Services Gross Profit. Cost of services revenues consist primarily of labor, materials and overhead relating to the installation, training, product maintenance and technical support, software development, and project management provided by us and costs associated with providing video content services. The gross profit percentage for services was flat at 38% in the nine months ended October 31, 2008 and 2009, respectively.
Software Revenues Gross Profit.Software segment gross margin of 61% for the nine months ended October 31, 2009 was three percentage points higher compared to the nine months ended October 31, 2008. The increase in Software gross margins is due mainly to a favorable product mix of higher margin VOD software products and higher Software services maintenance revenue year over year with comparable headcount-related costs.
Servers and Storage Gross Profit.Servers and Storage segment gross margin of 43% in the nine months ended October 31, 2009 was two percentage points lower than in the nine months ended October 31, 2008 due mainly to increased shipments of lower margin VOD servers and lower service margins as a result of higher VOD headcount-related.
Media Services Gross Profit.Media Services segment gross margin of 11% in the nine months ended October 31, 2009 was three percentage points lower than gross margin for the nine months ended October 31, 2008 due principally to the overlap of increased headcount related costs that occurred during the nine months ended October 31, 2009 associated with bringing all content processing in-house combined with related third party costs.
Research and Development. Research and development expenses consist primarily of the compensation of development personnel, depreciation of development and test equipment and an allocation of related facilities expenses. Research and development expenses increased from $32.0 million, or 22% of total revenues, in the nine months ended October 31, 2008, to $37.4 million or 25% of total revenues, in the nine months ended October 31, 2009. The increase year over year is primarily due to increased headcount costs related to the VOD servers and TV Navigator product lines and the inclusion of two months of expenses for eventIS.
Selling and Marketing. Selling and marketing expenses consist primarily of compensation expenses, including sales commissions, travel expenses and certain promotional expenses. Selling and marketing expenses decreased from $20.5 million, or 14% of total revenues, in the nine months ended October 31, 2008, to $19.6 million, or 13% of total revenues, in the nine months ended October 31, 2009. This decrease is primarily due to lower external commission expenses of $500,000 and lower travel expenses of $300,000.
General and Administrative. General and administrative expenses consist primarily of the compensation of executive, finance, human resource and administrative personnel, legal and accounting services and an allocation of related facilities expenses. In the nine months ended October 31, 2009, general and administrative expenses increased to $16.0 million, or 11% of total revenues, from $15.5 million, or 11% of total revenues, in the nine months ended October 31, 2008. The increase was primarily due to eventIS acquisition costs of $900,000.
Amortization of intangible assets. Amortization expense consists of the amortization of acquired intangible assets which are operating expenses and not considered costs of revenues. In the nine months ended October 31, 2009 and 2008, amortization expense was $1.8 million and $1.2 million, respectively. An additional $390,000 and $140,000 of amortization expense related to acquired technology was charged to cost of sales for the nine months ended October 31, 2009 and 2008, respectively. The increase in amortization expense was primarily due to the amortization of intangible assets acquired in connection with the acquisitions of eventIS and Mobix.
Interest and Other Income, net. Interest and other income, net was $739,000 in the nine months ended October 31, 2009, which consisted of $601,000 of interest income and $123,000 of translation gains. The $1.6 million in the nine months ended October 31, 2008 consisted of $1.8 million of interest income and $201,000 of translations losses. A $1.2 million decrease in interest income was from lower interest rates earned on the Company’s cash, cash equivalents and short-term investment portfolio balances during the nine months ended of October 31, 2009 compared to the corresponding periods in 2008. Translation gains and losses at our various foreign subsidiaries (where the functional currency is the US Dollar) are derived from fluctuations in exchange rates between the various currencies and the U.S. dollar.
Equity Loss in Earnings of Affiliates.Equity loss in earnings of affiliates was $517,000 and $576,000 in the nine months ended October 31, 2009 and 2008, respectively For the nine months ended October 31, 2009, $940,000 of equity loss was recognized from On Demand Deutschland, net of $423,000 in accreted gains related to customer contracts and content licensing agreements and a capital distribution related to the reimbursement of previously incurred costs. For the nine months ended October 31, 2008, the On Demand Deutschland loss was $1.1 million net of $520,000 in accreted gains related to customer contracts and content licensing agreements and a capital distribution related to the reimbursement of previously incurred costs.
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Income Tax Provision and Benefit.For the nine months ended October 31, 2009, we recorded an income tax provision of $337,000 resulting in an effective income tax provision rate of 16%. The income tax provision rate of 16% was primarily attributable to revenue in our foreign subsidiaries which are taxed at lower rates than in the U.S. and a discrete income tax of $0.4 million arising predominately from U.S. Federal return-to-provision adjustments for the fiscal 2009 corporate income tax return. For the nine months ended October 31, 2008, we recorded an income tax provision of $2.1 million resulting in an effective income tax provision rate of 27%.
As of October 31, 2009, the Company has maintained the full valuation allowance against its net U.S. and U.K. deferred tax assets primarily due to the uncertainties related to the Company’s ability to generate sufficient pre-tax income in the U.S. and U.K. to fully utilize these assets for fiscal 2010 and thereafter. If we generate sufficient pre-tax income in the future, some portion or all of the valuation allowance could be reversed and a corresponding increase in net income would be reported in future periods.
Off-Balance Sheet Arrangements
We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.
Liquidity and Capital Resources
Historically, we have financed our operations and capital expenditures primarily with cash on-hand and the proceeds from sales of our common stock. Cash and marketable securities decreased $32.4 million from $85.8 million at January 31, 2009 to $53.4 million at October 31, 2009. Working capital, excluding long-term marketable securities, decreased from $89.5 million at January 31, 2009 to $52.0 million at October 31, 2009. The decrease was a primarily the result of the acquisition of eventIS on September 1, 2009.
Net cash provided by operating activities was $10.3 million for the nine months ended October 31, 2009 compared to net cash provided by operating activities of $9.4 million for the nine months ended October 31, 2008. The net cash provided by operating activities for the nine months ended October 31, 2009 was primarily the result of net income and non-cash expenses of $11.4 million and a decrease of working capital of $2.3 million. The primary reason for the decrease in working capital was the increase of $4.4 million in inventory due to the build up for orders in the fourth quarter and a decrease of $4.9 million in accounts payable due to timing of payments offset by strong accounts receivable collections during the period.
Net cash used by investing activities was $41.6 million for the nine months ended October 31, 2009 compared to net cash used by investing activities of $9.2 million for the nine months ended October 31, 2008. Investment activity for the nine months ended October 31, 2009 consisted primarily of the purchase of property and equipment of $6.8 million, $2.5 million of contingent consideration payments to the former shareholders of Mobix and the purchase of eventIS for $32.3 million, net of cash acquired of $4.4 million.
Net cash used by financing activities was $441,000 for the nine months ended October 31, 2009 and net cash used by financing activities was $4.1 million for the nine months ended October 31, 2008. In the nine months ended October 31, 2009, the cash used by financing activities was due to the repurchase of $1.7 million of the Company’s stock partially offset by $1.1 million from the issuance of common stock in connection with stock option exercises and stock purchases under the Company’s Employee Stock Purchase Plan.
Effect of exchange rates on cash and cash equivalents of $710,000 was the result of the translation of ODG’s and eventIS’s cash balances, which use the British pound and the Euro, respectively, as their functional currencies, to U.S. dollars at October 31, 2009.
In connection with our acquisition of eventIS, we are obligated to pay annually $1.7 million in cash and to issue shares of restricted stock of SeaChange equating to approximately $1.1 million to the former eventIS shareholders on each of the first three anniversary dates following the acquisition. In addition, we have agreed to contingent earnout payments to the former eventIS shareholder principally related to the achievement of certain annual performance goals for eventIS and sales of SeaChange products and services. The revenue performance metrics will cover the three year period ending January 31, 2013 with payment upon achievement of these metrics occurring annually.
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On October 31, 2008, RBS Citizens (a subsidiary of the Royal Bank of Scotland Group plc) extended our $15.0 million revolving line of credit from October 31, 2008 through October 31, 2010. Loans made under this revolving line of credit bear interest at a rate per annum equal to the bank’s prime rate. Borrowings under this line of credit are collateralized by substantially all of our assets. The loan agreement requires SeaChange to comply with certain financial covenants. On August 31, 2009, these financial covenants were amended to reflect the acquisition of eventIS. As of October 31, 2009, we were in compliance with the amended financial covenants and there were no amounts outstanding under the revolving line of credit.
We are occasionally required to post letters of credit, issued by a financial institution, to secure certain sales contracts. Letters of credit generally authorize the financial institution to make a payment to the beneficiary upon the satisfaction of a certain event or the failure to satisfy an obligation. The letters of credit are generally posted for one-year terms and are usually automatically renewed upon maturity until such time as we have satisfied the commitment secured by the letter of credit. We are obligated to reimburse the issuer only if the beneficiary collects on the letter of credit. We believe that it is unlikely we will be required to fund a claim under our outstanding letters of credit. As of October 31, 2009, the full amount of the letters of credit of $731,000 was supported by our credit facility.
On March 11, 2009, our Board of Directors authorized through the repurchase of up to $20.0 million of our common stock, par value $.01 per share, through a share repurchase program. As authorized by the program, shares may be purchased in the open market or through privately negotiated transactions in a manner consistent with applicable securities laws and regulations, including pursuant to a Rule 10b5-1 plan that we maintain. This share repurchase program does not obligate us to acquire any specific number of shares and may be suspended or discontinued at any time. All repurchases are expected to be funded from our current cash and investment balances. The timing and amount of the shares to be repurchased will be based on market conditions and other factors, including price, corporate and regulatory requirements and alternative investment opportunities. The repurchase program is scheduled to terminate on January 31, 2010. During the nine months ended October 31, 2009, we repurchased 298,415 shares at a cost of $1.7 million.
On February 27, 2007, the On Demand Group Ltd. (“ODG”), our wholly-owned U.K. subsidiary, entered into an agreement with Tele-Munchen Fernseh GmbH & Co. Produktionsgesellschaft (TMG) to create a joint venture named On Demand Deutschland GmbH & Co. KG. The Shareholder’s Agreement requires ODG to provide cash contributions up to $4.2 million (USD equivalent) upon the request of the joint venture’s management and approval by the shareholders of the joint venture. During the nine months ended October 31, 2009, the ODG contributed approximately $0.8 million.
We believe that existing funds combined with available borrowings under the revolving line of credit and cash provided by future operating activities are adequate to satisfy our working capital, potential acquisitions and capital expenditure requirements and other contractual obligations for the foreseeable future, including at least the next 12 months. However, if our expectations are incorrect, we may need to raise additional funds to fund our operations, to take advantage of unanticipated strategic opportunities or to strengthen our financial position.
In addition, we actively review potential acquisitions that would complement our existing product offerings, enhance our technical capabilities or expand our marketing and sales presence. Any future transaction of this nature could require potentially significant amounts of capital or could require us to issue our stock and dilute existing stockholders. If adequate funds are not available, or are not available on acceptable terms, we may not be able to take advantage of market opportunities, to develop new products or to otherwise respond to competitive pressures.
Effects of Inflation
Management believes that financial results have not been significantly impacted by inflation and price changes in materials we use in manufacturing our products.
Significant Accounting Policies
Goodwill
In connection with acquisitions of operating entities, we recognize the excess of the purchase price over the fair value of the net assets acquired as goodwill. Goodwill is not amortized, but is evaluated for impairment, at the reporting unit level, annually in our third quarter as of August 1. Goodwill of a reporting unit also is tested for impairment on an interim basis in addition to the annual evaluation if an event occurs or circumstances change which would more likely than not reduce the fair value of a reporting unit below its carrying amount.
During the third quarter of fiscal 2010, we performed our annual impairment testing of goodwill. We first calculated the fair value of each reporting unit using a discounted cash flow methodology. We then performed “Step 1” and compared the fair value of each reporting unit of accounting to its carrying value as of August 1, 2009. Reporting units that we test are equivalent to our business segments. We have three reporting segments, the Software segment, Servers and Storage segment and Media Services segment. Goodwill assigned to our reportable segments as of August 1, 2009:
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| | Software | | Servers& Storage | | Media Services | | Total |
| | (inthousands) |
| Goodwill balance | $ | 10,162 | | $ | 754 | | $ | 16,437 | | $ | 27,353 |
The process of evaluating goodwill for impairment requires several judgments and assumptions to be made to determine the fair value of the reporting units, including the method used to determine fair value, discount rates, expected levels of cash flows, revenues and earnings, and the selection of comparable companies used to develop market based assumptions. Consistent with prior years, we employed a five year discounted cash flow methodology to arrive at the fair value of each reporting unit. In calculating the fair value, we derived the standalone projected five year cash flows for all three reporting units. This process starts with the projected cash flows of each of the three reporting units and then the cash flows are discounted. We use the discounted cash flow methodology as our principal technique as we believe that the discounted cash flows approach provides greater detail and opportunity to reflect facts, circumstances and economic conditions for each reporting unit.
We determined that based on “Step 1” of our annual goodwill test, the reporting fair values of all three of our reporting units containing goodwill balances exceeded their carrying values. In aggregate, there was excess fair value over the carrying value of the net assets ranging from $53-$73 million. Below is a summary of the fair values ranges calculated by the company as of August 1, 2009.
| | Premium Ranges over |
| | Carrying Value |
| | Software | 102%-138% |
| Servers and Storage | 67%-102% |
| Media Services | 15% |
Key data points included in the market capitalization calculation were as follows:
Shares outstanding as of August 1, 2009: 30.9 million; and
Trailing 32 day average closing price as of August 1, 2009: $8.30 per share.
Accordingly, as no impairment indictor existed as of August 1, 2009, our annual impairment date, and the implied fair value of goodwill did not exceed the carrying value of any of our three reporting units, we determined that goodwill was not at risk of failing “Step 1” and was appropriately stated as of August 1, 2009.
To validate our conclusions and determine the reasonableness of our annual impairment test, we performed the following:
Reconciled our estimated enterprise value to market capitalization comparing the aggregate, calculated fair value of our reporting units to our market capitalization as of August 1, 2009, our annual impairment test date. As compared with the market capitalization value of $256 million as of August 1, 2009, the aggregate carrying values of our three reporting units was approximately $178 million;
Prepared a “reporting unit” fair value calculation using discounted cash flows;
Reviewed the historical operating performance of each reporting unit for the current fiscal year;
Performed a sensitivity analysis on key assumptions such as weighted-average cost of capital and terminal growth rates; and
Reviewed market participant assumptions.
The discounted cash flows used to estimate fair values were based on assumptions regarding each reporting unit’s estimated projected future cash flows and estimated weighted-average cost of capital that a market participant would use in evaluating the reporting unit in a purchase transaction. We employed one weighted-average cost of capital rate for all our reporting units. The estimated weighted-average cost of capital was based on the risk-free interest rate and other factors such as equity risk premiums and the ratio of total debt to equity capital. In performing the annual impairment tests, we took steps to ensure appropriate and reasonable cash flow projections and assumptions were used. The average rate used to discount the estimated future cash flows for each of the reporting units was 18%.
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Our projections for the next five years included increased revenue and operating expenses, in line with the expected revenue growth over the next five years based on current market and economic conditions and our historical knowledge of the reporting units. Historical growth rates served as only one input to the projected future growth used in the goodwill impairment analysis. These historical growth rates were adjusted based on other inputs from management regarding anticipated customer contracts. We projected growth for each reporting unit ranging from 8% to 17% annually for the Software and Services and Storage segments, and from 11% to 26% annually for the Media Services segment. The higher projected growth for the Media Services segment is due to the recent contract wins by ODG. We estimated the operating expenses based on a rate consistent with the current experience for each reporting units and estimated revenue growth over the next five years. The failure of any of our reporting units to execute as forecasted over the next five years could have an adverse affect on our annual impairment test. Future adverse changes in market conditions or poor operating results of the reporting unit could result in losses or an inability to recover the carrying value of the investments in reporting units, thereby possibly requiring an impairment charge in the future. We record an impairment charge when we believe an investment has experienced a decline in value that is other-than-temporary.
We also monitor economic, legal and other factors as a whole and for each reporting unit between annual impairment tests to ensure that there are no indicators that make it more likely than not that there has been a decline in the fair value of the reporting unit below its carrying value. Specifically, we monitor industry trends, our market capitalization, recent and forecasted financial performance of our reporting units and the timing and nature of any restructuring activities. While our recent financial performance is below our most recent historical levels, we do not believe that there are any indicators of impairment as of October 31, 2009. If these estimates or the related assumptions change, we may be required to record non-cash impairment charges for these assets in the future.
Recently Issued Accounting Standard Updates
New Accounting Guidance Recently Adopted
Measuring Liabilities at Fair Value
In August 2009, the Financial Accounting Standards Board (“FASB”) issued an authoritative update toFair ValueMeasurements and Disclosures.This update provides amendments to reduce potential ambiguity in financial reporting when measuring the fair value of liabilities. Among other provisions, this update provides clarification in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using one or more of the valuation techniques described in the authoritative update. The update will become effective upon issuance for subsequent interim and annual periods. The Company’s effective adoption date is October 31, 2009. The Company has determined that the update had no impact on its financial condition and results operations.
Recent Accounting Guidance Not Yet Effective
Amendments to Consolidation of Variable Interest Entities
In June 2009, the FASB issued an authoritative update to address the elimination of the concept of a qualifying special purpose entity and to replace the quantitative-based risks and rewards calculation for determining which enterprise has a controlling financial interest in a variable interest entity. Also, the new guidance requires an ongoing assessment of whether an entity is the primary beneficiary of a variable interest entity. The amended approach focuses on identifying which enterprise has the power to direct the activities of a variable interest entity and the obligation to absorb losses of the entity or the right to receive benefits from the entity. Additionally, the update provides more timely and useful information about an enterprise’s involvement with a variable interest entity. The update will become effective for the first annual period starting after November 15, 2009. The Company is currently evaluating the impact of this standard on its Consolidated Financial Statements.
Revenue Recognition for Arrangements with Multiple Deliverables
In September 2009, the Financial Accounting Standards Boards (“FASB”) amended the guidance for revenue recognition in multiple-element arrangements. It has been amended to remove from the scope of industry specific revenue accounting guidance for software and software related transactions, tangible products containing software components and non-software components that function together to deliver the product’s essential functionality. The guidance now requires an entity to provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and the consideration allocated; and allocates revenue in an arrangement using estimated selling prices of deliverables for these products if a vendor does not have vendor-specific objective evidence (“VSOE”) or third-party evidence of selling price. The guidance also eliminates the use of the residual method and requires an entity to allocate revenue using the relative selling price method for these products. The accounting changes summarized are effective for fiscal years beginning on or after June 15, 2010, with early adoption permitted. Adoption may either be on a prospective basis or by retrospective application. The Company is currently assessing the impact of these amendments on its accounting and reporting systems and processes; however, at this time the Company is unable to quantify the impact of their adoption on its financial statements or determine the timing and method of its adoption.
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ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
Foreign Currency Exchange Risk
We face exposure to financial market risks, including adverse movements in foreign currency exchange rates and changes in interest rates. These exposures may change over time as business practices evolve and could have a material adverse impact on our financial results. Our foreign currency exchange exposure is primarily associated with product sales arrangements or settlement of intercompany payables and receivables among subsidiaries and its parent company, and/or investment/equity contingency considerations denominated in the local currency where the functional currency of the foreign subsidiary is the U.S. dollar.
Substantially all of our international product sales are payable in United States Dollars (USD) or in the case of our Media Services operations in the United Kingdom and eventIS in the Netherlands, payable in local currencies, providing a natural hedge for receipts and local payments. In light of the high proportion of our international businesses, we expect the risk of any adverse movements in foreign currency exchange rates could have an impact on our translated results within the Consolidated Statements of Operations. In addition, for the nine months ended October 31, 2009 the Company generated a foreign currency translation gain of $5.7 million which was recorded as accumulated other comprehensive gain increasing the Company’s equity section of the balance sheet over the prior year.
The Company has entered into a forward foreign currency exchange contract to manage exposure related to liabilities denominated in Euros. SeaChange does not enter into derivative financial instruments for trading purposes. At October 31, 2009, we had one forward contract to buy Euros totaling €1.2 million that settles on September 1, 2010. While SeaChange does not anticipate that near-term changes in exchange rates will have a material impact on its operating results, financial position and liquidity, a sudden and significant change in the value of foreign currencies could harm the Company’s operating results, financial position and liquidity.
The U.S. Dollar is the functional currency for a majority of our international subsidiaries, except for ODG, Mobix, eventIS and SeaChange B.V. All foreign currency gains and losses are included in interest and other income, net, in the accompanying Consolidated Statements of Operations. In the third quarter of fiscal year 2010, the Company recorded approximately $278,000 in gains due to international subsidiary translations and cash settlements of revenues and expenses.
Interest Rate Risk
Exposure to market risk for changes in interest rates relates primarily to the Company’s investment portfolio of marketable debt securities of various issuers, types and maturities and to SeaChange’s borrowings under its bank line of credit facility. The Company does not use derivative instruments in its investment portfolio, and its investment portfolio only includes highly liquid instruments. Our cash and marketable securities include cash equivalents, which we consider to be investments purchased with original maturities of nine months or less. There is risk that losses could be incurred if the Company were to sell any of its securities prior to stated maturity. Given the short maturities and investment grade quality of the portfolio holdings at October 31, 2009, a sharp rise in interest rates should not have a material adverse impact on the fair value of our investment portfolio. Additionally, our long term marketable investments, which are carried at the lower of cost or market, have fixed interest rates, and therefore are subject to changes in fair value.
At October 31, 2009, we had $10.8 million in short-term marketable securities and $11.0 million in long-term marketable securities. Of the $21.8 million in available-for-sale securities at October 31, 2009, the Company holds $1.0 million in auction rate securities ("ARS") that were intended to provide liquidity via an auction process that resets the applicable interest rate in the event there is no new investment in these securities. Due to the uncertainty in the credit markets, this $1.0 million ARS holding in our investment portfolio has failed to settle on its respective settlement date resulting in the illiquidity of this investment. Consequently, we have not been able to access these funds and do not expect to do so until a future auction of these investments is successful or a buyer is found outside the auction process. Although the maturity date of the underlying security of our ARS investment is twenty-two years, we currently have sufficient cash and cash equivalents, cash from operations and access to unused credit facilities to meet our short term liquidity requirements and do not anticipate that we will need to access our ARS investment. Accordingly, the Company has classified this investment as long-term and its fair value equals par at maturity.
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ITEM 4. Controls and Procedures
(a)Evaluation of disclosure controls and procedures. The Company evaluated the effectiveness of its disclosure controls and procedures, as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this quarterly report on Form 10-Q. William C. Styslinger, III, our Chief Executive Officer, and Kevin M. Bisson, our Chief Financial Officer, reviewed and participated in this evaluation. Based upon that evaluation, Messrs. Styslinger and Bisson concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report and as of the date of the evaluation.
(b)Changes in internal controls over financial reporting.As a result of the evaluation completed by the Company, and in which Messrs. Styslinger and Bisson participated, the Company has concluded that there were no changes during the fiscal quarter ended October 31, 2009 in its internal controls over financial reporting, which have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.
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PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
Litigation
None.
Other Matters
ARRIS Litigation
On July 31, 2009, Arris Corporation (“Arris”) filed a contempt motion in the U.S. District Court for the District of Delaware against SeaChange International relating to U.S. Patent No 5,805,804 (the “804 patent”), a patent owned by Arris. In its motion, Arris is seeking further patent royalties and the enforcement of the permanent injunction entered by the Court on April 6, 2006 against certain SeaChange products. On August 3, 2009, SeaChange filed a complaint seeking a declaratory judgment from the Court that its products do not infringe the ‘804 patent and asserting certain equitable defenses. SeaChange also filed a motion to consolidate the Arris contempt motion with the declaratory judgment action and requested a status conference on SeaChange’s declaratory judgment action.
On August 25, 2009, Arris filed 1) an answer to SeaChange’s complaint that included a counterclaim of patent infringement under the ‘804 patent; and 2) a motion to stay the declaratory judgment action until the resolution of the contempt motion. The Court has set a date of January 13, 2010 for a scheduling conference on SeaChange’s declaratory judgment action. SeaChange believes that Arris’ contempt motion is without merit, and that SeaChange products do not infringe the remaining claims under the ‘804 patent.
Indemnification and Warranties
SeaChange provides indemnification, to the extent permitted by law, to its officers, directors, employees and agents for liabilities arising from certain events or occurrences while the officer, director, employee, or agent is or was serving at SeaChange’s request in such capacity. With respect to acquisitions, SeaChange provides indemnification to or assumes indemnification obligations for the current and former directors, officers and employees of the acquired companies in accordance with the acquired companies’ bylaws and charter. As a matter of practice, SeaChange has maintained directors’ and officers’ liability insurance including coverage for directors and officers of acquired companies.
SeaChange enters into agreements in the ordinary course of business with customers, resellers, distributors, integrators and suppliers. Most of these agreements require SeaChange to defend and/or indemnify the other party against intellectual property infringement claims brought by a third party with respect to SeaChange’s products. From time to time, SeaChange also indemnifies customers and business partners for damages, losses and liabilities they may suffer or incur relating to personal injury, personal property damage, product liability, and environmental claims relating to the use of SeaChange’s products and services or resulting from the acts or omissions of SeaChange, its employees, authorized agents or subcontractors. For example, SeaChange has received requests from several of its customers for indemnification of patent litigation claims asserted by Acacia Media Technologies, USA Video Technology Corporation, Multimedia Patent Trust, Microsoft Corporation and VTran Media Technologies. Management performed an analysis of these requests, evaluating whether any potential losses were probable and estimable.
SeaChange warrants that its products, including software products, will substantially perform in accordance with its standard published specifications in effect at the time of delivery. Most warranties have at least a one year duration that generally commence upon installation. In addition, SeaChange provides maintenance support to customers and therefore allocates a portion of the product purchase price to the initial warranty period and recognizes revenue on a straight line basis over that warranty period related to both the warranty obligation and the maintenance support agreement. When SeaChange receives revenue for extended warranties beyond the standard duration, it is deferred and recognized on a straight line basis over the contract period. Related costs are expensed as incurred.
In the ordinary course of business, SeaChange provides minimum purchase guarantees to certain of its vendors to ensure continuity of supply against the market demand. Although some of these guarantees provide penalties for cancellations and/or modifications to the purchase commitments as the market demand decreases, most of the guarantees do not. Therefore, as the market demand decreases, SeaChange re-evaluates the accounting implications of guarantees and determines what charges, if any, should be recorded.
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With respect to its agreements covering product, business or entity divestitures and acquisitions, SeaChange provides certain representations and warranties and agrees to indemnify and hold such purchasers harmless against breaches of such representations, warranties and covenants. With respect to its acquisitions, SeaChange may, from time to time, assume the liability for certain events or occurrences that took place prior to the date of acquisition.
SeaChange provides such guarantees and indemnification obligations after considering the economics of the transaction and other factors including but not limited to the liquidity and credit risk of the other party in the transaction. SeaChange believes that the likelihood is remote that any such arrangement could have a material adverse effect on its financial position, results of operation or liquidity. SeaChange records liabilities, as disclosed above, for such guarantees based on the Company’s best estimate of probable losses which considers amounts recoverable under any recourse provisions.
ITEM 1A. Risk Factors
In addition to the other information set forth in this Form 10-Q, you should carefully consider the risk factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended January 31, 2009, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks that we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or future results.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
Repurchase of the Company’s Equity Securities
On March 11, 2009, SeaChange’s Board of Directors authorized repurchase of up to $20 million of its common stock, par value $.01 per share, through a share repurchase program. As authorized by the program, shares may be purchased in the open market or through privately negotiated transactions in a manner consistent with applicable securities laws and regulations, including pursuant to a Rule 10b5-1 plan maintained by the Company. This share repurchase program does not obligate the Company to acquire any specific number of shares and may be suspended or discontinued at any time. All repurchases are expected to be funded from the Company’s current cash and investment balances. The timing and amount of the shares to be repurchased will be based on market conditions and other factors, including price, corporate and regulatory requirements and alternative investment opportunities.
The repurchase program is scheduled to terminate on January 31, 2010. There were no stock purchases during the three months ended October 31, 2009. During the nine months ended October 31, 2009, the Company repurchased 298,415 shares at a cost of $1.7 million. As of October 31, 2009, the remaining maximum dollar value of shares that may yet be purchased under the program is $18.3 million.
ITEM 6. Exhibits
(a) Exhibits
| 31.1 | | Certification Pursuant to Rule 13a-14(a) of the Exchange Act, as Adopted Pursuant to Section 302 of the Sarbanes- Oxley Act of 2002 (filed herewith). |
| |
| 31.2 | | Certification Pursuant to Rule 13a-14(a) of the Exchange Act, as Adopted Pursuant to Section 302 of the Sarbanes- Oxley Act of 2002 (filed herewith). |
| |
| 32.1 | | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith). |
| |
| 32.2 | | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith). |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, SeaChange International, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: December 10, 2009
| SEACHANGE INTERNATIONAL, INC. |
| |
| |
| | by: | /S/ KEVINM. BISSON |
| | Kevin M. Bisson |
| | Chief Financial Officer, |
| | Senior Vice President, Finance and |
| | Administration, Treasurer and Secretary |
Index to Exhibits
| No. | | Description |
| 31.1 | | Certification Pursuant to Rule 13a-14(a) of the Exchange Act, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith). |
| | | |
| 31.2 | | Certification Pursuant to Rule 13a-14(a) of the Exchange Act, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith). |
| |
| 32.1 | | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith). |
| |
| 32.2 | | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith). |
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