Avid Technology Inc (AVID) 2005 Q1 法說會逐字稿

Welcome, everyone, to the Avid Technology first quarter earnings results conference call. This call is being recorded. For opening remarks and introductions, I would like to turn the call over to the Director of Investor Relations, Mr. Dean Ridlon. Please go ahead, sir.

Thank you and good afternoon, everyone. I'm Dean Ridlon, Avid Technology, Inc.'s Investor Relations Director. In a minute, I'll turn the call over to David Krall, Avid's President and CEO. However, before we begin, please note that this call will include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, including statements about the status of Avid's proposed acquisition of Pinnacle Systems, Inc., new product releases and functionality, and anticipated results of operations during 2005.

There are a number of factors that could cause actual events, or results, to differ materially from those indicated by such statements, such as the possibility that the Pinnacle acquisition will not close, or that the closing will be delayed, competitive factors, including pricing pressures, fluctuating currency exchange rates, adverse changes in general economic or market conditions, particularly in the concept creation industry, delays in product shipments, market acceptance of Avid's existing and new products and other important events and factors disclosed previously, and from time to time in Avid's filings with the U.S. Securities and Exchange Commission, including with respect to the transaction with Pinnacle systems, the joint proxy statement prospectus, to be filed by Avid and Pinnacle, with the SEC.

Ina addition, our forward-looking statements represent our estimates only as of today, April 28th, 2005, and should not be relied upon as representing our views as of any subsequent date. Avid undertakes no obligation to review or update these forward-looking statements.

During this call, we will be referring to non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with generally accepted accounting principals. The most directly comparable financial measures calculated in accordance with GAAP, and a reconciliation of these GAAP measures to these non-GAAP measures, are contained in the press release announcing this quarter's results and available in the investor section f our website, www.avid.com. And now I'd like to introduce David Krall, President and CEO of Avid.

Thank you, Dean. I'm David Krall and I'd like to welcome you to our first quarter 2005 results conference call. In a moment, I'll hand the call over to Paul Milbury, our CFO, who will provide a detailed review of this quarter's financial results. Then I'll discuss some of the highlights from this year's National Association of Broadcasters Convention and provide an update on our proposed acquisition of Pinnacle systems. Finally, Paul will come and update our financial outlook for 2005. Following our prepared remarks, Paul and I will be happy to take your questions.

Now let's look at our results. Today we reported our best ever first quarter revenue and net income. Revenue in Q1 was $166m, up 30% from Q1 of last year. Non-GAAP net income for the first quarter was $22.2m, up 48% from the first quarter of 2004. Both our video and audio businesses posted good results with continuing strength across all areas of our business.

I'll talk about NAB and the proposed Pinnacle acquisition in a few minutes, but first I'd like to hand it over to Paul to review the numbers in more detail. Paul.

Thank you, David and good afternoon, everyone. Before I get into the results, I would like to remind everyone that our earnings press release, which is posted on our website, includes both GAAP and non-GAAP financial statements and tables reconciling the 2 sets of numbers. During my remarks, I will be referring primarily to the non-GAAP numbers, so I encourage you to refer to the financial statements to reconcile back to the GAAP numbers.

Our Q1 results get us off to a good start for 2005, with revenue of $166m and year-over-year revenue growth of 30%. Pro forma operating profits grew by over 50% year-over-year and our operating profit margin increased by 180 basis points to 13.8% of revenue. Both our video and audio segments had solid, double-digit revenue growth and both achieved double-digit operating profitability.

Video revenues were $104.5m, up 14% year-over-year, with both our broadcast and post production businesses posting good results, and audio revenues were $61.5m, up 74% reflecting solid performance from DigiDesign and from M-Audio, following its addition to our audio business in the third quarter of 2004. Excluding the M-Audio acquisition, audio revenue still increased more than 15%.

Geographically, our Q1 Americas business grew 17% year-over-year. Our international business grew 47%, with Europe particularly strong. For the quarter, the business was split roughly 50/50 between Americas and international.

Gross margins for the quarter were 57.2%.

As you can see in the financial statements attached to our press release, non-GAAP operating expenses were $72.1m or 43.4% of revenue in Q1, excluding the amortization and stock-based compensations related to the acquisition of M-Audio. The sequential decrease from Q4 primarily represents lower accruals for various variable compensation programs.

Non-GAAP operating income, excluding amortization and stock-based compensation related to the M-Audio acquisition was $23m or 13.8% of revenue. Non-GAAP operating profit for our video segment was $15.1m, or 14.5% of revenue and operating profits for our audio segment was $7.9m, or 12.8% of revenue.

Interest and other income was $837,000 for the quarter. Our pro forma provision for income taxes, which excludes $173,000 of tax benefits related to amortization, was $1.6m. Excluding the amortization related tax benefit and stock-based compensation related to the M-Audio acquisition and acquisition related amortization, pro forma net income for Q1 was $22.2m, or $.60 per diluted share on 37.3 million shares outstanding. GAAP earnings per share were $.53.

Cash increased during the quarter by approximately $21m to $176m. During the quarter, net cash provided by operational activities was approximately $15m. Accrued liabilities declined significantly in the quarter, primarily as a result of the payout of 2004 bonuses and sales commissions. Cash from the exercise of stock options was approximately $6m.

Days sales outstanding at the end of the quarter increased to 53 and our inventory turnover was 5.2 times.

I will be back to you shortly to update our guidance for the balance of 2005, but now I'd like to turn the call back to David for a discussion of the business highlights from this past quarter.

Thanks, Paul. Since we've just returned from last week's NAB convention in Las Vegas, I'd like to provide an overview of our various market segments by discussing the innovations we introduced at the show.

We made major announcements across our post-production, broadcast, shared storage and audio businesses and the response to our new introductions was extremely positive. At the show, Avid won 11 industry awards, making it our most decorated NAB in recent years. So let's jump right in.

We kicked off our NAB product announcements by fulfilling a long-standing customer request for a finishing solution that combined 3 key ingredients -- immediate composer editing experience, the corrective and compositing tool set of our Avid Symphony software and the HD processing power over the Nitris digital non-linear accelerator. The result is the latest member of the Avid DNA family, the highly anticipated Avid Symphony Nitros system. This advanced finishing solution offers real time editing and effects capabilities for multi-streamed, 10-bit HD and standard definition media, plus total conform with the entire media composer product family. The fact that our new symphony Nitris system delivers total conform ensures that the install base of facilities using media composer systems for creative editorial can implement an SD or HD work flow with the editorial, finishing and mastering stages of post-production, without losing any information in the process.

Symphony Nitris is priced at $89,995 and is expected to ship in Q3 of this year. It represents an upgrade opportunity for the thousands of Symphony customers currently only producing standard definition material in the field today.

On another front in high end post, we delivered new versions of the media composer Adrenaline HD and Avid DS Nitris systems. Data Composer Adrenaline HD 2.1 supports the standard film frame rate of 24P at HD resolution. The system also supports the Panasonic P2 and Sony XD10 tapeless acquisition formats, extending the flexibility of the system as a facilitator of a truly all-digital post-production work flow.

The latest version of our Avid DS Nitris family adds powerful new finishing features and expanded functionality for digital intermediates, or DI, work flows. This means that customers in the feature film industry, who wish to bypass the costly and time consuming process of outputting their dailies to film, can use the Avid DS Nitris system to either directly play out their media or output it to a digital tape format for screening.

The latest versions of both Media Composer Adrenaline and Avid DS Nitris are designed to serve the growing number of DI customers in television and film, who are increasingly working with resolutions that are higher than HD, such as 2K and 4K files. At NAB, we spoke with a number of customers who create a good deal of prime-time and film-based programming and they told us that they plan to incorporate an integrated DI workflow within the next few years.

As more of our customers implement integrated workflows that encompass various stages of the post-production process, they're asking Avid to deliver more powerful tools for storing and sharing their media. With this in mind, we introduced versions 4.0 of the Avid Unity Shared Storage system, which delivers 4 gigabyte fiber channel throughput, twice the band width of the previous versions of the Avid Unity system. The new version also supports up to 20 terabytes of storage, providing a scalable shared storage architecture for post-production environments, where multiple editors need to collaborate on the same projects in real time.

For our boutique post-production customers who need to deliver mastering quality work on limited budgets, we extended the HD functionality of our Avid Express family by launching the Avid Express Studio HD system, a high definition version of the all-in-one content creation suite that we introduced at last year's NAB show. In keeping with our mission to offer HD functionality across our entire product line, the Avid Express Studio HD system supports a wide variety of HD formats and resolutions, while also providing tighter integration between the software applications that make up the system.

While we've added HD functionality to the Avid Express Studio family, we've also lowered the price points of both configurations of the system, the complete and essentials versions. This ensures that our customers can take advantage of new HD support and enhanced integration features without worrying about increasing their budgets.

Moving on to broadcast, we introduced a new product at NAB that is truly ground-breaking, and one that we believe is going to further transform the way news stories are produced. That system is called Avid iNews Instinct and it is a tool that empowers journalists, newsroom staff and producers to easily create stories with text and video footage without the need to learn a professional nonlinear editing system. With iNews Instinct, a journalist can type the text for a script and then drag and drop media clips to accompany certain portions of the text. The system automatically calculates whether the read-rate for the script will be longer than the video clip, so users immediately know whether they need to shorten or lengthen either the script or video clips to tighten up their stories. Once their work is complete, they can submit footage to a professional craft editor who can add compelling transitions, effects, titles and graphics or, depending on the situation, the journalist can send completed segments directly to a video server, where news directors can approve the content for broadcast.

As with the rest of the Avid end-to-end broadcast environment, the goal with iNews Instinct is to streamline the news production pipeline by helping our customers increase their speed, control and creativity. And more importantly, it extends our digital workload to the non-editor segment of the newsroom, in a way that makes sense to them, rather than just putting them in front of a non-linear editing tool that was really designed for professional editors.

We were very pleased with the response to iNews Instinct at NAB. ABC News placed an order for 100 systems and we're confident that the other broadcasters will follow ABC's lead. In fact, with an existing install base of 60,000 seeds of iNews, there's a huge opportunity for iNews Instinct to have a major impact on the broadcast industry.

iNews Instinct also resonated with the media at NAB, judging by the many favorable mentions we received in a wide range of publications, including some that don't specialize in coverage of broadcast technology, and 3 of the 11 awards that I mentioned earlier were specifically for iNews Instinct. Avid won 6 product awards in broadcast this year, which is a new record for us.

With the introduction of iNews Instinct, our goal is to extend the power of visual storytelling to every desktop in the newsroom.

In other broadcast product news from NAB, we introduced new versions of both of our news cutter editing solutions, which support a broad range of HD formats, as well as the Panasonic P2 and Sony XTCAM tapeless camera formats that I mentioned earlier.

And finally, we unveiled a new input/output device called Avid DN Exchange, which enables broadcasters to ingest HD media without the need to upgrade their SD interfaces and routers. In essence, Avid DN Exchange allows broadcast customers to encode HD signals from cameras, switchers, routers and decks to Avid DNX HD media for editing and finishing. As more and more broadcasters transition from analog to digital production, and consider how to accommodate HD workloads in their production pipelines, solutions like the Avid DN Exchange interface and the new version of the news cutter system, provide extensive HD support at the high level of performance for which Avid is known throughout the broadcast industry.

In our audio business, DigiDesign introduced the D-Command console, a more compact version of the popular D-Control work surface that serves as the hub of the ICON integrated console environment. Since its debut a year ago, more than 200 ICON systems have been sold, which a rate of adoption far beyond that of other large format consoles in the same time frame. With D-Command, many of the benefits of the D-Control console are now within the reach of a wider range of customers, since the D-Command price point is lower than that of D-Control, and its smaller footprint can accommodate almost any commercial studio, home studio, post-production or mobile recording environment. In the same way that medium format digital consoles became a staple of high-end personal and project studios in the mid-90's, D-Command promises to have a big impact on the middle sector of the professional recording market.

In late February, the DigiDesign Venue, Live Sound Environment began shipping. DigiDesign Venue is a purpose built, modular, live sound mixing and production environment that brings the benefits of a digital audio work station to live sound performances. This product enables us to pursue a significant opportunity to upgrade live sound mixing from analog to digital technology.

Another important milestone in audio during the quarter happened just before the NAB show when DigiDesign and M-Audio introduced the first slate of products that combine pro-tool software with M-Audio hardware. Known as the pro-tools M-Powered family, this line of products initially pairs 5 M-Audio interfaces, including the new Ozonic mini keyboard and audio IO device with pro tools LE software. This combination delivers pro tools functionality to a potential target audience of 400,000 existing M-audio customers who use qualified peripherals. Add this to the fact that we also had a record quarter in M-Box sales, and you see that there's a lot of activity going on in the home recording studio market place.

That concludes our overview of Avid's products segments. Before I hand the call to Paul to discuss our financial outlook for the balance of the 2005, I'd like to update you on the status of our planned acquisition of Pinnacle Systems, which we announced on March 21st of this year.

On the regulatory front, we are in the process of finalizing the joint proxy statement prospectus and the Form S4 related to the acquisition and we are looking forward to filing it shortly. We completed our Hart Stafford unit (ph) filing regarding an acquisition in the U.S. on April 15th, and we expect to submit our foreign anti-trust filings next week..

Given the time required for European regulatory clearances, we do not expect to close the acquisition before mid-July, versus our earlier target of late June to early July.

With respect to our preparations to hit the ground running following the closing, the integration teams at Avid and Pinnacle are using this interim period to develop comprehensive plans, focused on running the combined businesses moving forward. We continue to be excited about this planned acquisition, and we maintain our strong believe that the acquisition will enhance Avid's business at both the consumer and broadcast levels. We are looking forward to gaining both the necessary regulatory clearances and shareholder approvals so that we can finalize this acquisition and begin executing our integration plans.

Now I'd like to hand it back to Paul to update our 2005 financial expectations.

Thanks, David. My guidance today is for Avid as a standalone company and it excludes the impact of the Pinnacle acquisition. When we announced the acquisition on March 21st, we made certain assumptions about the timing of the closing and provided initial guidance on the impact of the acquisition on Avid's results for the second half of 2005 and for 2006. As David just said, the transaction will not close by July 1st, the analytical assumption in our initial deal guidance. We are not updating that guidance at this time, but expect to do so after the joint proxy statement prospectus in Form S4 are declared effective by the SEC.

During our last earnings conference call in early February, I provided guidance for 2005 revenue to be between $700 and $710m. I am modifying this range to $705 to $715m. We are raising our 2005 pro forma earnings per share guidance to $2.70 per share from the $2.65 per share provided during our February conference call. Our guidance for GAAP earnings per share is $2.45, including $2.5m of stock-based deferred compensation related to the M-Audio acquisition, $7.6m of acquisition related amortization, and $700,000 of tax credits.

Using the mid-point of our full year revenue range of $710m, we currently expect revenue to increase sequentially to approximately $179m in Q2, followed by approximately $181m in Q3 and approximately $193m in Q4. Gross margins are expected to moderate from the Q1 level and be slightly above 56% for the remainder of the year.

Pro forma operating expenses are expected to be approximately $296m for 2005. In Q2, operating expenses are expected to be $73.7m, higher than Q1 primarily as a result of the NAB trade show. Operating expenses are expect to further rise in Q3 to approximately $74.5m and to $75.5m in Q4, as we continue to grow the business.

GAAP operating expenses, which include acquisition related stock-based compensation and amortizations, are expected to be approximately $76.3m in Q2, $76.9 in Q3 and $77.9m in Q4.

Pro forma operating income is expected to be $21.8m in Q2, $27.5m in Q3 and $32.7m in Q4. GAAP operating income is expected to be $19.2m in Q2, $25.1m in Q3 and $30.3m in Q4.

Net other income is expected to be $800,000 per quarter for the balance of 2005.

Pro forma tax expense is expected to be $1.3m in Q2, $2.1m in Q3 and $2.5m in Q4. GAAP tax expense is expected to be lower than pro forma expense by about $200,000 in each of Q2, Q3 and Q4. Since we removed acquisition related amortization in arriving at our pro forma expenses, we also remove any tax benefits related to amortization.

Pro forma net income for the year is expected to be $100.7m, or $2.70 per diluted share based on 37.3 million shares outstanding. Pro forma net income is expected to be $21.3m, or $.58 per diluted share in Q2, $26.2m or $.70 per diluted share in Q3, and $31m or $.82 per diluted share in Q4.

The EPS estimates assume fully diluted shares of 37 million in Q2, 37.25 million in Q3 and 37.75 million in Q4.

To calculate GAAP earnings per share, we assume acquisition related amortization of $1.9m per quarter and stock-based deferred compensation of $700,000 in Q2 and $500,000 in each of Q3 and Q4. We continue to expect to end the year with approximately $250m of cash, excluding the Pinnacle acquisition, which we expect will add to that balance.

These conclude my remarks. David and I would now be pleased to take your questions.

Thank you. (Operator Instructions) And we'll take our first question from Steve Frankel with Adams, Harkness and Hill.

David and Paul, I wonder if we might get a little bit of product detail on the video side, and just directionally, what happened to Adrenaline and Nitris revenue in the quarter compared to Q4?

Well, in terms of Adrenaline revenue, it was actually our second best Adrenaline quarter ever. You'd have to go back to Q2 of -- or, excuse me, Q1 of 2004, when we ran a Meridian upgrade of Q2 -- Q2 of '04 when we ran a Meridian upgrade program. So this quarter, this past quarter, Q1 was actually our second best compared to that. And, in fact if you added in the HD upgrades to that, it would actually be our best quarter.

Okay. And what about Nitris?

Nitris also had a strong quarter, although I don't have those numbers right in front of me.

And, directionally, what happened with backlog in the quarter?

Well, if you look at our backlog plus deferred revenue compared to Q1 of a year ago, it actually went up.

Okay. And you didn't give us a number on what broadcast revenue was, or if you did, I missed it.

No, we didn't break out broadcast separately. On a year-over-year basis, our broadcast market segment, which includes everything we sell into broadcast, the gross rate was in excess of 20%.

Great. Thank you.

And now we'll move on to Richard Ingrassia with Roth Capital Partners.

Hi, guys, it's actually Pronia Gorman (ph) for Richard Ingrassia. Can you guys give us the break out for DNA and CapEx?

Capital expenditures for the quarter were around $4m and depreciation was $3m.

Okay. And then when you guys look at the upgrade opportunity you had with the DNA platform, where would you say right now -- what percentage of that opportunity would you say you've achieved so far?

Well, there are a couple of levels of upgrade opportunity. The first one is just moving from our previously installed base of DBDB (ph) customers and Meridian customers to the new DNA family, and that upgrade process is only partially completed. In fact, if we do a running total of our total number of DNA products sold today -- actually if I just zero in on the Adrenalines, we're approaching, or exceeding, the 9,000 mark, which is roughly a third of the installed base of our previous generation of systems. So we're roughly a third along the path of that.

But the second upgrade process that will also be taking place is going from standard definition to high definition, because the DNA family was designed from the beginning to be upgradeable to HD and we are only in the very beginning part of that upgrade cycle because that just started shipping in Q4 of last year.

Okay. And then a quick question on Pinnacle. When you look at their consumer business being down 20% year-over-year and the recent quarter, and they kind of mentioned that they expect it to grow 10 to 15% like it had been, going forward. How do you guys reconcile that?

Well, when we look at it -- I don't know how far back you'd have to look to find the data to support this statement, but we know that this fiscal year for Pinnacle is unique in the sense that it doesn't include a major upgrade of this Pinnacle studio product. But they will have gone -- when you count their fiscal Q4, which we're just entering, they will have gone an entire year without a major upgrade to the studio product and this is a very much an upgrade-driven business. So we don't find those results surprising. We do believe that the anticipated release of Studio Version 10 late this summer is actually going to be a driver, but that will be in the beginning of the next fiscal year, or most likely, actually during the time when the results are combined with Avid. We don't find those results surprising and I think they're consistent with a product which is just getting older in its product cycle.

Okay. And you guys might not have this information, but I'll ask it anyway. When you look at their consumer and business segment, how much of that is actually the consumer product, just at the low end.

Yes. I don't think we're in a position to be able to break that out.

Okay.

You'd really have to direct that question to them.

Yes. I think yesterday, they stated that 72% of their revenue was consumer, 28% broadcast, but it didn't break it down further than that. Is that what you're -- you're looking for the breakdown?

Right, the breakdown in the segment.

Yeah. We don't have that.

Okay. Thanks, guys. Good quarter.

We don't -- we have that in our models, obviously, but we can't disclose that. That's Pinnacle information.

Okay. Thank you.

We'll now move to Gene Munster with Piper Jaffray.

Hey, good afternoon. And if you could just take a step back here and big picture stuff here, David, is that talk about the curve, I guess, in terms of the HD curve and how you see that? How should we be thinking about that? Is this something that has an acceleration point? Is it a slowly rising tide and if there's any sort of numbers that you could put around that to get us comfortable with what that -- the growth curve of the industry looks like? And then just a quick follow-up and (inaudible) long answer to this, but how do you see Avid -- obviously the results have been good, but maybe you can talk about -- if you've seen anything relative to competition or in terms of how you guys sit on that curve?

Okay. Well, relative to the transition to HD, Gene, I think you could probably answer the question as well as me if you attended that key note on the transition. I think the summary answer is, if you look around the world, you see various stages in terms of where we are along in the transition, but it's certainly clear that the transition is upon us and we are in the early stages of it because the majority of the world's infrastructure is still producing content in standard definition. And even the programs that are being finished in HD today, are still very often using a standard definition offline workflow. So we see the majority of the opportunity in front of us in terms of turning over the HD infrastructure.

And a lot of people are thinking that we're getting to a tipping point, if you think that the acquisition side of the balance with what we heard from Sony at NAB is that they've sold 37,000 HDV cameras. That was a number that I think surprised a number of people and tells us that HDV is going to be a pretty hot acquisition format moving forward. And it's going to certainly spur things because it's a low-cost, high quality format. So we're excited about HDV. If you look on the consumption side, even though it's only roughly 12 million or so U.S. TV-watching households that currently have HD receivers, that number is expected to increase significantly during the course of this year and we're expecting that to continue to accelerate as prices drop.

So many different parts of that overall lifecycle for HD content are accelerating and that's a positive indicator for the industry. When you look at what we saw competitively at NAB, interestingly, it was in some ways a relatively quiet year in terms of what we saw on the broadcast front. And I think we were very pleased to see that the iNews Instinct product introduction was actually seen by many as being the big news at the show because we've take a very different approach to editing as viewed by a journalist, where the main thing is writing a script and marrying text and video together. And I think we saw a lot enthusiasm around that. We are very, very pleased with it.

How about just kind of changing gears in terms of Pinnacle. If I was going to look at the two different worlds, Avid's world, you guys just continue to block and tackle and slowly inch the bar upward of -- you're kind of on this curve. And if you look at Pinnacle's world, it's almost like you're in a whole different, I don't know, orbit. And how do you, I guess, reconcile some of Pinnacle's issues versus your strength? I mean is -- basically, I think a lot of investors think Pinnacle is a broken company. And is a company specific -- is it product specific -- as you look at Pinnacle as whole, how do you think about where you're going to dive into; maybe some more specifics on it, the products or people? What needs to be fixed on Pinnacle to make this acquisition really work?

Well, I think that if you look at what Pinnacle has been doing over the past several years and in fact, if you zero in, in particular, on Patty's efforts over the past roughly 12 months of turning the company around, she's been focusing the company on the things that it does well, and in this case, I think the on-air graphics and play-out servers are real highlights in the Pinnacle product lineup, and she's been moving away from areas that were non-strategic. Well, certainly, those moves weren't done in anticipation of a deal with Avid, but I would say that they have very appropriately positioned the company for this anticipated merger because it has moved away from areas that Pinnacle was unsuccessful and really emphasized the areas that Avid is most interested in. And these products will just fit in very nicely with the Avid product lineup and into the Avid channel. So we see that being a very complementary combination.

And then on the consumer side, as we've talked about from a strategic point of view, that business has been a well functioning business on the part of Pinnacle, and there's actually not a great deal that we need to even do to the consumer business to get that continuing to hum along. And we're seeing strategic benefit from combining our low-end audio products with Pinnacle's low-end video products to really create a great combination that will let us serve customers' needs from the beginner all the way up to the Academy Award winning editor. So we're very excited about what this can do for us strategically.

Okay. And then I guess just on that note too, as you --I don't want to take anything away from the strong quarter you guys had and the positive outlook, but as you kind of look at Pinnacle over the last few weeks, has anything changed in terms of how you think about Pinnacle, how you think about the accretion to the deal? Do you kind of see some of the announcements in the past couple weeks in the company?

Well from the point of strategically -- I'll let Paul just comment on the financial component of it, but from a strategic point of view, there hasn't been anything that we've heard either from Pinnacle or from the competition, that has altered our view of the strategic value of the deal.

Paul Milbury. Yes. And I think we obviously have known for some time that the Q3 revenues were going to be around $65m, so that's not a surprise and that really doesn't change the way we're modeling things going forward. At this point, as David mentioned, we're going to be -- now that we've gotten the quarter behind us and NAB behind us, we're going to be sort of reinvigorating some of our discussions and integration efforts and we'll be able to fine-tune our models.

I guess one of the other comments that I wanted to make, going back to the question David just answered about Pinnacle and it's business, just a little bit more detail on the couple of products that David mentioned. He mentioned the broadcast products, Decko (ph) and Media Stream, just relating back to one of the comments that I think was made on the Pinnacle call about the gross margins of the broadcast business at Pinnacle being in the high 30s to mid 40s, although I can't go into a great level of detail about specific information in that area, the gross margins associated with those products that we're most interested in, the Media Stream product and the Decko product, are substantially higher than the average gross margins that they reported for the broadcast business.

So in other words, you're going to be basically exiting lower margin broadcast products?

Well, I think that's kind of been happening, to a certain extent anyway, and certain lines of business have been declining. There's also a component of service revenue in the broadcast business that has margins that are quite a bit lower than the average.

Okay. Great. Well, I'll turn the call over. Thank you.

I'll take our next question Paul Coster with J.P. Morgan.

Good afternoon. The upward revision to your forward guidance, does that have anything to do with the delay in closing the Pinnacle deal?

No, not at all.

Okay. Why is the Pinnacle deal slightly delayed?

It's basically just a fine-tuning of the estimated completion of the European regulatory process.

Okay. You sounded a little bit hesitant announcing the financial -- the question about the financial impact of the results that we've seen from Pinnacle. Is that because of the slight delay to the deal or is there something a bit more fundamental happening there?

No, not at all. I just -- I wanted to stay consistent with what I had said earlier, that we weren't providing any update to the guidance that we gave on March 21st and I didn't want to get into that at this point.

Great. Got it. Pinnacle has said that there has been a little bit of disruption from the deal in their European channel. Can you comment upon that and what you can do to reassure that channel at the moment?

Well, a couple of things that we've already done, and you can understand that any channel would be worried that perhaps in some geographies, where there is an Avid dealer and a Pinnacle dealer, that the Pinnacle dealer might be worried that they might not be continued by Avid once we are in possession of the overall company. We've sent out a letter telling the dealers that we are fully intending to honor the previous agreements that are in place by Pinnacle, which I think provides some level of assurance. In addition, we don't mind -- and we've communicated this as well -- we don't mind having areas where we have multiple dealers in a particular geography and we think that if a dealer is serving Pinnacle well today, that they will serve the combined company well the day after the deal closes and we would like to continue that as well.

So I think there's a certain amount of trepidation that is understandable and in a case where a dealer has an option to just simply reduce the amount of inventory that they're carrying, in many cases, we expect that they will do that. And I think that Pinnacle has experienced that in the previous quarter and they'll experience that, to a certain extent, in this quarter as well, as people just lessen the amount of inventory that they carry. But I think the silver lining in that is that as we get the business moving forward, that we would expect the inventory levels to return to traditional carrying levels and I think that gives us a latent increase in demand in the future.

Right. Were you surprised at the cash balance that Pinnacle reported at the end of the quarter?

No, not really. I think they had a little over $90m at the end of their previous quarter and they had announced divestitures of roughly $40m. That would get us to roughly that amount.

Okay. These are helpful answers. The last question is, the move to 2K and 4K editing, this is presumably on the ingest and post-production side, but this is not a forward indicator of the U.S.'s move to digital cinema, presumably?

It's considered to be independent of that. It's simply part of the continuation of the replacement of film in a workflow, because, as you know, film has higher resolution than HD, and as people try to achieve the same quality that they're able to attain today in film, they need to go to resolutions beyond HD to things like 2K - 4K. Believe it or not, we've heard 8K, 16K as other formats that people are already exploring. So I think the good news part of it, from a manufacturer's point of view, is that there's lots of room to build great products that can process increasing amounts of data and ultimately our goal is to make sure we're providing cost effective tools and an efficient and effective workflow so people can have an all-digital production environment. That's really part of Avid's mission and these formats are things that you're going to certainly hear us talking more about in the future.

Great. Thank you.

And now we'll move on to Sasa Zorovic(ph) with Oppenheimer.

Sasa Zorovic(ph). Thank you. So regarding in particular this situation in Europe that Pinnacle has been observing, would you say that there has been many -- or what is sort of your comment on the ongoing in-demand? I understand some of the issues with the inventories and what-not -- but how about any trends regarding the in-demand?

We actually don't have a lot of specific information at this point in time. They just released their numbers yesterday. We will actually be sitting down with them in Mountain View next week, going over the quarter and the outlook and doing our integration planning, and we'll get a better idea at that point.

What is you sense from your standpoint about the in-demand in Europe?

Well, the things that we do have are -- like GFK data or NPD data and we don't see any shift overall in market share. We see Pinnacle continuing to be a strong player in maintaining shares, so we're thinking that this is simply a reduction of channel uptake. And as you know, they record revenue in Europe based on sell into the channel as opposed to sell through. So we're not surprised that those results were directly reflected in Pinnacle's revenues.

And once you post the acquisition, would you be planning on recognizing revenue in the sell through in Europe?

I think that's something that we'll be talking about and discussing whether the systems can be put in place to get the appropriate data and to move in that direction.

And then finally, if you could provide us update, if any, regarding -- and your sort of competitive position particularly if you -- vis-a-vis the Apple?

Yes. What's your question?

If you could provide us with an update?

Just in terms of product offerings at NAB or what -- I just want to --

Any sort of competitively -- your positioning versus theirs, any changes regarding that?

Okay. Well, certainly, Apple is in an interesting position where they're a partner as well as a competitor. So on the partner front, we're looking forward to supporting the new Tiger OS and that work is underway and we expect to be putting out our versions of Media Composer Adrenaline supporting the Tiger OS shortly. We also have announced that we're expecting to have HD versions of Adrenaline running on the Mac by the end of this year.

So on the partner front, we continue to make good progress. I guess I should also point out that on the audio side, M-Audio actually sells a lot of their peripherals along with Apple's products, too. So we benefit there, as well.

On the competition side, I think what you saw at NAB, if you had the opportunity to go, you would have seen some new product announcements on the part of Apple, as well as -- I think it's the opportunity that everybody uses to launch new products. We had launched our Express Pro product last year, introducing the new Avid Xpress Studio. We introduced that at NAB last year. Apple introduced their version of a studio product this year. I think we announced HDV last year. Apple came out with their HD version of Final Cut Pro this year. So I think what you're seeing is the typical introductions that people do at the show where they're launching their new products.

Thank you.

(Operator Instructions) We'll now move to Chris Rowen with Sun Trust Robinson Humphrey.

Paul, on the Pinnacle acquisition, I understand the desire not to give out a bunch of numbers and have to change them again. But can you, at least for us, kind of bound the amount of change you might see to the guidance, the combined guidance, you gave before? I mean, are we talking if it's a week, it could change the year by a nickel or are we -- I'm just afraid of leaving people to guess, or fear the worst if we don't -- if we had guidance and now, all of a sudden, we have no guidance.

Yes. I really can't put a -- I'm not saying that the number's going to change one or another. I'm just saying that we're not prepared to update it today.

So does that mean you --

And certainly nobody should read that we think the previous guidance is -- needs to be lowered based on recent results. That's not at all what we're saying.

Okay. Thanks. That's helpful. Thanks.

And we'll move to Steve Lidberg with Pacific Crest Securities for our next question.

Good afternoon, guys. I was hoping you could provide some thoughts on -- or color with regards to the health of the markets, and I guess particularly what you're seeing in Europe and the strength of the quarter there?

Well, I think one of the drivers that was a big factor for us this recent quarter in Europe was a very strong broadcast business. And if we just look at the transition cycle to all-digital production, we're seeing a strong uptake in Europe and our European team has actually done an excellent job in not only getting the business, but also significantly improving the gross margins associated with that business. In fact, in this most recent quarter, our European margins topped our geographies on the video side of our business. I had to look back in our records. I didn't find a previous quarter where they had been the top. So I think this is a new high for them and a good example of just very good execution.

And I guess, Paul, as you look at the guidance for the full year '05, obviously you took it up with most of that in what appears to be the back half of the year in Q4. Is that primarily a function of the activity that you're seeing around broadcast and the backlog related to that business, or are there some other factors that we should be thinking about?

Well, yes, it's the broadcast, but we've also got a number of new products that we're releasing. The Symphony Nitris product is expected to ship for the first time in Q3. So that explains part of the up-tick in Q3.

And correct me if I'm wrong, but in Q2 you also would be receiving a benefit from, I believe it was the TBA contract in France last year in Q2, in terms of the payment?

Yes. There was a final payment of about $.5m that was due in 1 year from the -- exactly.

Okay. Great, thank you.

And our next question comes from Jim Ricchiuti with Needham & Company. Mr. Ricchiuti, your line is open.

Thank you. I apologize if this was already asked. I joined the call just a couple minutes late. But, Paul, did you go over the operating margins for the video business and did -- were those 14.5% in the quarter?

Yes.

And I just wondered, David, I think you alluded to the strength and improving profitability in the European business -- other factors that contributed to the expansion on a sequential basis in the video business margins?

We had a strong growth quarter in Asia as well, so internationally, you saw our split go to virtually 50/50 between international and domestic business. So strong performance internationally, overall. I can't point to a particular product driver there. I think it was general uptake in the business, which is great for us to see in a Q1 because ordinarily, prior to NAB, we see things -- just wait in anticipation for new introductions at NAB and this year we saw people feeling comfortable continuing to conduct business.

Okay. Did you break out the broadcast portion of the business at all or talk about the growth rate that you saw year-over-year in that business?

We said it was over 20% year-over-year, but we didn't break out a specific number.

Okay. So as a percent of revenues, you're not willing to share that?

I just don't have that detail.

Okay. And one other follow-up question, just with respect to the video business, are you at all concerned about some reports of softening in the advertising market?

I guess I'd say I haven't seen any of the reports talking about that so I can't comment on it. If it is something happening, and we're not seeing it, again, primarily, we're driven by capital budgets as opposed to expense budgets on a quarterly basis. So from a capital point of view, I think our customers are still fully intending to make their investments.

Okay. And just with respect, David, to the audio business, or Paul, margins in that business, operating margins were 12.8%. Is that correct?

Yes.

And just the decline that you saw on that. Did you just talk at all about that on a sequential basis? What might have led to that? Is there some seasonality to that or is it a mix issue?

Yes, actually, there is a little bit of seasonality to that. The revenue for audio was down sequentially, the same as last year. Last year in the first quarter, audio operating profit margins were at 5.4% and then rebounded to 18% in the second quarter. So they're down in Q1 as revenue came down and then they came back. I would actually expect, although we're not providing specific guidance for the segment, that video operating profitability to be down slightly in the second quarter because we have the expenses associated with NAB that are a big tick-up for the video segment in the second quarter. And then I would expect audio operating margins also to increase with volumes in the second quarter.

Okay. Thanks very much.

Yes.

And our final question today comes from Gene Munster with Piper Jaffray.

Great. Just in time there. If you look the Pinnacle channel, are there some key vendors or key resellers you guys are going to be picking up? I would assume that there is some kind instant synergies with your existing proxy you can fill in with Pinnacle's channel. Is that a safe assumption?

Yes. It is true on the broadcast side, where there's a channel that they have in place that is certainly complementary to what we have. And then on the consumer side, that's a case where Pinnacle is bringing in a very large and well developed channel that we will be fully expecting to exploit over time with our audio product.

Okay. Dynamite. And then in terms of the broadcast issues and maybe direct sales people, any sort of expectations in terms of the headcount additions going forward maybe for the rest of this year; any thoughts on that?

Not really. Our plan all along has been to integrate the Pinnacle broadcast business into the Avid video business and have these teams work as part of the same team. And we are fully expecting the members of Pinnacle sales force to join ours. In fact, we've got a number of open reps that we've been holding off on hiring so that we'll have additional places to accommodate the Pinnacle team.

And I guess the reality is is that, yes, your broadcast direct sales force is going to now obviously increase with Pinnacle?

Yes. Yes.

And then lastly, the NOL, just kind of an update on that front, Paul?

No change from where we've been in previous discussions; still a very significant level of NOL and tax credits to shelter future earnings.

Do you have any idea in terms of how we should start thinking about when those start to come off, if you will?

No change from the previous guidance there that we don't expect that to be 2006, certainly.

Not in 2006?

Not in 2006.

Okay. Great. Thank you very much.

You're welcome.

And that does conclude today's question and answer session. And Mr. Krall, I'd like to turn the conference back over to you for any closing or additional remarks.

All right. Well, thank you and thank you all for joining us today. I'd like to invite you that if you do have any further questions, please feel free to contact us and we'll look forward to speaking to you all gain next quarter. Thanks.

That concludes today's conference. Thank you for your participation.