UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[x] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the quarterly period ended December 31, 1996 or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the transition period from
------------
to
-------------
Commission File Number: 72870
SONIC SOLUTIONS
(Exact name of registrant as specified in its charter)
CALIFORNIA 93-0925818
(State or other jurisdiction of (I.R.S.Employer
incorporation or organization) Identification No.)
101 ROWLAND WAY, SUITE 110 NOVATO, CA 94945
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (415) 893-8000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, no
par value
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes x No
----- -----
The number of outstanding shares of the registrant's Common Stock on January 31,
1997, was 7,584,787.
1
SONIC SOLUTIONS
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 1996
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION
ITEM 1. Condensed Financial Statements.......................... 3
Condensed Balance Sheets as of March 31, 1996
and December 31, 1996................................... 3
Condensed Statements of Operations for the
three and nine months ended December 31, 1995 and 1996.. 4
Condensed Statements of Cash Flows for the
nine months ended December 31, 1995 and 1996............ 5
Notes to Condensed Financial Statements................. 6
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations........... 9
PART II. OTHER INFORMATION
ITEM 6. Exhibits and Reports on Form 8-K........................ 16
Signatures ........................................................ 17
Exhibit 11.1 Statement Re: Computation of Per Share Amounts.......... 18
2
PART I -- FINANCIAL INFORMATION
ITEM 1. CONDENSED FINANCIAL STATEMENTS
SONIC SOLUTIONS
BALANCE SHEETS
(in thousands, except share amounts)
1996
------------------------------
ASSETS March 31, December 31,
------ ---------- -------------
(unaudited)
Current Assets:
Cash and cash equivalents...................................... $ 1,086 2,979
Short-term investments......................................... 2,106 2,975
Accounts receivable, net of allowance for returns and
doubtful accounts of $1,690 and $660 at March 31, 1996
and December 31, 1996, respectively......................... 4,101 2,989
Inventory...................................................... 1,881 1,476
Prepaid expenses and other current assets...................... 476 779
Refundable income taxes........................................ 1,600 176
Deferred income taxes.......................................... 1,018 1,018
------- ------
Total current assets.................................. 12,268 12,392
Fixed assets, net..................................................... 2,684 2,994
Purchased and internally developed software costs, net................ 1,273 1,731
Other assets.......................................................... 607 521
------- ------
Total assets.......................................... $16,832 17,638
======= ======
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current Liabilities:
Accounts payable and accrued liabilities...................... $ 2,753 3,104
Deferred revenue and deposits................................. 442 617
------- ------
Total current liabilities............................. 3,195 3,721
------- ------
Deferred income taxes................................................. 725 725
Subordinated debt..................................................... -- 3,723
Shareholders' Equity:
Common stock, no par value, 30,000,000 shares authorized; 7,493,628
and 7,584,787 shares issued and outstanding at March 31, 1996
and December 31, 1996, respectively................................ 13,133 13,638
Accumulated deficit................................................... (219) (4,169)
Unrealized gain (loss) on investments.............................. (2) --
------- ------
Total shareholders' equity............................ 12,912 9,469
------- ------
Commitments and contingencies
Total liabilities and shareholders' equity............ $16,832 17,638
======= ======
See Accompanying Notes to Condensed Financial Statements.
3
SONIC SOLUTIONS
STATEMENTS OF OPERATIONS
(in thousands, except per share amounts - unaudited)
Three Months Ended Nine Months Ended
-------------------- -------------------
December 31, December 31,
-------------------- -------------------
1995 1996 1995 1996
---------- -------- --------- --------
Net revenue........................................... $ 3,445 4,511 $11,443 11,614
Cost of revenue....................................... 1,651 2,003 5,561 5,538
------- ----- ------- ------
Gross profit.................................. 1,794 2,508 5,882 6,076
------- ----- ------- ------
Operating expenses:
Marketing and sales........................... 1,611 1,537 4,432 4,413
Research and development...................... 695 1,472 2,005 4,180
General and administrative.................... 362 425 1,443 1,461
------- ----- ------- ------
Total operating expenses...................... 2,668 3,434 7,880 10,054
------- ----- ------- ------
Operating loss................................ (874) (926) (1,998) (3,978)
Other income (expense)................................ 43 (1) 130 28
------- ----- ------- ------
Loss before income taxes...................... (831) (927) (1,868) (3,950)
Benefit for income taxes.............................. (291) 0 (655) 0
------- ----- ------- ------
Net loss...................................... ($540) (927) ($1,213) (3,950)
======= ===== ======= ======
Net loss per share.................................... ($0.07) (0.12) ($0.16) (0.52)
======= ===== ======= ======
Shares used in computing net loss per share........... 7,466 7,557 7,452 7,527
======= ===== ======= ======
SEE ACCOMPANYING NOTES TO CONDENSED FINANCIAL STATEMENTS.
4
SONIC SOLUTIONS
STATEMENTS OF CASH FLOWS
(in thousands, - unaudited)
Nine Months Ended
-----------------
December 31,
------------
1995 1996
---- ----
Cash flows from operating activities:
Net loss.................................................................. ($1,213) (3,950)
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization........................................... 606 1,181
Provision for returns and doubtful accounts............................. 271 50
Changes in operating assets and liabilities:
Accounts receivable.................................................. 758 1,062
Inventory............................................................ 111 405
Prepaid expenses and other current assets............................ (854) 1,121
Other assets......................................................... (25) 86
Accounts payable and accrued liabilities............................. (1,711) 351
Deferred revenue and deposits........................................ (77) 175
Income taxes payable................................................. (22) -
-------- ------
Net cash (used) provided by operating activities................. (2,156) 481
-------- ------
Cash flows from investing activities:
Purchase of fixed assets.................................................. (1,056) (1,238)
Additions to purchased and internally developed software.................. (510) (711)
Purchase of short-term investments........................................ - (2,975)
Proceeds from sale of short-term investments.............................. 3,737 2,108
-------- ------
Net cash provided (used) by investing activities....................... 2,171 (2,816)
-------- ------
Cash flows from financing activities:
Proceeds from issuances of common stock, net of issuance cost............. 111 125
Issuance of subordinated debt............................................. - 4,103
Borrowings on line of credit.............................................. 3,700 -
Repayments of line of credit.............................................. (3,700) -
-------- ------
Net cash provided by financing activities.............................. 111 4,228
-------- ------
Net increase (decrease) in cash and cash equivalents......................... 126 1,893
Cash and cash equivalents, beginning of period............................... 681 1,086
-------- ------
Cash and cash equivalents, end of period..................................... $ 807 2,979
======== ======
Supplemental disclosure of cash flow information:
Interest paid during period............................................... 28 16
======== ======
Non cash transactions:
During 1996, the Company wrote off $1,030 of uncollectible receivables
against the allowance for bad debt.
See Accompanying Notes to Condensed Financial Statements.
5
SONIC SOLUTIONS
NOTES TO CONDENSED FINANCIAL STATEMENTS
(unaudited)
(1) Basis of Presentation.
The accompanying unaudited condensed financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and in accordance with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. However, in the opinion of management, the
condensed financial statements include all adjustments (consisting of only
normal, recurring adjustments) necessary for their fair presentation. The
interim results are not necessarily indicative of results expected for a full
year. These unaudited condensed financial statements should be read in
conjunction with the financial statements and related notes included in the
Company's Form 10-K for the year ended March 31, 1996, filed with the Securities
and Exchange Commission.
(2) Short-term investments.
Short-term investments consist almost exclusively of commercial paper. The
Company has adopted the provisions of Statement of Financial Accounting
Standards No. 115, "Accounting for Certain Investments in Debt and Equity
Securities" and has classified its investments in certain debt and equity
securities as "available for sale". Such investments are recorded at fair
value, with unrealized gains and losses reported as a separate component of
shareholders' equity. The cost of securities sold is based upon the specific
identification method.
(3) Net Income (loss) Per Share.
Net income (loss) per share is computed using the weighted average number
of shares of common stock and dilutive common equivalent shares from stock
options (using the treasury stock method). The computation assumes that no
stock options were exercised where losses exist, as the effect would be anti
dilutive.
(4) Inventory.
The components of inventory consist of (in thousands):
March 31, December 31,
--------- ------------
1996 1996
---- ----
Raw materials...........................
Work-in-process......................... $1,180 952
Original equipment manufacturers goods.. 580 469
121 55
------ -----
$1,881 1,476
====== =====
6
(5) Deferred revenue and deposits.
Deferred revenue and deposits consist of (in thousands):
March 31 December 31,
-------- ------------
1996 1996
---- ----
Deferred maintenance revenue............ $ 401 616
Deposits and billings against sales 41 1
contracts.............................. ----- ----
Deferred revenue and deposits $ 442 617
===== ====
Maintenance revenue is recognized ratably over the term of the contract.
Customer deposits and billings against sales contracts are primarily related to
sales of DVD Creator systems.
(6) Long-Term Debt and Credit Facilities.
In December, 1996, the Company entered into a Loan and Security Agreement with
Silicon Valley Bank. The Agreement provides for up to $2,500,000 in available
borrowings based upon the Company's eligible accounts receivable balances, and
expires in December 1997. This Agreement provides for a variety of covenants,
including, among other things, that the Company maintain certain financial
ratios; and is collateralized by a security interest in substantially all of the
Company's assets. Interest on borrowings under this agreement is payable monthly
at a rate of three-quarters percent in excess of the prime rate. As of December
31, 1996, no borrowings were outstanding.
Also, in December, 1996, the Company obtained a $5,100,000 financing facility
with entities associated with Hambrecht & Quist. The facility includes
subordinated debt and equipment financing. During December, 1996, the Company
received $3,000,000 from Hambrecht & Quist Transition Capital, LLC and
$1,100,000 from Hambrecht & Quist Guaranty Finance, LLC, pursuant to the above
facility. The remaining $1,000,000 is a master lease line for financing of
future capital asset purchases. The facility with the Hambrecht & Quist
entities is secured by an interest in the Company's fixed assets and
substantially all the assets of the Company subordinate to the Silicon Valley
Bank Agreement discussed above. In connection with the financing facility, the
Company issued warrants to purchase 260,200 common shares to entities associated
with Hambrecht & Quist. The Hambrecht & Quist entities may exercise 130,100
shares at an exercise price of $10.00 at any time on or before December 24,
2003, and 130,100 shares at an exercise price of $7.00 at any time on or after
December 24, 1997 and before December 24, 2004. The Company recorded $377,000 of
deferred interest, which will be amortized to interest expense over the term of
the financing facility, attributable to the value of the warrants.
(7) Income Taxes.
The Company accounts for income taxes under 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.
7
(8) Industry and Geographic Information.
The Company markets its products in the United States and in foreign
countries through its sales personnel, dealers, and distributors. Export sales
account for a significant portion of the Company's net revenue and are
summarized by geographic area as follows (in thousands):
Three Months Ended Nine Months Ended
------------------ -----------------
December 31, December 31,
------------ ------------
1995 1996 1995 1996
---- ---- ---- ----
North America $1,746 1,813 $ 5,695 7,073
Export:
Europe.................... 517 885 2,038 1,837
Pacific Rim............... 945 1,624 3,044 2,181
Other international....... 237 189 666 523
------ ----- ------- ------
Total net revenue......... $3,445 4,511 $11,443 11,614
====== ===== ======= ======
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW, FORWARD LOOKING STATEMENTS AND CERTAIN FACTORS THAT MAY IMPACT FUTURE
RESULTS
To the extent that this report discusses future financial results,
information or expectations about products or markets, or otherwise makes
statements about future events, such statements are forward-looking and are
subject to a number of risks and uncertainties that could cause actual results
to differ materially from the statements made. These risks and uncertainties
include, among others, the timely introduction and acceptance of new products,
costs associated with new product introductions, the transition of products to
new hardware configurations and platforms, and other factors, including those
discussed in the Company's annual and quarterly reports on file with the
Securities and Exchange Commission. This report should be read in conjunction
with the Company's most recent annual report on Form 10-K on file with the
Securities and Exchange Commission, which contains a more detailed discussion of
the Company's business including risks and uncertainties that may affect future
results.
The Company commenced shipments of the Sonic System (also called "Sonic
Studio"), a professional digital audio workstation ("DAW") in the first calendar
quarter of 1989. Sales of the Sonic System product line including Sonic
developed software and Sonic manufactured hardware, third party developed
software and hardware peripheral devices and associated maintenance fees,
together with sales of MediaNet and DVD Creator have accounted for substantially
all of the Company's net revenue during the six fiscal years ended March 31,
1996 and the nine months ended December 31, 1996. The Company's future success
will depend in part on sales of the Sonic System to audio professionals. The
Company believes there is little growth in the overall market for professional
audio equipment. Sales of products by Sonic have depended upon the substitution
of digital audio workstations for other existing technologies, and Sonic's
ability to increase sales will continue to depend in large part on the continued
substitution of digital audio workstations for other technologies. The
Company's future success will also depend in large part on sales of the DVD
Creator system (see below). Any factor adversely affecting demand for or
delivery of the DVD Creator system would have a material adverse effect on the
Company's results of operations.
The Sonic System is an integrated assembly of software, signal processing
cards and other Sonic manufactured hardware, as well as, in some cases,
peripheral devices such as disk drives and CD printers which are purchased as
complete or largely complete devices from other manufacturers. The Sonic System
is integrated with a Macintosh computer which is not typically provided by the
Company. The Company's gross margin on the software and Sonic manufactured
hardware is generally over 60%, and the gross margin on hardware peripheral
devices is generally less than 30%. As a result, overall gross margin from
period to period will vary depending on the volume of peripheral devices
relative to Sonic developed software and Sonic manufactured hardware included in
net revenue. During fiscal year 1996, the Company's gross margins were
negatively impacted as a result of the various extra costs associated with the
problems experienced in executing a transition to a Sonic System product line
including the new USP ("Ultra-Sonic Processor") audio digital signal processing
("DSP") card. During the nine months ended December 31, 1996, the Company's
gross margins were negatively impacted as a result of lower than anticipated
revenue and costs associated with the initial shipments of DVD Creator systems.
In November, 1994, the Company introduced major changes to its Sonic System
product line including the introduction of its new USP card for higher end Sonic
System configurations as well as a repositioning of Sonic Systems based on the
older SSP-3 DSP card. The USP is the fourth generation card in the evolution of
the Company's DSP cards. The company incorporates the USP card in Sonic System
configurations priced at the mid-range and upper-end of the Sonic system product
line. The USP, like the SSP-3 card, is a high performance signal processing
card that allows the input, output, storage, retrieval, and processing of
digital audio. Compared to the SSP-3 card, the USP offers higher
9
processing speeds and the ability to handle more channels of digital audio input
and output per card, as well as the ability to play back from hard disk a larger
number of tracks of digital audio. The Company experienced a number of
difficulties in connection with this product transition which adversely affected
the operations of the Company in the third and fourth quarters of the fiscal
year ended March 31, 1995 and the fiscal year ended March 31, 1996.
In February, 1994, the Company began shipments of MediaNet, a high
performance, fully distributed networking system designed specifically to handle
digital audio, digital video, high resolution graphics and other multimedia data
types, for use with applications other than the Sonic System. In the fiscal
year ended March 31, 1996, and the nine months ended December 31, 1996, MediaNet
revenues constituted approximately 16% and 10% of Company revenues. Of total
MediaNet sales during fiscal 1996, and the nine months ended December 31, 1996,
approximately 67% and 64% were for use with applications other than the Sonic
System.
MediaNet allows users to share digital audio and other "multimedia" data
types efficiently among multiple workers in a facility. MediaNet consists of
specialized network adapter plug in cards installed in the NuBus or PCI bus of
an Apple Macintosh computer. MediaNet combines FDDI or CDDI (fiber-based or
copper-based 100 megabit token ring networking) technology with a special file
system running on SCSI disks attached directly to the network cards. This file
system, called the Media Optimized File System, addresses the needs of
multimedia applications. In addition to its use in digital audio applications,
MediaNet has uses in other areas whenever work groups wish to collaborate on
applications which require high, sustained rates of data transfer, a high degree
of compatibility with conventional computing systems and some degree of
guaranteed bandwidth.
In the last quarter of the 1996 fiscal year the Company became aware of
competitive announcements which would likely reduce demand for MediaNet in the
prepress industry. Based on these announcements, the Company began preparing
for an earlier than expected transition of the MediaNet product line to higher
performance technology, and, as a result, included various charges related to
this transition in the 1996 fiscal year results of operations.
It is the Company's intention to introduce in calendar year 1997 a second
generation MediaNet product line, incorporating newer networking technologies
and supporting increased performance levels. There can be no assurance that the
Company will be successful in developing such a product line, or that, if
successfully developed, such a second generation product line will be attractive
to customers when compared to other network product offerings. Further,
transition between the first generation and second generation product lines may
present a number of difficulties for the Company including slow sales or returns
of dealer stocks of the first generation product. Such difficulties could have
an adverse affect on results of operations in future periods.
In the fall of 1995, Apple Computer discontinued sale of Macintosh
computers with NuBus interfaces, transitioning to a product line based
exclusively on the PCI bus. While compatible equipment suppliers ("clone"
makers) have continued to supply NuBus computers until recently, they also have
signaled their intention to transition to product lines based exclusively on the
PCI bus. Shortly before the end of the 1996 fiscal year, the Company began
shipping MediaNet cards compatible with the PCI bus. In the month of June,
1996, the Company began shipping USP cards compatible with the PCI bus. In the
month of December, 1996, the Company began shipping SSP-3 cards compatible with
the PCI bus. While the Company believes that the new MediaNet, USP and SSP-3
cards will perform adequately in the hands of customers, there can be no
assurance that bugs or defects will not be discovered once such cards are
installed and in use.
In April, 1996 at the National Association of Broadcasters convention
(NAB), the Company introduced a new product line, the DVD Creator system. DVD
Creator is a networked production system for preparing titles for release on DVD
discs. DVD is a new, higher density optical disc format for the delivery of
video, audio and information. Please see the discussion contained in the
Company's Annual
10
Report on Form 10-K on file with the Securities and Exchange Commission for more
information on the DVD format, particularly the discussion under the heading
"Sonic Cinema & DVD Creator."
The DVD Creator system is comprised of three separable subsystems all of
which are used in preparing DVD titles: (1) an MPEG-2 variable bit rate video
compression subsystem (based on an IBM chip set incorporated into a circuit card
of the Company's design), (2) an audio preparation and encoding subsystem
(utilizing the Company's USP audio cards programmed to perform Dolby AC-3 and
MPEG-2 audio compression), and (3) an authoring and formatting subsystem
(incorporating Scenarist (also referred to as "Scenarist-2" or "Scenarist-DVD"),
a sophisticated DVD authoring system developed by Daikin Industries). The DVD
Creator subsystems are networked together via the Company's MediaNet networking
system. Sonic sells the elements of the DVD Creator system as an integrated
workgroup, and as separate standalone subsystems (for example, a customer may
choose to use Sonic's audio and authoring subsystems with another company's
video encoding system).
During the month of June, 1996, the Company began shipping the first
installation phase of the DVD Creator system for DVD encoding and premastering
including the audio and authoring subsystems. During the quarter ended
September 30, 1996, the Company began shipping the video subsystem of the DVD
Creator system. The Company expects to deliver additional updates of DVD
Creator software during the rest of the 1997 fiscal year and during the 1998
fiscal year. The entire DVD Creator System is complex, and incorporates leading
edge technologies. While it is the Company's current intention to continue
development and enhancement of the DVD Creator system, there can be no assurance
that development and enhancement of the DVD Creator system will be successfully
continued. There are a number of companies engaged in the development and
marketing of products which can perform some or all of the steps involved in
preparing titles for release in the DVD-Video format. Many of these companies
have long standing involvements with technologies involved in DVD-Video
premastering, and many of them have technical and/or financial resources which
are greater than Sonic's. Accordingly, there can be no assurance that the
Company's DVD Creator system, as developed and enhanced, will be preferred by
customers over competitive offerings. Further, since the Company and its
customers have had only limited experience to date with the DVD Creator system
in actual production, there can be no assurance that design flaws, limitations,
"bugs", or other problems will not be discovered in the DVD Creator system which
may be difficult or impossible to repair or address, or to repair or address in
a timely fashion. Under such circumstances the Company would potentially incur
significant costs related to addressing such problems, and the Company's sales
of new systems would undoubtedly be adversely affected.
Daikin Industries, which develops Scenarist, the DVD authoring and
formatting subsystem sold by Sonic, is continuing to develop and enhance
Scenarist. There have been a number of delays in the development of and release
of additional updates of Scenarist, and a number of problems have surfaced in
early use by customers. While Daikin has informed Sonic of its intention to
continue to develop Scenarist, and Sonic believes that Daikin will be successful
in doing so, such development is not under the direct control of Sonic, and
there can be no assurance that such development will address problems and add
necessary features in a timely fashion. Sonic distributes Scenarist-DVD under
an agreement, concluded in March, 1996 with Daikin, which provides for
essentially exclusive distribution rights outside of Japan. Under this
agreement (as modified via subsequent amendments), Sonic has certain
obligations, including, among others, adequate promotion of Scenarist-DVD and
minimum volume commitments. In the event that such obligations are not met,
Sonic might be unable to continue to distribute Scenarist-DVD, or be unable to
continue to distribute the system on an exclusive basis. This could have a
significant negative effect on Sonic's competitive position in the market for
DVD-Video premastering tools.
The DVD-Video format is widely expected to be introduced to consumers early
in calendar year 1997 in both North America and in Europe. The DVD-Video format
and players were introduced in Japan and other parts of Asia in late 1996. Many
industry observers expect the format to be attractive to consumers since it
combines high-quality digital video, six-channel surround sound, multiple
11
language tracks, sub-titles, and interactive story branching, among other
features and permits "feature length" movies and videos to be delivered on a
"Compact Disc" sized disc. As of the date of this report, the final
specification of the DVD-Video format has only recently been published by the
industry consortium which is developing and promoting the format. There have
been a number of delays in reaching agreement on the final specification
including disagreements within the consortium and among various companies,
industry associations and political organizations concerning issues involving
copyright protection schemes and sharing of royalty revenues from patented
technologies involved in the DVD format. While the Company expects that given
that finalization of the DVD-Video format has occurred, introduction of the
format will now take place rapidly in various areas of the world, there can be
no assurance that this will in fact happen, nor that the DVD format, once
introduced, will be attractive to consumers. Further delays in the introduction
of the DVD format, or lack of consumer acceptance of the format, once it is
introduced, would have a significant negative effect on demand for the Company's
DVD Creator systems. Given the Company's significant levels of expenditure on
DVD Creator development and marketing, under such conditions the Company's
future results of operations would be significantly adversely affected.
In December, 1996, the Company entered into a Loan and Security Agreement
with Silicon Valley Bank and a financing facility with entities associated with
Hambrecht & Quist. Also in December, 1996, the Company issued warrants to
entities associated with Hambrecht & Quist. See Note 6 to Notes to Condensed
Financial Statements.
The Company's quarterly operating results vary significantly depending on
the timing of new product introductions and enhancements by the Company and its
competitors and on the volume and timing of orders, which are difficult to
forecast. Customers generally order on an as-needed basis, and the Company
normally ships products within one week after receipt of an order. The results
of operations for any quarter are not necessarily indicative of the results to
be expected for any future period. A disproportionate percentage of the
Company's quarterly net revenue is typically generated in the last few weeks of
the quarter. A significant portion of the Company's operating expenses is
relatively fixed, and planned expenditures are based primarily on sales
forecasts. As a result, if revenue generated in the last few weeks of a quarter
do not meet with the Company's forecast, operating results may be materially
adversely affected.
The Company capitalizes a portion of its software development costs in
accordance with Statement of Financial Accounting Standard No. 86. Such costs
are amortized to cost of revenue over the estimated economic life of the
product, which is generally three years.
12
RESULTS OF OPERATIONS
The following table sets forth certain items from the Company's statements
of operations as a percentage of net revenue for the three and nine months ended
December 31, 1995 and 1996:
Three Months Ended Nine Months Ended
-------------------- ----------------------
December 31, December 31,
-------------------- ----------------------
1995 1996 1995 1996
--------- --------- -------- ---------
Net revenue.................................... 100.0% 100.0% 100.0% 100.0%
Cost of revenue................................ 47.9 44.4 48.6 47.7
------ ------ ------ ------
Gross profit................................... 52.1 55.6 51.4 52.3
Operating expenses:
Marketing and sales...................... 46.8 34.1 38.7 38.0
Research and development................. 20.2 32.6 17.5 36.0
General and administrative............... 10.5 9.4 12.6 12.6
------ ------ ------ ------
Total operating expenses....................... 77.5 76.1 68.8 86.6
------ ------ ------ ------
Operating loss................................. (25.4) (20.5) (17.4) (34.3)
Other income................................... 1.2 0.0 1.1 .3
Benefit for income taxes....................... (8.5) 0.0 (5.7) 0.0
------ ------ ------ ------
Net loss....................................... (15.7)% (20.5)% (10.6)% (34.0)%
====== ====== ====== ======
COMPARISON OF NINE AND THREE MONTHS ENDED DECEMBER 31
NET REVENUE. Net revenue increased from $3,445,000 for the quarter ended
December 31, 1995 to $4,511,000 for the quarter ended December 31, 1996,
representing an increase of 30.9%. For the nine months ended December 31, 1996,
net revenue increased from $11,443,000 to $11,614,000 compared to the same
period in the prior fiscal year, representing an increase of 1.5%. The increase
in net revenue for the quarter and nine months ended December 31, 1996 is
primarily due to sales of DVD Creator systems which is partially offset by the
decrease in MediaNet and Audio sales. The Company began shipping its DVD Creator
systems during the quarter ended June 30, 1996. The Company recognized
approximately $1,990,000 and $5,517,000 in DVD Creator revenue for quarter and
nine months ended December 31, 1996, respectively.
International sales accounted for 49% and 60% of net revenue for the
quarter ended December 31, 1995 and 1996, respectively. International sales
accounted for 50% and 39% of net revenue for the nine months ended December 31,
1995, and 1996, respectively. See Note 8 of Notes to Condensed Financial
Statements. International sales as a percentage of net revenue varies from
quarter to quarter due to the timing of international orders. During the
quarter ended December 31, 1996 international sales, as a percentage of net
revenue, increased due to sales of DVD Creator Systems which were primarily sold
to customers located overseas. The Company expects that international sales will
continue to represent a significant percentage of future revenue.
COST OF REVENUE. Cost of revenue, as a percentage of net revenue,
decreased from 47.9% for the quarter ended December 31, 1995 to 44.4% for the
quarter ended December 31, 1996. Cost of revenue, as a percentage of net
revenue, decreased from 48.6% for the nine months ended December 31, 1995 to
47.7% for the nine months ended December 31, 1996. Cost of revenue for the
quarter and nine months ended December 31, 1995 included additional costs
related to the "swap" and "customer satisfaction" programs in place to resolve
the transition difficulties associated with the Company's UltraSonic Processor
Product transition. Cost of revenue for the quarter and nine months ended
December 31, 1996 included a charge of approximately $281,000 for inventory
write-down related to the discontinuance of
13
the Sonic Cinema product line (Sonic Cinema was a system for Video CD
premastering and the predecessor to DVD Creator- see the Company's Annual Report
for fiscal year ended March 31, 1996 on Form 10K filed with the Securities and
Exchange Commission, particularly the discussion under "Sonic Cinema & DVD
Creator").
MARKETING AND SALES. Marketing and sales expenses decreased from
$1,611,000 for the quarter ended December 31, 1995 to $1,537,000 for the quarter
ended December 31, 1996 and decreased from $4,432,000 for the nine months ended
December 31, 1995 to $4,413,000 for the nine months ended December 31, 1996.
Marketing and sales represented 46.8%, 34.1%, 38.7% and 38.0% of net revenue for
the quarter ended December 31, 1995 and 1996 and the nine months ended December
31, 1995 and 1996, respectively. Marketing and sales expenses decreased for the
quarter and nine months ended December 31, 1996 relative to the same periods in
the prior year primarily due the reduction of commission expense. Dealer and
employee commission expense, as a percentage of net revenue decreased from
8.1% for the quarter ended December 31, 1995 to 4.4% for the quarter ended
December 31, 1996, and from 6.5% for the nine months ended December 31, 1995 to
3.8% for the nine months ended December 31, 1996. The decrease in commission
expense, as a percentage of net revenue, is primarily due to a shift in sales
mix away from direct sales (which generally involve a commission payable to a
dealer) to dealer sales (where no commission is ordinarily payable to a dealer).
The Company's marketing and sales headcount decreased from thirty-four at
December 31, 1995 to thirty-two at December 31, 1996.
RESEARCH AND DEVELOPMENT. Research and development expenses increased
from $695,000 for the quarter ended December 31, 1995 to $1,472,000 for the
quarter ended December 31, 1996 and increased from $2,005,000 for the nine
months ended December 31, 1995 to $4,180,000 for the nine months ended December
31, 1996. Research and development represented 20.2%, 32.6%, 17.5% and 36.0% of
net revenue for the quarter ended December 31, 1995 and 1996 and the nine months
ended December 31, 1995 and 1996, respectively. The Company capitalizes a
portion of its software development costs in accordance with Statement of
Financial Accounting Standard No. 86. Research and development expenses
increased primarily due to increase in headcount and increase of consulting and
prototype expenses associated with the development of the DVD Creator system.
Headcount for research and development increased from twenty-three at December
31, 1995 to thirty-two at December 31, 1996. Prototype and consulting expenses
can fluctuate significantly from period to period depending upon the status of
hardware development projects. The Company anticipates increased prototype and
consulting expenses related to new products, as well as increased salary
expenses from hiring additional software and hardware engineers in the future.
GENERAL AND ADMINISTRATIVE. General and administrative expense increased
from $362,000 for the quarter ended December 31, 1995 to $425,000 for the
quarter ended December 31, 1996 and from $1,443,000 for the nine months ended
December 31, 1995 to $1,461,000 for the nine months ended December 31, 1996.
General and administrative expenses represented 10.5%, 9.4%,12.6% and 12.6% of
net revenue for the quarter ended December 31, 1995 and 1996 and the nine months
ended December 31, 1995 and 1996, respectively. The dollar amounts have
remained relatively constant for the nine months ended December 31, 1996,
however, the Company anticipates that general and administrative expenses will
increase in the future as the Company's operations expand.
OTHER INCOME (EXPENSE). The income for the nine months ended December 31,
1995 is primarily due to interest income received on investments which were
purchased with cash not immediately needed for operations. The interest income
for the nine months ended December 31, 1996 was offset by interest expense.
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PROVISION (BENEFIT) FOR INCOME TAXES. The Company has presented a benefit
for income taxes for the quarter and nine months ended December 31, 1995,
computed at the combined federal and state effective corporate rate in
accordance with Statement of Financial Accounting Standards No. 109. The benefit
for taxes for the quarter ended December 31, 1995 was based upon an effective
rate of 35%. During the fiscal year ended March 31, 1996, the Company exhausted
its loss carryback capabilities, therefore no benefit was recorded during the
quarter and nine months ended December 31, 1996.
The Company accrues quarterly for income taxes based upon its projection
of its full year tax liability. This may result in significant adjustments
based on the actual quarterly results.
LIQUIDITY AND CAPITAL RESOURCES. The Company funded its operations
through fiscal 1994 primarily from cash flows from operations. In fiscal 1994
the Company completed a private sale of equity securities and an initial public
offering of Common Stock which generated net proceeds of approximately $10
million after all expenses and a one time special distribution to the former
subchapter S corporation shareholders.
In December, 1996, the Company entered into a Loan and Security Agreement
with Silicon Valley Bank, and a financing facility with entities associated with
Hambrecht & Quist. Also in December, 1996, the Company issued warrants to
entities associated with Hambrecht & Quist. See Note 6 to Notes to Condensed
Financial Statements. As of December 31, 1996, the Company had cash, cash
equivalents and short term investments of $5,954,000 and working capital of
$8,671,000.
The Company's operating activities have used cash of $2,156,000 for the
nine months ended December 31, 1995 and provided cash of $481,000 for the nine
months ended December 31, 1996. During the nine months ended December 31, 1996,
cash was used primarily to fund the net loss and was positively offset by the
receipt of the income tax refunds received from the Internal Revenue Service and
improvement in accounts receivable collections. The management of the Company
believes that existing cash, cash equivalents and short term investments, cash
generated from operations, and cash generated from short term borrowings will be
sufficient to meet the Company's cash and investment requirements at least
through the fourth quarter of fiscal 1998.
This Management's discussion and analysis should be read in conjunction
with the Management's discussion and analysis that accompanies the Company's
report on Form 10-K for the fiscal year ended March 31, 1996.
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PART II -- OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
11.1 Statement Re: Computation of Per Share Amounts.
(b) REPORTS ON FORM 8-K
None.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant, Sonic Solutions, has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized, in the City of Novato,
State of California, on the 13th day of February, 1997.
SONIC SOLUTIONS
Signature Date
--------- ----
/s/ Robert J. Doris February 13, 1997
- - ------------------------
Robert J. Doris
President and Director (Principal
Executive Officer)
/s/ A. Clay Leighton February 13, 1997
- - ------------------------
A. Clay Leighton
Vice President of Finance and
Chief Financial Officer (Principal
Financial Accounting Officer)
17