Avid Technology, Inc. (NASDAQ:AVID) Q2 2016 Earnings Conference Call August 3, 2016 5:00 PM ET
Robert Roose - Director of Corporate Development and Investor Relations
Louis Hernandez - Chairman, President and Chief Executive Officer
Ilan Sidi - Vice President of Human Resources and Interim Chief Financial Officer
Steven Frankel - Dougherty & Company LLC
Hamed Khorsand - BWS Financial, Inc.
Good day and welcome to the Avid Technology Q2 2016 Earnings Release Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Robert Roose. Please go ahead.
Thank you. Good afternoon. I'm Robert Roose, Director of Corporate Development and Investor Relations in Avid Technology. Welcome to our Q2 2016 earnings call. With me today are Louis Hernandez, Jr., Avid's Chairman, CEO and President; and Ilan Sidi, Avid's Interim Chief Financial Officer and Vice President of Human Resources.
On our call today, we will be using both non-GAAP measures and certain operational metrics, both of which are defined in our Form 8-K and supplemental financial and operational datasheet available on our Investor Relations webpage. These non-GAAP measures are also reconciled with GAAP measures in the slide deck that accompanies this call. The tables to our press release and in the supplemental financial and operational datasheet.
I would also like to remind you that certain statements made on this call are considered forward-looking statements within the meaning of the securities laws such as, for example, statements about expected future operating results and financial performance and the progress of our transformation. Forward-looking statements are inherently uncertain, not guarantees of future performance and are subject to certain risks and uncertainties that could cause actual results to differ materially from our historical experience and our present expectations or projections. Any forward-looking information relayed on this call speaks only as of this date and we undertake no obligations to update information, except as required by law.
For additional information, including a discussion of some of the key risks and uncertainties associated with these forward-looking statements, please see the Forward-Looking Statements section of our press release issued today as well as the Risk Factors and Forward-Looking Statements sections of our 2015 Annual Report on Form 10-K and the Quarterly Report on Form 10-Q filed with the SEC on Friday, August 5, 2016. Copies of these filings are available from the SEC, the Avid Technology website and our Investor Relations department.
We've also added a supplemental presentation in an effort to complement today's narrative. We hope that you will find it helpful. We will be recording today's call, which will be made available for a two-week replay. You may replay this conference call and access the supplemental presentation by going onto the Investor Relations page of our website and clicking the Events & Presentations tab. Later, we will be conducting a question-and-answer session and instructions will be given at that time.
And now, I would like to turn the call over to our Chairman, Chief Executive Officer and President, Louis Hernandez, Jr. Louis?
Thank you, Robert. And thank you everyone for joining us on our second quarter business update call. Let’s turn to Slide 6 and get started. We met or exceeded guidance for every metric this quarter bookings, adjusted free cash flow and non-GAAP operating expenses are all in line with guidance.
Non-GAAP revenue, adjusted EBITDA are above the guidance range. Non-GAAP revenue and adjusted EBITDA performance benefited from the recurring revenue growth from improved conversions of bookings and revenue backlog to revenue and that was partly driven by new software releases as well as tighter cost controls.
It’s important to note that even without the deferred revenue conversion related to software releases we would have been at the high-end of the guidance range. We've updated our guidance for the full-year 2016 reaffirming guidance for bookings and adjusted free cash flow and improved guidance for non-GAAP revenue adjusted EBITDA and non-GAAP operating expenses.
I think we've seen pretty strong trends in some of our key growth initiatives. We believe this is signaling the market acceptance of our strategy. The platform strategy continues to resonate and adoption by enterprise users is going in a strong pace of 47% from year-ago. Individuals are now benefiting from our cloud-enabled subscriptions and the subscriber base continues to expand almost quadrupling from a year-ago. We're on track to complete the transformation in mid-2017 as has been the plan since we announced the transformation.
We see continued progress in the transition to a recurring revenue model and our target for cost efficiency programs has increased to an annualized savings of $76 million up from $68 million. With the MediaCentral platform we're able to implement a more efficient operating model which is reflected in this guidance.
Let's turn to Slide 7. For those of you not familiar with our strategy at the beginning of our journey we completed a top to bottom strategic review that resulted in a sweeping transformation of the business that is scheduled be completed in Q2 of 2017.
You'll see in the upper left hand side, one of the conclusions we reach was the that Avid had it’s unbelievable brand heritage and great distribution operating in almost a 140 countries around the world. We also had category leading brands, it changed the way people worked in a variety of siloed-based product categories.
We decided to take advantage of our heritage of great distribution and brand and these products have put them under one common operating system called the Avid MediaCentral Platform, that’s the purple egg in the middle. Then on top of that, we added into suite our existing products and then allowed us to add applications both our own and third-parties to sit on this one integrated operating systems that we've built called the Avid MediaCentral Platform.
By doing this, that allowed Avid to participate in the higher growth areas, leverages distribution and brands, and start to position more aggressively by Tier. You will see at the bottom Tier 1, Tier 2, and Tier 3, we historically have operated primarily in Tier 1 through resellers and Tier 2 and only opportunistically in Tier 3. With this strategy, we can now price and bundle specific products to each of the Tiers thereby optimizing the Tier, increasing the total for addressable market, and increasing lifetime value of each customer.
The plan was to optimize the value by getting clients on the platform and grow in multiple dimensions, by adding suites with apps that solve the biggest issues on our own or third-party applications, we can then be getting the price impacted by tier, by segment, by geography.
So areas such as film or TV or digital audio, gaming, education, sports et cetera we can start combining apps that all run on a common shared platform to drive multiple growth dimension. The targeted result is to drive higher growth, a more diversified revenue model, higher recurring revenue, and a lower cost structure all by meeting the needs of the market in a more dramatic way in expanding our addressable market.
Let's turn on to the next Page now. I think we continue to make progress in executing on the platform strategy as demonstrated some of these key growth operating metrics. You'll see the platform adoption has increased 47% on a year-over-year basis. Subscriptions and digital are beginning to surge, if you remember we really targeted the Tier 3 area, got off to a slow start. It's really starting to surge now four times versus the same quarter the prior year and digital sales are also up significantly.
Recurring revenue continues it’s upward trajectory at 32% for the quarter and remember back in 2014 Q2, it was about 15%. So we continue to see a nice upward trajectory on the visibility to the business. I mentioned the cost efficiency is on track, you'll see the 6% and 5% annual reduction and normalized quarterly GAAP and non-GAAP operating expenses respectively.
$57 million of the annualized savings have been executed through Q2 of 2017. And I think the important thing for us is these efficiency gains are all allowing us to better serve clients by lining our organization, moving in place closer to the clients they serve and doing it at a lower cost.
Let's move on to the next Slide. I like to highlight a few of our key wins for the quarter. In Tier 1, the customers and projects, Tier 1 really validate our strategy overall. The platform is the anchor that enables us to expand business with our existing customers and maximize value over time. Once clients are on the platform they benefit from the efficiency, interoperability, and enterprise pricing, it’s becomes pretty sticky and they continue to buy from Avid.
And we are starting to see an increase in enterprise wide agreements which are often large multimillion dollar agreements, and these are often longer sales cycles because they are more strategic, but they result in more strategic relationships. So let me give you a few key wins for this quarter that were impactful to our results.
First in the upper left, you'll see the Tennis Channel. You probably know they are leading national cable channel focused on Tennis recently acquired by Sinclair Broadcast. Sinclair is the largest television station operator and local news provider in the United States and one of the most aggressive forward thinking media companies in the world. This deal leverages the groundbreaking enterprise agreement and platform deployment announced with Sinclair at the end of last year and is a clear example of how we can build on large deployments on MediaCentral platform.
The contract is to help the Tennis Channel update and transform its production workflows, utilizing the Avid MediaCentral platform and solutions. For Sinclair in the Tennis Channel is pretty straightforward, and more efficient workflow across the enterprise, and significant cost benefit in a more competitive operation all sitting on the same MediaCentral that they already invested in.
Cadena Tres is one of Mexico's largest channel and broadcast networks and you'll see that in the upper right hand corner. Cadena Tres was a previous customer of Orad something we are excited about in the business, that's a business we acquired last year. And this deal demonstrates our ability to leverage Orad’s channel and their network and installed base of customers to achieve a major cross sell of additional Avid products and increased wallet share by migrating them on to the MediaCentral platform and key solutions.
So by demonstrating to Cadena Tres that the Orad products can now operate on MediaCentral, it encourages them to get on the platform and buy additional products in Avid. The great deal hopefully more to come from that Orad base. Sky in the lower left probably a brand you've heard about, a large pan-European conglomerate, one of Europe's largest media companies, pay-TV satellite broadcasters.
Deutschland is, of course, they are German media business. This is an example of how we leverage the existing relationship with Sky and their previous adoption of the Avid solution set to update facilities and move them to the MediaCentral platform, a shared platform in order to help them create more efficiencies, improve their workflow, and add new capability to their production. We are meeting their needs at a much lower cost.
In lower right, another example going around the globe here back to the U.S., Fox is obviously a household name; it's one of the largest media companies in the U.S. and across the world. And in this case, we signed a multi-year enterprise-wide license agreement for key creative tools as part of the Avid Artist Suite that runs on the Avid MediaCentral platform. And this agreement covers a large majority of all U.S. based entities in the U.S. I mean for 20th Century Fox. So this is a really exciting time for us and for Fox and they are transforming their business just as we are and that's what made this a really nice partnership.
I am going to move on to the next slide now. And just highlight and explain some of the various initiatives that are driving the diversified growth strategy that we've talked about it. If you look at the upper left, and first on the left hand column, you'll see Tier 1, Tier 2, Tier 3. We talked about really having strategies to exploit each across the platform. This is starting to come with more clarity and more visibility. You'll see in the upper left, the Enterprise Deals. The industry is clearly in transition and is driving an increase in demand among our Tier 1 customers for large enterprise deals to drive efficiencies and to save money.
We have a robust pipeline of multi-year deals in transition and lots of interest in cloud host models which is just starting to emerge. So this is a key part of our strategy, is getting them on the platform and starting to bundle in many more products across the entire enterprise. We are seeing big receptivity here. Hopefully, we will close more of those deals going forward. You look down at the bottom, you'll see the Digital, this is more for Tier 2 and Tier 3. Our recent focus on improving our customer purchasing experience, making it easier for people to buy has had a pretty dramatic impact on our digital business.
Bookings are up 60% for the quarter and we are encouraged because this was an important part of our go-to-market strategy to penetrate deeper into Tier 3 customer segment, where we have such a large untapped opportunity. We basically are just making it easier to buy solutions from Avid in a digital way or through our digital partners. So they can seamlessly buy and just get right to work. And related to that you'll see the subscriptions, our subscription strategy continues to drive growth in Tier 3.
The cloud enabled subscribers are up for almost 4 times from Q2 of 2015, and so clients can now get the industry standard Artist Suite applications for one low monthly fee. This is a critical component of our Tier 3 strategy, because it creates a recurring revenue stream for customers are largely new to Avid and that's what's been happening so far. The majority of these clients are new to Avid.
So it's a huge advantage for us and I think over time, we also enjoy something that nobody else can offer and that is that it's not just the editor, it's not just the mixer, you can get the entire work flow from a storage archive augmented virtual reality sports graphics, all the capabilities you’ll need to offer a full cloud enabled package at an attractive subscription pricing over time. So this is an area that we will continue to lean into.
Looking [indiscernible] alliances. This is really a nation area, but it validates something very important. And this is where we certify third-party products on the platform and share economics with that third-party. We supply integrated interoperability and distribution and we've seen incredible enthusiasm from partners lining up to participate in the alliance program. It’s a very early days of the program, but I think we've on boarded a number of partners and the growth this quarter has validated the MediaCentral cross sell thesis.
As I indicated, the program can be a significant contributor of bookings we believe over time. And just as a reminder, we have now integrated hundreds of third-parties on to our platform, but we're only beginning to leverage our platform ecosystem by commercializing targeted alliances one by one. So there's really only a handful that we got started once they got certified to actively market and commercialize.
So we're talking about marketing and sales engagement, training et cetera and we've seen already enough list. So we're excited about what this can become again early days we recently announced the enhancement relationship with Adobe and which customers using Avid and Adobe can collaborate on an unprecedented level through a unique connector on MediaCentral platform.
So if you haven't worked in the industry you may not appreciate how mind-bending this is for somebody who is unlike a religious discussion as to which one you use to now not have to make that decision because you can both work together on the same file and collaborate at the same time via MediaCentral. So it takes away that point solution conversation allows you to open your mind to just embracing the entire Avid Everywhere suite.
This just won and many relationships are working on integrating the entire industry we just feel the industry is too fragmented we've talked about it. Now we can prove that this works and that's what's getting people more and more excited. And of course in the new products area all the way to the right, this is a key once you get people on the platform continue to layer on new products. We just have to get better and faster doing this.
Naturally in the second half of the year will be focused on the rollout of NEXIS the virtualized storage which is up sequentially. But we have lots of powerful new features towards the end of second quarter, which is going to open up different categories of the tiers and we believe will accelerate NEXIS.
There's important new MediaCentral features that we just launched new Sports [illustration] and graphic authoring product in time for the Olympics and another major event augmented in virtual reality enhancement, the steady stream of feature releases for Pro Tools, cloud collaboration other Artist Suite applications not to mention all the alliance is coming on Board.
So the platform benefits are really starting to come into focus come on full display. Long way to go but these are the things that are going to be driving our growth in the second half of the year and beyond.
So with that let me turn to the next page, Slide 11 here. I think overall we're on track to complete the transformation. If you look at the steps that we have laid out. We've completed the roll-off of non-marketed products. We've made great progress and on track for the optimization projects with the efficiency plans and then of course the amortization of pre-2011 deferred revenue in all material respects finish early next year.
So we're on track we have increased the efficiency program from $68 million to $76 million and you know this leaner more directed cost structure starting to emerge more clearly as we're finishing out these last steps. We've expanded our efficiency program really to just capitalize on the benefits of the shared services model. So as we're sharing more and more services. There's more and more costs that are freeing up and we can redeploy those in the higher growth areas and take some of the savings as well.
So the increase targeted savings that we've seen, we actually believe there may be even more next year for what we're seeing and this is a result of the product profitability and some of the analysis we're seeing from the platform itself. The industry is changing very rapidly we continue to adapt while we're executing our strategy and interesting time for everyone in the second half we are going to have a lot of work to do, we have to capitalize on our areas of strength, large enterprise deals, subscriptions, digital, alliances. We're going to respond with better execution in key areas like NEXIS virtualized storage, Orad, sports and graphics, live sound and audio areas.
And once the transformation is complete we’ll focus on platform growth, new products and new services, a shift to more recurring revenue and then continued efficiency gains without the burden of those revenue headwinds that we've been dealing with since the restatement. The results should be an improved in simpler economic expression as we move over.
So that's my update, now before I turn it over to Ilan, I want to remind you that Ilan has been serving as our Interim CFO over the last several months. While our CFO search is ongoing and we are meeting with the number of strong candidates, Ilan whose background includes financial and operational leadership roles including being a public company Chief Financial Officer.
He has been doing an excellent job for us and we're confident in his ability to continue effectively drive the finance function. At Avid while we take the necessary step to find the right permanent replacement. And you know we're taking a sufficient time because the next phase will be important, that will be more to growth oriented phase we want to make sure we get the right person.
So with that, Ilan please take us through the more detailed financial results.
Thank you, Louis, and good evening, everyone. Please turn to Slide 13, for an overview of our financial performance in the quarter. As Louis mentioned at the start of the call we exit second quarter revenue and adjusted EBITDA guidance and met guidance for bookings, adjusted free cash flow, and non-GAAP operating expenses. Booking came in at $106.7 million on a constant currency basis and $102.2 million on asset reported basis both within the range we provided on our last call.
Non-GAAP revenue of $134.4 million exceeded our guidance range of $105 million to $120 million. Recurring revenue performance was at the high end of our expectations. We also benefit from improved conversion of bookings and revenue backlog into revenue particularly in products in our Artist Suite as well as timing of revenue from some larger transactions.
The second quarter revenue included $15 million related to the continued benefit of releasing of Pro Tools version 12.5 late in Q1 and including the delivery of Cloud Collaboration to the market, as well as eliminating free support. However, even without the benefit of the Pro Tools conversion, we would have been at the top of the guidance range.
Adjusted EBITDA of $29.4 million also exceeded our guidance range which was $3 million to $9 million. This reflects the favorable impact of the higher revenue, stable material cost despite the growth in revenues as well as the impact of our cost efficiency program that Louis mentioned earlier in the call.
Adjusted free cash flow was the use of $30.2 million in the second quarter, close to the midpoint of our guidance range of an use of $27.5 million to $32.5 million. We expected the adjusted free cash flow would be used in the first half of the year and positive in the second half.
The first half of the year has seasonally high payments related to variable comp programs and trade shows. Also the first half has less benefit from our efficiency programs. Now that we are moving into H2, we expect to reap the benefits of those initiatives and generate positive cash flow. Later in the presentation, we will provide further detail on the factors that will drive positive free cash flow in the second half.
Turning now to the full Q2 financial results and our performance over time. As I mentioned, Q2 bookings were inline with guidance and they were up 1.5% on as reported LTM basis, reflecting our longer-term gross rent. On sequential basis, Q2 bookings also demonstrated positive momentum.
Reported booking were up 10.5% in the second quarter versus the first quarter of 2016, while constant currency booking were 8.8% over the same period. This was a broad based growth with a booking up across all customer tiers, geographics in most product lines.
We are excited about our performance in Q3 this quarter, which was up 13% year-over-year. Our individual cloud-embedded subscription booking were up 101% year-over-year and this contributed to strong digital bookings which were up 60% year-over-year. Our strategy and investment in this area including Cloud Collaboration to extend our platform into Q3 is converting into the strong bookings growth much of it from the net new customers.
We also encouraged to see bookings for our Alliance program gained traction this quarter, supporting growth across all customer tiers. This initiative is in its early stages, but we are optimistic that we will become significant contributor to growth as we expand customer Wallet Share, a cross-selling solution from extending the network of third-party partners.
As expected, on a year-over-year basis, bookings were down as a result of ongoing volatility in Tier 1 market, upward cycles and add new products and the slower start of some key products, which we expect to pick up in the second half of the year. We also had a difficult year-over-year comparison because of the many products we launched in Q2 2015.
Our Tier 1 markets in America and Europe have been mostly impacted by the industry transition. However, we number of potential Tier 1 deals in the pipeline. As Louis just highlighted, we signed some key deals with major media companies in the second quarter. We continue to grow the number of platform users in the mid double-digit and we are well positioned to expand our share of wallet through cross-selling and up-selling to our user base as we introduce new products and alliances.
With Avid Everywhere platform, we are uniquely positioned to meet the involving needs of large media companies. There are also areas that we believe have greater potential for growth and we have already taken steps to better position Avid for stronger performance in these areas in H2.
Storage grew sequentially in Q2 and we believe we can further accelerate growth in the second half. We needed to release the enhanced features for NEXIS, our virtualized shared storage solution that we delivered in Q2 and now we have award winning storage product and growing pipeline of deals.
We have also taken steps to improve performance of Orad including streamlining internal processes, increasing customer awareness. We received great feedback on the Orad graphic and sport products and we believe that would enhance execution with an accelerated growth in the second half.
And other key initiative in Q2 has been providing the S6L, our Live Sound Console model. Our S6L model has been breaking records and receiving really positive feedback. We believe with the future enhancement, we have introduced to the S6L. We have achieved similar success for this model.
Turning now to non-GAAP revenue performance. This was strong above guidance and up 22.4% over the same period in 2015. This goal was driven by strength in the recurring revenue as well as improved revenue backlog conversion. The higher conversion on backlog revenue and the revenue backlog are partially due to the product releases such as Media Composer version 8, Pro Tools version 12.5, and Sibelius version 8. This releases have eliminated the need to differ and then amortizes revenue over an extended period.
You will see a good portion of the year-on-year growth in the services category. In addition, our growth over the last year second quarter was assisted by Orad which is only in the result of one week last year. I will provide updated revenue guidance in a moment.
Non-GAAP gross margin increased from 60.7% last year to 67.1% in Q2 2016, representing an approximately 6.4 percentage point annual improvement. We made further progress with our cost efficiency program which continues to reduce our non-variable cost of sales on an organic basis. Margin expansion was also driven by the conversion of revenue backlog into revenue related to the release as I mentioned earlier, the most prominent being Pro Tools.
Our non-GAAP operating expenses for the quarter were $64.6 million, down 6% over Q2 2015. For comparison purposes, it's important to know that we acquired Orad at the end of Q2 2016. So there were only about $4 million more of operating expenses in the second quarter this year related to Orad. If you were to normalize Orad, our non-GAAP operating expenses will be lower by approximately 10% year-over-year. The decrease in our operating expenses has been driven by our cost efficiency program and I will provide more detail update later in the call.
Q2 adjusted EBITDA of $29.4 million was up significantly over the $1.4 million of adjusted EBITDA reported in Q2 2015, benefiting from strong revenue growth, effective cost controls and relatively flat material costs. On a sequential basis adjusted EBITDA was down in line with the sequential change in revenue.
Adjusted EBITDA margin was 21.9% for Q2 which is consistent with our full-year expectations for 2016 and up from 1.3% in the year ago period. Finally, adjusted free cash flow was a use of $30.2 million which is slightly improvement on last year and as I mentioned consistent with our expectation to use cash in the first half. We expect cash flow to be positive in the second half of the year.
Let me take a moment to update you on the progress that we are making with our efficiency program. As Louis mentioned earlier on the call, we are increasing our target of annualized efficiency gains from $68 million to $76 million. As a reminder, this figure represent annualized savings of our media 2015 run rate. We are on target to implement the majority of this efficiency gains in 2016, so that the cost savings will be largely reflected in our full-year 2017 results.
We have already implemented $57 million of annualized savings or almost 75% of the $76 million target as a result of the actions we have taken through June 2016. These cost savings are made possible by our platform strategy, the growing adoption, stability and maturity of the MediaCentral platform enable us to implement a more efficient operating model, because we can now share common technology tools across our portfolio and third-party products were able to reduce or eliminate the need for standalone Siloed processes and redundant workflows.
In addition, we are in the last phases of the talent alignment and facility rationalization projects designed to get the right people in the right places to best serve our market. Roughly two-thirds of our targeted savings are personal related and the remaining savings will be generated from rationalizing under facilities and optimizing third-parties understand.
Moving to Slide 16. Let me now update you on some of our balance sheet metrics. At the end of Q2, we had total liquidity of approximately $55 million including $50 million of cash. We expect to generate positive cash flow in the second half and have a strong liquidity position that will enable us to fund our investment program and complete our business transformation.
As of quarter end, our accounts receivables were $44.8 million, which was slightly above the level at the end of the Q1. DSO of 30 days were in line with the prior year quarter. Inventory was $53.9 million which is up quarter-over-quarter and as we being ramped up for our next generation storage solutions.
Revenue backlog was $465 million on June 30, versus $499 million at the end of Q1 a sequential decrease of $32 million, $8 million was related to pre-2011 and the balance was related to improve conversion of revenue backlog. I discussed earlier for the post 2010 periods.
On Slide 17, we have presented our Q3, 2016 financial guidance. We expect bookings between $100 million and $120 million on reported basis as compared to about $150 million in Q3, 2015. Constant currency bookings are expected to be between $105 million and $125 million as compared to $121 million that we reported in Q3, 2015.
Non-GAAP revenue is expected to be between $120 million and $135 million as compared to the $137 million reported last year. Non-GAAP operating expenses of $57 million to $62 million are expected to be approximately 9% to 16% lower than last year. We expect Q3, 2016 adjusted EBITDA to be between $21 million and $29 million as compared to $25 million in Q3, 2015.
Finally, we expect to move towards breakeven for adjusted free cash flow in Q3 with a range of $8 million use to a generation of $5 million. The primary bridging item for adjusted free cash flow for Q2, 2016 to Q3, 2016 guidance is our normal seasonality for spending a sequential improvement in booking and billings along for improved collection in the quarter as well as the benefit of overall lower spending due to our efficiency programs. As mentioned earlier and reflected in the full-year guidance we expect to begin generating a significant adjusted free cash flow in the fourth quarter of 2016.
Turning to the full-year on Slide 18. we are increasing our guidance for revenue and adjusted EBITDA. This reflects our expectation that we will sustain our improved rate of conversion booking into revenue. Adjusted EBITDA also will benefit from increased scope of our efficiency program that will enable us to realize incremental savings in 2016.
We're also improving our guidance range for non-GAAP operating expenses as a result of expand cost efficiency program. We are reaffirming the 2016 guidance for booking and adjusted free cash flow that we originally provided on March 15, 2016. The reaffirmation of our adjusted free cash flow guidance is based upon a number of factors including but not limited to. The strengthening of Tier-1 and Tier-2 markets including anticipated acceleration of sales of NEXIS, Orad and Audio.
A small number of large enterprise deals in the second half of the year most likely in Q4. Successful results from our growth initiatives around cross selling products from our new alliances partnerships, traditional end of year buying seasonality and successful execution of our efficiency program.
Before handling the call back to Louis. Let me walk you through the factors that bridge transitioned from a user of cash in the first half of 2016 to a generator of cash in the second half of 2016. At the midpoint of our guidance range we expect seasonality to contribute approximately $20 million of incremental cash flow.
Our second half bookings are typically higher than the first half reflecting customer buying patterns. In addition we typically have lower spending in H2 versus H1 because of the timing of factors such as tradeshow, taxes viable compensation payouts. Our cost efficiency program another cash management efforts will primarily drive our position to positive cash flow generation and it is expected to contribute of approximately $37 million in incremental cash flow in the second half versus the first half.
At the midpoint of our guidance range. In addition, to the efficiency program measure we have previously – that we have previously outlined we will benefit from improved cash management and more favorable bookings mix as we receive early payment on multi-year deals. Our cash profile in the second half of 2016 also will benefit from our pipeline of new products and larger enterprise deals I mentioned earlier.
We expect to continue generating strong growth in individual subscription and through Alliances. We also expect stronger growth in the second half from key products such as NEXIS, Orad, and Audio products. We expect these measures to contribute approximately $30 million of incremental cash flow in H2 versus H1 at the midpoint of our guidance range.
I'll now turn it back to Louis for some closing remarks. Louis?
Thanks, Ilan. Now wrap things up on in the final slide, Slide 21. Our Q2 results achieved or exceeded our guidance expectations. We have some key milestones to achieve for the second half of the year as you heard us discuss. We’re also very focused on achieving our cost and cash goals for the second half and fully realizing the benefits of the steps that we've been taking.
The end of the transformation is targeted for a few quarters away, and we remain very focused on the improved financial profile that we've laid out and moving on to the growth phase.
Operator, with that we’ll be happy to entertain questions.
Thank you. [Operator Instructions] And we go first to Steven Frankel with Dougherty.
Good afternoon, Louis. A couple questions, can we walk through again the pull down of deferred revenue on Pro Tools. How much was in the quarter and why was it done in two phases some in Q1 and more in Q2? And is there any more that might come between now and the end of the year from Pro Tools were another one of your key products?
Absolutely. Ilan, do you want to take the first stab at that. First, let me explain Steve that it's the software releases and the required accounting as a result of previously deferred items that we have to now book in the current quarter as required revenue booking and that is not just for Pro Tools, but Pro Tools is the most significant piece. And Ilan could you get in the total amount I think it was $15 million and then comment on the future period impact.
Yes, sure. So that the reason – so in the second quarter we recognized around $15 million and in the first quarter we recognized around $18 million. There are two reasons of the additional revenue that we recognized. In the first quarter, we recognized because of the new feature that we launched and also because of the PCS. And because we launched this product at the end of the quarter, it had minimum effect in the first quarter. In the second quarter, we had the full effect of the PCS conversion and this is the $15 million that we recognized.
And just to be clear was that $15 million annual revenue guidance for the quarter or this is what really drove the upside relative to your guidance for the quarter?
A portion of it was in our guidance. It was higher than we expected. And again the booking – when we book the transaction it's a good booking, it's a contract that we have, the accounting required us to defer over time depending on certain releases as those releases get released then we have to properly record the revenue in accordance with GAAP and that required us to take revenues that had been deferred and book it in the previous quarter. In the current quarter, we had built some of that into our revenue guidance, but it ended up being higher than we expected. And so that's why we wanted to highlight it even if you took all of it the $15 million impact that average still be at the high end of our guidance
Should we think about something similar that’s happening in the back half of the year as well across other product lines?
So we've provided the guidance for the full-year and we already incorporated the updated revenue for this – for the Pro Tools and other products?
Well, I guess what I’m getting at is that these events boost your gross margins and so trying to figure out from here. Is there something similar to this that’s going to keep gross margins at these levels? Or do gross margins now come down because the 100% margin revenue isn't there.
I think what he's saying is we’ve factored that into the overall guidance for the year. And it's mostly going to have an impact on future years. And if you look at our multiyear guidance which we're not commenting on now, but I think if you look at our kind of longer-term, we don't see any change in what we’d expect longer-term. We'll have to work through this deferral and then realization based on releases that we have.
And of course going forward, now that we're more aware of how to handle these releases. I would expect that you may not have a dislocation occurring, but for now Steve, if you look at the full-year guidance that is factored in any other such revenue that we believe will have to recognize based on releases that we have planned throughout the end of the year.
And let me switch gears to bookings, what were product bookings in the quarter and what did they do sequentially?
So product bookings were $41.2 million.
So that's down like $12 million sequentially, one would have thought that was NEXIS, it would have a sequential increase in product bookings, what's going on elsewhere to leave that number down.
So I think overall you're seeing subscriptions on the point solutions increase and I think in general Steve, before we got here you saw a pressure on point solutions. I think any vendor – if you look at the results of most vendors this is what we're seeing in the market. If you're going in with just a point solution, you're getting squeezed pretty hard and we certainly see that when we just have a point solution. What's happening on our Tier 1 business is we're bringing in MediaCentral that doing both the overall deal value and making up for the pricing pressure on point solutions. And in Tier 3 it's really converting over to a subscription in general.
And so I think you'll see as we shift to a more recurring revenue, you’ll see that services line go up. Now this quarter that services line was boosted by that $15 million a portion of which we expected and a portion which we didn’t, but if you strip that out and look at it – if you look at maintenance and subscription you'll see that that line will continue to grow and I think you should expect that to happen in product as a standalone to be under pressure except for NEXIS, because large clients still even though were fully cloud enabled for storage, we're still seeing a significant interest in an on-premise storage, even though we're seeing an interest in everything else moving to the cloud.
NEXIS had some key features that needed to be added in Q2 for the large enterprise deployment. You saw a nice increase quarter-over-quarter. I think you'll see that begin to accelerate as people work through their transition to NEXIS away from ISIS. It’s more powerful. It's purely software defined. It has a much lower cost to hardware component and it's been independent hardware component which shows the direction we're going and it's cheaper.
So we're getting some very strong receptivity once these features came out late in the quarter. I think you'll see that. We expect that to continue to increase. You'll see that product area go up their product line and go up, but in general I think in the industry Steve, any time you have somebody coming with a point product solution that's on-prem, they're probably seeing a lot of pricing pressure. We luckily have the enterprise model which can save money by buying more from us and then down in Tier 3, it's the subscriptions which are really [blowing] our results.
Okay. And then let's talk about the hockey stick, in the last few quarters you talked about kind of pressure at the end of the quarter, customers or you walking away from the table on deals. Give us an update on what’s your close rates looks like these days?
I think overall we have a very strong close rate; the problem is a high percentage of deals that are still closing in the last week or so and that's having the impact on our cash. So if you look at the conversion of cash to bookings in this quarter put aside those product release issues. We don't have the highest that the cash conversion we would like and that's in part due to these larger deals that are getting pushed to the very end of the quarter.
The good news is we're signing them at a much higher rate than early in the Avid cycles, so we're closing mostly the deals we want to close. I think people have learned, we're not going to budge on price and really the main impact now is to move the linearity early in the quarter, so we get the cash conversion faster. We're also looking at adjusting some of our cash policies to get more of that cash upfront instead of on a net 30 basis which we normally do today.
And so I would say that – the good news is we're signing more, the bad news they're still late in the quarter. And so if you think about the amount of deals we signed in the last quarter, which we don't disclosed, but it's quite significant. You might have been worried about the quarter from a booking perspective if you knew what we are looking at, but in fact small deals were committed deals just racing to the finish and people trying to negotiate at the end. We wouldn't give on price. We got the prices we wanted and a portion of the cash doesn't come in for net 30 days, so we're going to get a lot of cash coming in right after. And I suspect this will continue.
What I also believe is that once you get into the cross selling mode there's not pressured into quarter, but because a lot of our big clients are just adopting larger enterprise deals and I would say the majority of my time has been a pretty dramatic shift from last year right now most of my time is just working with the team on these larger enterprise deals. Because there are deals we haven't done before the only example we have is Sinclair and everyone slightly different that’s why we closed a few here in the second half.
And then could you break the debt down for me. How much are you - where are you on the line of credit and remind us how much that is for and then what's the convert balance at the end of Q2?
Absolutely. Let me guys take that Ilan and Robert one of you guys want to fill in there.
Well we're waiting for that Louis maybe give us an update on what the pipeline looks like for more Sinclair type deal. So large customers converting to more of a recurring revenue focus with you.
Thanks Steve. And Ilan are you tracking that we are not in the same room. So are you tracking that down? Okay, yes so I think the biggest shift two things have really happened and if you would have to talk to me six to 12 months ago two things I would have said is if we're interested in enterprise licensing and they were slightly interested in hearing about our cloud strategy mainly on point solutions like our Artist Suite.
Today there's been I don't know what happened but there's been a pretty dramatic shift. Almost everybody wants to talk about enterprise pricing, which is a pretty dramatic shift. So if you're going from you know paying $10 for a $1 each for – or $10 to 10 people to use a product $10 dollars for 10 people use a different product and $10 for 10 people to use a different product. Three different products from Avid each $10 for 10 different people to use it.
Now they want to say how much would it cost all 30 of our people in the whole place used all your products and this is an attempt to get the unit cost down on a per capita basis and what it means is they're going to have to eliminate other vendors. I think the advantage we have that I mention is we don't just have point solution products but we can actually give you the most comprehensive I can give you sports graphics, we can give you augmented virtual, we can give you creative tool storage, we can give you archive and play out something very few people can do. That's number one.
Number two, then want to talk about cloud as a way to save further money, so they want a enterprise wide license discussion to drive their unit cost down and then they want to see a posting pieces of it on the cloud will drive down their cost even further and those two things are probably the biggest accelerant in the last couple of quarters and it really overwhelmed my conversations with large client.
So we have a rapidly growing large enterprise deal pipeline. A couple problems to temper any excitement is number one Avid doesn't have a sustainable engine yet to process these easily. So right now we're kind of doing them one off with the executive team leading kind of the top 10 deals right now. I'm hoping that over time will have shifted our sales force in our go to market. So they were more ready to have those conversations in a cookie cutter mode than we are today and it's something we're pretty rapidly working on.
Right now Steve we are expecting to close a few large deals nothing Sinclair like but that's not what's built into our guidance but we are assuming we will close a few large enterprise deals in the second half of the year and those are active discussions right now. I don't know which or if or when but they're definitely targeted to close this year and they're pretty aggressive right now.
Ilan and Robert again you guys have those debt numbers.
Yes, so the overall long-term debt is $188 million of that the loan is $98 million and the convertible is around $89 million and we are not using any reversal.
Okay. Thank you. Ilan, how big was the revolver?
Great. Thank you. I will let somebody else ask some questions.
Thanks a lot of Steve.
We will go to Hamed Khorsand of BWS Financial.
Hi, just I guess the first question. Your boosting revenue a bit that you’re talking about lower cost exiting the year. But you are not changing your free cash flow guidance. Why is that?
Well, there is a few things we have to factor in on the free cash flow. First of all this quarter that we're in right now Q3, we're hoping to get through a breakeven. That's a pretty dramatic improvement from a cash usage of $30 million in Q2. And then that would mean we’re going to have a pretty significant increase in cash in Q4. And so I think this quarter will be a big validation point if we can shift from a negative 30 to a positive dollar or anything close to breakeven which is what our guidance is targeting.
And then in Q4, it's really the cash conversion. There is two things happening that we have to be careful of. One, the linearity of closing deals late in the quarter was such a big quarter, we didn't want to assume an over cash conversion. Two, a higher percentage recurring revenue, if we continue to see those subscriptions surge more of it is going to be cash comes over the period of the contract as opposed to upfront.
And then the biggest comfort as you saw was the cash and cost initiatives and that's about a $37 million anticipated benefit to cash, that's where we have the most comfort. The second most comfort – is that third most comfort I guess comes from the strategic initiatives and the second is the normal seasonality which can have some linearity issues. So when we factored all that in we wanted to make sure we had a chance to achieve it and didn't overreach and that's why we didn't adjust the bookings in there I mean the free cash flow and there is some work to get there and that's why we left that alone.
How much NEXIS revenue we should recognize in the quarter?
We don't break out any individual product, but it did increase sequentially.
So the point I'm trying to get to is that, in the press release you're talking about the percentage of bookings being 32% on recurring revenue. In Q1 it was 34% right, so obviously something diluted that. And from your commentary it seems like the only thing that could dilute that is NEXIS.
If you look at the digital sales number, up 60% compared to the subscriptions just to give you one example of other things that could impact it. You'll see that the subscriptions were up much more significantly. And what we're seeing in the Tier 3 areas individual products sales are under more pressure, that's been made up by digital sales, which is up 60%, but if you compare that to subscriptions is as much faster.
So your product sales I think across every dimension is dropping in the industry because of the pricing pressure, unless you can offer something else like a subscription on a point solution that shift the CapEx to OpEx and increase interoperability or in our Tier 1, the big advantage we have is really Avid MediaCentral, that’s the thing that’s causing everybody to willing to pay value because they're such savings.
So I think what you're going to continue to see as I was mentioning to Steve is this switch on the Tier 3 between subscription for our product. And then Tier 1, if it’s just an individual products sale, there is probably a lot of pricing pressure and that's what we're seeing more interest in the large enterprise deals because that's where you're really going to save money. Otherwise, the only way to save money as a client is to drive down vendors on individual product items. And I think that's that dynamic that you're seeing Hamed and I know there's a couple moving parts there, but those are the dynamics that we're seeing today.
Okay. My last question is related to the business climate. Obviously, you're seeing some increased spending right now. Is that really associated with just the business climate just changing last couple of quarters? I mean is it sustainable or you seeing anything different?
I think we're seeing a few things, number one, content is going crazy. It's actually accelerating, so more competition, that's good news. Distribution format is getting worse that’s costing our clients money. Optimizing value is becoming more intense because the yield curve is steeper, that means the long tail is more costly and so people are – you really only need to bet on winners because you can't really make money. So that's the dynamic.
So what does that mean for budget? Budgets are going up 3% to 4% from our last research, which we update periodically. And so the challenges for 3% increase in budget, increase your content by 400% and your channels and devices by 1000% and still make money.
And that's the challenge our clients have and that's why I think you're seeing everybody in the Tier 1 move to enterprise pricing in cloud. And while you're seeing in the down market, people move to subscription away from the inability to keep up to date with all the changes on point solution products. And if you're going to have a point solution, they wanted almost free.
I mean they're really – I didn't mention our first product that's also surging on us and our conversion rates are nice there, but that's the reality of the market. So is it sustainable? You have people like Netflix outspending and the largest media companies in the world on purchase content. They have – I don't know how much is public on them, but many, many scripted new shows, major motion films, a lot of competition and that's forcing everybody to want to drive down costs and I think that is going to continue.
And I think long-term either the cloud providers with a lower cost platform that's on the one end of the competition and point solution providers are I think that is going to keep see pricing pressure, it’s going to be a race to the [indiscernible]. If that's all you're living off of a single point solution product at least in my client base.
And I think that's the reality that I see. I think the spending is sustainable, but you've got to demonstrate value in ROI selling is stronger now than any time I've been in here. Luckily, we have the platform that that's emerging as the thing that can really drive a lot of cost savings for our clients.
Okay. Thank you.
And we will go now back to Steven Frankel.
Just to double check, so that Pro Tools $18 million that shows up in the maintenance and subscription line in terms of revenue whenever that goes into product?
Mostly. Yes, mostly.
Again mostly, so it’s in both?
Yes. So it’s within both.
Could you help us understand what the relative contribution…
The great majority is in the second line of services and product, I'm trying to get that past. It's in the maintenance and subscription line, is that correct Ilan. Okay, the majority. Maybe not the great majority is that right?
Yes. The majority, but not – it’s not like – there is no big difference between the two lines to the majority on the project.
Okay. Great. Thank you.
End of Q&A
And with no further questions, I’ll turn the call back to Mr. Robert Roose for closing remarks.
Thank you, and thank you everyone for joining our call today. We look forward to connecting with many of you very soon.
This concludes our conference. Thank you for your participation.
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