SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
Commission File Number: 0-21393
SEACHANGE INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
Delaware 04-3197974
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
124 Acton Street, Maynard, MA 01754
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (978) 897-0100
Securities Registered Pursuant To Section 12(b) Of The Act: None
Securities Registered Pursuant To Section 12(g) Of The Act:
Common Stock, $.01 par value
----------------------------
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceeding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
As of March 5, 1999 the aggregate market value of the voting stock held by non-
affiliates of the registrant, based upon the closing price for the registrant's
Common Stock on the Nasdaq National Market on such date was $48,774,090. The
number of shares of the registrant's Common Stock outstanding as of the close of
business on March 5, 1999 was 13,748,412.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the definitive Proxy Statement in connection with the Annual Meeting
of Stockholders to be held on or about June 17, 1999 to be filed pusuant to
Regulation 14A are incorporated by reference into Part III of this Form 10-K.
PART I
This Annual Report on Form 10-K includes certain statements of a forward-looking
nature which reflect the Company's current views relating to future events or
the future financial performance of the Company. These forward-looking
statements are only predictions and are subject to risks and uncertainties,
particularly the matters set forth in "Certain Risk Factors" below, which could
cause actual events or results to differ materially from historical results or
those indicated by such forward-looking statements.
ITEM 1. Business
SeaChange International, Inc. ("SeaChange"or the "Company") develops,
markets and supports products to manage, store and distribute digital video for
television operators, broadcast and telecommunications companies. The Company's
products utilize its proprietary distributed application software and standard
industry components to automate the management and distribution of short- and
long-form video streams including advertisements, movies, news updates and other
video programming requiring precise, accurate and continuous execution. The
Company's digital video products with their state-of-the-art electronic storage
and retrieval capabilities are designed to provide higher image quality and to
be more reliable, easier to use and less expensive than analog tape-based
systems. In addition, SeaChange's products enable its customers to increase
revenues by offering more targeted services such as geography-specific spot
advertising and video-on-demand movies.
SeaChange's products address a number of specific markets. The SeaChange
SPOT System is the leading digital advertisement and other short-form video
insertion system for the multichannel television market in terms of
installations in the United States, based on currently available industry
sources and the Company's internal data. A majority of SeaChange's customers
consist of major cable television operators and telecommunications companies in
the United States. The SeaChange SPOT System converts analog video forms such as
advertisements and news updates to digital video forms. It stores them in remote
or local digital libraries, and inserts them automatically into television
network streams. The SPOT System provides high run-rate accuracy and video image
quality, permits geographic and demographic specificity of advertisements and
reduces operating costs. The SeaChange Advertising Management Software operates
in conjunction with the SeaChange SPOT System to automate and simplify complex
sales, scheduling and billing processes for the multichannel television market.
The Company has two existing movie products and one video-on-demand (VOD)
product all for the movie markets. The Company sells the SeaChange Movie System
which provides long-form video storage and delivery for the pay-per-view movie
markets and the SeaChange GuestServe System for delivering video-on-demand and
other guest services, internet access and PC games in a hotel environment for
cable television and telecommunications companies. The Company also sells its
video server, which is designed to store and distribute video streams of various
lengths, and MediaCluster, SeaChange's proprietary software technology that
enables multiple video servers to operate together as an integrated video
server.
The Company introduced its Broadcast MediaCluster product in 1998, offering
play to air capability for commercials and syndicated or other programming for
broadcast television companies. During 1998, the Company installed broadcast
systems at customer locations including network affiliates in the United States
and broadcast companies internationally.
Finally, SeaChange has developed the SeaChange ITV (Interactive Television)
MediaCluster to provide residential video-on-demand and other interactive
services for cable television operators and telecommunications companies. During
1998, SeaChange entered into agreements with several cable companies to provide
SeaChange's ITV System for demonstration and testing of their video-on-demand
systems. The Company also has agreements with certain developers of digital
set-top boxes to test and integrate their products with SeaChange's ITV System.
The Company was incorporated in Delaware in July 1993.
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Industry Background
Television operators, the largest users of professional quality video,
historically have relied on videotape technology such as reel-to-reel technology
and tape cassettes for the storage and distribution of video streams. These
systems, which use video tape as the primary mechanism for the storage and
distribution of video, have substantial limitations. Video tapes and their
associated recording playback mechanisms are subject to mechanical failure and
generational loss of video quality. Tape-based systems also require significant
manual intervention, which makes them expensive and cumbersome to operate and
limits their flexibility for programming and schedule changes. Finally, video
tapes are bulky and have limited storage capacity.
Over the past decade, the limitations of video tape-based systems have
become increasingly apparent. Changes in government regulation and increased
competition have forced television operators, to seek new revenue sources and
reduce costs. In addition, television operators, to be competitive in the
widening home-entertainment market, must find and offer new and enhanced video
services while simultaneously improving the efficiency of their operations.
While video tape-based systems are sufficient for some traditional applications,
they do not meet the performance and cost requirements of these new, targeted
applications.
Cable Television Operators & Telecommunications Companies
According to industry sources, there are approximately 12,000 cable systems
currently in the United States, serving over 70 million households. In 1998, 96%
of all cable systems provided over 30 channels of programming to their
subscribers. Because cable television programming is sent over broadband lines,
operators can segment and target their programming to viewers in selected
geographies. In addition, the continuing growth in cable television's multiple
specialized programming networks, such as CNN, MTV and ESPN and other networks
such as Black Entertainment Television, the Discovery Channel and Nickelodeon,
allow advertisers to target viewers in selected demographic profiles.
Despite this advantage over television broadcasters, cable television
operators historically have not realized advertising revenues in proportion to
their share of television viewers. According to industry sources, in 1998, 48%
of all television viewers were watching cable networks, yet cable television
advertising revenue accounted for only 24% of the total television advertising
revenue. In addition, advertising represents the major source of revenue for
television broadcasters, while most cable television operators derive less than
5% of their gross revenue from advertising. The limitations of video tape-based
technology are a major factor which has prevented cable television operators
from historically exploiting their advantages over television broadcasters.
These systems are difficult to manage in multichannel and multi-zone
environments, resulting in relatively poor video insertion accuracy and high
operating costs.
Video-on-demand represents a new opportunity for cable television
operators. Increased channel capacity through the installation of fiber optic
cables is providing many cable television operators with the capacity to offer
video-on-demand to hotel and apartments using existing analog set-top boxes. The
addition of two way connectivity, and digital set-top boxes are providing many
cable television operators with the capacity to offer video-on-demand
programming capability throughout their subscriber base.
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The recent deregulation of the United States telecommunications industry
has lowered the legal barriers to entry for telecommunications companies to
enter the multichannel video delivery market. Telecommunications companies are
attempting to capitalize on the new growth opportunities by acquiring existing
cable television operators and by leveraging their existing telephony networks
to establish new multichannel video delivery operations. However,
telecommunications companies face the same limitations as cable television
operators in offering targeted, value-added services with analog tape-based
systems on a cost effective basis.
Increased demand for video and audio content over the internet will require
a substantial increase in storage capacity and bandwidth over time. The Company
believes that cable television operators and telecommunications companies will
play an integral role in providing these broadband internet applications. The
Company also believes that in order to offer high quality video applications
over the internet, cable television operators and telecommunications companies
will need storage and distribution products capable of complex management and
scheduling of video data streams.
Television Broadcasters
The more than 1,500 broadcast stations in the United States, including
network affiliates and independent stations, face many of the same technological
issues as cable television operators. Additionally, television broadcasters rely
on advertising for nearly all of their revenue and require high advertisement
run-rate reliability and image quality. To date, television broadcasters have
utilized tape-based systems with robotic libraries, which are cumbersome and
require high levels of maintenance and manual intervention to ensure that the
needed performance requirements are met. Also, the video tapes in these systems
need to be replaced frequently due to repeated use.
In addition, many broadcasters are contemplating the use of the recently
available digital bandwidth to originate multiple program streams. If this
application develops, television operators will require video storage and
delivery systems that can effectively manage and deliver these multiple
television signals.
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The SeaChange Solution
SeaChange develops, markets and supports digital video solutions designed
to enhance its customers' ability to store, retrieve, manage and distribute
short-and long-form video streams, including advertisements, movies, news
updates and other video programming requiring precise, accurate and continuous
execution. The Company's solutions are based on five core areas of
functionality: (i) real-time conversion of analog video into digital video
format; (ii) storage and retrieval of video content to and from digital
libraries; (iii) scheduled distribution of video streams between digital
libraries via local and wide area data networks; (iv) delivery of video streams
over single and multiple channels; and (v) management of video sales,
scheduling, billing and execution of related business transactions.
SeaChange uses these core capabilities to provide solutions to a number of
commercial markets. The Company's products are designed to provide a consistent
set of features and benefits, including:
Viewer Targeting. The Company's digital video products enable
television operators to efficiently target viewers in specific
demographic or geographic groups. The ability to target selected
viewers enables television operators to increase revenues by offering
more targeted services. The SeaChange SPOT System offers this
capability to television operators, the Broadcast MediaCluster product
offers this capability to broadcast companies while the SeaChange
Guestserve and ITV MediaCluster Systems make it possible for television
operators to offer video-on-demand movies to individual hotel rooms or
residences.
Cost Reduction. The Company's products are designed to provide its
customers operating cost reductions as compared to analog tape-based
systems due to, among other things, the elimination of video tapes and
their storage and lower operating personnel requirements. The Company
is also able to price its products on a competitive basis by using
standard operating systems and components. The Company believes that
the combination of competitive pricing of its products and reductions
in the operating costs of its customers results in attractive pay-back
periods on customers' initial capital outlay for the Company's
products.
Scalability. The Company's products are scalable to the needs of a
particular cable television operator or television broadcaster whether
operating in a single channel system concentrated in one specific zone
or a system with hundreds of channels serving multiple zones and
markets. Moreover, the Company's proprietary storage technology enables
the scalability of storage of digital video from a few minutes to
hundreds of hours of video.
Reliability. The Company's products eliminate the need for traditional
mechanical tape-based systems, thereby reducing the likelihood of
breakdowns. Furthermore, through the use of redundant components and
proprietary storage technology and application software, SeaChange's
products are designed to be fault resilient, providing the high
reliability required for television operations.
Scheduling Flexibility. The digitizing and storage of video streams
allows advertisements, news updates and movies to be inserted on
channels in local communities and allows cable television operators to
insert or delete video content rapidly. This flexibility enables the
provision of services such as video-on-demand movies and provides
advertisers and television broadcasters the opportunity to insert new
video content on short notice.
Video Image Quality. Because digital video streams do not degrade with
playback, image content and quality remain at the original professional
level even after multiple airings.
Ease of Use. The Company's products are simple to learn, require less
maintenance, and are less personnel intensive than analog systems. Due
to their innovative architecture, the Company's products offer a number
of features that simplify their use, including remote monitoring and
service and automated short- and long-form video distribution.
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Strategy
SeaChange's objective is to be the leader in the emerging market for the
storage, management and distribution of professional quality digital video. The
key elements of the Company's strategy are to:
Develop Long-Term Customer Relationships. The Company is focusing its
product development, marketing and direct sales efforts on developing long-
term customer relationships with cable television operators,
telecommunications companies and television broadcasters in the United
States and internationally. The Company has formed its customer
relationships by providing digital video solutions to address customers'
immediate problems, such as advertisement and other short-form video
insertion. The Company intends to continue to leverage its customer
relationships to offer new, compatible products to meet evolving market
needs, such as video-on-demand programming. The Company believes that the
fundamental shift from analog to digital video and the growing emphasis on
interactive technologies will continue to present opportunities for the
Company to develop, market and support its products to both its existing
customer base and to customers in additional markets.
Offer Complete Solutions. SeaChange's customers operate complex networks
that require the delivery and management of video programming across
multiple channels and target zones. SeaChange believes television operators
desire complete solutions that integrate all steps of digital video
delivery from scheduling to post-air verification and billing. To address
these needs, SeaChange provides integrated applications and support
services which are more valuable to customers than individual functional
products not specifically designed to work together. The Company believes
that providing complete solutions has been a significant factor in its
success and will be an increasingly important competitive advantage.
Establish and Maintain Technological Leadership Through Software. SeaChange
believes its competitive position is dependent in a large part on the
features and performance of its application and network and storage
software. As a result, the Company focuses a majority of its research and
development efforts on introducing new software applications and improving
its current software. The Company seeks to use standard hardware components
wherever possible to maintain its focus on software development.
Provide Superior Customer Service and Support. The Company's products
operate in environments where continuous operation is critical. As a
result, the Company believes that providing a high level of service and
support gives it a competitive advantage and is a differentiating factor in
developing key customer relationships. The Company's in-depth industry and
application knowledge allows it to better understand the service needs of
its customers. As of December 31, 1998 more than 34% of the Company's
employees were dedicated to customer service and support, including project
design and implementation, installation and training. In addition, using
remote diagnostic and communications features embedded in the Company's
products, the service organization has the ability to monitor the
performance of customer installations and, in most cases, rectify problems
remotely. Customers have access to service personnel via 24-hour, seven-day
a week telephone support.
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Products
SeaChange develops digital video products and related applications for the
television industry. Its products are marketed to cable television operators,
telecommunication companies, television broadcasters, systems integrators and
VARs.
SeaChange SPOT System
The SeaChange SPOT System automates the complex process of advertisement
and other video insertion across multiple channels and geographic zones for
cable television operators and telecommunications companies. Through its
proprietary software, the SeaChange SPOT System allows cable television
operators to insert local and regional advertisements and other short-form video
streams into the time allocated for these video streams by cable television
networks such as CNN, MTV, ESPN, Black Entertainment Television, the Discovery
Channel and Nickelodeon.
The SeaChange SPOT System is an integrated solution composed of software
applications, hardware platforms, data networks and easy to use graphical
interfaces. The SeaChange SPOT System is designed to be installed at local cable
transmission sites, known as headends, and advertising sales business offices.
The SeaChange video insertion process consists of six steps:
Encoding: The process begins with the SeaChange Encoding Station, which
is based on SeaChange's proprietary encoding software, where
analog-based short- and long-form video is digitized and
compressed in real-time using standard MPEG-2 hardware.
Storage: Digital video is then stored in a disk-based video library,
capable of storing thousands of spots, where the SeaChange
SPOT System organizes, manages and stores these video
streams.
Scheduling: SeaChange's advertising management software coordinates with
the traffic and billing application to determine the designated
time slot, channel and geographic zone for each video stream.
Distribution: SeaChange's strategic digital video software then copies the
video streams from the master video library and distributes
them over the operator's data network to headends, where they
are stored in video servers for future play.
Insertion: Following a network cue, the SeaChange video switch module
automatically initiates the conversion of video streams to
analog and inserts them into the network feed, where they are
then seen by television viewers.
Verification: After the video streams run, SeaChange's proprietary software
and hardware verifies the content, accuracy, timing and
placement of such video streams to facilitate proper customer
billing.
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SeaChange has developed two additional product offerings, the SeaChange
SPOT Long Form System ("the SeaChange SPOT LF System") and the SeaChange SPOT
PRO System, that are based on the SeaChange SPOT System technology. The
SeaChange SPOT LF System, which employs the same underlying technology and basic
functionality of the SeaChange SPOT System, is designed to be a platform for the
delivery of the long-form video streams in a multichannel environment. The
SeaChange SPOT LF System is designed to permit television operators to store,
manage and distribute long-form video streams, such as movies, infomercials and
other local origination programming. The SeaChange SPOT PRO System, also employs
the same underlying technology and basic functionality of the SeaChange SPOT
System and is designed to be a platform for the delivery of advertising and
other video content in a small to mid-sized television broadcast environment.
The selling price for the SeaChange SPOT Systems ranges from under $100,000 to
several million dollars with an average system selling price of approximately
$250,000.
SeaChange Advertising Management Software
The SeaChange Advertising Management Software (formerly Traffic and Billing
Software) is designed to permit television operators to manage advertising
sales, scheduling, packaging and billing operations. This product provides
advertising sales executives with: (i) management performance reports; (ii)
inventory tracking; and (iii) order entry, billing and accounts receivable
management. Advertising Management Software can be integrated with the SeaChange
SPOT System and is also compatible with many other advertisement insertion
systems currently in use.
Movie and Interactive Products
SeaChange Guestserve System. The SeaChange Guestserve System is a platform
for the storage and delivery of long-form video streams, particularly movies on
demand and interactive guest services such as hotel checkout, internet access
and PC games. The integrated system is designed to permit viewers in hotels and
apartments to choose particular movies on demand and also offers a variety of
ancillary programming services. SeaChange is marketing the SeaChange Guestserve
system to cable television operators. The cable television operators can package
full scale video-on-demand systems for hotels and apartments.
The integrated system consists of user interfaces and application hardware
and software, including set-top boxes and remote control devices, and
SeaChange's MediaCluster technology and software architecture for the delivery
and storage of movies. The video servers are installed at the cable headend and
the video is delivered over a dedicated fiber optic line. The integrated system
is designed to provide cable television operators with a new source of revenue
and a competitive advantage over the encroaching services of direct broadcast
satellite companies.
SeaChange Movie System. The SeaChange Movie System provides cable
television operators, pay-per-view (PPV) movie service providers and Direct-to-
Home (DTH) providers with capability to originate multiple PPV movie channels or
any other scheduled video programming. The Movie System includes SeaChange's
MediaCluster technology for storage and delivery of the video programming as
well as an MPEG-2 encoder for capturing movies from video tape, and scheduling
software and hardware to enable creating programming schedules for the PPV
channels. This system includes fault resiliency in both the video server
technology and scheduling technology so as to ensure the highest levels of up
time.
SeaChange ITV MediaCluster System. The Company has developed and is testing
its ITV MediaCluster system. This system will be sold to cable television
operators and other telecommunications companies and is intended to enable them
to offer movies on demand and other interactive services to their subscribers
who have digital set-top
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boxes and access two way cable plants. This system comprises MediaCluster
servers which will reside at headends or nodes in the cable system, control
software to manage and control the system, and interfaces to digital headend
modulators and control systems and subscriber management systems.
Broadcast Television Products
SeaChange Broadcast MediaCluster System. The SeaChange Broadcast
MediaCluster System is designed to provide high quality, MPEG-2 based video
storage and playback for use with automation systems in broadcast television
stations. This product is intended to replace on-air tape decks used to store
and play back advertising from video tape cart systems and, in some cases, to
replace the cart systems themselves. The SeaChange Broadcast MediaCluster System
is designed for customers in larger broadcast television markets which use
station automation systems or to smaller markets using control software included
in the system.
The SeaChange Broadcast MediaCluster System is designed to simultaneously
record, encode, store to a disk and play video content using SeaChange designed
MPEG-2 4:2:2 compression and decompression hardware. This product is designed
to seamlessly integrate into television broadcasters' current tape-based
operations and meet the high performance requirements of television
broadcasters.
OEM Products
Video Server 100 (and variants). The Video Server 100, which is the
Company's second generation video server, is designed to store and distribute
video streams of various lengths. The Video Server 100 together with the
MediaCluster provides the base technology for all of SeaChange's digital video
products. The Video Server 100 is offered to systems integrators and VARs as a
platform for the storage and delivery of primarily short-form video in a wide
range of applications.
The Video Server 100 provides custom power and packaging for software use
in professional video applications. It incorporates RAID technology and a
redundant power supply to enable the continuous uninterrupted airing of video.
The Video Server 100 uses industry standard components, which differentiates it
from various video servers based on proprietary processors and specialized
hardware components and operating systems.
MediaCluster. MediaCluster is SeaChange's proprietary software technology
that enables multiple Video Server 100s to operate together as an integrated
video server. While the Video Server 100 is the base technology for short-form
video applications, MediaCluster serves as the base technology for primarily
long-form video applications.
Through its software architecture, MediaCluster can join multiple SeaChange
Video Server 100s to support large-scale applications by storing large amounts
of video data and delivering multiple video streams, with no single point of
failure in the system. The Company has a patent for its MediaCluster technology.
The Company established a subsidiary, SeaChange Systems, at its Greenville,
New Hampshire location for the manufacture, development and OEM sale of the
Video Server 100 and MediaCluster products in 1997. Certain employees of the
Company or the subsidiary have been granted options and may be granted options
to acquire up to a 20% interest over time in the subsidiary.
Customer Service and Support
The Company installs, maintains and supports its products in North America,
Asia, South America and Europe. Annual maintenance contracts are generally
required for the first year of a customer's use of the Company's products. The
maintenance contracts are renewable on an annual basis. The Company also offers
basic and
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advanced formal on-site training for customer employees at the time of product
installation. The Company currently provides installation, maintenance and
support to international customers and also provides movie content in
conjunction with sales of SeaChange GuestServe System. The Company offers
technical support to customers, agents and distributors on a 24-hour, seven-day
a week basis.
Customers
The Company currently sells its products primarily to cable television
operators, broadcast and telecommunications companies.
The Company's customer base is highly concentrated among a limited number
of large customers, primarily due to the fact that the cable, movie, broadcast,
and telecommunications industries in the United States are dominated by a
limited number of large companies. A significant portion of the Company's
revenues in any given fiscal period have been derived from substantial orders
placed by these large organizations. In 1996, 1997 and 1998, revenues from the
Company's five largest customers represented approximately 76%, 68% and 54%,
respectively, of the Company's total revenues. Customers accounting for more
than 10% of total revenues consisted of Tele-Communications, Inc. (29%), U.S.
West Media Group (17%), Comcast Corporation (13%) and Time Warner, Inc. (12%)
in 1996; Tele-Communications, Inc. (24%), Time Warner, Inc. (18%) and Comcast
Corporation (10%) in 1997; Tele-Communications, Inc. (24%) and Time Warner,
Inc. (15%) in 1998. The Company expects that it will continue to be dependent
upon a limited number of customers for a significant portion of its revenues in
future periods. As a result of this customer concentration, the Company's
business, financial condition and results of operations could be materially
adversely affected by the failure of anticipated orders to materialize and by
deferrals or cancellations of orders as a result of changes in customer
requirements or new product announcements or introductions.
The Company believes that its backlog at any particular time is not
meaningful as an indicator of its future level of sales for any particular
period. Because of the nature of the Company's products and its use of standard
components, substantially all of the backlog at the end of a quarter can be
manufactured by the Company and is intended to be shipped by the end of the
following quarter. However, because of the requirements of particular customers
and, in respect to certain sales, the acceptance criteria necessary for revenue
recognition, such backlog may not be shipped or, if shipped, the related
revenues may not be recognized in such quarter. Therefore, there is no direct
correlation between the backlog at the end of any quarter and the Company's
total sales for the following quarter or other periods.
Selling and Marketing
The Company sells and markets its products in the United States primarily
through a direct field sales organization and internationally primarily through
independent agents and distributors, complemented by a coordinated marketing
effort of the Company's marketing group. Direct sales activities in the United
States are conducted from the Company's Massachusetts headquarters and seven
field offices. In October 1996, the Company entered into an exclusive sales and
marketing services agreement with a private Italian company to provide such
services throughout continental Europe. The Company also markets certain of its
products, namely the Video Server 100 and MediaCluster, to systems integrators
and VARs. As of December 31, 1998, the Company's selling and marketing
organization consisted of 32 people.
In light of the complexity of the Company's digital video products, the
Company primarily employs a consultative direct sales process. Working closely
with customers to understand and define their needs enables the Company to
obtain better information regarding market requirements, enhance its expertise
in its customers' industries, and more effectively and precisely convey to
customers how the Company's solutions address the customer's specific needs. In
addition to the direct sales process, customer references and visits by
potential customers to sites where the Company's products are in place are often
critical in the sales process.
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The Company uses several marketing programs focused on the Company's
targeted markets to support the sale and distribution of its products. The
Company uses exhibitions at a limited number of prominent industry trade shows
and conferences and presentations at technology seminars to promote awareness of
the Company and its products. The Company also publishes technical articles in
trade and technical journals and promotional product literature.
Research and Product Development
Management believes that the Company's success will depend to a substantial
degree upon its ability to develop and introduce in a timely fashion new
products and enhancements to its existing products that meet changing customer
requirements in the Company's current and new markets. The Company has in the
past made, and intends to continue to make, substantial investments in product
and technological development. Through its direct sales process the Company
monitors changing customer needs, changes in the marketplace and emerging
industry standards, and is therefore better able to focus its research and
development efforts to address such evolving industry requirements.
The Company's research and development expenditures totaled approximately
$5.4 million, $11.8 million and $15.8 million for the years ended December 31,
1996, 1997 and 1998, respectively. At December 31, 1998, 102 employees were
engaged in research and product development. The Company believes that the
experience of its product development personnel is an important factor in the
Company's success. The Company performs its research and product development
activities at its headquarters and in offices in Greenville, New Hampshire,
Atlanta, Georgia and Novato, California. The Company has historically expensed
its direct research and development costs as incurred.
The Company has a variety of new products being developed and tested,
including interactive television products for cable television operators and
telecommunications companies, digital play-to-air systems for television
broadcasters and the next version of its MediaCluster software. There can be no
assurance that the Company will be able to successfully develop and market such
products, or to identify, develop, manufacture, market or support other new
products or enhancements to its existing products successfully or on a timely
basis, that new Company products will gain market acceptance, or that the
Company will be able to respond effectively to product announcements by
competitors or technological changes.
Acquired In-Process Research and Development
In 1997, in connection with the acquisition of IPC, $5,290,000 of the
purchase price, based upon an independent appraisal, was allocated to in-process
research and development, resulting in an immediate charge to the Company's
operations as of the date of acquisition. The amount allocated to in-process
research and development represented technology which had not reached
technological feasability and did not have an alternative future use. The
Company was continuing development of the software applications and hardware
design of this in-process development as of December 31, 1998. Management
estimates the development of this in-process development to be completed during
1999 and for some features in 2000.
Manufacturing
The Company's manufacturing operations are located at facilities in
Maynard, Massachusetts and in Greenville, New Hampshire. The manufacturing
operations in Massachusetts consist primarily of component and subassembly
procurement, system integration and final assembly, testing and quality control
of the complete systems. The Company's operations in New Hampshire consist
primarily of component and subassembly procurement, video server integration and
final assembly, testing and quality control of the video servers. The Company
relies on independent contractors to manufacture components and subassemblies to
the Company's specifications. Each of the Company's products undergoes testing
and quality inspection at the final assembly stage.
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The Company attempts to use standard parts and components available from
multiple vendors. Certain components used in the Company's products, however,
are currently purchased from a single source, including a computer chassis
manufactured by Trimm Technologic Inc., a disk controller manufactured by Mylex
Corporation, an MPEG-2 decoder card manufactured by Vela Research, Inc. and an
MPEG-2 encoder manufactured by Optivision, Inc. While the Company believes that
there are alternative suppliers available for these components, the Company
believes that the procurement of such components from alternative suppliers
would take anywhere from 45-120 days. There can be no assurance that such
alternative components would be functionally equivalent or would be available on
a timely basis or on similar terms. The Company purchases several other
components from a single supplier, although the Company believes that
alternative suppliers for such components are readily available on a timely
basis. The Company generally purchases sole source or other components pursuant
to purchase orders placed from time to time in the ordinary course of business
and has no written agreements or guaranteed supply arrangements with its sole
source suppliers. The Company has experienced quality control problems and
supply shortages for sole source components in the past and there can be no
assurance that the Company will not experience significant quality control
problems or supply shortages for these components in the future. However, any
interruption in the supply of such single source components could have a
material adverse effect on the Company's business, financial condition and
results of operations. Because of the Company's reliance on these vendors, the
Company may also be subject to increases in component costs which could
adversely affect the Company's business, financial condition and results of
operations.
Competition
The markets in which the Company competes are characterized by intense
competition, with a large number of suppliers providing different types of
products to different segments of the markets. The Company currently competes
principally on the basis of: (i) the breadth of its products' features and
benefits, including the ability to precisely target viewers in specific
geographic or demographic groups, and the flexibility, scalability, professional
quality, ease of use, reliability and cost effectiveness of its products; and
(ii) the Company's reputation and the depth of its expertise, customer service
and support. While the Company believes that it currently competes favorably
overall with respect to these factors and that its ability to provide solutions
to manage, store and distribute digital video differentiates the Company from
its competitors, there can be no assurance that the Company will be able to
continue to compete successfully with respect to such factors.
In the digital advertisement insertion market, the Company generally
competes only with SkyConnect, Inc. In the market for long-form video products,
the Company competes with various computer companies offering video server
platforms such as Hewlett-Packard Company and Silicon Graphics, Inc., and more
traditional movie application providers like The Ascent Entertainment Group,
Panasonic Company, and Lodgenet Entertainment. In addition, the SeaChange
Advertising Management Software competes against certain products of Columbine
Cable Systems, Inc., Cable Computerized Management Systems, Inc., a subsidiary
of Indenet Inc., CAM Systems, Inc., a subsidiary of Starnet Inc., LAN
International USA, Inc., Visiontel, Inc. and various suppliers of sales,
scheduling and billing software products. In the television broadcast market,
the Company competes against Tektronix, Inc., Hewlett-Packard Company, Sony
Corporation, and ASC Incorporated. The Company expects the competition in each
of these markets to intensify in the future.
12
Many of the Company's current and prospective competitors have
significantly greater financial, technical, manufacturing, sales, marketing and
other resources than the Company. As a result, these competitors may be able to
devote greater resources to the development, promotion, sale and support of
their products than the Company. Moreover, these companies may introduce
additional products that are competitive with those of the Company or enter into
strategic relationships to offer complete solutions, and there can be no
assurance that the Company's products would compete effectively with such
products.
Although the Company believes that it has certain technological and other
advantages over its competitors, maintaining such advantages will require
continued investment by the Company in research and development, selling and
marketing and customer service and support. In addition, as the Company enters
new markets, distribution channels, technical requirements and competition
levels may be different than those in the Company's current markets. There can
be no assurance that the Company will be able to compete successfully against
either current or potential competitors in the future.
Proprietary Rights
The Company's success and its ability to compete is dependent, in part,
upon its proprietary rights. The Company has been granted one U.S. patent for
its MediaCluster technology and has filed a foreign patent application for the
same technology. In addition, the Company has other patent applications in
process for other technologies. In addition, the Company relies on a combination
of contractual rights, trademark laws, trade secrets and copyright laws to
establish and protect its proprietary rights in its products. There can be no
assurance that all of these patents will be issued or that, if issued, the
validity of such patents would be upheld. Nor can there be any assurance that
the steps taken by the Company to protect its intellectual property will be
adequate to prevent misappropriation of its technology or that the Company's
competitors will not independently develop technologies that are substantially
equivalent or superior to the Company's technology. In addition, the laws of
some foreign countries in which the Company's products are or may be distributed
do not protect the Company's proprietary rights to the same extent as do the
laws of the United States.
The Company is also subject to the risk of adverse claims and litigation
alleging infringement of intellectual property rights of others. The Company
attempts to ensure that its products do not infringe any existing proprietary
rights of others.
A version of the SeaChange Advertising and Management Software in limited
distribution was based on software the Company licensed from Summit Software
Systems, Inc. of Boulder, Colorado in May 1996. The Company has been granted a
perpetual, nonexclusive license to such software in return for the payment of an
up-front license fee and royalties for sales occurring prior to June 1998.
Employees
As of December 31, 1998, the Company employed 310 persons, including 102 in
research and development, 107 in customer service and support, 32 in selling and
marketing, 42 in manufacturing and 27 in finance and administration. One of the
Company's employees is represented by a collective bargaining arrangement. The
Company believes that its relations with its employees are good.
CERTAIN RISK FACTORS
Limited Operating History and Operating Results. The Company was founded in
July 1993 and commenced shipment of its initial products in the third quarter of
1994. Accordingly, the Company has only a limited operating
13
history upon which an evaluation of the Company and its prospects can be based.
The Company's prospects must be considered in light of the risks, expenses and
difficulties frequently encountered by companies in their early stage of
development, particularly companies in new and rapidly evolving markets. To
address these risks, the Company must, among other things, respond to
competitive developments, continue to attract, retain and motivate qualified
persons, and continue to upgrade its technologies and commercialize products and
services incorporating such technologies. There can be no assurance that the
Company will be successful in addressing such risks.
Fluctuations in Quarterly Operating Results. The Company's quarterly
operating results have in the past varied and in the future will be affected by
factors such as: (i) the timing and recognition of revenue from significant
orders, (ii) the seasonality of the placement of customer orders, (iii) the
success of the Company's products, (iv) increased competition, (v) changes in
the Company's pricing policies or those of its competitors, (vi) the financial
stability of major customers, (vii) new product introductions or enhancements by
competitors, (viii) delays in the introduction of products or product
enhancements by the Company, (ix) customer order deferrals in anticipation of
upgrades and new products, (x) the ability to access a sufficient supply of sole
source and third party components, (xi) the quality and market acceptance of new
products, (xii) the timing and nature of selling and marketing expenses (such as
trade shows and other promotions), (xiii) personnel changes, (xiv) the risks
associated with international sales as the Company expands its markets, and (xv)
economic conditions affecting the Company's customers. Any significant
cancellation or deferral of purchases of the Company's products could have a
material adverse effect on the Company's business, financial condition and
results of operations in any particular quarter, and to the extent significant
sales occur earlier than expected, operating results for subsequent quarters may
be adversely affected. The Company's expense levels are based, in part, on its
expectations as to future revenues, and the Company may be unable to adjust
spending in a timely manner to compensate for any revenue shortfall. If revenues
are below expectations, operating results are likely to be adversely affected
and net income may be disproportionately affected because a significant portion
of the Company's expenses do not vary with revenues.
Because of these factors, the Company believes that period-to-period
comparisons of its results of operations are not necessarily meaningful and
should not be relied upon as indications of future performance. Due to all of
the foregoing factors, in some future quarter the Company's operating results
may be below the expectations of public market analysts and investors.
Seasonality. The Company has experienced significant variations in the
revenue, expenses and operating results from quarter to quarter and such
variations are likely to continue. The Company believes that fluctuations in the
number of orders being placed from quarter to quarter is principally
attributable to the buying patterns and budgeting cycles of television operators
and broadcast companies, the primary buyers of the digital advertising systems
and broadcast systems, respectively. The Company expects that there will
continue to be fluctuations in the number and value of orders received. As a
result, the Company's results of operations have in the past and likely will, at
least in the near future, fluctuate in accordance with such purchasing activity.
Operating expenses also vary with the number, timing and significance of new
product and product enhancement introductions by the Company and its
competitors, increased competition, the gain or loss of significant customers,
the hiring of new personnel and general economic conditions. All of the above
factors are difficult for the Company to forecast, and these or other factors
may materially adversely affect the Company's business, financial condition and
results of operations for one quarter or a series of quarters. Only a small
portion of the Company's expenses vary with revenues in the short-term and there
would likely be a material adverse effect on the operating results of the
Company if future revenues are lower than expectations.
Management of Growth. The Company has experienced fluctuation in revenues
and expansion of its operations which have placed significant demands on the
Company's management, administrative and operational resources. The Company
believes that further improvements in management and operational controls are
needed, and would continue to be needed to manage any future growth. Continued
growth will also require the Company to hire more customer sevice and
administrative personnel, expand manufacturing and customer service
capabilities, and update or expand management information systems. There can be
no assurance that the Company will be able to attract and retain the necessary
personnel to accomplish its growth strategies or that it will not experience
14
constraints that will adversely affect its ability to satisfy customer demand in
a timely fashion or to satisfactorily support its customers and operations.
Also, the Company may in the future acquire complementary service or product
lines, technologies or businesses, although the Company has no present
understandings, commitments or agreements with respect to any significant
acquisitions. If the Company's management is unable to manage growth effectively
or integrate any acquisition into the Company's operations successfully, the
Company's business, financial condition and results of operations could be
materially and adversely affected.
Product Concentration. Sales of the SeaChange SPOT System have historically
accounted for a large percentage of the Company's revenues, and this product and
related enhancements are expected to continue to account for a significant
portion of the Company's revenues in 1999. The Company's success depends in part
on continued sales of the SeaChange SPOT System. A decline in demand or average
selling prices for the SeaChange SPOT System product line, whether as a result
of new product introductions by others, price competition, technological change,
inability to enhance the products in a timely fashion, or otherwise, would have
a material adverse effect on the Company's business, financial condition and
results of operations.
Highly Competitive Markets. The market for digital video, movie and
broadcast products is highly competitive. The Company currently competes against
suppliers of both analog tape-based and digital systems in the digital
advertisement insertion market and against both computer companies offering
video server platforms and more traditional movie application providers in the
movie system market. In the television broadcast market, the Company competes
against various computer companies offering video server platforms and
television equipment manufacturers. Due to the rapidly evolving markets in which
the Company competes, additional competitors with significant market presence
and financial resources, including computer hardware and software companies and
television equipment manufacturers, may enter those markets, thereby further
intensifying competition. Increased competition could result in price reductions
and loss of market share which would adversely affect the Company's business,
financial condition and results of operations. Many of the Company's current and
potential competitors have greater financial, selling and marketing, technical
and other resources than the Company. Moreover, the Company's competitors may
also foresee the course of market developments more accurately than the Company.
Although the Company believes it has certain technological and other advantages
over its competitors, realizing and maintaining such advantages will require a
continued high level of investment by the Company in research and product
development, marketing and customer service and support. There can be no
assurance that the Company will have sufficient resources to continue to make
such investments or that the Company will be able to make the technological
advances necessary to compete successfully with its existing competitors or with
new competitors.
Dependence on Emerging Digital Video Market. Cable television operators and
television broadcasters have historically relied on traditional analog
technology for video management, storage and distribution. Digital video
technology is still a relatively new technology and requires a significant
initial investment of capital. The Company's future growth will depend both on
the rate at which television operators convert to digital video systems and the
rate at which digital video technology expands to additional market segments.
There can be no assurance that the use of digital video technology will expand
among television operators or into additional markets. Any failure by the market
to accept digital video technology will have a material adverse effect on the
Company's business, financial condition and results of operations.
Risks Associated with Expansion into New Markets. To date the Company's
products have been purchased primarily by cable television operators and
telecommunications companies. The Company's success depends in part on the
penetration of new markets. In particular, the Company introduced broadcast
products during the quarter ended June 30, 1998 for use by television
broadcasters. These broadcast products will be directed toward a market that the
Company has not significantly addressed. There can be no assurance that the
Company will be successful in marketing and selling broadcast products to
customers in the broadcast television market. Any inability of the Company to
penetrate this new market would have a material adverse effect on the Company's
business, financial condition and results of operations.
15
Risk of New Product Introductions. The Company's future success requires
that it develop and market additional products that achieve significant market
acceptance and enhance its current products. The Company has recently introduced
its Guestserve and Broadcast MediaCluster Products and is developing its ITV
MediaCluster product for introduction. There can be no assurance that the
Company will not experience difficulties that could delay or prevent the
successful development, introduction and marketing of these and other new
products and enhancements, or that its new products and enhancements will
adequately meet the requirements of the marketplace and achieve market
acceptance. Announcements of currently planned or other new product offerings
may cause customers to defer purchasing existing Company products. Moreover,
there can be no assurance that, despite testing by the Company, and by current
and potential customers, errors or failures will not be found in the Company's
products, or, if discovered, successfully corrected in a timely manner. Such
errors or failures could cause delays in product introductions and shipments, or
require design modifications that could adversely affect the Company's
competitive position. The Company's inability to develop on a timely basis new
products, enhancements to existing products or error corrections, or the failure
of such new products or enhancements to achieve market acceptance could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Rapid Technological Change. The markets for the Company's products are
characterized by rapidly changing technology, evolving industry standards and
frequent new product introductions and enhancements. Future technological
advances in the television and video industries may result in the availability
of new products or services that could compete with the solutions provided by
the Company or reduce the cost of existing products or services, any of which
could enable the Company's existing or potential customers to fulfill their
video needs better and more cost efficiently than with the Company's products.
The Company's future success will depend on its ability to enhance its existing
digital video products, including the development of new applications for its
technology and to develop and introduce new products to meet and adapt to
changing customer requirements and emerging technologies. There can be no
assurance that the Company will be successful in enhancing its digital video
products or developing, manufacturing and marketing new products which satisfy
customer needs or achieve market acceptance. In addition, there can be no
assurance that services, products or technologies developed by others will not
render the Company's products or technologies uncompetitive, unmarketable or
obsolete, or that announcements of currently planned or other new product
offerings by either the Company or its competitors will not cause customers to
defer or fail to purchase existing Company solutions. The failure of the Company
to respond to rapidly changing technologies related to digital video could have
a material adverse effect on the Company's business, financial condition and
results of operations.
Significant Concentration of Customers. The Company's customer base is
highly concentrated among a limited number of large customers, and, therefore, a
limited number of customers account for a significant percentage of the
Company's revenues in any year. In 1996, 1997 and 1998, revenues from the
Company's five largest customers represented approximately 76%, 68% and 54%,
respectively, of the Company's total revenues. In 1996, 1997 and 1998 four,
three and two customers, respectively, each accounted for more than 10% of the
Company's revenues. The same two customers accounted for more than 10% of the
Company's revenues in each 1996, 1997 and 1998. The Company generally does not
have written continuing purchase agreements with its customers and does not have
any written agreements that require customers to purchase fixed minimum
quantities of the Company's products. The Company's sales to specific customers
tend to vary significantly from year to year depending upon such customers'
budgets for capital expenditures and new product introductions. In addition, the
Company derives a substantial portion of its revenues from products that have a
selling price in excess of $200,000. The Company believes that revenue derived
from current and future large customers will continue to represent a significant
proportion of its total revenues. The loss of, or reduced demand for products or
related services from, any of the Company's major customers could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Dependence on Sole Source Suppliers and Third Party Manufacturers. Certain
key components of the Company's products are currently purchased from a sole
supplier, including a computer chassis manufactured by Trimm Technologic Inc., a
disk controller manufactured by Mylex Corporation, an MPEG-2 decoder card
manufactured by Vela Research, Inc. and an MPEG-2 encoder manufactured by
16
Optivision, Inc. The Company has in the past experienced quality control
problems, where products did not meet specifications or were damaged in
shipping, and delays in the receipt of such components. These problems were
generally of short duration and did not have a material adverse effect on the
Company. However, the Company may in the future experience similar types of
problems which could be more severe or more prolonged. The inability to obtain
sufficient key components as required, or to develop alternative sources if and
as required in the future, could result in delays or reductions in product
shipments which, in turn, could have a material adverse effect on the Company's
business, financial condition and results of operations. Moreover, the Company
relies on a limited number of third parties who manufacture certain components
used in the Company's products. While to date there has been suitable third
party manufacturing capacity readily available at acceptable quality levels,
there can be no assurance that such manufacturers will be able to meet the
Company's future volume or quality requirements or that such services will
continue to be available to the Company at favorable prices. Any financial,
operational, production or quality assurance difficulties experienced by such
third party manufacturers that result in a reduction or interruption in supply
to the Company could have a material adverse effect on the Company's business,
financial condition and results of operations.
Regulation of Telecommunications and Television Industries. The
telecommunications and television industries are subject to extensive regulation
in the United States and other countries. The Company's business is dependent
upon the continued growth of such industries in the United States and
internationally. Although recent legislation has lowered the legal barriers to
entry for telecommunications companies into the United States multichannel
television market, there can be no assurance that such telecommunications
companies will successfully enter this or related markets. Moreover, the growth
of the Company's business internationally is dependent in part on similar
deregulation of the telecommunications industry abroad and there can be no
assurance that such deregulation will occur. Television operators are also
subject to extensive government regulation by the Federal Communications
Commission ("FCC") and other federal and state regulatory agencies. These
regulations could have the effect of limiting capital expenditures by television
operators and thus could have a material adverse effect on the Company's
business, financial condition and results of operations. The enactment by
federal, state or international governments of new laws or regulations, changes
in the interpretation of existing regulations or a reversal of the trend toward
deregulation in these industries could adversely affect the Company's customers,
and thereby materially adversely affect the Company's business, financial
condition and results of operations.
Lengthy Sales Cycle. Digital video, movie and broadcast products are
relatively complex and their purchase generally involves a significant
commitment of capital, with attendant delays frequently associated with large
capital expenditures and implementation procedures within an organization.
Moreover, the purchase of such products typically requires coordination and
agreement among a potential customer's corporate headquarters and its regional
and local operations. For these and other reasons, the sales cycle associated
with the purchase of the Company's digital video, movie and broadcast products
are typically lengthy and subject to a number of significant risks, including
customers' budgetary constraints and internal acceptance reviews, over which the
Company has little or no control. Based upon all of the foregoing, the Company
believes that the Company's quarterly revenues, expenses and operating results
are likely to vary significantly in the future, that period-to-period
comparisons of its results of operations are not necessarily meaningful and
that, in any event, such comparisons should not be relied upon as indications of
future performance.
Dependence on Key Personnel and Hiring of Additional Personnel. The
Company's success depends to a significant degree upon the continued
contributions of its key management, engineering, selling and marketing and
manufacturing personnel, many of whom would be difficult to replace. The Company
does not have employment contracts with its key personnel. The Company believes
its future success will also depend in large part upon its ability to attract
and retain highly skilled managerial, engineering, selling and marketing,
finance and manufacturing personnel. Competition for such personnel is intense,
and there can be no assurance that the Company will be successful in attracting
and retaining such personnel. The loss of the services of any of the key
personnel, the inability to attract or retain qualified personnel in the future
or delays in hiring required personnel, particularly software engineers and
sales personnel, could have a material adverse effect on the Company's business,
financial condition and results of operations.
17
Dependence on Proprietary Rights. The Company's success and its ability
to compete is dependent, in part, upon its proprietary rights. The Company
relies primarily on a combination of patent, copyright, trademark and trade
secret laws, as well as confidentiality procedures and contractual provisions to
protect its proprietary rights. There can be no assurance that such measures
will be adequate to protect the Company's proprietary rights. The Company
attempts to ensure that its products and technology do not infringe the
proprietary rights of third parties. However, there can be no assurance that
third parties will not assert infringement claims against the Company in the
future or that any such claims will not be successful.
Risks Associated with International Sales. International sales accounted
for approximately 5%, 12% and 13% of the Company's revenues in 1996, 1997 and
1998, respectively. The Company expects that international sales will account
for a significant portion of the Company's business in the future. However,
there can be no assurance that the Company will be able to maintain or increase
international sales of its products. International sales are subject to a
variety of risks, including difficulties in establishing and managing
international distribution channels, in servicing and supporting overseas
products and in translating products into foreign languages. International
operations are subject to difficulties in collecting accounts receivable,
staffing and managing personnel and enforcing intellectual property rights.
Other factors that can also adversely affect international operations include
fluctuations in the value of foreign currencies and currency exchange rates,
changes in import/export duties and quotas, introduction of tariff or non-tariff
barriers and economic or political changes in international markets.
Concentration of Ownership. The Company's officers, directors and their
affiliated entities, and other holders of 5% or more of the Company's
outstanding capital stock, together beneficially owned approximately 58.9% of
the outstanding shares of Common Stock of the Company as of March 5, 1999. As a
result, such persons will have the ability to elect the Company's directors and
to determine the outcome of corporate actions requiring stockholder approval,
irrespective of how other stockholders of the Company may vote. This
concentration of ownership may have the effect of delaying or preventing a
change in control of the Company which may be favored by a majority of the
remaining stockholders, or cause a change of control not favored by the
Company's other stockholders.
Year 2000 Issue. Although the Company does not expect that the Year 2000
issue will have a material effect on the Company's results of operations or
financial condition, the Company is potentially exposed to Year 2000 issues with
respect to internal software and external product offerings. If the Company's
internal systems or its products fail to operate properly as a result of Year
2000, the Company's results of operations and financial condition will be
materially and adversely impacted. The Company continues to evaluate the Year
2000 issue. For a discussion of the Company's Year 2000 readiness and risks
associated with the Year 2000 issue, see "Year 2000 Issue/Readiness Disclosure
Statement," particularly the subsection headed "Risks Associated with Year 2000
Issue" which appears in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" section of this Report on Form 10-K.
18
ITEM 2. Properties
The Company's corporate headquarters, which is also its principal
administrative, selling, marketing, customer service and support and product
development facility, is located in Maynard, Massachusetts and consists of
approximately 80,000 square feet under a lease which expires on March 31, 2005
with annual base rent of $379,000. The Company also leases approximately 29,000
square feet in a facility in Novato, California that is used for the development
and manufacture of certain movie products under a lease which expires in June,
2001, with an annual base rent of $393,000. The Company leases a facility of
approximately 9,000 square feet in Greenville, New Hampshire that is used for
the development and final assembly of its video servers. The Company also
leases small research and development and/or sales and support offices in
Atlanta, Georgia, Burlingame and San Francisco, California, Denver, Colorado,
Orlando, Florida, St. Louis, Missouri and Valbonne, France.
ITEM 3. Legal Proceedings
From time to time, the Company is involved in litigation relating to claims
arising out of its operations in the normal course of business. The Company
believes that it is not currently involved in any legal proceedings the
resolution of which, individually or in the aggregate, would have a material
adverse effect on the Company's business, financial condition or results of
operation.
ITEM 4. Submission of Matters To A Vote Of Securities Holders
No matters were submitted during the fourth quarter of the fiscal year
ended December 31, 1998 to a vote of security holders of the Company through the
solicitation of proxies or otherwise.
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters
The Company's Common Stock is traded on the Nasdaq National Market under
the symbol "SEAC." The following table sets forth the high and low closing sale
prices for the Common Stock for the periods indicated, as reported on the Nasdaq
National Market.
High Low
---- ---
Year ended December 31, 1998
First Quarter $ 8.500 $ 6.625
Second Quarter 13.000 5.938
Third Quarter 11.750 5.750
Fourth Quarter 8.750 5.750
Year ended December 31, 1997
First Quarter 30.875 14.750
Second Quarter 28.250 17.000
Third Quarter 28.750 14.500
Fourth Quarter 14.625 6.813
On March 5, 1999, the last reported sale price of the Common Stock on the
Nasdaq National Market was $8.625. As of March 5, 1999, there were approximately
159 stockholders of record of the Company's Common Stock, as shown in the
records of the Company's transfer agent. The Company believes that the number of
beneficial holders of the Company's Common Stock exceeds 2,500. The Company has
not paid any cash dividends on its capital stock since its inception, and does
not expect to pay cash dividends on its Common Stock in the foreseeable future.
The Company currently intends to retain all of its future earnings for use in
the operation and expansion of the business.
19
ITEM 6. Selected Financial Data
The following selected consolidated financial data should be read in
conjunction with the Company's consolidated financial statements and related
notes thereto and "Management's Discussion and Analysis of Financial Condition
and Results of Operations" included in Item 7. The consolidated statement of
operations data for each of the five years ended December 31, 1994, 1995, 1996,
1997 and 1998 and the consolidated balance sheet data at December 31, 1994,
1995, 1996, 1997 and 1998 are detailed below.
Year Ended December 31,
-----------------------------------------------
1994 1995 1996 1997 1998
------- -------- ------- --------- ---------
(in thousands, except per share data)
Consolidated Statement of Operations Data:
Revenues
Systems........................................... $5,037 $21,999 $45,745 $60,414 $58,033
Services.......................................... 116 1,204 3,521 7,473 13,737
Other............................................. 537 -- -- -- --
------ ------- ------- ------- -------
5,690 23,203 49,266 67,887 71,770
------ ------- ------- ------- -------
Costs of revenues
Systems........................................... 3,406 14,917 27,133 34,740 35,772
Services.......................................... 176 1,641 4,030 7,607 13,241
Other............................................. 304 -- -- -- --
------ ------- ------- ------- -------
3,886 16,558 31,163 42,347 49,013
------ ------- ------- ------- -------
Gross profit....................................... 1,804 6,645 18,103 25,540 22,757
------ ------- ------- ------- -------
Operating expenses:
Research and development.......................... 885 2,367 5,393 11,758 15,763
Selling and marketing............................. 443 1,609 4,254 6,049 8,231
General and administrative........................ 273 858 2,064 3,744 5,816
Restructuring of operations....................... -- -- -- -- 676
Write-off of acquired in-process
research and development......................... -- -- -- 5,290 --
------ ------- ------- ------- -------
1,601 4,834 11,711 26,841 30,486
------ ------- ------- ------- -------
Income (loss) from operations...................... 203 1,811 6,392 (1,301) (7,729)
Interest income, net............................... 7 113 353 657 223
------ ------- ------- ------- -------
Income (loss) before income taxes.................. 210 1,924 6,745 (644) (7,506)
Provision (benefit) for income taxes............... 55 713 2,483 1,776 (2,789)
------ ------- ------- ------- -------
Net income (loss).................................. $ 155 $ 1,211 $ 4,262 $(2,420) $(4,717)
====== ======= ======= ======= =======
Basic earnings (loss) per share (1)................ $.09 $.33 $.82 $(.24) $(.38)
====== ======= ======= ======= =======
Diluted earnings (loss) per share (1).............. $.02 $.11 $.36 $(.24) $(.38)
====== ======= ======= ======= =======
20
December 31,
-------------------------------------------------------
1994 1995 1996 1997 1998
-------- ---------- --------- --------- -----------
(in thousands)
Consolidated Balance Sheet Data:
Working capital.......................... $ 154 $ 3,493 $26,593 $24,490 $22,326
Total assets............................. 3,494 13,595 46,035 51,950 55,386
Long-term liabilities.................... -- -- -- -- 1,027
Deferred revenue......................... 152 767 2,192 3,851 5,495
Total liabilities........................ 2,977 8,644 14,205 17,468 24,733
Redeemable convertible preferred stock... -- 4,008 -- -- --
Total stockholders' equity............... 517 943 31,830 34,482 30,653
- --------------
(1) For an explanation of the determination of the number of shares used in
computing net income (loss) per share see Notes to Consolidated Financial
Statements.
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following discussion and analysis should be read in conjunction with
the Company's Consolidated Financial Statements and the related Notes included
elsewhere in this Annual Report on Form 10-K. The following discussion contains
certain trend analysis and other statements of a forward-looking nature relating
to future events or the future financial performance of the Company. Readers are
cautioned that such statements are only predictions and that actual results or
events may differ materially. In evaluating such statements, readers should
specifically consider the risk factors set forth in this Annual Report on Form
10-K, particularly the matters set forth under the caption ''Certain Risk
Factors,'' in Item 1 "Business", which could cause actual results to differ
materially from those indicated by such forward-looking statements.
21
Overview
The Company develops, markets, licenses and sells digital advertising
insertion, movie and broadcast systems and related services and movie content to
television operators, telecommunications companies, the hospitality and
commercial property markets and broadcast television companies. Revenues from
systems sales are recognized upon shipment provided that there are no
uncertainties regarding customer acceptance and collection of the related
receivables is probable. If such uncertainties exist, such as performance
criteria beyond the Company's standard terms and conditions, revenue is
recognized upon customer acceptance. Installation and training revenue is
deferred and recognized as these services are performed. Revenue from technical
support and maintenance contracts is deferred and recognized ratably over the
period of the related agreements, generally twelve months. Customers are billed
for installation, training and maintenance at the time of the product sale.
Revenue from content fees, primarily movies, is recognized in the period earned
based on noncancelable agreements.
The Company has experienced fluctuations in the number of orders being
placed from quarter to quarter. The Company believes this is principally
attributable to the buying patterns and budgeting cycles of television operators
and broadcast companies, the primary buyers of digital advertising insertion
systems and broadcast systems, respectively. The Company expects that there will
continue to be fluctuations in the number and value of orders received and that
at least in the near future, the Company's revenue and results of operations
will reflect these fluctuations.
The Company's results are significantly influenced by a number of factors,
including the Company's pricing, the costs of materials used in the Company's
products and the expansion of the Company's operations. The Company prices its
products and services based upon its costs as well as in consideration of the
prices of competitive products and services in the marketplace. The costs of
the Company's products primarily consist of the costs of components and
subassemblies that have generally declined over time. As a result of the growth
of the Company's business, operating expenses of the Company have increased in
the areas of research and development, selling and marketing, customer service
and support and administration.
On December 10, 1997, the Company acquired all of the outstanding capital
stock of IPC Interactive Pte. Ltd. ("IPC") which was renamed to SeaChange Asia
Pacific Operations Pte. Ltd. ("SC Asia"). SC Asia provides interactive
television network systems to the hospitality and commercial property markets.
The transaction was accounted for under the purchase method and, accordingly,
the results of operations of the Company include the operating results of SC
Asia from the date of acquisition.
Results of Operations
The following table sets forth for the periods indicated the percentage of
total revenues represented by certain items reflected in the Company's
Consolidated Statement of Operations. Gross profit shown for systems and
services revenues at the bottom of the table is stated as a percentage of
related revenues.
22
Year ended December 31,
-------------------------------
1996 1997 1998
------ ------ ------
Revenues:
Systems
Digital advertising insertion.............. 92.4 % 82.5 % 61.4 %
Movies..................................... .5 6.5 13.6
Broadcast.................................. -- -- 5.9
Services..................................... 7.1 11.0 19.1
----- ----- -----
100.0 100.0 100.0
----- ----- -----
Cost of revenues:
Systems
Digital advertising insertion.............. 54.6 47.7 37.0
Movies..................................... .5 3.5 9.5
Broadcast.................................. -- -- 3.4
Services..................................... 8.2 11.2 18.4
----- ----- -----
63.3 62.4 68.3
----- ----- -----
Gross profit................................. 36.7 37.6 31.7
----- ----- -----
Operating expenses:
Research and development............... 10.9 17.3 22.0
Selling and marketing.................. 8.6 8.9 11.5
General and administrative............. 4.2 5.5 8.1
Restructuring of operations........... .9
Write-off of acquired in-
process research and
development........................... -- 7.8 --
----- ----- -----
23.7 39.5 42.5
----- ----- -----
Income (loss) from operations................ 13.0 (2.0) (10.8)
Interest income, net......................... .7 1.0 .3
----- ----- -----
Income (loss) before income taxes............ 13.7 (1.0) (10.5)
Provision (benefit) for income taxes......... 5.0 2.6 (3.9)
----- ----- -----
Net income (loss)............................ 8.7 % (3.6)% (6.6)%
===== ===== =====
Gross profit:
Systems
Digital advertising insertion.............. 40.9 % 42.2 % 39.8 %
Movies..................................... -- 46.3 % 30.0 %
Broadcast.................................. -- -- 42.7 %
Services..................................... (14.5)% (1.8)% 3.6 %
Years ended December 31, 1996, 1997 and 1998
Revenues
Systems. The Company's systems revenues consist of sales of its digital
video insertion, movie and broadcast system products. Systems revenues
increased 32% from $45.7 million in 1996 to $60.4 million in 1997, and decreased
4% to $58.0 million in 1998. The increased systems revenues in 1997 compared to
1996 resulted from the increase in the number of the Company's digital video
insertion systems sold to television operators primarily in the United States
and the sale of approximately $4.4 million of movie systems compared to $232,000
in 1996. The decreased systems revenues in 1998 compared to 1997 resulted from
a decrease of approximately $11.9 million in digital advertising insertion
systems revenues, offset by an increase of $5.3 million in movie systems
revenues and an increase $4.2 million in broadcast systems revenues. The
decrease in digital advertising insertion systems revenues is primarily
attributable to a decrease in the volume of digital video insertion systems sold
due to a shift in spending by U.S. cable operators on these products. U.S. cable
operators have shifted their spending patterns to buy expansions to existing
systems and to buy smaller scale digital ad insertion systems. The increase in
1998 of movie systems revenues of approximately $5.3 million is primarily
attributable to an increase in the volume of movie systems sold as a result of
the acquisition of SC Asia. The increase in 1998 of approximately $4.2 million
in broadcast systems is attributable to the initial introduction of the product
during the quarter ended June 30, 1998. The Company expects future systems
revenue growth, if any, to come principally from its broadcast products.
23
For the years ended December 31, 1996, 1997 and 1998, certain customers
accounted for more than 10% of the Company's total revenues. Individual
customers accounted for 29%, 17%, 13% and 12% of total revenues in 1996; 24%,
18% and 10% of total revenues in 1997; and 24% and 15% of total revenues in
1998. The Company believes that revenues from current and future large
customers will continue to represent a significant proportion of total revenues.
International sales accounted for approximately 5%, 12% and 13% of total
revenues in the years ended December 31, 1996, 1997 and 1998, respectively. The
Company expects that international sales will continue to increase as a
percentage of the Company's business in the future. As of December 31, 1998, all
sales of the Company's products were made in United States dollars. The Company
does not expect to change this practice in the foreseeable future. Therefore,
the Company has not experienced, nor does it expect to experience in the near
term, any material impact from fluctuations in foreign currency exchange rates
on its results of operations or liquidity. If this practice changes in the
future, the Company will reevaluate its foreign currency exchange rate risk.
Services. The Company's services revenues consist of fees for
installation, training, product maintenance, technical support services and
movie content fees. The Company's services revenues increased 112% from
approximately $3.5 million in 1996 to $7.5 million in 1997, and increased 84% to
$13.7 million in 1998. These increases in services revenues primarily resulted
from the increase in product sales and renewals of maintenance and support
contracts related to the growing installed base of systems and additional
service revenues in the form of movie content fees as a result of the
acquisition of SC Asia.
Gross Profit
Systems. Costs of systems revenues consist primarily of the cost of
purchased components and subassemblies, labor and overhead relating to the final
assembly and testing of complete systems and related expenses. Costs of systems
revenues increased 28% from $27.1 million in 1996 to $34.7 million in 1997, and
increased 3% to $35.8 million in 1998. In 1996 and 1997, the increases in costs
of systems revenues primarily reflect the overall growth in systems sales,
partially offset by the change in product mix upon the introduction of the
second generation video insertion product in January 1996 and the decreasing
costs of various components. In 1998, the increases in costs of systems
revenues reflect increased manufacturing labor and overhead costs incurred to
support changes in the product mix, including the introduction of the broadcast
products.
Systems gross profit as a percentage of systems revenues was 40.7%, 42.5%
and 38.4% in 1996, 1997 and 1998, respectively. The increase in systems gross
profit in 1997 in digital advertising insertion systems resulted from lower
costs of certain purchased components and subassemblies for systems, the Company
achieving certain manufacturing efficiencies as a result of increased volume of
systems and design improvements in the second generation video insertion
product. The increase in systems gross profit in movie systems is attributable
to Company manufacturing and selling a greater number of movie systems, thereby
achieving certain manufacturing efficiencies as a result of increased volume of
systems. The decrease in systems gross profit in 1998 is attributable to a
shift in the mix of system sales and higher manufacturing labor and overhead
costs. The decrease in gross profit of digital advertising insertion systems is
primarily attributable to revenues including a greater percentage of smaller
scale digital ad insertion systems and expansions to existing systems which have
higher costs on certain purchased components and the overall higher
manufacturing labor and overhead costs. The decrease in gross profit of movie
systems is primarily attributable to higher costs on certain purchased
components, specifically set-top boxes, and overall higher manufacturing labor
and overhead costs. The gross profit of the broadcast products, introduced in
1998, offset the decreases in the gross profit of the movie and digital
advertising insertion systems products. The gross profits in 1996, 1997 and 1998
were impacted by increases of approximately $694,000, $1.7 million and $2.0
million, respectively, in the Company's inventory valuation allowance. The
Company evaluates inventory levels and expected usage on a periodic basis and
provides a valuation allowance for estimated inactive, obsolete and surplus
inventory.
Services. Costs of services revenues consist primarily of labor, materials
and overhead relating to the installation, training, product maintenance and
technical support services provided by the Company and costs associated with
providing movie content. Costs of services revenues increased 89% from
24
approximately $4.0 million in 1996 to $7.6 million in 1997, and increased 74% to
$13.2 million in 1998, primarily as a result of the costs associated with the
Company hiring and training additional service personnel to provide worldwide
support for the growing installed base of digital ad insertion, movie and
broadcast systems and costs associated with providing movie content. Costs of
services exceeded services revenues by 14.5% and 1.8% in 1996 and 1997,
respectively. Services gross profit as a percentage of services revenue was
3.6% in 1998. Improvements in the services gross profit in 1997 and 1998,
reflects the increases in the installed base of systems under service contracts.
Also, the services gross profit in 1998 includes gross profit generated from the
movie content fees as a result of the acquisition of SC Asia. The Company
expects that it will continue to experience fluctuations in gross profit as a
percentage of services revenue as a result of the timing of revenues from
product and maintenance support and other services to support the growing
installed base of systems and the timing of costs associated with the Company's
ongoing investment required to build a service organization to support the
installed base of systems and new products.
Research and Development. Research and development expenses consist
primarily of compensation of development personnel, depreciation of equipment
and an allocation of related facilities expenses. Research and development
expenses increased 118% from approximately $5.4 million in 1996 to $11.8 million
in 1997, and increased 34% to $15.8 million in 1998. The increases in the dollar
amounts in 1997 and 1998 were primarily attributable to the hiring and
contracting of additional development personnel which reflects the Company's
continuing investment in new products and in 1998, the additional resources
acquired with IPC. All internal software development costs to date have been
expensed by the Company. The Company expects that research and development
expenses will continue to increase in dollar amount as the Company continues its
development and support of new and existing products.
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 increased 42% from
approximately $4.3 million in 1996 to $6.0 million in 1997, and increased 36% to
$8.2 million in 1998. The increases in the dollar amounts were attributable to
the hiring of additional selling and marketing personnel, increased
international selling efforts and expanded promotional activities to support the
movie and broadcast products. In 1997, selling expenses were also higher due to
an increase in commission expenses relating to the higher revenue levels.
General and Administrative. General and administrative expenses consist
primarily of compensation of executive, finance, human resource and
administrative personnel, legal and accounting services and an allocation of
related facilities expenses. General and administrative expenses increased 81%
from $2.1 million in 1996 to approximately $3.7 million in 1997, and increased
55% to approximately $5.8 million in 1998. The increases in the dollar amounts
were primarily attributable to increased staffing and related costs to support
the Company's expanded operations and the acquisition of SC Asia. The Company
does not expect that general and administrative expenses will increase in dollar
amount in the foreseeable future.
Write-off of Acquired In-Process Research and Development. In connection
with the acquisition of IPC, the Company acquired certain technology that can be
used with the Company's video server technology to provide interactive
television network systems to the hospitality and commercial property markets.
As discussed in Note 5 to the consolidated financial statements, the Company
recorded a charge to operations of $5,290,000 for the write-off of in-process
research and development, the value of which was determined based upon an
independent appraisal. In addition, the Company recorded intangible assets of
$1,635,000 that included approximately $850,000 of software. Of the acquired
technology, the capitalized amount reflects the allocation of the purchase price
to the software technology deemed technologically feasible, including the
operating system and software for the distribution of movies over the network.
Acquired technology, including software to provide certain new interactive
features and functions over the network, included in the in-process write-off
reflects the purchase price allocated to technology currently under development
and not considered technologically feasible at the time of the acquisition and
with no alternative future use. The Company was continuing the development of
the software applications and hardware design of this in-process development as
of December 31, 1998. Management estimates the development of this in-process
development to be completed during 1999 and for some features in 2000.
25
Restructuring of Operations. In March 1998, the Company recorded a charge
of $676,000 for the restructuring of operations as part of a planned
consolidation of the operations of SC Asia. The charge for restructuring
included $569,000 related to the termination of 13 employees, a provision of
$60,000 related to the planned vacating of premises and $47,000 of compensation
expense associated with stock options for certain terminated employees. At
March 31, 1998, the Company had notified all terminated employees. All
restructuring charges were paid as of December 31, 1998.
Interest Income. Interest income was approximately $353,000, $657,000 and
$262,000 in 1996, 1997 and 1998, respectively. The increase in 1997 in interest
income primarily resulted from interest earned on a higher invested balance
primarily due to the net proceeds of $24.1 million from the initial public
offering of the Company's Common Stock in November 1996. The decrease in
interest income in 1998 primarily resulted from lower average invested balances
in 1998.
Provision for Income Taxes. The Company's effective tax rate was 36.8% in
1996. The Company's effective tax rate for 1997 was significantly impacted by
the write-off of the acquired in-process research and development which due to
the tax-free nature of the transaction to IPC stockholders, is not deductible
for tax purposes by the Company. Accordingly, in 1997 the Company recorded a
tax provision of approximately $1.8 million despite a book pre-tax operating
loss. The Company's effective tax benefit rate was 37.2% in 1998 due to the
taxable loss in 1998.
The Company had net deferred tax assets of $1,091,000 and $1,967,000 at
December 31, 1997 and 1998, respectively. The Company has made the determination
it is more likely than not that it will realize the benefits of the net deferred
tax assets. As a result of the acquisition of IPC, the Company acquired deferred
tax assets of $3.4 million, consisting primarily of net operating loss
carryforwards. As discussed in Note 7 of the consolidated financial statements,
the Company maintains a valuation allowance on the acquired net deferred tax
assets.
26
Quarterly Results of Operations
The following table presents certain unaudited quarterly information for
the eight quarters ended December 31, 1998. Gross profit shown for systems and
services revenues at the bottom of the table is stated as a percentage of
related revenues. This information is derived from unaudited financial
statements and has been prepared on the same basis as the Company's audited
financial statements which appear elsewhere in this Annual Report. In the
opinion of the Company's management, this data reflects all adjustments
(consisting only of normal recurring adjustments) necessary for a fair
presentation of the information when read in conjunction with the Company's
Consolidated Financial Statements and Notes thereto. The results for any quarter
are not necessarily indicative of future quarterly results, and the Company
believes that period-to-period comparisons should not be relied upon as an
indication of future performance.
Quarter Ended
----------------------------------------------------------------------------------------
March 31, June 30, Sept. 30, Dec. 31, March 31, June 30, Sept. 30, Dec. 31,
--------- -------- --------- --------- ---------- --------- ---------- ---------
1997 1997 1997 1997 1998 1998 1998 1998
-------- -------- --------- --------- ---------- --------- ---------- ---------
(in thousands)
Quarterly Financial Data (Unaudited):
Revenues
Systems.................................... $16,796 $20,184 $13,188 $10,246 $14,807 $13,207 $14,240 $15,779
Services................................... 1,256 1,668 2,063 2,486 3,362 3,373 3,548 3,454
------- ------- ------- ------- ------- ------- ------- -------
18,052 21,852 15,251 12,732 18,169 16,580 17,788 19,233
------- ------- ------- ------- ------- ------- ------- -------
Costs of revenues
Systems.................................... 9,457 11,079 7,889 6,315 8,967 8,223 8,897 9,685
Services................................... 1,386 1,622 1,953 2,646 3,043 3,108 3,755 3,335
------- ------- ------- ------- ------- ------- ------- -------
10,843 12,701 9,842 8,961 12,010 11,331 12,652 13,020
------- ------- ------- ------- ------- ------- ------- -------
Gross profit................................ 7,209 9,151 5,409 3,771 6,159 5,249 5,136 6,213
------- ------- ------- ------- ------- ------- ------- -------
Operating expenses
Research and development................... 2,416 2,750 3,159 3,433 4,003 3,900 3,897 3,963
Selling and marketing...................... 1,268 1,842 1,431 1,508 1,845 2,081 1,928 2,377
General and administrative................. 930 866 792 1,156 1,562 1,721 1,174 1,359
Restructuring of operations -- -- -- -- 676 -- -- --
Write-off of acquired in-process
research and development.................. -- -- -- 5,290 -- -- -- --
------- ------- ------- ------- ------- ------- ------- -------
4,614 5,458 5,382 11,387 8,086 7,702 6,999 7,699
------- ------- ------- ------- ------- ------- ------- -------
Income (loss) from operations.............. 2,595 3,693 27 (7,616) (1,927) (2,453) (1,863) (1,486)
Interest income, net....................... 200 187 136 134 103 76 20 24
------- ------- ------- ------- ------- ------- ------- -------
Income (loss) before income taxes.......... 2,795 3,880 163 (7,482) (1,824) (2,377) (1,843) (1,462)
Provision (benefit) for income taxes....... 1,062 1,475 61 ( 822) (709) (769) (770) ( 541)
------- ------- ------- ------- ------- ------- ------- -------
Net income (loss).......................... $ 1,733 $ 2,405 $ 102 $(6,660) $(1,115) $(1,608) $(1,073) $ ( 921)
======= ======= ======= ======= ======= ======= ======= =======
Basic earnings (loss) per share............. $ .19 $ .24 $ .01 $ (.61) $ (.10) $ (.13) $ (.08) $ (.07)
Diluted earnings (loss) per share........... $ .13 $ .18 $ .01 $ (.61) $ (.10) $ (.13) $ (.08) $ (.07)
Gross profit
Systems.................................... 43.7% 45.1% 40.2% 38.4% 39.4% 37.7% 37.5% 38.6%
Services................................... (10.4)% 2.8% 5.3% (6.4)% 9.5% 7.9% (5.8)% 3.4%
The Company has experienced significant variations in revenues, expenses
and operating results from quarter to quarter and such variations are likely to
continue. A significant portion of the Company's revenues have been generated
from a limited number of customers and it is difficult to predict the timing of
future orders and shipments to these and other customers. Customers can cancel
or reschedule shipments, and development or production difficulties could delay
shipments.
The Company has also experienced significant variations in its quarterly
systems gross margins. Changes in pricing policies, the product mix, the timing
and significance of new product introductions and product enhancements, and
fluctuations in the number of systems so affects manufacturing efficiencies
and, accordingly, the gross profits. Quarterly services gross margins have
historically fluctuated significantly because installation and training service
revenue varies by quarter while the related costs are relatively consistent by
quarter.
27
Operating expenses also vary with the number, timing and significance of
new product and product enhancement introductions by the Company and its
competitors, increased competition, the gain or loss of significant customers,
the hiring of new personnel and general economic conditions. All of the above
factors are difficult for the Company to forecast, and these or other factors
may materially adversely effect the Company's business, financial condition and
results of operations for one quarter or a series of quarters. Only a small
portion of the Company's expenses vary with revenues in the short-term and there
would likely be a material adverse effect on the operating results of the
Company if future revenues are lower than expectations.
Based upon all of the foregoing, the Company believes that quarterly
revenues and operating results are likely to vary significantly in the future
and that period-to-period comparisons of its results of operations are not
necessarily meaningful and, therefore, should not be relied upon as indications
of future performance.
Liquidity and Capital Resources
From inception through November 1996, the Company funded its operations
primarily through cash provided by operations and the private sale of equity
securities. In November 1996, in connection with the initial public offering of
the Company's Common Stock, the Company received net proceeds of $24.1 million.
Cash, cash equivalents and marketable securities decreased $7.2 million
from $12.3 million at December 31, 1997 to $5.1 million at December 31, 1998.
Working capital decreased from approximately $24.5 million at December 31, 1997
to approximately $22.3 million at December 31, 1998.
Net cash used in operating activities was approximately $1.9 million, $9.2
million and $7.5 million for the years ended December 31, 1996, 1997 and 1998,
respectively. The net cash used in operating activities during 1998 was the
result of the net loss adjusted for noncash expenses including depreciation and
amortization, deferred income taxes, inventory valuation allowance and the
changes in certain assets and liabilities. The significant net changes in assets
and liabilities that used cash in operations include increases in accounts
receivable, inventories and income taxes receivable. The net increase in
accounts receivable in 1998 of approximately $6.4 million is attributable to the
increase in revenues in the fourth quarter of 1998 compared to the same period
in 1997. The net increase in inventories in 1998 of approximately $2.4 million
is principally attributable to the increase in the number of product lines.
Income taxes receivable is attributable to the Company carrying back the taxable
loss in 1998 that results in a refund of income taxes.
Net cash used in investing activities was approximately $3.2 million and
$10.8 million for the years ended December 31, 1996 and 1997, respectively. Net
cash provided by investing activities was approximately $5.5 million in the year
ended December 31, 1998. Investment activity consisted primarily of capital
expenditures related to the acquisition of computer equipment, office furniture,
and other capital equipment required to support the expansion and growth of the
business.
Net cash provided by financing activities was approximately $22.3 million
and $4.1 million for the years ended December 31, 1996 and 1998, respectively.
Net cash used in financing activities was approximately $454,000 in the year
ended December 31, 1997. In 1996, the cash provided by financing activities
consisted primarily of net proceeds of $24.1 million from the initial public
offering of the Company's Common Stock in November 1996 offset by the purchase
of $2.0 million of treasury stock. In 1997, the cash used in financing
represented repayment of IPC's line of credit of approximately $700,000 and
payment of loans to related parties of approximately $437,000, offset by
$683,000 received in connection with the issuance common stock pursuant to the
both the exercise of stock options and purchases under the employee stock
purchase plan. In 1998, the cash provided by financing included $1.2 million and
$2.0 million borrowings under the equipment line of credit and line of credit,
respectively, and by $914,000 received in connection with the issuance of common
stock pursuant to both the exercise of stock options and purchases under the
employee stock purchase plan.
28
The Company has a $6.0 million revolving line of credit and a $3.0 million
equipment line of credit with a bank. The revolving line of credit expires in
October 1999 and the equipment line of credit expires in June 1999. Borrowings
under the lines of credit are secured by substantially all of the Company's
assets. Loans made under the revolving line of credit generally bear interest
at a rate per annum equal to the bank's base rate plus .5% (8.25 % at December
31, 1998). Loans made under the equipment loan bear interest at a rate per
annum equal to the bank's base rate plus 1.0% (8.75 % at December 31, 1998). The
loan agreement relating to the lines of credit requires that the Company provide
the bank with certain periodic financial reports and comply with certain
financial ratios including the maintenance of total liabilities, excluding
deferred revenue, to net worth of at least .80 to 1.0. At December 31, 1998 the
Company was in compliance with all covenants. As of December 31, 1998, the
Company had borrowed $2.0 million and $1.2 million against the line of credit
and the equipment line of credit, respectively.
The Company believes that existing funds together with available borrowings
under the line of credit and equipment line facility are adequate to satisfy its
working capital and capital expenditure requirements for the foreseeable future.
The Company had no material capital expenditure commitments as of
December 31, 1998.
Year 2000 Issue/Year 2000 Readiness Disclosure
Overview. The Company is completing its process of analyzing and addressing
what is known as the Year 2000 Issue. The Year 2000 Issue has arisen because
many existing computer programs use only two digits to identify a year in the
data field. These programs were designed and developed without considering the
impact of the upcoming change in the century and, accordingly, could misconstrue
dates such as "00" as the year 1900 rather than 2000. The failure of computer
programs and systems to properly recognize dates beginning in the year 2000
could adversely affect the Company's business activities.
The Company's Year 2000 Compliance Program. The Company is executing its
Year 2000 Compliance Program, the purpose of which is: to identify important
systems that are not yet Year 2000 compliant; to initiate replacement or
remedial action to assure that key systems will continue to operate in the Year
2000 and to test the replaced or remediated systems; to identify and contact key
suppliers, vendors, customers and business partners to evaluate their ability to
maintain normal operations in the Year 2000; and to develop appropriate
contingency plans for dealing with foreseeable Year 2000 complications. The
Company's Year 2000 Committee has made significant progress toward the
completion of these goals. The Committee continues to execute the Company's
Year 2000 Compliance Program and reports the results and status of the Company's
Year 2000 efforts to the Board of Directors. The Company expects to
substantially complete its Year 2000 Compliance Program activities by the end of
1999.
Information Technology Systems. The Company's critical internal information
technology ("IT") systems consist of its Electronic Mail system, Corporate
Communications system, Manufacturing database, desktop and file management
systems, Software Development tools and I/S Management tools. The Company also
uses a Call Center Management software tool for use in the Company's customer
service department. The Company has contacted the vendors of these systems and
obtained assurances that these IT systems are currently in material Year 2000
compliance. The Company continues to upgrade older versions of these systems
that may not be compliant and intends to finish these upgrades to achieve
material Year 2000 compliance. The Company is in the process of obtaining
written statements confirming such compliance from these vendors. The Company is
still in the process of evaluating other areas of its existing internal IT
systems at this time and will seek further assurances from its vendors as
necessary. The Company plans to test its critical IT systems during 1999. The
Company intends to evaluate the need for contingency plans for these internal IT
systems given the assurances of compliance the Company has received for these
systems. While the Company will work diligently with all of its IT system
providers, there is no guarantee that these IT system providers will meet Year
2000 compliance. The failure of any such IT system to be Year 2000 compliant
could have a negative effect on the business activities of the Company.
29
Non-Information Technology Systems. The Company is conducting an assessment
of its non-information technology systems (such as building security, voice
mail, telephone and other systems containing embedded microprocessors) and is in
the process of determining the nature and extent of any work that may be
required to make any non-IT systems Year 2000 compliant. The Company has made
Year 2000 compliance inquiries to the vendors of these systems, and intends to
track the responses to its inquiries and have the inquiry process completed
during the first half of 1999.
Third Party Suppliers, Vendors and Customers. The Company's Year 2000
Compliance Program also includes an investigation of the Year 2000 compliance of
its major suppliers, vendors, customers and business partners. For example, all
of the Company's products and services incorporate third party software and
hardware. The Company is in the process of evaluating its product components.
The Company has identified and contacted most of its third party suppliers of
hardware and software components regarding Year 2000 compliance and has
collected compliance statements from most of these suppliers. The Company has
learned that some features or functions of such third party components are not
Year 2000 compliant. However, in certain cases the Company does not use such
features or functions in its products and, to that extent, the Company believes
the non-compliance of such features and functions will not have a negative
impact on its products. In those cases where the non-compliance of third party
components does affect features or functions used by the Company in its
products, the Company intends to install upgrades (most of which are currently
available) to achieve material compliance. In addition, the Company is
completing the process of testing its application software. To date, the
Company has found only a few minor problems with its application software, and
has already created patches to this software. Given the number of components
and the complexity of the software incorporated in the Company's products and
services, the Company believes that in the course of conducting its Year 2000
Compliance Program it could reasonably discover that the Year 2000 problem may
affect its software or components. However, the Company regularly develops
software updates to its product offerings as a natural course of business and
the Company does not expect that these Year 2000 updates will be excessively
complex or expensive to implement. Still, there can be no assurances that there
will be no service interruption on the part of any of the Company's third party
suppliers due to the Year 2000 problem and this could have a material adverse
effect on the Company.
Year 2000 Costs and Expenses. To date, the costs associated with the Year
2000 Issue and the Company's Year 2000 Compliance Program have not been
material. The Company will incur costs that include internal resources,
software and equipment upgrades and replacement. Based on currently available
information, the Company believes that the expense associated with its ongoing
efforts will not be material and will be funded through operations, but the
Company has not completed its evaluation of its non-IT systems and its third
party relationships. If unforeseen compliance efforts are required or if
present compliance efforts are not completed on time, or if the cost of any
required updating, modification or replacement of the Company's systems or
equipment exceeds the Company's estimates, the Year 2000 Issue could result in
material costs and have a material adverse effect on the Company.
Contingency Plans. At the present time, the Company has not felt it
necessary to formulate any contingency plans for addressing problems due to the
Year 2000 Issue. The Company has been assured that its critical internal IT
systems are compliant by the vendors of those systems and the Company will
evaluate the need for contingency plans for internal IT systems given those
assurances. The Company is currently in the process of evaluating the Year 2000
Issue with respect to its non-IT systems and with respect to its major
suppliers, vendors, customers and business partners. As this evaluation process
proceeds, the Company will formulate appropriate contingency plans. The Company
expects that any required contingency planning will be completed no later than
the end of 1999.
Risks Associated with Year 2000 Issue. Various statements in this
discussion of Year 2000 are forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995 as discussed above under
"Factors That May Affect Future Results." These statements include statements
of the Company's expectations, statements with regard to schedules and expected
completion dates and statements regarding expected Year 2000 compliance.
30
These forward-looking statements are subject to various risk factors which may
materially affect the Company's efforts to achieve Year 2000 compliance. These
risk factors include the inability of the Company to complete the plans and
modifications that it has identified; the failure of software vendors to deliver
the upgrades and repairs to which they have committed; the wide variety of
information technology systems and components, both hardware and software, that
must be evaluated; any inaccuracy in the assessment of the cost and financial
exposure of the Company with respect to current and older versions of the
Company's products; the failure of software vendors to deliver upgrades and
repairs to which they have committed; and the large number of vendors and
customers with which the Company interacts. The Company's assessments of the
effects of Year 2000 on the Company are based, in part, upon information
received from third parties and the Company's reasonable reliance on that
information. Therefore, the risk that inaccurate information is supplied by
third parties upon which the Company reasonably relied must be considered as a
risk factor that might affect the Company's Year 2000 efforts. The Company is
attempting to reduce the risks by utilizing an organized approach, extensive
testing, and allowance of ample contingency time to address issues identified by
tests.
Effects of Inflation
Management believes that financial results have not been significantly
impacted by inflation and price changes.
31
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company faces 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 the Company's financial results. The Company's
primary exposure has been related to local currency revenue and operating
expenses in Europe and Asia. Historically, the Company has not hedged specific
currency exposures as gains and losses on foreign currency transactions have not
been material to date. At December 31, 1998, the Company had $3,226,000
outstanding related to variable rate U.S. dollar denominated shor-term debt.
The carrying value of these short-term borrowings approximates fair value due to
the short maturities of these instruments. Assuming a hypothetical 10% adverse
change in the interest rate, interest expense on these short-term borrowings
would increase by $40,000.
The carrying amounts reflected in the consolidated balance sheet of cash
and cash equivalents, trade receivables, and trade payables approximates fair
value at December 31, 1998 due to the short maturities of these instruments.
The Company maintains investment portfolio holdings of various issuers,
types, and maturities. The Company's cash and marketable securities include cash
equivalents, which the Company considers investments to be purchased with
original maturities of three months or less given the short maturities and
investment grade quality of the portfolio holdings at December 31, 1998, a sharp
rise in interest rates should not have a material adverse impact on the fair
value of the Company's investment portfolio. As a result, the Company does not
currently hedge these interest rate exposures.
ITEM 8. Financial Statements and Supplementary Data
The Company's Financial Statements and Schedules, together with the
auditors' reports thereon, appear at pages F-1 through F-20, and S-1 through
S-2, respectively, of this Form 10-K.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
PART III
ITEM 10. Directors and Executive Officers of the Registrant
Information concerning the directors of the Registrant is hereby
incorporated by reference from the information contained under the heading "
Election of Directors" in the Registrant's definitive proxy statement related to
the Registrant's 1998 Annual Meeting of Stockholders which will be filed with
the Commission within 120 days after the close of the fiscal year (the
"Definitive Proxy Statement").
Certain information concerning directors and executive officers of the
Registrant is hereby incorporated by reference to the information contained
under the heading "Occupations of Directors and Executive Officers" in the
Registrant's Definitive Proxy Statement.
Item 11. Executive Compensation
Information concerning executive compensation is hereby incorporated by
reference to the information contained under the heading "Compensation and Other
Information Concerning Directors and Officers" in the Definitive Proxy
Statement.
32
Item 12. Security Ownership of Certain Beneficial Owners and Managment
Information concerning security ownership of certain beneficial owners and
management is hereby incorporated by reference to the information contained
under the heading "Securities Ownership of Certain Beneficial Owners and
Management" in the Definitive Proxy Statement.
Item 13. Certain Relationships and Related Transactions
Information concerning certain relationships and related transactions is
hereby incorporated by reference to the information contained under the heading
"Certain Relationships and Related Transactions" in the Definitive Proxy
Statement.
33
ITEM 14. Exhibits and Financial Statement Schedules
PART IV
(a)(1) INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS
The following Consolidated Financial Statements of the Registrant are filed
as part of this report:
Page
----
Report of Independent Accountants F-1
Consolidated Balance Sheet as of December 31, 1997 and 1998 F-2
Consolidated Statement of Operations for the years ended December 31, 1996, 1997 and 1998 F-3
Consolidated Statement of Stockholders' Equity for the years ended December 31, 1996, 1997 and 1998 F-4
Consolidated Statement of Cash Flows for the years ended December 31, 1996, 1997 and 1998 F-5
Notes to Consolidated Financial Statements F-7
(a)(2) INDEX TO FINANCIAL STATEMENT SCHEDULES
The following Financial Statement Schedule of the Registrant is filed as
part of this report:
Page
----
Schedule I Report of Independent Accountants on Financial Statement Schedule S-1
Schedule II - Valuation and Qualifying Accounts and Reserves S-2
Schedules not listed above have been omitted because the information requested
to be set forth therein is not applicable or is shown in the accompanying
Consolidated Financial Statements or notes thereto.
(a)(3) INDEX TO EXHIBITS
See attached Exhibit Index of this Annual Report on Form 10-K.
(b) EXHIBITS
The Company hereby files as part of this Form 10-K the Exhibits listed in
Item 14 (a) (3) above. Exhibits which are incorporated herein by reference
can be inspected and copied at the public reference facilities maintained
by the Securities and Exchange Commision (the "Commission"), 450 Fifth
Street, N.W., Washington, D.C. 20549 and at the Commision's regional
offices located at Seven World Trade Center, 13th Floor, New York, New York
10048, and at the Citicorp Center, 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661. Copies of such material can also be obtained from
the Public Reference Section of the Commissiion, 450 Fifth Street, N.W.,
Washington, D.C. 20549, at prescribed rates. In addition the Company is
required to file electronic versions of certain of these documents with the
Commission through the Commission's Electronic Data Gathering, Analysis and
Retrieval (EDGAR) system. The Commission maintains a World Wide Web site at
http://www.sec.gov that contains the report, proxy and information
statements and other information regarding registrants that file
electronically with the Commission. The Common Stock of the Company is
traded on the Nasdaq National Market. Reports and other information
concerning the Company may be inspected at the National Association of
Securities Dealers, Inc. 1801 K Street, N.W., Washington, D.C. 20006.
(d) FINANCIAL STATEMENT SCHEDULES The Company hereby files as part of this Form
10-K the consolidated financial statements schedules listed in Item 14 (a)
(2) above, which are attached hereto.
34
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) 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: MARCH 22, 1999
SEACHANGE INTERNATIONAL, INC.
by: /s/ William C. Styslinger, III
----------------------------------
William C. Styslinger, III
President, Chief Executive Officer,
Chairman of the Board and Director.
POWER OF ATTORNEY AND SIGNATURES
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints William C. Styslinger, III and William L.
Fiedler, jointly and severally, his attorney-in-fact, each with the power of
substitution, for him in any and all capacities, to sign any amendments to this
Report on Form 10-K and to file same, with exhibits thereto and other documents
in connection therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming all that each of said attorneys-in-fact, or his
substitute or substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title(s) Date
--------- -------- ----
/s/ William C. Styslinger, III President, Chief Executive Officer, March 22, 1999
- --------------------------------- Chairman of the Board and Director
William C. Styslinger, III (Principal Executive Officer)
/s/ William L. Fiedler Vice President, Finance and March 22, 1999
- --------------------------------- Administration, Chief Financial
William L. Fiedler Officer and Treasurer (Principal
Financial and Accounting Officer)
/s/ Martin R. Hoffmann Director March 22, 1999
- ---------------------------------
Martin R. Hoffmann
/s/ Edward J. McGrath Director March 22, 1999
- ---------------------------------
Edward J. McGrath
/s/ Paul Saunders Director March 22, 1999
- ---------------------------------
Paul Saunders
/s/ Carmine Vona Director March 22, 1999
- ---------------------------------
Carmine Vona
35
Exhibit Index
Exhibit No. Description
- ----------- -----------
3.1 Amended and Restated Certification of Incorporation (incorporated by reference to the
Registrant's Annual Report on Form 10-K filied March 28, 1997).
3.2 Amended and Restated By-laws of the Company (incorporated by reference to the Registrant's
Annual Report on Form 10-K filed March 28, 1997).
4.1 (1) Form of Stock Restriction Agreement (incorporated by reference to Exhibit 4.3 to the Registrant's
Registration Statement on Form S-1, Registration No. 333-12233).
4.2 (1) Form of Stock Restriction Agreement Amendment (incorporated by reference to Exhibit 4.4 to the
Registrant's Registration Statement on Form S-1, Registration No. 333-12233).
10.1 (1) Amended and Restated 1995 Stock Option Plan (incorporated by reference to Exhibit 10.1 to the
Registrant's Registration Statement on Form S-1, Registration No. 333-12233).
10.2 (1) 1996 Non-Employee Director Stock Option Plan (incorporated by reference to Exhibit 10.2 to
the Registrant's Registration Statement on From S-1, Registration No. 333-12233).
10.3 * Lease Agreement dated May 28, 1998 between Robert Quirk, Trustee of Maynard Industial Properties
Associates Trust and the Company.
10.4 * Sublease agreement dated June 20, 1996 between Harding Lawson Associates, Inc. and the Company.
10.5 * Loan and Security Agreement dated November 10, 1990 between Silicon Valley Bank and the Company.
10.7 License Agreement dated May 30, 1996 between Summit Software Systems, Inc. and the Company
(incorporated by reference to Exhibit 10.7 to the Registrant's Registration Statement on From S-1,
Registration No. 333-12233).
10.8 Stock Purchase Agreement, dated December 10, 1997, by and among the Company, IPC Interactive Pte.
Ltd. and the shareholders of IPC Interactive Pte. Ltd. (incorporated by reference to Exhibit 10.12
to the Registrant's Annual Report on Form 10-K filed March 31, 1998.)
10.9 Registration Rights Agreement, dated December 10, 1997, by and among the Company, IPC Interactive Pte.
Ltd. and the shareholders of IPC Interactive Pte. Ltd. (incorporated by reference to Exhibit 10.13 to
the Registrant's Annual Report on Form 10-K filed March 31, 1998.)
10.10 Escrow Agreement, dated December 10, 1997, by and among the Company, IPC Interactive Pte. Ltd. and
the shareholders of IPC Interactive Pte. Ltd.and State Street Bank and Trust Company (incorporated
by reference to Exhibit 10.15 to the Registrant's Annual Report on Form 10-K filed March 31, 1998.)
21.1* List of Significant Subsidiaries
23.1* Consent of PricewaterhouseCoopers LLP.
27.1* Financial Data Schedule (For SEC Edgar Filing Only; Intentionally Omitted).
---------------------------
* Filed herewith.
36
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of SeaChange International, Inc.
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, of stockholders' equity and of cash flows
present fairly, in all material respects, the financial position of SeaChange
International, Inc. and its subsidiaries at December 31, 1997 and 1998 and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998, in conformity with generally accepted
accounting principles. These financial statement are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
financial statements in accordance with generally accepted auditing standards
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examing, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
/s/PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Boston, Massachusetts
January 29, 1999
F-1
SeaChange International, Inc.
Consolidated Balance Sheet
(in thousands, except share data)
December 31,
------------------------
1997 1998
---- ----
Assets
Current assets
Cash and cash equivalents $ 2,973 $ 5,115
Marketable securities 9,310 --
Accounts receivable, net of allowance for doubtful
accounts of $559 at December 31, 1997 and
$870 at December 31, 1998 12,535 18,975
Inventories 13,713 16,157
Income taxes receivable 1,131 2,117
Prepaid expenses 1,205 1,701
Deferred income taxes 1,091 1,967
------------------------
Total current assets 41,958 46,032
Property and equipment, net 8,303 7,981
Other assets 81 176
Goodwill and intangibles, net 1,608 1,197
------------------------
$51,950 $55,386
========================
Liabilities and Stockholders' Equity
Current liabilities
Line of credit $ -- $ 2,000
Current portion of equipment line of credit
and obligations under capital lease -- 555
Accounts payable 8,765 10,103
Accrued expenses 2,718 3,374
Customer deposits 2,049 1,704
Deferred revenue 3,851 5,495
Income taxes payable 85 475
------------------------
Total current liabilities 17,468 23,706
------------------------
Long-term equipment line of credit and
obligations under capital lease -- 1,027
------------------------
Commitments (Note 11)
Stockholders' Equity
Common stock, $.01 par value; 50,000,000
shares authorized; 13,593,594 shares and
13,736,892 shares issued at December 31,
1997 and 1998, respectively 136 138
Additional paid-in capital 31,218 32,177
Retained earnings (accumulated deficit) 3,114 (1,603)
Treasury stock, 9,000 shares -- --
Cumulative translation adjustment 14 (59)
------------------------
Total stockholders' equity 34,482 30,653
------------------------
$51,950 $55,386
========================
The accompanying notes are an integral part of these consolidated financial
statements.
F-2
SeaChange International, Inc.
Consolidated Statement of Operations
(in thousands, except share data)
Year ended December 31,
--------------------------------------
1996 1997 1998
---------------------------------------
Revenues
Systems $ 45,745 $ 60,414 $ 58,033
Services 3,521 7,473 13,737
--------------------------------------
49,266 67,887 71,770
--------------------------------------
Costs of revenues
Systems 27,133 34,740 35,772
Services 4,030 7,607 13,241
--------------------------------------
31,163 42,347 49,013
--------------------------------------
Gross profit 18,103 25,540 22,757
--------------------------------------
Operating expenses
Research and development 5,393 11,758 15,763
Selling and marketing 4,254 6,049 8,231
General and administrative 2,064 3,744 5,816
Restructuring of operations -- -- 676
Write-off of acquired
in-process research and
development -- 5,290 --
--------------------------------------
11,711 26,841 30,486
--------------------------------------
Income (loss) from operations 6,392 (1,301) (7,729)
Interest income, net 353 657 223
--------------------------------------
Income (loss) before income taxes 6,745 (644) (7,506)
Provision (benefit) for income taxes 2,483 1,776 (2,789)
--------------------------------------
Net income (loss) $ 4,262 $ (2,420) $ (4,717)
======================================
Basic earnings (loss) per share $ .82 $ (.24) $ (.38)
======================================
Diluted earnings (loss) per share $ .36 $ (.24) $ (.38)
======================================
Shares used in calculating:
Basic earnings per share 5,187,993 10,276,711 12,420,397
======================================
Diluted earnings per share 11,745,866 10,276,711 12,420,397
======================================
The accompanying notes are an integral part of these consolidated financial
statments.
F-3
SeaChange International, Inc.
Consolidated Statement of Stockholders' Equity
(in thousands, except share data)
Series A convertible Common Stock
preferred stock -------------------------------------- Retained
-------------------- Additional earnings
Number Number Par paid-in (accumulated
of shares Amount of shares value capital deficit)
------------------- --------- ----- --------- ------------
Balance at
December 31, 1995 11,808 $ -- 9,625,740 96 $ 374 $ 1,272
Purchase of
treasury stock -- -- -- -- -- --
Sale of common stock,
net of
issuance costs -- -- 1,810,000 18 24,052 --
Conversion of preferred
stock into
common stock (11,808) 2,260,856 23 3,985 --
Issuance of common stock
pursuant to exercise
of stock options -- -- 9,223 -- 9 --
Compensation expense
associated
with stock
issuance -- -- -- -- 126 --
Issuance of common stock
pursuant to
purchased
research and development -- -- 9,615 -- 144 --
Retirement of treasury
stock -- -- (856,200) (8) (2,523) --
Net income -- -- -- -- -- 4,262
--------------------------------------------------------------------------
Comprehensive income
Balance at
December 31, 1996 -- -- 12,859,234 129 26,167 5,534
Purchase of treasury stock -- -- (9,000) -- -- --
Compensation expense
associated
with stock issuance -- -- -- -- 45 --
Issuance of common stock
pursuant to
exercise
of stock options -- -- 88,999 1 203 --
Issuance of common stock
in connection
with employee stock
purchase plan -- -- 29,361 -- 479 --
Issuance of common stock
in connection
with acquisition
of IPC Interactive,
Pte. Ltd. -- -- 625,000 6 4,324 --
Translation adjustment -- -- -- -- -- --
Net loss -- -- -- -- -- (2,420)
-----------------------------------------------------------------------------
Comprehensive loss
Balance at
December 31, 1997 -- -- 13,593,594 136 31,218 3,114
Issuance of common stock
pursuant to
exercise
of stock options -- -- 90,527 2 506 --
Issuance of common stock
in connection
with employee
stock purchase plan -- -- 52,771 -- 406 --
Compensation expense
associated with stock
issuance -- -- -- -- 47 --
Translation adjustment -- -- -- -- -- --
Net loss -- -- -- -- -- (4,717)
-----------------------------------------------------------------------------
Comprehensive loss
Balance at
December 31, 1998 -- $ -- 13,736,892 $138 $32,177 $(1,603)
=============================================================================
Notes
Cumulative receivable Total
translation Treasury from stockholders' Comprehensive
Adjustment stock stockholders equity income (loss)
----------- ----------- ------------ ------------ --------------
Balance at
December 31, 1995 $ -- $ (4) $ (795) $ 943
Purchase of
treasury stock -- (2,527) 795 (1,732)
Sale of common stock,
net of issuance costs -- -- -- 24,070
Conversion of preferred
stock into common stock -- -- -- 4,008
Issuance of common stock
pursuant to
exercise of stock options -- -- -- 9
Compensation expense
associated with stock
issuance -- -- -- 126
Issuance of common stock
pursuant to
purchased
research and development -- -- -- 144
Retirement of treasury
stock -- 2,531 -- --
Net income -- -- -- 4,262 $ 4,262
-----------------------------------------------------------------------------------------------
Comprehensive income 4,262
========
Balance at
December 31, -- -- -- 31,830
1996
Purchase of -- -- -- --
treasury stock
Compensation expense
associated
with stock
issuance -- -- -- 45
Issuance of common stoc
pursuant to
exercise
of stock -- -- -- 204
options
Issuance of common stoc
in connection
with employee
stock purchase -- -- -- 479
plan
Issuance of common stoc
in connection
with
acquisition
of IPC -- -- -- 4,330
Interactive,
Pte. Ltd.
Translation 14 -- -- 14 14
adjustment
Net loss -- -- -- (2,420) (2,420)
-----------------------------------------------------------------------------------------------
Comprehensive loss (2,406)
========
Balance at
December 31, 14 -- -- 34,482
1997
Issuance of common
stock pursuant to
exercise
of stock -- -- -- 508
options
Issuance of common stock
in connection
with employee
stock purchase -- -- -- 406
plan
Compensation expense
associated
with stock
issuance -- -- -- 47
Translation (73) -- -- (73) (73)
adjustment
Net loss -- -- -- (4,717) (4,717)
------------------------------------------------------------------------------------------------
Comprehensive loss (4,790)
========
Balance at
December 31, $(59) $ -- $ -- $30,653 $(4,790)
1998
================================================================================================
The accompanying notes are an integral part of these Consolidated Financial Statements.
F-4
SeaChange International, Inc.
Consolidated Statement of Cash Flows
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (IN THOUSANDS)
Year ended December 31,
----------------------------------
1996 1997 1998
-------- -------- --------
Cash flows from operating activities
Net income (loss) $ 4,262 $ (2,420) $ (4,717)
Adjustments to reconcile net income (loss) to net cash used
in operating activities:
Depreciation and amortization 1,436 2,802 4,789
Inventory valuation allowance 694 1,730 2,016
Compensation expense associated with stock and stock options 126 45 47
Write-off of acquired in-process research and development -- 5,290 --
Research and development expense associated with common
stock issuance 144 -- --
Deferred income taxes (424) (516) (876)
Changes in assets and liabilities, net of the effect of the
acquisition of IPC Interactive Pte. Ltd. in 1997:
Accounts receivable (4,091) (4,381) (6,440)
Inventories (9,134) (7,069) (4,376)
Income taxes receivable -- (1,131) (986)
Prepaid expenses and other assets (468) (339) (591)
Accounts payable 4,165 (1,164) 1,265
Accrued expenses (126) (109) 656
Customer deposits 817 (3,260) (345)
Deferred revenue 1,425 1,273 1,644
Income taxes payable (720) 85 390
-------- -------- --------
Net cash used in operating activities (1,894) (9,164) (7,524)
-------- -------- --------
Cash flows from investing activities
Purchase of software (450) -- --
Purchases of property and equipment (2,792) (2,158) (3,766)
Proceeds from sale and maturity of marketable securities -- 8,966 10,212
Purchases of marketable securities -- (18,276) (902)
Cash acquired related to the acquisition of IPC Interactive
Pte. Ltd., net of transaction costs -- 665 --
-------- -------- --------
Net cash provided by (used in) investing activities (3,242) (10,803) 5,544
-------- -------- --------
Cash flows from financing activities
Proceeds from borrowings under equipment line of credit -- -- 1,226
Proceeds from borrowings under line of credit -- -- 2,000
Repayment of line of credit -- (700) --
Repayment of obligation under capital lease -- -- (18)
Proceeds from sale of common stock, net 24,079 683 914
Purchase of treasury stock (2,023) -- --
Notes payable to related parties -- (437) --
Repayments of loans from stockholders 290 -- --
-------- -------- --------
Net cash provided by (used in) financing activities 22,346 (454) 4,122
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 17,210 (20,421) 2,142
Cash and cash equivalents, beginning of year 6,184 23,394 2,973
-------- -------- --------
Cash and cash equivalents, end of year $ 23,394 $ 2,973 $ 5,115
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
SeaChange International, Inc.
Consolidated Statement of Cash Flows
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (IN THOUSANDS)
Year ended December 31,
----------------------------------
1996 1997 1998
-------- -------- --------
Supplemental disclosure of cash flow information:
Income taxes paid $ 3,854 $ 1,691 $ 132
Interest paid $ -- $ -- $ 35
Supplemental disclosure of noncash activity:
Transfer of items originally classified as inventories to
fixed assets $ 1,726 $ 1,829 $ 584
Transfer of items originally classified as fixed assets to
inventories $ -- $ -- $ 668
Purchase of treasury stock in lieu of cash payment of notes
receivable from stockholders $ 505 $ -- $ --
Equipment acquired under capital lease $ -- $ -- $ 374
Acquisition of all of the outstanding shares of IPC
Interactive Pte. Ltd. (Note 5):
Fair value of assets acquired (including intangible
assets and in-process research and development) -- $ 12,396 --
Fair value of common shares issued -- (4,330) --
Transaction costs -- (475) --
-------- -------- --------
Liabilities assumed -- $ 7,591 --
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
SeaChange International, Inc.
Notes to Consolidated Financial Statements
1. Nature of Business
The Company develops computer systems to digitally manage, store and
distribute video. Through December 31, 1998, substantially all of the
Company's revenues were derived from the sale of digital video insertion,
movie and broadcast systems and related services and content to cable
television operators, broadcast and telecommunications companies in the
United States and internationally.
2. Summary of Significant Accounting Policies
Significant accounting policies followed in the preparation of the
accompanying consolidated financial statements are as follows:
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All significant intercompany accounts and
transactions have been eliminated.
Revenue Recognition
Revenues from the sales of systems are recognized upon shipment provided
that there are no uncertainties regarding customer acceptance and collection
of the related receivables is probable. If such uncertainties exist, such
as performance criteria beyond the Company's standard terms and conditions,
revenue is recognized upon customer acceptance. Installation and training
revenue is deferred and recognized as these services are performed. Revenue
from technical support and maintenance contracts is deferred, if billed in
advance, and recognized ratably over the period of the related agreements,
generally twelve months. Revenue from content fees, primarily movies, is
recognized in the period earned based on noncancelable agreements. Customer
deposits represent advance payments from customers for systems.
Concentration of Credit Risk
Financial instruments which potentially expose the Company to concentrations
of credit risk include trade accounts receivable and marketable securities.
To minimize this risk, the Company evaluates customers' financial condition,
requires advance payments from certain of its customers and maintains
reserves for potential credit losses. At December 31, 1997 and 1998, the
Company had an allowance for doubtful accounts of $559,000 and $870,000,
respectively, to provide for potential credit losses and such losses to date
have not exceeded management's expectations. The Company invests its excess
cash in marketable securities, such as money market funds and municipal
securities with strong credit ratings.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from these estimates.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with an
original maturity of three months or less at the date of purchase to be cash
equivalents. The Company invests its excess cash in money market funds,
municipal securities and corporate debt securities that are subject to
minimal credit and market risk. Cash equivalents are classified as
available-for-sale and are carried at market value, and any unrealized gains
or losses are recorded as a part of stockholders' equity.
F-7
SeaChange International, Inc.
Notes to Consolidated Financial Statements (continued)
Property and Equipment
Property and equipment consist of office and computer equipment, leasehold
improvements, demonstration equipment, deployed assets and spare components
and assemblies used to service the Company's installed base. Demonstration
equipment consists of systems manufactured by the Company for use in
marketing and selling activities. Property and equipment are recorded at
cost and depreciated using the straight-line method over their estimated
useful lives. Leasehold improvements are amortized over the shorter of
their estimated useful lives or the term of the respective leases by use of
the straight-line method. Deployed assets consist primarily of hardware
owned and operated by the Company and installed at customer locations.
Deployed assets are depreciated over the life of the related service
agreements ranging from 3 to 7 years. Maintenance and repair costs are
expensed as incurred. Significant improvements are capitalized and
depreciated. Upon retirement or sale, the cost of the assets disposed of,
and the related accumulated depreciation, are removed from the accounts, and
any resulting gain or loss is included in the determination of net income.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined
using the first-in, first-out (FIFO) method. Inventories consist primarily
of components and subassemblies and finished products held for sale. Rapid
technological change and new product introductions and enhancements could
result in excess or obsolete inventory. To minimize this risk, the Company
evaluates inventory levels and expected usage on a periodic basis and
records valuation allowances as required.
The Company is dependent upon certain vendors for the manufacture of
significant components of its digital advertising insertion, movie and
broadcast systems. If these vendors were to become unwilling or unable to
continue to manufacture these products in required volumes, the Company
would have to identify and qualify acceptable alternative vendors. The
inability to develop alternate sources, if required in the future, could
result in delays or reductions in product shipments and thereby adversely
affect the Company's revenue and profits.
Goodwill and Intangible Assets
Goodwill and assembled workforce are amortized on a straight-line basis over
five to seven years. Software acquired in connection with acquisitions is
amortized over the greater of the amount computed using (a) the ratio that
current gross revenues for related products bear to total current and
anticipated future gross revenues for that product or (b) on a straight-line
basis over the estimated remaining life of the software. The Company
reviews goodwill and intangible assets for any impairment in accordance with
Statement of Financial Accounting Standards No. 121, Accounting for
Impairment of Long-Lived Assets to be Disposed Of, ("SFAS 121").
Research and Development and Software Development Costs
Costs incurred in the research and development of the Company's products are
expensed as incurred, except for certain software development costs. Costs
associated with the development of computer software are expensed prior to
establishing technological feasibility and capitalized thereafter until the
product is released for sale. Software development costs eligible for
capitalization to date have not been material to the Company's financial
statements. Costs associated with acquired software rights are capitalized
if technological feasibility of the software has been established.
Stock Compensation
Employee stock awards under the Company's compensation plans are accounted
for in accordance with Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, ("APB 25") and related
interpretations. The Company provides the disclosure requirements of
Statement of Financial Accounting Standards No. 123, Accounting for Stock-
Based Compensation, ("SFAS 123") and related interpretations. Nonemployee
stock awards are accounted for in accordance with Emerging Issues Task Force
Issue No. 96-18.
F-8
SeaChange International, Inc.
Notes to Consolidated Financial Statements (continued)
Foreign Currency Translation
The Company has determined that the functional currency of its foreign
subsidiaries is the local currency. Accordingly, assets and liabilities are
translated to U.S. dollars at current exchange rates as of each balance
sheet date. Income and expense items are translated using average exchange
rates during the year. Cumulative currency translation adjustments are
presented as a separate component of stockholders' equity. Transaction
gains and losses and unrealized gains and losses on intercompany receivables
are recognized in the Statement of Operations and have not been material to
date.
Advertising Costs
Advertising costs are charged to expense as incurred. Advertising costs
were $328,000, $659,000 and $624,000 for the years ended December 31, 1996,
1997 and 1998, respectively.
Earnings Per Share
Earnings per share are presented in accordance with Statement of Financial
Accounting Standards No. 128, Earnings Per Share, ("SFAS 128") which
requires the presentation of "basic" earnings per share and "diluted"
earnings per share. Basic earnings per share is computed by dividing income
available to common shareholders by the weighted-average shares of common
stock outstanding during the period. For the purposes of calculating
diluted earnings per share the denominator includes both the weighted
average number of shares of common stock outstanding during the period and
the weighted average number of potential common stock, such as stock options
and restricted stock.
For the years ended December 31, 1997 and 1998, 468,311 and 240,644 common
shares issuable upon the exercise of stock options, respectively, and
2,661,825 and 1,194,488 shares of unvested restricted common stock,
respectively, are antidilutive because the Company recorded a net loss for
the years and, therefore, have been excluded from the diluted earnings per
share computations.
Below is a summary of the shares used in calculating basic and diluted
earnings per share for the years indicated:
Year ended December 31,
---------------------------------
1996 1997 1998
---------- ---------- ----------
Weighted average number of shares
outstanding 5,187,993 10,276,711 12,420,397
Shares attributable to series A redeemable
convertible preferred stock 1,476,000 - -
Shares attributable to series B redeemable
convertible preferred stock 568,607 - -
Shares attributable to unvested restricted
common stock 4,109,925 - -
Dilutive stock options 403,341 - -
---------- ---------- ----------
Shares used in calculating diluted
earnings per share 11,745,866 10,276,711 12,420,397
========== ========== ==========
New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities, ("SFAS 133"). SFAS 133 will become
effective in January 2000. SFAS 133 requires that all derivative
instruments be recorded on the balance sheet at their fair value. Changes
in the fair value of derivatives are recorded each period in current
earnings or other comprehensive income,
F-9
SeaChange International, Inc.
Notes to Consolidated Financial Statements (continued)
depending on whether a derivative is designated as part of a hedge
transaction and, if it is, the type of hedge transaction. To date the
Company has not utilized derivative instruments or hedging activities and,
therefore, the adoption of SFAS 133 is not expected to have a material
impact on the Company's financial position or results of operations.
3. Consolidated Balance Sheet Detail
Cash, cash equivalents and marketable securities consist of the following:
December 31,
----------- ----------
1997 1998
----------- ----------
Cash and cash equivalents:
Cash $ 917,000 $2,090,000
Money market funds 506,000 2,005,000
Municipal securities 1,550,000 1,020,000
----------- ----------
2,973,000 5,115,000
Marketable securities:
Municipal securities 9,310,000 --
----------- ----------
$12,283,000 $5,115,000
=========== ==========
Marketable securities are classified as available-for-sale securities and
are carried at fair market value, which approximates amortized cost. The
contractual maturities of all available-for-sale securities classified as
cash equivalents are less than three months. Gross unrealized gains and
losses on securities for the years ended December 31, 1996, 1997 and 1998,
the cost of which is based upon the specific identification method, were not
significant.
Inventories consist of the following:
December 31,
------------------------
1997 1998
----------- -----------
Components and assemblies $11,932,000 $14,592,000
Finished products 1,781,000 1,565,000
----------- -----------
$13,713,000 $16,157,000
=========== ===========
Property and equipment consist of the following:
Estimated December 31,
useful life ----------- -----------
(years) 1997 1998
----------- ----------- -----------
Office furniture and equipment 5 $ 1,332,000 $ 1,565,000
Computer and demonstration equipment 3 8,140,000 9,089,000
Deployed assets 3-7 497,000 1,788,000
Service and spare components 5 2,000,000 2,584,000
Leasehold improvements 1-7 304,000 758,000
----------- -----------
12,273,000 15,784,000
Less -- Accumulated depreciation and amortization 3,970,000 7,803,000
----------- -----------
$ 8,303,000 $ 7,981,000
=========== ===========
F-10
SeaChange International, Inc.
Notes to Consolidated Financial Statements (continued)
Depreciation expense was $1,246,000, $2,515,000 and $3,833,000 for the years
ended December 31, 1996, 1997 and 1998, respectively.
Accrued expenses consist of the following:
December 31,
------------------------
1997 1998
----------- -----------
Accrued software license fees $ 630,000 $1,206,000
Accrued sales and use taxes 338,000 733,000
Other accrued expenses 1,750,000 1,435,000
---------- ----------
$2,718,000 $3,374,000
========== ==========
4. Segment Information
The Company has four reportable segments: digital advertising insertion,
movies and broadcast systems and services. The digital advertising
insertion systems segment provides products to digitally manage, store and
distribute digital video for television operators and telecommunications
companies. The movie systems segment comprises products to provide long-
form video storage and delivery for the pay-per-view markets for the
hospitality and commercial property markets. The broadcast systems segment
provides products for the storage, archival, on-air playback of advertising
and other video programming for the broadcast television industry. The
service segment provides installation, training, product maintenance and
technical support for the above systems and content which is distributed by
the movie product segment. The accounting policies of the segments are the
same as those described in the summary of significant accounting policies.
The Company does not measure the assets allocated to the segments. The
Company measures results of the segments based on the respective gross
profits. There were no intersegment sales or transfers. Long-lived assets
are principally located in the United States. The following summarizes the
revenues and cost of revenues by reportable segment:
Year ended December 31,
---------------------------------------------------------------
1996 1997 1998
--------------- ---------------- ------------------
Revenues
Digital advertising insertion $45,513 $55,977 $44,088
Movies 232 4,437 9,722
Broadcast - - 4,223
Services 3,521 7,473 13,737
--------------- ---------------- ------------------
$49,266 $67,887 $71,770
--------------- ---------------- ------------------
Costs of revenues
Digital advertising insertion $26,901 $32,356 $26,551
Movies 232 2,384 6,801
Broadcast - - 2,420
Services 4,030 7,607 13,241
--------------- ---------------- ------------------
$31,163 $42,347 $49,013
--------------- ---------------- ------------------
F-11
SeaChange International, Inc.
Notes to Consolidated Financial Statements (continued)
The following summarizes revenues by geographic locations:
Year ended December 31,
---------------------------------------------------------------
1996 1997 1998
--------------- ---------------- ------------------
Revenues
United States $46,875 $59,855 $62,343
Canada and South America - 2,696 691
Europe 2,391 4,481 4,272
Rest of world - 855 4,464
--------------- ---------------- ------------------
$49,266 $67,887 $71,770
=============== ================ ==================
For the years ended December 31, 1996, 1997 and 1998, certain customers
accounted for more than 10% of the Company's revenues. Individual customers
accounted for 29%, 17%, 13% and 12% of revenues in 1996; 24%, 18% and 10% in
1997; and 24% and 15% in 1998.
5. Acquisition and Restructuring of Operations
Acquisition
On December 10, 1997, the Company exchanged 625,000 shares of its common
stock for all of the outstanding capital stock of IPC Interactive Pte. Ltd.
("IPC") which was renamed to SeaChange Asia Pacific Operations Pte. Ltd.
("SC Asia"). SC Asia provides interactive television network systems to the
hospitality and commercial property markets. The total purchase price,
including transaction costs, was $4,805,000. The acquisition was accounted
for under the purchase method. Accordingly, the purchase price was
allocated to the estimated fair value of the acquired assets and liabilities
based upon an independent appraisal. A portion of the purchase price was
allocated to in-process research and development, resulting in an immediate
charge to the Company's operations of $5,290,000 at the date of
acquisition. The amount allocated to in-process research and development
represented technology which had not reached technological feasibility and
had no alternative future use. The appraisal also valued intangibles,
including assembled workforce and software. Goodwill and intangibles, net
of related accumulated amortization totaled $1,608,000 and $1,197,000 at
December 31, 1997 and 1998, respectively. Amortization expense was $27,000
and $411,000 for the years ended December 31, 1997 and 1998, respectively.
The consolidated results of operations include the operating results of IPC
from the date of acquisition.
The purchase price was allocated to the acquired assets and liabilities
as follows:
Tangible assets $ 5,471,000
Assumed liabilities (7,591,000)
Intangible assets:
In-process research and development 5,290,000
Software 850,000
Assembled workforce 280,000
Goodwill 505,000
-----------
$ 4,805,000
===========
F-12
SeaChange International, Inc.
Notes to Consolidated Financial Statements (continued)
Included in assumed liabilities were a line of credit of $700,000 and notes
payable to related parties of $437,000. The notes payable to related
parties were due to two companies owned by new shareholders of the Company
as a result of the acquisition. The Company paid these assumed liabilities
in full and canceled the line of credit prior to December 31, 1997.
The following unaudited pro forma data summarizes the consolidated results
of the Company and IPC as if the acquisition had occurred on February 1,
1996 (inception of IPC) and excludes the $5,290,000 charge for in-process
research and development. The unaudited pro forma information is not
necessarily indicative either of results of operations that would have
occurred had the purchase been made at the beginning of the periods
presented, or of future results of operations of the combined companies.
Pro forma for the year ended December 31,
-----------------------------------------
1996 1997
----------- ------------
(unaudited) (unaudited)
Revenues $60,372,000 $75,573,000
Net income (loss) $ 1,085,000 $(3,403,000)
Basic earnings (loss) per share $ .19 $ (.31)
Diluted earnings (loss) per share $ .09 $ (.31)
Restructuring of Operations
In March 1998, the Company recorded a charge of $676,000 for the
restructuring of operations as part of a planned consolidation of the
operations of SC Asia. The charge for restructuring included $569,000
related to the termination of 13 employees, a provision of $60,000 related
to the planned vacating of premises and $47,000 of compensation expense
associated with stock options for certain terminated employees. At March 31,
1998, the Company had notified all terminated employees. All restructuring
charges were paid as of December 31, 1998.
6. Lines of Credit
The Company has a $6.0 million revolving line of credit and a $3.0 million
equipment line of credit with a bank. The revolving line of credit expires
in October 1999 and the equipment line of credit expires in June 1999.
Borrowings under the lines of credit are secured by substantially all of the
Company's assets. Loans made under the revolving line of credit generally
bear interest at a rate per annum equal to the bank's base rate plus .5%
(8.25 % at December 31, 1998). Loans made under the equipment loan bear
interest at a rate per annum equal to the bank's base rate plus 1.0% (8.75%
at December 31, 1998). The loan agreement relating to the lines of credit
requires that the Company provide the bank with certain periodic financial
reports and comply with certain financial ratios including the maintenance
of total liabilities, excluding deferred revenue, to net worth of at least
.80 to 1.0. At December 31, 1998 the Company was in compliance with all
covenants. As of December 31, 1998, borrowings against the line of credit
were $2.0 million. As of December 31, 1998, borrowings against the equipment
line of credit were $1,226,000. Maturities of the equipment line of credit
are $491,000, $491,000 and $244,000 in 1999, 2000 and 2001, respectively.
F-13
SeaChange International, Inc.
Notes to Consolidated Financial Statements (continued)
7. Income Taxes
The components of the provision (benefit) for income taxes are as follows:
Year ended December 31,
--------------------------------------
1996 1997 1998
---------- ---------- -----------
Current provision (benefit):
Federal $2,346,000 $1,920,000 $(1,913,000)
State 561,000 371,000 -
---------- ---------- -----------
2,907,000 2,291,000 (1,913,000)
---------- ---------- -----------
Deferred benefit:
Federal (324,000) (394,000) (124,000)
State (100,000) (121,000) (752,000)
---------- ---------- -----------
(424,000) (515,000) (876,000)
---------- ---------- -----------
$2,483,000 $1,776,000 $(2,789,000)
========== ========== ===========
The components of deferred income taxes are as follows:
December 31,
-------------------------
1997 1998
----------- -----------
Deferred tax assets:
Inventories $ 769,000 $ 1,299,000
Allowance for doubtful accounts 209,000 320,000
Deferred revenue 96,000 126,000
Software 176,000 111,000
Accrued expenses - 153,000
State net operating loss carryforwards - 398,000
Acquired net operating loss carryforwards and
basis differences 3,361,000 3,361,000
----------- -----------
4,611,000 5,768,000
Valuation allowance (3,361,000) (3,361,000)
----------- -----------
Total deferred tax assets 1,250,000 2,407,000
----------- -----------
Deferred tax liabilities:
Property and equipment 157,000 430,000
Other 2,000 10,000
----------- -----------
Total deferred tax liabilities 159,000 440,000
----------- -----------
Net deferred income taxes $ 1,091,000 $ 1,967,000
=========== ===========
Deferred income taxes reflect the tax impact of temporary differences
between the amount of assets and liabilities for financial reporting
purposes and such amounts as measured by tax laws and regulations. Under
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes", the benefit associated with future deductible temporary differences
is recognized if it is more likely than not that the benefit will be
realized. The measurement of deferred tax assets is reduced by a valuation
allowance if, based upon the weight of available evidence, it is more likely
than not that some or all of the deferred tax assets will not be realized.
The valuation allowance of $3,361,000 at December 31, 1997 and 1998 relates
to net operating loss carryforwards and tax basis differences acquired in
the Company's purchase of SC Asia. These acquired deferred tax assets may
only be utilized to offset future taxable income attributable to SC Asia.
In addition, the recognition of these deferred tax assets are subject to
Internal Revenue Code change in ownership rules which may limit the amount
that can be utilized to offset future taxable income. The Company believes
that the valuation allowance is appropriate given the weight of objective
evidence, including the historical operating results of IPC. Any tax
benefits subsequently recognized related to these assets will first reduce
the remaining balance in goodwill and then other acquired intangible assets.
F-14
SeaChange International, Inc.
Notes to Consolidated Financial Statements (continued)
Based on the weight of available evidence, the Company believes its
remaining deferred tax assets will be realizable. The amount of the
deferred tax asset considered realizable is subject to change based on
future events. The Company will assess the need for the valuation allowance
at each balance sheet date based on all available evidence.
At December 31, 1998, the Company had federal and state net operating loss
carryforwards of approximately $11,278,000 which expire at various dates
through 2013 and foreign net operating loss carryforwards of approximately
$1,436,000 which do not expire.
The income tax provision computed using the federal statutory income tax
rate differs from the Company's effective tax rate primarily due to the
following:
Year ended December 31,
-------------------------------------
1996 1997 1998
---------- ---------- -----------
Statutory U.S. federal tax rate $2,293,000 $ (91,000) $(2,552,000)
State taxes, net of federal tax benefits 304,000 165,000 (496,000)
Other - 145,000 355,000
Research and development tax credits (135,000) (334,000) (316,000)
Foreign Sales Corporation exempt income (20,000) - -
Nondeductible expenses, including write-off of
acquired in-process research and
development in 1997 41,000 1,891,000 220,000
---------- ---------- -----------
$2,483,000 $1,776,000 $(2,789,000)
========== ========== ===========
The Company's effective tax rate was 36.8% in 1996. The Company's effective
tax rate for 1997 was significantly impacted by the write-off of acquired
in-process research and development which, due to the tax-free nature of the
transaction to IPC stockholders, is not deductible for tax purposes by the
Company. Accordingly, in 1997 the Company recorded a tax provision of
$1,776,000 despite a book pre-tax operating loss. The Company's effective
tax benefit rate was 37.2% in 1998.
8. Common Stock
Initial Public Offering
On November 5, 1996, the Company sold 1,810,000 shares of common stock to
the public in the Company's initial public offering at a price of $15.00 per
share. Proceeds to the Company, net of offering expenses, amounted to
$24,070,000. Upon the closing of the initial public offering all outstanding
convertible preferred stock of the Company automatically converted into a
total of 2,260,856 shares of common stock of the Company.
Stock Split
On September 6, 1996, the Board of Directors authorized a 3-for-2 stock
split of the Company's common stock, which became effective on October 30,
1996. All shares of common stock, common stock options, preferred stock
conversion ratios and per share amounts included in the accompanying
consolidated financial statements have been adjusted to give retroactive
effect to the stock split for 1996.
F-15
SeaChange International, Inc.
Notes to Consolidated Financial Statements (continued)
Restriction Agreements
Certain common shares are subject to stock restriction and repurchase
agreements under which the Company may repurchase unvested common shares at
the original issuance price and vested common shares at fair value upon
termination of a business relationship with the Company. Common shares
subject to these agreements vest ratably over a five-year period and, at
December 31, 1998, 652,500 of such shares are unvested.
Treasury Stock
In January 1996, the Company repurchased 431,250 shares of its common stock
and 1,286 shares of Series A Stock from certain employees and directors of
the Company. Of the common stock repurchased, 21,750 shares were held by
the stockholders for less than six months from the time the shares became
vested. Accordingly, compensation expense was recorded for the difference
between the repurchase price and the original purchase price paid by the
stockholders. Compensation expense recorded as a result of this transaction
was $91,000. In December 1996, the Board of Directors voted to retire all
shares of treasury stock held at December 31, 1996.
In 1997, the Company repurchased 9,000 shares of its common stock from an
employee of the Company. The shares were held for less than six months from
the time the shares became vested. Accordingly, compensation expense was
recorded for the difference between the repurchase price and the original
purchase price paid by the stockholder. Compensation expense recorded in
1997 as a result of this transaction was $45,000.
Reserved Shares
At December 31, 1998, the Company had 2,008,895 shares of common stock
reserved for issuance upon the exercise of common stock options and the
purchase of stock under the Employee Stock Purchase Plan.
9. Convertible Preferred Stock
Stock Authorization
The Board of Directors is authorized to issue from time to time up to an
aggregate of 5,000,000 shares of preferred stock, in one or more series.
Each such series of preferred stock shall have the number of shares,
designations, preferences, voting powers, qualifications and special or
relative rights or privileges to be determined by the Board of Directors,
including dividend rights, voting rights, redemption rights and sinking fund
provisions, liquidation preferences, conversion rights and preemptive
rights.
10. Stock Plans
Employee Stock Purchase Plan
In September 1996, the Company's Board of Directors adopted and the
stockholders approved an employee stock purchase plan (the "Stock Purchase
Plan"), effective January 1, 1997, which provides for the issuance of a
maximum of 300,000 shares of common stock to participating employees who
meet eligibility requirements. Employees who would immediately after the
grant own 5% or more of the total combined voting power or value of the
Company's stock and directors who are not employees of the Company may not
participate in the Stock Purchase Plan. The purchase price of the stock is
85% of the lesser of the average market price of the common stock on the
first or last business day of each six-month plan period. During 1997 and
1998, 29,361 and 52,771 shares of common stock, respectively, were issued
under the Stock Purchase Plan.
F-16
SeaChange International, Inc.
Notes to Consolidated Financial Statements (continued)
1995 Stock Option Plan
The 1995 Stock Option Plan (the "1995 Stock Option Plan") provides for the
grant of incentive stock options and nonqualified stock options for the
purchase of up to an aggregate of 1,950,000 shares of the Company's common
stock by officers, employees, consultants and directors of the Company. The
Board of Directors is responsible for administration of the 1995 Stock
Option Plan and determining the term of each option, option exercise price,
number of shares for which each option is granted and the rate at which each
option is exercisable. Options generally vest ratably over five years. The
Company may not grant an employee incentive stock options with a fair value
in excess of $100,000 that are initially exercisable during any one calendar
year.
Incentive stock options may be granted to employees at an exercise price per
share of not less than the fair value per common share on the date of the
grant (not less than 110% of the fair value in the case of holders of more
than 10% of the Company's voting stock). Nonqualified stock options may be
granted to any officer, employee, director or consultant at an exercise
price per share as determined by the Company's Board of Directors.
Options granted under the 1995 Stock Option Plan generally expire ten years
from the date of the grant (five years for incentive stock options granted
to holders of more than 10% of the Company's voting stock).
Director Stock Option Plan
In June 1996, the Company's Board of Directors adopted and the stockholders
approved a director stock option plan (the "Director Option Plan") which
provides for the grant of options to full time directors of the Company to
purchase a maximum of 30,000 shares of common stock under the Director
Option Plan. Under the Director Option Plan, participating directors
receive an option to purchase 3,375 shares of common stock per annum.
Options granted under the Director Option Plan vest as to 33-1/3% of the
shares underlying the option immediately upon the date of the grant, and
vest as to an additional 8-1/3% of the shares underlying the option at the
end of each of the next 8 quarters, provided that the optionee remains a
director. Directors will also receive, on each three-year anniversary of
such director's option grant date, an additional option to purchase 3,375
shares of common stock, provided that such director continues to serve on
the Board of Directors. All options granted under the Director Option Plan
have an exercise price equal to the fair value of the common stock on the
date of grant and a term of ten years from the date of grant.
Transactions under the 1995 Stock Option Plan and the Director Option Plan
during the years ended December 31, 1996, 1997 and 1998 are summarized as
follows:
F-17
SeaChange International, Inc.
Notes to Consolidated Financial Statements (continued)
Year ended December 31,
-----------------------------------------------------------
1996 1997 1998
----------------- ------------------- ------------------
Weighted Weighted Weighted
average average average
exercise exercise exercise
Shares price Shares price Shares price
-------- -------- --------- --------- --------- --------
Outstanding at
beginning of period 327,120 $ .92 739,334 $ 5.87 1,143,057 $11.40
Granted 472,510 8.79 585,536 18.03 889,729 7.43
Exercised (9,223) .85 (88,999) 2.30 (90,752) 5.56
Cancelled (51,073) 2.22 (92,814) 17.81 (532,818) 14.98
======== ========= =========
Outstanding at
period end 739,334 $5.87 1,143,057 $11.40 1,409,216 $ 8.01
======== ========= =========
Options exercisable
at period end 115,224 205,198 315,643
Weighted average fair value
of options granted
during the period $4.33 $11.00 $ 9.72
The following table summarizes information about employee and director stock
options outstanding at December 31, 1998:
Options outstanding at December 31, 1998
--------------------------------------------
Weighted
average
remaining Weighted
Number contractual average
outstanding life (years) exercise price
-------------- ------------ --------------
Range of exercise prices
$ .50 59,328 6.65 $ 0.50
1.23 to 1.36 101,121 3.88 1.31
4.20 to 6.00 415,513 9.51 5.76
6.67 to 9.38 643,382 8.92 8.24
10.19 to 15.00 105,683 8.56 11.51
15.50 to 21.50 22,314 8.30 19.33
28.75 to 33.75 61,875 7.75 28.96
--------------
1,409,216
==============
Options exercisable at December 31, 1998
------------------------------------------
Weighted
Number average
Range of exercise prices exercisable exercise price
$0.50 31,621 $ 0.50
1.23 to 1.36 57,651 1.31
4.20 to 6.00 41,849 4.96
6.67 to 9.38 127,986 7.92
10.19 to 15.00 27,516 11.34
15.50 to 21.50 6,833 19.32
28.75 to 33.75 22,187 28.95
----------
315,643
==========
Fair Value Disclosures
The Company applies APB 25 in accounting for employee stock awards.
Compensation expense of $126,000, $45,000 and $47,000 has been recorded for
the years ended December 31, 1996, 1997 and 1998, respectively. Had
compensation expense for the Company's employee stock plans been determined
based on the fair value at the grant dates, as prescribed in SFAS 123, the
Company's net income (loss) and earnings (loss) per share would have been as
follows:
F-18
SeaChange International, Inc.
Notes to Consolidated Financial Statements (continued)
Year ended December 31,
-------------------------------------
1996 1997 1998
---------- ----------- -----------
Net income (loss)
As reported $4,262,000 $(2,420,000) $(4,717,000)
Pro forma $4,205,000 $(3,290,000) $(6,601,000)
Basic earnings (loss) per share
As reported $ .82 $ (.24) $ (.38)
Pro forma $ .81 $ (.32) $ (.53)
Diluted earnings (loss) per share
As reported $ .36 $ (.24) $ (.38)
Pro forma $ .36 $ (.32) $ (.53)
For options granted prior to the Company's initial filing of its
Registration Statement on Form S-1 on September 18, 1996, the fair value of
each option grant was estimated on the date of grant using the minimum value
method. The fair value of each option granted subsequent to the initial
filing was estimated on the date of grant assuming a weighted average
volatility factor of 67%. Additional weighted average assumptions used for
grants during the years ended December 31, 1996, 1997 and 1998 included:
dividend yield of 0.0% for all periods; risk-free interest rates of 5.36% to
6.49% for options granted during the year ended December 31, 1996, 5.70% to
6.75% for options granted during the year ended December 31, 1997 and 6.00%
for options granted during the year ended December 31, 1998; and an expected
option term of 5 years for all periods.
Because additional option grants are expected to be made each year, the
above pro forma disclosures are not representative of pro forma effects of
reported net income for future years.
Stock Option Repricing
On January 23, 1998, the Compensation and Option Committee of the Board of
Directors of the Company ("Committee") determined that, because certain
stock options held by employees of the Company had an exercise price
significantly higher than the fair market value of the Company's common
stock, such stock options were not providing the desired incentive to
employees. Accordingly, the Committee granted those employees whose options
were between $15.00 and $24.63 per share an opportunity to cancel their
existing options for new options on a 1-for-1 basis, with a new five-year
vesting schedule beginning on January 23, 1998. Employees whose options were
above $24.63 were offered an opportunity to cancel their existing options
for new options on a 2-for-3 basis, with no change in their original vesting
schedule. As a result of this stock option repricing, new options were
granted to purchase 212,779 shares of common stock and the average exercise
price of such options was reduced from $22.19 per share to $8.25 per share,
the fair market value of the Company's common stock at the close of the
market on January 22, 1998. With the exception of one executive officer, the
Company's directors and executive officers were not eligible to participate
in this stock option repricing. During the execution of the stock option
repricing plan, the Company's stock price was below $8.25 per share and,
therefore, no compensation charge was recorded as a result of the stock
option repricing.
11. Commitments
The Company leases its operating facilities and certain office equipment
under noncancelable capital and operating leases which expire at various
dates through 2005. Rental expense under operating leases was approximately
$251,000,
F-19
SeaChange International, Inc.
Notes to Consolidated Financial Statements (continued)
$542,000 and $1,294,000 for the years ended December 31, 1996,
1997 and 1998, respectively. Future commitments under minimum lease
payments as of December 31, 1998 are as follows:
Capital Operating
Year ended December 31, 1999 $ 90,000 $1,460,000
2000 90,000 1,402,000
2001 90,000 1,143,000
2002 90,000 675,000
2003 66,000 524,000
Thereafter - 649,000
--------
Minimum lease payments 426,000
Less: Amount representing interest 70,000
--------
$356,000
--------
The Company had noncancelable purchase commitments for inventories of
approximately $3,000,000 at December 31, 1998.
In the ordinary course of business, the Company is subject to various types
of litigation. In the opinion of management, all litigation currently
pending or threatened will not have a material adverse effect on the
Company's financial position or results of operations.
12. Employee Benefit Plan
The Company sponsors a 401(k) retirement savings plan ( the "Plan").
Participation in the Plan is available to full-time employees who meet
eligibility requirements. Eligible employees may contribute up to 15% of
their annual salary, subject to certain limitations. The Company matches
contributions up to 25% of the first 6% of compensation contributed by the
employee to the Plan. During 1997 and 1998, the Company contributed $68,000
and $189,000, respectively, to the Plan. Prior to 1997, the Company did not
make contributions to the Plan.
F-20
SEACHANGE INTERNATIONAL, INC.
REPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULE
To the Board of Directors
of SeaChange International, Inc.
Our audits of the consolidated financial statements referred to in our report
dated January 29, 1999 appearing on page F-1 of this Form 10-K also included an
audit of the Financial Statement Schedule listed in Item 14 (a)(2) of this Form
10-K. In our opinion, this Financial Statement Schedule presents fairly, in all
material respects, the information set forth therein when read in conjunction
with the related consolidated financial statements.
PricewaterhouseCoopers LLP
Boston, Massachusetts
January 29, 1999
S-1
Schedule II
SEACHANGE INTERNATIONAL, INC.
VALUATION OF QUALIFYING ACCOUNTS AND RESERVES
Balance at Charged to
beginning of costs and Deductions and Balance at end
period expenses write-offs Other of period
-------------------- ----------------- --------------------- ------------- ----------------
Allowance for Doubtful Accounts:
Year ended December 31, 1996 $ 40,000 $ 133,000 $ - $ - $ 173,000
Year ended December 31, 1997 173,000 485,000 (174,000) 75,000 559,000
Year ended December 31, 1998 $ 559,000 $ 497,000 $ (186,000) $ - $ 870,000
Inventory Valuation Allowance:
Year ended December 31, 1996 $ 56,200 $ 693,800 $ - $ - $ 750,000
Year ended December 31, 1997 750,000 1,730,000 (1,076,000) 100,000 1,504,000
Year ended December 31, 1998 $1,504,000 $2,016,000 $ (919,000) $ - $2,601,000
S-2