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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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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 January 31, 2002
Commission File Number: 0-21393
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SEACHANGE INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
Delaware 04-3197974
(State or other (IRS Employer
jurisdiction of Identification No.)
incorporation or
organization)
124 Acton Street, Maynard, MA 01754
(Address of principal executive offices, including zip code)
(978)-897-0100
(Registrant's telephone number, including area code)
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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
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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 preceding 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 April 24, 2002 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
$269,535,524. The number of shares of the registrant's Common Stock outstanding
as of the close of business on April 24, 2002 was 26,549,558.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the definitive Proxy Statement in connection with the Annual
Meeting of Stockholders to be held on or about July 17, 2002 to be filed
pursuant to Regulation 14A are incorporated by reference into Part III of this
Form 10-K.
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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
We are a leading developer, manufacturer and marketer of systems, known as
video storage servers, that automate the management and distribution of
long-form video streams, such as movies or other feature presentations, and
short-form video streams, such as advertisements. We sell our products and
services to cable system operators, including Adelphia, AOL Time Warner, AT&T,
Cablevision, Charter Communications, Comcast and Cox Communications;
telecommunications companies, including Qwest; and broadcast television
companies, including The Ackerley Group, Echostar, Group W Broadcasting and
United Pan-Europe Corporation. We believe that our digital video systems enable
our customers to differentiate their service offerings to reduce subscriber
turnover and access new revenue generating opportunities from subscribers,
advertisers and electronic commerce initiatives. Using our systems, we believe
our customers can increase their revenues by offering additional services such
as video-on-demand movies and subscription video-on-demand programming, both of
which allow subscribers to watch content at any time with pause, rewind and
fast forward features. Our systems also allow our customers to insert targeted
advertising segments, known as spot advertising, into their local cable
programming. In addition, our systems enable cable system operators to offer
other interactive television services that allow subscribers to customize
and/or dynamically interact with their television viewing experience in a
manner similar to that experienced with the use of a personal computer.
Our digital video systems provide enhanced storage and retrieval
capabilities, multi-channel content delivery and highly automated information
and order processing. These technologies provide a foundation for products that
can be deployed in next generation systems capable of increased levels of
subscriber interactivity. Our technologies and systems mitigate the effects of
electronic signal dispersion and offer higher image quality and greater
reliability than analog tape based systems. We have received several awards for
technological excellence, including an Emmy Award in 2001 for our patented
MediaCluster technology.
Our broadband or high bandwidth network segment includes our ITV System
which digitally manages, stores and distributes digital video, allowing cable
system operators and telecommunications companies to offer video-on-demand and
other interactive television services, including interactive electronic
advertising and retrieval of Internet content through the television. Our ITV
System can be deployed in either a residential environment or a hotel
environment to deliver a wide variety of video services. The ITV System
delivers video-on-demand and other guest services, Internet access and personal
computer games in the hotel environment, and our movie system provides
long-form video storage and delivery for the pay-per-view movie markets. Since
2000, we have been selected to supply our ITV System in 22 domestic and
international commercial deployments of video-on-demand systems, including
deployments by five of the top seven cable system operators in the United
States. We test and integrate our ITV System with the digital set top boxes, or
hardware devices used to receive and unscramble television signals, of such
manufacturers as Scientific Atlanta, Motorola, Pace, Pioneer and Sony
Corporation.
In addition to our ITV System, our broadband business segment includes our
SPOT System, which is a system for the transmission of video content, known as
a video insertion system, for digital advertisements and other short-form
video. Based on currently available industry sources and our internal data, we
believe our SPOT System is the leading video insertion system in the United
States in the multi-channel television market for digital advertisements and
other short-form video. Our system converts analog video forms such as
advertisements and news updates to digital video forms, stores the digital
video forms in remote or local storage
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devices known as digital libraries, and inserts them automatically into
television network streams. The SPOT System provides high accuracy relative to
the volume of video being played and high video image quality, and permits
geographic and demographic specificity of advertisements. We believe our SPOT
System reduces operating costs by automating the management and distribution
process. Our Advertising Management Software product operates with our SPOT
System to automate and simplify complex sales, scheduling and billing processes
for the multi-channel television market. A majority of our customers for these
products consist of major cable system operators and telecommunications
companies in the United States. To date we have sold SPOT Systems to support
over 30,000 channels throughout the world. We believe that the capabilities of
our SPOT System will position us well as the opportunities to distribute
advertisements into a wide variety of digital media platforms and the market
for interactive advertising continues to increase.
Our broadcast network business segment includes our Broadcast MediaCluster
System, which allows broadcast television companies to directly transmit
content, such as commercials and other programming for broadcast television
companies, to their viewers through either single, multi-channel or satellite
based delivery systems. We believe that our Broadcast MediaCluster System will
eliminate the need for analog tape libraries and provide broadcasters with the
automated storage and playback features that they require. Since 1998, we have
installed our Broadcast MediaCluster System at customer locations including
network affiliates and multi-channel operations in the United States, Europe
and the Far East.
Industry Background
Cable System Operators and Telecommunications Companies
The number of cable subscribers has been estimated at 80 million in the
United States and 330 million worldwide. Over the last several years, cable
system operators have spent billions of dollars to upgrade their networks from
analog to digital, yielding a significant increase in available bandwidth,
channel capacity and two-way capability. We believe this investment by the
cable system operators reflects their commitment to video-on-demand,
advertising insertion, Internet access and other value added services, and
differentiates cable system operators from competing service providers such as
satellite delivery systems.
Video-on-demand represents a new opportunity for cable system operators. The
increased channel capacity through the installation of fiber optic cables has
provided many cable system operators with the capacity to offer video-on-demand
services to residential cable subscribers. In 2001, cable system operators and
telecommunications companies began the deployment of residential
video-on-demand, which allows subscribers to watch video programming at any
time with pause, rewind and fast forward capabilities. Six of the seven largest
cable system operators have begun deploying video-on-demand services in one or
more residential markets. The first application offered by cable system
operators has been movies on demand. Other applications in development include
subscription video-on-demand, news, sports and weather on demand, personal
video recording, targeted advertising for video-on-demand and music video and
audio on demand.
In addition, because cable television programming is sent over broadband, or
high bandwidth, networks, cable system operators have the opportunity to
segment and target their programming to viewers in selected geographies. We
believe that the ability of cable system operators to target viewers will
extend to personal targeting of advertisements to specific individuals. In
addition, 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, allows
advertisers to target viewers demographically. Despite this advantage over
television broadcasters, cable system operators historically have not realized
advertising revenues in proportion to their share of television viewers.
According to industry sources, in 2001, 35% of all television viewers were
watching ad-supported cable networks, yet cable television advertising revenue
accounted for only 23% of the total television advertising revenue. As cable
system operators gain the ability to target individual customers with
advertisements, we believe the amount of revenue derived by cable system
operators from advertising will increase.
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Increased demand for video and audio content over the Internet will also
require a substantial increase in storage capacity and bandwidth over time. We
believe that cable system operators and telecommunications companies will play
an integral role in providing these broadband Internet applications. We also
believe that in order to offer high quality video applications over the
Internet, cable system operators and telecommunications companies will need
storage and distribution products capable of complex management and scheduling
of video data streams.
Television Broadcasters
Both domestically and internationally, broadcast stations face many of the
same technological issues as cable system operators. Additionally, television
broadcasters rely on advertising for nearly all of their revenue and require
high accuracy and image quality relative to the volume of video being played.
The majority of television broadcasters utilize 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 videotapes in these systems need to be replaced frequently due to
repeated use.
Many television broadcasters are using digital bandwidth to originate
multiple program streams. As this application further develops, television
broadcasters will require more video storage and delivery systems that can
effectively manage and deliver these multiple television signals. In addition,
we believe that television broadcasters will continue to automate their entire
programming to reduce overall operating costs and improve reliability.
The SeaChange Solution
We are a leading developer, manufacturer and marketer of systems, known as
video storage servers, that automate the management and distribution of
long-form video streams, such as movies or other feature presentations, and
short-form video streams, such as advertisements. We market our products and
services to cable system operators, telecommunications companies and broadcast
television companies. Our solutions are based on the following four core areas
of functionality:
. storage and retrieval of video content to and from digital libraries;
. automated distribution of video streams between digital libraries by
means of local and wide area data networks;
. delivery of video streams over single and multiple channels; and
. management of video sales, scheduling, billing and execution of related
business transactions.
We use these core areas of functionality to provide solutions to a number of
commercial markets and are focused on providing solutions to meet the
opportunities demanded by next generation systems with increased levels of
subscriber interactivity. Our systems are designed to provide a consistent set
of features and benefits, including:
. Viewer Targeting. Our digital video products enable cable system
operators to efficiently target viewers in specific demographic or
geographic groups. We believe this allows operators to capitalize on new
revenue generating opportunities from subscribers and advertisers. Using
our ITV System, cable system operators are able to offer interactive
television services to individual residences or hotel rooms and, with our
SPOT System, operators can better target digital advertisement campaigns.
. Scalability. Our products are scalable in both video storage and video
output stream capacity. Our proprietary technology, including our
patented single-copy storage system, allows a single copy of content to
be streamed through all available outputs without the need for
duplication of content or re-routing between servers on the system. Our
storage technology and distributed architecture results in a highly
scalable system that reduces operational complexity and yields storage
and bandwidth
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efficiencies as the amount of available content and the number of
subscribers increase. Our products are scalable to the needs of our
customers whether operating in a single channel system concentrated in
one specific zone or a system with hundreds of channels serving multiple
markets and a large number of users within each market.
. Interoperability. Our products have been designed to be compatible with
a wide range of hardware systems and software applications used by cable
system operators to deliver their digital video offerings. These include
set top boxes from Motorola, Scientific Atlanta, Sony, Pioneer and Pace,
a variety of programming guides including TV Guide, Passport and
Worldgate, billing systems, service delivery systems and interactive
application control software.
. Automation. Our automated system allows cable system operators to
distribute and manage content without significant human intervention. We
believe this automation also allows our customers to minimize operating
personnel and equipment requirements resulting in cost savings and lower
ongoing operating costs.
. Reliability. Through the use of our proprietary storage technology and
application software and low-cost standard computer industry components,
our products are designed to be fault resilient, with no single point of
failure, providing the high reliability required for television and
video-on-demand operations.
Strategy
Our objective is to be the leader in the market for the storage, management
and distribution of professional quality digital video for the television
marketplace. The key elements of our strategy are to:
. Maintain and Extend Long-term Customer Relationships. We focus our
product development, marketing and direct sales efforts on maintaining
and extending long-term customer relationships with cable system
operators, telecommunications companies and television broadcasters in
the United States and internationally. We have formed important
relationships with customers by initially providing solutions such as
advertisement and other short-form video insertion, and we have extended
these relationships to include video-on-demand systems and other
interactive television services. We believe that the fundamental shift
from broadcast to on-demand video and the growing emphasis on interactive
technologies will continue to present opportunities for us to develop,
market and support our solutions to both our existing customer base and
to customers in additional markets.
. Offer Integrated Solutions. Our customers operate complex networks that
require the delivery and management of video programming across multiple
channels and target zones. We believe that cable system operators desire
solutions that can integrate all steps of digital video delivery, from
scheduling to post-air verification and billing, and that can
interoperate with existing and emerging third-party equipment and
software. To address these needs, we intend to continue to provide and
further develop, internally and with our partners, integrated
applications and support services for our customers. We believe that
providing complete integrated solutions has been a significant factor in
our success and will be an increasingly important competitive advantage.
. Establish and Maintain Technological Leadership. We believe our
competitive position is dependent in a large part on the features and
performance of our integrated systems. As a result, we focus our research
and development efforts on introducing systems with improved hardware and
software capabilities. We have been granted a patent for our single-copy
storage technology and have other patents pending. We have received
several awards for technological excellence, including an Emmy Award in
2001 for our patented MediaCluster storage technology.
. Provide Superior Customer Service and Support. Our products operate in
customer environments where continuous operation is critical. As a
result, we believe that providing a high level of service and support
give us a competitive advantage and is a differentiating factor in
developing and maintaining
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key customer relationships. Our in-depth industry and application
knowledge allows us to better understand the service needs of our
customers. As of January 31, 2002, over 35% of our 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 our 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.
Products
Broadband Products
SeaChange ITV System
We have developed and are deploying a video-on-demand system for sale to
cable television companies and other telecommunications companies. Our ITV
System consists of:
. our video storage servers which reside at headends or nodes in a cable
system and are used to play out or stream videos as requested;
. our Command Center control software to manage and control the system;
. our advertising systems hardware and software; and
. interfaces to digital headend modulators, control systems and subscriber
management systems.
Our ITV System currently allows our customers to offer the following
interactive services:
. Video-on-Demand. This interactive service allows residential users and
hotel guests to review lists of available movies, order individual movies
and view them in real time. Using this service, subscribers gain full
control over the video stream, including pause, fast-forward and rewind
functions. Billing is typically done through the subscriber's normal
cable bill, and movie choices are refreshed on a regular basis.
. Subscription Video-on-Demand. This interactive service provides premium
channel offerings, such as those offered by HBO, Showtime or Cinemax, in
an on-demand manner, as well as on a scheduled basis. Similar to our
video-on-demand interactive service described above, our subscription
video-on-demand service allows subscribers to review lists of available
premium channel content, order individual programs and watch them at home
with full video cassette recorder-like control over the video stream. As
in video-on-demand, billing flows through the normal cable bill.
In addition, our ITV System is designed to support the following
interactive services that are currently being developed by cable system
operators:
. Personal Time Television. This interactive service will provide users
with some level of control over live television, allowing users to gain
access to up to date program information, full video cassette
recorder-like control over the video stream, and the ability to watch one
program while recording another. This personal time television service,
using our servers and software located in cable company headends, will
provide functionality competitive with that provided by personal video
recorders, such as TiVo or Ultimate TV, to record television programs for
later viewing. The personal time television interactive service will
allow cable companies to offer time shifting and live television control
to their subscribers without the customers having to purchase a video
cassette recorder or personal video recorder.
. Targeted and Interactive Advertising. This interactive service will
support interactive advertising, or advertising where the subscriber
controls the path and delivery of an advertisement, in a personal time
television interactive service and in other forms of programming that
result in a dedicated
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communications link between that subscriber's set top box and the
video-on-demand system itself. This service will be competitive with
those provided by direct marketing and direct mail firms and may allow
purchases over the television, such as one might do with a web browser
over the Internet.
. Personalized News, Sports and Weather. This interactive service will
allow individual clips of video content to be aggregated into larger
segments, or even into programs. This service will allow cable system
operators to offer a service where information programs, such as news,
sports or weather, are customized to reflect a subscriber's personal
needs. We believe this business will allow cable system operators to gain
revenue from subscription fees and to provide a feature that cannot be
easily duplicated by satellite or broadcast television systems, resulting
in increased customer loyalty to the cable company.
The delivery of these current and anticipated interactive services
utilizes both our hardware and software through the following steps:
. Customer Selection. When a customer selects from their set top box a
video title to view, a message is transmitted from the set top box to our
video server system located at the headend of the cable system.
. Video Selection Execution. Our video server system receives the video
title request and retrieves the selection from the storage disk, which is
a compressed digital video file. Our software determines if the title has
space for advertising, and if so, retrieves the commercial content files
as well. The video files are loaded on the video server, which then
executes the files.
. Transmission to the Customer. A network management device assesses the
best route along the operator's network to deliver the video selection.
The video file is delivered to a modulator, which formats the video file
so that it can be delivered across the broadband network. The video file
is then delivered back to the customer's set top box.
. Customer Viewing. The set top box receives the video file and decrypts
the signal and delivers it to the television for viewing. The software in
the set top box provides the subscriber with the functionality of a
traditional video cassette recorder, allowing the customer to pause,
fast-forward and rewind the video file. Some set top boxes have storage
capabilities that enable the customer to store the video file for an
extended period of time.
. Billing. Content consumption records are kept by our software, and on a
regular basis, records of the movies, programs and commercials viewed are
exported to appropriate billing systems.
SeaChange SPOT System
Our SPOT System automates the complex process of advertisement and other
video insertion across multiple channels and geographic zones for cable
system operators and telecommunications companies. Through our embedded
proprietary software, our SPOT System allows cable system 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. Our SPOT System is also capable of inserting
advertising into digital cable channels and delivering targeted advertising,
as well as advertising with interactive links to content on the ITV System,
as well as other interactive advertising systems.
Our SPOT System is an integrated solution composed of software
applications, hardware platforms, data networks and easy to use graphical
interfaces. Our SPOT System is designed to be installed at local cable
transmission sites, known as headends, and advertising sales business
offices. Our video insertion process consists of six steps:
. Encoding. The process begins with our encoding software which in real
time transforms and compresses analog to digital short-and long-form
video.
. Storage. Our SPOT System organizes, manages and stores these video
streams in a disk-based video library capable of storing thousands of
spots.
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. Scheduling. Our 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. Our strategic digital video software then copies the video
files from the master video library and distributes them over the
operator's data network to appropriate headends, where they are stored in
video servers for future play.
. Insertion. Following a network cue, our video switch module
automatically inserts the video stream into the network feed (initiating
the analog conversion, if necessary), where they are then seen by
television viewers.
. Verification. After the video streams run, our proprietary software and
hardware verifies the content, accuracy, timing and placement of these
video streams to facilitate proper customer billing.
SeaChange Advertising Management Software
Our Advertising Management Software product, referred to in the past as
our Traffic and Billing Software product, is designed to permit cable system
operators to manage advertising sales, scheduling, packaging and billing
operations. This product provides management performance reports, inventory
management and optimization, interactive linkage construction, billing and
accounts receivable management. Our Advertising Management Software product
works with our SPOT System, our ITV System and with many other broadcast
automation systems.
Broadcast Products
SeaChange Broadcast MediaCluster System
Our Broadcast MediaCluster System is currently composed of three to seven
individual video servers arranged in a cluster acting as one system. This
system is designed to provide high quality, digital 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, movies and other programming from video tape cart systems
and, in some cases, to replace the cart systems themselves. Our Broadcast
MediaCluster System is designed for customers both in larger broadcast
television markets, which use station automation systems, and in smaller
markets, which use control software included in the system.
As with the ITV System in the broadband segment, our Broadcast
MediaCluster System is designed to simultaneously record, encode, store to a
disk and play video content using 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. Our Broadcast MediaCluster System
has features that enable the broadcaster to have end to end functionality
and reliability, including one feature that enables broadcasters to schedule
its programming for a week of television content.
Customer Service and Support
We install, maintain and support our products in North America, Asia, South
America and Europe. We offer basic and advanced formal on-site training for
customer employees. We currently provide installation, maintenance and support
to international customers and also provide movie content in conjunction with
sales of our ITV System to hotels. We offer technical support to customers,
agents and distributors on a 24-hour, seven-day a week basis. Our systems sales
always include at least one year of free maintenance.
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Customers
We currently sell our products primarily to cable system operators,
broadcast and telecommunications companies.
Our 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 our revenues in any given
fiscal period have been derived from substantial orders placed by these large
organizations. In the year ended December 31, 1999, the one month ended January
31, 2000, the year ended January 31, 2001, and the year ended January 31, 2002
revenues from our five largest customers represented approximately 47%, 47%,
44% and 58%, respectively, of our total revenues. Customers accounting for more
than 10% of total revenues consisted of AT&T Media Services (15%) and Time
Warner (10%) in 1999; AT&T Media Services (16%) and Time Warner (11%) in the
one month ended January 31, 2000; Time Warner (12%) and Cox Communications
(10%) in the year ended January 31, 2001; and Time Warner (20%), Comcast (15%)
and Cablevision (11%) in the year ended January 31, 2002. We expect that we
will continue to be dependent upon a limited number of customers for a
significant portion of our revenues in future periods. As a result of this
customer concentration, our 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. In addition, the concentration of customers may make variations
in revenue, expenses and operating results due to seasonality of orders more
pronounced.
We believe that our backlog at any particular time is not meaningful as an
indicator of our future level of sales for any particular period. Because of
the nature of our products and our use of standard components, substantially
all of the backlog at the end of a quarter can be manufactured by us and is
intended to be shipped by the end of the following quarter. However, because of
the requirements of particular customers these backlogs may not be shipped or,
if shipped, the related revenues may not be recognized in that quarter.
Therefore, there is no direct correlation between the backlog at the end of any
quarter and our total sales for the following quarter or other periods.
Selling and Marketing
We sell and market our products in the United States primarily through a
direct field sales organization and internationally through direct sales and
independent agents and distributors, complemented by a coordinated marketing
effort of our marketing group. Direct sales activities in the United States are
conducted from our Massachusetts headquarters and seven field offices. In
October 1996, we entered into an exclusive sales and marketing services
agreement with a private Italian company to provide these services throughout
continental Europe. We also market certain of our products to systems
integrators and value-added resellers.
In light of the complexity of our digital video products, we primarily
employ a consultative direct sales process. Working closely with customers to
understand and define their needs enables us to obtain better information
regarding market requirements, enhance our expertise in our customers'
industries, and more effectively and precisely convey to customers how our
solutions address the customer's specific needs. In addition to the direct
sales process, customer references and visits by potential customers to sites
where our products are in place are often critical in the sales process.
We use several marketing programs focused on our targeted markets to support
the sale and distribution of our products. We use exhibitions at a limited
number of prominent industry trade shows and conferences and presentations at
technology seminars to promote awareness of us and our products. We also
publish technical articles in trade and technical journals and promotional
product literature.
Research and Product Development
Our management believes that our success will depend to a substantial degree
upon our ability to develop and introduce in a timely fashion new products and
enhancements to our existing products that meet changing
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customer requirements in our current and new markets. We have in the past made,
and intend to continue to make, substantial investments in product and
technological development. Through our direct sales process we monitor changing
customer needs, changes in the marketplace and emerging industry standards, and
are therefore better able to focus our research and development efforts to
address these evolving industry requirements.
Our research and development expenditures totaled approximately $16.3
million, $1.8 million, $20.3 and $23.4 million for the year ended December 31,
1999, the one month ended January 31, 2000, the year ended January 31, 2001,
and the year ended January 31, 2002, respectively. At January 31, 2002, 151
employees were engaged in research and product development. We believe that the
experience of our product development personnel is an important factor in our
success. We perform our research and product development activities at our
headquarters and in offices in Greenville, New Hampshire; Atlanta, Georgia; and
Fort Washington, Pennsylvania. We have historically expensed our direct
research and development costs as incurred.
In December 1999, we enhanced our research and development capabilities
through the acquisition of Digital Video Arts, Ltd., a developer of custom
software products specializing in digital video and interactive television.
Manufacturing
Our 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. Our 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. We rely on
independent contractors to manufacture components and subassemblies to our
specifications. Each of our products undergoes testing and quality inspection
at the final assembly stage.
Competition
The markets in which we compete are characterized by intense competition,
with a large number of suppliers providing different types of products to
different segments of the markets. In new markets for our products, we compete
principally based on price. In markets in which we have an established
presence, we compete principally on the basis of the breadth of our products'
features and benefits, including the flexibility, scalability, professional
quality, ease of use, reliability and cost effectiveness of our products, and
our reputation and the depth of our expertise, customer service and support.
While we believe that we currently compete favorably overall with respect to
these factors and that our ability to provide solutions to manage, store and
distribute digital video differentiates us from our competitors, in the future
we may not be able to continue to compete successfully with respect to these
factors.
In the market for long-form video products including video-on-demand, we
compete with various companies offering video server platforms such as
Concurrent Computer Corp., nCube and Diva Systems Corp. In the television
broadcast market, we compete against Grass Valley Group, Inc., Pinnacle
Systems, Inc., Sony Corporation and Leitch Incorporated. In the digital
advertisement insertion market, we generally compete only with nCube (formerly
SkyConnect, Inc.). In addition, our 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. We expect
the competition in each of these markets to intensify in the future.
Many of our current and prospective competitors have significantly greater
financial, technical, manufacturing, sales, marketing and other resources than
us. As a result, these competitors may be able to devote greater resources to
the development, promotion, sale and support of their products than us.
Moreover, these
10
companies may introduce additional products that are competitive with ours or
enter into strategic relationships to offer complete solutions, and in the
future our products may not be able to compete effectively with these products.
Proprietary Rights
Our success and our ability to compete is dependent, in part, upon our
proprietary rights. We have been granted one U.S. patent for our MediaCluster
technology and have filed a foreign patent application for the same technology.
We also have other patent applications in process for extensions of our
existing technology and for other technologies. In addition, we rely on a
combination of contractual rights, trademark laws, trade secrets and copyright
laws to establish and protect our proprietary rights in our products. It is
possible that in the future not all of these patents will be issued or that, if
issued, the validity of these patents would be upheld. It is also possible that
the steps taken by us to protect our intellectual property will be inadequate
to prevent misappropriation of our technology or that our competitors will
independently develop technologies that are substantially equivalent or
superior to our technology. In addition, the laws of some foreign countries in
which our products are or may be distributed do not protect our proprietary
rights to the same extent as do the laws of the United States.
Employees
As of January 31, 2002, we employed 446 persons, including 151 in research
and development, 155 in customer service and support, 44 in selling and
marketing, 62 in manufacturing and 34 in finance and administration. We believe
that our relations with our employees are good.
11
CERTAIN RISK FACTORS THAT MAY AFFECT OUR BUSINESS
Our future success is dependent on the development of the emerging
video-on-demand market and if video-on-demand does not gain broad market
acceptance, our business may not grow as we have planned.
While our revenue growth to date has been primarily from sales of our
digital advertisement insertion products and related services, we believe our
future revenue growth will come predominately from sales and services related
to our video-on-demand products. The video-on-demand market is in the emerging
stages of development and involves a limited number of cable system operators.
The success of this market requires that cable system operators, particularly
the seven largest domestic cable system operators, continue to upgrade their
cable networks to support digital two-way transmission service and successfully
market video-on-demand and similar services to their cable television
subscribers. Cable system operators have only begun commercial deployment of
video-on-demand service to residential cable subscribers within the past year
and, accordingly, to date our digital video systems have been commercially
available only to a limited number of subscribers. As a result, the ability of
our digital video systems to support a substantial number of subscribers is
commercially unproven. If cable system operators fail to make the capital
expenditures necessary to upgrade their networks or determine that broad
deployment of video-on-demand services is not viable as a business proposition
or if our digital video systems cannot support a substantial number of
subscribers while maintaining a high level of performance, our revenues will
not grow as we have planned.
Because our customer base is highly concentrated among a limited number of
large customers, the loss of or reduced demand of these customers could have a
material adverse effect on our business, financial condition and results of
operations.
Our 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 our revenues in any year. Our five largest customers
have accounted for approximately half of our revenues in each of the past five
years. We generally do not have written continuing purchase agreements with our
customers and do not generally have written agreements that require customers
to purchase fixed minimum quantities of our products. Our sales to specific
customers tend to vary significantly from year to year depending upon these
customers' budgets for capital expenditures and new product introductions. We
believe that a significant amount of our revenues will continue to be derived
from a limited number of large customers. The loss of, or reduced demand for
products or related services from, any of our major customers could have a
material adverse effect on our business, financial condition and results of
operations.
Cancellation or deferral of purchases of our products could cause our operating
results to be below the expectations of the public market stock analysts who
cover our stock, resulting in a decrease in the market price of our common
stock.
We derive a substantial portion of our revenues from products that have a
selling price in excess of $200,000. Therefore, any significant cancellation or
deferral of purchases of our products could have a material adverse effect on
our business, financial condition and results of operations in any particular
quarter due to the resulting decrease in revenue and our relatively fixed
costs. In addition, to the extent significant sales occur earlier than
expected, operating results for subsequent quarters may be adversely affected
because our expense levels are based, in part, on our expectations as to our
future revenues, and we may be unable to adjust spending in a timely manner to
compensate for any revenue shortfall. Because of these factors, in some future
quarter our operating results may be below the expectations of public market
analysts and investors which may adversely affect the market price of our
common stock.
Seasonal trends may cause our quarterly operating results to fluctuate, making
period-to-period comparisons of our operating results meaningless.
We have experienced significant variations in the revenue, expenses and
operating results from quarter to quarter and these variations are likely to
continue. We believe that fluctuations in the number of orders being
12
placed from quarter to quarter are principally attributable to the buying
patterns and budgeting cycles of cable system operators and broadcast
companies, the primary buyers of the digital advertising systems and broadcast
systems, respectively. We expect that there will continue to be fluctuations in
the number and value of orders received. As a result, our results of operations
have in the past and likely will, at least in the near future, fluctuate in
accordance with this purchasing activity making period-to-period comparisons of
our operating results meaningless. In addition, because these factors are
difficult for us to forecast, our business, financial condition and results of
operations for one quarter or a series of quarters may be adversely affected
and below the expectations of public market analysts and investors, resulting
in a decrease in the market price of our common stock.
Due to the lengthy sales cycle involved in the sale of our products, our
quarterly results may vary and should not be relied on as an indication of
future performance.
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 these 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 our digital
video, movie and broadcast products is typically lengthy and subject to a
number of significant risks, including customers' budgetary constraints and
internal acceptance reviews, over which we have little or no control. Based
upon all of the foregoing, we believe that our quarterly revenues, expenses and
operating results are likely to vary significantly in the future, that
period-to-period comparisons of our results of operations are not necessarily
meaningful and that, in any event, these comparisons should not be relied upon
as indications of future performance.
If there were a decline in demand or average selling prices for our broadband
products, including our ITV System and SPOT System, our revenues would be
materially affected.
We expect our broadband products to continue to account for a significant
portion of our revenues. Accordingly, a decline in demand or average selling
prices for our broadband products, 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 our business, financial condition and results of operations.
If we are unable to manage our growth and the related expansion in our
operations effectively, our business may be harmed through a decreased ability
to monitor and control effectively our operations, and a decrease in the
quality of work and innovation of our employees.
Our ability to successfully offer products and services and implement our
business plan in a rapidly evolving market requires effective planning and
management. Not only are we growing in size, but we are also continuing to
transition towards greater reliance on our video-on-demand products for an
increased portion of our revenue. Our growth has placed, and our anticipated
future operations will continue to place, a significant strain on our
management, administrative, operational and other resources. To manage future
growth effectively, we must continue to improve our management and operational
controls, enhance our reporting systems and procedures, integrate new personnel
and manage expanded operations. A failure to manage our growth may harm our
business through a decreased ability to monitor and control effectively our
operations, and a decrease in the quality of work and innovation of our
employees upon which our business is dependent.
13
If content providers, such as movie studios, limit the scope of content
licensed for use in the digital video-on-demand market, our business, financial
condition and results of operations could be negatively affected because the
market for our products would be more limited than we currently believe and
have communicated to the financial markets.
The success of the video-on-demand market is contingent on content
providers, such as movie studios, permitting their content to be licensed for
use in this market. Content providers may, due to concerns regarding either or
both marketing and illegal duplication of the content, limit the extent to
which they provide content to the video-on-demand market. A limitation of
content for the video-on-demand market would indirectly limit the market for
our ITV System which is used in connection with that market.
If we are unable to successfully introduce to our marketplace new products or
enhancements to existing products, our financial condition and operating
results may be adversely affected by a decrease in purchases of our products.
Because our business plan is based on technological development in the form
of both development of new products and enhancements to our existing products,
our future success is dependent on our successful introduction to the
marketplace of these products and enhancements. In the future we may experience
difficulties that could delay or prevent the successful development,
introduction and marketing of these and other new products and enhancements, or
find that our new products and enhancements do not adequately meet the
requirements of the marketplace or achieve market acceptance. Announcements of
currently planned or other new product offerings may cause customers to defer
purchasing our existing products. Moreover, despite testing by us and by
current and potential customers, errors or failures may be found in our
products, and, even if discovered, may not be successfully corrected in a
timely manner. These errors or failures could cause delays in product
introductions and shipments, or require design modifications that could
adversely affect our competitive position. Our inability to develop new
products or enhancements on a timely basis or the failure of these new products
or enhancements to achieve market acceptance could have a material adverse
effect on our business, financial condition and results of operations.
Because we purchase certain of the components used in manufacturing our
products from sole suppliers and we use a limited number of third party
manufacturers to manufacture our products, our business, financial condition
and results of operation could be materially adversely affected by a failure of
these suppliers or manufacturers.
Certain key components of our products are currently purchased from a sole
supplier, including a computer chassis manufactured by Trimm Technologic Inc.,
a different computer chassis manufactured by JMR Electronics, Inc., an
interface controller video transmission board manufactured by Cyclone
Microsystems, Inc., a switch chassis manufactured by Ego Systems, a decoder
card manufactured by Vela Research, Inc. and an encoder card manufactured by
Optibase, Inc. We have in the past experienced quality control problems, where
products did not meet specifications or were damaged in shipping, and delays in
the receipt of these components. These problems were generally of short
duration and did not have a material adverse effect on us. However, we may in
the future experience similar types of problems which could be more severe or
more prolonged. While we believe that there are alternative suppliers available
for these components, we believe that the procurement of these components from
alternative suppliers could take up to four months. In addition, these
alternative components may not be functionally equivalent or may be unavailable
on a timely basis or on similar terms. 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 our business, financial condition
and results of operations.
In addition, we rely on a limited number of third parties who manufacture
certain components used in our products. While to date there has been suitable
third party manufacturing capacity readily available at acceptable quality
levels, in the future there may not be manufacturers that are able to meet our
future volume or quality
14
requirements at a price that is favorable to us. Any financial, operational,
production or quality assurance difficulties experienced by these third party
manufacturers that result in a reduction or interruption in supply to us could
have a material adverse effect on our business, financial condition and results
of operations.
If we are unable to successfully compete in our marketplace, our financial
condition and operating results may be adversely affected.
We currently compete against both computer companies offering video server
platforms and more traditional analog video playback systems. In the digital
advertisement insertion market, we compete against suppliers of both analog
tape-based and digital systems.
Due to the rapidly evolving markets in which we compete, 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 our business, financial condition and
results of operations. Many of our current and potential competitors have
greater financial, selling and marketing, technical and other resources than we
do. Moreover, our competitors may also foresee the course of market
developments more accurately than we. Although we believe that we have certain
technological and other advantages over our competitors, realizing and
maintaining these advantages will require a continued high level of investment
by us in research and product development, marketing and customer service and
support. In the future we may not have sufficient resources to continue to make
these investments or to make the technological advances necessary to compete
successfully with our existing competitors or with new competitors.
If we are unable to compete effectively, our business, prospects, financial
condition and operating results would be materially adversely affected because
of the difference in our operating results from the assumptions on which our
business model is based.
If we fail to respond to rapidly changing technologies related to digital
video, our business, financial condition and results of operations would be
materially adversely affected because the competitive advantage of our products
relative to those of our competitors would decrease.
The markets for our 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 us or reduce the cost of existing
products or services, any of which could enable our existing or potential
customers to fulfill their video needs better and more cost efficiently than
with our products. Our future success will depend on our ability to enhance our
existing digital video products, including the development of new applications
for our technology, and to develop and introduce new products to meet and adapt
to changing customer requirements and emerging technologies. In the future, we
may not be successful in enhancing our digital video products or developing,
manufacturing and marketing new products which satisfy customer needs or
achieve market acceptance. In addition, there may be services, products or
technologies developed by others that render our products or technologies
uncompetitive, unmarketable or obsolete, or announcements of currently planned
or other new product offerings either by us or our competitors that cause
customers to defer or fail to purchase our existing solutions.
Our ability to compete could be jeopardized if we are unable to protect our
intellectual property rights from third-party challenges.
Our success and ability to compete depends upon our ability to protect our
proprietary technology that is incorporated into our broadband and broadcast
products. We rely on a combination of patent, copyright, trademark and trade
secret laws and restrictions on disclosure to protect our intellectual property
rights. Although we have one issued patent, we cannot assure you that any
additional patents will be issued or that the issued
15
patent will not be invalidated. We also enter into confidentiality or license
agreements with our employees, consultants and corporate partners, and control
access to and distribution of our software, documentation and other proprietary
information.
Despite these precautions, it may be possible for a third party to copy or
otherwise misappropriate and use our products or technology without
authorization, particularly in foreign countries where the laws may not protect
our proprietary rights as fully as in the United States. We may need to resort
to litigation in the future to enforce our intellectual property rights, to
protect our trade secrets or to determine the validity and scope of the
proprietary rights of others. If competitors are able to use our technology,
our ability to compete effectively could be harmed.
We have been and in the future could become subject to litigation regarding
intellectual property rights, which could seriously harm our business and
require us to incur significant costs.
In recent years, there has been significant litigation in the United States
involving patents and other intellectual property rights. We have been and
currently are involved in significant intellectual property litigation, and we
may be a party to litigation in the future to enforce our intellectual property
rights or as a result of an allegation that we infringe others' intellectual
property. Any parties asserting that our products infringe upon their
proprietary rights would force us to defend ourselves and possibly our
customers or manufacturers against the alleged infringement. These claims and
any resulting lawsuit, if successful, could subject us to significant liability
for damages and invalidation of our proprietary rights. These lawsuits,
regardless of their success, would likely be time-consuming and expensive to
resolve and would divert management time and attention away from our operations.
Although we carry general liability insurance, our insurance may not cover
potential claims of this type or may not be adequate to indemnify us for all
liability that may be imposed. In addition, any potential intellectual property
litigation also could force us to stop selling, incorporating or using the
products that use the infringed intellectual property or obtain from the owner
of the infringed intellectual property right a license to sell or use the
relevant technology, although this license may not be available on reasonable
terms, or at all, or redesign those products that use the infringed
intellectual property. If we are forced to take any of the foregoing actions,
our business may be seriously harmed. You should refer to ''Legal Proceedings''
for a more detailed description of intellectual property litigation relating to
our MediaCluster technology.
Because our business is susceptible to risks associated with international
operations, we may not be able to maintain or increase international sales of
our products.
International sales have accounted for approximately 15% to 20% of our
revenues in each of the past five years. We expect that international sales
will account for a significant portion of our business in the future. However,
in the future we may be unable to maintain or increase international sales of
our products. International sales are subject to a variety of risks, including:
. difficulties in establishing and managing international distribution
channels;
. difficulties in selling, servicing and supporting overseas products and
in translating products into foreign languages;
. the uncertainty of laws and enforcement in certain countries relating to
the protection of intellectual property;
. multiple and possibly overlapping tax structures;
. currency and exchange rate fluctuations; and
. economic or political changes in international markets.
16
Future acquisitions may be difficult to integrate, disrupt our business, dilute
stockholder value or divert management attention.
As part of our business strategy, we may seek to acquire or invest in
businesses, products or technologies that we believe could complement or expand
our business, augment our market coverage, enhance our technical capabilities
or otherwise offer growth opportunities. Acquisitions could create risks for
us, including:
. difficulties in assimilation of acquired personnel, operations,
technologies or products which may affect our ability to develop new
products and services and compete in our rapidly changing marketplace due
to a resulting decrease in the quality of work and innovation of our
employees upon which our business is dependent; and
. adverse effects on our existing business relationships with suppliers and
customers, which may be of particular importance to our business because
our customer base is highly concentrated among a limited number of large
customers and we purchase certain of the components used in manufacturing
our product from a sole supplier and we use a limited number of third
party manufacturers to manufacture our product.
In addition, if we consummate acquisitions through an exchange of our
securities, our existing stockholders could suffer significant dilution. Any
future acquisitions, even if successfully completed, may not generate any
additional revenue or provide any benefit to our business.
The success of our business model could be influenced by changes in the
regulatory environment, such as changes that either would limit capital
expenditures by television operations or reverse the trend towards deregulation
in the industries in which we compete.
The telecommunications and television industries are subject to extensive
regulation which may limit the growth of our business, both in the United
States and other countries. The growth of our business internationally is
dependent in part on deregulation of the telecommunications industry abroad
similar to that which has occurred in the United States and the timing and
magnitude of which is uncertain. Cable system operators are subject to
extensive government regulation by the Federal Communications Commission and
other federal and state regulatory agencies. These regulations could have the
effect of limiting capital expenditures by cable system operators and thus
could have a material adverse effect on our 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 our customers, and thereby materially
adversely affect our business, financial condition and results of operations.
We may not be able to hire and retain highly skilled employees, particularly
managerial, engineering, selling and marketing, finance and manufacturing
personnel, which could affect our ability to compete effectively because our
business is technology-based and there is a shortage of these employees within
the New England area.
Our success depends to a significant degree upon the continued contributions
of our key management, engineering, selling and marketing and manufacturing
personnel, many of whom would be difficult to replace given the shortage within
the New England area of qualified persons for these positions. We do not have
employment contracts with our key personnel. We believe that our future success
will also depend in large part upon our ability to attract and retain highly
skilled managerial, engineering, selling and marketing, finance and
manufacturing personnel, as our business is technology-based. Because
competition for these personnel is intense, we may not be able to attract and
retain qualified personnel in the future. 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 our
business, financial condition and results of operations because our business is
technology-based.
17
Increasing political and social turmoil, such as terrorist and military
actions, increase the difficulty for us, our vendors and our customers to
accurately forecast and plan future business activities and could have a
material adverse effect on our business, financial condition and results of
operation.
Recent political and social turmoil, including the terrorist attacks of
September 11, 2001, can be expected to put further pressure on economic
conditions in the United States and worldwide. The political, social and
economic conditions make it difficult for us, our vendors and our customers to
accurately forecast and plan future business activities. Our business,
financial condition and results of operations may be materially adversely
affected by a fluctuation in revenue relative to our forecasted value, as we
may not be able to vary our incurred expenses in response to revenue actually
realized.
ITEM 2. Properties
Our corporate headquarters, which is also our principal administrative,
selling, marketing, customer service and support and product development
facility, is located in Maynard, Massachusetts and consists of approximately
105,000 square feet under a lease which expires on March 31, 2005 with annual
base rent of $610,000. We purchased approximately 24,000 square feet of office
and manufacturing space in Greenville, New Hampshire on February 15, 2000 for
$280,000. We also lease two facilities totaling approximately 13,000 square
feet in Greenville, New Hampshire that are used for the development and final
assembly of our video servers. In connection with the acquisition in December
1999 of Digital Video Arts, we entered into a lease for approximately 8,000
square feet of office space in Fort Washington, Pennsylvania, which is
primarily used for the development of custom software products for companies
specializing in digital video and interactive television. We also lease small
research and development and/or sales and support offices in Atlanta, Georgia,
Beijing, China, St. Louis, Missouri, Reno, Nevada, Valbonne, France, Singapore,
United Kingdom and Japan.
ITEM 3. Legal Proceedings
On June 13, 2000, we filed in the United States District Court for the
District of Delaware a lawsuit against one of our competitors, nCube Corp.,
whereby we alleged that nCube's MediaCube-4 product infringed a patent held by
us (Patent No. 5,862,312) relating to our MediaCluster technology. In
instituting the claim, we sought both a permanent injunction and damages in an
unspecified amount. nCube made a counterclaim against us that the patent held
by us was invalid and that nCube's MediaCube-4 product did not infringe our
patent. On September 6, 2000, nCube conceded that, based on a claim
construction ruling issued by the District Court on August 2000, nCube's
MediaCube-4 product infringed our patent. On September 25, 2000, a jury upheld
the validity of our patent. nCube has filed motions challenging both the jury's
verdict and the District Court's claim construction ruling. The District Court
has yet to rule on nCube's motions. At this time we are awaiting the court's
decision regarding a permanent injunction. Damages will be determined in future
proceedings.
On January 8, 2001, nCube Corp. filed a complaint against us in the United
States District Court for the District of Delaware alleging that our use of our
MediaCluster, MediaExpress and Media Server technology each infringe a patent
held by nCube (Patent No. 5,805,804). In instituting the claim, nCube has
sought both an injunction and monetary damages in an unspecified amount. We
responded on January 26, 2001, denying the claim of infringement. We also
asserted a counterclaim seeking a declaration from the District Court that U.S.
Patent No. 5,805,804 is invalid and not infringed. Discovery closed on December
14, 2001, at which time nCube limited its infringement allegations to the
MediaCluster technology only, and specifically alleged that our use of the
SeaChange ITV system infringed. A claim construction hearing is scheduled for
May 2, 2002.
On March 26, 2002, nCube Corp. filed a complaint against us in the United
States District Court for the District of Delaware seeking a declaratory
judgment that its redesigned MediaCube-4 product does not infringe U.S. Patent
No. 5,862,312 held by us. The complaint also alleges that nCube has been
damaged by a certain statement made by our Chief Executive Officer during a
public conference call to discuss our earnings on March 5, 2002. nCube is
seeking a public retraction of the statement and is seeking damages in an
unspecified amount.
18
On April 15, 2002, we moved to dismiss all claims on the grounds that the
patent-related issues are currently pending before the Court in the lawsuit
previously filed by us, and the Court lacks jurisdiction over the remaining
claims. That motion is still pending.
On June 14, 1999, we filed a defamation complaint against Jeffrey Putterman,
Lathrop Investment Management, Inc. and Concurrent Computer Corporation in the
Circuit Court of Pulaski County, Arkansas alleging that the defendants
conspired to injure our business and reputation in the marketplace. The
complaint further alleges that Mr. Putterman and Lathrop Investment Management,
Inc. defamed us through false postings on an Internet message board. The
complaint seeks unspecified amounts of compensatory and punitive damages. On
June 14, 2000, Concurrent filed a counterclaim under seal against us seeking
unspecified damages. On July 28, 2000, Concurrent filed a motion for summary
judgment on the claim of civil conspiracy and on January 4, 2001, the trial
court entered an order granting summary judgment for Concurrent on that claim.
We immediately requested reconsideration of this order or, in the alternative,
recertification for immediate appeal. On June 12, 2001, the trial court denied
the motion for reconsideration but made findings which permitted an immediate
appeal and on July 11, 2001 we filed an appeal. We expect oral arguments on the
appeal will be scheduled before June 15, 2002 and a decision on the appeal
before August 1, 2002. The claims against other defendants and counterclaims
are currently pending and no trial date has been set.
We cannot be certain of the outcome of the foregoing litigation, but plan to
oppose allegations against us and assert our claims against other parties
vigorously. In addition, as these claims are subject to additional discovery
and certain claims for damages are as yet unspecified, we are unable to
estimate the impact to our business, financial condition and results of
operations or cash flows.
ITEM 4. Submission of Matters To a Vote of Securities Holders
No matters were submitted during the fourth quarter of the fiscal year ended
January 31, 2002 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
Our 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
------ ------
Three Month Period Ended:
April 30, 2000........ $73.50 $30.00
July 31, 2000......... 41.19 21.08
October 31, 2000...... 40.75 19.06
January 31, 2001...... 34.75 16.38
April 30, 2001........ 26.25 10.38
July 31, 2001......... 27.18 14.63
October 31, 2001...... 29.30 15.29
January 31, 2002...... 37.78 25.75
On April 24, 2002, the last reported sale price of our common stock on the
Nasdaq national market was $11.90.
We have not paid any cash dividends on our capital stock since its
inception, and do not expect to pay cash dividends on our common stock in the
foreseeable future. We currently intend to retain all of our future earnings
for use in operation and expansion of the business.
As of January 31, 2002, we had 128 stockholders of record. We believe that
the number of beneficial holders of our common stock exceeds 2,500.
19
ITEM 6. Selected Financial Data
The following consolidated selected financial data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and our financial statements and related notes
included elsewhere in this annual report. The consolidated statement of
operations data for each of the years ended December 31, 1997, 1998 and 1999
and January 31, 2001 and 2002 and for the one month period ended January 31,
2000 and the consolidated balance sheet data at December 31, 1997, 1998 and
1999 and at January 31, 2000, 2001 and 2002 are detailed below. During the
fourth quarter of the year ended January 31, 2001, SeaChange implemented the
SEC's SAB 101 guidelines, retroactive to the beginning of the year (see Note 3
of the consolidated financial statements). The pro forma results for prior
periods presented below were calculated assuming the accounting change was made
retroactively to all prior periods presented. An explanation of the
determination of the number of shares used in computing net income (loss) per
share is given in the notes to the consolidated financial statements.
One month
ended Year ended
Year ended December 31, January 31, January 31,
------------------------- ----------- -----------------
1997 1998 1999 2000 2001 2002
------- ------- ------- ----------- ------- --------
(in thousands, except per share data)
Consolidated Statement of Operations Data:
Revenues:
Systems........................................................ $60,414 $58,033 $68,457 $ 226 $74,986 $ 87,569
Services....................................................... 8,268 14,891 16,764 1,484 23,482 28,210
------- ------- ------- ------- ------- --------
68,682 72,924 85,221 1,710 98,468 115,779
------- ------- ------- ------- ------- --------
Costs of revenues:
Systems........................................................ 34,740 35,772 38,889 633 39,928 49,127
Services....................................................... 7,898 13,611 14,962 1,445 18,798 21,030
------- ------- ------- ------- ------- --------
42,638 49,383 53,851 2,078 58,726 70,157
------- ------- ------- ------- ------- --------
Gross profit (loss)............................................... 26,044 23,541 31,370 (368) 39,742 45,622
------- ------- ------- ------- ------- --------
Operating expenses:
Research and development....................................... 11,758 15,763 16,302 1,764 20,283 23,359
Selling and marketing.......................................... 6,248 8,566 8,595 1,034 12,472 14,178
General and administrative..................................... 3,932 6,132 5,335 457 7,372 7,358
Restructuring of operations.................................... -- 676 -- -- -- --
Write-off of acquired in-process research and development...... 5,290 -- -- -- -- --
Acquisition costs.............................................. -- -- 684 -- -- --
------- ------- ------- ------- ------- --------
27,228 31,137 30,916 3,255 40,127 44,895
------- ------- ------- ------- ------- --------
Income (loss) from operations..................................... (1,184) (7,596) 454 (3,623) (385) 727
Interest income (expense), net.................................... 663 235 28 9 (212) (449)
------- ------- ------- ------- ------- --------
Income (loss) before income taxes and cumulative effect of change
in accounting principle.......................................... (521) (7,361) 482 (3,614) (597) 278
Provision (benefit) for income taxes.............................. 1776 (2,789) (15) (1,156) (690) (103)
------- ------- ------- ------- ------- --------
Income (loss) before cumulative effect of change in accounting
principle........................................................ (2,297) (4,572) 497 (2,458) 93 381
Cumulative effect of change in accounting principle, net of tax of
$732............................................................. -- -- -- -- (1,100) --
------- ------- ------- ------- ------- --------
Net income (loss)................................................. $(2,297) $(4,572) $ 497 $(2,458) $(1,007) $ 381
======= ======= ======= ======= ======= ========
Earnings (loss) per share before cumulative effect of change in
accounting principle:
Basic........................................................... $ (0.15) $ (0.24) $ 0.02 $ (0.12) $ 0.00 $ 0.02
======= ======= ======= ======= ======= ========
Diluted......................................................... $ (0.15) $ (0.24) $ 0.02 $ (0.12) $ 0.00 $ 0.02
======= ======= ======= ======= ======= ========
Earnings (loss) per share:
Basic........................................................... $ (0.15) $ (0.24) $ 0.02 $ (0.12) $ (0.05) $ 0.02
======= ======= ======= ======= ======= ========
Diluted......................................................... $ (0.15) $ (0.24) $ 0.02 $ (0.12) $ (0.05) $ 0.02
======= ======= ======= ======= ======= ========
Pro forma amounts assuming the change in accounting principle is
applied retroactively:
Revenue......................................................... $68,634 $71,790 $85,052 $ 2,144 $98,468
Net income (loss)............................................... (2,509) (5,276) 323 (2,163) 93
Basic earnings (loss) per share................................. (0.16) (0.28) 0.02 (0.10) 0.00
Diluted earnings (loss) per share............................... (0.16) (0.28) 0.01 (0.10) 0.00
20
As of December 31, As of January 31,
----------------------- ------------------------
1997 1998 1999 2000 2001 2002
------- ------- ------- ------- ------- --------
(in thousands)
Consolidated Balance Sheet Data:
Working capital.............................................. $24,949 $22,871 $23,365 $20,983 $28,819 $134,921
Total assets................................................. 52,512 54,527 62,304 56,712 88,253 192,977
Long-term liabilities........................................ -- 1,027 1,231 1,144 3,934 6,363
Deferred revenue............................................. 3,851 3,939 4,380 6,292 8,435 13,071
Total liabilities............................................ 17,510 23,207 27,963 24,761 42,951 38,851
Total stockholders' equity................................... 35,004 31,320 34,341 31,951 45,302 154,126
Pro forma amounts assuming the change in accounting principle is
applied retroactively:
Working capital.............................................. $24,737 $22,167 $23,191 $21,278 $28,819
Total assets................................................. 52,512 54,527 62,304 56,712 88,253
Long-term liabilities........................................ -- 1,027 1,231 1,144 3,934
Deferred revenue............................................. 3,899 5,073 4,549 5,857 8,435
Total liabilities............................................ 17,722 23,911 28,137 24,466 42,951
Total stockholders' equity................................... 34,792 30,616 34,167 32,246 45,302
ITEM 7. Management Discussion and Analysis of Financial Condition and Results
of Operations
You should read the following discussion and analysis together with our
financial statements, related notes and other financial information appearing
elsewhere in this Annual Report. In addition to historical information, the
following discussion and other parts of this Annual Report contain
forward-looking information that involves risks and uncertainties. Our actual
results could differ materially from those anticipated by such forward-looking
information due to competitive factors and other factors discussed under
"Certain Risk Factors" and elsewhere in this Annual Report.
Overview
We are a leading developer, manufacturer and marketer of systems, known as
video storage servers, that automate the management and distribution of
long-form video streams, such as movies or other feature presentations, and
short-form video streams, such as advertisements.
We have three reportable segments: broadband systems, broadcast systems and
services. The broadband systems segment includes products, such as our digital
advertising and video-on-demand products, that digitally manage, store and
distribute digital video for cable system operators and telecommunications
companies. The broadcast systems segment includes products for the storage,
archival, on-air playback of advertising and other video programming for the
broadcast television industry. Our system revenues are comprised of sales of
our broadband and broadcast systems. The service segment is comprised of
revenue related to product development contracts, installation, training,
product maintenance and technical support for all of the above systems, and
content which is distributed by the broadband product segment.
We have experienced fluctuations in our systems revenues from quarter to
quarter due to the timing of receipt of customer orders and the shipment of
those orders. The factors that impact the timing of receipt of customer orders
include among other factors: (1) the customer's obtaining authorized signatures
on their purchase orders; (2) budgetary approvals within the customer's company
for capital purchases; and (3) the ability to process the purchase order within
the customer's organization in a timely manner. Factors that may impact the
shipment of customer orders include: (1) the availability of material to
produce the product; and (2) the time required to produce and test the system
before delivery. Because the average sales price of our system is high, the
delay in the timing of receipt and shipment of any one customer order can
result in quarterly fluctuations in our revenue.
Our results are significantly influenced by a number of factors, including
our pricing, the costs of materials used in our products and the expansion of
our operations. We price our products and services based upon our costs as well
as in consideration of the prices of competitive products and services in the
marketplace. The costs
21
of our products primarily consist of the costs of components and subassemblies
that have generally declined over time. As a result of the growth of our
business, our operating expenses have increased in the areas of research and
development, selling and marketing, customer service and support and
administration. We expect that the events of September 11th and their aftermath
coupled with the already soft economy will continue to influence our operating
results into fiscal 2003. This impact is likely to be most significant in the
capital spending budgets of some of our cable and broadcast customers who we
believe depend on advertising revenues to fund their equipment purchases.
On December 30, 1999, we acquired all of the outstanding capital stock of
Digital Video Arts, Ltd. in exchange for 330,000 shares of our common stock
using an exchange ratio of 0.033 of one share of our common stock for each
share of Digital Video Arts. The acquisition was accounted for as a pooling of
interests. Digital Video Arts is a developer of custom software products
specializing in digital video and interactive television. As a result of the
acquisition, Digital Video Arts became our wholly-owned subsidiary. The
accompanying consolidated financial statements for all the periods presented
have been restated to include the results of operations, financial position and
cash flows of Digital Video Arts.
On January 31, 2002, we completed a public offering of 3,594,411 shares of
our common stock, consisting of 3,384,411 shares sold by us and 210,000 shares
sold by certain of our stockholders. Proceeds to SeaChange, net of underwriting
discounts and costs of the offering, were approximately $92.7 million.
Summary of Critical Accounting Policies; Significant Judgments and Estimates
Our discussion and analysis of our financial condition and results of
operations are based upon our Consolidated Financial Statements, which have
been prepared in accordance with accounting principles generally accepted in
the United States. The preparation of these financial statements requires us to
make significant estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. These items are regularly monitored and
analyzed by management for changes in facts and circumstances, and material
changes in these estimates could occur in the future. Changes in estimates are
recorded in the period in which they become known. We base our estimates on
historical experience and various other assumptions that we believe to be
reasonable under the circumstances. Actual results may differ from our
estimates if past experience or other assumptions do not turn out to be
substantially accurate.
A summary of those accounting policies that we believe are most critical to
fully understand and evaluate our financial results is set forth below. This
summary should be read in conjunction with our Consolidated Financial
Statements and the related Notes included elsewhere in this Annual Report.
Revenue Recognition and Allowance for Doubtful Accounts. Revenues from
sales of systems are recognized upon shipment provided title and risk of loss
have passed to the customer, there is evidence of an arrangement, fees are
fixed or determinable and collection of the related receivable is reasonably
assured. Installation, project management and training revenue is deferred and
recognized as these services are performed. Revenue from technical support and
maintenance is deferred and recognized ratably over the period of the related
agreements, generally one year. Customers are billed for installation, project
management, training and maintenance at the time of the product sale. If a
portion of the sales price is not due until installation of the system is
complete, that portion of the sales price is deferred until installation is
complete. Revenue from content fees, primarily movies, is recognized based on
the volume of monthly purchases that are made by hotel guests. Revenue from
product development contract services is recognized based on the time and
materials incurred to complete the work. Shipping and handling costs are
included in revenue and cost of revenues.
Our transactions frequently involve the sales of systems and services under
multiple element arrangements. Systems sales always include at least one year
of free technical support and maintenance services. Revenue under multiple
element arrangements is allocated to all elements except systems based upon the
fair value of those
22
elements. The amounts allocated to training, project management, technical
support and maintenance and content fees are based upon the price charged when
these elements are sold separately and unaccompanied by the other elements. The
amount allocated to installation revenue is based upon hourly rates and the
estimated time required to complete the service. The amount allocated to
systems is done on a residual method basis. Under this method, the total
arrangement value is allocated first to undelivered elements, based on their
fair values, with the remainder being allocated to systems revenue.
Installation, training and project management services are not essential to the
functionality of systems as these services do not alter the equipment's
capabilities, are available from other vendors and the systems are standard
products. For transactions in which consideration, including equity
instruments, is given to a customer, we account for the value of this
consideration as a reduction in revenue in our statement of operations (see
further discussion under "equity investments" within Management's Discussion
and Analysis and footnote 14 in the consolidated financial statements).
We recognize revenue for systems and services only in those situations where
collection from the customer is reasonably assured. Our normal payments terms
are 50% of the order due upon receipt of a customer purchase order, 25% due
upon shipment of the product to the customer and 25% due 45 days after shipment
of the product to the customer. Our finance management regularly monitors
timely payments from our customers and assesses any collection issues. We
perform on-going credit evaluations of our customer's financial condition but
generally do not require collateral from our customers. For a majority of our
international customers, we require an irrevocable letter of credit to be
issued by the customer before the purchase order is accepted. We maintain
allowances for doubtful accounts for estimated losses resulting from the
inability of our customers to make required payments and record these
allowances as a charge to operations within general and administrative
expenses. We base our estimates on our historical collection and write-off
experience, current trends, credit assessment, detailed analysis of specific
customer situations and percentage of our accounts receivable by aging
category. While such credit losses have historically been within our
expectations and the allowances established, we cannot guarantee that we will
continue to experience the same credit loss rates that we have in the past. If
the financial condition of our customers were to deteriorate, resulting in an
impairment of their ability to make payment, additional allowances may be
required. Our failure to accurately estimate the losses for doubtful accounts
and ensure that payments are received on a timely basis could have a material
adverse effect on our business, financial condition and results of operations.
Inventories and Reserves for Obsolescence. Inventories are stated at the
lower of cost or net realizable value. Cost is determined using the first-in,
first-out (FIFO) method. Inventories consist primarily of components and
subassemblies and finished products held for sale. All of our hardware
components are purchased from outside vendors. We depend upon certain vendors
for the manufacture of significant components for all of our products. If these
vendors were to become unwilling or unable to manufacture these products in
required volumes, we would have to identify and qualify acceptable alternative
vendors. The inability to develop alternative sources, if required in the
future, could result in delays or reductions in product shipments and thereby
adversely affect our financial condition and results of operations.
Our manufacturing and finance management and operations personnel regularly
monitor the inventories to ensure its carrying value is stated at the lower of
cost or net realizable value. On a quarterly basis, we use consistent
methodologies to evaluate all inventory for net realizable value. We record a
provision for excess and obsolete inventory when such an impairment is
identified through the quarterly review process. Excess and obsolete inventory,
consisting of on-hand components and subassemblies and finished products, is
written down to its estimated net realizable value, if less than cost. The
excess and obsolescence evaluation is based upon assumptions about future
demand, product mix and possible alternative uses and involves significant
judgments. If the inventory value is written down to its net realizable value,
and subsequently there is an increased demand for the inventory at a higher
value, the increased value of the inventory is not realized until the inventory
is sold.
Valuation of Long-Lived Assets. We defer legal costs associated with
defending our existing patents. If the patent defense is successful, the costs
are capitalized as an intangible asset and amortized over their estimated
remaining useful life. If the patent defense is unsuccessful, the amounts that
have been deferred are charged to
23
operating expense. Included in other assets at January 31, 2002 are deferred
legal costs of $1.4 million associated with on-going litigation related to the
nCube lawsuits. At January 31, 2002, goodwill and intangibles consisted of
$253,000 of net goodwill costs which will cease to be amortized beginning
February 1, 2002 and net capitalized patent defense costs of $3.9 million which
are being amortized to general and administrative expenses over their four year
estimated useful life.
In accordance with Financial Accounting Standards Board Statement No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to be Disposed of," ("SFAS No. 121") the carrying value of intangible assets
and other long-lived assets is reviewed on a regular basis for the existence of
facts or circumstances, both internally and externally, that may suggest
impairment. Factors we consider important which could trigger the impairment
review include:
. significant underperformance relative to historical or projected future
operating results;
. significant negative industry or economic trends;
. significant decline in our stock price for a sustained period;
. significant decline in our technological value as compared to the market;
and
. our market capitalization relative to net book value.
If such circumstances exist, we evaluate the carrying value of long-lived
assets to determine if impairment exists based upon estimated undiscounted
future cash flows over the remaining useful life of the assets and comparing
that value to the carrying value of the assets. If the carrying value of the
asset is greater than the estimated future cash flows, the asset is written
down to the estimated fair value. We determine the estimated fair value of the
assets on a projected discounted cash flow method using a discount rate
determined by management to be commensurate with the risk inherent in the
current business model. In determining expected future cash flows, assets are
grouped at the lowest level for which cash flows are identifiable and
independent of cash flows from other asset groups. To date, no such impairment
has been indicated. Our cash flow estimates contain management's best
estimates, using appropriate and customary assumptions and projections at the
time.
Equity Investments. On December 1, 2000, we and Comcast Cable
Communications, Inc. entered into a video-on-demand purchase agreement for our
interactive television video servers and related services. Under the terms of
the video-on-demand purchase agreement, Comcast has committed to purchase our
equipment capable of serving a minimum of one million cable subscribers by
approximately December 2002. In addition, Comcast may earn up to an additional
450,000 incentive common stock purchase warrants through December 2003 based on
the number of cable subscribers in excess of one million who are served by our
equipment which has been purchased by Comcast.
On February 28, 2001, we and Comcast SC signed and closed a common stock and
warrant purchase agreement. Under the terms of this agreement, we sold in a
private placement to Comcast SC for approximately $10 million an aggregate of
756,144 shares of our common stock and a warrant to purchase 100,000 shares of
our common stock with an exercise price of $13.225 per share.
We determined the intrinsic value of $586,000 related to the 756,144 shares
of common stock purchased on February 28, 2001 and measured the fair value of
$1.1 million related to the 100,000 common stock purchase warrants as of the
closing date and recorded these amounts as contra-equity. On April 30, 2001, we
recorded an additional contra-equity amount of $325,000 for the fair value of
the additional 25,000 common stock purchase warrants of our common stock as the
registration statement had not been declared effective on or before March 31,
2001 in accordance with the agreement. On June 13, 2001, the effective date of
the registration statement, we issued an additional 14,667 common stock
purchase warrants in accordance with the agreement, and recorded an additional
contra equity amount of $335,000, representing the incremental fair value of
the total warrants issued. Management determined the fair value of the warrants
using the Black-Scholes valuation model. The assumptions used in this valuation
included: a weighted average volatility factor of 100%, a dividend yield of
0.0%, a risk-free interest rate of 4.85%, and an expected warrant term of 5
years. If management had used
24
another valuation method or different valuation assumptions, the fair value of
the warrants may have significantly changed, which could have materially
impacted our results of operations. The total contra-equity amount of $2.4
million is being amortized as an offset to gross revenue in proportion to the
revenue recognized from the sale of equipment with respect to the first one
million subscribers Comcast has committed to under the video-on-demand purchase
agreement. We have estimated that the equipment value with respect to the first
one million subscribers is $30 million. This estimate is continuously monitored
and is subject to change. To the extent that this estimate changes in the
future, the amount of the remaining contra-equity amount will be adjusted
prospectively. For the year ended January 31, 2002, we amortized $1.2 million
of the deferred equity discount. As of January 31, 2002, the balance of the
deferred equity discount was $1.2 million. The fair value of the additional
incentive common stock purchase warrants will also be recorded as an offset to
gross revenue as the warrants are earned by Comcast, if any.
On November 29, 2001, we and Visible World entered into a Joint Development
and Marketing Agreement. The purpose of the partnership is to integrate the
advertising insertion product offerings that we offer with the software
technologies of Visible World, which would enable advertisers an end-to-end
solution for providing target advertising to their customers. The agreement is
for a one-year period with automatic annual renewal unless 90-day notice of
termination is given by either party. In conjunction with the arrangement,
Visible World issued us a fully vested warrant to purchase one million shares
of Series B Preferred Stock at an exercise price of $0.01 per share. The
warrant expires at the earlier of a) the consummation of a qualified public
offering, as defined in the agreement, by Visible World, b) the sale of Visible
World, as defined in the agreement or c) 10 years. Because the issuance of the
warrant to us under the terms of the agreement is in exchange for services to
be provided by us, the warrant is accounted for under the guidance of EITF
00-08, "Accounting by a Grantee for an Equity Instrument to be Received in
Conjunction with Providing Goods or Services." Management determined the fair
value of the warrant based on available financial information using the
Black-Scholes valuation model. The assumptions used in this valuation included:
a fair value of Visible World stock of $0.50 per share, a weighted average
volatility factor of 100%, a dividend yield of 0.0%, a risk-free interest rate
of 4.22%, and an expected warrant term of 5 years. If management had used
another valuation method or different valuation assumptions, the fair value of
the warrant may have significantly changed. We recorded the value of the
warrant of $493,000 as a long-term investment included in other assets with an
offsetting amount included in deferred revenue. We will recognize the deferred
revenue over a five year period, the expected term of the services. In
addition, we review the carrying value of our investment on a regular basis for
the existence of facts or circumstances, both internally and externally, that
may suggest impairment of the asset. It is possible that changes in facts or
circumstances related to the value of this investment could materially affect
our financial condition and results of operations.
Accounting for Income Taxes. We record income taxes using the asset and
liability method. Deferred income tax assets and liabilities are recognized for
the future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective income tax bases, and operating loss and tax credit carryforwards.
Our financial statements contain certain deferred tax assets which have arisen
primarily as a result of operating losses, as well as other temporary
differences between financial and tax accounting. We are required to establish
a valuation allowance if the likelihood of realization of deferred tax assets
is reduced. Significant management judgment is required in determining our
provision for income taxes, our deferred tax assets and liabilities and any
valuation allowance recorded against our deferred tax assets. We evaluate the
weight of all available evidence to determine whether it is more likely than
not that some portion or all of the deferred income tax assets will not be
realized. Although realizability is not assured, based on the weight of
available evidence, we believe it is more likely than not that all remaining
deferred tax assets will be realized. The amount of the deferred tax asset
considered realizable is subject to change based on future events, including
generating taxable income in future periods. We will continue to assess the
need for the valuation allowance at each balance sheet date based on all
available evidence. As a result of our operating profit in the year ended
January 31, 2002, forecasted operating income for the year ended January 31,
2003 and the expectation of profitability in future periods thereafter, we did
not record any additional valuation allowances during the year ended January
31, 2002. Had we recorded an additional allowance, we would have reported
25
materially different results. The amount of the deferred tax asset considered
realizable, however, could be reduced in the near term if we do not generate
sufficient taxable income in future periods. Our effective tax rate may vary
from period to period based on changes in estimated taxable income or loss,
changes to the valuation allowance, changes to federal, state or foreign tax
laws, future expansion into areas with varying country, state, and local income
tax rates, deductibility of certain costs and expenses by jurisdiction and as a
result of potential acquisitions.
Off-Balance Sheet Arrangements. We have not created, and are not party to,
any special-purpose or off-balance sheet entities for the purpose of raising
capital, incurring debt or operating parts of our business that are not
consolidated into our financial statements.We do not have any arrangements or
relationships with entities that are not consolidated into our financial
statements that are reasonably likely to materially affect our liquidity or the
availability of our capital resources.
Year Ended January 31, 2001 Compared to the Year Ended January 31, 2002
Systems Revenues. Our systems revenues consist of sales of our broadband
and broadcast products. Systems revenues increased 17% from $75.0 million in
the year ended January 31, 2001 to $87.6 million in the year ended January 31,
2002. Revenues from the broadband segment, which accounted for 55% of total
revenues in the year ended January 31, 2001 and 60% of total revenues in the
year ended January 31, 2002, increased from $54.4 million in 2001 to $69.5
million in 2002. Digital advertising system revenues were $26.3 million for the
year ended January 31, 2002 as compared to $40.0 million for the year ended
January 31, 2001. Interactive television systems revenues increased to $43.2
million for the year ended January 31, 2002 as compared to $14.4 million for
the year ended January 31, 2001. Reducing interactive television systems
revenue for the year ended January 31, 2002 was the amortization of $1.2
million related to the deferred equity discount associated with the Comcast
equity investment. The increase in broadband revenues is primarily attributable
to the initial deployment of residential video-on-demand systems in the United
States for cable operators, offset in part by a decline in the number of
expansion systems purchased by United States cable system operators for digital
advertising. Broadcast system segment revenues were $20.6 million in the year
ended January 31, 2001 compared to $18.0 million in the year ended January 31,
2002. The 12% decrease in broadcast revenues for the year ended January 31,
2002 was primarily attributable to a decrease in capital expenditures by
broadcast companies that we believe is tied to declining advertising revenues
earned by those companies. We expect future revenue growth, if any, to come
principally from our interactive television and broadcast system products as
cable and telecommunications companies continue to offer new video-on-demand
applications for their customers and the market for digital video servers
within the broadcast industry continues to expand. As revenues from broadcast
and interactive television products increase, the digital advertising products
will become a smaller portion of total system revenues. However, we believe
that there will be a continuing demand for expansions to existing digital
advertising insertion systems within the United States.
Services Revenues. Our services revenues consist of fees for installation,
training, product maintenance, technical support services, project management,
product development contracts and movie content fees. Our services revenues
increased 20% to $28.2 million in the year ended January 31, 2002 from $23.5
million in the year ended January 31, 2001. This increase in services revenues
primarily resulted from the renewals of technical support and maintenance
services, price increases on certain technical support and maintenance
services, the impact of a growing installed base of systems and a higher level
of product development services.
For the twelve-month periods ended January 31, 2001 and January 31, 2002,
certain customers each accounted for more than 10% of our total revenues.
Single customers each accounted for 12% and 10% of total revenues in the year
ended January 31, 2001 and 20%, 15% and 11% of total revenues in the year ended
January 31, 2002. Revenue from these customers was primarily in the broadband
segment. We believe that a significant amount of our revenues will continue to
be derived from a limited number of large customers.
26
International sales accounted for approximately 21% and 14% of total
revenues in the twelve-month periods ended January 31, 2001 and January 31,
2002, respectively. We expect that international sales will remain a
significant portion of our business in the future. As of January 31, 2002,
substantially all sales of our products were made in United States dollars.
Therefore, we have not experienced, nor do we expect to experience in the near
term, any material impact from fluctuations in foreign currency exchange rates
on our results of operations or liquidity. If this practice changes in the
future, we will reevaluate our foreign currency exchange rate risk.
Systems Gross Profit. 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 to $49.1 million in the year ended January 31,
2002 as compared to $39.9 million in the year ended January 31, 2001. In the
year ended January 31, 2002, the increase in costs of systems revenues reflects
higher systems revenue and higher material costs within the interactive
television products. We expect cost of systems revenues for the interactive
television products within the broadband segment to be higher as a percentage
of revenues as the products are first deployed and to decrease as a percentage
of revenues as the revenue level increases and we improve our manufacturing and
material purchasing efficiencies.
Systems gross profit as a percentage of systems revenues was 44% and 47% in
the year ended January 31, 2002 and January 31, 2001, respectively. The
decrease in systems gross profit in the year ended January 31, 2002 was
primarily due to the shift within the broadband segment from product sales of
higher gross profit ad insertion systems to lower gross profit interactive
television systems. We expect this product sales shift to continue, however, we
expect that gross profit for interactive television systems will improve as the
revenue level for interactive television systems increases and we improve our
manufacturing and purchasing efficiencies. Gross profit for the broadband
segment decreased from 48% for the year ended January 31, 2001 to 44% for the
year ended January 31, 2002 while gross profit for the broadcast segment
decreased from 44% to 43% for the year ended January 31, 2001 and the year
ended January 31, 2002, respectively.
Services Gross Profit. Costs of services revenues consist primarily of
labor, materials and overhead relating to the installation, training, product
maintenance and technical support services provided by us and costs associated
with providing movie content. Costs of services revenues increased 12% from
$18.8 million in the year ended January 31, 2001 to $21.0 million in the year
ended January 31, 2002, primarily as a result of increased revenues and the
costs associated with our hiring and training additional service personnel to
provide worldwide support for the growing installed base of broadband and
broadcast systems and costs associated with providing movie content. Services
gross profit as a percentage of services revenue was 20% in the year ended
January 31, 2001 and 25% in the year ended January 31, 2002. Improvements in
the services gross profit in the year ended January 31, 2002 reflect the
increase in the installed base of systems under maintenance, price increases on
certain annual technical support and maintenance services and higher product
development revenues.
Research and Development. Research and development expenses consist
primarily of the compensation of development personnel, depreciation of
development and test equipment and an allocation of related facilities
expenses. Research and development expenses increased 15% from approximately
$20.3 million in the year ended January 31, 2001 to $23.4 million in the year
ended January 31, 2002. The increase in the dollar amount was primarily
attributable to the hiring and contracting of additional development personnel
which reflects our continuing investment in new products. We expect that
research and development expenses will continue to increase in dollar amount as
we continue our 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 14% from $12.5
million in the year ended January 31, 2001 to $14.2 million in the year ended
January 31, 2002. This increase is primarily due to the hiring of additional
sales personnel for our broadcast and interactive television products,
increased sales commissions on higher revenues and higher marketing expenses
specifically for tradeshow and other promotional activities.
27
General and Administrative. General and administrative expenses consist
primarily of the compensation of executive, finance, human resource and
administrative personnel, legal and accounting services and an allocation of
related facilities expenses. General and administrative expenses remained flat
at $7.4 million in the year ended January 31, 2001 and January 31, 2002,
respectively.
Interest Expense (Income), Net. Interest expense, net, was approximately
$449,000 in the year ended January 31, 2002 and interest expense, net, was
approximately $212,000 in the year ended January 31, 2001. The increase in 2002
in interest expense, net, primarily resulted from interest expense on increased
borrowings under our lines of credit and borrowings under our construction loan.
Provision (Benefit) for Income Taxes. Our effective tax benefit rate was
37% in the year ended January 31, 2002. The effective tax rate for the year
ended January 31, 2002 was favorably impacted by the utilization of research
and development tax credits.
We had net deferred tax assets of $8.8 million at January 31, 2002. Although
realizability is not assured, based on the weight of available evidence, we
believe it is more likely than not that all remaining deferred tax assets will
be realized. The amount of the deferred tax assets considered realizable is
subject to change based on future events, including generating taxable income
in future periods. We will continue to assess the need for the valuation
allowance at each balance sheet date based on all available evidence. The
amount of the deferred tax assets considered realizable, however, could be
reduced in the near term, and the amount could be material, if we do not
generate sufficient taxable income in future periods. Any reduction of the
amount of the deferred tax assets would reduce net income in the period in
which the reduction occurs.
Cumulative effect change in accounting principle. During the fourth quarter
of the year ended January 31, 2001, we implemented the SEC's SAB 101
guidelines, retroactive to the beginning of the year. This was reported as a
cumulative effect of a change in accounting principle as of February 1, 2000.
Historically, for some of our sales transactions, a portion of the sales price,
typically 25%, was not due until installation occurred. We now defer revenue
recognition on the portion of the sales price not due until installation is
complete. The cumulative effect of the change in accounting principle on prior
years resulted in a charge to income of $1.1 million (net of income taxes of
$732,000) or $0.05 per diluted share which has been included in income for the
nine months ended October 31, 2000.
Year Ended December 31, 1999 Compared to the Year Ended January 31, 2001
Systems Revenues. Systems revenues increased 10% from $68.5 million in the
year ended December 31, 1999 to $75.0 million in the year ended January 31,
2001. Revenues from the broadband segment, which accounted for 55% of total
revenues in the year ended January 31, 2001 and 61% of total revenues in the
year ended December 31, 1999, increased from $51.7 million in 1999 to $54.4
million in 2001. Digital advertising system revenues were $40.0 million for the
year ended January 31, 2001 as compared to $44.6 million for the year ended
December 31, 1999. Interactive television systems revenues increased to $14.4
million for the year ended January 31, 2001 as compared to $7.1 million for the
year ended December 31, 1999. The increase in broadband revenues is primarily
attributable to the sale of interactive television systems to U.S. cable system
operators who began to deploy residential video-on-demand services to their
subscriber base during the year ended January 31, 2001, offset in part by a
decline in the number of expansion systems purchased by United States cable
system operators for digital advertising. Broadcast system segment revenues
were $20.6 million in the year ended January 31, 2001 compared to $16.8 million
in the year ended December 31, 1999. The 23% increase in broadcast revenues for
the year ended January 31, 2001 was primarily due to shipments for new
broadcast customers in the United States, Europe and the Far East.
Services Revenues. Our services revenues increased 40% to $23.5 million in
year ended January 31, 2001 from $16.8 million in the year ended December 31,
1999. This increase in services revenues primarily resulted from the renewals
of existing technical support and maintenance, price increases on certain
technical support and maintenance services, the impact of a growing installed
base of systems and a higher volume of product development services.
28
For the twelve-month periods ended January 31, 2001 and December 31, 1999,
certain customers each accounted for more than 10% of our total revenues.
Single customers each accounted for 12% and 10% of total revenues in the year
ended January 31, 2001 and 15% and 10% of total revenues in the year ended
December 31, 1999. Revenue from these customers was primarily in the broadband
segment. We believe that a significant amount of our revenues will continue to
be derived from a limited number of large customers.
International sales accounted for approximately 21% and 23% of total
revenues in the twelve-month periods ended January 31, 2001 and December 31,
1999, respectively.
Systems Gross Profit. Costs of systems revenues increased to $39.9 million
in the year ended January 31, 2001 as compared to $38.9 million in the year
ended December 31, 1999. In the year ended January 31, 2001, the cost of
systems revenues increased from the prior year primarily as a result of higher
systems revenues.
Systems gross profit as a percentage of systems revenues was 47% and 43% in
the year ended January 31, 2001 and December 31, 1999, respectively. The
increase in systems gross profit in the year ended January 31, 2001 was
primarily due to lower material and other manufacturing costs as a percentage
of systems revenue within the broadband segment and specifically for system
revenues for the digital advertising insertion products. We were able to reduce
manufacturing material costs principally through improved purchasing methods
despite the continued trend towards the purchase of smaller scale digital
advertising insertion systems and expansions to existing systems that have
higher material content. Gross profit for the broadband segment improved from
43% for the year ended December 31, 1999 to 48% for the year ended January 31,
2001 while gross profit for the broadcast segment was 44% and 45% for the year
ended January 31, 2001 and the year ended December 31, 1999, respectively.
Services Gross Profit. Costs of services revenues increased 26% from $15.0
million in the year ended December 31, 1999 to $18.8 million in the year ended
January 31, 2001, primarily as a result of increased revenues and the costs
associated with our hiring and training additional service personnel to provide
worldwide support for the growing installed base of broadband and broadcast
systems and costs associated with providing movie content. Services gross
profit as a percentage of services revenue was 20% in the year ended January
31, 2001 and 11% in the year ended December 31, 1999. Improvements in the
services gross profit in the year ended January 31, 2001 reflect the increase
in the installed base of systems under maintenance, price increases on certain
annual technical support and maintenance services and higher product
development revenues.
Research and Development. Research and development expenses increased 24%
from approximately $16.3 million in the year ended December 31, 1999 to $20.3
million in the year ended January 31, 2001. The increase in the dollar amount
was primarily attributable to the hiring and contracting of additional
development personnel which reflects our continuing investment in new products.
Selling and Marketing. Selling and marketing expenses increased 45% from
$8.6 million in the year ended December 31, 1999 to $12.5 million in the year
ended January 31, 2001. This increase is primarily due to the hiring of
additional sales personnel for our broadcast and interactive television
products, increased sales commissions on higher revenues and higher marketing
expenses specifically for tradeshow and other promotional activities.
General and Administrative. General and administrative expenses increased
38% from $5.3 million in the year ended December 31, 1999 to $7.4 million in
the year ended January 31, 2001. This increase is primarily due to increased
legal expenses associated with various litigation matters and accounting
expenses associated primarily with tax matters.
Interest Expense (Income), Net. Interest expense, net, was approximately
$212,000 in the year ended January 31, 2001 and interest income, net, was
approximately $28,000 in the year ended December 31, 1999. The increase in 2001
in interest expense, net, primarily resulted from interest expense on increased
borrowings under our lines of credit and new borrowings under our construction
loan.
29
Provision (Benefit) for Income Taxes. Our effective tax rate for the year
ended January 31, 2001 differed from the U.S. federal statutory tax rate due to
the utilization of research and development tax credits. Our effective tax
benefit rate was 116% for the year ended January 31, 2001 as compared to 3% for
the year ended December 31, 1999.
One Month Ended January 31, 2000 Compared to the One Month Ended January 31,
1999
Systems Revenues. Systems revenues decreased 68% from $697,000 in the one
month ended January 31, 1999 to $226,000 in the one month ended January 31,
2000. This decreased systems revenues resulted primarily from the timing of
receipt of customer orders and related shipment within both the broadband and
broadcast segments.
Services Revenues. Our services revenues increased 23% from approximately
$1.2 million in the one month ended January 31, 1999 to $1.5 million in the one
month ended January 31, 2000. This increase in services revenues resulted
primarily from renewals of technical support and maintenance contracts, higher
product development revenues and the impact of a growing installed base of
systems.
For the one month period ended January 31, 2000 and January 31, 1999,
certain customers accounted for more than 10% of our total revenues. Single
customers accounted for 16% and 11% of total revenues in the one month ended
January 31, 2000 and 17%, 12% and 10% of total revenues in the one month ended
January 31, 1999. Revenues from these customers were primarily in the broadband
segment.
International sales accounted for approximately 18% and 38% of total
revenues for the one month ended January 31, 2000 and January 31, 1999,
respectively.
Systems Gross Profit. Costs of systems revenues decreased 6% from $670,000
in the one month ended January 31, 1999 to $633,000 in the one month ended
January 31, 2000. For the one month ended January 31, 2000, the decrease in
cost of systems revenues primarily reflects lower systems revenue offset in
part by fixed manufacturing labor and overhead costs.
Systems gross profit as a percentage of systems revenues was a negative 180%
in the one month ended January 31, 2000. In the one month ended January 31,
1999, gross profit as a percentage of systems revenues was 4%. The decrease in
systems gross profit in 2000 was primarily due to lower systems revenue and
higher material and fixed manufacturing costs as a percentage of systems
revenues.
Services Gross Profit. Costs of services revenues increased 38% from
approximately $1.0 million in the one month ended January 31, 1999 to $1.4
million in the one month ended January 31, 2000, primarily as a result of the
costs associated with our hiring and training additional service personnel to
provide worldwide support for the growing installed base of broadband and
broadcast systems and costs associated with providing movie content. Services
gross profit as a percentage of services revenue decreased to 3% in the one
month ended January 31, 2000 compared to a gross profit margin of 13% in the
one month ended January 31, 1999.
Research and Development. Research and development expenses increased 33%
from approximately $1.3 million, in the one month ended January 31, 1999 to
$1.8 million in the one month ended January 31, 2000. The increase in the
dollar amount was primarily attributable to the hiring and contracting of
additional development personnel which reflects our continuing investment in
new products.
Selling and Marketing. Selling and marketing expenses increased 98% from
$522,000 in the one month ended January 31, 1999 to $1.0 million in the one
month ended January 31, 2000. This increase is primarily due to the hiring of
additional sales personnel for our broadcast and interactive television
products and higher tradeshow expenses.
General and Administrative. General and administrative expenses increased
2% from $447,000 in the one month ended January 31, 1999 to $457,000 in the one
month ended January 31, 2000.
Interest Income, Net. Interest income, net, was approximately $9,000 in the
one month ended January 31, 2000 and January 31, 1999, respectively.
Benefit for Income Taxes. Our effective tax benefit rate was 32% and 33% in
the one month ended January 31, 2000 and January 31, 1999, respectively.
30
Quarterly Results of Operations
The following tables present certain unaudited quarterly information for the
quarterly periods in the years ended January 31, 2001 and January 31, 2002. The
results for any quarter are not necessarily indicative of future quarterly
results, and we believe that period-to-period comparisons should not be relied
upon as an indication of future performance.
April 30, July 31, October 31, January 31, April 30, July 31, October 31, January 31,
2000 2000 2000 2001 2001 2001 2001 2002
--------- -------- ----------- ----------- --------- -------- ----------- -----------
(in thousands, except per share amounts)
Revenue........................................ $22,304 $25,356 $25,026 $25,782 $30,156 $27,024 $25,221 $33,378
Gross profit................................... 8,706 9,906 10,760 10,370 11,460 10,751 9,338 14,073
Operating expenses............................. 8,346 9,426 9,945 12,410 11,028 11,669 11,041 11,157
Income (loss) before cumulative effect of
change in accounting principle................ 263 330 512 (1,012) 182 (684) (1,212) 2,095
Cumulative effect of change in accounting
principle, net of tax of $732................. (1,100) -- -- -- -- -- -- --
Net income (loss).............................. (837) 330 512 (1,012) 182 (684) (1,212) 2,095
Earnings (loss) per share before cumulative
effect change in accounting principle--
Basic......................................... 0.01 0.02 0.02 (0.05) 0.01 (0.03) (0.05) 0.09
Earnings (loss) per share before cumulative
effect change in accounting principle--
Diluted....................................... 0.01 0.01 0.02 (0.05) 0.01 (0.03) (0.05) 0.09
Earnings (loss) per share--Basic............... (0.04) 0.02 0.02 (0.05) 0.01 (0.03) (0.05) 0.09
Earnings (loss) per share--Diluted............. (0.04) 0.01 0.02 (0.05) 0.01 (0.03) (0.05) 0.09
We have experienced significant variations in revenues, expenses and
operating results from quarter to quarter and such variations are likely to
continue. A significant portion of our 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. During the quarterly periods outlined above, we experienced
variations in our revenues from quarter to quarter primarily related to the
significant growth of our interactive television products in the broadband
segment and broadcast segment products.
We have also experienced significant variations in our 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 affects manufacturing efficiencies and,
accordingly, 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.
Operating expenses also vary with the number, timing and significance of new
product and product enhancement introductions by us and our competitors,
increased competition, the gain or loss of significant customers, the hiring of
new personnel and general economic conditions. During the quarterly periods
outlined above, we experienced certain fluctuations in our operating expenses.
During the year ended January 31, 2002, we increased headcount within our
research and development and sales and marketing areas to reflect our continued
investment in future product development and our desire to increase our
interactive television and broadcast revenues. As a result, our expenses in
both of these areas increased during the year. In addition, our selling and
marketing costs fluctuate from quarter to quarter as a result of large
tradeshows that take place in the first and third quarter of the year and
significant promotional costs that are incurred for new product introductions.
All of the above factors are difficult for us to forecast, and these or other
factors may have a materially adverse effect our business, financial condition
and results of operations for one quarter or a series of quarters. Only a small
portion of our expenses vary with revenues in the short-term and there would
likely be a material adverse effect on our operating results if future revenues
are lower than expectations.
Based upon all of the forgoing, we believe that quarterly revenues and
operating results are likely to vary significantly in the future and that
period-to-period comparisons of our results of operations are not necessarily
meaningful and, therefore, should not be relied upon as indications of future
performance.
31
Liquidity and Capital Resources
We have financed our operations and capital expenditures primarily with the
proceeds of our common stock, borrowings and cash flows generated from
operations. Cash and cash equivalents increased $97.8 million from $6.1 million
at January 31, 2001 to $103.9 million at January 31, 2002. Working capital
increased from approximately $28.8 million at January 31, 2001 to approximately
$134.9 million at January 31, 2002.
Net cash used in operating activities for the year ended January 31, 2001
was approximately $3.2 million and net cash provided by operating activities
for the year ended January 31, 2002 was $4.2 million. The net cash provided by
operating activities in the year ended January 31, 2002 was the result of the
net income adjusted for non-cash expenses including depreciation and
amortization of $8.5 million and the changes in certain operating assets and
liabilities. The significant net changes in assets and liabilities that
provided cash from operations included an increase in deferred revenues of
approximately $4.6 million. These items that generated cash from operations
were offset by an increase in accounts receivable of $2.8 million, a decrease
in accounts payable of $2.6 million, a decrease in customer deposits of $1.5
million and an increase in inventories of approximately $1.1 million. We expect
that the broadcast segment and the interactive television products within the
broadband segment will continue to require a significant amount of cash to fund
future product development, to manufacture and deploy customer test and
demonstration equipment and to meet higher revenue levels in both product
segments.
Net cash used in investing activities was approximately $12.8 million and
$8.6 million for the year ended January 31, 2001 and January 31, 2002,
respectively. Intangible assets increased by $2.7 million in 2002 as a result
of the successful defense of our patents. Investment activity consisted
primarily of capital expenditures related to capital equipment required to
support the expansion and growth of the business. We had no material capital
expenditure commitments as of January 31, 2002. We had non-cancelable purchase
commitments for inventories of approximately $4.7 million at January 31, 2002.
Net cash provided from financing activities was approximately $19.4 million
and approximately $102.2 million for the year ended January 31, 2001 and
January 31, 2002, respectively. In the year ended January 31, 2002, the cash
provided from financing activities included net proceeds of $92.7 million from
the completion of our public stock offering on January 31, 2002, $10.0 million
in connection with the issuance of common stock issued on February 28, 2001
from a private placement sale of common stock and a warrant to Comcast SC
Investment, Inc. (See Note 14 to the Consolidated Financial Statements) and an
additional $5.4 million in borrowings under the line of credit with a bank.
During the same period, cash used in financing activities included
approximately $4.0 million in repayments under our revolving line of credit and
$5.0 million in principal payments under our equipment line of credit and
capital lease obligations.
In October 2001, we entered into a $10.0 million revolving line of credit
with a bank that expires in October 2003. Loans made under this revolving line
of credit will bear interest at a rate per annum equal to the bank's prime
rate, 4.75% at January 31, 2002. As of January 31, 2002, we have borrowings of
$5.4 million under this revolving line of credit. Borrowings under this line of
credit are collateralized by substantially all of our assets. The loan
agreement requires that we provide the bank with certain periodic financial
reports and comply with certain financial ratios including a minimum level of
earnings before interest, taxes and depreciation and amortization on a trailing
twelve month basis. As of January 31, 2002, we were in compliance with these
financial covenants. The line of credit replaces our prior revolving line of
credit and equipment line with a different bank. In conjunction with entering
into the new bank line, we repaid to our prior lender all outstanding
borrowings under the equipment line of credit in an amount of $3.4 million. In
March 2002, we repaid the outstanding balance under the current line of credit
of $5.4 million plus accrued interest to the bank.
In October 2000, we entered into an agreement with a bank to finance $1.2
million of the construction costs related to the purchase and renovation of a
manufacturing mill in New Hampshire that we previously purchased in February
2000. During the construction period, interest accrued and was paid at a per
annum rate of 8.875%.
32
Upon occupancy of the building in November 2000, the loan converted into two
promissory notes whereby we will pay principal and interest based upon a fixed
interest rate per annum over a five and ten year period, respectively, of
8.875% at January 31, 2002. Borrowings under the loan are secured by the land
and buildings of the renovated mill.
The loan agreement requires that we provide the bank with certain periodic
financial reports and comply with certain financial ratios. At January 31,
2002, we were in compliance with all covenants. As of January 31, 2002,
borrowings outstanding under the loan were $1.1 million.
It is typical for us to experience fluctuations in our monthly operating
results primarily due to the timing of receiving customer orders and the
related shipment of these customer orders. As a result of these monthly
fluctuations, we may experience an increase in our inventories as a result of
procurement of both short and long lead components for anticipated orders for
both our product segments, a decrease in our accounts payable balance primarily
due to the timing of payments for materials purchased for prior month
shipments, a decrease in accounts receivable amounts as a result of customer
payments without corresponding customer shipments and a resulting decrease in
cash and cash equivalents.
We believe that existing funds together with available borrowings under the
revolving line of credit and the proceeds from this offering are adequate to
satisfy our working capital and capital expenditure requirements for the
foreseeable future.
The following table reflects our current contractual obligations:
Non-cancelable
Lease Bank Line of Construction
Commitments Credit Loan Inventory Total
-------------- ------------ ------------ --------- -------
(in thousands)
2003....... $1,713 $ -- $ 155 $4,700 $ 6,568
2004....... 1,163 5,400 170 -- 6,733
2005....... 1,058 -- 186 -- 1,244
2006....... 437 -- 203 -- 640
2007....... 318 -- 67 -- 385
Beyond 2007 233 -- 279 -- 512
------ ------ ------ ------ -------
Total...... $4,922 $5,400 $1,060 $4,700 $16,082
Effects of Inflation
Our management believes that financial results have not been significantly
impacted by inflation and price changes.
Recent Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 142 (''SFAS 142''), ''Goodwill and Other
Intangible Assets,'' which is effective for us on February 1, 2002. SFAS 142
requires, among other things, the discontinuance of goodwill amortization and
includes provisions for the reclassification of certain existing recognized
intangibles as goodwill, reassessment of the useful lives of existing
recognized intangibles, and reclassification of certain intangibles out of
previously reported goodwill. We believe the adoption of SFAS 142 will not have
a material impact on our current financial position and results of operations.
In August 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 143 (''SFAS 143''), ''Accounting for
Obligations Associated with the Retirement of Long-Lived Assets.'' SFAS 143
provides the accounting requirements for retirement obligations associated with
tangible
33
long-lived assets. SFAS 143 is effective for financial statements for fiscal
years beginning after June 15, 2002. We believe the adoption of SFAS 143 will
not have a material impact on our current financial position and results of
operations.
In October 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 144 (''SFAS 144''), ''Accounting for the
Impairment or Disposal of Long-Lived Assets.'' SFAS 144 requires one method of
accounting for long-lived assets disposed of by sale. SFAS 144 is effective for
financial statements issued for fiscal years beginning after December 15, 2001.
We believe the adoption of SFAS 144 will not have a material impact on our
current financial position and results of operations.
In November 2001, the Emerging Issues Task Force (EITF) reached a consensus
on EITF Issue 01-9, "Accounting for Consideration Given by a Vendor to a
Customer or Reseller of the Vendor's Products" ("EITF 01-9"). EITF 01-9
presumes that consideration, including equity instruments, from a vendor to a
customer or reseller of the vendor's products is a reduction of the selling
prices of the vendor's products and, therefore, should be characterized as a
reduction of revenue when recognized in the vendor's income statement and could
lead to negative revenue under certain circumstances. Revenue reduction is
required unless consideration relates to a separate identifiable benefit and
the benefit's fair value can be established. EITF 01-9 is effective for
financial statements issued for fiscal years beginning after December 15, 2001.
We believe the adoption of EITF 01-9 will not have a material impact on our
current financial position and results of operations as we currently apply its
guidance.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
We face exposure to financial market risks, including adverse movements in
foreign currency exchange rates and changes in interest rates. These exposures
may change over time as business practices evolve and could have a material
adverse impact on our financial results. Our primary exposure has been related
to local currency revenue and operating expenses in Europe and Asia.
Historically, we have not hedged specific currency exposures as gains and
losses on foreign currency transactions have not been material to date. At
January 31, 2001 and January 31, 2002, we had approximately $10.1 million and
$6.5 million outstanding related to variable rate U.S. dollar denominated 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 approximately $95,000 for the twelve month period
ended January 31, 2001 and $36,000 for the twelve month period ended January
31, 2002.
The carrying amounts reflected in the consolidated balance sheet of cash and
cash equivalents, trade receivables, and trade payables approximates fair value
at January 31, 2002 due to the short maturities of these instruments.
We maintain investment portfolio holdings of various issuers, types, and
maturities. Our cash and marketable securities include cash equivalents, which
we consider 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 January 31, 2002, a sharp rise in interest rates should
not have a material adverse impact on the fair value of our investment
portfolio. As a result, we do 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' report thereon, appear at pages F-1 through F-20, and S-1,
respectively, of this Form 10-K. The supplementary financial information
required by Item 302 of Regulation S-K is included in this Annual Report under
Item 5.
ITEM 9. Changes in Disagreements with Accountants and Financial Disclosure
Not applicable.
34
PART III
ITEM 10. Directors and Executive Officers of the Registrant
Information concerning the directors of SeaChange is hereby incorporated by
reference from the information contained under the heading "Election of
Directors" in SeaChange's definitive proxy statement related to SeaChange's
July 17, 2002 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 SeaChange
is hereby incorporated by reference to the information contained under the
heading "Occupations of Directors and Executive Officers" in SeaChange'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.
ITEM 12. Security and Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters
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.
PART IV
ITEM 14. Exhibits and Financial Statement Schedules, and Reports on Form 8-K
(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 January 31, 2001 and January 31, 2002............................ F-2
Consolidated Statement of Operations for the year ended December 31, 1999, the one month ended
January 31, 2000, the years ended January 31, 2001 and January 31, 2002, and the one month ended
January 31, 1999 (unaudited).................................................................... F-3
Consolidated Statement of Stockholders' Equity for the year ended December 31, 1999, the one month
ended January 31, 2000, the years ended January 31, 2001 and January 31, 2002, and the one month
ended January 31, 1999 (unaudited).............................................................. F-4
Consolidated Statement of Cash Flows for the year ended December 31, 1999, the one month ended
January 31, 2000, the years ended January 31, 2001 and January 31, 2002, and the one month ended
January 31, 1999 (unaudited).................................................................... F-5
Notes to Consolidated Financial Statements........................................................ F-6
35
(a)(2) INDEX TO FINANCIAL STATEMENT SCHEDULES
The following Financial Statement Schedule of the Registrant is filed as
part of this report:
Page
----
Schedule II -- Valuation and Qualifying Accounts and Reserves S-1
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) REPORTS ON FORM 8-K
The Registrant did not file any reports on Form 8-K during the three months
ended January 31, 2002.
(c) 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 Commission (the "Commission"), 450 Fifth Street, N.W.,
Washington, D.C. 20549. Copies of such material can also be obtained from the
Public Reference Section of the Commission, 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.
36
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: APRIL 29, 2002
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, April 29, 2002
William C. Styslinger, III Chairman of the Board and
Director (Principal
Executive Officer)
/s/ WILLIAM L. FIEDLER
- ------------------------------ Vice President, Finance April 29, 2002
William L. Fiedler and Administration, Chief
Financial Officer,
Secretary and Treasurer
(Principal Financial and
Accounting Officer)
/s/ MARTIN R. HOFFMANN
- ------------------------------ Director April 29, 2002
Martin R. Hoffmann
/S/ CARMINE VONA
- ------------------------------ Director April 29, 2002
Carmine Vona
/S/ THOMAS F. OLSON
- ------------------------------ Director April 29, 2002
Thomas F. Olson
37
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
3.1 --Amended and Restated Certificate of Incorporation of the Company (filed as Exhibit 3.3 to the
Company's Registration Statement on Form S-1 previously filed on November 4, 1996 with the
Commission (File No. 333-12233) and incorporated herein by reference).
3.2 --Certificate of Amendment, filed May 25, 2000 with the Secretary of State in the State of
Delaware, to the Amended and Restated Certificate of Incorporation of the Company (filed as
Exhibit 4.1 to the Company's Quarterly Report on 10-Q previously filed on December 15, 2000
with the Commission (Filed No. 000-21393) and incorporated herein by reference).
3.3 --Amended and Restated By-laws of the Company (filed as Exhibit 3.5 to the Company's
Registration Statement on Form S-1 previously filed on November 4, 1996 with the
Commission (File No. 333-12233) and incorporated herein by reference).
4.1 --Specimen certificate representing the Common Stock (filed as Exhibit 4.1 to the Company's
Registration Statement on Form S-1 previously filed on November 4, 1996 with the
Commission (File No. 333-12233) and incorporated herein by reference).
4.2 --Amended and Restated Certificate of Incorporation of the Company (filed as Exhibit 3.3 to the
Company's Registration Statement on Form S-1 previously filed on November 4, 1996 with the
Commission (File No. 333-12233) and incorporated herein by reference).
4.3 --Certificate of Amendment, filed May 25, 2000 with the Secretary of State in the State of
Delaware, to the Amended and Restated Certificate of Incorporation of the Company (filed as
Exhibit 4.2 to the Company's registration statement on Form S-3 previously filed on December
6, 2000 with the Commission (Filed No. 333-51386) and incorporated herein by reference).
10.1 --Amended and Restated 1995 Stock Option Plan (filed as Annex B to the Company's Proxy
Statement on Form 14a previously filed on May 31, 2001 with the Commission (File No. 000-
21393) and incorporated herein by reference).
10.2 --1996 Non-Employee Director Stock Option Plan (filed as Exhibit 10.2 to the Company's
Registration Statement on Form S-1 previously filed on November 4, 1996 with the
Commission (File No. 333-12233) and incorporated herein by reference).
10.3 --Second Amended and Restated 1996 Employee Stock Purchase Plan of the Company (filed as
Exhibit 10.3 to the Company's Registration Statement on Form S-1 previously filed on March
1, 2001 with the Commission (File No. 333-56410) and incorporated herein by reference).
10.4 --Loan Agreement, dated as of October 16, 2000, by and between the Company and the Bank of
New Hampshire, N.A. (filed as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q
previously filed on December 15, 2000 with the Commission (File No. 000-21393) and
incorporated herein by reference).
10.5 --Loan and Security Agreement, dated as of October 22, 2001, by and between Citizens Bank of
Massachusetts and the Company (filed as Exhibit 10.1 to the Company's Quarterly Report on
Form 10-Q previously filed on December 13, 2001 with the Commission (File No. 000-21393)
and incorporated herein by reference).
10.6 --Common Stock Purchase Agreement, dated as of May 23, 2000, by and between the Company
and Microsoft Corporation (filed as Exhibit 10.3 to the Company's Quarterly Report on Form
10-Q previously filed on September 14, 2000 with the Commission (File No. 000-21393) and
incorporated herein by reference).
10.7 --Registration Rights Agreement, dated as of May 23, 2000, by and between the Company and
Microsoft Corporation (filed as Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q
previously filed on September 14, 2000 with the Commission (File No. 000-21393) and
incorporated herein by reference).
10.8** --License and Development Agreement, dated as of May 8, 2000, by and between the Company
and Microsoft Licensing, Inc. (filed as Exhibit 10.5 to the Company's Amended Quarterly
Report on 10-Q for the quarterly period ended July 31, 2000 filed on March 1, 2001 with the
Commission (File No. 000-21393) and incorporated herein by reference).
38
Exhibit No. Description
- ----------- -----------
10.9** --Investment Term Sheet, dated as of May 8, 2000, by and between the Company and Microsoft
Corporation (filed as Exhibit 10.6 to the Company's Amended Quarterly Report on 10-Q for the
quarterly period ended July 31, 2000 filed on March 1, 2001 with the Commission (File No.
000-21393) and incorporated herein by reference).
10.10** --Video-on-Demand Purchase Agreement, dated as of December 1, 2000, by and between the
Company and Comcast Cable Communications of Pennsylvania, Inc. (filed as Exhibit 10.1 to
the Company's Quarterly Report on Form 10-Q filed on December 15, 2000 with the
Commission (File No. 000-21393) and incorporated herein by reference).
10.11 --Stock Purchase Agreement, dated as of February 28, 2001, by and between the Company and
Comcast SC Investment, Inc. (filed as Exhibit 10.15 to the Company's Registration Statement
on Form S-1 previously filed on March 1, 2001 with the Commission (File No. 333-56410) and
incorporated herein by reference).
10.12 --Amended and Restated Registration Rights Agreement, dated as of February 28, 2001, by and
between the Company and Comcast SC Investment, Inc. (filed as Exhibit 10.16 to the
Company's Registration Statement on Form S-1 previously filed on March 1, 2001 with the
Commission (File No. 333-56410) and incorporated herein by reference).
10.13 --Stock Purchase Agreement, dated as of December 10, 1997, by and among the Company, IPC
Interactive Pte. Ltd. and the shareholders of IPC Interactive Pte. Ltd. (filed as Exhibit 2.1 to the
Company's Current Report on Form 8-K previously filed on December 24, 1997 with the
Commission (File No. 000-21393) and incorporated herein by reference).
10.14 --Stock Purchase Agreement, dated as of December 30, 1999, by and among the Company,Digital
Video Arts, Ltd. and the stockholders of Digital Video Arts, Ltd. and Corum Group Ltd. (filed
as Exhibit 2.1 to the Company's Current Report on Form 8-K previously filed on January 14,
2000 with the Commission (File No. 000-21393) and incorporated herein by reference).
10.15 --License Agreement dated May 30, 1996 between Summit Software Systems, Inc. and the
Company (filed as Exhibit 10.7 to the Company's Registration Statement on Form S-1
previously filed on November 4, 1996 with the Commission (File No. 333-12233)and
incorporated herein by reference).
10.16 --Lease Agreement dated May 28, 1998 between Robert Quirk, Trustee of Maynard Industrial
Properties Associates Trust and the Company (filed as Exhibit 10.3 to the Company's Annual
Report on Form 10-K previously filed on March 24, 1999 with the Commission (File No. 000-
21393) and incorporated herein by reference).
21.1 --List of Significant Subsidiaries (filed as Exhibit 21.1 to the Company's Annual Report on Form
10-K/A previously filed on April 14, 2000 with the Commission (File No.000-21393) and
incorporated herein by reference).
23.1* --Consent of PricewaterhouseCoopers LLP
24.1 --Power of Attorney (included on signature page).
- --------
* Filed herewith.
** Confidential treatment requested as to certain portions of the document,
which portions have been omitted and filed separately with the Commission.
39
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of SeaChange International, Inc.:
In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) present fairly, in all material respects, the
financial position of SeaChange International, Inc. and its subsidiaries at
January 31, 2001 and 2002 and the results of their operations and their cash
flows for the year ended December 31, 1999, the one month ended January 31,
2000 and for each of the two years in the period ended January 31, 2002 in
conformity with accounting principles generally accepted in the United States
of America. In addition, in our opinion, the financial statement schedule
listed in the index appearing under Item 14(a)(2)presents fairly, in all
material respects, the information set forth therein when read in conjunction
with the related consolidated financial statements. These financial statements
and financial statement schedule are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements and financial statement schedule based on our audits. We conducted
our audits of these statements in accordance with auditing standards generally
accepted in the United States of America, 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 examining, 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 our
opinion.
As discussed in Note 3 to the consolidated financial statements, during the
year ended January 31, 2001, the Company changed its method of recognizing
revenue.
/s/ PricewaterhouseCoopers LLP
Boston, Massachusetts
March 1, 2002, except for the last
sentence of the second paragraph
of Note 7, as to which the
date is April 23, 2002
F-1
SEACHANGE INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEET
(in thousands, except share data)
January 31, January 31,
2001 2002
----------- -----------
Assets
Current assets:
Cash and cash equivalents..................................... $ 6,145 $103,898
Accounts receivable, net of allowance for doubtful accounts of
$742 at January 31, 2001 and $859
at January 31, 2002......................................... 27,112 29,916
Inventories................................................... 24,907 23,990
Prepaid expenses and other current assets..................... 2,671 2,311
Deferred income taxes......................................... 7,001 7,294
------- --------
Total current assets........................................ 67,836 167,409
Property and equipment, net.................................... 15,886 17,652
Deferred income taxes.......................................... 674 1,481
Other assets................................................... 1,159 2,252
Goodwill and intangibles....................................... 2,698 4,183
------- --------
$88,253 $192,977
======= ========
Liabilities and Stockholders' Equity
Current liabilities:
Revolving line of credit...................................... $ 4,000 $ --
Current portion of lines of credit and obligations under
capital lease............................................... 2,532 291
Accounts payable.............................................. 17,332 14,735
Accrued expenses.............................................. 1,816 1,837
Customer deposits............................................. 3,946 2,484
Deferred revenue.............................................. 8,435 13,071
Income taxes payable.......................................... 956 70
------- --------
Total current liabilities................................... 39,017 32,488
------- --------
Long-term portion of lines of credit and obligations under
capital lease................................................ 3,934 6,363
------- --------
Commitments and contingencies (Note 12)
Stockholders' Equity:
Convertible preferred stock, 5,000,000 shares authorized, none
outstanding.................................................. -- --
Common stock, $.01 par value; 100,000,000 shares authorized;
22,037,811 and 26,532,671 shares issued and outstanding at
January 31, 2001 and 2002, respectively...................... 221 265
Additional paid-in capital..................................... 50,157 159,914
Deferred equity discount....................................... -- (1,164)
Due from shareholders.......................................... -- (122)
Accumulated deficit............................................ (4,905) (4,524)
Accumulated other comprehensive loss........................... (171) (243)
------- --------
Total stockholders' equity.................................. 45,302 154,126
------- --------
$88,253 $192,977
======= ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-2
SEACHANGE INTERNATIONAL, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands, except per share data)
One One month
Year ended month ended Year ended Year ended ended
December 31, January 31, January 31, January 31, January 31,
1999 2000 2001 2002 1999
------------ ----------- ----------- ----------- -----------
(unaudited)
Revenues:
Systems............................................ $68,457 $ 226 $74,986 $ 87,569 $ 697
Services........................................... 16,764 1,484 23,482 28,210 1,211
------- ------- ------- -------- -------
85,221 1,710 98,468 115,779 1,908
------- ------- ------- -------- -------
Costs of revenues:
Systems............................................ 38,889 633 39,928 49,127 670
Services........................................... 14,962 1,445 18,798 21,030 1,049
------- ------- ------- -------- -------
53,851 2,078 58,726 70,157 1,719
------- ------- ------- -------- -------
Gross profit (loss)................................ 31,370 (368) 39,742 45,622 189
------- ------- ------- -------- -------
Operating expenses:
Research and development........................... 16,302 1,764 20,283 23,359 1,324
Selling and marketing.............................. 8,595 1,034 12,472 14,178 522
General and administrative......................... 5,335 457 7,372 7,358 447
Acquisition costs.................................. 684 -- -- -- --
------- ------- ------- -------- -------
30,916 3,255 40,127 44,895 2,293
------- ------- ------- -------- -------
Income (loss) from operations...................... 454 (3,623) (385) 727 (2,104)
Interest income (expense), net...................... 28 9 (212) (449) 9
------- ------- ------- -------- -------
Income (loss) before income taxes.................. 482 (3,614) (597) 278 (2,095)
Benefit for income taxes............................ (15) (1,156) (690) (103) (691)
------- ------- ------- -------- -------
Income (loss) before cumulative effect of change in
accounting principle.............................. 497 (2,458) 93 381 (1,404)
Cumulative effect of change in accounting principle,
net of tax of $732................................ -- -- (1,100) -- --
------- ------- ------- -------- -------
Net income (loss).................................. $ 497 $(2,458) $(1,007) $ 381 $(1,404)
======= ======= ======= ======== =======
Basic and diluted earnings (loss) per share before
cumulative effect of change in accounting
principle.......................................... $ 0.02 $ (0.12) $ 0.00 $ 0.02 $ (0.07)
Cumulative effect of change in accounting principle. -- -- (0.05) -- --
------- ------- ------- -------- -------
Basic and diluted earnings (loss) per share......... $ 0.02 $ (0.12) $ (0.05) $ 0.02 $ (0.07)
======= ======= ======= ======== =======
Pro forma amounts assuming the change in
accounting principle is applied retroactively:
Net income (loss).................................. $ 323 $(2,163) $ 93
======= ======= =======
Earnings (loss) per share--Basic................... $ 0.02 $ (0.10) $ 0.00
======= ======= =======
Earnings (loss) per share--Diluted................. $ 0.01 $ (0.10) $ 0.00
======= ======= =======
Shares used in calculating:
Basic earnings (loss) per share.................... 20,883 21,269 21,745 22,878 20,901
======= ======= ======= ======== =======
Diluted earnings (loss) per share.................. 21,774 21,269 23,234 23,917 20,901
======= ======= ======= ======== =======
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
SEACHANGE INTERNATIONAL, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(in thousands, except share data)
Common Stock
-----------------
Accumulated Total Compre-
Additional Deferred other Stock- hensive
Number Par paid-in Equity Due from Accumulated comprehensive holders' income
of shares value capital Discount Shareholders deficit loss Equity (loss)
---------- ----- ---------- -------- ------------ ----------- ------------- -------- -------
Balance at December 31, 1998....... 20,918,260 $209 $ 33,107 $ -- $ -- $(1,937) $ (59) $ 31,320
Issuance of common stock
pursuant to exercise of stock
options........................... 13,905 -- 50 -- -- -- -- 50
Translation adjustment............. 25 25 $ 25
Net loss........................... -- -- -- -- -- (1,404) -- (1,404) (1,404)
---------- ---- -------- ------- ----- ------- ----- -------- -------
Comprehensive loss................. $(1,379)
Balance at January 31, 1999
(unaudited)....................... 20,932,165 209 33,157 -- -- (3,341) (34) 29,991
Issuance of common stock
pursuant to exercise of stock
options........................... 296,848 3 1,145 -- -- -- -- 1,148
Issuance of common stock in
connection with employee stock
purchase plan..................... 87,014 1 422 -- -- -- -- 423
Issuance of common stock in
connection with Digital Video
Arts, Ltd. acquisition............ 17,078 -- 528 -- -- -- -- 528
Purchase and retirement of treasury
stock............................. (47,250) -- (1) -- -- -- -- (1)
Tax benefit from stock options..... -- -- 382 -- -- -- -- 382
Translation adjustment............. -- -- -- -- -- -- (31) (31) (31)
Net income......................... -- -- -- -- -- 1,901 -- 1,901 1,901
---------- ---- -------- ------- ----- ------- ----- -------- -------
Comprehensive income............... $ 1,870
Balance at December 31, 1999....... 21,285,855 213 35,633 -- -- (1,440) (65) 34,341
Issuance of common stock
pursuant to exercise of stock
options........................... 14,330 -- 62 -- -- -- -- 62
Translation adjustment............. -- -- -- -- -- -- 6 6 6
Net loss........................... -- -- -- -- -- (2,458) -- (2,458) (2,458)
---------- ---- -------- ------- ----- ------- ----- -------- -------
Comprehensive loss................. $(2,452)
Balance at January 31, 2000........ 21,300,185 213 35,695 -- -- (3,898) (59) 31,951
Issuance of common stock
pursuant to exercise of stock
options........................... 392,669 4 1,802 -- -- -- -- 1,806
Issuance of common stock in
connection with employee stock
purchase plan..................... 67,795 1 1,013 -- -- -- -- 1,014
Issuance of common stock in
connection with Microsoft
Corporation investment............ 277,162 3 9,997 -- -- -- -- 10,000
Tax benefit from stock options..... -- -- 1,650 -- -- -- -- 1,650
Translation adjustment............. -- -- -- -- -- -- (112) (112) (112)
Net loss........................... -- -- -- -- -- (1,007) -- (1,007) (1,007)
---------- ---- -------- ------- ----- ------- ----- -------- -------
Comprehensive loss................. $(1,119)
Balance at January 31, 2001........ 22,037,811 221 50,157 -- -- (4,905) (171) 45,302
Issuance of common stock
pursuant to exercise of stock
options........................... 282,683 3 2,451 -- (122) -- -- 2,332
Issuance of common stock in
connection with the employee
stock purchase plan............... 71,622 1 1,154 -- -- -- -- 1,155
Issuance of common stock in
connection with Comcast
investment........................ 756,144 7 12,148 (2,329) -- -- -- 9,826
Amortization of deferred equity
discount.......................... -- -- -- 1,165 -- -- -- 1,165
Issuance of common stock
pursuant to public offering net of
issuance costs.................... 3,384,411 33 92,654 -- -- -- -- 92,687
Tax benefit from stock options..... 1,350 -- -- -- -- 1,350
Translation adjustment............. -- -- -- -- -- -- (72) (72) (72)
Net income......................... -- -- -- -- -- 381 -- 381 381
---------- ---- -------- ------- ----- ------- ----- -------- -------
Comprehensive income............... $ 309
Balance at January 31, 2002........ 26,532,671 $265 $159,914 $(1,164) $(122) $(4,524) $(243) $154,126
========== ==== ======== ======= ===== ======= ===== ========
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)
One month One month
Year ended ended Year ended Year ended ended
December 31, January 31, January 31, January 31, January 31,
1999 2000 2001 2002 1999
------------ ----------- ----------- ----------- -----------
(unaudited)
Cash flows from operating activities:
Net income (loss)............................................... $ 497 $(2,458) $ (1,007) $ 381 $(1,404)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization.................................. 4,218 355 4,920 7,354 379
Inventory valuation allowance.................................. 458 -- 823 -- --
Amortization of deferred equity discount....................... -- -- -- 1,165 --
Acquisition costs.............................................. 684 -- -- -- --
Tax benefit from stock options................................. 382 -- 1,650 1,350 --
Deferred income taxes.......................................... (933) (1,156) (3,601) (1,100) (691)
Changes in operating assets and liabilities:
Accounts receivable........................................... (177) 1,084 (10,356) (2,804) 5,019
Inventories................................................... (4,257) (2,961) (5,126) (1,061) (1,630)
Prepaid expenses and other current assets and other
assets....................................................... 2,249 (46) (2,113) (804) (743)
Accounts payable.............................................. 4,935 (4,587) 6,881 (2,597) (2,678)
Accrued expenses.............................................. (61) (723) (960) 20 (652)
Customer deposits............................................. 388 336 1,518 (1,462) 188
Deferred revenue.............................................. 441 1,912 2,143 4,636 1,037
Income taxes payable.......................................... 200 (50) 1,981 (886) (115)
------- ------- -------- -------- -------
Net cash provided by (used in) operating activities......... 9,024 (8,294) (3,247) 4,192 (1,290)
------- ------- -------- -------- -------
Cash flows from investing activities:
Purchases of property and equipment............................. (3,130) (275) (10,276) (5,879) (62)
Increase in intangible assets................................... -- -- (2,500) (2,748) --
------- ------- -------- -------- -------
Net cash used in investing activities....................... (3,130) (275) (12,776) (8,627) (62)
------- ------- -------- -------- -------
Cash flows from financing activities:
Proceeds from borrowings under line of credit................... -- -- 4,000 5,410 --
Proceeds from borrowings under equipment line of credit......... 1,106 -- 4,823 -- --
Proceeds from borrowings under construction loan................ -- -- 1,183 -- --
Repayments under revolving line of credit....................... -- -- -- (4,000) --
Repayments under line of credit and equipment...................
line of credit................................................ (2,245) (72) (1,569) (5,021) (2,039)
Repayment of obligation under capital lease..................... (500) (18) (160) (201) (11)
Proceeds from issuance of common stock, net of issuance
costs.......................................................... 1,621 62 11,170 106,000 50
------- ------- -------- -------- -------
Net cash provided by (used in) financing activities......... (18) (28) 19,447 102,188 (2,000)
------- ------- -------- -------- -------
Net increase (decrease) in cash and cash equivalents............ 5,876 (8,597) 3,424 97,753 (3,352)
Cash and cash equivalents, beginning of period.................. 5,442 11,318 2,721 6,145 5,442
------- ------- -------- -------- -------
Cash and cash equivalents, end of period........................ $11,318 $ 2,721 $ 6,145 $103,898 $ 2,090
======= ======= ======== ======== =======
Supplemental disclosure of cash flow information:
Income taxes paid............................................... $ 81 $ -- $ 303 $ 749 $ --
Interest paid................................................... $ 210 $ 19 $ 473 $ 717 $ 17
Supplemental disclosure of noncash activity:
Transfer of items originally classified as inventories to fixed
assets......................................................... $ 227 $ -- $ -- $ 2,701 $ 109
Transfer of items originally classified as fixed assets to
inventories.................................................... $ 3,055 $ -- $ 515 $ 723 $ --
Equipment acquired under capital lease.......................... $ 336 $ -- $ -- $ -- $ --
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Nature of Business
SeaChange develops, manufactures and sells systems, known as video storage
servers, that automate the management and distribution of both short-form video
streams, such as advertisements, and long-form video streams, such as movies or
other feature presentations, each of which requires precise, accurate and
continuous execution, to cable system operators, telecommunications companies
and broadcast television companies. Through January 31, 2002, substantially all
of SeaChange's revenues were derived from the sale of broadband and broadcast
systems and related services and content to cable system operators, broadcast
and telecommunications companies in the United States and internationally.
In April 2000, SeaChange's Board of Directors voted to change SeaChange's
fiscal accounting year from December 31 to January 31, such that each fiscal
year begins in February and ends in January.
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 SeaChange and
its subsidiaries. All significant intercompany accounts and transactions have
been eliminated. Certain prior period amounts have been reclassified to conform
to current period presentation.
Revenue Recognition
Revenues from sales of systems are recognized upon shipment provided title
and risk of loss has passed to the customer, there is evidence of an
arrangement, fees are fixed or determinable and collection of the related
receivable is reasonably assured. Installation, project management and training
revenue is deferred and recognized as these services are performed. Revenue
from technical support and maintenance is deferred and recognized ratably over
the period of the related agreements, generally one year. Customers are billed
for installation, project management, training and maintenance at the time of
the product sale. If a portion of the sales price is not due until installation
of the system is complete, that portion of the sales price is deferred until
installation is complete. Revenue from content fees, primarily movies, is
recognized based on the volume of monthly purchases that are made by hotel
guests. Revenue from product development contract services is recognized based
on the time and materials incurred to complete the work. Shipping and handling
costs are included in revenue and cost of revenues.
SeaChange's transactions frequently involve the sales of systems and
services under multiple element arrangements. Systems sales always include one
year of free technical support and maintenance services. Revenue under multiple
element arrangements is allocated to all elements except systems based upon the
fair value of those elements. The amounts allocated to training, project
management, technical support and maintenance and content fees is based upon
the price charged when these elements are sold separately and unaccompanied by
the other elements. The amount allocated to installation revenue is based upon
hourly rates and the estimated time required to complete the service. The
amount allocated to systems is done on a residual method basis. Under this
method, the total arrangement value is allocated first to undelivered elements,
based on their fair values, with the remainder being allocated to systems
revenue. Installation, training and project management services are not
essential to the functionality of systems as these services do not alter the
equipment's capabilities, are available from other vendors and the systems are
standard products. For transactions in which consideration, including equity
instruments, is given to a customer, SeaChange accounts
F-6
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
for the value of this consideration as a reduction in revenue in its statement
of operations (see Note 14 in the consolidated financial statements for further
discussion).
Concentration of Credit Risk
Financial instruments which potentially expose SeaChange to concentrations
of credit risk include trade accounts receivable. To minimize this risk,
SeaChange evaluates customers' financial condition, requires advance payments
from certain of its customers and maintains reserves for potential credit
losses. At January 31, 2001 and January 31, 2002, SeaChange had an allowance
for doubtful accounts of $742,000 and $859,000, respectively, to provide for
potential credit losses and such losses to date have not exceeded management's
expectations.
In the year ended December 31, 1999, the one month ended January 31, 2000,
and the years ended January 31, 2001 and 2002, revenues from SeaChange's five
largest customers represented approximately 47%, 47%, 44%, and 58%
respectively, of SeaChange's total revenues. In the year ended December 31,
1999, the one month ended January 31, 2000, and the year ended January 31,
2001, two customers each accounted for more than 10% of SeaChange's revenues.
In the year ended January 31, 2002, three customers each accounted for more
than 10% of SeaChange's revenues.
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, Cash Equivalents and Marketable Securities
SeaChange considers all highly liquid investments purchased with an original
maturity of three months or less at the date of purchase to be cash
equivalents. SeaChange invests its excess cash in money market funds, municipal
securities and corporate debt securities that are subject to minimal credit and
market risk. Marketable securities 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. Gross unrealized gains and losses on securities
for the year ended December 31, 1999, the one month ended January 31, 2000, the
years ended January 31, 2001 and January 31, 2002, the cost of which is based
upon the specific identification method, were not significant.
Property and Equipment
Property and equipment consist of land and buildings, office and computer
equipment, leasehold improvements, demonstration equipment, deployed assets and
spare components and assemblies used to service SeaChange's installed base.
Demonstration equipment consists of systems manufactured by SeaChange 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 are the movie systems owned and manufactured by
SeaChange that are installed in a hotel environment. Deployed assets are
depreciated over the life of the related service agreements ranging from 2 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.
F-7
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Inventories
Inventories are stated at the lower of cost or net realizable value. Cost is
determined using the first-in, first-out (FIFO) method. Inventories consist
primarily of components and subassemblies and finished products held for sale.
All of SeaChange's hardware components are purchased from outside vendors.
SeaChange depends upon certain vendors for the manufacture of significant
components for all of its products. If these vendors were to become unwilling
or unable to manufacture these products in required volumes, SeaChange would
have to identify and qualify acceptable alternative vendors. The inability to
develop alternative sources, if required in the future, could result in delays
or reductions in product shipments and thereby adversely affect SeaChange's
financial condition and results of operations.
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 carrying value of
goodwill, intangible assets and other long-lived assets is reviewed on a
regular basis for the existence of facts or circumstances, both internally and
externally, that may suggest impairment. Factors SeaChange considers important
which could trigger the impairment review include:
. significant underperformance relative to historical or projected future
operating results;
. significant negative industry or economic trends;
. significant decline in our stock price for a sustained period;
. significant decline in our technological value as compared to the market;
and
. our market capitalization relative to net book value.
If such circumstances exist, SeaChange evaluates the carrying value of
long-lived assets to determine if impairment exists based upon estimated
undiscounted future cash flows over the remaining useful life of the assets and
comparing that value to the carrying value of the assets. If the carrying value
of the asset is greater than the estimated future cash flows, the asset is
written down to the estimated fair value. SeaChange determines the estimated
fair value of the assets on a projected discounted cash flow method using a
discount rate determined by management to be commensurate with the risk
inherent in the current business model. In determining expected future cash
flows, assets are grouped at the lowest level for which cash flows are
identifiable and independent of cash flows from other asset groups. To date, no
such impairment has been indicated. SeaChange's cash flow estimates contain
management's best estimates, using appropriate and customary assumptions and
projections at the time. It is possible that changes in these estimates in the
near term could materially affect SeaChange's financial condition and results
of operations.
SeaChange defers legal costs associated with defending its existing patents.
If the patent defense is successful, the costs are capitalized as an intangible
asset and amortized over their estimated remaining useful life. If the patent
defense is unsuccessful, the amounts that have been deferred are charged to
operating expense. Included in other assets at January 31, 2002 are deferred
legal costs of $1,450,000 associated with on-going litigation related to the
nCube lawsuits. At January 31, 2002, goodwill and intangibles consisted of
$253,000 of net goodwill costs which will cease to be amortized beginning
February 1, 2002 and net capitalized patent defense costs of $3,930,000 which
are being amortized to general and administrative expenses over their four year
estimated useful life. Accumulated amortization of goodwill and intangible
assets was $1,438,000 and $2,701,000 at January 31, 2001 and January 31, 2002,
respectively.
F-8
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Research and Development and Software Development Costs
Costs incurred in the research and development of SeaChange'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 SeaChange'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 SeaChange's and its subsidiaries' 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. SeaChange provides the disclosure requirements of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation", ("SFAS 123") and related interpretations. Non-employee stock
awards are accounted for in accordance with Emerging Issues Task Force Issue
No. 96-18, "Accounting for Equity Instruments That are Issued to Other than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services".
Foreign Currency Translation
SeaChange 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.
Comprehensive Income
Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" ("SFAS 130") requires that changes in comprehensive
income be shown in a financial statement that is displayed with the same
prominence as other financial statements. SeaChange has presented accumulated
other comprehensive income and other comprehensive income in the Statement of
Stockholders' Equity. Other comprehensive loss consists primarily of cumulative
translation adjustments.
Advertising Costs
Advertising costs are charged to expense as incurred. Advertising costs were
$857,000, $40,000, $1,089,000, and $543,000 for the year ended December 31,
1999, the one month ended January 31, 2000, and the years ended January 31,
2001, and 2002, 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
F-9
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
stock outstanding during the period and the weighted average number of
potential common stock, such as stock options and restricted stock.
For the one month ended January 31, 2000, 2,055,000 common shares issuable
upon the exercise of stock options are antidilutive because SeaChange recorded
a net loss for the period and, therefore, have been excluded from the diluted
earnings per share computation. For the years ended December 31, 1999, January
31, 2001 and January 31, 2002, 121,061, 474,459, and 2,083,978, respectively,
of common shares issuable upon the exercise of stock options have been excluded
from the diluted earnings per share computation as the exercise price of these
common shares were above the market price of the common stock at the periods
indicated.
Below is a summary of the shares used in calculating basic and diluted
earnings per share for the periods indicated:
One month
Year Ended Month Ended Year Ended Year Ended Ended
December 31, January 31, January 31, January 31, January 31,
1999 2000 2001 2002 1999
------------ ----------- ----------- ----------- -----------
(unaudited)
Weighted average shares used in calculating
earnings per share--Basic................ 20,883,000 21,269,000 21,745,000 22,878,000 20,901,000
Dilutive common stock equivalents.......... 891,000 -- 1,489,000 1,039,000 --
---------- ---------- ---------- ---------- ----------
Weighted average shares used in calculating
earnings per share--Diluted.............. 21,774,000 21,269,000 23,234,000 23,917,000 20,901,000
========== ========== ========== ========== ==========
New Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other
Intangible Assets," which is effective for SeaChange on February 1, 2002. SFAS
142 requires, among other things, the discontinuance of goodwill amortization
and includes provisions for the reclassification of certain existing recognized
intangibles as goodwill, reassessment of the useful lives of existing
recognized intangibles, and reclassification of certain intangibles out of
previously reported goodwill. SeaChange believes the adoption of SFAS 142 will
not have a material impact on its current financial position and results of
operations.
In August 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 143 ("SFAS 143"), "Accounting for
Obligations Associated with the Retirement of Long-Lived Assets." SFAS 143
provides the accounting requirements for retirement obligations associated with
tangible long-lived assets. SFAS 143 is effective for financial statements for
fiscal years beginning after June 15, 2002. SeaChange believes the adoption of
SFAS 143 will not have a material impact on its current financial position and
results of operations.
In October 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 144 ("SFAS 144"), "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS 144 requires one method of
accounting for long-lived assets disposed of by sale. SFAS 144 is effective for
financial statements issued for fiscal years beginning after December 15, 2001.
SeaChange believes the adoption of SFAS 144 will not have a material impact on
its current financial position and results of operations.
In November 2001, the Emerging Issues Task Force (EITF) reached a consensus
on EITF Issue 01-9, "Accounting for Consideration Given by a Vendor to a
Customer or Reseller of the Vendor's Products" ("EITF
F-10
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
01-9"). EITF 01-9 presumes that consideration, including equity instruments,
from a vendor to a customer or reseller of the vendor's products is a reduction
of the selling prices of the vendor's products and, therefore, should be
characterized as a reduction of revenue when recognized in the vendor's income
statement and could lead to negative revenue under certain circumstances.
Revenue reduction is required unless consideration relates to a separate
identifiable benefit and the benefit's fair value can be established. EITF 01-9
is effective for financial statements issued for fiscal years beginning after
December 15, 2001. SeaChange believes the adoption of EITF 01-9 will not have a
material impact on its current financial position and results of operations as
Seachange currently applies the guidance.
3. Change in Accounting Principle
In December 1999, the SEC issued Staff Accounting Bulletin No. 101, "Revenue
Recognition in Financial Statements" ("SAB 101"). SAB 101 summarizes certain
areas of the Staff's views in applying generally accepted accounting principles
to revenue recognition in financial statements. Historically, for some of
SeaChange's sales transactions, a portion of the sales price, typically 25%,
was not due until installation occurred. Under SAB 101 and the new accounting
method adopted retroactive to February 1, 2000, SeaChange now defers the
portion of the sales price not due until installation is complete. During the
fourth quarter of the year ended January 31, 2001, SeaChange implemented the
SEC's SAB 101 guidelines, retroactive to the beginning of the year. This was
reported as a cumulative effect of a change in accounting principle as of
February 1, 2000. The cumulative effect of the change in accounting principle
on prior years resulted in a charge to income of $1.1 million (net of income
taxes of $732,000), or $0.05 per diluted share, which has been included in
income for the year ended January 31, 2001. For the year ended January 31,
2001, SeaChange recognized $1.5 million in revenue that is included in the
cumulative effect adjustment as of February 1, 2000. During the year ended
January 31, 2001, SeaChange changed its standard payment terms such that no
portion of the sales price is due upon installation. The results for the first
three quarters of year ended January 31, 2001 have been restated to conform
with SAB 101. The pro forma results for prior periods presented in the
consolidated statement of operations were calculated assuming the accounting
change was made retroactively to all prior periods presented.
F-11
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. Consolidated Balance Sheet Detail
Inventories consist of the following:
January 31,
-----------------------
2001 2002
----------- -----------
Components and assemblies $18,695,000 $17,046,000
Finished products........ 6,212,000 6,944,000
----------- -----------
$24,907,000 $23,990,000
=========== ===========
Property and equipment consist of the following:
Estimated January 31,
useful life -----------------------
(years) 2001 2002
----------- ----------- -----------
Land........................................... $ 283,000 $ 283,000
Buildings...................................... 20 1,201,000 1,647,000
Office furniture and equipment................. 5 2,454,000 2,459,000
Computer and demonstration equipment........... 3 17,317,000 20,350,000
Deployed assets................................ 2-7 5,413,000 7,626,000
Service and spare components................... 5 2,951,000 4,030,000
Leasehold improvements......................... 1-7 1,676,000 1,604,000
Automobiles.................................... 5 101,000 101,000
----------- -----------
31,396,000 38,100,000
----------- -----------
Less--Accumulated depreciation and amortization 15,510,000 20,448,000
----------- -----------
$15,886,000 $17,652,000
=========== ===========
Depreciation expense was $3,806,000, $319,000, $4,345,000, and $6,091,000
for the year ended December 31, 1999, the month ended January 31, 2000, and the
years ended January 31, 2001 and 2002, respectively.
Accrued expenses consist of the following:
January 31,
---------------------
2001 2002
---------- ----------
Accrued commissions........ $ 203,000 $ 290,000
Accrued sales and use taxes 581,000 609,000
Other accrued expenses..... 1,032,000 938,000
---------- ----------
$1,816,000 $1,837,000
========== ==========
F-12
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
5. Segment Information
SeaChange has three reportable segments: broadband systems, broadcast
systems and services. The broadband systems segment provides products to
digitally manage, store and distribute digital video for cable system operators
and telecommunications companies. 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
all of the above systems and content which is distributed by the broadband
product segment. SeaChange does not measure the assets allocated to the
segments. SeaChange measures results of the segments based on their respective
gross profits. There were no inter-segment 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:
One month One month
Year ended ended Year ended Year ended ended
December 31, January 31, January 31, January 31, January 31,
1999 2000 2001 2002 1999
------------ ----------- ----------- ------------ -----------
(unaudited)
Revenues:
Broadband........ $51,664,000 $ 190,000 $54,412,000 $ 69,541,000 $ 467,000
Broadcast........ 16,793,000 36,000 20,574,000 18,028,000 230,000
Services......... 16,764,000 1,484,000 23,482,000 28,210,000 1,211,000
----------- ---------- ----------- ------------ ----------
$85,221,000 $1,710,000 $98,468,000 $115,779,000 $1,908,000
=========== ========== =========== ============ ==========
Costs of revenues:
Broadband........ $29,702,000 $ 503,000 $28,481,000 $ 38,899,000 $ 463,000
Broadcast........ 9,187,000 130,000 11,447,000 10,228,000 207,000
Services......... 14,962,000 1,445,000 18,798,000 21,030,000 1,049,000
----------- ---------- ----------- ------------ ----------
$53,851,000 $2,078,000 $58,726,000 $ 70,157,000 $1,719,000
=========== ========== =========== ============ ==========
The following summarizes revenues by geographic locations:
One month One month
Year ended ended Year ended Year ended ended
December 31, January 31, January 31, January 31, January 31,
1999 2000 2001 2002 1999
------------ ----------- ----------- ------------ -----------
(unaudited)
Revenues:
United States........... $65,730,000 $1,398,000 $78,025,000 $ 99,709,000 $1,185,000
Canada and South America 5,371,000 44,000 4,161,000 1,486,000 626,000
Europe.................. 9,777,000 234,000 8,827,000 7,325,000 19,000
Rest of world........... 4,343,000 34,000 7,455,000 7,259,000 78,000
----------- ---------- ----------- ------------ ----------
$85,221,000 $1,710,000 $98,468,000 $115,779,000 $1,908,000
=========== ========== =========== ============ ==========
F-13
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
For the year ended December 31, 1999, the one month ended January 31, 2000
and the years ended January 31, 2001 and January 31, 2002, certain customers
accounted for more than 10% of SeaChange's revenues. Individual customers
accounted for 15% and 10% in the year ended December 31, 1999; 16% and 11% in
the one month ended January 31, 2000; 12% and 10% in the year ended January 31,
2001, and 20%, 15% and 11% in the year ended January 31, 2002. The following
summarizes revenues by significant customer:
One month One month
Year ended ended Year ended Year ended ended
December 31, January 31, January 31, January 31, January 31,
1999 2000 2001 2002 1999
------------ ----------- ----------- ----------- -----------
(unaudited)
Customer A 15% 16% -- -- 17%
Customer B 10% 11% 12% 20% 12%
Customer C -- -- 10% -- 10%
Customer D -- -- -- 15% --
Customer E -- -- -- 11% --
6. Acquisition and Equity Investment
On December 30, 1999, SeaChange acquired all of the authorized and
outstanding common stock of Digital Video Arts, Ltd. in exchange for 330,000
shares of SeaChange's common stock using an exchange ratio of 0.033 of one
share of SeaChange's common stock for each share of Digital Video Arts. The
acquisition was accounted for as a pooling of interests. Digital Video Arts is
a developer of custom software products specializing in digital video and
interactive television. As a result of the acquisition, Digital Video Arts
became a wholly-owned subsidiary of SeaChange. Total revenues of $85.2 million
for the year ended December 31, 1999 consisted of $84.2 million of SeaChange's
revenues and $1.0 million of Digital Video Arts' revenues. Net income of
$497,000 for the same period consisted of SeaChange's net income of $1.1
million and Digital Video Arts' net loss of $592,000. Included in net income
were acquisition costs of $684,000 consisting primarily of professional service
fees. All intercompany transactions were eliminated in consolidation. Due to
the acquisition, Digital Video Arts' previously unrecognized tax benefits of
operating loss carryforwards were recognized by the combined Company in the
applicable period. The accompanying consolidated financial statements for all
the periods presented have been restated to include the results of operations,
financial position and cash flows of Digital Video Arts.
On November 29, 2001, SeaChange and Visible World entered into a Joint
Development and Marketing Agreement. The purpose of the partnership is to
integrate the advertising insertion product offerings that SeaChange offers
with the software technologies of Visible World, which would enable advertisers
an end-to-end solution for providing target advertising to their customers. The
agreement is for a one-year period with automatic annual renewal unless 90-day
notice of termination is given by either party. In conjunction with the
arrangement, Visible World issued SeaChange a fully vested warrant to purchase
one million shares of Series B Preferred Stock at an exercise price of $0.01
per share. The warrant expires at the earlier of a) the consummation of a
qualified public offering, as defined in the agreement, by Visible World, b)
the sale of Visible World, as defined in the agreement or c) 10 years. Because
the issuance of the warrant to SeaChange under the terms of the agreement is in
exchange for services to be provided by SeaChange, the warrant is accounted for
under the guidance of EITF 00-08, "Accounting by a Grantee for an Equity
Instrument to be Received in Conjunction with Providing Goods or Services."
Management determined the fair value of the warrant based on available
financial information using the Black-Scholes valuation method. SeaChange
recorded the value of the warrant of $493,000 as a long-term investment
included in other assets with an offsetting amount included in deferred
revenue. SeaChange will recognize the deferred revenue over a five year period,
the expected term of the services. In addition, SeaChange reviews the carrying
value of its investment on a regular basis for the existence of facts or
F-14
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
circumstances, both internally and externally, that may suggest impairment of
the asset. It is possible that changes in facts or circumstances related to the
value of this investment could materially affect SeaChange's financial
condition and results of operations.
7. Lines of Credit and Long-Term Bank Debt
SeaChange had a $6.0 million revolving line of credit and a $5.0 million
equipment line of credit with a bank. This revolving line of credit expired in
March 2000 and SeaChange's ability to make purchases under the equipment line
of credit expired in March 2000. In July 2000, SeaChange renewed its revolving
line of credit and equipment line of credit with that bank. The revolving line
of credit was extended until March 2001 and borrowings under the facility
increased to $7.5 million. The equipment line of credit was extended to provide
SeaChange additional equipment financing of $4.0 million through March 2001. In
addition, SeaChange entered into a $3.0 million line of credit facility with
the Export-Import Bank of the United States ("EXIM") which allowed SeaChange to
borrow money based upon eligible foreign customer account balances. The ability
to borrow funds by SeaChange under this facility also expired in March 2001.
In October 2001, SeaChange entered into a $10.0 million revolving line of
credit with a bank that expires in October 2003. Loans made under this
revolving line of credit will bear interest at a rate per annum equal to the
bank's prime rate, 4.75% at January 31, 2002. As of January 31, 2002, SeaChange
has borrowings of $5.4 million under this revolving line of credit. Borrowings
under this line of credit are collateralized by substantially all of
SeaChange's assets. The loan agreement requires that SeaChange provide the bank
with certain periodic financial reports and comply with certain financial
ratios including a minimum level of earnings before interest, taxes and
depreciation and amortization on a trailing twelve month basis. As of January
31, 2002, SeaChange was in compliance with these financial covenants. The line
of credit replaces SeaChange's prior revolving line of credit and equipment
line with a different bank. In conjunction with entering into the new bank
line, SeaChange repaid to its prior lender all outstanding borrowings under the
equipment line of credit in an amount of $3.4 million. In March 2002, SeaChange
repaid $5.4 million in outstanding borrowings under the current line of credit
plus accrued interest to the bank.
In October 2000, SeaChange entered into an agreement with a bank to finance
$1.2 million of the construction costs related to the purchase and renovation
of a manufacturing mill in New Hampshire that SeaChange previously purchased in
February 2000. During the construction period, interest accrued and was paid at
a per annum rate of 8.875%. Upon occupancy of the building, the loan converted
into two promissory notes whereby SeaChange will pay principal and interest
based upon a fixed interest rate per annum over a five and ten year period,
respectively (8.875% at January 31, 2002). Borrowings under the loan are
collateralized by the land and buildings of the renovated mill. The loan
agreement requires that SeaChange provide the bank with certain periodic
financial reports and comply with certain financial ratios. At January 31,
2002, SeaChange was in compliance with all covenants. As of January 31, 2002,
borrowings outstanding under the loan were $1.1 million.
Principal payments under the lines of credit and the construction loan are
payable over the next five years as follows:
Payments
----------
Year ended January 31, 2003 $ 155,000
2004.................... 5,570,000
2005.................... 186,000
2006.................... 203,000
2007.................... 67,000
Thereafter.............. 279,000
----------
Total...................... $6,460,000
==========
F-15
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
8. Income Taxes
The components of income (loss) before income taxes are as follows:
Year ended Month ended Year ended Year ended
December 31, January 31, January 31, January 31,
1999 2000 2001 2002
------------ ----------- ----------- -----------
Domestic $331,000 $(3,614,000) $(2,704,000) $352,000
Foreign. 151,000 -- 2,107,000 (74,000)
-------- ----------- ----------- --------
$482,000 $(3,614,000) $ (597,000) $278,000
======== =========== =========== ========
The components of the provision (benefit) for income taxes are as follows:
Year ended Month ended Year ended Year ended
December 31, January 31, January 31, January 31,
1999 2000 2001 2002
------------ ----------- ----------- -----------
Current provision (benefit):
Federal.................... $ 532,000 $ -- $ -- $ --
State...................... 354,000 -- -- --
Foreign.................... 56,000 -- -- 79,000
--------- ----------- --------- ---------
942,000 -- -- 79,000
========= =========== ========= =========
Deferred benefit:
Federal.................... (586,000) (889,000) (538,000) (82,000)
State...................... (371,000) (267,000) (86,000) 2,000
Foreign.................... -- -- (66,000) (102,000)
--------- ----------- --------- ---------
(957,000) (1,156,000) (690,000) (182,000)
--------- ----------- --------- ---------
$ (15,000) $(1,156,000) $(690,000) $(103,000)
========= =========== ========= =========
The components of deferred income taxes are as follows:
January 31, January 31,
2001 2002
----------- -----------
Deferred tax assets:
Inventories.................................................... $ 1,396,000 $ 1,175,000
Allowance for doubtful accounts................................ 207,000 403,000
Deferred revenue............................................... -- 398,000
Software....................................................... 97,000 88,000
Accrued expenses............................................... 8,000 308,000
Capitalized intangible costs................................... -- 457,000
Property and equipment......................................... 57,000 (462,000)
Research and development credit carryforwards.................. 1,358,000 1,791,000
Federal net operating loss carryforwards....................... 3,769,000 3,492,000
State net operating loss carryforwards......................... 717,000 1,000,000
Foreign net operating loss carryforwards....................... 66,000 125,000
Acquired net operating loss carryforwards and basis differences 3,361,000 3,361,000
----------- -----------
11,036,000 12,136,000
Valuation allowance............................................ (3,361,000) (3,361,000)
----------- -----------
Total deferred tax assets.................................... $ 7,675,000 $ 8,775,000
=========== ===========
F-16
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
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 January 31, 2001 and January 31,
2002 relates to net operating loss carryforwards and tax basis differences
acquired in SeaChange'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 is subject to
Internal Revenue Code change in ownership rules which may limit the amount that
can be utilized to offset future taxable income. SeaChange 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.
Although realizability is not assured, based on the weight of available
evidence, SeaChange believes it is more likely than not that all remaining
deferred tax assets will be realized. The amount of the deferred tax asset
considered realizable is subject to change based on future events, including
generating taxable income in future periods. SeaChange will continue to assess
the need for the valuation allowance at each balance sheet date based on all
available evidence. The amount of the deferred tax asset considered realizable,
however, could be reduced in the near term, and the amount could be material,
if SeaChange does not generate sufficient taxable income in future periods.
In accordance with APB 23, SeaChange does not provide for U.S. federal
income taxes on the earnings of its non-U.S. subsidiaries, as it is
management's plan to permanently reinvest in operations outside the U.S. At
January 31, 2002, undistributed earnings of approximately $138,000 are
considered by SeaChange to be permanently invested in certain foreign
subsidiaries. The amount of tax that would be owed if the profits were
distributed is approximately $47,000.
At January 31, 2002, SeaChange had federal and state net operating loss
carryforwards of approximately $10,270,000 and $15,391,000, respectively, which
expire at various dates through 2022.
At January 31, 2002, SeaChange had federal and state research and
development tax credit carryforwards of approximately $1,291,000 and $500,000,
respectively, which expire at various dates through 2022.
The income tax provision (benefit) computed using the federal statutory
income tax rate differs from SeaChange's effective tax rate primarily due to
the following:
Year Ended Month Ended Year Ended Year Ended
December 31, January 31, January 31, January 31,
1999 2000 2001 2002
------------ ----------- ----------- -----------
Statutory U.S. federal tax rate......................... $ 164,000 $(1,239,000) $(203,000) $ 95,000
State taxes after state tax credits, net of federal tax
benefits............................................. (12,000) (176,000) (28,000) (186,000)
Other.................................................. 98,000 278,000 (93,000) 183,000
Research and development tax credits................... (446,000) (25,000) (443,000) (195,000)
Non-deductible acquisition costs....................... 233,000 -- -- --
Acquired net operating losses........................... (192,000) -- -- --
Nondeductible expenses, including write-off of acquired
in-process research and development in 1997.......... 140,000 6,000 77,000 --
--------- ----------- --------- ---------
$ (15,000) $(1,156,000) $(690,000) $(103,000)
========= =========== ========= =========
F-17
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
SeaChange's effective tax benefit rate was 3% in the year ended December 31,
1999, 32% in the month ended January 31, 2000, 116% in the year ended January
31, 2001 and 37% in the year ended January 31, 2002. In the second quarter of
1999, the separate return limitation year (SRLY) regulations were finalized to
allow for the use of acquired net operating loss carryforwards where an
ownership change and an acquisition has taken place within a six month period.
As a result of SeaChange's acquisition of Digital Video Arts, SeaChange
recorded a tax benefit of $192,000 in the second quarter of 1999 related to the
use of Digital Video Arts net operating loss carryforwards. In the fourth
quarter of 1999, the federal research and development tax credit was
retroactively extended through June 30, 2004. As a result, SeaChange recorded a
tax benefit of $446,000 in the fourth quarter of 1999 related to the
utilization of these tax credits.
9. 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. Common Stock
Public Stock Offering
On January 31, 2002, SeaChange completed a public offering of 3,594,411
shares of its common stock, consisting of 3,384,411 shares sold by the Company
and 210,000 shares sold by certain of SeaChange's stockholders. Proceeds to
SeaChange, net of underwriting discounts and costs of the offering, were
approximately $92.7 million.
Microsoft Investment
On May 8, 2000, SeaChange and Microsoft Licensing, Inc. entered into a
licensing and development agreement whereby Microsoft agreed to license to
SeaChange certain technology to be used by SeaChange in connection with the
development by SeaChange of plug-ins for the streaming media server software
update currently being developed by Microsoft to its Windows NT/Windows 2000
operating system. Under the terms of the agreement, SeaChange is also entitled
to use the Microsoft technology to enhance SeaChange's software to use the
updated streaming media server software being developed by Microsoft. The
parties intend that SeaChange will be able to promote and ship the enhanced
SeaChange software as its primary streaming media system for all Microsoft
Windows 2000-based SeaChange systems.
In addition to the ability to use the technology owned by Microsoft and
licensed to SeaChange pursuant to the licensing and development agreement,
Microsoft purchased 277,162 shares of SeaChange's common stock for $10 million.
In addition, under the terms of the agreement, which expires in May 2003,
Microsoft may purchase approximately $10 million of additional shares of
SeaChange's common stock upon the satisfaction of certain commercial
milestones. The initial purchase of shares for $10 million was completed by
SeaChange and Microsoft on May 23, 2000.
F-18
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Stock Split
On December 10, 1999, the Board of Directors authorized a 3-for-2 stock
split of SeaChange's common stock, which became effective on December 27, 1999.
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 1999.
Treasury Stock
In 1999, SeaChange repurchased and retired 47,250 shares of its common stock
from employees of SeaChange. All of the shares were held for more than six
months from the time the shares became vested. Accordingly, no compensation
expense was recorded for the difference between the repurchase price and the
original purchase price paid by the stockholder.
Reserved Shares
At January 31, 2002, SeaChange had 8,039,793 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.
11. Stock Plans
Employee Stock Purchase Plan
In September 1996, SeaChange'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 450,000 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 SeaChange's stock and
directors who are not employees of SeaChange 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 the year ended December 31, 1999, the one
month ended January 31, 2000 and the years ended January 31, 2001, and January
31, 2002, 87,014, 0, 67,795 and 71,622, shares of common stock, respectively,
were issued under the Stock Purchase Plan. As of January 31, 2002, 100,370
shares are available under the Stock Purchase Plan for issuance.
1995 Stock Option Plan
The Amended and Restated 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 9,200,000 shares of
SeaChange's common stock by officers, employees, consultants and directors of
SeaChange. 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.
SeaChange 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 SeaChange'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 SeaChange's Board of Directors.
F-19
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
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 SeaChange's voting stock).
Director Stock Option Plan
In June 1996, SeaChange'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 SeaChange to
purchase a maximum of 45,000 shares of common stock under the Director Option
Plan. Under the Director Option Plan, participating directors receive an option
to purchase 5,062 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 5,062 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, 1999, the one month ended January 31, 2000
and the years ended January 31, 2001 and January 31, 2002 are summarized as
follows:
Year ended One month ended Year ended Year ended
December 31, 1999 January 31, 2000 January 31, 2001 January 31, 2002
------------------- ------------------- ------------------- -------------------
Weighted Weighted Weighted Weighted
average average average average
exercise exercise exercise exercise
Shares price Shares price Shares price Shares price
--------- -------- --------- -------- --------- -------- --------- --------
Outstanding at
beginning of
period........... 2,113,824 $ 5.34 2,040,053 $ 7.79 2,054,539 $ 8.29 3,464,964 $18.80
Granted............ 524,739 14.76 35,400 35.50 2,006,977 26.82 529,042 18.18
Exercised.......... (310,753) 3.94 (14,330) 4.28 (392,669) 4.57 (282,683) 8.80
Cancelled.......... (287,757) 6.00 (6,584) 6.61 (203,883) 19.57 (301,815) 22.34
========= ========= ========= =========
Outstanding at end
of period........ 2,040,053 $ 7.79 2,054,539 $ 8.29 3,464,964 $18.80 3,409,508 $19.27
========= ========= ========= =========
Options exercisable
at end of period. 594,265 625,387 834,024 1,234,322
Weighted average
fair value of
options granted
during the period $ 7.11 $26.57 $22.36 $14.92
F-20
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The following table summarizes information about employee and director stock
options outstanding at January 31, 2001 and January 31, 2002:
Options outstanding at January 31, 2001 Options outstanding at January 31, 2002
------------------------------------------- -------------------------------------------
Weighted average Weighted average
remaining Weighted remaining Weighted
Number contractual life average Number contractual life average
outstanding (years) exercise price outstanding (years) exercise price
----------- ---------------- -------------- ----------- ---------------- --------------
Range of exercise prices
$0.33 to 0.82....... 34,496 4.68 $ 0.70 32,303 3.68 $ 0.71
2.80 to 4.00....... 393,814 7.72 3.95 304,096 6.81 3.98
4.45 to 6.25....... 543,049 7.02 5.47 427,374 6.02 5.44
6.58 to 10.00....... 237,247 7.59 7.49 190,090 6.90 7.48
10.33 to 14.33....... 128,271 8.24 11.46 192,311 8.24 12.35
16.03 to 23.31....... 1,017,361 9.60 23.08 1,236,518 8.84 21.99
25.56 to 39.13....... 1,110,726 9.22 30.49 1,026,816 8.27 30.34
--------- ---- ------ --------- ---- ------
3,464,964 8.62 $18.80 3,409,508 7.93 $19.27
========= ==== ====== ========= ==== ======
Options exercisable at Options exercisable at
January 31, 2001 January 31, 2002
---------------------------- ----------------------------
Number Weighted average Number Weighted average
exercisable exercise price exercisable exercise price
----------- ---------------- ----------- ----------------
Range of exercise prices
$0.33 to 0.82....... 34,496 $ 0.70 32,303 $ 0.71
2.80 to 4.00....... 143,364 3.87 147,826 3.95
4.45 to 6.25....... 288,960 5.41 306,959 5.42
6.58 to 10.00....... 97,122 7.54 109,124 7.51
10.33 to 14.33....... 41,847 11.63 50,475 13.74
16.03 to 23.31....... 39,343 19.47 208,661 21.77
25.56 to 39.13....... 188,892 30.68 378,974 30.52
------- ------ --------- ------
834,024 $11.90 1,234,322 $16.14
======= ====== ========= ======
Fair Value Disclosures
SeaChange applies APB 25 in accounting for employee stock awards. Had
compensation expense for SeaChange's employee stock plans been determined based
on the fair value at the grant dates, as prescribed in SFAS 123, SeaChange's
net income (loss) and earnings (loss) per share would have been as follows:
Year ended Month ended Year ended Year ended
December 31, January 31, January 31, January 31,
1999 2000 2001 2002
------------ ----------- ------------ ------------
Net income (loss)
As reported..................... $497,000 $(2,458,000) $ (1,007,000) $ 381,000
Pro forma....................... $122,000 $(2,703,000) $(14,825,000) $(16,666,000)
Basic earnings (loss) per share
As reported..................... $ 0.02 $ (0.12) $ (0.05) $ 0.02
Pro forma....................... $ 0.01 $ (0.13) $ (0.68) $ (0.73)
Diluted earnings (loss) per share
As reported..................... $ 0.02 $ (0.12) $ (0.05) $ 0.02
Pro forma....................... $ 0.01 $ (0.13) $ (0.68) $ (0.73)
F-21
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The fair value of each option granted was estimated on the date of grant
assuming a weighted average volatility factor of 46% for the year ended
December 31, 1999, and 100% for the one month ended January 31, 2000 and the
year ended January 31, 2001 and January 31, 2002. Additional weighted average
assumptions used for grants during the year ended December 31, 1999, the one
month ended January 31, 2000 and the years ended January 31, 2001 and January
31, 2002, included: dividend yield of 0.0% for all periods; risk-free interest
rates of 5.5% for options granted during the year ended December 31, 1999 and
the one month ended January 31, 2000, 4.9% for options granted during the year
ended January 31, 2001; and 3.7% for options granted during the year ended
January 31, 2002 and an expected option term of 5 years for all periods.
Because additional option grants are expected to be made each year and
options vest over several years, the above pro forma disclosures are not
representative of pro forma effects of reported net income (loss) for future
years.
12. Commitments and Contingencies
SeaChange leases its operating facilities and certain office equipment under
non-cancelable capital and operating leases, which expire at various dates
through 2007. Rental expense under operating leases was approximately
$1,681,000, $167,000, $2,307,000 and $1,319,000 for the year ended December 31,
1999, the one month ended January 31, 2000, and the years ended January 31,
2001 and 2002, respectively. Future commitments under minimum lease payments as
of January 31, 2002 are as follows:
Capital Operating
-------- ----------
Year ended January 31, 2003....... $145,000 $1,577,000
2004............................. 60,000 1,105,000
2005............................. -- 1,058,000
2006............................. -- 437,000
2007............................. -- 318,000
Thereafter........................ -- 233,000
-------- ----------
Minimum lease payments............ 205,000 $4,728,000
==========
Less: Amount representing interest 11,000
--------
$194,000
========
SeaChange had non-cancelable purchase commitments for inventories of
approximately $4,700,000 at January 31, 2002.
On June 13, 2000, SeaChange filed in the United States District Court for
the District of Delaware a lawsuit against one of SeaChange's competitors,
nCube Corp., whereby SeaChange alleged that nCube's MediaCube-4 product
infringed a patent held by SeaChange (Patent No. 5,862,312) relating to
SeaChange's MediaCluster technology. In instituting the claim, Seachange sought
both a permanent injunction and damages in an unspecified amount. nCube made a
counterclaim against SeaChange that the patent held by SeaChange was invalid
and that nCube's MediaCube-4 product did not infringe SeaChange's patent. On
September 6, 2000, nCube conceded that, based on a claim construction ruling
issued by the District Court on August 2000, nCube's MediaCube-4 product
infringed SeaChange's patent. On September 25, 2000, a jury upheld the validity
of SeaChange's patent. nCube has filed motions challenging both the jury's
verdict and the District Court's claim construction ruling. The District Court
has yet to rule on nCube's motions. At this time SeaChange is awaiting the
court's decision regarding a permanent injunction. Damages will be determined
in future proceedings.
F-22
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
On January 8, 2001, nCube Corp. filed a complaint against SeaChange in the
United States District Court for the District of Delaware alleging that
SeaChange's use of SeaChange's MediaCluster, MediaExpress and Media Server
technology each infringe a patent held by nCube (Patent No. 5,805,804). In
instituting the claim, nCube has sought both an injunction and monetary damages
in an unspecified amount. SeaChange responded on January 26, 2001, denying the
claim of infringement. SeaChange also asserted a counterclaim seeking a
declaration from the District Court that U.S. Patent No. 5,805,804 is invalid
and not infringed. Discovery closed on December 14, 2001, at which time nCube
limited its infringement allegations to the MediaCluster technology only, and
specifically alleged that SeaChange's use of the SeaChange ITV system
infringed. A claim construction hearing is scheduled for May 2, 2002.
On March 26, 2002, nCube Corp. filed a complaint against SeaChange in the
United States District Court for the District of Delaware seeking a declaratory
judgment that its redesigned MediaCube-4 product does not infringe U.S. Patent
No. 5,862,312 held by SeaChange. The complaint also alleges that nCube has been
damaged by a certain statement made by SeaChange's Chief Executive Officer
during a public conference call to discuss SeaChange's earnings on March 5,
2002. nCube is seeking a public retraction of the statement and is seeking
damages in an unspecified amount. On April 15, 2002, SeaChange moved to dismiss
all claims on the grounds that the patent-related issues are currently pending
before the Court in the lawsuit previously filed by SeaChange, and the Court
lacks jurisdiction over the remaining claims. That motion is still pending.
On June 14, 1999, SeaChange filed a defamation complaint against Jeffrey
Putterman, Lathrop Investment Management, Inc. and Concurrent Computer
Corporation in the Circuit Court of Pulaski County, Arkansas alleging that the
defendants conspired to injure SeaChange's business and reputation in the
marketplace. The complaint further alleges that Mr. Putterman and Lathrop
Investment Management, Inc. defamed us through false postings on an Internet
message board. The complaint seeks unspecified amounts of compensatory and
punitive damages. On June 14, 2000, Concurrent filed a counterclaim under seal
against us seeking unspecified damages. On July 28, 2000, Concurrent filed a
motion for summary judgment on the claim of civil conspiracy and on January 4,
2001, the trial court entered an order granting summary judgment for Concurrent
on that claim. SeaChange immediately requested reconsideration of this order
or, in the alternative, recertification for immediate appeal. On June 12, 2001,
the trial court denied the motion for reconsideration but made findings which
permitted an immediate appeal and on July 11, 2001 SeaChange filed an appeal.
SeaChange expects oral arguments on the appeal will be scheduled before June
15, 2002 and a decision on the appeal before August 1, 2002. The claims against
other defendants and counterclaims are currently pending and no trial date has
been set.
SeaChange cannot be certain of the outcome of the foregoing litigation, but
plans to oppose allegations against us and assert SeaChange's claims against
other parties vigorously. In addition, as these claims are subject to
additional discovery and certain claims for damages are as yet unspecified,
SeaChange is unable to estimate the impact to SeaChange's business, financial
condition and results of operations or cash flows.
13. Employee Benefit Plan
SeaChange 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. SeaChange matches contributions
up to 25% of the first 6% of compensation contributed by the employee to the
Plan. During the year ended December 31, 1999, the one month ended January 31,
2000, and the years ended January 31, 2001 and January 31, 2002, SeaChange
contributed $225,000, $19,000, $286,000, and $360,000, respectively, to the
Plan.
F-23
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
14. Comcast Equity Investment and Video-On-Demand Purchase Agreements
On December 1, 2000, SeaChange and Comcast Cable Communications, Inc.
entered into a video-on-demand purchase agreement for SeaChange's interactive
television video servers and related services. Under the terms of the
video-on-demand purchase agreement, Comcast has committed to purchase
SeaChange's equipment capable of serving a minimum of one million cable
subscribers by approximately December 2002. SeaChange has estimated that the
equipment value with respect to the first one million subscribers is $30
million. In addition, Comcast may earn up to an additional 450,000 incentive
common stock purchase warrants through December 2003 based on the number of
cable subscribers in excess of one million who are served by SeaChange's
equipment which has been purchased by Comcast. In connection with the execution
of this commercial agreement, SeaChange entered into a common stock and warrant
purchase agreement, dated as of December 1, 2000, with Comcast SC Investment,
Inc., whereby Comcast SC agreed to purchase, subject to certain closing
conditions including registration of the shares purchased thereby, 466,255
shares of SeaChange's common stock for approximately $10 million and Comcast SC
would receive a warrant to purchase 100,000 shares, exercisable at $21.445 per
share, of SeaChange's common stock. This stock and warrant purchase agreement
was terminated by SeaChange and Comcast SC on February 28, 2001. The terms and
conditions of the video-on-demand purchase agreement have not been modified.
On February 28, 2001, SeaChange and Comcast SC signed and closed a new
common stock and warrant purchase agreement on terms similar to the prior
agreement. Under the terms of this new agreement, SeaChange sold in a private
placement to Comcast SC for approximately $10.0 million an aggregate of 756,144
shares of SeaChange's common stock and a warrant to purchase 100,000 shares of
SeaChange's common stock with an exercise price of $13.225 per share. Under
certain conditions determined upon the effectiveness of the registration of the
shares, the number of common shares purchased and the number of common stock
purchase warrants and related exercise price are subject to adjustment. An
additional number of shares of common stock would be issued to Comcast SC
without any additional consideration as is equal to the difference between
756,144, the number of shares of common stock issued on February 28, 2001, and
the number of shares obtained by dividing $10.0 million by the lower of 1) 92%
of the closing market price of SeaChange's common stock on the date of
effectiveness of the registration statement, and 2) the average of the closing
market price of SeaChange's common stock for the five trading days ending on
the effective date of the registration statement, if either of such prices is
lower than $13.225. The warrant agreement contains an adjustment mechanism such
that the warrant would be exercisable for an additional 25,000 shares of
SeaChange's common stock if the registration statement has not been declared
effective on or before March 31, 2001 and an additional 333.33 shares of
SeaChange's common stock per day beginning on and including May 1, 2001 for
each day up to and including the day the registration statement is declared
effective. The warrant agreement also provides that the exercise price of the
warrant would be reduced on the effective date of the registration statement to
the lower of 1) 92% of the closing market price of SeaChange's common stock on
the effective date of the registration statement, and 2) the average of the
closing market prices of SeaChange's common stock for the five trading days
ending on the date of effectiveness of the registration statement, if either of
such prices is lower than $13.225, the exercise price as of the closing date.
SeaChange determined the intrinsic value of $586,000 related to the 756,144
shares of common stock purchased on February 28, 2001 and measured the fair
value of $1.1 million related to the 100,000 common stock purchase warrants as
of the closing date and recorded these amounts as contra-equity. On April 30,
2001, SeaChange recorded an additional contra-equity amount of $325,000 for the
fair value of the additional 25,000 common stock purchase warrants of SeaChange
common stock as the registration statement had not been declared effective on
or before March 31, 2001. On June 13, 2001, the effective date of the
registration statement, SeaChange issued an additional 14,667 common stock
purchase warrants in accordance with the agreement, and recorded an additional
contra equity amount of $335,000, representing the incremental fair value of
the total
F-24
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
warrants issued. Based on the closing market price on the date of effectiveness
of the registration statement and the five trading days preceding the date of
effectiveness of the registration statement, no additional common shares were
issued to Comcast SC pursuant to the terms of the purchase agreement and
Comcast is not entitled to the issuance in the future of additional shares
pursuant to the terms of the purchase agreement. Also, based on the then
prevailing market prices of SeaChange's common stock, the exercise price of the
warrant was not reduced and is not subject to reduction in the future, other
than equitable adjustment in connection with a stock split or other comparable
event and future dilutive issuances.
The contra-equity amount is being amortized as an offset to gross revenue in
proportion to the revenue recognized from the sale of equipment with respect to
the first one million subscribers Comcast has committed to under the
video-on-demand purchase agreement. SeaChange has estimated that the equipment
value with respect to the first one million subscribers is $30 million. This
estimate is continuously monitored and is subject to change. To the extent that
this estimate changes in the future, the amount of the remaining contra-equity
amount will be adjusted prospectively. For the year ended January 31, 2002,
SeaChange amortized $1.2 million of the deferred equity discount. The fair
value of the additional incentive common stock purchase warrants will also be
recorded as an offset to gross revenue as the warrants are earned by Comcast,
if any.
F-25
Schedule II
SEACHANGE INTERNATIONAL, INC.
VALUATION OF QUALIFYING ACCOUNTS AND RESERVES
Balance at Charged to Deductions Balance at
beginning of costs and and write- end of
period expenses offs Other period
------------ ---------- ---------- -------- ----------
Allowance for Doubtful Accounts:
Year ended December 31, 1999.... $ 870,000 $ 225,000 $(187,000) $ -- $ 908,000
Month ended January 31, 2000.... $ 908,000 $ -- $ -- $ -- $ 908,000
Year ended January 31, 2001..... $ 908,000 $ 516,000 $(682,000) $ -- $ 742,000
Year ended January 31, 2002..... $ 742,000 $ 370,000 $(875,000) $622,000 $ 859,000
Inventory Valuation Allowance:
Year ended December 31, 1999.... $2,601,000 $ 458,000 $(395,000) $ -- $2,664,000
Month ended January 31, 2000.... $2,664,000 $ 11,000 $ -- $ -- $2,675,000
Year ended January 31, 2001..... $2,675,000 $ 823,000 $(722,000) $ -- $2,776,000
Year ended January 31, 2002..... $2,776,000 $(356,000) $ (66,000) $ -- $2,354,000
S-1