Avid announced third quarter 2018 earnings results for the three month period ending September 30, 2018. The presentation built upon on the format of the second quarter earnings report, which introduced a series of new metrics intended to better highlight Avid’s business transformation.
Recurring revenue (defined as subscription, maintenance, and long-term contracts) was 60% of Avid’s revenue in the quarter, up from 50% in the third quarter of 2017, and 57% during the second quarter of this year. Annual Contract Value (ACV) ended Q3 2018 at $249 million, a year-over-year increase of 12.2% and a sequential rise of 1.6%.
To use Avid’s CEO Jeff Rosica’s words (from earnings call), the recurring revenue and annual contract value “enhance the visibility and predictability of our business.” This is in turn increasing management’s ability to better manage the business, and is manifesting in improved operational efficiency – made visible in the decrease in operating expenses (discussed below). Here is an exact quotation of Jeff from the call, “Another indicator is our initial progress in establishing the necessary operational improvements that we’ve begun to make so that our business functions run more efficiently and at a lower cost.”
One observation true of Avid as well as the broader media technology supplier community is the leading indicators of a supplier’s business model transition are tending to appear in the operating expense categories as opposed to the revenue profile. This is not surprising because the great inefficiency in the media technology sector is the vast overlap of spend on sales & marketing and research & development.
Planned Update on Financing
Adding urgency to Avid’s operational efficiency initiatives is the Company’s capital structure. This was hinted at during management’s prepared remarks. “…we will be working to establish a more prudent long-term capital structure, being aware that our convertible bonds mature in June 2020” said Rosica.
The convertible bonds mentioned in Jeff’s statement stem from a $125 million June 2015 convertible bond offering by Avid. Those bonds have an annual interest rate of 2.00% and are convertible into Avid shares at an initial strike price of $21.94. At the time of issuance the strike price represented a 35% premium to Avid’s then share price of $16.25. Avid’s shares closed yesterday’s trading session at $5.70. Because the convertible price is deeply out of the money, the bonds trade at a steep discount to par. The above is a long way of pointing out that the current financing structure of Avid is not representative of what it will be in 18 months.
Avid’s long-term debt was $229.4 million at the end of the quarter. The balance is the combination of the aforementioned convertible offering coupled with a term loan and credit facility with Cerberus. The financing agreement with Cerberus has been amended twice and is imposing some limitations on Avid’s investing activities, including the maintenance of certain leverage ratios and restrictions on the uses of free cash flow. Avid’s CFO Ken Gayron stated on the Q3 call that Avid was compliant with the leverage covenant ratio at the end of Q3 and has significant cushion remaining.
In addition to the focus on operational efficiency, management added emphasis to the cash flow conversation of Avid’s quoted Adjusted EBITDA figures (a non-GAAP measure). EBITDA is an acronym for earnings before interest, taxes, depreciation, and amortization. It is commonly used as a shorthand for operational cash flow (though equally often misused). By management’s own admission, conversion from Adjusted EBITDA to free cash flow was poor during the quarter. The quoted figure for Adjusted EBITDA was $14.6 million in the quarter, whereas free cash flow was negative $6.4 million. Management attributed the poor conversion to changes in working capital and impact of seasonality on the timing of billings and collections. Avid is expecting strong cash flow generation in the fourth quarter.
Financial Metrics from Q3 2018 Earnings Result
GAAP revenue for Q3 2018 was $104.0 million, a decline of 1.1% versus Q3 2017 and an increase of 5.5% compared to the preceding quarter, Q2 2018.
On the earnings call, Avid’s management noted the strength of Avid’s storage and graphics business in the quarter, and called special attention to a 43% year-over-year growth in Avid’s e-commerce channel. Weakness was experience by Avid among Tier1 customers and with audio revenues in the quarter. Audio revenues were negatively impacted by a supply chain issue (now corrected).
Gross margins (GAAP) for the quarter were 58.3%, an increase of 100 basis points when compared to the year earlier period, and an increase of 120 basis points against the preceding quarter. Management attribute the improved gross margins to a 600 basis point year-over-year increase in hardware margins, driven by Avid’s storage and graphics businesses.
Operating income for Q3 2018 was $7.0 million, a 90% increase over operating income recorded in Q3 2017 and a substantial improvement over the operating loss of $2.1 million in Q2 2018.
Net income for the quarter was $0.9 million or $0.02 per share. This compares to Q3 2017 net income of $0.07 million or $0.00 per share and a net loss of $8.5 million or ($0.20) per share during the second quarter of 2018.
Product and Services Revenue Breakdown
- Software (non-GAAP) revenue for the quarter was $53.6 million, a 4.4% increase compared to the second quarter. The year-earlier period is not available. For the first nine months of 2018, Software represented 52% of overall revenue.
- Integrated solutions (hardware and integrated software) had revenue of $42.4 million in the quarter, an increase of 7.3% compared to the second quarter. Integrated solutions contributed 40% of revenue first three quarters of 2018.
- Services (professional services and training) revenue was $8.1 million, a 3.8% increase versus the preceding quarter. For year-to-date Services contributed 8% of total revenue.
Audio and Video Products and Solution Revenue Breakdown
- Video solution sales were $34.1 million during the quarter, a 26% rise above revenues during the year-earlier Q3 2017 and a 15.6% increase against the second quarter of 2018
- Audio solution revenue for the quarter was $18.0 million, a decrease of 33.9% against the year-earlier period and a sequential decline of 42.1%
Revenue by Geography
- Revenues from the United States were $37.1 million for the quarter, a 6.4% decrease against the year-earlier period of Q3 2017 and a decline of 2.7% compared to Q2 2018. As a percent of sales, the United States was 35.6% of total revenue in the quarter, which compares to 38% in Q3 2017 and 39% in Q2 2018.
- Revenue contribution from Other Americas was $7.5 million, a 1.2% increase against the year-earlier period and a 18.4% increase versus the sequential quarter. Other Americas represented 7.1% of revenue in the quarter.
- EMEA revenues were $43.2 million, a 3.9% increase against Q3 2017 and 7.4% against Q2 2018. EMEA was 41% of sales during the quarter. EMEA represented 38% of sales in Q3 2017 and 41% in Q2 2018.
- The Asia-Pacific region contributed $16.3 million [17.7, $13.9] in revenue for the quarter, a year-over-year decline of 7.9% and an increase of 17.2% compared to the previous quarter. Asia-Pacific was 15.6% of sales during the quarter. This compares to 16.8% in Q3 2017 and 14% in Q2 2018.
- R&D expenses for the quarter were $15.9 million, a 1.0% decline against Q3 2017 R&D levels, and a 6.5% decrease compared to Q2 2018. As a percentage of revenue R&D expenses were 15.3% for the quarter, compared to 15.2% of total revenue in Q3 2017 and 17.2% in Q2 2018.
- Sales and marketing costs for Q3 2018 were $23.5 million, a 8.5% decline versus Q3 2017 sales and marketing levels, and a 15.5% decline versus the preceding quarter (remember NAB expenses are in Q2). Sales and marketing expenses were 22.5% of Q3 2018 revenue, a slight decline against 24.4% of total revenue from the third quarter of 2017, and a substantial decrease compared to the 28.1% from Q2 2018.
- G&A expense was $13.6 million for Q3 2018, a decrease of 10.1% versus the year-earlier quarter, and a 2.7% decline against the preceding quarter. Expressed in terms of total revenue, G&A expense was 13.1% of sales in Q3 2018 versus 14.4% in Q3 2017, and 14.2% in the preceding quarter.
The Q3 2018 operating expenses are already benefiting from the latest operational efficiency initiative announced during the second quarter call. Avid’s CFO Ken Gayron indicated the operational efficiency initiatives resulted in a $1 million decrease to operating expenses in the quarter.
Bookings for the quarter were $119.4 million, a 16.1% increase over the year-earlier period and a 8.2% rise over the sequential quarter.
Total backlog was $370.9 million as of September 30, 2018, a year-over-year increase of 26.4% and a 5.8% increase versus June 30, 2018.
Avid maintained its revenue guidance for the full year 2018. Revenue is anticipated in the range of $410 million to $420 million. Management did lower the guidance for Free Cash Flow from $4-$12 million to a lower range of $2-$6 million.
The mid-point of the revenue guidance would represent a year-over-year decline in sales of slightly less than 1% versus 2017 revenues.
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