10-Q

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, 2010

¨           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

SONIC SOLUTIONS

(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)
7250 Redwood Blvd., Suite 300 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   x     No   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes   ¨    No   ¨

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 the definitions 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 August 5, 2010
Common stock, no par value per share	30,786,653

SONIC SOLUTIONS

FORM 10-Q

Table of Contents

Part I.	Financial Information		3
	Item 1.	Financial Statements:	3
		Condensed Consolidated Balance Sheets	3
		Condensed Consolidated Statements of Operations (unaudited)	4
		Condensed Consolidated Statements of Cash Flows (unaudited)	5
		Notes to Condensed Consolidated Financial Statements (unaudited)	6
	Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	14
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	23
	Item 4.	Controls and Procedures	23
Part II.	Other Information		23
	Item 1.	Legal Proceedings	23
	Item 1A.	Risk Factors	23
	Item 6.	Exhibits	24
	Signatures		25

2

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Sonic Solutions

Condensed Consolidated Balance Sheets

(in thousands, except share data)

	2010
	June 30			March 31
	(Unaudited)			(1)
ASSETS
Current assets:
Cash and cash equivalents	$	54,861		$	54,536
Accounts receivable, net of allowances of $1,742 and $2,511 at June 30, 2010 and March 31, 2010, respectively		11,900			11,270
Inventory		2,225			1,941
Prepaid expenses and other current assets		3,271			3,497
Deferred tax benefits		119			-
Total current assets		72,376			71,244
Fixed assets, net		1,590			1,670
Purchased software costs, net		159			165
Goodwill		4,628			4,628
Acquired intangibles, net		16,671			16,174
Deferred tax benefits, net of current portion		124			66
Other assets		1,308			1,463
Total assets	$	96,856		$	95,410
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable	$	4,177		$	3,892
Accrued expenses and other current liabilities		20,238			21,916
Deferred revenue		7,609			5,874
Capital leases		120			123
Total current liabilities		32,144			31,805
Other long term liabilities		1,887			889
Deferred revenue, net of current portion		169			76
Capital leases, net of current portion		6			37
Total liabilities		34,206			32,807
Commitments and contingencies (Note 7)
Shareholders' equity:
Common stock, no par value, 100,000,000 shares authorized; 30,762,590 and 30,610,102 shares issued and outstanding at June 30, 2010 and March 31, 2010, respectively		201,439			200,375
Accumulated deficit		(137,357	)		(136,289	)
Accumulated other comprehensive loss		(1,432	)		(1,483	)
Total shareholders' equity		62,650			62,603
Total liabilities and shareholders' equity	$	96,856		$	95,410

(1)  Derived from audited consolidated financial statements as of March 31, 2010.

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

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Sonic Solutions

Condensed Consolidated Statements of Operations

(in thousands, except per share data)

(Unaudited)

	Three Months Ended June 30,
	2010			2009
Net revenue	$	25,400		$	25,527
Cost of revenue		7,673			7,885
Gross profit		17,727			17,642
Operating expenses:
Marketing and sales		7,102			6,754
Research and development		5,933			7,114
General and administrative		4,680			4,752
Restructuring		-			520
DivX acquisition costs		1,618			-
Total operating expenses		19,333			19,140
Operating loss		(1,606	)		(1,498	)
Interest income		16			41
Interest expense		(42	)		(10	)
Other income (expense), net		(212	)		120
Loss before income taxes		(1,844	)		(1,347	)
Provision for (benefit of) income taxes		(776	)		484
Net loss	$	(1,068	)	$	(1,831	)
Net loss per share:
Basic and diluted	$	(0.03	)	$	(0.07	)
Shares used in computing net loss per share:
Basic and diluted		30,686			26,611

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

4

Sonic Solutions

Condensed Consolidated Statements of Cash Flows

(in thousands) 

(Unaudited)

	Three Months Ended June 30,
	2010			2009
Cash flows from operating activities:
Net loss	$	(1,068	)	$	(1,831	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		462			659
Deferred taxes		(177	)		(13	)
Provision for returns and doubtful accounts, net of write-offs and recoveries		7			17
Loss on disposition of asset		-			20
Share-based compensation		819			580
Fair value adjusted for vested warrant shares issued for strategic relationship		285
Decrease in restricted cash		-			456
Changes in operating assets and liabilities, net:
Accounts receivable		(526	)		3,192
Inventory		(281	)		(10	)
Prepaid expenses and other current assets		226			797
Other assets		155			(84	)
Accounts payable		285			1,006
Accrued liabilities		(880	)		(548	)
Deferred revenue		1,494			447
Net cash provided by operating activities		801			4,688
Cash flows from investing activities:
Purchase of fixed assets		(249	)		(75	)
Purchase of intangible assets		(200	)		-
Additions of purchased software		(28	)		(24	)
Net cash used in investing activities		(477	)		(99	)
Cash flows from financing activities:
Proceeds from exercise of common stock options		155			34
Cash used to net share settle equity awards		(178	)		(18	)
Principal payments on capital leases		(34	)		(29	)
Net cash used in financing activities		(57	)		(13	)
Effect of exchange rate changes on cash and cash equivalents		58			(1	)
Net increase in cash and cash equivalents		325			4,575
Cash and cash equivalents, beginning of period		54,536			19,408
Cash and cash equivalents, end of period	$	54,861		$	23,983
Supplemental disclosure of cash flow information:
Interest paid	$	42		$	10
Income taxes, net of refunds	$	105		$	365
Supplemental disclosure of non-cash transactions:
Original cost of fixed asset written-off	$	101		$	110
Intangible assets related to asset-purchase	$	(403	)	$	-

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

5

Sonic Solutions

Notes to Unaudited Condensed Consolidated Financial Statements

(in thousands except per share data)

NOTE 1 – BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying interim financial information is unaudited and includes all adjustments (consisting of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the financial position of Sonic Solutions (the “Company”) at June 30, 2010 and the results of operations and cash flows for the three months ended June 30, 2010 and 2009 in conformity with accounting principles generally accepted in the United States of America (“GAAP”).  The condensed consolidated balance sheet as of March 31, 2010 was derived from the audited consolidated financial statements at that date, but, in accordance with the rules and regulations of the United States Securities and Exchange Commission (“SEC”), does not include all of the information and notes required by GAAP for complete financial statements.  Operating results for the three months ended June 30, 2010 are not necessarily indicative of results that may be expected for the entire fiscal year. The financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended March 31, 2010, which was filed with the SEC on June 7, 2010 (the “Fiscal 2010 Form 10-K”).

Certain amounts in prior periods have been reclassified to conform to the current period presentation. The reclassifications had no impact on the Company’s net income or shareholders’ equity as previously reported. Unless otherwise indicated, all dollar amounts are in thousands except share and per share data. References to “fiscal year” refer to the Company’s fiscal year ending on March 31 of the designated year.  For example, “fiscal year 2010” refers to the fiscal year ended March 31, 2010.  Other references to “years” mean calendar years.

Significant Accounting Policies

There have been no material changes in the Company’s significant accounting polices during the three months ended June 30, 2010 compared to the significant accounting policies described in the Company’s Fiscal 2010 Form 10-K.

Use of estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Management’s judgments are based on what effect certain estimates, assumptions of future trends or events may have on the financial condition and results of operations reported in its financial statements. Actual results could differ materially from these estimates, assumptions, projections and judgments.

On an ongoing basis, the Company evaluates estimates used. The following accounting policies require management to make estimates, judgments and assumptions and are critical in fully understanding and evaluating the Company’s reported financial results:

· Revenue recognition

· Allowances for sales returns and doubtful accounts

· Share-based compensation

· Valuation of acquired businesses, assets and liabilities

· Goodwill, intangible assets and other long-lived assets

· Accrued liabilities

· Contingencies

· Income tax and deferred tax asset valuation

NOTE 2 – RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

The following is a summary of recent authoritative pronouncements that could impact or have impacted the Company’s accounting, reporting, and/or disclosure of financial information.

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In September 2009, the Emerging Issues Task Force (“EITF”) issued its final consensus for Accounting Standards Update (“ASU”) 2009-13 (formerly “EITF 08-1”), Revenue Arrangements with Multiple Deliverables, which will supersede the guidance in ASC 605-25 (previous authoritative guidance:  EITF 00-21, Revenue Arrangements with Multiple Deliverables).  ASU 2009-13 retains the criteria from ASC 605-5 for when delivered items in a multiple-deliverable arrangement should be considered separate units of accounting, but removes the previous separation criterion under ASC 605-25 that objective and reliable evidence of fair value of any undelivered items must exist for the delivered items to be considered a separate unit or separate units of accounting.  ASU 2009-13 introduces a selling price hierarchy for multiple deliverable arrangements and allows for management selling price estimates in cases where no vendor specific objective evidence or third party evidence is available.  Additionally, this guidance eliminates the residual method of allocation.  ASU 2009-13 is effective for fiscal years beginning on or after June 15, 2010.  The Company is currently evaluating ASU 2009-13 and the impact, if any, that it may have on its results of operations or financial position.

In September 2009, the EITF issued its final consensus for ASU 2009-14 (formerly “EITF 09-3”), Applicability of SOP 97-2 to Certain Arrangements that Include Software Elements, which amends the prior guidance to exclude tangible products that contain software and non-software components that function together to deliver the products’ “essential functionality” from the guidance on software revenue recognition.  The guidance is effective for fiscal years beginning after June 15, 2010; however, early adoption is permitted as of the beginning of an entity’s fiscal year.  Entities are required to adopt ASU 2009-13 and ASU 2009-14 concurrently.  The Company is in the process of determining the effect of the adoption of ASU 2009-14 and the impact, if any, that it may have on its results of operations or financial position.

In March 2010, the FASB reached a consensus on ASU 2010-17, Milestone Method of Revenue Recognition. ASU 2010-17 provides guidance on applying the milestone method to milestone payments for achieving specified performance measures when those payments are related to uncertain future events.  Entities can make an accounting policy election to recognize arrangement consideration received for achieving specified performance measures during the period in which the milestones are achieved, provided certain criteria are met.  The scope of this pronouncement is limited to transactions involving research or development.  ASU 2010-17 is effective for interim and annual periods beginning on or after June 15, 2010 with early adoption permitted.  The Company does not expect the adoption will have any material impact on its results of operations or financial position.

NOTE 3 - FAIR VALUE MEASUREMENTS

The Company’s money market funds are considered a Level 1 financial asset where the fair value is based on unadjusted quoted market prices and the account balance approximates its fair value due to its short term nature.  The primary objective of the Company’s investment in money market funds is to preserve capital for the purpose of funding operations and is not for trading or speculative purposes.  The following table presents the Company’s money market assets measured at fair value on a recurring basis at June 30, 2010 (in thousands):

	FairValueMeasurementsatReportingDate
	FairValueasof June30,2010		QuotedPricesin ActiveMarketsfor IdenticalAssets
			(Level 1)
Assets
Money market accounts (1)	$	43,021	$	43,021
Total	$	43,021	$	43,021
(1) Included in "Cash and cash equivalents" in the Balance Sheet.

The Company has direct investments in privately-held companies as of June 30, 2010 with a carrying value of $0.1 million included in Other Assets.  The Company’s direct investments are accounted for under the cost method, and are periodically assessed for other-than-temporary impairment.  If the Company determines that an other-than-temporary impairment has occurred, it writes down the investment to its fair value.  The Company estimates fair value of its cost method investments considering available information such as current cash positions, earnings and cash flow forecasts, recent operational performance and other readily available market data.

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NOTE 4 – INVENTORY

Inventory is stated at the lower of cost (first-in, first-out method) or market (estimated net realizable value) and consisted of the following (in thousands):

	June 30, 2010		March 31, 2010
Raw Materials	$	158	$	142
Finished Goods		2,067		1,799
	$	2,225	$	1,941

Reserves for excess and obsolete inventory are established based on an analysis of products on hand and sales trends.  Inventory is presented net of reductions for excess and obsolescence of $0.5 million at June 30, 2010 and March 31, 2010.  Inventory held on consignment at June 30, 2010 and March 31, 2010 was $2.1 million and $1.8 million, respectively.

NOTE 5 – PURCHASED SOFTWARE, GOODWILL AND ACQUIRED INTANGIBLES

The following table presents the components of the Company’s capitalized software, intangible assets and goodwill (in thousands):

		June 30, 2010							March 31, 2010
	Useful Life in Years	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount		Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
Goodwill	Indefinite	$	4,628		-		$	4,628	$	4,628	$	-		$	4,628
Purchased software	3		3,611		(3,452	)		159		3,584		(3,419	)		165
Acquired technology	3-6		14,720		(14,291	)		429		14,520		(14,277	)		243
Customer lists	2-15		17,256		(15,131	)		2,125		16,870		(15,040	)		1,830
Trademarks	3		267		(250	)		17		250		(249	)		1
Trademark/brand name	Indefinite		14,100		-			14,100		14,100		-			14,100
		$	54,582	$	(33,124	)	$	21,458	$	53,952	$	(32,985	)	$	20,967

The following table presents the activity of goodwill and other intangibles during the period from March 31, 2010 to June 30, 2010 (in thousands):

	March 31, 2010									June 30, 2010
Intangible asset	Net Carrying Amount		Additions		Adjustment		Amortization			Net Carrying Amount
Goodwill	$	4,628	$	-	$	-	$	-		$	4,628
Purchased software		165		27		4		(37	)		159
Acquired technology		243		200		-		(14	)		429
Customer lists		1,830		386		1		(92	)		2,125
Trademarks		1		17		-		(1	)		17
Trademark/brand name		14,100		-		-		-			14,100
	$	20,967	$	630	$	5	$	(144	)	$	21,458

Acquired intangibles with finite lives and purchased software are being amortized using accelerated and straight-line methods over their estimated useful lives.  Amortization of acquired intangibles was $0.1 million for the three months ended June 30, 2010 and 2009.  The future annual amortization expense of definitive-lived intangibles is expected to be as follows (in thousands):

8

Years Ending March 31,	Amortization Expense
2011 (remaining nine months)	$	422
2012		557
2013		408
2014		282
Thereafter		902
	$	2,571

NOTE 6 – ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

Accrued expenses and other current liabilities consist of (in thousands):

	2010
	June 30		March 31
Commissions payable	$	592	$	543
Accrued compensation and benefits		3,066		2,761
Accrued professional services		1,631		1,146
Accrued marketing costs		837		927
Accrued sales returns and discounts		1,533		2,124
Accrued royalties		3,330		2,629
Accrued restructuring costs		333		385
Income tax liabilities		562		2,729
Other tax liabilities		5,204		7,134
Other accrued expense		3,150		1,538
Total accrued expenses and other current liabilities	$	20,238	$	21,916

NOTE 7 – COMMITMENTS AND CONTINGENCIES

Leases

The Company leases certain facilities and equipment under non-cancelable operating and capital leases. Operating leases include leased facilities and capital leases include leased equipment.  Rent expense was approximately $1.0 million and $1.3 million for the three months ended June 30, 2010 and 2009, 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,	Operating Leases		Capital Leases		Total Lease Obligations
2011 (remaining nine months)	$	2,790	$	89	$	2,879
2012		1,497		32		1,529
2013		381		3		384
2014 and thereafter		52		2		54
	$	4,720	$	126	$	4,846

Contingencies

From time to time the Company is subject to various legal proceedings and claims, the outcomes of which are subject to significant uncertainty.  The Company accrues the loss contingency as a charge to income if it is probable and the amount of the loss can be reasonably estimated.  The Company did not record a loss contingency reserve in the first quarters of fiscal 2011 and 2010.

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Indemnification Obligations

In the normal course of business, the Company provides 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 its products or services.  The Company accrues 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, the Company is unable to estimate the maximum potential impact of these indemnifications on its future results of operations.  As permitted under California law and in accordance with its Bylaws and certain other commitments and agreements, the Company indemnifies its officers, directors and members of its senior management against certain claims and liabilities, subject to certain limits, while they serve at its request in such capacity.  The maximum amount of potential indemnification is unknown and potentially unlimited; however, the Company has D&O liability insurance that enables it to recover a portion of future indemnification claims paid, subject to retentions, conditions and limitations of those policies.

Purchase Commitments

In the normal course of business, the Company enters into various purchase commitments for goods and services. Total non-cancellable purchase commitments as of June 30, 2010 were approximately $1.4 million.The purchase commitments are mainly associated to contracts with royalties related to the Company’s Roxio Consumer products and RoxioNow business.

NOTE 8 – SHARE-BASED COMPENSATION 

The Company recognizes share-based compensation expense ratably over the vesting terms of the underlying share-based awards. Share-based compensation expense was as follows (in thousands):

	Three Months Ended June 30,
	2010		2009
Marketing  and sales	$	292	$	175
Research and development		98		83
General and administrative		429		322
	$	819	$	580

NOTE 9 - COMPREHENSIVE LOSS

Components of comprehensive loss, net of tax, were as follows (in thousands):

	Three Months Ended June 30,
	2010			2009
Net loss	$	(1,068	)	$	(1,831	)
Other comprehensive loss:
Foreign currency translation gains		51			20
Comprehensive loss	$	(1,017	)	$	(1,811	)

NOTE 10 – 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.  In assessing net deferred tax assets, management considers whether it is more likely than not that some or all of the deferred tax assets will not be realized.  When the Company does not believe realization of a deferred tax asset is more likely than not, it records a valuation allowance.

The Company calculated its projected annual effective tax rate for the fiscal year ending March 31, 2011 to be 36.9%. The rate for the three months ended June 30, 2010 differs from the statutory United States federal rate of 35% due to the tax rate differential on earnings in foreign jurisdictions and reserves for uncertain tax positions.

10

During the three months ended June 30, 2010, the Company recorded an income tax (benefit) of $(0.8) million.  After considering discrete items, the effective tax rate for the three months ended June 30, 2010 was 42.1%.   The Company does not provide for U.S. income taxes on undistributed earnings of its foreign operations that are intended to be invested indefinitely outside the U.S.

As of June 30, 2010, the Company continued to have a full valuation allowance against its U.S. net deferred tax assets (with the exception of certain deferred tax liabilities related to indefinite life intangible assets) and certain foreign jurisdictions’ net deferred tax assets.

There have been no material changes to the balance of unrecognized tax benefits reported at March 31, 2010.  The Company recognizes interest and penalties related to uncertain tax positions in income tax expense.  The amount of interest and penalties accrued at June 30, 2010 is not material.  The Company estimates that there will be no material changes in its uncertain tax positions in the next 12 months.

The Company files income tax returns in the U.S. federal jurisdiction, various U.S. state jurisdictions and foreign jurisdictions.  The Company is no longer subject to U.S. federal and state income tax examination by tax authorities for years prior to fiscal year 2004.  Foreign income tax matters for significant foreign jurisdictions have been concluded for years through fiscal year 2003.

NOTE 11 – SIGNIFICANT CUSTOMER INFORMATION, SEGMENT REPORTING AND GEOGRAPHIC INFORMATION

Significant Customer Information

The following table shows the Company’s significant customers for the three months ended June 30 2010, and 2009 (in percentages):

	Percent of Total Net Revenue
	Three Months Ended June 30,
Customer	2010			2009
Navarre		19	%		22	%
Digital River		18	%		21	%
Dell		10	%		14	%
Hewlett-Packard		9	%		14	%

Net Revenue by Segment

The Company differentiates between digital media content that is created by consumers (sometimes referred to herein as “personal” content) and digital content that is professionally created for mass consumption (sometimes referred to herein as “premium” content).  Accordingly, the Company organizes its business into two reportable operating segments targeted at these different forms of content: the “Roxio Consumer Products” segment, which offers products and services related to personal content, and the “Premium Content” segment, which offers products and services related to premium content.  These segments reflect the Company’s internal organizational structure, as well as the processes by which management makes operating decisions, allocates resources and assesses performance.  The Company’s Roxio Consumer Products segment accounted for approximately 80% and 88% during the three months ended June 30, 2010 and 2009, respectively.  The Company’s Premium Content segment accounted for approximately 20% and 12% during the three months ended June 30, 2010 and 2009, respectively.

The following tables show the net revenue attributable to the Company’s two reportable segments, operating results by segment, and revenue by geographic location (in thousands):

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	Three Months Ended June 30,
Net Revenue	2010		2009
Roxio Consumer Products	$	20,421	$	22,364
Premium Content		4,979		3,163
Total net revenue	$	25,400	$	25,527

Operating Losses by Segment (in thousands)

	Three Months Ended June 30,
Operating income (loss)	2010			2009
Roxio Consumer Products	$	5,629		$	6,515
Premium Content		(956	)		(2,779	)
Unallocated operating expenses		(6,279	)		(5,234	)
Total operating losses	$	(1,606	)	$	(1,498	)

Net Revenue by Geographic Location (in thousands)

	Three Months Ended June 30,
Revenue by region	2010		2009
United States	$	18,458	$	19,864
Export
Canada		845		151
France		357		23
Germany		426		647
United Kingdom		587		436
Europe: Other		1,238		706
Japan		1,977		2,499
Singapore		1,053		622
Taiwan		162		159
Other Pacific Rim		124		236
Other International		173		184
Total net revenue	$	25,400	$	25,527

The Company sells its products and services to customers categorized geographically by each customer’s country of domicile.  International net revenue was $6.9 million and $5.6 million for the three months ended June 30, 2010 and 2009, respectively.  

NOTE 12 – RESTRUCTURING

Each reporting period, the Company evaluates its accruals for vacated facilities, exit costs and employee separation costs to ensure the accruals are still appropriate. The associated accruals may be adjusted upward or downward upon the occurrence of future triggering events. Triggering events may include, but are not limited to, changes in estimated time to sublease, sublease terms, rates, and income. Due to extended contractual obligations of certain leases and the volatility of commercial real estate markets, the Company could make future adjustments to these accruals. The following table summarizes activity in  certain accrued restructuring expenses incurred by the Company (in thousands):

	January 2009 Restructuring
	Severance & Related Costs		Other Charges (1)			Total
Balances, March 31, 2010	$	-	$	385		$	385
Payments		-		(52	)		(52	)
Balances, June 30, 2010	$	-	$	333		$	333

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(1) “Other Charges” includes facility expenses associated to restructuring activities.

During the fourth quarter of fiscal 2009, the Company initiated a restructuring of the Company’s workforce and closure of certain leased facilities.  The workforce restructuring reduced worldwide headcount by approximately 75 positions and resulted in a restructuring charge of approximately $1.1 million related to building and office consolidations and associated charges.  During the first quarter of fiscal 2010, the Company adjusted its accrual by $0.3 million due to changes in its estimates regarding applicable office subleasing markets. No adjustments were made to the January 2009 Restructuring Plan during the first quarter of fiscal 2011.

NOTE 13 – SUBSEQUENT EVENTS

On June 1, 2010, the Company and DivX, Inc. (“DivX) entered into an Agreement and Plan of Merger (the “Merger Agreement”), pursuant to which DivX and the Company will combine their businesses through the merger of DivX with a newly formed, wholly owned subsidiary of the Company (the “DivX Acquisition”).  The Company’s and DivX’s obligations to consummate the DivX Acquisition are subject to the satisfaction or waiver of customary conditions, including (1) requisite approvals of their respective shareholders, (2) the absence of any law or order prohibiting the consummation of the DivX Acquisition, (3) the declaration by the SEC of the effectiveness of the registration statement relating to the shares of the Company's common stock to be issued to DivX stockholders pursuant to the Merger Agreement, (4) the expiration or termination of applicable waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (which occurred on July 15, 2010), and (5) the absence of any material adverse effect with respect to either party during the interim period between the execution of the Merger Agreement and consummation of the DivX Acquisition.  In addition, each party’s obligation to consummate the DivX Acquisition is subject to other specified customary conditions, including (a) the accuracy of the representations and warranties of the other party, subject to an overall material adverse effect qualification, and (b) material compliance by the other party with its covenants. The Merger Agreement provides each of the Company and DivX with specified termination rights.  If the Merger Agreement is terminated under circumstances specified in the Merger Agreement, DivX will be required to pay the Company a termination fee of $8.35 million.

As of June 30, 2010, the Company incurred approximately $1.6 million in expenses in connection with the DivX acquisition.  The Company cannot currently estimate the financial effect of the DivX Acquisition, but has incurred substantial expenses since June 30, 2010, and expects to incur additional expenses before the expected closing exclusive of any costs relating to integration of DivX operations.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

This Management’s Discussion and Analysis of Financial Condition and Results of Operations and other parts of this Quarterly Report on Form 10-Q contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934.  These forward-looking statements include, but are not limited to, statements regarding:  the markets for the Company’s products and services; macroeconomic conditions; consumer and business spending; leisure and entertainment related activities and related technologies; proliferation of Internet-connected devices; the Company’s competitive position; continued popularity of the DVD format; popularity of the Blu-ray Disc (“BD”) format; market for digital distribution of premium content; impact of restructuring plans; liquidity and capital needs; gross margins; operating expenses; significant customers, major distributors and key suppliers; content licensing; impacts of the Company’s pricing strategies; acquisitions and integration of related assets, business, personnel and systems; international operations; litigation or patent prosecution; intellectual property claims; and changes in effective tax rates.  These forward-looking statements are subject to risks and uncertainties that could cause actual results and events to differ.  Risks that may affect the Company’s operating results include, but are not limited to, those discussed in “Item 1.A Risk Factors” of this Quarterly Report on Form 10-Q and the “Risk Factors” section of the Fiscal 2010 Form 10-K.  Readers should carefully review the risk factors described in these filings and in other documents that the Company files from time to time with the SEC.

Overview of Business

The Company is a leading developer of products and services that enable the creation, management, and enjoyment of digital media content across a wide variety of technology platforms.  The Company’s products and services offer innovative technologies to consumers, original equipment manufacturers (“OEMs”), businesses, high-end professional DVD authoring experts and developers.  The Company distributes its products and services through retailers and distributors, personal computer (“PC”) and consumer electronic (“CE”) OEMs, Internet websites including www.roxio.com, and other channels.  The Company also licenses core technology and intellectual property to other software companies and technology manufacturers for integration into their own products and services.  Sonic software is intended for use with Microsoft Windows and Apple Mac operating systems, as well as some Linux environments and proprietary platforms.

Sonic products and services are used to accomplish a wide variety of tasks, including creating and distributing digital audio and video content in a variety of formats; renting, purchasing and enjoying Hollywood movies and other premium content; producing digital media photo and video shows for sharing online and via television, PCs and CE devices; recording and playback of digital content on DVD, BD, other storage media and portable devices; managing digital media on PCs and CE devices; and backing up and preserving digital information, both to local storage devices and on the Internet.

The Company differentiates between digital media content that is created by consumers (sometimes referred to herein as “personal” content) and digital content that is professionally created for mass consumption (sometimes referred to herein as “premium” content).  Accordingly, the Company organizes its business into two reportable operating segments targeted at these different forms of content:  the “Roxio Consumer Products” segment, which offers products and services related to personal content, and the “Premium Content” segment, which offers products and services related to premium content.  These segments reflect the Company’s internal organizational structure, as well as the processes by which management makes operating decisions, allocates resources and assesses performance.

Roxio Consumer Products Segment

The Roxio Consumer Products segment creates software and services that enable consumers to easily create, manage, and share personal digital media content on and across a broad range of connected devices.  A wide array of leading technology companies and developers rely on Roxio products, services and technologies to bring innovative digital media functionality to PCs and next-generation CE devices and platforms.  The Roxio Consumer Products segment offers products and services under a variety of names, including BackonTrack, Backup MyPC, CinePlayer, Crunch, Just!Burn, MyDVD, MyTV To Go, PhotoShow, PhotoSuite, Popcorn, RecordNow, Roxio Burn, Roxio Copy & Convert, Roxio Creator, Roxio Easy LP to MP3, Roxio Easy VHS to DVD, Toast, VideoWave, WinOnCD, and others.  These products are sold in a number of different versions and languages.  The Company distributes these products through various channels, including “bundling” arrangements with OEMs, volume licensing programs, its web store, and third party web-based and “bricks and mortar” retail stores.  The Company also markets the core technology that powers Roxio products to other companies who wish to build their own PC software products.

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Premium Content Segment

The Premium Content segment offers a range of products and services related to the creation, distribution and enjoyment of premium content.  As part of this segment, the Company also sells, rents and distributes premium entertainment content to consumers over the Internet under RoxioNow branding (in this Quarterly Report, this service may be referred to as the “RoxioNow Service”).  Also within this segment, the Professional Products Group offers software under the Scenarist, CineVision, and DVDit product names as well as under the Sonic and Roxio Professional brands to major motion picture studios, high-end authoring houses and other professional customers.  The Company also develops software components that it licenses to CE companies to enable their devices to offer premium content to consumers, and licenses intellectual property, including patents.

Recent Trends & Events

Due to the proliferation of computer technology, broadband Internet connectivity and personal electronic devices of all kinds, digital media content is now everywhere.  The Company’s products and services enable people to create, manage, enjoy and distribute premium and personal digital content, allowing them to organize and share their digital lives and memories in new and innovative ways.  The Company’s strategy is to utilize its technology, expertise and competitive positioning to deliver exciting products and services to enhance the value of digital media in people’s lives.  The Company faces evolving trends in the technology industry that can provide opportunities as well as potential risks, including:

· Optical Disc Playback Evolution – Optical disc technologies have enjoyed tremendous growth and extremely widespread consumer adoption, but they tend to evolve, mature and change rapidly.  For example, multiple DVD playback units (including set-top players, game consoles and PCs) are present in most households, but DVD sales are now falling as consumers have begun to embrace online alternatives, as well as new formats such as BD.  Sales of BD units and players have been growing rapidly, but the growth of the BD format has not yet fully compensated for the recent drop in DVD sales.  Other technological trends and events can also impact the demand for the Company’s digital media products and services.  For example, as new operating systems are introduced (for example, Windows 7 in October 2009), consumers are offered new tools for editing, formatting and burning digital media, and there are opportunities for software vendors such as the Company to provide products that are complementary to the new operating systems.

· Growth of Digital Distribution of Premium Content – Content owners, such as Hollywood studios, are increasingly offering sell-through and rental of premium content through digital distribution.  Simultaneously, a growing number of consumers are enjoying and taking advantage of the benefits of digital distribution of premium content.  As more Internet-enabled electronic devices offer delivery of premium content, the rate of adoption and number of title offerings should continue to increase.

· Digital Phone, Portable and Gaming Devices – Consumer usage of mobile phones, gaming consoles and portable CE devices, particularly those with high-end digital media capabilities, continues to increase worldwide.  The growing popularity of portable devices leads to greater demand for software products and services, such as those offered by the Company, that provide digital media management and functionality.

· Growth of Online Social Networks – Online social networks, such as Facebook and MySpace, increasingly feature personal digital photo, video and audio content, and these networks function as distribution platforms for sharing and enjoying digital media content.  The rising popularity of these networks and their platforms creates an increased demand for products and services that can capture, create, edit and manage digital media.

Proposed Acquisition of DivX.  On June 1, 2010, the Company and DivX entered into an Agreement and Plan of Merger (the “Merger Agreement”), pursuant to which DivX and the Company will combine their businesses through the merger of DivX with a newly formed, wholly owned subsidiary of the Company (the “DivX Acquisition”).At the effective time of the DivX Acquisition (the “Effective Time”), each share of DivX common stock issued and outstanding immediately prior to the Effective Time will be converted into the right to receive 0.514 shares of the Company’s common stock and $3.75 in cash.  The Merger Agreement contains customary representations, warranties and covenants of the Company and DivX including, among others, covenants (1) to use commercially reasonable efforts to conduct their respective businesses in the ordinary course during the interim period between the execution of the Merger Agreement and consummation of the DivX Acquisition, (2) not to engage in specified types of transactions during such period, and (3) not to solicit proposals relating to alternative business combination transactions or, subject to specified exceptions, enter into discussions or provide confidential information in connection with proposals for alternative business combination transactions.

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The Company’s and DivX’s obligations to consummate the DivX Acquisition are subject to the satisfaction or waiver of customary conditions, including (1) requisite approvals of their respective shareholders, (2) the absence of any law or order prohibiting the consummation of the DivX Acquisition, (3) the declaration by the SEC of the effectiveness of the registration statement relating to the shares of the Company's common stock to be issued to DivX stockholders pursuant to the Merger Agreement, (4) the expiration or termination of applicable waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (which occurred on July 15, 2010), and (5) the absence of any material adverse effect with respect to either party during the interim period between the execution of the Merger Agreement and consummation of the DivX Acquisition. In addition, each party’s obligation to consummate the DivX Acquisition is subject to other specified customary conditions, including (a) the accuracy of the representations and warranties of the other party, subject to an overall material adverse effect qualification, and (b) material compliance by the other party with its covenants.

The Merger Agreement provides each of the Company and DivX with specified termination rights.  If the Merger Agreement is terminated under circumstances specified in the Merger Agreement, DivX will be required to pay the Company a termination fee of $8.35 million.  See Part II, Item 1A, “Risk Factors” of this Quarterly Report on Form 10-Q and the “Risk Factors” section of the Fiscal 2010 Form 10-K for a discussion of the risks associated with the Company’s failure to close the DivX Acquisition and factors that impact the Company’s ability to successfully integrate DivX’s operations into its existing business.

Strategic Objectives

Enable Consumers to Buy and Play Premium Content Anywhere and at Anytime.  The Company believes that digital distribution of premium content will grow dramatically over the next few years, and that ultimately industry revenue from the digital distribution of premium content may surpass revenue from the sale and rental of premium content on optical media such as DVD and BD.  The Company has put substantial effort into its RoxioNow Service initiatives, as it believes that this area may offer a strong opportunity for counterbalancing the recent decline in DVD sales and the adverse impact of that trend on the Company’s operating results.  As the digital content ecosystem continues to expand and evolve, the Company aims to make its products and services available through an increasing range of platforms, devices and partners, with the goal that the Company’s technology will represent a symbol of compatibility and a common point of interaction for consumers who want to enjoy Hollywood movies and other premium digital content anywhere and anytime.

Develop and strengthen Roxio-branded products and services.  The Company seeks to build on the brand strength of its Roxio products and services by strengthening its relationships with OEMs and retail partners, while deepening its relationship with consumers by adding new products and services.  The Company continues to utilize its knowledge and expertise to develop and introduce products and services relating to new formats such as BD, and believes that these efforts will assist it in offsetting price pressure and declining sales associated with the DVD format.  Additionally, the Company plans to continue to enhance its Web-based offerings, add innovative solutions to its consumer product portfolio and extend the reach of the Roxio brand to a new audience of online users.

Outlook

While the continuing global economic downturn and the maturation of the DVD format have adversely impacted the Company’s business and financial results during recent periods, the Company believes that the digital distribution of premium content is poised to enjoy commercial success, and that its RoxioNow Service initiatives provide it with a strategic opportunity to grow its business rapidly in this area.  The Company further believes that it is well positioned to capitalize on its strong brand name, consumer market position, and OEM relationships as digital media formats such as BD continue to evolve.  The Company plans to continue to make significant strategic and financial progress during fiscal 2011 to keep costs in line with revenues while positioning the Company for revenue growth and margin improvement.

International Locations and Revenue

The Company is headquartered in Novato, California, and has sales and marketing offices in North America, Europe, Japan, China, Taiwan, Singapore and remote offices in a number of locations around the world.  In the three months ended June 30, 2010 and 2009, approximately 73% and 78% of net revenue was attributable to domestic sales while 27% and 22% of net revenue was attributable to international sales, respectively.  In the future, the Company may expand its operations, professional services and direct sales force abroad, thereby incurring additional operating expenses and capital expenditures.

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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

There have been no material changes in the Company’s critical accounting policies and estimates during the three months ended June 30, 2010 compared to those described in the Company’s Fiscal 2010 Form 10-K.

RESULTS OF OPERATIONS

Comparison of the Three Months Ended June 30, 2010 and 2009

The following table sets forth certain items from the Company’s statements of operations as a percentage of net revenue:

	Three Months Ended June 30,
	2010			2009
Net revenue		100	%		100	%
Cost of revenue		30	%		31	%
Gross profit		70	%		69	%
Operating expenses:
Marketing and sales		28	%		26	%
Research and development		23	%		28	%
General and administrative		19	%		19	%
Restructuring		0	%		2	%
DivX acquisition costs		6	%		0	%
Total operating expenses		76	%		75	%
Operating loss		(6	)%		(6	)%
Other income (expenses)		(1	)%		1	%
Loss before income taxes		(7	)%		(5	)%
Provision for (benefit of) income taxes		(3	)%		2	%
Net loss		(4	)%		(7	)%

Net Revenue Comparison of Three Months Ended June 30, 2010 and 2009

The following table is a comparison of net revenue by segment (in thousands other than percentages):

	Three Months Ended June 30,				2010 to 2009
Net Revenue	2010		2009		Inc (Dec)			% Change
Roxio Consumer Products	$	20,421	$	22,364	$	(1,943	)		(9	)%
Premium Content		4,979		3,163		1,816			57	%
Total net revenue	$	25,400	$	25,527	$	(127	)		(0	)%

Net revenue decreased by $0.1 million to $25.4 million for the three months ended June 30, 2010, from $25.5 million for the three months ended June 30, 2009.  The decrease in net revenue for the three months ended June 30, 2010 included a decrease of $1.9 million or 9% in Roxio Consumer Products which was offset by an increase of $1.8 million or 57% in Premium Content net revenue.  The Roxio Consumer Products segment experienced a $1.6 million reduction in OEM bundling revenue due to changes in product mixes, per-unit pricing pressure, and lower unit volumes, plus a $0.8 million reduction in sales through the Company’s web store channel as a result of extending the Toast product life cycle, along with the fact that the three months ended June 30, 2009 included the benefit of the release of the Roxio Easy VHS to DVD products.  The decrease in Roxio Consumer Products net revenue was partially offset by $0.5 million generated through retail sales due to fewer active discount programs and lower returns during the three months ended June 30, 2010, offset by lower unit sales.

The increase in Premium Content net revenue included an additional $1.0 million generated through the RoxioNow Service along with $0.8 million from services associated with the RoxioNow format adoption.  Also contributing to the increase in Premium Content revenue is $0.8 million in technology licensing revenue from several CE manufacturers.  The increase in Premium Content net revenue was partially offset by a $0.6 million reduction in professional products revenue resulting from continued global economic weakness affecting consumer demand and corporate spending.

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The following tables set forth a comparison of net revenue geographically (in thousands other than percentages):

	Three Months Ended June 30,
Net Revenue	2010		2009		Inc (Dec)			%
United States	$	18,458	$	19,864	$	(1,406	)		(7	)%
Export
Canada		845		151		694			460	%
France		357		23		334			1452	%
Germany		426		647		(221	)		(34	)%
United Kingdom		587		436		151			35	%
Other European		1,238		706		532			75	%
Japan		1,977		2,499		(522	)		(21	)%
Singapore		1,053		622		431			69	%
Taiwan		162		159		3			2	%
Other Pacific Rim		124		236		(112	)		(47	)%
Other International		173		184		(11	)		(6	)%
Net revenue	$	25,400	$	25,527	$	(127	)		(0	)%

Domestic sales accounted for 73% and 78% of net revenue for the three months ended June 30, 2010 and 2009, respectively.  The decrease in domestic revenue included a reduction in OEM bundling revenue of $2.4 million due to changes in product mixes, per-unit pricing pressure, and lower unit volumes.  This decrease was partially offset by $1.0 million generated through the RoxioNow Service.

International sales accounted for $6.9 million and $5.6 million, or 27% and 22% of net revenue for the three months ended June 30, 2010 and 2009, respectively.  The increase in international sales partially resulted from a $0.6 million one-time technology licensing contract with a Canadian CE manufacturer, along with a $0.4 million increase in royalty revenue from a Singapore OEM customer as a result of increased shipments.  Also contributing to the increase in international sales was $0.8 million from a one-time development contract associated with the delivery of Roxio Content for a customer in Ireland, off-set by $0.1 million in Switzerland revenue related to a CE development contract that was completed during fiscal year 2010.  These contracts were classified in Other European revenue.  The increase in international sales was partially offset by a $0.5 million reduction in Japan revenue due to fewer technology licensing contracts and a reduction in professional products revenue.

Significant Customers

The following table reflects sales to significant customers as a percentage of total net revenue and the related accounts receivable as a percentage of total receivables (in percentages):

	% of Total Net Revenue						% of Total Accounts Receivable
	Three Months Ended June 30,						Three Months Ended June 30,
Customer	2010			2009			2010			2009
Navarre		19	%		22	%		15	%		40	%
Digital River		18	%		21	%		11	%		12	%
Dell		10	%		14	%		4	%		8	%
Hewlett-Packard		9	%		14	%		14	%		0	%

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No other customer accounted for more than 10% of the Company’s revenue for the three months ended June 30, 2010 and 2009, respectively.  The Company sells products to Dell and Hewlett-Packard pursuant to individual supplements, exhibits or other attachments that are appended to the standard terms and conditions the Company has negotiated with each of these customers.  These standard terms and conditions include provisions relating to the delivery of the Company’s products, the customer’s distribution of these products, representations by the Company with respect to the quality of the products and the Company’s ownership of the products, obligations by the Company to comply with law, confidentiality obligations, and indemnification by the Company for breach of its representations or obligations.  The underlying agreements generally renew for one year periods, subject to annual termination by either party or termination for breach.  Under each agreement, the OEM has the sole discretion to decide whether to purchase any of the Company’s products.  The agreements are non-exclusive and do not contain any minimum purchase obligations or similar commitments.  The loss of Dell, Hewlett-Packard, or any other major customer would have a material adverse effect on the Company, if it were unable to replace that customer.

Revenue recognized from Digital River was pursuant to a reseller arrangement, and revenue recognized from Navarre was pursuant to a distribution arrangement.  The Digital River agreement covers the electronic delivery of Company software and the creation and maintenance of the shopping cart process for the Company’s online stores; the Navarre agreement provides for both physical and electronic delivery, and under both consignment and direct sale models.  The Company provides products to Digital River and Navarre pursuant to agreements with standard terms and conditions including provisions relating to the delivery of the Company’s products, distribution of these products, representations by the Company with respect to the quality of the products and the Company’s ownership of the products, obligations by the Company to comply with law, confidentiality obligations, and indemnification by the Company for breach of its representations or obligations.  The agreements generally renew for one-year periods, subject to annual termination by either party as well as other termination provisions, such as termination for breach.  The agreements are non-exclusive and do not contain any minimum purchase obligations or similar commitments.

It is impracticable for the Company to report the net revenues by significant customer per business segment for the three months ended June 30, 2010, and 2009, as some of the these customers may be in both segments.

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 and services, 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.  The following table reflects cost of revenue (in thousands other than percentages):

	Three Months Ended June 30,				2010 to 2009
	2010		2009		Inc (Dec)			% Change
Roxio Consumer Products	$	5,013	$	6,079	$	(1,066	)		(18	)%
Premium Content		2,660		1,806		854			47	%
Cost of revenue	$	7,673	$	7,885		(212	)		(3	)%

The Company’s overall cost of revenue as a percentage of net revenue decreased to 30% of net revenue for the three months ended June 30, 2010 from 31% for the three months ended June 30, 2009.  Roxio Consumer Products cost of revenue as a percentage of Roxio Consumer Products net revenue decreased to 25% for the three months ended June 30, 2010 compared to 27% for the three months ended June 30, 2009.  The lower cost of revenue percentages were driven by a 4% decrease in cost of revenue resulting from lower product costs due to lower retail sales and better pricing on certain promotional items within the Company’s products.  This was partly offset by a 2% increase in cost of revenue resulting from technical support costs caused by the addition of new product offerings.

Premium Content cost of revenue as a percentage of Premium Content net revenue decreased to 53% for the three months ended June 30, 2010 compared to 57% for the three months ended June 30, 2009. The lower cost of revenue percentages were driven by a 9% decrease in cost of revenue resulting from lower professional costs in royalties, product costs, technical support, and operations due to the Company’s restructuring activities and lower sales.  This was partly offset by a 5% increase in cost of revenue resulting from additional operational, royalty, development, and content costs associated with the RoxioNow Service.

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Operating Expenses for the Three Months Ended June 30, 2010 and 2009

Marketing and Sales

Marketing and sales expenses include salaries, benefits, sales commissions and share-based compensation expense for marketing and sales employees, promotions and incentive programs aimed to generate revenue such as advertising, trade shows, travel related costs, and facility costs related to marketing and sales personnel.  The following table reflects the Company’s marketing and sales operating expenses (in thousands other than percentages):

	Three Months Ended June 30,
	2010			2009			Increase (Decrease)
Marketing and sales expenses	$	7,102		$	6,754		$	348
Percentage of net revenue		28	%		26	%		2	%

Marketing and sales expenses increased by 5% for the three months ended June 30, 2010 compared to the same period in the prior year.  During the three months ended June 30, 2010, marketing and sales expenses as a percentage of net revenue increased 2% to 28% from 26% for the three months ended June 30, 2010 and 2009, respectively.

The increase during the three months ended June 30, 2010 compared to the same period in the prior year is due to increases in personnel related expenses of $0.3 million, and $0.2 million in travel related expenses, offset by a decrease of $0.2 million in facilities and other expenses.

The Company expects to continue to invest in marketing and sales of its products and services to develop market opportunities and promote its offerings while continuing to monitor its needs to reduce operating expenses to align with the Company’s financial condition.  In this effort, the Company experienced an increase in personnel related expenses as well as in travel related expenses due to increased efforts to expand and attract new customers and to maintain existing customers.  In the Company’s ongoing efforts to monitor costs and reduce operating costs, it was able to reduce facility costs related to building rent and telecommunication costs which contributed to the $0.2 million reduction in facilities and other expenses for marketing and sales.

Research and Development

Research and development expenses include salaries, benefits, share-based compensation expenses for engineers, contracted development efforts, facility costs related to engineering personnel, and expenses associated with equipment used for development.  The following table reflects the Company’s research and development operating expenses (in thousands other than percentages):

	Three Months Ended June 30,
	2010			2009			Increase (Decrease)
Research and development expenses	$	5,933		$	7,114		$	(1,181	)
Percentage of net revenue		23	%		28	%		(5	)%

Research and development expenses decreased by 17% for the three months ended June 30, 2010 compared to the same period in the prior year.  During the three months ended June 30, 2010, research and development expenses as a percentage of net revenue decreased 5% to 23% from 28% for the three months ended June 30, 2009.

The decrease for the three month period ended June 30, 2010, as compared to the same period in the prior year, includes a decrease in personnel related expenses of $1.1 million.  The decrease in personnel related expenses is attributable to a headcount reduction of approximately 13 persons as compared to the same period in the first quarter of 2010, as well as a reduction in outside consulting services, and a larger portion of the engineering time spent in the production and support of revenue-generating products and services which are reclassified to cost of revenue.

General and Administrative

General and administrative expenses include salaries, benefits, share-based compensation, outside consulting services, travel expenses, legal costs including loss contingency reserves, facility costs for finance, facilities, human resources, legal, information services and executive personnel.  The following table reflects the Company’s general and administrative operating expenses (in thousands other than percentages):

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	Three Months Ended June 30,
	2010			2009			Increase (Decrease)
General and administrative expenses	$	4,680		$	4,752		$	(72	)
Percentage of net revenue		18	%		19	%		(1	)%

General and administrative expenses decreased by 2% for the three months ended June 30, 2010 compared to the same period in the prior year.  During the three months ended June 30, 2010, general and administrative expenses as a percentage of net revenue decreased 1% to 18% from 19% for the three months ended June 30, 2010 and 2009, respectively.

Acquisition Costs

On June 1, 2010, the Company executed a Merger Agreement with DivX, as described above under “Proposed Acquisition of DivX.”  The Company currently expects to close the DivX Acquisition in September or October 2010, subject to the conditions described above.  The Merger Agreement does not contain a condition that allows the Company not to close if it does not obtain financing, as the Company expects to finance the cash portion of the consideration for the DivX Acquisition from the financial resources of DivX.  As of June 30, 2010, the Company incurred approximately $1.6 million in expenses in connection with the DivX acquisition.  The Company expects to incur additional expenses before the expected closing, exclusive of any costs relating to the integration of DivX operations.

Restructuring

Restructuring expenses consist primarily of one-time termination benefits such as severance and other employee related costs, contract termination costs related to facility expenses, and other associated costs.  The Company did not incur any restructuring expenses for the three months ended June 30, 2010 compared to $0.5 million for the three months ended June 30, 2009.  At each reporting period, the Company evaluates its accruals for vacated facilities, exit costs and employee separation costs to ensure the accruals are still appropriate.  There were no adjustments during the first quarter of fiscal 2011.

Provision (Benefit) for Income Taxes

The provision (benefit) for income taxes for the three months ended June 30, 2010 was $(0.8) million compared to a tax expense of $0.5 million for the three months ended June 30, 2009.  The Company calculated its projected annual effective tax rate for the year ending March 31, 2011 to be 36.9% compared to (60.9%) for the fiscal year ended March 31, 2010.  The projected annual effective tax rate for the year ending March 31, 2011 differs from the statutory United States federal rate of 35% due to the tax rate differential on earnings in foreign jurisdictions and reserves for uncertain tax positions.  The annual effective tax rate for the year ended March 31, 2010 differed from the statutory United States federal rate of 35% due to losses that were not more likely than not to be realizable and the tax rate differential on earnings in foreign jurisdictions.

Non-Operating Income for the Three Months Ended June 30, 2010 and 2009

Interest Income and Interest Expense, Net

Interest income includes interest earned on cash balances and long-term investments.  Interest income was $16 thousand and $41 thousand for the three months ended June 30, 2010 and 2009, respectively.  The decline in interest income is related to the decline in interest rates.

Interest expense relates to the finalization of tax audits.  Interest expense was $42 thousand and $10 thousand for the three months ended June 30, 2010 and 2009, respectively.

Other Income (Expense), Net:

The Company recorded $0.2 million of other expense for the three months ended June 30, 2010 as compared to $0.1 million of other income for the three months ended June 30, 2009.  This change was due to foreign exchange fluctuations.

21

LIQUIDITY AND CAPITAL RESOURCES

Cash and Cash Equivalents (in thousands other than percentages)

	June 30,		March 31,
	2010		2010		Inc (Dec)		Inc (Dec) %
Cash and cash equivalents	$	54,861	$	54,536	$	325		1	%
Working capital	$	40,232	$	39,439	$	793		2	%

As of June 30, 2010, the principal sources of liquidity include cash and cash equivalents of $54.9 million and net trade accounts receivable of $11.9 million. As of June 30, 2010, the Company had working capital of $40.2 million compared with working capital of $39.4 million at March 31, 2010. The increase in working capital of $0.8 million was due to a $0.7 million decrease in allowances related to the Company’s accounts receivable. The allowance pertains to the Company’s product returns, discounts and doubtful accounts. The Company’s distributor and retail arrangements provide for certain discounts, product rotation rights and permit certain product returns.  The Company estimates reserves for these rights of return based on historical return rates, timing of new product releases, and channel inventory levels.  Additionally, the Company maintains an allowance for doubtful accounts to reserve for potentially uncollectible accounts based on past collection history and specific risks identified in its portfolio of receivables.

The Company believes that existing cash and cash equivalents and cash generated from operations will be sufficient to meet its cash requirements for at least the next twelve months. The Company’s liquidity is affected by various risks and uncertainties, including, but not limited to, the risks detailed in “Risk Factors” section of the Fiscal 2010 Form 10-K.

Statement of Cash Flows Discussion

	June 30,			June 30,
(in thousands other than percentages)	2010			2009			Inc (Dec)			Inc (Dec) %
Net cash provided by (used by) operating activities	$	801		$	4,688		$	(3,887	)		(83	)%
Net cash provided by (used by) investing activities	$	(477	)	$	(99	)	$	(378	)		382	%
Net cash provided by (used by) financing activities	$	(57	)	$	(13	)	$	(44	)		338	%

Net cash provided by operating activities was $0.8 million for the three months ended June 30, 2010 as compared to net cash provided by operating activities of $4.7 million for the same period in the prior year.  The decline in cash provided by operating activities is due to an increase in accounts receivable of $3.7 million as a result of invoices being billed for certain development contracts at the end of the quarter, as well as timing of payments.

Net cash used in investing activities was $0.5 million for the three months ended June 30, 2010 as compared to net cash used in investing activities of $0.1 million for the same period in the prior year.  Net cash used in investing activities increased due to the purchase of fixed assets and intangible assets of $0.4 million for the three months ended June 30, 2010. The Company purchased $0.2 million in fixed assets which consisted of information techonology hardware purchases as well leasehold improvements as a result of an expansion of one of the Company’s offices. The increase in intangible assets is a result of a several transactions whereby the Company acquired groups of assets, as it was not purchasing self-sustaining integrated sets of activities and assets.

Net cash used in financing activities was $0.1 million for three months ended June 30, 2010 compared to net cash used in financing activities of $13 thousand for the same period in the prior year.  Upon vesting, RSUs are generally net share-settled to cover the required withholding tax and the remaining amount is converted into an equivalent number of shares of common stock.  RSUs vested during the first quarter of fiscal 2011 and 2010 were net-share settled such that the Company withheld shares with value equivalent to the employees’ minimum statutory obligation for the applicable income and other employment taxes, and remitted the cash to the appropriate taxing authorities.  Total payments for the employees’ tax obligations to the taxing authorities were $0.2 million and $18 thousand during the first quarter of fiscal 2011 and 2010, respectively.  These net-share settlements had the effect of share repurchases by the Company as they reduced the number of shares that would have otherwise been issued as a result of the vesting and did not represent an expense to the Company.

The Company believes its cash balances and cash flows generated by operations will be sufficient to satisfy its anticipated cash needs for working capital and capital expenditures for at least the next 12 months.  The Company expects that its actions to reduce operating expenses will allow it to generate operating cash flows sufficient to sustain operations, and to offset, in whole or in part, the potential impact of a decrease in future revenues.  However, the Company may require additional cash to fund acquisitions or investment opportunities.  In these instances, the Company may seek to raise such additional funds through public, private equity, debt financing, or from other sources.  The Company may not be able to obtain adequate or favorable financing at that time.  Any equity financing the Company may obtain may dilute existing ownership interests and any debt financing could contain covenants that impose limitations on the conduct of its business.

22

Off-Balance Sheet Arrangements  

The Company does 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 the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company has global operations and thus makes investments and enters into transactions in various foreign currencies.  The value of the Company’s consolidated assets and liabilities located outside the United States (translated at period end exchange rates) and income and expenses (translated using average rates prevailing during the period), are affected by the translation into the Company’s reporting currency (the U.S. Dollar).  Such translation adjustments are reported as a separate component of comprehensive income.  In future periods, foreign exchange rate fluctuations could have an increased impact on the Company’s reported results of operations.

Foreign currency fluctuations for the three months ended June 30, 2010 compared to March 31, 2010 remained consistent.  The Company’s market risk sensitive instruments were all entered into for non-trading purposes.  The Company does not engage in any hedging activities and does not use derivatives or equity instruments for cash investment purposes.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of the Company’s management, including its Chief Executive Officer (“CEO”) and its Chief Financial Officer (“CFO”), the Company conducted an evaluation of its disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act, as of the end of the period covered by this Quarterly Report on Form 10-Q. Based upon that evaluation, the CEO and the CFO have concluded that the design and operation of the Company’s disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and (ii) is accumulated and communicated to its management, including its CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

Changes to Internal Control over Financial Reporting

There were no changes to the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the period covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, its internal control over financial reporting.

PART II - OTHER INFORMATION

 ITEM 1. LEGAL PROCEEDINGS

See “Note 7 – Commitments and Contingencies” to the unaudited Condensed Consolidated Financial Statements included in this Quarterly Report.

ITEM 1A. RISK FACTORS 

There have been no material changes in information to the Risk Factors previously described in Part I, Item 1A of the Company’s Fiscal 2010 Form 10-K.  

23

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.

24

 SIGNATURES

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 6th  day of August, 2010.

SONIC SOLUTIONS
/s/ David C. Habiger	August 6, 2010
David C. Habiger President and Chief Executive Officer (Principal Executive Officer)
/s/ Paul F. Norris	August 6, 2010
Paul F. Norris Executive Vice President, Chief Financial Officer and General Counsel (Principal Financial/Accounting Officer)

25

EX-31.1

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 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 report;

3. Based on my knowledge, the financial statements, and other financial information included in this 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 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 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 report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this 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.

August 6, 2010
	/s/ David C. Habiger
	David C. Habiger
	President and Chief Executive Officer

EX-31.2

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 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 report;

3. Based on my knowledge, the financial statements, and other financial information included in this 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 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 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 report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this 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.

August 6, 2010
	/s/ Paul F. Norris
	Paul F. Norris
	Executive Vice President,
	Chief Financial Officer and General Counsel

EX-32.1

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 the Company on Form 10-Q for the period ended June 30, 2010 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.

Date: August 6, 2010
By:	/s/ David C. Habiger
Name: David C. Habiger
Title: President and Chief Executive Officer

EX-32.2

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 the Company on Form 10-Q for the period ended June 30, 2010 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Paul F. Norris, 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.

Date:	August 6, 2010
By:	/s/ Paul F. Norris
Name: Paul F. Norris
Title: Executive Vice President,
Chief Financial Officer and General Counsel