Monica Gould - IR Ed Terino - CEO Peter Faubert - CFO

Greg Mesniaeff - Drexel Hamilton Steven Frankel - Dougherty & Company John Zaro - Bourgeon Capital Matthew Galinko - Sidoti

Greetings, and welcome to the SeaChange International Fiscal 2017 Second Quarter Financial Results Conference Call. [Operator Instructions] I would now like to turn the conference over to your host, Monica Gould, Investor Relations for SeaChange. Thank you. You may now begin.

Thank you, Shea. Good afternoon, everyone, and thank you for joining us. SeaChange released results for the second quarter of fiscal 2017 ended July 30, 2016, today after the market closed. If you would like a copy of the release, you can access it on the IR section of our website, at schange.com/ir. With me on today's call are Ed Terino, Chief Executive Officer; and Peter Faubert, Chief Financial Officer. This call is being webcast and will be archived in the Investor Relations section of our website. Before it begins, I'd like to remind you that the information we're about to discuss today may include forward-looking statements, which are based on current expectations that are subject to a number of risks and uncertainties that may cause actual results to differ materially from expectations. These risks are outlined in our SEC filings, including our Annual Report on Form 10-K, which was filed on April 13, 2016. Any forward-looking statement should be considered in light of these factors. Additionally, this presentation contains certain non-GAAP or adjusted financial measures, as defined by the SEC. We have provided a reconciliation of these measures to the most directly comparable GAAP measures in the tables attached to the press release. And with that, I'd like to turn the call over to Ed for opening remarks.

Thank you, Monica. Good afternoon, everyone, and thank you for joining SeaChange's call today. Our second quarter performance was in line with the revised expectations we provided on our update call last week. As previously noted, the fiscal second quarter revenue shortfall was primarily due to an increase in the estimated time to complete active statements of work as well as some transactions that were expected to close in the second quarter, which were delayed due to shifts in customer schedules. The estimated time to complete active statements of work contributed almost $4 million to the revenue shortfall, while the transactions that were delayed from the second quarter contributed more than $1 million to the revenue shortfall. Although we have made significant progress in executing improvements to the company's operations, introducing new products, expanding sales capability and building a pipeline for the second half of fiscal 2017, the financial results from our actions are taking longer to achieve. With both senior management and our expanded sales organization engaging with customers and new prospects, we see strong evidence that substantial market opportunities for SeaChange exists in our core products of video platform, advertising, user experience and OTT. This has led to increased confidence that our pipeline is more robust as we enter the second half of fiscal 2017. The challenge now is to increase the speed at which we convert these opportunities into revenues. The operational improvements and cost optimization initiatives we have put in place already in fiscal 2017 and those planned for the third quarter will result in a more customer-focused organization that delivers more timely, better quality software with a substantially improved cost structure. Further, we have made significant progress in implementing improved business information systems and strengthening financial disciplines to better measure, monitor or report the performance of the company. The goal of these improvements is to enable SeaChange to return to profitability and positive cash flow by the fiscal year-end. Our actions aimed at improving our topline growth, including additional expansion of our sales organization, might be best viewed as a cumulative process that will grow stronger and more efficient with each successive quarter. Once fully implemented, our new cost structure will reduce our annual non-GAAP operating EPS breakeven point to the range of $90 million to $95 million in revenue. Despite some of our near-term challenges this quarter, we remain confident in our ability to attain the long-term targets that we introduced earlier this year, which included double digit -- consistent double-digit revenue growth, year-over-year revenue growth and double-digit operating margins within the next 2 to 3-year time frame. Now let me provide you an update on our progress with some of the key elements of our strategy. During the second quarter, we maintained our focus on improving our go-to-market capabilities, optimizing operating expenses and gross margins. I'm very pleased with the headway that our expanded sales organization has made in increasing sales leads and expanding our revenue pipeline. Since the first quarter of fiscal 2017, we have more than doubled our Rave pipeline, with much of this growth led by our new inside sales group. Moreover, we continue to make progress on converting our legacy Axiom back office customer base to Adrenalin and upgrading our existing Adrenalin customers to our latest release, which supports ultra high-definition video management and delivery, system failover between geographies to guarantee high availability and mission-critical reliability and enhanced promotional capabilities to drive viewer engagement and content use, such as binge-watching. During the second quarter, we secured a large Adrenalin upgrade with a North American customer, 2 Axiom to Adrenalin migrations in the Americas and a noteworthy new Rave OTT win with an international distributor of film and television content, which we plan to formally announce next week. We recorded some initial revenues from these transactions in the second fiscal quarter and expect to implement these upgrades in the second half of fiscal 2017. The user experience is becoming an increasingly important aspect of our customers' overall video monetization strategy. To fill this need, we will introduce new user experience products at the IBC Conference in Amsterdam next week, all of which were developed by our SeaChange Poland organization, formerly DCC Labs. We believe that our DCC Labs acquisition, which closed in the second quarter, not only significantly improves our margins and cost structure, but substantially strengthens SeaChange's ability to provide customers with highly strategic user experiences to help them enhance engagement with viewers and increased content revenue opportunities overall. With that, I will turn the call over to our CFO, Peter Faubert, to walk you through our financial results and provide you our outlook for the third quarter and full fiscal year. Peter, please go ahead.

Thank you, Ed, and good afternoon, everyone. I'll start by reviewing our second quarter results before providing you an outlook with the third quarter and full fiscal year of 2017. Total revenue in the second quarter was $18.5 million compared to $27.9 million in the year-ago quarter. As we noted last week, the revenue shortfall was primarily due to an increase in the estimated time to complete active statements of work as well as some other transactions that were expected to close in the quarter, which were delayed due to shifts in customer schedules. Total product revenue equaled $2.5 million in the second quarter or 14% of total revenue compared to $7 million in the year-ago quarter or 25% of total revenue. Video platform software was $1.8 million and accounted for 70% of total product revenue compared to $3.9 million or 56% of total product revenue in the second quarter of last year. Advertising software revenue declined to 0 from $0.2 million last year. User experience software totaled negative $0.1 million due to the software licenses that were included in the active statements of work where we updated the estimated time to complete. Hardware revenue was $0.4 million, down from $2.2 million last year, including -- included legacy VOD streamer revenues. Third-party product revenue declined to $0.4 million from $0.6 million in the second quarter of last year. Total service revenue in the second quarter was $15.9 million or 86% of total revenue, down from $20.9 million in the prior-year quarter. The decline was primarily due to the increase in the estimated time to complete active statements of work and was partially offset by an increase in back office professional services. Video platform professional services revenue increased to $5.7 million from $5.5 million in the year-ago quarter, and SaaS revenue was $0.8 million, which was flat with a year ago. Maintenance revenue totaled $9.1 million compared to $10.2 million a year ago. The decline in maintenance was driven by hardware consolidation from 2 customers that resulted in the reduction of the associated maintenance revenue. Maintenance revenue accounted for 49% of the total revenue in the quarter, up from 36% in the prior-year quarter. Revenue from international customers of $11.7 million in the second quarter accounted for 64% of total revenue compared to $16.1 million or 58% of revenue in the prior-year quarter. We had one customer account for 28% of total revenue in the second quarter and 4 additional customers each accounted for over 5% of total revenue. Our blended non-GAAP gross margin was 43% in the second quarter compared to 53% in the prior-year quarter. Product gross margins in the second quarter were 56% compared to 78% in the prior-year quarter, due to increases in the higher margin software revenue from the prior-year quarter. Service gross margins in the second quarter were 40%, down from 44% in the second quarter of last year. This was primarily due to the change in estimate of time to complete on active statements of work that resulted from lower revenue at the same cost. Thus, this reduced the margin contribution in the second quarter. Non-GAAP operating expenses in the second quarter were $15.4 million, a decline of 3% compared to $15.9 million in the prior-year quarter. This was driven by lower labor costs, which were reflected -- which reflected the initial benefits of transitioning our In-Home software development to our recently acquired DCC Labs group in Poland as well as restructuring efforts that we implemented in the first quarter of last year. We generated a non-GAAP operating loss of $0.21 per basic share compared to a non-GAAP operating loss of $0.04 per basic share in the year-ago quarter. Turning to our balance sheet. We ended the second quarter with cash and cash equivalents of approximately $51 million and no debt. In the second quarter, we used $8 million of cash for working capital needs and $5.4 million of cash for the acquisition of DCC Labs, which closed on May 5. We continue to anticipate that this acquisition will achieve approximately $8 million in annualized cost savings, and we remain on track to realize approximately $5 million of that savings in fiscal 2017. To date, we have realized approximately $1.5 million of that savings. We will also be implementing additional cost savings initiatives in the third quarter to support our goal of achieving profitability and positive cash flow by Q4. Following a review of our operations, liquidity and funding and investment in our product roadmap, we have determined that the ability to access certain amounts of foreign earnings would provide greater flexibility to meet our working capital needs. Accordingly in the second quarter of fiscal 2017, we withdrew the permanent reinvestment assertion on $58.6 million of earnings generated by our cap -- our Irish operations. As a result, we recorded a deferred tax liability of $14.7 million related to the foreign income taxes on these undistributed earnings. The deferred tax liability will not result in cash taxes in the short term, and we are working with our tax consultants to try to minimize the potential cash impact of this move in future periods. DSOs excluding unbilled receivables declined to 64 days in the second quarter from 90 days in the first quarter. Including unbilled receivables, DSOs decreased to 120 days from 193 days in the prior quarter. These reductions reflect our progress on improving collections and decreasing our unbilled receivables. Now I'd like to turn to our outlook for the third quarter and full fiscal year. We anticipate the third quarter of fiscal 2017 revenues to be in the range of $20 million to $23 million and non-GAAP operating loss to be in the range of $0.15 to $0.20 per basic share. For the full year, we now expect revenue in the range of $83 million to $88 million and non-GAAP operating loss to be in the range of $0.50 to $0.60 per basic share. With that, I'll hand the call back to Monica, and thank you very much.

Thank you, Peter. Shea, could you please provide instructions for the Q&A session?

[Operator Instructions] Our first question comes from Greg Mesniaeff from Drexel Hamilton.

Just a quick clarification, if I may. Did you say on the call that you in the quarter had 2 conversions of Axiom to Adrenalin in the U.S. and one Adrenalin upgrade? Is that right? Or did I hear that wrong?

That's correct.

And is it also correct that -- I think you've mentioned in earlier calls that you have the number of customers that are still waiting to be converted potentially from Axiom to Adrenalin is in the high 20s, right, or something like that?

We have about 40 total Axiom customers. We currently have about 14 quotes outstanding for that group of customers. And a good portion of our pipeline for the second half of the year includes customers who would be converting from Axiom to migration -- Axiom to Adrenaline. We've seen continued interest in the customer base, in the Axiom customer base, particularly in Latin America and South America where we have a large base of installation for Axiom. And we feel pretty encouraged by the ability to convert those customers to Adrenalin in the second half of this year.

Now based on the commentary you've made so far, it appears that there's been a significant upgrade to Adrenalin more recently and that some of the older Adrenalin upgrades are now being upgraded to the newer version, is that right?

Yes, we have one customer, a fairly sizable North American customer upgrade to the newest version of Adrenalin in the quarter. Again, in the pipeline for the second half of the year, we have several other of the Adrenalin customers that are looking to do upgrades to the newer version of Adrenalin later this year.

So all that being said, is it fair to say that the -- those Axiom customers that haven't upgraded at all yet are going to, in effect, leapfrog to the newest Adrenalin upgrade, is that correct? Or is there -- is it a gradual, incremental upgrade path?

No, no. They would go to the most current version of Adrenalin, which -- yes, they would go to the most current version.

Okay. And is there any kind of a financial incentive mechanism to do that at this point? I mean, can you go into any detail about that?

Yes, there are financial incentives that we put in place. One of the types of incentives we use is to give some credit for their Axiom licenses towards Adrenalin licenses. But clearly, the Adrenalin is a much more robust product offering, and we would expect to get some value in any upgrades for the upgrade from Axiom to Adrenalin.

And just one final follow-up. Those customers who have already initially upgraded from Axiom to Adrenalin, are you pursuing them for an upgrade now to the newer version? And how does that work financially for them?

That's exactly right. So it really depends on the size of the customer. But there are several customers who completed the Axiom migrations already to an older version of Adrenalin, in our pipeline for upgrades to the newer version of Adrenalin. Pricing would vary quite a bit based on how big the customer is and how many versions of the product they are upgrading from too. Does that make sense?

Yes. Thank you for that clarification. I’ll come back later.

Thank you. Our next question comes from Steven Frankel from Dougherty & Company.

Good afternoon. Can we start with a little more detail on this Irish tax change? What's the practical implication? Are you repatriating cash that's over there? Or this changes the tax rate on the ongoing business kind of -- why are you doing it and what does it do to cash and cash flow going forward?

Yes, we are repatriating cash. I would say that historically, the business was reinvesting in things like the DCC Labs acquisition and investing its cash overseas. Since then, we have seen a shift in resources and work being performed -- and more work is being performed here in the U.S. So we're -- what we're doing is we are repatriating some of that cash to fund some of the new product initiatives that we're working on here in the U.S.

And how much cash are you bringing back? And what kind of haircut is there to bring it back?

So there's not really a haircut. The tax liability is, right now, a non-cash charge. And we -- we're working with our tax consultants to try to mitigate the real cash impact of that going forward. And from a working capital perspective, we're using the cash to help supplement our working capital needs worldwide.

Okay. And can you give us a little more detail on the incremental cost savings measures that you're implementing in Q3? Kind of headcount reduction, what it's taking out of the run rate and OpEx, something like that?

Yes, still not defined. It's a combination of headcount reduction and other expenses across the board. It's also a worldwide process. So we're dealing with different locations, different governmental regulations worldwide. So we're working through all of that process right now and we hope to get the plan finalized by middle of this month.

Okay. And you talked about a nice pipeline of Axiom to Adrenalin upgrades in the backlog. If you sign some of those in the back half, what's the timetable between signing a customer and recognizing material revenue?

Yes, Steve, this is Ed. It can vary. But I would generally say that we would realize the revenue within a two to three-quarter time frame. So we -- for example, the two that we had this quarter, we signed them, we did realize a small amount of revenue -- both of that revenue will come next quarter and maybe then a little bit in the fourth quarter. So it usually lags a quarter or two, and it could be as much as three.

Okay. And the company in the past has talked about offering some of these smaller customers, especially in Latin America, a SaaS-based version of Adrenalin. Are you getting any traction with that? Or the customers were talking about going to the traditional license version?

Yes, most of them are looking at on-premises versions. We are offering them a hosted solution or a SaaS solution. I would say that lately, there's been more conversations from customers about transitioning away from the license model to a SaaS-based approach, and I think that will gain momentum probably later this year and into next year. So I think we'll start to see some of those migrations done on a SaaS basis, probably beginning later this year and into next year.

Okay. And then Ed, when you came in and took over for Jay, you talked about getting new products out by the end of the year that can generate material revenue. And you talked earlier in this call about DCC Labs introducing some products at IBC. Are those one and the same? Are those products that can contribute meaningfully this year? Or where are we on new product revenue contribution to the current year?

Yes, I think frankly, Steve, it's been a little slower than we would have liked. We had aspirations of launching a content -- an enhanced content management system sooner than we will. We think we'll be able to do something later this year. I don't think it will have any material impact on our revenues this year, but will next year. But the products that are being launched by DCC will -- they will have some impact. I don't think it will be significant in the third quarter. I think it will be mostly fourth quarter and fiscal 2018. So I would say, when you look at our revenue guidance, part of the adjustment is that we have had a bit of a slower introduction of some new products that's impacted our outlook for this year.

Okay. And what's your level of visibility into the million dollars worth of deals that slipped out of Q2? And your confidence level that those can be closed in the current fiscal year?

There were several and we have great visibility into them. They were at very, sort of, end decision points that didn't happen. So we're very confident that they will close this fiscal year. And we believe several of them will close this fiscal quarter, Q3.

Okay. Thank you.

Thank you. [Operator Instructions] Our next question comes from John Zaro from Bourgeon Capital.

Hi, guys. I think I've got this right. There's really nothing new than what you reported last week except -- or two weeks ago, except they're done. I mean, all these numbers are basically roughly the same? Is that correct?

Correct.

Okay. And there's really no action that can certainly have been taken in the last two weeks that's moving things along any more rapidly than we would have expected them to be on, correct?

Well, I think we've made some progress in our plan to reduce our cost structure. So as Peter alluded to, we're further along in that -- in the development of that plan and the execution of that plan.

And how much of -- in doing those and lowering the cost structure to $90 million, $95 million, is -- are going to be cash costs further reducing your amount of cash you hold? Or it’s just hard to say? At this point, you've already...

Yes. Really, it's hard to say. I mean, obviously, we're going to take some restructuring charges as a result of this move. But I don't see it being more significant than what we've done in the past in terms of the amount of restructuring charges. There isn't anything out of the ordinary that we're going to be doing. It's a normal restructuring.

Okay. So we're not expecting to see some big, hard cash charge for these restructuring done already?

No, it's more around the headcount reductions and managing some of our facilities.

Okay. And we're still on target with these various, sort of, markers along the road, I mean, for the Liberty rollout in September?

Yes, we are. I actually had an update and it was, I think, fairly positive around being ready. Obviously, it's not our call, it's generally the customer's call. But that's on target.

But it's like the third week in September, or something like that, second week of September? I'm not sure if I'm right.

I do not want to comment on specifics. I will just say that we are on target with our deliverables. I don't want to comment on a roll out, but we have another large European customers that has a rollout scheduled for the third one -- third calendar quarter and that's going along pretty well as well. So I think we've got good traction and progress on those.

Okay. And then we ought to be able to collect some cash and get some revenues. Okay. That’s it from me. Thank you guys very much.

Thank you. Our next question comes from Matthew Galinko from Sidoti.

Hey, good afternoon, guys. Most of mine have been taken. But maybe, I think you touched on doubling the Rave pipeline since the first quarter. Can you talk about what that means? Is that just a sheer number of potential customers in the pipeline? Or is there anything you could say quantitatively about the dollar value of what's in the pipeline? Or how much that's increased?

Yeah, I'm really pleased with the progress we've made in the quarter. Part of the reason we've made good progress has been attributed to two factors. One is, we've actually increased the number of dedicated account reps selling our Rave OTT offering. So we have three in EMEA, we have a couple here and then we have one in Asia Pac. And that's -- and we've also been able to get a lot better traction from using an inside -- our inside sales organization to do some lead generation. So overall, it's resulted in us being able to really increase the number of deals in the pipeline. And I will just tell you that almost all of these are new customers. So that's really exciting. There is a mix between providers of video content versus content owners and content aggregators. So there's a good mix there. Our goal is to try to get a double-digit number of wins this year. As I said in my comments, we had one this quarter, and we have a couple of opportunities that we think will hopefully close in the third quarter.

Got it. And can you help us understand a little bit more about your feeling on your competitive position, as you try to close that pipeline? Maybe who are you seeing? Or just how you feel about new lineup and your ability to close on the pipeline?

Well, again, we prefer not to see anybody in the competitive process, if we can. So our goal is to use our salespeople and their ability to connect with their network to be able to get into situations that are in a competitive bidding process. But we see all the players you would expect to see Kaltura, Ooyala, certainly Brightcove. So there is a lot of, sort of, evolution going on. There's a lot of players. And you're just going to come across a various number of competitors in any situation.

Got you. And then maybe one more. It's just, again, regarding the OTT opportunities. How do you see -- again, it's probably tough to comment until you close the deal. But when do you see the time to getting customers live once you sign a deal? Should it be a reasonably quick process? Or are we talking of three or four quarters to get them live?

No, it's a fairly quick process. I mean, the one that we'll announce is expected to really go live fairly quickly. It's the ramp that -- in the revenue opportunity that takes time, because the way they get rolled out, it's usually either one side or one group of potential subscribers at a time and then there's an adoption rate. And it just takes time for that. And then there's a usage factor. It takes time for that to really ramp. So generally, I think we look at a year as a timeline from when we start to see a fairly robust penetration and rollout.

Got it. All right. Thank you.

Thank you. [Operator Instructions] If we would have no further questions, I will turn the call back over to Ed Terino for closing remarks.

Thank you. Although our Q2 results were not what any of us had hoped, we're more convinced than ever that SeaChange has put in place an effective sales engineering and management team that is strengthening its engagement with its customers. This will allow us to capitalize on our industry-leading products and achieve financial results that the company is capable of delivering and investors expect. Thanks for joining us today and for your continued support and interest in SeaChange. Have a great evening. Good night.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.