SeaChange International, Inc. (NASDAQ:SEAC) Q3 2017 Earnings Conference Call December 6, 2016 5:00 PM ET
Ed Terino - CEO
Peter Faubert - CFO
Steven Frankel - Dougherty
Hamed Khorsand - BWS Financial
Matthew Galinko - Sidoti
Greetings, and welcome to the SeaChange International Third Quarter 2017 Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to your host, Ms. Lindsey Sabaris [ph], Investor Relations for SeaChange. Thank you. You may now begin.
Unidentified Company Representative
Thank you, Matt. Good afternoon, everyone, and thank you for joining us. SeaChange released results for the third quarter of fiscal 2017 ended October 31, 2016, today after the market closed. If you would like a copy of the release, you can access it on the IR section of our website, at schange.com/ir.
With me on today’s call are Ed Terino, Chief Executive Officer; and Peter Faubert, Chief Financial Officer. This call is being webcast and will be archived on the Investor Relations section of our website.
Before it begins, I’d like to remind you that the information we’re about to discuss today may include forward-looking statements, which 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 13, 2016. Any forward-looking statement should be considered in light of these factors.
Additionally, this presentation contains certain non-GAAP or adjusted financial measures, as defined by the SEC. We have provided a reconciliation of these measures to the most directly comparable GAAP measures in the tables attached to the press release.
And with that, I’d like to turn the call over to Ed for opening remarks.
Thank you, Lindsey. Good afternoon, everyone, and thank you for joining SeaChange’s call today. Our third quarter performance was in line with our expectations and the guidance we provided on our last earnings call.
Revenues of $20 million declined 31% year-over-year driven largely by lower service revenues. The decrease in professional service revenues was attributed to customer delays related to the deployment of video and home gateway platforms and a reduction in support and maintenance revenues related to several Tier 1 operators. We also experienced lower product revenues attributed to delays in decisions by several customers.
I would like to briefly touch on our progress with some of the strategic initiatives that I outlined earlier this year to increase revenue growth and return the company to profitability. To update you on Axiom to Adrenalin migrations, we were successful in closing a Latin American video on-demand and advertising customer to upgrade to our Adrenalin and Infusion platforms, as well as our content management system. With respect to Axiom to Adrenalin pipeline we have over 20 customers quoted for upgrades.
In North America, we won another new customer with a 7 figure booking for Adrenalin, replacing a video back office competitor in the process. In addition early in the fourth quarter, we won a new mobile customer in the Middle East for our Adrenalin back office, which will be deployed as a multi-screen IP TV solution to this customer’s mobile subscribers.
With respect to OTT, we continue to build our pipeline and get further penetration for two of our existing Rave customers, Filmbank and BBC. Filmbank has begun the pilot test with Into film, a UK based provider of film into the education market. As we enter the fiscal fourth quarter, we are seeing a number of opportunities for Rave in the Americas and in EMEA and our pipeline approaches 30 opportunities.
With respect to Adrenalin upgrades, we are pursuing several opportunities with customers in the Americas to upgrade to the latest version of Adrenalin in the fiscal fourth quarter and first quarter of fiscal 2018.
Regarding cloud based deployments of our Adrenalin back office, we are currently engaged with our largest customer to deliver a virtualized deployment of our Adrenalin back office running in one data center for 17 different countries. This project will enable our customer to maintain and upgrade all 17 countries at a significantly lower cost with far more frequency than is possible today.
Similar to the cloud based deployment approach employed by Comcast today for their X1 platform. Further we are beginning to see a growing demand for a similar cloud based virtualized deployment from our other Tier 1 operators. SeaChange’s Adrenalin back office platform enables customers to deploy their platform in a private or public cloud environment.
With respect to new product innovation, in the fiscal third quarter we announced the introduction of NitroX. A multi-platform user experience that provides a common user interface features and functionality across multiple devices including RDK based set-top boxes, Android set-top boxes, Legacy set-top boxes in mobile devices such as smartphones and tablets.
The target customers for NitroX are service providers and OTT players, who want to deploy one common user experience including Adrenalin enabled features such as restart TV, catch up TV and network PVR services across many different devices in their ecosystem. NitroX will begin shipping in the fiscal fourth quarter, initially launching on Android TV. We have a robust product roadmap for NitroX that includes delivering the product for Apple TV, Roku, Amazon Fire, Comcast and Samsung Tizen in the first half of fiscal 2018.
With respect to content management, we have experienced some delays in our product roadmap, we are confident that with a renewed focused by engineering facilitate by Mark Tubinis, our new SVP of Engineering and Global services, we can speed up development of our next generation content management platform to significantly improve our metadata enhancement capabilities and scalability.
We will be targeting pilot test for our enhanced content management platform with new and existing customers in early fiscal 2018. During the third quarter, we grew our sales organization with several new hires in Europe, Latin America and Asia Pacific, to improve our lead generation capability.
Our recently added insight sales and dedicated OTT sales teams are ramping well and have contributed to an increased pipeline for both Adrenalin and OTT opportunities. Our current focus on strengthening our sales organization is in Europe, to improve the pipeline as we have in the Americas.
During the third quarter, we also made significant progress on our restructuring efforts in order to optimize operating expenses and gross margins. So far in fiscal 2017 we've reduced our operating cost by close to $30 million on an annualized basis from three main initiatives. First, the discontinuance of Timeline Labs.
Second the acquisition of DCC Labs and the subsequent elimination of SeaChange in home positions in Milpitas, Indiana and Minerva [ph]. And third, the recently announced cost reduction program that is designed to improve the efficiency and effectiveness of the organization by targeting the elimination of over 140 full time positions numerous contractors and third party vendors.
We expect to realize the full benefits of the $30 million in cost reductions in fiscal 2018. Peter Faubert will provide an update on our progress with our cost reduction program in his report. For fiscal 2018 we remain focused on achieving revenue growth, profitability and positive cash flow.
With that I will turn the call over to Peter to walk you through our financial results and provide you our outlook for the fiscal fourth quarter and full fiscal year 2017. Peter, please go ahead.
Thank you, Ed. Good afternoon, everyone. I'll start by reviewing our third quarter results before providing you with an outlook for the fourth quarter and full fiscal year of 2017. We are seeing benefits of our investments in sales in the Americas. Our sales pipeline increased by 53% and our bookings increased by 140% through the third quarter of fiscal year 2017.
The bookings growth included a multiple year maintenance renewal with one customer. We continue to invest in sales in EMEA and expect similar traction in that region over the next couple of quarters. These increases have not translated to revenue growth yet, but we consider these metrics to be important steps in returning us to revenue growth.
Total revenue in the third quarter was $20 million compared to $28.7 million in the third quarter of last year. Total product revenue was $3.7 million in the third quarter or 19% of total revenue compared to $6.2 million in the year ago quarter or 22% of total revenue. Video platform software revenue was $1.8 million and accounted for 48% of the total product revenue compared to $3.1 million or 49% of the total product revenue in the third quarter of last year.
Advertising software revenue was $0.1 million down from $0.7 million last year. User experience software revenue was essentially flat year-over-year and totaled $0.2 million. Hardware revenue totaled $1.2 million down from $2.1 million last year including legacy VOD streamer revenues. Third party product revenue increased to $0.5 million from $0.2 million in the third quarter of last year.
Total service revenue in the third quarter was $16.2 million or 81% of total revenue, down from $22.6 million or 78% of total revenue in the third quarter of last year. As Ed mentioned earlier, the decline was due to a decrease in professional service and maintenance and support revenue. In addition the volume of implementation services related to product sales in both video platform and advertising decreased from the prior year.
Video platform professional service revenue totaled $5.2 million compared to $8.1 million in the year ago quarter. Managed services revenue, which include software-as-a-service and subscription services was $0.7 million compared to $2 million in the third quarter last year. The decrease from prior year there was related to the acceptance of a content delivery system by one customer that resulted in higher revenue in the prior year.
Maintenance revenue totaled $8.8 million or 54% of total service revenue compared to $10.7 million or 48% of total service revenue in the year ago quarter. The decline in maintenance revenue was driven by a decrease in the maintenance on legacy hardware at several Tier 1 operators.
In addition one Tier 1 operator is phasing out its maintenance and support with us as it transitions to its own back office. The maintenance revenue related to software licenses will increase as we upgrade more of our customers from Axiom to Adrenalin.
Revenue from international customers of $13.1 million in the third quarter accounted for 65% of total revenue compared to $16.9 million or 59% of total revenue in the prior year quarter. In the third quarter we had one customer account for 33% for total revenue, while three other customers each accounted for approximately 5% of total revenue.
Our blended GAAP gross profit margin was 49% in the third quarter compared to 24% in the prior year quarter. Excluding the provision for a loss contract and other non-GAAP charges in the third quarter of fiscal 2016, our blended non-GAAP gross profit margin was 51% in the third quarter compared to 57% in the prior year quarter.
Non-GAAP product gross margins in the third quarter was 51% compared to 75% in the prior year quarter, due primarily to an increase in third part product software and hardware incorporated in our product revenue in the third quarter this year compared to prior year.
GAAP service gross margin in the third quarter was 49% compared to 11% in the third quarter of last year. Excluding the provision for a loss contract and other non-GAAP charges in the third quarter of fiscal 2016, our non-GAAP service gross margin in the third quarter was 50% compared to 51% in the third quarter of last year.
Non-GAAP operating expenses declined 9% year-over-year to $14.4 million in the third quarter of this year from $15.9 million in the third quarter of last year. The reduction was driven by lower labor cost, which reflected the benefits of transitioning our In-Home software development to our recent acquired DCC Labs group in Poland, as well as our other restructuring efforts.
We generated a non-GAAP operating loss of $0.13 per basic share compared to a non-GAAP operating income of 0.01 per diluted share in the third quarter of last year.
Turning to our balance sheet, we ended the third quarter with cash and cash equivalents of approximately $38 million in no debt. In the third quarter we used $7.5 million of our cash for working capital needs. The decline in cash was greater than we anticipated due to the significant amount of accounts receivable being built in the last month of the quarter.
A portion of those builds amounts were expected to be collected in the third quarter. As a result our accounts receivable balance increased by approximately $12 million from the second quarter. We have already seen an increase in collections in November and our cash balance has increase by approximately $2 million month-over-month.
As a result of the late quarter billings DSOs excluding unbilled receivables totaled 113 days at the end of the quarter compared to 64 days in the second quarter. Including unbilled receivables DSOs totaled 148 days compared to 120 days in the prior quarter. We reduced our unbilled receivables by 32% to $7.9 million in the third quarter from $11.6 million in the second quarter of fiscal 2017. We expect unbilled receivables to further decline in Q4, which will further improved our working capital position.
Now, I would like to update you on the cost savings and restructuring efforts underway. We continue to realize savings related to the winding down of Timeline Labs operation and the restructuring of our In-Home business from Milpitas to Poland. Additionally during the third quarter we made substantial progress on the cost reduction program announced on our last earnings call. We continue to expect annualized savings from this cost reduction program to be approximately $15 million.
We have executed annualized cost savings of approximately $7.5 million to-date. Despite some of the international efforts taking longer than we originally expected, we remain on track to complete the cost reduction program in the fourth quarter of 2017. These measures are important steps in restoring SeaChange to profitability and positive cash flow.
Now, I’d like to turn to our outlook for the full fourth quarter and full fiscal year. We anticipate revenue for the fourth quarter of fiscal year 2017 to be in the range of $22 million to $24 million and non-GAAP operating loss to be in the range of $0.05 to $0.10 per basic share. For the full year we now expect revenue in the range of $82 million to $84 million and non-GAAP operating loss to be in the range of $0.60 to $0.65 per basic share.
With that, I'll hand the call back to Lindsey. Thank you very much.
Unidentified Company Representative
Thank you, Peter, Matt could you please provide instructions for the Q&A session.
Sure, at this time we’ll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Steven Frankel from Dougherty. Please go ahead.
Good afternoon. So Ed let’s start with Liberty update, last quarter you talked about DCC having some significant milestones that they needed to hit in September. Can you tell us whether you reached those milestone and have you received payments from Liberty was that part of that pull down in unbilled?
Yes it was. So we did hit the milestones -- some of the milestones. We -- the project that obviously was being worked on was a deployment of an in-home gateway for several Central European countries including Poland, Czechoslovakia and Austria. We did get to trial field test and we were able to go through that process and as a result of that we were able to bring down some of the unbilled receivables into accounts receivable.
That being said, Liberty has taken a decision to delay a little bit the go live dates from this sort of late third quarter into early next year. So at this point they are just spending more time obviously doing field test, obviously because of the time of year around the holidays, they don’t want to deploy a new in-home gateway during the heavy TV viewing season.
So do you have additional revenue that’s tied up because of that?
Yes we do. So once they go live there will be further reductions in the unbilled receivable and there will be further collections.
Okay. And then you talked about a Liberty cloud Adrenalin deployment, maybe help us understand timing of that and how we see that in revenue, is that a service project, is that a SaaS revenue. What’s that going to look like and when do we begin to see it?
So, we haven’t finalized negotiations on commercial terms. So at this point we are obviously in the middle of the project and we’re doing that on a professional service basis. The expectation is that they would expect to transition to a virtualized environment sometime in the second half of 2017 and we would expect to see the revenues in the form of license revenues as oppose to SaaS, although that’s still something that subject to further discussion and collaboration.
Okay. And are we already seeing the professional services around that or is that something that will grow professional services from here?
So we are seeing professional services we had them in the quarter, they will continue, they will be a little bit better in the fourth quarter and they will continue to happen as we get into calendar year 2017.
And you talked positively about Rave and I appreciate that, but when you look at the numbers it’s not just year-over-year where you had a tough comparison sequentially that business is declining. So help us understand why we should believe that Rave is a real business for you and you can ramp that up to something that become material.
It didn’t really decline sequentially. The sequential decline was attributed to some Timeline Labs revenue that was in the second quarter of about $100,000 or so, it was pretty flat quarter-to-quarter.
And you know as I said in my script, we’re in the pilot or pilot stage for our Filmbank and that hasn’t really started to ramp revenues yet, BBC obviously has been producing revenues, but once Filmbank is through their pilot, we should expect to see some growth in revenues for Rave.
Okay. And then on the receivables issue, I mean this has been a recurring pattern with you guys and yes, you collected $2 million early in the quarter, but that still leaves a big receivable balance. Is this one or two big customers that are just stretching you out or do you have something inside your organization that you're not doing right that's causing receivables to be such an issue?
Steve this is Peter. I would say that the good news is a lot of the billings that happened at the end of the quarter were related to us hitting some critical milestones in terms of delivery of our product to a particular customer and then negotiating the multi-year maintenance deal.
I would say that in general I think that our collections efforts have improved in terms of getting our customers comfortable with our products and what we're delivering and making sure that we're collecting our accounts receivable on a timely basis.
So we're seeing less of our receivables getting excessively aged. That being said we still have some out there that we have to collect. But I think we're making some improvements in that area.
Yeah Steve just to add to that, I'm actually quite pleased with the efforts that Peter has undertaken. I know the metrics don't look very good at the end of the third quarter, but I think we've made significant progress in this area. I think the big development is that the unbilled has work down. I think we'll see another significant increase in the unbilled here in Q4. Yes sorry increase.
Okay. And then while I'm picking on you or being on you, gross margins are still going the wrong way, what has to happen for product gross margins to start to turn around. Is that take this next generation of products which are late next year for that to happen?
Yeah Steve this is Peter again. I think if you look at just the trends in product revenue not only are we seeing a decrease in the higher margin software revenue as a percentage in clearly in terms of pure level of software license revenue. But the other factor is that we're seeing more third party hardware and software incorporated in some of our product sales.
So to improve that, yes I think selling new and innovative products with higher margins will help, but also getting to these Axiom to Adrenalin upgrades will come with much more software license fees and as a result higher margins that should drive that combined gross margin up.
And could you remind us how many Axiom to Adrenalin conversions do you have remaining in backlog?
I said in the script that we had about 20 quotes outstanding.
But how I look at other quotes, but in terms of deals in process there is just the one you talked about winning in the quarter?
Yeah there was the one deal we won in the quarter that was a fairly significant deal it was a 7 figure booking. But there is about 20 more to go.
And that 7 figure booking you won in the quarter takes how many quarters to turn to revenue?
I would say some of it came in this quarter and certainly some of it will come in over the next two quarters. The bulk of it being in Q4.
Okay, I'll pass it on. Thank you.
Our next question comes from Hamed Khorsand from BWS Financial. Please go ahead.
Hi. Just a question, are your customers moving more work to international or is there a solution that they want that you don't offer or can offer that's causing the delays in the upgrades?
No, I don't think they're moving to other vendors as much as it's a question of what are their priorities in terms of funding. I mean they have tremendous demands for way to invest their money. And traditional cable operators and telcos are obviously having to spend more money on content. And that sometimes delays some of their spending on infrastructure, which is what we support we’ll provide.
Okay. I got kind of disconnected so I may have missed this already, but could you tell us how much revenue you booked for Q4 so far?
We've really don't disclose how much revenue we've booked thus far in the quarter. Obviously we have pretty stringent revenue recognition practices. We generally have had I think some good experience early in the quarter on bookings so that's encouraging for us.
Okay. And then so in the past you've kind of given guidance and then you hit sometimes the lower end of the guidance like this time and then you reduced your guidance again. So how much credibility should we give this new guidance for the next quarter and for the fiscal year?
Well I think that the one thing I think Peter pointed out in his comments is that our pipeline has expanded. So I think that there is a greater likelihood that more of our pipeline will be converted into bookings. And more of those bookings will be converted into revenue.
So we're trying to be conservative so that we can hit our guidance. So I don't know if I have anything else to add to that.
Okay, thank you.
[Operator Instructions] And our next question comes from Matthew Galinko from Sidoti. Please go ahead.
Hey, good afternoon. On the -- I think you mentioned 30 opportunities in the pipeline for Rave OTT deals. Can you give us an idea what that was or how that changed sequentially. How many of those came from your sales force versus what might have been kind of percolating over the past few quarters? And then if you could kind of rank sort if any of those are really material in size or if they are largely at the low end of the spectrum?
Yes. We have really put a lot of effort into building out our Rave sales team. So we have a number of dedicated people. And I think we're seeing the results in terms of the pipeline growth from the fact that we have dedicated people here. So if we looked at the pipeline relative to the second quarter versus where it is, it's grown pretty significantly.
In terms of the size of the deals, it really is difficult to talk about them because of the nature of the implementations. I made a comment earlier about Filmbank which we won last quarter and how they are moving forward with rolling out their platform in the educational sector.
And they are going through a pilot, depending on the success of that pilot it could influence how quickly they roll it out to more educational environments and it could also delay based on what they experience. So it was very difficult to get any predictability around the revenue throughput that we’d see. I think the important thing to takeaway is that as we win more these opportunities it will eventually turn into revenue.
Got it. And maybe just in terms of the competition you feel on those deals or maybe put in other way, I mean where in the decision making process are those generally, are they still evaluating several vendors or they narrowed it down to couple or where do you stand competitively there?
It varies by each one of the transactions. I would say that there is a lot of very competitive situations. So I would say that we see more competition for Rave opportunities than we do for back office or user experience opportunities.
Got it. Lastly, you mentioned I think that the seven figure back office deal was competitive takeaway, I believe that was a North American win you talked about this quarter. Can you say anything more about how that came to be and how sticky you feel your presence is now that you've got the deal done.
Well we feel it's very sticky. I mean obviously they've entered into an agreement. I think it's a testament to the fact that our back office is in our view the best back office in the industry. I think we are able to power more subscribers with more content in a very responsive reliable way than some of our competitors and all of our competitors and I think that’s why we won this deal.
I think that we certainly have more opportunities like that, the challenge we face is that given our size compared to our competitors that’s where we need to convince customers to buy our products as oppose to our competitors.
Got it, thank you.
This concludes the question-and-answer session. I would now like to turn the floor back over to Mr. Terino, for any closing comments.
Thank you. While we would all like to see better financial results sooner, than we have been able to deliver, we are steadfast in our determination to successfully execute a turnaround here at SeaChange. We are clearly seeing progress and good signs from our customers. Thank you today for joining us on the call and for your continued support and interest in SeaChange. Good night.
This concludes today’s teleconference. Thank you for your participation. You may disconnect your lines at this time.