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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005
---------
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 an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).
Yes X No _____
The number of shares outstanding of the registrant's Common Stock as of April
18, 2005 was 35,153,890.
AVID TECHNOLOGY, INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005
TABLE OF CONTENTS
-----------------
PAGE
----
PART I. FINANCIAL INFORMATION
ITEM 1. Condensed Consolidated Financial Statements:
a) Condensed Consolidated Statements of Operations (unaudited)
for the three months ended March 31, 2005 and 2004 ...................1
b) Condensed Consolidated Balance Sheets (unaudited) as of
March 31, 2005 and December 31, 2004..................................2
c) Condensed Consolidated Statements of Cash Flows (unaudited)
for the three months ended March 31, 2005 and 2004 ...................3
d) Notes to Condensed Consolidated Financial Statements (unaudited)......4
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................13
ITEM 3. Quantitative and Qualitative Disclosure About Market Risk..........29
ITEM 4. Controls and Procedures............................................30
PART II. OTHER INFORMATION
ITEM 6. Exhibits ..........................................................31
SIGNATURES..................................................................32
EXHIBIT INDEX...............................................................33
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
March 31,
---------------------------
2005 2004
------------- ------------
Net revenues:
Product $147,378 $113,584
Services 18,623 13,790
------------- ------------
Total net revenues 166,001 127,374
Cost of revenues:
Product 60,897 46,514
Services 10,070 7,589
Amortization of intangible assets 281 -
------------- ------------
Total cost of revenues 71,248 54,103
------------- ------------
Gross profit 94,753 73,271
Operating expenses:
Research and development 24,679 22,292
Marketing and selling 39,647 29,854
General and administrative 8,497 5,886
Amortization of intangible assets 1,592 439
------------- ------------
Total operating expenses 74,415 58,471
------------- ------------
Operating income 20,338 14,800
Interest income 808 540
Interest expense (94) (83)
Other income (expense), net 123 (1,017)
------------- ------------
Income before income taxes 21,175 14,240
Provision for (benefit from) income taxes 1,429 (500)
------------- ------------
Net income $19,746 $14,740
============= ============
Net income per common share - basic $0.56 $0.47
Net income per common share - diluted $0.53 $0.44
Weighted average common shares
outstanding - basic 34,987 31,202
Weighted average common shares
outstanding - diluted 37,263 33,740
The accompanying notes are an integral part of the condensed consolidated
financial statements.
1
AVID TECHNOLOGY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
March 31, December 31,
------------- -------------
2005 2004
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents $92,227 $79,058
Marketable securities 83,965 76,361
Accounts receivable, net of allowances
of $8,860 and $9,334 at March 31, 2005
and December 31, 2004, respectively 97,182 97,536
Inventories 55,150 53,946
Current deferred tax assets, net 644 653
Prepaid expenses 8,527 7,550
Other current assets 7,267 11,204
------------- -------------
Total current assets 344,962 326,308
Property and equipment, net 29,523 29,092
Intangible assets, net 45,010 46,884
Goodwill 166,473 165,803
Long-term deferred tax assets, net 4,268 4,184
Other assets 4,182 3,963
------------- -------------
Total assets $594,418 $576,234
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $25,877 $26,517
Accrued compensation and benefits 20,434 30,468
Accrued expenses and other current liabilities 31,043 34,902
Income taxes payable 10,095 9,357
Deferred revenues 55,742 48,680
------------- -------------
Total current liabilities 143,191 149,924
Long-term debt and other liabilities 1,569 1,689
------------- -------------
Total liabilities 144,760 151,613
------------- -------------
Commitments and contingencies (Note 6)
Stockholders' equity:
Common stock 351 348
Additional paid-in capital 552,494 546,849
Accumulated deficit (103,030) (122,775)
Deferred compensation (3,547) (4,392)
Accumulated other comprehensive income 3,390 4,591
------------- -------------
Total stockholders' equity 449,658 424,621
------------- -------------
Total liabilities and stockholders' equity $594,418 $576,234
============= =============
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)
Three Months Ended March 31,
----------------------------
2005 2004
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $19,746 $14,740
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 5,267 3,277
Provision for (recovery of) doubtful accounts 400 (130)
Gain on disposal of fixed assets (55) --
Compensation expense from stock grants and options 842 13
Equity in income of non-consolidated company (60) (18)
Changes in operating assets and liabilities:
Accounts receivable (80) (5,083)
Inventories (1,403) 2,369
Prepaid expenses and other current assets 2,334 (1,547)
Accounts payable (755) 3,700
Income taxes payable 537 31
Accrued expenses, compensation and benefits (13,692) (8,178)
Deferred revenues 7,233 8,473
- ------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 20,314 17,647
- ------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (4,151) (4,417)
Payments for other long-term assets (280) (10)
Payments for business acquisitions, net of cash acquired -- (43,899)
Purchases of marketable securities (27,132) (9,066)
Proceeds from sales and maturities of marketable securities 19,411 14,705
- ------------------------------------------------------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (12,152) (42,687)
- ------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on capital lease obligations (24) (161)
Proceeds from issuance of common stock under employee stock plans 5,649 4,675
- ------------------------------------------------------------------------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 5,625 4,514
- ------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and cash equivalents (618) 37
- ------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 13,169 (20,489)
Cash and cash equivalents at beginning of period 79,058 77,124
- ------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $92,227 $56,635
- ------------------------------------------------------------------------------------------
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 presentation. 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, 2004 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, 2004 in its
2004 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.
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, inventory valuation and income tax asset valuation
allowances. Actual results could differ from those estimates.
In connection with preparation of the Company's Annual Report on Form 10-K for
the year ended December 31, 2004, the Company concluded that it was appropriate
to classify its investments in auction rate securities as marketable securities.
Previously, such investments were classified as cash and cash equivalents.
Accordingly, the Company has revised the classification to exclude from cash and
cash equivalents $23.4 million of auction rate securities at March 31, 2004, and
to include such amounts as marketable securities. In addition, the Company has
made corresponding adjustments to the accompanying statement of cash flows to
reflect the gross purchases and sales of these securities as investing
activities. As a result, cash used in investing activities decreased by $2.1
million for the three months ended March 31, 2004. This change in classification
does not affect previously reported cash flows from operations or from financing
activities.
2. NET INCOME PER COMMON SHARE
Basic and diluted net income per share were calculated as follows (in thousands,
except per share data):
Three Months Ended
March 31,
-----------------------
2005 2004
----------- ----------
Net income $19,746 $14,740
=========== ==========
Weighted average common shares outstanding - basic 34,987 31,202
Weighted average potential common stock:
Options 2,012 2,538
Warrant 264 --
----------- ----------
Weighted average common shares outstanding - diluted 37,263 33,740
=========== ==========
Net income per common share - basic $0.56 $0.47
Net income per common share - diluted $0.53 $0.44
4
Common stock options and a warrant that were considered anti-dilutive securities
since their exercise prices exceeded the average market price of the underlying
common stock during the period and, accordingly, were excluded from the diluted
net income per share calculations were as follows, on a weighted-average basis
(in thousands):
Three Months Ended
March 31,
-----------------------
2005 2004
----------- ----------
Options 350 157
Warrant -- 1,155
----------- ----------
Total anti-dilutive common stock
options and warrant 350 1,312
=========== ==========
3. ACQUISITIONS
M-Audio
In August 2004, Avid completed the acquisition of Midiman, Inc. d/b/a M-Audio
("M-Audio"), a leading provider of digital audio and MIDI (Musical Instrument
Digital Interface) solutions for musicians and audio professionals. Avid paid
cash of $79.6 million, net of cash acquired, of which $0.5 million is being paid
out over a two year period, and issued stock and options with a fair value of
$96.5 million. The market price of $42.72 used to value the Avid shares was
based on the five-day average closing price of the stock during the period
beginning two days before and ending two days after the date that the terms of
the acquisition were agreed to and announced publicly. The weighted average fair
value of $35.14 used to value the options was calculated using the same five-day
average, less the weighted average exercise price of the options. Avid also
incurred $3.3 million of transaction costs. The Company has integrated M-Audio
into its Audio segment and is marketing its line of audio products alongside
Digidesign's digital audio workstations for the professional and home/hobbyist
markets. The goodwill of $122.0 million resulting from the purchase price
allocation reflects the value of the underlying enterprise as well as synergies
that Avid expects to realize, including incremental sales of Digidesign
products. The following table summarizes the estimated fair value of the assets
acquired and liabilities assumed at the date of acquisition (in thousands):
Accounts receivable $7,288
Inventories 13,420
Other current assets 903
Equipment and other long-term assets 1,520
Identifiable intangible assets:
Customer relationships 28,000
Trade name 4,700
Non-compete covenant 1,200
Completed technology 4,500
Goodwill 122,022
---------
Total assets acquired 183,553
Accounts payable (4,626)
Other current liabilities (5,066)
Deferred compensation related to
stock options issued 5,500
---------
Net assets acquired $179,361
=========
As part of the purchase agreement, Avid may be required to make additional
payments to the former shareholders and option holders of M-Audio of up to $45.0
million, contingent upon the operating results of M-Audio through December 31,
2005. These payments, if required, will be made through the issuance of
additional Avid shares or options based on the ten-day average closing price of
the stock ending two days prior to the date the earn-out shares are distributed.
Any additional Avid shares issued to the former shareholders of M-Audio will be
recorded as additional purchase price allocated to goodwill. Any additional Avid
options issued to former option holders of M-Audio will be recorded as
stock-based compensation expense because future service is required for it to be
earned.
5
The identifiable intangible assets are being amortized over their estimated
useful lives of twelve years for customer relationships, six years for the trade
name, four years for the developed technology and two years for the non-compete
covenant. The twelve year life for customer relationships, although longer than
that used for similar intangible assets for other acquisitions by Avid, is
considered reasonable due to the similarities in their business to Avid's
Digidesign division, which has enjoyed long-term relationships with its
customers. Amortization expense totaled $1.2 million for the three months ended
March 31, 2005 and accumulated amortization of these intangible assets was $3.0
million at March 31, 2005. The $122.0 million of goodwill was assigned to the
Company's Audio segment and will not be amortized, in accordance with the
requirements of Statement of Financial Accounting Standards ("SFAS") No. 142,
"Goodwill and Other Intangible Assets". This goodwill and the identifiable
intangible assets are not deductible for tax purposes.
Avid Nordic AB
In September 2004, the Company acquired Avid Nordic AB, a Sweden-based exclusive
reseller of Avid products operating in the Nordic and Benelux regions of Europe,
for cash, net of cash acquired, of euro 6.1 million ($7.4 million) plus
transaction costs of $0.3 million. The Company previously had no ownership
interest in Avid Nordic AB. The acquisition allows Avid to directly serve
customers in this region. The following table summarizes the estimated fair
value of the assets acquired and liabilities assumed in the transaction (in
thousands):
Accounts receivable $3,702
Inventories 2,516
Other current assets 589
Equipment and other long-term assets 671
Identifiable intangible asset 4,700
Goodwill 1,955
---------
Total assets acquired 14,133
Accounts payable (2,571)
Note payable (1,203)
Other current liabilities (1,057)
Long term deferred tax liability (1,645)
---------
Net assets acquired $7,657
=========
The identifiable intangible asset represents customer relationships developed in
the region by Avid Nordic AB. This asset will be amortized over its estimated
useful life of five years. Amortization expense totaled $0.2 million for the
three months ended March 31, 2005 and accumulated amortization of this asset was
$0.5 million at March 31, 2005. The goodwill of $2.0 million resulting from the
purchase price allocation reflects the value of the assembled workforce and
existing infrastructure in the region. This goodwill was assigned to the Video
and Film Editing and Effects ("Video") segment and will not be amortized in
accordance with the requirements of SFAS No. 142. This goodwill and the customer
relationships intangible asset are not deductible for tax purposes. During the
quarter ended December 31, 2004, the goodwill was increased by $0.4 million to
$2.4 million due to a reduction in the estimated fair value of inventory and
other current assets acquired from Avid Nordic AB. The note payable represented
an overdraft facility with a bank, which was paid in full in December 2004.
As part of the purchase agreement, Avid may be required to make additional
payments to the former shareholders of Avid Nordic AB of up to euro 1.3 million
($1.8 million) contingent upon the operating results of Avid Nordic AB through
August 31, 2005. These payments will be recorded as additional purchase
consideration, allocated to goodwill. Through the first quarter of 2005 the
Company estimated that approximately euro 0.5 million ($0.7 million) of
additional purchase consideration had been earned and accordingly recorded an
increase to goodwill offset in accrued liabilities.
NXN Software GmbH
In January 2004, Avid acquired Munich, Germany-based NXN Software GmbH ("NXN"),
a leading provider of asset and production management systems specifically
targeted for the entertainment and computer graphics industries, for cash of
euro 35 million ($43.7 million) less cash acquired of $0.8 million. The Company
also incurred $1.3 million of transaction costs. The acquisition expands Avid's
offering in digital asset management by enabling the Company's film and video
post-production, broadcast, audio and 3D animation customers to leverage the
workflow capabilities of the NXN Alienbrain(R) product line. NXN is reported
6
within Avid's Video segment. The goodwill resulting from the purchase price
allocation reflects the synergies the Company expects to realize by integrating
the NXN technology with its other products. The following table summarizes the
estimated fair value of the assets acquired and liabilities assumed at the date
of acquisition (in thousands):
Current assets $2,049
Equipment and other long-term assets 584
Identifiable intangible assets 7,200
Deferred tax assets, net 2,480
Goodwill 38,813
---------
Total assets acquired 51,126
Current liabilities assumed (6,169)
---------
Net assets acquired $44,957
=========
The identifiable intangible assets include completed technology valued at $4.3
million, customer relationships valued at $2.1 million, and a trade name valued
at $0.8 million, which are being amortized over their estimated useful lives of
four to six years, three to six years, and six years, respectively. The weighted
average amortization period is 5.6 years for both completed technology and
customer relationships. Amortization expense relating to these intangibles was
$0.3 million for the three months ended March 31, 2005 and accumulated
amortization of these assets was $1.2 million at March 31, 2005. In December
2004, the Company reviewed the identifiable intangible assets acquired in the
NXN transaction and found the customer relationships intangible assets and the
trade name to be impaired. The impairment of the customer relationships
intangible assets was the result of the need to renegotiate contracts with
certain customers, which also had an impact on the fair value of the Alienbrain
trade name asset. The Company recalculated the fair values of these intangible
assets based on revised expected future cash flows reflecting the contract
renegotiations and recorded a charge of $1.2 million in December 2004 to write
them down to their revised fair values. This charge was included in the
statement of operations caption "Impairment of intangible assets" and was
charged to the Video segment. Also during the year ended December 31, 2004, the
$38.8 million of goodwill was reduced by $0.7 million to $38.1 million due to
finalizing the estimated fair value of deferred revenue acquired from NXN. This
goodwill was assigned to the Video segment and, in accordance with the
requirements of SFAS No. 142, will not be amortized. This goodwill and the
identifiable intangible assets are not deductible for tax purposes.
Pro Forma Financial Information for Acquisitions (Unaudited)
The results of operations of M-Audio, Avid Nordic and NXN 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 months ended March 31, 2004 as if the
acquisitions of both M-Audio and NXN had occurred at the beginning of 2004. The
Company's pro forma results of operations giving effect to the Avid Nordic AB
acquisition as if it had occurred at the beginning of 2004 is not included as it
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 2004, or of future
results.
Three Months Ended
March 31,
--------------------
2004
--------------------
(In thousands, except per share data)
Net revenues $145,290
Net income $13,479
Net income per share:
Basic $0.41
Diluted $0.37
7
Agreement to Acquire Pinnacle Systems, Inc.
On March 21, 2005, the Company announced that it had entered into a definitive
agreement to acquire Pinnacle Systems, Inc. (Pinnacle) in a cash and stock
transaction. Under the terms of the agreement, Pinnacle shareholders will
receive 0.0869 shares of Avid stock and $1.00 in cash for each Pinnacle share.
At closing, it is expected that Avid will issue approximately 6.2 million shares
and pay approximately $71.3 million in cash to Pinnacle shareholders. The
acquisition is subject to satisfying a number of closing conditions including
shareholder and regulatory approvals, and is expected to close in the third
quarter of 2005.
4. ACCOUNTS RECEIVABLE
Accounts receivable, net consisted of the following (in thousands):
March 31, December 31,
2005 2004
------------- -------------
Accounts receivable $106,042 $106,870
Less:
Allowance for doubtful accounts (4,333) (4,132)
Allowance for sales returns and rebates (4,527) (5,202)
------------- -------------
$97,182 $97,536
============= =============
The allowance for doubtful accounts represents an allowance for estimated bad
debt losses resulting from the inability of our customers to make required
payments for products or services. When evaluating the adequacy of the
allowances, the Company analyzes accounts receivable balances, historical bad
debt experience, customer concentrations, customer credit-worthiness and current
economic trends. 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 have not differed materially from
management's estimates. Allowances for rebates on purchases of certain products,
or rebates based on purchasing volume, are also accounted for as reductions to
revenue, in the same period that related revenues are recorded, or upon expected
achievement of purchasing volumes.
5. INVENTORIES
Inventories consisted of the following (in thousands):
March 31, December 31,
2005 2004
----------------- ----------------
Raw materials $21,348 $14,925
Work in process 3,752 3,622
Finished goods 30,050 35,399
----------------- ----------------
$55,150 $53,946
================= ================
As of March 31, 2005 and December 31, 2004, the finished goods inventory
included inventory at customer locations of $7.3 million and $9.0 million,
respectively, associated with product shipped to customers for which revenue had
not yet been recognized.
6. ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for stock-based awards to employees using the intrinsic
value method as prescribed by Accounting Principles Board ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees," and related interpretations.
Accordingly, no compensation expense is recorded for options issued to employees
in fixed amounts and with fixed exercise prices at least equal to the fair
market value of the Company's common stock at the date of grant. When the
exercise price of stock options granted to employees is less than the fair
market value of common stock at the date of grant, the Company records that
difference multiplied by the number of shares under option as deferred
compensation, which is then amortized over the vesting period of the options.
Additionally, deferred compensation is recorded for restricted stock granted to
employees based on the fair market value of the Company's common stock at date
of grant and is amortized over the period in which the restrictions lapse. The
8
Company reverses deferred compensation associated with unvested options issued
at below fair market value as well as unvested restricted stock upon the
cancellation of such options or shares for terminated employees. The Company
provides the disclosures required by SFAS No. 123, "Accounting for Stock-Based
Compensation," as amended by SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure". All stock-based awards to non-employees
are accounted for at their fair value in accordance with SFAS No. 123. There
were no stock-based awards granted to non-employees during the three months
ended March 31, 2005 or 2004.
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 stock-based employee awards (in thousands, except per share
data).
Three Months Ended March 31,
---------------------------
2005 2004
------------ ------------
Net income as reported $19,746 $14,740
Add: Stock-based employee compensation expense
included in reported net income, net of related
tax effect 842 13
Deduct: Total stock-based employee
compensation expense determined under the fair
value-based method for all awards, net of
related tax effect (4,820) (3,371)
------------ ------------
Pro forma net income $15,768 $11,382
============ ============
Net income per common share:
Basic-as reported $0.56 $0.47
Basic-pro forma $0.45 $0.36
Diluted-as reported $0.53 $0.44
Diluted-pro forma $0.43 $0.34
Under SFAS No. 123, the fair value of each option grant is estimated on the date
of grant using the Black-Scholes option pricing model and is amortized over the
stock option's vesting period.
7. 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 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.
From time to time, the Company provides indemnification provisions in agreements
with customers covering potential claims by third parties that Avid products
infringe their intellectual property rights. Pursuant to these indemnification
provisions, the Company agrees to indemnify customers for losses that they
suffer or incur in connection with any valid U.S. patent or copyright
infringement claim brought by a third party with respect to Avid 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 received any claims under these indemnification provisions. As a
result, the Company believes the estimated fair value of these indemnification
provisions is minimal.
As permitted under Delaware law, Avid has agreements whereby the Company
indemnifies its officers and directors for certain events or occurrences while
the officer or director is or was serving at Avid's request in such capacity.
The term of the indemnification period is for the 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,
9
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 March 31, 2005, of $4.3
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
March 31, 2005, 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 very 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 March 31, 2005 and
December 31, 2004, Avid's maximum recourse exposure totaled approximately $17.1
million and $17.2 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 refunds or concessions to the end
user 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 also 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 compared to the
funded amount outstanding at period end. At March 31, 2005 and December 31,
2004, the Company's accrual for estimated losses was $1.8 million and $2.2
million, respectively.
Avid provides warranty on hardware sold through its Video segment which
generally mirrors the manufacturers' warranties. The Company charges the related
material, labor and freight expense to cost of revenues in the period incurred.
With respect to the Audio segment, Avid provides warranty on externally sourced
and internally developed hardware and 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.
The following table sets forth the activity in the product warranty accrual
account (in thousands):
Three Months Ended
March 31, 2005
------------------
Accrual balance at December 31, 2004 $2,261
Accruals for product warranties 1,074
Cost of warranty claims (948)
------------------
Accrual balance at March 31, 2005 $2,387
==================
10
8. COMPREHENSIVE INCOME
Total comprehensive income, net of taxes, consists of net income, 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):
Three Months Ended March 31,
---------------------------
2005 2004
------------ ------------
Net income $19,746 $14,740
Net changes in:
Foreign currency translation adjustment (1,263) (581)
Unrealized gains on securities 62 57
------------ ------------
Total comprehensive income $18,545 $14,216
============ ============
9. SEGMENT INFORMATION
The Company's organizational structure is based on strategic business units that
offer various products to the principal markets in which the Company's products
are sold. These business units equate to two reportable segments: Video and Film
Editing and Effects, and Audio. The following is a summary of the Company's
operations by reportable segment (in thousands):
Three Months Ended March 31,
----------------------------
2005 2004
------------- -------------
Video and Film Editing and Effects:
Net revenues $104,485 $91,979
Operating income 15,115 13,344
Audio:
Net revenues $61,516 $35,395
Operating income 7,867 1,895
Combined Segments:
Net revenues $166,001 $127,374
Operating income 22,982 15,239
The following table reconciles operating income for reportable segments to the
total consolidated amounts for the three months ended March 31, 2005 and 2004
(in thousands):
Three Months Ended March 31,
----------------------------
2005 2004
------------- -------------
Total operating income for reportable segments $22,982 $15,239
Unallocated amounts:
Stock-based compensation (771) -
Amortization of acquisition-related
intangible assets (1,873) (439)
------------- -------------
Consolidated operating income $20,338 $14,800
============= =============
10. RESTRUCTURING AND OTHER COSTS, NET
In December 2002, the Company recorded a charge of $3.3 million in connection
with vacating excess space in its Tewksbury, Massachusetts; Daly City,
California; and Montreal, Canada facilities. The Daly City estimate was revised,
and an additional charge of $1.5 million was recorded in the fourth quarter of
2003.
The Company recorded the December 2003 and 2002 charges in accordance with the
guidance of SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities". SFAS 146 requires that a liability be recognized for an operating
lease that is not terminated based on the estimated remaining lease rental
costs, measured at its fair value on a discounted cash flow basis, when the
entity ceases using the rights conveyed by the operating lease. That amount is
reduced by any estimated sublease rentals, regardless of whether the entity
intends to enter into a sublease. Future changes in the fair value of the
Company's obligations are recorded through operating expenses. 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 corresponding adjustments to the accrual.
11
The following table sets forth the activity in the restructuring and other costs
accrual, which is included in Accrued expenses and other current liabilities,
for the three months ended March 31, 2005 (in thousands):
Accrual balance at December 31, 2004 $3,534
Cash payments, net (692)
------------
Accrual balance at March 31, 2005 $2,842
============
The leases, and payments against the amount accrued, extend through 2010 unless
the Company is able to negotiate an earlier termination.
11. RECENT ACCOUNTING PRONOUNCEMENTS
In November 2004, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 151, "Inventory Costs", an amendment of Accounting Research Bulletin ("ARB")
No. 43, which is the result of its efforts to converge U.S. accounting standards
for inventories with International Accounting Standards. SFAS No. 151 requires
idle facility expenses, freight, handling costs, and wasted material (spoilage)
costs to be recognized as current-period charges. It also requires that the
allocation of fixed production overheads to the costs of conversion be based on
the normal capacity of the production facilities. SFAS No. 151 will be effective
for inventory costs incurred during fiscal years beginning after June 15, 2005
(i.e. beginning January 1, 2006 for the Company). The Company is currently
evaluating the impact of SFAS No. 151 on its consolidated financial statements.
The adoption of this standard is not expected to have a material impact on the
Company's financial position or results of operations.
On December 16, 2004, the FASB released SFAS No. 123R. This new accounting
standard requires all forms of stock compensation, including stock options
issued to employees, to be reflected as an expense in the Company's financial
statements. On April 14, 2005, the Securities and Exchange Commission (`SEC")
approved a new rule that delays the effective date of SFAS No. 123R. Under the
new rule, SFAS No. 123R is now effective for public companies for annual, rather
than interim, periods that begin after June 15, 2005. SFAS No. 123R allows three
alternative methods of transitioning to the standard: modified prospective
application ("MPA"), without restatement of prior interim periods in the year of
adoption; MPA with restatement of prior interim periods in the year of adoption;
or modified retrospective application. The Company intends to use the MPA
without restatement alternative and to apply the revised standard beginning
January 1, 2006. Although the Company has not finalized its analysis, it expects
that the adoption of the revised standard will result in higher operating
expenses and lower earnings per share. [See Footnote 6, Accounting for
Stock-Based Compensation, for the pro forma impact on net income and income per
common share as if the Company had historically applied the fair value
recognition provisions of SFAS No. 123 to stock based employee awards.]
On October 22, 2004, the President signed the American Jobs Creation Act of 2004
("the Act"). The Act creates a temporary incentive for U.S. corporations to
repatriate accumulated income earned abroad by providing an 85 percent
dividends-received deduction for certain dividends from controlled foreign
corporations. The Act also creates a deduction on a percentage of the lesser of
qualified production activities income or taxable income. Although these
deductions are subject to a number of limitations and significant uncertainty
remains as to how to interpret numerous provisions in the Act, as of March 31,
2005, the Company believes that it had the information necessary to make an
informed decision on the impact of the Act. Based on the information available,
the Company has determined that its cash position in the U.S. is sufficient to
fund anticipated needs. The Company also believes that the repatriation of
income earned abroad would result in significant foreign withholding taxes that
otherwise would not have been incurred as well as additional U.S. tax
liabilities that may not be sufficiently offset by foreign tax credits.
Therefore, the Company does not currently plan to repatriate any income earned
abroad. The Company has also determined that the qualified production activities
deduction will not have a material impact on the fiscal 2005 tax provision due
to the expected amount of taxable income. These initial findings could change
based on clarification of the rules and changes in facts and circumstances of
the Company's operations and/or cash requirements in the U.S.
12
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
We develop, market, sell and support a wide range of software and
hardware for digital media production, management and distribution. Digital
media are video, audio or graphic elements in which the image, sound or picture
is recorded and stored as 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."
Make Media. Our Video and Film Editing and Effects ("Video")
segment offers digital, non-linear video and film editing systems and 3D and
special-effects software that enable users to manipulate moving pictures and
sound in a faster, easier, more creative, and more cost-effective manner than
using traditional analog tape-based systems. Non-linear systems allow editors
to access material instantaneously rather than requiring them to work
sequentially. Our Audio segment offers 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.
Manage Media. We provide complete network, storage, and database
solutions based on our Avid Unity MediaNetwork technology. This technology
enables users to simultaneously share and manage media assets throughout a
project or organization. The ability to manage digital media assets effectively
is a critical component of success for many broadcast and media companies with
multiple nonlinear editing workstations in a range of geographic locations. As
a result, professionals can collaborate seamlessly on all production elements,
and streamline the process for cost-effectively delivering compelling media
experiences and quickly "re-purposing" or finding new uses or markets for media
assets.
Move Media. We offer products that allow our customers to distribute
media over multiple platforms - including air, cable or satellite,
or through 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.
Our products are used worldwide in production and post-production
facilities; film studios; network, affiliate, independent and cable television
stations; recording studios; advertising agencies; government and educational
institutions; corporate communication departments; and by game developers and
Internet professionals. Projects produced by our customers using our products
have been honored with Oscar(R), Emmy(R), and Grammy(R) awards, as well as a
host of other international awards. In addition, we have also received numerous
awards for technical innovations, including Oscars, Emmys and a Grammy. 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.
An important part of our strategy for the past few years has included
expanding and enhancing our product lines and increasing revenues through both
acquisitions and internal development of products. In January 2004, we acquired
Germany-based NXN Software GmbH ("NXN"), a leading provider of asset and
production management systems specifically targeted for the entertainment and
computer graphics industries. This acquisition expands our offering in digital
asset management by enabling our film and video post-production, broadcast,
audio and 3D animation customers to leverage the workflow capabilities of the
NXN Alienbrain(R) product line. NXN has been integrated into our Video segment.
In August 2004, we completed the acquisition of California-based M-Audio, a
leading provider of digital audio and MIDI solutions for musicians and audio
professionals. We have integrated M-Audio into our Audio segment and is
marketing its line of audio products alongside Digidesign's digital audio
workstations for the professional and home/hobbyist markets. Finally, in
September 2004, we acquired Avid Nordic AB, a Sweden-based exclusive reseller of
our products operating in the Nordic and Benelux regions of Europe. This
acquisition allows us to directly serve customers in this region.
On March 20, 2005, we entered into a definitive agreement to acquire
California-based Pinnacle Systems, Inc. Under the terms of the agreement,
Pinnacle shareholders will receive 0.0869 shares of Avid stock and $1.00 in cash
for each Pinnacle share. At closing, it is expected that Avid will issue
approximately 6.2 million shares and pay $71.3 million in cash to Pinnacle
shareholders. The acquisition is subject to satisfying a number of closing
conditions, including shareholder and regulatory approvals, and is expected to
close in the third quarter of 2005.
13
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
its consolidated financial statements and accompanying notes. Note B of the
Notes to Consolidated Financial Statements in our 2004 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 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 these critical accounting policies may
by found in our 2004 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."
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 systems and related peripherals, licensing of related 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: Video and Audio. These business units are at the level for
which separate financial information for these business units is available and
is evaluated regularly by us when deciding how to allocate resources and
assessing performance. As such, our business units represent our reportable
segments under SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information".
Our Video segment produces non-linear video and film editing systems to
improve the productivity of video and film editors and broadcasters by enabling
them to edit moving pictures and sound in a faster, easier, more creative and
more 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 home videos. 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 automated mixing. This segment also includes our M-Audio product
family acquired in August 2004.
The following is a summary of our net revenues by segment for the
three-month periods ended March 31, 2005 and 2004 (dollars in thousands):
Three Months Ended March 31,
------------------------------------------------------------------------
% of % of
2005 Consolidated 2004 Consolidated % Change
Net Net Net Net in
Revenues revenues Revenues revenues Change Revenues
------------ ------------ ------------ ------------ --------- ----------
Video and Film Editing and Effects
Product Revenues: $86,140 51.9% $78,189 61.4% $7,951 10.2%
Service Revenues: 18,345 11.0% 13,790 10.8% 4,555 33.0%
------------ ------------ ------------ ------------ ---------
Total 104,485 62.9% 91,979 72.2% 12,506 13.6%
------------ ------------ ------------ ------------ ---------
Audio
Product Revenues: 61,238 36.9% 35,395 27.8% 25,843 73.0%
Service Revenues: 278 0.2% -- 0.0% 278 100.0%
------------ ------------ ------------ ------------ ---------
Total 61,516 37.1% 35,395 27.8% 26,121 73.8%
------------ ------------ ------------ ------------ ---------
Total Net Revenues: $166,001 100.0% $127,374 100.0% $38,627 30.3%
============ ============ ============ ============ =========
14
We estimate that 57%, or $4.6 million, of the increase in net product
revenues in our Video segment in 2005 as compared to 2004 was related to
increased sales volume of our products, including new products introduced after
the first quarter of 2004 such as Avid Airspeed and our new high-definition
("HD") versions of Avid Media Composer Adrenaline. The remaining 43%, or $3.4
million of growth is attributed to higher average selling prices of our
products. Average selling prices include the impact of changes in foreign
currency exchange rates and the impact of price changes, discounting and mix of
products (higher or lower-end) sold. The increase in service revenues comes
primarily from increases in maintenance contracts sold on our products as well
as increased professional services such as installation services provided in
connection with large broadcast news deals. For the Audio segment, we saw
increases in our core Digidesign Pro Tools products for both the professional
and home markets in the first quarter of 2005 as compared to the same period in
2004. Approximately 75%, or $19.6 million, of the increase was a result of the
inclusion of M-Audio products in the first quarter of 2005. M-Audio was acquired
in August 2004.
Net revenues derived through indirect channels were approximately 72%
for the three months ended March 31, 2005 compared to 76% for the comparable
period in 2004. The increase in direct selling from 2004 to 2005 was due
primarily to the growth in sales to our broadcast news customers, which are
direct sales and generally require a longer selling cycle. We expect sales to
broadcast news customers will be an area of continued revenue growth in the
future.
International sales (i.e., sales to customers outside the United States)
accounted for 56% of our first quarter 2005 net revenues, compared to 47% for
the first quarter of 2004. International sales increased by $32.4 million or 54%
in the first quarter of 2005 compared to the first quarter of 2004. The increase
in international sales in 2005 occurred in all regions including Europe, Asia,
Canada and Latin America, and was primarily due to an increased number of large
broadcast deals in those regions being a significant factor.
Gross Profit
Cost of revenues consists primarily of costs associated with the
procurement of components; post-sales customer support costs related to
maintenance contract revenue and other services; the assembly, testing, and
distribution of finished products; warehousing; and royalties for third-party
software 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.
The following is a summary of our cost of revenues and gross margin
percentages for the three-month periods ended March 31, 2005 and 2004 (dollars
in thousands):
Three Months Ended March 31,
--------------------------------------------------------------------------
% of Net % of Net Gross
Related Gross Related Gross Margin
2005 Revenues Margin % 2004 Revenues Margin % % Change
--------- ---------- ---------- --------- ---------- ---------- ----------
Product Cost of Revenues $60,897 41.3% 58.7% $46,514 41.0% 59.0% (0.3%)
Service Cost of Revenues 10,070 54.1% 45.9% 7,589 55.0% 45.0% 0.9%
Amortization of Technology 281 0.2% -- -- 0.0% 0.0% --
--------- ---------
Total $71,248 42.9% 57.1% $54,103 42.5% 57.5% (0.4%)
========= =========
The slight decrease in the product gross margin for 2005 reflects
primarily product mix, including the proportion of hardware costs on the
products sold, which was partly offset by a favorable impact of foreign currency
exchange rates on revenues, especially with respect to the euro. The service
gross margin increase in the first quarter of 2005 as compared to 2004 primarily
reflects increased service revenue volume. Our service cost infrastructure,
which is primarily personnel-related, did not grow at the same rate as the
revenues.
15
Research and Development
Three Months Ended March 31,
-----------------------------------------------
(dollars in thousands)
2005 2004
Expenses Expenses Change % Change
----------- ----------- ------------ ----------
Research and Development: $24,679 $22,292 $2,387 10.7%
Percentage of Net Revenues: 14.9% 17.5% (2.6%)
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. The
increase in research and development expenditures in 2005 was primarily due to
higher personnel-related costs, including the acquisitions of NXN and M-Audio
during 2004. Research and development expenses decreased as a percentage of net
revenues primarily as a result of the higher revenue base in 2005 compared to
2004.
Marketing and Selling
Three Months Ended March 31,
-----------------------------------------------
(dollars in thousands)
2005 2004
Expenses Expenses Change % Change
----------- ----------- ------------ ----------
Marketing and Selling $39,647 $29,854 $9,793 32.8%
Percentage of Net revenues: 23.9% 23.4% 0.5%
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. The increase in marketing and selling expenses was primarily
due to higher personnel-related costs, including salaries and related taxes and
benefits, in large part due to the acquisitions of NXN, M-Audio and Avid Nordic
during 2004. In the first quarter of 2005 we also had higher net foreign
exchange losses (specifically, remeasurement gains and losses on net monetary
assets denominated in foreign currencies, offset by hedging gains and losses),
which are included in marketing and selling expenses, than we had in the first
quarter of 2004.
General and Administrative
Three Months Ended March 31,
-----------------------------------------------
(dollars in thousands)
2005 2004
Expenses Expenses Change % Change
----------- ----------- ------------ ----------
General and Administrative $8,497 $5,886 $2,611 44.4%
Percentage of Net Revenues: 5.1% 4.6% 0.5%
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. The increase in
general and administrative expenditures in 2005 was primarily due to higher
personnel-related costs, including our acquisition of M-Audio in August 2004. We
also incurred higher audit and legal fees as a result of complying with the
Sarbanes-Oxley Act of 2002. The percentage increase in general and
administrative expense was due to the increases discussed above, with the impact
being offset by the higher revenue base in 2005.
16
Amortization of Acquisition-Related Intangible Assets
Three Months Ended March 31,
-------------------------------------
(dollars in thousands)
2005 2004 Change
------------ ------------ -----------
Amortization of Intangible Assets: $1,873 $439 $1,434
Percentage of Net Revenues: 1.1% 0.3% 0.8%
Included in amortization of intangible assets for the three-month period
ended March 31, 2005 is $0.3 million for cost of sales. 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. These assets
are amortized using the straight-line method over periods ranging from two to
twelve years. The increase in amortization expense of $1.2 million in the first
quarter of 2005 as compared to the same quarter in 2004 reflects acquisitions
that occurred during 2004 discussed below. We would expect amortization of
acquisition-related intangibles to continue through 2005 at approximately the
same level as in the three months ended March 31, 2005.
In January 2004, we acquired NXN Software GmbH, a provider of asset and
production management systems for the entertainment and computer graphics
industries, for cash consideration of euro 35 million ($43.7 million), less cash
acquired. As part of the purchase accounting allocation, we recorded $7.2
million of identifiable intangible assets, consisting of completed technologies,
customer relationships and a trade name, of which $1.2 million were written off
in December 2004.
In August 2004, we acquired M-Audio, a provider of digital audio and
MIDI solutions for musicians and audio professionals, for cash, net of cash
acquired, of $79.6 million and stock and stock options with a fair value of
$96.5 million. As part of the purchase accounting allocation, we recorded $38.4
million of identifiable intangible assets, consisting of completed technologies,
customer relationships, a trade name and a non-compete covenant. In September
2004, we acquired Avid Nordic AB, an exclusive reseller of our products, for
cash, net of cash acquired, of euro 6.1 million ($7.4 million). As part of the
purchase accounting allocation, we recorded $4.7 million of identifiable
intangible assets consisting solely of customer relationships.
Other Income (Expense), Net
Three Months Ended March 31,
-----------------------------------
(dollars in thousands)
2005 2004 Change
----------- ----------- -----------
Other Income and Expense, Net: $837 ($560) $1,397
Percentage of Net Revenues: 0.5% (0.4%) 0.9%
Other income and 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, net was due to a charge in 2004 of $1.1
million related to the settlement of a lawsuit, as well as increased interest
income earned in the first quarter of 2005 on higher average cash and marketable
securities balances.
17
Provision for Income Taxes
Three Months Ended March 31,
------------------------------------
(dollars in thousands)
2005 2004 Change
----------- ----------- ------------
Provision for (Benefit from) Income Taxes: $1,429 ($500) $1,929
Percentage of Net Revenues: 0.9% (0.4%) 1.3%
We account for income taxes under SFAS No. 109, "Accounting for Income
Taxes." SFAS No. 109 is an asset and liability approach that requires the
recognition of deferred tax assets and liabilities for the expected future tax
consequences of events that have been recognized in our financial statements or
tax returns. We account for investment tax credits as a reduction of income
taxes of the year in which the credit arises.
Our effective tax rate was 6.7% for the three months ended March 31,
2005 compared to (3.5%) for the three months ended March 31, 2004. The net tax
benefit for the first quarter of 2004 reflected the reversal of a $1.2 million
tax reserve resulting from the expiration of the statute of limitation on that
reserve item, offset partially by a tax provision of $0.7 million. The tax
provisions for the first quarter of 2005 and 2004 were substantially comprised
of taxes payable by our foreign subsidiaries, with only alternative minimum tax
provided on anticipated U.S taxable profits.
The tax rate in each year is significantly 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, which include timing differences related to amortization of
acquisition related intangible assets, depreciation, deferred revenue and other
reserves and accruals. SFAS No. 109 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
March 31, 2005, 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. In the quarter ended December 31, 2004, we removed
the valuation allowance related to deferred tax assets in our Irish
manufacturing operations. The decision to remove the valuation allowance was
based on the conclusion that it was more likely than not that the deferred tax
asset in Ireland would be realized. Due to the removal of the valuation
allowance, we now have a non-cash provision for income taxes related to our
Irish operations.
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 against certain deferred tax assets resulting from the
exercise of employee stock options, in accordance with SFAS No. 109, removal of
the valuation allowance related to these assets would result in a credit to
additional paid in capital. If the valuation allowance were to be removed in its
entirety, a non-cash reduction in income tax expense and a credit to paid in
capital would be recorded in the period of removal. To the extent no valuation
allowance is established for our deferred tax assets in future periods, future
financial statements would reflect a non-cash increase in income tax expense
until such time that the Company's deferred tax assets are fully utilized to
reduce taxes payable or expire.
Excluding the impact of the valuation allowance, our effective tax rate
would have been 30% for the three months ended March 31, 2005 and 31% for the
three months ended March 31, 2004. This rate differs from the Federal statutory
rate of 35% primarily due to income in foreign jurisdictions, which have lower
tax rates.
18
LIQUIDITY AND CAPITAL RESOURCES
We have funded our operations to date through both private and public
sales of equity securities, including stock option exercises from our employee
stock plans, as well as through cash flows from operations. As of March 31,
2005, our principal sources of liquidity included cash, cash equivalents and
marketable securities totaling $176.2 million.
With respect to cash flow, net cash provided by operating activities was
$20.3 million for the three months ended March 31, 2005 compared to $17.6
million for the same period in 2004. During the three months ended March 31,
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 a decrease in accrued expenses and accounts
payable. During the three months ended March 31, 2004, 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 accounts receivable and a decrease in accrued expenses.
At March 31, 2005 and December 31, 2004, we held inventory in the
amounts of $55.2 million and $53.9 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. We review all inventory balances regularly for excess
quantities or potential obsolescence and make appropriate adjustments to
write-down the inventories to reflect their estimated realizable value.
Accounts receivable decreased by $0.3 million to $97.2 million at March
31, 2005 from $97.5 million at December 31, 2004. These balances are net of
allowances for sales returns, bad debts and customer rebates, all of which we
estimate and record based on historical experience. Days sales outstanding in
accounts receivable increased from 50 days at December 31, 2004 to 53 days at
March 31, 2005. The increase in days sales outstanding is primarily attributable
to the timing of shipments during the three months and an increase in deferred
maintenance contract billings for which revenue is recognized ratably in future
quarters.
Net cash flow used in investing activities was $12.2 million for the
three months ended March 31, 2005 compared to $42.7 million for the same period
in 2004. We purchased $4.2 million of property and equipment during the three
months ended March 31, 2005 compared to $4.4 million in the same period of 2004.
Purchases of property and equipment in both 2005 and 2004 were primarily of
computer hardware and software to support research and development activities
and our information systems. Our full year capital spending for 2005 is
currently expected to be about $16.0 million, including purchases of hardware
and software to support activities in the research and development, information
systems and manufacturing areas, as well as for facilities renovations. However,
this amount could increase in the event we enter into strategic business
acquisitions or for other reasons. During the three months ended March 31, 2004,
we expended cash of $42.9 million for the purchase of NXN Software GmbH. Also, a
second payment of $1.0 million for our 2003 acquisition of Bomb Factory Digital
was made in early 2004, after resolution of acquisition-related contingencies.
We expect the cash payment for the Pinnacle acquisition to be approximately
$71.3 million upon closing, which is currently expected in the third quarter of
2005.
During the three months ended March 31, 2005 and 2004, we generated cash
of $5.6 million and $4.7 million, respectively, from the issuance of common
stock related to the exercise of stock options and our employee stock purchase
plan.
In connection with restructuring efforts during 2001 and prior periods,
as well as with the identification in 2003 and 2002 of excess space in various
locations, as of March 31, 2005 we have future cash obligations of approximately
$17.7 million under leases for which we have vacated the underlying facilities.
We have an associated restructuring accrual of $2.8 million at March 31, 2005
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. These
payments will be made over the remaining terms of the leases, which have varying
expiration dates through 2010, unless we are able to negotiate an earlier
termination. All restructuring related payments will be funded through working
capital.
Our cash requirements vary depending upon factors such as our planned
growth, capital expenditures, the possible acquisition of businesses or
technologies complementary to our business and obligations under past
restructuring programs. We believe 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
19
event 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 November 2004, the FASB issued SFAS No. 151, "Inventory Costs", an
amendment of ARB No. 43, which is the result of its efforts to converge U.S.
accounting standards for inventories with International Accounting Standards.
SFAS No. 151 requires idle facility expenses, freight, handling costs, and
wasted material (spoilage) costs to be recognized as current-period charges. It
also requires that the allocation of fixed production overheads to the costs of
conversion be based on the normal capacity of the production facilities. SFAS
No. 151 will be effective for inventory costs incurred during fiscal years
beginning after June 15, 2005 (i.e. beginning January 1, 2006 for the Company).
The Company is currently evaluating the impact of SFAS No. 151 on its
consolidated financial statements. The adoption of this standard is not expected
to have a material impact on the Company's financial position or results of
operations.
On December 16, 2004, the FASB released SFAS No. 123R. This new
accounting standard requires all forms of stock compensation, including stock
options issued to employees, to be reflected as an expense in the Company's
financial statements. On April 14, 2005, the Securities and Exchange Commission
(`SEC") approved a new rule that delays the effective date of SFAS No. 123R.
Under the new rule, SFAS No. 123R is now effective for public companies for
annual, rather than interim, periods that begin after June 15, 2005. SFAS No.
123R allows three alternative methods of transitioning to the standard: modified
prospective application ("MPA"), without restatement of prior interim periods in
the year of adoption; MPA with restatement of prior interim periods in the year
of adoption; or modified retrospective application. The Company intends to use
the MPA without restatement alternative and to apply the revised standard
beginning January 1, 2006. Although the Company has not finalized its analysis,
it expects that the adoption of the revised standard will result in higher
operating expenses and lower earnings per share. [See Footnote 6, Accounting for
Stock-Based Compensation, for the pro forma impact on net income and income per
common share as if the Company had historically applied the fair value
recognition provisions of SFAS No. 123 to stock based employee awards.]
On October 22, 2004, the President signed the American Jobs Creation Act
of 2004 ("the Act"). The Act creates a temporary incentive for U.S. corporations
to repatriate accumulated income earned abroad by providing an 85 percent
dividends-received deduction for certain dividends from controlled foreign
corporations. The Act also creates a deduction on a percentage of the lesser of
qualified production activities income or taxable income. Although these
deductions are subject to a number of limitations and significant uncertainty
remains as to how to interpret numerous provisions in the Act, as of March 31,
2005, the Company believes that it had the information necessary to make an
informed decision on the impact of the Act. Based on the information available,
the Company has determined that its cash position in the U.S. is sufficient to
fund anticipated needs. The Company also believes that the repatriation of
income earned abroad would result in significant foreign withholding taxes that
otherwise would not have been incurred as well as additional U.S. tax
liabilities that may not be sufficiently offset by foreign tax credits.
Therefore, the Company does not currently plan to repatriate any income earned
abroad. The Company has also determined that the qualified production activities
deduction will not have a material impact on the fiscal 2005 tax provision due
to the expected amount of taxable income. These initial findings could change
based on clarification of the rules and changes in facts and circumstances of
the Company's operations and/or cash requirements in the U.S.
20
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
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:
Our proposed merger with Pinnacle Systems, Inc., which we announced on March 21,
2005, could be delayed or not completed, and even if we are able to complete our
acquisition of Pinnacle, we may not be able to realize the expected benefits of
the merger.
Completion of our proposed merger with Pinnacle requires various
approvals to be obtained and other closing conditions to be satisfied. Required
approvals include Pinnacle shareholder approval of the merger, approval by our
stockholders of an increase in our authorized shares of common stock to provide
sufficient shares for issuance in the merger, and approvals under applicable
U.S. and foreign antitrust laws. In addition, Pinnacle has the right to
terminate our merger agreement if it determines, prior to Pinnacle shareholder
approval, that another unsolicited offer to acquire Pinnacle is more favorable
to the Pinnacle shareholders than the terms of our merger agreement with
Pinnacle, if Pinnacle pays us a termination fee of $15 million, and if various
other conditions are met. No assurance can be given that all required approvals
for the Pinnacle merger will be obtained, that all required closing conditions
will be satisfied, or that the Pinnacle merger will be completed.
Existing or potential customers of Pinnacle and our existing and
potential customers may, in response to the announcement or consummation of the
merger, delay or defer their purchasing decisions. In addition, customers and
prospective customers could choose not to purchase their respective products or
to reduce or eliminate current products because of perceived or actual conflicts
of interest or doubts about the combined company's ability to provide products
in a satisfactory manner. As a result, revenues that may have ordinarily been
received by us or Pinnacle may be delayed or not earned at all. In addition,
current and prospective Pinnacle employees could experience uncertainty about
their future roles within the combined company. This uncertainty may adversely
affect Pinnacle's ability to attract and retain key personnel. Difficulties with
respect to existing and potential customers or Pinnacle employees could have a
material adverse effect on our business following the merger.
Should we complete the merger, the successful integration of Pinnacle
will require, among other things, integration of Pinnacle's operations, policies
and personnel into our business. We may not achieve successful integration in a
timely manner, or at all, and we may not realize the anticipated benefits and
synergies of the merger to the extent, or in the timeframe, anticipated.
We will 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 after the merger.
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.
Our performance will depend in part on continued customer acceptance of our
digital nonlinear editing products.
We continue to introduce new digital non-linear products based on our
Digital Nonlinear Accelerator architecture, including upgrades and enhancements
to our Media Composer Adrenaline and NewsCutter Adrenaline systems, as well as
Avid Xpress Pro with Avid Mojo and Avid DS Nitris hardware. We will need to
continue to focus marketing and sales efforts on educating potential customers
and our resellers about the uses and benefits of these products. The future
success of certain of these products, such as 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. In addition, there are several other risks involved
with offering new products in general, including, 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. 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.
21
The digital media business is large, widely dispersed, and highly competitive,
and we may not be successful in growing our customer base or predicting customer
demand in this business.
We are continuing to enhance our status in the digital broadcast
business and have augmented our NewsCutter product offering with the Avid Unity
for News products, and other server, newsroom, and browser products. In this
business, in addition to or in lieu of discrete point products, customers will
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 expanding within the digital broadcast business or in
predicting and satisfying customer demand, our business and revenues could be
adversely affected.
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; and
o any of our large customers terminates its relationship with us or
significantly reduces the amount of business it does with us.
When we acquire other companies or businesses, we become subject to potential
events or circumstances that could hurt our business.
We periodically acquire other companies or businesses. For example, in
January 2004, we acquired NXN Software GmbH, a company that manufactures asset
and production management systems specifically targeted for the entertainment
and computer graphics industries, and in August 2004, we acquired Midiman, Inc.
(d/b/a M-Audio), a leading provider of digital audio and MIDI solutions for
musicians and audio professionals. The risks associated with such acquisitions
include, among others:
o the difficulty of assimilating the operations, policies and personnel of the
target companies;
o the failure to realize anticipated returns on investment, cost savings and
synergies;
o the diversion of management's time and attention;
o the dilution existing stockholders experience if we issue common stock or
other equity rights in the acquisition;
o the potential loss of key employees of the target company;
o the difficulty in complying with a variety of foreign laws and regulations;
o the impairment of relationships with customers or suppliers;
o the risks associated with contingent payments and earnouts;
o the possibility of incurring debt and amortization expenses 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.
22
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.
We compete with many other enterprises, and we expect competition to intensify
in the future.
The digital video and audio business 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. Delays or
difficulties in product development and introduction may also harm our business.
In addition to 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. 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. To the extent such companies discontinue their alliances with
Avid, it could have a negative impact on our business.
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.
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 component of M-Audio's business strategy is to expand into the highly
competitive consumer channel, a sales channel in which we have limited
experience.
Historically, a significant portion of our audio revenues has been
derived from sales to professional musicians and studios. M-Audio is currently
expanding its sales channel to include sales through the broader consumer
channel. Members of M-Audio's senior staff have experience in this channel, but
our overall experience addressing the consumer channel is limited, and the
process of developing a channel for non-specialty stores and establishing our
products in these stores will be difficult. While we are not anticipating that a
material portion of our revenues will come through the consumer audio channel in
the near term, there are costs related to pursuing the consumer channel that
are, to a large extent, fixed. As a result, we may be unable to adjust our
spending in a timely manner to compensate for any unexpected revenue shortfall,
which would harm our operating results. Also, to the extent we increase sales of
our audio products through the consumer channel, we expect to experience greater
seasonality in sales of such products. Typically, sales of consumer electronics
and software increase in the second half of the year, reaching their peak during
the year-end holiday season.
23
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 and manufacturing activities.
We generally own the software developed by these contractors. 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 such products or to supply or enhance such components,
such failure could imperil our supply and our ability to continue selling and
servicing products that use these components. Similarly, if any of our sole
source vendors should encounter technical, operating or financial difficulties,
such difficulties could threaten our supply of these products or components.
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 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, and are not able to increase the price of such products to offset
these 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 would likely harm 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 operating results 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;
24
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 "solution" sales, which typically have
longer selling and implementation cycles; and
o timing of delivery of solutions to customers.
Changes in any of these factors could adversely affect our operating results.
Our international operations expose us to significant exchange 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 understated 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
difficulty in protecting intellectual property.
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 with precision. 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.
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 our products may be harmed.
We sell many of our video products and services, and substantially all
of our audio products and services, indirectly through resellers and
distributors. In our audio segment, 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 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 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 final end-users, which could lead to a weakening of our relationships
with our resellers and could adversely affect our revenues.
25
Most of the resellers and distributors of our 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 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 segment products were
to exceed estimated levels, our revenues and operating results could be
adversely impacted.
Changes in accounting rules could adversely affect our future operating results.
Our financial statements are prepared in accordance with U.S. generally
accepted accounting principles. 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,
including changes in the rules regarding accounting for stock-based
compensation, may have a significant effect on our reported financial results.
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. Changes in the accounting rules that 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 piracy of our software exists. We expect software piracy to be a
persistent problem.
26
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
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.
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
connection with our anti-piracy program, designed to enforce copyright
protection of our software, we are a member of the Business Software Alliance
("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 violation of other local law. To date, none of
these lawsuits or counterclaims have had an adverse effect on our results of
operations, but should we become involved in material litigation, our cash flows
or financial position could be adversely effected.
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 the rules and regulations of the
Securities and Exchange Commission and the NASDAQ stock market increased the
scope, complexity and cost of our corporate governance, reporting and disclosure
practices. These laws, rules and regulations also may divert management's
attention from business operations, increase the cost of obtaining director and
officer liability insurance and 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, most 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 announcement of major acquisitions;
o a shift in financial markets; and
o global macroeconomic conditions.
27
Further, the stock market has experienced volatility with respect to the price
of equity securities of high technology companies generally, and this volatility
has, at times, appeared to be unrelated to or disproportionate to any of the
factors above.
28
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Market Risk
Our primary exposures to market risk are financial, including the effect
of volatility in currencies on asset and liability positions and revenue and
operating expenses of our international subsidiaries that are denominated in
foreign currencies, and the effect of fluctuations in interest rates earned on
our cash equivalents and marketable securities.
Foreign Currency Exchange Risk
We generally 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 (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 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 over- or understated during the periods
of currency volatility, we could experience unanticipated currency gains or
losses.
At March 31, 2005, we had $48.6 million of forward-exchange contracts
outstanding, denominated in euros, British pound, Japanese yen, Swedish krona,
Danish kroner, Norwegian krone, Canadian dollar, Singapore dollar and Korean
won, as a hedge against forecasted foreign currency-denominated receivables,
payables and cash balances. For the three month period ended March 31, 2005, net
gains resulting from forward-exchange contracts of $1.0 million were included in
results of operations, offset by net transaction and re-measurement losses on
the related asset and liabilities of $2.5 million. 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 March 31, 2005, we held $176.2 million in cash, cash equivalents and
marketable securities, including short-term corporate obligations, municipal
obligations, asset-backed securities, commercial paper and U.S. and Canadian
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.
29
ITEM 4. 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 March 31, 2005. 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 March 31, 2005, our chief executive officer and
chief financial officer concluded that, as of such date, our disclosure controls
and procedures were effective at the reasonable assurance level.
No change in our internal control over financial reporting occurred during the
fiscal quarter ended March 31, 2005 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
30
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS
(a) EXHIBITS
--------
2.1 Agreement and Plan of Merger, dated as of March 20, 2005, by and among
Avid Technology, Inc., Highest Mountain Corporation and Pinnacle
Systems, Inc. (incorporated by reference to Avid's Current Report on
Form 8-K as filed with the Commission on March 21, 2005).
10.1 Voting Agreement, dated as of March 20, 2005, by and among Avid
Technology, Inc., Pinnacle Systems, Inc. and officers and directors of
Avid Technology, Inc. (incorporated by reference to Avid's Current
Report on Form 8-K as filed with the Commission on March 21, 2005)
*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
31
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: May 10, 2005 By: /s/ Paul J. Milbury
--------------------------
Paul J. Milbury
Chief Financial Officer
(Principal Financial Officer)
Date: May 10, 2005 By: /s/ Carol L. Reid
--------------------------
Carol L. Reid
Vice President and Corporate Controller
(Principal Accounting Officer)
32
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
2.1 Agreement and Plan of Merger, dated as of March 20, 2005, by and among
Avid Technology, Inc., Highest Mountain Corporation and Pinnacle
Systems, Inc. (incorporated by reference to Avid's Current Report on
Form 8-K as filed with the Commission on March 21, 2005).
10.1 Voting Agreement, dated as of March 20, 2005, by and among Avid
Technology, Inc., Pinnacle Systems, Inc. and officers and directors of
Avid Technology, Inc. (incorporated by reference to Avid's Current
Report on Form 8-K as filed with the Commission on March 21, 2005)
*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
33