Avid sells its software through different pricing structures. For some products, Avid offers support contracts. Deferring revenue makes sense for those contracts. However, Avid also sells software for one-time payments. In my opinion, deferring some of the revenue from such sales creates a major accounting distortion. Avid already has the customer’s money so it does not make much sense to defer the revenues and profits on such sales.
Does a vendor have to provide post contract support?
I do not believe that Avid must release free updates/patches for many of its products (where no support contract was sold). Most companies do so because it builds goodwill among the customer base so that the software company can sell software in the future. Customers want to buy software products where it is likely that the vendor will stand behind the product and offer support and updates for a long time. For many professionals, their entire business depends on it. If a vendor discontinues the video editing system that they use, the customer will face a painful process of eventually having to build their business around a different system. This is less of a concern today because customers are no longer paying $100-300k for an Avid editing system (including the cost of RAID arrays and other hardware) and now mostly pay less than $10k. Still, many customers prefer vendors that are financially sound and are committed to standing behind their products. This is why Avid provided limited support for its discontinued high-end DS product. If Avid stopped all support for DS, Avid would alienate its other video editing customers. In practice, Avid could have done what Apple did and announced an end to supporting its high-end professional users. (Apple quickly reversed its decision to abandon technical support for Final Cut Pro users who used it for higher-end video editing.)
At the end of the day, Avid and its competitors provide some after-sale technical support and product updates to build goodwill with its customers. If anything, a reasonable accounting treatment would be to capitalize these expenses as goodwill. The customer’s trust and a vendor’s reputation for standing behind its products are valuable intangible assets. (In practice, allowing such subjective accounting would likely open the doors to abuse.)
Accounting technicalities
Big accounting firms offer white papers on revenue recognition practices for software:
- A shifting software revenue recognition landscape – PwC
- SOP 97-2, Software Revenue Recognition – Deloitte
Let’s talk about what happened in practice: Avid restated its financials and retroactively deferred a lot of its past profits into later years. In my opinion, this made Avid’s financial statements unnecessarily opaque and complicated. In my opinion:
- Avid should not have spent so much money on restating its financials. Supposedly it spent tens of millions of dollars according to its SEC filings.
- The amount of revenue that should be deferred into later years is subjective. For sales where Avid did not sell a support contract, I would have tried to defer as little revenue as possible.
Because the accounting creates distortions on the income statement, I would pay a lot more attention to the statement of cash flows. Avid’s cash and cash equivalents balance continues to slowly shrink.
Avid is shifting to a subscription system
Avid is moving towards selling its software through subscriptions rather than one-time payments. This will likely make Avid’s earnings less lumpy as a complete transition would get rid of revenue spikes around its product release cycles. I’m sure Wall Street will love this.
For the customer, subscriptions do not necessarily make a lot of sense.
- If the subscription verification system fails, the customer may be locked out from using their software. This is extremely painful for professionals who depend on a key piece of software to make a living, especially when they have deadlines to meet and cannot use their software. Adobe’s Creative Cloud outage was very painful to some Adobe customers.
- Subscriptions may create barriers to customers accessing archived projects a few to several years from now.
The short thesis in a nutshell
- The company is slowly losing money.
- Management is bad. They managed to get rid of the “golden goose” when they got rid of the original Sibelius development team. Many of the original Avid and Pro Tools software developers are leaving the company. The brain drain is very bad for the company in the long run.
Click the Avid tag to see all of my posts on the company.
*Disclosure: Short AVID.