Avid Technology Inc (AVID) 2011 Q2 法說會逐字稿

Good day, everyone, and welcome to the Avid Technology second quarter 2011 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. Tom Fitzsimmons. Please go ahead, sir.

Good afternoon. I'm Tom Fitzsimmons, Director of Investor Relations for Avid. I'd like to welcome you to today's call. With me today are Gary Greenfield, Avid's Chairman and CEO, and Ken Sexton, Executive Vice President and Chief Financial Officer and Administrative Officer.

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 that relate to future results or events, and are based on average current estimates and assumptions. Forward-looking statements may be identified by the use of forward-looking words such as anticipate, believe, could, estimate, and expect, or similar expressions. There are a number of factors that could cause actual events or results in future periods to differ materially from those indicated by these forward-looking statements, such as -- our ability to execute our strategic plan and meet customer needs; our ability to produce innovative products; changing market demand, particularly in the media industry; fluctuations in our revenue; competitive factors; or adverse changes in economic conditions.

Other important risk factors and uncertainties appear in our periodic reports and other filings with the SEC. In addition, our forward-looking statements represent our estimates only as of today, July 21, 2011, and should not be relied upon as representing our estimates or views on any subsequent date. We undertake no obligation to review or update these forward-looking statements, even if the estimates change.

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, and may not be comparable to similar non-GAAP measures used or reported by other companies. The non-GAAP measures do not reflect all the costs associated with the Company's operations determined in accordance with GAAP. The most directly comparable financial measures calculated in accordance with GAAP, and a reconciliation of GAAP to non-GAAP measures, are contained in our press release announcing this quarter's results, and are available in the Investor Relations section of our website at www.avid.com.

For the purpose of understanding our future business model, we will also provide some forward-looking analysis on this call on a non-GAAP and GAAP basis. Some of our GAAP financial measures are not accessible on a forward-looking basis, and the differences between our future GAAP and non-GAAP financial measures could be substantial.

And now, I would like to turn the call over to Gary.

Thank you, Tom. And welcome to our conference call for the second quarter of 2011. The financial performance of our second quarter was disappointing, but we believe the business fundamentals remain strong. Revenues for the second quarter were just over $160 million, which represents a 1% decrease, compared to the second quarter of 2010, and we reported a non-GAAP net loss of $3.9 million. Revenues were down about $5 million sequentially from the first quarter of 2011. The sequential decrease was mostly the result of revenue performance in Europe. We believe the weakness in Europe was the result of economic uncertainties in certain countries, as well as internal challenges which have led to a realignment of our sales team in Europe.

I will talk more about this in a moment. But let me first turn the call over to Ken to discuss our financial results in a bit more detail.

Thank you, Gary, and welcome to everyone on today's call. Revenues for the second quarter were $161.3 million, a decrease of 1% as compared to $162.2 million reported in the same period in 2010. The GAAP net loss for the second quarter was $11.9 million or $0.31 per share. This compares to a GAAP net loss in the second quarter of last year of $12.9 million or $0.34 per share.

The GAAP net loss for the second quarter of 2011 includes -- amortization of intangibles of $2.8 million; stock-based compensation of $4.5 million; restructuring and other costs, which were net favorable [$163,000]; a legal settlement of $192,000; acquisition related costs of $200,000; $597,000 loss on an asset sale; and a related favorable tax adjustment of $245,000. Excluding these items, which total $8 million, the second-quarter non-GAAP net loss was $3.9 million or $0.10 per share. This compares to a non-GAAP net loss of $2 million or $0.05 per share for the second quarter of 2010.

I will now discuss the second-quarter results in greater detail. Our revenue for the quarter were down 1% year on year, with modest growth in the Americas, but down in Europe and Asia. Changes in currency exchange rates benefited the second quarter of 2011. On a constant-dollar basis, revenues were down 4% year on year for the quarter. Overall product revenue for the second quarter were $129.2 million, down 4% year on year. Service revenues, which include maintenance, support, professional services, and training were $32.2 million, up 15% compared to last year's second quarter.

Video revenues for the second quarter were $96.3 million, up 3% compared to the second quarter of 2010. The majority of our service revenue is related to the video business, and was a key driver in our video year-on-year growth. We have focused on improving our attachment rates and renewal rates for maintenance support contracts, and are seeing the benefits of this in our results. Overall, we experienced a 3% decline in video product revenue.

However, our consumer video editing product family experienced double digit year-on-year growth, driven especially by sales of our new Avid studio product, which was released last quarter. We also continue to see strength in our shared storage offering, which includes ISIS 5,000 and 7,000 product lines. These areas of growth were offset by declines in our on-air graphics and news automation product offerings. Professional editors were down modestly year on year, with growth in Americas offset by a decrease in Asia.

Now looking at audio. Audio second-quarter revenues were $65.1 million, down 5% compared to last year. Europe accounted for most of the decline. Our higher-end systems sales, Pro Tools HD, were down in part due to the introduction of our new Native hardware offerings. We also saw a slowdown in sales of our audio interfaces and keyboards.

The control surface business continued to grow, and was up 17% year on year in the second quarter. It's worth noting here that the growth for control services is now organic, as our acquisition of Euphonix was finalized in April of 2010. We also had a strong quarter for speaker sales, which benefited from some of the promotional activity, and our Pro Tools software and I/O product families also grew year on year for the quarter.

Now I will discuss the second-quarter results beyond revenue, on both a GAAP and a non-GAAP basis. On a GAAP basis, we reported gross margins as a percentage of revenue of 51.1%, up 0.3 percentage points year on year and down 1 point sequentially. Our non-GAAP gross margins were 51.7%, about flat year on year, down 1 percentage point sequentially. Although gross margins benefited from exchange rates somewhat compared to last year, the second-quarter gross margins were negatively impacted by almost 1 percentage point due to 2 items. In the second quarter, we recognized a loss related to a professional service contract which was assumed in a prior year's acquisition. In addition, we incurred certain 1-time costs associated with a change in our third-party logistics strategy in North America.

Our GAAP operating expense was $94 million for the second quarter, down $1 million year on year, and up $4 million sequentially. The sequential increase is largely attributed to the benefit recognized in the first quarter of 2011, related to a reduction on our restructuring reserve. In addition, our stock-based compensation increased sequentially due to the timing of our annual grant cycle. Our non-GAAP operating expenses for the second quarter was $86.9 million, which represents a $1.5 million increase year on year, and was essentially flat with our first quarter. The year-on-year increase was due to changes in currency exchange rates.

The GAAP net loss for the quarter was $11.6 million, an improvement of $1.2 million year on year. Excluding the items I mentioned earlier, the non-GAAP operating loss for the second quarter was $3.4 million, compared to a $1.7 million non-GAAP operating loss in the second quarter of 2010.

Now turning to the balance sheet. We ended the quarter with $37.6 million of cash, up from $33.2 million as of March 31, 2011. As of June 30, 2011, we had drawn down $13 million on our line of credit. Our cash net of the credit line was $24.6 million, which is down $8.7 million from the beginning of the quarter. We used $7.2 million of cash for operations, which included $3.7 million of restructuring payments.

We had a sequential increase in our inventory and accounts receivable balances. Our inventories at quarter end was $129.8 million, which is up $4.7 million from the beginning of the quarter, and up $21.4 million from the beginning of the year. We had positioned inventory for a higher level of revenues for the quarter, which drove the sequential increase. Looking forward, we expect our inventory levels to come down somewhat in the second half of 2011, as we better optimize our supply chain.

Our annualized inventory turns for the second quarter were 2.5 turns. Our accounts receivable balance of $98.4 million represents 55 days sales outstanding, which is on the higher end of our historical ranges. Our aging remains healthy and is within historical ranges. On the personnel side, we ended the quarter with 1,946 employees, and 495 contractors.

As of now, I would like to hand things back over to Gary who will provide an update on the business.

Thanks, Ken. I will spend the next few minutes providing some context around the factors that had an impact on our business for the second quarter, and also discuss some of the indicators that will guide us as we move forward. The most significant challenge in Q2 was the performance outside of the Americas, particularly in Europe, where a number of market conditions contributed to a disappointing 15% sequential drop in revenues from Q1. With that in mind, I will cover our business from a regional standpoint, focusing on the most relevant issues as they relate to the revenue shortfall, starting with Europe.

I'm sure you have read about the economic challenges that are affecting certain European countries. Our Q2 results tell us that we are not immune from the impact of these events. Although global ad spending rose by 8.8% in the first quarter, the aggregated growth rate for ad spending across Europe advanced at a much slower rate. Western Europe posted only a 2.9% increase for ad spending in Q1, the lowest reported growth rate of all global regions in that quarter, with weakening economic conditions having a particularly negative impact on ad spending in Greece, Ireland, Italy, and Spain.

To complicate the external market pressures, we also experienced internal execution challenges in Europe, which led us to implement a new, decentralized sales organization this month, realigning our sales team into smaller regions. This will enable our sales force to get closer to local customer needs and purchasing dynamics that play an increasingly important role given the uncertainty of the economic situation across the region. With a more explicit sales strategy focused on regional needs, we believe Avid will be better positioned to build stronger, more personalized relationships with our customers, and power our field sales team to act locally and strengthen the relationships we have with local partners. We are looking forward to the positive impact these changes will have in the remainder of 2011 and beyond across Europe.

Turning to Asia, we experienced a sequential revenue decline of 3%. This is mostly related to the timing of larger deals for this region. Economic conditions in Asia and improving, with Japan beginning to emerge from tsunami/earthquake disaster of last March. Ad spending was up by more than 12% in Q1 in Asia Pacific.

In the Americas, we experienced modest year-on-year and sequential growth. The US economy continues to show signs of recovery, and ad spending increased nearly 6% in Q1. As we head into the fall television season, a gain of 14% is projected in broadcast ad revenue. And while Nielson reports that US TV ownership is down for the first time in 20 years, TV viewing has increased in 2011 by 22 minutes per month. Furthermore, a 2011 TV infrastructure report from Positive Flux, states that US TV stations are still transitioning to HD production, with only 40% of stations having full HD production and master control capabilities. These trends will serve us well, as we execute our sales plan for the remainder of the year.

Ken highlighted a few of the areas where we experienced some softness in audio, particularly related to some of our hardware offerings, and I would like to provide a little more context. As you know, we brought a range of Pro Tools offerings to the market last year, including our new hardware I/Os, a Native PCIE card, a new Inbox line, and version 9 of Pro Tools. The Native card serves an important group of budget-conscious customers who don't need the broad capabilities provided in our DSP card-based devices. We've tested the demand for the Native card in the market and believe with greater education in outbound marketing, we can shore up this part of our professional hardware business.

With our new Inbox line, which now works with our standalone Pro Tools software and other third-party recording software, we are gearing up a series of programs and promotions, and expect to drive greater demand for these offerings throughout Q3 and Q4. Lastly, our keyboard controller category experienced a year-on-year decline. This is a very competitive space, which requires strong channel partnerships. We have modified the dealer allowance structure we have with major partners, and expect to see the results of this strategy in the coming months. As Ken also mentioned, our control services, speaker lines, and Pro Tools software and I/O families all performed well. We are looking forward to continuing the momentum in these areas, and bolstering that growth by driving greater demand for audio hardware and software offerings.

In our professional customer segment category, we experienced a decrease in revenues year over year, and a slight increase sequentially. A number of our European musical instrument resellers had a difficult quarter, which introduced disruption in our sales. This segment, which is weighted toward audio offerings, encountered the challenges I just spoke about.

We continue to see the opportunity with the emergence of 3D. Successful projects like Avatar have created mass worldwide appeal for high-quality 3D movies. TV does, however, lag film in the shift, but we expect consumers will continue to demand more quality 3D content, and equipment standardization such as Blu-ray should fuel a worldwide proliferation, which in turn will accelerate the broadcast 3D migration. There are now 40 channels that have broadcast 3D content, and more than 50 3D movies are scheduled for release through 2013. With our newly organized European sales team, and a series of forthcoming sales and marketing promotions starting in our core audio customers, we are taking the actions to stimulate greater channel demand throughout the remainder of 2011.

Our video revenues were up, with the increase driven mainly by solid growth in both professional services and maintenance support contracts. Although product revenues for video were down about 3% year on year, we see an opportunity to drive unit growth due to our strong market position, especially in the wake of reaction among professional video editors to the latest release of Final Cut Pro X. We anticipate a strong response to our current cross-grade promotion announced 2 weeks ago, which for a limited time allows Final Cut editors to purchase Media Composer for just $9.95, a 60% discount off the regular MSRP.

To further capitalize on this opportunity, we held an event in Los Angeles last week where we met with hundreds of professional editors who use Final Cut and Adobe Premier. The event demonstrated Avid's ongoing support for anyone in the professional video or film post-production business, and gave us the opportunity to listen to the community first hand, as well as share our passion for doing whatever it takes to help the community members achieve their greater creative vision, however they define it. The event was well received, and represented an important first step to advance our share in the professional video segment.

Our media enterprise customer segment on year-to-date basis experienced year-on-year double digit growth, and for Q2 in the Americas media enterprise business, year on year and sequentially. That said, we saw only modest growth year on year and a sequential decline from Q1 to Q2 overall from this segment. As we've discussed in the past, the revenue in this segment can be lumpy due to the number of larger transactions and the timing in which large deal revenue is recognized.

We remain optimistic about the global opportunity within media enterprise. There's no question that we need to closely monitor economic conditions, that it might impact this part of our business, but the recent increases in consumer viewing habits, along with projected growth in broadcast up-front ad spending, suggest that the conditions are ripe for growth to accelerate in this area. These trends also indicate that our customers will continue to produce increasing amounts of content, which, over time, we believe will stimulate further demand for Avid's enterprise solutions, that provide better production and asset management tools and workflow productivity.

In addition, the continued move to cloud computing shows no signs of slowing down, another indicator for potential uplift in our media enterprise customer segment. As our media enterprise customers move to transform their businesses to cloud-based infrastructures, we continue to make R&D investments that will help Avid capitalize on this incremental opportunity. Furthermore, I should point out that this customer segment historically performs well in Q4 due to the common year-end budget and spending cycles of broadcasters.

In our creative enthusiast customer segment, revenues were flat year on year and saw sequential decline from Q1 to Q2. The year-on-year growth that the consumer video editing market enjoyed in the fourth quarter of 2010 and first quarter of 2011 slowed in Q2, as revenue levels were down modestly from 2010 levels. We expect that the overall growth going forward will be fairly slow. That said, we reported strong sales of our latest consumer video offering, the new Avid Studio, and are pleased that consumer research firm, NPD, confirmed that Avid reclaimed the number 1 position in the US consumer video editing space for May.

This growth was offset by year-on-year decline in our audio products for some of the reasons I discussed earlier. We believe our worldwide retail business will gain momentum in the second half of the year, given the increasing purchasing trends that take place in the fall and toward the year-end holidays.

Now, I would like to take a moment to recognize our continued innovation through a few Q2 milestones. We introduced Avid Scorch in the second quarter, our first application for the iPad, which enables customers to practice, perform, and purchase their favorite sheet music on the go, by transforming an iPad into an interactive score library, music stand, and sheet music store. With Native support for Avid's UCON protocol, post-production professionals can take advantage of Avid artist color to control the color-grading features of third-party color correction programs, including Blackmagic, DaVinci Resolve, Assimilate Scratch, Image Systems, Nucoda, and Pomfort Silverstack Set edition.

We released Avid Endgame, our new end-to-end video production solution that enables sports market organizations within leagues, teams, and facilities to deliver thrilling fan experiences, as well as drive enhanced brand visibility and revenue. We shipped Avid ISIS 5000-16, the next revolution of our open ISIS shared storage platform at a 16-terrabyte entry point that offers the same performance as the ISIS 5000-32 range, and delivers exceptional stability, performance, and flexibility to budget-conscious customers.

We shipped Pro Tools MP, the latest version of our Pro Tools software that allows M audio and hardware enthusiasts use recording, editing, and mixing features of Pro Tools in their home or project studios. We also received industry recognition for Pro Tools 9, which won a Musikmesse International Press Award, or MIPA, at the recent Musikmesse conference in Germany.

Ramping up, there is no question that it was a tough quarter with an unusual second quarter sequential decline in our revenue. As I mentioned, however, we remain confident that we are positioned to improve our performance in the second half of the year.

With that, I will turn the call back to Ken who will discuss our financial outlook for the remainder of 2011.

Thank you, Gary. Before I discuss our guidance for 2011, I wanted to remind everybody that it is our practice to provide only annual guidance, as we do not provide quarterly guidance. Today I would like to update this annual guidance based on our most current data. We believe the fundamentals of our business are solid, and we expect improved performance in the second half of 2011. We expect the second half of the year to benefit from -- normal seasonality of the business, especially on the retail side; visibility into large transactions, which are expected to be recognized in the second half of the year; improved sales alignment and execution especially in Europe; customer excitement around recent product introductions that will help drive revenue.

For 2011, we expect the revenue to be approximately $690 million to $710 million. And we expect our non-GAAP operating profit to be about 4% to 5% of revenue. We continue to expect a year-on-year improvement in our non-GAAP gross margins as a percentage of revenue, and a modest increase in operating expenses in the second half of the year compared to the first half. We expect our non-GAAP taxes and net interest expense to be around $7 million to $9 million for the full-year 2011.

The non-GAAP net income I just outlined would exclude the following charges -- stock-based compensation, amortization of intangibles, restructuring and other charges, acquisition related costs, legal settlements, gain or loss on sale of assets, and related tax adjustment. Based on what we know today, we expect that these items to result in a $23 million to $28 million of charges for 2011. And also for me to just go back in a moment when I said there would be a modest increase in operating expenses in the second half, I meant to say a modest decrease. So at the midpoint of our range that I have just discussed here, including these costs, would result in a GAAP net loss for 2011.

This concludes our remarks, and we would now be happy to take your questions.

Thank you.

(Operator Instructions)

We will take our first question from Paul Coster with JP Morgan.

Thanks. Ken, can you just break out consumer video from professional video?

Well, we don't give out the specific numbers in general. But, I think we talked in general about how much it makes up. That isn't a specific number -- we provide what professional video is because it exceeds 10% of our product line that exceeds 10% of our revenue base. But, we have never given consumer video out.

Okay. So what was the pro video? Sorry. I beg your pardon.

Pro video for last year made up about 13% of revenue for the full year. It was pretty similar for this quarter.

Got it. Thank you very much. So, are there any secular issues here? I saw here that you got a few product issues, and an execution issue in Asia and some of the markets are a bit soft. There's always this big disconnect between this sort of expectation that we have got maybe a 10% kind of growth in market in aggregate, across HD and far based and 3D and everything else that's going on. And yet, we always seem to struggle with the topline growth number.

I'm wondering do you think the competitive landscape has deteriorated, is there a sort of cannibalization of hardware going on? Is there -- 1 of things which I'm picking up a little bit recently, is the move to cloud-based solutions for the TV broadcasters, with that last 1 in mind, in particular, is there anything secular in nature here that you think is a challenge?

So, Paul let me take that 1, it's Gary. First of all, I think there is a lot of questions that a lot of questions that you asked there. Most of those questions related to our video revenue versus our other revenue. You take a look at the revenue as we described it, our video revenue was actually up year-on-year. One of the things we have done, even though I know you would say video product revenue is down versus up, 1 of the things that we have been doing is bundling into our newer products, maintenance revenue.

So, there are some allocation actions that are going on there, because we want the be sure that our customers repeat that maintenance and move it into the future. So, when we sell our ISIS 5000-16 or -32 today, as an example, we bundle maintenance in there, so you really should take a look at the total number of video revenue being up.

The second thing is that as we commented on in the Americas, our media enterprise, which is those customers that you are speaking about, did grow. Media enterprise grew double digits over Q1and grew high single digits on a year-on-year basis. We feel that if you're talking about the HD trends, if you are talking about all those types of things we continue to win at least our fair share, if not more than our fair share of transactions that are out there.

You comment on APAC execution issues. As we said we believe most of our international execution issues were driven by EMEA, by Europe and EMEA. In APAC, we knew, because of large deals, you are dealing with a much smaller number in APAC. APAC only represents 16%, 17%, I'm getting those numbers off the top of my head, but in that range, out of the total. And you're dealing with a smaller number there, and as a result 1 large acceptance deal impacts that number hugely. We feel that the APAC business is a healthy business, no issue there.

We acknowledge in EMEA, that it's disappointing. We do believe that we needed to realign our sales organization, we needed to realign the sales leadership on the ground and that is where some significant disappointment occurred for us, for the quarter that is there.

I think it's a combination of economic issues -- I'm sure you saw because you follow the media industry that some other people in the same segments that we're in also reported softness in EMEA, and of course we have a very high concentration of business there.

So, we really don't -- we actually see a competitive landscape shaping well in our favor. If you look at the pro video, as we said, we are growing, the HD, our integrated media enterprise. We just finished a seminar in New York City yesterday where Kirk Arnold, who is the Chief Operating Officer, literally told me if we had 2 more people they wouldn't fit in the room, we got so oversubscribed for it.

We believe that there continues to be a lot of interest in our products. Our consumer video edit product is back on top as we have some level of confidence -- this is in the United States -- as we had some level of confidence that it would be with new releases of Pinnacle Studio and Avid Studio.

At the end of the da,y if we go through all of this, there is no doubt we had a significant sales transition. We believe that the European organization, we needed to make some changes on the ground to focus on the more regional organization.

If I were to sum up the whole quarter, any 1 thing I would say, we are disappointed in Europe, for a variety of reasons that contributed to that. We obviously had some other issues out there, but our products are being well received, and if you've been following the blogs on Final Cut X, you would know Avid has been benefiting from the confusion over what market Apple is choosing to serve in the future.

My last thought is that if it is single digit and low single digit growth trend, the investors are going to have to wait a very long time to get a pay back in terms of operating margins, so I really welcome anything the Company does to ratchet down further on OpEx and bring down the break even point for the Company again. That's it. Thanks very much.

Thank you, Paul.

Moving on we will hear from Mike Olson with Piper Jaffray.

Thanks, good afternoon. Ken, what did you just say about OpEx? I just want to make sure, first you said it was going to be a slight increase and then you said it is a slight decrease actually for second half versus first half. Is that right?

Yes. I was comparing the second half to the first half. I would say that the slighter modest is the operative word, but since I originally said, in error, slight increase, instead of decrease, I apologize for that.

So OpEx should be down slightly in the second half versus the first half? Correct?

Correct.

Also, what about fiscal year, net income or pro forma EPS, for 2011, is there a number you can throw out on that?

Well, I think I have given all the basic data to get there. If you take the non-GAAP number, that I have given of the 4% to 5% of the 690 to 710 of revenue and you take $7 million to 9 million out for interest and taxes that will get you down to a net non-GAAP number. Although we don't project shares, you could look at our history of how the share counts have gone and they're not increasing significantly quarter to quarter. You could make a good solid estimate of what it is for the year.

And then, we gave you the estimate of what the GAAP/non-GAAP reconciled items are, which I believe was $23 million to $28 million. That will get you to a GAAP net loss.

Thanks. One other thing is you had mentioned there are a couple of things on this front, on the Final Cut front, but even though it's been only a month since launch, how would you describe the impact of the weaker Final Cut Pro release? Have you noticed any material impact on numbers? I know you are running some switcher promos and things like that. Is it having material impact at this point that you can tell?

Let me take that question. As far as units go, we have -- we actually started running in April the same promotion we described and brought it back as result of the -- once FCPX was actually announced -- we brought it back because of popular demands.

The number of units is certainly up. As we commented, it's also a quite a discount. Of course, our goal is to have more users which of course will translate down the line in to more of our other products. But on a revenue side, it certainly has not had a major impact in the short-term.

The second thing you should recognize is that that promo is really designed around the independent professional editor. Not that a post house or something can't buy it. But for an independent professional editor to go, hey let me try Media Composer, I've been a Final Cut, it's made it very accessible, particularly in conjunction with our opening up of the hardware I/O, et cetera there. And that's what we were trying to do is reach out to nonmedia composer, newer users, to get them to experience it.

On the third thing what I would say is, Kirk Arnold and I were out in LA in conjunction with this LA event last week, and we spent 3 days visiting customers in addition to the broader event. There were several conversations we had with customers, in this case I'm not talking about independent professionals. I'm talking about the post houses, et cetera that literally would not engage with us in a conversation just a few months before. I think we hope to see it translate into revenue.

When people asked us about competing with Final Cut, I always caution people to say professional editors are only 13% of our business, if it goes up a couple of percent or down a couple percent, it doesn't have a major impact. I would say that on the upside as well.

But if we can get these post houses, it does have the opportunity to translate into the broader Avid work flows. Those are conversations at this stage, because those are real changes in the way they do work and it's not a decision that's made overnight.

Okay. Thanks. Then, just 1 last 1. Is there a number that you could share for the user base of users of the pro video editing tools? Maybe what the Media Composer user base number is or something like that.

The people that buy come and go. I will give you a couple of numbers. Apple said that there was 2 million plus users of Final Cut that are out there. I don't know that we have published a number for Media Composer. It's a tough number to get at because of the number if student copies that are sold and everything else out there.

The number of users bought it in the past will range in the hundreds of thousands. The number of active users is very difficult to say because people have a tendency to buy upgrades, et cetera. I did see a quote from Norm Holland who is a professor -- he runs the editing track for University of Southern California -- in which he spoke to 100,000 professional editors.

And you can find that quote on the blogs, but you would have to take a look at information around it. I can't tell you if he was referring to US, I can't tell if he was referring to the hundred thousand FCP professional editors versus total market. But, still, from there you can get in the range. You are talking about in the hundreds of thousands, not in the millions. I don't mean the be vague but it's a number we try to arrive at ourselves. Very hard.

Got it. Thank you very much.

Now we will hear from Steve Frankel with Dougherty.

Good afternoon. So, I think I heard you say you were making changes on the keyboard interface side that sounded like you were going to offer better discounts to the dealers to help to drive sales. Is that a temporary thing or is that something we ought to think about as a permanent change in the business and has implications for gross margins going forward?

I think we specifically spoke to dealer allowances. I think discounts can create some confusion because, discounts, people think about as end-user discounts. What we have tried to do in working with our dealers and partners is, we have done some structural changes which allow us to create incentives for volume as you do it.

We basically have 2 layers of partnerships today. I'm simplifying, call it a level 1 and level 2, and if you are level 2, which means a certain investment you have made back in Avid, a certain volume commitment you've made and achieved, then we will offer some additional dealer allowances.

We do, every quarter, offer special promotional opportunities both with our dealers and end users, and those are promos. But, there has been some adjustment in our dealer allowance in response to our dealers. Just as we want to be informed by customers we want to be informed by our partners.

What is the inventory situation in the channel with these products that seem to have slowed down?

We don't have complete visibility to everything that is in the channel although we have pretty good visibility. We try nowadays that for channel partners we require them to provide periodic reporting to us on what is in the channel. From a channel standpoint, I would say that the inventory in the channel is remained relatively unchanged over the last several quarters. So, there is not a significant change in what is sitting in the channels.

In terms of the inventory on your balance sheet, I think it was this time last year where you were willing to set a goal for year end and working the inventory down. And given how rapidly the inventory has risen over the last couple of quarters, are you willing to give us a benchmark for where you want to have that inventory number at year end?

First up, I would say I was running in a little bit to the opposite problem a year ago, where I didn't have enough inventory. I had a shortage of inventory because demand was kind of surprising us on a few products and therefore for many of our products there is an 8-week or 12-week lead time.

This year, the inventory is little bit higher than we wanted on where it is at here at mid year. I don't have an exact number that I want to get it down to, but I'm expecting to make good progress on it by the end of the year and continue to make progress on it next year.

We have various items that we have going on in this particular area, including some brand new improved processes around this. And we basically have a strong organizational focus on it along with some recent additions to our management structure to focus on just this area.

Okay. One more question going back to the video business. I think you said -- actually, let's try to clarify it. The video product business, did that grow in the first quarter and when you talk about that number, are you including or excluding the consumer video offering?

When we say video, it includes the consumer video offerings, so that's an all inclusive number, and on the product side, let me look. I believe there was video product growth for the first quarter. I wanted -- almost certain there was.

If you back out the consumer product, would video have been up in the second quarter?

We said the consumer video revenue was up in the second quarter.

He said, if we exclude it would it be up, was the question. If we exclude it, would the video revenue have been up?

My point is consumer video revenue was up by itself, therefore if you excluded the decrease on the product side, it is a little bit greater.

That's what I was trying to get to. So, the video products was down what? In total?

We said the video products were down 3% compared to the prior quarter a year ago. The majority of what is sitting in video is professional type products, not consumer type products.

Right.

It might have changed but would not have -- I wouldn't believe that the percentage would change substantially.

Okay. That's helpful. Then, on the market share or potential market share shifts around Final Cut X, have you seen any changes in rental fleet behavior assuming those people could move a lot faster.

They can't move a lot faster. Because first of all the rental fleets have to change, they have the change themselves. Number 1. People are still using Final Cut 7. It's not like people are saying Final Cut 7 can do the job before FCPX was released. So, they are using Final Cut 7.

They are in motion in projects. When Final Cut X was announced, everything was already set for the fall TV season, as an example. We are not going to see -- I would not expect to see changes in businesses for Final Cut X for several months.

Okay.

I would love to say it's going to be tomorrow. I wouldn't anticipate it for several months. At the earliest.

Last question, what is happening with Pro Tools software upgrade. You had pretty good momentum last quarter. Did that continue into this quarter or have you run through the upgrade opportunity?

Quarter-on-quarter it would be down. It's not atypical. We announced it in Q4, and Q1 remained strong and by the third quarter afterwards it starts to fall. That's a typical flow.

Just to be clear, Gary is talking about sequentially down, not year-on-year.

Thank you.

Now Avian. Andrew Abrams has our next question.

Just a quick 1. I'm trying to understand the way the discount works for your replace your Final Cut with Media Composer 5. 5. If I'm a dealer, the dealers seem to look at this as a separate SKU from the normal sale of 5.5. Is there a big margin difference for them in terms of what they make on the discounted version versus the let's say the full version of -- do you guys eat that difference or do they participate in some of that difference?

The answer is they participate at the exact same percentage as we do. This was a promo that everyone wanted to bring back including our dealers, because everyone is interested in seeding the marketplace. It is a promo, it is downstream. We've had very much the support of our dealers and partners.

I should also note that one of the other things with Final Cut X that is probably missed on the investor community, is that it's only available in the Mac app store now. So, all the partners that had formerly been able to sell Final Cut can no longer -- that had been selling Final Cut 7 cannot sell Final Cut X.

So, that's an opportunity. In fact, when I was out in LA, and one of partners had signed with us that week, showed up at the LA event that had been a Final Cut distributer, as an example. That's another opportunity as we are reaching out to distribution channels on it.

Basically this -- if they go to Final Cut 10, they are no longer allowed to sell that, so that would give you or another competitor exclusivity away from Apple and the app store is the only place where Final Cut gets done.

At this time, I won't tell you that Apple won't bring it down -- at this time Final Cut 7 has been removed from the marketplace.

So, that means essentially there is no other place to buy Final Cut other than online in the app store?

Correct. I suspect some dealers probably bought inventory but that stuff will go away. You have to buy it at the app store and you can -- and by the way you have to buy it unit by unit. So, you can imagine if you are a broadcaster --

Buying 25 units.

Hit button. Hit button. Hit button. And you get the general picture. The partners like us want to sell the entire work flow. They -- it is another reason for them to work with Avid.

Obviously, there're other companies in the marketplace that would like them to work with them. I think what you are seeing is, at least in our professional market, and I worry about the market I'm focused in on, you will see a shifting by customers to companies that are focused on their work flow requirements.

Right. Has there ever been any data from your dealer network that shows kind of the relative either dollar value or units of Final Cut versus Media Composer.

We have never been able to get accurate information on it.

Thank you, I appreciate it.

Yes.

(Operator Instructions)

Now we will hear from Bobbi Coffey with Brigantine.

Hi guys. Can you spend a minute or 2 speaking about the landscape for the audio market and the growth rates you expect there and has that changed? I do understands there was an upgrade cycle, but what is the core level of growth that you expect on that side?

Let me answer the question about the landscape of the marketplace. The landscape of the marketplace is that the Pro Tools, the Pro Tools 9 release has been extremely successful. Both extremely successful in terms of number of the features that it has added for the marketplace, as well as for the fact that we opened it up, so that it remains the leading DAW that is sold in the marketplace. And it is -- if there is a product that is quite pervasive in the marketplace, in that space, it is Pro Tools.

As we have opened up Pro Tools to work with other hardware, of course, as opposed to having only the proprietary packaging of Avid I/O, that, of course, has created a lot of competition for those Pro Tools seats. And it's still the same players, but it's a lot of competition for those seats.

We, of course, have our hardware working with all DAWs, but since we're the vast majority of the marketplace for the DAW, there is more opportunity for others than there is for us terms of taking market share for others with our hardware. As you go through, it's a way to think about that.

Also people have been waiting for us to refresh some of our packaged software, that's 1 of the reasons I talked about the M-Powered for the M-Audio series in the marketplace. So it's still a Pro Tools -- it is still --the audio marketplace is still, when we are talking about Pro Audio, remains a Pro Tool-centric marketplace with people, envious of Pro Tools.

In a console space for audio, I was talking to someone recently and said, with our combination with Euphonix from a year ago, there are other digital console providers that service the community. People have said, hey look, now that Avid and Euphonix are together, we really aren't thinking about the other digital console players as much. That's not to say they are not competing with us, they are not trying, but it really has changed the landscape in terms of the broad range of digital consoles.

The consumer audio space is very, very competitive. It is a consumer marketplace. All you have to do is walk into any electronic store and see the range of consumer products that are there. We are competing with all of those that are there, with marketing, with promos, with whatever it might be. That remains competitive.

We don't describe our growth rates by video and audio, we describe our growth rates by market segment, so I wouldn't know what to tell you on that, because we have to think of it by segment, and we have to create that combination that is out there. Anyway, that's sort of the dynamic of the marketplace right now.

Thank you.

There appear to be no further questions at this time. I'll turn it back to Mr. Gary Greenfield for closing remarks.

Thanks everyone for joining us today. Should you have further questions, all of us will be available for follow up after today's call, either this evening or next week. We look forward to speaking with you next quarter. Thanks.

Ladies and gentlemen, that does conclude our conference call for today. Again, thank you for your participation.