| AVID TECHNOLOGY INC ITEM 1A RISK FACTORS Some of the statements in this Form 10-K relating to our future performance constitute forward-looking statements |
| Such forward-looking statements are based upon managementapstas current expectations and involve known and unknown risks |
| Realization of any of these risks may cause actual results to differ materially from the results described in the forward-looking statements |
| Certain of these risks are as follows: We may not be able to realize the expected benefits of our acquisition of Pinnacle Systems As a result of our recent acquisition of Pinnacle, we face challenges in several areas that could have an adverse effect on our business |
| In addition, some of the assumptions that we have relied upon, such as the achievement of operating synergies and revenue growth, may not be realized |
| As a result of these and other factors, the acquisition may not result in a financial condition superior to that which we would have achieved on a stand-alone basis |
| If our integration of Pinnacle is not successful, our results of operations could be harmed, employee morale could decline, key employees could leave and customers could cancel existing orders or choose not to place new ones |
| With the completion of the integration, the combined company must operate 11 as a unified organization utilizing common information and communication systems, operating procedures, financial controls and human resources practices |
| We may encounter difficulties, unforeseen costs and delays involved in integrating the Pinnacle business, including: o failure to successfully manage relationships with customers and with important third parties; o failure of customers to continue using the products and services of the combined company; o failure to properly integrate the professional film, video and broadcast businesses of Avid and Pinnacle; o challenges encountered in managing larger, more geographically dispersed operations; o difficulties in successfully integrating the management teams and employees of Avid and Pinnacle; o diversion of the attention of management from other ongoing business concerns; o potential incompatibility of technologies and systems; o potential impairment charges to write-down the carrying amount of goodwill and other intangible assets; and o potential incompatibility of business cultures |
| We will also face challenges inherent in efficiently managing an increased number of employees over large geographic distances, including the need to develop appropriate systems, policies, benefits and compliance programs |
| The inability to manage the organization of the combined company effectively could have a material adverse effect on our business |
| Our performance will depend in part on continued customer acceptance of our products |
| We regularly introduce new products, as well as upgrades and enhancements to existing products |
| We will need to continue to focus marketing and sales efforts on educating potential customers, as well as our resellers and distributors, about the uses and benefits of these products |
| The future success of certain of our video products, such as Avid DS Nitris, which enable high-definition production, will also depend on demand for high definition content and appliances, such as television sets and monitors, that utilize the high definition standard |
| Other risks involved with offering new products in general include, without limitation, the possibility of defects or errors, failure to meet customer expectations, delays in shipping new products and the introduction of similar products by our competitors |
| In addition, we occasionally introduce products in new markets, where we have little experience and may not overcome any barriers to entry |
| The introduction and transition to new products could also have a negative impact on the market for our existing products, which could adversely affect our revenues and business |
| The digital broadcast business is large, geographically dispersed and highly competitive, and we may not be successful in growing our customer base or predicting customer demand in this business |
| We are continuing to enhance our status in the digital broadcast business and have augmented our NewsCutter product offering with the Avid Unity for News products and other server, newsroom and browser products |
| In this business, in addition to or in lieu of discrete point products, customers often seek complex solutions involving highly integrated components (including the configuration of unique workflows) from a single or multiple vendors |
| Success in this business will require, among other things, creating and implementing compelling solutions and developing a strong, loyal customer base |
| In addition, large, complex broadcast orders often require us to devote significant sales, engineering, manufacturing, installation and support resources to ensure their successful and timely fulfillment |
| To the extent that customer demand for our broadcast solutions exceeds our expectations, we may encounter difficulties in the short term meeting our customers &apos needs |
| Meanwhile, our competitors may devote greater resources to the broadcast business than we do, or may be able to leverage their presence more effectively |
| If we are unsuccessful in expanding within the digital broadcast business or in predicting and satisfying customer demand, our business and revenues could be adversely affected |
| We have a significant presence in the audio business, and therefore, the growth of our audio business will depend in part on our ability to successfully introduce new products |
| Our Digidesign division has a significant presence in the audio business, due in large part to a series of successful product introductions |
| Our future success will depend in part upon our ability to offer, on a timely and cost-effective basis, new audio products and enhancements of our existing audio products |
| This can be a complex and uncertain process and we could experience design, manufacturing, marketing, or other difficulties that delay or prevent the introduction of new or enhanced products, or the integration of acquired products, which, in turn, could harm our business |
| 12 We will face challenges associated with sales of video and audio products to the consumer market |
| As a result of our recent acquisition of Pinnacle, we expect a material portion of our future revenue to come from sales to consumers of home video editing and viewing products |
| In addition, M-Audio is expanding its sales channel to include sales of its audio products through the consumer channel |
| The market for these consumer video and audio products is highly competitive and we expect to face price-based competition from competitors selling similar products |
| Although we acquired experienced personnel through our acquisitions of M-Audio and Pinnacle, Avidapstas prior experience in the consumer market is limited |
| If we are not successful marketing to this base of customers, our operating results could suffer |
| Furthermore, sales of consumer electronics and software typically increase in the second half of the year, reaching their peak during the year-end holiday season |
| As a result, to the extent we increase sales of our video and audio products through consumer channels, we expect to experience greater seasonality in our revenues |
| Another challenge that is particularly acute with respect to the sale of consumer software is software piracy |
| The unauthorized use of our proprietary technology is costly and efforts to restrict such unauthorized use are time-consuming |
| We are unable to accurately measure the extent to which piracy of our software exists, but we expect it to be a persistent problem |
| A portion of our revenue is dependent on sales of large, complex solutions |
| We expect sales of large, complex solutions to continue to constitute a material portion of our net revenue, particularly as news stations convert from analog, or tape-based, processes to digital formats |
| Our quarterly and annual revenues could fluctuate if: o sales to one or more of our customers are delayed or are not completed within a given quarter; o the contract terms preclude us from recognizing revenues relating to one or more significant contracts during a particular quarter; o news stations &apos migrations to networked digital infrastructure slows down; o we are unable to complete complex customer installations on schedule; o our customers reduce their capital investments in our products in response to slowing economic growth; or o any of our large customers terminates its relationship with us or significantly reduces the amount of business it does with us |
| We compete with many other enterprises and we expect competition to intensify in the future |
| The business segments in which we operate are highly competitive, with limited barriers to entry, and are characterized by pressure to reduce prices, incorporate new features and accelerate the release of new products |
| Some of our current and potential competitors have substantially greater financial, technical, distribution, support and marketing resources than we do |
| Such competitors may use these resources to lower their product costs, allowing them to reduce prices to levels at which we could not operate profitably |
| In addition to competing based on price, our products must also compete favorably with our competitors &apos products in terms of reliability, performance, ease of use, range of features, product enhancements, reputation and training |
| Delays or difficulties in product development and introduction may also harm our business |
| If we are unable to compete for our target customers effectively, our business and results of operations could suffer |
| New product announcements by our competitors and by us also could have the effect of reducing customer demand for our existing products |
| New product introductions require us to devote time and resources to training our sales channels in product features and target customers, with the temporary result that the sales channels may have less time to devote to selling our products |
| In addition, our introduction of new products and expansion of existing product offerings can put us into competition with companies with whom we formerly collaborated |
| In the event such companies discontinue their alliances with us, we could experience a negative impact on our business |
| Potential future acquisitions could be difficult to integrate, divert the attention of key personnel, disrupt our business, dilute stockholder value and impair our financial results |
| As part of our business strategy, we periodically acquire companies, technologies and products that we believe can improve our ability to compete in our core markets or allow us to enter new markets |
| For example, in August 2005, we acquired Pinnacle and in August 2004, we acquired M-Audio |
| The risks associated with such acquisitions include, among others: 13 o the difficulty of assimilating the operations, policies and personnel of the target companies; o the failure to realize anticipated returns on investment, cost savings and synergies; o the diversion of managementapstas time and attention; o the potential dilution to existing stockholders, if we issue common stock or other equity rights in the acquisition; o the potential loss of key employees of the target company; o the difficulty in complying with a variety of foreign laws and regulations, if so required; o the impairment of relationships with customers or suppliers; o the risks associated with contingent payments and earn-outs; o the possibility of incurring debt and amortization expenses, as well as impairment charges, related to goodwill and other intangible assets; and o unidentified issues not discovered in due diligence, which may include product quality issues and legal contingencies |
| Such acquisitions often involve significant transaction-related costs and could cause disruption to normal operations |
| In the future, we may also make debt or equity investments |
| If so, we may fail to realize anticipated returns on such investments |
| If we are unable to overcome or mitigate these risks, they could adversely affect our business and lower revenues |
| Our products are complex and may contain errors or defects resulting from such complexity |
| As we continue to enhance and expand our product offerings, our products have grown increasingly complex and, despite extensive testing and quality control, may contain errors or defects |
| Such errors or defects could cause us to issue corrective releases and could result in loss of revenues, delay of revenue recognition, increased product returns, lack of market acceptance and damage to our reputation |
| Poor global economic conditions could adversely affect demand for our products and the financial condition of our suppliers, distributors and resellers |
| The revenue growth and profitability of our business depends primarily on the overall demand for our products |
| If global economic conditions worsen, demand for our products may weaken, as could the financial health of our suppliers, distributors and resellers, which could adversely affect our revenues and business |
| Our use of independent firms and contractors to perform some of our product development and manufacturing activities could expose us to risks that could adversely impact our revenues |
| Independent firms and contractors, some of whom are located in other countries, perform some of our product development activities |
| We generally own the software developed by these contractors |
| We also rely on subcontractors for most of our manufacturing activities |
| Our strategy to rely on independent firms and contractors involves a number of significant risks, including loss of control over the manufacturing process, potential absence of adequate manufacturing capacity, potential delays in lead times and reduced control over delivery schedules, manufacturing yields, quality and cost |
| Furthermore, the use of independent firms and contractors, especially those located abroad, could expose us to risks related to governmental regulation, foreign taxation, intellectual property ownership and rights, exchange rate fluctuation, political instability and unrest, natural disasters and other risks, which could adversely impact our revenues |
| An interruption of our supply of certain products or key components from our sole source suppliers, or a price increase in such products or components, could hurt our business |
| We are dependent on a number of specific suppliers for certain products and key components of our products |
| We purchase these sole source products and components pursuant to purchase orders placed from time to time |
| We generally do not carry significant inventories of these sole source products and components and have no guaranteed supply arrangements |
| If any of our sole source vendors should fail to produce these products or components, our supply and our ability to continue selling and servicing products that use these components could be imperiled |
| Similarly, if any of our sole source vendors should encounter technical, operating or financial difficulties, our supply of these products or components would be threatened |
| While we believe that alternative sources for these products and components could be developed, or our products could be redesigned to permit the use of alternative components, an interruption of our supply could damage our business and negatively affect our operating results |
| 14 Our gross profit margin varies from product to product depending primarily on the proportion and cost of third-party hardware and software included in each product |
| From time to time, we add functionality and features to our products |
| If we effect such additions through the use of more, or more costly, third-party hardware or software and are not able to increase the price of our products to offset the increased costs, our gross profit margin on these products could decrease and our operating results could be adversely affected |
| We rely on third party software for some of our products and if we are unable to use or integrate such software, our product and service development may be delayed |
| We rely on certain software that we license from third parties, including software that is bundled with our products and sold to end users and software that is integrated with internally developed software and used in our products to perform key functions |
| These third-party software licenses may not continue to be available on commercially reasonable terms and the software may not be appropriately supported, maintained or enhanced by the licensors |
| The loss of licenses to, or inability to support, maintain and enhance, any such software, could result in increased costs, or in delays or reductions in product shipments until equivalent software could be developed, identified, licensed and integrated, which could adversely affect our business |
| Qualifying and supporting our products on multiple computer platforms is time consuming and expensive |
| Our software engineers devote significant time and effort to qualify and support our products on various computer platforms, including Microsoft and Apple platforms |
| Computer platform modifications and upgrades require additional time to be spent to ensure that our products function properly |
| To the extent that the current configuration of qualified and supported platforms changes, or we need to qualify and support new platforms, we could be required to expend valuable engineering resources, which could adversely affect our operating results |
| Our revenues and gross profit are dependent on several unpredictable factors |
| The revenue and gross profit from our products depend on many factors, including: o mix of products sold; o cost and proportion of third-party hardware and software included in such products; o product distribution channels; o acceptance of our new product introductions; o product offers and platform upgrades; o price discounts and sales promotion programs; o volume of sales of aftermarket hardware products; o costs of swapping or fixing products released to the market with defects; o provisions for inventory obsolescence; o competitive pressure on product prices; o costs incurred in connection with our broadcast and some of our audio solution sales, which typically have longer selling and implementation cycles; o timing of delivery of solutions to customers; and o foreign currency exchange impact on our revenues |
| Changes in any of these factors could adversely affect our operating results |
| Our international operations expose us to significant exchange rate fluctuations and regulatory, intellectual property and other risks which could harm our operating results |
| We generally derive approximately half of our revenues from customers outside of the United States |
| This business is, for the most part, transacted through international subsidiaries and generally in the currency of the end-user customers |
| Therefore, we are exposed to the risks that changes in foreign currency could adversely impact our revenues, net income (loss) and cash flow |
| To hedge against the foreign exchange exposure of certain forecasted receivables, payables and cash balances of our foreign subsidiaries, we enter into foreign currency forward-exchange contracts |
| The success of our hedging program depends on forecasts of transaction activity in the various currencies |
| To the extent that these forecasts are over- or under-stated during periods of currency volatility, we could experience currency gains or losses |
| 15 Other risks inherent in our international operations include changes in regulatory practices, environmental laws, tax laws, trade restrictions and tariffs, longer collection cycles for accounts receivable and greater difficulties in protecting our intellectual property |
| New environmental regulations could negatively impact our future operating results |
| The European Union, or EU, has finalized the Waste Electrical and Electronic Equipment, or WEEE, Directive, which makes producers, importers and/or distributors of specified electronic products, including some of our products, responsible for the collection, recycling, treatment and disposal of covered products |
| The WEEE Directive became effective in August 2005, although to date not all EU countries have adopted rules implementing the WEEE Directive |
| The EU has also passed the Restriction of Hazardous Substances, or RoHS, Directive, which places restrictions on lead and certain other substances contained in specified electronic products, including some of our products, sold in the EU after June 2006 |
| While the cost of compliance with these directives cannot be determined before the member states issue their final implementation guidance, the potential costs could be significant and could adversely affect our future operating results |
| Furthermore, failure to comply with the directives could result in substantial penalties and fines |
| Our operating costs are tied to projections of future revenues, which may differ from actual results |
| Our operating expense levels are based, in part, on our expectations of future revenues |
| Such future revenues are difficult to predict, especially as a result of our recent acquisition of Pinnacle |
| A significant portion of our business occurs near the end of each quarter, which can impact our ability to forecast revenues on a quarterly basis |
| Further, we are generally unable to reduce quarterly operating expense levels rapidly in the event that quarterly revenue levels fail to meet internal expectations |
| Therefore, if quarterly revenue levels fail to meet internal expectations upon which expense levels are based, our results of operations could be adversely affected |
| Terrorism, acts of war and other catastrophic events may seriously harm our business |
| Terrorism, acts of war, or other catastrophic events may disrupt our business and harm our employees, facilities, suppliers, distributors, resellers or customers, which could significantly impact our revenue and operating results |
| The increasing presence of these threats has created many economic and political uncertainties that could adversely affect our business and stock price in ways that cannot be predicted |
| We are predominantly uninsured for losses and interruptions caused by terrorism, acts of war and other catastrophic events |
| If we fail to maintain strong relationships with our resellers, distributors and suppliers, our ability to successfully deploy and sell our products may be harmed |
| We sell many of our Professional Video products and services and substantially all of our Audio and Consumer Video products and services, indirectly through resellers and distributors |
| In our Audio and Consumer Video segments, a few distributors account for a significant portion of the revenue in that segment |
| The loss of one or more key distributors could reduce our revenues |
| The resellers and distributors of our Professional Video segment products typically purchase Avid software and Avid-specific hardware from us and third-party components from various other vendors, in order to produce complete systems for resale |
| Any disruption to our resellers and distributors, or their third-party suppliers, could reduce our revenues |
| Increasingly, we are distributing our broadcast products directly, which could put us in competition with our resellers and distributors and could adversely affect our revenues |
| In addition, our resellers could diversify the manufacturers from whom they purchase products to sell to end-users, which could lead to a weakening of our relationships with our resellers and could adversely affect our revenues |
| Most of the resellers and distributors of our Professional Video products are not granted rights to return products after purchase and actual product returns from such resellers and distributors have been insignificant to date |
| Our revenue from sales of Audio and Consumer Video products is generally derived, however, from transactions with distributors and authorized resellers that typically allow limited rights of return, inventory stock rotation and price protection |
| Accordingly, reserves for estimated returns, exchanges and credits for price protection are recorded as a reduction of revenues upon shipment of the related products to such distributors and resellers, based upon our historical experience |
| To date, actual returns have not differed materially from managementapstas estimates |
| However, if returns of our Audio or Consumer Video segment products were to exceed estimated levels, our revenues and operating results could be adversely impacted |
| With respect to our Consumer Video segment, we have expanded our distribution network to include several consumer channels, including large distributors of products to computer software and hardware retailers, which in 16 turn sell products to end users |
| We also sell our Consumer Video products directly to certain retailers |
| Our Consumer Video product distribution network exposes us to the following risks, some of which are out of our control: o we are obligated to provide price protection to our retailers and distributors and, while the agreements limit the conditions under which products can be returned to us, we may be faced with product returns or price protection obligations; o retailers or distributors may not continue to stock and sell our consumer products; and o retailers and distributors often carry competing products |
| Changes in accounting rules could adversely affect our future operating results |
| Our financial statements are prepared in accordance with accounting principles generally accepted in the United States of America |
| These principles are subject to interpretation by various governing bodies, including the Financial Accounting Standards Board and the Securities and Exchange Commission, which promulgate and interpret appropriate accounting regulations |
| Changes from current accounting regulations may have a significant effect on our reported financial results |
| Furthermore, changes in the rules regarding accounting for stock-based compensation, which took effect on January 1, 2006, will result in higher operating expenses and lower earnings per share compared to prior periods |
| Our future growth could be harmed if we lose the services of certain employees |
| Our success depends upon the services of a talented and dedicated workforce, including members of our executive team and employees in technical positions |
| The loss of the services of one or more key employees could harm our business |
| Our success also depends upon our ability to attract and retain highly skilled new employees |
| Competition for such employees is intense in the industries and geographic areas in which we operate |
| However, changes in the accounting rules that will require us to expense stock options will impair our ability to provide these incentives without incurring compensation costs |
| If we are unable to compete successfully for talented employees, our business could suffer |
| If we fail to manage our growth effectively, our business could be harmed |
| Our success depends on our ability to manage the growth of our operations effectively |
| As a result of our acquisitions and increasing demand for our products and services, the scope of our operations has grown both domestically and internationally |
| Our management team will face challenges inherent in efficiently managing an increased number of employees over larger geographic distances |
| These challenges include implementing effective operational systems, procedures and controls, as well as training new personnel |
| Inability to successfully respond to these challenges could have a material adverse effect on the growth of our business |
| Our websites could subject us to legal claims that could harm our business |
| Some of our websites provide interactive information and services to our customers |
| To the extent that materials may be posted on or downloaded from these websites and distributed to others, we may be subject to claims for defamation, negligence, copyright or trademark infringement, personal injury, or other theories of liability based on the nature, content, publication or distribution of such materials |
| In addition, although we have attempted to limit our exposure by contract, we may also be subject to claims for indemnification by end users in the event that the security of our websites is compromised |
| As these websites are available on a worldwide basis, they could potentially be subject to a wide variety of international laws |
| We could incur substantial costs protecting our intellectual property or defending against a claim of infringement |
| Our ability to compete successfully and achieve future revenue growth depends, in part, on our ability to protect our proprietary technology and operate without infringing upon the intellectual property rights of others |
| We rely upon a combination of patent, copyright, trademark and trade secret laws, confidentiality procedures and contractual provisions, as well as required hardware components and security keys, to protect our proprietary technology |
| However, our means of protecting our proprietary rights may not be adequate |
| In addition, the laws of certain countries do not protect our proprietary technology to the same extent as do the laws of the United States |
| From time to time unauthorized parties have obtained, copied and used information that we consider proprietary |
| Policing the unauthorized use of our proprietary technology is costly and time-consuming and we are unable to measure the extent to which such unauthorized use, including piracy, of our software exists |
| We expect software piracy to continue to be a persistent problem |
| 17 We occasionally receive communications suggesting that our products may infringe the intellectual property rights of others |
| It is our practice to investigate the factual basis of such communications and negotiate licenses where appropriate |
| While it may be necessary or desirable in the future to obtain licenses relating to one or more products or relating to current or future technologies, we may be unable to do so on commercially reasonable terms |
| If we are unable to protect our proprietary technology or unable to negotiate licenses for the use of others &apos intellectual property, our business could be impaired |
| We also may be liable to some of our customers for damages that they may incur in connection with intellectual property claims |
| Although we attempt to limit our exposure to liability arising from infringement of third-party intellectual property rights in our agreements with customers, we may not always be successful |
| Moreover, even if a particular claim falls outside of our indemnity or warranty obligations to our customers, our customers may be entitled to additional contractual remedies against us |
| Regulations could be enacted that restrict our Internet initiatives |
| Federal, state and international authorities may adopt new laws or regulations governing the Internet, including laws or regulations covering issues such as privacy, distribution and content |
| For example, the EU has issued several directives regarding privacy and data protection, including the Directive on Data Protection and the Directive on Privacy and Electronic Communications |
| The enactment of legislation implementing such directives by EU member countries is ongoing |
| The enactment of this and similar legislation or regulations could curb our Internet sales and other initiatives, require changes in our sales and marketing practices and place additional financial burdens on our business |
| Our association with industry organizations could subject us to litigation |
| We are members of several industry organizations, trade associations and standards consortia |
| Membership in these and similar groups could subject us to litigation as a result of the activities of such groups |
| For example, in connection with our anti-piracy program, designed to enforce copyright protection of our software, we are a member of the Business Software Alliance, or BSA From time to time the BSA undertakes litigation against suspected copyright infringers |
| These lawsuits could lead to counterclaims alleging improper use of litigation or a violation of other local laws |
| To date, none of these lawsuits or counterclaims have adversely affected our results of operations, but, should we become involved in material litigation, our cash flows or financial position could be adversely affected |
| Compliance with rules and regulations concerning corporate governance has caused our operating expenses to increase and has put additional demands on our management |
| The Sarbanes-Oxley Act of 2002 and various rules and regulations promulgated by the SEC and the National Association of Securities Dealers in recent years have increased the scope, complexity and cost of our corporate governance, reporting and disclosure practices |
| These laws, rules and regulations also divert attention from business operations, increase the cost of obtaining director and officer liability insurance and may make it more difficult for us to attract and retain qualified executive officers, key personnel and members of our board of directors |
| If we experience problems with our third-party leasing program, our revenues could be adversely impacted |
| We have an established leasing program with a third party that allows certain of our customers to finance their purchases of our products |
| If this program ended abruptly or unexpectedly, some of our customers might be unable to purchase our products unless or until they were able to arrange for alternative financing, which could adversely impact our revenues |
| Our stock price may continue to be volatile |
| The market price of our common stock has experienced volatility in the past and could continue to fluctuate substantially in the future based upon a number of factors, many of which are beyond our control |
| These factors include: o changes in our quarterly operating results; o shortfalls in our revenues or earnings compared to securities analysts &apos expectations; o changes in analysts &apos recommendations or projections; o fluctuations in investors &apos perceptions of us or our competitors; 18 o shifts in the markets for our products; o development and marketing of products by our competitors; o changes in our relationships with suppliers, distributors, resellers, system integrators or customers; o announcements of major acquisitions; o a shift in financial markets; and o global macroeconomic conditions |
| Furthermore, the market prices of equity securities of high technology companies have generally demonstrated volatility in recent years and this volatility has, at times, appeared to be unrelated to or disproportionate to any of the factors above |