AVID TECHNOLOGY, INC.
Metropolitan Technology Park
One Park West
Tewksbury, MA 01876
November 12, 1998
OFIS Filer Support
SEC Operations Center
6432 General Green Way
Alexandria, VA 22312-2413
Re: Avid Technology, Inc.
File No. 0-21174
QUARTERLY REPORT ON FORM 10-Q
Ladies and Gentlemen:
Pursuant to regulations of the Securities and Exchange Commission,
submitted herewith for filing on behalf of Avid Technology, Inc. is the
Company's Quarterly Report on Form 10-Q for the fiscal quarter ended September
30, 1998.
This filing is being effected by direct transmission to the Commission's
EDGAR System.
Very truly yours,
/s/Frederic G. Hammond
Frederic G. Hammond
General Counsel
==============================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
Commission File Number 0-21174
AVID TECHNOLOGY, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 04-2977748
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
METROPOLITAN TECHNOLOGY PARK
ONE PARK WEST
TEWKSBURY, MA 01876
(Address of principal executive offices)
Registrant's telephone number, including area code: (978) 640-6789
Indicate by check mark whether the registrant has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports).
Yes X No _____
Indicate by check mark whether the registrant has been subject to such
filing requirements for the past 90 days.
Yes X No _____
The number of shares outstanding of the registrant's Common Stock as of November
9, 1998 was 24,499,653.
==============================================================================
AVID TECHNOLOGY, INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION
ITEM 1. Condensed Consolidated Financial Statements:
a) Condensed Consolidated Statements of Operations (unaudited)
for the three months ended September 30, 1998 and 1997, and the nine
months ended September 30, 1998 and 1997 ..............................1
b) Condensed Consolidated Balance Sheets as of September 30, 1998
(unaudited) and December 31, 1997......................................2
c) Condensed Consolidated Statements of Cash Flows (unaudited)
for the nine months ended September 30, 1998 and 1997 .................3
d) Notes to Condensed Consolidated Financial Statements (unaudited).......4
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations..............................13
PART II. OTHER INFORMATION
ITEM 6. Exhibits and Reports on Form 8-K.................................26
Signatures..................................................................27
EXHIBIT INDEX...............................................................28
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AVID TECHNOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
1998 1997 1998 1997
(unaudited) (unaudited) (unaudited) (unaudited)
Net revenues $ 116,185 $ 116,510 $ 337,779 $ 347,602
Cost of revenues 45,929 51,606 135,993 167,491
--------- --------- --------- ---------
Gross profit 70,256 64,904 201,786 180,111
--------- --------- --------- ---------
Operating expenses:
Research and development 22,757 18,598 63,685 53,310
Marketing and selling 30,967 30,109 89,245 89,094
General and administrative 6,902 6,734 19,931 18,830
Nonrecurring costs 193,741 193,741
Amortization of acquired
intangible assets 4,350 4,350
--------- --------- --------- ---------
Total operating expenses 258,717 55,441 370,952 161,234
Operating income (loss) (188,461) 9,463 (169,166) 18,877
Interest and other income, net 2,016 2,596 7,266 5,882
--------- --------- --------- ---------
Income (loss) before income
taxes (186,445) 12,059 (161,900) 24,759
Provision for (benefit from)
income taxes (42,105) 3,231 (34,497) 7,675
--------- --------- --------- ---------
Net income (loss) ($144,340) $8,828 ($127,403) $17,084
========= ========= ========= =========
Net income (loss) per common
share - basic ($5.97) $0.37 ($5.45) $0.75
========= ========= ========= =========
Net income (loss) per common
share - diluted ($5.97) $0.34 ($5.45) $0.72
========= ========= ========= =========
Weighted average common
shares outstanding - basic 24,190 23,912 23,396 22,875
========= ========= ========= =========
Weighted average common shares
outstanding - diluted 24,190 25,747 23,396 23,857
========= ========= ========= =========
The accompanying notes are an integral part of the condensed consolidated
financial statements.
AVID TECHNOLOGY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
September 30, December 31,
1998 1997
---------- ----------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $60,643 $108,308
Marketable securities 37,699 78,654
Accounts receivable, net of allowances of $7,923
and $7,529 in 1998 and 1997, respectively 73,760 79,773
Inventories 12,059 9,842
Deferred tax assets 16,975 17,160
Prepaid expenses 6,823 4,645
Other current assets 5,412 2,700
---------- ----------
Total current assets 213,371 301,082
Property and equipment, net 36,848 38,917
Long-term deferred tax assets 50,764 14,820
Acquired intangible assets 52,034
Other assets 2,878 1,986
---------- ----------
Total assets $355,895 $356,805
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $17,586 $22,166
Current portion of long-term debt 562 783
Accrued compensation and benefits 23,293 23,737
Accrued expenses 33,187 30,249
Income taxes payable 15,758 11,210
Deferred revenues 21,623 26,463
---------- ----------
Total current liabilities 112,009 114,608
Long-term debt, less current portion 7,622 403
Purchase consideration 64,883
Commitments and contingencies
Stockholders' equity:
Preferred stock
Common stock 265 242
Additional paid-in capital 344,582 252,307
Retained earnings (accumulated deficit) (108,433) 27,286
Treasury stock (59,543) (27,548)
Deferred compensation (4,308) (8,034)
Cumulative translation adjustment (1,254) (2,472)
Net unrealized gains on marketable securities 72 13
---------- ----------
Total stockholders' equity 171,381 241,794
---------- ----------
Total liabilities and stockholders' equity $355,895 $356,805
========== ==========
The accompanying notes are an integral part of the condensed consolidated
financial statements.
AVID TECHNOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Nine Months Ended
September 30,
----------------------
1998 1997
(unaudited) (unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ($127,403) $17,084
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Charge for acquired in-process research and
development, net of tax benefit 149,374
Depreciation and amortization 20,585 19,893
Compensation from stock grants and options 3,531
Provision for doubtful accounts 1,407 1,464
Changes in deferred tax assets 224 (151)
Tax benefit of stock option exercises 2,394
(Gain) loss on disposal of equipment (605) 218
Changes in operating assets and liabilities,
net of effects of acquisition:
Accounts receivable 13,174 90
Inventories (1,922) 11,813
Prepaid expenses and other current assets (3,493) (108)
Accounts payable (5,837) (1,259)
Income taxes payable 4,518 6,824
Accrued expenses, compensation and benefits (5,945) 18,962
Deferred revenues (6,491) 759
- ------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 41,117 77,983
- ------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment and other assets (12,462) (12,033)
Acquisition of business, net of cash
acquired (Notes 3 and 4) (78,416)
Capitalized software development costs (20) (107)
Proceeds from disposal of equipment 1,306 1,554
Purchases of marketable securities (128,759) (102,193)
Proceeds from sales of marketable securities 169,774 51,341
- ------------------------------------------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (48,577) (61,438)
- ------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of long-term debt (521) (1,593)
Purchase of common stock for treasury (51,144)
Proceeds from issuance of common stock 10,859 25,821
- ------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) FINANCING
ACTIVITIES (40,806) 24,228
- ------------------------------------------------------------------------------
Effects of exchange rate changes on cash and cash
equivalents 601 (864)
- ------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (47,665) 39,909
Cash and cash equivalents at beginning of period 108,308 75,795
- ------------------------------------------------------------------------------
Cash and cash equivalents at end of period $60,643 $115,704
- ------------------------------------------------------------------------------
The accompanying notes are an integral part of the condensed consolidated
financial statements.
PART I. FINANCIAL INFORMATION
ITEM 1D. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. FINANCIAL INFORMATION
The accompanying condensed consolidated financial statements include the
accounts of Avid Technology, Inc. and its wholly owned subsidiaries ("Avid" or
"the Company"). The interim financial statements are unaudited. However, in the
opinion of management, the condensed consolidated financial statements include
all adjustments, consisting of only normal, recurring adjustments, necessary for
their fair presentation. Interim results are not necessarily indicative of
results expected for a full year. The accompanying unaudited condensed financial
statements have been prepared in accordance with the instructions for Form 10-Q
and therefore do not include all information and footnotes necessary for a
complete presentation of operations, the financial position, and cash flows of
the Company, in conformity with generally accepted accounting principles. The
Company filed audited consolidated financial statements for the year ended
December 31, 1997 on Form 10-K which included all information and footnotes
necessary for such presentation.
The Company's preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the dates of the financial
statements and the reported amounts of revenues and expenses during the reported
periods. The most significant estimates included in these financial statements
include accounts receivable and sales allowances, inventory valuation and income
tax valuation allowances. Actual results could differ from those estimates.
2. NET INCOME (LOSS) PER COMMON SHARE
The Company computes basic and diluted earnings per share in accordance with
Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS
128"). The following tables reconcile the numerator and denominator of the basic
and diluted earnings per share computations shown on the Condensed Consolidated
Statements of Operations:
(in thousands, except per share data)
For the Three Months Ended
September 30,
-----------------------------------
1998 1997
------------ -------------
Basic EPS
Numerator:
Net income (loss) ($144,340) $8,828
Denominator:
Weighted common shares outstanding 24,190 23,912
Basic EPS ($5.97) $0.37
============ =============
Diluted EPS
Numerator:
Net income (loss) ($144,340) $8,828
Denominator:
Weighted common shares outstanding 24,190 23,912
Weighted common stock equivalents - 1,835
------------ -------------
24,190 25,747
Diluted EPS ($5.97) $0.34
============ =============
Options to purchase 2,285,526 weighted shares of common stock outstanding at
September 30, 1998 were excluded from the calculation of diluted earnings per
share because their inclusion would be anti-dilutive. Options to purchase 57,855
weighted shares of common stock outstanding at September 30, 1997, were excluded
from the calculation of diluted earnings per share because the exercise prices
of those options exceeded the average market price of common stock for the
three-month period ended September 30, 1997.
(in thousands, except per share data)
For the Nine Months Ended
September 30,
-----------------------------------
1998 1997
------------ -------------
Basic EPS
Numerator:
Net income (loss) ($127,403) $17,084
Denominator:
Weighted common shares outstanding 23,396 22,875
Basic EPS ($5.45) $0.75
============ ===========
Diluted EPS
Numerator:
Net income (loss) ($127,403) $17,084
Denominator:
Weighted common shares outstanding 23,396 22,875
Weighted common stock equivalents - 982
------------ -----------
23,396 23,857
Diluted EPS ($5.45) $0.72
============ ===========
Options to purchase 1,912,090 weighted shares of common stock outstanding at
September 30, 1998 were excluded from the calculation of diluted earnings per
share because their inclusion would be anti-dilutive. Options to purchase
302,195 weighted shares of common stock outstanding at September 30, 1997, were
excluded from the calculation of diluted earnings per share because the exercise
prices of those options exceeded the average market price of common stock for
the nine-month period ended September 30, 1997.
3. ACQUISITION OF SOFTIMAGE
On August 3, 1998, the Company acquired from Microsoft Corporation ("Microsoft")
the common stock of Softimage Inc. ("Softimage") and certain assets relating to
the business of Softimage. In connection with the acquisition, Avid paid $79.0
million in cash to Microsoft and issued to Microsoft (i) a subordinated note
(the "Note") in the amount of $5 million, due June 2003, (ii) 2,394,813 shares
of common stock, valued at $64.0 million, and (iii) a ten-year warrant to
purchase 1,155,235 shares of common stock at an exercise price of $47.65 per
share, valued at $26.2 million. In addition, Avid agreed to issue to Softimage
employees 40,706 shares of common stock, valued at $1.5 million, as well as
stock options with a nominal exercise price to purchase up to 1,820,817 shares
of common stock, valued at $68.2 million ("Avid Options"). Avid also incurred
fees of $4.0 million in connection with the transaction. Per terms of the
agreements, shares of common stock issued to Microsoft and the underlying
warrant may not be traded until August 3, 2001. Additionally, the principal
amount of the Note will be increased by $39.71 for each share underlying
forfeited Avid Options. The value of the Avid Options has been recorded on the
balance sheet as Purchase Consideration. As the underlying options either become
vested or are forfeited by employees, additional paid-in capital or the Note,
respectively, will be increased and Purchase Consideration will be reduced.
The acquisition was accounted for under the purchase method of accounting.
Accordingly, the results of operations of Softimage and the fair market value of
the acquired assets and assumed liabilities have been included in the financial
statements of the Company as of the acquisition date. The purchase price was
allocated to the acquired assets and assumed liabilities as follows (in
thousands):
Working capital, net $2,448
Property and equipment 3,505
Completed technologies 44,772
In-process research and
development 193,741
Work force 7,644
Tradename 4,172
Deferred tax liability (8,422)
-----------
$247,860
===========
The amounts allocated to tangible and intangible assets, including acquired
in-process research and development, were based on results of an independent
appraisal. Acquired in-process research and development represented development
projects in areas that had not reached technological feasibility and had no
alternative future use. Accordingly, the amount of $193.7 million was charged to
operations at the date of the acquisition, net of the related tax benefit of
$44.4 million. The amounts allocated to completed technologies, work force, and
tradename are being amortized on a straight-line basis over expected useful
lives of two and three years. The values of completed technologies and
in-process research and development were determined using a risk-adjusted,
discounted cash flow approach. The value of in-process research and development,
specifically, was determined by estimating the costs to develop the in-process
projects into commercially viable products, estimating the resulting net cash
flows from such projects, and discounting the net cash flows back to their
present values. The evaluation considered the inherent difficulties and
uncertainties in completing the development projects and the risks related to
the viability of and potential changes in future target markets.
In-process research and development projects identified at the acquisition date
include next-generation three-dimensional modeling, animation and rendering
software; new graphic, film and media management capabilities for
effects-intensive, on-line finishing applications for editing; and new editing
technology architectures to support collaborative work groups. The nature of the
efforts to develop the purchased in-process technology into commercially viable
products principally relate to (i) completion of the animation and real-time
playback architecture, completion and integration of architectural software
components, validation of the resulting architecture, and finalization of the
feature set; (ii) the rewriting of software code of the compositing engine to
accommodate significant new features, the rewriting of software code of the
titling component, and the rebuilding of the framework architecture; and (iii)
the design of a new architecture to support simultaneous and synchronized access
to projects and media data. If these projects are not successfully developed,
the sales and profitability of the Company may be adversely affected in future
periods.
No assets related to tax credits and carryforwards of Softimage were recorded at
the acquisition date due to the uncertainty of their realization. If any benefit
of these tax credits and carryforwards is realized in the future, the
non-current assets recorded upon the acquisition will be reduced at that time by
a corresponding amount, before any benefit is recognized in the statement of
operations.
Accumulated amortization associated with acquired intangible assets totaled $4.4
million at September 30, 1998. During the quarter ended September 30, 1998, the
Purchase Consideration recorded for the value of Avid Options was reduced by
approximately $3.3 million, resulting from increases to the Note of
approximately $2.5 million for forfeited options and by increases to additional
paid-in capital of approximately $0.8 million for options which became vested.
The following table presents unaudited pro forma information as if Avid and
Softimage had been combined as of the beginning of the periods presented. The
pro forma data are presented for illustrative purposes only and are not
necessarily indicative of the combined financial position or results of
operations of future periods or the results that actually would have resulted
had Avid and Softimage been a combined company during the specified periods. The
pro forma results include the effects of the purchase price allocation on
amortization of acquired intangible assets and exclude the acquisition-related
charge for the purchased in-process technology and related tax benefit.
Pro Forma Unaudited
(in thousands, except per share amounts)
For the Nine Months Ended September 30,
1998 1997
----------------- ------------------
Net revenue $360,784 $377,060
=============== ================
Net income (loss) $5,714 ($5,920)
=============== ================
Net income (loss) per common
share - basic $0.23 ($0.23)
=============== ================
Net income (loss) per common
share - diluted $0.20 ($0.23)
=============== ================
Weighted average common shares
outstanding - basic 25,305 25,310
=============== ================
Weighted average common shares
outstanding - diluted 28,591 25,310
=============== ================
4. SUPPLEMENTAL CASH FLOW INFORMATION
The following table reflects supplemental cash flow investing activities related
to the Softimage acquisition.
Nine Months Ended
September 30, 1998
-------------------
Fair value of:
Assets acquired $262,709
Liabilities assumed (18,850)
Debt, common stock, stock options
and warrant issued (164,859)
-------------------
Cash paid 79,000
Less: cash acquired (584)
-------------------
Net cash paid for acquisition $78,416
===================
5. INVENTORIES
Inventories consist of the following (in thousands):
September 30, December 31,
1998 1997
-------------- ---------------
Raw materials $7,488 $5,488
Work in process 1,913 674
Finished goods 2,658 3,680
-------------- ---------------
$12,059 $9,842
============== ===============
6. PROPERTY AND EQUIPMENT, NET
Property and equipment, net, consists of the following (in thousands):
September 30, December 31,
1998 1997
-------------- ---------------
Computer and video equipment $84,463 $75,042
Office equipment 4,916 4,652
Furniture and fixtures 7,030 6,820
Leasehold improvements 14,233 13,105
-------------- ---------------
110,642 99,619
Less accumulated depreciation and
amortization 73,794 60,702
-------------- ---------------
$36,848 $38,917
============== ===============
7. LINE OF CREDIT
The Company has an unsecured line of credit with a group of banks, which
provides for up to $35.0 million in revolving credit. The line of credit
agreement was renewed on June 30, 1998 to expire on June 29, 1999 and certain
covenants were subsequently amended as of September 30, 1998. Under the terms of
the agreement, the Company must pay an annual commitment fee of 1/4% of the
average daily unused portion of the facility, payable quarterly in arrears. The
Company has two loan options available under the agreement: the Base Rate Loan
and the LIBOR Rate Loan. The interest rates to be paid on the outstanding
borrowings for each loan annually are equal to the Base Rate or LIBOR plus
1.25%, respectively. Additionally, the Company is required to maintain certain
financial ratios and is bound by covenants over the life of the agreement,
including a restriction on the payment of dividends. The Company had no
borrowings against this facility during the nine-month period ended September
30, 1998.
8. LONG-TERM DEBT
In connection with the acquisition of Softimage, Avid issued a $5 million
subordinated note (the "Note"). The principal amount of the Note, including any
adjustments due to Avid Options, plus all unpaid accrued interest is due on June
15, 2003. The Note bears interest at 9.5% per annum, payable quarterly. The
interest rate of the Note will increase to 12.5% during any period of default in
payment of principal or interest. Through September 30, 1998, the Note has been
increased by approximately $2.5 million for forfeited Avid Options.
9. CONTINGENCIES
On June 7, 1995, the Company filed a patent infringement complaint in the United
States District Court for the District of Massachusetts against Data
Translation, Inc., a Marlboro, Massachusetts-based company. Avid is seeking
judgment against Data Translation that, among other things, Data Translation has
willfully infringed Avid's patent number 5,045,940, entitled "Video/Audio
Transmission System and Method." Avid is also seeking an award of treble damages
together with prejudgment interest and costs, Avid's costs and reasonable
attorneys' fees and an injunction to prohibit further infringement by Data
Translation. The litigation has been dismissed without prejudice (with leave to
refile) pending a decision by the U.S. Patent and Trademark Office on a reissue
patent application based on the issued patent.
On March 11, 1996, the Company was named as defendant in a patent infringement
suit filed in the United States District Court for the Western District of Texas
by Combined Logic Company, a California partnership located in Beverly Hills,
California. On May 16, 1996, the suit was transferred to the United States
District Court for the Southern District of New York on motion by the Company.
The complaint alleges infringement by Avid of U.S. patent number 4,258,385,
issued in 1981, and seeks injunctive relief, treble damages and costs, and
attorneys' fees. The Company believes that it has meritorious defenses to the
complaint and intends to contest it vigorously. However, an adverse resolution
of this litigation could have a material adverse effect on the Company's
consolidated financial position or results of operations in the period in which
the litigation is resolved. No costs have been accrued for this possible loss
contingency.
The Company also receives inquiries from time to time with regard to additional
possible patent infringement claims. These inquiries are generally referred to
counsel and are in various stages of discussion. If any infringement is
determined to exist, the Company may seek licenses or settlements. In addition,
from time to time as a normal incidence of the nature of the Company's business,
various claims, charges, and litigation have been asserted or commenced against
the Company arising from or related to contractual or employee relations,
intellectual property rights or product performance. Management does not believe
these claims will have a material adverse effect on the financial position or
results of operations of the Company.
10. CAPITAL STOCK
During June and July 1997, the Company granted 347,200 shares of $.01 par value
restricted common stock to certain employees under the 1997 Stock Incentive Plan
approved by the shareholders on June 4, 1997. These shares vest annually in 20%
increments beginning May 1, 1998. Accelerated vesting may occur if certain stock
price performance goals established by the Board of Directors are met. On May 1,
1998, an additional 20% of the restricted stock became vested due to the
attainment of specific stock performance goals. Unvested restricted shares are
subject to forfeiture in the event that an employee ceases to be employed by the
Company. The Company initially recorded, as a separate component of
stockholders' equity, deferred compensation of approximately $9.1 million with
respect to this restricted stock. This deferred compensation represents the
excess of fair value of the restricted shares at the date of the award over the
purchase price and is recorded as compensation expense ratably as the shares
vest.
On October 23, 1997, February 5, 1998, and October 21, 1998 the Company
announced that the Board of Directors authorized the repurchase of up to 1.0
million, 1.5 million, and 2.0 million shares, respectively, of the Company's
common stock. Purchases have been and will be made in the open market or in
privately negotiated transactions. The Company has used and will continue to use
any repurchased shares for its employee stock plans. As of December 31, 1997,
the Company had repurchased a total of 1.0 million shares at a cost of $28.8
million, which completed the program announced in October 1997. As of September
30, 1998, the Company had repurchased a total of 1.5 million shares of Avid
common stock at a cost of $51.1 million, which completed the program announced
during February 1998. These purchases under the program announced in February
1998, include the repurchase of 500,000 shares from Intel Corporation ("Intel").
Intel originally purchased 1,552,632 shares of Avid common stock in March 1997.
Subsequent to September 30, 1998 through November 9, 1998, the Company
repurchased approximately 176,000 additional shares of Avid common stock, under
the program announced in October 1998, at a cost of $4.1 million.
11. RECENT ACCOUNTING PRONOUNCEMENTS
On June 15, 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative
Instruments and Hedging Activities". SFAS 133 requires that all derivative
instruments be recorded on the balance sheet at their fair values. Changes in
the fair values of derivatives are recorded each period in current earnings or
other comprehensive income, depending on whether or not a derivative is
designated as part of a hedge transaction and, if it is, depending on the type
of hedge transaction. SFAS 133 is effective for all fiscal quarters of all
fiscal years beginning after June 15, 1999 (January 1, 2000 for the Company) and
its adoption is not expected to have a material impact on the Company's
financial position or results of operations.
Effective January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130 ("SFAS 130"), "Reporting Comprehensive Income". SFAS 130
requires the reporting of comprehensive income in addition to net income from
operations. Comprehensive income is a more inclusive reporting methodology that
includes disclosure of certain financial information that historically has not
been recognized in the calculation of net income. The adoption of SFAS 130 had
no impact on the Company's net income or stockholder's equity. Total
comprehensive income (loss), net of taxes, was ($143.6) million and $9.5 million
for the three-month period ended September 30, 1998 and 1997, respectively and
($126.5) million and $17.9 million for the nine-month period ended September 30,
1998 and 1997, respectively, which consists of net income, the net changes in
foreign currency translation adjustment and the net unrealized gains and losses
on available-for-sale securities.
In March 1998, Statement of Position 98-1, "Accounting for the Cost of Computer
Software Developed or Obtained for Internal Use" ("SOP 98-1"), was issued which
provides guidance on applying generally accepted accounting principles in
addressing whether and under what condition the costs of internal-use software
should be capitalized. SOP 98-1 is effective for transactions entered into in
fiscal years beginning after December 15, 1998, however earlier adoption is
encouraged. The Company adopted the guidelines of SOP 98-1 as of January 1,
1998, and the impact of such adoption was not material to results of operations
or cash flows for the three- and nine-month periods ended September 30, 1998.
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The text of this document may include forward-looking statements. Actual results
may differ materially from those described herein, depending on such factors as
are described herein, including under "Certain Factors That May Affect Future
Results."
Avid develops and provides digital film, video and audio editing and special
effects software and hardware technologies to create media content for
information and entertainment applications. Integrated with the Company's
digital storage and networking solutions, Avid's products are used worldwide in
film studios; video production and post-production facilities; network,
independent and cable television stations; recording studios; advertising
agencies; government and educational institutions; corporate communications
departments; and by consumers.
In August 1998, the Company acquired the common stock of Softimage and certain
assets related to the business of Softimage for total consideration of $247.9
million. Softimage is a leading developer of three-dimensional ("3D") animation,
video production, two-dimensional ("2D") cel animation ( a cel used in cel
animation consists of layers of two dimensional artwork which are changed on a
frame by frame basis creating an illusion of motion) and compositing software
solutions and technologies. The acquisition was recorded as a purchase and,
accordingly, the results of operations of Softimage have been included in the
Company's financial statements as of the acquisition date. The Company's results
of operations for the three and nine months ended September 30, 1998 include a
pre-tax charge $193.7 million for the value of acquired in-process research and
development and amortization of $4.4 million for acquired intangible assets as a
result of the acquisition.
RESULTS OF OPERATIONS
Net Revenues
The Company's net revenues have been derived mainly from the sales of disk-based
digital, nonlinear media editing systems and related peripherals, licensing of
related software, and sales of software maintenance contracts. Net revenues
decreased by $325,000 (0.3%) to $116.2 million in the quarter ended September
30, 1998 from $116.5 million in the same quarter of last year. Net revenues for
the nine months ended September 30, 1998 of $337.8 million decreased by $9.8
million (2.8%) from $347.6 million for the nine months ended September 30, 1997.
Revenues for the three months ended September 30, 1998 compared to the same
period in 1997 reflected decreased sales of Media Composer and storage products.
These decreases in revenues were largely offset by incremental Softimage
business and increased sales of digital audio products. The decrease in net
revenues for the nine months ended September 30, 1998 compared to the same
period in 1997 reflected decreased sales of system upgrades, Media Composer
products, Avid Cinema, and Broadcast products. These decreased revenues were
offset in part by increased sales of MCXpress and Avid Xpress products, customer
service, and incremental Softimage business. During the third quarter of 1998,
the Company began shipments of Pro Tools/24 MIX products, version 1.6 of
MCXpress, and Avid Marquee. Additionally, late in the third quarter 1998, the
Company began shipping the NewsCutter DV product. To date, returns of all
products have been immaterial.
The Company continues to shift an increasing proportion of its sales through
indirect channels such as distributors and resellers. Net revenues derived
through indirect channels were greater than 70% of net revenue for the three
months ended September 30, 1998, compared to greater than 60% in the same period
of last year.
International sales (sales to customers outside the U.S. and Canada) accounted
for approximately 48% and 46% of the Company's third quarter 1998 and 1997 net
revenues, respectively. International sales increased by 5.6% in the third
quarter of 1998 compared to the same period in 1997. International sales
accounted for approximately 48% of the Company's net revenues for the first nine
months of 1998 and 1997, respectively. International sales decreased by 2.2% in
the nine-month period ended September 30, 1998 from the same period in 1997.
International revenues reflected sluggishness in the Asia Pacific region offset
by increases in Europe. Additionally, revenue for the nine months was impacted
adversely by the strengthening of the U.S. dollar against various currencies.
Gross Profit
Cost of revenues consists primarily of costs associated with the acquisition of
components; the assembly, test, and distribution of finished products;
provisions for inventory obsolescence; warehousing; and post-sales customer
support costs. The resulting gross profit fluctuates based on factors such as
the mix of products sold, the cost and proportion of third-party hardware
included in the systems sold by the Company, the distribution channels through
which products are sold, the timing of new product introductions, the offering
of product upgrades, price discounts and other sales promotion programs, and
sales of aftermarket hardware products. Gross margin increased to 60.5% in the
third quarter of 1998 compared to 55.7% in the third quarter of 1997 and
increased to 59.7% for the nine-month period ended September 30, 1998 from 51.8%
for the same period in 1997. The increase during 1998 was primarily due to lower
material costs, continued improvements in manufacturing efficiencies, and
improved service margins. The Company currently expects that gross margins for
the remainder of 1998 will approximate the results of the three most recent
quarters.
Research and Development
Research and development expenses increased by $4.2 million (22.4%) in the third
quarter of 1998 compared to the same period in 1997 and increased $10.4 million
(19.5%) for the nine-month period ended September 30, 1998 compared to the same
period of 1997. These increased expenditures were primarily due to two months of
incremental Softimage costs as well as additions to the Company's engineering
staffs for the continued development of new and existing products. Research and
development expenses were 19.6% as a percentage of net revenues in the third
quarter of 1998 compared to 16.0% in the same quarter of 1997 and were 18.9%
compared to 15.3% for the nine-month periods ended September 30, 1998 and 1997,
respectively. These increases were primarily due to the increases in research
and development expenses noted above combined with lower revenues.
Marketing and Selling
Marketing and selling expenses increased by $858,000 (2.8%) in the third quarter
of 1998 compared to the same period in 1997 and increased by $151,000 (0.2%) for
the nine-month period ended September 30, 1998 compared to the same period in
1997. These increased expenditures in selling and marketing were primarily due
to two months of incremental Softimage costs as well as an increase in marketing
programs offset by ongoing savings in selling expenses as a result of the shift
to an indirect sales model. Marketing and selling expenses were 26.7% as a
percentage of net revenues in the third quarter of 1998 compared to 25.8% in the
same quarter of 1997 and were 26.4% compared to 25.6% for the nine-month periods
ended September 30, 1998 and 1997, respectively. These increases largely reflect
the higher selling and marketing expenditures noted above combined with lower
revenues.
General and Administrative
General and administrative expenses for the third quarter of 1998 increased by
$168,000 (2.5%) from the third quarter of 1997 and increased $1.1 million (5.8%)
for the nine-month period ended September 30, 1998, compared to the nine-month
period ended September 30, 1997. The increase in general and administrative
expenses for the three-month period ended September 30, 1998 compared to 1997
was primarily due to two months of incremental Softimage costs. The increase in
general and administrative expenses for the nine-month period ended September
30, 1998 compared to 1997 was primarily due to two months of incremental
Softimage costs. General and administrative expenses were 5.9% as a percentage
of net revenues in the third quarter of 1998 compared to 5.8% in the third
quarter of 1997 and were 5.9% for the nine-month period ended September 30, 1998
compared to 5.4% for the same period in 1997 primarily due to the incremental
Softimage costs as well as lower revenues.
Nonrecurring Costs and Amortization of Acquired Intangible Assets
In connection with the August 1998 acquisition of the business of Softimage, the
Company allocated $193.7 million to in-process research and development and
$56.6 million to intangible assets consisting of completed technologies, work
force and tradename. Acquired in-process research and development represented
development projects in areas that had not reached technological feasibility and
had no alternative future use. Accordingly, its value of $193.7 million was
expensed as of the acquisition date and is reflected as a nonrecurring charge to
operations for the three and nine months ended September 30, 1998. Results for
the three and nine months ended September 30, 1998 also reflect amortization of
$4.4 million associated with the acquired intangible assets and a tax benefit of
$44.4 million related to the charge for in-process research and development (see
Note 3 to the Condensed Consolidated Financial Statements). Excluding the
one-time charge, net of the related tax benefit, and the amortization associated
with the acquisition, the Company would have reported net income of $8.0 million
or $0.30 per diluted share and $25.0 million or $0.99 per diluted share for the
three and nine months ended September 30, 1998, respectively. Excluding only the
one-time charge associated with acquired in-process research and development,
net of the related tax benefit, the Company would have reported net income of
$5.0 million or $0.19 per diluted share and $22.0 million or $0.87 per diluted
share for the three and nine months ended September 30, 1998, respectively.
The amounts allocated to acquired tangible and intangible assets, including
acquired in-process research and development, were based on results of an
independent appraisal. The values of completed technologies and in-process
research and development were determined using a risk-adjusted, discounted cash
flow approach. The value of in-process research and development, specifically,
was determined by estimating the costs to develop the in-process projects into
commercially viable products, estimating the resulting net cash flows from such
projects, and discounting the net cash flows back to their present values. The
evaluation considered the inherent difficulties and uncertainties in completing
the development projects and the risks related to the viability of and potential
changes in future target markets.
In-process research and development projects identified at the acquisition date
include next-generation three-dimensional modeling, animation and rendering
software; new graphic, film and media management capabilities for
effects-intensive, on-line finishing applications for editing; and new editing
technology architectures to support collaborative work groups. The nature of the
efforts to develop the purchased in-process technology into commercially viable
products principally relate to (i) completion of the animation and real-time
playback architecture, completion and integration of architectural software
components, validation of the resulting architecture, and finalization of the
feature set; (ii) the rewriting of software code of the compositing engine to
accommodate significant new features, the rewriting of software code of the
titling component, and the rebuilding of the framework architecture; and (iii)
the design of a new architecture to support simultaneous and synchronized access
to projects and media data. If these projects are not successfully developed,
the sales and profitability of the Company may be adversely affected in future
periods. The estimated costs to be incurred to complete the development of the
in-process research and development projects total approximately $23 million
through the first half of 2000. The Company expects to begin to benefit from the
purchased in-process research and development from the first half of 1999
through the first half of 2000.
Interest and Other Income, Net
Interest and other income, net consists primarily of interest income, other
income and interest expense. Interest and other income, net for the third
quarter in 1998 decreased $580,000 as compared to the same period in 1997. For
the nine-month period ended September 30, 1998 as compared to the same period in
1997, interest and other income, net increased $1.4 million. The decrease in
interest and other income for the three-month period ended September 30, 1998
compared to 1997 was primarily due to a decrease in investment balances. The
increase in interest and other income for the nine-month period ended September
30, 1998 compared to 1997 was primarily due to higher investment balances.
Provision for (Benefit from) Income Taxes
The Company's effective tax rate was 22.6% and 21.3% for the three and nine
months ended September 30, 1998 compared to 26.8% for the three months ended
September 30, 1997 and 31% for the nine months ended September 30, 1997. The tax
rate for the three and nine months ended September 30, 1998 includes a benefit
of $44.4 million related to the pre-tax charge of $193.7 for the charge for
in-process technology associated with the Company's acquisition of Softimage. A
portion of the charge is not deductible for U.S. Federal tax purposes. Excluding
the charge and related tax benefit, the Company's effective tax rate would have
been 31% for the three and nine months ended September 30, 1998. The pro forma
1998 and actual 1997 effective tax rate of 31% is different from the Federal
statutory rate of 35% due primarily to the Company's foreign subsidiaries, which
are taxed in the aggregate at a lower rate, and the U.S Federal Research Tax
Credit. The effective tax rate of 26.8% for the three months ended September 30,
1997 reduced the year to date effective tax rate from 35% to 31% in the third
quarter of 1997. This reduction was primarily due to the tax law change which
extended the U.S. Federal Research Tax Credit for the full year as well as the
relative levels of profit within the Company's foreign subsidiaries, which are
taxed in the aggregate at a lower rate.
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its operations to date through both private and public
sales of equity securities as well as through cash flows from operations. As of
September 30, 1998, the Company's principal sources of liquidity included cash,
cash equivalents and marketable securities totaling approximately $98.3 million.
The Company's operating activities generated cash of $41.1 million in the nine
months ended September 30, 1998 compared to $78.0 million in the nine months
ended September 30, 1997. Cash was generated during the nine months ended
September 30, 1998 primarily from net income after adjustment for the charge for
in-process research and development in connection with the acquisition of
Softimage as well as from collections of accounts receivable and increases in
income taxes payable offset by decreases in accounts payable, accrued expenses
and deferred revenue. In the nine months ended September 30, 1997, cash was
generated primarily from net income as well as from increases in accrued
expenses and income taxes payable and reductions in inventory.
The Company purchased $12.5 million of property and equipment and other assets
during the nine months ended September 30, 1998, compared to $12.0 million in
the same period in 1997. These purchases included primarily hardware and
software for the Company's information systems and equipment to support research
and development activities. The Company also utilized $78.4 million, net of cash
acquired, in the acquisition of Softimage.
The Company has an unsecured line of credit with a group of banks which provides
for up to $35.0 million in revolving credit. The line of credit agreement was
renewed on June 30, 1998 to expire on June 29, 1999 and certain covenants were
subsequently amended on September 30, 1998. Under the terms of the agreement,
the Company must pay an annual commitment fee of 1/4% of the average daily
unused portion of the facility, payable quarterly in arrears. The Company has
two loan options available under the agreement: the Base Rate Loan and the LIBOR
Rate Loan. The interest rates to be paid on the outstanding borrowings for each
loan annually are equal to the Base Rate or LIBOR plus 1.25%, respectively.
Additionally, the Company is required to maintain certain financial ratios and
is bound by covenants over the life of the agreement, including a restriction on
the payment of dividends. The Company had no borrowings against this facility as
of September 30, 1998. The Company believes existing cash and marketable
securities, internally generated funds and available borrowings under its bank
credit line will be sufficient to meet the Company's cash requirements,
including capital expenditures and investments in product development, at least
through the next twelve months. In the event the Company requires additional
financing, the Company believes that it would be able to obtain such financing;
however, there can be no assurance that it would be successful in doing so, or
that it could do so on terms favorable to the Company.
On October 23, 1997, February 5, 1998, and October 21, 1998 the Company
announced that the Board of Directors authorized the repurchase of up to 1.0
million, 1.5 million shares, and 2.0 million, respectively, of the Company's
common stock. Purchases have been and will be made in the open market or in
privately negotiated transactions. The Company has used and will continue to use
any repurchased shares for its employee stock plans. As of December 31, 1997,
the Company had repurchased a total of 1.0 million shares at a cost of
approximately $28.8 million, which completed the program announced in October
1997. As of September 30, 1998, the Company had repurchased a total of 1.5
million shares at a cost of approximately $51.1 million, which completed the
program announced in February 1998. These purchases under the program announced
in February 1998 include the repurchase of 500,000 shares of Avid common stock
from Intel Corporation. Intel originally purchased 1,552,632 shares of Avid
common stock in March 1997. See Note 10 to Condensed Consolidated Financial
Statements herein. As of November 9, 1998, the Company had repurchased
approximately 176,000 shares of Avid common stock at a cost of approximately
$4.1 million under the program announced during October 1998.
Other planned uses of cash include the efforts to develop the purchased
in-process research and development related to the Softimage acquisition into
commercially viable products. The estimated costs to be incurred to complete the
development of in-process research and development projects total approximately
$23 million through the first half of the year 2000. Additionally, the note
issued to Microsoft Corporation in connection with the acquisition is due and
payable in June, 2003.
YEAR 2000 ISSUE
The Company, like many other companies, is taking steps to confirm and address
its readiness for any problems that may arise due to the "Year 2000 Issue." In
broad terms, the "Year 2000 Issue" refers to the possibility that a given
computer system, software product or other equipment utilizing microprocessors
may not correctly process dates beyond December 31, 1999 because such systems
are coded to accept only two digit entries in the date code field, and therefore
might read a date using "00" as the year 1900 rather than the year 2000. As a
result, a given system may fail to work at all or may give erroneous information
or miscalculations potentially causing a disruption in operations, including,
among other things, interruptions in manufacturing operations, a temporary
inability to process transactions, send invoices, or engage in similar normal
business transactions.
The Company has commenced a phased program to identify, assess, test, remediate,
and develop contingency plans for all mission-critical applications and products
potentially affected by the Year 2000 Issue ("the Y2K Program"), to be
substantially completed by June 30, 1999. The Company has also established a
Year 2000 Program Management Office to manage the Y2K Program. All Company
groups are represented and involved in the Y2K Program efforts. The Company has
also engaged a third-party consultant to assist with the Company's Y2K Program.
The goal of the Y2K Program is to determine that the particular product or asset
is "Year 2000 Ready"; that is, when used in its designated manner of use, prior
to, during or after the calendar year 2000, the product or asset will operate
correctly, including leap year and date sensitive calculations.
The Y2K Program has identified three potential areas of impact for review: (1)
the software and systems used in the Company's internal business processes; (2)
the Company's software and hardware products offered to customers; and (3) third
party vendors, manufacturers and suppliers.
The Company, utilizing a third-party consultant, is conducting its inventory and
assessment of internal applications and computer hardware. Some software
applications have been determined to be Year 2000 ready, and work is already
underway to address other applications which have not yet been determined to be
Year 2000 Ready based on their importance to the business and the estimated time
required to make them Year 2000 Ready. Currently, the Company is on target for
completing its inventory and assessment phase by December 31, 1998. All internal
software and hardware testing and any necessary remediation is expected to be
completed no later than June 30, 1999.
With regard to products sold by the Company, the Company's Year 2000 Program
efforts include assessment and testing of designated products currently or
recently sold by the Company for Year 2000 issues. Generally, for any such
products identified as being subject to the Year 2000 Issue, the Company plans
to take an appropriate action suited to the particular product, such as
preparing updates, recommending migration paths, providing patches, ceasing to
sell the product, or a combination of actions.
While the Company's goal is to ensure that the designated products currently or
recently sold are Year 2000 Ready, the actual performance of such Company
products will also require that systems used by the end user in conjunction with
the Company products be Year 2000 Ready and accurately exchange information with
such Company products.
The Company has initiated communication with significant suppliers to determine
the extent to which the Company's operations are vulnerable to those third
parties' failure to remediate their own Year 2000 issues. Suppliers of hardware,
software or other products that might contain embedded processors were requested
to provide certification regarding the Year 2000 Readiness status of their
products. The Company will continue to seek certification from non-responsive
suppliers and will continue to evaluate the importance of other existing vendors
and suppliers. In addition, in order to protect against the acquisition of
additional products that may not be Year 2000 Ready, the Company plans to
implement a policy that would require sufficient assurances that products sold
or licensed to the Company are Year 2000 Ready, prior to purchase of such
products.
Year 2000 Readiness activities are expected for the most part to be performed as
a part of the Company's normal sustaining activity. The Company is not currently
able to estimate the total cost of its Year 2000 identification, assessment,
remediation and testing efforts. The Company believes based on available
information that Year 2000 Readiness will be achieved in a timely manner.
However, satisfactorily addressing the Year 2000 Issue on a timely basis is
dependent on many factors, some of which are not completely within the Company's
control, including the continued availability of skilled resources, critical
suppliers and subcontractors meeting their commitments to be Year 2000 Ready,
and timely action by customers to address their own Year 2000 issues. If the
Company fails to adhere to its timeline for achieving Year 2000 Readiness for
these or any other unforeseen reasons, the costs could become material to the
Company's results of operations as the millennium approaches.
As with other companies generally, the Company's internal business operations
could be subject to the risks generally associated with the Year 2000 Issue.
Moreover, because the Company is in the business of selling computer software
and hardware products, the Company is also subject to the potential effect of
the Year 2000 Issue on the Company's products, thus making the Company's related
Year 2000 risk potentially greater than that of companies in other industries.
Despite the Company's evaluation and testing of its internal business operations
or products, there remains the risk that errors or defects related to the Year
2000 Issue may remain undetected.
Should the Company's internal systems, its software and/or hardware products
delivered to customers or the internal systems of one or more of its significant
vendors, manufacturers or suppliers fail to achieve Year 2000 readiness (or any
combination of those events), the Company's business and its results of
operations could be adversely affected in a variety of ways, including the delay
or loss of revenue, a diversion in development resources, delay or cancellation
of the product development, or increased service or warranty costs. There can be
no assurance that there will not be interruptions in the Company's operations,
other limitations of systems functionality, product failures, or significant
costs incurred to avoid such interruptions, limitations or failures.
The Company has not yet fully developed a contingency plan to address situations
that may result if the Company is unable to achieve Year 2000 Readiness of its
critical operations. Development of such contingency plans is in progress and is
expected to be completed by June 30, 1999. The Company is also subject to the
same unpredictable external forces that generally affect industry and commerce.
There can be no assurance that the Company will be able to develop a contingency
plan that will adequately address all Year 2000 issues that may arise.
EUROPEAN MONETARY UNION
On January 1, 1999, eleven of the fifteen member countries of the European Union
are scheduled to establish fixed conversion rates between their sovereign
currencies and the euro. As of that date, the participating countries have
agreed to adopt the euro as their common legal currency. However the legacy
currencies will also remain legal tender in the participating countries for a
transition period between January 1, 1999 and January 1, 2002. During this
transition period, public and private parties may elect to pay or charge for
goods and services using either the euro or the participating country's legacy
currency.
The Company established a task force to assess the potential impact to the
Company as a result of the introduction of the euro. The task force has
developed a plan for addressing potential operational issues. The plan includes
testing and evaluating system capabilities, determining euro and legacy currency
pricing strategies and analyzing the effects on the Company's currency exposure
and hedging practices. The Company's plan for testing and evaluating system
capabilities with respect to the euro will determine whether the Company will be
able to process euro-denominated transactions such as invoices, purchases,
payments and cash receipts, and whether such transactions will be properly
translated into the legacy and reporting currencies. The Company does not expect
the system and equipment conversion costs to be material. Due to numerous
uncertainties, the Company can not reasonably estimate the effects one common
currency will have on pricing and the resulting impact, if any, on the Company's
financial condition or results of operations.
NEW ACCOUNTING PRONOUNCEMENTS
On June 15, 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative
Instruments and Hedging Activities." SFAS 133 requires that all derivative
instruments be recorded on the balance sheet at their fair values. Changes in
the fair values of derivatives are recorded each period in current earnings or
other comprehensive income, depending on whether or not a derivative is
designated as part of a hedge transaction and, if it is, depending on the type
of hedge transaction. SFAS 133 is effective for all fiscal quarters of all
fiscal years beginning after June 15, 1999 (January 1, 2000 for the Company) and
its adoption is not expected to have a material impact on the Company's
financial position or results of operations.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
A number of uncertainties exist that could affect the Company's future operating
results, including, without limitation, the following:
The Company recently began shipping its Avid Symphony product, which is based on
Intel Architecture ("IA") -based computers and the Microsoft Windows NT
operating system, and its ProTools/24 MIX product. The Company expects that a
portion of its revenues for the fourth quarter will be attributable to sales of
these newly introduced products. However, if these products fail to achieve
anticipated levels of market acceptance, the Company's revenues and results of
operations would be adversely affected. In addition, the Company has from time
to time developed new products or upgraded existing products to incorporate
advances in enabling technologies. For example, the Company is continuing to
develop additional products that operate using IA - based computers and the
Windows NT operating system. There can be no assurance that customers will not
defer purchases of existing Apple-based and other products in anticipation of
the release of such new products, that the Company will be successful in
developing additional new products or that they will gain market acceptance, if
developed. Any deferral by customers of purchases of existing Apple-based or
other products or any failure by the Company to develop such new products in a
timely way or to gain market acceptance for them could have a material adverse
effect on the Company's business and results of operations.
Many of the Company's products operate primarily only on Apple computers. The
Company relies on Apple Computer, Inc. as the sole manufacturer of such
computers. There can be no assurance that customers will not purchase
competitors' products based on non-Apple computers, that Apple will continue to
develop, manufacture, and support products suitable for the Company's existing
and future markets or that the Company will be able to secure an adequate supply
of Apple computers, the occurrence of any of which could have a material adverse
effect on the Company's business and results of operations.
In August 1998, the Company consummated its acquisition of Softimage from
Microsoft. Softimage is a leading developer of 3D animation, video production,
2D cel animation and compositing software solutions and technologies. The
Company's business and results of operations could be materially adversely
affected in the event that the Company fails successfully to integrate the
business and operations of Softimage.
The Company's gross margin has fluctuated, and may continue to fluctuate, based
on factors such as the mix of products sold, cost and the proportion of
third-party hardware included in the systems sold by the Company, the
distribution channels through which products are sold, the timing of new product
introductions, the offering of product and platform upgrades, price discounts
and other sales promotion programs, the volume of sales of aftermarket hardware
products, the costs of swapping or fixing products released to the market with
errors or flaws, provisions for inventory obsolescence, allocations of overhead
costs to manufacturing and customer support costs to cost of goods, sales of
third-party computer hardware to its distributors, and competitive pressure on
selling prices of products. The Company's systems and software products
typically have higher gross margins than storage devices and product upgrades.
Gross profit varies from product to product depending primarily on the
proportion and cost of third-party hardware included in each product. The
Company, from time to time, adds functionality and features to its systems. If
such additions are accomplished through the use of more, or more costly,
third-party hardware, and if the Company does not increase the price of such
systems to offset these increased costs, the Company's gross margins on such
systems would be adversely affected. In addition, during the first nine months
of 1998, the Company installed server-based, all-digital broadcast newsroom
systems at certain customer sites. Some of these systems have been accepted by
customers, and the resulting revenues and associated costs were recognized by
the Company. Others of these systems have not yet been accepted by customers.
The Company believes that such installations, when and if fully recognized as
revenue on customer acceptance, will be profitable. However, the Company is
unable to determine whether and when the systems will be accepted. In any event,
the Company believes that, because of the high proportion of third-party
hardware, including computers and storage devices, included in such systems, the
gross margins on such sales will be lower than the gross margins generally on
the Company's other systems.
The Company has shifted an increasing proportion of its sales through indirect
channels such as distributors and resellers. The Company believes the overall
shift to indirect channels has resulted in an increase in the number of software
and circuit board "kits" sold through indirect channels in comparison with
turnkey systems consisting of CPUs, monitors, and peripheral devices, including
accompanying software and circuit boards, sold by the Company through its direct
sales force to customers. Resellers and distributors typically purchase software
and "kits" from the Company and other turnkey components from other vendor
sources in order to produce complete systems for resale. Therefore, to the
extent the Company increases its sales through indirect channels, its revenue
per unit sale will be less than it would have been had the same sale been made
directly by the Company. In the event the Company is unable to increase the
volume of sales in order to offset this decrease in revenue per unit sale or is
unable to continue to reduce its costs associated with such sales, profits could
be adversely affected.
The Company's operating expense levels are based, in part, on its expectations
of future revenues. In recent quarters approximately half of the Company's
revenues for the quarter have been recorded in the third month of the quarter.
Further, in many cases, quarterly operating expense levels cannot be reduced
rapidly in the event that quarterly revenue levels fail to meet internal
expectations. Therefore, if quarterly revenue levels fail to meet internal
expectations upon which expense levels are based, the Company's operating
results may be adversely affected and there can be no assurance that the Company
would be able to operate profitably. Reductions of certain operating expenses,
if incurred, in the face of lower than expected revenues could involve material
one-time charges associated with reductions in headcount, trimming product
lines, eliminating facilities and offices, and writing off certain assets.
The Company has significant deferred tax assets. The deferred tax assets reflect
the net tax effects of tax credit and operating loss carryforwards and temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Although
realization is not assured, management believes it is more likely than not that
all of the deferred tax asset will be realized. The amount of the deferred tax
asset considered realizable, however, could be reduced in the near term if
estimates of future taxable income are reduced.
The Company has expanded its product line to address the digital media
production needs of the television broadcast news market, online film and video
finishing market and the emerging market for multimedia production tools,
including the corporate user market. The Company has limited experience in
serving these markets, and there can be no assurance that the Company will be
able to develop such products successfully, that such products will achieve
widespread customer acceptance, or that the Company will be able to develop
distribution and support channels to serve these markets. A significant portion
of the Company's future growth will depend on customer acceptance in these and
other new markets. Any failure of such products to achieve market acceptance,
additional costs and expenses incurred by the Company to improve market
acceptance of such products and to develop new distribution and support
channels, or the withdrawal from the market of such products or of the Company
from such new markets could have a material adverse effect on the Company's
business and results of operations.
The Company is also dependent on a number of other suppliers as sole source
vendors of certain other key components of its products and systems. Components
purchased by the Company from sole source vendors include; video compression
chips manufactured by C-Cube Microsystems; a small computer systems interface
("SCSI") accelerator board from ATTO Technology; a 3D digital video effects
board from Pinnacle Systems; application specific integrated circuits ("ASICS")
from AMI, Atmel, and LSI Logic; digital signal processing integrated circuits
from Motorola; a fibre channel adapter card from Adaptec; a fibre channel
storage array from Data General's Clariion division; and a PCI expansion chassis
from Magma Inc. The Company purchases these sole source components pursuant to
purchase orders placed from time to time. The Company also manufactures certain
circuit boards under license from Truevision, Inc. The Company generally does
not carry significant inventories of these sole source components and has no
guaranteed supply arrangements. No assurance can be given that sole source
suppliers will devote the resources necessary to support the enhancement or
continued availability of such components or that any such supplier will not
encounter technical, operating or financial difficulties that might imperil the
Company's supply of such sole source components. While the Company believes that
alternative sources of supply for sole source components could be developed, or
systems redesigned to permit the use of alternative components, its business and
results of operations could be materially affected if it were to encounter an
untimely or extended interruption in its sources of supply.
The markets for digital media editing and production systems are intensely
competitive and subject to rapid change. The Company encounters competition in
the video and film editing and effects, digital news production, and
professional audio markets. Many current and potential competitors of the
Company have substantially greater financial, technical, distribution, support,
and marketing resources than the Company. Such competitors may use these
resources to lower their product costs and thus be able to lower prices to
levels at which the Company could not operate profitably. Further, such
competitors may be able to develop products comparable or superior to those of
the Company or adapt more quickly than the Company to new technologies or
evolving customer requirements. Accordingly, there can be no assurance that the
Company will be able to compete effectively in its target markets or that future
competition will not adversely affect its business and results of operations.
A significant portion of the Company's business is conducted in currencies other
than the U.S. dollar. Changes in the value of major foreign currencies relative
to the value of the U.S. dollar, therefore, could adversely affect future
revenues and operating results. The Company attempts to reduce the impact of
currency fluctuations on results through the use of forward exchange contracts
that hedge foreign currency-denominated intercompany net receivables or payable
balances. The Company has generally not hedged transactions with external
parties, although it periodically reevaluates its hedging practices.
The Company is involved in various legal proceedings, including patent
litigation; an adverse resolution of any such proceedings could have a material
adverse effect on the Company's business and results of operations. See Note 9
to Condensed Consolidated Financial Statements.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS.
4 Common Stock Purchase Warrant dated August 3, 1998 by and between
Avid Technology, Inc. and Microsoft Corporation.
10.1 Registration Rights Agreement dated as of August 3, 1998 by and
between Avid Technology, Inc. and Microsoft Corporation.
10.2 Ninth Amendment dated as of September 30, 1998 to Amended and Restated
Revolving Credit Agreement and Assignment, by and among Avid
Technology, Inc., BankBoston, N.A (formerly known as The First
National Bank of Boston) and the other lending institutions listed on
Schedule 1 to the Credit Agreement, amending certain provisions of the
Amended and Restated Revolving Credit Agreement dated as of June 30,
1995.
27 Financial Data Schedule
(b) REPORTS ON FORM 8-K. For the fiscal quarter ended September 30, 1998, the
Company filed current reports on Form 8-K on July 7, 1998 and August 12,
1998.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Avid Technology, Inc.
Date: November 12, 1998 By: /s/ William L. Flaherty
----------------- ------------------------------
William L. Flaherty, Senior Vice
President of Finance, Chief
Financial Officer and Treasurer
(Principal Financial Officer)
EXHIBIT INDEX
Exhibit No. Description
4 Common Stock Purchase Warrant dated August 3, 1998 by and between Avid
Technology, Inc. and Microsoft Corporation.
10.1 Registration Rights Agreement dated as of August 3, 1998 by and
between Avid Technology, Inc. and Microsoft Corporation.
10.2 Ninth Amendment dated as of September 30, 1998 to Amended and Restated
Revolving Credit Agreement and Assignment, by and among Avid
Technology, Inc., BankBoston, N.A (formerly known as The First
National Bank of Boston) and the other lending institutions listed on
Schedule 1 to the Credit Agreement, amending certain provisions of the
Amended and Restated Revolving Credit Agreement dated as of June 30,
1995.
27 Financial Data Schedule