We don't know for certain, but when we posted our May note highlighting Avid Technology's (NASDAQ:AVID) cash flow issues, we thought it more likely that management was simply incompetent. After the Q3 earnings report, our belief is that something stinks at AVID, and management is having a hard time containing the stench, as was very obvious during the Q&A portion of the Q3 earnings call.
We fully understand that the company is undergoing a painful transition to a more recurring revenue model and that aggressive accounting and missing guidance don't necessarily equate to fraud. However, there are a number of red flags that cause us concern:
Red Flag 1: The third surprise "one-time" revenue recognition treatment that has again saved the quarter from total disaster. The supposed one-time accounting change now amounts to about 50% of the company's 2016 EBITDA, without which it would violate its debt covenants. Management previously explained that the release of cloud collaboration for Pro Tools triggered a one-time accounting change that allowed the recognition of $18M of 100% margin deferred revenue in Q1. Much to everybody's surprise, this has occurred again in Q2, to the tune of $15M, and once more in Q3, this time at $12M. It is troubling when unusual and unexpected accounting changes are the buffer from default.
Red Flag 2: AVID is essentially operating without a CFO. The former CFO left suddenly and has disposed of 90% of his stock holdings. The interim CFO, who doubles as VP of HR, seems entirely ill-equipped for the position judging by his confusion on the conference calls. Furthermore, the supplemental tables on its Investor Relations site had bookings numbers after Q2 that did not add up. The Products number was $18M higher than what it had put in the table. We believe the interim CFO has a very poor handle on the numbers.
Red Flag 3: The almost comical cash flow guidance (full-year 2016 of $2-12M) the company provided in Q1 and reaffirmed after Q2 only to say "Oops" in Q3 (now it will be -$47M to -$37M) or, from high to low, $59M below guidance! The guidance defied logic to begin with, but what is even harder to fathom is why management reiterated guidance in the Q2 earnings report, when it MUST have had some indication that business was slowing. The cash flow bridge provided in the earnings presentation actually said "Expect Strong Second Half Adjusted Free Cash Flow."
Red Flag 4: A massive slashing of bookings (the lifeblood of this business) guidance from $500-536M to $391-421M (-22% at the midpoint) based on, according to CEO Louis Hernandez, customers being so excited for the next-generation storage product NEXIS, they are waiting for it to be rolled out in an enterprise version. This is the same pie-in-the-sky nonsense.
The excitement over the new NEXIS storage line initially launched for the non-enterprise market essentially has frozen the enterprise market, as they deferred normal upgrades and renewals of the existing storage product until the enterprise level features were delivered for NEXIS.
Red Flag 5: AVID has consistently misled investors regarding its cash flow situation. The company is in a constant state of restructuring, yet conveniently excludes restructuring payments in its FCF presentation, which is misleading at best. Cash Flow from Operations was ($3.9M), with FCF of ($2.6M). However, given that restructuring payments literally happen every single quarter, if we were to add them back in, FCF was instead ($6.3M) in the quarter and ($58.6M) on a year-to-date basis.
Red Flag 6: After the company reaffirmed guidance in the Q2 earnings report, investors sent the stock from around $6.50 per share to $9.50. With uncanny market timing, the aforementioned ex-CFO took this opportunity to virtually top-tick almost his entire holdings before the Q3 report. Frederick sold 152,813 shares on 8/12/16 at approximately $8.85 and then 457,506 shares on 8/15 and 8/16 at approximately $9.10.
Whether management is intentionally misleading investors is unclear, but the recently filed class action lawsuit may get to the bottom of the matter. If management is not misleading investors, then the only conclusion is that it has a horrible handle on the financials of its business. Free Cash Flow will now fall dramatically shy of its outlandish guidance ($0M vs. $48M at the midpoint), and the balance sheet will be stressed at year-end. Under the current agreement, the company has just $5M in available credit. To drum up liquidity, it is trying to increase the cash component of its enterprise deals. In a liquidation scenario, it is difficult to assess the value of the various business lines.
Disclosure: I am/we are short AVID.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.