Avid Technology, Inc. (NASDAQ:AVID) Q3 2018 Results Earnings Conference Call November 7, 2018 5:00 PM ET
Dean Ridlon - Vice President of IR
Jeff Rosica - President and CEO
Ken Gayron - EVP and CFO
Steven Frankel - Dougherty and Company
Vahid Khorsand - BWS Financial
Good day, and welcome to the Avid Q3 Earnings Conference Call. Today’s conference is being recorded.
At this time, I would like to turn the conference over to Dean Ridlon. Please go ahead, sir.
Thank you, Operator, and good evening, everyone. I am Dean Ridlon, Vice President of Investor Relations at Avid Technology. Welcome to our Q3 2018 earnings call. With me today are Jeff Rosica, Avid’s CEO and President; and Ken Gayron, Avid’s Executive Vice President and Chief Financial Officer.
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 tables to our press release and in the supplemental financial and operational datasheet available on the Investor Relations section of our website.
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. 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 we laid on this call speaks only as of this date, and we undertake no obligation to update the 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 2017 Annual Report on Form 10-K available from the SEC, the Avid Technology website or 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 available as a replay for a limited time. You may replay this conference call and access the supplemental presentation by going to 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'd like to turn the call over to Jeff.
Thank you, Dean, and thanks to everyone for joining us today for Avid's third quarter results call.
My prepared remarks primarily focus on our third quarter performance. Next week we are hosting our 2018 Investor Day event in new York where Avid's management team will provide better details by the Avid's strategy going forward, and the opportunity that we see.
Along with Ken and me, our leaders for products, marketing and sales will review how their functions are sharpening our overall operational performance, while increasing execution and how our work would translate into improvement in Avid's financial results.
We will also host a couple of panel fashions featuring participations from some of our largest customers and strategic partners that hopefully will bring an additional dimension of valuable insights. Our CFO, Ken Gayron, will provide a reminder about our Investor Day later on during this call. So before Ken get's started, let me get some of the details behind our Q3 results. I'd like to offer my own observations on the quarter and looking forward to Q4 and 2019. So let's get started.
Avid's new management team is hard at work. We're continuing to sharpen our strategy and making the needed operational refinements to enhance our business and deliver better financial results. One indicator of success can be seen in how we've been moving our business more towards software and subscriptions which are contributing to a steady increase in recurring revenue.
We're also continuing to see strong growth in subscriptions and other key strategic elements of our business that represent a significant contribution to our revenue and more importantly to our bottom line.
Another indicator is our initial progress in establishing the necessary operational improvements that we've begun to make so that our business functions run more efficiently and at a lower cost, which is part of the $20 million internal operational efficiency initiative discussed on our last earnings call.
We're encouraged by the improvement in our income statement during Q3 as it shows the implementation of our planning is beginning to yield results. That said, it remains clear to us that we have more work to do to return Avid to consistent revenue growth and generate stronger free cash flow.
Before Ken reviews the financials, let me add a bit of color to highlight the areas where we're making progress but also reflect on the areas where we need further improvement. Our booking saw a double digit increase versus the same quarter last year and we're also up sequentially driven by continued success in our signing additional long-term agreements in the quarter, including one with one of our key channel partners.
Q3 was our seventh consecutive quarter of delivering year-over-year bookings growth excluding greater China in each of those quarters. This has helped us to increase our backlog, to improve long-term revenue visibility, and build a better foundation to support future growth.
Our third quarter revenue was down slightly year-over-year but up sequentially. While there were several positive elements of our revenue performance in the quarter and we did continue to show sequential improvement, there was a couple of areas where downward pressure kept us from delivering growth from a year-on-year perspective.
We continue to see strong revenue growth from the software subscriptions which were largely driven by our growing e-commerce business. We also benefited from ongoing strength in revenues from our storage business which is continuing to perform well and we saw nice growth in our graphics business. We're also pleased that recurring revenue and annual contract value continued to increase. These are strategically important metrics for us as they enhance the visibility and the predictability of our business.
While our Tier 1 enterprise business does continue to show an improving trend, we expect its recovery to be a bit lumpy and as such we did experience weaker performance in that segment of our business in the quarter which was down on a year-over-year basis. Nevertheless, we're encouraged by the recent trends and the strength of our pipeline and expect further improvement in this business in Q4.
Next, although revenue for MediaCentral in Q3 was down year-over-year, it was up sequentially by nearly 90% due to the July release of the next generation platform and the Cloud UX. Over the coming quarters we expect that MediaCentral enterprise software suite to continue to improve its contribution to revenue as more customers take delivery and we continue to roll out key software updates planned for later this year and through the first half of 2019.
Now moving to our audio products. While our Pro Tools software continued to perform well and live sound is improving with the release of the first wave of key new product line extensions, supply headwinds did constrain Pro Audio hardware revenue in the quarter. We have already remedied this component supply issue going into Q4 and do not expect it to be a major constraint this quarter or going forward.
With the new leadership team we've brought in to drive our supply chain improvements and as we move to our new supply chain model with our new vendor, we expect these kind of issues to be minimized in the future.
Lastly, our maintenance revenues in the quarter were down as customers continued to shift from perpetual licenses to subscriptions. However, our perpetual revenue line is now stabilizing due to renewed growth in MediaCentral, and as a result we expect our maintenance revenues to stabilize in 2019. Our gross margins increased again this quarter reflecting the third consecutive quarter of sequential improvement driven primarily by better hardware margins.
This is starting to show the benefits of the changes we're making to our pricing and discounting policies, as well as initial contributions from our operational efficiency initiatives. This improvement in gross margins was in spite of downward pressure from our professional services business. I want to emphasize that we're continuing to make improvements to ensure a better margin profile for professional services in the future though it will take some time for those changes to become apparent in our reported financials.
We saw a nice year-over-year reduction in OpEx during the quarter, largely driven by early benefits from the initiatives we began earlier this year as part of our operational efficiency program. The increase in gross margin and the reduced OpEx resulted in the expansion of adjusted EBITDA margin, which was up nicely both year-over-year and sequentially.
Now admittedly EBITDA to free cash flow conversion was poor in the third quarter. Free cash flow was negatively impacted by changes in working capital and the timing of billings and collections. While free cash flow underperformed in the quarter, we do expect strong positive cash flow generation in Q4, which is expected to drive overall positive cash flow for the full year.
Let me now take a couple of minutes to highlight some of the Management team's priorities for the fourth quarter and going forward into 2019. Then I'll turn the call over to Ken, to review our Q3 results in detail.
First, as mentioned earlier, returning Avid to revenue growth and improving free cash flow are among our Management team's highest priorities, and we're focused on a number of areas to help enable this. We're continuing with our strategy to sign long-term agreements with our major customers and key partners, as well as expanding our high margin subscription based offerings during 2019, to help drive growth in both our recurring revenue and ACV.
We're placing heavy emphasis on prioritizing our product roadmaps to deliver the best risk adjusted returns and further optimize our go-to market efforts to maximize growth opportunities in the near-term not just long-term. An example of this was the recent launch of our new live sound consoles that began shipping at the end of September, and that we believe will have strong uptake and favorable margins which should possibly impact Q4.
In fact we have a number of development programs underway that we believe will make significant contributions as they are launched in Q4 and throughout 2019. We will continue to make strategic and smart R&D investments that will further reinforce our unique differentiation and deepen the value of Avid with the buyers and users of our solution.
We're also maintaining our strong focus in quick execution on delivering the $20 million in annual cost savings through our internal operational efficiency initiative. And lastly to strengthen Avid's ability to achieve our business objectives, we'll be working to establish a more prudent long-term capital structure, being aware that our convertible bonds mature in June 2020.
However, at this time we won't be making further comments or sharing our plans to address this as we obviously want to obtain the best outcome for our shareholders. So based on the progress we've been making in these areas, combined with the strengthening performance we are achieving across our operations, we remain confident in our ability to deliver growth, to improve adjusted EBITDA, and deliver better free cash flow conversion.
So now I'll hand the call over to Ken.
Thank you, Jeff, and good afternoon everyone.
As Jeff outlined earlier, we are making progress on our initiatives to improve our financial performance. There were a number of proof points in this quarter's results that are evident that these efforts are starting to payoff. We have more work to do while we're headed in the right direction. Let's now get into the details.
Q3 saw another quarter of bookings growth. Revenue was relatively in line with last year, while gross margin and adjusted EBITDA were ahead. Our cash flow was negative in the quarter due to working capital and the timing of billings and collections. Bookings were $119.4 million, an increase of 16% year-over-year and 8% sequentially. This growth was primarily driven by the signing of strategic purchase agreements with our larger resellers and enterprises.
Revenue was $104 million for the quarter, down 1% year-over-year but up 6% sequentially. We continue to see good growth in our e-commerce and subscription businesses. We also saw progress in MediaCentral license revenue, which grew sequentially with the release of the new version in July.
Storage was solid again this quarter and we were pleased by favorable results in graphics. As Jeff mentioned earlier, audio revenues primarily from Pro Tools related hardware were constrained due to a component supply issue. The situation has been improving and we expect supply to return to needed levels in Q4.
Excluding non-cash revenue, revenue was $102.5 million in Q3, roughly flat year-over-year and up 6% sequentially. Non-cash revenue includes software products that have been recognized on our outlook basis over many years under old revenue recognition standards even though we've collected the cash prior to 2016. The impact of non-cash revenue was approximately $1.5 million in Q3, 2018, down from $2.2 million in Q3, 2017.
Non-GAAP gross margin was 50% for the quarter, up 100 basis points year-over-year and up 110 basis points sequentially. We continue to see good margins for software in our Integrated Solutions like storage that contain high value, high margin software.
Our hardware margins were up 600 basis points year-over-year this quarter due to continued growth of our storage business an improvement in our high margin graphics business. Our margins on professional services this quarter again adversely impacted overall gross margins. We remain focused on making improvements in professional services and have taken some actions to help drive better performance.
Also in conjunction with moving to our new supply chain vendor, we have identified areas of opportunity including items like freight, logistics and raw material pricing that we expect to result in gross margin improvement as we move into 2019.
Non-GAAP operating expenses for the quarter were $50.8 million down $3 million from Q3, 2017. The improvement in operating expenses resulted from $1 million related to our operational efficiency initiatives, $1 million related to a reduction in litigation expenses and other G&A improvement.
Adjusted EBITDA was $14.6 million for the quarter, adjusted EBITDA margin was up 300 basis points year-over-year and sequentially was up 866 basis points. However, the improvement in adjusted EBITDA did not result in improved free cash flow which was negative $6.4 million in Q3 largely due to working capital and the timing of billings and collections.
During the quarter, we had more billings in the second half of the quarter which resulted in an increase in accounts receivable at September 30, 2018. Also our deferred revenue decreased during the quarter largely due to the timing of our maintenance billings which is at our seasonal low point in the third quarter plus recognition of $3.5 million in revenue from one large enterprise deal where cash was collected at the end of June.
We expect working capital to reverse in Q4 and be a strong source of cash as we collect receivables on the opening balance sheet in Q4 and build our deferred revenue balance during the quarter. As deferred revenue generally increases in the fourth quarter as we build a significant portion of our annual maintenance contract early in the fourth quarter and collect cash that exceeds the revenue recognized in the quarter. We remain confident in generating strong free cash flow in Q4 and we expect positive cash flow for the full 2018 year end.
Now moving to the balance sheet, as of September 30, 2018 we had $50.5 million of cash. This balance excludes the $8.5 million letter of credit issued in the first quarter in favor of one of our supply chain vendors as reflected as restricted cash. We expect the restricted cash to come back as unrestricted cash in the second quarter of 2019 as we’ll be making the transition to a new supply chain vendor at that time.
We ended Q3 at $51 million of accounts receivable up $3.3 million from June 30. Our billings pattern in Q3 cause an increase in accounts receivable and adversely impacted cash flow and working capital, but with the larger opening balance we expect to see stronger cash flow in Q4. Inventory was relatively flat sequentially where we continue to expect to see an increase in Q4 due to some planned new product releases and supply chain vendor transitions.
Deferred revenue was $88.2 million at September 30 down $9.5 million from the balance at June 30. Moving forward we expect deferred revenue to increase in Q4, 2018 similar to the historical patterns as we build significant portion of our annual maintenance revenue in the fourth quarter and collect cash that exceeds the revenue recognized in the quarter.
Contractually committed backlog was $370.9 million at September 30 and has grown by $78 million or 26% over the past year. Our backlog is a significant asset and we remain focused on continuing to harvest it to contribute to revenue, EBITDA and cash.
At the end of Q3 long-term debt was $229.4 million roughly flat with the balance at June 30. We were compliant with our leverage covenant ratio at the end of Q3 and have significant cushion with our required covenants.
For those of you who were with us on the Q2 call you saw that we introduced these new revenue categories to provide a more detailed view into Avid’s revenue streams that better aligns with our business strategy today.
Through the first nine months of 2018 revenue from software licenses and maintenance which includes both subscription and professional licenses was more than half of our revenue. We expect this category to continue to grow modestly and produce software margins of 80% plus.
Roughly 40% of revenue comes from our integrated hardware solutions. These solutions which combine hardware with high value, high-margin software generate attractive margins. Again we were pleased to see a strong improvement in our hardware margin of 600 basis points year-over-year driven by the growth of our storage graphics and service business.
The balance of our revenues comes from our services business which is the small portion of our revenue, where we are driving programs internally to increase the margin contribution moving forward. We expect to start using this presentation in our filings with the SEC starting next year which will provide a better view into our business and strategy moving forward.
Now on to recurring revenue, we introduced this graph last quarter to show the percentage of recurring and nonrecurring revenue for each period. As you can see the percentage of our revenue that is recurring has steadily increased providing us with more confidence in the predictability of our business. This quarter 60% of our total revenue is recurring up from 50% in Q3, 2017. We expect recurring revenue to continue to increase over time given the growth we're seeing in our subscription in our long-term agreements.
Turning to annual contract value, this graph shows our ACV has also steadily increased. ACV has grown by 12% year-over-year driven from our strategy focus on higher margin software subscription and long-term agreements. We expect to see continued growth in ACV over time given our strategy and our improving pipeline. The consistent increases in both recurring revenue and ACV are important metrics to us and provide visibility and confidence as a management team as we move forward.
With that review of Q3 now let's turn to guidance. Although we have more work to do, we are pleased with the progress we're making including seven quarters of consecutive year-over-year bookings growth, three quarters of sequential non-GAAP gross margin improvement and early proof points that are $20 million internal operational initiatives are helping to lower our operating expenses.
In Q4, we expect to return to year-over-year revenue growth for the first time since the second quarter of 2016 which should be a positive catalyst to our business and financial results. At this time, we are providing the following updated guidance for the full-year 2018. We are reaffirming our revenue guidance of $410 million to $420 million which is the same range we provided last quarter.
Our adjusted EBITDA guidance is $40 million to $46 million which is also the same range we provided last quarter. We have narrowed and tightened the range for free cash flow which is now expected to be between $2 million and $6 million for the year from $4 million to $12 million as we expect to make an investment in inventory in the fourth quarter to help facilitate the transition to a new supply chain vendor.
We expect this transition to result in $6 million of annual saving beginning in the third quarter of 2019. So believe this one time working capital investment will deliver significant cash savings in the next year.
Lastly I wanted to invite you to attend our 2018 Investor Day that is happening next Wednesday, November 14 at 10 AM Eastern at the Westin Grand Central on 42nd Street, New York. Jeff, myself and other senior leaders from Avid will be doing a deep dive into our business strategy, our products and go to market initiatives.
We’ll also have a customer and partner panel to provide a better sense of issues that face many of our customers, what are new opportunities for growth, and how partners are creating competitive advantages for the media entertainment industry. Finally I'll be providing our 2019 guidance an overview of our operating model through 2020/2021.
We believe all of this information will provide you with a better view into our business and show you why Avid is compelling investment in today's market. If you like to attend please RSVP to our VP of Investor Relations Dean Ridlon, whose contact information is included in our press release. We look forward to hopefully seeing many of you next week.
With that, I would like to turn the call back to Dean.
Thank you, Jeff and Ken. That concludes our prepared remarks and we are now happy to take your questions. Operator, please go ahead.
[Operator Instructions] We'll take our first question from Steven Frankel with Dougherty and Company.
So on these long-term agreements, how do we get comfortable that this isn't a trade-off of visibility for gross margin? The customer's incentive is to lock in the best price as possible and therefore that's just another headwind on your path to gross margin improvement?
Well, I would say Steve, we believe walking into long-term agreements is the right strategy. It's delivering growing recurring revenue and ACV. And then on the gross margin point you'll see that our gross margins over the last three quarters on non-GAAP have been increasing, which is positive. And you'll see that our EBITDA margin this quarter is moving in the right direction.
We feel very positive that our gross margins are going to continue to improve as we move into 2019. And based on some of the factors in terms of moving to the supply chain vendor, which we believe will have $6 million of annual savings and will continue to move people to higher margin software products that will drive gross margin.
And finally our integrated hardware solutions were up 600 basis points. So we feel those elements in terms of giving us comfort that gross margins are heading the right direction and then EBITDA margins are heading the right direction, provides us confidence that entering into a long-term agreement is the right strategy for the Company.
And can you give us a little more detail on the component issues that you faced in the audio business? Specifically what components and is this an industry problem or just an Avid supply chain specific problem that you are dealing with?
So we won't name the name, we won't name the supplier. We prefer not to do that but it is - it was a single-chip and it was an industry wide issue that got resolved rather quickly within the quarter but did put some constraint on us.
We still ship the lot in the area but it did constrain us and we did take some backlog into Q4. So it wasn't sure why the issue again, I don't really want to name the supplier but it's now gotten resolved and we feel comfortable that right now the all indications are we'll be at the needed level supply during Q4.
Was Q3 just that much more backend loaded than normal to lead to these working capital issues?
Yes. So on the receivable side you'll see that we have more billings in the second-half of the quarter as a result the accounts receivable balance is up. So that drove part of the working capital change. And then just generally Steven, our maintenance business Q3 seasonal low point and we read that in Q4 bill. Hardware and maintenance contracts in Q4 in front of cash ahead of revenue. So deferred revenue then declined in Q3 then builds in Q4.
So those working capital elements impacted cash flow but we're positively driving this strong free cash flow in Q4 and end the year with positive free cash flow within our guidance range.
And what's normal seasonality or linearity in a normal Q3?
In terms of billings roughly - our billings in the month are roughly 25%, 35% and then 45%. We had roughly a 10 point change in terms of the last month of billings. So it was roughly 55% in September 2018. So as a result we built a higher receivable balance in the quarter due to most of those billings coming in September. And that will be collected in Q4.
And do you feel like you have the business positioned to generate materially higher amount of free cash flow next year?
Yes, I would say first we have strong confidence that we’ll return to growth. The non-cash revenue elements that occurred in 2017 and also affected 2016 it impacted 2018 to a degree are moving away. So non-cash revenue is not a factor. We see improvements in gross margins, improvements in EBITDA margins from the $20 million of operational initiatives that are well underway.
So all those impacts will drive higher EBITDA margins and the supply chain transition will also improve working capital once its completed we think we believe we can operate the business with lower levels of inventory. So all those elements will lead us to believe that free cash flow will be significantly improved in 2019 and we’ll be delighted to share that with you at our Analyst Day next week.
[Operator Instructions] We'll take our next question from Vahid Khorsand with BWS Financial.
First question on the last call you had made mention of a new SaaS product coming out this year at the end of the year. Wanted to know if there was a timeline on that right now?
Yes, so the SaaS product we talked about was actually a shared library, basically it's a shared media management capability in the cloud and that is slated for the very end of the year. So I believe it’s [several hundred] days right from me but it’s late December.
As we said before, the SaaS won’t really have a meaningful even though we are doing some pilots this year really SaaS won’t have a meaningful contribution till it starts - really starts revenue contribution in the second half of 2019.
And then coming back to you the supply issue you had is that revenue you were just talking about backlog, is that revenue you booked for this quarter, is that revenue that’s going to be booked in the fourth quarter?
No, it was contracts booked in Q3 that we could have delivered more in Q3 if the supply was available. So we carry that as backlog in the Q4 and will deliver it in during the course of Q4.
And is that a meaningful number on your AR?
No, it wouldn’t be on the AR but…
Yes, so we were confident it’s not on account receivable but we have an uptick expected for Q4 on those products.
And then switching over to your recurring revenue splits that you have at 60% now, how much higher do you think that could go before it impacts gross margin?
Well we believe first we’re going to be detailing our operating model in 2021 at our Investor Day but recurring revenue has steadily improved. We believe we will continue to improve as we generate more subscription revenue. Subscription revenue carries higher gross margin, software margins in the 80% plus range. So we believe as recurring revenue grows, actual gross margin will prove. So that's a good sign as the company grows recurring revenue.
[Operator Instructions] At this time, I'm showing no further questions in the queue.
Okay, well then thank you again everyone for joining us today on our Q3 call. Hope to see many of you at our Investor Day next week. Otherwise we look forward to our next call when we will be reporting our Q4 and full year 2018 results. Have a good evening.
Thank you. Ladies and gentlemen this concludes today's teleconference. You may now disconnect.