UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2006
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Commission File Number 0-21174
AVID TECHNOLOGY, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 04-2977748
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
AVID TECHNOLOGY PARK
ONE PARK WEST
TEWKSBURY, MA 01876
(Address of principal executive offices)
Registrant's telephone number, including area code: (978) 640-6789
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer [X] Accelerated Filer Non-accelerated Filer
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes No [X]
The number of shares outstanding of the registrant's Common Stock as of July 24,
2006 was 42,327,550.
AVID TECHNOLOGY, INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2006
TABLE OF CONTENTS
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PAGE
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PART I. FINANCIAL INFORMATION
ITEM 1. Condensed Consolidated Financial Statements:
a) Condensed Consolidated Statements of Operations (unaudited)
for the three and six months ended June 30, 2006 and 2005 .......1
b) Condensed Consolidated Balance Sheets (unaudited)
as of June 30, 2006 and December 31, 2005........................2
c) Condensed Consolidated Statements of Cash Flows (unaudited)
for the six months ended June 30, 2006 and 2005..................3
d) Notes to Condensed Consolidated Financial Statements (unaudited).4
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................................17
ITEM 3. Quantitative and Qualitative Disclosure About Market Risk...........31
ITEM 4. Controls and Procedures.............................................32
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings...................................................33
ITEM 1A. Risk Factors........................................................33
ITEM 4. Submission of Matters to a Vote of Security Holders.................41
ITEM 6. Exhibits............................................................41
SIGNATURES...................................................................42
EXHIBIT INDEX................................................................43
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AVID TECHNOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- ------------------------
2006 2005 2006 2005
------------ ------------ ------------ -----------
Net revenues:
Product $197,960 $141,636 $392,323 $289,178
Services 24,266 18,415 47,973 36,874
------------ ------------ ------------ -----------
Total net revenues 222,226 160,051 440,296 326,052
------------ ------------ ------------ -----------
Cost of revenues:
Product 93,819 61,244 185,180 122,141
Services 13,812 10,027 27,127 20,097
Amortization of intangible assets 5,016 282 10,096 563
------------ ------------ ------------ -----------
Total cost of revenues 112,647 71,553 222,403 142,801
------------ ------------ ------------ -----------
Gross profit 109,579 88,498 217,893 183,251
------------ ------------ ------------ -----------
Operating expenses:
Research and development 35,617 24,910 71,113 49,589
Marketing and selling 52,583 38,452 102,495 76,294
General and administrative 15,853 10,471 30,990 20,773
Restructuring costs - - 1,066 -
In-process research and development - - 310 -
Amortization of intangible assets 3,977 1,593 7,642 3,185
------------ ------------ ------------ -----------
Total operating expenses 108,030 75,426 213,616 149,841
------------ ------------ ------------ -----------
Operating income 1,549 13,072 4,277 33,410
Interest income 2,144 1,052 4,213 1,860
Interest expense (89) (95) (187) (189)
Other income (expense), net (174) 222 (174) 345
------------ ------------ ------------ -----------
Income before income taxes 3,430 14,251 8,129 35,426
Provision for income taxes 731 685 2,084 2,114
------------ ------------ ------------ -----------
Net income $2,699 $13,566 $6,045 $33,312
============ ============ ============ ===========
Net income per common share - basic $0.06 $0.39 $0.14 $0.95
Net income per common share - diluted $0.06 $0.37 $0.14 $0.90
Weighted-average common shares 42,273 35,177 42,205 35,083
outstanding - basic
Weighted-average common shares 43,057 37,024 43,126 37,154
outstanding - diluted
The accompanying notes are an integral part of the condensed consolidated
financial statements.
1
AVID TECHNOLOGY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
June 30, December 31,
2006 2005
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents $152,672 $133,954
Marketable securities 85,475 104,476
Accounts receivable, net of allowances of
$22,212 and $22,233 at June 30, 2006 and
December 31, 2005, respectively 143,934 140,669
Inventories 121,979 96,845
Current deferred tax assets, net 566 528
Prepaid expenses 8,558 8,548
Other current assets 14,152 16,657
------------- -------------
Total current assets 527,336 501,677
Property and equipment, net 38,096 38,563
Intangible assets, net 110,248 118,676
Goodwill 410,895 396,902
Other assets 6,410 6,228
------------- -------------
Total assets $1,092,985 $1,062,046
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $52,459 $43,227
Accrued compensation and benefits 25,450 27,841
Accrued expenses and other current liabilities 51,426 55,443
Income taxes payable 15,625 13,027
Deferred revenues 66,913 62,863
------------- -------------
Total current liabilities 211,873 202,401
Long-term liabilities 18,790 20,048
------------- -------------
Total liabilities 230,663 222,449
------------- -------------
Contingencies (Note 8)
Stockholders' equity:
Common stock 423 421
Additional paid-in capital 939,907 928,703
Accumulated deficit (82,750) (88,795)
Deferred compensation - (1,830)
Accumulated other comprehensive income 4,742 1,098
------------- -------------
Total stockholders' equity 862,322 839,597
------------- -------------
Total liabilities and stockholders' equity $1,092,985 $1,062,046
============= =============
The accompanying notes are an integral part of the condensed consolidated
financial statements.
2
AVID TECHNOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Six Months Ended June 30,
2006 2005
------------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $6,045 $33,312
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 28,348 10,660
Provision for (recoveries of) doubtful accounts (1,107) 625
In-process research and development 310 -
Loss (gain) on disposal of fixed assets 133 (55)
Compensation expense from stock grants and options 8,860 1,514
Equity in loss (income) of non-consolidated company 203 (164)
Changes in deferred tax assets and liabilities, excluding initial (974) (345)
effects of acquisitions
Changes in operating assets and liabilities, excluding initial
effects of acquisitions:
Accounts receivable 3,269 (3,734)
Inventories (22,746) (10,169)
Prepaid expenses and other current assets 3,663 (3,763)
Accounts payable 4,840 2,577
Income taxes payable 1,790 1,001
Accrued expenses, compensation and benefits and other liabilities (8,318) (4,015)
Deferred revenues (778) 10,768
---------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 23,538 38,212
---------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (9,062) (8,221)
Payments for other long-term assets (569) (311)
Payments for business acquisitions, including transaction costs,
net of cash acquired (20,490) -
Purchases of marketable securities (31,439) (27,255)
Proceeds from sales of marketable securities 51,397 34,401
---------------------------------------------------------------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (10,163) (1,386)
---------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on capital lease obligations (37) (30)
Proceeds from issuance of common stock under employee stock plans 4,177 8,922
---------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 4,140 8,892
---------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and cash equivalents 1,203 (1,137)
---------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents 18,718 44,581
Cash and cash equivalents at beginning of period 133,954 79,058
---------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $152,672 $123,639
---------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of the condensed consolidated
financial statements.
3
PART I. FINANCIAL INFORMATION
ITEM 1D. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. FINANCIAL INFORMATION
The accompanying condensed consolidated financial statements include the
accounts of Avid Technology, Inc. and its wholly owned subsidiaries
(collectively, "Avid" or the "Company"). These financial statements are
unaudited. However, in the opinion of management, the condensed consolidated
financial statements include all adjustments, consisting of only normal,
recurring adjustments, necessary for their fair statement. Interim results are
not necessarily indicative of results expected for a full year. The accompanying
unaudited condensed consolidated financial statements have been prepared in
accordance with the instructions for Form 10-Q and therefore do not include all
information and footnotes necessary for a complete presentation of operations,
financial position and cash flows of the Company in conformity with generally
accepted accounting principles. The accompanying condensed consolidated balance
sheet as of December 31, 2005 was derived from Avid's audited consolidated
financial statements, but does not include all disclosures required by generally
accepted accounting principles. The Company filed audited consolidated financial
statements for the year ended December 31, 2005 in its 2005 Annual Report on
Form 10-K, which included all information and footnotes necessary for such
presentation; the financial statements contained in this Form 10-Q should be
read in conjunction with the audited consolidated financial statements in the
Form 10-K. Certain amounts in the prior years' financial statements have been
reclassified to conform to the current year presentation. As disclosed in the
Company's 2005 Annual Report on Form 10-K, during 2005, the Company began
reclassifying certain European administrative expenses as general and
administrative expense rather than as marketing and selling expense. During
2006, the Company began reclassifying the long-term portion of certain
liabilities from the captions 'deferred revenue' and 'accrued expenses and other
current liabilities' to 'long-term liabilities' in the Condensed Consolidated
Balance Sheets. See Note 6 for the amounts included in long-term liabilities for
each period presented.
The Company's preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosures of contingent assets and liabilities at
the dates of the financial statements and the reported amounts of revenues and
expenses during the reported periods. The most significant estimates reflected
in these financial statements include accounts receivable and sales allowances,
purchase accounting, stock-based compensation, inventory valuation and income
tax asset valuation allowances. Actual results could differ from those
estimates.
On April 13, 2006, the Company acquired Sundance Digital, Inc. ("Sundance"), a
Texas-based developer of automation and device control software for broadcast
video servers, tape transports, graphics systems and other broadcast station
equipment. The results of operations of Sundance have been included in the
Company's results of operations since the acquisition date (see Note 3).
On January 12, 2006, the Company acquired Medea Corporation ("Medea"), a
California-based provider of low cost storage solutions for real-time media
applications. The results of operations of Medea have been included in the
Company's results of operations since the acquisition date (see Note 3).
4
2. NET INCOME PER COMMON SHARE
Basic and diluted net income per share were as follows (in thousands, except per
share data):
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- -------------------------
2006 2005 2006 2005
------------ ------------ ----------- ------------
Net income $2,699 $13,566 $6,045 $33,312
============ ============ =========== ============
Weighted-average common shares outstanding - basic 42,273 35,177 42,205 35,083
Weighted-average potential common stock:
Options 784 1,707 921 1,866
Warrant - 140 - 205
------------ ------------ ----------- ------------
Weighted-average common shares outstanding - diluted 43,057 37,024 43,126 37,154
============ ============ =========== ============
Net income per common share - basic $0.06 $0.39 $0.14 $0.95
Net income per common share - diluted $0.06 $0.37 $0.14 $0.90
Common stock equivalents that were considered anti-dilutive securities and
excluded from the diluted net income per share calculations, were as follows, on
a weighted-average basis (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- -----------------------
2006 2005 2006 2005
----------- ---------- ----------- -----------
Options 2,590 852 2,529 564
Warrant 1,155 - 1,155 -
Restricted stock and restricted stock units 230 - 151 -
----------- ---------- ----------- -----------
Total anti-dilutive common stock equivalents 3,975 852 3,835 564
=========== ========== =========== ===========
3. ACQUISITIONS
Sundance
On April 13, 2006, Avid acquired all the outstanding shares of Sundance Digital,
Inc., a Texas-based developer of automation and device control software for
broadcast video servers, tape transports, graphics systems and other broadcast
station equipment, for cash of $12.5 million plus transaction costs of $0.2
million. The Company performed a preliminary allocation of the total purchase
price of $12.7 million to the net tangible and intangible assets of Sundance
based on their fair values as of the consummation of the acquisition. The
purchase price was allocated as follows: ($2.7) million to net liabilities
assumed, $5.6 million to amortizable identifiable intangible assets and the
remaining $9.8 million to goodwill. The goodwill, which reflects the value of
the assembled workforce and the synergies the Company expects to realize by
offering Sundance's broadcast automation products to its Professional Video
segment customers, is reported within the Professional Video segment and is not
deductible for tax purposes.
The Company used the cost approach to determine the value of the developed
technology and used the income approach to determine the values of the other
acquired intangible assets. The cost approach is based on the economic
principles of substitution and price equilibrium and requires an estimation of
the costs required to reproduce the intangible asset, which are then reduced for
depreciation of the asset. The income approach presumes that the value of an
asset can be estimated by the net economic benefit to be received over the life
of the asset, generally cash flows discounted to present value. This approach
typically uses a projection of revenues and expenses attributed to the
intangible asset to calculate a potential income stream which is then discounted
using a rate of return that is based on the weighted-average cost of capital
factored for the risk, or uncertainty, associated with achieving the projected
income stream. The weighted-average discount rate (or rate of return) used to
determine the value of Sundance's intangible assets was 20% and the effective
tax rate used was 35%.
The amortizable identifiable intangible assets include developed technology of
$3.9 million, customer relationships of $1.0 million, non-compete agreements of
$0.4 million and trademarks and trade name of $0.3 million. The values of the
customer relationships, non-compete agreements and trademarks and trade name,
which were determined using the income approach, are being amortized on a
5
straight-line basis over their estimated useful lives of six years, two years
and six years, respectively. The value of the developed technology, which was
determined using the cost approach, is being amortized over the greater of the
amount calculated using the ratio of current quarter revenue to the total of
current quarter and anticipated future revenues, or the straight-line method,
over the estimated useful life of three years. The weighted-average amortization
period for the amortizable identifiable intangible assets is approximately four
years. Amortization expense for these intangibles totaled $0.4 million for both
the three- and six-month periods ended June 30, 2006 and accumulated
amortization was $0.4 million at June 30, 2006.
Medea
On January 12, 2006, Avid acquired all the outstanding shares of Medea
Corporation, a California-based provider of local storage solutions for
real-time media applications, for cash of $8.9 million plus transaction costs of
$0.2 million. The Company performed a preliminary allocation of the total
purchase price of $9.1 million to the net tangible and intangible assets of
Medea based on their fair values as of the consummation of the acquisition. The
purchase price was allocated as follows: ($2.1) million to net liabilities
assumed, $3.8 million to amortizable identifiable intangible assets, $0.3
million to in-process research and development ("R&D") and the remaining $7.1
million to goodwill. During the second quarter of 2006, the Company continued
its analysis of the fair values of certain assets and liabilities, primarily
related to accruals for employee terminations. Accordingly, the Company recorded
an additional liability of $0.3 million and a corresponding increase to
goodwill. The total goodwill of $7.4 million, which reflects the value of the
assembled workforce and the synergies the Company expects to realize by offering
Medea's RAID (Redundant Array of Independent Disks) storage solutions to its
Professional Video segment customers, is reported within the Professional Video
segment and is not deductible for tax purposes.
The Company used the income approach to determine the value of the intangible
assets, using a weighted-average discount rate (or rate of return) of 19% and an
effective tax rate of 35%. The amortizable identifiable intangible assets
include developed technology of $2.7 million, customer relationships of $0.7
million, order backlog of $0.3 million and non-compete agreements of $0.1
million. The customer relationships, order backlog and non-compete agreements
are being amortized on a straight-line basis over their estimated useful lives
of six years, one-half year and two years, respectively. Developed technology is
being amortized over the greater of the amount calculated using the ratio of
current quarter revenue to the total of current quarter and anticipated future
revenues, or the straight-line method, over the estimated useful life of two and
one-half years. The weighted-average amortization period for the amortizable
identifiable intangible assets is approximately three years. Amortization
expense for these intangibles totaled $0.5 million and $1.0 million,
respectively, for the three- and six-month periods ended June 30, 2006 and
accumulated amortization was $1.0 million at June 30, 2006. The allocation of
$0.3 million to in-process R&D was expensed during the three months ended March
31, 2006.
Pinnacle
In August 2005, Avid completed the acquisition of California-based Pinnacle
Systems, Inc. ("Pinnacle"), a supplier of digital video products to customers
ranging from individuals to broadcasters. Avid paid $72.1 million in cash plus
common stock consideration of approximately $362.9 million in exchange for all
of the outstanding shares of Pinnacle. Avid also incurred $6.5 million of
transaction costs. The Company has included Pinnacle's broadcast and
professional offerings, including the Deko(R) on-air graphics system and the
MediaStream(TM) playout server, into its Professional Video segment and has
formed a new Consumer Video segment that offers Pinnacle's consumer products,
including Pinnacle Studio(TM) and other products.
During 2005, the Company allocated the total purchase price of $441.4 million as
follows: $91.8 million to net assets acquired, $123.1 million to identifiable
intangible assets (including $32.3 million of in-process R&D) and the remaining
$226.5 million to goodwill. During the first and second quarters of 2006, the
Company continued its analysis of the fair values of certain assets and
liabilities, in particular accruals for employee terminations, facilities
closures and contract terminations; inventory reserves and certain other
accruals. Accordingly, the Company recorded adjustments to these assets and
liabilities, resulting in a $3.1 million increase in the value of the net assets
acquired and a corresponding decrease to goodwill.
The identifiable intangible assets, with the exception of the in-process R&D,
which was expensed at the time of acquisition, are being amortized over their
estimated useful lives of six and one-half years for customer relationships,
seven years for the trade names and two to three years for the developed
technology. The weighted-average amortization period for these intangible assets
in total is approximately five years. These intangible assets are being
amortized using the straight-line method, with the exception of developed
technology. Developed technology is being amortized on a product-by-product
basis over the greater of: 1) the amount calculated using the ratio of current
quarter revenues to the total of current quarter and anticipated future revenues
over the estimated useful lives of two to three years; or 2) the straight-line
method over each product's remaining respective useful life. Amortization
6
expense for these intangibles totaled $6.3 million and $12.6 million,
respectively, for the three- and six-month periods ended June 30, 2006 and
accumulated amortization was $25.2 million at June 30, 2006.
The goodwill of $223.4 million resulting from the purchase price allocation
reflects the value of the underlying enterprise, as well as planned synergies
that Avid expects to realize, including incremental sales of legacy Avid
Professional Video products. Of the total $223.4 million of goodwill, $88.3
million has been assigned to the Company's Professional Video segment and $135.1
million has been assigned to the Consumer Video segment. This goodwill is not
deductible for tax purposes and will not be amortized for financial reporting
purposes, in accordance with the requirements of Statement of Financial
Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets".
Wizoo
In August 2005, Avid acquired all the outstanding shares of Wizoo Sound Design
GmbH ("Wizoo"), a Germany-based provider of virtual instruments for music
producers and sound designers. The total purchase price of $5.1 million was
allocated as follows: ($0.6 million) to net liabilities assumed, $1.2 million to
identifiable intangible assets, $0.1 million to in-process R&D and the remaining
$4.4 million to goodwill. The identifiable intangible assets, which include
developed technology of $0.6 million and license agreements of $0.6 million, are
being amortized on a straight-line basis over their estimated useful lives of
two to four years and three to four years, respectively. Amortization expense
for these intangibles totaled $0.1 million and $0.2 million, respectively, for
the three- and six-month periods ended June 30, 2006 and accumulated
amortization was $0.4 million at June 30, 2006. The goodwill of $4.4 million,
which reflects the value of the assembled workforce and the synergies the
Company hopes to realize by integrating the Wizoo technology with its other
products, is reported within the Company's Audio segment and is not deductible
for tax purposes.
As part of the purchase agreement, Avid may be required to make additional
payments to the former shareholders of Wizoo of up to 1.0 million euros ($1.2
million), contingent upon Wizoo achieving certain engineering milestones through
January 2008. These payments, if required, will be recorded as additional
purchase consideration, allocated to goodwill. As of June 30, 2006, two
engineering milestones have been met and $0.2 million has been recorded as
additional purchase price.
Pro Forma Financial Information for Acquisitions (Unaudited)
The results of operations of Sundance, Medea, Pinnacle and Wizoo have been
included in the results of operations of the Company since the respective date
of each acquisition. The following unaudited pro forma financial information
presents the results of operations for the three- and six-month periods ended
June 30, 2005 as if the acquisition of Pinnacle had occurred at the beginning of
2005. The Company's pro forma results of operations giving effect to the
Sundance, Medea and Wizoo acquisitions as if each had occurred at the beginning
of 2005 are not included as they would not differ materially from reported
results. The pro forma financial information for the combined entities has been
prepared for comparative purposes only and is not indicative of what actual
results would have been if the acquisitions had taken place at the beginning of
fiscal 2005, or of future results.
Three Months Ended Six Months Ended
June 30, 2005 June 30, 2005
------------------ -------------------
(In thousands, except per share data)
Net revenues $214,519 $445,724
Net loss ($4,651) ($25,709)
Net loss per share:
Basic ($0.11) ($0.62)
Diluted ($0.11) ($0.62)
Included in the pro forma net income reported above for the six-month period
ended June 30, 2005 is a charge of $32.3 million for in-process R&D related to
the Pinnacle acquisition.
Amortizing Identifiable Intangible Assets
As a result of the Company's acquisitions, amortizing identifiable intangible
assets consist of the following (in thousands):
7
June 30, 2006 December 31, 2005
--------------------------------- ---------------------------------
Accumulated Accumulated
Gross Amortization Net Gross Amortization Net
--------- ------------- --------- --------- ------------- ---------
Completed technologies $59,328 ($25,603) $33,725 $52,698 ($14,606) $38,092
Customer relationships 69,800 (11,204) 58,596 68,200 (6,755) 61,445
Trade names 20,516 (3,509) 17,007 20,245 (1,993) 18,252
Non-compete covenants 1,670 (1,179) 491 1,200 (818) 382
License agreements 560 (131) 429 560 (55) 505
Order Backlog 340 (340) - - - -
--------- ------------- --------- --------- ------------- ---------
$152,214 ($41,966) $110,248 $142,903 ($24,227) $118,676
========= ============= ========= ========= ============= =========
Amortization expense related to all intangible assets in the aggregate was $9.0
million and $1.9 million, respectively, for the three-month periods ended June
30, 2006 and 2005, and $17.7 million and $3.7 million, respectively, for the
six-month periods ended June 30, 2006 and 2005. The Company expects amortization
of these intangible assets to be approximately $17 million for the remainder of
2006, $27 million in 2007, $20 million in 2008, $13 million in 2009, $11 million
in 2010, $10 million in 2011 and $12 million thereafter.
4. ACCOUNTS RECEIVABLE
Accounts receivable, net consist of the following (in thousands):
June 30, December 31,
2006 2005
------------- ------------
Accounts receivable $166,146 $162,902
Less:
Allowance for doubtful accounts (2,969) (4,847)
Allowance for sales returns and rebates (19,243) (17,386)
------------- ------------
$143,934 $140,669
============= ============
The allowance for doubtful accounts represents a reserve for estimated bad debt
losses resulting from the inability of customers to make required payments for
products or services. When evaluating the adequacy of this allowance, the
Company analyzes accounts receivable balances, historical bad debt experience,
customer concentrations, customer credit-worthiness and current economic trends.
The allowance for sales returns and rebates, which includes allowances for
estimated returns, exchanges and credits for price protection, are provided as a
reduction of revenues in the same period that related revenues are recorded,
based upon the Company's historical experience. To date, actual returns and
other allowances have not differed materially from management's estimates.
The accounts receivable balances as of June 30, 2006 and December 31, 2005 are
net of approximately $20 million and $17 million, respectively, which represent
amounts for large solution and certain distributor sales that have been invoiced
but for which revenue has not been earned and payment is not due.
5. INVENTORIES
Inventories, net of related reserves, consist of the following (in thousands):
June 30, December 31,
2006 2005
-------------- --------------
Raw materials $43,281 $26,878
Work in process 9,841 13,040
Finished goods 68,857 56,927
-------------- --------------
$121,979 $96,845
============== ==============
As of June 30, 2006 and December 31, 2005, the finished goods inventory includes
inventory at customer locations of $11.6 million and $11.5 million,
respectively, associated with product shipped to customers for which revenue has
not yet been recognized.
8
6. LONG-TERM LIABILITIES
Long-term liabilities consist of the following (in thousands):
June 30, December 31,
2006 2005
-------------- --------------
Long-term deferred tax liability $7,871 $9,372
Long-term deferred revenue 4,631 3,171
Long-term deferred rent 3,295 3,644
Long-term accrued restructuring 2,993 3,861
-------------- --------------
$18,790 $20,048
============== ==============
7. ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company has several stock-based compensation plans under which employees,
officers, directors and consultants may be granted stock awards or options to
purchase the Company's common stock, generally at the market price on the date
of grant. Certain plans allow for options to be granted at below market price
under certain circumstances, although this is typically not the Company's
practice. The options become exercisable over various periods, typically four
years for employees and one year for non-employee directors, and have a maximum
term of ten years. As of June 30, 2006, 2,591,105 shares of common stock remain
available to cover future stock option grants under the Company's stock-based
compensation plans, including 2,227,063 shares that may alternatively be issued
as awards of restricted stock, restricted stock units or other forms of
stock-based compensation.
In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 123 (revised 2004), "Share-Based Payment" ("SFAS 123(R)"), which is a
revision of SFAS No. 123, "Accounting for Stock Based Compensation". SFAS 123(R)
requires employee stock-based compensation awards to be accounted for under the
fair value method and eliminates the ability to account for these instruments
under the intrinsic value method as prescribed by Accounting Principles Board
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees" and related
interpretations. The Company adopted SFAS 123(R) on January 1, 2006 using the
modified prospective application method as permitted under SFAS 123(R). Under
this method, the Company is required to record compensation cost, based on the
fair value estimated in accordance with SFAS 123(R), for stock-based awards
granted after the date of adoption over the requisite service periods for the
individual awards, which generally equals the vesting period. The Company is
also required to record compensation cost for the unvested portion of previously
granted stock-based awards outstanding at the date of adoption over the
requisite service periods for the individual awards based on the fair value
estimated in accordance with the original provisions of SFAS No. 123 adjusted
for forfeitures as required by SFAS 123(R).
Prior to the adoption of SFAS 123(R), the Company accounted for stock-based
compensation under the recognition and measurement principles of APB Opinion No.
25 and related interpretations. Accordingly, no compensation expense was
recorded for options issued to employees and directors in fixed amounts and with
fixed exercise prices at least equal to the market price of the Company's common
stock at the date of grant. In connection with the acquisition of M-Audio in
August 2004, the Company granted options to certain M-Audio employees at
exercise prices that were less than the market price of the Company's common
stock at the date of grant. The Company recorded the difference between the
exercise prices and the fair values of the options at the date of completion of
the acquisition, determined under the Black-Scholes method, multiplied by the
number of shares underlying the options, as deferred compensation. The
resulting deferred compensation is being expensed over the vesting period of
the options. Additionally, deferred compensation was recorded for
restricted stock granted to employees based on the market price of the Company's
common stock at the date of grant, which is being expensed over the period in
which the restrictions lapse. In connection with the adoption of SFAS 123(R) on
January 1, 2006, the Company reversed the remaining deferred compensation of
$1.8 million, with the offset to additional paid-in capital.
The following table illustrates the effect on net income and net income per
share as if the Company had applied the fair value recognition provisions of
SFAS No. 123 to all stock-based employee awards for the three- and six-month
periods ended June 30, 2005 (in thousands, except per share data):
9
Three Months Ended Six Months Ended
June 30, 2005 June 30, 2005
------------------ -----------------
Net income as reported $13,566 $33,312
Add: Stock-based employee compensation expense
included in reported net income, net of related
tax effects 672 1,514
Deduct: Total stock-based employee compensation
expense determined under the fair value based method
for all awards, net of related tax effects (5,904) (10,724)
------------------ -----------------
Pro forma net income $8,334 $24,102
================== =================
Net income per share:
Basic-as reported $0.39 $0.95
Basic-pro forma $0.24 $0.69
Diluted-as reported $0.37 $0.90
Diluted-pro forma $0.23 $0.66
Beginning with the adoption of SFAS 123(R) in the first quarter of 2006, the
Company recorded stock-based compensation expense for the fair value of stock
options. Stock-based compensation expense of $4.4 million and $8.9 million,
resulting from the adoption of SFAS 123(R), the acquisition of M-Audio and the
issuance of restricted stock and restricted stock units, was included in the
following captions in the Company's condensed consolidated statement of
operations for the three- and six-month periods ended June 30, 2006,
respectively (in thousands):
Three Months Ended Six Months Ended
June 30, 2006 June 30, 2006
------------------ ------------------
Product cost of revenues $131 $270
Services cost of revenues 208 427
Research and development expense 1,272 2,607
Marketing and selling expense 1,230 2,533
General and administrative expense 1,513 3,023
------------------ ------------------
$4,354 $8,860
================== ==================
The fair values of restricted stock awards, including restricted stock and
restricted stock units, are based on the intrinsic values of the awards at the
date of grant. As permitted under SFAS No. 123 and SFAS 123(R), the Company uses
the Black-Scholes option pricing model to estimate the fair value of stock
option grants. The Black-Scholes model relies on a number of key assumptions to
calculate estimated fair values. The following table sets forth the
weighted-average key assumptions and fair value results for stock options
granted during the three- and six-month periods ended June 30, 2006 and 2005:
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ------------------
2006 2005 2006 2005
------- ------- ------- --------
Expected dividend yield 0.00% 0.00% 0.00% 0.00%
Risk-free interest rate 5.01% 3.63% 4.86% 3.82%
Expected volatility 34.32% 48.00% 34.52% 50.80%
Expected life (in years) 4.63 4.17 4.48 4.09
Weighted-average fair value of options granted $14.17 $22.81 $15.11 $28.17
The dividend yield of zero is based on the fact that the Company has never paid
cash dividends and has no present intention to pay cash dividends. Since
adoption of SFAS 123(R) on January 1, 2006, the expected stock-price volatility
assumption used by the Company has been based on recent (six month trailing)
implied volatility calculations. These calculations are performed on
exchange-traded options of the Company's stock, based on the implied volatility
of long-term (nine to thirty-nine month term) exchange traded options, which is
10
consistent with the requirements of SFAS 123(R) and Securities and Exchange
Commission Staff Accounting Bulletin No. 107. The Company believes that using a
forward-looking, market-driven volatility assumption will result in the best
estimate of expected volatility. Prior to adoption of SFAS 123(R), the expected
volatility was based on historical volatilities of the underlying stock. The
risk-free interest rate is the U.S. Treasury security rate with a term equal to
the expected life of the option. The expected life is based on company-specific
historical experience. With regard to the estimate of the expected life, the
Company considers the exercise behavior of past grants and models the pattern of
aggregate exercises.
Based on the Company's historical turnover rates, an annualized estimated
forfeiture rate of 6.5% has been used in calculating the estimated compensation
cost for both the three- and six-month periods ended June 30, 2006. Additional
expense will be recorded if the actual forfeiture rates are lower than estimated
and a recovery of prior expense will be recorded if the actual forfeitures are
higher than estimated. Prior to the adoption of SFAS 123(R), forfeitures were
not estimated at the time of award.
Information with respect to options granted under all stock option plans is as
follows:
Six Months Ended June 30, 2006
--------------------------------------------------
Weighted- Aggregate
Weighted- Average Intrinsic
Shares Average Remaining Value
Exercise Contractual (in
Price Term thousands)
------------ --------- ----------- -----------
Options outstanding at December 31, 2005 4,220,174 $36.65
Granted 186,200 $41.64
Exercised (211,021) $16.33
Forfeited (114,873) $40.00
Canceled (23,268) $49.75
------------
Options outstanding at June 30, 2006 4,057,212 $37.77 7.35 $23,712
============
Options vested at June 30, 2006 and expected to vest 3,917,650 $37.48 7.30 $23,612
============
Options exercisable at June 30, 2006 2,355,662 $34.32 6.54 $20,611
============
The aggregate intrinsic value of stock options exercised during the six months
ended June 30, 2006 was approximately $5.3 million. Cash received from the
exercise of stock options for the six months ended June 30, 2006 was $3.4
million. The Company did not realize any actual tax benefit from the tax
deductions for stock option exercises during the six months ended June 30, 2006,
due to the full valuation allowance on the Company's U.S. deferred tax assets.
The following table summarizes the status of the Company's non-vested restricted
stock units as of December 31, 2005 and changes during the six months ended June
30, 2006:
Non-Vested Restricted Stock Units
--------------------------------------------------------
Weighted- Weighted-Average Aggregate
Average Remaining Intrinsic
Shares Grant-Date Recognition Value
Fair Value Period (in
thousands)
----------- --------- ------------------ ------------
Non-vested at December 31, 2005 - -
Granted 207,757 $47.01
Vested - -
Forfeited (2,950) $47.01
-----------
Non-vested at June 30, 2006 204,807 $47.01 3.69 $6,824
===========
11
The following table summarizes the status of the Company's non-vested restricted
stock as of December 31, 2005 and changes during the six months ended June 30,
2006:
Non-Vested Restricted Stock
--------------------------------------------------------
Weighted- Weighted-Average Aggregate
Average Remaining Intrinsic
Shares Grant-Date Recognition Value
Fair Value Period (in
thousands)
----------- --------- ------------------ ------------
Non-vested at December 31, 2005 15,000 $56.72
Granted 8,618 $47.01
Vested - -
Forfeited - -
-----------
Non-vested at June 30, 2006 23,618 $53.18 2.85 $787
===========
As of June 30, 2006, there was $33.6 million of total unrecognized compensation
cost, before forfeitures, related to non-vested stock-based compensation awards
granted under the Company's stock-based compensation plans. This cost will be
recognized over the next four years. The Company expects this amount to be
amortized as follows: $8.8 million during the remainder of 2006, $12.7 million
in 2007 and $12.1 million thereafter. The weighted-average recognition period of
the total unrecognized compensation cost is 1.41 years.
The Company's 1996 Employee Stock Purchase Plan, as amended through May 25,
2003, authorizes the issuance of a maximum of 1,700,000 shares of common stock
in quarterly offerings to employees at a price equal to 95% of the closing price
on the applicable offering termination date. As of June 30, 2006, 310,261 shares
remain available for issuance under this plan. Based on the plan design, the
Company's 1996 Employee Stock Purchase Plan is considered noncompensatory under
SFAS 123(R). Accordingly, the Company is not required to assign fair value to
shares issued from this plan.
8. CONTINGENCIES
Avid receives inquiries from time to time with regard to possible patent
infringement claims. If any infringement is determined to exist, the Company may
seek licenses or settlements. In addition, as a normal incidence of the nature
of the Company's business, various claims, charges and litigation have been
asserted or commenced from time to time against the Company arising from or
related to contractual or employee relations, intellectual property rights or
product performance. Management does not believe these claims will have a
material adverse effect on the financial position or results of operations of
the Company.
In April 2005, Avid was notified by the Korean Federal Trade Commission ("KFTC")
that a former reseller, Neat Information Telecommunication, Inc. ("Neat"), had
filed a petition against a subsidiary, Avid Technology Worldwide, Inc., alleging
unfair trade practices. On August 11, 2005, the KFTC issued a decision in favor
of Avid regarding the complaint filed by Neat. However, Neat filed a second
petition with the KFTC on October 17, 2005 alleging the same unfair trade
practices as those set forth in the former KFTC petition. On January 13, 2006,
Avid filed its response to the second KFTC petition denying Neat's allegations.
On February 16, 2006, the KFTC reaffirmed its earlier decision in favor of Avid
and concluded its review of the case. In addition, on October 14, 2005, Neat
filed a civil lawsuit in Seoul Central District Court against Avid Technology
Worldwide, Inc. alleging unfair trade practices. In the civil action, Neat is
seeking approximately $1.7 million in damages, plus interest and attorneys fees.
The Company has filed answers to the complaint denying Neat's allegations. Avid
believes that Neat's claims are without merit and intends to vigorously defend
the claim in these actions. Avid cannot predict the outcome of these actions at
this time and, accordingly, no costs have been accrued for any possible loss
contingency.
From time to time, the Company provides indemnification provisions in agreements
with customers covering potential claims by third parties of intellectual
property infringement. These agreements generally provide that the Company will
indemnify customers for losses incurred in connection with an infringement claim
brought by a third party with respect to the Company's products. These
indemnification provisions generally offer perpetual coverage for infringement
claims based upon the products covered by the agreement. The maximum potential
amount of future payments the Company could be required to make under these
indemnification provisions is theoretically unlimited; however, to date, the
Company has not incurred material costs related to these indemnification
provisions. As a result, the Company believes the estimated fair value of these
indemnification provisions is minimal.
12
As permitted under Delaware law, Avid has agreed to indemnify its officers and
directors for certain events that occur while the officer or director is serving
in such capacity. The term of the indemnification period is for each respective
officer's or director's lifetime. The maximum potential amount of future
payments the Company could be required to make under these indemnification
agreements is unlimited; however, Avid has mitigated the exposure through the
purchase of directors and officers insurance, which is intended to limit the
risk and, in most cases, enable the Company to recover all or a portion of any
future amounts paid. As a result of this insurance policy coverage and Avid's
related payment experience to date, the Company believes the estimated fair
value of these indemnification agreements is minimal.
The Company has a standby letter of credit at a bank that is used as a security
deposit in connection with the Company's Daly City, California office space
lease. In the event of default on this lease, the landlord would be eligible to
draw against this letter of credit to a maximum, as of June 30, 2006, of $3.5
million, subject to an annual reduction of approximately $0.8 million, but not
below $2.0 million. The letter of credit will remain in effect at $2.0 million
throughout the remaining lease period, which extends to September 2009. As of
June 30, 2006, the Company was not in default of this lease.
The Company, through a third party, provides lease financing options to its
customers, including end-users and, on a limited basis, resellers. During the
terms of these leases, which are generally three years, the Company remains
liable for any unpaid principal balance upon default by the end-user, but such
liability is limited in the aggregate based on a percentage of initial amounts
funded or, in certain cases, amounts of unpaid balances. At June 30, 2006 and
December 31, 2005, Avid's maximum recourse exposure totaled approximately $12.8
million and $13.0 million, respectively. The Company records revenue from these
transactions upon the shipment of products, provided that all other revenue
recognition criteria, including collectibility being reasonably assured, are
met. Because the Company has been providing these financing options to its
customers for many years, the Company has a substantial history of collecting
under these arrangements without providing significant refunds or concessions to
the end user, reseller or financing party. To date, the payment default rate has
consistently been between 2% and 4% per year of the original funded amount. This
low default rate results from the diligence of the third party leasing company
in screening applicants and in collecting amounts due, and because Avid actively
monitors its exposures under the financing program and participates in the
approval process for any lessees outside of agreed-upon credit-worthiness
metrics. The Company maintains a reserve for estimated losses under this
recourse lease program based on these historical default rates applied to the
funded amount outstanding at period end. At June 30, 2006 and December 31, 2005,
the Company's accrual for estimated losses was $1.9 million and $1.8 million,
respectively.
Avid provides warranties on externally sourced and internally developed
hardware. For internally developed hardware and in cases where the warranty
granted to customers for externally sourced hardware is greater than that
provided by the manufacturer, the Company records an accrual for the related
liability based on historical trends and actual material and labor costs. The
warranty period for all of the Company's products is generally 90 days to one
year, but can extend up to five years depending on the manufacturer's warranty
or local law.
The following table sets forth the activity in the product warranty accrual
account (in thousands):
Six Months Ended June 30,
------------------------------
2006 2005
-------------- -------------
Accrual balance at beginning of period $6,190 $2,261
Acquired product warranty 67 -
Accruals for product warranties 3,313 2,244
Cost of warranty claims (3,365) (1,727)
-------------- -------------
Accrual balance at end of period $6,205 $2,778
============== =============
The $3.4 million product warranty accrual increase from June 30, 2005 to June
30, 2006 is primarily the result of $3.1 million of acquired Pinnacle warranty
accruals.
9. COMPREHENSIVE INCOME
Total comprehensive income net of taxes consists of net income and the net
changes in foreign currency translation adjustment and net unrealized gains and
losses on available-for-sale securities. The following is a summary of the
Company's comprehensive income (in thousands):
13
Three Months Ended Six Months Ended
June 30, June 30,
------------------------ -----------------------
2006 2005 2006 2005
------------ ----------- ----------- -----------
Net income $2,699 $13,566 $6,045 $33,312
Net changes in:
Foreign currency translation adjustment 2,416 (1,923) 3,746 (3,186)
Unrealized gains (losses) on securities (18) 74 (102) 135
------------ ----------- ----------- -----------
Total comprehensive income $5,097 $11,717 $9,689 $30,261
============ =========== =========== ===========
10. SEGMENT INFORMATION
The Company's organizational structure is based on strategic business units,
each of which offers various products to the principal markets in which the
Company's products are sold. These business units equate to three reportable
segments: Professional Video, Audio and Consumer Video. The following is a
summary of the Company's operations by reportable segment (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- -------------------------
2006 2005 2006 2005
------------- ------------ ------------ ------------
Professional Video:
Net revenues $118,864 $94,984 $235,064 $199,469
Operating income 6,251 7,083 16,363 22,198
Audio:
Net revenues $74,262 $65,067 $147,009 $126,583
Operating income 10,199 8,465 19,791 16,332
Consumer Video:
Net revenues $29,100 - $58,223 -
Operating loss (1,625) - (4,045) -
Combined Segments:
Net revenues $222,226 $160,051 $440,296 $326,052
Operating income 14,825 15,548 32,109 38,530
Certain expenses are not included in the operating results of the reportable
segments because management does not consider them in evaluating operating
results of the segments. The following table reconciles operating income (loss)
for reportable segments to the total consolidated amounts for the three- and
six-month periods ended June 30, 2006 and 2005 (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- -----------------------
2006 2005 2006 2005
----------- ----------- ----------- -----------
Total operating income for reportable segments $14,825 $15,548 $32,109 $38,530
Unallocated amounts:
Restructuring costs - - (1,066) -
In-process research and development - - (310) -
Stock-based compensation (4,283) (601) (8,718) (1,372)
Amortization of acquisition-related
intangible assets (8,993) (1,875) (17,738) (3,748)
----------- ----------- ----------- -----------
Consolidated operating income $1,549 $13,072 $4,277 $33,410
=========== =========== =========== ===========
14
11. RESTRUCTURING COSTS AND ACCRUALS
In March 2006, the Company implemented a restructuring program within the
Consumer Video segment under which 23 employees worldwide, primarily in the
marketing and selling function and the research and development function, were
notified that their employment would be terminated. The purpose of the program
was to maximize the efficiency of the Company's organizational structure. In
connection with this action, the Company recorded a charge of $1.1 million.
Payments to the employees are expected to be completed during 2006.
In December 2005, the Company implemented a restructuring program under which
the employment of 20 employees worldwide was terminated and a portion of a
leased facility in Montreal, Canada was vacated. In connection with these
actions, the Company recorded charges of $0.8 million for employee terminations
and $0.5 million for continuing rent obligations on excess space vacated, net of
potential sublease income.
Also during 2005, the Company recorded a charge of $1.8 million in connection
with a revised estimate of the lease obligation associated with a facility that
was vacated as part of a restructuring plan in 1999. The revision was necessary
due to one of the subtenants in the facility giving notice of their intention to
discontinue their sublease. The lease extends through September 2010.
The Company recorded these charges in accordance with the guidance of SFAS No.
146, "Accounting for Costs Associated with Exit or Disposal Activities". These
restructuring charges and accruals require significant estimates and
assumptions, including sub-lease income assumptions. These estimates and
assumptions are monitored on at least a quarterly basis for changes in
circumstances and any corresponding adjustments to the accrual are recorded in
the Company's statement of operations in the period when such changes are known.
In connection with the August 2005 Pinnacle acquisition and the January 2006
Medea acquisition, the Company recorded accruals of $14.4 million for Pinnacle
in 2005 and $0.3 million for Medea in 2006 related to severance agreements and
lease or other contract terminations in accordance with EITF 95-3, "Recognition
of Liabilities in Connection with a Purchase Business Combination". Such amounts
recorded in connection with the Pinnacle and Medea acquisitions are reflected in
the purchase price allocations for the acquisitions and any adjustments to the
accruals are recorded as adjustments to goodwill (see Note 3) and are not
recorded in the Company's statement of operations.
The following table sets forth the activity in the restructuring and other costs
accruals for the six months ended June 30, 2006 (in thousands):
Non-Acquisition Acquisition Related
Related Restructuring Restructuring
Liabilities Liabilities
--------------------- ---------------------
Employee Facilities Employee Facilities
Related Related Related Related Total
--------------------- --------------------- ----------
Accrual balance at December 31, 2005 $129 $4,467 $2,976 $2,785 $10,357
New restructuring activities 1,134 - 257 - 1,391
Revisions of estimated liabilities (68) - (1,414) (646) (2,128)
Cash payments for employee-related charges (517) - (853) - (1,370)
Cash payments for facilities, net of
sublease income - (817) - (862) (1,679)
Foreign exchange impact on ending balance 68 180 140 125 513
--------------------- --------------------- ----------
Accrual balance at June 30, 2006 $746 $3,830 $1,106 $1,402 $7,084
===================== ===================== ==========
The employee-related accruals at June 30, 2006 represent severance and
outplacement costs to former employees that will be paid out within 2006.
The facilities-related accruals at June 30, 2006 represent estimated losses on
subleases of space vacated as part of the Company's restructuring actions. The
leases, and payments against the amounts accrued, extend through 2011 unless the
Company is able to negotiate earlier terminations.
15
12. RECENT ACCOUNTING PRONOUNCEMENTS
In June 2006, the FASB issued FASB Interpretation No. ("FIN") 48, "Accounting
for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109",
which prescribes a recognition threshold and measurement attribute for the
financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. FIN 48 will be effective for fiscal years
beginning after December 15, 2006, or January 1, 2007 for Avid. The Company has
not yet completed its evaluation of the impact of adoption on the Company's
financial position or results of operations.
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of
Financial Assets", an amendment to FASB Statement No. 140. SFAS No. 156 requires
recognition of a servicing asset or servicing liability whenever an entity
enters into certain service agreements which result in an obligation to service
a financial asset, and requires that servicing assets and servicing liabilities
be recognized at fair value, if practicable. SFAS No. 156 will be effective for
fiscal years beginning after September 15, 2006, or January 1, 2007 for Avid.
Adoption of SFAS No. 156 is not expected to have a material impact on the
Company's financial position or results of operations.
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain Hybrid
Financial Instruments", an amendment to FASB Statements No. 133 and 140. SFAS
No. 155 permits fair value remeasurement for any hybrid financial instrument
that contains an embedded derivative that otherwise would require bifurcation.
SFAS No. 155 will be effective for fiscal years beginning after September 15,
2006, or January 1, 2007 for Avid. As of June 30, 2006, the Company did not have
any hybrid financial instruments subject to the fair value election of SFAS No.
155.
In November 2005, the FASB issued FASB Staff Position No. FAS 123(R)-3,
"Transition Election Related to Accounting for Tax Effects of Share-Based
Payment Awards". The Company is considering whether to adopt the alternative
transition method provided in the FASB Staff Position ("FSP") for calculating
the tax effects of stock-based compensation pursuant to SFAS 123(R). The
alternative transition method includes simplified methods to establish the
beginning balance of the additional paid-in capital pool ("APIC Pool") related
to the excess tax benefits available to absorb tax deficiencies recognized
subsequent to the adoption of SFAS 123(R). The Company is currently evaluating
which transition method it will use for calculating its APIC Pool. An entity may
take up to one year from the later of its initial adoption of SFAS 123(R) or the
effective date of this FSP to evaluate its available transition alternatives and
make its one-time election. Until and unless the Company elects the transition
method described in the FSP, the transition method provided in SFAS 123(R) is
being followed. The Company expects to complete its evaluation by December 31,
2006.
In June 2005, the FASB issued FSP No. FAS 143-1, "Accounting for Electronic
Equipment Waste Obligations", or FSP 143-1, which provides guidance on the
accounting for obligations associated with the European Union, or EU, Directive
on Waste Electrical and Electronic Equipment, or the WEEE Directive. FSP 143-1
provides guidance on how to account for the effects of the WEEE Directive with
respect to historical waste associated with products in the market on or before
August 13, 2005. FSP 143-1 is required to be applied to the later of the first
reporting period ending after June 8, 2005 or the date of the adoption of the
WEEE Directive into law by the applicable EU member country. The Company is in
the process of registering with the member countries, as appropriate, and is
still awaiting guidance from these countries with respect to the compliance
costs and obligations for historical waste. Avid will continue to work with each
country to obtain guidance and will accrue for compliance costs when they are
probable and reasonably estimable. The accruals for these compliance costs may
have a material impact on the Company's financial position or results of
operations when guidance is issued by each member country.
13. SUBSEQUENT EVENTS
A stock repurchase program was approved by the Company's board of directors
effective July 21, 2006. Under this program, the Company was authorized to
repurchase up to $50 million of the Company's common stock through transactions
on the open market, in block trades or otherwise. The program was completed on
August 7, 2006 with 1,432,327 shares of the Company's common stock repurchased
from July 25, 2006 through the completion date. The stock repurchase program was
funded using the Company's working capital.
On July 28, 2006, the Company acquired Sibelius Software Limited ("Sibelius"),
a UK-based music applications software company and a leading provider of music
notation software in the education and professional markets, for cash
consideration of approximately (pound)12.4 million ($23 million). The
acquisition of Sibelius will allow the Company to broaden its Audio product
offerings and accelerate its expansion into the educational market.
16
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
EXECUTIVE OVERVIEW
We develop, market, sell and support a wide range of software and
hardware products for digital media production, management and distribution.
Digital media are video, audio or graphic elements in which an image or sound is
recorded and stored in digital values, as opposed to analog, or tape-based,
signals. Our diverse range of product and service offerings enables customers to
"Make, Manage and Move Media(TM)".
Make Media. Our products help every class of user create and use video
and audio assets, from the home user to the feature film professional. Our
Professional Video segment offers innovative video and film editing systems, as
well as 3D and special-effects software. These products enable professionals,
and aspiring professionals, in the post-production and broadcast markets to
manipulate moving pictures and sound in fast, easy, creative and cost-effective
ways. Our Audio segment offers consumer and professional digital audio software
applications and hardware systems for music, film, television, video,
broadcast, streaming media and web development. These systems are based upon
proprietary audio hardware, software and control surfaces, and allow users to
record, edit, mix, process and master audio in an integrated manner. Our
Consumer Video segment offers products for home video editing and TV viewing.
Our home video editing products allow users to create, edit and share video
content more easily and effectively, while our TV viewing products allow
consumers to view, record and time shift television programming on their
computers.
Manage Media. The ability to manage digital media assets effectively is
a critical component of success for all content creators. Our technology
enables users to simultaneously share and manage media assets throughout a
project or organization. As a result, professionals can collaborate in real
time on all production elements and streamline the process for cost-effective
management and delivery of media. In addition, our tools allow customers to
easily repurpose digital assets to take advantage of a variety of market
opportunities. For consumer applications, we also offer products that allow
users to manage their media projects, such as home movies or recorded music.
Move Media. Our products allow our customers to distribute media over
multiple platforms - including air, cable or satellite, or on the Internet. In
addition, we provide technology for playback directly to air for broadcast
television applications. Many of our products also support the broadcast of
streaming Internet video. For professionals as well as consumers, our
laptop-based editing systems, storage products and DVD authoring tools enable
easy portability of media.
Our products are used worldwide in production and post-production
facilities; film studios; network, affiliate, independent and cable television
stations; recording studios; performance venues; advertising agencies;
government and educational institutions; corporate communication departments;
and by game developers and Internet professionals, as well as by amateurs,
aspiring professionals and home hobbyists. Projects produced by customers using
our products have been honored with Oscar(R), Emmy(R) and Grammy(R) awards, in
addition to a host of other international awards. We have also received numerous
awards for technical innovations, including two Oscar awards, 12 Emmy awards and
a Grammy award. Oscar is a registered trademark and service mark of the Academy
of Motion Picture Arts and Sciences. Emmy is a registered trademark of
ATAS/NATAS. Grammy is a registered trademark of The National Academy of
Recording Arts and Sciences, Inc.
Our strategy consists of four key elements: deliver best of breed
stand-alone products, deliver integrated workflow for customers with multiple
systems, support open standards for media and deliver excellent customer
service. We continue to focus on enhancing our existing products and broadening
our product offerings to satisfy customer demand for new technology across the
spectrum of educational to consumer to professional markets. We continue to
position ourself and deliver new products and services to benefit from a number
of important industry trends, including the move to high-definition, or HD, in
television production, the switch to all-digital production in broadcast, the
growth of home audio studios, the move to digital audio mixing and the growth
of consumer video editing and consumption. Our products may be developed
internally or through acquisitions. As part of this strategy, we made the
following acquisitions in 2006.
o On July 28, 2006, we acquired Sibelius Software Limited, or Sibelius,
a UK-based music applications software company and a leading provider
of music notation software in the education and professional markets.
Our acquisition of Sibelius will allow us to broaden our Audio
product offerings and accelerate our expansion into the educational
market.
17
o On April 13, 2006, we acquired Sundance Digital, Inc., a Texas-based
developer of automation and device control software for broadcast
video servers, tape transports, graphics systems and other broadcast
station equipment. The acquisition of Sundance will allow us to offer
more open and streamlined broadcast production workflows across the
entire spectrum of media acquisition, production and transmission.
o On January 12, 2006, we acquired Medea Corporation, a
California-based provider of local storage solutions for real-time
media applications. The acquisition of Medea will allow us to provide
high performance, low cost RAID (Redundant Array of Independent
Disks) storage solutions to our Professional Video customers.
Total net revenues for the first six months of 2006 were $440.3 million,
an increase of $114.2 million, or 35%, compared to the first six months of last
year. Approximately 82% of this increase represents net revenues in 2006 from
Pinnacle, which was acquired in the third quarter of 2005. Net income for the
first six months of 2006 was $6.0 million, a decrease of $27.3 million, or 82%,
from the same period last year. However, $8.2 million of this decrease was the
direct result of the adoption of Statement of Financial Accounting Standards No.
123 (revised 2004), "Share-Based Payment", or SFAS 123(R), on January 1, 2006,
which requires the recognition of fair value expense for all stock-based
compensation awards. Net income for the first six months of 2006 also included
$17.7 million of acquisition-related amortization expense and $1.1 million of
restructuring costs, compared to $3.7 million of amortization expense and no
restructuring expense for the same period last year. Our operating activities
continue to generate positive cash flow with cash of $23.5 million provided by
operating activities in the first six months of 2006, compared to $38.2 million
for the same period last year.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements and related disclosures in
conformity with U.S. generally accepted accounting principles and our discussion
and analysis of our financial condition and results of operations requires us to
make judgments, assumptions and estimates that affect the amounts reported in
our consolidated financial statements and accompanying notes. Note B of the
Notes to Consolidated Financial Statements in our 2005 Annual Report on Form
10-K describes the significant accounting policies and methods used in the
preparation of our consolidated financial statements. We base our estimates on
historical experience and on various other assumptions that we believe are
reasonable under the circumstances, the results of which form the basis for
judgments about the carrying values of assets and liabilities. Actual results
may differ from these estimates.
We believe that our critical accounting policies are those related to
revenue recognition and allowances for product returns and exchanges, allowance
for bad debts and reserves for recourse under financing transactions,
inventories, business combinations, goodwill and intangible assets, stock-based
compensation and income tax assets. We believe these policies are critical
because they are important to the portrayal of our financial condition and
results of operations, and they require us to make judgments and estimates about
matters that are inherently uncertain. Additional information about our critical
accounting policies, except stock-based compensation, may by found in our 2005
Annual Report on Form 10-K in Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations", under the heading "Critical
Accounting Policies and Estimates". The critical accounting policy for
stock-based compensation, which follows, was added to our Quarterly Report on
Form 10-Q for the quarter ended March 31, 2006, as a result of the adoption of
SFAS 123(R) on January 1, 2006.
Stock-Based Compensation
During the first quarter of 2006, we adopted the provisions of and
accounted for stock-based compensation in accordance with Statement of Financial
Accounting Standards No. 123 (revised 2004), "Share-Based Payment", which is a
revision of SFAS No. 123, "Accounting for Stock Based Compensation". SFAS 123(R)
requires employee stock-based compensation awards to be accounted for under the
fair value method and eliminates the ability to account for these instruments
under the intrinsic value method as prescribed by Accounting Principles Board,
or APB, Opinion No. 25, "Accounting for Stock Issued to Employees" and related
interpretations. We adopted SFAS 123(R) on January 1, 2006 using the modified
prospective application method as permitted under SFAS 123(R). Under this
method, we are required to record compensation cost, based on the fair value
estimated in accordance with SFAS 123(R), for stock-based awards granted after
the date of adoption over the requisite service periods for the individual
awards, which generally equals the vesting period. We are also required to
record compensation cost for the unvested portion of previously granted
stock-based awards outstanding at the date of adoption over the requisite
service periods for the individual awards based on the fair value estimated in
accordance with the original provisions of SFAS No. 123 adjusted for forfeitures
as required by SFAS 123(R).
Prior to the adoption of SFAS 123(R), we accounted for stock-based
compensation under the recognition and measurement principles of APB Opinion No.
25 and related interpretations. Accordingly, no compensation expense was
recorded for options issued to employees and non-employee directors in fixed
amounts and with fixed exercise prices at least equal to the market price of our
18
common stock at the date of grant. In connection with our acquisition of M-Audio
in August 2004, we granted options to certain M-Audio employees at exercise
prices that were less than the market price of our common stock at the date of
grant. We recorded the difference between the exercise prices and the fair value
of the options at the date of completion of the acquisition, determined under
the Black-Scholes method, multiplied by the number of shares underlying the
options, as deferred compensation. The resulting deferred compensation is being
expensed over the vesting period of the options. Additionally, deferred
compensation was recorded for restricted stock granted to employees based on the
market price of our common stock at the date of grant, which is being expensed
over the period in which the restrictions lapse. In connection with the adoption
of SFAS 123(R) on January 1, 2006, we reversed the remaining deferred
compensation of $1.8 million, with the offset to additional paid-in capital.
In anticipation of the adoption of SFAS 123(R), on October 26, 2005, our
board of directors approved a partial acceleration of the vesting of all
outstanding options to purchase our common stock that were granted on February
17, 2005. Vesting was accelerated for options to purchase 371,587 shares of our
common stock with an exercise price of $65.81 per share, including options to
purchase 157,624 shares of our common stock held by our executive officers. The
decision to accelerate vesting of these options was made to avoid recognizing
compensation cost related to these out-of-the money options in our future
statements of operations upon the adoption of SFAS 123(R). It is estimated that
the maximum future compensation expense that would have been recorded in our
statements of operations had the vesting of these options not been accelerated
is approximately $4.4 million.
The fair values of restricted stock awards, including restricted stock
and restricted stock units, are based on the intrinsic values of the awards at
the date of grant. As permitted under SFAS No. 123 and SFAS 123(R), we use the
Black-Scholes option pricing model to estimate the fair value of stock option
grants. The Black-Scholes model relies on a number of key assumptions to
calculate estimated fair values. Our assumed dividend yield of zero is based on
the fact that we have never paid cash dividends and have no present intention to
pay cash dividends. Since adoption of SFAS 123(R) on January 1, 2006, the
expected stock-price volatility assumption used by us has been based on recent
(six month trailing) implied volatility calculations. These calculations are
performed on exchange traded options of our stock. We believe that using a
forward-looking market driven volatility assumption will result in the best
estimate of expected volatility. Prior to adoption of SFAS 123(R), the expected
volatility was based on the historical volatility of the underlying stock. The
assumed risk-free interest rate is the U.S. Treasury security rate with a term
equal to the expected life of the option. The assumed expected life is based on
company-specific historical experience. With regard to the estimate of the
expected life, we consider the exercise behavior of past grants and model the
pattern of aggregate exercises. Based on our historical turnover rates, an
annualized estimated forfeiture rate of 6.5% has been used in calculating the
estimated compensation cost for the three- and six-month periods ending June 30,
2006. Additional expense will be recorded if the actual forfeiture rates are
lower than estimated, and a recovery of prior expense will be recorded if the
actual forfeitures are higher than estimated. Prior to the adoption of SFAS
123(R), forfeitures were not estimated at the time of award.
If factors change and we employ different assumptions for estimating
stock-based compensation expense in future periods, or if we decide to use a
different valuation model, the stock-based compensation expense we recognize in
future periods may differ significantly from what we have recorded in the
current period and could materially affect our operating income, net income and
earnings per share. It may also result in a lack of comparability with other
companies that use different models, methods and assumptions. The Black-Scholes
option-pricing model was developed for use in estimating the fair value of
traded options that have no vesting restrictions and are fully transferable.
These characteristics are not present in our option grants. Existing valuation
models, including the Black-Scholes model, may not provide reliable measures of
the fair values of our stock-based compensation. Consequently, there is a risk
that our estimates of the fair values of our stock-based compensation awards on
the grant dates may bear little resemblance to the actual values realized upon
the exercise, expiration, early termination or forfeiture of those stock-based
payments in the future. Certain stock-based payments, such as employee stock
options, may expire with little or no intrinsic value compared to the fair
values originally estimated on the grant date and reported in our financial
statements. Alternatively, the value realized from these instruments may be
significantly higher than the fair values originally estimated on the grant date
and reported in our financial statements. The guidance in SFAS 123(R) is
relatively new and the application of these principles may be subject to further
interpretation and refinement over time. See Note 7 of the Condensed
Consolidated Financial Statements in Item 1 for further information regarding
our adoption of SFAS 123(R).
During the first quarter of 2006, we granted restricted stock units,
rather than stock options, as part of our annual stock-based compensation
program. During the first and second quarters of 2006, we also granted
restricted stock and stock options to new hires and for other purposes. In the
future, we may grant either stock awards, options, or other equity-based
instruments allowed by our stock-based compensation plans, or a combination
thereof, as part of our overall compensation strategy.
19
RESULTS OF OPERATIONS
Net Revenues
We develop, market, sell and support a wide range of software and
hardware for digital media production, management and distribution. Our net
revenues are derived mainly from the sales of computer-based digital, nonlinear
media editing and finishing systems and related peripherals including shared
storage systems, licensing of software and sales of related software maintenance
contracts. We are organized into strategic business units that reflect the
principal markets in which our products are sold: Professional Video, Audio and
Consumer Video. Discrete financial information is available for each business
unit and the operating results of these business units are evaluated regularly
to make decisions regarding the allocation of resources and to assess
performance. As such, these business units represent our reportable segments
under Statement of Financial Accounting Standards, or SFAS, No. 131,
"Disclosures about Segments of an Enterprise and Related Information".
Our Professional Video segment produces tools for digital non-linear
editing and finishing, data storage, digital asset management and on-air
graphics to improve the productivity of video and film editors and broadcasters
by enabling them to manipulate moving pictures and sound in a faster, easier,
more creative and cost-effective manner than by use of traditional analog
tape-based systems. The products in this operating segment are designed to
provide capabilities for editing and finishing feature films, television shows,
broadcast news programs, commercials, music videos and corporate and consumer
videos. Net revenues in this segment grew 18% to $235 million for the six months
ended June 30, 2006 as compared to the same period in 2005, while segment
operating income decreased 26% to $16.4 million. Segment operating income
excludes stock-based compensation and amortization of intangible assets, as
these costs are not considered when evaluating the operating results of our
segments. The revenue increase relates largely to our August 2005 acquisition of
Pinnacle, specifically the broadcast video portion of Pinnacle's business, and
to a lesser extent, our January 2006 acquisition of Medea, both of which were
incorporated into our Professional Video segment. The decrease in operating
income reflects lower gross margins due primarily to higher overhead costs and
an unfavorable impact from foreign currency fluctuations on revenue.
Our Audio segment produces digital audio systems for the audio market.
This operating segment includes products developed to provide audio recording,
editing, signal processing and mixing. Net revenues in this segment grew 16% to
$147 million for the six months ended June 30, 2006 as compared to the same
period in 2005, while segment operating income increased 21% to $19.8 million.
We continue to see strong demand for our products in both the professional and
home user markets of our Audio business with increased revenues from the
Digidesign(R) mixing consoles and M-Audio(R) product lines.
Our Consumer Video segment develops and markets products that allow
consumer users to create, edit, view and distribute rich media content including
video, photographs and audio. The Consumer Video segment was formed as part of
our August 2005 acquisition of Pinnacle, so a comparison of revenues and segment
operating results for the six months ended June 30, 2006 and the same period in
2005 is not meaningful. For the six months ended June 30, 2006, this segment had
an operating loss of $4.0 million on net revenues of $58.2 million. We have made
operational changes in this segment to address product reliability issues and
ensure that the business runs as efficiently as possible. We also have marketing
efforts planned for the third quarter in anticipation of the upcoming holiday
buying season.
20
The following is a summary of our net revenues by segment for the three-
and six-month periods ended June 30, 2006 and 2005, respectively:
Three Months Ended June 30,
--------------------------------------------------------------------------
(dollars in thousands)
2006 % of 2005 % of
Net Consolidated Net Consolidated % Change
Revenues Net Revenues Revenues Net Revenues Change in Revenues
----------- ------------- ----------- ------------- ---------- -----------
Professional Video:
Product revenues $94,972 42.7% $76,727 47.9% $18,245 23.8%
Services revenues 23,892 10.8% 18,257 11.4% 5,635 30.9%
----------- ------------- ----------- ------------- ----------
Total 118,864 53.5% 94,984 59.3% 23,880 25.1%
----------- ------------- ----------- ------------- ----------
Audio:
Product revenues 73,888 33.2% 64,909 40.6% 8,979 13.8%
Services revenues 374 0.2% 158 0.1% 216 136.7%
----------- ------------- ----------- ------------- ----------
Total 74,262 33.4% 65,067 40.7% 9,195 14.1%
----------- ------------- ----------- ------------- ----------
Consumer Video:
Product revenues 29,100 13.1% - - 29,100 100.0%
----------- ------------- ----------- ------------- ----------
Total 29,100 13.1% - - 29,100 100.0%
----------- ------------- ----------- ------------- ----------
Total net revenues: $222,226 100.0% $160,051 100.0% $62,175 38.8%
=========== ============= =========== ============= ==========
Six Months Ended June 30,
--------------------------------------------------------------------------
(dollars in thousands)
2006 % of 2005 % of
Net Consolidated Net Consolidated % Change
Revenues Net Revenues Revenues Net Revenues Change in Revenues
----------- ------------- ----------- ------------- ---------- -----------
Professional Video:
Product revenues $187,713 42.6% $162,867 50.0% 24,846 15.3%
Services revenues 47,351 10.8% 36,602 11.2% 10,749 29.4%
----------- ------------- ----------- ------------- ----------
Total 235,064 53.4% 199,469 61.2% 35,595 17.8%
----------- ------------- ----------- ------------- ----------
Audio:
Product revenues 146,387 33.2% 126,311 38.7% 20,076 15.9%
Services revenues 622 0.2% 272 0.1% 350 128.7%
----------- ------------- ----------- ------------- ----------
Total 147,009 33.4% 126,583 38.8% 20,426 16.1%
----------- ------------- ----------- ------------- ----------
Consumer Video:
Product revenues 58,223 13.2% - - 58,223 100.0%
----------- ------------- ----------- ------------- ----------
Total 58,223 13.2% - - 58,223 100.0%
----------- ------------- ----------- ------------- ----------
Total net revenues: $440,296 100.0% $326,052 100.0% $114,244 35.0%
=========== ============= =========== ============= ==========
We began selling Pinnacle products in the third quarter of 2005.
Therefore, there is no comparable data included in our Professional Video
revenues for the first two quarters of 2005. For the three- and six-month
periods ended June 30, 2006, Pinnacle products accounted for $13.4 million and
$28.8 million of Professional Video product revenues, respectively. The
remaining $4.8 million increase in Professional Video product revenues for the
three-month period ended June 30, 2006 was primarily due to increased revenues
from our shared-storage systems and high-end editing systems, including new
product introductions of Avid Unity ISIS(TM) and Symphony(TM) Nitriscc in the
third and fourth quarters of 2005, respectively. These increased revenues also
include a seasonality impact as HD post production product sales are typically
strong during the second quarter in preparation for the fall television
production season. These increases were partially offset by a decrease in Avid
Xpress Pro(R) unit sales, as expected, with the introduction of Media
Composer(R) software. We also experienced a strong increase in sales of our Avid
Mojo(R) family of products. Total revenues from our Media Composer family of
editing and finishing products remained relatively flat from the second quarter
of 2005 to 2006; however, these revenues represented increased unit sales of our
Adrenaline(TM) HD at a reduced average selling price, as well as revenues from
our software-only version of Media Composer, which was introduced in the second
quarter of 2006. For the six months ended June 30, 2006 compared to the same
21
period in 2005, the decrease of product revenues, excluding revenues from
Pinnacle products, was primarily due to decreased revenues for editing and
finishing products, which were mainly the result of lower average selling prices
in 2006 compared to strong results in the first quarter of 2005. Average selling
prices reflect the impact of price changes, mix of products sold and changes in
foreign currency exchange rates.
Services revenues consist primarily of maintenance contracts,
installation services and training. Professional Video services revenues
resulting from the Pinnacle acquisition were $3.1 million and $6.3 million for
the three- and six-month periods ended June 30, 2006, respectively. The
remaining increases were primarily due to increases in maintenance contracts
sold in connection with our products, as well as increased revenue generated
from professional services, such as installation services provided in connection
with large broadcast news deals.
The increase in revenue for our Audio segment for both the three- and
six-month periods was the result of increased revenues from Digidesign's live
sound mixing console, Venue, which began shipping in March 2005, as well as
increased revenues from their ICON mixing consoles, D-Control(TM) and
D-Command(TM), which began shipping in May 2005. We also saw an increase in our
core Digidesign Pro Tools(R) products for the professional and home markets.
The remaining increase was primarily due to increased revenues from M-Audio
products, in particular from increases in the control surface, guitar product,
keyboard and USB I/O product lines.
The Consumer Video segment was formed in the third quarter of 2005 with
our acquisition of Pinnacle; therefore, there is no comparable data for the
first two quarters of 2005. All of the revenues for the three- and six-month
periods ended June 30, 2006 represent revenue from the Pinnacle consumer
business acquired in August 2005. Net revenues for the Consumer Video segment
for the first quarter of 2006 was $29.1 million. Net revenues remained flat from
the first to second quarter of 2006, as a result of decreased revenues from the
home editing product line, offset by increased revenues from the TV viewing
product line. The decreased revenues from the home editing product line are due
to the lingering impact of quality issues surrounding our introduction of
Pinnacle Studio version 10 in the third quarter of 2005. During the first and
second quarters of 2006, we made improvements to the Pinnacle Studio product. We
are beginning to see improved user satisfaction ratings following our recently
introduced Pinnacle Studio Titanium edition software, but these
improvements have not yet materialized into increased revenues. The increase in
revenues from the TV viewing products was primarily due to the release of new
PCTV products across Europe, increased consumer demand during the 2006 World Cup
tournament and a focused introduction of our PCTV products into the U.S. during
the three months ended June 30, 2006.
Net revenues derived through indirect channels were 73% for both the
three- and six-month periods ended June 30, 2006 compared to 69% and 68%,
respectively, for the same periods in 2005. The increase in indirect selling is
due primarily to the acquisition of Pinnacle, whose consumer products are sold
almost exclusively through indirect channels.
For the three- and six-month periods ended June 30, 2006, international
sales accounted for 55% and 56% of our net revenues, respectively, compared to
54% and 55% of our net revenues, respectively, for the same periods in 2005.
International sales increased by $36.6 million, or 42%, and $67.3 million, or
37% for the three- and six-month periods ended June 30, 2006, respectively,
compared to the corresponding 2005 periods. The increase in international sales
occurred in Europe, Asia and Canada, and is primarily due to the acquisition of
Pinnacle, which has a significant portion of its sales in Europe and Asia.
Gross Profit
Cost of revenues consists primarily of costs associated with the
procurement of components; the assembly, testing and distribution of finished
products; warehousing; post-sales customer support costs related to maintenance
contract revenue and other services; and royalties for third-party software and
hardware included in our products. The resulting gross margin fluctuates based
on factors such as the mix of products sold, the cost and proportion of
third-party hardware and software included in the systems sold, the offering of
product upgrades, price discounts and other sales promotion programs, the
distribution channels through which products are sold, the timing of new product
introductions, sales of aftermarket hardware products such as disk drives and
currency exchange rate fluctuations.
22
The following is a summary of our cost of revenues and gross margin
percentages for the three and six-month periods ended June 30, 2006 and 2005:
Three Months Ended June 30,
-------------------------------------------------
(dollars in thousands)
Gross
Gross Gross Margin
2006 Margin % 2005 Margin % % Change
--------- -------- ---------- -------- ----------
Product cost of revenues $93,819 52.6% $61,244 56.8% (4.2%)
Services cost of revenues 13,812 43.1% 10,027 45.5% (2.4%)
Amortization of technology 5,016 - 282 - -
--------- ----------
Total $112,647 49.3% $71,553 55.3% (6.0%)
========= ==========
Six Months Ended June 30,
-------------------------------------------------
(dollars in thousands)
Gross
Gross Gross Margin
2006 Margin % 2005 Margin % % Change
--------- -------- --------- --------- -----------
Product cost of revenues $185,180 52.8% $122,141 57.8% (5.0%)
Services cost of revenues 27,127 43.5% 20,097 45.5% (2.0%)
Amortization of technology 10,096 - 563 - -
--------- ---------
Total $222,403 49.5% $142,801 56.2% (6.7%)
========= =========
The decrease in the product gross margin percentage for the three- and
six-month periods ended June 30, 2006, as compared to the same periods in 2005,
primarily reflects changes in product mix largely due to the acquisition of the
Pinnacle consumer business, as well as reduced product pricing due to
competitive pressures. Product gross margins were also negatively impacted by an
increased number of sales promotions, which were partially offset by increased
volumes.
The decrease in the services gross margin for the three and six-month
periods ended June 30, 2006, as compared to the same periods in 2005, primarily
reflects the impact of the Pinnacle acquisition which has lower services gross
margins. Amortization of technology included in the cost of sales primarily
represents the amortization of developed technology assets resulting from the
August 2005 Pinnacle acquisition.
Costs and Expenses
Beginning in the first quarter of 2006, with the adoption of SFAS
123(R), we recorded stock-based compensation expense for the fair value of stock
options. Stock-based compensation expense of $4.4 million and $8.9 million
resulting from the adoption of SFAS 123(R), the acquisition of M-Audio and the
issuance of restricted stock and restricted stock units, was included in the
following captions in our condensed consolidated statement of operations for the
three- and six-month periods ended June 30, 2006, respectively (in thousands):
Three Months Ended June 30, Six Months Ended June 30,
-------------------------- -------------------------
2006 2005 2006 2005
------------ ----------- ----------- -----------
Product cost of revenues $ 131 $ - $ 270 $ -
Services cost of revenues 208 - 427 -
Research and development expense 1,272 67 2,607 150
Marketing and selling expense 1,230 205 2,533 440
General and administrative expense 1,513 400 3,023 924
------------ ----------- ----------- -----------
$ 4,354 $ 672 $ 8,860 $ 1,514
============ =========== =========== ===========
As of June 30, 2006, there was $33.6 million of total unrecognized
compensation cost, before forfeitures, related to non-vested stock-based
compensation awards granted under our stock-based compensation plans. This cost
will be recognized over the next four years. We expect this amount to be
amortized as follows: $8.8 million during the remainder of 2006, $12.7 million
in 2007 and $12.1 million thereafter. See Note 7 of the Condensed Consolidated
Financial Statements in Item 1 for further information regarding our stock-based
compensation assumptions and expenses, including pro forma disclosures for the
three- and six-month periods ended June 30, 2005.
23
Research and Development
Three Months Ended June 30,
-----------------------------------------------
(dollars in thousands)
2006 2005
Expenses Expenses Change % Change
----------- ----------- ----------- -----------
Research and development $35,617 $24,910 $10,707 43.0%
As a percentage of net revenues 16.0% 15.6% 0.4%
Six Months Ended June 30,
-----------------------------------------------
(dollars in thousands)
2006 2005
Expenses Expenses Change % Change
----------- ----------- ----------- -----------
Research and development $71,113 $49,589 $21,524 43.4%
As a percentage of net revenues 16.2% 15.2% 1.0%
Research and development expenses include costs associated with the
development of new products and enhancement of existing products, and consist
primarily of employee salaries and benefits, facilities costs, depreciation,
consulting and temporary help, and prototype and development expenses. For the
three- and six-month periods ended June 30, 2006, the increase in research and
development expenditures was primarily due to an increase in personnel-related
and facilities costs, primarily resulting from the acquisition of Pinnacle in
August 2005. We also incurred increased stock-based compensation expense of $1.2
million and $2.5 million for the three- and six-month periods ended June 30,
2006, respectively, as a result of the adoption of SFAS 123(R) on January 1,
2006. The increase in research and development expense as a percentage of
revenues relates to the increase in stock-based compensation in 2006, as well as
to the other spending increases noted above.
Marketing and Selling
Three Months Ended June 30,
----------------------------------------------
(dollars in thousands)
2006 2005
Expenses Expenses Change % Change
----------- ----------- ----------- ----------
Marketing and selling $52,583 $38,452 $14,131 36.7%
As a percentage of net revenues 23.7% 24.0% (0.3%)
Six Months Ended June 30,
----------------------------------------------
(dollars in thousands)
2006 2005
Expenses Expenses Change % Change
----------- ----------- ----------- ----------
Marketing and selling $102,495 $76,294 $26,201 34.3%
As a percentage of net revenues 23.3% 23.4% (0.1%)
Marketing and selling expenses consist primarily of employee salaries
and benefits for sales, marketing and pre-sales customer support personnel,
commissions, travel expenses, advertising and promotional expenses, and
facilities costs. For the three- and six-month periods ended June 30, 2006, the
increase in marketing and selling expenses, as compared to the same periods last
year, was primarily due to higher spending for advertising, trade shows and
other marketing programs, as well as higher personnel-related costs, including
salaries and related taxes, benefits and commissions, in large part due to the
acquisition of Pinnacle in August 2005. We also spent more on consulting and
other outside services during the three- and six-month periods ended June 30,
2006 as compared to the corresponding periods in 2005. In addition, we incurred
increased stock-based compensation expense of $1.0 million and $2.1 million for
the three- and six-month periods ended June 30, 2006, respectively, as a result
of the adoption of SFAS 123(R) on January 1, 2006.
24
General and Administrative
Three Months Ended June 30,
-----------------------------------------------
(dollars in thousands)
2006 2005
Expenses Expenses Change % Change
----------- ----------- ----------- -----------
General and administrative $15,853 $10,471 $5,382 51.4%
As a percentage of net revenues 7.1% 6.5% 0.6%
Six Months Ended June 30,
-----------------------------------------------
(dollars in thousands)
2006 2005
Expenses Expenses Change % Change
----------- ----------- ----------- -----------
General and administrative $30,990 $20,773 $10,217 49.2%
As a percentage of net revenues 7.0% 6.4% 0.6%
General and administrative expenses consist primarily of employee
salaries and benefits for administrative, executive, finance and legal
personnel, audit and legal fees, insurance and facilities costs. For the three-
and six-month periods ended June 30, 2006, the increase in general and
administrative expenditures was due in large part to higher personnel-related
costs, as well as higher facilities-related costs and depreciation, all
primarily resulting from our acquisition of Pinnacle in August 2005. We also
incurred increased stock-based compensation expense of $1.1 million and $2.1
million for the three- and six-month periods ended June 30, 2006, respectively,
as a result of the adoption of SFAS 123(R) on January 1, 2006.
Restructuring and Other Costs
In March 2006, we implemented a restructuring program within our
Consumer Video segment under which 23 employees worldwide, primarily in the
marketing and selling function and the research and development function, were
notified that their employment would be terminated. The purpose of the program
was to maximize the efficiency of our organizational structure. In connection
with this action, we recorded a charge of $1.1 million in the statement of
operations. The estimated annual cost savings expected to result from this
restructuring action is approximately $2.9 million.
In-process Research and Development
During the six months ended June 30, 2006, we recorded in-process
research and development, or R&D, charges of $0.3 million related to the
acquisition of Medea. This in-process R&D charge represents product development
efforts that were underway at Medea at the time of the acquisition for which
technological feasibility had not yet been established. Technological
feasibility is established when either of the following criteria is met: 1)
detailed program design has been completed, documented and traced to product
specifications and its high-risk development issues have been resolved; or 2) a
working model of the product has been finished and determined to be complete and
consistent with the product design. Upon completion of the acquisition, Medea
did not have a completed product design or working model for this in-process
technology, and we determined that there was no future alternative use for the
technology beyond the stated purpose of the specific R&D project. Therefore, we
expensed the Medea in-process R&D during the three months ended March 31, 2006.
The key assumptions used in the Medea valuation consisted of the
expected completion dates for the in-process projects, estimated costs to
complete the projects, revenue and expense projections assuming future release
and a risk-adjusted discount rate. The discount rate considers risks such as
delays bringing the products to market and competitive pressures. For purposes
of valuing the in-process R&D of Medea, we used a discount rate of 20%.
25
Amortization of Acquisition-Related Intangible Assets
Three Months Ended June 30,
------------------------------------
(dollars in thousands)
2006 2005 Change
------------ ------------ -----------
Amortization of intangible assets $8,993 $1,875 $7,118
As a percentage of net revenues 4.0% 1.2% 2.8%
Six Months Ended June 30,
------------------------------------
(dollars in thousands)
2006 2005 Change
------------ ------------ -----------
Amortization of intangible assets $17,738 $3,748 $13,990
As a percentage of net revenues 4.0% 1.1% 2.9%
Included in amortization of intangible assets is $5.0 million and $10.1
million, respectively, for the three- and six-month periods ended June 30, 2006,
and $0.3 million and $0.6 million, respectively, for the three- and six-month
periods ended June 30, 2005, for amortization of developed technology which is
recorded within cost of revenues. Acquisition-related intangible assets result
from acquisitions accounted for under the purchase method of accounting and
include customer-related intangibles, developed technology, trade names and
other identifiable intangible assets with finite lives. These intangible assets
are amortized using the straight-line method, with the exception of developed
technology. Developed technology is being amortized over the greater of: 1) the
amount calculated using the ratio of current quarter revenues to the total of
current quarter and anticipated future revenues over the estimated useful lives
of two to three years; or 2) the straight-line method over each product's
remaining respective useful lives. The increase in amortization expense for the
three- and six-month periods ended June 30, 2006 reflects acquisitions that
occurred during 2005 and 2006 as discussed below.
For our Sundance acquisition, we allocated the $12.7 million purchase
price to the acquired net tangible and intangible assets based on their fair
values as of the consummation of the acquisition. As part of the purchase
accounting allocation, we recorded $5.6 million of amortizable identifiable
intangible assets, consisting of completed technology, customer relationships,
trademarks and trade names, and a non-compete covenant.
For our Medea acquisition, we allocated the $9.1 million purchase price
to the acquired net tangible and intangible assets based on their fair values as
of the consummation of the acquisition. As part of the purchase accounting
allocation, we recorded $3.8 million of amortizable identifiable intangible
assets, consisting of completed technology, customer relationships, non-compete
covenants and order backlog.
For our Pinnacle acquisition, we allocated the total Pinnacle purchase
price of $441.4 million to the acquired net tangible and intangible assets based
on their fair values as of the consummation of the acquisition. The
determination of these fair values included management's consideration of a
valuation of Pinnacle's intangible assets prepared by an independent valuation
specialist. As part of the purchase accounting allocation, we recorded $90.8
million of amortizable identifiable intangible assets, consisting of completed
technologies, customer relationships and trade names.
26
Other Income (Expense), Net
Three Months Ended June 30,
-----------------------------------
(dollars in thousands)
2006 2005 Change
----------- ----------- -----------
Other income (expense), net $1,881 $1,179 $702
As a percentage of net revenues 0.8% 0.7% 0.1%
Six Months Ended June 30,
-----------------------------------
(dollars in thousands)
2006 2005 Change
----------- ----------- -----------
Other income (expense), net $3,852 $2,016 $1,836
As a percentage of net revenues 0.9% 0.6% 0.3%
Other income (expense), net, generally consists of interest income,
interest expense and equity in income of a non-consolidated company.
The increase in other income and expense for the three- and six-month
periods ended June 30, 2006 was primarily due to increased interest income
earned on higher average cash and marketable securities balances.
Provision for Income Taxes, Net
Three Months Ended June 30,
-----------------------------------
(dollars in thousands)
2006 2005 Change
----------- ----------- -----------
Provision for income taxes, net $731 $685 $46
As a percentage of net revenues 0.3% 0.4% (0.1%)
Six Months Ended June 30,
-----------------------------------
(dollars in thousands)
2006 2005 Change
----------- ----------- -----------
Provision for income taxes, net $2,084 $2,114 ($30)
As a percentage of net revenues 0.5% 0.6% (0.1%)
Our effective tax rate was 21% and 5%, respectively, for the three-month
periods ended June 30, 2006 and 2005 and 26% and 6%, respectively, for the
six-month periods ended June 30, 2006 and 2005. The tax provisions for the
six-month periods ended June 30, 2006 and 2005 were substantially comprised of
taxes payable by our foreign subsidiaries and generally non-cash tax provisions
for Federal and state tax on anticipated U.S taxable profits. The increase in
the effective tax rate for the six months ended June 30, 2006, as compared to
the same period of 2005, results from: (1) an increased foreign effective tax
rate, (2) an increase in the Federal and state provisions caused by the absence
of net operating loss carry-forwards available to offset current year profits as
a result of the utilization of such carry-forwards and the related valuation
allowance recognized in prior years' tax provisions and (3) the impact of lower
profit before tax caused by increased acquisition related amortization and the
implementation of SFAS 123(R) requiring the expensing of stock-based
compensation as we generally recognize no significant U.S. tax benefit from
these expenses due to the full valuation allowance on our U.S deferred tax
assets. Except for a minimal amount of state tax payments, the Federal and state
tax provisions are non-cash provisions due to the tax impact of net operating
loss carry-forwards available from additional paid-in capital related stock
option deductions and acquisition related net operating loss carry-forwards.
27
The tax rate in each year is affected by net changes in the valuation
allowance against our deferred tax assets. We regularly review our deferred tax
assets for recoverability taking into consideration such factors as historical
losses after deductions for stock compensation, projected future taxable income
and the expected timing of the reversals of existing temporary differences. SFAS
No. 109, "Accounting for Income Taxes", requires us to record a valuation
allowance when it is more likely than not that some portion or all of the
deferred tax assets will not be realized. Based on the level of deferred tax
assets as of June 30, 2006, the level of historical U.S. losses after deductions
for stock compensation and the level of outstanding stock options which we
anticipate will generate significant U.S. tax deductions in the future, we have
determined that the uncertainty regarding the realization of these assets is
sufficient to warrant the continued establishment of a full valuation allowance
against the U.S. net deferred tax assets.
Our assessment of the valuation allowance on the U.S. deferred tax
assets could change in the future based upon our levels of pre-tax income and
other tax-related adjustments. Removal of the valuation allowance in whole or in
part would result in a non-cash reduction in income tax expense during the
period of removal. In addition, because a portion of the valuation allowance was
established to reserve certain deferred tax assets resulting from the exercise
of employee stock options, in accordance with SFAS No. 109 and SFAS 123(R),
removal of the valuation allowance related to these assets would occur upon
utilization of these deferred tax assets to reduce taxes payable and would
result in a credit to additional paid in capital within stockholders equity
rather than the provision for income taxes. To the extent no valuation allowance
is established for our deferred tax assets in future periods, future financial
statements would reflect an increase in income tax expense which would be on a
non-cash basis until such time as our deferred tax assets are all used to reduce
current taxes payable.
Excluding the impact of the valuation allowance, our effective tax rate
would have been 25% and 32%, respectively, for the three-month periods ended
June 30, 2006 and 2005 and 29% and 30%, respectively, for the six-month periods
ended June 30, 2006 and 2005. These rates differ from the Federal statutory rate
of 35% primarily due to income in foreign jurisdictions which have lower tax
rates.
LIQUIDITY AND CAPITAL RESOURCES
We have funded our operations in recent years through cash flows from
operations as well as from stock option exercises. As of June 30, 2006, our
principal sources of liquidity included cash, cash equivalents and marketable
securities totaling $238.1 million.
With respect to cash flow, net cash provided by operating activities was
$23.5 million for the six months ended June 30, 2006, compared to $38.2 million
for the same period in 2005. During the six months ended June 30, 2006, net cash
provided by operating activities primarily reflects net income adjusted for
depreciation and amortization and stock-award compensation, partially offset by
an increase in inventories and a decrease in accrued expenses. During the six
months ended June 30, 2005, net cash provided by operating activities primarily
reflects net income adjusted for depreciation and amortization, as well as an
increase in deferred revenue, partially offset by an increase in inventories and
a decrease in accrued expenses.
Accounts receivable increased by $3.2 million to $143.9 million at June
30, 2006 from $140.7 million at December 31, 2005. These balances are net of
allowances for sales returns, bad debts and customer rebates, all of which we
estimate and record based primarily on historical experience. Days sales
outstanding in accounts receivable increased from 52 days at December 31, 2005
to 58 days at June 30, 2006. The increase in days sales outstanding was
primarily attributable to the relative proportion of solution sales in each
period, which was higher in the quarter ended December 31, 2005 than in the
quarter ended June 30, 2006. These sales are typically paid prior to recognition
and therefore lower our days sales outstanding in the period when revenue is
recognized. The increase in days sales outstanding is also due to higher
concentration of revenue in the last two weeks of the quarter ended June 30,
2006 compared to the quarter ended December 31, 2005.
At June 30, 2006 and December 31, 2005, we held inventory in the amounts
of $122.0 million and $96.8 million, respectively. These balances include
stockroom, spares and demonstration equipment inventories at various locations
and inventory at customer sites related to shipments for which we have not yet
recognized revenue. The increase from December 31, 2005 of approximately $25
million was attributable to several operating initiatives. For the past year, we
have transitioned our products to comply with the European Union's
Directive on the Restriction of Hazardous Substances, or RoHS Directive. Due
to concern about possible slippage with key suppliers upon the
RoHS effective date of July 1, 2006, we transferred additional pre-RoHS
compliant inventory to Europe during the three months ended June 30, 2006. We
also had a higher inventory balance due to inventory build-up for new product
introductions expected in the third quarter of 2006, in-transit inventory
related to a new outsourced manufacturing program in Asia and inventory related
to the Sundance and Medea acquisitions. We expect the net inventory balance to
decline by year-end. We review all inventory balances regularly for excess
28
quantities or potential obsolescence and make appropriate adjustments as needed
to reserve or write-down the inventories to reflect their estimated realizable
value. We source inventory products and components pursuant to purchase orders
placed from time to time.
Net cash flow used in investing activities was $10.2 million for the six
months ended June 30, 2006 compared to $1.4 million for the same period in 2005.
The increase in net cash flow used in investing activities for the six months
ended June 30, 2006 was primarily the result of our acquisition of Sundance for
$12.7 million in cash and our acquisition of Medea for $9.1 million in cash,
partially offset by net proceeds resulting from the sale and purchase
of marketable securities. In July 2006, we acquired Sibelius
for cash consideration of approximately 12.4 million pounds sterling
($23 million).
We purchased $9.1 million of property and equipment during the six
months ended June 30, 2006 compared to $8.2 million in the same period of 2005.
Purchases of property and equipment in both quarters consisted primarily of
computer hardware and software to support our research and development
activities and information systems.
During the six months ended June 30, 2006 and 2005, we generated cash of
$4.1 million and $8.9 million, respectively, from financing activities,
primarily from the issuance of common stock related to the exercise of stock
options and our employee stock purchase plan.
In connection with non-acquisition related restructuring activities
during 2005 and prior periods, as of June 30, 2006, we have future cash
obligations of approximately $12.9 million under leases for which we have
vacated the underlying facilities. We have an associated restructuring accrual
of $3.8 million at June 30, 2006 representing the excess of our lease
commitments on space no longer used by us over expected payments to be received
on subleases of such facilities. Additionally, we have restructuring-related
severance obligations of $0.7 million in connection with restructuring
activities in the first quarter of 2006. The severance payments will be made
during 2006 while the lease payments will be made over the remaining terms of
the leases, which have varying expiration dates through 2011, unless we are able
to negotiate earlier terminations.
In connection with the Pinnacle acquisition in 2005, we recorded
restructuring accruals totaling $14.4 million related to severance ($10.0
million) and lease or other contract terminations ($4.4 million). In connection
with the January 2006 Medea acquisition, we recorded severance obligations of
$0.3 million. As of June 30, 2006, we have future cash obligations of
approximately $2.3 million under leases for which we have vacated the underlying
facilities, and restructuring accruals of $1.1 million and $1.4 million related
to acquisition-related severance and lease obligations, respectively. The
severance payments will be made during 2006. The lease payments will be made
over the remaining terms of the leases, which have varying expiration dates
through 2010. All payments related to restructuring actions are expected to be
funded through working capital. See Note 11 of the Condensed Consolidated
Financial Statements in Item 1 for the activity in the restructuring and other
costs accrual for the six months ended June 30, 2006.
A stock repurchase program was approved by our board of directors
effective July 21, 2006. Under this program, we were authorized to repurchase up
to $50 million of our common stock through transactions on the open market, in
block trades or otherwise. The program was completed on August 7, 2006 with
1,432,327 shares of our common stock repurchased from July 25, 2006 through the
completion date. The stock repurchase program was funded through working
capital.
Our cash requirements vary depending upon factors such as our planned
growth, capital expenditures, acquisitions of businesses or technologies and
obligations under past restructuring programs. We believe that our existing
cash, cash equivalents, marketable securities and funds generated from
operations will be sufficient to meet our operating cash requirements for at
least the next twelve months. In the event that we require additional financing,
we believe that we will be able to obtain such financing; however, there can be
no assurance that we would be successful in doing so, or that we could do so on
favorable terms.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2006, the Financial Standards Accounting Board, or FASB, issued
FASB Interpretation No. 48, or FIN 48, "Accounting for Uncertainty in Income
Taxes - An Interpretation of FASB Statement No. 109", which prescribes a
recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in a
tax return. FIN 48 will be effective for fiscal years beginning after December
15, 2006, or January 1, 2007 for Avid. We have not yet completed our evaluation
of the impact of adoption on our financial position or results of operations.
29
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing
of Financial Assets", an amendment to FASB Statement No. 140. SFAS No. 156
requires recognition of a servicing asset or servicing liability whenever an
entity enters into certain service agreements which result in an obligation to
service a financial asset, and requires that servicing assets and servicing
liabilities be recognized at fair value, if practicable. SFAS No. 156 will be
effective for fiscal years beginning after September 15, 2006, or January 1,
2007 for Avid. Adoption of SFAS No. 156 is not expected to have a material
impact on our financial position or results of operations.
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain
Hybrid Financial Instruments", an amendment to FASB Statements No. 133 and 140.
SFAS No. 155 permits fair value remeasurement for any hybrid financial
instrument that contains an embedded derivative that otherwise would require
bifurcation. SFAS No. 155 will be effective for fiscal years beginning after
September 15, 2006, or January 1, 2007 for Avid. As of June 30, 2006, we did not
have any hybrid financial instruments subject to the fair value election of SFAS
No. 155.
In November 2005, the FASB issued FASB Staff Position No. FAS 123(R)-3,
"Transition Election Related to Accounting for Tax Effects of Share-Based
Payment Awards". We are considering whether to adopt the alternative transition
method provided in the FASB Staff Position, or FSP, for calculating the tax
effects of stock-based compensation pursuant to SFAS 123(R). The alternative
transition method includes simplified methods to establish the beginning balance
of the additional paid-in capital pool, or APIC Pool, related to the excess tax
benefits available to absorb tax deficiencies recognized subsequent to the
adoption of SFAS 123(R). We are currently evaluating which transition method it
will use for calculating its APIC Pool. An entity may take up to one year from
the later of its initial adoption of SFAS 123(R) or the effective date of this
FSP to evaluate its available transition alternatives and make its one-time
election. Until and unless we elect the transition method described in the FSP,
the transition method provided in SFAS 123(R) is being followed. We expect to
complete our evaluation by December 31, 2006.
In June 2005, the FASB issued Staff Position No. FAS 143-1, "Accounting
for Electronic Equipment Waste Obligations", or FSP 143-1, which provides
guidance on the accounting for obligations associated with the European Union,
or EU, Directive on Waste Electrical and Electronic Equipment, or the WEEE
Directive. FSP 143-1 provides guidance on how to account for the effects of the
WEEE Directive with respect to historical waste associated with products in the
market on or before August 13, 2005. FSP 143-1 is required to be applied to the
later of the first reporting period ending after June 8, 2005 or the date of the
adoption of the WEEE Directive into law by the applicable EU member country. We
are in the process of registering with the member countries, as appropriate, and
are still awaiting guidance from these countries with respect to the compliance
costs and obligations for historical waste. We will continue to work with each
country to obtain guidance and will accrue for compliance costs when they are
probable and reasonably estimable. The accruals for these compliance costs may
have a material impact on our financial position or results of operations when
guidance is issued by each member country.
30
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Foreign Currency Exchange Risk
We have significant international operations and, therefore, our
revenues, earnings, cash flows and financial position are exposed to foreign
currency risk from foreign currency denominated receivables, payables, sales
transactions, as well as net investments in foreign operations.
We derive more than half of our revenues from customers outside the
United States. This business is, for the most part, transacted through
international subsidiaries and generally in the currency of the end-user
customers. Therefore, we are exposed to the risks that changes in foreign
currency could adversely impact our revenues, net income and cash flow. To hedge
against the foreign exchange exposure of certain forecasted receivables,
payables and cash balances of our foreign subsidiaries, we enter into short-term
foreign currency forward-exchange contracts. There are two objectives of our
foreign currency forward-exchange contract program: (1) to offset any foreign
exchange currency risk associated with cash receipts expected to be received
from our customers over the next 30 day period and (2) to offset the impact of
foreign currency exchange on our net monetary assets denominated in currencies
other than the U.S. dollar. These forward-exchange contracts typically mature
within 30 days of purchase. We record gains and losses associated with currency
rate changes on these contracts in results of operations, offsetting gains and
losses on the related assets and liabilities. The success of this hedging
program depends on forecasts of transaction activity in the various currencies
and contract rates versus financial statement rates. To the extent that these
forecasts are overstated or understated during the periods of currency
volatility, we could experience unanticipated currency gains or losses.
At June 30, 2006, we had foreign-exchange forward contracts outstanding
with an aggregate notional value of $58.3 million, denominated in the euro,
British pound, Swedish krona, Norwegian krone, Danish kroner, Canadian dollar,
Japanese Yen, Australian Dollar, Singapore dollar and Korean won, as a hedge
against forecasted foreign currency-denominated receivables, payables and cash
balances. For the six months ended June 30, 2006, net losses of $4.1 million
resulting from forward-exchange contracts were included in results of
operations, offset by net transaction and remeasurement gains on the related
assets and liabilities of $3.8 million. As of June 30, 2006, we also had a
foreign-exchange forward contract with a notional value of $23 million to hedge
our net investment in our Canadian subsidiary. At June 30, 2006, the fair value
of this forward contract was ($0.5) million. The currency effect of the net
investment hedge is deemed effective and is, therefore, reflected as a component
of foreign currency translation in accumulated other comprehensive income.
Interest effects of this hedge are reported in interest income.
A hypothetical 10% change in foreign currency rates would not have a
material impact on our results of operations, assuming the above-mentioned
forecast of foreign currency exposure is accurate, because the impact on the
forward contracts as a result of a 10% change would at least partially offset
the impact on the asset and liability positions of our foreign subsidiaries.
Interest Rate Risk
At June 30, 2006, we held $238.1 million in cash, cash equivalents and
marketable securities, including short-term corporate obligations, asset-backed
securities, commercial paper and U.S. government and government agency
obligations. Marketable securities are classified as "available for sale" and
are recorded on the balance sheet at market value, with any unrealized gain or
loss recorded in other comprehensive income (loss). A hypothetical 10% increase
or decrease in interest rates would not have a material impact on the fair
market value of these instruments due to their short maturity.
31
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer
and Chief Financial Officer, evaluated the effectiveness of our disclosure
controls and procedures as of June 30, 2006. The term "disclosure controls and
procedures", as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act,
means controls and other procedures of a company that are designed to ensure
that information required to be disclosed by a company in the reports that it
files or submits under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the SEC's rules and forms.
Disclosure controls and procedures include, without limitation, controls and
procedures designed to ensure that information required to be disclosed by a
company in the reports that it files or submits under the Exchange Act is
accumulated and communicated to the company's management, including its
principal executive and principal financial officers, as appropriate to allow
timely decisions regarding required disclosure. Management recognizes that any
controls and procedures, no matter how well designed and operated, can provide
only reasonable assurance of achieving their objectives and management
necessarily applies its judgment in evaluating the cost-benefit relationship of
possible controls and procedures. Based on the evaluation of our disclosure
controls and procedures as of June 30, 2006, our chief executive officer and
chief financial officer concluded that, as of such date, the Company's
disclosure controls and procedures were effective at the reasonable assurance
level.
Changes in Internal Control over Financial Reporting
Our management considers the acquisition of Pinnacle Systems, Inc. on
August 9, 2005 to be material to the results of operations, financial position
and cash flows of the Company from the date of acquisition through June 30, 2006
and considers the internal controls and procedures of Pinnacle to have a
material effect on our internal control over financial reporting. The Company
has executed an extension of our Sarbanes-Oxley Act Section 404 compliance
program to include Pinnacle's operations in fiscal 2006. We do not consider our
acquisitions of Sundance and Medea, each completed during the six months ended
June 30, 2006, to have a material effect on our internal control over financial
reporting.
32
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In April 2005, we were notified by the Korean Federal Trade Commission
("KFTC") that a former reseller, Neat Information Telecommunication, Inc.
("Neat"), had filed a petition against our subsidiary, Avid Technology
Worldwide, Inc., alleging unfair trade practices. On August 11, 2005, the KFTC
issued a decision in favor of Avid regarding the complaint filed by Neat.
However, Neat filed a second petition with the KFTC on October 17, 2005 alleging
the same unfair trade practices as those set forth in the former KFTC petition.
On January 13, 2006, we filed our response to the second KFTC petition denying
Neat's allegations. On February 16, 2006, the KFTC reaffirmed its earlier
decision in favor of Avid and concluded its review of the case. In addition, on
October 14, 2005, Neat filed a civil lawsuit in Seoul Central District Court
against Avid Technology Worldwide, Inc. alleging unfair trade practices. In the
civil action, Neat is seeking approximately $1.7 million in damages, plus
interest and attorneys' fees. We have filed answers to the complaint denying
Neat's allegations. We believe that Neat's claims are without merit and we
intend to defend ourselves vigorously in these actions. Because we cannot
predict the outcome of these actions at this time, no costs have been accrued
for any possible loss contingency.
We receive inquiries from time to time with regard to possible patent
infringement claims. If any infringement is determined to exist, we may seek
licenses or settlements. In addition, as a normal incidence of the nature of our
business, various claims, charges and litigation have been asserted or commenced
against the Company arising from or related to contractual or employee
relations, intellectual property rights or product performance. We do not
believe these claims will have a material adverse effect on our financial
position or results of operations.
ITEM 1A. RISK FACTORS
Some of the statements in this Form 10-Q relating to our future
performance constitute forward-looking statements. Such forward-looking
statements are based upon management's current expectations and involve known
and unknown risks. Realization of any of these risks may cause actual results to
differ materially from the results described in the forward-looking statements.
Certain of these risks are as follows:
We may not be able to realize the expected benefits of our acquisition of
Pinnacle Systems. As a result of our acquisition of Pinnacle Systems, Inc. in
2005, we face challenges in several areas that could have an adverse effect on
our business. For example, some of the assumptions that we relied upon, such as
the achievement of operating synergies and revenue growth, may not be realized.
We have encountered and may continue to encounter difficulties, unforeseen costs
and delays involved in integrating the Pinnacle business, including:
o failure to successfully manage relationships with customers and with
important third parties;
o failure of customers to continue using the products and services of the
combined company; and
o potential impairment charges to write-down the carrying amount of
goodwill and other intangible assets.
We also face challenges inherent in efficiently managing an increased
number of employees over large geographic distances, including the need to
develop appropriate systems, policies, benefits and compliance programs. The
inability to manage the organization of the combined company effectively could
have a material adverse effect on our business.
We will face challenges associated with sales of video and audio products to the
consumer market.
As a result of our acquisition of Pinnacle in 2005, a material portion
of our future revenue will come from sales to consumers of home video editing
and viewing products. In addition, M-Audio has expanded its sales channel to
include sales of its audio products through the consumer channel. The market for
these consumer video and audio products is highly competitive and we expect to
face price-based competition from competitors selling similar products. Although
we acquired experienced personnel through our acquisitions of M-Audio and
Pinnacle, Avid's prior experience in the consumer market is limited. If we are
not successful marketing to consumers, our operating results could suffer.
Furthermore, sales of consumer electronics and software typically increase in
the second half of the year, reaching their peak during the year-end holiday
season. As a result, to the extent we increase sales of our video and audio
products through consumer channels, we expect to experience greater seasonality
in our revenues.
Another challenge that is particularly acute with respect to the sale of
consumer software is software piracy. The unauthorized use of our proprietary
technology is costly and efforts to restrict such unauthorized use are
time-consuming. We are unable to accurately measure the extent to which piracy
of our software exists, but we expect it to be a persistent problem.
33
Our performance will depend in part on continued customer acceptance of our
products.
We regularly introduce new products, as well as upgrades and
enhancements to existing products. We will need to continue to focus marketing
and sales efforts on educating potential customers, as well as our resellers and
distributors, about the uses and benefits of these products. The future success
of certain of our video products, such as Symphony(TM) Nitris(R), Media
Composer(R) Adrenaline(TM) HD and Avid DS Nitris, which enable high-definition
production, will also depend on demand for high definition content and
appliances, such as television sets and monitors that utilize the high
definition standard. Other risks involved with offering new products in general
include, without limitation, the possibility of defects or errors, failure to
meet customer expectations, delays in shipping new products and the introduction
of similar products by our competitors. For example, we experienced initial
quality issues with the introduction of Pinnacle Studio version 10. There can be
no assurance that the improvements we have implemented will adequately address
these issues or that customers will accept the improvements. In addition, we
occasionally introduce products in new markets, where we have little experience
and may not overcome any barriers to entry. The introduction and transition to
new products could also have a negative impact on the market for our existing
products, which could adversely affect our revenues and business.
The digital broadcast business is large, geographically dispersed and highly
competitive, and we may not be successful in growing our customer base or
predicting customer demand in this business.
We continue to enhance our status in the digital broadcast business. In
this business, in addition to or in lieu of discrete point products, customers
often seek complex solutions involving highly integrated components, including
the configuration of unique workflows, from a single or multiple vendors.
Success in this business will require, among other things, creating and
implementing compelling solutions and developing a strong, loyal customer base.
In addition, large, complex broadcast orders often require us to devote
significant sales, engineering, manufacturing, installation and support
resources to ensure their successful and timely fulfillment. As the broadcast
business converts from analog to digital, our strategy has been to build our
broadcast solutions team in response to customer demand. To the extent that
customer demand for our broadcast solutions exceeds our expectations, we may
encounter difficulties in the short term meeting our customers' needs.
Meanwhile, our competitors may devote greater resources to the broadcast
business than we do, or may be able to leverage their presence more effectively.
If we are unsuccessful in our continued expansion within the digital broadcast
business or in predicting and satisfying customer demand, our business and
revenues could be adversely affected.
We have a significant presence in the audio business, and therefore, the growth
of our audio business will depend in part on our ability to successfully
introduce new products.
Our Digidesign division has a significant presence in the audio
business, due in large part to a series of successful product introductions. Our
future success will depend in part upon our ability to offer, on a timely and
cost-effective basis, new audio products and enhancements of our existing audio
products. This can be a complex and uncertain process, and we could experience
design, manufacturing, marketing, or other difficulties that delay or prevent
the introduction of new or enhanced products, or the integration of acquired
products, which, in turn, could harm our business.
A portion of our revenue is dependent on sales of large, complex solutions.
We expect sales of large, complex solutions to continue to constitute a
material portion of our net revenue, particularly as news stations convert from
analog, or tape-based, processes to digital formats. Our quarterly and annual
revenues could fluctuate if:
o sales to one or more of our customers are delayed or are not completed
within a given quarter;
o the contract terms preclude us from recognizing revenues relating to one
or more significant contracts during a particular quarter;
o news stations' migrations to networked digital infrastructure slows
down;
o we are unable to complete complex customer installations on schedule;
o our customers reduce their capital investments in our products in
response to slowing economic growth; or
o any of our large customers terminates its relationship with us or
significantly reduces the amount of business it does with us.
34
We compete with many other enterprises and we expect competition to intensify in
the future.
The business segments in which we operate are highly competitive, with
limited barriers to entry, and are characterized by pressure to reduce prices,
incorporate new features and accelerate the release of new products. Some of our
current and potential competitors have substantially greater financial,
technical, distribution, support and marketing resources than we do. Such
competitors may use these resources to lower their product costs, allowing them
to reduce prices to levels at which we could not operate profitably. In addition
to competing based on price, our products must also compete favorably with our
competitors' products in terms of reliability, performance, ease of use, range
of features, product enhancements, reputation and training. Delays or
difficulties in product development and introduction may also harm our business.
If we are unable to compete for our target customers effectively, our business
and results of operations could suffer.
New product announcements by our competitors and by us also could have
the effect of reducing customer demand for our existing products. New product
introductions require us to devote time and resources to training our sales
channels in product features and target customers, with the temporary result
that the sales channels may have less time to devote to selling our products. In
addition, our introduction of new products and expansion of existing product
offerings can put us into competition with companies with whom we formerly
collaborated. In the event such companies discontinue their alliances with us,
we could experience a negative impact on our business.
Recent and potential future acquisitions could be difficult to integrate, divert
the attention of key personnel, disrupt our business, dilute stockholder value
and impair our financial results.
As part of our business strategy, we periodically acquire companies,
technologies and products that we believe can improve our ability to compete in
our core markets or allow us to enter new markets. For example, in 2005, we
acquired Pinnacle and in 2006, we acquired Sundance and Medea. The risks
associated with such acquisitions include, among others:
o difficulty in assimilating the operations, policies and personnel of the
target companies;
o failure to realize anticipated returns on investment, cost savings and
synergies;
o diversion of management's time and attention;
o potential dilution to existing stockholders, if we issue common stock or
other equity rights in the acquisition;
o potential loss of key employees of the target company;
o difficulty in complying with a variety of foreign laws and regulations,
if so required;
o impairment of relationships with customers or suppliers;
o risks associated with contingent payments and earn-outs;
o possibility of incurring debt and amortization expenses, as well as
impairment charges, related to goodwill and other intangible assets; and
o unidentified issues not discovered in due diligence, which may include
product quality issues and legal contingencies.
Such acquisitions often involve significant transaction-related costs
and could cause disruption to normal operations. In the future, we may also make
debt or equity investments. If so, we may fail to realize anticipated returns on
such investments. If we are unable to overcome or mitigate these risks, they
could adversely affect our business and lower revenues.
Our products are complex and may contain errors or defects resulting from such
complexity.
As we continue to enhance and expand our product offerings, our products
have grown increasingly complex and, despite extensive testing and quality
control, may contain errors or defects. Such errors or defects could cause us to
issue corrective releases and could result in loss of revenues, delay of revenue
recognition, increased product returns, lack of market acceptance and damage to
our reputation.
Poor global economic conditions could adversely affect demand for our products
and the financial condition of our suppliers, distributors and resellers.
The revenue growth and profitability of our business depends primarily
on the overall demand for our products. If global economic conditions worsen,
demand for our products may weaken, as could the financial health of our
suppliers, distributors and resellers, which could adversely affect our revenues
and business.
35
Our use of independent firms and contractors to perform some of our product
development and manufacturing activities could expose us to risks that could
adversely impact our revenues.
Independent firms and contractors, some of whom are located in other
countries, perform some of our product development activities. We generally own
the software developed by these contractors. We also rely on subcontractors for
most of our manufacturing activities. Our strategy to rely on independent firms
and contractors involves a number of significant risks, including loss of
control over the manufacturing process, potential absence of adequate
manufacturing capacity, potential delays in lead times and reduced control over
delivery schedules, manufacturing yields, quality and cost. Furthermore, the use
of independent firms and contractors, especially those located abroad, could
expose us to risks related to governmental regulation, foreign taxation,
intellectual property ownership and rights, exchange rate fluctuation, political
instability and unrest, natural disasters and other risks, which could adversely
impact our revenues.
An interruption of our supply of certain products or key components from our
sole source suppliers, or a price increase in such products or components, could
hurt our business.
We are dependent on a number of specific suppliers for certain products
and key components of our products. We purchase these sole source products and
components pursuant to purchase orders placed from time to time. We generally do
not carry significant inventories of these sole source products and components
and have no guaranteed supply arrangements. If any of our sole source vendors
should fail to produce these products or components, our supply and our ability
to continue selling and servicing products that use these components could be
imperiled. Similarly, if any of our sole source vendors should encounter
technical, operating or financial difficulties, our supply of these products or
components would be threatened. While we believe that alternative sources for
these products and components could be developed, or our products could be
redesigned to permit the use of alternative components, an interruption of our
supply could damage our business and negatively affect our operating results.
Our gross profit margin varies from product to product depending
primarily on the proportion and cost of third-party hardware and software
included in each product. From time to time, we add functionality and features
to our products. If we effect such additions through the use of more, or more
costly, third-party hardware or software and are not able to increase the price
of our products to offset the increased costs, our gross profit margin on these
products could decrease and our operating results could be adversely affected.
We rely on third party software for some of our products and if we are unable to
use or integrate such software, our product and service development may be
delayed.
We rely on certain software that we license from third parties,
including software that is bundled with our products and sold to end users and
software that is integrated with internally developed software and used in our
products to perform key functions. These third-party software licenses may not
continue to be available on commercially reasonable terms and the software may
not be appropriately supported, maintained or enhanced by the licensors. The
loss of licenses to, or inability to support, maintain and enhance, any such
software, could result in increased costs, or in delays or reductions in product
shipments until equivalent software could be developed, identified, licensed and
integrated, which could adversely affect our business.
Qualifying and supporting our products on multiple computer platforms is time
consuming and expensive.
Our software engineers devote significant time and effort to qualify and
support our products on various computer platforms, including Microsoft and
Apple platforms. Computer platform modifications and upgrades require additional
time to be spent to ensure that our products function properly. To the extent
that the current configuration of qualified and supported platforms changes, or
we need to qualify and support new platforms, we could be required to expend
valuable engineering resources, which could adversely affect our operating
results.
Our revenues and gross profit are dependent on several unpredictable factors.
The revenue and gross profit from our products depend on many factors,
including:
o mix of products sold;
o cost and proportion of third-party hardware and software included in
such products;
o product distribution channels;
o acceptance of our new product introductions;
o product offers and platform upgrades;
36
o price discounts and sales promotion programs;
o volume of sales of aftermarket hardware products;
o costs of swapping or fixing products released to the market with
defects;
o provisions for inventory obsolescence;
o competitive pressure on product prices;
o costs incurred in connection with our broadcast and some of our audio
solution sales, which typically have longer selling and
implementation cycles;
o timing of delivery of solutions to customers; and
o foreign currency exchange impact on our revenues.
Changes in any of these factors could adversely affect our operating results.
Our international operations expose us to significant exchange rate fluctuations
and regulatory, intellectual property and other risks which could harm our
operating results.
We generally derive approximately half of our revenues from customers
outside of the United States. This business is, for the most part, transacted
through international subsidiaries and generally in the currency of the end-user
customers. Therefore, we are exposed to the risks that changes in foreign
currency could adversely impact our revenues, net income (loss) and cash flow.
To hedge against the foreign exchange exposure of certain forecasted
receivables, payables and cash balances of our foreign subsidiaries, we enter
into foreign currency forward-exchange contracts. The success of our hedging
program depends on forecasts of transaction activity in the various currencies.
To the extent that these forecasts are over- or under-stated during periods of
currency volatility, we could experience currency gains or losses.
Other risks inherent in our international operations include changes in
regulatory practices, environmental laws, tax laws, trade restrictions and
tariffs, longer collection cycles for accounts receivable and greater
difficulties in protecting our intellectual property.
We are subject to risks associated with compliance with environmental
regulations.
Many of our products are subject to various international, federal and
state laws governing the presence of chemical substances in these products and
the proper recycling of such products. We could incur substantial costs,
including penalties and fines, or our products could be enjoined from entering
certain jurisdictions, if we fail to comply with these environmental laws.
Our product design and procurement operations are becoming increasingly
complex as we adjust to new and future requirements relating to the composition
of our products, including the restrictions on lead, mercury, cadmium and
certain other substances under the Directive on the Restriction of Hazardous
Substances, or the RoHS Directive, which applies to products put on the market
in the European Union, or EU, as of July 1, 2006, and similar legislation
currently proposed in other jurisdictions, such as China, South Korea and
Australia, and certain states within the United States. The ultimate costs of
complying with the RoHS Directive and similar environmental laws and the timing
of these costs are difficult to predict.
We could also face significant costs and liabilities in connection with
product labeling and recycling legislation. The EU has enacted the Waste
Electrical and Electronic Equipment Directive, or the WEEE Directive, which
requires producers of certain electrical goods, including some of our products,
to label and be financially responsible for the collection, recycling, treatment
and disposal of these goods. The WEEE Directive became effective on August 13,
2005, although to date not all EU countries have adopted rules implementing the
WEEE Directive. Our potential liability resulting from the WEEE Directive and
similar environmental legislation in other jurisdictions, including the United
States, China and Japan, could be substantial and could have a material adverse
effect on our results of operations.
Our operating costs are tied to projections of future revenues, which may differ
from actual results.
Our operating expense levels are based, in part, on our expectations of
future revenues. Such future revenues are difficult to predict. A significant
portion of our business occurs near the end of each quarter, which can impact
our ability to forecast revenues on a quarterly basis. Further, we are generally
unable to reduce quarterly operating expense levels rapidly in the event that
quarterly revenue levels fail to meet internal expectations. Therefore, if
quarterly revenue levels fail to meet internal expectations upon which expense
levels are based, our results of operations could be adversely affected.
37
Terrorism, acts of war and other catastrophic events may seriously harm our
business.
Terrorism, acts of war, or other catastrophic events may disrupt our
business and harm our employees, facilities, suppliers, distributors, resellers
or customers, which could significantly impact our revenue and operating
results. The increasing presence of these threats has created many economic and
political uncertainties that could adversely affect our business and stock price
in ways that cannot be predicted. We are predominantly uninsured for losses and
interruptions caused by terrorism, acts of war and other catastrophic events.
If we fail to maintain strong relationships with our resellers, distributors and
suppliers, our ability to successfully deploy and sell our products may be
harmed.
We sell many of our Professional Video products and services and
substantially all of our Audio and Consumer Video products and services,
indirectly through resellers and distributors. In our Audio and Consumer Video
segments, a few distributors account for a significant portion of the revenue in
that segment. The loss of one or more key distributors could reduce our
revenues. The resellers and distributors of our Professional Video segment
products typically purchase Avid software and Avid-specific hardware from us and
third-party components from various other vendors, in order to produce complete
systems for resale. Any disruption to our resellers and distributors, or their
third-party suppliers, could reduce our revenues. Increasingly, we are
distributing our broadcast products directly, which could put us in competition
with our resellers and distributors and could adversely affect our revenues. In
addition, our resellers could diversify the manufacturers from whom they
purchase products to sell to end-users, which could lead to a weakening of our
relationships with our resellers and could adversely affect our revenues.
Most of the resellers and distributors of our Professional Video
products are not granted rights to return products after purchase and actual
product returns from such resellers and distributors have been insignificant to
date. Our revenue from sales of Audio and Consumer Video products is generally
derived, however, from transactions with distributors and authorized resellers
that typically allow limited rights of return, inventory stock rotation and
price protection. Accordingly, reserves for estimated returns, exchanges and
credits for price protection are recorded as a reduction of revenues upon
shipment of the related products to such distributors and resellers, based upon
our historical experience. To date, actual returns have not differed materially
from management's estimates. However, if returns of our Audio or Consumer Video
segment products were to exceed estimated levels, our revenues and operating
results could be adversely impacted.
With respect to our Consumer Video segment, we have expanded our
distribution network to include several consumer channels, including large
distributors of products to computer software and hardware retailers, which in
turn sell products to end users. We also sell our Consumer Video products
directly to certain retailers. Our Consumer Video product distribution network
exposes us to the following risks, some of which are out of our control:
o we are obligated to provide price protection to our retailers and
distributors and, while the agreements limit the conditions under which
products can be returned to us, we may be faced with product returns or
price protection obligations;
o retailers or distributors may not continue to stock and sell our
consumer products; and
o retailers and distributors often carry competing products.
Changes in accounting rules could adversely affect our future operating results.
Our financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America. These principles
are subject to interpretation by various governing bodies, including the
Financial Accounting Standards Board and the Securities and Exchange Commission,
which promulgate and interpret appropriate accounting regulations. Changes from
current accounting regulations, as well as the judgments and methods we use to
implement them, may have a significant effect on our reported financial results.
Furthermore, changes in the rules regarding accounting for stock-based
compensation, which took effect on January 1, 2006, have resulted in higher
operating expenses and lower earnings per share compared to prior periods.
Our future growth could be harmed if we lose the services of certain employees.
Our success depends upon the services of a talented and dedicated
workforce, including members of our executive team and employees in technical
positions. The loss of the services of one or more key employees could harm our
business. Our success also depends upon our ability to attract and retain highly
skilled new employees. Competition for such employees is intense in the
industries and geographic areas in which we operate. In the past, we have relied
on our ability to grant stock options as one mechanism for recruiting and
retaining highly skilled talent. However, changes in the accounting rules that
38
will require us to expense stock options will impair our ability to provide
these incentives without incurring compensation costs. If we are unable to
compete successfully for talented employees, our business could suffer.
If we fail to manage our growth effectively, our business could be harmed.
Our success depends on our ability to manage the growth of our
operations effectively. As a result of our acquisitions and increasing demand
for our products and services, the scope of our operations has grown both
domestically and internationally. Our management team will face challenges
inherent in efficiently managing an increased number of employees over larger
geographic distances. These challenges include implementing effective
operational systems, procedures and controls, as well as training new personnel.
Inability to successfully respond to these challenges could have a material
adverse effect on the growth of our business.
Our websites could subject us to legal claims that could harm our business.
Some of our websites provide interactive information and services to our
customers. To the extent that materials may be posted on or downloaded from
these websites and distributed to others, we may be subject to claims for
defamation, negligence, copyright or trademark infringement, personal injury, or
other theories of liability based on the nature, content, publication or
distribution of such materials. In addition, although we have attempted to limit
our exposure by contract, we may also be subject to claims for indemnification
by end users in the event that the security of our websites is compromised. As
these websites are available on a worldwide basis, they could potentially be
subject to a wide variety of international laws.
We could incur substantial costs protecting our intellectual property or
defending against a claim of infringement.
Our ability to compete successfully and achieve future revenue growth
depends, in part, on our ability to protect our proprietary technology and
operate without infringing upon the intellectual property rights of others. We
rely upon a combination of patent, copyright, trademark and trade secret laws,
confidentiality procedures and contractual provisions, as well as required
hardware components and security keys, to protect our proprietary technology.
However, our means of protecting our proprietary rights may not be adequate. In
addition, the laws of certain countries do not protect our proprietary
technology to the same extent as do the laws of the United States. From time to
time unauthorized parties have obtained, copied and used information that we
consider proprietary. Policing the unauthorized use of our proprietary
technology is costly and time-consuming and we are unable to measure the extent
to which such unauthorized use, including piracy, of our software exists. We
expect software piracy to continue to be a persistent problem.
We occasionally receive communications suggesting that our products may
infringe the intellectual property rights of others. It is our practice to
investigate the factual basis of such communications and negotiate licenses
where appropriate. While it may be necessary or desirable in the future to
obtain licenses relating to one or more products or relating to current or
future technologies, we may be unable to do so on commercially reasonable terms.
If we are unable to protect our proprietary technology or unable to negotiate
licenses for the use of others' intellectual property, our business could be
impaired.
We also may be liable to some of our customers for damages that they may
incur in connection with intellectual property claims. Although we attempt to
limit our exposure to liability arising from infringement of third-party
intellectual property rights in our agreements with customers, we may not always
be successful. If we are required to pay damages to our customers, or indemnify
our customers for damages they incur, our business could be harmed. Moreover,
even if a particular claim falls outside of our indemnity or warranty
obligations to our customers, our customers may be entitled to additional
contractual remedies against us.
Regulations could be enacted that restrict our Internet initiatives.
Federal, state and international authorities may adopt new laws or
regulations governing the Internet, including laws or regulations covering
issues such as privacy, distribution and content. For example, the EU has issued
several directives regarding privacy and data protection, including the
Directive on Data Protection and the Directive on Privacy and Electronic
Communications. The enactment of legislation implementing such directives by EU
member countries is ongoing. The enactment of this and similar legislation or
regulations could curb our Internet sales and other initiatives, require changes
in our sales and marketing practices and place additional financial burdens on
our business.
Our association with industry organizations could subject us to litigation.
We are members of several industry organizations, trade associations and
standards consortia. Membership in these and similar groups could subject us to
litigation as a result of the activities of such groups. For example, in
39
connection with our anti-piracy program, designed to enforce copyright
protection of our software, we are a member of the Business Software Alliance,
or BSA. From time to time the BSA undertakes litigation against suspected
copyright infringers. These lawsuits could lead to counterclaims alleging
improper use of litigation or a violation of other local laws. To date, none of
these lawsuits or counterclaims have adversely affected our results of
operations, but, should we become involved in material litigation, our cash
flows or financial position could be adversely affected.
Compliance with rules and regulations concerning corporate governance has caused
our operating expenses to increase and has put additional demands on our
management.
The Sarbanes-Oxley Act of 2002 and various rules and regulations
promulgated by the SEC and the National Association of Securities Dealers in
recent years have increased the scope, complexity and cost of our corporate
governance, reporting and disclosure practices. These laws, rules and
regulations also divert attention from business operations, increase the cost of
obtaining director and officer liability insurance and may make it more
difficult for us to attract and retain qualified executive officers, key
personnel and members of our board of directors.
If we experience problems with our third-party leasing program, our revenues
could be adversely impacted.
We have an established leasing program with a third party that allows
certain of our customers to finance their purchases of our products. If this
program ended abruptly or unexpectedly, some of our customers might be unable to
purchase our products unless or until they were able to arrange for alternative
financing, which could adversely impact our revenues.
Our stock price may continue to be volatile.
The market price of our common stock has experienced volatility in the
past and could continue to fluctuate substantially in the future based upon a
number of factors, many of which are beyond our control. These factors include:
o changes in our quarterly operating results;
o shortfalls in our revenues or earnings compared to securities analysts'
expectations;
o changes in analysts' recommendations or projections;
o fluctuations in investors' perceptions of us or our competitors;
o shifts in the markets for our products;
o development and marketing of products by our competitors;
o changes in our relationships with suppliers, distributors, resellers,
system integrators or customers;
o announcements of major acquisitions;
o a shift in financial markets; and
o global macroeconomic conditions.
Furthermore, the market prices of equity securities of high technology
companies have generally demonstrated volatility in recent years and this
volatility has, at times, appeared to be unrelated to or disproportionate to any
of the factors above.
40
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We held our annual meeting of stockholders on May 24, 2006. At the
meeting, George H. Billings and Nancy Hawthorne were reelected as Class I
Directors. The vote with respect to each nominee is set forth below:
Total Vote For Total Vote Withheld
Each Director From Each Director
-------------- -------------------
Mr. Billings 40,225,989 139,809
Ms. Hawthorne 38,448,012 1,917,786
The additional directors whose term of office continued after the meeting are
David A. Krall, Pamela F. Lenehan, Elizabeth M. Daley, John V. Guttag and
Youngme E. Moon.
In addition, the stockholders ratified the selection of Ernst & Young
LLP as the Company's independent auditors by a vote of 40,286,013 shares for,
64,887 shares against and 14,898 shares abstaining.
ITEM 6. EXHIBITS
#10.1 Form of Nonstatutory Stock Option Grant Terms and Conditions (Form for
Non-Employee Directors) (incorporated by reference to our Current Report
on Form 8-K as filed with the Commission on May 31, 2006)
*31.1 Certification of Principal Executive Officer pursuant to Rules 13a-14
and 15d-14 under the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
*31.2 Certification of Principal Financial Officer pursuant to Rules 13a-14
and 15d-14 under the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
*32.1 Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
---------------------
* Documents filed herewith
# Management contract or compensatory plan
41
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AVID TECHNOLOGY, INC.
Date: August 9, 2006 By: /s/ Paul J. Milbury
------------------------------------------
Paul J. Milbury
Vice President and Chief Financial Officer
(Principal Financial Officer)
Date: August 9, 2006 By: /s/ Joel E. Legon
--------------------------
Joel E. Legon
Vice President and Corporate Controller
(Principal Accounting Officer)
42
EXHIBIT INDEX
Exhibit No. Description
----------- -----------
#10.1 Form of Nonstatutory Stock Option Grant Terms and Conditions (Form for
Non-Employee Directors) (incorporated by reference to our Current Report
on Form 8-K as filed with the Commission on May 31, 2006)
*31.1 Certification of Principal Executive Officer pursuant to Rules 13a-14
and 15d-14 under the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
*31.2 Certification of Principal Financial Officer pursuant to Rules 13a-14
and 15d-14 under the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
*32.1 Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
---------------------
* Documents filed herewith
# Management contract or compensatory plan
43