Avid Technology, Inc. (NASDAQ:AVID) Q2 2015 Earnings Conference Call August 10, 2015 5:00 PM ET
Louis Hernandez, Jr. - Chairman, President and CEO
John Frederick - EVP, CFO and CAO
Jonathan Huang - VP, IR and Treasury
Steven Frankel - Dougherty & Co.
Hamed Khorsand - BWS Financial
Jason Kraft - Cato Partners
Matthew Galinko - Sidoti & Company
Good day, and welcome to the Avid Q2 2015 Earnings Release Call. Today’s conference is being recorded.
At this time, I would like to turn the conference over to Jonathan Huang. Please go ahead.
Good afternoon. I’m Jonathan Huang, Vice President of Investor Relations for Avid, and welcome to our earnings call. With me today are Louis Hernandez, Jr., Avid’s Chairman, Chief Executive Officer and President; and John Frederick, Executive Vice President, Chief Financial and Administrative Officer.
Before we get started, we wanted to note that during this presentation, we will be making forward-looking statements, including among others, statements related to our recently filed financial statements, future performance related to revenue, operating expenses, earnings, bookings, revenue backlog, revenue backlog amortization, bookings conversion rates, cost savings and free cash flow, anticipated benefits of our recently closed Orad acquisition, our future strategy and business plans, our product plans and our liquidity. These statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements.
Also, these statements are based on expectations as of today, August 10, 2015, and we expressly disclaim any obligation or undertaking to update or revise these statements, whether as a result of new information, future events, or otherwise. Please review the description of these statements and the risk factors described in our reports filed with the SEC.
In addition, we have presented a number of non-GAAP financial measures that we use to monitor our business, including non-GAAP revenue, non-GAAP operating results, adjusted EBITDA, adjusted free cash flow and non-GAAP operating income, non-GAAP gross margin, non-GAAP operating expense, non-GAAP taxes and other interest expense, all of which are defined and reconciled to the comparable GAAP measure in tables accompanying the release of our results. These non-GAAP measures reflect how Avid manages its businesses internally. Our non-GAAP measures may vary from how other companies present non-GAAP measures.
Non-GAAP financial measures are not based on a comprehensive set of accounting rules or principles, and are not intended to represent a measure of performance in accordance with or disclosures required by GAAP. When analyzing Avid’s operating performance, investors should not consider these non-GAAP financial measures as a substitute for net income or other measures prepared in accordance with GAAP.
We also reference bookings and revenue backlog, which are operational metrics we use to measure our business. Our definition of bookings and revenue backlog are included in our SEC filings and financial press releases. You may replay this conference call by going to the Investor Relations page of our Web site and clicking the Events & Presentations tab.
And now, I would like to turn the call over to our Chairman, Chief Executive Officer, and President, Louis Hernandez, Jr.
Louis Hernandez, Jr.
Thanks, Jonathan. Good afternoon, everyone. I’m pleased to be here with you today to provide an update on Avid’s ongoing transformation. It’s been another very busy quarter of incredible effort and important accomplishments. As you know, we’re updating guidance for the year, including raising the bookings and adjusted EBITDA range. This updated view is based upon our year-to-date results, the dramatic increase in revenue visibility, momentum on new products, benefits of the cost actions taken to-date, the integration of Orad, as well as other factors.
The outlook also factors in hurdles such as questions about the overall industry dynamics, the near-term impact of the accelerated shift in recurring revenue, and the continued elongated sales cycles that we have experienced. John will review the guidance bridge, which will illustrate why we have comfort in the updated annual guidance. I’d like to now add some color to the trends that we’re seeing, which impact our outlook.
One of the primary drivers in the comfort around raising full year adjusted EBITDA guidance is the increase in revenue visibility that I mentioned, which is due to three primary factors. First, approximately 17 million in new product sales that we expect to ship in the second half of the year. Second, over $10 million of known revenue resulting from improved business practices and their related accounting expression, which we expect to benefit the second half. And third, the increase in recurring revenue bookings during the quarter from customer support and subscriptions.
During the second quarter, we launched several new products that produced accelerated bookings. This included the S6L live audio console; the ISIS 1000, our new entry level professional grade storage product; and DNxIO, a new high resolution professional video interface that simplifies and accelerates the entire HD high-res and ultra HD workflow. These new products generated approximately 17 million of new bookings, which we expect to begin shipping in the second half of year, whereupon we would expect to record the related revenue in cash. Unless there are unforeseen issues with shipments, we have clear visibility into this revenue and cash in the remainder of 2015. In addition, once shipments begin, these new products should provide a catalyst for additional bookings and revenue for the rest of the year without the same dynamic of deferring these shipments.
The second item providing increased visibility is the post restatement adoption of a more traditional revenue recognition model whereby we no longer provide free updates beginning with Media Composer version 8.0. As a result, we no longer expect to be required to defer revenue for transactions that include Media Composer 8.0. Our guidance factors the impact of this more traditional revenue model, which we expect to have a material benefit in the second half of the year. The known impact through the second quarter that is expected to benefit the second half of the year is over $10 million, which does not include additional sales of Media Composer, which we will no longer be required to be deferred.
John will provide more detail on this change, but in short, this is an example where the accounting expression of an improved business process has resulted in a more preferable treatment than we originally applied based on the restatement. As you know, we incurred over $45 million in costs in completing the restatement. We appointed new auditors. We had a third-party audit firm review our work, had extensive outside consultants to help assess our accounting. I’m happy to see that our business factors post restatement are beginning to support a more traditional revenue model.
The final component offering greater comfort to improved visibility is the accelerated bookings mix shift towards higher recurring revenues. Bookings for the recurring revenue increased by 58% compared to the same period of the prior year. In Q2, recurring revenue bookings comprised 26% of our overall bookings as compared to only 15% just a year ago. This shift is occurring sooner than originally expected and has had near-term impact on revenue and earnings but helps us diversify our sources of revenue and migrate to a more predictable and visible revenue model.
Initially, we only expected new customers to take advantage of our subscription offerings, and we’re highly encouraged to see many of our legacy customers are also shifting to a recurring revenue model, whether it’s the subscription or customer support. The impact of this transition to a subscription or recurring revenue model has been well documented. Companies like Adobe and Autodesk both experienced short to medium-term growth pressures, but they progressed through this transition.
However, we believe that our transition will not be as dramatic as some of our peers. While others have forced customers to move off of perpetual contracts on to subscription, we recognize that this model does not work for all of our customers, and therefore we continue to offer a choice in pricing and deployment that suites our customers’ needs which we expect will mute the near-term impact of this transition.
I think this is probably best evidenced by the combination of growth in our guidance combined with a shift to a higher recurring revenue model. This has had a related impact in our overall contract backlog, specifically post 2010 revenue backlog has increased to 489 million, up 72 million or 17% from the same quarter last year. Backlog related to legacy Orad product lines represented about 3% of this increase. The growing backlog provides more visibility not only into the second half of the year, but also for future years.
Related to the recurring revenue discussion, during Q2, we reached an important milestone of over 10,000 active paid subscribers for the first time. Today, we now have over 12,000 active paid subscribers. This compares to just over 5,000 total subscribers at the end of 2014, about 1,000 total subscribers at the same time just a year ago. Similarly, we have over 130,000 requests for the free version of Pro Tools First since the announcement of its release earlier this year.
While we are methodically rolling out these releases to folks who signed up, we’ve already learned a great deal from this new initiative thus far and are continuing to refine the multitude of ways to maximize the lifetime value of these customers. We’re also continuing to invest in several digital marketing initiatives to better address the Tier 3 market, a largely untapped market for us of about $1.8 billion. We’re very excited about the progress that we have made and we’ll continue to keep you posted on the subscription adoption progress.
Let’s move on to the cost side. Of course, we’ve also assessed our progress on the cost optimization plan as part of our review of our guidance. We have not only made significant progress on these initiatives but believe that there are opportunities to further accelerate these plans in the second half of the year. During the second quarter, we started building out the infrastructure required to execute on our labor arbitrage plans. We established new offices in the Philippines and Taiwan for customer support and engineering. And in July, we also announced that we plan on opening a new Florida office, which will house administrative and back office staff. In Europe, we’ve begun recruiting software developers to be staffed in Poland.
These not only allow for greater efficiencies but also allow us to better match the geographic client needs to our resources. These ongoing labor-related efforts should help us realize material cost benefits in the back half of the calendar year even as we make the cash investments today. Overall, we anticipate that we will have a calendarized impact of about $5 million in savings in 2015 related to the labor arbitrage project.
We also factored in the progress on the Orad acquisition, which we announced in April and closed near the end of the quarter. And just as a reminder to all of you, Orad adds graphics, virtual studio and sports enhancement solutions that we plan to sell as applications on the platform and leverage our global distribution network that covers over 140 countries in order to drive greater cross-sell opportunities.
We see the addition of Orad products as the way to move more aggressively in some of the higher growth areas such as sports, live production and corporate segments. As mentioned earlier, we expect this acquisition will be accretive immediately from both an EBITDA and cash flow basis, and I’m pleased to say the integration efforts are well underway and progressing as expected.
Now I mentioned earlier in addition to the dramatically improved visibility in the second half with favorable cost trends and the Orad integration, we also consider potential hurdles that could impact our guidance. The primary trends were considered with the continued elongation of the sales cycle for Tier 1 accounts, the overall market dynamics of an industry that’s clearly in transition and the near-term implications of the acceleration in subscription and recurring revenue bookings.
We have talked in earlier calls about the elongated sales cycle as we’ve been increasingly experiencing in the Tier 1 market, and this is largely as we’ve engaged in more strategic and sophisticated discussions with our largest customers and we continue to focus on profitability and signing the right deals for us and for our customers.
In Q2, we saw about the same amount of large deal activity slip out into this quarter, as we saw slip out of Q1. The good news is given the traditional spending cycles of media enterprises, we expect the time of these buying decisions to accelerate and close in the calendar fourth quarter. In fact, last year our fourth quarter bookings represented 30% of our full year and this is in line with historically high fourth quarter seasonality.
We also observe the transition in the industry, which has resulted in inconsistent results for many of our peers, some of which have attributed to a shift in traditional broadcast spending. However, despite this broader spending trend, we still witnessed good growth in Europe even as others have struggled.
Interestingly, we believe our platform solution is geared towards achieving scale and cost efficiencies for our customers and further, we believe the stand of the platform actually enables them to more efficiently shift their businesses to models that include things like streaming and over-the-top content delivery. So we believe we are uniquely situated to help our customers through this transition.
In fact, we recently exceeded 25,000 MediaCentral licenses, which represents about a 70% growth in platform adoption in just the last year. That being said, we could certainly be impacted by an industry-wide pause in traditional broadcast technology investment as enterprises evaluate how to deploy their capital.
Now I’ve talked quite a bit earlier about the accelerated shift towards recurring revenue and the long-term benefits and near-term pressures that result. Clearly, we’re encouraged with the momentum as evidenced by the 58% increase in booked recurring revenue and the trajectory of subscription adoption. That dramatic shift does put near-term pressure on revenue, which we’ve factored into our outlook for 2015. But if that transition accelerates further, it could have an incremental impact on near-term results. Again, this is a trade we would happily make as it only increases revenue visibility on a long-term basis.
As for our actual results on a constant dollar basis, marketed bookings of 122.4 million increased about 4% over the first quarter and were essentially flat versus last year. Adjusted EBITDA in Q2 was 1.4 million, down 9.3 when compared to Q2 of last year primarily due to the impact of the pre-2011 revenue amortization and the new product bookings in the second quarter, which are expected to be converted to revenue in the second half of 2015.
Adjusted free cash flow was a use of about 31 million of cash for the quarter reflecting the payment at the beginning of the quarter of annual incentive comp via investments we are making in the low-cost regions that I mentioned earlier and the investment in the digital strategy to attack the Tier 3 market, and the timing of the new product shipments that I mentioned earlier. You will note that we also adjusted our annual adjusted free cash flow guidance to reflect the expected timing of cash conversions for second half activity. Now John will review the results further as well as provide a detailed bridge to our guidance.
As you know, we have emphasized annual performance when providing guidance as transformations are inherently difficult to predict from a timing perspective. However, it’s pretty clear we’ve made significant progress and based on the factors we reviewed, we are comfortable with the improved earnings guidance. MediaCentral units and new subscribers just hit significant growth milestones last year and we launched our new free creative tool offering to usher in what we hope to be the next generation of lifetime paying users.
We closed a number of strategic platform deals with key enterprise customers reflecting the continued large-scale adoption of our strategy. We started seeing the benefit from working our channel program, which was largely completed at the end of last year. In fact, we’ve seen early traction in all three of our targeted tiers.
On the cost side, we have aggressively accelerated the labor arbitrage talent and facility rationalization projects, as I described, and we also announced and closed the Orad acquisition and have had success in integrating that company to-date. We also closed 125 million convertible bond offering and $35 million revolving credit facility.
So in summary, our bookings on a constant dollar basis were flat, revenue was impacted by the timing of these new product shipments, the evolving accounting expression of the improved business practices and the shift to more recurring revenue, all of which will come back to us and benefit us.
Costs are in line with expectations and savings expected to accelerate as we ramp up facilities in lower cost locations. While we’re currently in a cash investment cycle, cash should benefit in the long run from each of the above. The transformation is on track and we’re progressing towards achieving the annual guidance metrics that we laid out.
As I mentioned earlier, John will be providing you with a detailed roadmap, which forms the basis for the updated financial guidance for 2015. As you’ll see, many of the components are based on actions that have already occurred and we expect to see the benefits in the second half of the year whether or not as book sales or executed cost actions, but the analysis intended for our transparency and to how we see the second half of 2015 playing out.
With that, I’d like to now ask John Frederick to review a more detailed financial results. John?
Thanks, Louis. As you just heard, we had a very busy and constructive second quarter and believe we continue to make progress on our three key financial goals namely stabilize and then grow bookings, improve our full year adjusted EBITDA performance in spite of the pre-2011 deferred revenue amortization burn down and three, generate meaningful cash flow and improved cash flow conversion of adjusted EBITDA.
During Q2, we achieved several milestones and continue to make progress on our transformation and while some of that success is reflected in the quarter’s results, in many cases we expect to see the financial expression over the coming quarters and years.
I’d like to remind everybody that we’re only providing full year guidance as any individual quarters not necessarily indicative of our expected performance for the year and the results of any one given quarter shouldn’t be over-weighted either to the positive or to the negative.
On a reported currency basis, bookings for the second quarter were $118 million, up 5% from the 112 million we reported in Q1 and down 8% from the 128 million reported in the second quarter of 2014 with the strengthening dollar accounting for about 7 million of the $9 million change over last year.
On a constant dollar basis, bookings for our marketed products were 122.4 million, a modest growth year-over-year. On an LTM basis, constant dollar bookings for marketed products were 502 million, down less than 2% from the LTM period ended June 2014.
As a reminder, we define bookings as the amount of revenue we expect to earn from an agreement between Avid and its customer for goods and services over the course of that agreement. We’ve established a bookings reserve, which is estimable and apply consistently each quarter. This booking reserve is formulaic in nature and is based on an analysis of historical cancellations as reviewed quarterly and updated annually.
Louis mentioned earlier that we had about $17 million in bookings in the second quarter related to new products announced at NAB in April. As a reminder, these products were the Avid S6L console, the Avid DNxIO, which is a hardware input and output device for Media Composer and the Avid ISIS 1000, our production storage offering for smaller enterprises and individual professionals.
The strength of these new product bookings validates customer excitement we experienced at AVID CONNECT, NAB and MAM [ph], and we believe bodes well as we continue to deliver a steady diet of new products and features. These products should begin shipping in late Q3 and in through Q4. In addition, we’ve seen a significant shift in the mix of the bookings to maintenance contracts and subscription over the past 12 months as a percentage of total LTM bookings, these categories increased to 31% of the overall bookings this quarter, up from 21% for the comparable period in 2014.
For the quarter, the percentage of bookings grew from 15% in Q2 2014 to 26% in Q2 2015. I would note that most of these bookings are related to support contracts and we’re still in the early days of our subscription rollout, but we currently have over 12,000 paid subscribers at present. We expect their support in subscription bookings will increase the amount of recurring revenue in our results and allow some smoothing of revenue over time.
Louis talked earlier about the elongation of the sales cycle that we highlighted last quarter. In Q2, we had a similar amount of deals slip out of this quarter as we did in Q1. We expect this trend to continue through Q4 at which time we expect spending to increase as many enterprises have heavy spend cycles in calendar fourth quarter traditionally.
We are pleased that bookings remain stable and expect to see solid growth in the second half of the year with the shipping of the new products, acceleration of our digital marketing for Tier 3 and adoption of our marketplace offerings. So with that, I’d like to touch on our cash position.
We ended the quarter with about $35 million of cash with nothing drawn on our new cash flow revolver. To help bridge our net cash position from the beginning of the year, if we start with $25 million of cash that we had at the beginning of the quarter, added $125 million related to the issuance of our convertible notes, we then use the 66 million net of cash required for the Orad acquisition, spent $11 million on the capped call related to our convertible offering which helps minimize equity shareholder dilution.
We had over $4 million of related lender costs and over $2 million of cash collateral that we to post related to letters of credit as we transition from Wells Fargo to the KeyBanc facility and $3 million of payments related to the restatement, restructuring and other uses of cash. The reminder of the cash change relates to an adjusted free cash flow use for the quarter of $32 million.
The adjusted free cash flow use was driven primarily by the timing of incentive compensation, the shift to more recurring revenue and key investments in growth and cost initiatives. You’ll recall that we talked about the timing of the payment of the 2014 variable compensation during the first quarter earnings call, and you’ll also recall that included things like the annual bonus, annual commissions and the like.
This item represented a significant free cash flow use in the quarter. Additionally, as we briefly mentioned before, we’ve seen an emerging trend of our customers taking support on products more frequently and often for longer timeframes. This mix shift to a more recurring revenue model provides enhanced future revenue visibility that has near-term cash implications.
Also impacting near-term cash is the growth in new product does not expect to be shipped until the second half. This is the $70 million that Louis referenced earlier, which should convert to cash mostly in Q4. Another cash consideration are the key investments in Avid Connect and NAB as well as new investments in low cost regions as part of our wage rate arbitrage, cost reduction program as well as investments in our digital strategy to increase sales in Tier 3.
In many ways, this past quarter was characterized by significant cash investments in future growth and cost reduction areas where we expect significant cash-on-cash returns. Adjusted EBITDA was 1.4 million compared to the 10.7 million in the second quarter of 2014. Approximately $9 million of this reduction resulted from lower amortization of pre-2011 deferred revenue.
Outside of that accounting impact, from an operating perspective, two meaningful trends impacted our operating results for the quarter. First, you’ve heard us talk about the uptake of our new products announced at NAB with 70 million of those products booked in Q2, which are expected to begin shipping late in Q3.
We’ve also seen a meaningful shift in bookings to recurring revenue model products. We therefore had a smaller portion of our bookings that were currently convertible to revenue, and while the enhanced recurring revenue sales provided future revenue visibility, it had a negative effect on current period revenue and earnings.
Part of the recurring revenue transition reflects a decision that was made last year to discontinue providing free software releases related to Media Composer version 8.0. This decision allows us to properly invest in the product and to be paid for those efforts. Our customers can take advantage of those investments by purchasing support or obtaining a subscription in the product.
The accounting expression of these operating decisions get reflected in both higher revenue backlog as well as the elimination of the company’s obligation of implied post contract support of PCS. Eliminating PCS for the product line will cause us to record revenue using a more traditional residual method of revenue recognition. Said differently, we expect to begin recording revenue mostly when we ship product provided it meets all the other revenue recognition criteria.
As I’ll expand on shortly, we have over $10 million of revenue and related EBITDA pertaining to recent sales of Media Composer hung up in deferred revenue, which we expect to convert to revenue in the second half of the year. We had anticipated this might convert during Q2 but given our restatement history, we wanted to make sure that we could fully demonstrate the cessation of PCS for accounting purposes before we started to record this revenue.
Additionally, we’ll continue to evaluate some of our other releases of products with similar characteristics that may lead to additional conversion of deferred revenue in upcoming quarters. We continue to see evidence of the sales cycle elongation, and while Q2 benefitted from most deals that fell out of Q1 and closed in Q2, we had a similar amount of deal activity shipped out of Q2.
While we expect the sales cycle to close up during the fourth quarter, it continues to be impactful on an interim basis for each quarter. The adverse impact of the stronger U.S. dollar on revenue was offset by the favorable impact on spending in foreign denominated currencies, so not a – this really wasn’t a significant theme in the quarter from an earnings perspective.
So now I’ll shift over to the operating results on both a GAAP and non-GAAP basis. As a reminder, the tables in our press release provides a description in reconciliation of our non-GAAP to GAAP results.
Revenue for Q2 was 110 million, which was down 12% or 50 million from the second quarter of 2014. Non-GAAP revenue, which excludes the impact of purchased accounting from the Orad acquisition, was also $110 million as the impact to purchased accounting in Q2 was negligible.
Many of the same factors that drove adjusted EBITDA performance also impacted revenue including lower amortization of pre-2011 deferred revenue, timing of shipment of new products, bookings mix, which was biased more towards recurring revenue, oriented products like support and subscription and lower sales and non-marketed products.
Additionally, the strengthening of the U.S. had an adverse impact in Q2 of about 4 million as compared with the same period last year. About 1 million of our Q2 revenue was from Orad products and services from the June 23 to June 30 period, so relatively minor in the quarter.
In Q2, product revenues were 76 million and services revenues were 34 million, of which about three quarters was related to support contracts. On a year-to-date basis, support and subscription revenue as a percentage of total revenue increased from the same period last year and made up about 24% of our overall revenue.
GAAP gross margin for the second quarter was 60.4%, which represented an increase of 90 basis points from the prior year. Non-GAAP gross margin was 60.7% for the second quarter, which was up over last year by 110 basis points and relatively flat sequentially.
Our variable direct product margin of approximately 76% was up about 230 basis points sequentially and about 170 basis points year-over-year. The major drivers of the overall gross margin improvement were favorable mix and lower overhead costs. Considering the reduction in 100% margin pre-2011 deferred revenue amortization recognized in the quarter, our gross margin as a percentage of revenue remains strong.
GAAP operating expenses were 74.5 million, down 2.1 million from Q2 2014. GAAP operating expenses included a credit of 1.1 million related to the restatement as compared to 6.7 million of restatement expense in the same period last year. The credit in this quarter represented the reversal of a previously accrued estimate for professional fees in the prior quarter.
Also, GAAP expenses include 3.3 million related to M&A activity, which is excluded from our non-GAAP results. Non-GAAP operating expenses of 68.7 million were up 1 million over last year and 4 million sequentially. The increase on a year-over-year basis versus Q2 2014 was driven by increased demand generation activities for our Tier 3 growth initiative and the inclusion of approximately $800,000 of operating expenses for Orad as well as higher hardware development costs associated with new products announced at NAB.
Our labor arbitrage initiatives and the strengthening dollar offset the majority of these increases. Based on the timing of the labor arbitrage projects and the recent momentum with newly opened offices in low cost geographies, we expect to see a more fulsome impact of these cost reductions in the second half.
The sequential increase in non-GAAP OpEx was driven by a few factors; the NAB and AC event in April, the increased demand generation activity that I just mentioned, the addition of Orad costs and a $2 million unfavorable swing in foreign exchange gains and losses. We had a $1.3 million gain in Q1 and about $700,000 loss in Q2.
I want to take a moment and discuss our approach to foreign exchange since we’re talking about FX. First, let me cover the accounting. The company accounts for its foreign exchange gains and losses in accordance with GAAP. The net FX impact reflected in our income statement as noted in the footnotes to our financial statements is recorded in selling and marketing expense, and includes both realized and unrealized gains and losses.
For the full year 2014, FX losses aggregated about $900,000 and thus far this year has totaled a gain of about $600,000, so relatively modest in both periods. The unrealized foreign currency gain presented in our statement of cash flows of approximately 4 million reflect only the unrealized non-cash portion of foreign currency gains while the amount in our statement of operations reflects the effect of both realized and unrealized gains and losses. And remember that net effect so far this year is in a gain of about 600,000 or 700,000, so again not really significant.
Putting aside the accounting treatment for a second, the company has from time to time identifiable FX exposures where we believe it’s prudent from a risk management perspective. The net speculates in a currency through the use of derivatives. We currently have a small hedge of around $2 million notional outstanding at the end of the quarter that we assumed in connection with the Orad acquisition.
Transitioning back to non-GAAP operating losses for the quarter, our non-GAAP operating loss was about $2 million as compared to operating income of 6.7 million in the same period last year. Similar to the change in adjusted EBITDA, the decrease in operating income was largely attributable to lower pre-2011 non-cash revenue as compared to last year and the timing and mix of bookings in the quarter.
Now let me provide an update on our labor arbitrage project. We’ve touched on that a few times in the course of this discussion and you’ll recall this is part of our overall cost saving initiatives. We’ve begun hiring associates and earnests in both Taiwan and the Philippines and by the end of the quarter we had 75 new employees in lower cost areas at a significantly lower average wage rate.
We expect to grow the facility located in Poland that we gained from the Orad acquisition in the fourth – I’m sorry, expect to grow that facility located in Poland from the Orad acquisition. And then we’re just starting to hire employees for the plant location in South Florida. We expect to accelerate these efforts throughout 2015 and 2016 and upon completion of the project, we’d anticipate that our non-GAAP adjusted operating costs to fall below 250 million on a pre-acquisition annual run rate basis. We expect to see about $5 million of that benefit in this year but currently anticipating completing the project until the end of 2016.
So next, I’ll turn to the balance sheet. We ended the second quarter with $35 million of cash and nothing drawn on our available line of credit. As I mentioned earlier, we issued $125 million in convertible notes during the quarter, which provided financing for the Orad acquisition, general working capital requirements and our share repurchase program.
Speaking of the share repurchase program, we’ve repurchased $8 million of Avid’s stock in the open market to-date – through today and the cash payments for these purchases didn’t happen until July, and you wouldn’t see that reflected yet in our June 30 results.
Accounts receivable as of June 30, 2015 was 55 million of which 10 million related to Orad. Excluding Orad, our DSO was approximately 37 days as compared to 39 days last quarter and 36 days last year. Inventory of 44 million included $5 million related to Orad. Excluding Orad, our inventory remains at a historical low. We may see a modest increase in the third quarter as we begin ramping production for our new products.
Deferred revenue was 393 million at the end of the quarter as compared to 430 million as of June 30, 2014. Our deferred revenue includes $4 million due to the Orad acquisition. Revenue backlog was 540 million at the end of Q2 as compared to 543 million in the same period last year. And if you remove the impact of the pre-2011 deferred revenue, our revenue backlog grew about 72 million or 17% to 489 million over last year reflecting the continued trend towards increased revenue visibility. The revenue backlog includes $13 million related to Orad.
Now I’d like to turn to the financial outlook for the remainder of 2015. You’ll recall our practices provide annual guidance and then update that guidance on a quarterly basis. In this update, we’ve included the impact of the acquired Orad product lines from June 23 through the end of 2015. And as we’ve discussed previously, we’re integrating the Orad product lines into our product assortments as a result and consistent with our other product lines, we won’t breaking Orad products out from our traditional business.
As Louis mentioned earlier, we’ve already begun an aggressive integration of Orad. We’ll offer their products in larger enterprise deals sold to existing Avid sales force as well as fully integrating the former Orad sales team into the Avid team. We’ll also be adding some of the development of Avid products to the Poland location, which was formally just Orad products. We’re doing this to maximize the economic benefit of the Orad business to the combined business, thus it will be no longer readily identifiable as a discrete business.
We’re increasing our guidance for 2015 for bookings revenue and adjusted EBITDA and I’ve adjusted the range for adjusted free cash flow for 2015 to reflect the anticipated timing of cash inflows and outflows given the anticipated product and service delivery times as well as higher levels of investment to accelerate our cost reduction programs.
Given all the variables that we’ve outlined thus far in the call, we’ve provided a 2015 guidance bridge in the supplemental tables attached to the press release announcing our second quarter results. We felt that this would be helpful as there are many moving parts, which contribute to and ultimately inform our full year guidance.
We now expect 2015 adjusted EBITDA to be in a range of $74 million to $80 million, up from the 72 million to 78 million that we’ve previously guided to. We expect adjusted free cash flow generation to be in a range of 12 million to 20 million from the 18 million to 30 million we previously provided.
The change in adjusted free cash flow is primarily driven by the timing of cash conversion of revenue in 2015 as well as capital spending related to cost reduction programs. Because of the tightening of deal activity and product shipments, we expect cash collections to ship from Q4 into the first quarter of 2015.
We are seeing a continuing trend where close to roughly 50% of our quarter’s bookings are occurring in the last two weeks of the quarter. This naturally has a pretty significant effect actually on free cash flow conversion of bookings, and as a consequence we believe it’s prudent to extend that trend through the end of the year as it doesn’t appear to be materially abating.
Additionally, as I mentioned during our last earnings call, adjusted free cash flow included estimated full year spending of $18 million to $20 million of capital expenditures. You’ll recall that that compares to about $13 million in the prior year. Given the acceleration of the labor arbitrage project, we’re extending the range by 2 million to $18 million to $20 million and anticipate being closer to the high end of that range.
As a reminder, the anticipated spike in capital spending for 2015 is related to the investments in our digital marketplace strategy, facility and infrastructure and lower cost regions as we execute on our wage rate arbitrage projects. We believe that both of these investments will have compelling returns on investment in the near term. After that investment cycle is completed, we would expect capital spending to track closer to our depreciation.
Our expectations around annual bookings on a constant dollar basis have improved and we’re guiding them to be up 2% to 6% over 2014, which translates roughly to a range of 530 million to 550 million. This compares to our prior guidance of 1% to 5% for an annual increase.
We expect the currency headwind to be about – on a net basis 4 percentage points, which is higher than our previous estimate. This is due in part to our expectation that European bookings will continue to be a higher portion of our mix in 2015 than originally anticipated.
Our mix of bookings in the second quarter 2015 alone increased to 43% of constant dollar bookings from the 38% in the year-ago period. We expect bookings to be weighted to the fourth quarter due to the timing of deal closures, our initiatives to accelerate sales in Tier 3 markets as well as our typically strong fourth quarter seasonality.
We expect 2015 revenue to be up between 2% and 4% from last year versus flat to 3% growth previously provided, and believe that gross margin as a percentage of revenue will be between 61% and 62% of revenue.
Non-GAAP operating expense is expected to be flat to up 4% as compared to 2014 with our cost improving initiatives offset by the inclusion of the Orad cost structure net of cost synergies and our outlook. I encourage you to review the 2015 guidance bridge attached to the release announcing our second quarter results.
While most of the line items in the bridge are relatively straightforward, I’d like to provide some commentary on a few. Essentially, we try to roll forward our first half results and apply the impact of items that occurred in the first half that we expect to be financially expressed in the second half to that run rate, then layer on the second half initiatives to provide a relatively transparent view on how we expect to achieve our full year guidance.
While some of these bridging items are simply the conversion of previously booked deals, we’ve also layered in traditional seasonality and specific initiatives which were all subject to execution and general market trends in the second half. As I mentioned earlier, the accounting expression of the decision to discontinue providing free software updates so we can continue to invest in our products have had two effects.
For some of our customers, they prefer to receive ongoing software updates and therefore select software support or adopt our subscription product. For others, they prefer to use the current version particularly if they’re working on a large project and they’ll upgrade when they believe the time is right for them.
In the case of Media Composer version 8, a product launched last year, we expect to recognize revenue more closely aligned with the sales of the products on a go-forward basis and expect that subscription and support customers can become a higher proportion of the Media Composer revenue over time, as we’ve seen the uptake of these products steadily increase despite having a digital strategy that’s really in its nascency.
This means that the bookings of the product, most of which were made in the past nine months along with any other products sold along with Media Composer or Media Composer cost of sales arrangement to be deferred should in large part be recognized in revenue in the back half of the year, likely Q3 similar to typical software companies using residual method of accounting for software.
While we considered whether this accounting should begin in Q2, we felt more comfortable given the restatement history to wait until Q3 so we have more evidence of the efficacy of our decision to discontinue the old business practice of giving software updates away for free. This was one of the products where Avid had a relatively long history of providing implied post contract support.
This should provide about $60 million of revenue to the full year based on the amount of Media Composer sold to-date, approximately $10 million of which would have been recorded in Q2 had we concluded on the cessation of implied PCS at that time. This change should dramatically improve our ability to convert bookings to revenue in a more timely basis.
We talked earlier about the $70 million of newly announced products where customers have placed a preorder. These products are expected to become generally available for shipment in Q3 and early Q4, as we expect the entire $70 million booked in the first half will convert into revenue during the second half of 2015 not to mention any new bookings that these products will generate in the second half.
The growth initiatives noted on the bridge are specific incremental actions we’ve initiated, which we believe should accelerate bookings and revenue in the second half. These actions largely consist of being more clear about the value of our products and the platform as well as related pricing and packaging options designed to incent buying decisions this year.
We also expect second half spending to be down $8 million, a portion is related to normal spending seasonality, for example, NAB and ACA events in the first half provide tailwind moving into the second half. We also expect our labor arbitrage initiative to begin to convert to savings at a more meaningful way, which when combined from the tailwind from the first half should contribute to our overall cost reductions.
From a cash flow perspective, you’ll note that we expect a more trajectory change from the first half to the second half largely driven by normal seasonality differences whereby there is traditionally more cash flow pressure in the front half of the year due to the timing of incentive payments, trade shows and bookings SKU. These normal trends are anticipated to be partially offset by increased CapEx expectations in the second half.
We’ve adjusted our adjusted free cash flow range to reflect the updated view on the timing of cash flow activity. With that continued trend of deals closing late in the quarter and the shift to a more recurring revenue model, it’s more likely that the cash impact of this activity will shift to early 2016 notwithstanding our efforts to accelerate within the quarter and within the year.
Additionally, given the focus on building out new locations for the labor arbitrage initiative, we plan on spending about $2 million more in CapEx for 2015 than originally anticipated. As a result, we have refined our view of adjusted free cash flow for 2015 to be between $12 million and $18 million.
GAAP to non-GAAP adjustments are expected to be approximately 40 million. These items include cost associated with stock-based compensation, restatement, restructuring expenses, amortization of intangibles, mergers and acquisitions and the impact of purchase accounting on acquired entities as well as tax-related adjustments. And finally, we expect non-GAAP taxes and interest expense to be approximately $3 million this year.
With that, I’ll turn it back to Louis for some closing remarks.
Louis Hernandez, Jr.
Thanks, John. To wrap up the first half of 2015, I’m excited [indiscernible] achieved operationally and I’m looking forward to seeing the financial conversion of that progress during the remainder of 2015. Visibility of revenue backlog, the continued momentum of large strategic customers and momentum from new products as well as the recurring revenue growth and the planned cost programs provide comfort around the full year targets.
We’re looking forward to hitting more milestones on our shift to a more recurring and diversified revenue model and our anxious to move as quickly as possible through this difficult transition period that is common for those who have gone through this shift. All of our work has laid the foundation for creating sustainable EBITDA growth and cash flow generation in coming years.
We’re looking forward to the remainder of 2015 and confidence in the full year guidance based on the factors that we’ve laid out. On behalf of the entire management team, thank you again for your support and we will look forward to talking to all of you soon.
At this time, I’ll be happy to take questions. Operator?
Thank you. [Operator Instructions]. We’ll take our first question from Steven Frankel with Dougherty.
Good afternoon. Let me just start with a simple one. So what’s your anticipated revenue for Orad in the back half, so I can start to think about what you’re saying about the underlying business?
That’s 22 million in the back half.
Okay. And the shortfall in bookings yet again this quarter, same issues as last quarter with customers pushing back on terms or is this more of a price discussion now that you’re getting into?
So, as you know, we don’t provide quarterly guidance on bookings.
No, you don’t but you started the quarter with a big – you had a nice start to the quarter and it ended ugly, so I’m just trying to understand what are the issues that are causing customers to not sign?
So I think in terms of the full year guidance, we provided a bridge and tried to lay out what we think is going to drive the full year guidance. We did see in the quarter a continuation of the elongation of the sales cycle, so the deals that rolled out of Q1 in fact were closed in early Q2. We saw a similar amount of deals roll out of Q2 into Q3. Our thesis for that reversing and ultimately closing in Q4 is the traditional sales cycle or traditional budget flush that you expect to see in some of the large enterprise customers. If you look in the balance of the year, though, there is a fair amount of seasonality that we anticipate as well as the continued efficacy of our new products in the balance of the year.
Louis Hernandez, Jr.
It’s true, Steve – go ahead, John. Were you finished?
Yes, I was done.
Louis Hernandez, Jr.
The impact, Steve, specifically and basically about the same amount that came in early in the quarter in that first month shifted out and that’s that elongation. I mean our goal was to stabilize bookings and have a mix shift. That is definitely happening. You’re seeing that in the gross margins. The only new variable is the percentage of recurring revenue and a greater impact on a couple of other dynamics. But if you look at the Tier 1, which is what you’re referring to, basically we saw a continuation of that elongated sales cycle. We expect that that will close in Q4 where we traditionally see that closing up. That’s why we feel good about the full year, and we factor that into the bridge that we showed you, the impact we think that will have. Separately, you’re seeing bookings relatively stable, but you’re continuing to see that mix shift. Non-marketed products, I think John, was about 3 million in bookings for the quarter where we intentionally didn’t go after that business as we’re continuing to try and see better and higher margins on our new products. And you saw that with the new products growth in the bookings and then also the impact of the change and the adoption of the business practice impacted the revenue and the earnings more than the bookings line. But on the bookings line, that one item that you’re referring to essentially is continuing. We think it will close in the fourth quarter.
Yes. So if I just kind of re-summarize some of that, Steve, if you put it in the context of what we wanted to accomplish, we wanted to stabilize bookings, we wanted to have sustainable EBITDA and we wanted to improve free cash flow. So our marketed products are essentially stable. We saw this emerging mix shift, which has a near-term impact, so mix to greater recurring revenue. Margins have been improving. Cost has been coming down, so from an earnings perspective, we’re comfortable with the progress that we have made. And then really from a free cash flow perspective and I probably should correct one of the numbers I gave at the end. Free cash flow guidance range is 12 to 20, not 12 to 18. The timing of bookings within the quarter and within the year we think is going to be a big factor as well as this emerging shift to recurring revenue. We continue to see about 50% or more of our bookings closed in the last two weeks of the quarter, and we’ve extended our outlook through the end of the year and into Q1 because of that phenomenon.
Louis Hernandez, Jr.
And to just follow-up, Steve – I’m sorry, one last point on it is if you just have the isolated Tier 1, you’d have likely seen it decline because of that rollover impact. That was made up by this surge in recurring revenue. As we mentioned, it was up about 58% and that also had an impact on our earnings and cash flow.
So what were the bookings of support contracts in the quarter? Can you give us the dollar value? I know you gave us that number at the end of last year.
Louis Hernandez, Jr.
Total recurring revenues, I think books were about 26% of the total bookings as compared to 15% in the same period the prior year.
And I’m always looking to get “broken out” separately.
Sorry, go ahead, Louis.
Louis Hernandez, Jr.
No, go ahead. [Indiscernible] asked the recurring revenue associated with support contract versus subscription.
Louis Hernandez, Jr.
We’re happy to provide that to you.
Yes, we can provide it offline or provide it separately and just give us just a moment, but what I would say is the subscription portion of the bookings is relatively small. It’s primarily support.
Okay. And the $16 million in revenue from the Media Composer accounting change, was that anticipated in your last full year guidance?
Yes, if you’ll recall, I cited three things for our view of EBITDA, and this will answer your question, the last item. That improving mix shift, lower cost, and improved conversion of bookings to revenue were really the three things that gave us confidence around EBITDA, so yes, the quick answer is yes. We anticipated that we would have improved conversion in the year. And I think we’ve got your number for support, it’s about 30 million in the quarter.
But let me go back to revenue a minute. So you were guiding around 535, 537 prior and you have 22 million coming in from Orad and you’ve taken revenue down to 544. So is that principally the hole in the bucket, these bookings that are getting pushed out?
Yes, it’s mostly the mix shift that we see that’s related to recurring revenue. And certainly we’re a little bit – we’re watching very carefully the proportion of bookings that are getting booked at the very end of the quarter, vis-à-vis our ability to convert it to revenue by shipping it by the end of the quarter.
Louis Hernandez, Jr.
I was going to say just to follow up on that, I think that’s why when you see the – if you go through and we’re happy to take you through it in more detail the reconciliation or the bridge. When you add the visibility we have on new products that just need to shift and then you take the change in business practice, which we did factor in as John just mentioned, that 16 million, 17 million. A portion of that could have possibly been in Q2. We just wanted more time to make sure there’s no questions about that, but that was factored in because we changed that practice coming out of the restatement. And so when you add those two in the bridge, I think you’ll see why we’re so comfortable with the raise in guidance for the year.
Yes, to add to that, so we announced that change from a business practice perspective about a year ago. That was one of the – the first steps was to communicate it to the marketplace. We did that in five or six different ways and places. And then we wanted to wait until people got off their first year of support to make sure the efficacy of the change in business practice was going to stick.
All right. And going back to the bookings that slipped, last quarter you were able to close those bookings early in Q2. Why weren’t you able to do the same thing this time around?
We didn’t --
Louis Hernandez, Jr.
We’re experiencing a similar phenomenon, Steven.
I guess I don’t understand what that means. That customer keeps pushing back or --?
Louis Hernandez, Jr.
Meaning that the deals that rollover last quarter, we signed it early in the following quarter and we’re seeing the same practice this quarter.
Okay. You didn’t make that clear before.
Louis Hernandez, Jr.
Correct. We did not make that clear this time. It’s because we got so many other issues in the bridge and because we think that elongation will continue until Q4, we didn’t want people to be misled into what it might impact on Q3 because we’re not providing Q3 guidance.
Louis Hernandez, Jr.
But we do think for the full year, we’re comfortable with the guidance that we provided because we think that gap will close. We think there will be some elongation but it won’t be as pronounced, because of the traditional seasonality. In terms of the buying behaviors, I think people are realizing we’re not cutting special deals at the end of a quarter and that seems to be working and that we’re seeing kind of a trend emerging also where we’re seeing more deals signed and have gone over into the following quarter. And we’re seeing a similar activity that we saw last quarter.
And what’s your stance to buying back further stock? The 8 million is all that you had authorized or do you have the ability to buy more?
We have sensibly bought what was authorized.
All right, thank you.
Louis Hernandez, Jr.
We’ll go next to Hamed Khorsand with BWS Financial.
Hi. Let me start off with can you walk us through how you’re expecting free cash flow of 12 million to 20 million if business burn through 30 million in the first two quarters of the year and then you’re commentary is that since bookings are happening – since revenue is being booked in the last two weeks of the quarter, the cash flow is being shift to the following quarter. So how comfortable are you that we can see like $50 million-odd of cash flow here in excess of CapEx?
Hi, Hamed. Yes, it’s a good question. So if you look at the pretty significant seasonality that we have in the back half of the year, that drives a big chunk of the cash flow. Also, the $17 million of bookings we had in the second quarter that should largely cash convert in this year, in the back half is also going to provide a bit of tailwind to achieving the guidance. And as you look at our cash flow bridge for our guidance, about $11 million of the improvement, it will come from the cash conversion of products that we shipped in the second half that were booked in the first half. Obviously, we’ve taken out the cost of the inventory associated with that 17 million as well as some impacts from our cost rationalization. But clearly the big driver on the bridge is going to be seasonality. And probably the easiest way to think about it is if you simply look at how much of our year traditionally gets shift into back half, you would naturally expect Q3 and Q4 to be much larger in total.
Louis Hernandez, Jr.
John, can I add one more thing to that and that’s that in the first half of the year if you normalize that, you have to keep in mind that we have two big cash trains. Number one is the bonus and incentive payments that occurred in Q2 that won’t repeat for the rest of the year and also we have our two largest events, Avid Connect and NAB in the second quarter and those also will not repeat. So in addition to the cash flow inflows, as John highlighted, we won’t have the outflow pressure that we have in the first half of the year. John, is that correct?
That’s absolutely correct.
Okay. And then my other question is as you update guidance, does that include Orad especially in just the EBITDA figure?
It’s included in all figures.
Okay. So the business outside Orad, it sounds like it’s still in deteriorating mode or is it moving more SaaS and that’s what making it look like that?
I’d say – again, if you put it back in the context of our three goals; so bookings we feel like it has stabilized. We see improved margins from the improving mix, lower costs, so the combination of all those factors give us some confidence around the full year. And I’d say our full year guidance isn’t really suggestive of a deteriorating business rather than really a business that’s really going through a transformation.
Louis Hernandez, Jr.
But I think, Hamed, you’re right. The new variable would be the mix because our goal was to stabilize bookings from a period of steady decline. We wanted to stabilize the bookings. We want to deemphasize less profitable products. That’s why you’ve seen our margins expand. Now the new products seem to be accelerating. And the big new news I guess if that were the continued story, there was a more rapid acceleration for recurring revenue, which we had anticipated to shift but we didn’t anticipate it this quickly. And so if you’re trying to isolate a new variable, I would suggest that that’s probably the new variable that we had to deal with. The products that shipped – that we booked, the 17 million that we record. We knew that was going to come in for the year. Those products are doing very well. They’ve actually exceeded expectation. We think that bodes well for the full year. The change in business practice and the financial expression; 16 million, 17 million, we knew that would come in for the year. We weren’t sure which quarter. That’s why we didn’t provide quarterly guidance. And for those that are trying to do quarters, we know that provides a difficultly in estimating by quarter, but we’re confident that’s coming in for the year. The big thing is this shift to recurring, it’s happening faster than we thought. And I think the fact that we’re able to still raise guidance and likely result in a much higher recurring revenue mix for the year, the combination that Steven highlighted, both support revenue and also the subscription we think bodes well for the future.
Okay. You said that there were 10,000 paid subscribers, so it went up by about 2,000 sequentially. How many of that were existing customers? How many of that were new customers, because of the SaaS product you have now?
Yes, it’s actually up to a little over 12,000 now. Actually 10,000 was just a milestone that we called out. And the large proportion of that are new customers. We have seen more legacy customers and anticipated that have adopted a subscription, but still the very large proportion of those are new customers to Avid.
Louis Hernandez, Jr.
Yes, I would say the interesting thing about what’s happening underneath all this is that we’ve now sold 25,000 MediaCentral licenses on the platform. Those are primarily the Tier 1 accounts. So they’re still borrowing the platform, which will lead to long-term cross selling, which shows to me that the vision for Avid Everywhere is working and it’s showing up in the units. Now what we need to do is continue to cross sell and up sell. On the licenses, like you said, we highlighted that we crossed the 10,000, now at 12,000 and that was up from about a 1,000 a year. So it’s been a pretty significant increase. And this is before we really have our Tier 3 strategy where we really expect the subscriptions to weave in. We have had our early returns better than we expected, but we think that the Tier 3 leadership, the programs, the systems, the processes, those are still being put in place so we’re encouraged with the early returns there on the subscription and that plus the increase in the other revenue – recurring revenue components is what caused the 58% increase in the recurring revenue bookings for the quarter.
Okay. Thank you.
Louis Hernandez, Jr.
We’ll go next to Jason Kraft with Cato Partners.
Louis Hernandez, Jr.
Hi. I’ll try and phrase this succinctly as possible. I think we all understand that this has been a pretty messy year and Avid’s had sort of a messy history and some would argue you guys are in a messy industry. But if I use your language on this call and from prior calls, citing a dramatic increase in revenue visibility, accelerating bookings and new products and recurring revenue, the timing of cash conversion cycles into next year including Orad and its benefits and also the cost rationalization programs that have been underway, I’d like to hear your comments if it’s time to really focus on what matters? And what I mean by that is a clean Avid and I’d say maybe the 2016 Avid and the resulting free cash flow per share generation. So simply just the real true cash flow power of Avid and as we clear all this kind of messy year, what 2016 is expected to look like and what you guys expect of the clean Avid? Thanks.
Louis Hernandez, Jr.
I’m going to let John take a shot at that but first I want to acknowledge and appreciate the transformation that we’re going through and that our shareholders are going through with us. We know it’s difficult that we only do full year guidance. As you know, we came in and did a full strategic review, felt that point solutions on a shrinking side of the budget within our clients was not a long-term strategy. We had to take some pretty aggressive actions both on the product side, as you know, and engaging with customers on a cost side. We’re right in the middle of it. The metrics that we’re measuring are the language that we use with you and I realize that we’re all looking forward to the day when those are clear when the non-marketed products fully run off, when the pre-2011 amortization runs off in early '17, when we’re finished with the cost programs, the key drivers as we believe at that point you will see accelerated bookings, revenue and EBITDA growth with high cash flow conversions. With that as a backdrop, John, could you provide as much clarity as we can for Jason to look forward to what we’re targeting even though we’re not providing any guidance into the out years.
Sure. So it’s a fair question and anytime you’re in a transformation as well as concurrently in an investment cycle, it does make the numbers a little hard to work through cleanly. So we appreciate your question. So if we kind of go with the things that we can either know or can reasonably expect, the whole design of the strategy around having a platform that you could cross sell and up sell effectively across would point towards a company that could generate at least improvements in revenue that are better than the market rates of growth. So we would reasonably expect over time to take share. From a gross margin’s perspective, we expect that we’ll continue to expand margins over time as we have fairly effectively over the last couple of years. And then from a cost structure perspective, Orad, we think that a cost structure of around $250 million exit run rate cost at the end of 2016 is very achievable. So that should give you an idea in rough order of magnitude what we expect the cash flow generation capabilities are. And then naturally as you normalize for the elongation of the sales cycle within a full year and you see more normalized buying activities as well as cash conversion activities, you wouldn’t expect to see quite the impact that we saw on a year in transition. The one thing I kind of caveat that is if we continue to see dramatic increases in recurring revenue, some more shift to subscription, that could have a dampening effect in near-term cash. But again, I think it’s a trade that we’d all be willing to make.
Okay. We’ll go next to Matthew Galinko with Sidoti.
Hi. Thanks for taking my question. I guess do you have any target in mind about percentage of bookings from recurring revenue as we move through the back half of the year?
We really don’t have a specific target in mind for the back half of the year. We did model a continuation of that trend in the baseline run rate of the business that we layered on specific initiatives, and those initiatives had a higher cash flow conversion rate. So the bookings of revenue conversion in the back half is going to naturally be higher, but we don’t have a specific target in mind.
Louis Hernandez, Jr.
And Matthew, one reason we wanted to provide that bridge because we knew that a reasonable question would be, how are you able to raise guidance if you’re seeing this kind of shift to recurring revenues? And the reason I mentioned in my part of the talk was that we still have – you can still buy perpetual and Tier 1 is still a meaningful part of our business and a lot of the new products that I mentioned that are doing so well are with Tier 1. And so while we expect that we planned on that current trajectory to continue, we also have the new products doing well as evidenced by the margins and the bookings that we discussed. And so we have that shift going on at the same time and that’s why we don’t think the trough that you typically see when you make this shift will be as dramatic, because we continue to allow people to buy and that’s how Tier 1 is mostly buying still on a licensed perpetual model. And so one of the things I mentioned earlier was you could end the year achieving higher guidance with a higher mix shift as well to recurring revenue, a combination that would be attractive I think. And that’s why we also wanted to mention that if possible it will actually accelerate, we could have an impact on what our results are but remember the new bookings, our new products which are mainly aimed at Tier 1 are also doing quite well right now. And so we just need to get on the other side, kind of like Jason mentioned in his question. We want to all get on the other side but we feel like we’ve got to stick to this plan. We can see it turning. There’s a lot of noise in the system until we get there, but we’re happy that we’re able to hold on bookings, see the margins expand and believe for the full year we’ll be able to demonstrate the goals that we had, which is sustained growth and adjusted EBITDA and superior cash flow conversion.
All right. Thank you.
Louis Hernandez, Jr.
It appears there are no further questions at this time. So I’d like to turn the conference back to our speakers for any additional or closing remarks.
Thank you everybody for joining our call today and we look forward to speaking with you very soon.
Louis Hernandez, Jr.
That does conclude today’s conference. We thank you for your participation.