In this edition of Fool on Call, we'll take a look at digital media specialist Avid Technology (NASDAQ:AVID). We'll highlight the challenges in the increasing complexity of projects among customers, and how the company is responding with an improved operational model. The discussion, taken from the third-quarter conference call, will be broken down into two parts:
1. The challenge: complexity
2. The response: solutions
But before going there, let's take a look at the company's third-quarter performance. In a prior look at the global leader in digital media creation, I commented on how difficult it has been for Wall Street analysts and the company's management for that matter, to accurately forecast how results will turn out. With the release of the earnings report, management has once again revised its full-year estimates, this time downward.
Wall Street didn't welcome the news, sending shares sharply south in recent trading, and for good reason. With the unpredictable nature of Avid's business, in which it is dealing with cutting-edge products that face software stability issues as glitches are worked out, in addition to uncertainties surrounding the timeliness of adoption by customers, it comes as no surprise that the stock performance has been equally unpredictable.
As far as the third quarter went, revenues increased 13.1% year over year. Excluding the impact of acquisitions, however, organic revenue growth increased about 7%. The top line was supported by continued strength in the professional video segment as media producers continue to move toward HD. Geographically, video sales in Europe and America were solid, both achieving a 9% increase over the same quarter a year ago.
Gross profit margins were 48.4%, significantly below the 53.3% mark it achieved in the year-ago period. Margins in its video business were "stable" but more than offset by weaker margins in its audio and consumer segments. We can assume that its Pinnacle acquisition with products more geared to the lower-margin consumer market is one reason for the decline.
Finally, reflecting various one-time charges, earnings for the quarter were $0.08 per diluted share, compared to a loss of $0.48 per share in the comparable period a year ago.
Turning our attention back to Avid Technology's new operational model:
1. The challenge
One of the first things that stood out for me in the call is very much related to what I have just been commenting on -- the inconsistency in the current business model. I've already mentioned two types of challenges Avid is facing, hindering its ability to accurately forecast revenues.
Adoption issues are one hurdle, as exemplified in sales for Pro-Tools HD systems that were "stalled" by third-party delays in getting the necessary updated plug-ins to run on Intel-based Macs. A second challenge is with the software itself, making sure the system is operable and stable. Pinnacle Studio 10, for example, is a product that Avid has spent some effort on in improving its "stability." Hopefully, this will translate into improved sales.
Beyond these two factors, there is a third obstacle that Avid must contend with, and that is the ever-increasing complexity of projects needed to address its customer's needs. One analyst asked during the Q&A portion of the call whether some of the issues it is dealing with are of an "execution" nature. CEO David Krall stated matter-of-factly that it "is not related to execution." Rather, he added, "The deal size continues to get larger, and as a consequence of that, the larger the deal, in general, the more complex it is. The more complex it is, the longer it takes to do installation, and also the longer it takes to fully educate and train all of the operators on how to use the new system."
We can see the direct effect of the phenomena in the company's third-quarter results. The broadcast segment, despite being an important growth market for Avid as producers transition to HD-format, actually saw sales decline 7% from last year because of "recognition timing." However, a clear indicator that business is booming in broadcasting can be found in bookings that are "up over 85% from Q3 of last year."
Is there a way it can smooth out its sales performance? Management believes so.
2. The response
The positive side -- reflected in deals that are growing in size and complexity -- is it shows that customers believe Avid Technology is capable of delivering with its suite of digital media creation products. But now it is up to Avid to deliver. On this point Krall added, "Additional complexity means that it just requires more careful and thoughtful planning, implementation, integration, training, and rollout."
To accomplish this end, the company has shifted around its management structure, bringing in new leadership to head over the Video division. The new manager is Graham Sharp, who was previously implementing a highly successful service-oriented, solutions-based model for Avid in Europe.
One of Graham's initial moves was to bring Video sales and service organizations "under one roof." We've seen how retailers like Best Buy (NYSE:BBY), Circuit City (NYSE:CC), and now even wholesalers like Costco (NASDAQ:COST) have responded to the increased complexity of tech products by subsequently increasing service levels to customers. Doing so not only makes for a more satisfied customer, but it also provides increased revenue potential.
In similar fashion, Avid sees the new solutions model delivering "better value for customers, while providing Avid with additional revenue opportunities within each facility." Even more, the changes are expected to "even out the selling and delivery of systems across the entire quarter," improve profitability, and, finally, provide better predictability in its revenue forecasts.
Capitalizing on the opportunity
Avid's influence in the digital media field is staggering. Whether it is Viacom's (NYSE:VIA) Paramount Pictures and its Flags of Our Fathers production, or Disney's (NYSE:DIS) revamping of ABC and ESPN broadcast centers with the latest in HD systems, Avid Technology is dominating an important and growing market.
But moving to a service-oriented, solutions-based model is critical for it to maximize its potential and fully capitalize on this opportunity. The move will increase profitability and improve forecasting of revenues, both of which are sure to please shareholders who have no doubt been on quite a rollercoaster ride in recent quarters.
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Fool contributor Jeremy MacNealy has no financial interest in any company mentioned. The Motley Fool has a disclosure policy.
