SeaChange International's (SEAC) CEO Raghu Rau On Q2 2015 Results - Earnings Call Transcript

SeaChange International (NASDAQ:SEAC)

Q2 2015 Earnings Conference Call

September 4, 2014 5:00 PM ET

Executives

Monica Gould – MD-The Blueshirt Group LLC

Raghu Rau – Chief Executive Officer

Anthony Dias – Chief Financial Officer

Analysts

Todd T. Mitchell – Brean Capital LLC

Hamed Khorsand – BWS Financial, Inc.

Michael A. Kupinski – Noble Financial Capital Markets

Steve Frankel – Dougherty & Co. LLC

Operator

Greetings, ladies and gentlemen, and welcome to the SeaChange International Fiscal 2015 Second Quarter Financial Results. At this time, all participants are in a listen-only mode. A 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, Ms. Monica Gould. Thank you, Ms. Gould. You may begin.

Monica Gould

Thank you, Jane. Good afternoon, everyone, and thank you for joining us. SeaChange released results for the second quarter of fiscal 2015 ended July 31, 2014 today after the market close. If you would like a copy of the release, you can access it on the IR section of the web site at www.schange.com/ir.

With me on today’s call are Raghu Rau, Chief Executive Officer; and Tony Dias, Chief Financial Officer. This call is being webcast and will be archived on the Investor Relations section of our website.

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 on April 4, 2014. Any forward-looking statements should be considered in light of these factors.

Additionally, this presentation contain 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, and good afternoon, everyone. Welcome to the SeaChange earnings call for the second quarter of fiscal 2015. On today’s call, we will review our second quarter performance, provide an update on our recent progress, and discuss our outlook for the remainder of fiscal 2015.

During the second quarter, SeaChange recorded revenue of $29.8 million, up 23% from the first quarter of fiscal 2015 and at the high end of our guidance range led by 73% sequential growth in product revenue. This strong growth reflected double-digit sequential advances in each of our new product categories. Due to this increased sales volume and higher mix of product revenue, we substantially lowered our non-GAAP operating loss to $0.08 per basic share from $0.22 in the prior quarter.

Now, I would like to review some of our recent progress with respect to acceptances, contracts and design wins. We continue to make good progress on a number of fronts, specifically during the second quarter, we received a multi-million dollar contract for one of our European Adrenalin and Nucleus design wins. This cable operator plans to launch both platforms by the third quarter of 2015. We expect this rollout to be more compressed compared to our early Nucleus deployments as we have already developed over 2,000 features gained valuable experience and completed numerous pre-integrations.

Additionally, as systems integrator for the project, we have better visibility into the timing of deployments and additional integrations. Our large multi-country Nucleus customer began a field trial of its new video gateway platform this summer and remains on track for commercial rollout in its first country later this year with more countries to follow. We also began work on several upgrades to existing Adrenalin deployments in the second quarter including a large cable service provider in North America and another that is now underway for a large cable operator in Asia Pacific.

Further, we recognized revenues for additional subscriber licenses for a large Adrenalin customer in Latin America driven by healthy growth in this provider subscriber base and its increased market penetration. We also delivered our Infusion linear advertising products to three of the largest U.S. cable and telco video service providers in the second quarter. We also continue to execute on our growth strategy for developing new and adjacent businesses as well as expanding into new and adjacent markets such as telco, mobile and OTT. Our first contract for the SeaChange Cloud Adrenalin offering demonstrates progress on both of these fronts as it also reflects our first pure play OTT content customer win.

As announced earlier today, SeaChange will deploy and manage Cloud Adrenalin service for the BBC Worldwide’s online BBC Store. This online Store will make television providers programs available online to consumers on any multi-screen device they choose. We anticipate recognizing initial revenue from this contract including recurring monthly fees and transactional revenue commencing early in the next calendar year. As a reminder, Cloud Adrenalin features a robust ecosystem of pre-integrated partners, which enable the service to be largely plug-and-play thereby easing integration requirements and reducing time to market. This service offering is targeted at smaller television service providers, OTT providers and content owners.

Based on the significant improvement and the anticipated receipt of customer acceptances for our new products since the beginning of the year, we continue to anticipate revenue growth and improvement in our profitability in the second half of fiscal 2015 relative to the first half. However, due to shifts in the timing of deployments planned for the second half of the year along with some residual acceptance delays, we believe our full year revenues will be slightly more back-end loaded.

Tony will walk you through some of the financial details of the quarter and provide more specific guidance on our outlook for the third quarter and full fiscal year. Before I turn the call over to Tony, I wanted to note that we will be demonstrating our latest Adrenalin, Nucleus and Infusion advancements next week at the IBC trade show in Amsterdam and later this month at Cable-Tec Expo in Denver. We invite you to take the opportunity to experience our software innovations for yourself.

With that, I’d turn the call over to our CFO, Tony Dias. Tony, please go ahead.

Anthony Dias

Thank you, Raghu. I will start by reviewing our second quarter results before providing our outlook for the third quarter and full fiscal year. For the second quarter of fiscal 2015, total revenues rose 23% sequentially to $29.8 million and came in at the high end of our guidance range. These results were driven by a 73% sequential increase in product revenue to $8.7 million with the new products accounting for approximately 48% of total product revenue.

As Raghu mentioned, we recorded strong double-digit sequential growth in each of our new product categories and total new product revenue increased over 50% of the first fiscal quarter. Moreover, legacy advertising product revenue also increased sequentially due to capacity and geographic expansions enabled by the latest Infusion software release.

Service revenues increased 9% sequentially to $21.1 million in the second quarter and account for 71% of total revenue. Over the last several quarters, a significant portion of our service revenue has been related to system integration work and other services related to planned deployments of new products in future quarters. Maintenance revenues rose slightly sequentially and year-over-year and continues to account for more than half of our service revenue.

Our blended gross margins increased to 53% on a non-GAAP basis from 46% in the first quarter due primarily to a higher mix of product revenue. Non-GAAP operating expenses remained essentially flat at $18.5 million. We substantially narrowed our non-GAAP operating loss to $0.08 per basic share compared to non-GAAP operating loss of $0.22 per basic share in the first quarter driven by a higher mix of software revenue.

Total revenue in the second quarter was driven by a 33% sequential increase in sales to U.S. customers. International sales rose 9% sequentially to kind of a 40% of total revenue in the second quarter compared to 45% in the prior quarter. Our balance sheet continues to be very strong. We closed the quarter with cash balance of approximately $111 million and no debt. During the second quarter, we utilized $2 million in cash to repurchase shares of our common stock under our $40 million stock buyback authorization. That brings the total stock repurchases to $5.5 million for the first half of this year.

Now, I’d like to turn to our outlook for the third quarter and full fiscal year. As Raghu mentioned earlier, due to a shift in the timing of deployments anticipated in the second half of the year along with some residual acceptance delays, we expect our quarterly results to be slightly more back-end loaded. These timing shifts combined with some of our new design wins will delay our previously anticipated reduction in incremental R&D costs until early next year. As such, we anticipate operating expenses to be flat in the second half compared to the first half of this fiscal year.

So typically, we expect third quarter revenue to be in the range of $29 million to $32 million and non-GAAP operating loss to be in the range of $0.05 to $0.09 per basic share. For the full year, we’ve narrowed our guidance for revenue to be in the range of $125 million to $130 million and non-GAAP operating results in the range of a loss of $0.12 per basic share at the low end of our revenue range to income on a fully diluted share basis of $0.02 per share at the high end. As I noted in our call in June, due to our net operating losses, we do not expect to be a cash tax payer domestically for the remainder of this fiscal year.

Thank you. With that, I’d like to hand the call back over to Monica.

Monica Gould

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

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Todd Mitchell with Brean Capital. Please proceed with your questions.

Todd T. Mitchell – Brean Capital LLC

Hi, thank you. So my question is Q4. Can you quantify the number of current projects that you have, which are behind in terms of customer acceptances at this point? And can you give us some sort of quantification in terms of this is – I reach for this every quarter, but what the pipeline or the backlog looks? And is it quantifiably bigger or smaller than the last time I asked you.

Raghu Rau

Okay. Thank you, Todd. First, let me answer the question on acceptances. In Q4, we had four acceptances that we had anticipated, which we didn’t yet. we got two of those in Q1 and one remained to be received, which we received in Q2. There is one residual from Q4 that we expect to receive in Q3.

For Q2, we have received all of the acceptances that we anticipated to accept – expect including the ones in Q1, which we did not get in Q1. However, when I say that we have improved our ability to be able to predict the number of acceptances we can get, we have improved in our processes to be able to better predict this and therefore, the acceptances that we expect to get is only one that was supposed to have been in Q4, which we now expect to get in Q3.

So as far as the pipeline is concerned, yes, we are working with a number of perspective customers, and we believe we are on track to be able to achieve at least two more new design wins for Nucleus before the end of this year and we expect to continue to win in a new Adrenalin wins, primarily in the fourth quarter. So the pipeline is looking much better than when you lost at that question.

Todd T. Mitchell – Brean Capital LLC

Okay, thank you. And so right now, basically, there is one customer in arrears, is what you are saying?

Raghu Rau

Correct.

Todd T. Mitchell – Brean Capital LLC

Or not in arrears, but one that’s behind schedule.

Raghu Rau

Yes.

Todd T. Mitchell – Brean Capital LLC

One is behind the schedule.

Raghu Rau

That’s correct. yes.

Todd T. Mitchell – Brean Capital LLC

And then if I look at, at the second half of the year is I am assuming from the shift in your guide, basically, something that was supposed to come in 3Q, may probably come in, in 4Q at this point?

Raghu Rau

Right. That’s how we have anticipated the acceptances. And yes, somewhat we would normally have thought we would have got in Q3. We’ve been conservative and believe it might be accepted only in Q4.

Todd T. Mitchell – Brean Capital LLC

Okay. And the total number of Nucleus wins at this point is five.

Raghu Rau

Yes.

Todd T. Mitchell – Brean Capital LLC

And you think that there’s prospects for two more.

Raghu Rau

Correct.

Todd T. Mitchell – Brean Capital LLC

Okay. And lastly, what is the source of increased R&D in the back half – increased operating expenses in the back half of the year?

Anthony Dias

No. We expect the back half of the year operating expenses to be similar to the first half of this year. We don’t expect an increase.

Todd T. Mitchell – Brean Capital LLC

Right. But higher than expected, I mean what…

Anthony Dias

Right, right. We were hoping to be able to reduce some of the incremental R&D expenses in Q4, which we believe, but it will be difficult to do now, primarily because of some increased investments in Nucleus, as well as the Cloud Adrenalin products.

Todd T. Mitchell – Brean Capital LLC

So those are the two areas of spending.

Anthony Dias

Correct.

Todd T. Mitchell – Brean Capital LLC

Okay. Thank you very much.

Operator

Thank you. Our next question comes from the line of Hamed Khorsand with BWS Financial. Please proceed with your question.

Hamed Khorsand – BWS Financial, Inc.

Hi. can you guys hear me?

Raghu Rau

Yes.

Anthony Dias

Yes.

Hamed Khorsand – BWS Financial, Inc.

Okay, perfect. First question I had was, why did you guys buy back and only buy $2 million of stock this quarter, I mean obviously, this was a big profit last quarter and obviously, can you guys be, would be aggressive given how much investor questions that were about it, what was the drawback could you guys held back?

Raghu Rau

Okay. Firstly, Hamed, let me clarify, the board does understand that we do not need the amount of cash we have for our normal operations. And we also understand the importance of a capital – strategic capital allocation strategy that would benefit the shareholders.

In this context, we have looked at potential acquisition targets including tuck-in technology acquisitions that would fuel continued long-term growth. However, because of inflated valuation expectations, we have not concluded any transactions yet. Buying back our stock has been a part of the overall capital allocation strategy. And as you know, the Board in May authorized an increase as well as extended the timeline of the previous authorization. It is the Board’s intention to continue to buyback stock opportunistically, but we are looking at this as a holistic strategy.

Hamed Khorsand – BWS Financial, Inc.

No, I get that but you guys had $20 million buyback, there was no reason to increase it to $40 million, I know with $2 million of buyback this quarter while at sometime gets you. So I’m just trying to understand where this management would decide as far as thinking those, as far as buybacks are concerned, as far as the business in general is concerned? If you’re only buying back $2 million and what – it sounds like the bottom of the last year and why did you buy it more stock at a higher price point?

Anthony Dias

I can’t speak to the amount that we would buy this quarter or the next quarter, but this definitely remains part of our capital allocation strategy. And as you know, we’ve got to look at it in terms of how much to use productively for growth building acquisitions versus how much you buyback. Since the first quarter has not yet been completed, I mean there is some caution in terms of how you use the capital.

Hamed Khorsand – BWS Financial, Inc.

Okay. And I’m switching gears, given that these rollout in Poland, is there a timing as far as when they can use up their entire license before they come back and buy more from you?

Raghu Rau

Well, there are encouraged by a few things that have happened. Number one, during the last earnings call, the CTO of Liberty has mentioned that the trial in Poland was I think in as words doing great. He also mentioned that they were going to use the same technology way beyond Poland including markets that were previously served by their earlier Horizon project. So that’s really encouraging in terms of the rollout of – and their intention.

We also know from what from what Comcast has said, that they are really pleased with the success of the X1 platform and the services that they were able to provide and they’re talking about going to the entire footprint like 2016. So that’s encouraging signs, but I can’t speak to the operator themselves and how soon this rollout will actually happen.

Hamed Khorsand – BWS Financial, Inc.

Okay. And just talking more broadly have you seen any market traction where service providers are moving towards our RDK but not using SeaChange?

Raghu Rau

No, SeaChange just mentioned in my script has already developed over 2,000 features for Nucleus. And we don’t believe there is any other company that even come close began to SeaChange plus in valuable experience that we have got working with the world’s largest service providers in the space is really second to none.

In addition, there is no one that has achieved integrations with all the major chip vendors and also being chosen by customers to push the Nucleus software in three different set-top box manufacturer of boxes. So we haven’t seen anything specific that competes against in the Nucleus. However, there are RDK based service provider companies, which provide some RDK related services. and of course, I mean the choice sometimes is do I go RDK now, or do I delay that till such time that I have the CapEx should be able to change out my set-top box using the chipsets and so on.

Hamed Khorsand – BWS Financial, Inc.

Okay, thank you.

Operator

Thank you. Our next question comes from the line of Michael Kupinski with Noble Financial. Please proceed with your question.

Michael A. Kupinski – Noble Financial Capital Markets

Thank you for taking the questions. I was wondering if you can explain how the company makes money on the BBC contract and if you can frame the revenue opportunity and especially, if there is any near-term costs that are going to be associated with the roll out there?

Raghu Rau

Yes, thank you, Mike for that question. Firstly, obviously, certain confidentiality reasons, I can’t disclose the pricing models for BBC, specifically. however I would like to be responsive to your question and the way Cloud Adrenalin pricing models work is, it depends on the nature of the service provider that’s a service provider, or a content owner, or it’s a broadcaster, there can be some variations associated with that. it can also be based on the variance of the mix of services they decide to choose from what the SeaChange Cloud Adrenalin can offer, but typically we look at three-year annuity in a payment for both the licenses as well as managing and hosting the service and we have a transaction model, so that we can get some upside based on the transaction volume and this is also sort of putting a stake in the success of the operators. So that they have a greater number of transactions, they win and we win as well.

I mean typically these Cloud Adrenalin projects would be multimillion dollars spread over three years. now the second part of your question was about cost. yes, we will incur some costs related to the development and some customization that will have to be done and revenue recognition will only happen next year – early next year. But it’s included in the OpEx numbers that we provided where we said the first half OpEx will be similar to the second half OpEx.

Michael A. Kupinski – Noble Financial Capital Markets

And in terms of just going back to the delays and some of the deployments, the time from the acceptance to the deployment, has anyone indicated to you why they’re currently delaying deployment?

Raghu Rau

No. I don’t think it’s any one particular reason, but remember these are very complex projects and whether multiple vendors to work with. one of the good things about this contract with this European, this multimillion dollar project that’s actually an eight million – eight figure contract is that we are the system integrator, we control and work with all of the ecosystem partners and are responsible for the end-to-end solution.

This is the first time we have taken on a project like this. this gives us greater visibility to acceptances, and greater visibility to controlling the schedules. And perviously, it was really the customer or some integrator that they chose that would do all of this and we would be one of the vendors, but because we, being at the sort of the heart of the network, it was really critical that the system worked we were responsible to see that everything has worked even though we were not a system integrator. So those were some of the challenges.

Michael A. Kupinski – Noble Financial Capital Markets

And in terms of all the feature sets, the 2,000 feature sets and so forth, has this changed in terms of developing these new feature sets because I think the last time you were closer to 1,000 and now 2,000. In terms of the lead times, do you think that you kind of will shorten that window and as it relates to your prospect of seeing acceleration in growth in the next fiscal year, how this all that relate to your thoughts on and how that will play out as you go forward?

Raghu Rau

Right. So, the deployment that we’re going to – we’ve just won with the Western European operator that involves a totally different chipset. It involves the new set-top box vendor, not the ones that we have worked with before but the time is significantly compressed to the previous deployments.

We have said before Q3 of next year, but we already have the software running with this feel and you box vendor and the new chip. So the fact that we’ve already built a number of these features and the experience with other deployments will shorten the cycle. So it could be anything between six to nine months depending on the nature of the work that needs to be accomplished.

Michael A. Kupinski – Noble Financial Capital Markets

In the BioPower question, is there any risk as we go into the next fiscal year on the prospect of seeing delays and deployments as it relates to the prospect of improved chips and so forth like the Broadcom chip or whatever? With that potentially – do you think that you will see any particular prospect of delays in deployment as it relates to that?

Raghu Rau

Well, the big thing that many of our operator customers wanted was the ability to do 4K. And at IBC, we are actually showing nucleus working with a 4K chip. And so I think once we get over that, I don’t believe that’s going to be a significant reason for any further delays. And also believe that once Liberty Global is commercially launched before the end of the year, this other deployments that we’re doing in Latin America and other parts of Europe starts getting launched. I think it’ll just create some new momentum.

Michael A. Kupinski – Noble Financial Capital Markets

Okay. All right. Thank you. That’s all I got.

Raghu Rau

Thank you, Mike.

Operator

Thank you. (Operator Instructions) Our next question comes from the line of Steven Frankel with Dougherty & Company. Please proceed with your question.

Steve Frankel – Dougherty & Co. LLC

Good afternoon. I want to dig into the Adrenalin deals that are slated for revenue in Q4. And do they involve any material, new equipment, whether it’d be set-top box or conditional access, any recipe that you haven’t done before. What kind of risk is there in it being kind of a new mix versus these are problems you’ve already tackled in the last year?

Raghu Rau

There are some new things. For instance, every operator has different legacy set-top boxes and they want to ensure that Adrenalin works with all of those different legacy set-top boxes. And that sometimes is a challenge because some of these boxes date back several years. And so – yes, I would say that there are still some differences associated with that.

Most of the other integrations we have already done. Like for instance, the conditional access vendors, the encoding providers, most of those have already been accomplished, but I wouldn’t say everything has been done.

Steve Frankel – Dougherty & Co. LLC

Okay. And how many adrenalin deals are in your forecast for Q4?

Anthony Dias

I don’t have the exact number, but I mean there are a number of adrenalin deals involved at various stages that we will – that we expect to get acceptance from.

Steve Frankel – Dougherty & Co. LLC

The four or five deals in that Q4 forecast.

Anthony Dias

Yeah. There are multiple deals.

Steve Frankel – Dougherty & Co. LLC

Okay, different question. What was customer concentration in the quarter?

Anthony Dias

There were three customers that accounted for over 10%.

Steve Frankel – Dougherty & Co. LLC

Fine. Three, each over 10%?

Anthony Dias

Yes.

Raghu Rau

Yes.

Steve Frankel – Dougherty & Co. LLC

Okay. And could you give us a more definitive number on maintenance? You said over 50%, that’s a pretty big state, could you tell us exactly what maintenance was in the quarter?

Anthony Dias

We mentioned it, but…

Raghu Rau

Yes. we said it’s typically a third of our total revenue last year.

Steve Frankel – Dougherty & Co. LLC

And what was it in the quarter? was it a third of total revenue?

Raghu Rau

Yes, it was…

Anthony Dias

A little less than a third.

Raghu Rau

Yes.

Steve Frankel – Dougherty & Co. LLC

Okay. And in my math…

Anthony Dias

I’m sorry, I meant a little more than a third.

Steve Frankel – Dougherty & Co. LLC

But on more than a third, okay.

Anthony Dias

Yes.

Steve Frankel – Dougherty & Co. LLC

And on a year-over-year basis, new products were still down, are at about 30% year-on-year if my math correct?

Anthony Dias

Yes. approximately that range, you are right.

Steve Frankel – Dougherty & Co. LLC

And will they – and they will be down again, I assume in Q3, but you hope that will be up in Q4?

Anthony Dias

Correct.

Raghu Rau

Correct.

Anthony Dias

We expect it to be sequentially up the next quarter, but, yes, down compared to the previous year and we expect it to be higher both sequentially as well as the previous year comparison in Q4.

Steve Frankel – Dougherty & Co. LLC

All right. And you go back to the stock buyback question. Are you using a 10b5 that’s got a formula that’s already been entered and not likely to be changed, or are you making kind of a monthly, or a day-to-day decision, whether to be active in the marketplace or not?

Anthony Dias

Well, there was a 10b5-1 plan in place, which was established after the trading window closed, just I mean, which was established just before the trading window closed, so that we could continue to acquire stock after the trading window closed. So after the trading window opens up again, which is three days from now, we would be free to buy stock in excess of any previous plans within the authorized amounts.

Steve Frankel – Dougherty & Co. LLC

Okay. and what was the average cost of the small amount of shares you bought during the quarter?

Raghu Rau

On top of my head, I don’t recall. We can back to you on that one.

Steve Frankel – Dougherty & Co. LLC

Okay, great. Thanks.

Operator

Thank you. (Operator Instructions). It appears there are no further questions at this time. I would like to turn the conference back to Raghu Rau for closing comments.

Raghu Rau

Okay. Thank you, everyone. I would like to thank all of you for joining us today and for your continued support and interest in SeaChange. I do hope some of you will be able to visit us at either at IBC or at Cable-Tec. Thank you and have a great evening.

Operator

Thank you. Ladies and gentlemen, this concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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