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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, if professional revenue generated in the last few weeks of a quarter or year do not meet our forecast, or if large license agreements are not finalized when forecasted.
Restatement and Related Proceedings
Restatement of Consolidated Financial Statements
We have restated our consolidated balance sheet as of March 31, 2006, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the fiscal years ended March 31, 2005 and March 31, 2006.
We have also restated the unaudited quarterly financial information and condensed financial statements for interim periods of fiscal year 2006, and the unaudited condensed financial statements for the quarters ended June 30, 2006 and September 30, 2006. These restatements reflect (a) additional cash and non-cash 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.
Effective October 1, 2006, we changed our method of recognizing OEM royalty revenue. We applied this change in accounting policy retrospectively to the fiscal year ended March 31, 2006, and the fiscal quarters ended June 30, 2006 and September 30, 2006, but determined that it was not practicable to apply the change to prior periods.
Stock Options Accounting
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 the present (the “Review Period”).
The review included all stock options granted during the Review Period, as well as certain already-outstanding options that were repriced at the commencement of the Review Period. In all, the review covered a total of approximately 2,300 stock option grants encompassing approximately 14 million shares of common stock under a total of seven stock option plans, and representing option grants to our directors, founders, officers and other employees (and including, among others, grants to newly-hired employees, individual or group performance awards, grants awarded in connection with acquisitions, and a limited number of grants to contractors).
During the course of the review, legal counsel to the Audit Committee, with the assistance of outside consultants, collected, processed and analyzed physical and electronic Company documents and records, including hard copy files, networked electronic documents and the computer hard drives of Company personnel who were involved in the administration of our stock option programs. Counsel to the Audit Committee was further assisted by an independent consulting firm engaged to assist in the collection, processing and analysis of options-related documentation. In all, approximately 665,000 electronic documents were collected and processed, and approximately 215,000 electronic documents and 35,000 pages of paper documents were reviewed. In addition, counsel conducted interviews of various Company personnel.
Supplementing the activities performed by and on behalf of the Audit Committee, our management engaged in a detailed process of compiling, analyzing and assessing the information available to it relating to our granting of stock options and administration of stock option plans during the Review Period. Information
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reviewed included, without limitation, documentation related to acquisitions and other transactions completed by us, public filings (by us and by individual grant recipients), board minutes and written consents, spreadsheets and databases used to memorialize and maintain option-related information, email communications and other transmittals of information to and from outside accountants, payroll information, standard forms used to record decisions regarding hiring and termination of employees and related salary and option grant decisions known as Employee Action Forms (“EAFs”), grant notices, offer letters, option statements, tax records, personnel files and other information.
With assistance from the independent consulting firm and input from the Audit Committee and its advisors, as well as based upon discussions with our independent auditors, our management created and maintained an extensive group of spreadsheets showing all options-related issuances, exercises and related data.
Based on the results of the review, we have concluded that a substantial number of stock options granted during the Review Period were not correctly accounted for in accordance with accounting principles generally accepted in the United States applicable at the time those grants were made. As a result, we are restating our historical financial statements to record adjustments for additional share-based compensation expense relating to past stock option grants in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123R (revised 2004), “Share-Based Payment,” and Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees,” and related payroll taxes, penalties, and other related amounts, to record additional share-based compensation expense associated with options granted to consultants and to record additional adjustments that were previously considered to be immaterial.
The review also identified less frequent errors in other categories including: grants to non-employees for which an incorrect amount of share-based compensation expense had been recognized, grants cancelled after the expiration date, and exercises occurring before vesting and after expiration. These errors were also addressed and reflected in the restatement of our historical financial statements.
Audit Committee Conclusions
Lack of Contemporaneous Grant Documentation; Focus on Quarterly Financial Reporting
For a large portion of options issued by us, particularly prior to September 23, 2005 (other than with respect to certain categories of options such as founder grants, director grants, grants issued associated with acquisitions, or grants issued as part of certain programs), there is little or no contemporaneous grant-specific documentation that satisfies the requirements for “measurement dates” under APB No. 25 and that would allow us to maintain the original grant date used for accounting purposes (the “Record Date”). Much of the transaction-specific documentation that was available in our records was unhelpful in establishing the date on which all required APB No. 25 elements were satisfied. For example, option grant agreements were typically dated “as of” with no separate date for the signature of a Company officer, and Company personnel indicated that these agreements were typically generated as part of the end-of-quarter reporting cycle, notwithstanding the Record Date appearing on the documents themselves.
Stock options were considered to be a routine part of employee compensation at the Company and, given this and the informal nature of our processes in general, it appears that insufficient attention was devoted to ensuring that grant documentation was prepared or finalized by the Record Date. Instead, while individual grants were identified and/or committed to on an ongoing basis, grant documentation was typically assembled and finalized in anticipation of quarterly SEC filings.
Our former Chief Executive Officer (“CEO”), to whom authority to make grants to employees other than executive officers had been delegated until September 23, 2005, indicated that he and others involved in the option granting process focused on the quarterly financial reporting cycle as the primary driver of decisions and completion of associated documentation regarding the granting of options. These decisions were recorded in spreadsheets which were then used to generate option tables for financial statement footnotes as well as diluted share counts for our financial statements. These spreadsheets (the “Periodic Spreadsheets”), were sent to an outside accounting firm to perform the necessary calculations as we prepared our quarterly and annual filings and remained subject to change until the point of transmittal.
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In early 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. Thereafter, at a meeting of our board of directors held on September 23, 2005, the board adopted a resolution creating an employee options subcommittee of the compensation committee comprised of our CEO and Chief Financial Officer (“CFO”). The purpose of the employee options subcommittee was to: serve as administrator for our various option plans (except for option awards to executive officers and to members of our board of directors, which awards are subject to approval by the board of directors); report to the board and to the compensation committee of the board at each regular quarterly meeting concerning grants made by the employee options subcommittee during the prior quarter; and to propose suggested changes to our various option plans as necessary and appropriate. In early 2006, we transitioned recordkeeping with respect to our employee equity awards to an external service, E*Trade. Although grants issued after September 23, 2005 did involve better contemporaneous documentation of grant decisions, the Audit Committee determined that there were still some specific grants where the documentation was incomplete for financial reporting purposes.
No Self Dealing or Favoritism
The Audit Committee did not find evidence that the officers or directors with responsibility for administration of our stock option programs had taken steps to provide themselves with options at better prices than those granted to other employees.
Our founders and directors typically received grants at preset times, normally at the meeting of our board of directors that immediately follows each annual shareholders meeting. Because the shareholders meetings and the board meeting immediately following the shareholders meeting were well documented, these grants were generally not determined to have Record Dates that required adjustment. In one case where full minutes were not available, certain measurement date adjustments were made based upon the supporting documentation that was available. Additionally, the Audit Committee identified two instances where written consents were used and the Company deemed the measurement date to be the date of the last signature. In both instances the change in measurement date was one day. Because the dates of the annual shareholders meetings and the board meetings scheduled to occur immediately following the annual shareholders meetings had been set well in advance (typically 60 to 90 days in advance), the Audit Committee found no evidence that knowledge of likely share price movements had been involved in selecting these dates in anticipation of the granting of options on these dates. Under this arrangement, our former CEO, who was empowered to issue grants to non-founder employees until September 23, 2005, received grants at preset times and was not in a position to benefit from the grants he made from time to time to our other employees.
Additionally, our more senior employees, including those involved in the administration of our option programs, generally received grants issued by our former CEO at the same times and by the same mechanisms as our less senior employees and officers. Our Audit Committee determined that stock option grant practices during the Review Period were applied uniformly by those of our management personnel who were directly and indirectly involved in the administration of our stock option programs, and that these processes were not used to selectively benefit any one group or individual within the Company.
No Intent to Decieve
After reviewing the available documentary evidence and information gathered through interviews of Company personnel, the Audit Committee concluded that the conduct of those who administered our options plans was not intentionally or knowingly wrongful. Specifically, the Audit Committee did not find any evidence that officers, employees, or directors of the Company had any knowledge that their handling of option grants violated stock option accounting rules during the Review Period. To the extent Sonic personnel authorized grants using incorrect or unreliable dates, the Audit Committee found no evidence of an intent to purposefully circumvent stock option accounting rules or to otherwise inaccurately report the financial results of the Company during the Review Period. Moreover, the Audit Committee found no indication of intent by those with responsibility for selecting grant dates to benefit personally at the expense of the Company. No Company personnel stated that they observed management back-date grants or commit other misconduct. Moreover, there were no documents indicating an intent to violate known accounting rules, or indicating any knowledge of misconduct in that regard.
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The Audit Committee received full support and cooperation from our management and employees during the course of the options review.
Additionally, the Audit Committee found that our personnel did not act with an intent to mislead auditors. While the Audit Committee noted instances in which personnel actively discussed how to correct mistakes related to the documentation and related accounting treatment, and when to inform auditors of those mistakes, it determined that such personnel took no actions designed to conceal information from our auditors.
Restatement Methodologies
In light of the review and in accordance with APB No. 25, other applicable literature (including, for the period commencing on April 1, 2006, SFAS No. 123R), and the guidance published by Conrad Hewitt, Chief Accountant, SEC, in a September 19, 2006 letter (the “SEC Letter”), we considered and applied the methodologies described below to determine the appropriate measurement dates for our historical stock option grants.
Applicable Standards
In determining corrected measurement dates for our historical option grants, we followed the requirements of APB No. 25, which deems the measurement date for an option grant to be the first date on which all of the following are known: (a) the identity of the individual employee who is entitled to receive the option grant; (b) the number of options that the individual employee is entitled to receive; and (c) the option’s exercise price. Under APB No. 25, the measurement date cannot be earlier than the date on which the grant is approved. In each instance where we determined that we cannot rely on the Record Date previously associated with an option, we considered alternate measurement dates based on our ability to establish or confirm, in our reasonable judgment, whether through other documentation or credible circumstantial information, when each of the elements associated with the determination of a measurement date for the option grant had been satisfied under applicable accounting principles. In making such determinations, we considered, among other things, the guidance in the SEC Letter, which provides that, where a company lacks definitive and complete documentation, it “must use all available relevant information” to form a reasonable conclusion with respect to, among other things, the appropriate dating for the option grant.
Information Types Considered
We analyzed all available information for each option grant. In considering this information relating to each option grant, we reached the following general conclusions:
| • | Board Minutes. For certain grants (primarily grants to board members and founders), board minutes (typically from board meetings held immediately after annual shareholder meetings) were considered to be definitive, reasonable and appropriate evidence of the best measurement dates for the grants in question. |
| • | Board Consents. Although not widely used, unanimous written consents of the board were similarly considered to be definitive, reasonable and appropriate evidence of the best measurement dates for grants described in such consents, subject to analysis of the date on which all board members had signed the consent. |
| • | Acquisition Dates. We evaluated the extrinsic information associated with certain company acquisitions and, except as described inAcquisition-Related Grants below, generally were able to conclude that the original Record Dates were reasonably supportable as the appropriate measurement dates for the options granted in connection with such transactions. |
| • | Individual Public Filings. Forms 3, 4 and/or 5 filed by grant recipients were considered to represent reasonable evidence of the existence of the underlying grants and to be a basis for establishing appropriate measurement dates. To the extent that the applicable Form was filed within two days of the Record Date described in the Form, we concluded that it is reasonable to consider this Record Date to be the appropriate measurement date. If, on the other hand, the Form was filed more than two days after the specified Record Date, we concluded that the filing date is an appropriate measurement date (absent information supporting an earlier date), but that the Record Date referenced in the Form is not, without additional reliable support, usable as the measurement date. |
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| • | Employee Offer Letters. Based upon the specific facts and circumstances described inHiring Grants below, we determined that certain of our offer letters triggered variable accounting treatment for a substantial portion of options issued to new employees during the Review Period. |
| • | Date of Hire. The hiring date (first day of work) was not, in itself, considered to be a valid measurement date, as there is no indication that our closing stock price on such dates was considered or memorialized in any way for stock grant purposes. However, as noted above with respect to employee offer letters, we determined that the date of hire may constitute the appropriate date for commencing variable accounting treatment for new hire grants, as described in more detail inHiring Grants below. |
| • | Employee Action Forms. Our EAFs do not provide sufficient evidence to establish appropriate measurement dates. While EAFs sometimes refer to a number of shares to be granted, they typically do not contain exercise price information, and they contemplate that future actions will be necessary to finalize the granting process. Further, although in some instances our former CEO (who had full authority to grant options to non-executive officer employees prior to September 23, 2005) signed EAFs, he did not typically date his signature and EAFs, in contrast to offer letters, were not usually provided to, or countersigned by, grant recipients. In addition, it appears that we did not follow a consistent policy, practice or pattern with regard to our use and execution of EAFs in connection with the option granting process. Accordingly, even though in some instances it is possible to reasonably conclude that an EAF was approved or otherwise recognized by a particular date — for example, sometimes EAFs were date-stamped when submitted to our payroll department or to our external payroll service, Automatic Data Processing, Inc., for processing — it does not necessarily follow that this approval constituted the final act in granting underlying stock options. Based on the totality of the facts and circumstances, we concluded that, in the absence of additional extrinsic information, EAFs do not constitute a reasonable basis for establishing measurement dates. |
| • | Vesting Base Dates. Stock options that were granted would be assigned a “base date” which would be used to calculate time options were held for purposes of calculating vesting. Stock option vesting base dates did not generally coincide with grant dates (vesting often would be designated to commence prior to the option grant reflected in our records, and would often correspond with other events or milestones such as the date of a performance review or the first date of employment at Sonic), and based on all available information, we concluded that vesting base dates should not be considered to establish appropriate measurement dates for APB No. 25 purposes. |
| • | Signed Grant Notices. ��A signed and dated grant notice (which would contain the date of grant, number of shares, recipient identity and exercise price) would, absent contrary information, be considered to represent definitive evidence of a measurement date for the applicable grant. To the extent any such grant notices were available, they were, absent evidence to the contrary, used in determining the proper measurement dates for the grants in question. As a general matter, though, until we changed our processes in September 23, 2005, we did not issue or retain signed/dated grant notices. |
| • | Periodic Spreadsheets. We concluded that option grant measurement dates can often reasonably be established by the dates on which extrinsic evidence demonstrates the existence of a Periodic Spreadsheet in final form. For example, in each applicable period through September 23, 2005, our practice was to send final Periodic Spreadsheets to an outside accounting firm used by us to assist in the calculation of compensation expense, diluted outstanding shares, and other matters relating to our SEC filings. In some cases, we were able to find evidence of the dates on which we sent final Periodic Spreadsheets to the outside accounting firm; in other cases, we located evidence showing the dates on which final Periodic Spreadsheets were sent back to us by the outside accounting firm. Absent additional evidence suggesting a different measurement date should be used, we used the date of transmission of these spreadsheets to or from our outside auditors as evidence of a measurement date. |
| • | Company Public Filings. In instances where no earlier reliable information exists, we concluded that the required granting actions would have occurred with finality no later than the dates on which |
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| | we filed our quarterly and annual reports. By this time, the Periodic Spreadsheet would need to have been finalized and provided to (and received back from) the outside accounting firm, so that applicable share-based compensation and earnings per diluted share disclosures, including options granted during the period in question, could be calculated and included in our filings. Accordingly, in the absence of other reliable information, we considered these dates, in some instances, to be the earliest dates that would qualify as measurement dates for purposes of APB No. 25. |
Methodology by Grant and Grant Category
The following analysis sets forth the methodologies applied to certain grants and grant categories. In addition to these general methodological approaches, where we had specific information regarding particular grants, we communicated with our independent auditors and our advisers, and reached consensus on the appropriate approach to accounting for such grants, consistent with the criteria of APB No. 25, related accounting literature, and the guidance of the SEC Letter.
Founder and Director Grants
The vast majority of grants to founders and directors were issued to coincide with our annual shareholder meeting. Grants of this type were typically authorized at our board meetings held immediately after our annual shareholder meetings, reflected in board minutes, and issued on the same date. We concluded that we have sufficient contemporaneous, extrinsic and reliable information to support and substantiate most of our founder and director Record Dates as appropriate measurement dates for purposes of APB No. 25 and other applicable literature. One exception to this general conclusion is that, in the single instance where we implemented the founders and directors grants agreed-upon at a board meeting by means of a subsequently- executed unanimous written consent, we concluded that the appropriate measurement date is the date of the final signature on the consent, rather than the original Record Date (which was the date of the meeting). In addition, a unanimous written consent was used to grant initial options to one of our directors when he was first elected to the board, and we concluded that the appropriate measurement date for that grant is the date that the final signature was added to the consent. Further, in one case where full minutes were not available, certain measurement date adjustments were made based upon the supporting documentation that was available. Finally, our conclusions regarding certain salary reduction grants are described inSalary Reduction Grants below.
Non-Founder Section 16 Officer Grants
Prior to September 23, 2005, our CEO would typically make grants to our non-founder executive officer(s) who are considered “executive officers” for purposes of Section 16 of the Exchange Act in the same manner as he would for non-executive employees of the Company. Pursuant to the delegation to him under our various option plans, the CEO generally did not have express authority to grant options to Section 16 officers, as this power was reserved for the board. Nevertheless, these grants were made in a consistent fashion and it is apparent that our board was aware of these option grants and did not disapprove of them. Furthermore, we have disclosed these grants in filed proxy statements, periodic reports and other public documents, and the parties to these grants (both the Company and the Section 16 officer recipient) have consistently honored the terms of the grants over a large number of years.
We concluded that, based on the facts and circumstances, the most appropriate and reasonable approach to these grants is to apply all APB No. 25 criteria in the same manner as such criteria are being applied to grants to our non-management employees (see discussionOther Employee Grants below) — that is, to recognize and acknowledge the existence of these grants, but to change measurement dates where there is insufficient information to reasonably conclude that the original Record Date satisfies the requirements of APB No. 25.
Since September 23, 2005, it has been our policy that all grants to our non-founder executive officers be made by the board, and be memorialized by contemporaneous documentation. As a practical matter, no such grants were issued after September 23, 2005.
Other Employee Grants
Under each of our various options plans, our CEO was delegated the authority to make grants to employees other than executive officers. As described above, except in particular circumstances (for example, grants made in the context of acquisitions and certain grants made after September 23, 2005), the Company
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employed a quarterly-focused grant process for non-founder employees and generally lack contemporaneous grant documentation sufficient to support the Record Dates for these option grants. Accordingly, we analyzed all available relevant information for each stock option grant in an attempt to determine the earliest point in time at which the evidence reasonably shows that all requisites for the establishment of a measurement date under APB No. 25 were satisfied. Except in specific circumstances (seeHiring Grants,Salary Reduction Grants,Acquisition-Related Grants andOther, below), or where we were able to locate contemporaneous grant documentation, this approach generally has resulted in our determining that the most appropriate measurement dates occur some time after the original Record Date in our records, often the date on which final Periodic Spreadsheets were sent to or received from the outside accounting firm we used for financial statement calculations, or the date on which we filed our quarterly or annual reports with respect to the grant(s) in question. Given the generally upward trend of our stock price during a substantial portion of the Review Period, moving to these “end of quarter” measurement dates generally results in a larger compensation charge and restatement amount.
As noted above, on September 23, 2005, our board created an employee options subcommittee to make grants under our option plans to recipients other than executive officers and to board members. This subcommittee reported on its activities to the board and compensation committee at each regularly-scheduled board meeting.
Hiring Grants
We concluded that variable accounting is the most appropriate restatement methodology for initial grants to newly-hired employees made after December 15, 1998 and prior to the adoption of new procedures in September 23, 2005, other than in connection with acquisitions. This conclusion is based upon Financial Accounting Standards Board (“FASB”) Interpretation No. (“FIN”) 44 (March 2000), “Accounting for Certain Transactions Involving Stock Compensation — An Interpretation of APB Opinion No. 25,” which provides that “if the exercise price of a fixed stock option award is reduced, the award shall be accounted for as variable from the date of the modification to the date the award is exercised, is forfeited, or expires unexercised.”
In reaching this conclusion, we considered the following facts and circumstances: (a) offer letters sent to new employees during this period were signed by our CEO, the same person who had full authority to make grants to such employees, (b) while the offer letters inform the new employees that an option grant will be made “shortly after” the commencement of employment, our actual practice — as reflected in our own grant records and documentation — was to make these initial grants over a significant period of time, up to several months after the start of employment, and (c) the offer letters, once signed by the employee, arguably constitute a legally binding commitment by us to issue option shares in the stated amount, as the grant obligation is not subject to any contingencies such as board approval. Under these facts and circumstances, we concluded that the most appropriate approach under APB No. 25 and FIN 44 is to treat the offer letters as constituting a grant at the initial hire date, with a subsequent repricing on a later date (whether the Record Date or an alternate measurement date determined as a result of the review).
Even though in a number of instances our share price at the subsequent measurement date was higher than the price on the initial hire date, due to the fact that the price declined in other instances we concluded that it is appropriate to apply variable accounting to this entire category of hiring grants, with the initial option grant date and vesting base date being deemed to have occurred on the hire date in all cases. Further, although we were not been able to locate signed copies of all offer letters associated with initial hire grants, because our practice was to utilize substantially similar letters signed by the former CEO for all new hires, we concluded that it is appropriate to apply variable accounting to these grants as well, based on the analysis described above.
Salary Reduction Grants
In March of 1998 and July of 2001, we offered salary reduction programs to certain of our senior employees. The programs allowed these employees to reduce their compensation and, for each dollar of reduced pay, the employee was entitled to an option to purchase one share of our common stock. For example, if an employee reduced his or her pay by $25,000, the employee was entitled to options to purchase 25,000 shares of our common stock. We never created any formal plans to document these programs, and
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formal board approval was not obtained, although a notation describing the 1998 salary reduction program was included in supporting materials provided to directors at the board meeting immediately prior to the reduction.
The 2001 salary reduction program was for one year, beginning July 1, 2001 and ending June 30, 2002. Payroll was paid semi-monthly, five days after the end of the payment period (that is, for mid-month payrolls, payment would be on the 20th; for month-end payrolls, payment would be on the 5th of the following month). The options under this program were issued and dated July 12, 2001, which was the payroll processing date for the semi-monthly pay period beginning on July 1, 2001. We concluded that this date is the appropriate measurement date.
The 1998 salary reduction program was also for one year, beginning May 1, 1998 and ending April 30, 1999. The options under this program were dated and issued March 3, 1998. As noted above, this salary reduction program was discussed at the March 3, 1998 board meeting, based on a package of supporting materials attached to the March 3, 1998 board minutes. Consistent with our approach to the 2001 salary reduction program, however, we concluded that the appropriate measurement date for these options should be May 12, 1998, the payroll processing date for the first payment period during the program period, since in theory a potential participant may have decided in the interim not to take part.
Acquisition-Related Grants
During the Review Period, we completed certain corporate acquisitions and, in connection with these transactions, issued certain option grants. Generally, these grants were described in offer letters signed by our then-CEO in which acquired employees were informed that they would receive the options at the time of closing of the relevant acquisition. These transactions include:
| • | Daikin. At a January 24, 2001 meeting, our board unanimously resolved to enter into an asset purchase agreement with and to acquire the assets of Daikin Industries, Ltd. The transaction closed on February 27, 2001 and was announced on February 28, 2001. As part of the acquisition, key members of Daikin joined the Company and were issued options dated February 27, 2001, the date of acquisition, at the closing price of our stock on that date. |
| • | Veritas. At a November 1, 2002 meeting, our board unanimously resolved to enter into an asset purchase agreement with and to acquire the assets of the Desktop and Mobile Division of VERITAS Software Corporation. On November 13, 2002, we entered into the asset purchase agreement, and the transaction closed and was announced on December 18, 2002. At the time of the acquisition, we issued options to employees who joined the Company through this acquisition. These options were issued on December 18, 2002 and the exercise price was the closing price on that date. |
| • | InterActual. At a December 2, 2003 meeting, our board unanimously resolved to acquire InterActual Technologies, Inc., by way of merger. We entered into the definitive agreement on January 31, 2004, the transaction closed on February 13, 2004, and was announced on February 19, 2004. At the time of the acquisition, we issued inducement grants to employees who joined the Company as a result of this transaction. These options were dated February 13, 2004 and the exercise price was the closing price on that date. |
| • | Ravisent. On May 29, 2002, we announced that we had entered into an agreement under which Axeda exclusively licensed its Ravisent software to us under terms that were essentially equivalent to ownership and, in connection with this transaction, we hired a number of Ravisent (Axeda) employees. Board minutes were not available but board materials dated May 28, 2002 indicate that the transaction closed Friday, May 24, 2002. Grants were issued on two different dates. One group of grants to 10 individuals was issued on May 28, 2002, with an exercise price equal to the closing stock price on that date. The other group of grants to 11 individuals was dated January 2, 2003, with an exercise price equal to our closing price on that date. For contractual reasons, Ravisent (Axeda) employees from the Pennsylvania office could not receive shares until January 2, 2003, their date of hire by us — accordingly, their options were issued on January 2, 2003, with the exercise price |
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| | equal to our closing price on that date. Based on the contractual terms, the hiring dates of these Pennsylvania employees, and the language in their offer letters, we concluded that we had reasonable evidence to support the Record Date of January 2, 2003 as the measurement date for accounting purposes. |
| • | Roxio (U.S. Grants). On December 17, 2004, we entered into an amended and restated asset purchase agreement and acquired Roxio’s consumer software division. We announced this acquisition on December 20, 2004 and filed a Form 8-K on December 23, 2004. At the time of the acquisition, we issued inducement grants to employees who joined the Company through this acquisition. In particular, we issued options to Roxio employees located in the United States on December 17, 2004, the closing date, and the exercise price was the closing price on that date. |
| • | Roxio (Foreign Grants). Because no appropriate foreign option plan was in place at the time that the Roxio transaction closed, we were unable to issue options to Roxio employees located outside of the United States at the time of closing of the transaction. Thereafter, at a meeting on March 15, 2005, our board adopted the 2005 Stock Incentive Plan (Non-U.S. Employees) and, according to our stock options records, options were issued to the non-U.S. Roxio employees on April 6, 2005, with the exercise price equal to the closing price on that date. Because the offer letters for these employees stated that the grants would be made at the time the acquisition closed, we concluded that variable accounting is the most appropriate restatement methodology for these options. |
With the exception of the Roxio foreign grants, which are described above, we determined that we have sufficient reliable evidence to reasonably support and maintain the original Record Dates as the appropriate measurement dates for purposes of APB No. 25 for our acquisition-related grants.
Other
In a number of isolated cases, we identified accounting errors that we corrected in accordance with APB No. 25 and other applicable accounting literature, including miscellaneous situations involving acceleration of vesting, extensions of exercise periods for vested options, grants to consultants that were erroneously accounted for as if they had been made to employees, repricing previously issued grants, missed grants, and other “one-off” situations.
Remedial Steps
As noted above, in early 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 transitioned administration of our employee equity awards to an external service, E*Trade. We have 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.
As a result of the options review, the Audit Committee additionally recommended, and our board of directors has adopted, certain other policies and procedures and actions with regard to stock option grants, including the following:
| • | The board has revoked all prior delegations of authority for granting equity awards, including its September 23, 2005 delegation to the employee options subcommittee, which was comprised of our CEO and CFO. |
| • | All equity awards will be made by the Compensation Committee or the full board of directors at scheduled meetings (either live or telephonic). Both the Compensation Committee and the board of directors will continue to avoid, whenever practicable, using unanimous written consents in lieu of live or telephonic meetings. To the extent unanimous written consents are used, each signature will be paired with a “dated” line, which will only be dated with the date the signatory actually signs the document. Email or electronic signatures will be used when possible to facilitate accurate documentation. |
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| • | Annual review grants to both non-Section 16 officers and Section 16 officers, and directors’ and founders’ grants, will occur once a year at a standard time (for example,at the Board meeting following the annual shareholders meeting). An exception process will be developed to deal with special needs and circumstances. |
| • | New hire and merit grants to non-Section 16 officers will occur at regular, predetermined intervals throughout the year. An exception process will be developed to deal with special needs and circumstances. |
| • | The Compensation Committee or the full board will receive, in advance of the relevant meeting, a written proposal of grants to be issued. The proposal will include all recipient names and positions, the number of shares proposed, the relevant plan, the vesting date and period, and a brief description of the business justification of the proposed award. |
| • | A finance department person will be made available to provide support and assistance to the Compensation Committee and the full board regarding equity grants. |
| • | The minutes for each applicable Compensation Committee or the full board meeting will document each decision relating to equity awards during the meeting in which decisions are made. |
| • | The Compensation Committee or the full board will designate management personnel to have primary responsibility, under the ultimate responsibility of the Compensation Committee and the board, to monitor our options processes to ensure that the processes contained in our incentive plans and the Compensation Committee’s charter are fully carried out with respect to each equity award. Management personnel will maintain, for a reasonable time, appropriate records of all equity awards proposed to the Compensation Committee or full board, whether approved or not. |
| • | To the extent not already in place, procedures will be established to ensure that our finance and accounting departments are timely advised of all equity grants and their terms, and to consider the accounting implications of each. In addition, to the extent not already in place, procedures will be established to ensure the adequate involvement of our human resources, finance and accounting departments in all employment arrangements that may have accounting implications. |
| • | Once approved, grants will not be modified except as expressly approved by the Compensation Committee or the full board. Approved awards will be promptly entered into our financial records and equity award database. |
| • | Our management has been directed to ensure that a training program is developed and implemented concerning: |
| • | the procedures and controls concerning equity grants; and |
| • | related accounting and legal implications. |
Employees with responsibility for equity grants will be required to participate in the training program. This training will also be incorporated into the new hire orientation program for people assuming similar roles. In addition, each member of senior management and the board will be directed to attend a Sonic-sponsored training program (including the services of outside experts as appropriate) concerning corporate governance and including discussions of public company accounting.
| • | Management has been directed to conduct regular reviews of equity grant records and processes, and to ensure that our processes are properly documented. |
| • | On a quarterly basis, management has been directed to confirm to the Audit Committee that equity grants made during the quarter comply with our internal procedures, proper accounting principles, and SEC disclosure requirements. The Audit Committee has been directed to discuss with our external auditors, on a regular basis, the external auditors’ review of our equity awards and their compliance with our internal procedures, proper accounting principles, and SEC disclosure requirements. |
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| • | Our CEO and CFO will report regularly at board meetings regarding the implementation of the measures described above. |
As noted above, the measurement dates of options issued to members of our board of directors (“Director Options”) were generally not changed as a result of the review. In a few cases, though, measurement dates have been revised to dates on which our closing stock price was higher than on the original Record Date. In order to avoid any question surrounding the treatment of such options, all of the members of our board of directors, including the board’s chairman (formerly the Company’s CEO), voluntarily agreed: (a) for unexercised Director Options with adjusted measurement dates, to re-price such options so that the new exercise price matches the price of our stock on the new measurement dates; and (b) for exercised Director Options with adjusted measurement dates, to repay to us the net difference between the initial exercise price and the price of our stock on the new measurement dates. Further, our former CFO, who was our only non-director Section 16 officer during the Review Period until September 23, 2005, also voluntarily agreed to the same re-pricing and repayment terms, in each case tied to the aggregate dollar amount of the re-pricing and repayment, respectively, agreed to by the person with the next highest dollar amount of re-pricing and repayment, who was our board chairman and former CEO. The aggregate dollar amount of the re-pricing described in this paragraph totals approximately $276,000, and the aggregate dollar amount of the repayments described in this paragraph totals approximately $106,000.
Our board of directors has taken steps to move the administration of our equity compensation plans away from management personnel and into the hands of the board and/or Compensation Committee. As noted above, our board of directors has revoked the delegation of authority to the employee options subcommittee, which was comprised of our CEO and CFO, and has implemented a variety of enhancements designed to ensure that all of our equity grants are properly made and documented. In addition, our board of directors has directed management to ensure that our CFO and/or chief accounting officer (or, if there is no chief accounting officer, controller) have significant public company accounting experience and qualify as a certified public accountant. Further, our board is considering the addition of another director with significant accounting or finance experience.
Tax Considerations
Based on measurement date changes resulting from our options review, certain grants of stock options made during the Review Period were priced below fair market value, rather than at fair market value. Consequently, certain grants intended to be classified as incentive stock options (“ISOs”), requiring pricing at no less than fair market value on the date of grant, should have been classified as nonqualified stock options (“NQs”). Additionally, certain options should have been treated as NQs since date of grant due to either plan limitations or ISO limitations. We did not withhold federal income taxes, state income taxes, FICA or Medicare on the options that were issued as ISOs that should have been treated as NQ stock options (due to their below-market grant pricing, plan limitations or ISO rules). We accrued payroll tax, penalty, and interest expenses related to NQ stock options originally classified as ISOs in the periods in which the underlying stock options were exercised. Then, in periods in which the liabilities were legally extinguished due to statutes of limitations, the expenses were reversed and recognized as a reduction of expense.
We informed the Internal Revenue Service (“IRS”) of potential payroll tax liabilities resulting from changes in measurement dates for stock options. However, no formal settlement negotiations have taken place. On January 15, 2008, we were notified by the IRS of a payroll tax audit covering the calendar years 2004, 2005 and 2006.
We recorded deferred tax assets as a result of the share-based compensation expense recorded through the restatement based on unexercised and uncanceled nonqualified stock options at the end of each reporting period. The recognized tax benefit related to affected stock options granted to officers was limited, in certain instances, due to the potential non-deductibility of the related expenses under Section 162(m) of the Code. This IRS rule limits the amount of executive compensation that may be deducted for U.S. tax purposes under certain circumstances.
Section 409A of the Code imposes additional taxes on our employees for stock options granted with an exercise price lower than the fair market value on the date of grant for all options or portions of options that vest after December 31, 2004. As a result of the change in measurement dates described above, certain stock
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options granted during the Review Period were issued at prices below fair market value on the revised measurement date. Management is considering possible ways to address the impact that Section 409A may have on our employees as a result of the exercise price of stock options being less than the fair market value of our common stock on the revised measurement dates. The IRS has issued transition rules under Section 409A that allow for a correction or cure for some of these options subject to Section 409A. We may offer non-officer employees who hold outstanding options the opportunity to cure their affected stock options. In connection with this cure, we may make future cash bonus payments to our non-officer employees in an undetermined amount. We recorded approximately $1.7 million in operating expense for estimated employee Section 409A taxes that we have elected to cover with respect to options that were exercised during the fourth quarter of fiscal year 2007.
Stock Options Restatement
Based on the errors noted above, we have recorded adjustments to share-based compensation, including payroll taxes, Section 409A penalties and other tax expense. There was no impact on revenue or net cash provided by operating activities as a result of this additional share-based compensation and related tax expense during the restatement periods.
The following table sets forth the effect of the stock option review restatement for each of the applicable fiscal years (in thousands):
 | | | | | | | | | | |
| | Stock Option Review Adjustments | | | | |
| Fiscal Year Ended | | Pre-Tax
Share-Based
Compensation
Expense
Adjustments | | Pre-Tax
Payroll Related
Tax Expense
(Benefit)
Adjustments | | Total
Pre-Tax
Impact | | Related
Income
Tax Expense
(Benefit)
Adjustments | | Net Expense
(Benefit)
After-Tax
Adjustments |
| March 31, 1998 (unaudited) | | $ | 60 | | | $ | — | | | $ | 60 | | | $ | — | | | $ | 60 | |
| March 31, 1999 (unaudited) | | | 613 | | | | 6 | | | | 619 | | | | — | | | | 619 | |
| March 31, 2000 (unaudited) | | | 1,175 | | | | 218 | | | | 1,393 | | | | — | | | | 1,393 | |
| March 31, 2001 (unaudited) | | | 812 | | | | 642 | | | | 1,454 | | | | — | | | | 1,454 | |
| March 31, 2002 (unaudited) | | | 3,026 | | | | 509 | | | | 3,535 | | | | — | | | | 3,535 | |
| March 31, 2003 (unaudited) | | | 2,707 | | | | 1,705 | | | | 4,412 | | | | — | | | | 4,412 | |
| March 31, 2004 (unaudited) | | | 8,177 | | | | 1,356 | | | | 9,533 | | | | — | | | | 9,533 | |
Cumulative effect at March 31,
2004 (unaudited) | | | 16,570 | | | | 4,436 | | | | 21,006 | | | | — | | | | 21,006 | |
| March 31, 2005 | | | 4,492 | | | | 583 | | | | 5,075 | | | | (69 | ) | | | 5,006 | |
| March 31, 2006(1) | | | 10,103 | | | | 2,782 | | | | 12,885 | | | | (13,196 | ) | | | (311 | ) |
Six Months Ended September 30,
2006 (unaudited) | | | 316 | | | | (1,514 | ) | | | (1,198 | ) | | | 225 | | | | (973 | ) |
| Total | | $ | 31,481 | | | $ | 6,287 | | | $ | 37,768 | | | $ | (13,040 | ) | | $ | 24,728 | |
| (1) | Prior to fiscal year 2006, we maintained a valuation allowance against our deferred tax assets. In fiscal year 2006, we reversed the majority of our valuation allowance against deferred tax assets due to our assessment, made at that time, that it was more likely than not that deferred tax assets would be realized. As a result of the restatement, we recorded additional deferred tax assets with respect to the periods covered by our options review. The $13.2 million income tax benefit in fiscal year 2006 relates to the release of valuation allowance against the additional deferred tax assets recorded with respect to fiscal years 2005 and prior as a result of the restatement, net of the current year effect. |
Change in Accounting Policy
Effective October 1, 2006, we elected to change our method of recognizing OEM royalty revenue. Previously, we generally recognized OEM royalty revenue in the period the OEM product shipped, provided we received the OEM royalty report before the preparation of our financial statements. We now generally recognize OEM revenue in the period we receive the OEM royalty report. We adopted the new method to improve
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reporting consistency across our OEM customers and reduce the length of the accounting close cycle. Comparative financial statements for fiscal year 2006 and quarterly financial information for the quarters ended June 30, 2006 and September 30, 2006 have been adjusted to apply the new method retrospectively.
Due primarily to a change in our accounting software in fiscal year 2005, retrospective application of this change in accounting policy to fiscal year 2005 and prior periods was not practicable. Therefore, we recorded the cumulative effect of the change as an adjustment to accumulated deficit at the beginning of fiscal year 2006.
The following table summarizes the effects of the retrospective application of this change in accounting policy on our consolidated statements of operations for fiscal year 2006, and for the quarters ended June 30 and September 30, 2006, and for the on-going current period charges to fiscal year 2007, as applicable (in thousands):
| | | | | | | | |
| | As Restated |
| | | Year Ended March 31,
2006 | | Three Months Ended |
| | | June 30,
2006 | | September 30,
2006 | | Year Ended
March 31,
2007 |
| Increase (decrease) in revenue | | $ | (1,068 | ) | | $ | 475 | | | $ | (609 | ) | | $ | 841 | |
| Decrease (increase) in costs | | | (14 | ) | | | (207 | ) | | | 62 | | | | (237 | ) |
| Tax benefit (expense) | | | 433 | | | | (107 | ) | | | 219 | | | | (242 | ) |
| Increase (decrease) in net income | | $ | (649 | ) | | $ | 161 | | | $ | (328 | ) | | $ | 362 | |
| Increase (decrease) in earnings per share | | $ | (0.02 | ) | | $ | 0.01 | | | $ | (0.01 | ) | | $ | 0.01 | |
The following table summarizes the effect of the retrospective application of this change in accounting policy on our consolidated balance sheets for fiscal year 2006, and for the on-going current period charges to fiscal year 2007, and for the quarters ended June 30 and September 30, 2006, as applicable (in thousands):
| | | | | | | | |
| | As Restated |
| | | March 31,
2006 | | June 30,
2006 | | September 30,
2006 | | March 31,
2007 |
| Decrease in accounts receivable | | $ | (4,161 | ) | | $ | (3,849 | ) | | $ | (4,936 | ) | | $ | (632 | ) |
| Increase in deferred tax assets | | $ | 433 | | | $ | 327 | | | $ | 545 | | | $ | 242 | |
| Decrease in accrued expenses | | $ | 560 | | | $ | 554 | | | $ | 620 | | | $ | 449 | |
| (Increase) decrease in deferred revenue | | $ | (366 | ) | | $ | (403 | ) | | $ | 70 | | | $ | (421 | ) |
| Increase (decrease) in accumulated deficit(1) | | $ | 3,534 | | | $ | 3,371 | | | $ | 3,701 | | | $ | (362 | ) |
| (1) | Amount includes cumulative adjustment of $2.9 million to the beginning retained earnings balance in fiscal year 2006. |
Other Adjustments
Revenue Adjustment
We identified that we had incorrectly recorded a sales transaction during the quarter ended June 30, 2006. This occurred from a sales agreement that we subsequently learned had additional terms that precluded us from recognizing revenue until full delivery was performed. As a result, an adjustment was made to decrease net revenues and increase deferred revenue by $0.4 million in the first quarter of fiscal year 2007. We will recognize $0.3 million of this amount as revenue during the first six months of fiscal year 2008.
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Adjustments to Goodwill and Income Taxes Related to the Roxio CSD Acquisition
In December 2004, we acquired the assets of the Roxio Consumer Software Division (“Roxio CSD”), which included a Canadian subsidiary. During 2007, we filed income tax returns for the acquired Canadian subsidiary covering the period from April 1, 2004 to March 31, 2006. As a result of filing the Canadian income tax returns and a review of our original acquisition accounting, we made the following adjustments:
| • | In fiscal 2005, we decreased goodwill by approximately $2.0 million and increased deferred tax assets, net of valuation allowance, to recognize deferred tax assets in the acquired Canadian subsidiary. These deferred tax assets relate to pre-acquisition net operating losses and other temporary items. |
| • | We recorded additional Canadian income tax expense for the fiscal years 2005 and 2006 of approximately $0.8 million and $0.3 million, respectively. |
| • | In fiscal year 2006, we reduced goodwill by $0.4 million and increased deferred tax assets for transactional costs incurred in connection with the Roxio CSD acquisition that are deductible for tax purposes. |
The adjustments did not result in any changes to cash flows in these fiscal years.
Income Statement Impact
The income statement impact of all adjustments and restatements are as follows (in thousands):
| | | | | | | | | | | | |
| | Net Income (Loss),
As Previously
Reported | | Restatement Adjustments, Net of Tax | | Net Income (Loss),
As Restated |
| Fiscal Year Ended March 31, | | Stock
Options | | Change in Accounting Policy | | Other | | Total |
| | | | | | | | (Decrease) Increase | | | | | |
| 1998 (unaudited) | | $ | (5,876 | ) | | $ | (60 | ) | | $ | — | | | $ | — | | | $ | (60 | ) | | $ | (5,936 | ) |
| 1999 (unaudited) | | | (1,859 | ) | | | (619 | ) | | | — | | | | — | | | | (619 | ) | | | (2,478 | ) |
| 2000 (unaudited) | | | (5,694 | ) | | | (1,393 | ) | | | — | | | | — | | | | (1,393 | ) | | | (7,087 | ) |
| 2001 (unaudited) | | | (5,855 | ) | | | (1,454 | ) | | | — | | | | — | | | | (1,454 | ) | | | (7,309 | ) |
| 2002 (unaudited) | | | (4,182 | ) | | | (3,535 | ) | | | — | | | | — | | | | (3,535 | ) | | | (7,717 | ) |
| 2003 (unaudited) | | | 2,537 | | | | (4,412 | ) | | | — | | | | — | | | | (4,412 | ) | | | (1,875 | ) |
| 2004 (unaudited) | | | 11,084 | | | | (9,533 | ) | | | — | | | | — | | | | (9,533 | ) | | | 1,551 | |
| Totals through March 31, 2004 (unaudited) | | | | | | | (21,006 | ) | | | — | | | | — | | | | (21,006 | ) | | | | |
| 2005 | | | 8,542 | | | | (5,006 | ) | | | — | | | | (789 | ) | | | (5,795 | ) | | | 2,747 | |
| 2006 | | | 19,927 | | | | 311 | | | | (649 | ) | | | (255 | ) | | | (593 | ) | | | 19,334 | |
Fiscal Year 2007 Quarter Ended
| | | | | | | | | | | | | | | | | | | | | | | | |
June 30, 2006 (unaudited)
| | | 4,090 | | | | 1,007 | | | | 161 | | | | (257 | ) | | | 911 | | | | 5,001 | |
September 30, 2006
(unaudited) | | | 2,669 | | | | (34 | ) | | | (328 | ) | | | — | | | | (362 | ) | | | 2,307 | |
| | | | | | | $ | (24,728 | ) | | $ | (816 | ) | | $ | (1,301 | ) | | $ | (26,845 | ) | | | | |
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The effects of these restatements on diluted earnings (loss) per share for fiscal years 2003 through 2006 and the first two quarters of fiscal year 2007 are as follows:
| | | | | | | | | | | | |
| | Diluted Earnings per Share,
As Previously Reported | |
Restatement Adjustments, Net of Tax | | Diluted
Earnings (Loss) per Share,
As Restated |
| Fiscal Year Ended March 31, | | Stock
Options | | Change in Accounting Policy | | Other | | Total |
| 2003 (unaudited) | | $ | 0.13 | | | $ | (0.24 | ) | | $ | 0.00 | | | $ | 0.00 | | | $ | (0.24 | ) | | $ | (0.11 | ) |
| 2004 (unaudited) | | $ | 0.46 | | | $ | (0.39 | ) | | $ | 0.00 | | | $ | 0.00 | | | $ | (0.39 | ) | | $ | 0.07 | |
| 2005 | | $ | 0.32 | | | $ | (0.19 | ) | | $ | 0.00 | | | $ | (0.02 | ) | | $ | (0.21 | ) | | $ | 0.11 | |
| 2006 | | $ | 0.73 | | | $ | 0.03 | | | $ | (0.01 | ) | | $ | (0.01 | ) | | $ | 0.01 | | | $ | 0.74 | |
Fiscal Year 2007 Quarter Ended
| | | | | | | | | | | | | | | | | | | | | | | | |
| June 30, 2006 (unaudited) | | $ | 0.15 | | | $ | 0.04 | | | $ | (0.00 | ) | | $ | (0.01 | ) | | $ | 0.03 | | | $ | 0.18 | |
September 30, 2006
(unaudited) | | $ | 0.10 | | | $ | 0.00 | | | $ | (0.02 | ) | | $ | 0.00 | | | $ | (0.02 | ) | | $ | 0.08 | |
Expenses Incurred in Connection with Options Review
We have incurred substantial expenses related to the review and analysis of the stock option grants, including approximately $6.7 million (unaudited) in costs for legal fees, external audit firm fees and external consulting fees through December 31, 2007. We expect to incur substantial additional fees in connection with stock option matters.
Legal Proceedings
Between March and May 2007, we were notified that a total of five shareholder derivative lawsuits had been filed by persons identifying themselves as Sonic 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 have been consolidated into one action captionedWilder v. Doris, et al., and on September 20, 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.
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. This action alleges various violations of the Exchange Act and the rules promulgated thereunder, and is based on substantially similar factual allegations and claims as in the derivative actions. Thereafter, 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.
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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.
Continued Nasdaq Listing
Because we were not able to timely file our Forms 10-Q for our fiscal quarters ended December 31, 2006, June 30, 2007 and September 30, 2007, did not timely file our Form 10-K for the our fiscal year ended March 31, 2007, and did not timely solicit proxies and hold our annual meeting 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.
On March 22, 2007, we attended a hearing with the Nasdaq Listing Qualifications Panel (the “Panel”), at which we sought an exception to the applicable Marketplace Rules requirements. Thereafter, on April 23, 2007, the Panel granted us an initial extension to regain compliance with Nasdaq’s listing requirements, on June 20, 2007, the Panel granted us an additional extension, on July 23, 2007 the Nasdaq Listing and Hearing Review Council (the “Listing Council”) notified us that it had determined to call for review the June 20, 2007 Panel decision, and, in a decision dated October 26, 2007, the Listing Counsel granted us a further exception to demonstrate compliance with all of the Global Select Market continued listing requirements until December 26, 2007. On December 12, 2007, we received a letter from the Board of Directors of The Nasdaq Stock Market LLC (the “Board”) notifying us that it was calling for review the decision of the Listing Council decision and granting us additional time to meet the applicable listing requirements, and on January 8, 2008, we received a letter informing us that it was allowing us until March 10, 2008, to file all delinquent periodic reports necessary to regain compliance. 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.
Overview of Business
We develop and market computer software related todigital 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 broadband, broadcast, mobile and optical disc formats such as Compact Audio Disc (“CD-Audio”), Digital Video Disc (“DVD”) as well as emerging 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 and Blu-ray Disc and other recordable disc formats; |
| • | editing audio and video programs; |
| • | 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, file systems on computers and other consumer electronic devices; |
| • | editing digital photographs and other images; 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.
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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.
Professional
Our professional segment consists of one component, our Professional Products Group. The Professional Products Group 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 HD DVD 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®, CineVisionTM, and DVDit® product names and Sonic® and Roxio ProfessionalTM 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 6% of our net revenue for fiscal year 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.
| • | Roxio Division — The Roxio Division offers a number of consumer digital media software products under the Roxio® brand name. Our applications include BackonTrackTM, Backup MyPC®, CinePlayer®, CrunchTM, Just!BurnTM, MyDVD®, MyTV To GoTM, PhotoSuite®, PopcornTM, RecordNow®, Roxio Copy & ConvertTM, Roxio Easy Media Creator®, Toast®, VideoWave®, WinOnCD®, and others. We sell and market these products through four primary channels: (1) product bundling arrangements with original equipment manufacturer (“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” resellers). Since the Roxio CSD acquisition in December 2004, we have transitioned all of our consumer applications software products to the Roxio brand. |
| • | Advanced Technology Group — The Advanced Technology Group 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 QflixTM brand names. Customers of our Advanced Technology Group 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. The Advanced Technology Group 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 the Advanced Technology Group 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 does not regularly review operating results broken out separately for the Roxio Division and Advanced Technology Group in deciding how to allocate resources or in
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assessing performance. Our consumer segment accounted for approximately 94% of our net revenue for fiscal year 2007. See Note 11 to the consolidated financial statements included in this Annual Report for a summary of our financial data by business segment.
Net revenue for fiscal year 2007 was comparable to fiscal year 2006. International sales slightly decreased from 23% of net revenue for fiscal year 2006 to 22% of net revenue for fiscal year 2007. Approximately 23% of our net revenue for fiscal year 2007 resulted from sales to Dell. Sales to our domestic and international distributors, Digital River and Navarre, accounted for 20% and 13%, of our revenues, respectively. The loss of any of these customers or distributors would have a material adverse effect on our financial results.
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 during December 2007. We expect to eliminate approximately 84 positions in connection with the office closure and incur severance-related costs of approximately $1.5 million and other one-time restructuring charges of approximately $1.5 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 could differ from these estimates. We regularly evaluate our estimates, judgments, and assumptions and make changes accordingly.
Of the significant accounting policies described in Note 1, “Summary of Operations and Significant Accounting Policies” in Notes to consolidated financial statements, we believe the following are the most critical to aid in understanding and evaluating our financial condition and results of operations.
Revenue Recognition
We derive our revenue primarily from licenses of our software products, software development agreements and maintenance and support. We also sell and license patents and patented technology. We recognize software-related revenue in accordance with American Institute of Certified Accountants (“AICPA”) Statement of Position (“SOP”) 97-2, “Software Revenue Recognition” as amended by SOP 98-9, and Staff Accounting Bulletin (“SAB”) 104, “Revenue Recognition in Financial Statements.” We recognize revenue when the following criteria have been met:
| • | Persuasive evidence of an arrangement exists, |
| • | Delivery has occurred or services have been rendered, |
| • | The arrangement fees are fixed or determinable, and |
| • | Collection is considered probable |
If we determine that any of the above criteria has not been met, we will defer recognition of the revenue until all the criteria have been met.
We generally consider arrangements with payment terms longer than six months from the time of delivery not to be fixed or determinable and recognize the related revenue as payments become due from the customer, provided all other revenue recognition criteria have been met. If we determine that collection of a fee is not probable, we defer the fees and recognize revenue upon cash receipt, provided all other revenue recognition criteria have been met.
We follow Emerging Issues Task Force (“EITF”) 99-19, “Reporting Revenue Gross as Principal versus Net as an Agent.” Generally, we record revenue at gross and record costs related to a sale in cost of revenue. In those cases where we are not the primary obligor or merchant of record and/or do not bear credit risk or earn a fixed transactional fee, we record revenue under the net method. When we record revenues at net, revenue is reported at the net amount received and retained by us.
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Multiple Element Arrangements
In arrangements that include multiple elements (e.g., software, specified upgrades, support services, installation services, and/or training), we allocate the total revenue to be earned under the arrangement to the elements based on their relative fair value, as determined by vendor-specific objective evidence of fair value (“VSOE”). VSOE is generally the price charged when that element is sold separately or, in the case of support services, annual renewal rates.
In arrangements where VSOE exists only for the undelivered elements, we use the “residual method” under SOP 98-9, under which we defer the full fair value of the undelivered elements and recognize the difference between the total arrangement fee and the amount deferred for undelivered items as revenue. If VSOE does not exist for all elements but the only undelivered element is maintenance and support, we recognize revenue from the arrangement ratably over the maintenance and support period. If VSOE does not exist for undelivered elements that are specified products or upgrades, we defer revenue until the earlier of the delivery of all elements or the point at which we determine VSOE for these undelivered elements.
Product Sales
Except in the case of consignment arrangements, we recognize revenue from the sale of our packaged software products when title transfers to the distributor or retailer. When we sell packaged software products to distributors and retailers on a consignment basis, we recognize revenue upon sell through to an end customer.
Our distributor arrangements often provide distributors with certain product rotation rights. In such situations, we recognize product sales in accordance with SFAS No. 48, “Revenue Recognition When Right of Return Exists.” We estimate returns based on our historical return experience and other factors such as channel inventory levels and the introduction of new products. These allowances are recorded as a reduction of revenues and as an offset to accounts receivable. If future return patterns differ from past return patterns, for example due to reduced demand for our product, we may be required to increase these allowances in the future and may be required to reduce future revenues.
In accordance with EITF 01-09, “Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor’s Product,” we account for cash consideration (such as sales incentives) that we give to our customers or resellers as a reduction of revenue rather than as an operating expense unless we receive a benefit that is separate from the customer’s purchase from us and for which we can reasonably estimate the fair value.
Software License Arrangements
Provided all other revenue recognition criteria have been met, we recognize revenue from software licensing arrangements upon delivery, or, in the case of per-unit royalty arrangements, upon sell through to an end user as evidenced by the receipt of a customer royalty report.
Software Development Arrangements
For arrangements that include development or other services that are essential to the functionality of the licensed software, we recognize revenue in accordance with SOP 81-1, “Accounting for Performance of Construction Type and Certain Production Type Contracts,” using the percentage-of-completion method. Under the percentage-of-completion method, management estimates the number of hours needed to complete a particular project, and revenues are recognized as the contract progresses to completion. Changes in estimates are recognized in the period in which they are known.
In certain instances, a development agreement may include additional undelivered elements, such as maintenance and support, or a specified upgrade or other deliverable, and VSOE of fair value may not exist for the undelivered elements, or we may not have sufficient experience with either the type of project or the customer involved to be able to make reliable estimates towards completion. If we cannot reliably estimate total profitability under the agreement but are reasonably assured that no loss will be realized on the agreement, we recognize revenue using the zero gross margin method. Under the zero gross margin method, revenue recognized under the contract equals costs incurred under the contract, and any profit is deferred until development is complete. We recognize the deferred gross profit over the remaining contractual service period (for example, the initial maintenance period).
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Allowance for Returns and Doubtful Accounts
Our distributor and retail arrangements provide for certain product rotation rights and permit certain product returns. We estimate reserves for these rights of return based on historical return rates, timing of new product releases, and channel inventory levels.
We maintain an allowance for doubtful accounts to reserve for potentially uncollectible accounts based on past collection history and specific risks identified in our portfolio of receivables. If the financial condition of our distributors or other customers deteriorates, resulting in an impairment of their ability to make payments, or if payments from distributors or other customers are significantly delayed, additional allowances may be required.
Goodwill, Intangible Assets and Other Long-Lived Assets
We account for goodwill and other intangible assets in accordance with SFAS No. 142, “Accounting for Goodwill and Other Intangible Assets.” SFAS No. 142 requires that goodwill and identifiable intangible assets with indefinite useful lives be tested for impairment at least annually, or more frequently if events and circumstances warrant.
We evaluate goodwill and indefinite life intangible assets for impairment by comparing the fair value of each of our reporting units to its carrying value including the goodwill allocated to that reporting unit. A reporting unit is an operating segment or one level below an operating segment often referred to as a component. For the purpose of evaluating goodwill, we combine the Roxio and ATG components of our consumer segment into one reporting unit as they have similar economic characteristics and it is difficult to draw a clear distinction between their operating activities. To determine the reporting unit’s fair value, we use the income approach under which we evaluate estimated discounted future cash flows of that unit. We base our cash flow assumptions on historical and forecasted revenue and operating costs.
We perform our annual impairment tests in our fourth fiscal quarter.
We evaluate long-lived assets, including intangible assets with finite useful lives, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. The determination of recoverability of long-lived assets and intangible assets with finite lives is based on an estimate of the undiscounted future cash flows resulting from the use of that asset and its eventual disposition. As of March 31, 2007, no events occurred that would lead us to believe that there has been any intangible asset impairment.
Share-Based Compensation
On April 1, 2006, we adopted SFAS No. 123R (revised 2004), “Share-Based Payment,” which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation,”and supersedes APB No. 25. SFAS No. 123R requires the measurement and recognition of compensation expense for all equity-based payment awards made to our employees and directors, including stock options and Restricted Stock Units (“RSUs”), based on estimated fair values. SFAS No. 123R applies to all outstanding and unvested share-based payment awards at adoption. On March 29, 2005, the SEC issued SAB 107 providing supplemental implementation guidance for SFAS No. 123R. We have applied the provisions of SAB 107 in our adoption of SFAS No. 123R.
We adopted SFAS No. 123R using the modified-prospective-transition method, under which prior periods are not revised for comparative purposes. Under the fair value recognition provisions of this statement, share-based compensation cost is measured at the grant date based on the fair value of the award and will be recognized over the requisite service period, which is generally the vesting period.
Prior to the adoption of SFAS No. 123R, we accounted for share-based compensation related to employee share-based compensation plans using the intrinsic value method in accordance with APB No. 25, and complied with the disclosure provisions of SFAS No. 123. The restated financial statements in this Annual Report set forth restated share-based compensation measured using the methods contained in APB No. 25 or SFAS No. 123R in relation to employee stock options for the applicable periods.
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We use the Black-Scholes-Merton option pricing model to determine the fair value of stock option shares. The determination of the fair value of share-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include our expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends. See Note 8 to consolidated financial statements for further information regarding these assumptions. The fair value of RSUs is equivalent to the market price of our common stock on the grant date.
If factors change, share-based compensation for the future periods may differ significantly from what we have recorded in the current period and could materially affect our operating income, net income and net income per share. Additionally, the Black-Scholes-Merton option pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable, which are characteristics not present in our option grants. Existing assumptions used and valuation modeling may not provide measures of the fair values of our share-based compensation that reflect the actual values realized upon the exercise, expiration, early termination or forfeiture of those share-based payments in the future. Certain share-based payments, such as stock options, may expire worthless or otherwise result in zero intrinsic value as compared to the fair values originally estimated on the grant date and reported in our financial statements. Alternatively, value may be realized from these instruments that are significantly higher than the fair values originally estimated on the grant date and reported in our financial statements. Currently, there are only very limited market-based mechanisms or other practical applications to verify the reliability and accuracy of the estimates stemming from these valuation models, and there is no means to compare and adjust the estimates to actual values.
In connection with our restatement of share-based compensation for fiscal years prior to fiscal year 2006 and fiscal quarters ended June 30 and September 30, 2006, we applied significant judgment in choosing whether to revise measurement dates for prior option grants, and in choosing the methodology for applying these revised measurement dates. See the “Explanatory Note” immediately preceding Item 1 of this Annual Report for further information.
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.
We are required to compute our income taxes in each federal, state, and international jurisdiction in which we operate. This process requires that we estimate the current tax exposure as well as assess temporary differences between the accounting and tax treatment of assets and liabilities, including items such as accruals and allowances not currently deductible for tax purposes. The income tax effects of the differences we identify are classified as current or long-term deferred tax assets and liabilities in our consolidated balance sheets. Our judgments, assumptions, and estimates relative to the current provision for income tax take into account current tax laws, our interpretation of current tax laws, and possible outcomes of current and future audits conducted by foreign and domestic tax authorities. Changes in tax laws or our interpretation of tax laws and the resolution of current and future tax audits could significantly impact the amounts provided for incomes taxes in our consolidated balance sheets and consolidated statements of operations.
Other Disclosures
Contingencies
As described in Part I, Item 3, “Legal Proceedings” and Part II, Item 8, Note 7, “Contingencies, Commitments and Credit Facilities,” in the Notes to consolidated financial statements, we are subject to various claims relating to products, technology, patent, shareholder and other matters. In accordance with 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.
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RESULTS OF OPERATIONS
The following table sets forth certain items from our statements of operations as a percentage of net revenue for fiscal years 2005 through 2007:
| | | | | | |
| | Years Ended March 31, |
| | | 2005 | | 2006 | | 2007 |
| | | As Restated | | As Restated | | |
| Net revenue | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % |
| Cost of revenue | | | 14.8 | | | | 23.1 | | | | 23.1 | |
| Gross profit | | | 85.2 | | | | 76.9 | | | | 76.9 | |
Operating expenses:
| | | | | | | | | | | | |
| Marketing and sales | | | 24.9 | | | | 24.1 | | | | 22.4 | |
| Research and development | | | 36.7 | | | | 29.9 | | | | 29.9 | |
| General and administrative | | | 13.0 | | | | 15.0 | | | | 13.8 | |
| Acquired in-process technology | | | 3.4 | | | | — | | | | 2.3 | |
| Abandoned acquisition | | | — | | | | — | | | | 0.7 | |
| Business integration | | | 2.3 | | | | 0.2 | | | | — | |
| Total operating expenses | | | 80.3 | | | | 69.2 | | | | 69.1 | |
| Operating income | | | 4.9 | | | | 7.7 | | | | 7.8 | |
| Other income (expense) | | | 0.2 | | | | (0.7 | ) | | | 0.5 | |
| Provision (benefit) for income taxes | | | 2.1 | | | | (6.1 | ) | | | 4.1 | |
| Net income | | | 3.0 | % | | | 13.1 | % | | | 4.2 | % |
Fiscal Year 2005, As Restated, Compared to Fiscal Year 2006, As Restated (in thousands)
Net Revenue
| | | | | | | | |
| | Years Ended March 31, |
| Net Revenues | | 2005 | | 2006 | | Inc (Dec) | | % |
| | | | | As Restated |
| Consumer products | | $ | 82,487 | | | $ | 136,354 | | | $ | 53,867 | | | | 65.3 | % |
| Professional products | | | 8,140 | | | | 11,254 | | | | 3,114 | | | | 38.3 | % |
| Net revenues | | $ | 90,627 | | | $ | 147,608 | | | $ | 56,981 | | | | 62.9 | % |
Net revenue increased 63% from $90.6 million, as restated, for the fiscal year ended March 31, 2005 to $147.6 million, as restated, for the fiscal year ended March 31, 2006. The increase in net revenue was primarily due to a 65% increase in consumer product sales driven by revenue from product lines acquired in the Roxio CSD acquisition and higher sales to OEM partners. Professional products revenue increased approximately 38%, primarily due to $2.7 million in revenue recognized on sales of new high-definition DVD products introduced during fiscal year 2006. Net revenue for fiscal year 2006 includes $2.1 million in revenue recognized from the sale of patents acquired with the Roxio CSD acquisition during the quarter ended June 30, 2005.
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| | | | | | | | |
| | Years Ended March 31, |
| Net Revenues | | 2005 | | 2006 | | Inc (Dec) | | % |
| | | | | As Restated | | | | |
| United States | | $ | 69,997 | | | $ | 113,100 | | | $ | 43,103 | | | | 61.6 | % |
Export
| |
| Canada | | | 224 | | | | 262 | | | | 38 | | | | 17.0 | % |
| France | | | 928 | | | | 2,338 | | | | 1,410 | | | | 151.9 | % |
| Germany | | | 2,896 | | | | 2,181 | | | | (715 | ) | | | -24.7 | % |
| United Kingdom | | | 1,572 | | | | 6,141 | | | | 4,569 | | | | 290.6 | % |
| Other European | | | 2,987 | | | | 4,530 | | | | 1,543 | | | | 51.7 | % |
| Japan | | | 9,845 | | | | 14,873 | | | | 5,028 | | | | 51.1 | % |
| Singapore | | | 104 | | | | 2,241 | | | | 2,137 | | | | 2054.8 | % |
| Taiwan | | | 1,288 | | | | 312 | | | | (976 | ) | | | -75.8 | % |
| Other Pacific Rim | | | 677 | | | | 1,300 | | | | 623 | | | | 92.0 | % |
| Other International | | | 109 | | | | 330 | | | | 221 | | | | 202.8 | % |
| Net revenues | | $ | 90,627 | | | $ | 147,608 | | | $ | 56,981 | | | | 62.9 | % |
International sales accounted for $20.6 million, or 23% of our net revenue in fiscal year 2005 compared to $34.5 million, as restated, or 23% of our net revenue in fiscal year 2006. The increase in international sales in fiscal year 2006 was consistent with our overall increase in worldwide revenues.
Significant Customers
The following table sets forth sales to significant customers as a percentage of net revenues and the related accounts receivable as a percentage of total receivables:
| | | | | | |
| | % of Total Revenues | | % of Total
Accounts
Receivable |
| | | Years Ended March 31, | | March 31,
2006 |
| Customer | | 2005 | | 2006 |
| | | | | As Restated | | As Restated |
| Dell | | | 33 | % | | | 20 | % | | | 13 | % |
| Ingram | | | 6 | % | | | 10 | % | | | 12 | % |
| Navarre | | | 5 | % | | | 12 | % | | | 11 | % |
| Digital River | | | 7 | % | | | 17 | % | | | 7 | % |
No other customer accounted for more than 10% of our revenue for fiscal years 2005 and 2006. Revenue recognized from Dell was pursuant to various development and licensing agreements. Revenue recognized from Ingram and Navarre was pursuant to distributor agreements assumed in connection with the business lines acquired with the Roxio CSD acquisition. Revenue recognized from Digital River was pursuant to a reseller agreement. 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 harm our sales and results of operations.
Cost of Revenue Cost of revenue consists mainly of the costs 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. Our cost of revenue as a percentage of net revenue increased from 14.8% in fiscal year 2005 to 23.1%, as restated, in fiscal year 2006. Cost of revenue increased primarily due to the higher costs associated with the consumer product lines acquired in the Roxio CSD acquisition. The increase is also due to the increase in amortization expense associated with the intangibles acquired as part of the Roxio CSD acquisition. We recorded $1.8 million and $5.1 of amortization in fiscal years 2005 and 2006, respectively.
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Included in cost of revenue in fiscal year 2006 is $1.2 million of costs related to the sale of certain patents acquired with the Roxio CSD acquisition.
Gross Profit
| | | | | | | | |
| | Years Ended March 31, |
| | | 2005 | | 2006 | | Inc (Dec) | | % |
| | | | | As Restated |
| Gross profit | | $ | 77,254 | | | $ | 113,476 | | | $ | 36,222 | | | | 46.9 | % |
| Gross profit as a percentage of revenue | | | 85.2 | % | | | 76.9 | % | | | -8.3 | % |
Our gross profit as a percentage of net revenue decreased from 85.2% in fiscal year 2005 to 76.9%, as restated, in fiscal year 2006, primarily due to the increase in cost of revenue as discussed above.
Marketing and Sales Marketing and sales expenses consist primarily 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 from $22.5 million, as restated, in fiscal year 2005 to $35.6 million, as restated, in fiscal year 2006. Marketing and sales represented 24.9%, as restated, and 24.1%, as restated, of net revenue for fiscal years 2005 and 2006, respectively.
The increase in marketing and sales expenses was primarily due to a $6.4 million increase in salary and benefit costs driven by the addition of 72 marketing and sales employees via the Roxio CSD acquisition, the related increase in promotional and advertising expenses of $3.1 million to support new products acquired in the Roxio CSD acquisition, and higher sales commissions associated with the overall increase in revenue and with the sale of certain patents acquired in the Roxio CSD acquisition. Further, we had a $1.3 million increase in facilities expenses attributable to the expanded operations resulting from the Roxio CSD acquisition. We recorded marketing and sales charges totaling $1.3 million and $3.8 million for share-based compensation expense and $0.1 million and $0.2 million for related payroll tax, Section 409A expense and other miscellaneous charges associated with the restatement in fiscal years 2005 and 2006, respectively.
Research and Development Research and development expenses consist primarily of employee salaries and benefits, facilities, travel and consulting expenses incurred in the development of new products. Our research and development expenses increased from $33.3 million, as restated, in fiscal year 2005 to $44.2 million, as restated, in fiscal year 2006. Research and development expenses represented 36.7%, as restated, and 29.9%, as restated, of net revenue for fiscal years 2005 and 2006, respectively.
Research and development expenses increased primarily due to a $7.0 million increase in salary and benefit costs and increased facility expense of $2.4 million. In December 2004, 113 research and development employees joined Sonic through the Roxio CSD acquisition. As a result of the restatement of fiscal years 2005 and 2006, we also recorded research and development charges of $1.5 million and $3.5 million for share-based compensation expense and $0.2 million and $0.1 million for related payroll tax, Section 409A expense and other miscellaneous charges associated with the restatement in fiscal years 2005 and 2006, respectively.
General and Administrative General and administrative expenses consist primarily of employee salaries and benefits, travel, overhead, corporate facilities expense, legal, accounting and other professional services expenses. General and administrative expenses increased from $11.8 million, as restated, in fiscal year 2005 to $22.2 million, as restated, in fiscal year 2006. General and administrative expenses represented 13.0%, as restated, and 15.0%, as restated, of net revenue for fiscal years 2005 and 2006, respectively.
General and administrative expenses increased in fiscal year 2006 primarily due to an $8.3 million increase in salary and benefit expenses related to the overall increase in our headcount from 296 at March 31, 2004 to 602 at March 31, 2005 to 637 at March 31, 2006 and a $2.4 million increase in professional service fees in fiscal 2006. During fiscal years 2005 and 2006, we incurred approximately $2.0 million and $1.5 million, respectively, in professional services expenses associated with the implementation of the requirements of Section 404 of the Sarbanes-Oxley Act. Finally, as a result of the restatement of fiscal years 2005 and 2006, we also recorded general and administrative charges of $1.6 million and $2.9 million for share-based compensation expense and $0.3 million and $2.4 million for related payroll tax, Section 409A expense and other miscellaneous charges associated with the restatement in fiscal years 2005 and 2006, respectively.
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Acquired In-Process Technology Acquired in-process technology expense of $3.1 million for fiscal year 2005 included the write-off of in-process research and development acquired in connection with the Roxio CSD acquisition. We identified research projects ongoing at the time of the Roxio CSD acquisition for which technological feasibility had not been established and no alternative future use existed. The value for each of the projects was determined by estimating the expected cash flows from the projects once commercially viable, discounting the net cash flows to their present value, and the applying a percentage of completion to the calculated value.
Business Integration Expense Business integration expenses represented costs incurred during the integration of the Roxio CSD business into our existing operations. These expenses included incremental costs consisting primarily of employee severance and lease exit costs totaling approximately $1.4 million, a portion of internal payroll costs for those employees who worked on the acquisition totaling approximately $0.7 million and incremental costs incurred by consultants who worked on the acquisition and integration totaling approximately $0.1 million.
Interest Income, Interest Expense, and Other Expenses, Net Other income in our consolidated statements of operations included the interest we earned on cash balances and short term investments and realized foreign currency gains. Interest income was approximately $1.0 million and $1.3 million for the fiscal years 2005 and 2006, respectively. Interest income increased as a result of our increased cash balances invested and rising interest rates. Interest expense for fiscal years 2005 and 2006 primarily consisted of interest expense of approximately $0.2 million and $1.8 million, respectively, relating to the interest due on the Union Bank of California N.A. Amended Credit Facility described under “Liquidity and Capital Resources” below. Other income and expense for fiscal years 2005 and 2006 included foreign currency transaction gains and losses. Other expense in fiscal years 2005 and 2006 also included write-downs of investments in other entities, which totaled approximately $0.1 million for both periods.
Provision for Income Taxes We recorded an income tax provision in the amount of $1.8 million, as restated, in fiscal 2005 and an income tax benefit of $9.2 million, as restated, in fiscal year 2006. In fiscal year 2006, we reversed the majority of our valuation allowances against deferred tax assets due to our assessment that it is more likely than not that these deferred assets will be realized.
Fiscal Year 2006, As Restated, Compared to Fiscal Year 2007 (in thousands)
| | | | | | | | |
| | Years Ended March 31, |
| Net Revenues | | 2006 | | 2007 | | Inc (Dec) | | % |
| | | As Restated |
| Roxio Division | | $ | 117,333 | | | $ | 122,326 | | | $ | 4,993 | | | | 4.3 | % |
| Advanced Technology Group | | | 19,021 | | | | 18,088 | | | | (933 | ) | | | (4.9%) | |
| Total consumer products | | | 136,354 | | | | 140,414 | | | | 4,060 | | | | 3.0 | % |
| Professional products | | | 11,254 | | | | 8,235 | | | | (3,019 | ) | | | -26.8 | % |
| Net revenues | | $ | 147,608 | | | $ | 148,649 | | | $ | 1,041 | | | | 0.7 | % |
Net revenue increased slightly from $147.6 million, as restated, for fiscal year 2006 to $148.6 million for fiscal year 2007. The increase in net revenue in fiscal 2007 was driven by a $4.1 million increase in consumer product revenues offset by a $3.0 million decrease in professional product revenue. Consumer product revenues increased due to higher revenue from new and existing OEM partners. The decrease in our professional products revenue was due to lower sales of standard definition DVD products and the content community’s slow adoption of new high-definition disc formats as a result of the continued competition between HD DVD and Blu-ray Disc. The decrease in the professional products revenue was also due to a change in revenue recognizable for the sale of software licenses when bundled with maintenance and support agreements. For the quarter ended December 31, 2006, we determined that we did not have VSOE for maintenance and support agreements associated with our professional products. Thus, beginning with the quarter ended December 31, 2006, we defer revenue associated with professional product software licenses when sold with bundled maintenance and support services and recognize the revenue over the maintenance and support period which is generally one year.
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| | | | | | | | |
| | Years Ended March 31, |
| Net Revenues | | 2006 | | 2007 | | Inc (Dec) | | % |
| | | As Restated |
| United States | | $ | 113,100 | | | $ | 116,371 | | | $ | 3,271 | | | | 2.9 | % |
Export
| | | | | | | | | | | | | | | | |
| Canada | | | 262 | | | | 615 | | | | 353 | | | | 134.7 | % |
| France | | | 2,338 | | | | 1,275 | | | | (1,063 | ) | | | -45.5 | % |
| Germany | | | 2,181 | | | | 3,038 | | | | 857 | | | | 39.3 | % |
| United Kingdom | | | 6,141 | | | | 3,821 | | | | (2,320 | ) | | | -37.8 | % |
| Other European | | | 4,530 | | | | 4,579 | | | | 49 | | | | 1.1 | % |
| Japan | | | 14,873 | | | | 13,282 | | | | (1,591 | ) | | | -10.7 | % |
| Singapore | | | 2,241 | | | | 3,682 | | | | 1,441 | | | | 64.3 | % |
| Taiwan | | | 312 | | | | 175 | | | | (137 | ) | | | -43.9 | % |
| Other Pacific Rim | | | 1,300 | | | | 1,588 | | | | 288 | | | | 22.2 | % |
| Other International | | | 330 | | | | 223 | | | | (107 | ) | | | -32.4 | % |
| Net revenues | | $ | 147,608 | | | $ | 148,649 | | | $ | 1,041 | | | | 0.7 | % |
International sales accounted for $34.5 million, as restated, or 23%, as restated, of our net revenue in fiscal year 2006 as compared to $32.3 million or 22% of our net revenue in fiscal year 2007. A decrease in international sales of our professional products, consistent with the overall decrease in sales of our professional products, contributed to a significant decrease in sales in France, United Kingdom, and Japan, offset by a significant increase in our sales of consumer products in the United States.
Significant Customers
| | | | | | |
| | % of Total Revenues | | % of Total
Accounts
Receivable |
| | | Years Ended March 31, | | March 31,
2007 |
| Customer | | 2006 | | 2007 |
| | | As Restated |
| Dell | | | 20 | % | | | 23 | % | | | 10 | % |
| Ingram | | | 10 | % | | | 9 | % | | | 11 | % |
| Digital River | | | 17 | % | | | 20 | % | | | 12 | % |
| Navarre | | | 12 | % | | | 13 | % | | | 12 | % |
No other customer accounted for more than 10% of our revenue for fiscal years 2006 and 2007. Revenue recognized from Dell 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 assumed in connection with the business lines acquired with the Roxio CSD acquisition. 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 harm our sales and results of operations.
Cost of Revenue Cost of revenue consists mainly of the costs 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. Our cost of revenue as a percentage of net revenue was 23.1%, as restated, of net revenue for fiscal year 2006, consistent with 23.1% for fiscal year 2007.
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Gross Profit
| | | | | | | | |
| | Years Ended March 31, |
| | | 2006 | | 2007 | | Inc (Dec) | | % |
| | | As Restated |
| Gross profit | | $ | 113,476 | | | $ | 114,260 | | | $ | 784 | | | | 0.7 | % |
| Gross profit as a percentage of revenue | | | 76.9 | % | | | 76.9 | % | | | 0.0 | % | | | | |
Our gross profit as a percentage of net revenue of 76.9%, as restated, for fiscal year 2006 remained constant at 76.9% for fiscal year 2007.
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 decreased from $35.6 million, as restated, in fiscal year 2006 to $33.3 million in fiscal year 2007. Marketing and sales represented 24.1%, as restated, and 22.4% of net revenue for fiscal years 2006 and 2007, respectively. The decrease was driven primarily by a decrease in share-based compensation and related expenses. As a result of the restatement of fiscal year 2006 and certain fiscal year 2007 periods, we included in marketing and sales $3.8 million and $1.3 million of share-based compensation expense, and $0.2 million and $0.8 million related payroll tax, Section 409A expense and other miscellaneous charges associated with the restatement for fiscal years 2006 and 2007, respectively. Additionally, fiscal year 2006 included $0.5 million in commission expense associated with the sale of certain patents acquired with the Roxio CSD acquisition. Marketing and sales headcount decreased from 158 at March 31, 2006 to 118 at March 31, 2007. We anticipate that marketing and sales expenses may increase in the future due to higher promotional spending to support new product initiatives.
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 slightly from $44.2 million, as restated in fiscal year 2006 to $44.5 million in fiscal year 2007. Research and development expenses represented 29.9% of net revenue for fiscal years 2006 and 2007.
Salaries and benefits costs increased by approximately $3.2 million and headcount grew from 394 at March 31, 2006 to 476 at March 31, 2007 as we expanded our research and development team in China. Computer software and supplies increased by $0.8 million. These increases were partially offset by a $1.3 million reduction in expenses incurred to translate and otherwise create localized versions of our products driven by a change to a lower cost localization vendor and decreased share-based compensation and related tax expense in fiscal year 2007. As a result of the restatement of fiscal year 2006 and certain fiscal year 2007 periods, research and development expenses included $3.5 million and $0.7 million of share-based compensation expense, and $0.1 million and $0.4 million of related payroll tax, Section 409A expense and other miscellaneous charges associated with the restatement, in fiscal years 2006 and 2007, respectively.
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. General and administrative expenses decreased from $22.2 million, as restated, in fiscal year 2006 to $20.5 million, in fiscal year 2007. General and administrative expenses represented 15.0%, as restated, and 13.8% of net revenue for fiscal years 2006 and 2007, respectively.
General and administrative expenses decreased primarily due to lower share-based compensation and related charges in fiscal year 2007. General and administrative expenses include $2.9 million and $0.7 million of share-based compensation expense, and $2.4 million and $0.7 million of related payroll tax, Section 409A expense and other miscellaneous charges for fiscal years 2006 and 2007, respectively. Other items affecting the change in general and administrative expenses included:
| • | Personnel related expenses increased approximately $1.1 million in fiscal year 2007 due to an increase in general and administrative headcount from 86 at March 31, 2006 to 140 at March 31, 2007. |
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| • | Fiscal year 2006 included the release of $1.3 million of reserves related to the allowance for returns and discounts as a reduction to general and administrative expenses following an analysis of reserves acquired in the Roxio CSD acquisition. |
| • | During fiscal 2007, we reduced reserves for contingent legal liabilities by approximately $0.7 million, net of acquired contingent liabilities due to favorable developments in certain potential claims. |
| • | We incurred approximately $0.6 million in professional service fees in connection with our voluntary review of historical stock option grant practices and related accounting. |
| • | In fiscal 2007 we recorded a charge of $0.3 million due primarily to a reduction in value added tax (“VAT”) receivables as a result of a VAT audit in a foreign subsidiary. |
We anticipate that general and administrative expenses will increase in fiscal year 2008, primarily due to professional fees and other expenses associated with our voluntary review of historical stock option grant practices and related accounting.
Business Integration Expense During fiscal year 2006, business integration expenses related primarily to costs incurred to complete the integration of the Roxio CSD business into our existing operations. We did not incur any business integration expenses during fiscal year 2007.
Abandoned Acquisition Expense Abandoned acquisition expenses in fiscal year 2007 consisted primarily of third party legal, accounting and other professional service fees in connection with an abandoned potential acquisition.
Interest Income, Interest Expense, and Other Expenses, Net Interest income in our consolidated statements of operations included the interest we earned on cash balances and short term investments. Interest income was approximately $1.3 million and $2.8 million for the fiscal years 2006 and 2007, respectively. Interest income increased as a result of higher average cash and short-term balances invested and rising interest rates. Interest expense for fiscal years 2006 and 2007 primarily consisted of interest expense of approximately $1.8 million and $2.0 million, respectively, relating to the interest due on the Union Bank of California N.A. (“UBOC”) Amended Credit Facility described under “Liquidity and Capital Resources” below. Other expenses for fiscal years 2006 and 2007 included foreign currency transaction gains and losses.
Provision for Income Taxes We recorded an income tax benefit in the amount of $9.2 million, as restated, in fiscal year 2006 and an income tax provision of $6.1 million in fiscal year 2007. In fiscal year 2006, we reversed the majority of our valuation allowances against deferred tax assets due to our assessment that it is more likely than not that these deferred assets will be realized.
Acquisitions
On December 17, 2004, we completed our purchase of the Roxio CSD. Under the terms of the transaction, we acquired substantially all of the assets of the Roxio CSD, including all products, intellectual property and trademarks, as well as the “Roxio” name. Under the terms of the Amended Purchase Agreement, we initially paid the seller $70.0 million in cash and issued 653,837 shares of our common stock valued at $8.6 million (together, the “Purchase Price”), plus an aggregate of approximately $2.3 million representing certain additional amounts payable under the Amended Purchase Agreement pursuant to working capital and channel inventory adjustment calculations. The common stock was valued using the closing price of our stock for the two days before through two days following August 9, 2004, the date of the original Purchase Agreement and announcement of the purchase. In addition, the Amended Purchase Agreement anticipated certain potential additional adjustments of the cash portion of the Purchase Price based on final working capital calculations. During the fourth quarter of fiscal year 2006, we made a final payment to the seller in the amount of $2.2 million in connection with the finalized working capital calculations and as a settlement of other obligations related to the acquisition. Two hundred and twelve former Roxio CSD employees joined Sonic. The majority of the employees are located in Santa Clara, California and Richmond Hill, Canada.
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
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shares of our common stock valued at approximately $0.5 million and estimated transaction costs of approximately $0.1 million. The acquisition expands 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 believe the extended consumer product portfolio will help further establish the brand as a choice for a broad range of channel partners, including major retailers, etailers, OEMs, and resellers.
LIQUIDITY AND CAPITAL RESOURCES
Our primary source of cash is from sales of our product. Our primary use of cash is for the payment of our operating expenses. Our principal source of liquidity is cash and cash equivalents and short-term investments. As of March 31, 2006 and 2007, we had cash, cash equivalents and short term investments of $61.1 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.
Our operating activities generated cash of $23.2 million in fiscal year 2006 and $18.7 million in fiscal year 2007. Significant sources of cash in fiscal year 2006 were: net income of $19.3 million inclusive of non-cash charges of $9.6 million and $10.2 million for depreciation and amortization expense and share-based compensation, respectively, and $12.3 million tax benefit from our employee stock option plans. The depreciation and amortization expenses increased primarily due to the amortization associated with the Roxio CSD acquisition. The share-based compensation and tax benefit from our employee stock option plans amounts were primarily due to the restatement associated with the voluntary stock option review. Significant uses of cash in fiscal year 2006 were: increase in provision for returns and doubtful accounts of $3.6 million, due to the increase in required reserves, increase in prepaid expenses and other assets of $2.7 million associated with various operating expenses, increase in deferred income taxes of $24.3 million, primarily as a result of the release of a valuation reserve against deferred tax assets and the restatement associated with the voluntary stock option review.
Significant sources of cash in fiscal year 2007 were: net income of $6.3 million inclusive of non-cash charges of $9.4 million, $2.8 million, and $3.4 million for depreciation and amortization expense, share-based compensation, and acquired in-process technology, respectively. The depreciation and amortization expenses are primarily associated with the Roxio and SystemOK acquisitions, and the acquired in-process technology expense is associated with the SystemOK acquisition. Significant uses of cash in fiscal year 2007 were: decrease in accrued liabilities of $3.2 million resulting from timing of payments on various liabilities, and a decrease in deferred revenue due to recognition of previously deferred amounts.
We used $44.9 million and $14.5 million of cash in investing activities in fiscal years 2006 and 2007, respectively. During fiscal 2006, net purchases of short term investments totaled $42.4 million. During fiscal year 2007, net purchases of short term investments totaled $4.9 million and we used $7.3 million for the purchase of SystemOK.
We generated $5.8 million in cash from financing activities during fiscal year 2006 and used $5.8 million during fiscal year 2007. Proceeds from the exercise of stock options generated the cash provided by financing activities in fiscal year 2006. During fiscal year 2007, we received $2.7 million from the exercise of stock options and made a $10.0 million payment on our credit facility with UBOC.
Our working capital decreased $6.1 million from $41.9 million at March 31, 2006 to $35.8 million at March 31, 2007. The decrease in working capital was primarily due to the reclassification of our borrowings under the UBOC bank note from long term to short term. The UBOC bank note expires and is due on March 31, 2008. Our ratio of current assets to current liabilities declined from 1.9:1 at March 31, 2006 to 1.6:1 at March 31, 2007.
In February 2004, we filed a Form S-3 Registration Statement, as amended, with the SEC to register our common stock, preferred stock and warrants to purchase common stock and preferred stock with an aggregate maximum offering price not to exceed $80 million. The registration statement was declared effective by the SEC. In June 2004, we completed an underwritten public offering of 1.3 million shares of our common stock to institutional investors at a price of $19.48 per share for gross proceeds of $25.3 million under an existing
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Form S-3 Registration Statement. We received net proceeds of approximately $23.9 million after deducting underwriting discounts and expenses associated with the offering.
On December 13, 2004 we entered into a Loan and Security Agreement with UBOC that provided for a three-year revolving credit facility. On December 20, 2005, we entered into the First Amendment to the Loan and Security Agreement (the “Amended Credit Facility”) which provided for $30.0 million of available funds for general corporate purposes. The Amended Credit Facility also clarified certain Credit Facility terms, amended the required leverage ratio and provided for letters of credit up to $30.0 million less any outstanding borrowings under the Amended Credit Facility.
The Amended Credit Facility 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 Loan Agreement, 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. We are also subject to certain reporting and financial covenants, which include requirements that we maintain specified financial ratios and a net profit for each quarter following the fourth quarter of fiscal year 2005. 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 in the Loan Agreement 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 March 31, 2007, the interest rate was 6.82%.
As a result of a $3.4 million charge for in-process technology associated with our acquisition of SystemOK, we recognized a net loss for the quarter ended December 31, 2006 and were not in compliance with the quarterly net profit covenant under the Amended Credit Facility. Additionally, we recognized a net loss in the quarter ended March 31, 2007 primarily due to charges for payroll taxes and employee taxes under Section 409A of the Code associated with our options review.
Subsequent to December 31, 2006 we did not file quarterly and annual financial statements in a timely manner as required under the Amended Credit Facility. Additionally, based on preliminary financial results, we determined that we were unlikely to meet the quarterly net profit covenant for the quarter ended June 30, 2007 and the required leverage ratio as of June 30, 2007. As a result of these issues, we entered into a Second Amendment to the Loan and Security Agreement with UBOC on September 28, 2007. The Second Amendment extended the maturity date of the Amended Credit Facility to March 31, 2008, provided waivers for violations of the reporting covenants and anticipated June 30, 2007 financial covenant violations, modified financial covenants and further restricted payment of dividends and distributions. The Second Amendment did not waive the quarterly net profit covenant violations for the quarters ended December 31, 2006 and March 31, 2007 as such violations were not known at the time.
As of March 31, 2007, the outstanding balance on the Amended Credit Facility was $20.0 million and was classified as a current liability. As of February 15, 2008, UBOC has not notified us of any intent to take the actions necessary to accelerate the repayment of our obligations under the agreement. We have not yet determined whether we will seek a further extension under the existing agreement, enter into a new credit facility agreement, or pay the outstanding balance in full upon expiration on March 31, 2008.
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
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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.
Contractual Obligations and Commitments
The following table summarizes our known contractual obligations to make future payments at March 31, 2007 (in thousands):
| | | | | | | | | | |
| | | | Payments Due by Period |
| Contractual Obligations | | Total | | Less
Than
1 Year | | 1 – 3 Years | | 3 – 5 Years | | More
Than 5
Years |
| Operating and capital leases(1) | | $ | 13,006 | | | $ | 4,550 | | | $ | 8,456 | | | $ | — | | | $ | — | |
| Debt obligation(2) | | | 21,364 | | | | 21,364 | | | | — | | | | — | | | | — | |
| Total | | $ | 34,370 | | | $ | 25,914 | | | $ | 8,456 | | | $ | — | | | $ | — | |
| (1) | Operating and capital leases includes our rent obligations on our properties and our site restoration obligation to restore one facility back to its original state upon termination of the lease. |
| (2) | As of March 31, 2007, the outstanding balance on the Amended Credit Facility with UBOC was $20.0 million. The Amended Credit Facility matures on March 31, 2008. Interest on our Credit Facility is calculated at the effective interest rate of 6.82% at March 31, 2007. |
We sell our software licenses and services to our customers under software license agreements. Each software license agreement contains the relevant terms of the contractual arrangement with the customer, and generally includes provisions that address indemnification of the customer against losses, expenses, and liabilities from damages that may be awarded against the customer in the event our software is found to infringe upon a third-party patent, copyright, trademark, or other proprietary right. Our standard software license agreement generally limits the scope of and remedies for such indemnification obligations in a variety of industry-standard respects, including, but not limited to, certain time- and geography-based scope limitations, limits on aggregate liability, and a right to replace an infringing product.
We believe our internal development processes and other policies and practices limit our exposure related to the indemnification provisions of our software license agreements. To date, we have not had to reimburse any of our customers for any losses related to these indemnification provisions and we are not aware of any material claims. We evaluate estimated losses for such indemnification provisions under SFAS No. 5, “Accounting for Contingencies,” as interpreted by FIN No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” We require our employees to sign a proprietary information and inventions agreement, in order to protect our confidential and proprietary information and to assign the rights of our employees’ development work to us.
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.
Recent Accounting Pronouncements
In June 2006, the FASB ratified the consensus reached by the EITF in Issue No. 06-03, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross Versus Net Presentation).” The EITF concluded that the presentation of taxes assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a customer such as sales, use, value added and certain excise taxes, is an accounting policy decision that should be disclosed in a company's financial statements. Additionally, companies that record such taxes on a gross basis should disclose the amounts of those taxes in interim and annual financial statements for each period for which an income statement is presented if those amounts are significant. EITF 06-03 is effective for
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fiscal years beginning after December 15, 2006. We previously have and currently present such taxes on a net basis. Therefore, the adoption of EITF 06-03 will not have a material impact on our financial position, results of operations or cash flows.
In July 2006, the FASB issued FIN 48, “Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109,” which clarifies the accounting for income taxes by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006 and is effective for us as of the beginning of fiscal year 2008. The differences, if any, between the amounts recognized in the statements of financial position prior to the adoption of FIN 48 and the amounts reported after adoption will be accounted for as a cumulative-effect adjustment recorded to the beginning balance of retained earnings. We are currently in the process of evaluating the effect of FIN 48 on our financial position and results of operations.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,”which defines fair value, establishes a framework for measuring fair value in accordance with GAAP, expands disclosures about fair value measurements, and applies under 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. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, with early adoption permitted. We will adopt SFAS No. 157 in fiscal year 2008 and 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 FASB Statement 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 arrangements and not to portions of instruments. SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. We will adopt SFAS No. 159 in fiscal year 2008 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. The standard 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. Statement 141(revised) is effective for fiscal years beginning after December 15, 2008, with early adoption prohibited. We will adopt SFAS No. 141(revised) in fiscal year 2010 and are currently evaluating what impact, if any, SFAS No. 141(revised) will have on our financial position or results of operations.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
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. See Note 10 to consolidated financial statements. We do not engage in any hedging activities.
We do not use derivatives or equity investments for cash investment purposes.
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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 March 31, 2007, we held $47.3 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 February 15, 2008, we had liquidated all but $2.0 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 primarily to our long-term debt obligations.
All borrowings at March 31, 2007 under our Amended Credit Facility currently bear interest at 6.82%, which represents the base rate, or LIBOR, plus the applicable margin. Interest is payable in accordance with credit agreements.
The following table estimates the impact of interest payments on cash flow from operations for the year ended March 31, 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 (in thousands):
| | | | | | | | | | |
| | Interest Rate
Decrease | | No Change
to Interest Rate
| | Interest Rate
Increase |
| | | 100 BPS | | 50 BPS | | 50 BPS | | 100 BPS |
| | | | $1,564 | | | | $1,464 | | | | $1,364 | | | | $1,264 | | | | $1,164 | |
Item 8. Financial Statements and Supplementary Data
The report of Independent Registered Public Accounting Firm, Consolidated Financial Statements and Notes to Consolidated Financial Statements follow.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders of
Sonic Solutions:
We have audited Sonic Solutions’ internal control over financial reporting as of March 31, 2007, based on criteria established inInternal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Sonic Solutions’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed 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. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. A material weakness regarding management’s failure to maintain sufficient personnel with an appropriate level of accounting knowledge, experience and training in the application of generally accepted accounting principles (GAAP) that provides oversight, supervision and timely reviews of staff work of account analysis and reconciliations has been identified and described in management’s assessment. A material weakness regarding failure to maintain sufficient oversight, review and supervision of staff and consultants’ work has been identified and described in management’s assessment. This material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2007 financial statements, and this report does not affect our report dated February 25, 2008 on those financial statements.
In our opinion, Sonic Solutions did not maintain, in all material respects, effective internal control over financial reporting as of March 31, 2007, based on the COSO criteria. We do not express an opinion or any other form of assurance on management’s statements referring to any corrective actions taken by the company after the date of management’s assessment.
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We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Sonic Solutions as of March 31, 2007 and 2006, restated, and the related consolidated statements of income and comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended March 31, 2007, and our report dated February 25, 2008 expressed an unqualified opinion thereon.
/s/ BDO Seidman, LLP
San Francisco, California
February 25, 2008
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders of
Sonic Solutions:
We have audited the accompanying consolidated balance sheets of Sonic Solutions and subsidiaries as of March 31, 2006 and 2007, and the related consolidated statements of operations, shareholders’ equity and comprehensive income (loss) and cash flows for each of the three years in the period ended March 31, 2007. In connection with our audits of the financial statements, we have also audited the schedule listed in the accompanying index. These consolidated financial statements and the schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and the schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Sonic Solutions and subsidiaries as of March 31, 2006 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended March 31, 2007, in conformity with accounting principles generally accepted in the United States of America.
Also in our opinion, the related schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects the information set forth therein.
We also have audited, in accordance with the standard of the Public Company Accounting Oversight Board (United States), the effectiveness of Sonic Solutions’ internal control over financial reporting as of March 31, 2007, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 25, 2008 expressed an adverse opinion thereon.
As discussed in Note 1 to the Notes to Consolidated Financial Statements, effective April 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards No. 123(R),Share-Based Payment, as revised.
As discussed in Note 2 to the Consolidated Financial Statements, the Company has restated its 2005 and 2006 financial statements.
/s/ BDO Seidman, LLP
San Francisco, California
February 25, 2008
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FINANCIAL STATEMENTS
SONIC SOLUTIONS
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
| | | | |
| | March 31, |
| | | 2006 | | 2007 |
| | | As Restated(1) | | |
ASSETS
| | | | | | | | |
Current assets:
| | | | | | | | |
| Cash and cash equivalents | | $ | 18,731 | | | $ | 17,090 | |
| Short-term investments | | | 42,350 | | | | 47,250 | |
| Accounts receivable, net of allowances of $5,235 and $4,778 at March 31, 2006 and 2007, respectively | | | 18,980 | | | | 17,855 | |
| Inventory | | | 689 | | | | 807 | |
| Deferred tax benefits | | | 3,879 | | | | 9,773 | |
| Prepaid expenses and other current assets | | | 3,771 | | | | 4,686 | |
| Total current assets | | | 88,400 | | | | 97,461 | |
| Fixed assets, net | | | 4,833 | | | | 3,241 | |
| Purchased and internally developed software costs, net | | | 1,266 | | | | 1,040 | |
| Goodwill | | | 51,673 | | | | 55,508 | |
| Acquired intangibles, net | | | 43,914 | | | | 40,172 | |
| Deferred tax benefit, net | | | 22,895 | | | | 15,489 | |
| Other assets | | | 1,355 | | | | 1,866 | |
| Total assets | | $ | 214,336 | | | $ | 214,777 | |
LIABILITIES AND SHAREHOLDERS' EQUITY
| | | | | | | | |
Current liabilities:
| | | | | | | | |
| Accounts payable | | $ | 7,833 | | | $ | 5,926 | |
| Accrued expenses and other current liabilities | | | 30,483 | | | | 30,188 | |
| Deferred revenue | | | 8,161 | | | | 5,558 | |
| Bank note payable | | | — | | | | 20,000 | |
| Total current liabilities | | | 46,477 | | | | 61,672 | |
| Bank note payable | | | 30,000 | | | | — | |
| Other long term liabilities, net of current portion | | | 375 | | | | 2,248 | |
| Deferred revenue, net of current portion | | | 2 | | | | 24 | |
| Total liabilities | | | 76,854 | | | | 63,944 | |
Commitments and contingencies (Note 7)
| | | | | | | | |
Shareholders' equity:
| | | | | | | | |
| Convertible preferred stock, no par value, 10,000,000 shares authorized; 0 shares issued outstanding at March 31, 2006, and 2007, respectively. | | | — | | | | — | |
| Common stock, no par value, 100,000,000 shares authorized; 25,685,953 and 26,197,119 shares issued and outstanding at March 31, 2006, and 2007, respectively | | | 155,484 | | | | 162,565 | |
| Accumulated other comprehensive loss | | | (937 | ) | | | (917 | ) |
| Accumulated deficit | | | (17,065 | ) | | | (10,815 | ) |
| Total shareholders' equity | | | 137,482 | | | | 150,833 | |
| Total liabilities and shareholders' equity | | $ | 214,336 | | | $ | 214,777 | |
| (1) | See Note 2 “Restatement of Consolidated Financial Statements and Change in Accounting Policy” to Consolidated Financial Statements. |
See accompanying notes to consolidated financial statements.
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CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share amounts)
| | | | | | |
| | Years Ended March 31, |
| | | 2005 | | 2006 | | 2007 |
| | | As Restated(1) | | As Restated(1) | | |
| Net revenue | | $ | 90,627 | | | $ | 147,608 | | | $ | 148,649 | |
| Cost of revenue | | | 13,373 | | | | 34,132 | | | | 34,389 | |
| Gross profit | | | 77,254 | | | | 113,476 | | | | 114,260 | |
Operating expenses:
| | | | | | | | | | | | |
| Marketing and sales(2) | | | 22,547 | | | | 35,606 | | | | 33,304 | |
| Research and development(2) | | | 33,299 | | | | 44,157 | | | | 44,513 | |
| General and administrative(2) | | | 11,777 | | | | 22,214 | | | | 20,487 | |
| Acquired in-process technology | | | 3,100 | | | | — | | | | 3,400 | |
| Abandoned acquisition | | | — | | | | — | | | | 1,016 | |
| Business integration | | | 2,190 | | | | 336 | | | | — | |
| | | | 72,913 | | | | 102,313 | | | | 102,720 | |
| Operating income | | | 4,341 | | | | 11,163 | | | | 11,540 | |
| Interest income | | | 998 | | | | 1,271 | | | | 2,845 | |
| Interest expense | | | (214 | ) | | | (1,846 | ) | | | (2,024 | ) |
| Other expense | | | (607 | ) | | | (431 | ) | | | (40 | ) |
| Income before income taxes | | | 4,518 | | | | 10,157 | | | | 12,321 | |
| Provision (benefit) for income taxes | | | 1,771 | | | | (9,177 | ) | | | 6,071 | |
| Net income | | $ | 2,747 | | | $ | 19,334 | | | $ | 6,250 | |
Net income per share:
| | | | | | | | | | | | |
| Basic | | $ | 0.12 | | | $ | 0.78 | | | $ | 0.24 | |
| Diluted | | $ | 0.11 | | | $ | 0.74 | | | $ | 0.23 | |
Shares used in computing net income per share:
| | | | | | | | | | | | |
| Basic | | | 23,347 | | | | 24,750 | | | | 25,982 | |
| Diluted | | | 24,952 | | | | 26,234 | | | | 27,431 | |
| (1) | See Note 2 “Restatement of Consolidated Financial Statements and Change in Accounting Policy” to Consolidated Financial Statements. |
| (2) | Includes share-based compensation expense as follows: |
| | | | | | |
| Marketing and sales | | $ | 1,345 | | | $ | 3,846 | | | $ | 1,284 | |
| Research and development | | | 1,527 | | | | 3,460 | | | | 740 | |
| General and administrative | | | 1,620 | | | | 2,928 | | | | 741 | |
| Total share-based compensation expense | | $ | 4,492 | | | $ | 10,234 | | | $ | 2,765 | |
See accompanying notes to consolidated financial statements.
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CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(in thousands)
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | | | | | Accumulated Deficit | | Accumulated
Other
Comprehensive
Loss | | Total
Shareholders’
Equity | | Other
Comprehensive
Income (Loss) |
| | | Common Stock |
| | | Shares | | Amount |
Balances at March 31, 2004, As
Previously Reported | | | 21,885 | | | $ | 70,994 | | | $ | (15,255 | ) | | $ | (16 | ) | | $ | 55,723 | | | | | |
| Cumulative effect of restatement | | | — | | | | 16,570 | | | | (21,006 | ) | | | — | | | | (4,436 | ) | | | | |
Balances at March 31, 2004 — As
Restated(1) | | | 21,885 | | | | 87,564 | | | | (36,261 | ) | | | (16 | ) | | | 51,287 | | | | | |
| Exercise of common stock options | | | 470 | | | | 2,101 | | | | — | | | | — | | | | 2,101 | | | | | |
| Share-based compensation expense | | | | | | | 4,492 | | | | — | | | | — | | | | 4,492 | | | | | |
| Issuance of common stock | | | 1,954 | | | | 32,531 | | | | — | | | | — | | | | 32,531 | | | | | |
Tax benefit from employee stock option
plans | | | — | | | | 353 | | | | — | | | | — | | | | 353 | | | | | |
| Foreign currency translation adjustment | | | — | | | | — | | | | — | | | | (258 | ) | | | (258 | ) | | $ | (258 | ) |
| Net income, restated | | | — | | | | — | | | | 2,747 | | | | — | | | | 2,747 | | | | 2,747 | |
Balances at March 31, 2005 — As
Restated(1) | | | 24,309 | | | | 127,041 | | | | (33,514 | ) | | | (274 | ) | | | 93,253 | | | $ | 2,489 | |
| Exercise of common stock options | | | 1,377 | | | | 5,864 | | | | — | | | | — | | | | 5,864 | | | | | |
| Share-based compensation expense | | | — | | | | 10,234 | | | | — | | | | — | | | | 10,234 | | | | | |
Tax benefit from employee stock option
plans | | | — | | | | 12,345 | | | | — | | | | — | | | | 12,345 | | | | | |
| Cummulative effect of accounting change, net of tax | | | — | | | | — | | | | (2,885 | ) | | | — | | | | (2,885 | ) | | $ | (2,885 | ) |
| Foreign currency translation adjustment | | | — | | | | — | | | | — | | | | (663 | ) | | | (663 | ) | | | (663 | ) |
| Net income, restated | | | — | | | | — | | | | 19,334 | | | | — | | | | 19,334 | | | | 19,334 | |
Balances at March 31, 2006 — As
Restated(1) | | | 25,686 | | | | 155,484 | | | | (17,065 | ) | | | (937 | ) | | | 137,482 | | | $ | 15,786 | |
| Exercise of common stock options | | | 480 | | | | 2,717 | | | | — | | | | — | | | | 2,717 | | | | | |
| Shares issued for SystemOK acquisition | | | 31 | | | | 489 | | | | — | | | | — | | | | 489 | | | | | |
| Share-based compensation expense | | | — | | | | 2,765 | | | | — | | | | — | | | | 2,765 | | | | | |
| Tax benefit from employee stock option plans | | | — | | | | 1,110 | | | | — | | | | — | | | | 1,110 | | | | | |
| Foreign currency translation adjustment | | | — | | | | — | | | | — | | | | 20 | | | | 20 | | | $ | 20 | |
| Net income | | | — | | | | — | | | | 6,250 | | | | — | | | | 6,250 | | | | 6,250 | |
| Balances at March 31, 2007 | | | 26,197 | | | $ | 162,565 | | | $ | (10,815 | ) | | $ | (917 | ) | | $ | 150,833 | | | $ | 6,270 | |
| (1) | See Note 2 “Restatement of Consolidated Financial Statements and Change in Accounting Policy” to Consolidated Financial Statements. |
See accompanying notes to consolidated financial statements.
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CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
| | | | | | |
| | Years Ended March 31, |
| | | 2005 | | 2006 | | 2007 |
| | | As Restated(1) | | As Restated(1) | | |
Cash flows from operating activities:
| | | | | | | | | | | | |
| Net income | | $ | 2,747 | | | $ | 19,334 | | | $ | 6,250 | |
Adjustments to reconcile net income to net cash generated by operating activities:
| | | | | | | | | | | | |
| Depreciation and amortization | | | 4,393 | | | | 9,607 | | | | 9,418 | |
| Deferred income taxes | | | (640 | ) | | | (24,330 | ) | | | 3,902 | |
| Provision for returns and doubtful accounts, net of write-offs | | | (108 | ) | | | (3,572 | ) | | | (457 | ) |
| Share-based compensation | | | 4,492 | | | | 10,234 | | | | 2,765 | |
| Tax benefit from employee stock option plans | | | 353 | | | | 12,345 | | | | 1,110 | |
| Excess tax benefit from share based compensation | | | — | | | | — | | | | (1,486 | ) |
| Acquired in-process technology | | | 3,100 | | | | — | | | | 3,400 | |
| Release of acquisition reserve | | | — | | | | (1,261 | ) | | | — | |
| Loss on disposal of assets | | | — | | | | 23 | | | | 162 | |
| Cumulative effect of accounting change in revenue recognition | | | — | | | | (2,885 | ) | | | — | |
| Changes in operating assets and liabilities, net | | | | | | | | | | | | |
| Accounts receivable | | | 319 | | | | (1,230 | ) | | | 2,902 | |
| Inventory | | | 401 | | | | 66 | | | | (117 | ) |
| Prepaid expenses and other assets | | | 781 | | | | (2,740 | ) | | | (879 | ) |
| Other Assets | | | (987 | ) | | | 1,228 | | | | (534 | ) |
| Acquired intangibles sold as part of operations | | | — | | | | 1,169 | | | | — | |
| Accounts payable | | | 4,477 | | | | (1,961 | ) | | | (1,908 | ) |
| Accrued liabilities and other current liabilities | | | 1,894 | | | | 4,909 | | | | (3,203 | ) |
| Deferred revenue | | | 967 | | | | 2,231 | | | | (2,581 | ) |
| Net cash provided by operating activities | | | 22,189 | | | | 23,167 | | | | 18,744 | |
Cash flows from investing activities:
| | | | | | | | | | | | |
| Purchase of fixed assets | | | (3,035 | ) | | | (1,761 | ) | | | (1,276 | ) |
| Additions to purchased and internally developed software | | | (635 | ) | | | (776 | ) | | | (1,110 | ) |
| InterActual goodwill adjustment | | | 245 | | | | — | | | | — | |
| Acquisition of Roxio CSD | | | (75,163 | ) | | | — | | | | — | |
| Acquisition of SystemOK, net of cash acquired | | | — | | | | — | | | | (7,258 | ) |
| Purchase of short term investment instruments | | | — | | | | (42,350 | ) | | | (47,951 | ) |
| Redemption of short term investment instruments | | | — | | | | — | | | | 43,050 | |
| Net cash used in investing activities | | | (78,588 | ) | | | (44,887 | ) | | | (14,545 | ) |
Cash flows from financing activities:
| | | | | | | | | | | | |
| Proceeds from issuance of common stock | | | 23,901 | | | | — | | | | — | |
| Proceeds from exercise of common stock options | | | 2,101 | | | | 5,865 | | | | 2,717 | |
| Excess tax benefits from share-based compensation | | | — | | | | | | | | 1,486 | |
| Borrowings on bank credit facility | | | 30,000 | | | | — | | | | — | |
| Payments on bank credit facility | | | — | | | | — | | | | (10,000 | ) |
| Principal payments on capital leases | | | (91 | ) | | | (89 | ) | | | (35 | ) |
| Net cash provided by (used in) financing activities | | | 55,911 | | | | 5,776 | | | | (5,832 | ) |
| Effect on exchange rate changes on cash and cash equivalents | | | (258 | ) | | | (761 | ) | | | (8 | ) |
| Net decrease in cash and cash equivalents | | | (746 | ) | | | (16,705 | ) | | | (1,641 | ) |
| Cash and cash equivalents at beginning of year | | | 36,182 | | | | 35,436 | | | | 18,731 | |
| Cash and cash equivalents at end of year | | $ | 35,436 | | | $ | 18,731 | | | $ | 17,090 | |
Supplemental disclosure of cash flow information:
| | | | | | | | | | | | |
| Interest paid during year | | $ | 342 | | | $ | 1,744 | | | $ | 1,071 | |
| Income taxes paid during year | | $ | — | | | $ | 980 | | | $ | 2,808 | |
Supplemental disclosure of non-cash transaction:
| | | | | | | | | | | | |
| Issuance of common stock for acquistions | | $ | 8,630 | | | $ | — | | | $ | 489 | |
| (1) | See Note 2 “Restatement of Consolidated Financial Statements and Change in Accounting Policy” to Consolidated Financial Statements. |
See accompanying notes to consolidated financial statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 1 — Summary of Operations and 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 broadband, broadcast, mobile and optical disc formats such as Compact Audio Disc (“CD-Audio”), Digital Video Disc (“DVD”) as well as emerging high definition 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.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of our subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates
We prepare our financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”). These accounting principles require management to make estimates, judgments, and assumptions that can significantly affect the revenues, expenses, assets, and liabilities as well as disclosure of contingent assets and liabilities reported in the 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.
Foreign Currency Translation
The functional currency of our foreign subsidiaries is the local currency. Assets and liabilities are translated into U.S. dollars at the exchange rate on the balance sheet date. Revenues and expenses are translated at the average exchange rate prevailing during the period. The related gains and losses from translation are recorded in accumulated other comprehensive income or (loss) in the balance sheet. Foreign currency transaction gains and losses are included in results of operations.
Cash Equivalents
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.
Short Term Investments
Short term investments consist of highly-rated (AAA/Aaa) auction rate securities. 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. We regularly monitor our investments in auction rate securities for liquidity and proper classification.
Short-term investments are reported at fair value and are subject to periodic impairment review with any unrealized gains or losses recorded in other comprehensive income. No impairment charges were recorded on any short-term investments during the years ended March 31, 2005, 2006, or 2007.
Fair Value of Financial Instruments
The reported amounts of our financial instruments, including cash and cash equivalents, accounts receivable (net of the allowance for returns and doubtful accounts), accounts payable and accrued liabilities,
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 1 — Summary of Operations and Significant Accounting Policies – (continued)
approximate fair value at March 31, 2006 and 2007 due to their short maturities. The carrying value of our debt obligation at March 31, 2007 approximates fair value, as the interest rate is consistent with current market rates.
Allowance for Returns and Doubtful Accounts
Our distributor and retail arrangements provide for certain product rotation rights and permit certain product returns. We estimate reserves for these rights of return based on historical return rates, timing of new product releases, and channel inventory levels.
We maintain an allowance for doubtful accounts to reserve for potentially uncollectible accounts based on past collection history and specific risks identified in our portfolio of receivables. If the financial condition of our distributors or other customers deteriorates, resulting in an impairment of their ability to make payments, or if payments from distributors or other customers are significantly delayed, additional allowances may be required.
Concentrations of Risk
Financial instruments that potentially subject us to concentrations of credit risk are cash, cash equivalents, short term investments, and accounts receivable. The majority of our cash, cash equivalents, and short term investments are placed with two financial institutions. Accounts receivable are unsecured and are derived from sales to customers.We maintain an allowance for doubtful accounts to provide against potential credit losses.
See Note 11 for significant customer information.
Inventory
Inventory is valued at the lower of cost, determined on a first-in, first-out basis, or market. Reserves for excess and obsolete inventory are established based on an analysis of products on hand and sales trends.
Fixed Assets, net
Fixed assets consist primarily of furniture, equipment, and leasehold improvements. Fixed assets are stated at cost less accumulated depreciation and amortization. We depreciate furniture and equipment using the straight-line method over the estimated useful lives of the respective assets which are generally three to five years. Leasehold improvements are amortized on a straight-line basis over the lesser of their estimated useful lives or the term of the lease.
Purchased and Internally Developed Software Costs, net
Purchased software is stated at cost less accumulated amortization. Purchased software is amortized on a straight-line basis over the estimated useful life of the software, which is generally three years.
Software development costs incurred prior to the establishment of technological feasibility are included in research and development expenses. Software development costs incurred between the establishment of technological feasibility and product release are capitalized, if material, and amortized over the estimated economic life of the product, which is generally three years.
Goodwill, Intangible Assets and Other Long-Lived Assets
We account for goodwill and other intangible assets in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Accounting for Goodwill and Other Intangible Assets.” SFAS No. 142 requires that goodwill and identifiable intangible assets with indefinite useful lives be tested for impairment at least annually, or more frequently if events and circumstances warrant.
We evaluate goodwill and indefinite life intangible assets for impairment by comparing the fair value of each of our reporting units to its carrying value including the goodwill allocated to that reporting unit. A
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 1 — Summary of Operations and Significant Accounting Policies – (continued)
reporting unit is an operating segment or one level below an operating segment often referred to as a component. For the purpose of evaluating goodwill, we combine the Roxio and ATG components of our consumer segment into one reporting unit as they have similar economic characteristics and it is difficult to draw a clear distinction between their operating activities. To determine the reporting unit’s fair value, we use the income approach under which we evaluate estimated discounted future cash flows of that unit. We base our cash flow assumptions on historical and forecasted revenue and operating costs.
We perform our annual impairment tests in our fourth fiscal quarter.
We evaluate long-lived assets, including intangible assets with finite useful lives, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. The determination of recoverability of long-lived assets and intangible assets with finite lives is based on an estimate of the undiscounted future cash flows resulting from the use of that asset and its eventual disposition. We did not incur any material impairment charges related to long-lived assets or intangible assets with finite lives during the fiscal years ended March 31, 2005, 2006 or 2007. As of March 31, 2007, no events occurred that would lead us to believe that there has been any intangible asset impairment.
Comprehensive Income (Loss)
We report comprehensive income or loss in accordance with SFAS No. 130, “Reporting Comprehensive Income.” SFAS No. 130 requires companies to classify items of comprehensive income by their nature in the consolidated financial statements and display the accumulated balance of other comprehensive income or loss separately from accumulated deficit and additional paid-in capital in the equity section of the consolidated balance sheets. Other comprehensive income or loss items have no impact on our net income or loss as presented in our Consolidated Statements of Operations. Our other comprehensive income (loss) is composed primarily foreign currency translation adjustments.
Revenue Recognition
We derive our revenue primarily from licenses of our software products, software development agreements and maintenance and support. We also sell and license patents and patented technology. We recognize software-related revenue in accordance with American Institute of Certified Accountants (“AICPA”) Statement of Position (“SOP”) 97-2, “Software Revenue Recognition” as amended by SOP 98-9, and Staff Accounting Bulletin (“SAB”) 104, “Revenue Recognition in Financial Statements.” We recognize revenue when the following criteria have been met:
| • | Persuasive evidence of an arrangement exists, |
| • | Delivery has occurred or services have been rendered, |
| • | The arrangement fees are fixed or determinable, and |
| • | Collection is considered probable |
If we determine that any of the above criteria has not been met, we will defer recognition of the revenue until all the criteria have been met.
We generally consider arrangements with payment terms longer than six months from the time of delivery not to be fixed or determinable and recognize the related revenue as payments become due from the customer, provided all other revenue recognition criteria have been met. If we determine that collection of a fee is not probable, we defer the fees and recognize revenue upon cash receipt, provided all other revenue recognition criteria have been met.
We follow Emerging Issues Task Force (“EITF”) 99-19, “Reporting Revenue Gross as Principal versus Net as an Agent.” Generally, we record revenue at gross and record costs related to a sale in cost of revenue.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 1 — Summary of Operations and Significant Accounting Policies – (continued)
In those cases where we are not the primary obligor or merchant of record and/or do not bear credit risk or earn a fixed transactional fee, we record revenue under the net method. When we record revenues at net, revenue is reported at the net amount received and retained by us.
Multiple Element Arrangements
In arrangements that include multiple elements (e.g., software, specified upgrades, support services, installation services, and/or training), we allocate the total revenue to be earned under the arrangement to the elements based on their relative fair value, as determined by vendor-specific objective evidence of fair value (“VSOE”). VSOE is generally the price charged when that element is sold separately or, in the case of support services, annual renewal rates.
In arrangements where VSOE exists only for the undelivered elements, we use the “residual method” under SOP 98-9, under which we defer the full fair value of the undelivered elements and recognize the difference between the total arrangement fee and the amount deferred for undelivered items as revenue. If VSOE does not exist for all elements but the only undelivered element is maintenance and support, we recognize revenue from the arrangement ratably over the maintenance and support period. If VSOE does not exist for undelivered elements that are specified products or upgrades, we defer revenue until the earlier of the delivery of all elements or the point at which we determine VSOE for these undelivered elements.
Product Sales
Except in the case of consignment arrangements, we recognize revenue from the sale of our packaged software products when title transfers to the distributor or retailer. When we sell packaged software products to distributors and retailers on a consignment basis, we recognize revenue upon sell through to an end customer.
Our distributor arrangements often provide distributors with certain product rotation rights. In such situations, we recognize product sales in accordance with SFAS No. 48, “Revenue Recognition When Right of Return Exists.” We estimate returns based on our historical return experience and other factors such as channel inventory levels and the introduction of new products. These allowances are recorded as a reduction of revenues and as an offset to accounts receivable. If future return patterns differ from past return patterns, for example due to reduced demand for our product, we may be required to increase these allowances in the future and may be required to reduce future revenues.
In accordance with EITF 01-09, “Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor’s Product,” we account for cash consideration (such as sales incentives) that we give to our customers or resellers as a reduction of revenue rather than as an operating expense unless we receive a benefit that is separate from the customer’s purchase from us and for which we can reasonably estimate the fair value.
Software License Arrangements
Provided all other revenue recognition criteria have been met, we recognize revenue from software licensing arrangements upon delivery, or, in the case of per-unit royalty arrangements, upon sell through to an end user as evidenced by the receipt of a customer royalty report.
Software Development Arrangements
For arrangements that include development or other services that are essential to the functionality of the licensed software, we recognize revenue in accordance with SOP 81-1, “Accounting for Performance of Construction Type and Certain Production Type Contracts,” using the percentage-of-completion method. Under the percentage-of-completion method, management estimates the number of hours needed to complete a particular project, and revenues are recognized as the contract progresses to completion. Changes in estimates are recognized in the period in which they are known.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 1 — Summary of Operations and Significant Accounting Policies – (continued)
In certain instances, a development agreement may include additional undelivered elements, such as maintenance and support, or a specified upgrade or other deliverable, and VSOE of fair value may not exist for the undelivered elements, or we may not have sufficient experience with either the type of project or the customer involved to be able to make reliable estimates towards completion. If we cannot reliably estimate total profitability under the agreement but are reasonably assured that no loss will be realized on the agreement, we recognize revenue using the zero gross margin method. Under the zero gross margin method, revenue recognized under the contract equals costs incurred under the contract and any profit is deferred until development is complete. We recognize the deferred gross profit over the remaining contractual service period (for example, the initial maintenance period).
Share-Based Compensation (As Restated — See Note 2)
On April 1, 2006, we adopted SFAS No. 123R (revised 2004) “Share-Based Payment,” which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes Accounting Principles Board (“APB”) No. 25 “Accounting for Stock Issued to Employees.” SFAS No. 123R requires the measurement and recognition of compensation expense for all equity-based payment awards made to our employees and directors, including stock options and Restricted Stock Units (“RSUs”), based on estimated fair values. SFAS No. 123R applies to all outstanding and unvested share-based payment awards at adoption. On March 29, 2005, the SEC issued SAB 107 providing supplemental implementation guidance for SFAS No. 123R. We have applied the provisions of SAB 107 in our adoption of SFAS No. 123R.
We adopted SFAS No. 123R using the modified-prospective-transition method, under which prior periods are not revised for comparative purposes. Under the fair value recognition provisions of this statement, we measure share-based compensation cost at the grant date based on the fair value of the award and recognize the cost on a straight-line basis over the requisite service period, which is generally the vesting period.
Prior to the adoption of SFAS No. 123R, we accounted for share-based compensation related to employee share-based compensation plans using the intrinsic value method in accordance with APB No. 25, and complied with the disclosure provisions of SFAS No. 123. The restated financial statements in this Annual report set forth restated share-based compensation measured using the methods contained in APB No. 25 or SFAS No. 123R in relation to employee stock options for the applicable periods.
We use the Black-Scholes-Merton option pricing model to determine the fair value of stock option shares. The determination of the fair value of share-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include our expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends. See Note 8 to consolidated financial statements for further information regarding these assumptions. The fair value of RSUs is equivalent to the market price of our common stock on the grant date.
If factors change, share-based compensation for the future periods may differ significantly from what we have recorded in the current period and could materially affect our operating income, net income and net income per share. Additionally, the Black-Scholes-Merton option pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable, which are characteristics not present in our option grants. Existing assumptions used and valuation modeling may not provide measures of the fair values of our share-based compensation that reflect the actual values realized upon the exercise, expiration, early termination or forfeiture of those share-based payments in the future. Certain share-based payments, such as stock options, may expire worthless or otherwise result in zero intrinsic value as compared to the fair values originally estimated on the grant date and reported in our financial statements. Alternatively, value may be realized from these instruments that are significantly higher than the fair values originally estimated on the grant date and reported in our financial statements. Currently, there are only
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very limited market-based mechanisms or other practical applications to verify the reliability and accuracy of the estimates stemming from these valuation models, and there is no means to compare and adjust the estimates to actual values.
In connection with our restatement of share-based compensation for fiscal years prior to fiscal year 2006 and fiscal quarters ended June 30 and September 30, 2006, we applied significant judgment in choosing whether to revise measurement dates for prior option grants, and in choosing the methodology for applying these revised measurement dates. See Note 2 to consolidated financial statements for further information.
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 temporary 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.
We are required to compute our income taxes in each federal, state, and international jurisdiction in which we operate. This process requires that we estimate the current tax exposure as well as assess temporary differences between the accounting and tax treatment of assets and liabilities, including items such as accruals and allowance not currently deductible for tax purposes. The income tax effects of the differences we identify are classified as current or long-term deferred tax assets and liabilities in our consolidated balance sheets. Our judgments, assumptions, and estimates relative to the current provision for income tax take into account current tax laws, our interpretation of current tax laws, and possible outcomes of current and future audits conducted by foreign and domestic tax authorities. Changes in tax laws or our interpretation of tax laws and the resolution of current and future tax audits could significantly impact the amounts provided for incomes taxes in our consolidated balance sheets and consolidated statements of operations.
Basic and Diluted Income Per Share
In accordance with SFAS No. 128, “Earnings per Share,” we report Earnings per Share (“EPS”), both basic and diluted, on the consolidated statement of operations. Basic EPS is based upon the weighted average number of common shares outstanding. Diluted EPS is computed using the weighted average common shares outstanding plus any potential common stock, except when their effect is anti-dilutive. Potential common stock includes common stock issuable upon the exercise of stock options and restricted stock units. See Note 13.
Recently Issued Accounting Pronouncements
In June 2006, the FASB ratified the consensuses reached by the EITF in Issue No. 06-03, “How Taxes Collected From Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross Versus Net Presentation).” The EITF concluded that the presentation of taxes assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a customer such as sales, use, value added and certain excise taxes, is an accounting policy decision that should be disclosed in a company's financial statements. Additionally, companies that record such taxes on a gross basis should disclose the amounts of those taxes in interim and annual financial statements for each period for which an income statement is presented if those amounts are significant. EITF 06-03 is effective for fiscal years beginning after December 15, 2006. We previously have and currently present such taxes on a net basis. Therefore, the adoption of EITF 06-03 will not have a material impact on our financial position, results of operations or cash flows.
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In July 2006, the FASB issued FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109,” which clarifies the accounting for income taxes by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006 and is effective for us as of the beginning of fiscal year 2008. The differences, if any, between the amounts recognized in the statements of financial position prior to the adoption of FIN 48 and the amounts reported after adoption will be accounted for as a cumulative-effect adjustment recorded to the beginning balance of retained earnings. We are currently in the process of evaluating the effect of FIN 48 on our financial position and results of operations.
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 under 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. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, with early adoption permitted. We will adopt SFAS No. 157 in fiscal year 2008 and 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 FASB Statement 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 arrangements and not to portions of instruments. SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. We will adopt SFAS No. 159 in fiscal year 2008 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. The standard 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. Statement 141(R) is effective for fiscal years beginning after December 15, 2008, with early adoption prohibited. We will evaluate the impact the provisions of SFAS No. 141(R) and will adopt this standard on April 1, 2009.
Note 2 — Restatement of Consolidated Financial Statements and Change in Accounting Policy
We are restating our consolidated balance sheet as of March 31, 2006, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the fiscal years ended March 31, 2005 and March 31, 2006.
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We are also restating the unaudited quarterly financial information and condensed financial statements for interim periods of fiscal year 2006, and the unaudited condensed consolidated financial statements for the quarters ended June 30, 2006 and September 30, 2006.
These restatements reflect (a) additional cash and non-cash 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.
Effective October 1, 2006, we changed our policy for recognizing original equipment manufacturer (“OEM”) royalty revenue. We applied this change in accounting policy retrospectively to the fiscal year ended March 31, 2006 and the quarters ended June 30, 2006 and September 30, 2006, but determined that it was not practicable to apply the change to prior periods.
Stock Options Accounting
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 the present (the “Review Period”).
The review included all stock options granted during the Review Period, as well as certain already-outstanding options that were repriced at the commencement of the Review Period. The review covered stock option grants under a total of seven stock option plans, and representing option grants to our directors, founders, officers and other employees (and including, among others, grants to newly-hired employees, individual or group performance awards, grants awarded in connection with acquisitions, and a limited number of grants to contractors).
During the course of the review, legal counsel to the Audit Committee, with the assistance of outside consultants, collected, processed and analyzed physical and electronic Company documents and records, including hard copy files, networked electronic documents and the computer hard drives of Company personnel who were involved in the administration of our stock option programs. Counsel to the Audit Committee was further assisted by an independent consulting firm engaged to assist in the collection, processing and analysis of options-related documentation.
Supplementing the activities performed by and on behalf of the Audit Committee, our management engaged in a detailed process of compiling, analyzing and assessing the information available to it relating to our granting of stock options and administration of stock option plans during the Review Period. Information reviewed included, without limitation, documentation related to acquisitions and other transactions completed by us, public filings (by us and by individual grant recipients), board minutes and written consents, spreadsheets and databases used to memorialize and maintain option-related information, email communications and other transmittals of information to and from outside accountants, payroll information, standard forms used to record decisions regarding hiring and termination of employees and related salary and option grant decisions known as Employee Action Forms (“EAFs”), grant notices, offer letters, option statements, tax records, personnel files and other information.
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With assistance from the independent consulting firm and input from the Audit Committee and its advisors, as well as based upon discussions with our independent auditors, our management created and maintained an extensive group of spreadsheets showing all options-related issuances, exercises and related data.
Based on the results of the review, we have concluded that a substantial number of stock options granted during the Review Period were not correctly accounted for in accordance with accounting principles generally accepted in the United States applicable at the time those grants were made. As a result, we are restating our historical financial statements to record adjustments for additional share-based compensation expense relating to past stock option grants in accordance with SFAS No. 123R and APB No. 25, and related payroll taxes, penalties, and other related amounts, to record additional share-based compensation expense associated with options granted to consultants and to record additional adjustments that were previously considered to be immaterial.
The review also identified less frequent errors in other categories including: grants to non-employees for which an incorrect amount of share-based compensation expense had been recognized, grants cancelled after the expiration date, and exercises occurring before vesting and after expiration. These errors were also addressed and reflected in the restatement of our historical financial statements.
Restatement Methodologies
In light of the review and in accordance with APB No. 25, other applicable literature (including, for the period commencing on April 1, 2006, SFAS No. 123R), and the guidance published by Conrad Hewitt, Chief Accountant, SEC, in a September 19, 2006 letter (the “SEC Letter”), we considered and applied the methodologies described below to determine the appropriate measurement dates for our historical stock option grants.
Applicable Standards
In determining corrected measurement dates for our historical option grants, we followed the requirements of APB No. 25, which deems the measurement date for an option grant to be the first date on which all of the following are known: (a) the identity of the individual employee who is entitled to receive the option grant; (b) the number of options that the individual employee is entitled to receive; and (c) the option’s exercise price. Under APB No. 25, the measurement date cannot be earlier than the date on which the grant is approved. In each instance where we determined that we cannot rely on the Record Date previously associated with an option, we considered alternate measurement dates based on our ability to establish or confirm, in our reasonable judgment, whether through other documentation or credible circumstantial information, when each of the elements associated with the determination of a measurement date for the option grant had been satisfied under applicable accounting principles. In making such determinations, we considered, among other things, the guidance in the SEC Letter, which provides that, where a company lacks definitive and complete documentation, it “must use all available relevant information” to form a reasonable conclusion with respect to, among other things, the appropriate dating for the option grant.
Information Types Considered
We analyzed all available information for each option grant. In considering this information relating to each option grant, we reached the following general conclusions:
| • | Board Minutes. For certain grants (primarily grants to board members and founders), board minutes (typically from board meetings held immediately after annual shareholder meetings) were considered to be definitive, reasonable and appropriate evidence of the best measurement dates for the grants in question. |
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| • | Board Consents. Although not widely used, unanimous written consents of the board were similarly considered to be definitive, reasonable and appropriate evidence of the best measurement dates for grants described in such consents, subject to analysis of the date on which all board members had signed the consent. |
| • | Acquisition Dates. We evaluated the extrinsic information associated with certain company acquisitions and, except as described inAcquisition-Related Grants below, generally were able to conclude that the original Record Dates were reasonably supportable as the appropriate measurement dates for the options granted in connection with such transactions. |
| • | Individual Public Filings. Forms 3, 4 and/or 5 filed by grant recipients were considered to represent reasonable evidence of the existence of the underlying grants and to be a basis for establishing appropriate measurement dates. To the extent that the applicable Form was filed within two days of the Record Date described in the Form, we concluded that it is reasonable to consider this Record Date to be the appropriate measurement date. If, on the other hand, the Form was filed more than two days after the specified Record Date, we concluded that the filing date is an appropriate measurement date (absent information supporting an earlier date), but that the Record Date referenced in the Form is not, without additional reliable support, usable as the measurement date. |
| • | Employee Offer Letters. Based upon the specific facts and circumstances described inHiring Grants below, we determined that certain of our offer letters triggered variable accounting treatment for a substantial portion of options issued to new employees during the Review Period. |
| • | Date of Hire. The hiring date (first day of work) was not, in itself, considered to be a valid measurement date, as there is no indication that our closing stock price on such dates was considered or memorialized in any way for stock grant purposes. However, as noted above with respect to employee offer letters, we determined that the date of hire may constitute the appropriate date for commencing variable accounting treatment for new hire grants, as described in more detail inHiring Grants below. |
| • | Employee Action Forms. Our EAFs do not provide sufficient evidence to establish appropriate measurement dates. While EAFs sometimes refer to a number of shares to be granted, they typically do not contain exercise price information, and they contemplate that future actions will be necessary to finalize the granting process. Further, although in some instances our former CEO (who had full authority to grant options to non-executive officer employees prior to September 23, 2005) signed EAFs, he did not typically date his signature and EAFs, in contrast to offer letters, were not usually provided to, or countersigned by, grant recipients. In addition, it appears that we did not follow a consistent policy, practice or pattern with regard to our use and execution of EAFs in connection with the option granting process. Accordingly, even though in some instances it is possible to reasonably conclude that an EAF was approved or otherwise recognized by a particular date — for example, sometimes EAFs were date-stamped when submitted to our payroll department or to our external payroll service, Automatic Data Processing, Inc., for processing — it does not necessarily follow that this approval constituted the final act in granting underlying stock options. Based on the totality of the facts and circumstances, we concluded that, in the absence of additional extrinsic information, EAFs do not constitute a reasonable basis for establishing measurement dates. |
| • | Vesting Base Dates. Stock options that were granted would be assigned a “base date” which would be used to calculate time options were held for purposes of calculating vesting. Stock option vesting base dates did not generally coincide with grant dates (vesting often would be designated to commence prior to the option grant reflected in our records, and would often correspond with other |
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| | events or milestones such as the date of a performance review or the first date of employment at Sonic), and based on all available information, we concluded that vesting base dates should not be considered to establish appropriate measurement dates for APB No. 25 purposes. |
| • | Signed Grant Notices. A signed and dated grant notice (which would contain the date of grant, number of shares, recipient identity and exercise price) would, absent contrary information, be considered to represent definitive evidence of a measurement date for the applicable grant. To the extent any such grant notices were available, they were, absent evidence to the contrary, used in determining the proper measurement dates for the grants in question. As a general matter, though, until we changed our processes in September 23, 2005, we did not issue or retain signed/dated grant notices. |
| • | Periodic Spreadsheets. We concluded that option grant measurement dates can often reasonably be established by the dates on which extrinsic evidence demonstrates the existence of a Periodic Spreadsheet in final form. For example, in each applicable period through September 23, 2005, our practice was to send final Periodic Spreadsheets to an outside accounting firm used by us to assist in the calculation of compensation expense, diluted outstanding shares, and other matters relating to our SEC filings. In some cases, we were able to find evidence of the dates on which we sent final Periodic Spreadsheets to the outside accounting firm; in other cases, we located evidence showing the dates on which final Periodic Spreadsheets were sent back to us by the outside accounting firm. Absent additional evidence suggesting a different measurement date should be used, we used the date of transmission of these spreadsheets to or from our outside auditors as evidence of a measurement date. |
| • | Company Public Filings. In instances where no earlier reliable information exists, we concluded that the required granting actions would have occurred with finality no later than the dates on which we filed our quarterly and annual reports. By this time, the Periodic Spreadsheet would need to have been finalized and provided to (and received back from) the outside accounting firm, so that applicable share-based compensation and earnings per diluted share disclosures, including options granted during the period in question, could be calculated and included in our filings. Accordingly, in the absence of other reliable information, we considered these dates, in some instances, to be the earliest dates that would qualify as measurement dates for purposes of APB No. 25. |
Methodology by Grant and Grant Category
The following analysis sets forth the methodologies applied to certain grants and grant categories. In addition to these general methodological approaches, where we had specific information regarding particular grants, we communicated with our independent auditors and our advisers, and reached consensus on the appropriate approach to accounting for such grants, consistent with the criteria of APB No. 25, related accounting literature, and the guidance of the SEC Letter.
Founder and Director Grants
The vast majority of grants to founders and directors were issued to coincide with our annual shareholder meeting. Grants of this type were typically authorized at our board meetings held immediately after our annual shareholder meetings, reflected in board minutes, and issued on the same date. We concluded that we have sufficient contemporaneous, extrinsic and reliable information to support and substantiate most of our founder and director Record Dates as appropriate measurement dates for purposes of APB No. 25 and other applicable literature. One exception to this general conclusion is that, in the single instance where we implemented the founders and directors grants agreed-upon at a board meeting by means of a subsequently- executed unanimous written consent, we concluded that the appropriate measurement date is the date of the final signature on the consent, rather than the original Record Date (which was the date of the meeting). In
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addition, a unanimous written consent was used to grant initial options to one of our directors when he was first elected to the board, and we concluded that the appropriate measurement date for that grant is the date that the final signature was added to the consent. Further, in one case where full minutes were not available, certain measurement date adjustments were made based upon the supporting documentation that was available. Finally, our conclusions regarding certain salary reduction grants are described inSalary Reduction Grants below.
Non-Founder Section 16 Officer Grants
Prior to September 23, 2005, our CEO would typically make grants to our non-founder executive officer(s) who are considered “executive officers” for purposes of Section 16 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), in the same manner as he would for non-executive employees of the Company. Pursuant to the delegation to him under our various option plans, the CEO generally did not have express authority to grant options to Section 16 officers, as this power was reserved for the board. Nevertheless, these grants were made in a consistent fashion and it is apparent that our board was aware of these option grants and did not disapprove of them. Furthermore, we have disclosed these grants in filed proxy statements, periodic reports and other public documents, and the parties to these grants (both the Company and the Section 16 officer recipient) have consistently honored the terms of the grants over a large number of years.
We concluded that, based on the facts and circumstances, the most appropriate and reasonable approach to these grants is to apply all APB No. 25 criteria in the same manner as such criteria are being applied to grants to our non-management employees (see discussionOther Employee Grants below) — that is, to recognize and acknowledge the existence of these grants, but to change measurement dates where there is insufficient information to reasonably conclude that the original Record Date satisfies the requirements of APB No. 25.
Since September 23, 2005, it has been our policy that all grants to our non-founder executive officers be made by the board, and be memorialized by contemporaneous documentation. As a practical matter, no such grants were issued after September 23, 2005.
Other Employee Grants
Under each of our various option plans, our CEO was delegated the authority to make grants to employees other than executive officers. As described above, except in particular circumstances (for example, grants made in the context of acquisitions and certain grants made after September 23, 2005), the Company employed a quarterly-focused grant process for non-founder employees and generally lack contemporaneous grant documentation sufficient to support the Record Dates for these option grants. Accordingly, we analyzed all available relevant information for each stock option grant in an attempt to determine the earliest point in time at which the evidence reasonably shows that all requisites for the establishment of a measurement date under APB No. 25 were satisfied. Except in specific circumstances (seeHiring Grants,Salary Reduction Grants,Acquisition-Related Grants andOther, below), or where we were able to locate contemporaneous grant documentation, this approach generally has resulted in our determining that the most appropriate measurement dates occur some time after the original Record Date in our records, often the date on which final Periodic Spreadsheets were sent to or received from the outside accounting firm we used for financial statement calculations, or the date on which we filed our quarterly or annual reports with respect to the grant(s) in question. Given the generally upward trend of our stock price during a substantial portion of the Review Period, moving to these “end of quarter” measurement dates generally results in a larger compensation charge and restatement amount.
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On September 23, 2005, our board created an employee options subcommittee to make grants under our option plans to recipients other than executive officers and to board members. This subcommittee reported on its activities to the board and compensation committee at each regularly-scheduled board meeting.
Hiring Grants
We concluded that variable accounting is the most appropriate restatement methodology for initial grants to newly-hired employees made after December 15, 1998 and prior to the adoption of new procedures in September 23, 2005, other than in connection with acquisitions. This conclusion is based upon Financial Accounting Standards Board (“FASB”) Interpretation No. (“FIN”) 44 (March 2000), “Accounting for Certain Transactions Involving Stock Compensation — An Interpretation of APB Opinion No. 25,” which provides that “if the exercise price of a fixed stock option award is reduced, the award shall be accounted for as variable from the date of the modification to the date the award is exercised, is forfeited, or expires unexercised.”
In reaching this conclusion, we considered the following facts and circumstances: (a) offer letters sent to new employees during this period were signed by our CEO, the same person who had full authority to make grants to such employees, (b) while the offer letters inform the new employees that an option grant will be made “shortly after” the commencement of employment, our actual practice — as reflected in our own grant records and documentation — was to make these initial grants over a significant period of time, up to several months after the start of employment, and (c) the offer letters, once signed by the employee, arguably constitute a legally binding commitment by us to issue option shares in the stated amount, as the grant obligation is not subject to any contingencies such as board approval. Under these facts and circumstances, we concluded that the most appropriate approach under APB No. 25 and FIN 44 is to treat the offer letters as constituting a grant at the initial hire date, with a subsequent repricing on a later date (whether the Record Date or an alternate measurement date determined as a result of the review).
Even though in a number of instances our share price at the subsequent measurement date was higher than the price on the initial hire date, due to the fact that the price declined in other instances we concluded that it is appropriate to apply variable accounting to this entire category of hiring grants, with the initial option grant date and vesting base date being deemed to have occurred on the hire date in all cases. Further, although we were not been able to locate signed copies of all offer letters associated with initial hire grants, because our practice was to utilize substantially similar letters signed by the former CEO for all new hires, we concluded that it is appropriate to apply variable accounting to these grants as well, based on the analysis described above.
Salary Reduction Grants
In March of 1998 and July of 2001, we offered salary reduction programs to certain of our senior employees. The programs allowed these employees to reduce their compensation and, for each dollar of reduced pay, the employee was entitled to an option to purchase one share of our common stock. For example, if an employee reduced his or her pay by $25,000, the employee was entitled to options to purchase 25,000 shares of our common stock. We never created any formal plans to document these programs, and formal board approval was not obtained, although a notation describing the 1998 salary reduction program was included in supporting materials provided to directors at the board meeting immediately prior to the reduction.
The 2001 salary reduction program was for one year, beginning July 1, 2001 and ending June 30, 2002. Payroll was paid semi-monthly, five days after the end of the payment period (that is, for mid-month payrolls, payment would be on the 20th; for month-end payrolls, payment would be on the 5th of the following month). The options under this program were issued and dated July 12, 2001, which was the payroll processing date for the semi-monthly pay period beginning on July 1, 2001. We concluded that this date is the appropriate measurement date.
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The 1998 salary reduction program was also for one year, beginning May 1, 1998 and ending April 30, 1999. The options under this program were dated and issued March 3, 1998. As noted above, this salary reduction program was discussed at the March 3, 1998 board meeting, based on a package of supporting materials attached to the March 3, 1998 board minutes. Consistent with our approach to the 2001 salary reduction program, however, we concluded that the appropriate measurement date for these options should be May 12, 1998, the payroll processing date for the first payment period during the program period, since in theory a potential participant may have decided in the interim not to take part.
Acquisition-Related Grants
During the Review Period, we completed certain corporate acquisitions and, in connection with these transactions, issued certain option grants. Generally, these grants were described in offer letters signed by our then-CEO in which acquired employees were informed that they would receive the options at the time of closing of the relevant acquisition. These transactions include:
| • | Daikin. At a January 24, 2001 meeting, our board unanimously resolved to enter into an asset purchase agreement with and to acquire the assets of Daikin Industries, Ltd. The transaction closed on February 27, 2001 and was announced on February 28, 2001. As part of the acquisition, key members of Daikin joined the Company and were issued options dated February 27, 2001, the date of acquisition, at the closing price of our stock on that date. |
| • | Veritas. At a November 1, 2002 meeting, our board unanimously resolved to enter into an asset purchase agreement with and to acquire the assets of the Desktop and Mobile Division of VERITAS Software Corporation. On November 13, 2002, we entered into the asset purchase agreement, and the transaction closed and was announced on December 18, 2002. At the time of the acquisition, we issued options to employees who joined the Company through this acquisition. These options were issued on December 18, 2002 and the exercise price was the closing price on that date. |
| • | InterActual. At a December 2, 2003 meeting, our board unanimously resolved to acquire InterActual Technologies, Inc., by way of merger. We entered into the definitive agreement on January 31, 2004, the transaction closed on February 13, 2004, and was announced on February 19, 2004. At the time of the acquisition, we issued inducement grants to employees who joined the Company as a result of this transaction. These options were dated February 13, 2004 and the exercise price was the closing price on that date. |
| • | Ravisent. On May 29, 2002, we announced that we had entered into an agreement under which Axeda exclusively licensed its Ravisent software to us under terms that were essentially equivalent to ownership and, in connection with this transaction, we hired a number of Ravisent (Axeda) employees. Board minutes were not available but board materials dated May 28, 2002 indicate that the transaction closed Friday, May 24, 2002. Grants were issued on two different dates. One group of grants to 10 individuals was issued on May 28, 2002, with an exercise price equal to the closing stock price on that date. The other group of grants to 11 individuals was dated January 2, 2003, with an exercise price equal to our closing price on that date. For contractual reasons, Ravisent (Axeda) employees from the Pennsylvania office could not receive shares until January 2, 2003, their date of hire by us — accordingly, their options were issued on January 2, 2003, with the exercise price equal to our closing price on that date. Based on the contractual terms, the hiring dates of these Pennsylvania employees, and the language in their offer letters, we concluded that we had reasonable evidence to support the Record Date of January 2, 2003 as the measurement date for accounting purposes. |
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March 31, 2005, 2006 and 2007
Note 2 — Restatement of Consolidated Financial Statements and Change in Accounting Policy – (continued)
| • | Roxio (U.S. Grants). On December 17, 2004, we entered into an amended and restated asset purchase agreement and acquired Roxio’s consumer software division. We announced this acquisition on December 20, 2004 and filed a Form 8-K on December 23, 2004. At the time of the acquisition, we issued inducement grants to employees who joined the Company through this acquisition. In particular, we issued options to Roxio employees located in the United States on December 17, 2004, the closing date, and the exercise price was the closing price on that date. |
| • | Roxio (Foreign Grants). Because no appropriate foreign option plan was in place at the time that the Roxio transaction closed, we were unable to issue options to Roxio employees located outside of the United States at the time of closing of the transaction. Thereafter, at a meeting on March 15, 2005, our board adopted the 2005 Stock Incentive Plan (Non-U.S. Employees) and, according to our stock options records, options were issued to the non-U.S. Roxio employees on April 6, 2005, with the exercise price equal to the closing price on that date. Because the offer letters for these employees stated that the grants would be made at the time the acquisition closed, we concluded that variable accounting is the most appropriate restatement methodology for these options. |
With the exception of the Roxio foreign grants, which are described above, we determined that we have sufficient reliable evidence to reasonably support and maintain the original Record Dates as the appropriate measurement dates for purposes of APB No. 25 for our acquisition-related grants.
Other
In a number of isolated cases, we identified accounting errors that we corrected in accordance with APB No. 25 and other applicable accounting literature, including miscellaneous situations involving acceleration of vesting, extensions of exercise periods for vested options, grants to consultants that were erroneously accounted for as if they had been made to employees, repricing previously issued grants, missed grants, and other “one-off” situations.
Tax Considerations
Based on measurement date changes resulting from our options review, certain grants of stock options made during the Review Period were priced below fair market value, rather than at fair market value. Consequently, certain grants intended to be classified as incentive stock options (“ISOs”), requiring pricing at no less than fair market value on the date of grant, should have been classified as nonqualified stock options (“NQs”). Additionally, certain options should have been treated as NQs since date of grant due to either plan limitations or ISO limitations. We did not withhold federal income taxes, state income taxes, FICA or Medicare on the options that were issued as ISOs that should have been treated as NQ stock options (due to their below-market grant pricing, plan limitations or ISO rules). We accrued payroll tax, penalty, and interest expenses related to NQ stock options originally classified as ISOs in the periods in which the underlying stock options were exercised. Then, in periods in which the liabilities were legally extinguished due to statutes of limitations, the expenses were reversed and recognized as a reduction of expense.
We informed the Internal Revenue Service (“IRS”) of potential payroll tax liabilities resulting from changes in measurement dates for stock options. However, no formal settlement negotiations have taken place. On January 15, 2008, we were notified by the IRS of a payroll tax audit covering the calendar years 2004, 2005 and 2006.
We recorded deferred tax assets as a result of the share-based compensation expense recorded through the restatement based on unexercised and uncanceled nonqualified stock options at the end of each reporting period. The recognized tax benefit related to affected stock options granted to officers was limited, in certain instances, due to the potential non-deductibility of the related expenses under Section 162(m) of the Internal
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March 31, 2005, 2006 and 2007
Note 2 — Restatement of Consolidated Financial Statements and Change in Accounting Policy – (continued)
Revenue Code of 1986, as amended (the “Code”). This IRS rule limits the amount of executive compensation that may be deducted for U.S. tax purposes under certain circumstances.
Section 409A of the Code imposes additional taxes on our employees for stock options granted with an exercise price lower than the fair market value on the date of grant for all options or portions of options that vest after December 31, 2004. As a result of the change in measurement dates described above, certain stock options granted during the Review Period were issued at prices below fair market value on the revised measurement date. Management is considering possible ways to address the impact that Section 409A may have on our employees as a result of the exercise price of stock options being less than the fair market value of our common stock on the revised measurement dates. The IRS has issued transition rules under Section 409A that allow for a correction or cure for some of these options subject to Section 409A. We may offer non-officer employees who hold outstanding options the opportunity to cure their affected stock options. In connection with this cure, we may make future cash bonus payments to our non-officer employees in an undetermined amount. We recorded approximately $1.7 million in operating expense for estimated employee Section 409A taxes that we have elected to cover with respect to options that were exercised during the fourth quarter of fiscal year 2007.
Stock Options Restatement
Based on the errors noted above, we have recorded adjustments to share-based compensation, including payroll taxes, Section 409A penalties and other tax expense. There was no impact on revenue or net cash provided by operating activities as a result of this additional share-based compensation and related tax expense during the restatement periods.
The following table sets forth the effect of the stock option review restatement for each of the applicable fiscal years (in thousands):
| | | | | | | | | | |
| | Stock Option Review Adjustments |
| Fiscal Year Ended | | Pre-Tax
Share-Based
Compensation
Expense
Adjustments | | Pre-Tax
Payroll
Related Tax
Expense
(Benefit)
Adjustments | | Total
Pre-Tax
Impact | | Related
Income Tax
Expense
(Benefit)
Adjustments | | Net Expense
(Benefit)
After-Tax
Adjustments |
| March 31, 1998 (unaudited) | | $ | 60 | | | $ | — | | | $ | 60 | | | $ | — | | | $ | 60 | |
| March 31, 1999 (unaudited) | | | 613 | | | | 6 | | | | 619 | | | | — | | | | 619 | |
| March 31, 2000 (unaudited) | | | 1,175 | | | | 218 | | | | 1,393 | | | | — | | | | 1,393 | |
| March 31, 2001 (unaudited) | | | 812 | | | | 642 | | | | 1,454 | | | | — | | | | 1,454 | |
| March 31, 2002 (unaudited) | | | 3,026 | | | | 509 | | | | 3,535 | | | | — | | | | 3,535 | |
| March 31, 2003 (unaudited) | | | 2,707 | | | | 1,705 | | | | 4,412 | | | | — | | | | 4,412 | |
| March 31, 2004 (unaudited) | | | 8,177 | | | | 1,356 | | | | 9,533 | | | | — | | | | 9,533 | |
| Cumulative effect at March 31, 2004 (unaudited) | | | 16,570 | | | | 4,436 | | | | 21,006 | | | | — | | | | 21,006 | |
| March 31, 2005 | | | 4,492 | | | | 583 | | | | 5,075 | | | | (69 | ) | | | 5,006 | |
| March 31, 2006(1) | | | 10,103 | | | | 2,782 | | | | 12,885 | | | | (13,196 | ) | | | (311 | ) |
| Six Months Ended September 30, 2006 (unaudited) | | | 316 | | | | (1,514 | ) | | | (1,198 | ) | | | 225 | | | | (973 | ) |
| Total | | $ | 31,481 | | | $ | 6,287 | | | $ | 37,768 | | | $ | (13,040 | ) | | $ | 24,728 | |
| (1) | Prior to fiscal year 2006, we maintained a valuation allowance against our deferred tax assets. In fiscal year 2006, we reversed the majority of our valuation allowance against deferred tax assets due to our assessment, made at that time, that it was more likely than not that deferred tax assets would be realized. As a result of the restatement, we recorded additional deferred tax assets with respect to the periods |
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 2 — Restatement of Consolidated Financial Statements and Change in Accounting Policy – (continued)
| | covered by our options review. The $13.2 million income tax benefit in fiscal year 2006 relates to the release of valuation allowance against the additional deferred tax assets recorded with respect to fiscal years 2005 and prior as a result of the restatement, net of the current year effect. |
Change in Accounting Policy
Effective October 1, 2006, we elected to change our method of recognizing OEM royalty revenue. Previously, we generally recognized OEM royalty revenue in the period the OEM product shipped, provided we received the OEM royalty report before the preparation of our financial statements. We now generally recognize OEM revenue in the period we receive the OEM royalty report. We adopted the new method to improve reporting consistency across our OEM customers and reduce the length of the accounting close cycle. Comparative financial statements for fiscal year 2006 and quarterly financial information for the quarters ended June 30, 2006 and September 30, 2006 have been adjusted to apply the change in accounting policy retrospectively.
Due primarily to a change in our accounting software in fiscal year 2005, retrospective application of this change in accounting policy to fiscal year 2005 and prior periods was not practicable. Therefore, we recorded the cumulative effect of the change as an adjustment to accumulated deficit at the beginning of fiscal year 2006.
The following table summarizes the effects of the retrospective application of this change in accounting policy on our consolidated financial statements for fiscal year 2006, and for the quarters ended June 30 and September 30, 2006, and for the on-going current period charges to fiscal year 2007, applicable (in thousands):
| | | | | | | | |
| | As Restated |
| | | Year Ended
March 31,
2006 | | Three Months Ended |
| | | June 30,
2006 | | September 30,
2006 | | Year Ended
March 31,
2007 |
| Increase (decrease) in revenue | | $ | (1,068 | ) | | $ | 475 | | | $ | (609 | ) | | $ | 841 | |
| Decrease (increase) in costs | | | (14 | ) | | | (207 | ) | | | 62 | | | | (237 | ) |
| Tax benefit (expense) | | | 433 | | | | (107 | ) | | | 219 | | | | (242 | ) |
| Increase (decrease) in net income | | $ | (649 | ) | | $ | 161 | | | $ | (328 | ) | | $ | 362 | |
| Increase (decrease) in earnings per share | | $ | (0.02 | ) | | $ | 0.01 | | | $ | (0.01 | ) | | $ | 0.01 | |
The following table summarizes the effect of the retrospective application of this change in accounting policy on our consolidated balance sheets for fiscal year 2006, and for the quarters ended June 30 and September 30, 2006, and for the on-going current period charges to fiscal year 2007, as applicable (in thousands):
| | | | | | | | |
| | As Restated |
| | | March 31, 2006 | | June 30,
2006 | | September 30,
2006 | | March 31, 2007 |
| Decrease in accounts receivable | | $ | (4,161 | ) | | $ | (3,849 | ) | | $ | (4,936 | ) | | $ | (632 | ) |
| Increase in deferred tax assets | | $ | 433 | | | $ | 327 | | | $ | 545 | | | $ | 242 | |
| Decrease in accrued expenses | | $ | 560 | | | $ | 554 | | | $ | 620 | | | $ | 449 | |
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 2 — Restatement of Consolidated Financial Statements and Change in Accounting Policy – (continued)
| | | | | | | | |
| | As Restated |
| | | March 31, 2006 | | June 30,
2006 | | September 30,
2006 | | March 31, 2007 |
| (Increase) decrease in deferred revenue | | $ | (366 | ) | | $ | (403 | ) | | $ | 70 | | | $ | (421 | ) |
Increase (decrease) in
accumulated deficit(1) | | $ | 3,534 | | | $ | 3,371 | | | $ | 3,701 | | | $ | (362 | ) |
| (1) | Amount includes cumulative adjustment of $2.9 million to the beginning retained earnings balance in fiscal year 2006. |
Other Adjustments
Revenue Adjustment
We identified that we had incorrectly recorded a sales transaction during the first quarter of 2007. This occurred from a sales agreement that we subsequently learned had additional terms that precluded us from recognizing revenue until full delivery was performed. As a result, an adjustment was made to decrease net revenues and increase deferred revenue by $0.4 million in the first quarter of fiscal year 2007. We will recognize $0.3 million of this amount as revenue during the first six months of fiscal year 2008.
Adjustments to Goodwill and Income Taxes Related to the Roxio CSD Acquisition
In December 2004, we acquired the assets of the Roxio Consumer Software Division (“Roxio CSD”), which included a Canadian subsidiary. During 2007, we filed income tax returns for the acquired Canadian subsidiary covering the period from April 1, 2004 to March 31, 2006. As a result of filing the Canadian income tax returns and a review of our original acquisition accounting, we made the following adjustments:
| • | In fiscal 2005, we decreased goodwill by approximately $2.0 million and increased deferred tax assets, net of valuation allowance, to recognize deferred tax assets in the acquired Canadian subsidiary. These deferred tax assets relate to pre-acquisition net operating losses and other temporary items. |
| • | We recorded additional Canadian income tax expense for the fiscal years 2005 and 2006 of approximately $0.8 million and $0.3 million, respectively. |
| • | In fiscal year 2006, we reduced goodwill by $0.4 million and increased deferred tax assets for transactional costs incurred in connection with the Roxio CSD acquisition that are deductible for tax purposes. |
The adjustments did not result in any changes to cash flows in these fiscal years.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 2 — Restatement of Consolidated Financial Statements and Change in Accounting Policy – (continued)
Income Statement Impact
The income statement impact of all adjustments and restatements are as follows (in thousands):
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | | | Restatement Adjustments, Net of Tax |
| Fiscal Year Ended March 31, | | Net Income
(Loss), As
Previously
Reported | | Stock
Options | | Change in
Accounting
Policy | | Other | | Total | | Net Income
(Loss), As
Restated |
| | | | | (Decrease) Increase | | |
| 1998 (unaudited) | | $ | (5,876 | ) | | $ | (60 | ) | | $ | — | | | $ | — | | | $ | (60 | ) | | $ | (5,936 | ) |
| 1999 (unaudited) | | | (1,859 | ) | | | (619 | ) | | | — | | | | — | | | | (619 | ) | | | (2,478 | ) |
| 2000 (unaudited) | | | (5,694 | ) | | | (1,393 | ) | | | — | | | | — | | | | (1,393 | ) | | | (7,087 | ) |
| 2001 (unaudited) | | | (5,855 | ) | | | (1,454 | ) | | | — | | | | — | | | | (1,454 | ) | | | (7,309 | ) |
| 2002 (unaudited) | | | (4,182 | ) | | | (3,535 | ) | | | — | | | | — | | | | (3,535 | ) | | | (7,717 | ) |
| 2003 (unaudited) | | | 2,537 | | | | (4,412 | ) | | | — | | | | — | | | | (4,412 | ) | | | (1,875 | ) |
| 2004 (unaudited) | | | 11,084 | | | | (9,533 | ) | | | — | | | | — | | | | (9,533 | ) | | | 1,551 | |
| Totals through March 31, 2004 (unaudited) | | | | | | | (21,006 | ) | | | — | | | | — | | | | (21,006 | ) | | | | |
| 2005 | | | 8,542 | | | | (5,006 | ) | | | — | | | | (789 | ) | | | (5,795 | ) | | | 2,747 | |
Fiscal year 2006 quarter ended
| | | | | | | | | | | | | | | | | | | | | | | | |
| June 30, 2005 (unaudited) | | | 5,904 | | | | 7,125 | | | | 329 | | | | — | | | | 7,454 | | | | 13,358 | |
| September 30, 2005 (unaudited) | | | 3,102 | | | | (3,775 | ) | | | (197 | ) | | | — | | | | (3,972 | ) | | | (870 | ) |
| December 31, 2005 (unaudited) | | | 8,201 | | | | 3,993 | | | | (1,499 | ) | | | — | | | | 2,494 | | | | 10,695 | |
| March 31, 2006 (unaudited) | | | 2,720 | | | | (7,032 | ) | | | 718 | | | | (255 | ) | | | (6,569 | ) | | | (3,849 | ) |
| Fiscal year 2006 | | $ | 19,927 | | | | 311 | | | | (649 | ) | | | (255 | ) | | | (593 | ) | | $ | 19,334 | |
Fiscal year 2007 quarter ended
| | | | | | | | | | | | | | | | | | | | | | | | |
| June 30, 2006 (unaudited) | | $ | 4,090 | | | | 1,007 | | | | 161 | | | | (257 | ) | | | 911 | | | $ | 5,001 | |
| September 30, 2006 (unaudited) | | | 2,669 | | | | (34 | ) | | | (328 | ) | | | — | | | | (362 | ) | | | 2,307 | |
| | | | | | | $ | (24,728 | ) | | $ | (816 | ) | | $ | (1,301 | ) | | $ | (26,845 | ) |
The effects of these restatements on diluted earnings (loss) per share for fiscal years 2003 through 2006 and the first two quarters of fiscal year 2007 are as follows (in thousands):
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | | | Restatement Adjustments, Net of Tax |
| Fiscal Year Ended March 31, | | Diluted
Earnings Per
Share, As
Previously
Reported | | Stock
Options | | Change in
Accounting
Policy | | Other | | Total | | Diluted
Earnings
(Loss)
Per Share,
As Restated |
| 2003 (unaudited) | | $ | 0.13 | | | $ | (0.24 | ) | | $ | 0.00 | | | $ | 0.00 | | | $ | (0.24 | ) | | $ | (0.11 | ) |
| 2004 (unaudited) | | $ | 0.46 | | | $ | (0.39 | ) | | $ | 0.00 | | | $ | 0.00 | | | $ | (0.39 | ) | | $ | 0.07 | |
| 2005 | | $ | 0.32 | | | $ | (0.19 | ) | | $ | 0.00 | | | $ | (0.02 | ) | | $ | (0.21 | ) | | $ | 0.11 | |
Fiscal year 2006 quarter ended
| | | | | | | | | | | | | | | | | | | | | | | | |
| June 30, 2005 (unaudited) | | $ | 0.22 | | | $ | 0.28 | | | $ | 0.02 | | | $ | 0.00 | | | $ | 0.30 | | | $ | 0.52 | |
| September 30, 2005 (unaudited) | | $ | 0.11 | | | $ | (0.15 | ) | | $ | 0.00 | | | $ | 0.00 | | | $ | (0.15 | ) | | $ | (0.04 | ) |
| December 31, 2005 (unaudited) | | $ | 0.30 | | | $ | 0.16 | | | $ | (0.05 | ) | | $ | 0.00 | | | $ | 0.11 | | | $ | 0.41 | |
| March 31, 2006 (unaudited) | | $ | 0.10 | | | $ | (0.26 | ) | | $ | 0.02 | | | $ | (0.01 | ) | | $ | (0.25 | ) | | $ | (0.15 | ) |
| Fiscal year 2006 | | $ | 0.73 | | | $ | 0.03 | | | $ | (0.01 | ) | | $ | (0.01 | ) | | $ | 0.01 | | | $ | 0.74 | |
Fiscal year 2007 quarter ended
| | | | | | | | | | | | | | | | | | | | | | | | |
| June 30, 2006 (unaudited) | | $ | 0.15 | | | $ | 0.04 | | | $ | (0.00 | ) | | $ | (0.01 | ) | | $ | 0.03 | | | $ | 0.18 | |
| September 30, 2006 (unaudited) | | $ | 0.10 | | | $ | (0.00 | ) | | $ | (0.02 | ) | | $ | 0.00 | | | $ | (0.02 | ) | | $ | 0.08 | |
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 2 — Restatement of Consolidated Financial Statements and Change in Accounting Policy – (continued)
Expenses Incurred in Connection with Options Review
We have incurred substantial expenses related to the review and analysis of the stock option grants, including approximately $6.7 million (unaudited) in costs for legal fees, external audit firm fees and external consulting fees through December 31, 2007. We expect to incur substantial additional fees in connection with stock option matters.
Restatement Impact on the Consolidated Financial Statements
The following presents the effect of the restatement adjustments by financial statement line item for the consolidated balance sheet as of March 31, 2006, statements of operations for the years ended March 31, 2005 and 2006, the statements of cash flows for the years ended March 31, 2005 and 2006.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 2 — Restatement of Consolidated Financial Statements and Change in Accounting Policy – (continued)
CONSOLIDATED BALANCE SHEET
(in thousands, except share amounts)
| | | | | | |
| | March 31, 2006 |
| | | As
Previously
Reported | | Adjustments | | As Restated |
ASSETS
| | | | | | | | | | | | |
Current assets:
| | | | | | | | | | | | |
| Cash and cash equivalents | | $ | 18,731 | | | $ | — | | | $ | 18,731 | |
| Short-term investments | | | 42,350 | | | | — | | | | 42,350 | |
| Accounts receivable, net of allowance of $5,235 | | | 23,141 | | | | (4,161 | ) | | | 18,980 | |
| Inventory | | | 689 | | | | — | | | | 689 | |
| Deferred tax benefits | | | 3,879 | | | | — | | | | 3,879 | |
| Prepaid expenses and other current assets | | | 3,771 | | | | — | | | | 3,771 | |
| Total current assets | | | 92,561 | | | | (4,161 | ) | | | 88,400 | |
| Fixed assets, net | | | 4,833 | | | | — | | | | 4,833 | |
| Purchased and internally developed software costs, net | | | 1,266 | | | | — | | | | 1,266 | |
| Goodwill | | | 54,151 | | | | (2,478 | ) | | | 51,673 | |
| Acquired intangibles, net | | | 43,914 | | | | — | | | | 43,914 | |
| Deferred tax benefit, net | | | 11,391 | | | | 11,504 | | | | 22,895 | |
| Other assets | | | 1,355 | | | | — | | | | 1,355 | |
| Total assets | | $ | 209,471 | | | $ | 4,865 | | | $ | 214,336 | |
LIABILITIES AND SHAREHOLDERS' EQUITY
| | | | | | | | | | | | |
Current Liabilities:
| | | | | | | | | | | | |
| Accounts payable | | $ | 7,833 | | | $ | — | | | $ | 7,833 | |
| Accrued expenses and other current liabilities | | | 24,309 | | | | 6,174 | | | | 30,483 | |
| Deferred revenue | | | 7,795 | | | | 366 | | | | 8,161 | |
| Total current liabilities | | | 39,937 | | | | 6,540 | | | | 46,477 | |
| Bank note payable | | | 30,000 | | | | — | | | | 30,000 | |
| Other long term liabilities, net of current portion | | | 375 | | | | — | | | | 375 | |
| Deferred revenue, net of current portion | | | 2 | | | | — | | | | 2 | |
| Total liabilities | | | 70,314 | | | | 6,540 | | | | 76,854 | |
Shareholders' equity:
| | | | | | | | | | | | |
| Convertible preferred stock, no par value, 10,000,000 shares authorized; 0 shares issued and outstanding at March 31, 2006 | | | — | | | | — | | | | — | |
Common stock, no par value, 100,000,000 shares authorized; 25,685,953 shares issued and outstanding at March 31,
2006 | | | 126,880 | | | | 28,604 | | | | 155,484 | |
| Accumulated other comprehensive income (loss) | | | (937 | ) | | | — | | | | (937 | ) |
| Accumulated earnings (deficit) | | | 13,214 | | | | (30,279 | ) | | | (17,065 | ) |
| Total shareholders' equity | | | 139,157 | | | | (1,675 | ) | | | 137,482 | |
| Total liabilities and shareholders' equity | | $ | 209,471 | | | $ | 4,865 | | | $ | 214,336 | |
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 2 — Restatement of Consolidated Financial Statements and Change in Accounting Policy – (continued)
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share amounts)
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | Year Ended March 31, 2005 | | Year Ended March 31, 2006 |
| | | As
Previously
Reported | | Adjustments | | As Restated | | As
Previously
Reported | | Adjustments | | As Restated |
Consolidated Statements of Operations Data:
| | | | | | | | | | | | | | | | | | | | | | | | |
| Net revenue | | $ | 90,627 | | | $ | — | | | $ | 90,627 | | | $ | 148,676 | | | $ | (1,068 | ) | | $ | 147,608 | |
| Cost of revenue | | | 13,373 | | | | — | | | | 13,373 | | | | 34,118 | | | | 14 | | | | 34,132 | |
| Gross profit | | | 77,254 | | | | — | | | | 77,254 | | | | 114,558 | | | | (1,082 | ) | | | 113,476 | |
Operating expenses:
| | | | | | | | | | | | | | | | | | | | | | | | |
| Marketing and sales(1) | | | 21,117 | | | | 1,430 | | | | 22,547 | | | | 31,605 | | | | 4,001 | | | | 35,606 | |
| Research and development(1) | | | 31,618 | | | | 1,681 | | | | 33,299 | | | | 40,560 | | | | 3,597 | | | | 44,157 | |
| General and administrative(1) | | | 9,845 | | | | 1,932 | | | | 11,777 | | | | 17,019 | | | | 5,195 | | | | 22,214 | |
| Acquired in-process technology | | | 3,100 | | | | — | | | | 3,100 | | | | — | | | | — | | | | — | |
| Business integration | | | 2,190 | | | | — | | | | 2,190 | | | | 336 | | | | — | | | | 336 | |
| Total operating expenses | | | 67,870 | | | | 5,043 | | | | 72,913 | | | | 89,520 | | | | 12,793 | | | | 102,313 | |
| Operating income | | | 9,384 | | | | (5,043 | ) | | | 4,341 | | | | 25,038 | | | | (13,875 | ) | | | 11,163 | |
| Interest income | | | 998 | | | | — | | | | 998 | | | | 1,271 | | | | — | | | | 1,271 | |
| Interest expense | | | (182 | ) | | | (32 | ) | | | (214 | ) | | | (1,754 | ) | | | (92 | ) | | | (1,846 | ) |
| Other expense | | | (607 | ) | | | — | | | | (607 | ) | | | (431 | ) | | | — | | | | (431 | ) |
| Income before income taxes | | | 9,593 | | | | (5,075 | ) | | | 4,518 | | | | 24,124 | | | | (13,967 | ) | | | 10,157 | |
| Provision for income taxes | | | 1,051 | | | | 720 | | | | 1,771 | | | | 4,197 | | | | (13,374 | ) | | | (9,177 | ) |
| Net income | | $ | 8,542 | | | $ | (5,795 | ) | | $ | 2,747 | | | $ | 19,927 | | | $ | (593 | ) | | $ | 19,334 | |
Net income per share:
| | | | | | | | | | | | | | | | | | | | | | | | |
| Basic | | $ | 0.37 | | | $ | (0.25 | ) | | $ | 0.12 | | | $ | 0.81 | | | $ | (0.03 | ) | | $ | 0.78 | |
| Diluted | | $ | 0.32 | | | $ | (0.21 | ) | | $ | 0.11 | | | $ | 0.73 | | | $ | 0.01 | | | $ | 0.74 | |
Shares used in per share calculation:
| | | | | | | | | | | | | | | | | | | | | | | | |
| Basic | | | 23,347 | | | | — | | | | 23,347 | | | | 24,750 | | | | — | | | | 24,750 | |
| Diluted | | | 26,529 | | | | (1,577 | ) | | | 24,952 | | | | 27,421 | | | | (1,187 | ) | | | 26,234 | |
(1) Includes share-based compensation expense as follows:
| |
| Marketing and sales | | $ | — | | | $ | 1,345 | | | $ | 1,345 | | | $ | — | | | $ | 3,846 | | | $ | 3,846 | |
| Research and development | | | — | | | | 1,527 | | | | 1,527 | | | | — | | | | 3,460 | | | | 3,460 | |
| General and administrative | | | — | | | | 1,620 | | | | 1,620 | | | | 131 | | | | 2,797 | | | | 2,928 | |
| Total share-based compensation expense | | $ | — | | | $ | 4,492 | | | $ | 4,492 | | | $ | 131 | | | $ | 10,103 | | | $ | 10,234 | |
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 2 — Restatement of Consolidated Financial Statements and Change in Accounting Policy – (continued)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | Years Ended March 31, |
| | | 2005 | | 2006 |
| | | As
Previously
Reported | | Adjustments | | As Restated | | As
Previously
Reported | | Adjustments | | As Restated |
Cash flows from operating activities:
| | | | | | | | | | | | | | | | | | | | | | | | |
| Net income | | $ | 8,542 | | | $ | (5,795 | ) | | $ | 2,747 | | | $ | 19,927 | | | $ | (593 | ) | | $ | 19,334 | |
Adjustments to reconcile net income to net cash provided by operating activities:
| | | | | | | | | | | | | | | | | | | | | | | | |
| Depreciation and amortization | | | 4,393 | | | | — | | | | 4,393 | | | | 9,607 | | | | — | | | | 9,607 | |
| Deferred income taxes | | | (640 | ) | | | — | | | | (640 | ) | | | (14,297 | ) | | | (10,033 | ) | | | (24,330 | ) |
| Provision for returns and doubtful accounts, net of write-offs | | | (108 | ) | | | — | | | | (108 | ) | | | (3,572 | ) | | | — | | | | (3,572 | ) |
| Share-based compensation | | | — | | | | 4,492 | | | | 4,492 | | | | 131 | | | | 10,103 | | | | 10,234 | |
| Tax benefit from employee stock option plans | | | 784 | | | | (431 | ) | | | 353 | | | | 14,474 | | | | (2,129 | ) | | | 12,345 | |
| Acquired in-process technology | | | 3,100 | | | | — | | | | 3,100 | | | | — | | | | — | | | | — | |
| Release of acquisition reserve | | | — | | | | — | | | | — | | | | (1,261 | ) | | | — | | | | (1,261 | ) |
| Loss on disposal of assets | | | — | | | | — | | | | — | | | | 23 | | | | — | | | | 23 | |
| Cumulative effect of accounting change in revenue recognition | | | — | | | | — | | | | — | | | | — | | | | (2,885 | ) | | | (2,885 | ) |
| Changes in operating assets and liabilities, net | |
| Accounts receivable | | | 319 | | | | — | | | | 319 | | | | (5,391 | ) | | | 4,161 | | | | (1,230 | ) |
| Inventory | | | 401 | | | | — | | | | 401 | | | | 66 | | | | — | | | | 66 | |
| Prepaid expenses and other assets | | | 781 | | | | — | | | | 781 | | | | (2,257 | ) | | | (483 | ) | | | (2,740 | ) |
| Other assets | | | (987 | ) | | | — | | | | (987 | ) | | | 1,228 | | | | — | | | | 1,228 | |
| Acquired intangibles sold as part of operations | | | — | | | | — | | | | — | | | | 1,169 | | | | — | | | | 1,169 | |
| Accounts payable | | | 4,477 | | | | — | | | | 4,477 | | | | (1,961 | ) | | | — | | | | (1,961 | ) |
| Accrued liabilities | | | 160 | | | | 1,734 | | | | 1,894 | | | | 3,416 | | | | 1,493 | | | | 4,909 | |
| Deferred revenue | | | 967 | | | | — | | | | 967 | | | | 1,865 | | | | 366 | | | | 2,231 | |
| Net cash provided by operating activities | | | 22,189 | | | | — | | | | 22,189 | | | | 23,167 | | | | — | | | | 23,167 | |
Cash flows from investing activities:
| | | | | | | | | | | | | | | | | | | | | | | | |
| Purchase of fixed assets | | | (3,035 | ) | | | — | | | | (3,035 | ) | | | (1,761 | ) | | | — | | | | (1,761 | ) |
| Additions to purchased and internally developed software | | | (635 | ) | | | — | | | | (635 | ) | | | (776 | ) | | | — | | | | (776 | ) |
| InterActual goodwill adjustment | | | 245 | | | | — | | | | 245 | | | | — | | | | — | | | | — | |
| Acquisition of Roxio CSD | | | (75,163 | ) | | | — | | | | (75,163 | ) | | | — | | | | — | | | | — | |
| Purchase of short term investment instruments | | | — | | | | — | | | | — | | | | (42,350 | ) | | | — | | | | (42,350 | ) |
| Net cash used in investing activities | | | (78,588 | ) | | | — | | | | (78,588 | ) | | | (44,887 | ) | | | — | | | | (44,887 | ) |
Cash flows from financing activities:
| | | | | | | | | | | | | | | | | | | | | | | | |
| Proceeds from issuance of common stock | | | 23,901 | | | | — | | | | 23,901 | | | | — | | | | — | | | | — | |
| Proceeds from exercise of common stock options | | | 2,101 | | | | — | | | | 2,101 | | | | 5,865 | | | | — | | | | 5,865 | |
| Borrowings on bank credit facility | | | 30,000 | | | | — | | | | 30,000 | | | | — | | | | — | | | | — | |
| Principal payments on capital leases | | | (91 | ) | | | — | | | | (91 | ) | | | (89 | ) | | | — | | | | (89 | ) |
| Net cash provided by financing activities | | | 55,911 | | | | — | | | | 55,911 | | | | 5,776 | | | | — | | | | 5,776 | |
| Effect on exchange rate changes on cash and cash equivalents | | | (258 | ) | | | — | | | | (258 | ) | | | (761 | ) | | | — | | | | (761 | ) |
| Net decrease in cash and cash equivalents | | | (746 | ) | | | — | | | | (746 | ) | | | (16,705 | ) | | | — | | | | (16,705 | ) |
| Cash and cash equivalents at beginning of year | | | 36,182 | | | | — | | | | 36,182 | | | | 35,436 | | | | — | | | | 35,436 | |
| Cash and cash equivalents at end of year | | $ | 35,436 | | | $ | — | | | $ | 35,436 | | | $ | 18,731 | | | $ | — | | | $ | 18,731 | |
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 2 — Restatement of Consolidated Financial Statements and Change in Accounting Policy – (continued)
As a result of the aforementioned restatement the related disclosures included in the Notes to consolidated financial statements have been revised where so indicated as restated. See also Note 14 for information related to the restatement of the quarters within the March 31, 2006 fiscal year and the quarters ended June 30 and September 30, 2006. As noted in our Form 8-K filed February 2, 2007, our previously filed Annual Reports on Form 10-K and Quarterly Reports on Form 10-Q will not be amended and may no longer be relied on.
Note 3 — Inventory
The components of inventory consist of (in thousands):
| | | | |
| | March 31, |
| | | 2006 | | 2007 |
| Finished goods | | $ | 649 | | | $ | 782 | |
| Work in-process | | | 40 | | | | 25 | |
| | | $ | 689 | | | $ | 807 | |
Finished goods inventory included inventory on consignment of $0.2 million and $0.6 million at March 31, 2006 and 2007, respectively.
Note 4 — Fixed Assets
Fixed assets consist of (in thousands):
| | | | |
| | 2006 | | 2007 |
| Equipment, furniture and fixtures | | $ | 15,317 | | | $ | 13,422 | |
| Less accumulated depreciation | | | (10,484 | ) | | | (10,181 | ) |
| | | $ | 4,833 | | | $ | 3,241 | |
Note 5 — Purchased, Internally Developed Software, Goodwill and Acquired Intangibles
The components of all intangible assets, excluding goodwill, were as follow (in thousands):
Purchased and internally developed software:
| | | | | | | | | | |
| | | | March 31, 2006 | | March 31,
2007 |
| | | Useful
Life in
Years | | Net
Carrying
Amount | | Gross
Carrying
Amount | | Accumulated Amortization | | Net
Carrying
Amount |
| Purchased software | | | 3 | | | $ | 842 | | | $ | 3,055 | | | $ | (2,152 | ) | | $ | 903 | |
| Internally developed software | | | 3 | | | | 424 | | | | 9,812 | | | | (9,675 | ) | | | 137 | |
| | | | | | | $ | 1,266 | | | $ | 12,867 | | | $ | (11,827 | ) | | $ | 1,040 | |
Amortization of internally developed software costs was $0.4 million, $0.3 million and $0.3 million for the years ended March 31, 2005, 2006 and 2007, respectively.
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March 31, 2005, 2006 and 2007
Note 5 — Purchased, Internally Developed Software, Goodwill and Acquired Intangibles – (continued)
Acquired Intangibles (in thousands):
| | | | | | | | | | |
| | | | March 31, 2006 | | March 31,
2007 |
| | | Useful
Life in
Years | | Net
Carrying
Amount | | Gross
Carrying
Amount | | Accumulated Amortization | | Net
Carrying
Amount |
| Acquired technology | | | 3 – 5 | | | $ | 7,081 | | | $ | 12,614 | | | $ | (6,917 | ) | | $ | 5,697 | |
| Customer lists | | | 4 – 15 | | | | 11,081 | | | | 14,640 | | | | (5,865 | ) | | | 8,775 | |
| Trademarks | | | 3 | | | | 52 | | | | 180 | | | | (180 | ) | | | — | |
| Brand name | | | Indefinite | | | | 25,700 | | | | 25,700 | | | | — | | | | 25,700 | |
| | | | | | | $ | 43,914 | | | $ | 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 $1.7 million, $5.1million and $5.4 million for the years ended March 31, 2005, 2006 and 2007, respectively. The future annual amortization expense is expected to be as follows (in thousands):
| | |
| Year Ending March 31, | | Amortization Expense |
| 2008 | | $ | 4,784 | |
| 2009 | | | 4,219 | |
| 2010 | | | 2,064 | |
| 2011 | | | 1,241 | |
| 2012 | | | 896 | |
| Thereafter | | | 1,268 | |
| | | $ | 14,472 | |
The following tables present a roll-forward of the goodwill and other intangibles for the 2007 and 2006 fiscal years (in thousands):
| | | | | | | | |
| | March 31,
2005 | | Adjustments(2)(3)(4) | | Amortization(1) | | March 31,
2006 |
| | | As Restated | | | | | | As Restated |
| Goodwill | | $ | 52,616 | | | $ | (943 | ) | | $ | — | | | $ | 51,673 | |
| Acquired Technology | | | 9,543 | | | | — | | | | (2,462 | ) | | | 7,081 | |
| Trademark/brand name | | | 25,812 | | | | — | | | | (60 | ) | | | 25,752 | |
| Customer lists/contacts | | | 13,691 | | | | — | | | | (2,610 | ) | | | 11,081 | |
| | | $ | 101,662 | | | $ | (943 | ) | | $ | (5,132 | ) | | $ | 95,587 | |
| | | | | | | | |
| | March 31, 2006 | | Additions(5) | | Amortization(1) | | March 31, 2007 |
| | | As Restated | | |
| Goodwill | | $ | 51,673 | | | $ | 3,835 | | | $ | — | | | $ | 55,508 | |
| Acquired Technology | | | 7,081 | | | | 1,500 | | | | (2,884 | ) | | | 5,697 | |
| Trademark/brand name | | | 25,752 | | | | — | | | | (52 | ) | | | 25,700 | |
| Customer lists/contacts | | | 11,081 | | | | 200 | | | | (2,506 | ) | | | 8,775 | |
| | | $ | 95,587 | | | $ | 5,535 | | | $ | (5,442 | ) | | $ | 95,680 | |
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March 31, 2005, 2006 and 2007
Note 5 — Purchased, Internally Developed Software, Goodwill and Acquired Intangibles – (continued)
| (1) | Amortization of intangibles is included in “Cost of Revenue” in our Statements of Operations. |
| (2) | Includes a $0.5 million adjustment to goodwill acquired related to the December 2004 Roxio CSD acquisition to reflect the revaluation of the cost of patents acquired in the amount of $1.2 million, net of final payment to seller of $1.0 million and other adjustments to net assets and liabilities acquired, as discussed in Note 13. |
| (3) | Includes a ($1.0 million) adjustment to goodwill related to the InterActual acquisition completed in fiscal year ended March 31, 2004 related to recognition of a deferred tax asset, net of a valuation allowance, for the acquired net operating losses. |
| (4) | Includes a ($0.4 million) adjustment to goodwill acquired related to the December 2004 Roxio CSD acquisition to reflect transaction costs incurred in connection with the acquisition that are deductible for tax purposes. |
| (5) | Includes amounts capitalized in connection with the SystemOK, AB (“SystemOK”) acquisition completed in November 2006. |
Note 6 — Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities consist of (in thousands):
| | | | |
| | March 31, |
| | | 2006 | | 2007 |
| | | As Restated | | |
| Commissions payable | | $ | 1,060 | | | $ | 724 | |
| Accrued compensation and benefits | | | 4,424 | | | | 4,056 | |
| Accrued professional services | | | 3,000 | | | | 4,432 | |
| Accrued marketing costs | | | 2,246 | | | | 1,380 | |
| Accrued royalties | | | 4,669 | | | | 5,441 | |
| Accrued acquisition/restructuring costs | | | 1,608 | | | | — | |
| Taxes payable and other tax liabilities | | | 10,894 | | | | 11,886 | |
| Other | | | 2,582 | | | | 2,269 | |
| | | $ | 30,483 | | | $ | 30,188 | |
Note 7 — 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 was approximately $2.9 million, $4.0 million and $4.7 million for the fiscal years ended March 31, 2005, 2006 and 2007, 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 | | $ | 4,550 | |
| 2009 | | | 3,896 | |
| 2010 | | | 2,596 | |
| 2011 | | | 1,264 | |
| 2012 | | | — | |
| Thereafter | | | — | |
| | | $ | 12,306 | |
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 7 — Contingencies, Commitments and Credit Facilities – (continued)
Litigation Matters
As part of the Roxio CSD acquisition, we acquired all of the capital stock of MGI Software Corporation (“MGI”). Prior to the Roxio CSD acquisition, Roxio and MGI were notified by a number of companies that certain of their respective software products, which we acquired in the Roxio CSD acquisition, may infringe patents owned by those companies. In addition, Roxio and MGI were notified by a number of OEM customers, who bundle the Roxio and MGI software products with their own computer products, that such OEMs were approached by certain of these companies claiming possible patent infringement by Roxio and MGI. We have been separately approached by companies claiming patent infringement. We currently have accruals of approximately $1.9 million on our balance sheet related to the settlement of certain 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.
Between March and May 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 have been consolidated into one action captionedWilder v. Doris, et al., and on September 20, 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.
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. This action alleges various violations of the Exchange Act and the rules promulgated thereunder, and is based on substantially similar factual allegations and claims as in the derivative actions. Thereafter, 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.
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.
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. On December 20, 2005, we entered into the First Amendment to the Loan and Security Agreement (the “Amended Credit Facility”),
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 7 — Contingencies, Commitments and Credit Facilities – (continued)
which provided for $30.0 million of available funds for general corporate purposes. The Amended Credit Facility also clarified certain Credit Facility terms, amended the required leverage ratio and also provided for letters of credit up to $30.0 million less any outstanding borrowings under the Amended Credit Facility.
The Amended Credit Facility 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 Loan Agreement, 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. We are also subject to certain reporting and financial covenants, which include requirements that we maintain specified financial ratios and a net profit for each quarter following the fourth quarter of fiscal year 2005. 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 in the Loan Agreement 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 March 31, 2007, the interest rate was 6.82%.
As a result of a $3.4 million charge for in-process technology associated with our acquisition of SystemOK, we recognized a net loss for the quarter ended December 31, 2006 and were not in compliance with the quarterly net profit covenant under the Amended Credit Facility. Additionally, we recognized a net loss in the quarter ended March 31, 2007 primarily due to charges for payroll taxes and employee taxes under Section 409A of the Code associated with our voluntary review of our historical stock option grant practices and related accounting.
Subsequent to December 31, 2006 we did not file quarterly and annual financial statements in a timely manner as required under the Amended Credit Facility. Additionally, based on preliminary financial results, we determined that we were unlikely to meet the quarterly net profit covenant for the quarter ended June 30, 2007 and the required leverage ratio as of June 30, 2007. As a result of these issues, we entered into a Second Amendment to the Loan and Security Agreement with UBOC on September 28, 2007 (the “Second Amendment”). The Second Amendment extended the maturity date of the Amended Credit Facility to March 31, 2008, provided waivers for violations of the reporting covenants and anticipated June 30, 2007 financial covenant violations, modified financial covenants and further restricted payment of dividends and distributions. The Second Amendment did not waive the potential quarterly net profit covenant violations for the quarters ended December 31, 2006 and March 31, 2007 as such violations were not known at the time.
As of March 31, 2007, the outstanding balance on the Amended Credit Facility was $20.0 million and was classified as a current liability. As of February 15, 2008, UBOC has not notified us of any intent to take the actions necessary to accelerate the repayment of our obligations under the Amended Credit Facility.
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 for certain events or
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 7 — Contingencies, Commitments and Credit Facilities – (continued)
occurrences, subject to certain limits, while they were serving 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 review of our historic stock option granting practices and the related restatement, related governmental inquiries, and shareholder derivative litigation and class action litigation described herein. The maximum amount of potential future 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 the 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.In fiscal year 2007 we made $0.9 million in matching contributions to plan. We made no contributions to this plan in fiscal years 2005 and 2006.
Note 8 — Shareholders’ Equity
On February 5, 2004, we filed a Form S-3 Registration Statement, as amended, with the SEC to register our common stock, preferred stock and warrants to purchase common stock and preferred stock with an aggregate maximum offering price not to exceed $80.0 million. The registration statement had previously been declared effective by the SEC; however, due to our delinquency in certain periodic SEC filings in connection with our option review, we are not currently able to utilize the remaining shares registered under this registration statement.
On June 23, 2004, we announced an underwritten public offering of 1.3 million shares of our common stock to institutional investors at a price of $19.48 per share for gross proceeds of $25.3 million under the Form S-3 Registration Statement. The transaction was completed and the stock was issued to investors on June 28, 2004. We received net proceeds of approximately $23.9 million after deducting underwriting discounts and expenses associated with the offering.
As part of the purchase price for the Roxio CSD, pursuant to the terms of the Amended Purchase Agreement, we issued to the seller 0.7 million shares of our common stock valued at $8.6 million.
As part of the purchase price for SystemOK, pursuant to the terms of the purchase agreement, we issued 31,566 shares of our common stock valued at approximately $0.5 million.
Stock Options
Under our September 1989 Stock Option Plan (the “1989 Plan”), options to purchase up to an aggregate of 2.1 million shares of common stock may be granted to key employees, directors and consultants. Grants of options to our directors may not exceed 140,000 shares. The 1989 Plan provides for issuing both incentive stock options, which must be granted at fair market value at the date of grant, and nonqualified stock options, which must be granted at not less than 85% of fair market value of the stock. Options under the 1989 Plan generally vest over four years from the date of grant. Our board of directors and Compensation Committee administer the 1989 Plan. No more options may be granted under the 1989 Plan.
During 1995, we adopted the 1994 Non-Employee Directors Stock Option Plan (the “Non-Employee Plan”), which provides for the grant of stock options to our non-employee directors. Under this plan, stock options are granted annually at the fair market value of our common stock on the date of grant. The number of options so granted annually is fixed by the plan. The total number of shares to be issued under this plan may not exceed 100,000 shares. The Non-Employee Plan provides for issuing both incentive stock options, which must be granted at fair market value at the date of grant, and nonqualified stock options, which must be granted at not less than 85% of fair market value of the stock. Options under the Non-Employee Plan generally vest over four years from the date of grant. Our board of directors and Compensation Committee administer the Non-Employee Plan.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 8 — Shareholders’ Equity – (continued)
During 1998, we adopted the Sonic Solutions 1998 Stock Option Plan (the “1998 Plan”). The 1998 Plan covers 1.0 million shares of common stock, with an annual increase in the number of shares available for issuance under the 1998 Plan on the last day of each fiscal year; provided that the total number of shares issuable under the plan shall not exceed 2.0 million. The 1998 Plan provides for issuing both incentive stock options, which must be granted at fair market value at the date of grant, and nonqualified stock options, which must be granted at not less than 85% of fair market value of the stock. Options under the 1998 Plan generally vest over four years from the date of grant. Our board of directors and Compensation Committee administer the 1998 Plan.
In 2000, we adopted the Sonic Solutions 2000 Stock Option Plan (the “2000 Plan”). The 2000 Plan covers 3.0 million shares of Common Stock with an annual increase in the number of shares available for issuance under the 2000 Plan on the last day of each fiscal year, provided that the total number of shares issuable under the plan shall not exceed 3.75 million shares.Under this plan, stock options are granted annually at the fair market value of our common stock on the date of grant. The 2000 Plan provides for issuing both incentive stock options, which must be granted at fair market value at the date of grant, and nonqualified stock options, which must be granted at not less than 85% of fair market value of the stock. Options under the 2000 Plan generally vest over four years from the date of grant. The options generally expire ten years from the date of grant and are canceled three months after termination of employment. Our board of directors and Compensation Committee administer the 2000 Plan.
In February 2004, we adopted the 2004 Stock Incentive Plan (the “2004 SIP”) and reserved 2.0 million shares of common stock solely for the grant of “inducement” stock options and other share-based awards. The 2004 SIP did not require shareholder approval. These shares may be issued in connection with the recruitment of employees in future acquisitions and in the recruitment of other employees in the future. The 2004 SIP provides for issuing nonqualified stock options. The options generally expire ten years from the date of grant and are canceled three months after termination of employment. Our board of directors and Compensation Committee administer the 2004 SIP.
In June 2004, we adopted the Sonic Solutions 2004 Equity Compensation Plan (the “2004 Plan”) and the shareholders approved the 2004 Plan in September, 2004. The 2004 Plan originally covered 3,000,000 shares of common stock, but 750,000 shares are now reserved for issuance under the 2005 Plan. The 2004 Plan provides for the grant of stock options, restricted stock, restricted stock units, stock appreciation rights and dividend equivalent rights (collectively referred to as “awards”). Stock options granted under the 2004 Plan may be either incentive stock options under the provisions of Section 422 of the Code, or nonqualified stock options. Incentive stock options may be granted only to employees. Awards other than incentive stock options may be granted to employees, directors and consultants. Options under the 2004 Plan generally vest over four years from the date of grant. The options generally expire ten years from the date of grant and are canceled three months after termination of employment. Our board of directors and Compensation Committee administer the 2004. Plan.
In March 2005, we adopted the 2005 Stock Incentive Plan (Non-U.S. Employees) (“Non-U.S. Plan”). The terms and the purposes of the Non-U.S. Plan and the 2004 Stock Incentive Plan are substantially similar. The Board of Directors reserved 750,000 shares of common stock for issuance under the Non-U.S. Plan which were previously reserved under the 2004 Stock Incentive Plan. Options may only be granted to Employees (a) who have not previously been an Employee or Director of the Company or a Related Entity or (b) following a bonafide period of non-employment or non-service to the Company or a Related Entity. The Non-US Plan provides for issuing nonqualified stock. Options under the 2005 Plan generally vest over four years from the date of grant. The options generally expire ten years from the date of grant and are canceled three months after termination of employment. Our board of directors and Compensation Committee administer the Non-US Plan.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 8 — Shareholders’ Equity – (continued)
A summary of our option activity is presented below:
| | | | | | | | |
| | Number of
Shares | | Weighted
Average
Exercise
Price | | Weighted
Average
Remaining
Contractual
Life (Years) | | Aggregate
Intrinsic Value
|
| | | | | (in thousands) |
| Outstanding at March 31, 2004, As Restated | | | 4,983,487 | | | $ | 6.24 | | | | | | | | | |
| Options granted | | | 1,809,419 | | | $ | 18.11 | | | | | | | | | |
| Options exercised | | | (466,665 | ) | | $ | 4.51 | | | | | | | | | |
| Options forfeited or expired | | | (169,781 | ) | | $ | 12.05 | | | | | | | | | |
| Outstanding at March 31, 2005, As Restated | | | 6,156,460 | | | $ | 9.70 | | | | 6.21 | | | $ | 39,689 | |
| Options granted | | | 2,999,004 | | | $ | 17.27 | | | | | | | | | |
| Options exercised | | | (1,376,133 | ) | | $ | 4.23 | | | | | | | | | |
| Options forfeited or expired | | | (483,062 | ) | | $ | 17.94 | | | | | | | | | |
| Outstanding at March 31, 2006, As Restated | | | 7,296,269 | | | $ | 13.30 | | | | 6.87 | | | $ | 38,026 | |
| Options granted | | | 56,600 | | | $ | 15.77 | | | | | | | | | |
| Options exercised | | | (479,537 | ) | | $ | 5.64 | | | | | | | | | |
| Options forfeited or expired | | | (254,057 | ) | | $ | 17.16 | | | | | | | | | |
| Outstanding at March 31, 2007 | | | 6,619,275 | | | $ | 13.72 | | | | 6.38 | | | $ | 17,584 | |
| Options exercisable at March 31, 2007 | | | 6,543,616 | | | $ | 13.73 | | | | 6.37 | | | $ | 17,420 | |
Aggregate intrinsic value represents the difference between our closing stock price on the last trading day of the fiscal period, which was $14.10 on March 30, 2007, and the exercise price for the options that were in-the-money at March 31, 2007. During fiscal year 2007, the total intrinsic value of stock options exercised was $5.2 million.
The following table summarizes information about stock options outstanding and exercisable at March 31, 2007:
| | | | | | | | | | |
| | Options Outstanding | | Options Exercisable |
| Range of Exercise Price | | Number of
Shares | | Weighted
Average
Remaining
Contractual
Term (Years) | | Weighted
Average
Exercise
Price | | Number of
Shares | | Weighted
Average
Exercise
Price |
| $1.1200 to $2.5625 | | | 582,291 | | | | 3.16 | | | $ | 1.69 | | | | 582,291 | | | $ | 1.69 | |
| $2.5626 to $5.3200 | | | 670,801 | | | | 4.67 | | | | 3.98 | | | | 667,165 | | | | 3.98 | |
| $5.3201 to $13.4730 | | | 569,748 | | | | 5.61 | | | | 8.04 | | | | 546,964 | | | | 8.02 | |
| $13.4731 to $15.5500 | | | 1,349,823 | | | | 7.28 | | | | 14.52 | | | | 1,320,823 | | | | 14.52 | |
| $15.5001 to $16.5400 | | | 654,582 | | | | 7.64 | | | | 16.06 | | | | 654,582 | | | | 16.06 | |
| $16.5401 to $20.8600 | | | 2,792,030 | | | | 6.89 | | | | 18.81 | | | | 2,771,791 | | | | 18.82 | |
| $1.1200 to $20.8600 | | | 6,619,275 | | | | 6.38 | | | $ | 13.72 | | | | 6,543,616 | | | $ | 13.73 | |
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 8 — Shareholders’ Equity – (continued)
Restricted Stock Units (“RSUs”)
During fiscal year 2007, we granted RSUs under the 2004 Equity Compensation Plan. A summary of RSU activity during fiscal year 2007 is as follows:
| | | | |
| | Number of
Shares | | Weighted
Average
Grant Date
Fair Value |
| Outstanding at March 31, 2006 | | | — | | | $ | — | |
| RSUs granted | | | 368,000 | | | | 15.07 | |
| RSUs canceled | | | (13,300 | ) | | | 15.07 | |
| Outstanding at March 31, 2007 | | | 354,700 | | | $ | 15.07 | |
At March 31, 2007, none of the RSUs outstanding were vested.
The weighted average grant date fair value was determined based on the closing market price of our common stock on the date of the award. The grant date fair value of RSU awards is recognized as compensation cost, on a straight-line basis over the four year vesting period. The total umamortized share-based compensation expense related to unvested RSUs at March 31, 2007 was $3.9 million. The aggregate intrinsic value of the outstanding RSUs at March 31, 2007 was $5.0 million, using the closing price of $14.10 per share as of March 31, 2007.
Acceleration of Stock Option Vesting
On January 30, 2006, we accelerated the vesting of all unvested and outstanding stock options awarded on or before January 30, 2006 with an exercise price greater than $13.50. The closing price of our common stock on January 30, 2006 was $16.46 per share. As a result of this acceleration, the additional expense was approximately $38,000 in accordance with APB No. 25 in the year ended March 31, 2006.
Share-Based Compensation
On April 1, 2006, we adopted SFAS No. 123R. See Note 1 for a description of our adoption of SFAS No. 123R. We use the Black-Scholes-Merton option pricing model to determine the fair value of stock option shares. The determination of the fair value of share-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include our expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends.
We estimate the volatility of our common stock by generally using our historical volatility blended with an implied volatility rate. Management determined that a blended volatility was more reflective of our market conditions and a better indicator of expected volatility than using purely historical volatility. Prior to April 1, 2006, we based the volatility assumption solely on our historical volatility for pro forma disclosure purposes. We will continue to monitor relevant factors used to measure expected volatility for future option grants on a quarterly basis.
The risk-free interest rates are derived from schedules published by the U.S. Federal Reserve appropriate for the term of our stock options.
The expected term of employee stock options represents the weighted-average period that the stock options are expected to remain outstanding. We derived the expected term assumption based on our historical settlement experience and expected behavior of unsettled options, while giving consideration to vesting schedules and options that have life cycles less than the contractual terms and vesting schedules in accordance with guidance in SFAS No. 123R and SAB 107.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 8 — Shareholders’ Equity – (continued)
Prior to the adoption of SFAS No. 123R, we accounted for share-based compensation related to employee share-based compensation plans using the intrinsic value method prescribed by APB No. 25 as allowed under SFAS No. 123. The restated financial statements in this Annual Report set forth restated share-based compensation measured using the intrinsic value method in relation to employee stock options for the applicable periods.
The weighted-average fair value of options granted and the related assumptions used are as follows:
| | | | | | |
| | Years Ended March 31, |
| | | 2005 | | 2006 | | 2007 |
| | | As Restated | | As Restated | | |
| Weighted-average fair value of options granted | | $ | 11.80 | | | $ | 11.27 | | | $ | 10.37 | |
| Risk-free interest rate | | | 3.2 | % | | | 4.2 | % | | | 5.0 | % |
| Expected volatility | | | 89 | % | | | 82 | % | | | 75 | % |
| Expected life (in years) | | | 3.6 | | | | 3.8 | | | | 5.0 | |
| Expected dividend | | | 0 | % | | | 0 | % | | | 0 | % |
The following table summarizes share-based compensation expense related to employee stock options, employee stock purchases and restricted stock unit grants for the fiscal year ended March 31, 2007 as recorded in accordance with SFAS No. 123R (including the effect of the restatements) (in thousands):
| | |
| | Year Ended
March 31,
2007 |
| Marketing and sales | | $ | 1,284 | |
| Research and development | | | 740 | |
| General and administrative | | | 741 | |
| | | $ | 2,765 | |
The expense for the year ended March 31, 2007 includes a charge of $0.1 million attributable to the extension of exercise periods for the modification of vested options under SFAS No. 123(R) for employees terminated from November 15, 2006 to March 31, 2007.
As of March 31, 2007, total unamortized share-based compensation expense related to non-vested stock options was $4.6 million, which is expected to be recognized over a weighted average period of approximately one year.
If we had applied the fair value recognition provisions of SFAS 123 for the fiscal years 2005 and 2006, our net income (loss) and net income (loss) per share would have been adjusted to the pro forma amounts shown below (in thousands, except per share data), respectively:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 8 — Shareholders’ Equity – (continued)
| | | | |
| | Years Ended March 31, |
| | | 2005 | | 2006 |
| | | As Restated | | As Restated |
| Net income, restated(1) | | $ | 2,747 | | | $ | 19,334 | |
| Add: Stock-based compensation expense included in restated net income, net of related tax effects(2) | | | 2,695 | | | | 6,062 | |
Deduct: Stock based employee compensation expense determined under the fair value method for all awards, net of
related tax effects | | | (6,610 | ) | | | (31,495 | ) |
| Pro forma net income (loss) | | $ | (1,168 | ) | | $ | (6,099 | ) |
| Reported basic net income per share | | $ | 0.12 | | | $ | 0.78 | |
| Reported diluted net income per share | | $ | 0.11 | | | $ | 0.74 | |
| Pro forma basic net income (loss) per share | | $ | (0.05 | ) | | $ | (0.25 | ) |
| Pro forma diluted net income (loss) per share | | $ | (0.05 | ) | | $ | (0.23 | ) |
| (1) | See Note 2 — Restatement of Consolidated Financial Statements and Change in Accounting Policy. |
| (2) | Includes effects of stock option vesting acceleration recognized in advance of adoption of SFAS 123R. |
Note 9 — Earnings Per Share
The following table sets forth the computation of basic and diluted income per share (in thousands, except per share data):
| | | | | | |
| | Years Ended March 31, |
| | | 2005 | | 2006 | | 2007 |
| | | As Restated | | As Restated | | |
| Net Income | | $ | 2,747 | | | $ | 19,334 | | | $ | 6,250 | |
Shares:
| | | | | | | | | | | | |
| Weighted average shares outstanding (basic) | | | 23,347 | | | | 24,750 | | | | 25,982 | |
Effect of dilutive common stock options
and RSUs | | | 1,605 | | | | 1,484 | | | | 1,449 | |
| Weighted average shares outstanding (diluted) | | | 24,952 | | | | 26,234 | | | | 27,431 | |
Net income per share:
| | | | | | | | | | | | |
| Basic | | $ | 0.12 | | | $ | 0.78 | | | $ | 0.24 | |
| Diluted | | $ | 0.11 | | | $ | 0.74 | | | $ | 0.23 | |
For the years ended March 31, 2005, 2006 and 2007 outstanding options for 0.9 million, 1.7 million and, 3.6 million shares, respectively, were excluded from the calculation of diluted net income per share, as the inclusion of such shares would have had an anti-dilutive effect.
Note 10 — Income Taxes
Income tax expense for the year ended March 31, 2005, as restated, consists of (in thousands):
| | | | | | |
| | Current | | Deferred | | Total |
| | | As Restated | | As Restated | | As Restated |
| US Federal | | $ | 252 | | | $ | — | | | $ | 252 | |
| State and Local | | | 80 | | | | — | | | | 80 | |
| Foreign | | | 590 | | | | 849 | | | | 1,439 | |
| | | $ | 922 | | | $ | 849 | | | $ | 1,771 | |
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 10 — Income Taxes – (continued)
Income tax expense (benefit) for the year ended March 31, 2006, as restated, consists of (in thousands):
| | | | | | |
| | Current | | Deferred | | Total |
| | | As Restated | | As Restated | | As Restated |
| US Federal | | $ | 550 | | | $ | (8,960 | ) | | $ | (8,410 | ) |
| State and Local | | | 1,125 | | | | (3,024 | ) | | | (1,899 | ) |
| Foreign | | | 610 | | | | 522 | | | | 1,132 | |
| | | $ | 2,285 | | | $ | (11,462 | ) | | $ | (9,177 | ) |
Income tax expense (benefit) for the year ended March 31, 2007 consists of (in thousands):
| | | | | | |
| | Current | | Deferred | | Total |
| US Federal | | $ | 537 | | | $ | 4,092 | | | $ | 4,629 | |
| State and Local | | | 913 | | | | (487 | ) | | | 426 | |
| Foreign | | | 1,056 | | | | (40 | ) | | | 1,016 | |
| | | $ | 2,506 | | | $ | 3,565 | | | $ | 6,071 | |
The differences between income taxes computed using the applicable statutory federal income tax rate (34% for fiscal year 2005; 35% for fiscal years 2006 and 2007) and that shown in the statements of operations are summarized as follows (in thousands):
| | | | | | |
| | Years Ended March 31, |
| | | 2005 | | 2006 | | 2007 |
| | | As Restated | | As Restated | | |
| Computed tax at statutory rate | | $ | 1,536 | | | $ | 3,555 | | | $ | 4,393 | |
| State taxes, net of federal benefit | | | 62 | | | | 510 | | | | 636 | |
| Extraterritorial income exclusion and qualified production income deduction | | | (75 | ) | | | (512 | ) | | | (38 | ) |
| Change in valuation allowance and related adjustments to additional paid in capital | | | — | | | | (17,375 | ) | | | — | |
| Research and development credits | | | (1,841 | ) | | | 3,440 | | | | (1,249 | ) |
| SystemOK acquired in process technology write-off | | | — | | | | — | | | | 952 | |
| Foreign rate differential | | | 1,440 | | | | 348 | | | | 728 | |
| Other differences | | | 649 | | | | 857 | | | | 649 | |
| | | $ | 1,771 | | | $ | (9,177 | ) | | $ | 6,071 | |
The other permanent differences consist of provision to return true up adjustments, book expenses for incentive stock options, and certain meals and entertainment expenses and penalties.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 10 — Income Taxes – (continued)
The components of deferred taxes are as follows (in thousands):
| | | | |
| | March 31, |
| | | 2006 | | 2007 |
| | | As Restated | | |
Deferred tax assets:
| | | | | | | | |
| Accounts receivable | | $ | 470 | | | $ | 278 | |
| Inventories | | | 251 | | | | 221 | |
| Tax credit carryforwards | | | 10,687 | | | | 13,246 | |
| Net operating losses | | | 8,452 | | | | 3,980 | |
| Accrued vacation pay | | | 655 | | | | 917 | |
| Commissions and bonuses | | | 89 | | | | 40 | |
| Fixed assets | | | 246 | | | | 284 | |
| Other reserves | | | 5,405 | | | | 5,854 | |
| Stock option compensation | | | 4,965 | | | | 5,386 | |
| Gross deferred tax assets | | | 31,220 | | | | 30,206 | |
| Valuation allowance | | | (2,612 | ) | | | (3,084 | ) |
| Total deferred tax assets, net of valuation allowance | | | 28,608 | | | | 27,122 | |
Deferred tax liabilities:
| | | | | | | | |
| Intangible assets | | | (298 | ) | | | (1,218 | ) |
| State income taxes | | | (1,842 | ) | | | (2,207 | ) |
| Research and experimental expenses | | | (22 | ) | | | 42 | |
| Total deferred tax liability | | | (2,162 | ) | | | (3,383 | ) |
| Net deferred taxes | | $ | 26,446 | | | $ | 23,739 | |
See description of restatement in Note 2, “Restatement of Consolidated Financial Statements and Change in Accounting Policy.”
As of March 31, 2007, we have gross deferred tax assets for net operating loss carryforwards of $4.0 million including $2.3 million related to our acquisition of InterActual Technologies, Inc. The loss carryforwards expire between 2011 and 2020.
As of March 31, 2007, we have cumulative unused federal and California R&D tax credits of approximately $5.1 million and $4.7 million, respectively, that can be used to reduce federal and California income taxes. The federal R&D credits expire from 2013 through 2026; California credits carryforward indefinitely. As of March 31, 2007, we have cumulative foreign tax credits of approximately $3.1 million that expire from 2008 through 2015. In addition we have alternative minimum tax credit carryforwards of approximately $0.2 million available to offset regular income tax over an indefinite period and $0.1 million of California manufacturing investment credits that expire in 2011 and 2012.
The $3.1 million valuation allowance consists of a reserve of $1.7 million for acquired InterActual net operating loss carryforwards that may not be utilized due primarily to an annual limitation under Code Section 382 and a reserve of $1.4 million against Canadian deferred tax assets that are unlikely to be realized.
Pursuant to APB No. 23 “Accounting for Income Taxes — Special Areas,” U.S. corporate income taxes were not provided on a cumulative total of approximately $1.2 million of undistributed net foreign earnings for all non-U.S. subsidiaries. We intend to indefinitely reinvest these funds in their respective operations outside the U.S.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 11 — Significant Customer Information, Segment Reporting and Geographic Information
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 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 presented for the Roxio Division and 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; 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 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 DVD-Video creation tools and playback, CD-Audio, CD-ROM and DVD-ROM making tools, tools focused on the new high-definition formats, as well as data backup software intended for use by entry-level professionals, enthusiasts and consumers. Included in this segment is the software we acquired in connection with the Roxio CSD and SystemOK acquisitions. Our consumer segment’s products also include software that we license to other companies for inclusion in their products.
The professional audio and video segment includes advanced DVD-Video and high definition creation tools, which are intended for use by highly skilled content creation customers, high-end authoring houses, major motion picture studios and disc replicators.
The following tables show the revenue by product line, net revenues attributable to the components of consumer products segment, operating results by segment, revenue by geographic location, long-lived assets and significant customer information:
Net Revenue by Segment (in thousands):
| | | | | | |
| | Years Ended March 31, |
| | | 2005 | | 2006 | | 2007 |
| | | As Restated |
Net revenue
| | | | | | | | | | | | |
| Consumer | | $ | 82,487 | | | $ | 136,354 | | | $ | 140,414 | |
| Professional audio and video | | | 8,140 | | | | 11,254 | | | | 8,235 | |
| Total net revenue | | $ | 90,627 | | | $ | 147,608 | | | $ | 148,649 | |
Net revenues attributable to the two components of our consumer products segment were as follows:
| | | | |
| | Years Ended March, 31 |
| | | 2006 | | 2007 |
| | | As Restated |
| Roxio Division | | $ | 117,333 | | | $ | 122,326 | |
| Advanced Technology Group | | | 19,021 | | | | 18,088 | |
| Total consumer products net revenue | | $ | 136,354 | | | $ | 140,414 | |
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 11 — Significant Customer Information, Segment Reporting and Geographic Information – (continued)
Net revenue by component of our consumer products division is not presented for fiscal year 2005 because, due primarily to a change in our accounting software in fiscal 2005, we determined that it was impracticable to do so.
Operating Income (Loss) by Segment (in thousands):
| | | | | | |
| | Years Ended March 31, |
| | | 2005 | | 2006 | | 2007 |
| | | As Restated | | As Restated | | |
Operating income (loss)
| | | | | | | | | | | | |
| Consumer | | $ | 23,866 | | | $ | 37,150 | | | $ | 45,536 | |
| Professional audio and video | | | (1,450 | ) | | | 197 | | | | (3,363 | ) |
| Unallocated operating expenses | | | (18,075 | ) | | | (26,184 | ) | | | (30,633 | ) |
| Total operating income | | $ | 4,341 | | | $ | 11,163 | | | $ | 11,540 | |
Revenues by Geographic Location (in thousands):
| | | | | | |
| | Years Ended March 31, |
| | | 2005 | | 2006 | | 2007 |
| | | As Restated |
| United States | | $ | 69,997 | | | $ | 113,100 | | | $ | 116,371 | |
Export
| | | | | | | | | | | | |
| Canada | | | 224 | | | | 262 | | | | 615 | |
| France | | | 928 | | | | 2,338 | | | | 1,275 | |
| Germany | | | 2,896 | | | | 2,181 | | | | 3,038 | |
| United Kingdom | | | 1,572 | | | | 6,141 | | | | 3,821 | |
| Other European | | | 2,987 | | | | 4,530 | | | | 4,579 | |
| Japan | | | 9,845 | | | | 14,873 | | | | 13,282 | |
| Singapore | | | 104 | | | | 2,241 | | | | 3,682 | |
| Taiwan | | | 1,288 | | | | 312 | | | | 175 | |
| Other Pacific Rim | | | 677 | | | | 1,300 | | | | 1,588 | |
| Other International | | | 109 | | | | 330 | | | | 223 | |
| Total net revenue | | $ | 90,627 | | | $ | 147,608 | | | $ | 148,649 | |
We sell our products to customers categorized geographically by each customer’s country of domicile.
Long-lived assets (excluding goodwill and other intangible assets) by country (in thousands):
| | | | |
| | March 31, |
| | | 2006 | | 2007 |
| United States | | $ | 3,800 | | | $ | 2,153 | |
| Japan | | | 191 | | | | 168 | |
| Canada | | | 456 | | | | 351 | |
| Other International | | | 386 | | | | 569 | |
| Total long-lived assets | | $ | 4,833 | | | $ | 3,241 | |
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 11 — Significant Customer Information, Segment Reporting and Geographic Information – (continued)
Significant customer information:
| | | | | | | | | | |
| | Percent of Total Net Revenue | | Percent of
Total Accounts
Receivable |
| | | Years Ended March 31, | | March 31, |
| | | 2005 | | 2006 | | 2007 | | 2006 | | 2007 |
| | | As Restated | | As Restated | | |
| Dell | | | 33 | % | | | 20 | % | | | 23 | % | | | 13 | % | | | 10 | % |
| Ingram | | | 6 | % | | | 10 | % | | | 9 | % | | | 12 | % | | | 11 | % |
| Navarre | | | 5 | % | | | 12 | % | | | 13 | % | | | 11 | % | | | 12 | % |
| Digital River | | | 7 | % | | | 17 | % | | | 20 | % | | | 7 | % | | | 12 | % |
Revenue recognized from Dell is pursuant to development and licensing agreements. Revenue recognized from Ingram and Navarre is pursuant to distributor agreements. Revenue recognized from Digital River is pursuant to a reseller agreement entered into during fiscal year 2006, resulting in a change of relationship from third party provider to reseller.
Note 12 — SystemOK Acquisition
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, net of cash acquired | | | 8,692 | |
| Estimated transaction costs | | | 167 | |
| Total purchase price, net of cash acquired | | $ | 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 beginning on November 6, 2006.
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March 31, 2005, 2006 and 2007
Note 12 — SystemOK Acquisition – (continued)
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 is included as a separate line item on our consolidated statements of operations for the fiscal year ended March 31, 2007.
Note 13 — Roxio CSD Acquisition
On December 17, 2004, we closed our previously announced purchase of the Roxio CSD. This acquisition has provided us with a well-recognized set of consumer software brands, access to long-standing distribution channels, strong product marketing expertise and key relationships with top-tier retail outlets.
Under the terms of the transaction, we acquired substantially all of the assets of the Roxio CSD, including all products, intellectual property and trademarks, as well as the “Roxio” name. At closing, we paid the seller $70.0 million and issued it 653,837 shares of our common stock valued at $8.6 million, plus an aggregate of approximately $2.3 million representing the initial working capital and channel inventory adjustments. The common stock was valued using the closing price of our stock for the two days before through two days following August 9, 2004. During the fourth quarter of fiscal year 2006, we paid an additional $2.2 million to the seller in satisfaction of a final working capital adjustment and other remaining obligations related to the acquisition. Of this amount, $1.2 million related to various amounts previously accrued and $1.0 million was recorded as an increase in goodwill.
We allocated the purchase price to assets purchased and liabilities assumed based on their relative fair values with the excess recorded as goodwill. The amounts and components of the purchase price along with the allocation of the purchase price are as follows (in thousands):
| | |
| Fair market value of liabilities assumed less tangible assets acquired | | $ | (5,056 | ) |
| Core developed technology | | | 9,100 | |
| Customer contracts | | | 13,100 | |
| Brand (trade) names | | | 25,700 | |
| Acquired in process technology | | | 3,100 | |
| Goodwill | | | 39,865 | |
| Net assets acquired | | $ | 85,809 | |
| Common stock issued | | | 8,630 | |
| Cash | | | 73,323 | |
| Transaction costs | | | 3,856 | |
| Total purchase price | | $ | 85,809 | |
The value of identifiable intangible assets was determined in accordance with SFAS No. 141. Core developed technology represents technology products that had been introduced into the market, were generating revenue and/or had reached technological feasibility as of the close of the transaction. The value is calculated based on an estimate of the implicit income derived from this technology. Core developed technology is estimated to have a useful life of four to five years, amortized on a straight line basis. The value of
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 13 — Roxio CSD Acquisition – (continued)
customer contracts represents the implicit income derived as a result of the distribution channels and customers of the Roxio CSD. Based on historical attrition rates, the useful life of the customer contracts is estimated to be 10 years, amortized using an accelerated method over the estimated useful life. The value of trade names is calculated based on the overall revenue stream of products and an estimated royalty rate. The royalty rate was determined in part by reviewing industry data regarding royalties paid for the use of a third party trade name. Based on the plan to continue to use the existing trade names, the useful life is indefinite and accordingly the value will not be amortized.
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 this acquisition, we identified five research and development projects involving the creation of next generation versions of certain primary software products for which technological feasibility had not been established and no alternative future uses existed. These projects ranged from approximately 35% to 70% complete at the time of acquisition, and we generally anticipated that these projects would have been completed and would be generating revenue by the end of calendar year 2005. Accordingly, the acquired in-process technology was expensed upon consummation of the acquisition and is included as a separate line item on our consolidated statements of operations for the fiscal year ended March 31, 2005.
Included in net assets acquired were receivable reserves totaling approximately $9.3 million. Through March 31, 2006, approximately $7.0 million in various claims, returns, adjustments, and discounts were charged against pre-acquisition reserves. As of March 31, 2006, based on an analysis of the remaining exposure, we released approximately $1.3 million of these reserves as a credit to sales returns in the accompanying statements of operations, leaving a remaining balance of approximately $1.1 million. The remaining reserves were utilized in fiscal 2007.
Included in transaction costs are approximately $1.0 million of transaction-related liabilities, including approximately $0.7 million for severance payments to former Roxio CSD employees and approximately $0.3 million for exit costs associated with the Roxio CSD facilities. Execution of these restructuring plans began within a few months of the date of close of the transaction.
As part of this acquisition, we assumed certain restructuring liabilities that consisted primarily of lease obligations for certain facilities previously exited by the Roxio CSD. The activity for the restructuring liabilities was as follows (in thousands):
| | |
| | Facility Exit
Costs |
| Liability recorded at acquisition date | | $ | 2,214 | |
| Payments | | | (3,191 | ) |
| Adjustments | | | 977 | |
| Balance at March 31, 2007 | | $ | — | |
During the quarter ended March 31, 2005, we incurred additional expenses of approximately $2.2 million to transition the Roxio CSD business into our existing operations. These expenses included incremental costs consisting primarily of employee severance and lease exit costs totaling approximately $1.4 million, a portion of internal payroll costs for those employees who worked on the acquisition totaling approximately $0.7 million and incremental costs incurred by consultants who worked on the acquisition and integration totaling approximately $0.1 million.
Results for the Roxio CSD have been included in our consolidated results beginning on December 18, 2004. The following pro forma results of operations for the fiscal year ended 2005 are as if the acquisition occurred on April 1, 2004. The pro forma information has been presented for illustrative purposes only and is
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 13 — Roxio CSD Acquisition – (continued)
not necessarily indicative of the combined non-recurring items which consist of acquired in-process technology expense of $3.1 million and business integration expense of $2.2 million.
| | |
| (in thousands, except per share amounts) | | 2005 |
| | | As Restated |
| Net revenue | | $ | 174,000 | |
| Net income | | $ | 29,300 | |
| Basic net income per share | | $ | 1.25 | |
| Diluted net income per share | | $ | 1.17 | |
Note 14 — Quarterly Financial Data (Unaudited)
Summarized quarterly financial information for fiscal years 2006 and 2007 is as follows (in thousands, except per share amounts):
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | Quarter Ended |
| | | June 30,
2005 | | September 30, 2005 | | December 31, 2005 | | March 31, 2006 | | June 30,
2006 | | September 30, 2006 | | December 31, 2006 | | March 31, 2007 |
| | | As Restated(1) | | As Restated(1) | | As Restated(1) | | As Restated(1) | | As Restated(1) | | As Restated(1) | | | | |
| Net revenue | | $ | 36,162 | | | $ | 31,699 | | | $ | 37,563 | | | $ | 42,184 | | | $ | 36,934 | | | $ | 35,244 | | | $ | 38,714 | | | $ | 37,757 | |
| Gross profit | | | 26,302 | | | | 24,466 | | | | 28,841 | | | | 33,867 | | | | 29,011 | | | | 27,215 | | | | 29,818 | | | | 28,214 | |
| Operating income (loss) | | | (289 | ) | | | (238 | ) | | | 8,483 | | | | 3,207 | | | | 7,841 | | | | 3,566 | | | | 1,702 | | | | (1,570 | ) |
| Net income (loss) | | | 13,358 | | | | (870 | ) | | | 10,695 | | | | (3,849 | ) | | | 5,001 | | | | 2,307 | | | | (240 | ) | | | (819 | ) |
| Basic income (loss) per share | | $ | 0.55 | | | $ | (0.04 | ) | | $ | 0.43 | | | $ | (0.15 | ) | | $ | 0.19 | | | $ | 0.09 | | | $ | (0.01 | ) | | $ | (0.03 | ) |
| Weighted average shares used in computing per share amounts | | | 24,350 | | | | 24,586 | | | | 24,806 | | | | 25,259 | | | | 25,778 | | | | 25,922 | | | | 26,059 | | | | 26,167 | |
| Diluted income (loss) per share | | $ | 0.52 | | | $ | (0.04 | ) | | $ | 0.41 | | | $ | (0.15 | ) | | $ | 0.18 | | | $ | 0.08 | | | $ | (0.01 | ) | | $ | (0.03 | ) |
| Weighted average shares used in computing per share amounts | | | 25,811 | | | | 24,586 | | | | 26,198 | | | | 25,259 | | | | 27,412 | | | | 27,217 | | | | 26,059 | | | | 26,167 | |
Common Stock Price Range
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| High | | $ | 18.88 | | | $ | 21.82 | | | $ | 22.02 | | | $ | 20.30 | | | $ | 18.38 | | | $ | 16.95 | | | $ | 17.81 | | | $ | 18.58 | |
| Low | | $ | 13.70 | | | $ | 17.60 | | | $ | 14.00 | | | $ | 14.66 | | | $ | 14.31 | | | $ | 13.42 | | | $ | 14.39 | | | $ | 13.84 | |
| (1) | See Note 2, “Restatement of Consolidated Financial Statements and Change in Accounting Policy” to the Consolidated Financial Statements. |
The following presents the effect of the restatement adjustments by financial statement line item for the Quarterly (Unaudited) Consolidated Balance Sheets and Statements of Operations for fiscal year 2006 the first two quarters of fiscal year 2007. See Note 2, “Restatement of Consolidated Financial Statements and Change in Accounting Policy” to the consolidated financial statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 14 — Quarterly Financial Data (Unaudited) – (continued)
UNAUDITED CONSOLIDATED BALANCE SHEETS
(in thousands)
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
| | June 30, 2005 | | September 30, 2005 | | December 31, 2005 |
| | | Previously
Reported | | Adjustments | | As
Restated | | Previously
Reported | | Adjustments | | As
Restated | | Previously
Reported | | Adjustments | | As
Restated |
ASSETS
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Current assets:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Cash and cash equivalents | | $ | 42,853 | | | $ | — | | | $ | 42,853 | | | $ | 18,741 | | | $ | — | | | $ | 18,741 | | | $ | 15,726 | | | $ | — | | | $ | 15,726 | |
| Short-term investments | | | — | | | | — | | | | — | | | | 26,100 | | | | — | | | | 26,100 | | | | 33,925 | | | | — | | | | 33,925 | |
| Accounts receivable, net of allowances | | | 13,628 | | | | (2,775 | ) | | | 10,853 | | | | 16,978 | | | | (2,847 | ) | | | 14,131 | | | | 23,664 | | | | (5,843 | ) | | | 17,821 | |
| Inventory | | | 715 | | | | — | | | | 715 | | | | 546 | | | | — | | | | 546 | | | | 687 | | | | — | | | | 687 | |
| Prepaid expenses and other current assets | | | 2,334 | | | | — | | | | 2,334 | | | | 3,044 | | | | — | | | | 3,044 | | | | 3,735 | | | | — | | | | 3,735 | |
| Total current assets | | | 59,530 | | | | (2,775 | ) | | | 56,755 | | | | 65,409 | | | | (2,847 | ) | | | 62,562 | | | | 77,737 | | | | (5,843 | ) | | | 71,894 | |
| Fixed assets, net | | | 6,569 | | | | — | | | | 6,569 | | | | 6,187 | | | | — | | | | 6,187 | | | | 5,447 | | | | — | | | | 5,447 | |
| Purchased and internally developed software costs, net | | | 1,485 | | | | — | | | | 1,485 | | | | 1,405 | | | | — | | | | 1,405 | | | | 1,347 | | | | — | | | | 1,347 | |
| Goodwill | | | 53,269 | | | | (2,048 | ) | | | 51,221 | | | | 53,481 | | | | (2,048 | ) | | | 51,433 | | | | 54,159 | | | | (2,048 | ) | | | 52,111 | |
| Acquired intangibles, net | | | 47,731 | | | | — | | | | 47,731 | | | | 46,413 | | | | — | | | | 46,413 | | | | 45,115 | | | | — | | | | 45,115 | |
| Deferred tax benefit, net | | | — | | | | 10,475 | | | | 10,475 | | | | — | | | | 9,988 | | | | 9,988 | | | | — | | | | 13,318 | | | | 13,318 | |
| Other assets | | | 6,521 | | | | — | | | | 6,521 | | | | 6,689 | | | | — | | | | 6,689 | | | | 6,322 | | | | — | | | | 6,322 | |
| Total assets | | $ | 175,105 | | | $ | 5,652 | | | $ | 180,757 | | | $ | 179,584 | | | $ | 5,093 | | | $ | 184,677 | | | $ | 190,127 | | | $ | 5,427 | | | $ | 195,554 | |
LIABILITIES AND SHAREHOLDERS' EQUITY
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Current liabilities:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Accounts payable | | $ | 9,325 | | | $ | — | | | $ | 9,325 | | | $ | 6,891 | | | $ | — | | | $ | 6,891 | | | $ | 6,123 | | | $ | — | | | $ | 6,123 | |
| Accrued expenses and other current liabilities | | | 20,456 | | | | 4,723 | | | | 25,179 | | | | 23,467 | | | | 5,087 | | | | 28,554 | | | | 24,257 | | | | 4,657 | | | | 28,914 | |
| Deferred revenue | | | 6,919 | | | | (257 | ) | | | 6,662 | | | | 7,143 | | | | (80 | ) | | | 7,063 | | | | 10,237 | | | | 135 | | | | 10,372 | |
| Total current liabilities | | | 36,700 | | | | 4,466 | | | | 41,166 | | | | 37,501 | | | | 5,007 | | | | 42,508 | | | | 40,617 | | | | 4,792 | | | | 45,409 | |
| Bank note payable | | | 30,000 | | | | — | | | | 30,000 | | | | 30,000 | | | | — | | | | 30,000 | | | | 30,000 | | | | — | | | | 30,000 | |
| Other long term liabilities, net of current portion | | | 2,191 | | | | — | | | | 2,191 | | | | 1,029 | | | | — | | | | 1,029 | | | | 175 | | | | — | | | | 175 | |
| Deferred revenue, net of current portion | | | 679 | | | | — | | | | 679 | | | | 607 | | | | — | | | | 607 | | | | 481 | | | | — | | | | 481 | |
| Total liabilities | | | 69,570 | | | | 4,466 | | | | 74,036 | | | | 69,137 | | | | 5,007 | | | | 74,144 | | | | 71,273 | | | | 4,792 | | | | 76,065 | |
Stockholders' equity:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Convertible preferred stock | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
| Common stock | | | 106,669 | | | | 23,420 | | | | 130,089 | | | | 109,021 | | | | 26,294 | | | | 135,315 | | | | 109,256 | | | | 24,350 | | | | 133,606 | |
Accumulated other
comprehensive loss | | | (325 | ) | | | — | | | | (325 | ) | | | (867 | ) | | | — | | | | (867 | ) | | | (896 | ) | | | — | | | | (896 | ) |
| Accumulated earnings (deficit) | | | (809 | ) | | | (22,234 | ) | | | (23,043 | ) | | | 2,293 | | | | (26,208 | ) | | | (23,915 | ) | | | 10,494 | | | | (23,715 | ) | | | (13,221 | ) |
| Total stockholders' equity | | | 105,535 | | | | 1,186 | | | | 106,721 | | | | 110,447 | | | | 86 | | | | 110,533 | | | | 118,854 | | | | 635 | | | | 119,489 | |
Total liabilities and
shareholders’ equity | | $ | 175,105 | | | $ | 5,652 | | | $ | 180,757 | | | $ | 179,584 | | | $ | 5,093 | | | $ | 184,677 | | | $ | 190,127 | | | $ | 5,427 | | | $ | 195,554 | |
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 14 — Quarterly Financial Data (Unaudited) – (continued)
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | For the Three Months Ended |
| | | June 30, 2005 | | September 30, 2005 |
| | | As
Previously Reported | | Adjustments | | As
Restated | | As
Previously Reported | | Adjustments | | As
Restated |
| Net revenue | | $ | 35,519 | | | $ | 643 | | | $ | 36,162 | | | $ | 31,948 | | | $ | (249 | ) | | $ | 31,699 | |
| Cost of revenue | | | 9,765 | | | | 95 | | | | 9,860 | | | | 7,154 | | | | 79 | | | | 7,233 | |
| Gross profit | | | 25,754 | | | | 548 | | | | 26,302 | | | | 24,794 | | | | (328 | ) | | | 24,466 | |
Operating expenses:
| | | | | | | | | | | | | | | | | | | | | | | | |
| Marketing and sales | | | 8,523 | | | | 1,056 | | | | 9,579 | | | | 7,354 | | | | 971 | | | | 8,325 | |
| Research and development | | | 9,874 | | | | 1,149 | | | | 11,023 | | | | 10,819 | | | | 1,102 | | | | 11,921 | |
| General and administrative | | | 4,909 | | | | 785 | | | | 5,694 | | | | 3,354 | | | | 1,063 | | | | 4,417 | |
| Business intergration | | | 295 | | | | — | | | | 295 | | | | 41 | | | | — | | | | 41 | |
| Total operating expenses | | | 23,601 | | | | 2,990 | | | | 26,591 | | | | 21,568 | | | | 3,136 | | | | 24,704 | |
| Operating income (loss) | | | 2,153 | | | | (2,442 | ) | | | (289 | ) | | | 3,226 | | | | (3,464 | ) | | | (238 | ) |
| Interest income | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
| Interest expense | | | — | | | | (21 | ) | | | (21 | ) | | | — | | | | (22 | ) | | | (22 | ) |
| Other expense | | | (113 | ) | | | — | | | | (113 | ) | | | (234 | ) | | | — | | | | (234 | ) |
| Income (loss) before income taxes | | | 2,040 | | | | (2,463 | ) | | | (423 | ) | | | 2,992 | | | | (3,486 | ) | | | (494 | ) |
| Provision (benefit) for income taxes | | | (3,864 | ) | | | (9,917 | ) | | | (13,781 | ) | | | (110 | ) | | | 486 | | | | 376 | |
| Net income (loss) | | $ | 5,904 | | | $ | 7,454 | | | $ | 13,358 | | | $ | 3,102 | | | $ | (3,972 | ) | | $ | (870 | ) |
Net income (loss) per share:
| | | | | | | | | | | | | | | | | | | | | | | | |
| Basic | | $ | 0.24 | | | $ | 0.30 | | | $ | 0.55 | | | $ | 0.13 | | | $ | (0.17 | ) | | $ | (0.04 | ) |
| Diluted | | $ | 0.21 | | | $ | 0.30 | | | $ | 0.52 | | | $ | 0.11 | | | $ | (0.15 | ) | | $ | (0.04 | ) |
Shares used in per share calculation:
| | | | | | | | | | | | | | | | | | | | | | | | |
| Basic | | | 24,350 | | | | — | | | | 24,350 | | | | 24,586 | | | | — | | | | 24,586 | |
| Diluted | | | 27,499 | | | | (1,688 | ) | | | 25,811 | | | | 27,975 | | | | — | | | | 24,586 | |
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 14 — Quarterly Financial Data (Unaudited) – (continued)
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | For the Three Months Ended |
| | | December 31, 2005 | | March 31, 2006 |
| | | As
Previously
Reported | | Adjustments | | As
Restated | | As
Previously
Reported | | Adjustments | | As
Restated |
| Net revenue | | $ | 40,774 | | | $ | (3,211 | ) | | $ | 37,563 | | | $ | 40,435 | | | $ | 1,749 | | | $ | 42,184 | |
| Cost of revenue | | | 9,435 | | | | (713 | ) | | | 8,722 | | | | 7,764 | | | | 553 | | | | 8,317 | |
| Gross profit | | | 31,339 | | | | (2,498 | ) | | | 28,841 | | | | 32,671 | | | | 1,196 | | | | 33,867 | |
Operating expenses:
| | | | | | | | | | | | | | | | | | | | | | | | |
| Marketing and sales | | | 7,751 | | | | (686 | ) | | | 7,065 | | | | 7,977 | | | | 2,660 | | | | 10,637 | |
| Research and development | | | 10,133 | | | | (1,059 | ) | | | 9,074 | | | | 9,734 | | | | 2,405 | | | | 12,139 | |
| General and administrative | | | 4,158 | | | | 61 | | | | 4,219 | | | | 4,598 | | | | 3,286 | | | | 7,884 | |
| Total operating expenses | | | 22,042 | | | | (1,684 | ) | | | 20,358 | | | | 22,309 | | | | 8,351 | | | | 30,660 | |
| Operating income | | | 9,297 | | | | (814 | ) | | | 8,483 | | | | 10,362 | | | | (7,155 | ) | | | 3,207 | |
| Interest income | | | — | | | | — | | | | — | | | | 1,271 | | | | — | | | | 1,271 | |
| Interest expense | | | — | | | | (23 | ) | | | (23 | ) | | | (1,754 | ) | | | (26 | ) | | | (1,780 | ) |
| Other income (expense), net | | | (445 | ) | | | — | | | | (445 | ) | | | 361 | | | | — | | | | 361 | |
| Income (loss) before income taxes | | | 8,852 | | | | (837 | ) | | | 8,015 | | | | 10,240 | | | | (7,181 | ) | | | 3,059 | |
| Provision (benefit) for income taxes | | | 651 | | | | (3,331 | ) | | | (2,680 | ) | | | 7,520 | | | | (612 | ) | | | 6,908 | |
| Net income (loss) | | $ | 8,201 | | | $ | 2,494 | | | $ | 10,695 | | | $ | 2,720 | | | $ | (6,569 | ) | | $ | (3,849 | ) |
Net income (loss) per share:
| | | | | | | | | | | | | | | | | | | | | | | | |
| Basic | | $ | 0.33 | | | $ | 0.10 | | | $ | 0.43 | | | $ | 0.11 | | | $ | (0.26 | ) | | $ | (0.15 | ) |
| Diluted | | $ | 0.30 | | | $ | 0.11 | | | $ | 0.41 | | | $ | 0.10 | | | $ | (0.25 | ) | | $ | (0.15 | ) |
Shares used in per share calculation:
| | | | | | | | | | | | | | | | | | | | | | | | |
| Basic | | | 24,806 | | | | — | | | | 24,806 | | | | 25,259 | | | | — | | | | 25,259 | |
| Diluted | | | 27,117 | | | | (919 | ) | | | 26,198 | | | | 27,043 | | | | — | | | | 25,259 | |
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SONIC SOLUTIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 14 — Quarterly Financial Data (Unaudited) – (continued)
UNAUDITED CONSOLIDATED BALANCE SHEETS
(in thousands)
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | June 30, 2006 | | September 30, 2006 |
| | | As
Previously
Reported | | Adjustments | | As
Restated | | As
Previously
Reported | | Adjustments | | As
Restated |
ASSETS
| | | | | | | | | | | | | | | | | | | | | | | | |
Current assets:
| | | | | | | | | | | | | | | | | | | | | | | | |
| Cash and cash equivalents | | $ | 11,719 | | | $ | — | | | $ | 11,719 | | | $ | 16,344 | | | $ | — | | | $ | 16,344 | |
| Short-term investments | | | 53,375 | | | | — | | | | 53,375 | | | | 44,275 | | | | — | | | | 44,275 | |
| Accounts receivable, net of allowances | | | 23,760 | | | | (3,849 | ) | | | 19,911 | | | | 22,563 | | | | (4,936 | ) | | | 17,627 | |
| Inventory | | | 515 | | | | — | | | | 515 | | | | 458 | | | | — | | | | 458 | |
| Deferred tax benefit | | | 3,879 | | | | — | | | | 3,879 | | | | 4,037 | | | | — | | | | 4,037 | |
| Prepaid expenses and other current assets | | | 3,767 | | | | — | | | | 3,767 | | | | 3,454 | | | | — | | | | 3,454 | |
| Total current assets | | | 97,015 | | | | (3,849 | ) | | | 93,166 | | | | 91,131 | | | | (4,936 | ) | | | 86,195 | |
| Fixed assets, net | | | 4,145 | | | | — | | | | 4,145 | | | | 3,775 | | | | — | | | | 3,775 | |
| Purchased and internally developed software costs, net | | | 1,053 | | | | — | | | | 1,053 | | | | 885 | | | | — | | | | 885 | |
| Goodwill | | | 54,151 | | | | (2,478 | ) | | | 51,673 | | | | 54,151 | | | | (2,478 | ) | | | 51,673 | |
| Acquired intangibles, net | | | 42,745 | | | | — | | | | 42,745 | | | | 41,576 | | | | — | | | | 41,576 | |
| Deferred tax benefit | | | 11,391 | | | | 11,194 | | | | 22,585 | | | | 8,921 | | | | 11,537 | | | | 20,458 | |
| Other assets | | | 1,089 | | | | — | | | | 1,089 | | | | 946 | | | | — | | | | 946 | |
| Total assets | | $ | 211,589 | | | $ | 4,867 | | | $ | 216,456 | | | $ | 201,385 | | | $ | 4,123 | | | $ | 205,508 | |
LIABILITIES AND SHAREHOLDERS' EQUITY
| | | | | | | | | | | | | | | | |
Current liabilities:
| | | | | | | | | | | | | | | | | | | | | | | | |
| Accounts payable | | $ | 5,185 | | | $ | — | | | $ | 5,185 | | | $ | 4,903 | | | $ | — | | | $ | 4,903 | |
| Accrued expenses and other current liabilties | | | 24,542 | | | | 4,650 | | | | 29,192 | | | | 21,152 | | | | 4,594 | | | | 25,746 | |
| Deferred revenue | | | 6,033 | | | | 831 | | | | 6,864 | | | | 5,206 | | | | 358 | | | | 5,564 | |
| Bank note payable | | | — | | | | — | | | | — | | | | 20,000 | | | | — | | | | 20,000 | |
| Total current liabilities | | | 35,760 | | | | 5,481 | | | | 41,241 | | | | 51,261 | | | | 4,952 | | | | 56,213 | |
| Bank note payable | | | 30,000 | | | | — | | | | 30,000 | | | | — | | | | — | | | | — | |
| Other long term liabilities, net of current portion | | | 335 | | | | — | | | | 335 | | | | 585 | | | | — | | | | 585 | |
| Deferred revenue, net of current portion | | | 82 | | | | — | | | | 82 | | | | 59 | | | | — | | | | 59 | |
| Total liabilities | | | 66,177 | | | | 5,481 | | | | 71,658 | | | | 51,905 | | | | 4,952 | | | | 56,857 | |
Shareholders' equity:
| | | | | | | | | | | | | | | | | | | | | | | | |
| Convertible preferred stock | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
| Common stock | | | 129,180 | | | | 28,763 | | | | 157,943 | | | | 130,571 | | | | 28,911 | | | | 159,482 | |
| Accumulated other comprehensive loss | | | (1,072 | ) | | | — | | | | (1,072 | ) | | | (1,064 | ) | | | — | | | | (1,064 | ) |
| Accumulated earnings | | | 17,304 | | | | (29,377 | ) | | | (12,073 | ) | | | 19,973 | | | | (29,740 | ) | | | (9,767 | ) |
| Total shareholders' equity | | | 145,412 | | | | (614 | ) | | | 144,798 | | | | 149,480 | | | | (829 | ) | | | 148,651 | |
| Total liabilities and shareholders' equity | | $ | 211,589 | | | $ | 4,867 | | | $ | 216,456 | | | $ | 201,385 | | | $ | 4,123 | | | $ | 205,508 | |
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SONIC SOLUTIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 14 — Quarterly Financial Data (Unaudited) – (continued)
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | For the Three Months Ended |
| | | June 30, 2006 | | September 30, 2006 |
| | | As
Previously
Reported | | Adjustments | | As
Restated | | As
Previously
Reported | | Adjustments | | As
Restated |
| Net revenue | | $ | 36,886 | | | $ | 48 | | | $ | 36,934 | | | $ | 35,853 | | | $ | (609 | ) | | $ | 35,244 | |
| Cost of revenue | | | 7,716 | | | | 207 | | | | 7,923 | | | | 8,091 | | | | (62 | ) | | | 8,029 | |
| Gross profit | | | 29,170 | | | | (159 | ) | | | 29,011 | | | | 27,762 | | | | (547 | ) | | | 27,215 | |
| Marketing and sales | | | 7,529 | | | | (308 | ) | | | 7,221 | | | | 7,698 | | | | 111 | | | | 7,809 | |
| Research and development | | | 10,732 | | | | (262 | ) | | | 10,470 | | | | 10,283 | | | | 40 | | | | 10,323 | |
| General and administrative | | | 4,264 | | | | (785 | ) | | | 3,479 | | | | 4,531 | | | | (30 | ) | | | 4,501 | |
| Abandoned acquisition | | | — | | | | — | | | | — | | | | 1,016 | | | | — | | | | 1,016 | |
| Total operating expenses | | | 22,525 | | | | (1,355 | ) | | | 21,170 | | | | 23,528 | | | | 121 | | | | 23,649 | |
| Operating income | | | 6,645 | | | | 1,196 | | | | 7,841 | | | | 4,234 | | | | (668 | ) | | | 3,566 | |
| Interest income | | | 676 | | | | — | | | | 676 | | | | 789 | | | | — | | | | 789 | |
| Interest expense | | | (512 | ) | | | 4 | | | | (508 | ) | | | (534 | ) | | | (40 | ) | | | (574 | ) |
| Other expense, net | | | (6 | ) | | | — | | | | (6 | ) | | | (65 | ) | | | — | | | | (65 | ) |
| Income before income taxes | | | 6,803 | | | | 1,200 | | | | 8,003 | | | | 4,424 | | | | (708 | ) | | | 3,716 | |
| Provision for income taxes | | | 2,713 | | | | 289 | | | | 3,002 | | | | 1,755 | | | | (346 | ) | | | 1,409 | |
| Net income | | $ | 4,090 | | | $ | 911 | | | $ | 5,001 | | | $ | 2,669 | | | $ | (362 | ) | | $ | 2,307 | |
Net income per share:
| | | | | | | | | | | | | | | | | | | | | | | | |
| Basic | | $ | 0.16 | | | $ | 0.03 | | | $ | 0.19 | | | $ | 0.10 | | | $ | (0.01 | ) | | $ | 0.09 | |
| Diluted | | $ | 0.15 | | | $ | 0.03 | | | $ | 0.18 | | | $ | 0.10 | | | $ | (0.02 | ) | | $ | 0.08 | |
Shares used in per share calculation:
| | | | | | | | | | | | | | | | | | | | | | | | |
| Basic | | | 25,778 | | | | — | | | | 25,778 | | | | 25,922 | | | | — | | | | 25,922 | |
| Diluted | | | 27,414 | | | | (2 | ) | | | 27,412 | | | | 27,253 | | | | (36 | ) | | | 27,217 | |
Note 15 — Subsequent Events
Continued Nasdaq Listing
Because we were not able to timely file our Form 10-Qs for our fiscal quarters ended December 31, 2006, June 30, 2007 and September 30, 2007, did not timely file our Form 10-K for the our fiscal year ended March 31, 2007, and did not timely solicit proxies and hold our annual meeting 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.
On March 22, 2007, we attended a hearing with the Nasdaq Listing Qualifications Panel (the “Panel”), at which we sought an exception to the applicable Marketplace Rules requirements. Thereafter, on April 23, 2007, the Panel granted us an initial extension to regain compliance with Nasdaq’s listing requirements, on June 20, 2007, the Panel granted us an additional extension, on July 23, 2007 the Nasdaq Listing and Hearing Review Council (the “Listing Council”) notified us that it had determined to call for review the June 20,
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SONIC SOLUTIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005, 2006 and 2007
Note 15 — Subsequent Events – (continued)
2007 Panel decision, and, in a decision dated October 26, 2007, the Listing Counsel granted us a further exception to demonstrate compliance with all of the Global Select Market continued listing requirements until December 26, 2007. On December 12, 2007, we received a letter from the Board of Directors of The Nasdaq Stock Market LLC (the “Board”) notifying us that it was calling for review the decision of the Listing Council decision and granting us additional time to meet the applicable listing requirements, and on January 8, 2008, we received a letter informing us that it was allowing us until March 10, 2008, to file all delinquent periodic reports necessary to regain compliance. 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 a result of a $3.4 million charge for in-process technology associated with our acquisition of SystemOK, we recognized a net loss for the quarter ended December 31, 2006 and were not in compliance with the quarterly net profit covenant of the Amended Credit Facility. Additionally, we recognized a net loss in the quarter ended March 31, 2007 primarily due to charges for payroll taxes and employee taxes under Section 409A of the Code associated with our voluntary review of our historical stock option grant practices and related accounting.
Subsequent to December 31, 2006 we did not file quarterly and annual financial statements in a timely manner as required under the Amended Credit Facility. Additionally, based on preliminary financial results, we determined that we were unlikely to meet the quarterly net profit covenant for the quarter ended June 30, 2007 and the required leverage ratio as of June 30, 2007. As a result of these issues, we entered into the Second Amendment. The Second Amendment extended the maturity date of the Amended Credit Facility to March 31, 2008, provided waivers for violations of the reporting covenants and anticipated June 30, 2007 financial covenant violations, modified financial covenants and further restricted payment of dividends and distributions. The Second Amendment did not waive the potential quarterly net profit covenant violations for the quarters ended December 31, 2006 and March 31, 2007 as such violations were not known at the time.
As of March 31, 2007, the outstanding balance on the Amended Credit Facility was $20.0 million and was classified as a current liability. As of February 15, 2008, UBOC has not notified us of any intent to take the actions necessary to accelerate the repayment of our obligations under the Amended Credit Facility.
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 expect a reduction in headcount of approximately 84 employees due to the Richmond Hill office closure.
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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
We changed our independent registered public accounting firm in July 2005 from KPMG LLP (“KPMG”) to BDO Seidman, LLP. Information regarding the change in the independent registered public accounting firm was reported in our Current Report on Form 8-K dated July 26, 2005. There were no disagreements or any reportable events requiring disclosure under Item 304(b) of Regulation S-K.
Item 9A. Controls and Procedures
a. Evaluation of Disclosure Controls and Procedures.
Our CEO and newly-appointed Interim CFO (the “Certifying Officers”) have conducted an evaluation of our disclosure controls and procedures as of March 31, 2007, the end of the period covered by this Annual Report. As defined under Sections 13a-15(e) and 15d-15(e) of the Exchange Act, the term “disclosure controls and procedures” means controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including the issuer’s chief executive officer and chief financial officer, to allow timely decisions regarding required disclosure. Based on their evaluation, for the reasons set forth below, the Certifying Officers have concluded that, as of March 31, 2007, our disclosure controls and procedures were not effective due to the material weakness identified in Management’s Report on Internal Control over Financial Reporting immediately below.
b. Management’s Report on Internal Control Over Financial Reporting
Our management, under the supervision of the Certifying Officers, is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act. An internal control system is designed to provide reasonable assurance regarding the preparation and fair presentation of published financial statements. Management has assessed the effectiveness of our internal control over financial reporting as of March 31, 2007. In making its assessment of internal control over financial reporting, management used the criteria set forth by the Committee of Sponsoring Organizations (“COSO”) of the Treadway Commission in its report entitled “Internal Control — Integrated Framework.”
Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Internal control over financial reporting includes those policies and procedures that:
| (1) | pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect our transactions and dispositions of the assets; |
| (2) | provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that our receipts and expenditures are being made only in accordance with authorizations of our management and board of directors; and |
| (3) | provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements. |
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.
As a result of our assessment, performed on the basis of the COSO criteria, management identified control deficiencies that, in the aggregate, constitute a material weakness in our financial reporting set forth below, and has concluded that, based on the specified criteria, we did not maintain effective internal control over financial reporting as of March 31, 2007:
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
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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 this Form 10-K for the year ended March 31, 2007.
BDO Seidman, LLP has issued an auditors’ report on our internal control over financial reporting. The auditors’ report is included in the Report of BDO Seidman, LLP, Independent Registered Public Accounting Firm, that appears on page 80 of this Annual Report on Form 10-K.
c. Changes in Internal Control over Financial Reporting
Remediation of Fiscal Year 2006 Material Weakness
During fiscal year 2007, our management implemented the following changes in internal control over financial reporting to address the material weakness in our internal control over financial reporting identified in the prior fiscal year:
| 1 | We engaged a third party to consult on tax related acquisition issues. |
| 2 | We completed a physical inventory of acquired fixed assets. During the process of completing the physical inventory count, we tagged certain fixed assets to facilitate future physical inventory counts. |
| 3 | We hired a new revenue manager, with the appropriate level of knowledge and experience in the application of GAAP, to manage the accounting associated with our retail channel activities. |
As of March 31, 2007, we completed the execution of our remediation plan, evaluated and tested the effectiveness of the controls as of March 31, 2007. While management noted the material weakness in fiscal 2007 relating to our lacking sufficient resources to maintain internal control over financial reporting while simultaneously managing a complex restatement and re-auditing process, management determined that the fiscal 2006 material weakness has been remediated through the steps identified above.
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. 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.
Options Administration and Options Restatement
As disclosed in the Explanatory Note, Note 2 of our Notes to Consolidated Financial Statements, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” on February 1, 2007, prior to the end of our fiscal year 2007, 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.
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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 subsequently 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.
In addition, as discussed in the 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 were remediated and did not constitute a material weakness as of March 31, 2007.
Other
Except as noted above, there were no changes in our internal control over financial reporting during the fourth quarter of fiscal year 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B. Other Information
Not applicable.
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PART III
Item 10. Directors, Executive Officers and Corporate Governance
Directors
The following sets forth certain information regarding the members of our board of directors as of February 25, 2008.
| | | | | | |
| Name | | Age | | Position | | Director Since |
| Robert J. Doris | | 55 | | Chairman of the Board of Directors | | 1986 |
| Mary C. Sauer | | 55 | | Director | | 1986 |
| Robert M. Greber | | 69 | | Director | | 1993 |
| Peter J. Marguglio | | 61 | | Director | | 1986 |
| R. Warren Langley | | 65 | | Director | | 2001 |
Mr. Doris is married to Ms. Sauer. There are no other family relationships between any director or executive officer of Sonic.
Robert J. Doris. Mr. Doris co-founded Sonic in 1986 and has served as Chairman of the Board since 1986, as Chief Executive Officer from 1986 to September 2005, and as President from 1986 to April 2005. In September 2005 Mr. Doris became the non-executive Chairman of the Board, and all services performed by Mr. Doris since that time have been in his capacity as a board member. Prior to 1986, Mr. Doris held the positions of President of The Droid Works, a subsidiary of Lucasfilm Ltd., Vice President of Lucasfilm, and General Manager of the Lucasfilm Computer Division. Mr. Doris received B.A., J.D. and M.B.A. degrees from Harvard University.
Mary C. Sauer. Ms. Sauer co-founded Sonic in 1986 and served as a vice president from 1986 to September 26, 2005, including as Senior Vice President of Marketing and Sales from February 1993 to September, 2005, and has served as a director from 1986 until the present. Since September 2005, all services performed by Ms. Sauer have been in her capacity as a board member. Prior to 1986, Ms. Sauer was Vice President of Marketing for The Droid Works, and prior to joining The Droid Works, Ms. Sauer was Director of Marketing for the Lucasfilm Computer Division. Ms. Sauer received a B.F.A. from Washington University in St. Louis and an M.B.A. in Finance and Marketing from the Wharton School of the University of Pennsylvania.
Robert M. Greber. Mr. Greber has served as a director of Sonic since August 1993.Mr. Greber served as President and Chief Operating Officer of The Pacific Stock Exchange from 1990 to 1995. From 1996, until his retirement in 1999, Mr. Greber was Chairman and Chief Executive Officer of The Pacific Stock Exchange. From 1985 to 1987, Mr. Greber was President and Chief Executive Officer of Diagnostic Networks, Inc., a network of Magnetic Resonance Imaging Centers which was merged into NMR America in 1987. From 1982 to 1985, Mr. Greber was President and Chief Executive Officer of Lucasfilm Ltd. Before joining Lucasfilm, Mr. Greber was associated with the firm of Merrill Lynch where he was Vice President and Manager of the Los Angeles Institutional Office. Mr. Greber holds a B.S. in Finance from Temple University.
Peter J. Marguglio. Mr. Marguglio has served as a director of Sonic since 1986. Mr. Marguglio has worked at Eatec Corporation, a software company, where he was President and a director, since 1990 and until February 19, 2008, when Eatec was sold to Agilysis, Inc. Mr. Marguglio is currently acting as an advisor to Agilysis. Prior to joining Eatec, Mr. Marguglio was President of Resource Marketing, Inc., an equipment leasing firm he founded in 1981. Mr. Marguglio holds a Mechanical Engineering degree from the University of Washington and an M.B.A. degree from Stanford University.
R. Warren Langley. Mr. Langley has served as a director of Sonic since 2001. Mr. Langley has been a consultant and the Managing Principal of the GuruWizard Fund, LLC, a venture capital firm that emphasizes social investing, since 2000. Mr. Langley also has been on the Board of Advisiors of Sun Trading LLC, a privately held partnership, since October 2007. From 1996 until 1999, Mr. Langley served as President and Chief Operating Officer of The Pacific Stock Exchange. From 1987 to 1998, he was a Principal and Chief Operating Officer of Hull Trading, a proprietary derivatives trading firm. Mr. Langley has also worked as Director of Operations Research and Industrial Engineering at United Airlines and in several capacities in the
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software, energy, and defense consulting industries after serving in the United States Air Force for fifteen years. Mr. Langley holds a B.S. degree in Engineering Science from the United States Air Force Academy, an S.M. degree in Astronautical Engineering from Massachusetts Institute of Technology, and a Phd in Operations Research from Georgia Institute of Technology.
Executive Officers
The following table sets forth information regarding our executive officers as of February 25, 2008.
| | | | |
| Name | | Age | | Position |
| David C. Habiger | | 38 | | Chief Executive Officer and President |
| A. Clay Leighton | | 51 | | Chief Operating Officer |
| Mark Ely | | 38 | | Executive Vice President of Strategy |
| Paul F. Norris | | 46 | | Executive Vice President, Interim Chief Financial Officer and General Counsel |
David C. Habiger. Mr. Habiger joined Sonic in 1993 as a regional sales manager. From 1993 until 2000 Mr. Habiger served in a number of sales and marketing management roles at Sonic of increasing responsibility and importance. From 2000 until 2002, Mr. Habiger was Worldwide Vice President of Sales for Sonic. Mr. Habiger was Senior Vice President and General Manager from 2002 to 2003 and then General Manager from 2003 to April 2005 of the Roxio Division, where he played a key role in the development of Sonic’s OEM and retail markets for consumer software. In April 2005 Mr. Habiger was appointed President and COO. In September 2005, Mr. Habiger was appointed President and CEO. Mr. Habiger received a B.B.A. from St. Norbert College and an M.B.A. from the University of Chicago. Since September 2007 Mr. Habiger has served as a director for Akimbo, Inc.
A. Clay Leighton. Mr. Leighton joined Sonic in 1993 as Vice President of Finance. In 1999, Mr. Leighton was named Senior Vice President of Worldwide Operations and Finance and Chief Financial Officer. In September 2005, Mr. Leighton was named Executive Vice President and Chief Financial Officer. In February 2008, Mr. Leighton was named Chief Operating Officer. Prior to joining Sonic, from 1990 to 1992, he was Vice President, Finance and Chief Financial Officer for RESNA Industries Inc., an environmental services firm. From 1988 to 1989 he was Vice President, Finance and Chief Financial Officer for Command Data Systems, a software company specializing in software for the public safety market. Previously, Mr. Leighton worked as strategy consultant for the Boston Consulting Group. Mr. Leighton received a B.A. from Wesleyan University and an M.B.A. from the Amos Tuck School of Business Administration at Dartmouth College.
Mark Ely. Mr. Ely joined Sonic in 1992 as a Customer Service Representative. Over the years, Mr. Ely was promoted to Product Marketing Manager, Director of Marketing, General Manager Desktop Products and, in 2004, Senior Vice President of Strategic Planning. In September 2005, Mr. Ely was named Executive Vice President of Strategy. Mr. Ely received a B.A. from Middlebury College and an M.B.A. from the UCLA Anderson School of Management.
Paul F. Norris. Mr. Norris joined Sonic in 2005 as Senior Vice President and General Counsel. In February 2008, Mr. Norris has become Sonic’s Executive Vice President, Interim Chief Financial Officer and General Counsel. Prior to joining Sonic, from 2000 to 2005, Mr. Norris was a partner at Steiner Norris PLLC, a law firm he co-founded in Seattle, Washington. Mr. Norris received a B.A. from Yale University and a J.D. from Harvard Law School.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires our directors and executive officers, and persons who own more than 10% of our common stock, to file reports of ownership and reports of changes in ownership of our common stock with the SEC. Executive officers, directors and owners of greater than 10% of our stock are required by SEC regulations to furnish us with copies of all Section 16(a) reports they file.
Based solely upon a review of the filings, in respect of the fiscal year ended March 31, 2007, furnished pursuant to Rule 16a-3(e) promulgated under the Exchange Act or advice that no filings were required, we are not aware of any late Section 16(a) filings for such fiscal year.
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Audit Committee
We have a separately designated Audit Committee of our board of directors that is comprised of Messrs. Greber, Langley and Marguglio. Our board of directors has determined that Mr. Greber qualifies as a financial expert according to the SEC’s regulations. See “Committees” below for a statement regarding Mr. Greber’s indpendence in accordance with applicable regulations and standards.
Changes in Procedure for Stockholder Recommendations for Director Nominees
The nominating committee has no formal policy with respect to consideration of stockholder recommended director candidates and will consider potential candidates for director that are brought to the committee’s attention by stockholders. Our board of directors believes it is appropriate not to establish a formal policy in light of the absence of any stockholder recommended director candidates in the past. There have been no changes to this process.
Code of Business Conduct and Ethics
Our Code of Business Conduct and Ethics covers all employees, officers and directors, including our principal executive, financial and accounting officers. A copy of our Code of Business Conduct and Ethics can be found on our web site,www.sonic.com. Any amendments to the Code of Business Conduct and Ethics will be posted on our website.
Director Independence
Our board of directors has determined that three non-employee directors of the board, Messrs. Greber, Langley and Marguglio, are “independent” as that term is defined in Rule 4200 of Nasdaq’s Marketplace Rules. In making this determination, the board considered transactions and relationships between each director or his or her immediate family and Sonic and its subsidiaries. The purpose of this review was to determine whether any such relationships or transactions were material and, therefore, inconsistent with a determination that the director is independent. As a result of this review, the board affirmatively determined, based on its understanding of such transactions and relationships, that all of the non-employee directors are independent and, therefore, a majority of the members of the board are independent pursuant to applicable Nasdaq rules.
Committees
The board of directors held a total of seven meetings during the fiscal year ended March 31, 2007. No director participated in fewer than 75% of the total number of meetings of the board of directors and all meetings of committees of the board of directors, if any, upon which such director served. The members of the Audit Committee meet separately on a regular basis without any non-independent members of the board of directors or members of management present. The chairman of the Audit Committee acts as the chairman of such meeting of the independent directors.
During the fiscal year ended March 31, 2007, and currently, the Audit Committee consisted solely of independent directors, namely, Messrs. Marguglio, Greber and Langley, with Mr. Greber serving as chairman. After considering transactions and relationships between each member of the Audit Committee or his immediate family and Sonic and its subsidiaries and reviewing the qualifications of the members of the Audit Committee, the board has determined that all current members of the Audit Committee are (1) “independent” as that term is defined in Section 10A of the Exchange Act; (2) “independent” as that term is defined in Rule 4200 of Nasdaq’s Marketplace Rules; and (3) financially literate. Our board of directors also determined that Mr. Greber qualifies as an “audit committee financial expert,” as defined by the applicable rules of the Exchange Act, pursuant to, among other things, his association with The Pacific Stock Exchange in various capacities, including Chairman, Chief Executive Officer and Chief Operating Officer, and his position as Chief Executive Officer of Diagnostic Network, Inc., and in those capacities had acquired the relevant experience and expertise and has the attributes set forth in the applicable rules as being required for an audit committee financial expert.
The Audit Committee, pursuant to its charter, is directly responsible for the appointment, compensation, retention and oversight of our independent auditors. In addition, the Audit Committee is responsible for approving the audit and non-audit services performed by the independent auditors; consulting with the independent auditors about the scope of the audit and reviewing with them the results of their examination and
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reviewing our financial control procedures and personnel. The Audit Committee also has established procedures for (a) the receipt, retention and treatment of complaints received by us regarding accounting, internal accounting controls or auditing matters, and (b) the confidential, anonymous submission by our employees of concerns regarding questionable accounting or auditing matters. The Audit Committee held six meetings during the fiscal year ended March 31, 2007
In September 2005, our board of directors appointed a Compensation Committee and adopted the Charter of the Compensation Committee of Sonic Solutions. The Compensation Committee is comprised entirely of independent directors, namely, Messrs. Marguglio, Greber and Langley, with Mr. Greber serving as chairman. Pursuant to its charter, the Compensation Committee’s functions include assisting the board in determining the compensation for our executive officers, including our Chief Executive Officer; administering certain aspects of our stock option plans, subject to the authority of the compensation committee to delegate the tasks associated with the administration of the plans; and assisting the board in other matters as appropriate.
In September 2005, our board of directors also appointed a Nominating Committee and adopted the Charter of the Nominating Committee of Sonic Solutions. The Nominating Committee is comprised entirely of independent directors, namely, Messrs. Marguglio, Greber and Langley, with Mr. Greber serving as chairman. Pursuant to its charter, the Nominating Committee’s functions include assisting the board in monitoring the size and composition of the board; considering and making recommendations to the board with respect to the nominations or elections of directors; and assisting the board in other duties as the board shall from time to time prescribe.
The current board committee arrangement, whereby all independent directors serve on the Audit Committee, Compensation Committee and Nominating Committees, derives from the facts that the size of the board is relatively small, all independent directors have significant experience in operating companies of approximately our size, all independent directors are financially sophisticated, and all independent directors have evidenced willingness to devote time and attention to board and board committee activities. In the future, depending on possible changes in the size and composition of the board, the board may vary its current practices relative to board committees. For example, it may in the future not designate all of the independent directors to serve on the Audit Committee, and it may specifically appoint certain directors to serve on the Compensation and Nominating Committees rather than have all of the same individuals serve on the Audit, Compensation and Nominating committees.
Item 11. Executive Compensation
Compensation Discussion and Analysis
Overview of the Company’s Executive Compensation Program
In September 2005, our board of directors appointed a Compensation Committee and adopted the Charter of the Compensation Committee of Sonic Solutions. The Compensation Committee is responsible for, among other things, (a) assisting the board in discharging its responsibilities relating to compensation of our directors and executive officers; and (b) producing an annual report on executive officer compensation for inclusion in our proxy statement, in accordance with applicable rules and regulations. In September 2005, the board approved the base salaries and option grants for Mr. Habiger and Mr. Leighton. In January 2007, the board approved Executive Employment Agreements for Messrs. Habiger, Leighton and Ely.
Compensation Objectives and Strategy
Our core compensation philosophy is to pay our executive officers competitive levels of compensation that best reflect their individual responsibilities and contributions to Sonic, while providing incentives to achieve our business and financial objectives. Our principal objectives and strategy concerning our executive compensation program are as follows:
| • | To design compensation packages that will attract, retain, and motivate highly qualified key employees who can be instrumental to our long-term success; |
| • | to pay competitively in relation to similar audio and video software and hardware companies and to provide appropriate reward opportunities for achieving high levels of performance compared to similar organizations in the marketplace; |
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| • | to emphasize individual excellence and encourage all employees, not just our executive officers, to take initiative and lead projects that enhance our overall effectiveness; |
| • | to emphasize sustained performance by aligning rewards with shareholder interests; and |
| • | to motivate executives and employees to achieve our annual and long-term business goals and encourage behavior toward the fulfillment of those objectives. |
We do not have a formal executive evaluation and compensation program with specified performance objectives, targets or ranges. Our board of directors has not historically used any formal benchmarking data or surveys to establish compensation levels, instead generally relying on publicly-available information regarding compensation levels of similar audio and video software and hardware companies as well as its own general business knowledge to design compensation packages that it believes are competitive and provide appropriate reward opportunities for achieving high levels of performance, compared to those similar organizations in the marketplace.
In keeping with our compensation objectives and strategy, our board of directors approved our entry into Executive Employment Agreements with our executive officers in January 2007. These agreements did not modify base salaries, rights to participate in long term or annual incentive plans, or other current compensation components for the executive officers, but do contain certain express change of control and termination benefits (see “Employment Agreements,” below). Our board believes that these agreements are beneficial in that they provide a certain level of employment protection to these executives, fostering long term-behavior, emphasizing sustained performance and the achievement of long-term business goals, and assisting us in retaining our most senior personnel, all without requiring us to increase the total compensation amounts now paid to those executives. Each year, the board of directors, taking into account any input provided by the Compensation Committee, will review and evaluate the compensation paid to our executive officers and determine the base salary, bonus and the equity related grants for each executive officer.
Role of Executive Officers in Compensation Decisions
In the ordinary course, our CEO evaluates the personnel who report directly to him. The Compensation Committee may consider these evaluations and any recommendations of our CEO in determining the base salaries, adjustments to base salaries, bonuses and equity based awards for each of our named executive officers, other than the CEO. The Compensation Committee and/or our full board of directors may exercise its discretion in modifying any recommended adjustments or awards to executives.
Elements of Compensation
Compensation for each executive officer for fiscal year 2007 consisted of a base salary, the opportunity to receive an annual bonus in the form of cash, stock and/or grants of restricted stock units (“RSUs”), options to acquire common stock, and other benefits (e.g., matching contribution made by us under our 401(K) plan). We provide a competitive salary and benefits package that we believe is consistent with market practice for our industry and the size of our company, and allows us to attract and retain executives and employees. We have not established minimum stock ownership guidelines for our executive officers or adopted a policy requiring them to retain their Sonic stock ownership for any period of time. In general, all other employee benefits that our executive officers receive, such as matching contributions under our 401(K) plan, are the same benefits available on a non-discriminatory basis to our other salaried employees.
We choose to build our compensation program for named executive officers around these elements because each individual component is useful in achieving one or more of the objectives of the program and we believe that, together, they have been and will continue to be effective in achieving our overall objectives.
Weighting of Elements
We do not have an express policy or formulaic method for weighting the different elements of compensation or for allocating between long-term and short-term compensation. The use and weight of each compensation element is based on a subjective determination by our board of directors and/or Compensation Committee of the importance of each element in meeting our overall objectives.
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Non-cash compensation includes grants of stock options and/or RSUs. Stock options and RSUs provide long-term incentives to increase shareholder value as well as a retention mechanism for highly-valued named executive officers. The board’s intention is to grant competitive equity compensation awards.
Base Salary. We provide our named executive officers and other employees a fixed amount of cash compensation — salary — for the executive’s work. Salaries for named executive officers are established each year by the board, taking into account any input provided by the Compensation Committee. The Compensation Committee and board determine the base salaries of our named executive officers annually by subjectively evaluating the responsibilities of their position, the experience and performance of the individual.
The amount of each executive’s salary is determined based on a number of factors including:
| • | an assessment of individual contribution as judged by the CEO (other than with respect to his own salary), as well as the Compensation Committee and/or board; |
| • | relationship with the salaries of other executives at comparable companies; and |
| • | our overall financial results. |
For fiscal year 2007, as illustrated in our Summary Compensation Table below, base salaries of our named executive officers represented an average of approximately 68% of total compensation (which included base salary, cash incentive compensation, stock options expense and matching contributions made to the named executive under our 401(k) plan). The Compensation Committee considers that this percentage is relatively high, due to the fact that no RSUs or stock options were granted to our named executive officers during fiscal year 2007 as a consequence of the delay in our annual shareholders’ meeting (and the immediately ensuing board meeting at which such equity compensation is typically granted). Accordingly, while we do not target salary at a particular percentage of total compensation, the Compensation Committee anticipates that the percentage may be lower in future periods.
Bonuses. We provide bonuses to compensate our executive officers for their performance over the past year at the discretion of the Compensation Committee and board. We do not establish a pool for bonuses, target bonuses at a particular percentage of base salary or base decisions on other set formula or criteria, but rather bases bonus-granting decisions on an individual assessment of the executive’s contribution to our company and achievement of corporate goals as well as our financial performance. Further, the Executive Employment Agreements approved in January 2007 do not include a specific amount or target for a bonus payment. While the Compensation Committee views bonuses as an important component of compensation, it does not regard bonuses as something that our named executive officers should count on or expect to receive on an annual basis; rather the Compensation Committee views bonuses as a means of providing reasonable compensation for “above and beyond” services. During fiscal year 2007, Mr. Ely received a bonus of $59,861, in part based on recognition of Mr. Ely’s assumption of the role of General Manager of The Roxio Division during the year. No other bonuses were awarded to our executive officers.
Equity-Based Incentives. The Compensation Committee and board strongly believe that it is important for key employees who have primary responsibility for the management, growth, and future success of our company to have significant equity ownership interest in Sonic and to have the potential to gain financially from Sonic stock price increases. The interests of shareholders, executives and employees should thereby be more closely aligned. The Compensation Committee and board seek to provide such ownership interest to executives and key employees by grants of RSUs or grants of options to purchase shares of our common stock in the future at a price equal to fair market value at the date of grant. The board determines the amounts of long-term incentive awards after considering cost and dilution impact, market trends relating to long-term incentive compensation, the individual’s position with us, remaining availability under our stock option plans and other any other factors it deems relevant. We believe the term and vesting schedule of our stock options and RSUs provide additional incentive to management to focus on long-term growth and market performance of our stock.
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Under our stock option plans, shares of our common stock may be purchased at the option price set by us. All grants must be exercised according to the provisions of our stock option plans. All outstanding options expire on the earlier of ten years after the date of grant or 90 days after an option holder’s termination of service with us.
Change in Control Provisions. As further described under “Employment Agreements,” our executive officers are entitled to specified percentages of their annual base salaries then in effect and all of their outstanding unvested stock options, RSUs, or other equity compensation will immediately vest in full, in the event of a change in control (as defined). The change in control provisions in these agreements are designed to offer protection to these employees to recognize their many years of commitment to us and our continuing success.
Other Benefits. We provide standard employee benefits to all of our employees. Benefits available to executive and non-executive employees include health insurance, vacation, disability insurance, life insurance and participation in our 401(k) plan and employee stock option and RSU programs. We do not offer any supplemental executive health and welfare or retirement programs, or provide any other supplemental benefits or perquisites, to our executives.
Impact of Tax and Accounting on Compensation Decisions
Section 162(m) of the Code limits the deductibility of compensation paid to certain executive officers in excess of $1 million unless the compensation is performance based.
When determining amounts of equity grants to executives and employees under our equity incentive program, the Compensation Committee considers the compensation charges associated with the grants. Beginning on April 1, 2006, we began accounting for share-based compensation in accordance with the requirements of SFAS No. 123R. Under SFAS No. 123R, grants of stock options result in compensation expense equal to the fair value of the options, which is calculated using a Black-Scholes option pricing model. The fair value of restricted stock units is equivalent to the market price of our common stock on the grant date. The expense is recognized over the option vesting period.
Chief Executive Officer Compensation
Mr. Habiger’s compensation as CEO for fiscal year 2007 was established by the board in accordance with the guidelines described in this Annual Report. For fiscal year 2007, Mr. Habiger’s salary was $350,000. Mr. Habiger’s base salary represented approximately 56% of his total compensation, with the balance primarily consisting of $266,000 for option awards granted prior to fiscal year 2007 calculated in accordance with SFAS 123(R).
Compensation Committee Report
The members of the Compensation Committee have reviewed and discussed the Compensation Discussion and Analysis contained herein with our management and, based on the review and discussion, has recommended to our board of directors that the Compensation Discussion and Analysis be included in this Annual Report on Form 10-K for the fiscal year ended March 31, 2007.
Submitted by the Compensation Committee
Robert M. Greber, Chairman
R. Warren Langley
Peter J. Marguglio
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Compensation Tables
SUMMARY COMPENSATION TABLE
The following table shows for the fiscal year ended March 31, 2007, compensation awarded to, paid to, or earned by, our “principal executive officer”, “principal financial officer” and other executive officer as of March 31, 2007 (collectively, the “Named Executive Officers”):
| | | | | | | | | | | | |
| Name and Principal Position | | Fiscal
Year | | Salary
($) | | Bonus
($) | | Option Awards
($)(1) | | All Other
Compensation
($)(2) | | Total
($) |
David C. Habiger
President and Chief Executive Officer | | | 2007 | | | | 350,000 | | | | — | | | | 265,913 | | | | 11,863 | | | | 627,776 | |
A. Clay Leighton(3)
Executive Vice President and Chief Financial Officer | | | 2007 | | | | 300,000 | | | | — | | | | — | | | | 11,800 | | | | 311,800 | |
Mark Ely
Executive Vice President of Strategy | | | 2007 | | | | 249,670 | | | | 59,861 | | | | 53,183 | | | | 11,693 | | | | 374,407 | |
| (1) | This column represents the compensation expense recognized for financial statement reporting purposes in fiscal year 2007 for stock options granted in fiscal year 2007 and in prior fiscal years, in accordance with SFAS 123(R). Pursuant to SEC rules, the amounts shown exclude the impact of estimated forfeitures related to service-based vesting conditions. Please refer to Note 8, “Shareholders' Equity,” in the Notes to Consolidated Financial Statements for the relevant assumptions used to determine the compensation cost of our stock and option awards. |
| (2) | Consists of matching contributions made by the Company on behalf of the named executive to the Company's 401(k) plan. |
| (3) | Mr. Leighton was appointed Chief Operating Officer on February 25, 2008. |
During the fiscal year ended March 31, 2007, no grants of plan-based awards to the Named Executive Officers occurred.
Outstanding Equity Awards at Fiscal Year End
The following table shows for the fiscal year ended March 31, 2007, certain information regarding outstanding equity awards at fiscal year end for the Named Executive Officers.
| | | | | | | | |
| | Option Awards |
| Name | | Number of Securities Underlying Unexercised Options (#) Exercisable | | Number of Securities Underlying Unexercised Options(1) (#) Unexercisable | | Option
Exercise Price ($) | | Option
Expiration
Date |
| David C. Habiger | | | 400,000 | | | | | | | | 19.99 | | | | 9/23/2015 | |
| A. Clay Leighton | | | 30,000 | | | | | | | | 2.56 | | | | 7/22/2007 | |
| | | | 30,000 | | | | | | | | 2.56 | | | | 3/3/2008 | |
| | | | 20,000 | | | | | | | | 1.12 | | | | 7/12/2011 | |
| | | | 103,000 | | | | | | | | 1.17 | | | | 10/25/2011 | |
| | | | 100,000 | | | | | | | | 3.97 | | | | 3/11/2013 | |
| | | | 100,000 | | | | | | | | 17.49 | | | | 5/10/2014 | |
| | | | 200,000 | | | | | | | | 19.99 | | | | 9/23/2015 | |
| Mark Ely | | | 11,254 | | | | 625 | | | | 3.97 | | | | 3/11/2013 | |
| | | | 40,000 | | | | | | | | 17.16 | | | | 3/24/2014 | |
| | | | 40,000 | | | | | | | | 16.62 | | | | 7/29/2014 | |
| | | | 40,000 | | | | | | | | 19.76 | | | | 9/21/2015 | |
| (1) | All unexercisable stock options vest one-fourth each year over a four year period commencing on the date of grant. |
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Options Exercised
The following table shows, for the fiscal year ended March 31, 2007, the number of shares of our common stock acquired by each Named Executive Officer upon exercise of stock options in fiscal year 2007 and the corresponding dollar amounts realized upon exercise.
| | | | |
| | Option Awards |
| Name | | Number of Shares Acquired on Exercise (#) | | Value Realized on
Exercise ($)(1) |
| David C. Habiger | | | — | | | | — | |
| A. Clay Leighton | | | — | | | | — | |
| Mark Ely | | | 28,071 | | | | 342,308 | |
| (1) | Represents the number of options exercised multiplied by the difference between the market price of our common stock on the exercise date and the exercise price of the options. |
Employment Agreements
On January 23, 2007, our board of directors approved Executive Employment Agreements for David C. Habiger, A. Clay Leighton, and Mark Ely. The specific terms of these arrangements, as well as an estimate of the compensation that would have been payable had they been triggered as of fiscal year end, are described in detail in the section entitled “Potential Payments upon Termination or Change in Control” below.
The Executive Employment Agreement for Mr. Habiger, our President and Chief Executive Officer (the “Habiger Agreement”), provides for a base salary of $350,000, which is the same as his base salary prior to the effective date of the Habiger Agreement, and the right to participate in any long term or annual incentive plans maintained by us for our executives. The Habiger Agreement provides that (i) if Mr. Habiger’s employment is terminated without Cause or if Mr. Habiger terminates his employment for Good Reason, unless such termination occurs within 180 days of a Change in Control, we will make a lump sum payment to Mr. Habiger equal to 175% of his annual base salary at the level in effect immediately prior to his termination; and (ii) in the event of a Change in Control, all of Mr. Habiger’s outstanding unvested stock options, RSUs, or other equity compensation will immediately vest in full and we will make a lump sum payment equal to 175% of his annual base salary at the level in effect at the time of the Change in Control.
The Executive Employment Agreement for Mr. Leighton, our Company’s Chief Operating Officer (the “Leighton Agreement”), provides for a base salary of $300,000, which is the same as his base salary prior to the effective date of the Leighton Agreement, and the right to participate in any long term or annual incentive plans maintained by us for our executives. The Leighton Agreement provides that (i) if Mr. Leighton’s employment is terminated without Cause or if Mr. Leighton terminates his employment for Good Reason, unless such termination occurs within 180 days of a Change in Control, we will make a lump sum payment to Mr. Leighton equal to 100% of his annual base salary at the level in effect immediately prior to his termination; and (ii) in the event of a Change in Control, all of Mr. Leighton’s outstanding unvested stock options, RSUs, or other equity compensation will immediately vest in full and we will make a lump sum payment equal to 100% of his annual base salary at the level in effect at the time of the Change in Control.
The Executive Employment Agreement for Mr. Ely, our Executive Vice President of Strategy (the “Ely Agreement”), provides for a base salary of $300,000 and the right to participate in any long term or annual incentive plans maintained by us for our executives. The Ely Agreement provides that (i) if Mr. Ely’s employment is terminated without Cause or if Mr. Ely terminates his employment for Good Reason, unless such termination occurs within 180 days of a Change in Control, we will make a lump sum payment to Mr. Ely equal to 100% of his annual base salary at the level in effect immediately prior to his termination; and (ii) in the event of a Change in Control, all of Mr. Ely’s outstanding unvested stock options, RSUs, or other equity compensation will immediately vest in full and we will make a lump sum payment equal to 100% of his annual base salary at the level in effect at the time of the Change in Control.
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Each of the Executive Employment Agreements contains the following terms:
For purposes hereof, “Cause” shall mean (i) Executive’s conviction of any felony under federal or state law, or any fraud, misappropriation or embezzlement, or (ii) Executive’s breach of a fiduciary duty owed to Company or commission of a material violation of Section 4 [relating to confidential
information].
Executive may voluntarily terminate his employment with Company for Good Reason within 30 days of the occurrence of: (a) a material adverse change in Executive’s position causing it to be of materially less stature or responsibility without Executive’s written consent, and such a materially adverse change shall in all events be deemed to occur if Executive no longer serves as [his position], unless Executive consents in writing to such change; (b) a reduction, without Executive’s written consent, in his level of compensation (including base salary and fringe benefits); (c) a relocation of his principal place of employment by more than 50 miles, or (d) failure to cure a material breach by Company (or its successor) of this Agreement within thirty (30) days after written notice from Executive to the Company identifying such breach.
For purposes of this Agreement, “Change in Control” shall have the same meaning as “Corporate Transaction,” as such term is defined in the Company’s 2004 Equity Compensation Plan.
Potential Payments upon Termination or Change in Control
The following table summarizes our estimated cost of severance payments had the executive’s employment terminated without cause or if he had terminated his employment for good reason as of March 31, 2007:
| | |
| Name | | Cash Payment ($) |
| David C. Habiger | | | 612,500 | |
| A. Clay Leighton | | | 300,000 | |
| Mark Ely | | | 300,000 | |
The following table summarizes our estimated cost of severance payments had a Change of Control occurred on March 31, 2007:
| | | | |
| Name | | Cash Payment ($) | | Other Benefits
($)(1) |
| David C. Habiger | | | 612,500 | | | | — | |
| A. Clay Leighton | | | 300,000 | | | | — | |
| Mark Ely | | | 300,000 | | | | 6,331 | |
| (1) | Represents the value of all unvested stock options held as of March 31, 2007 that would accelerate calculated by multiplying the number of unvested shares by the closing price of our common stock on March 30, 2007 (the last trading day of fiscal year 2007) less the exercise price of such stock options. |
Director Compensation
Non-employee Director Compensation
On January 23, 2007, our board of directors approved the Board of Directors Compensation Policy (the “Policy”). Pursuant to the Policy, the board shall review the annual compensation targets, including cash compensation target percentage, at each annual meeting of the board for the non-employee board members (each, an “Outside Director”) and each Outside Director who serves as chairman of either the board or a standing committee of the Board (each, a “Chairman”). The Policy provides for an initial annual compensation target of $100,000 for an Outside Director and for each Chairman an initial annual compensation target equal to 120% of the annual compensation target for an Outside Director. The Policy sets the initial cash compensation target percentage at 30% of annual compensation target and the initial equity compensation target percentage at 70%, for both Outside Directors and Chairmen.
In the event the annual meeting of the board is scheduled later than October 1 in any year, then, in light of the inability to calculate the next year’s annual equity compensation target percentage as contemplated
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under the Policy until such meeting is held, the Policy provides that effective on October 1 of that year the equity compensation target percentage for both Outside Directors and Chairmen shall be shall be reduced to 0% and the cash compensation target percentage for both Outside Directors and Chairmen shall be increased to 100%, each until the occurrence of such annual meeting.
The following table sets forth information for the fiscal year ended March 31, 2007 regarding compensation of our non-employee directors:
| | | | | | |
| Name | | Fees Earned or Paid in Cash ($) | | Option Awards
($)(1) | | Total ($) |
| Robert J. Doris(2) | | | 158,250 | | | | — | | | | 158,250 | |
| Mary C. Sauer(2) | | | 131,705 | | | | — | | | | 131,705 | |
| Robert M. Greber | | | 78,750 | | | | 19,650 | | | | 98,400 | |
| Peter J. Marguglio | | | 65,000 | | | | 15,720 | | | | 80,720 | |
| R. Warren Langley | | | 65,000 | | | | 15,720 | | | | 80,720 | |
| (1) | This column represents the compensation expense recognized for financial statement reporting purposes in fiscal year 2007 for stock options granted in fiscal 2007 and in prior fiscal years, in accordance with SFAS 123(R). Pursuant to SEC rules, the amounts shown exclude the impact of estimated forfeitures related to service-based vesting conditions. Please refer to Note 8, “Shareholders’ Equity,” in the Notes to Consolidated Financial Statements for the relevant assumptions used to determine the compensation cost of our stock and option awards. |
| (2) | In lieu of the outside Directors Compensation Policy, Mr. Doris and Ms. Sauer received the above amounts in consideration of their providing advisory services to the Company’s executives. |
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
The following table sets forth certain information regarding beneficial ownership of the common stock as of February 15, 2008 (i) by each person who is known by us to beneficially own more than 5% of the outstanding shares of our common stock, (ii) by each of our directors, (iii) by each of our Named Executive Officers, and (iv) by all directors and executive officers as a group.
| | | | |
| Name and Address(1) | | Number of Shares
Beneficially Owned(2) | | Percentage of Shares Beneficially Owned(2) |
Royce and Associates
1414 Avenue of the Americas
New York, NY 10019 | | | 3,251,000 | | | | 12 | % |
William Blair & Company, L.L.C.(4)
222 W Adams
Chicago, IL 60606 | | | 2,837,500 | | | | 11 | % |
Manning & Napier Advisors, Inc.(5)
290 Woodcliff Drive
Fairport, NY 14450 | | | 1,363,650 | | | | 5 | % |
Directors and Offices
| | | | | | | | |
| Robert J. Doris(6) | | | 1,593,063 | | | | 6 | % |
| Mary C. Sauer(7) | | | 730,972 | | | | 3 | % |
| The Doris-Sauer Revocable Trust(8) | | | 103,516 | | | | * | |
| Peter Marguglio(9) | | | 336,443 | | | | 1 | % |
| Robert M. Greber(10) | | | 107,500 | | | | * | |
| R. Warren Langley(10) | | | 94,000 | | | | * | |
| David C. Habiger(10) | | | 400,000 | | | | 2 | % |
| A. Clay Leighton(11) | | | 632,500 | | | | 2 | % |
| Mark Ely(10) | | | 131,879 | | | | * | |
| All directors and executive officers as a group (9 persons) | | | 4,208,373 | | | | 16 | % |
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| (1) | Unless otherwise indicated, the address of each person is c/o Sonic Solutions, 101 Rowland Way, Suite 110, Novato, CA 94945. |
| (2) | This table is based upon information supplied by directors, officers and principal shareholders. Applicable percentage ownership for each shareholder is based on 26,353,277 shares of common stock outstanding as of February 15, 2008, together with applicable options for such shareholders. Beneficial ownership is determined in accordance with SEC rules and generally includes voting or investment power with respect to securities, subject to community property laws where applicable. Shares of common stock subject to options are deemed outstanding for the purpose of computing the percentage ownership of the person holding such options, but are not treated as outstanding for computing the percentage ownership of any other person. |
| (3) | The information is based solely on Schedule 13G filed with the SEC by Royce and Associates on January 31, 2008. |
| (4) | The information is based solely on Schedule 13G filed with the SEC by William Blair & Company, L.L.C. on January 9, 2008. |
| (5) | The information is based solely on Schedule 13G filed with the SEC by Mainning & Napier Advisors, Inc., on February 8, 2008. |
| (5) | Includes 1,003,519 shares owned by Mr. Doris, and 589,544 shares issuable upon exercise of options which will be exercisable within 60 days of February 15, 2008. Total shares exclude indirect shares owned or issuable upon exercise of options by Ms. Sauer who is married to Mr. Doris, and excludes shares owned by the Doris-Sauer Trust. |
| (7) | Includes 466,167 shares owned by Ms. Sauer, and 264,805 shares issuable upon exercise of options which will be exercisable within 60 days of February 15, 2008. Total shares exclude indirect shares owned or issuable upon exercise of options by Mr. Doris who is married to Ms. Sauer, and excludes shares owned by the Doris-Sauer Trust. |
| (8) | Includes shareds owned by the Doris-Sauer Revocable Trust u/a/d 5 Nov 2004. Revocable trust established by Robert Doris and Mary Sauer, husband and wife. Each of Mr. Doris and Ms. Sauer are joint trustees of the Trust and each person has the power to vote and dispose of any and all securities held by the Trust. |
| (9) | Includes 193,443 shares owned by Mr. Marguglio, and 143,000 shares issuable upon exercise of options which will be exercisable within 60 days of February 15, 2008. |
| (10) | Consists of shares issuable upon exercise of options which will be exercisable within 60 days of February 15, 2008. |
| (11) | Includes 109,500 shares owned by Mr. Leighton and 523,000 shares issuable upon exercise of options which will be exercisable within 60 days of February 15, 2008. |
Item 13. Certain Relationships, Related Transactions and Director Independence
We have agreed to indemnify each of our directors and executive officers to the fullest extent permitted by California law.
All transactions between us and our officers, directors, principal stockholders and affiliates have been and will be approved by a majority of our board of directors, including a majority of the disinterested, non-employee directors, and have been or will be on terms no less favorable to us than could be obtained from unaffiliated third parties.
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Item 14. Principal Accounting Fees and Services
BDO Seidman, LLP performed services for us in fiscal years 2007 and 2006 related to financial statement audit work, quarterly reviews, tax services, special projects and other ongoing consulting projects. Fees paid or payable to BDO Seidman in fiscal years 2006 and 2007 were as follows (in thousands):
| | | | |
| | Year Ended March 31, |
| | | 2006 | | 2007 |
| Audit(1) | | $ | 1,426 | | | $ | 1,524 | |
| Audit Related Fees(2) | | | — | | | | 102 | |
| Tax Fees | | | — | | | | — | |
| All Other Fees | | | — | | | | — | |
| Total Fees | | $ | 1,426 | | | $ | 1,626 | |
| (1) | Audit fees are fees related to professional services rendered by BDO Seidman, LLP in connection with the audit of our financial statements and our internal controls over financial reporting, the reviews of our interim financial statements included in each of our quarterly reports on Form 10-Q, international statutory audits, the re-audit of our 2005 financial statements, stock option review of other SEC filings. |
| (2) | Audit-related fees are for assurance and related services by BDO Seidman, LLP that are reasonably related to the performance of the audit or review of our financial statements. |
Pre-Approval Policy
Under the Sarbanes-Oxley Act, all audit and non-audit services performed by BDO Seidman must be approved in advance by our Audit Committee to assure that such services do not impair the auditors’ independence from us. In accordance with its pre-approval policies and procedures, our Audit Committee pre-approved all audit and non-audit services prior to them being performed by BDO Seidman during the fiscal year ended March 31, 2007.
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PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports On Form 8-K
(a) 1.Financial Statements.
See Item 8 of this Report.
(a) 2.Financial Statements Schedule.
Schedule II — Valuation and Qualifying Accounts
All other schedules are omitted because they are not required, or are not applicable, or the information is included in the financial statements.
(a) 3.Exhibits:
| | | | |
| Exhibit | | Note | | Title |
| 3.1 | | (1) | | Restated Articles of Incorporation |
| 3.2 | | (1) | | Amended and Restated By-Laws |
| 3.3 | | (8) | | Certificate of Amendment of Restated Articles of Incorporation |
| 4.1 | | (1) | | Specimen Common Stock Certificate |
| 10.1 | | (12) | | Loan and Security Agreement between Registrant and Union Bank of California, N.A., dated December 13, 2004 |
| 10.2 | | (2) | | Lease Agreement between Golden Gate Plaza and Registrant, dated January 26, 1995 |
| 10.3 | | (15) | | Amendment to Lease Agreement between Golden Gate Plaza and Registrant, dated November 20, 2000 |
| 10.4 | | (14) | | Tri-Partite Agreement between Roxio, Inc., Registrant and Entrust, Inc., dated December 17, 2004 |
| 10.5 | | (14) | | Third Amendment to Lease between C&B Ventures-Napa Two LLC and Registrant, dated February 4, 2005 |
| 10.6 | | (7) | | Amended Registration Rights Agreement by and between VERITAS Operating Corporation and Registrant, dated December 18, 2002 |
| 10.7 | | (4) | | Distribution Agreement between Registrant and Daikin Industries, Ltd., dated February 27, 2001 |
| 10.8 | | (1) | | Form of Indemnity Agreement |
| 10.9 | | (1) | | 1989 Amended and Restated Stock Option Plan (compensatory plan) |
| 10.10 | | (3) | | 1998 Stock Option Plan (compensatory plan) |
| 10.11 | | (10) | | Sonic Solutions 2004 Equity Compensation Plan |
| 10.12 | | (10) | | Sonic Solutions 2004 Equity Compensation Plan Notice of Stock Option Award for Robert J. Doris and Stock Option Award Agreement |
| 10.13 | | (10) | | Sonic Solutions 2004 Equity Compensation Plan Notice of Stock Option Award for Mary C. Sauer and Stock Option Award Agreement |
| 10.14 | | (10) | | Sonic Solutions 2004 Equity Compensation Plan Notice of Stock Option Award for Robert Greber and Stock Option Award Agreement |
| 10.15 | | (10) | | Sonic Solutions 2004 Equity Compensation Plan Notice of Stock Option Award for Peter Marguglio and Stock Option Award Agreement |
| 10.16 | | (10) | | Sonic Solutions 2004 Equity Compensation Plan Notice of Stock Option Award for Warren R. Langley and Stock Option Award Agreement |
| 10.17 | | (11) | | Sonic Solutions 2004 Stock Incentive Plan |
| 10.18 | | (16) | | Sonic Solutions 2005 Stock Incentive Plan (Non-U.S. Employees) |
| 10.19 | | (17) | | First Amendment to Loan and Security Agreement, dated December 20, 2005, by and between Sonic Solutions and Union Bank of California, N.A. |
| 10.20 | | | | Third Sublease Amending Agreement between Entrust, Inc. and Sonic Solutions dated July 5, 2006. |
| 10.21 | | (19) | | Executive Employment Agreement, effective as of January 23, 2007, by and between Sonic Solutions and David C. Habiger. |
| 10.22 | | (19) | | Executive Employment Agreement, effective as of January 23, 2007, by and between Sonic Solutions and A. Clay Leighton. |
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| | | | |
| Exhibit | | Note | | Title |
| 10.23 | | (19) | | Executive Employment Agreement, effective as of January 23, 2007, by and between Sonic Solutions and Mark Ely. |
| 10.24 | | (19) | | Board of Directors Compensation Policy, effective as of January 23, 2007. |
| 10.25 | | (20) | | Second Amendment to Loan and Security Agreement, dated September 28, 2007, by and between Sonic Solutions and Union Bank of California, N.A. |
| 10.26 | | (21) | | Third Party Security Agreement, dated September 28, 2007, by and between InterActual Technologies, Inc. and Union Bank of California, N.A. |
| 10.27 | | (22) | | Amended and Restated Executive Employment Agreement, effective as of February 25, 2008 hereof, by and between Sonic Solutions and Paul F. Norris. |
| 21.1 | | * | | List of subsidiaries |
| 23.1 | | * | | Consent of BDO Seidman, LLP, Independent Registered Public Accounting Firm |
| 31.1 | | * | | Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer |
| 31.2 | | * | | Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer |
| 32.1 | | * | | Section 1350 Certification of Chief Executive Officer |
| 32.2 | | * | | Section 1350 Certification of Chief Financial Officer |
| (1) | Incorporated by reference to exhibits to Registration Statement on Form S-1 effective February 10, 1994. |
| (2) | Incorporated by reference to exhibits to Annual Report on Form 10-K for the fiscal year ended March 31, 1996. |
| (3) | Incorporated by reference to Appendix A to the Registrant’s Definitive Proxy Statement filed on July 21, 1998. |
| (4) | Incorporated by reference to exhibits to Current Report on Form 8-K filed on March 14, 2001. |
| (5) | Incorporated by reference to exhibits to Current Report on Form 8-K filed on December 19, 2001. |
| (6) | Incorporated by reference to exhibits to Current Report on Form 8-K filed on November 20, 2002. |
| (7) | Incorporated by reference to Exhibit 99.3 to Current Report on Form 8-K filed on December 30, 2002. |
| (8) | Incorporated by reference to Exhibit 3.5 to Report on Form 10-Q filed on November 12, 2003. |
| (9) | Incorporated by reference to Exhibit 99.1 to Current Report on Form 8-K filed on March 1, 2004. |
| (10) | Incorporated by reference to exhibits to Current Report on Form 8-K filed on September 13, 2004. |
| (11) | Incorporated by reference to Exhibit 10.7 to Quarterly Report on Form 10-Q for the quarter ended September 30, 2004. |
| (12) | Incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed on December 16, 2004. |
| (13) | Incorporated by reference to Exhibit 2.1 to Current Report on Form 8-K filed December 23, 2004. |
| (14) | Incorporated by reference to exhibits to Quarterly Report on Form 10-Q for the quarter ended December 31, 2004. |
| (15) | Incorporated by reference to exhibits to Registration Statement on Form S-1 effective May 21, 2001. |
| (16) | Incorporated by reference to Exhibit 10.21 to Annual Report on Form 10-K for the year ended March 31, 2005. |
| (17) | Incorporated by reference to Exhibit 10.1 to Quarterly Report on Form 10-Q for the quarter ended December 31, 2005. |
| (18) | Incorporated by reference to Exhibit 10.1 to Report on Form 10-Q filed on August 14, 2006. |
| (19) | Incorporated by reference to exhibits to Current Report on Form 8-K filed on January 24, 2007. |
| (20) | Incorporated by reference to Exhibit 10.1 to Quarterly Report on Form 10-Q for the quarter ended December 31, 2006. |
| (21) | Incorporated by reference to Exhibit 10.2 to Quarterly Report on Form 10-Q for the quarter ended December 31, 2006. |
| (22) | Incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed on February 25, 2008. |
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SCHEDULE II
FINANCIAL STATEMENT SCHEDULE
SONIC SOLUTIONS
VALUATION AND QUALIFYING ACCOUNTS
Years Ended March 31, 2005, 2006 and 2007
(in thousands)
| | | | | | | | | | |
| | Balance at Beginning of Period | | Charged to Costs and Expenses | | Charged to Other Accounts | | Deductions | | Balance at End of Period |
Allowance for doubtful accounts
| | | | | | | | | | | | | | | | | | | | |
| Year ended March 31, 2005 | | $ | 1,139 | (a) | | $ | 155 | | | $ | 309 | | | $ | (341 | ) | | $ | 1,262 | |
| Year ended March 31, 2006 | | | 1,262 | | | | 672 | | | | (378 | ) | | | (313 | ) | | | 1,243 | |
| Year ended March 31, 2007 | | | 1,243 | | | | 39 | | | | — | | | | (618 | ) | | | 664 | |
Sales discounts, returns and allowances
| | | | | | | | | | | | | | | | | | | | |
| Year ended March 31, 2005 | | | 9,346 | (a) | | | — | | | | 2,726 | | | | (2,957 | ) | | | 9,115 | |
| Year ended March 31, 2006 | | | 9,115 | | | | (1,061 | ) | | | 11,978 | | | | (16,040 | ) | | | 3,992 | |
| Year ended March 31, 2007 | | | 3,992 | | | | (49 | ) | | | 16,797 | | | | (16,626 | ) | | | 4,114 | |
| (a) | Includes balances from the Roxio CSD acquisition as of the December 17, 2004 opening balance sheet. |
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SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto, duly authorized on February 25, 2008.
SONIC SOLUTIONS
| By: | /s/ David C. Habiger
David C. Habiger
President and Chief Executive Officer |
Pursuant to the requirements of the Exchange Act, this report has been signed below by the following persons on behalf of Sonic Solutions and in the capacities and on the dates indicated.
| | | | |
| Signature | | Title | | Date |
/s/ David C. Habiger
David C. Habiger | | President and Chief Executive Officer
(Principal Executive Officer) | | February 25, 2008 |
/s/ Robert J. Doris
Robert J. Doris | | Director | | February 25, 2008 |
/s/ Robert M. Greber
Robert M. Greber | | Director | | February 25, 2008 |
/s/ Peter J. Marguglio
Peter J. Marguglio | | Director | | February 25, 2008 |
/s/ R. Warren Langley
R. Warren Langley | | Director | | February 25, 2008 |
/s/ Mary C. Sauer
Mary C. Sauer | | Director | | February 25, 2008 |
/s/ Paul F. Norris
Paul F. Norris | | Executive Vice President, Interim Chief Financial Officer and General Counsel
(Principal Financial/Accounting Officer) | | February 25, 2008 |
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