full year. However, we are targeting higher profitability in fiscal 2015 relative to our anticipated fiscal 2014 performance through cost reductions and increases in new product revenues.

We believe we are creating significant long-term value for our shareholders, both with the design wins we already have in place and with those we expect to receive, most notably for our Nucleus video gateway software in which we continue to invest. As such, we remain confident in the strength of our market position and long-term growth potential. Our long-term target model remains unchanged, with gross margins at or above 60% and operating margins at approximately 15%.

Tony will now walk you through some additional financial details of the fourth quarter and provide additional color on our initial guidance for fiscal 2015. Tony, please go ahead.

Anthony C. Dias

Thank you, Raghu.

Due to the issues Raghu mentioned impacting our results, we now expect fiscal -- fourth quarter fiscal 2014 revenues in the range of $34.5 million to $35.5 million, and non-GAAP operating income of $0.01 to $0.02 per fully diluted share on a share count of approximately 33.7 million. This compares to our prior guidance of $40 million to $45 million and non-GAAP operating income of $0.15 to $0.20 per fully diluted share. We anticipate a GAAP operating loss of $0.03 to $0.04 per basic share for the fourth quarter of fiscal 2014. Over 70% of our fourth quarter revenue came from services. Due to the highest service -- services revenues, margins for the fourth quarter were approximately 50%.

For the full fiscal 2014, we anticipate revenues in the range of $145 million to $146 million, and non-GAAP operating income of $0.24 to $0.25 per fully diluted share, and GAAP operating loss of $0.05 to $0.07 per basic share.

We ended fiscal 2014 with even stronger balance sheet. Cash increased to $128.1 million as of January 31, 2014, up from $126.4 million in the prior quarter, and we continue to carry no debt. Moreover, we implemented a 10b5-1 stock repurchase plan to execute, and our Board of Directors previously authorized 25 million stock buyback.

Due to the order delays we have experienced, combined with our continued legacy product declines, our preliminary outlook for fiscal 2015 suggests our revenues will be flat to down relative to anticipated fiscal 2014 performance.

SeaChange is targeting higher profitability in fiscal 2015 relative to our anticipated fiscal 2014 performance through cost reductions and increases in new product revenues. On our regular scheduled conference call in early April, we'll provide a detailed review of our fourth quarter and full year fiscal 2014 final results. In addition, we'll provide more details for fiscal 2015 guidance.

Thank you. With that, I will hand the call back to Monica.

Monica Gould

Thank you, Tony. Shay, could you please provide instructions for the Q&A session?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Todd Mitchell from Brean Capital.

Todd T. Mitchell - Brean Capital LLC, Research Division

One of the things that -- I've queried you guys on this before, but I'd like to kind of explore this issue again in this forum is, how can we think about the pipeline or a backlog number, and -- so that part of this thing here is you continue to win new deals but they keep getting pushed out in terms of revenue acceptance. Is there any way that you could provide us some kind of metric for what that pipeline or backlog looks like and distinguishing, I guess, between what you sometimes refer to as pipeline and what is financially known as a backlog?

Raghavendra Rau

Right. Thank you, Todd. Yes, let me give you some detail about the typical quarter in a little -- the structure of a typical quarter in a little more detail. Approximately 30% of our business is recurring. That is licensing and maintenance revenues, which we know we are going to get. Another 30% consists of design wins. We have a visibility, too, and it is dependent on acceptance, final acceptance. The remaining approximately 40% is revenue that is booked and shipped in the quarter. These are typically follow-on orders from existing customers and new orders upgrades from existing customers, primarily related to capacity upgrades, and feature and functionality enhancement. This is a bit harder to predict and is the area that led to our shortfall this quarter besides the issue of some acceptances. We take this very seriously, some -- but some things like timing of orders are sometimes out of our control. And considering the legacy declines we are expecting and the customer concentration and timing of our sales, we probably need to consider whether it is even prudent or possible to give a very specific guidance on a quarterly basis in this final transitional year. And also to answer your question most specifically about the pipeline, a lot of the revenue that we are able to recognize, particularly for Nucleus, we are able to recognize now only the professional services in revenue, but we'll recognize more revenue of license revenues when the deployments actually happen, and on the set-top box with SeaChange software is rolled out. And so there's a time lag between the design wins and when those rollouts happen. And those rollouts can happen as much as over the next 7 years. And so the fact that we have got some very significant design wins from some of the world's very large operators does give us a lot of long-term opportunity in terms of revenues and significant margins.

Todd T. Mitchell - Brean Capital LLC, Research Division

So, if I look at a deal for Nucleus and you get a mandate from XYZ service provider and you spend, what, 6 to 9 months kind of doing professional service work as you spec it out with the systems integrator and the OEMs that provide the hardware, and at some point, there's a customer acceptance, and then you go into a licensing mode. So if you work through the professional services component, isn't there a fair degree of surety that you have -- that you'll get the licensing component within and to some visibility, as to what kind of magnitude that will be within the next 12 minutes -- months of getting to the end of the professional services component?

Raghavendra Rau

Yes. We will, but it all depends on the rollout of the boxes. I mean we get -- let's say, our customer rolls out 100,000 boxes, then we will get a license component for those 100,000. As they rollout the whole network, convert the whole network subscribers to digital service, that's the period when we will get the balance.

Todd T. Mitchell - Brean Capital LLC, Research Division

And there's no way you can give us any kind of visibility on what these -- and is -- or is there some way we could think of it in terms of the formula of what the professional service component is as to the licensing component? I just -- it seems to be that you are winning design wins but this continual push out of the rev rec on the licensing component doesn't give a lot of people comfort. I mean, sort of what -- how can we think about that basically?

Raghavendra Rau

Right. I think one metric is the number of subscribers that some of our -- a number of households that some of our customers pass where we've got design wins. And based on that, I mean, based on the rollout of the digital services, I mean, we have some estimates of what it can be, but it's not book to backlog, per se.

Todd T. Mitchell - Brean Capital LLC, Research Division

Okay. And the last question and then I'll jump out. But -- so in the components that were -- so versus the last quarter wins you took down the year, and that was basically to push out rev rec on deals on next-gen, what's happened now, in terms of this quarter is this 40% of -- booked and shipped in the quarter, is it fair to assume that, that is prior gen product?

Raghavendra Rau

Yes, most of that is prior gen. That had been -- I would say, maybe about 30% is new software upgrades. The balance are legacy products.

Todd T. Mitchell - Brean Capital LLC, Research Division

Okay. And I'm sorry. And also, in terms of your '15 guide, is that versus what you now anticipate the results to be or what you anticipated them to be before?

Raghavendra Rau

2015 is what we now anticipate them to be.

Todd T. Mitchell - Brean Capital LLC, Research Division

Basis -- versus this new number that you've put out for the year?

Anthony C. Dias

Correct.

Raghavendra Rau

Correct.

Operator

Our next question comes from Michael Kupinski from Noble Financial.

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

There have been some media reports that Liberty Global has had some operational issues with its rollout of gateway products, and I was wondering if how this may have affected you or is this, to some degree, part of the issues that you're experiencing in terms of your agreements with them? And then especially, as it relates to the timing of how they roll out the product, just curious, I understand that you maybe you get payment for the first initial 1 million subscriber rollout, where they might be in terms of updating their gateway products in the set-top boxes?

Raghavendra Rau

Right. At a recent conference call, they did mention about cloud horizon and the launch of cloud horizon. This is where the UI is hosted in the cloud and sort of the next generation of services that they intend to launch. They did not speak of any delay, and I certainly won't speak to any delay from customer perspective. We believe we're on track to achieve what we set out to do with them. And so we are very, very comfortable in terms of where we are with respect to their project. And I think they are as well.

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

And in terms of just the basics of the business itself, Raghu, I was wondering if -- the 2015 outlook, it's pretty much in line with what we're looking for. We weren't really too -- looking for an acceptable year anyway. But I guess the pace of new products, it seems like it's tempered just a little bit, or do you feel like the legacy business is falling off a little bit more in terms of your revenue guidance being roughly flat to down a little bit from 2014?

Raghavendra Rau

Right. Let me start with the legacy decline. That's not surprised us. We did expect that legacy declines would be in the range of 10% of our total revenues. So that has -- that view has not changed. And as I have mentioned, this is the final year where those legacy declines will really be material because after that, the decline will be very moderate. It won't be significant on a dollar basis. As far as the new products go, yes, we have experienced some delays in terms of some of these new design wins. And the reason for that is not necessarily that they're considering whether to buy SeaChange product or not, we believe that we're still very well-positioned with some major operators. And we did announce one more design win in the fourth quarter. I just announced that a little earlier today. However, that is because they have a large number of other products to decide on, new set-top box, new conditional access vendor, maybe a new chip, maybe a support for 4K, and that, yes, has delayed things over the next 2 quarters and that is pushing out some of the new revenues that we were expecting.

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

And in terms of some of the -- obviously, some -- there's been some disruption given the fact that Comcast is trying to buy Time Warner and all these sort of things might have created some anxiety in terms of the capital spend, maybe from Comcast, or even Time Warner for that matter. Can you give us a little color on maybe what might be happening with the largest cable operators and the potential merger? I know that Time Warner is not a big customer of yours because they develop their own software solutions, but do you anticipate that their technology is lower or has less functionality than that of Comcast? And obviously, you are looking at Comcast to upgrade their systems to the next-generation systems. Does this potential merger create any potential delays related to the timing of their upgrades? Any thoughts on how you see the potential merger kind of affecting you?

Raghavendra Rau

Right. So what I see, Mike, is that the merger is really not -- hasn't impacted our business in any way at present. It hasn't resulted in any delays because -- and my understanding is that if that merger, the closure, it will take several more months to even close. So having said that, Comcast is a very big customer of SeaChange and a very important customer of SeaChange with whom we've had a historical relationship. We worked with them on the RDK right at the outset. And so we're very hopeful that the fact if they do acquire Time Warner, who has not been a historical customer for SeaChange for a number of reasons, we have the opportunity to -- we may be able to grow our business with the merged company.

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

And in terms of any disruption with the talks of Comcast in terms of their upgrade cycle given their focus now on the merger, I mean, any color that you can add in terms of your discussions with them?

Raghavendra Rau

No. I haven't seen -- at least, none of us have seen any disruption or any delay. They really -- they've been very successful in the launch of the X1 product, and as you know we -- SeaChange software is involved there. And they're very happy with the customer acceptance. In fact, I've heard that they've had new subscriber additions for the first time in a few years. So they're very happy with the rollout. And we're very much supporting them to the best extent that we can.

Operator

Our next question comes from Hamed Khorsand from BWS Financial.

Hamed Khorsand - BWS Financial Inc.

Just, really, 2 main questions here. First off, the companies or the customers you just announced on this call, about winning or gaining of design wins from them. How many of them were you expecting in your fiscal fourth quarter?

Raghavendra Rau

Okay. The ones that we mentioned, we won a fifth design win for a Nucleus video gateway software -- with a European customer. We were expecting that, so that has happened. However, we did not recognize any revenue from that customer in the fourth quarter. We are hopeful we will recognize some revenue in the first quarter and then as they rollout. That was one. The Adrenalin deployment, which was finally accepted by a Scandinavian customer, yes, we were able to recognize the revenue for that in the quarter. The other one I mentioned was we received a large order from a North American customer to upgrade their legacy Axiom to Adrenalin. There, we were able to recognize some revenue based on some shipments that we made in the quarter, more will be recognized over the next several quarters.

Hamed Khorsand - BWS Financial Inc.

Okay. So I guess every one of these announcements that you made today, you were already expecting them to be made some time in the last 3, 4 months, right?

Raghavendra Rau

Yes.

Hamed Khorsand - BWS Financial Inc.

Okay. So what I'm trying to get to is, what's in the pipeline as far as new potential customers that you think you can get signed? Is there a quantity you're targeting?

Raghavendra Rau

Yes. So we are targeting to win some design wins in Asia, for instance. We are targeting to win some more European customers, one more North American customer. So yes, we are continuing to target several more design wins.

Hamed Khorsand - BWS Financial Inc.

And then, why the lag between acceptance and revenue? I mean, it seems as -- there's initial lag in getting the acceptance, now there's another lag in getting revenue. Why is so many lags?

Raghavendra Rau

No, no. There is no lag when -- to get acceptance once it is deployed. That's -- there is no lag. I mean, as soon as it's finally accepted, we can recognize a revenue. I think what you may be referring to is acceptance of contracts. So when we receive a contract, yes, there is a certain lag because it depends on percentage of completion or achieving certain milestones.

Hamed Khorsand - BWS Financial Inc.

Okay. And my last question is that, it sounds like you haven't seen much of a change as far as the market dynamics go from the last call as far as the service operators, just to take into consideration the whole entire network before making a decision. I mean, is that still the same thing you're still seeing?

Raghavendra Rau

Yes. I would say we've seen probably a 2-quarter push out of some wins which pushes out revenue.

Operator

[Operator Instructions] Our next question comes from Russell Anmuth from Gotham Holdings.

Russell Anmuth

Are you able to hear me?

Raghavendra Rau

Yes.

Russell Anmuth

Okay. Sorry, I'm on speaker. So given the company's products, its positioning, the minimal enterprise value of the company and the potential -- and the replacement value of the company, is the board considering hiring investment bankers to sell the company? And if not, why not?

Raghavendra Rau

Yes. Well, that's a -- it's a tough question here to answer. We are not -- as you know, we did run a process in 2011 where the board looked at -- in various options, including the potential sale of the company. At the conclusion of that process, the board determined that it was in the best interest of the shareholders to continue to be an independent standalone company and ensure that we address the strategic challenges that -- of SeaChange that we saw at that time. And I'll just take a moment to explain what we have accomplished in the last 2.5 years after we began that transformation.

Russell Anmuth

Understood that the company is a much more, like, valuable enterprise than it was in 2011.

Raghavendra Rau

Correct. We divested -- yes, we divested 2 barely profitable noncore businesses. We increased cash by tens of millions of dollars. We invested significantly in R&D. We won the trust and design wins from the world's largest operators. And in spite of losing approximately 10% of product revenues in each of the last 2 years and in fiscal 2015 as well, we -- through legacy product declines, we are going to generate 65%. In fact, this last quarter, we generated 65% of our product from new revenues. So -- and we're also creating long-term value from our Nucleus design wins. So the company doesn't feel the need to hire investment bankers at this time. However, as you know, we are a public company, and if there is any consolidation that happen in the industry, I'm sure the board will consider those opportunities. It's not that the board is not considering those opportunities.

Russell Anmuth

Okay. So in light of all this, and in the interim, with the company's big balance sheet, why not implement a much bigger stock buyback and at least try and create some value for shareholders in terms of price? We certainly understand and appreciate the long-term and the medium-term value that the company is creating with its unique positioning. But with -- sitting with a $128 million in cash that you're not putting to work more -- or you're not able to put to work more effectively in the business at the moment, why not do a relative monster-sized buyback?

Raghavendra Rau

Right. The board has authorized a $25 million stock buyback, and we have put a 10b5-1 plan in place. We do expect to be making purchases in this quarter. However, we're also looking at potential acquisitions that are accretive and to use our cash productively. So we're looking at all of the options.

Operator

Thank you. At this time, we have no further questions. I will turn the call back over to Raghu for any closing comments.

Raghavendra Rau

No -- again, as I mentioned, we were very disappointed that we came below the guidance. But we're all -- noses are to the grindstone here, and we are going to do our best in the interest of the shareholders to meet our guidance in the future. Thank you.

Operator

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

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Source: SeaChange International Inc., Q4 2014 Guidance/Update Call, Feb 25, 2014
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