Avid Technology Inc (AVID) 2020 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Avid Technology Second Quarter 2020 Earnings Call. Today's call is being recorded. At this time, I'd like to turn the call over to Whit Rappole, Vice President of Investor Relations. Please go ahead.

Thank you, Christie. Good afternoon, everyone, and thank you for joining us today for Avid Technology's Second Quarter 2020 Earnings Call. My name is Whit Rappole, Avid's Vice President for Corporate Development and Investor Relations. With me this afternoon are Jeff Rosica, our Chief Executive Officer and President; and Ken Gayron, our Chief Financial Officer and EVP. In their prepared remarks, Jeff will provide an overview of our business, and then Ken will provide a more detailed review of our financial and operating results, followed by time for your questions.

We issued our earnings release earlier this afternoon, and we have prepared a slide presentation that we will refer to on this call. The press release and presentation are currently available on our website at ir.avid.com, and a replay of this call will be available on our website for a limited time.

During today's call, management will reference certain non-GAAP financial metrics and operational metrics. In accordance with Regulation G, both the appendix to our earnings release today and our investor website contain a reconciliation of the most closely associated GAAP financial information to the non-GAAP measures and also definitions for the operational measures used on this call and in the presentation. Unless otherwise noted by management during the call, all figures noted by management during the call are non-GAAP figures.

In addition, certain statements made during today's presentation contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Our comments and answers to your questions on this call as well as the accompanying slide deck may include statements that are forward-looking and that pertain to future results or outcomes. Actual future results or occurrences may differ materially from these forward-looking statements. For more information, including a discussion of some of the key risks and uncertainties associated with these forward-looking statements, please see our press release issued today, our 10-Q for the 3 months ending June 30, 2020, and our 10-K for the year ending December 31, 2019, on file with the SEC.

With that, let me turn the call over to our CEO and President, Jeff Rosica, for his remarks.

Thank you, Whit, and thanks for joining us to review Avid's second quarter 2020 results that we released earlier today. We're pleased to speak with you about the company's resilience and the progress we've been making while facing the difficult business climate as a result of the global COVID-19 pandemic. As we discussed in prior calls, we've been in a transition at Avid as we increase our emphasis on our software subscription business and recurring revenues. This quarter, we really saw the benefits of that transition begin to play out with the most profitable second quarter we delivered in 3 years.

Across Avid, we rapidly adjusted our strategy and appropriately reoriented our teams to effectively respond to the challenges created by the COVID-19 situation and to help our customers adapt to the changed environment so they can continue to produce and deliver the high-quality content that consumers demand. The commitment we've demonstrated to help our customers manage through COVID-19 further cemented our position and reputation with customers of all types. At the same time, we, thus far, effectively mitigated the impact of the pandemic on our company's profitability with comprehensive planning and aggressive management actions.

Today, along with Avid's CFO, Ken Gayron, we will review our Q2 results and continuing efforts -- or effects of the global pandemic on our business and how we're becoming better positioned for the future. In addition, we'll discuss the continued strength and advantages of our long-term strategy to grow recurring revenue streams and increase our efficiency and effectiveness in the way we work and serve our customers.

Now let's start with the important takeaways from Q2. During the second quarter, Avid continued to work with our media and industry customers to rapidly adapt to the new working conditions caused by the COVID-19 situation. However, the headwinds on our business that started at the end of the first quarter persisted through the second quarter. The nonrecurring revenue parts of Avid's business related to product sales and professional services bore the greatest impact [related] to an expected year-over-year and sequential decline in Avid's total revenue for the quarter.

The positive side of our second quarter revenue performance came from the continued strength in the recurring revenue portions of our business. The annual contract value from our subscription, maintenance and long-term agreements also continues to grow, increasing 8% year-over-year and up slightly over Q1. This is even more impressive given the challenging business climate we're facing like so many others are around the globe. In fact, we renewed 4 of 5 strategic purchasing agreements that were up for renewal during the quarter, with the one renewal being a live sound partner that we expect to revisit once that end market has recovered. We also added a new global strategic purchasing agreement with one of our largest systems integration partners that serves media and entertainment and other industries. And in the quarter, the strong growth in subscription revenue continued.

In spite of the extensive global disruption and the lower revenue during the quarter, we were able to deliver significantly improved margins and profitability during the second quarter as the cost savings we quickly implemented early in the quarter in both operating expenses and nonmaterial cost of sales and thus the efforts across the company to remain disciplined and focused on execution yielded improved results. Our rapid response to the developing pandemic not only helped us to persevere through Q2 but also contributed to better financial performance in spite of the anticipated revenue headwinds. We're confident that our COVID mitigation programs and the associated cost savings measures will continue to benefit the company going forward as we weather the pandemic through the second half of this year.

Now as mentioned, the recurring revenue portions of our business continued to demonstrate strength during the second quarter and, again, buoyed overall performance amid the impact of COVID-19. Subscription revenue climbed again in the quarter by over 68% year-over-year as we continued to see rapid growth in the number of paid subscriptions for our creative software tools. We started to see increased revenue contribution from our enterprise cloud business including from the cloud services agreement that we signed with a major media company at the end of the first quarter.

In Q2, our gross margin continued to improve, coming in at over 65%, which was up 600 basis points year-over-year as we benefited from the mix shift to more software sales and as we reduced expenses in our nonmaterial COGS during the quarter. Maintenance revenue has continued to be relatively stable, and combined with the strong subscription revenue growth, we saw combined subscription plus maintenance revenue grew 13.5% year-over-year.

Our e-commerce business continued to show strong growth, increasing 28% year-over-year to over $19 million during the quarter, representing an annual run rate of nearly $80 million. Over the last few years, our e-commerce business has grown into a large, strategic, profitable and valuable route to market for subscriptions, perpetual license and maintenance agreements for our creative software tools.

During the second quarter, the growth in subscriptions, the improved gross margin and the efforts we made on controlling costs during the pandemic resulted in a 43% year-over-year increase in adjusted EBITDA. And finally, we continue to see significant interest from our customers in our new cloud solutions, such as Avid Edit On Demand to support remote workers and distributor workflows at studios, broadcasters and [foreign] remote productions.

Now during the second quarter and as anticipated, we continued to encounter COVID-related challenges in the nonrecurring portions of our business as we saw weakened demand due to the ongoing disruption in live music, major sporting events and film and TV production. We continue to believe these are temporary factors that we expect to abate as the pandemic subsides, eventually allowing our industry to return to its normal pace of creativity and production. Overall, the business of Avid's channel partners has also been impacted by the temporary reduced demand and by -- subsequently, they have remained careful with their stocking orders as many continued to exercise tight management of their inventory levels.

Additionally, some of Avid's enterprise customers, such as television broadcasters, film studios and post houses, have temporarily delayed some of their purchases and paused some of their larger projects due to the business climate and restricted access to facilities caused by the ongoing pandemic. We continue working very closely with these customers and anticipate closing on several of these opportunities in the second half of 2020 as the market adapts to the pandemic and as restrictions ease.

As we look forward to the third quarter and the rest of 2020, we expect that the market environment for our solutions will continue to be impacted by COVID-19, but we do expect a gradual but potentially uneven recovery as the second half progresses and as live sports and live entertainment slowly return, film and television productions resume and as companies continue to improve their capabilities to work amid the COVID environment. We expect that the recurring portions of our business will continue to hold up and for our combined subscription and maintenance revenue to continue its strong growth as more customers adopt to our subscription offerings, including from our conversion to paid subscriptions of many of the free, temporary, 90-day licenses that we provided to customers during March and April and from the expected launch of the more enterprise subscription offerings that we're going to have later this year.

In addition, we continue to see opportunity to grow our cloud offerings to enable work from home, remote editing and other media workflows through the cloud. Given the external market conditions, we'll remain focused on growing these high-quality revenue streams from subscription and cloud and SaaS, and we'll remain vigilant on controlling our operating expenses and nonmaterial COGS to optimize our profitability and free cash flow.

The COVID-19 pandemic has also created opportunities to grow the strategic portions of our business. We are adjusting our strategy and our investments to respond to the changes in the market, which are informed by ongoing discussions with customers across the media industry, placing greater focus on the products and solutions that we believe will drive profitable growth as we emerge in the post-COVID environment. We're also in the process of realigning our cost structure, and we are committed to making a change as they're necessary to ensure that Avid exits this pandemic as a stronger and more profitable company to deliver to shareholders the kind of results they expect from a company with our recurring revenue software business.

Now with that, I will now hand the call over to Ken Gayron, who will offer more details behind our Q2 2020 results. Over to you, Ken.

Thank you, Jeff, and good afternoon, everyone. As noted above, Jeff and I will be referring to non-GAAP figures unless noted.

Overall, we are pleased with our business and financial results for the second quarter of 2020 given the macro challenges facing our business in the quarter. Our recurring revenue sources, including subscription and maintenance revenues, have remained healthy, while the nonrecurring portion of the business continues to be negatively impacted by weak external market demand related to COVID-19.

Our focus in the second quarter was on effectively managing the business to profitability. And as a result of these efforts, we were able to deliver healthy adjusted EBITDA albeit on lower revenue and to limit our negative free cash flow in the quarter, all while incrementally improving the balance sheet. We are cautiously optimistic that the actions we've taken should position us to achieve year-over-year improvement in profitability as the external market environment gradually recovers. With that, let's now get into the details of our second quarter financial results.

GAAP revenue was $79.3 million during the second quarter, down 19.7% year-over-year. Recurring revenue was strong as combined subscription and maintenance revenue was $47 million, up 13.5% year-over-year, while nonrecurring revenue from hardware and perpetual licenses was down due to the impact of sales of COVID-19 crisis. At constant currency, our second quarter 2020 revenue was down [20.1%] year-over-year as the relatively stronger euro compared to the U.S. dollar negatively impacted revenue by about 0.4%.

Gross margin was 65.4% for the first quarter, up 600 basis points year-over-year. The increase was due to a more favorable revenue mix of higher-margin subscription and maintenance revenue as well as the impact of our cost savings initiatives on nonmaterial cost of goods sold.

Operating expenses for the quarter were $40.5 million, an $11.3 million decrease year-over-year and a $10.8 million decrease from the first quarter of 2020. The year-over-year decrease in operating expenses was due to the benefits from our cost savings efforts, including $6.6 million from temporary furloughs and wage reductions we implemented at the beginning of April, $3 million from travel reductions and $3 million from marketing spend reductions, partially offset by a bonus accrual of $1.3 million.

Adjusted EBITDA was $13.5 million in the second quarter, up 43% or $4.1 million year-over-year due to the benefit of higher gross margin and lower spending. Adjusted EBITDA margin was strong at 17% in the second quarter, a significant improvement from 9.5% in the prior year period. Non-GAAP net income per share was $0.12 for the second quarter, up 10% -- up $0.10 year-over-year, reflecting the increase in non-GAAP operating income. Free cash flow was negative $5.2 million in the quarter, down $700,000 year-over-year, resulting from lower billings as well as a large change in working capital.

Working capital was a use of cash of $12 million in the quarter, reflecting an unfavorable working capital change of $7 million compared to the prior year period. During the quarter, the company reduced its accounts payable by $21 million year-over-year to facilitate an improvement in vendor pricing that benefited margins. The reduction in accounts payable, plus improvement in cost structure and profitability, provides a strong foundation for higher free cash flow for the second half of 2020.

Now moving to recurring revenue and annual contract value. The percentage of our revenue that is recurring continues to steadily increase. For the 12 months ending June 30, 2020, 70% of total revenue was recurring, up from 58% in the 12 months ending June 30, 2019. LTM recurring revenue percentage increased due to higher subscription revenue and revenue from long-term agreements as well as lower nonrecurring product and professional services revenue in the first half of 2020. While we are focused on building the recurring revenue portion of our business and we expect recurring revenue percentage to continue to increase in the long term, we believe it is elevated in the second quarter given the short-term volatility in nonrecurring hardware and perpetual product revenue. And therefore, it may be uneven sequentially during the next few quarters as the nonrecurring product in professional services revenue starts to rebound from the current depressed levels due to COVID.

Annual contract value was $265 million at the end of the quarter, up 8% year-over-year, benefiting from increased subscription revenue and greater contribution from long-term agreements year-over-year. During the second quarter, we added one new multimillion-dollar strategic purchase agreement and renewed 4 of 5 long-term agreements in the quarter. The one agreement we did not renew was with a channel partner who serves the live sound market. We expect to revisit this agreement with this partner as the live sound market recovers.

As we look into the details of our revenue streams, we continue to be encouraged by the continued resilience and growth of our subscription base. In the second quarter, we added roughly 24,000 net new subscriptions for our creative software solutions, and our total subscription count reached 242,000 at quarter end, an increase of 64% year-over-year. Subscriptions growth was particularly strong in Pro Tools, up 7% year-over-year; and Media Composer, up 52% year-over-year. The number of net new subscriptions was slightly lower in the second quarter than in the first quarter due to the early waves of users preparing to work remotely at the onset of the pandemic during March.

Additionally, we continue to see a shift towards annual paid upfront contracts, which we believe are a higher-quality revenue stream for Avid when compared to monthly paid subscriptions. Annual paid up subscriptions grew 310% year-over-year in the second quarter and now represent 22% of total subscription from 9% a year ago. Lower-quality revenue month-to-month subscriptions were down 20% year-over-year and now account for only 9% of total subscriptions, down from 19% a year ago. We believe that the growing share of annual paid up subscriptions is a result of pricing changes we implemented in July 2019, and that the share of annual paid upfront subscriptions will continue to grow as more of our enterprise customers adopt subscriptions and continue to optimize our pricing models.

The growth in subscriptions and impact of our early cloud business drove continued growth in subscription revenue during the second quarter with subscription revenue reaching $16.4 million, an increase of 68% year-over-year. From a cash perspective, billings for subscriptions increased 80% year-over-year in the second quarter, above the growth rate in subscriptions, due to the increase in annual paid upfront contracts and price increases. Finally, when we look at the total creative tool users, both subscriptions and active maintenance agreements, the total number has grown 22% year-over-year at June 30, 2020, to about 404,000 as the growth in paid subscriptions far exceeds the decline in active maintenance contracts.

Now moving to the composition of our revenues. Maintenance revenue was $30.6 million during the second quarter, down 3.4% year-over-year. We continue to see the impact of the end of support for legacy storage solutions and slowly declining noncash revenue that flows through the maintenance line. Excluding these factors, maintenance revenue would have been down 0.7% year-over-year due primarily to reduced first year maintenance revenue from lower product sales in the first and second quarters.

While subscription revenue continues to grow, perpetual license revenue was down 20.8% year-over-year due to continued weakness in MediaCentral perpetual sales due to COVID-19 and to a portion of our customers selecting subscriptions rather than perpetual licenses for our creative software products. Gross margin on software licenses and maintenance was 85.6% in the quarter, up 40 basis points year-over-year.

The company's hardware/integrated software revenue was $20.8 million in the second quarter, down 50.1% year-over-year due to the impact of COVID-19 on customer operations and purchasing decisions. The revenue line was impacted by a decline in sales of storage solutions in video service due to the impact of COVID-19 on studio and broadcast customers as well as a substantial decline in live sound audio sales caused by significantly less activity in music concert tours and festivals resulting from COVID.

As companies and economies reopen, we expect to see improvement in hardware/integrated software in future quarters as we believe there will be a strong resurgence in content creation requiring our integrated solutions. Gross margin from hardware products/integrated solutions was 25.8% in the second quarter, down 1,100 basis points year-over-year as lower production volumes did not absorb as much of the manufacturing overhead in the quarter, and the mix shift within hardware was a greater contribution of lower-margin audio products versus higher-margin storage products.

The balance of our revenue comes from professional services business. Professional services revenue was $4.6 million in the second quarter, down 33% year-over-year as certain projects were pushed out due to limited ability of professional services personnel to be on-site at customer locations. Gross margin on professional services was 8.9% in the quarter, down 220 basis points year-over-year due to lower utilization.

As of June 30, we had a cash balance of $55.7 million, down from $81 million at March 31, 2020. Cash balances decreased due to the use of cash to repay $29 million in convertible notes and negative free cash flow in the quarter, offset by $7.8 million of proceeds from the PPP loan. At June 30, we had total debt of $230.7 million, down $21.8 million (sic) [$21.1 million] from March 31. During the quarter, we experienced a reduction in our leverage ratio with the improvement in our LTM adjusted EBITDA, with our net debt to adjusted EBITDA falling from -- falling to 3.4x as of June 30 from 3.6x at March 31.

On May 19, we amended our credit facility to provide for additional covenant flexibility. As part of the amendment, we also removed the second tier of covenants when liquidity falls below $60 million. The amendment increased our interest rate by 50 basis points to LIBOR plus 675. However, as we continue to improve our profitability, we will continue to evaluate paths to improve our cost of capital moving forward. As of June 30, we reported leverage under our credit agreement of 4.3x, down from 4.6x at March 31. With our amended covenant levels plus the improvement in our leverage ratio, we have substantial cushion against the 6x maximum leverage covenant at June 30.

Finally, let's turn to our outlook. The continuing COVID-19 pandemic and its potential impact on our business and market demand for our products is still uncertain. Given the level of uncertainty, we are only providing a limited outlook for the third quarter and the remainder of the year and not providing official guidance. Our current expectation for the third quarter is for the weakness that we saw during the second quarter to continue. However, we expect to see a gradual yet uneven recovery of the market.

We expect that recurring revenue will continue to perform well but that the nonrecurring portions of our business will remain challenged in the near term. We expect that the growth in subscription will continue and maintenance will remain stable. So combined subscription plus maintenance revenue will continue to grow year-over-year in the third quarter. We expect that the cost savings efforts implemented starting in April will continue to reduce year-over-year operating expenses, yielding sequential and year-over-year increases in adjusted EBITDA in the third quarter.

As we look to the remainder of 2020, we continue to evaluate various scenarios for how the COVID-19 situation could play out in our business. Although we currently expect the market to begin a gradual yet uneven recovery, overall demand for certain projects will remain relatively weak into the second half of 2020. We do expect pent-up demand to surface when restrictions ease and more production resumes. We believe the demand for our subscription offerings should remain healthy as content creators individually and within studios strive to continue to deliver new content for their audiences.

We expect that the cost-saving measures we implemented during Q2 will deliver more than $30 million year-over-year operating expense reductions for fiscal year '20. Taken together, we expect that both adjusted EBITDA margin should be higher year-over-year, and free cash flow should be positive for the full year 2020. Also, as we exit 2020, we expect that approximately 60% of the cost savings measures taken during 2020 will become permanent in 2021 as we realign our cost structure so that Avid is positioned to exit the pandemic as a stronger and more profitable company.

With that, I'd like to turn the call back to Whit.

Thank you, Ken. Thank you, Jeff. That concludes our prepared remarks, and we are now happy to take your questions. Christie, go ahead.

(Operator Instructions) First, we'll go to Josh Nichols from B. Riley.

Great to see how well the management team has navigated a very challenging quarter, maintaining profitability and actually improving. One thing I did want to ask is, could you provide any outlook on what you're seeing as far as the magnitude of a hardware rebound in the last couple months? And if you could potentially kind of subdivide that between what you're seeing for the traditional hardware and also storage, that would provide a little bit more color and be helpful.

Yes. So Josh, thank you for your question. I would say we expect the market to gradually improve in terms of the hardware business. It has been impacted due to the situation. But I would say, in general, we expect Q3 to be an improvement over Q2, and then Q4 should be a better quarter. And I would say that we expect to see subscription and maintenance to continue to perform well and then the hardware to recover.

I would say in terms of the hardware, we see audio being the strength and that will continue to perform well. And then likely, as broadcasters and studios look to continue to fill their content pipelines, we expect the on-prem software and then storage to continue to rebound more towards the back half of the year.

And then switching gears a little bit. I think really the longer-term Avid story is about the company's growth that you've seen in this recurring revenue in the subscription base. You said you expect the maintenance revenue to remain relatively stable in the back half. Do you think that the subscription revenue growth that you've seen in the second quarter is kind of durable and expected to maintain through the back half of the year?

Yes. So I would say that we feel good about the subscription business. We feel Q3 will be a very good quarter as well as Q4. I think we did benefit a little bit from people working at home in the first quarter. But in general, we feel like these growth rates in subscription will continue to remain healthy in that subscription plus maintenance, which accelerated its growth rate from 11% in Q1 to 14% in Q2, we expect that to continue to be low double digits and that will be ahead of our initial guidance. So we see the highest quality revenue streams growing more in this environment than we initially expected. So we continue to see positive outlook in that piece of the business.

And then last question for me is the company has recently released a new enterprise offering. I heard on the call earlier, Jeff, that there's a couple more in the pipe. What's the expectation for how quickly the company will be able to get some of these larger enterprise customers onto a more subscription basis over the next, like, 12 months or so?

Well, yes, I think -- look, I think it's going to be -- good question. It's going to be gradual to some degree, but we will see. I think every quarter, hopefully -- our plan is to have new customers sign up every quarter. So we'll -- the product actually -- [normally], the wider project -- the wider product that goes across all of our platform products, including MediaCentral, actually releases in the third quarter. A lot of our channel partners are aware of it now, but they'd formally release this in the September time frame. And then we expect from there forward, we'll be doing a lot of work with customers and move many of them to subscription. So I think the trend will continue where we'll see -- our expectation or our anticipation is that we'll see probably a few [joining in the] quarter.

And we'll take our next question from Nehal Chokshi from Northland Capital Markets.

Congrats on the amazing subscription quarter there. I want to focus on the nonrecurring portion of the business, though. Pre-COVID, what percent of that nonrecurring was associated with audio and what percent was video?

I'll let Ken [read down].

Yes. So I would say on a pre-COVID basis, audio was still the main contributor of the business in terms of the hardware. I would say on the audio, when you look at that revenue line, it was roughly 40% of the business. It is growing in the COVID environment because we are seeing some weakness in the video and the storage, but we expect that to rebalance as we move into the back half of the year and into early 2021.

Okay. And based on what you are seeing now, how would you characterize video content production levels relative to what -- how -- what you saw during the June quarter and then relative to pre-COVID levels? And then remind us, what's the lag between filming and when demand is generated for the Avid products, if there is any lag?

Nehal, this is Jeff. So I'll try to answer that. Well, there's no -- let me say, there's no actual market data that comes out that quickly that we can actually see by quarter where the levels are. I'll say this, that the -- obviously, the June quarter was kind of the eye of the storm with all the pandemic. So it's expected to be the worst quarter of all, obviously, from a production standpoint.

As far as where we are in Q3, we are seeing a gradual warming, especially outside of the U.S. But even in the U.S., we're seeing -- or the Americas, I should say, we are seeing some return to production. It's a little bit lighter in L.A. and New York, but we are seeing production start up in Canada and in other parts where they feel like they've got a better ability to go back to work. But they are starting to warm up. In other parts of the world, it's going a little bit quicker.

So I wouldn't give a percentage. I would say that this quarter is looking to be sequentially better, obviously, than what we saw in Q2. And even within Q2, it was gradually starting to recover late -- very late in the quarter. So I think it's sequential. I wouldn't want to give an estimate yet, but I would say that we are making decent progress now on a global basis. Productions are just starting to get to either -- they're either back in production or they're planning to get back in production, doing the work they have to do to produce the show, sometimes in a different way than they were pre-COVID.

As far as the lag time, it really depends. Some shows that are more live-oriented that need the equipment right away to produce the show, their needs are usually pretty quick. They'll be coming after us -- they'll be coming to someone like Avid as soon as preproduction is in a serious stage. Others, more like film content, can be a few months between the time of principal photography is, shooting and when they need to actually do post production. I hope that answers your question.

That's very helpful. My last -- yes, it does. And then my last question is on the subscription side. What type of market share do you think Avid has in the lower end of the market on video and audio? I know it's tough to size, but just broad stroke market share because clearly, you guys are gaining share right now. Just broad stroke market share would help gauge what's going to be the duration of this above-market growth rate that you guys are experiencing right now.

Yes. Well, I think on the video side, we have a lot of room to move. There's a lot of companies who have share in that space. So while Avid is -- probably has a very significant share at the high end, as you know, at the lower end of the market where you have more individual creatives, our share is probably sub-15%, in the 10% to 15% in that market. So there's a lot of room for us to grow in that space at the lower end where a lot of other tools are competing. But again, as you've seen from the numbers that we're seeing good growth.

On the music and audio creation -- or music creation and audio post side, we have a larger market share there. I would say, again, at the lower end, we're probably around, I'm going to say, 30%, 40% of the market, let's say. And there's several players that make up to the remainder of the market. So even there, again, there's still lots of room for us to move.

(Operator Instructions) Next, we'll go to Jack Vander Aarde from Maxim Group.

I guess let's start with a question for Jeff. So based on your conversations with some of your larger enterprise customers or even potential customers that are not currently on a multiyear contract, are there any specific end verticals or customer types that you would say are slower to rebound or less likely to make a large purchase in the next 1 to 2 quarters? And then on the flip side, are there any specific customers in certain end verticals that are rebounding faster or better than you would have expected, say, from a month or 2 ago?

Yes, that's a good question. So on the markets, I think markets that are advertising -- where a lot of their revenues come from advertising, they're going to probably be a little bit longer. I think if a larger percentage of their business is advertising, probably the longer it will be for them to potentially start making larger investments. But that's not a black and white answer. There are people who are already investing in that space. But I'd say, if I think of things as a collective, it's probably going to be slower to move than, let's say, people who are doing streaming services or subscription-based content services. Those are going to return quicker. Actually, anybody in the content creation ecosystem, in a -- that's supplying content or creating content for a subscription-based or anything in that caliber, they're going to come back a lot faster because those business models require a constant stream of new content and otherwise, people will turn the service off. And so I think those markets are moving a little more quickly.

We are seeing, too, in markets around the world, the more public domain or the government type of areas, those are starting to see some [ramp] already. So I think it really depends. There's a lot of nuances you have to look at. There's what country are we talking about, how much of the business is advertising, how much of it is subscription-based. There's a lot of metrics that go with that. And of course, if you're a post-production provider and you're working with Hollywood, obviously, your recovery is going to be based on when production gets back into full swing.

Great. No, that's very helpful. And then I guess a question for Ken. So in your prepared remarks, too, profitability benefited from this $11 million or so of reduced operating expenses or cost savings, which is a good chunk of that planned $30 million or so target for 2020. Did I hear correctly, Ken, that about 60%, 6-0, 60% of the cost savings in 2020 will be permanent as you head into 2021? So I guess, that's $18 million or so. Is that correct?

Yes, that's correct. So $30 million was the OpEx savings. We believe 60% roughly will be permanent in 2021. We feel good about the movement that we're making in certain areas of the cost savings. And as we are benefiting from those programs, we want to try to realize a majority of those. So 60% is what we feel comfortable saying in our cost structure in 2021 is we want to drive continued improvement in profitability for our shareholders.

Sure. That's helpful. And then in case I missed it, did you guys -- I think part of the cost savings plan, too, was for some savings opportunity. I think it was about $10 million or so as the target for cost of goods sold savings in 2020. Did you guys experience -- or any savings from the cost of goods sold line? And then do you have any similar guideline or framework for what percent of that would be permanent heading into 2021 as well?

Yes. I would say we -- our goal is $10 million for the year. We're on track. We're actually slightly ahead in that based on our Q2 results, and you can see that in our gross margin. Our gross margin is 65%, up 700 (sic) [600] basis points from the year-over-year period. I would say, in general, we're probably going to be in the 30% to 40% area on the COGS. I would say that's probably a good estimate at this point for us in 2021. We are getting the benefits of continued vendor negotiations that will continue to drive that number. So that's an estimate I would have for you for 2021.

Okay. That's helpful. And then just one more for me. I'm looking at -- through the 10-Q and I noticed like the gross margin for product sales contracted about 550 basis points or so for the 3 months. Just wondering how much of this is related to the temporary headwinds from COVID-19 or essentially, just less fixed cost absorption due to the lower product revenue scale. Or how much is actually due to normal business factors, such as like pricing pressure or other maybe discounting or anything like that?

Yes. So when we look at our product business, we look at both product margin and then obviously gross margin, which includes the overheads. Our product margin year-on-year was held up pretty well. And that margin was impacted by a mix shift more to audio, which is lower margin than our storage. So the product margin, we feel really good about. The overheads were not absorbed, obviously, when revenues are down in the hardware side. So as that business rebounds, as the market gradually recovers, I will -- we should see a fairly large increase in the hardware margin as those overheads are absorbed.

So as Jeff and I pointed out, we expect a gradual recovery. It should be -- it could be uneven. But in general, we're seeing better health of the market. So as hardware revenue improves, we should see that gross margin on the product side improve as well because we'll be able to absorb the overheads.

Okay. And then actually, just as a follow-up to that, too, is your target for adjusted EBITDA margin for the year, which is supposed -- I think you kind of not explicitly but -- or formally said, but you expect it to be up year-over-year. Is -- do you embed that sort of product gross margin expansion into that comment about adjusted EBITDA and [getting] higher in 2020 versus 2019?

Yes. So we expect adjusted EBITDA margin to improve this year and you can see the benefits. Obviously, we -- EBITDA margin was 17% this quarter. It was 9% a year ago. So you can see the improvements that we're making on the cost structure that's driving the higher profitability as well as the improvement in COGS that's driving the favorable gross margin in addition to the higher-quality revenue. So when we look -- think about that margin, we expect some improvement in the hardware margin in the back half of the year to help get to our goal. So that is -- there is some recovery really in the fourth quarter that we expect to get to those levels.

And we'll go next to Samad Samana from Jefferies.

Maybe I'll start on maybe how the pipeline has changed and how deal wins look now that we're several months removed from the Disney-Microsoft partnership announcement. I know that received a lot of visibility at the time, and I know a lot has changed in the world. But I'm curious if that's having some of that intended effect of drawing larger content providers into the pipeline.

Samad, this is Jeff. Let me answer it for you. So I think -- yes, the intended effect we had, while obviously COVID, in the very beginning, kind of offset the trend, it's -- I think it's stabilized now. And we -- as we mentioned, we haven't named the company yet, but there was another major media company that we signed an agreement with in Q1 that started to convert to revenue in Q2. There are others that we've signed around the world that are maybe not as large as those 2, but are pretty significant sized companies. And those are starting, hopefully, to contribute in the second half. And we're continuing to see a lot of -- a heavy amount of work in those -- in customers around that area.

Selling in the cloud is a little bit different because you go through a process of doing POCs and doing things to prove out that you can do what they need you to do in the cloud. But that work is all going very well. Our team is almost overtaxed. They're quite busy working. And so that funnel is improving, and we are converting some of that from the funnel. So I think so far, we're pleased with it.

Great. And maybe just -- and I apologize if you already addressed this, but as I think about with some live entertainment, even though it's not in-person, but coming back, for instance, the NBA coming back and pivots in other forms of media, is that -- how much of that allows you to use maybe existing product that these kind of providers have purchased from Avid versus maybe driving some incremental spend that's either in new areas or in "bubbles"? I guess how should we think about maybe that being at least a short-term salve or opportunity, if at all?

Well, I think -- I mean it really depends. It's all of the above. Some customers have upgraded recently, so maybe they don't need to spend a lot in the short term. Others have put things off and so they need to invest. I would say, in general, getting back -- even if there isn't [spans on the sand], it's still good they're getting back because by the sports getting back, you're not generating new advertising revenue or at least improve the advertising revenue, you're getting eyeballs back to TV at those times of the day or evening when they want those eyeballs. So I think it's going to eventually help the advertising revenue, which by default helps the economics of those broadcasters or media companies. So that's a good thing. The more the return and the faster the return, the better it is for us.

As far as who needs equipment, again, it's all over the map. Some people need it immediately. Some people have already given us contracts to help get something upgraded or get something additional put in. Others are waiting a little bit longer to see whether those season plays out. So again, it really depends on the sports and where the broadcasters or people who are -- own the rights to that, what their plan is for their particular environment. But the general answer is the more that gets back into production, Samad, the better for us.

Right. Well, I know I, along with everybody else, is rooting for more [safe way] as possible, so we're hopeful to go out. And then look, obviously, the company has done a lot in terms of cost-cutting measures to benefit the bottom line and keep the balance sheet safe. But how should we think about maybe -- is there any opportunity for tactical M&A for Avid in this type of environment where maybe some of your smaller competitors or adjacent pieces might be struggling whereas the company's balance sheet is in good shape? How should we maybe think about that opportunity in the next 6 to 12 months?

Well, I wouldn't want to be specific about it. There's nothing specific I would share. I think obviously, generally, in a market like this, those opportunities are likely to present themselves. I don't think they're going to do it immediately. But I think eventually, you're going to see those opportunities present themselves. Look, all I'll say is Avid, like any technology company, is going to stay and pay attention and keep our eye on what's happening in the market and what may be interesting to us. But right now, in the near term, we're focused on execution to ensure we've got the right profitability profile and cash flow profile. But we're paying attention. We're keeping our eyes open.

Got you. And then, Ken, I think this one's probably more for you. But as I think about the cloud subscriptions, that continues to be an area that impresses. And have you seen any patterns in terms of retention amongst cohorts, maybe the customers you signed at the end of March versus, call it, as the months have gone along in this? Or any changes or stabilization or getting -- as you think about the different cohorts of those sign-ups?

We're actually, overall, seeing an improvement in retention rates on the subscription side during this environment. Also strategically, we're pushing more of the business to annual paid annual versus the monthly paid monthly, and there's a significant improvement in that quality of revenue stream in terms of retention rates. So those 2 strategies continue to nurture customers, continue to push people to annual paid annual. We're starting to see kind of an improvement in the retention rate in that subscription. We will continue to do that because that's a very important piece of that business and its outlook.

And we have no further questions in the queue. At this time, I'd like to turn it back to Jeff Rosica for closing remarks.

Well, thank you, operator, and thanks, everyone, again. So let me just close by saying we remain enthusiastic about the opportunities for Avid. We are committed to supporting our customers through the COVID-19 pandemic, and we'll remain vigilant in our cost savings efforts as we operate the business responsibly given the current environment. And we're looking forward to strategically positioning Avid to capitalize on the profitable growth opportunities expected in the post-COVID environment.

So thank you to our investors, analysts and others for joining us today. I hope everyone will remain safe and healthy. We look forward to speaking with you again soon.

And that does conclude our call for today. Thank you for your participation. You may now disconnect.