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AVID > SEC Filings for AVID > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for AVID TECHNOLOGY, INC.

Form 10-Q for AVID TECHNOLOGY, INC.


9-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

EXECUTIVE OVERVIEW

Our Company

We are a leading provider of digital media content-creation products and solutions for audio, film, video an broadcast professionals, as well as artists and musicians. Our audio and video solutions are designed to be extensions of the people using them, so that they amplify creativity, speed production processes and provide the science behind the art of making great creative experiences. We provide our products and solutions to customers in two market segments: Media Enterprise, which consists of broadcast, government, sports and other organizations that acquire, create, process, and/or distribute audio and video content to a large audience for communication, entertainment, analysis, and/or forensic purposes; and Post and Professionals, which is composed of individual artists and entities that create audio and video media as a paid service, but who do not distribute media to end consumers on a large scale.

We historically also served the Creative Enthusiast market segment, but on July 2, 2012, as a result of a strategic review of Avid's


business and the markets we serve, we announced a series of strategic actions initiated to focus on our Media Enterprise and Post and Professionals market segments and to drive improved operating performance. These actions included the divestiture of most of our consumer focused product lines, a rationalization of our business operations, and a reduction in force (the "2012 Plan") . We believe that these actions will generate several advantages for us as they will allow us to focus on the Media Enterprise and Post and Professionals market segments, the markets where we expect the highest growth. In addition we expect these actions will reduce complexity of our operations, improve operational efficiencies, and allow us to change our cost structure, by moving away from lower growth, lower margin sectors to drive improved financial performance.

As part of these actions, on July 2, 2012, we sold a group of consumer audio products to Numark Industries, L.P. ("Numark") for approximately $11.8 million and sold a group of consumer video products to Corel Corporation ("Corel") for approximately $3.0 million.

During the nine months ended September 30, 2012, as part of the 2012 Plan we recorded restructuring charges of approximately $25.1 million, including approximately $15.4 million related to employee severance obligations and $9.4 million related to closure or partial closure of facilities and $0.3 million for contract termination costs. We do not expect any significant further actions under the plan which we expect to be completed prior to December 31, 2012. The proceeds from the divestitures of the consumer product lines are expected to offset the majority of the cash restructuring charges paid in 2012.

We expect to realize significant estimated annualized cost savings, from both the restructuring actions and the consumer product line divestitures. These savings will appear in each of our cost of sales and operating expenses lines in our statement of operations. In addition, since the product material margin from these divested product lines was lower than the average material margin for our ongoing products, we expect overall gross margins to improve going forward due to favorable product mix and our cost reduction efforts.

We remain firmly committed to the professional markets and the devices and control services that support the Media Enterprise and Post and Professionals customers. These strategic actions described above will enable us to focus effectively on our core business as the leading provider of video and audio content-creations and management solutions for these professional markets.

See Note 7, Divestitures, and Note 13, Restructuring Costs and Accruals, to our Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for additional details and the related accounting for these consumer product line divestitures and the 2012 restructuring plan. See also the Results of Operations section below for additional information on revenue from divested product lines and expected trends.

We evaluate goodwill for impairment on an annual basis or more frequently if impairment indicators are present based upon the fair value of our reporting unit. We will perform our annual goodwill impairment test during the fourth quarter of 2012. Given the recent decline and continued volatility in the price of our common stock, it is possible that we will need to perform a hypothetical purchase price allocation for our single reporting unit, allocating the reporting unit's estimated fair value to its assets and liabilities, and to determine the implied fair value of goodwill. If the implied fair value of goodwill is less than the carrying value of goodwill, an impairment loss would be recognized for the difference. In addition we review intangible assets and other long-lived assets for impairment whenever indicators of impairment exist. While we cannot make a determination at this time, it is possible that goodwill, intangible assets and other long-lived assets impairment loss will be recorded in the fourth quarter of 2012.

Revisions to Prior Period Amounts

While preparing our financial statements for the three months ended March 31, 2012, we identified and corrected certain errors related to the accounting for an intercompany note made between two of our international subsidiaries that occurred in the fourth quarter of 2007. We determined that we should have accrued withholding taxes of approximately $3.8 million at the time of the loan, and as a result, we had understated the provision for income taxes in 2007 and income taxes payable reported on our balance sheets for each period subsequent to the transaction. Additionally, as the tax was not withheld and paid to the taxing authority, we are subject to interest and penalties on the unpaid balance, commencing in the three months ended March 31, 2009 and for subsequent periods. Interest and penalties totaled approximately $1.2 million ($0.8 million interest and $0.4 million penalties) and $1.0 million ($0.6 million interest and $0.4 million penalties) at September 30, 2012 and December 31, 2011 (Revised), respectively. During the three months ended June 30, 2012, we recorded a discrete tax benefit of approximately $3.8 million when it determined that we would repay the intercompany note and file a refund claim for the withholding taxes due (see Note 16 to our Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q). During the three months ended September 30, 2012, the intercompany note was repaid. We have commenced an administrative proceeding requesting the abatement of any penalties from the taxing authorities. As of September 30, 2012 we have no assurance that these penalties will


be abated.

In accordance with Securities and Exchange Commission ("SEC") Staff Accounting Bulletin Nos. 99 and 108 ("SAB 99" and "SAB 108"), we evaluated these errors and, based on an analysis of quantitative and qualitative factors, determined that they were immaterial to each of the prior reporting periods affected and, therefore, amendment of previously filed reports with the SEC was not required. However, if the adjustments to correct the cumulative effect of the aforementioned errors and other previously unrecorded immaterial errors had been recorded in the three months ended March 31, 2012, we believe the impact would have been significant and would impact comparisons to prior periods. Therefore, as required by SAB 108, we have revised in our Form 10-Q for the period ended March 31, 2012 previously reported financial information for each quarter of 2011 and for the years ended December 31, 2011 and 2010. In addition to correcting these withholding tax errors, we recorded other adjustments to prior period amounts to correct other previously unrecorded immaterial errors. Also, in accordance with SAB 108, we will include this revised financial information when we file subsequent reports on Form 10-Q and Form 10-K or file a registration statement under the Securities Act of 1933, as amended.

The Condensed Consolidated Statement of Operations for the three and nine months ended September 30, 2011 (Revised) have been revised to reflect the effect of the withholding tax errors described above and the other immaterial errors and is presented herein. See Note 1 to our Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for additional information on these revisions.

The Condensed Consolidated Balance Sheet at December 31, 2011 (Revised) has been revised to reflect the cumulative effect of the errors described above and other immaterial errors and are presented herein. See Note 1 to our Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for additional information on these revisions.

The adjustments to the Condensed Consolidated Statement of Cash Flows for each period resulted in immaterial changes to the amounts previously reported for net cash provided by (used in) operating activities, investing activities and financing activities in these periods.

                               Financial Summary

The following table sets forth certain items from our consolidated statements of
operations as a percentage of net revenues for the three and nine months ended
September 30, 2012 and 2011 (Revised):

                                       28
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                                   Three Months Ended September 30,         Nine Months Ended September 30,
                                       2012            2011 (Revised)          2012            2011 (Revised)
Net revenues:
Product revenues                        71.5  %                79.9  %          76.4  %                80.8  %
Services revenues                       28.5  %                20.1  %          23.6  %                19.2  %
Total net revenues                     100.0  %               100.0  %         100.0  %               100.0  %
Cost of revenues                        47.2  %                46.3  %          50.1  %                47.6  %
Gross margin                            52.8  %                53.7  %          49.9  %                52.4  %
Operating expenses:
Research and development                18.2  %                17.6  %          17.7  %                18.2  %
Marketing and selling                   28.8  %                27.7  %          28.9  %                27.7  %
General and administrative               8.3  %                 8.2  %           9.0  %                 8.7  %
Amortization of intangible
assets                                   0.6  %                 1.3  %           0.8  %                 1.3  %
Restructuring costs, net                10.0  %                 1.6  %           6.6  %                 0.3  %
(Gain) loss on sales of assets          (0.2 )%                   -  %           2.2  %                 0.1  %
Total operating expenses                65.7  %                56.4  %          65.2  %                56.3  %
Operating loss                         (12.9 )%                (2.7 )%         (15.3 )%                (3.9 )%
Interest and other income
(expense), net                          (0.3 )%                (0.3 )%          (0.2 )%                (0.3 )%
Loss before income taxes               (13.2 )%                (3.0 )%         (15.5 )%                (4.2 )%
Provision for income taxes, net          0.5  %                 1.6  %           0.5  %                 0.6  %
Net loss                               (13.7 )%                (4.6 )%         (16.0 )%                (4.8 )%

Total net revenues for the three-month period ended September 30, 2012 were $127.2 million, a decrease of $37.5 million compared to the same period in 2011, with revenues from products decreasing by 31.0% and services revenues increasing by 9.8%. Total net revenues for the nine-month period ended September 30, 2012 were $436.7 million, a decrease of $55.5 million compared to the same period in 2011, with revenues from products decreasing by 16.1% and services revenues increasing by 9.1%. We divested most of our consumer product lines on July 2, 2012. Included within net revenues for the nine-month periods ended September 30, 2012 is approximately $1.0 million for estimated sales returns related to the divestiture of the consumer audio and consumer video product lines. During the three months ended September 30, 2012, compared to the same period in 2011, ongoing video products revenues decreased by $15.4 million and ongoing audio products revenues decreased by $7.7 million, while ongoing services revenues increased $3.3 million. During the nine months ended September 30, 2012, compared to the same period in 2011, ongoing video products revenues and ongoing audio products revenues decreased by $18.4 million and $8.7 million, respectively, while ongoing services revenues increased $8.6 million. We believe the decrease in our ongoing product revenues for the three and nine-month periods ended September 30, 2012 was driven by the timing of new product introductions, product transitions, sales execution in the Americas and transitional issues experienced in the three months ended September 30, 2012 as we implemented the restructuring plan and divestitures. The increase in our ongoing services revenues was primarily the result of strong growth in our professional services, as well as increased maintenance revenues, driven by improved attachment rates for maintenance contracts on new product sales and strong contract renewal rates. Since 2010, we began to include maintenance contracts with certain product sales, which has had a positive effect on our maintenance revenues. The changes in revenues are discussed in further detail in the section titled "Results of Operations" below.

The following table sets forth the percentage of our net revenues attributable to geographic regions for the three and nine months ended September 30, 2012 and 2011 (Revised):

                                     Three Months Ended           Nine Months Ended
                                       September 30,                September 30,
                                    2012           2011          2012           2011
                                                 (Revised)                    (Revised)
Americas                             49%            52%           49%            51%
Europe, Middle East and Africa       37%            34%           37%            36%
Asia-Pacific                         14%            14%           14%            13%


Our gross margin percentage for the three and nine-month periods ended September 30, 2012 decreased to 52.8% and 49.9%, respectively, compared to 53.7% and 52.4%, respectively, for the same period in 2011. This change was driven by a decrease in products gross margin percentage to 50.8% and 48.7% for the three and nine-month periods ended September 30, 2012, respectively, compared to 54.4% and 52.8% for the three and nine-month periods ended September 30, 2011 (Revised), respectively. These decreases were partially offset by increases in services gross margin percentage to 58.4% and 59.0% for the three and nine-month periods ended September 30, 2012, compared to 52.8% and 53.0% for the three and nine-month periods ended September 30, 2011 (Revised). The decrease in our products gross margin percentage for the three and nine-month periods ended September 30, 2012 compared to the same periods in 2011 was largely driven by the decrease in our products revenues on relatively fixed costs for materials management and logistics, a shift in product mix weighted toward some lower margin products and the initiation of incentive promotions to sell certain of our older products that are at end-of-life or transitioning to new versions. We continue to bundle the first-year maintenance support, which has adversely impacted product gross margin, but should improve our service margins. As a result of the consumer product line divestitures and cost reduction efforts, we expect overall gross margins to improve as we move forward into Q4' 2012 and 2013. The increase in our services gross margin percentage for the three and nine-month periods ended September 30, 2012 compared to the same periods in 2011 was largely driven by the increase in services revenues from maintenance contracts, which have higher gross margins than professional services and training.

For the three-month period ended September 30, 2012, we incurred a net loss of $17.4 million, compared to a net loss of $7.6 million for the same period in 2011. The increase in net loss was largely a result of our 2012 restructuring plan and loss on sales of assets for the consumer product line divestitures announced on July 2, 2012. The net loss for the three months ended September 30, 2012 included charges of $1.4 million for acquisition-related intangible asset amortization and restructuring costs and costs and recoveries related to divestitures of $11.2 million. The net loss for the three months ended September 30, 2011 (Revised) included $2.8 million for acquisition-related intangible asset amortization and $2.7 million for restructuring costs.

At September 30, 2012, our cash balance was $71.4 million, an increase of $38.5 million from December 31, 2011 (Revised), and we had no outstanding borrowings against our lines of credit. At September 30, 2012, our inventory balance was $80.4 million, a decrease of $31.0 million from December 31, 2011 (Revised). Our days sales outstanding in accounts receivable was 53 days, which is consistent with historical levels.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our management's discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. We make estimates and assumptions in the preparation of our consolidated financial statements that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances. However, 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; stock-based compensation; the valuation of business combinations, goodwill and intangible assets; divestitures; and income tax assets and liabilities. We believe these policies are critical because they most significantly affect the portrayal of our financial condition and results of operations and involve our most difficult and subjective estimates and judgments. Our critical accounting policies may be found in our 2011 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", except for our critical accounting policy on divestitures, which is included below.

Divestitures
In accordance with the Financial Accounting Standards Board's Accounting Standards Codification ("ASC") topic No. 360, Property, Plant, and Equipment, we classify the assets and liabilities of a business as held-for-sale when management approves and commits to a formal plan of sale and it is probable that the sale will be completed. The carrying value of the net assets of the business held-for-sale are then recorded at the lower of their carrying value or fair market value, less costs to sell, and we cease to record depreciation and amortization expense associated with assets held-for-sale. As discussed in Note 7 to our Consolidated Financial Statements included in this Quarterly Report on Form 10-Q, we completed the sales of the consumer audio and consumer video product lines in the third quarter of 2012.


When we measure the gain (loss) on sale of a disposal group that is part of a reporting unit, we determine whether a portion of the goodwill of the reporting unit should be allocated to the disposal group if it constitutes a business. If the disposal group is considered a business, as defined by ASC Topic 350, Intangibles-Goodwill and Other, the goodwill of the reporting unit is allocated based on the relative fair values of the disposal group and the portion of the reporting unit remaining. We determined that the consumer audio and consumer video product lines each constituted a business; therefore, the estimated loss on sales of assets of each of these businesses included an allocation of $6.4 million and $1.6 million, respectively, of goodwill from our single reporting unit. Even though it was determined that the consumer audio and consumer video product lines constituted a business, we concluded that these businesses did not represent a component of our company that would require the presentation of the divestiture as discontinued operations. We made this determination based on the fact that the consumer audio and consumer video product lines do not have operations or cash flows that are clearly distinguishable and largely independent from the rest of our single reporting unit.


RESULTS OF OPERATIONS

NET REVENUES

Our net revenues are derived mainly from sales of computer-based digital, nonlinear media-editing and finishing systems and related peripherals, including shared-storage systems, software licenses, and related professional services and maintenance contracts.

                Net Revenues for the Three Months Ended September 30, 2012 and 2011
                                       (dollars in thousands)
                                              2012                  Change                 2011
                                          Net Revenues                                 Net Revenues
                                                                $             %         (Revised)
Video products revenues                 $       47,089     $  (20,564 )    (30.4)%    $     67,653
Audio products revenues                         41,982        (22,020 )    (34.4)%          64,002
Recoveries related to divestitures               1,807          1,807      100.0%                -
Products revenues                               90,878        (40,777 )    (31.0)%         131,655
Services revenues                               36,297          3,254       9.8%            33,043
Total net revenues                      $      127,175     $  (37,523 )    (22.8)%    $    164,698

                Net Revenues for the Nine Months Ended September 30, 2012 and 2011
                                      (dollars in thousands)
                                             2012                  Change                 2011
                                         Net Revenues                                 Net Revenues
                                                               $             %         (Revised)
Video products revenues                 $     167,002     $  (31,630 )    (15.9)%    $    198,632
Audio products revenues                       167,880        (31,377 )    (15.7)%         199,257
Less allowances related to divestitures        (1,041 )       (1,041 )   (100.0)%               -
Products revenues                             333,841        (64,048 )    (16.1)%         397,889
Services revenues                             102,905          8,562       9.1%            94,343
Total net revenues                      $     436,746     $  (55,486 )    (11.3)%    $    492,232



                                 Net Revenues of Divested Consumer Product Lines
                                             (dollars in thousands)
                                    Three Months Ended September 30,          Nine Months Ended September 30,
                                        2012           2011 (Revised)            2012            2011 (Revised)
Divested consumer video products
revenues                         $          1,938     $         6,097     $           8,617     $        22,409
Divested consumer audio products
revenues                                    2,243              15,804                27,093              50,355
Total revenues from divested
product lines                    $          4,181     $        21,901     $          35,710     $        72,764


                                     Net Revenues of the Ongoing Business
                                            (dollars in thousands)
                                     Three Months Ended September 30,       Nine Months Ended September 30,
                                         2012           2011 (Revised)          2012           2011 (Revised)
Ongoing video product revenue               46,107             61,556             157,867            176,223
Ongoing video service revenue               34,918             31,782              98,550             90,433
     Sub-Total ongoing video
revenue                                     81,025             93,338             256,417            266,656
Ongoing audio product revenue               40,595             48,291             140,374            149,092
Ongoing audio service revenue                1,374              1,168               4,245              3,720
     Sub-Total ongoing audio
revenue                                     41,969             49,459             144,619            152,812
Totals
     Ongoing product                        86,702            109,847             298,241            325,315
     Ongoing Services                       36,292             32,950             102,795             94,153
     Total ongoing revenue                 122,994            142,797             401,036            419,468
Total revenues from divested
product lines                                4,181             21,901              35,710             72,764
Total net revenues                         127,175            164,698             436,746            492,232

Video Products Revenues

Video products revenues decreased $20.6 million, or 30.4%, for the three-month period ended September 30, 2012 compared to the same period in 2011, and decreased $31.6 million, or 15.9%, for the nine-month period ended September 30, 2012 compared to the same period in 2011. During the first half of 2012, we experienced a decrease in our consumer video-editing revenues due to lower unit sales as a result of continued weakness in the consumer video-editing market in the 2012 period. We divested our consumer video-editing product lines on July 2, 2012. Ongoing video products revenues decreased $15.4 million, or 25.1%, for the three-month period ended September 30, 2012 compared to the same period in 2011, and decreased $18.4 million, or 10.4%, for the nine-month period ended September 30, 2012 compared to the same period in 2011. We believe the decrease in ongoing video product revenues for the three-month period ended September 30, 2012, compared to the prior period, was primarily due to sales execution issues, largely in the Americas, and transitional issues related to our restructuring plans and divestitures. For the nine-month period ended September 30, 2012, . . .

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