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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
-- OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 31, 2002
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to _________
Commission File Number: 0-21393
SEACHANGE INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
Delaware 04-3197974
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
124 Acton Street, Maynard, MA 01754
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (978) 897-0100
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 whether the registrant is an accelerated filer (as
defined in 12b-2 of the Exchange Act).
YES [_] NO [_]
The number of shares outstanding of the registrant's Common Stock on December
11, 2002 was 26,734,866.
SEACHANGE INTERNATIONAL, INC.
Table of Contents
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheet
at October 31, 2002 (unaudited) and January 31, 2002 .................. 3
Condensed Consolidated Statement of Operations
Three and nine months ended October 31, 2002 and
October 31, 2001 (unaudited) .......................................... 4
Condensed Consolidated Statement of Cash Flows
Nine months ended October 31, 2002 and
October 31, 2001 (unaudited) .......................................... 5
Notes to Condensed Consolidated Financial Statements ..................... 6-14
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations ............... 15-24
Item 3. Quantitative and Qualitative Disclosures About
Market Risk .................................................... 24
Item 4. Controls and Procedures ........................................ 24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings .............................................. 25
Item 2. Changes in Securities and Use of Proceeds ...................... 27
Item 6. Exhibits and Reports on Form 8-K ............................... 27
SIGNATURES ......................................................................... 28
CERTIFICATIONS ..................................................................... 28
2
ITEM I. Financial Statements
SEACHANGE INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
October 31, January 31,
2002 2002
---- ----
(unaudited)
Assets
Current assets
Cash and cash equivalents ............................................... $ 92,888 $ 103,898
Accounts receivable, net of allowance for doubtful accounts
of $1,198 at October 31, 2002 and $859 at January 31, 2002 ............ 22,184 29,916
Inventories ............................................................. 26,218 23,990
Income tax receivable ................................................... 1,528 118
Prepaid expenses and other current assets ............................... 3,017 2,193
Deferred income taxes ................................................... -- 7,294
--------- ----------
Total current assets .................................................... 145,835 167,409
Property and equipment, net ................................................... 15,361 17,652
Deferred income taxes ......................................................... -- 1,481
Investment in affiliates ...................................................... 2,972 493
Other assets .................................................................. 220 1,759
Intangibles, net .............................................................. 2,973 3,930
Goodwill, net ................................................................. 253 253
--------- ----------
$ 167,614 $ 192,977
========= ==========
Liabilities and Stockholders' Equity
Current liabilities
Current portion of line of credit and obligations under capital
leases ................................................................ $ 232 $ 291
Accounts payable ........................................................ 7,701 14,735
Accrued litigation reserve .............................................. 10,992 --
Other accrued expenses .................................................. 2,359 1,837
Customer deposits ....................................................... 536 2,484
Deferred revenue ........................................................ 11,795 13,071
Income taxes payable .................................................... 85 70
--------- ----------
Total current liabilities ............................................... 33,700 32,488
--------- ----------
Long-term line of credit and obligations under capital leases ................. 788 6,363
--------- ----------
Commitments and contingencies (Notes 8 and 10)
Stockholders' Equity
Convertible preferred stock, 5,000,000 shares authorized, none outstanding .... -- --
Common stock, $.01 par value; 100,000,000 shares authorized; 26,635,959 and
26,532,671 shares issued and outstanding at October 31, 2002 and
January 31, 2002, respectively .......................................... 266 265
Additional paid-in capital .................................................... 160,589 159,914
Deferred equity discount ...................................................... -- (1,164)
Due from stockholders ......................................................... -- (122)
Accumulated deficit ........................................................... (27,535) (4,524)
Accumulated other comprehensive loss .......................................... (194) (243)
--------- ----------
Total stockholders' equity .................................................... 133,126 154,126
--------- ----------
$ 167,614 $ 192,977
========= ==========
The accompanying notes are an integral part of these
condensed consolidated financial statements.
3
SEACHANGE INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands, except per share data)
(unaudited)
Three months ended Nine months ended
------------------ -----------------
October 31, October 31, October 31, October 31,
2002 2001 2002 2001
----------- ----------- ----------- -----------
Revenues:
Systems ............................................. $ 25,945 $ 17,776 $ 78,361 $ 60,829
Services ............................................ 7,926 7,445 22,543 21,572
--------- --------- --------- ---------
33,871 25,221 100,904 82,401
Cost of revenues:
Systems ............................................. 15,801 10,682 47,156 35,208
Services ............................................ 5,153 5,201 15,924 15,644
--------- --------- --------- ---------
20,954 15,883 63,080 50,852
--------- --------- --------- ---------
Gross profit ............................................ 12,917 9,338 37,824 31,549
--------- --------- --------- ---------
Operating expenses:
Research and development ............................ 6,478 5,883 19,145 17,560
Selling and marketing ............................... 3,994 3,410 12,012 10,599
General and administrative .......................... 3,290 1,748 23,338 5,579
--------- --------- --------- ---------
13,762 11,041 54,495 33,738
--------- --------- --------- ---------
Loss from operations .................................... (845) (1,703) (16,671) (2,189)
Interest income (expense), net .......................... 304 (80) 1,024 (332)
--------- --------- --------- ---------
Loss before income taxes ............................ (541) (1,783) (15,647) (2,521)
Income tax expense (benefit) ............................ - (571) 7,364 (807)
--------- --------- --------- ---------
Net loss ................................................ $ (541) $ (1,212) $ (23,011) $ (1,714)
========= ========= ========= =========
Basic and diluted loss per share ........................ $ (0.02) $ (0.05) $ (0.87) $ (0.08)
========= ========= ========= =========
Weighted average common shares outstanding:
Basic and diluted .............................. 26,635 22,939 26,592 22,796
========= ========= ========= =========
The accompanying notes are an integral part of these
condensed consolidated financial statements.
4
SEACHANGE INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(in thousands)
(unaudited)
Nine months ended
-----------------
October 31, October 31,
2002 2001
------ ------
Cash flows from operating activities:
Net loss ........................................................................ $(23,011) $(1,714)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization ............................................. 6,459 5,268
Amortization of deferred equity discount .................................. 1,414 1,142
Deferred taxes ............................................................ 7,364 (807)
Changes in operating assets and liabilities:
Accounts receivable ................................................... 7,732 2,796
Inventories ........................................................... (2,700) (533)
Prepaid expenses and other current assets and other assets ............ 766 (506)
Accounts payable ...................................................... (7,034) (1,201)
Accrued litigation reserve ............................................ 10,992 --
Other accrued expenses ................................................ 403 72
Customer deposits ..................................................... (1,948) (3,000)
Deferred revenue ...................................................... (1,276) 927
Income taxes payable .................................................. 15 (485)
-------- -------
Net cash provided by (used in) operating activities .............. (824) 1,959
-------- -------
Cash flows from investing activities:
Purchases of property and equipment ............................................. (2,568) (5,559)
Purchase of intangible assets ................................................... (171) (2,709)
Investment in affiliates ........................................................ (2,479) --
-------- -------
Net cash used in investing activities ............................ (5,218) (8,268)
-------- -------
Cash flows from financing activities:
Borrowings under equipment line of credit ....................................... -- 5,409
Repayment of borrowings under revolving line of credit .......................... -- (4,000)
Repayment of borrowings under construction loan and equipment line of credit .... (5,520) (4,967)
Repayment of obligations under capital lease .................................... (114) (150)
Net proceeds from issuance of common stock ...................................... 544 11,152
Collection of notes receivable from stockholders ................................ 122 --
-------- -------
Net cash provided by (used in) financing activities .............. (4,968) 7,444
-------- -------
Net increase (decrease) in cash and cash equivalents ................................ (11,010) 1,135
Cash and cash equivalents, beginning of period ...................................... 103,898 6,145
-------- -------
Cash and cash equivalents, end of period ............................................ $ 92,888 $ 7,280
======== =======
Supplemental disclosure of noncash activities
Transfer of items originally classified as fixed assets to inventories .......... $ 1,445 $ 530
Transfer of items originally classified as inventories to fixed assets .......... $ 1,917 $ 1,047
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements include
the accounts of SeaChange International, Inc. and its subsidiaries. SeaChange
believes that the unaudited condensed consolidated financial statements reflect
all adjustments (consisting of only normal recurring adjustments), necessary for
a fair statement of SeaChange's financial position, results of operations and
cash flows at the dates and for the periods indicated. The results of operations
for the periods presented are not necessarily indicative of results expected for
the full fiscal year or any other future periods. The unaudited condensed
consolidated financial statements should be read in conjunction with the
consolidated financial statements and related notes for the year ended January
31, 2002, included in SeaChange's Annual Report on Form 10-K for such fiscal
year. The balance sheet at January 31, 2002 was derived from audited financial
information.
2. Revenue Recognition
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.
SeaChange's 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 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 and 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 for the value of this consideration
as a reduction in revenue in its statement of operations (see Note 9 to the
condensed consolidated financial statements for further discussion).
3. Earnings Per Share
For the three and nine months ended October 31, 2002 and October 31, 2001,
common shares of 4,506,486 and 3,503,315 respectively, 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 loss per
share computation.
6
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
Below is a summary of the shares used in calculating basic and diluted earnings
per share for the periods indicated:
Three months ended Nine months ended
------------------ -----------------
October 31, October 31, October 31, October 31,
2002 2001 2002 2001
----------- ----------- ----------- -----------
Weighted average shares used in calculating earnings per share--
Basic.......................................................... 26,635 22,939 26,592 22,796
Dilutive common stock equivalents.............................. -- -- -- --
------ ------ ------ ------
Weighted average shares used in calculating earnings per share-
Diluted........................................................ 26,635 22,939 26,592 22,796
====== ====== ====== ======
4. Inventories
Inventories consist of the following:
October 31, January 31,
2002 2002
---------- ---------
Components and assemblies........................................ $19,544 $17,046
Finished products................................................ 6,674 6,944
------- ---------
$26,218 $23,990
======= =========
5. Comprehensive Loss
SeaChange's comprehensive loss was as follows:
Three months ended Nine months ended
------------------ -----------------
October 31, October 31, October 31, October 31
2002 2001 2002 2001
------- ------- ---------- ---------
Net loss................................................................ $(541) $(1,212) $(23,011) $(1,714)
Other comprehensive income (expense), net of tax:
Foreign currency translation adjustment, net of
tax of $ -, $4, $- and $(11), respectively........................ (28) 7 49 (22)
----- -------- --------- --------
Other comprehensive income (expense).................................... (28) 7 49 (22)
----- -------- --------- --------
Comprehensive loss...................................................... $(569) $(1,205) $(22,962) $(1,736)
===== ======== ========= ========
6. 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:
7
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
Three months ended Nine months ended
------------------ -----------------
October 31, October 31, October 31, October 31,
2002 2001 2002 2001
----------- ----- ------ ------
Revenues
Broadband...................... $22,373 $13,629 $ 63,148 $48,158
Broadcast...................... 3,572 4,147 15,213 12,671
Services....................... 7,926 7,445 22,543 21,572
------- ------- -------- -------
Total.......................... $33,871 $25,221 $100,904 $82,401
------- ------- -------- -------
Costs of revenues
Broadband...................... $13,739 $8,256 $ 38,859 $27,956
Broadcast...................... 2,062 2,426 8,297 7,252
Services....................... 5,153 5,201 15,924 15,644
------- ------- -------- -------
Total.......................... $20,954 $15,883 $ 63,080 $50,852
======= ======= ======== =======
The following summarizes revenues by geographic locations:
Revenues
United States $29,996 $21,635 $ 87,860 $71,313
Canada and South America 578 406 2,226 940
Europe 2,468 1,292 5,998 5,185
Asia Pacific and rest of world 829 1,888 4,820 4,963
------- ------- -------- -------
Total $33,871 $25,221 $100,904 $82,401
======= ======= ======== =======
For the three and nine months ended October 31, 2002 and October 31, 2001, a
limited number of SeaChange's customers each accounted for more than 10% of
SeaChange's total revenues. Four single customers accounted for 19%, 17%, 14%
and 13% of total revenues in the three months ended October 31, 2002 and a
single customer accounted for 38% of total revenues in the three months ended
October 31, 2001. Three single customers accounted for 21%, 17% and 10% of total
revenues in the nine months ended October 31, 2002 and two single customers
accounted for 20% and 17% of total revenues in the nine months ended October 31,
2001. Revenue from these customers was in the broadband segment. SeaChange
believes that revenues from current and future large customers will continue to
represent a significant proportion of total revenues.
7. Goodwill and Intangible Assets
In July 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other
Intangible Assets," which was 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 from previously
reported goodwill. This analysis, which was completed during the quarter ended
April 30, 2002 resulted in $253,000 being identified as goodwill and the
remaining gross carrying value of $5.4 million with an accumulated amortization
balance of $2.1 million being identified as patent related intangibles.
SeaChange reassessed the useful lives of the intangible assets and determined
that the lives were appropriate. For the three and nine months ended October 31,
2002, SeaChange amortized $384,000 and $1.1 million, respectively, of the patent
intangibles as general and administrative expenses and estimates annual
amortization expense to be $1.5 million for the fiscal year ending January 31,
2003 and 2004, and $1.0 million for the fiscal year ending January 31, 2005. In
accordance with SFAS 142, SeaChange completed the transitional impairment test
of its goodwill as of July 31, 2002 and no adjustment to goodwill was necessary.
As of February 1, 2002, SeaChange ceased the amortization of goodwill. The
following is the effect on net loss and net loss per share had SFAS 142 been in
effect for the three and nine months ended October 31, 2002 and October 31, 2001
(in thousands, except per share amounts):
8
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
Three months ended Nine months ended
------------------ -----------------
October 31, 2002 October 31, 2001 October 31, 2002 October 31, 2001
---------------- ---------------- ---------------- ----------------
Net loss ............................................... $ (541) $(1,212) $ (23,011) $ (1,714)
Add back: Impact of goodwill amortization,
net of tax of $-, $10, $- and $30, respectively ... -- 22 -- 66
------ -------- --------- --------
Adjusted net loss ...................................... $ (541) $(1,190) $ (23,011) $ (1,648)
====== ======== ========= ========
Net loss per share- basic and diluted .................. $(0.02) $ (0.05) $ (0.87) $ (0.08)
Add back: Impact of goodwill amortization,
net of taxes ....................................... (0.00) (0.00) (0.00) (0.00)
------ -------- --------- --------
Adjusted net loss per share- basic and diluted ......... $(0.02) $ (0.05) $ (0.87) $ (0.08)
====== ======== ========= ========
8. Legal Proceedings
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 SeaChange's patent 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.
On March 28, 2002, the Court denied nCube's motion for a new trial and on
September 30, 2002, the Court denied nCube's motions for judgment as a matter of
law. Any damages and injunctive relief against nCube will not be awarded until
after appeal.
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 Patent No. 5,805,804 held by nCube ("`804"). In
instituting the claim, nCube sought both an injunction and monetary damages. On
May 29, 2002, the jury rendered a verdict that SeaChange infringed the nCube
`804 patent. Based on a reasonable royalty rate of 7%, the jury determined that
damages through January 31, 2002 amounted to $2,035,829 and that SeaChange owes
a 7% royalty on subsequent sales of the accused video-on-demand products. The
jury also found that SeaChange's infringement was willful and the court will
determine whether to enhance the damages in a later proceeding. In accordance
with SFAS No. 5, "Accounting for Contingencies," SeaChange recorded certain
charges to reflect this unfavorable jury verdict against SeaChange in the first
quarter of fiscal 2003. The charges recorded totaled $14.4 million and included
provisions for estimated damages and treble damages relating to the shipments of
the accused video-on-demand ("VOD") systems through April 30, 2002, legal
expenses including $1.5 million of SeaChange deferred legal costs that had been
included in other assets as of January 31, 2002, and accrued interest on total
damages. The legal expenses paid through October 31, 2002 of $3.6 million
includes $1.5 million of SeaChange legal expense that had been included in other
assets as of January 31, 2002 and SeaChange litigation expenses paid in the
first and second quarters of fiscal 2003 related to pre-verdict legal services.
9
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
Estimated damages on the accused VOD shipments through April 30, 2002 ............................. $ 2,787,000
Estimated treble damages on the accused VOD shipments
through April 30, 2002 ....................................................................... 5,574,000
Estimated legal fees (including write-off of capitalized legal costs and nCube legal fees) ........ 5,621,000
Accrued interest on estimated damages and treble damages
through April 30, 2002 ....................................................................... 418,000
------------
14,400,000
Additional accrued interest on estimated damages and treble damages through
October 31, 2002 ............................................................................. 213,000
Legal expenses paid through October 31, 2002 ...................................................... (3,621,000)
------------
Accrued litigation reserve as of October 31, 2002 ................................................. $ 10,992,000
============
These estimates reflect SeaChange's best estimate of its exposure based on
information currently available. However, SeaChange believes that any liability
ultimately incurred after pursuing all legal options will not likely exceed the
provision recorded in the first quarter, except for on-going legal fees
associated with the dispute and additional accrued interest. Other than the
payment of SeaChange's legal fees, any payment of the other amounts recorded as
charges will only occur in the event that the jury verdict is upheld and treble
damages are awarded. SeaChange is contesting both the jury's verdict and the
Court's underlying patent claim construction in post-trial motions and, if
necessary, expects to contest the verdict and claim construction by appeal to
the United States Court of Appeals for the Federal Circuit. Any injunctive
relief against SeaChange will not be determined until after appeal. Even in the
event that the Court issues an injunction against SeaChange prohibiting
SeaChange from selling the accused video-on-demand products, SeaChange believes
that such injunction would have a minimal impact on its ability to ship products
and meet customer demands because SeaChange has implemented a revised version of
the software which SeaChange believes does not infringe the nCube `804 patent.
SeaChange and nCube have made a submission to the Court requesting that the
Court decide post-trial motions in these two cases at the same time, thereby
aligning these two cases for simultaneous appeal.
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. On June 25, 2002, the Court stayed
that action pending resolution of the appeals in the previously filed lawsuit.
In addition, nCube has asserted that SeaChange infringes several other patents
and that it may take legal action in the future. SeaChange believes that it does
not infringe any valid claim in these other patents.
SeaChange cannot be certain of the outcome of the foregoing current or potential
litigation, but plans to vigorously defend itself against allegations made
against SeaChange and oppose allegations that may be brought against SeaChange
in the future. Accordingly, SeaChange is unable to determine the ultimate impact
of this litigation on SeaChange's business, financial condition and results of
operations or cash flows.
10
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
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 SeaChange 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 SeaChange 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. 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. On October 2, 2002, the Arkansas Court
of Appeals reversed the judgment entered in favor of Concurrent and remanded the
matter to the trial court. The Arkansas Supreme Court declined Concurrent's
request for review. Once remand is finalized, SeaChange's claims against all
defendants and any counterclaims will be set for trial. SeaChange cannot be
certain of the outcome of the foregoing litigation, but plans to vigorously
oppose allegations against SeaChange and assert SeaChange's claims against other
parties. 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.
On October 30, 2002, a purported class action lawsuit was filed in the United
States District Court for the District of Massachusetts by Leon and Rena Beylus,
individually and on behalf of all others similarly situated, against SeaChange,
Morgan Stanley & Co. Incorporated, Thomas Weisel Partners LLC, RBC Dain
Rauscher, Inc., William C. Styslinger, III, William L. Fiedler, Martin R.
Hoffmann, Thomas F. Olson and Carmine Vona ( the "Beylus Complaint"). On
November 26, 2002, a purported class action complaint was filed in the United
States District Court for the District of Massachusetts against the same parties
by Panther Partners, Inc. (collectively with the Beylus Complaint, the
"Complaints"). The Complaints allege that the registration statement and
prospectus issued by SeaChange in connection with its stock offering completed
on January 31, 2002 contained statements that were materially inaccurate. The
plaintiffs are seeking damages in an unspecified amount, together with interest
thereon, recissory damages, reimbursement of costs and expenses, and further
relief that the court may determine to be appropriate. SeaChange believes the
allegations in the Complaints are without merit and intends to defend itself
vigorously in these matters.
9. 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 video-on-demand
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. 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
11
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
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
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 was 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 had originally estimated that the
equipment value with respect to the first one million subscribers to be $30
million. In April 2002, SeaChange revised this estimate to $25 million based on
price decreases within the video-on-demand equipment market. For the three
months ended July 31, 2002, SeaChange amortized $925,000 of the deferred equity
discount, which represented the remainder of the deferred equity discount
related to the first one million subscribers.
In May 2002, SeaChange issued Comcast 15,235 incentive common stock purchase
warrants based on the number of cable subscribers in excess of the first one
million subscribers that will be served by SeaChange equipment. The exercise
price of the incentive common stock purchase warrants of $11.94 was based on the
average closing market price of SeaChange's common stock for the fifteen trading
days ending on the agreed upon determination date of April 26, 2002. SeaChange
recorded a contra-equity amount of $125,000 representing the fair value of the
additional incentive common stock purchase warrants issued. During the three
months ended July 31, 2002, SeaChange amortized the $125,000 of the deferred
equity discount as an offset to gross revenue because the warrants were earned
by Comcast.
12
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
In August 2002, SeaChange issued Comcast an additional 887 incentive common
stock purchase warrants based on the number of cable subscribers in excess of
the first one million subscribers that will be served by SeaChange equipment.
The exercise price of the incentive common stock purchase warrants of $8.01 was
based on the average closing market price of SeaChange's common stock for the
fifteen trading days ending on the determination date of June 30, 2002.
SeaChange recorded $6,000 as an offset to gross product revenue representing the
fair value of the 887 additional incentive common stock purchase warrants
issued. In addition, during the three months ended October 31, 2002, SeaChange
recorded $118,000 as an offset to gross product revenue representing the
estimated fair value of 28,053 additional incentive common stock purchase
warrants, based on the number of cable subscribers in excess of the first one
million subscribers, earned by Comcast as of October 31, 2002. The estimated
fair value of the common stock purchase warrants was based on the average
closing market price of SeaChange's common stock for the fifteen trading days
ending on October 31, 2002.
10. Investment in Affiliates
On October 29, 2002, SeaChange entered into a Subscription and Shareholders
Agreement (the "Subscription Agreement") with ON Demand Group Limited ("ODG"), a
company incorporated in England and Wales that provides video-on-demand services
in Europe. Pursuant to the Subscription Agreement, SeaChange invested 1.5
million U.K. pounds Sterling (approximately $2.3 million) in exchange for
600,000 newly issued ordinary shares of ODG representing approximately 23% of
the total outstanding capital stock of ODG as of October 29, 2002. In connection
with this Subscription Agreement, SeaChange entered into a Business Development
Agreement with ODG for a minimum of five years whereby ODG agreed to exclusively
purchase and to market and promote SeaChange's video-on-demand systems and
software worldwide in connection with furnishing video-on-demand services to
ODG's customers.
As part of the Subscription Agreement, SeaChange has committed to purchase in
two separate tranches, additional ordinary shares and preference shares of ODG
from ODG and certain of its existing shareholders for an additional aggregate
purchase price of up to 8.5 million U.K. pounds Sterling subject to ODG's
satisfaction of certain conditions as set forth in the Subscription Agreement.
Preference shares of ODG are non-voting equity shares that have certain rights
and restrictions as outlined in ODG's Articles of Association, including but not
limited to annual dividends, liquidation preferences and redemption/repurchase
rights. In the first tranche, SeaChange agreed to purchase an additional 200,000
newly issued ordinary shares of ODG for an aggregate purchase price of 500,000
U.K. pounds Sterling, and an additional 400,000 ordinary shares of ODG from
certain existing shareholders of ODG for an aggregate purchase price of 1.0
million U.K. pounds Sterling, subject to ODG's satisfaction of the conditions
set forth in the Subscription Agreement for the first investment tranche,
including the execution of an agreement by ODG with a major European cable
operator for the supply of video-on-demand products and services to the
customers of such European cable operator on or prior to December 31, 2002. In
the second tranche, SeaChange agreed to purchase an additional 309,350 newly
issued ordinary shares of ODG for an aggregate purchase price of 773,375 U.K.
pounds Sterling, and an additional 6,226,625 newly issued preference shares of
ODG for an aggregate purchase price of 6,226,625 U.K. pounds Sterling, subject
to ODG's satisfaction of the conditions as set forth in the Subscription
Agreement for the second investment tranche, including the satisfaction of all
of the conditions for the first tranche and the execution of certain content
provision agreements by ODG with at least three studios providing for the supply
of content for video-on-demand service on or prior to December 31, 2003. In the
event of the expiration or the termination, for any reason other than breach of
contract, of the Business Development Agreement, ODG, upon written notification
from SeaChange, shall procure the sale or redemption of all the shares held by
SeaChange at a price equal to the then current fair value of such shares in
respect to the ordinary shares, and the redemption value of the preference
shares as defined in the Articles of Association.
SeaChange accounts for its investment in ODG under the equity method of
accounting in accordance with APB Opinion No. 18, "The Equity Method of
Accounting for Investments in Common Stock."
As disclosed in SeaChange's Current Report on Form 8-K filed November 13, 2002,
SeaChange will file the financial statements required by Item 7 of Form 8-K as
soon as practicable, but in any event not later than January 13, 2003.
13
SEACHANGE INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
11. Income Taxes
SeaChange has deferred tax assets that have arisen primarily as a result of
operating losses incurred and other temporary differences between book and tax
accounting. Statement of Financial Accounting Standards No. 109, "Accounting for
Income Taxes," requires the establishment of a valuation allowance when, based
on an evaluation of objective evidence, there is a likelihood that some portion
or all of the deferred tax assets will not be realized. SeaChange continually
reviews the adequacy of the valuation allowance for deferred tax assets. As a
result of recognizing a $14.8 million operating loss during the three months
ended April 30, 2002, SeaChange has determined that it is more likely than not
that its deferred tax assets will not be realized and accordingly has recorded
income tax expense and valuation allowance against the net deferred tax assets
of $7.4 million. If SeaChange generates future taxable income against which
these tax attributes may be applied, some portion or all of the valuation
allowance would be reversed and a corresponding increase in net income would be
reported in future periods.
12. New Accounting Pronouncements
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 financial position and results of
operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," ("SFAS 146") which will become effective for
exit or disposal activities initiated after January 31, 2003. SFAS 146 addresses
financial accounting and reporting for costs associated with exit or disposal
activities and supersedes Emerging Issues Task Force Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." SeaChange
believes the adoption of SFAS 146 will not have a material impact on its
financial position and results of operations.
14
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Factors That May Affect Future Results
Any statements contained in this Form 10-Q that do not describe historical facts
may constitute forward-looking statements as that term is defined in the Private
Securities Litigation Reform Act of 1995. These statements relate to future
events or our future financial performance and are identified by words such as
"may," "will," "could," "should," "expect," "plan," "intend," "seek,"
"anticipate," "believe," "estimate," "potential," or "continue" or other
comparable terms or the negative of those terms. Forward-looking statements in
this Form 10-Q include certain statements regarding the effect of certain
accounting standards on our financial position and results of operations, the
effect of certain legal claims against us, projected changes in our revenues,
earnings and expenses, exchange rate sensitivity, interest rate sensitivity,
liquidity, product introductions and general market conditions. Our actual
future results may differ significantly from those stated in any forward-looking
statements. Any such forward-looking statements contained herein are based on
current expectations, but are subject to a number of risks and uncertainties
that may cause actual results to differ materially from expectations. The
factors that could cause actual future results to differ materially from current
expectations include the following: the emergence and acceptance of the
video-on-demand market; the loss of one of the Company's large customers; the
cancellation or deferral of purchases of the Company's products; a decline in
demand or average selling price for the Company's broadband products; the
Company's ability to manage its growth; content providers limiting the scope of
content licensed for use in the video-on-demand market; the Company's ability to
introduce new products or enhancements to existing products; the Company's
dependence on certain sole source suppliers and third-party manufacturers; the
Company's ability to compete in its marketplace; the Company's ability to
respond to changing technologies; the Company's ability to protect its
intellectual property rights and the expenses that may be incurred by the
Company to protect its intellectual property rights; an unfavorable result of
current or future litigation, including our current patent litigation with nCube
Corp. and the current securities class action lawsuits filed against us; the
risks associated with international sales; the Company's ability to integrate
the operations of acquired subsidiaries; changes in the regulatory environment;
the Company's ability to hire and retain highly skilled employees; and
increasing social and political turmoil. Further information on factors that
could cause actual results to differ from those anticipated is detailed in
various filings made by us from time to time with the Securities and Exchange
Commission, including but not limited to, those appearing under the caption
"Certain Risk Factors" in our Annual Report on Form 10-K filed with the
Securities and Exchange Commission on April 30, 2002. Any forward-looking
statements should be considered in light of those factors.
Overview
We are a leading developer, manufacturer, and marketer of systems, known as
video-storage servers, that automate the management and distribution of both
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 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 and on-air playback of advertising and other video programming for the
broadcast television industry. Systems 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.
15
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 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, operating expenses have increased in the areas of
research and development, selling and marketing, customer service and support
and administration. We expect that the soft economy will continue to influence
our operating results during fiscal 2003. This impact is likely to be most
significant in the capital spending budgets of some of our cable and broadcast
customers whom we believe depend on advertising revenues to fund their capital
equipment purchases.
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 condensed 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 in our Annual
Report on Form 10-K filed with the Securities and Exchange Commission on April
30, 2002. In addition, as a result of changes in facts and circumstances
relating to certain litigation and income tax matters, the adoption of SFAS 142,
"Goodwill and Other Intangible Assets" and our investment in affiliates, we have
updated below those accounting policies that we believe are most critical to
fully understand and evaluate our financial results, and these policies should
be read in conjunction with our Consolidated Financial Statements and the
related Notes included in our Annual Report on Form 10-K filed with the
Securities and Exchange Commission on April 30, 2002.
Accounting for Contingencies. During the quarter ended April 30, 2002, we
recorded a $14.4 million charge to operations in connection with the unfavorable
jury verdict received against SeaChange related to the patent infringement claim
filed by nCube Corp. on January 8, 2001. In accordance with Statement of
Financial Accounting Standards No. 5, "Accounting for Contingencies," and
related guidance, we determined that based upon the unfavorable jury verdict
stating that our infringement was willful, we determined that it was probable
that certain deferred legal costs previously incurred in connection with
defending an existing patent had become impaired and that liabilities for
damages, treble damages, legal fees, including estimated nCube legal fees, and
related accrued interest had been incurred as of April 30, 2002. We also were
able to develop reasonable estimates of our loss based on information then
currently available about the jury's verdict concerning willful infringement and
related damages and the likelihood of treble damages. Other than the payment of
our legal fees, any payment of the other amounts recorded as one-time charges
will only occur in the event that the jury verdict is upheld and treble damages
are awarded. We believe that any liability ultimately incurred after pursuing
all legal options will not likely exceed the provision recorded in the quarter
ended April 30, 2002 except for the continuation of accrued interest. However,
we have revised our ongoing legal expenses based on legal expenses incurred in
the last two fiscal quarters and we expect to incur on-going legal fees and will
continue to accrue interest on the potential damages award in the aggregate
amount of approximately $800,000 to $900,000 per fiscal quarter until the matter
is resolved. For the three months ended October 31, 2002, approximately $900,000
in legal fees and accrued interest on the potential damages award related to
this litigation were recorded as general and administrative expenses.
Valuation of Long-Lived Assets. In accordance with Statement of Financial
Accounting Standards Board No. 144, "Accounting for the Impairment or Disposal
of Long-Lived Assets," which we adopted on February 1, 2002, 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 internal and external, that
may suggest an asset is not recoverable - that is, the carrying amount of the
asset exceeds the sum of the undiscounted cash flows expected to result from the
asset's use and eventual disposition. Factors we consider important that could
trigger the impairment review include:
16
.. significant underperformance relative to historical or projected future
operating results;
.. significant negative industry or economic trends;
.. significant decrease in the market value of the long-lived asset;
.. significant adverse change to the extent or manner in which a long-lived
asset is being used or in its physical condition;
.. significant adverse change in legal factors or in the business climate
that could affect the value of a long-lived asset;
.. 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. Our cash flow estimates contain management's best estimates, using
appropriate and customary assumptions and projections at the time.
Intangible assets, net consisted of capitalized patent defense costs of $3.3
million which are being amortized to general and administrative expenses over
their four year estimated useful life. In connection with the above patent
infringement jury verdict in May 2002, we wrote-off $1.5 million of certain
deferred legal costs that had become impaired.
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 the deferred tax assets
is reduced based on an evaluation of objective verifiable evidence. Significant
management judgment is required in determining our income tax expense (benefit),
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. As a result of
recognizing a $14.8 million operating loss during the quarter ended April 30,
2002, we determined that it is more likely than not that our deferred tax assets
will not be realized and accordingly we recorded income tax expense and
valuation allowance against the net deferred tax assets of $7.4 million. 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. If we generate future taxable income
against which these tax attributes may be applied, some portion or all of the
valuation allowance would be reversed and a corresponding increase in net income
would be reported in the future.
Investment in Affiliates. On October 29, 2002, we entered into a Subscription
and Shareholders Agreement (the "Subscription Agreement") with ON Demand Group
Limited ("ODG"), a company incorporated in England and Wales that provides
video-on-demand services in Europe. Pursuant to the Subscription Agreement, we
invested 1.5 million U.K. pounds Sterling (approximately $2.3 million) in
exchange for 600,000 newly issued ordinary shares of ODG representing
approximately 23% of the total outstanding capital stock of ODG as of October
29, 2002. In connection with this Subscription Agreement, we entered into a
Business Development Agreement with ODG for a minimum period of five years
whereby ODG agreed to exclusively purchase and to market and promote our
video-on-demand systems and software worldwide in connection with furnishing
video-on-demand services to ODG's customers. The realization of our investments
in equity securities may be affected by the affiliate's ability to obtain
adequate funding and execute its business plans, general market conditions,
industry considerations specific to the affiliate's business, and other factors.
The inability of an affiliate to obtain future funding or successfully execute
its business plan could adversely affect our earnings in the periods affected by
those events. Future adverse changes in market conditions or poor operating
results of underlying investments could result in losses or in inability to
recover the carrying value of the investments that may not be reflected in an
investment's current carrying value, thereby possibly requiring an impairment
charge in the future. We record an impairment charge when we believe an
investment has experienced a decline in value other-than-temporary.
17
Principles of Consolidation. We consolidate the balance sheets and results of
operations of all wholly and majority owned subsidiaries. We also hold minority
investments in the common stock of certain private companies having product
offerings or customer relationships that are strategic to us. These investments
in affiliates include investments accounted for under the cost method and the
equity method of accounting. Under the cost method of accounting, which
generally applies to investments that represent less than a 20% ownership
interest of the equity shares of the affiliate, the investments are carried at
cost and we monitor the investments for impairment and make appropriate
reductions in the carrying value, if necessary. Under the equity method of
accounting, which generally applies to investments that represent 20% to 50%
ownership of the equity securities of the affiliate, our proportionate ownership
share of the earnings or losses of the affiliate is included in equity income in
our consolidated statement of operations.
For transactions involving the sale of our products and services to an
affiliated entity in which we have an equity ownership interest, the extent of
revenue and profit recognized varies based on the level of equity interest we
hold. When our equity ownership interest in the affiliated customer is less than
20%, generally no revenue or profit is deferred or eliminated upon the sale of
our products to an affiliated entity. When our equity ownership interest is
between 20% and 50%, provided that we do not control the affiliated entity, we
generally recognize revenue upon shipment but we eliminate a portion of the
profit equal to our equity ownership interest in the entity. The profit is
eliminated through a charge to equity in the earnings of affiliated entities
with a corresponding reduction in the carrying value of the investment in the
affiliate.
Three Months Ended October 31, 2002 Compared to the Three Months Ended October
31, 2001
Revenues
Systems. Our systems revenues consist of sales within our broadband segment
(primarily digital advertising and video-on-demand systems) and our broadcast
segment. Systems revenues increased 46% to $25.9 million in the three months
ended October 31, 2002 from $17.8 million in the three months ended October 31,
2001. Revenues from the broadband segment, which accounted for 66% and 54% of
total revenues in the three months ended October 31, 2002 and 2001,
respectively, increased to $22.4 million in 2002 as compared to $13.6 million in
2001. Video-on-demand system revenues were $15.3 million for the three months
ended October 31, 2002 as compared to $10.2 million in the comparable quarter in
the prior year primarily due to increased deployments of residential
video-on-demand systems in the United States for U.S. cable operators. Included
as a reduction in the video-on-demand systems revenue in the three months ended
October 31, 2002 was the amortization of $124,000 related to the deferred equity
discount associated with the Comcast equity investment. Digital advertising
system revenues were $7.0 million for the three months ended October 31, 2002 as
compared to $3.4 million in the prior year. The increase in advertising system
revenues was a result of expansions to existing digital advertising insertion
systems by several U.S. cable operators. Broadcast system segment revenues were
$3.6 million in the three months ended October 31, 2002 as compared to $4.1
million in the three months ended October 31, 2001. We expect future revenue
growth, if any, to come principally from our video-on-demand 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. We do not
expect the Business Development Agreement with ODG to have a significant impact
on our video-on-demand revenues until late fiscal 2004 or fiscal 2005. As
revenues from broadcast and video-on-demand products increase, the digital
advertising products will become a smaller portion of total system revenues.
However, we believe that there will be continued demand for expansions to
existing digital advertising insertion systems within the U.S. and growth
potential for new interactive advertising systems in the future.
Services. Our services revenues consist of fees for installation, training,
product maintenance, technical support services and movie content fees. Our
services revenues increased 7% to $7.9 million in the three months ended October
31, 2002 from $7.4 million in the three months ended October 31, 2001. This
increase in services revenues primarily resulted from the renewals of technical
support and maintenance services and the impact of a growing installed base of
systems offset in part by a lower level of product development services.
For the three-month periods ended October 31, 2002 and October 31, 2001, a
limited number of our customers each accounted for more than 10% of our total
revenues. Four single customers accounted for 19%, 17%, 14% and 13% of total
revenues in the three months ended October 31, 2002, and a single customer
accounted for 38% of total revenues in the three months ended October 31, 2001.
Revenue from these customers was in the broadband segment. We believe that
revenues from current and future large customers will continue to represent a
significant proportion of total revenues.
18
International sales accounted for approximately 11% and 14% of total revenues in
the three-month periods ended October 31, 2002 and October 31, 2001,
respectively. We expect that international sales will become a more significant
portion of our business in the future. As of October 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 financial position. If this practice changes in the future, we
will reevaluate our foreign currency exchange rate risk.
Gross Profit
Systems. Costs of systems revenues consist primarily of the cost of purchased
components and subassemblies, labor and overhead relating to the final assembly
and testing of complete systems and related expenses. Costs of systems revenues
increased 48% to $15.8 million in the three months ended October 31, 2002 as
compared to $10.7 million in the three months ended October 31, 2001. In the
three months ended October 31, 2002, the increase in costs of systems revenues
reflects higher systems revenue and higher material costs within the
video-on-demand products. We expect cost of systems revenues as a percentage of
revenues for the video-on-demand products within the broadband segment to remain
at high levels as the products are first deployed and to decrease as the revenue
level increases and we improve our manufacturing and material purchasing
efficiencies through fiscal 2004.
Systems gross profit as a percentage of systems revenues was 39% and 40% in the
three months ended October 31, 2002 and October 31, 2001, respectively. Gross
profit for the broadband and broadcast segments remained flat at 39% and 42%,
respectively for each of the three-month periods ended October 31, 2002 and
October 31, 2001.
Services. Costs of services revenues consist primarily of labor, materials and
overhead relating to the installation, training, product maintenance and
technical support services provided by us and costs associated with providing
movie content. Costs of services revenues remained flat at $5.2 million in the
three months ended October 31, 2002 and the three months ended October 31, 2001,
respectively. Services gross profit as a percentage of services revenue was 35%
in the three months ended October 31, 2002 and 30% in the three months ended
October 31, 2001. We expect that we will continue to experience fluctuations in
gross profit as a percentage of services revenue as a result of the timing of
revenues from technical support and other services to support the growing
installed base of systems and the timing of costs associated with our ongoing
investment required to build a service organization to support the installed
base of systems and new products.
Research and Development. Research and development expenses consist primarily of
compensation of development personnel, depreciation of equipment and an
allocation of related facilities expenses. Research and development expenses
increased 10% to $6.5 million in the three months ended October 31, 2002 as
compared to $5.9 million in the three months ended October 31, 2001. The
increase in the three months ended October 31, 2002 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 in comparison to
similar periods in prior years as we continue to develop and support our 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 17% to $4.0
million in the three months ended October 31, 2002 from $3.4 million in the
three months ended October 31, 2001. The increase was primarily due to the
hiring of additional sales personnel for our video-on-demand and broadcast
products, higher commissions on increased revenues and higher travel and other
promotional related costs.
General and Administrative. General and administrative expenses consist
primarily of provision for litigation and related expenses resulting from the
nCube jury verdict, compensation of executive, finance, human resource and
administrative personnel, legal and accounting services and an allocation of
related facilities expenses. General and administrative expenses increased to
$3.3 million in the three-month period ended October 31, 2002, as compared to
$1.7 million in the three-month period ended October 31, 2001. This increase is
primarily due to legal expenses and accrued interest on potentially awarded
damages of approximately $900,000 associated with the unfavorable jury verdict
in connection with the litigation with nCube. We have revised our ongoing legal
expenses based on legal expenses incurred in each of the last two quarters and
we expect to incur on-going legal fees and accrued interest in the aggregate
amount of approximately $800,000 to $900,000 per fiscal quarter until the matter
is resolved. We intend to vigorously contest both the jury's verdict and the
U.S. District Court's underlying patent claim construction both in post-trial
motions and, if necessary, by way of an appeal to the United States Court of
Appeals for the Federal Circuit. We have filed counter claims in connection with
the above nCube `804 patent litigation.
19
Interest Income (Expense), net. Interest expense, net was $80,000 for the three
months ended October 31, 2001 and interest income, net was $304,000 for the
three months ended October 31, 2002. The increase in interest income, net in the
three months ended October 31, 2002 primarily resulted from interest on invested
cash balances resulting from our public stock offering which closed on January
31, 2002.
Income Tax Expense. Primarily as a result of the $14.4 million charge to
operations recorded in the first quarter of fiscal 2003 related to the
unfavorable jury verdict in the nCube litigation, we have determined that it is
more likely than not that our deferred tax assets as of October 31, 2002 will
not be realized. Accordingly, we recorded income tax expense of $7.4 million in
the three months ended April, 30, 2002 for a valuation allowance against all net
deferred tax assets and we have not recorded any income tax benefit in the three
months ended October 31, 2002. We will continue to assess the need for the
valuation allowance at each balance sheet date based on all available evidence,
including generating sufficient taxable income in future periods. Our effective
tax rate of 32% for the quarter ended October 31, 2001 was favorably impacted by
the utilization of research and development tax credits.
Nine Months Ended October 31, 2002 Compared to the Nine Months Ended October 31,
2001
Revenues
Systems. Systems revenues increased 29% to $78.4 million in the nine months
ended October 31, 2002 from $60.8 million in the nine months ended October 31,
2001. Revenues from the broadband segment, which accounted for 63% and 58% of
total revenues in the nine months ended October 31, 2002 and 2001, respectively,
increased to $63.1 million in 2002 as compared to $48.2 million in 2001.
Video-on-demand system revenues were $46.5 million for the nine months ended
October 31, 2002 as compared to $32.8 million in the prior year primarily due to
increased deployments of residential video-on-demand systems in the United
States for U.S. cable operators. Included as a reduction in the video-on-demand
systems revenue was the amortization of $1.4 million related to the deferred
equity discount associated with the Comcast equity investment. During the nine
months ended October 31, 2002, there were overall price decreases within the
video-on-demand equipment market due to competitive pressures and we believe
there may be future price decreases for these products as well. Digital
advertising system revenues were $16.6 million for the nine months ended October
31, 2002 as compared to $15.4 million in the prior year. The increase resulted
primarily from the rise in the number of expansion systems purchased by U.S.
cable operators in the third quarter of fiscal 2003. Broadcast system segment
revenues were $15.2 million in the nine months ended October 31, 2002 as
compared to $12.7 million in the nine months ended October 31, 2001. The
increase in broadcast system revenues was a result of increased market
penetration in the U.S. and Asia Pacific. We expect future revenue growth, if
any, to come principally from our video-on-demand 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. We do not expect the Business
Development Agreement with ODG to have a significant impact on our
video-on-demand revenues until late fiscal 2004 or fiscal 2005. As revenues from
broadcast and video-on-demand products increase, the digital advertising
products will become a smaller portion of total system revenues. However, we
believe that there will be a continued demand for expansions to existing digital
advertising insertion systems within the U.S. and growth potential for new
interactive advertising systems in the future.
Services. Our services revenues increased 5% to $22.5 million in the nine months
ended October 31, 2002 from $21.6 million in the nine months ended October 31,
2001. This increase in services revenues primarily resulted from the renewals of
technical support and maintenance services and the impact of a growing installed
base of systems offset in part by a lower level of product development services.
For the nine-month periods ended October 31, 2002 and October 31, 2001, a
limited number of our customers each accounted for more than 10% of our total
revenues. Three single customers accounted for 21% 17% and 10% of total revenues
in the nine months ended October 31, 2002 and two single customers accounted for
20% and 17% of total revenues in the nine months ended October 31, 2001. Revenue
from these customers was primarily in the broadband segment. We believe that
revenues from current and future large customers will continue to represent a
significant proportion of total revenues.
20
International sales accounted for approximately 13% and 14% of total revenues in
the nine-month periods ended October 31, 2002 and October 31, 2001,
respectively. We expect that international sales will become a more significant
portion of our business in the future. As of October 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 financial position. If this practice changes in the future, we
will reevaluate our foreign currency exchange rate risk.
Gross Profit
Systems. Costs of systems revenues increased 34% to $47.2 million in the nine
months ended October 31, 2002 as compared to $35.2 million in the nine months
ended October 31, 2001. In the nine months ended October 31, 2002, the increase
in costs of systems revenues reflects higher systems revenue and higher material
costs within the video-on-demand products. We expect cost of systems revenues as
a percentage of revenues for the video-on-demand products within the broadband
segment to remain at high levels as the products are first deployed and to
decrease as the revenue level increases and we improve our manufacturing and
material purchasing efficiencies through fiscal 2004.
Systems gross profit as a percentage of systems revenues was 40% and 42% in the
nine months ended October 31, 2002 and October 31, 2001, respectively. The
decrease in systems gross profit in the nine months ended October 31, 2002 was
primarily due to the shift within broadband products sales from higher gross
profit advertising systems to lower gross profit video-on-demand systems
resulting from competitive price decreases on our products. Gross profit for the
broadband segment decreased to 39% for the nine months ended October 31, 2002 as
compared to 42% for the nine months ended October 31, 2001 while gross profit
for the broadcast segment increased to 46% for the nine months ended October 31,
2002 compared to 43% for the nine months ended October 31, 2001.
Services. Costs of services revenues increased slightly to $15.9 million in the
nine months ended October 31, 2002 from $15.6 million in the nine months ended
October 31, 2001. Services gross profit as a percentage of services revenue was
29% in the nine months ended October 31, 2002 and 27% in the nine months ended
October 31, 2001. We expect that we will continue to experience fluctuations in
gross profit as a percentage of services revenue as a result of the timing of
revenues from technical support and other services to support the growing
installed base of systems and the timing of costs associated with our ongoing
investment required to build a service organization to support the installed
base of systems and new products.
Research and Development. Research and development expenses increased 9% to
$19.1 million in the nine months ended October 31, 2002 as compared to $17.6
million in the nine months ended October 31, 2001. The increase in the nine
months ended October 31, 2002 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 in comparison to similar periods in
prior years as we continue to develop and support our new and existing products.
Selling and Marketing. Selling and marketing expenses increased 13% to $12.0
million in the nine months ended October 31, 2002 from $10.6 million in the nine
months ended October 31, 2001. The increase was primarily due to the hiring of
additional sales personnel for our video-on-demand and broadcast products,
higher commissions on increased revenues, higher travel and other promotional
related costs.
General and Administrative. General and administrative expenses increased to
$23.3 million in the nine-month period ended October 31, 2002, as compared to
$5.6 million in the nine-month period ended October 31, 2001. This increase is
primarily due to the recording of charges of $14.4 million in the first quarter
of fiscal 2003 associated with an unfavorable jury verdict in connection with
the litigation with nCube, additional $1.8 million in on-going legal and accrued
interest related to the above litigation and the increase in accounts receivable
reserves, principally a $500,000 provision against outstanding amounts owed by
Adelphia Communications Corp. which filed for bankruptcy in June 2002. We have
revised our ongoing legal expenses based on legal expenses incurred in each of
the last two fiscal quarter and we expect to incur on-going legal fees and
accrued interest on awarded potential damages in the aggregate amount of
approximately $800,000 to $900,000 per fiscal quarter until the matter is
resolved. The charges recorded for the nCube jury verdict totaled $14.4 million
and included provisions for estimated damages and treble damages relating to the
shipments of the accused video-on-demand ("VOD") systems through April 30, 2002,
legal expenses, including estimated nCube legal fees and $1.5 million of our
legal costs that had been included in other assets as of January 31, 2002, and
accrued interest on total damages. The legal expenses paid through October 31,
2002 of $3.6 million include $1.5 million of SeaChange legal expense that had
been included in other assets as of January 31, 2002 and litigation expenses
paid in the first and second quarters of fiscal 2003 related to pre-verdict
legal services.
21
Estimated damages on the accused VOD shipments through April 30, 2002 ............... $ 2,787,000
Estimated treble damages on the accused VOD shipments through April 30, 2002 ........ 5,574,000
Estimated legal fees (including the write-off of capitalized legal costs and nCube
legal fees) ...................................................................... 5,621,000
Accrued interest on estimated damages and treble damages through April 30, 2002 ..... 418,000
-----------
14,400,000
Additional accrued interest on estimated damages and treble damages through
October 31, 2002 ................................................................. 213,000
Legal expenses paid through October 31, 2002 ........................................ (3,621,000)
-----------
Accrued litigation reserve as of October, 31, 2002 .................................. $10,992,000
===========
Accrued litigation reserve estimates reflects our best estimate of our exposure
based on information currently available. However, we believe that any liability
ultimately incurred after pursuing all legal options will not likely exceed the
provision recorded in the first quarter, except for on-going legal fees
associated with this dispute and additional accrued interest. Other than the
payment of our legal fees, any payment of the other amounts recorded as charges
will only occur in the event that the jury verdict is upheld and treble damages
are ultimately awarded. We are contesting both the jury's verdict and the
Court's underlying patent claim construction in post-trial motions and, if
necessary, expect to contest the verdict and claim construction by appeal to the
United States Court of Appeals for the Federal Circuit. Any injunctive relief
against us will not be determined until after appeal. Even in the event that the
Court issues an injunction against us prohibiting us from selling the accused
video-on-demand products, we believe that such injunction would have a minimal
impact on our ability to ship products and meet customer demands because we have
implemented a revised version of the software which we believe does not infringe
the nCube `804 patent.
Interest Income (Expense), net. Interest expense, net was $332,000 for the nine
months ended October 31, 2001 and interest income, net was $1.0 million for the
nine months ended October 31, 2002. The increase in interest income, net in the
nine months ended October 31, 2002 primarily resulted from interest on invested
cash balances resulting from our public stock offering which closed on January
31, 2002.
Income Tax Expense. Primarily as a result of the $14.4 million charge to
operations recorded in the first quarter of fiscal 2003 related to the
unfavorable jury verdict in the nCube litigation, we have determined that it is
more likely than not that our deferred tax assets as of October 31, 2002 will
not be realized. Accordingly, we recorded income tax expense of $7.4 million for
a valuation allowance against all net deferred tax assets. We will continue to
assess the need for the valuation allowance at each balance sheet date based on
all available evidence, including generating sufficient taxable income in future
periods. Our effective tax rate of 32% for the nine months ended October 31,
2001 was favorably impacted by the utilization of research and development tax
credits.
Liquidity and Capital Resources
We have financed our operations and capital expenditures primarily with the
proceeds of sales of our common stock, borrowings and cash flows generated from
operations. Cash and cash equivalents decreased $11.0 million from $103.9
million at January 31, 2002 to $92.9 million at October 31, 2002. Working
capital (consisting of current assets less current liabilities) decreased from
approximately $134.9 million at January 31, 2002 to approximately $112.1 million
at October 31, 2002.
Net cash used in operating activities was approximately $800,000 for the nine
months ended October 31, 2002. Net cash provided by operating activities was
$2.0 million for the nine months ended October 31, 2001. The net cash used in
operating activities for the nine months ended October 31, 2002 was the result
of the net loss of $23.0 million adjusted for non-cash expenses including
depreciation and amortization of $7.9 million and the changes in certain
operating assets and liabilities. The significant net changes in operating
assets and liabilities that provided cash from operations included the increase
in accrued litigation reserve of $11.0 million related primarily to the non-cash
charges to operations recorded in connection with the nCube jury verdict in the
first quarter of fiscal 2003, and a decrease in accounts receivable of $7.7
million. Those items that generated cash from operations were offset by an
increase in inventories of approximately $2.7 million, a decrease in accounts
payable of $7.0 million and a decrease in customer deposits of $1.9 million. We
expect that the broadcast segment and the video-on-demand 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.
22
Net cash used in investing activities was approximately $5.2 million and $8.3
million for the nine months ended October 31, 2002, and October 31, 2001,
respectively. Investment activity consisted primarily of expenditures for
capital equipment required to support the expansion and growth of the business
and the initial investment in ODG of approximately $2.3 million.
Net cash used in financing activities was approximately $5.0 million and net
cash provided by financing activities was approximately $7.4 million for the
nine months ended October 31, 2002, and October 31, 2001, respectively. In the
nine months ended October 31, 2002, the cash used in financing activities
included approximately $5.6 million in principal repayments of outstanding loans
under the 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 October 31, 2002. Borrowings under this line of credit are
collateralized by substantially all of our assets. In March 2002, we repaid the
outstanding balance under the current line of credit of $5.4 million plus
accrued interest to the bank. As of October 31, 2002, we had no borrowings under
this revolving line of credit. 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 October
31, 2002, the Company was in compliance with the financial covenants.
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%. 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 October 31, 2002. Borrowings under the loan are
collaterized 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 annual financial ratios. We were in compliance with the
financial covenants as of October 31, 2002. As of October 31, 2002, borrowings
outstanding under the loan were $1.0 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 fluctuations in our inventories as a result of procurement of
both short and long lead components for anticipated orders for both our product
segments, in our accounts payable balance primarily due to the timing of
payments for materials purchased for prior month shipments, in accounts
receivable amounts as a result of the timing of customer payments without
corresponding customer shipments and in cash and cash equivalents.
As part of the Subscription and Shareholders Agreement (the "Subscription
Agreement") that we entered into with ON Demand Group Limited ("ODG") on October
29, 2002, we have committed to purchase in two separate tranches, additional
ordinary shares and preference shares of ODG from ODG and certain of its
existing shareholders for an additional aggregate purchase price of up to 8.5
million U.K. pounds Sterling subject to ODG's satisfaction of certain conditions
as set forth in the Subscription Agreement. Preference shares of ODG are
non-voting equity shares that have certain rights and restrictions as outlined
in ODG's Articles of Association, including but not limited to annual dividends,
liquidation preferences and redemption/repurchase rights. In the first tranche,
we would purchase an additional 200,000 newly issued ordinary shares of ODG for
an aggregate purchase price of 500,000 U.K. pounds Sterling, and an additional
400,000 ordinary shares of ODG from certain existing shareholders of ODG for an
aggregate purchase price of 1.0 million U.K. pounds Sterling, subject to ODG's
satisfaction of the conditions as set forth in the Subscription Agreement for
the first investment tranche, including the execution of an agreement by ODG
with a major European cable operator for the supply of video-on-demand products
and services to the customers of such European cable operator on or prior to
December 31, 2002. In the second tranche, we agreed to purchase an additional
309,350 newly issued ordinary shares of ODG for an aggregate purchase price of
773,375 U.K. pounds Sterling, and an additional 6,226,625 newly issued
preference shares of ODG for an aggregate purchase price of 6,226,625 U.K.
pounds Sterling, subject to ODG's satisfaction of the conditions as set forth in
the Subscription Agreement for the second investment tranche, including the
satisfaction of all of the conditions for the first tranche and the execution of
certain content provision agreements by ODG with at least three studios
providing for the supply of content for video-on-demand service on or prior to
December 31, 2003. In the event of the expiration or the termination, for any
reason other than breach of contract, of the Business Development Agreement,
ODG, upon written notification from us, shall procure the sale or redemption of
all the shares held by us at a price equal to the then current fair value for
the ordinary shares and the redemption value of the preference shares as defined
in the Articles of Association.
23
We believe that existing funds together with available borrowings under the
revolving line of credit and the proceeds from our public stock offering are
adequate to satisfy our working capital and capital expenditure requirements and
our commitments to affiliates requirements for the foreseeable future.
We had no material capital expenditure commitments as of October 31, 2002.
Effects of Inflation
Management believes that financial results have not been significantly impacted
by inflation and price changes.
Recent Accounting Pronouncements
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. We believe the adoption of SFAS 143 will
not have a material impact on our financial position and results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," ("SFAS 146") which will become effective for
exit or disposal activities initiated after January 31, 2003. SFAS 146 addresses
financial accounting and reporting for costs associated with exit or disposal
activities and supersedes Emerging Issues Task Force Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." We believe the
adoption of SFAS 146 will not have a material impact on our financial position
and results of operations.
ITEM 3. 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 October 31,
2002, we had approximately $1,000,000 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 $5,000.
The carrying amounts reflected in the consolidated balance sheet of cash and
cash equivalents, trade receivables, and trade payables approximates fair value
at October 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 October 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 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
Within ninety days prior to the filing date of this Quarterly Report on
Form 10-Q, we evaluated the effectiveness of our disclosure controls and
procedures, as defined in Rules 13a-14(c) and 15d-14(c) under the Securities
Exchange Act of 1934, as amended. Based upon that evaluation, William C.
Styslinger, III, our Chief Executive Officer, and William L. Fiedler, our Chief
Financial Officer, concluded that our disclosure controls and procedures are
effective.
24
(b) Changes in Internal Controls
There were no significant changes in our internal controls or in other
factors that could significantly affect our internal controls subsequent to the
date we last evaluated our internal controls, including any corrective actions
with regard to significant deficiencies and material weaknesses.
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
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 SeaChange's patent 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.
On March 28, 2002, the Court denied nCube's motion for a new trial and on
September 30, 2002, the Court denied nCube's motions for judgment as a matter of
law. Any damages and injunctive relief against nCube will not be awarded until
after appeal.
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 Patent No. 5,805,804 held by nCube ("`804"). In
instituting the claim, nCube sought both an injunction and monetary damages. On
May 29, 2002, the jury rendered a verdict that SeaChange infringed the nCube
`804 patent. Based on a reasonable royalty rate of 7%, the jury determined that
damages through January 31, 2002 amounted to $2,035,829 and that SeaChange owes
a 7% royalty on subsequent sales of the accused video-on-demand products. The
jury also found that SeaChange's infringement was willful and the court will
determine whether to enhance the damages in a later proceeding. In accordance
with SFAS No. 5, "Accounting for Contingencies", SeaChange recorded certain
charges to reflect this unfavorable jury verdict against SeaChange in the first
quarter of fiscal 2003. The charges recorded totaled $14.4 million and included
provisions for estimated damages and treble damages relating to the shipments of
the accused video-on-demand ("VOD") systems through April 30, 2002, legal
expenses including $1.5 million of SeaChange legal expense that had been
included in other assets as of January 31, 2002, and accrued interest on total
damages. The legal expenses paid through July 31, 2002 of $3.6 million include
$1.5 million of SeaChange legal expense that had been included in other assets
as of January 31, 2002 and litigation expenses paid in the first and second
quarters of fiscal 2003 related to pre-verdict legal services.
Estimated damages on the accused VOD shipments through April 30, 2002 .................................... $ 2,787,000
Estimated treble damages on the accused VOD shipments
through April 30, 2002 .............................................................................. 5,574,000
Estimated legal fees (including write-off of capitalized legal costs and nCube legal fees) ............... 5,621,000
Accrued interest on estimated damages and treble damages
through April 30, 2002 .............................................................................. 418,000
-----------
14,400,000
Additional accrued interest on estimated damages and treble damages through
October 31, 2002 .................................................................................... 213,000
Legal expenses paid through October 31, 2002 ............................................................. (3,621,000)
-----------
Accrued litigation reserve as of October 31, 2002 ........................................................ $10,992,000
===========
25
These estimates reflect SeaChanges's best estimate of its exposure based on
information currently available. However, SeaChange believes that any liability
ultimately incurred after pursuing all legal options will not likely exceed the
provision recorded in the first quarter, except for on-going legal fees
associated with this dispute and additional accrued interest. Other than the
payment of SeaChange's legal fees, any payment of the other amounts recorded as
charges will only occur in the event that the jury verdict is upheld and treble
damages are awarded. SeaChange is contesting both the jury's verdict and the
Court's underlying patent claim construction in post-trial motions and, if
necessary, expects to contest the verdict and claim construction by appeal to
the United States Court of Appeals for the Federal Circuit. Any injunctive
relief against SeaChange will not be determined until after appeal. Even in the
event that the Court issues an injunction against SeaChange prohibiting
SeaChange from selling the accused video- on-demand products, SeaChange believes
that such injunction would have a minimal impact on its ability to ship products
and meet customer demands because SeaChange has implemented a revised version of
the software which SeaChange believes does not infringe the nCube `804 patent.
SeaChange and nCube have made a submission to the Court requesting that the
Court decide post-trial motions in these two cases at the same time, thereby
aligning these two cases for simultaneous appeal.
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. On June 25, 2002, the Court stayed
that action pending resolution of the appeals in the previously filed lawsuit.
In addition, nCube has asserted that SeaChange infringes several other patents
and that it may take legal action in the future. SeaChange believes that it does
not infringe any valid claim in these other patents.
SeaChange cannot be certain of the outcome of the foregoing current or potential
litigation, but plans to oppose allegations against SeaChange and oppose
allegations that may be bought against SeaChange in the future. Accordingly,
SeaChange is unable to determine the impact to SeaChange's business, financial
condition and results of operations or cash flows.
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 SeaChange 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 SeaChange 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. 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. On October 2, 2002, the Arkansas Court
of Appeals reversed the judgment entered in favor of Concurrent and remanded the
matter to the trial court. The Arkansas Supreme Court declined Concurrent's
request for review. Once remand is finalized, SeaChange's claims against all
defendants and any counterclaims will be set for trial. SeaChange cannot be
certain of the outcome of the foregoing litigation, but plans to vigorously
oppose allegations against SeaChange and assert SeaChange's claims against other
parties. 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.
26
On October 30, 2002, a purported class action lawsuit was filed in the United
States District Court for the District of Massachusetts by Leon and Rena Beylus,
individually and on behalf of all others similarly situated, against SeaChange,
Morgan Stanley & Co. Incorporated, Thomas Weisel Partners LLC, RBC Dain
Rauscher, Inc., William C. Styslinger, III, William L. Fiedler, Martin R.
Hoffmann, Thomas F. Olson and Carmine Vona ( the "Beylus Complaint"). On
November 26, 2002, a purported class action complaint was filed in the United
States District Court for the District of Massachusetts against the same parties
by Panther Partners, Inc. (collectively with the Beylus Complaint, the
"Complaints"). The Complaints allege that the registration statement and
prospectus issued by SeaChange in connection with its stock offering completed
on January 31, 2002 contained statements that were materially inaccurate. The
plaintiffs are seeking damages in an unspecified amount, together with interest
thereon, recissory damages, reimbursement of costs and expenses, and further
relief that the court may determine to be appropriate. SeaChange believes the
allegations in the Complaints are without merit and intends to defend itself
vigorously in these matters.
Item 2. Changes in Securities and Use of Proceeds
In August 2002, pursuant to the terms of that certain Video-on-Demand Purchase
Agreement, dated as of December 1, 2000, by and between SeaChange and Comcast
Cable Communications of Pennsylvania, Inc., SeaChange issued to Comcast Cable SC
Investment, Inc. ("Comcast SC") a warrant exercisable for eight hundred
eighty-seven (887) shares of SeaChange's common stock, $0.01 par value per
share. The exercise price of the incentive common stock purchase warrants of
$8.01 was based on the average closing market price of SeaChange's common stock
for the fifteen trading days ending on the determination date, June 30, 2002.
This issuance was exempt from the registration requirements of the Securities
Act of 1933, as amended, pursuant to Section 4(2) thereof, as SeaChange did not
make any general solicitation relating to the issuance of these warrants. No
underwriter was used in connection with this transaction.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.1 Subscription and Shareholders Agreement, dated as of October 29, 2002, by
and between SeaChange International, Inc., ON Demand Group Limited and
the other parties thereto (filed as Exhibit 2.1 to the Company's Current
Report on Form 8-K previously filed on November 13, 2002 with the
Commission (File No. 000-21393) and incorporated herein by reference).
10.2 Articles of Association of ON Demand Group Limited, as adopted by
special resolution passed on October 28, 2002 (filed as Exhibit 2.2 to
the Company's Current Report on Form 8-K previously filed on November 13,
2002 with the Commission (File No. 000-21393) and incorporated herein by
reference).
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)
(b) Reports on Form 8-K.
Not applicable.
27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, SeaChange
International, Inc. has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
Dated: December 13, 2002
SEACHANGE INTERNATIONAL, INC.
by: /s/ William L. Fiedler
William L. Fiedler
Vice President, Finance and Administration,
Chief Financial Officer, Treasurer and Secretary
(Principal Financial and Accounting Officer;
Authorized Officer)
CERTIFICATIONS
I, William C. Styslinger, III, certify that:
1. I have reviewed this quarterly report on Form 10-Q of SeaChange
International, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
28
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: December 13, 2002
/s/ William C. Styslinger, III
- -------------------------------
William C. Styslinger, III
President and Chief Executive Officer
(Principal Executive Officer)
I, William L. Fiedler, certify that:
1. I have reviewed this quarterly report on Form 10-Q of SeaChange
International, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
29
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: December 13, 2002
/s/ William L. Fiedler
- ----------------------
William L. Fiedler
Chief Financial Officer, Vice President, Finance and Administration,
Treasurer and Secretary
(Principal Financial and Accounting Officer)
30
Index to Exhibits
No. Description
10.1 Subscription and Shareholders Agreement, dated as of October 29, 2002, by
and between SeaChange International, Inc., ON Demand Group Limited and
the other parties thereto (filed as Exhibit 2.1 to the Company's Current
Report on Form 8-K previously filed on November 13, 2002 with the
Commission (File No. 000-21393) and incorporated herein by reference).
10.2 Articles of Association of ON Demand Group Limited, as adopted by special
resolution passed on October 28, 2002 (filed as Exhibit 2.2 to the
Company's Current Report on Form 8-K previously filed on November 13,
2002 with the Commission (File No. 000-21393) and incorporated herein by
reference).
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)
31