Avid Technology Inc (AVID) 2006 Q4 法說會逐字稿

Please stand by. We're about to begin. Thanks so much for holding ladies and gentlemen and welcome to the AVID Technology fourth quarter earnings results conference call. Just a reminder, today's call is being recorded and now for opening remarks and introductions, I would like to turn the conference over to the director of investor relations, Mr. Dean Ridlon. Sir, please go ahead.

Thank you. Good afternoon everyone. I'm 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 2007.

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 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 US Securities and Exchange Commission.

In addition, our forward looking statements represent our estimates only as of today, February 1, 2007, 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 principles. 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's section of 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 fourth 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 a few highlights from the operations of each of our businesses. Finally Paul will come back and update our financial outlook.

Following our prepared remarks, Paul and I would be happy to take your questions.

In summary, our revenue for Q4 was $239 million. Broken down by business unit, our audio segment performed well, rebounding from the slow down in demand for Pro Tools HD system experienced last quarter.

Consumer had a solid quarter with slightly higher than expected revenues based on strong demand in Europe.

Revenues from our professional video business continued to lag and I'll discuss some of the underlying causes and the actions we are taking to address these issues in a few minutes.

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

Thank you, David and good afternoon everyone. First of all I wanted to bring to your attention that the 8K that AVID filed today includes information about my decision to accept an offer to join a smaller, private technology company in the Boston area as VP of operations and chief financial officer. I'm not disclosing the name of the corporation I am joining at this time so that this company can determine the best time to release the information to the public.

This is a personal decision I have made based on the uniqueness of this new opportunity for me personally and professionally and believe me, this was a very difficult decision for me to make to leave AVID.

I plan to remain as CFO of AVID through March 2 and will stay through the completion of the company's 2006 404 assertion process and the filing of the company's form 10K. At that time the company's controller, Joel Legon, will assume the role of acting CFO.

We will not provide any additional information on my situation on this call so we would ask you not to ask any questions later in the Q&A.

As David said, revenue for the fourth quarter was $239 million, up sequentially but down slightly from Q4 of 2005. Our revenues and operating profits were lower than expected this quarter as a result of continuing issues in our video division. We've not received the necessary customer acceptances on several large broadcast deals and we were unable, for operational reasons, to move as many deals as we had expected from backlog to revenue.

GAAP gross margins were roughly the same as Q3 at 48.1% including $4.9 million of non-cash charges for acquisition related amortization and $296,000 of stock based compensation. Without these non-cash charges, gross margins would have been 50.2%, which was lower than we had expected.

Video gross margins were down substantially from the prior quarter while audio and consumer gross margins both improved from Q3.

The decline in video's gross margin was related to several factors. Our service margins were lower due to lower service revenue on a relatively fixed cost base. In addition, we had a number of lower margin deals due the inclusion of third party products and losses on the CNN contract we assumed after the Pinnacle acquisition. We expect video gross margins to increase from the Q4 levels during 2007 based on improved product mix.

Operating expenses in the fourth quarter included a non-cash charge of $53 million for the impairment of the goodwill associated with the acquisition of Pinnacle Systems in August 2005. As a result of completing its annual goodwill impairment test in the fourth quarter, the company concluded that the fair value of the consumer business unit had declined below the book value, resulting in the impairment charge.

The company also incurred restructuring charges of $3.2 million as a result of reorganizations within the professional video and consumer segments that took place during the quarter.

GAAP net loss before taxes was $45.2 million and our GAAP tax provision was $7.3 million, resulting in a net loss of $52.6 million or $1.28 per share on 41 million average basic shares outstanding.

The main reason for such a high tax on a loss of $45.2 million is that the $53 million goodwill impairment is not tax deductible. In addition, there was a negative impact from the utilization of acquired Pinnacle tax assets. The utilization of these assets is treated as a reduction of purchase price rather than a P&L benefit.

Non-GAAP tax expense was approximately $400,000. The main reason for such a low tax rate in Q4 was the reduction in the full year tax rate from our Q3 estimate of 16.8% to a final rate of 12.5%. The fourth quarter included the catch up adjustment required to bring the full year rate down by 4.3 points to 12.5%. As a result of the impact of the impairment charge in Q4 and a planned corporate restructuring of some of our international entities, we are no longer anticipating a reversal of the deferred tax asset valuation allowance in 2007. We previously indicated that our non-GAAP tax rate would increase to 25% in 2007. We now expect the rate to be approximately 20%.

Included in our press release there was a breakdown of certain items that are included in our results. These items total $75.1 million and include the goodwill impairment charge related to the Pinnacle acquisition, acquisition related amortization, stock based compensation, restructuring, in process R&D and related tax adjustments.

The reason these items have been highlighted is that when we measure the performance of our business units and when we disclose our business segment results externally, we do not include these items.

Adding the $75.1 million in charges to our GAAP net loss results in GAAP net income of $22.5 million for the fourth quarter. Using fully diluted shares of 41.7 million non-GAAP earnings per share would be $0.54.

I would now like to get into a little more detail about the operating performance of our three business segments, professional video, audio and consumer video. Repeating what I said earlier, in addition to interest and taxes, we exclude the following items from our business segment results in Q4. First, the $53 million impairment charge; second, $8.4 million of non-cash charges related to acquisition related amortization of intangibles, $3.6 million of non-cash stock based compensation and $3.2 million of restructuring costs related to actions in our professional video and consumer businesses.

Professional video revenues were approximately $118 million, down both sequentially and from Q4 of last year. Video operating expenses were up a little more than $1 million sequentially. As a result of the lower revenues and gross margins that I talked about a few minutes ago, video operating profits decreased sequentially by $9.6 million to $4 million or 3.4% of revenues.

For the full year, video revenues were up 7% to $479.4 million. Operating profits were $34 million or 7.1% of revenue.

Clearly this was a disappointing year for our video business unit on both the top and bottom lines. However, video did end the year with its highest backlog ever, more than twice the amount that it had at the end of 2005.

Audio revenues recovered nicely from last quarter and were up 12% over both Q3 and the same quarter of a year ago. The increase was primarily the result of a rebound in revenues from Pro Tools HD systems. Audio gross margins improved sequentially while operating expenses were flat sequentially. As a result audio operating profits increased sequentially by $6.7 million to $16 million or 19.3% of revenues.

For the full year, audio revenues were up 14% to $304.4 million. Operating profits were $45.1 million or 14.8% of revenues.

Audio's performance for the year was very solid and in line with our original operating plan.

As expected, consumer revenues were up sequentially to $38.1 million. Gross margins were also up sequentially and operating expenses were slightly lower in the quarter as a result of several cost cutting measures.

As a result the consumer unit generated an operating profit of $1.3 million after posting a loss of $2.4 million for Q3.

For the full year, consumer revenues were $126.8 million and operating loss was $5.2 million.

Summing up the business segment results for the quarter, total revenues were $239 million. Gross margins were 50.2% and operating expenses were approximately $99 million.

Operating profit increased sequentially to $21.3 million or 8.9% of revenues.

For the full year, revenues were $910.6 million. Gross margins were 51.3%. Operating expenses were $393.3 million or 43% of revenue and operating profits were $73.9 million or 8.1% of revenue.

Turning to the balance sheet, cash was up a little over $12 million to $172 million. Receivables were down and DSO's declined but inventory was up nearly $10 million primarily as a result of an increase in inventory related to deferred revenue deals.

I'd now like to hand it back to David to review some of the highlights from the quarter.

Thanks, Paul. At this point I'll review our three business segments and provide some details around the operations of each group, starting with video.

As Paul mentioned, our Q4 performance in video did not meet our expectations. The primary reason for the shortfall was our inability to recognize revenue from a handful of large enterprise deals right at the end of the quarter. We've mentioned on past calls that these large deals are broad in scope in terms of product and work flow complexities, installation requirements and in training and education of personnel. As a result, a few of the deals that we had hoped to close and recognize in Q4 were pushed out of the quarter.

Since this type of delay of big deals has happened at quarter end before, it's worth digging into further detail regarding why this happens and what we are actively doing to address it.

To start with, a big deal is exactly like it sounds. It's generally a large order comprised of multiple product deliverables, which could include products from third parties. In addition there is usually a service component which includes installation, training, and/or product support. Sometimes AVID serves as the prime contractor, integrating products from third parties and taking responsibility for the successful implementation of the entire deal. From this description it's easy to see that a delay to the project can come from many sources. It could be caused by a product delay, from AVID or a third party, there could be a product change order, which increases or alters the scope of a particular deliverable.

Training can be delayed due to availability of client personnel, which is sometimes unpredictable due to conflicting commitments, vacations, or difficulty in hiring the right person. Final acceptance may be delayed because of unilateral decisions on the part of the customer to delay their on-air date.

These provide just a flavor of the reasons why a deal may be delayed and it can only take one of these to move the date.

So if that describes the problem, what can we do about it? There are a number of initiatives already underway to help, although there is no single fix to the entire issue.

First, we have created a new team internally within our video division, which is responsible for reconciling our customer requirements against our in-house development road map. This ensures that AVID product deliverables are clearly identified and tracked for each big deal.

Second, the sales compensation plan in the Americas and Asia Pacific has been changed to be based on revenue and gross margin dollars instead of bookings. This new comp plan, which is already in place successfully in Europe, encourages the sales team to quote deals that don't incorporate customer requests for future deliverables. Put another way, it rewards our sales team for selling only what is currently shipping.

Third, we have created a worldwide enterprise team, which is responsible for interfacing with our global customers on a world wide basis. This will replace the structure we used previously where we dealt with our global customers separately in each of our three worldwide geographies. This approach should improve the uniformity of solutions we sell to our global customers, leading to less customization in each area and consequently improving the predictability of delivery.

Lastly, because of the complex nature of our big deals, we currently recognize all revenue on a completed contact basis. In other words, we wait until all essential services have been delivered and the customer has signed a final acceptance document before we recognize any revenue. Over the past few years, however, the company has established a successful history of installing large broadcast solutions. We will be reviewing changes to our business practices that may allow us to recognize revenue as services are delivered. Any changes in business practices will take time to implement but would be a further way to improve predictability.

As we mentioned last quarter, we have appointed a new general manager, Graham Sharp, to lead our video division. While Graham has already made great progress in his first few months, it's clear that we still have much work in front of us to align our business with the changes that are occurring in the marketplace.

In broadcast, for example, average deal sizes continue to increase. Our broadcast business now represents roughly half of our video revenue.

Our success in this market is gratifying and as the world's broadcasters and media enterprises move to adopt our most advanced and integrated solutions, we realize that we need to evolve our business so that we can deliver these solutions as predictably as we could ship stand alone editing systems in years past.

And despite the Q4 revenue shortfall in our broadcast segment, you should know that our post segment showed positive growth compared to Q4 of last year and was up 13% for the full year compared to 2005. We also experienced positive results on a number of product fronts in Q4 including record quarterly revenue for our workgroup solutions, strong demand for our low cost shared storage solutions, Avid Unity LANshare, and solid performance of the device control and automation systems we acquired from Sundance Digital in April of last year.

In addition, the bookings we completed in Q4 brought our big deal backlog to record levels. The deal pipeline for converting newsrooms from tape based to digital workloads remains healthy and we are increasingly seeing opportunities to take newsrooms further along the conversion path to HD production.

In a recent example a customer who initially bought a digital newsroom solution from AVID approximately four years ago, for over a million dollars, is now evaluating upgrading that system to HD at an estimated cost roughly equal to the initial installation. This shifts our view of the broadcast transition from tape based to network solutions from a one time event to an ongoing process of conversion, upgrades and expansion on a steady state basis.

To summarize the discussion of our video business, there's no question that we were disappointed with this segment's numbers in Q4 and there's no doubt that we still have work to do. Graham and the rest of his team are continuing to implement changes that are intended to improve the predictability and performance of the segment's operations. Of course these kinds of changes take time to work through the business and so the impact they will have on our results won't all be immediate.

That said we feel good about the progress we're making and expect to see the benefits impacting our financial results as 2007 progresses.

Switching now to audio and on a much more positive note, the business rebounded nicely from the softness we experienced in Q3 and exceeded our expectations for Q4. These results were fueled by a number of product initiatives in our professional audio business including a significant increase in upgrades for Pro Tools HD systems and a healthy uptick over Q3 in sales of new core Pro Tools workstations.

Also, our venue live sound systems had a record quarter, driven by the introduction of Profile, a new compact mixing console targeted at small and mid sized live sound environments such as houses of worship, corporate events, theaters, nightclubs and remote broadcasts.

At the lower end of the audio market we experienced solid contributions driven by the expansion of our Mbox product family, which now includes the smallest and most affordable Pro Tools LE system ever introduced, the Mbox 2 Mini.

M-Audio's Fast Track Pro, a USB audio and MIDI device for mobile recording, also performed well.

Finally, our acquisition of Sibelius in July of 2006 is showing good results with an end of year promotion driving strong sales of Sibelius 4, the company's flagship software for writing, playing, printing and publishing music.

Turning away from product and market performance, our audio division recently returned from this year's National Association of Music Merchants Conference, also called NAMM, where all three of our audio companies, Digi, M-Audio and Sibelius shared a booth and displayed virtually every audio product in our lineup to dealers, customers, prospects and the media. It was an impressive and unified face of AVID's audio division but maintained the vibe, pulse and cultural identity of each individual company.

As far as news from the show floor, one of the biggest hits was our preview of the latest edition to our virtual instruments lineup, called Structure. Structure is a powerful virtual instrument plug-in that provides audio professionals with musical instrument sampling capabilities for any music or post production project.

We also introduced a new family of professional audio plug-ins that mimic analog tape effects in digital recordings as well as new DJ performance systems, multi-media speakers, keyboards and virtual synthesizers. We're looking forward to shipping all of our new systems in the months ahead and driving further penetration across the entire audio market segment.

Moving along to consumer, we talked on past calls about some of the internal changes we've made to improve this business. Based on the revenue that our consumer division posted in Q4, which slightly exceeded our forecast, we've returned to a stable operating environment.

As expected, both our Pinnacle studio editing software and our TV viewing product families performed well in Europe and the Americas due to the end of the year holiday buying season. In fact it's worth noting that data published by the consumer research firm, NPD, showed that Pinnacle's PCTV HD Pro Stick was the number one selling external PCTV tuner device in the US during the fourth quarter. Given that this country has been slow to adopt computer TV tuner technology, as compared to Europe; this puts us in an excellent position to further capitalize on this opportunity as the trend to embrace mobile TV viewing continues.

With this opportunity however comes the challenge of achieving higher gross margins for our hardware based TV viewing products. Because the mix of hardware and software systems has become skewed toward our PCTV line, we are falling short of our longer term profitability targets. Because of that near the end of Q4 we initiated a restructuring within our consumer business to help reduce OPEX and to streamline our TV viewing operations.

We expect the benefits of this restructuring along with other initiatives to return our consumer business to profitability for the full year in 2007.

I'd now like Paul to discuss our guidance. Paul?

Thank you, David. Before I move on to the guidance, I'd like to clarify the statement that I made earlier reconciling the GAAP net loss to the non-GAAP net income. Adding the $75.1 million of charges that I listed to our GAAP net loss of $52.6 million results in non-GAAP net income of $22.5 million or $0.54 for the fourth quarter.

We currently expect it to take at least another quarter to get beyond some of the video issues with which we are dealing. Our current expectation for Q1 is for revenue in the $225 million to $230 million area and GAAP earnings per share in the area of a loss of $0.08 to a profit of $0.02.

Excluding approximately $8 million of acquisition related amortization and $4 million of stock based compensation, we expect non-GAAP earnings per share to be in the area of $0.15 to $0.25. This assumes a non-GAAP tax rate of approximately 20%.

Gross margins are expected to improve in Q1 over Q4 by at least one full point.

Operating expenses in Q1 are expected to rise significantly over Q4 of 2006. The most significant reason is an increase in overall compensation expense due to a number of factors. The first is that in Q4 we reversed 2006 bonus accruals that had been booked in previous quarters so we actually had negative bonus expense. In Q1 as we begin to accrue for 2007 bonus plans, the result is a significant sequential increase because the base is a negative number.

Secondly, the cost of providing employee benefits increases fairly significantly in the first quarter of the year versus the end of the year due to the front end nature of payroll taxes.

And finally, we are adding staff in our audio division starting in Q1 this year after a year of very constrained hiring.

Operating profits in Q1, excluding $8 million of acquisition related amortization and $4 million of stock based compensation, are expected to be in the area of $6 million to $10 million. Other income is expected to be approximately $1.5 million and the non-GAAP tax rate, as I said earlier, is expected to be approximately 20%.

At this point we are going to keep our guidance for the balance of 2007 at a high level. In Q2 we expect to begin to see the benefits of the positive changes we are making in our video division. We would expect revenues and earnings per share to increase substantially from Q1 to Q2.

For the full year, our current outlook is for revenue growth consistent with our longer term model of 8% to 10% organic growth. Although we would expect operating profits to grow faster than revenue, we would not expect that to be the case for earnings per share due to the expected increase in our tax rate in 2007.

We would expect EPS growth in line with revenue growth at the high end of the 8% to 10% revenue range.

These conclude my remarks. Now David and I would be happy to take your questions.

Thank you, gentlemen. [OPERATOR INSTRUCTIONS]

And we go first today to Gene Munster at Piper Jaffray.

Good afternoon and Paul, best wishes. You really dedicated a lot to AVID over the past six years or seven years. David, could you talk a little bit about just the magnitude of this reorganization? You kind of outlined some of it but maybe you could go into a little bit more detail in terms of percentage of head count or any metrics on those points.

Sure. Well, I'm assuming that you're speaking specifically about the video business in terms of the management changes that we've made. Is that correct?

Yes. And is it just management changes or is there more broader changes to improve the operating profile of the company?

Yes, there are several things going on. So at the management level, we've obviously got a new general manager. We have a new head of worldwide sales, a new head of sales in Europe and Asia as well. We've got a new head of product marketing and of product management as well as changes within both of those organizations. And some of these are due to internal promotions that have then allowed other people to move forward.

We also had a restructuring component in part associated with closing a facility that we had in California. Overall in the quarter 32 people were affected by our restructuring efforts. There were 27 in video and 5 in consumer.

So the overall changes are mostly in terms of management and new positions but there were some restructuring of people within the division.

Okay and I guess in terms of the potential profitability when you talk about kind of reaccelerating some possibility of having faster earnings growth, can you kind of outline maybe a long term operating margin target?

I don't think so at this time, Gene. I think we will be talking about that at the Investor Day in mid February.

Okay and then I guess just long term, what would the tax rate (indiscernible) coming back down but then you talked about a higher tax rate this year but what's the tax rate we should use for our models?

Well as I said we had originally expected a reversal or a partial reversal of the valuation allowance sometime in '07 and that was going to push the tax rate up to 25%. That's not now expected to happen. At this point, I don't have a good enough picture of '08 to know whether that's going to continue in '08 or that the valuation allowance is just pushed out a year, in which case the tax rate would be 20% this year then go up to 25% in '08.

Okay and I think, Paul, you had talked about kind of the inventory levels and the reasons for it going up were kind of some deals slipping. Can you kind of walk through the mechanics of how that works, why inventory would go up? You basically had inventory that was ready to ship out or it actually shipped out or kind of walk through that?

Yes, when we ship out a big deal and it goes out to the customer's site during the sort of installation process, it stays on our books as inventory until such time as we actually recognize the revenue and relieve the inventory, so almost all of the increase, the sequential increase in inventory from Q3 to Q4 was related to those types of deals.

Okay and then just lastly, I know David you went through in kind of detail in terms of kind of how the mechanics of this worked but one of the concerns about AVID has been just a great team and it's just that the underlying business doesn't seem to come through and I know you gave reasons why deals kind of slipped this quarter and so forth. I guess what makes you confident that there is going to be kind of a rebound in the business? Maybe you could talk about the percentage of your base that's on high-def right now and or just something where we can at least get some sort of hope that there is light at the end of the tunnel here.

Sure. Well if you look at the three business units, I think you can see where we're positioned in each of them. In consumer we've made a lot of changes during the course of the year and feel that from a product point of view and from an organizational structure point of view we're positioned right now for improvement through 2007. So we think we've taken our lumps and we've made the proper adjustments and that at this point it's going to be on an improving trend.

With audio I think we agree that audio has been performing well both at Digi and at M-Audio and we even had good performance from Sibelius even though they've only been part of the business for a very short while, so I feel like audio is in a good place. We're making some investments in audio this year but those are investments that we actually expect to be paying off fairly shortly as well. So we feel good about that part of our business.

If you look at video and you separate it into the two main segments of post and broadcast with each being roughly half of our revenue in the segment, the post side, as I mentioned, we were up 13% year over year in terms of revenue from that segment so I consider that to actually be good performance. So then if we just zero it down and say boy, the trouble was located in broadcast, from a bookings point of view we're actually doing quite well. So we see ourselves storing up revenue that can be recognized in the future and in essence it's a double-edged sword.

As the deals become larger and more complex, the great side is that there's more and more revenue that gets stored up in that bucket, but the downside is that the revenue recognition becomes much more complex for all the reasons that I detailed. And that's why we've got such an extensive effort going on internally to mitigate the three variables in that factor so we can make it as predictable as possible and we do believe that this situation will be improving in the future.

But I think you can see the conservatism that we've applied for our forecast for Q1 and that includes this notion that we can't completely predict exactly when these deals will close because many of the factors are still out of our control. But we can see them in the backlog so we know that they are there.

Okay. Last quarter you gave kind of a growth in HD and then also a percentage of your installed base that was editing on high-def. Can you give out those numbers this quarter?

Yes, if you just think about the Adrenaline sales, and Adrenaline for us is good bellwether because it's our top editor in terms of revenue, what we saw historically was that a smaller percentage of the systems, of Adrenaline were being sold fully featured for HD. Last quarter in Q4 we saw that percentage being greater than half of the systems going out the door were fully equipped for HD and we also continue to have good revenue associated with customers installing or upgrading their standard definition versions of Adrenaline for full HD. So we're seeing that trend shifting over the past couple quarters to being the case where now the majority of the Adrenalines going out the door are equipped for HD.

Can you give us an apples to apples comparison after (indiscernible) for HD? Last quarter the metrics you gave us was just overall growth was I think it was like 24% or something from June? Is there an apples to apples comparison that we can look at for the growth of HD there?

You know off the top of my head I think we've gone from about 20 to 40 and then now to about 58 so it's been an uptick of almost, roughly 20% per quarter for the past couple of quarters.

And that's percentage of systems that are HDs?

Of the Adrenaline systems going out the door that are equipped for HD right out the door.

Okay, great. Thank you.

Sure.

And we'll take our next question now from Steven Frankel at Canaccord Adams.

David, one of the issues that seemed to haunt the company all year long was delivering products on time. Could you give us an update on some of those keys products like all of the modules and the Interplay that were promised at NAB and have those been delivered and what's the status of Adrenaline HD on Intel based MACs?

Okay I guess starting first with that one, the Adrenaline HD on Intel based MACs, that was originally scheduled for Q4 of this year. One of the things that we did however in evaluating the performance of that system and just simply looking at the quality levels, we were not satisfied with the MTBF or the mean time between failure results of our testing on that product and we actually intentionally delayed that to Q1 of this year. So our current expectation is that that product will ship in March but it's also our current expectation that our customers will be very happy with it because we believe it will be a very solid and high performing system at that point.

One of the things that's probably worth talking about in general that does come back to the increasing complexity of our systems, as we sell interconnected systems that are involved with shared storage or media asset management, any failure of the system can bring the whole thing down if it's not engineered right so we're being very careful in terms of our testing and looking at the individual performance and the interactions between components and we're making a concerted effort to increase the quality level of each of the individual components so that we can ensure stability of the overall system.

So that increased focus has caused us to intentionally move out the ship dates of a number of products.

With Interplay in particular we have shipped Interplay version one. We've got an update version of that coming out. We don't have all of the features that we showed at NAB but we've got the majority that we had intended for first customer ship and that product we shouldn't be thinking of it as a short term and we're done. In fact, Interplay is going to be a product with a long life span that gets enhanced each year.

Okay and on these large deals that were delayed in Q4, you mentioned that some of the issues that could hold them up are things like training. Have any of these deals gone to revenue in Q1 in the first month?

We're not going to quantify it but yes, I'm sure that some of those deals have gone to revenue in Q1.

Okay and how about an update on the high end of your storage business, specifically the ISIS product line. How's that doing and have you solved the cannibalization with your Unity customers who stopped buying because of [inaudible] prices?

Well I think we have a fairly clear delineation between what the focus is for the ISIS product versus our higher end AVID Unity media network product and in particular what ISIS is targeted for is customers who need higher client connectivity, over 100 clients moving actually up fairly quickly to roughly 300 clients connected. Unity doesn't have; our Unity media network product does not have the ability to scale to that many clients but what it is targeted for is smaller groups who need to work at higher definition. So if we have a small workgroup of HD clients who need to be connected, AVID Unity media network is the right product for them.

So the two products are targeted at different segments of the market. If we think about the large broadcast facilities, though, which I think is probably what your question is targeted at; those are generally clearly ISIS customers.

And on the CNN contract, is that a one time hickey or are you going to feel continued pain from that Pinnacle contract as we get into '07?

I think that's pretty much a one time thing so that's behind us.

Great. Thank you.

We'll go next now to Paul Coster at JP Morgan.

Thank you. Good afternoon. A few quick questions. David, you said that you feel like you got past the momentum in the Pinnacle consumer division anyway now. What does that mean in terms of revenues? Should we expect year on year growth as the patent for fiscal year '07 now or does it mean something else?

Yes, we are expecting year over year growth in our consumer segment. And we are expecting a return to profitability for the full year.

Okay, that's good. You've previously in years past talked of an organic growth rate of about 8% to 10%, 12%, 10% to 12% even. We seem to be revising down our expectations here and yet my channel checks and my customer checks more specifically suggests the industry's in reasonably good health at the moment. What was happening? Is the secular growth rate slowing or are you losing market share or am I missing something?

I think specifically for 2007 it's one of those between years where there are no elections or Olympics and just given that those tend to be fairly significant drivers in the industry, it does just cause a slight dampening in overall growth for the overall industry.

Is there any risk that these, the deals in backlog simply do not get closed and/or the fact that you're having trouble closing some of these deals starts to resonate through the industry and does harm to your reputation?

I'm not aware of any deals that went away from our backlog. In essence, these are just simply taking time for us to complete all of the elements of the deal. In some cases even though we haven't recognized revenue, the systems are actually in full use and the customer may even be on air. So it's very unlikely that a customer would go through the case of installation and even begin training, et cetera and then pull out a system.

Yes, there are a number of these large deals that are actually on the air and operating today.

What about the reputation risk? I remember when Pinnacle started to run into these issues. The competition turned around and said they can't close these deals because the product's not ready. Is that a risk for you?

No, I guess, I'll let Paul comment on it too. I guess from my perspective in many of these cases the customer has already paid us. If they've already paid us and they're already on air and for some reason we're not yet able to recognized revenue, I don't want to give the impression that our customers aren't sympathetic but frankly it's not their problem. If they've paid us and they're on air and we can't close it for some other detail, they're actually a happy customer and can be a good reference site, et cetera. In many cases it's just more of an accounting detail we need to go through to actually complete that process for revenue recognition.

So again, I'm not aware of; this is not a case of unhappy customers.

Okay, got it. And in the consumer space, now as for that matter really in the post production space, to what extent is Vista going to change the seasonality of your business and what risks and upsides are associated with Vista?

I think in general in the consumer marketplace Vista is viewed favorably as a boon for the PC industry because it does offer product benefits for customers who don't have Vista today and it's a reason to go out and buy a higher powered machine with dual core multi processor and with a higher performance graphics card.

We have a version of Studio, which is going to be coming out shortly, which is targeted for Vista. It's our Vista release and that's expected to come out shortly and we expect that to be favorably impacted by the release of the Vista operating system.

All right. Thank you very much.

You're welcome.

[OPERATOR INSTRUCTIONS] And next from Needham and Company we go to Jim Ricchiuti.

Thank you. I was wondering did you mention how much the broadcast business was down in Q4?

For the full year the broadcast business was down roughly 10%.

10% and I don't know, Paul, if you have it handy but just for the quarter itself.

For the fourth quarter I think it was closer to 20% on a year over year basis. This actually; people often ask us about organic/non-organic and we make an adjustment for the Pinnacle acquisition when we do that so I think in the fourth quarter year over year, as reported broadcast was down 20% but on an organic basis, excluding Pinnacle, it was down less than that, 15% or so.

And another point just worth mentioning is that that's again looking at the revenue number. If we look at the number of big deals that we booked, that number year over year was up approximately 20%. So again we're talking about this going into backlog and the reported results look worse than the actual performance of the business.

Yes, I was going to make that comment earlier when Gene Munster was on the phone. In terms of broadcast, large broadcast newsroom deals in 2006 versus 2005, the dollar value of those deals booked in '06 versus '05 was up about 50% and that was a combination of an increase in the number of deals and an increase in the average size of the deals.

I wanted to just follow up on the deal size and some of the factors that are driving the increase there and I'm wondering also if there isn't in some of these deals the delays in closing them issues also on the customer side, customer change orders and whatnot. Can you talk a little bit about both number one, what's driving the deal size growth, what elements of it, and number two, you listed several factors for the reasons for the deals not closing, but are there any one or two that are [goal spotting] issues?

Jim, I just want to clarify a statistic I gave you earlier. Broadcast for the year grew about 2% on an as-reported basis but declined around 10% organically.

Got it. Thank you. And I don't know if you heard that question, I just wanted to pursue a little bit on the broadcast side, what's driving the average deal size up and if there are any one or two issues among the issues you cited that are really contributing to these delays in closing these orders, these deals?

Yes, I can comment on deal size. Deal sizes are going up for a few reasons. One is if we just look at the product offerings that we have, that we can put into a deal, with the addition of the products that we got from Pinnacle's broadcast business, we've now got additional servers and on-air graphic components that can be added, so there's more in our toolbox that we can apply for providing solutions.

The other thing that has happened is our own scalability continues to increase so as the client count for ISIS moves higher and as the underlying storage for ISIS moves higher, we're able to provide more and more of what our customers are asking for. In many cases they've wanted to buy more from us and we were the limiting factor. I would even say today we continue to be the limiting factor. There are deals that we could get if we could scale larger. It is only a matter of time before we achieve that and so I would expect that deal sizes will continue to grow in the future.

In terms of your comment about changes, there's not a specific thing that is the cause of changes. In many cases, this, when we go into a facility and we're putting in a large system, it's a significant change for the facility itself and very often they aren't completely set on all of the specifications of what it is that they want. So they go in with an original agreement and there are just change orders, usually minor, that happen in terms of configurations, et cetera.

David, are the issues in broadcast, are they more concentrated in the North American market or are you seeing this also, these challenges, in Europe and parts of Asia as well? Thank you.

It doesn't tend to be geographically isolated. This is more the nature of the beast in the broadcast business.

Okay. Thank you very much.

You're welcome.

We'll go next now to Chris Rowen at Soleil Securities.

Hi guys. Paul, can you give us some idea in terms of looking back at the cash flow, the free cash flow over the last couple of years? Despite the troubles, you guys have been generating positive earnings, yet there doesn't seem to be a whole lot drop in the cash. Can you kind of give the high level factors for that and then specifically on the fourth quarter, can you tell us some of the key uses of cash to approximate the cash flow statement?

I can give you a high level overview of the full year and then the high level perspective on the fourth quarter itself. So for the full year, cash was down $66 million and starting at the top, income adjusted for non-cash items generated probably about $85 million of cash for the year. And then we had increases in working capital primarily inventory, which was up substantially for the year, as you know. Increases in working capital consumed about $48 million of that cash flow coming in from operations.

In addition to that we had capital spending of about $22 million for the year and we spent approximately $44 million on a number of acquisitions during the year.

And then in terms of net equity flows, given we had a $50 million stock repurchase in the third quarter, net equity outflows were about $37 million, which is the stock buyback net of inflows from various employees' stock plans.

So that kind of gives you the overview for the full year.

And in the fourth quarter cash was up about $12 million. On the income side, adjusted for most of the non-cash items about $20 million came in but about $6 million of that was consumed by increases in working capital, again inventory is one of the issues there.

And then the company spent about $6 million on capital expenditures and received about $4 million from the various equity plans.

Okay, so going forward, do you think that some of that working capital issues will drain and that operating cash flow can start to more approximate your pro forma net income or do you think it will continue to be a building situation?

No, we're not anticipating it to be a building situation. We have significant focus now across the company on inventory. I would expect for 2007 inventory turns by the end of the year to improve and be back up at least over four, which means that we're expecting the absolute level of inventory that we have today to come down in the area of $20 million.

And then in terms of the large projects, moving to a percent complete recognition, I think that sounds like a great idea, though it could create some tough comps as you comp against large projects recognized all at once. How much, if broadcast is half of the video business, how much of broadcast, just roughly, is big project revenue?

I don't have a definitive statistic on that but I would say that it's clearly less than half.

Okay.

Because obviously there's a significant level of ongoing follow on business from the broadcasters that comes with, comes after those initial installations and conversions.

And then, David, this is just a kind of an operational question or a go to market question. I think the idea of compensating your sales people on what you guys can actually deliver is a good change and I wonder if there's any value in taking that further and in terms of your approach at NAB, the practice of promising products that aren't ready yet, it seems to me like the threat to you guys in both the Pro Video space and the broadcast space is coming from below. It's no longer high end competitors and so I wonder about the value of promising the next newfangled technology when you guys are already ahead of your key competitors and it's potentially stalling deals down the road.

Your comment, I'm sure there are people within AVID listening to this call who are smiling right now because there's a fair number of people who agree with that approach. In general what we've tried to do when we announced new products is if it's in an area that we don't currently sell products, then we're more willing to talk about something that might be a future. It's much more problematic if you talk about new features around a product that's currently shipping and it's something that we're increasingly careful about and I do expect that we will be moving in that direction at this NAB. But I can't really tell you a whole lot more about what we're planning on doing but obviously we've been putting a lot of thought into this year's NAB.

Great. Thanks a lot.

And we'll go next now to Barbara Coffey at Kaufman Brothers.

Yes, just a quick follow up. You spoke briefly about how you expect Vista to offset the consumer side of the market. On the professional side, could you update me on what sort of percentage of your users are even using PCs and how you expect them to shift over to the new platform, and is there a timing issue on that?

In general, these sorts of changes are not as big a deal for our professional customers because often professionals are willing to let their operating system lag behind the latest release. In fact they typically prefer that because they don't want to be the first one on a new platform as that platform undergoes patch releases and fairly rapid changes. So my guess is that at the professional part of the marketplace, folks will want to stay on the current operating system that they have until probably the first one or two patch releases come out to Vista, which this overall process wouldn't surprise me if it took six months to a year and that gives us plenty of time to have our systems ported over and fully vetted as well.

In general, just the way to think about it is that at the professional level people are buying a specialized system, which very often is solely used for our editing so that often is the only application that is run on it and the underlying operating system is not as significant.

Regarding your question of what percentage of our business is on the PC, the majority of our professional business on the video side of our business is on the PC.

Thank you.

And we go next now to Carla Cooper at Baird.

Hi, good afternoon. I wanted to take a crack at seeing if you could enumerate the amount of revenue that you thought was held up by some of the revenue recognition matters that you talked about. Can you quantify that or give us a time frame around it?

What do you mean by a time frame?

Time frame for when you think that you will get some of those sign offs. I mean, are we talking quarters or months or weeks?

Well there's, in every quarter we've got sort of deals being booked and deals coming out of backlog and deals being recognized so there's sort of a regular flow there. As we indicated when we gave the guidance that we're expecting to continue to be fighting this battle of getting deals out of the backlog and the necessary deliverables delivered so that we can recognize the revenue. We've got significant focus on that inside the company right now and as I also said earlier about the second quarter we are expecting to really begin to see the benefits of the efforts that we're devoting to this in the second quarter.

Got it. And then just a quick clarification question. You mentioned that part of the video business was up 13%. I think you said the post business was up 13%?

Yes, our post market segment, which is half of the post--.

Yes. Was that a reference to Q4 or the entire year?

For the year.

Okay. And then do you have the number for Q4?

The post production business in the fourth quarter grew around 4% to 5% both organically and as reported.

Okay, great. Thanks very much.

And we'll go next now to Joe Arsenio at Arsenio Capital Management.

Yes, I'm listening to what you've been saying about the inventory situation and it seems that, and I guess this would be the appropriate interpretation, you were carrying inventory on your books that's actually installed at the customer and they're using it today but you're not able to recognize it as revenue. Is that correct? The inventory is installed, it's operating, they're using it, but revenue has not been recognized.

Yes.

Okay. And I know you've answered this question three or four different ways but, and I may have missed the response regarding the magnitude of the inventory that's installed, operating but not recognized. What is the sum?

I would say approximately $25 million in total.

Okay, so that doesn't entirely explain the increase in inventory, I don't think but I could be wrong.

For the full year?

Yes.

No, it probably doesn't. We've had some increases in inventory in the consumer business that we have talked about as well and we had some increases outside of the big deals in the video business as well this quarter.

Okay, so if we look at--

We also had, I'm sorry, we also had some acquisitions that we did during the year that added to our inventory.

Right. So if I'm interpreting your game plan correctly, the plan for the first six months at least is to try to work the collective inventories down using all your various approaches and generally re-liquefy or improve the liquidity on the balance sheet. Is that correct?

Yes.

Okay and then going forward, the sales practices are changed in order to reduce the amount of deferred revenue.

Reduce, or get more revenue.

Yes, in this case you don't want to, you want to avoid having excess inventory so the result of that I guess is the reduction in the revenue growth projection. Is that a corollary to this game plan?

No. Not at all. When we move the deals from the backlog in inventory to revenue, they become revenue when the inventory gets released.

Right, but your future revenue, your new bookings are likely to be diminished because you're not promising as many undeliverables so potentially you're not pulling revenues out of the future as easily. But the gist of it is that we're looking at enhanced liquidity sometime in the middle of the year.

Yes.

Okay. Thank you very much.

You're welcome.

And ladies and gentlemen, that is all the time we do have for questions today. I'd like to turn the conference back over to you, Mr. Krall, for any closing or additional remarks.

All right, well I'd like to thank you all for joining us today. I'd also like to take a moment to thank Paul Milbury for his service to this company and I wish him the best of luck in the future, so thank you, Paul.

Both Paul and I will be available for follow up after today's call. I'd also like to remind everyone that we're holding our Annual Investor Day at our corporate headquarters in Tewksbury on Thursday, February 15. If you plan on attending, please RSVP to Dean Ridlon.

So thank you all and good night.

And again that does complete our conference call. We thank you all for joining us and we wish you all a great day. Goodbye.