Avid Technology, Inc.

Good afternoon, ladies and gentlemen, and welcome to Avid Technologies' first quarter 2023 earnings conference call. My name is Whit Rappel, Avid's Vice President for Corporate Development and Investor Relations. Please note that this call is being recorded today, May 4th, 2023, at 5.30 p.m. Eastern Time. 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 detailed review of our financial and operating results, followed by time for 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 the events and presentations page of our investor relations website at ir.avid.com. And shortly following the conclusion of this call, a replay will be available on our IR 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 metrics used on this call and in the presentation. Unless otherwise noted, all figures noted by management during the call are non-GAAP figures except for revenue, which is always GAAP. 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. These forward-looking statements are based on our current beliefs and information available as of today. 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 and our most recent annual report on Form 10-K and quarterly report on Form 10-Q filed with the SEC. With that, let me turn the call over to our CEO and President, Jeff Rosica, for his remarks.

Thanks, Whit, and my thanks to everyone who is joining us today to review AVID's first quarter results. Let me get started right away by offering a summary of the three big takeaways for the quarter before I dive a bit into each of these points. First and foremost, we're quite pleased with the performance of the strategic recurring revenue portion of the business in Q1, with our subscription and SaaS business continuing to perform very well. Subscription revenue was up nicely year over year, with subscription ARR up over 31% year over year on a constant currency basis. And we continue to consistently add to our overall subscriber base in the quarter. Next, we continued to see strong overall customer demand and bookings for our integrated solutions, though as we worked through resolving the ongoing supply chain issues, we did face more significant temporary challenges and costs in the quarter specific to our audio hardware products than we had anticipated. This created substantial and unexpected gross margin headwinds for audio hardware, which impacted overall profitability and free cash flow in the quarter. We firmly believe that these issues are transitory as we work through resolution of these issues caused by the impacts from the macro supply chain situation. And our teams have good line of sight to resolve the majority of the issues we're currently seeing as we proceed through the balance of the year. And we expect to normalize hardware gross margins by the second half of 2023. Also, we're taking further proactive cost savings measures to help mitigate these near-term headwinds that we're managing through, which Ken and I will both discuss further in our prepared remarks. And lastly, with the continued strong subscription performance, AR growth, and bookings trend, combined with our proactive measures in managing costs to protect against near-term macro headwinds, We continue to have full confidence in our long-term growth strategy and the outlook for the year. And as such, we are reaffirming our guidance for the full year. Now, let me dig in a bit more and provide some specifics on each of these areas. We continue to see strong adoption of our creative tool subscriptions and enterprise subscription and SaaS offerings, which resulted in quite solid growth in our overall subscription business in the quarter. Subscription ARR grew year over year at over 31% at constant currency to 150 million, which helped drive total ARR to 247 million, representing growth over 9% year over year at constant currency. Our subscriber base continued to grow nicely, with us adding approximately 20,700 active paid software subscriptions, which brings our total to over 526,700 at the end of the quarter, representing an increase of 22% year over year. Our creative tools are an essential part of our subscription growth, and we continue to see strength in this area, especially for the key products Pro Tools and Media Composer. As part of our growth strategy in the music creation segment, we continue to innovate and further grow the Pro Tools subscription business with current customers and also attracting more of the next generation music creatives. As we continue to ramp up our strategic focus on the music creation space and are gearing up for a very important product release plan for the second half, we announced a new Pro Tools program called Sonic Drop, which provides subscribers access to a monthly mix of new samples, loops, and instrument presets. I'm really excited about the new Pro Tools innovation that is coming for music creators, and we look forward to unveiling it later this year, as we strongly believe that extending Pro Tools deeper and wider into the music creation space should drive meaningful acceleration in subscriber growth. Adoption of enterprise subscriptions continues to trend very well and create our confidence in the growth trajectory of our overall subscription business. And ARR per subscription seat continued to improve as enterprise subscriptions becomes a larger portion of the business. Two weeks ago at the NAB show in Las Vegas, we announced a new agreement with Televisa Univision to collaborate on moving the content production workflows across their portfolio of international media properties to Google Cloud as part of their strategic innovation plans, enabling them to meet spikes in content demand and maximize cost efficiency by leveraging our Flex subscription offerings in the cloud. I believe that this announcement offers another proof point of our market leadership and first mover advantage as the media industry is starting to move to cloud-based workflows and SaaS solutions. As I mentioned earlier, we did continue to see good customer demand and bookings for integrated solutions in Q1. While integrated solutions revenue increased slightly this quarter to 28.7 million, our backlog does remain elevated due to the remaining supply chain constraints and continued good demand. and we ended the first quarter with a backlog of over 20 million. We still expect to resolve the current situation over the next couple of quarters and expect to end 2023 in a more normalized state. And as I highlighted before, during the first quarter, we did experience greater gross margin headwinds than we anticipated with our audio hardware products. Specifically, gross profit on audio hardware was adversely impacted by temporary higher costs of producing these products as we work through resolving the impacts of the macro supply chain situation on this specific portion of our business. The impact on the audio hardware gross profits did have a flow-through impact to EBITDA, EPS, and free cash flow in the quarter. As I discussed previously, we are currently taking further proactive cost savings measures and working diligently to mitigate the effects of the global supply chain situation on our business and drive the financial performance of the company. Also, back in April, we announced the MTRX2 audio interface that was very well received by the market, which replaces the current MTRX interface that has been one of the products that has had significant component supply issues. The new MTRX2, which utilizes newer FPA technology that is less expensive and has better availability, is expected to begin shipments during Q2 and should improve volumes and margins in this important product area. While we experienced issues with our audio hardware, we saw continued success and solid financial performance with our storage business. New product offerings to new markets, as well as the cloud and on-prem software subscription options that we now offer, have driven sustained success in this area of the integrated solutions business. Last month, we announced the availability of Avid Nexus cloud nearline storage for our edit-on-demand SaaS offering, bringing highly cost-efficient nearline storage to cloud-based content creation workflows, as well as unveiling the new Nexus F2 SSD storage solution for ultra-high resolution and ultra-high performance video workflows, both of which were very well received by customers and prospects at the recent NAB show. Our enterprise subscription agreements are quite valuable for the company, especially with the multi-year contractual commitment, as well as the resulting uplift and increase in ARR that we are realizing. This has motivated us to accelerate the end of life of our remaining perpetual software license options, which is the right business decision for the company, though it does create a bit of a near-term comparative headwind for us. As a management team that is quite experienced and proven at navigating various macro headwinds over the past few years, we remain hyper-focused on delivering improved earnings and free cash flow in 2023, and as such, are proactively managing our cost structure. As previously mentioned, we offered a voluntary early retirement program during the first quarter, and along with other significant cost savings initiatives that we're executing on this quarter, we have confidence that we can offset the temporary margin shortfalls that we're currently experiencing to help ensure that we stay on track to deliver on our profitability and cash flow targets for the year. And we're making the right cost decisions to also protect and help self-fund our strategic innovation and digital transformation as part of our long-term growth plan. Ken will offer some specific financial details on the additional cost savings plans that we're currently implementing during his comments. Extending on my earlier remarks, we're seeing sustained strength in our opportunity funnel and sales pipeline and continue to see strength in our overall bookings in the quarter, which are up more than 20% year over year. One of our global routes to market is through our channel partners. And as we've talked about previously, we have established an agreement called the Strategic Purchase Agreement, or SPA, as a premium level of the Avid Reseller Program, which is only available to our highest performing, most engaged, and invested partners. As of the first quarter of 2023, we now have over 70 channel partners around the globe who are on SPAs, and these strategic partners are playing a key role in helping drive strong bookings growth. Now let's talk about where we see things going forward from a business perspective. We expect continued strength in subscription and an increase in ARR going forward. As I mentioned on the call last quarter, we believe ARR is really the right metric for investors to understand the real underlying growth trajectory of our subscription and SaaS business. With our shift to subscription and SaaS, we do expect maintenance revenue to trend down over time. However, we do expect increased hardware shipments, planned pricing adjustments, and solid renewal rates to contribute to stabilizing maintenance revenue during the remaining quarters of 2023. We will continue investing in innovation and digital transformation, which are important to our strategic growth plan, while very carefully managing our overall cost structure. As I mentioned earlier, we will focus on self-funding our growth initiatives through specific restructuring efforts and proactive cost management and controls. As this management team has done multiple times previously, we are committed to taking the appropriate actions to deliver profitability throughout business cycles, and we're taking the actions to do so again as we navigate the current macro environment. With an improving line of sight to resolving the current supply chain challenges, which admittedly have been a bit more stubborn to resolve than we anticipated, we do fully expect the supply chain conditions temporarily impacting audio hardware shipments and margins to gradually improve starting in Q2 and through the second half. With the planned cost savings measures, along with planned price actions to address our audio hardware concerns, I am confident we have the necessary action plans in place to mitigate these issues by the second half of 2023. While we are taking a cautious stance for Q2, we remain confident in the overall performance trajectory of the business and with the continued strength of our subscription business and bookings trend. Combined with the proactive measures we're taking to manage costs in order to protect against near-term macro headwinds, we continue to have full confidence in our long-term growth strategy and the outlook for the year. And as I mentioned in my opening comments, we are reaffirming guidance for the full year. So with that, let me now turn the call over to Ken to review some of the financial details. Take it away, Ken.

Thank you, Jeff, and good afternoon, everyone. In the first quarter, we continued our strong performance in our core subscription business and growing our recurring revenue. Our focus for the remainder of 2023 will build to further build our high margin subscription revenue, proactively manage our costs and continue to stay on track with our long term model. We expect these efforts to result in improving profitability as we move through 2023. Given this, we are reaffirming our annual guidance for fiscal year 23. With that, let's now turn to the details of our first quarter financial results. Annual recurring revenue based on the annualization of subscription and maintenance bookings was $247 million in the first quarter, an increase of $19 million or 8% year-over-year and 9% year-over-year at constant currency. Growth in ARR was due to subscription ARR growth of 30% as we continue to convert maintenance customers to subscription revenue at healthy uplifts while adding new customers. At constant currency, subscription ARR increased 31% year over year. Additionally, the unshipped integrated solutions backlog, which was 20 million at March 31st, negatively impacted the maintenance ARR as the unshipped orders would have contributed about 2 million to maintenance ARR, negatively impacting ARR growth by 1%. Absent this, our ARR growth would have been in excess of 10% year over year at constant currency. We continue to focus on growing our recurring revenue from subscription, maintenance, and other revenue under long-term agreements to drive greater predictability in our business. As of the end of the first quarter, LTM recurring revenue was 85% of total revenue, up from 79% a year ago and in line with our long-term model. Now let us look at the results of the first quarter of 2023, beginning with subscription. We are encouraged by the continued growth of our subscription base. Our total active paid software subscription count reached approximately 526,700 at the end of the first quarter, an increase of 22% year over year. Creative subscription growth was healthy and solid, and enterprise subscription performance in the first quarter continued to exceed our expectations. We added approximately 13,300 new creative subscriptions for growth of 14.8% year over year, led by a sequential increase in both Pro Tools and Media Composer net ads and continued growth in Sibelius. We now have over 100,000 Media Composer subscriptions, an important milestone for the company. Overall, we are highly confident in the consistent growth of our creative tools subscription business, but expect to see strong improvement in license growth in revenue in the second half with the introduction of our music creation applications and pro tools that Jeff mentioned earlier. Moving to our enterprise business, Media Central subscriptions grew to approximately 53,300, an increase of about 7,400 during the first quarter, representing year-over-year growth of 176%. The increase in enterprise subscriptions furthers our confidence in the transition of our existing customer base to subscription. We believe we have converted about 40% of Media Central maintenance customers to subscription as of March 31 and still have a large opportunity in Media Central ahead of us, plus over $40 million of storage, video server, and graphics maintenance that will move to subscription over time. As our enterprise subscription business continues to become a more meaningful part of our subscription mix, It is continuing to positively impact our overall price per seat as the price of an enterprise seat is a multiple of the price per seat of a creative seat. The impact is helping to drive a 6.7% year-over-year increase in subscription ARR per active paid software subscription. The consistent growth in the number of paid subscriptions drove continued growth in subscription revenue during the first quarter, which reached $39.4 million, an increase of 19.5% year-over-year and 21.2% on a constant currency basis. Now moving to subscription plus maintenance. During the first quarter, maintenance revenue was $22.6 million, down 20% year-over-year. Many maintenance contracts are renewed around year end. We have seen an associated decline in software maintenance from Q4 to Q1. As we continue to successfully convert our enterprise customers to subscription offerings at healthy uplifts in excess of 150%, we expect to see a reduction in the related software maintenance revenue from those customers. However, we expect hardware maintenance revenue to improve due to the price increases plus expected higher hardware revenue and associated maintenance beginning in the second quarter, as we expect our backlog will be depleted to normal levels by year end. As a result, we believe total maintenance revenue will be stable at 22 to 23 million per quarter for the remainder of 2023. supported by the current $97 million in maintenance ARR at the end of Q1. Total subscription and maintenance revenue increased year-over-year by 1.2% in the first quarter and 4.1% on a constant currency basis, driven by the strong subscription performance offset by the decline in maintenance software and temporary headwinds on maintenance hardware that should reverse going forward. Our subscription and maintenance gross margin was 85.9% in the first quarter, up 320 basis points year over year. Now let's look at our integrated solutions performance. In the first quarter, integrated solutions revenue was 28.7 million, an increase of 1.8% year over year, as we continue to work through the remaining supply chain issues that have hindered our audio hardware production capacity. We ended the first quarter of 2023 with 20 million of contractually committed backlog at March 31st. Our integrated solutions gross margin was 29.2% in the first quarter, down 1,200 basis points year over year. As Jeff said, although we made some progress in resolving the supply chain challenges, we did see an impact on audio hardware gross margins in the first quarter. Approximately 1.5 million of the year-over-year gross profit decline was due to purchase price variation and the cost of components for audio hardware. 1.1 million was due to the shipments of audio hardware in the quarter from age backlog at old sale prices but higher components costs. And 900,000 was due to a higher mix of lower margin audio products in the quarter and higher production costs. Together, these impacts cause a $3.5 million year-over-year gross profit decline in the quarter, which flowed directly to operating income and EBITDA. We are driving additional price increases to recapture margins, including surcharges on age backlog, and we expect to see an improvement in our key component costs. As a result, we are highly confident that our integrated solutions gross margins will improve in Q2 23 and get back to more normal levels of 40% plus in the second half of the year. Now moving to the rest of our revenue. Perpetual license revenue was a half a million in the first quarter of 23, a decrease of 89.5% year over year as we continue to de-emphasize perpetual software and move to subscription software as we execute our plan to end-of-life perpetual solutions. The large amount of perpetual revenue in the prior year made our year-over-year comparison more challenging in Q1 23, but moving forward, the amount of perpetual revenue in our prior year periods will be much less of an issue for year-over-year comparisons going forward. In the first quarter, our professional services and training revenue was 6.5 million, an increase of 9.4% year-over-year and 12.5% year-over-year on a constant currency basis. During the first quarter, we also continued to make progress with our projects to make our solutions available on AWS and Google Cloud, which continues to track to our plan. Now let us look at the rest of our results for the first quarter of 2023. Total revenue in the first quarter was $97.8 million, down 2.8% year-over-year and flat at constant currency, reflecting the strong performance across subscription as well as the perpetual decline. Non-GAAP gross margin was 64% for the first quarter, down 280 basis points year-over-year and down 180 basis points at constant currency. This was due to the decline in integrated solutions gross margin, despite strong margin improvement from our strategic subscription and maintenance revenue, as discussed previously. Non-GAAP operating expenses were $52.2 million in the first quarter, a $2.5 million increase year over year. As part of our efforts to control our spending while preserving our ability to invest in high growth areas, we have taken several actions. During the first quarter, we implemented a voluntary early retirement program, which is expected to reduce costs by approximately $2 million in fiscal year 23. In the second quarter, we are implementing a restructuring, which is expected to reduce costs by an additional $13 million in fiscal year 23. As a result of these actions and other cost savings efforts, we expect our operating expenses to decline the second half of 2023, resulting in operating expenses of approximately $215 million for fiscal year 23. There is buy-in across the entire senior management team on managing our cost base while protecting investment in our subscription business to drive improved profitability and long-term value creation for our shareholders. Adjusted EBITDA was $12.7 million in the first quarter, down $6.5 million year over year, reflecting the lower gross profit from integrated solutions and higher operating expenses as discussed. Finally, non-GAAP earnings per share was $0.15 for the first quarter, down $0.18 year over year, reflecting the lower adjusted EBITDA and higher interest expense due to increase in base rates. Free cash flow was negative $6.5 million in the quarter, down $11 million year over year due to the reduction in adjusted EBITDA and higher inventory to support the planned increases in integrated solution shipments starting in Q2 23, plus timing of receivables collections at the end of the Q1. We ended the first quarter of fiscal year 23 in a strong financial position with net debt to EBITDA of 2.1 times. As discussed during our fourth quarter in fiscal year 2022 earnings presentation on March 1st, we will continue to invest in our growth initiative to drive our subscription revenue, but we'll be very prudent in our overall expense management to improve our free cash flow in 2023. Also, we expect working capital to be more of a benefit in the second half of 2023, which should assist free cash flow along with the improvements we expect to see in our profitability. Finally, we continue to execute corporate actions to enhance long-term shareholder value. During the first quarter, we repurchased 16,000 shares for $400,000, reflecting an average price of $26.74 per share, bringing the total repurchases to 2.9 million shares or 78.4 million under the $115 million authorization. We will continue to deploy capital prudently in the most responsible way to drive long-term shareholder value. Let's now turn to guidance. As Jeff said, we are confident in the underlying strength of our business. We expect continued strong growth in our subscription business and a positive trajectory given the strength in our bookings the last two quarters. Additionally, with the improvements in our cost structure, we expect to see significant growth in profitability and cash flow in the second half of the year. We also continue to expect to see gradual improvement in the integrated solutions gross margins beginning in the second quarter of 2023 that will eventually return to 40% plus margin levels in the second half of the year. In terms of guidance for the second quarter of 2023, our guidance is as follows. ARR at the end of the period of 246 to 251 million. At the midpoint, this reflects 8% year-over-year growth and approximately 30% year-over-year growth for subscription ARR. Sequentially, the ARR growth is slightly ahead of Q1 2023. Total revenue guidance of 101 to 111 million. At the midpoint, this reflects 8.5% growth year-on-year. Adjusted EBITDA guidance of 13 million to 20 million. and non-GAAP earnings per share guidance of 15 cents to 30 cents, assuming 44.1 million shares outstanding. At this time, we are also affirming our guidance for full year 2023 that was discussed during our fourth quarter and fiscal year 2022 earnings presentation on March 1st. Our guidance for 2023 ARR at the end of the period remains 270 to 280 million, a range which represents year-over-year revenue growth of 12.3% at the midpoint. We believe ARR will accelerate in the second half with improving growth from Pro Tools, continued transition of Media Central maintenance customers to subscription, renewal of our first cohort of Media Central enterprise customers positive uplifts in the second half of the year, and a rebound in our hardware maintenance revenue. Our guidance for 2023 total revenue remains 447 to 472 million, a range which represents year-over-year revenue growth of 10.1% at the midpoint. Our guidance for 2023 subscription and maintenance revenue remains 292 million to 302 million, a range which represents year-over-year growth of 13.7% at the midpoint. Our guidance for 2023 adjusted EBITDA remains 95 to 105 million, Our guidance for 2023 non-GAAP EPS remains 153 to $1.75, assuming 45 million shares outstanding. And our guidance for 2023 free cash flow as adjusted remains 50 to 60 million, which includes $7 million in cash restructuring charges. Our 2023 free cash flow guidance reflects the improvement in profitability and improvement in working capital, slightly offset by higher cash interest expense due to higher base rates and restructuring costs. With that, I'd like to turn the call back to Whit.