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SEACHANGE INTERNATIONAL INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
(Edgar Glimpses Via Acquire Media NewsEdge) Forward-Looking Statements
This Form 10-Q contains or incorporates forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995, which involve
risks and uncertainties. The following information should be read in conjunction
with the unaudited consolidated financial information and the notes thereto
included in this Form 10-Q. You should not place undue reliance on these
forward-looking statements. Actual events or results may differ materially due
to competitive factors and other factors referred to in Part I, Item 1A. "Risk
Factors" in our Form 10-K for our fiscal year ended January 31, 2012 and
elsewhere in this Form 10-Q. These factors may cause our actual results to
differ materially from any forward-looking statement. These forward-looking
statements are based on current expectations, estimates, forecasts and
projections about the industry and markets in which we operate, and management's
beliefs and assumptions. We undertake no obligation to update or revise the
statements in light of future developments. In addition, other written or oral
statements that constitute forward-looking statements may be made by us or on
our behalf. Words such as "expect," "anticipate," "intend," "plan," "believe,"
"could," "estimate," "may," "target," "project," or variations of such words and
similar expressions are intended to identify such forward-looking statements.
These statements are not guarantees of future performance and involve certain
risks, uncertainties, and assumptions that are difficult to predict.
Business Overview
We are a global leader in the development and delivery of multi-screen video
headquartered in Acton, Massachusetts. Our products and services facilitate the
storage, management and distribution of video, television programming, and
advertising content to cable system operators, telecommunications companies and
mobile operators. We currently operate under one reporting segment.
During the first nine months of fiscal 2013, we have made significant progress
to execute on our strategy to transform the Company into a software company.
This includes:
· Successfully divesting our two business segments that were non-core to our
strategy;
· Continuing our investment in our next generation product offerings in our back
office products (Adrenalin and Nitro), advertising products (Infusion and
AdPulse) and our home gateway Nucleus product line. We also announced many new
worldwide customer wins for these new products as we help our customers achieve
their goals of reducing operating and capital costs as well as customer churn;
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· Reducing the size of our overall executive management team and appointing new
leadership in key positions, including the Chief Executive Officer and Chief
Financial Officer, Head of EMEA/Asia Pac, U.S. Sales, Marketing, and a Chief
Architect;
· Streamlining other areas of our business through headcount and non-headcount
cost reductions;
· Ensuring quality in everything we do and monitoring our results for continuous
improvement; and
· Executing and producing the financial and operational results we as a
management team have set out to achieve.
Our focus in the fourth quarter of fiscal 2013 and into fiscal 2014 will be to
continue to grow our revenues as our customers upgrade or purchase our next
generation product offerings, expand to new and adjacent markets such as mobile
and internet protocol television ("IPTV") operators, expand our efforts into
Asia, and invest in new technologies through acquisition or direct investments.
We will also continue to review our overall cost structure and make adjustments
that we feel are necessary to achieve our desired financial results. Lastly, our
key focus will be to continue to work closely with our customers and provide
them with quality products and superior customer service as we help them achieve
their long-term business goals.
Following the divestiture of the Broadcast Servers and Storage and Media
Services businesses, the remaining Software and Streaming businesses were
organized into one reporting segment called Software. We will not report
multiple business segments due to the nature of the products offered to
customers, the market characteristics of each operating segment and our
management structure.
We have experienced fluctuations in our revenues from quarter to quarter due to:
• the budgetary approvals from the customer for capital purchases;
• the ability to process the purchase order within the customer's organization in
a timely manner;
• the availability of the product;
• the time required to deliver and install the product; and
• the customer's acceptance of the products and services.
In addition, many customers may delay or reduce capital expenditures. This,
together with other factors, could result in reductions in sales of our
products, longer sales cycles, difficulties in collection of accounts
receivable, excess and obsolete inventory, gross margin deterioration, slower
adoption of new technologies, increased price competition, and supplier
difficulties.
Our operating results are significantly influenced by a number of factors,
including the mix of products sold and services provided, pricing and the costs
of materials used in our products. We price our products and services based upon
our costs and consideration of the prices of competitive products and services
in the marketplace. As a result of the growth of our business, our operating
expenses have historically increased in the areas of research and development,
selling and marketing, and administration. In the current state of the economy,
we expect that customers may still have limited capital spending budgets as we
believe they are dependent on advertising revenues to fund their capital
purchases. Accordingly, we expect our financial results to vary from quarter to
quarter and our historical financial results are not necessarily indicative of
future performance. In light of the higher proportion of our international
business, we expect movements in foreign exchange rates to have a greater impact
on our financial condition and results of operations in the future.
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RESULTS OF OPERATIONS
The following table sets forth our statement of operations data for the three
and nine months ended October 31, 2012 and 2011:
Three Months Ended Nine Months Ended
October 31, October 31,
2012 2011 2012 2011
(amounts in thousands)
Revenues:
Products $ 15,213 $ 21,267 $ 40,681 $ 53,669
Services 24,036 21,646 71,932 67,799
Total revenues 39,249 42,913 112,613 121,468
Costs of revenues:
Products 5,504 5,184 13,771 14,691
Services 13,807 12,512 39,287 36,054
Amortization of intangible
assets 520 769 1,548 1,886Stock-based compensation expense (85 ) 140 109 380
Inventory write-down - - 1,752 -
Total cost of revenues 19,746 18,605 56,467 53,011
Operating expenses:
Research and development 9,423 10,518 29,042 30,436
Selling and marketing 3,905 5,112 11,987 15,802
General and administrative 3,728 4,111 12,126 12,247
Amortization of intangible
assets 969 948 2,891 2,863
Stock-based compensation expense 813 878 2,947 2,754
Earn-outs and change in fair
value of earn-outs 64 1,412 1,667 1,517
Professional fees: acquisitions,
divestitures, litigation, and
strategic alternatives 26 597 1,445 1,873
Severance and other
restructuring 1,476 (6 ) 2,918 221
Total operating expenses 20,404 23,570 65,023 67,713
(Loss) income from operations (901 ) 738 (8,877 ) 744
Other income (expense), net 337 (127 ) (92 ) 128
Gain on sale of investment in
affiliates - - 814 -
Income tax benefit (882 ) (368 ) (766 ) (583 )
Equity income in earnings of
affiliates 49 129 75 215
Net (loss) income from
continuing operations $ 367 $ 1,108 $ (7,314 ) $ 1,670
Revenues
The following table summarizes information about our revenues for the three and
nine months ended October 31, 2012 and 2011:
Three Months Ended Increase/ Increase/ Nine Months Ended Increase/ Increase/
October 31, (Decrease) (Decrease) October 31, (Decrease) (Decrease)
2012 2011 $ Amount % Change 2012 2011 $ Amount % Change
(amounts in thousands, except for percentage data)
Software Revenues:
Products $ 15,213 $ 21,267 $ (6,054 ) (28.5 )% $ 40,681 $ 53,669 $ (12,988 ) (24.2 )%
Services 24,036 21,646 2,390 11.0 % 71,932 67,799 4,133 6.1 %
Total revenues 39,249 42,913 (3,664 ) (8.5 )% 112,613 121,468 (8,855 ) (7.3 )%
Cost of product revenues 6,024 5,953 71 1.2 % 15,319 16,577 (1,258 ) (7.6 )%
Cost of service revenues 13,722 12,652 1,070 8.5 % 39,396 36,434 2,962 8.1 %
Inventory write-down - - - N/A 1,752 - 1,752 N/A
Total cost of revenues 19,746 18,605 1,141 6.1 % 56,467 53,011 3,456 6.5 %
Gross profit $ 19,503 $ 24,308 $ (4,805 ) (19.8 )% $ 56,146 $ 68,457 $ (12,311 ) (18.0 )%
Gross product profit margin 60.4 % 72.0 % (11.6 )% 58.0 % 69.1 % (11.1 )%
Gross service profit margin 42.9 % 41.6 % 1.3 % 45.2 % 46.3 % (1.1 )%
Gross profit margin 49.7 % 56.6 % (6.9 )% 49.9 % 56.4 % (6.5 )%
Product Revenue. Product revenue for the three months ended October 31, 2012
decreased $6.1 million, or 28.5% over the same period of fiscal 2012, primarily
due to the following:
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· A $2.5 million decrease in back office revenue for the period. The decrease was
primarily due to lower demand for our legacy products from North American
customers and a $1.9 million decrease due to a change in classification of
revenue recorded from our subscription agreement with Comcast from the prior
fiscal year. This agreement included specified product enhancements in the
prior fiscal year and therefore was recorded as product revenues. The current
agreement with Comcast signed in the second quarter of fiscal 2013 contains no
specified product enhancements and so revenue recognized under this agreement
is now recorded as service revenue;
· Lower advertising product revenues of $0.5 million due to lower license revenue
from North American service providers, a result of lower demand for our legacy
products;
· A $2.1 million decrease in home gateway revenues due to significant home
gateway licensing transactions with a large domestic customer during the third
quarter of fiscal 2012, for which there was no comparable amount in the same
period of fiscal 2013; and
· A $1.1 million decrease in revenues from sales of VOD servers, as large
shipments of VOD servers were made to customers in North America and Asia in
the third quarter of fiscal 2012 that was partially offset by higher shipments
of VOD servers to a Latin American customer this quarter.
Product revenue for the nine months ended October 31, 2012 decreased $13.0
million, or 24.2% over the same period of fiscal 2012, primarily due to the
following:
· An $8.1 million decrease for the nine month period in back office revenue due
to the change in classification of revenue from the Comcast subscription
agreement mentioned above, which resulted in a $5.2 million decrease in product
revenues. Additionally, there was a decrease in product revenues in the nine
month period due to lower demand for our legacy products from North American
customers;
· Lower advertising product revenues of $4.1 million primarily due to lower
license revenue from North American service providers a result of lower demand
for our legacy products;
· A $2.1 million decrease in home gateway revenues due to a significant home
gateway licensing transaction with a large domestic customer during the third
quarter of fiscal 2012, for which there was no comparable amount in the same
period of fiscal 2013; and
· Revenues from sales of VOD servers increased $1.1 million during the first nine
months of fiscal 2013 as compared to the same period of fiscal 2012 primarily
due to a higher number of shipments to Latin American customers this fiscal
year that was partially offset by lower shipments of VOD servers to a customer
in Asia.
Service Revenue. Service revenue for the three and nine months ended October 31,
2012 increased $2.4 million, or 11.0%, and $4.1 million, or 6.1%, respectively,
as compared to the same periods of fiscal 2012.
· The $2.4 million increase for the three month period was primarily a result of
higher home gateway service revenues from several domestic customers during the
current period; and
· The $4.1 million increase for the nine month period was primarily a result of a
$5.9 million increase in home gateway service revenues from several domestic
customers, a $0.5 million increase in maintenance revenues from our European
customers and higher service revenue due to the change in classification of
revenue recognized under the Comcast subscription agreement, as noted above.
These increases were partially offset by lower VOD and advertising professional
services revenues domestically.
For the third quarter of fiscal 2013 and fiscal 2012, two customers accounted
for 31% and 38% of our total revenues, respectively. For the first nine months
of fiscal 2013 and fiscal 2012, these same two customers accounted for 30% and
37% of our total revenues, respectively. We believe that a significant amount of
our revenues will continue to be derived from a limited number of customers.
International sales accounted for 43% and 37% of total revenues in the third
quarter of fiscal 2013 and fiscal 2012, respectively. For the nine months ended
October 31, 2012 and 2011, international sales accounted for 40% and 38%,
respectively. We believe that international product and service revenues will
continue to be a significant portion of our business in the future.
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Gross Profit and Margin. Cost of product revenues consists primarily of the cost
of purchased material components and subassemblies, labor and overhead relating
to the final assembly and testing of complete systems and related expenses, and
labor and overhead costs related to software development contracts. Gross profit
margin decreased 6.9% and 6.5%, respectively, for the three and nine month
periods ending October 31, 2012, as compared to the same periods of the prior
year, primarily due to the following:
· Gross product profit margin decreased by 12 percentage points to 60% for the
three months ended October 31, 2012 due primarily to the product mix of higher
revenues from reselling certain third party back office products, which carry
lower margins, and the impact from the large home gateway licensing transaction
during the third quarter of last fiscal year, which positively impacted product
margins during the prior year;
· Gross product profit margin decreased 11 percentage points for the nine months
ended October 31, 2012, from 69% in the same period of the prior fiscal year.
The 11 percentage point decrease was primarily due to a $1.8 million inventory
write-down during the second quarter of fiscal 2013, the mix of higher revenues
from reselling certain third-party back office products, a decrease in
advertising revenues which typically carry higher margins and a favorable
impact to product margins last fiscal year from the large home gateway
licensing transaction;
· Service margins increased one percentage point to 43% for the three months
ended October 31, 2012, as compared to same period last year, primarily due to
lower professional service headcount costs as we continue to review our cost
structure; and
· Service margins decreased one percentage point from 46% for the nine months
ended October 31, 2012, as compared to the same period of last year, primarily
due to higher absorption of research and development to cost of sales, a result
of higher home gateway service revenues which require greater customization
work. This was partially offset by lower professional services costs.
Inventory Write-down. In the nine months ended October 31, 2012, we incurred a
$1.8 million charge for inventory write-downs due to lower foreseeable demand
for some of our legacy product lines, in particular, hardware components related
to certain discontinued VOD server product lines, as we focus on selling the new
products being developed. We will continue to review our inventory levels and
may record additional inventory write-downs in future periods.
Operating Expenses
Research and Development
The following table provides information regarding the change in research and
development expenses during the periods presented:
Three Months Ended Increase/ Increase/ Nine Months Ended Increase/ Increase/
October 31, (Decrease) (Decrease) October 31, (Decrease) (Decrease)
2012 2011 $ Amount % Change 2012 2011 $ Amount % Change
(amounts in thousands, except for percentage data)
Research and development expenses $ 9,423 $ 10,518 $ (1,095 ) (10.4 )% $ 29,042 $ 30,436 $ (1,394 ) (4.6 )%
% of total revenue
24.0. % 24.5. % 25.8. % 25.1. %
Research and development expenses consist primarily of employee costs, which
include salaries, benefits and related payroll taxes, depreciation of
development and test equipment and an allocation of related facility expenses.
During the three and nine months ended October 31, 2012, our total research and
development expenses decreased by $1.1 million and $1.4 million, respectively,
as compared to the same periods of fiscal 2012 as we had lower costs associated
with a decrease in headcount, primarily in the VOD server product lines, and a
higher absorption of research and development to cost of sales due to higher
home gateway service revenues which require customization work which resulted in
a decrease in research and development expenses of $2.0 million for the three
months ended and $4.1 million for the nine months ended October 31, 2012. These
decreases were partially offset by an increase in outside contract labor costs
as we bring new products to market in the fourth quarter of fiscal 2013. We will
continue to focus our investment in research and development on our next
generation product offerings.
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Selling and Marketing
The following table provides information regarding the change in selling and
marketing expenses during the periods presented:
Three Months Ended Increase/ Increase/ NIne Months Ended Increase/ Increase/
October 31, (Decrease) (Decrease) October 31, (Decrease) (Decrease)
2012 2011 $ Amount % Change 2012 2011 $ Amount % Change
(amountsin thousands, except for percentage data)
Selling and marketing expenses $ 3,905 $ 5,112 $ (1,207 )
(23.6 )% $ 11,987 $ 15,802 $ (3,815 ) (24.1 )%
% of total revenue 9.9. % 11.9. % 10.6. % 13.0. %
Selling and marketing expenses consist primarily of payroll costs, which include
salaries and related payroll taxes, benefits and commissions, travel expenses
and certain promotional expenses. Selling and marketing expenses decreased $1.2
million, or 23.6%, in the third quarter of fiscal 2013 and $3.8 million, or
24.1%, during the first nine months of fiscal 2013 when compared to the same
periods of fiscal 2012. The decreases were primarily due to a reduction in
headcounts during the periods which resulted in corresponding reductions in
commissions and travel expenses.
General and Administrative
The following table provides information regarding the change in general and
administrative expenses during the periods presented:
Three Months Ended Increase/ Increase/ Nine Months Ended Increase/ Increase/
October 31, (Decrease) (Decrease) October 31, (Decrease) (Decrease)
2012 2011 $ Amount % Change 2012 2011 $ Amount % Change
(amounts inthousands, except for percentage data)
General and administrative
expenses $ 3,728 $ 4,111 $ (383 ) (9.3 )% $ 12,126 $ 12,247 $ (121 ) (1.0 )%
% of total revenue 9.5. % 9.6. % 10.8. % 10.1. %
General and administrative expenses consist primarily of employee costs, which
include salaries and related payroll taxes and benefit-related costs, legal and
accounting services and an allocation of related facilities expenses. General
and administrative expenses decreased $0.4 million, or 9.3%, during the third
quarter of fiscal 2013 and $0.1 million, or 1.0%, during the first nine months
ended October 31, 2012, as compared to the same periods of fiscal 2012. These
decreases were due to lower finance headcount related costs and lower corporate
legal fees.
Amortization of Intangible Assets
The following table provides information regarding the change in amortization of
intangible assets expenses during the periods presented:
Three Months Ended Increase/ Increase/ Nine Months Ended Increase/ Increase/
October 31, (Decrease) (Decrease) October 31, (Decrease) (Decrease)
2012 2011 $ Amount % Change 2012 2011 $ Amount % Change
(amounts in thousands, except for percentage data)
Amortization of intangible assets $ 1,489 $ 1,717 $ (228 ) (13.3 )% $ 4,439 $ 4,749 $ (310 ) (6.5 )%
% of total revenue 3.8. % 4.0. % 3.9. % 3.9. %
Amortization expense is primarily related to the costs of acquired intangible
assets. Amortization is also based on the future economic value of the related
intangible assets which is generally higher in the earlier years of the assets'
lives. During the third quarter of fiscal 2013 and the first nine months of
fiscal 2013, we incurred amortization expenses of $0.5 million and $1.5 million,
respectively, which were charged to cost of sales. This is compared to $0.8
million and $1.9 million for the same periods of fiscal 2012. Additionally, for
the third quarter and first nine months of fiscal 2013 we recorded amortization
expense of $1.0 million and $2.9 million in operating expenses, compared to $0.9
million and $2.9 million, respectively, for the same periods of fiscal 2012Stock-based Compensation Expense
The following table provides information regarding the change in stock-based
compensation expense during the periods presented:
Three Months Ended Increase/ Increase/ Nine Months Ended Increase/ Increase/
October 31, (Decrease) (Decrease) October 31, (Decrease) (Decrease)
2012 2011 $ Amount % Change 2012 2011 $ Amount % Change
(amounts in thousands, except for percentage data)
Stock-based compensation expense $ 728 $ 1,018 $ (290 ) (28.5 )% $ 3,056 $ 3,134 $ (78 ) (2.5 )%
% of total revenue 1.9. % 2.4. % 2.7. % 2.6. %
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Stock-based compensation expense is related to the issuance of stock grants to
our employees, executives and Board of Directors. Stock-based compensation
expense decreased $0.3 million, or 28.5%, during the three months ended and $0.1
million for the nine months ended October 31, 2012, as compared to the same
periods of fiscal 2012. These decreases were primarily due to a reduction in
overall executive headcount in fiscal 2013 and the fourth quarter of fiscal
2012, partially offset by an increase in expenses related to the
performance-based stock compensation package granted to our new Chief Executive
Officer, who was appointed to his permanent position on May 1, 2012.
Earn-outs and Change in Fair Value of Earn-outs
The following table provides information regarding the change in earn-outs and
change in fair value of earn-out expenses during the periods presented:
Three Months Ended Increase/ Increase/ Nine Months Ended Increase/ Increase/
October 31, (Decrease) (Decrease) October 31, (Decrease) (Decrease)
2012 2011 $ Amount % Change 2012 2011 $ Amount % Change
(amounts inthousands, except for percentage data)
Earn-outs and change in
fair value of earn-outs $ 64 $ 1,412 $ (1,348 ) (95.5 )% $ 1,667 $ 1,517 $ 150 9.9. %
% of total revenue 0.2. % 3.3. % 1.5. % 1.2. %
Earn-out costs include changes in the fair value of acquisition-related
contingent consideration, and changes in contingent liabilities related to
estimated earn-out payments. During the second quarter of fiscal 2013, we
revised our estimate of potential earn-out payments to the former shareholders
of VividLogic and recorded a liability of $1.5 million in other accrued expenses
on our consolidated balance sheet, to reflect estimated future financial
performance compared to the respective earn-out criteria. For the three and nine
month periods ended October 31, 2012, we have made cash earn-out payments of
$3.1 million and $7.3 million, respectively.
Professional Fees- Acquisitions, Divestitures, Litigation, and Strategic
Alternatives
The following table provides information regarding the change in professional
fees expenses associated with acquisitions, divestitures, litigation and
strategic alternatives during the periods presented:
Three Months Ended Increase/ Increase/ Nine Months Ended Increase/ Increase/
October 31, (Decrease) (Decrease) October 31, (Decrease) (Decrease)
2012 2011 $ Amount % Change 2012 2011 $ Amount % Change
(amountsin thousands, except for percentage data)
Professional fees:
acquisitions, divestitures,
litigation and strategic
alternatives $ 26 $ 597 $ (571 ) (95.6 )% $ 1,445 $ 1,873 $ (428 ) (22.9 )%
% of total revenue 0.1. % 1.4. % 1.3. % 1.5. %
Professional fees in fiscal 2013 are primarily related to fees paid to outside
counsel for the divestiture of our Broadcast Servers and Storage business and
our Media Services business. It also consists of fees to defend our patent
litigation with ARRIS. During the third quarter of fiscal 2013, we incurred
minimal charges related to our divestitures. The $0.6 million decrease in
professional fees for the three months ended October 31, 2012, as compared to
the same period last year was a result of a decrease in charges related to our
review of strategic alternatives and patent litigation fees relating to the
ARRIS litigation.
For the nine months ended October 31, 2012, professional fees decreased $0.4
million, as compared to the same period last year as we incurred significant
costs associated with our review of strategic alternatives and the ARRIS patent
litigation, which was partially offset by professional fees incurred in fiscal
2013 relating to our divestitures during the first quarter of fiscal 2013 and
the acquisition of Flashlight during the second quarter of fiscal 2013.
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Severance and Other Restructuring Expenses
The following table provides information regarding the change in severance and
other restructuring expenses during the periods presented:
Three Months Ended Increase/ Increase/ Nine Months Ended Increase/ Increase/
October 31, (Decrease) (Decrease) October 31, (Decrease) (Decrease)
2012 2011 $ Amount % Change 2012 2011 $ Amount % Change
(amountsin thousands, except for percentage data)
Severance and other
restructuring expenses $ 1,476 $ (6 ) $ 1,482 >(100 )% $ 2,918 $ 221 $ 2,697 >100%
% of total revenue 3.8. % (0.0 )% 2.6. % 0.2. %
Severance and other restructuring expenses increased $1.5 million and $2.7
million for the three and nine months ended October 31, 2012, respectively, as
compared to the same periods of fiscal 2012. During the third quarter of fiscal
2013, we incurred severance charges of $1.3 million related to the departure of
nine employees, including two senior executives, as we continued to take actions
to lower our cost structure and improve our financial performance. We also
incurred a $0.2 million charge to reduce the value of our building in New
Hampshire.
For the nine months ended October 31, 2012, we incurred $1.7 million of
severance charges relating to the reduction of 30 employees this fiscal year. In
addition, we also incurred a $0.8 million charge to write off leasehold
improvements for the reduction of space and certain other fixed assets in our
leased facility in the Philippines, significantly reducing the size of this
facility. We also incurred the $0.2 million charge to reduce the value of our
building in New Hampshire and one-time charges totaling $0.2 million for a
sign-on bonus, relocation expenses and recruitment fees that relate to the
hiring and appointment of a permanent Chief Executive Officer on May 1, 2012.
For the three and nine month period ended October 31, 2012, we have made cash
severance payments of $0.8 million and $2.9 million, respectively.
Income Tax Benefit
Three Months Ended Increase/ Increase/ Nine Months Ended Increase/ Increase/
October 31, (Decrease) (Decrease) October 31, (Decrease) (Decrease)
2012 2011 $ Amount % Change 2012 2011 $ Amount % Change
(amounts inthousands, except for percentage data)
Income tax benefit $ (882 ) $ (368 ) $ (514 ) 139.7. % $ (766 ) $ (583 ) $ (183 ) 31.4. %
Effective tax rate 156.4. % (60.2 )% 9.4. % (66.9 )%
For the three and nine months ended October 31, 2012, we recorded income tax
benefits of $0.9 million and $0.8 million, respectively on losses before tax of
$0.6 million for the three month period and $8.2 million for the nine month
period. During the third quarter of fiscal 2013, we recognized $0.5 million of
tax benefits resulting from the expiration of the statute of limitations for
uncertain tax positions. The statute of limitations varies by the various
jurisdictions in which we operate. In any given year, statute of limitations in
certain jurisdictions may lapse without examination and any uncertain tax
position taken in these years will result in reduction of the liability for
unrecognized tax benefits for that year. Our tax provision is primarily due to
income tax expense in certain states and profitable foreign jurisdictions. Our
effective tax rate of (3.2%) was based on the full fiscal year estimates and
projected profitability in the fourth quarter of fiscal 2013. In addition, our
benefit is affected by the geographic jurisdiction in which the worldwide income
or losses have incurred, resulting in the difference between the federal
statutory rate of 35% and the forecasted effective tax rate.
In addition, we incurred a $9.6 million U.S. capital tax loss as a result of the
sale of our Media Services segment. We have determined it's more likely than not
that we will not benefit from this capital loss carryforward. Therefore, we have
provided a 100% valuation allowance against the capital loss.
Our effective tax rate in fiscal 2013 and in future periods may fluctuate on a
quarterly basis based as a result of changes in the valuation of our deferred
tax assets, changes in actual results versus our estimates, or changes in tax
laws, regulations, accounting principles, or interpretations thereof. We
regularly review our tax positions in each significant taxing jurisdiction in
the process of evaluating our unrecognized tax benefits. We make adjustments to
our unrecognized tax benefits when: i) facts and circumstance regarding a tax
position change, causing a change in management's judgment regarding that tax
position; ii) a tax position is effectively settled with a tax authority; and/or
iii) the statute of limitations expires regarding a tax position.
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Non-GAAP Measures. Beginning with the first quarter of fiscal 2013, we changed
our reported non-GAAP measure of financial performance to both non-GAAP income
from operations and adjusted EBITDA. We define non-GAAP income from operations
as U.S. GAAP operating income or loss plus stock-based compensation expenses,
amortization of intangible assets, inventory write-downs, earn-outs and change
in fair value of earn-outs, professional fees associated with acquisitions,
divestitures, litigation and strategic alternatives and severance and other
restructuring costs. We define adjusted EBITDA as U.S. GAAP operating income or
loss before depreciation expense, amortization of intangible assets, stock-based
compensation expense, inventory write-downs, earn-outs and change in fair value
of earn-outs, professional fees associated with acquisitions, divestitures,
litigation and strategic alternatives, and severance and other restructuring
costs. In periodic communications, we have discussed non-GAAP income from
operations and also believe that adjusted EBITDA are both important measures
that are not calculated according to U.S. GAAP. We use non-GAAP income from
operations and adjusted EBITDA in internal forecasts and models when
establishing internal operating budgets, supplementing the financial results and
forecasts reported to our Board of Directors, determining a component of bonus
compensation for executive officers and other key employees based on operating
performance and evaluating short-term and long-term operating trends in our
operations. We believe that non-GAAP income from operations and adjusted EBITDA
financial measures assist in providing an enhanced understanding of our
underlying operational measures to manage the business, to evaluate performance
compared to prior periods and the marketplace, and to establish operational
goals. We believe that these non-GAAP financial adjustments are useful to
investors because they allow investors to evaluate the effectiveness of the
methodology and information used by management in our financial and operational
decision-making.
Non-GAAP income from operations and adjusted EBITDA are non-GAAP financial
measures and should not be considered in isolation or as a substitute for
financial information provided in accordance with U.S. GAAP. These non-GAAP
financial measures may not be computed in the same manner as similarly titled
measures used by other companies. We expect to continue to incur expenses
similar to the non-GAAP income from operations and adjusted EBITDA financial
adjustments described above, and investors should not infer from our
presentation of this non-GAAP financial measure that these costs are unusual,
infrequent or non-recurring.
26
The following tables include the reconciliations of our U.S. GAAP income or loss
from operations, the most directly comparable U.S. GAAP financial measure, to
our non-GAAP income from operations and the reconciliation of our U.S. GAAP
income or loss from operations to our adjusted EBITDA for the three and nine
months ended October 31, 2012 and 2011 (amounts in thousands, except per share
and percentage data):
Three Months Ended Three Months Ended
October 31, 2012 October 31, 2011
GAAP GAAP
As Reported Adjustments Non-GAAP As Reported Adjustments Non-GAAP
Revenues:
Products $ 15,213 $ - $ 15,213 $ 21,267 $ - $ 21,267
Services 24,036 - 24,036 21,646 - 21,646
Total revenues 39,249 - 39,249 42,913 - 42,913
Cost of revenues:
Products 5,504 - 5,504 5,184 - 5,184
Services 13,807 - 13,807 12,512 - 12,512
Amortization of intangible
assets 520 (520 ) - 769 (769 ) -
Stock-based compensation (85 ) 85 - 140 (140 ) -
Inventory write-down - - - - - -
Total cost of revenues 19,746 (435 ) 19,311 18,605 (909 ) 17,696
Gross profit 19,503 435 19,938 24,308 909 25,217
Gross profit percentage 49.7 % 1.1 % 50.8 % 56.6 % 2.1 % 58.8 %
Operating expenses:
Research and development 9,423 - 9,423 10,518 - 10,518
Selling and marketing 3,905 - 3,905 5,112 - 5,112
General and administrative 3,728 - 3,728 4,111 - 4,111
Amortization of intangible
assets 969 (969 ) - 948 (948 ) -
Stock-based compensation
expense 813 (813 ) - 878 (878 ) -
Earn-outs and change in fair
value of earn-outs 64 (64 ) - 1,412 (1,412 ) -
Professional fees:
acquisitions, divestitures,
litigation and strategic
alternatives 26 (26 ) - 597 (597 ) -
Severance and other
restructuring costs 1,476 (1,476 ) - (6 ) 6 -
Total operating expenses 20,404 (3,348 ) 17,056 23,570 (3,829 ) 19,741
(Loss) income from operations $ (901 ) $ 3,783 $ 2,882 $ 738 $ 4,738 $ 5,476
(Loss) income from operations
percentage (2.3 )% 9.6 % 7.3 % 1.7 % 11.0 % 12.8 %
Basic shares outstanding 32,474 32,132
Basic non-GAAP earnings per
share $ 0.09 $ 0.17
Adjusted EBITDA:
(Loss) income from operations $ (901 ) $ 738
Depreciation expense 1,034 1,274
Amortization of intangible
assets 1,489 1,717
Stock-based compensation
expense 728 1,018
Earn-outs and changes in fair
value 64 1,412
Professional fees:
acquisitions, divestitures,
etc. 26 597
Inventory write-down - -
Severance and other
restructuring 1,476 (6 )
Adjusted EBITDA $ 3,916 $ 6,750
Adjusted EBITDA % 10.0 % 15.7 %
27
Nine Months Ended Nine Months Ended
October 31, 2012 October 31, 2011
GAAP GAAP
As Reported Adjustments Non-GAAP As Reported Adjustments Non-GAAP
Revenues:
Products $ 40,681 $ - $ 40,681 $ 53,669 $ - $ 53,669
Services 71,932 - 71,932 67,799 - 67,799
Total revenues 112,613 - 112,613 121,468 - 121,468
Cost of revenues:
Products 13,771 - 13,771 14,691 - 14,691
Services 39,287 - 39,287 36,054 - 36,054
Amortization of intangible
assets 1,548 (1,548 ) - 1,886 (1,886 ) -
Stock-based compensation 109 (109 ) - 380 (380 ) -
Inventory write-down 1,752 (1,752 ) - - - -
Total cost of revenues 56,467 (3,409 ) 53,058 53,011 (2,266 ) 50,745
Gross profit 56,146 3,409 59,555 68,457 2,266 70,723
Gross profit percentage 49.9 % 3.0 % 52.9 % 56.4 % 1.9 % 58.2 %
Operating expenses:
Research and development 29,042 - 29,042 30,436 - 30,436
Selling and marketing 11,987 - 11,987 15,802 - 15,802
General and administrative 12,126 - 12,126 12,247 - 12,247
Amortization of intangible
assets 2,891 (2,891 ) - 2,863 (2,863 ) -
Stock-based compensation
expense 2,947 (2,947 ) - 2,754 (2,754 ) -
Earn-outs and change in fair
value of earn-outs 1,667 (1,667 ) - 1,517 (1,517 ) -
Professional fees:
acquisitions, divestitures,
litigation and strategic
alternatives 1,445 (1,445 ) - 1,873 (1,873 ) -
Severance and other
restructuring costs 2,918 (2,918 ) - 221 (221 ) -
Total operating expenses 65,023 (11,868 ) 53,155 67,713 (9,228 ) 58,485
(Loss) income from operations $ (8,877 ) $ 15,277 $ 6,400 $ 744 $ 11,494 $ 12,238
(Loss) income from operations
percentage (7.9 )% 13.6 % 5.7 % 0.6 % 9.5 % 10.1 %
Basic shares outstanding 32,554 32,055
Basic non-GAAP earnings per
share $ 0.20 $ 0.38
Adjusted EBITDA:
(Loss) income from operations $ (8,877 ) $ 744
Depreciation expense 3,341 4,157
Amortization of intangible
assets 4,439 4,749
Stock-based compensation
expense 3,056 3,134
Earn-outs and changes in fair
value 1,667 1,517
Professional fees:
acquisitions, divestitures,
etc. 1,445 1,873
Inventory write-down 1,752 -
Severance and other
restructuring 2,918 221
Adjusted EBITDA $ 9,741 $ 16,395
Adjusted EBITDA % 8.6 % 13.5 %
In managing and reviewing our business performance, we exclude a number of items
required by U.S. GAAP. Management believes that excluding these items is useful
in understanding the trends and managing our operations. We provide these
supplemental non-GAAP measures in order to assist the investment community to
see SeaChange through the "eyes of management," and therefore enhance the
understanding of SeaChange's operating performance. Non-GAAP financial measures
should be viewed in addition to, not as an alternative to, our reported results
prepared in accordance with U.S. GAAP. Our non-GAAP financial measures reflect
adjustments based on the following items:
Amortization of Intangible Assets. We incur amortization expense of intangible
assets related to various acquisitions that have been made in recent years.
These intangible assets are valued at the time of acquisition, are then
amortized over a period of several years after the acquisition and generally
cannot be changed or influenced by management after the acquisition. We believe
that exclusion of these expenses allows comparisons of operating results that
are consistent over time for the Company's newly-acquired and long-held
businesses.
Stock-Based Compensation Expense. We incur expenses related to stock-based
compensation included in our U.S. GAAP presentation of cost of revenues,
selling, general and administrative expense and research and development
expense. Although stock-based compensation is an expense we incur and is viewed
as a form of compensation, the expense varies in amount from period to period,
and is affected by market forces that are difficult to predict and are not
within the control of management, such as the market price and volatility of our
shares, risk-free interest rates and the expected term and forfeiture ratesof
the awards.
28
Inventory Write-down. We incur inventory write-downs of our legacy product lines
as we end the life of certain product lines to focus on selling the new products
being developed.
Earn-Outs and Change in Fair Value of Earn-Outs. Earn-outs and the change in the
fair value of the earn-outs are considered by management to be non-recurring
expenses to the former shareholders of the businesses we acquire. We also incur
expense due to changes in fair value related to contingent consideration that we
believe would otherwise impair comparability among periods.
Professional Fees: Acquisitions, Divestitures, Litigation, and Strategic
Alternatives. We have excluded the effect of legal professional costs associated
with our acquisitions, divestitures, litigation and strategic alternatives
because the amount and timing of the expenses are largely non-recurring.
Severance and Other Restructuring. We incurred charges due to the restructuring
of our business, including severance charges and facility reductions resulting
from our restructuring and streamlining efforts and any changes due to revised
estimates, which we generally would not have otherwise incurred in the periods
presented as part of our continuing operations. We also incurred charges for the
hiring and appointment of the Chief Executive Officer.
Depreciation Expense. We incur depreciation expense related to capital assets
purchased to support the ongoing operations of the business. These assets are
recorded at cost and are depreciated using the straight-line method over the
useful life of the asset. Purchases of such assets may vary significantly from
period to period and without any correlation to underlying operating
performance. Management believes that exclusion of depreciation expense allows
comparisons of operating results that are consistent across past, present and
future periods.
Off-Balance Sheet Arrangements
We do not have any relationships with unconsolidated entities or financial
partnerships, such as entities often referred to as structured finance or
special purpose entities, which would have been established for the purpose of
facilitating off-balance sheet arrangements. As such, we are not exposed to any
financing, liquidity, market or credit risk that could arise if we had engaged
in such relationships.
Liquidity and Capital Resources
The following table includes key line items of our consolidated statements of
cash flows:
Nine Months Ended Increase/
October 31, (Decrease)
2012 2011 $ Amount
(amounts in thousands)
Total cash (used in) provided by operating
activities $ (2,676 ) $ 6,941 $ (9,617 )
Total cash provided by (used in) investing
activities 12,257 (11,383 ) 23,640
Total cash (used in) provided by financing
activities (4,938 ) 1,789 (6,727 )
Effect of exchange rate changes on cash (170 ) 166 (336 )
Net increase (decrease) in cash $ 4,473 $ (2,487) $ 6,960
Historically, we have financed our operations and capital expenditures primarily
with cash on-hand. Cash, restricted cash, and marketable securities increased
from $93.8 million at January 31, 2012 to $100.0 million at October 31, 2012.
The increase in our cash and marketable securities of $6.2 million was primarily
due to the proceeds from the sale of the Broadcast Servers and Storage and Media
Service businesses, which resulted in us receiving total net proceeds of $24.1
million, and non-cash expenses of $13.3 million. These proceeds were primarily
offset by a use of cash from our net losses of $7.3 million, changes in
operating assets and liabilities of $8.5 million, capital expenditures of $2.4
million, earn-out payments of $7.9 million and the purchase of $6.1 million of
stock under a share repurchase program.
29
Operating Activities
Below are key line items affecting cash from operating activities:
Nine Months Ended Increase/
October 31, (Decrease)
2012 2011 $ Amount
(amounts in thousands)
Net (loss) income from continuing operations $ (7,314 ) $ 1,670
$ (8,984 )
Adjustments to reconcile net (loss) income
to cash (used in) provided by operating
activities 12,414 15,599 (3,185 )
Net income including adjustments 5,100 17,269 (12,169 )
Decrease in accounts receivable 1,089 5,955 (4,866 )
Increase in prepaid expenses and other
current assets (2,484 ) (2,252 ) (232 )
Increase in accrued expenses 2,262 935 1,327
Decrease in deferred revenues (6,389 ) (7,752 ) 1,363
All other - net (2,971 ) (9,354 ) 6,383
Net cash (used in) provided by operarting
activities from continuing operations (3,393 ) 4,801 (8,194 )
Net cash provided by operating activities
from discontinued operations 717 2,140 (1,423 )
$ (2,676 ) $ 6,941 $ (9,617 )
We used net cash in operating activities from continuing operations of $3.4
million for the nine months ended October 31, 2012. Our net loss from continuing
operations adjusted for non-cash expenses provided cash of $6.4 million which
was primarily offset by a $6.4 million decrease in deferred revenues resulting
from lower annual renewals of post warranty contracts and $2.9 million usedfor
severance payments.
Investing Activities
Cash flows from investing activities are as follows:
Nine Months Ended Increase/
October 31, (Decrease)
2012 2011 $ Amount
(amounts in thousands)
Purchases of property and equipment $ (2,423 ) $ (931 ) $ (1,492 )
Purchases of marketable securities (12,110 ) (14,909 ) 2,799
Proceeds from sale and maturity of
marketable securities 11,205 9,492 1,713
Additional proceeds from sale of equity
investment 814 - 814
Acquisition of businesses and payment of
contingent consideration, net of cash
acquired (7,866 ) (3,653 ) (4,213 )
(Increase) decrease in restricted cash (923 ) 136 (1,059 )
Net cash used in investing activities from
continuing operations (11,303 ) (9,865 ) (1,438 )
Net cash provided by (used in) investing
activities from discontinued operations 23,560 (1,518) 25,078
$ 12,257 $ (11,383 ) $ 23,640
We used $11.3 million of cash in investing activities from continuing operations
primarily related to the purchase of capital assets of $2.4 million, $7.9
million of earn-out payments to the former shareholders of eventIS and
VividLogic, $0.3 million for the acquisition of Flashlight assets and $0.9
million of net marketable security purchases. This cash used in investing
activities was offset by $0.8 million in additional proceeds that we received in
the second quarter of fiscal 2013 from the sale of our equity investment in
InSite One, Inc. in fiscal 2012.
30
Financing Activities
Cash flows from financing activities are as follows:
Nine Months Ended Increase/
October 31, (Decrease)
2012 2011 $ Amount
(amounts in thousands)
Repurchases of our common stock (6,078 ) - (6,078 )
Proceeds from issuance of common stock relating
to stock option exercises 1,140 1,789 (649 )
Net cash (used in) provided by investing
activities from continuing operations (4,938 ) 1,789 (6,727 )
Net cash provided by investing activities from
discontinued operations - - -
$ (4,938 ) $ 1,789 $ (6,727 )
We used $4.9 million in cash from our financing activities primarily due to
using $6.1 million in cash for the purchase of stock under a stock repurchase
plan during the third quarter of fiscal 2013. This amount was partially offset
by the issuance of common stock for the exercise of employee stock optionsof
$1.1 million.
Effect of exchange rate changes decreased cash and cash equivalents by $0.2
million for the nine months ended October 31, 2012, due to the translation of
European subsidiaries cash balances, which use the Euro as their functional
currency, to U.S. dollars.
On September 1, 2009, we completed the acquisition of eventIS from a holding
company in which Erwin van Dommelen, who was President of SeaChange Software
from March 2010 to September 2012, has a 32% interest in the holding company.
Under the terms of the definitive agreement, SeaChange paid $36.6 million upon
the closing of the transaction on September 1, 2009. In addition, SeaChange was
obligated to pay €1.2 million (approximately $1.5 million) in cash to the former
eventIS shareholders on each of the first three anniversary dates following the
acquisition. SeaChange was also obligated on each of the aforementioned
anniversary dates to issue shares of restricted stock of SeaChange equating to
€800,000 (approximately $1.0 million) annually to the former eventIS
shareholders. The purchase price also included a performance-based component
principally related to the achievement of certain annual revenue targets for
eventIS and SeaChange products and services. The revenue performance metrics
will cover the three year period ending January 31, 2013 with payment upon
achievement of these metrics occurring annually. We have made cash payments to
date to the holding company of $47.0 million and issued approximately 304,000
restricted common shares. On September 1, 2012, we amended the eventIS share
purchase agreement with the holding company and as a result, we will accelerate
unvested restricted shares of approximately 102,000 shares on September 1, 2013.
Obligated cash payments of €1.7 million (approximately $2.2 million) were also
paid in the third quarter of fiscal 2013. The amendment did not change the total
amount of payments payable under the purchase agreement. We estimated an
additional $0.7 million may become due under the earn-out provisions of the
eventIS share purchase agreement, which will be paid to the holding company if
certain performance goals are met.
Under the share purchase agreement with the former shareholders of VividLogic,
we are obligated to make a fixed payment of $1.0 million on February 1, 2013.
Additional earn-out payments may be earned for the year ending January 31, 2013,
and if certain performance goals are met. We estimated that the earn-out
payments to be made by the end of fiscal 2013 based on qualifying product
revenue will be $1.5 million which we have recorded as a liability in our
consolidated balance sheet as of October 31, 2012.
Our $20.0 million revolving line of credit with RBS Citizens expired on October
31, 2012. On November 28, 2012, we entered into a letter agreement with JP
Morgan for a demand discretionary line of credit and a Demand Promissory Note in
the aggregate amount of $20.0 million (the "Line of Credit"). Borrowings under
the Line of Credit will be used to finance working capital needs and for general
corporate purposes. The Line of Credit expires on November 27, 2013. We
currently do not have any borrowings under this line.
We are occasionally required to post customer performance bonds, issued by a
financial institution, to secure certain sales contracts. Customer performance
bonds generally authorize the financial institution to make a payment to the
beneficiary upon the satisfaction of a certain event or the failure to satisfy
an obligation. The customer performance bonds are generally posted for one-year
terms and are usually automatically renewed upon maturity until such time as we
have satisfied the commitment secured by the customer performance bond. We are
obligated to reimburse the issuer only if the beneficiary collects on the
customer performance bonds. We currently have a customer performance bond
outstanding totaling $0.9 million which was previously secured under the RBS
Citizens line of credit. This performance bond will be transferred under the
recently signed demand line of credit with JP Morgan, but as an interim
procedure until the performance bond is transferred, we signed a Pledge and
Security Agreement with RBS Citizens which requires us to reimburse RBS Citizens
for all amounts paid under the customer performance bonds. As such, we
transferred $0.9 million to restricted cash on our consolidated balance sheet as
of October 31, 2012 to cover these outstanding customer performance bonds.
31
We believe that existing funds combined with available borrowings under the line
of credit and cash provided by future operating activities are adequate to
satisfy our working capital, potential acquisitions and capital expenditure
requirements and other contractual obligations for the foreseeable future,
including at least the next 12 months. However, if our expectations are
incorrect, we may need to raise additional funds to fund our operations, to take
advantage of unanticipated strategic opportunities or to strengthen our
financial position.
In addition, we actively review potential acquisitions that would complement our
existing product offerings, enhance our technical capabilities or expand our
marketing and sales presence. Any future transaction of this nature could
require potentially significant amounts of capital or could require us to issue
our stock and dilute existing stockholders. If adequate funds are not available,
or are not available on acceptable terms, we may not be able to take advantage
of market opportunities, to develop new products or to otherwise respond to
competitive pressures.
On March 28, 2012, our Board of Directors authorized the repurchase of up to
$25.0 million of our common stock, par value $0.01 per share, through a share
repurchase program. The repurchase program terminates on January 31, 2013. Under
the program, management is authorized to repurchase shares through Rule 10b5-1
plans, open market purchases, privately negotiated transactions, block purchases
or otherwise in accordance with applicable federal securities laws, including
Rule 10b-18 of the Securities Exchange Act of 1934. We executed a Rule 10b5-1
plan commencing in September 2012. This share repurchase program does not
obligate us to acquire any specific number of shares and may be suspended or
discontinued at any time. All repurchases are expected to be funded from our
current cash and investment balances. The timing and amount of the shares to be
repurchased will be based on market conditions and other factors, including
price, corporate and regulatory requirements, and alternative investment
opportunities. As of October 31, 2012, we have repurchased a total of 749,524
shares of our common stock at an average price of $8.11 per share and used a
total of $6.1 million of cash, including fees.
Effects of Inflation
Management believes that financial results have not been significantly impacted
by inflation and price changes in materials we use in manufacturing our
products.
Critical Accounting Policies and Significant Judgment and Estimates
Revenue Recognition
Our transactions frequently involve the sales of hardware, software, systems and
services in multiple element arrangements. Revenues from sales of hardware,
software and systems that do not require significant modification or
customization of the underlying software are recognized when title and risk of
loss has passed to the customer, there is evidence of an arrangement, fees are
fixed or determinable and collection of the related receivable is considered
probable. Customers are billed for installation, training, project management
and at least one year of product maintenance and technical support at the time
of the product sale. Revenue from these activities is deferred at the time of
the product sale and recognized ratably over the period in which these services
are performed. Revenue from ongoing product maintenance and technical support
agreements are recognized ratably over the period of the related agreements.
Revenue from software development contracts that include significant
modification or customization, including software product enhancements, is
recognized based on the percentage of completion contract accounting method
using labor efforts expended in relation to estimates of total labor efforts to
complete the contract. Accounting for contract amendments and customer change
orders are included in contract accounting when executed. Revenue from shipping
and handling costs and other out-of-pocket expenses reimbursed by customers are
included in revenues and cost of revenues. Our share of intercompany profits
associated with sales and services provided to affiliated companies are
eliminated in consolidation in proportion to our equity ownership.
Under the software revenue recognition rules, the fee is allocated to the
various elements based on VSOE of fair value. Under this method, the total
arrangement value is allocated first to undelivered elements, based on their
fair values, with the remainder being allocated to the delivered elements. Where
fair value of undelivered service elements has not been established, the total
arrangement value is recognized over the period during which the services are
performed. The amounts allocated to undelivered elements, which may include
project management, training, installation, maintenance and technical support
and certain hardware and software components, are based upon the price charged
when these elements are sold separately and unaccompanied by the other elements.
The amount allocated to installation, training and project management revenue is
based upon standard hourly billing rates and the estimated time required to
complete the service. These services are not essential to the functionality of
systems as these services do not alter the equipment's capabilities, are
available from other vendors and the systems are standard products. For multiple
element arrangements that include software development with significant
modification or customization and systems sales where VSOE of the fair value
does not exist for the undelivered elements of the arrangement (other than
maintenance and technical support), percentage of completion accounting is
applied for revenue recognition purposes to the entire arrangement with the
exception of maintenance and technical support.
32
Under the revenue recognition rules for tangible products as amended by ASU
2009-13, the fee from a multiple-deliverable arrangement is allocated to each of
the deliverables based upon their relative selling prices as determined by a
selling-price hierarchy. A deliverable in an arrangement qualifies as a separate
unit of accounting if the delivered item has value to the customer on a
stand-alone basis. A delivered item that does not qualify as a separate unit of
accounting is combined with the other undelivered items in the arrangement and
revenue is recognized for those combined deliverables as a single unit of
accounting. The selling price used for each deliverable is based upon VSOE if
available, TPE if VSOE is not available, and BESP if neither VSOE nor TPE are
available. TPE is the price of our or any competitor's largely interchangeable
products or services in stand-alone sales to similarly situated customers. BESP
is the price at which we would sell the deliverable if it were sold regularly on
a stand-alone basis, considering market conditions and entity-specific factors.
The selling prices used in the relative selling price allocation method for
certain of our services are based upon VSOE. The selling prices used in the
relative selling price allocation method for third-party products from other
vendors are based upon TPE. The selling prices used in the relative selling
price allocation method for our hardware products; software, subscriptions, and
customized services for which VSOE does not exist are based upon BESP. We do not
believe TPE exists for these products and services because they are
differentiated from competing products and services in terms of functionality
and performance and there are no competing products or services that are largely
interchangeable. We establish BESP with consideration for market conditions,
such as the impact of competition and geographic considerations, and
entity-specific factors, such as the cost of the product, discounts provided and
profit objectives. Management believes that BESP is reflective of reasonable
pricing of that deliverable as if priced on a stand-alone basis.
Goodwill
In connection with acquisitions of operating entities, we recognize the excess
of the purchase price over the fair value of the net assets acquired as
goodwill. Goodwill is not amortized, but is evaluated for impairment, at the
reporting unit level, annually in our third quarter beginning August 1. Goodwill
of a reporting unit may be tested for impairment on an interim basis, in
addition to the annual evaluation, if an event occurs or circumstances change
which would more likely than not reduce the fair value of a reporting unitbelow
its carrying amount.
During the third quarter of fiscal 2013, we performed our annual impairment test
of goodwill. FASB guidance released in September 2011 allows for a step to first
assess qualitative factors to determine whether it was more likely than not that
the fair value was less than our carrying value. We chose to skip this step and
calculated the fair value using the two-step goodwill impairment test. We first
calculated the fair value of the reporting unit using two generally accepted
approaches for valuing businesses. We then performed "Step 1" and compared the
calculated fair value to the carrying value, which was $42.9 million as of
August 1, 2012.
The process of evaluating goodwill for impairment requires several judgments and
assumptions to be made to determine the fair value of the reporting units,
including the method used to determine fair value, discount rates, expected
levels of cash flows, revenues and earnings, and the selection of comparable
companies used to develop market based assumptions. We may employ three
generally accepted approaches for valuing businesses: the market approach, the
income approach, and the asset-based (cost) approach to arrive at the fair
value. In calculating the fair value, we derived the standalone projected five
year cash flows for the Company. This process started with the projected cash
flows which were discounted. The choice of which approach and methods to use in
a particular situation depends on the facts and circumstances.
We determined that based on "Step 1" of our annual goodwill test, the fair value
of the Company's goodwill balance exceeded its carrying value. In aggregate,
there was excess fair value over the carrying value of the net assets ranging
from $50-$85 million. The ranges of fair value over and above the carrying value
calculated by the company as of August 1, 2012 ranged from 62% to 107%.
Key data points included in the calculation of market capitalization of $240.5
million were as follows:
· Shares outstanding as of August 1, 2012 were 32,628,768; and
· $7.37 closing price as of August 1, 2012.
33
Accordingly, since no impairment indicator existed as of August 1, 2012, our
annual impairment date, and the implied fair value of goodwill exceeded the
carrying value, we determined that goodwill was not at risk of failing "Step 1"
and was appropriately stated as of August 1, 2012.
To validate our conclusions and determine the reasonableness of our annual
impairment test, we performed the following:
· Reconciled our estimated enterprise value to market capitalization comparing
the calculated fair value to our market capitalization as of August 1, 2012,
our annual impairment test date. Our implied fair value decreased between $70.9
million and $79.8 million when comparing August 1, 2012 and August 1, 2011;
· Prepared a "reporting unit" fair value calculation using three different
approaches;
· Reviewed our historical operating performance for the current fiscal year;
· Performed a sensitivity analysis on key assumptions such as weighted-average
cost of capital and terminal growth rates; and
· Reviewed market participant assumptions.
We used two generally accepted approaches to value the Company. The Market
approach provides value indications through a comparison with guideline public
companies or guideline transactions. The valuation multiple is an expression of
what investors believe to be a reasonable valuation relative to a measure of
financial information such as revenues, earnings or cashflows. The Income
approach provides value indications through an analysis of its projected
earnings, discounted to present value. We employed a weighted-average cost of
capital rate. The estimated weighted-average cost of capital was based on the
risk-free interest rate and other factors such as equity risk premiums and the
ratio of total debt to equity capital. In performing the annual impairment
tests, we took steps to ensure appropriate and reasonable cash flow projections
and assumptions were used. The discount rate used to estimate future cash flows
was 14.5%.
Our projections for the next five years included increased revenue and operating
expenses, in line with the expected revenue growth over the next five years
based on current market and economic conditions and our historical knowledge.
Historical growth rates served as only one input to the projected future growth
used in the goodwill impairment analysis. These historical growth rates were
adjusted based on other inputs regarding anticipated customer contracts. The
forecasts have incorporated any changes to the revenue and operating expense
resulting from the third quarter of fiscal 2013. We estimated the operating
expenses based on a rate consistent with the current experience and estimated
revenue growth over the next five years. A failure to execute as forecasted over
the next five years could have an adverse effect on our annual impairment test.
Future adverse changes in market conditions or poor operating results of the
reporting unit could result in losses or an inability to recover the carrying
value of the investment in the reporting unit, thereby possibly requiring an
impairment charge in the future. We record an impairment charge when we believe
an investment has experienced a decline in value that is other-than-temporary.
In May 2012, as part of our strategy to transform the Company into a pure-play
software company, we completed the sale of the Broadcast Servers and Storage and
Media Services businesses. We currently operate under one reporting unit. As a
result of the sale of Media Services we incurred a non-cash goodwill impairment
charge of approximately $17 million that we recorded in the first quarter of
fiscal 2013. The goodwill table below shows the amount of goodwill relating to
continued operations as of October 31, 2012. Goodwill related to our Broadcast
Servers and Storage business of $0.6 million was excluded from our January 31,
2012 balance, as we signed a definitive asset sale agreement to sell our
Broadcast Server and Storage business in March 2012, before we filed our Form
10-K. No impairment was recorded as a result of the sale of the Broadcast
Servers and Storage business.
Media
Software Services Total
Balance at January 31, 2012 $ 44,414 $ 19,226 $ 63,640Goodwill related to discontinued operations 110 (19,226 ) (19,116 )
Cumulative translation adjustment
(395 ) - (395 )
Balance at October 31, 2012 $ 44,129 $ - $ 44,129
34
We also monitor economic, legal and other factors as a whole between annual
impairment tests to ensure that there are no indicators that make it more likely
than not that there has been a decline in our fair value below our carrying
value. Specifically, we monitor industry trends, our market capitalization,
recent and forecasted financial performance and the timing and nature of any
restructuring activities. We do not believe that there are any indicators of
impairment as of October 31, 2012. If these estimates or the related assumptions
change, we may be required to record non-cash impairment charges for these
assets in the future.
Recent Accounting Standard Updates
Impact of Recently Adopted Accounting Guidance
Goodwill Impairment Test
In September 2011, the FASB issued ASU 2011-08, "Intangibles - Goodwill and
Other: Testing Goodwill for Impairment," which provided additional guidance on
the annual and interim goodwill impairment testing. The guidance became
effective for the Company at the beginning of fiscal 2013. This guidance
provides entities with an option to first assess qualitative factors to
determine whether it is more likely than not that the fair value of a reporting
unit is less than its carrying amount. If it is determined, on the basis of
qualitative factors, that the fair value of the reporting unit is more likely
than not less than the carrying amount, the two-step goodwill impairment test
will be required. The adoption of this update had no impact on the Company's
consolidated financial statements. See Note 6, "Goodwill and Intangible Assets",
for further information on the Company's annual impairment tests.
Fair Value Measurements
In May 2011, the FASB issued ASU 2011-04, "Fair Value Measurement - Amendments
to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S.
GAAP and IFRS," which amended previous guidance clarifying how to measure and
disclose fair value. The guidance became effective for us at the beginning of
fiscal 2013. The update amends the application of the "highest and best use"
concept to be used only in the measurement of the fair value of nonfinancial
assets, clarifies that the measurement of the fair value of equity-classified
financial instruments should be performed from the perspective of a market
participant who holds the instrument as an asset, clarifies that an entity that
manages a group of financial assets and liabilities on the basis of its net risk
exposure to those risks can measure those financial instruments on the basis of
its net exposure to those risks, and clarifies when premiums and discounts
should be taken into account when measuring fair value. This guidance results in
a consistent definition of fair value and common requirements for the
measurement of and disclosure about fair value between International Financial
Reporting Standards ("IFRS") and U.S. GAAP. The guidance also changes some fair
value measurement principles and enhances disclosure requirements related to
activities in Level 3 of the fair value hierarchy. Besides a change in
disclosure requirements, the adoption of this update had no impact on our
consolidated financial statements.
Recent Accounting Guidance Not Yet Effective
Indefinite-Lived Intangible Assets
In July 2012, the FASB issued ASU 2012-02, "Intangibles - Goodwill and Other:
Testing Indefinite-Lived Intangible Assets for Impairment," which amends
previous guidance on the annual and interim testing of indefinite-lived
intangible assets for impairment. The guidance becomes effective at the
beginning of our 2014 fiscal year, although early adoption is permitted. The
update provides entities with the option of first assessing qualitative factors
to determine whether it is more than likely than not that the fair value of an
indefinite-lived intangible asset is less than its carrying amount. If it is
determined, on the basis of qualitative factors, that the fair value of the
indefinite-lived intangible asset is more likely than not less than the carrying
amount, a quantitative impairment test would still be required. We perform
annual impairment tests in the third quarter of each fiscal year. The adoption
of this update is not expected to have a significant impact on our consolidated
financial statements.
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