Avid Technology Inc (AVID) 2006 Q2 法說會逐字稿

Good day, and welcome, everyone, to the Avid Technology Second Quarter Earnings Results Conference Call. Today's 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 am Dean Ridlon, Avid Technology Inc.'s Investor Relations Director. I'd like to welcome you to today's call. 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 projected growth of existing or new markets, and anticipated results of operations during 2006.

There are a number of factors that could cause actual events or results to differ materially from those indicated by such statements, such as competitive factors, including Avid's ability to anticipate customer needs, and market acceptance of Avid's existing and new products, delays in product shipments, pricing pressures, fluctuating currency exchange rates, and adverse changes in general economic or market conditions, particularly in the content creation industry.

Other important events and factors appear in Avid's filings with the U.S. Securities and Exchange Commission. In addition, our forward-looking statements represent our estimates only as of today, July 20, 2006, 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.

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 Second Quarter 2006 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 will discuss some highlights from the quarter. Finally, Paul will come back and update our financial outlook for the rest of 2006. Following our prepared remarks, Paul and I would be happy to take your questions.

Avid delivered solid results in Q2. Revenues were $222.2 million, up nearly 40% from a year ago and in line with our plans. Contributing substantially to these results was the on-schedule delivery of all of the new products announced at the National Association of Broadcasters Convention in April that were scheduled to ship during the second quarter. We continue to emphasize the importance of delivering new products to our customers on time, and our Interplay non-linear workflow engine is still expected to ship in the third quarter.

In broadcast, we had a strong bookings quarter and increased our backlog substantially. We continued to rebuild our consumer business and the improvements that have been made to Pinnacle Studio 10 are being reflected by significant increases in user satisfaction ratings. Finally, our audio business had another good quarter highlighted by strong performances in both our home recording and live sound markets.

We are also announcing today that Avid's Board of Directors approved a program to repurchase up to $50 million of stock. The repurchases will be funded out of working capital.

I'd now like to hand it over to Paul to review the quarterly numbers in detail.

Thank you, David, and good afternoon, everyone. Our earnings press release contained a table highlighting certain non-cash items and related tax effects that are included in our GAAP P&L. We feel it is important to highlight these non-cash items as an indicator of the Company's cash generation capability.

The following items were included in the table for Q2 2006. First, acquisition-related and amortization charges totaling $9 million, or $0.21 per diluted share. Second, non-cash stock-based compensation charges of $4.3 million, or $0.10 per share. And thirdly, tax adjustments, primarily related to the foregoing non-cash charges, totaling a benefit of $1.5 million, or $0.03 per diluted share. The net total of these items is $0.28 per diluted share. When I refer to our operating segment profits later on, I will be excluding these items, since we don't allocate them to our business units.

Second quarter revenues were $222.2 million, up 2%, sequentially, and up nearly 40% from the second quarter of 2005. Organically, revenues grew in the 8 to 9% area year-over-year. GAAP EPS was $0.06 per share, including the net charge of $0.28 per share related to the items I've previously detailed and which are contained in our earnings press release.

Professional video revenues were in line with our plan at $118.9 million, up 25% year-over-year and approximately 2% sequentially. Excluding the estimated impact of the Pinnacle Media and Sundance acquisitions, professional video sales were up approximately 5 to 6% year-over-year. Roughly 50% of professional video sales for the quarter were to the broadcast market and 50% were to the post-production market.

Operating profit for the professional video unit was $6.2 million, or 5.3% of revenue. In addition to achieving its plan for the quarter, our video unit also substantially increased its backlog going into the second half of the year. Audio revenues were $74.3 million, up 14% year-over-year, and approximately 2% sequentially. In audio, we had strong sales of our traditional core products, as well as strong sales of our ICON and Venue mixing products.

Operating profit for the audio division was $10.2 million, or 13.7% of revenue. Consumer video revenues were level sequentially at $29.1 million in Q2, which was in line with our plan. However, home editing revenues were lower than expected. The lower than expected home editing revenues were offset by higher TV viewing revenues, but these products have lower margins.

Our consumer business unit reduced its operating loss from $2.4 million in Q1 to $1.6 million in Q2. GAAP gross margins were 49.3%, including acquisition-related amortization and stock-based compensation. Included in cost of goods sold is $5 million of non-cash acquisition-related amortization and $339,000 of non-cash stock-based compensation. These non-cash charges reduce GAAP gross margins by approximately 2.4 percentage points.

Lower consumer division gross margins, due to the higher percentage of TV viewing product sales, contributed to the decline in gross margins from Q1 to Q2. GAAP operating expenses were $108 million, including $7.9 million for acquisition-related amortization and stock-based compensation. Expenses were up, reflecting our participation in NAB and the acquisition of Sundance Digital. GAAP operating profit was $1.6 million, including $13.3 million of non-cash charges for acquisition-related amortization and stock-based compensation.

GAAP income tax--income before taxes was $3.4 million and our GAAP tax provision was $731,000, resulting in GAAP net income of $2.7 million, or earnings per diluted share of $0.06 on $43.1 million average diluted shares outstanding. Included in the GAAP EPS were the $0.28 per diluted share of non-cash items detailed earlier.

Our cash position as of the end of the quarter was approximately $238 million, roughly the same as at the end of Q1. During the quarter, we acquired Sundance Digital for approximately $11 million. Accounts receivable increased by approximately $12 million. Although DSOs increased to 58 days due to a variety of factors, including the Sundance acquisition, receivables aging improved with amounts over 60 days declining from 11.5% to 11.1% of the total.

Inventory increased by approximately $20 million sequentially as a result of a number of operating initiatives. We've been working for more than a year on transitioning our products to meet the requirements of the European RoHS directive. We were concerned, however, about possible slippage with key suppliers and therefore transferred additional pre-RoHS inventory to the EU during the quarter.

In addition, we built inventory in advance of a number of new product introductions expected in Q3. We expect inventory to decline to about 100 million by the end of the year. I will be back to update the guidance for the rest of 2006 after David reviews some of the highlights from the quarter.

Thanks, Paul. I'd like to continue with an overview of our business segments starting with video. On our last call, we provided an update on the broad range of new and enhanced products we introduced at NAB. I am pleased to report that all systems planned for Q2 release began shipping within the quarter. In our editing line, we released our new Media Composer software, Avid Mojo SDI, version 5.5 of Avid ExpressPro, version 8 of Avid DS Nitris, and version 6.5 of the Avid Newscutter family. We also shipped the latest versions of our shared storage systems, including Avid Unity ISIS 1.1, which now scales up to 192 terabytes of storage capacity and up to 150 clients, and versions 4.2 of Avid Unity Media Network and Avid Unity LAN Share, both with double their previous storage capacities.

And last but not least, we shipped the on-air graphics solutions we announced at the show, including version 4 of Dekocast, Version 7 of Thunder, and the new Thunder Station system.

Delivering all of these systems on time contributed substantially to the overall revenue performance we posted for video in Q2. Before I dive into a few specific details on how some of these products did in the quarter, I'd also like to mention that we're currently on track in Q3 to ship the remaining key products we introduced at NAB, including Interplay.

Now I'd like to talk about some specific product details. Last quarter, we mentioned how the lead count information we collected from attendees during NAB was almost 50% higher than in 2005. In Q2, we saw some of these leads turn into the first wave of sales. In particular, within the Media Composer family, we--which now includes our new software-only version as well as new pricing for Adrenalin, we increased our total revenues sequentially. We not only experienced increased sales to new customers, but also saw strong upgrade demand from existing Avid ExpressPro customers.

The large install base of Avid ExpressPro and Avid Express DV users is obviously a pool for upgrades in future quarters as well.

Also associated with our new version of Media Composer software, customers have the choice of adding hardware acceleration, either at the time of purchase or as a future upgrade. This could include adding our new Avid Mojo SDI accelerator or our Adrenalin hardware.

Our new price point for Adrenalin HD helped to almost double the number of HD Media Composer systems we sold in Q2, compared to Q1 of this year. We also saw an increase in upgrades to HD from our standard definition customers. This further underscores the HD adoption trend for those in our core editorial markets, many of whom have been holding out for the right moment to make the transition to an offline HD editing system.

Based on conversations with our customers, we believe this transition is still in its early phases, with less than a third of the editing seats converted to HD. We are also encouraged by the increased adoption of HD by rental facilities. The main evidence of this conversion is coming from our core Hollywood markets, where we're seeing an uptick in the number of rental facilities that are making significant investments in Media Composer and Avid Adrenalin HD systems in particular. Given that many professionals in the post-production community often look to Hollywood to gauge the acceptance of new technologies, we are extremely encouraged by the momentum that we're generating in this region.

Another product family that fared well in Q2 was our Avid Mojo line, thanks to the introduction of Avid Mojo SDI, a new member of the Avid DNA family, that can be paired with either Media Composer or Avid ExpressPro software. This is a compelling hardware add-on for many customers because it adds a serial digital interface for high quality professional video and audio connections for most professional decks and cameras to our previous generation of Avid Mojo accelerators.

Thanks to the introduction of Avid Mojo SDI, the unit count for this product family increased approximately 23% over Q1, resulting in our best quarter ever for Avid Mojo. The higher price point of the SDI unit helped to increase our revenue for the Avid Mojo product line by more than 50% in Q2 versus Q1.

Turning to the advanced finishing market, we continue to gain momentum with our Symphony Nitris and Avid DS Nitris systems. Symphony Nitris achieved important sales in Q2 to Savannah College of Art and Design and to Wexler Video. With the summer purchasing season for HD post-production systems now upon us in preparation for fall television work, we believe Avid is in a strong position to further extend its leadership in this market segment.

Switching gears to broadcast, we continue to see the ongoing proliferation of HD upgrades, a significant add-on opportunity that we've talked about on past calls, as broadcasters began to carry special events, news and sports programming in high depth. Similar in profile to the Winter Olympics earlier this year was the 2006 World Cup Tournament, which kicked off in early June and ended in July.

With the goal of delivering up-to-the-minute HD coverage of the tournament to millions of viewers around the globe, a range of broadcasters installed Avid workflows to get the job done. Some examples include BBC Resources post-production, which deployed its first completely tapeless high definition workflow using a mix of Media Composer Adrenalin, Avid Unity, Avid AirSpeed, and Symphony Nitris systems. With these systems, BBC Resources shared content across multiple geographies and produced daily highlights packages in HD using the Avid DNX HD compression format.

[TBS Techa] relied on a diverse mix of Avid equipment to provide HD coverage, including an Avid Unity, multiple seats of Avid ExpressPro, Media Composer Adrenaline systems for producing media in Avid DNX HD, one Symphony Nitris workstation, and a DigiDesign Pro-Tools HD digital audio workstation. TBS Techa delivered live game broadcasts and highlights for sports shows produced on location in Germany and distributed them to audiences in Mexico, Central America, and the United States.

And finally, Televisa, the broadcast division of Groupo Televisa SA, which is the largest media company in the Spanish-speaking world, also deployed three Deko 3000 character generators and two Thunder servers to create on-air graphics for live coverage and news highlights packages. The graphics systems were used in conjunction with Media Composer Adrenaline and Symphony Nitris systems to assemble the HD programs before broadcasting them to audiences in Mexico.

These are just a few quick snapshots of how our broadcast customers are increasingly turning to Avid workflows to help them deliver major events with impact and in high quality HD. In terms of our quarterly broadcast business, there were a number of highlights worth mentioning. This quarter, we booked a healthy mix of smaller market and mid-sized stations. But we also had a strong representation of larger deals, which doubled our average deal size over last quarter. In fact, in Q2, the U.S. achieved its second highest quarterly average for deal size, and Europe attained a new record for average deal size. This data supports our belief that the mix of remaining broadcast deals will continue to include large revenue opportunities.

Furthermore, we also increased our backlog this quarter, increasing the total by $20 million over last quarter, and achieving a new high in that category as well. This points to the overall health of our broadcast business and improves our visibility as we head into the second half of 2006. We believe that the transition from tape-based to digital workflows in the world's broadcasters remains in the early stages, and we estimate that roughly two-thirds of the stations have yet to convert.

Looking beyond end-to-end deals, we also experienced a 15% sequential increase in Q2 revenue for on-air graphics. For those of you who aren’t familiar with this segment of our broadcast business, it includes the Avid Deko graphics creation system and the Avid Thunder live production servers that we acquired from Pinnacle last year. These products often sit in an adjacent workflow to the newsroom, but also provide facility-wide access to visual branding templates and graphic elements that enhance a channel's identity in news, sports, and entertainment programming.

Turning to storage and networking, we performed very well in Q2, booking record revenue for our family of Avid Unity products. Revenue for Avid Unity ISIS was up quarter-over-quarter with sales to a number of customers, including Wexler Video, which purchased three systems to meet growing shared storage demand in the Hollywood market.

Another sale worth highlighting is Hearst Argyle Television, which purchased six Avid Unity ISIS systems to link together seven of its 25 stations.

At the other end of the shared storage spectrum, our Avid Unity LAN Share system also achieved strong revenue growth, up more than 40% over Q1. This system now provides twice the storage capacity of previous versions and is ideal for boutique, post, and small market broadcast customers who are looking for an affordable and a reliable shared storage system.

The last thing I'd like to mention regarding storage relates to our add-on business for the additional capacity that customers often purchase to augment the headroom of the systems they already own. As you know, last quarter we reported slower than expected sales for this area, but I'm pleased to say that we've regained our momentum for add-on storage in Q2.

One final area of our video segment I'd like to highlight is 3-D, which did well in Q2. As you know, Face Robot is our new facial animation system that started shipping during the quarter. The software is showing early signs of promise and we're looking forward to showcasing this innovative technology and our other 3-D products at the upcoming [Sigrath] Trade Show, which will take place in Boston during the first week of August.

Those are the highlights for our video division in Q2. Now I'd like to spend a couple of minutes talking about audio. As Paul mentioned, our audio division had another strong quarter with revenue increases sequentially and for the year. Some of the highlights that led to this growth include continued demand for our audio products at the upper end of the professional market. In particular, Digi Design's live sound console, Venue, achieved solid revenue growth with a 30% increase over Q1, a record quarter for this product.

Our flagship studio mixing system, D-Control, which continues to lead the conversion from analog to digital mixing, also posted a strong 24% unit increase from Q1.

In the home recording segment, a number of products made strong contributions as well, including computer-based recording devices, such as Digi Design's M-Box 2 audio interface and M Audio's Black Box, a digital amplifier modeling system for guitarists. M Audio's Axiom line of midi keyboard controllers also performed well.

Moving along to our consumer division, Paul mentioned that revenue overall was flat sequentially. That said, we continue to work very hard to make sure that business is running as efficiently as possible. We made operational changes within the engineering organization and focused the development team on fixing the problems associated with Pinnacle Studio 10. We are making progress. Customers are beginning to validate the improved performance of our Pinnacle Studio Titanium Edition, with satisfaction ratings jumping from 54% earlier in the year up to over 70% at the close of Q2.

We believe that the improved stability of Pinnacle Studio software, coupled with the marketing efforts we've planned for Q3, will position this product well for the critical end of the year holiday buying season. Competitively, Pinnacle Studio continues to maintain a strong position relative to some of our biggest competitors, which include Sony, Adobe, and [Magics].

Looking beyond studio, our TV viewing systems performed quite well in Q2 following the May release of our family of PC TV products across Europe and Asia. Demand for these products was fueled by an increase in consumer spending associated with the World Cup and the desire to be able to watch the tournament on a computer from any location. In fact, this new product introduction enabled us to increase revenues for our TV viewing line by nearly 50% over Q1.

That concludes our business overview for Q2. As we head into the second half of '06, we anticipate that our recent Q2 product releases will continue to have a positive impact on our performance. We're also looking forward to shipping additional products in Q3, most notably Avid Interplay, and believe this revolutionary new system will play a positive role in generating new business opportunities alongside the diverse mix of content creation management and distribution technologies we currently offer.

With that, I'd like to hand it back to Paul for guidance on the second half of 2006.

Thanks, David. On our last call, we said that we expected full year revenue to be in the range of $940 to $970 million. Currently, we think it's much more likely that full year revenues will be somewhere in the lower half of that range. Full year GAAP EPS is expected to be in the range of $0.78 to $0.88 per diluted share on a little under 43 million shares outstanding.

For the full year, there are some significant non-cash items included in our GAAP EPS. The following items are included - (1) non-cash acquisition-related amortization and in-process R&D charges totaling $36.1 million, or $0.84 per diluted share; (2) non-cash stock-based compensation charges totaling $17.2 million, or $0.40 per diluted share; (3) restructuring charges included in Q1 totaling $1.1 million, or $0.03 per share. These non-cash charges reduce full year GAAP EPS by $1.27 per diluted share.

In this updated guidance, the primary change is that we have lowered our second half outlook for the consumer business for both revenue and profit. Although we have made substantial progress improving the quality of our studio product, and this is being reflected in customer feedback, there is substantial softness in the overall market right now. We expect consumer revenues for the year to be in the area of $120 million. This is well below our original plan for the business. Although we currently expect to earn a small profit in Q4, we expect to lose money in our consumer business for the full year.

Full year GAAP gross margins are expected to be approximately 50%, including $21 million of acquisition-related amortization and stock-based compensation. These non-cash charges reduce gross margins by approximately 2.2 percentage points. GAAP operating expenses are expected to be between $428 and $433 million, including approximately $33 million of non-cash acquisition-related amortization and stock-based compensation.

We currently expect other income for the year to be approximately $8 million. Full year tax expense is expected to be between $14 and $16 million.

For Q3, we currently expect a sequential increase in revenues combined with a sequential decline in operating expenses. Therefore, we would expect a significant improvement in EPS in Q3 versus Q2 - as much as $0.15 a share improvement.

For Q4, our current expectation is for a very significant sequential improvement in EPS, based on substantially increased revenues, partially offset by slightly higher operating expenses. The expected Q4 sequential revenue increase results from revenue increases in all three of our divisions with by far the largest increase coming from our professional video division.

We expect to end 2006 with approximately $260 million of cash, assuming that the recently approved share buyback program is completed by year-end, and excluding any new M&A activity.

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

Thank you. (Operator Instructions.) And our first question will come from Steve Frankel with Canaccord Adams.

David, could you start by giving us an update on the PlayOut server business? I know that was an issue in Q1 and you didn't talk about it. So could you give us a little detail on what's going on there? And then, for Paul, just on the GAAP guidance, comparing the full year to the previous full year guidance you gave in Q1. Are the only changes in the operating business in that the assumptions for all of the non-cash charges are the same?

Pretty much so, Steve. So if you were to add back those items that we took out to the GAAP numbers we gave you, it would be comparable to the last guidance. So the $1.27 added to the $0.78--$0.88 a share.

And relative to your question, Steve, on just how we're doing on PlayOut servers. We had talked previously about those products being targeted competitively. We actually stabilized that business in Q2. And, in fact, Deco and Thunder units were both up from Q1, and from a revenue point of view, all three combined totaled an increase in revenue.

Okay. And where do you think you are in reworking the Pinnacle supply chain, especially on the broadcast side?

Well, there's two--we've talked in the past about making changes to the supply chain. On the broadcast side, it's actually not as significant in the sense that what we have is the current products that we will be continuing to shift, but very likely using similar production methods that we've had historically for those product lines. Where we're making the more significant changes are on the consumer side, where we're now leveraging our experience with M Audio volume manufacturing in China and applying that to the Pinnacle consumer business.

And will we see the impact of those changes in Q4, or that's more of an '07 event?

Yes, we're already seeing the benefits of that now in terms of the COGs associated with our products. Not all of the products, but it's actually feathering its way through our product line-up. By Q4 of this year, I would expect that transition to be in large part completed.

Thank you.

(Operator Instructions.) We'll move to Gene Munster with Piper Jaffray.

Hey. Good afternoon. And Paul, if we could just make sure we got the math correct here--is if you look at the non-GAAP number it sounds like you're guiding for '06 somewhere between 205 and 215. Does that sound correct?

Yes, that's right.

Okay. And then, second, just in terms of the big picture here. We kind of talk about it every quarter. I'm glad to see the consumer numbers coming down. I feel like those are kind of at a point where it takes the pressure off some of the numbers. But from a big picture perspective, you talked about a third of the industry has moved to high def. Can you give a little bit of insight to where that number comes from?

And second is that the price increase--the last time you guys did this, it also had a significant positive impact on your business. Should we continue to see some acceleration? And do you think that is something that is going to--we're going to look back and say that that was an inflection point in the business? Or is it more kind of a rising tide?

Well, I'll address the conversion ratio question, Gene. Just--this is based on talking to our current install base in terms of looking at the seats that they have and what percentage of those seats are still in SD versus having made the move to HD. In fact, if we just look at our own numbers for sales of Adrenalin systems and we back that up over the life of the product, the total install base of Adrenalin systems are only 16% in HD. So we see a large upgrade opportunity to move those standard definition Adrenalin systems to HD Adrenalin.

And a positive sign that we saw this quarter in Q2 was that 37% of the outgoing systems were in HD for this most recent quarter. And we do think that that is related in part to the trends moving more toward HD, but also, the more favorable pricing that we had for the HD option.

Okay. So you can just look at your own install base and calculate that they are only a fraction of that 15% that's moved to high def?

Yes. When we look at our own numbers it's 16%.

Okay. And then, I guess another more important question here is one of the things that people have been concerned about is that you had such huge growth for a number of years in broadcast--that with the absolute number of broadcasters is still small that has moved to digital. The number that has really meaningful budgets had already converted. What's your take on that?

Well, I think that's a part we covered in the script component of today where we talked about the fact that in the U.S. it was their second highest average deal size ever. Likewise, in Europe, it was their largest average deal size ever for us selling end-to-end systems. If we look worldwide and compare the average from Q1 to Q2, the average deal size actually doubled.

So if we looked at then one layer deeper, and we look at the components of that, we had a much larger number and a larger percentage of greater than $1 million deals. In fact, one in the $7 million category and one in the $5 million category. So we're seeing a nice sprinkling of very large deals. And we don't see that diminishing. So I think that this is a very good data point of the marketplace to realize that all of the big systems were not the first ones to move. And, in fact, one of the goals that we had for ISIS was our ability to go after some of these really big deals. So this is not going to be the last of the large multi-million dollar opportunities that you see.

Okay. And one last question, Paul, you said that backlog for [OR] backlog or broadcast backlog was up 20 million sequentially?

Yes, I had mentioned that in my part, and, yes.

Okay. And what was it up sequentially from March '05 to June '05? I know that June '05 was a difficult quarter, but what was the sequential change that period?

At the same period a year ago--I don't have that number in front of me.

It was--I'm sort of--it was less than 10.

Okay, great. That's fantastic. Thank you.

Thanks, Gene.

Our next question comes from Paul Coster with JP Morgan.

Good afternoon. I think in the past you've talked about organic growth rates for your businesses in the sort of 10 to 12% range, excluding the consumer business. And currently, we're seeing organic growth probably in the single digits. What is the disconnect? Have we got the--sort of the growth rate wrong or is it--are you sort of temporarily losing some market share?

Well, we're expecting I think organic growth rates for our professional video and audio businesses in the 10% area for this year. So that would be a little bit higher than 10% for the audio division and high single-digits this year for the video division - coming off a slow start, obviously, in the first half of the year.

So it's partly sort of seasonality. But also, presumably your own product cycle is affecting the entire industry at the moment.

Well, we--as you know, got off to a slow start here in the first half of the year, especially in the broadcast part of our business, which has been the most rapidly growing part of the video business. And, obviously, looking at the first part of the year for broadcast revenues being flattish, we're looking at a substantial acceleration of that growth into the double digits in the second half of the year.

Okay. Got it. In the first half of the year, do you feel that you lost ground competitively? I know that in the last quarter you saw some point solutions [taking] you off I think in the PlayOut server space and perhaps in [indiscernible]. But is that persisting or do you feel that it's a fairly constant competitive landscape now - both broadcast and post-production?

I would say that in broadcast and post that we feel like we're maintaining our share. And we've got some good data points to support that. And, in fact, now with the introduction of our software-only version of Media Composer, we've got higher unit volume. So if you talk about unit market share, we have the opportunity now with a lower-priced, but fully-featured version of Media Composer to go after a segment of the market that we weren't really fully serving before.

This also gives us a great upgrade opportunity for the Express DV and ExpressPro customers out there to now upgrade to a full blown version of Media Composer. That install base today is roughly 66,000 users. So it's a fairly sizable opportunity for us to go after for upgrades to Media Composer software.

Okay. Last question. On the studio side of the business, is there anything beyond the customer satisfaction ratings that kind of gives you comfort here? For instance, have you had any commitments from your retail channel in North America or elsewhere regarding shelf space allocation or in--channel inventory commitments going into the holiday season? Anything that we can sort of derive some comfort from to point to recovery of that business?

Well, those purchases have not been made yet. They will be made in the upcoming months though fairly shortly for the holiday season. We believe that there's not going to be any change in terms of the resellers commitments to the Pinnacle product line.

Also, if we just look at some of the narrower data that we do have - for example, the NPD data for the U.S. video editing software marketplace, we've actually got signs of increased market share for the Pinnacle Studio product. And we do believe that that is directly related to the improvements in quality. In fact, if we look back over the last two and a half months, roughly, we see a 10-point increase in market share relative to the competition in that market segment.

Okay. All right. Thanks very much.

You're welcome.

And we'll now move to Jim Ricchiuti with Needham and Company.

Hi. Good afternoon. I'm just wondering if there is anything you can point to in terms of the overall industry softness in the consumer business and what plans you might have to maybe try to jumpstart demand as we get closer to the holiday season?

Well--this is David. I'll just jump in in terms of what we saw in Q2 relative to Q1. Again, going back to NPD data, we do see that Q2 showed a decline - at least in the first two months of the quarter of Q2 - relative to the first two months in the quarter of Q1, on the order of around 20%. And we looked at the segments of personal productivity software, video editing software, and photo editing software. So we're seeing those trends applied to different software categories for the first two months of the quarter. We didn't have the data relative to the last month of the quarter.

So we're seeing a typical seasonality that is taking place, but we also believe that there is some softness just simply related to the general economy. As we serve the consumer marketplace, we end up being more affected by consumer concerns relative to inflation or interest rates, et cetera.

Now, as we look forward in the year, these are factors that have gone into us lowering our expectations for the second half of the year, although we still are anticipating some strong growth over our performance in the first half of the year.

Okay. David, I wonder if you could also just comment on the strengths that you're seeing in the audio business. I mean, it seems very broad-based. It sounds like it's a combination of some of the newer products you've introduced over the past year, year and a half. But is there all market share gain, or is it just a general healthy market that you're seeing out there?

A great question and it is broad-based. Our core of Pro Tools market continues to do very well - that's our Pro Tools PDM market. And we've had very good performance in both the music industry and the audio post industry. And where we're seeing even more rapid growth is in the home studio recording market where we've got M Box 2, and also, where we've got our pro lineup of M Audio products. And we're seeing some really good growth in the M Audio line of products, even higher than our overall average for audio.

And then, as we also mentioned, at the higher end mixing side of things, we're getting good growth in our studio mixing products - eControl and ICON - and very good growth in Venue, and that's our live performance mixing solution that is--it hit a record in Q2.

As you look at that market versus the way you viewed that market perhaps a year ago, have you increased your expectations for the longer-term growth of it or is it just--you think it's again a very health environment?

I'd view--the analogy I'd give is driving a car and what we're seeing is that as we get closer, our headlights are looking out further and we just see more growth available to us in the future in the live sound marketplace and in the mixing marketplace. So nothing that is a short-term limit to how much those markets can grow. And we are very pleased with our performance there because, in particular, with Venue and live performance, this is our first entrant into that marketplace. And that is a fairly sizable new market opportunity for Avid.

Okay. And one final question. Just when do you--would you expect to be involved in shipping the betas for Interplay?

The betas for Interplay--I'm--I would estimate given that we're going to be actually estimating to do final shipment of the product the middle of next month, that the betas are already in the hands of customers.

Okay. And--thank you.

You're welcome.

And we'll move to Randy Scherago with First Albany.

Hi, guys. Just a follow-up question because you guys went over it fairly quickly. The audio business is going great gangbusters. But I sort of missed what the--the sort of the split was between the professional versus the personal. And then, the second question is with M Audio have you actually started any sort of distribution in Europe with it yet? And have you seen any success with your professional business also in Europe?

Randy, this is Paul. Can you be more specific about your question?

Yes. I was just trying to break apart what part of the audio business was growing faster - Digi Design versus M Audio - and how M Audio and also the professional business is doing with your distribution in Europe now.

Well, if we look at our numbers for Q2, M Audio grew slightly faster than Digi - roughly 18% for the quarter year-over-year versus Digi at around 12% for the quarter year-over-year, but still good growth in both areas. Relative to your question of are we distributing the M Audio products in Europe. Yes, we already do have distribution of M Audio there. One of the new things that we had talked about doing was putting some of M Audio's lower end products into the Pinnacle consumer channel. We are just starting to do that with the Piano Wizard product, as well as the Podcast Factory. So we'll be putting that out over the Pinnacle channel.

And what sort of price point is that sort of Pinnacle consumer channel? I mean, is there--?

--Roughly $100 to $200.

Okay. All right. Thank you.

You're welcome.

Our next question comes from Brian Gagnon with Gagnon Securities.

Hey, Paul. Brian and Neil. The major difference in your forecast between Q1 and Q2 is a lowering of the Pinnacle estimates?

Yes, Neil. Substantially all of the lower outlook for revenue and EPS for the second half is related to reduction in our revenue and profit outlook for consumer.

Consumer means Pinnacle?

Yes.

Okay. Thank you.

Our next question comes from Chris Rowen with Soleil.

Hi, guys. You--I guess revenue was up $4 million sequentially. The consumer was flat and it sounded like just about every product was dramatically up sequentially - at least the ones you talked about. Can you give us an indication of some of the things that might have been down or weaker in the--outside of the consumer segment that might have offset some of those dramatic increases you talked about?

I don't have - beyond what was in the script - product by product breakouts. We usually don't breakout product line-specific information.

But were there any broad areas within either PlayOut servers or--?

--PlayOut servers--just--my recollection is PlayOut servers might have been down a million net-net for all of those different products in that PlayOut server category.

Okay. And then, what's the outlook for reporting taxes in 2007 at this point?

Really nothing's changed with respect to our outlook for taxes for '07. Obviously, as I say each time this question comes up, it's something that we need to look at on a regular basis and it's a function of the outlook and levels of profitability and the NOLs that we have. So I think we'll probably have some more--something more specific or definitive to say when we give the first '07 guidance in October. But nothing's changed with respect to our outlook for--certainly for when we expect to pay taxes. We don't expect to pay taxes for many, many years.

And as you know, if and when we do start to have to accrue for U.S. taxes, it starts with a reversal of the valuation allowance, which is a one-time positive hit and that creates the tax asset, which is then used to absorb the tax expense going forward as we accrue it. But there's no new information on that at this point.

Okay, thanks. Then, finally, have you done anything--any kind of internal audits? Can you say anything about your feelings on exposure to the options [backdating] issue?

Yes. I think I can--well, let me start with the last part of that in terms of my feelings. I think that we have been administratively very conscious of that over the years, so I feel pretty confident that we don't have any issues. We have done - at least at this point - a cursory informal kind of look-back, which confirmed that I don't think we have any issues. But we're probably just going to do something a little bit more formally to just put the belt on top of the suspenders.

Great. It sounds good. Thanks a lot.

And Steve Lidberg with Pacific Crest Securities has our next question.

Good afternoon. I was wondering relative to the profit margin of the broadcast business - sequentially down in the quarter. What is that attributed to and kind of thought process and migrating that back up to more traditional levels? And then, I guess, also, as it relates to more the post-production side of the business - the introduction of the Media Composer software-only package. Can you give us your initial thoughts on how that's being received in the market place? And more specifically, kind of thoughts relative to cannibalization of the hardware/software combined solutions.

Yes. I don't--I'm not sure exactly what you're referring to with respect to the broadcast margin because I don't think I made any specific comments about the broadcast margin.

Well, you're--if you look at operating margin--or relative to video, I guess. Video overall--.

--Video.--

--Was 5% versus 8% last quarter and then 13% in the December quarter.

Oh, okay. Well, I think the big issue always in Q2 in the video division is that they have a very substantial increase in operating expenses related to NAB. So if you look I think just about any year, operating expenses go up more than revenue does in the second quarter making operating profitability lower.

I guess, then, looking at it from a year-over-year perspective and the downtick from June of '05 to June of '06, is that just the inclusion of the Pinnacle business being lower margins on PlayOut? But I would imagine that actually carries potentially higher margins.

Overall, the Pinnacle businesses have lower margins.

Okay.

And Steve, I'll address your question about Media Composer software. Relative to just how we did with that product in meeting our expectations, it did meet our expectations for the quarter. As you could imagine, a lower priced product would have higher volumes than our previously priced product, and it did. It sold at over double the volumes that our regular Media Composer Adrenalin sold at.

But we didn't experience substantial cannibalization. In fact, if you think about the sorts of numbers that we talk about each quarter, we talked about selling roughly 1,000 units of Media Composer Adrenalin per quarter. If we look at what we did last quarter in Q2 and we add the sales of new Adrenalin, plus the sales of HD options, so those customers moving a standard def to a high def Adrenalin, that number was 988. So very close to that same 1,000 number.

So minimal cannibalization and very strong incremental sales of Media Composer in a software-only version. And then, as I mentioned previously, if we look at the upgrade opportunity, we had a nice upgrade business from our ExpressPro customers. And we have a fairly sizable install base of 66,000 ExpressPro plus Express DV customers who we can now target for upgrade to the full blown version of Media Composer software.

And lastly, Paul, can you give a breakdown of the stock-based comp? I got the gross margin when you gave that. Can you break out the remainder as it relates to operating expense? Thanks.

For what period, Steve?

For the June quarter.

Stock-based compensation was $4.3 million.

Right. Do you have the breakout between sales and marketing and G&A and R&D?

Oh, about .3 is in--no, I don't have the breakdown by function. I'm sorry.

Okay. I'll follow-up. Thanks.

Okay.

And our next question will come from Sasa Zorovic with Oppenheimer.

Yes. So firstly, sort of a housekeeping question here. What is the impact of currency on the quarter?

On a year-over-year basis it was pretty neutral. On a sequential quarter basis it was probably positive - several million at the top line.

Several million on the top line--you got a benefit from currency [inaudible]?

Yes, if you just run--if you just do the math using the current exchange rate versus the exchange rate a quarter ago and don't try to factor any other operating decisions that might have been made on the basis of those, you'd get a several million dollar benefit.

Okay. And then, my second question would be regarding margin and the margin outlook. Now, if we were to think about sort of improving the margins just like the operating margins [inaudible], do you think we'll need some additional kind of cost-cutting here or you ought to be really coming - over the next several quarters - and not necessarily year-over year [indiscernible]?

Yes. Sasa, I--was that a question about the overall Company?

Yes, or parts [inaudible] if you want to answer [inaudible].

I don't--I think that with the reduction in outlook for revenue in the consumer business, obviously, we're going to look at all aspects of that business. The first priority is to try to improve the revenue picture and actually do better than that from a revenue perspective. But beyond that, as you know, in response to lower than expected revenues in the first quarter in consumer, we did take some action and cut some costs. And I'd expect that we'd continue to sort of focus on that as the revenue stays at these levels.

With respect to the rest of the Company - audio and video. No, I wouldn't expect any kind of cost-cutting going forward. We're looking at pretty significant growth in both audio and video in the back half of the year.

Just--could you like give us an update maybe on the broadcasting side a little bit regarding sort of the competition there in terms of your being able to grow as the market--and hopefully outpace the market in the second half?

This is David. I'll comment on that. We've in the past talked about the fact that we've won more of these end-to-end deals than all of our competitors combined. That means that we believe that we have greater than 50% share of those end-to-end deals. We've also talked about how incrementally we believe we're winning in the roughly 70% category of the deals that we see today. That number has remained stable and what's good about the current position is that we also have more to sell those customers with the addition of our products from Pinnacle, as well as the new ISIS shared storage solution. We can sell more to those customers. I think that's a contributing factor to the fairly sizable increase in our average deal size this quarter.

So to us, it's not only just the number of customers, but also, how much you can sell to them and both of those are in a good position right now.

Okay. Then, finally, what I want to ask regarding the Media Composer, the software-only production, was I guess a very positive [inaudible] product. Apparently, in the second quarter it didn't really affect much, sort of 1,000 [inaudible]. But it was introduced towards the very end of the quarter. I was wondering how we ought to think or what sort of your estimates are in terms of how the products are like--they are cannibalizing one another for the remainder of the year?

Well, our estimate relative to the ongoing revenue from the combination of both of those products is that that product line as a family will increase over the course of the year. And relative to customers choosing one product versus another, it's difficult for us to dial that in precisely. If the impact that we saw in Q2 is consistent though, we will expect to have an ongoing strong business of Adrenalin SD plus the HD sales over the course of the year.

Even though we didn't start shipping Media Composer software until the end of Q2, because we announced it at NAB, customers had plenty of time to think about it prior to making an Adrenalin SD or HD purchase. So we're encouraged by the fact that a fairly sizeable number continue to buy our higher end offerings. And I think it's reflective of Avid's strong market position in the mid to higher-end of the offline editing marketplace.

Thank you very much.

Thanks, Sasa.

And we'll move to Chris McDonald with Kennedy Capital.

Hi. Can you just provide some additional detail on what you're doing to position the studio product--?

Position it in what way? Hello? I think he got cut off in mid-question. Hello?

--I realize you've fixed the technical part of the product, but more from a sales and marketing standpoint, what you're doing to reverse consumer sentiment relative to studio.

Oh, I see. Okay. Well, what we have been doing is--first of all, fixing the problem is the number one job because no amount of PR after the fact can fix the problem if the product itself is not working to customers' expectations. So that has been a primary effort. We've I think substantially improved the quality of the product and we just introduced the Studio Titanium Edition, which is different branding and allows customers to purchase the Pinnacle product not associated with the Studio 10.0 brand. I think that we've seen positive impact from that.

Now as we go forward supported by a product that is working and is very stable, we'll be doing marketing campaigns over all the standard methods that we would normally do. There's no substantial change to what we would do in previous years. We'll be doing that--targeted for Q3 and lining up for the holiday buying season.

So there's no dramatic change we're doing. It's mainly fixing the problem, having very good customer support to help customers who are having existing problems, and then, running it like a normal business going forward.

Okay. Thank you.

There are no more questions in the queue. At this time, I would like to turn the conference back over to you, Mr.--I'm sorry, Mr. Krall, for any closing remarks. Please go ahead.

Well, thank you. I know we've run a little over today, but I'd like to thank you all for joining us and say that should you have any further questions, please feel free to contact us directly. And we'll look forward to speaking with you again next quarter. Thank you.

And this does conclude today's conference. We thank you for your participation and you may disconnect at this time.