| SEACHANGE INTERNATIONAL INC ITEM 1A Risk Factors Any statements contained in this Form 10-K that do not describe historical facts may constitute forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995 |
| These statements relate to future events or our future financial performance and are identified by words such as “may,” “will,” “could,” “should,” “expect,” “plan,” “intend,” “seek,” “anticipate,” “believe,” “estimate,” “potential,” or “continue” or other comparable terms or the negative of those terms |
| Forward-looking statements in this Form 10-K include certain statements regarding the effect of certain accounting standards on our financial position and results of operations, the effect of certain legal claims against us, projected changes in our revenues, earnings and expenses, exchange rate sensitivity, interest rate sensitivity, liquidity, product introductions, industry changes and general market conditions |
| Our actual future results may differ significantly from those stated in any forward-looking statements |
| Any such forward-looking statements contained herein are based on current expectations, but are subject to a number of risks and uncertainties that may cause actual results to differ materially from expectations |
| Factors that may cause such differences include, but are not limited to, the factors discussed below |
| Each of these factors, and others, are discussed from time to time in our filings with the SEC Our future success is dependent on the continued development of the video-on-demand market and if video-on-demand does not gain broad market acceptance, our business may not continue to grow |
| An increasing portion of our revenue in the last year has come from sales and services related to our video-on-demand products |
| However, the video-on-demand market continues to develop as a commercial market and may not gain broad market acceptance |
| The potential size of the video-on-demand market and the timing of its development are uncertain |
| The success of this market requires that broadband system operators, particularly the seven largest domestic cable system operators, continue to upgrade their cable networks to support digital two-way transmission service and successfully market video-on-demand and similar services to their cable television subscribers |
| Some cable system operators are still in the early stages of commercial deployment of video-on-demand service to major residential cable markets and, accordingly, to date our digital video systems have been commercially available only to a limited number of subscribers |
| In addition, telecommunications companies have also begun to adapt their networks to support digital two-way transmission and begun marketing video-on-demand services |
| If cable system operators and telecommunications companies fail to make the capital expenditures necessary to upgrade their networks or determine that broad deployment of video-on-demand services is not viable as a business proposition or if our digital video systems cannot support a substantial number of subscribers while maintaining a high level of performance, our revenues will not grow as we have planned |
| 14 ______________________________________________________________________ Because our customer base is highly concentrated among a limited number of large customers, the loss of or reduced demand of these customers could have a material adverse effect on our business, financial condition and results of operations |
| Our customer base is highly concentrated among a limited number of large customers, and, therefore, a limited number of customers account for a significant percentage of our revenues in any year |
| Our five largest customers have accounted for approximately half of our revenues in each of the past five years and our largest customer has represented approximately 25prca and 50prca of our revenues in fiscal 2006 and fiscal 2005, respectively |
| We generally do not have written agreements that require customers to purchase fixed minimum quantities of our products |
| Our sales to specific customers tend to vary significantly from year to year depending upon these customers’ budgets for capital expenditures and our new product introductions |
| We believe that a significant amount of our revenues will continue to be derived from a limited number of large customers in the future |
| The loss of, or reduced demand for products or related services from, any of our major customers could have a material adverse effect on our business, financial condition and results of operations |
| Cancellation or deferral of purchases of our products could cause our operating results to be below the expectations of the public market stock analysts who cover our stock, resulting in a decrease in the market price of our common stock |
| We derive a substantial portion of our revenues from purchase orders that exceed dlra1dtta0 million in value |
| Therefore, any significant cancellation or deferral of purchases of our products could have a material adverse effect on our business, financial condition and results of operations in any particular quarter due to the resulting decrease in revenue and gross margin and our relatively fixed costs |
| In addition, to the extent significant sales occur earlier than expected, operating results for subsequent quarters may be adversely affected because our operating costs and expenses are based, in part, on our expectations of future revenues, and we may be unable to adjust spending in a timely manner to compensate for any revenue shortfall |
| Because of these factors, in some future quarter our operating results may be below the expectations of public market analysts and investors which may adversely affect the market price of our common stock |
| Timing of significant customer orders may cause our quarterly operating results to fluctuate, making period-to-period comparisons of our operating results less meaningful |
| We have experienced significant variations in the revenue, expenses and operating results from quarter to quarter and these variations are likely to continue |
| We believe that fluctuations in the number of orders being placed from quarter to quarter are principally attributable to the buying patterns and budgeting cycles of broadband system operators, including telecommunications companies, and broadcast companies, the primary buyers of the digital video-on-demand, advertising and broadcast systems, respectively |
| We expect that there will continue to be fluctuations in the number and value of orders received |
| As a result, our results of operations have in the past and likely will, at least in the near future, fluctuate in accordance with this purchasing activity making period-to-period comparisons of our operating results less meaningful |
| In addition, because these factors are difficult for us to forecast, our business, financial condition and results of operations for one quarter or a series of quarters may be adversely affected and below the expectations of public market analysts and investors, resulting in a decrease in the market price of our common stock |
| Due to the lengthy sales cycle involved in the sale of our products, our quarterly results may vary and should not be relied on as an indication of future performance |
| Digital video-on-demand, advertising, movie and broadcast products are relatively complex and their purchase generally involve a significant commitment of capital, with attendant delays frequently associated with large capital expenditures and implementation procedures within an organization |
| Moreover, the purchase of these products typically requires coordination and agreement among a potential customer’s corporate headquarters and its regional and local operations |
| For these and other reasons, the sales cycle associated with the purchase of our digital video-on-demand, advertising, movie and broadcast products is typically lengthy and 15 ______________________________________________________________________ subject to a number of significant risks, including customers’ budgetary constraints and internal acceptance reviews, over which we have little or no control |
| Based upon all of the foregoing, we believe that our quarterly revenues and operating results are likely to vary significantly in the future, that period-to-period comparisons of our results of operations are not necessarily meaningful and that these comparisons should not be relied upon as indications of future performance |
| If there were a decline in demand or average selling prices for our broadband products, including our Video-On-Demand Systems and Advertising Systems, our revenues and operating results would be materially affected |
| We expect our broadband products to continue to account for a significant portion of our revenues |
| Accordingly, a decline in demand or average selling prices for our broadband products, whether as a result of new product introductions by others, price competition, technological change, inability to enhance the products in a timely fashion, or otherwise, could have a material adverse effect on our business, financial condition and results of operations |
| During fiscal 2005, our video-on-demand prices decreased approximately 33prca from the prior fiscal year |
| In fiscal 2006, we experienced a similar trend in pricing pressure from our competitors |
| In addition, we experienced a significant decline in revenues during fiscal 2006 as compared to fiscal 2005 |
| The decline in revenues in fiscal 2006 was primarily attributable to a decline in video-on-demand revenues due to unanticipated delays in the order receipt, shipment and acceptance of certain orders |
| If we are unable to manage our growth and the related expansion in our operations effectively, our business may be harmed through a diminished ability to monitor and control effectively our operations, and a decrease in the quality of work and innovation of our employees |
| Our ability to successfully offer new products and services and implement our business plan in a rapidly evolving market requires effective planning and management |
| We are also continuing to transition towards greater reliance on our video-on-demand products and services for an increased portion of our total revenue |
| In light of the growing complexities in managing our expanding portfolio of products and services, our anticipated future operations will continue to strain our operational and administrative resources |
| To manage future growth effectively, we must continue to improve our management, our operational controls and internal controls over financial reporting, and to integrate our recently acquired businesses and our new personnel and to manage our expanding international operations |
| A failure to manage our growth may harm our business through a decreased ability to monitor and control effectively our operations, and a decrease in the quality of work and innovation of our employees upon which our business is dependent |
| Our ability to compete could be jeopardized if we are unable to protect our intellectual property rights from third-party challenges |
| Our success and ability to compete depends upon our ability to protect our proprietary technology that is incorporated into our broadband and broadcast products |
| We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights |
| Although we have several issued patents, we cannot assure that any additional patents will be issued or that the issued patents will not be invalidated |
| We also enter into confidentiality or license agreements with our employees, consultants and corporate partners, and control access to and distribution of our software, documentation and other proprietary information |
| Despite these precautions, it may be possible for a third party to copy or otherwise misappropriate and use our products or technology without authorization, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States |
| We may need to resort to litigation in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others |
| If competitors are able to use our technology, our ability to compete effectively could be harmed |
| 16 ______________________________________________________________________ We have been and in the future could become subject to litigation regarding intellectual property rights, which could seriously harm our business and require us to incur significant legal costs to defend our intellectual property rights |
| The industry in which we operate is characterized by vigorous protection and pursuit of intellectual property rights or positions, which on occasion, have resulted in significant and often protracted litigation |
| We have from time to time received, and may in the future receive, communications from third parties asserting infringements on patent or other intellectual property rights covering our products or processes |
| We have been and currently are involved in significant intellectual property litigation, and we may be a party to litigation in the future to enforce our intellectual property rights or as a result of an allegation that we infringe others’ intellectual property |
| Any parties asserting that our products infringe upon their proprietary rights would force us to defend ourselves and possibly our customers or manufacturers against the alleged infringement, as many of our commercial agreements require us to defend and/or indemnify the other party against intellectual property infringement claims brought by a third party with respect to our products |
| These claims and any resulting lawsuit, if successful, could subject us to significant liability for damages and invalidation of our proprietary rights |
| In the case of a willful infringer, the definition of which is unclear, any such damages may be trebled |
| This possibility of multiple damages serves to increase the incentive for plaintiffs to bring such litigation |
| In addition, these lawsuits, regardless of their success, would likely be time-consuming and expensive to resolve and would divert management time and attention away from our operations |
| Although we carry general liability insurance, our insurance may not cover potential claims of this type or may not be adequate to indemnify us for all liability that may be imposed |
| In addition, any potential intellectual property litigation also could force us to stop selling, incorporating or using the products that use the infringed intellectual property or obtain from the owner of the infringed intellectual property right a license to sell or use the relevant technology, although this license may not be available on reasonable terms, or at all, or redesign those products that use the infringed intellectual property |
| If we are forced to take any of the foregoing actions, our business may be seriously harmed |
| You should refer to Note 12 to our Consolidated Financial Statements included herewith for a more detailed description of intellectual property litigation relating to our MediaCluster technology |
| If content providers, such as movie studios, limit the scope of content licensed for use in the digital video-on-demand market, our business, financial condition and results of operations could be negatively affected because the potential market for our products would be more limited than we currently believe and have communicated to the financial markets |
| The success of the video-on-demand market is contingent on content providers, such as movie studios, permitting their content to be licensed for use in this market |
| Content providers may, due to concerns regarding either or both marketing and illegal duplication of the content, limit the extent to which they provide content to the video-on-demand market |
| A limitation of content for the video-on-demand market would indirectly limit the market for our video-on-demand system which is used in connection with that market |
| If we are unable to successfully introduce new products or enhancements to existing products, our financial condition and operating results may be adversely affected by a decrease in sales of our products |
| Because our business plan is based on technological development of new products and enhancements to our existing products, our future success is dependent on our successful introduction of these new products and enhancements |
| In the future we may experience difficulties that could delay or prevent the successful development, introduction and marketing of these and other new products and enhancements, or find that our new products and enhancements do not adequately meet the requirements of the marketplace or achieve market acceptance |
| Announcements of currently planned or other new product offerings may cause customers to defer purchasing our existing products |
| Moreover, despite testing by us and by current and potential customers, errors or failures may be found in our products, and, even if discovered, may not be successfully corrected in a timely 17 ______________________________________________________________________ manner |
| These errors or failures could cause delays in product introductions and shipments, or require design modifications that could adversely affect our competitive position |
| Our inability to develop new products or enhancements on a timely basis or the failure of these new products or enhancements to achieve market acceptance could have a material adverse effect on our business, financial condition and results of operations |
| Because we purchase certain material components used in manufacturing our products from sole suppliers and we use a limited number of third party manufacturers to manufacture our products, our business, financial condition and results of operations could be materially adversely affected by a failure of these suppliers or manufacturers |
| Certain key components of our products are currently purchased from a sole supplier, including a computer chassis manufactured by JMR Electronics, Inc, another computer chassis manufactured by Enclosure Concepts, Inc, an interface controller video transmission board manufactured by Cyclone Microsystems, Inc, encoder and decoder software from Ligos, Inc |
| and CINergy Gmbh and certain digital video chips from Mellanox |
| We have in the past experienced quality control problems, where products did not meet specifications or were damaged in shipping, and delays in the receipt of these components |
| These problems were generally of short duration and did not have a material adverse effect on our business and results of operations |
| However, we may in the future experience similar types of problems which could be more severe or more prolonged |
| While we believe that there are alternative suppliers available for these components, we believe that the procurement of these components from alternative suppliers could take up to four months |
| In addition, these alternative components may not be functionally equivalent or may be unavailable on a timely basis or on similar terms |
| The inability to obtain sufficient key components as required, or to develop alternative sources if and as required in the future, could result in delays or reductions in product shipments which, in turn, could have a material adverse effect on our business, financial condition and results of operations |
| In addition, we rely on a limited number of third parties who manufacture certain components used in our products |
| While to date there has been suitable third party manufacturing capacity readily available at acceptable quality levels, in the future there may not be manufacturers that are able to meet our future volume or quality requirements at a price that is favorable to us |
| Any financial, operational, production or quality assurance difficulties experienced by these third party manufacturers that result in a reduction or interruption in supply to us could have a material adverse effect on our business, financial condition and results of operations |
| If we are unable to successfully compete in our marketplace, our financial condition and operating results may be adversely affected |
| We currently compete against both computer companies offering video server platforms and more traditional analog video playback systems |
| In the digital advertisement insertion market, we compete against suppliers of both analog tape-based and digital systems |
| Due to the rapidly evolving markets in which we compete, additional competitors with significant market presence and financial resources, including computer hardware and software companies and television equipment manufacturers, may enter those markets, thereby further intensifying competition |
| Increased competition could result in price reductions and loss of market share which would adversely affect our business, financial condition and results of operations |
| Many of our current and potential competitors have greater financial, selling and marketing, technical and other resources than we do |
| Moreover, our competitors may also foresee the course of market developments more accurately than we |
| Although we believe that we have certain technological and other advantages over our competitors, realizing and maintaining these advantages will require a continued high level of investment by us in research and product development, marketing and customer service and support |
| In the future we may not have sufficient resources to continue to make these investments or to make the technological advances necessary to compete successfully with our existing competitors or with new competitors |
| If we are unable to compete effectively, our business, prospects, financial condition and operating results would be materially adversely affected because of the difference in our operating results from the assumptions on which our business model is based |
| 18 ______________________________________________________________________ If we fail to respond to rapidly changing technologies related to digital video, our business, financial condition and results of operations would be materially adversely affected because the competitive advantage of our products relative to those of our competitors would decrease |
| The markets for our products are characterized by rapidly changing technology, evolving industry standards and frequent new product introductions and enhancements |
| Future technological advances in the television and video industries may result in the availability of new products or services that could compete with the solutions provided by us or reduce the cost of existing products or services, any of which could enable our existing or potential customers to fulfill their video needs better and more cost efficiently than with our products |
| Our future success will depend on our ability to enhance our existing digital video products, including the development of new applications for our technology, and to develop and introduce new products to meet and adapt to changing customer requirements and emerging technologies |
| In the future, we may not be successful in enhancing our digital video products or developing, manufacturing and marketing new products which satisfy customer needs or achieve market acceptance |
| In addition, there may be services, products or technologies developed by others that render our products or technologies uncompetitive, unmarketable or obsolete, or announcements of currently planned or other new product offerings either by us or our competitors that cause customers to defer or fail to purchase our existing solutions |
| Because our business is susceptible to risks associated with international operations, we may not be able to maintain or increase international sales of our products |
| International product and service revenues ranged from 12prca to 40prca of our total revenues in each of the past five years |
| Our international operations are expected to continue to account for a significant portion of our business in the future |
| However, in the future we may be unable to maintain or increase international sales of our products and services |
| International sales are subject to a variety of risks, including: • difficulties in establishing and managing international distribution channels; • difficulties in selling, servicing and supporting overseas products and in translating products into foreign languages; • the uncertainty of laws and enforcement in certain countries relating to the protection of intellectual property; • multiple and possibly overlapping tax structures; • currency and exchange rate fluctuations; and • economic or political changes in international markets |
| Our financial condition and results of operations could be materially adversely affected by the performance of the companies in which we have made and may in the future make equity investments |
| As discussed in “Management’s Discussion and Analysis” we have made equity investments in other companies, including Filmflex, Movies Limited, Casa Systems, Inc, Minerva Networks, Inc |
| and InSite One, Inc, during fiscal 2006 and we may in the future make additional investments in these and/or other companies |
| These investments may require additional capital and may not generate the expected rate of return on investment through equity method income and/or unrealized or realized gains in the future than we believed at the time of making the investment |
| This may adversely affect our financial condition or results of operations |
| Also, investments in development-stage companies may generate other than temporary declines in fair value of our investment that would result in impairment charges |
| 19 ______________________________________________________________________ Recent and future acquisitions may be difficult to integrate, disrupt our business, dilute stockholder value or divert management attention |
| As part of our business strategy, we recently acquired or may seek to acquire or invest in new businesses, products or technologies that we believe could complement or expand our business, augment our market coverage, enhance our technical capabilities or otherwise offer growth opportunities |
| Acquisitions could create risks for us, including: • difficulties in assimilation of acquired personnel, operations, technologies or products which may affect our ability to develop new products and services and compete in our rapidly changing marketplace due to a resulting decrease in the quality of work and innovation of our employees upon which our business is dependent; and • adverse effects on our existing business relationships with suppliers and customers, which may be of particular importance to our business because our customer base is highly concentrated among a limited number of large customers, we purchase certain components used in manufacturing our products from sole suppliers and we use a limited number of third party manufacturers to manufacture our product |
| In addition, if we consummate acquisitions through an exchange of our securities, our existing stockholders could suffer significant dilution |
| Any future acquisitions, even if successfully completed, may not generate any additional revenue or provide any benefit to our business |
| The success of our business model could be influenced by changes in the regulatory environment, such as changes that either would limit capital expenditures by television operators or reverse the trend towards deregulation in the industries in which we compete |
| The telecommunications and television industries are subject to extensive regulation which may limit the growth of our business, both in the United States and other countries |
| The growth of our business internationally is dependent in part on deregulation of the telecommunications industry abroad similar to that which has occurred in the United States and the timing and magnitude of which is uncertain |
| Broadband system operators are subject to extensive government regulation by the Federal Communications Commission and other federal and state regulatory agencies |
| These regulations could have the effect of limiting capital expenditures by broadband system operators and thus could have a material adverse effect on our business, financial condition and results of operations |
| The enactment by federal, state or international governments of new laws or regulations, changes in the interpretation of existing regulations or a reversal of the trend toward deregulation in these industries could adversely affect our customers, and thereby materially adversely affect our business, financial condition and results of operations |
| We may not be able to hire and retain highly skilled employees, particularly managerial, engineering, customer service, selling and marketing, finance and manufacturing personnel, which could affect our ability to compete effectively because our business is technology-based and there is a shortage of these employees within the New England area |
| Our success depends to a significant degree upon the continued contributions of our key management, engineering, customer service, selling and marketing, finance and manufacturing personnel, many of whom would be difficult to replace given the shortage within the New England area of qualified persons for these positions |
| We do not have employment contracts with our key personnel |
| We believe that our future success will also depend in large part upon our ability to attract and retain highly skilled managerial, engineering, customer service, selling and marketing, finance and manufacturing personnel, as our business is technology-based |
| Because competition for these personnel is intense, we may not be able to attract and retain qualified personnel in the future |
| The loss of the services of any of the key personnel, the inability to attract or retain qualified personnel in the future or delays in hiring required personnel, particularly software engineers and sales personnel, could have a material adverse effect on our business, financial condition and results of operations because our business is technology-based |
| 20 ______________________________________________________________________ Increasing political and social turmoil, such as terrorist and military actions, increase the difficulty for us, our vendors and our customers to accurately forecast and plan future business activities and could have a material adverse effect on our business, financial condition and results of operation |
| Recent political and social turmoil, including the terrorist attacks of September 11, 2001 and armed conflict involving the United States of America, may put further pressure on economic conditions in the United States and worldwide |
| The political, social and economic conditions make it difficult for us, our vendors and our customers to accurately forecast and plan future business activities |
| Our business, financial condition and results of operations may be materially adversely affected by a fluctuation in revenue relative to our forecasted value, as we may not be able to vary our incurred expenses in response to revenue actually realized |