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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
--- OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996
Commission File Number: 0-21393
SEACHANGE INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
Delaware 04-3197974
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
124 Acton Street, Maynard, MA 01754
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (508) 897-0100
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE
----------------------------
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceeding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes_X_ No__
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [ ].
As of March 20, 1997 the aggregate market value of the voting stock held by non-
affiliates of the registrant, based upon the closing price for the registrant's
Common Stock on the Nasdaq National Market on such date was $63,537,244. The
number of shares of the registrant's Common Stock outstanding as of the close of
business on March 20, 1997 was 12,877,733.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the definitive Proxy Statement in connection with the Annual Meeting
of Stockholders to be held on or about May 29, 1997 to be filed pusuant to
Regulation 14A are incorporated by reference into Part III of this Form 10-K.
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PART I
This Annual Report on Form 10-K includes certain statements of a forward-looking
nature which reflect the Company's current views relating to future events or
the future financial performance of the Company. These forward-looking
statements are only predictions and are subject to risks and uncertainties,
particularly the matters set forth in "Certain Risk Factors" below, which could
cause actual events or results to differ materially from historical results or
those indicated by such forward-looking statements.
ITEM 1. BUSINESS
SeaChange International, Inc. ("SeaChange"or the "Company") provides software-
based products to manage, store and distribute digital video for cable
television operators and telecommunications companies. The Company's products
utilize its proprietary distributed application software and standard industry
components to automate the management and distribution of short- and long-form
video streams including advertisements, movies, news updates and other video
programming requiring precise, accurate and continuous execution. The Company's
digital video products are designed to provide higher image quality and to be
more reliable, easier to use and less expensive than analog tape-based systems.
In addition, SeaChange's products enable its customers to increase revenues by
offering more targeted services such as geography-specific spot advertising and
Video-On-Demand movies.
SeaChange's products address a number of specific markets. The SeaChange SPOT
System is the leading digital advertisement and other short-form video insertion
system for the multichannel television market in terms of installations in the
United States, based on currently available industry sources and the Company's
internal data. The SeaChange SPOT System encodes analog video forms such as
advertisements and news updates, stores them in remote or local digital
libraries, and inserts them automatically into television network streams. The
SPOT System provides high run-rate accuracy and video image quality, permits
geographic and demographic specificity of advertisements and reduces operating
costs. The Company has recently introduced the SeaChange Movie System, which
provides long-form video storage and delivery for the Video-On-Demand and pay-
per-view movie markets and is developing the SeaChange Programming System, a
long-form video storage and delivery product for cable television operators and
telecommunications companies. The SeaChange Traffic and Billing Software
operates in conjunction with the SeaChange SPOT System to automate and simplify
complex sales, scheduling and billing processes for the multichannel television
market. The Company also sells its Video Server 100, which is designed to store
and distribute video streams of various lengths, and MediaCluster, SeaChange's
proprietary software technology that enables multiple Video Server 100s to
operate together as an integrated video server, to systems integrators and value
added resellers (''VARs''). In addition, the Company is developing digital play-
to-air systems for the broadcast television industry.
The Company was incorporated in Delaware in July 1993 under the name SeaView
Technology, Inc. and changed its name to SeaChange Technology, Inc. in September
1993 and to SeaChange International, Inc. in March 1996.
INDUSTRY BACKGROUND
Television operators, the largest users of professional quality video,
historically have relied on analog technology for the storage and distribution
of video streams. Analog systems, which use video tapes as the primary mechanism
for the storage and distribution of video, have substantial limitations. Analog
tapes and their associated playback mechanisms are subject to mechanical failure
and generational loss of video quality. Analog tape-based systems also require
significant manual intervention, which makes them expensive and cumbersome to
operate and
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also limits their flexibility for programming changes. Finally, analog tapes are
bulky and have limited storage capacity.
Over the past decade, the limitations of analog tape-based systems have become
increasingly apparent. Changes in government regulation and increased
competition have forced television operators to seek new revenue sources and
reduce costs. In addition, television operators are increasingly seeking to
offer new and enhanced video services while simultaneously improving the
efficiency of their operations. While analog tape-based systems are sufficient
for some traditional applications, they do not meet the performance and cost
requirements of these new, targeted applications.
Cable Television Operators & Telecommunications Companies
According to industry sources, there are approximately 11,000 cable systems
currently in the United States, serving over 64 million households. In 1995,
57.3% of all cable systems provided between 30 and 53 channels of programming as
compared to 35.9% in 1985. Because cable television programming is sent over
broadband lines, operators can segment and target their programming to viewers
in selected geographies. In addition, the continuing growth in cable
television's multiple specialized programming networks, such as CNN, MTV and
ESPN and newer networks such as Black Entertainment Television, the Discovery
Channel and Nickelodeon, allow advertisers to target viewers in selected
demographic profiles.
Despite this advantage over television broadcasters, cable television
operators historically have not realized advertising revenues in proportion to
their share of television viewers. According to industry sources, in 1995, 36%
of all television viewers were watching cable networks, yet cable television
advertising revenue accounted for only 16% of the total television advertising
revenue. In addition, advertising represents the major source of revenue for
television broadcasters, while most cable television operators derive less than
5% of their gross revenue from advertising. The limitations of analog tape-based
technology are a major factor which has prevented cable television operators
from historically exploiting their advantages over television broadcasters.
Analog systems are difficult to manage in multichannel and multi-zone
environments, resulting in relatively poor video insertion accuracy and high
operating costs.
Video-On-Demand represents a new opportunity for cable television operators.
Industry sources project that the Video-On-Demand market will generate
approximately $1.8 billion in revenues for cable television operators in 1999.
Increased channel capacity through the installation of fiber optic cables is
providing many cable television operators with the capacity to offer Video-On-
Demand programming capability to hotels and apartments. However, these complex
applications which demand reliable, rapid and cost-effective management and
operation are not as practical or feasible with existing analog technology.
The recent deregulation of the United States telecommunications industry has
lowered the legal barriers to entry for telecommunications companies to enter
the multichannel video delivery market. Telecommunications companies are
attempting to capitalize on the new growth opportunities by acquiring existing
cable television operators and by leveraging their existing telephony networks
to establish new multichannel video delivery operations. However,
telecommunications companies face the same limitations as cable television
operators in cost-effectively offering targeted, value-added services with
analog tape-based systems.
Increased demand for video and audio content over the Internet will require a
substantial increase in storage capacity and bandwidth over time. The Company
believes that cable television operators and telecommunications companies will
play an integral role in providing these broadband Internet applications. The
Company also believes that in order to offer high quality video applications
over the Internet, cable television operators and telecommunications companies
will need storage and distribution products capable of complex management and
scheduling of video data streams.
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Television Broadcasters
The more than 1,500 broadcast stations in the United States, including network
affiliates and independent stations, face many of the same technological issues
as cable television operators. Additionally, television broadcasters rely on
advertising for nearly all of their revenue and require high advertisement run-
rate reliability and image quality. To date, television broadcasters have
utilized tape-based systems with robotic libraries, which are cumbersome and
require high levels of maintenance and manual intervention to ensure that the
needed performance requirements are met. Also, the video tapes in these systems
need to be replaced frequently due to repeated use.
In addition, many broadcasters are contemplating the use of the cable
infrastructure for the delivery of geography-specific advertising. These
broadcasters will insert targeted advertising into their television signals and
distribute them directly, often via microwave, to cable operators' distribution
sites. If this application develops, television operators will require video
storage and delivery systems that can effectively manage and deliver multiple
television signals to targeted markets.
Initial Digital Video Products
Over the past five years, several companies have introduced digital video
products aimed at addressing the limitations of analog tape-based systems. These
products generally have been expensive, not scalable, difficult to program and
have poor video quality. In addition, many initial digital video products have
required users to integrate several components from different vendors to create
a complete solution, which is time consuming, technologically difficult and
often results in poor system performance.
THE SEACHANGE SOLUTION
SeaChange develops, markets and supports software-based digital video
solutions designed to enhance its customers' ability to store, retrieve, manage
and distribute short- and long-form video streams, including advertisements,
movies, news updates and other video programming requiring precise, accurate and
continuous execution. The Company's solutions are based on five core areas of
functionality: (i) real-time conversion of analog video into digital video
format; (ii) storage and retrieval of video content to and from digital
libraries; (iii) scheduled distribution of video streams between digital
libraries via local and wide area data networks; (iv) delivery of video streams
over single and multiple channels; and (v) management of video sales,
scheduling, billing and execution of related business transactions.
SeaChange uses these core capabilities to provide solutions to a number of
commercial markets. The Company's products are designed to provide a consistent
set of features and benefits, including:
Viewer Targeting. The Company's digital video products enable television
operators to efficiently target viewers in specific demographic or geographic
groups. The ability to target selected viewers enables television operators to
increase revenues by offering more targeted services. The SeaChange SPOT
System offers this capability to television operators, while the SeaChange
Movie System makes it possible for television operators to offer Video-On-
Demand movies to individual hotel rooms or apartments.
Cost Reduction. The Company's products are designed to provide its customers
operating cost reductions as compared to analog tape-based systems due to,
among other things, the elimination of video tapes and their storage and lower
operating personnel requirements. The Company is also able to price its
products on a competitive basis by using standard operating systems and
components. The Company believes that the combination of competitive pricing
of its products and reductions in the operating costs of its customers results
in attractive pay-back periods on customers' initial capital outlay for the
Company's products.
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Scalability. The Company's products are scalable to the needs of a
particular cable television operator or television broadcaster whether
operating in a single channel system concentrated in one specific zone or a
system with hundreds of channels serving multiple zones and markets. Moreover,
the Company's proprietary storage technology enables the scalability of
storage of digital video from a few minutes to hundreds of hours of video.
Reliability. The Company's products eliminate the need for traditional
mechanical tape-based systems, thereby reducing the likelihood of breakdowns.
Furthermore, through the use of redundant components and proprietary storage
technology and application software, SeaChange's products are designed to be
fault resilient, providing the high reliability required for television
operations.
Scheduling Flexibility. The digitizing and storage of video streams allows
advertisements, news updates and movies to be inserted on channels in local
communities and allows cable television operators to insert or delete video
content rapidly. This flexibility enables the provision of services such as
Video-On-Demand movies and provides advertisers and television broadcasters
the opportunity to insert new video content on short notice.
Video Image Quality. Because digital video streams do not degrade with
playback, image content and quality remain at the original professional level
even after multiple airings.
Ease of Use. The Company's products are simple to learn, require less
maintenance, and are less personnel intensive than analog systems. Due to
their innovative architecture, the Company's products offer a number of
features that simplify their use, including remote monitoring and service and
automated short- and long-form video distribution.
STRATEGY
SeaChange's objective is to be a leader in the emerging market for the
storage, management and distribution of professional quality digital video. The
key elements of the Company's strategy are to:
Develop Long-Term Customer Relationships. The Company is focusing its
product development, marketing and direct sales efforts on developing long-
term customer relationships with cable television operators,
telecommunications companies and television broadcasters in the United States
and internationally. The Company has formed its customer relationships by
providing software-based digital video solutions to address customers'
immediate problems, such as advertisement and other short-form video
insertion. The Company intends to continue to leverage its customer
relationships to offer new, compatible products to meet evolving market needs,
such as Video-On-Demand programming. The Company believes that the
fundamental shift from analog to digital video and the growing emphasis on
interactive technologies will continue to present opportunities for the
Company to develop, market and support its products to both its existing
customer base and to customers in additional markets.
Offer Complete Solutions. SeaChange's customers operate complex networks
that require the delivery and management of video programming across multiple
channels and target zones. SeaChange believes television operators desire
complete solutions that integrate all steps of digital video delivery from
scheduling to post-air verification and billing. To address these needs,
SeaChange provides integrated applications and support services which are more
valuable to customers than individual functional products not specifically
designed to work together. The Company believes that providing complete
solutions has been a significant factor in its success and will be an
increasingly important competitive advantage.
Establish and Maintain Technological Leadership Through Software. SeaChange
believes its competitive position is dependent in large part on the features
and performance of its application and network and storage
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software. As a result, the Company focuses a majority of its research and
development efforts on introducing new software applications and improving its
current software. The Company seeks to use standard hardware components
wherever possible to maintain its focus on software development.
Provide Superior Customer Service and Support. The Company's products
operate in environments where continuous operation is critical. As a result,
the Company believes that providing a high level of service and support gives
it a competitive advantage and is a differentiating factor in developing key
customer relationships. The Company's in-depth industry and application
knowledge allows it to better understand the service needs of its customers.
As of December 31, 1996, more than 30% of the Company's employees were
dedicated to customer service and support, including project design and
implementation, installation and training. In addition, using remote
diagnostic and communications features embedded in the Company's products, the
service organization has the ability to monitor the performance of customer
installations and, in most cases, rectify problems remotely. Customers have
access to service personnel via 24-hour, seven-day a week telephone support.
PRODUCTS
SeaChange develops digital video products and related applications for the
television industry. Its products are marketed to cable television operators,
telecommunication companies, television broadcasters, systems integrators and
VARs.
SeaChange SPOT System
The SeaChange SPOT System automates the complex process of advertisement and
other video insertion across multiple channels and geographic zones for cable
television operators and telecommunications companies. Through its proprietary
software, the SeaChange SPOT System allows cable television operators to insert
local and regional advertisements and other short-form video streams into the
time allocated for these video streams by cable television networks such as CNN,
MTV, ESPN, Black Entertainment Television, the Discovery Channel and
Nickelodeon.
The SeaChange SPOT System is an integrated solution composed of software
applications, hardware platforms, data networks and easy to use graphical
interfaces. The SeaChange SPOT System is designed to be installed at local cable
transmission sites, known as headends, and advertising sales business offices.
The SeaChange video insertion process consists of six steps:
Encoding: The process begins with the SeaChange Encoding Station, which is
based on SeaChange's proprietary encoding software, where analog-
based short- and long-form video is digitized and compressed in
real-time using standard MPEG-2 hardware.
Storage: Digital video is then stored in a disk-based video library,
capable of storing thousands of spots, where the SeaChange SPOT
System organizes, manages and stores these video streams.
Scheduling: SeaChange's scheduling and management software coordinates with
the traffic and billing application to determine the designated
time slot, channel and geographic zone for each video stream.
Distribution: SeaChange's strategic digital video software then copies the
video streams from the master video library and distributes them
over the operator's data network to headends, where they are
stored in video servers for future play.
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Insertion: Following a network cue, the SeaChange video switch module
automatically initiates the conversion of video streams to analog
and inserts them into the network feed, where they are then seen
by television viewers.
Verification: After the video streams run, SeaChange's proprietary software and
hardware verifies the content, accuracy, timing and placement of
such video streams to facilitate proper customer billing.
The selling price for a base SeaChange SPOT System is approximately $250,000;
to date, the largest single sale of a SeaChange SPOT System was $2.5 million.
SeaChange Traffic and Billing Software
The SeaChange Traffic and Billing Software is based on software the Company
has licensed from a third party and is designed to permit television operators
to manage advertising sales, scheduling, packaging and billing operations. This
product provides advertising sales executives with: (i) management performance
reports; (ii) inventory tracking; and (iii) order entry, billing and accounts
receivable management. Traffic and Billing Software can be integrated with the
SeaChange SPOT System and is also compatible with many other advertisement
insertion systems currently in use. The Company introduced the SeaChange
Traffic and Billing Software in the second quarter of 1996.
Long-Form Video Products
SeaChange is developing and marketing two products for the management and
delivery of long-form video content for cable television operators and
telecommunications companies.
SeaChange Movie System. SeaChange has developed a new product, the
SeaChange Movie System, which is a platform for the storage and delivery of
long-form video streams, particularly movies. SeaChange has worked together with
IPC Interactive (''IPC''), a provider of Video-On-Demand systems, to integrate
IPC's Guestnet system and its related movie programming with the SeaChange Movie
System. The integrated system is designed to permit viewers in hotels and
apartments to choose particular movies on demand and also offers a variety of
ancillary programming services, such as local programming and advertisements.
The Company and IPC have joint marketing rights to the integrated system.
SeaChange is marketing the SeaChange Movie System featuring the Guestnet movie
programming to cable television operators, acting as a sales representative for
the IPC portion of the system. IPC is entitled to market this product, acting as
a dealer or sales representative for the SeaChange portion of the system. The
cable television operators can package full scale Video-On-Demand systems
for hotels and apartments.
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The integrated system consists of user interfaces and application hardware and
software, including set-top boxes and remote control devices, provided by IPC
and SeaChange's Video Server 100 technology and software architecture for the
delivery and storage of movies. The video servers will be installed at the cable
headend and the video will be delivered over a dedicated fiber optic line. The
integrated system is designed to provide cable television operators with a new
source of revenue and a competitive advantage over the encroaching services of
direct broadcast satellite companies. The SeaChange Movie System has been sold
to one customer for use with the Guestnet movie programming.
In addition, the SeaChange Movie System may be used by television operators to
provide pay-per-view movies. Pay-per-view movies are presented at regular
intervals and viewers can order and begin watching a movie at a time convenient
to them. The Company has begun marketing the SeaChange Movie System to
television operators for pay-per-view movies and has received an order for one
system with a sales price of approximately $300,000.
SeaChange Programming System. The SeaChange Programming System, which
employs the same underlying technology and basic functionality of the SeaChange
SPOT System, is designed to be a platform for the delivery of long-form video
streams in a multichannel environment. The SeaChange Programming System is
designed to permit television operators to store, manage and distribute long-
form video streams, such as movies, infomercials, and other local origination
programming. The SeaChange Programming System is designed to provide for the
storage of up to a terabyte of digital video (approximately 250 feature length
movies on-line), which is expected to accommodate most current customer
applications. Its proprietary software applications are designed to enable
television operators to easily schedule and manage the automated delivery of
movies, infomercials and other local programming.
The SeaChange Programming System is designed to have a number of advantages
over traditional analog tape-based systems. It is designed to provide a high
level of scheduling control to reduce personnel needs and improve scheduling
flexibility. By sharing common functions with the SeaChange SPOT System such as
encoding, scheduling, storage libraries and networks, the SeaChange Programming
System is designed to leverage a customer's existing investment in SeaChange
products. The Company is currently marketing the SeaChange Programming System.
Broadcast Television Products
SeaChange plans to introduce two offerings to the television broadcast market
in 1997.
SeaChange Extensible Disk Play-to-Air System. The SeaChange Extensible Disk
Play-to-Air System is designed to provide high quality, MPEG-2 based video
storage and playback for use with automation systems in broadcast television
stations. This product is intended to replace on-air tape decks used to store
and play back advertising from video tape cart systems and, in some cases, to
replace the cart systems themselves. The SeaChange Extensible Disk Play-to-Air
System is designed for customers in larger broadcast television markets which
use station automation systems.
The SeaChange Extensible Disk Play-to-Air System is designed to simultaneously
record, encode, store to a disk and play video content, using industry standard
MPEG-2 compression. This product is designed to seamlessly integrate into
television broadcasters' current tape-based operations and meet the high
performance requirements of television broadcasters.
SeaChange Commercial Playback System. The SeaChange Commercial Playback
System is designed to store, manage and distribute advertisements and other
short-form video streams for broadcast stations where broadcast automation
systems are not widely deployed. This product is designed to have the same
functionality and features of the SeaChange SPOT System but is designed to be
tailored for the high performance requirements of the broadcast television
environment.
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The SeaChange Commercial Playback System is designed to encode advertisements
and other short-form video streams from video tape, interface with sales and
billing systems for scheduling and verification, and store and manage large
libraries of short-form video streams. The Company believes that the SeaChange
Commercial Playback System will often be a first step toward automation for many
television broadcasters.
OEM Products
The Company currently markets two original equipment manufacturer (''OEM'')
products.
Video Server 100. The Video Server 100, which is the Company's second
generation video server, is designed to store and distribute video streams of
various lengths. The Video Server 100 provides the base technology for all of
SeaChange's digital video products and is offered to systems integrators and
VARs as a platform for the storage and delivery of video in a wide range of
applications.
The Video Server 100 provides custom power and packaging and software for use
in professional video applications. It has features such as RAID and a redundant
power supply to enable continuous uninterrupted airing of video. The Video
Server 100 uses industry standard components, which differentiates it from
various video servers based on proprietary processors and specialized hardware
components and operating systems. The OEM list price of the Video Server 100 is
$32,000.
MediaCluster. MediaCluster is SeaChange's proprietary software technology
that enables multiple Video Server 100s to operate together as an integrated
video server. While the Video Server 100 is the base technology for short-form
video applications, MediaCluster serves as the base technology for long-form
video applications.
Through its software architecture, MediaCluster can join multiple Video
Server 100s to support large-scale applications by storing large amounts of
video data and delivering multiple video streams, with no single point of
failure in the system. The Company currently has a patent application pending
for its MediaCluster technology. Although MediaCluster software technology
has been integrated into the SeaChange SPOT System and the SeaChange Movie
System, the Company has not to date sold MediaCluster to any customer on a
stand-alone basis. The Company is currently marketing the first generation of
MediaCluster and plans to introduce a new version of MediaCluster in 1997.
The Company is in the process of establishing a subsidiary at its Greenville,
New Hampshire location for the manufacture, development and OEM sale of the
Video Server 100 and MediaCluster products. The Company expects that certain
employees of the Company or the subsidiary will acquire up to a 20% interest
over time in the subsidiary and that the Company will own the remaining 80%. The
Company intends that the subsidiary will license the necessary technology from
the Company and will manufacture these products on a contract basis for the
Company. The subsidiary will have the right to sell these products to OEM
customers that do not compete with the Company. The Company intends to provide
administrative and management services and, at least initially, selling and
marketing and customer support services, to the subsidiary on a negotiated fee
basis. It is expected that the subsidiary will conduct research and development
on video server-based products, including the Video Server 100 and MediaCluster
products, and will license all developments to the Company on a royalty-free
basis. It is intended that after three years, the Company will have the right,
but not the obligation, to acquire the 20% interest from the employees at fair
market value.
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CUSTOMER SERVICE AND SUPPORT
The Company installs, maintains and supports its products in the United States
and Canada. Annual maintenance contracts are generally required for the first
year of a customer's use of the Company's products and customers are billed for
the initial maintenance fee at the time of the placement of the purchase order.
The maintenance contracts are renewable on an annual basis. The Company also
offers basic and advanced formal on-site training for customer employees at the
time of product installation. The Company currently provides installation,
maintenance and support to international customers but, in the future, may
provide such services through agents and distributors.
The Company offers technical support to customers, agents and distributors on
a 24-hour, seven-day a week basis. Support engineers are committed to providing
a response to technical support calls within two hours. The Company's products
are designed with remote diagnostic capabilities which permit the support
engineers to immediately begin to diagnose any problems without having to travel
to the customer's location, thereby reducing both response time and cost. When
necessary, however, support engineers are dispatched to the customer's facility.
The Company's commitment to service is evidenced by the fact that as of December
31, 1996 more than 30% of Company employees were providing customer service and
support, including project design and implementation, installation and training.
CUSTOMERS
The Company currently sells its products primarily to cable television
operators and telecommunications companies. In addition, the Company is
developing several products for television broadcasters.
The Company's customer base is highly concentrated among a limited number of
large customers, primarily due to the fact that the cable and telecommunications
industries in the United States are dominated by a limited number of large
companies. A significant portion of the Company's revenues in any given fiscal
period have been derived from substantial orders placed by these large
organizations. In 1994, 1995 and 1996, revenues from the Company's five largest
customers represented approximately 95%, 91% and 76%, respectively, of the
Company's total revenues. Customers accounting for more than 10% of total
revenues consisted of Continental Cablevision (50%), Cox Communications, Inc.
(18%), Digital Equipment Corporation (11%) and Time Warner, Inc. (10%) in 1994;
Continental Cablevision (29%), Tele-Communications, Inc. (29%), Time Warner,
Inc. (16%) and Cox Communications, Inc. (12%) in 1995; and Tele-Communications,
Inc. (29%), U.S. West Media Group (17%), Comcast Corporation (13%) and Time
Warner, Inc. (12%) in 1996. The Company expects that it will continue to be
dependent upon a limited number of customers for a significant portion of its
revenues in future periods. As a result of this customer concentration, the
Company's business, financial condition and results of operations could be
materially adversely affected by the failure of anticipated orders to
materialize and by deferrals or cancellations of orders as a result of changes
in customer requirements or new product announcements or introductions.
The Company believes that its backlog at any particular time is not meaningful
as an indicator of its future level of sales for any particular period. Because
of the software-based nature of the Company's products and its use of standard
components, substantially all of the backlog at the end of a quarter can be
manufactured by the Company and is intended to be shipped by the end of the
following quarter. However, because of the requirements of particular customers,
the seasonality of the business and, in respect to certain sales, the acceptance
criteria necessary for revenue recognition, such backlog may not be shipped or,
if shipped, the related revenues may not be recognized in such quarter.
Therefore, there is no direct correlation between the backlog at the end of any
quarter and the Company's total sales for the following quarter or other
periods.
SELLING AND MARKETING
The Company sells and markets its products in the United States primarily
through a direct field sales organization and internationally primarily through
independent agents and distributors, complemented by a coordinated marketing
effort of the Company's marketing group. Direct sales activities in the United
States are
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conducted from the Company's Massachusetts headquarters and five field offices.
In October 1996, the Company entered into an exclusive sales and marketing
representative agreement with a private Italian company which covers continental
Europe. The Company also markets certain of its products, namely the Video
Server 100 and MediaCluster, to systems integrators and VARs. As of December 31,
1996, the Company's selling and marketing organization consisted of 13 people.
In light of the complexity of the Company's digital video products, the
Company primarily employs a consultative direct sales process. Working closely
with customers to understand and define their needs enables the Company to
obtain better information regarding market requirements, enhance its expertise
in its customers' industries, and more effectively and precisely convey to
customers how the Company's solutions address the customer's specific needs. In
addition to the direct sales process, customer references and visits by
potential customers to sites where the Company's products are in place are often
critical in the sales process.
The Company uses several marketing programs focused on the Company's targeted
markets to support the sale and distribution of its products. The Company uses
exhibitions at a limited number of prominent industry trade shows and
conferences and presentations at technology seminars to promote awareness of the
Company and its products. The Company also publishes technical articles in trade
and technical journals and product promotional literature.
RESEARCH AND PRODUCT DEVELOPMENT
Management believes that the Company's success will depend to a substantial
degree upon its ability to develop and introduce in a timely fashion new
products and enhancements to its existing products that meet changing customer
requirements in the Company's current and new markets. The Company has in the
past made, and intends to continue to make, substantial investments in product
and technological development. Through its direct sales process the Company
monitors changing customer needs, changes in the marketplace and emerging
industry standards, and is therefore better able to focus its research and
development efforts to address such evolving industry requirements.
The Company's research and development expenditures totaled approximately
$885,000, $2.4 million and $5.4 million for the years ended December 31, 1994,
1995 and 1996, respectively. At December 31, 1996, 55 employees were engaged in
research and product development. The Company believes that the experience of
its product development personnel is an important factor in the Company's
success. The Company performs its research and product development activities at
its headquarters and in offices in Greenville, New Hampshire, Atlanta, Georgia,
and Englewood, Colorado. The Company has historically expensed its direct
research and development costs as incurred.
The Company has a variety of new products being developed and tested,
including long-form video products for cable television operators and
telecommunications companies, digital play-to-air systems for television
broadcasters and the next version of its MediaCluster software. There can be no
assurance that the Company will be able to successfully develop and market such
products, or to identify, develop, manufacture, market or support other new
products or enhancements to its existing products successfully or on a timely
basis, that new Company products will gain market acceptance, or that the
Company will be able to respond effectively to product announcements by
competitors or technological changes.
MANUFACTURING
The Company's manufacturing operations are located at facilities in Maynard,
Massachusetts and in Greenville, New Hampshire. The manufacturing operations in
Massachusetts consist primarily of component and subassembly procurement, system
integration and final assembly, testing and quality control of the complete
systems. The
11
Company's operations in New Hampshire consist primarily of component and
subassembly procurement, video server integration and final assembly, testing
and quality control of the video servers. The Company relies on independent
contractors to manufacture components and subassemblies to the Company's
specifications. Each of the Company's products undergoes testing and quality
inspection at the final assembly stage.
The Company attempts to use standard parts and components available from
multiple vendors. Certain components used in the Company's products, however,
are currently purchased from a single source, including a computer chassis
manufactured by Trimm Technologic Inc., a disk controller manufactured by Mylex
Corporation, an MPEG-2 decoder card manufactured by Vela Research, Inc., disk
drives manufactured by Seagate Technology, Inc. and an MPEG-2 encoder
manufactured by Optivision, Inc. While the Company believes that there are
alternative suppliers available for the foregoing components, the Company
believes that the procurement of such components from alternative suppliers
would take anywhere from 45-120 days. There can be no assurance that such
alternative components would be functionally equivalent or would be available on
a timely basis or on similar terms. The Company purchases several other
components from a single supplier, although the Company believes that
alternative suppliers for such components are readily available on a timely
basis. The Company generally purchases sole source or other components pursuant
to purchase orders placed from time to time in the ordinary course of business
and has no written agreements or guaranteed supply arrangements with its sole
source suppliers. The Company has experienced quality control problems and
supply shortages for sole source components in the past and there can be no
assurance that the Company will not experience significant quality control
problems or supply shortages for these components in the future. The Company has
begun to increase its inventory of these components. However, any interruption
in the supply of such single source components could have a material adverse
effect on the Company's business, financial condition and results of operations.
Because of the Company's reliance on these vendors, the Company may also be
subject to increases in component costs which could adversely affect the
Company's business, financial condition and results of operations.
COMPETITION
The markets in which the Company competes are characterized by intense
competition, with a large number of suppliers providing different types of
products to different segments of the markets. The Company currently competes
principally on the basis of: (i) the breadth of its products' features and
benefits, including the ability to precisely target viewers in specific
geographic or demographic groups, and the flexibility, scalability, professional
quality, ease of use, reliability and cost effectiveness of its products; and
(ii) the Company's reputation and the depth of its expertise, customer service
and support. While the Company believes that it currently competes favorably
overall with respect to these factors and that its ability to provide software-
based solutions to manage, store and distribute digital video differentiates the
Company from its competitors, there can be no assurance that the Company will be
able to continue to compete successfully with respect to such factors.
In the digital advertisement insertion market, the Company generally competes
with Channelmatic Inc., a subsidiary of Indenet, Inc., Sony Corporation,
SkyConnect, Inc., Digital Equipment Corporation, and various suppliers of
traditional analog tape-based systems. In the market for long-form video
products, the Company competes against various computer companies offering video
server platforms such as Hewlett-Packard Company, Digital Equipment Corporation,
and Silicon Graphics, Inc., and more traditional movie application providers
like The Ascent Entertainment Group, Panasonic Company, and Lodgenet
Entertainment. In addition, the SeaChange Traffic and Billing Software competes
against certain products of Columbine Cable Systems, Inc., Cable Computerized
Management Systems, Inc., a subsidiary of Indenet Inc., CAM Systems, Inc., a
subsidiary of Starnet Inc., LAN International USA, Inc., Visiontel, Inc. and
various suppliers of sales, scheduling and billing software products. When the
Company introduces a product for the television broadcast market, the Company
expects to compete against Tektronix, Inc., BTS Inc., a division of Robert Bosch
GMBH, Hewlett-Packard Company, Sony Corporation, Silicon Graphics, Inc., Sun
Microsystems, Inc. and ASC Incorporated. The Company expects the competition in
each of these markets to intensify.
12
Many of the Company's current and prospective competitors have significantly
greater financial, technical, manufacturing, sales, marketing and other
resources than the Company. As a result, these competitors may be able to devote
greater resources to the development, promotion, sale and support of their
products than the Company. Moreover, these companies may introduce additional
products that are competitive with those of the Company or enter into strategic
relationships to offer complete solutions, and there can be no assurance that
the Company's products would compete effectively with such products.
Although the Company believes that it has certain technological and other
advantages over its competitors, maintaining such advantages will require
continued investment by the Company in research and development, selling and
marketing and customer service and support. In addition, as the Company enters
new markets, distribution channels, technical requirements and levels and bases
of competition may be different than those in the Company's current markets.
There can be no assurance that the Company will be able to compete successfully
against either current or potential competitors in the future.
PROPRIETARY RIGHTS
The Company's success and its ability to compete is dependent, in part, upon
its proprietary rights. Although the Company has filed one U.S. and one foreign
patent application for its MediaCluster technology, it does not hold any issued
patents and currently relies on a combination of contractual rights, trademark
laws, trade secrets and copyright laws to establish and protect its proprietary
rights in its products. There can be no assurance that a patent will be issued
with respect to the pending application or that, if issued, the validity of such
patent would be upheld. Nor can there be any assurance that the steps taken by
the Company to protect its intellectual property will be adequate to prevent
misappropriation of its technology or that the Company's competitors will not
independently develop technologies that are substantially equivalent or superior
to the Company's technology. In addition, the laws of some foreign countries in
which the Company's products are or may be distributed do not protect the
Company's proprietary rights to the same extent as do the laws of the United
States.
The Company is also subject to the risk of adverse claims and litigation
alleging infringement of intellectual property rights of others. The Company
attempts to ensure that its products do not infringe any existing proprietary
rights of others. The Company received a letter in January 1996 stating that the
Company's video insertion system may be utilizing technology patented by a third
party. The Company did not respond to such letter and has received no further
communication from the holder of these patents. The Company does not believe
that its products infringe such patents. There can be no assurance that the
holder of these patents or other third parties will not assert infringement
claims against the Company in the future based on patents, copyrights,
trademarks or trade secrets, or that any such claims will not be successful. The
Company could incur substantial costs in defending itself and its customers
against any such claims, regardless of the merits of such claims. Parties making
such claims may be able to obtain injunctive or other equitable relief which
could effectively block the Company's ability to sell its products in the United
States and abroad, and could result in significant litigation costs and expenses
or an award of substantial damages. In the event of a successful claim of
infringement, the Company and its customers may be required to obtain one or
more licenses from third parties or to develop alternative technologies. There
can be no assurance that the Company or its customers could obtain necessary
licenses from third parties at a reasonable cost or at all, or would be able to
develop alternative technologies. The defense of any lawsuit could result in
time consuming and expensive litigation, damages, license fees, royalty payments
and restrictions on the Company's ability to sell its products, any of which
could have a material adverse effect on the Company's business, financial
condition and results of operations.
The SeaChange Traffic and Billing Software is based on software the Company
licensed from Summit Software Systems, Inc. of Boulder, Colorado in May 1996.
The Company has been granted a perpetual, nonexclusive license to such software
in return for the payment of an up-front license fee and royalties for sales
occurring prior to June 1998.
13
EMPLOYEES
As of December 31, 1996, the Company employed 143 persons, including 55 in
research and development, 46 in customer service and support, 13 in selling and
marketing, 15 in manufacturing and 14 in finance and administration. None of the
Company's employees is represented by a collective bargaining arrangement, and
the Company believes that its relations with its employees are good.
CERTAIN RISK FACTORS
Limited Operating History and Operating Results. The Company was founded in
July 1993 and commenced shipment of its initial products in the third quarter of
1994. Accordingly, the Company has only a limited operating history upon which
an evaluation of the Company and its prospects can be based. The Company's
prospects must be considered in light of the risks, expenses and difficulties
frequently encountered by companies in their early stage of development,
particularly companies in new and rapidly evolving markets. To address these
risks, the Company must, among other things, respond to competitive
developments, continue to attract, retain and motivate qualified persons, and
continue to upgrade its technologies and commercialize products and services
incorporating such technologies. There can be no assurance that the Company will
be successful in addressing such risks. Increases in operating expenses are
expected to continue and may result in a decrease in operating income.
Fluctuations in Quarterly Operating Results. The Company's quarterly
operating results have in the past varied and in the future will be affected by
factors such as: (i) the timing and recognition of revenue from significant
orders, (ii) the seasonality of the placement of customer orders, (iii) the
success of the Company's products, (iv) increased competition, (v) changes in
the Company's pricing policies or those of its competitors, (vi) the financial
stability of major customers, (vii) new product introductions or enhancements by
competitors, (viii) delays in the introduction of products or product
enhancements by the Company, (ix) customer order deferrals in anticipation of
upgrades and new products, (x) the ability to access a sufficient supply of sole
source and third party components, (xi) the quality and market acceptance of new
products, (xii) the timing and nature of selling and marketing expenses (such as
trade shows and other promotions), (xiii) personnel changes, and (xiv) economic
conditions affecting the Company's customers. Any significant cancellation or
deferral of purchases of the Company's products could have a material adverse
effect on the Company's business, financial condition and results of operations
in any particular quarter, and to the extent significant sales occur earlier
than expected, operating results for subsequent quarters may be adversely
affected. The Company's expense levels are based, in part, on its expectations
as to future revenues, and the Company may be unable to adjust spending in a
timely manner to compensate for any revenue shortfall. If revenues are below
expectations, operating results are likely to be adversely affected and net
income may be disproportionately affected because a significant portion of the
Company's expenses do not vary with revenues.
Because of these factors, the Company believes that period-to-period
comparisons of its results of operations are not necessarily meaningful and
should not be relied upon as indications of future performance. Due to all of
the foregoing factors, in some future quarter the Company's operating results
may be below the expectations of public market analysts and investors.
Seasonality. The Company's business has been seasonal with more orders being
placed and greater revenues being recognized in the first and second quarters
than in the third and fourth quarters. The Company believes that the
concentration of order placements in specific quarterly periods is due to
customers' buying patterns and budgeting cycles in the cable television
industry. The Company anticipates that these patterns will continue in the
future. As a result, the Company's results of operations have in the past and
likely will in the future vary seasonally in accordance with such purchasing
activity. Due to the relatively fixed nature of certain of the Company's costs
14
throughout each quarterly period, including personnel and facilities costs, the
decline of revenues in any quarter typically results in lower profitability in
that quarter.
Management of Growth. The Company has experienced growth in revenues and
expansion of its operations which have placed significant demands on the
Company's management, administrative and operational resources. The Company
believes that further improvements in management and operational controls are
needed, and would continue to be needed to manage any future growth. Continued
growth will also require the Company to hire more technical, selling and
marketing, support and administrative personnel, expand manufacturing and
customer service capabilities, and update or expand management information
systems. There can be no assurance that the Company will be able to attract and
retain the necessary personnel to accomplish its growth strategies or that it
will not experience constraints that will adversely affect its ability to
satisfy customer demand in a timely fashion or to satisfactorily support its
customers and operations. Also, the Company may in the future acquire
complementary service or product lines, technologies or businesses, although the
Company has no present understandings, commitments or agreements with respect to
any significant acquisitions. If the Company's management is unable to manage
growth effectively or integrate any acquisition into the Company's operations
successfully, the Company's business, financial condition and results of
operations could be materially and adversely affected.
Product Concentration. Sales of the SeaChange SPOT System have accounted for
substantially all of the Company's revenues to date, and this product and
related enhancements are expected to continue to account for a majority of the
Company's revenues at least through 1997. The Company's success depends in part
on continued sales of the SeaChange SPOT System. A decline in demand or average
selling prices for the SeaChange SPOT System product line, whether as a result
of new product introductions by others, price competition, technological change,
inability to enhance the products in a timely fashion, or otherwise, would have
a material adverse effect on the Company's business, financial condition and
results of operations.
Highly Competitive Market. The market for digital video products is highly
competitive. The Company currently competes against suppliers of both analog
tape-based and digital systems in the advertisement insertion market and against
both computer companies offering video server platforms and more traditional
movie application providers in the movie system market. When the Company
introduces products in the television broadcast market, the Company expects to
compete in that market against various computer companies offering video server
platforms and television equipment manufacturers. Due to the rapidly evolving
markets in which the Company competes, additional competitors with significant
market presence and financial resources, including computer hardware and
software companies and television equipment manufacturers, may enter those
markets, thereby further intensifying competition. Increased competition could
result in price reductions and loss of market share which would adversely affect
the Company's business, financial condition and results of operations. Many of
the Company's current and potential competitors have greater financial, selling
and marketing, technical and other resources than the Company. Moreover, the
Company's competitors may also foresee the course of market developments more
accurately than the Company. Although the Company believes it has certain
technological and other advantages over its competitors, realizing and
maintaining such advantages will require a continued high level of investment by
the Company in research and product development, marketing and customer service
and support. There can be no assurance that the Company will have sufficient
resources to continue to make such investments or that the Company will be able
to make the technological advances necessary to compete successfully with its
existing competitors or with new competitors.
Dependence on Emerging Digital Video Market. Cable television operators and
television broadcasters have historically relied on traditional analog
technology for video management, storage and distribution. Digital video
technology is still a relatively new technology and requires a significant
initial investment of capital. The Company's future growth will depend both on
the rate at which television operators convert to digital video systems and the
rate at which digital video technology expands to additional market segments.
There can be no assurance that the use of digital video technology will expand
among television operators or into additional markets. Any failure by the market
to accept digital video technology will have a material adverse affect on the
Company's business, financial condition and results of operations.
15
Risks Associated with Expansion into New Markets. To date the Company's
products have been purchased primarily by cable television operators and
telecommunications companies. The Company's success depends in part on the
penetration of new markets. In particular, the Company plans to introduce
several products for use by television broadcasters. These broadcast products
will be directed toward a market that the Company has not previously addressed.
There can be no assurance that the Company will be successful in marketing and
selling these new products to customers in the broadcast television market. Any
inability of the Company to penetrate this new market would have a material
adverse effect on the Company's business, financial condition and results of
operations.
Risk of New Product Introductions. The Company's future success requires
that it develop and market additional products that achieve significant market
acceptance and enhance its current products. The Company has recently introduced
a new product which enables television operators to provide Video-On-Demand and
scheduled playback services to hotels and apartments. The success of this
product may depend in part on relationships with movie content providers. There
can be no assurance that the Company will not experience difficulties that could
delay or prevent the successful development, introduction and marketing of this
and other new products and enhancements, or that its new products and
enhancements will adequately meet the requirements of the marketplace and
achieve market acceptance. Announcements of currently planned or other new
product offerings may cause customers to defer purchasing existing Company
products. Moreover, there can be no assurance that, despite testing by the
Company, and by current and potential customers, errors or failures will not be
found in the Company's products, or, if discovered, successfully corrected in a
timely manner. Such errors or failures could cause delays in product
introductions and shipments, or require design modifications that could
adversely affect the Company's competitive position. The Company's inability to
develop on a timely basis new products, enhancements to existing products or
error corrections, or the failure of such new products or enhancements to
achieve market acceptance could have a material adverse effect on the Company's
business, financial condition and results of operations.
Rapid Technological Change. The markets for the Company's products are
characterized by rapidly changing technology, evolving industry standards and
frequent new product introductions and enhancements. Future technological
advances in the television and video industries may result in the availability
of new products or services that could compete with the software-based solutions
provided by the Company or reduce the cost of existing products or services, any
of which could enable the Company's existing or potential customers to fulfill
their video needs better and more cost efficiently than with the Company's
products. The Company's future success will depend on its ability to enhance its
existing digital video products, including the development of new applications
for its technology and to develop and introduce new products to meet and adapt
to changing customer requirements and emerging technologies. There can be no
assurance that the Company will be successful in enhancing its digital video
products or developing, manufacturing and marketing new products which satisfy
customer needs or achieve market acceptance. In addition, there can be no
assurance that services, products or technologies developed by others will not
render the Company's products or technologies uncompetitive, unmarketable or
obsolete, or that announcements of currently planned or other new product
offerings by either the Company or its competitors will not cause customers to
defer or fail to purchase existing Company solutions. The failure of the Company
to respond to rapidly changing technologies related to digital video could have
a material adverse effect on the Company's business, financial condition and
results of operations.
Significant Concentration of Customers. The Company's customer base is
highly concentrated among a limited number of large customers, primarily due to
the fact that the cable television and telecommunications industries in the
United States are dominated by a limited number of large companies. A fairly
limited number of customers account for a significant percentage of the
Company's revenues in any year. In 1994, 1995 and 1996, revenues from the
Company's five largest customers represented approximately 95%, 91% and 76%,
respectively, of the Company's total revenues. In each of 1994, 1995 and 1996,
four customers each accounted for more than 10% of the Company's revenues, one
of which accounted for more than 10% of the Company's revenues in each such
period. The Company generally does not have written continuing purchase
agreements with its customers and does not have any written agreements that
require customers to purchase fixed minimum quantities of the
16
Company's products. The Company's sales to specific customers tend to vary
significantly from year to year depending upon such customers' budgets for
capital expenditures and new product introductions. In addition, the Company
derives a substantial portion of its revenues from products that have a selling
price in excess of $200,000. The Company believes that revenue derived from
current and future large customers will continue to represent a significant
proportion of its total revenues. The loss of, or reduced demand for products or
related services from, any of the Company's major customers could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Dependence on Sole Source Suppliers and Third Party Manufacturers. Certain
key components of the Company's products are currently purchased from a sole
supplier, including a computer chassis manufactured by Trimm Technologic Inc., a
disk controller manufactured by Mylex Corporation, an MPEG-2 decoder card
manufactured by Vela Research, Inc. and an MPEG-2 encoder manufactured by
Optivision, Inc. The Company does not have material written supply agreements
with these or any of its suppliers. The Company has in the past experienced
quality control problems, where products did not meet specifications or were
damaged in shipping, and delays in the receipt of such components. These
problems were generally of short duration and did not have a material adverse
effect on the Company. However, the Company may in the future experience similar
types of problems which could be more severe or more prolonged. The inability to
obtain sufficient key components as required, or to develop alternative sources
if and as required in the future, could result in delays or reductions in
product shipments which, in turn, could have a material adverse effect on the
Company's business, financial condition and results of operations. Moreover, the
Company relies on a limited number of third parties who manufacture certain
components used in the Company's products. While to date there has been suitable
third party manufacturing capacity readily available at acceptable quality
levels, there can be no assurance that such manufacturers will be able to meet
the Company's future volume or quality requirements or that such services will
continue to be available to the Company at favorable prices. Any financial,
operational, production or quality assurance difficulties experienced by such
third party manufacturers that result in a reduction or interruption in supply
to the Company could have a material adverse effect on the Company's business,
financial condition and results of operations.
Regulation of Telecommunications and Television Industries. The
telecommunications and television industries are subject to extensive regulation
in the United States and other countries. The Company's business is dependent
upon the continued growth of such industries in the United States and
internationally. Although recent legislation has lowered the legal barriers to
entry for telecommunications companies into the United States multichannel
television market, there can be no assurance that such telecommunications
companies will successfully enter this or related markets. Moreover, the growth
of the Company's business internationally is dependent in part on similar
deregulation of the telecommunications industry abroad and there can be no
assurance that such deregulation will occur. Television operators are also
subject to extensive government regulation by the Federal Communications
Commission (''FCC'') and other federal and state regulatory agencies. These
regulations could have the effect of limiting capital expenditures by television
operators and thus could have a material adverse effect on the Company's
business, financial condition and results of operations. The enactment by
federal, state or international governments of new laws or regulations, changes
in the interpretation of existing regulations or a reversal of the trend toward
deregulation in these industries could adversely affect the Company's customers,
and thereby materially adversely affect the Company's business, financial
condition and results of operations.
Lengthy Sales Cycle. Digital video products are relatively complex and their
purchase generally involves a significant commitment of capital, with attendant
delays frequently associated with large capital expenditures and implementation
procedures within an organization. Moreover, the purchase of such products
typically requires coordination and agreement among a potential customer's
corporate headquarters and its regional and local operations. For these and
other reasons, the sales cycle associated with the purchase of the Company's
digital video products is typically lengthy and subject to a number of
significant risks, including customers' budgetary constraints and internal
acceptance reviews, over which the Company has little or no control. Based upon
all of the foregoing, the Company believes that the Company's quarterly
revenues, expenses and operating results are likely to vary
17
significantly in the future, that period-to-period comparisons of its results of
operations are not necessarily meaningful and that, in any event, such
comparisons should not be relied upon as indications of future performance.
Dependence on Key Personnel and Hiring of Additional Personnel. The
Company's success depends to a significant degree upon the continued
contributions of its key management, engineering, selling and marketing and
manufacturing personnel, many of whom would be difficult to replace. The Company
does not have employment contracts with its key personnel. The Company believes
its future success will also depend in large part upon its ability to attract
and retain highly skilled managerial, engineering, selling and marketing,
finance and manufacturing personnel. Competition for such personnel is intense,
and there can be no assurance that the Company will be successful in attracting
and retaining such personnel. The loss of the services of any of the key
personnel, the inability to attract or retain qualified personnel in the future
or delays in hiring required personnel, particularly software engineers and
sales personnel, could have a material adverse effect on the Company's business,
financial condition and results of operations.
Dependence on Proprietary Rights. The Company's success and its ability to
compete is dependent, in part, upon its proprietary rights. The Company relies
primarily on a combination of patent, copyright, trademark and trade secret
laws, as well as confidentiality procedures and contractual provisions to
protect its proprietary rights. There can be no assurance that such measures
will be adequate to protect the Company's proprietary rights. The Company
attempts to ensure that its products and technology do not infringe the
proprietary rights of third parties. The Company received a letter in January
1996 stating that the Company's video insertion system may be utilizing
technology patented by a third party. The Company did not respond to such letter
and has received no further communication from the holder of these patents. The
Company does not believe that its products infringe the patents mentioned in
such letter. However, there can be no assurance that the holder of these patents
or other third parties will not assert infringement claims against the Company
in the future or that any such claim will not be successful.
Risks Associated with International Sales. Prior to 1996, the Company
derived no significant revenues from international operations. International
sales accounted for approximately 5% of the Company's revenues in 1996, and
the Company expects that international sales will account for a significant
portion of the Company's business in the future. However, there can be no
assurance that the Company will be able to maintain or increase international
sales of its products. International sales are subject to a variety of risks,
including difficulties in establishing and managing international distribution
channels, in servicing and supporting overseas products and in translating
products into foreign languages. International operations are subject to
difficulties in collecting accounts receivable, staffing and managing personnel
and enforcing intellectual property rights. Other factors that can also
adversely affect international operations include fluctuations in the value of
foreign currencies and currency exchange rates, changes in import/export duties
and quotas, introduction of tariff or non-tariff barriers and economic or
political changes in international markets.
Concentration of Ownership. The Company's officers, directors and their
affiliated entities, and other holders of 5% or more of the Company's
outstanding capital stock, together beneficially owned approximately 68% of
the outstanding shares of Common Stock of the Company as of March 20, 1997. As
a result, such persons will have the ability to elect the Company's directors
and to determine the outcome of corporate actions requiring stockholder
approval, irrespective of how other stockholders of the Company may vote. This
concentration of ownership may have the effect of delaying or preventing a
change in control of the Company which may be favored by a majority of the
remaining stockholders, or cause a change of control not favored by the
Company's other stockholders.
ITEM 2. PROPERTIES
The Company's corporate headquarters, which is also its principal
administrative, selling and marketing, customer service and support and product
development facility, is located in Maynard, Massachusetts and consists of
approximately 27,000 square feet under a lease which expires on March 31, 1998,
with an annual base rent of $107,000 for 1996 and 1997. The Company leased an
additional 10,000 square feet in the same building beginning
18
in January 1997 which expires on March 31, 1998, with an annual base rent of
$52,000. The Company moved its Massachusetts manufacturing facility to such
space in February 1997. The Company leases a facility of approximately 9,000
square feet in Greenville, New Hampshire that is used for the development and
final assembly of its video servers. The Company also leases small research and
development and sales and support offices in Atlanta, Georgia, Englewood,
Colorado, Burlingame, California and St. Louis, Missouri. The Company believes
its existing and planned facilities are adequate for its current needs and that
suitable additional or substitute space will be available as needed.
ITEM 3. LEGAL PROCEEDINGS
From time to time, the Company is involved in litigation relating to claims
arising out of its operations in the normal course of business. The Company
believes that it is not currently involved in any legal proceedings the
resolution of which, individually or in the aggregate, would have a material
adverse effect on the Company's business, financial condition or results of
operation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
No matters were submitted during the fourth quarter of the fiscal year ended
December 31, 1996 to a vote of security holders of the Company through the
solicitation of proxies or otherwise.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq National Market under the
symbol "SEAC." Public trading of the Common Stock commenced on November 5,
1996. Prior to such date, there was no public market for the Common Stock. The
following table sets forth the high and low closing sale prices for the Common
Stock for the periods indicated, as reported on the Nasdaq National Market.
High Low
---- ---
Year ended December 31, 1996
Fourth Quarter (from November 5, 1996) $39.50 $17.38
On March 20, 1997, the last reported sale price of the Common Stock on the
Nasdaq National Market was $15.50. As of March 20, 1997, there were
approximately 136 stockholders of record of the Company's Common Stock, as shown
in the records of the Company's transfer agent. The Company believes that most
of its stock (other than shares held by its officers and directors) is held in
street names through one or more nominees. The Company has not paid any cash
dividends on its capital stock since its inception, and does not expect to pay
cash dividends on its Common Stock in the foreseeable future. The Company
currently intends to retain all of its future earnings for use in the operation
and expansion of the business.
19
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with the Company's consolidated financial statements and related
notes thereto and "Management's Discussion and Analysis of Financial Condition
and Results of Operations" included in Item 7. The consolidated statement of
income data for the period from July 9, 1993 (inception) through December 31,
1993 and each of the three years ended December 31, 1994, 1995 and 1996 and the
consolidated balance sheet data at December 31, 1993, 1994, 1995 and 1996 are
detailed below.
PERIOD FROM
JULY 9, 1993
(INCEPTION YEAR ENDED
THROUGH DECEMBER 31,
DECEMBER 31, ------------
1993 1994 1995 1996
------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENT OF INCOME DATA:
Revenues:
Systems.......................................... $ -- $ 5,037 $21,999 $45,745
Services......................................... -- 116 1,203 3,521
Other............................................ 213 537 -- --
------ ------- ------- -------
213 5,690 23,202 49,266
------ ------- ------- -------
Costs of revenues:
Systems.......................................... -- 3,406 14,917 27,133
Services......................................... -- 176 1,641 4,030
Other............................................ 112 304 -- --
------- ------- ------- -------
112 3,886 16,558 31,163
------- ------- ------- -------
Gross profit....................................... 101 1,804 6,644 18,103
------- ------- ------- -------
Operating expenses:
Research and development......................... 43 885 2,367 5,394
Selling and marketing............................ 16 443 1,609 4,254
General and administrative....................... 59 273 858 2,064
------- ------- ------- -------
118 1,601 4,834 11,712
------- ------- ------- -------
Income (loss) from operations...................... (17) 203 1,810 6,391
Interest income (expense), net..................... (1) 7 114 354
------- ------- ------- -------
Income (loss) before income taxes.................. (18) 210 1,924 6,745
Provision for income taxes......................... -- 55 713 2,483
------- ------- ------- -------
Net income (loss).................................. $ (18) $ 155 $ 1,211 $ 4,262
======= ======= ======= =======
Net income (loss) per share (1).................... $ (.01) $ .02 $ .10 $ .36
======= ======= ======= =======
Weighted average common shares and
equivalent common shares outstanding (1).......... 2,700 9,399 11,575 11,900
======= ======= ======= =======
DECEMBER 31,
---------------------------------------------
1993 1994 1995 1996
------ ------ ------- -------
(IN THOUSANDS)
CONSOLIDATED BALANCE SHEET DATA:
Working capital.................................... $ 90 $ 154 $ 3,493 $26,593
Total assets....................................... 228 3,494 13,595 46,035
Long-term liabilities.............................. 125 -- -- --
Deferred revenue................................... 72 152 767 2,192
Total liabilities.................................. 246 2,977 8,644 14,205
Redeemable convertible preferred stock............. -- -- 4,008 --
Total stockholders' equity (deficit)............... (18) 517 943 31,830
(1) For an explanation of the determination of the number of shares used in
computing net income (loss) per share see Notes to Consolidated Financial
Statements.
20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion and analysis should be read in conjunction with the
Company's Consolidated Financial Statements and the related Notes included
elsewhere in this Annual Report on Form 10-K. The following discussion contains
certain trend analysis and other statements of a forward-looking nature relating
to future events or the future financial performance of the Company. Readers are
cautioned that such statements are only predictions and that actual results or
events may differ materially. In evaluating such statements, readers should
specifically consider the risk factors set forth in this Annual Report on Form
10-K, particularly the matters set forth under the caption ''Certain Risk
Factors,'' in Item 1 "Business", which could cause actual results to differ
materially from those indicated by such forward-looking statements.
OVERVIEW
The Company shipped its first digital video insertion product, the SeaChange
SPOT System, in the third quarter of 1994. Through December 31, 1996,
substantially all of the Company's revenues were derived from the sale of
SeaChange SPOT Systems and related services to cable television operators and
telecommunications companies in the United States. Revenues from the sale of
systems is recognized upon shipment provided that there are no uncertainties
regarding customer acceptance and collection of the related receivable is
probable. If uncertainties exist, such as performance criteria beyond the
Company's standard terms and conditions, revenue is recognized upon customer
acceptance. Installation and training revenue is deferred and recognized as
these services are performed. Revenue from technical support and maintenance
contracts is deferred and recognized ratably over the period of the related
agreements, generally twelve months. Customers are billed for installation,
training and maintenance at the time of the product sale and to date, the
Company typically receives at least 50% of the total product and services sales
price at the time of the placement of the purchase order.
The Company's business has been seasonal with more customer orders being
placed and greater revenues being generated in the first and second quarters
than in the third and fourth quarters. The Company believes that this pattern
of order placements in specific quarterly periods is due to customers' buying
patterns and budgeting cycles in the cable television industry. Many television
operators want new video insertion systems to be operational in the second half
of the year in order to be able to respond to higher seasonal advertising demand
from their customers in these periods. The Company expects that these patterns
will continue and that, at least in the near future, the Company's revenues and
results of operations will reflect these seasonal variations.
The Company first achieved profitability in the fourth quarter of 1994. The
Company's profitability is significantly influenced by a number of factors,
including the Company's pricing, the costs of materials used in the Company's
products and the expansion of the Company's operations. The Company prices its
products and services based on its costs as well as the prices of competitive
products and services in the marketplace. Although the Company historically has
not offered discounts or promotional prices for its products and services, in
the third quarter of 1995, the Company decreased the selling price of its first
generation digital video insertion system in anticipation of the introduction of
the second generation system in January 1996. The price decrease had a negative
effect on the Company's gross margin in the last six months of 1995 and the
first six months of 1996. The costs of the Company's products primarily consist
of the costs of components and subassemblies. The costs of such materials have
generally declined over time. As a result of the expansion of the Company's
operations, operating expenses of the Company have increased in the areas of
research and development, selling and marketing, and customer service and
support and related infrastructure. The Company anticipates the addition of
personnel and
21
related infrastructure as it seeks to increase revenue, develop
new products, enter new markets and expand internationally.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated the percentage of
total revenues represented by certain items reflected in the Company's
Consolidated Statement of Income. Gross profit shown for systems and services
revenues at the bottom of the table is stated as a percentage of related
revenues.
YEAR ENDED
DECEMBER 31,
----------------------
1994 1995 1996
------ ------ ------
Revenues:
Systems............................ 88.5% 94.8% 92.9%
Services........................... 2.0 5.2 7.1
Other.............................. 9.5 -- --
----- ----- -----
100.0 100.0 100.0
----- ----- -----
Cost of revenues:
Systems............................ 59.9 64.3 55.1
Services........................... 3.1 7.1 8.2
Other.............................. 5.3 -- --
----- ----- -----
68.3 71.4 63.3
----- ----- -----
Gross profit 31.7 28.6 36.7
----- ----- -----
Operating expenses:
Research and development........... 15.5 10.2 10.9
Selling and marketing.............. 7.8 6.9 8.6
General and administrative......... 4.8 3.7 4.2
----- ----- -----
28.1 20.8 23.7
----- ----- -----
Income from operations................ 3.6 7.8 13.0
Interest, net .1 .5 .7
----- ----- -----
Income before income taxes............ 3.7 8.3 13.7
Provision for income taxes............ 1.0 3.1 5.0
----- ----- -----
Net income............................ 2.7% 5.2% 8.7%
===== ===== =====
Gross profit:
Systems............................ 32.4% 32.2% 40.7%
Services........................... (52.0) (36.4) (14.5)
YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
REVENUES
Systems. The Company's systems revenues consist of sales of its digital
video insertion products. The Company sold its first digital insertion system
in the third quarter of 1994. Systems revenues increased 337% from $5.0 million
in 1994 to $22.0 million in 1995, and increased 108% to $45.7 million in 1996.
The increases in systems revenues resulted from the increase in the number of
the Company's digital video insertion systems sold to television operators
primarily in the United States, partially offset in 1995 and the first six
months of 1996 by a price reduction on first generation systems. The increased
systems revenues in 1996 reflect the Company's introduction, in January 1996, of
the second generation of its digital video insertion system which significantly
22
improved the scalability and performance of the Company's products, and the
subsequent increase in the number of systems sold.
For the years ended December 31, 1994, 1995 and 1996, certain customers
accounted for more than 10% of the Company's total revenues. Individual
customers accounted for 50%, 18%, 11% and 10% of total revenues in 1994, 29%,
29%,16% and 12% of total revenues in 1995 and 29%, 17%, 13% and 12% of total
revenues in 1996. The Company believes that revenues from current and future
large customers will continue to represent a significant proportion of total
revenues.
International sales accounted for approximately 5% of total revenues in the
year ended December 31, 1996, and the Company expects that international sales
will account for a significant portion of the Company's business in the future.
Prior to 1996, the Company derived no significant revenues from international
operations. As of December 31, 1996, all sales of the Company's products have
been made in United States dollars and the Company expects this pattern to
continue in the foreseeable future. Therefore, the Company has not experienced,
nor does it expect to experience in the near term, any impact from fluctuations
in foreign currency exchange rates on its results of operations or liquidity.
If this practice changes in the future, the Company will reevaluate its foreign
currency exchange rate risk.
Services. The Company's services revenues consist of fees for
installation, training, product maintenance and technical support services. The
Company's services revenues increased 936% from approximately $116,000 in 1994
to $1.2 million in 1995, and increased 193% to $3.5 million in 1996. These
increases in services revenues primarily resulted from the increase in product
sales and renewals of maintenance and support contracts related to the growing
installed base of systems.
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, testing and quality control of complete systems and related expenses.
Costs of systems revenues increased 338% from $3.4 million in 1994 to $14.9
million in 1995, and increased 82% to $27.1 million in 1996. The increases in
costs of systems revenues primarily reflect the overall growth in systems sales,
partially offset by the change in product mix upon the introduction of the
second generation video insertion product in January 1996 and the decreasing
costs of various components.
Systems gross profit as a percentage of systems revenues was 32.4%, 32.2%
and 40.7% in 1994, 1995 and 1996, respectively. The increases in systems gross
profit in 1996 resulted from design improvements in the second generation video
insertion product, lower costs of certain purchased components and subassemblies
and the Company achieving certain manufacturing efficiencies as a result of
increased volume. The increase in 1996 was partially offset by an increase of
approximately $694,000 in the Company's inventory valuation allowance in 1996.
The Company evaluates inventory levels and expected usage on a periodic basis
and provides a valuation allowance for estimated inactive, obsolete and surplus
inventory.
Services. Costs of services revenues consist primarily of labor, materials
and overhead relating to the installation, training, product maintenance and
technical support services provided by the Company. Costs of service revenues
increased 830% from approximately $176,000 in 1994 to $1.6 million in 1995, and
increased 146% to $4.0 million in 1996, primarily as a result of the costs
associated with the Company building a service organization to support the
installed base of systems. Cost of services exceeded services revenues by
52.0%, 36.4% and 14.5% in 1994, 1995 and 1996, respectively. Improvements in
the services negative gross profit in 1996 resulted from providing product and
maintenance support to the growing installed base of systems.
RESEARCH AND DEVELOPMENT. Research and development expenses consist
primarily of compensation of development personnel, depreciation of equipment,
and an allocation of related facility expenses. Research and development
expenses increased 168% from approximately $885,000 in 1994 to $2.4 million in
1995, and increased
23
128% to $5.4 million in 1996. The increases in the dollar
amounts were primarily attributable to the hiring of additional development
personnel. All internal software development costs have been expensed by the
Company. The Company anticipates that it will continue to devote substantial
resources to its research and development efforts and that research and
development expenses will increase in dollar amount in 1997.
SELLING AND MARKETING. Selling and marketing expenses consist primarily of
compensation expenses, including sales commissions and travel expenses,
depreciation of equipment and certain promotional expenses. Selling and
marketing expense increased 263% from approximately $444,000 in 1994 to $1.6
million in 1995, and increased 164% to $4.3 million in 1996. The increases in
the dollar amounts were attributable to the hiring of additional selling and
marketing personnel, expanded promotional activities, and an increase in
commissions relating to increased revenues. The Company expects that selling
and marketing expenses will continue to increase in dollar amount as the Company
hires additional personnel and expands selling and marketing activities in 1997.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist
primarily of compensation of executive, finance, human resource and
administrative personnel, legal and accounting services and an allocation of
related facility expenses. General and administrative expenses increased 214%
from $273,000 in 1994 to approximately $858,000 in 1995, and increased 140% to
$2.1 million in 1996. The increases in the dollar amounts were attributable to
increased staffing to support the Company's growth and increased legal expenses.
The Company believes that its general and administrative expenses will continue
to increase as a result of an expansion of the Company's administrative staff to
support its growing operations and as a result of expenses associated with being
a public company.
INTEREST INCOME. Interest income was $7,000 in 1994 and approximately
$113,000 in 1995 compared to approximately $354,000 in 1996. The increase in
interest income primarily resulted from interest earned on a higher invested
balance primarily due to the net proceeds of $24.1 million from the initial
public offering of the Company's Common Stock in November 1996.
PROVISION FOR INCOME TAXES. The Company's effective tax rates were 37.1%
and 36.8%, in 1995 and 1996, respectively. In 1994, full utilization of net
operating loss carryforwards and the effects of the research and development tax
credit resulted in an effective tax rate of 26.2%.
24
QUARTERLY RESULTS OF OPERATIONS
The following table presents certain unaudited quarterly information for the
eight quarters ended December 31, 1996. Gross profit shown for systems and
services revenues at the bottom of the table is stated as a percentage of
related revenues. This information is derived from unaudited financial
statements and has been prepared on the same basis as the Company's audited
financial statements which appear elsewhere in this Annual Report on Form 10-K.
In the opinion of the Company's management, this data reflects all adjustments
(consisting only of normal recurring adjustments) necessary for a fair
presentation of the information when read in conjunction with the Company's
Consolidated Financial Statements and Notes thereto. The results for any quarter
are not necessarily indicative of future quarterly results of operations, and
the Company believes that period-to-period comparisons should not be relied upon
as an indication of future performance.
QUARTER ENDED
------------------------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30, SEPT. 30, DEC. 31,
---------- --------- ---------- --------- ---------- --------- ---------- ---------
1995 1995 1995 1995 1996 1996 1996 1996
---------- --------- ---------- --------- ---------- --------- ---------- ---------
(IN THOUSANDS)
QUARTERLY FINANCIAL DATA (UNAUDITED):
Revenues:
Systems........................... . $4,544 $6,471 $5,340 $5,644 $ 9,684 $13,222 $11,738 $11,101
Services.......................... . 262 300 281 360 545 903 1,188 885
------ ------ ------ ------ ------- ------- ------- -------
4,806 6,771 5,621 6,004 10,229 14,125 12,926 11,986
------ ------ ------ ------ ------- ------- ------- -------
Costs of revenues:
Systems........................... . 2,994 4,058 3,598 4,267 6,342 8,088 6,665 6,038
Services.......................... . 213 336 480 612 729 1,087 1,055 1,159
------ ------ ------ ------ ------- ------- ------- -------
3,207 4,394 4,078 4,879 7,071 9,175 7,720 7,197
------ ------ ------ ------ ------- ------- ------- -------
Gross profit....................... . 1,599 2,377 1,543 1,125 3,158 4,950 5,206 4,789
------ ------ ------ ------ ------- ------- ------- -------
Operating expenses:
Research and development.......... . 484 563 626 694 992 994 1,256 2,151
Selling and marketing............. . 295 486 356 472 755 1,155 1,125 1,219
General and administrative........ . 208 193 234 223 294 568 648 554
------ ------ ------ ------ ------- ------- ------- -------
987 1,242 1,216 1,389 2,041 2,717 3,029 3,924
------ ------ ------ ------ ------- ------- ------- -------
Income (loss) from operations...... . 612 1,135 327 (264) 1,117 2,233 2,177 865
Interest income (expense), net..... . 29 18 11 56 48 52 37 216
------ ------ ------ ------ ------- ------- ------- -------
Income (loss) before income taxes.. . 641 1,153 338 (208) 1,165 2,285 2,214 1,081
Provision (benefit) for income taxes. 237 428 125 (77) 446 882 788 367
------ ------ ------ ------ ------- ------- ------- -------
Net income (loss).................. . $ 404 $ 725 $ 213 $ (131) $ 719 $ 1,403 $ 1,426 $ 714
====== ====== ====== ====== ======= ======= ======= =======
Gross profit:
Systems........................... . 34.1% 37.3% 32.6% 24.4% 34.5% 38.8% 43.2% 45.6%
Services.......................... . 18.8 (11.9) (71.1) (70.0) (33.7) (20.5) 11.2 (31.0)
The Company has experienced significant variations in revenues, expenses and
operating results from quarter to quarter and such variations are likely to
continue. A significant portion of the Company's revenues have been generated
from a limited number of customers and it is difficult to predict the timing of
future orders and shipments to these and other customers. Customers can cancel
or reschedule shipments, and development or production difficulties could delay
shipments.
The Company has also experienced significant variations in its quarterly gross
margins. In the third quarter of 1995, the Company decreased the selling price
of its first generation SeaChange SPOT digital video insertion system in
anticipation of the introduction of the second generation system in January
1996. This price reduction had a negative impact on the Company's systems gross
margins in the last two quarters of 1995 and the first quarter of 1996.
Quarterly service gross margins have historically fluctuated significantly since
installation and training service revenue is recognized upon completion, the
timing of which may vary, while the related costs are incurred and recognized
ratably.
25
Operating expenses also vary with the number, timing and significance of
new product and product enhancement introductions by the Company and its
competitors, increased competition, changes in pricing policies by the Company
or its competitors, the gain or loss of significant customers, the hiring of new
personnel and general economic conditions. All of the above factors are
difficult for the Company to forecast, and these or other factors may materially
adversely effect the Company's business, financial condition and results of
operations for one quarter or a series of quarters. Only a small portion of the
Company's expenses vary with revenues in the short-term and there would likely
be a material adverse effect on the operating results of the Company if revenues
are lower than expectations.
Based upon all of the foregoing, the Company believes that quarterly
revenues and operating results are likely to vary significantly in the future
and that period-to-period comparisons of its results of operations are not
necessarily meaningful and should not be relied upon as indications of future
performance.
LIQUIDITY AND CAPITAL RESOURCES
From inception through November 1996, the Company funded its operations
primarily through cash provided by operations and the private sale of equity
securities. In November 1996, in connection with the initial public offering of
the Company's Common Stock, the Company received net proceeds of $24.1 million.
Cash and cash equivalents increased $17.2 million from $6.2 million at
December 31, 1995 to $23.4 million at December 31, 1996. Working capital
increased from approximately $3.5 million at December 31, 1995 to approximately
$26.6 million at December 31, 1996.
Net cash provided by operating activities was approximately $618,000 and
$2.8 million for the years ended December 31, 1994 and 1995, respectively. Net
cash used in operating activities was $1.9 million for the year ended December
31, 1996. The cash provided by operating activities in 1994 was primarily the
result of an increase in customer deposits, which represent advance payments
from customers. Cash flows related to customer deposits are dependent upon the
timing, volume and size of customer orders. The increase in 1995 was primarily
attributable to the increased profitability of the Company's operations, and
increases in accounts payable and accrued expenses, partially offset by
increases in accounts receivable, related to the increase in overall product
revenues, and increased inventory procurement in anticipation of the
introduction of the Company's second generation digital video insertion system
in early 1996. Net cash used in operating activities in 1996 was primarily due
to increased accounts receivable and inventories, partially offset by net income
adjusted for noncash expenses including depreciation and amortization and
increased current liabilities. Accounts receivable increased from $3.3 million
at December 31, 1995 to $7.4 million at December 31, 1996, an increase of $4.1
million, or 123%. The increase in accounts receivable in 1996 is primarily
attributable to the increased revenue levels. Total revenues recognized in the
quarter ended December 31, 1995 were $6.0 million compared to $12.0 million in
the quarter ended December 31, 1996, a 100% increase. Inventories increased from
$2.4 million at December 31, 1995 to $9.2 million at December 31, 1996, an
increase of $6.7 million, or 275%. The increase in inventories in 1996 is
attributable to additional inventory to support the Company's current and
anticipated revenue growth and to service the growing installed base of systems.
Net cash used in investing activities was approximately $207,000, $659,000
and $3.2 million for the years ended December 31, 1994, 1995 and 1996,
respectively. Investment activity consisted primarily of capital expenditures
related to the acquisition of computer equipment, office furniture, and other
capital equipment required to support the expansion and growth of the business.
In addition, in June 1996 the Company paid $450,000 for a software license.
Net cash provided by financing activities was approximately $251,000, $3.2
million and $22.3 million for the years ended December 31, 1994, 1995 and 1996,
respectively. In 1994, the cash provided by financing activities included the
private sale of equity securities. In 1995, the cash provided by financing
activities included $4.0
26
million received in connection with the issuance of the Series B Convertible
Redeemable Preferred Stock, partially offset by a $795,000 cash outlay related
to loans to stockholders. In 1996 the cash provided by financing activities
consisted primarily of net proceeds of $24.1 million from the initial public
offering of the Company's Common Stock in November 1996 offset by the purchase
of $2.0 million of treasury stock.
The Company has a $6.0 million revolving line of credit and a $1.5 million
equipment line of credit with a bank. The revolving line of credit expires in
September 1997 and the equipment line expires in March 1997. The Company does
not intend to renew the equipment line of credit. Borrowings under the lines of
credit are secured by substantially all of the Company's assets. Loans made
under the revolving line of credit will bear interest at a rate per annum equal
to, at the Company's option, the bank's base rate or LIBOR, plus an applicable
margin. Loans made under the equipment line of credit will bear interest at a
rate per annum equal to the bank's base rate. The loan agreement relating to the
lines of credit requires that the Company provide the bank with certain periodic
financial reports and comply with certain financial ratios. As of December 31,
1996, the Company had not borrowed against either of these lines.
The Company believes that its existing cash, together with available
borrowings under the lines of credit, are sufficient to meet the Company's
requirements through at least 1997.
The Company had no material capital expenditure commitments as of December
31, 1996.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's Financial Statements and Schedules, together with the
auditors' reports thereon, appear at pages F-1 through F-12, and S-1 through S-
2, respectively, of this Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information concerning the directors of the Registrant is hereby
incorporated by reference from the information contained under the heading "
Election of Directors" in the Registrant's definitive proxy statement related to
the Registrant's 1997 Annual Meeting of Stockholders which will be filed with
the Commission within 120 days after the close of the fiscal year (the
"Definitive Proxy Statement").
Certain information concerning directors and executive officers of the
Registrant is hereby incorporated by reference to the information contained
under the heading "Occupations of Directors and Executive Officers" in the
Registrant's Definitive Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation is hereby incorporated by
reference to the information contained under the heading "Compensation and Other
Information Concerning Directors and Officers" in the Definitive Proxy
Statement.
27
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning security ownership of certain beneficial owners and
management is hereby incorporated by reference to the information contained
under the heading "Securities Ownership of Certain Beneficial Owners and
Management" in the Definitive Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning certain relationships and related transactions is
hereby incorporated by reference to the information contained under the heading
"Certain Relationships and Related Transactions" in the Definitive Proxy
Statement.
28
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS
The following Consolidated Financial Statements of the Registrant are filed as part of this report:
Page
----
Report of Independent Accountants F-1
Consolidated Balance Sheet as of December 31, 1995 and 1996 F-2
Consolidated Statement of Income for the years ended December 31, 1994, 1995 and 1996 F-3
Consolidated Statement of Stockholders' Equity for the years ended December 31, 1994,
1995 and 1996 F-4
Consolidated Statement of Cash Flows for the years ended December 31, 1994, 1995 and 1996 F-5
Notes to Consolidated Financial Statements F-6
(a)(2) INDEX TO FINANCIAL STATEMENT SCHEDULES
The following Financial Statement Schedule of the Registrant is filed as part of this report:
Page
----
Schedule II - Valuation and Qualifying Accounts and Reserves S-2
Schedules not listed above have been omitted because the information requested
to be set forth therein is not applicable or is shown in the accompanying
Consolidated Financial Statements or notes thereto.
(a)(3) INDEX TO EXHIBITS
See attached Exhibit Index of this Annual Report on Form 10-K.
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the period.
29
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, SeaChange International, Inc. has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: MARCH 28, 1997
SEACHANGE INTERNATIONAL, INC.
by: /s/ William C. Styslinger, III
----------------------------------
William C. Styslinger, III
President, Chief Executive Officer,
Chairman of the Board and Director.
POWER OF ATTORNEY AND SIGNATURES
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints William C. Styslinger, III and Joseph S.
Tibbetts, Jr., jointly and severally, his attorney-in-fact, each with the power
of substitution, for him in any and all capacities, to sign any amendments to
this Report on Form 10-K and to file same, with exhibits thereto and other
documents in connection therewith, with the Securities and Exchange Commission,
hereby ratifying and confirming all that each of said attorneys-in-fact, or his
substitute or substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE(S) DATE
--------- -------- ----
/s/ William C. Styslinger, III President, Chief Executive March 28, 1997
- ------------------------------ Officer, Chairman of the Board --------------
WILLIAM C. STYSLINGER, III and Director (Principal
Executive Officer)
/s/ Joseph S. Tibbetts, Jr. Vice President, Finance and March 28, 1997
- --------------------------- Administration, Chief Financial --------------
JOSEPH S. TIBBETTS, JR. Officer and Treasurer
(Principal Financial and
Accounting Officer)
/s/ Martin R. Hoffmann Director March 28, 1997
- ---------------------- --------------
MARTIN R. HOFFMANN
/s/ Edward J. McGrath Director March 28, 1997
- --------------------- --------------
EDWARD J. MCGRATH
/s/ Paul Saunders Director March 28, 1997
- ----------------- --------------
PAUL SAUNDERS
/s/ Carmine Vona Director March 28, 1997
- ---------------- --------------
CARMINE VONA
30
- ---------------------------------
REPORT OF INDEPENDENT ACCOUNTANTS
- ---------------------------------
TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF SEACHANGE INTERNATIONAL, INC.
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income, of stockholders' equity and of cash flows
present fairly, in all material respects, the financial position of SeaChange
International, Inc. and its subsidiaries at December 31, 1995 and 1996 and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1996, in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
Price Waterhouse LLP
Boston, Massachusetts
January 22, 1997
F-1
- --------------------------
CONSOLIDATED BALANCE SHEET
- --------------------------------------------------------------------------------
December 31,
1995 1996
ASSETS
Current assets:
Cash and cash equivalents $ 6,184,100 $23,394,200
Accounts receivable, net of allowance for doubtful
accounts of $40,000 at December 31, 1995 and
$173,000 at December 31, 1996 3,335,200 7,425,800
Inventories 2,438,500 9,152,700
Prepaid expenses 27,700 250,400
Deferred income taxes 151,000 575,100
-------------------------
Total current assets 12,136,500 40,798,200
Property and equipment, net 1,433,100 4,704,700
Other assets 25,400 531,700
-------------------------
$13,595,000 $46,034,600
-------------------------
-------------------------
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,139,700 $ 7,304,700
Accrued expenses 1,935,500 1,809,700
Customer deposits 2,082,200 2,898,700
Deferred revenue 766,600 2,191,800
Income taxes payable 720,000 --
-------------------------
Total current liabilities 8,644,000 14,204,900
-------------------------
Commitments (Note 9)
Series B redeemable convertible preferred stock,
$.01 par value; 1,000,000 shares of preferred stock
authorized; 650,487 shares designated, issued and
outstanding at December 31, 1995, at issuance
price, net of issuance costs; none outstanding at
December 31, 1996 4,008,100 --
-------------------------
STOCKHOLDERS' EQUITY
Series A convertible preferred stock, $.01 par value;
1,000,000 shares of preferred stock authorized;
30,000 shares designated, 11,808 shares issued at
December 31, 1995, at issuance price; none
outstanding at December 31, 1996 100 --
Common stock, $.01 par value; 50,000,000 shares
authorized; 9,625,740 shares and 12,859,234 shares
issued at December 31, 1995 and 1996, respectively 96,300 128,600
Additional paid-in capital 373,600 26,167,400
Retained earnings 1,271,500 5,533,700
Treasury stock, 424,950 shares of common stock
at December 31, 1995; none at December 31, 1996 (3,600) --
Notes receivable from stockholders (795,000) --
-------------------------
Total stockholders' equity 942,900 31,829,700
-------------------------
$13,595,000 $46,034,600
=========================
The accompanying notes are an integral part of these financial statements.
F-2
CONSOLIDATED STATEMENT OF INCOME
Year ended December 31,
1994 1995 1996
REVENUES
Systems $5,037,000 $21,999,300 $45,745,200
Services 116,100 1,203,300 3,521,200
Other 536,900 -- --
------------------------------------
5,690,000 23,202,600 49,266,400
------------------------------------
COSTS OF REVENUES
Systems 3,405,600 14,916,900 27,132,700
Services 176,500 1,641,000 4,030,300
Other 303,700 -- --
------------------------------------
3,885,800 16,557,900 31,163,000
------------------------------------
Gross profit 1,804,200 6,644,700 18,103,400
------------------------------------
OPERATING EXPENSES
Research and development 884,700 2,367,300 5,394,000
Selling and marketing 443,700 1,608,600 4,253,800
General and administrative 273,000 858,400 2,064,100
------------------------------------
1,601,400 4,834,300 11,711,900
------------------------------------
Income from operations 202,800 1,810,400 6,391,500
Interest income, net 7,000 113,400 353,600
------------------------------------
Income before income taxes 209,800 1,923,800 6,745,100
Provision for income taxes 55,000 713,000 2,482,900
------------------------------------
Net income $ 154,800 $ 1,210,800 $ 4,262,200
====================================
Net income per share $ .02 $ .10 $ .36
====================================
Weighted average common shares and
equivalent common shares outstanding 9,399,480 11,575,320 11,900,483
====================================
The accompanying notes are an integral part of these financial statements.
F-3
- ----------------------------------------------
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------
Series A
convertible
preferred Common stock
------------------ ------------------- Retained Notes
Additional earnings receivable Total
Number Number Par paid-in (accumulated Treasury from stockholders'
of shares Amount of shares value capital deficit) stock stockholders equity
Balance at
December 31, 1993 -- $ -- 3,150,000 $ 31,500 $ -- $ (49,000) $ -- $ -- $ (17,500)
Sale of common stock -- -- 6,159,615 61,600 -- (45,100) -- -- 16,500
Conversion of notes
payable to Series A
preferred stock 5,000 -- -- -- 128,500 -- -- -- 128,500
Sale of Series A
preferred stock 6,808 100 -- -- 238,200 -- -- -- 238,300
Purchase of treasury
stock -- -- -- -- -- -- (3,600) -- (3,600)
Net income -- -- -- -- -- 154,800 -- -- 154,800
---------------------------------------------------------------------------------------------------------
Balance at
December 31, 1994 11,808 100 9,309,615 93,100 366,700 60,700 (3,600) -- 517,000
Sale of common stock -- -- 316,125 3,200 6,900 -- -- -- 10,100
Loans to stockholders -- -- -- -- -- -- -- (795,000) (795,000)
Net income -- -- -- -- -- 1,210,800 -- -- 1,210,800
---------------------------------------------------------------------------------------------------------
Balance at
December 31, 1995 11,808 100 9,625,740 96,300 373,600 1,271,500 (3,600) (795,000) 942,900
Purchase of treasury
stock -- -- -- -- -- -- (2,527,600) 795,000 (1,732,600)
Sale of common stock,
net of stock issuance
costs -- -- 1,810,000 18,100 24,051,700 -- -- -- 24,069,800
Conversion of preferred
stock into common
stock (11,808) (100) 2,260,856 22,600 3,985,600 -- -- -- 4,008,100
Sale of common stock
pursuant to exercise
of stock options -- -- 9,223 100 8,900 -- -- -- 9,000
Compensation expense
associated with stock
options -- -- -- -- 126,100 -- -- -- 126,100
Issuance of common
stock pursuant to
purchased research
and development -- -- 9,615 100 144,100 -- -- -- 144,200
Retirement of
treasury stock -- -- (856,200) (8,600) (2,522,600) -- 2,531,200 -- --
Net income -- -- -- -- -- 4,262,200 -- -- 4,262,200
---------------------------------------------------------------------------------------------------------
Balance at
December 31, 1996 -- -- 12,859,234 $ 128,600 $26,167,400 $5,533,700 $ -- $ -- $31,829,700
=========================================================================================================
The accompanying notes are an integral part of these financial statements.
F-4
CONSOLIDATED STATEMENT OF CASH FLOWS/INCREASE
(DECREASE) IN CASH AND CASH EQUIVALANTS
Year ended December 31,
1994 1995 1996
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 154,800 $ 1,210,800 $ 4,262,200
Adjustments to reconcile net income
to net cash provided by (used in)
operating activities:
Depreciation and amortization 38,900 230,200 1,435,500
Inventory valuation allowance -- 56,200 693,800
Compensation expense associated
with stock options -- -- 126,100
Research and development expense
associated with common stock issuance -- -- 144,200
Deferred income taxes (66,000) (85,000) (424,100)
Changes in assets and liabilities:
Accounts receivable (1,375,200) (2,035,000) (4,090,600)
Inventories (962,200) (2,280,000) (9,133,500)
Prepaid expenses and other assets (31,800) (14,900) (468,600)
Accounts payable 1,065,000 2,069,300 4,165,000
Accrued expenses 209,800 1,693,000 (125,800)
Customer deposits 1,382,700 699,500 816,500
Deferred revenue 80,500 614,500 1,425,200
Income taxes payable 121,000 599,000 (720,000)
---------------------------------------------
Net cash provided by (used in) operating activities 617,500 2,757,600 (1,894,100)
---------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of software -- -- (450,000)
Purchases of property and equipment (207,300) (659,400) (2,792,000)
---------------------------------------------
Net cash used in investing activities (207,300) (659,400) (3,242,000)
---------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Repayment of notes payable -- (8,000) --
Proceeds from sale of convertible
preferred stock, net 238,300 4,008,100 --
Proceeds from sale of common stock, net 16,500 10,100 24,078,800
Purchase of treasury stock (3,600) -- (2,022,600)
(Loans to) repayments from stockholders -- (795,000) 290,000
---------------------------------------------
Net cash provided by financing activities 251,200 3,215,200 22,346,200
---------------------------------------------
Net increase in cash and cash equivalents 661,400 5,313,400 17,210,100
Cash and cash equivalents, beginning of year 209,300 870,700 6,184,100
---------------------------------------------
Cash and cash equivalents, end of year $ 870,700 $ 6,184,100 $23,394,200
=============================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid $ 3,700 $ -- $ --
Income taxes paid $ -- $ 180,000 $ 3,853,600
SUPPLEMENTAL DISCLOSURE OF NONCASH ACTIVITY
Conversion of notes payable plus accrued
interest to Series A convertible preferred stock $ 128,500 $ -- $ --
Receipt of computer equipment in lieu of cash
payment of accounts receivable from customer $ -- $ 75,000 $ --
Transfer of items originally classified as
inventories to fixed assets $ 171,500 $ 576,000 $ 1,725,500
Purchase of treasury stock in lieu of cash
payment of notes receivable from stockholders $ -- $ -- $ 505,000
---------------------------------------------
The accompanying notes are an integral part of these financial statements.
F-5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- ---------------------
1 NATURE OF BUSINESS
- ---------------------
The Company develops software-based products to manage, store and distribute
digital video. Through December 31, 1996, substantially all of the Company's
revenues have been derived from sales of digital video insertion systems (the
"SeaChange SPOT System") to cable television operators and telecommunications
companies in the United States.
- ---------------------------------------------
2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- ---------------------------------------------
Significant accounting policies followed in the preparation of the accompanying
consolidated financial statements are as follows:
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. All significant intercompany transactions have
been eliminated.
REVENUE RECOGNITION
Revenue from the sale of systems is recognized upon shipment provided that there
are no uncertainties regarding customer acceptance and collection of the related
receivable is probable. If such uncertainties exist, such as performance
criteria beyond the Company's standard terms and conditions, revenue is
recognized upon customer acceptance. Installation and training revenue is
deferred and recognized as these services are performed. Revenue from technical
support and maintenance contracts is deferred and recognized ratably over the
period of the related agreements, generally twelve months. Customer deposits
represent advance payments from customers for systems.
Other revenue was recognized pursuant to a software development contract as work
was performed and defined milestones were attained. Nonrefundable payments
received under the contract prior to the attainment of defined milestones were
recorded as deferred revenue.
CONCENTRATION OF CREDIT RISK AND SIGNIFICANT CUSTOMERS
Financial instruments which potentially expose the Company to concentrations of
credit risk include trade accounts receivable. To minimize this risk, the
Company evaluates customers' financial condition and requires advance payments
from the majority of its customers. At December 31, 1995 and 1996, the Company
had an allowance for doubtful accounts of $40,000 and $173,000, respectively, to
provide for potential credit losses and such losses to date have not exceeded
management's expectations.
For the years ended December 31, 1994, 1995 and 1996, certain customers
accounted for more than 10% of the Company's revenues. Individual customers
accounted for 50%, 18%, 11% and 10% of revenues in 1994; 29%, 29%, 16% and 12%
in 1995; and 29%, 17%, 13% and 12% in 1996.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from these estimates.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with an original
maturity of three months or less to be cash equivalents. The Company invests its
excess cash in U.S. Government securities, money market funds of major financial
institutions and high grade commercial and municipal paper that are subject to
minimal credit and market risk. Cash equivalents are classified as available-
for-sale and are carried at market value, and any unrealized gains or losses are
recorded as a part of stockholders' equity.
PROPERTY AND EQUIPMENT
Property and equipment consist of office and computer equipment, leasehold
improvements, demonstration equipment and spare components and assemblies used
to service the Company's installed base. Demonstration equipment consists of
systems manufactured by the Company for use in the Company's marketing and
selling efforts. Property and equipment are recorded at cost and depreciated
using the straight-line method over their estimated useful lives. Leasehold
improvements are amortized over the shorter of their estimated useful lives or
the term of the respective leases by use of the straight-line method.
Maintenance and repair costs are expensed as incurred.
F-6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined using
the first-in, first-out (FIFO) method. Inventories consist primarily of
components and subassemblies and finished products held for sale. Rapid
technological change and new product introductions and enhancements could result
in excess or obsolete inventory. To minimize this risk, the Company evaluates
inventory levels and expected usage on a periodic basis and records valuation
allowances as required.
The Company is dependent upon certain vendors for the manufacture of significant
components of its digital advertising insertion system. If these vendors were
to become unwilling or unable to continue to manufacture these products in
required volumes, the Company would have to identify and qualify acceptable
alternative vendors. The inability to develop alternate sources, if required in
the future, could result in delays or reductions in product shipments.
RESEARCH AND DEVELOPMENT AND SOFTWARE DEVELOPMENT COSTS
Costs incurred in the research and development of the Company's products are
expensed as incurred, except for certain software development costs. Costs
associated with the development of computer software are expensed prior to
establishing technological feasibility and capitalized thereafter until the
product is released for sale. Software development costs eligible for
capitalization to date have not been material to the Company's financial
statements. Costs associated with acquired software rights are capitalized if
technological feasibility of the software has been established.
At December 31, 1996, other assets includes $460,400 of software purchased in
May 1996, net of amortization. The software is amortized over its estimated
economic life of two years and the related amortization expense for the year
ended December 31, 1996 totaled $189,600 and is included in the cost of systems
revenues.
STOCK COMPENSATION
Employee stock awards under the Company's compensation plans are accounted for
in accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees." In January 1996, the Company adopted the disclosure
requirements of Statement of Financial Accounting Standards No. 123 ("FAS 123"),
"Accounting for Stock-Based Compensation".
ADVERTISING COSTS
Advertising costs are charged to expense as incurred. Advertising costs were
$34,800, $173,900 and $328,000 for the years ended December 31, 1994, 1995 and
1996, respectively.
NET INCOME PER SHARE
Net income per share was determined by dividing net income by the weighted
average number of common shares and common share equivalents outstanding during
the period. Common share equivalents are comprised of common stock options and
convertible preferred stock and have been included in the calculation to the
extent their effect is dilutive. Pursuant to Securities and Exchange Commission
Staff Accounting Bulletin No. 83, common share equivalents issued at prices
below the initial public offering price in the twelve months preceding the
initial public offering have been included in the calculation for all periods
prior to the initial public offering.
3 CONSOLIDATED BALANCE SHEET DETAIL
Investments consist of the following:
At December 31, 1995 and 1996, the Company's cash equivalents included
approximately $4,700,000 and $997,000, respectively, of U.S. Government
securities. The securities were classified as held-to-maturity and stated at
amortized cost, which approximated fair value.
At December 31, 1996, the original maturity of all securities was three months
or less, and accordingly, all investments were classified as cash equivalents.
There were no investments classified as available-for-sale at December 31, 1995.
Available-for-sale securities included in cash and cash equivalents consisted of
the following at December 31, 1996.
Amortized Unrealized
cost gains Losses Fair value
Money market funds $ 296,800 $ -- $ -- $ 296,800
Municipal securities 12,600,000 -- -- 12,600,000
Corporate debt securities 9,485,100 -- -- 9,485,100
-----------------------------------------------
$22,381,900 $ -- $ -- $22,381,900
===============================================
Gains and losses realized upon the sale of securities, the cost of which is
based upon the specific identification method, were not significant.
F-7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Inventories consist of the following:
December 31,
1995 1996
Components and assemblies $2,261,100 $6,524,300
Finished products 177,400 2,628,400
------------------------
$2,438,500 $9,152,700
========================
Property and equipment consist of the
following:
Estimated
useful life December 31,
(years) 1995 1996
Office furniture and equipment 5 $ 108,300 $ 432,100
Computer equipment 3 1,156,300 2,607,500
Demonstration equipment 3 -- 1,963,400
Service and spare components 5 350,000 1,050,400
Leasehold improvements 1-3 47,700 106,700
------------------------
1,662,300 6,160,100
Less - Accumulated depreciation 229,200 1,455,400
------------------------
$1,433,100 $4,704,700
========================
Depreciation expense was $38,900, $230,200 and $1,245,900 for the years ended
December 31, 1994, 1995 and 1996, respectively.
Accrued expenses consist of the following:
December 31,
1995 1996
Accrued software license fees $ 444,000 $ 367,400
Accrued sales and use taxes 1,247,800 608,500
Other accrued expenses 243,700 833,800
------------------------
$1,935,500 $1,809,700
========================
4 INCOME TAXES
The components of the provision for income taxes are as follows:
Year ended December 31,
1994 1995 1996
Current provision:
Federal $116,000 $652,000 $2,345,500
State 5,000 146,000 561,500
---------------------------------
121,000 798,000 2,907,000
---------------------------------
Deferred benefit:
Federal (51,000) (65,000) (324,000)
State (15,000) (20,000) (100,100)
---------------------------------
(66,000) (85,000) (424,100)
---------------------------------
$ 55,000 $713,000 $2,482,900
=================================
F-8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The components of deferred tax assets and liabilities are as follows:
December 31,
1995 1996
Deferred tax assets:
Inventory $ 55,300 $366,400
Allowance for doubtful accounts 15,700 65,500
Deferred revenue 92,100 118,000
Software -- 121,600
-----------------------
Total deferred tax assets 163,100 671,500
Deferred tax liabilities 12,100 96,400
-----------------------
Net deferred tax assets $151,000 $575,100
=======================
The income tax provision computed using the federal statutory income tax rate
differs from the Company's effective tax rate primarily due to the following:
Year ended December 31,
1994 1995 1996
Statutory U.S. federal tax rate 34.0% 34.0% 34.0%
State taxes, net of federal tax benefit 1.7 4.4 4.5
Utilization of operating loss carryforwards (.5) --- ---
Research and development tax credits (10.9) (2.8) (2.0)
Foreign sales corporation exempt income --- --- (.3)
Nondeductible expenses 1.9 1.5 .6
---------------------------
26.2% 37.1% 36.8%
===========================
5 CONVERTIBLE PREFERRED STOCK CONVERSION
SERIES B CONVERTIBLE PREFERRED STOCK
In October and November 1995, the Company sold 650,487 shares of Series B
Redeemable Convertible Preferred Stock for $4,008,100, net of issuance costs of
$85,500.
CONVERSION
Upon closing of the initial public offering, in November 1996, the 650,487
shares of Series B Redeemable Convertible Preferred Stock and 11,808 shares of
Series A Convertible Preferred Stock were automatically converted into a total
of 2,260,856 shares of common stock.
STOCK AUTHORIZATION
The Board of Directors is authorized to issue from time to time up to an
aggregate of 5,000,000 shares of preferred stock, in one or more series. Each
such series of preferred stock shall have the number of shares, designations,
preferences, voting powers, qualifications and special or relative rights or
privileges to be determined by the Board of Directors, including dividend
rights, voting rights, redemption rights and sinking fund provisions, liqui-
dation preferences, conversion rights and preemptive rights.
6 COMMON STOCK
INITIAL PUBLIC OFFERING
On November 5, 1996, the Company sold 1,810,000 shares of common stock to the
public in the Company's initial public offering at a price of $15.00 per share.
Proceeds to the Company, net of offering expenses, amounted to $24,069,800.
STOCK SPLITS
Effective August 3, 1995, the Company's Board of Directors approved a 100-for-1
stock split of the Company's common stock. On September 6, 1996, the Board of
Directors authorized a 3-for-2 stock split of the Company's common stock, which
became effective on October 30, 1996. All shares of common stock, common stock
options, preferred stock conversion ratios and per share amounts included in the
accompanying consolidated financial statements have been adjusted to give
retroactive effect to the stock splits for all years presented.
F-9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
RESTRICTION AGREEMENTS
The holders of 6,871,625 common shares have entered into stock restriction and
repurchase agreements under which the Company may repurchase unvested common
shares at the original issuance price and vested common shares at fair value
upon termination of a business relationship with the Company. Common shares
subject to these agreements vest ratably over a five-year period and, at
December 31, 1996, 3,584,280 of such shares are unvested.
TREASURY STOCK
In January 1996, the Company repurchased 431,250 shares of its common stock and
1,286 shares of Series A Stock from certain employees and directors of the
Company. Of the common stock repurchased, 21,750 shares were held by the
stockholders for less than six months from the time the shares became vested.
Accordingly, compensation expense was recorded for the difference between the
repurchase price and the original purchase price paid by the stockholders.
Compensation expense recorded as a result of this transaction was $91,000. In
December 1996, the Board of Directors voted to retire all shares of treasury
stock held at December 31, 1996.
NOTES RECEIVABLE FROM STOCKHOLDERS
The principal amount of the notes receivable from stockholders at December 31,
1995 was payable at the earlier of (i) six months from the date of issuance or
(ii) the closing of any sale to a third party or redemption by the Company
of pledged shares of the Company's common stock or preferred stock. Interest on
the principal amount outstanding accrued at a rate of 5.9% per annum. These
loans were secured by common stock held by the noteholders and, consequently,
the loans are reflected as an offset to stockholders' equity at December 31,
1995. In January 1996, the notes were settled in connection with the repurchase
by the Company of the common stock and Series A Stock noted above.
RESERVED SHARES
At December 31, 1996, the Company has 2,270,777 shares of common stock reserved
for issuance upon the exercise of common stock options and the purchase of stock
under the Employee Stock Purchase Plan.
7 STOCK PLANS
1995 STOCK OPTION PLAN
The 1995 Stock Option Plan (the "1995 Stock Option Plan") provides for the grant
of incentive stock options and nonqualified stock options for the purchase of up
to an aggregate of 1,950,000 shares of the Company's common stock by officers,
employees, consultants and directors of the Company. The Board of Directors is
responsible for administration of the 1995 Stock Option Plan. The Board of
Directors determines the term of each option, option exercise price, number of
shares for which each option is granted and the rate at which each option is
exercisable. Options generally vest ratably over five years. The Company may not
grant an employee incentive stock options with a fair value in excess of
$100,000 that is first exercisable during any one calendar year.
Incentive stock options may be granted to employees at an exercise price per
share of not less than the fair value per common share on the date of the grant
(not less than 110% of the fair value in the case of holders of more than 10% of
the Company's voting stock). Nonqualified stock options may be granted to any
officer, employee, director or consultant at an exercise price per share, as
determined by the Company's Board of Directors.
Options granted under the 1995 Stock Option Plan generally expire ten years from
the date of the grant (five years for incentive stock options granted to holders
of more than 10% of the Company's voting stock).
DIRECTOR STOCK OPTION PLAN
In June 1996, the Company's Board of Directors adopted and the stockholders
approved a Director Stock Option Plan (the "Director Option Plan") which
provides for the grant of options to full-time directors of the Company to
purchase a maximum of 30,000 shares of common stock. Under the Director Option
Plan, participating directors receive an option to purchase 3,375 shares of
common stock. Options granted under the Director Option Plan vest as to
33-1/3% of the shares underlying the option immediately upon the date of the
grant, and vest as to an additional 8-1/3% of the shares underlying the option
at the end of each of the next 8 quarters, provided that the optionee remains a
director. Directors will also receive, on each three-year anniversary of such
director's option grant date, an additional option to puchase 3,375 shares of
common stock, provided that such director continues to serve on the Board of
Directors. All options granted under the Director Option Plan have an exercise
price equal to the fair value of the common stock on the date of grant and a
term of ten years from the date of grant.
F-10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
EMPLOYEE STOCK PURCHASE PLAN
In September 1996, the Company's Board of Directors adopted and the stockholders
approved an employee stock purchase plan (the "Stock Purchase Plan"), effective
January 1, 1997, which provides for the issuance of a maximum of 300,000 shares
of common stock to participating employees who meet eligibility requirements.
Employees who would immediately after the grant own 5% or more of the total
combined voting power or value of the Company's stock and directors who are not
employees of the Company may not participate in the Stock Purchase Plan. The
purchase price of the stock is 85% of the lesser of the market price of the
common stock on the first or last business day of each six-month plan period.
Transactions under the 1995 Stock Option Plan and the Director Option Plan
during the year ended December 31, 1995 and 1996 are summarized as follows:
Year ended December 31,
1995 1996
Weighted average Weighted average
Shares exercise price Shares exercise price
Outstanding at beginning of period 327,120 $ .92
Granted 327,120 $ .92 472,510 $ 8.79
Exercised -- -- (9,223) $ .85
Cancelled -- -- (51,073) $ 2.22
-------------------------------------------------------------
Outstanding at period end 327,120 739,334
=============================================================
Options exercisable at period end -- 115,224
Weighted average fair value of
options granted during the period $ .32 $ 4.33
The following table summarizes information about employee and director stock
options outstanding at December 31, 1996:
Options outstanding at December 31, 1996
------------------------------------------------
Weighted
average
remaining Weighted
contractual Number average
Range of exercise prices life (years) outstanding exercise price
$.50 8.65 129,734 $ .50
1.23 to 1.36 7.29 156,600 $ 1.28
4.20 to 5.00 9.10 97,425 $ 4.48
6.67 to 9.33 9.47 280,050 $ 7.34
10.67 to 15.00 9.76 45,975 $12.62
33.75 9.98 29,550 $33.75
------------------------------------------------
739,334
================================================
Options exercisable at December 31, 1996
------------------------------------------------
Weighted
Number average
Range of exercise prices exercisable exercise price
$.50 46,151 $ .50
1.23 to 1.36 30,982 $ 1.28
4.20 to 5.00 3,030 $ 4.20
6.67 to 9.33 35,061 $ 7.33
10.67 to 15.00 -- --
33.75 -- --
------------------------------------------------
115,224
================================================
F-11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
FAIR VALUE DISCLOSURES
Had compensation cost for the Company's option plans been determined based on
the fair value at the grant dates, as prescribed in FAS 123, the Company's net
income and net income per share would have been as follows:
Year ended December 31,
1995 1996
Net income
As reported $1,210,800 $4,262,200
Pro forma $1,207,800 $4,204,600
Net income per share
As reported $ .10 $ .36
Pro forma $ .10 $ .35
For options granted prior to the Company's initial filing of its Registration
Statement on Form S-1, on September 18, 1996, the fair value of each option
grant was estimated on the date of grant using the minimum value method. The
fair value of each option granted subsequent to the initial filing was estimated
on the date of grant assuming a weighted average volatility factor of 0.67.
Additional weighted average assumptions used for grants during the years ended
December 31, 1995 and 1996 included: dividend yield of 0.0% for both periods;
risk-free interest rates of 5.89% to 6.00% for options granted during the year
ended December 31, 1995 and 5.36% to 6.49% for options granted during the year
ended December 31, 1996; and an expected option term of 5 years for both
periods.
Because additional option grants are expected to be made each year, the above
pro forma disclosures are not representative of pro forma effects of reported
net income for future years.
8 LINES OF CREDIT
In September 1996, the Company entered into a $6.0 million revolving line of
credit and a $1.5 million equipment line of credit with a bank. The revolving
line of credit expires in September 1997 and the equipment line of credit
expires in March 1997. Borrowings under the lines of credit are secured by
substantially all of the Company's assets. Loans made under the revolving line
of credit will bear interest at a rate per annum equal to, at the Company's
option, the bank's base rate or LIBOR plus an applicable margin. Loans made
under the equipment line of credit will bear interest at a rate per annum equal
to the bank's base rate. The loan agreement relating to the lines of credit
requires that the Company provide the bank with certain periodic financial
reports and comply with certain financial ratios. As of December 31, 1996, the
Company had not borrowed against either of these lines.
9 COMMITMENTS
The Company leases its operating facilities and certain office equipment under
noncancelable operating leases which expire at various dates through 1998.
Rental expense under operating leases was approximately $53,000, $154,000 and
$251,000 for the years ended December 31, 1994, 1995 and 1996, respectively.
Future minimum lease payments as of December 31, 1996 are as follows:
For the year ended December 31, 1997 $396,700
1998 136,200
1999 21,600
2000 14,200
2001 and thereafter 10,700
--------
$579,400
========
10 EMPLOYEE BENEFIT PLAN
The Company sponsors a 401(k) retirement savings plan. Participation in the plan
is available to full-time employees who meet eligibility requirements. Eligible
employees may contribute up to 15% of their salary, subject to certain
limitations. Company contributions to the plan may be made at the discretion of
the Board of Directors. Through December 31, 1996, the Company made no
contributions.
F-12
SEACHANGE INTERNATIONAL, INC.
REPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULE
To the Board of Directors of SeaChange International, Inc.
Our audits of the consolidated financial statements referred to in our report
dated January 22, 1997 appearing on page F-1 of this Form 10-K also include an
audit of the Financial Statement Schedule listed in Item 14(a) of this Form
10-K. In our opinion, this Financial Statement Schedule presents fairly, in all
material respects, the information set forth therein when read in conjunction
with the related consolidated financial statements.
PRICE WATERHOUSE LLP
Boston, Massachusetts
January 22, 1997
S-1
SCHEDULE II
SEACHANGE INTERNATIONAL, INC.
VALUATION OF QUALIFYING ACCOUNTS AND RESERVES
BALANCE AT CHARGED TO DEDUCTIONS
BEGINNING OF COSTS AND AND BALANCE AT END
PERIOD EXPENSES WRITE-OFFS OF PERIOD
-------------- -------------- --------------- --------------
Allowance for Doubtful
Accounts:
Year ended December 31, 1994 $ - $ - $ - $ -
Year ended December 31, 1995 - 40,000 - 40,000
Year ended December 31, 1996 40,000 133,000 - 173,000
Inventory Valuation Allowance:
Year ended December 31, 1994 - - - -
Year ended December 31, 1995 - 56,200 - 56,200
Year ended December 31, 1996 56,200 693,800 - 750,000
S-2
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION PAGE
- ----------- ----------- ----
3.1* Amended and Restated Certification of Incorporation.
3.2* Amended and Restated By-laws of the Company.
4.1 Specimen certificate representing the Common Stock (incorporated by reference to Exhibit 4.1 to the
Registrant's Registration Statement on Form S-1, Registration No. 333-12233).
4.2 Series B Preferred Stock Purchase Agreement, dated October 26, 1995 between the Company and the
persons listed on Schedule 1.1 attached thereto (incorporated by reference to Exhibit 4.2 to the
Registrant's Registration Statement on Form S-1, Registration No. 333-12233).
4.3 Form of Stock Restriction Agreement (incorporated by reference to Exhibit 4.3 to the Registrant's
Registration Statement on Form S-1, Registration No. 333-12233).
4.4 Form of Stock Restriction Agreement Admendment (incorporated by reference to Exhibit 4.4 to the
Registrant's Registration Statement on Form S-1, Registration No. 333-12233).
10.1 Amended and Restated 1995 Stock Option Plan (incorporated by reference to Exhibit 10.1 to the
Registrant's Registration Statement on Form S-1 Registration No. 333-12233).
10.2 1996 Non-Employee Director Stock Option Plan (incorporated by reference to Exhibit 10.2 to the
Registrant's Registration Statement on From S-1, Registration No. 333-12233).
10.3 Lease Agreement dated March 10, 1995 between Thomas B. O'Brien, Trustee of Jelric Realty Trust
u/d/t dated 9/18/68 and the Company (incorporated by reference to Exhibit 10.3 to the Registrant's
Registration Statement on From S-1, Registration No. 333-12233).
10.4 Sublease Agreement dated March 19, 1996 between IPL Systems, Inc. and the Company (incorporated by
reference to Exhibit 10.4 to the Registrant's Registration Statement on From S-1,
Registration No. 333-12233).
10.5 Indenture of Lease dated October 1, 1995 between Alden T. Greenwood and the Company (incorporated by
reference to Exhibit 10.5 to the Registrant's Registration Statement on From S-1, Registration
No. 333-12233).
10.6 Letter Agreement dated as of June 12, 1996 between Joseph S. Tibbetts, Jr. and the Company
(incorporated by reference to Exhibit 10.6 to the Registrant's Registration Statement on From S-1,
Registration No. 333-12233).
10.7 License Agreement dated May 30, 1996 between Summit Software Systems, Inc. and the Company
(incorporated by reference to Exhibit 10.7 to the Registrant's Registration Statement on Form S-1,
Registration No. 333-12233).
10.8 Loan and Security Agreement, dated September 25, 1996, between the Company and BayBank, N.A.
(incorporated by reference to Exhibit 10.8 to the Registrant's Registration Statement on Form S-1,
Registration No. 333-12233).
10.9 Working Capital Line of Credit-Master Note dated September 25, 1996, between the Company and
BayBank, N.A. (incorporated by reference to Exhibit 10.9 to the Registrant's Registration Statement
on From S-1, Registration No. 333-12233).
10.10 Equipment Line of Credit-Master Note dated September 25, 1996, between the Company and BayBank,
N.A. (incorporated by reference to Exhibit 10.10 to the Registrant's Registration Statement on
From S-1, Registration No. 333-12233).
10.11 Sales and Marketing Representative Agreement dated October 11, 1996, between the Company and
Media Power S.n.c. (incorporated by reference to Exhibit 10.11 to the Registrant's Registration
Statement on From S-1, Registration No. 333-12233).
11.1* Statement re: computation of net income per share.
23.1* Consent of Price Waterhouse LLP.
27.1* Financial Data Schedule (For SEC Edgar Filing Only; Intentionally Omitted).
- ------------
* Filed herewith.