-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, CYd1Ab//j0GaVQH9+u3NWmZ3cABpBy4sJIcNx/UbkNZq09tmsraLBXIJdXQXjkPI W9V7kr1JX74WYt38zsktFw== 0001144204-08-025920.txt : 20080505 0001144204-08-025920.hdr.sgml : 20080505 20080505061350 ACCESSION NUMBER: 0001144204-08-025920 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20070630 FILED AS OF DATE: 20080505 DATE AS OF CHANGE: 20080505 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SONIC SOLUTIONS/CA/ CENTRAL INDEX KEY: 0000916235 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER INTEGRATED SYSTEMS DESIGN [7373] IRS NUMBER: 930925818 STATE OF INCORPORATION: CA FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-23190 FILM NUMBER: 08800733 BUSINESS ADDRESS: STREET 1: 101 ROWLAND WAY STREET 2: STE 110 CITY: NOVATO STATE: CA ZIP: 94945 BUSINESS PHONE: 4158938000 MAIL ADDRESS: STREET 1: 101 ROWLAND WAY STREET 2: STE 110 CITY: NOVATO STATE: CA ZIP: 94945 10-Q 1 v112236_10q.htm Unassociated Document
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
(Mark One) 
x
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the Quarterly Period Ended June 30, 2007
 
o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the transition period from                      to                      
 
Commission File Number: 000-23190
 
(Exact name of registrant as specified in its charter)
 
CALIFORNIA
93-0925818
(State or other jurisdiction of
incorporation or organization)
(I.R.S. employer
identification number)
   
101 Rowland Way, Suite 110 Novato, CA
94945
(Address of principal executive offices)
(zip code)

(415) 893-8000
(Registrant’s telephone number, including area code)   
 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
Yes   ¨    No   x
 
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer    ¨
  
Accelerated filer   x
Non-accelerated filer   ¨
  
Smaller reporting company   ¨
(Do not check if a smaller reporting company)
    

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes   ¨    No   x

Indicate the number of shares outstanding of each of the Issuer’s classes of common stock, as of the latest practicable date.
 
Class
  
Outstanding May 1, 2008
Common stock, no par value per share
  
26,383,277
 
 
SONIC SOLUTIONS

FORM 10-Q
For the quarterly period ended June 30, 2007

Table of Contents

Other Information
3
   
PART I – FINANCIAL INFORMATION
4
   
ITEM 1. FINANCIAL STATEMENTS
4
   
Condensed Consolidated Balance Sheets
4
   
Condensed Consolidated Statements of Operations
5
   
Condensed Consolidated Statements of Cash Flows
6
   
Notes to Condensed Consolidated Financial Statements
7
   
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
21
   
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
30
   
ITEM 4. CONTROLS AND PROCEDURES
31
   
PART II - OTHER INFORMATION
33
   
ITEM 1. LEGAL PROCEEDINGS
33
   
ITEM 1A. RISK FACTORS.
34
   
ITEM 6. EXHIBITS.
37
   
SIGNATURES
38
 
2
 
Other Information

Forward-Looking Statements

This Quarterly Report on Form 10-Q for the three months ended June 30, 2007 (this “Quarterly Report”) includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All statements included or incorporated by reference into this Quarterly Report, other than statements that are purely historical in nature, are forward-looking statements. We have based these forward-looking statements on our current expectations and projections about future events. Our actual results could differ materially from those discussed in, or implied by, these forward-looking statements. Words such as “believe,” “anticipate,” “expect,” ‘‘intend,” “plan,” “estimate,” “project,” “will,” “may” and other similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these words. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. Forward-looking statements include, but are not necessarily limited to, those relating to:
 
 
·
competing products that may, now or in the future, be available to consumers;
 
 
·
our plans to develop and market new products or services, including next-generation high definition products;
 
 
·
the demand for, trends regarding and the impact on our business of next-generation high definition formats;
 
 
·
the number or nature of potential licensees for our products;
 
 
·
the strategic benefits of our patent program;
 
 
·
the growth of our web-based retail channels and the decline of revenues from professional products and services;
 
 
·
our expectations regarding trends in the personal computer (“PC”) and consumer electronics (“CE”) industries;
 
 
·
our expectations regarding non-traditional bundling arrangements;
 
 
·
our expectations regarding the Qflix and technology licensing program;
 
 
·
availability of additional financing to satisfy our working capital and other requirements;
 
 
·
our ability to improve our financial performance;
 
 
·
other competitive pressures;
 
 
·
expenses associated with our stock option review, litigation defense and financial restatement;
 
 
·
changes to improve our controls relating to the process of granting stock option and other deferred compensation awards;
 
 
·
future acquisitions and other business combinations, if any, effected by us or our competitors;
 
 
·
the impact of our efforts to comply with laws and regulations, including the Sarbanes-Oxley Act of 2002, as amended (the “Sarbanes-Oxley Act”);
 
 
·
potential remedial actions under Section 409A of the Internal Revenue Code of 1986, as amended (the “Code”); and
 
 
·
estimated tax credits available to us and tax rates applicable to us.
 
Factors that could cause actual results or conditions to differ from those anticipated by these and other forward-looking statements include those more fully described under Part II, Item 1A, “Risk Factors” and elsewhere in this Quarterly Report. Except as required by law, we do not assume any obligation to update or revise these forward-looking statements to reflect new events or circumstances. You should assume that the information appearing in this Quarterly Report is accurate only as of the date on the front cover of this document. Our business, financial condition, results of operations and prospects may have changed since that date.
 
Restatement and Change in Accounting Policy
 
This Quarterly Report contains restated financial information for the three months ended June 30, 2006. Previously filed quarterly reports on Form 10-Q have not been amended and should not be relied upon. Please see Note 2 “Restatement of Consolidated Financial Statements and Change in Accounting Policy” to the condensed consolidated financial statements included in this Quarterly Report as well as our Annual Report on Form 10-K for the fiscal year ended March 31, 2007 (the “2007 Form 10-K”) for additional discussions and information regarding these restatements .
 
3
 
 
Sonic Solutions
(in thousands, except share amounts)

   
2007
  
   
June 30
  
March 31*
  
   
(unaudited)
      
ASSETS
          
Current assets:
          
Cash and cash equivalents
  
$
22,659
  
$
17,090
  
Short term investments
    
43,050
   
47,250
 
Accounts receivable, net of allowance for returns and doubtful accounts of $2,973 and $2,526 at June 30, 2007 and March 31, 2007, respectively
    
14,265
    
20,107
 
Inventory
    
657
   
807
 
Deferred tax benefits
    
12,095
   
9,773
 
Prepaid expenses and other current assets
    
4,507
   
4,686
 
Total current assets
    
97,233
   
99,713
  
Fixed assets, net
    
3,383
   
3,241
 
Purchased and internally developed software costs, net
    
954
   
1,040
 
Goodwill
    
55,620
   
55,508
 
Acquired intangibles, net
    
38,976
   
40,172
 
Deferred tax benefits, net of current portion
    
14,707
   
15,489
 
Other assets
    
1,766
   
1,866
 
Total assets
  
$
212,639
  
$
217,029
  
               
LIABILITIES AND SHAREHOLDERS' EQUITY
              
Current liabilities:
              
Accounts payable
  
$
5,393
  
$
5,926
  
Accrued expenses and other current liabilities
    
31,234
    
32,440
  
Deferred revenue, current portion
    
5,629
   
5,558
 
Bank note payable
    
20,000
   
20,000
 
Total current liabilities
    
62,256
   
63,924
  
Other long term liabilities, net of current portion
    
2,703
   
2,248
 
Deferred revenue, net of current portion
    
37
   
24
 
Total liabilities
    
64,996
   
66,196
  
Commitments and contingencies (Note 6)
              
Shareholders' equity:
              
Common stock, no par value, 100,000,000 shares authorized; 26,197,119 and 26,197,119 shares issued and outstanding at June 30, 2007 and March 31, 2007, respectively
    
162,217
   
162,565
 
Accumulated other comprehensive loss
    
(1,202
)
  
(917
)
Accumulated deficit
   
(13,372
)
  
(10,815
)
Total shareholders' equity
    
147,643
   
150,833
 
Total liabilities and shareholders' equity
  
$
212,639
  
$
217,029
  

* The consolidated balance sheet at March 31, 2007 has been derived from the Company’s audited consolidated financial statements on Form 10-K at that date, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

See accompanying notes to condensed consolidated financial statements.
 
4
 
Sonic Solutions
(in thousands, except per share amounts — unaudited)

   
Three Months Ended June 30,
  
   
2007
  
2006
  
       
As Restated
  
Net revenue
  
$
30,111
  
$
36,934
  
Cost of revenue
   
7,928
   
7,923
 
Gross profit
    
22,183
   
29,011
 
               
Operating expenses
              
Marketing and sales
   
8,641
   
7,221
 
Research and development 
    
11,646
   
10,470
 
General and administrative
   
6,047
   
3,479
 
Total operating expenses
    
26,334
   
21,170
 
Operating income (loss)
    
(4,151
)
  
7,841
 
Interest income
    
699
   
676
 
Interest expense
    
(284
)
  
(508
)
Other expense, net
    
(74
)
  
(6
)
Income (loss) before income taxes
    
(3,810
)
  
8,003
 
Provision for (benefit of) income taxes
    
(1,853
)
  
3,002
 
Net income (loss)
  
$
(1,957
)
$
5,001
  
               
Net income (loss) per share:
              
Basic
  
$
(0.07
)
$
0.19
  
Diluted
  
$
(0.07
)
$
0.18
  
               
Shares used in computing net income (loss) per share:
              
Basic
    
26,197
   
25,778
 
Diluted
    
26,197
   
27,412
 

See accompanying notes to condensed consolidated financial statements.
 
5
 
(in thousands — unaudited) 
 
   
Three Months Ended June 30,
  
   
2007
  
2006
  
       
As Restated
  
Cash flows from operating activities:
          
Net income (loss)
 
$
(1,957
)
$
5,001
  
               
Adjustments to reconcile net income (loss) to net cash generated by operating activities:
      
Depreciation and amortization
    
1,993
   
2,264
 
Deferred taxes
    
(1,981
)
  
288
 
Provision for returns and doubtful accounts, net of write-offs and recoveries
    
1,181
   
(906
)
Tax benefit (expense) from employee stock option plan
    
(54
)
  
1,002
 
Excess tax benefits from share-based compensation
    
-
   
(931
)
Share-based compensation
    
484
   
835
 
Changes in operating assets and liabilities
            
Accounts receivable
    
4,661
    
573
 
Inventory
    
149
   
174
 
Prepaid expenses and other current assets
    
180
   
79
 
Other assets
    
100
   
192
 
Accounts payable
    
(533
)
  
(2,542
)
Accrued liabilities
    
(1,809
)
  
(2,025
)
Deferred revenue
    
84
   
(1,217
)
Net cash generated by operating activities
    
2,498
   
2,787
 
               
Cash flows from investing activities:
              
Purchase of fixed assets
    
(820
)
  
(188
)
Purchase of short term investment instruments
    
(1,375
)
  
-
 
Redemption of short term instruments
    
5,575
   
(11,025
)
Additions to purchased and internally developed software
    
(116
)
  
(6
)
Net cash provided by (used in) investing activities
    
3,264
   
(11,219
)
               
Cash flows from financing activities:
              
Proceeds from exercise of common stock options
    
-
   
629
 
Excess tax benefits from share-based compensation
    
-
   
931
 
Proceeds from issuance of common stock
    
-
   
(12
)
Principal payments on capital leases
    
(1
)
  
-
 
Net cash generated by (used in) financing activities
    
(1
)
  
1,548
 
               
Effect of exchange rate changes on cash and cash equivalents
    
(192
)
  
(128
)
Net increase (decrease) in cash and cash equivalents
    
5,569
   
(7,012
)
Cash and cash equivalents, beginning of period
    
17,090
   
18,731
 
Cash and cash equivalents, end of period
  
$
22,659
  
$
11,719
  
               
Supplemental disclosure of cash flow information:
              
Interest paid
 
$
372
  
$
495
  
Income taxes paid
 
$
432
  
$
796
  

See accompanying notes to condensed consolidated financial statements.
 
6
 
Sonic Solutions
(unaudited)
 
Note 1 - Summary of Operations and Selected Significant Accounting Policies
 
Operations

We develop and market computer software related to digital media - that is, data, photographs, audio, interactive features and video in digital formats. Our products create, design and deliver digital media across a wide variety of playback platforms, including Internet, broadcast, mobile and optical disc formats such as Compact Audio Disc (“CD-Audio”), Digital Video Disc (“DVD”), and Blu-ray Disc (“BD”) as well as other formats.

We sell our products to both consumer and professional end users. We also license the software technology underlying our products to other companies to incorporate into products they develop. Most of the software we sell is intended for use in the Windows and Macintosh operating system environments, but some operate in Linux environments or on proprietary platforms as well.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of Sonic Solutions, referred to as “we,” “Sonic,” “our,” “us,” or “the Company,” have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X and mean Sonic Solutions together with its subsidiaries, except where the context otherwise requires. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. However, in the opinion of management, the condensed consolidated financial statements include all adjustments, consisting of only normal, recurring adjustments and restatements (as discussed below in Note 2), necessary for their fair presentation. The interim results are not necessarily indicative of results expected for a full year. These unaudited condensed consolidated financial statements should be read in conjunction with the financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2007 (the “2007 Form 10-K”) filed with the Securities and Exchange Commission (“SEC”) on February 26, 2008. Certain prior year amounts in the Condensed Consolidated Financial Statements and notes thereto have been reclassified to conform to the current year presentation.
 
Quantities or results referred to as “to date” or “as of this date” mean as of or to June 30, 2007, unless otherwise specifically noted. References to “FY” or “fiscal year” refer to our fiscal year ending on March 31 of the designated year. For example, “FY 2007” and “fiscal year 2007” each refer to the fiscal year ending March 31, 2007. Other references to “years” mean calendar years.

This Quarterly Report on Form 10-Q (this “Quarterly Report”) includes references to certain of our trademarks and registered trademarks. Products or service names of other companies mentioned in this Quarterly Report may be trademarks or registered trademarks of their respective owners.

There were no significant changes in our significant accounting policies during the three months ended June 30, 2007 compared to the significant accounting policies described in our 2007 Form 10-K, other than the adoption of Financial Accounting Standards Boards (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – An Interpretation of FASB Statement No. 109” (“FIN 48”), discussed below.

Income Taxes – Adoption of FIN 48

In June 2006, the FASB issued FIN 48, which became effective for us as of April 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes by prescribing rules for recognition, measurement and classification in our financial statements of tax positions taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.

For tax benefits to be recognized under FIN 48, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. See Note 11 “Income Taxes” to the condensed consolidated financial statements included in this Quarterly Report.
 
7
 
Recently Issued Accounting Pronouncements

In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measures,” which defines fair value, establishes a framework for measuring fair value in accordance with GAAP, expands disclosures about fair value measurements, and applies other accounting pronouncements that require or permit fair value measurements. SFAS No. 157 does not require any new fair value measurements, but may change current practice for some entities. The FASB has issued an interpretation that defers the implementation of SFAS No. 157 for non-financial assets and liabilities until fiscal years beginning after November 15, 2008, with the remainder of SFAS No. 157 effective for financial statements issued for fiscal years beginning after November 15, 2007, with early adoption permitted. SFAS No. 157 is effective as of April 1, 2008 for our 2009 fiscal year, including interim periods within our 2009 fiscal year, with the exception of the one year deferral for non-financial assets and liabilities, which will be effective for our fiscal year 2010. We are currently evaluating what impact, if any, SFAS No. 157 will have on our financial position or results of operations.
  
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115.” SFAS No. 159 permits an entity to choose to measure many financial instruments and certain other items at fair value. Most of the provisions in SFAS No. 159 are elective; however, the amendment to SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” applies to all entities with available-for-sale and trading securities. The fair value option established by SFAS No. 159 permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity will report unrealized gains and losses, on items for which the fair value option has been elected, in earnings at each subsequent reporting date. The fair value option (a) may be applied instrument by instrument, with a few exceptions, such as investments otherwise accounted for by the equity method, (b) is irrevocable (unless a new election date occurs), and (c) is applied only to entire instruments and not to portions of instruments. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. We will adopt SFAS No. 159 in fiscal year 2009 and are currently evaluating what impact, if any, SFAS No. 159 will have on our financial position or results of operations.
 
In December 2007, the FASB issued SFAS No. 141 (revised), “Business Combinations” (“SFAS No. 141R”). SFAS No. 141R changes the accounting for business combinations including the measurement of acquirer shares issued in consideration for a business combination, the recognition of contingent consideration, the accounting for pre-acquisition gain and loss contingencies, the recognition of capitalized in-process research and development, the accounting for acquisition-related restructuring cost accruals, the treatment of acquisition related transaction costs and the recognition of changes in the acquirer’s income tax valuation allowance. SFAS No. 141R is effective for fiscal years beginning after December 15, 2008, with early adoption prohibited. We will adopt SFAS No. 141R in fiscal year 2010 and are currently evaluating what impact, if any, SFAS No. 141R will have on our financial position or results of operations.

Note 2 – Restatement of Consolidated Financial Statements and Change in Accounting Policy

On February 1, 2007, we announced that we had commenced a voluntary review of our historical stock option grant practices and related accounting. The review was initiated by our management and was conducted by the audit committee (the “Audit Committee”) of our board of directors, comprised solely of independent directors, with the assistance of legal counsel and outside consultants.
 
The Audit Committee and its advisors conducted an extensive review of our historical stock option grant practices and related accounting, including an assessment and review of our options granting policies and procedures, internal records, supporting documentation and e-mail communications, as well as interviews of Company personnel. The review focused on the period from March 3, 1998, when we engaged in a general repricing of our then-outstanding underwater options, through December 31, 2006.

Effective the third quarter ended December 31, 2006, we changed our policy on how we recognize original equipment manufacturer (“OEM”) royalty revenue. We applied this change in accounting policy retrospectively to fiscal year 2006 and to the quarters ended June 30, 2006 and September 30, 2006, but determined that it was not practicable to apply the change to prior periods.

On February 26, 2008, following the conclusion of our options review, we filed our 2007 Form 10-K as well as our Quarterly Report on Form 10-Q for the three and nine month periods ended December 31, 2006 (the “December 2006 Form 10-Q”). In the December 2006 Form 10-Q, we restated our condensed consolidated balance sheets as of March 31, 2006, condensed consolidated statements of operations for the three and nine month periods ended December 31, 2005, condensed consolidated statement of cash flows for the nine month period ended December 31, 2005, and the related Notes to condensed consolidated financial statements. In the 2007 Form 10-K, we restated our condensed consolidated balance sheet at March 31, 2006, our condensed consolidated statements of operations for our 2005 and 2006 fiscal years, our condensed consolidated statements of shareholders’ equity for our 2005 and 2006 fiscal years, our condensed consolidated statements of cash flows for our 2005 and 2006 fiscal years, our quarterly financial data as of and for the quarters ended in fiscal year 2006, our selected financial data as of and for our 2003, 2004, 2005 and 2006 fiscal years, and our quarterly financial data as of and for the first two quarters in our 2007 fiscal year. The 2007 Form 10-K also included a “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (“MD&A”) section, which discussed our restated results and supersedes the MD&A section in our annual report on Form 10-K for the fiscal year ended March 31, 2006 as it related to our 2005 and 2006 fiscal years.
 
8
 
The restatements in the 2007 Form 10-K and the December 2006 Form 10-Q reflected (a) additional share-based compensation expense and the associated payroll tax and other expenses relating to employee stock option grants through the second quarter of fiscal year 2007, (b) adjustments to revenue and cost of revenue due to a voluntary change in revenue recognition policy, (c) other adjustments and (d) related tax adjustments. Total cumulative adjustments from these restatements decreased our previously reported net income by $27.4 million on a cumulative basis through March 31, 2006. For the three months ended June 30, 2006, these restatements increased previously reported net income by approximately $0.9 million. The fiscal year 2007 information included in the financial statements in this Quarterly Report reflects these restatements.

The following tables present the effects of these restatements on our previously reported condensed consolidated balance sheet and condensed consolidated statement of operations for the three months ended June 30, 2006 (in thousands, except share and per share amounts):
 
9
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEET

   
For the three months ended
  
   
June 30, 2006
  
   
As
          
   
Previously
  
Adjustments
  
As
 
   
Reported (1)
  
Inc (Dec)
  
Restated
  
ASSETS
              
Current assets:
              
Cash and cash equivalents
  
$
11,719
  
$
-
  
$
11,719
  
Short-term investments
    
53,375
    
-
    
53,375
  
Accounts receivable, net of allowances
    
26,222
    
(3,849
)
  
22,373
  
Inventory
    
515
    
-
    
515
  
Deferred tax benefits
    
3,879
    
-
    
3,879
  
Prepaid expenses and other current assets
    
3,767
    
-
    
3,767
  
Total current assets
    
99,477
    
(3,849
)
  
95,628
  
Fixed assets, net
    
4,145
    
-
    
4,145
  
Purchased and internally developed software costs, net
    
1,053
    
-
    
1,053
  
Goodwill
    
54,151
    
(2,478
)
  
51,673
  
Acquired intangibles, net
    
42,745
    
-
    
42,745
  
Deferred tax benefits, net of current portion
    
11,391
    
11,194
    
22,585
  
Other assets
    
1,089
    
-
    
1,089
  
Total assets
  
$
214,051
  
$
4,867
  
$
218,918
  
                     
LIABILITIES AND SHAREHOLDERS’ EQUITY
                    
Current liabilities:
                    
Accounts payable
  
$
5,185
  
$
-
  
$
5,185
  
Accrued expenses and other current liabilties
    
27,004
    
4,650
    
31,654
  
Deferred revenue
    
6,033
    
831
    
6,864
  
Bank note payable
    
-
    
-
    
-
  
Total current liabilities
    
38,222
    
5,481
    
43,703
  
                     
Bank note payable
    
30,000
    
-
    
30,000
  
Other long term liabilities, net of current portion
    
335
    
-
    
335
  
Deferred revenue, net of current portion
    
82
    
-
    
82
  
Total liabilities
    
68,639
    
5,481
    
74,120
  
                     
Shareholders' equity:
                    
Common stock
    
129,180
    
28,763
    
157,943
  
Accumulated other comprehensive loss
    
(1,072
)
  
-
    
(1,072
)
Accumulated earnings
    
17,304
    
(29,377
)
  
(12,073
)
Total shareholders' equity
    
145,412
    
(614
)
  
144,798
  
Total liabilities and shareholders' equity
  
$
214,051
  
$
4,867
  
$
218,918
  
 
*(1) Certain previously reported amounts have been reclassified to conform to the current year presentation.
 
10

UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

   
For the three months ended June 30, 2006
  
       
Adjustments - Increase (Decrease)
      
   
As
      
Change in
              
   
Previously
  
Stock
  
Accounting
          
As
  
   
Reported
  
Options (1)
  
Policy (2)
  
Other (3)
  
Total
  
Restated
  
                           
Net revenue
  
$
36,886
  
$
-
  
$
475
  
$
(427
)
$
48
  
$
36,934
  
Cost of revenue
    
7,716
    
-
    
207
    
-
    
207
    
7,923
  
Gross profit
    
29,170
    
-
    
268
    
(427
)
  
(159
)
  
29,011
  
Operating expenses:
                                      
Marketing and sales
    
7,529
    
(308
)
  
-
    
-
    
(308
)
  
7,221
  
Research and development
    
10,732
    
(262
)
  
-
    
-
    
(262
)
  
10,470
  
General and administrative
    
4,264
    
(785
)
  
-
    
-
    
(785
)
  
3,479
  
Abandoned acquisition
    
-
    
-
    
-
    
-
    
-
    
-
  
Total operating expenses
    
22,525
    
(1,355
)
  
-
    
-
    
(1,355
)
  
21,170
  
Operating income
   
6,645
    
1,355
    
268
    
(427
)
  
1,196
    
7,841
  
Interest income
    
676
    
-
    
-
    
-
    
-
    
676
  
Interest expense
    
(512
)
  
4
    
-
    
-
    
4
    
(508
)
Other expense, net
    
(6
)
  
-
    
-
    
-
    
-
    
(6
)
Income before income taxes
    
6,803
    
1,359
    
268
    
(427
)
  
1,200
    
8,003
  
Provision for income taxes
    
2,713
    
352
    
107
    
(170
)
  
289
    
3,002
  
Net income
 
$
4,090
  
$
1,007
  
$
161
  
$
(257
)
$
911
  
$
5,001
  
                                       
Net income per share:
                                      
Basic
  
$
0.16
  
$
0.04
  
$
0.01
  
$
(0.01
)
$
0.03
  
$
0.19
  
Diluted
  
$
0.15
  
$
0.04
  
$
0.01
  
$
(0.01
)
$
0.03
  
$
0.18
  
Shares used in per share calculation:
                                      
Basic
    
25,778
    
-
    
-
    
-
    
-
    
25,778
  
Diluted
    
27,414
    
(2
)
  
-
    
-
    
(2
)
  
27,412
  
                                       
Includes stock-based compensation expense as follows:
                                      
Marketing and sales
  
$
410
  
$
50
  
$
-
  
$
-
  
$
50
  
$
460
  
Research and development
    
142
    
55
    
-
    
-
    
55
    
197
  
General and administrative
    
117
    
66
    
-
    
-
    
66
    
183
  
Total share-based compensation expense
  
$
669
  
$
171
  
$
-
  
$
-
  
$
171
  
$
840
  
    
(1)  Includes adjustments resulting from the voluntary stock option review, for share-based compensation expense and related tax adjustments.
(2)  Includes adjustments resulting from the retrospective application of the change in our method of recognizing OEM royalty revenue.
(3)  Includes adjustments for a correction of an incorrectly previously recorded sales transaction during the first quarter of 2007.

For additional information regarding the restatements, please refer to our 2007 Form 10-K, including the Explanatory Note Regarding Restatement and Change in Accounting Policy, Item 7,”Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 2 to the condensed consolidated financial statements included in the 2007 Form 10-K.
 
11

Note 3 – Inventory

The components of inventory consist of (in thousands):

   
2007
  
   
June 30
  
March 31
  
   
(unaudited)
      
Work in-process
  
$
1
  
$
25
  
Finished goods
    
656
    
782
  
   
$
657
  
$
807
  

Note 4 – Purchased, Internally Developed Software, Goodwill and Acquired Intangibles

The components of all intangible assets, excluding goodwill, consist of (in thousands):
 
Purchased and internally developed software:

       
June 30, 2007
  
March 31, 2007
  
   
Useful
Life in
Years
  
Gross
Carrying
Amount
  
Accumulated
Amortization
  
Net Carrying
Amount
  
Gross
Carrying
Amount
  
Accumulated
Amortization
  
Net Carrying
Amount
  
Purchased software
      
3
    
$
6,497
    
$
(5,646
)  
$
851
    
$
3,055
    
$
(2,152
)  
$
903
    
Internally developed software
    
3
    
6,486
    
(6,383
)
  
103
    
9,812
    
(9,675
)
  
137
  
         
$
12,983
  
$
(12,029
)
$
954
  
$
12,867
  
$
(11,827
)
$
1,040
  
 
Amortization of internally developed software costs was $35,000 and $0.1 million for the three months ended June 30, 2007 and 2006, respectively.
 
Acquired Intangibles:

       
June 30, 2007
  
March 31, 2007
  
   
Useful
Life in
Years
  
Gross
Carrying
Amount
  
Accumulated
Amortization
  
Net Carrying
Amount
  
Gross
Carrying
Amount
  
Accumulated
Amortization
  
Net Carrying
Amount
  
Acquired technology
      
3-5
    
$
12,614
    
$
(7,573
)  
$
5,041
    
$
12,614
    
$
(6,917
)  
$
5,697
  
Customer lists
    
4-15
    
14,640
    
(6,405
)
  
8,235
    
14,640
    
(5,865
)
  
8,775
  
Trademarks
    
3
    
180
    
(180
)
  
-
    
180
    
(180
)
  
-
  
Brand name
    
Indefinite
    
25,700
    
-
    
25,700
    
25,700
    
-
    
25,700
  
         
$
53,134
  
$
(14,158
)
$
38,976
  
$
53,134
  
$
(12,962
)
$
40,172
  
 
The acquired intangibles are being amortized using accelerated and straight-line methods over their estimated useful lives. Amortization of acquired intangibles was $1.2 million and $1.2 million for the three months ended June 30, 2007 and 2006, respectively. The future annual amortization expense of these acquired intangibles is expected to be as follows (in thousands):

Years Ending March 31, 
  
Amortization
Expense
  
2008 (remaining nine months)
  
$
3,588
  
2009
    
4,220
 
2010
    
2,064
 
2011
    
1,241
 
2012
    
896
 
Thereafter
    
1,267
 
   
$
13,276
  

We evaluate the remaining useful life of intangible assets not subject to amortization, such as brand names, each annual reporting period, or when events and circumstances indicate that impairment might have occurred, to determine whether events and circumstances continue to support an indefinite useful life. If it is determined the asset now has a definite useful life, that intangible asset is then amortized prospectively over its remaining useful life. In addition, we test goodwill and indefinite-lived assets for impairment at least annually. If impairment is found, the asset is reduced to its net fair value at date of impairment.
 
12
 
The following table presents the activity of goodwill and other acquired intangibles during the period from March 31, 2007 to June 30, 2007 (in thousands):
 
   
June 30, 2007
          
March 31, 2007
  
   
Net Carrying
Amount
  
Adjustment (1)
  
Amortization (2)
  
Net Carrying
Amount
  
Goodwill
  
$
55,620
  
$
112
  
$
-
  
$
55,508
  
Acquired technology
    
5,041
    
-
    
(656
)
  
5,697
  
Customer lists/contracts
    
8,235
    
-
    
(540
)
  
8,775
  
Trademarks/brand name
    
25,700
    
-
    
-
    
25,700
  
   
$
94,596
  
$
112
  
$
(1,196
)
$
95,680
  

(1) Includes adjustment to goodwill related to the adoption of FIN 48 on April 1, 2007.
(2) Amortization of intangibles is included in “Cost of Revenue” in our Condensed Consolidated Statement of Operations.

Note 5 – Accrued Expenses and Other Current Liabilities
 
Accrued expenses and other current liabilities consist of (in thousands):

   
2007
  
   
June 30
  
March 31
  
Commissions payable
  
$
748
  
$
724
  
Accrued compensation and benefits
    
4,100
    
4,056
  
Accrued professional services
    
5,406
    
4,432
  
Accrued marketing costs
    
1,137
    
1,380
  
Accrued sales returns and discounts     2,986     2,252  
Accrued royalties
    
3,659
    
5,441
  
Income taxes payable and other tax liabilities
    
9,651
    
11,886
  
Accrued other expense
    
3,547
    
2,269
  
Total accrued expenses and other current liabilities
  
$
31,234
  
$
32,440
  

Note 6 – Contingencies, Commitments and Credit Facilities
 
Operating Leases
 
We lease certain facilities and equipment under non-cancelable operating and capital leases. Operating leases include leased facilities and capital leases include leased equipment. Rent expense under operating leases for the quarters ended June 30, 2007 and 2006 was approximately $1.1 million and $1.1 million, respectively.
 
Future payments under various operating and capital leases that have initial remaining non-cancelable lease terms in excess of one year are as follows (in thousands):
 
Years Ending March 31,
 
Lease
Obligations
  
2008 (remaining nine months)
  
$
3,335
  
2009
    
3,872
  
2010
    
2,596
  
2011
    
1,264
  
Thereafter
    
-
  
   
$
11,067
  

Litigation Matters

From time to time, we (and our predecessors in interest, including Roxio, Inc., and MGI Software Corporation (“MGI”)) have been notified by companies that certain of our software products may infringe patents owned by those companies. In addition, we (and our predecessors in interest) have been notified by certain of our OEM customers that they, too, have been approached by certain companies claiming possible patent infringement by our products. At June 30, 2007 we had accruals of approximately $1.7 million on our balance sheet related to these infringement claims. The amount, if any, necessary to settle other patent claims cannot be determined at this time. There are no assurances that the amount we have accrued to settle these patent infringement claims is sufficient.
 
13
 
Between March and June 2007, we were notified that a total of five shareholder derivative lawsuits had been filed by persons identifying themselves as our shareholders and purporting to act on our behalf, naming us as a nominal defendant and naming some of our current and former officers and directors as defendants. Four of these actions were filed in the United States District Court for the Northern District of California, and one was filed in the Superior Court of California for the County of Marin.

In these actions, the plaintiffs assert claims against the individual defendants for violations of the Exchange Act, violations of the California Corporations Code, breach of fiduciary duty and/or aiding and abetting, abuse of control, gross mismanagement, corporate waste, unjust enrichment, rescission, constructive fraud, and an accounting and a constructive trust. The plaintiffs’ claims concern the granting of stock options by us and the alleged filing of false and misleading financial statements. All of these claims are asserted derivatively on our behalf. The plaintiffs seek, among other relief, an indeterminate amount of damages from the individual defendants and a judgment directing us to reform our corporate governance.

The federal cases were consolidated on August 2, 2007, into one action captioned Wilder v. Doris, et al. (C07-1500) (N.D. Cal.). On September 19, 2007, the court in the state action granted our motion to stay that proceeding in its entirety until final resolution of the consolidated federal action. The court in the state action is scheduled to review the status of the stay on September 16, 2008.

In addition to the derivative actions, two putative shareholder class actions have been filed against us and various of our executive officers and directors. On October 4, 2007, a putative shareholder class action was filed in the United States District Court for the Northern District of California, against us and various of our executive officers and directors on behalf of a proposed class of plaintiffs comprised of persons that purchased our shares between October 4, 2002 and May 17, 2007. On March 21, 2008, plaintiffs filed a consolidated amended complaint against us and various of our executive officers and directors on behalf of a proposed class of plaintiffs comprised of persons that purchased our shares between October 23, 2002 and May 17, 2007. This action alleges various violations of the Exchange Act and the rules thereunder, and is based on substantially similar factual allegations and claims as in the derivative actions.

On November 16, 2007, a putative shareholder class action was filed in the Superior Court of California for the County of Marin, against us and various of our executive officers and directors on behalf of a proposed class of plaintiffs comprised of persons that purchased our shares between July 12, 2001 and May 17, 2007. This action alleges breach of fiduciary duties, and is based on substantially similar factual allegations and claims as in the other lawsuits. The court in the state putative shareholder class action sustained our demurrers to the complaint with leave to amend. On April 21, 2008, the plaintiffs in that action filed an amended complaint.
 
Credit Facilities

On December 13, 2004 we entered into a Loan and Security Agreement with the Union Bank of California (“UBOC”) that provided for a three-year revolving credit facility (as subsequently amended, the “Amended Credit Facility”). The Amended Credit Facility provides for letters of credit up to $30 million and is guaranteed and secured by substantially all of our assets, including assets of our domestic subsidiaries, who are guarantors of the Amended Credit Facility. Under the terms of the Amended Credit Facility, we are subject to certain limitations, including limitations on our ability to incur additional debt, sell assets, make distributions, make investments, make acquisitions, and grant liens. The Amended Credit Facility also requires us to meet certain affirmative covenants, including requirements that we maintain specified financial ratios and a net profit for each quarter. The Amended Credit Facility is subject to customary events of default, the occurrence of which could lead to an acceleration of our obligations.
 
The interest rate charged on borrowings under the Amended Credit Facility can vary depending on the types of loans we select. Our options for the rate include (a) the Base Rate or (b) a LIBOR Rate plus an applicable margin (the “LIBOR Option”). The Base Rate is defined as the higher of the Federal Funds rate as in effect from time to time plus 0.5% or the rate of interest most recently announced from time to time by UBOC as its United States Dollar “reference rate.” The applicable margin for LIBOR loans is 1.50%. As of June 30, 2007, the interest rate was 6.82%.
 
In recent periods, we have not been in compliance with certain of the financial ratio, net profit and other covenants under the Amended Credit Facility and, as a consequence have entered into amendments with UBOC that have modified certain financial covenants, waived certain covenant violations, and extended the term of the credit facility. Most recently, we entered into an amendment on March 31, 2008 that, among other things, waived certain defaults and extended the term of the facility through June 30, 2008. We are currently evaluating our options for either negotiating an additional extension of the term of the current facility or securing a new facility.
 
14
 
As of June 30, 2007, the outstanding balance on the Amended Credit Facility was $20.0 million and was classified as a current liability.

Indemnification Obligations

In the normal course of business, we provide indemnifications of varying scopes, including limited product warranties and indemnification of customers against claims of intellectual property infringement made by third parties arising from the use of our products or services. We accrue for known indemnification issues if a loss is probable and can be reasonably estimated. Historically, costs related to these indemnifications have not been significant, but because potential future costs are highly variable, we are unable to estimate the maximum potential impact of these indemnifications on our future results of operations.

We, as permitted under California law and in accordance with our Bylaws and certain other commitments and agreements, indemnify our officers, directors and members of our senior management against certain claims and liabilities, subject to certain limits, while they serve at our request in such capacity. In this regard, we have received, or expect to receive, requests for indemnification by certain current and former officers and directors in connection with our stock options review, shareholder derivative and class action litigation described herein. The maximum amount of potential indemnification is unknown and potentially unlimited; however, we have directors’ and officers’ liability insurance policies that enable us to recover a portion of future indemnification claims paid, subject to retentions, conditions and limitations of those policies.
 
Other 

We sponsor a 401(k) savings plan that covers most of our U.S. employees. Participants may contribute a portion of their compensation to the plan subject to IRS limits.   During the quarter ended June 30, 2007, we made matching contributions of approximately $0.3 million for the quarter ended March 31, 2007. As of June 30, 2007, we had accrued approximately $0.3 million for first quarter fiscal year 2008 matching amounts. As of June 30, 2006, we had accrued approximately $0.3 million for the first quarter of fiscal year 2007 matching amounts. 

Note 7 – Shareholders’ Equity

During the three months ended June 30, 2007, no options were granted or exercised.

Note 8 - Employee Share-Based Compensation 
 

   
Three Months Ended June 30,
  
   
2007
  
2006
  
       
As Restated
  
Marketing and sales
  
$
242
  
$
460
  
Research and development
    
168
    
197
  
General and administrative
    
74
    
183
  
   
$
484
  
$
840
  
We recognize share-based compensation ratably over the vesting terms of the underlying share-based awards.
 
15
 
Note 9 - Comprehensive Income (Loss)

The components of comprehensive income (loss), net of tax, were as follows (in thousands):

   
Three Months Ended June 30,
  
   
2007
  
2006
  
       
As Restated
  
Net income (loss)
  
$
(1,957
)
$
5,001
  
Other comprehensive loss:
              
Foreign currency translation losses
    
(285
)
  
(135
)
Comprehensive income (loss)
  
$
(2,242
)
$
4,866
  
 
Note 10 – Earnings per Share

The following table sets forth the computation of basic and diluted income (loss) per share (in thousands, except per share data): 
   
Three Months Ended June 30,
  
   
2007
  
2006
  
       
As Restated
  
Net income (loss)
  
$
(1,957
)
$
5,001
  
Shares:
              
Weighted average shares outstanding (basic)
    
26,197
    
25,778
  
Effect of dilutive common stock options and restricted stock units
    
-
    
1,634
  
Weighted average shares outstanding (diluted)
    
26,197
    
27,412
  
Net income (loss) per share:
              
Basic
  
$
(0.07
)
$
0.19
  
Diluted
  
$
(0.07
)
$
0.18
  
 
 
Note 11 – Income Taxes

We account for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes.” The provision for income taxes is calculated using the asset and liability method of accounting. Under the asset and liability method, deferred tax assets and liabilities are recognized based on the future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using the tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. When we do not believe realization of a deferred tax asset is likely, we record a valuation allowance.

During the quarter ended June 30, 2007, we recorded an income tax benefit of $1.9 million. We calculated our projected annual effective tax rate for the year ending March 31, 2008 to be 40.5%. After considering discrete items, the effective tax rate for the three months ended June 30, 2007 is 48.6%. This rate differs from the statutory federal rate of 35% primarily due to state taxes, federal and California research and development tax credits and a tax rate differential in certain foreign jurisdictions. We do not provide for U.S. income taxes on undistributed earnings of our foreign operations that are intended to be invested indefinitely outside the U.S.

As of June 30, 2007, we maintained a valuation allowance of approximately $1.7 million against our InterActual Technologies subsidiary’s net operating losses due to the limitation on the utilization of these losses under Code Section 382. We have also established a full valuation allowance for our Canada subsidiary’s deferred tax assets as a result of the closure of its facilities in late 2007. We believe that due to this closure, we will more-likely-than-not be unable to realize these deferred tax assets.

We adopted FIN 48 on April 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes by prescribing rules for recognition, measurement and classification in our financial statements of tax positions taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. For tax benefits to be recognized under FIN 48, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement.

16
 
As a result of the adoption of FIN 48, we recorded cumulative adjustments to the beginning balances of Accumulated Deficit of $0.6 million, goodwill of $0.1 million and Additional Paid-in Capital of $0.8 million.

As of the date of adoption, we had $4.3 million of gross unrecognized tax benefits, $1.5 million of which would affect our effective tax rate if recognized. There were no material changes to these amounts during the three months ended June 30, 2007.

We file our income tax returns in the U.S. federal jurisdiction, various U.S. states and foreign jurisdictions. We are no longer subject to U.S. federal and state income tax examination by tax authorities for years prior to 2003. Foreign income tax matters for significant foreign jurisdictions have been concluded for years through 2002.

We recognize interest and penalties related to uncertain tax positions in income tax expense. As of April 1, 2007 we had accrued $0.1 million of interest and penalties. The amount of interest and penalties accrued during the three months ended June 30, 2007 was not material.

We estimate that there will be no material changes in our uncertain tax positions during our 2008 fiscal year.

Note 12 – Significant Customer Information and Segment Reporting
 
SFAS No. 131, ‘‘Disclosures about Segments of an Enterprise and Related Information,’’ requires us to report certain information about our operating segments. An operating segment is a component of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance.

Our Chief Executive Officer (“CEO”) is our chief operating decision maker. For the purpose of allocating resources and assessing performance, the CEO reviews financial information allocated into our professional products segment and our consumer products segment. While certain financial information related to our consumer products segment is also presented separately for the Roxio Division and the Advanced Technology Group (“ATG”), it is difficult to draw a clear distinction between their business activities; both sell or license CD/DVD burning, CD/DVD playback and related digital media products ultimately targeted at consumers; ATG develops much of the core engine technology behind both its own and Roxio products; our engineers, sales staff and other personnel transfer and/or share responsibilities between the two units in order to efficiently manage business flow and meet client needs; the two units often share budget and management responsibilities for particular initiatives; and both units engage in similar sales processes targeted at similar potential customers. For these reasons, our CEO does not regularly review operating results broken out separately for the Roxio Division and ATG in deciding how to allocate resources or in assessing performance.

The consumer segment includes software-only DVD-Video creation tools and DVD-Video playback software products intended for use by lower end professionals, enthusiasts or “prosumers,” and consumers, and software-only CD-Audio, CD-ROM and DVD-ROM making tools, as well as data backup software. Included in this segment is also the software we acquired in connection with the Roxio CSD acquisition. Our consumer segment’s products also include software that we license to other companies for inclusion in their products.

Our professional products segment includes advanced creation tools for DVD-Video, Blu-ray Disc and other formats, which are intended for use by high-end technically-oriented customers and professional videographers who may offer media creation services for a fee.

17
 
The following tables show the net revenue attributable to the two components of our consumer products segment and by product line, operating results by segment, revenue by geographic location, long-lived assets and significant customer information:
 
Revenues by Segment (in thousands):
 
   
Three Months Ended
June 30,
  
   
2007
  
2006
  
       
As Restated
  
Net revenues
              
Roxio Division
  
$
25,206
  
$
29,250
  
Advanced Technology Group
    
3,788
    
4,926
  
Total consumer products
    
28,994
    
34,176
  
Professional products
    
1,117
    
2,758
  
Total net revenues
  
$
30,111
  
$
36,934
  
 

   
Three Months Ended
June 30,
  
   
2007
  
2006
  
       
As Restated
  
Operating income (loss)
          
Consumer products
  
$
3,942
  
$
12,543
  
Professional products
    
(1,928
)
  
(106
)
Unallocated operating expenses
    
(6,165
)
  
(4,596
)
Total operating income (loss)
  
$
(4,151
)
$
7,841
  
  
Net Revenue by Geographic Location (in thousands):

   
Three Months Ended
June 30,
  
Net Revenues
  
2007
  
2006
  
       
As Restated
  
United States
  
$
25,158
  
$
27,509
  
Export
              
Canada
    
342
    
96
  
France
    
360
    
378
  
Germany
    
635
    
398
  
United Kingdom
    
809
    
616
  
Other European
    
1,054
    
1,009
  
Japan
    
414
    
5,399
  
Singapore
    
923
    
974
  
Taiwan
    
4
    
9
  
Other Pacific Rim
    
346
    
477
  
Other International
    
66
    
69
  
Total net revenues
  
$
30,111
  
$
36,934
  
 
We sell our products to customers categorized geographically by each customer’s country of domicile.

18
 
Long-lived assets (excluding goodwill and other intangible assets) by country (in thousands):
   
June 30, 
  
March 31,
  
   
2007
  
2007
  
United States
  
$
2,170
  
$
2,153
  
Canada
    
478
    
351
  
China
    
460
    
500
  
Japan
    
146
    
168
  
Other International
    
129
    
69
  
Total net assets
  
$
3,383
  
$
3,241
  
 
Significant Customer Information:

   
Percent of Total Net Revenues
  
Percent of Total Accounts
Receivable
  
   
Three Months Ended June 30,
  
June 30,
  
   
2007
  
2006
  
2007
  
2006
  
Dell
    
23
%
  
24
%
  
11
%
  
12
%
Digital River
    
23
%
  
18
%
  
13
%
  
8
%
Hewlett-Packard
    
15
%
  
7
%
  
12
%
  
1
%
Ingram
    
10
%
  
8
%
  
12
%
  
10
%
Navarre
    
10
%
  
10
%
  
10
%
  
10
%
         
Revenue recognized from Dell and Hewlett-Packard is pursuant to development and licensing agreements; revenue recognized from Ingram and Navarre is pursuant to distributor agreements; and revenue recognized from Digital River is pursuant to a reseller agreement.

Note 13 – SystemOK, AB Acquisition (“SystemOK”)

On November 6, 2006, we acquired all of the shares of SystemOK, a software company based in Gotenburg, Sweden, for a total purchase price, net of cash acquired, of $9.3 million, comprised of $8.7 million in cash, $1.6 million of which is not payable until the resolution of certain pre-acquisition contingencies, 31,566 shares of our common stock valued at approximately $0.5 million and estimated transaction costs of approximately $0.1 million. The acquisition expands on our existing consumer product line of digital media management, creation, and enjoyment tools with the addition of comprehensive system protection, recovery, and backup applications.

We allocated the purchase price to assets purchased and liabilities assumed based on their relative fair values with the excess recorded as goodwill. Based on the evaluation and review of the assets, the amounts and components of the purchase price along with the allocation of the purchase price are as follows (in thousands):
 
Common stock issued
  
$
489
  
Cash
    
8,692
  
Estimated transaction costs
    
167
  
Total purchase price
  
$
9,348
  
         
Current assets, net
  
$
1,328
  
Core developed technology
    
1,500
  
Customer contracts
    
200
  
Acquired in process technology
    
3,400
  
Goodwill
    
4,497
  
Current liabilities, net
    
(623
)
Deferred tax liability
    
(954
)
Net assets acquired
  
$
9,348
  
 
The transaction costs above of approximately $0.1 million were for professional services, including legal, tax, audit and advisory services.
 
Results for SystemOK have been included in our consolidated results since the acquisition on November 6, 2006.
 
19

Acquired in-process technology includes the value of products in the development stage that were not considered to have reached technological feasibility or have alternative future use at the time of acquisition. In connection with the SystemOK acquisition, we identified one research and development project involving the creation of the next generation version of their primary software product for which technological feasibility had not been established and no alternative future uses existed. The value of the acquired in-process technology was estimated by using the excess-earnings method of the income approach based on a discounted cash flow rate of 19%. This project was approximately 85% complete at the time of acquisition, and we anticipated that this project would have been completed and begun generating revenue by the end of fiscal year 2008. Accordingly, the acquired in-process technology was expensed upon consummation of the acquisition and included as a separate line item on our consolidated statements of operations for the three and nine month periods ended December 31, 2006.

Note 14 – Subsequent Events

Because we were not able to timely file our Form 10-Qs for our fiscal quarters ended December 31, 2006, June 30, 2007, September 30, 2007 and December 31, 2007, did not timely file our 2007 Form 10-K, and did not timely solicit proxies and hold our annual meeting of shareholders for our 2006 fiscal year, we have received Nasdaq Staff Determination notices regarding our noncompliance with applicable Nasdaq Marketplace Rules. The notices, which we expected and which were issued in accordance with standard Nasdaq procedures, informed us that our common stock was subject to delisting from the Nasdaq Global Select Market if we did not regain compliance. As we have previously announced, our filings and the holding of our fiscal year 2006 annual meeting were delayed due to our voluntary review of our historical and current stock option grant practices and related accounting. Additionally, because we have not been able to timely file our periodic reports, we did not timely solicit proxies or hold our annual meeting of shareholders for our 2007 fiscal year.
 
Most recently, in a letter dated March 6, 2008, the Board of Directors of The Nasdaq Stock Market LLC (the “Board”) notified us that it was granting us an additional exception providing us until May 12, 2008 to file all delinquent periodic reports necessary to regain compliance with Nasdaq’s filing requirements. If we fail to meet this deadline and the Board does not allow us additional time, our shares would be subject to delisting from The Nasdaq Global Select Market.

Union Bank Credit Facility Amendment
 
As described above in Note 6, “Contingencies, Commitments and Credit Facilities – Credit Facilities,” to the condensed consolidated financial statements included in this Quarterly Report, on March 31, 2008 we entered into an amendment with UBOC that, among other things, waived certain defaults under the Amended Credit Facility and extended its term through June 30, 2008.

Richmond Hill Office Closure

On October 25, 2007, we initiated a restructuring plan to reorganize our operations, optimize our engineering and development efforts, and reduce our workforce by closing our office in Richmond Hill, Canada. We expect to incur substantial severance and other one-time restructuring charges in connection with this closing. We reduced our headcount by approximately 84 employees due to the Richmond Hill office closure.

uMedia Digital Technology Corporation Acquisition
 
On February 29, 2008, we entered into an Asset Purchase Agreement with uMedia Digital Technology Corporation, a Chinese software development company (“uMedia”) whereby we acquired substantially all the assets of uMedia for a purchase price of approximately $0.4 million. In connection with the acquisition we acquired seven employees.

Simple Star, Inc. Acquisition
 
On April 24, 2008, we entered into an Asset Purchase Agreement with Simple Star, Inc., a software development company (“Simple Star”) whereby we acquired substantially all the assets of Simple Star for a purchase price of approximately $6.0 million, with $5 million payable in cash at closing and the balance of $1 million plus accrued interest and less any indemnifiable amounts payable on the first anniversary of closing. In connection with the acquisition we acquired twenty-five employees.
 
20
 
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Certain Factors that Make Future Results Difficult to Predict; Certain Items to Remember When Reading Our Financial Statements

Our quarterly and annual operating results vary significantly depending on the timing of new product introductions, product enhancements by us and by our competitors, and the finalization of the terms and deliveries under our larger software license agreements. Our results also depend on the volume and timing of our professional customer orders and on shipments of our original equipment manufacturer (“OEM”) partners, which are difficult to forecast. Because our OEM partners report shipments during or at the end of the period, we do not have an order backlog that can assist us in forecasting results. For these reasons, as well as those described under “Risk Factors,” in Item 1A below, our results of operations for any quarter or any year are a poor indicator of the results to be expected in any future quarter or year.
 
Our ongoing operating expenses are relatively fixed, and we plan our expenditures based primarily on sales forecasts. As a result, operating results can be negatively affected if OEM partner shipments do not meet our forecast, or if large license agreements are not finalized when forecasted.

This Quarterly Report contains restated financial information for the three months ended June 30, 2006. Previously filed quarterly reports of Form 10-Q have not been amended and should not be relied upon. Please see Note 2, “Restatement of Consolidated Financial Statements and Change in Accounting Policy,” to the condensed consolidated financial statements included in this Quarterly Report as well as our 2007 Form 10-K for additional discussions and information regarding these restatements.

Overview of Business
 
We develop and market computer software related to digital media - that is, data, photographs, audio, interactive features and video in digital formats. Our products create, design and deliver digital media across a wide variety of playback platforms, including Internet, broadcast, mobile and optical disc formats such as Compact Audio Disc (“CD-Audio”), Digital Video Disc (“DVD”), and Blu-ray Disc as well as other formats. Our software is used to accomplish a variety of tasks, including:
 
 
·
creating digital audio and video titles in the CD-Audio, DVD, Blu-ray Disc and other formats;
 
 
·
recording data files on CD, DVD, Blu-ray Disc and other recordable disc formats recordable discs;
 
 
·
editing digital audio, photos and video;
 
 
·
playing DVD, Blu-ray Disc and other disc formats, as well as digital content from other storage media and portable devices;
 
 
·
transferring digital media and data between computer and portable devices such as mobile phones, portable game players, and personal audio or video players;
 
 
·
managing digital media on computers and other consumer electronic devices;
 
 
·
securely burning CSS-encrypted DVDs using the Qflix standard; and
 
 
·
backing up the information contained on hard disks attached to PCs and CE devices.
 
  We sell our products to both consumer and professional end users. We also license the software technology underlying our products to other companies to incorporate into products they develop. Most of the software we sell is intended for use in the Windows and Macintosh operating system environments, but some operate in Linux environments or on proprietary platforms as well.
 
We organize our business into two reportable operating segments: professional and consumer. These segments reflect our internal organization and the processes by which our management makes operating decisions, allocates resources and assesses performance.

21
 
Professional
 
Our professional segment consists of one component, our Professional Products Group (“PPG”). PPG develops, sells, and provides technical support for a range of comprehensive authoring solutions that enable commercial content owners such as major Hollywood motion picture studios to create and distribute high-end commercially released packaged media DVD-Video, Blu-ray Disc and other titles to mass consumer markets worldwide. 
 
Intended for use by highly skilled content creation customers, high-end authoring houses, major motion picture studios and disc replicators, our professional solutions are marketed and sold under the Scenarist®, CineVision™, and DVDit® product names and Sonic® and Roxio Professional™ brands. We also sell content development technology, products and services under the InterActual® brand name, enabling professional DVD-ROM publishers to create advanced interactivity and seamless Internet connectivity for DVD-Video titles. Additionally, we license and/or bundle some of our professional authoring products to third-party companies. Our InterActual-enabled software DVD player is licensed to Hollywood studios for inclusion on motion picture packaged media releases to consumers who view DVD-Video discs on PCs. Our professional products and services are offered to our customers through a worldwide sales force augmented with a specialized dealer network. Our professional products and services accounted for approximately 4% of our net revenue for the quarter ended June 30, 2007.
 
Consumer
 
Our consumer segment consists of components that share similar technologies, products, services, production processes, customers, and distribution methods: the Roxio Division and the Advanced Technology Group (“ATG”).
 
 
·
Roxio Division - The Roxio Division offers a number of consumer digital media software products under the Roxio® brand name. Our applications include BackonTrack™, Backup MyPC®, CinePlayer®, Crunch™, Just!Burn™, MyDVD®, MyTV To Go™, PhotoSuite®, Popcorn, RecordNow®, Roxio Copy & Convert™, Roxio Easy Media Creator®, Toast®, VideoWave®, WinOnCD®, and others. We sell and market these products through four primary channels: (1) product bundling arrangements with OEM suppliers of related products, (2) volume licensing programs (“VLP”) to corporate purchasers, (3) direct-to-consumer sales on our web store and (4) retail resellers (both online and “bricks and mortar”).
 
 
·
Advanced Technology Group - ATG develops software and software components that it supplies to the other two operating units and that it licenses to PC and CE application developers. We market much of this software under the Roxio, AuthorScript®, CinePlayer, and Qflix™ brand names. ATG customers include OEM suppliers who wish to integrate our technology into products similar to the ones we distribute directly to end users through our Roxio Division. ATG also collaborates with our corporate strategy group in the management of our patent program, under which we develop, acquire, license and sell patents.
 
We group the Roxio Division and ATG into a single segment since it is difficult to draw a clear distinction between their business activities: both sell or license CD/DVD burning, CD/DVD playback and related digital media products ultimately targeted at consumers; the Advanced Technology Group develops much of the core engine technology behind both its own and Roxio products; our engineers, sales staff and other personnel transfer and/or share responsibilities between the two units in order to efficiently manage business flow and meet client needs; the two units often share budget and management responsibilities for particular initiatives; and both units engage in similar sales processes targeted at similar potential customers. For these reasons, our management, including our CEO, does not regularly review operating results broken out separately for the Roxio Division and ATG in deciding how to allocate resources or in assessing performance. Our consumer segment accounted for approximately 96% of our net revenue for the quarter ended June 30, 2007. See Note 12, “Significant Customer Information and Segment Reporting” to the condensed consolidated financial statements included in this Quarterly Report for a summary of our financial data by business segment.
 
On October 25, 2007, we initiated a restructuring plan to reorganize our operations, optimize our engineering and development efforts, and reduce our workforce by closing our Richmond Hill Canada office. In December 2007 we eliminated approximately 84 positions in connection with the office closure and incurred severance-related costs of approximately $1.7 million and other one-time restructuring charges of approximately $1.2 million.
 
CRITICAL ACCOUNTING POLICIES AND ESTIMATES

We prepare our consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”). In preparing our consolidated financial statements, we make estimates, judgments, and assumptions that can significantly affect the amounts reported in our consolidated financial statements. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates. We regularly evaluate our estimates, judgments, and assumptions and make changes accordingly.
 
22
 
There have been no significant changes in our critical accounting policies during the three months ended June 30, 2007 compared to the critical accounting policies described in our 2007 Form 10-K other than the adoption of Financial Accounting Standards Boards (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – An Interpretation of FASB Statement No. 109” (“FIN 48”) discussed below.
 
Income Taxes – Adoption of FIN 48

In June 2006, the FASB issued FIN 48, which became effective for us as of April 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes by prescribing rules for recognition, measurement and classification in our financial statements of tax positions taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.

For tax benefits to be recognized under FIN 48, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. See Note 11 “Income Taxes” to the condensed consolidated financial statements included in this Quarterly Report.

Other Disclosures
 
Contingencies
 
As described in Note 6, “Contingencies, Commitments and Credit Facilities,” to the condensed consolidated financial statements in this Quarterly Report, and Part II, Item 1, “Legal Proceedings,” included in this Quarterly Report, we are subject to various claims relating to products, technology, patent, shareholder and other matters. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 5, “Accounting for Contingencies,” we are required to assess the likelihood of any adverse outcomes and the potential range of probable losses in these matters. The amount of loss accrual, if any, is determined after careful analysis of each matter, and is subject to adjustment if warranted.

23
 
RESULTS OF OPERATIONS

The following table sets forth certain items from our statements of operations as a percentage of net revenue for the three months ended June 30, 2007 and 2006, respectively (in percentages):
 
   
Three Months Ended June 30,
 
   
2007
  
2006
  
       
As Restated
  
Net revenue
    
100
%
  
100
%
Cost of revenue
    
26
%
  
21
%
Gross profit
    
74
%
  
79
%
               
Operating expenses:
              
Marketing and sales
    
29
%
  
20
%
Research and development
    
39
%
  
28
%
General and administrative
    
20
%
  
10
%
Total operating expenses
    
88
%
  
58
%
Operating income (loss)
    
(14
)%
  
21
%
Other income
   
2
%
  
1
%
Income (loss) before income taxes
    
(12
)%
  
22
%
Provision for (benefit of) income taxes
    
(6
)%
  
8
%
Net income (loss)
    
(6
)%
  
14
%
 
Comparison of Three Months Ended June 30, 2007 and 2006

 The following table is a comparison of net revenue by division:
 
   
Three Months Ended June 30,
  
Net Revenues
  
2007
  
2006
  
(Decrease)
  
%
  
       
As Restated
          
Roxio Division
  
$
25,206
  
$
29,250
  
$
(4,044
)
  
(14
)%
Advanced Technology Group
    
3,788
   
4,926
   
(1,138
)
  
(23
)%
Total consumer products
    
28,994
   
34,176
   
(5,182
)
  
(15
)%
Professional products
    
1,117
   
2,758
   
(1,641
)
  
(59
)%
Net revenues
  
$
30,111
  
$
36,934
  
$
(6,823
)
  
(18
)%

Net revenue was $30.1 million for the three months ended June 30, 2007 a decrease of $6.8 million or 18% from the three months ended June 30, 2006. The decrease in net revenue was primarily due to a decrease in consumer product revenue of approximately 15% and a decrease in professional products revenue of approximately 59%. The decreases in consumer products revenue resulted from a decrease of $1.9 million in revenue from Dell, a $1.2 million reduction in revenue due to increased returns reserves established for slow moving inventory in Japan and anticipated returns from a former Japanese web store reseller with which we terminated our relationship at the end of June 2007, and overall softness in the consumer software market. Additionally, our ATG revenue for the three months ended June 30, 2006 included a multi-year license extension fee of approximately $1.7 million from a Japanese customer, for which there was no corresponding amount during the three months ended June 30, 2007. The decrease in professional products revenue was due to lower overall product shipments caused by continued delays in the widespread adoption of high-definition video/TV formats and a change in our revenue recognition method for the sale of professional software licenses when bundled with maintenance and support agreements. We defer revenue associated with professional product software licenses when sold with bundled maintenance and support services whenever we lack of vendor specific objective evidence (“VSOE”) of the fair value of such maintenance and support services. Beginning with the quarter ended December 31, 2006, certain of our PPG bundled deals did not support VSOE for maintenance and support and, accordingly, we recognize the revenue over the maintenance and support period, which is generally one year.
 
24
 
   
Three Months Ended June 30,
          
Net Revenues
  
2007
  
2006
  
Inc (Dec)
  
%
  
       
As Restated
          
United States
  
$
25,158
  
$
27,509
  
$
(2,351
)
  
(9
)%
Export
                          
Canada
    
342
   
96
   
246
   
256
%
France
    
360
   
378
   
(18
)
  
(5
)%
Germany
    
635
   
398
   
237
   
60
%
United Kingdom
    
809
   
616
   
193
   
31
%
Other European
    
1,054
   
1,009
   
45
   
4
%
Japan
    
414
   
5,399
   
(4,985
)
  
(92
)%
Singapore
    
923
   
974
   
(51
)
  
(5
)%
Taiwan
    
4
   
9
   
(5
)
  
(56
)%
Other Pacific Rim
    
346
   
477
   
(131
)
  
(27
)%
Other International
    
66
   
69
   
(3
)
  
(4
)%
Net revenues
  
$
30,111
  
$
36,934
  
$
(6,823
)
  
(18
)%
 
International sales accounted for $5.0 million and $9.4 million, or 16% and 26% of our net revenue for the three months ended June 30, 2007 and 2006, respectively. The decrease in international sales is primarily due to lower revenue from Japan, as described above. In addition, the quarter ended June 30, 2006 included a $1.7 million multi-year license extension fee for a Japanese customer with no corresponding license extension in the quarter ended June 30, 2007, also as described above. International sales historically have ranged from somewhat less than 20% to slightly less than 50% of our total sales, and we expect that they will continue to represent a significant but variable percentage of future revenue.

Significant Customers. The following table reflects sales to significant customers as a percentage of total sales and the related accounts receivable as a percentage of total receivables:
 
   
% of Total Net Revenues
  
% of Total Accounts
Receivable
  
   
Three Months Ended
June 30,
  
June 30,
  
Customer
  
2007
  
2006
  
2007
  
2006
  
Dell
    
23
%
  
24
%
  
11
%
  
12
%
Digital River
    
23
%
  
18
%
  
13
%
  
8
%
Hewlett-Packard
    
15
%
  
7
%
  
12
%
  
1
%
Ingram
    
10
%
  
8
%
  
12
%
  
10
%
Navarre
    
10
%
  
10
%
  
10
%
  
10
%
 
No other customer accounted for more than 10% of our revenue for the periods presented. Revenue recognized from Dell and Hewlett-Packard was pursuant to various development and licensing agreements. Revenue recognized from Digital River was pursuant to a reseller agreement. Revenue recognized from Ingram and Navarre was pursuant to distributor agreements. The loss of any one of these customers and our inability to obtain new customers to replace the lost revenue in a timely manner would have a material adverse effect on our financial results.

Cost of Revenue. Cost of revenue consists mainly of third party licensing expenses, employee salaries and benefits for personnel directly involved in the production and support of revenue-generating products, packaging and distribution costs, if applicable, and amortization of acquired and internally-developed software and intangible assets. In the case of consumer software distributed in retail channels, cost of revenue also includes the cost of packaging, if any, and certain distribution costs. Our cost of revenue as a percentage of net revenue increased 5% to 26% for the three months ended June 30, 2007 from 21% for the three months ended June 30, 2006. The increase in cost of revenue as a percentage of net revenue was due to the following:
 
 
·
Approximately 40% of the increase was due to higher third party licensing costs as a percent of net revenue. Certain of our third party licensing expenses are fixed and these fixed expenses represent a higher percentage of lower net revenue. Additionally, we have added more third-party royalty-bearing features to recent versions of our consumer products.
 
25
 
 
·
Approximately 40% of the increase was due to higher product costs, primarily for the consumer products. This increase in product costs was also due to the impact of fixed period expenses against lower net revenues. Additionally, consumer product costs increased due to changes in retail packaging and the bundling of certain promotional items with our products.
 
 
·
Approximately 20% of the increase was due to our relatively fixed cost of amortization of acquired intangible assets against lower net revenue.
 
Gross Profit.

   
Three Months Ended June 30,
 
   
2007
  
2006
  
(Decrease)
  
%
  
       
As Restated
          
Gross profit
  
$
22,183
  
$
29,011
  
$
(6,828
)
  
(24
)%
Gross profit as a percentage of revenue
    
74
%
  
79
%
  
(5
)%
      
 
Our gross profit as a percentage of net revenue decreased to 74% for the three months ended June 30, 2007 from 79% for the three months ended June 30, 2006. The decrease in our gross profit for the three months ended June 30, 2007 was primarily due to the increase in cost of sales as a percentage of net revenue discussed above.
 
Marketing and Sales. Marketing and sales expenses consist mainly of employee salaries and benefits, travel, marketing, and other promotional expenses, facilities expense and dealer and employee sales commissions. Our marketing and sales expenses increased 20% to $8.6 million for the three months ended June 30, 2007 from $7.2 million for the three months ended June 30, 2006. Marketing and sales expenses represented 29% and 20% of net revenue for the three months ended June 30, 2007 and 2006, respectively.

Marketing and sales expenses for the three months ended June 30, 2007 increased primarily due to an increase in advertising and promotional expense of approximately $0.7 million. Advertising and promotional expenses were lower for the three months ended June 30, 2006 due to the reversal of a marketing expense accrual related to expired retail market development fund (“MDF”) claim liabilities of approximately $0.6 million. Personnel-related costs increased approximately $0.9 million, primarily due to an increase in headcount to 129 at June 30, 2007 from 116 at June 30, 2006. These increases were offset in part by a reduction in share-based compensation expense of approximately $0.2 million. Share-based compensation expense was $0.2 million and $0.5 million for the three months ended June 30, 2007 and 2006, respectively.
 
Research and Development. Research and development expenses consist mainly of employee salaries and benefits, facilities, travel and consulting expenses incurred in the development of new products. Our research and development expenses increased 10% to $11.6 million for the three months ended June 30, 2007 from $10.5 million for the three months ended June 30, 2006. Research and development expenses represented 39% and 28% of net revenue for the three months ended June 30, 2007 and 2006, respectively. Research and development expenses increased for the three months ended June 30, 2007 primarily due to higher personnel-related expense of approximately $1.1 million due to an increase in engineering headcount to 496 from 380. The majority of the increase in headcount, 101 employees, was due to our continued expansion of our Chinese research and development capabilities. This increase was offset in part, by lower share-based compensation expense of approximately $0.1 million. Share-based compensation expense was $0.1 million and $0.2 million for the three months ended June 30, 2007 and 2006, respectively.

We anticipate that research and development expenses may increase as a percentage of net revenue over the next year primarily due to the expense associated with the closure of our Richmond Hill Canada office. Subsequent to the office closure, we anticipate that research and development expenses may decrease as a percentage of net revenue.
 
General and Administrative. General and administrative expenses consist mainly of employee salaries and benefits, travel, overhead, corporate facilities expense, legal, accounting and other professional services expenses. Our general and administrative expenses increased 74% or $2.5 million to $6.0 million for the three months ended June 30, 2007 from $3.5 million for the three months ended June 30, 2006. Our general and administrative expenses represented 20% and 9% of net revenue for the three months ended June 30, 2007 and 2006, respectively. The increase in general and administrative expenses was primarily due to approximately $2.3 million in expense incurred in connection with the voluntary review of our historical and current stock option grant practices and related accounting. The remaining increase was primarily associated with our overall increase in headcount and facilities. Overall headcount increased to 757 at June 30, 2007 from 627 at June 30, 2006. We anticipate that general and administrative expenses may increase due to costs associated with the completion of the stock option review.

26
 
Interest Income, Interest Expense, and Other Expenses, Net. Interest income included the interest we earned on cash balances and short-term investments. Interest income was approximately $0.7 million for each of the three months ended June 30, 2007 and 2006. Interest expense was approximately $0.3 and $0.5 million for the three months ended June 30, 2007 and 2006. Interest expense, related to the Union Bank of California N.A. (“UBOC”) Amended Credit Facility described under “Liquidity and Capital Resources” below, decreased primarily due to our payment of $10.0 million on the Amended Credit Facility. Other expenses, net for the three months ended June 30, 2007 and 2006 included foreign currency transaction gains and losses.
 
Provision (Benefit) for Income Taxes. During the quarter ended June 30, 2007, we recorded an income tax benefit of $1.9 million. We calculated our projected annual effective tax rate for the year ending March 31, 2008 to be 40.5%. After considering discrete items, the effective tax rate for the three months ended June 30, 2007 is 48.6%. This rate differs from the statutory federal rate of 35% primarily due to state taxes, federal and California research and development tax credits and a tax rate differential in certain foreign jurisdictions. We do not provide for U.S. income taxes on undistributed earnings of our foreign operations that are intended to be invested indefinitely outside the U.S.

During the quarter ended June 30, 2006, we recorded income tax expense of approximately $3.0 million.

As of June 30, 2007, we maintained a valuation allowance of approximately $1.7 million against our InterActual Technologies subsidiary’s net operating losses due to the limitation on the utilization of these losses under Code Section 382. We have also established a full valuation allowance for our Canada subsidiary’s deferred tax assets as a result of the closure of its facilities in late 2007. We believe that due to this closure, we will more-likely-than-not be unable to realize these deferred tax assets.

We adopted FIN 48 on April 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes by prescribing rules for recognition, measurement and classification in our financial statements of tax positions taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. For tax benefits to be recognized under FIN 48, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement.

As a result of the adoption of FIN 48, we recorded cumulative adjustments to the beginning balances of Accumulated Deficit of $0.6 million, Goodwill of $0.1 million and Additional Paid-in Capital of $0.8 million.

As of the date of adoption, we had $4.3 million of gross unrecognized tax benefits, $1.5 million of which would affect our effective tax rate if recognized. There were no material changes to these amounts during the three months ended June 30, 2007.

We file our income tax returns in the U.S. federal jurisdiction, various U.S. states and foreign jurisdictions. We are no longer subject to U.S. federal and state income tax examination by tax authorities for years prior to 2003. Foreign income tax matters for significant foreign jurisdictions have been concluded for years through 2002.

We recognize interest and penalties related to uncertain tax positions in income tax expense. As of April 1, 2007 we had accrued $0.1 million of interest and penalties. The amount of interest and penalties accrued during the three months ended June 30, 2007 was not material.

We estimate that there will be no material changes in our uncertain tax positions during our 2008 fiscal year.
 
Acquisitions. On November 6, 2006, we acquired all of the shares of SystemOK, a software company based in Gotenburg, Sweden, for a total purchase price, net of cash acquired, of $9.3 million, comprised of $8.7 million in cash, $1.6 million of which is not payable until the resolution of certain pre-acquisition contingencies, 31,566 shares of our common stock valued at approximately $0.5 million and estimated transaction costs of approximately $0.1 million. The acquisition expanded our existing Roxio product line of digital media management, creation, and enjoyment tools with the addition of comprehensive system protection, recovery, and backup applications.

LIQUIDITY AND CAPITAL RESOURCES

Our primary source of cash is from sales of our products. Our primary use of cash is for the payment of our operating expenses. Our principal source of liquidity is cash, cash equivalents and short-term investments. As of June 30, 2007 and March 31, 2006, we had cash, cash equivalents and short term investments of $65.7 million and $64.3 million, respectively. We believe that existing cash and cash equivalents and cash generated from operations will be sufficient to meet our cash requirements for at least the next 12 months.

27
 
Our operating activities generated cash of $2.5 million and $2.8 million for the three months ended June 30, 2007 and 2006, respectively. By increasing our collections efforts, we were able to reduce our accounts receivable by $4.7 million for the three months ended June 30, 2007, representing a significant source of cash for us during this period. During this same period, significant uses of cash included our making payments to decrease our accounts payable by $0.5 million and our reduction of accrued liabilities by $1.8 million as a result of the timing of payments on various payables and liabilities incurred during the normal course of business.

For the three months ended June 30, 2006, our most significant source of cash was our net income of $5.0 million. During this same period, significant uses of cash included our making payments to decrease our accounts payable by $2.5 million, and our reduction of accrued liabilities by $2.0 million as a result of the timing of payments on various payables and liabilities incurred during the normal course of business.

Our investing activities generated cash of $3.3 million and used cash of $11.2 million for the three months ended June 30, 2007 and 2006, respectively. For the three months ended June 30, 2007, our net redemptions of short term investments totaled $4.2 million and we used $0.9 million to purchase various fixed assets. For the three months ended June 30, 2006, our net purchases of short term investments totaled $11.0 million and we used $0.2 million to purchase various fixed assets.

We generated $0.5 million and $1.5 million in cash from financing activities during the three months ended June 30, 2007 and 2006, respectively. For the three months ended June 30, 2006, we received $0.6 million from the exercise of stock options and realized excess tax benefits from share-based compensation of $0.9 million.

Our working capital decreased $0.8 million to $35.0 million at June 30, 2007 from $35.8 million at March 31, 2007. The decrease in working capital was primarily due to the decrease in accounts receivable as discussed above. Our ratio of current assets to current liabilities remained consistent at 1.6:1 at June 30, 2007 and March 31, 2007.

On December 13, 2004 we entered into a Loan and Security Agreement with UBOC that provided for a three-year revolving credit facility (as subsequently amended, the “Amended Credit Facility”). The Amended Credit Facility provides for letters of credit up to $30 million and is guaranteed and secured by substantially all of our assets, including assets of our domestic subsidiaries, who are guarantors of the Amended Credit Facility. Under the terms of the Amended Credit Facility, we are subject to certain limitations, including limitations on our ability to incur additional debt, sell assets, make distributions, make investments, make acquisitions, and grant liens. The Amended Credit Facility also requires us to meet certain affirmative covenants, including requirements that we maintain specified financial ratios and a net profit for each quarter. The Amended Credit Facility is subject to customary events of default, the occurrence of which could lead to an acceleration of our obligations.

The interest rate charged on borrowings under the Amended Credit Facility can vary depending on the types of loans we select. Our options for the rate include (a) the Base Rate or (b) a LIBOR Rate plus an applicable margin (the “LIBOR Option”). The Base Rate is defined as the higher of the Federal Funds rate as in effect from time to time plus 0.5% or the rate of interest most recently announced from time to time by UBOC as its United States Dollar “reference rate.” The applicable margin for LIBOR loans is 1.50%. As of June 30, 2007, the interest rate was 6.82%.

In recent periods, we have not been in compliance with certain of the financial ratio, net profit and other covenants under the Amended Credit Facility and, as a consequence have entered into certain amendments with UBOC that have modified certain financial covenants, waived certain covenant violations, and extended the term of the credit facility. Most recently, we entered into an amendment on March 31, 2008 that, among other things, waived certain defaults and extended the term of the facility through June 30, 2008. We are currently evaluating our options for either negotiating an additional extension of the term of the current facility or securing a new facility.

As of June 30, 2007, the outstanding balance on the Amended Credit Facility was $20.0 million and was classified as a current liability.

As part of our business strategy, we regularly evaluate potential acquisitions of businesses, products and technologies. Accordingly, a portion of our available cash may be used at any time for the acquisition of complementary products or businesses. Such potential transactions may require substantial capital resources, which may require us to seek additional debt or equity financing. If additional funds are raised through the issuance of equity securities, the percentage ownership of our current shareholders will be reduced, shareholders may experience additional dilution or such equity securities may have rights, preferences or privileges senior to those of the holders of our common stock. We cannot assure you that we will be able to successfully identify suitable acquisition candidates, complete acquisitions, integrate acquired products or businesses into our current operations, or expand into new markets. Furthermore, we cannot assure you that additional financing will be available to us in any required time frame and on commercially reasonable terms, if at all. If adequate funds are not available or are not available on acceptable terms, we may be unable to continue operations, develop our products, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements, any of which could have a material adverse effect on our business, financial condition and operating results.

28
 
Off-Balance Sheet Arrangements 

We do not have any off-balance sheet arrangements, as such term is defined by applicable SEC rules, that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.

Recently Issued Accounting Pronouncements

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measures,” which defines fair value, establishes a framework for measuring fair value in accordance with GAAP, expands disclosures about fair value measurements, and applies other accounting pronouncements that require or permit fair value measurements. SFAS No. 157 does not require any new fair value measurements, but may change current practice for some entities. The FASB has issued an interpretation that defers the implementation of SFAS No. 157 effective for non-financial assets and liabilities until fiscal years beginning after November 15, 2008, with the remainder of SFAS No. 157 effective for financial statements issued for fiscal years beginning after November 15, 2007, with early adoption permitted. SFAS No. 157 is effective as of April 1, 2008 for our 2009 fiscal year, including interim periods within our 2009 fiscal year, with the exception of the one year deferral for non-financial assets and liabilities, which will be effective for our fiscal year 2010. We are currently evaluating what impact, if any, SFAS No. 157 will have on our financial position or results of operations.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115.” SFAS No. 159 permits an entity to choose to measure many financial instruments and certain other items at fair value. Most of the provisions in SFAS No. 159 are elective; however, the amendment to SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” applies to all entities with available-for-sale and trading securities. The fair value option established by SFAS No. 159 permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity will report unrealized gains and losses, on items for which the fair value option has been elected, in earnings at each subsequent reporting date. The fair value option (a) may be applied instrument by instrument, with a few exceptions, such as investments otherwise accounted for by the equity method, (b) is irrevocable (unless a new election date occurs), and (c) is applied only to entire instruments and not to portions of instruments. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. We will adopt SFAS No. 159 in fiscal year 2009 and are currently evaluating what impact, if any, SFAS No. 159 will have on our financial position or results of operations.

In December 2007, the FASB issued SFAS No. 141 (revised), “Business Combinations” (“SFAS No. 141R”). SFAS No. 141R changes the accounting for business combinations including the measurement of acquirer shares issued in consideration for a business combination, the recognition of contingent consideration, the accounting for pre-acquisition gain and loss contingencies, the recognition of capitalized in-process research and development, the accounting for acquisition-related restructuring cost accruals, the treatment of acquisition related transaction costs and the recognition of changes in the acquirer’s income tax valuation allowance. SFAS No. 141R is effective for fiscal years beginning after December 15, 2008, with early adoption prohibited. We will adopt SFAS No. 141R in fiscal year 2010 and are currently evaluating what impact, if any, SFAS No. 141R will have on our financial position or results of operations.

29

Our market risk disclosures set forth in Item 7A of our 2007 Form 10-K have not changed materially. Most of our international sales are denominated in U.S. dollars, although we are experiencing an increase in some of our sales and development contracts which are denominated in foreign currencies. We do not engage in any hedging activities.
 
We do not use derivatives or equity investments for cash investment purposes.
 
Cash equivalents consist of short-term, highly-liquid investments with original maturities of three months or less and are stated at cost which approximates market value. Cash equivalents consist of money market funds.
 
As of June 30, 2007, we held $43.1 million of investments in highly-rated (AAA/Aaa) auction rate securities which are classified as short-term investments in our balance sheet. Our auction rate securities are variable-rate debt instruments with longer stated maturities whose interest rates are reset at predetermined intervals of less than one year through a Dutch auction system. Although our auction rate securities have been readily marketable, if an auction were to fail, our ability to liquidate our investment and fully recover the carrying value of our investment in the near term may not exist.
 
As of March 31, 2008, we had liquidated all but $1.1 million of our auction rate security investments and invested the proceeds in money market accounts.
 
Our exposure to market risk for changes in interest rates relates to our cash equivalents, short-term debt obligations and auction rate securities.
 
As of June 30, 2007, all borrowings under our Amended Credit Facility bear interest at 6.82%, which represents the Base Rate, or LIBOR, plus the applicable margin, as defined. Interest is payable in accordance with the Amended Credit Facility.
 
The following table estimates the changes to cash flow from operations as of June 30, 2007 if interest rates were to fluctuate by 100 or 50 basis points, or bps (where 100 basis points represents one percentage point), for a twelve-month period:

Interest Rate Decrease
  
No Change to 
  
Interest Rate Increase
  
100 bps
  
50 bps
  
Interest Rate
  
50 bps
  
100 bps
  
                   
$
1,164
  
$
1,264
  
$
1,364
  
$
1,464
  
$
1,564
  

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ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our management evaluated, with the participation of our Chief Executive Officer (“CEO”) and our Interim Chief Financial Officer (“CFO”), the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report. Due to the fact that the material weakness in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) identified in our 2007 Form 10-K, our CEO and CFO have concluded that our disclosure controls and procedures were not effective as of June 30, 2007.

The material weakness in our internal control over financial reporting that was identified in our 2007 Form 10-K is as follows:

We lacked sufficient qualified personnel with an appropriate level of knowledge and experience in the application of GAAP, to exercise proper oversight over our financial reporting function and address the requirements of our normal financial accounting and reporting needs while we were simultaneously engaged in a restatement and re-audit of prior financial statements in connection with our stock option review. Our financial and accounting organization was not adequately staffed to support our financial accounting and reporting needs during our year-end close while also supporting the significant additional work associated with the stock option review and related restatement and a re-audit of our fiscal year 2005. Moreover, due to our lack of sufficient internal staffing, we had to rely too heavily on external consultants to assist in the financial reporting and close process and the calculation of share-based compensation and associated payroll tax and other expenses associated with our stock option review and were unable to perform adequate and timely reviews of staff work and account reconciliations. These issues resulted in various adjustments, including adjustments to our calculations of share-based compensation associated with the restatement, an adjustment based upon a sales transaction that we subsequently learned had additional terms, and an adjustment to our calculations of amortization of acquired intangibles. These adjustments were identified by management and our independent registered public accountants and were recorded prior to the filing of our 2007 Form 10-K.

Changes to Internal Control over Financial Reporting

Remediation Plans

Subsequent to the end of fiscal year 2007, our management has commenced a number of steps designed to remediate the fiscal year 2007 material weakness. Management believes that, upon our completion of the options review, restatement and re-auditing process and as we are able to become current in our periodic SEC filings, we will have resolved many of the underlying conditions giving rise to this material weakness. We currently have an interim chief financial officer, and, in addition to considering the various options relating to the permanent chief financial officer position, we are now in the process of searching for a permanent financial controller with significant accounting experience. In addition, management intends to engage in an increased effort to fill open positions with permanent staff with the appropriate training, experience, and knowledge of GAAP as necessary to enable us to maintain internal control over financial reporting. In addition, we will augment the strength of our accounting function by having members of our senior management and board of directors attend a Sonic-sponsored training program (including the services of outside experts as appropriate) concerning corporate governance and including discussions of public company accounting. As of March 31, 2008, our chief executive officer has attended a training program in this area, and we have made several specific training program options available to our senior management and board of directors.

Options Administration and Options Restatement

As disclosed in the 2007 Form 10-K, we commenced a voluntary review of our historical stock option grant practices and related accounting. We recently completed this review and concluded that a substantial number of stock options granted from early 1998 through mid 2006 were not correctly accounted for in accordance with GAAP, and have restated our historical financial statements based on our conclusions.

In considering the implications of this review on our internal control over financial reporting, our management noted that: (a) in 2005, as part of our efforts to improve internal control compliance and reporting as required by the Sarbanes-Oxley Act, we commenced a process of formalizing and improving our stock option granting and administration processes and hired a certified equity professional with experience managing stock award plans and implemented E*Trade’s Equity Edge software program to track and manage our stock award program; (b) in 2006, we adopted policies relating to granting employees restricted stock units (“RSUs”), which do not raise certain of the measurement date issues that exist for stock options, and in November 2006 made a grant of RSUs to employees as the general form of deferred equity compensation to these employees; and (c) during the pendency of our options review and restatement process, we did not issue any stock options. We are currently in the process of searching for a qualified employee to manage our stock award plans and the Equity Edge program.

31
 
In addition, as discussed in the 2007 Form 10-K (see Explanatory Note and “Management’s Discussion and Analysis of Financial Condition and Results of Operations”), we are implementing significant additional revisions to our internal control structure surrounding our stock option grant practices, including the formalization of documentation with respect to appropriate approvals for stock option grants and additional levels of review with respect to stock option grant terms, which management believes should facilitate the prevention and/or detection of material errors in future periods. As such, management concluded that the previous control deficiencies which resulted in a restatement of prior financial statements have been remediated and did not constitute a material weakness as of March 31, 2007 or June 30, 2007.

There were no other changes in our internal control over financial reporting during the first quarter of fiscal 2008 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

32
 
ITEM 1. LEGAL PROCEEDINGS
 
Between March and June 2007, we were notified that a total of five shareholder derivative lawsuits had been filed by persons identifying themselves as our shareholders and purporting to act on our behalf, naming us as a nominal defendant and naming some of our current and former officers and directors as defendants. Four of these actions were filed in the United States District Court for the Northern District of California, and one was filed in the Superior Court of California for the County of Marin.

In these actions, the plaintiffs assert claims against the individual defendants for violations of the Exchange Act, violations of the California Corporations Code, breach of fiduciary duty and/or aiding and abetting, abuse of control, gross mismanagement, corporate waste, unjust enrichment, rescission, constructive fraud, and an accounting and a constructive trust. The plaintiffs’ claims concern the granting of stock options by us and the alleged filing of false and misleading financial statements. All of these claims are asserted derivatively on our behalf. The plaintiffs seek, among other relief, an indeterminate amount of damages from the individual defendants and a judgment directing us to reform our corporate governance.

The federal cases were consolidated on August 2, 2007, into one action captioned Wilder v. Doris, et al. (C07-1500) (N.D. Cal.). On September 19, 2007, the court in the state action granted our motion to stay that proceeding in its entirety until final resolution of the consolidated federal action. The court in the state action is scheduled to review the status of the stay on September 16, 2008.

In addition to the derivative actions, two putative shareholder class actions have been filed against us and various of our executive officers and directors. On October 4, 2007, a putative shareholder class action was filed in the United States District Court for the Northern District of California, against us and various of our executive officers and directors on behalf of a proposed class of plaintiffs comprised of persons that purchased our shares between October 4, 2002 and May 17, 2007. On March 21, 2008, plaintiffs filed a consolidated amended complaint against us and various of our executive officers and directors on behalf of a proposed class of plaintiffs comprised of persons that purchased our shares between October 23, 2002 and May 17, 2007. This action alleges various violations of the Exchange Act and the rules thereunder, and is based on substantially similar factual allegations and claims as in the derivative actions.

On November 16, 2007, a putative shareholder class action was filed in the Superior Court of California for the County of Marin, against us and various of our executive officers and directors on behalf of a proposed class of plaintiffs comprised of persons that purchased our shares between July 12, 2001 and May 17, 2007. This action alleges breach of fiduciary duties, and is based on substantially similar factual allegations and claims as in the other lawsuits. The court in the state putative shareholder class action sustained our demurrers to the complaint with leave to amend. On April 21, 2008, the plaintiffs in that action filed an amended complaint.
 
We may become subject to additional private or government actions. The expense of defending such litigation may be significant. In addition, an unfavorable outcome in such litigation could have a material adverse effect on our business and financial statements.
 
In addition to the legal proceedings identified above, from time to time we are subject to legal proceedings, claims, investigations and proceedings in the ordinary course of business, including claims of alleged infringement of third-party patents and other intellectual property rights, commercial, employment and other matters. As noted, we have made a provision for various legal proceedings. This provision is reviewed at least quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to particular cases. Litigation is inherently unpredictable. However, we believe that we have valid defenses with respect to the legal matters pending against us. It is possible, nevertheless, that our consolidated financial position, cash flows or results of operations could be affected by the resolution of one or more of such matters.
 
33
 
ITEM 1A. RISK FACTORS. 

Our operations and financial results are subject to various risks and uncertainties that could materially affect our business, financial conditions, results of operations and the trading price of our Common Stock. We continue to face numerous risks and challenges in the execution of our business strategy. The risks and uncertainties described below and in other documents we have filed with the SEC are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. The risks identified below and in other documents we have filed with the SEC could harm our business and cause the value of our shares to decline. We cannot, however, estimate the likelihood that our shares may decline in value or the amount by which they may decline.

Our 2007 Form 10-K identifies important risk factors facing our business in Part I, Item 1A under the heading “Risk Factors,” under the headings listed below. There are no material changes to the Risk Factors disclosed in our 2007 Form 10-K and we encourage you to read the information included under “Risk Factors’ in the 2007 Form 10-K.
 
34
 
 
·
Matters relating to or arising from our stock option review, including litigation and potential additional expenses, may adversely affect our business and results of operations.
 
 
·
If we do not regain and maintain compliance with the listing requirements of The Nasdaq Global Select Market, our common stock could be delisted, which could, among other things, reduce the price of our common stock and the levels of liquidity available to our shareholders.
 
 
·
As a result of review of our historical stock option granting practices and related restatements, we could be investigated by the SEC, the Department of Justice, the IRS or other governmental authority.
 
 
·
We may experience potential fluctuations in our quarterly operating results, face unpredictability of future revenue and incur losses in the future.
 
 
·
Changes in our product and service offerings could cause us to defer the recognition of revenue, which could harm our operating results and adversely impact our ability to forecast revenue.
 
 
·
Failure to successfully integrate any business we have acquired or may acquire in the future could negatively impact our results of operations, financial condition and business.
 
 
·
Our failure to manage our expansion may adversely affect us.
 
 
·
We need to develop and introduce new and enhanced products in a timely manner to remain competitive.
 
 
·
We depend on a limited number of customers for a significant portion of our revenue, and the loss of one or more of these customers could materially harm our operating results, business and financial condition.
 
 
·
We are subject to risks associated with international operations that may harm our business.
 
 
·
We may incur losses associated with currency fluctuations and may not effectively reduce our exposure.
 
 
·
We invest in highly-rated (AAA/Aaa) auction rate securities which are subject to risks that may cause losses and affect our liquidity.
 
 
·
We may engage in future acquisitions that could dilute our existing shareholders’ ownership and harm our business, results of operations and financial condition.
 
 
·
Our product prices may decline, which could harm our operating results.
 
 
·
Our reliance on a limited number of suppliers for our manufacturing makes us vulnerable to supplier operational problems.
 
 
·
Because a large portion of our net revenue is from OEM customers, the potential success of our products is tied to the success of their product sales.
 
 
·
Changes in requirements or business models of our OEM customers may affect negatively our financial results.
 
 
·
We rely on distributors, resellers and retailers to sell our products, and disruptions to these channels would affect adversely our ability to generate revenues from the sale of our products.
 
 
·
If we fail to protect our intellectual property rights we may not be able to market our products successfully.
 
 
·
Other companies’ intellectual property rights may interfere with our current or future product development and sales.
 
 
·
We may become involved in costly and time-consuming patent litigation.
 
 
·
We may be liable to some of our customers for damages that they incur in connection with intellectual property claims.
 
 
·
Some of our competitors possess greater technological and financial resources than we do, may produce better or more cost-effective products than ours and may be more effective than we are in marketing and promoting their products.
 
 
·
Because our products are designed to comply with industry standards, to the extent that we cannot distinguish our products from those produced by our competitors, our current distributors and customers may choose alternate products or choose to purchase products from multiple vendors. We may be unable to compete effectively if we cannot produce products more quickly or at lower cost than our competitors.
 
 
·
Revenue derived from our professional products and services has declined in recent years and may continue to decline.
 
35
 
 
·
We may encounter significant challenges as our business depends increasingly on sales of consumer products.
 
 
·
With the growth in the Internet as a medium to download and purchase software, we expect to face increasing competition from smaller software providers.
 
 
·
Our revolving credit facility imposes significant operating and financial restrictions, which may prevent us from capitalizing on business opportunities and taking some actions.
 
 
·
We may be unable to utilize loss carry forwards in the future.
 
 
·
Our web store makes us vulnerable to third party operational problems and other risks.
 
 
·
Undetected errors or failures found in our products may result in loss of or delay in market acceptance, which could seriously harm our reputation and business.
 
 
·
Our executive officers and other key personnel are critical to our business, and because there is significant competition for personnel in our industry, we may not be able to attract and retain qualified personnel.
 
 
·
Our stock price has been volatile, is likely to continue to be volatile, and could decline substantially.
 
 
·
Failure to comply with internal control attestation requirements could lead to loss of public confidence in our financial statements and negatively impact our stock price.
 
 
·
Changes in financial accounting standards or practices may cause adverse unexpected financial reporting fluctuations and affect our reported results of operations.
 
 
·
Qualifying and supporting our products on multiple computer platforms is time consuming and expensive.
 
 
·
We are vulnerable to earthquakes, labor issues and other unexpected events.
 
This list does not include all risks that could affect our business and if these or any other risks or uncertainties materialize, or in our underlying assumptions are inaccurate, actual results could differ materially from past and from our expected future results.
 
36

ITEM 6. EXHIBITS.
31.1
Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
 
31.2
Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
 
32.1
Certification of the Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
 
32.2
Certification of the Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
37
 
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, in the City of Novato, State of California, on the 2nd day of May, 2008.
 
SONIC SOLUTIONS
  
 
 
  
 
/s/ David C. Habiger   
  
May 2, 2008 
     
David C. Habiger
President and Chief Executive Officer
(Principal Executive Officer)
    
 
  
 
 /s/ Paul F. Norris
  
May 2, 2008 
     
Paul F. Norris
Executive Vice President and
Interim Chief Financial Officer
(Principal Financial/Accounting Officer)
    
 
38
 EX-31.1 2 v112236_ex31-1.htm Unassociated Document
EXHIBIT 31.1
CERTIFICATION
 
I, David C. Habiger, certify that:
 
1. I have reviewed this quarterly report on Form 10-Q of Sonic Solutions;
 
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
 
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
 
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
 
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this quarterly report based on such evaluation; and

d) Disclosed in this quarterly report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
 
a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

May 2, 2008
  
 
/s/ David C. Habiger  
   
 
David C. Habiger
 
President and Chief Executive Officer
 
 EX-31.2 3 v112236_ex31-2.htm Unassociated Document
EXHIBIT 31.2
 
CERTIFICATION
 
I, Paul F. Norris, certify that:
 
1. I have reviewed this quarterly report on Form 10-Q of Sonic Solutions;
 
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
 
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
 
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
 
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this quarterly report based on such evaluation; and

d) Disclosed in this quarterly report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
 
a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
 
May 2, 2008
  
 
/s/ Paul F. Norris
   
 
Paul F. Norris
 
Executive Vice President and
 
Interim Chief Financial Officer
 
EX-32.1 4 v112236_ex32-1.htm Unassociated Document
EXHIBIT 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
 
In connection with the Quarterly Report of Sonic Solutions (the “Company”) on Form 10-Q for the period ended June 30, 2007 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, David C. Habiger, Chief Executive Officer of the Company, hereby certify as of the date hereof, solely for purposes of Title 18, Chapter 63, Section 1350 of the United States Code, that to the best of my knowledge:
(1)
The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2)
The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company at the dates and for the periods indicated.
 
This certification has not been, and shall not be deemed, “filed” with the Securities and Exchange Commission.
 
 
By:
/s/ David C. Habiger
  
 
Name: David C. Habiger
Title: President and Chief Executive Officer

EX-32.2 5 v112236_ex32-2.htm Unassociated Document
EXHIBIT 32.2
 
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
 
In connection with the Quarterly Report of Sonic Solutions (the “Company”) on Form 10-Q for the period ended June 30, 2007 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Paul F. Norris, Interim Chief Financial Officer of the Company, hereby certify as of the date hereof, solely for purposes of Title 18, Chapter 63, Section 1350 of the United States Code, that to the best of my knowledge:
 
(1)
The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2)
The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company at the dates and for the periods indicated.
 
This certification has not been, and shall not be deemed, “filed” with the Securities and Exchange Commission.

Date: May 2, 2008

By:
/s/ Paul F. Norris
  
 
Name: Paul F. Norris
Title: Executive Vice President and
Interim Chief Financial Officer
 
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