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Executives

Martha Schaefer - Director, Investor Relations

Kevin Bisson - Chief Financial Officer

Bill Styslinger - President and Chief Executive Officer

Yvette Kanouff - Chief Strategy Officer

Analysts

John Groover - Groover & McBain

Ali Mogharabi - B. Riley & Company

Blair King - Avondale Partners

Greg Mesniaeff - Needham & Company

Alan Davis - D.A. Davidson

Johnny Brown - Stevens Incorporated

SeaChange International, Inc. (SEAC) Q2 2009 Earnings Call September 4, 2008 5:00 PM ET

Operator

Good evening. My name is Lisa and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Second 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). Thank you.

Ms. Schaefer, you may begin your conference.

Martha Schaefer - Director, Investor Relations

Thank you, Lisa. Good afternoon everyone and thank you for joining us today. We'll be discussing the financial results for our second quarter of our fiscal year 2009. Our press release went out about an hour ago and is available on our website on the Investor Relations page.

Before we begin, I need 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 materially from expectations. These risks are outlined in our SEC filings including 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. Yvette Kanouff, Chief Strategy Officer is with us today to provide a product and market overview for our software business unit. Following our prepared remarks, we will be happy to take your questions.

At this point, I would like to hand the call over to Kevin.

Kevin Bisson – Chief Financial Officer

Thanks Martha and good afternoon everyone. Turning now to our second quarter results for fiscal 2009, revenue for the second quarter amounted to $50.7 million, which was $6.5 million or 15% higher and total revenue of $44.2 million recorded in the second quarter of last year.

From an operating segment perspective, revenue from our software segment for the quarter was $31.9 million, which was $4.5 million or 16% higher and revenue of $27.4 million for the second quarter of last year. The year-over-year increase in revenue was due primarily to increased Axiom related software deployments at Comcast, Cox and two other North American based service providers along with increased advertising insertion revenue related to increased high definition channel requirements for two of our largest US based MSO customers.

Software segment revenue in the second quarter also benefited favorably from higher installation revenue related to the completion of projects initiated in prior periods. The increase in software business unit revenue was partially offset by lower Comcast software development revenue related to the timing of projects initiated and completed in this year’s second quarter compared to last year’s second quarter.

Our servers and storage segment generated $14.9 million in revenue for the second quarter, which was $2.5 million or 20% higher and revenue of $12.4 million included in the second quarter of last year. The increase in servers and storage revenue between years was due primarily to increased VOD server shipments to Comcast and one other large domestic US cable television company as well as higher field services revenue related to increased year-over-year VOD server deployments.

The media services segment had revenue for the second quarter of $3.9 million, which was $600,000 lower than revenue of $4.5 million generated in the second quarter of fiscal 2008. The decrease in media services revenue between years was mainly due to lower non-recurring professional services revenue related to the completion of a project in last year’s second quarter for Latin American customer.

Geographically, revenue for the second quarter of fiscal 2009 includes 68% in North America, 21% in Europe, Middle East and Africa, 9% in Asia Pacific and 2% in Latin America. Consistent with prior quarters Comcast and Virgin Media were 10% or greater customers in the second quarter of fiscal 2009.

Revenue for the first six months of fiscal 2009 amounted to $96.1 million, which was $13.1 million or 16% higher then the $83 million of revenue generated in the first half of fiscal 2008. Revenue growth in the first six months of this fiscal year was driven primarily by increased VOD and advertising insertion software license revenue from several large US based cable television customers and higher VOD server and software installation and maintenance services revenue tied to increased year-over-year VOD server and software deployments.

Total gross margin of 48.6% for the second quarter was 14.3 points higher than the total gross margin of 34.3% for the second quarter of fiscal 2008. Last year’s second quarter results included approximately $6 million of expenses related to certain cost reduction actions undertaken in that quarter, of that amount approximately $4.8 million of the expenses were manufacturing or service related causing gross margins to be reduced in last year’s second quarter by approximately 11 points. Excluding the impact of these expenses, this year’s second quarter gross margin of 48.6% was 3.6 points higher than the adjusted gross margin of 45% for the second quarter of last year.

Looking at gross margin by operating segment, software segment gross margin of 54.9% was 3.2 points higher than the adjusted software gross margin of 51.7% for the second quarter of last year. The increase in software gross margin was due to a greater mix of higher margin Axiom and advertising insertion software revenue combined with increased service margins due to the favorable absorption of field service costs during this year’s second quarter.

Service and storage gross margin of 44.6% for the second quarter of fiscal 2009 was 1.8 points higher than the adjusted gross margin of 42.8% for the second quarter of fiscal 2008. The increase in gross margin for the servers and storage segments between years was due primarily to the realization of cost savings from the cost reduction actions initiated in last year’s second quarter together with improved service margins related to favorable absorption of service personnel costs.

Media services gross margin of 12.4% for the second quarter was 11.6 points lower than gross margin of 24% for the second quarter of last year due mainly to the absence in this year’s second quarter of high margin non-recurring professional services revenue that was realized in last year’s second quarter. Increased year-over-year headcount to support new business activity also contributed to the reduction in gross margin in this year’s second quarter.

Total gross margin for the first six months of fiscal 2009 was 49.3%, which was 4 points higher than adjusted gross margin of 45.3% for the first half of last year. The increase in gross margin for the first six months of fiscal 2009 compared with the first half of fiscal 2008 was due principally to a larger proportion of higher margin Axiom set-top box and advertising insertion software revenue as well as improvements in manufacturing and service cost absorption between years that was tied partially to the savings generated from last year’s cost reduction actions.

Operating expenses for the second quarter of $23.5 million was $200,000 lower from the $23.7 million of operating expenses incurred in the second quarter of last year. Included in the reported operating expenses in last year’s second quarter was $1.2 million of expenses related to the cost reduction actions implemented in that quarter. Excluding these expenses the $1 million increase in operating expenses in this year’s second quarter compared to last year relates mainly to higher selling expenses caused by higher sales commissions and higher headcount and travel expenses offset by lower general and administrative expenses due to lower headcount and lower outside accounting fees.

For the first six months of fiscal 2009 operating expenses were $45.9 million, which was $1.6 millions higher than operating expenses adjusted for last year’s second quarter cost reduction actions of $44.3 million.

Higher selling and marketing expenses were partially offset by lower general and administrative expenses as well as lower amortization of intangibles due to the sale of the company’s equity interest in Filmflex in the fourth quarter of last year.

Net income for the second quarter of fiscal 2009 was $1.5 million compared to a net loss of $7.9 million for the second quarter of last year. The corresponding earnings per share for the second quarter of fiscal 2009 was $0.05 per share compared to a $0.27 per share loss for the same period last year.

Expenses incurred in connection with the cost reduction actions taken in last year’s second quarter increased the net loss and net loss per share for last year’s second quarter by $6 million and $0.20 per share respectively.

For the first six months of fiscal 2009 net income was $1.8 million compared to a net loss of $12.4 million for the six months of last year for the first six months of last year. The corresponding earnings per share for the first half of fiscal 2009 was $0.06 per share as compared to a $0.42 loss per share loss for the first half of fiscal 2008. Similar to my earlier remarks, expenses related to the cost reduction actions in last year’s second quarter increased fiscal 2008 first half 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 second quarter with cash and investments of $78.1 million, which was $900,000 lower than the $79 million of cash and investments at April 30 of this year. The company generated $4.6 million of cash in the quarter from operations as measured by net income and adding back $3.1 million of non-cash depreciation, amortization and stock based compensation. In addition, cash during the quarter was favorably impacted by a $2.6 million increase in customer deposits and a $2.2 million increase in deferred revenue.

Offsetting these sources of cash during the quarter was $7.2 million of capital expenditures with most of this amount related to the purchase of a facility in the UK to house ODG’s operation.

The company also repurchased 551,000 shares of its stock at a cost of $4 million during the second quarter as part of it’s previously announced stock buyback program in February of this year.

I’ll now turn it over to Bill.

Bill Styslinger - President and Chief Executive Officer

Thank you, Kevin, and good afternoon everyone. Coming off a solid first quarter, we continue to build momentum in our fiscal 2009 by second quarter performance. Revenues for the second quarter were $50.7 million with a 15% increase over the last year’s second quarter. Gross margin strengthened 49% for the second quarter and a continued focus on control over operating expenses led to a net income of close to $1.5 million.

From balance sheet perspective SeaChange has $78 million of cash with no debt. Cash flow from operations is combined with improved working capital performance produced close to $10 million of cash during the quarter. We spent some cash to purchase a facility for ODG, our media services operations in the UK. This purchase will help improve our margins by allowing us to bring in-house content entering functions at lower cost then is currently provided by third party.

In addition we returned $4 million to shareholders during the second quarter as part of our stock buyback program. Since we announced the stock buyback program in February, the company has repurchased 834,000 shares at a cost of $6 million.

I will spend the next several minutes discussing the key drivers of our financial performance in the second quarter after which I will turn the call over Yvette, who will walk through how we size the market opportunity for our software business unit. Our largest business unit software has a strong quarter with revenues of nearly $32 million, which was up 6% sequentially from a very good first quarter. Our VOD software business had a solid quarter by increased deployments of Axiom software license and Comcast in connection with their storage expansion. Our VOD software revenue also had had continued traction in cost as the second quarter included two additional sites of Axiom, for both the swap out and competitors’ software and licenses for large stream expansion.

Over the last three quarters we have converted six Cox sites to Axiom based VOD software as part of the Cox’s plan to standardize its largest software platform with SeaChange. We expect to convert more Cox sites to Axiom throughout the second half of the fiscal year.

In second quarter, software revenue growth benefited from continued strength in our advertising insertion product line fueled by sustained high levels of spending additional high definition channel.

As a final point in our software business you will see that $30 million or approximately 40% of total software segment revenue in the second quarter was services revenue. This revenue was boosted by very strong performance from our new professional services unit we created about 12 months ago, a new manager is brought in to a high level scale selling and execution and is really paying off.

That skill was key to our win as the video systems integrator for Turk Telekom. Professional service is an area of emphasis for SeaChange as we build our base for recurring revenue. We’ll periodically report on the progress of this important initiative. For service and storage segment had a robust sequential revenue growth of 32% in the second quarter led by significant increase in shipments of large service to Comcast in connection with its build out to increased VOD streaming and storage capacity.

Our second quarter included significant product services to CableVision and Verizon. Second quarter also marked our first quarter of significant commercial deployments of flash memory service. We believe we are well ahead of our competitors in deployments of new videos storage technology that delivers high performance competitive prices yet offers lower operational cost to our service provider customers than to disc or DRAM alternatives. Early fall we expect flash memory service to become a larger share of our total VOD service shipments.

Media services revenue in second quarter was down slightly from the first quarter as higher sequential revenues from Virgin Media more than offset by one time professional services revenue generated in the first quarter. Virgin Media continues to be a significant contributor to only achieve top line performance as VOD usage among subscribers continues to grow. In fact Virgin Media publicize monthly VOD use in the second quarter average 38 million views which was almost double the 20 million average monthly views for the second quarter of the previous year.

In addition, Virgin recently launched BBC iPlayer as part of its VOD platform that offers over 350 hours of BBC broad content. iPlayer has been a low bid rate in an offering, so as the only high quality television service provider carry iPlayer is not surprising that [Vergent] announced 10.5 million iPlayers views for June alone.

Again with ODGs revenue type of the amount of VOD content process on behalf of Virgin Media the more VOD views by Virgin’s customers’ is greater revenue for ODG. ODG announce during the second quarter has been awarded a contract by Hellenic Telecommunications or OTE. This is the largest telecom to provide and outsource the VOD service. Under the agreement ODG will provide content acquisition and management services as well of the shifting OTE in marketing the new VOD services to it’s subscribers base.

OTE currently has 5 million fixed line and 700,000 broadband customers. Revenue from the OTE deal and others in the works will greatly boost our media service unit’s revenue in FY10.

The German speaking countries are subsidiary of ODG, 50% owned with the Munich based Tele München Gruppe as suddenly expanded the number of homes cable receiving services to over 2 million across the networks of Cable Deutschland Germany, Unimedia and Telekom Austria. Digital home based across the networks expected to increase by more than 20% in the coming years.

At the same time ODG has also supported its distribution drive by improving its content offerings with multiyear movie output deals of Warner Brothers and Fox as well as deals with a whole variety of TV serial suppliers. Surely ODG will launch SD of the movie and TV services in Austria. And it’s in advance discussions with double the numbers of service providers using SVOD and [SPOD] services in the region. Growth in Germany will therefore come from increased comps capable receiving ODG services on existing clients’ platforms new and more advanced content services and more service providers.

Finally, as mentioned previously we purchased a facility in UK in the second quarter for approximately $6.3 million to house ODG’s operations, which were previously housed under separate leased facility. The decision to move to a large facility was driven by the need to improve ODG’s margin by bringing digital editing services in-house at a cost significantly lower than what ODG’s suppliers are now charging.

Our second quarter revenues were at historic levels we continue to demonstrate the operating leverage seen over the last several quarters with the gross margin at 49% for the quarter. Margins in the software business continue to drive overall margin performance we were particularly pleased to generate a mid 40 gross margin for our service and storage business in a competitive environment.

Gross margin dropped from increased revenue as combined with containment of operating expenses led to another profitable quarter to SeaChange. In fact, since the cost reduction actions we took in last year’s second quarter we’ve been profitable for every quarter since.

Turning to our guidance for the remainder of fiscal 2009, we reiterate top line growth to be 10% higher for fiscal 2009 compared to 2008. Our guidance is driven by continued strong spending from North American Cable and Telco service providers on VOD server and software products.

Increased software development revenues from our large customer and continued high level of advertising insertion order activity to satisfy increased high-definition channel requirements. We expect the company to be profitable in the second half of fiscal 2009 driven by software margin strength and containment of operating expenses.

I would like now to turn the discussion over to Yvette, who will discuss how we size the market opportunity for software. Yvette?

Yvette Kanouff - Chief Strategy Officer

Thanks Bill. As we promised on the last call, we will give -- we would like to give an overview of our software business today. First, a little background on how the software business is composed, the business unit consist of three components. In home software, infrastructure software and application software, each of these has three types of revenue, product revenue, professional services revenue and recurring upgrade enhancement and maintenance revenue.

Before we talk more about that let me explain what the product in the three main categories are; to start with the In home appliance software, in most set top boxes there is a software component needed to make on demand work we build that software.

In some cases, we also build the user interface that the consumer uses to browse through titles. We also sell middle ware which provides a common platform that allows them to use the functions of the set top box. Other company’s applications then run on the middle ware to provide customer services like start over or look back.

Our In home software can also run on non set top box devices such as personal computers or mobile devices as you may have seen it at one of our trade show demonstrations. This In home software product line has been a good business for us, we even run SeaChange In home software for non SeaChange VOD sites and we have really close partnerships on this front.

Some of the products that fall into the category of in home software that you may have heard of include VOD link, CMOD TV navigators, CDAC and Multiverse. The second component is infrastructure software also called video backoffice software. We offer several back-office software components such as our Axiom product and our TV business system software. These components are critical in the next generation networks as they manage system band with allocations, streaming management for on demand or switch digital asset management, in just management, filling interfaces, consumer up sale capabilities and much more. Consider the backoffice software to be the brains behind the management of the network and hardware.

The third and final software component that we build is applications. The largest application of ours is advertising which uses our backoffice and sometimes our in-home software to manage intelligent advertising insertion. Applications also include products such as recommendation engines, internet over the top applications, DVD on demand, games and more.

So, now that you see what our software is made up of, let’s go back to the revenue discussion. Last year our software revenue was about $120 million, some of that is in the sale of new product and professional services such as our new deployment or our new site. We also get a significant amount of growth from streaming expansion and increased usage rates as we’ve discussed on prior calls.

Let me review how each software category revenue breaks out. Typically the market associates a price per video stream on the backoffice software which is why increased usage rates are a key to growth. Professional services are charged by the service provided like system designs, system integration, installation services training and more. This is the really lucrative area for us as Bill discussed where we’ve been seeing good potential for growth especially in cases like Turk Telekom, where we function as a full system integrator.

In home client software however is charged by the set-top box, application software can be charged by content bandwidth site licenses and there are other various methods. And then of course, there is the recurring revenue where our customers pay for upgrade subscriptions, maintenance services, which is usually a percentage of the list price of the product that’s in question. So, you can see that software modeling is a bit complex so let me try to put it in the perspective in a consistent way. Given that we have approximately 40 million on demand households that we are serving with our software. We equate the revenue per subscriber to about $3 per year. That’s a blended rate of various revenue types that keeps it easy for the sake of this walk through. Keep in mind that any license sale automatically turns into recurring revenue sale. So, that blend of number is reasonable to use. Today our recurring revenue is well over half of the total software revenue. One more thing that I would like to bring up about the $3 per subscriber number is that this number is being trending up for us and our goal is to have the per subscriber number be around $4 to $5. Obviously, the increased usage rates are an easy way to see that number go up. Another factor for growth is the ongoing expansion of our software offerings and features.

So, let’s look at some market numbers to help make sense of the potential for all the software. I’ll use Keegan numbers to help us on this call. So, we’ll start by looking at all television households in the world. We evaluate the television household country by country. So, our first plans, you might think that we are targeting the approximate 1.2 billion television households that exist in the world and yes, that is the end goal for us but I’ll break it down a little bit more. What’s interesting to us is that the top television countries are China, India, Russia and the US. And, I mentioned that because it gives you some understanding as to the markets that we’ve been targeting and that we’ve been discussing with you over the past few years.

So, now I’d like to move on to IPTV by country. The top five countries here are Japan, South Korea, China, France and the US are different mix than what we saw in overall television households. We have software products of all three areas for IPTV with deployments like Turk Telekom and Verizon. We see IPTV in general to be an area where SeaChange can offer its software solutions and have significant revenue growth potential.

Finally, digital cable forecast showed the top five countries as a mixture of China, India, Japan, Germany, The UK, Canada and the US. As you know, we are extremely well positioned in this market and the largest market in the world is the United States, which is the country in which we show strong leadership. Keegan’s number will show there will be 11,315,000 IPTV subscribers going into 2008 and 45,030,000 subscribers at the end of 2012. By comparison, digital cable subscribers going into 2008 are 93,621,000, with 278,432,000 at the end of 2012. So, putting together our market leadership, our deployed households and this Keegan market data, we can see the 40 million on demand households is a mall subset of where we can go. Even at the current win rate and blended per subscriber rate our growth looks promising. For example, achieving the equivalent market share in 2012, with IPTV and digital cable would yield SeaChange about a 123 million subscribers. Our revenue at the current $3 per subscriber would thus yield 370 million. Similarly, the target $5 dollars per subscriber would yield 615 million. I need to point out that when we see digital cable numbers that many of these are still one way household. So, as these convert two way households, our potential be then greater than just the add on growth that’s obvious from the numbers I provided.

Hopefully, the explanation of how the software business works combined with the market analysis helps you share some of the enthusiasm that we’ve have been talking about as it relates to the future of our software business. So, I can’t go without giving you a few updates on the quarter as Bill and Kevin discussed it was a good quarter for SeaChange and good for the software business. We had 3 new on demand advertising sales, one in South America, one in Asia and one in North America.

We had 4 new sites in which we replaced non-SeaChange back office vendors and we had three new Greenfield deployments. That’s all in addition to the current growth and significant expansion of our software in North America.

That’s it for the software review. And we’ll be happy to answer any questions during the Q&A. And again I do hope that I shed some light on how positive the opportunity is for us as well as how well we’ve done in this space.

As to the market numbers, hopefully they helped shed some light on a few decisions we’ve made in the past years. We open an office with significant engineering in Shanghai, and a primary focus of theirs has been the markets -- has been on building up the markets in China and India. We’ve had a big focus on the UK with our Telewest and NTL wins which now of course are Virgin Media. Additionally, we’ve been talking to you about our on demand Deutschland Group, which is based in Munich kicking off the German market with wins that cover Deutschland and Unity Media. We have offices in Japan, and we discussed significant launches there. We’re the software application advertising and server technology for South Korea’s largest cable providers CJ cable and of course we were very proud of our market leadership in Canada and the United States. All of these are some of the countries that I mentioned as key countries that are market leaders in IPTV and digital cable. We believe we are focused on the right markets with the right products and we look forward to a strong remainder of the year.

So, with that I will open the line to any questions you may have for us.

Question-and-Answer Session

Operator

(Operator Instruction). And our first question will come from John Groover with Groover & McBain.

John Groover

Hi. Congratulations on a great quarter. My question deals with -- Q2 by $3 million, yet you kept your annual guidance at 10%, which if you have just kept your third and fourth quarters the same as the second, you will get there, yes if you look back in history you third and fourth quarters are better than the second quarter over years except for one. So, I guess my question is why are you just keeping your forecast the same, is that conservatism or is there some reasoning behind that, that the second quarter was extraordinary.

Kevin Bisson

We are carefully not providing any guidance, we provided that numbers at the beginning of the year, our strategy as you know over the years has been to provide no guidance and that would be the part to actually provide you more guidance through the second half.

John Groover

I’m sorry?

Kevin Bisson

To provide you a different number for the year would be departure from our strategy of not providing guidance. We are not making any statements about how the second half is going to occur.

John Groover

So, we shouldn’t listen to the 10% there, its not, that’s not guidance?

Kevin Bisson

The guidance we gave at the beginning of the year remains right, I don’t think we have any…

John Groover

I thought, how you did that reiterate that 10%? It's that what you’re saying, I thought I read that in the press release.

Kevin Bisson

Yes, we did reiterate 10% top line guidance year-over-year.

John Groover

Okay. And then I guess my question also…

Kevin Bisson

We are not predicting any slow down in the second half.

John Groover

Okay. Let me ask you different wise normally your second half is better then two times your second quarter, any reason this year should be any difference?

Kevin Bisson

No.

John Groover

Thank you.

Operator

Our next question will come from Ali Mogharabi with B. Riley & Company.

Ali Mogharabi

Hi guys. A couple of quick things on ODG specifically. There the new deals for ODG, when do you think revenues will be recognized for those, are they going to be this year or next year and or those, if this year’s orders actually included in the 10% top line guidance for the year?

Kevin Bisson

Primarily the contribution of those new deals will be next fiscal year, that will be something of contribution in the second half of this year.

Ali Mogharabi

Okay.

Kevin Bisson

Yeah, I think we, the -- telecommunications should be launching in back end of this year, but at those point you will see material revenue coming from that beginning in next year, I think the German joint ventures are contributing revenue this year. And so, but their contributions included in that 10%...

Bill Styslinger

Revenue from the…

Kevin Bisson

Processing.

Bill Styslinger

Processing revenue

Ali Mogharabi

Okay. If you can stay with me here I got a couple of more questions. One, regarding basically the impact of the global economy. As you guys know we have had a slowdown here. It’s looking like we are going to have one or actually they are having one out there in Europe. I’m assuming all of that is taken into account for the guidance that you have provided, correct?

Bill Styslinger

We don’t see any slowdown in VOD activity. The reason is that in general it’s partly competitive environment between various service providers. And their focus on two key services one of which is data service number one and number two is VOD. We don’t see any slowdown in VOD.

Ali Mogharabi

Okay. And then, on the software side, I think you mentioned over 50% of the software revenues are recurring. With that in mind I’m wondering or I’m assuming that gross margins should be although of course, they are pretty impressive but they should be a little bit higher. Why aren’t they higher?

Yvette Kanouff

Well, the recurring revenue is comprised of I think I talked about a couple of things that they involve. Several of which are services like maintenance services and some of which are upgrades. And so, those upgrades are actually the development of ongoing -- I wouldn’t say R&D, its just the development of ongoing features and enhancement to the software.

Kevin Bisson

I think you will see over time higher gross margins.

Ali Mogharabi

Okay. And then, hopefully actually couple of more, I’m sure you guys have heard the news about [Nebuad] and basically so called targeted advertising that those guys were trying to do through ISP. I just want to make sure that the advanced advertising whether its addressable or interactive that you guys are actually providing technology for on the video on demand side is based on the demographic data that all other advertisers have access to. So you guys, there is no risk associated with the news about Nebuad for you guys, is that correct?

Yvette Kanouff

Well, we have kept it really neutral of what the data is that the ad is placed based on. So, it’s somewhat irrelevant to what we do. We provided the technology to enable the ad targeting based on something. Whatever that something is, it can come from various sources, it can come from just viewing it, it can come from an external source, completely neutral of us.

Kevin Bisson

Typically what I thought mostly is they would use data bases for home…

Ali Mogharabi

Right, okay, that’s good to hear. That’s the example what I wanted to hear. That’s what I’ve been hearing from the cable operators more, more specifically Comcast is that those guys are not at risk to that of course. If they are not I mean it’s additional business for you going forward more opportunities to sell your technology. All right. And, then the last thing I see increase in R&D in sales and then lower G&A is this a trend that we should look for going forward?

Bill Styslinger

There should be modest increases in those areas. I’m happy to see G&A particularly go down.

Kevin Bisson

Yeah, if it builds, rather G&A will continue to go down, but I think yeah, we reiterated a number of times in the call, we’ve done a pretty nice job of controlling operating expense growth. I think R&D will continue to grow but I think the between selling market and G&A I think we can hold that neutral that slightly up going forward.

Ali Mogharabi

Got you. Thanks guys.

Operator

Our next question will come from Blair King with Avondale Partners.

Blair King

Hi guys, thanks for taking my call. Just a quick question, I will start with the gross margins side, Bill you would or you are going to guess you probably hate doing this but, in terms of you know trying to model out the $3 per sub the $5 per sub, and do it within a period of time that falls over the next few months. Where do you see gross margins really kind of trending over the course of the next few quarters if you look at the if there is any possibly can you give that kind of information?

Bill Styslinger

That was the most nicely put request for projection I’ve heard in a long time. So, -- but, I’m going to pass over any hint of projections to Kevin here.

Kevin Bisson

No, I think that as we stated our overall margins are approaching 50% in the last quarter we were at 50%, we have been telling investors over the course of the last couple of years since I have been here that are longer term model is to get an overall margins of 50%. I think we are there, I think our opportunity for margin growth going forward is on the software side I think people, we have said that publicly, how quickly we are going to get there and when that’s going to happen, to Bill’s point we are not in a position to model that by quarter. But, I think it’s suffice to say is there is a lot more runway for software margin growth going forward and we are going to do whatever we can to accomplish that.

Bill Styslinger

Let me just point out again, one of the things I did earlier in discussion was that mass contributor professional services but the margins historically professional services have been very poor. Also they are mechanism by which you avoid custom development in your product, software product. Right? So being highly skilled there does couple of things, one is to improve those margins directly. Professional services, two avoids the encumbrance of -- a custom development on your product development and three it boost those revenues hopefully and increasingly good margins. I think that’s going to be one of the areas that we will look to see the help of the improved margins, professional services directly, that’s training, installation, systems integration, consulting, customs development. So, all of that should over time grow and become better and better margin to contribute to an overall better software margin. My think the other thing that will contribute to higher margins in software over time will be growing volume in the software maintenance. As that goes up those margins get better and will tend to help bring the overall software margin to something that looks like something you’re familiar with software business.

Blair King

Okay. That’s really helpful. And just one last question I had, it sound with all the activity that you have got going on, would you expect to see additional 10% customers this year or early next year outside the Comcast and Virgin Media?

Bill Styslinger

There are several other customers. Is that your question, I mean, I would say that tune for us to say there are several other customers.

Kevin Bisson

Yeah, There are one or two that are somewhat close but, to project whether they are going to happen at the end of this year, I don’t think, I think want to position say that at this point but, there are one or two of them that are fairly close?

Blair King

Okay, that’s really helpful. I appreciate you guys taking my call and congratulations on a super quarter.

Kevin Bisson

Okay, thanks Blair.

Bill Styslinger

Thanks Blair.

Operator

Thank you. Our next question will come from Greg Mesniaeff with Needham & Company.

Bill Styslinger

Hello Greg.

Greg Mesniaeff

Yeah, hi how are you? Just a question on the guidance you gave earlier, the 10%. Given the obvious shift towards software based model like with Axiom and everything and the opportunities that you laid out, is it maybe fair to say that apparently conservative 10% number is in some part due to a hardware transition that you’re anticipating or maybe anticipating?

Bill Styslinger

Let me just, because I got this question twice. And it sounds like we are holding back on something, right? When actual fact what we are trying to do is maintain our strategy of no guidance, right? Let me just tell you why it was 10% put out to begin with. If you recall that period of time, there was lot of concerns by people who were supplying this industry as to where they were going, what was happening right? We wanted to give some comfort to our investors as there would be some dependable growth and so we said 10%. We are not making any further statement, that’s what we are trying to say here.

Greg Mesniaeff

Got you. Okay, another reason I asked was because a transition towards higher software mix often is associated with higher margins and maybe somewhat of deceleration in the top line, so I thought maybe that, was something…?

Bill Styslinger

In fact, I think what we were hoping to point out Greg, today is that software market opportunity is extremely large. I think it seems large, I mean, for us it’s timing and enjoy, I think we are making very good progress within enormously attractive footprint rather it was in very count.

Greg Mesniaeff

Sure. And I had actually purposely that’s stagnation to my second question, perfectly which was I was hoping you could maybe give us some more color on your current tone of business was with Verizon and with Cox?

Bill Styslinger

Well, Cox, I think we spent some time there in the discussion, both these rated myself in and Kevin has spent time on Cox and how things seem to be going quite well in Cox in the roll out of our software products as they standardize on our software products. So, I would say it’s going quite well. And as far as Verizon, Verizon is quite proud of their association with the key change based on the successes of the VOD products, I mean, the VOD product is running very, very reliably, right, and as a contraries I think we are in very, very good shape with Verizon.

Greg Mesniaeff

Okay, thank you.

Operator

Thank you. And our next question will come from Alan Davis with D.A. Davidson.

Alan Davis

Yeah, just a couple of follow-up questions here. You know, it sounds like in North America, I’m trying to the focus on your large customers there, from a I guess video on demand server and Axiom software and ad insertion perspective, all those three lines sounds like the near term out look remains pretty robust, is that fair to say?

Bill Styslinger

Yeah.

Alan Davis

Okay. And then another question on your flash server business I’m curious. A, what’s the impact of gross margins is there a meaningful positive impact and then. B, how quickly can that become a significant product for you in terms of its affect on gross margins and obviously revenues?

Kevin Bisson

That is the lumpiest portion of our business, right. So, as far as server storage has been, there is a lot of good developments there and there are some strong competitors there. And I think we done quite well with our installed base there. But I would say the lumpiness of that business always makes us careful to not say much.

Alan Davis

Fair enough.

Bill Styslinger

We have very strong products, very strong install base, right? Great opportunities that is generally a lumpy business.

Alan Davis

Okay.

Kevin Bisson

I think Alan; with that margins in that business have been pretty good. We are in mid 40% margins this quarter for service and storage again most, a lot of that being driven by our VOD server business. I think that as Bill pointed out in a competitive environment I think that’s pretty favorable.

Alan Davis

Okay. And with Turk Telekom, I’m assuming no changes in the overall revenue expectations there and certainly for Phase I. Is that still kind of a calendar 2009 expectation there for those revenues?

Bill Styslinger

Yeah, it certainly has its right.

Kevin Bisson

Yeah, I think you know, we still got some more to do on it. But I think it’s going well but I think that’s a reasonable assumption to make.

Alan Davis

Okay. And then, one bookkeeping question. If you break out stock comp, depreciation and amortization for me? If not I can get it later.

Kevin Bisson

Yeah, why don’t we – I can get it for you later.

Alan Davis

Okay. Thanks.

Kevin Bisson

Okay.

Operator

(Operator Instructions). And our next question will come from Johnny Brown with Stevens Incorporated.

Johnny Brown

Hi, guys. I know you don’t want to say a whole lot about your server and storage business but I noticed that it did tick up a little bit in terms of proportionate total revenues in the quarter. And I was wondering with the flash revenue, if we could expect it to continue kind of an uptick at least here in the short-term until you really get a ramp in your software business?

Bill Styslinger

Kevin is smiling because (inaudible) reference in the guidance is not here, right.

Johnny Brown

We got to push you on it.

Kevin Bisson

Yeah, I appreciate the specification, that’s good.

Bill Styslinger

The Flash server has, is very attractive. As focused on the (inaudible) buyers, right. And so, I think there is good potential on the revenue side and the margin side.

Kevin Bisson

Yeah, Johnny, we mentioned before, the Bill’s point earlier, this is the lumpiest part of our business, which makes it extremely difficult for us to forecast. So, it presents an air of reluctance for us to do that publicly. So, suffice to say it was a very good quarter. Again a lot of it had to do with shipments of which good chunk of them were flash server shipments but thrust to say that’s going to continue over the next several quarters, the business is too lumpy for us to even get that, I think what Styslinger is trying to say is it’s fair to continue consistently every quarter. We shy from that.

Johnny Brown

Okay. Fair enough. Another question just kind of in general I think cable and Telco CapEx kind of tends to be just a little bit slower in the winter months when it’s cold and the weather bad and what not. It’s hard to put lines in the ground. Do you see does that seasonality tend to impact your product and service offerings in the fourth quarter?

Kevin Bisson

I think we’ve been both -- been down in the fourth quarter and up in the first quarter in last two years.

Bill Styslinger

A lot more variables involved. Everything from, what the individual cable customers’ budgets look like to because we are a capital expenditure for them. As you know capital expenditures are discretionary to whether they are in a build out cycle or not. So I think to isolate to one variable like seasonality is with no disrespect somewhat crude. I think it’s a lot of variables that are involved and there have been some quarters, winter quarters where we have done quite well and some where they have done not as well. So again, back to the -- what we mentioned earlier the lumpiness of this business, particularly in the service and storage makes it very difficult quarter-to-quarter to give indication of the level of these revenue for that.

Yvette Kanouff

I think, the question specifically related to weather trends because we are not an outside plant company, we don’t see weather related issues to affect us as what you were implying. So, we do see things that were companies have tried to spend all capital expenditures before they lose it or in some cases ran out as Kevin mentioned but not really weather related specifics at the end of the year.

Johnny Brown

That’s what I was trying to get to. I know your products wouldn’t be affected by that. But I didn’t know its like the chronological order of the rollouts would kind of impact your offerings due to variables in the weather and what not that comes in the winter months. So, okay that helps. And, that does it for me. Congrats on a good quarter. Thanks a lot.

Kevin Bisson

Thanks John.

Operator

At this time we have a follow up from Alan Davis with D.A. Davidson.

Alan Davis

Just two quick follow ups for you guys, first of all what’s the expectation for Comcast software development revenues second half and get bit down in the first half a little bit.

Bill Styslinger

I’m inclined not to say anything.

Alan Davis

I’ll move on. Then secondly, getting your average revenue per households $3 to $5 how much of that will be driven by increased video on demand stream versus how much it dependant on new product offerings from SeaChange?

Yvette Kanouff

Well, they are both valid factors for enabling that growth and maybe even just those two is an over simplification, it’s very difficult to try to do this in an earning call like this. But, at the simplest level it’s not really broken out by what percentage is due to which of those two factors, its just that those are two very obvious factors that can have that number go up, right? So, one thing is as more customers begin to see the value in paying for ongoing upgrades that number will go up as a whole for all of our subscriber base. As the simultaneous usage goes up, again, because so much of the software is still on a per stream basis as I walk through, that’s just logical that will increase if the streaming rate doubles then that revenue doubles. It’s an easy way to see that that number will go up. As to which will happen in what order I don’t have a crystal ball for that. But there’s still a lot different knobs that can turn that number up. So, I think that was the reason I mentioned them.

Bill Styslinger

I personally think it’s the same drivers is – you can see the enormous jump that occurred in Virgin Media as BBC iPlayer went online. Now you hear the conversations going on between the large broadcasters and the cable operators, telephone operators with more cooperation around their best content driven by ads. So, I would say if you are going to look to see what drives things from $3 to $5 dollars. I would say the biggest driver is going to be some of the external process. High quality television content.

Yvette Kanouff

And, one other thing to add is -- is that we are really enthusiastic about the interest network DDR, because that usage increases has great affects on all of our software. So, again it’s a raise for which of these things is going to take off, but that’s not, we are excited about as well.

Bill Styslinger

I have to reemphasize that to put in the call, I think often the question (inaudible) enthusiasm

Alan Davis

Okay. And, it sounds like for that on the software side on that part of the business that’s driven on a per stream basis you don’t see high risk of pricing erosion there?

Bill Styslinger

As the volume gets up undoubtedly the pricing for stream will go down. Right but, we expect that, we expect that prices to go down at a lower rate than the pull up in volume.

Alan Davis

Okay.

Bill Styslinger

They are hanging, about prices and we’re doing okay.

Operator

Our next question will come from Blair King with Avondale Partners.

Blair King

Actually Alan just asked the question I was going to ask, but an interesting point did come up. And that was this network based PVR, I know there was some talk about the cable vision ruling recently. And so, maybe Bill you could give us a little update on how you see that playing out and what that means for a company like yours?

Bill Styslinger

The best expect probably the best. We have a lot of activity going on a lot of accounts.

Yvette Kanouff

Yeah, I mean I guess the only thing I will say about it is the concept of network PVR enables the true concept of one-on-one connection, one-on-one streaming connections for everybody. And, that kind of unit casting model just means a lot more streams, a lot more simultaneous usage. And because we do price on a per stream basis that just means a lot more software licenses, hardware sales, it’s just good for our company all around. So, we are pretty excited abut the thought of the industry moving that direction. And everything being done over the network is it means, its being done with all of the equipment and software that we provide. So, it’s very exciting.

Bill Styslinger

It also has significant advantages in our hybrid platforms for PVR.

Blair King

Okay. Thanks, guys. I appreciate it.

Operator

At this time there are no further questions.

Bill Styslinger

Well, again we performed well in the quarter. Our accounts, products and services are in excellent shape. We are in really great position to continue to perform well. So, I’m looking forward to another good discussion with you in November and I thank you for calling in and have a good evening.

Operator

This does conclude today’s conference call you may now disconnect.

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Source: SeaChange International, Inc. Q2 2009 Earnings Call Transcript
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